PAGENO="0001" t7O(~ I i2~O~ ~ i~ F, ~ LEGISLATIVE HISTORY OF H.R. 13103 89th Congress FOREIGN INVESTORS TAX ACT OF 1966 PUBLIC LAW 89-809 COMMITTEE ON WAYS AND MEANS U.S. HOUSE OF REPRESENTATIVES NINETIETH CONGRESS FIRST SESSION PART 1 I ~ Prepared by the Staff of the Committee on Ways and Means for the use of the Committee on Ways and Means U.S. GOVERNMENT PRINTING OFFICE 71-2970 WASHINGTON : 1967 For sale by the Superintendent of Documents, U.S. Government Printing Office Washington, D.C. 20402 Price $3.50 PAGENO="0002" COMMITTEE ON WAYS AND MEANS WILBUR D. MILLS, Arkansas, Chairman JOHN W. J3YRNES, Wisconsin THOMAS B. CURTIS, Missouri JAMES B. UTT, California JACKSON E. BETTS, Ohio HE RMAN T. SCHNEEBELI, Pennsylvania HAROLD R. COLLIER, Illinois JOEL T. BROYHILL, Virginia JAMES F. BATTIN, Montana BARBER B. CONABLE, JR., New York GEORGE BUSH, Texas LEO H. IRWIN, Chief Counsel JOHN W. MARTIN, Jr., Assistant Chief Counsel JOHN P. BAKER, Professional Staff RAYMOND A. DRISCOLL, Professional Staff HAROLD T. LAMAR, Professional Staff JAMES W. KELLEY, Professional Staff CECIL H. KING, California HALE BOGGS, Louisiana FRANK M. KARSTEN, Missouri A. S. HERLONG, JR., Florida JOHN C. WATTS, Kentucky AL ULLMAN, Oregon JAMES A. BURKE, Massachusetts MARTHA W. GRIFFITHS, Michigan GEORGE M. RHODES, Pennsylvania DAN ROSTENKOWSKI, Illinois PHIL M. LAN DRUM, Georgia CHARLES A. VANIK, Ohio RICHARD H. FULTON, Tennessee JACOB IL GILBERT, New York WILLIAM ir. QTJEALY, Minority C'ounsel 11 PAGENO="0003" INTRODUCTION The legislative history of H.R. 13103 is a compilation of legislative history materials relating to the enactment of Public Law 89-809. The purpose of this history is to make readily available all of the public documents containing pertinent information relative to the enactment of the law. This document sets forth in chronological order the action taken by Congress with respect to this law. For example, section 1 sets forth the public law; section 2, H.R. 5916 as introduced in the House of Representatives; section 3, an explanation by the Treasury Depart- ment of the act to remove tax barriers to foreign investment in the United States, which was inserted in the Congressional Record on March 8, 1965, by Chairman Wilbur D. Mills, and so on. This document contains: (a) the hearings on H.R. 5916 before the Committee on Ways and Means on June 30 and July 1, 1965 (which include: H.R. 5916 as introduced in the House of Representatives; press release of the Committee on Ways and Means, dated June 18, 1965, announcing invitation for interested persons to submit written statements on H.R. 5916; and press release of the Committee on Ways and Means, dated June 24, 1965, announcing public hearings on H.R. 5916); (b) written statements by interested individuals and organizations on H.R. 11297 submitted to the Committee on Ways and Means (which include: H.R. 11297 as introduced in the House of Representatives on September 28, 1965, together with summary of principal provisions and comparative print showing changes which would be made in existing law); and (c) hearings on H.R. 13103 before the Committee on Ways and Means on March 7, 1966 (which include: press release of the Committee on Ways and Means, dated February 24, 1966, announcing the hearings on H.R. 13103 and H.R. 13103 as introduced in the House of Representatives). The hearings held by the Senate Committee on Finance on H.R. 13103 are also contained in this document. Included in these hearings is H.R. 13103 as passed by the House of Representatives and referred to the Senate Committee on Finance. Documents incorporated in the hearings and written statements mentioned above are not set out separately in this document; however, appropriate cross-references are made. The material contained herein has been inserted in toto; therefore, the original pagination appears in all cases. In order to facilitate the utilization of the House and Senate floor debates on H.R. 13103, this document contains an alphabetical listing of Members of Congress with cross-references to their remarks on the floor of the House or the Senate, as the case may be. In this connec- tion, however, the page numbers refer to the pages of this document. The floor debates are taken from the Congressional Record for the 111 PAGENO="0004" date indicated. The page numbers of the daily Congressional Record are bracketed. During the course of its consideration .of H.R. 13103, the Senate Committee on Finance added amendments to the bill, some of which were the substance of bills that were reported by the Committee on Ways and Means and in some cases, had been passed by the House of Representatives. One situation involves a Senate-passed bill that was reported by the Committee on Ways and Means. These bills appear in the appendix to this document along with the appropriate committee reports and House and Senate floor debates where appropriate. iv PAGENO="0005" CONTENTS TABLE SHOWING CONTENTS OF EACH PART Page Part 1: Sections 1 through 21 1-1162 Part 2: Sections 22 through appendix 1163-2189 Introduction iii Chronological history of the legislation vii Alphabetical listing of Members of Congress with cross-references to floor debates: A. House floor debate on bill ix B. Senate floor debate on bill ix C. House floor debate on conference report x D. Senate floor debate on conference report x Section 1. Public law 1 2. H. R. 5916 as introduced in the House of Representatives 57 3. Explanation by the Department of the Treasury of the act to remove tax barriers to foreign investment in the United States, inserted in the Congressional Record on March 8, 1965, by Chairman Wilbur D. Mills 4. Press release of the Committee on Ways and Means dated June 18, 1965, announcing invitation for interested persons to submit written statements on H. R. 5916 the act to remove tax barriers to foreign investment in the United States 67 5. Press release of the Committee on Ways and Means dated June 24, 1965, announcing public hearings on H.R. 5916 69 6. Report to the President of the United States from the Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securi- ties and Increased Foreign Financing for U.S. Corporations Operating Abroad (Fowler Task Force) 71 7. Public hearings before the Committee on Ways and Means on H. R. 5916 117 8. Summary of recommendations for revisions given in statements pre- sented to the Committee on Ways and Means 287 9. H.R. 11297 as introduced in the House of Representatives 303 10. H.R. 11297 the Foreign Investors Tax Act of 1965 as introduced in the House of Representatives on September 28, 1965, together with summary of principal provisions and comparative print showing changes which would be made in existing law 305 11. Written statements by interested individuals and organizations on H.R. 11297 submitted to the Committee on Ways and Means 307 12. Press release of the Committee on Ways and Means, dated February 24, 1966, announcing 1-day public hearing on new features of Foreign Investors Tax Act of 1965 (H.R. 11297) which will be introduced as a clean bill on Monday, February 28, 1966 517 13. H. R. 13103 as introduced in the House of Representatives 519 14. Public hearings before the Committee on Ways and Means on H. R. 13103 521 15. Press release of the Committee on Ways and Means, dated March 17, 1966, announcing that the committee ordered favorably reported to the House, with amendments, H.R. 13103, the Foreign Investors Tax Act of 1966 573 1-6. Bill as reported by the Committee on Ways and Means 577 V PAGENO="0006" Section Page 17. Committeereport - 661 18. House floor debate 847 19. Bill as passed by the House and referred to the Senate Committee on Finance 873 20. Press release of the Senate Committee on Finance, dated July 29, 1966, announcing hearings on Foreign Investors Tax Act of 1966 875 21. Hearings before the Senate Committee on Finance 879 22. Press release of the Senate Committee on Finance, dated October 4, 1966, announcing that the Committee orders foreign investors tax bill reported 1163 23. Bill as reported by Senate Committee on Finance 1171 24. Committee report 1405 25. Senate floor debate 1493 26. Bill as passed by the Senate with amendments of the Senate 1603 27. Summary of Senate amendments 1841 28. Conference report 1865 29. House floor debate on conference report 1883 30. Senate floor debate on conference report 1913 31. Senate Committee on Finance summary of Presidential Election Cam- paign Fund Act of 1966 (title III of Public Law 89-809) 1977 32. Summary of the Foreign Investors Tax Act of 1966; Presidential Election Campaign Fund Act; and other amendments 1987 33. Press release, office of the White House press secretary (Fredericks- burg, Tex.) dated November 13, 1966, statement by the President upon signing the Foreign Investors Tax Act of 1966-H.R. 13103~. 2051 APPENDIX I. H.R. 10, a bill to amend the Internal Revenue Code of 1954 to permit pension and profit-sharing plans to provide contributions or benefits on a non-discriminatory basis for certain self-employed individuals without special limitations on the amount of contributions (sec. 204 of Public Law 89-809) 2057 II. H. R. 11765, income tax treatment of certain straddle transactions (sec. 210 of Public Law 89-809) 2121 III. S. 1013, to clarify the components of, and to assist in the management of, the national debt and the tax structure (sec. 402 of Public Law 89-809) 2151 IV. H.R. 18230, to amend the Internal Revenue Code of 1954 to provide that the term "purchase" for purposes of section 334(b)(2) is to include certain indirect purchases of stock through the purchase of the stock of another corporation (sec. 202 of Public Law 89-809) - - 2179 vi PAGENO="0007" CHRONOLOGICAL HISTORY OF THE LEGISLATION Date Fowler task force report presented to the President_ - Apr. 27, 1964. House bill number H.R. 5916. Date bill introduced in House of Representatives Mar. 8, 1965. Dates of public hearings before the House Committee on June 30 and July 1, Ways and Means (on H.R. 5916). 1965. house bill number (superseding H.R. 5916) H.R. 11297. Date bill introduced in House of Representatives Sept. 28, 1965. house bill number (superseding H.R. 11297) H.R. 13103. Date bill introduced in House of Representatives Feb. 28, 1966. Date of public hearings before the House Committee on Ways and Means (on H.R. 13103) - Mar. 7, 1966. Date bill reported by Committee on Ways and Means - - Apr. 26, 1966. House report number H. Rept. No. 1450. Date rule obtained-H. Res. 880, providing for a closed rule, waiving points of order against, 3 hours of debate, committee amendments, and one motion to recommit~. June 7, 1966. Date of House floor debate and final passage June 15, 1966. Rule: H. Res. 880 adopted by voice vote. Final passage: Passed by a voice vote. Dates of public hearings before the Senate Committee on Finance Aug.8,9,andl0,1966 Date bill reported by Senate Committee on Finance Oct. 11, 1966. Senate report number S. Rept. No. 1707. Dates of Senate floor debate Oct. 12 and 13, 1966. Date bill passed the Senate Oct. 13, 1966. Final passage: Passed by a record vote-58 yeas, 18 nays, 24 not voting. Date conference report filed Oct. 19, 1966. Conference report number Rept. No. 2327. Date conference report presented to House of Repre- sentatives Oct. 19, 1966. Date conference report adopted by House of Representa- tives Oct. 20, 1966. Vote: 171 yeas, 46 nays, 221 not voting. Date conference report presented to and adopted by the Senate Oct. 22, 1966. Date signed by the President Nov. 13, 1966. Public law number Public Law 89-809. vii PAGENO="0008" PAGENO="0009" ALPHABETICAL LISTING OF MEMBERS OF CONGRESS WITH CROSS-REFERENCES TO FLOOR DEBATES A. HOUSE FLOOR DEBATE ON BILL Page numbers (of this Members of the House document) Battin, James F. (Montana) 853 Byrnes, John W. (Wisconsin) 854, 855 Curtis, Thomas B. (Missouri) 853-855 de la Garza, Eligio (Texas) 853-854 Gross, H. R.(Iowa) 852 Madden, Ray J. (Indiana 849 Mills, Wilbur D. (Arkansas) 849-854, 855, 869 Smith, H. Allen (California) 849 B. SENATE FLOOR DEBATE ON BILL Members of the Senate Aiken, George D. (Vermont) 1552-1554, 1557-1558, 1564, 1595 Bayh, Birch E. (Indiana) 1577-1578 Bennett, Wallace F. (Utah) 1582 Carlson, Frank (Kansas) 1568, 1573-1574, 1594 Cotton, Norris (New Hampshire) 1546-1547, 1555-1557, 1560, 1569-1571, 1595 Dirksen, Everett McKinley (Illinois) 1582, 1594, 1595 Dominick, Peter H. (Colorado) 1569 Ervin, Samuel J., Jr. (North Carolina) 1583 Fong, Hiram L. (Hawaii) 1588-1590 Gore, Albert (Tennessee) 1538, 1540-1541, 1560-1562, 1566, 1569-1570, 1574, 1577-1582 Griffin, Robert P. (Michigan) 1598 Hartke, Vance (Indiana) 1568-1569, 1571-1573, 1575, 1577-1578, 1583 Holland, Spessard L. (Florida) 1599 Javits, Jacob K. (New York) 1587-1588 Jordan, B. Everett (North Carolina) 1568 Lausche, Frank J. (Ohio) 1525-1526, 1528, 1532-1537, 1542-1544, 1547, 1549-1550, 1561, 1563-1565, 1569, 1583, 1593, 1595-1596 Long, Edward V. (Missouri) 1569 Long, Russell B. (Louisiana) 1523-1540, 1542-1543, 1547-1551, 1552-1566, 1569-1570, 1571, 1574-1578, 1583-1584, 1588, 1590, 1592-1593, 1594, 1596-1598, 1599-1600 McCarthy, Eugene J. (Minnesota) 1539-1540, 1564-1565, 1577 Magnuson, Warren G. (Washington) 1557 Mansfield, Mike (Montana) 1495, 1567, 1575-1576, 1583, 1588, 1594, 1600-1601 Morton, Thruston B. (Kentucky) 1537, 1598 Murphy, George (California) 1549, 1558-1560, 1576 Nelson, Gaylord (Wisconsin) 1548 Pastore, John 0. (Rhode Island) 1551, 1552, 1553-1554, 1596-1598 Robertson, A. Willis (Virginia) 1592 Russell, Donald S. (South Carolina) 1569 Russell, Richard B. (Georgia) 1575 Scott, Hugh (Pennsylvania) 1546 Simpson, Milward L. (Wyoming) 1582, 1597 Smathers, George A. (Florida) 1599 Sparkman, John (Alabama) 1569 Stennis, John (Mississippi) 1569 Symington, Stuart (Missouri) 1554-1556 Talmadge, Herman E. (Georgia) 1537- 1538, 1542, 1568, 1590-1592, 1594, 1600 Thurmond, Strom (South Carolina) 1554, 1557-1558 Williams, John J. (Delaware) 1534, 1538, 1540, 1542-1547, 1550-1552, 1556, 1561-1564, 1566, 1574, 1582, 1592-1594, 1595-1597, 1599 Yarborough, Ralph W. (Texas) 1584-1587, 1590, 1592-1594, 1595 Young, Stephen M. (Ohio) 1552 ix PAGENO="0010" C. HOUSE FLOOR DEBATE ON CONFERENCE REPORT Page numbers Members of the House (of this document) Battin; James F. (Montana) 1900 Bingham, Jonathan B. (New York) 1906 Byrnes, John W. (Wisconsin) 1905 Curtis, Thomas B. (Missouri) 1893, 1902-1904, 1907, 1908 Dingell, John D. (Michigan) 1902, 1904-1905 Fraser, Donald M. (Minnesota) 1907 Fulton, James G. (Pennsylvania) 1906-1907 Griffiths, Martha W. (Michigan) 1901 Harsha, William H. (Ohio) 1901 Joelson, Charles S. (New Jersey) 1905-1906 Keogh, Eugene J. (New York) 1899-1900, 1902 Long, Clarence D. (Maryland) 1902, 1904 MacGregor, Clark (Minnesota) 1899 Mills, Wilbur D. (Arkansas) 1885, 1892-1908 Rumsfeld, Donald (Illinois) 1903 Smith, Howard W. (Virginia) 1892-1894 Vivian, Weston E. (Michigan) 1907 Watson, Albert W. (South Carolina) 1900-1901 D. SENATE FLOOR DEBATE ON CONFERENCE REPORT Members of the Senate Byrd, Robert C. (West Virginia) 1967 Clark, Joseph S. (Pennsylvania) 1954-1955 Gore, Albert (Tennessee) 1918-1919, 1923, 1927, 1930, 1933-1935, 1937, 1943, 1952-1961, 1963-1964 Hickenlooper, Bourke B. (Iowa) 1959-1960 Holland, Spessard L. (Florida) - 1917 Kuchel, Thomas H. (California) 1922 Lausche, Frank J. (Ohio) 1916, 1920-1922, 1932-1936, 1941-1942, 1944-1947, 1956-1961 Long, Russel B. (Louisiana) 1915, 1917-1918, 1920, 1922, 1923-1931, 1933-1934, 1936, 1941, 1943, 1946-1952, 1962-1965, 1968-1976. McCarthy, Eugene J. (Minnesota) 1931, 1935 Mansfield, Michael J. (Montana) 1915-1923, 1955, 1959, 1961, 1962, 1964 Monroney, A. S. Mike (Oklahoma) 1955 Morse, Wayne (Oregon) 1917 Murphy, George (California) 1926-1928, 1965-1966 Pastore, John 0. (Rhode Island) 1916-1917 Randolph, Jennings (West Virginia) 1967-1968 Smathers, George A. (Florida) 1920-1921, 1947-1954, 1957, 1966 Williams, John J. (Delaware) 1919-1920, 1930-1947, 1965 x PAGENO="0011" SECTION 1 PUBLIC LAW 89-809 (1) PAGENO="0012" PAGENO="0013" Public Law 89-809 89th Congress, H. R. 13103 November 13, 1966 - ~fl ~tt 80 STAT. 1539 To provide equitable tax treatment for foreign investment in the United States, to establish a Presidential Election Campaign Fund to assist in financing the* costs of presidential election campaigns, and for other purposes. Be it enacted by the Senate and House of Repre8entatives of the United States of America in Congress assem~bled, Foreign Inves.- tors Tax Act SECTION 1. TABLE OF CONTENTS, ETC. of 1966 and (a) TABLE OF CONTENTS.- Presidential Sec. 1. Table of contents, etc. Election Cam- (a) Table of contents. paign Fund Act (b) Ainendmentof 1954 Code. of 1966, TITLE I-FOREIGN INVESTORS TAX A~YJ~ Sec. 102. Source of income. (a) Interest. (b) Dividends. (c) Personal services. (d) Definitions. (e) Effective dates. Sec. 103. Nonresident alien individuals. (a) Tax on nonresident alien individuals. (b) Gross income. (c) Deductions. - (d) Allowance of deductions and credits. (e) Beneficiaries of estates and trusts. (f) Expatriation to avoid tax. (g) Partial exclusion of dividends. (h) Withholding of tax on nonresident aliens.. (i) Liability for withheld tax. (j) Declaration of estimated income tax by individuals. (k) Collection of income tax at source on wages. (1) Definitions of foreign estate or trust. (in) Conforming amendment. (a) Effective dates. Sec. 104. Foreign corporations. S (a) Tax on income not connected with United States business. (b) Tax on income connected with United States business. (c) Withholding of tax on foreign corporations. (d) Dividends received from certain foreign corporations. (e) Dividends received from certain wholly-owned foreign subsidiaries. (f) Distributions of certain foreign corporations. (g) Unrelated business taxable income. (h) Corporations subject to personal holding company tax. (I) Amendments with respect to foreign corporations carrying on insurance business in United States. S (j) Subpart F income. (k) Gain from certain sales or exchanges of stock in certain foreign corporations. S -. (1) Declaration of estimated income tax by corporations. (m) Technical amendments. (n) Effective dates. Sec. 105. Special tax provisions. (a) Income affected by -treaty. (b) Adjustment of tax because of burdensome or discriminatory foreign taxes. (c) Clerical amendments. (d) Effective date. (e) Elections by nonresident United States citizens who are subject to for~ eign community property laws. (f) Presumptive date of payment for tax withheld under chapter 3. S~ec. 106. Foreign tax credit. (a) Allowance of credit to certain nonresident aliens and foreign corpora. tions. (b) Alien residents of the United States or Puerto Rico. (c) Foreign tax credit In respect of interest received from foreign sub- sidiaries. S Sec. 107. Amendments to preserve existing law on deductions under section 931. (a) Deductions. (b) Effective date. 3 PAGENO="0014" Pub. Law 89-809 - 2 - November 13, 1966 8Q STAT. 1540 TITLE I-FOREIGN INVESTORS TAX ACT-Continued Sec. 108. Estates of nonresidents not citizens. (a) Rateof tax. (b) Credits against tax. (c) Property within the United States. (d) Property without the United States. (e) Definition of taxable estate. (f) Special methods of computing tax. (g) Estate tax returns. (h) Clerical amendment. (I) Effective date. Sec. 109. Tax on gifts of nonresidesits not citizens. (a) Imposition of tax. (b) Transfers in generaL (C) Effective date. Sec. no: Treaty obligations. TITLE Il-OTHER AMENDMENTS TO INTERNAL REVENUE CODE Sec. 201. Application of investment credit to property used In possessions of the United States. (a) Property used by domestic corporations, etc. (b) Effective date. Sec. 202. Basis of property received on liquidation of subsidiary. (a) Definition of purchase. (b) Period of acquisition. (c) Distribution of installment obligations. (d) Effective dates. Sec. 203. Transfers of property to investment companies controlled by transferors~ (a) Transfers to investment companies. (b) Investment companies required to file registration statement with S.E.C. (c) Effective date. Sec. 204. Removal of special limitations with respect to deductibility of con- tributions to pension plans by self-employed individuals. (a) Removal of special limitations. (b) Conforming amendments. (c) Definition of earned income. (d) Effective date. Sec. 205. Treatment of certain Income of authors, inventors, etc., as earned income for retirement plan purposes. (a) Income from disposition of property created by taxpayer. (b) Effective date. Sec. 206. Exclusion of certain rents from personal holding company income. (a) Rents from leases of certain tangible personal property. (b) Technical amendments. (c) Effective date. Sec. 207. Percentage depletion rate for certain clay bearing alumina. (a) 23 percent rate. (b) Treatment processes. (c) Effective date. Sec. 208. Percentage depletion rate for clam and oyster shells. (a) 15 percent rate. (b) Effective date. Sec. 209. Percentage depletion rate for certain clay,, shale, and slate. (a) 73k-percent rate. (b) Conforming amendment. (c) Effective date. Sec. 210. Straddles. (a) Treatment as short-term capital gain. (b) Effective date. Sec. 211. Tax treatment of per-unit retain allocations. (a) Tax treatment of cooperatives. (b) Tax treatment by patrons. (c) Definitions. (d) Information reporting. (e) Effective dates. (f) Transition rule. Sec. 212. ExcIse tax rate on ambulances and hearses. (a) Classification as automobiles. (b) Effective date. 4 PAGENO="0015" November 13, 1966 - 3 - Pub. Law 89-809 80 STAT. 1541 TITLE Il-OTHER AMENDMENTS PC) INTERNAL REVENUE CODE-Continued Sec. 213. ApplicabIlity of exclusion from Interest equalization tax of certain loans to assure raw materials sources. (a) Exception to exclusion. (b) Technical amendments. (c) Effective date. Sec. 214. Exclusion from interest equalization tax for certain acquisitions by Insurance companies. (a) New companies and companies operating In former less developed countries. (b) Effective date. Sec. 215. Exclusion from Interest equalization tax of certain acquisitions by foreign branches of domestic banks. (a) Authority for modification of executive orders. (b) Effective date. TITLE Ill-PRESIDENTIAL ELECTION CAMPAIGN FUND ACT Sec. 301. Short title. Sec. 302. Authority for designation of $1 of Income tax payments to presidential election campaign fund. Sec. 303. PresIdential election campaign fund. (a) Establishment. (b) Transfers to the fund. (c) Payments from fund. (d) Transfers to general fund. Sec. 304. Establishment of advisory board'. Sec. 305. Appropriations authorized. TITLE IV-MISCELLANEOUS PROVISIONS Sec. 401. Treasury notes payable in foreign currency. Sec. 4~. Reports tO clarify the national debt and tax structure. (b) AMENDMENT OF 1954 C0DE.-Except as otherwise expressly provided, wherever in titles I, II, and III, of this Act an amendment or repeal is expressed in terms of an amendment to, or repeal of,. a section or other provision, the reference is to a section or other provi- sion of the Internal Revenue Code of 1954. TITLE I-FOREIGN INVESTORS TAX. ACT SEC. 101. SHORT TITLE. This title may be cited as the "Foreign Investors Tax Act of 1966". SEC. 102. SOURCE OF INCOME. (a) IN'rElUIST.- (1) (A) Subparagraph (A) of section 861 (a) (1) (relatinif to 68A Stat. 275. interest from sources within the United States) is amendea to 26 USC 861. read as follows: "(A) interest on amounts described in subsection (c) re- ceived by a nonresident alien individual or a foreign corpo- ration, if such interest is not effectively connected with the conduct of a trade or business witMn the United States,". (B) Section 861 is amended by adding at the end thereof the following new subsection: "(c) INTEREsT ON Thceosrrs, Em-For purposes of subsection (a) (1) (A), the amounts described in this subsection are- "(1) deposits with persons carrying on the banking business, "(2) deposits or withdrawable accounts with savings institu- tions chartered and supervised as savings and loan or sunilar as- sociations under Federal or State law, but only to the extent that amounts paid or credited on such deposits or accounts are deducti- 5 PAGENO="0016" Pub. Law 89-809 - 4 - November 13, 1966 80 STAT. 1542 68A Stat. 78, ble under section 591 (determined without regard to section 265) 204. in computing the taxable income of such institutions, and .26 USC 265, 591. "(3) amounts held by an insurance company under an agree~ ment to pay interest thereon. Effective with respect to amounts paid or credited after December 31, 1972, subsection (a) (1) (A) and this subsection shall cease to apply.". 26 USC 861. (2) Section 861(a) (1) is amendea by striking out subpara- graphs (B) and (C) and inserting in lieu thereof the following: "(B) interest received from a resident alien individual or a domestic corporation, when it is shown to the satisfaction of the Secretary or his delegate that less than 20 percent of the gross income from all sources of such individual or such corporation has been derived from sources within the United States, as determined under the provisions of this part, for the 3-year period ending with the close of the taxable year of such individual or such corporation preceding the pay- ment of such interest, or for such part of such period as may be applicable, "(C) interest received from a foreign corporation (other than interest paid or credited after December 31, 1972, by a domestic branch of a foreign corporation, if such branch is engaged in the commercial banking business), when it is shown to the satisfaction of the Secretary or his delegate that less than 50 percent of the gross income from all sources of such foreign corporation for the 3-year period ending with the close of its taxable year preceding the payment of such interest (or for such part of such period as the corpora- tion has been in existence) was effectively connected with the conduct of a trade or business within the United States, "(D) in the case of interest received from a foreign corpo- ration (other than interestpaid or credited after December 31, 1972, by a domestic branch of a foreign corporation, if such branch is engaged in the commercial banking business), 50 percent or more of the gross income of which from all sources for the 3.year period ending with the close of its taxable year preceding the payment of such interest (or for such part of such period as the corporation has been in existence) was effectively connected with the conduct of a trade or business within the United States, an amount of such interest which bears the same ratio to such interest, as the gross income of such foreign corporation for such period which was not effec- tively connected with the conduct of a trade or business within the United States bears to its gross income from all sources, "(E) income derived by a foreign central bank of issue from bankers' acceptances, and "(F) interest on deposits with a foreign branch of a domes- tic corporation or a domestic partnership, if such branch is engaged in the commercial banking business." (3) Section 861 (relatino. to income from sources within the United States) is amended' by adding after subsection (c) (as added by paragraph (1) (B)) the following new subsection: "(d) SPECIAL Rtruss roi' APPLICATION OF PARAGRAPHS (1) (B), (1) (C), (1) (D), AND (2) (B) OF SUBSECTION (a).- "(1) NEW EwrrriEs.-For purposes of paragraphs (1) (B), (1)(C), (1)(D), and (2)(B) of subsection (a), if the resident alien individual, domestic corporation, or foreign corporation, as the case may be, has no gross income from any source for the 3.year period (or part thereof) specified, the 20 percent test or the 50 percent test, as the case may be, shall `be applied with respect to the taxable year of the payor in which payment of the. interest or dividends, as ~he case may be, is made, 6 PAGENO="0017" November 13, 1966 - 5 - Pub. Law 89-809 - ~ STAT. 1543 "(2) TItANSITI0N RULE.-FOr purposes of paragraphs (1) (C), (1) (D), and (2) (B) of subsection (a), the gross income of the foreign corporation for any period before the first taxable year beginning after December 31, 1966, which is effectively connected with the conduct of a trade or business within the United States is an amount equal to the gross income for such period from sources within the United States." (4) (A) Section 895 (relating to income derived by a foreign 75 Stat. 64. central bank of issue from obligations of the Unite{ States) is 26 USC 895. amended to read as follows: "SEC. 895. INCOME DERIVED BY A FOREIGN CENTRAL BANK OF ISSUE FROM OBLIGATIONS OF TIlE UNITED STATES OR FROM BANK DEPOSITS. "Income derived by a foreign central bank of issue from obligations of the United States or of any agency or instrumentality thereof (including beneficial interests, participations7 and other instruments issued under section 302(c) of the Federal National Mortgage Associa- tion Charter Act (12 U.S.C. 1717)) which are owned by such foreign 78 Stat. 800; central bank of issue, or derived from interest on deposits with persons ~!I!~, p. 164. carrying on the banking business, shall not be included in gross income and shall be exempt from taxation under this subtitle unless such obligations dr deposits are held for, or used in connection with, the conduct of commercial banking functions or other commercial activi- ties. For purposes of the preceding sentence the Bank for Inter- national Settlements shall be treated as a foreign central bank of issue." (B) The table of sections for subpart C of part II of sub- chapter N of chapter 1 is amended by striking out the item relating to section 895 and inserting in lieu thereof the following: "Sec. 895. Income derived by a foreign central bank of issue from obligations of the United States or from bank deposits." (b) DIvIDEND5.-Section 861 (a) (2) (B) (relating to dividends 68A Stat. 275. from sources within the United States) is amended to read as follows: 26 USC 861. "(B) from a foreign corporation unless less than 50 per- cent of the gross income from all sources of such foreign corporation for the 3-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was effectively connected with the conduct of a trade or business within the United States; but only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period which was effectively connected with the conduct of a trade or business within the United States bears to its gross income from all sources; but dividends (other than dividends for which a deduction is allowable under section 245 (b)) from a foreign ~ P. 1558. corporation shall, for purposes of subpart A of part III 26 USC 901-905; (relating to foreign tax credit), be treated as income from ~ p. 1568. sources without the United Btates to the extent (and only to the extent) exceeding the amount which is 100/85ths of the amount of the deduction allowable under section 245 in respect of such dividends, or". (c) PERSONAL Sxavicus.-Section 86.1(a) (3) (C) (ii) (relating to income from personal, services) is amended to read as follows: "(ii) an individual ~:ho is a citizen or resident of the Unite4 States, a domestic partnership, or a domestic cor- poration, if such labor or services are performed for an office or place of business maintained in a foreign country 71-297 0-67-pt. 1-2 7 PAGENO="0018" Pub. Law 89-809 - 6 - November 13 1966 80 STAT. 1544 - - ~ - - or in a possession of the United States by such individ- ual, partnership, or corporation." 68A Stat. 278. (d) DRFINITI0NS.-Section 864 (relating to definitions) is 26 USC 864. amended- (1) by striking out "For purposes of this part," and inserting in lieu thereof "(a) SAIL, ETC.-For purposes of this part,"; and (2) by adding at the end thereof the following new subsections: "(b) TRADE OR Busn~tss WITHIN THE UNITED STAnis.-For pur- poses of this part, part II, and chapter 3, the term `trade or business within the United States' includes the performance of personal serv- ices within the United States at any time within the taxable year, but does not include- "(1) PERFORMANCE OF PERSONAL SERVICES FOR FOREIGN EM- PI~oYER.-The performance of personal services- "(A) for a nonresident alien individual, foreign partner- ship, or foreign corporation, not engaged in trade or business within the United States, or "(B) for an office or place of business maintained in a foreign country or in a possession of the United States by an individual who is a citizen or resident of the United States or by a domestic partnership or a domestic corporation, by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year and whose compensation for such services does not exceed in the aggregate $3,000. "(2) TRADING IN SECURITIES OR COMMODITIES.- "(A) Smcxs AND SECURITIES.- "(i) IN OENERAL.-Trading in stocks or securities through a resident broker, commission agent, custodian, or other independent agent. "(ii) TRADING FOR TAXPAYER'S OWN ACCOUNT.-Trading in stocks or securities for the taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such employee or agent has discretionary authority to make decisions in effecting the transactions. This clause shall not apply in the case of a dealer in stocks or securities, or in the case of a corporation (other than a corporation which is, or but ~ p. 1559. for section 542(c) (7) or 543(b) (1) (C) would be, a per- sonal holding company) the principal business of which is trading in stocks or securities for its own account, if its principal office is in the United States. "(B) CoMMoDrrnis.--- "(i) IN GENERAL.-Trading in commodities through a resident broker, commission agent, custodian, or other independent agent. "(ii) TRADING FOR TAXPAYER'S OWN ACC0UNT.-Trading in commodities for the taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such employee or agent has discre- tionary authority to make decisions in effecting the trans- actions. This clause shall not apply in the case of a dealer in commodities. "(iii) LIMPFATI0N.-Clauses (i) and (ii) shall apply only if the commodities are of a kind customarily dealt in on an organized commodity exchange and if the 8 PAGENO="0019" November 13, 1966 - 7 - Pub. Law 89-809 80 STAT. 1545 transaction is of a kind customarily consummated at such place. "(C) LixrrrATloN.-Subparagraphs (A)(i) and (B) (i) shall apply only if, at no time during the taxable year, the taxpayer has an office or other fixed place of business in the United States through which or by the direction of which the transactions in stocks or securities, or in commodities, as the case may be, are effected. "(c) EFFECTIVELY CONNECTED INCOME, ETC.- "(1) GENERAL RULE.-For purposes of this title- "(A) In the case of a nonresident alien individual or a foreign corporation engaged in trade or business within the United States during the taxable year, the rules set forth in paragraphs (2), (3), and (4) shall apply in determining the income, gain, or loss which shall be treated as effectively con- nected with the conduct of a trade or business within the United States. "(B) Except as provided in section 871(d) or sections 882 (d) and (e), in the case of a nonresident alien individual or a ~ pp. 1547, foreign corporation not engaged in trade or business within 1555. the United States during the taxable year, no income, gain, or loss shall be treated as effectively connected wit.h the conduct of a trade or business within the United States. "(2) PERIODICAL, ETC., INCOME FROM SOURCES WITHIN UNITED STATES-FACTORS.-Ifl determining whether income from sources within the United States of the types described in section 871 (a) (1) or section 881(a), or whether gain or loss from sources within the United States from the sale or exchange of capital assets, is effectively connected with the conduct of a trade or busi- ness within the United States, the factors taken into account shall include whether- "(A) the income, gain, or loss is derived from assets used in or held for use in the conduct of such trade or business, or "(B) the activities of such trade or business were a material factor in the realization of the income, gain, or loss. In determining whether an asset is used in or held for use in the conduct of such trade or business or whether the activities of such trade or business were a material factor in realizing an item of income, gain, or loss, due regard shall be given to whether or not such asset or such income, gain, or loss was accounted for through such trade or business. In applying this paragraph and para- graph (4), interest referred to in section 861(a) (1) (A) shall be ~2, p. 1541. considered income from sources within the United States. "(3) OTHER INCOME FROM SOURCES WITHIN UNITED STATES.- All income, gain, or loss from sources within the United States (other than income, gain, or loss to which paragraph (2) applies) shall be treated as effectively connected with the conduct of a trade or business within the United States. "(4) INCOME FROM SOURCES WITHOUT UNITED STATEs.- "(A) Except as provided in subparagraphs (B) and (C), no income, gain, or loss from sources without the United States shall be treated as effectively connected with the con- duct of a trade or business within the United States. "(B) Income, gain, or loss from sources without the United States shall be treated as effectively connected with the con- duct of a trade or business within the United States by a nonresident alien individual or a foreign corporation if such person has an office or other fixed place of business within the United States to which such income, gain, or loss is att.ributable and such income, gain, or loss- 9 PAGENO="0020" Pub. Law 89-809 - 8 - November 13, 1966 80 STAT. 1546 "(i) consists of rents or royalties for the use of or for the privilege of using intangible property described 68A Stat. 277. in section 862(a) (4) (including any gain or loss realized 26 USC 862. on the sale of such property) derived in the active con- duct of such trade or business; "(ii) consists of dividends or interest, or gain or loss from the sale or exchange of stock or notes, bonds, or other evidences of indebtedness, and either is derived in the active conduct of a banking, financing, or similar business within the United States or is received by a corporation the principal business of which is trading in stocks or securities for its own account; or "(iii) is derived from the sale (without the United States) through such* office or other fixed place of busi- 26 USC 1221. ness of personal property described in section 1221(1), except that this clause shall not apply if the property is sold for use, consumption, or disposition outside the tTnited States and an office or other fixed place of busi- ness of the taxpayer outside the United States partici- pated materially in such sale. "(C) In the case of a foreign corporation taxable under 73 Stat. 112. part I of subchapter L, any mcome from sources without 26 USC 801-820. the United Sta1~es which is attributable to its United States business shall be treated as effectively connected with the conduct of a trade or business within the UnitedStates. "(D) No income from sources without the United States shall be treated as effectively connected. with the conduct of a trade or business within the United States if it either- "(i) consists of dividends, interest, or royalties paid by a foreign corporation in which the taxpayer owns 76 Stat. 1018. (within the meanmg of section 958(a)), or is considered 26 USC 958. as owning (by applying the ownership rules of section 958(b)), more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or "(ii) is subpart F income within the meaning of see- 26 USC 952, tion952(a). "(5) Iluuis FOR APPLICATION or PARAGRAPH (4) (B) .-For pur- poses of subparagraph (B) of paragraph (4)- "(A) in determining whether a nonresident alien individ- ual or a foreign corporation has an office or other fixed place of business, an office or other fixed place of business of an agent shall be disregarded unless such agent (i) has the authority to negotiate and conclude contracts in the name of the nonresident alien individual or foreign corporation and regularly exercises that authority or has a stock of merchan- - dise from which he regularly fills orders on behalf of such individual or foreign corporation, and (ii) is not a general commission agent, broker, or other agent of independent status acting in the ordinary course of his business, "(B) income, gain, or loss shall not be considered as attrib- utable to an office or other fixed place of business within the United States unless such office or fixed place of business is a material factor in the production of such income, gain, or loss and such office or fixed place of business regularly carries on activities of the type from which such income, gain, or loss is derived, and "(C) the income, gain, or loss which shall be attributable to an office or other fixed place of business within the United States shall be the income, gain, or loss property allocable thereto, but, in the case of a sale described in clause (iii) of - 10 PAGENO="0021" November 13, 1966 9 - Pub. Law 89-809 80 STAT. 1547 such subparagraph, the income which shall be treated as attributable to an office or other fixed place of business within the United States shall not exceed the income which would be derived from sources within the United States if the sale were made in the United States." (e) EvrI~oTIvE DATES.- (1) The amendments made by subsections (a), (c), and (d) shall apply with respect to taxable years beginning after December 31,1966; except that in applying section 864(c) (4) (B) (iii) of the Internal Revenue Code of 1954 (as added by subsection (d)) with respect to a binding contract entered into on or before Feb- ruary 24, 1966, activities in the United States on or before such date in negotiating or carrying out such contract shall not be taken into account. (2) The amendments made by subsection (b) shall apply with respect to amounts received after December 31, 1966. SEC. 103. NONRESIDENT ALIEN INDIVIDUALS. (a) TAX ON NONRESIDENT ALIEN INDIVIDUALS.- (1) Section 871 (relating to tax on nonresident alien individ- 68A Stat. 278. uals) is amended to read as follows: 26 USC 871. "SEC. 871. TAX ON NONRESIDENT ALIEN INDIVIDUALS. "(a) INCOME NOT CONNECTED WITH UNITED STATES BUSINESS- 30 PERCENT TAx.- "(1) INCOME OTHER THAN CAPITAL GAINS.-There is hereby imposed for each taxable year a tax of 30 percent of the amount received from sources within the United States by a nonresident alien individual as- "(A) interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, "(B) gains described in section 402 (a) (2), 403 (a) (2), or 631 (b) or (c), and gains on transfers described in. section 1235 made on or before October 4, 1966, 26 USC 402, "(C) in the case of bonds or other evidences of indebted- 403, 631, 1235. ness issued after September 28, 1965, amounts which under section 1232 are considered as gains from the sale or exchange 26 USC 1232. of property which is not a capital asset, and "(D) gains from the sale or exchange after October 4, 1966, of patents, copyrights, secret processes and formulas, good will, trademarks, trade brands, franchises, and other like property, or of any interest in any such property, to the extent such gains are from payments which are contingent on the productivity, use, or disposition of the property or interest sold or exchanged, or from payments which are treated as being so contingent under subsection (e), but only to the extent the amount so received is not effectively connected with the conduct of a trade or business within the United States. "(2) CAPITAL GAINS OF ALIENS PRESENT IN THE UNITED STATES 183 DAYS OR M0RE.-In the case of a nonresident alien individual pres- ent in the United States for a period or periods aggregating 183 days or more during the taxable year, there is hereby imposed for such year a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from the sale or exchange at any time during such year of capital assets exceed his losses, allocable to sources within the United States, from the sale or exchange at any time during such year of capital assets. For purposes of this paragraph, gains and losses shall be taken 11 PAGENO="0022" Pub. Law 89-809 - 10 - November 13, 1966 80 STAT. 1548 into account only if, and to the extent that, they would be recog- nized and taken into account if such gains and losses were effec- tively connected with the conduct of a trade or business within the United States, except that such gains and losses shall be deter- mined without regard to section 1202 (relating to deduction for capital gains) and such losses shall be determined without the benefits of the capital loss carryover provided in section 1212. Any gain or loss which is taken into account in determining the tax under paragraph (1) or subsection (b) shall not be taken into account in determining the tax under this paragraph. For pur- poses of the 183-day requirement of this paragraph, a nonresident alien individual not engaged in trade or business within the United States who has not established a taxable year for any prior period shall be treated as having a taxable year which is the calendar year. "(b) INcoME CONNECTED WITh UNITED STATES BUSINESS-GRADU- ATED RATE OF TAX.- "(1) IMPosITION OF TAX.-A nonresident alien individual engaged in trade or business within the United States during the taxable year shall be taxable as provided in section 1 or 1201(b) on his taxable income which is effectively connected with the conduct of a trade or business within the United States. "(2) DETERMINATION OF TAXABLE. INCOME.-Ifl determining taxable income for purposes of paragraph (1), gross income includes only gross income which is effectively connecte4 with the conduct of a trade or business within the United States. "(c) PARTICIPANTS IN CERTAIN EXCHANGE OR TRAINING PROGRAMS.- For purposes of this section, a nonresident alien individual who (with- out regard to this subsection) is not engaged in trade or business within the United States and who is temporarily present in the United States as a nonimmigrant under subparagraph (F) or (.1) of section 101(a) (15) of the Immigration and Nationality Act, as amended (8 U.S.C. 1101 (a) (15) (F) or (J)), shall be treated as a nonresident alien individual engaged in trade or business within the United States, and any income described in section 1441(b) (1) or (2) which is received by such individual shall, to the extent derived from sources within the TJnited States, be treated as effectively connected with the conduct of a trade or business within the United States. "(d) ELECTION To TREAT REAL PROPERTY INCOME AS INCOME CON- NECTED WITH UNITED STATES BUSINESS.- "(1) IN GENERAL.-A nonresident alien individual who during the taxable year derives any income- "(A) from real property held for the production of income and located in the United States, or from any interest in such real property, including (i) gains from the sale or exchange of such real property or an interest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and "(B) which, but for this subsection, would not be treated as income which is effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. In such case, such income shall be taxable as provided in subsection (b) (1) whether or not such individual is engaged in trade or business within the United States during the taxable year. An election under this para- graph for any taxable year shall remain in effect for all subse- quent taxable years, except that it may be revoked with the 68A Stat. 320. 26 USC 1202. 26 USC 1212. 26 Usc 1, 1201; ~ p. 1550. 66 Stat. 168; 75 Stat, 534. 75 Stat. 536. 26 Usc 1441. 68A Stat. 213. 26 USC 631. 12 PAGENO="0023" November 13, 1966 11 - Pub. Law 89-809 80 STAT. 1549 consent of the Secretary or his delegate with respect to any taxable year. "(2) ELECTION AFTER REvOCATI0N.-If an election has been made under paragraph (1) and such election has been revoked, a new election may not be made under such paragraph for any taxable year before the 5th taxable year which begins after the first taxable year for which such revocation is effective2 unless the Secretary or his delegate consents to such new election. "(3) FORM AND TIME OF ELECTION AND REVOCATION.-An election under paragraph (1), and any revocation of such an election, may be made only in such manner and at such time as the Secre- tary or his delegate may by regulations prescribe. "(e) GAINS FROM SALE OR ExCHANGE OF CERTAIN INTANGIBLE PROP- ERTY.-FOI' purposes of subsection (a) (1) (D), and for purposes of sections 881 (a) (4), 1441 (b),and 1442 (a)- 68A Stat. 357. "(1) `PAYMENTS TREATED AS CONTINGENT ON USE, ETC.-If more 26 USC 1441. than 50 percent of the gain for any taxable year from the sale ~ pp. 1555, or exchange of any patent, copyright, secret process or formula, good will, trademark, trade brand, franchise, or other like prop- erty, or of any interest in any such property, is from payments which are contingent on the productivity, use, or disposition of such property or interest, all of the gain for the taxable year from the sale or exchange of such property or interest shall be treated as being from payments which are contingent on the productivity, use, or disposition of such property or interest. "(2) SOURCE RULE.-Ifl determining -whether gains described in subsection (a) (1) (D) and section 881 (a) (4) are received from sources within the United States, such gains shall be treated as rentals or royalties for the use of, or privilege of using, property or an interest in property. "(f) CERTAIN ANNUITIES RECEIVED UNDER QTL%LIFIED PLANS.-FOr purposes of this section, gross income does not include any amount received as an annuity under a qualified annuity plan described in section 403 (a) (1), or from a qualified trust described in section 72 Stat. 1622. 401(a) which is exempt from tax under section 501(a), if- 26 USC 403. "(1) all of the personal services by reason of which such 26 USC 401, annuity is payable were either (A) personal services performed 501. outside the United States by an individual who, at the time of `performance of such personal services, was a nonresident alien, or (B) personal services described in section 864(b) (1) per- ~ p. 1544. formed within the United States by such individual, and "(2) at the time the first amount is paid as such annuity under such annuity plan, or by such trust, 90 percent or more of the - employees for whom contributions or benefits are provided under such annuity plan, or under the plan or plans of which such trust is a part, are citizens or residents of the United States." "(g) CROSS REFERENCES.- - "(1) For tax treatment of certain amounts distributed by the United States to nonresident alien individuals, see section 402(a)(4). "(2) For taxation of nonresident alien individuals who are expatri- * ate United States citizens, see section 877. "(3) For doubling of tax on citizens of certain foreign countries, see section 891. "(4) For adjustment of tax in case of nationals or residents of cer- tain foreign countries, see section 896. "(5) For withholding of tax at source on nonresident alien individ- uals, see section 1441. "(6) For the requirement of making a declaration of estimated tax by certain nonresident alien individuals, see section 6015(i)." 13 PAGENO="0024" Pub. Law 89-.809 - 12 - November 13, 1966 80 SPAT. 1550 68A Stat. 7. (2) Section 1 (relating to tax on individuals) is amended by 26 USC 1. redesignatin~ subsection. (d) as subsection (e), and by inserting aftersubsection (c) the following new subsection: "(d) NONRESIDENT ALIENS.-In the case of a nonresident alien indi- vidual, the tax imposed by subsection (a) shall apply only as provided ~ p. 1547; by section 871 or 877." ~ p. 1551. (b) GROSS INCOME.- 26 USC 872. (1) Subsection (a) of section 872 (relating to gross income of nonresident alien individuals) is amended to read as follows: "(a) GENERAL Ruu~.-In the case of a nonresident alien individual, gross income includes only- "(1) gross income which is derived from sources within the United States and which is not effectively connected with the con- duct of a trade or business within the United States, and "(2) gross income which is effectively connected with the con- duct of a trade or business within the United States." 75 Stat, 536. (2) Subparagraph (B) of section 872(b) (3) (relating to com- pensation of participants in certain exchange or training pro- grams) is amended by striking out "by a domestic corporation" and inserting in lieu thereof "by a domestic corporation, a domes- tic partnership, or an individual who is a citizen or resident of the United States'. (3) Subsection (b) of section 872 (relating to exclusions from gross income) is amended by adding at the end thereof the fol- lowing new paragraph: "(4) CERTAIN BOND INCOME OF RESIDENTS OF THE RYUKYU ISLANDS OR THE TEUST TERRITORY OF THE PACIFIC ISLANDS.- Income derived by a nonresident alien individual from a series B or series H United States savings bond, if such individual acquired such bond while a resident of the Ryukyu Islands or the Trust Territory of the Pacific Islands." (c) DEDUCTIONS.- 26 USC 873. (1) Section 873 (relating to deductions allowed to nonresident alien individuals) is amended to read as follows: "SEC. 873. DEDUCTIONS. "(a) GENERAL Ruzj~.-In the case of a nonresident alien individ- ual, the deductions shall be allowed only for purposes of section 871(b) and (except as provided by subsection (b)) only if and to the extent that they are connected with income which is effectively connected with the conduct of a trade or business within the United States; and the proper apportionment and allocation of the deductions for this purpose shall be determined as provided in regulations prescribed by the Secretary or his delegate. "(b) ExcEvrIoxs.-~The following deductions shall be allowed whether or not they are connected with income which is effectively connected with thc conduct of a trade or business within the United States: "(1) Losszs.-The deduction, for losses of property not con- nected with the trade or business if arising from certain casualties 78 Stat. 43. or theft, allowed by section 165(c) (3), but only if the loss is of 26 USC 165. property located within the United States. "~2) CHARITABLE CONTRIBUTI0NS.-The deduction for charita- 68A Stat. 58. ble contributions and gifts allowed by section 170. 26 USC 170. "(3) PERSONAL ExEMPTI0N.-The deduction for personal 26 USC 151. exemptions allowed by section 151, except that in the case of a nonresident alien individual who is not a resident of a contiguous country only one exemption shall be allowed under section 151. 14 PAGENO="0025" November 13, 1966 - 13 - Pub. Law 89-8_Q9_ 80 STAT 1551 "(c) CROSS REFERENCES.- "(1) For disallowance of standard deduction, see section 142(b)(1). "(2) For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b)(1)." (2) Section 154(3) (relating to cross references in respect of 68A Stat. 45. deductions for personal exemptions) is amended to. read ~ 26 USC 154. follows: "(3) For exemptions of nonresident aliens, see section 873(b)(3)." (d) ALLOWANCE OF' DEDUCTIONS AND CRm)ITS.-Subsection (a) of section 874 (relating to filing of returns) is amended to read as fol- 26 USC 874. lows: "(a) RETURN PREREQUISITE To ALLOWANCE.-A nonresident alien individual shall receive the benefit of the deductions and credits allowed to him in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true and accurate return, in the man- ner prescribed in subtitle F (sec. 6001 and following, relating to pro- cedure and administration), including therein all the information which the Secretary or his delegate may deem necessary for the calcu- lation of such deductions and credits. This subsection shall not be construed to deny the credits provided by sections 31 and 32 for tax 26 USC 31, 32. withheld at source or the credit provided by section 39 for certain 79 Stat * 167. uses of gasoline and lubricating oil?' 26 USC 39. (e) BENEFICIARIES OF ESTATES AND TRUSTS.- (1) Section 875 (relating to partnerships) is amended to read 68A Stat. 281. as follows: 26 USC 875. "SEC. 875. PARTNERSHIPS; BENEFICIARIES OF ESTATES AND TRUSTS. "For purposes of this subtitle- "(1) a nonresident alien individual or foreign corporation shall be considered as being engaged in a trade or business within the United States if the partnership of which such individual or corporation is a member is so engaged, and "(2) a nonresident alien individual or foreign corporation which is a beneficiary of an estate Or trust which is engaged in any trade or business within the United States shall be treated as being engaged in such trade or businesa within the United States." (2) The table of sections for subpart A of part II of sub- chapter N of chapter 1 is amended b~y striking out the item relat- ing to section 875 and inserting in lieu thereof the following: "See. 875. PartnershIps; beneficiaries of estates and trusts." (f) EXPATRIATION To Avom TAx.- (1) Subpart A of part II of subchapter N of chapter 1 (relat- ing to nonresident alien individuals) is amended by redesignating section 877 as section 878, and by inserting after section 876 the 26 USC 877. following new section: "SEC. 877. EXPATRIATION TO AVOID TAX. "(a) IN GENERAL.-EVery nonresident alien individual who at any time after March 8, 1965, and within the 10-year period immediately preceding the close of the taxable year lost United States citizenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle B, shall be taxable 26 USC 1..2524. for such taxable year in the manner provided in subsection (b) if the tax imposed pursuant to such subsection exceeds the tax which, without regard to this section, is imposed pursuant to section 871. ~ p. 1547. "(b) ALTERNATIVE TAx.-A nonresident alien individual described in subsection (a) shall be taxable for the taxable year as provided in sectioni or section 1201(b), except that- 26 USC 1, 1201; ~ ~. 1550.~. 15 PAGENO="0026" Pub. Law 89-809 - 14 - November 13, 1966 80 STAT. 1552 - - "(1) the gross income shall include only the gross income ~ p. 1550. described in section 872(a) (as modified by subsection (c) of this section), and "(2) the deductions shall be allowed if and to the extent that they are connected with the gross income included under this sec- tion, except that the capital loss carryover provided by section 78 Stat, 99. 1212(b) shall not be allowed; and the proper allocation and 26 USC 1212. apportionment of the deductions for this purpose shall be deter- mined as provided under regulations prescribed by the Secretary or his delegate. For purposes of paragraph (2), the deductions allowed by section ~j, p. 1550. 873(b) shall be allowed; and the deduction (for losses not connected with the trade or business if incurred in transactions entered into for 68A Stat. 49. profit) allowed by section 165(c) (2) shall be allowed, but only if the 26 USC 165. profit, if such transaction had resulted in a profit, would be included in gross income under this section. "(c) SPECIAL RULES OF SouRc]i.-For purposes of subsection (b), the fol1owin~ items of gross income shall be treated as income from sources within the United States: "(1) SALE OF PR0PERTy.-Gajns on the sale or exchange of property (other than stock or debt obligations) located in the United States. "(2) STOCK OR DEBT 0BLIGATIONs.-(~ajns on the sale or exchange of stock issued by a domestic corporation or debt obligations of United States persons or of the United States, a State or political subdivision thereof, or the District of Columbia. "(d) EXCEPTION FOR Loss OF CITIZENSHIP FOR CERTAIN CAUSES.- Subsection (a) shall not apply to a nonresident alien individual whose loss of United States citizenship resulted from the application of sec- tion 301(b), 350, or 355 of the Immigration and Nationality Act, as 66 Stat, 236. amended (8U.S.C.1401(b),1482,or1487) "(e) BURDEN Or Pnoor.-If the Secretary or his delegate establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction for the taxable year in the taxes on his probable income for such year, the burden of proving for such taxable year that such loss of citizenship did not have for one of its principal purposes the avoid- 26 USC 1-2524. ance of taxes under this subtitle or subtitle B shall be on such individual." (2) The table of sections for subpart. A of part II of subchapter N of chapter 1 is amended by striking out the item relating to section 877 and inserting in lieu thereof the following: "Sec. 877. Expatriation to avoid tax. "Sec. 878. Foreign educational, charitable, and certain other exempt organizations." (g) PARTIAL EXCLUSION OF DIvmEND5.-Subsectjon (d) of section 26 USC 116. 116 (relating to certain nonresident aliens ineligible for exclusion) is amended to read as follows: "(d) CERTAIN NONRESIDENT ALIENS INELIOIJiLE FOR ExCLU5I0N.-In the case of a nonresident alien individual, subsection (a) shall apply only- "(1) in determining the tax imposed for the taxable year pursu- ~ p. 1547. ant to section 871(b) (1) and only in respect of dividends which are effectively connected with the conduct of a trade or business within the United States, or "(2) in determining the tax imposed for the taxable year pursu- ~ P. 1551. ant to section 877(b) ." 16 PAGENO="0027" November 13, 1966 - 15 - Pub. Law 89- 809 eo STAT. 1553 (h) WITHHOLDING OF TAX ON NONRESIDENT ALrEN5.-Section 1441 68A Stat. 357. (relating to withholding of tax on nonresident aliens) is amended- 26 USC 1441. (1) by striking out ",*or of any partnership not engaged in trade or business within the United States and composed in whole or in part of nonresident aliens," in subsection (a) and msertmg in lieu thereof "or of any foreign partnership"; (2) by striking out "(except interest on deposits with persons carrying on the banking business paid to persons not engaged in business in the United States)" in subsection (b); (3) by striking out "and amounts described in section 402(a) (2)" and all that follows in the first sentence of subsection (b) and inserting in lieu thereof "gains described in section 402(a) (2), 403(a) (2), or 631 (b) or (c), amounts subject to tax under sec- tion 871(a) (1) (C), gains subject to tax under section 871(a) (1) (D), and gains on transfers described in section 1235 made 26 USC 402, 403, on or before October 4, 1966."; 631, 1235, Ante, (4) by adding at the end of subsection (b) the following new P* 1547. sentence: "In the case of a nonresident alien individual who is a member of a domestic partnership, the items of income referred to in subsection (a) shall be treated as referring to items specified in this subsection included in his distributive share of the income of such partnership."; (5) by striking out paragraph (1) of subsection (c) and insert- ing in lieu thereof the following new paragraph: "(1) INCOME CONNECTED WITH UNITED STATES BUSINESS.-NO * deduction or withholding under subsection (a) shall be required in the case of any item of income (other than compensation for personal services) which is effectively connected with the conduct of a trade or business within the United States and which is included in the gross income of the recipient under section 871 (b) (2) for the taxable year."; (6) by amending paragraph (4) of subsection (c) to read as 75 Stat. 536. follows: "(4) COMPENSATION OF CERTAIN ALIENs.-Tjnder regulations prescribed by the Secretary or his delegate, compensation for per- sonal services may be exempted from deduction and withholding under subsection (a)."; (7) by striking out "amounts described in section 402(a) (2), section 403(a) (2), section 631 (b) and (c), and section 1235, which are considered to be gains from the sale or exchange of capital assets," in paragraph (5) of subsection (c) and inserting in lieu thereof "gains described in section 402 (a) (2), 403 (a) (2), or 631 (b) or (c), gains subject to tax under section 871 (a) (1) (D), and gains on transfers described in section 1235 made on or before October 4, 1966,", and by striking out "proceeds from such sale or exchange," in such paragraph and inserting in lieu thereof "amount payable,"; * (8) by adding at the end of subsection (c) the following new 70 Stat. 563. paragraph: - "(7) CERTAIN ANNUITIES RECEIVED UNDER QUALIFIED PLANS.-NO deduction or withholding under subsection (a) shall be required in the case of any amount received as an annuity if such amount is, under section 871 (f), exempt from the tax imposed by section 871 (a)."; and (9) by redesignating subsection (d) as (e), and by inserting after ~ubsection (c) the following new subsection: "(d) EXEMPTION OF CERTAIN FOREIGN PARTNI~RSHIPS.-SUbject to such terms and conditions as may be provided by regulations pre- scribed by the Secretary or his delegate, subsection (a) shall not apply 17 PAGENO="0028" 80 STAT. 1554 Pub. Law 89-809 - 16 - November 13~ 1966 in the case of a foreign partnership engaged in trade or business within the United States if the Secretary or his delegate determines that the requirements of subsection (a) impose an undue administra- tive burden and that the collection of the tax imposed by section ~ p. 1547. 871 (a) on the members of such partnership who are nonresident alien individuals will not be jeopardized by the exemption." 68A Stat. 360. (i) LIABILITY FOR WITHHELD TAX.-Section 1461 (relating to 26 USC 1461. return and payment of withheld tax) is amended to read as follows: "SEC. 146L LIABILITY FOR WITHHELD TAX. "Every person required to deduct and withhold any tax under this 26 USC 1441.. chapter is hereby made liable for such tax and is hereby indemnified 1465. agamst the claims and demands of any person for the amount of any payments made in accordance with the provision~ of this chapter." (j) DECLARATION OF ESTIMATED INCOME TAX BY INDIVIDUALS.- 74 Stat. 1000. Section 6015 (relating to declaration of estimated income tax by 26 USC 6015. individuals) is amended- (1) by striking out that portion of subsection (a) which pre- cedes paragraph (1) and inserting in lieu thereof the followmg: "(a) REQUIREMENT OF DEcLAintnoN.-Except as otherwise provided in subsection (i), every individual shall make a declaration of his estimated tax for the taxable year if-~j (2) by redesignating subsection (i) as subsection (j) and (3) by inserting after subsection (h) the following new sub- section: "(i) NONRESIDENT ALIEN INrvInUALs.-_NO declaration shall be required to be made under this section by a nonresident alien indi- vidual unless- 26 USC 3401-. "(1) withholding under chapter 24 is made applicable to the 3404. wages, as defined in section 3401 (a), of such individual, "(2) such individual has income (other than compensation for personal services subject to deduction and withholding under section 1441) which is effectively connected with the conduct of a trade or business within the United States, or "(3) such individual is a resident of Puerto Rico during the entire taxable year." (k) COLLECTION OF INCOME TAX AT SOURCE ON WAGiss.-Subsection (a) of section 3401 (relating to definition of wages for purposes of collection of income tax at source) is amended by striking out para- graphs (6) and (7) and inserting in lieu thereof the following: "(6) for such services, performed by a nonresident alien indi- vidual, as may be designated by regulations prescribed by the Secretary or his delegate; or". (1) DEFINITIONS OF FOREIGN ESTATE OR TRUST.- 76 Stat. 988. (1) Section 7701 (a) (31) (defining foreign estate or trust) is 26 USC 7701. amended by striking out "from sources without the United States" and inserting in lieu thereof ", from sources without the United States which is not effectively connected with the conduct of a trade or business within the United States,". Repeal. (2) Section 1493 (defining foreign trust for purposes of chap- 68A Stat. 365. ter 5) is repealed. 26 USC 1493. (m) CONFORMING AMENDMENT.-The first sentence of section 26 USC 932. 932(a) (relating to citizens of possessions of the United States) is amended to read as follows: "Any individual who is a citizen of any possession of the United States (but not otherwise a citizen of the United States) and who is not a resident of the United States shall be 26 USC 1-1563. subject to taxation under this subtitle in the same manner and subject to the same conditions as in the case of a nonresident alien individual." 18 PAGENO="0029" November 13, 1966 - 17 - Pub. Law 89- 809 __________- 80 STAT. 1555 (n) EFFECTIVE DATES.- (1) The amendments made by this section (other than the amendments made by subsections (h), (i), and. (k)) shall apply with respect to taxable years beginning after December 31, 1966. (2) The amendments made by subsection (h) shall apply with respect to payments made in taxable years of recipients beginning after December 31, 1966. (3) The amendments made by subsection (i) shall apply with respect to payments occurring after December 31,1966. (4) The amendments made by subsection (k) shall apply with respect to remuneration paid after December 31, 1966. SEC. 104. FOREIGN CORPORATIONS. (a) TAX ON INCOME NOT CONNECTED WITH UNITED STATES BUSI- NE5S.-Section 881 (relating to tax on foreign corporations not engaged 68A Stat. 282. in business in the United States) is amended to read as follows: 26 USC 881. "SEC. 881. TAX ON INCOME OF FOREIGN CORPORATIONS NOT CON- NECTED WITH UNITED STATES BUSINESS. "(a) IMrosrrIoN OF TAX.-There is hereby imposed for each tax- able year a tax of 30 percent of the amount received from sources within the United States by a foreign corporation as- "(1) interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, "(2) gains described in section 631 (b) or (c), 26 USC 631. "(3) in the case of bonds or other evidences of indebtedness issued after September 28, 1965, amounts which under section 1232 are considered as gains from the sale or exchange of prop- 26 USC 1232. erty which is not a capital asset, and "(4) gains from the sale or exchange after October 4, 1966, of patents, copyrights, secret processes and formulas, good will, trademarks, trade brands, franchises, and other like property, or of any interest in any such property, to the extent such gains are from payments which are contingent on the productivity, use, or disposition of the property or interest sold or exchanged, or from payments which are treated as being so contingent under section 871(e), . ~ p. 1547. but only to the extent the amount so received is not effectively con- nected with the conduct of a trade or business within the United States. "(b) DOUBLING OF TAx.- "For doubling of tax on corporations of certain foreign countries, see section 891." (b) TAX ON INCOME CONNECTED WITH UNrrm) STATES BusINEss.- (1) Section 882 (relating to tax on resident foreign corpo- 26 USC 882. rations) is amended to read as follows: "SEC. 882. TAX ON INCOME OF FOREIGN CORPORATIONS CONNECTED WITH UNITED STATES BUSINESS. "(a) NORMAL TAX AND SURTAX.-. "(1) IMPOSITION OF rAx.-A foreign corporation engaged in trade or business within the United States during the taxable year shall be taxable as provided in section 11 or 1201 (a) on its 78 Stat. 25; taxable income which is effectively connected with the conduct ~ P. 1557. of a trade or business within the United States. 26 USC 11. "(2) DETERMINATION OF TAXABLE INCOME.-Ifl determining 26 USC 1201, taxable income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct of a trade or business within the United States. "(b) GRoss INCOME.-Ifl the case of a foreign corporation, gross income includes only- 19 PAGENO="0030" 80 STAT. 1556 Pub. Law 89-.809 18 - November 13, 1966 68A Stat. 58. 26 Usc 170, 26 USC 6001~. 7852. 26 USC 541. 26 USC 32. 79 Stat, 167. 26 USC 39. ~ p. 1568. 26 USC 901; ~ P. 1569. 26 USC 631. "(1) gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, and "(2) gross income which is effectively'connected with the con- duct of a trade or business within the United States. "(c) ALLOWANCE OF DEDUCTIONS AND CREDITS.- "(1) AlLocATIoN OF DEDUCTIONS.- "(A) GENERAL RULE.-In the case of a foreign corporation, the deductions shall be allowed only for purposes of subsec- tion (a) and (except as provided by subparagraph (B)) only if and to the extent that they are connected with income which is effectively connected with the conduct of a trade or business within the United States; and the proper apportion- ment and allocation of the deductions for this purpose shall be determined as provided in regulations prescribed by the Secretary or his delegate. "(B) CHARITABLE CONTRIBUTIONS.-The deduction for charitable contributions and gifts provided by section 170 shall be allowed whether or not connected with income which is effectively connected with the conduct of a trade or business withiii the United States. "(2) DEDUCTIONS AND CREDITS ALLOWED ONLY IF RETURN FILED.- A foreign corporation shall receive the benefit of the deductions and credits allowed to it in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true and accurate return, in the manner prescribed in subtitle F, including therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. The preceding sentence shall not apply for purposes of the tax imposed by section 541 (relating to personal holding company tax), and shall not be construed to deny the credit provided by section 32 for tax witl1held at source or the credit provided by section 39 for certain uses of gasoline and lubricating oil. "(3) FOREIGN TAX CREDIT.-Except as provided by section 906, forbign corporations shall not be allowed the credit against the tax for taxes of foreign countries and possessions of the United States allowed by section 901. "(4) CROSS REFERENCE.- "For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b)(1). "(d) ELECTION To TREAT REAL PROPERTY INCOME AS INCOME CON- NECTED WITH UNITED STATES BUSINESS.- "(1) IN GENERAL.-A foreign corporation which during the taxable year derives any income- "(A) from real property located in the United States, or from any interest in such real property, including (i) gains from the sale or exchange of real property or an interest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c),and "(B) which, but for this subsection, would not be treated as income effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. In such case, such income shall be taxable as provided in subsection (a) (1) whether or not such corporation is engaged in trade or business within the 20 PAGENO="0031" November 13, 1966 - 19 - Pub. Law 89- 809 80 STAT. ].55 United States during the taxable year. An election under this* paragraph for any taxable year shall remain in effect for all subsequent taxable years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any tax- able year. "(2) ELECTION AFIRE REVOCATION, ETc.-Paragraphs (2) and (3) of section 871(d) shall apply in respect of elections under this ~ p. 1547. subsection in the same manner and to the same extent as they apply in respect of elections under section 871(d). "(e) INTEREST ON UNITED STATES OBLIGATIONS RECEIVED BY BANKS ORGANIZED IN PossEssloNS.-In the case of a corporation created or organized in, or under the law of, a possession of the United States which is carrying on the banking business in a possession of the United States, interest on obligations of the United States shall- "(1) for purposes of this subpart, be treated as income which is effectively connected with the conduct of~a trade or business within the United States, and "(2) shall be taxable as provided in subsection (a) (1) whether or not such corporation is engaged in trade or business within the United States during the taxable year. "(f) RETURNS OF TAX BY AGENT.-If any foreign corporation has no office or place of business in the United States but has an agent in the United States, the return required under section 6012 shall be 68A Stat. 732. made by the agent." 26 USC 6012. (2) (A) Subsection (e) of section 11 (relatin~ to exceptions 78 Stat. 25. from tax on corporations) is amended by inserting "or" at the 26 USC 11. end of paragraph (2), by striking out "~ or" at the end of para- graph (3) and inserting a period in lieu thereof, and by striking out paragraph (4). (B) Section 11 (relating to tax on corporations) is amended by adding at the end thereof the following new subsection: "(f) FOREIGN C0RP0RATI0N5.-In the case of a foreign corporation, the tax imposed by subsection (a) shall apply only as provided by section 882." ~ p. 1555. (3) The table of sections for subpart B of part II of sub- chapter N of chapter 1 is amended by striking out the items relat- ing to sections 881 and 882 and inserting in lieu thereof the following: "Sec. 881. Tax on Income of foreign corporations not connected with United States business. "Sec. 882. Tax on income of foreign corporations connected with United States business." (c) WITHHOLDING OF TAX ON FOREIGN C0RP0RATI0N5.-Section 1442 (relating to withholding of tax on foreign corporations) is 68A Stat. 358. amended to read as follows: 26 USC 1442. "SEC. 1442. WITHHOLDING OF TAX ON FOREIGN CORPORATIONS. "(a) GENERAL RULE.-In the case of foreign corporations subject to taxation under this subtitle, there shall be deducted and withheld 26 USC 1-1563. at the source in the same manner and on the same items of income as is provided in section 1441 or section 1451 a tax equal to 30 percent 26 USC 1441, thereof; except that, in the case of interest described in section 1451 1451 ~ p. (relating to tax-tree covenant bonds), the deduction and withholding 1553. shall be at the rate specified therein. For purposes of the preceding sentence, the references in section 1441(b) to sections 871(a) (1) (0) and (D) shall be treated as referring to sections 881(a) (3) and (4), ~ p. 1555. the reference in section 1441(c) (1) to section 871(b) (2) shall be treated as referring to section 842 or section 882 (a) (2), as the case ~ p. 1561. 21 PAGENO="0032" Pub. Law 89.809 - 20 - November 13, 1966 80 STAT. 1558 may be, and the reference in section 1441(c) (5) to section 871(a) ~ pp. 1547, (1) (D) shall be treated as referring to section 881 (a) (4). 1553, 1555 * "(b) EXEMPTI0N.-Subject to such terms and conditions as may be provided by regulations prescribed by the Secretary or his dele- gate, subsection (a) shall not apply in the case of a foreign corporation engaged in trade or business within the United States if the Secretary or his delegate determines that the requirements of subsection (a) impose an undue administrative burden and that the collection of the tax imposed by section 881 on such corporation will not be jeopardized by the exemption." (d) DIVIDENDS RECEIVED FROM CERTAIN FOREIGN CORPORATIONS.- 68A Stat. 73; Subsection (a) of section 245 (relating to the allowance of a deduction 76 Stat, 977. in respect of dividends received from a foreign corporation) is 26 USC 245, amended- (1) by striking out "and has derived 50 percent or more of its gross income from sources within the United States," in that por- tion of subsection (a) which precedes paragraph (1) and by inserting in lieu thereof "and if 50 percent or more of the gross income of such corporation from all sources for such period is effectively connected with the conduct of a trade or business with- in the United States,"; (2) by striking out "from sources within the United States" in paragraph (1) and inserting in lieu thereof "which is effec- tively c nnected with the conduct of a trade or business within the United States"; (3) by striking out "from sources within the United States" in paragraph (2) and inserting in lieu thereof ", which is effectively connected with the conduct of a trade or business within the United States,"; and (4) by adding after paragraph (2) the following new sentence: "For purposes of this subsection, the gross income of the foreign cor- poration for any period before the first taxable year beginning after December 31, 1966, which is effectively connected with the conduct of a trade or business within the United States is an amount equal to the gross income for such period from sources within the United States." (e) DIVIDENDS RECEIVED FROM CERTAIN WHOLLY-OWNED FOREIGN SUBSIDIARIES.- (1) Section 245 (relating to dividends received from certain foreign corporations) is amended by redesignating subsection (b) as(c), and by inserting after subsection (a) the following new subsection: "(b) CERTAIN DIVIDENDS RECEIVED FROM WHOLLY OWNED FOREIGN SUBSIDIARIES.- "(1) IN GENERAL.-In the case of dividends described in para- graph (2) received from a foreign corporation by a domestic cor- poration which, for its taxable year in which such dividends are received, owns (directly or indirectly) all of the outstanding stock of such foreign corporation, there shall be allowed as a deduction (in lieu of the deduction provided by subsection (a)) an amount equal to 100 percent of such dividends. "(2) ELIGIBLE DIVIDENDS.-Paragraph (1) shall apply only to dividends which are paid out of the earnings and profits of a foreign corporation for a taxable year during which- "(A) all of its outstanding stock is owned (directly or indirectly) by the domestic corporation to which such divi- dends are paid; and "(B) all of its gross income from all sources is effectively connected with the conduct of a trade Or business within the United States. 22 PAGENO="0033" November 13, 1966 - 21 - Pub. Law 89- 809 80 STAT. 1559 "(3) EXCEPTION.-Paragraph (1) shall not apply to any divi- clends if an election under section 1562 is effective for either- 78 Stat. 117. "(A) the taxable year of the domestic corporation in 26 USC 1562. which such dividends are received, or "(B) the taxable year of the foreign corporation out of the earnings and profits of which such dividends are paid." (2) Subsection (a) of such section 245 is amended by adding at ~ p. 1558. the end thereof (after the sentence added by subsection (d) (4)) the following new sentence: "For purposes of paragraph (2), there shall not be taken into account any taxable year within such uninterrupted period if, with respect to dividends paid out of the earnings and profits of such year, the deduction provided by sub- section (b) would be allowable." (3) Subsection (c) of such section 245 (as redesignated by paragraph (1)) is amended by striking out "subsection (a)" and inserting in lieu thereof "subsections (a) and (b) ". (f) DI5TRIBIYrI0Ns OF CERTAIN FOREIGN CoRPoRA~noNs.-5ection 301(b) (1) (C) (relating to certain corporate distributees of foreign 76 Stat. 977. corporations) is amended- 26 USC 301. (1) by striking out "gross income from sources within the United States" in clause (i) and inserting in lieu thereof "gross income which is effectively connected with the conduct of a trade or business within the United States"; (2) by striking out "gross income from sources without the United States" in clause (ii) and inserting in lieu thereof "gross income which is not effectively connected with the conduct of a trade or business within the United States"; and (3) by adding at the end thereof the following new sentences: "For purposes of clause (i), the gross income of a foreign cor- poration for any period before its first taxable year beginning after December 31, 1966, which is effectively connected with the conduct of a trade or business within the United States is an amount equal to the gross income for such period from sources within the United States. For purposes of clause (ii), the gross income of a foreign corporation for any period before its first taxable. year beginning after December 31, 1966, which is not effectively connected with the conduct of a trade or business within the United States is an amount equal to the gross income for such period from sources without the United States." (g) UNRELATED BTJSINESS TAXABLE TNCOME.-The last sentence of section 512(a) (relating to definition) is amended to read as follows: 68A Stat. 170. "In the case of an organization described in section 511 which is a ~ foreign organization, the unrelated business taxable income shall be its unrelated business taxable income which is effectively connected with the conduct of a trade or business within the TTnited States." (h) CORPORATIONS SUBJECT TO PERSONAL HOLDING Co~IPANy TAX.- (1) Paragraph (7) of section 542(c) (relating to corporations 68A Stat. 186; not subject to personal holding company tax) is amended to read 78 Stat. 79. as follows "(7) a foreign corporation (other than a corporation which has income to which section 543 (a) (7) applies for the taxable 78 Stat. 81. year), if all of its stock outstanding during the last half of the 26 USC 543. taxable year is owned by nonresident alien individuals, whether directly or indirectly through foreign estates, foreign trusts, foreign partnerships, or other foreign corporations;". (2) Section 543(b) (1) (relating to definition of ordinary gross income) is amended- (A) by striking out "and" at the end of subparagraph (A), 71-297 O-67-pt. 1-3 23 PAGENO="0034" Pub. Law 89-809 - 22 - November 13, 1966 80 STAT. 1560 (B) by striking out the period at the end of subparagraph (B) and inserting in lieu thereof ", and", and (C) by inserting after subparagraph (B) the following new subparagraph: "(C) in the case of a foreign corporation all of the out- standing stock of which during the last half of the taxable year is owned by nonresident alien individuals (whether directly or indirectly through foreign estates, foreign trusts, foreign partnerships, or other foreign corporations), all items of income which would, but for this subparagraph, constitute personal holding company income under any paragraph of subsection (a) other than paragraph (7) thereof :" 68A Stat. 189. (3) Section 545 (relating to definition of undistributed per- 26 USC 545.* sonal holding company income) is amended- (A) by striking out subsection (a) and inserting in lieu. thereof the following: "(a) DEFINITI0N.-For purposes of this part, the term `undistrib- uted personal holding company income' means the taxable income of a personal holding company adjusted in the manner provided in sub- sections (b), (c), and (d), minus the dividends paid deduction as 26 USC 561. defined in section 561. In the case of a personal holding company which is a foreign corporation, not more than 10 percent in value of the outstanding stock of which is owned (within the meaning of see- 76 Stat. 1018. tion 958(a)) during the last half of the taxable year by United States 26 USC 958. persons, the term `undistributed personal holding company income' means the amount determined by multiplying the undistributed per- sonal holding company income (determined without regard to this sentence) by the percentage in value of its outstanding stock which is the greatest percentage in value of its outstanding stock so owned by United States persons on any one day during such period."; and (B) by adding at the end thereof the following new sub- section: "(d) CERTAIN FoInIGN CoRPon~rIoNs.-Tn the case of a foreign cor- porat.ion all of the outstanding stock of which during the last half of the taxable year is owned by nonresident alien individuals (whether. directly or indirectly through foreign estates, foreign trusts, foreign partnerships, or other foreign corporations), the taxable income for purposes of subsection (a) shall be the income which constitutes 78 Stat, 81. personal holding company income under section 543 (a) (7), reduced 26 USC 543. by the deductions attributable to such income, and adjusted, with respect to such income, in t.he manner provided in subsection (b) ." 26 USC 6671- (4) (A) Subchapter B of chapter 68 (relating to assessable 6881. penalties) is amended by adding at the end thereof the following ~ p* 61~ new section: "SEC. 6683. FAILURE OF FOREIGN CORPORATION TO FILE RETURN OF PERSONAL HOLDING COMPANY TAX. "Any foreign corporation which- "(1) is a personal holding company for any taxable year, and "(2) fails to file or to cause to be filed with the Secretary or his delegat.e a true and accurate return of the tax imposed by section 26 USC 541. Ml, shall, in addition to other penalties provided by law, pay a penalty 26 USC 1-1388. equal to 10 percent of the taxes imposed by chapter 1 (including the tax imposed by section 541) on such foreign corporation for such tax- able year." (B) The table of sections for such subchapter B is amended by adding at. the end thereof the following new item: "Sec. 6683. Failure of foreign corporation to file return of personal holding company tax." 24 PAGENO="0035" November 13, 1966 - 23 - Pub. Law 89-809 - --- - -- - - - 80 STAT. 1561 (i) AMENDMENTS WITH RESPECT TO FOREIGN CORPORATIONS CARRY- ING ON INSURANCE BUSINESS IN UNITED STATES.- (1) Section 842 (relating to computation of gross income) is 68A Stat. 267. amended to read as follows: 26 Usc 842. "SEC. 842. FOREIGN CORPORATIONS CARRYING ON INSURANCE BUSINESS. "If a foreign corporation carrying on an insurance business within the United States would qualify under part I, II, or III of this sub- chapter for the taxable year if (without regard to income not effec- 26 usc 801-832. tively connected with the conduct of any trade or business within the United States) it were a domestic corporation, such corporation shall be taxable under such part on its income effectively connected with its conduct of any trade or business within the United States. With respect to the remainder of its income, which is from sources within the United States, such a foreign corporation shall be taxable as pro- vided in section 881." ~ p. 1555. (2) The table of sections for part IV of subchapter L of chapter 1 is amended by striking out the item relating to section 842 and inserting in lieu thereof the following: "Sec. 842. Foreign corporations carrying on insurance business." (3) Section 819 (relating to foreign life insurance companies) 73 Stat. 136. is amended- 26 usc 819. (A) by striking out subsections (a) and (d) and by redes- ignatmg subsections (b) and (c) as subsections (a) and (b), (B) by striking out "In the case of any company described in subsection (a)," in subsection (a) (1) (as redesignated by subparagraph (A)) and inserting in lieu thereof "In the case of any foreign corporation taxable under this part,", (C) by striking out "subsection (c)"in the last sentence of subsection (a) (2) (as redesignated by subparagraph (A)) and inserting in lieu thereof "subsection (b) ", (D) by adding at the end of subsection (a) (as redesig- nated by subparagraph (A)) the following new paragraph: "(3) REDUCTION OF SECTION 881 TAX.-Ifl the case of any for- eign corporation taxable under this part, there shall be deter- mined- "(A) the amount which would be subject to tax under section 881 if the amount taxable under. such section were determined without regard to sections 103 and 894, and 68A Stat, 29. "(B) the amount of the reduction provided by para- 26 USC 103. graph (1). *?..2.~.' P' 1563. The tax under section 881 (determined without regard to this paragraph) shall be reduced (but not below zero) by an amount which is the same proportion of such tax as the amount referred to in subparagraph (B) is of the amount referred to in sub- paragraph (A); but such reduction in tax shall not exceed the increase in tax under this part by reason of the reduction pro- vided by paragraph (1).", (B) by striking out "for purposes of subsection (a)" each place it appears in subsection (b) (as redesignated by sub- paragraph (A)) and inserting in lieu thereof "with respect to a foreign corporation", (F) by striking out "foreign life insurance company" each place it appears in such subsection (b) and inserting in lieu thereof "foreign corporation", (G) by striking out "subsection (b) (2) (A)" each place it appears in such subsection (b) and inserting in lieu thereof "subsection (a) (2) (A)", 25 PAGENO="0036" Pub. Law 89- 809 80 STAT. 1562 - 24 - November 13, 1966 76 Stat, 989. 26 Usc 821. 68A Stat. 263; 76 Stat, 992. 26 usc 822. 26 usc 831. 26 usc 832. 26 usc 841. ~ P. 1568. 76 Stat. 1008. 26 usc 952. 76 Stat. 1041. 26 usc 1248. (H) by striking out "subsection (b) (2) (B)" in para- graph (2) (B) (ii) of such subsection (b) and inserting in lieu thereof "subsection (a) (2) (~B)", and (I) by adding at the end thereof the following new sub- section: "(c) CRoss REFERENCE.- "For taxation of foreign corporations carrying on life insurance business withia the United States, see section 842." (4) Section 821 (relating to tax on mutual insurance compa- nies to which part II applies) is amended- (A) by striking out subsection (e) and by redesignating subsections (f) and (g) as subsections (e) and (f), and (B) by adding at the end of subsection (f) (as redesig- nated by subparagraph (A)) the following: "(3) For taxation of foreign corporations carrying on an insurance business within the United States, see section 842." (5) Section 822 (relating to determination of taxable invest- ment income) is amended by striking out subsection (e) and by redesignating subsection (f) as subsection (e). (6) Section 831 (relating to tax on certain other insurance companies) is amended- (A) by striking out subsection (b) and by redesignating subsection (c) as subsection (b), and (B) by amending subsection (d) to read as follows: "(c) Cnoss REFERENCES.- "(1) For alternative tax in case of capital gains, see section 1201(a). "(2) For taxation of foreign corporations carrying on an insurance business within the United States, see section 842." (7) Section 832 (relating to insurance company taxable income) is amended by striking out subsection (d) and by redesig- nating subsection (e) as subsection (d). (8) The second sentence of section 841 (relating to credit for foreign taxes) is amended by striking out "sentence," and insert- ing in lieu thereof "sentence (and for purposes of applying sec- tion 906 with respect to a foreign corporation subject to tax under this subchapter),". (j) SUBPART F INcoME.-Section 952(b) (relating to exclusion of United States income) is amended to read as follows: "(b) ExcLusIoN OF UNITED STATES INCOME.-In the case of a con- rolled foreign corporation, subpart F income does not include any item of income from sources within the United States which is effec- lively connected with the conduct by such corporation of a trade or business within the United States unless such item is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation of the United States." (k) GAIN FROM CERTAIN SALES OR EXCHANGES OF STOCK IN CERTAIN FOREIGN CoRPoRA~noNS.-Paragraph (4) of section 1248(d) (relating to exclusions from earnings and profits) is amended to read as follows: "(4) UNITED STATES INCOME.-Afly item includible in gross income of the foreign corporation under this chapter- "(A) for any taxable year beginning before January 1, 1967, as income derived from sources within the United States of a foreign corporation engaged in trade or business within the United States, or "(B) for any taxable year beginning after December 31, 1966, as income effectively connected with the conduct by such corporation of a trade or business within the United States. 26 PAGENO="0037" November 13, 1966 - 25 - Pub. Law 89-809 80 STAT. 1563 This paragraph shall not apply with respect to any item which is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation of the United States." (1) DECLARATION OF ESTIMATED INCOME TAX BY Com?oRATIoNs.- Section 6016 (relating to declarations of estimated income tax by 68A Stat. 738; corporations) is amendeU by redesignating subsection (f) as subsec- 78 Stat. 29. tion (g) and by inserting after subsection (e) the following new 26 USC 6016, subsection: "(f) CERTAIN FormiGN CORPORATIONS.-FOr purposes of this section and section 6655, in the case of, a foreign corporation subject to taxa- 26 USC 6655. tion under section 11 or 1201(a), or under subchapter L of chapter 1, the tax imposed by section 881 shall be treated as a tax imposed by 26 USC ii, 801- section 11." 843, 1201. (m) TECHNICAL AMENDMENTS.- ~.2 pp. 1555, (1) Section 884 is amended to read as follows: C 884 "SEC. 884. CROSS REFERENCES. "(1) For special provisions relating to unrelated business income of foreign educational, charitable, and certain other exempt orga- nizations, see section 512(a). "(2) For special provisions relating to foreign corporations carry. ~ng on an insurance business within the United States, see section 842. "(3) For rules applicable in determining whether any foreign cor. poration is engaged in trade or business within the United States, see section 864(b). "(4) For adjustment of tax in case of corporations of certain for- eign countries, see section 896. "(5) For allowance of credit against the tax in case of a foreign corporation having income effectively connected with the conduct of a trade or business within the United States, see section 906. "(6) For withholding at source of tax on income of foreign cor- porations, see section 1442." (2) Section 953(b) (3) (F) is amended by striking out 76 Stat. 1009. "832(b) (5)" and inserting in lieu thereof "832(c) (5)". 26 USC 953. (3) Section 1249 (a) is amended by striking out "Except as pro- 76 Stat. 1045. vided in subsection (c) , gain" and inserting in lieu thereof "Gain". 26 USC 1249. (n) EFFECTIVE DATES.-The amendments made by this section (other than subsection (k)) shall apply with respect to taxable years beginning after December 31, 1966. The amendment made by sub- section (k) shall apply with respect to sales or exchanges occurring after December 31, 1966. SEC. 105. SPECIAL TAX PROVISIONS. (a) INCOME AFFECTED BY TFEATY.-Section 894 (relating to income 68A Stat. 284. exempt under treaties) is amended to read as follows: 26 USC 894. "SEC. 894. INCOME AFFECTED BY TREATY. "(a) INCOME ExEMI'r UNDER TREATY.-InCome of any kind, to the extent required by any treaty obligation of the United States, shall not be included in gross income and shall be exempt from taxa- tion under this subtitle. "(b) PERMANENT ESTABLISHMENT IN UNITED STATES.-For pur- poses of applying any exemption from, or reduction of, any tax pro- vided by any treaty to which the United States is a party with respect to income which is not effectively connected with the conduct of a trade or business within the United States, a nonresident alien indi- vidual or a foreign corporation sh~fl be deemed not to have a per- manent establishment in the United States at any time during the taxable year. This subsection shall not apply, in respect of the tax computed under section 877(b) ." . ~ p. 1551. (b) ADJUSTMENT OF TAX BECAUSE OF BURDENSOME OR DISCRIMINA- TORY FOREIGN TARES.-Subpart (3 of part II of subchapter N of chap- ter 1 (relating to miscellaneous provisions applicable to nonresident 26 USC 891-895. 27 PAGENO="0038" Pub. Law 89-809 - 26 - November 13, 1966 80 STAT. 1564 aliens and foreign corporations) is amended by adding at the end thereof the following new section: "SEC. 896. ADJUSTMENT OF TAX ON NATIONALS, RESIDENTS, AND CORPORATIONS OF CERTAIN FOREIGN COUNTRIES. "(a) IMPosmoN OF MORE BURDENSOME TAXES BY FOREIGN COUN- TRY.-Whenever the President finds that- "(1) under the laws of any foreign country, considering the tax system of such foreign country, citizens of the United States not residents of such foreign country or domestic corporations are being subjected to more burdensome taxes, on any item of income received by such citizens or corporations from sources within such foreign country, than taxes imposed by the provisions of this 68A Stat. 4. subtitle on similar income derived from sources within the United 26 USC 11563. States by residents or corporations of such foreign country, "(2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such taxes so that they are no more burdensome than taxes imposed by the provisions of this subtitle on similar income derived from sources within the United States by residents or corporations of such foreign coun- try, and "(3) it is in the public interest to apply pre-1967 tax provisions in accordance with the provisions of this subsection to residents or corporations of such foreign country, the President shall proclaim that the tax on such similar income derived from sources within the United States by residents or corpora- - tions of such foreign country shall, for taxable years beginning after * such proclamation, be determined under this subtitle without regard 26 USC 861-972- to amendments made to this subchapter and chapter 3 on or after the 1441.4465. date of enactment of this section. "(b) IMPOSITION OF DISCRIMINATORY TAXES BY FOREIGN COUNTRY.- \~Thenever the President finds that- "(1) under the laws of any foreign country, citizens of the United States or domestic corporations (or any class of such citizens or corporations) are, with respect to any item of income, being subjected to a higher effective rate of tax than are nationals, residents, or corj?orations of such foreign country (or a similar class of such nationals, residents, or corporations) under similar circumstances; "(2) such foreign country, when requested by the United States to do so, has not acted to eliminate such higher effective rate of tax; and "(3) it is in the public interest to adjust, in accordance with the provisions of this subsection, the effective rate of tax imposed by this subtitle on similar income of nationals, residents, or corpo- rations of such foreign country (or such similar class of such nationals, residents, or corporations), the President shall proclaim that the tax on similar income of nationals, residents, or corporations of such foreign country (or such similar class of such nationals, residents, or corporations) shall, for taxable years beginning after such proclamation, be adjusted so as to cause the effective rate of tax imposed by this subtitle on such similar income to be substantially equal to the effective rate of tax imposed by such foreign country on such item of income of citizens of the United States or domestic corporations (or such class of citizens or corporations). In implementing a proclamation made under this subsection, the effective* rate .of tax imposed by this subtitle on an item of income may be adjusted by the disallowance, in whole or in part, of any deduction, credit, or exemption which would otherwise 28 PAGENO="0039" November 13, 1966 - 27 Pub. Law 89-809 80 STAT. 1565 be allowed with respect to that item of income or by increasing the rate of tax otherwise applicable to that item of income. "(c) ALusvIATI0N OF MORE BURDENSOME OR DISCRIMINATORY TAxE5.-Whenever the President finds that- "(1) the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that citizens of the United States not residents of such foreign country or domestic corporations are no longer subject to more burdensome taxes on the item of income derived by such citizens or corporations from sources within such for- ei~n country, or `(2) the laws of any foreign country with respect to which the President has made a proclamation under subsection (b) have been modified so that citizens of the United States or domestic corporations (or any class of such citizens or corporations) are no longer subject to a higher effective rate of tax on the item of income, he shall proclaim that the tax imposed by this subtitle on the similar 68A Stat. 4. income of nationals, residents, or corporations of such foreign country 26 USC 1-1563. shall, for any taxable year beginning after such proclamation, be determined under this subtitle without regard to such subsection. "(d) NOTIFICATION OF CONGRESS REQUIRED.-NO proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclama- tion. "(e) IMPLEMENTATION BY REGtrI~ATIoNs.-The Secretary or his delegate shall prescribe such regulations as he deems necessary or appropriate to implement this section." (c) CLERICAL AMENDMENTS.-The table of sections for subpart C of part II of subchapter N of chapter 1 is amended- (1) by striking out the item relating to section 894 and insert- ing in lieu thereof "Sec. 894. Income affected by treaty."; (2) by adding at the end of such table the following: "Sec. 890. Adjustment of tax on nationals, residents, and corporations of certain foreign countries." (d) EFFECTIVE DATE.-The amendments made by this section (other than subsections (e) and (f)) shall apply with respect to tax- able years beginning after December 31, 1966. (e) ELECTIONS BY NONRESIDENT UNITED STATES CITIZENS WHO ARE SUBJECT TO FOREIGN COMMUNITY PROPERTY LAWS.- (1) Part III of subchapter N of chapter 1 (relating to income 68A Stat. 285; from sources without the United States) is amended by adding 76 Stat. 1006. at the end thereof the following new subpart: 26 USC 901.972. "Subpart H-Income of Certain Nonresident United States Citizens Subject to Foreign Community Property Laws "Sec. 981. Election as to treatment of Income subject to foreign community property laws. "SEC. 981. ELECTION AS TO TREATMENT OF INCOME SUBJECT TO FOREIGN COMMUNITY PROPERTY LAWS. "(a) GENERAL RULE.-In the case of any taxable year beginning after December 31, 1966, if- "(1) an individual is (A) a citizen of the United States, (B) a bona fide resident of a foreign country or countries during the entire taxable year, and (C) married at the close of the taxable 29 PAGENO="0040" Pub. Law 89-809 - 28 - November 13, 1966 80 STAT. 1566 year to a spouse who is a nonresident alien during the entire taxable year, and "(2) such individual and his spouse elect to have subsection (b) apply to their community income under foreign community property laws, then subsection (b) shall apply to such income of such individual and such spouse for the taxable year and for all subsequent taxable years for which the requirements of paragraph (1) are met, unless the Secretary or his delegate consents to a termination of the election. "(b) TREATMENT OF COMMUNITY INc0ME.-For any taxable year to which an election made under subsection (a) applies, the corn- munity income under foreign community property laws of the husband and wife making the election shall be treated as follows: "(1) Earned income (within the meaning of the first sentence 76 Stat. 1004. of section 911(b) ), other than trade or.business income and a part- 26 USC 911. ner's distributive share of partnership income, shall be treated as the income of the spouse who rendered the personal services. "(2) Trade or business income, and a partner's distributive share of nartnership income, shall be treated as provided in 68A Stat. 354; sectionl4O2(a)(5). 68 Stat. 1087. "(3) Community income not described in paragraph (1) or 26 USC 1402. (2) which is derived from the separate property (as determined under the applicable foreign community property law) Of one spouse shal be treated as the income of such spouse. "(4) All other such community income shall be treated as pro- vided in the applicable foreign community property law. "(c) ELECTION FOR PRE-1967 YEARS.- "(1) ELECTI0N.-If an individual meets the requirements of subsections (a) (1) (A) and (C) for any taxable year beginning before January 1, 1967, and if such individual and the spouse referred to in subsection (a) (1) (C) elect under this subsection, then paragraph (2) of this subsection shall apply to their com- munity income under foreign community property laws for all open taxable years beginning before January 1, 1967 (whether under this chapter, the corresponding provisions of the Internal 53 Stat. 1. Revenue Code of 1939, or the corresponding provisions of prior revenue laws). for which the requirements of subsection (a) (1) (A) and (C) are met. "(2) EFFECT OF ELECTI0N.-For any taxable year to which an election made under this subsection applies, the community income under foreign community property laws of the husband and wife making the election shall be treated as provided by subsection (b), except that the other community income described in paragraph (4) of subsection (b) shall be treated as the income of the spouse who, for such taxable year, had gross income under paragraphs (1), (2), and (3) of subsection (b), plus separate gross income, greater than that of the other spouse. "(d) Tnii FOR MAKING ELECTIONS; PERIOD OF LIMITATIONS; ETC.- "(1) TIME.-An election under subsection (a) or (c) for a taxable year may be made at any time while such year is still open, and shall be made in such manner as the Secretary or his delegate shall by regulations prescribe. "(2) EXTENSION OF PERIOD FOR ASSESSING DEFICIENCIES AND MAKING REFUNDs.-If any taxable year to which an election under subsection (a) or (c) applies is open at the time such election is made, the period for assessing a deficiency against, and the period for filing claim for credit or refund of any overpayment by, the husband and wife for such taxable year, to the extent such defi- 30 PAGENO="0041" * November 13, 1966 - 29 - Pub. Law 89- 809 - 80 STAT. 1567 ciency or overpayment is attributable to such an election, shall not expire before 1 year after the date of such election. "(3) ALIEN SPOUSE NEED NOT JOIN IN SUBSECTION (c) ELECTION IN CERTAIN CASES.-If the Secretary or his delegate determines- "(A) that an election under subsection (c) would not affect the liability for Federal income tax of the spouse referred to in subsection (a) (1) (C) for any taxable year, or "(B) that the effect on such liability for tax cannot be ascertained and that to deny the election to the citizen of the United States would be inequitable and cause undue hard- ship, such spouse shall not be required to join in such election, and paragraph (2) of this subsection shall not apply with respect to such spouse. "(4) INTEREST.-TO the extent that any overpayment or defi- ciency for a taxable year is attributable to an election made under this section, no interest shall be allowed or paid for any period before the day which is 1 year after the date of such election. "(e) DEFINITIONS AND SPECIAL RUuis.-For purposes of this section- "(1) DEDUCTI0NS.-J)e,ductions shall be treated in .a manner consistent with the manner provided by this section for the income to which they relate. "(2) OPEN YEARS.-A taxable year of a citizen of the United States and his spouse shall be treated as `open' if the period for assessing a deficiency against such citizen for such year has not expired before the date of the election under subsection (a) or (c), as the case may be. "(3) ELECTIONS IN CASE OF DECEDENTS.-Tf a husband or wife is deceased his election under this section may be made by his execu- tor, administrator, or other person charged with his property. "(4) DEATH OF SPOUSE DURING TAXABLE YEAR.-In applying sub- section (a) (1) (C), and in determining under subsection (c) (2) which spouse has the greater income for a taxable year, if a hus- band or wife dies the taxable year of the surviving spouse shall be treated as ending on the date of such death." (2) The table of subparts for such part III is amended by adding at the end thereof the following: "Subpart H. Income of certain nonresident United States citizens subject to foreign community property laws." (3) Section 911(d) (relating to earned income from sources 76 Stat. 1005. without the United States) is amended- 26 Usc 911. (A) by striking out "For administrative" and inserting in lieu thereof the following: "(1) For administrative"; and (B) by adding at the end thereof the following: "(2) For elections as to treatment of income subject to foreign community property laws, see section 981." (f) PRESUMPTIVE DATE OF PAYMENT FOR TAX WITHHELD U~nRE CHAPTER 3.- (1) Section 6513(b) (relating to time tax is considered paid in 68A Stat. 812. the case of prepaid income tax) is amended to read as follows: 26 USC 6513. "(b) PREPAID INcoME TAX.-FOr purposes of section 65,11 or 6512- 26 USC 6511, "(1) Any tax actually deducted and withheld at the source 6512. during any calendar year under chapter 24 shall, in respect of the 26 USC 3401.- recipient of the income, be deemed to have been paid by him on the 3404. 15th day of the fourth month following the close of his taxable year with respect to which such tax is.allowable as a credit under section 31. 26 USC 31. 31 PAGENO="0042" Pub. Law 89-. 809 - 30 -. November 13, 1966 80 STAT. 1568. 68A Stat. 732. 26 Usc 6012. 26 USC 1441.. 1465. 26 USC 6513. 26 USC 6501. 26 USC 901-905. 76 Stat. 999. ~ pp. 1550, 1555. "(2) Any amount paid as estimated income tax for any taxable year shall be deemed to have been paid on the last day prescribed for filing the return under section 6012 for such taxable year (determined without regard to any extension of time for filing such return). "(3) Any tax withheld at the source under chapter 3 shall, in respect of the recipient of the income, be deemed to have been paid by such recipient on the last day prescribed for filing the retw'n under section 6012 for the taxable year (determined without regard to any extension of time for filing) with respect to which such tax is allowable as a credit under section 1462. For this pur- pose, any exemption granted under section 6012 from the requirement of filing a return shall be disregarded." (2) Section 6513(c) (relating to return and payment of Social Security taxes and income tax withholding) is amended- (A) by striking out "chapter 21 or 24" and inserting in lieu thereof "chapter 3, 21, or 24"; and (B) by striking out "remuneration" in paragraph (2) and inserting in lieu thereof "remuneration or other amount". (3) Section 6501(b) (relating to time returns deemed filed) is amended- (A) by striking out "chapter 21 or 24" in paragraphs (1) and (2) and inserting in lieu thereof "chapter 3, 21, or 24"; and (B) by inserting after "taxes" in the heading of para- graph (2) "and tax imposed by chapter 3". (4) The amendments made by this subsection shall take effect on the date of the enactment of this Act. SEC. 106. FOREIGN TAX CREDIT. (a) ALLOWANCE OF CREDIT TO CERTAIN NONRESIDENT ALIENS AND FOREIGN CORPORATIONS.- (1) Subpart A of part III of subchapter N of chapter 1 (relat- ing to foreign tax credit) is amended by adding at the end thereof the following new section: "SEC. 906. NONRESIDENT ALIEN INDIVIDLTALS AND FOREIGN COR. PORATIONS. "(a) ALLOWANCE OF CREDIT.-A nonresident alien individual or a foreign corporation engaged in trade or business within the United States during the taxable year shall be allowed a credit under sec- tion 901 for the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year (or deemed, under sec- tion 902, paid or accrued during the taxable year) to any foreign coun- try or possession of the United States with respect to income effec- tive~y connected with the conduct of a trade or business within the United States. "(b) -SPECL~L R.un~s.- "(1) For purposes of subsection (a) and for purposes of deter- mining the deductions allowable under sections 873 (a) and 882(c), in determining the amount of any tax paid or accrued to any foreign country or possession there shall not be taken into account any amount of tax to the extent the tax so paid or accrued is imposed with respect to income from sources within the United States which would not be taxed by such foreign country or possession but for the fact that- "(A) in the case of a nonresident alien individual, such individual is a citizen or resident of such foreign country or possession, or 32 PAGENO="0043" November 13, 1966 31 Pub. Law 89-809 8O~T. 15~ "(B) in the case of a foreign corporation, such corporation was created or organized under the law of such foreign coun- try or possession or is domiciled for tax purposes in such country or possession. "(2) For purposes of subsection (a), in applying section 904 68A Stat. 287. the taxpayer's taxable income shall be treated as consisting only of 26 USC 904. the taxable income effectively connected with the taxpayer's con- duct of a trade or business within the United States. "(3) The credit allowed pursuant to subsection (a) shall not be allowed against any tax imposed by section 871(a) (relating to ~ p. 1547. income of nonresident alien individual not connected with United States business) or 881 (relating to income of foreign corporations ~ p. 1555. not connected with United States business). "(4) For purposes of sections 902 (a) and 78, a foreign corpora- 76 Stat, 999, tion choosing the benefits of this subpart which receives dividends 1001. shall, with respect to such dividends, be treated as a domestic 26 USC 78, 902, corporation." (2) The table of sections for such subpart A is amended by adding at the end thereof the following: "Sec. 906. Nonresident alien individuals and foreign corporations." (3) Section 874(c) is amended by striking out 68A Stat. 281. "(c) FOREIGN TAx CREDIT NOT ALLOWED.-A. nonresident" and 26 USC 874. insertinor in lieu thereof the following: "(c) ~`OREIGN TAX CRimrr._~LExcept as provided in section 906, a ~, p. 1568. nonresident". (4) Subsection (b) of section 901 (relating to amount allowed) 26 USC 901. is amended by redesignating paragraph (4) as paragraph (5), and by inserting after paragraph (3) the following new paragraph: "(4) NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN CORPORA- TIoNs.-In the case of any nonresident alien individual not described in section 876 and in the case of any foreign corporation, 26 USC 876. the amount determined pursuant to section 906; and". (5) Paragraph (5) (as redesignated) of section 901(b) is amended by striking out "Or (3)," and inserting in lieu thereof "(3), or (4),". (6) The amendments made by this subsection shall apply with respect to taxable years beginning after December 31, 1966. In applying section 904 of the Internal Revenue Code of 1954 with respect to section 906 of such Code, no amount may be carried from or to any taxable year beginning before January 1, 1967, and no such year shall be taken into account. (b) ALIEN RESIDENTS OF THE UNITED STATES OR PUERTO Rico.- (1) Paragraph (3) of section 901(b) (relating to amount of foreign tax credit ñilowed in case of alien resident of the United States or Puerto Rico) is amended by striking out ", if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country". (2) Section 901 is amended by redesignating subsections (c) and (d) as subsections (d) and (e), and by inserting after sub- section (b) the following new subsection: "(c) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN RESIDENTS.- Whenever the President finds that- "(1) a foreign country, in imposing income, war profits, and excess profits taxes, does not allow to citizens of the United States residing in such foreign country a credit for any such taxes paid 33 PAGENO="0044" Pub. Law 89-809 - 32 November 13, 1966 80 STAT. 1570 68A Stat. 378. 26 USC 2014. 76 Stat. 1002. 26 USC 904. 68A Stat. 369. 26 Usc 1504. or accrued to the United States or any foreign country, as the case may be, similar to the credit allowed under subsection (b) (3), "(2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit to citizens of the United States residing in such foreign country, and "(3) it is in the public interest to allow the credit under sub- section (b) (3) to citizens or subjects of such foreign country only if it allows such a similar credit to citizens of the United States residing in such foreign country, the President shall proclaim that, for taxable years beginning while the proclamation remains in effect, the credit under subsection (b) (3) shall be allowed to citizens or subjects of such foreign country only if such foreign country, in imposing income, war profits, and excess profits taxes, allows to citizens of the United States residing in such foreign country such a similar credit." (3) Section 2014 (relating to credit for foreign death taxes) is amended by striking out the second sentence of subsection (a), and by adding at the end of such section the following new subsection: "(h) SmnI~R Cm~rnT REQUIRED FOR CERTAIN ALIEN RESIDENTS.- Whenever the President finds that- "(1) a foreign country, in imposing estate, inheritance, legacy, Or succession taxes, does not allow to citizens of the United States resident in such foreign country at the time of death a credit similar to the credit allowed under subsection (a), "(2) such foreign country, when requested by the United States to do so has not acted to provide such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, and "(3) it is in the public interest to allow the credit under sub- section (a) in the case of citizens or subjects of such foreign country only if it allows such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, the President shall proclaim that, in the case of citizens or subjects of such foreign country dying while the proclamation remains in effect, the credit under subsection (a) shall be allowed only if such foreign country allows such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death." (4) The amendments made by this subsection (other than para- graph (3)) shall apply with respect to taxable years beginning after December 31, 1966. The amendment made by paragraph (3) shall apply with respect to estates of decedents dying after the date of the enactment of this Act. (c) FOREIGN TAX CREDF2 IN RESPECT OF INTEREST RECEIVED FROM FOREIGN SUBsIDIARIEs.- (1) Section 904(f) (2) (relating to application of limitations on foreign tax credit in case of certain interest income) is amended- (A) by striking out subparagraph (C) and inserting in lieu thereof the following: "(C) received from a corporation in which the taxpayer (or one or more includible corporations in an affiliated group, as defined in section 1504, of which the taxpayer is a member) owns, directly or indirectly, at least 10 percent of the voting stock,". 34 PAGENO="0045" November 13, 1966 33 - Pub. Law 89-809 80 S~~,~571 (B) by adding at the end thereof the following new sen- tence: "For purposes of subparagraph (0), stock owned, directly or indirectly, by or for a foreign corporation shall be considered as being proportionately owned by its shareholders." (2) The amendments made by paragraph (1) shall apply to interest received after December 31, 1965, in taxable years ending after such date. SEC. 107. AMENDMENT TO PRESERVE EXISTING LAW ON DEDUCTIONS UNDER SECTION 93L (a) DED1JCFI0Ns.-Subsection (d) of section 931 (relating to deduc- 68A Stab. 291. tions) is amended to read as follows: 26 Usc 931. "(d) DEnUCTI0Ns.- "(1) GENERAL RtTLE.-Except as otherwise provided in this sub- section and subsection (e), in the case of persons entitled to the benefits of this section the deductions shall be allowed only if and to the extent that they are connected with income from sources within the United States; and the proper apportionment and al- location of the deductions with respect to sources of incOme within and without the United States shall be determined as provided in part I, under regulations prescribed by the Secretary or his 26 USC 861-864. delegate. "(2) ExcEPTIoNs.-The following deductions shall be allowed whether or not they are connected with income from sources with- in the United States: "(A) The deduction, for losses not connected with the trade or business if incurred in transactions entered into for profit, allowed by section 165(c) (2), but only if the profit, if sucl~i 26 USC 165. transaction had resulted in a profit, would be taxable under this subtitie. "(B) The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c) (3), but only if the lOss is 78 Stab. 43. of property within the United States. "(C) The deduction for charitable contributions and gifts allowed by section 170. 26 USC 170. "(3) DEDUCTION DISALLOWED.- "For disallowance of standard deduction, see section 142(b)(2)." (b) EFFECTIVE DATE.-The amendment made by this section shall apply with respect to taxable years beginning after December 31, 1966. SEC. 10& ESTATES OF NONRESIDENTS NOT CITIZENS. (a) RATE OF TAx.-Subsection (a) of section 2101 (relating to tax 26 USC 2101. imposed in case of estates of nonresidents not citizens) is amended to read as follows: "(a) RATE OF TAx.-Except as provided in section 2107, a tax ~ P.'573* computed in accordance with the following table is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States: 26 USC 2106. "If the taxable estate is: The tax shall be: Not over $100,000 5% of the taxable estate. Over $100,000 but not over $500,000 $5,000, plus 10% of excess over $100,000. Over $500,000 but not over $i,000,000 $45,000, plus 15% of excess over $500,000. Over $1,000,000 but not over $2,000,000 $120,000, plus 20% of excess over $1,000,000. Over $2,000,000 $320,000, plus 25% of excess over $2,000,000." 35 PAGENO="0046" Pub. Law 89-809 - 34 - November 13, 1966 80 STAT. 1572 68A Stat. 397. (b) CIuDITS AGAINST TAx.-Section 2102 (relating to credits 26 Usc 2102. allowed against estate tax) is amended to read as follows: "SEC. 2102. CREDITS AGAINST TAX. ~ p. 1571. "(a) IN GENERAL.-The tax imposed by section 2101 shall be credited with the amounts determined in accordance with sections 26 usc 2011- 2011 to 2013, inclusive (relating to State death taxes, gift tax, and 2013, tax on prior transfers), subject to the special limitation provided in subsection (b). "(b) SPECIAL LIMITATI0N.-The maximum credit allowed under section 2011 against the tax imposed by section 2101 for State death taxes paid shall be an amount which bears the same ratio to the cretht computed as provided in section 2011(b) as the value of the property, as determined for purposes of this chapter, upon which State death taxes were paid and which is included in the gross estate under section 26 usc 2103, 2103 bears to the value of the total gross estate under section 2103. For purposes of this subsection, the term `State death taxes' means the taxes described in section 2011(a)." 26 usc 2104. (c) PROPERTY WITHIN THE UNITED STATES.-Section 2104 (relat- ing to property within the United States) is amended by adding at the end thereof the following new subsection: 26 usc 2101~ "(c) DEBT OBLIGATI0NS.-For purposes of this subchapter, debt 2106. obligations of- ~ p. 1573. "(1) a United States person, or "(2) the United States, a State or any political subdivision thereof, or the District of Columbia, owned and held by a nonresident not a citizen of the United States shall be deemed property within the United States. With respect to estates of decedents dying after December 31, 1972, del?osits with a domestic branch of a foreign corporation, if such branch is engaged in the commercial banking business, shall, for purposes of this subchapter, be deemed property within the United States. This subsection shall not apply to a debt obligation to which section 2105(b) applies or to a debt obligation of a domestic corporation if any interest on such obligation, were such interest received by the decedent at the time of ~ i. 1542 his death, would be treated by reason of section 861 (a) (1) (B) as income from sources without the United States." (d) PROPERTY WITHOUT THE UNPFED STATE8.-Subsection (b) of 26 usc 2105. section 2105 (relating to bank deposits) is amended to read as follows: "(b) CERTAIN BANK DEPOSITS, ETÔ.-For purposes of this sub- chapter- ~ p. 1541. "(1) amounts described in section 861(c) if any interest thereon, were such interest received by the decedent at the time of his death, would be treated by reason of section 861 (a) (1) (A) as income from sources without the United States, and "(2) deposits with a foreign branch of a domestic corporation or domestic partnership, if such branch is engaged in the commer- cial banking business, shall not be deemedproperty within the United States." (e) DEFINITION OF TAXABLE E5TATE.-Paragraph (3) of section 74 Stat. 1000. 2106(a) (relating to deduction of exemption from gross estate) is 26 usc 2106. amended to read as follows: "(3) ExEMp'rIoN.- "(A) GENERAL RULE.-An exemption of $30,000. "(B) RESIDENTS OF POSSESSIONS OF THE UNITED STATES.- In the case of a decedent who is considered to be a `non- resident not a citizen of the United States' under the pro- 74 Stat. 999. visions of section 2209, the exemption shall be the greater of 26 usc 2209. (i) $30,000, or (ii) that proportion of the exemption 68A Stat. 389. authorized by section 2052 which the value of that part of 26 usc 2052. 36 PAGENO="0047" November 13, 19.66 35 Pub. Law 89-809 80 STAT. 1573 the decedent's gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated." (f) SPECIAL METHODS OF COMPUTING TAx.-Subchapter B of chap- ter 11 (relating to estates of nónresidents not citizens) is amended by 68A Stat. 397. adding at the end thereof the following new sections: 26 USC 2101 "SEC. 2107. EXPATRIATION TO AVOID TAX. "(a) RATE OF TAX.-A tax computed in accordance with the table contained in section 2001 is hereby imposed on the transfer of the tax- 26 USC 2001. able estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States dying after the date of enactment of this section, if after March 8, 1965, and within the 10-year period ending with the date of death such decedent lost United. States citizenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. "(b) GRoss ESTATE.-FOr purposes of the tax imposed by subsection (a), the value of the gross estate of every decedent to whom subsec- tion (a) applies shall be determined as provided in section 2103, except that- "(1) if such decedent owned (within the meaning of section 958(a)) at the time of his death 10 percent or more of the total 76 Stat. 1018. combined voting power of all classes of stock entitled to vote of a 26 USC 958. foreign corporation, and "(2) if such decedent owned (within the meaning of section 958(a)), or is considered to have owned (by applying the owner- ship rules of section 958(b)), at the time of his death, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of such foreign corporation, then that proportion of the fair market value of the stock of such foreign corporation owned (within the meaning of section 958(a)) by such decedent at the time of his death, which the fair market value of any assets owned by such foreign corporation and situated in the United States, at the time of his death, bears to the total fair market value of all assets owned by such foreign corporation at the time of his death, shall be included in the gross estate of such decedent. For pur- poses of the preceding sentence, a decedent shall be treated as owning stock of a foreign corporation at the time of his death if, at the time of a transfer, by trust or otherwise, within the meaning of sections 2035 to 2038, inclusive, he owned such stock. . 26 USC 2035-. "(c) CREDITS.-The tax imposed by subsection (a) shall be credited 2038. with the amounts determined in accordance with section 2102. ~ p* 1572. "(d) EXCEPTION FOR Loss OF CITIZENSHIP FOR CERTAIN CAUSES.- Subsection (a) shall not apply to the tran8fer of the estate of a dece- dent whose loss of United States citizenship resulted from the appli- cation of section 301(b), 350, or 355 of the Immigration and Nation- ality Act, as amended (8 U.S.C. 1401 (b), 1482, or 1487). 66 Stat. 236. "(e) BURDEN OF PR00F.-If the Secretary or his delegate estab- lishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction in the estate, inheritance, legacy, and succession taxes in respect of the transfer of his estate, the burden of proving that such loss of citizenship did not have for one of its principal purposes the avOidance of taxes under this subtitle or subtitle A shall be on the executor of such individual's estate. "SEC. 2108. APPLICATION OF PRE-1967 ESTATE TAX PROVISIONS. "(a) IMPOSITION OF Moiiz BURDENSOME TAX BY FOREIGN CouN- mr.-Whenever the President finds that- "(1) under the laws of any foreign country, considering the tax system of such foreign country, a more burdensome tax is 37 PAGENO="0048" Pub. Law 89-809 - 36 - November 13, 1966 80 STAT. 1574 - - imposed by such foreign country on the transfer of estates of decedents who were citizens of the United States and not resi- dents of such foreign country than the tax imposed by this sub- chapter on the transfer of estates of decedents who were residents * of such foreign country, "(2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such tax so that it is no more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign * country, and "(3) it is in the public interest to apply pre-1967 tax provisions in accordance with this section to the transfer of estates of decedents who were residents of such foreign country, the President shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to amendments made to sections 2101 (relating to tax imposed), ~ pp. 1571, 2102 (relating to credits against tax), 2106 (relating to taxable estate), 1572. and 6018 (relating to estate tax returns) on or after the date of enactment of this section. "(b) ALLEVIATION OF MORE BURDENSOME TAx.-Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that the tax on the transfer of estates of dece- dents who were citizens of the United States and not residents of such foreign country is no longer more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were resi- dents of such foreign country, he shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to subsection (a). "(c) NoTIFiCATIoN OF CONGRESS REQUIRED.-TNO proclamation shall he issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the house of Representatives of his intention to issue such proclamation. "(d) IMPLEMENTATION BY REGULATI0NS.-The Secretary or his dele- gate shall prescribe such regulations as may be necessary or appro- 1)riate to implement this section." 68A Stat. 739. (g) ESTATE TAX RETTENs.-Paragraph (2) of section 6018 (a) 26 USC 6018. (relating to estates of nonresidents not citizens) is amended by strik- ing out "$2,000" and inserting in lieu thereof "$30,000". (h) CLERICAL AMENDMENT.-The table of sections for subchapter B of chapter ii (relating to estates of nonresidents not citizens) is amended by adding at the end thereof the following: "Sec. 2107. Expatriation to avoid tax. "Sec. 2108. Application of pre-1967 estate tax provisions." (i) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to estates of decedents dying after the date of the enactment of this Act. SEC. 109. TAX ON GIFTS OF NONRESIDENTS NOT CITIZENS. 26 USC 2501, (a) hrPosITIoN OF TAx.-Subsection (a) of section 2501 (relating to general rule for imposition of tax) is amended to read as follows: "(a) TAXABLE TRANSFERS.- "(1) GENERAL RtTLE.-For the calendar year 1955 and each calendar year thereafter a tax, computed as provided in section 26 USC 2502. 2502, is hereby imposed on the transfer of property by gift during such calendar year by any individual, resident or nonresident. 38 PAGENO="0049" November 13, 1966 - 37 - Pub. Law 89-809 80 STAT. 1575 "(2) TRANSFERS OF INTANGIBLE PR0PERTY.-Except as provided in paragraph (3), paragraph (1) shall not apply to the transfer of intangible property by a nonresident not a citizen of the United States. "(3) ExcEPTIoNs.-Paragraph (2) shall not apply in the case of a donor who at any time after March 8, 1965, and within the 10-year period ending with the date of transfer lost United States citizenship unless- "(A) such donor's loss of United States citizenship resulted from the application of section 301(b), 350, or 355 of the Im~ migration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487), or 66 Stat. 236. "(B) such loss did not have for one of its principal pur- poses the avoidance of taxes under this subtitle or subtitle A. 68A Stat. 4. "(4) BURDEN OF PROOF.-If the Secretary or his delegate estab- 26 Usc 1-2524. lishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for paragraph (3), result in a substantial reduction for the calendar year in the taxes on the transfer of property by gift, the burden of proving that such loss of citizenship did npt have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A shall be on such individual." (b) TRANSFERS IN.GENERAL.-Subsection (b) of section 2511 (relat- 26 USC 2511. ing to situs rule for stock in a corporation) is amended to read as follows: "(b) INTANGIBLE PROPERTY.-FOr purposes of this chapter, in the case of a nonresident not a citizen of the United States who is excepted from the application of section 2501 (a) (2)- ~ p. 1574. "(1) shares of stock issued by a domestic corporation, and "(2) debt obligations of- "(A) a United States person, or "(B) the United States, a State or any political subdivision thereof, or the District of Columbia, which are owned and held by such nonresident shall be deemed to be property situated within the United States." (c) EFFECTIVE DATE.-The amendments made by this section shall apply with. respect to the calender year 1967 and all calendar years thereafter. SEC. 110. TREATY OBLIGATIONS. No amendment made by this title shall apply in any case where its application would be contrary to any treaty obligation of the United States. For purposes of the preceding sentence, the extension of a benefit provided by any amendment made by this title shall not be deemed to be contrary to a treaty obligation of the United States. TITLE 11-OTHER AMENDMENTS TO INTERNAL REVENUE CODE SEC. 201. APPLICATION OF INVESTMENT CREDIT TO PROPERTY USED IN POSSESSIONS OF THE UNITED STATES. (a) PROPERTY ~JSED BY DOMESTIC CORPORATIONS, ETc.-Section 48(a) (2) (B) (relating to property used outside the United States) 76 Stat. 967. is amended- 26 USC 48. (1) by striking out "and" at the end of clause (v); (2) by striking out. the period at the end of clause (vi) and inserting in lieu thereof "; and"; and (3) by adding at the end thereof the following new clause: "(vii) any property which is owned by a domestic .. corporation (other than a corporation entitled to the 71-297 O-67-pt. 1-4 39 PAGENO="0050" Pub. Law 89-809 - 38 - November 13, 1966 80 STAT. 1576 benefits of section 931 or 934(b)) or by a United States citizen (other than a citizen entitled to the benefits of 68A Stat, 291; section 931, 932, 933, or 934(c)) and which is used pre- 74 Stat, 998. dominantly in a possession of the United States by such 26 USC 931934. a corporation or such a citizen, or by a corporation created or organized in, or under the law of, a possession of the United States." (b) ErrncTIvE DATE.-The amendments made by subsection (a) shall apply to taxable years ending after December 31, 1965, but only with respect to property placed in service after such date. In apply- 76 Stat. 963. ing section 46(b) of the Internal Revenue Code of 1954 (relating to 26 USC 46. carryback and carryover of unused credits), the amount of any invest- ment credit carryback to any taxable year ending on or before Decem- ber 31, 1965, shall be determined without regard to the amendments made by this section. SEC. 202. BASIS OF PROPERTY RECEIVED ON LIQUIDATION OF SUB- SIDIARY. 26 USC 334. (a) DzrINITI0N OP PtTRCHASE.-Section 334(b) (3) (relating to definition of purchase) is amended by adding at the end thereof the following new sentence: "Notwithstanding subparagraph (C) of this paragraph, for pur- poses of paragraph (2) (B), the term `purchase' also means an acquisition of stock from a corporation when ownership of such 26 USC 318. stock would be attributed under section 318 (a) to the person acquiring such stock, if the stock of such corporation by reason of which such ownership would be attributed was acquired by purchase (within the meaning of the preceding sentence) ." (b) PERIOD OF Acx~msmoN.-Section 334(b) (2) (B) (relating to exception) is amended by striking out "during a period of not more than 12 months," and inserting in lieu thereof "during a 12-month period beginning with the earlier of- "(i) the date of the first acquisition by purchase of such stock, or "(ii) if any of such stock was acquired in an acquisi- tion which is a purchase within the meaning of the sec- ond sentence of paragraph (3), the date on which the distributee is first considered under section 318(a) as owning stock owned by the corporation from which such acquisition was made,". (c) DISTRIBUTION OF INSTALLMENT OBLIoA~noNs.-Section 453(d) 26 USC 453. (4) (A) ~relating to distribution of installment obligations in certain liquidations) is amended to read as follows: "(A) LIQUIDATIONS TO WHICH SECTION 332 APPLIES.-If- an installment obligation is distributed in a liqui- 26 USC 332. dation to which section 332 (relating to complete liquida- tions of subsidiaries) applies, and "(ii) the basis of such obligation in the hands of the distributee is determined under section 334(b) (1), then no gain or loss with respect to the distribution of such obligation shall be recognized by the distributing corpora- tion." (d) EFFEcTIVE DATES.-The amendment made by subsection (a) shall apply only with respect to acquisitions of stock after December 31, 1965. The amendments made by subsections (b) and (c) shall apply only with respect to distributions made after the date of the enactment of this Act. 40 PAGENO="0051" November 13, 1966 - 39 - Pub. Law 89-809 80 STAT. 1577 SEC. 203. TRANSFERS OF PROPERTY TO INVESTMENT COMPANIES CONTROLLED BY TRANSFERORS. (a) TRANSFERS TO INVESTMENT COMPANIE5.-The first sentence of section 351 (a) (relating to transfer to corporation controlled by the 68A Stat. 111. transferor) is amended by striking out "to a corporation" and insert- 26 USC 351. ing in lieu thereof "to a corporation (including, in the case of trans- fers made on or before June 30, 1961', an investment company) ". (b) INVESTMENT COMPANIES REQUIRED TO Fir~s REGIsm~rIoN STATEMENT WITH THE S.E.C.-Section 351 is amended by redesi - nating subsection (d) as subsection (e) and by inserting after su - section (c) the following new subsection: "(d) APPLICATION OF JUNE 30, 1967, DA~rn.-For purposes of this section, if, in connection with the transaction, a registration state- ment is required to be filed with the Securities and Exchange Com- mission, a transfer of property to an investment company shall be treated as made on or before June 30, 1967, only if- "(1) such transfer is made on or before such date, "(2) the registration statement was filed with the Securities and Exchange Commission before January 1, 1967, and the aggre- gate issue price of the stock and securities of the investment com- pany which are issued in the transaction does not exceed the aggregate amount therefor specified in the registration statement as of the close of December 31, 1966, and "(3) the transfer of property to the investment company in the transaction includes only property deposited before May 1, 1967." (c) EFFECTIVE DAI~.-The amendments made by subsections (a) and (b) shall apply with respect to transfers of property to invest- ment companies whether made before, on, or after the date of the en- actment of this Act. SEC. 204. REMOVAL OF SPECIAL LIMITATIONS WITH RESPECT TO DE- DUCTIBILITY OF CONTRIBUTIONS TO PENSION PLANS BY SELF-EMPLOYED INDIVIDUALS. (a) REMOVAL OF SPECIAL LIMITA1'~ioNs.-Paragraph (10) of section Repeal. 404(a) (relating to special limitation on amount allowed as deduction 76 Stat. 820. for self-employed individuals for contributions to certain pension, 26 USC 404. etc., plans) is repealed. (b) CONFORMING AMENDMENTs.- (1) Each of the following provisions of section 401 is amended by 26 USC 401. striking out "(determined without regard to section 404(a) (10))" each place it appears: (A) Subsection (a) (10) (A) (ii). (B) Subparagraphs (A) and (B) of subsection (d) (5). (C) Subparagraph (A) of subsection (d) (6). (D) Subparagraphs (A) and (B) (i) of subsection (e) (1). (E) Subparagraphs (B) and (C) and the last sentence of sub- section (e) (3). (2) Subparagraph (A) of section 404(e) (2) is amended by striking out "(determined without regard to subsection (a) (10) ) ". (3) Paragraph (1) and subparagraph (B) of paragraph (2) of section 404(e) are each amended by striking out "(determined without regard to paragraph (10) thereof) ". (c) DEFINITION OF EARNED INCOME.-Section 401 (c) (2) (relating 76 Stat. 811. to definition of earned income for certain pension and profit-sharin plans) is amended by striking out subparagraphs (A) and (B) an inserting in lieu thereof the following: 41 PAGENO="0052" Pub. Law 89-809 - 40 - NovemLer 13, 1966 "(A) IN GENERAL.-The term `earned income' means the net earnings from self-employment (as defined in section 1402(a)), but such net earnings ~hall be determined- "(i) only with respect to a trade or business in which personal services of the taxpayer are a material income- producing factor, "(ii) without regard to paragraphs (4) and (5) of section 1402(c), "(iii) in the case of any individual who is treated as an employee under sections 3121(d) (3) (A), (C), or (D) ,without regard to paragraph (2) of section 1402(c), and "(iv) without regard to items which are not. included in gross income for purposes of this chapter, and the deductions properly allocable to or chargeable against such items. For purposes of this subparagraph, section 1402, as in effect for a taxable year ending on December 31, 1962, shall be treated as having been in effect for all taxable years ending before such date." (d) EFFECTIVE DAI~.-The amendments made by subsections (a) and (b) ~shall apply with respect to taxable years beginning after December 31, 1967. SEC. 205. TREATMENT OF CERTAIN INCOME OF AUTHORS, INVENTORS, ETC., AS EARNED INCOME FOR RETIREMENT PLAN PURPOSES. (a) INco~rE FROM DISPOSITION OF PROPERTY CREATED BY TAX- PAYER.-Section 401(c) (2) (relating to definition of earned income) is amended by adding at the end thereof the following new subpara- graph: "(C) INCOME FROM DISPOSITION OF CERTAIN PROPERTY.-FOr purposes of this section, the term `earned income' includes gains (other than any gai.n which is treated under any provi- sion of this chapter as gain from the sale or exchange of a capital asset) and net earnings derived from the sale or other disposition of, the transfer of any interest in, or the licensing of the use of property (other than good will.) by an individual whose personal efforts created such property." (b) EFFECTIVE DA~n~.-The amendment made by subsection (a) shall apply to taxable years ending after the date of the enactment of this Act. SEC. 206. EXCLUSION OF CERTAIN RENTS FROM PERSONAL HOLDING COMPANY INCOME. (a) RENTS FROM LEASES OF CERTAIN TANGIBLE PERSONAL PROP- 78 Stat. 84, ERTY.-Section 543(b) (3) (relating to adjusted income from rents) 26 USC 543. is amended by striking out "but does not include amounts constituting personal holding company income under subsection (a) (6), nor copy- right royalties (as defined in subsection ~a) (4) nor produced film rents (as defined in subsection (a) (5) (B))." and inserting in lieu thereof the following: "but such term does not include- "(A) amounts constituting personal holding company income under subsection (a) (6), "(B) copyright royalties (as defined in subsection (a)(4)), "(C) produced film rents (as defined in subsection (a) or `(D) compensation, however designated, for the use of, or the right to use, any tangible personal property manu- 80 STAT. 1578 68A Stat. 353. 26 USC 1402. 79 Stat. 381. 26 USC 3121. 74 Stat. 945. ~ p. 1577. 42 PAGENO="0053" November 13, 1966 41 Pub. Law 89-.809 - 80 STAT. 1579 factured or produced by the taxpayer, if during the taxable year the taxpayer is engaged in substantial manufacturing or production of tangible personal property of the same type." (b) TECHNICAL AMENDMENTS.- (1) Section 543(a) (2) (relating to adjusted income from rents 78 Stat. 81. included in personal holding company income) is amended by 26 USC 543. striking out the last sentence thereof. (2) Section 543(b) (2) (relating to definition of adjusted ordi- nary gross income) is amended by adding at the end thereof the following new subparagraph: "(D) CERTAIN EXCLUDED RENTS.-FrOnl the gross income consisting of compensation described in subparagraph (D) of paragraph (3) subtract the amount allowable as deductions for the items described in clauses (i), (ii), (iii), and (iv) of subparagraph (A) to the extent allocable, under regulations prescribed by the Secretary or his delegate, to such gross income. The amount subtracted under this subparagraph shall not exceed such gross income." (c) EFFEcTIVE DATE.-The amendments made by subsections (a) and (b) shall apply to taxable years beginning after the date of the enact- ment of this Act. Such amendments shall also apply, at the election of the taxpayer (made at such time and in such manner as the Secre- tary or his delegate may prescribe), to taxable years beginning on or before such date and ending after December 31, 1965. SEC. 207. PERCENTAGE DEPLETION RATE FOR CERTAIN CLAY BEAR- ING ALUMINA. (a) 23 PERCENT RAVE.-Section 613(b) (relating to percentage 68A Stat. 208; depletion rates) is amended- 74 Stat. 291. (1) by inserting "clay, laterite, and nephelite syenite" after 26 USC 613. "anorthosite" in paragraph (2) (B) ; and (2) by striking out "if paragraph (5) (B) does not apply" in paragraph (3) (B) and inserting in lieu thereof "if neither para- graph (2) (B) nor (5) (B) applies". (b) EFFECTIVE DATE.-The amendments made by subsection (a) shall apply to taxable years beginning after the date of the enactment of this Act. SEC. 208. PERCENTAGE DEPLETION RATE FOR CLAM AND OYSTER SHELLS. (a) 15 PERCENT RATE.-SeCtiOfl 613(b) (relating to percentage depletion rates) is amended- (1) by striking out "mollusk shells (including clam shells and oyster shells) ," in paragraph (5) (A), and (2) by inserting "mollusk shells (including clam shells and oyster shells) ," after "marble," in paragraph (6). (b) EFFECTIVE DATE.-The amendments made by subsection (a) shall apply to taxable years beginning after the date of the enactment of this Act. SEC. 209. PERCENTAGE DEPLETION RATE FOR CERTAIN CLAY, SHALE, AND SLATE. (a) ~½ PERCENT RATE-Section 613(b) (relating to percentage tiepletion rates) is amended- (1) by renumbering paragraphs (5) and (6) as (6) and (7), respectively, and by inserting after paragraph (4) the following new paragraph: "(5) 71/2 percent-clay and shale used or sold for i,mse in the manufacture of sewer pipe or brick, and clay, shale, and slate used or sold for use as sintered or burned lightweight aggregates. 43 PAGENO="0054" Pub. Law 89-809 - 42 - November 13, 1966 80 STAT. 1580 (2) by striking out in paragraph (3) (B) (as amended by sec- tion 207(a) (2)) "if neither paragraph (2) (B) nor (5) (B) applies" and inserting in lieu thereof "if neither paragraph (2) (B), (5),or (6)(B) applies"; (3) by striking out m paragraph (6) (as renumbered by para- graph (1)) "shale, and stone, except stone described in para- graph (s)" and inserting in lieu thereof "shale (except shale de- scribed in paragraph (5)), and stone (except stone described rn paragraph (7))"; (4) by striking out, in subparagraph (B) of paragraph (6) (as so renumbered), "building or paving brick," and by striking out "sewer pipe,"; and (5) by inserting after "any such other mineral" in paragraph (7) (as so renumbered) "(other than slate to which paragraph (5) applies)". 74 Stat. 293. (b) CONFORMING AMENDMENT.-SeCtiOn 613(c) (4) (G) (relating 26 USC 613. to treatment processes) is amended by striking out "paragraph (5) (B)" and inserting in lieu thereof "paragraph (5) or (6) (B)". (c) EFFECTIVE DAFE.-The amendments made by subsections (a) and (b) shall apply to taxable years beginning after the date of the enactment of this Act. SEC. 210. STRADDLES. 72 Stat. 1644. (a) TREATMENT AS SHORT-TERM CAPITAL GAIN.-Section 1234 26 USC 1234. (relating to options) is amended by redesignating subsection (c) as subsection (d) and by inserting after subsection (b) the following new subsection: "(c) SPECIAL RULE FOR GRANTORS OF STRADDLES.- "(1) GAIN ON LAP5E.-In the case of gain on lapse of an option granted by the taxpayer as part of a straddle, the gain shall be deemed to be gain from the sale or exchange of a capital asset held for not more than 6 months on the day that the option expired. "(2) ExcEP'rIoN.-This subsection shall not apply to any per- son who holds securities for sale to customers in the ordinary course of his trade or business. "(3) DEFINITIONS.-FOr purposes of this subsection- "(A) The term `straddle' means a simultaneously granted combination of an option to buy, and an option to sell, the same quantity of a security at the same price during the same period of time. "(B) The term `security' has the meaning assigned to 68A Stat, 330. such term by section 1236 (c) ." 26 USC 1236. (b) EFFECTIVE DAFE.-The amendments made by subsection (a) shall apply to straddle transactions entered into after January 25, 1965, in taxable years ending after such date. SEC. 211. TAX TREATMENT OF PER-UNIT RETAIN ALLOCATIONS. (a) TAX TREATMENT OF COOPERATIVES.- 76 Stat. 1046. (1) Section 1382(a) (relating to gross income of cooperatives) 26 USC 1382. is amended by striking out the periodat the end thereof and insert- ing "or by reason of any amount paid to a patron as a per-unit 26 USC 1388. retain allocation (as defined in section 1388(f) ) ." (2) Section 1382(b) is amended- (A) by striking out "(b) PATRONAGE Dlvmmms.-" and inserting in lieu thereof "(b) PATRONAGE DIVIDENDS AND PER-UNIT RETAIN Au~ocATIoNs.-", (B) by striking out "or" at the end of paragraph (1), 44 PAGENO="0055" November 13, 1966 - 43 - Pub. Law 89-809 . .. -- -~ 80 STAT. 1581 (C) by striking out the period at the end of paragraph (2) and inserting a semicolon in lieu thereof, (D) by striking out the sentence following paragraph (2) and inserting in lieu thereof the following: "(3) as per-unit retain allocations, to the extent paid in qualified per-unit retain certificates (as defined in section 1388(h)) with ~ p. 1583. respect to marketing occurring during such taxable year; or "(4) in money or other property (except per-unit retain cer- tificates) in redemption of a nonqualifled per-unit retain certificate which was paid as a per-unit retain allocation during the payment period for the taxable year during which the marketing occurred. For purposes of this title, any amount not taken into account under the preceding sentence shall, in the case of an amount described in paragraph (1) or (2), be treated in the same manner as an item of gross income and as a deduction therefrom, and in the case of an amount described in paragraph (3) or (4), be treated as a deduction in arriving at gross income." (3) Section 1382(e) is amended to read as follows: 76 Stat. 1047. "(e) PRODUCTS MAnxirrlir UNDER POOLING ARRANGEMENTS.-For 26 USC 1382. purposes of subsection (b), in the case of a pooling arrangement for the marketing of products- "(1) the patronage shall (to the extent provided in regulations prescribed by the Secretary or his delegate) be treated as patron- age occurring during the taxable year in which the pooi closes, and "(2) the marketing of products shall be treated as occurring during any of the taxable years in which the pool is open." (4) Section 1382(f) is amended by striking out "subsection (b)" and inserting in lieu thereof "paragraphs (1) an4 (2) of subsection (b) ". (5) The heading for section 1383 is amended by striking out 26 USC 1383. the period at the end thereof and inserting "OR NONQUALIFIED PER-UNIT RETAIN CERTIFICATES." (6) Section 1383(a) is amended- (A) by striking out "section 1382(b) (2)" and inserting in lieu thereof "section 1382(b) (2) or (4),", (B) by striking out "nonqualified written notices of allôca- tion" each place it appears and inserting in lieu thereof "non- qualified written notices of allocation or nonqualifled per- unit retain certificates", and (C) by striking out "qualified written notices of alloca- tion" and inserting in lieu thereof "qualified written notices of allocation or qualified per-unit retain certificates (as the case may be) ". (7) Section 1383(b) (2) is amended- (A) by striking out "nonqualified written notice of alloca- tion" and inserting in lieu thereof "nonqualified written notice of allocation or nonqualified per-unit retain certificate", (B) by striking out "qualified written notice of alloca- tion" and inserting in lieu thereof "qualified written notice of allocation or qualified per-unit retain certificate (as the case may be)", (C) by striking out "such written notice of allocation" and inserting in lieu thereof "such written notice of alloca- tion or per-unit retain certificate", and (D) by striking out "section 1382(b) (2)" and inserting in lieu thereof "section 1382(b) (2) or (4),". 45 PAGENO="0056" Pub. Law 89-809 - 44 - November 13, 1966 80 STAT. 1582 (8) The table of sections for part I of subchapter T of chapter 1 is amended by striking out- "Sec. 1383. Computation of tax where cooperative redeems non- qualified written notices of allocation." and inserting in lieu thereof- "Sec. 1383. Computation of tax where cooperative redeems non- qualified written notices of allocation or nonqualified per-unit retain certificates." (b) TAX TREATMENT BY PATRONS.- 76 Stat. 1048. (1) Section 1385(a) is amended by striking out "and" at the 26 USC 1385. end of paragraph (1), by striking out the period at the end of paragraph (2) and inserting in lieu thereof ", and", and by add- ing at the end thereof the following new paragraph: "(3) the amount of any per-unit retain allocation which is paid in qualified per-unit retain certificates and which is received by him during the taxable year from an organization described in 26 USC 1381. section 1381(a)." (2) The heading for section 1385(c) is amended by striking out "ALLOCATIoN" and inserting in lieu thereof "ALLOCATION AND CERTAIN NONQUALIFIED PER-UNIT RETAIN CERTIFICATES". (3) Section 1385(c) (1) is amended to read as follows: "(1) APPLICATION OF SUBSECTION.-This subsection shall apply to- "(A) any nonqualified written notice of allocation which- "(i) was paid as a patronage dividend, or "(ii) was paid by an organization described in section 1381 (a) (1) on a patronage basis with respect to earnings derived from business or sources described in section 26 USC 1382. 1382(c) (2) (A),and "(B) any nonqualified per-unit retain certificate which was paid as a per-unit retain allocation." (4) Section 1385(c) (2) is amended- (A) by striking out "nonqualified written notice of allo- cation" and inserting in lieu thereof "nonqualified written notice of allocation or nonqualified per-unit retain certifi- cate", and (B) by striking out "such written notice of allocation" each place it appears and inserting in lieu thereof "such written notice of allocation or per-unit retain certificate". (5) The table of parts for subchapter T of chapter 1 is amended by striking out- "Part II. Tax treatment by patrons of patronage dividends." and inserting in lieu thereof- "Part II. Tax treatment by patrons of patronage dividends and per- unit retain allocations." (c) DEFn~rrIONs.- 26 USC 1388, (1) (A) Section 1388(e) (1) is amended by striking out "allo- cation)" and inserting in lieu thereof "allocation or a per-unit retain certificate) ". (B) Section 1388(e) (2) is amended by striking out "alloca- tion" and inserting in lieu thereof "allocation or qualified per-unit retain certificate". (2) Section 1388 is amended by adding at the end thereof the following new subsections: "(f) PER-UNPF RETAIN Au~ocAi'ioN.-For purposes of this sub- chapter, the term `per-unit retain allocation' means any allocation, by an organization to which part I of this subchapter applies, other than 46 PAGENO="0057" November 13, 1966 - 45 - Pub. Law 89-809 80 STAT 158~ by payment in money or other property (except per-unit retain cer- tificates) to a patron with respect to products marketed for him, the amount of which is fixed without reference to the net earnings of the organization pursuant to an agreement between the organization and the patron. "(g) PER-UNIT RETAIN CERTIFICATE.-FOr purposes of this sub- chapter, the term `per-unit retain certificate' means any written notice which discloses to the recipient the stated dollar amount of a per-unit retain allocation to him by the organization. "(h) QUALIFIED PER-UNIT RETAIN CERTIFICATE.- "(1) DJrZINIm.-For purposes of this subchapter, the term. `qualified per-unit retain certificate' means any per-unit retain certificate~ which the aistributee has agreed, in the manner pro- vided in paragraph (2), to take into account at its stated dollar amount as provided in section 1385 (a). 76 Stat. 1048. "(2) MANNER OF OBTAINING AGREEMENT.-A distributee shall 26 USC 1385. agree to take a per-unit retain certificate into account as provided in paragraph (1) only by-. "(A) making such agreement in writing, or "(B) obtaining or retaining membership in the organiza- tion after- "(i) such organization has adopted (after the date of the enactment of this subsection) a bylaw providing that membership in the organization constitutes such agreement, and "(ii) he has received a written notification and copy of such bylaw. "(3) PERIOD FOR WHICH AGREEMENT IS EFFECTIVE.- "(A) GENERAL RULE.-Except as provided in subpara- graph (B)- "(i) an agreement described in paragraph (2) (A) shall be an agreement with respect to all products deliv- ered by the distributee to the organization during the taxable year of the organization during which such agreement is made and all subsequent taxable years of the organization; and "(ii) an agreement described in paragraph (2) (B) shall be an agreement with respect to all products deliv- ered by the distributes to the. organization after he received the notification and copy described in para- graph (2)(B)(ii). "(B) REVOCATION, ETC.- "(i) Any agreement described in paragraph (2) (A) may be revoked (in writing) by the distributee at any time. Any such revocation shall be effective with respect to products delivered by the distributee on or after the first day of the first taxable year of the organization beginnmg after the revocation is filed with the orga- nization; except that in the case of a pooling arrangement described in sectioh 1382(e) a revocation made by a dis- 76 Stat. 1046. tributee shall not be effective as to any products which 26 USC 1382. were delivered to the organization by the distributes before such revocation. "(ii) Any agreement described in paragraph (2) (B) shall not be effective with respect to any products delivered after the distributee ceases to be a member of the organization or after the bylaws of the organization cease to contain the provision described in paragraph (2) (B) (i). 47 PAGENO="0058" 80 STAT. 1584 Pub~ Law 89-.809 46 November 13, 1966 "(i) NONQUALIFIED PER-UNIT RETAIN CERTIFICATE.-FOr purposes of this subchapter, the term `nonqualified per-unit retain certificate' means a per-unit retain certificate which is not described in sub- section (h) ." (d) INFORMATION REPORTING.- 76 Stat, 1054. (1) AMOUNTS SUBJECT TO REPORTING-Section 6044(b) (1) is 26 USC 6044. amended by striking out "and" at the end of subparagraph (B), by striking out the period at the end of subparagraph (C) and inserting in lieu thereof ", and", and by adding after subpara- graph (C) the following new subparagraphs: "(D) the amount of any per-unit retain allocation (as p. 1582. defined in section 1388(f)) which is paid in qualified per-unit retain certificates (as defined in section 1388(h)), and p. 1581. "(E) any amount described in section 1382 (b) (4) (relat- ing to redemption of nonqualified per-unit retain certifi- cates)." (2) 1)ETERMINATION OF AMOUNT PAID.- (A) Section 6044(d) (1) is amended by striking out "allo- cation)" and inserting in lieu thereof "allocation or a quali- fied per-unit retain certificate)". (B) Section 6044(d) (2) is amended by striking out "allo- cation" and inserting in lieu thereof "allocation or a qualified per-unit retain certificate". (e) EFFECTIVE DATES.- (1) The amendments made by subsections (a), (b), and (c) shall apply to per-unit retain allocations made during taxable 76 Stat. 1045. years of an organization described in section 1381 (a) (relatmg 26 USC 1381, to organizations to which part I of subchapter T of chapter 1 applies) beginning after April 30, 1966, with respect to products delivered during such years. (2) The amendments made by subsection (d) shall apply with respect to calendar years after 1966. (f) TRANSITION Ruud.- (1) Except as provided in paragraph (2), a written agreement between a patron and a cooperative association- (A) which ckarly provides that the patron agrees to treat the stated dollar amounts of all per-unit retain certificates issued to him by the association as representing cash distribu- tions which he has, of his own choice, reinvested in the coop- erative association, (B) which is revocable by the patron at any time after the close of the taxable year in which it was made, (C) which was entered into after October 14, 1965, and before the date of the enactment of this Act, and (D) which is in effect on the date of the enactment of this Act, and with respect to which a written notice of revocation has not been furnished to the cooperative association, shall be effective (for the period prescribed in the agreement) for purposes of section 1388(h) of the Internal Revenue Code of 1954 as if entered into, pursuant to such section, after the date of the enactment of this Act. (2) An agreement described in paragraphs (1) (A) and (C) which was included in a by-law of the cooperative association and which is in effect on the date of the enactment of this Act shall be effective for purposes of section 1388(h) of such Code only for taxable years of the association beginning before May 1, 1967. 48 PAGENO="0059" November 13, 1966 47 - Pub. Law 89-809 80 STAT. 1585] SEC~ 212. EXCISE TAX RATE ON AMBULANCES AND HEARSES. (a) CLASSIFICATION AS AuToMoBIL~ES.-Section 4062 (relating to 68A Stat. 482; definitions applicable to the tax on motor vehicles) is amended by 78 Stat. 1086. adding at the end thereof the following new subsection: 26 USC 4062. "(b) AMBULANCES, HEARSES, ETc.-For purposes of section 4061 (a), a sale of an ambulance, hearse, or combination ambulance-hearse 26 USC 4061, shall be considered to be a sale of an automobile chassis and an auto- mobile body enumerated in subparagraph (B) of section 4061 (a) (2)." 79 Stat. 136. (b) EFFEcTIVE DAVE.-The amendment made by subsection (a) shall apply with respect to articles sold after the date of the enact- ment of this Act. SEC. 213. APPLICABILITY OF EXCLUSION FROM INTEREST EQUALIZA- TION TAX OF CERTAIN LOANS TO ASSURE RAW MATERI- ALS SOURCES. (a) Exci~ruIoN TO ExcLusIoN.-Section 4914(d) (relating to loans 78 Stat. 813. to assure raw materials sources) is amended by adding at the end 26 USC 4914. thereof the following new paragraph: "(3) ExcEI'rIoN.-The exclusion from tax provided by para- graph (1) shall not apply in any case where the acquisition of the debt obligation of the foreign corporation is made with an intent to sell, or to offer to sell, any part of such debt obligation to United States persons." (b) TECHNICAL AMENDMENTS.-(1) Section 4914(j) (1) (relating to loss of entitlement to exclusion in case of certain subsequent trans- fers) is amended- (A) by striking out in subparagraph (A) ", or the exclu- sion provided by subsection (d),", and (B) by striking out "subsection (d) or (f)"in subpara- graph (D) and inserting in lieu thereof "subsection (f) ". (2) Section 4918 (relating to exemption for prior American 78 Stat. 831. ownership) is amended by adding at the end thereof the follow- 26 USC 4918. ing new subsection: "(g) CERTAIN DEBT OBLIGATIONS AiusINo OUT OF LOANS To ASSURE RAW MATERIAL SOURcII5.-Under regulations prescribed by the Secre- tary or his delegate, subsection (a) shall not apply to the acquisition by a United States person of any debt obligation to which section 4914(d) applied where the acquisition of the debt obligation by such person is made with an intent to sell, or to offer to sell, any part of such debt obligation to United States persons. The preceding sen- tence shall not apply if the tax imposed by section 4911 has applied 78 Stat. 809. to any prior acquisition of such debt obligation." 26 USC 4911. (c) EFFECTIVE DAFE.-The amendments made by subsections (a) and (b) shall apply with respect to acquisitions of debt obligations made after the date of the enactment of this Act. SEC. 214. EXCLUSION FROM INTEREST EQUALIZATION TAX FOR CER- TAIN ACQUISITIONS BY INSURANCE COMPANIES. (a) NEw COMPANIES AND COMPANIES OPERATING IN FORMER LESS DEVELOPED C0UNTRIE5.-Sectlon 4914(e) (relating to acquisitions by insurance companies doing business in foreign countries) is amended- (1) by striking out "at the time of the initial designation" in the last sentence of paragraph (2); (2) by striking out "An" in the first sentence of paragraph (3) (A)(i) and inserting in lieu thereof "Except as provided in clause (iii), an (3) by striking out "under this subpariwraph" in paragraph (3) (A) (ii) and inserting in lieu thereof `~nder clause (i)"; (4) by adding after clause (ii) of paragraph (3) (A) the fol- lowing new clauses: 49 PAGENO="0060" Pub. Law 89-809 - 48 - November 13, 1966 80 STAT. 1586 "(iii) INITIAL DESIGNATION AFIER OCTOBER 2~ 1964.-An insurance company which was not in existence on October 2,1964, or was otherwise ineligible to establish a fund (or funds) of assets described in paragraph (2) by making an initial designation under clause (i) on or before such date, may establish (and thereafter currently maintain) such fund (or funds) of assets at any time after the enactment of this clause by designating stock of a foreign issuer or a debt obligation of a foreign obligor as a part of such fund in accordance with the provisions of clause (iv) (if applicable) and subparagraph (B) (i). "(iv) FUNDS INVOLVING CURRENCIES or FORMER LESS DEVELOPED COITNTRIES.-An insurance company desiring to establish a fund under clause (iii) with respect to insurance contracts payable in the currency of a country designated as a less developed country on October 2, 1964, which thereafter has such designation termmated 78 Stat. 827. by an Executive order issued under section 4916(b), 26 USC 4916. shall designate as assets of such fund, to the extent per- mitted by subparagraph (E), the stock of foreign issuers or debt obligations of foreign obligors as follows: First, stock and debt obligations having a period remaining to maturity of at least 1 year (other than stock or a debt obligation described in section 4916(a)) acquired before July 19, 1963, and owned by the company on the date which the President, in accordance with section 4916 (b), communicates to Congress his intention to ter- minate the status of such country as a less developed country; second, stock and debt obligations having a period remaining to maturity of at least 1 year described in section 4916(a) (and owned by the company on the date of such termination) which, at the time of acquisi- tion, qualified for the exclusion provided in such section because of the status of such country as a less developed country; and third, such stock or debt obligations as the company may elect to designate under subparagraph (B) (i). The period remaining to maturity referred to in the preceding sentence shall be determined as of the date of the President's communication to Congress."; (5) by. striking out "TO MAINTAIN FUND'~ in the heading of para- 79 Stat. 959. graph (3) (B); 26 USC 4914. (6) by striking out "as provided in subparagraph ~A) (ii)" in paragraph (3) (B) (i) and inserting in lieu thereof `under sub- paragraphs (A) (i) and (ii)"; (7) by inserting before the period at the end of the first sentence 78 Stat. 819. of paragraph (3) (C) the following:"; except that, with respect to a fund established under subparagraph (A) (iii), stock or debt obligations acquired before the establishment of such fund may not be designated as part of such fund under this subparagraph"; (8) by striking out "subparagraph (B)," in paragraph (3) (E) (i) and inserting in lieu thereof "subparagraph (A) (iv), (B),"; (9) by striking out "subparagraph (A)" in paragraph (4) (B) (i) and inserting in lieu thereof "subparagraph (A) (i)"; (10) by striking out "paragraph (3) (A)" in paragraph (4) (B) (ii) and inserting in lieu thereof "paragraph (3) (A) (i)"; and 50 PAGENO="0061" November 13, 1966 - 49 - Pub. Law 89-809 80 STAT. 1587 (11) by adding at the end of paragraph (4) the following new 78 Stat. 820. paragraph: 26 USC 4914. "(C) SPECIAL RUL]L-For purposes of subparagraph (A), if a country designated as a less developed country on Septem- ber 2, 1964, thereafter has such designation terminated by an Executive order issued under section 4916(b), all insurance 78 Stat. 827. contracts payable in the currency of such country which 26 USC 4916. were entered into before such designation was terminated shall be treated as insurance contracts payable in the cur- rency of a country other than a less developed country." (b) EFFECTIVE DATE.-The amendments made by subsection . (a) shall take effect on the day after the date of the enactment of this Act. SEC. 215. EXCLUSION FROM INTEREST EQUALIZATION TAX OF CER- TAIN ACQUISITIONS BY FOREIGN BRANCHES OF DO- MESTIC BANKS. (a) AUTHORITY FOR MODIFICATION OF EXECUTIVE OIWERS.-Section 4931 (a) (i'elating to commercial bank loans) is amended by adding at 78 Stat. 839. the end thereof the following new sentence: "Clause (A) of the preced- 26 USC 4931. ing sentence shall not prevent a modification of such Executive order (or any modification thereof) to exclude from the application of sub- section (b) acquisitions by commercial banks, through branches located outside the United States, of debt obligations of foreign obli- gors payable in currency of the United States." (b) EFFEcTIVE DA~rE.-The amendment made by subsection (a) shall apply with respect to acquisitions of debt obligations made after the date of the enactment of this Act. TITLE 111-PRESIDENTIAL ELECTION CAMPAIGN FUND ACT SEC. 301. SHORT TITLE. This title may be cited as the "Presidential Election Campaign Fund Act of 1966". SEC. 302. AUTHORITY FOR DESIGNATION OF $1 OF INCOME TAX PAY- MENTS TO PRESIDENTIAL ELECTION CAMPAIGN FUND. (a) Subchapter A of chapter 61 of the Internal Revenue Code of 68A Stat. 731. 1954 (relating to returns and records) is amended by adding at the 26 USC 6001~ end thereof the following new part: 6091. "PART VIlI-DESIGNATION OF INCOME TAX PAYMENTS TO PRESIDENTIAL ELECTION CAMPAIGN FUND "Sec. 6096. Designation by individuals. "SEC. 6096. DESIGNATION BY INDIVIDUALS. "(a) IN GEwioL&L.-Every individual (other than a nonresident alien) whose income tax liability for any taxable year is $1 or more may designate that $1 shall be paid into the Presidential Election Campaign Fund established by section 303 of the Presidential Election Campaign Fund Act of 1966. "(b) INCoi~n~ TAX LIABILITY.-FOr purposes of subsection (a), the income tax liability of an individual for any taxable year is the amount of the tax imposed by chapter 1 on such individual for such 26 USC 1-1388. taxable year (as shown on his return), reduced by the sum of the credits (as shown in his return) allowable under sections 32(2), 33, 35, 37, and 38. 76 Stat. 962, 51 PAGENO="0062" Pub. Law 89-809 - 50 - November 13, 1966 "(c) MANNER AND TIME OF DESIGNATION.-A desiguation under. subsection (a) may be made with respect to any taxable year, in such 80 STAT. 1587 manner as the Secretary or his delegate may prescribe by regulations- 80 STAT. 1588 "(1) at the time of filing the return of the tax imposed by chapter 1 for such taxable year, or "(2) at any other time (after the time of filing the return of 68A Stat, 4. the tax imposed by chapter 1 for such taxable year) specified in 26 USC 1-1~88. regulations prescribed by the Secretary or his delegate." (b) The table of parts for subchapter A of chapter 61 of such Code is amended by adding at the end thereof the following new item: "Part VIII. Designation of income tax payments to Presidential Election Campaign Fund." (c) The amendments made by this section shall apply with respect to income tax liability for taxable years beginning after December 31, 1966. SEC. 303. PRESIDENTIAL ELECTION CAMPAIGN FUND. (a) ESTABLIsITMENT.-There is hereby established on the hooks of the Treasury of the United States a special fund to be known as the "Presidential Election Campaign Fund" (hereafter in this section referred to as the "Fund"). The Fund shall consist of amounts trans- ferred to it as provided in this section. (b) TRANSFERS TO THE FUND.-The Secretary of the Treasury shall, from time to time, transfer to the Fund an amount equal to the sum of the amounts designated by individuals under section 6096 of the ~ p. 1587. Internal Revenue Code of 1954 for payment into the Fund. (c) PAYMENTS FROM FUND.- (1) IN GENERAL.-The Secretary of the Treasury shall, with respect to each presidential campaign, pay out of the Fund, as authorized by appropriation Acts, into the treasury of each politi- cal party which has complied with the provisions of paragraph (3) an amount (subject to the limitation in paragraph (3) (B)) determined under paragraph (2). (2) DETERMINATION OF AMOUNTS.- (A) Each political party whose candidate for President at the preceding presidential election received 15,000,000 or more popular votes as the candidate of such political party shall be entitled to payments under paragraph (1) with respect to a presidential campaign equal to the excess over $5,000,000 of- (1) $1 multiplied by the total number of popular - votes cast in the preceding presidential election for can- didates of political parties whose candidates received 15,00Q,~0 or more popular votes as the candidates of such political parties, divided by (ii) the number of political parties whose candidates in the preceding presidential election received 15,000,000 or more popular votes as the candidates of such political parties. (B) Each political party whose candidate for President at the preceding presidential election received more than 5,000,000, but less than 15,000,000, popular votes as the can- didate of such political party shall be entitled to payments under paragraph (1) with respect to a presidential cam- paign equal to $1 multiplied by the number of popular votes in excess of 5,000,000 received by such candidate as the 52 PAGENO="0063" November 13, 1966 - 51 - Pub. Law 89-809 candidate of such political party in the preceding presiden.. tial election. (C) Payments under paragraph (1) shall be made with respect to each presidential campaign at such times as the Secretary of the Treasury may prescribe by regulations, 80 STAT* ~ except that no payment with respect to any presidential cam- 80 STAT. 1589 paign shall be made before September 1 of the year of the presidential election with respect to which such campaign is conducted. If at the time so prescribed for any such pay- ments, the moneys in the Fund are insufficient for the Secre- tarv to pay into the treasury of each political party which is entitled to a payment under paragraph (1) the amount to which such party is entitled, the payment to all such parties at such time shall be reduced pro rata, and the amounts not paid at such time shall be paid when there are sufficient moneys in the Fund. (3) LIMITAviONS.- (A) No payment shall be made under paragraph (1) into the treasury of a political party with respect to any presiden- tial campaign unless the treasurer of such party has certified to the Comptroller General the total amount spent or incurred (prior to the date of the certification) by such party in carry- ing on such presidential campaign, and has furnished such records and other information as may be requested by the Comptroller General. (B) No payment shall be made under paragraph (1) into the treasury of a political party with respect to any presiden- tial campaign in an amount which, when added to previous payments made to such party, exceeds the amount spent or incurred by such party in carrying on such presidential campaign. (4)The Comptroller General shall certify to the Secretary of the Treasury the amounts payable to any political party under paragraph (1). The Comptroller General's determination as to the popular vote received by any candidate of any political party shall be final and not subject to review. The Comptroller Gen- eral is authorized to prescribe such rules and regulations, and to conduct such examinations and investigations, as he determines necessary to carry out his duties and functions under this sub- section. (5) DErINITI0N5.-For purposes of this subsection- Definitions. (A) The term "political party" means any political party which presents a candidate for election to the office of Presi- dent of the United States. (B) The term "presidential campaign" means the political campaign held every fourth year for the election of presiden- tial and vice presidential electors. (C) The term "presidential election" means the election of presidential electors. (d) TRANSFERS TO GENERAL FUND.-If, after any presidential-cam- paign and after all political parties which are entitled to payments under subsection (c) with respect to such presidential campaign have been paid the amounts to which they are entitled under subsection (c), there are moneys remaining in the Fund, the Secretary of the Treasury shall transfer the moneys so remaining to the general fund of the Treasury. 53 PAGENO="0064" Pub. Law 89-809 - 52 - November 13, 1966 SEC. 304. ESTABLISHMENT OF ADVISORY BOARD. (a) There is hereby established an advisory board to be known as the Presidential Election Campaign Fund Advisory Board (here- after in this section referred to as the "Board"). It shall be the duty and function of the Board to counsel and assist the Comptroller Gen- ~ eral in the performance of the duties imposed on him under section 80 STAT. 1590 ~ 303~~&Act. Nembership. 7Nie Board shall be composed of two members representing each political party whose candidate for President at the last presi- dential election received 15,000,000 or more popular votes as the candi- date of such political party, which members shall be appointed by the Comptroller General from recommendations submitted by each such political party, and of three additional members selected by the mem- Term of offioe * bers so appointed by the Comptroller General. The term of the first members of the Board shall expire on the 60th day after the date of the first presidential election following the date of the enactment of this Act and the term of subsequent members of the Board shall begin on the 61st day after the date of a presidential election and expire on the 60th day following the date of the subsequent presidential election. The Board shall select a Chairman from among its members. Compensation. (c) Members of the Board shall receive compensation at the rate of $75 a day for each day they are engaged in performing duties and functions as such members, including travel time, and, while away from their homes or regular places of business, shall be allowed travel expenses, including per diem in lieu of subsistence, as authorized by law for persons in the Government service employed intermittently. (d) Service by an individual as a member of the Board shall not, * for purposes of any other law of the United States, be considered as service as an officer or employee of the United States. SEC. 305. APPROPRIATIONS AUTHORIZED. There are authorized to be appropriated, out of the Presidential Elections Campaign Fund, such sums as may be necessary to enable the Secretary of the Treasury to make payments under section 303 of this Act. TITLE IV-MISCELLANEOUS PROVISIONS SEC. 401. TREASURY NOTES PAYABLE IN FOREIGN CURRENCY. Section 16 of the Second Liberty Bond Act, as amended (31 U.S.C. 40 Stat, 505, 766), is amended by striking out "bonds" wherever it appears therein and inserting in lieu thereof "bonds, notes,". SEC. 402. REPORTS TO CLARIFY THE NATIONAL DEBT AND TAX STRUC- TURE. The Secretary of the Treasury shall, on the first day of each regular session of the Congress, submit to the Senate and the House of Repre- sentatives a report setting forth, as of the close of the preceding June 30 (beginning with the report as of June 30, 1967), the aggregate and individual amounts of the contingent liabilities and the unfunded lia- bilities of the Government, and of each department, agency, and instru- mentality thereof, including, so far as practicable, trust fund liabilities, Government corporations' liabilities, indirect liabilities not included as a part of the public debt, and liabilities of insurance and annuity programs, including their actuarial status. The report shall also set forth the collateral pledged, or the assets available (or to be realized), as security for such liabilities (Government securities to be separately noted), and shall also set forth all other assets specifically available to 54 PAGENO="0065" November 13, 1966 - 53 - Pub. Law 89-809 80 STAT. 1590 liquidate such liabilities of the Government. The report shall set forth the required data in a concise form, with such explanatory mate- rial (includmg such analysis of khe significance of the liabilities in terms of past experience and probable risk) as the Secretary may determine to be necessary or desirable, and shall include total amounts of each category according to the department, agency, or instrumen- tality involved. Approved November 13, 1966. LEGISLATIVE HISTORY: HOUSE REPORTS: No. 1450 (Comm. on Ways and Means) and No. 2327 (Comm. of Conference). SEN&TE REPORT No, 1707 (Comm. on Finance). CONGRESSIONAL RECORD, Vol. 112 (1966): June 15: Considered and passed House, Oct. 12: Considered in Senate. Oct. 13: Considered and passed Senate, anended. Oct. 20: House agreed to conference report. Oct. 22: Senate agreed to conference report. 55 71-297 0-67-pt. 1-5 PAGENO="0066" PAGENO="0067" SECTION 2 H.R. 5916 AS INTRODUCED IN THE HOUSE OF REPRESENTATIVES (See Section 7 of this document, page 123) 57 PAGENO="0068" PAGENO="0069" SECTION 3 EXPLANATION BY THE DEPARTMENT OF THE TREAS URY OF THE ACT TO REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES, IN.. SERTED IN THE CONGRESSIONAL RECORD ON MARCH 8, 1965, BY CHAIRMAN WILBUR D. MILLS 59 PAGENO="0070" PAGENO="0071" [P. 4260] [March 8, 1965] EXPLANAT[ON BY THE DEPART- MENT OF THE TREASURY OF THE ACT TO REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES Mr. MILLS. Mr. Speaker, I ask unani- mous consent that there be inserted at this point in the RECORD an explanation prepared by the Treasury Department of the bill H.R. 5916 which I introduced today entitled "An act to remove tax barriers to foreign investment in the United States." I am advised by the Government Printing Office that the es- timated cost of printing this explana- tion is $343. Notwithstanding the cost I request that this* be inserted in the RECORD. The SPEAKER. Is there objection to the request of the gentleman from Arkansas? There was no objection. The matter referred to follows: EXPLANATION OF HR. 5916, AN ACT To Rz- MOVE TAx BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES (Prepared by the Treasury Department) GENERAL EXPLANATION Introduction In his balance-of-payments message of February 10, 1965, the President proposed a series of measures designed to reinforce the program to correct the balance-of-payments deficit of the United States. Among the proposals made by the President is one to remove the tax deterrents to foreign invest- ment in U.S. corporate securities so as to im- prove our balance of payments by~ encour- aging an increase in such investment. The recommended legislation described herein would effectuate this proposal. The review of the tax treatment of non- resident foreigners and foreign corporations Investing in the United States resulting in these legislative recommendations was prompted in large measure by the report of the Task Force on Promoting Increased Foreign Investment In U.S. Corporate Se- curities. This task force, which was headed by the then Under Secretary of the Treasury, Henry H. Fowler, was directed, among other things, to review U.S. Government and private activities which adversely affect for- eign purchases of the securities of U.S. pri- vate companies. In its report, the task force made 39 recommendations designed to help the United States reduce its balance-of-pay- ments deficit and defend its gold reserves. Among these were several directed at chang- ing the tax treatment of foreign Investors [P. 4261] so as "to remove a number of elements in our tax structure which unnecessarily com- plicate and inhibit investment in U.S. cor- porate securities without generating material tax revenues." The task force report cau- tioned, however, that Its tax recommenda- tions were not intended to turn the United States Into a tax haven, nor to drain funds from developing countries. The legislation being requested deals with all of the tax areas discussed in the task force report, although in certain instances the action suggested differs from the pro- posals made by the task force. Furthermore, the draft bill contains recommendations in areas not mentioned In the task force re- port which deal with problems which came to light In the Treasury Department's study of the present system of taxing nonresident foreigners and foreign corporations. It should be emphasized that the recommenda- tions embodied in the proposed legislation were considered not only from the viewpoint of their impact on the balance of payments, but also to insure that they contributed to a rational and consistent program for the taxation of foreign individuals and foreign corporations. Thus, all legislative sugges- tions made herein are justifiable on con- ventional tax policy grounds. It is estimated that the adoption of these proposals would result in a net revenue loss on an annual basis of less than $5 million. Foreign purchases of U.S. stocks constitute the largest single source of long-term capital inflow into the United States, with even greater potential for the future. Net pur- chases have averaged $190 million a year be- tween 1956 and 1963, while the outstanding value of foreign-held stocks has risen from $6.1 to $12.5 billion during this period. It is extremely difficult to measure the precise impact of this proposed legislation on our balance of payments because of the various factors affecting the level of foreign invest- ment in the United States. It Is anticipated that, when combined with an expanding U.S. economy, the proposed legislation will result over the years in a significant increase in such investment. Most provisions of the draft bill are pro- posed to become effective to taxable years beginning after December 31, 1965. How- ever, those provisions which provide a re- vised estate tax treatment for the estates of foreigners are made applicable to the estates of decedents dying after the date of enact- ment of the proposed legislation. In addi- tion, those special provisions applicable to US. citizens who have surrendered their U.S. citizenship are made applicable if the sur- render occurred after March 8, 1965. Specific recommendations The following paragraphs dcscribe the specific changes in the Internal Revenue Code of 1954 which are proposed. For this purpose the technical language of the In- ternal Revenue Code has been used, e.g., for- eigners are described by the technical term "alien." 1. Graduated rates: Eliminate the taxa- tion at graduated rates of U.S. source income of nonresident alien individuals not doing business in the United States. Under present law, honresident aliens de- riving more than $21,200 of Income from U.S. sources are subject to regular U.S. graduated rates and are required to file returns. How- ever, graduated rates on investment income already are eliminated by treaty in the case of almost all industrial countries, except where a taxpayer is doing business in the United States and has a permanent estab- lishment here. Only a very small amount of revenue is collected from graduated rates at present. For example, for 1962 graduated rates resulted in the collection of $746,743 above the taxes already withheld. Although graduated rates are rarely applicable they complicate our tax law and tend to frighten and confuse foreign Investors. 61 PAGENO="0072" Thus, graduated rates, whether applied to investment income or such types of income as pensions, annuities, alimony, and the like, serve no clearly defined purpose, deter for- eign investment, and should be eliminated. The elimination of graduated rates will limit `the liability of nonresident aliens not en- gaged in trade or business to taxes withheld, and where the alien is not engaged in trade or business here no return need be made. (However, graduated rates would be retained for the U.S. business income of nonresident aliens engaged in trade or business here.) 2. Segregation of investment and business income and related matters: Provide that (a) nonresident alien individuals engaged in * trade or business in the United States be * taxed on investment (nonbusiness) income at the 30 percent statutory withholding rate, or applicable treaty rate, rather than at grad- uated rates; (b) foreign corporations engaged in business in the United States be denied the 85-percent dividends-received deduction and be exempt from tax on their capital gains from investments in U.S. stocks; (c) non- resident alien individuals and foreign cor- porations not be deemed engaged in trade or business in the United States because of investment activity in the United States or because they have granted a discretionary power to a U.S. banker, broker, or adviser; and (d) nonresident alien individuals and foreign corporations be given an election to compute income from real property and min- eral royalties on a net income basis and be taxed at graduated rates on such income as if engaged in trade or business in the United States. Segregation of business and investment income Under present law, if a nonresident alien is engaged in trade or business within the United States, he is subject to tax on all his U.S. income (including capital gains), even though some of the income is not derived from the conduct of the trade or business, at the same rate as U.S. citizens. A nonresident alien individual engaged In trade or business in the United States should be subject to taxation on his investment in- come on the same basis as a nonresident alien not so engaged. Thus his investment income would be taxed at the 30-percent statutory rate or applicable treaty rate, rather than at graduated rates. For the pur- pose of determining the applicability of treaty rates the alien will be deemed not to have a permanent establishment in this country. All business income should remain subject to tax at graduated rates, but the rates on business income would be computed without regard to the amount of investment income. This change conforms to the trend in in- ternational treaty negotiations to separate investment income from business income. Whether a taxpayer is helped or harmed by segregating his investment from his business income, separate treatment is proper and equitable. Investment decisions may be made on the same basis whether or not the alien is engaged in business here, since in- come arising from investments here will not be subject to taxation at graduated rates in either event. Moreover, a nonresident alien individual engaged in trade or business here should not be taxed on capital gains realized in the United States which are unrelated to the business activity carried on by him in this country, except where he would be subject to tax on those gains under the rules pertain- ing to nonresident aliens generally. Tax treatment of income from U.S. stock in- vestments by foreign corporations Under present law all the activities of a corporation are treated as part of its trade or business. Thus, for example, all its ex- penses are treated as deductible as business expenses. Accordingly, it would be inap- propriate to segregate a foreign corporation's US. investment income from its U.S. busi- ness income. However, there is one abuse in this area which should be eliminated. Fre- quently, a foreign corporation with stock investments in the United States engages in trade or business here in some min6r way (such as by owning a few parcels of real estate) and then claims the 85-percent div- idends-received deduction on its stock In- vestments in the United States. Such a corporation thereby may pay far less than the 30-percent statutory or treaty withhold- ing rate on its U.S. dividend income, al- though its position is essentially the same as that of a foreign corporation doing busi- ness elsewhere which has U.S. investment income. To eliminate this abuse and treat all ror- eign corporations with investments in U.S. stocks alike, the 85-percent dividends-re- celved deduction should be denied to foreign corporations doing, business here. Their in- come from stock investments would be made subject to the 30-percent statutory with- holding rate, or any lesser treaty rate ap- plicable to such income, rather than regular than regular U.S. corporate rates. For the purpose of determining whether the treaty rates on dividend income apply, a foreign corporation will be deemed not to have a permanent establishment in this country. To fully equate the tax treatment of stock investments of foreign corporations doing business in the United States with that of foreign corporations not doing business here, such corporations are exempted from the U.S. tax on capital gains realized on their U.S. stock investments. Definition of "engaged in trade or business" Present law provides that the term "en- gaged in trade or business" does not include the effecting, through a resident bro~er, commission agent, or custodian, of transac- tions in the United States in stocks, securi- ties, or commodities. There is some confu- sion as to whether the amount of activity in an investment account, or the granting of a discretionary power to a U.S. banker, broker, or adviser, will place a nonresident alien outside of this exception for security transactions so that he is enpged in trade or business in the United States. This un- certainty may deter investment in the United States and is' undesirable as a matter of tax policy. The fact that a discretionary power of in- vestment has been given to a U.S. broker or banker does not really bear a relation to the foreigner's ability to carry out transac- tions in the United States-the discretionary power is merely a more efficient method of operating rather than having the investor consulted on every investment decision and frequently is merely a safeguard to protect him in case of world turmoil. Nor, where the alien is an investor, is the volume of transactions material in determining wheth- er he is engaged in trade or business. Accordingly, the proposed legislation makes clear that Individuals or corporations are not engaged In trade or business because of in- 62 PAGENO="0073" vestment activityin the United States or be- cause they have granted a discretionary in- vestment power to a U.S. banker, broker, or adviser. No legislative change is necessary to provide that the volume of transactions is not material in determining whether an investor is engaged ta trade or business ifl the United States as~ this is the rule under present law. Real estate income and mineral royalties Under present law it is not clear whether a nonresident alien (or foreign corq)oration) is engaged in trade or business in the United States by rea.son of the mere owner- ship of unimproved real property or real property subject to a strict net lease, or by reason of an agent's activities in connection with the selection of real estate investments In the United States. [P. 4262) If because of such activity a nonresident alien is considered as not engaged in trade or business l~c becomes subject to withhold- ing tax on his gross rents. Since the con- sequent tax could exceed his net income, the taxation on a gross basis of income from real property should not be continued where taxation on a net basis at graduated U.S. rates would be more appropriate. Therefore, a nonresident alien or foreign corporation should be given an election to compute their income from real propert~ (including Income front minerals and other natural resources) on a net income basis and at regular U.S. rates as if they were engaged in trade or business in the United States. Such an election is comparable to the one now appearing in many treaties to which the Unite dStatcs is a party. Such an election would not effect the method of taxation ap- plied to his other income. 3. Capital gains: Eliminate the provision taxing capital gains realized by a nonresi- dent alien when he Is physically present in the United States, and extend from 90 to 183 days the period of presence in the United States during the year which makes nonresi- dent aliens taxable on all their capital gains. The underlying policy of U.S. taxation of nonresident alien Individuals has been to exempt capital gains realized from sources In thIs country. This policy has been proper both from a tax policy standpoint anti from the viewpoint of our balance of payments. However, existing law has two limitations: U.S. capital gains realized by a nonresident alien while he is physically present in the United States, or realized chiring a year in which he is present in the United States for 90 days or more, are subject to a U.S. tax of 30 percent. The limitations now contained in our law, especially the physical presence test, con- tain illogical elements and are likely to have a negative impact on foreigners who are weighing the advantages and disadvantages of investing In the United States. Tile phy- sical presence test was added to the law. autcr~ World War II when many nonresident alien traders were frequently present in this country. Since this 15 no longer true, and moreover, since the tax may be readily avoided by passing tithe to the property out- side the United States, the provision now serves little purpose. However, it does pose a threat to the foreign investor which may deter him from investing in this country and therefore should be eliminated. The limitation relating to presence in the United States for 00 days or more in a partIcular year should be retained, but the period should be lengthened to 183 days. This extension will remove a minor deter- rent to travel in the United States and help mitigate the harsh consequences which may arlee under the existing rule if a nonresi- dent alien realized capital gains at the be- gInning of a taxable year during which he later spends 00 days or more in the United States. 4. Personal holding company and "second dividend" taxes: (a) Exempt foreign corpor- :ttious owned entirely by nonresident alien Individuals, whether or not doing business in the Thiited States, from the personal hold- ing company tax; (b) modify the applica- tion of the "second dividend tax" of section 8G1 (a) (2) (B) so that it only applies to the dIvidends of foreign corporations doing busi-,, rices in the United States which have over Co percent U.S. source income. Under present law any foreign corporation with U.S. investment income, whether or not doing busineas here, may be a personal hold- ing company unless It is owned entirely by nonresident aliens, and unless its gross in- come from U.S. sources is less than 50 per- cent of its gross income from all sources. The personal holding company tax should not apply to foreign corporations owned en- tinely by nonresident aliens. The only reasOfl for applying our personal holding companY tax to foreign corporations qwned by non-' resident aliens has been to prevent the ac- cumulation of income in holding companies organized to avoid the graduated rates. With the elimination of graduated rates as sug- gested in recommendation 1 (and the revi- sion of the second dividend tax, dlsctisscd below), U.S. investment income In the hands of foreign corporations will have borne the U.S. taxes properly applicable to it and ac- cumulation of such income will not result in the avoIdance of U.S. taxes Imposed on the company's shareholders. Hence, there Is no longer any reason to continue to apply the personal holding company tax to these cor- porations. With respect to the "second dividend tax," section 861(a) (2) (B) now provides that if a corporation derives 50 percent or more of.. Its gross income for the preceding 3-year period from the United States, its dividends shall be treated as U.S. source incomo to the extent the dividends are attributable to In- come from the United States. As a result such dividends arc subject to U.S. tax when received by a nonresident alien. This tax is often referred to as the "second dividend tax." However, under section 1441(c) (1) a foreign corporation is riot required to with- hold ~ax on its dividends unless it is engaged in business in the United States and, in addition, more than 85 percent of its gross income is derived from U.S. sources. It is now proposed to levy this second dividend tax only where the foreign corpora- tion does.business in the United States, and 80 percent or more of its gross income (other than dividends and capital gains on stock) is derived from U.S. sources. Where a for- eign corporation is not doing business in the United States, It will pay U.S. withholding taxes on all investment income and other fixed or determinable gains and profits de- rived from the United States, and since that is all the tax its foreign shareholders would owe if they received the income directly, flO second tax seems warranted, With the adoption of the rule that the in- come from the U.S. stock investmenta of for- 63 PAGENO="0074" cign corporations doing business here. be taxed at flat statutory or treaty withholding rates, no further U.S. tax should be imposed on such income. Therefore, in applying the proposed 80 percent test, such Income of the foreign corporation, whether from U.S. or foreign sources, should be disregarded and the test applied only to the corporation's other income, Furthermore, if the 80 per- cent rule Is met, the dividends of such cor- porations should be subject to tax only to the extent that such dividends are from U.S. source income other than income from stock investments in the United States, Withholding requirements should conform to the incidence of tax, and therefore with- holding should be required on dividends paid by foreign corporations doing business in the United States with 80 percent or more U.S. source income to the extent such dividends are from U.S. source income other than in- come from stock investments in the United States. With tho adoption of the revisions pro- posed in U.S. system of taxing nonresident aliens and foreign corporations, the regu- lations dealing with the accumulated earn- ings tax will be revised to eliminate the ap- plication of this tax to foreign corporations not doing business in the United St~t~ which are owned entirely by nonrcs;de~s aliens. The accumulation of earnings by such corporations will not result in the avoidance of U.S. taxes. However, because of possible avoidance of the revised second dividend tax, the accumulated earnings tax will remain applicable to foreign corpora" tions doing business here. 5. Estate tax and related matters: (a) In- crease the $2000 exemption from. tax to $30,000 and substitute for regular U.S. csta~e tax rates a 5-10-15 percent rate schedule; (b). provide that bonds issued by domestic corpo- rations or governmental units and held by - nonresident aliens arc property wit~')n the United States and therefore are subject to estate tax; and (C) provide that transfers of intangible property by a nonresIdent alien cngagcd in business in the United States are not subject to gift tax. It is generally believed that high csL-Lte taxes on foreign investors are one of the most important deterrents in our tax laws to foreign investment in the United States. Our rates in ninny cases are higher than those of other countries and in these situations, de- spite tax conventions and statutory foreign estate tax crcdits,nonresiclents who invest in the United States suffer an estate tax burden. Moreover, under present law a nonresident alien's estate must pay heavier estate taxes on its U.S. assets than would the estate of a U.S. citizen owning the same assets. To mitigate this deterrent to investment and to rationalize the estate tax treatment of nonresident aliens, the exemption for es- tates of nonresident alien dcccclents should be increased from $2,000 to $30,000 and such estates should be subject to tax at the .fol- lowing rates: If the taxable estate is not over $100,000, the tax should be 5 percent of the taxablc estate.. If the taxable estate is over $100,000 but not over $750,000, the tax shall be $5,000, plus 10 percent of excess over $100,000. IL the taxable estate is over $750,000, the tax shall be $70,000, plus 15 percent of excc~s over $750,000. The increase in exemption and rcthtcei rates will bring U.S. effective estate tax rates on nonresident aliens to a level somewhat higher than those.. Imposed upon resident estates in Switzerland, Germany, France, and the Netherlands, for cxam,le, but substar.- tially below those imposed on resIdent catates in the tJn1tec~ Kingdom, Canada, and It~.l)'. Thus U.S. investment from there latter countries bears no higher estate tax than local Investment because of foreign tax credits or exemptions provided in such coun- tries. The proposed tax treatment of the U.S. estates of nonresident aliens is similar to the treatment accorded the estates of non- residents by Canada, whose rates on the estates of its citizens are comparable to our own. Where additional reductions arc justi- fied these may be made by treaty. These changes should result in more ap- propriate estate tax treatment of nonresident aliens and thereby improve the climate for foreign investment in the United Staten. Particularly in the case of nonresident alien deccdents who have only a small amount ni U.S. property in their estates, present U.S. rates and the limited exemption provicl'~d result in an excessive effective rate of estate tax. The proposed changes correct this sit- uation. The new rates will produce for non- resident aliens' estates an effective rate o tax on U.S. assets which In many cases Is comparable to th~at applicable to U.S. citi- zens who may avail themselves of the $00,000 exemption a~ t marital deduction (which are not avaliablo to nonresident aliens). The following figures show the effective rates for nonresident aliens under present law, and the effective rates produced by the proposed exemption and rates as comparen to those applicable to the estates of U.S. citizens electing and not electing the marital deduction: 978. gross estate Nonresi. dent alien under present law- Nonresi' dent alien under propo?cd law - U.S. churn with snarital deduct- then ITS. dhln'n withttt marital de'iiic- thou $50,000 100,0CC) i00.000______ l,C0O,000.,._~ 5,0O0,000~...... 12.5 17.3 22.8 38.8 .43.0 . 2.0 3.0 7.4 8.8 12.6 [P. 4263) As part of this revision of the estate tax, the situs rule with respect to -bunds should be changed. The present rule, very fre- quently modified by treaty, is that bonds have situs where they are physically located. This rule is illogical, permits tax avoidance, and Is not a suitable way to determine whether bonds are subject to an estate tax as their location is one of their least sig- nificant characteristics for tax purposes. Other intangible debt obligations are pres- ently treated as property within the United States if issued by or enforcible against a lomestic corporation or resident of the United States. Accordingly, It is recom- .aiended that our law be amended to provide that bonds issued by domestic corporations or domestic governmental units and held by nonresident aliens are property within the United States and therefore subject to estate tax. Furthermore, a present defect in the oper- * ation of the credit against the estate tax for State death taxes in the case of non-j resident aliens should be corrected. Un- der present law the the estate of a non- resident alien may receive the Lull credit 8.0 11.1 16.9 3.,) SC. 7 45,3 64 PAGENO="0075" permitted by section 2011 even though only a portion of the property subject to Federal tax was taxed by a State. The amount of credit permitted by section 2011 in the case of nonresident aliens should be limited to that portion of the credit allowed the estate which is allocable to property taxed by both the State and the Federal Government. Our gift tax law as it applies to nonresi- dent aliens should be revised. Under pres- ent law a nonresident alien doing business in the United States is subject to gift tax on transfers of U.S. intangible property. This rule has little significance from the stand- point of revenue and tax equity. Therefore, our law should be amended to provide that transfers of intangible property by a nonresi- dent alien, whether or not engaged in bus!- ness in the United States, are not subject to gift tax. Gifts or tangibles situated in the United States which are owned by i~on- resident aliens will continue to be subjeát to U.S. gift taxes. 6. Expatriate American citizens: Subject the U.S. source income of expatriate citizens of the United States to income tax at regular U.S. rates and their U.S. estates to estate tax at regular U.S. rates, where they surren- der their U.S. citizenship within 10 years preceding the taxable year in question unless the surrender was not tax motivated. As a result of the proposed elimination of graduated rates, taken together with the proposed change in our estate tax as it ap- plies to nonresident aliens, an American citi- zen who gives up his citizenship and moves to a foreign country would be able to very substantially reduce his U.S. estate and in- come tax liabilities. While it may be doubted that there are many US. citizens who would be willing to give up their U.S. citizenship no matter how substantial the tax incentive, a tax incentive so great might lead some Americans to sur- render their citizenship for the ultimate benefit of their families. Thus, it seems desirable, if progressive rates are eliminated for nonresident aliens and our estate tax on the estates of nonresident aliens is signifi- cantly reduced, that steps be taken to limit the tax advantages of alienage for our citizens. The recommended legislation accomplishes this by providing that a nonresident alien who surrendered his U.S. citizenship within the preceding 10 years shall remain subject to tax at regular U.S. rates on all income de- rived from U.S. sources. A similar rule would apply for estate tax purposes to the U.S. estates of expatriate citizens of the United States. Thus, the U.~. property owned by ex- patriates would be taxed at the estate tax rates applicable to our citizens (but without the $60,000 exemption, marital deduction and other such provisions applicable to our citi.. cons), in cases where the alien decedent's surrender of citizenship took place less than 10 years before the day of his death. The $30,000 exemption granted nonresident aliens would be allowed to expatriate citizens. To prevent an expatriate from avoiding regular U.S. rates on his U.S. income by transferring his U.S. property to a foreign corporation, or disposing of it overseas, the recommended legislation treats profits from the sale or exchange of U.S. property by an expatriate as being U.S. source income. To preclude the use of a foreign corporation by an expatriate to hold his U.S. property and thus avoid U.S. estate taxes at regular U.S. rates, an expatriate is treated as owning his pro rata share of the U.S. property held by any foreign corporation in which he alone owns a 10 percent interest and which he, together with related parties, controls. Fur- thermore, the recommended legislation makes gifts by expatriates of intangibles sit- uated in the United States subject to gift tax. These provisions would be applicable only to expatriates who surrendered their citizen- ship after March 8, 1965, and would not apply if contravened by the provisions of a tax convention with a foreign country. Moreover, they would not be applicable if the expatriate can establish that the avoid- ance of U.S. tax was not a principal reason for his surrender of citizenship. 7. Retaining treaty bargaining position: Provide that the President be given author- ity to eliminate with respect to a particular foreign country any liberalizing changes which have been enacted, if he finds that the country concerned has not acted to pro- vide reciprocal concessions for our citizens after being requested to do so by the United States. One difficulty which may arise from the. liberalizing changes being proposed in U.S. tax law is that it may place the United States at a disadvantage in negotiating con- cessions for Americans abroad as respects foreign tax laws. Moreover, the failure to obtain concessions abroad may have an effect upon our revenues since the foreign income and estate tax credits we grant our citizens mean that the United States bears a large share of the burden of foreign taxa- tion of U.S. citizens. To protect the bar- gaining power of the United States the Pres- ident should therefore be authorized to reapply present law to the residents of any foreign country which he finds has not acted (when requested by the United States to do so, as in treaty negotiations) to pro- vide for our citizens as respects their U.S. income or estates substantially the same benefits as those enjoyed by its citizens as a result of the proposed legislative changes. The provisions reapplied would be limited to the area or areas where our citizens were disadvantaged. Furthermore, the provi- sions reapplied could be partly mitigated, if that were desirable, by treaty with the other country. It is essential, if we are to revise our sys- tem of taxing nonresident aliens as is being suggested, that this recommendation be adopted. Otherwise, we risk sacrificing the interests of our citizens subject to tax abroad and reducing our revenues in an effort to simplify the taxes imposed upon nonresident * aliens. 8. Quarterly payment of withheld taxes: Provide that withholding agents collecting taxes from amounts paid to nonresident aliens be required to remit such taxes on a quarterly basis. Under the present system, withholding agents are required to remit taxes withheld on aliens during any calendar year on or be- fore March 15 after the close of such year. This procedure varies considerably from that applicable to domestic income tax withheld from wages and employee and employer FICA taxes, where quarterly (in some cases monthly) payments are required. Withholding on income derived by non- resident aliens should be brought more closely into line wtih the domestic income tax system. There is no reason to permit withholding agents to keep nonresident aliens' taxes for periods which may exceed 65 PAGENO="0076" a full year before being required to remit those taxes, when employers must remit taxes withheld on domestic wages at least quar- terly. The Government loses the use of the revenue, which revenue in 1962 exceeded $80 million, for the entire year. Accordingly, section 1461 requiring the return and pay- ment of taxes withheld on aliens by March 15 should be revised to eliminate this spe- cific requirement. The Secretary or his dele- gate would then exercise~ the general author- ity granted him under sections 6011 and 6071 and require withholding agents to re- turn and remit taxes withheld on income derived by nonresident aliens quarterly. However, no detailed quarterly return would be required. * 9. Exemption for bank deposits: Under present law, an exemption from income taxes, withholding, and estate taxes Is provided for bank deposits of nonresident alien individ- uals not doing business in the United States. By administrative interpretation, deposits In some savings and loan associations are treated as bank deposits for purposes of these exemptions, but such exemptions do not apply to most savings and loan associations. There does not appear to be any justification for this distinction between types of savings and loan associations and it should be elimi- nated by extending these exemptions to all* such associations. 10. Foreign tax credit-similar credit re- quirement: Section 901(b) (3) provides that resident aliens are entitled to a foreign tax credit only if their native country allows a similar credit to our citizens residing in that country. Apparently the provision is de- signed to encourage foreign countries to grant similar credits to our citizens. How- ever, this requirement works a hardship on refugees from totalitarian governments. For example,, the Castro government is not con- cerned with whether Cubans in this country receive a foreign tax credit. Therefore, it is recommended that the similar credit require- ment of section 901(b) (3) be eliminated, subject to reinstatement by the President where the foreign country, upon request, re- fuses to provide a similar credit for U.S. citizens. Of course, no request would or- dinarily be made In a case, such as Cuba. where the possible reinstatement of the pres- ent reciprocity requirement would have little or no effect upon the foreign government's policy toward U.S. citizens. 11. Stjtxnp taxes on original Issuances and transfers of foreign stocks and bonds in the United States to foreign purchasers: Our stamp tax on certificates of indebtedness is imposed on issuances and transfers within the territorial jurisdiction of the United States. The stamp tax on issuances of stock does not apply to stock issued by a foreign corporation, but the transfer tax applies to transfers in the United States. These taxes have forced U.S. underwriters who handle issuances of foreign bonds and stocks and their original distribution to foreign pur- chasers to handle closings overseas. In view of the limited association of such issuances and transfers with the United States and the fact that these taxes are ordinarily avoided by moving the transactions outside the United States, our law should be revised to exempt original offerings of foreign issuers to foreign purchasers from our stamp taxes where only the issuances and transfers take place in the United States. Such an exemp- tion would facilitate such transactions and their handling by U.S. underwriters and is consistent ~with our balance-of-payments objectives. [P. 4264) 12. Withhoidlr.g taxes on savings bond In- tercat: The T~yukyu Islandz~ the principal is- land of which Is Okinawa, and the. Trust Territory or the Pacific, principally the Caro- line, Marrhall, and Mariana Islands, although under tho protection and control of the United States, are technically foreign terri- tory. Thus, the islanders are nonresident nliena and subject to a 30-percent with- holding tax on interest on U.S. savings bonds. This interferes with the selling of U.S. savings bonds. Therefore, the 30-per- cent withholding tax as It applies to. the In- terest income realized from U.S. savings bonds by native residents of these Islands should be eliminated. It addition to the changes discussed above, the proposed legislation makes a number of clarifying and conforming changes to pres- ent law. - 66 PAGENO="0077" SECTION 4 PRESS RELEASE OF THE COMMITTEE ON WAYS AND MEANS DATED JUNE 18, 1965, ANNOUNCING INVITA- TION FOR INTERESTED PERSONS TO SUBMIT WRIVFEN STATEMENTS ON H.R. 5916 THE ACT TO REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES (See Section 7 of this document, page 144) PAGENO="0078" PAGENO="0079" SECTION 5 PRESS RELEASE OF THE COMMITTEE ON WAYS AND MEANS DATED JUNE 24, 1965, ANNOUNCING PUBLIC HEARINGS ON H.R. 5916 (See Section 7 of this document, page 145) 69 PAGENO="0080" PAGENO="0081" SECTION 6 REPORT TO THE PRESIDENT OF THE UNITED STATES FROM THE TASK FORCE ON PROMOTING INCREASED FOREIGN INVESTMENT IN UNITED STATES CORPO- RATE SECURITIES AND INCREASED FOREIGN FINANC- ING FOR UNITED STATES CORPORATIONS OPERATING ABROAD (FOWLER TASK FORCE) 71 7 1-297 0-67-pt. 1-6 PAGENO="0082" PAGENO="0083" Report to the President of the United States FROM THE TASK FORCE ON Promoting Increased Foreign Investment In United States Corporate Securities AND Increased Foreign Financing For United States Corporations Operating Abroad 73 PAGENO="0084" PAGENO="0085" CONTENTS Page Terms of Reference III Letter of Transmittal v I. Introduction 1 II. Actions Involving the U.S. Financial Community 5 Seffing U.S. Corporate Securities Abroad 5 Adapting U.S. Corporate Securities to Foreign Markets 9 Seffing U.S. Investment Company Shares Abroad~. 10 Providing Information to Foreign Investors 11 Attracting Foreign Deposits in U.S. Banks.~.. - 13 III. Actions Involving U.S.-Based International Corporations 15 Increasing Foreign Ownership of the Securities of U.S. Corporations 15 Maximizing the Use of Foreign Sources of Debt Financing 18 IV. Actions Involving the U.S. Government 21 Revising U.S. Taxation of Foreign Investors 21 Reducing Restraints on the Sale of U.S. Securities in Other Capital Markets 30 V. Conclusion 35 (I) 75 PAGENO="0086" PAGENO="0087" TERMS OF REFERENCE As one of 10 actions in his program to reduce the deficit in. the U.S. balance of payments and defend U.S~ gold reserves, President Kennedy, on October 2, 1963, appointed this Task Force and charged it with developing programs in the three following areas: (1) A broad and intensive effort by the U.S. financial com- munity to market securities of U.S. private companies to foreign investors, and to increase the availability of foreign financing for U.S. business operating abroad; (2) A review of U.S. Government and private activities which adversely affect foreign purchases of the -securities of U.S. private companies; and (3) The identification and critical appraisal of the legal, administrative, and institutional restrictions remaining in the capital markets of other industrial nations of the free world which prevent the purchase of U.S. securities and hamper U.S. companies in financing their operations abroad from non-U.S. sources. In December 1963, President Johnson reaffirmed President Ken- nedy's charge to the Task Force and asked that its report be sub- mitted to him. (Ifi) 77 PAGENO="0088" PAGENO="0089" LETTER OF TRANSMITTAL Ar~n. 27, 1964. DEAn Mn. PRESIDENT: As charged by President Kennedy and reaffirmed by you, we have examined ways and means of promoting increased foreign investment in the securities of U.S. private companies and increased foreign financing for U.S. business operating abroad. Herewith we submit our views as to the nature of the prob- lems, the obstacles to be surmounted, and our recommendations for actions by the private sector and the Government. We have endeavored to limit our recommendations to measures which we believe can produce tangible results within at least the medium term. It should be recognized that no single recommendation of ours can be expected to have a sudden or dramatic effect on the balance of payments. Carrying out our reconunendations will require a broad range of actions by U.S. international business organiza- tions and U.S. financial firms, the executive branch of the Govern- ment and the Congress. Efforts by the United States to attract and retain foreign investment can succeed, we believe, only if they occur within a framework of sound U.S. fiscal and monetary policies. Confident that the programs which we recommend can contribute to reducing the deficit in our international transactions, we pledge our own best efforts toward achieving their success. Very respectfully yours, HENRY H. FOWLER, Chairman. ROBERT M. MCKINNEY, Executive Officer. CHARLES A. COOMBS. FREDRICK M. EATON, G. KEITH FUNSTON. GEORGE F. JAMES. GEORGE J. LENESS. ANDRE MEYER. DORSEY RICHARDSON. ARTHUR K. WATSON. WALTER B. WRISTON. JOHN M. YOUNG. RALPH A. YOUNG. THE PRESIDENT, The White House. (V) 79 PAGENO="0090" PAGENO="0091" I. Introduction The magnitude and persistence of past U.S. balance-of-payments deficits, accompanied by large gold losses, have been of increasing concern both to the public and private sectors of our country. This situation, if allowed to continue indefinitely, would endanger our in- ternational financial position. During the past 9 months there has been an improvement in our balance of payments. Since some of this improvement may be only temporary, the importance of dealing with the basic factors involved in the problem is in no way diminished. Significantly, our balance-of-payments deficit does not arise because of any general inability to compete in international markets. Indeed, we have had a large export; surplus of commercial goods and services. However, this surplus, which includes the current return from U.S. foreign investments, has not been large enough to offset our Govern- ment expenditures abroad for defense and for economic aid, together with our outflow of new private capital. That our exports of capital-especially in the form of long-term investment-have been on a large scale is natural. The U.S. economy generates a large volume of savings. No other country has a com- parable capacity to supply capital both at home and abroad. As a result, the United States has supplied much of the free world demand for capital throughout the postwar period. Returns from these in- vestments, already a major favorable element in our balance of pay- ments, will be even more important in the future. Nevertheless, concentrated outflows of private capital can create severe difficulties, even for a country with the financial strength of the United States. Difficulties arise particularly when such capital movements occur at a time when the dollar is already under pressure for other reasons. The United States experienced such a combination of conditions in 1962 and early 1963. This created a situation which-had it been permitted to continue unchecked- could have imperiled the stability of the dollar and, hence, of the international monetary system. These conditions led to a series of actions by the U.S. Govern- ment in July 1963. This program included measures to: (1) raise short-term interest rates, (2) reduce further Government expendi- tures overseas, (3) expand commercial exports, (4) increase for- eign tourism in the United States, and (5) finance the balance-of-pay- (1) 81 PAGENO="0092" ments deficit in ways that result in a minimum drain on our gold stock. In addition, the President requested congressional approval of the pro- posed interest equalization tax on purchases of foreign securities by U.S. residents, designed as a temporary expedient to stem the accelerat- ing outflow of private capital into foreign portfolio investments. In his message presenting this program, President Kennedy an- nounced his decision to create this Task Force and set forth its terms of reference. In carrying out its assignment, the Task Force called for advice and assistance from major segments of the U.S. industrial and financial communities. The counsel received from representatives of investment banking and brokerage firms, securities exchanges, investment companies, commercial banks and industrial corpora- tions has contributed greatly to the effectiveness and realism of the Task Force's deliberations. The purpose of our report is to set forth actions which we recoin- mend be taken by the U.S. private sector and the U.S. Govermnent, designed- 1. To improve the U.S. balance of international payments by increasing foreign investment in U.S. corporate securities; 2. To guide U.S.-based international corporations into making increased use of the poois of savings now accumulating in in- dustrial nations in which they do business; and 3. To help establish conditions under which restraining in- fluences on capital flows between the industrially advanced countries-including the proposed U.S. interest equalization tax-can be removed, diminished or allowed to expire. Because of the favorable prospects for the U.S. economy, some of the savings accumulated in other industrial countries are flowing here for investment. It is not unreasonable to expect that this flow could be increased, particularly if U.S. taxation of foreign investors and other inhibiting factors were alleviated and our private selling efforts reinforced. The incentives and influences governing international capital flows are, however, complex and not wholly predictable. Habits and fears derived from a lifetime of experience with wars, inflation, depressions, and crises are at least as important in influencing investment decisions as are the day-to-day movements of security prices, dividend rates and economic indicators. Against this background, the main concern of the Task Force has been to satisfy itself that its recommendations will operate in the right direction, and as promptly as possible. 2 82 PAGENO="0093" The findings and recommendations of this reporf are directed to four main areas: First, the U.S. financial community; that is, investment banking and brokerage firms, commercial banks, investment companies and securities exchanges. Second, U.S. industrial corporations with substantial opera- tions overseas. Third, U.S. taxation of foreign investors in U.S. securities and the clarification of questions which have arisen in connection with the administration of Federal securities laws. Fourth, the reduction-or elimination, where circumstances permit-of monetary, legal, administrative and institutional re- strictions abroad which inhibit investment by foreigners in the securities of U.S. corporations and which hamper U.S. com- panies in financing their oversea operations from foreign sources. 3 83 PAGENO="0094" PAGENO="0095" II. Actions Involving the U.S. Financial Community This section of the report presents our views as to measures which the U.S. securities industry-brokers, dealers, investment bankers, se- curities exchanges, and investment companies-and commercial banks, in cooperation with U.S. corporations whose shares are publicly held, can take to increase the ownership of U.S. corporate securities by investors in the other industrial nations of the free world. Direct ownership of equity securities by the public is not nearly so broad in other countries as in the United States. Foreigners owning U.S. securities tend to be wealthy, sophisticated investors. In most countries facilities for serving a broad investing public have not been developed as intensively as in the United States. Most investors abroad encounter difficulty in obtaining information about companies and securities. Securities transactions are generally handled through banks, which make little or no effort to encourage equity investment by customers with small accounts. Indirect ownership of equities through institutions, such as pension and insurance funds, is at a less- developed stage abroad than in the United States; moreover, the num- ber and size of such institutions are considerably smaller than in the United States. Despite these circumstances, we believe foreign pur- chases of U.S. securities can be significantly expanded. Our recommendations here are concerned with (1) selling U.S. cor- porate securities abroad, (2) adapting U.S. corporate securities to for- eign markets, (3) selling U.S. investment company shares abroad, (4) providing information to foreign investors, and (5) attracting foreign bank deposits. Selling U.S. Corporate Securities Abroad Recommendation No. 1: U.S. investment bankers and brokerage firms should intensify their efforts to develop facili- ties for reaching foreign investors directly. Recommendation No. 2: U.S. investment bankers and brokerage firms should seek modification of foreign regulations and practices which unduly restrict the ability (5) 85 PAGENO="0096" of U.S. firms to promote the sale of U.S. securi- ties or to deal directly with potential foreign customers. Foreigners may buy U.S. corporate securities by: (1) placing orders with foreign banks or brokers, who in turn may either place the orders with U.S. firms for execution in the U.S. market or execute the orders on a foreign exchange or in the foreign over-the-counter market; or (2) placing orders directly with brokers in the United States or with their oversea offices for execution in the United States. However, not all of these channels are open in all countries. Despite the recent growth in offices of U.S. brokerage firms abroad, sales efforts by U.S. brokers are hampered in most for. eign countries *by restrictions on advertising or direct approaches to potential investors. In some countries, U.S. brokerage firms are prohibited from soliciting securities business of any kind. In others they are permitted to deal only with banks. Opportunities may exist to open new channels for dealing di- rectly with the local investing public. Every effort should be made to find and utilize such opportunities, even though it may require modification of established practices or governmental regu- lations. Recommendation No. 3: U.S. investment bankers and brokerage firms, with the cooperation of interested U.S. corpora- tions, should endeavor to obtain shares of U.S. corporations for distribution abroad. In certain cases it may be possible for U.S. securities firms to obtain blocks of U.S. securities for distribution exclusively abroad. Distri- bution abroad may involve a greater amount of time and effort and, possibly, greater compensation to foreign broker-dealer firms than would distribution in the United States. However, as pointed out be- low, certain circumstances may be present which would significantly increase the attractiveness of exclusive oversea distribution. One source of such blocks would be outstanding securities that would have to be registered with the Securities and Exchange Commission (SEC) if sold in the United States. However, because of the time and expense involved, or for other reasons, it may not be desirable to register such blocks. Holders of such securities might prefer to have U.S. securities firms undertake distribution abroad, and thus avoid the inconvenience and cost of registration with the Securities and Ex- 6 86 PAGENO="0097" change Commission. U.S. corporations could cooperate by directing attention of large stockholders to the possible advantages of selling blocks in foreign markets. Where the expenses can be justified by sound business purposes, in- terested IJ.S. corporations might be willing to absorb costs of distribut- ing their shares abroad. In such circumstances, blocks of shares could be provided by two means: First, corporations wishing to raise addi- tional capital could, where feasible, issue new shares for sale abroad. Second, corporations which consider it advantageous and prac- tical to have increased foreign ownership of their shares, but which do not need new capital, might have blocks of their outstanding shares acquired in the open market for eventual redistribution abroad. It would be shortsighted, however, to take advantage of lack of regulations in other countries comparable to those of the Securities and Exchange Commission in the United States. As long as ade- quate disclosures are made when issues are being offered abroad, there should be no need to go through the formality and expense of regis- tration in the United States. Recommendation No. 4: The Securities and Exchange Commission should issue a release setting forth the circuin- stances under which it would normally issue a "no action" letter providing that no registra- tion be required on public offerings of securities outside of the United States to foreign pur- chasers, including dealers. The Securities and Exchange Commission heretofore has been helpful in issuing "no action" letters in individual cases when the facts permitted. If a general policy could be set forth, however, it would clarify the position of the Commission in this regard and facilitate the activities of U.S. investment bankers in foreign markets. It would also be helpful if such a policy statement indicated that (1) a simultaneous private placement of the same securities in the United States would not prevent the issuance of a "no action" letter, and (2) the sale could be conducted from and closed in the United States. Recommendation No. 5: The Securities and Exchange Commission should issue a release eliminating the require- 7 87 7 1-297 0-67-pt. 1-7 PAGENO="0098" ment that foreign underwriters participating exclusively in distributions of securities to non- residents of the U.S. register as broker-dealers. Foreign securities dealers are often asked to participate in a U.S. underwriting or selling syndicate. Although the Securities and Exchange Commission has attempted on a case-by-case basis to free such foreign dealers from the necessity to register as broker-dealers, enough uncertainty remains to make this situation an impediment to the successful distribution of U.S. securities abroad. There should be no requirement for foreign brokers to register even though they may belong to an underwriting or sell- ing group, other members of which are engaged in the distribution of the same securities in the United States. Recommendation No. 6: U.S. investment bankers should include foreign banks and securities firms as underwriters, whenever possible, or as selling group members in new offerings and secondary distributions of either domestic or foreign securities. The inclusion of foreign banks and securities firms as members of the underwriting groups for domestic or foreign securities would directly involve them in the responsibility for the success- ful distribution of a portion of the offerings abroad. Recommendation No. 7: U.S. investment bankers and brokerage firms should organize the underwriting and distribu- tion of dollar-denominated foreign securities issues so that the maximum possible amount is sold to investors abroad. In the past several years, sales to foreigners of new securities issues underwritten in the United States have been primarily for- eign government and foreign corporate bonds (including converti- ble debt securities) denominated in U.S. dollars. Since the pro- posal of the interest equalization tax, however, such issues in the U.S. capital market have been practically nonexistent. When final action has been taken on the tax and the market for newly issued foreign securities reopens, U.S. investment bankers should endeavor 8 88 PAGENO="0099" to place the largest possible proportion of these securities abroad in order to minimize the impact on our balance of payments. (From the standpoint of the foreign borrower whose securities are subject to the interest equalization tax, this will reduce the amount of the issue subject to the tax.) Similar efforts should be made with respect to foreign securities offered in the TJ.S. market which are exempt from this tax. Recommendation No. 8: U.S. commercial banks should intensify efforts to attract foreign trust accounts for investment in U.S. corporate securities. Typically, trust accounts of foreigners managed by U.S. com- mercial banks are invested in U.S. securities; thus their growth is a positive factor in our balance of payments. New trust ac- counts could be solicited by: (a) more intensive use of foreign branches for this purpose; (b) oversea sales visits by trust officers; and (c) establishment of oversea trust companies or related facilities. Recommendation No. 9: The Securities and Exchange Commission should serve as an information center regarding listing requirements, and distribution regulations and practices abroad. The Securities and Exchange Commission has expressed to the Task Force its willingness to serve as a clearinghouse for in- formation on relevant foreign securities laws and practices and on issuers' experiences in selling securities overseas. Adapting U.S. Corporate Securities To Foreign Markets Recommendation No. 10: Major U.S. corporations should arrange for U.S. banks and trust companies to issue, through their foreign branches and correspond- ents, depositary receipts for U.S. corporate shares. The Task Force believes that depositary receipts in bearer or registered form, which would be "good delivery" internationally, would be useful in facilitating foreign investment in U.S. cor- 9 89 PAGENO="0100" porate securities. Trading of depositary receipts on foreign stock exchanges would be facilitated by having them (1) denominated in fractions of whole shares, thus bringing the unit prices closer to those customary in foreign markets, and (2) printed in the language of the country in which they are to be traded. The costs of the depositary receipts now available to European investors are borne by the holders. Corporations whose securities are already available in depositary receipt form, or who wish to initiate depositary receipt arrangements, should consider absorb- ing some of the costs of the service. Some foreign corporations whose shares are traded in the United States in the form of American Depositary Receipts presently bear such costs. Selling U.S. Investment Company Shares Abroad Foreign holdings of U.S. investment company shares have shown a steady increase over the years. initial foreign participation was primarily through purchase of shares of closed-end investment com- panies. A few of these have had, and continue to have, substantial foreign shareholders; some are listed on European stock exchanges. With the cooperation of the companies concerned, foreign interest in this medium for investment in the U.S. economy can be increased. Since the foreign distribution of U.S. open-end investment com- pany (mutual fund) shares is largely through banks and brokers, op- portunities for direct solicitation by the issuers are limited. A few specialized U.S. sales organizations solicit foreign investors directly, primarily in countries without developed financial institutions. Recommendation No. 11: U.S. investment companies should plan and carry out a program to acquaint foreign investors with the advantages of owning U.S. closed-end invest- ment company shares. Recommendation No. 12: Distributors of U.S. open-end investment com- pany shares should devise methods for achieving additional foreign distribution of such shares, where locally permitted. Recommendation No. 13: U.S. investment company distributors should seek the modification of foreign regulations and practices which restrict the availability of their shares to foreign investors. 10 90 PAGENO="0101" 1?ecorn'm~endation No. 14: U.S. closed-end investment companies should seek to place original and secondary offerings of their shares with foreign investors and, where feasible, list these shares on major foreign exchanges. The Investment Company Institute has agreed to inform its member companies of the objectives of this Task Force, suggesting that they undertake more active study of foreign distribution opportunities. Some foreign banks and securities dealers on which U.S. investment companies depend for distribution offer shares of their own investment companies. Nevertheless, there are banks and other potential dis- tributors in Europe and elsewhere who do not have competitive issues to offer. More aggressive search for such distributors would un- doubtedly develop additional sales. In addition, the Institute is studying the feasibility of a detailed country-by-country review of legal, tax, and registration requirements to assist the educational and promotional efforts of U.S. mutual fund sponsors. It is also considering translation into foreign languages of basic materials describing investment companies. Providing Information to Foreign Investors The flow of information on securities markets and individual cor- porations which the U.S. public receives as a matter of course from the press, radio, brokerage firms, advisory services, and directly from companies is unique. Abroad, comparable information is not readily available. Thus information disclosed by publicly owned U.S. cor- porations is one of our most effective potential aids as we seek to channel a growing share of foreign savings into U.S. investments. Recom1mendation No. 15: In order to promote the purchase of U.S. cor- porate securities abroad- (a) the U.S. financial community should cooperate closely with major U.S. corporations in the dissemination of corporate reports in for- eign languages and in the publication of finan- cial data in foreign newspapers; (b) U.S. investment bankers and broker- age firms should prepare research and statistical reports in foreign languages for distribution to foreign investors through local banks and secu- 11 91 PAGENO="0102" rities firms and promote the publication of more detailed U.S. stock market and financial infor- mation in the foreign press; (c) facilities of U.S. commercial banks should be fully utilized to distribute to foreign financial institutions and investors reports, pref- erably in foreign languages, on the U.S. econ- omy; (d) U.S. securities exchanges should take advantage of new communication techniques and reduced rates to promote broader use abroad of stock quotation and financial news services; (e) U.S. investment bankers and brokerage firms should offer securities orientation and `sales training programs to personnel of foreign banks and securities firms; and (f) U.S. investment bankers, brokerage firms and securities exchanges should work with their foreign counterparts and the foreign press to broaden share ownership by foreign investors. Some U.S.-based international companies already publish reports in foreign languages. Distribution of reports directly to investors abroad is more difficult than in the United States, however, and is complicated by the predominant foreign practice of not regis- tering shares in the names of beneficial owners. Consequently, it is necessary for such companies to work closely with foreign banks to insure that their reports reach the actual shareowners. Com- panies also should take particular care to include the foreign news services and the foreign press in news distributions. U.S. securities firms are an important channel abroad for market information on U.S. securities. But since local regulations or traditions limit their ability to reach the public directly in' many countries, U.S. firms now concentrate their efforts on supplying material to foreign banks and brokers. Still missing, however, is a means for providing broader circulation of U.S. market news to the general public abroad. To ifil the requirement, U.S. securi- ties firms with foreign offices should supply local newspapers with abridged tables of prices of U.S. securities converted to local cur- rencies. They should ascertain and provide the type of daily market news foreign papers will publish. U.S. commercial banks now do a thorough job of keeping U.S. firms informed of financial conditions abroad. Beyond this, they 12 92 PAGENO="0103" should intensify their efforts to acquaint foreigners with the general desirability of investing in the United States. The full stock ticker service, which until now has been pro- hibitively expensive outside the United States and Canada, is making its appearance overseas. Because up-to-the-minute price information is a necessary brokerage service, this should encourage foreign investment in U.S. securities. Personnel of foreign banks and brokerage firms who deal di- rectly with ultimate purchasers abroad often have little knowl- edge of U.S. securities or U.S. market procedures. Representa- tives of U.S. international securities firms should consider offering such personnel condensed versions of the training given registered representatives in the United States. Educational programs designed to broaden share ownership would be advantageous to all industrialized countries. Here the U.S. securities industry can play a constructive role, both directly and by assisting their foreign counterparts in devising, and con- ducting their own information programs. Attracting Foreign Deposits in U.S. Banks Recommendation No. 16: The Congress should adopt legislation discon- tinuing mandatory regulation of maximum in- terest rates on domestic and foreign time deposits. Recommendation No. 17: Pending adoption of such legislation, the Federal Reserve Board of Governors should administer Regulation Q in a flexible manner permitting U.S. commercial banks to meet internationally competitive interest rates on both domestic and foreign time deposits. Foreign time deposits with maturities exceeding 1 year in U.S. banks are similar to foreign purchases of long-term securities in their effect on the U.S. balance of payments. Encouraging such deposits thus is clearly within the terms of reference of the Task Force. While an increase in short-term deposits in the United States by foreigners would not reduce the U.S. payments deficit as cus- tomarily defined, it would tend, at least temporarily, to reduce the volume of liquid dollar assets that foreign central banks might use to buy gold. 13 93 PAGENO="0104" Similarly, greater short-term investment in this country by U.S. residents and corporations who would otherwise place their funds abroad would directly reduce the U.S. payments deficit. The growth in time deposits in U.S. banks in recent years has reflected increases in rates paid on such deposits, following increases in the maximum rates under regulations of the Federal Reserve Board of Governors and the Federal Deposit Insurance Corporation. Foreign official time deposits have likewise risen substantially since their exemption from regulation in October 1962. The objective of increasing commercial banks' ability to com- pete for foreign time deposits could be enhanced either (1) by legislation completely abolishing the power of the Board of Gov- ernors of the Federal Reserve System to regulate maximum in- terest rates on time deposits, or (2) by placing that authority on a standby basis, as the present administration has proposed. Members of the Task Force are divided in their opinion as to which of these alternatives should be used to achieve this ob- jective; hence no recommendation as between these alternatives is made. 14 94 PAGENO="0105" III. Actions Involving U.S.-Based International Corporations Dividends, interest, and other receipts from existing U.S. direct investments abroad have, in recent years, been about twice as large as our new direct investment outlays in foreign countries. It is clear, therefore, that foreign operations of U.S.-based international corporations are already making an important positive contribution to the U.S. balance of payments. Nevertheless, for limited periods of time and with respect to certain areas of the world, our outflows of capital can exceed our receipts from those areas. Hence, it is also clear that programs designed to (1) increase foreign ownership of the shares of U.S. corporations and (2) maximize the use of for- eign sources of finance can increase the overall positive contribu- tion which U.S.-based international corporations make to the U.S. balance of payments. We set forth below specific programs we believe will be of inter- est to managements of international corporations based in the United States. These programs are not presented as detailed pre- scriptions for action, since the complexity of the subject matter makes that impossible. Rather, they are suggested as general pro- cedures which might prove feasible under certain circumstances. Increasing Foreign Ownership of the Securities of U.S. Corpora- tions Increasing foreign ownership of the securities of U.S. corporations will require initiatives by both the U.S. private and public sectors. In section II we have discussed actions by brokerage and investment banking firms, investment companies, commercial banks, and the se- curities exchanges. In this section we take up actions by the corpora- tions themselves. Recommendation No. 18: U.S.-based international corporations should con- sider the advantages of increased local owner- ship of their parent company shares in countries in which they have affiliates. (15) 95 PAGENO="0106" Recommendation No. 19: Where consideration under Recommendation No. 18 above is favorable, corporations should col- laborate with the U.S. ftnancial commuuity in encouraging greater foreign ownership of their shares. In addition to the balance-of-payments impact, there is yet an- other dimension to the role of free world international corporations, wherever based. Through their plants, distribution facilities and other business operations, strong local relationships have been de- veloped to encourage and support their growth. These relations would be further strengthened if they were extended to include that of corporation to stockholder. Recommendation No. 20: U.S. securities exchanges should submit a plan acceptable to the Securities and Exchange Com- mission permitting U.S.-based international cor- porations to encourage foreign ownership of their stock. Under this plan, which would be publicly announced and open to all brokers, a corporation would be permitted to pay whatever compensation is necessary to achieve distribution of its securities abroad. The broker receiving the compensation would be per- mitted to pay all or part of such compensation to the employee or foreign broker producing the order. Once initiated, such a plan would continue until terminated by the corporation. Recommendation No.21: The Treasury Department should issue a ruling that would establish the tax deductibility of costs incurred by U.S. corporations in arranging for se- curities firms to place their securities outside the United States as part of programs to improve their oversea relationships. The Task Force recognizes that any plan undertaken by a corpora- tion to distribute its shares abroad would involve certain costs. How- ever, in many cases, the good will which would be created by corpora- tions having a substantial number of shareholders in other countries where they do business might be considered to justify the costs. Since many U.S. corporations have already adopted programs in the nature 16 96 PAGENO="0107" of institutional advertising, designed ~o improve their oversea rela- tionships, it would appear that any expenses incurred in encouraging securities firms to place stock overseas as a part of these programs should be appropriate deductions from taxable income as ordinary andnecessary business expenses. Recommendation No. 22: Corporations should collaborate with U.S. invest- ment bankers in the utilization by the latter of techniques for distribution abroad of new or sec- ondary issues of their stock. Some corporations may find that there are advantages in having blocks of their stock sold abroad. U.S. investment bankers can sug- gest a variety of means by which such blocks can be made available for distribution abroad. The cooperation of the U.S. corporations involved is essential to the success of such a distribution. Recommendation No. 23: U.S. corporations should offer their shares to em- ployees in foreign countries where stock purchase, supplemental compensation or other incentive plans are feasible and desirable. Many U.S. corporations encourage employee ownership of parent company shares; some offer financial incentives to promote such ownership by their oversea employees. Most cQuntries permit such plans, although some restrict purchase of foreign shares by their na- tionals. Where savings plans for foreign employees are currently in force or are under ~onsideration, parent company stock could form an important feature of such plans, subject, of course, to local regu- lations. Funded pension plans of foreign aflhiates may also offer scope for greater investment in U.S. securities. Many foreign nationals employed by U.S. companies abroad may be unfamiliar with shares but may have had experience with interest- paying investments. Hence, convertible bonds of the parent com- panies or of their subsidiaries would be in some `cases attractive in- struments for employee savings plans. Recommendation No. 24: U.S.-~based international corporations should consider the advantages of listing their shares on foreign stock exchanges. 97 PAGENO="0108" Many large U.S. corporations are not listed on foreign stock ex- changes; other U.S. companies are listed on exchanges of some coun- tries but not on others. Although most foreign trading in listed U.S. corporate securities will probably continue to take place on exchanges in New York, listing of such securities on foreign securities exchanges should stimulate their purchase by foreigners. Financial and other information regarding U.S. corporate issuers derived from listing applications and reporting requirements would be disseminated abroad in local languages. Also, listing would assist in creating local markets for such securities, an important consideration in connection with local public offerings or large private placements of securities. After initial holdings of their stock abroad have been estab- lished, U.S.-based international corporations should make every effort to insure adequate continuing local markets for the shares. Maximizing the Use of Foreign Sources of Debt Financing Foreign debt financing raises fewer policy issues for U.S. cor- porations with foreign subsidiaries than does the issuance and sale of equity securities. The primary factors to be considered are the relative availability of loan funds, the costs of such financing considered in conjunction with exchange risks, and the basic char- acteristics of local sources of finance. Many countries strictly limit access to their capital markets by all borrowers. They also limit the amount of credit even if access is gained. It should be emphasized, however, that these limita-. tions are less severe with respect to local companies, even though they may be affiliates of U.S. parent corporations. Generally speaking, the level of interest rates and other financ- ing costs tend to be higher abroad. These costs and other limita- tions have been of greater importance in long-term debt issues than in short- and medium-term financing from banks and other financial institutions. Accordingly, many oversea subsidiaries have relied on short-term financing to a greater degree than would be considered sound financial practice in domestic operations. Such short-term loans are actively sought by foreign banks and foreign affiliates of U.S. banks, within the limits of available funds and local government policies. These banking connections have become important sources of local influence and information for U.S. business firms operating abroad. Oonsequently, they are often relied on even where costs may be somewhat higher than for other sources of financing. In this connection, the Task Force notes that the ability of over- sea branches and affiliates of U.S. banks to provide foreign debt financing is enhanced by making Public Law 480 and other counter- .18 98 PAGENO="0109" part funds available to such branches and affiliates. This practice, already of long standing, should be encouraged to the greatest extent feasible consistent with other objectives of the program, where possible placing such funds on a long-term basis and thereby facilitat- ing badly needed capital loans. Recommendation No. 25: U.S.-based international corporations should in- struct their senior officers and policy groups to keep foreign financial operations under constant review, examining as standard procedure all pro- posals for new financing from the standpoint of the effect of their actions on the U.S. balance of payments. With achievement of a high degree of convertibility and the diminution of exchange risks, the incentives for maximizing for- eign sources of financing are not as strong as several years ago. Nevertheless, we believe that the introduction of U.S. balance-of- payments considerations into all corporate financial decisions could do much to increase corporate borrowing abroad. All corporations operating abroad, as a matter of routine, rely on normal trade credits, accrued tax liabilities, and other sources of work- ing capital not involving borrowing. These sources are significant and opportunities for further expansion should be actively sought. Recommendation No. 26: U.S.-based international corporations should, where feasible, finance their foreign operations in a manner which minimizes the outlay of cash. The use of securities where foreign properties are being acquired improves the balance of payments to the extent that it reduces the immediate outflow of cash funds from the United States or avoids the use of funds which otherwise might be remitted to the United States. Many governments actively solicit the establishment of foreign firms in developing regions. Special inducements are offered, such as low rentals for new plant facilities, tax advantages, and attractive local financing. By taking advantage of these oppor- tunities, U.S. companies planning to produce abroad can reduce the need for capital funds from the United States. U.S. corporations investing overseas should examine the possi- bility of utilizing foreign currency loans (the so-called "Cooley Loans") made available in certain countries by the U.S. Govern- 19 99 PAGENO="0110" mont out of receipts from the sale of surplus agricultural com- modities under Public Law 480. Recommendation No. 27: In eases where new capital is required, U.S.- based international corporations should consider, in appropriate cases, broadening local ownership by offering in foreign capital markets bonds or preferred stock of their local affiliates convert- ible into common shares of the U.S. parent cor- poration. Convertible securities should appeal to foreign investors because they can be designed to provide-in addition to conversion privi- leges-the interest rate, maturity, sinking fund, redemption, and other provisions conforming to the local markets' requirements. Whether converted or not, and whether issued in dollar denomina- tions or in the currency of a foreign country, the sale of such securities would reduce the amount of direct dollar investment by U.S. parent companies. As the issuer of the securities would be a foreign subsidiary, a foreign purchaser would be free of U.S. tax on the dividends or interest payments, although shares issued on con- version would be those of the U.S. parent. Recommendation No. 28: U.S.-based international corporations should be encouraged to make available, through trade or banking chaimels, specific case studies of foreign financing operations to small- or medium-sized U.S. firms interested in foreign operations but less aware of foreign financing opportunities. As we have seen, commercial banks and agencies of foreign govern- ments provide U.S. firms with information on foreign financing. In- dustrial corporations and trade associations through well-organized programs could supplement this information by providing special information for U.S. firms planning to operate abroad. Specific case studies of foreign financing operations of individual industrial cor- porations could be distributed by the corporations themselves or by business schools and business and financial organizations. Such studies would also be appropriate for seminars in schools of business administration. They would be invaluable to small- and medium- sized corporations which may be less aware of the opportunities for foreign financing and its implications for the U.S. balance-of-pay- ments problem. 20 100 PAGENO="0111" IV. Actions Involving the U.S. Government Efforts by the private business community to market U.S. corporate securities to foreign investors and to increase the availability of for- eign financing for U.S. corporations operating abroad should be ac- companied by U.S. Government efforts to reduce existing deterrents to these activities which arise from practices, regulations, and law here and abroad. Preceding sections of this report have referred to specific areas where the modification of U.S. laws and Government practices-as administered by the Treasury Department, the Securities and Ex- change Commission, and the Federal Reserve Board-would facilitate private programs. In this section, we recommend revision of U.S. taxation of foreign investors in U.S. securities. The Task Force wishes to stress that no tax concessions to U.S. corporations or individuals `are recommended. Our recommendations here relate solely to the removal or reduction of obstacles to foreign investment in U.S. securities. The U.S. Government should take appropriate action where monetary, legal, administrative, and institutional restrictions in other countries inhibit the purchase of U.S. corporate securities by foreign investors and hamper U.S. companies in financing their oversea operations from foreign sources. Primarily, this will, involve diplomatic initiatives, either bilaterally. or multilaterally. This section will also identify foreign governmental restraints and practices to which diplomatic initiatives should be addressed. As might be expected, views held by various members of the Task Force reflect the division of opinion over the desirability of the inter- est equalization tax, fully developed in hearings before the House Ways and Means Committee. It does not seem necessary to review these differences here; nevertheless, nothing said or unsaid in this report is intended to represent any departure from the views individ- ual members may continue to hold on this subject. Revising U.S. Taxation of Foreign Investors Revision of U.S. taxation of foreign investors is one of the most immediate and productive ways to increase the flow of foreign capital to this country. (21) 101 PAGENO="0112" Our recom.mendations for changes in taxation of foreign investors are intended to remove a number of elements in our tax structure which unnecessarily complicate and inhibit investment in U.S. cor- porate securities without generating material tax revenues. They are not intended to turn the United States into a tax haven, nor to drain funds from developing countries. Basic Provisions in Internal Revenue Code for Taxation of Non- resident Alien Individuals and Foreign Corporations Except as provided in tax treaties with cerfain countries, nonresi- dent alien individuals not engaged in trade or business in the United States are taxed at a minimum of 30 percent on (a) dividends, inter- est, and other periodic income from U.S. sources, and (b) capital gains in the United States under the circumstances specified below. This 30-percent tax is applied against gross income and is withheld at the source, except in the case of taxable capital gains and other minor exceptions. If such gross income from U.S.. sources in any year ex- ceeds $19,000,1 nonresident alien individuals are required to compute the tax on their U.S. source net income at regular rates if this method of computation yields a higher total tax than the minimum 30 percent tax on gross income. Nonresident alien individuals engaged in trade or business within the United States are, in general, subject to tax on all their U.S. source income, including capital gains (whether or not derived from the conduct of such trade or business) on the same basis and at the same rates as U.S. citizens. Nonresident alien individuals not engaged in trade or business in the United States are taxed, at rates specified above, on capital gains realized in the United States if they are (a) physically present in the United States for 90 days or more during a taxable year, or (b) physically present in the United States when the gain is realized. * The U.S. property of nonreside,nt alien decedents (which by definition includes shares of U.S. corporations) is subject to U.S. estate tax at normal rates. Foreign corporations engaged in trade or business in the United States are taxed on all of their U.S. source income, whether or not derived from the conduct of such trade or business, on the same basis and at the same rates as domestic corporations. For- eign corporations not engaged in trade or business within the United States are taxed at a fiat rate of 30 percent on the gross amount of dividends, interest, and other periodic income received from U.S. sources, but are not taxed on capital gains. In addition, any foreign corporation meeting the personal holding company tests is subject, with certain exceptions, to a 1 $Z1,200 in 1965 and thereafter. 102 PAGENO="0113" tax of 70 percent on its undistributed personal holding company income. Moreover, if any such corporation derived more than 50 percent of its gross income for a 3-year period from U.S. sources, that percentage of its dividends equal to the percentage of its gross income derived from U.S. sources is treated as U.S. source income to the shareholders themselves and taxed accordingly. Reciprocal tax treaties in effect with most of the industrialized countries of the world modify the basic provisions of the Internal Revenue Code which are summarized above. Most of the treaties reduce the rate of withholding tax on dividends and interest paid to residents (both individuals and corporations) of the treaty country. Typically the rate is reduced from 30 percent to 15 percent on dividends and from 30 percent to 15 percent, or in some cases zero, on interest. The provisions for progressive taxa- tion of individuals whose income from U.S. sources in any year exceeds $19,000 generally are eliminated. Certain treaties elimi- nate capital gains tax liability. Most of the benefits available to foreign investors under the treaties are restricted to residents of the treaty country who are not engaged in trade or business within the United States through a permament establishment. Specific Recommendations Our recommendations have been conceived as a package, designed in part to simplify the tax laws and reporting requirements applicable to foreign investors, in part to reduce taxation of foreign investors and in part to make evident to the world that the United States welcomes foreign investment. To the degree that the package approach is discarded and the package is broken down into its components, some being accepted and other rejected, more of the potential impact will be lost than might necessarily be ex- pected by analysis of the financial effect of any particular proposal. The major source of U.S. tax revenue from foreign investors is the withholding tax currently imposed on dividends and interest paid such investors by U.S. corporations. We have not recom- mended the removal of, or a reduction in, this tax. Thus adop- tion of our recommendations would not materially reduce tax revenues and would leave intact the major bargaining point for the United States should it desire in the future to negotiate new or modified reciprocal tax treaties with other countries. The withholding tax on dividends and interest, in some cases, certainly deters investment by foreigners in the United States, and the different rates of withholding tax provided by the Code and the various treaties are a source of confusion. The United States should, however, first attempt to attract foreign investment by 23 71-297 O-67-pt. 1-8 103 PAGENO="0114" attacking the several areas of taxation that deter investment without generating material revenues. Adoption of our recommendations would not eliminate the need to extend and modernize our tax treaties. Among other desirable changes: the United States should work for the reciprocal reduc- tion of withholding taxes on dividends and interest and toward reciprocal elimination of all taxes on the income of pension trusts and similar investors that are exempt from tax in their country of residence. Such changes will, however, take time. Recommendation No. 29: Eliminate U.S. estate taxes on all intangible personal property of nonresident alien dece- dents. U.S. estate taxes, especially as applied to shares of U.S. corpora- tions owned by nonresident alien decedents (which are subject to U.S. estate taxes irrespective of whether they are held in this country or abroad), are believed to be one of the most important deterrents in our tax laws to foreign investment in the United States. U.S. estate tax rates are materially in excess of those existing in many countries of the world and, despite the treaties in effect with several countries, the taxes paid on a nonresident alien decedent's estate, some portion of which is invested in the United States, generally would be greater than those paid on a non- resident alien decedent's estate, no portion of which is invested in the United States. We understand that the revenues received by the United States as a result of estate taxes levied on intangible personal property in estates of nonresidçpt alien decedents are not large. Under existing U.S. tax law, a foreigner willing to go through the expense and trouble of establishing a personal holding com- pany, incorporated abroad, and assuring himself that this person- nal holding company does not run afoul of the U.S. penalty taxes on undistributed personal holding company income, can already legally avoid estate taxes. Consequently, for suçh an investor U.S. estate taxes are avoidable through complicated and expensive pro- cedures, while for other foreign investors they are likely to result in a considerable tax penalty. This is an unsound situation which di- rectly deters foreign investment in the United States and signifi- cantly worsens the overall image of this country as a desirable place to invest. 24 104 PAGENO="0115" Recommendation No. 30: Eliminate (with respect to income not connected with the conduct of a trade or business) the provisions for progressive taxation of U.S. source income of nonresident alien individuals in excess of $19,000 and provide that no non- resident alien whose tax liability is fully satis- fied by withholding shall be required to ifie returns. The provision for progressive taxation of foreign investors and th~ companion requirement to file returns, in our opinion constitutes one of the major sources of confusion and misunderstanding for po- tential foreign investors in the United States. The revenues pro- duced by this tax are understood to be negligible. Progressive taxation of foreign investors does not exist in many other indus- trialized countries of the world. Treaties with most industrialized countrie.c already eliminate the provision for progressive taxation of nonresident alien individuals who are residents of treaty countries. However, there are through- out the world vast sums of capital that have left their countries of origin. Typically, these funds are held in treaty countries by residents of nontreaty countries. If the provisions for progressive taxation of nonresident alien individuals were removed from the Code, the position of the United States in competing with other industrialized nations for such capital would be strengthened. Furthermore, we must recognize that the actual fiscal impact of this, or any other, tax law on the persons to whom it applies does not measure the extent to which the law deters or limits potential investment by persons who are unwilling or unable to master its complexities. This is especially true when dealing with foreigners, whose familiarity with U.S. laws and practices is limited. Even those foreigners with substantial funds available for investment often find it troublesome and expensive to obtain sound U.S. tax advice, with the result that they channel their investments else- where. Were the Internal Revenue Code amended to eliminate pro- gressive taxation of nonresident alien individuals not engaged in trade or business within the United States, the entire U.S. tax liability of substantially all such aliens would automatically be fully satisfied by withholding at the source. These aliens would have no actual, or potential, additional tax liability and no returns 25 105 PAGENO="0116" to file. There could be no confusion as to the applicability of our tax laws to them. This would be highly desirable. Reoom~nvendation No. 31: Eliminate the provision for taxation of capital gains realized by a nouresident alien individual when he is physically present in the United States; extend from 90 to 180 days during a tax- able year the time that a nonresident alien in- thvidual may spend in the United States before becoming subject to tax on all capital gains realized by him during such year. Many foreign countries do not tax capital gains, and the threat of such taxation in the United States, therefore, deters investment in the United States by foreigners. In principle, the United States already exempts from taxation capital gains real- ized by nonresident alien individuals and foreign corporations not engaged in trade or business in the United States. But this exemption is limited by the imposition of a tax on capital gains realized when a foreign individual is present in the United States and by the imposition of tax on all capital gains realized by a foreigner in any year during which he is present in the United States for 90 days or more. These limitations are sufficiently stringent and, in the case of the physical presence test, sufficiently illogical that they impair the basic concept that capital gains of nonresident alien investors are exempt from U.S. taxation. It is our understanding that the revenues stemming from capital gains taxation imposed as a result of these limitations are smalL The physical presence test would appear to have no practical justification and, although easily avoided, it poses a potential trap for the unwary, unsophisticated or uninformed investor. As such, it contributes to the feeling among foreign investors that invest- ment in the United States is complicated and potentially hazard- ous from a tax standpoint. The 90-day test is, in our opinion, too short a period. Eliminating the physical presence test entirely and extending the 90-day period to 180 days would, we believe, remove most of the present unfavorable impact of potential capital gains taxation. 2. 106 PAGENO="0117" Recommendation No. 32: Provide that a nonresident alien individual en- gaged in trade or business within the United States be taxed at regular rates only on income connected with such trade or business. There is obvious justification for taxing nonresident alien in- dividuals at regular rates on earnings from a trade or business conducted within the United States. However, the logic of ex- tending such taxation to the investment income of foreign in- vestors is open to question. This provision certainly deters foreign businessmen operating in the United States from becom- ing investors in the United States, and may also deter foreigners already investing in the United States from commencing a trade or business here. Tne problem posed by the present system of taxation may be par- ticularly acute in the case of foreign investors owning and operating real estate (or having it operated for them). Such investors are deemed engaged in a trade or business, even though the real estate activities may be more in the nature of an investment than a business. Real estate investors of this type are often large potential investors in securities. To the extent that an investor is engaged in one of these two activities, he is to a great degree precluded from engaging in the other. We recognize the administrative complications the Internal Rev- enue Service would face in segregating a foreign investor's activities along the lines discussed above. But we believe that this is an impor- tant part of the package of recommendations for attracting additional foreign investment and that an attempt should be made to resolve these difficulties. Recommendation No. 33: Amend the definition of personal holding com- panies appearing in the Internal Revenue Code so that foreign corporations owned entirely by nonresident alien individuals are excluded from the definition. The penalty provisions of the personal holding company tax were designed to prevent the use of holding corporations as a device to 27 107 PAGENO="0118" escape the graduated tax rates applicable to individuals. Elimination of progressive taxation on the nonbusiness income of nonresident alien individuals, therefore, would remove a basic reason for imposing penalty taxes on personal holding companies entirely owned by non- resident aliens. Such corporations are currently excluded from the definition of personal holding companies if less than 50 percent of their gross income is derived from U.S. sources. If the exclusion were broadened, as we have recommended, this would remove the sub- stantial incentive existing under current law to limit the portion of such corporations' assets which is invested in the United States. This change would have no effect on the taxation of personal holding com- panies having U.S. shareholders. Recommeiidation No. 34: Clarify the definitions of engaging in trade or business to make it clear: (i) that a nonresident alien individual or foreign corporation investing in the United States will not be deemed engaged in trade or business because of activity in an in- vestment account or by granting a discretionary investment power to a U.S. banker, broker, or adviser; and (ii) that a nonresident alien individ- ual or foreign corporation will not be deemed en- gaged in trade or business by reason of the mere ownership of real property, by reason of a strict net lease, or by reason of an agent's activity in connection with the selection of real estate invest- ments in the United States. There is a general feeling of confusion among foreign investors over the application to investment activities of the tests for en- gaging in trade or business. This confusion certainly fosters a fear among foreign investors that they may through inadvertence be deemed to have engaged in trade or business and thereby be- come subject to regular U.S. taxation on their income and gains. These fears, whether or not realistic, unquestionably are a deterrent to foreign investment in this country. Clarification of three major points through the issuance of regu- lations or rulings would aid materially in eliminating the existing confusion and fears. One would be to make it clear that the degree of activity in a securities account is not a factor in determining 28 108 PAGENO="0119" whether or not a nonresident alien individual or foreign corpora- tion is engaged in trade or business in the United States. The second would be to affirm that the granting by a nonresident alien individual or a foreign corporation of a discretionary power for the purchase and sale of securities to a U.S. banker, broker, or adviser does not constitute engaging in trade or business in the United States. Third, under present law, many advisers feel that any ownership of real property by foreign investors creates a question of doing business. Clarification of this question should have a favorable effect on the amount of real estate investments made by foreign investors in the United States and probably also on the amount of security investments made by foreign investors desiring to own both real estate and stocks. Implementation Basic to our recommendations is the belief that any steps taken must be unilateral moves by the United States. Negotiation of reciprocal tax treaties typically extends over many years and re- sults in separate rules for each treaty country. To attempt to implement our recommendations through treaty negotiation would vitiate the possibility of their having an immediate impact on the balance of payments. Decisive unilateral action is necessary to preserve the package concept which is essential if our recommenda- tions are to have their maximum favorable impact on investor psychology throughout the world. We do not believe it sound to defer changes in U.S. taxation of foreign investors on the grounds that there still exist restrictions on the ability of U.S. securities firms to market the securities of U.S. corporations abroad. Although such restrictions do exist, many important industrialized countries do not prevent their resi- dents from purchasing U.S. securities through one channel or an- other. Thus there are substantial sums of foreign capital that are susceptible to being attracted to the United States for investment, if the tax laws of this country are amended to make such invest- ment more attractive. In fact, the existence of other restrictions on the flow of foreign investment to the United States and the time needed to have these restrictions removed are strong argu- ments in favor of making unilateral changes in our tax laws. These, changes can be made with a minimum of delay. Conclusion Our recommendations for tax revision, if adopted as a package, would greatly simplify the entire question of U.S. taxation of 29 109 PAGENO="0120" foreign investors. Adoption of our recommendations would re- move the substantial deterrent to foreign investment in the United States posed by a certain unwillingness among potential foreign investors to undertake complicated procedures for minimizing U.S. taxes. These procedures are often necessary if the investor is to avoid tax burdens which limit the attractiveness of investment in the United States. Complexities of the current system of U.S. taxation of foreign investors discourage these investors and ad- visers who endeavor to live within the confines of the law and good conscience. These complexities result in minuscule tax reve- nue, substantially reduce the incentive to invest here and encour- age disrespect for our laws. Reducing Restraints on the Sale of U.S. Securities in Other Capital Markets The monetary disturbances of the 1930's, followed by World War II and the abnormal needs and circumstances of reconstruc- tion, left Europe and most other advanced areas of the world with relatively small and inefficient capital markets. These markets were separated from each other and from the remainder of the world by numerous monetary, legal, administrative, and institu- tional restrictions. Much progress has been made in recent years toward removing controls on the movement of capital between industrial countries and toward improving the internal function- ing of their capital markets. Nevertheless, restrictions still un- pede foreign purchases of U.S. securities and limit the ability of U.S. firms to obtain long-term financing for their oversea opera- tions from foreign sources. Although the Task Force has conducted an intensive study of re- strictions in other capital markets, we have not attempted to set forth all of our findings here. The identification and critical appraisal of restrictions remaining in the capital markets of other industrial countries have been covered extensively in a recent study by the Treasury Department, made publicly available by the Joint Economic Committee of Congress. In this section of our re- port, we summarize the most important legal and administrative obstacles abroad which impede foreign investment in U.S. corporate securities. No useful purposes would, we believe, be served by making detailed recommendations as to the removal of foreign restrictions or methods by which other countries could improve their domestic capital markets. In each country these matters are often complex and technical; they involve delicate domestic rela- tionships; frequently they transcend financial considerations and en- compass national policies well beyond the terms of reference of the Task Force. It should be noted that efforts to remove restraining 30 110 PAGENO="0121" influences on sales of U.S. securities to foreigners will raise in foreign financial markets the question of the continuance of the U.S. interest equalization tax as a factor affecting the sales of foreign securities to U.S. citizens, however temporary and special its basis. Exchange Controls Recommendation No. 35: The Department of State and the Treasury De- partment should take bilateral diplomatic action aimed at securing the step-by-step removal of remaining exchange controls on capital transac- tions between advanced capital-forming coun- tries and the discontinuance or liberalization of special exchange markets or procedures for in- vestment transactions. Substantial progress has been made in removing exchange con- trols, yet the situation is still far from satisfactory. Only the United States, Canada, Germany and Switzerland are free of ex- change controls. Although adopting the aim of full liberalization, France, Italy, the Benelux countries and Austria have preserved. certain restrictions. A third group of countries, which includes the United Kingdom, Ireland, Japan, Australia, Spain and the Scandi- navian countries, retain a wide range of controls for balance of pay- ments and monetary policy reasons. The impact of exchange controls varies according to the opera- tions regulated. In general, treatment of direct investment is the most liberal; the treatment of financial loans (that is, loans not linked to commercial transactions) is the least liberal. Treatment of portfolio investment has been formally "liberalized" in Austria and the Common Market countries, but even some of these countries re- tain practices which tend to be restrictive. In some countries, for example, foreign securities may be pur- chased only through authorized banks. In some cases, certificates of ownership of foreign securities must be kept on deposit at these banks; in other cases purchases of foreign securities which are not listed on securities exchanges sometimes require the prior approval of exchange control authorities. Japan, Australia, Spain, Ireland and the Scandinavian coun- tries all exercise tight control over foreign portfolio investments; except in rare instances, their nationals are not permitted to buy foreign securities. Although residents of the United Kingdom may freely acquire foreign listed securities and certain U.S. over- the-counter securities, they can do so only with funds obtained from 31 111 PAGENO="0122" the limited pool of "investment dollars" which now sell at a pre- mium of about 11 percent, after having been as high as 14 percent earlier in 1964. These "investment dollars" represent primarily the proceeds of sales for dollars or other foreign currencies, of foreign securities held by United Kingdom residents. Capital Issues Control Recommendation No. 36: The Department of State and. the Treasury De- partment should encourage and support the enlargement of free world capital markets and urge countries with balance of payments sur- pluses to relax their capital issues control in order to permit an expanded volume of inter- national lending. New issues of foreign securities are carefully controlled in most major countries. The liberalization of capital issues raises sensi- tive questions because sales of new securities issues have a direct impact on interest rates, patterns of investment and the balance of payments. Some countries restrict distributions of foreign securi- ties in attempts to prevent heavy demand for capital by foreign borrowers from driving up domestic interest rates and siphoning off a high proportion of domestic savings. In some countries direct controls over securities issues are in part designed to channel financial resources into investments considered of high priority by the government concerned. Although there has been some recent relaxation with respect to foreign borrowing in the United King- dom, the capital issues control policy of that country generally has been to reserve the London new issues market for sterling securities for residents of the sterling area and the European Free Trade Area. Regulation of Institutional Investors Recommendation No. 37: The Department of State and the Treasury De- partment should request that the Organization of Economic Cooperation and Development (OECD) initiate a comprehensive review of the practices and regulations in member countries relating to investment portfolios of financial institutions. 32 112 PAGENO="0123" Regulations governing the investment portfolios of institutions such as commercial banks, insurance companies, savings banks, in- vestment companies and pension funds-while principally de- signed to protect depositors, shareholders, or policyholders-often tend in practice to create protected markets for certain privileged borrowers and to restrict foreign investment. Foreign securities, even when denominated in domestic currencies or protected against exchange risks, are usually discriminated against by regulatory authorities. Offerings of new or secondary issues of foreign securities in particular are much more difficult to market abroad when certain large institutional investors are not allowed to sub- scribe. Financial institutions in most countries have gradually been per~ mitted to increase the proportion of their assets held in equities. The risk involved in holding good-quality foreign securities would, in many cases, be no greater than the risk involved in investing in many domestic securities. We believe serious consideration should be given to relaxing restrictions on the amount of securities denom- inated in foreign currencies that can be held by such institutions. Role of International Organizations Recommendation No. 38: The Department of State and the Treasury De- partment should, through appropriate inter- national bodies, particularly the OECD, advocate the step-by-step relaxation of monetary, legal, in- stitutional, and administrative restrictions on capital movements, together with other actions designed to increase the breadth and efficiency of free world capital markets. The international movement of capital is kept under constant review by the Organization for Economic Cooperation and Develop- ment, to which the United States belongs. This organization can and should be more intensively utilized as a forum for review and confrontation on restrictions impeding the flow of capital among its members. Similarly, the OECD can assist in developing more effective capital markets in countries where these markets have lagged behind rapid industrial growth. Recommendation No. 39: The Department of State and the Treasury De- partment should urge the International Mone.- tary Fund to encourage step-by-step elimination 33 113 PAGENO="0124" of capital controls. The Fund should be re- quested to prepare a study dealing with remain- ing capital controls and how their elimination can encourage stabilizing movements of long-term capital and thus contribute to balanced inter- national payments. The International Monetary Fund can play an important role in eliminating restrictions on long-term capital movements as- sociated with security purchases. Member countries are required to inform the Fund of capital restrictions they impose. Annual consultations of the Fund provide an opportunity for review and for comments by the U.S. Executive Director. Although the Fund can- not formally take exception to capital restrictions-since its ap- proving jurisdiction is limited to restrictions on current transac- tions-it can indicate that removal of capital restrictions would be helpful to the international financial mechanism. The decision by the Fund in 1961 to make its resources available to finance balance- of-payments deficits arising from capital outflows should help en- courage countries to eliminate capital controls. 34 114 PAGENO="0125" V. Conclusion Other industrial nations, especially those in Western Europe, have made impressive economic progress in the postwar period. This has been reflected in the growing volume of savings and the strengthened balance-of-payments position of most of these countries. Moreover, the institutional framework for foreign portfolio invest- ment in U.S. corporate securities has been strengthened in recent years. U.S. financial firms have a large and growing number of oversea branches and affiliates staffed with highly trained personnel. This, together with the current vigor of the U.S. economy, has created an environment favorable to increased sales abroad of the shares of U.S. corporations. At the same time, many U.S. corporations have established them- selves in industrial countries where capital markets are expanding; prospective investors in these countries can readily identify these corporations with products and services of internationally recognized quality. The framework for financing abroad these foreign opera- tions of U.S. corporations has thus also been strengthened. In our investigations, however, we have found a number of obstacles-both at home and abroad-which limit increased foreign investment in U.S. private companies. In this report, we have identi- fied the more important of these restraints and have made recom- mendations which, in our opinion, could improve the U.S. balance-of- payments position in this area within a reasonable period of time. Concerted efforts in both the public and private sectors of our country are required if these recommendations are to prove effective. U.S. corporations and financial firms are already making an im- portant and growing contribution to our receipts from abroad. Be- cause of our overall balance-of-payments problem, however, it is im- perative that every effort be made to increase this contribution. To this end, our report has outlined a variety of actions in several areas. Collectively, these actions could yield impressive results. We urge the U.S. financial community, U.S. industrial corporations, and the U.S. Government to give close and continuing attention to the problems and opportunities set forth in our report. The increased freedom of capital movement and increased participa- tion by foreign citizens and financial institutions in the ownership and financing of U.S. business will serve to strengthen the economic and political ties of the free world as well as its monetary system. (35) 115 PAGENO="0126" Therefore, we attach special importance to our recommendations con~ cerning possible reduction or elimination of obstacles to the inter- national flow of capital. The work of the Task Force has, we feel, resulted in increased exchange of information in areas of potential cooperation between the financial community, industrial corporations, and public agencies. Our final recommendation is that this exchange of information and cooperation be continued. 36 116 PAGENO="0127" SECTION 7 HEARINGS BEFORE THE COMMITTEE ON WAYS AND MEANS ON H.R. 5916 117 PAGENO="0128" PAGENO="0129" REMOVAL OF TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES HEARINGS BEFORE THE COMMITTEE ON WAYS AND MEANS HOUSE OF REPRESENTATIVES EIGHTY-NINTH CONGRESS FIRST SESSION ALONG WITH WRITTEN COMMENTS SUBMITTED TO THE COMMITTEE ON WAYS AND MEANS ON H.R. 5916 TO REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES JUNE 30 AND JULY 1, 1965 Printed for the use of the Committee on Ways and Means S 119 71-297 0-67-pt. 1-9 PAGENO="0130" COMMITTEE ON WAYS AND MEANS WILBUR D. MILLS, Arkansas, Chairman CECIL R. KING, California HALE BOGGS, Louisiana EUGENE J. KEOGH, New York FRANK M. KARSTEN, Missouri A. S. HERLONG, Ja., Florida JOHN C. WATTS, Kentucky AL ULLMAN, Oregon JAMES A. BURKE, Massachusetts CLARK W. THOMPSON, Texas MAR PHA W. GRIFFITHS, Michigan W. PAT JENNINGS, Virginia GEORGE M. RHODES, Pennsylvania DAN ROSTENKOWSKI, Illinois PHIL M. LANDRUM, Georgia CHARLES A. VANIK, Ohio RICHARD H. FULTON, Tennessee LEO H. IRWIN, Chief Counsel JOHN M. MARTIN, Ia., Assistant Chief Counsel WILLIAM H. QUEALY, Minority Counsel JOHN W. BYRNES, Wisconsin THOMAS B. CURTIS, Missouri JAMES B. UTT, California JACKSON E. BETTS, Ohio HERMAN T. SCHNEEBELI, Pennsylvania HAROLD H. COLLIER, Illinois JOEL T. BROYHILL, Virginia JAMES F. BATTIN, Montana 11 120 PAGENO="0131" CONTENTS H.R. 5916, a bill to amend the Internal Revenue Code of 1954 to remove tax barriers to foreign investment in the United States, to make certain Pag technical amendments, and for other purposes 1 Treasury explanation of proposed legislation to increase foreign investment intheUnitedStates 14 Press release dated June 18, 1965, announcing invitation for interested persons to submit written statements on H.R. 5916 the act to remove tax barriers to foreign investment in the United States 22 Press release dated June 24, 1965, announcing public hearings on H.R. 5916, the act to remove tax barriers to foreign investment in the United States. 23 STATEMENTS OF GOVERNMENT WITNESSES Treasury, Department of: Fowler, Hon. Henry H., Secretary 24 Surrey, Hon. Stanley S., Assistant Secretary 24 STATEMENTS OF PUBLIC WITNESSES American Life Insurance Co., Paul M. Anderson, director 75 Anderson, Paul M., director, American Life Insurance Co. and the United States Life Insurance Co 75 Baker, McKenzie & Hightower, Michael Waris, Jr 80 Eaton, Fredrick M., member of task force on promoting increased foreign investment in U.S. corporate securities 66 Lesser, Saul, associate general counsel, United States Life Insurance Co. - 75 United States Life Insurance Co.: Anderson, Paul M., director 75 Lesser, Saul, associate general counsel 75 Waris, Michael, Jr., Baker, McKenzie & Hightower 80 WRITTEN STATEMENTS BY PUBLIC WITNESSES American Bankers Association, Reese H. Harris, Jr 87 American Institute of Certified Public Accountants, Thomas J. Graves, general chairman, committee on Federal taxation 88 American Life Convention, Glendon E. Johnson, vice president and general counsel 95 Association of Stock Exchange Firms, Wffliam T. Kemble, president. - 96 Association of the Bar of the City of New York, Clifford L. Porter, chair- man, Committee on Taxation 96 Brady, Joseph B., vice president, National Foreign Trade Council 130 Buck, Charles W., president, United States Trust Co. of New YorkJ 144 Cleary, Gottlieb, Steen & Hamilton - 104 Conston, Henry S 146 Crass, M. F., Jr., secretary-treasurer, Manufacturing Chemists Association_ 128 Engstrom, William R 106 First National City Bank, Wafter B. Wriston, executive vice president. - - - 106 Funston, G. Keith, president, New York Stock Exchange 138 Goodwin, Charles, Jr., Shearman & Sterling 141 Graves, Thomas J., general chairman, committee on Federal taxation, American Institute of Certified Public Accountants 88 Haack, Robert W., president, National Association of Securities Dealers_ 130 Harris, Reese H., Jr., American Bankers Association 87 Herrick, Smith, Donald, Farley & Ketchum, Fulton C~ Underhay 111 Investment Co. Institute, Dorsey Richardson, president 113 Investors League, Inc., Wffliam Jackman, president 114 in 121 PAGENO="0132" CONTENTS Page Jaekman, William, president, Investors League, Inc - 114 James, George F., Socony Mobil Oil Co 114 Johnson, Glendon E., vice president and general counsel, American Life Convention 95 Kemble, William T., president, Association of Stock Exchange Firms_ - - - 96 Kimble, Kenneth L., vice president and general counsel, Life Insurance Association of America 95 Life Insurance Association of America, Kenneth L. Kimble, vice president and general counsel 95 McKinney, Robert 114 Manufacturing Chemists Association, M. F. Crass, Jr., secretary-treasurer_ 128 National Association of Securities Dealers, Robert W. Haack, president. - 130 National Foreign Trade Council, Joseph B. Brady, vice president 130 New York Stock Exchange, G. Keith Funston, president 138 Porter, Clifford L., chairman, Committee on Taxation, Association of the Bar of the City of New York 96 Real Estate Trade Mission to Europe, J. D. Sawyer, chairman 141 Richardson, Dorsey, president, Investment Co. Institute 113 Rudd, Charles R., executive committee, Wool Associates of the New York Cotton Exchange 149 Sawyer, J. D., chairman, Real Estate Trade Mission to Europe 141 Shearman & Sterling, Charles Goodwin, Jr 141 Troop, Glen, United States Savings & Loan League 144 Underhay, Fulton C., Herrick, Smith, Donald, Farley & Ket'chum 111 United States Savings & Loan League, Glen Troop 144 United States Trust Co. of New York, Charles W. Buek, president 144 Watson, Arthur K., International Business Machines Corp 149 Wool Associates of the New York Cotton Exchange, Charles R. Rudd, executive committee 149 Wriston, Walter B., executive vice president, First National City Bank - 106 Young, John M 150 SUMMARIES OF PUBLIC WITNESSES' STATEMENTS 151 MATERIAL SUPPLIED FOR THE RECORD Comparison of H.R. 5916 with treatment under existing treaties 40 Comparison of Treasury recommendations of H.R. 5916 with recommenda- tions of Fowler Task Force 45 Eaton, Fredrick M., letter dated June 24, 1965, to Chairman Mills with memorandum enclosed 71 Meyer, Andre, letter dated June 24, 1965, to Chairman Mifis with memo- *randum enclosed 71 Recommendations contained in the Fowler task force report 37 Treasury, Department of: Net sales of U.S. corporate stocks in 1964 54 Position regarding the proposal contained in H.R. 5916 to amend estate tax provisions applicable to nonresident alien decedents- 64 122 PAGENO="0133" REMOVAL OF TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES WEDNESDAY, ~1UNE 30, 1965 HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, Washington, D.C. The committee met at 10 a.m., pursuant to call, in the committee room, Longworth House Office Building, Hon. A. S. Herlong, Jr., presiding. Mr. HERLONG. The committee will come to order. This hearing is for the purpose of receiving testimony on H.R. 5916, a bill introduced at the request of the administration, to remove tax barriers to foreign investment in the United States. This bill was developed on the basis of the so-called Fowler task force. That task force consisted of a very distinguished group of tax specialists. Without objection, a copy of the bill, H.R. 5916, a copy of the press release announcing these hearings, a copy of the press release which was issued earlier inviting written comments by the interested public and a Treasury Department release dated March 8, 1965, explaining the proposed legislation, will be made a part of the record at this point. Also, without objection, the written comments which we have received from the interested public will be made a part of the published record. (The information referred to follows:) [HR. ,5916, 89th Cong., 1st sass.] A BILL To amend the Internal Revenue Code of 1954 to remove tax barriers to foreign investment in the United States, to make certain technical amendments, and for other purposes. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SECTION 1. SHORT TITLE, ETC. (a) SHORT TITLE.-This Act may be cited as the "Act to remove tax barriers to foreign investment in the United States". (b) AMENDMENT OF 1954 C0DE.-Except as otherwise expressly provided, whenever in this Act an amendment or repeal is expressed in terms of an amend- ment to, or repeal of, a section or other provision, the reference shall be considered to be made to a section or other provision of the Internal Revenue Code of 1954. SEC. 2. INCOME FROM SOURCES WITHIN THE UNITED STATES. (a) INTEREST FROM UNITED STATES S0URCE5.-Section 861(a) (1) (relating to interest frcm sources within the United States) is amended by striking out "and" at the end of subparagraph (B), by striking out, the period at the end of sub- paragraph (C) and inserting in lieu thereof ", and", and by adding at the end thereof the following new subparagraph: "(D) Amounts paid to, or credited to the accounts of, depositors or holders of accounts not engaged in business within the United States on deposits or withdrawable accounts with savings institutions chartered and supervised as -savings --and loan- or similar associationsunder~FederaI~~~ or State law, if such amounts are deductible under section 591 in com- puting the taxable income of suc~i institutions." 1 123 PAGENO="0134" 2 REMOVE TAX BARRIERS TO FOREIGN INVESTMEWP IN U.S. (b) DIVIDENDS FROM UNITED STATES SouRcEs.-Section 861(a) (2) (B) (relating to dividends from sources within the United States) is amended to read as follows: "(B) from a foreign corporation engaged in trade or business within the United States unless less than 80 percent of the gross business income of such foreign corporation for the 3-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under the provisions of this part; but only in an amount which bears the same ratio to such dividends as the gross business income of the corporation for such period derived from sources within the United States bears to its gross income from all sources; but dividends from a foreign corpora- tion shall, for purposes of subpart A of part III (relating to foreign tax credit), be treated as income from sources without the United States to the extent exceeding the amount which is 100/85ths of the amount of the deduction allowable under section 245 in respect of such dividends, or (c) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to interest or dividends paid in taxable years beginning after De- cember 31, 1965. SEC. 3. NONRESIDENT ALIEN INDIVIDUALS. (a) TAX ON NONRESIDENT ALIEN INDIvIDUAL5.-SectiOn 871 (relating to tax on nonresident alien individuals) is amended to read as follows: "SEC. 871. TAX ON NONRESIDENT ALIEN INDIVIDUALS. "(a) No UNITED STATES BU5INE55-30 PERCENT TAX.-There is hereby imposed for each taxable year, in lieu of the tax imposed by section 1, on the amount received, by every nonresident alien individual not engaged in trade or business within the United States, from sources within the United States, as interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income (including amounts described in section 402(a)(2), section 403(a) (2), section 631 (b) and (c), and section 1235, which are considered to be gains from the sale or exchange of capital assets), a tax of 30 percent of such amount. "(b) UNITED STATES BUSINESS.- "(1) BUSINESS INCOME-GRADUATED RATE OF TAX.-A nonresident alien individual engaged in trade or business within the United States shall be taxable as provided in section 1 on that portion of his taxable income from sources within the United States which is business income, and the amount of tax under this paragraph shall be determined without taking into account any income which is not business income. "(2) NoNBUsINEss INCOME-33 PERCENT TAx.-There is hereby imposed for each taxable year, in lieu of the tax imposed by section 1, on the amount received, by every nonresident alien individual engaged in trade or business within the United States, from sources within the United States, as income other than income taxable under paragraph (1), a tax of 30 percent of such amount. The tax imposed by this paragraph shall not apply to gains from the sale or exchange of capital assets but shall apply to amounts described in section 402(a) (2), section 403(a) (2), section 631 (b) and (c), and section 1235 which are considered to be gains from the sale or exchange of capital assets. "(3) BUSINESS INCOME DEFINED.-Ifl the case of a nonresident alien individual, business income includes all income derived from the conduct of a trade or business, wherever carried on, by such individual, including gains derived from the sale or exchange of property used in the conduct of a trade or business, except that such income shall not include dividends or gain from the sale or exchange of stock in a corporation. "(c) ENGAGED IN TRADE OR BUSINEsS DEFINED.-FOr purposes of part I, this this section, sections 881 and 882, and* chapter 3, the term `engaged in trade or business within the United States' includes the performance of personal services within the United States at any time within the taxable year, but does not include- "(1) PERFORMANCE OF PERSONAL SERVICES FOR FOREIGN EMPLOYER.-The performance of personal services, for a nonresident alien individual, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or for an office or place of business maintained by a domestic corporation in a foreign country or in a possession of the United States, by a 124 PAGENO="0135" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 3 nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year and whose, compensation for such services does not exceed in the aggregate $3,000, or "(2) TRADING IN SECURITIES OR COMMODITIES.- "(A) SECURITIEs.-Trading in stocks or securities for one's own account, whether transactions are effected directly, or by way of an agent, through a resident broker, commission agent, `custodian, or other independent agent, and, except where the person so trading is a dealer in securities, whether or not any such agent has discretionary authority to make decisions in effecting such transactions, or "(B) C0MM0DITIE5.-Trading in commodities for one's own account, whether tran sactions are effected directly, or by way of agent, through a resident broker, commission agent, custodian, or other independent agent, and, except where the person so trading is a dealer in commodities, whether or not any such agent has discretionary authority to make decisions in effecting such transactions, if such commodities are of a kind customarily dealt in on an organized commodity exchange and if the transaction is of a kind customarily consummated at such place. "(d) CAPITAL GAINS OF ALIENS PRESENT IN THE UNITED STATES 183 DAYS OR M0RE.-In the case of a nonresident alien individual present in the United States for a period or periods aggregating 183 days or more during the taxable year there is hereby imposed for such year, in lieu of the tax imposed by section 1, a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from the sale or exchange at `any time during such year of capital assets exceeds his losses, allocable to sources within the United States, from the sale or exchange at any time during such year of capital assets. For purposes of this subsection, gains and losses shall be taken into account only if, and to the extent `that, they would be recognized and taken into account if such individual's total income were business income on which the tax were being determined under subsection (b)(1), except that such gains and losses shall be determined without regard to section 1202 (relating to deduction for capital gains) and such' losses shall be determined without the benefits of the capital loss carry- over provided in section, 1212. Any gain or loss which is taken into account in determining the tax under subsection (a) or (b) shall not be taken into account in determining the tax under this subsection. "(e) PARTICIPANTS IN CERTAIN EXCHANGE OR TRAINING PROGRAMS.-FOr purposes of this section, a nonresident alien individual who (without regard to this subsection) is not engaged in trade or business within the United States and who is temporarily present in the United States as a nonimmigrant under sub- paragraph (F) or (J) of section 101(a) (15) of the Immigration and Nationality Act, as amended (8 U.S.C. 1101(a)(15) (F) or (J)), shall be treated as a nonresident alien individual engaged in trade or business within the United States, and any income described in section 1441(b) (1) or (2) which is received by such individual ~halI be treated as businessincome. "(f) ELECTION To TREAT REAL PROPERTY INCOME AS BUSINESS INCOME.- "(1) IN GENERAL.-NOtwithstanding subsections (a) and (b)(2), a non- resident alien individual who during' the taxable year derives from sources within the United States any income from real property, or from any interest in real property, including gains from the sale or exchange of real property, rents or royalties from the operation of mines, wells, or other natural deposits, and dividends (to the extent constituting income from real property) received from a real estate investment trust described in section 857, may, under reg- ulations prescribed by the Secretary or his delegate, elect for such taxable year to treat all such income as business income which is taxable in the manner provided by subsection (b)(1). `An election under this paragraph for any taxable year shall remain in effect for all subsequent taxable `years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. "(2) ELECTION AFTER REv0cATI0N.-If an election has been made under, paragraph (1) and such election has been revoked, a new election may not be made under such paragraph for any taxable year prior to the fifth taxable year which begins after `the first taxable year for which' such revocation is effective, unless the Secretary or his delegate consents to such new election. "(3) FORM AND, TIME OF ELECTION AND REVOcATION.-A11 election under paragraph (1), and any revocation of such an election, may be made only in such manner and at such time as the Secretary or his delegate may by regu- lations prescribe. 125 PAGENO="0136" 4. REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. `4(g) CROSS REFERENCES.- "(1) For tax treatment of certain amounts distributed by the United States to nonresident alien individuals, see section 402(a) (4). "(2) For taxation of expatriate United States citizens on income from' United States sources, see section 878. "(3) For doubling of tax on citizens of certain foreign countries, see section 891. "(4) For reinstatement of pre-1966 tax provisions in the case of residents: of certain foreign countries, see section 896. "(5) For exemption from withholding on nonresident alien individuals.. electing to treat certain real property income as business income, see section 1441(c) (7). "(6) For the requirement of making a declaration of estimated tax by non-- resident alien individuals described in paragraph (5), see section 6015(a). "(7) For taxation of gains realized upon certain transfers to domestic~ corporations, see section 1250(d) (3)." (b) EXCLUSIONS FROM GRoss INCOME-SectiOn 872(b) (relating to exclusions: from gross income of nonresident alien individuals) is amended by adding at the~ end thereof the following new paragraph: "(4) BOND INTEREST OF RESIDENTS OF THE RYTJKYU ISLANDS OR THE TRUST TERRITORY OF THE PACIFIC I5LAND5.-Interest on series E and series H United States savings bonds owned by nonresident alien individuals who during the entire taxable year are residents of the Ryukyu Islands or the Trust Territory of the Pacific Islands." (c) DEDUcTI0Ns.-Section 873 (relating to deductions allowed to nonresident~ alien individuals) is amended to read as follows: "SEC. 873. DEDUCTIONS. "(a) GENERAL RULE.-Except as provided in section 871(d) and subsection. (b), in the case of a nonresident alien individual the deductions shall be allowed only if and to the extent that they are connected with business income from sources within the United States; and the proper apportionment and allocation of the deductions with respect to sources of income within and without the United States shall be determined as provided in part I, under regulations prescribed by the Secretary or his delegate. "(b) EXCEPTIONS.-The following deductions shall be allowed whether or not they are connected with income from sources within the United States: "(1) Lossns.-The `deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c)(3), but only if the loss is of property within the United States. "(2) CHARITABLE CONTRIBTJTIO Ns.-The deduction for charitable contribu- tions and gifts allowed by section 170, but only for contributions or giftsmade to domestic corporations, or to community chests, funds, or foundations, created in the United States. "(3) PERSONAL EXEMPTION.-The deduction for personal exemptions al- lowed by section 151, except that in the case of a nonresident alien individual who is not a resident of a contiguous country only one exemption under~ such section shall be allowed. "(c) STANDARD DEDUCTION.-FOr disallowance of standard deduction, see sec- tion 142(b) (1)." (d) EXPATRIATION To AVOID TAx.-Subpart A of part II of subchapter N of chapter 1 (relating to nonresident alien individuals) is amended by inserting after- section 877 the following new section: "SEC. 878. EXPATRIATION TO AVOID TAX. "(a) IN GENERAL.-EVery nonresident alien individual who at any time within the 10-year period immediately preceding the close of the taxable year lost United. States citizenship, unless such loss did not have for one of its principal purposes the avoidance of United States taxes, shall be taxable for such taxable year in the~ manner provided in subsection (b) if the tax imposed pursuant to such subsection exceeds the tax which, without regard to this section, is imposed for such taxable year under. section 871. "(b) ALTERNATIVE TAX.-A nonresident alien individual described in subsec- tion (a) shall be taxable for the taxable year as provided in section 1 except that- - "(1) the gross income shall include only the gross income derived from sources within the United States, determined as provided in part I to the- extent not otherwise provided in subsection (c), and 126 PAGENO="0137" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 5 "(2) the deductions shall be allowed to the extent, and in the manner pro- vided by, section 931 in the case of a citizen of the United States entitled to the benefits of such section, except that the capital loss carryover provided by section 1212(b) shall not be allowed. - "(c) SPECIAL RULES OF S0URcE.-For purposes of subsection (b), the follow- ring items of gross income shall be treated as income from sources within the United States: "(1) SALE OF PR0PERTY.-Gains, profits, and income derived from the sale or exchange of property (other than stock in corporations or debt obli- gations) situated in the United States. "(2) STOCKS OR DEBT 0BLIGATI0N5.-Gains, profits, and income derived from the sale or exchange of stocks or debt obligations issued by or en- forceable against United States persons. "(d) EXCEPTION FOR Loss OF CITIZENSHIP FOR CERTAIN CAU5Es.-Subsection (a) shall not apply to a nonresident alien individual who has lost United States *citizenship under section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). * "(e) BURDEN OF PR00F.-For purposes of subsection (a), the burden of proving that an individual's loss of United States citizenship did not have for one of its principal purposes the avoidance of United States taxes shall be on such in- dividual." ~(e) CREDIT FOR PARTIALLY TAX-EXEMPT INTERE5T.-SUbsection (c) of section .35 (relating to certain nonresident aliens ineligible for credit) is amended to read as follows: "(c) CREDIT NOT APPLICABLE TO TAX ON CERTAIN INCOME OF NONRESIDENT ALIENs~-In the case of a nonresident alien individual, credit shall be allowed under subsection (a) only- "(1) against the tax imposed for the taxable year under section 871 (b) (1) and only in respect of interest which constitutes business income, or "(2) against the tax imposed for the taxable year under section 878(b)." (f) `PARTIAL EXCLUSION OF DIvIDEND5.-Subsection (d) of section 116 (relating *~ certain nonresident aliens ineligible for exclusion) is amended to read as follows: "(d) CERTAIN NONRESIDENT ALIENS INELIGIBLE FOR EXCLU5I0N.-In the case of a nonresident alien individual, subsection (a) shall apply only in determin- ing the tax imposed for the taxable year under section 878(b)." (g) WITHHOLDING OF TAX ON NONRESIDENT ALIENs.-Section 1441 (relating to withholding of tax on nonresident aliens) is amended- (1) by striking out "(except interest on deposits with persons carrying on the banking business paid to persons not engaged in business in the United States)" in subsection (b); (2) by strinking out paragraph (1) of subsection (c) and inserting in lieu thereof the following new paragraph: "(1) BUSINESS INc0ME.-No deduction or withholding under subsection (a) shall be required in the case of any item of income which is business income on which a tax is imposed for the taxable year under section 871(b) (1)."; and - (3) by adding at the end of subsection (c) the following new paragraph: "(7) ELECTION TO TREAT REAL PROPERTY INCOME AS BUSINESS INCOME.- No deduction or withholding under subsection (a) shall be required in the case of any income from real property described in section 871(f) if such income is treated as business income pursuant to an election made under such section." (h) LIABILITY FOR WITHHELD TAX. Section 1461 (relating to return and pay.- ment of withheld tax) is amended to read as follows: "SEC. 1461. LIABILITY FOR WITHHELD TAX. "Every person required to deduct and withhold any tax under this chapter is hereby made liable for such tax and is hereby indemnified against the claims and demands of any person for the amount of any payments made in accordance with the provisions of this chapter." (i) DECLARATION OF ESTIMATED INCOME TAX BY INDIVIDUALS.-Section 6015 (relating to declaration of estimated income tax by individuals) is amended- (1) by striking out that portion of subsection (a) which precedes paragraph (1) and inserting in li~u thereof the following: "(a) REQUIREMENT OF DEcLARATI0N.-Except as otherwise provided * in -subsection (i), every individual shall make a declaration of his estimated tax for the taxable year if-"; and (2) by redesignating subsection (i) as subsection (j) and by inserting after subsection (h) the following new subsection: 127 PAGENO="0138" 6 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. "(i) NONRESIDENT ALIEN INDIVIDUALS.-NO declaration shall be required to be made under this section by a nonresident alien individual unless- "(1) withholding under chapter 24 is made applicable to the wages, as defined in section 3401 (a), of such individual, "(2) such individual is a resident of Puerto Rico during the entire taxable year, "(3) such individual is an expatriate United States citizen whose tax for the taxable year is imposed pursuant to section 878(b), "(4) such individual is exempt under section 1441(c)(1) for the taxable year from deduction and withholding under section 1441(a) on business in- come, or "(5) such individual is exemptunder section 1441(c) (7) for the taxable year from deduction and withholding under section 1441(a) on income from real property." (j) GAIN FROM DIsPoSITIoNS OF CERTAIN DEPRECIABLE REALTY.-The second sentence of paragraph (3) of section 1250(d) (relating tO certain tax-free transac- tions) is amended to read as follows: "This paragraph shall not apply to- "(A) a disposition to an organization (other than a cooperative de- scribed in section 521) which is exempt from the tax imposed by this chapter, or "(B) a transfer of property by a nonresident alien individual, a foreign estate or trust,, or a foreign partnership, to a domestic corporation~ in exchange for stock or securities in such corporation in a transaction to which section 351 applies." (k) TECHNICAL AMENDMENTS.- (1) Section 154(3) (relating to cross references in respect of deductions for personal exemptions) is amended to read as follows: "(3) For exemptions of nonresident aliens, see section 873(b) (3) ." (2) The table of sections for subpart A of part II of subchapter N of chapter 1 (riating to nonresident alien individuals) is amended by inserting at the end thereof the following: "Sec. 878. ExpatrIation to xvoid tax." (1) EFFECTIVE DATES.- (1) The amendments made by this section (other than the amendments made by subsection (g)) `shall apply with respect to taxable years beginning after December 31, 1965, `except that subsection (d) shall apply only in the case of an individual who has lost, United States citizenship after March 8, 1965. , (2) The amelidments made by subsection (g) shall apply with respect to payments occurring after December 31, 1965. SEC. 4. FOREIGN CORPORATIONS. (a)' TA.x ON FoREIGN CORPORATIONS NOT ENGAGED IN BUSINESS IN UNITED STATE5.-Section 881 (relating to imposition of tax) is amended- (1) by `striking out "(except interest on deposits with persons cari~ying on the banking business)" in subsection (a); (?) by redesignating subsection (b) as subsection (c); and (3) by adding after subsection (a) the following new subsection: "(b) ELECTION To TREAT REAL PROPERTY INCOME AS BUSINESS INCOME. Notwithstanding subsection (a), a foreign corporation, not engaged in trade or business within the United States, which during the taxable year derives from sources within the United States any income from real property, or from any interest in real property, including gains from the sale or exchange of real property, rents or royalties from the operation of mines, wells, or other natural deposits, and dividends (to the extent constituting income from real property) received from a real estate investment trust described in section 857, may, under regulations prescribed by the Secretary or his delegate, elect for such year ,to treat all such income as business income, which is taxable in the manner proyided by section 882(a) (1). The election provided by this subsection shall be made in accordance with, and subject to, the provisions of section 871(f)." (b) TAX ON RESIDENT FOREIGN C0RP0RATION5.-Section 882 (relating to tax on resident foreign corporations) is amended to read as follows: "SEC. 882. TAX ON RESIDENT FOREIGN CORPORATIONS.' "(a) IMPoSITIoN OF TAX.- "(1) BUSINESS INCOME-'NORMAL TAX AND SURTAX.-A foreign corporation engaged in trade or business within the United States shall be taxable as 128 PAGENO="0139" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 7 provided in section 11 on that portion of its taxable income from sources within the United States which is business income, and the amount of tax under this paragraph shall be determined without taking into account any income which is not business income. "(2) NONBUSINESS INCOME-30 PERCENT TAX.-~There is hereby imposed for each taxable year, in lieu of the taxes imposed by section 11, on the amount received by every foreign corporation engaged in trade or business within the United States, from sources within the United States, as non- business income, a tax of 30 percent of such amount. "(3) BusINEss INCOME DEFINED.-In the case of a foreign corporation business income includes all income derived from sources within the United States other than the income described in paragraph (4), except that business income shall not include gain from the sale or exchange of stock in a corpora- tion. "(4) NoNBusiNEss INCOME DEFINED.-In the case of a foreign corporation nonbusiness income shall consist of dividends and amounts described in section 631 (b) and (c) which are considered to be gains from the sale or exchange of capital assets. "(b) GROSS INC0ME.-In the case of a foreign corporation, gross income in~~ eludes only the gross income from sources within the United States. "(c) ALLOWANCE OF DEDUCTiONS AND CREDITS.- "(1) DEDUCTIONS ALLOWED ONLY IF RETURN FILED.-A foreign corpora- tion shall receive the benefit of the deductions allowed to it in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true true and accurate return of its total income received from all sources in the United States, in the manner prescribed in subtitle F, including therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions. "(2) ALLOCATION OF DEDUCTIONS.- "(A) GENERAL RULE.-Except as provided in subparagraph (B), in the case of a foreign corporation the deductions shall be allowed only if and to the extent that they are connected with business income from sources within the United States; and the proper apportionment and allocation of the deductions with respect to sources within and without the United States shall be determined as provided in part I, under regu- lations prescribed by the Secretary or his delegate. "(B) CHARITABLE CONTRIBUTI0NS.-The deduction for charitable con- tributions and gifts allowed by section 170 shall be allowed whether or not connected with income from sources within the United States. "(3) FOREIGN TAX CREDIT.-Foreign corporations shall not be aUowed the credits against the tax for taxes of foreign countries and possessions of the United States allowed by section 901. "(d) RETURNS OF TAX BY AGENT.-If any foreign corporation has no office or place of business in the United States but has an agent in the United States, the return required under section 6012 shall be made by the agent." (c) CROSS REFERENCES.-SeCtiOn 884 (relating to cross references) is amended to read as follows: "SEC. 884. CROSS REFERENCES. "(1) For special provisions relating to unrelated business income of foreign educational, charitable, and certain other exempt organizations, see section 512(a). "(2) For special provisions relating to foreign insurance companies, see subehapter L (sec. 801 and following). "(3) For rules applicable in determining whether any foreign corporation is engaged in trade or business within the United States, see section 871(c). "(4) For reinstatement of pre-1966 tax provisions in the case of corpora- tions of certain foreign countries, see section 896. "(5) For withholding at source of tax on income of foreign corporations, see section 1442. "(6) For exemption from withholding on foreign corporations electing to treat certain real property income as business income, see section 1441(c) (7). "(7) For the requirement of making a declaration of estimated tbx by foreign corporations described in paragraph (6), see section 6016(a)." (d) DECLARATIONS OF ESTIMATED INCOME TAX BY C0RP0RATI0Ns.-Subsection (a) of section 6016 (relating to the requirement of declarations) is amended to read as follows: 129 PAGENO="0140" 8 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. "(a) REQUIREMENT OF DECLARATION.-EVery corporation subject to taxation under section 11 or 1201(a), or subchapter L of chapter 1 (relating to insurance companies), including every foreign corporation which is exempt under section 1441 (c) (7) for the taxable year from deduction and withholding under section 1442, *shall make a declaration of estimated tax under chapter 1 for the taxable year if its income tax imposed by chapter 1 for such taxable year, reduced by the credits against tax provided by part IV of subchapter A of chapter 1, can reasonably be expected to exceed $100,000." (e) CORPORATIONS SUBJECT TO PERSONAL HOLDING COMPANY TAx.-Para- graph (7) of Section 542(c) (relating to corporations not subject to the personal holding company tax) is amended to read as follows: "(7) a foreign corporation if all of its stock outstanding during the last half of the taxable year is owned by nonresident alien individuals, whether directly or indirectly through other foreign corporations;". (f) AMENDMENTS To PRESERVE EXISTING LAW WITH RESPECT TO CERTAIN FOREIGN INSURANCE COMPANIES.- (1) TAXABLE iNVESTMENT INCOME OF CERTAIN MUTUAL INSURANCE coMpANIEs-Subsection (e) of section 822 (relating to foreign mutual insur- ance companies other than life or marine) is amended by striking out the period at the end thereof and inserting in lieu thereof the following: ", deter- mined as though the entire gross income from ~ources within the United States were business income." (2) TAXABLE INCOME OF MUTUAL MARINE INSURANCE AND OTHER INSUR- ANCE cOMPANIES.-SUbSeCtiOn (d) of section 832 (relating to taxable income of foreign insurance companies other than life or mutual and foreign mutual marine) is amended by striking out the period at the end thereof and inserting in lieu thereof the following: ", determined as though the entire gross income from sources within the United States were business income." (g) DIVIDENDS RECEIVED FROM CERTAIN FOREIGN CORPORATIONS-Sub- section (a) of section 245 (relating to the allowance of a deduction in respect of dividends received from a foreign corporation) is amended- (1) by striking out "as the gross income of such foreign corporation" in paragraph (1) and inserting in lieu thereof "as the sum of the gross business income and the gross nonbusiness income of such foreign corporation"; and (2) by striking out "as the gross income of such foreign corporation" in paragraph (2) and inserting in lieu thereof "as the sum of the gross business income and the gross nonbusiness income of such foreign corporation". (h) TECHNICAL AMENDMENTS.- (1) Subsection (e) of section 11 (relating to exceptions from the application of the normal tax and surtax to corporations) is amended by striking out "or" at the end of paragraph (3), by Striking out the period at the end of paragraph (4) and inserting in lieu thereof, "or", and by adding at the end thereof the following new paragraph: "(5) section 882(a) (2) (relating to nonbusiness income of a foreign cor- poration engaged in trade or business within the United States) to the extent that the income of such corporation is subject to the tax imposed by such section." (2) Subsection (i) of section 170 (relating to other cross references in * respect of charitable contributions) is amended by redesignating paragraphs (5) through (8) as paragraphs (6) through (9) and by adding after paragraph * (4) the following new paragraph: "(5) For charitable contributions of resident foreign corporations, see section 882(c) (2)." (3) Section 891 (relating to doubling of rates of tax on citizens and cor- porations of certain countries) is amended by striking out "and 881" and inserting in lieu thereof "881, and 882". (i) EFFECTIVE DATE.-The amendments made by this section shall apply in respect of taxable years beginning after December 31, 1965. In applying the amendment made by subsection (g) (2), the gross income of the foreign corporation for taxable years beginning before January 1, 1966, shall be determined without regard to the amendments made by such subsection. SEC. 5. SPECIAL TAX PROVISIONS. (a) APPLICATION OF PRE-1966 TAX PriovrSIoNS.-Subpart C of part II of subchapter N of chapter 1 (relating to miscellaneous provisions applicable to nonresident aliens and foreign corporations) is amended by adding at the end thereof the following new section: 130 PAGENO="0141" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. ~ "SEC. 896. APPLICATION OF PRE-1966 TAX PROVISIONS. "(a) IMPosITIoN OF MORE BURDENSOME TAXES BY FOREIGN COUNTRY.- Whenever the President finds that- "(1) under the laws of any foreign country, considering the tax system of such foreign country, oitizens of the United States not residents of such foreign country or corporations of the United States are being subjected to more burdensome taxes, on any item of income received by such citizens or corpora- tions from sources within such foreign country, than taxes imposed by the provisions of this subtitle on similar income derived from sources within the United States by residents or corporations of such foreign country, "(2) such foreign country, when requested by the United States to do so~ has not acted to revise or reduce such taxes so that they are no more burden- some than taxes imposed by the provisions of this subtitle on similar incom~ derived from sources within the United States by residents or corporations of such foreign country, and "(3) it is in the public interest to apply pre-1966 tax provisions in accord- ance with the provisions of this section to residents or corporations of such foreign country, the President shall proclaim that the tax on such similar income derived from sources within the United States by residents and corporations of such foreign country shall, for taxable years beginning after such proclamation, be determined under this subtitle without regard to amendments made to this subchapter on Or after the date of enactment of this section. "(b) ALLEVIATiON OF MORE BURDENSOME TAxEs-Whenever the President finds that the laws of any foreign country with respect to which the President has rnaçle a proclamation under subsection (a) have been modified so that such citizens or corporations of the United States are no longer subject to more burden- some taxes on such item of income derived by such citizens or corporations from sources within such foreign country, he shall proclaim that the tax on such similar income derived from sources within the United States by residents and corpora- tions of such foreign country shall, for any taxable year beginning after such proclamation, be determined under this subtitle by taking into account amend- ments made to this subchapter on or after the date of enactment of this section. "(c) NOTIFICATION OF CONGRESS REQUIRED.-NO proclamation shall be issued by the President pursuant to this section unless, at least thirty days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. "(d) IMPLEMENTATION BY REGULATIONS-The Secretary or his delegate shall prescribe such regulations as he deems necessary or appropriate to implement this section." (b) CLERICAL AMENDMENT.-The table of sections for subpart C of part II of subchapter N of chapter 1 is amended by adding at the end thereof the following: "Sec. 896. Application of pre-1966 tax provisions." (c) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to taxable years beginning after December 31, 1965. SEC. 6. FOREIGN TAX CREDIT. (a) CREDIT ALLOWED TO ALIEN RESIDENTS OF THE UNITED STATES OR PUERTO * RIC0.-Subsection (b) of section 901 (relating to the amount of foreign tax credit allowed) is amended to read as follows: "(b) AMOUNT ALL0WED.-Subject to the applicable limitation of section 904, the following amounts shall be allowed as the credit under subsection (a): "(1) INDIVIDUALS AND DOMESTIC CORPORATIONS.-In the case of an indi- vidual who is a citizen or resident of the United States or who is a bona fide resident of Puerto Rico during the entire taxable year and in the case of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; and "(2) PARTNERSHIPS AND ESTATES.-Ifl the case of any individual de- scribed in paragraph (1), who is a member of a partnership or a beneficiary of an estate or trust, the amount of the proportionate share of the taxes (described in such paragraph) of the partnership or the estate or trust paid or accrued during the taxable year to a foreign country or to any possession of the United States, as the case may be." (b) SIMILAR CREDIT REQUIREMENT5.-Subsections (c) and (d) of section 901 (relating to corporations treated as foreign and to cross references, respectively) 131 PAGENO="0142" 10 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. are redesignated as subsections (d) and (e), and the following new subsection is added after subsection (b): "(c) SIMILAR CREDIT. REQUIRED FOR CERTAIN ALIEN REsIDENT5.-Whenever the President finds that- "(1) in the case of an alien individual who is a resident of the United States or who is a bona fide resident of Puerto Rico during the entire taxable year, the foreign country of which such alien resident is a citizen or subject, in imposing income, war profits, and excess profits taxes, does not allow to *ci~izens of the United States residing in such foreign country a credit similar to the credit allowed under subsection (b), * "(2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit to citizens of the United States residing in such foreign country, and "(3) it is in the public interest to allow the credit under subsection (b) to such alien resident of the United States or Puerto Rico only if such foreign country allows such a similar credit to citizens of the United States residing in such foreign country, the President shall proclaim that, for taxable years beginning after such procla.. mation, such alien resident of the United States or Puerto Rico shall be allowed the credit under subsection (b) only if such foreign country, in imposing income, war profits, and excess profits taxes, allows to citizens of the United States residing in such foreign country a credit similar to the credit allowed under such subsection." (c) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to taxable years beginning after December 31, 1965. SEC. 7. AMENDMENT TO PRESERVE EXISTING LAW ON DEDUCTIONS UNDER SEC- TION 931. (a) DEDUcTI0N5.-Subsection. (d) of section 931 (relating to deductions) is amended 4o read as follows: "(d) DEDUCTIONS.- "(1) GENERAL RULE.-EXCept as otherwise provided in this subsection and subsection (e), in the case of persons entitled to the benefits of this section the deductions shall be allowed only if and to the extent that they are connected with income from sources within the United States; and the proper apportionment and allocation of the deductions with respect to sources of income within and without the United States shall be determined as provided in part I, under regulations prescribed by the Secretary or his delegate. "(2) ExcEPTIONS~-The following deductions shall be allowed whether or not they are connected with income from sources within the United States: "(A) The deduction, for losses not connected with the trade or business if incurred in transactions entered into for profit, allowed by section 165(c)(2), but only if the profit, if such transaction had re- suited in a profit, would be taxable under this subtitle. "(B) The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c)(3), but only if the loss is of property within the United States. "(C) The deduction for charitable contributions and gifts allowed by section 170, but, in the case of a citizen of the United States entitled to the benefits of this section, only for contributions or gifts made to domestic corporations, or to community chests, funds or foundations, created in the United States. "(3) DEDUCTION m5ALL0wED.-For disallowance of standard deduction, see section 142(b) (2)." (b) EFFECTIVE DArE.-The amendment made by this section shall apply with respect to taxable years beginning after December 31, 1965. SEC. 8. ESTATES OF NONRESIDENTS NOT CITIZENS. (a) RATE OF TAx.-Subsection (a) of section 2101 (relating to tax imposed in case of estates of nonresidents not citizens) is amended to read as follows: "(a) RATE OF TAx.-A tax computed in accordance with the following table, except as provided in section 2107, is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States dying after the enactment of this section: If the taxable estate is: The tax shall be: Not over $100,000 5% of the taxable estate. Over $100,000 but not over $750,000 $5,000, plus 10% of excess over $100,000. Over $750,000 $70,000, plus 10% of excess over $750,000." 132 PAGENO="0143" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.s. 11 (b) CREDITS AGAINST TAx.-Section 2102 (relating to credits allowed against estate tax) is amended to read as follows: "SEC. 2102. CREDITS AGAINST TAX. "(a) IN GENERAL.-The tax imposed by section 2101 shall be credited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), subject to the special limitation provided in subsection (b). "(b) SPECIAL LIMITATI0N.-The maximum credit allowed under section 2011 against the tax imposed by section 2101 for State death taxes paid shall be an amount which bears the same ratio to the credit computed as provided in section 2011(b) as the value of the property, at the date of death, upon which State *death taxes were paid and which is included in the gross estate under section 2103 bears to the value of the total gross estate under section 2103. For purposes of this subsection, the term `State death taxes' means the taxes described in section 2011(a)." (e) PROPERTY WITHIN THE UNITED STATE5.-Section 2104 (relating to prop- erty within the United States) is amended by adding at the end thereof the following new subsection: "(c) DEBT OBLIGATI0N5.-For purposes of this subchapter debt obligations owned by a nonresident not a citizen of the United States shall be deemed prop- erty within the United States if issued by or enforcible against- "(1) a citizen or resident of the United States, a domestic partnership, domestic estate or trust, or domestic corporation; or "(2) the United States, a State, or a possession of the United States, or any political subdivision of any of the foregoing, or the District of Columbia." (d) PROPERTY WITHOUT THE UNITED STATEs.-Subsection (b) of section 2105 (relating to bank deposits) is amended to read as follows: "(b) BANK DEPOSITS AND WITHDRAWABLE AccouNTs.-For purposes of this subchapter, the following items shall not be deemed property within the United States: "(1) BANKING IN5TITUTI0N5.-Any moneys deposited with any person carrying on the banking business, by or for a nonresident not a citizen of the United States who was not engaged in business in the United States at the time of his death. "(2) MUTUAL SAVINGS BANKS, ETC.-Any moneys deposited, or placed in withdrawable accounts, with savings institutions chartered and supervised as savings and loan or similar associations under Federal or State law, by or for a nonresident not a citizen of the United States who was not engaged in business in the United States at the time of his death, if amounts paid or credited on such deposits or accounts are deductible under section 591 in computing the taxable income of such institutions." (e) DEFINITION OF TAXABLE EsTATE.-Paragraph (3) of section 2106(a) (relating to deduction of exemption from gross estate) is amended to read as follows: "(3) EXEMPTION.- "(A) GENERAL RULE.-An exemption of $30,000. "(B) RESIDENTS OF POSSESSIONS OF THE UNITED STATES.-Ifl the case of a decedent who is considered to be a `nonresident not a citizen of the United States' under the provisions of section. 2209, the exemption shall be the greater of (i) $30,000, or (ii) that portion of the exemption author- ized by section 2052 which the value of that part of the decedent's gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated." (f) SPECIAL METHODS OF COMPUTING TAx.-Subchapter B of chapter 11 (relating to estates of nonresidents not citizens) is amended by adding at the end thereof the following new sections: "SEC. 2107. EXPATRIATION TO AVOID TAX. "(a) RATE OF TAx~-A tax computed in accordance with the table contained in section 2001 is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States dying after the date of enactment of this section, if within the 10-year period ending with the date of death such decedent lost United States citizenship and such loss had for one of its principal purposes the avoidance of United States taxes. "(b) GROSS ESTATE.-FOr purposes of the tax imposed by subsection (a), the value of the gross estate of every decedent to whom subsection (a) applies shall be determined as provided in section 2103, except that- 133 PAGENO="0144" 12 -ERMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN ~J5 "(1) if such decedent owned (within the meaning of section 958(a)) at the time of his death 10 percent or more of the total combined voting power of all classes of stock entitled to vote of a foreign corporation, and "(2) if such decedent owned (within the meaning of section 958(a)), or is considered to have owned (by applying the ownership rules of section 958(b) without regard to section 958(b) (1)), at the time of his death, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of such foreign corporation, then that proportion of the fair market value of the outstanding stock of such foreign corporation owned (within the meaning of section 958(a)) by such decedent at the time of his death, which the fair market value of any assets owned by such foreign corporation and situated in the United States, at the time of his death, bears to the total fair market value of all assets owned by such foreign corporation at the .time of his death, shall be included in the gross estate of such decedent. "(c) CREDIT5.-The tax imposed by subsection (a) shall be credited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating th State death taxes, gift tax, and tax on prior transfers). "(d) EXCEPTION FOR Loss OF CITIZENSHIP FOR CERTAIN CAUsE5.-Subsection (a) shall not apply to the transfer of the estate of a decedent who lost United States citizenship under section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). "(e) BURDEN OF PRooF-For purposes of subsection (a), the burden of proving that a decedent's loss of United States citizenship did not have for one of its principal purposes the avoidance of United States taxes shall be on the executor of the estate of such decedent. "SEC. 2108. APPLICATION OF PRE-1966 TAX PROVISIONS. "(a) IMPOSITION OF MORE BURDENSOME TAX BY FOREIGN COUNTRY.-When- ever the President finds that- "(1) under the laws of any foreign country, considering the tax system of such foreign country, a more burdensome tax is imposed by such foreign * country on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, "(2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such tax so that it is no more burdensome than the tax imposed by this subchapter on the transfer of estates of dccc- dents who were residents of such foreign country, and "(3) it is in the public interest to apply pre-1966 tax provisions in accord. ance with this section to the transfer of estates of decedents who were residents of such foreign country, the President shall proclaim that the tax on the transfer of the estate of every decedentwho was a resident of such foreign country at the time of his death shall, in the case of decedents dying after such proclamation, be determined under this subchapter without regard to amendments made to such subchapter on or after the date of enactment of this section. "(b) ALLEvIATION OF MORE BURDENSOME TAx.-Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that the tax on the transfer of estates of decedents who were such citizens of the United States is no longer more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, he shall pro- claim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after such proclamation, be determined under this subchapter by taking into account amendments made to such subchapter on or after the date of enactment of this section. "(c) NOTIFICATION OF CoNGRESS REQUIRED.-NO proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. "(d) IMPLEMENTATION BY REGULATIONS.-The Secretary or his delegqte shall prescribe such regulations as may be necessary or appropriate to implement this section." 134 PAGENO="0145" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 131 (g) CLERICAL AMENDMENT.-The table of sections for subchapter B of chapter 11 (relating to estates of nonresidents not citizens) is amended by adding at the end thereof the following: "Sec. 2107. Expatriation to avoid tax. "Sec. 2108. Application of pre.1966 tax provisions." (h) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to estates of decedents dying after the date of the enactment of this Act, except that section 2107, as added by subsection (f), shall apply only in the case of a decedent who has lost United States citizenship after March 8, 1965. SEC. 9. GIFT TAX OF NONRESIDENTS NOT CITIZENS. (a) IMPOsITION OF TAx.-Subsection (a) of section 2501 (relating to general. rule for imposition of tax) is amended to read as follows: "(a) TAXABLE TRANSFERS.- "(1) GENERAL RULE.-For the calendar year 1955 and each calendar year thereafter a tax, computed as provided in section 2502, is hereby imposed, except as provided in paragraph (2), on the transfer of property by gift during such calendar year by any individual, resident or nonresident. "(2) TRANSFERS OF INTANGIBLE PR0PERTY.-Except as provided in para- graph (3), paragraph (1) shall not apply to the transfer of intangible property by a nonresident not a citizen of the United States. "(3) EXCEPTI0Ns.-Paragraph (2) shall not apply in the case of a donor who at any time within the 10-year period ending with the date of transfer lost United States citizenship unless- "(A) such donor has lost United States citizenship under section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487), or "(B) such loss did not have for one of its principal purposes the avoid- ance of United States taxes. "(4) BURDEN OF PROOF.-For purposes of paragraph (3) (B), the burden of proving that a donor's loss of United States citizenship did not have for one of its principal purposes the avoidance of United States taxes shall be on such donor." (b) TRANSFERS IN GENERAL.-Subsection (b) of section 2511 (relating to situs rule for stock in a corporation) is amended to read as follows: "(b) INTANGIBLE PROPERTY.-FOr purposes of this chapter, in the case of a donor excepted from the application of section 2501 (a) (2)-, "(1) shares of stock owned by such donor and issued by a domestic corpora- tion, and "(2) debt obligations owned by such donor and issued by or euforcible against- "(A) a citizen or resident of the United States, a domestic partnership, domestic estate or trust, or domestic corporation, or "(B) the United States, a State, or a possession of the United States or any political subdivision of any of the foregoing, or the District of Columbia, shall be deemed to be property situated within the United States." (c) EFECTIVE DATE.-The amendments made by this section shall apply with respect to the calendar year 1966 and all calendar years thereafter, except that the exception to section 2501(a)(2), as added by subsection (a), shall apply only in the case of a donor who has lost United States citizenship after March 8, 1965~ SEC. 10. DOCUMENTARY STAMP TAXES. (a) EXEMPTION FOR CERTAIN FOREIGN IN5TRUMENTS.-Section 4382 (relating. to exemptions from documentary stamp taxes) is amended by adding at the end thereof the following new subsection: "(c) ORIGINAL OFFERING BY FOREIGN ISSUERS TO FOREIGN PURCHASERS.- The taxes imposed by sections 4311, 4321, and 4331 shall not apply to the issuance, delivery, or transfer of any shares or certificates of stock or certificates of indebted- ness to make effective the original issuance of such instruments by a foreign issuer to foreign purchasers, whether or not such transaction is accomplished through a domestic underwriter." (b) EFFECTIVE DATE.-The amendment made by this section shall take effect. on January 1, 1966. 7 1-297 O-67-pt. i-iø 135 PAGENO="0146" 14 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. SEC. 11. TREATY OBLIGATIONS. (a) IN GENERAL.-NO amendment made by this Act shall apply in any case where its application would be contrary to any treaty obligation of the United States. (b) ABSENCE OF PERMANENT E5TABLI5HMENT.-In determining the rate of tax under section 871(b) (2) or section 882(a) (2), as amended by this Act, on income which is not business income, a nonresident alien individual or foreign corporation shall be deemed, for purposes of applying any treaty obligation of the United States, not to have a permanent establishment in the United States at any time during the taxable year. TREASURY DEPARTMENT, Washington, D.C., March 8, 1966. PROPOSED LEGISLATION To INCREASE FOREIGN INVESTMENT IN THE UNITED STATES The Treasury tàday submitted to the Congress proposed tax legislation de- signed to increase foreign investment in the ,United States. Drafts of the proposed legislation, titled "An Act To Remove Tax Barriers to Foreign Investment in the United States," were sent to Speaker McCormack and Vice President Humphrey. Chairman Mills of the House Ways and Means Committee has stated that he will introduce it. The proposed legislation is part of President Johnson's program to improve the U.S. balance of payments, which was announced in his message to the Congress on February 10, 1965. The legislation contains proposed changes in the present tax law. These changes are designed to stimulate foreign investment in the United States by removing existing tax barriers to such investment. The proposed changes grew out of the Treasury study of recommendations made to President Johnson last April by the Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securities. This task force was composed of leaders in the business and financial community and was headed by the then Under Secretary of the Treasury, Henry H. Fowler. The changes affect the taxation of foreign individuals and foreign corporations. Many of the provisions in the present law which will be revised or eliminated by the proposed legislation have tended to complicate or inhibit investment in U.S. corporate securities without generating any significant tax revenues. The total annual revenue loss from enactment of the proposed legislation is estimated to be less than $5 miffion. Foreign purchases of U.S. corporate securities are the greatest single souroc of long-term capital inflow for the United States. Between 1956 and 1963, such purchases averaged $190 million a year. During that time the value of foreign- held stocks outstanding more than doubled-going from $6.1 billion to $12.5 billion. There is no estimate of the immediate benefit from the proposed legisla- tion in terms of increased investment, but over time it is expected that the legisla- tion would result in increased purchases of such securities of roughly $100 million to $200 million a year. The bill proposes three major tax changes affecting foreigners and foreign cor- porations and a number of minor changes. The major changes are: 1. Reduction of the rate of U.S. estate tax applicable to foreigners to bring the tax treatment of foreigners more in line with the rates usually paid by American citizens, and with general international practice. Tbe reduction would replace the present maximum rate of 77 percent for foreigners with a maximum rate of 15 percent, and replace the present $2,000 exemption with a $30,000 exemption. 2. Elimination of the provision in the present law which makes foreigners' nonbusiness income, such as dividends and interest, subject to tax at regular U.S. individual tax rates if it exceeds $21,200. The tax on such income would be limited to the flat 30 percent withholding rate provided by statute or any lower withhold- ing rate which may be provided by treaty. Business income would continue to be taxed at regular U.S. rates if the foreigner is engaged in business here. 3. Elimination of the present provision for taxation of capital gains realized by a foreigner simply because he was present in the United States at the time of the particular transaction. At the same time, the period that a foreigner may spend in the United States, without becoming subject to tax on all U.S. capital gains for the taxable year, would be extended from 90 days to 183 days. 136 PAGENO="0147" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN 11.5. 15 Since the application of the U.S. estate tax to foreigners is one of the biggest barriers to foreign investment in the United States, its reduction is probably the most important of the major changes. For example, the proposed change would reduce the estate tax for a foreigner with a U.S. gross estate of $100,000 from about $17,300 to about $3,000 A~U.S. citizen would pay about the same tax on such an estate if he didnotclaihi the mdrital deduction, and would pay no tax if he did. (Foreigners are not alldwed to claim the marital deduction.) The proposed legislation also contains provisions dealing with former U.S. citizens who in the future give up their citizenship and live outside the United States in order to avoid U.S. taxes. It would require such former citizens to pay regular U.S. income and estate taxes on income from or property in the United States, if they gave up their U.S. citizenship less than 10 years before. This would not apply to former citizens who could show that the surrender of their citizenship was no~ tax motivated. There are also other provisions designed to contribute to more rational and consistent tax treatment of foreigners and foreign corporations. (A general explanation of the proposed legislation is attached.) ACT TO REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES GENERAL EXPLANATION INTRODUCTION In his balance of payments message of February 10, 1965, the President proposed a series of measures designed to reinforce the program to correct the balance-of- payments deficit of the United States. Among the proposals made by the President is one to remove the tax deterrents to foreign investment in U.S. corporate securities so as to improve our balance of payments by encouraging an increase in such investment. The recommended legislation described herein would effectuate this proposal. The review of the tax treatment of nonresident foreigners and foreign corpora- tions investing in the United States resulting in these legislative recommendations was prompted in large: measure by the report of the Task Force on Promoting Increased Foreign Inve ae~it in U.S. Corporate Securities. This task force, which was headed by the then Under Secretary of the Treasury Henry H Fowler was directed, among other things, to review U.S. Government and private activi- ties which adversely affect foreign purchases of the securities of U.S. private companies. In its report, the task force made 39 recommendations designed to help the United States reduce its balance-of-payments deficit and defend its gold reserves. Among* these ~were several directed at changing the tax treatment of foreign investors so as "to remove a number of elements in our tax structure which unnecessarily complicate and inhibit investment in U.S. corporate securities without generating material tax revenues." The task force report cautioned, however, that its tax recommendations were not intended to turn the United States into a tax haven, nor to drain funds from developing countries. The legislation being requested deals with all of the tax areas discussed in the task force report, although in certain instances the action suggested differs from the proposals made by the task force. Furthermore, the draft bill contains recommendations in areas not mentioned in the task force report which deal with problems which came to light in the Treasury Department's study of the present system of taxing nonresident foreigners and foreign corporations. It should be emphasized that the recommendations embodied in the proposed legislation were considered not only from the viewpoint of their impact on the balance of payments, but also to insure that they contributed to a rational and consistent program for the taxation of foreign individuals and foreign corporations. Thus, all legislative suggestions made herein are justifiable on conventional tax policy grounds. It is estimated that the adoption of these proposals would result in a net revenue loss on an annual basis of less than $5 million. Foreign purchases of U.S. stocks constitute the largest single source of long- term capital inflow into the United States, with even greater potential for the future. Net purchases have averaged $190 million a year between 1956 and 1963, while the outstanding value of foreign-held stocks has risen from $6.1 billion to $12.5 billion during this period. It is extremely difficult to measure the precise impact of this proposed legislation on our balance of payments because of the 137 PAGENO="0148" 16 REMOVE TAX BARRIERS TO FOREIGN INVESTMEI~T IN U.S. various factors affecting the level of foreign investment in the United States. It. is anticipated that, when combined with an expanding U.S. economy, the proposed~ legislation will result over the years in a significant increase in such investment. Most provisions of the draft bill are proposed to become effective to taxable years beginning after December 31, 1965. However, those provisions which pro- vide a revised estate tax treatment for the estates of foreigners are made appli-~ cable to the estates of decedents dying after the date of the enactment of the pro- posed legislation. In addition, those special provisions applicable to U.S. citizens who have surrendered their U.S. citizenship are made applicable if the surrender occurred after March 8, 1965. SPECIFIC RECOMMENDATIONS The following paragraphs describe the specific changes in the Internal Revenue Code of 1954 which are proposed. For this purpose the technical language of the Internal Revenue Code has been used; e.g., foreigners are described by the tech- nical term "alien." 1. Graduated rates.-Eliminate the taxation at graduated rates of U.S. source income of nonresident alien individuals not doing businesa in the United States. Under present law, nonresident aliens deriving more than $21,200 of income from U.S. sources are subject to regular U.S. graduated rates and are required to file returns. However, graduated rates on investment income already are elimi- nated by treaty in the case of almost all industrial countries, except where a tax- payer is doing business in the United States and has a permanent establishment here. Only a very small amount of revenue is collected from graduated rates at present. For example, for 1962 graduated rates resulted in the collection of~ $746,743 above the taxes already withheld. Although graduated rates are rarely applicable they complicate our tax law and tend to frighten and confuse foreign investors. Thus, graduated rates, whether applied to investment income or such types of income as pensions, annuities, alimony, and the like, serve no clearly defined purpose, deter foreign investment, and should be eliminated. The elimination of* graduated rates will limit the liability of nonresident aliens not engaged in trade* or business to taxes withheld, and where the alien is not engaged in trade or business here no return need be made. (However, graduated rates would be retained for the U.S. business income of nonresident aliens engaged in trade or* business here.) 2. Segregation of investment and business income and related matters.-Provide that (a) nonresident alien individuals engaged in trade or business in the United States be taxed on investment (nonbusiness) income at the 30-percent statutory withholding rate, or applicable treaty rate, rather than at graduated rates; (b) foreign corporations engaged in business in the United States be denied the* 85-percent dividends-received deduction and be exempt from tax on their capital gains from investments in U.S. stocks; (c) nonresident alien individuals and foreign corporations not be deemed engaged in trade or business in the United States because of investment activity in the United States or because they have* granted a discretionary power to a U.S. banker, broker, or adviser; and (d) non- resident alien individuals and foreign corporations be. given an election to compute income from real property and mineral royalties on a net income basis and be taxed at graduated rates on such income as if engaged in trade or business in the United States. Segregation of business and investment income Under present law, if a nonresident alien is engaged in trade or business within the United States, he is subject to tax on all his U.S. income (including capital gains), even though some of the income is not derived from the conduct of the trade or business, at the same rates as U.S. citizens. A nonresident alien individual engaged in trade or business in the United States should be subject to taxation on his investment income on the same basis. as a nonresident alien not so engaged. Thus his investment income would be ta.xed at the 30-percent statutory rate or applicable treaty rate, rather than at graduated rates. For the purpose of determining the applicability of treaty rates the alien will be deemed not to have a permanent establishment in this. country. All business income should remain subject to tax at graduated rates, but the rates on business income would be computed without regard to the amount. of investment income. This change conforms to the trend in international treaty negotiations to sepa- rate investment income from business income. Whether a taxpayer is helped or 138 PAGENO="0149" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 17 harmed by segregating his investment from his business income, separate treat-~ ment is proper and equitable. Investment decisions may be made on the same basis whether or not the alien is engaged in business here, since income arising from investments here will not be subject to taxation at graduated rates in either event. Moreover, a nonresident alien individual engaged in trade or business here should not be taxed on capital gains realized in the United States which are unrelated to the business activity carried on by him in this country, except where he would be subject to tax on those gains under, the rules pertaining to nonresident aliens generally. Tax treatment of income from U.S. stock investments by foreign corporations Under present law all the activities of a corporation are treated as part of its trade or business. Thus, for example, all its expenses are treated as deductible as business expenses. Accordingly, it would be inappropriate to segregate a `foreign corporation's U.S. "investment" income from its U.S. "business" income. However, there is one abuse in this area which should be eliminated. Frequently, a foreign corporation with stock investments in the United States engages in trade or business here in some minor way (such as by owning a few parcels of real estate) and then claims the 85-percent dividends-received deduction on its stock investments in the United States. Such a corporation thereby may pay far less than the 30-percent statutory or treaty withholding rate on its U.S. dividend income, although its position is essentially the same as that of a foreign corporation doing business elsewhere which has U.S. investment income. To eliminate this abuse and treat all foreign corporations with investments in U.S. stocks alike,, the 85-percent dividends-received deduction should be denied to foreign corporations doing business here. Their income from stock invest- ments would be made subject to the 30-percent statutory withholding rate, or any lesser treaty rate applicable to such income, rather than regular U.S. corporate rates. For the purpose of determining whether the treaty rates on dividend income apply, a foreign corporation will be deemed not to have a permanent *establl~hment in this country. To fully equate the tax treatinent~öFitk~~'~ investments of foreign corporations doing business in the United States with that of foreign corporations not doing business here, such corporations are ex- *empted from the U.S. tax on capital gains realized on their U.S. stock investments. Definition of "Engaged in trade or business" Present law provides that the term "engaged in trade or business" does not include the effecting, through a resident broker, commission agent, or custodian, of transactions in the United States in stocks, securities, or commodities. There is some confusion as to whether the amount of activity in an investment account, ~or the granting of a discretionary power to a U.S. banker, broker, or adviser, will place a. nonresident alien outside of this exception for security transactions so that he is engaged in trade or business in the United States. This uncertainty may deter investment in the United States and is undersirable as a matter of tax policy. . The fact that a discretionary power of investment has been given to a U.S. broker or banker does not really bear a relation to the foreigner's ability to carry `out transactions in the United States-the discretionary power is merely a more * efficient method of operating rather than having the investor consulted on every investment decision and frequently is mreely a safeguard to protect him in case of world turmoil. Nor, where the alien is an investor, is the volume of transactions material in determining whether he is engaged in trade or business. Accordingly, `the"proposed 1egisla'ton-mni~es--elear--that---individuals or corpora- tions are not engaged in trade or business because of investment activity in the United States or because they have granted a discretionary investment power to `a U.S. banker, broker, or adviser. No legislative change is necessary to provide that the volume of transactions is not material in determining whether an investor is engaged in trade or business in the United States as this is the rule under present law. Real estate income and mineral royalties Under present law it is not clear whether a nonresident alien (or foreign cor - poration) is engaged in trade or business in the United States by reason .of the mere ownership of unimproved real property or real property subject to a strict net lease, or by reason of an agent's activities in connection with the selection of real estate investments in the United States. If because of such activity a nonresident alien is considered as not engaged in trade or business he becomes subject to withholding tax on his gross rents. Since 139 PAGENO="0150" 18 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. the consequent tax could exceed his net income, the taxation on a gross basis of income from real property should not be continued where taxation on a net basis at graduated U.S. rates would be more appropriate. Therefore, a nonresident alien or foreign corporation should be given an election to compute their income from real property (including income from minerals and other natural resources) on a net income basis and at regular U.S. rates as if they were engaged in trade or business in the United States. Such an elec- tion is comparable to the one now appearing in many treaties to which the United States is a party. Such an election would not effect thn method of taxation applied to his other income. 3. Capital gains.-Eliminate the provision taxing capital gains realized by a. nonresident alien when he is physically present in the United States, and extend from 90 to 183 days the period of presence in the United States during the year which makes nonresident aliens taxable on all their capital gains. The underlying policy of U.S. taxation of nonresident alien individuals has been to exempt capital gains realized from sources in this country. This policy has been proper both from a tax policy standpoint and from the viewpoint of our balance of payments. However, existing law has two limitations: U.S. capital gains realized by a nonresident alien while he is physically present in the United~ States, or realized during a year in which he is present in the United States for 90 days or more, are subject to a U.S. tax of 30 percent. The limitations now contained in our law, especially the physical presence test, contain illogical elements and are likely to have a negative impact on foreigners who are weighing the advantages and disadvantages of investing in the United States. The physical presence test was added to the law after World War H when many nonresident alien traders were frequently present in this country. Since this is no longer true, and moreover, since the tax may be readily avoided by passing title to the property outside the United States, the provision now serves little purpose. However, it does pose a threat to the foreign investor which may deter him from investing in this country and therefore should be eliminated. The limitation relating to presence in the United States for 90 days or more in a particular year should be retained, but the period should be lengthened to 183 days. This extension will remove a minor deterrent to travel in the United States and help mitigate the harsh consequences which may arise .under the existing rule if a nonresident alien realized capital gains at the beginning of a taxable year during which he later spends 90 days or more in the United States. 4. Personal holding company and "second dividend" ta~ces.-(a) Exempt foreign corporations owned entirely by nonresident alien individuals, whether or not doing business in the United States, from the personal holding company tax; (b) modify the application of the "second dividend tax" of section 861(a) (2) (B) so that it only applies to the dividends of foreign corporations doing business in the United States which have over 80 percent U.S. source income. Under present law any foreign corporation with U.S. investment income, whe- ther or not doing business here, may be a personal holding company unless it is owned entirely by nonresident aliens, and unless its gross income from U.S. sources is less than 50 percent of its gross income fromaligources. The personal holding company tax should not apply to foreign corporations owned entirely by nonresident aliens. The only reason for applying our personal holding company tax to foreign corporations owned by nonresident aliens has been to prevent the accumulation of income in holding companies organized to avoid the graduated rates. With the elimination of graduated rates as suggested in recom- mendation 1 (and the revision of the second dividend tax, discussed below), U.S. investment income in the hands of foreign corporations will have borne the U.S. taxes properly applicable to it and accumulation of such income will not result in the avoidance of U.S. taxes imposed on the company's shareholders. Hence~ there is no longer any reason to continue to apply the personal holding company tax to these corporations. With respect to the "second dividend tax," section 861(a) (2) (B) now provides that if a corporation derives 50 percent or more of its gross income for the preceding 3-year period from the United States, its dividends shall be treated as U.S. source income to the extent the dividends are attributable to income from the United States. As a result such dividends are subject to U.S. tax when received by a nonresident alien. This tax is often referred to as the "second dividend tax." However, under section 1441(c) (1) a foreign corporation is not required to with- hold tax on its dividends unless it is engaged in business in the United States and, in addition, more than 85 percent of its gross income is derived from U.S~ sources. 140 PAGENO="0151" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 1D It is now proposed to levy this second dividend tax only where the foreign corporation does business in the United States, and 80 percent or more of its gross income (other than dividends and capital gains on stock) is derived from U.S. sources. Where a foreign corporation is not doing business in the United States, it will pay U.S. withholding taxes on all investment income and other * fixed or determinable gains and profits derived frOm the United States, and since that is all the tax its foreign shareholders would owe if they received the income directly, no second tax seems warranted. With the adoption of the rule that the income from the U.S. stock investments of foreign corporations doing business here be taxed at fiat statutory or treaty withholding rates, no further U.S. tax should be imposed on such income. There-. fore, in applying theproposed 80 percent test, suchincome of the foreign corpora- tion, whether from United States or foreign sources, should be disregarded and the test applied only to the corporation's other income. Furthermore, if the 8Q percent rule is met, the dividends of such corporations should be subject to tax only to the extent that such dividends are from U.S. source income other than income from stock investments in the United States. Withholding requirements should conform to the incidence of tax, and therefore withholding should be required on dividends paid by foreign corporations doing business in the United States with 80 percent or more U.S. source income to the extent such dividends are from U.S. source income other than income from stock investments in the United States. With the adoption of the revisions proposed in U.S. system of taxing non- resident aliens and foreign corporations, the regulations dealing with the accumu- lated earnings tax will be revised to eliminate the application of this tax to foreign corporations not doing business in the United States which are owned entirely by nonresident aliens. The accumulation of earnings by such corporations will not result in the avoidant~e of U.S. taxes. However, because of possible avoidance of the revised second dividend tax, the accumulated earnings tax will remain applicable to foreign corporations doing business here. 5. Estate. tax and related matters.-(a) Increase the $2,000 exemption from tax to $30,000 and substitute for regular U.S. estate tax rates a 5-10-15 percent rate schedule; (b) provide that bonds issued by domestic corporations or governmental units and held by nonresident aliens are property within the United States and therefore are subject to estate tax; and (c) provide that transfers of intangible property by a nonresident alien engaged in business in the United States are not subject to gift tax. It is generally believed that high estate taxes on foreign investors are one of the most important deterrents in our tax laws to foreign investment in the United States. Our rates in many cases are higher than those of other countries and in these. situations, despite tax conventions and statutory foreign estate tax credits, nonresidents who invest in the United States suffer an estate tax burden. More- over, under present law a nonresident alien's estate must pay heavier estate taxes on its U.S. assets than would the estate of a U.S. citizen owning the same assets. To mitigate this deterrent to investment and to rationalize the estate tax treatment of nonresident aliens, the exemption for estates of nonresident alien decedents should be increased from $2,000 to. $30,000 and such estates should be subject to tax at the following rates: If the taxable estate is- The tax shall be- Not over $100,000. 5 percent of the taxable estate. Over $100,000 but not over $750,000._ $5,000, plus 10 percent of excess over $100,000. Over $750,000 $70,000, plus 15 percent of excess over $750,000. The increase in exemption and reduced rates will bring U.S. effective estate tax rates on nonresident aliens to a level somewhat higher than those imposed upon resident estates in Switzerland, Germany, France, and the Netherlands, for example, but substantially below those imposed on resident estates in the United Kingdom, Canada, and Italy. Thus U.S. investment from these latter countries bears no higher estate tax than local investment because of foreign tax credits or exemptions provided in such countries. The proposed tax treatment of the U.S. estates of nonresident aliens is similar to the treatment accorded the estates of nonresidents by Canada, whose rates on the estates of its citizens are comparable to our own. Where additional reductions are justified these may be made by treaty. These changes should result in more appropriate estate tax treatment of non- resident aliens and thereby improve the climate for foreign investment in the 141 PAGENO="0152" 20 REMOVE TAX BARRIERS~ TO FOREIGN INVESTMENT IN U.S. United States. Particularly in the case' of nonresident alien decedents who have only a small amount of U.S. property in their estates, present U.S. rates and the limited exemption provided result in an excessive effective rate of estate tax. The proposed changes correct this situation. The new rates will produce for nonresident aliens' estates an effective rate of tax on U.S. assets which in many cases is comparable to that applicable to U.S. citizens who may avail themselves of the $60,000 exemption and marital deduction (which are not available to non- resident aliens). The following figures show the effective rates for nonresident aliens under present law, and the effective rates produced by the proposed exemption and rates as compared to those applicable to the estates of U.S. citizens electing and not electing the marital deduction: U.S. gross estate Nonresident alien under present law Nonresident alien under proposed law U.S. citizen with marital deduction U.S. citizen without marital deduction $60,000 $100,000 $500,000 $1,000,000 $5,000,000 12.5 17.3 25.8 38.8 43.0 2.0 3. 0 7. 4 8.8 12. 6 8.0 11. 1 16.9 3. 0 22. 1 26. 7 42. 3 As part of this revision of the estate tax, the situs rule with respect to bonds `should be changed. The present rule, very frequently modified by treaty, is `that bonds have situs where they are physically located. This rule is illogical, permits tax avoidance, and is not a suitable way to determine whether bonds are `subject to an estate tax as their location is one of their least significant character- istics for tax purposes. Other intangible debt obligations are presently treated as property within the United States if issued by or enforcible against a domestic corporation or resident of the United States. Accordingly, it is recommended that our law be amended to provide that bonds issued by domestic corporations or domestic governmental units and held by nonresident aliens are property within the United States and therefore subject to estate tax. Furthermore, a present defect in the operation of the credit against the estate tax for State death taxes in the case of nonresident aliens should be corrected. Under present law the estate of a nonresident alien may receive the full credit permitted by section 2011 even though only a portion of the property subject to Federal tax was taxed by a State. The amount of credit permitted by section 2011 in the case of nonresident aliens should be limited to that portion of the ~credit allowed the estate which is allocable to property taxed by both the State and the Federal Government. Our gift tax law as it applies to nonresident aliens should be revised. Under present law a nonresident alien doing business in the United States is subject to gift tax on transfers of U.S. intangible property. This rule has little significance from the standpoint of revenue and tax equity. Therefore, our law should be amended to provide that transfers of intangible property by a nonresident alien, whether or not engaged in business in the United States, are not subject to gift tax. Gifts of tangibles situated in the United States which are owned by nonresi- dent aliens will continue to be subject to U.S. gift taxes. 6. Expatriate American' citizens.-Subject the U.S. source income of expatriate citizens of the United States to income tax at regular U.S. rates and their U.S. estates to estate tax at regular U.S. rates, where they surrendëre& their U.S. citizenship within 10 years preceding the taxable year in question unless the surrender was not tax motivated. As a result of the proposed elimination of graduated rates, taken together with `the proposed change in our estate tax as it applies to nonresident aliens, an Ameri- can citizen who gives up his citizenship and moves to a foreign country would be able to very substantially reduce his US. estate and income tax liabilities. While it may be doubted that there are many U.S. citizens who would be willing to give up `their U.S. citizenship no matter how substantial the tax incentive, a tax incentive so great might lead some Americans to surrender their citizenship for the ultimate benefit of their families. Thus, it seems desirable, if progressive rates are eliminated for nonresident aliens and our estate tax on the estates of non- resident aliens is significantly reduced, that steps be taken to limit the tax advan- tages of. alienage for our citizens. The recommended legislation accomplishes this by providing that a nonresident ~alien who surrendered his U.S. citizenship within the preceding 10 years shall re- 142 PAGENO="0153" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 21 main subject to tax at regular U.S. rates on all income derived from U.S. sources.. A similar rule would apply for estate tax purposes to the U.S. estates of expatriate citizens of the United States. Thus, the U.S. property owned by expatriates would be taxed at the estate tax rates applicable to our citizens (but without the $60,000 exemption, marital deduction, and other such provisions applicable to our citizens), in cases where the alien decedent's surrender of citizenship took place less than 10 years before the day of his death. The $30,000 exemption granted nonresident aliens would be allowed to expatriate citizens. To prevent an expatriate from avoiding regular U.S. rates on his U.S. income by transferring his U.S. property to a foreign corporation, or disposing of it overseas,. the recommended legislation treats profits from the sale or exchange of U.S. prop- erty by an expatriate as being U.S. source income. To preclude the use of a foreign corporation by an expatriate to hold his U.S. property and thus avoid U.S. estate taxes at regular U.S. rates, an expatriate is treated as owning his pro rata share of the U.S. property held by any foreign corporation in which he alone owns a 10-percent interest and which he, together with related parties, controls. Fur- thermore, the recommended legislation makes gifts by expatriates of intangibles situated in the U.S. subject to gift tax. These provisions would be applicable only to expatriates who surrendered their citizenship after March 8, 1965, and would not apply if contravened by the pro- visions of a tax convention with a foreign country. Moreover, they would not be applicable if the expatriate can establish that the avoidance of U.S. tax was not a principal reason for his surrender of citizenship. 7. Retaining treaty bargaining position.-Provide that the President be given authority to eliminate with respect to a particular foreign country any liberalizing ehanges which have been enacted, if he finds thatthe country concerned has not acted to provide reciprocal concessions for our citizens after being requested to do so by the United States. One difficulty which may arise from the liberalizing changes being proposed in U.S. tax law is that it may place the United States at a disadvantage in negotiating concessions for Americans abroad as respects foreign tax laws. Moreover, the failure to obtain concessions abroad may have an effect upon our revenues since the foreign income and estate tax credits we grant our citizens mean that the~ United States bears a large share of the burden of foreign taxation of U.S. citizens. To protect the bargaining power of the United States the President should, therefore, be authorized to reapply present law to the residents of any foreign country which he finds has not acted (when requested by the United States to do so, as in treaty negotiations) to provide for our citizens as respects their U.S.. income or estates substantially the same benefits as those enjoyed by its citizens as a result of the proposed legislative changes. The provisions reapplied would be limited to the area or areas where our citizens were disadvantaged. Furthermore, the provisions reapplied could be partly mitigated, if that were desirable, by treaty with the other country. It is essential, if we are to revise our system of taxing nonresident aliens as is being suggested, that this recommendation be adopted. Otherwise, we risk sacrificing the interests of our citizens subject to tax abroad and reducing our revenues in an effort to simplify the taxes imposed upon nonresident aliens. 8. Quarterly payment of withheld taxes.-Provide that withholding agents collecting taxes from amounts paid to nonresident aliens be required to remit such. taxes on a quarterly basis. Under the present system, withholding agents are required to remit taxes withheld on aliens during any calendar year on or before March 15 after the close of such year. This procedure varies considerably from that applicable to domestic income tax withheld from wages and employee and employer FICA taxes, where* quarterly (in some cases monthly) pay~nents are required. Withholding on income derived by nonresident aliens should be brought more closely into line with the domestic income tax system. There is no reason to permit withholding agents to keep nonresident aliens' taxes for periods which may exceed a full year before being required to remit those taxes, when employers must remit taxes withheld on domestic wages at least quarterly. The Government loses the use of the revenue, which revenue in 1962 exceeded $80 million, for the~ entire year. Accordingly, section 1461 requiring the return and payment of taxes withheld on aliens by March 15 should be revised to eliminate this specific requirement. The Secretary or his delegate would then exercise the general. authority granted him under sections 6011 and 6071 and require withholding agents to return and remit taxes withheld on income derived by nonresident aliens quarterly. However, no detailed quarterly return would be required. 143 PAGENO="0154" 22 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 9. Exemption for bank deposits.-Under present law, an exemption from income taxes, withholding, and estate taxes is provided for bank deposits of nonresident alien individuals not doing business in the United States. By administrative interpretation, deposits in some savings and loan associations are treated as bank deposits for purposes of these exemptions, but such exemptions do not apply to most savings and loan associations. There does not appear to be any justifica. tion for this distinction between types of savings and loan associations and it should be eliminated by extending these exemptions to all such associations. 10. Foreign tax credit-similar credit requirement.-Section 901(b)(3) provides that resident aliens are entitled to a foreign tax credit only if their native country allows a similar credit to our citizens residing in that country. Apparently the provision is designed to encourage foreign countries to grant similar credits to our *citizens. However, this requirement works a hardship on refugees from totalitarian governments. For example, the Castro government is not concerned with whether Cubans in this country receive a foreign tax credit. Therefore, it is recommended that the similar credit requirement of section 901(b)(3) be elimi- nated, subject to reinstatement by `the President where the foreign country, upon request, refuses to provide a similar credit for U.S. citizens. Of course, no request would ordinarily be made in a case, such as Cuba, where the possible reinstate- ment of the present reciprocity requirement would have little or no effect upon the foreign government's policy toward U.S. citizens. 11. Stamp taxes on original issurances and transfers of foreign stocks and bonds in the United States to foreign purchasers.-Our stamp tax on certificates of in- debtedness is imposed on issuances and transfers within the territorial jurisdiction of the United States. The stamp tax on issuances of stock does not apply to stock issued by a foreign corporation, but the transfer tax applies to transfers in the United States. These taxes have forced U.S. underwriters who handle issuances of foreign bonds and stocks and their original distribution to foreign purchasers to handle closings overseas. In view of the limited association of such issuances and transfers with the United States and the fact that these taxes are ordinarily avoided by moving the transactions outside the United States, our law should be revised to exempt original offerings of foreign issuers to foreign purchasers from our stamp taxes where only the issuances and transfers take place in the United States. Such an exemption would facilitate such transactions and their handling by U.S. underwriters and is consistent with our balance-of- payments objectives. 12. Withholding taxes on savings bond interest. The Ryukyu Islands, the principal island of which is Okinawa, and the Trust Territory of the Pacific, principally the Caroline, Marshall, and Mariana Islands, although under the protection and control of the United States, are technically foreign territory. Thus, the islanders are nonresident aliens and subject to a 30-percent withholding tax on interest on U.S. savings bonds. This interferes with the selling of U.S. savings bonds. Therefore, the 30-percent withholding tax as it applies to the interest income realized from U.S. savings bonds by native residents of these islands should.be eliminated. In addition to the changes discussed above, the proposed legislation makes a number of clarifying and conforming changes to present law. MARCH 8, 1965. [Press release for June 18, 1965] CHAIRMAN WILBUR D. MILLS, DEMOCRAT, OF ARKANSAS, COMMITTEE ON WAYS AND MEANS, ANNOUNCES INVITATION ~OR INTERESTED PERSONS To SUBMIT WRITTEN STATEMENTS ON H.R. 5916 Subject: HR. 5916, act to remove tax barriers to foreign investment in the United States Chairman Wilbur D. Mills, Democrat, of Arkansas, Committee on Ways and Means, U.S. House of Representatives, today announced that interested persons are invited to submit written statements on H. R. 5916, the Act To Remove Tax Barriers to Foreign Investment in the United States. The chairman stated that anyone interested in submitted statements on this legislation should do so not later than the close of business Friday, June 25, 1965. Cutoff date As indicated, the cutoff date for the submission of written statements is no later than the close of business Friday, June 25, 1965. It should be noted that this bill was introduced on March 8, 1965, and has been available to interested persons 144 PAGENO="0155" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 23 for study since that time. Forty copies of the written statements should be submitted to Leo H. Irwin, chief counsel, Committee on Ways and Means, 1102 Longworth House Office Building, Washington, D.C. Committee procedure The committee will consider these written statements in executive session along with the statement of the Treasury Department setting forth reasons for its pro- posal of the bill. Format of written statements (a) Summary of comments and recommendations.-The chairman requested that the written statements contain a topical outline or summary of the main points which the interested.taxpp~er makes relating to the bill. This will facilitate the -consideration of the written statements. (b) Subject headings.-The chairman also requested that the detailed written statements contain subject headings geared to the summary presented so as to facilitate committee consideration. [Press release for June 24, 1965] CHAIRMAN WILBUR D. MILLS, DEMOCRAT, OF ARKANSAS, COMMITTEE ON WAYS AND MEANS, ANNOUNCES PUBLIC HEARING ON H.R. 5916 Subject: H. R. 5916, the act .to remove the barriers to foreign investment in the United States. Chairman Wilbur D. Mills, Democrat, Arkansas, Committee on Ways and Means, U.S. House of Representatives, today announced the details of the hearing on H. R. 5916, the administration proposal to remove tax barriers to foreign ~investment in the United States. This hearing will be held on Wednesday, -June 30, 1965. Witnesses The Secretary of the Treasury, the Honorable Henry H. Fowler, will testify -in behalf of the administration, and a member of the "Fowler Task Force," the Presidential - task force which investigated this area some months ago and the recommendati~on~ of which resulted in the development of the legislation will also testify. If any requests are received from the general public, such witnesses will be scheduled following the above witnesses. -Cutoff date for requests to be heard The cutoff date for requests to be heard is not later than the close of business Monday, June 28, 1965. Any requests to be heard should be submitted to Leo H. Irwin, chief counsel, Committee on Ways and Means, 1102 Longworth House -Office Building, Washington, D.C. Written comments It will be recalled on June 18, 1965, an announcement was issued stating that the committee would be pleased to receive any written comments on this bill which interested individuals might care to submit. If any such comments are received, they will be prinjed as part of the printed record of the hearing. If anyone requests to appear in person to testify, it is requested that 60 copies of the written statement be submitted at least 24 hours in advance of his scheduled appearance. In the case of those submitting statements in lieu of a personal appearance, at least three copies of such statement should be submitted by the close of business Wednesday, June 30, 1965. Statements should include a summary sheet, and subject headings. Notification of witnesses If any requests are received by the cutoff date, the individual wifi be advised prior to the date of the hearing by the chief counsel as to scheduling. Any further -details will be provided at that time. Our first witness this morning is the Honorable Henry H. Fowler, :Secretary of the Treasury. Mr. Secretary, we are very pleased to have you here and you may proceed as you wish. 145 PAGENO="0156" 24 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. STATEMENT OF HON. HENRY H. FOWLER, SECRETARY OF THE TREASURY; ACCOMPANIED BY STANLEY S. SURREY, ASSISTANT SECRETARY, DEPARTMENT OF THE TREASURY Secretary FOWLER. Thank you, Mr. Chairman. I am appearing before you to urge prompt and favorable action on H.R. 5916, legis- lation which is intended to reduce tax barriers to foreign investment in the United States. Passage of this bill will serve two important national objectives. First, it constitutes a comprehensive and integrated revision of our present system of taxing foreign individuals and foreign corporations on income derived from the United States, bringing our system of taxing foreigners into line with the rules existing generally in the other developed countries of the world. Second, the bifi will make a significant contribution to our balance of payments by serving to eliminate the impediments now existing in our tax laws to foreign investment in the United States. The background of these proposals, Mr. Chairman, goes back to mid-i 963. In his balance-of-payments message of July 18, 1963, President Kennedy announced he was appointing a task force to review U.S. Government and private activities which adversely affect foreign purchases of the securities of U.S. companies. The group was composed of representatives of finance, business, and government. This task force, of which I had the privilege of serving as chairman, studied various courses of action which could be adopted not only by the publiè sector, which is the area before the committee today, but* also by the private sector, to carry on activities that would be designed to induce larger amounts of investment from abrOad in U.S. private corporate securities, real estate, and related matters. Everyone was conscious at that time of the fact there was a very strong flow of capital out of the United States which was having an unfavorable short-term impact on our balance of payments. Every- one was also conscious that there was, and had historically been, a strong desire on the part of persons and institutions with savings in Western Europe to own U.S. private securities and other properties. Therefore, it was felt that a thorough reexamination of any impedi- ments to the flow of foreign capital to the United States that might exist by reason of laws, regulations, and so forth, was necessary. With this in mind, industrial corporations operating abroad, invest- ment banking houses, commercial banking houses, and brokerage concerns with offices abroad, were all brought together to determine what might be done to encourage the flow of foreign investment capital to the United States, with the thought that over the long pull we should g~t a better balance in capital flows. Such a result would, of course, have a healthy impact on our balance-of-payments deficit. It would also produce the kind of permanent arrangements that over the long pull would enable us to return to a period of relatively free capital movement, which is what we all want to get back to after the temporary measures we ~re now pursuing have served their purpose. So it was in that framework that President Kennedy in his July 1963 message indicated that such a study would be made. It was also in this framework that President Johnson said in his February 10,, 1965 message to the Congress that: 146 PAGENO="0157" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.s. 25 In order to stimulate greater inflow of capital from advanced industrial coun- tries, the Secretary of the Treasury will request legislation generally along the lines recommended by a Presidential task force. Following the initial establishment of the task force in the fall of 1963, it conducted a very intensive examination of the situation both here and abroad. In April 1964, it issued its report containing some .39 recommendations calling for a broad range of actions by U.S. international business organizations and financial firms, as well as by the Federal Government, to bring about broader foreign ownership of U.S. corporate securities. I would like to interpolate that it was my privilege to serve as chair- man of this group and that I have never seen a group of men who so * conscientiously and generously devoted their time, effort, and personal resources to such a careful and earnest study of a problem. Although the task force report which emerged was small in terms of bulk, and very sharp and concise on the various areas of concern, the tremendous body of accumulated information and experience made available through the group was synthesized in the preparation of the report. I think not only the President, but the Congress and the general public as well, should be grateful to those who participated in this activity, particularly those in the private sector. Among. the recommendations directed toward the Government, those dealing with the taxation of foreign individuals and foreign corporations have the most significant and immediate impact. Issuance of the task force report prompted a broad and intensive review by the Treasury of the rules governing taxation by the United States of foreign individuals and foreign corporations. * This review considered these rules not only from the standpoint of the balance of payments, but also from the viewpoint of, conventional tax policy considerations. As a result of this review, the Treasury Department on March 8, 1965,' submitted to the Congress legislation containing not only pro- posals in all of the tax areas dealt with in the task force report, but * also in other areas where it appeared that change was desirable to make the present system more consistent with rational tax treatment of foreign investment. The Treasury Department a~rees with the task force conclusion that many of the existing rules applicable to foreign investors in the United .States are outmoded and not only serve to deter foreign investment but are inconsistent with sound tax policy. These rules were enacted many years' ago and `do not reflect the changes in economic conditions which have occurred over the last 15 years. Examples of tax rules which impede foreign investment in this country are many: The present level of. our estate tax-higher on foreigners than on U.S. citizens-is completely out of line with the rates generally prevailing elsewhere in the world and acts as a sigmfi- cant deterrent to potential foreign investors. Also, the fact that we require tax returns from foreigners merely because they make passive investments here is inconsistent with international tax practice and hinders foreign investment. These and other provisions in the Internal Revenue Code contribute to the widely held view that invest- ment in U.S. securities poses such serious tax problems for the ordmary foreign investor that it cannot be undertaken without the benefit oi expensive tax advice. 147 PAGENO="0158" 26 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. At the same time, some of these provisions are extremely difficult, if not impossible, to enforce, or are susceptible of relatively easy avoidance by the sophisticated foreign investor. Since they deter many foreign investors and are avoided by the rest, they give rise to almost no tax revenue. Enactment of all of the changes proposed in H.R. 5916 beFore you will result in a revenue loss of less than $5 million annually. However, in proposing these changes, we have kept in mind the importance of not converting the United States into a tax haven nor of diverting funds to the United States from less developed countries. The purpose of this bill is to remove tax barriers which have served to discourage foreigners from making investments in the United States, in comparison with other competing areas. At the same time we recognize that no purpose will be served if the bill violates international tax standards, thereby setting off a struggle among the developed nations of the world tO attract foreign investors through tax devices. To attract foreign investors, the United States must offer not "tax breaks" or "tax gimmicks"-it must offer a growing and dynamic economy. We believe our record of economic growth over the last 5 years and our prospects for the future are sufficient to induce a substantial increase in foreign investment if our tax system does not act as a bar. Now as to the impact of H.R. 5916 on the balance of payments, which was the governing inspiration of the establishment of the task force in 1963, there is no way of estimating with any degree of precision the impact of the bill on foreign investment in the United States or the resulting benefit to our balance of payments. The factors govern- ing securities investment are many and complex. Even in purely domestic transactions, intangibles such as habit, convenience, and past experience may be as important as yields, price-earnings ratios, and other economic indicators. Although difficult* to quantify, there is ample evidence of a sizable potential for attracting foreign investment in U.S. corpOrate securities, particularly stocks, by residents of the prosperous countries of conti- nentil Europe. After more than a decade of rapidly rising incomes, Europeans have to a large extent fulfilled many of their most pressing consumer needs and are accumulating savings at a high rate. mdi- viduals in Europe are turning increasingly toward securities invest- ment, as shown by the rising activity on European stock exchanges, the krge number of new offices opening in Europe by American securities firms, and rising sales of mutual fund shares. Yet, even now, in Europe only one person in 30 is a shareowner as compared to one in 11 in the United States. At the end of 1964, foreigners held an estimated $12.8 billion of U.S. cOrporate stocks valued at market prices. In every year smce 1950 except two, foreign purchases of U.S. stocks have exceeded for.. eign sales. In the 6 years between 1959 and 1964, net purchases by foreigners averaged $141 mfflion. These net figures are the residual of much larger gross purchases and sales which in recent years have been on the order of $2 3/2 bfflion to $33'~ bfflion annually. You can see that a small percentage shift in the ratio of purchases to sales, therefore, could have had a very substantial effect on the net balance of transactions. If the amount of additional investment expected to result from H.R. 5916 were merely a function of the amount of tax saved, there 148 PAGENO="0159" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 27 would be little improvement in the balance of payments. More im- portant than the small tax savings to foreigners, however, is the sub- stantial effect which will result from the simplification and rational- ization of our tax treatment of foreign investors.. Our high estate tax on foreigners, for example, is widely considered by experts to be one of the biggest barriers to foreign investment. While the change in the estate tax proposed by H.R. 5916 would eliminate $3 million out of about $5 million of tax levied, each year, existing estate tax rates almost certainly deter many foreigners from investing here at all. This is particularly so when the exemption is limited to only $2,000-any investment whatsoever will subject the estate to tax and require filing of an estate tax return, with the re- sulting expenses. It is not surprising under these circumstances that the small foreign investor avoids purchasing U.S. stocks because of the inconvenience of the estate tax; the big investor also avoids such purchasing but because of the size of the tax itself. Viewed in this light, it is clear that the changes contained in H.R. 5916 should in time materially increase the volume of foreign invest- ment in the United States. Based on the sizable potential for foreign purchases of U.S. corporate stocks which is known to exist, we expect `that the legislation will eventually result in an additional capital inflow on the order of $100 mfflion to $200 million per year, other factors remaining unchanged. Considerable time-perhaps 1 to 2 years or maybe more-wifi be required before foreigners can'complete the adjustment of their portfolios to take advantage of H.R. 5916, but a substantial impact may be felt in the period just ahead. Specific proposals contained in H.R. 5916: I will review the princi- pal substantive changes which are embodied in the proposal. First, as to the estate tax it is generally felt that our current system of taxing the U.S. estates (involving only the U.S. assets) of foreign decedents is ine4uitable and constitutes one of the most significant barriers in our tax laws to* increasing foreign investment in U.S. corporate securities Under present law, a foreign decedent is taxable at regular U.S. `estate. tax rates, ranging up to 77 percent, on U.S. property held at `death. `Morover, the U.S. estates of foreign decedents are entitled only to' a $2,000 exemption, compared with a' $60,000 exemption `available to U.S. citizen decedents, and are not entitled to the marital deduction available to U.S. citizen decedents. `Thus, U.S. estate tax rates applied' to nonresidents are in most cases considerably higher than' those of other countries and therefore foreigners who invest in `the United States suffer an estate tax burden. In addition, a foreign decedent's estate must pay heavier estate taxes on its U.S. assets than would the estate of a U.S. citizen owning the same assets. H.R. 5916 would increase the exemption for the U.S. estates of `foreign decedents from $2,000 to $30,000 and would tax `such estates on the basis of a 5-, 10-, 15-percent rate schedule. With this significant `increase in the exemption and sharp reduction in rates, the effectjve U.S. estate tax rate on foreign decedents would no longer be consider- ably higher than most other countries and would be more closely comparable to the rates prevailing elsewhere. This change should have an important psychological effect on foreigners contemplating investment in U.S. securities. Where the gross U.S. estate would be less than $30,000, there would be no 149 PAGENO="0160" :28 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. estate tax, and no need to file an estate tax return. In those instances where the estate is larger, the effective rate would be sharply reduced and would be comparable to the effective rate of tax of a U.S. citizen who utilizes the $60,000 exemption and the marital deduction. As to capital gains, the present system of taxing capital gains realized by foreigners has contributed to the view that investment in the United States is something which should be approached cau- tiously because of the possibility of inadvertently becoming subject to tax. The Internal Revenue Code now provides for a general exemption from capital gains tax for nonresident foreigners not doing business in the United. States with two exceptions. First, the for- eigner's gains are subject to U.S. capital gains tax if he is physically present in the United States when the gain is realized, and second, all gains during the year are taxable if he spends 90 days or more in the United States during that year. The physical presence restriction can be easily avoided by the experienced foreign investor if he arranges to be outside the country when the gain is realized, but is a potential trap to the foreigner who is not aware of its existence. The bill would eliminate this restriction from the general capital gains exemption. In addition, the bill would extend the 90-day period which a for- eigner may spend here without being subject to capital gains tax to 183 days. This will make the provision more consistent with inter- national standards governing the taxation of foreigners residing in a country for a substantial period. It will also minimize the possibility that a foreigner will be taxed on capital gains realized at the beginning of a taxable year if he later spends a substantial amount of time in the United States during that year. As to graduated income tax rates at the present time, foreign indi- viduals not doing business in the United States who derive more than $21,200 of investment income from U.S. sources are subject to regular * U.S. income tax graduated rates on that income and are required to file returns. These requirements have produced little revenue, in part because we have eliminated graduated rate taxation of investment income in almost all of our treaties with the other industrialized countries and in part because of the ease with which this provision is avoided. Moreover, it has been. indicated that graduated rate taxation and the accompanying return req~uirement may represent a substantial deterrent to foreign investment in the United States. * H.R. 5916 eliminates all progressive taxation of nonresident for- ei~ners not doing business here and removes the requirement for fllmg returns in such cases. The liability of foreign investors deriving U.S. investment income would thus be limited to the tax withheld at the statutory 30-percent rate or the lower applicable treaty rate. The legislation would continue graduated rate taxation for foreigners who are doing business in the United States. These rules are con- sistent with the practices of most other industrialized countries. The fourth recommendation has to do with segregation of invest- ment and business income. Under present law, if a foreign individual is doing business in the United States he is subject to tax on all of his U.S. income, whether or not connected with his business operations, on the same basis in general as a U.S. citizen. H.R. 5916 would separate the business income of a foreign individual engaged in busi- ness here from his nonbusiness income, and would tax the nonbusiness 150 PAGENO="0161" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 29 income at the 30-percent statutory withholding rate or at the lower appropriate treaty rate. All business income would remain subject to tax at graduated rates. With respect to foreign corporations doing business in the United States (so-called resident foreign corporations), which also have stock investments here, H.R. 5916 would likewise separate dividend income from the other income of the foreign corporation. Under the legisla- tion, a resident foreign corporation deriving such dividend income from the United States would thus be taxable on its dividend income at the statutory 30-percent rate or at the lower applicable treaty rate. As a result, the foreign corporation would no longer receive the deduc- tion now afforded under the Internal Revenue Code to dividends re- ceived by one corporation from another corp&ration. The elimination of the dividends received deduction as respects resident foreign corporations is in part designed to end an abuse which has developed.. Frequently, a foreign corporation with stock invest- ments in the United States engages in trade or business here in some minor way and then claims the dividends received deduction on its stock investments.. Such a corporation ends up paying far less than the 30-percent statutory or applicable treaty rate Gil its U.S. dividends, even though its position is basically the same as a corporation which is not doing business here which derives investment income from the United States. In, those cases where the applicable treaty rate is 5 percent (the rate set by certain treaties where subsidiary dividends are involved), the resident foreign corporation will benefit from this pro- posed change. As to definition of the term "engaged in trade of business"-H.R. 5916 makes clear that individuals or corporations are not engaged in trade or business in the United States-and thus subject to tax at regular graduated rates rather than the 30-percent withholding rate or lower treaty rate-because of investment activities here or because they have granted a discretionary investment power to a U.S. banker, broker, or adviser. This provision should have the effect of removing much of the uncertainty which now surrounds the question of what amounts to engaging in trade or business in the United States. Un- certainty of this type is undesirable as a matter of tax policy .and has the effect of limiting foreign investment in the United States. Many foreigners are afraid of investing in U.S. stocks if they cannot give a U.S. bank or broker authority to act for them. This change will have relatively limited impact, however, since under the legislation, business income does not include dividends or gains from the sale of stock. The bifi also changes present law by giving foreign individuals and corporations an election to compute their income from real property on a net income basis at regular U.S. rates rather than at the 30-percent withholding rate Or lower treaty rate on gross income. This type of treatment is common in the treaties to which the United States is a party and is designed to deal with the problem which arises from the fact that the expenses of operating real property may be high and cannot be taken into consideration if the income from real peoprety is subject to withholding tax. As to personal holding companies and the "second dividend tax,"- HR. 5916 chang3s the personal holding company provisions of the Internal Revenue Code as applied to the U.S. investment income of 151 71-297 0-67-pt. 1-11 PAGENO="0162" 30 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. foreign corporations and also modifies the application of the so- called second dividend tax. Under the bifi, foreign corporations owned entirely by forthgners would be exempt from the personal holding company tax. This is possible because of the elimination of graduated rates as applied to foreigners which is contained elsewhere in the bill, which makes the application of the personal holding company provision t~ corporations wholly owned by foreigners no longer appropriate. Under the bifi, the "second dividend tax" (which is levied on divi-. dends distributed by a foreign corporation if the corporation derives 50 percent or more of its income from the United States) would be applied only to the dividend distributions of foreign corporations doing business in the United States which have over 80 percent U.S. source income. It is desirable to retain this part of the tax to cover those cases where a resident foreign corporation has the great bulk of its business operations in the United States and to treat dividends of such a corporation as being from U.S. sources. These changes should have the effect of eliminating application of the personal holding company tax and "second dividend tax" in many cases where they now apply, and which may now act as a deter- rent tD foreign inv3stment. As to expatriate American citizens-the provisions of H.R. 5916 which eliminate graduated rates for foreign individuals and sub.. stantially reduce the estate tax liability of foreign decedents may create a substantial tax incentive to U.S. citizens who might wish to surrender their citizenship in order to take advantage of these changes in the law. While it is doubtful whether there are many who would be willing to take such a step, stifi the incentive would be present and might be utilized. }LR. 5916 deals .with this problem by providing that an individual who had surrendered his U.S. citizenship for tax reasons within the preceding 10 years shall be subject to U.S. taxation with respect to his U.S. income and assets at the rates applicable to citizens. Such individuals wifi therefore not receive the beneLts of this legisla-. tion but will be taxed as nonresident foreigners are at present. As I mentioned,~ these provisions would not apply if the expatriate American citizen can establish that the avoidance of U.S. taxes was not a principal reason for his surrender of ultizenship. As to retaining the treaty bargaining position of the U.S.-the risk is present that by making the changes provided in H.R. 5916, the United States may be placed at a considerable disadvantage in negotiating similar concessions for Americans. In order to protect the bargaining position of the United States in international tax treaty negotiations, H.R. 5916 therefore authorizes the President, where he determines such action to be in the public interest, to re- apply present law to the residents of any foreign country which he finds has not acted to provide our citizens substantially the same bene"ts for investment in that country as those enjoyed by its citizens on their investments in the United States as a result of this legislation. If this authority were invoked, it could be limited to those investment situations as to which U.S. citizens were not being given comparable treatment. We believe that the presence of such a provision wifi be a material aid in our securing appropriate provisions respecting these matters in our international tax treaties. 152 PAGENO="0163" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 31. In conclusion, our current system of taxing foreign investors in the United States contains elements which are inconsistent with generally accepted international tax policy principles and which, at the same time, act to discourage foreign investment in the United States. H.R. 5916 is designed to reshape our present system in order to make it a more rational vehicle for taxing foreign individuals and corporations. The legislation is an essential element of the President's compre- hensive program for dealing with our balance-of-payments problem on an enduring basis. This is not a quick emergency action to deal with any special problem in the next year or two. It is a part of the longer term program that I have discussed on occasion with members of this committee that can, over a long period of years, better enable us to return to the free market principles which we hope can be main.- tamed as a permanent basis. As such, it is one of the aspects of the President's program which is expected to have a longer term impact on our balance of payments. Foreigners wifi invest in this country as long as our economy remains prosperous and stable. However, it cannot be expected that the level of foreign investment will reach its full potential so long as provisions exist in our tax laws which serve to discourage foreign investment and which are not in accord with international tax standards. H.R. 5916 wifi eliminate or modify the provisions of present law which have complicated our system of taxing foreigners but have resulted in little revenue being realized. Adoption of H.R. 5916 will lead to a simpler and more rational method of taxing forergners. It will also be an important step in moving toward the elimination of our balance-of-payments deficit and the strengthening of the international position of the dollar and, I might say, of sustaining an equilibrium in our balance of payments over the long pull with the minimum reliance on the temporary measures that are now necessary. Because this legislation will contribute to these two vital national objectives, I urge you to support it. One additional comment, Mr. Chairman and members of the com- mittee. Before some of you were able to be present, I said at the outset that to my personal knowledge these recommendations before you did not come out of any quick or superficial examination of the problem. They had their origin in President Kennedy's balance-of- payments message of July 1963, in which he announced that he would designate a task force composed of representatives of business, finance, and government to survey all factors that tended to deter a healthy two-way flow of capital, particularly the flow of foreign investment in U.S. private securities. Such a task force was established in the fall of 1963. As I said before, the very well informed and experienced group of private citizens who participated devoted large amounts of their time and effort to what I think they viewed as a very real public service. There is no question, and there ought to be no question in anyone's mind, that there was also an element of very appropriate self-interest involved because the benefits flowing from the development of foreign investment in the United States will accrue to not only the public, but also to a more effective participation on the part of U.S. companies, investment banking houses, brokerage concerns, and the whole com- plex of institutions that are a part of our capital market system~ 153 PAGENO="0164" 32 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. However, serving as a member and as chairman of the task force, I think it only fair to say that very strenuous and worthwhile effort was devoted to reexamining what was being done, and could be done, on the private sector to complement Government activities and bring about this desired objective. I understand that the committee will receive from outside sources both written and other communications indicating the extent to v Inch the private sector has inaugurated complementary efforts to this particular proposal. For that reason, I will not speak to that particular issue because those who are better informed about it will have communicated directly with the committee. However, I would like to say that the tax proposals before you were considered both by the private and the public members of the task force as perhaps the most significant element in this program. Therefore, it would be a signal, not only to potential .foreign investors but also to the financial community, that the Congress of the United States considered this matter ~n the national interest and worthy of their attention. The report was submitted to the President in April 1964 and, as you know, I left Government service shortly thereafter. Therefore, I did not participate actively in the preparation of the proposals that were submitted to the Congress in March of this year. However, I know that Secretary Surrey and his staff and the related staff in~ the Office of International Affairs devoted a great deal of time in the inter- vening months to preparation of these proposals. Many of the proposals are technical in nature. For that reason, I have asked Secretary Surrey to be here with me today since he has the detailed technical familiarity with the wa~ in which they operate in the context of the present tax system, and equally significantly, the way these proposals mesh into the system of international tax treaties which are an important and related part of the topic before you. I will try to deal with the questions you have and ask Secretary Surrey to participate as the situation may require. Mr. HERLONG. Thank you, Mr. Secretary. We appreciate your full and complete statement. The thought just struck me as you were testifying there that we are planning to go into a long-range program to encourage foreign in- vestments in the United States. We have just completed working on a program to discourage American investments in foreign countries. If this flow starts coming back to us what is to prevent these other countries from putting in their version of an interest equalization tax such as we have just acted on? Secretary FOWLER., I think, Mr. Chairman, that the gap is the other way. I think if you will examine this task force report as it has to do with the obstacles to foreign investment in the United States that are imposed by foreign governments, you will find that there is a considerable set of barriers. Therefore, an important part of this overall program is to promote an increased two-way flow of capital between the United States and Western Europe, Japan, and other countries. Some of the recommendations of the task force report deal with public and private efforts to encourage other coun-~ tries to diminish the barriers they established, primarily in the postwar period, when they felt it necessary to restrict, through exchange restrictions and otherwise, the outflow of capital. 154 PAGENO="0165" REMOVE ~TAX' `TB'ARRIERS TO ;F0REIGN INVESTMENT IN U.S. 33 There is no doubt in anybody's mind, although I think the mem- bers of the task force would have to speak for themselves on this, that we must continue to treat, and think of, the interest equalization tax as a temporary measure and one which we hope can be eliminated with the passage of time. I think the fact that, there is an interest equalization tax measure has served to bring home to many foreign government officials a recognition of the fact that they have their own permanent barriers to investment, which, incidentally, have existed for a long time. I be- lieve that the work of the Organization for Economic Co'operation and Development, of which the United States is a participant, is very much concerned with the prospects of diminishing these permanent obstacles to free capital movements. I think this objective should continue to be a very important part of the long-range policy objectives of the United States, and I hope, as you and members of the committee hope, that the time can come in which we can remove what we think of, and what should properly be considered, as temporary barriers. I hope we can soon approach an atmosphere in which we can expect a healthy two-way flow of capital to take care of the situation without harsh government control measures either on this side of the water or on the other side of the water. Mr. HERLONG. Thank you, sir. The only point that was in my mind was as interested as we are, and we are definitely interested, in our balance-of-payments problem, we certainly `must assume that the other people on the other side are just as interested in their own. balance-of-payments problem. Secretary FOWLER. That is right. Mr. HERLONG. Are there questions? Mr. BYRNES. Mr. Chairman. Mr. HERLONG. Mr. Byrnes. Mr. BYRNES. Mr. Secretary, what you have here, as I understand it, is a situation where we have entered into treaties with most of the industrial nations of the world relating to the taxation of dividends and interest primarily, haven't we? Secretary FOWLER. That is right. Mr. BYRNES. Let's take dividends, for instance. As I understand it, the rate is 15 percent. Secretary FOWLER. That is correct in most of the treaty provisions. Mr. BYRNES. This proposes a rate of 30 percent? Secretary FOWLER. No, this does not propose any change affecting the countries with which we have treaty arrangements. Mr. BYRNES. No, but under the law you have a flat rate `unless there was a treaty existing and then it would be the lesser of the two. Secretary FOWLER. That is right. Mr. BYRNES. But my point is I wonder how much effect this is really going to have when one recognizes the fact that you already have a 15-percent rate, or in other words a lower rate than is in the bill, by treaty' with the industrial nations. They' are already paying a lower rate of tax. Secretary FOWLER. Insofar as dividends are concerned, I think it really pretty much leaves the present law the way it is. Mr. BYRNES. Then the bill does not relieve anyone. ` 155 PAGENO="0166" .34 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Secretary FOWLER. But don't forget the other provisions, such as those dealing with the estate tax, with capital gains, graduated income tax rates, segregation of business income from investment income- Mr. BYRNES. You misunderstand the purport of my question. I. am not suggesting that the bifi itself as a whole doesn't. do anything. I am just trying to focus at the one aspect of dividends. We move to a flat 30-percent rate in the absence of treaty. Secretary FOWLER. That is right. Mr. BYRNES. While already the rate of tax on dividends of resi- dents of the industrial nations by treaty for the most part is 15 per- cent, and it will continue to be 15 percent. Secretary FOWLER. That is right. Mr. BYRNES. So that 1 wonder whether the dividend provision will have any particular impact. I am not saying we shouldn't enact it, but I am just wondering whether that would have any particular im- pact as far as investments here are concerned. Secretary FOWLER. Insofar as that phase of our taxation of foreign investment is concerned, it is primarily a maintenance of the status quo and it is certainly a debatable point as to whether changes should be effected. The task force committee considered that at some length. There were differences of opinion. There were those that felt perhaps there should be some, let's say, waiver or diminution of taxation of dividends. There was another opinion. Our opinion in the Treasury Depart.. ment was that the retention of the status quo in this particular area, Congressman Byrnes, was an important aspect of retaining, you might say, a degree of adequate bargaining power in connection with the tax treaties. Mr. BYRNES. You are maintaining some bargaining power because you are maintaining 15 percentage points as an area of bargaining, aren't you? You can enter into the same kind of a treaty with some other country where you don't have a treaty today. You can offer that country a reduction to 15 percentage points from a 30-percentage-- point tax. Secretary FOWLER. That is correct. Mr. BYRNES. But you have given up some~ of your bargaining power, have you not, by going down to the 30 percent as a flat unilateral action by this country? Secretary FOWLER. I don't think very much, if any. I think we retain the essential bargaining power that we have in that area. Mr. BYRNES. Either the 30 percent is meaningless or it is a reduc~ tion in the rate. Secretary FOWLER. Let Mr. Surrey comment. Mr. BYRNES. The 30 percent makes a change in the tax rate appli- cable where a treaty does not exist. Then they automatically get this. All you leave for treaty bargaining is whether you will go down to 15 percent. Mr. SURREY. At present, Mr. Byrnes, the rate is 30 percent in the law, but if the individual's total income from the United States is more than $21,000, then we go to graduated rates. Mr. BYRNES. That is right. Mr. SURREY. What we have removed, as you said, is the graduated rate provision, leaving the rate at 30 percent for everybody regardless of the level of income. 156 PAGENO="0167" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 35 Mr. BYRNES. That is right. Mr. SURREY. However, with respect to the right of the President to withdraw that with respect to any country that does not give us reciprocal treatment, that extends also to the graduated rate provision. Mr. BYRNES. That is one of the things I wanted to get to, which is another revenue concept that we are writing into the law. Mr. SURREY. Yes. Mr. BYRNES. This is a new concept, when we reduce the tax, which really is what you are doing here, but the President has the right if he wants to withdraw that lower rate and make the person subject to a higher rate. Do we have anything analogous to this, where we let the President determine what rate of tax an individual or a group of individuals is going to pay? Mr. SURREY. We have a present provision in the law that if the President finds another countr.y is discriminating against U.S. citizens, he can so find and the rates of tax on citizens of that country are increased. In other words, there is a provision now in the law that gives the President authority to act in some cases where he finds discrimination. There are other situations in the law here and there where the treat- ment given by the Congress is conditional upon reciprocal treatment by the foreign country. For example, we do not reduce the taxation of foreign shipping companies unless we find that the foreign country in turn does not tax our shipping companies. There are one or two provisions of that nature indicating that certain concessions will not be allowed unless there is reciprocity, and we have taken those analogies and tried to put them into one coherent provision to cover the various situations that the Secretary has indicated. Mr. BYRNES. We have a situation under section 891, for the doubling of the rate of tax, where the foreign country discriminates against U.S. citizens. Has that ever been used? Mr. SURREY. It hasn't been used. The fact that it hasn't been used may be due to the presence of the provision. Normally countries try not to discriminate with respect to persons of a single country. Mr. BYRNES. If memory serves me correctly there was a complaint that the Japanese last year had discriminated in some kind of a tax. I foreget what the details were. I guess this was the section they were referring to that should be invoked by the Government. In other words, this provision in this bill relating to the authority of the President to withdraw the liberalization is not a new concept. Mr. SURREY. I think it draws its foundations from present con- ~cepts, but it takes those present concepts and builds them into a provision which we think is necessary to complement the unilateral ~iction that the United States is taking in this bilL Mr. BYRNES. This wasn't the recommendation of the task force? Secretary FOWLER. This was not. I think the problem that we are concerned with here was discussed, but it was not specifically treated in the report. Mr. SURREY. I think it grew about because the task force thought that we ought to move unilaterally in all these areas, that the United States just by statute grant all these privileges. The Treasury was initially more concerned about doing this through treaty. The ta~k force thought that process would be too slow, so 157 PAGENO="0168" 36 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. this device of acting unilaterally and affording some protection for the United States was discussed. Mr. BYRNES. What you have done here, it seems to me, is halfway between the treaty concept and the unilateral concept, haven't you, that is being recommended by the Treasury? Mr. SURREY. It is an endeavor to accomplish really both objectives, to act quickly and unilaterally, bu t at the same time to preserve an international position for the United States if it becomes necessary where, in engaging in our treaties, we don't get reciprocal action. Secretary FOWLER. In commenting on tax treaties at one point the task force said, on page 24 of the report: Adoption of our recommendations would not eliminate the need to extend and modernize our tax treaties. Among other desirable changes: The United States should work for the reciprocal reduction of withholding taxes on dividends and interestand toward the reciprocal elimination of all taxes on the in come of pension trusts and similar investors that are exempt from tax in their country of residence. Such changes will, however, take time. I don't think that goes to your particular point at all, Congressman Byrnes, and I oniy cite it as recognition of the fact that you have already observed that this is something of a mixed bag. You can accomplish a certain amount through unilateral action, of which this bill is an example, but there will still be areas, and Secretary Surrey is currently engaged in significant negotiations in the tax treaty area which go beyond the purview of this particular bill. Mr. BYRNES. Do the presumptions contained in the bill with respect to corporations not having permanent establishment in the country, mean that we presume they don't have a permanent estab- lishment? Mr. SURREY. No; I wouldn't put it quite that way, Mr. Byrnes. There is a provision in the bifi that reads that way, but I think its technical effect is not quite what you read into it. Mr. BYRNES. You said today that under the treaties if you did not have a permanent establishment in the country, then you would pay the 15-percent rate, but if you had a permanent establishment then you paid the regular U.S. rates. Mr. SURREY. That is the present law. Mr. BYRNES. That is the present law? Mr. SURREY. That is right. Mr. BYRNES. But what you would be saying under this bill is that a corporation is assumed not to have a permanent establishment. Mr. SUhREY. As to its dividend income. Mr. BYRNES. As to its dividend income? Mr. SURREY. The bill happens to say presently just dividends and capital gain. Mr. BYRNES. You are then liberalizing in a sense what is already contained in treaties? Mr. SURREY. We are for some corporations and we are for prac- tically all individuals. Some corporations, if they are doing business here in the United States, may prefer the present treatment. That is one of the problems we wanted to discuss because that gives them the intercorporate dividend deduction, which may therefore give a rate of less than 15 percent. I might say, Mr. Byrnes, with respect to withholding on corpora- tions, where you have a parent company and subsidiaries in the United States the rate sometimes drops to 5 percent under our treaties. 158 PAGENO="0169" REMOVE .TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 37 In. other words, we run from 5 to 15 percent: for withholding with respect to subsidiary-parent relationships and we run about 15 percent for portfolio investments. Mr. BYRNES. I wondered whether in this again there was another situation where what we were doing was giving away certain bar- gaining latitude that we might have in getting some concessions for our people. Mr. SURREY. We are, and again that would be preserved in the overall section dealing with that, because we are presently engaged in some negotiations in which we are seeking this result in treaties. One or two of our recent treaties which will be released shortly move in this direction, but it is a matter in which you do have to bargain with the other country. Secretary FOWLER. I think, Mr. Byrnes, we could give you some comparison of what the situation is under the treaty and what the situation wifi be in connection with these proposals. For example, there is no question but what the estate tax proposal adds up to this: That no treaty we have today is more liberal than the pioposal made in this bifi, and no treaty substantially parallels H.R. 5916. I could go down with the other provisions if the committee is interested and give similar comparisons. Take the question of graduated rates. No treaty is more liberal. However, almost all treaties reduce the 30-percent flat withholding on certain types of income, usually to 15 percent, sometimes to 10 percent, sometimes to 5 percent. Sometimes the type of income is exempt, for example interest income. Therefore, what we have is a proposal, and a recommendation, for unilateral action by the Congress of the United States which may to some degree, as Mr. Surrey has indicated, diminish our bargaining power. However, to the extent that is a factor, it is our conviction that it is substantially outweighed by the advantages that will accrue in terms of the overall objective of promoting foreign investment in the United States. This, together with the improvements it makes in the tax system and other benefits are the price that we would quite willingly pay for whatever diminution of bargaining power might be entailed. Mr. BYRNES. Thank you, sir. The CHAIRMAN. Mr. Secretary, I have before me a verbatim list of the recommendations contained in the Fowler task force report compiled by the staff. There are 39 of those recommendations, as I recall. At this point I would ask unanimous consent that this list be placed in the record. (The information referred to follows:) RECOMMENDATIONS CONTAINED IN THE FOWLER TASK FORCE REPORT (Compiled by the staff) 1. U.S. investment bankers and brokerage firms should intensify their efforts to develop facilities for reaching foreign investors directly. 2. U.S. investment bankers and brokerage firms should seek modification of foreign regulations and practices which unduly restrict the ability of U.S. firms 159 PAGENO="0170" 38 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. to promote the sale of U.S. securities or to deal directly with potential foreign customers. 3. U.S. investment bankers and brokerage firms, with the cooperation of interested U.S. corporations, should endeavor to obtain shares of U.S. corporations for distribution abroad. 4. The Securities and Exchange Commission should issue a release setting forth the circumstances under which it would normally issue a "no action" letter pro- viding that no registration be required on public offerings of securities outside of the United States to foreign purchasers, including dealers.. 5. The Securities and Exchange Commission should issue a release eliminating the requirement that foreign underwriters participating exclusively in distribu- tions of securities to nonresidents of the United States register as broker-dealers. 6. U.S. investment bankers should include foreign banks and securities firms as underwriters, whenever possible, or as selling group members in new offerings and secondary distributions of either domestic or foreign securities. 7. U.S. investment bankers and brokerage firms should organize the under- writing and distribution of dollar-denominated foreign securities issues so that the maximum possible amount is sold to investors abroad. 8. U.S. commercial banks should intensify efforts to attract foreign trust ac- counts for investment in U.S. corporate securities. 9. The Securities and Exchange Commission should serve as an information center regarding listing requirewents, and distribution regulations and practices abroad. 10. Major U.S. corporations should arrange for U.S. banks and trust compa- nies to issue, through their foreign branches and correspondents, depositary re- ceipts for U.S. corporate shares. 11. U.S. investment companies should plan and carry out a program to acquaint foreign investors with the advantages of owning U.S. closed-end investment com- pany shares. 12. Distributors of U.S. open-end investment company shares should devise methods for achieving additional foreign distribution of such shares, where locally permitted. 13. U.S. investment company distributors should seek the modification of foreign regulations and practices which restrict the availability of their shares to foreign investors. 14. U.S. closed-end investment companies should seek to place original and secondary offerings of their shares with foreign investors and, where feasible, list these shares on major foreign exchanges. 15. In order to promote the purchase of U.S. corporate securities abroad: (a) The U.S. financial community should cooperate closely with major U.S. corporations in the dissemination of corporate reports in foreign languages and in the publication of financial data in foreign newspapers; (b) U.S. investment bankers and brokerage firms should prepare research and statistical reports in foreign languages for distribution to foreign investors through local banks and securities firms and promote the publication of more detailed U.S. stock market and financial information in the foreign press; (c) Facilities of U.S. commercial banks should be fully utilized to distribute to foreign financial institutions and investors reports, preferably in foreign languages, on the U.S. economy; (d) U.S. securities exchanges should take advantage of new communication techniques and reduced rates to promote broader use abroad of stock quotation and financial news services; (e) U.S. investment bankers and brokerage firms should offer securities orienta- tion and sales training programs to personnel of foreign banks and securities firms; and (f) U.S. investment bankers, brokerage firms, and securities exchanges should work with their foreign counterparts and the foreign press to broaden share owciersliip by foreign investors. 16. The Congress should adopt legislation discontinuing mandatory regulation of maximum iaterest rates on domestic and foreign time deposits. 17. Peadin~ adDption of such legislation, the Federal Reserve Board of Gover- nors should administer regulation Q in a flexible manner permitting U.S. commer- 160 PAGENO="0171" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 39 cial banks to meet internationally competitive interest rates on both domestic and foreign time deposits. 18. U.S-based international corporations should consider the advantages of increased local ownership of their parent company shares in countries in which they have affiliates. 19. Where consideration under recommendation No. 18 above is favorable, corporations should collaborate with the U.S. financial community in encouraging greater foreign ownership of their shares. 20. U.S. securities exchanges should submit a plan acceptable to the Securities and Exchange Commission permitting U.S.-based international corporations to encourage foreign ownership of their stock. 21. The Treasury Department should issue a ruling that would establish the tax deductibility of costs incurred by U.S. corporations in. arranging for securities firms to place their securities outside the United States as part of programs to improve their oi~ersea relationships. 22. Corporations should collaborate with U.S. investment bankers in the utili- zation by the latter of techniques for distribution abroad of new or secondary issues of their stock. 23. U.S. corporations should offer their shares to employees in foreign countries where stock purchase, supplemental compensation, or other incentive plans are feasible and desirable. 24. U.S.-based international corporations should consider the advantages of listing their shares on foreign stock exchanges. 25. U.S.-based international corporations should instruct their senior officers and policy groups to keep foreign financial operations under constant review, examining as standard procedure all proposals for new financing from the stand- point of the effect of their actions on the U.S. balance of payments. 26. IJ.S.-based international corporations should, where feasible, finance their foreign operations in a manner which minimizes the outlay of cash. 27. In cases where new capital is required, U.S.-based international corpora- tions should consider, in appropriate cases, broadening local ownership by offering in foreign capital markets bonds or preferred stock of their local affiliates con-. vertible into common shares of the U.S. parent corporation. 28. U.S.-based international corporations should be encouraged to make available, through trade or banking channels, specific case studies of foreign financing operations to small- or medium-sized U.S. firms interested in foreign operations but less aware of foreign financing opportunities. 29. Eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents. 30. Eliminate (with respect to income not connected with the conduct of a trade or business) the provisions for progressive taxation of U.S. source income of nonresident alien individuals in excess of $19,000 and provide that no non- resident alien whose tax liability is fully satisfied by withholding shall be required to file returns. 31. Eliminate the provision for taxation of capital gains realized by a non- resident alien individual when he is physically present in the United States; extend from ~0 to 180 days during a taxable year the time that a nonresident alien individual may spend in the United States before becoming subject to tax on all capital gains realized by him during such year. 32. Provide that a nonresident alien individual engaged in trade or business within the United States be taxed at regular rates only on income connected with such trade or business. 33. Amend the definition of personal holding companies appearing in the Internal Revenue Code so that foreign corporations owned entirely by nonresident alien individuals are excluded from the definition. 34. Clarify the definitions of engaging in trade or business to make it clear: (i) that a nonresident alien individual or foreign corporation investing in the United States will not be deemed engaged in trade or business because of activity in an investment account or by granting a discretionary investment power to a U.S. banker, broker, or adviser; and (ii) that a nonresident alien individual or 161 PAGENO="0172" 40 REMOVE TAX: BARRIERS TO FOREIGN INVESTMENT IN U.S. foreign corporation will not be deemed engaged in trade or business by reason of the mere ownership of real property, by reason of a strict net lease, or by reason `of an agent's activity in connection with the selection of real estate investments in the United States. 35. The Department of State and the Treasury Department should take bi- lateral diplomatic action aimed at securing the step-by-step removal of remaining `exchange controls on capital transactions between advanced capital-forming countries and the discontinuance or liberalization of special `exchange markets or procedures for investment transactions. 36. The Department of State and the Treasury Department should encourage and support the enlargement of free world capital markets and urge countries with~ balance-of-payments surpluses to relax their capital issues control in order to permit an expanded volume of international lending. 37. The Department of State and the Treasury Department should request that the Organization of Economic Cooperation and Development (OECD) initiate a comprehensive r,eview of the practices and regulations in member countries relating to investment portfolios of financial institutions. 38. The Department of State and the Treasury Department should, through appropriate international bodies, particularly the OECD, advocate the step-by- step relaxation of monetary, legal, institutional, and administrative restrictions on capital movements, together with other actions designed to increase the breadth and efficiency of free world capital markets. 39. The Department of State and the Treasury Department should urge the International Monetary Fund to encourage step-by-step elimination of capital controls. The Fund should be requested to prepare a study dealing with re- maining capital controls and how their elimination can encourage stabilizing movements of long-term capital and thus contribute to balanced international payments. COMPARISON OF H.R. 5916 WITH TREATMENT UNDER EXISTING TREATIES 1. Graduated rates applicable in certain instances Under the existing statute (altered in many instances by treaty as noted below) a nonresident alien's U.S. source income is taxed at progressive income tax rates if he derives gross income of more than $21,200 from U.S. sources. An individual engaged in a trade or business in the United States is also taxed at progressive rates on his U.S. source income even if he derives less than $21,200 from U.S.. sources. Both the Fowler Task Force and the Treasury recommendations call for elimi- nation of progressive taxation when a nonresident alien's U.S. source income `exceeds $21,200. The Fowler Task Force recommended that a nonresident alien individual engaged in a trade or business within the United States be taxed at regular rates only on income connected with such trade or business. The `Treasury proposal would tax investment income at the 30 percent statutory holding rate or the applicable treaty rate (whichever is less) rather than graduated rates. For purposes of determining the applicability of treaty rates to dividends and capital gain, the alien will be deemed not to have a permanent establishment in this country. The following table indicates the treaty rates applicable to investment income under existing treaties with the countries listed. Although the chart is specifically, addressed to withholding, the applicable tax rates are the same due to the necessity to withhold from nonresident aliens an amount equal to their tax liability. It is to be noted that in most instances the favorable treaty rate applicable to investment income only applies where the nonresident alien does not have a permanent establishment in the United States. Under the Treasury recom- mendations granting the statutory or treaty rate ,(whichever is lesser) to the investment income of nonresident aliens engaged in a trade or business in the United States, the alien will be deemed not to have a permanent establishment in this country. 162 PAGENO="0173" REMOVE TAX BAR RS;~PO~ :FOREiO~INVESTMRNP I~t :Th~ 41 [In percent] Real estate . rentals and Country Dividends Interest Royalties natural resource . * royalties Australia 2 6 15 ~~15 NE `E 1 E `E NE 4NE Austria - Belgium Canada - Denmark Finland France Germany Greece Honduras `15 `15 1315 3815 `15 `15 NE NE 1 15 1 15 `E `E `15 `E `E `E 1 E 115 `E `E `E 1 E `E `E NE 1 `15 NE NE 4NE 4 .~NE 4 Ireland 2 6 15 1 3 15 NE 1 3 15 `~ ~5 2 E NE 115 `E 1 E . 2 E 1 E 1 15 1 E I E . 2 4 15 Nit NE NE NE Italy Japan Netherlands Netherlands Antilles New Zealand 13615 NE NE NE Norway Pakistan ~~15 1715 `E NE `E `E 4NE NE SouthAfrica NE NE NE ~NE Sweden 15 1 E E NE Switzerland United Kingdom United Kingdom colonies 15 1 5 2 E 2 E 1 E 4 NE 2 15 2 4 15 23 15 2 3 15 E E Definitions: E-Exempt. N.E-Not exempt: Tax to be withheld .at the statutory rate prescribed by secs. 1441 and 1442 of the Internal Revenue Code of 1954 (generally 30percent). 1 Applicable if no permanent establishment in the United States. 2 Applicable if no permanent establishment ia the United States and subject to tax of the other contracting party. The rate is 5 percent on dividends paid by domestic subsidiary corporations subject to prescribed condi- tions. Recipient may elect to be subject to tax on a net basis by filing form 1040-B. I Recipient may elect to be subject to tax on a net basis but only on real property by filing form 1040-B. 6 Applicable to a nonresident alien not engaged in a trade or business in the United States. `Applicable only when certain Pakistani corporations are the recipients. ~. Foreign corporations and investment income The Treasury recommends that corporations engaged in business in the United States be denied the 95-percent dividends received deduction; be subject to the 30-percent statutory rate or the treaty rate (whichever is lesser) on income frOm stock investments; and be exempt from tax on their capital gains from investment in U.S. stocks. For determining the applicability of treaty rates, the corporation will be deemed not to have a permanent establishment in this country. The Fowler task force made no comparable recommendations. The special 15-percent treaty rates applicable for dividends (see chart above) are generally applicable to corporations receiving dividends. In the case of Australia, Denmark, Finland, Ireland, Italy, Netherlands, Netherlands Antilles, New Zealand, Norway, Switzerland, United Kingdom, and United Kingdom colonies, the rate is 5 percent on dividends paid by domestic subsidiary corpora- tions under certain prescribed conditions. 3. Engaging in a trade or business Both the Fowler task force and the Treasury recommendations would clarify the definition of engaging in a trade or business to make it clear that a nonresident alien investing in the United States will not be deemed engaged in a trade or business because of activity in an investment account or by granting a discre- tionary investment power to a U.S. banker, broker, or adviser. The Fowler task force also recommended adoption of a provision making it clear that a nonresident alien individual or foreign corporation will not. be deemed engaged in a~ trade or business by. reason of the mere ownership of real property, by reason of a strict net lease, or by reason of an agents activity in connection with a selection of real estate investments in the United States. The Treasury did not act on this recommendation. 163 PAGENO="0174" 42 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT I~ U.S. The questions involved in this recommendation are not generally covered by existing treaties. Treaties are concerned with a question of "a permanent estab- lishment" and not the definition of a trade or business. 4. Real property income and mineral royalties The Treasury recommends that nonresident alien individuals and foreign corporations be given an election to compute income from real property and mineral royalties on a net income basis and be taxed at graduated rates on such income as if engaged in a trade or business in the United States. The Fowler task force made no comparable recommendation. Under existing treaties nonresident alien individuals from many countries can now elect to be subject at regular tax rates on a net basis by filing form 1040-B. The countries involved are Australia, Austria, Belgium, Finland, France, Ger- many, Greece, Honduras, Ireland, Italy, Japan, Netherlands, Netherlands Antilles, Norway, South African, Switzerland, United Kingdom, and United Kingdom colonies. In addition, Canadian nonresident aliens can elect such treatment by filing form 1040-B but only on real property income. 5. Capital gains The Treasury proposes to eliminate the provision taxing capital gains realized by a nonresident alien when he is physically present in the United States, and to entend from 90 to 183 days the period of presence in the United States during the year which makes nonresident aliens taxable on all their capital gains. The Fowler task force made a similar recommendation, but instead of the figure 183 days used 180 days. Our treaties with Canada, France, Sweden, and the United Kingdom exempt to some extent capital gains derived by residents of those countries having no permanent establishment in the United States. The United Kingdom and Cana- dian treaties exempt all capital gains; the Swedish treaty exempts all capital gains except those derived from transfers of real property; and the French treaty exempts only capital gains from transfers of securities. 6. Personal holding company and "second dividend" taxes The Treasury proposal is identical with the Fowler task force recommendation in exempting foreign corporations owned entirely by. nonresident~ alien indi- viduaLs, whether or not doing business in the United States, from the personal holding company tax. In addition, the Treasury proposes to nullify the applica- tion of the "second dividend" tax of section 861(a) (2)(B) so that it only applies to the dividends of foreign corporations doing business in the United States which have over 80 percent U.S. source income. 7. Estate tax exemption and rates The Fowler task force recommended eliminating U.S. estate taxes on all intan- gible personal property of nonresident alien decedents. The Treasury did not act on this recommendation but instead proposes to increase the $2,000 exemption from tax to $30,000 and substitute for regular U.S. estate tax rates (which go as high as 77 percent) a 5-10-15 percent rate schedule. Under the applicable treaties, debt obligations normally have their situs either in the domicile of the decedent or at his place of residence. However, stocks nor- mally have their situs at the place of incorporation under the treaties. Presum- ably the stock of U.S. corporations is included in many of the estates of nonresident aliens and the Fowler task force recommendation would have had an impact in these cases. The proposal of the Treasury to increase the $2,000 exemption to $30,000 will provide benefits to the estates of nonresident aliens where the applicable treaties govern, because of the type of exemption usually provided in the treaties. Under the usual exemption, a contracting state in imposing taxes on a decedent not domiciled at the time of his death in its territory must grant a portion of its spe- cific exemption to the estate. Subject to certain variations, the portion of the exemption granted bears the same proportion to the total exemption as the prop- erty taxed bears to the total estate of the decedent. By raising the specific ex- emption the U.S. raises the dollar amount of the exemption that will normally be granted to a nonresident alien's estate. This type of exemption is granted in the estate tax treaties with Australia, Finland, France, Greece, Italy, Japan, Norway, and Switzerland. The Canadian treaty contains a different exemption which will also be liberalized by the Treasury's proposal. 164 PAGENO="0175" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 43 Due to the credit mechanisms in existing treaties, the Treasury proposal to substitute a 5-10-15 percent rate schedule for the regular U.S. rates will provide benefits to the estates of nonresident aliens that will be largely nullified by in- creases in the tax they owe in their domiciliary state. Under the usual treaty provisions, the domiciliary state allows a credit against its estate tax for taxes of the other contracting state attributable to property located in the latter state. The credit cannot exceed the lesser of the tax attributable to such property under the laws of the domiciliary state or the other contracting party. The liberalized rates proposed by the Treasury will reduce the credit for U.S. taxes paid available to the estate in filing its tax return in the domiciliary state. However, where U.S. rates greatly exceed the rates of the other contracting party or where no applicable treaty governs, the benefit will not necessarily be canceled out. This type of credit provision is contained in treaties with Canada, United Kingdom, France, Australia, Finland, Greece, Ireland, Italy, Japan, Norway, and Switzer- land. 8. Related estate tax matters The Treasury proposes to: (a) provide that bonds issued by domestic corpora- tions or governmental units and held by nonresident aliens are property ~vithin the U.S. and therefore are subject to estate tax; (b) provide that transfers of intangible property by a nonresident. alien engaged in business in the United States are not subject to gift tax; and (c) provide that the amount of credit for State death taxes granted nonresident aliens is limited to that portion of the credit allowed the estate which is allocable to property taxed by both the State and the Federal Government. The Fowler task force made no recommendations in this regard. .9. Expatriate American citizens The Treasury proposes to subject the U.S. source income of expatriate citizens of the United States to income tax at regular U.S. rates and their U.S. estates to estate tax at regular U.S. rates, where they surrendered their U.S. citizenship within 10 years preceding the taxable year in question unless the surrender was not tax motivated. The Fowler task force made no recommendations in this regard. 10. Retaining treaty bargaining position The Treasury proposes to provide that the President be given authority to eliminate with respect to a particular foreign country any liberalizing changes which have been enacted, if he finds that the country concerned has not acted to provide reciprocal concessions for our citizens after being requ ested to do so by the United States. The Fowler task force made no recommendations in this regard. 11. Quarterly payment of withheld taxes The Treasury proposes to provide that withholding agents collecting taxes from amounts paid to nonresident aliens be required to remit such taxes on a quarterly basis. The Fowler task force made no recommendations in this regard. 113. Exemption for bank deposits The Treasury proposes to extend to the deposits of savings and loans associa- tions the exemption from income taxes, withholding, and estate taxes provided by present law for bank deposits of nonresident alien individuals not doing business in the United States. The Fowler task force made no recommendations in this regard. The following treaties exempt all interest from withholding taxes: Austria, Denmark, Finland, Germany, Greece, Honduras, Ireland, Netherlands, Nether- lands Antilles, Norway, United Kingdon, United Kingdom Colonies. 13. Foreign tax credit-Similar credit reouirement The Treasury proposes to amend present law by eliminating the similar credit requirement of section ~01(b)(3), subject to reinstatement by the President where the foreign country refuses a request to provide a similar credit for U.S. citizens. The similar credit requirement of present law allows a foreign tax credit to resident aliens only if the native country allows a similar credit to our citizens residing in that country. The Fowler task force made no recommendations in this regard. 165 PAGENO="0176" 44 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 14. Stamp taxes * The Treasury proposes to amend present law to exempt from the stamp tax on * certificates original offerings of foreign issuers where only the issuances and trans- fers take place in the United States. The Fowler task force made no recommendations in this regard. 15. Withholding taxes on savings bond interest. The Treasury proposes to eliminate the 30 percent withholding tax as it applies to the interest income realized from U.S. savings bonds by native residents of the Ryukyu Islands (Okinawa and others) and the Trust Territory of thePacific (principally the Caroline, Marshall, and Mariana Islands). * The Fowler task force made no recommendations in this regard. (Prepared by office of the minority counsel, Committee on Ways and Means.) 166 PAGENO="0177" TREASURY RECOMMENDATIONS 1. Graduated rates.-Eliminate the taxation at graduated rates of U.S. source income of nonresident alien individuals not doing bus- iness in the United States. Under existing law all of a nonresident alien's U.S. source income is taxed at regular rates if he derives gross income of more than $21,200 from U.S. sources. Where nonresident alien is not engaged in a trade or business in the United States, no return need be made. 2. Segregation of investment and business income and related matters.-Provide that- (a) nonresident alien individuals engaged in trade or business in the United States be taxed on investment (nonbusiness) income at the 30-percent statutory withholding rate, or ap- plicable treaty rate (for purposes of determining the applica- bility of treaty rates, the alien will be deemed not to have a permanent establishment in this country) rather than at graduated rates; (b) foreign corporations engaged in business in the United States be denied the 85-percent dividends received deduction be subject to the 30-percent rate (or lesser treaty rate assuming a nonpermanent establishment) on income from stock invest- ments; and be exempt from tax on their capital gains from investments in U.S. stocks. (c) Nonresident alien individuals and foreign corporations not be deemed engaged in trade or business in the United States because of investment activity in the United States or because they have granted a discretionary power to a U.S. banker, broker, or adviser; FOWLER TASK FORCE 1. Eliminate (with respect to income not connected with the conduct of a trade or business) the provisions for progressive taxa- tion of U.S. source income of nonresident alien individuals in excess of $19,000 ($21,200 after 1965) and provide that no nonresident alien whose tax liability is fully satisfied by withholding shall be required to file returns. (Recommendation No. 30.) 2. (a) Provide that a nonresident alien individual engaged in trade or business within the United States be taxed at regular rates only on income connected with such trade or business. (Recommendation No. 32.) (c) Clarify the definitions of engaging in trade or business to make it clear: (i) that a nonresident alien individual or foreign corporation investing in the United States will not be deemed engaged in trade or business because of activity in an invest- ment account or by granting a discretionary investment power to a U.S. banker, broker, or adviser. (Recommendation No. 34(i).) A nonresident alien individual or foreign corporation will not be deemed engaged in trade or business by reason of the mere ownership of real property, by reason of a strict net lease, or by reason of an agent's activity in connection with the selection C) COMPARISON OF TREASURY RECOMMENDATIONS OF ll.R. 5916 WITH RECOMMENDATIONS OF FOwLER TASK FORCE (5) None. PAGENO="0178" TREASURY RECOMMENDATIONS FOWLER TASK FORCE (d) Nonresident alien individuals and foreign corporations be given an election to compute income from real property and mineral royalties on a net income basis and be taxed at grad- uated rates on such income as if engaged in trade or business in the United States. 3. Capital gains.-Eliminate the provisions taxing capital gains realized by a nonresident alien when he is physically present in the United States, and extend from 90 to 183 days the period of presence in the United States during the year which makes nonresident aliens taxable on all their capital gains. 4. Personal holding company and "second dividend" taxes.- (a) Exempt foreign corporations owned entirely by nonresident alien individuals, whether or not doing business in the United States, from ther personal holding company tax; (b) Modify the application of the "second dividend tax" of sec- tion 861 (a)(2)(B) so that it only applies to the dividends of foreign corporations doing business in the United States which have over 80 percent U.S. source income. 5. Estate tax and related matters.- (a) Increase the $2,000 exemption from tax to $30,000 and sub- stitute for regular U.S. estate tax rates a 5-, 10-, 15-percent rate schedule; (b) Provide that bonds issued by domestic corporations or governmental units and held by nonresident aliens are property within the United States and therefore are subject to estate tax; and (c) Provide that transfers of intangible property by a nonresident alien engaged in business in the United States are not subject to gift tax. 6. Expatriate American citizens.-Subject the U.S. source income of expatriate citizens of the United States to income tax at regular U.S. rates and their U.S. estates to estate tax at regular U.S. rates, where they surrendered their U.S. citizenship within 10 years preceding the taxable year in question unless the surrender was not tax motivated. of real estate investments in the United States. (Recommen- dation No. 34(u)-not in Treasury bill.) (d) None. Eliminate the provision for taxation of capital gains realized by a nonresident alien individual when he is physically present in the United States; extend from 90 to 180 days during a taxable year the time that a nonresident alien individual may spend in the United States before becoming subject to tax on all capital gains realized by him during such year. (Recommendation No. 31.) (a) Amend the definition of personal holding companies appearing in the Internal Revenue Code so that foreign corporations owned entirely by nonresident alien individuals are excluded from the definition. (Recommendation No. 33.) (b) None. Eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents. None. LTJ 0 .~ Lmi PAGENO="0179" 7. Retaining treaty bargaining position.-Provide that the Presi- None. dent be given authority to eliminate with respect to a particular foreign country and liberalizing changes which have been enacted, if he finds that the country concerned has not acted to provide reciprocal concessions for our citizens after being requested to do . so by the United States. 8. Quarterly payment of withheld taxes.-Provide that withholding None. agents collecting taxes from amounts paid to nonresident aliens be required to remit such taxes on a quarterly basis. 9. Exemption for bank deposits.-Extends to. the deposits of None. savings and loans associations the exemption from income taxes, withholding, and estate taxes provided by present law for bank deposits of nonresident alien individuals not doing business in the United States. . 10. Foreign tax credit-Similar credit requirement.-Amends pres- None. ent law by eliminating the similar credit requirement of section 901(b)(3) subject to reinstatement by the President where the foreign country refuses a request to provide a similar credit for U.S. citizens. The similar credit requirement of present law allows 0 a foreign tax credit to resident aliens only if the native country ~ allows a similar credit to our citizens residing in that country. 11. Stamp taxes.-Amend present law to exempt from the stamp None. tax on certificates original offerings of foreign issuers where only the issuances and transfers take place in the United States. 12. Withholding taxes on savings bond interest.-Eliminates the None. 30-percent withholding tax as it applies to the interest income realized from U.S. savings bonds by native residents of the Ryukyu Islands (Okinawa and others) and the Trust Territory of the Pacific (principally the Caroline, Marshall, and Mariana Islands). (Prepared by office of minority counsel, Committee on Ways and Means.) PAGENO="0180" 48 REMOVE TAX . BARRIERS TO FOREIGN INVESTMENT IN U.S. The CHAIRMAN. Is there objection? I wanted to ask you, if you would, Mr. Secretary, to point out to the committee wherein the bill, H.R. 5916, differs from the Fowler task force report. Which of the 39 items, for example, are not included in the bill, and which of the recommendations are modified in the bill? Secretary FOWLER. I think, Mr. Chairman, that the most signifi- cant difference, and the only one worth consideration, is No. 29. The CHAIRMAN. Pardon me for interrupting you, but I thought you or I in the beginning should point out that some of these recommenda- tions, of course, of the Fowler task force report are not actually tax matters. Secretary FOWLER. Right. The first 28 are really outside the scope of this bill. The CHAIRMAN. Outside the jurisdiction of taxation and this committee, so my inquiry really is limited to 29, 30, 31, 32, 33, 34, 35, 36, 37, 38, and 39 presumably. Secretary FOwLER. Actually 29 to 34. Recommendations 35 tc~ 39 have to do with what might be called diplomatic action- The CHAIRMAN. Rather than tax action. All right. Secretary FOwLER (continuing). To secure a lowering of the barriers that might exist to foreign investment in the United States by foreign. governments. The CHAIRMAN. Let's put it this way then. With respect to those recommendations of the Fowler task force report which deal with taxation, how do they differ from the provisions of H.R. 5916? Secretary FOWLER. First, Mr. Chairman, the most significant one I think has to do with recommendation No. 29. The task force report recommended that, the Congress eliminate U.S. estate tax on all intangible personal property of nonresident alien decedents. The recommendations of H.R. 5916 would fall short of that task force recommendation. The bill before you would increase the exemption for U.S. estates of foreign decedents from $2,000 to $30,000 and would tax such estates on the basis of a 5-, 10-, 15-percent rate schedule. With this significant increase in the exemption and the reduction in rates, the effective U.S. estate tax rate on foreign decedents would no longer be considerably higher than most other countries and would be more comparable to rates prevailing elsewhere. The task force recommendation which is contained in the report on this matter, I think, is worthy of the committee's attention. , In this connection, and with your permission, I would like to read briefly from the task force report: U.S. estate taxes, especially as applied to shares of U.S. corporations owned by nonresident alien decedents (which are subject to U.S. estate taxes irrespective of whether they are held in this country or abroad), are believed to be one of the most important deterrents in our tax laws to foreign investment in the United States. U.S. estate tax rates are materially in excess of those existing in many countries of the world and, despite the treaties in effect with several countries, the taxes paid on a nonresident alien decedent's estate, some portion of which is invested in the United States, generally would be greater than. those paid on a nonresident alien decedent's estate, no portion of which is invested in the United States. We understand that the revenues received by the United States as a result of `estate taxes levied on intangible personal property in estates of nonresident alien de- cedents are not large. Under existing U.S. tax law, a foreigner willing to go through the expense and trouble of establishing a personal holding company, incorporated abroad, and assuring himself that this personal holding company does not run afoul of the 170 PAGENO="0181" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN u.s. 49 U.S. penalty taxes on undistributed personal holding company income, can already legally avoid estate taxes. Consequently, for such an investor U.S. estate taxes are avoidable through complicated and expensive procedures, while for other foreign investors they are likely to result in a considerable tax penalty. This is an unsound situation which directly deters foreign investment in the United States and significantly worsens the overall image of this country as a desirable place to invest. I think, therefore, that the recommendation in H.iR. 5916 and the recommendation of the task fOrce adopt the same basic point of view and the same premise and the same governing considerations. The recommendation of the task force simpiy goes further and says, in effect, that the advantages we would gain from complete elimina- tion outweigh any revenue we might obtain from a retention of the estate tax law. I think the Treasury's position can roughly be characterized as limiting relief so that the tax on the estates of nonresident alien decedents is comparable to the tax applicable to estates of U.S. citizens. That is the basic margin of difference between the two. * The CHAIRMAN. Is it the Treasury's position that the Fowler task force recommendation for eliminating the U.S. estate taxes on all intangible personal property of nonresident alien decedents should not be enacted? * Secretary FOWLER. I am in this position, Mr. Chairman. As a member of the task force and its chairman, I go along with the task force recommendation-and now as Secretary of the Treasury, I approve of the Treasury recommendation. Insofar as they are different, I would be inclined to say that this Secretary of the Treasury would not strongly resist any effort on the part of the Congress to go further and adopt the task force report. The CHAIRMAN. I was not endeavoring to in any way embarrass the Secretary by that question. Secretary FOWLER. You are not embarrassing me at all. I think I am expressing an attitude. I do think that this is something the committee ouotht to carefully examine and it may well wish to come out for the full elimination which the task force report recommended. With regard to any further analysis of the reasons for the Treasury position, I would like to have Secretary Surrey comment so that the committee can be informed. (A memorandum on this matter appears at p. 64). * The CHAIRMAN. Let me ask you briefly, if I may, Mr. Secretary, before we go to Assistant Secretary Surrey, is this now the principal difference, or are there some other differences in the recommendations of the task force report? * Secretary FOWLER. I think this is the only significant difference, and I think to the extent there are other differences the Treasury proposals have gone somewhat beyond the task force recommenda- tions. These additional differences are of a minor nature and not of very great consequence. The proposal fully reflects and carries out the task force recommendations in all the other provisions. The CHAIRMAN. Is there anything in H.R. 5916 that was not dealt with by the task force report? Secretary FOWLER. Yes; there are some provisions. In a sense, as the statement indicates, we have made this the occasion not only for implementing the task force report, but for generally revising and dealing, with, and in a sense rationalizing, the outworn and obsolete 171 PAGENO="0182" 50 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. provisions. We thought the Congress would want to deal with this problem in full at this particular time. The CHAIRMAN. But there is nothing in the bill, HR. 5916 I pre-. sume that does not deal with the subject matter of removing tax barriers. Secretary FOWLER. That is correct, sir. The CHAIRMAN. To foreign investment. Secretary FOWLER. All additional matters are directly related t& the specific problem area that recommendations 29 through 34 are directed. The CHAIRMAN. Mr. Curtis. Mr. CURTIS. Mr. Chairman, just following up on that, our minority staff prepared a comparison and I was just going to say that it might be well to put that in the record. The CHAIRMAN. I was not aware of the fact that the minority staff bad prepared this. Let's put it in the record where the other matter was inserted. All right, without objection then this too will be included in the record at that point. (The above mentioned material will be found on p. 45.) Mr. CURTIS. Mr. Fowler, I think I have a list here of 15 points and I roughly counted about 8 recommendations on which the Treasury has incorporated recommendations on which the Fowler task force had no recommendation. Secretary FOWLER. That is right. Mr. CURTIS. So any comments you might want to make there would be helpful. Secretary FOWLER. Thank you, Congressman Curtis. Mr. CURTIS. Incidentally, as Mr. Mifis points out to me, on page 5 of the statement, having read these differences, they mostly seem to be where you are tightening up to insure the fact that we don't create sort of a tax haven. Secretary FOWLER. That is correct. Mr. CURTIS. Most of them seem to be of that nature and the Fowler task force apparently didn't get into that. Secretary FOWLER. The task force didn't get into that technical are in detail. Mr. CURTIS. I want to pick up a little bit on the line of questioning that Mr. Herlong started to get this picture in relation to the interest equalization tax. On page 7 of your statement you give this picture: "At the end of 1964, foreigners held an estimated $12.8 billion of U.S. corporate stocks valued at market prices. In every year since 1950 except 2, foreign pur- chases of U.S. stocks exceeded foreign sales. In the 6 years between 1959 and 1964, net purchases by foreigners averaged $141 million." You then go on to say: "These net figures are the residualed of much larger gross purchases and sales which in recent years have been on the order of $23~ to $3~4 billion." Now, Mr. Secretary, Mr. Funston, president of the New York Stock Exchange, testified before the Ways and Means Committee and pointed out to us that foreigners were the net, sellers of out-. standing U.S. securities in 1964 for the first time in over 15 years and the net sales of domestic stocks by the foreigners in 1964 totaled $350 million compared to sizable net purchases in the previous 5 years~ 172 PAGENO="0183" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 51 The suggestion has been made that this reflects a belief by foreigners that the interest equalization tax was only a first step toward further restrictions on international flow of funds and reflected the fact, as Mr. Funston suggested, that foreign brokers and dealers who cannot sell their securities in the United States are far less receptive to the efforts of U.S. brokers and dealers to sell U.S. securities abroad. The point of this, if this is an accurate picture, is that this is an entirely different picture of the context than the one on page 7 in your statement. Doing these kinds of things that are suggested in this bifi is going to be incidental to increasing foreign investment in U.S. securities if we have had this kind of impact as a result of the interest equalization tax. I would appreciate any comments you might make. This is the picture apparently. and we are heading into sort of a war between countries abroad in further restricting capital flows which many of us suggested was bound to occur if we passed the interest equalization tax. That kind of effort in the proposed bill then is almost, meaning- less. Secretary FOwLER. First let me observe what is fairly obvious- that the proposals before you for the tax treatment of foreign invest- ment in this country are, as you have indicated, a part of a much broader complex of problems. The task force report, itself necessarily adopted the point of view that this is a very large and complicated problem. The fact that only a half dozen, you might say-I think it is 6 or 7-of the 39 recommendations of the task force are refle.cted in the legis~ation before you indicates this. Mr. Funston was a member of the task force and we had consider- able discussion in our deliberations of the very aspect of the problem that you raise. As a matter of fact, on pages 30 and 31 of the task force report were some general comments on reducing restraints on the sale of U.S. securities in other capital markets. For example, recommendation 35 is to the effect that the Department of State and the Treasury Department should take bilateral diplomatic action aimed at securing the step-by-step removal of remaining exchange controls on capital transactions between advanced capital-forming countries and the discontinuance or liberalization of special exchange markets or procedures for investment transactions. Some of the other recommendations relate to capital issues control, the regulation of institutional investors, and the role of international organizations. .A1l these recommendations are addressed to this problem. Let me quote from page 30 of the report: Although the task force has conducted an intensive study of restrictions in other capital markets, we have not attempted to set forth all of our findings here. The identification and critical appraisal of restrictions remaining in the capital markets of other industrial countries have been covered extensively in a recent study by the Treasury Department, made publicly available by the Joint Eco- nomic Committee of Congress. In this section of our report, we summarize the most important legal and administrative obstacles abroad which impede foreign investment in U.S. corporate securities. No useful purposes would, we believe, be served by making detailed recommendations as to the removal of foreign restrictions or methods by which other countries~ could improve their domestic capital markets. In each country these matters are often complex and technical; they involve delicate domestic relationships; frequently they transcend financial considerations and encompass national policies well beyond the terms of reference of the task force. It should be noted that efforts to remove restraining influences on sales of U.S. securities to foreigners will raise in foreign financial markets the 173 PAGENO="0184" 52 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. question of the continuance of the U.S. interest equalization tax as a factor affecting the sales of foreign securities to U.S. citizens, however temporary and special its basis. So I think the question you raise is one that we certainly concerned ourselves with at that time and this statement was an attempt to flag the problem. Mr. CURTIS. Exactly. As I pointed up, and now Treasury comes in and ignores the flag and actually comes and presents to this committee really not an accurate picture of what this sutation of foreign invest- ments in U.S. corporate stocks really is. You give a picture here from 1950 to 1964 and then you say: "In the 6 years between 1959 and 1964, net purchases by foreigners averaged $141 mfflion." I have pointed out that the point that should be stressed is that * foreigners were net sellers of outstanding U.S. securities in 1964 for the first time in over 15 years and net sales of domestic stocks by foreigners in 1964 amounted to $350 million. I note your average figure you give for 5 years, $141 million, con- ceals this unusual event in 1964 with the contrast of sizable net purchases of the previous 5 years. That gives you a lower average of $141 mfflion actually. Your average if you eliminate the minus $350 mfflion was considerably more, and the stark reality is that here the administration comes in to assist this theory of doing something to encourage removal of tax barriers to foreign investments in the United States, and at the same time if this rationale is right through the interest equalization tax is just making it impossible to encourage foreign investment. Secretary FOWLER. Congressman Curtis, I think it is just as plain as it can be that the interest equalization tax has been presented and dealt with by the Congress as a temporary measure. The measures before you are part of a long-term program that we hope can be coupled with other activities that are outlined in the task force report which we hope can lead to a situation in which we can, consistent with our responsibilities as a key currency, recommend the discontinuance of the interest equalization tax. We hope at that time, and in the intervening period, that other countries that have serious restraints on capital flows and on invest- ment by their citizens outside the country can also pull down these barriers; but the important point is, Congressman Curtis, that this is a part of a long-term effort of which I think you are one of the leading advocates. Mr. CURTIS. I surely am, yes. Secretary FOWLER. I don't believe that it is necessary for us to review again today, although I am happy to do so, the rationale of the recommendations for a further continuance of the interest equali- zation tax. Let me point out that this task force report was issued in April 1964. We had had a very good first quarter that year in terms of balance of payments. We were looking forward to what seemed to be a reasonably favorable prospect, and you and I are familiar with what has happened in the last quarter, and the last 6 months, of 1964, and what was continuing in the first month of 1965, We know that we had a particular, we hope a passing, situa- tion to deal with. 174 PAGENO="0185" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 53 I have said repeatedly before this committee that I trust, along with you, that the time can come sometime in the not too distant future when we can throw out these restraints on the free movement of capital without running the grave risk of inviting back a very sub- stantial balance-of-payments deficit. Mr. CURTIS. Here is the point, Mr. Secretary. Just as your Fowler report points out, although you don't want to get into this business of making detailed recommendations as to removal of foreign restrictions and methods by which other countries could improve their domestic capital markets, you clearly recognize that this is the situa- tion. Now I think you are saying that these kinds of restrictions are being increased by countries abroad, not decreased, because of the very policies that we have taken in the interest equalization tax. That is why it is pertinent to our discussions here because these are tax treaties in which you are going to have to deal with other nations and you can't come in on the one hand-I don't imagine you can have successfully-and argue for a liberalization in the tax area, when at the same time you are imposing these very rough restrictions on U.S. capital flow abroad. I don't see how you can separate the very rea- sons that you have mentioned, that this is a long-range situation. You are creating difficulties, I would suggest, through the interest equalization tax. Every day it is on the books the problems become more complex. Foreign nations are looking for news ways of retalia- tion and certainly the Treasury and the administration should be shocked into some sort of action I would think when the figures of 1964 show this turnaround of net foreign investment in the United States. Secretary FOWLER. Congressman Curtis, the facts are that the interest equalization tax, rather than causing foreign governments to inaugurate additional and further restrictions, has served as much as *any other development to focus the attention of foreign govermnents, and of international bodies such as the OECD, to the very fact that there is a permanent structure of foreign controls on the movements of capital. These controls are getting more attention today in Western Europe than they have at any time since the war. So the fear that you have has not been realized. I think the emphasis is the other way. Mr. CURTIS. Mr. Secretary, then please explain to me why in 1964 you had this great turn around where the net sales of domestic stock by foreigners in 1964 totaled $350 million compared to sizable net purchases in the previous 5 years. There is what we are faced with and this is not the context in which your statement is made, because I read what your statement said as far as this picture is concerned. I just think the administration is hiding from reality. It isn't a question of fear. It is a question of fact. What is your explanation of this fact? Secretary FOWLER. I don't have an explanation of that fact. I think my statement points out that there are many, many factors that are at work that change the ratios of gross to net in the balance. For example, in 1958 there was also a net sales figure. Mr. CURTIS. What was that, do you know? Secretary FOWLER. $56 million. 175 PAGENO="0186" M REMOVE TAX BARRIERS TQ FOREIGN INVESTMEW2 IN U.S. Mr. CURTIS. I notice there is this actual discrepancy between Mr. Funston's statement and yours. You give 2 years. He has only the one, and I was curious about which year was the other year. Secretary FOWLER. 1958 is the one, and, in 1958 there was a net sales figure of $56 million. Mr. CURTIS. $56 million. Secretary FOWLER. Yes, sir; and for the first 4 months of 1965, according to our records, there is still a net sales figure, but it is running at the rate of $33 million for the first 4 months. Mr. CURTIS. Let me be sure at least for the record that as far as the Treasury is concerned you are not suggesting that there is any other factor other than the interest equalization tax that has brought this turnaround in net sales?. Secretary FOWLER. I certainly am suggesting that there may be many other factors that are at work. Mr. CURTIS. That is what the record is here for. I have concluded there is a direct causal relation and I just want to be sure that there aren't some factors that the Treasury would like to suggest other than the interest equalization tax that has brought this about. It certainly isn't our tax laws because they have been the same throughout this period. There has been no change in that. Well, let's leave the record open so that you can supply any other factors. (The following material was subsequently submitted by the Treasury Department:) NET SALES OF U.S. CORPORATE STOCKS IN 1964 As in previous years, the magnitude of gross purchases and of gross sales by foreigners of American corporate stocks in 1964 was in the billions of dollars and it is difficult to isolate the myriad of reasons which produce a particular net figure. Nevertheless, two special factors undoubtedly account in some measure for the turn from net purchases by foreigners to net sales in 1964. The first of these relates to British Government holdings of securities of American corpora- tions which it .had acquired from its nationals during World War II. It is the normal practice to exclude such equity holdings from the calculation of foreign exchange reserves, and in order to make its holdings readily available to reinforce British reserves in the event such `action should be found to be necessary, the Government of the United Kingdom inaugurated a program designed to increase the proportion of the British Government's holdings of dollar securities which were in a liquid form. While the British Government has not announced the amount of its sales of U.S. securities in 1964 (and 1965), Chancellor Callaghan said on June30, 1965, "These operations had now carried to a point where the portfolio could be used to reinforce the United Kingdom reserves at short notice. The second of these special factors was the large-scale repatriation of foreign assets by firms in Switzerland and certain other European countries where domes- tic credit policies in 1964 had produced a severe shortage of capital. Although the magnitude of this repatriation cannot be quantified, Swiss authorities have indicated publicly there was a relatively large volume of repatriation of foreign assets on the part of Swiss residents in 1964 induced by the tightness of the money market in Switzerland. Similar conditions existed in some other European countries. 176 PAGENO="0187" REMOVE TAX BARRIERS TO FOR1~IGN INVESTMENT IN u.s. Ma - th~. "4~"4 "4 ~ 4CC) 0C0 "4 00 ~ 4- "4 CO `00 CC - 04)0 4~ 00 - I .-CCO 4'- 400000 II I I ~40"4 4-Ot-. ~ 000 4-0000 I'j*~'j~I I I `44 0 00 CCC CC "40)44300000000000044-4'- 4C~) 4- 443000000000)000 00 CC II I t_, ~" -~ 40 - 4- 4000000 C) "44-000000000000 ~400 CC CC C) COt'. 44300 C) ~ 4-CC 000)4CC) ceC3443 000000 4-4443443 44300 C0"4C)4- ~ ~ ~ CC "4 4-~-0 0)00 C') ~ C') 80 ~ 443 804434') 0 C') CC 00 4.80 COO ~ 00 443 00000) ~ 00004-443,-) 4-CC 443CC CC C') 44344300 C') `4, 0 0 ,~ CC 400000 ~ 0004CC) 04') C0 0 ~ `)` 03 0000 C) CCC- C') CC ~ CC ~ 4- ~4 C) .,,,,~,00 ~C 4- CO `)`CO C') CCC) CC ~4 0 C') 4-0 004- 4CC) C' C) C) CC~CC~C0C'4~) ,4, 0 `4, C) 0 0 C) 0 0 00 `C g `C I. ,`~ .~ I 4-0,0004-4-"4 C') 00 ~ C) 4-4-4-4- CC ~ `CC) COCCOCCCO 0040000 4-000) C) ~ 4-0 C') 404-0004- C~c4C~CCC'0')~-4 OCC3CC00004-0443 44344300 00000000 `0')C 404000 ~. :80)00 C) C43000'-CC4-0'0 C) `04') `)4 4C C')~-4 ~ 4-4-4-C) C) ~ 00 COO C) CO `)4 `)4 C') ~4)000 `4'- 00~7 I II 04- 004CC') *~3 ~ ~o ;~;~ I - .~ ~ 4--~ `)4 "44-4-4-O4-C)O4-C)C)0CC~-0 4- `0 40C) 00000 4'-COC04--0~C~C,~ I `0~'~'0 4-,-),') ~~~ CO ~)C'30 ~ : `)400"4 COO I I 4000 ~"4 I 0 4-8004 ~ `OCOO 0000"4 000400000044-00 I 000~3C0~ `0~-4j 00"')'°C-00443I `00) 00)0 0000 0) 0 80 4C "404000000 I I I I I "440043000000 ~ O4- 00000000)004 C')'-) ~ ~ 00)000 ~ "4400000 ~ 00)000 ~ ~0 4C')4 0 ~ 004-00)'-) ~ `-4 C) 0)004-C) "4 ~ C) o 0)80 t-~ 4000cC 0004000 0 0 00 `C 0 0 `C ,gJ `C. 07cq 0 0 000 `CC CC 0)04 .0.41 4000 CC. 00 44 0 C) C `C 41 `~ C) .~EE 177 PAGENO="0188" 54b REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Mr. CURTIS. Then let me agree with you now that what I am saying still should not deter this committee from considering how we could properly improve our tax laws. I wasn't interjecting the points I have been making as a deterrent. I simply do say, though, that the administration has to start getting its various recommendations to the Congress together so that there is some consistency. I have pointed this out in trade matters. We are moving to this. business in the Canadian-American auto treaty of bilateral, of a specif- ic product dealing, which is the reverse of the theory of the Reciprocal Trade Act of 1962 and the Kennedy Round, and just in so many in- stances there seems to be no consistent policy of the adminstration in this area of foreign trade and international finance. * Secretary FOWLER. I think we can go on this. I simpiy repeat again that as far as my position is concerned, when I appeared before this committee earlier to recommend the extension of the interest equalization tax, it was on the samepremise-that it was a temporary measure that I hoped, with you, we could at an early date dispense with. This particular proposal is for a long-term measure that I hope, if it gets on the books, can be maintained indefinitely as one part of a broad effort by our private sector, by foreign governments, and the whole area reflected in these recommendations, to encourage the free movement of capital. Mr. CURTIS. I don't want to rehash it further. We have done enough rehashing and I think it has been necessary to do so, but this pinpoints what I was saying when I was interrogating you on the interest equalization tax. I was saying I would have liked to have seen some appraisal on the part of Treasury of the damage that was coming about from the interest equalization tax because I am sure when you say that it should be only temporary you are saying that there is some damage being caused, but you think the net benefits are there. . I question that, but I thought your statement presented' to the committee on it was gravely lacking in calling to our attention the areas where damage is being created. This is why I have taken this occasion to point up a specific area, and there are many other areas where I would suggest great damage is resulting. If we only put the damage out in relation to the benefits, possibly the administration might change its policy and recognize, or hopefully might .see, that, the damage is much greater than the temporary benefits. Secretary FOWLER. While we are assessing benefits let me say that I think one of the additional benefits not necessarily contemplated when the interest equalization tax was proposed is that it has served to focus everyone's attention on the importance of the fact that, in addition to selling foreign securities in U.S. markets, it is important to try to promote the development of the sale of U.S. securities to foreigners. I think over the long pull the interest equalization tax 178 PAGENO="0189" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 55 has focused attention on the fact that there are things we could do in this area which we haven't yet done, but which would serve to create a better opportunity for the movement of capital this way. Mr. CURTIS. I wifi at least remark it is an ill wind that doesn't blow some good. Now, there is one area that has not been gone into and I know it is a difficult one to have statistics about, but what about direct investment? We have been talking really of investment in stocks, but direct in- vestment has been found, as we found out again in the interest equal- ization tax, to be one of the big areas, and do we have any idea of what the picture is on direct foreign investment? Secretary FOWLER. I am glad you raised that, Congressman Curtis, because it enables me to say that the task force in interpreting and applying its terms of reference felt that an examination by it of invest- ment by foreign individuals and concerns in brick and mortar or fac- tories, operations of that sort, was not to be included in the purview of the task force. There has been a unit in the Department of Com- merce for some years which has been directed to the so-called direct investment factor and we purposely avoided duplicating the studies and examination of what is involved in that particular problem. To some extent the tax laws and the recommendations that are in front of you would, I think, affect that situation, but that, as well as investment in real estate, was not the focus of the recommendations. However, I think one of the principal impacts of these recommenda- tions might very well be on foreign investment in U.S; real estate. Mr. CURTIS. Help me here. What is the ratio of American invest- ment in foreign securities to American direct investment? ~Secr-etary-~-FowI-ER-. I-don't~know-whether Fam c-ompI~tely~cur~ on that, but my impression is that a rough rule of thumb would be that of our total investment abroad, about two-thirds tends to go into direct investment and the other third into portfolio investment. The reverse is true of foreign investment in this country, by far the pre- dominant percentage of foreign investment in the United States is in securities, or so-called portfolio investmenj and onlyji third of foreign holdings are in what we would call direct investment. Mr. CURTIS. That is very helpful, and then we will have the record open too so that you can supply more accurate figures if you have them in this area. Secretary FOWLER. Right. Mr. CURTIS. And any comments that you would make. (The following material was received by the committee:) End of 1963: Percent U.S. direct investment abroad as percent of total U.S. long-term private investment abroad 69. 8 Foreign direct investment in the United States as percent of total for- eign long-term private investment in the United States 34. 9 179 PAGENO="0190" 56 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Mr. CURTIS. As I was going over these tax recommendations many of them would affect direct investment the same way that they would the other kind. Secretary FOWLER. Yes. Mr. CURTIS. And that would be helpful. Secretary FOWLER. I think to whatever extent they would affect them it would be a beneficial effect. Mr. CURTIS. I think so. Secretary FOWLER. And encouraging more direct investment. Mr. CURTIS. One aspect of your recommendations, particularly estate tax, seemed to be to treat foreigners equally with the way we treat our own citizens. That of course appeals to me strongly. What worries me, though, as we go on to some of these other recommendations it looks like we might be giving foreigners a privilege which we do not extend to our- own taxpayers. Am I correct in that observation? Secretary FOWLER. I think I would tend to put it this way: We are tending to follow more closely the pattern of international tax treatment of foreigners followed by other countries. To the extent the element you mention is present, it is one that generally character- izes other countries' tax treatment of their own citizens as compared~ to tax treatment of foreigners. Mr. CURTIS. When this committee goes into executive session to consider the details of these recommendations I think that is just one rule of thumb I am going to try to employ, because that is the way to prevent the tax haven rather than some of these somewhat punitive approaches. For instance, just trying to figure out whether a person has changed his citizenship for tax reasons or for other reasons, I view that with a jaundiced eye. I would much prefer to follow the guidelines of trying to treat our citizens and foreign citizens for tax purposes as equally as we can. To that extent, many of these recommendations would be accepted by applying this rule of equity. Secretary FOWLER. I think another guideline to follow there, Congressman Curtis, if I may just suggest it again, is that in making these comparisons it would also be useful to compare the proposals with the type of treatment U.S. citizens are given by foreign govern- ments under their tax laws. Mr. CURTIS. Well, yes; I agree with that. Secretary FOWLER. I am not talking about the tax haven treatment,. but I mean the generalized tax treatment. Mr. CURTIS. I might as well pick this point up because I had it noted here. On page 20 you refer to "the generally accepted inter-* national tax policy principles," and I wasn't quite sure what they were or how you conceive of what are "generally accepted international tax policy principles." Is this the result of study, or is this a general conclusion? Secretary FOWLER. I would hate to have to produce a compact statement of those principles. What we would have to bring up to you is a large stack of international tax treaties, both those that have 180. PAGENO="0191" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 57 been negotiated between this country and other countries, as well as those negotiated solely between foreign countries. Moreover, the OECD is presently involved in a considerable study in this area for the purpose of harmonizing tax treaty policies. I also think the Common Market countries are also working toward a similar objective. Mr. CURTIS. I thought that was the position the committee was going to be in, that we are going to have to sort of look at each one of these tax treaties. Unfortunately we don't have a little handbook to follow to look at as to what the accepted principles are. On page 11, for example, you point out on capital gains: "The present system of taxing capital gains realized by foreigners has contributed to the view that investment in the United States is something that should be approached cautiously," et cetera, and I was thinking generally with respect to international tax policy principles. We have a much more liberal interpretation of what is capital gain than the British, for example. Many of the things that we call capital gain they regard as ordinary income and I would wonder, for example, vis-a-vis Great Britain, whether the net result was that we weren't more liberal in our overall tax treatment because we don't regard as ordinary income a number of things that they do. This would be one of the details we would have to get into in a reconciliation. Secretary FOWLER. I think I will ask Secretary Surrey to comment on that because he has been dealing with the tax treaty problem rather substantially in recent months. Mr. SURREY. It is very hard to say. Most of the capital gains that are involved are generally sales of stock and securities and the definitions are roughly the same if the foreign country has a tax on * capital gains. Some foreign countries do not have a tax on capital gains. The British tax on capital gains, if the bill before Parliament is adopted, will be somewhat stiffer than ours. The rate would be higher. Mr. CURTIS. This is true. You are directing your attention to securities? Mr. SURREY. Yes. Mr. CURTIS. The complexities you have to get into in ordinary income are not in this area. Mr. SURREY. That is right. Mr. CURTIS. Thank you. Mr. ULLMAN (presiding). Without objection the record will be kept open in the cases indicated by Congressman Curtis. Mr. Burke? Mr. BURKE. Mr. Secretary, do you see anything in this bill that would give a foreign investor an advantage over an American investor, say, in the line of a direct investment because of the tax breaks he would be getting? Secretary FOWLER. I don't believe I do, Congressman Burke. I don't believe I see any advantage in that respect. Mr. BURKE. Do you see the possibility of any loophole being established here whereby American money could be turned over to 181 PAGENO="0192" 58 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. a foreign investor who could invest that money here in the United States and thereby escape the taxes that would ordinarily be paid? Secretary FOWLER. This is, of course, the problem that we contend with constantly in our current laws as they are written. I don't believe that the changes before you will materially or substantially change the challenge that always exists to the Internal Revenue Service to deal with that kind of problem. I think that the principal concern that we have in that regard is reflected in the proposal having to do with treatment of expatriate American citizens. Although there might be some differences, as Congressman Curtis has indicated, about whether the test proposed is the most practical one, we do think some such provision, either that provision or a better provision, is necessary to deal with the problem of the American citizen who would give up his citizenship in order to take advantage of these particular provisions. Mr. BURKE. Do yOu think there are sufficient safeguards in this bill to guard against that? Secretary FOWLER. I think we would take the position that there are sufficient safeguards. I think experience might prove that some- thing more would be necessary, but I think this would be the right basis on which to begin. Mr. BURKE. Under the provisions of this bill let's just take a hypo- thetical case. Suppose some company wanted to open up a manu- facturing plant here in America, say, for one of these small foreign cars and they invested here in the plant, bought the real estate, owned it lock, stock, and barrel, wouldn't they be in a rather advan- tageous position over their American competitor? Secretary FOWLER. I don't think that this bill would change that situation in any particular. The only area which would be at all concerned is if the same concern, in addition to dealing in foreign cars, acquired a number of U.S. corporate securities and earned a good deal of investment income collateral to its regular business. Then that portion of its income which could be attributed to invest- ment income would be aflected by some of the changes, sometimes better and sometimes worse, by the provisions of this bill. Mr. BURKE. Is there anything in the provisions of this bill whereby there is American money sent abroad to a foreign investor who would invest here in this country and yet that American money is actually part of this foreign investment firm? Do they receive the benefits of this bill? Secretary FOWLER. I think what you have in mind is a beneficial real ownership which is masked by what purports to be an outright transfer of funds or release of funds. The situation would be exactly the same as it is today. We have that enforcement problem that we contend with. I don't think it is terribly serious, but it is something that the Internal Revenue Service has to be constantly alert to. I don't believe that this bill will substantially affect or induce that kind of practice any more than is the case under our tax laws today. Mr. BURKE. What I am referring to is where American money buys stock, say, in a foreign corporation as an investment corporation in the foreign country and that corporation in turn invests its money back over here. Secretary FOWLER. I would like to think about it a little bit more and perhaps supply a full answer to your inquiry, Congressman 182 PAGENO="0193" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN u.s, 59 Burke, but my immediate answer and reaction is that this bill would not benefit or induce that kind of conduct. Mr. BURKE. What I am trying to get at is, is there anything in this bill here that would induce American money to be sent abroad to invest in foreign investment corporations who would later come back here `and invest it here. Secretary FOWLER. I see exactly what concerns you, but I think our opinion is that that would not be induced or promoted by these proposals. These proposals really go to making it easier for the smaller investor in Western Europe to invest in U.S. securities. As I have indicated, only 1 person in 30 in Western Europe now has investments in securities. This is not nearly as good a ratio as we have here in the United States; but it is going to come up over the course of time. These provisions really go to encodraging that kind of an individual, whether it be on his own or in some institutional context, to consider American securities as a part of his portfolio. We do have about $13 billion worth of current investment from abroad in U.S. holdings and securities, but I see, as did the members of the task force, substantial opportunity over the long range for that volume to build up. I think that is the principal appeal of the proposal. I believe that the practice you referred to goes on and is induced by the tax system generally. There are great inducements, as you know, in many areas for both individuals and companies to base themselves in a foreign jurisdiction where the rate of local taxation is far less than that in the United States. However, I don't believe that particular practice is going to be substantially changed or increased by the provisions that we have submitted here. There are already large inducements for the person who really is trying to evade taxes in that fashion today. Mr. ULLMAN. Are there additional questions? Mr. Schneebeli. Mr. SCHNEEBELI. Mr. Secretary, what is the difference in tax revenues between your recommendations as the task force chairman and your recommendations as Secretary of the Treasury? Secretary FOWLER. I think about $2 to $3 million. Mr. SCHNEEBELI. Do we have any figures for the record that would establish the trend of the percentage of foreign ownerships in our securities, 25 or 50 years ago compared with today? The reason why I ask is I believe there is quite a downward trend since, for instance, at the turn of the century I presume foreign owner- ship of our railroads was quite large and since then 1 would assume that there is a downward trend. Secretary FOWLER. I am perfectly sure you are right in your assumption. I don't have the exact figures. Mr. SCHNEEBELI. I would be interested in knowing what the foreign ownership in our securities was 50 years ago compared to today. I think it would be very interesting and I think the change would be quite precipitous. Secretary FOWLER. Yes; I would agree I think it would focus to some extent on this problem. Mr. SCHNEEBELI. I think it would buttress your argument to show a vast difference in ownership over the years. Secretary FOWLER. If the record will remain open for us we will try to supply it. 71-297 O-67-pt. 1-13 183 PAGENO="0194" 60 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. (The information referred to follows:) Data of the type referred to are not readily available. Some impression of the relative size of foreign holdings, however, can be gained from the following: Foreign ownership of U.S. stocks as percent of market value of outstanding U.S. corporate stocks Percent. End of 1946 2. 5 Endof 1963 2.1 Mr. SCHNEEBELI. I think the record should show what the per- centage was 25 to 50 years ago compared with today. Mr. ULLMAN. Without objection the record will remain open. Mr. Broyhifi? Mr. BROYHILL. Mr. Secretary, does $141 million in net purchases made during the past 6 years reflect the earnings on those investments, the dividends paid? Secretary FOWLER. No; that reflects I think more the balance of purchases against sales. In other words, the gross volume of pur- chases and sales runs in the neighborhood of $2~ to $3~ billion in a year, but when you net it out the $141 mfflion figure represents net purchases. Mr. BROYHILL. Then under the $141 million there is not much of a margin if there were many dividends paid. Is it possible that we could actually have had a net loss of balance of payments during that period due to dividends being paid out. Secretary FOWLER. Of course there is no question but what the increase in the rate of foreign holdings in the United States wifi over the long-term reflect, presumably in dividends or capital gains with- drawn, an outflow of funds. Otherwise there would be no induce-* ment for foreign investment here. I think you put your finger on a point-that the long-term conse- quences of increased foreign ownership of U.S. corporate securities does entail a withdrawal of earnings from this country. That is the reason that Great Britain and France prior to the war, and Germany as well, had a policy of encouraging this type of investments for the long pull. There was a national policy of encouraging that for the very reason you indicate. Since the war this hasn't really caught hold again as a matter, of national policy throughout Western Europe. I think that we have to look also at the political consequences of such a policy. I think my own attitude on this would be that it makes for a healthier set of political and economic interrelationships between citizens of various countries if U.S. citizens have some stake in secu- rities of foreign corporations and if a large number of individuals in other countries have a stake in the United States. I think it is just like tourism. It is like U.S. companies doing business abroad, foreign companies doing it here. The more this economic interrelationship can be encouraged, I think the better the overall understanding and allegiances, alliances, or friendship, whatever term you want to apply to it, are apt to be engendered. Mr. BROYHILL. Did I infer correctly from your remarks that there possibly has been a. loss in balance of payments during the past 6 years as a result of foreign investment in this c9untry-we are talking about 6 years-with $141 million net gain in purchases? I under- stand over the long run it has resulted in a loss in balance of pay- 184 PAGENO="0195" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 61 ments, but has there not been an actual loss over the past 6 years? That is when we experienced a lot of additional diffl~uIty in the balance of payments. Secretary FOWLER. At least $13 bfflion worth of American securities are owned abroad. The extent dividends have been remitted does, of course, enter into the outflow, but that has to be balanced against what we~ get from our investments abroad. I don't know what you are netting it against. That is my difficulty in answering your question. There is an im- pact on our balance of payments as a U.S. company, and as General Motors Corp., pays dividends on its stock to someone who holds that security in Great Britain. Mr. BROYHILL. That is what causes some of us, and certainly it is causing me, some difficulty in understanding why the interest equalization tax will not in the long run cause more problems in balance of payments. Should not increase in our investments abroad, in the long run also bring back a favorable increase in the balance of payments. Secretary FOWLER. I think, to bring the interest equalization tax into this for a moment again, you are looking at a very short-run effect. You are looking at a law which, in a sense, causes an American who has been following foreign securities and building up his portfolio in that particular area to pause at this particular time for what we hope will be a brief span of years. It is a short-term deterrent to U.S. investment in foreign bonds and foreign stocks. That is its very purpose, because we feel at this particular period of time the initial capital investment by the individual will be so far in excess of the early returns that would come in the form of dividends and interest in the years immediately ahead when we presumably are trying to lick this balance-of-payments problem, the balance of benefits for the short term is in the national interest as against perhaps the balance of benefits over a long term. Mr. BROYHILL. You said in your statement that you did not know for certain as to what balance-of-payments effect this bifi would have. Secretary FOWLER.. I would think that over the long term, looking again now into 1975 to 1980 as a span, that a net increase in foreign investments in the United States- Mr. BROYHILL. Increase of purchases rather than the net dividends, net result of incoming capital. Secretary FOWLER. That is right. It is the outlay of capital now that I have in mind in making that statement. Mr. ULLMAN. Are there further questions? Mr. Battin. Mr. BATTIN. Thank you, Mr. Chairman. Do you have, Mr. Secretary, any idea of what the average foreign investor's capital outlay would be in the United States? Secretary FOWLER. No, I don't believe we do. I think that you could probably get the best information on that from some of the private institutions, let's say, a brokerage firm like Merrifi Lynch that has very extensive brokerage offices in Western Europe. They can give you a much better picture of the makeup of the average customer that comes into that brokerage house. Mr. BATTIN. What prompts the question is the figure that you use in the exemption that would be applied to the estate tax. 185 PAGENO="0196" 62 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Secretary FOWLER. On the estate tax, I think I can give you some information just in terms of the returns that we have from it now. When the returns filed in 1960 and 1961 are distributed by gross estate classes, approximately 90 percent of the returns are con- centrated in the gross estate class zero to $60,000. Out of a total number of returns of 1,375, 1,231 fall in the class, zero to $60,000; 67 returns in the $60,000 to $100,000 category; 22 returns in the $100,00Q to $150,000 estate tax class; 21 returns in the $150,000 to $200,000 estate tax class; 14 returns in the $200,000 to $300,000 category; 13 in the $300,000 to $500,000 catagory; 5 returns in the $500,000 to $1. million category, and 2 in the $1 million to $5 mfflion category. Mr. BATTIN. There have been reports in the press that the indus- trialized countries of Europe are becoming a little hard pressed for capital, at least in the world capital market. Again going back to the interest equalization business-and we had as much discussion here this morning about that as the bill before us-I believe in discussing that bill, interest equalization tax, there was an indication by some that it would be helpful if there was in existence outside of the United States another money market. The paper this morning indicates that you met yesterday with the Chancellor of the British Exchequer to discuss ways to increase the amount of money available to finance world trade. If at one time you are encouraging capital to come into this country by the elimination of tax restrictions and thus encourage its investment here and at the same time discouraging the export of U.S. capital into the foreign market does it not become basically the position of the United States that at least for a period of time we are not willing to cooperate in trying to finance world trade? Secretary FOWLER. No, not at all. I think, as a matter of fact, the record of the United States in this regard is thoroughly understood and appreciated by the central bankers, and by the Ministers of Finance in Western Europe. They understand as well as we do that the most substantial contribution the United States can make today to the free world monetary system is to bring its balance of payments into equilibrium and keep it there as a support to the dollar as the key currency. As a matter of fact, most oi~ the financial and economic authorities in Western Europe that we are in contact with have not the concern that you have attributed to some observers that our progress in dealing with our balance of payments is causing these difficulties. They are concerned with the continued outflow of dollars in the form of U.S. deficits, in effect creating a tendency to inflationary con- ditions in those particular areas. I think they are quite receptive to the voluntary program that the President has proposed, and which has been accepted and is being carried on, and tend to applaud our efforts in this regard because of their primary concern, which we share, that our first job here is to get our own balance of payments into equi- librium and keep it there. That is the most substantial thing that we can do to facilitate world trade development. Now, as we make progress in that area, and I am not trying now to assess the degree of our progress in that area, we recognize along with other people that some mechanism for the orderly creation* of ad- ditional international liquidity, as it is called, which our dollar deficits 186 PAGENO="0197" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN US. 63 have hitherto supplied, ought to be arrived at. We are just as anxious as we can to negotiate changes in the international monetary arrange-. ments so that over the long pull, and this is not something today or tomorrow-I don't think the other governments are fearful of any current damage that we might do-but over a period of time if we get into a balance and stayed there, then there is a question of where this additional liquidity comes from. Therefore, we share their concern that there be an adequate mechanism for creating the additional liquidity that our deficits have hitherto provided. We are hopeful that we can work out these arrangements. How- ever, it takes two to tango and they depend upon agreements by others, We cannot agree to changes in the system that amount to what would be a retrogression or diminishing of the effectiveness of the interna-. tional monetary system. Mr. BATTIN. Mr. Secretary, I want to share your view that getting our balance of payments into line is probably one of the most impor-. tant tasks that you have as Secretary and I think the times that you have appeared before this committee since you were sworn in have indicated your real concern in this field. I would also like to comment, since you were the chairman of the task force that gathered the information presented with this bifi, H.R. 5916. I think the suggestions as well as the explanations that have been made with the recommendations are well done and the task force should be congratulated. Secretary FOWLER. Thank you very much. Very little credit is due to me. Ambassador McKinney, who was the executive director of the force, worked many long, hard months and I can say that every member of the task force, and they include a lot of very, very busy men who had other duties and responsibilities as their business and corporate identification would indicate, contributed most gener- ously of their time and effort. It was really very much of a joint production. It was not one of these operations in which just a few people from the Government did the work. A great deal of work went into what you have generously indicated is a very small, but I think worthwhile, package. Mr. TJLLMAN. Are there further questions? Mr. Secretary, I believe the record is incomplete in one regard. You asked Mr. Surrey to give us a brief explanation as to why the Treasury recommended retaining low-rate estate taxes rather than following the recommendations of the task force. Mr. Surrey, would you like to do that and submit it for the record, or could you do it very briefly? Mr. SURREY. I can do it briefly right now. It doesn't make any difference. Mr. ULLMAN. We have some witnesses from New York and I think it would be better if you submitted a short statement for the record. Mr. SURREY. All right. Mr. TJLLMAN. Without objection that will appear in the record at this point. Mr. SURREY. All right. (The information referred to follows:) 187 PAGENO="0198" 64 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. STATEMENT OF TREASURY POSITION REGARDING THE PROPOSAL CONTAINED IN H.R. 5916 To AMEND ESTATE TAX PROVISIONS APPLICABLE TO NONRESIDENT ALIEN DECEDENTS H. R. 5916 would amend our present system of taxing the estates of nonresident alien decedents by increasing the present $2,000 exemption to$30,000, and sub- stituting a 5-10-15 percent rate schedule for the regular U.S. estate tax rates (ranging up to 77 percent) now applicable to the estates of such decedents. The Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securities recommended (recommendation No. 29) that U.S. estate taxes on intangible personal property be eliminated. The changes contained in H. R. 5916 should result in lower estate taxes on non- resident aliens and thereby improve the climate for foreign investment in the United States. Present U.S. rates and the limited exemption applicable to non- resident alien decedents result in an excessive effective rate of estate tax. These rates have resulted in proper concern that our estate tax is a deterrent to foreign investment in the United States. The proposed changes correct this situation. The new rates effect a sweeping reduction in the present effective rate of tax- from almost 80 to 100 percent of the present tax is eliminated. The new rates will produce for nonresident aliens' estates an effective rate of tax on U.S. assets which in many cases is comparable to that applicable to U.S. citizens who avail them- selves of the $60,000 exemption and marital deduction (which are not available to nonresident aliens). The attached tables show the effective rates and dollar amounts of U.S. estate tax for nonresident aliens under present law and the effective rates produced by the proposed exemption, compared with the rates and tax applicable to the estates of U.S. citizens electing and not electing the marital deduction. It should be pointed out that even the task force did not recommend complete elimination of the estate tax. Even under the task force recommendation, the estate tax would remain applicable to all tangible property, including real property and personalty, owned by a nonresident alien decedent. The objections to the task force approach are as follows: (1) Although we receive only $5 million in revenue annually from our estate tax on nonresident aliens, it would appear inequitable to completely relieve non- resident aliens holding U.S. intangible property from estate tax when U.S. citizens are subject to an estate tax. (2) Elimination of the tax on intangibles, which constitute between 85 and 95 percent of the taxable assets held by nonresident aliens, would remove the princi- -pal impact of the tax. Yet the Internal Revenue Service would be required to maintain enforcement activities to collect the tax in those cases where tangible assets were held. Elimination of the tax on intangibles would discriminate against aliens who chose to invest in real property, for example, rather than stocks. In such a case, most aliens investing in real estate would probably incorporate their investments to avoid the tax, reducing the tax base even further. (3) The matter of international tax rules governing the estate tax has been dis- cussed in the Organization for Economic Cooperation and Development (OECD). Some of the countries are willing to eliminate by treaty the estate tax on intangibles owned by foreign decedents. This is not true, however, of the United Kingdom, Canada, and Japan. Where countries have registered shares rather than bearer shares-such as the United States-they are apparently less willing to eliminate their. estate tax on intangible property where foreigners are involved. If other countries begin to utilize registered shares more frequently, it may be expected that they might wish to retain their estate taxes on intangibles since the likelihood of collecting the tax would be far greater. (4) Elimination of the tax on intangibles would mean that we would be less likely to receive information on the foreign assets of U.S. estates. Our ability to exchange information on alien-owned property in the United States under our treaty arrangements enables us to obtain information about our citizens who die, and have assets abroad, and we may be handicapped here in the future if we have little or no information to exhange. The same may be true of information which other countries may have about Americans who die abroad with assets here. (5) The changes embodied in H.R. 5916 accomplish the principal objective in- tended by the task force recommendation and yet do not raise the problems dis- cussed above. The increase in exemption and reduced rates proposed in H.R. 5916 will bring U.S. effective estate tax rates on nonresident aliens to a level somewhat higher than those imposed upon resident estates in Switzerland, Germany, France, and the 188 PAGENO="0199" REMOVE TAX. BARRIERS TO FOREIGN INVESTMENT IN U.S. 65 Netherlands, for example, but substantially below those imposed on resident estates in the United Kingdom, Canada, and Italy. Thus, investment in the United States from these latter countries would bear no higher estate tax than investments made domestically because of exemptions or credits that the latter Lountries allow for U.S. taxes. The proposed tax treatment of the U.S. estates of nonresident aliens is substantially similar to the treatment accorded the estates of nonresidents by Canada, whose rates on the estates of its citizens are comparable -to our own. Where additional reductions are justified, these may be made by treaty. For these reasons, the Treasury urges that the estate tax changes embodied in H.R. 5916 be adopted. Effective rates of U.S. tax on U.S. estates of nonresident aliens and U.S. citizens U.S. gross estate 1 Effective rate of tax Present treatment of nonresident alien Nonresident alien2 U.S. citizen . With marital deduction 3 Without marl- tal deduction $2,000 $l0,000...._ $30,000 $60,000 2.9 7. 7 12. 5 17.3 23. 0 25. 8 27. 5 28. 8 43. 0 53.3 - 2. 0 3.0 5. 8 7. 4 7. 9 & 8 12. 6 iao . - 3. 0 & 0 9.9 11. 1 16.9 21.2 . 3.0 16. 1 22. 1 24. 8 26. 7 42.3 52.8 $100,000 $250,000 - - -- $500,000 $750,000 - - -- $1,000,000 $5,000,000 $10,000,000 1 10 percent of gross estate is deducted for funeral and other expenses of U.S. citizens and nonresident aliens. 2 Effective rate of tax with $30,000 exemption and rate schedule as follows: If taxable estate is- The tax shall be- Not over $100,000 -- 5 percent of the taxable estate. Over $100,000 but not over $750,000 $5,000+10 percent of excess over $100,000. Over $750,000 $70,000 +15 percent of excess over $750,000. 3 Effective rate of tax on U.S. citizens under current rate schedule with $60,000 exemption and marital ileduction. Effective rate of tax on U.S. citizens under current rate schedule with $60,000 exemption but without marital deduction. Source: Office of the Secretary of the Treasury, Office of Tax Analysis, July 2, 1965. 189 PAGENO="0200" 66 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Dollar amounts of U.S. tax on U.S. estates of nonresident aliens and U.S. citizens U.S. gross estate 1 . Amounts of U.S. tax Present treatment of nonresident alien Nonresident alien 2 U.S. citizen With marital deduction 3 ~rithout marital deduction $2,000.._ sio,00o - -- $30,000 $290 2, 300 7,500 17, 300 57, 500 129, 000 206, 250 288, 000 2, 150, 000 5, 330, 000 ---- $1,200 3,000 14, 500 37, 000 59, 250 88,000 630, 000 1, 300, 000 $7, 500 40, 000 74, 250 111,000 845, 000 2, 120, 000 $3, 000 40, 250 110, 500 186,000 267, 000 2, 115,000 5, 280,000 $lOO,000 - -- $250,000 - -- $soo,000 - . $750,000 - - - $1,000,000 $5,00,00(L..__ $10,000,000 1.10 percent of gross estate is deducted for funeral and other expenses of U.S. citizens and nonresident aliens. 2 Effective rate of tax with $30,000 exemption and rate schedule as follows: * If taxable estate is- The tax shall be- * Not over $100,000 - - - 5 percent of the taxable estate * Over $100,000 but not over $750,000 $5,000 plus 10 percent of excess over $100,000 Over $750,000 $70,000 plus 15 percent of excess over $750,000 .3 Effective rate of tax on U.S. citizens under current rate schedule with $50,000 exemption and martial deduction. Effective rate of tax on U.S. citizens under current rate schedule with $60,000 exemption but without marital deduction. Source: Office of the Secretary of the Treasury, Office of Tax Analysis, July 2, 1965. Mr. TJLLMAN. Mr. Secretary, we thank you very much for your testimony before us. It has been very helpful to us. Secretary FOWLER. Thank you very much, Mr. Chairman. Mr. TJLLMAN. We have some additional witnesses from out of town and I would like to proceed as long as we can prior to a quorum call. The next witness is Mr. Fredrick Eaton. Is Mr. Eaton here? Mr. Eaton, we welcome you before the committee. You are a member of the task force and have worked hard and long on this problem. Will you please state your name and who you represent here for the committee and proceed as you wish? STATEMENT OF FREDRICK M. EATON, NEW YORK, MEMBER OF TASK FORCE ON PROMOTING INCREASED FOREIGN INVEST- MENT IN U.S. CORPORATE SECURITIES, ACCOMPANIED BY PETER NITZE Mr. EATON. Thank You, Mr. Chairman and gentlemen. I will briefly review for you the activities of the task force and its recom- mendations. My primary purpose here is to tell you in general terms the results that have been accomplished in the private sector in the area of its recommendations. In some detail, I have furnished this to each of you in a report which was signed by Ambassador McKinney; the executive officer of the task force of which Mr. Fowler was the chairman. The members of the task force are set forth in the task force report which I believe you have and represented a fairly broad section of both industry and of finance. This group was formed in the summer and fall of 1963 and its report was filed in the spring of 1964. The report was divided into three major sections. One was sug- gestions to business and finance as to what could be done to help on 190 PAGENO="0201" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 67 the balance-of-payments problem; second was directed to the Securities and Exchange Commission; and the third to the Treasury and there-. fore to this committee. The Securities and Exchange Commission, in large part Chairman Cohen, then a member of the Commission, was extremely helpful. In the early days of July of 1964, shortly after the report was ified, the Securities and Exchange Commission issued a release which carried out all of the recommendations which were made by the task force to the SEC. They were extremely helpful. I will not go into them. They were of a technical nature. I will be glad to answer any specific questions that you have at the end, but I don't believe they are of any material moment to this committee other than that it made it far easier for our investment banking firms to offer securities abroad and far easier to bring foreign participants into the U S. syndicates. The second area, and probably the most important area, were the recommendations which had to do with the tax bifi and tax changes which the committee felt would be helpful in stimulating foreign in- vestment in American securities. The bill that is before you in general carries out each of those recommendations faithfully and goes -beyond it in many respects. There is the one exception that~ was raised here this morning that of the estate tax. I hope very much that the committee will consider the recommendation of the task force, which is to eliminate all estate taxes on all intangibles, specifically stocks and bonds that are held by foreigners. The provision in this bill goes a long way as far as rates are con- cerned. It reduces the rate to a maximum of 15 percent and that amount isn't reached until the estate is over $5 million, so that the rates are not now too important. The figures given you by the Secretary this morning indicate that the magnitude of all estate taxes that were taken in under existing law was $5 mfflion per year and the recommendations in this bill, if this bill is enacted, willreduce these to $2 mfflion. Two million dollars is a sizable amount of money, but, if the judg- ment of the investment community is correct, the benefits which would come from the flow of dollars into securities in this country would be far, far, far greater than the $2 million that would be lost in the revenue measure. As the Secretary indicated, the problem is not simply rate. It is not wanting to become involved in our system of estate taxes. I would hope very much that the committee wifi consider possibly eliminating the estate taxes entirely in this area. To move into another area, engagement in business in the United States, a technical concept, the ~committee made recommendations in this area. Those recommendations were carried out, were effected in the bifi. They have raised two or three technical problems that I am not sure I am technically competent to describe to you. We have furnished you a technical memorandum on it. One, however, I would like to comment on. There is a degree of uncertainty in the present law as to whether the granting of discretion to bankers and to brokerage houses in this country to purchase or sell securities may not constitute doing business in the United States with all of the attendant difficulties that doing business in the United States involves. This has been eliminated entirely except for one area. 191 PAGENO="0202" 68 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. The bill provides that anyone who is engaged in the securities business abroad, if he gives discretion here, may then, or will then, become engaged in business here. There isn't any doubt but what a foreign security dealer if he is actually engaged in business here should be subject to the same taxes that our own security dealers are, but not simply because they are members of various syndicates that are now being formed to distribute U.S. securities abroad. Incidentally, in connecton with General Motors syndicate, some 48 foreign firms were brought in as members of that syndicate. Under the terms of a syndicate agreement discretion is granted to the syndicate managers who are U.S. banking houses to buy and sell and stablize the market in securities, to lay off transactions-I won't go into the details. There should be a technical amendment made here and I have advised the counsel to your committee and Secretary Surrey of the problem-so that it will not discourage the very thing which the action of the SEC and which this bill is intended to encourage, which is to bring foreign security firms in to assist us in selling our securities abroad. The intercorporate dividend tax provision creates a problem and again I have furnished information in that area to counsel to the committee and Secretary Surrey. With those very limited exceptions not only does this bill carry out all the recommendations in the task force report, but goes beyond it and the private members of the task force are very heavily indebted to Secretary Surrey and his staff and to Chairman Mills for introducing this bill. I will go on for a moment, if I may have the time, Mr. Chairman, to comment briefly on those recommendations that were directed to the private sector. So complete was the cooperation of the Govern- ment sector that the private sector felt that they should go as far as they could to carry out the recommendations which in effect they had made to themselves. I would like to quickly emphasize that many of the things that I am going to comment on were brought about and occasioned by a combination of events and not alone by this task force recommenda- tion. Therefore I would not want to indicate that the steps that have been taken over the last 12 months to help on the balance-of-payments problem were directly a result of the task force report. Some of the specific suggestions in the task force report helped to educate both the banking and the industrial community as to the opportunities which did exist abroad for investment there. One of the areas that was recommended was that we place American securities abroad, and within the last 12 months there have been something in the neighborhood of, $100 million in American securities placed abroad. I won't try to detail them. I have to some extent in the report that has been ified with you. General Motors placed $50 million. Ford~ was $30 million, Minnesota Mining was $3 mfflion, Cutter Labora- tories, and there have been others that I won't bother you with. Another area that was recommended was that U.S. companies borrow money abroad for their foreign financing rather than to invest our funds here in the foreign company. Fortunately the interest equalization tax does not apply to a corporation that invests money in a foreign subsidiary or any foreign company in which it owns more than 10 percent of the stock, so the equalization tax did not prevent this flow of funds. 192 PAGENO="0203" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 69 As a result of the recent effort of President Johnson and the tightness of the balance of payments there have been substantial borrowings abroad. Socony Mobil has just recently sold an issue of deutsche marks and sterling notes. The General Motors Co. have borrowed upward of $60 million in Belgium to build their plants over there. Again the details of these have been furnished to you. The task force recommended that investment banking houses here endeavor to place foreign dollar bonds abroad whith no longer are attractive to this market because of the interest equulization tax and in the last 12 months over $200 mfflion of foreign dollar bonds have been placed abroad. There have been several Japanese issues, the city of Tokyo, Nippon Electric. Copenhagen Telephone and a number of Finnish issues have been placed abroad, Mexican issues, Italian issues. The sum is quite substantial. There was a recommendation that the investment banking houses, the brokerage, houses, increase their activity abroad. There are today some 180 branches of New York Stock Exchange houses abroad. That does not represent the last year. That is the aggregate of them. In the last year there was something maybe in the neighborhood of 20. Again the details have been given to you. There has been very substantial additional activity by these firms abroad. They have many more representatives abroad. The bank-. ing houses, the conirnercial bankers, have done the same thing. Additional branches have been opened. The first National City Bank, the Morgan Guaranty, Bank of America, have been extremely active in disseminating information and endeavoring to bring deposits into this country rather than to have the flow of moneys go out. On the New York Stock Exchange, recommendations were made that they encourage listing abroad. There have been some 20-odd companies that have listed their securities either in Luxembourg on the Paris Bourse, on the Amsterdam Exchange, or on the London Exchange, and I have given you those. The Kaiser Co. is one. Three M is another. General Motors has had some additional listing as had Ford, and the details have been furnished you. On investment tri~sts, recommendations have been made in that area and there have been very substantial activities on the part of investment trusts to sell their shares abroad. Certain of them have issued bearer deposit receipts to make the securities more salable in Europe. I would be glad to furnish you any additional information that the committee would like to have in this area. I have endeavored to be brief here to save the committee's time. On the question of the tax bill, I am not technically competent to go much further than I have, but if there are any questions that you would like to have me answer I will endeavor to do it or to provide you with the information. My associate, who is Peter Nitze, also of New York, is far more familiar in that area than I am. Thank you very much. Mr. ULLMAN. Mr. Eaton, you `have given some very helpful testimony. For the purpose of the record would you state the name of the gentlemen with you. Mr. EATON. Peter Nitze, N-i-t-z-e. We are both of New York City. 193 PAGENO="0204" 70 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT 1W TJ.8~ Mr. ULLMAN. Thank you very much. Insofar as the tax bill before us is concerned, as you have indicated, it goes further than your recommendations. Do you and the task force approve of the addi- tional items that are in the tax bill beyond- Mr. EATON. Never formally. We have not met formally on it, but I can say that both Mr. Meyer and I who were primarily responsi- ble for the tax activity of the committee do approve of it. Mr. TJLLMAN. Thank you, Mr. Eaton. Are there questions? Mr. BYRNES. I did want to compliment Mr. Eaton and the other members of the task force for the service they performed and the recommendations and the actions that were forthcoming as a result of it. I think they were very salutary and I do appreciate Mr. Eaton's coming to testify and to help us in this tax legislation. As I. understand it, you really only have a difference in one item, between what the task force recommended, and you still recommend, and what the Treasury proposes. That is in the area of the estate tax. Mr. EATON. That is correct. We have two or three technical points that I have commented on. I don't want to stress their unimportance. Mr. BYRNES. No. Mr. EATON. Because they are important. I also should add that there are other areas of changes that might be made in the tax structure that might also be helpful in encouraging foreign investment, but I have limited myself, and I intend to, solely to those that were covered by the task force report, I don't mean by so doing to indicate that there may not be other changes that wifi be recommended by others that might not also be helpful in the balance-of-payments problem. Mr. BYRNES. Are there any outstanding recommendations that the task force made with respect to changes in the tax law that are not included in the recommendations of the Treasury? Mr. EATON. No, other than the estate tax. Mr. BYRNES. And the other variations that you have are technical aspects that arise `out of the application of the specific legislative recommendations of the Treasury as contained in the bifi? Mr. EATON. That is correct. iMr. BYRNES. Rather than the principle involved necessarily. Mr. EATON. That is correct. Mr. BYRNES. Is that right? Mr. EATON. As always happens when a very technical statue is redrafted, it raises some other problems. As an example, under this bifi it would be quite possible for a foreign investment banking house to set up and trade in the United States and not pay any capital gains tax. This ought to be corrected because foreigners who do a security business here ought to be taxed. The Treasury is well aware of that and I am sure will correct it. Mr. BYRNES. Our technicians and the Treasury technicians have been apprised of the technical points that you have found that may be defective and this should have attention. Mr. EATON. That is correct. There are only two or three of them and I don't think they present a ~problem for either of us. Mr. BYRNES. Thank you very much. Mr. TJLLMAN. Thank you for appearing here. You have been very helpful. Mr. EATON. Thank you very much. 194 PAGENO="0205" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 71 (Letter, to Mr. Mifis from Mr. Meyer and Mr. Eaton follows:) NEW YORK, N.Y. June ~4, 1965. Re H.R. 5916: Fowler task force. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, U.S. House of Representatives, 1102 Longworth House Office Building, Washington, D.C. DEAR Ma. MILLS: The undersigned were members of the Task Force on Pro.. moting Increased Foreign Investment in U.S. Corporate Securities and were assigned the primary responsibility for the tax recommendations of the task force. We are submitting this letter in response to your announcement of June 18, 1965, inviting interested persons to submit statements on H.R. 5916. H.R. 5916 implements most of the substantive tax recommendations contained in the task force report and we urge strongly that this bill be given prompt and favorable consideration by your committee. There are, however, certain areas in which we believe the current text of H.R. ~5916 would fail to achieve the objectives of the task force. I. ESTATE TAX The bill would substantially reduce estate tax rates on estates of nonresident alien decedents. Although this rate reduction may help to increase foreign invest- ment in the United States, it falls considerably short of the task force recoinmenda- tion that all estate taxes on the intangible property of nonresident alien decedents he eliminated. The task force's recommendation reflects the strong opinion of its members that the severe deterrent effect of U.S. taxation of the estates of non- resident alien decedents cannot be eliminated merely by a reduction in rates. The problem is in very large part psychological resulting from the great reluctance of many potential foreign investors to subject themselves to possible liability for any type of capital levy imposed by another country or to the requirement of filing tax returns in another country. It is the opinion of the task force that the ability of the United States and foreign banks and ~ecurities firms to inform their-fareigi clients-that--the-purchase- of U.S. corporate securities would under no circumstances subject them to U.S. estate taxes or the requirement of filing a U.S. estate tax return would be an important stimulus to the sale of U.S. corporate securities to foreign investors. H.R. 5916 falis short of this goal. We have been advised that the aggregate of all U.S. estate taxes paid by foreigners on their U.S. property has been in the neighborhood of $3 million to $6 million annually; the proposed new rates undoubtedly would reduce this figure substantially. Thus, adoption of the task force recommendation would involve no large loss of revenue to the United. States. We would hope that you would not find this loss of revenue important, particularly in comparison with the very real stimulus to the sale of U.S. corporate securities to foreign investors which would result from adoption of this recommendation. II. FOREIGN UNDERWRITERS AND SECURITIES DEALERS We are enclosing a separate memorandum discussing, in some detail, certain problems arising under the provisions of H.R. 5916 relating to the taxation of securities profits of resident foreign corporations and the effect of discretionary authority given to a U.S. agent in connection with securities and commodities trading activity. One of the problems set forth in the enclosed memorandum is of vital importance to ~the entire program of promoting increased foreign investment in U.S. crporate securities. Increasingly, U.S. investment banking houses, in response to the recommendations of the task force and to President Johnson's appeal, have included foreign banks and securities firms in underwriting syndicates and selling groups formed to distribute U.S. equity securities. As a result of this trend more than $75 million of such securities have been sold to foreign investors in recent months. (A report furnished to your committee by Ambassador Robert M. McKinney, executive officer of the task force, will further document this trend.) The task force had made the following recommendation: "Clarify the definitions of engaging in trade or business to make it clear: (i) that a nonresident alien individual or foreign corporation investing in the United 195 PAGENO="0206" 72 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. States will not be deemed engaged in trade or business because of activity in an investment account or by granting a discretionary investment power to a U.S. banker, broker, or adviser; * * In an effort to implement this recommendation H.R. 5916 would amend section 871 (c) to read, in relevant part, as follows: "(c) ENGAGED IN TRADE OR B~USINESs DEFINED._* * * the term `engaged in trade or business within the United States' * * * does no include- * * * * * * * "(2) TRADING IN SECURITIES OR COMMODITIES.- "(A) SEcv~x~IEs.-Trading in stocks or securities for one's own EccOUnt, whether transactions are effected directly, or by way of an 4lgent, through a resident broker, commission agent, custodian, or other independent agent, and, except where the person so trading is a dealer in securities, whether or not any such agent has discretionary authority to make decisions in effecting such transactions." In our opinion the proposed amendment easily can be interpreted as implying that a dealer in securities will be deemed to be engaged in trade or business in the United States if any discretion is granted by such dealer to a U.S. agent. The usual forms of agreement among underwriters employed by U.S. investment banking firms contain provisions whereby the members of the underwriting group grant to the managing underwriter the power, in his discretion, to sell certain of the securities being underwritten to institutions and dealers on behalf of the members of the syndicate, to engage in stabilizing transactions, and to take. certain other actions which may result in the realization of a profit by all members of the group. If foreign banks and securities firms believed that par- ticipating in a U.S.-managed underwriting syndicate might result in such foreign firms being deemed to be engaged in trade or business in the United States, the present trend of increasing distribution of underwritten securities to foreign investors probably would be reversed. It is clear that it is not the intent of H.R. 5916 to create an obstacle to the sale of securities to foreign investors. Accordingly, we recommend that through regulation, published ruling, statement in the committee report, or such other manner as may be deemed appropriate, the above described inference that can be drawn from the propos.ed amendment to IRC section 871 (c) be clearly eliminated. Very truly yours. ANDRE MEYER. FREDERICK M. EATON. JUNE 24, 1965. Memorandum to: Hon. Wilbur D. Mills, Chairman, Committee on Ways and Means, U.S. House of Representatives, 1102 Longworth House Office Building, Washington, D.C. Subject: H.R. 5916. Review of H. R. 5916 has revealed certain situations in which the provisions of the bill would lead to results which appear inconsistent with the intent of the bill. 1. Discretionary authority given to a U.S. agent in connection with securities and commodities trading activity H.R. 5916 is designed to increase foreign investment in the United States. One of the principal methods for achieving such an increase is the stimulation of a more widespread distribution of securities of U.S. issuers among foreign investors. In order to effect such distribution it is important that foreign banks and securities firms be included in underwriting groups having U.S. managers. As was recog- nized by the task force in its recommendation No. 6: "U.S: investment bankers should include foreign banks and securities firms as underwriters, whenever possible, or as selling group members in new offerings and secondary distributions of either domestic or foreign securities." One of the principal obstacles to the inclusion of foreign banks and firms in such underwriting groups was eliminated when the Securities and Exchange Commis- sion adopted task force recommendation No. 5 that: "The Securities and Exchange Commission should issue a release eliminating the requirement that foreign underwriters participating exclusively in distribu- tions of securities to nonresidents of the U.S. register as broker-dealers." (See SEC Releases No. 33-4708 and No. 34-7366, July 9, 1964, 29 F.R. 9828.) 196 PAGENO="0207" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 73 However, another of the obstacles to the inclusion of foreign banks and firms in such underwriting groups lies in the tax field. Rather than eliminating this obstacle, the current provision of H.R. 5916 would make it more acute. In many underwriting groups the syndicate manager reserves the right to sell certain of the securities being underwritten to institutions and dealers on behalf of the members of the syndicate, to engage in stabilizing transactions, and to take certain other actions which may result in the realization of a profit by all members of the group. There is considerable risk that in taking such actions the syndicate manager may be regarded as the agent of all of the other members of the group. Under section 3 of the bill the definition of "engaged in trade or business within the United States" appearing in IRC section 871(c) would be amended to provide that nonresident alien investors who are not dealers in securities or commodities could grant discretionary authority to a U.S. agent or broker without thereby being deemed to he engaged in trade or business within the United States. The clear implication of this provision in its current form is that a dealer in securities or commodities will be deemed to be engaged in trade or business in the United States if any discretion is granted to a U.S. agent. Thus, the risks to a foreign bank or securities firm of participating in a U.S.-managed underwriting group would become acute. The current text of these proposals raises certain other problems. Under the proposed amendments, any foreign bank,1 securities firm or commodities firm granting discretionary power to a U.S. agent or securities or commodities broker would be regarded as engaged in trade or business here. This would be true even if the discretionary authority was in fact granted on behalf of individual or corporate clients of the foreign bank or firm, or if the discretionary authority was granted with respect to the investment account of the bank or firm. In view of the fact that a very substantial portion of the securities and com- modities business received from nonresident alien individuals and foreign corpora- tions is effected through foreign banks and dealers, it appears that the current text of the proposals would, in many cases, fail to have the intended effect and might, in fact, have an adverse effect on our balance of payments. As is recognized in the Treasury press release accompanying H.R. 5916, the granting of a discretionary power of investment "does not really bear a relation to the foreigner's ability to carry out transactions in the United States-the discretionary power is merely a more efficient method of operating rather than having the investor consulted on every investment decision and frequently is merely a safeguard to protect him in case of world turmoil." The above considerations appear applicable in cases where a foreign bank or securities firm is operating its own investment account or acting on behalf of its customers as well as in cases of a direct grant of authority from a nonresident alien individual to a U.S. broker. While it is equitable that a foreign bank or firm should not be permitted to operate a regular business in the United States as a securities or commodities dealer without being deemed to be engaged in trade or business here, the bill could be amended to take care of this situation without creating the problems referred to above. It is suggested that the proposed amendments to IRO section 871(c)(2) be altered to read as follows: "(2) TRADING IN SECURITIES OR COMMODITIES.- (A) SEcuRITIES.-Trading in stock or securities whether transaotions are effected directly, or by way of an agent, through a resident broker, com- mission agent, custodian, or other independent agent, and (except where such stocks or securities are held by the taxpayer primarily for sale to cus- tomers in the United States in the ordinary course of its trade or business) whether or not any such agent has discretionary authority to make decisions in effecting such transactions, or (B) COMMODITIES-Trading in commodities whether transactions are effected directly, or by way of agent, through a resident broker, commission agent, custodian, or other independent agent, and (except where such com- modities are held by the taxpayer primarily, for sale to customers in the United States in the ordinary course of its trade or business) wheiher or not any such agent has discretionary authority to make decisions iii effecting such transactions, if such commodities are of a kind customarily dealt in on an organized commodity exchange and if the transaction is of a kind cus- tomarily consummated at such place." 1 Contrary to U.S. practice most foreign banks are "dealers" in securities. 197 PAGENO="0208" 74 REMOVE~TAX BARRIERS TO FOREIGN INVESTMENT IN ILS. * In addition, it should be made clear by regulation or published ruling that a foreign dealer or underwriter would not be deemed to be engaged in trade or business hereby reason of participation in an underwriting group having a U.S. manager. 2. Taxation of securities profits of resident foreign corporations Under section 4 of the bill a resident foreign corporation would be taxed at ordinary rates on its business income from U.S. sources and at a flat 30-percent rate on its nonbusiness income from U.S. sources. Business income and nonbusiness income are defined as follows in the proposed amendments to IRO section 882: "(3) BusiNEss INCOME DEFINED.-Ifl the case of a foreign corporation business income includes all income derived from sources within the United States other than the income described in paragraph (4), except that business income shall not include gain from the sale or exchange of stock in a corporation. "(4) NONBUSINESS INCOME DEFINED.-Ifl the case of a foreign corporation. nonbusiness income shall consist of dividends and amounts described in section 631 (b) and (c) which are considered to be gains from the sale or exchange of capital assets." Under these definitions gains realized by a foreign corporation from the sale of corporate stock would be excluded from both business and nonbusiness income and, therefore, totally exempt from U.S. tax. In mcst cases this exclusion will serve the basic purpose of H. R. 5916. How- ever, under the bill as currently drafted, it would be possible for U.S. persons to finance and operate a securities dealer business in the United States through the medium of a resident foreign corporation and thereby accumulate profits from trading in corporate stock substantially free of tax at the corporate. level. If the corporation were a "regular dealer in stock or securities," its income from sales of corporate stock would not be "foreign personal holding company income" or "Subpart F income" and the shareholders would be subject to tax only on amounts actually distributed to them by the corporation (see IRC sees. 543 (a) (2), 952, 954). Therefore, a substantial tax benefit might be accorded to persons making no contribution to an improvement of the U.S. balance of payments. This apparently unintended result could be eliminated by amending the definition of business income to read as follows: "(3) BusiNEss INCOME DEFINED.-In the case of a foreign corporation business income includes all income derived from sources within the United States other than income described in paragraph (4), except that business income shall include net gains from the sale or exchange of stock in corporations only if such stock is held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business." Mr. TJLLMAN. We have two additional witnesses. Unfortunately, we have to adjourn for the day. Mr. Anderson, will it be possible for you to come back tomorrow? Mr. ANDERSON. Yes, sir. Mr. ULLMAN. Tomorrow morning at 10 o'clock. And Mr. Waris? Mr. WARIS. Yes. Mr. ULLMAN. We will expect you back here then in this committee room at 10 a.m., and the committee is adjourned until 10 o'clock tomorrow morrnng. (Whereupon, at 12:47 p.m., the committee recessed to reconvene at 10 a.m., Thursday, July 1, 1965.) 198 PAGENO="0209" REMOVAL OF TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES THURSDAY, JI7LY 1, 1965 HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, Washington, D.C. The committee met at 10 a.m., pursuant to recess, in the committee room, Longworth House Office Building, Hon. W. Pat Jennings, pre-~ siding. Mr. JENNINGS. The committee will come to order. Yesterday when the hearing was suspended the next witness was Mr. Paul Anderson, who wants to appear in behalf of the American Life Insurance Co. and the United States Life Insurance Co. in the city of New York in reference to H.R. 5916. Is Mr. Anderson present? If you will come forward, Mr. Ander-~ son, we will be glad to hear from you at this time. If you will intro- duce yourself, Mr. Anderson and give your name to the reporter and the gentleman who is accompanying you, you may proceed. STATEMENT OF PAUL M. ANDERSON, AMERICAN LIFE INSUR- ANCE CO. AND THE UNITED STATES LIFE INSURANCE CO. IN THE CITY OF NEW YORK; ACCOMPANIED BY SAUL LESSER, ASSOCIATE GENERAL COUNSEL, UNITED STATES LIFE INSUR.~ ANCE CO. Mr. ANDERSON. Thank you, Mr. Chairman. Mr. Chairman and members of the committee, my name is Paul M. Anderson. I am a resident of New York City and a director of the American Life Insur-~ ante Co. of Wilmington, Del., and of the United States Life Insurance Co. in the city of New York. I have been engaged in all aspects of the life insurance business with the exception of actuarial science for 40 years, 17 of which were spent abroad in the service of large life insurance companies which were substantially interested in the foreign market. I am speaking on behalf of the American Life Insurance Co. and the United States Life Insurance Co. in the city of New York, pro~ posing exemption for interest and earnings paid under life insurance contracts to nonresident aliens not doing business in the United States. The Life Insurance Association of America and the American Life Convention Associations who represent the bulk of the life insurance companies in the United States, have submitted for the record a~ statement proposing the same amendment to the bifi as we are pro.~ posing. 75 7 1-297 O-67-pt. 1-14 199 PAGENO="0210" 76 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. I submitted to you a statement which I am about to read. Under the present law, exemption from income tax and withholding is accorded interest on bank deposits paid to nonresident aliens not engaged in business in the United States. IRC, section 861(a) (1) (A). H.R. 5916 would extend that exemp- tion to all deposits in savings and loan associations. }II.R. 5916, section 2(a), page 2, lines 4-2 1, amending section 861 (a)(1). It is urged that H.R. 5916 be further amended to accord similar exemption from withholding tax to the interest or earnings element paid to non- resident aliens under life insurance company contracts, for the reason that to do so will (a) improve the U.S. balance-of-payments position by permitting U.S. life insurance companies to write nonresident alien business now barred to them competitively by the present with- holding tax handicap, (b) increase the taxable income of U.S. life insurance companies, and (c) as a matter of fairness and equity, give purchases of U.S. life insurance company contracts the same treat- ment as that afforded now to purchasers of bank certificates of deposit, and as proposed with Treasury backing, to be given purchas- ers of certificates of mutual savings and loan associations. This amendment can be effected by further amending section 861 (a)(1) IRC (relating to interest from sources within the United States) by adding thereto the following subparagraph (at p. 2, line 21 of H.R. 5916): "(E) interest and earnings paid pursuant to policies or contracts issued by life insurance companies." It is respectfully submitted that the* time is long overdue to give life insurance companies equal treatment with banks by extending to them the same exemption from withholding tax which persons carrying on the banking business have enjoyed since the Revenue Act of 1921. That the matter may not have been rais~d in the past four decades is probably due to the fact that U.S. life insurance companies have only in recent years been concerned with sales in the nonresident alien market, especially in less developed countries without double taxation treaties with the United States. That situation has changed. An increasing number of American life insurance companies are now seeking such business. The success of their efforts is obviously. beneficial to the United States in its present balance-of-payments squeeze. The requirement of withholding on annuity contracts has for decades kept American life insurance companies from competing for annuity business in the nonresident alien market except where treaty exemptions applied. For this reason, U.S. employers operating in nontreaty territories; for example, most of Latin America, have had to pay our substantial premiums to foreign insurance companies to fund U.S. dollar pension plans for their alien employees. Very recently, this competitive handicap has been compounded by Revenue Ruling 64-5 1, IRB 1964-6, 11 which requires withholding on the gain derived from life insurance surrenders and endowment maturities. In effect, U.S. life insurance companies are now non-competitive in the nonresident alien market in all customary lines of life insurance except term insurance. 200 PAGENO="0211" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 77 We have made a careful check of the position of foreign companies -who represent our principal competition in the Western Hemisphere. By all odds the severest competition comes from the Canadian companies and we are definitely advised that these companies do not withhold on the gain realized on the surrender of life insurance policies, on the maturity of endowment policies, or on annuity payments and periodic payments of policy proceeds. The Canadians do withhold on interest-at the rate of 15 percent as Lagainst 30 percent for U.S. companies-when policy proceeds are left on deposit with the company and they do withhold at the 15 percent rate on gains when annuity contracts are surrendered prior to maturity. These two exceptions both represent very unusual situations and even in the area of these exceptions the rate of withholding is one-half that applicable to American companies. The point is that in the typical and usual situation there is no withholding and the competitive advantage of the Canadian companies is complete. Neither the British nor Swiss companies withhold on ordinary life insurance proceeds paid on surrenders and endowment maturities. They do withhold on annuity income. The business we are talking about is U.S. source business on which, typically, the policy is issued in the United States and the premium is paid out of dollar funds. The insureds are nonresident aliens or foreign corporations not doing business in the United States, with U.S. funds at their disposal. In the case of group pension annuities the insureds may be U.S. corporations wishing to fund in U.S. dollars plans for their alien employer. * Under the present law, bank deposits are the only tax-free invest- ment available to such aliens and foreign corporations with dollar funds in hand. Surely it makes sense to give them the alternative investment of U.S. life insurance policies and annuities which earn interest and which also afford insurance protection. From the point of view of dollar conservation, the alien with dollars who wants insurance today will buy it from non-U.S. companies, and in so doing drain the dollars out of the United States. Futhermore, the amendment we propose can only help, not hurt, the tax revenue position. Especially since the 1964 revenue ruling, U.S. life insurers are effectively barred in most cases from this non- resident alien market, since they cannot meet foreign competition. The amendment would open up this market to our domestic insurers and thereby increase their taxable revenue income. It is difficult to estimate what the premium volume might be on this `alien business if U.S. life insurance companies could compete for it on equal terms with Canadian and other foreign companies. Because of the present withholding handicap, the premium volume of the U.S. companies is small, and since the 1964 revenue ruling, may be expected to decline in the future. * The relevant premium figures of the Canadian companies are not available to us, but we believe their volume on this business to be `substantial. We also believe that if the U.S. companies could compete for this business on an equal footing they would realize many millions of dollars of additional premiums which now go to non-U.S. companies. It may be argued that to extend the exemption to life insurance -companies necessarily opens the door to a further extension to mutual 201 PAGENO="0212" 78 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. funds and corporate securities generally. We do not believe that any such logical imperative exists. Banks and insurance companies should be treated alike. Both are financial institutions which pay out earnings on other people's money committed to their charge. It is otherwise with typical corporate securities issued by commercial and industrial com-~ panies which are not in the business of money management. The line has to be drawn somewhere. Canadian, British and Swiss companies have drawn the line to exempt life insurance proceeds from withholding tax. There is no logical reason why we should not do. the same. There are two points to be made. First, as a matter of equity the earnings on life insurance policies should, in principle, be as free- from withholding on earnings as bank deposits, or as proposed with Treasury support, the certificates of mutual savings and loan asso- ciations. Secondly, with regard to our balance-of-payments crisis, foreigners. with access to U.S. dollars should be encouraged to invest in U.S. life insurance policies, if life insurance is what they want. Mr. Chairman, I wish to apologize. I failed to introduce my associate, Mr. Saul Lesser, associate general counsel of the United. States Life Insurance Co. Mr. JENNINGS. Fine, Mr. Anderson. Do you have anything to add to the statement that was just given by Mr. Anderson? Mr. LESSER. No, I do not. Mr. JENNINGS. Mr. Anderson, I noticed the proposed amendment. on page 2 which reads: "Interest and earnings paid pursuant to policies. or contracts issued by life insurance companies." Are you thinking of existing contracts? As I envision this if this amendment were added to the bill you might extend insurance contracts to cover most any type of operation other than just the contractual relation between an insured and the insurance company. Mr. ANDERSON. We had not thought of anything except the contractual relation. I am not particularly insistent that this be. the exact wording. It is more to convey the sense of what we meant,. sir. Mr. JENNINGS. You see the point. Mr. ANDERSON. Yes, sir. Mr. JENNINGS. If there were contracts by life insurance companies as broad as this amendment is you could extend most any type of contract. You could even get into the savings and loan business~ You could get into the banking business. You could have a contract and have a company say, "Deposit so much with us. We will pay interest on it. That interest will be nontaxable." As broad as this is I think you could put in most anything.. Mr. ANDERSON. Most of those conditions that you are mentioning: we are precluded from engaging in by the regulatory authorities~ We are limited to life insurance contracts with insurecis or the bene-~ ficiaries of insureds. Mr. JENNINGS. Are there other questions, Mr. Byrnes?: 202 PAGENO="0213" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN u.s. 7t) Mr. BYRNES. Mr. Anderson, how are these funds treated under the ~app1icable tax treaties? Are they exempt or not? Mr. ANDERSON. I would like Mr. Lesser to answer that question, :Sfl'. Mr. LESSER. Under most of the treaties the interest and annuity income is exempt by treaty. However, the treaties do not cover the situation which is the subject of revenue ruling 64-51 which taxes the gain on surrenders of insurance or maturities. For example, we had a situation with a nonresident alien residing in France whose policy matures after 30 years with a very small gain and the treaty did not cover such a situation and we had to withhold .30 percent on the gain. `We asked for a ruling from the Internal Revenue to equate such a ;gain on maturity with annuity or income or interest under the treaty and we were advised that it is not the same and it is subject to with- holding, so this type of gain is not covered under existing treaties. Also much of this business which Mr. Anderson is talking about comes from nontreaty countries, particularly in Latin America. Mr. BYRNES. You mentioned that. That is why I am asking whether these earnings are exempt under t~i~ies we have with the industrial countries. Are the earnings exempt under these treaties? Mr; LESSER. Not completely. The annuity income may be exempt. Mr. BYRNES. Let me understand what you mean by not completely. Mr. LESSER. As I thought I explained, annuity income is usually exempt by treaty. Interest on deposits is usually exempt by treaty, but the gain that a policyholder realizes when a policy matures or is surrendered is not covered under existing treaties. Mr. BYRNES. I understand. Have you discussed this matter with the Treasury Department, particularly as it relates to the balance-of- payments problem and the policy to encourage greater foreign invest- ment in the United States? Mr. LESSER. Yes, sir. We met with the staff of the Treasury and we submitted our proposal and we explained our position at length, and we received acknowledgment from Mr. Surrey that it would be given careful consideration, but we have had no further word from .the Treasury. Mr. BYRNES. How long ago was it? Mr. LESSER. I would say approximately a month ago. Mr. BYRNES. In other words, it was subsequent to the submission to this committee and the Congress of a draft proposal by the Treasury .Department? Mr. LESSER. It was subsequent to that date; yes, sir. Mr. BYRNES. Because that was sometimG in March. Mr. LESSER. Yes. Mr. BYRNES. Thank you very much. Mr. KARSTEN (presiding). Are there further questions? If not, we thank you very much, Mr. Anderson, for your appear- ance. We appreciate the information you have given us. Mr. ANDERSON. Thank you, sir. Mr. KARSTEN. Our next witness is Michael Waris. Mr. Waris. 203 PAGENO="0214" 80 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. STATEMENT OF MICHAEL WARIS, JR., BAKER, McKENZIE & HIGHTOWER, WASHINGTON, D.C.; ACCOMPANIED BY PETER. L. BRIGER. Mr. WARTs. Mr. Chairman and members of the committee, my name is Michael Waris, Jr., and. appearing with me today is Peter L. Briger. We are both of the law firm of Baker, McKenzie & High- tower and are appearing on its behalf. We have previously ified with the committee a more formal state-~ ment which I believe you have before you. We would like that made- a part of the record. Mr. KARSTE~N. Without objection it will be made a part of ther record. (The statement referred to follows:) STATEMENT SUBMITTED BY IRA T. WENDER, MICHAEL WARIS, JR., AND PETER L. BRIGER, OF BAKER, MCKENZIE & HIGHTOWER, RELATING TO H.R. 5916 I. INTRODUCTION A. H.R. 5916 is designed to stimulate foreign investment in this country as a means of improving our balance of payments. (In this regard we find the legis- lation beneficial for the country and practicable.) B. Secondarily, H. R. 5916 is designed to make the taxation of foreigners more uniform and consistent. C. In this connection, itcontains a proposed amendment which would- (1) Eliminate the intercorporate dividends received deduction in the case of all resident foreign corporations; and (2) Exempt such corporations on capital gains realized on U.S. stock investments. II. DISCUSSION A. The purposes of the proposed amendment are as follows: 1. To eliminate the intercorporate dividends received credit for resident foreign corporations that are essentially passive holding or investment companies; and 2. To segregate business income from investment income. B. The proposed amendment goes beyond its stated purposes: 1. Because of its generalized applicability, the proposed amendment wouldl deny the intercorporate dividends received deduction to foreign corporations engaged in active, substantial business in the United States; and 2. Dividend income received by foreign corporations from affiliated domeS-- tic subsidiaries is, in essence, business income. B. The result of such a broad legislative approach would be an unwarranted~ disruption and elimination of a traditional and legitimate means which foreign. corporations have used to conduct business in the United States. C. The effect of the proposed amendment might also be to discourage existing and potential long-term investment in this country by foreign corporations. III. RECOMMENDATIONS Foreign corporations that are actively engaged in business in the United States and that have made substantial, permanent type investments in domestic cor- porationS (at least a 10-percent-equity interest) should be permitted to elect either: (1) The treatment provided under existing law for resident foreign cor-- porations (the availability of the intercorporate dividends received deduction, but a tax on capital gains realized in connection wit-h U.S. stock investments);: or (2) The tax treatment provided in the proposed amendment (no intercor- porate dividends received deduction, but exemption from tax on capital gains~ on U.S. stock investments). 204 PAGENO="0215" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 81 I. INTRODUCTION The purpose of this memorandum is to express our views upon one particular aspect of the proposed legislation contained in H.R. 5916. Before doing that, we would like to indicate that we believe the basic legislation contained therein to be good for the country and practicable from an operational and administrative standpoint. Therefore, in general, we are in favor of the bill. However, there s one specific portion thereof which we believe runs counter to the fundamental purpose of the bill and would cause unwarranted disruption of traditional, legi- timate business patterns. The particular provision to which we refer is a proposed amendment to section 882 of the Internal Revenue Code of 1954 and is contained in section 4(b) of H. R. 5916. The proposed amendment would (1) eliminate the the intercorporate dividends received deduction in the case of all resident foreign corporations and (2) exempt such corporations from tax on capital gains realized in connection with their U.S. stock investments. Dividends received would thus become subject to the 30-percent statutory withholding rate or any lesser treaty rate applicable to such income, rather than the previous 7.2-percent maximum rate of tax thereon. Essentially, the proposed amendment presents the following three problems: (1) it applies to a much wider class of taxpayers than is necessary to curb the specific abuse which led to its proposal; (2) it would, in its present form, disrupt arid foreclose a traditional and legitimate means that a number of foreign corporations have historically used to conduct business in this country; and (3) unless modified, it might very well have the effect of. discouraging existing and potential long-term investment here by large foreign corporations despite the fact that the avowed purpose of H. R. 5916 is to stimulate and foster foreign investment in the United States as part of a pro- gram to improve our balance of payments. II. DISCUSSION A. The purpose of the proposed amendment The purpose of the proposed amendment, as indicated in the Treasury release dated March 8, 1965, accompanying H.R. 5916, would appear to be twofold. (1) First of all, the amendment is designed to curb a rather narrow and limited abuse which occurs when certain foreign corporations, that are essentially passive investment or holding companies, engage in trade or business in the United States in some minor way (such as through the ownership of several parcels of real estate) and thereby qualify for the 85-percent intercorporate dividends received deduc- tion with respect to their U.S. stock investments. The proposed amendment, however, goes far beyond this stated purpose. Because of its generalized ap-- plicability, the amendment would deny the intercorporate dividends received deduction even to foreign corporations which are actively engaged in substantial, active business operations in this country. (2) In the second place, the pro- posed amendment is designed to segregate business income from investment in- come in connection with the taxation of foreign persons. The proposed amend- ment is defective in this respect, for in the case of a number of foreign corporations it would classify as investment income ~what is, in essence, business income. This occurs because the proposed amendment fails to treat as business income the dividends received by a resident foreign corporation from affiliated domestic subsidiaries. A foreign corporation which conducts business here through a branch may also, for a variety of reasons, engage in one or more additional busi- nesses in this country through ownership of affiliated domestic subsidiaries. The dividend income received from such affiliated companies is actually business income. B. The result of such a broad legislative approach would be to foreclose to resident foreign corporations a traditional and legitimate means of conducting business in this country While this statement is not being made on behalf of any particular foreign cor- poration, it appears to us on the basis of our own experience that there are a number of concerns that (1) would be adversely affected by the proposed amendment as presently drafted and (2) would have to alter substantially the nature of their operations in this country as a result of the loss of the intercorporate dividend deduction. It is true that, for the most part, foreign corporations conducting business in the United States will do so through a domestic subsidiary in order to avoid complicated problems of allocation of income. However, there is a large number of foreign corporations which, for historical or other reasons, conduct 205 PAGENO="0216" 82 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. substantial active businesses here through branches. Foreign banks are one example of the type of foreign corporation that would be adversely affected by the proposed amendment. Generally, banks in their foreign operations prefer to conduct business through. *a branch, rather than through a subsidiary, in order to have the benefit of their "home office" reserves or deposits. In New York alone, there are about a dozen ~foreign banks that conduct operations through branch offices. A number of such banks have wholly owned domestic subsidiaries which engage in businesses that the parent is not permitted to engage in directly. Thus, a number of foreign banks have wholly owned domestic subsidiaries that conduct a fiduciary business or a safe deposit business. There are undoubtedly a number of other legitimate business reasons which require foreign corporations to conduct their business operations in the United States in branch form rather than through domestic subsidiaries. For example, a foreign corporation might not be permitted to assign certain assets (such as a license, franchise, or trademark) needed in the conduct of a particular business in this country. Or it may be that charter provisions or debt restrictions prevent a foreign corporation from transferring assets to a U.S. subsidiary or from con- ducting particular activities through a U.S. subsidiary. Aside from the banking fields, there are other areas where the proposed amend- ment would work undue hardship. At least one of the large Japanese trading companies has several branch offices in the United States. These branch offices generate annual sales of between $300 and $400 million. This Japanese trading company has also acquired a majority stock interest in at least one U.S. operating subsidiary. Perhaps the widest use by foreign corporations of branch offices, together with affiliated domestic subsidiaries, as a means of conducting business ~ii this country occurs in the insurance field. It is interesting to note that foreign insurance companies which conduct an insurance business here through branch offices are not affected by the proposed amendment. The reason that their right to the intercorporate dividend deduction was not disturbed is probably because of the Treasury's recognition of the wide use made of this type of operation in the insurance industry. (It is likely, however, that there are situations where foreign insurance companies do, through branch operations, engage in other types of business in this country, such as the management of domestic subsidiaries which conduct an insurance or other business. Such foreign insurance companies would be adversely affected by the proposed amendment.) The issue certainly is not a hypothetical matter, for the above-described situ- ations represent specific, concrete examples of foreign corporations which conduct business here in branch form and which would be hurt by the proposed amend- ment although they do not fit within the specific rationale underlying the amend- ment. To deprive foreign corporations, which conduct business through this type of structure, of the intercorporate dividends received deduction would cause severe dislocation of legitimate, long-standing business operations in this country by foreign corporations. C'. The effect of the proposed amendment might also be to discourage existing and potential investment in this country by foreign corporations with branch offices here Although the amendments to sections 881 and 882 proposed by the Treasury `would in general appear to stimulate investment in U.S. securities (especially by foreign individuals and probably to a lesser extent by foreign corporations) as a result of the elimination of any tax on capital gain realized upon U.S. stock investments,' the amendment might very well have the additional effect of discouraging existing and potential long-term investment in this country by a number of large foreign corporations which conduct substantial, active businesses here through branch operations and through domestic subsidiaries. This result appears unwarranted and unintended in view of the fact that (1) the manifest purpose of H. R. 5916 is to stimulate foreign investment in the United States and (2) this type of operation involves no abuse or element of tax avoidance. III. RECOMMENDATIONS It is our belief that dividends received by foreign corporations from U.S. su1~sidiaries in which they have made significant and permanent-type investments lIt is a well-known fact that the yield on U.S. stocks is generally lower than on foreign stocks, but that the appreciation factor on U.S. stocks Is often attractive to foreign Investors. 206 PAGENO="0217" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN u.s. 83 should be regarded as business income. In view of the fact that a 10-percent stock interest has been recently used as an indicia of significant control (cf. seo. 951 and sec. 4915 of the Internal Revenue Code of 1954), perhaps a 10-percent equity ownership test would provide a suitable yardstick for determining whether dividend income qualifies as business income. Over the years, Congress has consistently taken great pains to provide excep- tions and savings clauses in tax legislation in order to avoid inequity and unin- tended hardship that may occur in connection with the adoption of a new general rule. We submit that the instant situation needs such distinguishing treatment. The abuse that the Treasury is concerned with is the cloaking of what is essentially an investment operation with a thin veneer of operating activity. If it is that type of avoidance which the Treasury is interested in preventing, the result could be accomplished, without discouraging foreign investment of a permanent type in this country and without dislocating existing foreign business structures, through the application of some type of "active business" test. The "active business" tests set forth in the regulations under section 954 (Treas. Regs. sec. 1.954-2(d) (1) (i) (ii) and (iii)) or section 355 (Treas. Regs. sec. 1.355-1 (c)) would seem to provide pertinent guidelines that could be utilized in connection with the proposed amendment. Jnouropinionthe underlying purppse of H.R. 5916 and the elimination of the specific abuse about which the Treasury is concerned can be ~ by extending to those foreign operations, that satisfy an "active business" test and a "permanent investment" requirement, the option to elect either (1) the tax treatment provided in the proposed amendment (no intercorporate dividends received deduction, but an exemption from tax on capital gains on U.S. stock investments) or (2) the tax treatment provided for resident foreign corporations under the existing provisions of the law (the avalability of the intercorporate dividends received deduction, but a tax on capital gains realized in connection with U.S. stock investments). Mr. WARIS. Thank you. I would like then today to proceed on the basis of a less formal statement which I believe you also have - - - before you. Mr. KARSTEN. We will be pleased to hear you. Mr. WARm. We would first like to state that we wholeheartedly support the general objectives of H.R. 5916. The aim of this legis- lation, to promote increased investment by foreigners in stock of U.S. corporations by removing existing tax barriers, is a highly desirable one at the present time. The bill is all the more praise- worthy because of its positive character. Our purpose here today is to comment on one specific provision in the bill which has an effect directly opposite to the bill's important basic objective. This provision would tend to discourage significant direct investment by foreign corporations in U.S. operating subsidi- aries and to disrupt legitimate patterns that foreign corporations have traditionally employed in connection with their conduct of business in this country. The particular provision to which we refer is the proposed amend- ment to section 882 of the Internal Revenue Code of 1954 and is contained in section 4(b) of H.R. 5916. This amendment would (1) eliminate the 85-percent intercorporate dividends received deduction in the case of all resident foreign corpora- tions, and (2) exempt such corporations from tax on capital gains realized on their U.S. stock investments. The proposed amendment would have the effect of sub)ecting dividends received by resident foreign corporations to the 30-percent statutory withholding rate or any lesser, treaty rate applicable to such income, rather than the previous 7.2-percent maximum rate of tax. Essentially., what we are concerned about is the mandatory appli- cation of the proposed amendment to foreign corporations which 207 PAGENO="0218" 84 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. conduct active substantial businesses in this country, both through a branch operation as well as through direct investments in U.S. operating companies. Although the proposed amendment might tend to stimulate some.~ what the purchase of U.S. stocks by foreign corporations seeking to earn capital gains in connection with trading activities, on the other hand, the amendment would also tend to discourage long-term direct investment in domestic operating companies by other foreign corpora- tions. To us this result appears unwarranted and, indeed, perhaps un- intended in view of the basic purpose of the bill (namely to stimulate foreign investment in this country), and in view of the two specific reasons advanced by the Treasury in support of the proposed amend- ment. To understand some of Treasury's reasons for this proposal and the objections which we have to it, it is helpful to refer to the Treas- ury's explanation of the provision which is dated March 8, 1965, and which accompanied the bifi when it was sent to the Congress. I quote now the Treasury explanation. There is one abuse in this area which should be eliminated. Frequently, a foreign corporation with stock investments in the United States engages in trade or business here in some minor way (such as by ~owning a few parcels of real estate) and then claims the 85-percent dividends received deduction on its stock investments in the United States. Such a corporation thereby may pay far less than the 30-percent statutory or treaty withholding rate on its U.S. dividend income, although its position is essentially the same as that of a foreign corporation doing business elsewhere which has U.S. investment income. To eliminate this abuse and treat all foreign corporations with investments in U.S. stocks alike, the 85-percent dividends received deduction should be denied to foreign corporations doing business here. We have no quarrel with Treasury's desire to curb this type of abuse. On the other hand, we do object to the remedy which the Treasury proposes. Essentially, the proposed amendment presents the follow- ing three problems: (1) it applies to a much wider class of taxpayers than is necessary to curb the specific abuse which led to its proposal; (2) it would, in its present form, disrupt a traditional and legitimate means that a number of foreign corporations have historically used to conduct business in this country; and (3) unless modified, it might very well have the effect of discouraging existing and potential long-term investment here by large foreign corporations despite the fact that the avowed purpose of H.R. 5916 is to stimulate and foster foreign invest- ment in the United States as part of our program to improve our balance of payments. Why, particularly in the context of H.It. 5916 should a foreign cor- poration which is actively engaged in substantial business here be treated less favorably than a domestic corporation with respect to dividends received from U.S. operating affiliates? The theory of the 85-percent, dividends-received deduction is to relieve income which has already been subjected to a full layer of U.S. corporate income tax from another large tax at the corporate level. There appears to be no good reason for failing to apply this theory to dividends received from domestic operating subsidiaries by a foreign corporation actively engaged in business in this country. 208 PAGENO="0219" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT fl~ u.s. 85 * Certainly, changing this long-established rule at this time will not have the effect of encouraging such foreign corporations to increase their investments in the stock of T5.S. corporations. The second purpose of the proposed amendment, as indicated by the Treasury, is to segregate the investment income of foreign persons from their active business income in order to subject such investment income to uniform U.S. tax treatment. Here again, the provisions of the bill in their present form fail to accomphish their aim in some cases and for essentially the same reason-they are too broad in their scope, automatically classifying all dividend income as passive investment income. In the case of many foreign corporations what is classified as invest- ment income under the bill is in essence business income. This occurs because the proposed amendment fails to treat as business income the dividends received by a resident foreign corporation from domestic corporations in which they have made direct investments. * A foreign corporation which conducts business here through a branch may also, for historical or other reasons, engage in one or more addi- tional businesses in this country through ownership of affiliated domestic subsidiaries. These are in the nature of direct investments-the type of invest- *ment which contains a sufficiently great element of management activity to entitle them to exclusion from the interest equalization tax-which, as you are so well aware, is designed to reach passive portfolio type investments. It seems clear to us, therefore, that dividends received from such affiliated companies are actually busi- ness income. Nevertheless, under the bill they would be treated as passive investment income, and as a consequence, these direct investments by foreigners in U.S. ventures might be adversely affected by the ~enactment of H.R. 5916. Furthermore, the Treasury objective of uniform tax treatment on the dividend income of foreign corporations would not be achieved under the proposed amendment since the rate of tax on such income would vary on a country-by-country basis depending upon the difference in the applicable treaty rates. This issue certainly is not a hypothetical matter. From our own experience we are aware of a number of foreign corporations which conduct substantial active businesses here, both through branch operations and affiliated domestic subsidiaries. Foreign banks are a good example. In connection with their foreign operations banks generally prefer to conduct business through a branch rather than through a subsidiary, in order to obtain the benefit of their "home office" reserves. In New York alone, about a dozen foreign banks conduct operations through branch offices and a number of these have wholly owned domestic subsidiaries which engage in businesses that the foreign banking parent is not permitted to engage in directly. For example, a number of foreign banks have wholly owned do- mestic subsidiaries carrying on fiduciary and safe-deposit businesses. Another situation with which we are familiar involves a large Japanese trading company having several branch offices in the United States. This Japanese company has also acquired a substantial stock interest in at least one U.S. operating subsidiary. 209 PAGENO="0220" 86 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. To deprive these, and similarly situated foreign corporations, of the intercorporate dividend received deduction at this time would cause an unwarranted and perhaps unintended, disruption of tradi-~ tional and legitimate patterns of doing business in this co~untry by foreign corporations. As I have mentioned several times now, we feel that such a step might well discourage these companies from making further U.S. stock investments in the future. Finally, I would like to call your attention to one interesting note,. that one group of foreign corporations in which this pattern of doing business i~ fairly common will be completely unaffected by the amend- ment in question. These are foreign insurance companies. Under the bill the dividends received deduction is withdrawn only from those foreign corporations which are taxed under section 11. Since foreign insurance companies are taxed under section 801 and following sections, they are not affected by the bifi. Obviously, we think this treatment of insurance companies is proper and fully in keeping with the objectives of H.R. 5916. We think other foreign corporations with bona fide business operations in this country should be taxed in the same manner. In view of the foregoing we offer the following recommendations: That foreign corporations which are actively engaged in business in the United States and that have made substantial, permanent type investments in domestic corporations for example, at least a 10 percent equity interest, should be permitted to elect either: * (1) The treatment provided under existing law for resident foreign* corporations, that is, they would have the availability of the inter- corporate dividends received deduction, but a tax on capital gains realized in connection with U.S. stock investments or the alternative~ (2) The tax treatment provided in the proposed amendment, that is, no incorporate dividend received deduction, but be exempt from the tax on capital gains when they dispose of their U.S. stocks. Thank you, Mr. Chairman. Mr. KARSTEN. Dies that conclude your statement, Mr. Waris? Mr. WArns. That does. Mr. KARSTEN. Are there questions of Mr. Waris? If not, we thank you for your appearance and we appreciate your giving us the benefit of your views on this legislation. Mr. WARIS. Thank you. Mr. KARSTEN. That concludes the witnesses scheduled for this morning. In fact it concludes the public hearings on this legislation~ The committee will stand adjourned. (Whereupon, at 10:45 a.m., the committee was adjourned.) 210 PAGENO="0221" WRITTEN STATEMENTS RECEIVED BY* THE COM-. MITTEE ON WAYS AND MEANS ON H.R. 5916, REMOVING TAX BARRIERS TO FOREIGN INVEST- MENT IN THE UNITED STATES AND MAKING CERTAIN TECHNICAL AMENDMENTS TRUST DIVISION, THE AMERICAN BANKERS ASSOCIATION, New York, N.Y., June ~4, 1965. Hon. WILBUR D. MILLS, Chairmav, Committee on Ways and Means, House of Representatives, Washington, D.C. DEAR MR. MILLS: I am writing to you, on behalf of the Trust Division of the American Bankers Association, in connection with the provision impoing~the~estate~tax on nonresident-aliens7-proposed~n~---~-- H.R. 5916. The imposition of any estate tax on estates of nonresident aliens will always be a deterrent to their investing in U.S. securities, and the difference between no tax and a small tax is not just .one of degree but of principle. However, if the estate tax on such nonrc~ident aliens cannot be eliminated entirely, then we urge that the provisions of H.R. 5916 be amended to incorporate the recommendation of the Fowler Tax Force to "Eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents." As pointed out in the Fowler report, a foreigner with sufficient funds who is willing to go to the necessary trouble and expense can establish a personal holding company in suèh a way as to avoid estate taxes legally. On the other hand, foreigners with amounts to invest which do not justify a holding company are reluctant to buy U.S. securities because of the possibility of the estate tax. It may quite properly be argued that the present bifi by providing for an increased exemption and lower tax rates should encourage investments by aliens of relatively small means. However, as long as there is a tax aliens will be concerned about what the future rate of tax might be and this one fact would still be the major deterrent to their investing in this country. The revenues received by the United States from estate taxes on intangible personal property in estates of nonresident alien decedents are said to be relatively minor. The elimination of the tax would not cost much in revenue, would encourage foreign investment in the United States, and what little revenue is lost might very well be more than made up by the increased income taxes paid by U.S. banks and brokers on their increased foreign business. The principle of jurisdiction to tax that intangibles follow the person is still a pretty sound one, and it would fully justify treating intangibles differently from tangible property situated in this country. IRespectfully yours, REESE H. HARRIS, Jr. 87 211 PAGENO="0222" - 8& REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. COMMITTEE ON FEDERAL TAXATION OF THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS Comments and recommendations regarding ILR. 5916, a bill to amend the Internal Revenue Code of 1954 to remove tax barriers to foreign investment in the United States. GENERAL COMMENTS A principal purpose of HR. 5916 is to alleviate this country's. balance-of-payments problem by decreasing or removing tax barriers. to foreign investment here. The institute's committee on Federal. taxation is in favor of the underlying aims of the proposed legislation. Certain provisions, however, appear to contradict the intent of the bill. Other provisions seem to need clarification. The granting of tax benefits to nationals and entities of other countries is unilateral in nature and could hamper efforts to obtain. similar benefits for U.S. citizens and entities in treaty negotiations.. Accordingly, we support the principle of section 5 of the bill (line 21, p. 27, through line 11, p. 30) pertaining to the application of pre-1966~ tax provisions. It will give the U.S. team of treaty negotiators an aid they will need. 212 PAGENO="0223" SPECIFIC COMMENTS AND RECOMMENDATIONS Bill section 3: Proposed code section: (1) 871(a) Subject of the tax on nonresident alien individuals (page 4, line 6, 9-i 1; page, 5, lines 3-4) ~ In proposed Sections 871 (a) and (b), the words "gross income, of" should replace ~ the words "amount received, by" to conform to Regulations Section 1.871-7(b)(1). (2) 87 1(a) It appears that the words "salaries," "wages," "compensation," and "emolunients" ~ in proposed Section 871(a) would never have any effect, since such income under pro- ?I~ posed Section 87 1(c) could be realized only from engaging in a trade or business. While ~ this language is taken from present Section 871(a) and also appears elsewhere (e.g., ~ present Section 1441), confusion might be avoided by eliminating these words from proposed Section 871(a). *(3) 871(c) Suggested change in purposes for which the term trade or business i~ defined (page 5, line 23) ~ Proposed Section 871(c) commencing at line 22 of page 5 pertains to the definition ~ of engaging in trade or business in the case of the tax on nonresident alien individuals. Present Sections 881 and 882 are mentioned on line 23. These sections pertain to ~ foreign corporations. It is suggested that mention of these sections might be more appropriate elsewhere, ci CI) PAGENO="0224" (4) 871(c) (1) Performance of Personal Services for Foreign Employer (Page 6, lines 3-14) The Bill states that the term "engaged in trade or business within the United States" does not include the performance of personal services within the United States by a nonresident alien individual for designated types of foreign employers if the in- dividual is temporarily present in the United States for not more than 90 days during a year and his compensation for such services does not exceed $3,000. Among the types of foreign employers covered are offices or places of business maintained by a domestic corporation in a foreign country or in a possession of the United States. The provisions would not apply to an office or place of business maintained by a U.S. citizen or resident alien or by a domestic partnership in a foreign country. This situation appears to be inequitable. It is suggested that the inequity be removed by adding immediately after the words "domestic corporation" in line 8, page 6 the words "domestic partnership, U.S. citizen, or resident alien." It is further suggested that, the Bill be amended to make these same changes in present Section 861 (a) (3) (c) (ii). (5) 871(d) Conforming the Phraseology Applicable to Gains a~nd Losses (Page 7, lines 18 and 19) The phrase used in lines 18 and 19, page 7, in reference to the word "losses" is: "allocable to sources within the United States." It would seem preferable to continue to use the phrase "derived from sources within the United States" as it is used in lines 16 and 17 with reference to the word "gains." (6) 871(d) Clarification of Taxation of Capital Gains of Nonresident Alien Individuals Under Certain 871(b) (1), (2), (3) Circumstances (Page 7, lines 20-25) Proposed Section 87 1(d) starting at line 10, page 7, appears to mean that a nonresident alien individual present in the United States for 183 days or more in a PAGENO="0225" taxable year is to be subjected to a tax of 30% on net capital gains derived from sources within the United States. But then lines 20 through 25, page 7 seem to state, through reference to proposed Section 871(b) (1), lines 17-25, page 4, as modified by proposed Sections 871(b) (2) and 871 (b)(3), lines 1-21, page 5 that capital gains are not to be p taxed. We suggest that clarification is needed. It is assumed that the intent of the Bill is to subject nonresident aliens who are present in the United States for 183 days or more during a year to a 30-percent rate of tax. This provision places such an alien in a disadvantageous position in comparison with a domestic investor, because under the provisions of lines 1-4, page 8, the alterna- tive tax and capital loss carryover provisions are not to be allowed. This seems con~ trary to the intent of the Bill. Bill section 4: Proposed code section: (7) 881 Suggested Reduction in Rate of Tax on Portfolio Investments of Foreign Oorporations Not Engaged in Business in the United kStates (Page 21, lines 1-7) It is noted that the 30-percent rate of present Section 881 on portfolio invest- ments of foreign corporations not engaged in business in the United States is not proposed to be changed. We believe some reduction should be made to further the purpose of the legislation to provide an incentive for investments in the United States. (8) 882(c) (1) Softening of Provision Disallowing All Deductions for Failure to File a Return (Page 21, line 22 through page 22, line 7) The disallowance of all deductions for failure to file a return under proposed Section 882(c)(1), is an unusually harsh provision. Even though this provision is a part of the present law, the purposes of the Bill would seem to indicate that the provision should be softened. PAGENO="0226" Bill section 6: Proposed code section: (9) V 901(c) Consistency in Provisions Requiring Thirty-Day Notice Prior to Presidential Proclamation ~ (Page 32, line 12) V V V To be consistent with proposed Sections 896 and 2108, proposed Section 90 1(c) LT~ should require a thirty-day notice to Congress before a proclamation is made by the ~ President. Bifi section 7: w Proposed code section: V V (10) V V V V V 931 (d)(2) Apparent Inequity in Deductions Allowed to U.S. Possessions Corporations V(Page 33, ~ lines 17-18, and 23-24; page 34, line 3) V Section 7 of the Bill commencing at line 22, page 32, is entitled "Amendment to Preserve Existing Law on Deductions Under Section 931." Present Section 931 ~ pertains to citizens of the United States or domestic corporations deriving income from ~ V sources within possessions of the United States. The deductions granted under ~ proposed Section 931(d) (2), lines 12-25, page 33, are those described in present Sections Z V 165(c) (2) and 165(c) (3) pertaining to individuals and not to corporations. Accordingly, ~ the Bill seems to provide that if goods are purchased in the United States and lost by ~ fire while still in this country, a deduction will be allowed to an individual owner of such c,~ goods, but not to a U.S. possessions corporation. This does not seem to be equitable. ~ Bill sections 8 and 9: V t~'i Proposed code section: V V (11) 2107 V V V V 2501 (a)(3) Suggested Softening of Estate and Gift Tax Provisions Affecting U.S. Property of Ex- 2511(b) patriates (Page 38, line 12 to page 40, line 11; page 43, lines 16-25; page 44, lines 6-24) V V Section 8 of the bill, starting at line 13, page 34, will substantially revise and lower the estate tax of nonresidents who are citizens of V the United States. However, pro- PAGENO="0227" posed Section 2107 commencing at line 12, page 38 would retain to a major extent the existing provisions of our estate tax law with respect to those nonresident aliens who, within a ten-year period ending with the date of death, lost U.S. citizenship, and such ~ loss had for one of its principal purposes the avoidance of U.S. taxes. Such an ex- patriate would be subject to the present estate tax rates with respect to that portion ~ of his estate, which at the date of death was located in the United States. The following ~ types of property would be deemed to be located within the United States: stock in U.S. corporations, debt obligations issued by or enforceable against U.S. persons, and ~ stock in foreign corporations controlled by the decedent at the date of death to the ~ extent of the decedent's proportional interest in the value of assets owned by that foreign ~ corporation which are situated in the United States. Under proposed Section 2107(e), the burden of proving that a decedent's loss of ~ United States citizenship did not have for one of its principal purposes the avoidance of United States taxes shall be on the executor of the decedent's estate. It will be difficult for the executors of any expatriate to meet this burden of proof. In the or- dinary case such a result is probably appropriate. However, in the case of an individual ~ who became a U.S. citizen by naturalization process and then loses his U.S. citizenship ~ or surrenders it upon returning to his native country, the provisions of proposed ~ Section 2107 should apply only to that portion of the gross estate situated in the United States, which is in the ratio of the portion of such gross estate going to U.S. heirs to the total of. such gross estate. . Section 9 of the Bill commencing on line 1, page 43, would substantially change ~ the liability to gift tax of nonresident alien individuals. Proposed Section. 2501 (a) (3) ~ and proposed Section 2511(b) would continue the present gift tax liability with respect ~ to expatriates. The burden of proving an. absence of tax avoidance purpose in the z loss of United States citizenship is on the donor. As in the case of the estate tax, ~ where a naturalized U.S. citizen loses his U.S. citizenship or surrenders it upon return- ~ ing to his native country, the provisions of proposed Sections 2501(a)(3) and 2511(b) ~ which are applicable to expatriates, should apply only to gifts to U.S. citizens. PAGENO="0228" (12) Treaty obligations; absence of permanent establishment (page 45, line p25; page 46, line 7) ~ The effect of Section 11(b) of the Bifi is to treat a nonresident alien individual 1~i or a resident foreign corporation which is engaged in trade or business within the ~ United States as not having a permanent establishment in the United States. Such ~ persons would thus be entitled to the lower treaty withholding rates on nonbusiness ~ income. This benefit should also be extended to nonresident alien individuals and foreign corporations which are not engaged in trade or business, but which do have a permanent establishment in the United States. For example, ownership of certain ~ real property in the United States may constitute having a permanent establishment without being engaged in trade or business. Proposed Sections 871(f) (starting at line ~ 20, page 8) and 88 1(b) (starting at line 22, page 19) provide elections to treat real ~ property income as business income; however, there may be non-income-producing real CI~ property which could constitute a permanent establishment. PTJ Other provisions of the present code requiring clarification The application of a withholding tax to salaries of nonresident aliens for services performed in the United States is now unclear, since present Section 3401 (a) (6) exempts wages paid to an alien individual so that withholding will fall under present Section 1441. The Bifi provides that all salaries, wages, etc. will be taxable at regular graduated ~ rates. Since it is already proposed that present Section 1441 be amended to provide ~ no withholding on income taxed under proposed Section 871(b) (1), present Section 3401 should also be amended so that a nonresident alien will be subject to the withholding tax under present Section 3401 in the same manner as any citizen or resident. ci PAGENO="0229" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 9~5 AMERICAN LIFE CoNvExrIoN AND LIFE INSURANCE ASSOCIATION OF AMERICA JUNE 30, 1965.. Re H.R. 5916, to remove tax barriers to foreign investment in the United States. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, U.S. House of Representatives, Washington, D.C. DEAR CONGRESSMAN MILLS: The American Life Convention and the Life Insurance Association of America are two associations with an aggregate membership of 329 life insurance companies in the United States and Canada which have in force approximately 94 per-. cent of the legal reserve life insurance written in the United States. H.R. 5916 would encourage the investment of foreign funds in the United States by removing tax barriers to such investment. To this end the bill would, among other things, exempt from the 30 percent withholding tax "amounts" paid to nonresident aliens not engaged in~ business within the United States on deposits with Savings and loan associations. Since 1921 interest paid to such liens on bank deposits has been exempted from tax. In contrast, similar amounts paid to such nonresident aliens under life insurance contracts have been, and would under the bill remain: subject to the 30-percent withholding tax. These amounts include such items as interest on dividend accumulations, interest on amounts held under supplementary contracts, certain amounts received under an annuity contract, and (more recently)-certain~-amounts--reeeived~--~---~--- on the surrender of a life insurance contract or on the maturity of an endowment contract. We believe that these amounts should receive the same exemption as amounts paid by savings and loan associatiouis or banks. Such treatment would both accomplish equity and further the overall purpose of the bill. We therefore respectfully urge that the Ways and Means Com- mittee amend section 2 of H.R. 5916 to exempt amounts of the type referred to above paid under life insurance, endowment, or annuity) contracts. Sincerely yours, AMERICAN LIFE CONVENTION, GLENDON E. JOHNSON, Vice President and General Counsel. LIFE INSURANCE ASSOCIATION OF AMERICA, KENNETH L. KIMBLE, Vice President and General 0i'wnsel. 219 PAGENO="0230" 96 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. AssociATIoN OF STOCK EXCHANGE FIRMS, New York, N.Y., June 24, 1965. Re: H.R. 5916, an act to remove tax barrier to foreign investors in the United States. Hon. WILBIJR D. MILLS, Chairman, Ways and Means Committee, House of Representatives, Washington, D.C. DEAR CHAIRMAN MILLS: As president of the Association of Stock Exchange Firms, I would like to express my enthusiastic approval of H.R. 5916 now before your committee. The Association of Stock Exchange Firms is the voluntary trade organization for some 600 member firms of the New York Stock Exchange. The association's membership is nationwide, and many of our members have foreign branches as well. The members of our organization have long felt the need for an effective program designed to encourage foreign investment in Amen.. can securities. We believe that the application of certain U.S. tax laws to foreigners and foreign institutions has greatly restricted the growth of such investments to the detriment of the U.S. international balance of payments. In conclusion, I would like to state that I have read the statement of the president of the New York Stock Exchange, filed with your committee on June 25, and wish to express the wholehearted approval of this association for all that is contained in that statement. We urge your committee to take prompt action in this area of much needed tax reform. Sincerely, WILLIAM T. KEMBLE, President. * THE ASSoCIATIoN OF THE BAR OF THE CITY OF NEW YORK, June 1965. COMMITTEE ON TAXATION Comments on H.R. 5916, an act to remove tax barriers to foreign investment in the United States MEMBERS OF THE COMMITTEE Clifford L., Porter, chairman Wilbur H. Friedman Joseph E. Bachelder, III James Glascock, Jr. John C. Baity Saul Duff Kronovet Renato Beghe James A. Levitan Wayne Chapman Donald R. Osborn Wallace J; Clarfield James R. Rowen Walter C. Cliff, secretary David Sachs John A. Corry David G. Sacks Arthur A. Feder David Simon Hans J. Frank David E. Watts Victor H. Frank, Jr. H. Gilmer Wells Set forth below are the comments of the Committee on Taxation of the Association of the Bar of the City of New York on H.R. 5916. The committee has restricted its review to the technical aspects of 220 PAGENO="0231" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 97 the bill and; does not comment on the tax policy and economic policy considerations involved. Section 1(a) The committee is of the view that the short title of the act is much too long and unwieldy and recommends that a shorter title, such as "Foreigners Investment Act of 1965," be adopted. Section 2(b) The term "gross business income" is undefined in the proposed section 861(a)(2)(B). To remove any doubt as to its meaning, it is suggested that immediately following the phrase "gross business income" in the second sentence of the section there be inserted "as defined in section 882(a)(3)." In its present form the proposed amendment to section 861 (a)(2)(B) could subject to TJ.S. taxation dividends from a foreign corporation engaged in business within the United States so long as 80 percent of its gross business income was derived from sources within the United States even though the gross business income of such corporation con- stituted only an insignificant portion of the corporation's entire income. For example,. if only 10 percent of a corporation's entire income con- stituted gross business income and 80 percent or more of such gross business income was derived from sources within the United States, an insignificant fraction of the dividends paid by such corporation would be deemed income from sources within the United States. The insignificant amount of revenue derived from this does not justify the burden imposed upon the payor corporation or the administrative 4lifficulties imposed upon the Internal Revenue Service. It is there- fore suggested that a de minimis rule be adopted and that it be pro- vided that section 861 (a)(2)(B) not be applicable unless, for example, at least 2~5 percent of the foreign corporation's entire income consti- tutes gross business income as defined in section 882(a) (3). Section 2(c) This provision, pertaining: to the effective date of section 2, should be amended so as to make it clear that it applies to interest credited as well as interest paid. It is suggested that it be amended to read. as follows: "The amendments made by this section shall apply with respect to interest paid or credited or dividends paid in taxable years beginning after December 31,. 1965.". With this amendment the pro- vision would conform with section 2(a) of the bill. Section 3~ Proposed section 871(b) (3), defining business income, excludes from that category "dividends or gain from the sale or exchange of stock in a corporation." Interest and gain from the sale of sectirities apparently `~vou1d be treated as "business income." No reason is apparent for the differentiation between dividends and interest or between gain from the sale of securities as distinguished from stock. It therefore is suggested that consideration be given in section 871(b)(3) and in section 882(a)(3) to the exclusion from the category of business income of interest as well as dividends and gain from the sale of securities as well as stock. An exception could be made for interest earned in the conduct of a banking business. Consideration should be given here and at section 882(a)(3) to the intended treat- 221 PAGENO="0232" 98 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. ment of gains which are treated as capital gains, although not derived from a sale or exchange, such as distributions under section 301(c) (3) (A) and section 852(b) (3) (B). It also appears that in its present form proposed section 871 (b)(3) would exclude from the category of business income, gains from the sale or exchange of stock by a dealer in securities. It is not clear that thi~ result is intended. Section 871(c) (2) (A) impliedly provides that a dealer in securities is engaged in trade or business within the United States. Section 871(b)(3) and section 882(a)(3) should be reviewed from the policy viewpoint to determine whether or not there should be included in the category of business income, gains realized upon the sale of stock or securities by a dealer in securities. The Treasury Department release of March 8, 1965, accompanying hR. 5916, states that no legislative change is necessary to provide that the volume of transactions is not material in determining whether an investor is engaged in trade or business in the United States since this is the rule under existing law. It is not felt that the existing law in this regard is as clear as the Treasury release would indicate arid it therefore is suggested that a specific clause be inserted in the proposed section 871 (c)(2) affirmatively stating that the volume of securities or commodities transactions is not material in the determination of whether an investor is engaged in trade or business within the United States. Proposed section 87 1(1) permits a nonresident alien to elect to be taxed on a net basis with respectS to income from real property, rents, or royalties from the opration of mines, wells, or other natural deposits, and gains from the sale or exchange of real property, etc. In its present form the section does not cover gains or income from the disposition of timber. Since there appears to be no valid reason for this omission, consideration should be given to the amendment of the section to permit a nonresident alien individual to elect to be taxed on the gains or income from the disposition of timber on a net basis. Such election, however, should be limited to those cases wherein an election under section 631(a) of the code is not made. Section 871(f) should also indicate whether interest on a loan secured by a mortgage on real property falls within the election. The phrase "under regulations prescribed by the Secretary or his delegate" appearing in the seventh line of proposed section 871 (f)(1) should be deleted inasmuch as it is redundant in view of the provisions of proposed section 871(f) (3). The revision of section 871 accomplished by section 3 of the bifi fails to resolve an ambiguity under present law in the use of the term "taxable year." Under this bill, as under present law, tax con- sequences follow from the presence of the nonresident alien for specified numbers of days "during the taxable year" or from the receipt of specified amounts of income "during the taxable year." Where in the course of a calendar or fiscal year the taxpayer's status changes from a citizen, or resident alien, to a nonresident alien, or vice versa, however, it is not clear whether the change of status is considered to close the taxable year. For example, an alien, reporting on the calendar year basis, is resident and physically present in the United States for the first 9 months of 1966. On October 1, 1966 he becomes a nonresident alien, and during the remaining 3 months of the year realizes net gains from 222 PAGENO="0233" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 99 capital assets allocable to sources within the United States. If "the taxable year" is the calendar year 1966, proposed section 871(d) is applicable; if "the taxable year" is the period from October 1 to December 31, it is not. Existing authorities are in conffict. In I.T. 3237, 1938-2 C.B. 188, 2 taxable years were in effect recognized in that the full statutory dollar allowance was permitted in the nonresident period and the additional income in the resident portion of the calendar year was ignored. However, the resident and nonresident portions were in effect treated as a single taxable year in Rev. Rut 64-60, I.R.B. 1964-9, 7 (standard deduction); I.T. 3926, 1948-2 C.B. 48 (optional tax table); Van der Elst v. Commissioner, 223 F. 2d 771 (2d Cir. 1955) (capital gain); Rev. Rul. 56-365, 1956-2 C.B. 934, and Matthew Klaas, 36 T.C. 239 (1961) (joint return). Cf., G.C.M. 10759, XI-2 C.B. 99 (1932) (one return only). Clarifying legislation therefore is recommended, either in section 441, section 7701 (a)(23), or in part II of subchapter N. Sections 3(d)(e)(f), 8(f), 9 (a), (b): Expatriation While most of the proposed changes in the Internal Revenue Code of 1954 embodied in H.R. 5916 reflect recommendations contained in the April 27, 1964, report of the Task Force on Promoting Increased Foreign Investment, the proposals pertaining to expatriates go beyond that report. In the introductiOn to its general explanation, the Treasury Department release explaining H.R. 5916 states that "all legislative suggestions made herein are justifiable on conventional tax policy grounds." Such a conclusion, it is submitted, is clearly wrong in the case of the alternative tax provisions intended to penalize, for income, estate and gift tax purposes, certain persons who give up their U.S. citizenship for the purpose of reducing their. U.S. taxes. Section 6 of the release, concerning expatriate American citizens, states: While it may be doubted that there are many U.S. citizens who would be willing to give up their U.S. citizen- ship no matter how substantial the tax incentive, a tax incentive so great (referring to the elimination of progressive rates for nonresident aliens and the reduction of estate tax on estates of nonresident aliens) might lead some Americans to surrender their citizenship for the ultimate benefit of their families. As a practical matter, the complexities which the proposed ex- patriate tax provisions would introduce into the tax law raise serious doubt as to the wisdom in adopting them even if some Americans thus might be restrained from expatriating themselves. Certainly it is doubtful that much revenue would be gained from these provisions. As a matter policy, it hardly seems necessary or desirable for the United States to engage itself in the enforcement of these complicated provisions against persons willing to give up their citizenship. Section 3(d) It is recommended that the title of section 878 be changed to "Tax on Certain Expatriates." Compare titles of other sections in part II of subchapter N of chapter 1, particularly sections 871, 881, and 882. 223 PAGENO="0234" 100 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. The clause starting with "if the tax" in the last two lines of sub- section (a) of section 878, should be changed to read as follows: if the tax for the taxable year computed pursuant to. such subsection exceeds the tax for the taxable year computed without regard to this section. In making computations to determine the applicability of an alternative tax it would not seem appropriate to speak of a "tax imposed." See e.g., section 1341 (a) of the code. The phrase "to the extent not otherwise" in the third line of sub.. section (b)(1) of section 878 should be changed to ", subject to the modifications." The suggested rephrasing is for the purpose of making clear that the determination will still be made under part I. In the second line of subsection (c) (1) of section 878 "in corpora- tions" should be deleted and "debt obligations" should be changed to read "evidences of indebtedness constituting property." In subsection (c)(2) of section 878 "stocks or debt obligations" should be changed, in both places where those words appear, to read "stock or evidences of indebtedness." These changes are suggested in order to conform the terminology to that used in other areas of the code. The first two lines of text of subsection (d) of section 878 should be changed to read as follows: Subsection (a) shall not apply to a nonresident alien individual whose loss of United States citizenship results from the applicability of * * * This change is recommended in order to take into account the case of a person who lost citizenship under one of the indicated pro- visions, was restored to citizenship and then lost citizenship again for reasons other than the application of one of the listed sections. It also is noted that section 350 of the Immigration and Nationality Act (8 U.S.C. 1482), unlike the other two provisions cited, involves a voluntary loss of citizenship. It is not clear why this section, applicable to persons who at birth acquired dual nationality, has been included. Its deletion should be considered. Section 3(e) In paragraph 2 of subsection (c) of section 35 "under" should be changed to read "in accordance with." Section 3(f) In subsection (d) of section 116 "under" should be changed tc~ read "in accordance with." Section 8(f) It is recommended that the title of section 2107 be changed to "Tax on Estates of Certain Expatriates." The definition of expatriate status for purposes of section 2107 should be the same as that for purposes of section 878. Therefore, it is suggested that in subsection (a) of section 2107 the last clause, which starts with "if within the 10-year period," be changed to read as follows: If within the 10-year period immediately preceding the date of death such decedent lost United States citizenship, unless such loss did not have as one of its principal purposes the avoidance of United States taxes. 224 PAGENO="0235" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 101 It is recommended that consideration be given to the deletion of subsection (b) of section 2107. This subsection introduces extremely complicated computations~ into the determination of the taxable estates of expatriates. It is questioned whether the limited revenue benefits would warrant adding to the complexity of the code. In subsection (c) of section 2107 "sections 2011 to 2013, inclusive" should be changed to read "section 2102." Section 2102, as amended, would modify section 2011, and it already incorporates sections 2011 to 2013. inclusive. In subsection (d) of section 2107 the first two lines of the text, plus the first word of the third line, should be changed to read as follows:, Subsection (a) shall not apply to the transfer of the estate of a decedent whose loss of United States citizenship resulted from the applicability of * * The foregoing change is recommended for the same reasons indicated above in regard to section 3(d) of the bill. Section 9(a) It is recommended that "ending with" in the second line of sub.. section(a) (3) of section 2501 be changed to read "immediately. pre-. ceding" and that subparagraphs (A) and (B) of subsection (a)(3) be changed to read as follows: (A) such loss did not have for one of its principal purposes the avoidance of United States taxes, or (B) such, loss resulted from the applicability of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). As noted above in regard to section 3(d) of the bill, it is not clear why exception is made in the case of voluntary loss of citizenship under section 350 of the Immigration and Nationality Act. Section 9(b) In subsection (b)(2) of section 2511 "debt obligations" should be changed to read "evidences of indebtedness constituting property which are." Section 4(b): Tax on resident foreign corporations The bifi amends section 882 of the code to subject a resident foreign corporation to normal and surtax upon its taxable income from U.S. sources which is business income and to subject its nonbusiness income to a flat 30-percent tax (or such lesser amount as may be provided by~ treaty). As a result of classifying dividend income as nonbusiness income, a resident foreign corporation is denied the right to the dividends received deduction. By thus subjecting a resident foreign corporation to a higher rate, of tax on dividends as is now the case under existing law, the bifi seems to defeat its announced purpose of encouraging foreign investments in the United States. Similarly, a resident foreign corporation is thereby placed at a competitive dis- advantage with U.S. corporations. Accordingly, consideration should be given to permitting a resident foreign corporation to continue to utilize the dividends received deduction in respect of its dividend income. 225 PAGENO="0236" 102 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Section 4(e) In order to permit exclusion from personal holding company tax section 542(c)(7) requires that all the stock of a corporation out- standing during the last half of the taxable year be owned by non- resident alien individuals, "whether directly or through other foreign corporations." Consideration should be given to a revision of the quoted phrase, which appears in present law, to cover ownership through foreign trusts, estates or partnerships where all of the part- ners or beneficiaries are nonresident aliens. (Compare section 958(a) (2).) Section 4(g) It is suggested that consideration be given to limiting the dividends received deduction provided by section 245(a) for dividends from foreign corporations which are subject to tax under chapter 1 to those received from a foreign corporation which has derived 80 percent or more of its gross business income from sources within the United States rather than to those which have derived 50 percent or more of the gross income from sources within the United States, as presently provided. This change would be consistent with section 2(b) of the bill, which amends section 861 (a)(2)(B) so that dividends received by a foreign corporatiOn engaged in a trade or business within the United States would be considered U.S. source income unless less than 80 percent of the gross business income of the foreign corporation is derived from sources within the United States. Section 6: Foreign tax credit Section 6 of H.R. 5916 amends the foreign tax credit provisions of code section 901 to eliminate the "similar credit" requirement in the case of nonresident aliens, subject to reinstatement by the President where a foreign country on request refuses to provide a similar credit for U.S. citizens. While the proposed statutory language handles this change satis- factorily, there is an additional substantive change which probably ~vas intended but which the explanatory. material submitted by the Treasury does not cover. Under existing section 901 (b)(3), if a similar credit is not granted by the native country of an alien resi- dent of the United States or Puerto Rico, no credit will be given such person for taxes. paid or accrued to any foreign country. However, no similar credit requirement appears in section 901 (b)(2), having to do with taxes paid to a possession of the United States, and hence a nonresident alien is entitled to a credit for taxes paid to a U.S. possession even where no foreign tax credit is available under section 901 (b)(3). On the other hand, under section 901 as amended by section 6 of the bill, a presidential proclamation denying a tax credit to alien residents of the United States or Puerto Rico apparently would apply to the entire credit otherwise allowable under new section 901(b), and therefore would deny the credit. for taxes paid to ~t U.S. possession as well as taxes paid to foreign countries. It should be made clear that under. the proposed legislation, as under existing law, a resident alien wifi have the right to protest a determination by the executive department that a foreign. country dOes not satisfy the similar credit requirement. The fact that such a finding by the President is a condition precedent to his proclama- tion may indicate that this finding is a matter of discretion which 226 PAGENO="0237" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 103 may not be judicially set aside in seeking to render the proclamation void, absent an abuse of discretion. If so, it seems arguable that this finding also may be exempt from an attack on the merits in deter~~ mining whether under the proclamation a foreign tax law provides a similar credit. It should be made clear that once a proclamation is issued, the nonresident alien will have the same remedies to contest the denial of a foreign tax credit as he has under existing law. Section 8(b): Estates of nonresidents not citizens, credits against tax. The maximum credit for State death taxes is limited by proposed section 2102(b). This limitation is defined in terms of a ratio of (1) the value of the property "at the date of death" subject to State death taxes to (2) the value of the total gross estate. If alternate valuatioii is elected, the use of the date of death value for the numerator of the fraction might result in substantial distortion. Accordingly, the phrase "at the date of death" should be eliminated. Section 8(c): Property `within the United States By this provision of the bill, section 2104(c) of the code is amended to make it clear that where a debt obligation of a U.S. obligor is owned by a nonresident alien, the obligation shall be t~reated as property within the United States no matter where it is located. However, from the standpoint of clarity it would appear that it should also be made clear that a foreign obligation physically located in the United States will not be treated as property within the United States. This result would seem to be a logical extension of the proposal with respect to U.S. obligations. The same con ment can be mndinder~sect~on~-~ 9(b) which amends section 2501(a) (2) to set forth similar situs rules in the gift tax area. Section 8(f) Proposed section 2108 of the code allows the President by proclama- tion, to apply the pre-1966 estate tax law to residents of foreign countries under certain conditions. It is stated that the President shall proclaim that the tax be determined without regard to amend- ments made "on or after the date of enactment of this section." Since the nature of amendments which will be made in the future is unknown, it would seem advisable to restrict the presidential authority to the amendments made by the pending bill. If it should be desired to grant the same authority to the President with respect to future amendments, such authority can be granted in the future legislation. This comment is equally applicable to section 5 of the bill. Additional considerations 1. It is submitted that consideration should be given to the in~ clusion of a provision in the bifi that would permit domestic fiduciaries to administer estates and trusts for the exclusive benefit of foreign beneficiaries and remaindermen without being subjected to capital gains tax in respect of gains realized upon the sales of the trusts' or estates' portfolio securities. It is recognized that such a rule would be in derogation of existing case law. 2. Consideration also should be given to abolishing the present requirement that a visiting alien, before departing from the United States, must secure a tax clearance and sailing permit. Present procedures in this regard are harassing and annoying to visiting aliens and do not produce a significant amount of revenue. 227 PAGENO="0238" 104 IiEMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. CLEARY, GOTTLIEB, STEEN & HAMILTON JUNE 24, 1965. MEMORANDUM REGARDING THE DEFINITION OF NONBUSINESS INCOME UNDER SECTION 4 OF H.R. 5916 In connection with the administration's program to improve the IJ.S. balance of payments, the Fowler Committee Report of April 27, 1964, proposed a number of related changes in U.S. tax laws governing the receipt of U.S. sou~rce income by foreign investors. The recom- mendations of the Fowler Committee Report have been further developed by the Treasury and are incorporated in H.R. 5916, which is designed, in the words of the Treasury, "to stimulate foreign investment in the United States by removing existing tax barriers to such investment." The principal thrust of this legislation is toward a less complicated and more favorable tax treatment of portfolio investments by foreigners in U.S. corporate securities. Virtually everyone considers interest income as a form of invest- ment income, and it has been so considered by the Treasury and Con- gress in the past as, for example, in the definitions of personal holding company income (I.R.C. sec. 543) and subpart F income (I.R.C. secs. 952 and 954). This same policy is employed in section 3 of H.R. 5916, which defines the nonbusiness income of nonresident alien indivi~ duals in a manner that would include income from debt securities. (The Treasury press release of Mar. 8, 1965, describing H.R. 5916, refers on p. 2 to foreigners' nonbusiness income, "such as dividends and interest.") It is with surprise, therefore, that one finds in section 4 of H.R. 5916 that the proposed definition of nonbusiness income of a foreign corporation engaged in trade or business in the United States does not include interest from debt securities. It is not clear to us what policy would be furthered by not including income from debt obligations in the definition of nonbusiness income in this section. If it has been omitted out of a concern over possible tax avoidance possibilities, we believe that any such possibilities should be attacked directly and not by excluding interest income. Section 4 of H.R. 5916 proposes to amend section 882 of the Internal Revenue Code, relating to the income of foreign corpora- tions, to define "business income" and "nonbusiness income." The characterization of income under these definitions controls the U.S. income tax consequences for foreign corporations in several situations.' Nonbusiness income is limited in the proposed definition under section 882(a) (3) and (4) to dividends and capital gains from the sale of corporate stock, and amounts described in section 631 (b) and (c). Foreign corporate investors, including foreign~.based investment companies investing in U.S. securities, frequently include bonds, debentures, and other debt securities of U.S. issuers in their portfolios. We believe that the failure to grant favorable tax treatment for income from such investments on a par with stock investments 1 The definition of nonbusiness income will be significant in the following principal cases: (1) All foreign corporations (whether or not such corporations are engaged in trade or business in the U.S.) will be subject to a flat 30 percent withholding tax rate on their nonbusiness income; (2) the U.S. second dividend tax under I. R.C. sec. 861(a) (2) (B) wifi not apply to nonbusiness income.I 228 PAGENO="0239" REIMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 105 results in an unwarranted limitation on the flex~biity of foreign- owned portfolios of U.S. securities. It would, for example, discourage the investment policy of a number of existing foreign investment companies and mutual funds that now invest exclusively in U.S. stocks and bonds. In some situations, the discrimination against income from debt securities will result in unnecessarily complex arrangements for foreign portfolios containing investments in U.S. securities. This arises, for example, in the situation in which it is proposed to eliminate the "second dividend" tax of section 861 (a)(2)(B) so that such tax will hereafter apply only to dividends paid by foreign corporations that are engaged in business in the United States and which have 80 percent or more of their business income from U.S. sources. (See sec. 2 of H.R. 5916 amending I.R.C. see. 861 (a)(2)(B).) As indicated by the Treasury explanation, if a foreign corporation is an investment com- pany investing in U.S. securities and receiving as its total income only dividend and interest income and capital gains from the sale of securities from U;S. sources, the second. dividend tax will be applicable to the corporation's distribution to its stockholders of dividends representing income received in the form of interest or capital gains from the sale or exchange of United States debt securities, i.e., its U.S. business income, unless the foreign corporation has more than 20 percent of its total business income (excluding for this computation all nonbusiness income from all sources) from sources outside of the United States. This imposes a mechanical limitation on foreign investment companies, particularly those investing exclusively in U.S. securities, that seems unwarranted in the light of the purposes of the act. Unless section 882 is amended, as suggested above, after enactment of H.R. 5916 the present 48-percent U.S. corporate tax rate will continue to be imposed on interest income from U.S. sources where a foreign corporation is engaged in trade or business in the United States.2 A combination of the U.S. corporate tax rate, in addition to the potential second dividend withholding tax, would continue to be an impediment to investment in U.S. debt securities for portfolios of foreign corporate investors. Notwithstanding theattempted clarifica- tion of H.R. 5916 of when a foreign corporation is engaged in trade or business in the United States, the answer to this question will not always be clear and foreign investors and their tax advisors will not be certain of the impact of U.S. taxes imposed on the basis of that determination. It seems to be doubtful policy to have such un- certainty extend to the U.S. tax treatment of interest income. _________ CLEARY, GOTTLIEB, STEEN & HAMILTON. 2 present 30-percent withholding rate (or a lower tax treaty rate) would remain in effect in the case of corporations not engaged in trade or business in the United States. 229 PAGENO="0240" 106 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. WILLIAM R. ENGSTROM BOSTON, MASS., June 28, 1965. THE WAYS AND MEANS COMMITTEE, The House of Representatives, Washington, D.C. GENTLEMEN: In regard to your forthcoming deliberations toward liberalizing tax barriers to foreign investment in the United States, may I request that these factors be also entertained: 1. U.S. foreign policy is best served by the strengthening of the economies of other countries, particularly the lesser developed ones, since with the strengthening of these economies their internal politics also strengthen. But to the extent that foreign entrepreneurs invest in the United States we debilitate the program of investment in foreign countries and thereby undermine our own foreign policy. 2. The U.S. balance-of-payments position is not really as critical as the present method of bookkeeping may indicate and if the Congress passes this legislation it will give the appearance of panic, since this is hardly as sound an approach to solving the problem as, say, would be the institution of giving tax relief on export sales as a method of encouraging greater exports. Cordially yours, SEDGWICK, ENGSTROM & Co., INC. WILLIAM R. ENGSTROM. FIRST NATIONAL CITY BANK, New York, N.Y., June 29, 1965. Re H.R. 5916. LEO H. IRWIN, Esq., Chief Counsel, Committee on Ways and Means, 1102 Longworth House Office Building, Washington, D.C. DEAR SIR: Enclosed is a proposed amendment to H.R. 5916 dealing with interest payments by foreign branches of U.S. banks, together with our supporting memorandum. We urge that the Ways and Means Committee include our proposed language in the bill when it is reported to the House. Sincerely yours, WALTER B. WRISTON. FOREIGN BRANCH BANK INTEREST MEMORANDUM IN SUPPORT OF PROPOSED AMENDMENT TO INTERNAL REVENUE CODE SECTION 861 (A)(1) Summary of comments This memorandum relates to a proposed new subparagraph (B) to be added to Internal Revenue Code, section 861(a) (1), to exclude from the definition of income from sources within the United States interest paid by foreign branches of U.S. banks. Under existing law interest on deposits with persons carrying on the banking business paid to persons not engaged in business within the United States is not 230 PAGENO="0241" ,REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 107 income from sources within the United States. The proposed amend.. ment would also exclude interest paid by foreign branches of U.S. banks without regard to whether the depositor was engaged in businesq in the United States. Competitive disadvantages to U.S. banks operating abroad The proposed amendment would remove an ambiguity in existing law that has imposed a severe hardship on U.S. banks operating through foreign branches, by placing them at a competitive dis- advantage in their efforts to offer services to their foreign customers comparable to those offered by foreign banks. The question of whether a foreign corporation is engaged in business in the United States is frequently not free from doubt, particularly where the foreign corporation is affiliated in some manner with a U.S. corpora- tion. While the foreign corporation would prefer to keep its time deposits with a foreign branch of a U.S. bank, it frequently deposits its money with a foreign bank because it fears that in the event it should at some later date be held to be engaged in business in the United States, interest income from the foreign branch of the U.S. bank would be taxable, while interest income from a foreign bank would clearly not be taxable as income from sources within the United States. Separate identity of foreign branch banks The proposed amendment comports with existing nontax law and banking practice in treating a foreign branch of a U.S. bank as a ~ of overseas banking, where practically for all but tax purposes a foreign branch is regarded as a separate foreign corporation. For example not only is a foreign branch of a U.S. bank exempt from certain regulations of the Federal Reserve Board of Governors, such as those limiting interest rates it may pay, but for the express purpose of permitting foreign branches to compete on equal terms with local banks of other foreign countries, the same regulations also may permit the foreign branch to exercise powers which a domestic U.S. bank could not exercise (12 U.S.C. § 604(a). H. Rept. 2047, 87th Cong., 2d sess. 1962, United States Code Congressional & Administrative News, p. 242). In addition, foreign branches of U.S. banks are subject to the regulatory laws of a foreign country. Deposits in these branches are regarded for nontax purposes as payable there and only there; thus, amounts standing to the credit of a depositor of a Havana branch of a bank with a head office in New York have been held not subject to attachment served by process on the head office. Clinton Trust Co. v. Compania Azucarera Central, Mabay, (S.A., 172 Misc. 148, 14 N.Y.S. 2d 743 (Sup. Ct. N.Y. Co. 1939) aff'd 258 App. Div. 780). A nonresident alien depositor in a foreign branch has no substantial contacts with the United States as to that deposit whether or not he is otherwise engaged in business in the United States. The deposit is made outside the United States pursuant to an agreement made outside the United States and under the laws of a foreign country. The funds derived by foreign branches of U.S. banks are almost always loaned or invested outside the United States. It should be kept in mind that foreign branches of American banks are not merely windows through which deposits are made and with- 71-297 O-67-pt. 1-16 231 PAGENO="0242" 108 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. drawn from a general pooi of assets. Each deposit contract is made with a particular branch in a particular country, subject to the laws and exchange controls of that country. It is payable at that branch only, and only in the currency that was deposited. A foreign corpora- tion cannot make a French franc deposit in France and expect to draw against it in dollars in New York. In order to use in the United States the deposits which it has in a foreign branch, the depositor would have to transfer funds out of that branch, and, if a different currency is involved, would have to make a sale of his funds in ex- change for the dollars that he would want. Thus, foreign branches of U.S. banks operate, as a matter of economics and banking law, in basically the same way as banks incorporated locally in the countries where they do business; and the interest which these branches pay is not attributable to earning assets of the depositor in the United States. The futility of trying to tax foreign source interest income The present law attempts to tax income generated wholly outside the United States, payable to recipients who are not U.S. persons. It does not attempt to tax these payments in all cases, however, but only where the payor happens to be incorporated in the United States and then only when it operates through foreign branches rather than locally incorporated foreign subsidiaries. In view of this peculiar twist in the law, any foreign person or corporation suspecting that it may be found to do business in the United States, has merely to withdraw its money from the foreign branch of an American bank and place it on deposit with a local bank across the street. The issue presented by the proposed amendment is not whether these foreign interest payments will be taxed-they are not taxed under present law, except in a few cases where the corporate treasurer is unenlightened. The real issue is whether the strained language of the present Internal Revenue Code, section 861, wifi continue to keep these interest-bearing deposits out of the foreign branches of American banks. The corporate treasurer's decision As the law now stands, before the treasurer of a foreign corporation will put an interest-bearing deposit with the foreign branch of an American bank he must satisfy himself that his corporation is not doing business in the United States. In making this decision he must bear in mind that his conclusion does not control but rather that the findings of an Internal Revenue Service agent, perhaps several years later, will determine whether his interest is taxed under the terms of section 861. If his conclusion differs from that of the agent, he is faced with expensive legal proceedings, or payment of the tax, or both. His decision is obvious: The money must be put with the foreign bank regardless of what his opinion may be on this question. The American bank therefore loses not only those deposits which are taxable under section 861 but other deposits which are frightened away through the corporate treasurer's understandable caution. Many of th~se corporations are American owned or controlled and, other factors being equal, would prefer to do business with an American bank if they could. The possibility of an ultimately favorable decision on the question of doing business will not, and should not, satisfy the prudent corporate treasurer. The legal terms are too hard 232 PAGENO="0243" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 109 for him to define, and the safe alternative, banking with a local bank, is too easy to use. While under some tax treaties interest is taxed at a lower rate, this consideration would. not overcome the prudent corporate treasurer's reluctance to deposit funds with a foreign branch of an American bank. The United States still does not have tax treaties with many countries, and, even where it does, a lower rate of tax on interest stifi does not equal the absolute freedom from U.S. taxes afforded by depositing funds in a local bank. Strengthening competitive position of Li .S. ban/cs helps balance of payments The proposed amendment would permit U.S. banks operating abroad through branches to meet foreign competition engendered not by any business skifi or acumen of the foreign banks but solely by the unfavorable U.S. tax laws. Strengthening the competitive position of the U.S. banks operating abroad not only comports with the ex- pressed purposes of the Foreign Banking Act, but also expresses a policy reflected elsewhere in the Internal Revenue Code and Regula- tions. For example, Executive Order 1198 (February 10, 1965) issued by the President under the interest equalization tax (IRC 4931(a)) specifically exempts from the tax foreign branch loans made in a foreign currency by a commercial bank at a branc~V1ocated out- side the United States. Moreover, loans of this nature arising out of foreign branch deposits do not worsen the balance-of-payments position of the United States. Indeed, even the tightly restrictive "Federal Reserve Guidelines for Foreign Lending Activities" (Cir- cular No. 5628, March 5, 1965) recognize that the balance-of-pay-. ments program is not designed to hamper the lending activities of foreign branches insofar as the funds utilized are derived from foreign sources and do not add to the dollar outflow. This is true whether* the loans and deposits are made in foreign currencies or European dollars. The proposed amendment supports the overall purpose of H.R. 5916 in easing the balance-of-payments problem in two ways. First, it encourages foreign individuals and, more particularly, corporations to deposit funds with U.S. banks. Second, it strengthens U.S. banking in foreign areas permitting them to render important sup- porting functions to American export trade. Exports, it has been emphasized by the late President Kennedy, are the only ultimate solution to the balance-of-payments problem. (See President's message on balance of payments, July 18, 1963, p. 3; lET. Rept. 1046, 88th Cong., 1st sess., p. 17.) It is believed that any revenue loss arising out of the proposed amendment would be negligible, since deposits of foreign corporations or individuals who are or may be engaged in business in this country are not now being made in foreign branches of U.S. banks, so no taxes are being paid on any interest derived therefrom. Any possible revenue loss, moreover, would, in all probability, be more than made up by the increased taxes paid by U.S. banks on increased foreign branch earnings which, of course, would continue to be taxed by the United States whether repatriated in dollars or not. The exemption which the amendment proposes is the only means to induce these foreign corporations to channel their overseas deposits 233 PAGENO="0244" 110 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. into American bank branches. The result wifi be a net gain both in the Federal tax revenue and in the U.S. balance of payments. FOREIGN BRANCH BANK INTEREST PROPOSED AMENDMENT TO JIB. 5916 Section 2. Income from sources within the United States: (a) Interest from U.S. sources.-Seetion 86 1(a)(1) (relating to in- terest from sources within the United States) is amended to read as follows: SEC. 861. (a) GRoss INCOME FROM SOURCES WITHIN THE UNITED STATES.-The following items of gross income shall be treated as income from sources within the United States. (1) INTEREsT.-Interest from the United States, any territory, any political subdivision of a territory, or the District of Columbia, and interest on bonds, notes or other interest-bearing obligations of residents, corporate or otherwise, not including- (A) interest on deposits with any persons carry- ing on the banking business paid to persons not engaged in business within the United States; (B) interest on deposits with foreign branches of persons carrying on the banking business. For purposes of this subparagraph, the term "foreign branch" shall mean a foreign branch established under the authority of section 9 or section 25 of the Federal Reserve Act (12 U.S.C. 321 or 601); (C) interest received from a resident alien in- dividual, a resident foreign corporation, or a do- mestic corporation, when it is shown to the satis- faction of the Secretary or his delegate that less than 20 percent of the gross income of such resident payor or domestic corporation has been derived from sources within the United States, as determined under the provisions of this part, for the 3-year period ending with the close of the taxable year of such payor preceding the payment of such interest, or for such part of such period as may be applicable; (D) income derived by a foreign central bank of issue from bankers' acceptances; and (E) amounts paid to, or credited to the accounts of, depositors or holders of accounts not engaged within the United States on deposits or withrdraw- able accounts with savings institutions chartered and supervised as savings and loan or similar associations under Federal or State law, if such amounts are deductible under section 591 in com- puting the taxable income of such institutions. 234 PAGENO="0245" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 111 HERRICK, SMITH, DONALD, FARLEY & KETCHUM, Boston, Mass., June ~3, 1965. Hon. WILBUR D. MILLS, Chairman, House Ways and Means Committee, Rouse Of/ice Building, Washington, D.C. DEAR CONGRESSMAN MILLS: It is understood that your committee has mvited comments on proposed legislation to encourage foreigners to invest in the United States. The observations below are addressed to the provisions affecting the U.S. estate tax in H.R. 5916, 89th Congress, 1st session, which you mtroduced in the House of Representatives on March 8. 1. Expatriation to avoid estate tax H.R. 5916, page 38, would add a new section 2107 to the Interna Revenue code providing in part: (a) RATE oFTAx~-Ataxcomputed~in ãcir~liWi1h~~ the table contained in section 2001 is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States dying after the date of enactment of this section, if `within the 10-year period endivg with the date of death such decedent lost United States citizenship and such loss had for one of its principal purposes the avoidance of United States taxes. The main purpose of the underlined portion is doubtless to dis- courage resident U.S. citizens from renouncing their citizenship and thereby having their estates taxed at the rates applicable to nonresi- -dents. It can be expected that an executor will have a heavy burden in proving that a decedent who renounced his citizenship did not have as one of his principal purposes the avoidance of U.S. taxes. `This burden is entirely appropriate when a U.S. citizen residing in the United States on March 8, 1965, thereafter renounces his citizen- ship. It is, I believe, an unfair burden to place upon the executor of a U.S. citizen who was a nonresident of the United States for most of his life or for many years before 1965. The following situation is not uncommon: F, a Canadian, emmi- grated to the United States in 1920, became naturalized here, married ~i, woman born in Canada, and died in 1923 leaving a child, C, who was torn in the United States and, therefore, a citizen of the United States. Upon her husband's death, the widow returns to her home in Canada with the infant C. C lives in Canada for the rest of his life. Many reasons may prompt C to renounce his U.S. citizenship and become a citizen of the country in which he was brought up, educated, and has made his living. In these circumstances the execu- tor should not have the burden above mentioned if C happens to become a Canadian citizen within 10 years prior to his death. It is recommended that 2107(d) be amended as follows: (d) EXCEPTION FOR Loss OF CITIZENSHIP FOR CERTAIN CAusEs.-Subsection (a) shall not apply to the transfer of the estate of a decedent - (1) who lost U.S. citizenship under section 30 1(b), 350, or 355, of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487); or 235 PAGENO="0246" 112 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S, (2) who was a nonresident of the United States throughout the 10-year period ending with the date upon which he lost U.S. citizenship. 2. U.S. estate taxes on intangible personal property of nonresident aliens The Fowler Committee's recommendation No. 29 is as foll&ws (p. 24): 1 Recommendation No. 29.-Eliminate U.S. estate taxes on all intangible personal property of nonresident alien de- cedents: U.S. estate taxes, especially as applied to shares of U.S. corporations owned by nonresident alien decedents (which are subject to U.S. estate taxes irrespective of whether they are held in this country or abroad), are believed to be one of the most important deterrents in our tax laws to foreign investment in the United States. U.S. estate tax rates are materially in excess of those existing in many countries of the world and, despite the treaties in effect with several countries, the taxes paid on a nonresident alien decedent's estate, some portion of which is invested in the United~ States, generally would be greater than those paid on a nonresident alien decedent's estate, no portion of which is invested in the United States. We understand that the revenues received by the United States as a result of estate taxes levied on intangible personal property in estates of nonresident alien decedents are not large. [Emphasis added.] The adoption of recommendation No. 29 of the Fowler committee will establish a rule easily understood by foreigners and wifi do more to encourage foreigners to purchase securities of U.S. corporations than will the limited approach of special estate tax rates for foreigners. 3. Provicions disregarding the corporate entity conflict with estate tax conventions The proposed new section 2107(b), pages 38-39 of IEI.R. 5916, disregards the separate existence of foreign corporations in certain cases when a U.S. citizen expatriates himself: in order to have the reduced estate tax rates apply to his estate. The adoption of this principle of disregarding the corporate entity appears to be in conflict with estate tax conventions, for example, the United States-Canada Estate Tax Convention signed February 17, 1961 as interpreted by the Committee on Foreign Relations.2 Under section 2107(b) if a foreign decedent owns a stated percent- age of the shares of a foreign corporation which owns assets situated in the United States, the value of a stated proportion of the assets of the foreign corporation would be included in his U.S. gross estate. Under the situs rules of the United States-Canada Estate Tax Con- vention shares of stock of a foreign corporation have a situs outside the United States and real estate located in the United States has a situs in the United States for taxation purposes; The Foreign Rela- tions Committee specifically dealt with the situation of a foreign corporation owning various types of property. That committee acted I Report to the President of the United States from the Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securities, etc., dated Apr. 27, 1964. 2 Treaties, Commerce Clearing House, No. 1318Q gives the text of the Foreign Relations Committee's Report on the United States-Canada Estate Tax Convention. 236 PAGENO="0247" ~REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 113 upon the Convention with the understanding that in these circum-~ stances the real property in the United States owned by the foreign foreign corporation should not have a situs for estate tax purposes in the United States. The same principle was illustrated in the com- mittee's report with respect to other types of property, such as ships and aircraft. It would be regrettable to depart from the principle established by the Foreign Relations Committee by adopting section 2 107(b), even for the entirely worthy cause of discouraging U.S. resident citizens from surrendering their citizenship for the sake of lower estate taxes. If, however, the rules of section 2 107(b) are retained in the bill, it is suggested that conffict with the Estate Tax Convention be kept to a. minimum by a clear statement that, for estate tax purposes, the cor- porate entity of a foreign corporation is to be disregarded only in the situation where the foreign decedent has given up his U.S. citizenship for purposes of avoiding or reducing the U.S. estate taxes. A copy of this letter is being sent to each member of the Committec~ on Ways and Means. Respectfully submitted. FULTON C. UNDERHAY. INVESTMENT Co. INSTITuTE, New York, N.Y., June 23, 1965. Re H.R. 5916, "Act to remove tax barriers to foreign investment in the United States." Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, House of Representatives 1102 Longworth House Office Building, Washington, D.C. DEAR CHAIRMAN MILLS: H.R. 5916 is largely based on the recom- mendations of the Presidential Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securities. Having had the honor of serving as a member of that task force, I am pleased, per- sonally and as president of the Investment Co. Institute, to express t& you approval in general of the bill without reference to its technicalities. While the bjll does not go as far as the task force's recommendation that the U.S. estate tax on intangible personal property of nonresident decedents be eliminated entirely, I understand that there may be technical reasons. for this. Assuming these reasons to be valid, the reduction of the maximum rate 77 to 15 percent and the replacement of the present $2,000 exemption with a $30,000 exemption represent a long step in the right direction and should be supported. Other major provisions of the bill, such as those relating to non- business income and withholding and also relating to taxation of capital gains, are substantially in accordance with the task force's. recommendations. It is gratifying that the Treasury has so promptly acted on the recommendations of the task force designed to increase foreign invest- ment in the United States. I appreciate the opportunity to express these views to you. Very truly yours, DORSEY RICHARDSON, President~ 237 PAGENO="0248" 114 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. INVESTORS LEAGUE, INC., New York, N.Y., June 24, 1965. Congressman WILBUR D. MILLS, Chairman, Committee on Ways and Means, House Office Building, Washington, D.C. M~ DEAR CONGRESSMAN MILLS: I wish to acknowledge and thank you and other members of your committee for your invitation to the Investors League to submit a statement on H.R. 5916, the "Act to remove tax barriers to foreign investment in the United States." Believing that such legislation will improve our country's serious balance-of-payments problem, we favor its enactment. Inasmuch as our written statement would closely parallel `that of the `New York Stock Exchange, for the convenience of your committee, we are submitting no further written testimony. Sincerely yours, WILLIAM JACKMAN, President. JUNE 29, 1965. GEORGE JAMES Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, U.S. House of Representatives, Washington, D.C.: In re hearings on H.R. 5916, as an industry member `of the Fowler Task Force I wish to associate myself with support of H.R. 5916 and with the specific recommendations for improvement of this proposed legislation as contained in the letter to you of June 24 from Mr. Andre Meyer and Mr. Frederick M. Eaton. Respectfully, GEORGE F. JAMES, Socony Mobil Oil Co. ROBERT MCKINNEY SANTA FE, N. MEX., June' 24, 1965. H.R. 5916: Task force. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, U.S. House of Repre- sentatives, Washington, D.C. DEAR MR. MILLS: In response to your announcement of June 18 inviting interested persons to submit written statements with respect to H.R. 5916, I enclose herewith a summary of some of the actions taken by the so-called private sector to implement those recommenda- tions of the Fowler task force directed toward it. I believe that the enclosed report clearly indicates that the private sector has made a substantial contribution to the general" effort to improve our balance- of-payments situation. `I should like, in addition, to point out that the help given by Chairman Cohen and his staff at the, SEC and by Assistant Secretary Surrey and his staff at the Treasury in implementing those re'commen- dations of the task force directed toward them has been extremely encouraging to the private sector. 238 PAGENO="0249" * REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 115 Speaking on behalf of the task force I sincerely hope that your committee will give prompt and favorable consideration to H.R. 5916. Very truly yours, ROBERT MCKINNEY. JUNE 22, 1965. IMPLEMENTATION OF TASK FORCE RECOMMENDATIONS BY PRIVATE SECTOR 1 A. U.S. FINANCIAL COMMUNITY Recommendation No. 1 U.S. investment bankers and brokerage firms should intensify their efforts to develop facilities for reaching foreign investors directly. Recommendation No. 2 U.S. investment bankers and brokerage firms should seejc modi- fication of foreign regulations and practices which unduly restrict the ability of U.S. firms to promote the sale of U.S. securities or to deal directly with potential foreign customers. (a) As of December 31, 1964, NYSE member firms had 182 offices in 27 foreign countries. This compares with a total of 170 offices in 24 countries as of January 1, 1964. (b) The Member Firms Department of the NYSE has embarked on a program of staff visitations of overseas offices of members. One .important~aiim.of these visits is to increase the efficiency, volume and scope of such operations. The information ~ will be used in part to review the appropriateness of present domestic- ally oriented rules and regulations of the exchange to overseas opera- tions of member firms. (c) Since the end~ of 1963, Merrill Lynch has opened four sales offices outside the United States, improved its internal wiréö~i~ cations system between its United States and its European offices, installed "Quotron" in four of its overseas offices, and is establishing in Europe an over-the-counter trading market for foreign dollar bonds. (d) In December 1964 E. F. Hutton announced it had installed a direct teletype wire service to Banco de Comercio in Mexico City. (e) White, Weld & Co. has five offices abroad which contribute to the distribution of its underwriting participations with foreign investors.. (f) On March 15, 1965, Smith, Barney & Co. opened a representa- tive office in Paris under the direction of a person designated vice president and European representative. (g) Kuhn Loeb has increased and strengthened its contacts with foreign investment institutions and individuals with a view toward developing further foreign investment in U.S. securities. (It) Loeb, Rhoades has taken steps to improve its telex coromunica- tion abroad and to extend and speed the facilities it has for communi- cation with foreign financial mstitutions which are interested in American securities for it~ clients. (i) Bache & Co. continues to broaden its coverage of foreign markets through a wide network of foreign branches and representatives. 1 This information was assembled from March to lune 1965. AccordIngly, some of the information ob. tamed may not be entirely up to date. 239 PAGENO="0250" 116. REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Both as investment bankers and brokers, the firm constantly seeks to improve its contacts with foreign investors and to overcome any restrictions on their ability to invest in U.S. securities. The firm has been instrumental in interesting a number of U.S. firms in listing their securities on foreign exchanges. Recommendation No. 3 U.S. investment bankers and brokerage firms, with the cooperation of interested U.S. corporations, should endeavor to obtain shares of U.S. corporations for distribution abroad. Recommendation No. 22 Corporations should collaborate with U.S. investment bankers in the utilization by the latter of techniques for distribution abroad of new or secondary issues of their stock. (a) On March 17, 1965, a 2,815,106-share secondary offering of GM common stock was released to the public. It is estimated that approximately 500,000 shares (approximately $100 per share) were sold abroad. The underwriting group was headed by Morgan Stanley & Co. (b) Morgan Stanley & Co. has explored with other clients the possi- bility of placing blocks of common stock with foreign investors, and has provided a number of its clients information regarding costs and procedures of listing on various foreign exchanges. (c) On July 8, 1964, a 33,000-share nonregistered secondary offering of Cutter Labs common stock was distributed outside the United States to non-U.S. persons. The distribution was handled entirely by Merrill Lynch. (d) Bache & Co. is an important distributor of secondary offerings of the shares of U.S. corporations, and its foreign offices are important participants in such distributions. (e) On June 8, 1965, a secondary distribution of 250,000 shares ~ $58.625 per share) of Minnesota Mining & Manufacturing Co. common stock was offered to the public. The underwiiting was headed by Lazard Freres & Co. Approximately 17 foreign under- writers purchasing approximately 75,000 shares participated in the underwriting group. (f) TOn June 10, 1965, the First National City Bank offered to stockholders the right to subscribe to an issue of $266,307,500, 4 per- cent convertible capital notes due 1990. The notes are convertible into capital stock unless previously redeemed. A significant effort to place these notes abroad was and is being made. At least 3 foreign underwriters participated in the underwriting group and approxi- mately 60 foreign dealers were invited to participate in the selling group. (g) On June 22, 1965 the Ford Foundation offered to the public 6 mfflion shares of Ford Motor Co. common stock (approximately $52 per share). Perhaps as much as 10 percent of this offering was sold overseas. Submanagers of a 59-n'ember European syndicate included Deutsche Bank AG for distribution in Germany; Lazard Freres & Cie for the rest ofContinental Europe, and Morgan Grenfell .& Co. Ltd. and Lazard Broi~hers & Co., Ltd. jointly for the United Kingdom. 240 PAGENO="0251" (REMOVE TAX BARRIERS TO FOREIGN. INVESTMENT IN U.S.. 117 Recommendation No. 6 U.S. investment bankers should include foreign banks and securities firms as underwriters, whenever possible, or as selling group members in new offerings and secondary distributions of either domestic or foreign securities. (a) The March 17, 1965, GM secondary underwriting group included 30 overseas investment houses underwriting over 10 percent of the shares. (b) The underwriting syndicate for the April 26, 1965, Chrysler offering of rights includes four Japanese firms. Although the present underwriting is not complete, it is reasonable to assume that some part of it wifi be purchnsed by foreign investors. (c) While no foreign underwriters were included in the syndicates, significant amounts of the following issues were placed abroad through foreign selling groups: Baystate Corp. (138,285 shares); Savanna Electric (150,000) shares); the Southern Co. (510,000 shares); Southern California Edison (1,500,000 shares). (d) Private placements and public offerings in which Bache & Co. participates either. as manager, syndicate member, or selling group member frequently included foreign banks and securities firms as participants. Recommendation No. 7 U~S. investment bankers and brokerage firms should organize the underwriting and distribution of dollar-denominated foreign secur- ities issues so that the maximum possible amount is sold to investors abroad. (a) During 1964 the NYSE listed three foreign bond issues sold entirely outside the United States as a consequence of the interest equalization tax: Copenhagen Telephone Co., Inc., the Japan Develop- ment Bank and the Metropolis of Tokyo. Two additional issues of this type are in process. (b) Between October 1964 and May 1965 the following six offerings of bonds totaling $135 million were registered with the SEC, managed by U.S. investment bankers, and underwritten by~ international con- sortiums: (Foreign underwriters participating in each. of the under- writing groups placed an average of 36 percent of each such offering). (1) May 5, 1965: Commonwealth of Australia.-$25 million bonds; 43 foreign underwriters, 58 percent of issue. (The 43 foreign firms are located . in 9 European countries. In addition, a substantial number of European dealers partici- pated as selling group members. The entire issue (which is subject to the interest equalization tax). is being placed outside the United States, and application has been made to list the bonds on both the London and New York Stock Exchanges.) (2) December 15, 1964: European Investment Bank.-$25 million bonds; 50 foreign underwriters, 62 percent of issue. (This issue was placed entirely abroad, although listed on the New York Stock Exchange.) (3) October 27, 1964: Mexico.-$35 mfflion bonds; five foreign underwriters, 26 percent of issue. (4) January 19, 1965: Republic of the Philippines.-$15 million bonds; seven foreign underwriters, 21 percent of issue. 241 PAGENO="0252" 118 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. (5) January 26, 1965: Republic of Portugal .-$20 million bonds; 33 foreign underwriters, 47 percent of issue. (These 5% percent bonds were exempt from the interest * equalization tax. Of the total, $5,377,000 were distributed directly abroad by 36 overseas investment houses in the under- writing group. An additional $3,465,000 were distributed abroad by 49 overseas investment houses who. became members of the selling group. * (6) April 21, 1965: Republic qf Venezeula.-$15 million bonds; three South American underwriters, 5 percent of issue. (c) Two bond issues of the Republic of Finland. and one of the city of Helsinki were issued between May 1964 and March 1965. These three issues totaled $40 million of which $23 million were sold to foreigners. The underwriting group included Harriman Ripley, Kuhn Loeb, Lazard and Smith, Barney. The $10 million offering of the city of Helsinki 6% percent bonds, due 1977, was offered on March 25, 1965. (d) White Weld invited foreign banks and securities firms as under- writers of the following issues managed by them: (The entire amount of these securities was subscribed for from abroad.) (1) $8 mfflion Kesko Oy 6% percent bonds due June 1, 1976. (2) $12 million Sumitomo Chemical Co. 6% percent bonds due December 1, 1979. (3) 15,000 units (about $15 million) international income fund. (e) The First Boston Corp. has included foreign underwriters as well as foreign selling group members in all of its foreign dollar issues The $20 million Japan Development Bank issue was sold entirely abroad. Foreign sales of the $25 million Mexican Government issue amounted to approximately 50 percent of the total. (f) Certain Japanese securities firms were included as underwriters and several European banks were included as members of the selling group in the $22.5 million offering of Nippon Telegraph & Telephone Public Corp. 5% percent guaranteed bonds due 1980, which was offered publicly on April 8, 1965. The managers were Dillon Read, First Boston Corp., and Smith, Barney. The issue was exempt from the interest equalization tax. Distribution studies are still being made but over 12 percent of this issue was distributed directly abroad through 46 overseas investment houses who participated in the selling group. (g) In September 1964, a $15 million issue of city of Oslo 5% percent sinking fund bonds due September 15, 1984, was offered largely in Europe under the management of four US. firms, and many European banks participated in the selling group. This offering was placed entirely outside the United States, although listed on the New York Stock Exchange. (h) In July 1964, three U.S. firms and one European bank made a $15 million offering of 5%-percent sinking fund debentures due 1984 of the Copenhagen Telephone Co. In addition, several European. banks were included in the seffing group. (i) The $22,500,000 issue for the metropolis of Tokyo was placed entirely outside the United States in April 1964, although listed on the New York Stock Exchange. (j) In December 1963 an issue of U.S. $5 mfflion 6%-percent con- vertible debentures due 1978 of Canon Camera Kabushiki Kaisha was 242 PAGENO="0253" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 119 sold entirely outside the United States by an underwriting group headed by Carl M. Loeb, Rhoades & Co., two London firms and one Tokyo firm. (Ic) In July 1964 an issue of US$13,745,000, and 45,020,000, DM 5% percent bonds of Instituto Per La Ricostruzione Industriale with warrants to purchase Finsider shares was sold entirely outside the United States by an underwriting group headed by Carl M. Loeb, Rhoades & Co. and three European firms. The underwriting group was made up almost entirely by foreign firms. (1) In December 1964 an offering of rights of 953,154 shares of Philippine Long Distance Telephone Co., with standby by an under- writing group headed by Carl M. Loeb, Rhoades & Co. was made public. Foreign firms underwrote 14 percent of the issue. The subscription price was payable either in U.S. dollars or Philippine pesos. * (m) Bache & Co. participates in numerous offerings of dollar- denominated foreign securities and employs its foreign facilities to a maximum extent in this regard. Recommendation No. 8 U.S. commercial banks should intensify efforts to attract foreign trust accounts for investment in U.S. corporate securities. (a) FNCB has set up a full-time continental representative office and has greatly increased trips abroad by senior trust officers. Rec~mmendatjon No. 10 Major U.S. corporations should arrange for U.S. banks and trust companies to issue, through their foreign branches and correspondents, depositary receipts for U.S. corporate shares. (a) In connection with the March 17, 1956, GM secondary, bearer depositary receipts, each representing one-twentieth of a GM share, were issued by Barclay's bank and listed on the London Stock Exchange. (b) FNCB was instrumental in setting up and making workable through its Brussels branch, Intertrust S.A., which sells depositary receipts for two U.S. mutual funds (Fundamental Investors, Inc., and Diversified Growth Stock Fund, Inc.) which are attracting con- siderable investment interest in Europe. Other similar efforts are currently under consideration. Recommendation No. 11 U.S. investment companies should plan and carry out a program to acquaint foreign investors with the advantages of owning U.S. closed end investment company shares. Recommendation No. 12 Distributors of U.S. open end investment company shares should devise methods for achieving additional foreign distrjbution of such shares, where locally permitted. Recommendation No. 13 U.S. investment company distributors should seek the modification of foreign regulations and practices which restrict the availability of their shares to foreign investors. 243 PAGENO="0254" 120 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN tT.S.. Recommendation No. 14 U.S. closed end investment companies should seek to place original. and secondary offerings of their shares with foreign investors and, where feasible, list these shares on major foreign exchanges. (a) In 1964, sales of shares of open end investment companies in Canada and in other foreign countries reached $115.2 mfflion, a substantial increase over the 1963 figure of $61.5 mfflion. The current estimate for the calendar year 1965 indicates another sub- stantial increase to $280 million. This increase stems primarily from an ability of distributors to adapt to the particular legal structures- existing in foreign countries. (b) One fund has been incorporated abroad that invests solely in the shares of American mutual funds, and several others are in the process of formation. (c) One closed end investment company group has recently placed. a block of shares worth several million dollars abroad, and its invest-~ ment banking associate is contemplating additional foreign offices. One large closed end investment company was recently listed on the Paris and Amsterdam exchanges. (d) Translations of basic explanations of mutual funds and their advantages have been made available in German, Spanish, Italian, French, Finnish, Dutch, and Chinese. One of the basic publications of the Investment Co. Institute has been translated into Spanish. (e) The Investment Co. Institute has initiated the regular collection of data concerning foreign markets, and a study of foreign investwient companies in late 1964 has been circulated to members and the public. The institute has underway a study of foreign investment company holdings of U.S. securities and the changes therein. (J) White Weld has devised a plan to the satisfaction of the British Exchange Control whereby a British subject was permitted to con- tinue his mutual fund investment program after his return to Great Britain, and has shown a Swedish bank how it may lend to an in- vestor in Abyssinia with such a program as collateral. (g) Bache & Co., as a distributor of open end investment company shares, constantly employs its foreign facilities to interest foreign investors in such shares. In its offering of shares of the Japan Fund, Inc., a closed end investment company, in July of 1963, it included the Netherlands Overseas Corp., N.Y., in the underwriting group and subsequently the shares of the fund were listed on the Amsterdam Stock Exchange. Recommendation No. 15 In order to promote the purchase of U.S. corporate securities abroad- (a) the U.S. financial community should cooperate closely with major U.S. corporations in the dissemination of corporate reports in foreign languages and in the publication of financial data in foreign newspapers; (b) U.S. investment bankers and brokerage firms should pre- pare research and statistical reports in foreign languages for distribution to foreign investors through local banks and securi- ties firms and promote the publication of more detailed U.S. stock market and financial information in the foreign press; 244 PAGENO="0255" IREMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 121 (c) facilities of U.S. commercial banks should be fully utilized to distribute to foreign financial institutions and investors reports, preferably in foreign languages, on the U.S. economy; (d) U.S. securities exchanges should take advantage of new communication techniques and reduced rates to promote broader use abroad of stock quotation and financial news services; (e) U.S. investment bankers and brokerage firms should offer securities orientation and sales training programs to personnel of foreign banks and securities firms; and (f) U.S. investment bankers, brokerage firms, and securities exchanges should work with their foreign counterparts and the foreign press to broaden share ownership by foreign investors. (a) On March 25, 1965, the New York Stock Exchange issued a statement in which it proposed to cooperate with stock exchanges throughout the free world to ease the tech- nical difficulties of effecting securities transactions among investors in different countries. In this statement the exchange also offered its services as a clearinghouse of inter- national financial intelligence to American companies and securities firms to aid such companies to list their securities on overseas exchanges, develop stock participation plans for foreign employees and, generally, to broaden overseas dis- tribution of their securities. (b) NYSE ticker tapes are now in Switzerland. More important has been the growth of electronic desk devices that permit foreign brokers to "dial" bid and asked prices of NYSE stocks,. The combination of ticker tapes and desk devices are in operation in most foreign countries. In all, the number of tickers in foreign offices increased from 49 to 68 during 1964. (c) Mr. Funston, president of the NYSE, recently jour- neyed to Australia mainly for the purpose of encouraging Australian investment in American securities. (d) The NYSE is currently planning a booklet to be pub- lished in several foreign languages outlining the advantages of investment in NYSE securities to foreign investors. (e) NYSE is writing to all foreign exchanges requesting information on their listing requirements and hopes to work toward greater unity in standards among exchanges in this matter. In this way the NYSE is able to facilitate foreign listings by American corporations. (f) Approximately a dozen U.S. corporations now print their annual reports in foreign languages; e.g., Phffip Morris, GM, Morgan Guaranty, Ford, FNCB, and IBM, et cetera. Many of these corporations printed their annual reports in foreign languages for the first time in 1965. Summaries of GM's annual report are also printed in prominent foreign newspapers and periodicals. (g) Merrill Lynch has offered its facilities tO numerous trainees of foreign banks and brokerage houses.2 2Itis noted that many New York banks and financial firms have training programs of this type. Accord- ingly, the several examples noted under this recommendation No. 15 are illustrative rather than exceptional. 245 PAGENO="0256" 122 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. (h) The "Transunit" division of Merrill Lynch in Geneva has translated and printed in several languages numerous investment reports. (i) Morgan Stanley & Co. has from time to time accepted personnel of foreign banks, investment firms, and government agencies for training in its methods of underwriting and sell- ing of securities. In addition, financial personnel of various foreign corporate clients have spent varying periods of time in the firm receiving training and orientation in U.S. financial procedures. (j) White Weld has arranged for the foreign employees of its foreign offices to receive formal and practical training in New York, and has occasionally offered training to foreigners not so employed. (k) The First Boston Corp. has from time to time had personnel of foreign banks and securities firms visit New York for extended periods of time, during which visits its officers and personnel explained the various aspects of its business. (1) In October 1964, Smith, Barney & Co. sponsored an investment seminar in Brussels which was attended by 100 to 120 representatives of European banks. This was a research conference specifically aimed at acquainting European invest- ment officers with surveys of American industry, including specific reference to a broad list of American companies in these industries. (m) Kuhn Loeb has continued to offer personnel of foreign banks and securities firms training facilities with its firm, and has instructed them in U.S. techniques of securities analysis and dissemination of information so as to encourage broadened share ownership by foreign investors. Its trainees have come from such diverse coun- tries as the United Kingdom, France, Germany, Belgium, Italy, and Japan. (n) Loeb Rhoades translated in late 1964 into French and German a review and 5-year economic projection of conditions in the United States. This was sent broadly to banks and other financial houses overseas. To some extent the firm has been translating bulletins into French to increase the interest of nationals of the country in U.S. securities. (o) Loeb Rhoades has had a steady stream of trainees of foreign bankers and brokerage firms visiting its offices for varying *periods of time to undertake a training in American securities and securities markets. (p) Bache & Co. disseminates a substantial volume of printed information on U.S. securities through its foreign system, supplies latest quotations on many securities to the foreign press via its wire system, and quite frequently plays host to foreign bankers and staff members of foreign securities firms for various periods of time to assist them in better understanding opportunities for investment in the United States. 246 PAGENO="0257" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 123 B. U.S.-BASED INTERNATIONAL CORPORATIONS Recommendation No. 18 U.S.-based international corporations should consider the advan- tages of increased local ownership of their parent company shares in countries in which they have affiliates. Recommendation No. 19 Where consideration under recommendation No. 18, above, is fa- vorable, corporations should collaborate with the U.S. financial community in encouraging greater foreign ownership of their shares. (a) IBM World Trade realizes the advantages of increased foreign ownership of parent company shares and, therefore, has had this stock listed on stock exchanges in Canada, Switzerland, France, and Germany. Listings on exchanges in other countries are under con- sideration. Collaboration with the U.S. financial community, how- ever, was not felt necessary. (b) Union Carbide has considered the possibility ~f1Iöcal ownership of its shares in countries in which it has affiliates. Recently, one of its senior corporate officers spoke in the United Kingdom and Scotland for the purpose of interesting~potentiai foreign ~ Carbide. (c) Bache & Co. has consulted with various U.S.-based corpora- tions with a view to offering its cooperation in the implementation of recommendations Nos. 18 and 19. Recommendation No. 20 U.S. securities exchanges should submit a plan acceptable to the Securities and Exchange Commission permitting U.S.-based inter- national corporations to encourage foreign ownership of their stock. (a) Such a plan has been approved in principle by the New York Stock Exchange Board of Governors, and discussed with the SEC. However, serious questions have come up regarding the practicability of marketing the securities of U.S. corporations overseas permanently through special sales efforts. Recommendation No. 23 1.LS. corporations should offer their shares to employees in foreign countries where stock purchase, supplemental compensation, or other incentive plans are feasible and desirable. (a) IBM has for some time had a plan designed to promote pur- chase of its stock by employees in foreign countries. (b) Employees of subsidiary companies, other than Du Pont of Canada who are awarded bonuses under the parent company bonus plan, receive a portion of their bonuses in Du Pont stock as do domestic employees. (c) Currently all GM executives in overseas countries are awarded as part of their bonus awards GM common stock, except in New Zealand where exchange restrictions prohibit such awards. All salaried employees in Canada participate in a savings program for the purchase of common stoCk and GM is actively engaged in working out ways to institute similar programs in other foreign countries. (d) FNCB has made available a stock purchase plan for all its employees everywhere in the world. 71-297 0-67-pt. 1-17 247 PAGENO="0258" 124 REMOVE TAX BARRIERS P0 FOREIGN INVESTMENT IN U.S. Recommendation No. 24 U.S-based international corporations should consider the advan- tages of listing their shares on foreign stock exchanges. (a) Chrysler, Hertz, and Buckingham Corp., have recently listed their shares on the London Stock Exchange. Chrysler stock is now listed on the Toronto, Montreal, Paris, and London Stock Exchanges. (b) IBM has listed its shares on stock exchanges in Canada, Switzer- land, France, and Germany, and has under consideration listing on exchanges in other countries such as the London Exchange. (c) Lehman Corp., Libby, McNeill & Libby, and Hertz have listed on the Paris Exchange. (d) Caterpifiar Tractor Co. was recently listed on the Paris and the London Exchanges. (e). Litton has listed on the Amsterdam and Zurich Exchanges. (J) W. It. Grace has listed on the Amsterdam Exchange. (g) Since July 1963, 32 Eurodollar issues totaling $448,500,000 have been listed on the Luxembourg Stock Exchange. (h) In 1963 Mobil listed its shares on the Paris Bourse. The cor- poration has under current review the feasibility of further foreign listings of its shares. (i) GM recently listed on the London Stock Exchange in connection with its March 17, 1965, secondary offering. GM common stock has for several years been listed on two exchanges in Canada, two ex- changes in Germany, and on the Paris and Brussels Exchanges. (j) FNCB has listed on the London (prior to April 1964), Amster- dam, Montreal, and Toronto Exchanges (August 1964). (ic) Union Carbide shares are listed on stock exchanges in Amster- dam, Brussels, Antwerp, and Paris, and under active consideration *is a listing on a German stock exchange. Stock of subsidiaries are listed on stock exchanges in Australia, Brazil, Canada, India, and Mexico. (1) In addition to assisting a few U.S. companies with listing on foreign stock exchanges, White Weld has prepared and made available to most of the large New York banks, and to international law firms, details on the procedures for listing American stocks on the principal European stock exchanges. (m) The First Boston Corp. has from time to time advised and encouraged the listing abroad of the stock of several corporations. (n) A number of Kuhn Loeb's corporate clients have been con- sidering the advantages of listing their shares on foreign stock ex- changes, and the firm has assisted them in evaluating the cost and other factors necessary to arrive at a decision on such listing. (o) Celanese has recently listed its stock on the Amsterdam Ex- change. Recommendation No. 25 U.S.-based international corporations should instruct their senior officers and policy groups to keep foreign financial operations under constant review, examining as standard procedure all proposals for new financing from the standpoint of the effect of their actions on the U.S. balance of payments. (a)~.IBM World Trade, Standard Oil (New Jersey), Du Pont, Union Carbide, and GM report that seni9r officers have been so instructed, etc. 248 PAGENO="0259" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN u.s. 125 (b) The treasurer's department of Socony Mobil prepares regularly for senior management a review of all operations of the corporation which have a bearing on the U.S. balance of payments. Recommendation No. 26 U.S.-based international corporations should, where feasible, finance their foreign operations in a manner which minimizes the outlay of cash. (a) GM is planning to finance a new plant in Antwerp. The re- quired funds will be provided by retained earnings and borrowings in local currency to be repaid out of future earnings. The company has not released figures indicating the amounts involved, but news- papers have noted that the project could involve expenditures equiva- lent to approximately $100 million. Borrowing arrangements are now being negotiated by the company. It is expected that the major part of the borrowing will be in the form of 5-year loans by Belgium's Societe Nationale de Credit a' L'Industrie and a consortium of banks in Belgium. Under the provisions of Belgium's 1959 incentive law, the Government has agreed to grant a reduction of 2~ percent in the rate of interest to be charged during the fIrst 2 years on one-half of the long-term borrowing. (b) IBM World Trade has for some time sought to make maximum use of foreign source financing and hopes to increase such this year. (c) Chrysler is planning approximately $250 million of expenditures overseas in 1965 and 1966, principally in Australia, France, Canada, and South Africa. The company has stated that substantial funds for such expenditures will come from reinvestment of earnings of foreign subsidiaries or from borrowing outside the United States. (d) Hilton International has scheduled five new hotels for opening in 1965, all of which will make use of foreign capital for fixed assets. Hilton will provide working capital and accept a lease for operating the units. (e) Kennecott Copper Co. is working on an agreement with the Chilean Government under which capital for expansion of the Braden Mine will be supplied by the Government and by international lending agencies. (j) Ford Motor Co. is expected to announce an £8 million sterling long-term debenture by its Australian company. Carrying at least 73~ percent interest, this debenture will be guaranteed both on capital and income by the parent company. Henry Ford 2d has said that the company plans to finance virtually all-of its expenditures for foreign facility investments in 1965 through funds generated outside the United States, and that these expenditures are es1~imated at about $300 million.- (g) Socony Mobil has formed a subsidiary company, Mobil Oil Holdings S.A., in Luxembourg, specifically to raise funds overseas. The funds will be used to assist in financing the capital needs of Mobil affiliates outside the United States. None of the securities of the new subsidiary will be offered for sale in the United States. On June 16, 1-965, - Mobil announced completion of arrangements to raise the equivalent. of nearly~ $28~mil1ion through the public issuance of bonds by. ~ucb subsi~iary. The boi~ds will carry an interest coupon of 5~ percent an4 b~. offere~l at a price of 97 to yield approximately 6.05 percent to maturity. The bonds will not be offered for sale i-n the 249 PAGENO="0260" 126 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. United States and purchasers will have the option of receiving pay- ment of principal or interest in sterling or German marks at a fixed rate of 11.17 DM to the pound. Socony Mobil is also negotiating a 15-year bond issue with S. G. Warburg, London bankers, in the approximate amount of 10 million pounds sterling. All in all, the company reports that the net increase during 1964 of its overseas borrowing was almost $50 million, and that a further substantial net increase in such borrowing is anticipated in 1965. (h) Westinghouse Air Brake has stated that it intends to raise 1.6 million pounds sterling outside of the United States. (i) Du Pont notes that in some cases it has rented plant sites rather than purchased them. (j) FNCB's two foreign investment affiliates (First National City Overseas Investment Corp. and International Banking Corp.) have in the last 18 months set up financing affiliates in the United Kingdom, Spain, Philippines, New Zealand, and South Africa which, for modest. initial dollar investments, make available many multiples of financing to U.S.-based international corporations. (Ic) General Foods Corp. borr9wed money abroad to finance its recent acquisition of a controlling interest in a coffee business in Spain. (1) Armstrong Cork Co. is revising financing of projects in Britain and West Germany to include more foreign source borrowing. (m) Continued heavy capital expansion of the foreign subsidiaries of Honeywell, Inc., in 1965 is being financed by borrowings outside of the United States. (m) Standard Oil Co. of California will maximize usage of foreign currencies to finance its 1965 capital and exploratory outlays. (o) CIT Financial Corp. is planning a private placement of two issues of notes totaling $95 million. The notes are to be sold in Canada for Canadian dollars, proceeds to be used to finance expansion by the company's Canadian subsidiary, Canadian Acceptance Corp. (p) In October 1964 a 25-percent interest (2,500,000 shares at $24 per share) in the wholly owned major Canadian operating subsidiary of Union Carbide (Union Carbide of Canada, Ltd.) was sold to the Canadian public. This subsidiary now has approximately 13,000 Canadian stockholders. The company plans to raise funds for its European expansion from European banks wherever possible. (q) The Treasury Department has summarized by industry the responses of U.S. corporations to the Commerce Department's pro- gram for business concerns under the President's balance-of-payments program as follows: 1. Mining.-There are several firms with large mining ventures where the total costs range from $100 to $200 million. In the typical case they expect to obtain about one-third of the total requirement abroad. They have had some success in getting loan commitments from banks in the host countries, but this will provide little additional for the future. The typical company mentions borrowings of over $20 miljion in Europe, but~ there are * indications that they are having difficulties, especially where they had counted on the United Kingdom money markets~ Any financing from Japan is tied in with Japanese equity in the venture. 250 PAGENO="0261" ~REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 127 2. Manufacturing.-Manufacturers of durable goods will in- dividually borrow from $3 to over $20 million abroad through local foreign banking and other credit facilities. Funds will be obtained primarily in the United Kingdom, Germany, Canada, Belgium, and Switzerland. In cases where commitments were listed, a total of $10 million will be borrowed in Belgium, $4 million m the United Kingdom, and $2 miffion in Germany. It was noted that oversea borrowing by foreign subsidiaries has become difficult because of heavy previous borrowing. 3. R'ubber.-Rubber companies have been substantial bor- rowers of funds abroad. A typical company hopes to borrow about $20 to $30 million abroad in 1965 to finance new construc- tion, expansion, and modernization of foreign affiliates. Funds will be obtained largely through short or long-term bank credit in host countries. 4. Transportation equipment.-Manufacturers of automobiles, automotive products, and other transportation equipment will borrow heavily abroad during 1965. In some cases, foreign financing will exceed $50 million. Funds will be secured pri- marily from Germany, France, and the United Kingdom. In keeping with traditional policy, -foreign expenditur~s-JLb~~ restricted to amounts which can be financed through loans in local currencies and cash flows generated abroad. 5. Petroleum.-The international oil companies have large oiititthidingforeign~credits, but~only -a- ~few -companies_c peet~~ important net increases. Where increases are indicated they will involve drawings under standby agreements with British, Dutch, and Swiss banks. A large corporate bond issue has been con- sidered in the German market. One company indicated the intention to borrow nearly $100 million during 1965. 6. C'hemicals.-Some chemical firms have given a good deal of study to foreign borrowing and have investigated a variety of arrangements. Borrowing by local affiliates is being buttressed by parent company guarantees in the case of one. major firm. Insurance company loans, leaseback arrangements and mortgage possibilities have been considered in addition to bank loans. A firm with an active investment program underway has loan commitments totaling $30~ million from Italian, British, and French banks. Typical borrowing mentioned by chemical companies were for small net increases in bank credit from a~ variety of sources. Equity financing is being used extensively in this industry, including even some of the less-advanced countries such as Spain. (r) The Federal Reserve Bank of New York states that the U.S~ banking system and nonbank financial institutions have responded wholeheartedly to the voluntary restraint program. As a result, the growth of bank credit has been effectively restricted and the balance-of-payments position has greatly improved. (s) Du Pont of Canada, Ltd., recently offered 500,000 . shares at $53.50 per share ($26,750,000) to Canadian investors. (t) Scott Paper of Canada, Ltd., recently offered 35,400 shares at $26.25 pershare ($929,250) to Canadian investors. 251 PAGENO="0262" 128 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Recommendation No. 27 In cases where new capital is required, U.S.-based international corporations should consider, in appropriate cases, broadening local ownership by offering in foreign capital markets bonds or preferred stock of their local affiliates convertible into common shares of the U.S. parent corporation. (a) IBM World Trade has issued debentures in France, Italy, and the United Kingdom. Recommendation No. 28 U.S.-based international corporations should be encouraged to make available, through trade or banking channels, specific case studies of foreign financing operations to small- or medium-sized U.S. firms interested in foreign operations but less aware of foreign financing opportunities. (a) IBM World Trade has so cooperated by participating in the American Management Association seminars on the financing of foreign operations. MANUFACTURING CHEMISTS' ASSOCIATION, INC., Washington, D.C., June 30, 1966. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, House of Representatives, Washington, D. C. DEAR MR. CHAIRMAN: The Manufacturing Chemists' Association, Inc., wishes to present its views regarding the provisions of H.R. 5916, a proposed act to remove tax barriers to foreign investment in the United States. The association is a nonprofit trade association of 196 U.S. member companie3, large and small, that together account for more than 90 percent of the productive capacity of the chemical industry in this country. * Many 11S.-based international corporations have deemed it both advantageous and in the national interest to finance their foreign opera- tions in a manner which minimizes outlays of U.S. dollars. This action has been taken in response to the President's request for the cooperation of the business community in alleviating the deficit in the U.S. balance of payments and is consistent with recommenda- tions 25, 26, and 27, of the report to the President from the task force on "promoting Increased Foreign Investment in U.S. Corporate Securities and Increased Foreign Financing for U.S~ Corporations Operating Abroad". In recent months there has been an indication of increased offerings of bonds in foreign capital markets as specifically suggested in recom- mendation No. 27 to raise funds for expansion of business operations abroad without detriment to the U.S. balance-of-payments position. As an inducement to foreign purchasers it was noted in the commen- tary on recommendation No. 27 that, since the issuer of the securities would be a foreign subsidiary, the purchaser would not have to cope with U.S. tax problems. In making such offerings U.S. corporations have not always found it expedient to have each of their foreign subsidiaries issue securities abroad, but rather to centralize issuance in one entity established for the purpose of financing the subsidiaries in that manner. In addition, 252 PAGENO="0263" BEMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.s. 129 it may be preferable to establish such an international financing orga- nization in the Unied States rather than abroad. Under the present estate tax law of the United States with respect to debt obligations, this can be done without subjecting the estate of a nonresident alien purchaser of the securities to such tax. The law now provides that bonds situated outside of the United States on the date of the non- resident decedent's death are not subject to imposition of U.S. estate tax. Paragraph (c) of section 8 of H.R. 5916 would change the estate tax situs rule of section 2104 of the internal Revenue Code of 1954 to provide that debt obligations owned by a nonresident alien shall be deemed to constitute U.S. situs property "if issued by or enforceable against a domestic corporation." This, in fact, would extend the rule presently applied in determining situs of stock of a domestic corpora- tion to debt obligations issued by such entity. Therefore, under this new rule the estate of a nonresident decedent containing bonds issued by a domestic company would for the first time be subject to U.S. estate tax liability. Although, under the other provisions of the proposed act, the estate tax liability of foreigners owning U.S. property at death would gen- erally be modified favorably and although such provisions would cushion the impact of the broadening of the estate tax base to include U.S. issued bonds, foreign investors understandably are interested in avoiding any estate tax liability in the United States. This consider- tion may well have a detrimental effect upon a nonresident alien's decision to participate or not to participate in a bond offering abroad by a U.S. corporation. As noted in recommen4ation 29 of the task *force report, "The U.S. estate taxes * * * are believed to be one of the most important deterrents in our tax laws to foreign investment in the United States." Accordingly, the proposed change in the situs rule with respect to bonds is directly contrary to recommendation 29 in which the elimination of U.S. estate taxes on "all intangible per- sonal property of nonresident alien decedents" was proposed. In view of the Treasury Department's interest in the continuing improvement of this country's balance-of-payments position, tax barriers should be removed from the path of those directly or in- directly contributing to the improvement of that position. To this end, it is urged that recommendation 29 of the task force report be effectively implemented by providing that all intangibles situated outside the United States at the date of a nonresident alien's death be excluded from such decedent's gross estate. This solution would seem to constitute the most effective and simplest method of inducing foreigners to invest here. It is worthy of note that the estate tax rules contained in the pro- posed act on the situs of bonds and other securities do not apply for purposes of determining a bona fide nonresident alien's gift tax liability. In fact, under ELR. 5916 the gift tax situs rules would be liberalized with respect to stock issued by a domestic corporation to provide that the nonresident alien will never under any circumstances be subject to gift tax liability on the transfer of intangibles. It is urged that a consistent rule should apply for the purpose of subjecting a nonresident alien to estate tax, particularly in view of the close relationship betw~en the two taxes. 253 PAGENO="0264" 130 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. In conclusion, we recommend that H.R. 5916 be revised so that exemption be granted with respect to any intangibles owned by a nonresident alien decedent at his death as provided in recommenda- tion No. 29 of the task force report. However, if total exemption with respect to all intangibles is not considered feasible, it is suggested that the proposal contained in H.R. 5916 to amend the situs rule on debt obligations be rejected and that the present law on the subject be retained. The Manufacturing Chemists' Association, Inc., appreciates this opportunity of presenting its views on H.IR. 5916 and requests that this letter be made a part of the record of hearings on the bill. Very truly yours, M. F. CRASS, Jr., Secretary-Treasurer. NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC., H~ashington, D.C., June 25, 1965. Re H.R. 5916, act to remove tax barriers to foreign investment in the United Sta.tes. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, U.S. House of Represent- atives, Longworth House Office Building, Washington, D.C. DEAR MR. MILLS: While the association does not have a formal statement to submit On H.R. 5916, we support the purposes of the bill to stimulate foreign investment in the United States by removing existing tax barriers to such investment. We believe it is a construc- tive approach to improve the U.S. balance-of-payments problem and and should have an overall beneficial effect on the U.S. financial community. Very truly yours, ROBERT W. HAACK, President. NATIONAL FOREIGN TRADE COUNCIL, INC., New York, N.Y., June 24, 1965. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, House of Representatives, Washington, D.C. DEAR MR. CHAIRMAN: The National Foreign Trade Council, Inc., is pleased to respond to your invitation of June 18, 1965, to submit written statements on H.R. 5916, the act to remove tax barriers to foreign investment in the United States. As you know, the purpose of the bifi is to carry out certain legis- lative recommendations of a Presidential task force, headed by then Under Secretary Fowler, appointed to advise on ways in which more U.S. securities could be sold abroad to help meet the balance-of- payments problem. The National Foreign Trade Council recommends enactment of H.R. 5916. As the report of the task force indicates, adoption of such legislation would "remove a number of elements in our tax structure which unnecessarily complicate and inhibit investment in U.S. corporate securities without generating material tax revenues. 254 PAGENO="0265" REMOVE TAX BXR'E1EE~ TO FOREIGN INVESTMENT IN U.s. 131 They are not intended to turn the United States into a tax haven, nor to drain funds from developing countries." In so doing, the U.S. balance of payments would be bettered, and long-i'ange benefits to U.S. corporations operating abroad would also result. The council is of the opinion that the objectives of H.R. 5916 could be more fully attained if the bill were modified somewhat. A sum- mary of our recommendations in this respect is contained in ap- pendix I. The task force report also contained certain other recommendations, addressed to the financial and business community, as to certain actions it ~could'take to assist in achieng-~thebjective~--In4his connection, the council earlier this year sent to a number of its mem- bers, with substantial operations outside the United States, a ques- tionnaire concerning the recommendations in the report of the Fowler task force designated "Actions Involving U.S.-Based International * Corporations." A summary of the responsesis containedin appendix II for your information. Sincerely, yours, JOSEPH B. BRADY, APPENDIX I SUGGESTED CHANGES TO H.R. 5916 Taxation of estates of nonresident aliens The most desirable change in connection with the taxation of ~estates of nonresident aliens which could be added to the bill is that recommended in the report of the Fowler task force; namely, that the bifi should "eliminate U.S. estate taxes on all intangilbe personal property of nonresident alien decedents." Any tax on estates of nonresident decedents, particularly those with comparatively small amounts of property in the United States, could form an obstacle to investment in U.S. securities. Even if the present provisions of the `bifi were enacted aliens may well be concerned that the 5-, 10,- and 15-percent rates might be increased. If H.R. 5916 as introduced were enacted, taxes on estates of non- resident aliens could be avoided by the formation of a corporation to hold any property of such aliens. However, since the formation and maintenance of a corporation is complicated and expensive this procedure would appeal only to aliens with large amounts of property in the United States, and not to aliens with small or medium amounts of property in the United States. It is believed that the changes in the bifi are intended especially to induce the latter group to invest in the United States. Graduated taxes-Filing of return should not be required Recommendation 3~ of the Fowler report concerning the imposition of graduated tax on aliens has been implemented by the Treasury proposals and provisions of H.R. 5916. However the bill should contain an affirmative statement to the effect that where the non- business income of a nonresident alien, not engaged in trade or business, is subject to withholding, no return need be made by the alien. Possibly the bill as introduced imples that in such a situation no return need be made. However, in order to avoid any misunder- 255 PAGENO="0266" 132 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S.. standing it would be desirable to have the bill so provide. A second choice would be to have a statement contained in the report of the Committee on Ways and. Means to the effect that it was anticipated that regulations of the Internal Revenue Service should so..provide. Engaged in trade or business-Dealer in securities Proposed section 871(c), H.R. 5916, as introduced, defines "engaged in trade or business within the United States." It provides that the term does not include "certain trading in securities or commodities" (871(c) (2)). However, there seems to be excepted from this exemp- tion situation "where the pierson so trading is a dealer in securities." This provision of the bill, as introduced, is contrary to one of the basic proposals of the report of the Fowler task* force, reflected in several recommendations; namely, that foreign security dealers should be encouraged tO participate in the marketing to foreigners of U.S. securities. The bifi as introduced could be so interpreted as to provide a real obstacle to any activity in the United States of any foreign dealer in securities. It is urged that the Committee on Ways and Means take appropriate action to correct the provision as now contained in the bifi. APPENDIX II SUMMARY OF RESPONS'ES TO NFTC QUESTIONNAIRE RELATING TO CERTAIN RECOMMENDATIONS IN THE FOWLER TASK FORCE RE- PORT Recommendations 3, 10, 18, 19, 22, 24 Some of the more significant replies to this set of recommendations, all of which generally are concerned with the making available for distribution abroad of shares of U.S. corporations are set forth below. In the principal financial markets where investment in U.S. securities is permitted and practiced appreciably the company's shares are now readily available through either (1) current listings on foreign stock exchanges; (2) active trading on an unlisted basis; or (3) ready access to the New York markets. * * Company's stock is listed on Zurich Exchange where * U.S. stock certificates endorsed in blank are good delivery. Company's stock was previously listed in Amsterdam and Brussels, where depositary receipts in bearer form were issued by local trust companies. Company is also contem- plating issuing its annual report in several foreign languages. The company's common stock is now traded in on about eight European markets. Several foreigners are now shareowners in the company. Depository receipts for the company's stock are now offered by at least two European * banking firms. Parent company shares available to local residents in all countries in which company has affiliai~es. Company has pointed out to government and industrial leaders in these countries that they could participate in the enterprise through the ownership of shares. 256 PAGENO="0267" REMOVE TAX BARRIERS TO P0RET~N "I E~MENT IN u.s 133 The company's shares are presently listed on ftmr foreign exchanges (London, Paris, Toronto, and MOntreal) and the company is planning to list its shares in Switzerland. With respect to increasing foreign ownership of U.S. parent company shares, the company has long recognized that there may be benefits associated with wider ownership of its shares, such as increased sales of its products and a reduction in dis- crimination on the part of some countries against companies owned by foreigners. However, their experience has been that~ it is difficult to distinguish in the countries where the* company has been listed any significant increase in sales or reduction in discriminatory practices which can be attributed solely, or even in part, to listing. Accordingly, the com- pany has been willing to list its shares on foreign exchanges where it is possible to do so at a reasonable cost, but has been reluctant to do so where it entails: significant costs as has sometimes been the situation. The . company's shares are~ currently listed and/or traded on several foreign exchanges. Company does collaborate with U.S. financial community in encouraging foreign ownership of its shares. Company collaborates by listing its shares on foreign exchanges and by promoting the company abroad. Company has collaborated with the U.S~ financial com- munity in encouraging greater foreign ownership of its shares. A large secondary offering of the company's common shares was successfully placed abroad: The company has recently made available to various representatives of the financial community, as well as others interested in this area, copies' of its annual report in condensed form for distribution abroad in several foreign languages. During 1964 the company added additional foreign languages in which its report was published. Also the company has had summaries of the re- port printed in prominent foreign newspapers and periodicals. The company has distributed these reports to a number of other American companies and there are indications that many of them will also prepare foreign language versions. Company has traditionally used foreign sources of debt' financing. Company has also engaged in public borrowing on the Swiss capital market. Company's Swiss subsidiary issued a large debenture issue in Switzerland, which was underwritten by a Swiss banking syndicate, sold publicly and listed on several Swiss stock exchanges.' Company is also on the waiting list for a new Swiss franc debenture issue but. the Swiss monetary authorities, are rationing long-term Swiss capital and at this time the company cannot predict when. their next issue may be offered. Parent company's shares are listed on several foreign stock exchanges. Also the company is actively investigating the possible listing of its parent company shares on other foreign stock exchanges. 257 PAGENO="0268" 134 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. Company expects its stock to be listed on two foreign stock exchanges shortly. It also expects to be listed on the French Stock Exchange unless recent proposed French legislation makes it inadvisable to do so. Company is planning to list its stock on several other foreign stock ex- changes in the near future unless it develops that local regulations make it inadvisable to do so. Company has also made inquiries regarding the possibility of listmg on Australian and Brazilian exchanges; however, company has been informed that the Governments of those countries wifi not permit it. at this time. Recommendation No. 23 This recommendation concerns the specific technique of U.S. corporations offering shares to their employees in foreign countries. Company has or is in the process of offering shares to employees in foreign countries under incentive stock purchase plan. Shares have recently been made available for purchase by employee members of a provident fund in one foreign affiliated company. Company has for some time offered shares to both U.S. and foreign resident employees as well as many nationals. Program is part of company's worldwide stock option plan. Employees of subsidiary companies (excluding Canada) who are awarded bonus under parent company bonus plan receive a portion of these awards in the company's stock exactly the same as domestic employees. Company offers its shares to employees in foreign countries through two foreign employee savings thrift plans involving parent company stock. For many years Canadian salaried employees of company who participate in its incentive program have received shares of company's common stock as part of their awards. This program was expanded to include overseas participants in company's incentive program within the last few years and currently stock is awarded as part of their bonus awards to executives in all overseas countries, except New Zealand where exchange restrictions do not permit. Company's salaried employees in Canada have been participating for a number of years in a savings program for the purchase of common stock. There are, of course, impediments in many countries to such a program. Company has been actively engaged for several years in studying the problems and hopes in the near future to work out methods for similar programs in some of the other countries where it has principal interests. Company's stock purchase plan is not restricted to U.S. employees; company now has many foreign participants in the plan. 258 PAGENO="0269" REMOVE TAX BARRIERS `TO FOREIGN INVESTMENT IN U.S. 135 In addition, stock options are, from time to time, offered to foreign employees. Recommendations 25 and 26 These recommendations which concern the instruction of senior officers to review financial operations from the standpoint of their effect on the U.S. balance of payments and also that U.S. corporations, where feasible, should finance their foreign operations in a manner which minimizes the outlay of cash, are considered together. Some of the significant responses to these questions are as follows: A major responsibility of senior personnel is to examine all new financing proposals from the standpoint of their effect on the U.S. balance-of -payments. It has been-the~c-om~~~ pany's policy for many years for all investment abroad to be financed through foreign borrowings and earnings; this policy will be continued in the future. Recent statement by President Johnson and amplification by Secretary Connor makes it more important than ever that all American companies cooperate to the fullest extent in this effort. Prior to February 1965 little attention was paid to the problem. Henceforth it will receive highest level attention, and maximum foreign financing will be sought for most major projects. For a long time the company has been alert to the U.S. balance-of-payments implications of its worldwide invest- ment program. In this respect, the company is very con- scious of the significant positive contribution its overseas operations made to the U.S. balance. The company has sought all along to maximize the con- tribution it can make to the American balance of payments, and has carefully reviewed its foreign financial operations with this objective in mind. The company intends to support fully the new program recently outlined by President Johnson. Company has made a definite point of instructing all the groups in company that are involved in this decision area, both in the United States and abroad. The company has reexamined and will continue to reexamine its policies, and practices controlling international transactions in an effort aggressively to do its part in solving the U.S. balance-of- payments problem. The company is participating in the President's voluntary program to improve the U.S. balance of payments. One of the ways in which they are contributing to the program is to review carefully any new financing of overseas operations. Whenever practical, financing will be obtained abroad and every effort will be made to minimize cash outflows which would hurt the U.S. balance of payments. Company has been cooperating fully with the President's voluntary program to reduce the U.S. balance-of-payments deficit. 259 PAGENO="0270" .i36 REMOVE TAX BAR~LERS TO. FOREIGN INVESTMENT. IN U.S. Company has an internal system which produces a balance- of-payments ledger so that all transactions may be examined in light of the effect on the balance of payments. Com- pany's estimate for the year 1965 shows that it should be* * able to meet the guideline improvement, in its favorable bal- ance-of-payments contribution, suggested by the Department of Commerce. Since the general realization of the seriousness of the American problem concerning its balance of payments and the President's appeal for industry cooperation, company has been examining, as standard procedure, all of its foreign operations requiring new investments to seek the alternates that will minimize the problem. Company has been traditionally taking opportunities of financing to a very large extent its foreign operations from funds generated outside the United States. It has also been company's policy to invite foreign participation in its new ventures in many instances and in this way provide the addi- tional financing required to expand its foreign operations. Company's proposed new foreign projects do include, without exception, provision for extensive local borrowing as well as local participation in equity. Company has earnestly tried to comply with the Presi- dent's request concerning action to improve the U.S. balance- of-payments position, and, to that end, will certainly make much more serious efforts in the future to find foreign sources for capitalizing proposed foreign ventures. Company examines opportunities to minimize the outlay of cash. In some cases, for example, the company has rented plant sites rather than purchased them. It has also endeav- ored to obtain "Cooley loans" without, however, ever having any success in this respect due to unwillingness of the local governments, in countries such as Brazil, to make these funds available to U.S.-owned companies. In the past, the company has generally preferred to finance its foreign operations from retained earnings and fresh capital from the United States. Company is utilizing some local borrowing and is now considering extending local coverage. Company's overseas affiliates normally rely heavily on their respective internally generated funds and local borrow- ing sources for their financial requirements. Company noted* that this recommendation has been superseded by the program of voluntary cooperation to improve the U.S. balance of payments. The company intends to comply and hopes to achieve an improvement of 15 tO 20 percent over 1964 in the company's balance of pay- ments for 1965. As a matter of long-standing policy, the company has relied on local sources to meet the financing requirements of its overseas investments, principally by retained earnings or 260 PAGENO="0271" REMOVE TAX BARRIERS TO FOREIGN fl~VESTME~T r~ U.s. 137 by local borrowings. The company plans to continue this policy. It has been the practice of the company, wherever practi- cable, to minimize the outlay of U.S. dollars and to finance foreign operations in foreign currencies. The company follows the practice in several foreign countreis, accepting the burden of higher interest rates to make this possible. To the extent that foreign currencies are available, the company expects to continue to finance foreign operations in this manner. The company has sought to do this in one foreign country but has not been successful. However, the company hopes to change this, and is now attempting to arrange sources of financing in the local currency. The company noted that it has been active in connection with all recommendations of the Fowler task force. Ifartic- ular emphasis, however, has been directed to the financing and ownership of foreign operations. It has always been the policy of the company to encourage local participation in the ownership of operations outside the United States and in practically all instances there is such ownership. In addition, these foreign operations are financed as largely as possible through local borrowings and the expansion of these opera- tions has been on the basis of funds generated locally. During 1964 company undertook to increase its overseas borrowing in the so-called developed areas by a sub- stantial margin. In line with the recommendations of the Fowler task force and, more recently, the President's voluntary program to assist the balance of payments, the company intends for the future to make every reason- able effort to finance its overseas investments from foreign sources. A further substantial net increase in borrowing is anticipated in 1965. Company is aware of the desirability of minimizing the outlay of cash in the financing of foreign operations. In many instances, a large amount of the fixed invest- ment in new manufacturing plants is represented by ma- chinery shipped from the United States. In addition; where feasible, company strives to take advantage of inducements offered by governments in the establishment of new manufacturing facilities, which will minimize the use of cash from the United States. Recommendation 27 This recommendation concerns the offering in foreign markets of bonds or preferred stock of U.S. corporations convertible into common shares. ~ The response to this particular recommendation was comparatively unenthusiastic-typical of the replies are the following: Recommendation does not appear practical to company at this time because conversion of securities issued by foreign 261 PAGENO="0272" 138 REMOVE TAX BAREIERS TO FORE~IGN INVESTMENT IN U.S. affiliates into common stock of the parent company in the United States would create serious legal and accounting problems. Company has studied the feasibility of such a proposal in the past. There are a number of impediments which must be overcome. The company is continuing to study the matter with a view toward its eventual implementation where circumstances permit if the impediments can be satisfactorily resolved. The company has not carried out the actions suggested in the recommendation and does not have any plans for such action in the near future. The company noted that this recommendation appears to have too many complications and possible tax disadvantages. Recommendation 28 This recommendation concerns making available information' concerning foreign financing to companies interested in foreign operations but less aware of foreign-financing opportunities. Some of the responses to this recommendation follow: The company has been and will continue to assist small- or medium-sized firms by answering direct inquiries for specific information or by supplying answers to questions such as those submitted by NFTC. Members of the company's organization have frequently been called upon by business schools, management seminars, and official conferences to share the benefit of the company's long experience in international finance with others more recently engaged in a foreign investment program. The company noted that they are happy to take part in these educational seminars. The company has carried out this recommendation through the preparation of case studies, participation in management seminars, and is prepared to do more, if requested. STATEMENT OF G. KEITH FUNSTON, PRESIDENT, NEw YORK STocK EXCHANGE, ON H.R. 5916 The New York Stock Exchange welcomes this opportunity to com- ment on the proposed tax legislation embodied in H.R. 5916 and en-~ titled "An act to remove tax barriers to foreign investment in the United States." The legislation incorporates, in large part, the recommendations of the Presidential Task Force on the Balance of Payments (the Fo.wler committee report), of which the exchange' president was a member. Adoption of this legislation would do much to stimulate the long-term flow of foreign capital to the United States, in part by removing archaic restrictions on these capital flows. The securities industry has long advocated removal of these restrictions. The exchange applauds the fact that the administration proposals will, enhance the freedom of movement in the international flow of capitaL funds. 262 PAGENO="0273" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 139 The legislation as written can be strengthened in several ways, though, as discussed below, and moved closer to its objective of pro- viding greater stimulus to foreign `investment. In addition, the effec- tiveness of a program to encourage foreign investment in U.S. securi- ties may be enhanced by adopting several measures not included in `the tax bill. First, concerning the bill itself, the exchange suggests the following :Rdjustments: 1. Elimination of es/ate tax on nonresident aliens.-Section 8 of the bifi prop'oses that estate tax rates be reduced to 20 to 30 percent of present levels, thereby taxing nonresident aliens at about the same `rates as U.S. citizens who claim a marital deduction. This proposal `stops considerably short of the Fowler committee recommendation to "eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents." Though the proposed rates would be `below those imposed on `resident estates in the United Kingdom, `Canada, and Italy, they would be higher than those imposed in `Switzerland, Germany, France, and the Netherlands. Thus, the proposal favors the residents of some countries while discriminating against those of others. The complete elimination of estate taxes would result in a much "greater stimulus to foreign investment than any partial reduction in rates. First, since even the proposed tax rates are higher than those now levied in many other countries, this deterrent to investment by residents of those countries would remain. Second, many foreigners ~are discouraged from investing here by the requirement to ifie estate tax returns. This requirement would, of course, be eliminated if the tax were removed. Eliminating the estate tax on nonresident aliens would result in a `very small loss of revenue. The tax has yielded between $3 and $5 mfflion annually in recent years, and would probably yield only about $1 mfflion under the proposed legislation. Even if the rate schedule proposed in the bill is adopted, all estates *of over $2,000 will apparently still be required to ifie a return despite an increase in the exemption from $2,000 to $30,000. Again, since the filing requirement discourages foreign investment, the exchange sug- ~gests that estates of under $30,000 be exempted from reporting. In addition, if it is administratively feasible, section 2105 of the Internal Revenue Code should be amended so that all funds awaiting `investment would not be considered property within the United States for estate tax purposes. Nonresident aliens' deposits in banks and savings and loan' associations are not considered property under `the proposed legislation, and this exemption might appropriately be extended to their free credit balances with brokers. 2. Defil?ition of "engaged in trade or business."-The legislation `proposes to amend section 871, subsection c of the Code, to (a) exclude from the term "engaged in trade or business within the United States," "trading in stocks or securities for one's own account, whether trans- actions are effected directly, or by way of an agent, through a resident broker, commission agent, custodian, or other independent agent, `and, exc'ept where the person so trading is a dealer in securities, "whether or not any such agent has discretionary authority to make decisions in effecting such transactions" and (b) to apply `a similar exclusion to those trading in commodities for their own account. 263 71-297 O-67-pt. 1-18 PAGENO="0274" 140 REMOVE TAX BARRIERS. TO FOREIGN INVESTMENT IN U.S. The New. York Stock Exchange sees no reason for considering a~ securities or commodities dealer as engaged in business in the United States if he grants discretionary authority to an agent in a trade for his own account. The exchange recommends, therefore, that the phrase "except where the person so trading is a dealer in securities [or commodities]" be stricken from the bill. 3. Repeal of withholding on interest and dividend payments.- Consideration might be given to unilateral repeal of the withholding tax on interest and dividends paid to foreigners, or to the reduction of the percentage withheld. The withholding tax clearly de~ters invest- ment by foreigners, and its repeal or reduction would appreciably stimulate foreign purchases of U.S. securities. If the potential revenue loss makes unilateral action undesirable (the U.S. obtained, perhaps, $100 milhionfrom the withholding tax in 1964), the U.S. should press for mutual reductions in the withholding tax with as many foreign countries as possible. Since transactions in outstanding securities have generally produced an inflow of funds to the United States, mutual reductions in the withholding rate would probably stimulate more foreign purchases of U.S. securities than U.S. purchases of foreign securities--except for the temporary adverse effect of the interest equalization tax. 4. Easing taxes on foreign pension trusts.-Taxes and other restric- tions imposed on foreign pension trusts and similar investors should be eased. Domestic pension funds enjoy a tax exemption on their in- vestment income. Foreign pension funds cannot obtain this exemp- tion without going through the difficult procedure of obtaining ap- proval from numerous Government agencies. As a result, these investors are discouraged from investing here, especially if they are exempt from taxes in their country of domicile. Pension funds in some foreign countries have become increasingly important in recent years. For example, the Joint Economic Com- mittee study of European capital markets indicates that pension funds in Britain have been one of the most rapidly growing sectors in that country's financial structure, and had investments of $10 biffion at the end of 1962.' It seems reasonable to assume, therefore, that by according foreign pension funds a tax treatment similar to that en- joyed by domestic funds, a considerable capital flow into the United States might be stimulated. Further, we assume that Treasury regu- lations can provide safeguards necessary to prevent any abuse of this legislation. Consequently, taxes on the income of foreign pension funds and similar institutional investors sh9uld be eliminated by law; alterna- tively, these investors should be able to obtain tax exemption more readily. As a minimum step, the United States should work toward the mutual elimination of taxes on these types of investors. The exchange believes that adoption of these amendments and additions would enhance the effectiveness of the proposed legislation considerably. Respectfuily submitted. G. KEITH FUNSTON, President, New York Stock Exchange. 1 U.S. Congress, Joint Economic Committee, "A Description and Analysis of Certain European Capital Markets," 1964, p. 238. 264 PAGENO="0275" REMOVE TAX BAI~RIERS TO FOREIGN INVESTMENT :IN-U.& 141 NEW YORK, N.Y., Jnne 24, 1965. WILBUR D. MILLS, Chairman, Committee on Ways and Means, U.S. House of Representatives, Washington, D.C.: Concur with all provisions of H.R. 5916 on removal of tax barriers to foreign.investment in the United States with the exception of limited exemption in case of taxable estate we prefer recommendation No. 29 of report of Fowler task force and strongly urge complete elimination of estate taxes on all intangible personal property of nonresident alien decedents. It is our opinion that this tax is the major deterrent to foreign investors, participation in U.S. investments. REAL ESTATE TRADE MISSION TO EUROPE, J. D. SAWYER, Chairman. SHEARMAN & STERLING, New York, June 25, 1965. H.R. 5916: Act to remove tax barriers to foreign investment in the United States. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, U.S. House of Representatives, Washington 25, D.C. DEAR SIR: Pursuant to your request for statements with respect to the above legislation, I enclose a copy of a memorandum I sub.. mitted to Hon. Stanley S. Surrey, Assistant Secretary of the Treasury, under date of May 12, 1965. You will note that a change was suggested in H.R. 5916 to eliminate an inequity to one of our clients, Schiumberger, Ltd., a foreign corporation with its principal office in the United States. Schlumber~er, Ltd., which has, annual revenues in the magnitude of $300 miffion, is listed on the New York Stock Exchange and a check for interest equalization tax purposes established that' more than 65 percent of its outstanding stock is owned of record by U.S. persons. Historically, Schiumberger, Ltd., has never derived any benefit from the provisions of the income tax treaty between the United States' and the Netherlands because it is `resident in the United States. H.R. 5916 would make the provisions of the treaty applicable for the first time to Schlumberger, Ltd.'s dividend income from its U.S. sub- sidiaries. This would have the effect of increasing the U.S. tax rate from 7.2 to 30 percent on dividends from a U.S. holding company subsidiary owning U.S. operating subsidiaries, despite the fact that such earnings had already been subjected to U.S. income tax at ordinary rates on a consolidated return. The *tax could not be avoided by including Schlumberger, Ltd., in the consolidated return because it is a foreign corporation, ineligible to be a member of an affiliated group for U.S. tax purposes. ` Very truly yours, ` ` CHARLES GOODWIN, Jr, 265 PAGENO="0276" 142 REMOVE TAX BARRIERS TO' FOREIGN INVESTMENT IN U.S~ SHEARMAN & STERLING, New York, N.Y., May 12, 1965. Memorandum to Hon. Stanley S. Surrey, Assistant Secretary of the Treasury. :Subject: H.R. 5916 and article 7 of the Income Tax Treaty between the United States and the Netherlands. The purpose of this memorandum is to point out an' inequity in article 7 of the Income Tax Treaty between the, United States and the Netherlands (the "treaty") when considered in conjunction with the proposed legislation concerning taxation of foreign investments ("H.R. 5916"). The problems arises because under section 4 of H.R. 5916 dividends paid to a Netherland-Antilles Corp. which owns the stock of a U.S. holding corporation, which in turn owns the stock of U.S. operating corporations, will be taxed at a 30 percent rate although under article 7 of the treaty the rate of such tax would be limited to 5 percent if the Netherland-Antifies Corp. owned the stock of the U.S. operating company directly.. * Schiumberger, Ltd. ("SL") is a Netherland-Antifies Corp. which commenced business in 1957. At the time SL was organized an Internal Revenue Code, section 367, ruling was obtained to the effect that the exchanges involved in such organization were not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax. SL is sole stockholder of two U.S. corporations each of which has U.S. subsidiaries. Since SL is a foreign corporation, the U.S. companies have not been permitted to file a single consolidated return. For various management and business reasons and in order to permit the filing of n single consolidated return SL proposes to combine its U.S. subsidiaries into a single affiliated group under a U.S. holding company. In the absence of the proposed plan of reorganization, SL would qualify under H.R. 5916 and the United States-Netherlands' Income Tax Treaty for the 5-percent tax on dividends received from its U.S. operating subsidiaries. However, under the protocol of September 28, 1964, article 7 of the treaty (which limits the tax on dividends to 15 or 5 percent) is made inapplicable to dividends received by a Netherland-Antifies Corp. if it is receiving certain tax benefits under Netherland-Antilles law (which benefits SL is receiving) unless the payer of the dividends, that is the U.S. corporation, is owned at least 25 percent by the foreign èorporation, and: "(a) the payer of such income is a U.S. corporation (other than a U.S. corporation~, 60 percent or more of the gross income of which is' derived from interest except to the extent derived by a corporation the principal business of which is the making of loans, div'idends, royalties, rents from real property, or gain from the sale or other disposition of stock, securities, or real property, or gain from the sale or other disposition of stock, securities, or real property)." [Emphasis added.] Under the proposed reorganization the new U.S. corporation as the parent of the U.S. operating companies would receive most of its income from dividends from such subsidiaries and, accordingly, under the protocol the dividends from the U.S. corporation to SL would not qualify for the treaty rate but would be taxed at a 30- percent rate under H.R. 5916. 266 PAGENO="0277" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN u.s. 143 There would appear to be no policy reason why the 5-percent rate should not apply to dividends from the new U.S. company to Sb. Dividends from wholly owned operating subsidiaries are not the type of investment income against which the protocol is directed. It is submitted that the nature of the U.S. parent company's income should be determined not by looking at it individually, but by looking at the consolidated income of the entire group. To do otherwise would be to penalize the form of the U.S. organization despite the substance of the consolidated operations which generate the income from which the dividends paid to Sb are derived. This argument has even greater weight when it is considered that.the U.S. subsidiary of Sb and its subsidiaries intend to file consolidated returns. Under the consolidated return regulations dividends received by one member of an affiliated group from another member are not treated as dividends for consolidated taxable income purposes. (1.1502-31(b)'(2) (ii), (v)) but are ignored. In this connection it is most significant that in article VII of the treaty itself dividends received by a U.S. subsidiary from its sub- sidiary corporation are, not considered the type of passive income which would cause dividends to the Netherlands parent to be taxed at a rate greater than the reduced rate. To the same effect see the U.S. tax treaties with Austria, Denmark, Finland, Ireland, Israel, Italy, buxembourg, New Zealand, Norway, Sweden, Switzerland, and the United Kingdom. The treaty with the Netherlands and all of the above treaties provide that dividend income "other than" dividend income from a subsidiary corporation is considered in determining whether `the payer has the specific amount of passive income which will deprive it of the benefit of the reduced rate. In addition, the draft Double Taxation Convention on Income ,and Capital prepared by the Organization for Economic Cooperation and Development (OECD) provides that dividends paid by a. company to a resident of the other contracting state shall be taxed by the country of payment at not more than 15 percent (. percent where the recipient is a corporation which owns 25 percent or more of the stock of the paying corporation). Thus, under the draft provision dividends received by a U.S. company from its U.S. subsidiaries and paid to a foreign parent would be .taxed at a 5-percent rate. H.R. 5916 should be amended to eliminate the above-described inequity. This could be accomplished in either of the following ways: (1) Add a new subsection to section 11 to provide that income received by a U.S. corporation from a subsidiary corporation shall not, for the purpose of applying any treaty obligation of the United States, be considered dividend income. (2) Add a new subsection to section 11 to provide that for purposes of applying any treaty obligation of the United States the income of a U.S. corporation, if it so elects, shall be computed on a consolidated basis. There are probably other equally effective ways of eliminating.the above inequity; for example, in the pending protocol to the treaty with the Netherlands or in the regulations under the 1964 protocol to the effect that the "other than" exception set forth in the treaty would apply as if set forth in full in the protocol. * * CHARLES GOODWIN, Jr. 267 PAGENO="0278" :144 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S~ STATEMENT OF UNITED STATES SAVINGS & LOAN LEAGUE RE H.R. 5916 The United States Savings & Loan League enthusiastically endorses the provisions of H.R. 5916 by Chairman Mifis relating to nonresident aliens not doing business in the United States. For many years now, interest paid on the bank deposits of this special category of persons has been treated for Federal tax purposes as income not arising from sources within the United States. The result has been that interest paid on bank deposits to such persons has been exempted under the withholding requirement applicable to other income payable to such persons. This distinction carries over into the estate tax law and relieves from estate taxes the bank de- posits of nonresident aliens not doing business in the United States. These exemptions have not been applied to savings accounts in mutual savings and loan associations. On the other hand, a technical ruling does exempt the earnings on accounts of these individuals with most stock-type savings and loan associations. This difference in treatment has resulted in mutual institutions losing many accounts of this type. Obviously some of this money has been withdrawn from the United States. This difference in treatment between the savings accounts in com- mercial banks, mutual savings banks, and stock-type associations and the treatment afforded savings accounts in mutual savings associations would be corrected by H.R. 5916. It should be pointed out that elsewhere in the Internal Revenue Code earnings on savings accounts in savings and loan associations are treated in the same manner as are earnings on the savings accounts in commercial banks and mutual savings banks. For example, dividends paid by savings and loan associations are treated as interest. Also, the tax laws have not permitted any dividend deduction or credit for those dividends paid by savings and loan associations. * The Treasury Department has recommended that this distinction be eliminated, and the United States Savings & Loan League strongly concurs. The league respectfully requests that this legislation be enacted. UNITED STATES TRUST Co. OF NEW YORK, New York, N.Y., June ~4, 1965. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, House of Representatives, Washington, D.C. DEAR MR. CHAIRMAN: I am taking the liberty of writing to you to express to you and your committee the point of view of the United States Trust Co. of New York on legislation pending before you to increasel foreign investment in the United States, and particularly H~R. 5916 which you introduced on March 8, 1965. As your committee is aware from testimony by our chairman, Mr. Hoyt Ammidon, given before you on March 20, 1963 (hearings on the tax recommendations of the President, pt. 5, p. 2725), the United States Trust Co. of New York is a banking institution which 268 PAGENO="0279" REMOVE TAX BARRIERS TO FOREIGN n~vii~sm~'r r~ ms. 145 has specialized for 110 years in trusts and investment management for individuals; members of families; and religious, educational, and charitable institutions of all kinds; and. for pension and retire- ment funds of corporations; employee associations and labor unions; and a number of public authorities. We number among our custOmers many overseas financial organizations but only a very few individuals who are foreign nationals. In this important business of the, conservation and investment of funds for others, we have very close contact with individual investors abroad. From this contact we are able to say to you and your committee that it is perfectly clear to us that many foreign nationals who would like to invest in the U.S. securities markets are absolutely unwilling to do so so long' as there is any estate tax on securities they may have in this country at time of death. The problem here is not limited to the economic burden imposed on a person's estate by the U.S. estate tax, as no dOubt an economic burden on the nonresident alien decedent's estate is already imposed by the inheritance and estate tax laws of his country of domicile. The thrust of the case against any U.S. estate tax is that nonresident aliens do not wish to be faced with. any of the reporting and filing requirements and their related expenses to which they would become subject so. long as any U.S. tax remains in effect; and, rather than face these, they prefer to avoid completely the ownership in this country of American securities. We believe that the approach which the Treasury Department has taken in suggesting legislation to your committee which would, with respect to nonresident aliens' estates in the United States at time of death, increase the exemption and substitute for U.S. estate tax rates a lower rate schedule and would provide ëertain other ameliorative measures, is headed in the right direction. We applaud the Treasury objective as stated in the Department's release of March 5, 1965, entitled, "Proposed Legislation To Increase Foreign Investment in the United States," and as proposed to be carried into effect by section 8 of the bifi. The only trouble is that these proposals do not go far enough to reach the goal. * We believe that the only effective measure to attract investment in the United States by nonresident foreign individuals would be' to repeal the estate tax entirely. In our opinion, this is the only way by. which any substantial flow of investment funds from nonresident alien individuals can be attracted to this country. We, therefore, hope that your committee will see fit to move in the direction which the Treasury Department has pointed in its recom- mendation to you, but carry it through to its logical conclusion by providing for the repeal of the estate tax on nonresident alien decedents. Although we are not in possession of the revenue figures, it is our impression that the estate tax on nonresident alien decedents does not bring any significant revenue to the Treasury at the present time. We believe that the revenue from taxes at the rates stated in your bifi would likewise be insignificant. Thus, the complete repeal of these' taxes would not affect the revenue in any significant way. On the other hand, we believe that a good many hundred of millions of dollars would be invested in the U.S. securities markets by foreign 269 PAGENO="0280" 146 REMOVE TAX BARRIERS F0R~N. INVES/PM~NT ~ U.S., nationals if they felt that their funds would not be subject to estate tax by the U.S. Government. Very respectfully yours, CHARLES W. BUEK, President. COMMENTS BY HENRY S. CONSTON, OF WALTER & CONSTON, NEW YORK, N~Y., ON H.R. 5916, AN Ac~ To REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES ESTATE TAXES H.R. 5916 has recognized the deterrent effect which the present method of taxing nonresident alien estates has on direct foreign investment in U.S. securities by providing a limited measure of relief in this area. It is submitted that this relief in some respects is mis- placed and wifi benefit owners of non-investment-type assets which serve to increase the outflow of gold. TAX BASE Present law imposes the tax on the entire gross estate which at the time of death is situated within the United States. This includes the following property (IRC sec. 2104): (a) All tangibles physically located here; except certain works of art on loan for exhibition; (b) Those intangibles the written evidence of which is treated as the property itself (such as bonds) if physically located here; (c) Shares of stock of U.S. corporations, regardless of location; (d) Moneys on deposit with banks (but only if the decedent was engaged in business in the United States); and (e) Other intangibles (except insurance on decedent's life) if issued by or enforceable against a resident of the United States, a domestic corporation, or governmental unit. Section 8 of H.R. 5916 would amend these rules as follows: (a) All debt obligations, no matter where the evidence thereof is physically located, would be taxable if issued by or enforceable against U.S. citizens, residents, or entities. Other debt obligations continue to be taxable if evidence thereof is physically located here; and (b) Deposits with Federal and State savings and loan associations by decedents who are not engaged in business here are excluded from the tax base. It is submitted that these proposed amendments are far too re- strictive. Instead of narrowing the tax base, the amendment would subject to tax many debt obligations which are presently not includ- able in the gross estate. In order to attract foreign investment, it would appear desirable to exclude from the taxable gross estate of nonresident aliens, regard- less of whether engaged in trade or business here or not, all debt obligations and shares of stock of noncontrolled corporations. Prscautionary measures should, however, be taken to reduce tax avoidance through the use of corporations to hold otherwise taxable property. At present tax avoidance by nonresident alien estates is 270 PAGENO="0281" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT n~ u.s. 147 widespread through the use of corporations to hold U.S. investments. It would appear desirable to include in the taxable estate shares of stock and debt obligations of U.S. corporations controlled by the decedent and his family. Moreover, property located within~ the United States and owned by foreign corporations controlled by non.~ resident aliens or their families should be included in the taxable estate. EXEMPTION AND RATE OF TAX H.R. 5916 proposes to increase the exemption for nonresident alien estates from $2,000 to $30,000 and to reduce tax rates to a maximum of 15 percent. By excluding debt obligations and shares of stock from the tax base, the two principal media for the attraction of foreign capital would be freed from the estate tax burden. No purpose can, how.. ever, be served by permitting more advantageous tax treatment for noninvestment-type assets such as patents. Accordingly, it is felt that property which remains includable in the gross estate be subjected to the same $60,000 exemption and be eligible for the marital deduction as are estates of U.S. citizens or residents. RETURNS H.R. 5916 does not coordinate the amendments relative to estate taxes with the return requirements. Code section 6018(b) should be amended to require the filing of the return only if the gross estate exceeds the exemption. OTHER STATUTORY DEFECTS The amendment to code section 2102(b) as contained in section 8(b) of the bifi does not make provision for estates using the alternative valuation date under code section 2032. GIFT TAX Under sections 2501 and 2511 of the code, nonresident aliens not engaged in trade or business in the United States are subjected to gift tax only on transfers of tangible property located here. Nonresident aliens who are engaged in business here are also subjected to taxation on gifts of intangibles located in the United States-that is, shares of stock of domestic corporations and evidences of indebtedness of domestic obligors which are physically located here. Section 9 of H.R. 5916 proposes to exempt gifts of intangibles by nonresident aliens from gift tax whether or not the donor is engaged in business here. Certainly, the abolition of the distinction between persons doing business in the United States and those not so engaged should be endorsed. However, tax avoidance could be prevented only if the tax base for gift tax purposes were changed so as to be identical to the estate tax base. In accordance with the recommendation herein contained, shares of stock and evidences of indebtedness of non- controlled corporations would be excluded. However, there appears to be no reason why assets which serve to bolster the outflow of gold, such as patents, should be tax exempt. 271 PAGENO="0282" 148 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. ADDITIONAL RECOMMENDATIONS (1) Interest income of nonresident aliens Many domestic corporations wishing to invest in foreign countries are forced to borrow U.S. funds for this purpose because foreign lenders are unwilling to allow interest payments to be reduced by U.S. withholding taxes. The most practical approach to this problem would be to exempt interest completely from gross income of non- resident aliens. If this approach were considered to be too radical, an amendment to section 861 (a)(1) pursuant to which interest paid on loans, the proceeds of which are used exclusively outside the United States, would be considered to be income from sources outside the United States could remedy this situation. (2) Tax base * The tax base used for nonresident aliens not engaged in trade or business here (sec. 871(a)) and nonresident foreign corporations (sec. 881(a)) should be broadened. The term "fixed or determinable annual or periodical income" was first incorporated into the code in 1936. It has undergone little change since that time. As a result, such loophole closing sections as 341 (collapsible corporations), 1245 and 1250 (depreciation recapture) and 306 (preferred stock bail outs) create loopholes for nonresident aliens since gain from the sale of noncapital assets is not taxable to nonresident aliens. It would perhaps be preferable to broaden the tax base of nonresident aliens not engaged in business here and nonresident foreign corporations to include all U.S. source income with the exception of interest as stated above, certain capital gains and income from the sale of prop- erty which is includable in inventory or which is used in the taxpayer's trade or business. (3) Capital gains While the liberalization of the taxation of capital gains of non- resident alien individuals is endorsed, there appears to be no reason to exempt from taxation proceeds from the sale of patents (not qualifying under IRC sec. 1235), copyrights, trademarks or other similar rights. These should be excluded from the liberalized capital gains rules. In the event that a nonresident alien is subjected to taxation on capital gains by virtue of his presence in the United States for 183 days or more, the tax rate thereon should not exceed the 25 percent applicable to U.S. citizens. MOreover, such persons should be allowed to take advantage of the 5 year capital loss carryover. (4) Certificates of compliance An unreasonable administrative requirement is set forth in IRO section 6851(d) under which nonresident aliens, subject to certain exceptions, must secure certificates of compliance with the income tax laws prior to departure from the United States~ In practice, this rule is not strictly enforced. Nevertheless, the fact that it is on the books presents an annoyance and a form of discrimination against foreigners which should be abolished. 272 PAGENO="0283" * REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN u.s. 149 (5) Accumulated earnings tax Under section 531, a corporation becomes subject to the penalty tax for failure to distribute unreasonably accumulated surplus. In cases where domestic corporations are controlled by nonresident aliens, this provision requires the remittance of dollars to foreign countries. It would be desirable to remove this stimulus to the out- flow of gold by specifying that the accumulated earnings tax shall not apply to corporations which are controlled by nonresident aliens. ARMONK, N.Y., June 24, 1965. Hon. WILBUR D. MILLS, House of Representatives, Washington, D. C.: Having been a member of the Fowler committee I would like to urge your favorable consideration of the tax bifi, HR. 5916, relating to the committee's recommendations. Having just read the National Foreign Trade Council statement on H.R. 5916 I believe that this merits your consideration also. Thank you. ARTHUR K. WATSON. WooL ASSOCIATES OF THE NEW YORK COTTON EXCHANGE, INC., New York, N.Y. COMMITTEE ON WAYS AND MEANS, House of Representatives, Longworth House OJJi.~e Building, Washington, D.C. GENTLEMEN: The Wool Associates of the New York Cotton Ex- change, Inc., favors the princples of H.R. 5916, the act to remove tax barriers to foreign investment in the United States. This organiza- tion, however, believes that the new tax on foreign dealers in commodi- ties proposed in the bill will prevent the attainment of its objectives. It is the opinion of the wool asso ciates that the bifi will- (1) Decrease certain foreign investments in the United States; and (2) Add to the gold deficit. DECREASE CERTAIN FOREIGN INVESTMENTS IN THE UNITED STATES The Wool Associates of the New York Cotton Exchange, Inc., pro- vides a marketplace for trading in wool top and grease wool for future delivery. Many of the orders executed on the exchange originate in foreign lands. Should the bill be adopted in its present form, an addi- tional tax barrier will be erected. This barrier will divert such orders to similar exchanges in foreign lands. Hence, foreign investments in wool top and grease wool futures in the United States wifi be dras- tically decreased. 273 PAGENO="0284" 150 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. ADD TO THE GOLD DEFICIT Member firms of the Wool Associates of the New York Cotton: Exchange, Inc., require the accounts of their customers to be protected by deposits of cash margins. Overseas customers, who will be sub-~ jected to a tax which does not presently exist, wifi close their accounts in the United States. Cash margin deposits will be withdrawn to finance transaction in foreign futures exchanges. The effect on the gold deficit will be twofold: (a) Gold currently in the United States wifi be withdrawn; and (b) a potential inflow of gold will be diverted to foreign nations. For these reasons the Wool Associates of the New York Cotton. Exchange, Inc., believes that current provisions of the bill fail to achieve the desired result. The. wool associates earnestly urges the committee to exempt foreign dealers in commodities from the pro- posed tax embodied in H.R. 5916. On behalf of the Wool Associates of the New York Cotton Exchange, Inc., I thank the committee for the opportunity to present these views~ Sincerely, CHARLES R. RUDD, Executive Committee. NEW YORK, N.Y., June 25, 1965. Hon. WILBUR D. MILLS, Committee on Ways and Means, House of Representatives, Longworth House Office Building, Washington, D.C.: As a member of the Presidental task force on promoting increased foreign investment in U.S. corporate securities and as a general partner in the firm of Morgan Stanley & Co., 2 Wall Street, New York, I urge strongly that H.R. 5916 be given prompt and favorable considera- tion by your committee. I have also reviewed the proposed letter and memorandum to you from Robert McKinney and from Messrs. Andre Meyer and Frederick M. Eaton and confirmed in general my agreement with the suggestions of proposed changes in }LR. 5916 recommended by Messrs. Meyer and Eaton. Respectfully submitted. JOHN M. YOUNG. 274 PAGENO="0285" SUMMARY OF RECOMMENDATIONS FOR REVISIONS GIVEN IN STATEMENTS TO THE COMMITTEE ON WAYS AND MEANS Prepared by the staff of' the Joint Committee on Internal Revenue Taxation ~PART ONE. SUMMARY OF COMMENTS ON PRINCIPAL PROVISIONS OF THE BILL 1. Source rules A. Section 2(a) of the bill.-Under present law, some interest paid by savings institutions to nonresident aliens is income from U.S. sources and is subject to tax. The bil] would amend code section 861(a) (1) to provide that all such interest is not included in U.S. source income, so that it would not be taxable income to nonresident aliens. Comments American Life Insurance Co. and th4e United States Life Insurance Co. in the City of New York A similar exemption should be provided by statute for the interest or earnings element paid to nonresident aliens under life insurance company contracts. This will improve the U.S. balance of payments, will increase the taxable income of U.S. life insurance companies and, finally and most important, will put nonresident alien investors in American life insurance in the same position as similar persons investing in U.S. savings institutions. American Life tjonvention and Life Insurance Association of' America Strongly urges that similar exemption be provided for interest paid to nonresident aliens on life insurance. United States Savings and Loan League Strongly supports enactment of this provision. Henry S. Conston, New York attorney Exempt interest income from the gross income of nonresident aliens. Alternatively, treat interest on loans, proceeds of which are used exclusively outside the United States, as income from sources outside the United States. B. Section 2(b) of the bill.-Under present law, a pro rata portion of dividend income from a foreign corporation is considered U.S. source income if more than 50 percent of the corporation's gross income is *derived from U.S. sources. It is proposed to amend code section :861(a) (2) (B) to include in U.S. source income dividends from foreign corporations, but only if such corporations are engaged in trade or business within the United States. If more than 80 percent of the gross business income of such a corporation was U.S. source income, then a fraction (the gross business income of the corporation from U.S. sources divided by its gross income from all sources) of the ~dividend income from such corporation would be included in U.S. 151 275 PAGENO="0286" 152 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. source income. Thus distributions by a foreign corporation doing business here of amounts originally received by it as dividends from U.S. corporations wi]i not result in the imposition of any American income tax a second time if less than 80 percent of the gross business income of the corporation is from sources in the United States. Comments Association of the Bar of the City. of New York, Committee on Taxation A de minimis rule should be adopted providing that code section 861(a)(2)(B) not be applicable ~unless at least 25 percent of the foreign corporation's entire income constitutes "gross business income" under code section 882(a) (3). II. Taxation of nonresident alien individuals (sec. 3 of the bill) Under present law, a nonresident alien individual engaged in busi- ness in the United States is taxed on all his U.S. source income in the same manner as a resident would be taxed. The bill would amend code section 871 to tax the business income of nonresident alien individuals engaged in business in the United States separately from the nonbusiness income of these individuals. The nonbusiness income would be taxed in the same manner as such income is taxed in the case of nonresident alien individuals who are not engaged in busi- ness in. the United States. Comments S. B. Bledsoe of Salvage c~ Lee, representing the Board of Trade of the City of Chicago The board of trade is concerned with the definition of the term "engaged in business within the United States." It fears that the language will exclude foreign commodity traders from the benefits of the bill and that as a result business will be diverte& to foreign commodity markets. G. Keith Funston (a member of the task force), representing the New York Stock Exchange Expand the exclusion from "engaged in trade or business within the United States" to cover foreign securities and commodities dealers trading for their own accounts, whether or not these dealers grant discretionary authority to agents in the United States. Repeal or reduce the withholding tax on interest and dividends paid to foreigners. Charles R. Rudd, representing the Wool Association of the New York Cotton Exchange, Inc. The bill imposes an unjust tax on foreign dealers in commodities and in this respect is objectionable. Joseph B. Brady, representing the National Foreign Trade Council, Inc. Securities dealers should be encouraged to participate in the marketing of U.S. securities to foreigners by including such dealers in the securities trading exemption from the definition of "engaged in trade or business within the United States." 276 PAGENO="0287" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 153 Returns should not be required in those situations where the nonbusiness income of nonresident aliens not engaged in trade or business in the United States is subject to withholding. Frederick M. Eaton, representing the Fowler Task Force A foreign dealer or underwriter should not be deemed to be engaged in a trade or business in the United States by reason of participation in an underwriting group having a U.S. manager. H.R. 5916 provides that the term "engaged in a trade or busi- ness within the United States" does not include trading in securities for one's own account whether the transactions are effected directly or indirectly except where a person "so trading is a dealer in securities, whether or not any such agent has discre- tionary authority to make decisions affecting such transactions." He suggests that this amendment can be interpreted as implying that a dealer in the type of case cited above is engaged in a trade or business here. American Institute of Certified Public Accountants, Corn- mittee on Federal Taxation Employees of foreign offices of domestic partnerships, U.S. citizens, and resident aliens should have the same exemption as that provided for employees of domestic corporations under present law, in code section 871(c). Henry S. Conston, New York attorney Broaden the income tax base from "fixed or determinable annual or periodical gains, profits, and income" to include all U.S. source income except interest, certain capital gains, and income from the sale of inventory or items used in the taxpayer's trade or business. There is no reason to give preferred capital gains treatment to proceeds from the sale of patents (other than sales to which sec. 1235 is applicable), copyrights, trademarks, or similar rights. Nonresident aliens subject to the tax on capital gains should have the benefits of the same 25-percent maximum tax rate and capital loss carryover provisions as U.S. citizens enjoy. Association of the Bar of the City of New York, Committee on Taxation The penalties for expatriation should not be eliminated as to those who acquired dual nationality at birth, and subsequently voluntarily chose other than U.S. nationality. Section 350 of the Immigtation and Nationality Act. The proposed code section 871 (c)(2) should explicity state that the volume of securities or commodities transactions is not material in the determination of whether an investor is engaged in trade or business within the United States. The proposed code section 871 (f) permits a nonresident alien individual to elect to be taxed on a net basis with respect to certain types of income. This election should also be available to income from the disposition of timber, but only in those cases where an election under code section 631 (a) is not made. The term "taxable year" is ambiguous both under present law and under the bill. The ambiguity should be eliminated, in 277 PAGENO="0288" J54 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. view of the fact that it often results in a variation of tax treatment depending upon the particular authority that is interpreting the term in the particular case. The expatriation proposals in sections 3, 8, and 9 of the bill are too harsh. They introduce many complexities not warranted by the problem of U.S. expatriates. The bill provides that dividends and gains from the sale of stock are excluded from the category of business income. There should also be excluded interest (other than interest earned in the conduct of a banking business) and gains from the sale of other securities. Consideration should be given to excluding from the definition *of business income those capital gains which are not derived from sales or exchanges, such as distributions under section 301(c) (3) (A). The proposed code section 871 (b)(3) would exclude from "business income" gains from. the sale or exchange of stock by securities dealers. The association urges a policy review of this provision to determine whether this exclusion is intended. III. Taxation of foreign corporations (sec. 4 of the bill) Under present law, a foreign corporation engaged in business in the United States is taxed on all its U.S. source income in the same man- ner as a domestic corporation and gets a dividends received deduction for dividends from domestic corporations (resulting in a maximum effective tax rate of 7.2 percent on such dividends). Under the bill, code section 882 would be amended to include dividends in "non- business income" of such a corporation, and would tax such income ~at a 30-percent rate or the lower applicable treaty rate. Comments Association of the Bar of the City of New York Code section 542(c) (7) excludes from the definition of "personal holding company" certain foreign corporations whose stock is wholly owned by nonresident alien individuals, directly or through other foreign corporations. The indirect ownership provision should be expanded to include stock owned through foreign trusts, estates, and partnerships, all of the beneficiaries or partners of which are nonresident aliens. The present requirement that a foreign corporation derive at least 50 percent of its gross income from sources within the United States in order to have that corporation's dividends be eligible for the dividends-received deduction, should' be increased to 80 percent. Section 4(b) of the bifi, amending section 882 of the code, has the effect of denying to resident foreign corporations the dividends- received deduction presently allowed to them. This would seem to run counter to the purpose of the bill to encourage foreign investment in the United States. The bill provides that dividends and gains from the sale of stock are excluded from the category of business income. There should also be excluded interest (other than interest earned in the con- duct of a banking business) and gains from the sale of other securities. 278 PAGENO="0289" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 155~ Consideration should be given to excluding from the definition of "business income" those capital gains which are not derived. from sales or exchanges, such as distributions under code section. 301(c) (3) (A). The proposed code section 882 (a) (3) would exclude from "business income" gains from the sale or exchange of stock by securities dealers. A policy review should be made to deter- mine whether this exclusion is intended. Ira T. Wender, Micha~el Waric, Jr., and Peter L. Briger of Baker, McKenzie cQ~ Hightower Foreign corporations that are actively engaged in business in the United States and that have made substantial, permanent type investments in domestic corporations (at least a 10-percent equity interest) should be permitted to elect either- (1) The treatment provided under existing law for resi- dent foreign corporations (the availability of the inter- corporate dividends received deduction, but a tax on capital gains realized in connection with U.S. stock investments); or (2) The tax treatment provided in the proposed amend- ment (no intercorporate dividends received deduction, but. exemption from tax on capital gains on U.S. stock invest-. ments). Frederick M. Eaton, representing the Fowler Task Force Under the proposed definitions of business and nonbusiness income, capital gains realized by a foreign corporation would be excluded from business and nonbusiness income, and therefore totally exempt from U.S. tax. This would make it possible for U.S. persons to finance and operate a securities dealer business in the. United States through the medium of a resident foreign corporation, thereby accumulating profits from trading in corpo- rate stock substantially free of tax at the corporate level. To prevent this unintended result, he would amend the definition of business income to provide that this term is to include net gains from the sale or exchange of stock in corporations if such stock is held by the taxpayer primarily for sale to customers ordinarily in the course of its trade or business. American Institute of Certified Public Accountants, Corn- mittee on Federal Taxation There should be a reduction in the present 30-percent tax rate on investment income of foreign corporations not engaged in business in the United States. Present law and the proposed section 882(c)(1) should be amended to soften the provision disallowing all deductions in the event of unexcused failure to ifie returns. Henry S. Conston, New York attorney The accumulated earnings tax should not apply to corporations. controlled by nonresident aliens, since such application encourages transmission of U.S. dollars abroad. Cleary, Gottlieb, Steen cQ~ Hamilton Under present law, a foreign corporation engaged in trade or business in the United States pays the full 48 percent U.S. cor-. 71-297 O-67-pt. i_is 279 PAGENO="0290" * 156 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. pprate tax rate on interest received by it on debt securities it owns. The bifi proposes to give special treatment to the dividend income received by foreign corporations engaged in business in the United States, but makes no special provision for interest income received by such corporations. Thus, the present method of taxation of interest income would continue, and foreign cor- pprations would be discouraged from investing in debt securities. This would keep foreign corporations engaged in business here from investing in debt securities here and would, in other cases, result in "unnecessarily complex arrangements for foreign port- folios containing investments in U.S. securities." Therefore interest received by a foreign corporation doing business in the United States should be treated as nonbusiness income (like dividends). Such avoidance possibilities as may appear should be dealt with directly and specifically. * Shearman & Sterling Schlumberger, Ltd. (SL) is a foreign corporation with its principal office in the United States. It has two wholly owned domestic subsidiaries, each of which own a number of domestic operating subsidiaries. (It presently plans to merge the two domestic subsidiaries into a single domestic holding company.) Under H.R. 5916, SL would pay a 30-percent tax on the dividends from its subsidiary or subsidiaries. It would pay. a lower rate of tax (5 percent) if it could qualify for the special treatment in the Netherlands Antifies Treaty. However, it cannot qualify for that treatment because the income of its subsidiary will be * dividend income. Accordingly, H.R. 5916 should be amended to provide that dividend income received by a U.S. corporation from a subsidiary corporation shall not be treated as "dividend income" for certain treaty purposes. Alternatively, for purposes of qualifying for the special treaty treatment, the U.S. holding companies should be permitted to compute their income on a consolidated basis as if all operations were owned directly Iby a single entity. G. Keith Fnnston (a member of the task force), representing the New York Stock Exchange Repeal or reduce the withholding tax on interest and dividends paid to foreign corporations. IV. Estate tax on nonresident aliens (sec. 8 of the bill) The bill would amend the law to increase from $2,000 to $30,000 the exemption from estate tax for nonresident aliens. In addition, the rates at which the estate whould be taxed would be greatly lowered the tax beginning at 5 percent on the first $100,000 and never going over a 15 percent rate. Comments * Association of the Bar of the City of New York, Committee on Taxation The expatriation proposals in sections 3, 8, and 9 of the bill are too harsh. They introduce many complexities not war- ranted by the problem of U.S. expatriates. 280 PAGENO="0291" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 157 The penalties for expatriation should not be eliminated as to those who acquired dual nationality at birth and subsequently voluntarily chose other than U.S. nationality. Section 350 of the Immigration and Nationality Act. Code section 2107(b), providing special rules for determing the value of the gross estate of an expatriate under certain circum-. stances, should be eliminated since it adds too much complexity to warrant the limited revenue benefits of the provision. The bill would authorize the President under certain circum- stances to set aside, in the case of an estate of a foreign residenL~, estate tax amendments made by this bill or later, acts. Since we do not know what amendments will be made in `the future, it would seem advisable to limit this authority to the setting aside of the amendments made by the pending bill. G. Keith Funston (a member of the task force), representing the New York Stock Exchange Eliminate the estate tax on estates of nonresident aliens. Alternatively, exempt estates of under' $30,000 from the require- ment of ffling estate tax returns and also exclude from t~axable estates all funds awaiting investments, such as brokers' free credit balances. Joseph B. Brady, representing the Ntitional Foreign Trade Council, Inc. Section 8 of the bifi `should be amended to eliminate the estate tax on estates of nonresident alien decedents. *This tax can be avoided by the formation of corporations under other sections of the bill. That vehicle would be resorted to by those with large amounts of property in the United States. Elimination of the tax would encourage the holders of small amounts of property to invest in the United States. Henry S. Conston, New York attorney Section 8 of the bill should be amended to exclude from the taxable estates of nonresident aliens all debt obligations and stock of noncontrolled corporations. In order to reduce, tax avoidance, there should be included in the gross estates of such persons debt obligations and stock of controlled U.S. `corporations and also U.S. property owned by controlled foreign corporations. If the above proposal is agreed to, then it is .not necessary to further relieve such estates from tax. It would then be~ proper to return to existing law on the taxable estate. Dorsey I&hardson, president, Investment Company Insti- tute and member of the Fowler Task Forte He expresses approval in general of the bill, although pointing out that it does not go as far as the task force recommendation eliminating U.S. estate tax on intangible personal property of nonresident decedents. He states, however, that he understands there are technical reasons for not recommending the complete elimination and therefore apparently endorses the bill as pre- sented. ` 281 PAGENO="0292" 158 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. American Institute of Certified Public Accountants, Committ~e on Federal Taxation The proposed code section 2107 excludes certain expatriates from the beneficial estate tax rates provided by the bill. In the case of expatriation of a naturalized citizen who loses his U.S. citizenship upon returning to his native country, this exclusion: should apply only to that proportionate part of the gross estate situated in the United States which is equal to the ratio of that part of the gross estate going to U.S. heirs, over the total gross. estate. Reese H. Harris, Jr., representing the Trust Division, Amen- can Bankers Association No estate tax should be imposed on estates of nonresident aliens. Alternatively the Fowler Task Force recommendation should be adopted to eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents. Manufacturing Chemist's Association, Inc. Under present law, bonds owned by a nonresident alien are subject to the U.S. estate tax only if the actual paper instruments are physically in the United States. The bifi would change this rule to provide that bonds of U.S. corporations would be subject to U.S. estate tax regardless of where the pieces of paper were lo- cated. The organization states that some of its members have followed the President's recommendations and the suggestions of the Fowler Task Force in raising capital for foreign operations.. In order to minimize the outlay of U.S. dollars, some members of the association have sold bonds of U.S. obligors in foreign capital markets to raise funds needed abroad. The buyers of these bonds are not subject to U.S. estate tax under existing law unless the bonds are located in the United States. However,. these individuals would become subject to the U.S. estate tax as to these bonds under the situs rule proposed by the bifi. Accord- ingly, the bifi should be amended to provide that intangibles. owned by nonresident aliens be exempted from the estate tax altogether. Alternatively, the present situs rules should be retained. Frederick M. Eaton, representing the Fowler Task Force It is better to eliminate all estate taxes on intangible property of nonresident alien decedents, rather than reduce the estate tax. rate from 5 percent to 15 percent and increase the exemption' from $2,000 to $30,000. From a psychological standpoint, it is important to eliminate the tax. Since the present revenue of all U.S. estate taxes paid by foreigners on U.S. property is between $3 and $6 mfflion. the loss from complete elimination cannot be great, in view of the fact that most of the $3 to $6 mfflion would be lost anyway,under the lower rates proposed by the Treasury. U.S. Trust Co. The bill moves in the right direction in lessening the estate tax on nonresident aliens but it does not go far enough. In order to really encourage foreign investment in the United States, the estate tax on nonresident aliens should be eliminated altogether 282 PAGENO="0293" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT t~ U.s. 159 so that they would be encouraged to freely buy in the U.S. securities markets. In addition to the financial question, the need for reporting and giving information discourages many potential foreign investors. Real Estate Trade Mission to Europe, J. D. Sawyer, chairmam Urges complete elimination of estate tax on intangible property of nonresident alien decedents. Fultom C. Underliay of Herrick, Smith, Donald & Ketehum, attorneys Suggests modifications in expatriation provisions dealing with the estate tax. Urges complete elimination of an estate tax on intangible personal property owned by nonresident aliens. PART TWO. SUMMARY OF OTHER COMMENTS ON THE BILL Henry S. Constom, New York attorney Equalize the gift tax treatment of nonresident aliens engaged in trade or business here and those not so engaged. Make the tax base for the gift tax the same as that for the estate tax. (See wecommendations of Henry S. Conston in Part One, IV, above.) Abolish the code section 685 1(d) certification of compliance requirement for nonresident aliens seeking to depart the United States. The requirement is not strictly enforced and constitutes an annoyance for and discrimination against foreigners. Association of the Bar of the City of New York, Committee on Taxation A resident alien should have the right to protest a Presidential ~determination that a foreign country does not satisy the "similar -credit" requirement for allowance of the foreign tax credit. Domestic fiduciaries should be permitted. to administer estates ~and trusts for the exclusive benefit of fcreign beneficiaries and remaindermen without being. subject to capital gains tax on the sale of portfolio securities. Consideration also should be given to abolishing the present requirement that a visiting alien, before departing from the United ~States, must secure a tax clearance and sailing permit. Present -procedures in this regard are harassing and. annoying to visiting aliens and do not produce a significant amount of revenue. The gift tax penalties for expatriation should not be eliminated as to those who acquired dual nationality at birth and subse- quently voluntarily chose other than U~S. nationality. Section :350 of the Immigration and Nationality Act. The expatriation proposals in seclions 3, 8, and 9 of the bill are too harsh. They introduce many. complexities not warranted by the problem of U.S. expatriates. G. Keith Funston (a member of the task force), representing the New York Stock Exchange Eliminate or ease taxes and other restrictions imposed on ~foreign pension trusts and similar institutional investors. 283 PAGENO="0294" 160 REMOVE ~I'AX BARRIERS TO FOREIGN INVESTMET~T IN U.S. Support Group for Progressive Banking and First National City Bank, Walter B. WristOn, executive vice president The interest paid by a foreign branch of a U.S. bank to a foreign depositor should be exempt from TJ~S. income tax whether or not the foreign depositor is deemed to be "doing business in the United States." If the deposits were. in a foreign bank they would not be subject to U.S. tax even though the foreign depositor was engaged in a trade Or business here. American Institute of Certified Public Accountants, Com- mittee on Federal Taxation Nonresident alien individuals and foreign corporations who do not engage in trade or business in the United States should have the same exemption from the "permanent establishment" provisions as is given by . section 11(b) of the bill to such persons who do engage in trade or business within the United States. The proposed code sections 2501 and 2511 exclude certain expatriates from the beneficial gift tax rates provided by the bill. In the case of expatriation of a naturalized citizen who loses his U.S. citizenship upon returning to his native country, this exclusion should apply only to gifts to U.S. citizens. Robert McKinney, member of task force Submits a summary of some of the actions taken . by the so- called private sector to implement those recommendations of the Fowler task force directed toward it. States that the private sector .has made substantial contribu-. tions to the general effort to improve the balance-of-payments situation. Adds that help given by Chairman Cohen and his staff at the SEC and by Assistant Secretary Surrey and his staff at the Treasury has been extremely encouraging. Urges favorable consideration of H.R. 5916. William Engstrom Disagrees with philosophy of the bill. Believes it will tend to debilitate the program of investment in less developed areas. Association of.Stoclcs Exchange Firms Expresses "enthusiastic approval" of the bifi. Agrees with statements of Mr. Funston representing New York Stock Exchange.. Arthur K. Watson, International Business Machines Supports bill and approves statement of National Foreign Trade Council. Investors League, Inc., William Jackman, president Supports the bill and agrees with position taken by G. Keith Funston representing the New York Stock Exchange. George F. James, Socony Mobil Oil Co., member of task force Supports the bifi and agrees with suggestions of Andre Meyer and Frederick M. Eaton. Real Estate Trade Mission to Europe, J. D. Sawyer, chairman Supports the bill generally. 284 PAGENO="0295" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN U.S. 161 National Association of Securities Dealers, Inc., Robert W. Haack Supports the bill. John M. Young, member of task force Strongly supports bill. Agrees with recommendations made by Andre Meyer and Frederick Eaton.. N0TE.-The persons named made many additional comments of a technical nature not involving policy questions. These comments wifi be carefully considered in work on the bill by the draftsmen and the staff members. 285 PAGENO="0296" PAGENO="0297" SECTION 8 SUMMARY OF RECOMMENDATIONS FOR REVISIONS GIVEN IN STATEMENTS PRESENTED TO THE COMMITTEE ON WAYS AND MEANS 287 PAGENO="0298" PAGENO="0299" ACT TO REMOVE TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES (Fowler Task Force Report) (H.R. 5916) SUMMARY OF RECOMMENDATIONS FOR REVISIONS GIVEN IN STATEMENTS PRESENTED TO THE COMMITTEE ON WAYS AND MEANS HOUSE OF REPRESENTATIVES JULY 6, 1965 Prepared by the staff of the Joint Committee on Internal Revenue Taxation U.S. GOVERNMENT PRINTING OFFICE WASHINGTON :. 1965 JCS-9-65 289 PAGENO="0300" PAGENO="0301" DIGEST OF STATEMENTS SUBMITTED ON H.R. 5916, "ACT TO REMOVE' TAX BARRIERS TO FOREIGN INVESTMENT IN THE UNITED STATES" PART ONE. SUMMARY OF COMMENTS ON PRINCIPAL PROVISIONS OF THE BILL I. Sonrce rules A. Section 2(a) of the bill.-Under present law, some interest paid by savings institutions to nonresident aliens is income from U.S. sources and is subject to tax. The bill would amend code section 861(a)(1) to provide that all such interest is not included in U.S. source income, so that it would not be taxable income to nonresident aliens. Comments American Life Insurance Co. and the United States Life Insurance Co. in the City of New York A similar exemption should be provided by statute for the interest or earnings element paid to nonresident aliens under life insurance company contracts. This will improve the U.S. balance of payments, will increase the taxable income of U.S. life insurance companies and,, finally and most important, will put nonresident alien investors in American "life :insurance in the same position as similar persons investing in U.S. savings institutions. American Life Convention and Life Insurance Association of America Strongly urges that similar exemption be provided for interest paid to nonresident aliens on life insurance. United States Savings and Loan League Strongly supports enactment of this provision. Henry S. Conston, New York attorney Exempt interest income from the gross income of nonresident aliens. Alternatively, treat interest on loans, proceeds of which are used exclusively outside the United States, as income from sources outside the United States. B. Section 2(b) of the bil.-Under present law, a pro rata portion of dividend income from a foreign corporation is considered U.S. source income if more than 50 percent of the corporation's gross income is derived from U.S. sources. , It is proposed to amend code section 861(a) (2)(B) to include in U.S. source income dividends from foreign corporations, but only if such corporations are engaged in trade or business~ within the United States. If more than 80 percent of the gross business income of such a corporation was U.S. source income, then a fraction (the' gross business income of the corporation from U.S. sources divided by its gross income `from all sources)' of `the dividend income from such corporation would be included in U.S. 1 291 PAGENO="0302" 2 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT source income. Thus distributions by a foreign corporation doing business here of amounts originally received by it as dividends from U.S. corporations will not result in the imposition of any American~ income tax a second time if less than 80 percent of the gross business income of the corporation is from sources in the United States. `C~omments Association of the Bar of the City of. New York, Committee on Taxation A de minimis rule should be adopted providing that code section 861 (a)(2)(B) not be applicable unless at least 25 percent of the foreign corporation's entire income: constitutes "gross business income" under code section 882 (a) (3). ii. Taxation of nonresident alien individuaLs (sec. 3 of the bill) Under present law, a nonresident alien individual engaged. in busi- fië~s in `the United States is taxed on all his U.S. source income'in the same manner as a resident would be `taxed. `The bill would amend code section 871 to tax the business' income of nonresident alien individuals engaged in business in the United States separately ~from the nonbusiness, income of these individuals. The nonbusiness iM'come wOuld be taxed in the same mannOr as such income is taxed in the case of nonresident alien individuals whQ are not engaged in busi- ness m the United States Comments' S. B. Bledsoe of Salvage & Lee, representing the Board of Trade of the City of Chicago `The board of trade is concerned with the definition of the term "engaged in `business within the United States." It fears that the language will exclude foreign commodity traders from the ,.~benefits of the bill and that as a result business will be diverted~ to foreign commodity markets. 0. Keith Funston (a member of the task force), representing the New York Stock Exchange Expand the exclusion from "engaged in trade or business within the United States" to cover foreign securities and commodities dealers trading for their own accounts, whether or not these dealers grant discretiona~ry authority to agents in the United States. Repeal or reduce the withholding tax on' interest and dividends paid to foreigners. Charles R. Rudd, representing the Wool Association of the * New York Cotton Exchange, Inc. * " The bifi imposes an unjust tax on foreign dealers in commodities and in this respec.t is objectionable. Joseph B. Brady, representing the National Foreign Trade Council, Inc. Securities dealers should be encouraged to participate in the marketing of U.S. securities to foreigners by including such~ dealers in `the securities trading exemption from the definition of "engaged in trade or business within the United States." 292 PAGENO="0303" REMOVE. TAX BARRIERS TO FOREIGN INVESTMENT 3 Returns should not be required in those situations where the nonbusiness income of nonresident aliens not engaged m trade or business in the United States is subject to withholding. Frederick M. Eaton, representing the Fowler Task Force A foreign dealer or underwriter should not be deemed to be engaged in a trade or business in the United States by reason of participation in an underwriting group having a U.S. manager. H.R. 5916 provides that the term "engaged in a trade or busi- ness within the United States" does not include trading in securities for one's own account whether the transactions are effected directly or indirectly except where a person "so trading is a dealer in securities, whether or not any such agent has discre- tionary authority to make decisions affecting such transactions." He suggests that this amendment can be interpreted as implying that a dealer in the type of case cited above is engaged in a trade or business here. American Institute of Certified Public Accountants, Com- mittee on Federal Taxation Employees of foreign offices of domestic partnerships, U.S. citizens, and resident aliens should have the same exemption as that provided for employees of domestic corporations under present law, in code section 871(c). Henry S. Conston, New York attorney Broaden the income tax base from "fixed or determinable annual or periodical gains, profits, and income" to include all U.S. source income except interest, certain capital gains, and income from the. sale of inventory or items used in the taxpayer's trade or business. There is no reason to give preferred capital gains treatment to proceeds from the sale of patents (other than sales to which sec. 1235 is applicable), copyrights, trademarks, or similar rights. Nonresident aliens subject to the tax on capital gains should have the benefits of the same 25-percent maximum tax rate and capital loss carryover provisions as U.S. citizens enjoy. Association of the Bar of the City of New York, Committee on Taxation The penalties for expatriation should not be eliminated as to those who acquired dual nationality at birth, and subsequently voluntarily chose other than U.S. nationality. Section 350 of the Immigration and Nationality Act. The proposed code section 871 (c)(2) should explicity state that the volume of securities or commodities transactions is not material in the determination of whether an investor is engaged in trade or business within the United States. The proposed code section 871 (f) permits a nonresident alien individual to ulect to be taxed on a net basis with respect to certain types of income. This election should also be available to income from the disposition of timber, but only in those cases where an election under code section 631 (a) is not made. The term "taxable year" is ambiguous both under present law and under the bill. The ambiguity should be eliminated, in 293 PAGENO="0304" 4 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT view of the fact that it often results in a variation of tax treatment depending upon the particular authority that is interpreting the term in the particular case. The expatriation proposals in sections 3, 8, and 9 of the bill are too harsh. They introduce many complexities not warranted by the problem of U.S. expatriates. The bill provides that dividends and gains from the sale of stock are excluded from the category of business income. There should also be excluded interest (other than interest earned in the conduct of a banking business) and gains from the sale of other securities. Consideration should be given to excluding from the definition of business income thosecapital gains which are not derived from sales or exchanges, such as distributions under section 301(c)(3)(A). The proposed code section 871 (b)(3) would exclude from "business income" gains from the sale or exchange of stock by securities dealers. The association urges a policy review of this provision to determine whether this exclusion is intended. III. Taxation of foreign corporations (sec. 4 of the bill) Under present law, a foreign corporation engaged in business in the United States is taxed on all its U.S. source income in the same man- ner as a domestic corporation and gets a dividends received deduction for dividends from domestic corporations (resi~i1ting in a maximum effective tax rate of 7.2 percent on such dividends). Under the bill, code section 882 would be amended to include dividends in "non- business income" of such a corporation, and would tax such income at a 30-percent rate or the lower applicable treaty rate. Comments Association of the Bar of the City of New York Code section 542(c) (7) excludes from the definition of "personal holding company" certain foreign corporations whose stock is wholly owned by nonresident alien individuals, directly or through other foreign corporations. The indirect ownership provision should be expanded to include stock owned through foreign trusts, estates, and partnerships, all of the beneficiaries or partners of which are nonresident aliens. The present requirement that a foreign corporation derive at least 50 percent of its gross income from sources within the United States in order to have that corporation's dividends be eligible for the dividends-received deduction, should be increased to 80 percent. Section 4(b) of the bill, amending section 882 of the code, has the effect of denying to resident foreign corporations the dividends- received deduction presently allowed to them. This would seem to run counter to the purpose of the bill to encourage foreign investment in the United States. The bill provides that dividends and gains from the sale of stock are excluded from the category of business income. There should also be excluded interest (other than interest earned in the con- duct of a banking business) and gains from the sale of other securities. 294 PAGENO="0305" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT .5 Consideration should be given to excluding from the definition of "business income" those capital gains which are not derived from sales or exchanges, such as distributions under code section 301(c) (3) (A). The proposed code section 882(a) (3-) would exclude from "business income" gains from the sale or exchange of stock* by securities dealers. A policy review should be made to deter- mine whether this exclusion is intended. Ira T. Wender, Michael Waric, Jr., and Peter L. Briger of Baker, McKenzie & Hightower Foreign corporations that are actively engaged in business in the United States and that have made substantial, permanent type investments in domestic corporations (at least a 10-percent equity interest) should be permitted to elect either- (1) The -treatment provided under existing law for resi- dent foreign corporations (the availability of the inter- corporate dividends received deduction, but a tax on capital gains realized in connection with U.S. stock investments); or (2) The tax treatment provided in the proposed amend- ment (no intercorporate dividends received deduction, but exemption from tax on capital gains on U.S. stock invest- ments). Frederick M. Eaton, representing the Fowler Task Force Under the proposed definitions of business and -nonbusiness income, capital gains realized by a foreign corporation would be excluded from business and nonbusiness income, and therefore totally exempt from U.S. tax. This would make it possible for U.S. persons to finance and operate a securities dealer business in the United States through the medium of a resident foreign corporation, thereby accumulating profits from trading in corpo- rate stock substantially free of tax at the corporate level. To prevent this unintended result, he would amend the definition of business income to provide that this term is to include net gains from the sale or exchange of stock in corporations if such stock is held by the taxpayer primarily for sale to customers ordinarily in the course of its trade or business. American institute of Certified Public Accountants, Com- mittee on Federal Taxation There should be a reduction in the present 30-percent tax rate on investment income of foreign corporations not engaged in business in the United States. Present law and the proposed section 882(c)(1) . should, be amended to soften the provision disallowing all deductions in the event of unexcused failure to ifie returns. Henry S. Conston, New York attorney The accumulated earnings tax should not apply to corporations controlled by nonresident aliens, since such application encourages transmission of U.S. dollars abroad. Cleary, Gottlieb, Steen & Hamilton Under present law, a foreign corporation engaged in trade or business in the United States pays the full 48 percent U.S. cor- 71-297 O-67-pt. 1-20 295 PAGENO="0306" 6 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT porate tax rate on interest received by it on debt securities it owns. The bill proposes to give special treatment to the dividend income received by foreign corporations engaged in business in the United States, but makes no special provision for interest income received by such colJ?orations. Thus, the present method of taxation of interest income would continue, and foreign cor- .porations would be discouraged from investing in debt securities. This would keep foreign corporations engaged in business here from investing in debt securities here and would, in other cases, result in "unnecessarily complex arrangements for foreign port- folios containing investments in U.S. securities." Therefore interest received by a foreign corporation doing business in the United States should be treated as nonbusiness income (like dividends). Such avoidance possibilities as may appear should be dealt with directly and specifically. Shearman & Sterling Schlumberger, Ltd. (SL) is a foreign corporation with its principal office in the United States. It has two wholly owned domestic subsidiaries, each of which own a number of domestic operating subsidiaries. (It presently plans to merge the two domestic subsidiaries into a single domestic holding company.) Under H.R. 5916, SL would pay a 30-percent tax on the dividends from its subsidiary or subsidiaries. It would pay a lower rate of tax (5 percent) if it could qualify for the special treatment in the Netherlands Antifies Treaty. However, it cannot qualify for that treatment because the income ~of its subsidiary will be dividend income. Accordingly, H.R. 5916 should be amended to provide that dividend income received by a U.S. corporation from a subsidiary corporation shall not be treated as "dividend income" for certain treaty purposes. Alternatively, for purposes of qualifying for the special treaty treatment, the U.S. holding companies should be permitted to compute their income on a consolidated basis as if all operations were owned directly by a single entity. U. Keith Funston (a member of the task force), representing the New York Stock Exchange Repeal or reduce the withholding tax on interest and dividends paid to foreign corporations. IV. Estate tax on nonresident aliens (sec. 8 of the bill) The bill would amend the law to increase from $2,000 to $30,000 the exemption from estate tax for nonresident aliens. In addition, the rates at which the estate whould be taxed would be greatly lowered the tax beginning at 5 percent on the first $100,000 and never going over a 15 percent rate. Comments Association of the Bar of the City of New York, Committee on Taxation The expatriation proposals in sections 3, 8, and 9 of the bill are too harsh. They introduce many complexities not war- ranted by the problem of U.S. expatriates. 296 PAGENO="0307" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT 7 The penalties for expatriation should not be eliminated as to those who acquired dual nationality at birth and subsequently voluntarily chose other than U.S. nationality. Section 350 of the Immigration and Nationality Act. Code section 2 107(b), providing special rules for determing the value of the gross estate of an expatriate under certain circum- stances, should be' eliminated since it adds too much complexity to warrant the limited revenue benefits of the provision. The bill would authorize the President under certain circum- stances to set aside, in the case of an estate of a foreign resident, estate tax amendments made by this bill or later acts. Since we do not know what ameudments will be made in the future, it would seem advisable to limit this authority to the setting aside of the amendments made by the pending bill. 0. Keith Funston (a member of the task force), representing the New York Stock Exchange Eliminate the estate tax on estates of nonresident aliens. Alternatively, exempt estates of under $30,000 from the require- ment of ffling estate tax returns and also exclude from taxable estates all funds awaiting investments, such as brokers' free credit balances. Joseph B. Brady, representing the Ntitional Foreign Trade Council, Inc. Section 8 of the bifi should be amended to eliminate the estate tax on estates of nonresident alien decedents. This tax can be avoided by the formation of corporations under other sections of the bill. That vehicle would be resorted to by those with large amounts of property in the United States. Elimination of the tax would encourage the holders of small amounts of property to invest in the United States. Henry S. C'onston, New York attorney Section 8 of the bifi should be amended to exclude from the taxable estates of nonresident aliens all debt obligations and stock of noncontrolled corporations. In order to reduce tax avoidance, there should be included in the gross estates of such persons debt obligations and stock of controlled U.S. corporations and also U.S. property owned by controlled foreign corporations. If the above proposal is agreed to, then it is not necessary to further relieve such estates from tax. It would then be proper to return to existing law on the taxable estate. Dorsey Richardson, president, Investment Company Insti- tute and member of the Fowler Task Force He expresses approval in general of the bill, although pointing out that it does not go as far as the task force recommendation eliminating U.S. estate tax on intangible personal property of nonresident decedents. He states, however, that he understands there are technical reasons for not recommending the complete elimination and therefore apparently endorses the bill as pre- sented. 297 PAGENO="0308" 8 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT American Institute of Cert'~/ied Public Accountants, Committee on Federal Taxation The proposed code section 2107 excludes certain expatriates frOm the beneficial estate tax rates provided by the bill. In the case of expatriation of a naturalized citizen who loses his U.S. citizenship upon returning to his native country, this exclusion should apply only to that proportionate part of the gross estate situated in the United States which is equal to the ratio of that part of the gross estate going to U.S. heirs, over the total gross estate. Reese H. Harric, Jr., representing the Trust Division, Ameri- can Bankers Association No estate tax should be imposed on estates of nonresident aliens. Alternatively the Fowler Task Force recommendation should be adopted to eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents. Manufacturing Chemict's Association, Inc. Under present law, bonds owned by a nonresident alien are subject to the U.S. estate tax only if the actual paper instruments are physically in the United States. The bill would change this rule to provide that bonds of U.S. corporations would be subject to U.S. estate tax regardless of where the pieces of paper were lo- cated. The organization states that some of its members have followed the President's recommendations and the suggestions of the Fowler Task Force in raising capital for foreign operations. In order to minimize the outlay of U.S. dollars, some members of the association have sold bonds of U.S. obligors in foreign *capital markets to raise funds needed abroad. The buyers of these bonds are not subject to U.S. estate tax under existing law unless the bonds are located in the United States. However, these individuals would become subject to the U.S. estate tax as to these bonds under the situs rule proposed by the bifi. Accord- ingly, the bifi should be amended to provide that intangibles owned by nonresident aliens be exempted from the estate tax altogether. Alternatively, the present situs rules* should be retained. Frederick M. Eaton, representing the Fowler Task Force It is better to eliminate all estate taxes on intangible property of nonresident alien decedents, rather than reduce the estate tax rate from 5 percent to 15 percent and increase the exemption from $2,000 to $30,000. From a psychological standpoint, it is important to eliminate the tax. Since the present revenue of all U.S. estate taxes paid by foreigners on U.S. property is between $3 and $6 million, the loss from complete elimination cannot be great, in view of the fact that most of the $3. to $6 mfflion would be lost anyway, under the lower rates proposed by the Treasury. U.S. Trust Co. The bill moves in the right direction in lessening the estate tax on nonresident aliens but it does not go far enough. In order to really encourage foreign investment in the United States, the estate tax on nonresident aliens should be eliminated altogether 298 PAGENO="0309" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT 9 so that they would be encouraged to freely buy in the U.S. securities markets. In addition to the financial question, the need for reporting and giving information discourages many potential foreign investors. Real Estate Trade Mission to Europe, J. D. Sawyer, chairman Urges complete elimination of estate tax on intangible property of nonresident alien decedents. Fulton C. Underhay of Herrick, Smith, Donald & Ketchum, attorneys Suggests modifications in expatriation provisions dealing with the estate tax. Urges complete elimination of an estate tax on intangible personal property owned by nonresident aliens. PART TWO. SUMMARY OF OTHER COMMENTS ON THE BILL Henry S. Conston, New York attorney Equalize the gift tax treatment of nonresident aliens engaged in trade or business here and those not so engaged. Make the tax base for the gift tax the same as that for the estate tax. (See recommendations of Henry S. Conston in Part One, IV, above.) Abolish the code section 6851 (d) certification of compliance requirement for nonresident aliens seeking to depart the United States. The requirement is not strictly enforced and constitutes an annoyance for and discrimination against foreigners. Association of the Bar of the City of New York, Committee on Taxation A resident alien should have the right to protest a Presidential determination that a foreign country does not satisy the "similar credit" requirement for allowance of the foreign tax credit. Domestic fiduciaries should be permitted to administer estates and trusts for the exclusive benefit of fcreign beneficiaries and remaindermen without being subject to capital gains tax on the sale of portfolio securities. Consideration also should be given to abolishing the present requirement that a visiting alien, before departing from the United States, must secure a tax clearance and sailing permit. Present procedures in this regard are harassing and annoying to visiting aliens and do not produce a significant amount of revenue. The gift tax penalties for expatriation should not be eliminated as to those who acquired dual nationality at birth and subse- quently voluntarily chose other than U.S. nationality. Section 350 of the Immigration and Nationality Act. The expatriation proposals in sections 3, 8, and 9 of the bill are too harsh. They introduce many complexities not warranted by the problem of U.S. expatriates. 0. Keith Funston (a member of the task force), representing the New York Stock Exchange Eliminate or ease taxes and other restrictions imposed on foreign pension trusts and similar institutional investors. 299 PAGENO="0310" 10 REMOVE TAX BARRIERS TO FOREIGN INVESTMENT Support Group for Progressive Banking The interest paid by a foreign branch of a U.S. bank to a foreign depositor should be exempt from U.S. income tax whether or not the .foreign depositor is deemed to~ be "doing business in the United States." If the deposits were in a foreign bank they would not be subject to U.S. tax even though the.foreign depositor was engaged in a trade or business here. American Institute of Gert~fied Public Accountants, Gom~ mittee on Federal Taxation Nonresident alien individuals and foreign corporations who do not. engage in trade or business in the United States should. have the same exemption from the "permanent establishment" provisions as is given by section 11(b) of the bill to such persons who do engage in trade or business within the United States. The proposed co4e sections 2501 and 2511 exclude certain expatriates from the beneficial gift tax rates provided by the bill. In the case of expatriation of a naturalized citizen who loses his U.S. citizenship upon returning to his native country, this exclusion should apply only to gifts to U.S. citizens. Robert McKinney, member of task force Submits a summary of some of the actions taken by the so- called private sector to implement those recommendations of the Fowler task force directed toward it. States that the private sector has made substantial contribu-~ tions to the genera~l effort to improve the balance-of-payments. situation. Adds that help given by Chairman Cohen and his staff at the SEC and by Assistant Secretary. Surrey and his staff at the Treasury has been extremely encouraging. Urges favorable consideration of H.R. 5916. William Engstrom Disagrees with philosophy of the bifi. Believes it will tend to debilitate the program of investment in less developed areas. Association of Stocks Exchange Firms Expresses "enthusiastic approval" of the bill. Agrees with statements of Mr. Funston representing New York Stock Exchange. Arthur K. Watson, International Business Machines Supports bill and approves statement of National Foreign Trade Council. Investors League, Inc., William Jackman, president Supports the bill and agrees with position taken by G. Keith Funston~ representing the New York Stock Exchange. George F. James, Socony Mobil Oil Go., member of task force Supports the bill and agrees with suggestions of Andre Meyer and Frederick M. Eaton. Real Estate Trade Micsiort to Europe, J. D. Sawyer, chairman Supports the bill generally. 300 PAGENO="0311" REMOVE TAX BARRIERS TO FOREIGN INVESTMENT 11 National Association of Securities Dealers, Inc., Robert W. Haack Supports the bill. John M. Young, member of task force Strongly supports bill. Agrees with recommendations made by Andre Meyer and Frederick Eaton. N0TE.-The persons named made many additional comments of a technical nature not involving policy questions. These comments will be carefully considered in work on the bill by the draftsmen and the staff members. 301 PAGENO="0312" PAGENO="0313" SECTION 9 H.R. 11297 AS. INTRODUCED IN THE HOUSE OF REPRESENTATIVES (See Section 11 of this document, page 319) 303 PAGENO="0314" PAGENO="0315" SECTION 10 H.R. 11297 THE "FOREIGN INVESTORS TAX ACT OF 1965" AS INTRODUCED IN THE HOUSE OF REPRE- SENTATIVES ON SEPTEMBER 28 1965, TOGETHER WITh SUMMARY OF PRINCIPAL PROVISIONS AND COM- PARATIVE PRINT SHOWING CHANGES WHICH WOULD BE MADE IN EXISTING LAW (See Section 11 of this document, page 319) 305 PAGENO="0316" PAGENO="0317" SECTION 11 WRITTEN STATEMENTS BY INTERESTED INDIVIDUALS AND ORGANIZATIONS ON H.R. 11297 SUBMITTED TO THE COMMITTEE ON WAYS AND MEANS 307 PAGENO="0318" PAGENO="0319" WRITTEN STATEMENTS BY INTERESTED INDIVIDUALS AND ORGANIZATIONS ON H.R. 11297 THE FOREIGN INVESTORS TAX ACT OF 1965 SUBMITTED TO COMMITTEE ON WAYS AND MEANS EIGHTY-NINTH CONGRESS SECOND SESSION w Printed for the use of the Committee on Ways and Means U.S. GOVERNMENT PRINTING OFFICE WASHINGTON: 1966 309 PAGENO="0320" COMMITTEE ON WAYS AND MEANS WILBUR D. MILLS, Arkansas, Chairman CECIL R. KING, California JOHN W. BYRNES, Wisconsin HALE BOGGS, Louisiana THOMAS B. CURTIS, Missouri EUGENE J. KEOGH, New York JAMES B. 1JTT, California FRANK M. KARSTEN, Missouri JACKSON K. BETTS, Ohio A. S. HERLONG, JL, Florida HERMAN T. SCHNEEBELI, Pennsylvania JOHN C. WATTS, Kentucky HAROLD R. COLLIER. Illinois AL ULLMAN, Oregon JOEL P. BROYHILL~ Virginia JAMES A. BURKE, Massachusetts JAMES F. BATTIN, Montana CLARK W. THOMPSON, Texas MARTHA W. GRIFFITHS, Michigan W. PAT JENNINGS, Virginia GEORGE M. RHODES, Pennsylvania DAN ROSTENKOWSKI, illinois PHIL M. LANDRUM, Georgia CHARLES A. VANIK, Ohio RICHARD H. FULTON, Tennessee LEO H. IRwIN, Chief Counsel JOHN M. MARTIN, Jr., Assistant Chief Counsel WILLIAM H. QuRALY; Minority Counsel II 310 PAGENO="0321" CONTENTS H.R. 11297, The Foreign Investors Tax Act of 1965, as intro- duced in the House of Representatives on September 28, 1965, together with summary of principal provisions and comparative print showing changes which would be made in Page existinglaw 1 Aluminum Co. of America, E. A. Vaughn, vice president and controller 111 American Bankers Association, Archie K. Davis, president. - - 112 American Cyanamid Co., R. C. Plumb 114 American Institute of Certified Public Accountants, Donald T. Burns, general chairman, Committee on Federal Taxation - 114 ~Association of the Bar of the City of New York, Laurence F. Casey, chairman 119 Baker, McKenzie & Hightower, Michael Waris, Jr., Esq 129 Bankers' Association for Foreign Trade, Gerard E. Keidel, president 130 Brainerd,AndrewW.,Esq 131 Bristol-Myers Co., Augustus W. Kelley, vice president and tax counsel 131 Chrysler Corp., Brian T. 0, Keefe, manager, tax department~ 132 Clark Equipment Co., R. F. Sumerwell, tax manager 132 Continental Iffinois National Bank & Trust Co. of Chicago, David M. Kennedy, chairman 133 Coudert Bros., E. A. Dominianni, Esq 135 Davis, Polk, Wardwell, Sunderland & Kiendl, John P. Carroll, Jr., Escj 135 Dawson, Griffin, Pickens & Riddell, James W. Riddell, Esq - - - 147 First National City Bank, Walter B. Wriston, executive vice president 149 Gonzalez, Hon. Henry B., a Representative m Congress from the State of Texas 150 Greenberg, Charles, North Massapequa, N.Y 151 Hubachek, Kelly, Mifier, Rauch & Kirby, George W. Rauch, Esq 152 Institute of U.S. Taxation of Foreign Income, Inc., Paul D. Seghers, president 157 International Economic Policy Association, N. R. Danielian, president 159 International Telephone & Telegraph 160 Manufacturers Life Insurance Co., E. C. Robinson, associate secretary 161 m 71-297 0-67-pt 1-21 311 PAGENO="0322" IV CONTENTS Manufacturing Chemists' Association, Inc., G. H. Decker, Page president 169 Morgan Guaranty Trust CoW, Thomas S. Gates, chairman of the board 170 Moses&Singer,BurtonJoelAltrens 174 National Foreign Trade Council, Inc., Robert J. Kelliher, chairman, Tax Committee 175 New York Chamber of Commerce, Frank A. Brady, Jr., Research Department 181 New York Clearing House, George Champion, president 183 New York County Lawyers Association, Committee on l1axa- tion, Carter T. Louthan, chairman 185 New York State Bar Association, Thomas C. Plowden- Wardilaw, chairman 190 New York Stock Exchange, G. Keith Funston, president - 197 Proprietary Association, Howard A. Prentice, executive vice presidentandtreasurer 201 SWverman, Henry R., Esq., Saul S. Silverman, Law Offices~,. - 202 Socony Mobil Oil Co., Inc., George F. James, senior vice president 202 Upjohn International, Inc., R. M. Boudeman, president 204 312 PAGENO="0323" 89th ~ } COMMITTEE PRINT H.R. 11297 THE "FOREIGN INVESTORS TAX ACT OF 1965" As Introduced ~n the HOUSE OF REPRESENTATIVES on September 28, 1965 TOGETHER WITH SUMMARY OF PRINCIPAL PROVISIONS AND Comparative Print Showing Changes Which Would Be Made in Existing Law COMMITTEE ON WAYS AND MEANS U.S. House of Representatives NOTE: This document is not a committee report. It is being printed for informational purposes only Printed for the use of the Committee on Ways and Means 313 PAGENO="0324" 2 FOREIGN INVESTORS TAX ACT OF 1965 COMMITTEE ON WAYS AND MEANS CECIL R. KING, California HALE BOGGS, Louisiana EUGENE J. KEOGH, New York FRANK M. KARSTEN, Missouri A. S. HERLONG, JR., Florida JOHN C. WATTS, Kentucky AL ULLMAN, Oregon JAMES A. BURKE, Massachusetts CLARK W. THOMPSON, Texas MARTHA W. GRIFFITHS, Michigan W. PAT JENNINGS, Virginia GEORGE M. RHODES, Pennsylvania DAN ROSTENKOWSKI, Illinois PHIL M. LANDRUM~ Georgia CHARLES A. VANIK, Ohio RICHARD H. FULTON, Tennessee WILBUR D. MILLS, Arkansas, Ciaifrmnan JOHN W. BYRNES, Wisconsin THOMAS B. CURTIS, Missouri JAMES B. TJTT, California JACKSON E. BETTS, Ohio HERMAN T. SCHNEEBELI, Pennsylvania HAROLD IL COLLIER, flhlnols JOEL T. BROYHILL, Virginia JAMES F. BATTIN, Monthna PROFESSIONAL STAFF Lao H. IRWIN, C'hiefCbunsei JoHN M. MARTIN, Jr., Assistant Chief Clounsel WILLIAM IL QUE.4LY, Minority O,unael II 314 PAGENO="0325" FOREIGN INVESTORS TAX ACT OF 1965 3 CONTENTS I. H.R. 11297, the Foreign Investors Tax Act of 1965, as introduced in Page the Ilouse of Representatives on September 28, 1965 3 II. Summary of principal provisions 31 UI. Changes in existing law which would be made by H.R. 11297, as introduced 37 m 315 PAGENO="0326" PAGENO="0327" FOREIGN INVESTORS TAX ACT OF 1965 5 H.R. 11297, THE FOREIGN INVESTORS TAX ACT OF 1965 This document contains three parts: I, H.R. 11297, the Foreign Investors Tax Act of 1965, as introduced in the House of Represent&- tives on September 28, 1965 ; II, a summary of the principal provisions of H.R. 11297; and III, a comparative print showing the changes which would be made in existing law by H.R. 11297. The bill was introduced by Chairman Wilbur P. Mills at the in- struction of the Committee on Ways and Means in order to make it available for the information of the general public. Comments re- ceived will be reviewed by the committee before the bill is reported to the House in the next session of the Congress. It is a modified version of H.R. 5916, which was an administration proposal originating from the recommendations of the so-called Fowler task force. H.R. 11297 contains the essential elements of the predecessor bill (H.R. 5916), but with certain modifications. 1 317 PAGENO="0328" PAGENO="0329" FOREIGN INVESTORS TAX ACT OF 1965 7 I. 8Dm CONGRESS 1ST SESSION H.R. 11297 IN THE HOUSE OF REPRESENTATIVES SEPTEMBER 28, 1965 Mr. MILLS introduced the following bill; which was referred to the Committee on Ways and Means A BILL To amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States. Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SECTION 1. SHORT TITLE, ETC. (a) SHORT TITLE.-This Act may be cited as the "Foreign Investors Tax Act of 1965". (b) TABLE OF CONTENTS.- SEC. 1. Short title, etc. (a) Short title. (b) Table of contents. (c) Amendment of 1954 Code. SEC. 2. Source of income. (a) Interest. (b) Dividends. (c) Personal services. (d) Definitions. (e) Effective dates. SEC. 3. Nonresident alien individuals. (a) Tax on nonresident alien individuals: "SEC. 87L Tax on nonresident alien. individuals. "(a) Income not connected with United States business-30 percent tax. "(b) Income connected with United States business-graduated rate of tax. "(c) Participants in certain exchange or training programs. "(d) Election to treat real property Income as income connected with United States business. "(e) Cross references." (b) Gross income. (c) Deductions. (d) Allowance of deductions and credits. (e) Expatriation to avoid tax: "SEC. 877. Expatriation to. avoid tax. "(a) In generaL "(h) Alternative tax. . "(c) Special rules of source. 3 319 PAGENO="0330" 8 FOREIGN INVESTORS TAX ACT OF 1965 "(d) Exception for loss of citizenship for certain causes. "(e) Burden of proof." (f) Partial exclusion of dividends. (g) Withholding of tax on nonresident aliens. (h) Liability for withheld tax. (i) Declaration of estimated income tax by individuals. (j) Gain from dispositions of certain depreciable realty. (k) Collection of income tax at source on wages. (1) Definition of foreign estate or trust (m) Conforming amendment (n) Effective dates. SEc. 4. Foreign corportaions. (a) Tax on income not connected with United States business: "SEC. 881. Income of foreign corporations not connected with United States business. "(a) Imposition of tax. "(b) Doubling of tax." *(b) Tax on income connected with United States business: "Si~x. 882. Income of foreign corporations connected with United States business.. "(a) Normal tax and surtax. "(b) Gross income. "(c) Allowance of deductions and credits. "(d) Election to treat real property income as income connected with United States business. "(e) Returns of tax by agent. "(f) Foreign corporations." (c) Withholding of tax on foregin corporations. (d) Dividends received from certain foreign corporations. (e) Unrelated business taxable income. (f) Corporations subject to personal holding company tax. (g) Amendments with respect to foreign corporations carrying on Insurance business in United States. * (h) Subpart F income. (1) Gain from certain, sales or exchanges of stock in certain foreign corporations. (j) Technical amendments. (k) Effective dates. SEc. 5. Special tax provisions. (a) Income affected by treaty. (b) Application of pre-1966 income tax provisions: "Ssc~ 896. Application of pre-1966 income tax provisions. "(a) Imposition of more burdensome taxes by `foreign country. "(b) Alleviation of more burdensome taxes. "(c) Notification of Congress required. "(d) Implementation by regulations." (c) Clerical amendments. (d) Effective date. SEC. 6. Foreign tax credit. (a) Alowance of credit to certain nonresident aliens and foreign corporations. (b) Alien residents of the'United States or Puerto Rico. `Szc. 7. Amendment to preserve existing law on deductions under section 931. (a) Deductions. (b) Effective date. * `Szc. 8. Estates of nonresidents not citizens. * (a) Rateof tax. (b) Credits against tax. (c) Property withinthe United States. (d) Property without the United States. (e) Definition of taxable estate. (f) Special methods of computing tax: "SEe. 2107. Expatriation to avoid tax. * "(a) Rateof tax. "(b) Gross estate. "(c) Credits. "(d) Exception for loss of citizenship for certain causes. 4 320 PAGENO="0331" FOREIGN INVESTORS TAX ACT OF 1965 9 "(e) Burden of proof. "Szo. 2108. Application of pre-1966 estate taxprovisions. "(a) Imposition of more burdensome tax by foreign country. "(b) Alleviation of more burdensome tax. "(c) Notification of Congress required. "(d) Implementation by regulations." (g) Estate tax returns. (h) Clerical amendment. (1) Effective date. SEc. 9. Tax on gifts of nonresidents not citizens. (a) Imposition of tax. (b) Transfers in generaL (c) Effective date. Szc. 10. Treaty obligations. (a) AMENDMENT OF 1954 C0DE.-Except as otherwise expressly pro- vided, whenever in this Act an amendment or repeal is expressed in terms of an amendment to, or repeal of, a section or other provision, the reference is to a section or other provision of the Internal Revenue Code of 1954. SEC. 2. SOURCE OF INCOME. (a) IN~reiu~sT.- (1) (A) Subparagraph (A) of section 861 (a) (1) (relating to interest from sources within the United States) is amended to read as follows: "(A) interest on amounts described in subsection (c) re- ceived by a nonresident alien individual or a foreign corpora- tion if such interest is not effectively connected with the conduct of a trade or business within the United States,". (B) Section 861 is amended by adding at the end thereof the following new subsection: "(c) INi~EaiissT ON DErosrrs, ETC.-For purposes of subsection (a) (1) (A), the amounts described in this subsection are- "(1) deposits with persons carrying on the banking business, "(2) deposits or withdrawable accounts with savings institu- tions chartered and supervised as savings and loan or similar associations under Federal or State law, but only to the extent that amounts paid. or credited on such deposits or accounts are deductible under section~ 591 in computing the taxable income of such institutions, and "(3) amounts held by an insurance company under an agree- ment to pay interest thereon. Effective with respect to amounts paid or credited after December 31, 1970, subsection (a) (1) (A) and this subsection shall cease to apply." (2) Section 861 (a) (1) is amended by striking out "and" at the end of subparagraph (B), by striking out the period at the end of subparagraph (C) and inserting m lieu thereof ", and", and by addmg at the end thereof the following new subparagraph: "(D) interest on deposits with a foreign branch of a domestic corporation, if such branch is engaged in the com- mercial banking business and if such deposits are payable only in foreign currency." (3(A) Section 895 (relating to income derived by a foreign central bank of issue from obligations of the United States) is wniended- (i) by striking out "shall not be included" and inserting 5 321 PAGENO="0332" FOREIGN INVESTORS TAX ACT OF 1965 10 in lieu thereof ", or from interest on deposits with persons carrying on the banking business, shall not be included"; (ii) by striking out "such obligations" and inserting in lieu thereof "such obligations or deposits"; (iii) by adding at the end thereof the following new sen- tence: "For purposes of the preceding sentence, the Bank for International Settlements shall be treated as a foreign cen- tral bank of issue with respect to interest on deposits with persons carrying on the banking business."; and (iv) by striking out the heading and inserting in lieu thereof the following: .. "SEC. 895. INCOME DERIVED BY A FOREIGN CENTRAL BANK OF ISSUE FROM OBLIGATIONS OF THE UNITED STATES OR FROM* BANK DEPOSITS." (B) The table of sections for subpart C of part II of :sub- chapter N of chapter 1 is amended by striking Out the item relat- ing to section 895 and inserting in lieu thereof the following: "Sec. 895. Income derived by a foreign central bank of issue from obligations of the United States or from bank deposits." * (b) DIVIDENDS.-. . . . (1) Section 861 (a) (2) (B) (relating to,dividends from sources * within the United States) is amended to read as: follows: "(B) from a foreign corporation m~less less than 80 per- cent of the gross income of such foreign corpóratión for the 3-year period ending with the close of its taxable year pi~e- ceding the declaration of such dividends (or for such. part. of such period as the corporation . has been in existence). was * effectively connected with the conduct of a trade or business within the United States; hut' only in an amount which bears * the same ratio to such;dividends' as the gross: income of the * . corporation for such period which is effectively . connected with the conduct of a trade or business within, the United * States bears to its gross income from all sources; but divi- * dends from a foreign corporation shall, for purposes: of sub- part A of part III (relating t.o foreign tax credit), be treated as income from sources without the United States to the ex- tent (and only to the extent) exceeding the .amount which is 100/85t.hs of .the amount of the deduction allowable under section 245 in respect of such. dividends, or". . (2) Section 861 (a) (2) is amended by adding after subpara- graph (C) the following: . . . . "For purposes of subparagraph (B), the gross income of the foreign corporation for any period before the first taxable year beginning after December 31, 1965, which is effectively connected with the conduct of a trade or business within the United States is an amount equal to. the gross income for such period from sources within the United States." (c) PERSONAL SERvICES.-Section 861 (a) (3) (C) (ii) (relating to in- come from personal services) is amended to read as follows: "(ii) an individual who is a citizen or resident of the United States, a domestic partnership, or a domestic 6 322 PAGENO="0333" FOREIGN INVESTORS TAX ACT OF 1965 11 corporation, if such labor or services are performed for an office or pla.c~ of business maintained in a foreign country or in a possession of the United States by such individual, partnership, or corporation." (d) DEr'INITI0NS.-Section 864 (relating to definitions) is amended- (1) by striking out "For purposes of this part," and inserting in lieu thereof "(a) SALE, ETC.-FOr purposes of this part,"; and (2) by adding at the end thereof the following new subsections: "(b) TItADE OR BUSINESS WITHIN THE UNITED STATES.-FOr pur- poses of this part, part II, and chapter 3, the term `trade Or business within the United States' includes the performance of personal services within the United States at any time within the taxable' year, but does not include- "(1) PERFORMANCE OF PERSONAL SERVICES FOR FOREIGN EM- PLOYER.-The performance of personai services- "(A) for a nonresident alien individual, foreign partner- ship, or foreign corporation, not engaged in trade or business within the United States, or "(B) for an office or place of business maintained in a foreign country or in a possession of the United States by an individual who is a citizen or resident of. the United States or by a domestic partnership or a domestic ëorporation, by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year and whose compensation for such services does not exceed in the aggregate $3,O(X). "(2) TRADING IN SECURITIES OF COMMODITIES.- H' "(A) STOCKS AND SECURITIES.- H "(i) Except in the case of a dealer in stocks or securi- ties, trading in stocks or securities for the taxpayer's own account, whether by the taxpayer ~r his employees or through, a resident broker, commission agent, custodian, or other agent, and whether oi nOt any such' agent has discretionary authority to make decisions in effecting the transactiOns. This clause shall not apply in the case"óf~. corporation (other than `a corporation which 1s,o~ but for section 542(c) (7) would be, a personal `holding' co~m- pany) the principal business of whichis tradingin stocks or securities for its own' account, if tts principal office is in the United States; . ` "(ii) In the case of a person who is a dealer in' stocks or securities, trading in stocks or' securities for his own account through a resident' broker, commission agent, custodian, or other independent agent. "(B) COMMODITIES.- "(i) Except in the case of a dealer iii commodities, trading in commodities for t.he taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent., and' whether or nOt any such agent'has discretion- ary authority to make decisions in effecting the trans- actions. ` - 7. 323 PAGENO="0334" 12 FOREIGN INVESTORS TAX ACT OF 1965 "(ii) In the case of a person who is a dealer in com- modities, trading in `commodities for his own account through a resident broker, commission agent, custodian, or other independent agent. "(iii) Clauses (i) and (ii) apply only if the commodi- ties are of a kind customarily dealt in on an organized commodity exchange and if the transaction is of a kind customarily consummated at such place. "(C) LmuTATIoNs.-Subparagra~hs (A) (ii) and (B) (ii) shall apply only if, at no time durmg the taxable year, the taxpayer has an office or place of business in the United States through which or by the direction of which the transactions in sthck~ or securities, or in commodities, as the case may be, are effected. "(c) EFFECTIVELY CONNECTED INCOME, Erc.-For purposes of this title, factors to be taken into account in determining whether gains, profits, and income or loss shall be treated as `effectively connected' with the conduct of a trade or business within the United States by a nonresident alien individual or foreign corporation include whether-~ "(1) the gains, profits, and income or loss are derived from as- sets used in or held for use in the conduct of such trade or business, "(2) the gains, profits, and income or loss are accounted for through such trade or business, or "(3) the activities of the trade or business were a material fac- tor in the realization of the gains, profits, and income or loss." (e) EF1rEcrIvi~DATEs.- (1) The amendments made by subsections (a) and (b) shall apply with respeôtto payments occurring after December 31, 1965. (2) The amendments made by subsections (c) and (d) shall apply with respect to taxable years beginning after December 31, 1965. SEC. 3. NONRESIDENT ALIEN INDIVIDUALS. (a) TAX ON NONRESIDENT ALIEN INDIVIDUALS.- (1) Section 871 (relating to tax on nonresident alien individ- uals) is amended to read as follows: "SEC. 871. TAX ON NONRESIDENT ALIEN INDIVIDUALS. "(a) INC0IE NoT CONNECTED WrrH UNITED STATES BUSINESS- 30 PERCENT TAX.- "(1) INCOME OTKER THAN CAPITAL GAINS.-There is hereby imposed for each taxable year a tax of 30 percent of the amount re- ceived from sources within the United States by a nonresident alien individual as- "(A) interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, "(B). gains described in section 402(a) (2), .403(a) (2), or 631 (b) or (c), and gains on transfers described in section 1235, and "(`C) amounts which under section 341, or under section 1232 (in the case of bonds or other evidences of indebtedness issued after September 28, 1965), are treated as gains from the sale or exchange of property which is not a capital asset, 8 324 PAGENO="0335" FOREIGN INVESTORS TAX ACT OF 1965 13 but only to the extent the amount SO received is not effectively con- nected with the conduct of a. trade or business within the United States. "(2) CAPITAL GAINS OF ALIENS PRESENT IN THE UNITED STATES 183. DAYS OR M0RE.-In the case of a nonresident alien individual present in th~ tTnited States for a period or periods aggregating 183 days or more during the taxable year, there is hereby imposed for such year a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from the sale or exchange at any time during such year of capital assets exceed his losses, allocable to sources within the United States, from the sale or exchange at any time ~during such year of capital assets. For purposes of this paragraph, gains and losses shall be taken into account only if, and to the extent that, they would be recognized and taken into account if such gains and losses were effectively connected with the conduct of a trade or business with- in the United States, except that such gains and losses shall be determined without regard to section 1202 (relating to deduction for capital gains) and such losses shall be. determined without the benefits of the capital loss carryover provided in sect.ion 1212. Any gain~ or loss which is taken into account in determining the tax under paragraph (1) or subsection (b) shall not be taken into account in determining the tax under this paragraph. For purposes of the 183-day requirement of this paragraph, a nonresi- dent alien individual not engaged in trade or business within the United States who has not established a taxable year for any prior period shall be treated as having a taxable year which is* the calendar year. "(b) INCoME CONNECTED WITH UNITED STATES Busn~ss- GRADUATED RATE OF TAX.- "(1) IMPOSITIoN OF TAx.-A nonresident alien individu~i engaged in trade or business within the United States during the taxable year (or during any preceding taxable year beginning after December 31, 1965) shall be taxabTe as provided in section 1 or 1201 (b) on his taxable income which is effectively connected with the conduct of such trade or business. "(2) DETERMIN4TION OF TAXABLE INC0ME.-In determining tax- able income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct * of the trade or business within the United States. "(c) PARTICIPANTS IN CERTAIN EXCHANGE OF TRAINING PROGRAMS.- For purposes of this section, a nonresident alien individual (who with- out regard to this subsection) is nOt engaged in trade or business within the United States and who is temporarily present in the United States as a nonimmigrant under subparagraph (F) or (J) of section 101(a) (15) of the Immigration and Nationality Act, as amended (8 U.S.C. 1101(a) (15) (F) or (J)), shall be treated as a nonresident alien mdi. vidual engaged in trade or business within the United States, and any income described in section 1441(b) (1) or (2) which is received by such individual shall, to the extent derived from sources within the United States, be treated as effectively connected with the conduct of a trade or business within the United States. . 9 325 PAGENO="0336" 14 FOREIGN INVESTORS TAX ACT OF 1965 "(d) ELECTION To TREAT REAL PROPERTY INCOME AS INCOME CON- NECTED WITH UNITED STATES BUSINESS.- S "(1) IN GENERAL-A nonresident alien individual who during the taxable year derives any income- * "(A) from real property located in the United States, or from any interest in such real property, including (i) gains from the sale or exchange of real property or an interest therein, (ii) rents or royalties from mines, wells, or other * natural deposits, and (iii) gains described in section 631 (b) or (c), and "(B) which, but for this subsection, would not be treated * as income which is effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as in- come which is effectively connected with the conduct of a trade * or business within the United States. An election under this paragraph for any taxable year shall remain in effect for all sub- * sequent taxable years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable * year. "(2) ELECTION AFI'ER REVOCATION.-If an election has been made under paragraph (1) and such election has been revoked, a new election may not be made under such paragraph for any taxable year before the 5th taxable year which begins after the first taxable year for which such revocation is effective, unless the Secretary or ~his delegate consents to such new election. "(3) FORM AND TIME OF ELECTION AND REVOCATION.-Afl elec- tion under paragraph (1), and any revocation of such an election, may be made Only in such manner and at such time as the Secre- tary or his delegate may by regulations prescribe. * "(e) CROSS REFERENCES.- * "(1) For tax treatment of certain amounts distributed by the United States to nonresident alien individuals, see section 402(a)(4). "(2) For taxation of nonresident alien individuals who are ex- patriate United States citizens, see section 877. "(3) For doubling of tax on citizens of certain foreign countries, see section 891. "(4) For reinstatement of pre-1966 income tax provisions in the case of residents of certain foreign countries, see section 896. * "(5) For withholding of tax at source on nonresident alien mdi- viduals, see section 1441.; "(6) For the requirement of making a declaration of estimated tax by certain nonresidei(t alien individuals, see section 6015(i). * "(7) For taxation of gains realized upon certain transfers to domestic corporations, see section 1250(dX3)." (2) Section 1 (relating to tax on individuals) is amended by redesignatin~ subsection (d) as subsection (e), and by inserting * after subsection (c) the following new subsection: 4'(d) NONRESIDENT ALIEN5.-In the case of a nonresident alien in- dividual, the tax imposed by subsection (a) shall apply only as pro- vided by. section 871(b) or 877." (b) GROSS INCOME.- `(1) Subsection (a) of section 872 (relating.to gross income of nonresident alien individuals) is amended to read as follows: "(a) OENERAL RtTLE.-In the case of a nonresident alien individual, gross mcome includes only- _. 10 326 PAGENO="0337" FOREIGN INVESTORS TAX ACT OF 1965 15 "(1) gross income which is derived from sources within the United States and which is not effectively connected with the con- duct of a trade or business within the United States, and "(2) gross income which is effectively connected with the con- duct of a trade or business within the United States." (2) Subparagraph (B) of section 872(b) (3) relating to com- pensation of participants in certain exchange or training pro- grams) is amended by striking out "by a domestic corporation" and inserting in lieu thereof "by a domestic corporation, a domes- tic partnership, or an individual who is a citizen or resident of the United States". (3) Subsection (b) of section 872 (relating to exclusions from gross income) is amended by adding at the end thereof the follow- ing new paragraph: "(4) BOND INTEREST OF RESIDENTS OF THE RYUKYU ISLANDS OR THE TRUST TERRITORY OF THE PACIFIC I5LAND5.-Income derived by a nonresident alien individual from a series E or series H United States savings bond, if such individual acquired such bond while a resident of the Byukyu Islands or the Trust Territory of the Pacific Islands." (c) DEDUCTIONS.- (1) Section 873 (relating to deductions allowed to nonresident alien individuals) is amended to read as follows: "SEC. 873. DEDUCTIONS. "(a) GENERAL Rui~.-In the case of a nonresident alien individual, the deductions shall be allowed only for purposes of section 871(b) and (except as provided by subsection (b)) only if and to the extent that they are effectively connected with the conduct of a trade or busi- ness within the United States; and the proper apportionment and allocation of the deductions for this purpose shall be determined as provided in regulations prescribed by the Secretary or his delegate. "(b) ExC~i'~noNs.-The following deductions shall be allowed whether or not they are effectively connected with the con4uct of a trade or business within the United States: - "(1) LossEs.-The deduction, for losses of property not con- nected with the trade or business if arising from certain casualties or theft, allowed by section 1~5(c) (3), but only if the loss is of property located within the United States. "(2) CHARITABLE C0NTRIBUTIONS.-The deduction for charitable contributions and gifts allowed by section 170. "(3) PERSONAL ExEMPTI0N5.-The deduction for personal ex- emptions allowed by section 151, except that in the case of a non- resident alien individual who is not a resident of a contiguous coun- try only one exemption shall be allowed under section 151. "(c) Citoss REFERENCES.- "(1) For disallowance of standard deduction, see section 142(b)(1). * "(2) For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b)(1)." (2) Section 154(3) (relating to cross references in respect. of * deductions for personal. exemptions) is amended to read as follows: : . 11 7 1-297 0-67-pt. 1-22 327 PAGENO="0338" 16 FOREIGN INVESTORS TAX ACT OF 1965 "(3) For exemptions of nonresident aliens, see section 873(b)(3)." (d) ALLOWANCE OF DEDUCTIONS AND CimDrrs.-Subsection (a) of section 874 (relating to filing of returns) is amended to read as follows: "(a) RETURN PREREQUISITE TO ALLOWANCE.-A nonresident alien individual shall receive the benefit of the deductions and credits al- lowed to him in this subtitie only by filing or causing to be filed with the Secretary or his delegate a true and accurate return, in the manner prescribed in subtitle F (sec. 6001 and following, relating to procedure and administration), including therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. This subsection shall not be construed to deny the credits provided by sections 31 and 32 for tax withheld at source or the credit provided by section 39 for certain uses of gasoline and lubricating oil." (e) EXPATRIATION To Avom TAX.- (1) Subpart A of part II of subchapter N of chapter 1 (relating to nonresident alien individuals) is amended by redesignating section 877 as sectiOn 878, and by inserting after section 876 the following new section: `SEC. 877. EXPATRIATION TO AVOID TAX. "(a) IN .GENERAL.-EVery nonresident alien individual who at any time after March 8, 1965, and within the 5-year period immediately preceding the close of the taxable year lost tTnited States citizenship, unless such loss did not have for one of its principal purposes the avoid- ance of. taxes under this subtitle or subtitle B,shall be taxable for such taxable year in the manner provided in subsection (b) if the tax im- posed pursuant to such subsection exceeds the tax which, without regard to this section, is imposed pursuant to section 871. "(b) ALTERNATIVE TAx.-A nonresident alien individual described in subsection (a) shall be taxable for the taxable year as provided in section 1 or section 1201 (b), except that- "(1) the gross income shall include only the gross income described in sectiOn 872(a) (as modified by subsection (c) of this section), and "(2) the deductions shall be allowed if and to the extent that they are connected with the gross income included under this section, except that the capital loss carryover provided by. section 1212(b) shall not be allowed; and the proper allocation and ap- portionment of the deduct.ions for this purpose shall be deter- mined as provided under regulations prescribed by the Secretary or his delegate. For purposes of paragraph (2), the deductions allowed by section 813(b) shall be allOwed; . and the deduction. (for losses nOt connected with the trade or business if incurred in transactions entered into for profit) allowed by section 165(c) (2) shall be allowed, but only if the profit, if such transaction had resulted in a profit, would be included m grOss income under. this section. "(0) SPEcIAL RULES or SotrnCE.-For purposes of subsection (b), the following items of gross income shall be treated as income from sOurces within the United States: "(1) SALE 0FPROPERTY.-Gains on the sale or exchange of prop- erty (other than stock or debt obligations) located in the United States. 12 328 PAGENO="0339" FOREIGN INVESTORS TAX ACT OF 1965 17 "(2) STOCK OR DEBT 0BLmATI0NS.-Gains on the sale or ex- change of stock issued by a domestic corporation or debt obliga- tions of United States persons or of the United States, a State or * political subdivision thereof, or the District of Columbia. * ."(d) EXCEPTION FOR L~)SS OF CPTIzENSHIP FOR CERTAIN CAusi~s.- Subsection (a) shall not apply toa nonresident alien individual whose loss of United States citizenship resulted from the application of sec- tion 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). ." (e) BUEDEN OF PRo0F.-If the Secretary or his delegate establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction for the taxable year in the taxes on his probable income for such year, the burden of proving for such taxable year that such loss of citizen- ship did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle B shall be on such individual." (2) The table of sections for subpart A of part II of subchapter. N of chapter 1 (relating to nonresident alien individuals) is amended by striking out the item relating to section 877 and inserting in lieu thereof the following: "Sec. 877. Expatriation to avoid tax. "Sec. 878. Foreign educational, charitable, and certain other eneinpt organizations." (f) PARTIAL EXCLUSION OF Divmic~s.-Subsection (d) of section 116 (relating to certain nonresident aliens ineligible for exclusion) is amended to read as follows: "(d) CERTAIN NONRESIDENT ALIENS INELIGIBLE FOR ExCLU5I0N.-In the case of a nonresident alien individual, subsection (a) shall apply only- "(1) in determining the tax imposed for the taxable year pur- suant to section 871(b) (1) andonly in respect of dividendE which are effectively connected with the conduct of a trade or business within the United States, or "(2) in determining the tax imposed for the taxable year pur- suant to section 877(b)." (g) WITHHOLDING OF TAX ON NONRESIDENT ALIENS.-Section 1441 (relating to withholding of tax on nonresident aliens) is amended- (1) by striking out "(except interest on deposits with persons carrying on the banking business paid to persons not engaged in business in the United ~t~ates)" in subsection (b); (2) by striking out "and amounts described in section 402 (a) (2)" and all that follows in the first sentence of subsection (b) and inserting in lieu thereof "and gains described in section 402(a) (2), 403(a) (2), or 631 (b) or (c), and gains on transfers described in section 1235."; (3) by striking out paragraph (1) of subsection (c) and insert- ing in lieu thereof the following new paragraph: "(1) INCOME CONNECTED WITH UNITED STATES BUSINI~SS.-NO deduction or withholding under subsection (a) shall be required in the, case of, any item of income. (other than compensation for personal services) which is effectively connected with the conduct of a trade or business within the United States and on which a tax is imposed for the taxable year pursuant to section 871(b) (1)."; 13 329 PAGENO="0340" 18 FOREIGN INVESTORS TAX ACT OF 1965 (4) by amending paragraph (4) of subsection (c) to read as follows: "(4) COMPENSATrON OF CERTAIN ALIENS.-Under regulations prescribed by the Secretary or his delegate, compensation for per- sonal services may be exempted from deduction and withholding under subsection (a)."; and (5) by striking out "amounts in section 402(a) (2), section 403(a) (2), section 631 (b) and (c), and section 1235, which are considered to be gains from the sale of exchange of capital assets," in paragraph (5.) and of subsection (c) and inserting in lieu thereof "gains described in section 402(a) (2), 403(a) (2), or 631 (b) or (c), and gains on tranfers described in section 1235,", and by striking out "proceeds from such sale or exchange," in such paragraph and inserting in lieu thereof "amount payable,". (h) LIABILITY FOR WITHHELD TAx.-Section 1461 (relating to re- turn and payment of withheld tax) is amended to read as follows: "SEC. 1461. LIABILITY FOR WITHHELD TAL "Every person required to deduct and withhold any tax under this chapter is hereby made liable for such tax and is hereby indemnified against the claims and demands of any person for the amount of any payments made in accordance with the provisions of this chapter." (i) DECLARATION OF Es TED INCOME TAX BY INDIVIDUALS.- Section 6015 (relating to declaration of estimated income tax by indi- viduals) is amended- (1) by striking out that portion of subsectiOn (a) which pre- cedes paragraph (1) and inserting in lieu thereof the following: "(a) REQUIREMENT OF DECLARATION.-EXCept as otherwise pro- vided in subsection (i), every individual shall make a declaration of his estimated tax for the taxable year if-"; (2) by redesignating subsection (i) as subsection (j.); and (3) by inserting after subsection (h) the following new sub- section: "(i) No~i~smEwr ALIEN INDIVIDUALS.-No declaration shall be required to be made under this section by a nonresident alien indi- vidual unless- "(1)~' withholding under chapter 24 is made applicable to the wages, as defined in section 3401(a), of such individual, "(2) such individual has income which is effectively connected with the conduct of a trade or business within the United States, or "(3) such individual is a resident of Puerto Rico during the entire taxable year." fl . (j) GAIN FROM DlslosrnoNs OF CERTAIN DEPRECIABLE REALTY.- The second sentence of paragraph (3) of section 1250(d). (relating to certain tax-free transactions) is amended to read as follows: "This paragraph shall not apply to- "(A) a disposition to an organization (other than a cooperative described m section 521) which is exempt from tax imposed by this chapter, or . . 14 330 PAGENO="0341" FOREIGN INVESTORS TAX ACT OF 1965 19 "(B) a transfer of property by a nonresident alien individual, a foreign estate or trust, or a foreign partnership, to a domestic corporation in exchange for stock or securities in such corporation in a transaction to which section 351 applies." (k) CoI4u~c'rIoN OF INCOME TAX AT SOURCE ON WAGES.-Subsection (a) of section 3401 (relating to definition of. wages for purposes of collection of income tax at source) is amended by striking out para- graphs (6) and (7) and inserting in lieu thereof the following: "(6) for such services, performed by a nonresident alien individual, as may be designated by regulations prescribed by the Secretary or his delegate; or". (1) DEFINITION OF FLREIGN ESTATE OR TRuST.-Section 7701 (a) (31) (defining foreign estate or trust) is amended by striking out "from sources without the United States" and inserting in lieu there- of ", from sources without the United States which is not effectively connected with the conduct of a trade or business within the United States,". (m) CONFORMING AMENDMENT.-ThC first sentence of section 932(a) (relating to citizens of possessions of the United States) is amended to read as follows: "Any individual who is a citizen of any posssession of the United States (but not otherwise a citizen of the United States) and who is not a resident of the United States shall be subject to taxation under this subtitle in the same manner and subject. to the same conditions as in the case of a nonresident alien individual." (n) EFFEcTIVE DATES.- (1) The amendments made by this section (other than the amendments made by subsections (g), (h), and (k)) shall apply with respect to taxable years beginning after December 31, 1965. (2) The amendments made by subsections (g) and (h) shail apply with respect to payments occurring after December 31,1965. (3) The amendments made by subsection (k) shall apply with respect to remuneration paid after December 31,1965. SEC. 4. FOREIGN CORPORATIONS. (a) TAX ON INCOME No'r CONNECTED WITH UNITED STATES Busi- ~ss.-Section 881 (relating to tax on foreign corporations not engaged in business in the United States) is amended to read as follows: "SEC. 881. INCOME OF FOREIGN CORPORATIONS NOT CONNECTED WIT!! UNITED STATES BUSINESS. "(a) IMPOSITION OF TAx.-There is hereby imposed for esch taxable year a tax of 30 percent of the amount received from sources within the United States by a foreign corporation as- "(1) interest, dividends, rents, salaries, wages, permiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodicai gains, profits, and income, "(2) gains described in section 631 (b) or (c), and * "(3) amounts which under section 341, or under section. 1232 * (in the case of bonds or other evidences of indebtedness issued after September 28, 1965), are treated as gains from the sale or ex- change of property which is not a capital asset, 15 331 PAGENO="0342" 20 FOREIGN INVESTORS TAX ACT OF 1965 but only to the extent the amount so received is not effectively con- nected with the conduct of a trade or business within the United States. "(b) DotrmaNo OF TAX.- "For doubling of tax on corporations of certain foreign countries, see section 8,91." (b) TAX ON INCOME CONNECTED WITH UNITED STATES BUSINESS.- (1) Section 882 (relating to tax on resident foreign corpora- tions) is amended to read as follows: "SEC. 882. INCOME OF FOREIGN CORPORATIONS CONNECTED WITH UNITED STATES BUSINESS. "(a) NORMAL TAx A~D SURTAX.- ," (1) IMPOSITION OF TAx.-A foreign corporation engaged in trade or business within the United States during the taxable year. (or during any preceding taxable year beginning after December 31, 1965) shall be taxable as provided in section 11 or 1201 (a) on its taxable income which is effectively connected with the conduct of such trade or business. * "(2) DETERMINATION OF TAXABLE INC0ME.-In determining tax- able income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct of the trade or business within the United States. "(b) GROSS INC0ME.-In the case of a foreign corporation, gross income includes only- "(1) gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, and. "(2) gross income which is effectively connected with the con- duct of a trade or business within the United States. "(c) ALLOWANCE `OF DEDUCTIONS AND CREnI~.- "(1) ALLOCATION OF DEDUCTIONS.- "(A) GENERAL RULE.-In the case of a foreign corporation, the deductions shall be allowed only for purposes of sub- section .(a) and (except as provided by subparagraph (B)) only if and to the extent that they. are effectively connected with the conduct of a trade or business within the United * States; and the proper apportionment and allocation of the. deductions for this purpose shall be determined as provided * in regulations prescribed by. the Secretary or his delegate. "(B) CHARITABLE . CONTRIBtJTIONS.-The deduction for charitable contributions and gifts provided by section 170 shall be allowed whether or nc)t effectively connected with the conduct ..of a trade or business within the United States.. "(2) DEDUCTIONS AND CREDITS ALLOWED ONLY IF RETURN FILED.- A foreign corporation shall receive the benefit of the deductions and credits allowed to it in this subtitle only by. filing or causing to be filed with the Secretary or his de1~ate a true. and accurate return, in' the manner prescribed in' subtitle F, inclduing therein all the information which the S~cretary r his delegate may deem necessary for the c'tlculation of such deductions and credits This paragraph shall not be construed to. deny the credit provided by section 32 for tax withheld at source or the credit provided by section 39 for certain uses of gasoline and lubricating oil 16 332 PAGENO="0343" FOREIGN INVESTORS TAX ACT OF 1965 21 "(3) FOREIGN TAX CREDIT.-EXCept as provided by section 906, foreign. corporations shall not be allowed the credit against the tax for taxes of foreign countries and possessions of the United States allowed bysection 901. "(4) CRoss REFERENCES.- "For rule that certain foreign taxes are not to be taken into account in determining deductions or credits, see section 906(b)(1'). "(d) ELECTION To TREAT REAL PROPERTY INCOME AS INCOME CON- NECTED Wrm UNITED STATES BUSINESS.- "(1) IN GENERAL.-A foreign corporation which during the taxable year derives any income- "(A) from real property located in the United States, or from any interest in such real property, including (i) gains from the sale or exchange of real property or an in- terest therein, (ii) rents or' royalties from mines, wells, or other natural deposits, and (iii) grains described in section 631 (b) or (c),and "(B) which, but for this subsection, would not be treated as income effectively co~uieoted with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. An election under this para- graph for any taxable year shall remain in effect for all subse- quent taxaNe years, except that it may be revoked with the con- sent of the Secretary or his delegate with respect to any taxable year. "(2) ELECTION AFFER REVOCATION, zrc.-Paragraphs (2) and (3) of section 871(d) shall apply in respect of elections under this subsection in the same manner and to the same extent as they~ apply in respect of elections under section 871(d). "(e) Riir'miis OF TAX BY AOENT.-If any foreign corporation has no office or place of business in.the United States buc has an agent in the United States, the return reqi~ired under section 6012 shall be made by the agent." (2)(A) Subsection (e) of section 11 (relating to exceptions from tax on corporations) is amended by inserting "or" at the end of paragraJ~h (2), by striking out", or" at the end of para- * graph (3) and inserting a period in lieu thereof, and by striking outparagraph (4). * (B) Section 11 (relating to tax on corporations) is amended by adding at the end thereof the following new subsection: "(f) FOREIGN ConroEATIoNs.-In the case of a foreign corporation, the tax imposed by subsection (a) shall apply only as provided by section 882." (3) The ta~ble of sections for subpart B of part II of sub- chapter N of chapter 1 is amended by striking out the items re- lating to sections 881 and 882 and inserting in lieu thereof the following: `~Se~. 881. Income of forelng eoi~Yorations not connected with United States business. "Sec. 882. In~ome of foreign corporation's connected with United States business." 17 333 PAGENO="0344" 22 FOREIGN INVESTORS TAX ACT OF 1965 (c) WITHHOLDING OF TAx ON FOREIGN CoRroRxrrqNs.-Section 144'2 (relating to withholding of tax on foreign corporations) is amended by striking out "not engaged in trade or business within the United States", and by adding at the end thereof the following new sentence: "For purposes of the preceding sentence, the reference in section 1441(c) (1) to section 871 (b)(1) shall be treated as referring to section 882(a)." (d) DIVIDENDS REci~vi~n FROM CERTAIN FOREIGN CoRPo1~&TIoNs.- Subsection (a) of section 245 (relating to the allowance of a deduction in respect of dividends received from a foreign corporation) is amended- (1) by striking out "and has derived 50 percent or more of its gross income from sources within the United States," in that por-. tion of subsection (a) which precedes paragraph (1) and by in- serting in lieu thereof "and if 50 percent or more of the gross income of such corporation from all sources for such period is effectively conneôted wit.h the conduct of a trade or business within the United States,"; (2) by striking out "from sources within the United States" in * paragraph (1) and inserting in lieu thereof "which is effectively connected with the conduct of a trade or business within the United States"; (3) by striking out "frOm sources within the United States" in paragraph (2) and inserting in lieu thereof ", which is effec- tively connected with thecOnduct of a trade or business within the. United States,"; and (4). by adding after paragraph (2) the follOwing new sentence: "For purppses of this subsection, the gross income of the foreign corpo- ration for any period before the first tax'tble year beginning after December 31, .1965,: which is effectivOl~i connected with the conduct of a trade or büsinëss within the United States is an amount equal to the gross income for such period from sou~ces within the United. States." (e) UNRELATED BusINi~s `T.&XABLE INCOME -~--The last sentence of sectio~i 512(a) (relating to definition) is amended to read as follows "In the casO of an OrganizatiOn dsè~ribed in section 511 which is a5fo~r- eign organization, the unrelated business taxable incOme shall be its unrelated business takable mconie which is effectivel3~ connected with the conduct of a trade.or business withii the United States." (f) CORPORATIONS SuM~'r ~o PERSOi~AI HOIDING COMPANY T&x - Paragraph (7) of section 542(c) (rsiatiñg to corporations not subject to the personal holding company tax) i~ amended td~read~ as. follows: "(7) a foreign corporation, if all of its stock outstanding dur- ing the last half of the ta~able yCar is owned by nonresident aJièn individuals, whether dirsctly or indirectly through foreign estates, foreign ttu~ts, foreig~i ~krtnerships, or ot~ier foreign S corporations;". (g) AMENDMENTS WITH RESPECT `ro FOREIGN CORPORATIONS CARRY- ING ON INStIRANCE BUSINESS IN UNITED STATES.- (1) Section 842 (relating to computation of gross income) is amended to read as follows: 18 334 PAGENO="0345" FOREIGN INVESTORS TAX ACT OF 1965 23 "SEC. 842. FOREIGN CORPORATIONS CARRYING ON INSURANCE BUS!- NESS. "If `a foreign corporation carrying on an insurance business within the United States. would qualify under part I, II, or III of this sub- chapter for the taxable year if (without regard to income not effec- .tively connected with the conduct of any trade or business within the United States) it were a domestic corporation, such corporation shall be taxable under such part on its income effectively connected with its conduct of any trade or business within the United States. *With re- spect to the remainder of its income, which is from sources within the United States, such a foreign corporation shall be taxable as provided in section 881." (2) The table of sections for part IV of subchapter L of chap- ter 1 is amended by striking out the item relating to section 842 and inserting in lieu thereof the following "Sec. 842. Foreign .corporal,ions carrying on insurance business." (3) Section 819 (relating to foreign life insurance companies) is ameiided- .. (A) by striking oift subsections (a) and r(d) and by redes- ignating subsections (b) and (c) as subsections (a) and (b), (B)' by striking out "In the case of any company described I in subsection (a) ," in subsection (a) (1) (as redesignated by subparagraph (A)) `and inserting in lieu thereof "Iii the case ofany foreign corporation taxable under this part,", (C) by striking out "subsection (c)"in the last sentence of subsection (a) (2) (as redesignated by subparagraph (A)) and inserting in lieu'théreof "subsection (b) ", (D) `by striking out "for purposes of subsection (a)" eacb place it appears in subsection (b) (as redesignated by sub- paragraph (A)), and inserting in lieu thereof "with respect to a foreign corporation",' (E) *by . striking. out "foreign life insurance company" each place it appears in such siThsection (b) and inserting in lieu thereof "foi'eign corporation", (F) by striking out "subsection (b) (2) (A)" each place it `appears iii such subsection (`b) and inserting in lieu thereof "subsection (a)(2)(A)", ~(G) by striking out "subsection (b) (2) (B)"in paragraph. ~(2) (B) (ii) of such subsection(b) and inserting in lieu there- ~of "subsection `(a) (2) (B) ", and (H) by adding at the end thereof the following new sub- .section: * "(c) `CRoss REFERENCE.- . .. .. "For taxation of foreign corporations carrying on life insurance business within the United States, see section 842." (`4) .: Section' 821 (`relating to tax on mutual insurance compa- nies to' which part II applies) is amended- (A) by striking out' subsectiOn (e) and by redesigriating subsections (f) and (g) as subsections (e) and (f), and 19 335 PAGENO="0346" 24 FOREIGN INVESTORS TAX ACT OF 1965 * (B) by adding at the end of subsection (f) (as redesig- * nated by subparagraph (A)) the following: "(3) For taxation of foreign corporations carrying on an insurance business within the United States, see section 842." (5) Section 822 (relating to determination of taxable invest- ment income) is amended by striking out subsection (e) and by redesignating subsection (f) as subsection (e). (6) Section 831 (relating to tax on certain other insurance companies) is amended- (A) by striking out subsection (b). and by redesignating subsection (c) as subsection (b), and (B) by amending subsection (d) to read as follows: "(c) CROSS REFERENCES.- "(1) For alternative tax in case of capital gains, see section 1201)(a). "(2) For taxation of foreign corporations carrying on an insurance - business within the United States, see section 842." (7) Section 832 (relating to insurance company taxable in- come) is amended by striking out subsection (d) and by redesig- nating subsection (e) as subsection (d). (8) The second sentence of section 841 (relating to credit for foreign taxes) is amended by striking out "sentence," and in- serting in lieu thereof "sentence (and for purposes of applying section 906 with respect to a foreign insurance company) ,". (h) SUBPART F INC0ME.-Section 952(b) (relating to exclusion of United States income) is amended to read as follows: "(b) EXCLUSION OF UNITED STATES INC0ME.-In the case of a con- trolled foreign corporation, subpart F income does. not include any item of income effectively connected with the conduct by such corpo- ration of a trade or business within the United States unless such item is exempt from taxation (or is subject to a reduced rate of tax) pur- suant to a treaty obligation of the United States." (i) GAIN FROM CERTAIN SALES OR EXCHANGES OF Sa'ocx IN CER- TAIN FOREIGN CORPoi~&TIoNS.-Paragraph (4) of se~tion 1248(d) (re- lating to exclusions from earnings and profits) is amended to read asfollows: "(4) UNrr1~ STATES INC0ME.-Any item includible in gross income of the foreign corporation under this chapter- "(A) for any taxable year beginning before January 1, 1966, as income derived from sources within the United States of a foreign corporation engaged in trade or business within the United States, or "(B) for any taxable year beginning after December 31, 1965, as income effectively connected with the conduct by such corporation of a trade or business within the United States. This paragraph shall not apply with respect to any item which is exempt from taxation (or is subject to a reduced rate of tax) pur- suant to a treaty obligation of the United States." (j) TECHNICAL AMENDMENTS.- (1) Section 884 is amended to read as follows: 20 336 PAGENO="0347" FOREIGN INVESTORS TAX ACT OF 1965 25 "SEC~ 884. CROSS REFERENCES. "(I) For special provisions relating to unrelated business income of foreign educational, charitable, and certain other exempt orga- nizations, see section 512(a). "(2) For special provisions relating to foreign insuance com- panies, see section 842. "(3) For rules applicable in determining whether any foreign corporation is engaged in trade or business within the United States, see section 864(b). "(4) For reinstatement of pre-1966 income tax provisions in the case of corporations of certain foreign countries, see section 896. "(5) For allowance of credit against the tax in case of a foreign corporation having income effectively connected with the conduct of a trade or business within the United States, see section 906. "(6) For withholding at source of tax on income of foreign corporations, see section 1442." (2) Section 953(b) (3) (F) is amended by striking out "832(b) (5)" and inserting in lien thereof "832(c) (5) ". (3) Seedon 1249 (a) is amended by striking out "Except as provided in subsection (c), gain" and inserting in lieu thereof Gain". (k) EFF1~IvE DATES.-The amendments made by this section (other than subsections (c) and (i)) shall apply with respect to tax- able years beginning after December 31, 1965. The amendments made by subsection (c) shall apply with respect to payments occurring after December 31, 1965. The amendment made by subsection (i) shall apply with respect to sales or exchanges occurring after December 31, 1965. SEC. 5. SPECIAL TAX PROVISIONS. (a) INcO1~n~ AFFECTED BY TREATY.-Section 894 (relating to income exempt under treaties) is amended to read as follows: "SEC. 894. INCOME AFFECTED BY TREATY. "(a) . INco~n~ ExJ~tPT UNDER TREATY.-Income of. any kind, to the extent required by any treaty obligation of the United States, shall not be included in gross income and shall be exempt from taxation under this subtitle. "(b) PERMANENT ESTABLISHMENT IN UNITED STATES.-FOr pur- poses of applying any exemption from, or reduction of, any tax pro- vided by any treaty to which the United States is a party with respect to income which is not effectively connected with the conduct of a trade or business within the United States, a nonresident alien individ- ual or foreign corporation shall be deemed not to have a permanent establishment in the United States at any time during the taxable year. This subsection shall not apply in respect of the tax computed under section 877(b)." (b) APPLICATION OF PRE-1966 INCOME TAX PRovIsIoNs.-Subpart 0 of part II of subchapter N of chapter 1 (relating to miscellaneous pro- visions applicable to nonresident aliens and foreign corporations) is amended by adding at the end thereof the following new section: "SEC. 896. APPLICATION OF PRE-1966 INCOME TAX PROVISIONS. "(a) IMPOSITION OF Mom~ BURDENSOME TAx]~s BY Fo1u~aoN OotrN- TRY.-Whenever the President finds that- "(1) under the laws of any foreign country, considering the tax system of such foreign country, citizens of the United States 21 337 PAGENO="0348" 26 FOREIGN INVESTORS TAX ACT OF 1965 not residents of such foreign country or domestic corporations are * being subjected to more burdensome taxes, on any item of income * received by such citizens or corporations from sources within such foreign country, than taxes imposed by the provisions of this subtitle on similar income derived from sources within the United States by residents or corporations of such foreign country, "(2) such foreign country, when requested by the' United States to do so, has not acted to revise or reduce such taxes so that they are no more burdensome than taxes imposed by the provisions of this subtitle on similar income derived from sources within the United States by residents or corporations of such foreign coun- try, and "(3) it is in the public interest to apply pre-1966 tax provisions in accordance with the provisions of this section to residents or corporations of such foreign country, the President shall proclaim that the tax on such similar income de- rived from sources within the United States by residents or corpora- tions of such foi~eign country shall, for taxable years beginning after such proclamation, be determined under this subtitle without regard to amendments made to this subchapter and chapter 3 on or after the date of enactment of this section. "(b) ALLEVIATION OF Moitj~ BURDENSOME TAxi~s.-Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that citizens of the United States not residents of such foreign country or domestic corporations are no longer sub- ject to more burdensome taxes on such item of income derived by such citizens or corporations from sources within such foreign country, he shall proclaim that the tax on such similar income derived from sources within the United States by residents or corporations of such foreign country shall, for any taxable year beginning after such proclamation, be determined under this subtitle without regard to subsection (a). "(c) NYrIFICATION OF CONGRESS R.EQU1RED.-NO proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. "(d) IMPLEMENTATION BY REGULATI0NS.-The Secretary or his dele- gate shall prescribe such regulations as he deems necessary or appro- priate to implement this section." (c) CLERICAL AMENDMENTS.-The table of sections for subpart C of part II of subchapter N of chapter us amended- (1) by striking out the item relating to section 894 and in- serting in lieu thereof "Sec. 894. Income affected by treaty."; (2) by adding at the end of such table the following: "Sec. 896. Application of pre-1966 income tax provisions." (d) EFFECTIVE DAnS.-The amendments made by this section shall apply with respect to taxable years beginning after December 31, 1965. 22 338 PAGENO="0349" FOREIGN INVESTORS TAX ACT OF 1965 27 SEC. 6. FOREIGN TAX CREDIT~ (a) ALLOWANCE OF CREDIT `ro CERTAIN NONRESIDENT ALIENS AND FOREIGN CORPORATIONS.- (1) Subpart A of part III of subchapter N of chapter 1 (re- lating to foreign tax credit) is amended by adding at the end thereof the following new section: "SEC. 906. NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN COR- PORATIONS. "(a) ALLOWANCE OF CREDIT.-A nonresident alien individual or a foreign corporation engaged in trade or business within the United States during the taxable year (or during any preceding taxable year beginning after December 31, 1965) shall be allowed a credit under section 901 for the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year (or deemed, under section 902, paid or accrued during the taxable year) to any foreign country or possession of the United States with respect to income effectively connected with the conduct of the trade or business within the United States. "(b) SPECIAL RULES.- "(1) or purposes of subsection (a) and for purposes of deter- mining the deductions allowable under sections 873 (a) and 882(c), in determining the amount of any tax paid or accrued to any foreign country or possession there shall not be taken into account any amount of tax to the extent the tax so paid or accrued is imposed with respect to income which would not be taxed by such foreign country or possession but for the fact that- "(A) in the case of a nonresident alien individual, such individual is a citizen or resident of such foreign country or possession, or "(B) in the case of a foreign corporation, such corpora- tion was created or organized under the law of such foreign foreign country or possession or is domiciled for tax pur- poses in such country or possession. "(2) For purposes of subsection (a), in applying section 904 the taxpayer's taxable income shall be treated as consisting only of the taxable income effectively connected with the taxpayer's conduct of the trade or business within the United States. "(3) The credit allowed pursuant to subsection (a) shall not be allowed against any tax imposed by section 871 (a) (relating to income of nonresident alien individual not connected with United States business) or 881 (relating to income of foreign corporations not connected with United States business). "(4) For purposes of sections 902(a) and 78, a foreign corpora- tion choosing the benefits of this subpart which receives dividends shall, with respect to such dividends, be treated as a domestic corporation." ç2) The table of sections for such subpart A is amended by adding at the end thereof the following: 23 339 PAGENO="0350" 28 FOREIGN INVESTORS TAX ACT OF 1965 "Sec. 906. Nonresident alien individuals und foreign corporations." (3) Section 874(c) is amended by striking out "(c) F0InIGN TAX CREDIT NOT ALLOWED.-A nonresident" and in- serting in lieu thereof.the following:: "(c) FOREIGN TAX CiuuuT.-Except as provided in section 906, a nonresident". (4) Subsection (b) of section 901 (relating to amount allowed) is amended by redesignating paragraph (4) as paragraph (5), and by inserting after paragraph. (3) the following new paragraph: "(4) NONRESIDENT . ALIEN~ INDIVIDUALS AND FOREIGN CORPORA- TI0N5.-In the case of any nonresident alien individual or a for- eign corporation, the amount determined pursuant to section 906; and".. (5) Paragraph (5) (as redesignated) of section 901(b). is amended by striking out "or (3)," and inserting in lieu thereof "(3),or (4),". (6) The amendments made by this subsection shall apply with respect to taxable years beginning after December 31, 1~65. In applying section 904 of the Internal Revenue Code of 1954 with respect to section 906 of such Code, no amount may be carried from or to any taxable year beginning before January 1, 1966, and no such year shall be taken into account. (b) ALIEN RESIDENTS OF THE UNITED STATES OR PUERTO RIco.- (1) Paragraph (3) of section 901(b) (relating to amount of foreign tax credit allowed in case of alien resident of the United States or Puerto Rico) is amended by striking out ", if the foreign country of which such alien resident is a citizen or subject, in im- posing such taxes, allows a similar credit to citizens of the United States residing in such country". (2) Section 901 is amended by redesignating subsections (c) and (d) as subsections (d) and (e), and by inserting after sub- section (b) the following new subsection: "(c) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN RESIDENTS.- Whenever the President finds that- "(1) a foreign country, in imposing income, war profits, and e~cess profits taxes, does not allow to citizens of the United States residing in. such foreign country a credit for any such taxes paid or accrued to the United States or any foreign country. as the case may be, similar to the credit allowed under subsection (b) (3), "(2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit to citizens of the United States residing in such foreign country, and "(3) it is in the public interest to allow the credit under sub- section (b) (3) to citizens or subjects of such foreign country only if it allows such a similar credit to citizens of the United States residing in such foreign country~ the President shall proclaim that, for taxable years beginning while the proclamation remains in effect, the credit under subsection (b) (3) shall be allowed to citizens or subjects of such foreign country only 24 340 PAGENO="0351" FOREIGN INVESTORS TAX ACT OF 1965 29 if such foreign country, in imposing income, war profits, and excess profits taxes, allows to citizens of the United States residing in such foreign country such a similar credit." (3) Section 2014 (relating to credit for foreign death taxes) is amended by striking out the second sentence of subsection (a), and by adding at the end of such section the follqwing new subsection: (h) SIMILAR CREDIT REQUIRED FOR CERTAIN AÜEN RESIDENTS.- Whenever the President finds that- "(1) a foreign country, in imposing estate, inheritance, legacy, or succession taxes, does not allow to citizens of the United States resident in such foreign country at the time of death a credit sirni- lar to the credit allowed under subsection (a), "(2) such foreign country, when requestth by the United States to do so, has not acted to provide such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, and "(3) it is in the public interest to allow the credit under sub- section (a) in the case of citizens or subjects of such foreign country only if it allows such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, the President shall proclaim that, in the case of citizens or subjects of such foreign country dying while the proclamation remains in effect, the credit under subsection (a) shall be allowed only if such foreign country allows such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death." (4) The amendments made by this subsection (other than para- graph (3)) shall apply with respect to taxable years beginning after December 31, 1965. The amendment made by paragraph (3) shall apply with respect to estates of decedents dying after the date of the enactment of this Act. SEC. 7. AMENDMENT TO PRESERVE EXISTING LAW ON DEDUCTIONS UNDER SECTION 931. (a) DEDuc~roNs.-Subsection (d) of section 931 (relating to do. ductions) is amended to read as follows: "(d) DEDUCrIONS.- * "(1) GENERAL RULE.-Except as otherwise provided in this subsection and subsection (e), in the case of persons entitled to the benefits of this section the deductions shall be allowed only if and to the extent that they are connected with income from sources within the United States; and the proper apportionment and allocation of the deduction~s with respect to sources of income within and without the United Statets shall. be determined as provided in part I, under regulations prescribed by the Secretary or his delegate. ** * * "(2) ExcEynoNs.-The following deductions shall be allowed whether or not they are connected with income from sources within the United States: * "(A) The deduction, for losses not connected with the. trade or business if incurred in transactions entered into for 25 341 PAGENO="0352" 30 FOREIGN INVESTORS TAX ACT OF 1965 profit, allowed by section 165(c) (2), but only if the profit, if such transaction had resulted in a profit, would be taxable under this subtitle. "(B) The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c) (3), but only if the loss is of property within the United States. "(C) The deduction for charitable contributions and gifts allowed by section 170. "(8) DEDUCTION DISALLOWED.- "For disallowance of standard deduction, see section 142(b)(2)." (b) EFFECTIVE DA~r1~.-The amendment made by this section shall apply with respect to taxable years beginning after December 31, 1965. SEC. 8. ESTATES OF NONRESIDENTS NOT CITIZENS~ (a) RATE or TAx.-Subsection (a) of section 2101 (relating to tax imposed in case of estates of nonresidents not citizens) is amended to read as follows: "(a) RATE OF TAx.-Except as provided in section 2107~ a tax com- puted in accordance with the following table is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States: "If the taxable estate is: The tax shall be: Not over $100,000 5% of the taxable estate. Over $100,000 but not over $500,000 $5,000, plus 10% of excess over $100,000. Over $500,000 but not over $1,000,000 $45,000, plus 15% of excess over $500,000. Over $1,000,000 but not over $2,000,000 $120,000, plus 20% of excess over $1,000,000. Over $2,000,000 $320,000, plus 25% of excess over $2,000,000." (b) CREDITS Ao~w~rsT TAx,-Section 2102 (relating to credits al-. lowed against estate tax) is amended to read as follows: "SEC. 2102. CREDITS AGAINST TAX. "(a) IN GENERAL.-The tax imposed by section 2101 shall be cred- ited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), subject to the special limitation provided in subsec- tion (b). "(b) SPECIAL LIMrrATI0N.-The maximum credit allowed under section 2011 against the tax imposed by section 2101 for State death taxes paid shall be an amount which bears the same ratio to the credit computed as provided in section 2011(b) as the value of the property, as determined for purposes of this chapter, upon which State death taxes were paid and which is included in the gross estate under section 2103 bears to the value of the total gross estate under section 2103. For purposes of this subsection, the term `State death taxes' means the taxes described in section 2011 (a) ." 26 342 PAGENO="0353" FOREIGN INVESTORS TAX ACT OF 1965 31 (c) PROPERTY WITHIN THE UNITED STATES.-Section 2104 (relating to property within the United States) is amended by adding at the end thereof the following new subsection: "(c) DEBT OBLIGATIONS.-FOr purposes of this subchapter, debt obligations of- "(1) a United States person, or "(2) the United States, a State or any political subdivision thereof, or the District of Columbia, owned by a nonresident not a citizen of the United States shall be deemed property within the United States." (d) PROPERTY WITHOUT THE UNITED STATE5.-Subsection (b) of section 2105 (relating to bank deposits) is amended to read as follows: "(b) DEPOSITS IN CERTAIN FOREIGN BRANCHES.-FOr purposes of this subchapter, deposits in a foreign branch of a domestic corpora- tion, if such branch is engaged in the commercial banking business and if such deposits are payable only in foreign currency, shall not be deemed property within the United States." (e) DEFINITION OF TAXABLE EsTATE.-Paragraph (3) of section 2106(a) (relating to deduction of exemption from gross estate) is amended to read as follows: "(3) EXEMPTION.- "(A) GENERAL RULE.-An exemption of $30,000. "(B) RESIDENTS OF POSSESSIONS OF THE UNITED STATES.- In the case of a decedent who is considered to be a `nonresi- dent not a citizen of the United States' under the provisions of section 2209, the exemption shall be the greater of (i) $30,000, or (ii) that proportion of the exemption authorized by section 2052 which the value of that part of the decedent's gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated." (f) SPECIAL METHODS OF COMPUTING TAx.-Subchapter B of chap- ter 11 (relating to estates of nonresidents not citizens) is amended by adding at the end thereof the following new sections: "SEC. 2107. EXPATRIATION TO AVOID TAX. "(a) RATE OF TAX.-A tax computed in accordance with the table contained in section 2001 is hereby imposed on the transfer of the tax- able estate, determined as provided in section 2106, of every decedent nonresident not. a citizen of the United States dying after the date of enactment of this section, if after March 8, 1965, and within the 10- year period ending with the date of death such decedent lost United States citizenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. "(b) GRoss ESTATE.-FOr purposes of the tax imposed by sub- section (a), the value of the gross estate of every decedent to whom subsection (a) applies shall be determined as provided in section 2103, except that- 27 71-297 0-67-pt. 1-23 PAGENO="0354" 32 FOREIGN INVESTORS TAX ACT OF 1965 "(1) if such decedent owned (within the meaning of section 958 (a)) at the time of his death 10 percent or more of the total combined voting power of all classes of stock entitled to vote of a foreign corporation, and "(2) if such decedent owned. (within the meaning of section 958(a), or is considered to have owned (by applying the owner- ship rules of section 958(b)), at the time of his death, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of such foreign corporation, then that proportion of the fair market value of the stock of such foreign corporation owned (within the meaning of sec-tion 958(a)) by such decedent at the time of his death, which the fair market value of any assets owned by such foreign corporation and situated in the United States, at the time of his death, bears to the total fair market value of all assets owned by such foreign corporation at the time of his death, shall be included in the gross estate of such decedent. For purposes of the preceding sentence, a decedent shall be treated as own- ing stock of a foreign. corporation at the time of his death if, at the time of a transfer, by trust or otherwise, within the meaning of sec- tions 2035 to 2038, inclusive, he owned such stock. "(c) CREDITS.-The tax imposed by subsection (a). shall be credited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), as modified by section 2102(b). "(d) ExcEr'rIoN FOR LOSS OF CITIZENSHIP FOR CERTAIN CAUSES.- Subsection (a) shall not apply to the transfer of the estate of a decedent whose loss of United States citizenship resulted from the application of section 301(b), 350, or 355 of the Immigration. and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). "(e) BURDEN OF PRoor.-If the Secretary or his delegate establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction in the estate, inheritance, legacy, and succession taxes in respect of the transfer of his estate, the burden of proving that such loss of citizen- ship did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A shall be on the executor of such individual's estate. "SEC. 2108. APPLICATION OF .PRE4966 ESTATE TAX PROVISIONS. "(a.) IMPOSITION OF Moiu~ BURDENSOME TAX BY FOREIGN Cotrx~r.- Whenever the President finds that- "(1) under the laws of any foreign country, considering the tax system of such foreign country, a more burdensome tax is imposed by such foreign country on the transfer of estates of decedents who were citizens of the United States and not residents of such.foreign country than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, ... . . . "(2) such foreign country, when requested by the. United States to do so, has not acted to revise or reduce such tax so that it is no more burdensome than the tax imposed by this subchapter 28 344 PAGENO="0355" FOREIGN INVESTORS TAX ACT OF 1965 33 on th&transfer of estates of. decedents who were residents of such foreign country, and * "(3) it is in the public interest to apply pre-1966 tax provisions in accordance with this section to the transfer of estates of. deced~ ents who were residents of. such foreign country, the President shall proclaim that the tax On the transfer of. the estate of every decedent who was a resident of such' foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to amendments made to sections 2101 (relating to tax imposed), 2102 (relating to credits against tax), and 6018 (relating to estate tax returns) on orafter the date of enactment of this section. "(b) ALLEVIATION OF MORE BURDENSOME TAx.-Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that the tax on the transfer of estates of deced- ents who were citizens of the United States and not residents of such foreign country. is no longer more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were resi- dents of such foreign country, he shall proclaim, that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapterwithout regard to subsection (a). "(c). NOTIEICATION OF CONGRESS REQUIRED.-NO Proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to su6h proclamation, . be has notified the Senate and the House of Representatives of his intention to issue such proclamation. "(d) IMPLEMENTATION BY Rixnm4TIows.-The Secretary or his dele- gate shall prescribe such regulations as may be necessary or appropri- ate to implement this section." (g) ESTATE TAX R]rrimNs.-Paragraph (2) of section 6018(a) (relating to estates of nonresidents not citizens) is amended by strikiiI~ out "$2,000" and inserting in lieu thereof "$30,000". (h) CLERICAL AMENDMENT.-The table of sections for subchapter B of chapter 11 (relating to estates of nonresidents not citizens) is amended by adding at the end thereof the following: "Sec. 2107. Expatriation to avoid tax. "Sec. 2108. Application of pre-1966 estate tax provisions." (i) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to estates of decedents dying after the date of the enactment of this Act.. SEC. 9. TAX ON GIFTS OF NONRESIDENTS NOT CITIZENS. (a) IMPOSITION OF TAx.-SubsectiOn (a) of section2501 (relating to general rule for `imposition of tax) is amended to read as follows: "(a) TAXABLE TRANSFERS.- . "(1) GENERAL EULE.-For the calendar year 1955 and each calendar year thereafter a tax, computed as provided in section 2502, is hereby imposed on the transfer of property by gift during such calendar year by any individual, resident, or nonresident. 29 345 PAGENO="0356" 34 FOREIGN INVESTORS TAX ACT OF 1965 "(2) TRANSFERS OF INTANGIBLE .PR0PERTY.-Except as provided in paragraph (3), paragraph (1) shall not apply to the transfer * of intangible property by a nonresident not a citizen of the United * States. "(3) ExC]~rIoNs.-Paragraph (2) shall not apply in the case of a donor who at any time after March 8, 1965, and within the 10- year period ending with the date of transfer lost United States citizenship unless- "(A) such donor's loss of United States citizenship resulted from the application of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487), or "(B) such loss did not have for one of its principal pur- poses the avoidance of taxes under this subtitle or subtitle A. "(4) BURDEN OF pRooF.-If the Secretary or his delegate estab- lishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for paragraph (3), result in a substantial reduction for the calendar year in the taxes on the transfer of property by gift, the burden of proving that such loss of citizenship did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A shall be on such individual." (b) TRANSFERS n~ GEx~iRAL.-Subsection (b) of section 2511 (relat- ing to situs rule for stock in a corporation) is amended to read as follows: "(b) INTANGIBLE PR0PERTY.-For purposes of this chapter, in the case of a nonresident not a citizen of the United States who is excepted from the application of section 2501(a) (2)- "(1) shares of stock issued by a domestic corporation, and "(2) debt obligations of- "(A) a United States person, or "(B) the United States, a State or any political sub- division thereof, or the District of Columbia, which are owned by such nonresident shall be deemed to be property situated within the United States." (c) EFFECTIVE DAI'i.-The amendments made by this section shall apply with respect to the calendar year 1966 and all calendar years thereafter. SEC. 10. TREATY OBLIGATIONS. No amendment made by this Act shall apply in any case where its application would be contrary to `any treaty obligation of the United States. For purposes of the preceding sentence, the extension. of a benefit provided by any amendment made by this Act shall not be deemed to be contrary to a treaty obligation of the United States. 30 346 PAGENO="0357" FOREIGN INVESTORS TAX ACT OF 1965 35 II. SUMMARY OF PRINCIPAL PROVISIONS The bill modifies the income, estate, and gift tax treatment of nonresident aliens and the income tax treatment of foreign corpora- tions. The purposes of the bifi are to modernize the present U.S. tax treatment of foreigners and to encourage foreign investment in the United States-thereby beneficially affecting the U.S. balance of payments-by removing tax barrisrs to such investment. The bill restructures the income tax treatment of foreigners to make them taxable at the regular U.S. graduated rates on their income which is "effectively connected" with the conduct by them of a trade or business in the United States. The U.S. source income of foreigners that is not so connected is to be taxable at a flat rate of 30 percent (or a lesser applicable treaty rate) regardless of whether the foreigner is engaged in trade or business in the United States. The bill also. provides a new lower schedule of estate tax rates applicable to the estates of nonresident aliens and increases the exemption for such estates from $2,000 to $30,000. Under the bifi, nonresident aliens engaged in business in the United States will no longer be subject to the gift tax on transfers of intangible property. The following is a listing of the principal changes made by the bill in the order in which they appear in the bill: 1. Source rule for interest on ban/c deposits.-Present law makes interest on U.S. bank deposits foreign source income when paid to persons not engaged in business in the United States. The bill amends this source rule, effective January 1, 1971, to conform it to the soijrce rule generally applicable to other forms of interest. Thus, from that time on this interest will constitute U.S. source income. 2. Source rule for interest on deposits with sasings and loan associations or insurance companies.-The bill extends the above exception (for the next 5 years) to interest on deposits or withdrawable accounts with savings and loan associations and to interest on amounts left on deposit with insurance companies. 3. Source rule for interest on deposits with foreign banking branches of U.S. corporations.-The bill provides that the interest on foreign currency deposits with foreign banking branches of U.S. corporations is to be classified as income from sources without the United States regardless of whether the depositor is engaged in business in the United States. 4. Exemptionjor interest on bank deposits of foreign central banks of i$sue or of the Bank for International Settlements.-The bill provides that the interest on bank deposits of a foreign central bank of issue or of the Bank for International Settlements is to be exempt from U.S. tax unless the deposits are held for use in connection with the conduct of commercial banking functions or other commercial activities. 5. Source rule for dividends paid by foreign corporations ("second dividend" tax).-The bill provides that a portion of the dividends paid by a foreign corporation are to be treated as U.S. source income 31 347 PAGENO="0358" 36 FOREIGN INVESTORS TAX ACT OF 1965 only if 80 percent or more of the gross income of the corporation for the preceding 3 years was effectively connected with the conduct of a trade or business in the United States. The portion considered to be from sources in the United States equals the portion of the foreign corporation's income for that period which is effectively connected to such trade or business. Under present law, a portion of a foreign corporation's dividends are considered to be from U.S.. sources if 50 percent or more of its income for the 3 preceding years was from U.S. sources. 6. Com"ensation for certain personal services.-The bill, adds the foreign of~ce or place of business of a citizen or resident of the United States or of a domestic partnership to the list of foreign employers whose payments of compensation to nonresident alien employees for services rendered in the United States is to be treated as having a source without the United States. Similarly, the `bifi provides that the performance of services in the United States for a foreign office or place of business of such U.S. employers does not constitute engaging in a trade or business in the United `States by such employees. As under present law, these special rules apply only if the alien is tem- porarily present in the United States for not more than 90 days in the taxable year and the compensation does not exceed $3,000.. 7. Trading in stock or securities or in commodities.-The bill excludes from the term "engaged in trade or business in the United States" trading in stocks or securities or in commodities in the United States by nonresident aliens or foreign corporations (other than dealers) in person or through an agent . who has discretion to carry on such trading activities. However, a foreign investment company whose principal office is in the United States will be considered engaged in trade or business here. The exclusion of present law only applies if the trading is done through a resident independent agent not :having discretion. This rule' continues to apply to foreign dealers. 8. Income "effectively connected" `with the conduct of a trade or business * in the United States.-The bill prescribes factors to be taken into account in determining whether an item of income is "effectively connected" with the conduct of a trade or business in the United `States. Among the factors to be considered are whether-. (1) the gains, profits, and income or loss are derived from assets used in or held for use in the conduct of such trade or business, . (2) the gains, profits, and income or loss are accounted for through such trade or business, or (3) the activities of the trade or business were .a material factor in the realization of the gains, profits, and income or loss. Under this rule,, income may be "effectively connected" to a branch office in the United `States even though the income itself is, from foreign sources (a foreign: tax credit is allowed under ,appropriate circumstances in such cases). 9. Tax on ordinary incOme of nonresident alien individuals.-The bill provides for the taxation of the income of nonresident alien individuals which is "effectively connected" with the conduct of a trade or business in the. United States at the regular graduated rates applicable to individuaLs, and for the taxation of income not so con- nected at a flat 30-percent rate (or the lover. applical~le treaty rate). 32 348 PAGENO="0359" FOREIGN INVESTORS TAX ACT OF 1965 37 Under present law, if individuals are engaged in a trade or business in the United States or if their income exceeds $21,200, they are taxed at the graduated rates (in the case of incomes above $21,200, a flat rate applies under present law if it results in a larger tax). 10. Treatment of capital gains of nonresident alien individuals.- The bill provides for the taxation of the U.S. capital gains of a non-. resident alien individual which are not effectively connected with a U.S. business oniy if the alien was in the United States for 183 days or more during a taxable year. The present rule taxed the U.S. capital gains of an alien who is not engaged in business in the United States if he was present in the United States for 90 days or more and, in any event, if the gains occurred during the alien's presence in the United States. 11. Income from real property.-The bill permits a foreigner to elect to treat income from U.S. real property as income which is effectively connected with the conduct of a trade or business in the United States (in cases in which t1~is is not, in fact, true). This enables such a taxpayer to receive the benefits of the deductions connected with this mcome and to be taxable at the regular graduated rates on it.. 12. U.S. savings bond interest of residents of the Ryukjju Islands or the Pacific Trust Territories.-The bill exempts from U.S. mcome tax interest derived by nonresident aliens from series E or Ii savmgs bonds if they were acquired while the alien was a resident of the Ryukyu Islands (includes Okinawa) or of the Trust Territory of the Pacific Islands. 13. Income tax: Expatriation to avoid tax.-The bill provides for imposition (for 5 years after loss of citizenship) of income tax at the regular graduated rates on the gross income (generally U.S. source income) of a citizen who has expatriated with one of his principal pur.~ poses being the avoidance of U.S. taxes. (However, the Government. must est~ablish the probability that the expatriate substantially reduced his income taxes.) 14. Withholding of tax on nonresident aliens.-The bill provides~ that withholding is not required with respect to income which is "effectively connected" with the conduct of a trade or business in the United States. It also permits the Treasury Department to exempt compensation for personal services from nonresident alien withholding (generally at 30 percent) and instead to require domestic wage with- holding (14 percent) on such comp~nsation. 15. Liability for withheld taxi-The bifi provides, in effect, for the quarterly filing of returns and the quarterly remittance of the taxes withheld in the case of payments to foreigners, in the same manner as the code provides generally, instead of the present annual filing of returns and remittances of tax in these cases. 16. Gain from dieposition of certain depreciable real property.-The bifi removes, in the case of a foreigner, the limitation on the real estate depreciation "recapture" provision which presently limits the amount to be "recaptured" in an exchange of real property for the stock of a controlled corporation. 17. Income tax on foreign corporations .-T he bill imposes the income tax at the regular corporate rates on the income of a foreign corpora-. tion which is "effectively connected" with the conduct of a trade or business m the Umted States and at a flat 30-percent rate (or appli- cable treaty rate) on the U.S. source income of such a corporation 349 PAGENO="0360" 38 FOREIGN INVESTORS TAX ACT OF 1965 which is not so connected. Under present law, if a foreign corpora- tion has a trade or business in the United States, all of its income from U.S. sources is taxed at the regular corporate rates. Only if the foreign corporation is not engaged in a trade or business here, does the fiat 30-percent rate (or applicable treaty rate) apply to its income from U.S. sources. 18. Income from real property.-The bifi permits a foreign corpora- tion to elect to treat income from United States real property as income winch is effectively connected with the conduct of a trade or business in the United States (in cases in which this is not, in fact, true). This enables such a corporation to receive the benefits of the deductions connected with this income and to be taxable at the regular corporate income tax rates on it. 19. Withholding of tax on foreign corporations.-The bill requires withholding at a 30-percent rate (or lower applicable treaty rate) on payments to a foreign corporation of income which is not effectively connected with the conduct of a trade or business in the United States irrespective of whether the corporation is engaged in business in the United States. Under present law withholding is required only if the corporation is. not engaged in a trade or business within the United States. 20. Deduction for divide'iids' received from foreign corporations.-The bifi conforms the 85.-percent dividends received deduction provision applicable to dividends received from fOreign corporations to the "effectively connected income" concept. Instead of providing this deduction where 50 percent or more of its gross income is from U.S. sources, the bill makes the deduction available only where 50 percent of its gross income is effectively connected with the conduct of a U.S. trade or business. 21. Corporations subject to personal holding company tax.-The bill exempts from the personal holding company tax a foreign corporation if all of its stock outstanding during the last half of its taxable year is owned by foreigners whether, held by them directly or in4irectly through foreign estates, foreign trusts, foreign partnerships, or other foreign corporations. Under present law this exemption applies only if the foreign corporation derives less than 50 percent of its income from U.S. sources. * 22. Foreign corporations carrying on insurance business in the United States.-The bill provides that foreign insurance companies are to be taxed in the same manner as domestic insurance companies on their income which is effectively connected with the conduct of a trade or business within the United States. Income which is not so connected (even though the company is engaged in an msurance business here) is to be taxed in the same manner~ as foreign corporations generally; i.e., at a flat 30-percent rate (or at the lower applicable treaty rate). 23. Income affected by treaty.-The bill pro~ndes that in the case of income which is not effectively connected with the conduct of a trade or business within the United States, any reduced rate of tax under., a treaty (or exemption from tax) applicable where there is no permanent establishment in the United States is also to be apphcable to such income even though there is a permanent establishment in the United States. 24. Application of pre-1966 income tax provisions.-The bill, in car- tam circumstances, permits the President to reinstate the income tax provisions of the code in effect prior to the enactment of this bill with 34 350 PAGENO="0361" FOREIGN INVESTORS TAX ACT OF 1965 39 respect to tii~ income~ tax applicable to residents or corporations of a specified foreign country. The President may reinstate these taxes if the laws of the foreign country in question impose upon the income of U.S. nQnresident citizens or U.S. corporations more burdensome taxes with respect to any item of income than the taxes imposed by the United States on similar income derived from sources within the United States by residents or corporations of such foreign country. The provisions are to be reinstated, however, only where the foreign country has been. requested by the United States to correct the situation and has not done so, and the President finds it is in the public interest to apply the pre-1966 tax provisions. 25. Foreign tax credit.-The bill allows a foreign tax credit to nonresident aliens and foreign corporations with respect to income from sources without the United States, which is effectively connected with the conduct of a trade or business within the United States. No credit or deduction will be allowed for taxes paid to a country solely by reason of the foreigners being domiciled there for tax purposes. 26. Similar income tax credit requirement.-Present law provides for the disallowance of the foreign tax credit to foreigners who are resident in the United States if the foreign country of which they are nationals does not allow a similar credit to U.S. citizens who are resident in the foreign country. The bill provides that the credit is to be disallowed in such cases only where the President has requested the allowance of such credit. to US. citizens resident there, and his request having been turned down, he finds that the disallowance of the credit to the foreigners is in the public interest. 27. Similar estate tax credit requirement.-Present law provides in certain cases for the disallowance of the estate tax credit for foreign death taxes paid by the estate of an alien decedent who dies a resident in the United States where the country of which the decedent was a national does not allow a similar credit for U.S. citizens. The bill modifies this provision in the same way as described above in the case of the foreign tax credit under the income tax provisions. 28. Estate tax rates.-The bill provides a new schedule of estate tax rates applicable to estates of nonresident aliens. The rates are as follows: Tax rate on described portion of Taxable estate taxable estate (percent) 1st $100,000 5 From $100,000 to $500,000 10 From $500,000 to $1,000,000 15 From $1,000,000 to $2,000,000 20 Over $2,000,000 25 These rates are designed to accord approximately the same treat- ment as that applicable to U.S. citizen decedents eligible for the maxi- mum marital deduction (taking into account the change in exemptions described in No. 33 below). 29. Oredit for State death taxes paid.-The bifi limits the credit for State death taxes allowable to the estate of a nonresident alien to the same proportion of the Federal taxes which the value of the prop- erty upon which the State death taxes are imposed bears to the total gross estate. 30. Property within the United States.-The bifi provides that for purposes of determining the tax on estates of nonresident aliens, debt obligations (including bonds) of a U.S. person, the United States, a 35 351 PAGENO="0362" 40 FOREIGN INVESTORS TAX ACT OF 1965 State or political subdivision of a* State, or the District of Columbia Owned by the decedent are deemed to be property within the United States. This has the effect of including bonds of U.S. corporations in the U.S. estate tax base of nonresident alien decedents even though physically located outside the United States. 31. Property without the United States.-The bifi deletes the rule of present law that provides that bank deposits of nonresident aliens who were not engaged in business in the United States are property without the United States for purposes of computing the estate tax of such an alien. Thus, such bank deposits in the future will be in their U.S. estate tax base. 32. Deposits in foreign banking braiwhes of U.S. corporatioms.-The bill provides that deposits in a foreign branch of a U.S. corporation which is engaged in a commercial banking business are to be treated as property without the United States if the deposits are payable only in foreign currency. Thus such amounts will not be included in the U.S. estate tax base of a nonresident alien decedent. 33. Estate tax exer~ptiort for nonresident aliens.-The bifi increases the exemption from U.S. estate tax in the case of estates of nonresident aliens from $2,000 to $30,000. 34. Estate tax: Ea~patriation to avoid lax.-The bifi provides for the taxation of the U.S. assets of an estate of a nonresident alien at the regular estate tax rates if within 10 years of his death the alien had expatriated from the United States with one of the principal purposes bemg the avoidance of U.S. taxes. (However, the Government must establish the probability that the expatriation substantially reduced his death taxes.) 35. Application of pre-1966 estate tax provisions.-The bill, in certain circumstances, permits the President to reinstate certain estate tax provisions of the code in effect prior to the enactment of this bill with respect to the estate taxes applicable to residents of a specified foreign country. The President may reinstate these taxes if the laws of the foreign country in question impose upon the death of U.S. nonresident citizens with estates in such country more burden- some taxes than the taxes imposed by the United States on similar estates situated within the United States of nonresident alien inilivid- uals of such foreign country. The provisions are to be reinstated, however, only where the foreign country has been requested by the United States to correct the situation and has not done so and the President finds it is in the public interest to apply the pre-1966 tax provisions. * 36. Estate tax returns.-The bill provides that the estate of a non- resident alien is required to~ ifie an estate tax return only if its U.S. gross estate exceeds $30,000, instead of $2,000 as under present law. * 37. Tax on gifts o/ nonresident aliens.-The bill excludes from the gift tax transfers of mtan~ible property by nonresident aliens whether or not they are engaged m business in the United States (but not in the case of expatriates for a period of up to 10 years). 38. Treaty obligations.-The bill provides that the amendments made by this bifi are not to apply where their application would be contrary to any treaty obligation of the United States. (However, the extension of a tax benefit provided by this bill is not to be deemed to be contrary of a treaty obligation.) 36 352 PAGENO="0363" FOREIGN INVESTORS TAX ACT OF 1965 41 III. CHANGES IN EXISTING LAW WHICH WOULD BE MADE BY H.R. 11297, AS INTRODUCED Changes in existing law which would be made by H.R. 11297, 89th Congress (a bill to amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States), as introduced, are shown as follows (existing law proposed to be omitted is enclosed in black brackets, new matter is printed in italic, existing law in which no change is proposed is shown in roman): Subtitle A-Income Taxes * * * * * ** * CHAPTER 1-NORMAL TAXES AND SURTAXES * * * * * * * Subchapter A-Determination of Tax Liabifity * * * *. * * * PART I-TAX ON INDIVIDUALS * * * * * * * SEC. 1. TAX IMPOSED. (a) RATES o~ TAX ON INDIVIDUALS.- * * *_ * * * * (d) NoH1~sIDENT AzIENS.-Ir& the case of a nonresident alien individual, the tax imposed by subsection (a) shall apply only as provided by section 871(b) or 877. ((d)] (e) CROSS REFBRENCE.-. For definition of taxable income, see section 63. * * * * * * * PART Il-TAX ON CORPORATIONS Sec. 11. Tax imposed. Sec. 12. Cross references relating to tax on corporations. SEC. 11. TAX IMPOSED. (a) CORPORATIONS IN GENERAL.-A tax is hereby imposed for each taxable year on the taxable income of every corporation. The tax shall consist of a normal tax computed under subsection (b) and a surtax computed under subsection (c). 37 353 PAGENO="0364" 42 FOREIGN INVESTORS TAX ACT OF 1965 (b) NORMAL TAx.-The normal tax is equal to the following per- centage of the taxable income: (1) 30 percent, in the case of a taxable year beginning before January 1, 1964, and (2) 22 percent, in the case of a taxable year beginning after December 31, 1963. (c) SuRTAx.-The surtax is equal to the following percentage of the amount by which the taxable income exceeds the surtax exemption for the taxable year: (1) 22 percent, in the case of a taxable year beginning before January 1,1964. * (2) 28 percent, in the case of a taxable year beginning after * December 31, 1963, and before January 1, 1965, and (3) 26 percent, in the case of a taxable year beginning after. December 31, 1964. (d) SURTAX ExEMPTI0N.-For purposes of this subtitle, the surtax exemption for any taxable year is $25,000, except that, with respect to a corporation to which section 1561 (relating to surtax exemptions in case of certain controlled corporations) applies for the taxable year, the surtax exemption for the taxable year is the amount determined under such section. (e) EXCEPTI0Ns.-Subsection (a) shall not apply to a corporation subject to a tax imposed by- (1) section 594 (relating to mutual savings banks conducting life insurance business), (2) subchapter L (sec. 801 and following, relating to insurance companies), or (3) subchapter M (sec. 851 and following, relating to regulated investment companies and real estate investment trusts) (, or]. ((4) section 881(a) (relating to foreign corporations not engaged in business in United States).] (J) Foi~Eiw.~i C0RP0RATI0NS.-In the case of a foreign corporation, the tax imposed by subsection (a) shall apply only as provided by section 88~d. * * * * * * * Subchapter B-Computation of Taxable Income * * * * * * * PART Ill-ITEMS SPECIFICALLY EXCLUDED FROM GROSS INCOME * * * * * * * SEC. 116. PARTIAL EXCLUSION OF DIVIDENDS RECEIVED BY INDI- VIDUALS. (a) EXCLUSION FROM GROSS INC0ME.-Effective with respect to any taxable year ending after July 31, 1954, gross income does not include 38 354 PAGENO="0365" FOREIGN INVESTORS TAX ACT OF 1965 43 amounts received by an individual as dividends from domestic corpo- rations, to the extent that the dividends do not exceed $100. If the dividends received in a taxable year exceed $100, the exclusion pro- vided by the preceding sentence shall apply to the dividends first received in such year. * * * * * * * (d) CERTAIN NONRESIDENT ALIENS INELIGIBLE FOR ExcLusIoN.- (Subsection (a) does not apply to a nonresident alien individual with respect to whom a tax is imposed for the taxable year under section 871(a)] In the case of a nonresident alien individual, subsection (a) shall apply only- (1) in determining the tax imposed for the taxable year pursuant to section 871 (b) (1) and only in respect of dividends which are effectively connected with the conduct of a trade or business within the United States, or (~) in determining the tax imposed for the taxable year pursuant to section 877(b). * * * * * * * SEC. 154. CROSS REFERENCES. (1) For definitions of "husband" and "wife", as used in section 152 (b)(4), see section 7701(a) (17). (2) For deductions of estates and trusts, ir lieu of the exemptions under section 151, see section 642(b). (3) For exemptions of nonresident aliens, see section (873(d)] 873(b) (3). (4) For exemptions of citizens deriving income mainly from sources within possessions of the United States, see section 931(e). * * * * * * * PART VIll-SPECIAL DEDUCTIONS FOR CORPORATIONS * * * * * * * SEC. 245. DIVIDENDS RECEIVED FROM CERTAIN FOREIGN CORPORA- TIONS. (a) GENERAL RULE.-In the case of dividends received from a foreign corporation (other than a foreign personal holding company) which is subject to taxation under this chapter, if, for an uninterrupted period of not less than 36 months ending with the close of such foreign corporation's taxable year in which such dividends are paid (or, if the corporation has not been in existence for 36 months at the close of such taxable year, for the period the foreign corporation has been in existence as of the close of such taxable year) such foreign corporation has been engaged in trade or business within the United States (and has derived 50 percent or more of its gross income from sources within the United States,] and if 50 percent or more of the gross income of such corporation from all sources for such period ie effectively connected with 39 355 PAGENO="0366" 44 FOREIGN INVESTORS TAX ACT OF 1965 the conduct of a trade or business within the United States, there shall be ~allowed as a deduction in the case of a corporation- (1) An amount equal to the percent (specified in section 24S ~for the taxable year) of the dividends received out of its earnings and profits specified in paragraph (2) of the first sentence of sec- tion 316(a), but such amount shall not exceed an amount which bears the same ratio to such percent of such dividends received out of such earnings and profits as the gross income of such foreign corporation for the taxable year (from sources within the United States] which is effectively connected with the conduct of a trade or business `within the United States bears to its gross income from all * sources for such taxable year, and (2) An amount equal to the percent (specified in section 243 for the taxable year) of the dividends received out of that part of its earnings and profits specified in paragraph (1) of the first sentence of section 316(a) accumulated after the beginning of such uninterrupted period, but such amount shall not exceed an amount which bears the same ratio to such percent of such divi- dends received out of such accumulated earnings and profits as the gross income of such foreign corporation (from sources within the United States], which is effectively connected with the conduct of a trade or business within the United States, for the por- tion of such uninterrupted period ending at the beginning of such taxable year bears to its gross income from all sources for such portion of such uninterrupted period. For purposes of this subsection, the gross income of the foreign corporation for any period before the first taxable year beginning after December 31, 1965, which is effectively connected with the conduct of a trade or business `within the United States is an amount eQua1l to the gross income for such period from sources within the United States. * * * * * * * Subchapter F-Exempt Organizations * * * * * * * PART Il-TAXATION OF BUSINESS INCOME OF CERTAIN EXEMPT ORGANIZATIONS * * * * * * * * SEC. 512. UNRELATED BUSINESS TAXABLE INCOME. (a) DEFINITI0N.-The term "unrelated business taxable income" means the gross income derived by any organization from any unre- lated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed by this chapter which are directly connected with the carrying on of such trade or business, both com- puted with the exceptions, additions, and limitations provided in sub-' 40 356 PAGENO="0367" FOREIGN INVESTORS TAX ACT OF 1965 45 section (b). In the case of an organization described in section 511 which is a foreign organization, the unrelated business taxable income shall be its unrelated business taxable income (derived from sources within the United States determined under subchapter N (sec. 861 and following, relating to tax based on income from sources within or without the United States)] whi~~h is effectively connected with the conduct of a trade or business within the United States. * * * * * * * Subchapter G-Corporations Used To Avoid Income Tax on Shareholders * * * * * * * PART Il-PERSONAL HOLDING COMPANIES * * * * * * * SEC. ~542. DEFINITION OF PERSONAL HOLDING COMPANY. * * * * . * * * (c). EXCEPTIONS.-The term "personal. holding company" as defined in subsection (a) does not include- * * * * * * * ((7) a foreign corporation if- *. ((A) its gross income from sources within the United States for the period specified in section 861(a) (2) (B) is less than 50 percent of. its total gross income from all sources, and ((B) all of its stQck outstanding during the last half of * the taxable~ year is owned by nonresident alien individuals, whether directly or indirectly through other for~ign cor- * porations;] . . *,* . ** (7) a foreigr& corporatiQn, if all of ito' o'to~1c outetanding during *t&e last:, half of. the taxable year is owned by noc"tresiclent alien indi~viduals, whether directly . or. indirectly ~hrough..foreign estates, foreig~. trusts, foreign pa1rtnerships,.or other foreign corporations; * * .** ...*` *~:.. .* * 41 357 PAGENO="0368" 46 . FOREIGN INVESTORS TAX ACT OF 1965 Subchapter ~h~wance Compathes * . * * * PART I-LIFE INSURANCE COMPANIES * * * . * * * * Subpart E-Miscellaneous provisions * * * * * * * SEC. 819. FOREIGN LIFE. INSURANCE COMPANIES. ((a) CARRYING ON UNITED STATES INSURANCE BUSINESS.-A for- ëign life insurance company carrying on a life insurance business within the United States, if with respect to its United States business it would qualify as a life insurance company under section 801, shall be taxable on the United States business of such company in the same manner as a domestic life insurance company.] ((b)] (a) ADJUSTMENT WHERE SURPLUS HELD IN UNITED STATES Is LESS THAN SPECIFIED MINIMUM.- (1) IN GENERAL.-In the case of any (company described in subsection (a)] foreign corporation taxable under thi$ part, if the minimum figure determined under paragraph (2) exceeds the surplus held in the United States, then- (A) the amount of the policy and other contract liability requirements (determined under section 805 without regard to this subsection), and (B) the amount of the required interest (determined under section 809(a) (2) without regard to this subsection), shall each be reduced by an amount determined by multiplying such excess by the current earnings rate (as defined in section 805(b) (2)). (2) DEFINITIONS.-FOr purposes of paragraph (1)- (A) The minimum figure is the amount determined by multiplying the taxpayer's total insurance liabilities on United. States business by- (i) in the case of a taxable year beginning before January 1, 1959, 9 percent, and (ii) in the case of a taxable year beginning after IYe~ cember 31, 1958, a: percentage for such year to be determined and proclaimed by the Secretary or his delegate. The percentage determined and proclaimed by the Secretary or his delegate under clausa (ii) shall be based on such data with respect to domestic life insurance companies for the preceding taxable year as the Secretary or his delegate con- siders representative. Such percentage shall be computed on the basis of a ratio the numerator of which is the excess 42 358 PAGENO="0369" FOREIGN INVESTORS TAX ACT OF 1965 47 of the assets over the total insurance liabilities, and the denominator of which is the total insurance liabilities, (B) The surplus held in the United States is the excess of the assets held in the United States over the total insurance liabilities on United States business. For purposes of this paragraph and subsection [(c)] (b), the term "total insurance liabilities" means the sum of the total reserves (as defined in section 801(c)) plus (to the extent not included in total reserves) the items referred to in paragraphs (3), (4), and (5) of section 810(c). [(c)] (b) DISTRIBUTIONS TO SHAREHOLDERS.- (1) IN GENERAL.-In applying sections 802(b)(3) and 815 (for purposes of subsection (a)], `with respect to a foreign corporation the amount of the distributions to shareholders shall be deter-. mined by multiplying the total amount of the distributions to shareholders (within the meaning of section 815) of the foreign (life insurance company] corporation by whichever of the follow- ing percentages is selected by the taxpayer for the taxable year: (A) the percentage which the minimum figure for the taxable year (determined under subsection ((b)] (a)(2)(A)) is of the excess of the assets of the company over the total insurance liabilities; or (B) the percentage which the total insurance liabilities on United States business for the taxable year is of the com- pany's total insurance liabilities. (2) DISTRIBUTIONS PURSUANT TO CERTAIN MUTUALIZATIONS.- In applying section 815(e) (for purposes of subsection (a)] with respect to a foreign corporation- (A) the paid-in capital and paid-in surplus referred to in section 815(e)(1)(A) of a foreign (life insurance company] corporation is the portion of such capital and surplus deter- mined by multiplying such capital and surplus by the per- centage selected for the taxable year under paragraph (1); and (B) the excess referred to in section 815(e) (2) (A) (i) (with- out the adjustment provided by section 815(e)(2)(B)) is whichever of the following is the greater: (i) the minimum figure for 1958 determined under subsection ((b)] (a) (2) (A), or (ii) the surplus described in subsection ((b)] (a) (2) (B) (determined as of December 31, 1958). ((d) No UNITED STATES INSURANCE BusINEss.-Foreign life in- surance companies not carrying on an insurance business within the United States shall not be taxable under this part but shall be taxable as other foreign corporations.] 43 7 1-297 0-67--pt. 1-24 359 PAGENO="0370" 48 FOREIGN INVESTORS TAX ACT OF 1965 (c) Ui~oss REFERENCE.- For taxation of foreign corporations carrying on life insurance businesS withtn the United States, see section 842. * ~* .* ** ~*. * * PART.II---MUTUAL INSURANCE COMPANIES. (OTHER THAN LIFE AND CERTAIN MARINE INSURANCE COMPANIES AND OTHER THAN FIRE OR FLOOD INSURANCE COM- PANIES WHICH OPERATE. ON BASIS OF PERPETUAL * POLICIES OR PREMIUM DEPOSITS) * * * * * * * SEC. 821. TAX ON MUTUAL INSURANCE COMPANIES TO WHICH PART II APPLIES. * * * * ** * * ((e) No UNITED STATES INSURANCE BusINEss.-Foreign mutual inèurance companies (other than a life insurance company and other than a fire, flood, or marine insurance company subject to the tax imposed by section 831) not carrying on an insurance business within the United States shall not be subject to this part but shall be taxable as other foreign corporations.] . - ((f)] (e) SPECIAL TRANSITIONAL UNDERWRITING Loss.- * * * . *** * * * ((g)] (f) CROSS REFERENCES - * * * * * * * (1) For exemption from tax~ of certain mutual insurance companies, see section 501(c)(15). * (2) For alternative tax in case of capita' gains, see section 1201(a). (3) For taxation of foreign corporations carrying on an in- *surance business within the United ~tates; see section 842. - **._ _.* . * .*_*~** * SEC 822 DETERMINATION OF TAXABLE INVESTMENT INCOME (a) DEFI&rrIONS.~-~-FOr ptir~oses of this part- (1)~The te~th `~ta~abIe investment incOme" ~e~ns the gross investment income, miniis the deductions provided in sub.. section (c) (2) The term "investment lOss" means the amount by which the deductions provided m subsection (c) exceed the g1~oss mvest- ment in~m~. ..` . ,. . (b) GROSS INVESTMENT INCOME -For purposes ~f subsection (a), the ~term "gross Investment mcome" means the sum of the following (1) The gross amo~nnt of income during the taxable year from- (A) interest, dividends, rents; and ~oya1~ie~, (B) the entering into of any lease, mortgage, or other instruthent Or agre~merit from which the in~mahcecompan~ derives interest, rents, or royalties, 44 360 PAGENO="0371" FOREIGN INVESTORS TAX ACT OF 1965 49 (C) the alteration or termination of any instrument or * agreement described in subparagraph (B), and (D) gains from sales or exchanges of capital assets to the extent provided in subchapter P (sec. 1201 and following, relating to capital gains and losses). (2) The gross income during the taxable year from any trade or business (other than an insurance business) carried on by the insurance company, or by a partnership of which the insurance company is a partner. In computing gross income under this paragraph, there shall be excluded any item described in para- graph (1). (c) DEDuCTI0N5.-In computing taxable investment income, the following deductions shall be allowed: (1) TAX-FREE INTEREST.-The amount of interest which under section. 103 is excluded for the taxable year from .gross income. . . (2) INVESTh~ENT ExPENSES.-Investment expenses paid or accrued during the taxable year. If any general expenses are in part assigned to or included in the investment expenses, the total deduction under this paragraph shall not exceed one-fourth of 1 * percent of the mean of the book value of the invested assets held at the beginning and end of the taxable year plus one-fourth of * the amount by which taxable.. investment income (computed * without any deduction for.investment expenses allowed by this paragraph,. for tax-free interest allowed by. paragraph (1), or for partially tax-exempt interest and dividends received allowed by paragraph (7)), exceeds 3% percent. of. the book. value of the mean of the invested assets held at the beginning and end of the taxable year. . . .. . . *~ **.. (3) REAL ESTATE.. EXPENSES.-Taxes (as provided in section 164) ,.and other expenses, paid or accrued during the taxable year exclusively on~ or with respect. to the~ real Ostate owned~ by the company. No deduction.,shall be allowed~ undei this par~raph for any amount paid out for new buildings, Or :ior .perrnnnent improvements or betterments. made to increase the value of any property~ . : . . .* .. . (4)* DEPRECIATION.-The.~ depreciation deduction allowed by section.167. ... * . . . . .* .. . (5) I.NPEREST: PAID .0R ACCRUED~All interest paid oi~ accrued within the taxable year on indebtedness, exceptOn indebtedness incurred~or :oontinuedto purchase or carry Obligatiot~s (other than .obligatio~.of thO.United States issued after September 24, 1917, and originally subscribed for by the taxpayer) the interest on which is wholly exempt from taxation under this subtitle. 45 361 PAGENO="0372" 50 FOREIGN INVESTORS TAX ACT OF 1965 (6) CAPITAL LOSSES.-Capital losses to the extent provided in subchapter P (sec. 1201 and following) plus losses from capital assets sold or exchanged in order to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends and similar distributions to. policyholders. Capital assets shall be considered as sold or exchanged in order to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends and similar distributions to policyholders to the extent that the gross receipts from their sale or exchange are not greater than the excess, if any, for the taxable year of the sum of dividends and similar distributions paid to policyholders, losses paid, and expenses paid over the sum of the items described in subsection (b) (other than paragraph (1)(D) thereof) and net premiums received. In the application of section 1212 for purposes of this. section, the net capital loss for the taxable year shall be the amount by' which losses for such year from sales or exchanges of capital assets exceeds the sum of the gains from such sales or exchanges and whichever of the following amounts is the lesser: (A) the t~ xable investment income (computed without regard to gains or losses from sales or exchanges of capital assets or to the deduction provided in section 242 for partially tax-exempt interest); or (B) losses from the sale or exchange of capital assets sold or exchanged to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends and similar distributions to policyholders. (7) SPECIAL DEDUCTI0NS.-The special deductions allowed by part VIII (except section 248) of subchapter B (sec. 241 and following, relating to partially tax-exempt interest and to divi- dends received). In applying section 246(b) (relating to limital tion on aggregate amount of deductions for dividends received) for purposes of this paragraph, the reference in such section to "taxable income" shall be treated as a reference to "taxabe- investment income." (8) TRADE OR BUSINESS DEDUCTIONS.-The deductions allowed by this subtitle (without regard to this part) which are attrib- utable to any trade or business (other than an insurance business) carried on by the insurance company, or by a partnership of which the insurance company is a partner; except that for pur- poses of this paragraph- (A) any item, to the extent attributable to the carrying on of the insurance business, shall not be taken into account, and (B) the deduction for net operating losses provided in section 172 shall not be allowed. 46 362 PAGENO="0373" FOREIGN INVESTORS TAX ACT OF 1965 51 (9) DEPLETTON.-The deduction allowed by section 611 (relat.. ing to depletion). (d) OTHER APPLICABLE RULES.- (1) RENTAL VALUE OF REAL ESTATE.-The deduction under subsection (c) (3) or (4) on account of any real estate owned and occupied in whole or in part by a mutual insurance company subject to the tax imposed by section 821 shall be limited to an amount which bears the same ratio to such deduction (computed without regard to this paragraph) as the rental Value of the space not so occupied bears to the rental Value of the entire property. (2) AMoRTIzATIoN OF PREMIUM AND ACCRUAL OF DIsCOUNT.- The gross amount of income during the taxable year from interest, the deduction provided in subsection (c)(1), and the deduction allowed by section 242 (relating to partially tax-exempt interest) shall each be decreased to reflect the appropriate amortization of premium and increased to reflect the appropriate accrual of dis- count attributable to the taxable year on bonds, notes, deben.. tures, or other evidences of indebtedness held by a -mutual in- surance company subject to the tax imposed by section 821. Such amortization and accrual shall be determined- (A) in accordance with the method regularly employed by such company, if such method is reasonable, and (B) in all other cases, in accordance with regulations prescribed by the Secretary or his delegate. For taxable years beginning after December 31, 1962, no accrual of discount shall be required under this paragraph on any bond (as defined in section 171(d)). (3) DOUBLE DEDUCTI0NS.-Nothrng in this part shall permit the same item to be deducted more than once. ((e) FOREIGN MUTUAL INSURANCE COMPANIES OTHER THAN LIFE OR *MARINE.-In the case of a foreign mutual insurance company (other than a life or marine insurance company or a fire insurance com- pany subject to the tax imposed by section 831), the taxable invest- ment income shall be the taxable income ~from sources within the United States (computed without regard to the deductions allowed by subsection (c)(7)), and the gross amount of income from the items described in subsection (b) (other than paragraph (1)(D) thereof) and net premiums shall be the amount of such income from sources within the United States. In the case of a company to which the preceding sentence applies, the deductions allowed in this section shall be allowed to the extent provided in subpart B of part II of subchapter N (sec. 881 and following) in the case of a foreign corporation engaged in trade or business within the United States.] 47 363 PAGENO="0374" 52 FOREIGN INVESTORS TAX ACT OF 1965 ((f)] (e)' DEFINITI0Ns.-For purposes of this part- (1) NET PREMIuMs.-The term "net premiums" means gross premiums (including deposits and assessments) written or re- ceived on insurance contracts during the taxable year less return * premiums and premiums paid or incurred for reinsurance. Amounts returned where the amount is not fixed in the insurance contract but depends on the experience of the company or the discretion of the management shall not be included in return premiums but shall be treated as dividends to policyholders under paragraph (2). (2) DIvIDENDs TO P0LIcYH0LDE'Rs.-The term "dividends to policyholders" means dividends and similar distributions paid or declared to policyholders. For purposes of the preceding sen- tence, the term "paid or declared" shall be construed according to the method regularly employed, in keeping the books of the insurance company. * a.. * * * a * a PART Ill-OTHER INSURANCE COMPANIES Sec. 831. Tax on insurance companies (other than life or mutual), * . . mutual marine insurance companies, and certain mutual fire or flood insurance companies. Sec. 832. Insurance company taxable income. SEC. 831. TAX ON INSURANCE COMPANIES (OTHER THAN LIFE OR MUTUAL), MUTUAL MARINE INSURANCE COMPANIES, AND CERTAIN MUTUAL FIRE OR FLOOD INSURANCE COMPANIES. S (a) .IMPosrnoN ol' TAx.-Taxes computed as provided in sectino 11 shall be imposed. for each taxable year on the taxable income of- (1.) every insurance company (other than a life or mutual * insurance company),: . . . . (2) every mutual marine insurance company, and. (3) every.mutual. fire orfiopd :irisur&nce company- (A) exclusively issuing perpetual policies, or s : ** .. (B) whose :principai business. is the issuance. of policiee for which the premium deposits are the same, regardless of the length of the term. for which the policies. are written, if the unabsorbed portion of such premium deposits no~ requi~ed for ~losses, ~expenses, or establishment of . i'eserve~ :is~ ~eturned or c~edited to the policyholder. on . ~ancellation Tor expiration of the policy. * : * *. ~ *`. (kb) No UNITED ~TATE5 INSuRANCEBusINEss.-Forelgn insurance companies (other than a~ life or muthal~insurance company), foreign mutual marine insurance companies, and foreign mutual fire insurance companies described in subsection (a), not carrying on an insurance 48 364 PAGENO="0375" FOREIGN INVESTORS TAX ACT OF 1965 53 business within the United States, shall not be subject to this part but shall be taxable as other foreign corporations.] ((c)] (b) ELECTION FOR MULTIPLE LINE COMPANY To BE TAXED ON TOTAL INCOME.- (1) IN GENERAL.-Any mutual insurance company engaged in writing marine, fire, and casualty insurance which for any 5-year * period beginning after December 31, 1941, and ending before January 1, 1962, was subject to the tax imposed by section 831 (or the tax imposed by corresponding provisions of prior law) may. elect, in such manner and at such time as the Secretary or his delegate may by regulations prescribe, to be subject to tho tax imposed by section 831, whether or not marine insurance is its * predominant source of premium income. (2) EFFECT OF ELECTION.-If an election is made under paragraph (1), the electing company shall (in lieu of being subject to the tax imposed by section 821) be subject to the tax imposed by this section for taxable years beginning after December 31, 1961. Such.election shall not be revoked except with the consent of the Secretary or his delegate. ((d) ALTERNATIVE TAX. ON CAPITAL GAINS.- [For alternative tax in case of capital gains, see section 1201(a).] (c) CRoss REFERENCE.- (1) For alternative tax in case of capital gains, see section 1201(a).. (2) For taxation of foreign corporations carrying on an in.. surance business within the United States, see section 842. SEC. 832. iNSURANCE COMPANY TAXABLE INCOME. * * * * * * ((d) TAXABLE INcOME OF FOREIGN INSURANCE COMPANIES OTHER THAN LIFE OR MUTUAL AND FOREIGN MUTUAL MARINE.-In the case of a foreign insurance company (other than a life or mutual insurance company), a foreign mutual marine insurance company, and a foreign mutual fire insurance company described in section 831 (a), the taxable income shall be the taxable income from sources within the United States. In the case of a company to which the preceding sentence applies, the deductions allowed in this section shall be allowed to the extent provided in subpart B of part II of subchapter N (sec. 881 and following) in the case of a foreign corpora- tion engaged in trade or business within the United States.] ((e)] (d) DOUBLE DEDuCTI0N5.-Nothing in this section shall. permit the same item to be deducted more than once. * * * . * * * * 49 365 PAGENO="0376" 54 FOREIGN INVESTORS TAX ACT OF 1965 PART IV-PROVISIONS OF GENERAL APPLICATION Sec. 841. Credit for foreign taxes. [Sec. 842. Computation of gross income.] Sec. 845. Foreign corporations carrying on insurance business. Sec. 843. Annual accounting period. SEC. 841. CREDIT FOR FOREIGN TAXES. The taxes imposed by foreign countries or possessions of the United States shall be allowed as a credit against the tax of a domestic insurance company subject to the tax imposed by section 802, 821, or 831, to the extent provided in the case of a domestic corporation in section 901 (relating to foreign tax credit). For purposes of the preceding sentence (and for purposes of applying section 906 with respect to aforeigrt insurance company), the term "taxable income" as used in section 904 means- (1) in the case of. the tax imposed by section 802, the life insurance company taxable income (as defined in section 802(b)), (2) in the case of the tax imposed by section 821(a), the mutual insurance company taxable income (as defined in section 821(b)); and in the case of the tax imposed by section 821(c), the taxable investment income (as defined in section 822(a)), and (3) in the case of the tax imposed by section 831, the taxable income (as defined in section 832(a)). [SEC. 842. COMPUTATION OF GROSS INCOME. (The gross income of insurance companies subject to the tax imposed by section 802 or 831 shall not be determined in the manner provided in part. I of subchapter N (relating to determination of sources of income).] SEC. 842. FOREIGN CORPORATIONS CARRYING ON INSURANCE BUSINESS. if a foreign corporation carrying on an insurance business within the United States would qualify under part I, II, or III of this subchapter for the taxable year if (without regard to income not effectively connected with 4he conduct of any trade or business within the United States) it were a domestic corporation, such corporation shall be taxable under such part on its income effectively connected with its conduct of any trade or business within the United States. With respect to the remainder of it& income, which is jrom sources within the United States, such a foreign corporation shall be taxable as provided in section 881. * * * * * * * 50 366 PAGENO="0377" FOREIGN INVESTORS TAX ACT OF 1965 55 Subchapter N-Tax Based on Income From Sources Within or Without the United States Part I. Determination of sources of income. Part II. Nonresident aliens and foreign corporations. Part 111. Income from sources without the United States. PART I-DETERMINATION OF SOURCES OF INCOME Sec. 861. Income from sources within the United States. Sec. 862. Income from sources without the United States. Sec. 863. Items not specified in section 861 or 862. Sec. 864. Definitions. SEC. 861. INCOME FROM SOURCES WITHIN THE UNITED STATES. (a) GROSS INCOME FROM SOURCES WITHIN UNITED STATES.-The following items of gross income shall be treated as income from sources within the United States: (1) INTEREST.-Interest from the United States, any Tern-. tory, any political subdivision of a Territory, or the District of Columbia, and interest on bonds, notes, or other interest.. bearing obligations of residents, corporate or otherwise, not including- ((A) interest on deposits with persons carrying on the banking business paid to persons not engaged in business within the United States,] (A) iaterest on amounts described in subsection (c) re- ceived by a~nonresident alien individual or a foreign corpora- tion, if such interest is not effectively connected `with the conduct of a trade or business within the United States, (B) interest received from a resident alien individual, a resident foreign corporation, or a domestic corporation, when it is shown to the satisfaction of the Secretary or his delegate that less than 20 percent of the gross income of such resident payor or domestic corporation has been de- rived from sources within the United States, as determined under the provisions of this part, for the 3-year period ending with the close of the taxable year of such payor preceding the payment of such interest, or for such part of such period as may be applicable, (and] (C) income derived by a foreign central bank of issue from bankers' acceptances(.], and (D) interest on deposits with a foreign branch of a domestic corporation, if such branch is engaged in the commercial banking bwsiness and if such deposits are payable only in foreign currency. 51 367 PAGENO="0378" 56 FOREIGN INVESTORS TAX ACT OF 1965 (2) DIvIDENDs.-The amount received as dividends- (A) from a domestic corporation other than a corporation entitled to the benefits of section 931, and other than a corporation less than 20 percent of whose gross income is shown to the satisfaction of the Secietary or his delegate to have been derived from sources within the United States, as determined under the provisions of this part, for the 3-year period ending with the close of the taxable year of such corporation preceding the declaration of such dividends (or for such part of such. period as the corporation has been in existence), or (B) from a foreign corporation unless less than (50] 80 percent of ~the gross income of such foreign corporation for the 3-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was [derived from sources] effectively connected with the conduct of a trade or business within the United States (as deter- mined under the provisions of this part]; but only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period (derived from sources] which is effectively connected with the conduct of a trade or business within the United States bears to its gross income from all sources; but dividends from a foreign corpora- tion shall, for purposes of subpart A of part III (relating to foreign tax credit), be treated as income from sources without the United States to the extent (and only to the extent) exceeding the amount which is 100/85ths of the amount of the deduction allowable under section 245 in respect of such dividends, or (0) from a foreign corporation to the extent that such amount is required by section 243(d) (relating to certain dividends from foreign corporations) to be treated as divi- dends from a domestic corporation which is subject to taxa- tion under this chapter, and to such extent subparagraph (B) shall not apply to such amount. For purposes of subparagraph (B), the gross income of the foreign corporation for any period before the first taxable year beginning after December 31, 1965, which is effectively connected with the conduct of a trade or business within the United States `is an amount equal to the gross income for such period from sources within the United States. (3) PERSONAL sERvIcEs.-Compensation for labor or personal services performed in the United States; except that compensation for labor or services performed in the United States shall not be 52 368 PAGENO="0379" FOREIGN INVESTORS TAX ACT OF 19 6~ 57 deemed to be income from sources within the United States if- (A) the labor or services are performed by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year, (B) such compensation does not exceed $3,000 in the aggregate, and (0) the compensation is for labor or services performed as an employee of or under a contract with- (i) a nonresident alien, foreign partnerthip, or foreign corporation, not engaged in trade or business within the United States, or (ii) an individual who is a citizen or resident of the United States, a domestic partnership, or a domestic corporation, if such labor or services are performed for an office or place of business maintained in a foreign country or in a possession of the United States by such individual, partnership, or corporation. (4) RENTALS AND R0YALTIES.-Rentals or royalties froni property located in the United States or from any interest in such property, including rentals or royalties for the use of or for the privilege of using in the Unired States patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, fr'anchises, and other like property. (5) SALE OF REAL pR0PERTY.-Gains, profits, and income from the sale of real property located in the United States. (6) SALE OF PERSONAL PROPERTY.-Ga.1n5, profits, and income derived from the purchase of personal property without the United States (other than within a possession of the United States) and its sale within the United States. (b) TAXABLE INCOME FROM SOURCES WITHIN UNITED STATES.- From the items of gross income specified in subsection (a) as being income from sources within the United States there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as taxable income from sources within the United States. (c) INTEREST ON DEPOSITS, ETC.-For purposes of subsection (a)(1)(A), the amounts described in this subsection are- (1) deposits with persons carrying on the banking business, (2) deposits or withdrawable accounts with savings institutions chartered and supervised as savings and loan or similar associations `under Federal or State law, but only to the extent that amounts paid 53 369 PAGENO="0380" 58 FOREIGN INVESTORS TAX ACT OF 1965 or credited on siu~h deposits or accounts are deductible under section 591 in computing the taxable income of such institutions~ and (3) amounts held .l~y an insurance company under an agreement to pay interest thereon. Effective `with respect to amounts paid or credited after December 31, 1970, subsection (a) (1) (A) and this subsection shall cease to apply. SEC. 862. INCOME FROM SOURCES WITHOUT THE UNITED STATES. (a) GROSS INCOME FROM SOURCES WITHOUT UNITED STATES.-TIIO following items of gross income shall be treated as income from SOUrCeS without the United States: (1) interest other than that derived from sources within the United States as provided in section 861 (a)(1); (2) dividends other than those derived from sources within the United States as provided in section 861 (a)(2); (3) compensation for labor or personal services performed without the United States; (4) rentals or royalties from property located* without the * United States or from any interest in such property, including * rentals or royalties for the use of or for the privilege of using without the United States patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and other like properties; (5) gains, profits, and income from the sale o~ real property located without the United States; and (6) gains, profits, and income derived from the purchase of personal property within the United States and its sale without the United States. (b) TAXABLE INCOME FROM SOURCES WITHOUT UNITED STATES.- From the items of gross income specified in subsection (a) there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto, and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be treated in full as taxable income from sources without the United States. SEC. 863. ITEMS NOT SPECIFIED IN SECTION 861 OR 862. (a) ALLOCATION UNDER REGULATIONS.-Items of gross income, expenses, losses, and deductions, other than those specified in sections 861 (a) and 862(a), shall be allocated or apportioned to sources within or without the United States, under regulations prescribed by the Secretary or his delegate. Where items of gross income are separately allocated to sources within the United States, there shall be deducted (for the purpose of computing the taxable income therefrom) the expenses, losses, and other deductions properly apportioned or alloW 54 370 PAGENO="0381" FOREIGN INVESTORS TAX ACT OF 1965 59 cated thereto and a ratable part of other expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as taxable income from sources within the United States. (b) INcoME PARTLY FROM WITHiN AND PARTLY FRoM WITHOUT THE UNITED SPATES.-In the case of gross income derived from sources partly within and partly without the United States, the taxable income may first be computed by deducting the expenses, losses, or other J&luctions apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income; and the portion of such taxable income attributable to sources within the United States may be determined by processes~ or formulas of general apportionment prescribed by the Secretary or his delegate. Gains, profits, and income- (1) from transportation or other services rendered partly within and partly without the United States, (2) from the sale of personal property produced (in whole or in part) by the taxpayer within and sold without the United States, or produced (in whole or in part) by the taxpayer without and sold within the United States, or (3) derived from the purchase of personal property within a possession of the United States and its sale within the United States, shall be treated as derived partly from sources within and partly from sources without the United States. SEC. 864. DEFINITIONS. (a) S~E, Erc.-For purposes of this part, the word "sale" includes "exchange"; the word "sold" includes "exchanged"; and the word "produced" includes "created", "fabricated", "manufactured", "ex- tracted", "processed", "cured", or "aged". (b) TRADE OR BUSINESS WITHIN THE UNITED STATES-FOr pur- poses of this part, part II, and chapter 3, the term "trade or bw~iness within the United States" includes the performance of personal services within the United States at any time within the taxable year, but does not include- (1) PERFORMANCE OF PERSONAL SERVICES FOR FOREIGN EM- PLOYER.-The performance of personal services- (A) for a nonresident alien individual, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or (B) for an office or place of business maintained in aforeign country or in a possession of the United States by an individual who is a citizen or resident of the United States or by a domestic partnership or a domestic corporation, 55 371 PAGENO="0382" 60 FOREIGN INVESTORS TAX ACT OF 1965 by a nonresident alien individual temporarily present in'~the United States for a period or perioSs not exceeding a total. of 90 days during the taxable year and whose compensation for such services does not exceed in the aggregate $3,000. (~) TRADING IN SECURITIES OR COMMODITIES.- (A) STOCKS AND SECURITIES.- (i) Except in the case of a dealer in stocks or securities, trading in stocks or securities for the taxpayer's own ~zc- count, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such agent has discretionary authority to make decisions in effecting the transactions. This clause shall not apply in the case of a corporation (other than a corporation whish is, or but for section 542 (c) (7) would be, a personal holding company) the principal business of whieh is trading in stocks or secu- rities for its own account, `if its principal office is in the United States. (ii) In the case of a person who is a dealer in stocks or securities, trading in stocks or securities for his own account, through a resident broker, commission agent, custodian, or other independent agent. (B) COMMODITIES.- (i) Except in the case of a dealer in commodities, trading in commodities for the taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian,, or other agent, and whether or not any such agent ha,s discretionary `authority to make decisions in effecting the transactions. (ii) In the case of a person who is a dealer in com- modities, trading in commodities for his own account through a resident broker, commission agent, custodian, or other independent agent. (iii) Clauses (i) and (ii) apply only if the commodities are of a kind customarily dealt in on an organized corn- modity exchange and ~f the transaction is of a kind customarily consummated at such place. (C) LIMITATI0N.-Subparagraphs (A)(ii) and (B)(ii) shall apply only if, at no time during the taxable year, the taxpayer has an office or place of business in the United States through which or by the direction of which the transactions in stocks or securities, or in commodities, as the case may be, are effected. (c) EFFECTIVELY CONNECTED INCOME, ETC.-For purposes of this title, factors to be taken into account in determining whether gains, profits, and income or loss shall be treated as "effectively connected" with the 56 372 PAGENO="0383" FOREIGN INVESTORS TAX ACT OF 1965 61 condii~ct of a trade or business within the United States by a nonresident alien individual or foreign corporation include whether- (1) the gains, profits, and income or loss are derived from assets 2 used in or held'for use in the conduct of such trade or business, (2) the gains, profits, and income or loss are accounted for through such trade or business, or (3) the activities of the trade or business were a material factor in the realiz~tion of the gains, profits, and income or loss. PART Il-NONRESIDENT ALIENS AND FOREIGN CORPORATIONS Subpart A. Nonresident alien individuals. Subpart B. Foreign corporations. Subpart C. Miscellaneous provisions. Subpart A-Nonresident Alien Individuals Sec. 871. Tax on nonresident alien individuals. Sec. 872.. Gross income. Sec. 873. Deductions. Sec. 874. Allowance of deductions and credits. Sec. 875. Partnerships. Sec. 876. Alien residents of Puerto Rico. Sec. 877. Expatriation to avoid tax. * . Sec. (877] 878. Foreign educational, charitable, and certain other exempt organizations. SEC. 87!. TAX ON NONRESIDENT ALIEN INDIVIDUALS. ((a) No UNITED STATES BUSINESS-30 PERCENT TAX.- ((1) IMPoSITIoN OF TAX.-Except as otherwise provided in subsection (b) there is hereby imposed for each taxable year, in lieu of the tax imposed by section 1, on the amount received, by every nonresident alien individual not engaged in trade or business within the United States, from sources within the United States, as interest (except' interest on `deposits with persons * carrying on the banking business), dividends, rents, salaries, wages, premiums, annuities,, compensations, remunerations, emoluments, or other fixed' or determinable annual or periodical gains, profits,' and income (including amounts described in section 402(a)(2), section 403(a)(2), section 631 (b) and (c), and section 1235, which are consid~red .to be gains from the sale or exchange of capital assets)',' a tax of 30 percent of such amount. ((2) CAPITAL GAINS OF ALIENS TEMPORARILY PRESENT IN THE UNITED 5TATE5.-In the case of a nonresident alien individual not engaged in trade or business in the United States, there is - hereby imposed for each taxable year, in addition to' the tax imposed by paragraph (1)- 57 373 PAGENO="0384" 62 FOREIGN INVESTORS TAX ACT OF 196.5 * . ((A) if he is present in the United States for a period or periods aggregating less than 90 days during such taxable year-a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from sales or exchanges of capital. assets effected during his presence in the United States exceed his losses, allocable to sources within the United States, from such sales or exchanges effected during such presence; or ((B) if he is present in the United States for a period or periods aggregating 90 days or more during such taxable year-a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from sales or exchanges of capital assets effected at any time during such year exceed his losses, allocable to sources within the United States, from such sales or exchanges effected at any time during such year. For purpOses of this paragraph, gains and losses shall be taken into account only if, and to the extent that, they would be rec- ognized and taken into account if such individual were engaged in trade or business in the United States, except that such gains and losses shall be computed without regard to section 1202 (relating to deduction for capital gains) and such losses shall be determined without the benefits of the capital loss carryover pro-. vided in section 1212.] (a) INCoME NOT CONNECTED WITH UNITED STATES BUSINESS- 30 PERCENT TAX.- (1) INCOME OTHER THAN CAPITAL GAINS.-There is hereby im- posed for each taxable year a tax of 30 percent of the amount received from sources within the United States by a nonresident alienS in- dividval as- (A) interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other freed or determinable annual or periodical gains, profits, and income, (B) gains described in section 402 (a) (2), 403 (a) (2), or 631 (b) or (c), and gains on transfers described in section 1235, and (C) amounts which under section 341, or under section 1232 (in the case of bonde or other evidences of indebtedness issued after ), are treated as gains from the sale or exchange of property which is not a capital asset, but only to the extent the amounts so received is not effectively connected with the conduct of a trade or business within the United States.. (2) CAPITAL GAINS OF ALIENS PRESENT IN THE UNITED STATES 188 DAYS OR MORE.-In the case of a nonresident alien individual present in the United States for a period or periods aggregating 183 58 374 PAGENO="0385" FOREIGN INVESTORS TAX ACT OF 1965 63 days or more during the taxable year, there is hereby imposed for such year a tax of 30 percent of the amount by which his gains, derived from sources `within, the United States, from the sale or exchange at any time during such year of capital assets exceed his losses, allocable to sources `within the United States, from the sale or exchange at any time during such year of capital assets. For purposes of this paragraph, gains and losses shall be taken into account only if, and to the extent that, they would be recognized and taken into account if such gains and losses were effectively connected with the conduct of a trade or business within the United States, except that such gains and losses shall be determined `without regard to section 1~302 (relating to deduction for capital gains) and such losses shall be determined without the benefits of the capital loss carryover provided in section 19~12. Any gain or loss which is taken into account in determining the tax under paragraph (1) or s'u~bsection (b) shall not be taken into account in determining the tax under this paragraph. For purposes of the 183-day requirement of this paragraph, a nonresident alien individual not engaged in trade or business within the United States who has not established a taxable year for any prior period shall be treated as having a taxable year which is the calendar year. ((b) No UNITED STATES BUSINESS-REGULAR TAX.-A non- resident alien individual not engaged in trade or business within the United States shall be taxable without regard to subsection (a) if during the taxable year the sum of the aggregate amount received from the sources specified in subsection (a)(l), plus the amount by which gains from sales or exchanges of capital assets exceed losses from such sales or exchanges (determined in accordance with sub section (a)(2)) is more than $19,000 in the case of a taxable year beginning in 1964 or more than $21,200 in the case of a taxable year beginning after 1964, except that- ((1) the gross income shall include only income from the sources specified in subsection (a) (1) plus any gain (to the extent provided in subchapter P; sec. 1201 and following, relating to capital gains and losses) from a sale or exchange of a capital asset if such gain would be taken into account were the tax being determined under ~ubsection (a)(2); ((2) the deductions (other than the deduction for charitable contributions and gifts provided in section 873(c)) shall' be allowed only if and to the extent that they are properly allocable to the gross income from the sources specified in subsection (a), except that any loss from the sale or exchange of a capital asset shall be allowed (to the extent provided in subchapter P without the benefit of the capital loss carryover provided in section 1212) if ~such loss would be taken into account were the tax being de- termined under subsection (a)(2). 59 71-297 0-67-pt. 1-25 375 PAGENO="0386" 64 FOREIGN INVESTORS TAX ACT OF 1965 * ` (If (without regard to this sentence) the amount of the taxes imposed in the case of such an individual under section' 1 or under section 1201(b), minus the credit under section 35, is an amount * which is less than 30 percent of the sum of- ((A) the aggregate amount received from the sources specified; in subsection (a)(1), plus.. * . ((B) the amount, determined under subsection (a)(2), * by which gains from sales or exchanges of capital assets exceed losses from such sales or exchanges, then this subsection shall not apply and subsection (a) shall apply. For purposes of this subsection, the term "aggregate amount received from the sources specified in subsection (a)(1)" shall be applied without any exclusion under section 116.. ((c) UNiTED STATES BUSINESS.-A nonresident alien individual engaged in trade or business within the United States shall be taxable without regard to subsection (a). For~ purposes of part I,. this section, sections 881 and 882, and chapter 3, the term "engaged in trade or business within the United States" includes the performance of personal services within the United States at any time within the taxable year, but does not include. the performance of personal services- ((1) for a nonresident alien individual, foreign partnership, * or foreign corporation, not engaged in trade or business within the United States, or . .. * ((2) for an office or place of business maintained by a domestic corporation in a foreign country or in a possession of the United States, by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year and whose compensation for such services does no~ exceed in the aggregate $3,000. Such term does not include the effecting, through a resident broker, commission agent, or custodian, .of transactions in the United States in stocks or securities, or in commodities (if of a kind customarily dealt in on an organized commodity exchange, if the transaction is of the kind customarily consummated at such place, and if the alien, partnership, or corpo- ration has no office or placeS of business in the United States at any time during the `taxable year through which; or by the direction of which such transactions in commodities are effected).] (b) INcoME CONNECTED WITH UNITED STATES BusIN.ess-GRADu- .ATED RATE OF TAX.- . `. (1) IMPoSITIoN OF TAX.-A nonrevident alien individual en- gaged in trade or business `within the United States during the taxable year (or during any preceding taxable year beginning after * December 31, 1965) shall be taxable as provided in. section 1 or 376 PAGENO="0387" FOREIGN INVESTORS TAX ACT OF 1965 65 1201(b) on his taxable income which is effectively connected `with the conduct of such trade or business. (2) DETERMIffATION OF TAXABLE INCOME.-In determining taxable income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct of the trade or b'usiness within the United States. ((d)] (c~ PARTICIPANTS IN CERTAIN EXCHANGE OR TRAINING PROGRAMS.-FOr purposes of this section, a nonresident alien indi- vidual who (without regard to this subsection) is not engaged in trade or business within the United States and who is temporarily present in the United States as a nonimmigrant under subparagraph (F) or (J) of section 101 (a) (15) of the Immigration and Nationality Act, as amended (8 U.S.C. 1101 (a) (15) (F) or (J)), shall be treated as a nonresident alien individual engaged in trade or business within the United States, and any income described in section 14.41 (b) (1) or (2) which is received by such individual shall, to the extent derived from sources within the United States, be treated as effectively connected with the conduct of a trade or business within the United States. (d) ELECTION To 7REAT REAL PROPERTY INCOME AS INCOME (JOj',TNECTED WITH UNITED STATES BUSINESS.- (1) IN GENERAL.-A nonresident alien individual who during the taxable year derives any income- (A) from real property located in the United States, or from any interest in such real property, including (i) gains from the sale or exchange of real property or an interest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and (B) which, but for this subsection, would not be treated as income which is effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. An election under this paragraph for any taxable year shall remain in effect for all subsequent taxable years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. (2) ELECTION AFTER REv0cATI0N.-If an election has been made under paragraph (1) and such election has been revoked, a new election may not be made under such paragraph for any taxable year before the 5th taxable year which begins after the first taxable year for which such revocation is effective, unless the Secretary or his delegate consents to such new election. (3) FORM AND TIME OF ELECTION AND REVOCATIOL-An election under paragraph (1), and any revocation of such an election, may be made only in such manner and at such time as the Secretary or his delegate may by regulations prescribe. 61 377 PAGENO="0388" 66 FOREIGN INVESTORS TAX ACT OF 1965 (e) CROSS REFERENCES.- ((2)] (1) For tax treatment of certain amounts distributed by the United States to nonresident alien individuals, see section 402(a)(4). (2) For taxation of nonresident alien individuals who are expatriate United States citizens, see section 877. ((1)] (3) For doubling of tax on citizens of certain foreign countries, see section 891. (4) For reinstatement of pre-1966 income tax provisions ifl the case of residents of certain foreign countries, see section 896. * (5) For withholding of tax at source on nonresident alien in~ dividuals, see section 144L * (6) For the requirement of making a declaration of estimated tax by certain nonresident alien individuals, see section 6015(i). (7) For taxation of gains realized upon certain transfers to domestic corporations, see section 1250(d)(3) SEC. 872. GROSS INCOME. * (a) GENERAL RuLE.-In the case of a nonresident alien individual, gross income includes only- (1) (the] gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, and (2) gross income which is effectively connected `with the conduct of a trade or business within the United States. (b) ExcLusloNs.-The following items shall not be included in gross income of a nonresident alien individual, and shall be exempt from taxation under this subtitle: * (1) SHIPs UNDER FOREIGN FLAG.-Earnings derived from the operation of a ship or ships documented under the laws of a foreign country which grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. (2) AIRCRAFT OF FOREIGN REGISTRL-Earnings derived from the operation of aircraft registered under the laws of a foreign country which grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. (3) COMPENSATION OF PARTICIPANTS IN CERTAIN EXCHANGE OR TRAINING PR0GRAM5.-Compensation paid by a foreign employer to a nonresident alien individual for the period he is temporarily present in the United States as a~ nonimmigrant under sub-. paragraph (F) or (J) of section 101 (a)(15) of the immigration and Nationality Act, as amended. For purposes of this para- graph, the term "foreign employer" means- (A) a nonresident alien individual, foreign partnership, or foreign corporation, or * *.. (B) an office or place of business maintained in a foreign country or in a possession of the United States by a domestic 62 378 PAGENO="0389" FOREIGN INVESTORS TAX ACT OF 1965 67 (corporation] corporation, a domestic partnership, or an~ individual who ie' a citizen or resident of the United States. (4) BOND INTEREST OF RESIDENTS OF THE RYUKYU ISLANDS 0R THE TRUST TERRITORY OF THE PACIFIC ISLAHDS.-Income derived by a nonresident alien individualfrom a series E or series H United States savings bond, if s'uch individual acquired such bond while a resident of the Ryukyu Islande or the Trust Territory of the Pac'tfic I8lande. SEC. 873. DEDUCTIONS. ((a) GENERAL RULE.-In the case of a nonresident alien individual the deductions shall be allowed only if and to the extent that they are connected with income from sources within the United States; and the proper apportionment and allocation of the deductions wi~th respect to sources of income within and without the United States shall be determined as provided in part I, under regulations prescribed by the Secretary or his delegate. ((b) LossEs.- ((1) The deduction, for losses not connected with the trade or business if incurred in transactions entered into for profit allowed by section 165(c)(2) (relating to losses) shall be allowed whether or not connected with income from sources within the United States, but only if the profit, if such transaction had resulted in a profit, would be taxable under this subtitle. ((2) The deduction for losses of property not connected with the trade or business if arising from certain casualties or theft~ allowed by section 165(c)(3), shall be allowed whether or not connected with income from sources within the United States, but only if the loss is of property within the United States. ((c) CHARITABLE OoNTmBuTIoNs.-The deduction for charitable contributions and gifts provided by section 170 shall be allowed whether or not connected with income from sources within the United. States, but only as to contributions or gifts made to domestic corpora~ tions, or to community chests, funds, or foundations, created in the United States. ((d) PERSONAL ExEMPTI0N.-In the case of a nonresident aliem individual who is not a resident of a contiguous country, only one exemption under section 151 shall be allowed as a deduction. ((e) STANDARD DEDUCTION.- (For disallowance of standard deduction, see section 142 (b) (I).]' (a) GENERAL RULE.-In the case of a nonresident alien individual, the ~deductions shall be allowed only for purposes of section 871(b) and (except as provided by subsection (b)) only if and to the extent that they are effectively connected with the conduct of a trade or b'ueine8s within the United &ates; and the proper apportionment and allocation of the 63 379 PAGENO="0390" 68 FOREIGN INVESTORS TAX ACT OF 1965 deductions for this purpose shall be determined as provided in regulations prescribed by the Secretary or his delegate. (b) EXCEPTIoNS .-The following deductions shall be allowed whether or not they are effectively connected with the conduct of a trade or business within the United States: (1) LossEs.-The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c) (3) , but only if the loss is of property located within the United States. (2) CHARITABLE CONTRIBUTIONS.-The deduction for charitable contributions and gifts allowed by section 170. (3) PERSONAL E1EMPTI0N.-The deduction for personal exemp. tions allowed by section 151, except that in the case of a nonresident alien individual who is not a resident of a contiguous country only one exemption shall be allowed under section 151.. (c) CROSS REFERENCES.- (1) For disallowance of standard deduction, see section 142(b) (1). (2) For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b) (1). SEC. 874. ALLOWANCE OF DEDUCTIONS AND CREDITS. (a) RETURN PREREQUISITE TO ALLOWANCE.-A nonresident alien individual shall receive the benefit of the deductions and credits al. lowed to him in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true and accurate return (of his total income received from all sources in the United States], in the manner prescribed in subtitle F (sec. 6001 and following, relating to procedure and administration), including therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. This subsection shall not be construed to deny the credits provided by sections 31 and 32 for tax withheld at (the] source or the credit provided by section 39 for certain uses of gasoline and lubricating oil. (b) TAX WITHHELD AT S0URCE.-The benefit of the deduction for exemptions under sectic~n 151 may, in the discretion of the Secretary or his delegate, and under regulations prescribed by the Secretary *or his delegate, be received by a nonresident alien individual entitled thereto, by filing a claim therefor with the withholding agent. (c) (FOREIGN TAX CREDIT NOT ALLOWED.-A nonresident] FOREIGN TAX CREDIT.-Except as provided in section 906, a nonresi-. 4ent alien individual shall not be allowed the credits against the tax for taxes of foreign countries and possessions of the United States allowed by section 901. 64 380 PAGENO="0391" FOREIGN INVESTORS TAX ACT OF 1965 69 SEC. 875. PARTNERSHIPS. For purposes of this subtitle, a nonresident alien individual shall be considered as being engaged in a trade or business within the United States if the partnership of which he is a member is so engaged. SEC. 876. ALIEN RESIDENTS OF PUERTO RICO. (a) No APPLICATION TO CERTAIN ALIEN RESIDENTS OF PUERTO Rico.-This subpart shall not apply to an alien individual who is a bona fide resident of Puerto Rico during the entire taxable year, and such alien shall be subject to the tax imposed by section 1. (b) CROSS REFERENCE.- For exclusion from gross income of income derived from sources within Puerto Rico, see section 933. SEC. 877. EXPATRIATION TO AVOID TAX. (a) IN GENERAL.-EVery nonresident alien individual who at any time after March 8, 1965, and within the 5-year period immediately pre- ceding the close of the taxable year lost United States citizenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle B, shall be taxable for such taxable year in the manner provided in subsection (b) if the tax imposed pursuant to such subsection exceeds the tax which, without regard to this section, is imposed pursuant to section 871. (b) ALTERNATIVE TAX.-A nonresident alien individual described in subsection (a) shall be taxable for the taxable year as provided in section 1 or section 1201(b), except that- (1) the gross income shall include only the gross income described in section 872(a) (as modified by subsection (c) of this section), and * (2) the deductions shall be allowed if and to the extent that they are connected with the gross income included under this section, except that the capital loss carryover provided by section 1212(b) shall not be allowed; and the proper allocation and apportionment of the deductions for this purpose shall be determined as provided under regulations prescribed by the Secretary or his delegate. For purposes of paragraph (2), the deductions allowed by section 873(b) shall be allowed; and the deduction (for losses not connected with the trade or business if incurred in transactions entered into for profit) allo'wed by section 165(c) (2) shall be allowed, but only if the profit, if such transaction had resulted in a profit, would be included in gross income under this section. (c) SPECIAL RULES OF S0URcE.-For purposes of subsection (b), the following items of gross income shall be treated as income from sources within the United States: (1) SALE OF PROPERTY.- Gains on the sale or exchange of property (other than stock or debt obligations) located in the United States. 65 381 PAGENO="0392" FOREIGN INVESTORS TAX ACT OF 1965 (2) STOCK OR DEBT OBLIGATIONS.-Gains on the sale or exchange `of stock issued by a domestic corporation or debt obligations of United States persons or of the United States, a State or political subdivision thereof, or the District of Columbia. (d) EXCEPTION FOR LOSS OF CITIZENSHIP FOR CERTAIN CAUSES.- Subsection (a) shall not apply to a nonresident alien individual whose loss of United States citizenship resulted from the application of section .301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). (e) Burden of Proof.-If the Secretary or his delegate establishes that it is reasonable to believe that an indivuidal's loss of United States citizenship would, but for this section, result in a substantial reduction *for the taxable year in the taxes on his probable income for such year, the burden of proving for such taxable year that such loss of citizenship did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle B shall be on such individual. SEC. (877] 878. FOREIGN EDUCATIONAL, CHARITABLE, AND CERTAIN OTHER EXEMPT ORGANIZATIONS. -For special provisions relating to unrelated business income of foreign educational, charitable, and other exempt trusts, see section 512(a). Subpart B-Foreign Corporations (Sec. 881. Tax on foreign corporations not engaged in business in United States.] (Sec. 882. Tax on resident foreign corporations.] - Sec. 881. Income of foreign corporations not connected with United States business. Sec. 885. Income of foreign corporations connected with United States business. Sec. 883. Exclusions from gross income. Sec. 884. Cross references. [SEC. 881. TAX ON FOREIGN CORPORATIONS NOT ENGAGED IN BUSI- NESS IN UNITED STATES. [(a) IMPosITIoN OF TAX.-In the case of every foreign corporation not engaged in trade or business within the United States, there is hereby imposed for each taxable year, in lieu of the taxes imposed by section 11, a tax of 30 percent of the amount received from sources within the United States as interest (except interest on deposits with persons carrying on the banking business), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emolu- Inents, or other fixed or determinable annual or periodical gains, profits, and income (including amounts described in section 631 (b) and (c) which are considered to be gains from the sale or exchange of capital assets).] 66 382 PAGENO="0393" FOREIGN INVESTORS TAX ACT OF 19 65 71 SEC. 881. INCOME OF FOREIGN CORPORATIONS NOT CONNECTED WITH UNITED STATES BUSINESS. (a) IMPoSITIoN o~ TAX.-There is hereby imposed for each taxable ~year a tax of 30 percent of the amount received from sources within the United States by aforeign~ corporation as- (1) interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or de- terminable annual or periodical gains, profits, and income, (2) gains described in section 631 (b) or (c), and (3) amounts which under section 341, or under section 1232 (in the case of bonds or other evidences of indebtedness issued after are treated as gains from the sale or ex- change of property which is not a capital asset, ô'ut only to the extent the amount so received is not effectively connected with the conduct of a trade or business within the United States. (b) DOUBLING OF TAX.-. For doubling of tax on corporations of certain foreign countries, see section 891. SEC. 882. (TAX ON RESIDENT FOREIGN CORPORATIONS.] INCOME OF FOREIGN CORPORATIONS CONNECTED WITH UNITED STATES BUSINESS. (a) NORMAL TAX AND SURTAX.- (1) IMPOSITION OF TAX.-A foreign corporation engaged in trade or business within the United States during the taxable year (or during any preceding taxable year beginning after December 31, 1965) shall be taxable as provided in section 11 or 1201(a) on its taxable income which is effectively connected with the conduct of such trade or business. (2) DETERMINATION OF TAXABLE INc0ME.-In determining tax.. able income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct of the trade or business within the United States. (b) GROSS INCOME.-Ifl the case of a foreign corporation, gross income includes only- (1) (the] gross income which is derived from sources within the United States[.] and which is not effectively connected with the conduct of a trade or business within the United States, and (2) gross income which is effectively connected with the conduct of a trade or business within the United States. (c) ALLOWANCE OF DEDUCTIONS AND CREDITS.- ((2)] (1) ALLOCATION OF DEDUCTIONS.- (A) GE.wERAL RrJLE.-In the case of a foreign corporation, the deductions shall be allowed only for purposes of subsection (a) and (except as provided by subparagraph (B)) only if and to the extent that they are effectively connected with [income 67 383 PAGENO="0394" 2 FOREIGN INVESTORS TAX ACT OF 1965 from sources] the conduct of a trade or business within the United States; and the proper apportionment and allocation of the deductions (with respect to sources within and without the United States] for this purpose shall be determined as provided in (part I, under] regulations prescribed by the Secretary or his delegate. ((3)] (B) CHARITABLE C0NTRIBUTIONS.-The deduction for charitable contributions and gifts (provided] allowed by section 170 shall be allowed whether or not effectively con- nected with (income from sources] the conduct of a trade or business within the United States. ((1)] (2) DEDUCTIONS AND CREDITS ALLOWED ONLY IF RETURN FILED.-A foreign corporation shall receive the benefit of the de- ductions and credits allowed to it in this subtitle only by ffling or causing to be filed with the Secretary or his delegate a true and accurate return (of its total income received from all sources in the United States], in the manner prescribed in subtitle F, includ- ing therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. This paragraph shall not be construed to deny the credit provided by section 32 for tax withheld at source or the credit provided by section 39 for certain uses of gasoline and lubricating oil. ((4)] (3) FOREIGN TAX CREDIT.-(Foreigll] Except as pro- vided by section 906, foreign corporations shall not be allowed the [credits] credit against the tax for taxes of foreign countries and possessions of the United States allowed by section 901. (4) GROSS REFERENCE.- For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b) (1). (d) ELECTION To TREAT REAL PROPERTY INCOME AS INCOME CONNECTED WITH UNITED STATES BUSINESS.- (1) IN GENERAL .-Aforeign corporation which during the taxable year derives any income- (A) from real property located in the United States, or from any interest in such real property, including (i) gains from the sale or exchange of real property or an interest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and (B) which, but for this subsection, would not be treated as income effectively connected with the conduct of a trade or busi- ness within the United States, may elect for such taxable year to treat all such income as income which is effectively connected `with the conduct of a trade or business within the United States. An election under this paragraph for any 68 384 PAGENO="0395" FOREIGN INVESTORS TAX ACT OF 1965 73 taxable year shall remain in effect for all subsequent taxable years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. (2) ELECTIoN AFTER REVOCATION, ETC.-Paragraphs (2) and (3) of section 871(d) shall apply in respect of elections under this subsection in the same manner and to the same extent as they apply in respect of elections under section 871(d). ((d)] (e) RETURNS OF TAX BY AGENT.-Jf any foreign corporation has no office or place of business in the United States but has an agent in the United States, the return required under section 6012 shall be made by the agent. SEC. 883. EXCLUSIONS FROM GROSS INCOME. The following items shall not be included in gross income of a foreign corporation, and shall be exempt from taxation under this subtitle: (1) SHIPS UNDER FOREIGN FLAG.-Earnings derived from the operation of a ship or ships documented under the laws of a foreign country which grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. (2) AIRCRAFT OF FOREIGN REGISTRY.-Earnings derived from the operation of aircraft registered under the laws of a foreign country which grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. SEC. 884. CROSS REFERENCES. ((4)] (1) For special provisions relating to unrelated business in- come of foreign educational, charitable, and certain other exempt organizations, see section 512(a). ((3)] (2) For special provisions relating to foreign insurance corn.. panies, see (subchapter L (sec. 801 and following)] section 842. ((2)] (3) For rules applicable in determining whether any foreign corporation is engaged in trade or business within the United States, see section (871(c)] 864(b). (4) For reinstatement of pre-1966 income tax provisions in the case of corporations of certain foreign countries, see section 896. (5) For allowance of credit against the tax in case of a foreign corporation having income effectively connected with the con- duct of a trade or business within the United States, see section 906. ((1)] (6) For withholding at source of tax on income of foreign corporations, see section 1442. 69 385 PAGENO="0396" 74 FOREIGN INVESTORS TAX ACT OF 1965 Subpart C-Miscellaneous Provisions Sec. 891. Doubling of rates of tax on citizens and corporations of certain foreign countries. Sec. 892.. Income of foreign governments and of international organizations. Sec. 893. Compensation of employees of foreign governments or international organizations. (Sec. 894. Income exempt under treaty.] Sec. 894. Income affected by treaty. Sec. 895. Income derived by a foreign central bank of issue from obligations of the United States or from bank depoeiL9. Sec. 896. Application of pre-1966 income tax provision8. SEC. 891. DOUBLING OF RATES OF TAX ON CITiZENS AND CORPORA.. TIONS OF CERTAIN FOREIGN COUNTRIES. Whenever the President finds that, under the laws of any foreign country, citizens or corporations of the United States are being subjected to discriminatory or extraterritorial taxes, the President shall so proclaim and the rates of tax imposed by sections 1, 3, 11, 802, 821, 831, 852, 871, and 881 shall, for the taxable year during which such proclamation is made and for each taxable year thereafter, be doubled in the case of each citizen and corporation of such foreign country; but the tax at such doubled rate shall be considered as imposed by such sections as the case may be. In no ca~se shall this section operate to increase the taxes imposed by such sections (com- puted without regard to this section) to an amount in excess~ of 80 percent of the taxable income of the taxpayer (computed without regard to the deductions allowable under section 151 and under part VIII of subchapter B). Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclamation under the preceding provisions of this section have been modified so that discriminatory and extraterritorial taxes applicable to citizens and corporations of the United States have been removed, he shall so proclaim, and the provisions of this section providing for doubled rates of tax shall not apply to any citizen or corporation of such foreign country with respect to any taxable year beginning after such proclamation is made. SEC. 892. INCOME OF FOREIGN GOVERNMENTS AND OF INTER- NATIONAL ORGANIZATIONS. The income of foreign governments or international organizations received from investments in the United States in stocks, bonds, or other domestic securities, owned by such foreign governments or by international organizations, or from interest on deposits in banks in the United States of moneys belonging to such foreign governments or international organizations, or from any other source within the United States, shall not be included in gross income and shall be exempt from taxation under this subtitle. 70 386 PAGENO="0397" FOREIGN INVESTORS TAX ACT OF 1965 75 SEC. 893. COMPENSATION OF EMPLOYEES OF FOREIGN GOVERN. MENTS OR INTERNATIONAL ORGANIZATIONS. (a) RULE FOR EXCLUSION.-Wages, fees, or salary of any employee of a foreign government or of an international organization (including a consular or other officer, or a nondiplomatic representative), received as compensation for official services to such government or interna-. tional organization shall not be included in gross income and shall be exempt from taxation under this subtitle if- (1) such employee is not a citizen of the United States*~ or is a citizen of the Republic of the Philippines (whether or not a citizen of the United States); and (2) in the case of an employee of a foreign government, the services are of a character similar to those performed by employees of the Government of the United States in foreign countries; and (3) iii the case of an employee of a foreign government, the foreign government grants an equivalent exemption to employees of the Government of the United States performing similar serv- ices in such foreign country. (b) CERTIFICATE BY SECRETARY OF STATE.-The Secretary of State shall certify to the Secretary of the Treasury the names of the foreign countries which grant an equivalent exemption to the employees of the Government of the United States performing services in such foreign countries, and the character of the services performed by employees of the Government of the United States in foreign countries. SEC. 894. INCOME AFFECTED BY TREATY. (a) INCOME EXEMPT UNDER TREATY.-Income of any kind, to the extent required by any treaty obligation of the United States, shall not be included in gross income and shall be exempt from taxation under this subtitle. (b) PERMANENT ESTABLISHMENT IN UNITED STATES.-For pur- poses of applying any exemption from, or reduction of, any tax provided by any treaty to which the United States is a party with respect to income which is not effectively connected with the conduct of a trade or business within the Uvited States, a nonresident alien individual or foreign corporation shall be deemed not to have a permanent establishment in the United States at any time during the taxable year. This subsection shall not apply in respect of the tax computed under section 877(b). SEC. 895. INCOME DERIVED BY A FOREIGN CENTRAL BANK OF ISSUE FROM OBLIGATIONS OF THE UNITED STATES OR FROM BANK DEPOSITS. Income derived by a foreign central bank of issue from obligations of the United States owned by such foreign central bank of issue, or from interest on deposits with persons carrying on the banking business, shall not be included in gross income and shall be exempt from taxa-. tion under this subtitle unless such obligations or deposits are held for, 71 387 PAGENO="0398" 76. FOREIGN INVESTORS TAX ACT OF 1965 or used in connection with, the conduct of commercial banking functions or other commercial activities. For purposes of the preceding sentence, the Bank for International Settlements shall be treated as aforeign central bank of issue with respect to interest on deposits with persons carrying on the banking business. SEC. 896. APPLICATION OF PRE-1966 INCOME TAX PROVISIONS. (a) IMPoSITIoN OF MORE BURDENSOME TAXES BY FOREIGN CouN~ TRY.-Whenever the President finds that- (1) under the laws of any foreign country, considering the tax system of such foreign country, citizens of the United States not residents of such foreign country or domestic corporations are being subjected to more burdensome taxes, on any item of income received by such citizens or corporations from sources within such foreign country, than taxes imposed by the provisions of this subtitle on similar income derived from sources within the United States by residents or corporations of such foreign country. (~) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such taxes so that they are no more burdensome than taxes imposed by the provisions of this subtitle on similar income derived from sources within the United States by residents or corporations of such foreign country, and (3) it is in the public interest to apply pre-1966 tax provisions in accordance with the provisions of this section to residents or corporations of such foreign country, the President shall proclaim that the tax on such similar income derived from sources within the Tinited States by residents or corporations of such foreign country shall, for taxable years beginning after such procla.~ mation, be determined under this subtitle without regard to amendments made to this subchapter and chapter 3 on or after the date of enactment of this section. (b) ALLEVIATION OF MORE BURDENSOME TAXES.-WheneVer the President finde that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that citizens of the United States not residents of such foreign country or domestic corporations are no longer subject to more burdenS some taxes on such item of income derived by such citizens or corporations from sources within such foreign country, he shall proclaim that the tax on such similar income derived from sources within the United States by residents or corporations of such foreign country shall, for any taxable year beginning after such proclamation, be determined under this subtitle without regard to subsection (a). (c) NOTIFICATION OF CONGRESS REQUIRED.-NO proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to. issue such proclamation. 72 388 PAGENO="0399" FOREIGN INVESTORS TAX ACT OF 1965 77 (d) IMPLEMENTATION BY REGULATI0Ns.-The Secretary or his dele- gate shall prescribe such regulations as he deems necessary or appropriate. to implement this section. PART Ill-INCOME FROM SOURCES WITHOUT THE UNITED STATES Subpart A. Foreign tax credit. Subpart B. Earned income of citizens of United States. Subpart C. Western Hemisphere trade corporations. Subpart D. Possessions of the United States. Subpart E. China Trade Act corporations~ Subpart F. Controlled Foreign Corporations. Subpart G. Export Trade Corporations. Subpart A-Foreign Tax Credit Sec. 901. Taxes of foreign countries and of possessions of United States. Sec. 902. Credit for corporate stockholder in foreign corporation. Sec. 903. Credit for taxes in lieu of income, etc., taxes. Sec. 904. Limitation on credit. Sec. 905. Applicable rules. Sec. 906. Nonresident alien individuals and foreign corporations. SEC. 901. TAXES OF FOREIGN COUNTRIES AND OF POSSESSIONS OF UNITED STATES. (a) ALLOWANCE op Cirema~.-If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the applicable limitation of section 904, be credited with the amounts provided in the applicable paragraph of subsection (b) plus, in the case of a corporation, the taxes deemed to have been paid under sections 902 and 960. Such chOice for any taxable year may be made or changed at any time before the expiration of the period prescribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year. The credit shall not be allowed against the tax imposed by section 531 (relating to the tax on accumu- lated earnings), against the additional tax imposed for the taxable year under section 1333 (relating to war loss recoveries), or against the personal holding company tax imposed by section 541. (b) AMOUNT ALLoWED.~-Subject to the applicable limitation of section 904, the following amounts shall be allowed as the credit under subsection (a): (1) CITIzENS AND DOMESTIC CORP0RATIONS.-In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; and (2) RESIDENT OF THE UNITED STATES OR PUERTO RICO.-In the case of a resident of the United States and in the case of an 73 389 PAGENO="0400" 78 FOREIGN INVESTORS TAX ACT OF 1965 individual who is a bona fide resident of Puerto Rico during the entire taxable year, the amount of any such taxes paid or accrued during the taxable year to any possession of the United States; and (3) ALIEN RESIDENT OF THE UNITED STATES OR PUERTO RICO.- In the case of an alien resident ~f the United States and in the case of an alien individual who is a bona fide resident of Puerto Rico during the entire taxable year, the amount of any such taxes paid or accrued during the taxable year to any foreign country(, if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country]; and (4) NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN CORPORA- TIONS.-ITh the case of any nonresident alien individual or a foreign corporation, the amount determined pursuant to section 906; and ((4)](5) PARTNERSHIPS AND ESTATES.-In the case of any individual described in paragraph (1), (2), (or (3),] (3), or (4), who is a member of a partnership or a beneficiary of an estate or trust, the amount of his proportionate share of the taxes (de- scribed in Such paragraph) of the partnership or the estate or trust paid or accrued during the taxable year to a foreign country or to any possession of the United States, as the case may be. (c) SIMILAR CREDIT REQUIRED FOR CEETAIN ALIEN RESIDENTS.- Whenever the President finde that- (1) a foreign country, in imposing income, war profits, and excess profits taxes, does not allow to citizens of the iLinited States residing in such foreign country a credit for any such taxes paid or accrued to the United States or any foreign country, as the case may be, similar to the credit allowed under subsection(b)(3), (~) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit to citizens of the United States residing in such foreign country, and (3) ii ie in the public interest to allow the credit under subsection (b)(3) to citizens or subjects of such foreign country only if it allows such a similar credit to citizens of the United States residing in such foreign country, the President shall proclaim that, for taxable years beginning while the proclamation remains in effect, the credit under subsection (b)(3) shall be allowed to citizens or subjects of such foreign country only if such foreign country, in imposing income, war profits, and excess profits taxes, allows to citizens of the United States residing in such foreign country such a similar credit. (cc)] td) CORPORATIONS TREATED AS FOREIGN.-FOr purposes of this subpart, the following corporations shall be treated as foreign corporations 74 390 PAGENO="0401" FOREIGN INVESTORS TAX ACT OF 1965 79 (1) a corporation entitled to the benefits of section 931, by reason of receiving a large percentage of its .gross income from sources within a possession of the United States; and (2) a corporation organized under the China Trade Act, 1922 (15 U.S.C., chapter 4), and entitled to the deduction provided in section 941. [(d)] (e) Onoss REFERENCE.-~ (1) For deductions of income, war profits, and excess profits taxes paid to a foreign country or a possession of the United States, see sections 164 and 275. (2) For right of each partner to make election under this section, see section 703 (b). (3) For right of estate or trust to the credit for taxes imposed by foreign countries and possessions of the United States under this section, see section 642 (a) (2). (4) For reduction of credit for failure of a United States person to fur- nish certain information with respect to a foreign corporation controlled by him, see section 6038. * * * * * * SEC. 906. NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN COR- PORATIONS. (a) ALLOWANCE OF CIREDIT.-A nonresident alienS individual or a foreign corporation engaged in trade or business within the United States during the taxable year (or during any preceding taxable year beginning after December 31, 1965) shall be allowed a credit under section 901 for the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year (or deemed, under section 902, paid or accrued duriivg the taxable year) to any foreign country or possession of the United States with respect to income effectively connected with the conduct of the trade or business within the United States. (b) SPECIAL RULES.- (1) For purposes of subsection (a) and for purposes of deter- mining the deductions allowable under sections 873(a) and 882(c), in determining the amount of any tax paid or accrued to any foreign country or possession there shall not be taken into account any amount of tax to the extent the tax so paid or accrued is imposed with respect to income which would not be taxed by such foreign country or possession but for the fact that- (A) in the case of a nonresident alien individual, such individual i a citizen or resident of such foreign country or possession, or (B) in the case of a foreign corporation, such corporation was created or organized under the law of such foreign coun.try or possession or is domiciled for tax purposes in such country or possession. (2) For purposes of subsection (a), in applying section 904 the taxpayer's taxable income shall be treated as consisting ouly of the 71-297 0-67-pt. 1-26 391 PAGENO="0402" 80 FOREIGN INVESTORS TAX ACT OF 1965 taxable income effectively connected with the taxpayer's conduct of the trade or business within the United States. (3) Th,e credit allowed pursuant to subsection (a) shall not be allowed against any tax imposed by section 871(a) (relating to income of nonresident alien individual not connected with United States business) or 881 (relating to income of foreign corporations not connected with United States business). (4) For purposes of sections 902(a) and 78, aforeign corporation choosing the benefits of this subpart which receives dividends shall, with respect to such dividends, be treated as a domestic corporation. *`:~, * * * * * * Subpart D-Possessions of the United States Sec. 931. Income from sources within possessions of the~ United States. * Sec. 932. Citizens of possessions of the United States. Sec. 933. Income from sources within Puerto Rico. Sec. 934. Limitation on reduction in income tax liability incurred to the Virgin Islands. SEC. 931. INCOME FROM SOURCES WITHIN POSSESSIONS OF THE UNITED STATES. (a) GENERAL RULE.-In the case of citizens of the United States or domestic corporations, gross income means only gross income from sources within the United States if the conditions of both paragraph (1) and paragraph (2) are satisfied: (1) THREE-YEAR PERI0D.-If 80 percent or more of the gross income of such citizen or domestic corporation (computed without the benefit of this section) for the 3-year period immediately preceding the close of the taxable year (or for such part of such period immediately preceding the close of such taxable year as may be applicable) was derived from sources within a possession of the United States; and (2) TRADE OR BTJSINESS.-If- (A) in the case of such corporation, 50 percent or more of its gross income (computed without the benefit of this sec- tion) for such period or such part thereof was derived from the active conduct of a trade or business within a possession of the United States; or * (B) in the case of such citizen, 50 percent or more of his gross income (computed without the benefit of this section) for such period or such part thereof was derived from the active cOnduct of a trade or business within a possession * of the United States either on his own account or as an employee or agent of another. (b) AMOUNTS RECEIVED IN UNITED STATEs.-Notwithstanding subsection (a), there shall be included m gross mcome all amounts 76 392 PAGENO="0403" FOREIGN INVESTORS TAX ACT OF 1965 81 received by such citizens or corporations within the United States, whether derived from sources within or without the United States. (c) DEFINITI0N.-For purposes of this section, the term "possession of the United States" does not include the Virgin Islands of the United States, and such term when used with respect to citizens of the United States does not include Puerto Rico. ((d) DEDUcTIoNs.- * ((1) Citizens of the United States entitled to the benefits of this. section shall have the same deductions as are allowed by section 873 in the case of a nonresident alien individual engaged * in trade or business within the United States. ((2) Domestic corporations entitled to the benefits of this section shall have the same deductions as are allowed by section 882 (c) in the case of a foreign corporation engaged in trade or business within the United States.] (d) DEDucTIoNS.- (1) GENERAL RuLE.-Except as otherwise provided in this sub- section and subsection (e), in the case of persons entitled to the benefits of this section the deductions shall be allowed only if and to the extent that they are connected with income from sources within the United States; and the proper apportionment and allocation of the deductions with respect to sources of income within and without the United States shall be determined as provided in part I, under regulations prescribed by the Secretary or his delegate. (2) EXcEPTI0N5.-The following deductions shall be allowed whether or not they are connected with income from sources within the United States: (A) The deduction, for losses not connected with the trade or business if incurred in transactions entered into for profit, allowed by section 165(c) (2), but only if the profit, if such transaction had resulted in a profit, would be taxable under this subtitle. (B) The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft,. allowed by section 165(c) (3), but only if the loss is of property within the United States. (0) The d&Wction for charitable contributions and gifts allowed by section 170. (3) DEDUCTION DISALLOWED.- For disallowance of standard deduction, see section 142(b) (2). (e) DEDUcTIoN FOR PERSONAL EXEMPTION.-A citizen of the United States entitled to the benefits of this section shall be allowed a deduc- tion for only one exemption under section 151. (f) ALLOWANCE OF DEDUCTIONS AND CREDIT5.-Persons entitled to the benefits of this section shall receive the benefit of the deductions 77 393 PAGENO="0404" 82 FOREIGN INVESTORS TAX ACT OF 1965 and credits allowed to them in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true and accurate return of their total income received from all sources in the United States, in the manner prescribed in subtitle F, including therein all the infor. mation which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. (g) FOREIGN TAX CREDIT.-Persons entitled to the benefits of this section shall not be allowed the credits against the tax for taxes of foreign countries and possessions of the United States allowed by section 901. (h) INTERNEES.-In the case of a citizen of the United States interned by the enemy while serving as an employee within a possession of the United States- (1) if such citizen was confined in any place not within a posses. sion of the United States, such place of confinement shall, for purposes of this section, be considered as within a possession of the United States; and (2) subsection (b) shall not apply to any compensation received within the United States by such citizen attributable to the period of time during which such citizen was interned by the enemy. (i) EMPLOYEES OF TIlE UNITED SPA~s.-For purposes of this sec- (ion, amounts paid for services performed by a citizen of the United States as an employee of the United States or any agency thereof shall be deemed to be derived from sources within the United States. SEC. 932. CITIZENS OF POSSESSIONS OF THE UNITED STATES. (a) GENERAL RULE.-Afly individual who is a citizen of any posses- sion of the United States (but not otherwise a citizen of the United States) and who is not a resident of the United States shall be subject to taxation under this subtitle (only as to income derived from sources within the United States, and in such case the tax shall be computed and paid] in the same manner and subject to the same conditions as in the case of (other persons who are taxable only as to income de-. rived from such sources] a nonresident alien individual. This section shall have no application in the case of a citizen of Puerto Rico. (b)VIRGIN ESLANDS.-NOthlng in this section shall be construed to alter or amend the Act entitled "An Act making appropriations for the naval service for the fiscal year ending June 30, 1922, and for other purposes", approved July 12, 1921 (48 U.S.C. 1397), relating to the imposition of income taxes in the Virgin Islands of the United States. 78 394 PAGENO="0405" FOREIGN INVESTORS TAX ACT OF 1965 83 (c) GUAM.- For applicability of United States income tax laws in Guam, see sec- tion 31 of the Act of August 1, 1950 (48 U.S.C. 1421i); for disposition of the proceeds of such taxes, see section 30 of such Act (48 U.S.C. 1421h). * .* * * * * a Subpart F-Controlled Foreign Corporations Sec. 951. Amounts included in gross income of United States shareholders. Sec. 952. Subpart F income defined. Sec. 953. Income from insurance of United States risks. * * * * * * * SEC. 952. SUBPART F INCOME DEFINED. fa) IN GENERAL.-FOr purposes of this subpart, the term "subpart F income" means, in the case of any controlled foreign corporation, the sum of- (1) the income derived from the insurance of United States risks (as determined under section 953), and (2) the foreign base company income (as determined under section 954). ((b) EXCLUSION OF UNITED STATES INCOME.-Subpart F income does not include any item includible in gross income under this chapter (other than this subpart) as income derived from sources within the United States of a foreign corporation engaged in trade or business in the United States.] (6) EICLUSIoN 07 UNITED STATES INCOME.-In the caee of a con- trolled foreign corporation, subpart F income does not include any item of income effectively connccted `with the conduct by such corporation of a trade or bustnes8 within the United States `unless such item is exempt from taxation (or is 8ubject to a reduced rate of tax) pursuant to a treaty obliga- tion of the United States. (c) LIMITATION.-FOr purposes of subsection (a), the subpart F income of any controlled foreign corporation for any taxable year shall not exceed the earnings and pEofits of such corporation for such year reduced by the amount (if any) by which- (1) an amount equal to- (A) the sum of the deficits in earnings and profits for prior taxable years beginning after December 31, 1962, plus (B) the sum of the deficits in earnings and profits for taxable years beginning after December 31, 1959, and before January 1, 1963 (reduced by the sum of the earnings and profits for such taxable years); exceeds (2) an amount equal to the sum of the earnings and profits for prior taxable years beginning after December 31, 1962, al- located to other earnings and profits under section 959(c) (3). 79 395 PAGENO="0406" 84 FOREIGN INVESTORS TAX ACT OF 1965 For purposes of the preceding sentence, any deficit in earnings and profits for any prior taxable year shall be taken into account under paragraph (1) for any taxable year only to the extent it has not been taken into account under such paragraph for any preceding taxable year to reduce earnings and profits of such preceding year. (d) SPECIAL RULE IN CASE OF INDIRECT OwNER5HIP.-For pur- poses of subsection (c), if- (1) a United States shareholder owns (within the meaning of section 958(a)) stock of a foreign corporation, and by reason of such ownership owns (within the meaning of such section) stock of any other foreign corporation, and (2) any of such foreign corporations has a deficit in earnings and profits for the taxable year, then the earnings and profits for the taxable year of each such foreign corporation which is a controlled foreign corporation shall, with respect to such United States shareholder, be properly reduced to take into account any deficit described in paragraph (2) in such manner as the Secretary or his delegate shall prescribe by regulations. SEC. 953. INCOME FROM INSURANCE OF UNITED STATES RISKS. (a) GENERAL RULE.-For purposes of section 952 (a)(1), the term "income derived from the insurance of United States risks" means that income which- (1) is attributable to the reinsurance or the issuing of any insurance or annuity contract- (A) in connection with property in, or liability arising-'out of activity in, or in connection with the lives or hálth of residents of, the United States, or (B) in connection with risks not include&in subparagraph (A) as the result of any arrangement whereby another cor- poration receives a substantially equal amount of premiums or other consideration in respect to any reinsurance or the issuing of any insurance or annuity contract in connection with property in, or liability arising out of activity in, or in connection with the lives or health of residents of, the United States, a~nd (2) would (subject to the modifications provided by paragraphs (1), (2), and (3)/of subsection (b)) be taxed under subchapter L of this chapter if such income were the income of a domestic insurance corporation. This section shall apply only in the case of a controlled foreign corporation which receives, during any taxable year, premiums or other consideration in respect of the reinsurance, and the issuing, of insurance and annuity contracts described in paragraph (1) in excess of 5 percent of the total of premiums and other consideration received 80 396 PAGENO="0407" FOREIGN INVESTORS TAX ACT OF 1965 85 during such taxable year in respect of all reinsurance and issuing of insurance and annuity contracts. (b) SPECIAL RULES.-For purposes of subsection (a)- (1) In the application of part I of subchapter L, life insurance company taxable income is the gain from operations as defined in section 809(b). (2) A corporation which would, if it were a domestic insurance corporation, be taxable under part II of subchapter L shall apply subsection (a) as if it were taxable under part III of subchapter L. (3) The following provisions of subchapter L shall not apply: (A) Section 809(d)(4) (operations loss deduction). (B) Section 809(d) (5) (certain nonparticipating contracts). (C) Section 809(d)(6) (group life, accident, and health insurance). (D) Section 809(d)(10) (small business deduction). (E) Section 817(b) (gain on property held on December 31, 1958, and certain substituted property acquired after 1958). (F) Section (832(b) (5)] 832(c) (5) (certain capital losses) (4) The items referred to in- (A) section 809(c)(1) (relating to gross amount of pre~ miums and other considerations), (B) section 809(c)(2) (relating to net decrease in reserves), (C) section 809(d)(2) (relating to net increase on reserves), and (D) section 832(b)(4) (relating to premiums earned on insurance contracts), shall be taken into account only to the extent they are in respect of any reinsurance or the issuing of any insurance or annuity contract described in subsection (a)(1). (5) All items of income, expenses, losses, and deductions (other than those taken into account under paragraph (4)) shall be properly allocated or apportioned under regulations prescribed by the Secretary or his delegate. * * * * * * 81 397 PAGENO="0408" 86 FOREIGN INVESTORS TAX ACT OF 1965 Subchapter P-Capital Gains and Losses * * *~ * * * * PART IY-SPECIAL RULES FOR DETERMINING CAPITAL GAINS AND LOSSES * * * * * * * SEC. 1248. GAIN FROM CERTAIN SALES OR EXCHANGES OF STOCK IN CERTAIN FOREIGN CORPORATIONS. * * * * * * * (d) ExcLusIoNs FROM EARNINGS AND PR0FITS.-For purposes of this section, the following amounts shall be excluded, with respect to any United States person, from the earnings and profits of a foreign corporation: * * * * * * * (4) UNITED STATES INCOME.-Afly item inc~udible in gross income of the foreign corporation under this chapter- (A) for any taxable year beginning before January 1, 1966, as income derived from sources within the United States of a foreign corporation engaged in trade or business (in] within the United States, or (B) for any taxable year beginning after December 31, 1965, as income effectively connected with the conduct by such corpora- tion of a trade or business within the United States. This paragraph shall not apply with respect to any item which is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation of the United States. * * * * * * * SEC. 1249. GAIN FROM CERTAIN SALES OR EXCHANGES OF PATENTS ETC., TO FOREIGN CORPORATIONS. (a) GENERAL RULE.-(Except as provided in subsection (c), gain] Gain from the sale or exchange after December 31, 1962, of a patent, an invention, model, or design (whether or not patented), a copyright, a secret formula or process, or any other similar property right to any foreign corporation by any United States person (as defined in section 770 1(a)(30)) which controls such foreign corpora- tion shall, if such gain would (but for the provisions of this sub- section) be gain from the sale or exchange of a capital asset or of property described in section 1231, be considered as gain from the sale or exchange of property `which is neither a capital asset nor `property described in section 1231. (b) CONTROL.-FOr purposes of subsection (a), control means, with respect to any foreign corporation, the ownership, directly or indirectly, of stock possessing more than 50 percent of the total 82 398 PAGENO="0409" FOREIGN INVESTORS TAX ACT OF 1965 87 combined voting power of all classes of stock entitled to vote. For purposes of this subsection, the rules for determining ownership of stock prescribed by section 958 shall apply. SEC. 1250. GAIN FROM DISPOSITIONS OF CERTAIN DEPRECIABLE REALTY. * * * * * * (d) Exceptions and Limitations.- * * * * * * * (3) CERTAIN TAX-FREE TRANsACTIONS.-If the basis of property in the hands of a transferee is determined by reference to its basis in the hands of the transferor by reason of the application of section 332, 351, 361, 371(a), 374(a), 721, or 731, then the amount of gain taken into account by the transferor under subsection (a)(1) shall not exceed the amount of gain recognized to the trans- feror on the transfer of such property (determined without re- gard to this section). This paragraph shall not apply to- (A) a disposition to an organization (other than a coopera- tive described in section 521) which is exempt from [the] tax imposed by this chapter, or (B) a transfer of property by a nonresident alien individual, a foreign estate or trust, or a foreign partnership, to a domestic corporation in exchange for stock or securities in such corpora- tion in a transaction to which section 351 applies. * * * * * * * CHAPTER 3-WITHHOLDING OF TAX ON NON- RESIDENT ALIENS AND FOREIGN CORPORATIONS AND TAX-FREE COVENANT BONDS SUBCHAPTER A. Nonresident aliens and foreign corporations. SUBCHAPTER B. Tax-free covenant bonds. SUBCHAPTER C. Application of withholding provisions. Subchapter A-Nonresident Miens and Foreign Corporations Sec. 1441. Withholding of tax on nonresident aliens. Sec. 1442. Withholding of tax on foreign corporations. Sec. 1443. Foreign tax-exempt organizations. SEC. 1441. WITHHOLDING OF TAX ON NONRESIDENT ALIENS. (a) GENERAL RuLE.-Except as otherwise provided in subsection (c), all persons, in whatever capacity acting (including lessees or mortgagors of real or personal property, fiduciaries, employers, and all officers and employees of the United States) having the control, receipt, custody, disposal, or payment of any of the items of income specified in subsection~. (b) (to the extent that any of such items con- stitutes gross income from sources within the United States), of any nonresident alien individual, or of any partnership not engaged in 83 399 PAGENO="0410" 88 FOREIGN INVESTORS TAX ACT OF 1965 trade or business within the United States and composed in whole or in part of nonresident aliens, shall (except in the cases provided for in section 1451 and except as otherwise provided in regulations pre-. scribed by the Secretary or his delegate under section 874) deduct and withhold from such items a tax equal to 30 percent thereof, except that in the case of any item of income specified in the second sentence of subsection (b), the tax shall be equal to 14 percent of such item. (b) INcoME ITEMs.-The items of income referred to in subsection (a) are interest ((except interest on deposits with persons carrying on the banking business paid to persons not engaged in business in the United States)], dividends, rent, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income, (and amounts described in section 402(a) (2) , section 403(a)(2), section 631 (b) and (c), and section 1235, which are considered to be gains from the sale or exchange of capital assets.] and gains described in section 402(a) (2), 403(a) (2), or 631 (b) or (c), and gains on transfers described in section 1235. The items of income referred to in sub- section (a) from which tax shall be deducted and withheld at the rate of 14 percent are- (1) that portion of any scholarship or fellowship grant which is received by a nonresident alien individual who is temporarily present in the United States as a nonimmigrant under sub-. paragraph (F) or (J) of section 101(a).(15) of the Immigration and Nationality Act, as amended, and which is not excluded from gross income under section 117(a) (1), solely by reason of section 117(b) (2) (B); and (2) amounts described in subparagraphs (A), (B), (0), and (D) of section 1 17(a)(2) which are received by any such non-. resident alien individual and which are incident to a scholarship or fellowship grant to which section 117(a)(1) applies, but only to the extent such amounts are includible in gross income. (c) EXCEPTIONS.- ((1) DIVIDENDS OF FOREIGN C0RP0RATI0NS.-No deduction or withholding under subsection (a) shall be required in the case of dividends paid by a foreign corporation unless (A) such corpo- ration is engaged in trade or business within the United States, and (B) more than 85 percent of the gross income of such corporation for the 3-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under part I of subchapter N of chapter 1.] 84 400 PAGENO="0411" FOREIGN INVESTORS TAX ACT OF 1965 89 (1) INCOME CONNECTED WITH UNITED STATES BUSINESS.-NO ded'uction or `withholding vnder subsection (a) shall be required in the case of any item of income (other than compensation for personal services) which is effectively connected `with the conduct of a trade or business within the United States and on which a tax is imposed for the taxable year pursuant to section 871 (b)(1).' (2) OWNER tTNKNOWN.-The Secretary or his delegate may authorize the, tax under subsection (a) to be deducted and withheld from the interest upon any securities the owners of which are not known to the withholding agent. (3) BONDS WITH EXTENDED MATURITY DATES.-The deduction and withholding in the case of interest on bonds, mortgages, or deeds of trust or other similar obligations of a corporation, within subsections (a), (b), and (c) of section 1451 were it not for the fact that the maturity date of such obligations has been ex-. tended on or after January 1, 1934, and the liability assumed by the debtor exceeds 27% percent of the interest, shall not exceed the rate of 27% percent per annum. (4) COMPENSATION OF CERTAIN ALIEN5.-Under regulations prescribed by the Secretary or his delegate, (there] compensation for personal services may be exempted from deduction and with- holding under subsection (a) (the compensation for personal services of- ((A) nonresident alien individuals who enter and leave the United States at frequent intervals, and ((B) a nonresident alien individual for the period he is `temporarily present in the United States as a nonimmigrant under subparagraph (F) or (J) of seètion 101(a)(15) of the Immigration and Nationality Act, as amended]. (5) SPECIAL ITEMS.-In the case of (amounts described in section 402(a) (2), section 403(a) (2), section 631 (b) and (c), and section 1235, which are considered to be gains from the sale or exchange of capital assets,] gains described in section 402(a) (2) 403(a) (2), or 631 (b) or (c), and gains on transfers described in section 1235, the amount required to be deducted and withheld shall, if the amount of subh gain is not known to the withholding agent, be such amount, not exceeding 30 percent of the (proceeds from such sale or exchange] amount payable, as may be necessary to assure that the tax deducted and withheld shall not be less than 30 percent of such gain. 85 401 PAGENO="0412" 90 FOREIGN INVESTORS TAX ACT OF 1965 (6) PER DIEM OF CERTAIN ALIENS.-NO deduction or with. holding under subsection (a) shall be required in the case of amounts of per diem for subsistence paid by the United States Government (directly or by contract) to any nonresident alien individual who is engaged in any program of training in the United States under the Mutual Security Act of 1954, as amended. (d) ALIEN RESIDENT OF PUERTO RIC0.-For purposes of this sec-S lion, the term "nonresident alien individual" includes an alien resident of Puerto Rico. SEC. 1442. WITHHOLDING OF TAX ON FOREIGN CORPORATIONS. In the case of foreign corporations subject to taxation under this subtitle (not engaged in trade or business within the United States], there shall be deducted and withheld at the source in the same manner and on the same items of income as is provided in section 1441 or section 1451 a tax equal to 30 percent thereof; except that, in the case of interest described in section 1451 (relating to tax-free covenant bonds), the deduction and withholding shall be at the rate specified therein. For purposes of the preceding sentence, the reference ~n sectwn 1441(c) (1) to section 871(b) (1) 8hall be treated as referring to sectwn Subchapter C-Application of Withholding Provisions * * * * * * * SEC. 1461. [RETURN AND PAYMENT OF] LIABILITY FOR WITHHELD TAX. Every person required to deduct and withhold any tax under this chapter (shall, on or before March 15 of each year, make return thereof and pay the tax to the officer designated in section 6151. Every such person] is hereby made liable for such tax and is hereby indemnified against the claims and demands of any person for the amount of any payments made in accordance with the provisions of this chapter. * * * * * * * 86 402 PAGENO="0413" 91 FOREIGN INVESTORS TAX ACT OF 1965 Subtitle B-Estate and Gift Taxes * * * * * CHAPTER 11-ESTATE TAX * * * * Subchapter A-Estates of Citizens or Residents * * * * * PART I-TAX IMPOSED Sec. 2001. Rate of tax. Sec. 2002. Liability for payment. SEC. 2001. RATE OF TAX. A tax computed in accordance with the following table is hereby imposed on the tran~fer of the taxable estate, determined as provided in section 2051, of every decedent, citizen or resident of the United States dying after the date of enactment of this title: If the taxable estate is: The tax shall be: Not over $5,000 3% of the taxable estate. Over $5,000 but not over $10,000..__.~ - - $150, plus 7% of excess over $5,000. Over $10,000 but not over $20,000 $500, plus 11% of excess over $10,000. $1,600, plus 14% of excess over $20,000. $3,000, plus 18% of excess over $30,000. $4,800, plus 22% of excess over $40,000. $7,OpO, plus 25% of excess over $50,000. $9,500, plus 28% of excess over $60,000. $20,700, plus 30% of excess over $100,000. $65,700, plus 32% of excess over $250,000. $145,700, plus 35% of excess over $500,000. $233,200, plus 37% of excess over $750,000. $325,700, plus 39% of excess over $1,000,000. $423,200, plus 42% of excess over $1,250,000. * * * * * * Over $20,000 but not over $30,000 Over $30,000 but not over $40,000 Over $40,000 but not over $50,000 Over $50,000 but not over $60,000 Over $60,000 but not over $100,000 Over $100,000 but not over $250,000 Over $250,000 but not over $500,000 Over $500,000 but not over $750,000 Over $750,000 but not over $l,000,000_ Over $1,000,000 but not over $1,250,000___ Over $1,250,000 but not over $1,500,000_ 87 403 PAGENO="0414" 92 FOREIGN INVESTORS TAX ACT OF 1965 If the taxable estate is: The tax shall be: Over $1,500,000 but not over $2,000,000~_~ $528,200, plus 45% of excess over $1,500,000. Over $2,000,000 but not over $2,500,000__~ $753,200, plus 49% of excess over / $2,000,000. Over $2,500,000 but not over $3,000,000___ $998,200, plus 53% of excess over $2,500,000. Over $3,000,000 but not over $3,500,000___ $1,263,200, plus 56% of excess over $3,000,000. Over $3,500,000 but not over $4,000,000~__ $1,543,200, plus 59% of excess over $3,500,000. Over $4,000,000 but not over $5,000,000~__ $1,838,200, plus 63% of excess over $4,000,000. Over $5,000,000 but not over $6,000,000~__ $2,468,200, plus 67% of excess over $5,000,000. Over $6,000,000 but not over $7,000,000~__ $3,138,200, plus 70% of excess over $6,000,000. Over $7,000,000 but not over $8,000,000~__ $3,838,200, plus 73% of excess over $7,000,000. Over $8,000,000 but not over $10,000,000~_ $4,568,200, plus 76% of excess over $8,060,000. Over $10,000,000 $6,088,200, plus 77% of excess over $10,000,000. SEC. 2002. LIABILITY FOR PAYMENT. The tax imposed by this chapter shall be paid by the executor. PART Il-CREDITS AGAINST TAX * * * * * * SEC. 2014. CREDIT FOR FOREiGN DEATH TAXES. (a) IN GENERAL.-The tax imposed by section 2001 shall be credited with the amount of any estate, inheritance, legacy, or succession taxes actually paid to any foreign country in respect of any property situated within such foreign country and included in the gross estate (not including any such taxes paid with respect to the estate of a person other than the decedent). (If the decedent at the time of his death was not a citizen of the United States, credit shall not be allowed under this section unless the foreign country of which such decedent was a citizen or subject, in imposing such taxes, allows a similar credit in the case of a citizen of the United States resident in such country.] The determination of the country within which property is situated shall be made in accordance with the rules applicable under sub- chapter B (sec. 2101 and following) in determining whether property is situated within or without the United States. (b) LIMITATIONS ON CREDIT.-The credit provided in this section with respect to such taxes paid to any foreign country- (1) shall not, with respect to any such tax, exceed an amount which bears the same ratio to the amount of such tax actually paid to such foreign country as the value of property which is- 88 404 PAGENO="0415" FOREIGN INVESTORS TAX ACT OF 1965 93 (A) situated within such foreign country, (B) subjected to such tax, and (C) included in the gross estate bears to the value of all property subjected to such tax; and (2) shall not, with respect to all such taxes, exceed an amount which bears the same ratio to the tax imposed by section 2001 (after deducting from such tax the credits provided by sections 2011 and 2012) as the value of property which is- (A) situated within such foreign country, (B) subjected to the taxes of such foreign country, and (C) included in the gross estate bears to the value of the entire gross estate reduced by the aggre- gate amount of the deductions allowed under sections 2055 and 2056. (c) VALUATION OF PROPERTY.- (1) The values referred to in the ratio stated in subsection (b)(1) are the values determined for purposes of the tax imposed by such foreign country. (2) The values referred to in the ratio stated in subsection (b) (2) are the values determined under this chapter; but, in applying such ratio, the value of any property described in subparagraphs (A), (B), and (C) thereof shall be reduced by such amount as will properly reflect, in accordance with regulations prescribed by the Secretary or his delegate, the deductions allowed in respect of such pi~operty under sections 2055 and 2056 (relating to charitable and marital deductions). (d) PROOF OF CREDrr.-The credit provided in this section shall be allowed only if the taxpayer establishes to the satisfaction of the Secretary or his delegate- (1) the amount of taxes actually paid to the foreign country, (2) the amount and date of each payment thereof, (3) the description and value of the property in respect of which such taxes are imposed, and (4) all other information necessary for the verification and computation of the credit. (e) PERIOD OF LIMITATION.-.The credit provided in this section shall be allowed only for such taxes as were actually paid and credit therefor claimed within 4 y~ars after the filing of the return required l)y section 6018, except ~that- (1) If a petition for redetermination of a deficiency has been filed with the Tax Court withij~i the time prescribed in section 6213(a), then within such 4-year period or before the expiration of 60 days after the decision of the Tax Court becomes final. (2) If, under section 6161, an extension of time has been granted for payment of the tax shown on the return, or of a 89 405 PAGENO="0416" FOREIGN INVESTORS TAX ACT OF 1965 deficiency, then within such 4-year period or before the date of the expiration of the period of the extension. Refund based on such credit may (despite the provisions of sections 6511 and 6512) be made if claim therefor is ified within the period above provided. Any such refund shall be made without interest. (f) ADDITIONAL LIMITATION IN CASES INvoLVING A DEDUCTION UNDER SECTION 2053(d).-In any case where a deduction is allowed under s~'ction 2053(d) for an estate, succession, legacy, or inheritance tax imposed by and actually paid to any foreign country upon a transfer by the decedent for public, charitable or religious uses described in section 2055, the property described in subparagraphs (A), (B), and (C) of paragraphs (1) and (2) of subsection (b) of this section shall not include any property in respect of which such deduc- tion is allowed under section 2053(d). (g) POSSESSION OF UNITED STATES DEEMED A FOREIGN COUNTRY.- For purposes of the the credits authorized by this section, each posses- sion of the United States shall be deemed to be a foreign country. (h) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN RESIDENTS.- Whenever the President finds that- (1) a foreign country, `in imposing estate, inheritance, legacy, or succession taxes, does not allow to citizens of the United States resident in such foreign country at the time of death a credit similar to the credit allowed under subsection (a), (~) such foreign country, when requested by the United States to do so,has not acted to provide such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, and (3) it is in the public interest to allow the credit under subsection (a) in the case of citizens or subjects of such foreign country only if it allows such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, the President shall proclaim that, in the case of citizens or subjects of such foreign country dying while the proclamation `remains in effect, the credit v~nder subsection (a) shall be allowed only `if such foreign country allows such a similar credit in the case of citizens of the United States resident in such foreign country, at the time of death. * *. * * * * ..*. 90 406 PAGENO="0417" FOREIGN INVESTORS TAX ACT OF 1965 95 Subchapter B-Estates of Nonresidents Not Citizens Sec. 2101. Tax imposed. Sec. 2102. Credits against tax. Sec. 2103. Definition of gross estate. Sec. 2104. Property within the United States. Sec. 2105. Property without the United States. Sec. 2106. Taxable estate. Sec. 2107. Expatriation to avoid tax. Sec. p108. Application of pre-1986 estate tax provisions. SEC. 2101. TAX IMPOSED~. ((a) IN GENERAL.-A tax computed in accordance with the table contained in section 2001 is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States dying after the dt~te of enactment of this title.] (a) RATE OF TA1.-Except as provided in section 2107, a tax corn- p'uted in accordance with the following table is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States: If the taxable estate is: The tax shall be: Not over $100,000 5% of the taxable estate. Over $100,000 but not over $500,000 $5,000, plus 10% of excess over $100,000. Over $500,000 but not over $1,000,000 $45,000, plus 15% of excess over $500,000. Over $1,000,000 but not over $2,000,000~ - - - $120,000, plus 20% of excess over $1,000,000. Over $2,000,000 $320,000, plus 25% of excess over $2,000,000. (b) PROPERTY HELD BY ALIEN PROPERTY CUSTODIAN.- For taxes in connection with property or interests transferred to or vested in the Alien Property Custodian, see section 36 of the Trading with the Enemy Act, as added by the Act of August 8, 1946 (60 Stat. 929; 50 U.S.C. App. 36). SEC. 2102. CREDITS AGAINST TAX. (a) IN GENER~4z~.-The tax imposed by section 2101 shall be credited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), subject to the special limitation provided in sub- 8ect%on (b). (b) SPEcI~tz~ LmITATI0N.-The maximum credit allowed under sec- tion 2011 against the tax imposed by section 2101 for State death taxes paid shall be an amount which bears the same ratio to the credit computed as provided in section 2011(b) as the value of the property, as determined for purposes of this chapter, upon which State death taxes were paid and which is included in the gross estate under section 2103 bears to the value of the total gross estate under section 2103. For purposes of this sub- 91 71-297 0-67-pt. 1-27 407 PAGENO="0418" 96 FOREIGN INVESTORS TAX ACT OF 1965 section, the term "State death taxes" means the taxes described in section 2011 (a). SEC. 2103. DEFINITION OF GROSS ESTATE. For the purpose of the tax imposed by section 2101, the value of the gross estate of every decedent nonresident not a citizen of the United States shall be that part of his gross estate (determined as provided in section 2031) which at the time of his death is situated in the United States. SEC. 2104. PROPERTY WITHIN THE UNITED STATES. (a) STOCK IN CORPORATION.-FOr purposes of this subchapter shares of stock owned and held by a nonresident not a citizen of the United States shall be deemed property within the United States only if issued by a domestic corporation. (b) REVOCABLE TRANSFERS AND TRANSFERS IN CONTE1~PLATION OF DEATH.-FOr purposes of this subchapter, any property of which the decedent has made a transfer, by trust or otherwise, within the meaning of sections 2035 to. 2038, inclusive, shall be deemed to be situated in the United States, if so situated either at the time of the transfer or at the time of the decedent's death. (c) DEBT OBLIGATIoNs .-For purposes of this subchapter, debt obligations of- (1) a United States person, or (2) the United States, a State or any political subdivision thereof, or the District of Columbia, owned by a nonresident not a citizen of the United States shall be deemed property within the United States. SEC. 2105. PROPERTY WITHOUT THE UNITED STATES. (a) PROCEEDS OF LIFE IN5URANCE.-For purposes of this sub.. chapter, the amount receivable as insurance on the life of a nonresident not a citizen of the United States shall not be deemed property within the United States. ((b) BANK DEPosITs.-For purposes of this subchapter, any moneys deposited with any person carrying on the banking business, by or for a nonresident not a citizen of the United States who was not engaged in business in the United States at the time of his death shall not be deemed property within the United States.] (b) DEPosITS IN CERTAIN FOREIGN BRANCHES.-FOr purposes of this subchapter, deposits in a foreign branch of a domestic corporation, ~f s'uch branch is engaged in the commercial banking b'usiness and if such deposits are payable only in foreign currency, shall not be deemed property within the United States. (c) WORKS OF ART ON LOAN FOR ExIIIBITI0N.-For purposes of this subchapter, works of art owned by a nonresident not a citizen of the United States shall not be deemed property within the United States if such works of art are- 92 408 PAGENO="0419" FOREIGN INVESTORS TAX ACT OF 1965 97 (1) imported into the United States solely for exhibition purposes, (2) loaned for such purposes, to a public gallery or museum, no part of the net earnings of which inures to the benefit of any private stockholder or individual, and (3) at the time of the death of the owner, on exhibition, or en route to or from exhibition, in such a public gallery or museum. SEC. 2106. TAXABLE ESTATE. (a) DEFINITION OF TAXABLE ESTATE.-FOr purposes of the tax imposed by section 2101, the value of the taxable estate of every decedent nonresident not a citizen of the United States shall be de-. termined by deducting from the value of that part of his gross estate which at the time of his death is situated in the United States- (1) EXPENSES, LOSSES, INDEBTEDNESS, AND TAxE5.-That pro- portion of the deductions specified in sections 2053 and 2054 (other than the deductions described in the following sentence) which the value of such part bears to the value of his entire gross estate, wherever situated. Any deduction allowable under sec.. tion 2053 in the case of a claim against the estate which was founded on a promise or agreement but was not contracted for an adequate and full consideration in money or money's worth shall be allowable under this paragraph to the extent that it would be allowable as a deduction under paragraph (2) if such promise or agreement constituted a bequest. (2) TRANSFERS FOR PUBLIC, CHARITABLE, AND RELIGIOUS USES.- (A) IN GENERAL.-The amount of all bequests, legacies, devises, or transfers (including the interest which falls into any such bequest, legacy, devise, or transfer as a result of an irrevocable disclaimer of a bequest, legacy, devise, trans- fer, or power, if the disclaimer is made before the date pre- scribed for the filing of the estate tax return)- (i) to or for the use of the United States, any State, Territory, any political subdivision thereof, or the Dis- trict of Columbia, for exclusively public purposes; (ii) to or for the use of any domestic corporation organized and operated exclusively for religious, char- itable, scientific, literary, or educational purposes, including the encouragement of art and the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private stockholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation; or 93 409 PAGENO="0420" 98 FOREIGN INVESTORS TAX ACT OF 1965 (iii) to a trustee or trustees, or a fraternal society, order, or association operating under the lodge system, but only if such contributions or gifts are to be used within the United States by such trustee or trustees, or by such fraternal society, order, or association, ex- clusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animal~, and no substantial part of the ac- * tivities of such trustee or trustees, or of such fraternal society, order, or association, is carrying on propaganda, or otherwise attempting, to influence legislation. (B) POWERS OF APPOINTMEN~T.-Property includible in the decedent's gross estate under section 2041 (relating to powers of appointment) received by a donee described in this paragraph shall, for purposes of this paragraph, be considered a bequest of such decedent. (0) DEATH TAXES PAYABLE OUT OF BEQUESTS.-If the tax imposed by section 2101, or any estate, succession, legacy, or inheritance taxes, are, either by the terms of the will, by the law of the jurisdiction under which the estate is administered, or by the law of the jurisdiction imposing the particular tax, payable in whole or in part out of the bequests, legacies, or devises otherwise deductible under this paragraph, then the amount deductible under this paragraph shall be the amount of. such bequests, legacies, or devises reduced by the amount of such taxes. (D) LIMITATIoN ON DEDUCTION.-The amount of the deduction under this paragraph for any transfer shall not exceed the value of the transferred property required to be inqiuded in the gross estate. (F) DISALLOWANCE OF DEDUCTIONS IN CERTAIN CASES.- For disallowance of certain charitable, etc., deductions otherwise allowable under this. paragraph [section], see sections 503 and 681. (F) OTHER CROSS REFERENCES.- (1) For option as to time for valuation for purpose of deduction under this paragraph [section], see section 2032. (2) For exemption of bequests to or for benefit of Library of Congress, see section 5 of the Act of March 3, 1925, as amended (56 Stat. 765; 2 U.S.C. 161). (3) For construction of bequests for benefit of the library of the Post Office Department as bequests to or for the use of the United States, see section 2 of the Act of August 8. 1946 (60 Stat. 924; 5 U.S.C. 393). (4) For exemption of bequests for benefit of Office of Naval Records and Library, Navy Department, see section 2 of the Act of March 4, 1937 (50 Stat. 25; 5 U.S.C. 419b~. 94 410 PAGENO="0421" FOREIGN INVESTORS TAX ACT OF 1965 99 (5) For exemption of bequests to or for benefit of National Park Service, see section 5 of the Act of July 10, 1935 (49 Stat. 478; 16 U.S.C. 19c). (6) For construction of devises or bequests accepted by the Secretary of State under the Foreign Service Act of 1946 as devises or bequests to or for the use of the United States, see section 1021 Ce) of that Act (60 Stat. 1032; 22 U.S.C. 809). * (7) For construction `of gifts or bequests of money accepted by the Attorney General for credit to "Commissary Funds, Federal Prisons" as gifts or bequests to or for the use of the United States, see section 2 of the Act of May 15, 1952, 66 Stat. 73, as amended by the Act of July 9, 1952, 66 Stat. 479 (31 U.S.C. 725s-4). (8) For payment of tax on bequests of United States obligations to the United States, see section 24 of the Second Liberty Bond Act, as amended (59 Stat. 48, .~ 4; 31 U.S.C. 757e). (9) For construction of bequests for benefit of or use in con.. nection with the Naval Academy as bequests to or for the use of the United States, see section 3 of the Act of March 31, 1944 (58 Stat. 135; 34 U.S.C. 1115b). (10) For exemption of bequests for benefit of Naval Academy Museum, see section 4 of the Act of March 26, 1938 (52 Stat. 119; 34 U.S.C. 1119). 5 5 5 (11) For exemption of bequests received by National Archives Trust Fund Board, see section 7 of the National Archives Trust Fund Board Act (55 Stat. 582; 44 U.S.C. 300gg). (3) EXEMPTION.- (A) GENERAL RULE.-An exemption of ($2,000] $30,000. * (B) RESIDENTS OF POSSESSIONS OF THE UNITED STATES.- In the case of a decedent who is considered to be a "non.. resident not a citizen of the United States" under the pro-. visions of section 2209, the exemption shall be the greater of (i) [$2,000] $30,000, or (ii) that proportion of the exemp-~ tion authorized by section 2052 which the value of that part of the decedent's gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated. S (b) CONDITION OF ALLOWANCE OF DEDUCTIONS.-NO deduction shall be allowed under paragraphs (1) and (2) of subsection (a) in the case of a nonresident not a citizen of the United States unless the executor includes in the return required to be ified under section 6018 the value at the time of his' death of that part of the gross estate of such nonresident not situated in the United States. (c) UNITED STATES B0NDS.-For purposes of section 2103, the value of the gross estate (determined as provided in section 2031) of a decedent who was not engaged in business in the United States at the time of his death- S * (1) shall not include obligations issued by the United States before March 1, 1941; and (2) shall include obligations issued by the United States on or after March 1, 1941. * 95 411 PAGENO="0422" 100 FOREIGN LNVESTORS TAX ACT OF 1965 SEC. 2107. EXPATRIATION TO A VOID TAX. (a) RATE OF TAI.-A tax computed in accordance with the table con- tained in section 2001 is hereby imposed on the transfer of the taxable estate, determiiied as provided in section 2106, of every decedent non- resident not a citizen of the United States dying after the date of enactment of this section, `if after March 8, 1965, and within the 10-year period ending with the date of death such decedent lost United States citizenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. (b) GRoss ESTATE.-FOr purposes of the tax imposed by subsection (a),. the value of the gross estate of every decedent to whom subsection (a~ applies shall be determined as `orovided in section 2103, except that- (1) if such decedent owned (within the meaning of section 958(a)) at the time of his death 10 percent or more of the total combined voting power of all classes of stock entitled to vote of a foreign corporation, and (2) if éuch decedent owned (within the meaning of section 958(a)), or is considered to have owned (by applying the ownership rules of section 958(b)), at the time of his death, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of such foreign corporation, then that proportion of the fair market value of the stock of such foreign corporation owned (within the meaning of section 958(a)) by such decedent at the time of his death, which the fair market value of any assets owned by such foreign corporation and situated in the United States, at the time of his death, bears to the total fair market value of all assets owned by such foreign corporation at the time of his death, shall be included in the gross estate of such decedent. For purposes of the preceding sentence, a decedent shall be treated as owning stock of a foreign corporation at the time of his death if, at the time of a transfer, by trust or otherwise, within the meaning of sections 2035 to 2038, inclusive, he owned such stock. (c) CREDITS.- The tax imposed by subsection (a) shall be credited with the amounts determined in accordance with sections 2011 to 2013, in- clusive (relating to State death taxes, gift tax, and tax on prior transfers), as modified by section 2102(b). (d) EXCEPTION. FOR LOSS OF CITIZENSHIP FOR CRRTAIN CA USES.- Subsection (a) shall not apply to the transfer of the estate of a decedent whose loss of United States citizenship resulted from the application of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). (e) BURDEN OF PR00F.-Jf the Secretary or his delegate establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction in the estate, inheritance, legacy, and succession taxes in respect of the transfer of his estate, the burden of proving that such liss of citizenship did not have for one of its principal purposes the avoidance of taxes under 96 412 PAGENO="0423" FOREIGN INVESTORs TAX ACT OF 1965 101 this subtitle or subtitle A shall be on the executor of such individual's estate. SEC. 2108. APPLICATION OF PRE-1966 ESTATE TAX PROVISIONS. (a) IMPosITIoN OF MORE BURDENSOME TAX BY FoREIGN COUNTRY.- Whenever the President finde that- (1) under the laws of any foreign country, considering the tax system of such foreign country, a more burdensome tax is imposed by such foreign country on the transfer of estates of decedents who were citizens of the United Slates and not residents of such foreign country than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, (2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such tax so that it is no more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, and (3) it is in the public interest to apply pre-1966 tax provisions in accordance v~ith this section to the transfer of estates of decedertts who were residents of such foreign country, the President shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to amendments made to sections 2101 (relating to tax imposed), 2102 (re- lating to credits against tax), and 6018 (relating to estate tax returns) on or after the date of enactment of this section. (b) ALLEVIATION OF MORE BURDENSOME TAX.-Whenever the Presi- dent finde that the laws of any foreign country with respect to which the President has made -a proclamation under subsection (a) have been modified so that the tax on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country is no longer more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, he shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such procla- mation, be determined under this subchapter without regard to sub- section (a). (c) NOTIFICATION OF CONGRE~S .REQUIRED.-No proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. (d) IMPLEMENTATION BY REGULATIONS.-The Secretary or his dele- gate shall prescribe such regulations as may be necessary or appropriate to implement this section. * `* * * * * * .97 413 PAGENO="0424" 102 FOREIGN INVESTORS TAX ACT OF 1965 CHAPTER 12-GIFT TAX Subchapter A. Determination of tax liability. Subchapter B. Transfers.. Subchapter C. Deductions. Subchapter A-Determination of Tax Liability Sec. 2501. Imposition of tax. Sec. 2502. Rate of tax. Sec. 2503. Taxable gifts. Sec. 2504. Taxable gifts for preceding years. SEC. 2501. IMPOSITION OF TAX. (a) TAXABLE TRANSFERS.- (1) GENERAL RuLE.-For the calendar year 1955 and each calendar year thereafter a tax, computed as provided in section * 2502, is hereby imposed on the transfer of property by gift during such calendar year by any individual, resident or nonresident ~except transfers]. (2) TRANFERS OF INTANGIBLE PROPERTY.-Except as provided in varagravh (3), paragraph (1) shall not apply to the transfer of intangible property by a nonresident not a citizen of the United States (who was ~iot engaged in business in the United States during such calendar year]. (3) EXCEPTI0NS.-Paragraph (2) shall not apply in the case of a donor who at any time after March 8, 1965, and within the 10-year period ending with the date of transfer lost United States citizenship unless- (A) such donor's loss of United States citizenship resulted from the application of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487), or (B) such loss did `not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. (4) BURDEN OF PRooF.-If the Secretary or his delegate estab- lishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for paragraph (3), result in a substantial reduction for the calendar year in the taxes on the transfer of property by gift, the burden of proving that such loss of citizenship did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A shall be on such individual. (b) CERTAIN RESIDENTS OF POSSESSIONS CONSIDERED CITIZENS OF THE UNITED STATES.-A donor who is a citizen of the United States and a resident of a possession thereof shall, for purposes of the tax imposed by this chapter, be considered a "citizen" of the United States within the meaning of that term wherever used in this title unless he acquired his United Sta~.tes.. citizenship solely by reason of 98 414 PAGENO="0425" FOREIGN INVESTORS TAX ACT OF 1965 103 (1) his being a citizen of such possession of the United States, or (2) his birth or residence within such possession of the United States. (c) CERTAIN RESIDENTS OF POSSESSIONS CONSIDERED NONRESI~ DENTS NOT CITIZENS OF THE UNITED STATES.-A donor who is a citizen of the United States and a resident of a possession thereof shall, for purposes of the tax imposed by this chapter, be considered a "nonresident not a citizen of the United States" within the meaning of that term wherever used in this title, but only if such donor acquired * his United States citizenship solely by reason of (1) his being a citizen of such possession of the United States, or (2) his birth or residence within such possession of the United States. (d) CROSS REFERENCES.- (1) For increase in basis of property acquired by gift for gift tax paid, see section 1015(d). (2) For exclusion of transfers of property outside the United States by a nonresident who is not a citizen of the United States, ~see section 2511(a). * * * * * * * Subchapter B--Transfers * * * * * * * SEC. 2511. TRANSFERS IN GENERAL. (a) Sc0PE.-Subject to the limitations contained in this chapter,. the tax imposed by section 2501 shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible; but in the case of a nonresident not a citizen of the United States, shall apply to a~ transfer only if the property is situated within the United States. ((b) STOCK IN CoRP0RATION.-Shares of stock owned and held by a nonresident not a citizen of the United States shall be deemed property within the United States only if issued by a domestic cor- poration.] (b) INTANGIBLE PROPERTY.-For purposes of this chapter, in the case of a nonresident not a citizen of the United States who is excepted from the application of section ~5O1 (a)(2)- (1) shares of stock issued by a domestic corporation, and (~) debt obligations of- * (A) a United States person, or (B) the United States, a State or any political subdivision thereof, or the District of Oolumbia, which are owned by such nonresident shall be deemed to be property situated `within the United States. * *. * * * * * 99 415 PAGENO="0426" 104 FOREIGN INVESTORS TAX ACT OF 1965 CHAPTER 24-COLLECTION OF INCOME TAX AT SOURCE ON WAGES Sec. 3401. Definitions. Sec. 3402. Income tax collected at source. Sec. 3403. Liability for tax. Sec. 3404. Return and payment by governmental employer. SEC. 3401. DEFINITIONS. (a) WAGES.-FOr purposes of this chapter, the term "wages" means all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value of all remuneration paid in any medium other than cash; except that such term shall not include remuneration paid- (1) for active service as a member of the Armed Forces of the United States performed in a month for which such member is entitled to the benefits of section 112; or (2) for agricultural labor (as defined in section 3121(g)); or (3) for domestic service in a private home, local college club, or local chapter of a college fraternity or sorority; or (4) for service not in the course of the employer's trade or business performed in any calendar quarter by an employee, unless the cash remuneration paid for such service is $50 or more and such service was performed by an individual who is regularly employed by such employer to perform such service. For purposes oT this paragraph, an individual shall be deemed to be regularly employed by an employer during a calendar quarter only if- (A) on each of some 24 days during such quarter such individual performs for such employer for some portion of the day service not in the course of the employer's trade or business; or (B) such individual was regularly employed (as deter- mined under subparagraph (A)) by such employer in the performance of such service during the preceding calendar quarter; or (5) for services by a citizen or resident of the United States for~ a foreign government or an international organization; or ((6) for services performed by a nonresident alien individual, other than- ((A) a resident of a contiguous country who enters and leaves the United States at frequent intervals; or ((B) a resident of Puerto Rico if such services are per- formed as an employee of the United States or any agency thereof; or 100 416 PAGENO="0427" FOREIGN INVESTORS TAX ACT OF 1965 105 ((C) an individual who is temporarily present in the United States as a nonimmigrant under subparagraph (F) or (J) of section 1O1(a)(15) of the Immigration and Nation- ality Act, as amended, if such remuneration is exempt, under section 1441(c) (4) (B), from deduction and with- holding under section 144 1(a), and is not exempt from taxation under section 872(b) (3); or] ((7)] (6) for such services, performed by a nonresident alien :individual (who is a resident of a contiguous country and who -enters and leaves the United States at frequent intervals], as may be designated by regulations prescribed by the Secretary or his delegate; or (8)(A) for services for an employer (other than the United States or any agency thereof)- (i) performed by a citizen of the United States if, at the time of the payment of such remuneration, it is reasonable to believe that such remuneration will be excluded from gross income under section 911; or (ii) performed in a foreign country or in a possession of the United States by such a citizen if, at the time of the payment of such remuneration, the employer is required by the law of any foreign country or possession of the United States to withhold income tax upon such remuneration; or (B) for services for an employer (other than the United States or any agency thereof) performed by a citizen of the United States within a possession of the United States (other than Puerto Rico), if it is reasonable to believe that at least 80 percent of the remuneration to be paid to the employee by such employer during the calendar year will be for such services; or (C) for services for an employer (other than the United States or any agency thereof) performed by a citizen of the United States within Puerto Rico, if it is reasonable to believe that during the entire calendar year the employee will be a bona fide resident of Puerto Rico; or * * * * * * * 101* 417 PAGENO="0428" 106 FOREIGN INVESTO~ TAX ACT OF 1965 Subtitle F-Procedurt and Administration * * * * * * * CHAPTER 61-INFORMATION AND RETURNS * * * * * * * Subchapter A-Returns and Records * * * * * * * PART Il-TAX RETURNS OR STATEMENTS * * * * * * * Subpart B-Income Tax Returns * * * * * * SEC. 6015. DECLARATION OF ESTIMATED INCOME TAX BY iNDI- VIDUALS. (a) REQUIREMENT OF DEcLARATI0N.-(Every] Except as other.~ wise provided in subsection (i), every individual ((other than a non- resident alien with respect to whose wages, as defined in section 3401(a), withholding' under chapter 24 is not made applicable, but including every alien individual who is a resident of Puerto Ric& during the entire taxable year)] shall make a declaration of his estimated tax for the taxable year if- (1) the gross income for the taxable year can reasonably be~ expected to exceed- (A) $5,000, in the case of- (i) a single individual other than a head of a house-P hold (as defined in section 1 (b)(2)) or a surviving spouse (as defined in section 2(b)); (ii) a married individual not entitled under subsection (b) to file a joint declaration with his spouse; or (iii) a married individual entitled under subsection (b) to ifie a joint declaration with his spouse, but only if the aggregate gross income of such individual and his `spouse for the taxable year can reasonably be ex- pected to exceed $10,000; or (B) $10,000, in the case of- (i) a head of a household (as defined in section 1(b)(2)); or (ii) a surviving spouse (as defined in section 2(b)); or (2) the gross income can reasonably be expected to include' more than $200 from. sources other than~.. wages (aC defined in section 3401 (a)). Notwithstanding the provisions of this subsection, no declaration is required if the estimated tax (as defined in subsection (c)) can reason- ably be expected to be less than $40.. 102 418 PAGENO="0429" FOREIGN INVESTORS TAX ACT OF 1965 107 (b) JOINT DECLARATION BY HUSBAND AND WIFE.-In the case of a husband and wife, a single declaration under this section may be made by them jointly, in which case the liability with respect to the estimated tax shall be joint and several. No joint declaration may be made if either the husband or the wife is a nonresident alien, if they are sepa- rated under a decree of divorce or of separate maintenance, or if they have different taxable years. If a joint declaration is made but a joint return is not made for the taxable year, the estimated tax for such year may be treated as the estimated tax of either the husband or the wife, or may be divided between them. (c) ESTIMATED TAX.-FOr purposes of this title, in the case of an individual, the term "estimated tax" means the amount which the individual estimates as the amount of the income tax imposed by chapter 1 for the taxable year, minus the amount which the individual estimates as the sum of any credits against tax provided by part IV of subchapter A of chapter 1. (d) CONTENTS OF DECLARATION.-The declaration shall contain such pertinent information as the Secretary or his delegate may by forms or regulations prescribe. (e) AMENDMENT OF DECLARATION.-An individual may make amendments of a declaration filed during the taxable year under regulations prescribed by the Secretary or his delegate. (f) RETURN AS DECLARATION OR AMENDMENT.-If on or before January 31 (or February 15, in the case of an individual referred to in section 6073(b), relating to income from farming or fishing) of the succeeding taxable year the taxpayer files a return, for the taxable year for which the declaration is required, and pays in full the amount. computed on the return as payable, then, under regulations prescribed by the Secretary Or his delegate- (1) if the declaration is not required to be ified during the taxable year, but is required to be filed on or before January 15~ such. return shall be considered as such declaration; and (2) if the tax shown on the return (reduced by the sum of the credits against tax provided by part IV of subchapter A of chapter 1) is greater than the estimated tax shown in a declaration previously made, or in the last amendment thereof, such return shall be considered as the amendment of the declaration per- mitted by subsection (e) to be filed on or before January 15. In the application of this subsection in the case of a taxable year beginning on any date other than January 1, there shall be substituted, for the 15th or last day of the months specified in this subsection, the 15th or last day of the months which correspond thereto. (g) SHORT TAXABLE YEARS.-An individual with a taxable year of less than 12 months shall make a declaration in accorda~nce with regulations prescribed by the Secretary or his delegate. 103 419 PAGENO="0430" 108 FOREIGN INVESTORS TAX ACT OF 1965 (h) ESTATES AND TRUSTS.-The provisions of this section shall not apply to an estate or trust. (i) NONRESIDENT ALIEN INDIVIDUALS.-NO. declaration shall be required to be made under this section by a nonresident alien individual unless- (1) withholding under chapter 24 is made applicable to the wages, as defined in section 34~1 (a), of such individual, (2) such individual has income which `is effectively connected `with the conduct of a trade or buciness within the United States, or (3) such individual is a resident of Puert~o Rico during the entire taxable year. ((i)] (5) APPLICABILITY.-ThiS section shall be applicable only with respect to taxable years beginning after December 31, 1954; and sections 58, 59, and 60 of the Internal Revenue Code of 1939 shall continue in force with respect to taxable years beginning before January 1, 1955. * * * * * * * SEC. 6018. ESTATE TAX RETURNS. (a) RETURNS BY EXECUTOR.- (1) CITIZENS OR RESIDENTS.-In all cases where the gross estate at the death of a citizen or resident exceeds $60,000, the executor shall make a return with respect to the estate tax im- posed by subtitle B. (2) NONRESIDENTS NOT CITIZENS OF TUE UNITED STATES.-Ifl the case of the estate of every nonresident not a citizen of the United States if that part of the gross. estate which is situated in the United States exceeds f$2,000] $30,000, the executor shall make a return with respect to the estate tax imposed by sub- title B. (b) RETURNS BY BENEFICIARIES.-If the executor is unable to make a complete return as to any part of the gross estate of the decedent, he shall include in his return a description of such part and the name of every person holding a legal or beneficial interest therein. Upon notice from the Secretary or his delegate such person shall in like manner make a return as to such part of the gross estate. * * * * * * * 104 420 PAGENO="0431" FOREIGN INVESTORS TAX ACT OF 1965 109 CHAPTER 79-DEFINITIONS * * * * * * * SEC. 7701. DEFINITIONS. (a) When used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof- * * * * * * * (31) FOREIGN ESTATE OR TRTJsT.-The terms "foreign estate" and "foreign trust" mean an estate or trust, as the case may be, the income of (which from] which, from sources without the (United States is] United States which is not etlectively connected with the conduct of a trade or business within the United States, is not includible in gross income under subtitle A. * * * * * * * 105 421 PAGENO="0432" 422 PAGENO="0433" WRITTEN STATEMENTS ON H.R. 11297, FOREIGN INVESTORS TAX ACT OF 1965 ALUMINUM Co. OF A~nuucA, Pittsburgh, Pa., February 14, 1966. Hon. WILBUR Th MiLr4s, Chairman, Howse Ways and Mea~ Camm.ittee, House Office Building, Washington, D.C. Th~&i~ CHAIRMAN MILLS: It is my understanding that your com- mittee intends to consider in executive session on Wednesday, Feb- ruary 16, 1966, H.R. 11297 entitled "Foreign Investors Tax Act of 1965." We are most alarmed by what seems to be a fundamental change in U.S. concepts applicable to taxation of foreign corporations and foreign-earned income. Under current law, a foreign corporation is subject to U.S. tax only. where the corporation derives income from sources within the. United States. The derivation of such income has heretofore been determined under the generally precise source rules in sections 861 through 863 of the Internal Revenue Code. As now written, H.R. 11297 would radically depart from these established jurisdictional concepts and subject foreign corporations to U.S. tax on income which is "effectively connected" with the conduct of a trade or business within the United States. The question of when a foreign corporation "is engaged in business within the United States" is itself not easily answered. The subject bill would inject greater vagueness and uncertainty into this area of international business planning by adopting, as a jurisdictional prin- ciple of taxation, an~ entirely new, undefined and untested concept of "effective connection." We are deeply concerned that such a radical change in the inter- national aspects of our tax system is being considered. Accordingly, we strongly urge that this proposed language be deleted from H.R. 11297 or alternatively that further study be made of the feasibility and practicality of such a test, including the ~cheduling of public hearings. Please let me know if I can be of any assistance to you in this matter. Sincerely, E. A. VAUGHN, Vice President and ControlZer. 111 423 7 1-297 O-67-pt. 1-28 PAGENO="0434" 112 FOREIGN INVESTORS TAX ACT OF 1965 THE AMERICAN BANKERS ASSOCIATION, New Yoi~1c, N.Y., February 15,1966. Hon. W1u3uR D. MILLS,' Chairman, Howse Ways and Means Con~mittee, L~ngworth How9e Office Building, Washington, D.C. Th~1AI Mn. Mru~s: The American Bankers Association, on behalf of its member banks, is seriously concerned with certain provisions con- tained in H.R. 11297, a bill to amend the lnternal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States, which is pending before your committee. Section 2 of the bill would amend the Internal Revenue Code of 1954 and make interest on bank deposits received by a nonresident alien individual or a foreign corporation, if such interest is not effectively connected with the conduct of a trade or business within the United States, subject to U.S. income taxes for amounts paid or credited after December 31, 1970. Section 8(d) of the bill also amends the Internal Revenue Code of 1954 to treat bank deposits of nonresident aliens who are not engaged in business in the United States as property within the United States and thereby subject to U.S. estate taxes. In our opinion, these changes in the present law which makes inter- est on U.S. bank deposits foreign source income when paid to persons not engaged in business in the United States, and which treats bank deposits of nonresident aliens not engaged in business in the United States as property without the United States for purposes of comput- ing the estate taxes of such aliens, would adversely affect the ability of U.S. commercial banks to support international trade and would cause deterioration in the U.S. balance of payments and in our gold stock. The overall purposes of H.R. 11297, as stated by the Committee on Ways and Means in its summary of the principal provisions of the bill, are "to modernize the present U.S. tax treatment of foreigners and to encourage foreign investment in the United States-thereby beneficially affecting the U.S. balance of payments-by removing tax barriers to such investment." These objectives are highly comménda- ble. However, the provisions of the bill referred to above, as relates to commercial banking, would be self-defeating; since, in our view, they would cause an outflow of funds from the United States. Deposits of private foreigners, which run into several billions of dollars, have given American banks resources for lending in support of international trade and development. Since bank liabilities to foreigners are greater than bank claims upon foreigners, it is clear that such deposits have further provided a means of financing the U.S. balance-of-payments deficit. Data of the Department of Commerce show increases in short-term dollar holdings of private foreigners (mostly deposits) since 1958 have helped finance the U.S. balance of payments on an average of $800 million a year. Repayment of these obligations would involve shifts into official dollar holdings that would be eligible for conversion into gold. A moyeme~nt of tl~is gold out of the United States would impose unwante~l presäures ii'iternatiOnally on our country. The importance of retaining foreign bank deposits in this country from the standpoint of our balance of payments was considered an important factor by the Banking and Currency Committee in its report on H.R. 5306, 89th Congress, 1st session (Rept. 336), a bill to continue 424 PAGENO="0435" FOREIGN INVESTORS TAX ACT OF 1965 113 the authority of domestic banks to pay interest on time deposits of foreign governments at rates differing from those applicable to domes- tic depositors. The committee, in recommending passage of }I.R. 5306, stated that "the object of the bill is to extend existing provisions of law designed to encourage foreign governments and monetary author- ities to maintain dollar accounts in this country rather than convert these dollar accounts directly into gold or to transfer the funds to other financial centers, whereupon they could be acquired by official institutions of other countries and be converted into gold." Bringing our international payments into balance is difficult, par- ticularly in light of the present magnitude of U.S. Government com- mitments in support of world peace and development. As an emer- gency expedient, American businessmen and bankers have been en- listed in a voluntary program of restraints on U.S. capital outflow to eliminate the deficits. This effort should not be undermined by intro- ducing penalties on foreign deposits with American banks. We should recall that the purpose of tax legislation in this area at this time is to create a more attractive climate for foreign investments in the United States. Even the threat of the contemplated action is harmful, affect- ing foreigners' decisions to open or maintain accounts with American banks. Beyond balance-of-payments considerations, sharp reductions in dollar deposits from abroad would frustrate U.S. monetary policy. Deposits from foreigners exceed loans to foreigners. A significant ~ortion of this margin is used for loans and investments in the United states. Thus, if deposits from foreigners are sharply curtailed, the domestic credit market would be placed under pressure. Although monetary authorities could, over time, alleviate this situation by add- ing to domestic bank reserves, sharp losses of foreign deposits would at best be disruptive to the domestic financial system. Sharp deposit losses would have a comparable impact on the international financial system. It is recognized that the bill provides that the amendments made by it are not to apply where application would be contrary to any treaty obligation of the United States and that there is a 5-year period before the income tax would be effective on bank deposits. Never- theless, legislation of this character is apt to have an unwholesome immediate effect on investor psychology and we can look to a prompt outflow of funds seeking investment outlets in other countries. In conclusion, the foregoing mentioned amendments of the 1954 code, as proposed by H.R. 11297- Would impair the ability of American banks to hold and to attract foreign demand and time balances. Would have an adverse impact on the U.S. balance of payments and gold stock. Would inject an unsettling element in domestic and world fin- ancial markets as deposits from foreigners were reduced. Would discriminate against American businessmen and banks in their effort to obtain a fair share of international markets. Would cast further doubt on the future value of the U.S. dollar. We strongly urge that these provisions of H.R. 11297, as relates to commercial banks, be deleted, in the interests of the United States and international economies. Very truly yours, ARCHIE K. DAvIs, President. 425 PAGENO="0436" 114 FOREIGN INVESTORS TAX. ACT OF 1965 AMERICAN CYANAMID Co., Februarji 15,1966. Hon. WIUrnE D. Miii.s, Chairman, Committee on Ways and Means, House Office Building: With reference to H.R. 11297 which you introduced to remove tax barriers to foreign investment in the United States, we are concerned that its provisions may adversely affect foreign subsidiaries of U.S. corporations. Certain new and indefinite provisions have been incor- porated in H.R. 11297 which were not present in its predecessor bill, H.R. 5916. In order to clarify the effect of this bill, particularly as it may apply tax to U.S. corporate interests, we urge that hearings be held on H.R. 11297 and request your support in this connection. R. C. PLUMB. AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, Los Angeles, Calif., Janwiry 12,1966. lion. WILBUR P. Mni~s, Chairman, Ways and Mea~ Committee, Longworth House Office Building, Washington, D.C. DEAR MR. Mu4ts: On September 28 you introduced H.R. 11297 to replace H.R. 5916 regarding foreign investment in the United States. The institute's committee on Federal `taxation has reviewed H.R. 11297 and submits for your committee's consideration the enclosed comments and recommendations on the bill. Our comments on H.R. 5916 were submitted to you on June 24, 1965. There are a number of major differences between H.R. 11297 and H.R. 5916. As discussed in detail in our statement, we believe that four of these changes would tend to work against the bill's primary purpose that is, the removal of tax barriers to foreign investment in the United States. Moreover, these changes constitute such a major revision of the U.S. tax laws that we believe additional public hear- ings should be scheduled before your committee acts on H.R. 11297. Under separate cover we are sending 40 additional copies of our comments to Mr. Leo H. Irwin, chief counsel. Sincerely, DONALD T. BURNS, General Chairman, Committee on Federal Taxation. COMMENTS AND RECOMMENDATIONS OF COMMIT2EE ON FEDERAL TAXATION GENERAL COMMENTS H.R. 11297 is a modified version of an earlier bill, H.R. 5916. This committee finds that four modifications would tend to work against the bill's primary purpose, the removal of tax barriers to foreign invest- ment in the United States. Further, these modifications constitute such a major revision of U.S. tax laws that additional public hearings would seem to be appropriate. The study which this committee has been able to devote to these changes suggests that they may have unin- 426 PAGENO="0437" FOREIGN INVESTORS TAX ACT OF 1965 115 tended and serious tax effects. The changes may also bring other ad- verse economic effects, particularly on the U.S. balance of payments. The questionable changes which are proposed in H.R. 11297 are as follows: (1) The introduction of an entirely new concept, that non- resident aliens and foreign corporations engaged in trade or busi- ness in the United States would be taxed on worldwide income "effectively connected" therewith. Current law taxes such per- sons on their U.S. source income only. (2) After 1970, interest on U.S. bank deposits would be sub- ject to U.S. tax although paid to persons not engaged in business here. (3) U.S. bank deposits would be included in the gross estate of nonresident alien decedents even though not engaged in business in the United States. (4) The bill imposes higher estate tax rates on nonresident alien decedents than those proposed in H.R. 5916. The committee is aware of the need to evaluate other than balance- of-payments considerations in the preparation of such legislation, but the specific factors which led to the adoption of these changes have not been made clear. That the need for the changes is not immediately obvious is demonstrated by the fact that they were not proposed until very, recently, although the kind of changes desirable with regard to U.S. taxation of foreign persons has been under continuous study since the formation of the Fowler task force in October 1963. The changes cited above are discussed in some detail in items 1, 6, 9, and 10 of the attached "specific comments and recOmmendations." It is believed that the discussion makes clear the need for public hearings before the Committee on Ways and Means decides to recommend these major tax changes to the House of Representatives. SPECIFIC COMMENTS AND RECOMMENDATIONS Bill section 2: Proposed code section 861 (a) (1) (A) and (D); 861 (c) (1) Interest on U.S. bank deposits (p.4, lines 9-14; p.5, lines 1-18; p. 6, lines 3-6) .-The effect of the proposed amendments would be to subject interest on U.S. bank deposits and similar amounts to with- holding of tax at source with respect to payments after December 31, 1970. There are two obvious reasons for questioning the proposed change: (1) This exemption, which has been in force since 1921, has been considered desirable to encourage the use of U.S. banks by foreign persons for deposits and financial transactions. (2) The nexus for such taxation of income from U.S. bank deposits is so slender as to raise doubts as to the rationale for the change. While the effect of this change would be delayed for several years, it is not considered desirable because it creates another complication regarding investment in the United States. Such complications are believed to act as a current psychological deterrent to U.S. investment by nonresident aliens, even though the financial deterrent of U.S. with- holding tax will not occur until 1971. 427 PAGENO="0438" 116 FOREIGN INVESTORS TAX ACT OF 1965 Another questionable change is the provision that the interest on deposits with foreign banking branches of U.S. corporations will be viewed as income from sources without the United States provided the deposit is in a foreign currency. After 1970 this provision will tend to force the deposit of the vast amounts of "Eurodollars" to be deposited with foreign banks in order to avoid U.S. taxation of the interest income. Bill section 3: Proposed code section 871 (a) (2) Subject of the tace on non-resident alien individuals (p. 73, line 15; p. 14, line 4) .-In proposed section 871(a), the words "gross income" should replace the words "amount received." In regulations section 1.871-7(b) (1) there is the following clarification: "For the purposes of section 871 (a) (1) `amount received' means `gross income." Bill section 3: Proposed code section 871(a) (3) Page 13, lines 17-19.-This proposed subsection describes the kinds of income not connected with a U.S. business which shall be subject to tax at the rate of 30 percent. It repeats the enumeration of the types of income presently described in section 871 (a) (1), in- cluding the words "salaries," "wages," "compensations," "remunera- tions," and "emoluments." Under proposed section 864(b) the per- formance of personal services within the United States will constitute engaging in a trade or business within the United States except under certain limited circumstances. Remunerations for such personal serv- ices, therefore, would be taxed at graduated rates under proposed section 871(b) as income effectively connected with the conduct of a trade or business within the United States. Accordingly, proposed section 871 (a) should be revised to exclude the terms cited above which are descriptive of payments for personal services. Bill section 3: Proposed code section 871 (a) (2) (4) Conforniing the phraseology applicable to gains and losses (p. 14, lines 15 and 16) .-The phrase used in lines 15 and 16, page 14, in reference to the word "losses" is: "allocable to sources within the United States." It would seem preferable to continue to use the phrase "derived from sources within the United States" as it is used in line 13 with reference to the word "gains." Bill section 3: Proposed code section 871 (a) (2) (5) Deterin~ination of capital gains of aliens present in the United States 183 days or more.-It is assumed that the intent of the bill is to subject nonresident aliens who are present in the United States for 183 days or more during a year to a 30-percent rate of tax. This provision places such an alien in a disadvantageous position in com- parison with a domestic investor, because under the provisions of lines 22-24, page 14, and lines 1-2, page 15, the alternative tax and capital loss carryover provisions are not to be allowed. This seems contrary to the intent of the bill. We recommend that the rate of tax be 25 percent and that consideration be given to allowing t,he deduction of capital loss carryovers. Bill section 3: Proposed code sections 871 (b) and 882 (6) Income "effectivel~j connected" iiith a U.S. trade or business (p. 15, lines 14-20, and p. 32, lines 8-14) .-It is proposed that non- 428 PAGENO="0439" FOREIGN INVESTORS TAX ACT OF 1965 117 resident aliens and foreign corporations engaged in trade or business within the United States would be subject to regular rates of tax on worldwide income "effectively connected" with such trade or busi- ness. This is the most surprising change in the bill, as compared with H.R. 5916, because it represents a real innovation in U.S. taxation of foreign persons. Heretofore foreign corporations and nonresident alien individuals engaged in trade or business here have been subject to U.S. income tax only on U.S.-source income. It has been said that the adoption of the "effectively connected" concept is in accord with the OECD model income tax convention and with our new treaty approach as evidenced by the recent protocol with Germany. Our study of these documents and of the reports of the Department of State and of the staff of the Joint Committee on Internal Revenue Taxation on the German protocol has disclosed no indication that foreign source. income would be taxed. Article III of the convention with Germany as amended, dealing with the taxation of the industrial or commercial profits of an enterprise, does not even use the term "effectively connected" and article XV, dealing with the avoidance of double taxation, limits the allowable tax credits and/or exclusions from taxable income to income having its source in the other country. We believe that enactment of H.R. 11297 could lead to serious prob- lems of double taxation, particularly with regard to foreign sub- sidiaries of U.S. corporations. If such a foreign subsidiary were subjected to U.S. taxes under this principle, double taxation would result when the U.S. parent corporation receives dividends from the subsidiary since no credit is permitted for U.S. income taxes paid by a foreign corporation. It is recognized that a motivating factor in this proposal to tax foreign persons engaged in trade or business in the United States on their worldwide income is concern that otherwise tax avoidance may be permitted. We do not believe that major tax avoidance does result under the existing provisions for taxation of such foreign persons. The Treasury has various ways of dealing with efforts to avoid U.S. income taxes, such as section 482, arrangements under various income tax treaties, and its ability to challenge such devices as the mere arrangement of title passage outside the United States for tax avoidance purposes. The majority of our existing tax treaties contain provisions which limit the imposition of tax to income from sources within the taxing country. These include Australia, Austria, Denmark, Finland, Greece, Honduras, Ireland, Italy, Japan, Luxembourg, the Nether- lands, New Zealand, Norway, Switzerland, and the United Kingdom. Since H.R. 11297 provides that the changes which it would make in U.S. tax law would not contravene any existing treaties, the treaties with the above-named countries would require amendment before the foreign source income of their corporations could be taxed by the United States. The foreign tax credit proposed under new section 906 would not be allowed for taxes paid to a country solely by reason of the foreign person being domiciled there for tax purposes. This could result in double taxation where the country of domicile imposes limitations on allowable credits for foreign taxes which are similar to 429 PAGENO="0440" 118 FOREIGN INVESTORS TAX ACT OF 1965 the ~ rules. In such a case, where the U.S. taxes income which is derived from a third country, the country of domicile would not permit a foreign tax credit for the U.S. taxes paid on income derived from the third country. Consideration should be given to defining more precisely the criteria given for the term "effectively connected" in section 864 (c) (p. 12, lines 10-23). Otherwise, it is likely to discourage U.S. port- folio investment by foreign persons engaged in trade or business here, because in many cases they could not be sure of obtaining the generally lower rates of tax on investment income. For the foregoing reasons we believe that it would be preferable to provide that a foreign corporation or. a nonresident alien individual engaged in trade or business in the United States be taxed only oit its 1J.S.-source income effectively connected with the U.S. trade or business. We strongly urge that, if the Congress feels impelled to abandon the long-existing source of income rules in favor of this new and untried "effectively connected" concept. the committee reports should indicate clearly that the exercise by a U.S. corporation of management func- tions for a foreign subsidiary will not be considered to be the engage- ment in a trade or business within the United States by such foreign subsidiary. We also urge that code section 245 be amended to sub- stitute the term "10 percent" wherever the term "50 percent" presently is used. This would permit a fractionalized dividends received credit in the majority of cases and would ameliorate, although not eliminate, the double taxation problems which we have described heretofore. BiU section 4: Proposed code section 882(c) (2) (7) Softening of provision disallowing all deductione for failure to file a return (p. 33, line 21 thro'ngh p. 34, line 8) .-The disallowance of all deductions and most credits for failure to file a return under pro- posed section 882(c) (2), is an unusually harsh provision. Even though this provision is a part; of the present law, the purposes of the bill would seem to indicate that the provision should be softened. Bill section 6: Proposed code sections 901(c) and 2014(h) (8) Consistency in provisions requiring 30-day `notice prior to Presi- dential proclamation (p. 53, line 17, and p. 54, line 19; cf. p. 48, line 3 and p. 63, line 25) .-To be consistent with proposed sections 896 and 2108, proposed sections 901 (c) and 2014(h) should require a 30-day notice to Congress before a proclamation is made by the President. Bill section 8: Proposed code section 2101 (a) (9) Rate of estate tax on nonresident alien decedents (p. 56, lines 21- 933 and p. 57, lines 1-2) .-The Fowler Task Force Report contained a recommendation to "eliminate U.S. estate taxes on all intangible per- sonal propert;y of nonresident. alien decedents." We believe this rec- ommendation should be followed. As pointed out in the report: "Under existing U.S. tax law, a foreigner willing to go through the expense and trouble of establishing a personal holding company, in- corporated abroad, and assuring himself that this personal holding company does not run afoul of the U.S. penalty taxes or undistributed personal holding company income, can already legally avoid estate taxes." 430 PAGENO="0441" FOREIGN INVESTORS TAX ACT OF 1965 119 The possibility of using such a holding company would be made even easier due to a provision in the bill which would exempt from the personal holding company tax a foreign corporation if all of its stock is owned by foreigners. Sophisticated investors may take advantage of this means of escaping estate tax ; others will reject the complications and addi- tional costs. It would seem preferable to enable both types of m- vestors to acquire TJ.S. securities without concern for a substantial U.S. estate tax. Bill section 8: Proposed code section ~1O5(b) (10) Inclusion of bank deposits in the gross estate (p. 58, lines 18-24) .-The bill would remove the existing exemption from the gross estate for U.S. bank deposits owned by a nonresident alien decedent who was not engaged in business in the United States at the time of his death. This provision should be eliminated from the bill since, if enacted, it is likely to have an immediately adverse effect on the U.S. balance of payments. The exclusion of bank deposits from the gross estate. would also result from the adoption of the recommendation in item 9 above. In any event, as far as bank deposits are concerned, the proposed inclusion in the gross estate is clearly in the wrong direction. Tm~ AssOCIA~noN OF THE BAR OF THE Crrr OF NEW Yom~, COMMITrEE ON TAXATION, New York. January 19, 1966. Hon. WILBUR D. MILr~s. Chairman, Ways and Means Committee of the Honee of Representa- tives, New House Office Building, Washington, D.C. DEAR MR. MILLS: This committee has in preparation a report con- cerning H.R. 11297, the Foreign Investors Tax Act of 1965, which is critical of certain provisions of the bill. We hope to file the report with your committee within the next 10 days. We would appreciate notice of any hearings to be held on the bill. Respectfully yours, LAURENCE F. CASEY, C'hairman. COMMENTS ON H.R. 11297-FOREIGN INVESTORS TAX ACT OF 1965 Set forth below are the comments of the Committee on Taxation of the Association of the Bar of the City of New York on H.R. 11297. According to the Ways and Means Committee's summary, a prin- cipal purpose of the bill is to encourage foreign investment in the United States-thereby beneficially affecting the U.S. balance of payments-by removing tax barriers to such investment. The com- mittee believes that certain changes made under the bill will have. precisely the contrary effect. For instance, the elimination of the income and estate tax exemptions relating to U.S. bank deposits must lead to withdrawals of substantial existing deposits from, and dis- courage potential deposits in, this country. 431 PAGENO="0442" 120 FOREIGN INVESTORS TAX ACT OF 1965 One further aspect of the bill may well serve to discourage invest- ment in the United States. Under present law, it is possible to give fairly definite advice to a foreign corporation or partnership wishing to establish a branch in this country as to what part of its income will be treated as income from sources within the United States and sub- ject to tax here. H.R. 11297 would abandon the use of these clearly defined "source" rules and instead subject to U.S. tax all income that is "effectively connected" with a U.S. branch operation. The "ef- fectively connected" concept is vague and ill defined. To the extent that the bill substitutes an unclear standard of taxability for a clear one, making it more difficult for a foreign investor to determine what U.S. tax he will pay, it will, in the committee's opinion, serve to discourage investment in the TJnited States. Our detailed. comments are submitted under six principal headings, as follows: SOURCE OF INCOME Section ~(a). Interest The general effect of this provision is to extend the present exclu- sion of interest on bank deposits from U.S.-source income to interest paid by savings and loan associations and to interest paid on amounts held by an insurance company under an agreement to pay interest thereon. However, with one minor exception described below, the present exclusion of bank deposit interest from U.S.-source income as well as the proposed extension will terminate on December 31, 1970. Thus, all such interest paid or credited after December 31, 1970, will be subjected to a 30-percent withholding rate (or to any lower treaty withholding rate). It is believed that such change, even though deferred to 1970, will tend to discourage new deposits of substantial sums with U.S. banks, as well as encouraging the with- drawal of substantia.l deposits presently held by foreigners. Section 2(a) of the bill adds a new subparagraph to the code ex- cluding from "U.S. source income" interest paid on foreign currency deposits in foreign branches of U.S. banks, a change which is neces- sary because of the proposed termination of the present exclusion of bank interest from U.S. source income. This provision is desirable but should be extended to cover all interest paid by foreign branches of U.S. banks. If interest on dollar deposits in foreign branches of U.S. banks is subject to U.S. withholding taxes, such branches will be noncompetitive with local foreign banks. The resulting reduction in their earnings may te.nd to worsen the U.S. balance of payments. Should the above restriction induce the incorporation of their foreign branches by U.S. banks, the balance of payments may be further worsened by the accumulation of their earnings free of U.S. tax in such incorporated branches. Section ~(b). Dividends froim foreign corporations This section modifies present code section 861(a) (2) (B) to provide that dividends from a foreign corporation are to be considered income from U.S. sources only if 80 percent of the corporation's gross income for the preceding 3-year period consisted of income effectively con- nected with the conduct of a trade or business within the United States. This change represents a marked liberalization of the present requirements for exclusion of dividends of foreign corporations from 432 PAGENO="0443" FOREIGN INVESTORS TAX ACT OF 1965 121 U.S. source income and the committee questions the necessity there- for. Presumably the change is designed to eliminate the so-called second dividend tax, particularly with respect to investment income. However, where a foreign corporation is carrying on activities here which are effectively connected with a U.S. trade or business, there would seem to be no reason why the withholding tax should not apply. Accordingly, it is suggested that the present requirement be retained, or more appropriately, reduced below 50 percent. In any event, in the interest of clarity, the word "total" should be added before the words "gross income" where they first appear in the subparagraph and the words "from all sources" should be added after the words "gross income." Since under the bill provisions (sec. 4(b)) * amending section 882 (b), the "gross income" of. a foreign corporation would be limited to income from sources within the United States plus "effectively connected" income, section 861 (a) (2) (B), as pro- posed, would produce an unintended result. Section 2(c). Personal services This provision desirably broadens the present exclusion from U.S. source income of the earnings of employees of (i) foreign corporations or (ii) foreign branches of U.S. corporations who earn less than $3,000 and are present here for less than 90 days, the exclusion being extended to employees of foreign offices of U.S. partnerships or individuals. No change has been made in the basic $3,000 exclusionary test. Since this figure has been part of the code at least since 1939 (and apparently has its genesis in sec. 201(c) of the Revenue Act of 1917), and since wage levels have increased materially in that period, consideration might be given to increasing this amount. The exclusion presently applies to employees of foreign corpora- tions, etc., where the employer is not engaged in trade or business in the United States if the employee is employed by a foreign office of the foreign employer. There would seem to be no basis for putting employees of a foreign branch of a foreign employer engaged in trade or businese here in a worse position than that of employees of a foreign branch of a U.S. corporation. Section 861 (a) (3) (C) (i) of the code and proposed section 864(b) (1) (A) should be amended to extend this exclusion to employees of a foreign branch of a foreign employer engaged in business in the United States. Section 2(d): DefInition of "trade or business within the United States" Proposed code section 864(b) (2) (A) `would provide that trading in stocks or securities through a resident broker custodian or other agent having discretionary authority would not constitute the carrying on of a trade or business within the United States. This is a desirable amendment which should aid in effectuating the purposes of the bill. The Treasury Department release of March 8, 1965, accompanying H.R. 5916, stated that no legislative change is necessary to provide that the volume of transactions is not material in determining whether an investor is engaged in trade or business in the United States since this is the rule under existing law. It is not believed that existing law in this regard is as clear as the Treasury release would indicate and it is therefore suggested that a specific clause be inserted in the pro- posed section 864(b) (2) affirmatively stating that the volume of secu- 433 PAGENO="0444" 122 FOREIGN LNVESTORS TAX ACT OF 1965 rities or commodities transactions is not material in the determination of whether an investor is engaged in trade or business within the United States. Income "effectively connected" with a U.$. trade or business The bill actually utilizes the "effectively connected" concept for two purposes. First, the concept is used to determine whether dividends, interest, royalties, and other ordinarily "passive" types of income which are admittedly subject to U.S. tax are part of the income of a U.S. trade or business and properly subject to full rates of U.S. inco~ine tax or subject only to normally lower withholding tax rates. This use of the "effectively connected" concept parallels its use in the recent protocol to the United States-German Income Tax Convention and in the OECD Draft Double Taxation Convention. To this extent the use of the concept is proper and desirable, even recognizing the areas of question which underlie its interpretation. However, the bill then uses the "effectively connected" concept in a way in which it is not used in U.S. tax conventions or in the OECD draft. It is this second use of the concept which the committee believes represents a serious and undesirable departure from present law. Under present law if a foreign corporation or nonresident alien is engaged in trade or business in the United States, then U.S. tax is im~ posed on the industrial and commercial income 1 of that trade or busi- ness to the extent that it is "from sources within the United States" (IRC sees. 872(a), 882(b)). The code and regulations contain fairly precise definitions of what is and is not income from sources within the United States and the case and other authority is now sufficiently clear so that definite answers can be given to the bulk of source of income questions arising in connection with industrial and commercial income. However, the bill would discard all of these established and well-un- derstood rules and would treat as income of the foreign person's U.S. trade or business all income "effectively connected" with that trade or business without reference to its "source." Proposed section 864(c) would provide a series of fairly amorphous "factors" which are to be "taken into account" in determining whether income is "effectively connected" with a U.S. trade or business. These "factors" provide no answers to the following everyday questions that will necessarily arise in applying the "effectively connected" concept. If goods are processed here and then shipped to a foreign country where they are sold through stores, with the benefit of extensive adver- tising, what part of the profit on sale is "effectively connected" with the trade or business carried on in the United States? What portion of the income from a sale of goods is effectively connected with the U.S. trade or business if goods are processed both here and abroad and then sold abroad? Suppose that the foreign corporation holds foreign. patents, without which goods manufactured here could not be sold abroad. Does this affect the amount of income "effectively connected" with the U.S. trade or business? Suppose that a foreign corporation managed in this country operates oilflelds throughout the world. What portion of its income is "effectively connected" with its U.S. trade or business? 1The code does not use the term "industrial or commercial income." The term as used here provides a convenient description of the types of income which will be affected by this change in present law. 434 PAGENO="0445" FOREIGN INVESTORS TAX ACT OF 1965 123 There would seem to be only two alternative solutions in each of the foregoing cases. Either the entire income from the entire industrial and commercial income producing activity here and abroad is subject to U.S. tax or only part is so subject. If it is intended to subject all of such income to tax, this certainly represents a drastic and question- able change in our tax system. If only part of the income from the entire profitmaking activity is subject to U.S. tax then "source" rules will have to be provided and the bill simply becomes a vehicle for the rewriting of the source of income rules; and if this is what is intended, the rules should be set forth specifically in the bill and should not be left to committee reports or "guidelines." The committee believes that this second and noveJ use of the "effec- tively connected" concept should riot be adopted. Well-defined principles provided by the present source rules should be retained for purposes of determining what part of the industrial or commercial profits of a foreign person engaged in trade or business in the United States are to be taxed by the United States. This can be done by adding the words "from sources within the United States" after the words "gross income" in proposed section 882(b) (2) and after the words "gross income" the second time that they appear in proposed section 872(a) (2). Similar changes would be required in other pro- visions of the bill where the "effectively connected" phrasing appears. Adoption of the "effectively connected" concept will mean the imposition of U.S. taxes on income of foreign corporations not pres- ently subject thereto; and as this occurs, the risk of double taxation of the same income will increase notwithstanding the foreign tax credit and extension thereof proposed in section 0 of the bill. This provision would allow to foreign taxpayers engaged in trade or business in the United States a credit not presently allowed for foreign taxes imposed upon income "effectively connected" with the U.S. trade or business. The credit would not be allowed with respect to taxes which would not be imposed by the foreign jurisdiction but for the fact that the taxpayer was a citizen or resident of such country or was incorporated in that country. The* committee believes that it will be extremely difficult in many cases for taxpayers to demonstrate that a particular tax would not have been assessed hut for the fact of the taxpayer's citizenship, residence, or incorporation in the foreign jurisdiction. No'n~resident aliens Section 3 would establish new rules for the application of the in- come tax to nonresident aliens. 1. The committee believes that the following substantive changes are Sound and are appropriately carried out by the proposed bill. (a) Nonresident aliens, would be taxed separately on~ income effectively connected with a U.S. trade or business and income not so connected. Under the proposed bill, income not effectively connected with U.S. trade or business will be taxed at a 30-per- cent rate (or at a lower treaty rate, if applicable), and income which is effectively connected with a U.S. trade or business will be taxed at the regular graduated rate applicable to individuals. Under present law, the graduated rates apply only if nonresident aliens are engaged in trade or business in the United States or if their income ex~eeds $21;200. 435 PAGENO="0446" 124 FOREIGN INVESTORS TAX ACT OF 1965 (b) A nonresident alien is not to be subject to TJ.S. tax on capital gains unless he is here for more than 183 days during the year or unless such gains are effectively connected with a U.S. business. (c) Every nonresident alien, irrespective of whether he is en- gaged in business here, may elect to treat certain real property and mineral income as connected with a business in order to obtain deductions (such as depreciation and depletion) attributable to such income. 2. A major change proposed by the bill is that, in determining the taxation of a nonresident alien engaged in business here, an alien is to be taxed on his taxable income which is effectively connected with the trade or business conducted in the United States. While precise rules are not spelled out, it appears that the concept is intended to be broader than the present concept of gross income from U.S. sources. For the reasons stated in the discussion of section 2 of the bill, it is believed that this change is inadvisable. 3. The withholding rules are amended to eliminate withholding on any item of income (other than compensation for personal services) *which is effectively connected with conduct of a trade or business in the United States. It is believed that withholding should continue to be governed by the source of income rules, as these provide a much more objective and practicable standard for a withholding agent. At least, withholding shçuld continue to be required with respect to divi- dends and interest. Under the proposed changes, there would be too great an incentive for persons to file false information with the with- holding agent. 4. The definition of periodic income from U.S. sources (income subject to 30 percent tax) would be expanded to include income from the sale or liquidation of a collapsible corporation (sec. 341) and from original issue discount (sec. 1232). The committee believes that this extension of the definition of "periodic income" is inadvisable. The change would not result in any appreciable increase in tax collec- tions, since the tax coul4 easily be avoided by selling outside of the United States. Since it is sometimes difficult to know whether or not section 341 or section 1232 is applicable in the first instance, this expan- sion would tend to increase the uncertainty of taxation of nonresident aliens, which the proposed bill is supposedly designed to reduce. 5. As noted above, a nonresident alien may elect to treat income from certain real property as connected with a business in order to obtain the benefit of deductions attributable to such income. This election is equally applicable to a foreign corporation and the following com- ments are pertinent both to the election available to a nonresident alien individual and the election available to a foreign corporation. The committee recommends that the election be extended to include personal property "associated" with the real property involved. For example, if a nonresident makes the election with regard to a hotel subject to a net lease, such election would also relate to all personal property in the hotel subject to the lease, so that the nonresident would not have one rule applying to the hotel lease and another rule applying to the lease of the personalty associated with the hotel. Also, it is not clear whether the election would extend to interest from mortgages on real property. Under the various tax conventions mortgage interest, 436 PAGENO="0447" FOREIGN INVESTORS TAX ACT OF 1965 125 more often than not, is specifically excluded from the concept of "income from real property." It is therefore recommended that pro- posed section 871(d) (A) be amended to make it clear that interest from mortgages on real property is not "income from real property." A similar change should be made in proposed section 882(d). Proposed sections 873 (a) and 882(c) (1) (A), in providing for the allowance of deductions and credits in respect of U.S. income, limit the deductions, to circumstances in which they are "effectively con- nected with the conduct of a trade or business within the United States." it is recommended that these proposed sections be changed by inserting "attributable to income which is" immediately preceding the phrase quoted in the preceding sentence, so that it is clear when an election is made to treat real property income as income connected with a U.S. business that such election effectively permits the non- resident to obtain the offsetting deductions, the purpose of the election in the first instance. Finally, the committee questions whether the election under sections 871(d) and 882(d) should extend to gains described in present code section 631 (b) or (c). Since such gains are, also defined as periodic income, it would appear that a nonresident individual or corporation would always make the election in order to obtain a lower effective tax rate and possible use of such deductions against other business income. Foreign corporatioi~ Under section 4, a foreign corporation engaged in trade or business in the `United States, like a nonresident alien similarly so engaged, would be taxed as if it were a resident on its taxable income which is effectively connected with the trade or business conducted here. Again, it appears that the concept of "effectively connected with the trade or business" is intended to be broader than the present concept of gross income from U.S. sources. For the reasons stated in the discussion of section 2 of the bill, it is believed that this change is inadvisable. Section 4(a). Ta~re on incoime not connected with 17.5. bwsiness The title suggested for proposed code section 881, "Income of For- eign Corporations Not Connected With U.S. Business," fails to indi- cate, as it should, that a tax is imposed by that section. Accordingly, it is recommended that the section's title be amended by the addition of "Tax on" at the beginning thereof. Proposed section 881 (a) (1), reflecting changes made in proposed section 861 (a) (1) (A), would eliminate from the category of non- taxable interest, interest on deposits with persons carrying on the banknig business. For the reasons stated in the discussion of section 2(a) of the bill, it is believed that this change is inconsistent with the purpose of the bill to encourage foreigners to invest in the United States. Proposed section 881 (a) also would expand the definition of peri- odic income from U.S. sources (income subject to 30 percent tax) to include income from the sale or liquidation of a collapsible corpora- tion (sec. 341) and from original issue discount (sec. 1232). For reasons stated in the discussion of section 3 of the bill, it is believed this extension of the definition of "periodic income" is inadvisable. 437 PAGENO="0448" 126 FOREIGN INVESTORS TAX ACT OF 1965 Section 4(b). Tax on income connected with U.S. bv1siness It is recoimnended that the title to pro~x)sed section 882 be changed by adding at the beginning thereof the words "Tax on." It is recommended that subsection (a) of proposed section 882 be changed to read as follows: "(a) Imposition of tax-A foreign corporation engaged in trade or business within the United States during the taxable year (or during any preceding taxable year beginning after December 31, 1965) shall be taxable as provided in section 11 or 1201 (a) on its taxable income determined on the basis of its gross income as described in subsection (b) (2) ." The caption, "Imposition of Tax," would be consistent' with the caption to proposed section 881 (a) and the intended limitation of taxable income can be accomplished without a separate paragraph. Proposed section 882(c) (1) (A), in providing for allowance of deductions and credits in respect of U.S. business income, limits the deductions to circumstances in which they are "effectively connected with the conduct of a trade or business within the United States." For reasons already given in respect of the similar provision affectin nonresident alien individuals in section 3 of the bill, it is recommende that the proposed section 882(c) (1) (A) be changed by inserting "attributable to income" immediately preceding the phrase quoted in the preceding sentence. Proposed section 882(d) (1) (A) permits a foreign corporation to treat gains described in present code section 631 (b) or (c) as income connected with a U.S. business. For reasons stated in the discussion of section 3, in respect of the similar election granted to nonresident aliens, it is believed that this election in respect of section 631 (b) or (c) income is not desirable. Proposed section 882(e) would seem to prohibit a direct filing of a return by a foreign corporation in the circumstances there described. It is recommended that, in order to assure that the foreign corpora- tion may itself file the return, the words "unless such return is made by such foreign corporation" be added at the end of the sentence. The withholding rules are amended to eliminate withholding on any item of income (other than compensation for personal services) which is effectively connected with the conduct of a trade or business in the United States. As stated in respect of section 3 of the bill it is believed that withholding should continue to be governed by the source of income rules. Section 4(b) (3) of the bill, containing proposed changes in the table of sections for subpart B of part II of subchapter N of chapter 1, should be changed to reflect the above-recommended changes in the titles to sections 881 and 882. Thus, the words "Tax on" should be inserted at the beginning of the titles given for sections 881 and 882. Section 4(d). Dividends received from certain foreign corporations It is recommended that the amendment of section 245(a) of the code, as proposed in section 4(d) (1) of the bill, be changed by adding "total" before "gross income." Compare present code section 542(c) (7) (A). The addition of `~total" would seem to negate any argu- ment that the various statutory exclusions applicable to gross income 438 PAGENO="0449" FOREIGN INVESTORS TAX ACT OF 1965 127 of foreign corporations, see, for example, present code section 883, should be taken into account in determining gross income for this purpose. Section 4(f). Corporations subject to personal holding company tax The proposed section 542(c) would change the present rule for excluding certain foreign corporations from classification as a per- sonal holding company. Under the proposed rule indirect owner- ship by nonresident alien individuals through foreign estates, for- eign trusts, foreign partnerships as well as through other foreign corporations would be taken into account. It is unclear why attribu- tion through partnerships is limited to foreign partnerships. It is recommended that the word "foreign" immediately preceding "part- nerships" be deleted. Section 4(g). Foreign corporations carrying on insurance business in * the United States It is recommended that the title to proposed section 842 be changed by adding at the beginning thereof the words "Tax on." A cor- responding change would be required in paragraph (2) of section 4(g) of the bill, *hich would amend the table of sections for part IV of subchapter L of chapter 1 of the code. Estate and gift taxes The task force recommended the elimination of the Federal estate tax on intangible property of nonresident alien decedents. It is wide- ly believed that the estate tax is a significant deterrent to foreign investment in U.S. securities. Nonetheless, the Treasury decision in presenting H.R. 5916 to retain an estate tax with relatively large exemption ($30,000) and with relatively low rates (a maximum of 15 percent and only 5 percent on the first taxable $100,000) was prob- ably warranted. The committee takes no position regarding the de- sirability, from the standpoint of encouraging U.S. investments, of the proposed maximum 25 percent rate instead of the 15 percent maxi- mum rate proposed in H.R. 5916. Section 8 (:b) would provide a new technical limitation on the credit for State death taxes. Though argnments can be made as to ~ limitation keyed to the kind of limitation that a domiciliary of the United States might have, in the cont~xt of a bill designed to reas- sure foreigners with respect to the low impact of death duties in this country, the introduction of any such limitation seems undesirable. In addition, the limitation may operate somewhat unevenly depend- ing upon how many intangible assets the decedent had which were not assignable to any State of the United States. Section 8(c) would amend section 2104 to make it clear that where a debt obligation of a U.S. obligor is owned by a nonresident alien, the obligation shall be treated as property within the United States no matter where it is located. However, it should also be made clear that a foreign obligation physically located in the United States will not be treated as property within the United States, a result which would be only a logical extension of the proposal with respect to U.S. obligations. The same comment can be made respecting section 9(b) which would amend section 2511(b) to set forth similar situs rules in the gift tax area. 71-297 0-67--pt. 1-29 439 PAGENO="0450" 128 FOREIGN INVESTORS TAX ACT OF 1985 Expatriation Sections 3(e), 8(f), and 9(a) contain alternative provisions designed to penalize for income, estate, and gift tax purposes certain persons ~cvho surrender their U.S. citizenship for the purpose of reducing their U.S. taxes. The Task Force on Promoting Increased Foreign Invest- ments did not recommend such penalties and it may be questioned whether, on the one hand, the position of nonresident aliens is so greatly improved by the bill that U.S. citizens not otherwise prompted to expatriate themselves for tax reasons will now be induced to do so or, on the other hand, whether the penalties themselves are severe enough to prevent significant tax advantage from being gained for such surrender-as to justify adding these complexities and uncer- tainties to an already overburdened code. How, for example, can the Commissioner, with any semblance of uniformity of treatment, proceed to establish that "it is reasonable to believe" that an expatriate would have gained, but for proposed section 877, a "substantial" reduction of taxes on "probable income" for the year? In the case of estate tax on expatriates, would the "substantial" reduction in taxes be computed by reference to assets owned at expatriation or those owned at death, possibly 10 years later? Enforcement of such a provision can hardly be uniform; and lack of uniformity is further suggested in the excep- tion provided for cases of dual citizenship. Moreover, it seems ques- tionable whether, from a national policy standpoint, the United States should undertake such measures against persons willing to surrender their citizenship. Section 3(e). Expatriation to avoid tax It is recommended that the title of proposed section 877 be changed to "Tax on Certain Expatriates." Compare titles of other sections in part II of subchapter N of chapter 1, particularly sections 871,881, and 882. The clause starting with "if the tax" in the last two lines of sub- section (a) of section 877 should be changed to read as follows:' "if the tax for the taxable year computed pursuant to such subsection ex- ceeds the tax for the taxable year computed without regard to this section." In making computations to determine the applicability of an alter- native tax it would not seem appropriate to speak of a "tax imposed." See, e.g., section 1341 (a) of the code. In the second line of subsection (c) (1) of proposed section 877, "debt obligations" (in the title and text) should be changed to "evi- dences of indebtedness," in order to conform to the terminology used in other areas of the code, e.g., sections 164 and 1232. Section8(f). Special methods of computing estate tax It is recommended that the title of section 2107 be changed to "Tax on Estates of Certain Expatriates." Section 9(b). Gift tax transfers In subsection (b) (2) of section 2511 "debt obligations" should be changed to read "evidences of indebtedness". 440 PAGENO="0451" FOREIGN INVESTORS TAX ACT OF 1965 129 BAKER, MCKENZIE & HIGHTOWER, Arron~~s AT LAW, Washington, D.C., February 11,1966. Re H.R. 11297-"Effectively connected" and certain partnerships. Dr. LAURENCE N. WOODWORTH, Chief of Staff, Joint Committee on Internal Revenue Taa~atwn, Washington, D.C. Di~&R DR. WOODWORTH: This is to call your attention to a. possible unintended repeal of a basic partnership rule by the "effectively con- nected" income concept proposed by H.R. 11297. The problem involves U.S. partnerships with branch offices in various foreign countries. A number of large accounting and law partnerships exemplify the situation. The partners in many of the foreign offices of these partnerships are nonresident aliens. As you know, under the provisions of section 704 (a) and section 702(a) (8), and the regulations thereunder, the partners by the terms of their partnership agreement can provide that the distributive share of the nonresident alien partners is to be derived from the income earned in their respective foreign countries. The effect of such provision, of course, is to establish that such partnership income does not have its source in the United States and accordingly is not subject to taxa- tion by the United States. This well-settled rule of partnership law is in accord with the basic objectives of subchapter K. In its present form, in the absence of a committee report explana- tion, it is possible to construe the definition of "effectively connected" income contained in proposed section 864(c) in H.R. 11297 as abro- gating the foregoing rule of subchapter K. The problem is created by the following language of proposed section 864(c): "For purposes of this title, factors to be taken into account to determine whether gains, profits, and income or loss shall be treated as `effectively connected' with the conduct of a trade or business in the United States by a non-resident alien individual or foreign corporation include whether- * * * * * * * (2) the. gains, profits, and income or loss are accounted for through such trade or business * * I am aware that at least one partnership maintains a centralized system of bookkeeping whereby the income and expenditures of its various foreign branches are recorded and the overall operation of the firm coordinated. The broa.d language of the statute, i.e., whether income is "accounted for through such trade or business," could conceivably result in subjecting the foreign source income of the nonresident alien partners of such partnership to Federal income taxation. Clearly, such a result does not appear to be the objective of H.R. 11297. And, of course, the statute merely lists a number of factors which are to be taken into account and does not state that the existence of one or all of these factors necessarily leads to the con- clusion that the income has been effectively connected with a U.S. trade or business. Nevertheless, there is sufficient basis in the statute to warrant serious concern on the part of p.artners who might be af- fected by such a possible construction of the law. It is the purpose of this letter to urge that the committee make it clear either in the 441 PAGENO="0452" 130 FOREIGN INVESTORS TAX ACT OF 1965 statute or in its report that subchapter K rules above outlined are in no way affected by H.R. 11297. I shall, of course, be glad to expand. on this matter or supply you with any additional information you may like to have. Thank you in advance for your consideration of this matter. Sincerely yours, MICHAEL WARIS, Jr., Esq. BANKERS' AssocL&'rIoN FOR FORBIGN Tn~DE, Chicago, Iii., February 8,1966. Hon. WILBUR D. MUL5, Chairman, Howie Ways and Means Committee, How~e Office Bui Wing, Washington, D.C. DJ~R MR. MILLS: The board of directors of the Bankers' Associa- tion for Foreign Trade has asked me to record with you our most serious reservations regarding certain portions of the proposed For- eign Investors Tax Act, H.R. 11297, the stated purpose of which is to encourage foreign investments in the United States. We recognize and applaud those provisions in the bill which will encourage overseas investment in our country. However, we are par- ticularly concerned with the effect of section 861 (effective after De- cember 31, 1970) which would treat as taxable income interest paid by U.S. banks and their overseas branches on deposits of nonresident alien individuals or foreign corporations, and section 2105 (effective upon enactment) which would treat as part of the taxable estates of nonresident alien individuals dollar deposits with American banks and their foreign branches. We submit that it is untimely to propose additional taxes on foreign dollar deposits when we so urgently need these funds to support loans which finance our domestic and international trade and particularly at a time when we should be encouraging overseas holders of dollars to continue to invest them here to support our balance-of-payments efforts. The American banking system must compete with foreign banks throughout the world for U.S. dollar deposits. Increased tax burdens on such deposits will only encourage overseas holders of dollar bal- ances to transfer them to foreign banks overseas or to convert them to other currencies to eventually become a drain on our gold reserves. Even though the proposed tax in section 861 will not become effec- tive until 1971, its enactment would have an unsettling interim effect on the international money markets and we see no worthy purpose to be served by passing legislation now which attempts to anticipate conditions 5 years hence. The effectiveness of American banks to compete with foreign banks for dollar deposits can only be impaired by the imposition of new taxes now and the prospects of increased taxes in the future. The un- favorable impact on the 11.5. balance of payments and the adverse effect on money markets both in the United States and abroad are not warranted by the modest revenue these taxes would produce. We strongly urge that sections 861 and 2105 be eliminated from H.R. 11297. Respectfully yours, G. E. KEIDEL, President. 442 PAGENO="0453" FOREIGN INVESTORS TAX ACT OF 1965 131 CrncAGo, ILL., December ~3, 1965. Hon. WILBUR D. MILLS, Ways and Means Committee, Hov~se of Representatives, Washington, D.C. DEAR MR. MILLS: I am advised that H.R. 11297 provides that for- eign corporations be taxed in the United States on their worldwide income in any way "effectively connected" with the conduct of a trade or business in the United States. As the chairman of your committee for some years, I am virtually certain that you are `aware that the dis- crimination and identification of various species and sources of income have for about 45 years rested on the little words "derived from sources within the United States" and "derived from sources without the United States": These phrases have undergone the refinement and the gloss of scores of Treasury rulings and court cases, and have come to have such significance and meaning as to give some certainty and definition to the law. In fact, there are few phrases in the code which are by this time better known, more lucid in their present interpreta~ tion and more of a stabilizing force for the proper respecting and understnading of the law applicable. The words "effectively connec~ted" have no meaning in tax history, either by analogy or precedent: They inject novelty, uncertainty and ambiguity into an area otherwise orderly and sound. As a student and worker in the foreign tax-foreign operations field for some 15 years, I respectfully urge that this new bill be considered at very great length before permitting the eradication of those other sections of the law which have served so well for decades to accurately identify the sources of virtually all forms of income. I realize that the argument will be made that the superaddition of the words "effectively connected" do not destroy the meaning of the old source tests: I submit to you that the source tests have already been established effectively and respon- sibly, and that instead of adding to their existing vigor, the new words destroy their meaning. Yours sincerely, ANDREW W. BRAINERD, Esq. BRISTOL-MYERS Co., New York, N.Y., February 15, 1966. Re H.R. 11297, Foreign Investor's Tax Act of 19~5. Hon. WILBUR D. Mui4s, Ho'us~ of Representatives, Washington, D.C. Sn~: H.R. 11297 introduces a new concept into the Internal Revenue Code; namely, that foreign corporations engaged in trade or business in the United States would be taxed on worldwide income "effectively connected" therewith. Heretofore foreign corporations engaged in trade or business in the United States have been subject to U.S. income tax only on U.S. source income. Because the term "effectively connected" is a brandne.w term having vast implications to companies such as ours with worldwide foreign 443 PAGENO="0454" 132 FOREIGN INVESTORS TAX ACT OF 1965 operations, we earnestly request that you hold public hearings on this bill. Very truly yours, AUGUSTUS W. KELLEY, Vice President and Taa~ Counsel. CHRYSLER CORP., February 23,1966. Subject: H.R. 11297-The Foreign Investor's Tax Act. Hon. WILBUR D. MILLS, Chairiman, Hause Ways and Means Committee, Ww~hington, D.C. DEAR CONGRESSMAN MILLS: Several of the provisions of H.R. 11297 have come to our attention, which provisions, after careful study, we respectfully request be amended as follows: I. That section 8(c) be amended by adding at the end thereof the following new subsection: "(3) For purposes of this section, the term `debt obligation' shall not include the debt obligation of a United States person, as defined in section 4920(a) (4), which derives less than 20 percent of the gross income from sources outside the United States for the 3-year period immediately preceding the close of its taxable year or for such part of such period as may be applicable." This amendment would facilitate the obtaining of funds abroad by U.S. businesses for their overseas capital requirements. II. That the following language of proposed sections 881 and 882 "effectively connected with the conduct of a trade or business within the United States" be deleted and that the present language in such sections be restored. The proposed .new language, "effectively connected," is too vague and uncertain and would compound the uncertainty and confusion already caused by section 482. The present rules are precise and per- mit taxpayers to know the source of their income. In competitive business dealings, it is important for companies to know what coun- tries are going to tax their income. Your consideration of the above recommendations will be deeply appreciated. Yours very truly, BRIAN T. O'KEEFE, Manager, Tax Department. CLARK EQUIPMENT Co., Buchanan, Mich., February 21, 1966. Re House bill 11297. Hon. WILBUR D. MILI4s, Chairman. Committee on Ways and Means, House of Representatives, Washington, D.C. M~ DEAR MR. MILLS: It is our opinion that this bill, at is is written today, will create some very serious problems for American industry if it is allowed to become law. We object to the bill not only for tax 444 PAGENO="0455" FOREIGN INVESTORS TAX ACT OF, 1965 133 reasons, as it might affect our company, but also because we do not believe that it will have the desired beneficial effect on the balance of payments or make investment in the United States more appealing to foreign investors. The language of House bill H.R. 11297 is so vague that it is difficult *to determine what it means and what it will accomplish. Yet, at the same time the language is so broad in application, that a reasonable interpretation of it indicates that the "effectively connected" prin- ciple could result in inequitable taxation of foreign income earned outside the United States by foreign manufacturing subsidiaries of US. corporations. In other words, double taxation of income could easily result from the provisions of this bill. We respectfully request that public hearings be held so that the true significance and possible impact &f the provisions of H.R. 11297 will become clear to you before you ~ormally act on the administration's request that the bill be passed by Congress. Sincerely yours, R. F. SUMERWELL, Ta~ Manager. CONTINENTAL ILLINOIS NATIONAL BANK & TRUST Co. OF CHICAGO, OFFICE OF CHAIRMAN OF THE BOARD, Chicago, III., January 19, 1986. Hon. WILBUR D. Mu~s, How~e o/ Representatives, Washington, D.C. DEAR MR. Mmi~s: The Foreign Investors Tax Act of 1965 (H.R. 11297) which has recently been referred to the Committee on Ways and Means contains a number of desirable provisions designed to promote foreign investment in the United States by removing tax barriers. It is regrettable that the bill also proposes changes in the present U.S. income tax treatment of deposits of nonresident aliens in U.S. banks and in their branches abroad. These deposit provisions would have a serious adverse effect on the ability of American banks to attract and~ maintain deposits from foreign sources and would result in a large outflow of funds from the United States. I am sure you will agree that this would not be in furtherance of our national objective to im- prove the U.S. balance-of-payments position, which is the primary aim of the proposed legislation. Those sections of the new bill imposing a withholding tax on the interest earned by foreigne~ra.~o~i deposits in U.S. banks would in- evitably cause a large outflow of funds from the T nited States. Our experience shows that foreigners are very much aware of U.S. taxes and deposits would simply be transferred to Canadian, European, and other foreign banks in order to avoid the withholding tax. Thus, no additional tax revenue would be provided by the legislation. In fact, the proposal would probably result in a revenue loss to the Government since U.S. banks would have less available deposit funds from foreign 445 PAGENO="0456" 134 FOREIGN INVESTORS TAX ACT OF 1965 sources and therefore would generate less profit subject to U.S. tax. Although the provisions would not take effect until 1971, there would without doubt be an earlier withdrawal of deposits. One provision of the bill exempts foreign currency deposits in branches abroad but subjects U.S. dollar deposits to the tax. This provision would result in the complete disappearance from U.S. branches of dollar deposits and a large outflow of dollars from the United States to Europe. Dollar deposits maintained by non-U.S. residents in U.S. branches abroad represent extremely large sums, reaching into the hundreds of millions of dollars. In the case of our bank, more than half of the dollar deposits maintained in our London branches in the year 1965 were held by the branches in an interbranch account with our head office. No doubt, a similar situation exists in other U.S. banks. The balance of the dollar deposits of our branches, those not transferred to the United States, are used for financing in Europe or for activities of our branches in the United Kingdom. In the event the dollar deposits of our London branches were transferred to other banks, we would be forced to transfer substantial sums abroad to maintain our branch operations. We recognize that the proposed legislation is not designed to apply a withholding tax to all deposits from abroad. Time deposits from foreign official institutions would continue to be exempted and de- mand deposits (which do not earn interest) would not seem to be affected. However, there is a strong interrelationship between the various types of foreign, deposit accounts and our foreign financing activities. The disappearance of interest-bearing U.S. dollar deposits from private sources would substantially reduce the funds `we lend abroad. As a consequence demand deposits related to `foreign fi- nancing would be reduced, as would time deposits from official institu- tions which are frequently held with us as compensating balances in connection with foreign loans. About 95 percent of our dollar de- posits in London comes from commercial banks; these would be di- rectly subject to the withholding tax. About the same percentage of our foreign time deposits in the United States comes from official institutions; while these would continue to be exempted, the indirect result would be a reduction in official time deposits. It is surprising that a bill `which was designed to improve the U.S. balance of payments should contain new withholding tax provisions which would make it unattractive for foreigners to maintain interest- bearing dollar deposits with U.S. banks and would thus inevitably have an adverse effect on our balance of payments. H.R. 11297 would remove the withholding tax exemption on deposits of nonresident aliens, which has been part of the law since 1921 and which we under- stand was designed to encourage foreigners to transact financing busi- ness through U.S. banks. I feel sure that you will agree that the bill should be modified to exclude its present provisions for applying a new withholding tax on the interest earned by foreigners on deposits with U.S. banks. Sincerely, DAVID M. KENNEDY. 446 PAGENO="0457" FOREIGN INVESTORS TAX ACT OF 1965 135 COUDERT BROS., ATTORNEYS AND COnNSEI~RS AT LAW, New York, N.Y., February 14,1966. Mr. Wiunm D. MILLS, Chairman, Committee o~n Ways and Means, Howse of Representatives, Washington, D.C. DEAR MR. MILLS: We have noted with interest the proposed changes to the Internal Revenue Code as set forth in H.R. 11297 (Foreign Investors Tax Act of 1965). In view of the far-reaching changes proposed in this act, which iii- elude the introduction of certain new and undefined concepts, it is respectfully submitted that your committee schedule hearings before the act is approved and sent to the House of Representatives. The dimension of the changes and unforeseen effects of the "effec- tively connected" concept are so great .as to make hearings on the sub- ject an absolute necessity. It is my underst.anding that the Committee on Foreign Tax Problems of the Tax Section of the American Bar Association is preparing comments on the act which are in the process of completion. I am sure that these comments as well as other public comments that can be considered at open hearings will be of great interest to your committee and, accordingly, hearings should be scheduled. Respectfully yours, E. A. Do1~nNIANNI, Esq. DAvIs, Poi~, WARDWELL, SUNDERLAND & KIENDL, New York, N.Y., February ~4, 1966. Hon. WILI3tTR D. MILLS. Chairman. Committee on Ways and Means, Home of Representatives, Washington, D.C. DEAR SIR: This letter èomments on two aspects of H.R. 11297 now before your committee. It. is respectfully submitted that those provi- sionsof the bill dealing with gain from the sale of collapsible corpora- tion stock, original issue discount and interest paid by foreign branches of domestic banks should be reexamined in the light of the technical and policy questions which they raise. I Technical and Policy Problems Suggested by Proposal To Tax Gain From the Sale of Stock in Collapsible Corporations and Original issue Discount on the Same Basis as investment income There is no published explanation of the proposal to amend Section 871(a) (1) to provide a new subparagraph (C) and amend section 881 (a) to provide a new paragraph (3) taxing section 341 gains and section 1232 gains realized by nonresident aliens and foreign corpora- tions as if they were investment income. The application, of these provisions to the two classes of income require separate considera- tion, for the classes of income themselves present different problems. Presumably, both categories of income have been equated with those 447 PAGENO="0458" 136 FOREIGN INVESTORS TAX ACT OF. 1965 Items of pseudo capital gain already taxed to nonresident alien individuals and foreign corporations as investment income would be. However, lumping these two classes of income with investment in- come produces technical problems which the bill does not resolve. Moreover, this treatment appears to overlook policy problems which are interlocked with the technical problems. TECHNICAL PROBLEMS OF ENFORCEMENT The bill would amend section 1441(b) to revise the definition of items subject to withholding, but would not require withholding out of section 341 or section 1232 gains which would be taxed by the amended sections 871 and 881. Therefore, as the bill stands, there seems little prospect that the law taxing these gains would be enforced effectively. At the same time, it must be conceded that to require withholding from section 1232 gains would be cumbersome and to require withholding from section 341 gains would not only be burden- some, but could result in serious and unjustified penalties on domestic taxpayers. Withholding from section 1232 gains would be mechanically diffi- cult in even the simplest case, since the section 1232 gains realized by various taxpayers who sell bonds of a single series on the same day will vary according to their holding periods. More important, sec- tion 1232 applies only when a creditor has, overall, realized a gain from a sale of a debt instrument ~r upon its retirement. Accordingly, a withholding agent would be unable to compute the section 1232 gain of a seller (or holder at maturity) even if he knew the creditor's holding period and the total original issue discount inherent in the debt instrument at its inception. The withholding agent would have to know the taxpayer's basis as well. To apply the rules of section 1441(c) (5) to withholding on section. 1232 gains would be an extremely harsh remedy, completely incon- sistent with the basic purpose of the bifl. A modified version of the rule of section 1441(c) (5) could be drawn to require that 30 percent of all the original issue discount inherent in a debt instrument (not 30 percent of the proceeds from its sale or retirement) be withheld unless the creditor provided the withholding agent with the data concerning his holding period and basis required to make the necessary com- putations. Even a withholding tax based on the principle of section 1441(c) (5) could be avoided readily in most cases by foreign holder A selling a U.S. debt instrument originally issued at a discount to foreign holder B outside the Unite.d States. B would thereby be placed in a position in which he could present the instrument for payment or sell it in a U.S. market, with a full disclosure of all facts relevant to his owner- ship but avoid withholding almost completely because the section 1232 gain allocable to his ownership would be minute. There would seem to be no practical method of guarding against this. In particu- lar, full withholding levied against the last foreign holder, leaving him to recoup against his assignors and his assignors' predecessors would often produce more tax than would be due from a series of domestic holders all taxable at 30 percent, since some of the remote holders may have been people who have realized overall losses from 448 PAGENO="0459" FOREIGN INVESTORS TAX ACT OF 1965 137 their investments and who would, therefore, never have been subject. to section 1232 tax had they been residents.1 Most important, the excessively harsh results of such a system to unwary foreigners who were ultimate holders of a discount instrument would certainly drive away foreign investments in U.S. securities. The mechanical complexities involved in withholding from section 341 gains would be much greater when account is taken of the endless intricacies of sectiOn 341(d) and section 341(e). It seems clear that a withholding requirement would present problems of administration infinitely more complex than those which can be anticipated from withholding on those pseudo capital gains which are presently sub- ject to section 1441. Beyond the mechanical complexities it would produce, the applica- tion of a withholding rule to section 341 gains would, inevitably, in- volve disputes as to the basic applicability of the taxing,section. Pre- sumably, a withholding agent could avoid these by withholding 30 percent of the proceeds of a sale transaction as if section 1441 (c) (5) were applicable even if it were not specifically made so. However, if a withholding requirement were introduced, it would be inevitable that some Americans who purchased stock from foreign sellers would realize only after the event, and to their sorrow, that they had bought stock in a collapsible corporation from a foreigner and had become personally liable for a withholding tax. When this occurred, it would almost certainly occur under circumstances in which the foreign seller would be unavailable and the American purchaser would find it im- possible to marshal evidence to defend against the applicability of the tax and impossible to recoup withholding tax from the person to whom it was in truth chargeable. Although a rule applying with- holding to section 1232 gains would certainly not produce as many dis- putes over the basic applicability of the law as a requirement to with- hold from section 341 gains would, there are substantial areas in which there is doubt whether original issue discount is inherent in a debt instrument (for example, if a debt instrument is given in payment for property purchased). For all the above reasons, it seems both impractical and inequitable to extend section 1441 to require Americans to withhold on section 341 or section 1232 gains taxable toforeigners under the proposed amend- ments to sections 871 and 881. Thus, while the proposed extensions of sections 871 and 881 cannot be enforced effectively in their present form, it also seems unlikely that they could be enforced practically through withholding. It seems fundamentally wrong to enact any statute taxing foreigners if it can be anticipated that the statute can- not be thoroughly and equitably enforced. TECHNICAL AND POLICY PROBLEMS SUGGESTED BY THE SOURCE RULES The application of the source rules of the code suggests technical problems involved in an attempt to tax gains in the sale of collapsi- ble corporation stock and original issue discount as investment in- 1 Were a withholding tax imposed on the lines suggested, some of the prior holders might be U.S. citizens or residents not subject to withholding who had long since paid the tax allocable to those portions of the original issue discount Inherent In the instrument which were realized by them at the termination of their holding periods. 449 PAGENO="0460" 138 FOREIGN INVESTORS TAX ACT OF 1965 come. A consideration of these technical problems suggests funda- mental policy questions about the proposed statutory amendments. It seems clear that gain from the sale of a collapsible stock has its source at the place where the stock is sold. Accordingly, the pro- posed amendments to sections 871 and 881 could easily be avoided by a knowledgeable foreigner simply by selling his collapsible stock abroad. Thus, in so far as they apply to section 341 gains, the amendments would do little more than create a trap for the unwary. It is interesting to note that section 341 is not drawn with reference to U.S. individual income tax on the shareholders of the collapsible corporation. (Compare section 341(b) (1) with section 532(a) drawn to achieve a fundamentally similar purpose.) Taking the statute liter- ally, there seems no bar to regarding a foreign corporation as collap- sible even though it has had no contact whatever with the United States until the day its sole shareholder brings the certificate rep- resenting its stock into this country to sell it to an American purchaser. If that conclusion is correct, the bill would tax a Frenchman who sold the stock of a French corporation operating in France to an Amer- ican at a closing in the United States if the French corporation met* the collapsible tests. As a bare minimum, the bill should be revised to make it clear that this cannot occur. The basic statutory pattern of section 341 perhaps implies that gain from collapsible stock should be considered to have as its source the place which would have been the source of the collapsible corpora- iion's gain had it realized its income at the corporate level. Such a highly specialized source rule would certainly require extensive amend- ments of sections 8.1 et seq. based on assumptions about where unreal- ized gain would have been realized had it been realized. It is difficult to imagine that even the most elaborate provisions would function well in their application to any collapsible corporation other than one which was almost solely a real estate corporation. The bill treats section 341 gains and section 1232 gains as if they presented identical technical problems in the context of the bill. As noted above, they would produce somewhat different problems were an attempt made to enforce the tax by withholding. The technical differences between the classes of income becomes even clearer when source of income problems are considered. It seems clear that original issue discount taxable under section 1232 has a hermaphroditic character for income tax purposes. It is not subject to withholding because it is neither interest nor fixed or determinable annual or periodical income. Nonetheless, its functional equivalence to interest has required that discount income arising from a debt instrument be treated as income from the same source as stated interest paid or accrued on the same debt instrument. See appendix A. Accordingly, it seems clear that the amendments to sections 871 and 881 would tax only those original issue discounts realized on the obligations of debtors whose stated interest payments would have a U.S. source. Ibid. Although the conclusion from the authorities seems clear, the proposed amendments to sections 871 and 881 should not be enacted unless an explicit source rule for original issue discounts is made a part of the bill. 450 PAGENO="0461" FOREIGN INVESTORS TAX ACT OF 1965 139 GENERAL COMMENT If the TJnited States lack general jurisdiction over a person realiz- ing income from U.S. sources, it simply cannot make a seamless web of the tax law applicable to him unless it adopts wit.hholding rules so harsh and impractical that they will cripple ordinary business transactions and drive bona fide foreign investors away from the United States. Upon analysis, it seems that section 341 and section 1232 (particularly the former) cannot apply fairly and effectively to foreigners over whom we do not have personal jurisdiction. Under these circumstances, it seems preferable to admit the deficiency and devote administrative and legislative effort to other problems which are more pressing than the closing of theoretical gaps which these provisions of the code may present. II Policy Problem Suggested by Proposed Am~endnient of the Source Rule for Interest Paid by Foreign Branches of Domestic Banks The events of the last 6 months have demonstrated that the existing Source rule for commercial bank interest puts U.S. banks operating abroad through branches at a disadvantage in coniparison with for- eign banks and those U.S. banks which operate through foreign sub- sidiaries rather than branches. U.S. corporations attempting to com- ply with the President's balance-of-payments objectives have raised extensive funds by long-term borrowings in European capital markets on the bonds of their financing subsidiaries so that the financing of their offshore operating subsidiaries may be accomplished without a dollar drain. Pending their ultimate use, the proceeds of these so- called Eurodollar bonds have been placed on short-term interest-~bear- ing deposit. The financing subsidiaries which are the issuers of Euro- dollar bonds must, as a practical matter, limit their income to foreign Source income.2 Accordingly, Eurodollar bond proceeds have been placed with foreign banks or the foreign affiliates of U.S. banks, depriving the foreign branches of U.S. banks of substantial business which they could have attracted under other source rules. The proposed new section 861 (a) (1) (D) would amend the interest source rifles so that interest paid on foreign currency deposits by a foreign branch of a U.S. bank would be foreign source income. How- ever, this would not substantially, ameliorate the practical disadvan- tage imposed upon foreign branches of U.S. banks by the present source rule, since the principal completitive area in which the existing rules create a disadvantage is one in which dollar deposits are in- volved. It is submitted that the last clause of the proposed section 861(a) (1) (D) should be deleted and it should provide that any in- terest paid by a foreign branch of a U.S. corporation will be regarded as foreign source income so long as the foreign branch itself is en- gaged in a commercial banking business and the interest paid is on an obligation incurred in the course of that business by that branch. Very truly yours, ________ JOHN P. CARROLL, Jr~, Esq. 2 These financing subsidiaries would be required to withhold U.S. tax on their interest payments if they did not realize more than 80 percent of their income from foreign sources. Sec. 8&1(a) (1).. European investors have been willing to Invest In their debt instruments only on the condition that these financing subsidiaries Indemnify the investors for with- holding from them. Accordingly, withholding liabilities would be borne not by the Euro- pean Investors but by the financing subsidiaries. 451 PAGENO="0462" 140 FOREIGN INVESTORS TAX ACT OF 1965 APPENDIX A SOtrRCE OF ORIGINAL Issm~ DISCOUNT INCOME Under sections 861 (a) (1) (B) and 862 (a) (1) of the Internal Reve- nue Code, the source of "interest" received from a domestic corpora- tion may be either domestic or foreign. Interest paid by a domestic corporation constitutes income from sources without the United States if the corporation which paid it derived less than 20 percent of its gross income from united States sources during the three year period ending with the taxable year in which the interest was paid, or the lesser period since it was incorporated. Otherwise, interest paid by a domestic corporation constitutes income from sources within the United States. The purpose of this, memorandum is to demon- strate that the source of original issue discount income is determined in the same manner as "interest". 1. UNDER CASE LAW AND RULINGS ORIGINAL ISSUE DISCOUNT HAS BEEN EQUATED WITH INTEREST Where a debt instrument provides for a fixed return upon the money loaned payable at regular intervals by the borrower, those payments are customarily referred to as "interest". Where some or all of the return is provided instead by a lesser amount of money being loaned than the principal amount payable at maturity, the difference between principal and the amount loaned constitutes "origi- nal issue discount".1 Original issue discount thus performs the same function as stated interest by providing the lender a fixed return upon his loan. The functional equivalence of interest and original issue discount for income tax purposes is inherent in the definitions of "interest"' that have been `employed for income tax purposes. For example, the Supreme Court has characterized "interest" as: "~ * * the amount which one has contracted to pay for the use of borrowed money" and as: * * compensation for the use or forbearance of money." Old Colony Railroad Company v. Com'imigsioner, 284 U.S. 552, 560 (1932); Deputy v. du Pont, 308 U.S. 488,498 (1940)., Original issue discount clearly fulfills the function of "interest" as so defined. Similarly, § 1.543-1 (b) (2) of the Income Tax Regulations, describ- ing personal holding company income, ~provides that: "The term `interest' means any amounts, includible in gross income, received for the use of money loaned". See also Regulations § 1.856-2(c) (2) (ii), respecting real estate in- vestment trusts, providing that "interest" includes "only the amount which constitutes lawful interest for the loan or forbearance of money." Because original issue discount performs the same economic func- tion as interest, it has consistently been held that absent a compelling reason (not present here) for differentiating between the two forms of income, earned original issue discount is governed by the same rules `The term "original issue discount" as used in this memorandum is employed in the sense mentioned, except where the context indicates that the section i232(b) (i) definition is intended. The principal difference in the two definitions is that section 1232(b) (1) excludes discount of less than ~4 % a year. 452 PAGENO="0463" FOREIGN INVESTORS TAX ACT OF 1965 141 as interest for income tax. purposes. The precedents directly in point are reviewed under the following topic. Authorities equating original issue discount income with interest under other sections of the Code are then discussed. Finally, reference will be made to legislation which demonstrates a Congressional intent that earned original is- sue discount and interest be treated in the same manner. A. Authorities as to the Source of Original Issue Discount Income Hold That the Source iA the Same as for Interest The question of the source of original issue discount income was considered by the Service in I.T. 2330, VT-i C.B. 76. Tinder section 233 of the Revenue Act of 1926, as under section 882(b) of the Internal Revenue Code, foreign corporations were subject to tax only upon domestic source income. Section 217(a) (1) of the 1926 Act, like sec- tion 861 (a) (1) (B) of the Code, provided that "interest" from domes- tic corporations deriving 20 percent or more of their gross income from United States sources constituted United States source income. The question posed was whether this latter section was determinative of the source of income received by a foreign corporation which had purchased, and held to maturity, bankers acceptances issued at a dis- count by United States corporations which derived at least 20 percent of their gross income from this country. T.T. 2330 held that irrespective of where payment was made at ma- turity, the source of income was to be determined in the same manner as interest and that therefore the taxpayer had received United States source income subject to tax. In equating the source rules for original issue discount income and interest, it was stated that: "~ * * It is believed that the gain derived upon the receipt of the principal at maturity of an interest-bearing obligation which was pur- chased at a discOunt should be regarded as having the same source as interest; that is, that the source of income depends upon the status of the obligor. * * ~" VT-i 0.11. at page 77. Prior to I.T. 2330 the Service had concluded that for withholding tax purposes appreciation upon bankers acceptances did not constitute "interest" or other "fixed or determinable annual or periodical in- come" under the sections corresponding to sections 1441 and 1442 of the Code; requiring withholding upon such types of United States source income paid to nonresident aliens and foreign corporations not in business here. 0.1024, 2 C.B. 189; T.T. 1398, 1-2, C. B. 149. These rulings would appear to have been based largely upon the practical consideration that since the amount of original issue discount income cannot be determined unless the purchase price of the obligation is known, a contrary conclusion would have resulted in withholding agents often being unable to compute the tax to be withheld. Tinder section 231 (a) of the Revenue Act of 1936, United States source income of foreign corporations not in business in the United States was, for the first time, subject to tax only if it was of a type that was also subject to withholding, that is, "fixed or determinable annual or periodical gains, profits, and income." This limitation is now embodied in section 881 (a) of the Code.2. As a consequence, even though under I.T. 2330 the source of income from bankers acceptances 2 A like limitation applies to United States source income of nonresident alien mdi- viduals not engaged in trade or business In this country. 1936 Revenue Act, § 211(a); code § 871. - 453 PAGENO="0464" 142 FOREIGN INVESTORS TAX ACT OF 1965 issued by United States corporations at a discount is domestic, it no longer is taxable to foreign corporations not engaged in trade or business in this country. It is clear, however, that the characterization of original issue dis- count income for this purpose does not carry over to the source rules. This conclusion, follows not only from I.T. 2330-which was promul- gated after 0.1024 and I.T. 1398-but from the fact that I.T. 1398 had itself spelled out that the source rule was different than the with- holding rule. I.T. 1398 held in part, that: ~ * * where an agent in this country of a foreign bank, a corpora- tion not having an office or place of business in the United States, purchases in this country bank acceptances at a certain rate of dis- count, and sells such acceptances for a price greater than the price for which purchased, the amount of gain received as the result of the transaction represents income from sources within the United States but not such income as is subject to withholding. * * *~Y 1-2 C.B. 149. See also O.D. 890,4 C.B. 114, holding that gain realized by a foreign corporation or nonresident alien not in business in the United States upon the retirement of bonds of a foreign government or foreign cor- portions, regardless of whether payable at maturity abroad or in the United States "is in neither case derived from sources within the United States and, therefore, is not taxable." Only a single court decision has been found dealing with the source of earned original issue discount, He7~ering v. Stein, 115 F. 2d 468 (4th Cir. 1940), aff'g 40 B.T.A. 848 (1939), nonacq. 1940-1 C.B. 8, and the decision also accords with the source rules followed in the above rulings. Taxpayers in Stein were members of a German bank- ing firm which dealt in negotiable instruments issued by the firm's customers in Germany. A transaction began by the firm acquiring a draft drawn by a customer for an amount less than face; that is, the firm acquired the paper at a "discount". It then transmitted the draft to New York where a United States bank "accepted" it by agreeing to pay the face amount. Immediately after "acceptance" the taxpayers' firm sold the paper either to the accepting bank or to a third party for an amount greater than it had paid for the draft but still less than face. The "discount" on the sale after acceptance reflected the accepting bank's credit, since it had become the principal obligor. The firm had secured this credit through agreeing to pay the bank a fee for accept- ing the draft. and by agreeing to repurchase all drafts presented to the bank at. face two days before maturity. The Commissioner argued that the members of the banking firm realized income from United States sources under the source of income rules governing the purchase and sale of property, since the firm had "purchased" drafts outside the United States and resold them in the ITnited States. The Board held that the income was not taxable be- cause the acquisition was not a "purchase." 40 B.T.A. at pp. 853, 855. The Court of Appeals decision made this same mechanical point. 115 F. 2d at pp. 411, 472. However, the Court of Appeals went further and pointed out that the essence of the entire transaction was that the taxpayers' firm had advanced funds to its customers in Germany at a rate exceeding the costs of the firm's financing those advances in the United States. Accordingly, 454 PAGENO="0465" `FOREIGN INVESTORS TAX ACT OF 1965 143 * * The profit of the taxpayers was realized by virtue of the fact that t.hey lent the money in Germany to their local customers at a much higher rate of interest than the taxpayers were compelled to pay to the New York Bank." 115 F. 2d at page 472. The Court of Appeals decision in Stein stands for the same proposi- tion as I.T. 2330. That is, that since original discount income is the functional equivalent of interest, the source of earned original issue discount is whatever would have been the source of stated interest were such interest paid by the obligor. B. Authorities in Other Areas Treat Origi~nal Issue Diecount Inconie the Same a~s Interest 1. Gain attributable to original i&sue discount co'iutitutes ordinary income and not capital gain The alternative to treating earned original issue discount as interest is to view the income as gain from the sale or exchange of property. If so viewed, sections 861 (a) (1) and 862(a) (1) of the Code, dealing with the source of interest income, would not apply and source would be determined under the source rules pertaining to the sale of personal property. See Code Section 861(a) (6) and lRgs. § 861-7(a). in United States v. Midland-Ross Corp., 381 U.S. 54 (1965) and Dixon v. United States 381 U.S. 68 (1965) the Supreme Court con- sidered in a different context this same question of whether original issue discount income should be taxed as interest or as gain from the sale of property. Both cases involved taxpayers who had purchased non-interest-bearing promissory notes from the issuers at prices below the face amounts of the notes and had sold the notes at a profit in a year prior to enactment of the provisions of section 1232 of the 1954 Code taxing earned original issue discount as ordinary income. The tax- payers claimed capital gains treatment under section 117(a) of the Internal Revenue Code of 1939, corresponding to section 1222 of the 1954 Code, which provided in part, that gain from the "sale or ex- change of a capital asset" held for more than six months constitutes long-term capital gain. The Court denied capital gains treatment in both instances, resting its opinion primarily upon the functional identity of original issue discount income and interest. It reasoned: "Earned original issue discount serves the same function as stated interest, concededly ordinary income and not a capital asset; it is simply `compensation for the use or forbearance of money.' Deputy v. Du Pont, 308 U.S. 488, 498; of. Lubin v. Commissioner, 335 F. 2d 209 (C.A. 2d Cir.) * * * The $6 earned on a one-year note for $106 issued for $100 is precisely like the $6 earned on a one-year loan of $100 at 6% stated interest. The application of general principles would indicate, therefore, that earned original issue discount, like stated interest, should be taxed under §22(a) as ordinary income." ~ United States v. Midland-Ross Corp., 381 U.S. at pp. 57-58. 3 In view of the decisions in Midkrn4-Ross and Dio'on~ it may be desirable for the Service to reconsider O.D. 534, 2 C.B. 103. O.D. 534 held that (1) the collection at maturity by foreign corporations. and nonresident alien individuals of British Treasury bills purchased by them in the United States at a discount constitutes income from sources outside the United States, whether collected in a foreign country or from a British paying agent in the United States, whereas (2) profit upon sale of the same bills in the United States consti- tutes United States source income. It is believed that the latter holding can be reconciled with Midland-Ross and Diccon only insofar as the profit Is assumed to arise from apprecia- tion of the securities due to a change In market conditions and cannot be reconciled insofar as the profit is attributable to the approach of the maturity date of the bills. 7 1-297 0-67-pt. 1-30 455 PAGENO="0466" 144 FOREIGN INVESTORS TAX ACT OF 1965 This reasoning is equally applicable to the question of the source of original issue discount income and, it is submitted, requires that the source of such income, like interest, be determined by the status of the payer. ~3. Earned original issue discount upon State and local obligations constitutes tax-free interest Section 103(a) of the Code exempts "interest" on state and local obligations from income tax. Where a state or municipality issues its bonds at a discount, the question arises whether a taxpayer who has purchased the bonds may treat as exempt under section 103 (a) that portion of his gain upon sale or redemption of the bond as is attribut- able to the period he held it. The Service has long answered this question affirmatively. G.C.M. 10452, XI-1 C.B. 18; I.T. 2629, XI-1 C.B. 20; G.C.M. 21890, 1940-1 C.B. 85; Rev. Rul. 60-210, 1960-1 C.B. 38. As stated in Rev. Rul. 6Q- 210, the ruling position of the Service has been that: ~ * * discount at which bonds and similar obligations were issued constitutes compensation (where noninterest-bearing), or additional compensation (where interest-bearing), which the obligor had con- tracted to pay for the use of the money loaned and, hence, was equiva- lent to interest for Federal income tax purposes. * * ~" 1960-1 C.B. at page 39, emphasis in the original. The approach of the Service, exemplified in the quoted passage from Rev. Rul. 60-210, coincides with the rationale of the Midlac'wZ -Ross and Dixon decisions. As suggested under the preceding heading, the same considerations apply with equal force in determining the source of original issue discount income. 3. Where a corporation sells its bonds it may amortize ariginal issue discount and deduct the amount amortized over the life of the bonds in the same manner as annual interest Section 1.61-12(c) (3) of the Income Tax Regulations provides, in pertinent part, that: "If bonds are issued by a corporation at a discount, the net amount of such discount is deductible and should be prorated or amortized over the life of the bonds. * * *~ This Regulation is another example of the general rule that original issue discount is to be treated as interest for income tax purposes. As explained by the Supreme Court in a case allowing deduction of amortization of bond discount and of related commissions incurred in marketing the bonds: "Both commissions and discount, as the Government concedes, are factors in arriving at the actual amount of interest paid for the use of capital procured by a bond issue. The difference between the capital realized by the issue and par value, which is to be paid at maturity, must be added to the aggregate coupon payments in order to arrive at the total interest paid. * * ~ Helvering v. Union Pa~ifle. Railroad Company, 293 U.S. 282,286 (1934). 4. Original issue discount income is treated as interest for personal holding company purposes Under Section 543 (a) (1) of the Code, "personal holding company income" includes "interest". As noted earlier in this memorandum, the Regulations under Section 543 provide that: 456 PAGENO="0467" FOREIGN INVESTORS TAX ACT OF 1965 145 "The term `interest' means any amounts, includible in gross income received for the use of money loaned. * * ~ Regs. § 1.543-1 (b) (2). In Mayflower Investment Company v. Commissioner, 239 F. 2d 624 (5th Cir. 1956), affirming 24 T.C. 729 (1955), the Court held that the difference between an amount loaned by the taxpayer and the greater amount payable to it upon maturity of the note constituted "interest" for this purpose. As a consequence, the taxpayer was held to be a personal holding company and was subject to personal holding com- pany tax. In construing the word "interest" as extending to the income in question, the Court relied upon Section 29.503-2 of Regulations 111 under the 1939 Code, containing the language above quoted from the present Regulations § 1.543-1 (b) (2), and upon the Supreme Court's definition in Deputyv. du Pont, 308 U.S. 488, 498 (1940), supra, that "interest" is "compensation for the use or forbearance of money". C. Congress Has Manifested an Intent That Earned Original Issue Discauint Should be Treated as Interest Evidence that Congress considers gain from obligations issued at a discount to be governed by the source rules for interest is furnished by section 861 (a) (1) (C) of the Code. Section 861 (a) (1) provides that "interest" upon domestic obligations constitutes income from sources within the United States, with certain exceptions, of which the last is: "(C) income derived by a foreign central bank of issue from bankers' acceptances." The assumption of Congress in enacting section 119(a) (1) (C) of the Rvenue Act of 1928, which was the statutory predecessor of the present rule, appears to have been that without special legislation, the acceptances of United States bankers would produce United States source income in all cases. H.R. Rep. No. 2, 70th Cong., 1st Sess. 21 (1927); 5. Rep. No. 960, 70th Cong., 1st Sess. 29 (1928). At the tim~ of that enactment foreign central banks could not rely upon the rulings holding that such income was not "fixed or determinable an- nual or periodical gains, profits and income" since, until the Revenue Act of 1936, the failure of United States source income to fit that de- scription only relieved the withholding agent from the c~bligation to withhold and did not provide an exemption to the ultimate recipient. See I.T. 1398,1-2 C.B. 149, supra. More recently Congress has demonstrated on various occasions that except where, as in section 861 (a) (1) (C), it has provided otherwise, it considers that original issue discount income is to be treated the same as interest for income tax purposes. A prominent example of the congressional design that the two forms of income be equated is pro- vided in section 1232 of the 1954 Code. Subsections (a) (2) and (b) of Section 1232 were enacted in the Revenue Code of 1954 to provide rules governing the taxation of amounts received on the sale, exchange or retirement of post-1964 ob- hgations issued at a discount. Section 117(f) of the 1939 Code had provided that amounts received upon retirement of bonds were to be considered as "received in exchange" for the bonds. With Section 117(f) as the starting point, it was logical to include the new pro- visions among those relating to capital gains and losses, and to state the general rule and the exceptions thereto in terms of gain from the 457 PAGENO="0468" 146 FOREIGN INVESTORS TAX ACT OF 1965 sale or exchange of property. The Committee Reports indicate clear- ly that original issue discount was viewed as interest income; the phrase "gain from the sale or exchange of property which is not a capital asset" employed in section 1232(a) (2) to describe the treat- ment of income to which the new provisions applied was intended to assure that earned discount would be reported as ordinary income and not as capital gain. H. Rep. No. 1337, 83d Cong., 2d Sess. 83, A.277 (1954) ; S. Rep. No. 1622, 83d Cong., 2d Sess. 112 (1954). For example, the Senate Finance Committee stated that: "In these cases, that part of the amount received on a sale or cx- change which may represent a partial recovery of discount on original issue is a form of interest income and in fact is deductible as an in- terest payment by the issuing corporation." S. Rep. No. 1622 at page 112, emphasis supplied; see also H. Rept. No. 1337 at page 83, embody- ing the italicized language. Section 1232(a) (2) (B) (i), which excepts discount upon tax exempt obligations from the ordinary income treatment provided by Section 1232, further demonstrates that Congress viewed original issue dis- count as a form ~f interest. Section 483 of the Code also illustrates that Congress views original issue discount and interest . income as virtually identical for tax pur- poses. This section, enacted in 1964, requires, under certain circum- stances, that the difference between the present value of an obliga- tion and the face amount thereof (an amount analogous to original issue discount) be reported as interest income when installment paper received in exchange for property bears an unrealistically low interest rate, or no interest, at all. H. Rep. No. 749, 88th Cong. 1st Sess. .73, A84 (1963); S. Rep. No. 830, 88th Cong. 2d. Sess. 101-102 (1964). Section 483 classifies the imputed discount factor as interest, where- as Section 1232 prescribes that original issue discount is to be taxed as "gain from the sale or exchange of property which is not a capital asset". The difference in terminology is due to the difference between the factors which led to enactment of the respective sections, and not to a distinction ,in the nature of the income. The confused history of Section 117(f) of the 1939 Code, whIch had been enacted to ensure that retirement of a bond would be treated as a sale or exchange, but which had been interpreted by some courts to. mean that original issue discount was a capital asset, prompted Congress to enact subsections 1932(a) (2) and (b) in 1954. Litigation in which the Internal Rev- enue Service sought unsuccessfully to impute interest when a contract did not call for it led to the enactment of Section 483. Sec Kings ford Company, 41 T.C. 646, 659 (1964), and cases cited therein. Al- though Section 483 was intended to halt "manipulation of the capital gains provisions,"4, it was more appropriate to couch the section in terms of interest than in the language of the capital gains and loss sections because it- (1) Applied to buyers as well as sellers, (2) Included transactions resulting in a loss as well as those producing gain, and (3) Included detailed standards for the determinatiOn .of un- stated interest. ~ Statement by Secretary of Treasury, submitted to House Ways and Means Committee on February 6, 1963, CCH Report 12, vol. 50, pp. 89-90; Part I, Hearings, February 6, 7, and 8, 1963, at pp. 152-156. 458 PAGENO="0469" FOREIGN INVESTORS TAX ACT OF 1965 147 Another recently enacted Code section also has an important bear- ing upon the proper characterization of original issue discount. Sec- tion 904(f) was added to the Code by section 10 of the Revenue Act of 1962 to prevent taxpayers whose foreign tax credits exceeded the allowable limitation under section 904 (prior to its amendment) from increasing the creditable amount by investing in foreign debt obliga- tions. S. Report No. 1881, 87th Cong. 2d Sess., 1962-3 C.B. 707, 778 (1962). An underlying purpose of the section was to remove "an artificial inducement to the movement of U.S. capital abroad". 1962-3 C.B. at page 778. Section 904(f) requires that in determining the limitation on credit a taxpayer compute separately, and without respect to the overall limitation, the amount of limitation on "interest income", as described in section 904(f) (2), and on all other income. "Interest" is not defined in the statute or committee reports, nor have proposed regu- lations under section 904(f) been promulgated. Section 904(f) could. be easily flouted if the Service were to con- clude that the source of original issue discount were to be determined under rules respecting gain from the sale of property rather than the rules respecting interest. A taxpayer with excess foreign tax credits would then be free to increase its allowable foreign tax credit by pur- chasing indebtednesses issued by foreign corporations at a discount and either holding the obligations to maturity or selling them abroad before maturity. Assuming the gain was not taxed, or was only lightly taxed, by the foreign country, taxpayers in this manner would be able to increase their foreign tax credits allowable under section 904 notwithstanding enactmentof section 904(f) .~ For the reasons stated above, it seems clear that the source of origi- nal issue discount income in any case is the same as the source of stated interest paid by the obligor on the discount instrument under the rules of section 861 (a) (1) (B) and 862 (a) (1) of the Internal Revenue Code. DAWSON, GRIFFIN, PICKENS & RIDDELL, Washington, D.C., February 11, 1966. MEMORANDUM To: HOn.WILBUE D~ MILLS, Chairman, Committee on Ways and Means, U.S. House of Representatives. From: JAMES W. R1DDELL. Re Europe-Dollar companies and section 904(f). Many U.S. corporations are confronted with the necessity for for- eign expansion and have been unable to do so because of the balance- of-payments problem. Several U.S. taxpayers have obtained the ~ If earned original Issue discount were not treated as interest for source of income purposes, taxpayers might also be able to increase their section 904 limitation by purchasing obligations of domestic obligors at a discount and selling the obligations abroad before maturity. Whether they would be successful would depend upon whether the courst chose to follow such decisions as Commi88ioner V. Phillips, 27?5 F. 2d 33 (4th Cir. 1960, rev'g, 30 T.C. 866 (1958),, and Arnfeldv. Commissioner, 163 F. Supp. 865 (Court of Claims 1958), cert. den. 359. U.S. 943, holdIng that sales of endowment policies shortly before maturity produced ordinary income, or followed the line of cases typified by Barber-Green Americas, Inc., 35 T.C. 365 (19fi0), acq. 1961-2 C.B. 4, 1964-2 C.B. 4, which refused to apply a "tax avoidance" exception to the rule that sales income is realized In the country where title to the property sold passes. See Regs. § 1.861-7(a). It would seem likely that where the discount obligations were sold abroad well before their maturity date. the latter cases would control and the gain would constitute foreign source income. 459 PAGENO="0470" 148 FOREIGN INVESTORS TAX ACT OF 1965 required funds by borrowing TJ.S. dollars in foreign countries. This type of financing is intended solely to assist in improving the balance- of-payments position of the United States in compliance with the voluntary cooperation program instituted by the President. It should be noted that this procedure is considerably more expen- sive than direct borrowing in the United States. This allegedly high money cost is the basis of a derivative action instituted by a stock- holder of Standard Oil of Indiana (see Wall Street Journal, Feb. 8, 1966). The preponderance of the companies obtaining funds in this man- ner have formed a new domestic corporation to issue the bonds and loan the proceeds to foreign affiliates. It is, of course, possible that withholding taxes will be imposed by various foreign countries with respect to interest paid to the financing subsidiary by the debtor for- eign affiliates. The ultimate cost of these taxes to the domestic parent and the affiliated group will depend largely upon the extent to which they may be claimed as foreign tax credit under IRC sections 901 et seq. It is possible that there may be a loss of foreign tax credit in re- spect to amounts withheld on interest payments (as described above) by reason of* the additional limitations imposed by section 904(f). This provision limits the foreign tax credit otherwise available in the case of certain interest income. It requires the segregation of such interest from all other foreign income in applying the general code limitations on the use of foreign tax credits and restricts the tax- payer to the use of the "per country limitation" in respect thereof. The following is an illustration of the loss of foreign tax credit which may result under section 904(f). Interest received by domestic finance company from for- eign affiliate (say, 6 percent of 5,000,000) $300, 000 Amount withheld at source (say, 30 percent of $300,000) -- 90, 000 Expense attributable to interest income under "per country limitation" (say, 4~/2 percent of $5,000,000) 225,000 Net income derived from foreign country 75,000 Limitation for purposes of U.S. tax (48 percent of $75,000) 36, 000 Unused foreign tax credit 54,000 Thus, in the above example, the amount withheld at source is im- posed on gross income, while the per conutry limitation is based upon net income. Section 904(f) does not apply to interest received from a corpora- tion in which the taxpayer owns directly at least 10 percent of the vot- ing stock. Therefore, it is conceivable that the impact of section 904(f) could be avoided simply by contributing to the capital of the domestic finance company 10 percent of the capital stock of all for- eigri subsidiaries from which interest income would be received. This, however, is a most undesirable alternative inasmuch as it produces a complicated and unwieldy corporate structure. It should be noted also that the contribution route may not be, avail- able in the case of second-tier foreign subsidiaries. Furthermore, section 367 poses a problem in such a corporate reorganization. *Rather than, go to the extreme of altering the corporate structure by means of capital contributions, as described above, the same result 460 PAGENO="0471" FOREIGN INVESTORS TAX ACT OF 1965 149 could be obtained if section 904(f) (1) (C) could `be amended to read as follows: "(C) Received from a corporation in which the taxpayer owns' or, if the taxpayer is a member of an affiliated group (as defined in sec- tion 1504(a), except that section 1504(b) (3). shall not apply) if an- other member of the affiliated group owns at least 10 percent of the ~voting stock * * ~" [Italic denotes additional language to be inserted in the statute.] In essence, it appears to me, that borrowing U.S. dollars in foreign markets is occasioned solely by the desire to comply with the Presi- dent's voluntary program. It appears to be highly inequitable that a substantial detriment such as loss of foreign tax credit should be a direct consequence of such compliance. Moreover, the creation of a completely unwieldy corporate structure should not be necessitated in order to avoid such loss of foreign tax credit. I shall be pleased to furnish any additional information you may require. JAMES W. RIDDELL. FIRST NATIONAL CITY BANK, New York, N.Y., December 9~7, 1965. Hon. WILBUR MILLS, Chairman, House Ways and Means Co-momittee, House of Representatives, Washington, D.C. DEAR MR. CHAIRMAN: In `late 1963, I served on a Presidential Task Force chaired by Henry Fowler, then Under Secretary of the Treasury, to examine ways and means~ of promoting increased foreign invest- ment in the securities of U.S. private companies and increased foreign financing for U.S. business operating abroad. One of the areas where we made several recommendations was in the field of taxation. These recommendations for changes in taxation of foreign investors were intended to remove elements in our tax structure which complicate investment in this country without generating material tax revenues. Our proposals were conceived to simplify the tax laws and reporting requirements applicable to foreign investors; in part, to reduce taxa- tion of foreign investors and also to make evident to the world that we welcome foreign investment. A review of the tax laws involving f or- eign investment in this country was high on our list of priorities for encouraging foreigners to make investments in our country. The latest result of our efforts in this field is the present Foreign Investors Tax Act of 1965 (H.R. 11297), which is now pending with the House Ways and Means Committee. The current version of this bill proposes changes which, in my opinion, are regressive and not in harmony with our recommendations, to wit: (1) to increase estate tax rates for nonresident alien decedents over the rates originally recoimnended, and (2) the introduction of income and estate taxation on interest earned by foreigners on their deposits in U.S. banks. We are particularly concerned with the portion of the bill which proposes a withholding tax after December 31, 1970, on interest income from de- posits of nonresident foreigners with our bank or branches of our bank in the United States or abroad. We have received a number of letters from our foreign branches overseas which point out' very 461 PAGENO="0472" 150 FOREIGN INVESTORS TAX ACP OF 1965 strongly that should such a law be enacted, our foreign branches would suffer considerable loss of dollar and foreign currency deposits as non- resident foreigners holding these deposits would merely walk across the street and put their money with Canadian, British, or European banks not doing business here and thereby avoid the tax. IDeposits of such foreigners with our head office and domestic branches would likewise be shifted to foreign banks not subject to U.S. jurisdiction. This would have a drastic effect on our balance of payments and, certainly, this was not the intention of our committee. It is also evident that there would be no gain in revenue but probably a loss of tax payable by U.S. banks on the income they would generate on such deposits if the present interest-bearing deposits seek areas outside of the United States, where such tax would not apply. We do not see any benefit from the proposed changes in this bill, while on the other hand the undesirable effects are substantial. We are, naturally, very much concerned with the adverse effects this bill in its present form would have on our deposit base both here and abroad, but just as important is the drastic effect it would have on our balance-of-payments position shOuld it be enacted. Sincerely, WALTER B. WRISTON, Executive Vice President. `HousE OF REPRESENTATIVES, Washington, D.C., January 13, 1966. Hon. WILBUR D. MILLS, Chairman of Ways an~ Means, House of Representatives, Washington, D.C. DEAR Mit. CHAIRMAN: This letter concerns H.R. 5916 and H.R. 11297 in the Foreign Investors Tax Act. It is my understanding that H.R. 11297 supersedes entirely H.R. 5916 on which hearings have already been held. It is also my under- standing that additional public hearings have not been scheduled for H.R. 11297. This bill would have a serious impact on the economy of my district and all of south Texas because of our many ties with Mexico and other Latin American areas. It seems to me that a num- ber of recent changes in the law have already hurt commerce and trade with Mexico, and* it is my strong conviction that if this trend is not reversed, irreparable damage can result. I would hope that any public hearings will be held on the new bill H.R. 11297, so that persons interested, including myself, would have a chance to express themselves on the contemplated changes in the tax laws with respect to foreign investment in the United States. As you know, the banking industry has already made a significant contribu- tion on a voluntary basis in our balance-of-trade problem. Sincerely yours, HENRY B. GONZALEZ, Member of Congress. 462 PAGENO="0473" FOREIGN INVESTORS TAX ACT OF 1965 151 NORTH MASSAPEQUA, LONG ISLAND, N.Y., February ~d1, 1966. Hon. WILBUR D. MILLS, House of Representatives, S Washington, D.C. DEAR CONGRESSMAN MILLS: Your committee now has H.R. 11297 under consideration. Originally a tax bill was recommended by the Fowler committee to reform U.S. taxation in order to stimulate foreign investment in the United States. In its present form, H.R. 11297 would reduce U.S. exports by taxing foreign purchasing entities in the United States, make it more difficult for U.S. firms to earn income on their direct foreign investments, tend to reduce foreign investment in the United States, and in general, worsen the U.S. balance-of-payments problem. H.R. 11297 introduces a radical concept of nexus in attributing and taxing the global income of a foreign corporation "effectively con- nected with" the conduct of a trade or business in the United States. The traditional source-of-income rules would give way to nebulous and vague guidelines such as whether the business activities in the U.S. are a "material factor" in generating any income of the foreign corporation. Thus, a stigma would be placed on foreign subsidiaries owned by a U.S. corporation which has an international division to provide certain managerial services. Under current law, and current practice, the U.S. corporation would charge its subsidiaries for this service or face a reallocation under section 482 of the Internal Revenue Code. This new bill would in fact attempt to attribute "income" of the foreign subsidiary to the United~ States, which subsidiary in fact conducts no real business in the United States, merely due to the general "overseeing function" of the U.S. parent who is interested in its foreign investment. These same nebulous guidelines could also encompass income of a foreign corporation who purchases in the United States for resale abroad. Under current rules the sales destina- tion is the primary source of income. It is difficult to understand how the United States could tax a foreign corporation which merely purchases goods in this country and it is even more difficult to under- stand how such a bill would help our balance of payments by dis- couraging foreign purchasers. It is our opinion that this new doctrine will contravene the tradi- tional rules of "permanent establishment" in U.S. double-tax treaties and impose almost insurmountable problems in international tax planning. If the stated purpose of the bill, "to modernize the present U.S. tax treatment of foreigners and to encourage foreign investment in the United States" is to be accomplished, its application should be limited to corporations which are majority owned by foreigners. We respectfully urge that hearings on this bill be held by the House Ways and Means Committee so that the business community can comment on the inequity of its provisions. Thank you for your consideration. CHARLES GREENBERG. 463 PAGENO="0474" 152 FOREIGN INVESTORS TAX ACT OF 1965 HUBACTIEK, KELLY, MILLER, RAnCH & KIRBY, ATTORNEYS AT LAW, Chicago, Iii., December 3, 1965. Re Section 8 of H.R. 11297. Hon. WILBUR D. Mua~s, Chairman, Ways and Means Committee, House of Representatives, Washington, D.C. DEAR MR. MILLS: It is clear that the estate tax proposals in section 8 of H.R. 11297 would not improve our balance-of-payments deficit or defend our gold reserves. On the contrary, enactment of these pro- posals would have the opposite effect. The key recommendation of the President's task force was com- plete elimination of U.S. estate taxes on all intangible personal prop- erty of nonresident alien decedents. The task force pointed out that the annual estate tax revenue loss would be negligible. H.R. 11297 effectively rejects this task force recommendation. In the first place, the task force recognized that the United States could not expect to attract substantial foreign investment in securities so long as our estate tax rates are appreciably higher than those im- posed by other countries. Even the 5- 10- 15-percent rate schedule proposed in H.R. 5916 would be higher than the corresponding rate schedules of Switzerland, France, Germany, and the Netherlands-the most prosperous countries in continental Europe. It. is inconceivable, therefore, that citizens of those countries would be encouraged to in- vest here by reason of the even higher 5- to 25-percent rate proposed by RB. 11297. In the second place, section 8 of H.R. 11297 proposes to greatly en- large the traditional estate tax base applicable to nonresident alien decedents. This would be extremely unwise and would go flatly con- trary to the stated objectives of the bill. Requiring the inclusion of corporate bonds and bank deposits in the estate tax base will not only fail to attract foreign invesment but will drive existing foreign invest- ment away. Enormous foreign cash and bond balances have built up here under existing law. If sections 8(c) and 8(d) are enacted, these balances will be withdrawn by the simple expedients of writing a check or tax-free sales. In the third place, the task force recommendations to the private sector of our economy have been adopted to a most encouraging degree. Enactment of section 8 of H.R. 11297 would represent a total failure by the Government to support the U.S. financial community in its renewed effort; to attract foreign investment. * Mr. Mills, I urge your committee to reject section 8 of H.R. 11297 and to adopt instead the task force recommendation to eliminate the estate tax on intangible personal property. The job of reducing our balance-of-payments deficit and reversing our gold drain must be ac- complished. It deserves positive and direct action by the Congress. Section 8 of H.R. 11297 obviously is not the answer. Sincerely yours, GEORGE W. RAnCH. 464 PAGENO="0475" FOREIGN INVESTORS TAX ACT OF 1965 153 HUBACHEI~, KELLY, MILLER,: RAUCH. & KIRBY, ATIORNEYS AT LAW, Chicago, Ill., February 14,1966. Re Section 8 of H.R. 11297. Hon. WILBuR D. MILLS, Chairiman, Coine~mittee on Ways and Means, House of Representatiives, Washington, D.C. DL~R CONGRESSMAN MILLS: The stated purposes of H.R. 11297 are to modernize the present U.S. tax treatment of foreigners and to en- courage foreign investment in the LTni.ted States. Section 8 of that bill, which revises the U.S. estate taxation of nonresident alien de- cedents, obviously fails to achieve these purposes. In fact, enactment of this section 8 would have a decidedly adverse effect on our balance- of-payments position. The President's task force flatly stated that the present U.S. estate tax situation constitutes one of the major deterrents to foreign invest- ment in this country and recommended complete elimination of the tax on intangible personalty owned by nonresident alien decedents. Section 8 of H.R. 11297 proposes new estate tax rates on nonresident alien decedents ranging up to 25 percent and at the same time broad- ens the present estate tax base by requiring the inclusion of U.S. cor- porate bonds (located outside~ the United States) and bank deposits, which are exempted under present law. This proposal is absurd. It carnpletely ig-nores the task force recommendation and reality. For- eigners will not be encouraged to invest more money here. Far from it. They will simply liquidate their present U.S. bond investments and bank accounts and take the proceeds abroad to escape the 11.8. tax. The result would be an immediate gold drain in the hundreds of millions of dollars. Furthermore, section 8 could have a disastrous effect on the present efforts of U.S. corporations to obtain foreign financing. For example, in 1965, U.S. corporations placed abroad a total of $339 million in Eurodollar bonds and are already placing an additional $190 million so far this year. By subjecting these bonds to possible U.S. estate tax, section 8 could seriously impair their market and force 11.5. corporations to finance their foreign operations with U.S. dollars. If the Congress really means business about wanting to improve our disastrous balance-of-payments situation, the task force estate tax pro- posal should be adopted. As a possibly acceptable alternative, estate tax rates no higher than the 5-10-15 percent scale which you proposed in H.R. 5~)16 should be adopted and the present estate tax exemption of bank account,s and bonds should be retained. I have attached a substitute version of section 8 of H.R. 11297 which reflects this out- side alternative. I urge you to recommend to your committee that either the task force proposal or this substitute for section 8 be adopted. Respectfully yours, GEORGE W. RAUCH. 465 PAGENO="0476" FOREIGN INVESTORS TAX ACT OF 1965 154 SEC. 8. ESTATES OF NONRESIDENTS NOT CITIZENS. (a) RATE OF TAx.-Subsection (a) of section 2101 (relating to tax imposed in case of estates of nonresidents not citizens) is amended to read as follows: "(a) RATE OF TAx.-Except as provided in section 2107, a tax com- puted in accordance with the following table is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States: "If the taxable estate is: The tax shall be: Not over $100,000 5 percent of the taxable estate. Over $100,000 but not over $5,000, plus 10 percent of $750 000 excess over $100,000. Over $1T50,000 $70,000, plus 15 percent of excess over $750,000." (b) CREDITS AGAINST TAx.-Section 2102 (relating to credits al- lowed against estate tax) is amended to read as follows: "SEC. 2102. CREDITS AGAINST TAX. "(a) IN GENERAL.-The tax imposed by section 2101 shall be credited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), subject to the special limitation provided in sub- section (b). "(b) SPECIAL LIMITATI0N.-The maximum credit allowed under section 2011 against the tax imposed by section 2101 for State death taxes paid shall be an amount which bears the same ratio to the credit computed as provided in section 2011(b) as the value of the property, as determied for purposes of this chapter, upon which State death taxes were paid and which is included in the gross estate under section 2103, bears to the value of the total gross estate under section 2103. For purposes of this subsection, the term `State death taxes' means the taxes described in section 2011 (a) ." (c) Dr~mTIoN OF TAXABLE ESTATE.-Paragraph (3) of section 2106 (a) (relating to deduction of exemption from gross estate) is amended to read as foflows: "(3) ExE~n'rIoN.- "(A) GENERAL RULE.-An exemption of $30,000. "(B) RESIDENTS OF POSSESSIONS OF THE UNITED 5TATE5.-In the case of a decedent who is considered to be a `nonresident not a citizen of the United States' under the provisions of section 209, the exemption shall be the greater of (i) $30,000, or (ii) that pro- portion of the exemption authorized by section 2052 which the, value of that part of the decedent's, gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated." (d) SPECIAL M~noDs OF COMPUTING `TAx.-Subchapter B of chap- ter 11 (relating to estates of nonresidents not citizens) is amended by adding at the end thereof the following new sections: 466 PAGENO="0477" FOREIGN INVESTORS TAX ACT OF 1965 155 "SEC. 2107. EXPATRIATION TO AVOID TAX. "(a) RAm Or TAX.-A tax computed in accordance with the table contained in section 2001 i~ hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every dece- dent nonresident not a citizen of the United States dying after the date of enactment of this section, if after March 8, 1965, and within the 10-year period ending with the date of death such decedent lost United States citizenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. "(b) GROSS E5TAm.-For purposes of the tax imposed by subsec- tion (a), the value of. the gross estate of every decedent to whom subsection (a) applies shall be determined as provided in section 2103, except that- "(1) if such decedent owned (within the meaning of section 958 (a)) at the time of his death 10 percent or more of the total combined voting power of all classes of stock entitled to vote of a foreign corporation, and "(2) if such decedent owned (within the meaning of section 958(a)), or is considered to have owned (by applying the owner- ship rules of section 958(b)), at the time of his death, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of such foreign corporation, then that proportion of the fair market value of the stock of such foreign corporation owned (w.ithin the meaning of section 958(a)) by such decedent at the time of his death, which the fair market value of any assets owned by such foreign corporation and situated in the United States, at the time of his death, bears to the total fair market value of all assets owned by such foreign corporation at the time of his death, shall be included in the gross estate of such decedent. For purposes of the preceding sentence, a decedent shall be treated as owning stock of a foreign corporation at the time of his death if, at the time of a transfer, by trust or otherwise, within the meaning of sections 2035 to 2038, inclusive, he owned such stock. "(c) CREDITS.-The tax imposed by subsection (a) shall be credited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), as modified by section 2102(b). "(d) EXCEPTION FOR Loss oi~ CITIzEN5rnp FOR CERTAIN CAusEs.-- Subsection (a) shall not apply to the transfer of the estate of a decedent whose loss of United States citizenship resulted from the application of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401 (b), 1482, or 1487). "(e) BURDEN or Pnoor.-If the Secretary or his delegate estab- lishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a sub- stantial reduction in the estate, inheritance, legacy, and succession taxes in respect of the transfer of his estate, the burden of proving that such loss of citizenship did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A shall be on the executor of such individual's estate. 467 PAGENO="0478" 156 FOREIGN INVESTORS TAX ACT OF 1965 "SEC. 2108. APPLICATION OF PRE-1966 ESTATE TAX PRO- VISIONS. "(a) IMPosrrION OF MORIt BURDENSOME TAX BY FoimIoN COUNTRY.- Whenever the President finds that- "(1) under the. laws of any foreign country, considering the tax system of such foreign country, a more burdensome tax is imposed by such foreign country on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign. country, "(2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such tax so that it is no more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such for- eign country, and "(3) it is in the public interest to apply pre-1966 tax provisions in accordance with this section to the transfer of estates of dece- dents who were residents of such foreign country, the President shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to amendments made to sections 2101 (relating to tax imposed), * 2102 (relating to credits against tax), and 6018 (relating to estate tax returns) on or after the date of enactment of this section. "(b) ALLEVIATION OF Moim BURDENSOME TAx.-Whenever the Presi- ident finds that the laws of any foreign country with respect to which the President had made a proclamation under subsection (a) have been modified so that the tax on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country is no longer more. burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, he shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to subsection (a). "(c) NoTIFICATION OF CONGRESS REQUIRED.-NO proclamation shall be issued by the President. pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. "(d) IMPLEMENTATION BY REGULATIONS.-The Secretary or his dele- gate shall prescribe such regulations as may be necessary or appro- priate to implement this section." (e) ESTATE TAX RETURN5.-Paragraph (2) of section 6018 (a) (relating to estates of nonresidents not citizens) is amended by strik- ing out "$2,000" and inserting in lieu thereof "$30,000". (f) CLERICAL AMENDMENT.-The table of sections for subchapter B of chapter 11 (relating to estates of nonresidents not citizens) is amended by adding at the end thereof the following: "Sec. 2107. Expatriation to avoid tax. "Sec. 2108. Appiicatioii of pre-1966 estate tax provisions." 468 PAGENO="0479" FOREIGN INVESTORS TAX ACT OF 1965 157 (g) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to estates of decedents dying after the date of the enactment of this Act. INSTITUTE ON U.S. TAXATION OF FOREiGN INCOME, INC., New York, N.Y., February 18,1966. Re H.R. 11297. Hon. LEo H. IRWIN, Chief Counsel, Committee on Ways and Means, House of Representatives, Washington, D.C. DEAR Mit. IRWIN: The position of this institute can be very briefly stated with respect to H.R. 11297. We have no opposition to its prompt passage, provided that it is limited to its announced purpose, to com- ply with the express wish of President Johnson: "~ * * to modernize the present U.S. tax treatment of foreigners and to encourage foreign investment in the United States-thereby beneficially affecting the U.S. balance-of-payments__by removing tax barriers to such investment." In order to avoid harmful effects whi~h otherwise would result to U.S. corporations engaged in foreign trade and to the U.S. balance- of-payments, it is essential that the "effectively connected" provisions of H.R. 11297 (e.g., proposed amended Internal Revenue Code sec. 882) be limited so as to be applicable only to foreign corporations con- trolled by foreigners (i.e., by person.s other than U.S. persons). If the title and statement of the purpose of H.R. 11297 fairly state its purpose, there is no reason why its application should not be limited to foreign investors and foreign investments in the United States. That is all we ask-and we earnestly request the opportunity to bring out the facts in open hearings on these new provisions of H.R. 11297. We recognize that it would be impossible to correct what are be- lieved to be technical flaws in H.R. 11297 and still effect its prompt passage as desired by the administration. However, we feel that it is worth while to point out a few of these flaws: 1. H.R. 11297 would do away with the exemption otherwise allowable under the Export Trade Corporation provisions of Internal Revenue Code section 970 (proposed new sec. 952(b)). 2. The proposed new section 906 (a) apparently would allow a foreign subsidiary corporation credit for foreign taxes paid and deemed paid by it with respect to U.S. income subject to. tax under the "effectively connected" provisions and also would allow its U.S. parent credit for the same foreign income taxes deemed paid by it (the U.S. corporation) with respect to divi- dends received from such foreign subsidiary. 3. There is no indication that, if the worldwide income of a foreign subsidiary were connected with~ its U.S. activities, the amount subject to tax under the proposed section 882 would be limited to the portion properly allocable to such U.S. activities. 4. Apparently, no consideration has been given to the effect of the `effectively connected" provisions (e.g., proposed sec. 882 469 PAGENO="0480" 158 FOREIGN INVESTORS TAX ACT OF 1965 and sec. 952(b)) upon the "minimum distribution" provisions of section 963. Time and space do not permit further enumeration of technical flaws in this bifl. The substantive objection is that in attempting to afford U.S. tax incentives to foreign investors, it would impose various unjustifiable penalties on foreign corporations owned and controled by U.S. persons. You are respectfully requested to distribute copies of this state- ment to members of the Ways and Means Committee and to include this statement in the committee print. Thanking you in advance for your attention to this request, I reniarn, Sincerely yours, PAur~ D. SEGHERS, President. INSTITUTE ON U.S. TAXATION OF FOREIGN INCOME, INC., New York, N.Y., February 19,1966. Re H.R. 11297. Hon. LEO H. IRWIN, Chief Cownsel, Com'in'ittee on Ways and Means, House of Representa- tires, Washington, D.C. Th~R MR. IRwIN: Please add to our letter dated yesterday (Febru- ary 18) our suggestion for wording to. accomplish the recommended changes in the provisions of H.R. 11297 so as not to penalize foreign corporations owned by U.S. persons. In lieu of the amendment of IRC section 882(b) proposed in sec- tion 4(b) of H.R. 11297, we suggest the following: "(b) GROSS INCOME.- "(1) FoREIGN OWNED Coiu'oRATIoNs.-In the case of a foreign cor- poration controlled (through the ownership, direct or indirect, of more than 50 percent of its voting stock) by persons who are not U.S. persons (as defined in sec. 957) gross income includes only- "(A) gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, and "(B) gross income which is effectively connected with the con- duct of a trade or business within the United States, to the extent attributable to such activities. "(2) OTHER FOREIGN C0RP0RATI0N5.-In the case of all other foreign corporations, gross income includes only gross income from sources within the United States." This wording would: (1) Limit the application~ of the proposed new "effectively con- nected" provisions to those persons whom H.R. 11297 is intended to benefit, foreign investors, without adding new burdens of U.S. taxes on U.S. manufacturers and other U.S. corporations having for- eign subsidiariesengaged in foreign trade, and (2) Limit the impact of the proposed "effectively connected" provi- `i'~ns so as to tax foreign-owned and controlled foreign corporations 470 PAGENO="0481" FOREIGN INVESTORS TAX ACT OF 1965 159 on only so much of their foreign income as is attributable to their activities in the United States. Both of these results would be more in harmony with the stated purposes of H.R.. 11297 than would the consequences of the section 882(b) proposed in H.R. 11297 (as introduced). The change we propose herein would eliminate the need for the amendment of IRC section 952(b), now proposed in H.R. 11297, and thus would avoid the nullification, in many instances, of the benefits intended to be afforded by section 970 to "Export Trade Corpora- lions," and avoid many other complications under "subpart F." In addition to the serious defects in 11.11. 11297 enumerated inour February 18 letter, we point out that, under H.R. 11297 as intro- duced, "effectively connected" income would, in some cases, be taxed twice, at full U.S. corporation rates; first to the foreign corporation and then, when distributed as a dividend, to its U.S. parent corpora- tion, without allowing any credit or other relief from this unbearable burden. To continue to point out defects in H.R. 11297 when applied to U.S.- owned and controlled corporations would only distract attention from the one essential issue-the vital need to exclude such U.S.-owned corporations from the application of these novel "effectively con- nected" provisions. We will greatly appreciate your cooperation in transmitting our suggestions to the chairman and members of the Committee on Ways and Means and including in the committee print our two letters sub- mitting these suggestions. Very truly yours, PAUL D. SEGHERS, President. INTERNATIONAL ECONOMIC PoLICY ASSOCIATION, Washington, D.C., Februai~y 9,196G. Hon. WILBUR P. MILLS, Chairman, House Ways and Means Committee, Washington, D.C. DEAR CONGRESSMAN MILLS: The attention of the International Eco- nomic Policy Association, representing some of the major American industrial corporations with substantial investments abroad, has been called to the provisions of H.1R. 11297, introduced by you last Sep- tember. While this bill generally incorporates the provisions of H.R. 5916, the so-called Fowler bill, designed to encourage foreign investment in the Unit~d States, H.R. 11297 goes far beyond the original Fowler bill in incorporating substantial changes in the basic rules for de- termining the income of foreign corporations doing business in the United States. Since original enactment in 1918, such corporations have been taxed only on their income from clearly defined ILS. sources. Under the propo~ed proyisions of }I.R. 11297, such corporations may be subject to U.S. income .ta~ tm income that is "effectively connected" with the United States even though such income is, adnuttedly, from non-U.S. sources. 71-297 O-67-pt. 1-31 471 PAGENO="0482" 160 FOREIGN INVESTORS TAX ACT OF 1965 It is not the purpose of this letter to question the advisability or inadvisability of such a fundamental change in U.S. tax law. Etow- ever, the association is firmly convinced that a change having such a profound impact on historical U.S. tax principles is one that should require the most thorough consideration by your committee. We sincerely believe that the constitutional obligation imposed on the House of Representatives to propose revenue legislation requires full public exploration of all basic changes in U.S. tax provisions and we must, in honesty, state that we feel that it would be remiss for Con- gress to make such far-reaching changes without affording an oppor- tunity for full public hearings. We know that your committee is fully aware of the proposed legis- lation but we doubt whether all U.S. taxpayers affected by it are fully cognizant of the substantive changes proposed in this bill. Although comments on H.R. 5916 were requested, public hearings have never been held. Accordingly, we respectfully request that your committee hold public hearings on H.R. 11297. If such hearings are held, we wish to assure you that the IEPA will endeavor to present constructive views on the proposed legislation and on any modifications to this legislation that we feel are desirable. Sincerely yours, N. R. DANIELIAN, President. STATEMENT BY INTERNATIONAL TELEPHONE & TELEGRAPH ON H.R. 11297 H.R. 11297, more commonly known as the Fowler bill, is a bill designed to encourage foreign investment in the United States. It has received a broad spectrum of public support for these objectives. However, as introduced by Chairman Mills last September the bill contains a significant change in basic U.S. tax policy, a change that has not had the benefit of full public discussion or understanding. Since the earliest days of income taxation in this country, going back to the Revenue Acts of 1916 and 1918, a foreign corporation engaged in trade or business within the United States has been taxed only on its income from clearly defined sources within the United States. However section IV of H.R. 11297 changes this long-estab- lished pattern of taxation by amending section 882 of the Internal Revenue Code to subject a foreign corporation engaged in trade or business within the United States to taxation on its income which is "effectively connected" with the conduct of such trade or business. Under this proposed fundamental change in U.S. tax law, the tra- ditional source rules now contained in sections 861 through 864 of the code are no longer to determine the scope of U.S. taxation of foreign corporations engaged in trade or business in the United States. From a position of relative certainty permitting business judgment and action, foreign corporations which wish to engage in trade or business within the United States will have to act at their peril, with exposure to U.S. income tax being limited only by the vague general concept "effectively connected income." 472 PAGENO="0483" FOREIGN INVESTORS TAX ACT OF 1965 161 No greater criticism of this vague concept can be found, it is sub- mitted, then the inability of the draftsman of H.R. 11297 to define the term "effectively connected income." Section II of H.R. 11297 amending section 864 of the code relating to definitions under the source of income rules seeks to define the term "effectively connected income, etc.," but the proposed definition does not even purport to be a definition; it merely lists three factors which are to be "taken into account" in determining whether income is "effectively connected" with the conduct of a trade or business. These factors are: (1) Whether the income is derived from assets used in, or held for use in, the conduct of such trade or business; (2) whether income is accounted for through such trade or business; or (3) whether activities of trade or business were a material factor in the realization of the income. These three factors are merely three additional elements of uncer- tainty added to the basic uncertainty of "effectively connected income." Uncertainty added to. uncertainty is a far cry from operating under the relatively certain source rules now contained in the code, rules which have been amplified by years of experience, Treasury regula- tions and rulings, and court decisions. The underlying purpose be- hind H.R. 11297 is to encourage foreign investment in the United States. The almost certain broadening of a foreign corporation's in- come subject to U.S. tax liability under H.R. 11297 will lead to no such encouragement. On the contrary, it will lead. to foreign corporations withdrawing from the United States to the further impairment of our balance-of-payments position. This is not a purpose consistent with the committee studies that led to the introduction of EI.R. 11297. Taxpayers concerned about the impact of this almost hidden change incorporated in H.R. 11297 have received informal assurance from Treasury officials that the bill, if enacted, will be administered syrn- pathetically but the function of the Internal Revenue Service is to protect the revenue of the United States and statements of intended "sympathetic administration" by Treasury officials today cannot and will not prevent the Internal Revenue Service from the most possible restrictive enforcement tomorrow. The "effectively connected income" approach sought by the Treasury Department will lead to taxation measured not by rule of law but by administrator's fiat. It is sub- mitted that no such approach should be enacted. The MANIIFACTtTRERS Lin~ INSURANCE Co., Toronto, Canada, Januar~j 19, 1966. Re H.R. 11297, Foreign Investors Tax Act of 1965. Dr. LAURENCE N. WOODWORTH, Chief of Staff, Joint Com4mittee on Interma~Revenue Taxation, Washington, D.C. DE~i~ DR. WOODWORTH: Enclosed are three copies of the memoran- dum which it was arranged we should prepare following our meeting with you and your associates in Washington on December 16 last. The points discussed are features of the above bill which present spe- 473 PAGENO="0484" 162 FOREIGN INVESTORS TAX ACT OF 1965 cial problems for Canadian life insurance companies doing business in the United States, and are an elaboration of the questions con-. sidered in regard to them at the medting. The points in question relate to (a) income effectively connected and income not effectively eon- nected, (b) settlement of proposed section 881 tax, and (c) adjustment of proposed section 881 tax for any overlapping due to the operation of the minimum surplus provision of section 819. May I say again how much we appreciated the opportunity of meet- ing with you and your associates. The meeting was most helpful and we believe the memorandum will serve to recapitulate our comments. This letter and memorandum are written on behalf of the 13 Cana- dian life insurance companies doing business in the United States. Sincerely, (S) E. C. ROBINSON, Associate Secretary. (Per favor of Mr. Kenneth L. Kimble, vice president and general counsel, Life Insurance Association of America, Washington, D.C.) Memorandum to: Dr. Laurence N. Woodworth, Chief of Staff, Joint Coimnittee on Internal Revenue Taxation. ILR. 11297-FOREIGN INVESTORS TAX ACT OF 1965 This memorandum relates to our discussion with you and your as- sociates, Messrs. Vie Willett and Carl Nordberg, in Washington on December 16, respecting features of the above bill affecting the income tax procedure of foreign life insurance companies doing business in the United States. For ready reference, we give below the names, apart from yourselves, of those who joined in the meeting: Mr. Kenneth L. Kimble, vice president and general counsel, LIAA. Mr. William B. Harman, Jr., associate general counsel, ALC. Mr. A. E. Loadman, vice president and actuary, the Great-West Life. Mr. H. E. Harland, associate actuary, the Great-West Life. Mr. T. B. Morrison, actuarial vice president, the Manufacturers Life. Mr. E. C. Robinson, associate secretary, the Manufacturers Life. Mr. L. J. Brown, associate actuary, the Sun Life. It was arranged that, in the memorandum, we should review our comments on the following three points- (a) Income effectively connected and income not effectively connected. (b) Settlement of proposed section 881 tax. (c) Adjustment of proposed section 881 tax for any overlap- ping due to the operation of the minimum surplus provision of section 819. (a) Income "effectively connected" and "income not effectively con- nected" A foreign life insurance company which qualifies as a life insurance company under section 801 of the code, is, in accordance with the pro- visions of section 819(a), taxable on its U.S. business in the same man- ner as a domestic life insurance company. 474 PAGENO="0485" FOREIGN INVESTORS TAX ACT OF 1965 163 H.R. 11297 would amend the code by deleting section 819 (a) and in its place would provide a new tax procedure for such compames involving a new nomenclature for defining taxable income. Under section 842 of the new bill, a qualifying foreign life insur- nnce company would be taxed on "income effectively connected with the conduct of any trade. or business within the United States" at regular corporate tax rates. In addition, under new section 881, in- come, as there defined, from sources within the United States not ~ffectively connected would be taxed at the 30 percent'statutory with- holding rate or lower treaty rates. Under the new procedure, the tax- able income of such companies is to be classified under one or other of the foregoing categories of income, and it therefore becomes essential that there should be clear guidelines for such classification of taxable income. Evidently, new section 842 replaces existing section 819(a). There- fore, based on the intent indicated in paragraph 22 of the committee print, we conclude that the expression "income effectively connected, etc." in new section 842 has the same connotation as "United States business" in section 819 (a) in relation to a qualifying foreign life insurance company doing business in the United States. It has been recognized that the authoritative source of information respecting the U.S. business of a foreign life insurance company is the annual statement of its U.S. business which such company is re- quired to prepare on the form prescribed by the National Association ~f Insurance Commissioners. This statement includes, among other relevant data, the income, disbursements, reserves, etc., in respect to policies issued to persons resident in the United States at the time of issue, even though some of these policyholders may subsequently be- come residents outside the United States. It also includes, under the heading of "Assets," in addition to policy assets, the statutory de- posits and trusteed assets required to match U.S. policy liabilities. The investment income from all such assets is, of course, also reported in the statement. Because of the need for classification of taxable income under the proposed new tax procedure, we urge that either the law or the regu- lations should expressly provide that income effectively connected with the conduct of any trade or business within the United States, in the case of a foreign life insurance company, will be basically that re- ported in the annual statement of the U.S. business of such company on the NATO form. The need for a special provision of this kind for our companies, be- yond the definition in new section 864(c), arises on two counts in * particular- (a) Foreign life insurance companies seem to be the only foreign corporations of any kind whose taxable income is subject to a special adjustment, as under existing 819(b), and for this reason the definition of our effectively connected income should not necessarily follow the usual rules; (b) Our companies, along with life insurance companies gen- erally, are to be distinguished from most other types of corpo- rations in regard to their major function as investors in securi- ties of substantial funds. Because of this, our companies have income from extensive investments in the United States. The 475 PAGENO="0486" 164 FOREIGN INVESTORS TAX ACT OF 1965 major portion of such investment income would arise from invest- ments in the United States in connection with U.S. business. How- ever, our companies have additional investments in the United States held in relation to liabilities arising from non-U.S. busi- ness. The income from these investments is not connected with U.S. business. State insurance laws require foreign life insurance companies to maintain assets on deposit with approved trustees or State of- ficials in the United States sufficient, at market value, to cover liabilities to U.S. policyholders and creditors. Only such de- posited assets can be identified, by the company or others con- cerned, as being effectively connected with U.S. business. Fur- thermore, the operation of the minimum surplus requirement of section 819 (b) insures, for income tax purposes, the adequacy of the amount of such deposited assets. Such assets are, of course, those reported in the aforementioned annual statement. We feel it is imperative, therefore, that there be a clear provision identify- ing income effectively connected as that reported in the aiinuai statement of U.S. business. It seems only reasonable to us that such definite guidelines should be spelled out either in the law or regulations. With income effectively connected clearly defined, as suggested in the foregoing, income from sources within the United States from in- vestments in the United States not included in the annual statement of U.S. business, would fall automatically to be classified as income not connected and be taxable as provided in proposed section 881. With respect to this income not connected, our position taxwise would be the same as in the case of a foreign corporation not engaged iii trade or business in the United States in receipt of similar income from sources within the United States. (14 Settlement of proposed section 881 tax Under proposed section 1442, the tax imposed by new section 881 would be collected by deduction and withholding at the source. Our companies will be in receipt of investment income as defined in new section 881, from sources within the United States arising from both deposited and nondeposited assets. The income from the former being effectively connected will not be subject to withholding. With respect to the latter, the income being not connected would normally be sub- ject to withholding of tax at the source. Because of this situation, we foresee problems with respect to the application of withholding of tax at the source, and particularly so since not infrequently some issues of bonds and shares might be partly deposited and partly not deposited. Because of the volume involved, it would be complicated and costly for our companies to keep the payers of interest and dividends advised as to when withholding applied and when it did not. To `avoid these difficulties, we suggest that in the case of our com- panies and for others where a comparable problem existed, provision be made for settlement of the tax annually rather than by withhold- ing. This could be done by means of a return filed annually in which such investment income as defined in new section 881 would be reported. This could possibly be done by a provision in the statute, under which the Secretary of the Treasury would be given authority to vary 476 PAGENO="0487" FOREIGN INVESTORS TAX ACT OF 1965 165 the withholding requirements of section 1442 where, `in his judgment, circumstances warranted it. A similar situation exists with respect to U.S. life insurance com- panies subject to withholding tax in Canada. Under the authority of section 109(4) of the Canadian Income Tax Act, regulations (800- 804) were made in 1953 whereby the withholding provisions were made inapplicable in the case of such companies and requiring them to file an annual return and make an annual settlement of the tax. Annual settlement in this way of the tax payable under new sec- tion 881 would, we feel, also provide a simple and convenient means for making any adjustments found necessary by reason of any over- lap, due to the operation of the minimum surplus requirement of sec- tion 819(a), of tax payable under new section 842. (c) Adjustment of proposed section 881 tax for any overlapping due to the operation of the minimum surplus provision of section 819 Overlapping of tax may occur when tax payable under new sec- tion 842 involves an adjustment by reason of the operation of the minimum surplus requirement of section 819, in the case of a com- pany subject to tax on income not effectively connected under proposed section 881. To avoid double taxation where any such overlapping occurs, we suggest that provision be made for an ad- justment in taxes payable under proposed section 881. For the purposes of such an adjustment, provision might be made for reducing the tax payable under proposed section 881, in the ratio which the amount of the adjustment resulting from the operation of the minimum surplus provision of section 819 bears to the amount of income, including any tax exempt income, as defined in proposed sec- tion 881 provided that the said ratio should never exceed unity and prov1ded further that the reduction in tax should not exceed the additional tax payable under section 842, by reason of the operation of the section 819 adjustment. In the previous paragraph, the first proviso would insure that the reduction in tax would never exceed the tax payable under new sec- tion 881, and the second proviso would preclude any reduction in tax in excess of the additional tax incurred under new section 842 by reason of the operation of the minimum surplus provision of section 819. Tm~ MANUFACTURERS Liri~ INSURANCE Co., Toronto, Canada, January ~7, 1966. Re H.R. 11297, Foreign Investors Tax Act of 1965. Dr. LAURENCE N. WOODWORTH, Chief of Staff, Joint Committee on Internal Revenue Taxation, Washington, D.C. DEAR DR. WOODWORTH: With my letter of January 19, I sent you a memorandum dealing with some provisions of this bill which present special problems for Canadian life insurance companies doing business in the United States. As a supplement to that memorandum, we have prepared draft revisions of a few sections of the bill which would give effect to the suggestions made in the memorandum. This draft has been pre- pared in the hope that it may be of some assistance to you if the bill is to be revised for this purpose. 477 PAGENO="0488" 166 FOREIGN INVESTORS TAX ACT OF 1965 Three copies of our draft are attached, and include the following material: Section 819(a) .-A new subsection suggested to define the effec- tively connected income to be taxed under part 1 of subchapter L. To avoid interpretative and administrative difficulties in future, as previously expressed, if at all possible it would be most desirable to include some provision on this point in the proposed bill. If this is not possible, we would hope that some provisions substantially as suggested would be included in the committee report and regulations. Section 819(b) (3) .-A new subparagraph dealing with the reduc- tion of section 881 tax for the overlap referred to in our memoran- dum. Presumably, any provision on this point should be included in the bill itself, inasmuch as the 819(b) (1) adjustment was included. in full detail in the 1959 act. Section 819(b) (1) and (2) and section 819(c) .-Minor changes intended only to make the language conform more closely to that used in the other sections of our draft. Section 1442.-A new subsection (b) is suggested to permit ex- emption from withholding. Section 842 and section 894.-Included as possibly suggesting some clarification of the intent of the sections of the proposed bill. Please be assured that we very much appreciate the cooperation you have extended to us. If further information or discussion would be helpful to you in any way, we would be glad to have the opportunity to send you a further memorandum or to meet with you again. Sincerely, (5) E.C.R0BINs0N, Associate Secretary. Per favo'i. of Mr. Kenneth L. Kimble, vice president and general counsel, Life Insurance Association of America, Washington, D.C. SECTION 819. FOREIGN. LIFE INSURANCE COMPANIES (a) CARRYING ON UNrr1~D STATES INSURANCE BusINEss.-In the case of any foreign corporation carrying on a life insurance business within the United States, if with respect to its trade or business conducted within the United States it would qualify as a life insur- ance company under section 801, (1) all computations entering into the determination of its in- come effectively connected with its conduct of its trade or business within the United States and the determination of the tax pay- able thereon under this part shall be made, except as otherwise provided in this part, on the basis of the income, disbursements, assets, liabilities, and surplus reported in the annual statement for the taxable year of the United States business of such com- pany in the form prescribed by the National Association of In- surance Commissioners, and (~) the acquisition and holding for investment purposes only of stocks, bonds, mortgages, or other securities, land or other property, which are not reported in such annual statement, and the collection of investment income therefrom and the sale and reinvestment of the proceeds thereof, shall not constitute the conduct of a trade or business. 478 PAGENO="0489" FOREIGN INVESTORS TAX ACT OF 1965 167 (b) AIXJ-USTMENT WHERE SURPLUS ON UNIFEI) STATES INSURANCE BusINi~.ss Is LESS THAN SPECIFIED Mnmnmt.- (1) IN GENERAL.-III the case of any foreign Corporation de- scribed in subsection (a), if the minimum figure determined under paragraph (2) exceeds the surplus on its United States insurance business, then- (A) the amount of the policy and other contract liability requirements (determined under section 805 without regard to this subsection), and (B) the amount of the required interest (determined un- der section 809(a) (2) without regard to this subsection), shall each be reduced by an amount, hereinafter referred to as the amount of the adjustment, determined by multiplying such excess by the current earnings rate (as defined in section 805(b) (2)). (2) DEFINrrrnN5.-For purposes of paragraph (1)- (A) The minimum figure is the amount determined by multiplying the taxpayer's total insurance liabilities on United States insurance business by- (i) in the case of a taxable year beginning before January 1, 1959, 9 percent, and (ii) in the case of a taxable year beginning after De- cember 31, 1958, a percentage for such year to be de- termined and proclaimed by the Secretary or his del- egate. The percentage determined and proclaimed by the Secretary or his delegate under clause (ii) shall be based on such data with respect to domestic life insurance companies for the preceding taxable year as the Secretary or his delegate considers repre- sentative. Such percentage shall be computed on the basis of a ratio the numerator of which is the excess of the assets over the total insurance liabilities, and the denominator of which is the total insurance liabilities, (B) The surplus on United States insurance business is the excess of the assets reported for such taxpayer's United States insurance business over the total insurance liabilities on such business. For purposes of this paragraph and subsection (c), the term "total insurance liabilities" means the sum of the total reserves (as defined in section 801 (c)) plus (to the extent not included in total reserves) the items referred to in paragraphs (3), (4), and (5) of section 810(c). (3) REDUCTION or Srxxno~- 881 TAx.-In the case of any for- eign corporation described in subsection (a), there shall be deter- mined- (A) the amount of the income, prior to exemption of tax- exempt interest, which without regard to this paragraph or to such exemption would be subject to tax under section 881, and (B) the amount of the adjustment referred to in paragraph (1) or the amount referred to in subparagraph (A) of this paragraph, whichever is the lesser, and (C) the excess, if any, of the amount of tax payable under this part over the amount which would be payable if such tax were computed without regard to the minimum surplus adjustment provided in paragraph (1). 479 PAGENO="0490" 168 FOREIGN INVESTORS TAX ACT OF 1965 The amount of tax determined without regard to this paragraph under section 881 (after giving effect to allowable exclusions and exemptions and to any treaty obligation of the United States) shall be reduced by an amount which is the same proportion of such tax as the amount referred to in subparagraph (B) is of the amount referred to in subparagraph (A), but the amount of such reduction shall not be greater than the amount of the excess re- ferred to in subparagraph (C). (c) DIsTRIBu'rIoN TO SHAREHOLDERS.- (1) IN GEi~RAL.-Ifl applying sections 802(b) (3) and 815, with respect to a foreign corporation described in subsection (a), the amount of the distributions to shareholders shall be deter- mined by multiplying the total amount of the distributions to shareholders (within the meaning of section 815) of the foreign corporation by whichever of the following percentages is selected by the taxpayer for the taxable year: (A) the percentage which the minimum fio~ure for the taxable year (determined under subsection (b~ (2) (A)) is of the excess of the assets of the company over the total insurance liabilities; or (B) the percentage which the total insurance liabilities on United States insurance business for the taxable year is of the company's total insurance liabilities. (2) DIsTEIBU1'IoNs PURSUANT TO CERTAIN MUTUALIZATIONS.-Ifl applying section 815(e) with respect to a foreign corporation de- scribed in subsection (a) - (A) the paid-in capital and paid-in surplus referred to in section 815(e) (1) (A) of such foreign corporation is the por- tion of such capital and surplus determined by multiplying such capital and surplus by the percentage selected for the taxable year under paragraph (1); and (B) the excess referred to in section 815(e) (2) (A) (i (without the adjustment provided by section 815(e) (2) (B) is whichever of the following is the greater: (i) the minimum figure for 1958 determined under sub- section (b) (2) (A), or (ii) the surplus described in subsection (b) (2) (B) (determined as of December 31, 1958). SUGGESTED REVISION OF SECTION 842 SEC. 842. FOREIGN CORPORATIONS CARRYING ON INSURANCE BUSINESS. If a foreign corporation carrying on an insurance business within the United States would qualify with respect to its trade or business `conducted within the United States under part I, II or III of this subchapter for the taxable year if it were a domestic corporation, it shall be taxable under such part (and not under section 882) on its income effectively connected with it.s conduct of any trade or business within the United States. With respect to the remainder of its in- come which' is from sources within the United States, such a foreign corporation shall be taxable as provided in section 881. (Explanation: ELR. 11297, as intrOduced, includes a wording in section 842 that seems to assume that the qualification test can 480 PAGENO="0491" FOREIGN INVESTORS TAX ACT OP 1965 169 be made solely on the basis of income. Since the qualificatiort tests actually depend on other elements of the operation, for ox-. ample, reserves, we have suggested a wording that may be more satfsfactory. We have also included in brackets the words "and not under section 882", to underline the intent of section 842. We do not think the above draft alters the intent of section 842 in any way.) SEC. 894. INCOME AFFECTED BY TREATY. (a) INco1~tu~ Exr~n~r UNDER Th~rx~-Incorne of any kind, to the extent required by any treaty obligation of the United States, shall not be included in gross income and shall be exempt from taxation under this subtitle. (b) PERMANENT ESTABLISHMENT IN UNITED STATES.-FOr purposes of applying, with respect to income which is not effectively connected with the conduct of a trade or business within the United States, any exemption from, or reduction of any tax provided by any treaty to which the United States is a party, a nonresident alien individual or a foreign corporation shall be deemed not to have a permanent establishment in the United States at any time during the taxable year. This subsection shall not apply in respect of the. tax computed under section 877(b). (Explanation: In line 5 of subsection (b) above the word "a" has been added before "foreign corporation" to remove any pos- sible misinterpreation of the existing wording to mean nonresi- dent foreign corporation. This is in accordance with our under- standing of the intent of section 8~4.) SEC. 1442. WITHHOLDING OF TAX ON FOREIGN CORPORATIONS (a) In the case of foreign corporations subject to taxation under this subtitle there shall be deducted and withheld at the source in the same manner and on the same items of income as is provided in section 1441 or section 1451 a tax equal to 30 percent thereof; except that, in the case of interest described in section 1451 (relating to tax-free covenant bonds), the deduction and withholding shall be at the rate specified therein. For purposes of the preceding sentence, the reference in section 1441(c) (1) to section 871(b) (1) shall be treated as referring to section 842 or 882 (a) as the case may be. (b) Under regulations prescribed by the Secretary or his delegate, any items of income payable to a foreign life insurance company taxable under part 1 of subchapter L may be exempted from deduc- tion and withholding under subsection (a). MANUFAC~rURING CHEMISTS' AssoowrIoN, INC. Washington, D.C., February ~3, 1966. HON. WILBUR P. MILLS, Chairm,an, Ways and Means Comm~ittee, House of Representatives, Washington, D.C. DEAR MR. CHAIRMAN: This letter is being sent to you on behalf of the Manufacturing Chemists' Association (MCA), a nonprofit trade 481 PAGENO="0492" 170 FOREIGN INVESTORS TAX ACT OF 1965 association including 192 U.S. member companies, large and small, which together account for more than 90 percent of the country's productive capacity for chemicals. Our association has reviewed 1{.R. 11297, the Foreign Investors Tax Act of 1965, introduced by you last year. We understand the purpose of this bill is to remove tax barriers to investment in the United States by foreigners and thereby contribute to an improvement in our balance of payments. Although the predecessor bill, H.R. 5916, was the subject of public hearings before your committee in 1965, that bill did not contain the new concept which would be incorporated in section 882 of the Internal Revenue Code that foreign corporations engaged in trade or business in the United States would be taxed on all of their income which is "effectively connected" with the conduct of such trade or business. We are seriously concerned with this new concept in that it represents a very significant change from the past basis upon which foreign corporations engaged in t~a.de or business in the United States were taxed. We believe that it would be quite helpful to your committee and taxpayers alike if public hearings were held on this new provision in H.R. 11297, and we would like to respectfully request that this be done. Sincerely, G. H. DECKER, President. MORGAN GUARANTY TRUST Co. ør NEW YORK, New York, N.Y., January 31,1966. Hon. WILBUR MmL5, ChaiDiman, Hovse Ways and Means Committee, House of Representatives, Washington, D.C. DEAR MR~ Mu~Ls: I understand that your committee is holding hear- ings currently concerning H.R. 11297, the so-called Foreign Investors Tax Act. There are some parts of this bill as presently written which we believe would be detrimental to the U.S. balance of payments, if passed. I enclose a memorandum which outlines the reasons we think it would have this effect. I understand that Mr. Thornton D. Strecker, deputy comptroller of this bank, outlined verbally our thoughts to Mr. L. M. Woodworth of your staff last week, but if we can supply any further information we would be pleased to do so. Sincerely, THOMAS S. GATES, Chairman of the Board. MEMORANDUM: PosITIoN OF MORGAN GUARANTY TRUST Co. or NEW YORK ON PRorosw H.R. 11297, THE FoIu~IGN INVESTORS TAX ACT OF 1965 There are three proposals in the above bill which in our view will have a serious adverse effect on the U.S. balance of payments: (1) Proposed imposition of income tax (and withholding thereof) on interest received by nonresident aliens, foreign cor- 482 PAGENO="0493" FOREIGN INVESTORS TAX ACT OF 1965 171 porations, and banks other than foreign central banks, not doing business in the United States, on U.S. dollar deposits in the domestic offices or foreign offices of U.S. banks; (2) Proposed estate tax on L.S. dollar deposits of nonresident aliens not doing business in the United States at the time of death where such deposits are held in the domestic offices or foreign offices of U.S. banks~ (3) The pr.oposed~ change to subject to Federal estate tax bonds issued by the U.S. government, political subdivisions thereof, and U.S. corporations when owned by nonresident alimis not doing business in the United States even where these bonds were located outside the United States at time of death. The proposed change mentioned in (1) above seems to us of major importance. Based on published statistics of the Federal Reserve System and the U.S. Treasury as of September 30, 1965, foreign indi- viduals, foreign corporations, and foreign commercial banks held over $2 billion in time deposits in the domestic offices of U.S. banks. it is hard to believeS that a very large part of these deposits would not be quickly withdrawn if made subject to income tax on a withholding basis. It is true that perhaps part of these funds will continue to be held by their owners in dollars with foreign banks in such leading Euro-currency markets as London and that the dollars will then be carried as current dollar deposits with U.S. correspondents of these foreign banks. However, we believe that there would be an increased. tendency on the part of the owners of such dollars to swap or convert them to other currencies. Both of these actions would probably have the effect of changing unofficial claims on the United States to official claims by central banks and thereby pose a threat to the U.S. gold reserve. We know of no available nationwide statistics giving deposits in foreign branches of U.S. banks. However, the Bank of England re- ports that at the end of September 1965 American banks held deposits from non-United Kingdom depositors equivalent to $2.7 billion; we believe it reasonable to assume that about $1.5 billion of these deposits were interest-bearing dollar deposits from foreign individual and cor- porate, including bank (other than central bank), sources. We would also estimate that there was another $0.5 billion of such interest-bear- ing dollar deposits in foreign branches of U.S. banks outside of the United Kingdom. A good proportion of these funds is presently re- deposited by the foreign branches of the U.S. banks with their head offices. Another large percentage of these funds is loaned by these for- eign branches to U.S. corporations to enable the latter to finance their businesses abroad without hurting the U.S. balance of payments. Im- position of an income tax on these deposits we feel would mean that they would quickly disappear from the branches of the U.S. banks going to foreign banks operating into the Euro-currency markets. Again some of these funds would be held as current dollar deposits by these foreign banks with their correspondents in the United States, but there would be a tendency to swap or to sell outright these funds f or foreign currencies, changing their status to an official claim against the United States. The foreign banks would not be as likely to channel as great a proportion of their funds to help financing of sub- sidiaries of U.S. corporations abroad as would American branch 483 PAGENO="0494" 172 FOREIGN INVESTORS TAX ACT OF 1965 banks. We believe also that the proposed tax would have the effect of relegating the foreign branches of the U.S. banks to minor factors in the Euro-currency markets thereby reducing their foreign earnings which are a credit to the balance of payments and a source of U.S. income tax revenue. The proposed estate tax mentioned under (2) above would be put into effect immediately and would, we believe, force withdrawal of a very large proportion of the foreign individual deposit accounts in U.S. banks, both those held in their domestic offices and those in their foreign branches. We know of no source which gives the amount of the deposits of foreign individuals `but we think they are a sizable part of the $2 billion estimate given above as a total of deposits in the domestic offices of U.S. `banks of foreign individuals, corporations, and banks (other than central banks) not doing business in the United States. They are probably a smaller percentage of the $2 billion total of such deposits held by foreign branches of U.S. banks. In the past these deposits of foreign individuals have been held by the U.S. banks both in the United States and abroad because of the stability of the U.S. dollar and of the banks which have `their capital in this currency. This factor has been enough to overcome certain advan- tages offifered by foreign banks often including a higher interest rate for U.S. `dollar deposits. However, we believe that an estate tax on these deposits would quickly force foreign depositors to other deposi- tories for their funds. Estate administration in the United States is difficult and expensive for nonresident aliens. The simplicity under present law of transfer of bank deposits through the means of a joint account without the necessity of fihin~ tax returns is important to their heirs. Inclusion of bank deposits in the taxable estate would add administrative complications as an additional deterent to alien bank deposits in the United States. Point (3) above requires no extensive comment. A provision to in- clude additional intangibles in the taxable estate of nonresident alien certainly has no place in a bill designed to aid the U.S. balance of pay- ments by encouraging investment in the United States. For the foregoing reasons it is a certainty, if this bill is passed as written, that U.S. banks will not only fail to attract further cash de- posits from nonresident alien individuals and foreign corporations not `doing business in the United States, but is an equal certainty that American banks will lose a substantial portion of their present de- posits from these customers. Obviously loss of all or part of $4 bil- lion deposits in U.S. banks will have a major effect on the U.S. balance of payments. Although in lesser amounts the same effect would be produced as regards to individual accounts as a result of the proposed immediate imposition of the estate tax, regardless of whether or not the payment of income tax oninterest earned is deferred until 1971. The bill likewise contains administrative problems for the nonresi- dent alien, the Internal Revenue `Service and withholding agents. Section 3(h) of the above bill amends section 1461 of the Internal Rev- enue Code by eliminating the provision in that section for the filing of withholding tax returns and the payment of tax by March 15 of each succeeding year. The presumption is that quarterly returns ac- companied by the payment of tax will be required. This will represent a substantial increase in the amount of work involved in handling tax 484 PAGENO="0495" FOREIGN INVESTORS TAX ACT OF 1965 173 withholding returns and payments to the Internal Revenue Service. Instead of one annual return, a withholding agent will presumably be faced with the prospect of preparing and filing withholding returns four times each year. It should also be noted that with respect to nonresident alien trust beneficiaries, withholding is initially accomplished on the basis of re- mittances made to them. Since principai account deductions enter into the computation of "distributable net income" the total amount of tax- able income from U.S. sources is not known until after the close of the taxable year. In most cases there will be an excess withheld which, under present procedures, is refunded to the beneficiary before the tax is paid to the Internal Revenue Service on March 15. If the full amount of tax is to be paid currently, the beneficiaries will be required to file U.S. income tax returns and claims for refund to obtain the excess amounts withheld. Accordingly, both nonresident alien taxpayers and the Internal Revenue Service will be put to `additional labor and expense. Furthermore, tax `treaties that are negotiated and finalized within a given year often provide that the new rates are retroactive to `the preceding January 1. Regulations have usually authorized with- holding `agents to refund any excess withholding. If the tax had already been paid to the Internal Revenue Service, `any adjustments would have to be made by the Service after application by the non- resident alien. Having stated our principal objections to H.R. 11297 as introduced, we should add one favorable comment coupled with a recommendation for further improvement. The bill introduces a long-needed change in the source of income rules by including as foreign source income interest paid on deposits in foreign branches of American banks, regardless of the nationality or business connection with the United States of the recipient. However, the c'hange is limited to deposits payable in foreign currency; interest on dollar deposits remains sub- ject to the same source rules as deposits in the United States. It is recommended that the treatment as foreign source income of interest paid by. foreign branches of American banks be extended to include interest paid on dollar deposits, as well as on foreign currency deposits as proposed in H.R. 11297. Interest received from a fore~r. bank is foreign source income, whether paid on foreign currenc~v r dollar deposits. Any provision of U.S. law which places `a foreign branch of an American bank at a disadvantage in competing for de- posits with its foreign bank `competitors is likely to result in a net loss of revenue to the U.S. Treasury, and more important to U.S. balance- of-payments considerations, will drive deposits from the U.S. banking system into foreign banking systems where among other things, they could become a claim on our gold, as noted above. To summarize, it is our view that there are serious imperfections ~n H.R. 11297 if its purpose is to benefit the U.S. balance of payments. We believe it would not only fail to encourage foreign investment in the United `States; it would actually deter such investment and increase the likelihood of gold withdrawals. Accordingly, we strongly urge a return to the basic recommendations of the Presidential task force under the chairmanship of. `Secretary of the Treasury Fowler, then Undersecretary of the Treasury, one of which was the elimination of 485 PAGENO="0496" 174 FOREIGN INVESTORS TAX ACT OF 1965 U.S. estate taxes on all intangible personal property of nonresident alien decedents. Those recommendations in our opinion were not only soundly conceived but realistic as well in terms of the problem to be solved. The proposal in H.R. 11297 to tax U.S. bank interest paid to nonresident aliens and foreign corporations not doing business in the United States (for the first time since the Revenue Act of 1921) is completely contrary to the recommendations of the task force and should be eliminated. With respect to potential administrative problems created alike for the Internal Revenue Service, withholding agents and aliens by elimi- nation of annual reporting and payment of withheld taxes, and pre- sumably the ultimate substitution of quarterly reports, these problems probably have relatively little effect on balance of payments, and opposition to this provision is obviously secondary in importance to the other stated objections to H.R. 11297. However, the needless introduction of new administrative problems has no relationship to the stated purposes of the bill and should be eliminated. On the other hand, treatment as foreign source income of interest paid on foreign currency deposits in foreign branches of American banks is a step in the right direction toward tax equality between foreign banks and American branch banks in competing for deposits abroad, and similar treatment for interest paid on dollar deposits would be even more beneficial to the balance of payments in retaining and attracting dollars to the American banking system. WMLITdi H. PAGE, Executive Vice President. MosEs & SINGER, New York, N.Y., December 23, 1965. Re Foreign Investors Tax Act of 1965 (H.R. 11297). Hon. WILBUR D. Mii~s, Chairman, Co~rnfrn~ittee on Ways and Means, Hoii.&e of Representatives, Washington, D.C. Dii&n CHAIRMAN MILLS: Reference is made to section 4 of the pro- posed Foreign Investors Tax Act of 1965 (H.R. 11297) in which it is proposed to amend paragraph (7) of section 542(c) of the Internal Revenue Code of 1~54, relating to corporations not subject to the per- sonal holding company tax, as follows: "(7) A foreign corporation, if all of its stock outstanding during the last half of the taxable year is owned by nonresident alien indi- viduals, whether directly or indirectly through foreign estates, foreign trusts, foreign partnerships, or other foreign corporations ;". It is submitted that the jurdisdiction in which a corporation is incorporated should be irrelevant in an income tax system concerned with substance and not with form. On a parity of reasoning with that underlying the proposed amendment concerning the exemption from the personal holding company tax of foreign corporations with certain foreign shareholders, a similar exemption provided for domestic corporations with foreign shareholders and solely investment income. If this were done, foreigners wishing to invest in American stock and securities would be able to do so through the vehicle of a 486 PAGENO="0497" FOREIGN INVESTORS TAX ACT OF 1965 175 corporation incorporated under the laws of any of the States of the United States as well as one incorporated in the Bahamas, Panama, Switzerland, Lichtenstein, etc. The suggested technical amendment would have no adverse effect on the U.S. Treasury, but would permit foreigners wishing to invest in U.S. stock and securities to do so through a U.S. corporation as well as a foreign entity, and, if they chose a U.S. entity, it would give the United States a greater degree of supervision over the activities of such investors and gain revenue for the various States in which such corporations are incorporated. Finally, and most important, it would subject such domestic corpora- tions to the regular U.S. income tax, thereby gaining revenue for the Treasury. I trust you and your committee will favorably consider the forego- ing technical amendment. If you or your committee have any questions concerning the fore- going, please feel free to contact the undersigned. Yours very truly, BURTON JOEL A}IRENS. NATIONAL FOREIGN TRADE COUNCIL, INC., New York, N.Y., February 4,1966. Re Foreign Investors Tax Actof 1965 (H.R. 11297). Hon. WILBUR D. MILLs, Chairman, Committee on Ways and Means, House of Representatives, Washington, D.C. DEAR Mn. CHAIRMAN: You will recall my letter to you of January 14,1966, and the accompanying memorandum concerning H.R. 11297. In order to insure that there is no misunderstanding, I want to take this opportunity to point out that our comments beginning on page 4 pertaining to interest paid to nonresident aliens and foreign corpora- tions on U.S. bank deposits apply also to savings and loan associations and amounts deposited with insurance companies. I have particular reference to the last paragraph on page 5 and the first paragraph on page 6. Sincerely yours, ROBERT J. KELLIHER, Chairman, Tax Committee. NATIONAL FOREIGN TRADE COUNCIL, INC., New York, N.Y., January 14,1966. Re Foreign Investors Tax Act of 1965 (H.R. 11297). Hon. WILBUR. D. MILLS, Chairman, Committee on Ways and Means, House of Representatives, Washington, D.C. Dm~.n MR. CHAIRMAN: When the Foreign Investors Tax Act of 1965, H.R. 11297, was introduced, it was indicated that comments received would be reviewed by the Ways and Means Committee before the bill is reported to the House in the next session of Congress. 71-297 0-67-pt. 1-32 487 PAGENO="0498" 176 FOREIGN INVESTORS TAX ACT OF 196~ The National Foreign Trade Council had commented on the earlier bill in a letter to you dated July 7, 1965, indicating a general approval of that bill as being in accord with the legislative recommendations of the Fowler Task Force, which had been appointed to advise on ways in which more U.S. securities could be sold abroad to help meet the balance-of-payments problem. Three recommendations for changes in H.R. 5916 were submitted to you at that time. The National Foreign Trade Council has reviewed H.R. 11297 from the standpoint of the stated policy of the report of the Fowler Task Force. The present bill, like the earlier bill, would make important changes in U.S. taxation of foreign investors in U.S~. securities which should help to encourage investments in the United States. However, certain other changes made in the later bill would appear to be con- *trary to the general policies sst forth in the report of the Fowler Task Force. These changes are as follows: 1. The increases in the estate tax rates on nonresident individ- uals, as compared with those in H.R. 5916, and the inclusion in the `taxable estate of bank deposits owned by nonresident alien individuals not engaged in trade or business in the United states, tend to work contrary to the purpose of this legislation. 2. The taxation of interest on bank deposits received after 1970 by nonresident alien individuals and foreign corporations not en- gaged in trade or business in the United States eliminates from our law a longstanding inducement t.o the making of such invest- ments in the United States. 3. The proposal to tax nonresident aliens and foreign corpora- tions engaged in trade or business in the United States on income from sources outside of the United States, if it is "effectively con- nected" with the U.S. trade or business, is a radical extension of the existing scope of our tax law. Its effect would be contrary to the purposes of this bill. It is a major change of policy which the council believes is unwarranted and at least deserves careful and separate consideration. It is in conflict with most treaties with regard to the taxation of U.S. branches of foreign companies, and therefore would be inoperative in those cases. These matters are discussed in somewhat greater detail in the at- tached memorandum. The Fowler Task Force did not recommend the elimination of U.S. withholding tax on dividends and interest paid to nonresident alien individuals and foreign corporations, apparently because of the ex- pected reduction of revenue and the possible adverse effect on the bar- gaining power of the United States in treaty negotiations. However, elimination of the tax would be a ~major incentive to foreign invest- ment in the United States which might well justify the loss of revenue, and the President's power under proposed section 896 to reinstate existing income tax provisions, would preserve the treaty bargaining power. The National Foreign Trade Council therefore suggests that your committee consider the elimination of tax on dividends and inter- est paid to nonresident aliens and foreign corporations, if such interest is not effectively connected with a trade or business in the United States. . The National Foreign Trade Council believes that the foregoing matters are sufficiently important that hearings should be held on this 488 PAGENO="0499" FOREIGN INVESTORS TAX ACT OF 1965 177 bill before it is submitted to the House of Representatives in the cur- rent session of Congress. Sincerely yours, ROBERT J. KELLIHER, Chairman, Tax Com1mittee. THE F0IUnGN INVESTORS TAX ACT OF 1965 The Foreign Investors Tax Act of 1965, introduced shortly before Congress adjourned, makes three changes which seem to the National Foreign Trade Council to be contrary to the legislation's original in- tent. This bill, H.R. 11297, grew out of recommendations of the Fowler Task Force for changes in taxation of foreign investors to improve the U.S. balance of payments by stimulating foreign invest- ment in the United States. An earlier version of the proposed legisla- tion, H.R. 5916, was found to be generally in line with the original recommendations. But the current version, H.R. 11297, proposes changes which, by comparison with the earlier version of the bill or the original recommendations of the Fowler Committee, must be viewed as backward steps in three respects: increased estate tax rates for non- resident alien decedents, and inclusion of certain intangible property presently excluded from their estate tax base; introduction of a novel concept with regard to taxation of nonresident aliens and foreign corporations engaged in trade or business in the United States; and the introduction of income taxation of interest On U.S. bank deposits owned by nonresident aliens and foreign corporations not doing busi- ness in the United States. RECOMMENDATIONS OF THE ~FOWLER TASK FORCE~~ The Presidential task force, appointed to study ways to improve the U.S. balance of payments by stimulating foreign investment, produced many recommendations, including several for changes in U.S. tax laws. Among the tax recommendations were- (1) "Eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents." (2) "Provide that a nonresident alien individual engaged in trade or business within the United States be taxed at regular rates only on income connected with such trade or business." This change would give such persons the benefit of the generally lower rates of U.S. taxation of investment income. (The graduated rates on income over $19,000 were also to be eliminated.) H.R. 5916 On March 8, 1965, H.R. 5916 was introduced. The National Foreign Trade Council concluded that the bill generally followed the Fowler report recommendations, except that estate tax rates were reduced to a maximum of 15 percent rather than eliminated. The estate tax ex- emption was increased from $2,000 to $30,000. In its comments on H.R. 5916, the National Foreign Trade Council recommended that the most desirable change which might be made in that bill would be to return to the original recommendation of the 489 PAGENO="0500" 178 FOREIGN INVESTORS TAX ACT OF 1965 Fowler task force; namely, to "eliminate U.S. estate taxes on all in- tangible personal property of nonresident alien decedents." Another recommendation made by the Council at that time was to* make it clear that nonresident alien individuals who were not engaged in trade or business within the United States should not be required to file income tax returns provided, of course, that their tax had been satisfied by withholding at source. It also recommended that foreign security dealers should be encouraged to participate in the marketing to foreigners of U.S. securities by modifying the definition of the term "engaged in trade or business within the United States." This would permit these dealers to participate in such marketing without being treated as engaged in trade or business in this country. ILR. 11297 U.S. estate tacti As compared with H.R. 5916, this bill would increase estate tax rates on estates of nonresident aliens to a maximum of 25 percent, thus giv- ing less incentive for foreign investment in the United States than was given by H.R. 5916. H.R. 11297 would include in the taxable estate of a nonresident alien certain intangible personal property which is excluded from the estate under present law. Such property includes (a) bank deposits of a nonresident alien not engaged in business in the TJnited States, and (b) debt obligations of a U.S. person (including a U.S. corporation), the United States, a State or political subdivision of a State, or the District of Columbia, even though such obligations are physically lo- cated abroad. There is no doubt that these provisions will have an adverse effect on foreign investment in the United States. Interest paid to nonresident aliens and foreign corporations on U.S. bank deposits Since the Revenue Act of 1921, interest on deposits with persons carrying on the banking business paid to persons not engaged in trade or business within the United States has been treated as foreign source income and consequently not subject to U.S. income tax. In considering the merit.s of this exclusion from taxable income, the House Ways and Means Committee report (67th Cong., 1st sess.) indicated that "the loss of revenue which would result if this deduc- tion were allowed would be relatively small in amount, while the exemption of such interest~ from taxation would be in keeping with the action of other countries and would encourage nonresident alien individuals and foreign corporations to transact financial business through institutions located in the United States." H.R. 11297 would completely change this long standing rule of law in that interest paid on bank deposits to nonresident aliens and foreign corporations after December 31, 1970, will become subject to i'ftcome tax even though the recipient may not be doing business in the TJnited States. The technical change in source definitions made by t.he bill affecting bank interest during the interim period 1966 through 1970 is not objectionable since it is not less favorable than existing law in its treatment of U.S. bank interest paid to foreigners. It is submitted that the factors prevailing in today's economy are even more compelling than in the 1920's in requiring that interest 490 PAGENO="0501" FOREIGN INVESTORS TAX ACT OF 1965 179 paid on U.S. bank deposits to nonresident alien individuals and foreign corporations not doing business in the United States continue to be exempt from U.S. taxation. The U.S. balance-of-payments problem would be made more acute if this interest were taxed since it seems reasonable to believe that a substantial part of the under- lying deposits would be transferred to foreign banks. If this were to happen there would be an increased likelihood of these dollars shifting from private to public hands and then becoming a claim on our gold. In addition, it is evident there would be no gain in U.S. tax revenue but in fact a loss, since the shifting of these deposits to foreign banks not subject to U.S. taxation would reduce taxable income otherwise generated by U.S. banks on these deposits. H.R. 11297 is intended to encourage foreign investment in the United States by removing tax barriers to such investment, thereby beneficially affecting the U.S. balance of payments. To quote Secre- tary Fowler in his report to the President of the United States from the Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securities and Increased Foreign Financing for U.S. Corporations Operating Abroad, "The United States should, how- ever, first attempt to. attract foreign investment by attacking the several areas of taxation that deter investment without generating material revenues." The proposed estate tax treatment of. U~S. bank deposits and the proposed income taxation of bank interest after 1970 are completely inconsistent with these purposes and will undoubtedly lead to the withdrawal of funds presently employed in our economy. The NFTC does not object to the proposed treatment o'f U.S. bank interest paid to nonresident aliens and foreign corporations between January 1, 1966, and December 31, 1970, which in effect continues the exemption which has existed since 1921, and strongly recommends that this treatment be continued in respect of such interest paid after December 31, 1970. interest paid to nonresident aliens and foreign corporations on foreign currency deposits with foreign branches of U.S. ban/es Under current law, interest on foreign currency deposits with foreign branches of U.S. banks is exempt from U.S. income tax only if the recipient is not doing business in the United States. The proposed bill would categorize such interest as being from foreign sources and thus exempt from U.S. tax if not effectively connected with a U.S. trade or business. The NFTC agrees with the proposed treatment as foreign source income of interest paid on foreign currency deposits with foreign branches of U.S. banks, and strongly urges that interest paid by such branches on U.S. dollar deposits should be accorded the same treatment. Any provision of U.S. tax law which places a foreign branch of a U.s. bank at a competitive disadvantage with a foreign bank can only result ultimately in a loss to the~ U.S. Treasury and will drive these dollar deposits outside of the U.S. banking system. Transfer of dollar deposits from the U.S. banking system to foreign banks makes them vulnerable to a demand for conversion into gold, as noted above. 491 PAGENO="0502" 180 FOREIGN INVESTORS TAX ACT OF 1965 NEW TAX CONCEPT-"EFFECTIVELY CONNECTED" One of the recommendations of the Fowler Committee was that foreign investors who are engaged in trade or business in the United States should nevertheless be entitled to have their U.S.-source-invest- ment income taxed at the same rates as persons who were not so en- gaged. In H.R. 11297, there are provisions to segregate and sepa- rately tax investment income and noninvestment income. However, the bill also contains a provision under which the tax on nonresident aliens and foreign corporations will be extended to sources outside the United States if it is "effectively connected" with their U.S. trade or business. The principle of taxing foreign corporations only on their U.S.- source income is so fundamental in existing law that the proposed change requires many collateral amendments of the code. While the bill makes amendments to the provisions relating to foreign tax credits and dividends-received deductions, these changes are so complex that extended study would be required to determine whether these changes are all that are necessary and to evaluate the importance of the cases in which there may not be complete alleviation of double taxation as a result of the changes. The introduction of this concept could result in a radical change in the paterns of U.S. taxation of foreign corporations owned by U.S. corporations and individuals. The language which is contained in the proposed revision of the bill could be interpreted to enable the im- position of U.S. income taxes on foreign subsidiaries of U.S. corpora- tions which have relatively minor activities on the part of officers of the foreign subsidiary or officers of the parent corporation on behalf of the subsidiary. Such a change is undesirable and seems unnecessary in light of the major review and overhaul of the taxation of such cor- porations undertaken in the Revenue Act of 1962. The introduction of such a novel concept as taxing foreign persons on their income from sources without the United States seems inap- propriate in this legislation because it is not connected with the pri- mary purpose of the bill. Approximately three-quarters of our income tax treaties provide that where a foreign corporation has a permanent establishment in the United States such permanent establishment is subject to tax only on its U.S.-source income attributable to the permanent establishment. The term "effectively connected" is not defined in the bill, but in- stead, proposed section 864(c) merely cites three factors which should be taken into account in determining whether gains, profits, and in- come or loss shall be treated as "effectively connected" with the con- duct of a trade or business within the United States. It is considered that the lack of a clear definition of "effectively connected" would tend to discourage U.S. investment. Nonresident aliens and foreign corporations in trade or business in the United States could not be sure whether they would be entitled to the invest- ment rate of U.S. taxation on their U.S. investment income or whether their foreign source income would also become subject to U.S. tax. 492 PAGENO="0503" FOREIGN INVESTORS TAX ACT OF 1065 181 RECOMMENDATIONS 1. As to estate taxation of nonresident aliens, it is recommended that the initial suggestion of the Fowler task force with regard to the elimination of U.S. estate taxes on intangible personal property of non- resident aliens de,cedents be followed. 2. It is recommended that interest paid on deposits in foreign branches of U.S. banks be treated as foreign source income. This treatment is proposed in H.R. 11297 for foreign currency deposits; it should be extended to include dollar deposits. 3. As to income taxation of interest paid on bank deposits m the United States to nonresident aliens and foreign corporations not domg business in the United States, it is recommended that the treatment proposed in H.R. 11297 for the period 1966 through 1970, which in effect continues the present exemption which has existed since 1921, be continued after 1970. 4. As to the taxation of nonresident aliens and foreign corporations engaged in trade or business in the United States, it is recommended that such persons be taxed only on their U.S. source income. It is further recommended that the term "effectively connected" be defined so as to eliminate the problems discussed above. 5. Because of the importance of the above-described changes in the U.S. tax law proposed by H.R. 11297, it is urged that hearings be held by the Ways and Means Committee to consider the full implications of the proposals. NEW YORK CHAMBER OF COMMERCE, New York, N.Y., January 11, 1966. To the Members of the Committee on Finance and Currency and Committee on Taceation, New York Chamber of Commerce, New York, N.Y. GENTLEMEN: Mr. Norris Johnson, chairman of the Committee on Finance and Currency has drafted the attached memorandum on H.R. 11297, pointing out certain discriminations against American banks which are included in this bill. If enacted into law, these in- equities would not only penalize American banks, but they would have the direct opposite effect for which H.R. 11297 is intended to produce-to alleviate the balance-of-payments deficit. Mr. Johnson believes that a joint statement on H.R. 11297 by the Committee on Finance and Currency and the Committee on Taxation should be drafted to make known the chamber's views on this bill. Mr. Weston Vernon, Jr., chairman of the Committee on Taxation concurs with this suggestion. A statement will be drafted in the near future for submission to members of both committees. In the meantime, if any committee member wishes to express any opinion on the memorandum or the bill itself, please contact me. Sincerely yours, FRANK A. BRADY, Jr., Research Department. 493 PAGENO="0504" 182 FOREIGN INVESTORS TAX ACT OF 1965 H.R. 11297-Proposed Foreign Investors Tax Act The balance-of-payments problem requires corrective measures along many fronts. One of these is to make it more attractive for foreigners to hold U.S. dollar investments in the United States. Toward this end, beginning in 1962, the Congress authorized exemp- tion of foreign official time deposits from interest rate ceilings under the Federal Reserve's Regulation Q, the Treasury increased Treasury bill offerings to help lift their yields, and the Federal Reserve suc- cessively raised discount rates. On April 27, 1964, the Fowler Com- mittee submitted to President .Johnson a report, originally requested by President Kennedy, on the subject of "Promoting Increased Foreign Investment in U.S. Corporate Securities and Increased Foreign Financing for U.S. Corporations Operating Abroad." Pres- ident Johnson's balance-of-payments program dated February 10, 1965, recommended new legislation to increase the incentives for foreigners to invest in U.S. corporate securities. The proposed Foreign Investors Tax Act, H.R. 11297, has the purpose of encouraging foreign investment in the United States by removing tax barriers to such investment. A number of provisions in the bill will contribute to that end. Some other provisions, losing sight of the essential purpose, would make investments in the United States less attractive and hence damage the balance of payments. The bill would make subject to U.S.. income taxation interest paid to nonresident aliens 1 and make immediately subject to U.S. estate taxation bank deposits of nonresident aliens when held in dollars with American banks and their branches. These discriminations against American banks, and against dollar deposits, are certainly un- called for. There are many competitive foreign institutions eager to take on the business of American banks and to shift funds into foreign currencies or Eurodollars as required to relieve themselves and their customers of U.S. tax liabilities. Foreign jurisdictions, like the United Kingdom and Canada, which carry on an international banking business, a.s a matter of course exempt from income taxation interest on deposits paid to nonresident aliens. It needs to be understood that the United States has financed past balance-of-payments deficits by encouraging foreigners to place and keep dollar deposits with U.S. banks. Apart from deposits of tax exempt foreign Official institutions, the amount involved is approxi- mately $10 billion. If private holders of dollars in New York moved these dollars into foreign currencies, there would be an increase in foreign official holdings of dollars convertible into gold. The result might be the same if the dollars were moved into Eurodollar deposits with foreign banks. All the other benefits of the legislation could be quickly undone. It is inappropriate to the role of the dollar as the world's key currency to remove existing exemptions from taxation of bank de- posits of nonresident aliens. It is incredible that such a step should be seriously considered at the present moment with effects of under- `The latest available form of the bill would make this provision apply after Dec. 31, 1970, with exemptions in favor of foreign central banks of issue and otherwise as may be provided in tax treaties. 494 PAGENO="0505" FOREIGN INVESTORS TAX ACT OF 1965 183 mining laborious other efforts, to bring our international payments into balance and stop the gold drain. We need to attract foreign money, not drive it out. Noinus 0. JoHNsoN. DECEMBER 29, 1965. NEW YORK CLEARING HOuSE, New York, N.Y., January 19, 1966. Hon. WILBtrR D. MILLS, Chairman, Ways and Means Committee, House of Representatives, Washington, D.C. DEAR MR. MILLS: The member banks of the New York Clearing House Association are disturbed by certain provisions of the bill now before your committee described as the "Foreign Investors Tax Act of 1965" (H.R. 11297). I enclose a memorandum setting forth our views on this bill which I hope will be helpful to you. Copies of the memorandum are also being sent to the members of your committee and to its staff. If the Clearing House can be of further assistance in this matter please call on us. Sincerely yours. GEORGE CHAMPION, President. MEMORANDuM RELATING TO H.R. 11297 This memorandum is submitted by the New York Clearing House Association to emphasize the conflict between the Government's over- riding policy of encouraging foreign investments in the United States and the proposals of H.R. 11297 to end the exemption of nonresident foreign individuals and foreign corporations not engaged in business within the United States from .U.S. income and estate taxes on their bank deposits. The exemption, from U.S. income tax for U.S. bank deposit interest received from nonresident foreign individuals or foreign corpora- tions not engaged in business within the. United States was first in- serted into the Internal Revenue Code in 1921. The proponents of the exemption were at that time deeply concerned that U.S. banks were being prevented by reason of the U.S. tax on bank interest paid `to such persons from effectively competing with foreign banks for the business of these foreign individuals and corporations. Since similar `taxes were not imposed by most countries whose banks were competing with ours, Congress determined that the welfare of the United States would best be served by eliminating our income tax on this category of interest. These considerations are even more urgent today. The threat to our balance of payments if such interest, becomes tax- able now or in the near future points up the importance of main- *taining the present exemption. As introduced to the Ways and Means Committee of the House of Representatives, H.R. 11297 would subject interest paid to nonresi- dent foreign individuals and foreign corporations not engaged in 495 PAGENO="0506" 184 FOREIGN INVESTORS TAX ACT OF 1965 business in the United States (hereafter collectively referred to as "nonresident foreigners") to a fiat 30-percent tax, beginning on January 1, 1971. Assuming U.S. bank interest rates of between 4 and 5 percent, the tax would reduce the net yield on invested prin- cipal to nonresident foreigners by between 1 and 11/2 percent per annum. In proposing to repeal the estate tax exemption for U.S. bank deposits held by nonresident foreign individuals, the bill, if enacted in its present form, would provide an added reason for such persons withdrawing their U.S. bank accounts. * It is clear that a decline of between 1 and 11/2 percent in the yield on U.S. bank deposits would make most foreign investors look eTse- where for higher interest rates. The interest equalization tax itself, our prime weapon in the struggle to right our balance of payments, is based on the principle that a 1-percent change in yield has a critical effect on willingness to invest. In the words of President Kennedy, the tax is designed to "increase by approximately 1 percent, the interest cost to foreigners of obtaining capital in this country, and thus help equalize interest rate patterns for longer term financing in the United States and abroad." Transfers of capital presently deposited in U.S. banks by nonresi- dent foreigners would be welcomed by many foreign countries where bank interest rates are at least as high as in the United States and where bank interest paid to nonresident foreign depositors is tax exempt. Among the Western European countries offering these benefits are the Netherlands, West Germany, Sweden, Denmark, Fin- land, and Greece. While there is no formal exemption from United Kingdom in- come tax on interest derived by nonresidents from money ~eposited in United Kingdom banks, United Kingdom law does not provide for withholding income tax on such interest at source, and the Chan- cellor of the Exchequer stated on March 9, 1965, that "it is not the general practice of the Inland Revenue to raise assessments on such interests." If past experience is a fair guide, it can be reasonably expected that passage of H.R. 11297 in its present form will result in the transfer to banks in other countries of a large percentage of the deposits of nonresident foreigners in U.S. banks. Any changes in the Internal Revenue Code which might lead to this result would be destructive of the stated purpose of H.R. 11297 "to encourage foreign investment in the United States-thereby ben- eficially affecting the U.S. balance of payments-by removing tax barriers to such investments." These changes would frustrate the recommendation of the Task Force on Promoting Increased Foreign Investment that foreign deposits be attracted to U.S. banks by raismg interest rates paid to foreigners. The changes would be inconsistent with President Johnson's personal appeal to leading bankers and businessmen at the White House on February 18, 1965, to repatriate all liquid funds not urgently needed abroad. They would also be inconsistent with the directives to private business, both banking and 496 PAGENO="0507" FOREIGN INVESTORS TAX ACT OF 1965 185 nonbanking, contained in the voluntary 1966 guidelines addressed by the Board of Governors of the Federal Reserve System to financial institutions, and with the letter of Secretary of Commerce Connor to major industrial enterprises asking that they retain the maximum possible amount of liquid funds in this country. Finally, the proposed changes would run counter to the purpose of the interest equalization tax, which is to restrain capital outflow from the United States to those very countries whose banks would probably benefit most from a transfer of bank deposits of nonresident foreigners out of the United States. Having expressed our concern on the adverse points in H.R. 11297, we would like to express agreement with the change in source rules which would classify interest paid by foreign branches of American banks on foreign currency deposits as foreign source income. We would urge that this same treatment be granted to interest paid on dollar deposits in foreign branches of American banks. In view of the above, we urge the elimination from H.R. 11297 of the proposed amendments to sections 861 and 2104 of the Internal Revenue Code which would subject to income and estate taxation bank deposits and interest thereon owned by nonresident foreign indi- viduals and foreign corporations not engaged in business within the United States. The New York Clearing House Association: The Bank of New York; the Chase Manhattan Bank (National Association); First National City Bank; Chemical Bank New York Trust Co.; Morgan Guaranty Trust Co. of New York; Manufacturers Hanover Trust Co.; Irving Trust Co.; Bankers Trust Co.; Marine Midland Grace Trust Co. of New York; United States Trust Co. of New York. JANtTARY 19, 1966. NEw Yom~ COUNTY LAWYERS AssooI~rIoN, CoM3nrrui~ ON TAXATON, New York, N.Y., January 18,1966. Hon. WILBUR D. MILLS Chairman, Ways and IJIeai~ Committee, House of Representatives, Washington, D.C. DEAR Mit. Mn~s: This committee has made a study of the Foreign Investors Tax Act of 1965 (H.R. 11297) and wishes to file a memo- randum objecting to certain provisions thereof. However, due to the extreme pressure of work over the yearend, we have been unable to complete the memorandum. I should appreciate it if you would advise when hearings on the bill will be held and the deadline for filing objections thereto. Very truly yours, O~um~ T. LOUTHAN, Chairm,a'm. 497 PAGENO="0508" 186 FOREIGN INVESTORS TAX ACT OF 1965 NEW YORK COUNTY LAWYERS AssoclA'rIoN COMMITTEE OF TAXATION Report on H.R. 11~97, The Fo'reign Investors Tacii Act of 1965 Arthur M. Arnold Donald H. Kaliman Richard A. Challed Mason G. Kassel James A. Cuddihy Jay 0. Kramer, Secretary Lawrence X. Cusack Marvin Lyons Aaron M. Diamond Ambrose V. McCall, Jr. Edward A. Fogel Ira J. Palestin Maurice C. Greenbaum Ernest Rubenstein Alex M. Hamburg J. Wesley Seward Malcolm Johnson Jack Turret Wallace S. Jones Marvin W. Weinstein Carter T. Louthan, Chairman A. GENERAL COMMENTS 1. Bank accounts and bonds Since the Revenue Act of 1921, the interest on bank deposits has been exempt from income tax and such deposits have been excluded from the gross estate for estate tax purposes when received by~ or owned by, nonresident aliens not engaged in business in the United States. Such provisions were adopted for the purpose of encouraging nonresident aliens to open and maintain back deposits in the country. Section 2(a) of the bill amends the present law to expand the cov- erage of the present income tax exemption with respect to interest on hank deposits,. but then provides for the repeal of the exemption as to interest paid or credited after December 31, 1970. The bill also provides that interest on a deposit made by a nonresident alien with the foreign branch of a U.S. bank will be exempt only if it is payable in a foreign currency and is not effectively connected with a business carried on in the United States. Section 8 of the bill provides that after the date of enactment of the act, a dollar deposit made by a non- resident alien with the foreign branch of a U.S. bank will be subject to estate tax. Under present law bonds issued by U.S. obligors are subject to estate tax when owned by nonresident. aliens, only if the bond is phys- ically located in the United States. Section' 8 of the bill, which is ef- fective immediately, will subject bonds to the estate tax irrespective of their location, if issued by U.S. obligors. A major purpose of the bill is stated to be the encouragement of foreign investment in the United States so as to help the U.S. balance of payments. The 5-year delay in the repeal of the income tax exemp- tion with respect to bank interest presumably was designed to encour- age such deposits during the 5-year period. However, aliens are quite sensitive to estate tax liabilities and the possibility of incurring estate tax on such' deposits or on bonds of U.S. obligors undoubtedly will in- duce many nonresident alien individuals to close out their bank de- posits and to dispose of bonds of U.S. obligors immediately, despite the temporary continuance of the income tax exemption. The failure to grant an estate tax exemption as to dollar deposits' with foreign branches of U.S. banks also will have an immediate 498 PAGENO="0509" FOREIGN INVESTORS TAX ACT OF 1965 187 adverse effect on the U.S. balance of payments as well as on the profits of the U.S. banks having such foreign branches. Very few nonresi- dent alien individuals will leave dollar deposits with the foreign branch of a U.S. bank and risk incurring estate tax liability, when they can achieve equal security by opening a dollar account with a Swiss bank which is prohibited by law from disclosing their interest in the Swiss bank's deposit with its U.S. correspondent. Disallowing the interest exemption as to dollar deposits with foreign branches of U.S. banks will put the branches at a competitive disadvantage with foreign banks. Many U.S. corporations have formed financing subsidiaries to borrow U.S. dollars abroad. Loans are then made by the financing subsidiary to a subsidiary which wishes to expand its operations. If such a subsidiary has more funds than it currently needs, it will normally deposit them with the foreign branch of a U.S. corporation. However, the tax disadvantage of do- ing so, undoubtedly will cause such subsidiaries to temporarily invest their excess dollars in some other manner. This inability of the foreign branch of a U.S. bank to compete for such funds inevitably will have an adverse effect upon the bank's ability to earn profits as well as upon the U.S. balance of payments. In view of the foregoing, we recommend that the proposed dis- allowance of these exemptions and the change in the situs rule as* to bonds not be enacted. On the other hand, we approve of the pro- posed expansion of the income tax exemption but recommend that the limitation as to foreign currency in the case of foreign branches and the repeal of the exemptions after December 31, 1970, not be enacted. 2. Income effectively connected with the conduct of a trade or business Under the present statute, a nonresident alien not engaged in trade or business in the United States is subject to a flat rate of tax with- held at the source from fixed or determinable annual or periodical in- come from sources within the United States. If such income exceeds $21,200 a return must be filed and a tax paid at graduated rates. If a nonresident alien is engaged in trade or business in the United States, the present statute requires a return to be filed to report the income from sources within the United States and that the tax be computed thereon in the same manner as is applicable to residents. The determination of whether income is. from sources within or without the United States is made under statutory rules which have been in effect for so long that their meaning is pretty well fixed. Under the bill, the flat withholding tax will be applicable only if the income is not effectively connected with the conduct of a trade or busi- ness in the United States. The requirement that tax be paid at gradu- ated rates if the income exceeds $21,200 is dropped. If, on the other hand, the income is effectively connected with the conduct of a trade or business in the United States, it will be subject to tax at graduated rates, even though under the normal source rules it would be deemed to be from sources without the United States. Thus the taxability of income and the method of taxing it is made to depend upon whether the income is or is not effectively connected with the conduct of a trade or business in the United States rather than upon whether the taxpayer is engaged in trade or business in the United States and the usual source rules. 499 PAGENO="0510" 188 FOREIGN INVESTORS TAX ACT OF 1965 The term "effectively connected" had its genesis in the OEOD model treaty and has been used in the new United States-German Income Tax Convention. The concept involves a term which is novel and has no clear meaning in ordinary speech, nor does a resort to the diction- ary produce a sensible meaning for the term. The statute does not attempt to define the term, but section 2(c) sets out three factors which are to be taken into account in determining whether gams, profits and income, or loss are to be treated as effectively connected with the conduct of a trade or business. However, only the factors set forth in subdivisions (1) and (3) are similar to the factors men- tioned in the Memorandum of Understanding with Respect to the Protocol to the United States-German Income Tax Convention. The factor mentioned in subdivision (2) of the statute but not in the memorandum of understanding is whether the gains, profits or in- come, or loss are accounted for through such trade or business. The new factor added by the statute is an extremely loose concept and seems likely to cause considerable adminstrative difficulty. If the rule is applied literally, it is apt to be a trap for the unwary and a facile means of evasion for the sophisticated. If the rule is to be ap- plied on the basis of what the Service decides should have been ac- counted for through such trade or business, great uncertainty will be injected into the statute. Accounting is not an exact science and com- petent accountants can disagree violently as to what is good account- ing practice in a particular situation. Except where uniform accounting rules are imposed upon taxpayers by regulatory authorities, as for example in the case of insurance com- panies, accounting rules should be omitted as a factor. The first factor-whether assets are used in the conduct of the trade or business-also may unduly favor taxpayers who are well advised and penalize those who are not. If the cash requirements of a U.S. branch of a foreign corporation fluctuate from time to time, it may become desirable to make a temporary investment of the excess cash. If an investment in U.S. bonds appeared desirable, the cash would be remitted to the home office which would then invest it. Under those circumstances, the interest would not appear to be effectively connected with the U.S. business and thus would incur the withhold- ing tax of 30 percent, or the rate might be reduced to 15 percent or entirely eliminated by a treaty. If an investment in U.S. stocks appeared desirable, the cash would be left under the control of the branch, which would make and hold the investment. Under those circumstances, the dividends would seem to be effectively connected with the branch's business. The dividends received deduction allowable under those circumstances would reduce the effective rate of tax to 7.2 percent. In view of the genesis of the term "effectively connected" there is another factor which deserves consideration. Austria, Belgium, Can- ada, Denmark, England, France, the Federal Republic of Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Nor- way, Portugal, Spain, Sweden, Switzerland, and Turkey are members of OECD. Presumably one or more or all of those countries may uti- lize the term in treaties with other countries. If the concept is written into the statute, it would seem desirable for the committee reports to 500 PAGENO="0511" FOREIGN INVESTORS TAX ACT OF 1965 189 make it clear that the administrative or judicial int~rpretation placed upon the term by the officials or courts of these other countries should be ignored in determining the meaning of our statute. It seems questionable whether the uncertainties inherent in the "effectively connected" concept should be injected into the law at this time when every effort should be made to encourage foreign invest- ment in the United States. B. TECHNICAL PROBLEMS 1. Electione to treat real property income as effectively connected with U.S. bv~siness Under sections 3(d) and 4(d) nonresident alien individuals and for- eign corporations are given an election to treat investment real prop- erty as effectively connected with the conduct of a trade or business in the United States so as to pay tax upon the net income rather than upon the gross. This provision is similar to provisions in many in- come-tax conventions except that the election is irrevocable (unless the Secretary consents to its revocation) whereas the treaties permit the election to be made annually. It would appear desirable to grant the election annually, or to at least put some limit upon the applicability of the election. Otherwise the election may continue to be binding for years after the disposition of property which originally occasioned the election with unantici- pated tax results flowing from an isolated sale of real property or the receipt of natural resource royalties. This situation also will make it necessary for those aliens who have the right to make annual elections under treaties to be careful to specify that their election is being made under the treaty rather than under the statute. ~3. Withholding Under section 3(g) of the bill, withholding is required with respect' to fixed or determinable annual or periodical income (as well as cer- tain items which do not fit that description) from sources within the United States, as determined under normal source rules, unless the income is effectively connected with the conduct of a trade or business in the United States. In view of the uncertainty which inevitably will arise as to whether certain items of income are effectively connected with the conduct of a business in the United States, withholding agents will act at their' peril. If they reach the wrong answer as to whether the income is effectively connected with the U.S. business, they will be liable to the United States for failing to withhold or to the alien payee for with- holding when they should not have. Withholding agents should be required to withhold only where the applicable rules are easily de- terminable. Similar considerations apply to the requirement that the tax be withheld (unless the gain is `effectively connected with the business) from gains realized in "collapsible" transactions and upon the re- demption of bonds issued at a discount. Foreigners will not be encouraged to invest here if they are required to consider provisions as complex as these nor should withholding agents (who `receive no 501 PAGENO="0512" 190 FOREIGN INVESTORS TAX ACT OF 1965 compensation for withholding) be required to act at their peril in determining such a complex question. 3. Insurance companies Section 4 of the bill applies the same general rules to foreign insur- ance companies as are applied to other foreign* corporations. The income effectively connected with the insurance business carried. on in the United States is taxed in the same manner as that of domestic insurance companies, while income not so connected is subject to the Hat tax withheld at the source. The difference in the effective rate of tax upon dividends (7.2 or 30 percent) under the two rules, makes the determination of whether dividend income is effectievly connected with the conduct of the U.S. business, of extreme importance to foreign insurers doing t~usiness here. In the event the "effectively connected" concept is adopted, it would seem that the investment income should be deemed to be effectively connected with the conduct of the U.S. insurance business. If there is any doubt as to this the statute should be clarified. Section 4(j) (2) amends section 953(b) (3) (F) of the code with respect to insurance companies, by substituting 832(c) (5) for 832 (b) (5). This change has nothing to do with the changes being made by the bill, but merely corrects an error in the present law. The erro- neous reference 832(b) (5) had the effect of disallowing insurance losses rather than capital losses as clearly intended. The correction therefore should be made retroactively, rather than to limit it to tax- able years beginning after December 31, 1965, as provided by sec- tion 4(k). _____ NEW YORK STATE BAR AssoCIATIoN, TAX SECTION, February 10,1966. LEO H. IRWIN, Esq., Chief Counsel, Committee on Ways and Means, House of Representatives, Washington, D.C. DEA.n Su~: Enclosed for the use of the chairman and members of the House Ways and Means Committee and their staff are 20 copies of a report on H.R. 11297 which was prepared by the Subcommittee on Income Tax Problems of Nonresident Aliens, which is a subcom- mittee of the Personal Income Tax Committee of the tax section of the New York State Bar Association. We will forward 10 more copies of this report to you as soon as they are available. The enclosed report has been approved by the executive committee of the tax section of the New York State Bar Association, but it has not been submitted to the bar association as a whole or to the executive committee of the bar association. Accordingly, the views expressed should be regarded as the views of the persons preparing and reviewing the report rather than the official position of the New York State Bar Association. We hope that the comments contained in this report will prove useful. Very truly yours, THOMAS C. PLOWDEN-WARDLAW, Chairman. 502 PAGENO="0513" FOREIGN INVESTORS TAX ACT OF 1965 191 NEW YORK STATE BAR ASSOCIATION, TAX SECTION Martin A. Roeder, chairman, Charles J. Block, Martin D. Ginsburg, Saul Duff Kronovet, James C. Plowden-Wardlaw, and David R. Tihinghast, January 15, 1966 REPORT OF SUBCOMMITIEE ON INco~IE Tax PROBLEMS OP NONRESIDENT ALIENS WITH RESPECT TO H.R. 11297. Bill section 93(a) (1) (A): IRC section861(a) (1) (4) and (c) (2)-~ Interest The purpose of this amendment is to extend the present exemption. ~f interest.on dep~isits with persons carrying on the banking business to amounts earned on accounts maintained with Federal or State chartered savings and loan associations (such interest is often labeled a "dividend" by the savings institution). This will end a great deal of current confusion. Nonresident aliens are often surprised when a. withholding tax is deducted from interest earned on such accounts due to the. fact tnat the alien is technically a "shareholder" instead of a creditor. The proposed amendment is limited to cases where the "amounts" paid or credited are "deductible" by the association under section 591, i.e., where such amounts are withdrawable on demand, subject to customary notice. This limitation will cause uncertainty since exist- ing section 861 (a) (1) (A) and proposed section 861(c) (1) (interest ~n deposits w.ith persons carrying on the banking business) contain no such requirement. Further, reference to section 591 requires con- sideration of section 265, which disallows interest paid to purchase or carry tax-exempt bonds. Since savings and loan associations often purchase municipal bonds, it is possible that, due to application of section 265, a portion of the interest paid to depositors or account :hoiders will not be deductible under section 591. This bill purports to encourage foreign investment in the United `States by removing tax barriers to such investment. In line with. this intent, it is suggested that reference to section 591 be deleted; or in the alternative, the addition to the phrase "without regard to section 265" should be inserted after "section 591." it is further suggested that this amendment be expanded so as to cover certificates of deposit, a form of investment which, in recent years, has expanded enormously. While it is believed that present section 861(a) (1) (A) (and proposed section 861(c) (1)) are appli- cable to certificates of deposit, there is some uncertainty on the point in banking circles, with the result that many banks are reluctant to sell CD's to nonresident aliens. CD's are technically deposits . (reserve ~requiremeiTts apply) and a clarification ofthe law is in order. Proposed section 861 (c) (3) would further extend the exemption to "amounts held by an insurance company under .an agreement to pay interest thereon." While this amendment is probably intended to cover funds left with life insurance companies by beneficiaries, annui- tants, and owners of matured policies, the proposed text literally would include interest paid by any insurance company (life or casualty) to its noteholders, bondholders, or other creditors. A clarification of this p~roposed subsection is ~aecessary. 503 71-297 0-67-pt. 1-33 PAGENO="0514" * 192 FOREIGN INVESTORS TAX ACT OF 1965 Bill 8ectson 2(b) (1): IRC section 861(a) (2) (B)-Dividends This section states that dividends received from a foreign corpora- tion will be deemed to be income from U.S. sources unless "less than 80 percent of the gross income of such foreign corporation for the 3- year period ending with the close of its taxable year * * * was effec- tively connected with the conduct of a trade or business within the United States * * s." If 80 percent or more of such gross income was effectively connected with the conduct of a trade or business within the United States, income is deemed to be from U.S. sources in the ratio that the gross income which is effectively connected with the conduct of a U.S. trade or business bears to total "gross income from all sources." It is not clear whether the "gross income" of the foreign corporation for purposes of applying the 80-percent test is intended to be its gross income from U.S. sources only or its gross income from all sources. In this regard, reference should be made to proposed section 872(a) and section 82(b), both of which define gross income as income from U.S. sources or income which is effectively connected with the conduct of a trade or business within the United States whatever the source. Ref- erence should also be made to the formula portion of section 861 (a) (2) (B) which expressly specifies "gross income from all sources" [italics supplied] when foreign as well, as domestic income is to be considered. To avoid ambiguity, the point should be clarified. It is submitted that the term "gross income" as used in the opening phrase of this section should be followed by the phrase "from all sources." The policy considerations behind the proposed change are unclear. The summary of the new bill furnished by the Committee on Ways and Means refers to this provision as pertaining to the "second divi- dend" tax. Although such a characterization might be correct under- present law (where the foreign corporation receiving dividends from sources within the United States may be subject to withholding tax upon the distribution thereof as a second such dividend), it seems in- apposite in the new bill where the withholding tax on the foreign corporation applies only, when 80 percent or more of the gross in- come of such foreign corporation is effectively connected with the conduct of a trade or business in the United States. Manifestly, such type of income., would include little or no dividend income-and it is unlikely that any withholding tax would ever be a "second dividend" tax. Since the policy of the new bill is to very sharply narrow the number of cases in which the withholding tax in the case of a foreign corporation is to apply, it is submitted that the concept should be ex- cised from the statute completely (as is done, in effect, by several treaties) and dividends from foreign corporations should never be considered as being income from sources within the United States.' Bill section 2(d) (1) IRC section 864(b) (1)-Personal Services This section excludes from the definition of trade or business within the United States the performance of personal services by a nonresi- dent alien under certain circumstances. The section, however, leaves open the question of whether a nonresident alien working for a foreign entity in the United States, although himself not deemed to be en- `David Tilhinghast, Esq., a member of the subcommittee, expresses no views on this point. 504 PAGENO="0515" FOREIGN INVESTORS TAX ACT OF 1965 193 gaged in trade or business under section 864(b) (1), will, neverthe- less, cause his foreign employer to be deemed to be engaged in trade or business in the United States. It is recommended that a decision be made as to whether the foreign employer in such cases should be deemed to be engaged in trade or business here and that the decision be spelled out in the statute. The proposed section also raises the question of why a nonresident alien working for a domestic entity with an office or place of business abroad is treated differently from a nonresident alien working for a domestic entity that has no office or place of business abroad. The determinative facts would appear to be that a nonresident alien is employed by a U.S. entity, that the normal working location of the nonresident alien is abroad, and that he is required to be present in the United States only for limited periods of time. It would appear that the 90-day-$3,000 rule is a sufficient test by itself. Bill section 2(d) (1): IRU section 864(b) (2)-Trading in securities This proposed section provides that trading in stocks or securities for the nonresident alien's own account will generally not be deemed a "trade or business in the United States." However, a foreign in- vestment company is denied this benefit "if its principal office is in the United States." Since many incorporation statutes provide that the "principal office" of a corporation must be in the country of in- corporation, it should be made clear that the phrase "principal office" as used in the proposed bill is used to describe the actual activities of the office rather than the statutory office. Perhaps the phrase should be expanded to read, "if its main, principal or most important office is in the United States." Bill sections 2(d) (1), 3(a) (1), 3(b) (1), 4(b): IRC sections 864(c), 871(b), 872(a), 882(b)-Effectively connected incOme-Gross income The proposed bill does away with the "force of attraction" prin- ciple (whereby the foreigner's engaging in business in the United States causes all of his U.S. source income to be taxed at normal rates) which characterizes the present law. Under the new concept, the foreigner (individual or corporate) will be subject to progressive taxation on net income only with respect to his "taxable income effectively connected. with the conduct of his trade or business." Thus, the same foreigner may have various types of income-income from passive investment and income effectively connected to a U.S. trade or business-each subject to a different method of U.S. taxation. This subcommittee feels that the new approach is sound in principle. Since the bill provides no definition of "effectively connected" income, other than to lay down guidelines (sec. 864(c)) as to the factors to be considered in reaching a determination, it is to be expected that ad- ministrative difficulties will ensue and that results, at least for a while, will be haphazard. No ready solution is available. The subcommittee, tiowever, is of the opinion that the inclusion of "effectively connected" income from sources outside the United States is not justified. Source rules have, over the years, become well known to the Internal Revenue Service and the public, and the increased reve- nue from the attempt to enlarge the tax base by inclusion of "effec- 505 PAGENO="0516" 194 FOREIGN INVESTORS TAX ACT OF 1e65 tively connected" income from foreign sources would not, it is felt,~ justify the proposed radical departure. from the older rules., More- over, the proposed extension does not fall within one of the stated: objectives of the bill to encourage foreign investment in the United. States. Bill section 3(a) (1) IRU section 871 (a) (1)-Periodic income' This section imposes~ a flat 30-percent tax on periodic incomet of' nonresident aliens ~hidh is not effectively connected with the conduct of a trade or business within the United States. The familiar enu- meration of interest, dividends, rents, etc. is retained. Also retained: is the taxation of gains under section 1235 (gains from the sale or exchange of patents). In addition, the 30-percent tax will now apply to gain on the sale, exchange, or liquidation of stock of a collapsible corporation (sec. 341) and ,to "interest" earned on bonds or other- original discount debt instruments issued `after a specified date (sec. 1232). The provisions of new proposed section 871 (a) (2) (relating to~ capital gains) will not apply to section 1235 income. It therefore appears that capital losses cannot offset section 1235 gains. In ef- fect, gains realized by nonresident `alien inventors would be treated as- ordinary investment income, subject to a 30-percent tax, without off- set. The law thus discriminates against foreign inventors, as it denies them the `capital gain treatment `accorded. resident inventors, with the anomalous result that a relief statute (`sec. 1235) actually results~ in a detriment to a foreign inventor who might, but for section. 1235, get ,capital gain, treatment under sections 1221 et seq. Con- sideration should be given to. allowing foreign inventors capital gain treatment (often. resulting in no tax) to the extent that, they would: qualify therefor without the benefit of section 1235. Bill section 3(a) (1): IRU section 871 (a) (2)-Capital gains This section imposes a capital gains tax upon nonresident alien in- dividuals who are present in the United States' for 183 days or more during the taxable year at the flat rate of 30 `percent. No capital. gains tax is imposed upon foreign corporations except to the extent that such gains are effectively connected with a U.S. trade `orbusiriess.. Sections 881,882. A question exists as to the proper tax treatment of sales made on the installment basis. If a nonresident alien is present for the re- quired period during the year of sale but is not present in the United States for the required period during the year of' receipt of an install- ment, it would appear that he is not subject to tax tinder section. 871 (a) (2)' in respect ofsuch installment. ` It is to be noted that no provision is made in respect of the capital gains of foreign estates or trusts. Since in many cases it is difficult to~ conceive of a "presence" in the United States of a foreign estate or trust, except inventories, it would appear that such estates or tnists~ may often not' be subject t'o U.S. tax on its capital gains. Although the' subcommittee prefers not to comment on policy ques- tions, the members `of the subcommittee believe that the proposed' capital gains tax on nonresident aliens would not only' be difficult to~ enforce but is in the nature of a "nuisance" tax rather than a revenue 506 PAGENO="0517" FOREIGN INVESTORS TAX ACT OF 1965 195 measure. Little if any revenue can be derived from this source since the tax can easily be avoided by (a) selling the asset abroad, (b) forming foreign corporations for U.S. investments or, apparently, (c) setting up foreign trusts for such investments. Under these cir- cumstances, the proposed capital gains tax would be applicable in most cases only to unsophisticated nonresident aliens as distinguished from aliens who have the advice of tax counsel. For the foregoing reasons, despite a possible justification of the capital gains tax on theoretical grounds, it is recommended that the capital gains tax on nonresident aliens be completely eliminated except with respect to capital gains effectively connected with the conduct of a trade or busi- ness in the United States. Bill section 3(a) (1) : IRU section 871(d)-Real estate income Proposed section 871(d) grants to the non-resident-alien individual an election to have certain U.S.-source income from specified interests in real property, including gain from the sale of realty, treated as "income which is effectively connected with the conduct of a trade or business within the United States," and thus as income taxed in the manner provided in proposed section 871 (b) which renders such income taxable as provided in section 1 or section 1201 (b) of the code. (a) Proposed section 871(d) does not make reference to loss on the sale or exchange of realty, suggesting that only gain is to be taken into account. The provision should be clarified. Compare proposed section 873. (b) As a matter of basic policy, quaere why the election should not be given with respect to all U.S. source income rather than just realty income. The comparable provision of prior H.R. 5916 was a proposed section 871 (f). In this subcommittee's report on that section there appeared criticisms in addition to the above comments. The new provision of H.R. 11297 eliminates those additional criticisms. Bill section 3(b) (3): IRU section 87~ ( b) (4)-Savings bonds income Proposed section 872(b) (4) would exclude from U.S. source gross income of certain non-resident-alien individuals "income" from series E and series H bonds. The text of the provision correctly refers to "income" on such bonds but the `heading.of proposed section 872(b) (4) incorrectly refers to "interest" on bonds. As the reference to interest is inappropriate in the case of series E bonds, it should be changed in the heading to read "income". Bill section 3(e) (1): IRC section 877-Ecepatriation The proposed amendment would, unless none of the principal pur- poses of the expatriation was to avoid U.S. income, estate or gift tax, subject expatriates to regular income taxes, for a period of 5 years after expatriation, on their U.S.-source income, defined to include gains on all sales of property located in the United States and on sales of stock and securities of U.S. corporations, plus their "effectively connected" income even if from foreinn sources. It does not seem appropriate that a principal purpose to avoid estate tax or gift tax should have the prescribed income tax effects. It is suggested that references to subtitle B be eliminated from the open- 507 PAGENO="0518" 196 FOREIGN INVESTORS TAX ACT OF 1965 ing sentence. Cf. Section 8(f) of the bill from which it is recom- mended that references to subtitle A be deleted. Section 10 of the bill provides that no amendment made thereby shall supersede an existing treaty. Accordingly, an expatriate to a treaty country would presumably still enjoy the benefits thereof (~.g., limitation of tax `on dividends to 15 percent, on in~tere5t to 5 percent, etc.). Although it is true that, to some extent, our treaties provide these benefits only to countries in which the domestic rates are them- selves high, thus discouraging expatriation to them, this subcommittee is of the view that once the policy to `tax expatriates is adopted (as to which this subcommittee expresses no view), section 10 of the bill should be amended to provide that the new proposed section 877 over- ride existing treaties (Cf. sec. 31 of the 1962 R.A~). The proposed new treatment of capital gains realized by an ex- patriate applies even to gains on assets acquired after expatriation. This appears an undue extension of the proposal, and it is suggested that the Secretary or his delegate be empowered to alleviate the effect of the proposed amendment in cases where the property on which the gains are realized was afteracquired. Per contra, the new proposal probably does not reach gains on installment sales made during the 5-year period, but includible in income thereafter. Consideration should be giveI~ as to whether `this situation should be covered. The proposed section provides that if an expatriate's "taxes on his probable income" `are shown to be substantially reduced, the burden of proving that the expatriation did not have as one of its principal pur- poses the avoidance of U.S. taxes shall be on the taxpayer. It is not clear whether the "taxes on his probable income" means only the U.S. taxes thereon or the entire tax burden thereon including the taxes of the country of his expatriation. This `should be clarified. Cf. section 963. It seems clear that nothing in the proposed amendment changes the status- of the expatriate as a nonresident alien for definitional pur- poses under the Internal Revenue Code. For example, the expatriate should not be deemed to be a "United States citizen or resident" under section 552(a) (2). It is recommended, however, that this be. made absolutely clear by appropriate committee report or otherwise in the course of enactment. Bill section 4(b) (1) IRC section 88~2 (c) (~) -Necessity to file return This section permits deductions allowed "in this subtitle" to a for- eign corporation only if it files a true and accurate return of its total income from U.S. sources. It is noted that the section, as under present law, applies to foreign corporations that are personal holding com- panies and, because of the broad language, "in this subtitle," operates to disallow dividends-paid deductions unless a return is filed. It is recommended that the section be revised so as to allow specif- ically the dividends-paid deduction for personal holding company tax purposes whether or not a return has been filed and that the change be made retroactive to 1954. In practice, foreign corporations that are owned, essentially, by nonresident aliens and which believe that their liability has been fully met by withholding at the source, may fail to file U.S. income tax returns. In a number of instances, such corporations may make dividend distributions to nonresident alien 508 PAGENO="0519" FOREIGN INVESTORS TAX ACT OF 1965 197 shareholders. If subsequent investigation or audit discloses that the corporations in question were personal holding companies, especially since only U.S. source income is considered, the corporations may be placed in an impossible position. It is not believed that any useful purpose is served by continuing the present rule,, and it is suggested that past inequities caused by this rule be corrected by makmg the suggested change retroaótive. Bill section 4(b) (1) IRC section 889d (e) -Corporate return by agent Proposed section 882(e) does not differ from current law, but a clari- fication in language may nevertheless be desirable. The provision states that if a' foreign corporation has an agent but not an office or place of business in the United States, its tax return "shall be made by the agents [emphasis supplied]. it would appear preferable to add at the end of the sentence, immediately following the quoted phrase, "un- less such return is made by the foreign corporation directly." Bill section. 4(k)-Effective dates The amendments made by section 4 of the bill are applicable, gen- erally, in respect of taxable years beginning after December 31, 1965. As previously recommended in respect of proposed section 882(c) (2) of the code, if the dividends paid deduction is allowed for personal holding company tax purposes, whether or not a return is filed by a foreign corporation, such change should be made retroactive to 1954. Consideration should also be given as to whether the proposed revision of section 542(c) (sec. 4(f) of the bill), exempting a foreign corpora- tion from personal holding company status if all its stock during the last half of a taxable year is owned by nonresident-alien individuals, should not also be made retroactive. Dated January 15, 1966. STATEMENT OF G. KEITH FUNSTON, PRESIDENT, NEW YORK STOCK EXCHANGE SUMMARY The New York Stock Exchange enthusiastically supports the basic goals of the proposed legislation-to increase incentives for foreigners to invest in the United States. We regard the bill as a vital and neces- sary step toward inducing foreigners to invest here. It accepts a con- tention long held by the exchange regarding the need to unfetter international securities transactions from overly rigid constraints. It moves significantly toward the recommendations of the Presidential *Task Force on Promoting Foreign Investment and Increased Foreign Financing headed by now Secretary of the Treasury Henry H. Fowler. One of the stated objectives of that `report was, "To help establish conditions under which restraining influences on capital flows between the industrially advanced nations * * * can be re- moved, diminished, or allowed to expire." If U.S. taxation, of for- eign investors and other inhibiting factors are alleviated and our private selling efforts are reinforced, given the favorable prospects for the U.S. economy, it is not unreasonable to expect the savings 509 PAGENO="0520" 198 FOREIGN INVESTORS TAX ACT OF 1965 accumulated in other industrial countries flowing here for investment to be increased-to the benefit of our balance of payments. Despite this general endorsement, we have serious reservations~ about a number of provisions in the bill which conflict with its overall objective of stimulating foreign investment in the United States and aiding our balance of payments. The exchange, therefore, suggests the following deletions, amendments and additions to H.R. 11297: 1. Delete the provisions which make bank deposits of foreigners subject to the estate tax, and which provide that whether or not they are engaged in business here foreigners would be taxed on interest they receive on U.S. bank deposits after 1970. 2. Eliminate .the estate tax on nonresident aliens completely, instead: of providing only a rate reduction. 3. If estates continue to be taxed, retain the situs rule on bonds. Iti addition, exclude customers' cash balances with brokers awaiting in- vestment from property considered taxable for estate tax purposes. 4. Repeal or reduce the withholding tax levied on interest and divi- dents paid to foreigners. As a minimum step, press for mutual reduc-- tions with other countries in the percentage withheld. 5. Eliminate or ease taxes and other restrictions imposed on foreign pension trusts and similar institutional investors. 6. The exchange specifically endorses the language in section 2 of the bill referring to "Trading in Securities and Commodities," as re- vised from the original administration proposals. H.R. 11297, the Foreign Investors Tax Act of 1966, accepts the philosophy and recommendations of the Presidential Task Force on the Balance of Payments (the Fowler Committee), of which the ex- change president was a member. It codifies steps long advocated by representatives of the exchange community regarding international financing. The task force recommendations were originally embodied in H.R. 5916, submitted by the administration to the Congress for~ consideration in 1965. In its statement on }l.R. 5916, the exchange noted that, "Adoption of this legislation would do much to stimulate the long-term flow of foreign capital to the United States, in part by removing archaic restrictions on the flows. The securities industry has long advocated removal of such restrictions. The exchange ap- plauds the fact that the proposed legislation will enhance the free- dom of movement in the international flow of capital funds." The legislation, appropriately cest, should aid our balance-of-pay ments problem. As the late President Kennedy observed in his last balance-of-payments message to the Congress, "Securities of U.S. prin- vate firms could be and should be one of our bestselling exports." This proposed legislation, by removing some bothersome and complex re- straints, should make American securities a good deal more salable to foreign investors. Although supporting the basic philosophy of the bill, we wish to bring to the attention of the Congress our serious reservations about specific provisions of the current version of this proposal. We have great concern that unless these provisions are modified, the legisla- tion might well produce unfavorable rather than favorable reactions in the financial markets of the world and on our balance of payments. The changes from the original (H.R. 5916) version of the bill which appear in H.R. 11297 tend to undercut a good deal of the legislation's 510 PAGENO="0521" FOREIGN INVESTORS TAX ACT OF 1965 199 basic purpose of stimulating foreign investment in the United States. Specifically, the provisions which make bank deposits of foreigners subject to the estate tax, and which provide that foreigners, whether or not they are engaged in business here, would, after 1970, be taxed on the interest they receive on deposits in U.S. banks and savings. and loan associations, will surely lead to a sizable outflow of foreign capital. .. At the end of October 1965, total banking liabilities to foreigners amounted to close to $30 billion. The Treasury estimates that per- haps $5 billion of these deposits would be potentially subject to either the estate tax or to. annual taxation of interest income. It seems rea- sonable to assume that part, perhaps the major part, of this $5 billion would be withdrawn over a period of time from the U.S. banks in response to these changes. Consequently, the exchange strongly urges that the proposed legis- lation be. revised to omit those sections which change the treatment of bank deposits of foreigners. An impediment to the free flow of international capital funds will thereby be avoided and our balance-of- payments position will not be damaged. Apart from these sections, the legislation as written can he ma- terially strengthened in several other ways, as discussed below, and moved closed to its objective, as outlined by the Fowler Committee, of providing greater stimulus to foreign investment. In addition, the effectiveness of a program. to encourage foreign investment in U.S. securities may be enhanced by adopting several measures not included in the tax bill. Consequently, the exchange suggests the following adjustments and additions: .. 1. Elimination of estate tax on nonresident aliens.-Section 8. of the bill proposes that .estate tax rates .be reduced to between 25 and 40 percent of present levels, thereby taxing nonresident aliens at about the . same rates . as U.S. citizens who claim a marital deduction. We recommend the complete elimination of estate taxes on nonresident aliens. .. This woul4 provide a much greater stimulus to foreign invest- ment in the United States than any rate reduction, and therefore be a much greater help to our balance of payments. First, many foreigners are discouraged from investing here by the existing requirement that they file estate tax returns.. This deterrent would be removed if the tax were eliminated. Second, since even the proposed tax rates are higher .than .those now levied in many countries, investment by resi- dents of those countries would still be discouraged. The rates now in the bill are higher than the ones proposed by the administration, and stop far short of the Fowler committee recom- mendation to "eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents." Though the proposed rates would be below those levied on resident estates in the United King- dom, Canada, and Italy, they would be higher than those imposed in Switzerland, Germany, France, and the Netherlands. Thus, the legis- lation favors the residents of some countries while~ discriminating against those of others. . . Elimination of the estate tax. on nonresident aliens would result in a very small revenue loss. The tax has produced revenues of between $3 and $5 million annually in recent years, and would probably yield 511 PAGENO="0522" 200 FOREIGN INVESTORS TAX ACT OF 1965 only about $1 million under the proposed legislation. An additional revenue loss of $1 million would seem to be a very small price to pay for the removal of a major deterrent to foreign investment. The benefits of the change to our balance of payments would in itself be ample compensation for the revenue loss. 2. Elimination of situs rule on bonds.-If the rate schedule pro- posed in the legislation is adopted, the exchange strongly urges that the situs rule regarding bonds not be changed. A change in the situs rule would have a decidedly adverse effect on the balance of payments. Under President Johnson's voluntary program to reduce capital outflows, American companies are being urged to finance their over- seas investments through local borrowing. Over $300 million worth of bonds were floated in Europe in 1965 in response to the President's appeal. The proposed change in the situs rule could jeopardize this program by placing an unnecessary block on the efforts of American firms to finance their overseas expansion in foreign capital markets. Foreign investors would clearly become reluctant to purchase bonds of American companies if this exposed them to U.S. estate taxation. Moreover, it would be extremely difficult administratively to enforce this change in the law. Since bonds are generally issued in bearer form, we known of no practical way of identifying their ownets for tax collection purposes. 3. Exemption of free credit balances from estate taxation.-The exchange also suggests, if foreigners remain subject to the estate tax, that section 2105 of the Internal Revenue Code be amended so that all funds awaiting investment not be considered property within the United States for estate tax purposes. This should apply not only to deposits in banks and savings and loan associations, but also to free credit balances with brokers. 4. Definition of "engaged in trade or business."-The exchange wishes specifically to endorse the language referring to "trading in securities or commodities" under the revision of section 864 of the In- ternal Revenue Code. The language pertaining to trading by dealers in securities and commodities under the original administration pro- posals was vague, and the risk of misinterpretation was great. The revised language in H.R. 11297 clarifies the intent of the legislation. 5. Repeal of withholding on interest and dividend payments.-Con- sideration should be given to unilateral repeal of the withholding tax on interest and dividends paid to foreigners. A reduction in the per- `centage withheld would be a minimum step in this direction. The withholding tax clearly deters investment by foreigners, and its repeal or reduction would appreciably stimulate foreign purchases of U.S. securities. if the potential revenue loss makes unilateral action undesirable (the United States obtained perhaps $100 million from the withhold- ing tax in 1965), the United States should press for mutual reductions in the withholding tax with as many foreign countries as possible. Since transactions in outstanding securities have generally produced an inflow of funds to the United States, mutual reductions in the with- holding rate could be expected to stimulate more foreign purchases of TI.S. securities than U.S. purchases of foreign securities-even con- :sidering the temporary adverse effect of the interest equalization tax. 512. PAGENO="0523" FOREIGN INVESTORS TAX ACT OF 1965 201 6. Easing taxes on foreign pension trusts.-Taxes and other restric- tions imposed on foreign pension trusts and similar investors should be eased. Domestic pension funds enjoy a tax exemption on their investment income. Foreign pension funds cannot obtain this ex- emption without going through the difficult procedure of obtaining approval from numerous agencies of the U.S. Government. As a re- sult, these investors are discouraged from investing here, especially if they are exempt from taxes in their country of domicile. Pension funds in some foreign countries have grown dramatically in recent years. For example, the Joint Economic Committee study of European capital markets indicates that pension funds in Great Britain have been one of the fastest growing institutions in that. country's financial structure, and had investments of $10 billion at the end of 1962.1 Further growth is fully expected. It seems reason- able to assume, therefore, that by according foreign pension funds a tax treatment similar to that enjoyed by domestic funds, a consider.. able capital flow into the United States might be stimulated. Further, one can be confident that the Treasury in its regulations can provide the safeguards necessary to prevent any abuse of this legislation. Consequently, taxes on the income of foreign pension . funds and similar institutional investors should be eliminated by law.; alterna- tively, these investors should be able to obtain tax exemption more readily. As a minimum step, the United States should work toward the mutual elimination of taxes on these types of~ investors. The exchange, in endorsing the spirit of . this bill, believes that * adoption of these changes, amendments, and additions would greatly enhance its effectiveness and better achieve its objective of stimulat- ing foreign investment and aiding our balance-of-payments position. THE PROPRIETARY AssOoI~rIoN, Washington, D.C., February ~1, 1966. Re H.R. 11297. Hon. WILBUR D. MILr~s, Chairman, House Ways and Means Committee, U.S. House of Representatives, Washington, D.C. DEAR MR. CHAIRMAN: The Proprietary Association respectfully recommends that public hearings be held on H.R. 11297. Although we recognize that public hearings were held last year on H.R. 5916, the forerunner of H.R. 11297, substantive changes have been made since that time which go beyond the original proposed legislation. Because of these changes we believe that hearings on the present bill (H.R. 11297) would be in the public interest. Respectfully submitted. HOWARD A. PRENTICE, Exeoutive Vice President and Treasurer. 1U.S. Congress, Joint Economic Committee, "A Description and Analysis of Certain European Capital Markets," 11AM, p. 238. 513 PAGENO="0524" 202 FOREIGN INVESTORS TAX ACT OF 1965 SAUL S. SILVERMAN, LAW OrrIcEs, New York, N.Y., February 18,1966. Re H.R. 11297. Hon. Wu~Bun D. MILLS, Chairman, House Ways and Means Coinuimittee, House of Representatives, Washington, D.C. DEAR Sin: We have recently reviewed the report on H.R. 11297, published by the House Ways and Means Committee. The report indicates that executive, administrative, teelmical, pur- chasing, or other activities in `the Unithd States on behalf of or for the benefit of a foreign corporation could result in the foreign cor- poration being subjected to U.S. taxation on its income from sources outside of the United States if H.R. 11297 were enacted in its, present form. It is our opinion that this new tax burden on foreign corporations is arbitrary and discriminatOry and we hereby make known our most strong opposition and objection to this bill. That is, if a foreign corporation conducts its entire operating activity in a foreign country, activity on behalf of the foreign corporation in the United States of the type outlined above should not subject it to U.S. taxation on the foreign source income. ` This is clearly a `tenuous coniiection to tax liability. Further, thus far no standards as to what constitutes activity on behalf `of a foreign corporation have been promulgated. If these standards are as all encompassing as indicated by the report, then U.S.-owned foreign corporations with foreign source income will ac- quire a double tax nexus. This is in contrast with the stated purpose of the bill, which is directed at the taxation of foreign corporations. In order to harmonize with this purpose, the bill should provide that it be applicable only to foreign corporations the stock of which is majority owned by foreigners. We respectfully request that you consider this viewpoint and that you advise us as to the disposition of our request for public hearings on H.R. 11297. Very truly yours, SAUL S. SILVERMAN, By HENRY R. SILVERMAN., `SOcONY MOBIL OIL Co., INC., * New York, N.Y., January ~8, 1966. Re Foreign Investors Tax Act. Hon. WILBUR D. MILLS, Chairman, Committee on Ways and Means, House of Representatives, Washington, D.C. DEAR MR. CHAIRMAN: The purpose of this letter is to express con- cern over certain provisions of the Foreign Investors Tax Act, H.R. 11297, and to suggest the desirability of public hearings on, this bill. 514 PAGENO="0525" FOREIGN INVESTORS TAX ACT OF 1965 203 Concern over the precise terms of this bill arises from two causes, tone more.narrowly related to the specific purpose of the legislation and the other of potentially much wider consequence. In the first category, I refer to the inclusion in the bill of the follow- ing features: 1. Estate tax at rates up to 25 percent (as contrasted with 15 percent in H.R. 5916 and zero as recommended by the Fowler task force) on intangible personal property of nonresident-alien decedents. 2. Inclusion of U.S. bank deposits owned by nonresident aliens not engaged. in trade or commerce in the United States* in the taxable estate of aliens dying after enactment of tbe bill. 3. Inclusion in the taxable estate of nonresident aliens of bonds issued. by domestic. corporations or governmental units in this country although held by the nonresident alien outside the United States. 4. The indicated intention after December 31, 1970, to tax in- terest received by nonresident-alien individuals or foreign cor- porations on U.S. bank deposits. All of these changes have some tendency to discourage foreign in- vestment in U.S. securities and none, I believe, will produce any significant revenue. For this reason, as one who was a member of the Fowler task force and as an officer of a corporation having a tre- .mendous interest in the U.S. balance of payments, I regret and respect- fully counsel against these provisions. Even more significant are the provisions of H.R. 11297 which would include in the United States taxable income of nonresident aliens and foreign corporations engaged in trade or business in the United States their worldwide income provided that it is "effectively connected" with the U.S. trade or business. This departure from source rules in the taxation of foreigners is a major departure from long-existing tax jurisprudence in this country. This statutory language and the proposed statement of criteria for ~determining "effective connection" are so broadly drawn as to result in great uncertainty: wide areas would have to be filled in part by `Treasury regulations and decisions and in part by the results of litiga- tion. We understand from conferences. with members of the Treasury Department that this vagueness has been recognized but it is their view that the report of your committee will solve the problem through a de- `tailed discussion of the applicability of the new provisions. It would seem preferable that the relevant provisions of H.R. 11297 be strength- ened and clarified to reduce the need for relying upon lengthy explana- `tions inyour committee's report. We understand that certain relatively narrow tax situations moti- vate the Treasury in this context; specifically, we have been advised that the new provisions are aimed at nonresident alien individuals and foreign corporations controlled abroad and are not aimed at the con- trolled foreign subsidiaries of U.S. corporations. Your committee took the leading role in formulating provisions in the Revenue Act of 1962 which deal with controlled foreign corporations as now defined ]fl section 957(a). It seems that it would be unnecessary and unwise to subject such corporations both to the subpart F income provisions 515 PAGENO="0526" 204 FOREIGN INVESTORS TAX ACT OF 1965 and to the uncertainty of the "effectively controlled" provisions. Olar-~ ification could be most effectively accomplished by amending the pro- posed wording of section 882 as now continued m H.R. 11297. One~ way in which this might be done would be to insert a provision such.. `as that contained in the attachment to this letter. If your committee would be uncertain as to the advisability of this change, then we would strongly request an opportunity for public hearings. ~"We will be happy to discuss this matter with you at your conven- ience, or to supply you with any additional information which you may desire. We are enclosing sufficient copies of this letter so that you may dis-- tribute them to members of your committee should you so desire. Very truly yours, GEORGE F. JAMES, SeniorVice President. PRoPos1~ REVISION OP SECTION 882 AS CONTAINED IN THE F0REIGN INVESTORS TAX ACT Section 882 as contained in section 4(b) of the Foreign Investors- Tax Act, H.R. 11297, should be modified by inserting a provision along the following lines: "(d) CONTROLLED Foiu~IGN C0RPOILATIONS.-In the case of a con- trolled foreign corporation as defined in section 957(a), gross income shall include only gross income from sources within the United States.. Deductions allowable under subsection (c) of this section shall be~ allowed only to the extent connected with income from sources within.. the United States." The succeeding subsections would be renumbered (e) and (f)~ accordingly. JANUARY 25, 1966. UPJOHN INTERNATIONAL, INC., Kalamazoo, Mich., February .71,1966. WILBUR D. Mu~i~s, Chairman, House Ways and Means Comm~ittee, House Office Building, Washington, D.C.: Our company respectfully requests public hearings on H.R. 11297,~ designed to encourage foreign investments in the United States. Sub- stantial changes are incorporated in historical rules for determining income of foreign corporations doing business in the United States. Hearmgs are specifically needed to clarify language "effectively connected." R. M. BOUDEMAN, President.. 516 PAGENO="0527" SECTION 12 PRESS RELEASE OF THE COMMITTEE ON WAYS AND MEANS DATED FEBRUARY 24, 1966, ANNOUNCING ONE-DAY PUBLIC HEARING ON NEW FEATURES OF ~`FOREIGN INVESTORS TAX ACT OF 1965" (H.R. 11297) WHICH WILL BE INTRODUCED AS A "CLEAN BILL" ON MONDAY, FEBRUARY 28, 1966 (See Section 14 of this document, page 527) 517 PAGENO="0528" PAGENO="0529" SECTION 13 H.R. 13103 AS INTRODUCED IN THE REPRESENTATIVES HOUSE OF (See Sect ion 14 of this document, pa ge 530) 519 71-2970-67-pt. 1-34 PAGENO="0530" PAGENO="0531" SECTION 14 HEARINGS BEFORE THE COMMITTEE ON WAYS AND MEANS ON H.R. 13103 521 PAGENO="0532" PAGENO="0533" FOREIGN INVESTORS TAX ACT OF 1966 HEARINGS BEFORE THE COMMITTEE ON WAYS AND MEANS HOUSE OF REPRESENTATIVES EIGHTY-NINTH CONGRESS SECOND SESSION ON H.R. 13103 TO AMEND THE INTERNAL REVENUE CODE OF 19~4 TO PROVIDE EQUITABLE TAX TREATMENT FOR FOREIGN INVESTMENT IN THE UNITED STATES MARCH 7, 1966 Printed for the use of the Committee on Ways and Means U.S. GOVERNMENT PRINTING OFFICE WASHINGTON: 1~6 523 PAGENO="0534" COMMITTEE ON WAYS AND MEANS WILBUR D. MILLS, Arkansas, Ghairmcrn CECIL R. KING, Calliornia HALE BOGGS, Louisiana EUGENE J. KEOGH, New York FRANK M. KARSTEN, Missouri A. S. HERLONG, Ja., Florida JOHN C. WATTS, Kentucky AL ULLMAN, Oregon JAMES A. BURKE, Massachusetts CLARK W. THOMPSON, Texas MARTHA W. GRIFFITHS, Michigan W. PAT JENNINGS, Virginia GEORGE M. RHODES, Pennsylvania DAN RO,STENKOWSKI, Illinois PHIL M. LANDRUM, Georgia CHARLES A. VANIK, Ohio RICHARD H. FULTON, Tennessee JOHN W. BYRNES, Wisconsin THOMAS B. CURTIS, Missouri JAMES B. UTT, California JACKSON E. BETTS, Ohio HERMAN T. SCHNEEBELI, Pennsylvania HAROLD R. COLLIER, Illinois JOEL T. BROYHILL, Virginia JAMES F. BATTIN, Montana II LEO H. IRwIN, Chief Coun8ei JOHN M. MARTIN, Jr., A8sistant Chief Coun8ei WILLIAM H. QuEAL~, Minority Coun8ei 524 PAGENO="0535" CONTENTS Press release dated February 24, 1966, an~1ouncing 1-day public hearing on new features of revised version of Foreign Investors Act of 1965 (H.R. 11297) which was introduced as ~a clean bill (H.R. 13103) on Monday, Pa~ February 28, 1966 1 H.R. 13103, a bill to amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States.. - - 4 STATEMENT OF PUBLIC WITNESS Institute on U.S. Taxation of Foreign Income, Paul D. Seghers, president.... 25 MATERIAL SUBMITTED FOR THE RECORD American Institute of Certified Public Accountants, Donald T. Burns, gen- eral chairman, Committee on Federal Taxation 31 American Life Insurance Co., Gordon B. Tweedy, chairman of the board,.. - 45 Coudert Brothers 32 International Economic Policy Association, N.R. Danielian, president._ - 33 Machinery & AlliedJ Products Institute, Charles W. Stewart, president__ 33 Manufacturing Chemists' Association, Inc., G. H. Decker, president 34 National Association of Manufacturers, Donald H. Gleason, chairman, Subcommittee on International Taxation, NAM Taxation Committee.. - 35 National Foreign Trade Council, Inc., Robert J. Kelliher, chairman, NFTC Tax Committee 36 New Yotk County Lawyers Association, Special Subcommittee of the Committee on Taxation - 41 Proprietary Association, Arthur J. Kiriacon, chairman, Tax Committee. - - - 43 Root, Barrett, Cohen, Knapp & Smith, David Simon 44 Socony Mobil Oil Co., Inc., George F. James, senior vice president 45 United States Life Insurance Co. in the City of New York, Saul Lesser, associate general counsel 45 m 525 PAGENO="0536" PAGENO="0537" FOREIGN INVESTORS TAX ACT OF 1966 MONDAY, MARCH 7, 1966 HOUSE OF REPRESENTATIVES, C0MMITiiE ON WAYS AND MEANS, Wa$h~ington, D.C. The committee met at 10 a.m., pursuant to notice, in the committee room, Longwort.h House Office Building, Hon. Wilbur D. Mills (chair- man of the committee) presiding. The CHAIRMAN. The committee will please be in order. The purpose of the hearing today is to receive comments from the interested public on H.R; 13103, the Foreign Investors Tax Act of 1966. This bill supersedes H.R. 11297 and H.R. 5916. It. will be recalled that the committee conducted public hearings on the original bill, H.R. 5916, and also received written comments on H.R. 11297. Without objection a copy of the press release announcing these hearings, along with a copy of the bill, H.R. 13103, will be made a part of the record. (The documents referred to follow:) FEBRUARY 24, 1966. CHAIRMAN WILBUR P. MILLS, DEMOCRAT, OF ARKANSAS, COMMn"rEB ON WAYS AND MEANS, ANNOUNCES 1-DAY PUBLIC HEARING ON NEW FEATURES OF FOREIGN INVESTORS TAX Ace OF 1965 (H.R. 11297) WHICH WILL BE INTRODUCED AS A `CLEAN BLLL" ON MONDAY, FEBRUARY 28, 1966 SUBJECT AND DATE OF HEARING Chairman Wilbur D. Mills, Democrat, of Arkansas, Committee on Ways and Means, today announced the decision of the Committee on Ways and Means to conduct a public hearing on Monday, March 7, 1966, on the new features of a revised version of H.R. 11297, the Foreign Investors Tax Act of 1965, which is being drafted and which will be introduced by the chairman in the form of a new bill on Monday, February 28, 1966. The printed text of such new bill will be available on Tuesday morning, March 1, 1966. Chairman Mills emphasized that the hearing would cover only the new fea- tures of the new bill which he will introduce. These are generally described below. It is mandatory that persons with a similar interest coordinate and consolidate their `testimony and designate one spokesman, as described more fully below. CUTOFF DATE FOR REQUESTS The cutoff date for requests to be heard is 12 o'clock noon, Friday, March 4, 1966. Requests to be heard should be submitted to the chief counsel of the Com- mittee on Ways and Means, Mr. Leo H. Irwin, room 1102, Longworth House Of- fice Building, Washington, D.C., not later than noon Friday, March 4, 1966. BACKGROUND It will be recalled that on March 8, 1965, Chairman Mills, at the request of the administration, introduced H.R. 5916, a bill to remove tax barriers to foreign investment in the United States, to make certain technical amendments, and for 1 527 PAGENO="0538" 2 FOREIGN INVESTORS TAX ACT OF. 1966 other purposes, which was developed by the administration on the basis of the recommendations of the so-called Fowler Task Force. The Committee on Ways and Means conducted public hearings on this legislation on June 30 and July 1, 1965, and received testimony not only from Secretary of the Treasury Fowler, but also from interested public witnesses who asked to be heard, as well as rep- resentatives of the task force which developed the original recommendations. In addition, numerous written statements were received by the committee and made a part of the published hearings on H.R. 5916. The printed hearings were made available to the general public. It will be further recalled that in July 1965, the Committee on Ways and Means met for several days in executive session to consider the provisions of H.R 5916 in the light of the testimony which had been received from the Treasury Department and from the interested public witnesses as well as the written statements on the bill. At the conclusion of the executive consideration of this subject, Chairman Mills, at the direction of the Committee on Ways and Means, introduced a new bill on this subject, H.R. 11297, on September 28, 1965, which succeeded H.R. 5916 and is known as the Foreign Investors Tax Act of 1965. Immediately following the introduction of H.R. 11297, a printed explana- tion of its provisions was made available to the public. In this printed explana- tion an invitation was issued to the general public to express their views on the bill, as follows: "The bill was introduced by Chairman Wilbur D. Mills at the instruction of the Committee on Ways and Means in order to make it available* for the information of the general public. Comments received will be reviewed by the committee before the bill is reported to the House in the next session of the Congress." As a result of that announcement, numerous written com- ments were received during the fall of 1965 and in the early weeks of the cur- rent year. These comments were all consolidated and made available to the members of the Committee on Ways and Means for their consideration. The bill which Chairman Mills plans to introduce on Monday, February 28, represents a further refinement of H.R. 11297, particularly with respect to the concept of "effectively connected" income, It is only on the further refine- ments of this proposed legislation that the Committe on Ways and Means will receive testimony on Monday, March 7, 1966. Chairman Mills emphasized that the committee is interested only in receiv- ing comments on the further refinements of this legislation and is not inter- ested in receiving a duplication of comments which have already been presented to the committee in the public hearings on June 30 and July 1, 1965, and in the written comments which have been made available to the committee during the fall of 1965and in the early weeks of the current year. DIFFERENCES BETWEEN H.R. 11297 AND THE BILL TO BE INTRODUCED The most significant respects in which the provisions of the revised bill dif- fers from those contained in H.R. 11297 are: The provision relating to interest paid on deposits with the foreign branch of a U.S. bank has been amended so that such interest will not be treated as in- come from sources within the United States regardless of whether the deposit is in dollars or in a foreign currency. In addition,. all such deposits held by non- resident aliens will he exempt from estate tax. The effective date of the pro- vision subjecting to tax interest paid to foreigners on deposits with U.S. banks has been postponed to January 1, 1972. The section in HR. 11297 dealing with "effectively connected" income has also been revised. While the new bill continues the segregation of U.S. invest- ment income from U.S. business income Which was provided for in H.R. 11297, it substantially limits the foreign source income which may be treated as being effectively connected to a U.S. business. Under the provisions of the new bill, foreign source income will only be treated as effectively connected with a U.S. business if the foreigner conducts such business through an office or other fixed place of business within the United States to which such income is at- tributable and such income is of certain specified types. These types of income *are (1) royalties for the use of intangible property, which are derived in the active conduct of a licensing business, (2) dividend, interest, and gains from the sale of stock, securities or notes derived in the conduct of a banking, 528 PAGENO="0539" FOREIGN INVESTORS TAX ACT OF 1966 3 financing, or similar business or, in some cases, an investment company, and (3) sales income attributable to the foreigner's U.S. office, but, except in the case of goods sold for use in the United States, only if the foreigner does not have an office outside the United States which participates materially in making the sale. Moreover, under no circumstances will foreign source income which is sub- part F income or which consists of dividends, interest or royalties pa.id by a subsidiary or other affiliated foreign company be treated as effectively con- nected with a U.S. business. COORDINATION OF TESTIMONY The chairman further stated that, due to the heavy schedule of the committee, the hearing must be completed on March 7, 1966, and to that end it is mandatory that all interested individuals and organizations with a similar interest coordi- nate their testimony and designate one spokesman in order to conserve the time of the committee, prevent repetition, and assure that all aspects of the matter will be given appropriate attention within the time allocation. The committee will be pleased to receive from any interested person a written statement for inclusion in the printed record of the hearing in lieu of a personal appearance. These statements will be given the same full consideration as though the statements had been presented in person. In such cases, where statements are submitted in lieu of a personal appearance, a minimum of three copies of the statement should be submitted by the close of business Monday, March 7, 1966. CONTENTS OF REQUESTS TO BE HEARD In order to eliminate repetitious testimony and to properly schedule witnesses and allocate time, it will be necessary for the requests to be heard to specify- (1) The name, address, and capacity in which the witness will appear; (2) The list of persons the witness represents or, in the case of an associ- ation or other organization, their total membership and where possible a membership list of the association or organization; (3) The amount of time the witness desires in which to present his direct oral testimony; (4) An indication of whether or not the witness is supporting or opposing the changes in the bill; and (5) A summary of the comments and recommendations which the witness proposes to make. WRITTEN STATEMENTS In the case of those persons who are scheduled to appear and testify, it is re- quested that 60 copies of their written statements be submitted at least 24 hours in advance of their scheduled appearance. If it is desired an additional 60 copies may be submitted for distribution to the press and the interested public on the witness' date of appearance. Persons submitting written statements in lieu of a personal appearance may also, if they desire, submit an additional 60 copies of their statements for distribution to the committee members and the interested departmental and legislative staffs pending the printing of the public hearings, which will include such statements along the oral testimony of those persons who appear in person. An additional 60 copies may be submitted for the press and the interested public if it is desired. FORMAT OF ALL WRITTEN STATEMENTS To more usefully serve their purpose, all written statements should begin with a Summary of comments and recommendations and the detailed statements which follow should contain subject headings conforming to the summary of comments and recommendations. 529 PAGENO="0540" 4 FOREIGN INVESTORS TAX ACT OF 1966 [H.R. 13103, 89th Cong., 1st sess. Introduced by Mr. Mills on February 28, 1966.] A BILL To amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States Be it enacted by the Senate and House of Representatives of the United States of Ameriva in Congress assembled, SECTION 1. SHORT TITLE, ETC. (a) SHORT TITLE.-This Act may be cited as the "Foreign Investors Tax Act of 1966". (b) TABLE or CONTENTS.- SEC. 1. Short title, etc. (a) Short title. (b) Table of contents. (c) Amendment of 1954 Code. Szc. 2. Source of income. (a) Interest. (b) Dividends. (c) Personal services. (d) Definitions. (e) Effective dates. SEC. 3. Nonresident alien individuals. (a) Tax on nonresident alien individuals: "SEc. 871. Tax on nonresident alien individuals. "(a) Income not connected with United States business-30 percent tax. "(b) Income connected with United States buslness-graduated rate of tax. "(c)' Participants in certain exchange or training programs. "(d) Election to treat real property income as income connected with United States business. "(e) Cross references." (b) Gross income. (c) Deductions. - (d) Allowance of deductions and credits. (e) Expatriation to avoid tax: "SEC. 877. Expatriation to avoid tax. "(a) In general. "(b) Alternative tax. "(C) Special rules of source. "(d) Exception for loss of citizenship for certain causes. "(e) Burden of proof." (f) Partial exclusion of dividends. (g) Withholding of tax on nonresident aliens. (h) Liability for withheld tax. (i) Declaration of estimated income tax by individuals. (j) Gain from dispositions of certain depreciable realty. (k) Collection of income tax at source on wages. (1) `Definition of foreign estate or trust. (m) Conforming amendment. (n) Effective dates. SEC. 4. Foreign corporations. (a), Tax on income not connected with United States business: "SEC. 881. Income of foreign corporations not connected with United States business. "(a) Imposition of tax. "(b) Doubling of tax." (b) Tax on income connected with United States business: "SEC. 882. Income of foreign corporations connected with United States business. "(a) Normal tax and surtax. "(b) Gross income. "(c) Allowance of deductions and credits. "(d) Election to treat real property income as income connected with United States business. "(e) Returns of tax by agent. "(f) Foreign corporations." (c) Withholding of tax on foreign corporations. (d) Dividends received from certain foreign corporations. (e) Unrelated business taxable income. (f) Corporations subject to personal holding company' tax. (g) Amendments with respect to foreign corporations carrying on insurance busi- ness in United States. (h) Subpart F income. (i) Qain from certain sales or exchanges of stock in certain foreiga corporations. (j) Declaration of estimated income tax by corporations. (k) Technical amendments. (1) Effective dates. `Snc. 5. Special tax provisions. (a) Income affected by treaty. (b) Application of pre-1967 Income tax provisions: 530 PAGENO="0541" FOREIGN INVESTORS TAX ACT OF 1966 .5 "SEc. 896. Application of pre-1967 income tax provisions. "(a) Imposition of more burdensome taxes by foreign country. "(b) Alleviation of more burdensome taxes. "(c) Notification of Congress required. "(d) Implementation by regulations." (c) Clerical amendments. (d) Effective date. SEC. 6. Foreign tax credit. (a) Allowance of credit to certain nonresident aliens and foreign corporations. (b) Allen residents of the United States or Puerto Rico. SEC. 7. Amendment to preserve existing law on deductions under section 931. (a), Deductions~ (b) Effective date. SEC. 8. Estates of nonresidents not citizens. (a) Rate of tax. (b) Credits against tax. (c) Property within the United States. (d) Property without the United States. (e) Definition of taxable estate. (f) Special methods of computing tax: "SEc. 2107. Expatriation to avoid tax. "(a) Rate of tax. "(b) Gross estate. "(c) Credits. "(d)' Exception for loss of citizenship for certain causes. "(e) Burden of proof. "Szc. 2108. Application of pre-1967 estate tax provisions. "(a) Imposition of more burdensome tax by foreign country. "(b) Alleviation of more burdensome tax. "(c) Notification of Congress required. "(d) Implementation by regulations." - (g) Estate tax returns. (h) Clerical amendment. (i) Effective date. SEC. 0. Tax on gifts of nonresidents not citizens. (a). Imposition of tax. (b) Transfers in general. (c) Effective date. SEC. 10. Treaty obligations. (c) AMENDMICNT OF 1954 CODE.-EXCept ais otherwise expressly provided, when- ever in this Act an amendment or repeal is expressed in `terms of an amendment to, or repeal of, a `section or other provision, the reference is to a section or other provision of the Internal Revenue Code of 1954. SEC. 2. SOURCE OF INCOME. (a) INPF.REST.- (1) (A) Subparagraph (A) of section 861 (a) (1) (relating to interest from sources within the United States) is amended to read as follows: "(A) interest on amounts described in subsection (c) received by a nonresident alien individual or a foreign corporation, if such interest is not effectively connected with the conduct of a trade or business within the United States,". (B) Section 861 is amended by adding at the end thereof the following new subsection: "(c) INFEREST ON DEPosrrs, ETc.-For purposes of subsection (a) (1) (A), the amounts described in this subsection are-. "(1) deposits with persons carrying on the banking business, "(2) deposits or withdrawable accounts with savings institutions char- tered and supervised as savings and loan or similar associations under Federal or State law, but only `to the extent that amounts paid or credited on such deposits or accounts are dedugtible under section 591 in computing the taxable income of such institutions, and "(3) amounts held by an insurance company under an agreement to pay interest thereon. Effective with respect to amounts paid or credited after December 31, 1971, subsection (a) (1) (A) and this subsection shall cease to apply." (2) Section 861 (a) (1) is amended by striking out "and" at the end of subparagraph (B), by striking out the period at the end of `subparagraph (C) and inserting in lieu thereof ", and", and by adding at the end thereof the following new subparagraph: "(D) interest on deposits with. a foreign branch of a domestic cor- poration, if such branch is engaged in the commercial banking `business." (3) (A) Section 895 (relating to income derived by a foreign central bank of issue from obligations `of `the United States) i's amended- 531 PAGENO="0542" 6 FOREIGN INVESTORS TAX ACT OF 1966 (i) by striking out "shall not be inciudedr' and inserting in lieu thereof ", or from interest; on deposits with persons carrying on the banking business, shall not be included"; (ii) by striking out "such obligations" and inserting in lieu thereof "such obligations or deposits"; (iii) by adding at the end thereof the following new sentence: "For purposes of the preceding sentence, the Bank for International Settle- ments shall be treated a~ a foreign `central bank of issue with respect to interest on deposits with persons carrying on the banking business."; and (iv) by striking out the heading and inserting in lieu thereof the following: "SEC. 895. INCOME DERIVED BY A FOREIGN CENTRAL BANK OF ISSUE FROM OBLIGATIONS OF THE UNITED STATES OR FROM BANK DEPOSITS." (B) The table of `sections for subpart C of part II of subchapter N of chapter 1 is amended by striking out the item relating to section 895 and inserting in lieu thereof the following: "Sec. 895. Income derived by a foreign central bank of Issue from obligations of the United States or from bank deposits." (b) DIVIDENDS.- (1) Section 861(a) (2) sot~rces within the `United State8 Existing section 861 (a) (1) provides generally that interest paid by a resident of the United' States, corporate or otherwise, is income from sources within the United States. Subparagraph (A) of sec- tion 861(a) (1) excepts interest paid on deposits with persons carrying on the banking business from this rule if such interest is paid to per- sons not engaged in business in the United States. Paragraph (1) (A) of section 2(a) of the bill revises existing sub- paragraph (A) of section 861(a) (1) to provide in effect that interest on the amounts described in new subsection (c) of section 861, as added by paragraph (1) (B) of section 2(a) of the bill, is not' con- sidered income from sources within the United States if such interest is paid (or credited) to a nonresident alien individual or foreign cor- poration before January 1, 1972, and such interest is not effectively connected with the conduct of a trade or business within the United States by such recipient. The amendment of section 861(a) (1) (A) is effective for taxable years beginning after December 31, 1966, but such section shall cease to apply in the case of amounts paid or credited after December 31, 1971. Paragraph (1) (B) of section 2(a) of the bill amends section 861 of the code by adding a new subsection (c) which describes the amounts the interest on which is.subjectto the source rule of new section 861 (a) (1) (A). The amounts so described are (1) deposits with* persons carrying on the banking business (including certificates of deposit); (2) deposits or withdrawable accounts with mutual savings banks, cooperative banks, domestic building and loan associations, and other savings institutions chartered and supervised as savings and loan Or * similar associations under Federal or State law, but only to the extent that the amounts paid or credited on such deposits or accounts (in respect of which a determination is being made under sec. 861 (a) (1)) are of a type which are deductible under section 591 of the code (relat- ing to deductions for dividends paid on deposits) in computing the taxable income of such institutions; and (3) amounts held by an insur- ance company under an agreement to pay interest thereon.. New sec- tion 861(c) is effective for taxable years beginning after December 31, 1966. The rule in existing section 861(a) (1) (A) with respect to interest on bank deposits has been revised in amended section 861(a) (1) (A) so as to apply only if the interest is not effectively connected with the, conduct of a trade or business within the United .States and only when' received by a nonresident alien individual or a foreign corporation. Deposits and withdrawable accounts with savings and loan or similar associations are included in new section 861 (c) (2) so that interest (and so-called dividends) paid on such deposits or withdrawable 717 PAGENO="0728" 52 FOREIGN `INVESTORS TAX ACT OF .1966 accounts are treated in the same manner as interest on bank deposits. Under section 591 of the code amounts paid to, or credited to the accounts of, depositors or holders of `accounts as dividends or interest on their deposits or withdrawable accounts are deductible by the association if the depositor or holder of account is entitled to with- draw such amounts on demand, subjectto customary notice of intention to withdraw. . The provisions of amended section 861 (a) (1) (A) do not apply to amounts paid by such savings and loan or similar associa- tions on or with respect to shares of capital stock of such associations, or on or with respect to funds held in restricted accounts which rep- resent a proprietary interest in such associations. Interest on amounts held by insurance companies under an agreed- ment to pay interest thereon is also subject to the provisions of amended section 861(a) (1) (A). In determining under new section 861 (c) (3) whether an `amount is. held by an insurance company un- der an agreement to pay interest thereon the same rules are to apply as are applied under section 6049(b) (1) (D) of the code (relating to returns regarding payments of interest). Thus, for example, the provisions of amended section 861 (a) (1) (A) apply to interest paid on policy "dividend" accumulations and interest paid with respect to the proceeds of insurance policies left with the insurer. The so-called interest element in the case of annuity or installment payments under life insurance or endowment contracts does not constitute interest for such purposes. Amended section 861 (a) (1) (A) does not apply to interest paid by an insurance company to its creditors on notes, bonds or similar evidences of indebtedness. The provisions of amended section 861 (a) (1) (A) and of new sec- tion 861 (c) cease to apply in the case of amounts paid or credited after December 31, 1971. Interest on deposits ~irtth foreign banking branches of domestic cor- porations Paragraph (2) of section 2(a) of the bill amends section 861 (a) (1) of the code `by adding a new subparagraph (D) providing that, for taxable years beginning after December 31, 1966, interest on de- posits with a foreign branch of a domestic corporation is not income from sources within the United States if the foreign branch with which the deposit' `is made is engaged in the commercial banking busi- ness. This rule will apply to such interest notwithstanding the fact that the recipient is a citizen or resident of the United States or do- mestic corporation or that the interest is effectively connected with the conduct of a trade or business within the United States by a non- resident alien or a foreign corporation. It is not necessary for this purpose that the paying corporation be carrying on a banking business within the United States. Since under the provisions of section 862(a) (1) such' interest is treated as income from sources without the Unit- ed States, the interest will be considered to be from sources within the foreign country in which the foreign bran'ch is located. Interest on bank deposits of foreign centraZ banks of iss'ue or the Bank for InternationaZ Settlements Paragraph (3) of section 2(a) of the bill amends section 895 of the code (relating to income derived by a foreign central bank `of issue 718 PAGENO="0729" FOREIGN INVESTORS TAX ACT OF 1966 53 from obligations of the United States) and makes conforming amend- ments. Under present section 895 income derived by a foreign cen- tral bank of issue from obligations of `the United States owned by such bank is excluded from gross income, if such oblig&tions are not held for, or used in connection with, the conduct of commercial bank- ing functions or other commercial activities of such bank. Amended section 895 continues existing law and provides a similar exclusion with respect to interest derived by a foreign central bank of issue from deposits with persons carrying on the banking business; it also contains a new provision under which the Bank for International Set- tlements will be entitled to exclude from gross income interest derived on deposits with persons carrying on the banking business if such de- posits are not held for, or used in connection with, the conduct of com- mercial banking functions or other commercial activities by such de- positor. These amendments are effective for taxable years beginning after December 31, 1966. It is to be noted, however, that the exclusion under section 895 for interest on deposits with persons carrying on the banking business will continue to apply in the case of amounts paid or credited after December 31, 1971,~'even though the provisions of amended section 861 (a) (1) (A) cease to apply to amounts paid or credited after that date. (b) Dividend&-Subsectjon (b) of section 2 of the bill amends sec- tion 861 (a) (2) of the code (relating to dividends from sources within the United States). Dividends froirt foreign corporations Paragraph (1) of section 2(b) of the bill amends subparagraph (B) of section 861 (a) (2) of the code (relating to the source of dividends from a foreign corporation). Under present section 861 (a) (2) (B), if a foreign corporation derives 50 percent or more of its gross income from sources within the United States for the applicable period pre- ceding the declaration of dividends, an amount which bears the same ratio to such dividends as the gross income of the corporation for such period from sources within the United States bears to its gross income from all sources for such period is considered to be a dividend from sources within the United States. Under amended section 861 (a) (2) (B) dividends paid by a foreign corporation are from sources within the United States only if 80 per- cent or more of the total gross~ income of such corporation from all sources for the applicable period preceding the declaration of the divi- dends was effectively connected with the conduct of a trade or busi- ness within the United States by such foreign corporation. The amount of the dividends treated as income from sources within the United States in such case is the amount which bears the same ratio to the dividends which are paid as the gross income of the foreign corporation for such period which is effectively connected with the conduct of a trade or business in the United States bears to the gross income of such corporation from all sources for such period. This amendment is effective with respect to dividends received after Decem- ber 31, 1966; but, to the extent that gross income of the foreign cor- poration for any period before its first taxable year beginning after December 31, 1966, must be taken into account in determining the ap- pheation of amended section 861 (a) (2) (B), the gross income of such 719 PAGENO="0730" 54 FOREIGN INVESTORS TAX A~TIY OF 1966 corporatiOn for such period from sources within the United States will be considered, by reason of the amendment contained in paragraph (2) of section 2(b) of the bill, to be gross income effectively connected with the conduct of a trade or business within the United States. The substance of the provision in section 861 (a)'(2) (B) of the code which provides in effect that, for purposes of determining the foreign tax credit, dividends paid by a foreign corporation are from sources without the United. States to the extent that they exceed an amount which is 100/85ths of the amount of the deduction allowable under sec- tion 245 of the code in respect of such dividends is not changed by the bill. Thus, for example, if a dividend paid by a foreign corporation is not considered to be from sources within the United States under amended section 861 (a) (2) (B) because less, than 80 percent of such corporation's gross income from all sources for the applicable period was effectively connected with its conduct of a trade or business in the United States, and if the recipient of such dividend is a corpora- tion which is allowed a deduction in respect of such dividend under section 245, as amended by section 4(d) `of the bill, because 50 percent or more of the foreign corporation's gross income from all sources for the applicable period was effectively connected with the conduct of a trade or business within, the United States by the foreign corporation, only a portion of such dividend is treated. as income from sources without the United States for purposes of the foreign tax credit. (c) Personal services.-Subsection (c) of section 2 of the bill amends subparagraph (C) (ii) of section 861(a) (3) of the code (re- lating to the source of income from personal services). The amend- ment is effective for taxable years beginning after December 31, 1966. Existing section 861(a) (3) provides that compensation for personal services performed in the United States is income from sources with- in the United States except in a case where the tests contained in sub- paragraphs (A), (B), and (C) are satisfied in respect of the compensa- tion. Subparagraph (C) (ii) presently provides, as one of the tests to be satisfied, that the exception to the general source rule of section 861 (a) (3) applies `only if the compensation is for services performed by the nonresident alien individual as an employee of, or under a con- tract' with, a domestic corporation, if the services are performed for an office or place' of business maintained in a foreign country' or in a possession of the United States by such domestic corporation. The test: prescribed by amended subparagraph (C) (ii) continues the ex- isting provision but broadens it so as to apply to services performed by the nonresident alien individual for an office or place of business maintained in a foreign country or in a possession of the United States by an individual who is a citizen or resident of the United States or by a domestic partnership. (d) De~2nitions.-Subsection (d) (1) of section 2 of the bill amends section 864 of the code (relating to definitions) by redesignating the existing provisions of section 864 as section 864(a). Subsection (d) (2) of section 2 of the bill adds new subsection (b) (relating to trade Or business within the United States) and new subsection (c) (relating to effectively connected income) to section 864. These amendments are effective for taxable years beginning after Decem- ber 31, 1966. 720 PAGENO="0731" FOREIGN INVESTORS TAX ACT OF 1966 55 Trade or business within the United States New section 864(b) specifies rules for determining whether certain activities do, or do not, constitute engaging in trade or business within the United States for purposes of part I (relating to determination of sources of income) of subchapter N of the code, of part II (relating to nonresident aliens and foreign corporations) of subchapter N, and of chapter 3 (relating to withholding of tax on nonresident aliens and foreign corporations and tax free covenant bonds) Of the code. A similar provision in existing section 871 (c) of the code is deleted from section 871, as amended by section 3(a) of the bill, and replaced by the provisions of new section 864(b). Paragraph (1)' of new section 864(b) is substantively identical to the provisions of the second sentence of existing section 871 (c) (relat- ing to U.S. business), except that the test of existing section 871(c) (2) has been broadened to conform to section 861 (a) (3) (C) (ii), as amended by subsection (c) of this section of the bill. This conform- ing amendment permits the nonresident alien individual, subject to the other conditions, to perform services in the United States for an office or place of business maintained in a foreign country or in a possession of the United States by an individual who is a citizen or resident of the United States or by a domestic partnership (as well as by a domestic corporation) yet not be considered to be engaged in trade or business within the United States. Paragraph (2) of new section 864(b) concerns trading in stocks, securities, or commodities. Existing section 871(c) of the code pro- vides that a nonresident alien individual or foreign corporation is not engaged in trade or business within the United States if he effects, through a resident broker, commission agent, or custodian, transactions in the United States~ in stocks or securities. This provision has been so interpreted, however, that the noresident alien individual is engaged in trade or business within the United States if the trading in securities would otherwise constitute engaging in trade or business and if the trading transactions are effected while the nonresident alien individual i~ present in the United States (Zareh Nubar, 13 T.C. 566 (1949)., rev'd 185 F. 2d 584 (4th Cir. 1950), cert. denied 341 U.S. 925 (1951)). It has also been held that a nonresident alien individual is engaged in trade or business in the United States when his trading in securities is other- wise sufficient to constitute a trade or business and such transactions are effected by a resident agent who exercises discretionary authority with respect to such trading (Fernand Adda, 10 T.C. 273 (1948), aff'd 171 F. 2d 457 (4th Cir. 1948), cert. denied 336 U.S. 952 (1949)). Subparagraph (A) (i) of section 864(b) (2) provides generally that a nonresident alien individual or foreign corporation who is not a dealer in stocks or securities is not engaged in trade or business within the United States by reason of trading in stocks or securities for the taxpayer's own account, irrespective of where the activities instru- mental to such trading are performed or how the actual trading trans- actions are effected. It is immaterial whether the corporation or in- dividual conducts the trading activities and effects the stock or security transactions himself or through his employees or uses agents in the United States, whether independent or dependent, to perform any or all of the functions instrumental to such trading. It is also immaterial 721 PAGENO="0732" 56 FOREIGN INVESTORS TAX ACT OF 1966 whether any such employee or agent, `wherever located, is authorized to exercise his own discretion in trading activities conducted, or in effecting transactions, on behalf of his employer or principal. More- over, the volume of stock or security transactions effected during the taxable year is not material in determining under section 864(b) (2) (A) (i) whether the individual or corporation is engaged in trade or business within the United States. The provisions of subparagraph (A) (i) of section 864(b) (2) do not apply to a corporation the principal business of which is trading in stocks or securities for its own account and which maintains its prin- cipal office in the United States, unless such corporation is a personal holding company or would be a personal holding company but for sec- tion 542(c) (7) of the code, as amended by section 4(f) of the bill. Thus, for example, where a foreign investment company (which is not a personal holding company, other than by reason of section 542(c) (7)) has its principal office in the United States it is to be con- sidered to be engaged in trade or business within the United States by reason of its trading in the United States in stocks or securities, and its income from its trading activities, as well as the dividends and in- terest received on the stocks and securities it holds as a result of such trading activities, constitute income effectively connected with its conduct of a trade or business within the United States. On the other hand, if the foreign investment company does not have its principal office in the United States, it is entitled. to all the benefits provided by new section 864(b) (2) (A) (i) in respect of its trading in stocks or securities for its own account as are accorded under such section to a nonresident alien individual who is not a dealer in stocks or securi- ties. For purposes of making the determination in respect of the foreign corporation's "principal office," a foreign corporation will 1~ considered to have only one principal office; and an office will not be considered to be the principal office of `a foreign corporation solely because it is a statutory office of such corporation. Subparagraph (A) (ii) of section 864(b) (2) permits nonresident alier, individuals and foreign corporations who are dealers in stocks or securities to trade in stocks or securities through a resident broker, corn- mission agent, custodian, or other independent agent without being considered to be engaged in trade or business within the United States by reason of such activities. However, this provision is limited by subparagraph (C) of section 864(b) (2), as added b~ this section of the bill, and applies only if the dealer does not maintain an office or place of business in the United States at any time during the taxable year through which, or `by the direction of which, the transactions in stocks or securities are effected. Subparagraph (B) of section 864(b) (2) provides generally that a nonresident alien individual or a forei~rn corporation may engage in certain trading activities in commodities for the taxpayer's own ac- count without being engaged in trade or business within the United States. The rules set out in subparagraph (B) are basically identical to those contained in subparagraph (A) of new section 864(b) (2) con- cerning trading in stocks or securities, except that (1) the provision applicable to traders who are not dealers in commodities applies whether or not such persons are corporations the principal business 722 PAGENO="0733" FOREIGN INVESTORS TAX ACT OF 1966 57 of which is trading in commodities and the principal office of which is in the United States; and (2) in the case of both dealers and nondeal- ers, the provisions of subparagraph (B) apply Only if the commodi- ties traded are of a kind customarily dealt in on an organized com- modity exchange and if the transaction is of a kind customarily con- summated at such place. This last exception, which is contained in subparagraph (B) (iii) of section 864(b) (2) corresponds to provi- sionscontained in existing section 871 (c) of the code. Subparagraph (C) of section 846(b) (2) limits the application of subparagraphs (A) and (B) of that section, as those subparagraphs apply to dealers in stocks or securities or conTimodities, to those cases in which such dealers have no office or place of business within the United States at any time during the taxable year which is respon- sible, directly or indirectly, for effecting the trading activities. A similar provision is contained in existing section 871 (c), but the exist- in~ provision does not apply to transactions in stocks or securities and it is not limited in its application to dealers only. For purposes of paragraph (2) of amended section 864(b), a person who is a dealer in securities or commodities shall be considered a dealer in securities or commodities, even though such person's transactions in securities or commodities conducted in the United States would not constitute such person as a dealer. Effectively connected incoime, etc. New section 864(c) contains rules to be used in determining whether income, gain, or loss is effectively connected with the conduct of a trade or business within the United States by a nonresident alien in- dividual or foreign corporation. Income, gain, or loss which is effec- tively connected with the conduct of a trade or business within the United States is taken into account in determining the tax imposed in accordance with sections 871 (b) and 882(a), as amended by sections 3(a) and 4(b) of the bill, respectively. Income, gain, or loss from sources within the United States which is not effectively connected with the conduct of a trade or business within the United States may be taken into account in determining the tax imposed by sections 871 (a) and 881, as amended by sections 3(a) and 4(a) of the bill, respectively. Existing law does not require a determination as to whether income is, or is not, effectively connected with the conduct of a trade or business within the United States by a nonresident alien individual or by a foreign corporation. General rule Paragraph (1) of new subsection (c) provides that the rules con- tained in paragraphs (2), (3), and (4) of such subsection for deter- mining whether income, gain, or loss shall be treated as effectively connected with the conduct of a trade or business within the United States shall apply only in the case of a nonresident alien individual, or of a foreign corporation, which is engaged in trade or business within the United States at some time during the taxable year for which the tax is being determined. Such paragraph also provides that no income, gain, or loss derived by a nonresident alien individual, or a foreign corporation, not engaged in trade or business within the United States during the taxable year will be treated as effectively 723 PAGENO="0734" 58 FOREIGN INVESTORS TAX ACT OF . 1966 connected with the conduct of a trade or business within the United States, except in the case of income from real property derived from sources within the United States during a taxable year for which the election provided by amended section 871(d) or 882(d) is in effect. Pe~iodical, etc., income from sou~rces within United States-Factors Paragruph (2) of new subsection (c) contains rules for determining whether certain income, gain, or loss, from sources within the United States is effectively connected with the conduct of a trade or business within the United States. Under these rules hi making the determina- tion as to whether* income or gains from sources within the United States which are of the type described in amended section 871 (a) (1) or 881(a), or gain or loss from sources within the United States de- rived from the sale, or exchange of property which is a capital asset (as defined in sec. 1221 of the code), will be considered effectively con- nected with the conduct of a trade or business within the. United States, factors such as those specified in subparagraphs (A) and (B) of such paragraph (2) are to be taken into account. The factors specified in' subparagraphs (A) and (B) of para- graph (2). are whether first, the income, gain, `or loss is derived from assets used in, or held for use in, the conduct of the trade or business within the United States; and second, the activities of such trade or * business within the United States were a material factor in the realiza- tion of the income, gain, or loss. In applying these factors, due re- gard is to be given to whether or not such asset or such income, gain, or loss was accounted for through such trade or business. Thus, in determining the income which is effectively connected with the conduct of a trade or business in the United States, consideration will be given to the fact that the asset giving rise to the income, gain, `or loss de- * scribed in `paragraph (2),' or such income, gain, or loss itself, is carried on books `of account separately kept for the trade `or business conducted in the United States. In determining whether income, gain, or loss, of the types described in paragraph (2), of new subsection (c), is effectively connected with the conduct of a trade or business within the United States, particular attention will be given to the first factor; i.e., whether the asset giv- ing rise to such income, gain, or loss is used in, or held for use in, such trade or business. This factor is especially important in the case of. income of a passive type where business activities are not likely to be a'direct or material contributor to the realization of this income. How- ever, even in this case, the contribution of activities in carrying on a trade or business to the realization of the income, gain, or loss will also be taken into account if such activities are an important factor in con- tributing to the realization of the income. This business activity factor will be of primary significance in the case of income described in para- graph (2), whether generally passive or not, where the operation is a financial, banking, or similar business or is a licensing business and the income arises from these activities. In the case of a corporation, ac- tivity relating to management of investments will not be treated as related to the conduct of a trade or business within the United States unless the maintenance of such investments constitutes the principal activity of such corporation. 724 PAGENO="0735" FOREIGN INVESTORS TAX ACT OF 1966 59 In general, an asset held for the principal purpose of promoting the conduct of a trade or business, in the United States is to be considered held for use in such trade or business, and any income,, gain, or loss de- rived from such asset will be treated as effectively connected with the conduct of such trade or business. The income, gain, or loss derived from an asset acquired in the ordinary course of a trade or business conducted in the United States (e.g., interest on a trade account receiv- able) will generally be considered derived from the activities of such trade or business and treated as effectively connected with the conduct of such trade or business. Example.-F, a foreign corporation, is engaged in manufacturmg operations in the United States. In order to secure a constant source of supply for its U.S. factory, F corporation purchases stock in domestic corporation N. Dividends on, and any gain realized on the disposition of, such stock will be considered income effectively con- nected with the conduct of the U.S. business. If there is no direct relationship between the U.S. business and the holding of the asset, such asset will not generally be considered used in, or held for use in, such business, and the income from such asset will not be considered effectively connected with the conduct of such business. In determining whether such a direct relationship exists, consideration is to be given primarily to the connection between the asset and the needs of the U.S. business. However, also to be taken into account in applying the factors are: (1) the source of the funds or other assets which were used to acquire the asset in question; (2) the disposition of the income from such asset; and (3) the extent of management and control by the U.S. business over such asset. Generally, the ~presence of these three factors is to be determinative of the assets being used in the business without showing that the income or assets are needed in the U.S. business. The significance to be attached to the disposition of the income will depend on the amount of such income and its relation to the other ac- tivities of the U.S. business. Management activities relating to an asset are to be taken into account in determining whether a particular asset is used in, or held for use in, the conduct of a trade or business within the United States only if they are significant in relation to the investments involved. Income from investment assets is not to be con- sidered effectively connected with the conduct of a U.S. business merely because employees of that business exercise management or control over such assets. Investment income realized by a nonresident alien individual en- gaged in business within the United States by reason of his perform- ing personal services in the United States will not be treated as income effectively connected with the conduct of a trade or business within the United States, unless there is a direct economic relation- ship between his holding of the assets from which such income results and his business of performing the personal services. Where there is * such a relationship, as for example, where such ~n individual pur- chases stock in a domestic corporation to assure the opportunity of performing personal services in the United States for such corporation, income derived from such assets may be effectively connected with his conduct of such business within the United States. 725 PAGENO="0736" 60 FOREIGN INVESTORS TAX ACT OF 1966 These principles in respect of income described in paragraph (2) from U.S. sources may be illustrated by the following examples: Example (1) .-M is a foreign corporation engaged in industrial manufacturing in a foreign country. Corporation M maintains a branch in the United States which acts as importer and distributor of the merchandise manufactured abroad; by reason of such branch activities, M corporation is engaged in business in the United States. The branch in the United States is required to hold a large current cash balance for business purposes, but the amount of the cash balance required varies because of the fluctuating seasonal nature of the branch's business. During periods when large cash balances are not required the branch invests the surplus amount in U.S. Treasury bills. These Treasury bills are considered assets used in, or held for use in, the U.S. business, irrespective of where the bills are physically located and irrespective to which office of M corporation the interest thereon is paid. Accordingly, such interest is income effectively con- nected with the conduct of the business in the United States. Example (~) .-The facts are the same as in example (1) except that M corporation also receives interest on overdue accounts receivable which it acquired on the sale of goods through the U.S. branch. Such interest is effectively connected with the conduct of the business within the United States since the activities of the U.S. branch were a material factor in the realization of such income. Example (3) .-O, a foreign corporation engaged in the manufac- .ture of goods, maintains a factory in the United States and by reason of its activities therein is engaged in business in the United States. Corporation 0 owns securities of domestic corporations, such secu- rities having been purchased with funds from 0 corporation's general surplus reserves, and engages a stock brokerage firm in the United States to manage such securities. The brokerage firm is engaged by the U.S. factory and is instructed to deposit all income and gains derived from such securities in the New York bank account of the factory in the United States. This account is not needed to meet such factory's operating expenses. All such income and gains are not ef- fectively connected with the conduct of the business within the United States because the assets giving rise to such income and gains are not held for use in such business. Example (4) .-X, a foreign corporation engaged in the manu- facture of goods in a foreign country, maintains a branch in the United States and by reason of the activities of such branch is engaged in business in the United States. Corporation X invests excess cash, which is generated by the branch and not needed in its business, in securities issued by domestic corporations. The securities are held in the name of X corporation in a brokerage office in the. United States, which office receives and remits all income from the securities to X corporation's home office abroad. The officers of the U.S. branch have authority to manage the securities held in X corporation's brokerage account. The dividends and interest paid on the securities, and any gain or loss resulting from the sale or exchange of the securi- ties, are not effectively connected with the conduct of the business within the United States, because such assets are not used in, or held for use in, such business. 726 PAGENO="0737" FOREIGN INVESTORS TAX ACT OF 1966 61 Example (5) .-Y, a foreign corporation, maintains a branch in the United States. The branch holds on its books stock of domestic corporation D, a wholly owned subsidiary of Y corporation. There is no relationship between the `business of D corporation and of Y corporation's branch in the United States, and the offices of D report to the home office of Y and not to the U.S. branch. Dividends paid on the stock of D corporation are paid to Y corporation's branch in the United States and are mingled with its general funds. However, such branch has no need in its business for the cash so received. The stock of D corporation is not used, or held for use in, the business of Y corporation's branch, and dividends paid on such stock are not effectively connected with such business. Example (6) .-Z, a foreign corporation, has a branch in the United States which acts as an importer and distributor of merchandise. As a result, Z corporation is engaged in business in the United States. Corporation Z also licenses patents to U.S. persons for use in the United States. The businesses in which such patents are used have no direct relationship to the business carried on in Z corporation's branch in the United States, although the merchandise marketed, by the branch is similar in type to that manufactured under the patents. The negotiations and other activities leading up to the consummation of these licenses are conducted by employees of Z corporation who are not connected with the U.S. branch of Z corporation. ~oyalties received by Z corporation as a result of `these licenses are not effectively connected with the conduct of its business in the United States because the activities of the `business conducted within the United States were not a material factor in the production of such income. For purposes of applying the provisions of paragraphs (2) and (4) of new subsection (c) in determining whether interest described in amended section 861 (a) (1) (A) is effectively connected with the conduct of a trade or business within the United States (thereby de- termining under sec. 861(a) (1) (A) whether such interest is from sources within or without the United' States), such interest shall be assumed to be income from sources within the United States to which the rules of such paragraph (2) ~`apply and shall not be subject to the rule provided in such paragraph (4). However, if interest described in section 861 (a) (1) (A) is determined to be income from sources without the United States (because not effectively connected with the, conduct of a trade or business within the United States by reason of the rules of par. (2) of new subsec. (c)), such interest will not be considered to be effectively connected with the conduct of a trade or business within the United States pursuant to the rules provided in paragraph (4) of new subsection (c). Other income from sources within United States Paragraph (3) of new subsection (c) provides that all income, gain, or loss derived from sources within the United States (other than any income, gain, or loss to which par. (2) applies) by a non- resident alien individual, or by a foreign corporation, engaged in trade or business within the United States during the taxable year shall be treated as effectively connected with the conduct of a trade or business within the United States. Thus, the bill does not change the taxation of income from U.S. sources derived by a nonresident 7 1-297 0-67-pt. 1-47 727 PAGENO="0738" 62 FOREIGN INVESTORS TAX ACT OF 1966. alien individual, or by a foreign corporation, engaged in trade . or business within the United States, if such income does not consist of income of `the types described in section 871(a) (1) or 881 (a) or of gains from the sale or exchange of capital assets. On the other hand, all income from sources within the United States, other than gains from the sale or exchange of capital assets which are not effec- tively connected with the conduct of a trade or business within the United States, are subject to `U.S. tax, either under amended section. 871 (a) (1) or 871(b) in the case of a nonresident alien individual who is engaged in trade or business within the United States, or under amended section 881 or 882(a) in the case of a foreign corpora- tion, which is engaged in trade or business within the United States. Gains which are not effectively connected with the conduct of a trade or business within the United States and which are derived from. sources within the United States from the sale or exchange of capital assets are subject to U.S. tax only if the provisions of amended section 871 (a) (2) apply. The income, gain, or loss to which. paragraph (3) applies will be treated as income effectively connected with the conduct of a trade or business within the United States, whether or not there is any connection between such incOme, gain, or loss and the trade or business `being carried on in the United States during the taxable year in respect of which the tax is being determined~ Income from sources without the United State8 Paragraph (4) of new subsection (c) contains the rules applicable for determining, in the case of a nonresident alien individual, or of a foreign corporation, engaged in trade or business within the United States during the taxable year, whether income, gain, or loss from sources without the United States is to be treated as income, gain, or loss which is effectively connected with the conduct of a trade or busi- ness within the'United States. General rwle Subparagraph (A) of paragraph (4) provides that, except as pro- vided in subparagraphs (B) and (C), no income from sources with- out the United States is to be treated `as effectively connected with the. conduct of a trade or business within the United States. Under ex- isting law, a nonresident alien individual or a foreign corporation is not subject to U.S. tax upon any of its income derived' from sources outside the United States, except in the case of a life insurance com- pany to which section 819(a) of the code applies. The provisions of sections 861 through 863 of the code are to apply in determinng- whether an item, of income is from sources within or without the. United States. Section 864(c) does not affect these rules of source in. sections 861 through 863 (except in the case of interest described in.. amended sec. 861(c) and of dividends described in. amended sec.. 861(a) (2) (B)). . * Zncow1e attributable to bwsiness office in the United States Subparagraph (B) of paragraph (4) describes certain' types of in-~ come, gain, or loss which, although treated as income, gain, or loss' `fi~om sources without the United States, may be treated as income, gain, or loss effectively connected with the conduct of a trade or business within the United States and therefore be taken into account for purposes of ~728 PAGENO="0739" FOREIGN INVESTORS TAX ACT OF 1966 63 determining the tax imposed pursuant to amended section 871 (b) or 882 (a) of the code. To be so treated, the requirements of subpara- graph (B), including the specific requirements of either clause (i), (ii), or (iii) thereof, must be satisfied. Income, gain, or loss described in clause (i), (ii), or (in) of sub- paragraph (B) is to be treated as effectively connected with the con- duct of a trade or business within the United States only if the non- resident alien individual or the foreign corporation is engaged in trade or business within the United States during the taxable year and main- tains a business office or other fixed place of business within the United States during such year. In addition, the items of income, gain, or loss described in clause (i), (ii), or (iii) must be attributable to such~ business office or other fixed place of business. A nonresident alien individual or foreign corporation is not to be considered to have a business office or other fixed place of business in the United States merely because such alien individual or foreign cor- poration uses another person's office or other fixed place of business in the United States through which to transact business, if the alien in- dividual's or foreign corporation's business activities in such office or other fixed place of business are relatively sporadic or infrequent, tak- ing into account the overall needs and conduct of the business of such alien individual or foreign corporation. A foreign corporation will not be considered to have a business office or other fixed place of busi- ness in the United States merely because a person controlling such corporation has a business office or other fixed place of business in the United States from which he exercises general supervision and control over the policies of such foreign corporation. Example (1) .-A, a foreign corporation, is engaged in the business of buying and selling tangible personal property. Corporation A is a wholly owned subsidiary of B, a domestic corporation engaged in the business of buying and selling similar property, which has an office in the United States. Officers of B corporation are generally responsible for the policies followed by A corporation and are directors of A corporation, but A corporation has an independent group of officers, none of whom are regularly employed in the United States. In addi- tion to this group of A corporation officers, that corporation has a rnamiging director, C, who is also an officer of B corporation but who is permanently stationed outside the U.S. The day-to-day conduct of A corporation's business is handled by C and its other officers, but they regularly confer with the officers of B corporation and on occasion visit B corporation's office in the United States, at which times they continue to conduct the business of A corporation. Absent other cir- cumstances, A corporation does not have a business officeor other fixed place of business in the United States, even though it may be engaged in trade or business within the United States. Example (~) .-The facts are the same as in example (1) except that, on rare occasions, an employee of B corporation receives an order which he, after consultation with officials of A corporation and because B corporation cannot fill the order, accepts on behalf of A corporation rather than on behalf of B corporation. B cor- poration does not hold itself out as a person which those wishing to do business with A corporation should contact. Assuming that orders 729 PAGENO="0740" 64 FOREIGN INVESTORS TAX ACT OF 1966 are seldom handled in this manner and that they do not constitute a significant part of A corporation's business, A corporation will not be considered to have a business office or other fixed place of business in the United States because of these activities of an employee of B corpo- ration. * Exam~ple (3) .-The facts are the same as in example (1) except that all orders received by A corporation are subject to review by an officer of B corporation before acceptance. Corporation A has a business office in the United States. For the determination of the income attributable to such office, see the discussion below. Income, gain, or loss described in clause (i), (ii), or (iii) of subpara- graph (B) is not to be considered effectively connected with the con- duct of a trade or business in the United States unless such income, gain, or loss is attributable to a business office Or other fixed place of business located in the United States. For this purpose, if only a part of the income, gain, or loss from a transaction, or series of transactions, is properly considered attributable to such office or other fixed place of business within the United States, only that part shall be treated as ef- fectively óonnected with the conduct of a trade or business within the United States. In general, if a nonresident alien individual or foreign. corporation has only one business office or other fixed place of business, and such office or other fixed place of business is located within the United States, all of such taxpayer's income described in clause (i), (ii), or (iii) of subparagraph (B) will be considered attributable to such office or other fixed place of business. The items of income, gain, or loss to which subparagraph (B) applies are described in clauses (i), (ii), and (iii), thereof, respectively. Rents or royalties Clause (i) of subparagraph (B) applies to rents or royalties for the use of, or for the privilege of using, intangible personal property lo- cated without the United States or from any interest in such property, including rents or royalties for the use, or for the privilege of using, outside the United States, patents, copyrights, secret processes and formulas, good will, trademarks, trade brands, franchises, and other like properties, and any gain or loss realized on the sale of any such property. It does not apply to rents or royalties paid for the use of, or for the privilege of using, real property or tangible personal property. In general, an item of income constituting rents or royalties to which clause (1) of subparagraph. (B) applies will not be attributed to a business office or other fixed place of business in the United States unless the lease or license giving rise to such income is made by or through such office or other fixed place of business. For this purpose, a lease or license is to be treated as made by or through a busi- ness office or other fixed place of business in the United States if such office or other fixed place of business either actively participates in soliciting, negotiating, or performing other activities required to arrange, the lease or license from which such rents or royalties are derived or performs significant services incident to such lease or license. However, no income to . which clause (i) applies will be attributed to a business office or other fixed place of business in the United States merely because such office or other fixed place of busi- 730 PAGENO="0741" FOREIGN INVESTORS TAX ACT OF 1966 65 ness (1) developed or otherwise acquired the property which is leased or licensed or (2) exercised general supervision over the activities of the persons directly responsible for carrying on the activities (of solicit- ing, negotiating, servicing, etc.) described in the preceding sentence.. Example.-F, a foreign corporation, is engaged in the active con- duct of a business of licensing patents which it has either purchased or developed in the United States. *Corporation F has an office in the United States. Licenses for the use of such patents outside the United States are negotiated by other than the U.S. office of F corporation, sub- ject to approval by an officer of such corporation at his office in New York. All services which are rendered to F corporation's foreign licensees are performed by employees of F corporation's offices outside the United States. None of the income, gain, or loss resulting from the foreign licenses so negotiated by F corporation is attributable to its office in the United States and therefore is not effectively connected with its conduct of the business in the United States. Dividends, interest, or gains derived in financing business Clause (ii) of subparagraph (B) applies to dividends or interest, or to gain or loss from the sale or exchange of stock or notes, bonds, or other evidences of indebtedness, if such items of income or loss are either derived in the active conduct of a banking, financing, or similar business within the United States by the nonresident alien individual or foreign corporation or received by a foreign corporation the prin- cipal business of whièh is trading in stocks or securities for its own account. Absent unusual circumstances, any income, gain, or loss described in clause (ii) which is derived in the active conduct of a banking, financing, or similar business within the United States either will be attributed in whole to the business office or other fixed place of busi- ness maintained within the United States by the nonresident alien individual or foreign corporation or will not be attributed in any degree to such office or other fixed place of business. Under section 864 (b) (2) (A), as added by section 2(d) of the bill, a foreign corpora- tion, the principal business of which is trading in stocks or securities for its own account, is to be treated as engaged in trade or business in the United States by reason of its stock or securities transac- tions in the United States if it (1) maintains its principal office in the United States and (2) is not a personal holding company (or a com- pany which would be a personal holding company except for amended sec. 542(c). (7) of the code). If such a foreign corporation trades in the United States in stocks or securities and by reason of section 864 (b) (2)(A) is treated as not being engaged in trade or business within the United States, no income described in clause (ii) of subparagraph (B) which is from sources without the United States will be treated as at- tributable to any office orother fixed place of business such corporation may have in the United States, even though such office or other fixed place of bus1ness participates in, or is used in, the conduct of such trading activities. In general, income described in clause (ii) of subparagraph (B) does not include income from stocks or securities which are purchased for investment purposes only, and a corporation will not be treated as having as its principal business trading in stocks or securities, merely 731 PAGENO="0742" * 66 FOREIGN INVESTORS TAX ACT OF 1966 because of incidental investments held by it. Thus, a foreign cor- poration whose principal activity is holding stocks or securities of corporations in which it owns a significant percentage of the out- standing vOting stock will generally not be considered to have as its principal business trading in stocks or securities. Exam~ple.-M, a foreign corporation, owns voting stock in corpora- tions A, B, and C, its holdings in such corporations constituting 15, 20, and 100 percent, respectively, of their outstanding voting stock. Each of such stock holdings by M `corporation represents approxi- mately 20 percent of M corporation's total assets. The remainmg 40 percent of M corporation's assets consist of other investments, 20 per- cent being invested in foreign government securities and stocks and bonds of other corporations in which M corporation does not own a significant percentage of the voting stock, and 20 percent being in- vested in bonds issued by B corporation. None of the assets of M corporation are held for sale, but, if the officers of such corporation were to believe another investment would be preferable to its holdings of such securities of foreign governments and such other corporations, M corporation would sell such securities and reinvest the proceeds therefrom. For purposes of section 864(c) (4) (B) (ii), M corporation is not engaged in the active conduct o1~ a banking, financing, or similar business and does not have for its principal business trading in stocks or securities for its own account. &z2es of inventory through United States office Clause (iii) of subparagraph (B) applies to income derived from the sale outside the United States of personal property described in section 1221 (1) of the code (inventory items and property held pri- marily for sale to customers in the ordinary course of business) if the sale, was made through the business office or other fixed place of busi- ness maintained in the United States by the nonresident alien individ- ual or foreign corporation. For this purpose, a sale is to be con- sid.ered as made through a business office or other fixed place of business in the United States only if such office or other fixed place of business actively participates in soliciting, negotiating, or performing other activities required to arrange for such sale. Sales made as a result of an order solicited by, or received in, a business office or other fixed place of business in the United States, are to be considered as made through such office or other fixed place of business except where an order is re- ceived unsolicited in the office or other fixed place of business and such office or other fixed place of business is not held out to potential custom- ers as the place to which orders directed to the nonresident alien in- dividual or foreign corporation should be sent. In determining whether a sale of personal property is made through a business office or fixed place of business within the United States, section 2(e) of the bill (relating to effective dates) provides that activities conducted in the United States on or before February 24, 1966, in negotiating or carry- ing out a binding contract entered into on or before such date are not to be taken into account. If a sale is made through a business office or other fixed place of business in the United States, the amount of income realized on the sale which will be treated' as attributable to such office or other fixed place of biisiness in the United States shall not exceed the amount 732 PAGENO="0743" FOREIGN INVESTORS TAX ACT OF 196~ 67 which would be treated as gross income fromsources within the United States under sections 861 through 863 of the code if the property had been sold in the United States. Thus, for example, if a foreign cor- poration's branch in the United States sells outside the United States for use in the United States, goods which the home office of the cor- poration manufactures in a foreign country, the profit attributable to the branch in the United States may not exceed the income which under section 863 would be from sources within the United States if the goods had been sold in the United States. In no case, however, will any income from a sale outside the United States of purchased personal property described in section 1221 (1) of the code, where such sale is made through a business office or other fixed place of business in the United States by a nonresident alien individual or a foreign corporation, be treated as effectively connected with the conduct of a trade or business within the United States if the pr~perty is sold for use, consumption, or disposition outside the United States and an office or other fixed place of business maintained by the non- resident alien individual or foreign corporation outside the United States participated materially in such sale. For this purpose, an office or other fixed place of business maintained outside the United States will be considered to have participated materially in a sale if such foreign office or other fixed place of business (1) solicited the order which is the basis for the sale, (2) negotiated the contract of sale, or (3) performed significant services incident to such sale which were necessary to its consummation and were not subject to a separate agreement between the seller and the buyer. A foreign office or other fixed placeof business will not be considered to have participated ma- terially in a sale merely because (1) the sale is made subject to the final approval of such office or other. fixed place of business, (2) the property sold was held in, and distributed from, such office or other fixed place of business, (3) such office or other fixed place of business was used for purposes of having title to the property pass outside the United States, or (4) such office or other fixed place of business per- formed merely clerical functions incident to such sale. Generally, all the income derived from the sale outside the United States of personal property for use, consumption, or disposition out- side the United States which would be United States source income if the property had been sold within the United States will be treated, for purposes of section 864(c) (4) (B), as attributable to a business office or other fixed place of business within the United States if the sale is made through such office or other fixed place of business and no office or other fixed place of business maintained by the taxpayer outside the United. States participated materially in such sale. Income from United States life iusurance business Subparagraph (C) of paragraph (4) provides that, in the case of a foreign corporation which is carrying on a life insurance business in the United States and is taxable, as provided by section 842 of the code, as amended by section 4(g) (1) of the bill, on its income which is effectively connected with the conduct of a life insurance business within the United States, all income of such corporation from sources without the United States which is attributable to its U.S. business 733 PAGENO="0744" 68' FOREIGN INVESTORS TAX A~T OF 1966 shall be treated as effectively connected with the conduct of a trade or business within the United States* This provision is consistent with the treatment accorded by existing section 819(a) of the code in the case of a foreign life insurance company carrying on a life insurance business within the United States. Excludeddividends, interest, royalties, and subpart F income Subparagraph (D) of paragraph (4) provides, notwithstanding the provisions of subparagraphs (B) and (C), that certain types of income, gain, or loss from sources without the United States are in no case to be treated as effectively connected with the conduct of a trade or business within the United States by a nonresident alien individual or foreign corporation. Clause (i) of subparagraph (D) provides for the exclusion of dividends, interest, or royalties from sources without the United States paid by a foreign corporation in which the tax- payer owns (within the meaning of sec. 958(a) of the code), or is con- sidered as owning (by applying the constructive ownership rules of sec. 958(b) ), more than 50 percent of the total combined voting pcwer of all classes of stock entitled to vote. Clause (ii) of subparagraph (D) provides for the exclusion of any * income from sources without the United States which is subpart F income within the meaning of section 952(a) of the code. Under that section a foreign corporation can `have subpart F income only if it is a controlled foreign corporation within the meaning of section 957. In general, the subpart F income of a controlled foreign corpo- ra:tion is includible in the income of its shareholders who are U.S. shareholders within the meaning of section 951(b). However, excep- tions to this general rule are provided by sections 951 (c). and (d) and 963 of the code. For purposes of the exclusion provided by clause (ii) of subparagraph (D), income of a controlled foreign corporation may be subpart F income even though some of such income is not in- cludible in the income of a U.S. shareholder under section 951 because of the ownership of shares in such company by foreign shareholders. However, income of a controlled foreign corporation will not be con- sidered subpart F income for purposes of clause (ii) of subparagraph (D) if it is excluded from subpart F income by any provision of sub- part F of part III of subchapter N of chapter 1 of the code. (e) Effective dates.-Subsection (e) of section 2 of the bill provides the effective dates for the amendments made by section 2 of the bill. Paragraph (1) `provides that the amendments made by subsections (a), (c), and (d) apply with respect to taxable years beginning after December 31, 1966, except that in applying section 864(c) (4) (B) (iii) of the code, as added by subsection (d) of section 2, with respect to a binding contract entered into on or before February 24, 1966, activities in the United States on or before such date in negotiating or carrying out such contract are not to be taken into account. Para- graph (2) provides that the amendments made by subsection (b) apply with respect to amounts received after December 31, 1966. Section 861 (c) of the code, as added by subsection (a) (1) (B) of section 2, also provides that amended section 861 (a) (1) (A) and new section 861 (c) `are to cease to apply with respect `to amounts paid or credited after December 31, 1971. 734 PAGENO="0745" FOREIGN INVESTORS TAX ACT OF 1966 69 SECTION 3 OF BILL. NONRESIDENT ALIEN INDIVIDUALS (a) Ta4v on nonresident alien indi'viduals.-Subsection (a) of sec- tion 3 of the bill amends section 871 of the code (relating to the tax- ation of nonresident alien individuals). The amendment is effective for taxable years beginning after December 31, 1966. Under existing section 871 nonresident alien individuals who are not engaged in trade or business in the United States at any time during the taxable year are subject under subsection (a) (1) to a flat tax of 30 percent on all fixed or determinable annual or periodical income from sources within the United States as well `as on certain amounts treated as gains from the sale or exchange of a capital asset. Capital gains from sources within the United States are taxed at a flat rate of 30 percent under subsection (a) (2): If such individual is present in the United States for less than .90 days during the taxable year, only the gains realized during his presence in the United States are taxed; if he is present in the United' States 90 days or more during the taxable year, all the gains realized during the taxable year are taxed. If the nonresident alien individual who is not engaged in trade or business within the United States at any time during the taxable year derives more than $21,200 in income described in section 871 (a) from sources within the United States, section 871(b) of existing law provides that he is subject to tax on that income at the graduated rates, provided in section 1 or 1201 (b) if the tax so computed is 30 percent or more of such income. Section 871(c) of existing law provides that nonresident alien indi- viduals engaged in trade or business within the United States at any time during the taxable year are taxable on all income from U.S. sources at the graduated rates prescribed by section 1 or 1201(b) ; such section also prescribes rules for determining whether a nonresident alien individual or a foreign corporation is, or is not, engaged in trade or business within the United States. Existing section 871(d) con- tains special rules for treating participants in certain exchange or training programs as though they were engaged in trade or business within the United States, and section 871(e) contains cross references. A number of substantive changes in the manner of taxing nonresi- dent alien individuals are accomplished by the amendment of existing section 871. Under amended section 871 a flat tax of 30 percent is imposed on certain income from sources within the United States which is not effectively connected with the conduct of a trade or busi- ness within the United States, including, capital gains realized during the taxable year if the nonresident alien individual is present in the tTnited States 183 days or more during the taxable year.; the graduated tax under section 1 or 1201(b) is imposed upon all income, regardless of its source, which is effectively connected with the conduct of a trade or busmess within the United States; and an election is provided to treat certain real property income as income which is effectively con- nected with the conduct of a trade or business within the United States. The graduated tax imposed by existing section 871(b) is eliminated, and the definition of engaged in trade or business within the United States is revised and transferred to new section 864(b) by section 2(d) (1) of the bifi. 735 PAGENO="0746" 70 - FOREIGN INVESTORS TAX ACT OF 1966 CODE SECTION 871. TAX ON NONRESIDENT ALIEN INDIVIDUALS (a)' Incorme not co'nrnected with U.S. business-3O-peroen~t tar.- Subsection (a) of amended section 871 imposes a. tax on certain gross, income received by a nonresident alien individual from sources within the United States which is not effectively connected with the conduct of a trade or business within the United. States. The tax applies whether or not the individual is engaged in trade or business within the United States during the taxable year. Income other titan capitc'2 gains Paragraph (1) of amended section 871 (a) provides that three cate- gories of income are taxable at a flat rate of 30 percent if such income is from sources within the United States and is not effectively con- nected with the conduct of a trade or business within the United States by the individual receiving such income. The types of mcome subject to tax at the 30-percent rate are: (1) Interest, dividends, rents, salaries, wages, premiums, an- nuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income; (2) Gains described in section 402(a) (2),403(a) (2), or 631 (b) or(c), and gains on transfers described in section 1235, of the code; and (3) Amounts which under section 341 of the code, or amounts which under section 1232: of the code (in the case of bonds or other evidences of indebtedness issued after September 28, 1965), are treated as gains from the sale or exchange of property which * is not a capital asset. The tax of 30 percent is imposed on the aggregate amount of the specified items of such gains, profits, or income, but only to the extent such items constitute gross income from sources within the United States. It is intended that, in the case ,of gains derived from the disposition of `timber, coal, or iron ore,' which under section 631 (b) or (c) are treated as gains on the sale of such property, the full amount of the gain is subject to the tax of 30 percent without taking into account the application of section 1231 of the code for purposes of determining whether such gains are considered as gains from sales or exchanges of capital assets. Thus, the 30-percent tax applies to the section 631 (b) or (c) gains, whether or not they are considered to be gains from the sale or exchange of capital assets. This is a change from existing law, which provides that the section 631 (b) or (c) amounts are taxable only if they are considered to be gains from the sale or exchange of capital assets, and from the regula- tions under section 871, which provide that the 30-percent tax applies to the gain which is considered in accordance with section 1231 to be gain from the sale or exchange of a capital asset. However, if the non- resident alien individual is otherwise required, in determining his tax for the taxable year, to apply the provisions of section 1231, the gains described in section 631 (b) or (c) which are taken into account in determining the tax under amended section 871 (a) (1) will not again be taken into account for purposes of applying section 1231.. Since the gains described in sections 402(a) (2) and 403 (a) (2), and the gains 736 PAGENO="0747" FOREIGN INVESTORS TAX ACT OF 1966 71 on transfers described in section 1235, are always considered to be gains from the sale or exchange of a capital asset, it is not necessary to make the distinction which is made in the case of gains described in section 631 (b) or (c). The 30-percent tax imposed by paragraph (1) of section .871 (a) applies to all nonresident alien individuals who are not engaged in in trade of business within the United States at any time during the taxable year. In addition, it applies to all nonresident alien individ- uals who are engaged in trade or business within the United States at any time during the taxable year, but only with respect to the items of income described in that paragraph which are not effectively con- nected with the conduct of a trade or business within the United States, whether or not the same trade or business engaged in during the tax- able year. Items of income taxable under paragraph (1) are not to be taken into account in determining the tax under section. 871(b) on income which is effectively connected with the conduct of a trade or business within the United States. The determination of what income is effectively connected with the conduct of a trade or bnsiness within the United States is to be made in accordance with the provisions of section 864(c), as added by section 2(d) (2) of the bill. Capital gai~ of alie~s pi.esevltt in the United States 183 days oii more Paragraph (2) of section 871 (a) provides the rules for taxation of capital gains derived from sources within the United States by non- resident alien individuals, whether or not they are engaged in trade or business within the United States. It does not apply to gains which are considered to be capital gains and are taxed under section 871 (a) (1) (B) or to capital gains which are taxed under section 871(b) as being effectively connected with the conduct of a trade or business within the United States. Capital gains from U.S. sources to which section 871 (a) (2) applies are taxable under such section only if the nonresident alien individual is present within the United States for a period or periods aggregating 183 days or more during the taxable year during which such gain is realized. In such a case a flat rate tax of 30 percent is imposed on the amount by which the capital gains derived by such individual from sources within the United States and arising from sales or exchanges occurring during the year exceed .the capital losses which are allocable to sources within the United States and result from sales or exchanges occurring during the year. In determining those gains which are subject to the 30-percent tax imposed by paragraph (2) there shall be taken into account all gains and losses treated under subtitle A of the code as gain or loss from the sale or exchange of property which is a capital asset, except those gains which are considered to be capital gains and are specified in section 871 (a) (1) (B) and those capital gains and losses which are effectively connected with the conduct of a trade or business within the United States. The amount of gains subject to the tax of 30 percent imposed by paragraph (2) may not be reduced by the application of the deduc- tion for capital gains provided in section 1202 of the code, or by the application of the capital loss carryover provided in section 1212 of the code. For purposes of applying the 183-day rule contained in paragraph (2), a nonresident alien individual who is not engaged in trade or 737 PAGENO="0748" 72 FOREIGN INVESTORS TAX ACT OF 1966 business within the United States at any time during the taxable year and who has not previously established a taxable year, as defined in section 441(b) of the code, is considered to have a taxable year which is a calendar year, as defined in section 441 (d). `Subsequent adoption of a fiscal year as the taxable year will be treated as a change in the taxpayer's annual accounting period to which section 442 applies and may only be made with the approval of the Secretary or his delegate. If in the course of the taxable year an individual changes his status from that of a citizen or resident of the United States to that of a nonresident alien individual, or vice versa, the determination for purposes of paragraph (2) whether the individual has been present in the United States for'~ 183 days or more during the taxable year shall be made by taking into account the entire taxable year, and not )ust that portion of the taxable year during which he has the, status of a nonresident alien individual. Ded'uctions The 30-percent `tax of section 871 (a) is imposed upon the gross amount of gains, profits, `and income subject to tax, and no deductions are allowed except to the extent of taking lossess into account for purposes of determining the excess amount of capital gains taxable under section 871 (a) (2). The tax is not imposed, however, upon that portion of any item which does not constitute gross income, and thus, tor example, the tax imposed under section 871 (`a) (1) on an annuity would be determined after the application of section 72 of the code. For rules pertaining to deductions, see section 873, as amended `by sub- section (c) of this section of the bill. (b) Incom~e connected `with U.S. business-Graduated rate of tax.- Section 871 (b) provides for the imposition of a graduated tax on ,the income derived by a nonresident alien individual which is effectively connected with the conduct of a trade or business within the United States. I'imposition of tax Paragraph (1) of section 871(b) provides for a tax, to `be com- puted at the graduated rates provided in section 1 or 1201(b), on the taxable income of a nonresident alien individual which is effectively connected with the conduct of a trade or business within the United States by such individual, whether such income is derived from sources within, or from sources without, the United States. Except `as pro- vided in amended section 871(d), the t'ax provided pursuant to the provisions of paragraph (1) applies only if the nonresident alien Individual is engaged in trade or business within the United States at some time during the taxable year for which the tax is `being deter- mined. The tax imposed pursuant to paragraph (1) is imposed only on the nonresident alien individual's taxable income which is effectively con- nected with any trade or business carried on by such individual within the United States, even though the trade or business with which the income is effectively connected is not the same as that currently car- ried on within the United States by such individual. Any income of such individual which is not effectively connected with a trade or ,business carried on within the United States is not to be taken into 738 PAGENO="0749" FOREIGN INVESTORS TAX ACT OF 1966 73 account in determining the tax imposed pursuant to paragraph (1), even though such income is not subject to the 30-percent tax imposed by section 871(a). Similarly, losses which are not effectively con- nected with the conduct of a trade or business within the United States are not to be taken into account in determining the tax under subpara- graph (1) except as provided in section 873 (b), as amended by sub- section (c) of this section of the bill. The determination of whether the nonresident alien individual is engaged in trade or business within the United States, and the deter- mination of what gross income is. to be treated as effectively connected with the conduct of such trade or business, are to be made under the rules set out in section 864 (b) and (c.), as added by section 2(d) of the bill. Since a nonresident alien individual is considered to be en- gaged in trade or business within the United States by reason of per~ forming personal services therein, such as an employee, the wages,. salaries, fees, compensations, emoluments, or other remuneration, in- cluding bOnuses, received for such personal services* are income effëc- tively connected with the conduct of such trade or business. Pensions~ retirement pay, or annuities attributable to such services constitute income which is effectively connected with the conduct of such trade or business within the United States if the recipient of such incOme is engaged in trade or business within the United States in the taxable year of such recipient in which such income is received. Determination of tcucable income Paragraph (2) of section 871(b) provides that, in determining taxable income for purposes of paragraph (1), gross income includes only the individual's gross income which is effectively connected with the conduct of a trade or business within the United States by such individual. The deductions from such gross income are to be deter- mined in accordance with section 873, as amended by subsection (c) of this section of the bill. Thus, in determining the tax rate to be applied under section 1 of the code to the taxable income which is effectively connected with the conduct of a trade or business within the United States, none of the income upon which a tax is imposed under section 871 (a) is taken into account. (c) Participants in certain e~rchange or training programs.-Sub- section (c) of section 871 conforms the provisions of existing section 871(d) to the. amended structure of section 871. Under this.amended subsection, a nonresident alien individual who is not engaged in trade or business within the United States and who is tempOrarily present in the United States as a noniminigrant under subparagraph (F) or (J) of section 101 (a) (15) of the Immigration and Nationality Act (relating to visiting students, teachers, trainees, etc.) is treated as if he were engaged in trade or business within the United States. The amended provision further provides that, for purposes of section 871, the, portion of any scholarship or fellowship grant received by such individual which is not excluded from gross income under section 117 (a) (1) of the code solely by reason of section 117(b) (2) (B), as well as . amounts (to the extent includible in gross income) received for travel, research, clerical help, or equipment, incident to such scholar- ship or fellowship grant, shall, to the extent derived from sources 739 PAGENO="0750" 74 FOREIGN INVESTORS TAX ACT OF 1966 within the United States, be treated as income effectively connected with the conduct of a trade or business within the United States. (d) Election to treat real property income as ineDme connected with United States b'usaness.-Subsection (d) of section 871 provides that a nonresident alien mdividual may, subject to certain limitations, elect to treat certam mcome from real property as income effectively `connected with the conduct of a trade or business within the United :States. The election is available to all nonresident alien individuals, whether or not engaged in trade or business within the United States ~during the taxable year for which the election is made. In general Paragraph (1) of section 871(d) provides that an election may be .~made with respect to any income from real property held for the pro- ~duction of income and located in the United States, or from any inter- `est in such'real property, including (1.) gains from the sale or exchange of any such real property or any interest in such property; (2) rents or royalties from mines, wells, or other natural deposits; and (3) gains referred to in section 631 (b) or (c) of the code. The election may be made only with respect to such income which is not effectively con- iiected with the conduct of a trade or business within the United States. For this purpose, income from such real property does not `include either interest on a debt obligation secured by a mortgage of ~real property or any portion of a dividend paid by a corporation or a trust (such as a real estate investment trust described in sec. 857 of the code) which derives income from real property. Income from such real property does include, however, that portion of the income included under section 652 or 662 of the code in the income of the beneficiary of a trust which is treated as consisting of income from real property. A nonresident `alien individual who makes the election under para- graph (1) will determine the tax on his income from such real property as provided in section 871 (b) even though he is not engaged in trade or business in the United States during the taxable year. Such individ- ual is entitled to the deductions which are allowed by section 873, as amended by subsection (c) of this section of the bill, but none of such deductions shall be allowed in determining any tax under amended section 871 (a) on income which is not effectively connected with the conduct of a trade or business within the United States. Income which is treated pursuant to an election under paragraph (1) as income effectively connected with the conduct of a trade or business within the United States is to be aggregated, for purposes of deter- mining the tax imposed pursuant to section 871(b), with all other income for the taxable year which is effectively connected with the conduct of a trade or business within the United States. To the extent that deductions are connected with income from such real property in respect of which an election is made under paragraph (1), such deductions shall be treated as connected' with income which is effec- tively connected with the conduct' of a trade or business within the United States. An election under paragraph (1) applies' to all gains, profits, and income derived from such real property, or from any interest in such real property, located in the United States, whether or not such gains, profits, and income would be subject to tax under amended section 740 PAGENO="0751" FOREIGN INVESTORS TAX ACT OF 1966 75 871(a) (1) or (2) had no election been made. If there are no gains, profits, and income which are derived from real property located m the United States, or from any interest in such real property, during the taxable year and which are taxable under section 871(a) (1) or (2), an election under paragraph (1) may not be made. But if an election has been properly made in respect of a taxable year, the election remains in effect, unless properly revoked, for subsequent taxable years with respect to all such real property located in the United States, or from any interest therein, even though during any such subsequent taxable year there are no gains, profits, or income derived from such real property. The election under paragraph (1) is not to apply with respect to real property, e.g. a personal residence, which was not held for the production of income or with respect to gains, profits, and income from any transaction which was not entered into for profit. Any real property located in the United States in respect of which an election under paragraph (1) is properly in effect is to be treated as a capital asset which, if depreciable, will be subject to the allowance for de- preciation provided in section 167 of the bode, but is not to be treated as property used in the trade or business for purposes of section 172(d) (4) (A) (i), 1221 (2), or 1231 (b) of the code. Thus, for ex- ample, if a taxpayer makes the election under paragraph (1) and while such election is in effect sells nonincome-producing real property held for investment purposes, any gain realized on such sale is to be gain realized on the sale of a capital asset and is to be gain which is effec- tively connected with the conduct of a trade or business within the United States for purposes of section 871(b). If such sale results in a loss, the loss is not to be treated as a capital loss to which section 871(a) (2) applies. If property with respect to which the election applies is transferred to a domestic corporation in a transaction to which section 351 of the code applies, and if at the time of the transfer such property is section 1250 property, all or part of the gain realized on the transfer may be recognized and treated as gain from the sale or exchange of property which is neither a capital asset nor property described in section 1231. See t1~e. (amendment to section 1250(d) of the code made by. sub- section (j) of this section of the bill. Once made, the election under paragraph (1) applies to all income from real property held for the production of income, which is not otherwise effectively connected with the conduct of a trade or business within the United States, derived by the electing individual in any subsequent taxable years. The election may be revoked only with the consent of the Secretary of the Treasury or his delegate. The provisions of paragraph (1) may be illustrated by the following example~: Exampie.-A, a nonresident alien individual, owns two parcels of real estate located in the United States. One parcel is improved with an office building which A has leased on a long-term, net-lease basis. The other parcel is unimproved and is held for investment purposes. During the taxable year 1967, A is at no time present in the United States or engaged in trade or business within the United States. In 1967, A elects to have the income from the improved real estate treated as income which is effectively connected with the conduct of 741 PAGENO="0752" .76 FOREIGN INVESTORS TAX ACT OF 1966 * a trade or business within the United States. A has no other income from United States sources during the taxable year. In determinmg * his income subject to tax under section 1 of the code, A is allowed any deductions which are allowable under amended section 873; and for such purposes deductions attributable to such real property and to the income therefrom is to be treated as connected with in- *conie which is effectively connected with the conduct of a trade or business: within the United States. In 1968, A sells the unimproved parcel of real estate held for investment, the election under section 871(d) still.heing in effect. Any gain realized, from such sale, and A's income for the year from the rental property, are subject to tax und~r section 1 or 1201 (b). If such sale is at a loss, the loss will be treated as a. capital loss which is deductible under amended sections 873 (a) and 1212(b) of the code. Election after revocation . Paragraph (2) of section 871(d) provides that if an election made pursuant to the provisions of paragraph (1) has been revoked, a new election may not be made for any taxable year before the fifth taxable year beginning after the first taxable year for which such revocation was effective. A new election may be made at any time, however, if the electing individual secures the consent of the Secretary of the Treasury or his delegate. Farm and time of election and revocation Paragraph (3) of section 871(d) provides that the election provided by paragraph (1), and any revocation thereof, is to be made in accord- ance with the regulations to be issued by the Secretary of the Treasury or his delegate. (e) Cross references.-Subsection (e) of section 871 contains a list of cross references to certain other sections of the code. SECTION 3 OF BILL-CONTINtTED Conforming amendment Paragraph (2) of section 3(a) of the bill amends section 1 of the code (relating to tax on individuals) by redesi~nating subsection (d) as subsection (e) and by adding a. new subsection (d). The new subsection provides that the tax imposed under subsection (a) of sec- tion 1 applies to nonresident alien individuals only to the extent so - provided by section 871 (b) or 877. The amendment is effective for taxable years beginning after December 31, 1966. (b) Gross income.-Subsection (b) of section 3 of the bill amends section 872 of the code (relating to gross income of a nonresident alien individual), effective for taxable years beginning after December 31, 1966. Under existing law, the gross income of a nonresident alien individual includes only gross income from sources within the United States. Certain items of income are expressly excluded from gross income under existing section 872(b). . General rule . Paragraph (1) . of section 3(b) of the bill amends section 872 (a) to provide that the gross income of a nonresident alien individual includes only that income from sources within the United States which 742 PAGENO="0753" FOREIGN iNVESTORS TAX ACT OF 1966 77 is not effectively connected with the conduct of a trade or business within the United States and all income (whether or not derived from sOurces within the United States) which is effectively connected with the conduct of a trade or. business within the United States. ExcZ~siorts Paragraph (9) of section 3(b) of the bill amends subparagraph (B) of section 872(b) (3) (relating to the exclusion from gross income of * certain compensation of participants in certain exchange or training programs). Under existing law the exclusion from gross income ap- plies only to compensation paid a qualifying nonresident alien indi- vidual by a "foreign employer," which term is defined under subpara- graph (B) to~ include an* office or place of business maintained in a foreign country or in a possession of the United States by a domestic corporation. The amendment made .by this paragraph provides that an office or place of business maintained in a foreign country or in a possession of the United States by a domestic partnership or by an individual who is a citizen or resident of the United States is also within the meaning of the term "foreign employer." This amendment is consistent with the amendment of section 861 (a) (3) (C) (ii) made * by section 2(c) of the bill and with the provisions of section 864 (b) (1) (B), as added by section 2(d) of the bill. Bond interest of residents of the Ryulcyu Islands or the 7'rnst Tern- tor~,i of the Pcwifi1c lslcmds Paragraph (3) of section 3(b) of the bill adds a new paragraph (4) to section 872(b). This new paragraph excludes from the gross in- come of a nonresident alien individual any income derived by such individual from a series E or series H United States savings bond, if such individual acquired such bond while a resident of the Ryukyu Islands or the Trust Territory of the Pacific Islands. (C) Deductions.-Paragraph (1) of section 3(c) of the bill amends section 873 of the code (relating to deductions allowed nonresident alien individuals). Paragraph (2) of section 3(c) of the bill amends section 154(3) of the code (relating to cross references with respect to deductions for personal exemptions), to provide the proper cross reference to section 873(b) (3), as amended by this section of the bill. These amendments are effective for taxable years beginning after De- *CCiflb9J'31, 1966. Under existing law nonresident alien individuals engaged in trade or business within the United States at any time during the taxable year are entitled to the deductions allowable under subtitle A (relat- ing to income taxes) of the code, but only if and to the extent that such deductions are connected with income from sources within the United States. Deductions are allowed for the following items whether or not connected with income from sources within the United States: (1) Losses incurred in transactions entered into for profit, if any income from such transaction would have been subject to tax; (2) casualty or theft losses of property located in the United States; (3) charitable contributions made to certain U.S. charitable organiza- tions other than charitable trusts; and (4) one personal exemption (except in the case of a resident of Canada or Mexico, who is allowed the regular personal exemptions). 7 1-297 0-67-pt. 1-48 743 PAGENO="0754" 78 FOREIGN INVESTORS TAX ACT OF 1966 CODE SECTION 873. DEDUCTIONS (a) General rule.-Section 873(a) of the code, as amended by sec- tion 3(c) of the bill, provides that, generally, a nonresident alien indi- vidual is allowed the deductions allowable under subtitle A of the code, but only if and to the extent that such deductions are connected with income which is effectively connected with the conduct of a trade or business within the United States. The deductions so allowed may be taken only by a nonresident alien individual who is determining his tax in accordance with amended section 871(b) by reason of having gros~s income which is effectively connected with the co~iduct of a trade Or business within the United States or gross income which is treated as effectively connected .with the conduct of a trade or business within the United States by virtue of an election made pursuant to section 871(d), as added by section 3(a) of the bill. No deductions are to be allowed in determining the tax imposed by amended section 871 (a). Under subsection (a) of section 873 the rules governing the proper apportionment and allocation of deductions for purposes of the appli- cation of such subsection are to be prescribed in regulations issued by the Secretary of the Treasury or his delegate. (b) Eaieeptio~s.-Section 873(b) provides that, for purposes of determining the tax in accordance with amended section 871(b), a nenresident alien individual who has income which is effectively con- nected with the conduct of a trade or business within the United States (or income which is so treated pursuant to an election under amended sec. 871(d)) is allowed certain deductions in determining his taxable income, whether or not such deductions are connected with income which is effectively connected with the conduct of a trade or business within the United States. The deductions so allowed under amended section 873(b) are: (1) The deduction for casualty or. theft losses of property located within the United States allowed under section 165(c) (3) of the code; (2) the deduction for charitable con- tributions find gifts allowed under section 170 of the code, including contributions or gifts to or for a trust described in section 170(c) (2); and (3) the deduction for personal exemptions allowed by section 151 of the code (in the case of a nonresident alien individual who is not a resident of Canada or Mexico, only one such exemption is allowable). For purposes of determining the application of the limitations con- tained in section 170(b) of the code on the amount of the deduction for charitable contributions or gifts, only that income for the taxable year which is effectively connected with the conduct of a trade or business within the United States, plus any income from real property which pursuant to an election under amended section 871 (d) is treated as income so effectively connected, is to be taken into account. If in the case of a nonresident alien individual whose tax for the taxable year is determined in accordance with amended section 871(b) the deductions allowed by section 873 exceed the gross income which is effectively connected with the conduct of a trade or business within the United States (and any income which is treated pursuant to an election under amended sec.. 871 (d) as income so effectively con- nected), such excess, to the extent constituting a net operating loss under section 172(c) of the code, may be carried, in accordance with 744 PAGENO="0755" FOREIGN INVESTORS TAX ACT OF 1966 79 section 172(b) of the code, to other taxable years for which the tax is imposed pursuant to amended section 871(b). For purposes of de- termming the amount by which the net operating loss is reduced under section 172(b) (2) in determining the amount of carryback or carryover, any income on which the tax for the taxable year is imposed pursuant to amended section 871 (a) is not to be taken into account; but, even though such income is the only income for the taxable year, such taxable year is to count as one of the taxable years to which such loss may be carried under section 172(b) (1). (c) Cr088 refereiwes.-Subsection (c) of section 873 contains cross references to certaifl.. ot~her . sections of the code. SECTION 3 OF BILL-CONTINUED (d) Allowanee of d Jueti~c'n~ and credits.-Subsection (d) of sec- tion 3 of the bill amends section 874(a) of the code (relating to the filing of a proper return as a prerequisite to the allowance of deduc- tions and credits) by deleting the reference therein to income received from all sources in the United States. The Secretary of the Treasury or his delegate may, therefore, require the nonresident alien individ- *ual to file, as a prerequisite to the allowance of deductions and credits, a true and accurate return of his income . from sources within the United States in the case of income not effectively connected with the conduct of a trade or business within the United States, . and from sources within and without the United States in the case of income effectively connected with the conduct of a trade or business within the United States. This amendment is effective for taxable years beginning after December 31, 1966. (e) Expatriation to avoid tax.-Subparagraph (e) of section 3 of the bill adds a new section 877 (relating to expatriation to avoid tax) * to the code and makes a conforming amendment. Paragraph (1) of section 3(e) amends subpart A of part II of subchapterN of chapter 1 of the code (relating to nonresident alien individuals) by redesig- nating existing section 877 as section 878, and by inserting after sec- tion 876 a new section 877. Paragraph (2) of section 3(e) amends the table of sections for subpart A of part II of subchapter N of chap- ter 1 of the code, to conform to the amendments made by paragraph. (1) of section 3(e) These amendments are effective for taxable years beginning after December 31, 19(~6. CODE SECTION 877. EXPATRIATION TO AVOID TAX (a) In general.-Subsection (a) of new section 877 contains a special rule applicable to nonresident alien individuals who, at any time after March 8, 1965, and within the 5-year period immediately preceding the close of the taxable year, lost their U.S. citizenship. The provisions of this subsection apply only if one of the principal pur- poses of such loss of citizenship was the avoidance of U.S. income, gift, or estate taxes. Expatriate U.S. citizens to whom this subsection ap- plies are to determine their tax as nonresident alien individuals in ac- cordance with the provisions of section 871, as amended by section 3(a) of the bill. However, if the tax so determined is less than the tax de- 745 PAGENO="0756" 80 FOREIGN INVESTORS TAX ACT OF 1966 termined in accordance with subsection (b) of this section, the tax imposed pursuant to such subsection is to apply. (b) Alte'rnxztive tax.-Subsection (b) of section 877 contains special rules for the determination of an alternative tax under section 1 or 1201 (b) of the code in the case of nonresident alien individuals who are expatriate U.S.. citizens to whom subsection .(a) of this section applies.. In determining taxable income for.pui~poses:of~this alterna- tive tax, paragraph (1) provides that the gross income includes the gross income derived from sources within the United States which is not effectively connected with the conduct of a trade. or business within the United States plus the gross income derived from sources within and without the United States which is effectively connected with the conduct of a trade or business within the United States, except that the special source rules of subsection (c) of this section shall also apply. For this purpose the determination of the source of income is to be made under the rules of sections 861 through 863 of the code, as amended by section 2 of the bill, to the extent such rules are not in- consistent with the special source rules contained in subsection (c) of this section. Under paragraph (2) deductions allowable nnd~r subtitle A of the code are to be deducted from the gross income so determined, but only if and to the extent that such deductions are connected with the gross income so determined, and the proper allocation and apportionment of deductions for this purpose is to be determined wider regulations prescribed by the Secretary of the Treasury or his delegate. No de- duction is allowed, however, for the capital loss carryover provided by section 1212(b) of the code. The following deductions are specifically allowed by paragraph (2), whether or not they are connected with in- coihe~from.sources within the'Unitcd~States or with~ineome which is effectively connected with the conduct of a trade or business within the United States and whether or not the nonresident alien individual is engaged in trade or business within the United States: (1) The deduction for theft and casualty losses of nonbusiness property, as allowed by section 165(c) (3), if such property is lo- cated in the United States at the time of loss; (2) The deduction for charitable contributions and gifts, as pro- vided by section 170 of the code; (3) One personal exemption allowed by section 151 of the code, except th~t an expatriate ~itizen who is a resident ~f Canada or Mexico may take all the exemptions available to him under sec- tion 151; and (4) The deduction for losses not connected with a trade or business if incurred in a transaction entered into for profit, as al- lowed by section 165 (c) (2) of the code, but only if the profit on such transaction, had such transaction resulted in a profit, would be included in gross income pursuant to paragraph (1) of this. subsection. In applying the limitations under section 170(b) of the code for purposes of determining the alternative tax imposed pursuant to ~ub- section (b) of this section, the adjusted gross income is to be determined under sections 62 and 170 (b) of t.he code after taking into account the gross income determined under this subsection. 746 PAGENO="0757" FOREIGN INVESTORS TAX ACT OF 1966 81 A. nonresident alien individual determining the alternative tax under subsection (b) may not take the standard deduction provided by see- tion 141 of the code or use the tax table prescribed by section 3 of the code. The term "nonresident alien individual" as used in other sec- tions of the code, includes `a nonresident' alien individual to whom section 877 applies. (c) Special rules of source.-Subsection (c) of section 877 con- tains speciaLrules of source. which are~ used in determining the gross income of an individual to whom subsection (b) applies. Sale of property Paragraph (1) of section 877(c) provides that, for purposes of sec- tion 877 (b), all gain, profits, and income from the sale or exchange of property located in the United States at the time of such sale or ex- change is income from sources within the United States. This rule applies to all property, other than stock in a corporation or debt obli- gations, whether such property `is real or personal, tangible or intan- gible. Stock or debt obligations Paragraph (2) of section"877'(e) provides that, for purposes.Of sec- tion 877(b), any gain from the sale or exchange of the following prop- erty is income from sources within the United States: Stock issued by a domestic corporation; debt obligations of a U.S. person (as de- fined in section 7701 (a) (30) of the code); and deibt obligations of the United States, a State or political subdivision of a State, or the District of Columbia. For this purpose the actual location of such stock or debt obligations (or evidence of indebtedness) at the time of the sale or exchange is immaterial. A debt obligation is to be con- sidered an obligation of a United States person, the United States, a State or political subdivision of a State, or the District of Columbia, only if such person or political unit is the principal obligor under the terms of the obljgation. (d) Exceptioivfor Zoss'of citieenship for certain cav~es.-Subsection (d) of section 877 provides that the alternative tax imposed pursuant to subsection (a), and determined pursuant to subsections (b) and (c), does not apply to an expatriate U.S. citizen whose loss `of such citizen- ship resulted from the application of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401 (b), 1482, or 1487). Section 301(b) of that act provides that certain individuals who are born outside the United States. of parents one of whom is an alien shall lose their U.S. citizenship if, within a specified period following the date of birth, they fail to be continuously physically present in the United States, for at least 5 consecutive years. Section 350 of that act provides that under certain circumstances an individual who at birth acquires U.S. citizenship and citizenship of a foreign country and who claims the benefit of his foreign citizenship shall lose his U.s. citizenship if, after he has attained the age of 22 years, he maintains a continuous residence for 3 years in the country of his foreign citizenship. Section 355 of that act provides that under cer- tain circumstances a U.S. citizen who is under 21 years of age and whose residence is in a foreign country with a parent who loses U.S. citizenship for specified causes shall lose his U.S. citizenship if he acquires the citizenship of such foreign country. 747 PAGENO="0758" 82 FOREIGN INVESTORS TAX AC'T OF 1966 (e) Burden of proof.-Subsection (e) of section 877 provides that~ in determining whether a principal purpose for the loss of U.S. citizen- ship by an expatriate citizen was the avoidance of U.S. income, gift,. or estate taxes, the Secretary of the Treasury or his delegate must first establish that it is reasonable to believe that the loss of U.S. citizenship would, but for section 877, result in a substantial reduction, for the taxable year in respect of which section 877 is being applied, in the taxes (domestic and foreign) on his probable income for such year from all sources. In establishing this, the Secretary or his delegate may, in the absence of factual information concerning the individual's income from all sOurces during the taxable year, determine the tax on the probable income of such individual, as determined on the basis of information available to the Secretary. The probable income may, in appropriate cases, be determined on the basis of the individual's income for the preceding taxable year. The individual concerned may refute the Secretary's determination concerning such probable income, by showing what his income for the period actually was. The Secretary or his delegate, in the absence of the actual income tax liability of the expatriate U.S. citizen to the foreign country of which he is a citizen or resident, will be considered to have established that it is reasonable to believe that a substantial tax reduction resulted from such indivi4ual's loss of U.S. citizenship if it is shown that,. under the laws of the foreign country of which such individual is a. citizen or resident, such individual could be expected to pay an income tax for the taxable year substantially lower than the income tax which he would have paid had he remained a citizen of the United `States during such year. For this purpose, only those taxes imposed by the foreign country of which the expatriate is a citizen or resident which are income, taxes, or taxes in lieu of income taxes, and taxes imposed. by the United States will be taken into account. If under the foreign country's taxation system the political subdivisions of such country impose income taxes, such taxes shall also be taken into account in. determining the expat.ri9.t.e's taxes on his .probable income. Once it has been established that it is reasonable to believe that such taxes (domestic and foreign) of the expatriate U.S. citizen on. his probable income are less as a result of his loss of U.S. citizenship. than they would be had he remained a citizen of the United States,. such individual has the burden of proving that the principal purpose' of such loss of citizenship was not the avoidance of U.S. income,, gift,. or estate taxes. SECTION 3 OF BILL-CONTINUED (f) Partial ececlw?ion of dividends.-Subsection (f) of section 3 of the bill amends section 116(d) of the code (relating to certain non- resident alien individuals ineligible for the divi lend exclusion) by providing that the $100 dividend exclusion provided by section 116(a) applies only in determining (1) the graduated tax imposed on the income of a nonresident alien individual' `pursuant to amended sec- tion 871(b), if tl'ie dividends with respect to which the exclusion is claimed are effectively connected with the conduct of a trade or `busi- ness within' the United States, `or (2) . the graduated tax imposed on 748 PAGENO="0759" FOREIGN INVESTORS TAX ACT OF 1966 83 the income of an expatriate U.S. citizen pursuant to section 877(b), as added by section 3(e) of the bill. Citizens of possessions of the United States who are taxed pursuant to section 932 of the code, as amended by section 3(m) of the bill, and who therefore determine their taxes in the manner prescribed by amended section 871 or new section 877(b), are also entitled in accordance with this subsection to the exclusion provided by section 11~(a). The amendments provided by section 3(f) of the bill are effective for taxable years beginning after Decem- ber 31, 1966. (g) Withholding of taco on iwnresident aliens.-Subsection (g) of section 3 of the bill amends section 1441 of the code (relating to the withholding of tax on nonresident alien individuals). The amend- ment is effective for taxable years beginning after December 31, 1966. Under existing section 1441, persons having the control, receipt, custody, disposal, or payment of certain enumerated items of gross in- come, such as dividends, interest, and rents, from sources within the United States are required to withhold a tax of 30 percent when such amounts are paid to or for nonresident alien individuals, or any part- nership not engaged in trade or business within the United States and composed in whole, or in part, of nonresident alien individuals. A special tax of 14 percent is withheld in the case of certain scholarship and fellowship grants and certain expense reimbursements incident thereto. Paragraph (1) of section 3(g) of the bill amends section 1441(b) to conform that section to the amendments of section 861 made by sec- tion 2(a) (1) of the bill. Thus, for example, interest on deposits in the United States with persons carrying on the banking business will not be subject to withholding under section 1441(a) if such interest is received by a nonresident alien individual or foreign corporation and is not effectively connected with the conduct of a trade or business within the United States. In the case of such interest paid after De- cember 31,. 1971, however, withholding will be required.. Paragraph (2) of section 3(g) amends section 1441(b) to conform that section to section 871(a) (1); as amended by section 3(a) of the bill. Paragraph (3) of section 3(g) adds a new paragraph (1 )to section 1441(c) in lieu of the existing paragraph (1) of such section. The new paragraph (1) provides that no withholding is required under section 1441(a) with respect to any income which is effectively con- nected with the conduct of a trade or business within the United States by the recipient individual, if for the taxable year of such recipient a tax is imposed on such income pursuant to section 871(b), as amended by section 3(a) of the bill. This exception from withholding also applies to income from real property which, pursuant to an election under section 871(d), as amended by section 3(a) of the bill, is treated as income which is effectively connected with the conduct of a. trade or business within the United States, but it does not apply to any income received as compensation for personal services, such income being subject to the provisions of amended section 1441(e) (4). It is anticipated that regulations prescribed by the Secretary or his delegate will provide for the furnishing of a statement or form to the withholding agent in order to identify income which is effectively connected with the 749 PAGENO="0760" 84 FOREIGN INVESTORS TAX ACT OF 1966 conduct of a trade or business within the TJnite~d States on which a tax is imposed for the taxable year pursuant to amended section 871 (b). Individuals exempt from withholding under new paragraph (1). are required to make a declaration of estimated income tax, as provided in section 6015(i) (2) of the code, as amended by section 3(i) of the bill. Existing paragraph (1) of section 1441(c) is deleted by paragraph (3) of section 3(g) of the bill, so that all dividends paid by a foreign corpo- ration. will be subject to withholding under section 1441 (a) to the extent such dividends are from sources within the United States under section 861 (a) (2) (B), as amended by sections 2(b) (1) of the bill, and are not effectively connected with the conduct of a trade or business within the United States. Paragraph (4) of section 3(g) of the bill amends paragraph (4) of section 1441(c).' Amended paragraph (4) provides that compen- sation for personal services may be exempted from withholding under section 1441(a) pursuant to regulations prescribed by the Secretary of the Treasury or his delegate. This amendment is correlated with a similar amendment of section 3401 (a) (relating to collection of income tax at source on wages) by section 3(k) of the bill. Existing section 1441(c) (4) provides for the exemption, pursuant to regulations, from withholding on compensation for personal services of nonresident: aliens who enter and leave the United States at frequent intervals or who are temporarily present in the United States under subparagraph (F) or (J) of section 101(a) (15) of the Immigration and Nationality Act. It is anticipated that regulations to be prescribed under amended paragraph (4) will continue exemptions presently accorded by regula- tions under that paragraph and, in general, will exempt from with- holding under chapter 3 any other compensation of a nonresident alien individual upon which withholding will be required under chapter 24 of the code. Paragraph (5) of section 3(g) amends paragraph (5) of section 1441(c) in order to conform to section 871 (a) (1), as amended by sec- tion 3(a) of the bill. (h) Liability for withheld tax.-Subsection (h) of section 3 of the bill amends section 1461 of the code (relating to liability for withheld tax) to remove the provision requiring the annual return and payment of amounts withheld pursuant to the provisions of chapter 3 of the code. New return and payment requirements will be in accordance with the provisions of sections 6011 (a), 6091 (a), and 6151 (a) of the code. The Secretary of the Treasury or his delegate may authorize under section 6302 (c) the use of Government depositaries in respect of such tax, if circumstances warrant the use of such procedure. The amendment applies with respect to payments occurring after Decem- ber 31, 1966. (i) Declaration of estimated income tax by indi'viduals.-Subsection (i) of section 3 of the bill amends section 6015 of the code (relating to declaration of estimated income tax by individuals). The amendment is effective for taxable years beginning after December 31, 1966. Under existing section 6015 (a) only those nonresident alien indi- viduals who are subject to withholding on wages under. section 3402 of the code, or who are, or expect to be, residents of Puerto Rico for the entire taxable year, are required to make a declaration of esti- 750 PAGENO="0761" FOREIGN INVESTORS TAX ACT OF 1968 85 mated tax. Under section 6015(i), as amended by this subsection, a declaration of estimated income tax is required of a nonresident alien individual who (1) is subject to withholding on wages under section 3402; (2) has income (other than compensation for personal services which is subject to withholding under sec. 1441) which is effectively connected with the conduct of a trade or business within the United States; or (3) is, or expects to be, a re$ident of Puerto Rico during the entire taxable year. Section 6015(i) (2), as amended, also applies to a nonresident alien individual whose income from real property is treated, pursuant to an election under amended section 871(d), as income which is effectively connected with the conduct of a trade or business within the United States. (j) Gain froim di$position8 of certain depreciable reaUy.-Subsec- tion (j) of section 3 of the bill amends paragraph (3) of section 1250(d) of the code (relating to certain tax free transactions). The amendment is effective for taxable years beginning after December 31, 1966. Under present paragraph (3) of section 1250(d) a trans- feror disposing of depreciable real property described in section 1250(c), in a transfer to which section 332, 351, 361, 371(a), 374(a), 721, or 731 of the code applies, is sulject to the non-capital-gain treatment provided by section 1250(a) (1) only if, and to the extent that, gain is recognized to the transferor on the transfer. The amend- ment made in paragraph (3) of section 1250(d) by this subsection provides, in effect, that if a nonresident alien individual, a foreign estate or trust, or a foreign partnership transfers section 1250 prop- erty to a domestic corporation in exchange for stock or securities in such corporation in a section 351 transaction, the amount of resulting gain is subject to the provisions of section 1250(a) (1) irrespective of the amount of gain recognized to the transferor under section 351 t~n the transfer. (k) Collection of inco?me taa, at source on wages.-Subsection (k) of section 3 of the bill amends section 3401 (a) of the code (relating to the definition of wages for purposes of collection of income tax at source) by striking out paragraphs (6) and (7) which except the remuneration for services performed by certain nonresident alien individuals from the withholding requirement and inserting a new paragraph (6). The amendment is effective with respect to remu- neration paid after December 31, 1966. The new paragraph (6) ex- cepts from the term "wages" only such remuneration paid for the services performed by a nonresident alien individual as is designated by regulations prescribed by the Secretary of the Treasury or his delegate. This amendment is correlated with the amendment of sec- tion 1441(c) (4) made by section 3(g) of the bill with respect to withholding under chapter 3 of the code from the compensation for personal services of a nonresident alien individual It is anticipated that regulations under amended paragraph (6) will continue exemp- tions presently accorded by regulations under existing section 3401 (a) (6) and (7) and will extend withholding under chapter 24 of the code to certain compensation of nonresident alien individuals which is now subject to withholding under chapter 3. Remuneration of a nonr~sident alien individual which is made subject to withhold- ing under chapter 24 will be exemFt from withholding under chap- ter 3. 751 PAGENO="0762" 86 FOREIGN INVESTORS TAX ACT OF 1966 (Z) Definition of foreign estate or tru$t.-Subsection (I) of section 3 of the bill contains a conforming amendment of section 7701 (a) (31) of the code (defining foreign estate or trust). The amendment is effective for taxable years beginning after December 31, 1966. Exist- ing paragraph (31) defines a foreign estate or trust as an estate or trust the income of which from sources, without the United States is not includible in gross income under subtitle A. This is correlated with existing section 872(a) of the code, which provides that the gross income of a nonresident alien individual includes only the gross income from sources within the United States. A conforming amendment in the definition of a foreign estate or trust is necessary, since under section 872(a) (2), as amended by section 3(h) (1) of the bill, a. non- resident alien individual must include in gross income the income from sources without the United States which is effectively connected with the conduct' of a trade or business within the United. States. (Qm) Confo~iming `amendm~ent.-Subsection (m) of section 3 of the bill contains a conforming amendment to section 932 (a) of the code (relating to citizens of possessions of the United States). The amend- ment is effective for taxable years beginning after December 31, 1966.' As amended, section 932(a) continues the substance of existing law by providing that citizens of a possession of the United States, other than Puerto Rico, who are not otherwise citizens of the United States, are to be taxed in the same manner as nonresident alien individuals. (~n1) Effective dates.-Subsection (n) of section 3 of the bill pro- vides the effective dates for the several provisions of such section. Paragraph (1) provides that the provisions of section 3, other than .the amendments made by. subsections (h) and (k), apply with respect to taxable years beginning after December 31, 1966. Paragraph (2) provides that the amendments made by subsection (h) (relating to liability for taxes withheld under ch. 3) apply with respect to pay- ments occurring after December 31, 1966. Paragraph (3) provides that the amendments made by subsection (k) (relating to withhold- ing on wages under ch. 24) apply to remuneration paid after Decem- ber 31, 1966. By reason of the provisions of section 861(c), as added by section 2(a) (1) (B) of the bill, amended section 861 (a) (1) (A) and new section 861(c) will cease to apply with respect to amounts paid or credited after December 31, 1971. SECTION 4 OF BILL. FOREIGN CORPORATIONS (a) Tax on income not connected with United States business.- Subsection (a) of section 4 of the bill amends section 881 of the code. The amendment is effective for. taxable years beginning after Decem- ber 31, 1966. Existing section 881 applies only to foreign corporations not engaged in trade or business in the United States at any time during the taxable year. Such corporations are presently subject to a flat tax of 30 percent on all fixed or determinable annual or periodical income derived from sources within the United States and on amounts. described in section 631 (b) and (c) of the code (relating to certain disposals of timber, coal, or iron ore) which are considered to be gains from the sale or exchange of capital assets and are `derived from sources within the United States. 752 PAGENO="0763" FOREIGN INVESTORS TAX ACT OF 1966 87 `CODE SECTION 881. INCOME OF FOREIGN CORPORATIONS NOT CONNECTED WITH UNITED STATES BUSINESS (a) Imposition of twz~.-Subsection (a) of section 881 of the code, as amended by section 4(a) of the bill, imposes a tax of 30 percent on substantially the same income from sources within the United States * ~as that which is taxed at 30 percent under existing section 881 (a), but the tax under amended section 881 (a) is imposed only to the extent `the income is not effectively connected with the conduct of a trade or business within the United States. Subsection (a) of amended section 881 applies to the items of income enumerated therein whether or not* the corporation is engaged in trade or business in the United States during the taxable year for which the tax is being determined; but, if -the corporation is not so engaged, under section 864(c) (1) (B), as -added by section 2(d) of the bill, none of its income shall be treated as `effectively connected with the conduct of a trade or business within the United States even though such income is attributable to a trade or business carried on in the United States by the recipient in a previous taxable year. Thus, in the case of a foreign corporation not engaged in trade or business at any time during the taxable year, a 30-percent tax is imposed by amended section 881 (a) upon the items of income enumerated therein which are received from sources within the United *`State~; no other tax isimposed for the taxable year. Paragraphs (1), (2), and (3) of section 881 (a) specify the income to which section 881(a)* applies. The items of income described in paragraph (1) are' also described in existing section 881 (a'), but the parenthetical expression containing a reference to interest on bank `deposits has been eliminated. Paragraph (2) includes gains de- scribed in section 631 (b) and (c), but section 1231 is not taken into `account in determining the amount subject to tax. Paragraph (3) -describes two items of income which are also subject to the 30-percent `tax but which are not described in existing section 881 (a). They are -amounts which under section 341 of the code, or which under section 1232 of the code (in the case of bonds or other evidences of indebted- ness issued after September 28, 1965), are treated as gains from the sale -or exchange of property which is not a capital asset. None of the amounts described in paragraphs (1), (2), and (3) are subject to the 30-percent tax unless they are from sources within the United States. Gains from the sale or exchange of a capital asset (other than amounts to which amended sec. 881 (a) (2) and (3) applies) are subject to tax only if they are received by a foreign corporation which is engaged in trade or business within the United States at some time during the taxable year for which thetax is being determined and are effectively connected with the conduct of a trade or business within the United States. (b) Dotthling of taa~.-Subsection (b) of section 881 contains a cross reference to section 891 of the code (relating to doubling of tax on corporations of certain foreign countries)., SECTION 4 OF BILL-CONTINUED (b) Ta~v on income connected with United States bws'iness.-Par- agraph (1) of section 4(b) of the bill amends section 882 of the code (relating `to tax on resident foreign corporations), and paragraphs 753 PAGENO="0764" 88 FOREIGN INVESTORS TAX A~T OF 1966 (2) and (3) of section 4(b) make certain technical or conforming amendments. The amendments are effective for taxable years begin- ning after December 31, 1966. Under existing law a foreign corporation en~aged in trade or busi- ness within the United States at any time during the taxable year is subject to the tax imposed by section 11 or 1201 (a) of the code on. all of its income derived from sources within the United States. Except in the case of the charitable deduction allowed by section 170~ deductions are allowed in computing,. taxable, income only to the extent that they are connected with. income `from' sources within the United States. No foreign tax credit is allowed a foreign corpora- tion under existing law. CODE SECTION 882. INCOME OF FOREIGN CORPORATIONS CONNECTED WITh UNITED STATES BUSINESS (a) Normal tax aiird surtax.-Subsc3ction (`a) *of section 882, as amended by section 4(b) of this bill, concerns the imposition of tax on income which is effectively connected with the conduct of a trade or business within the United States. Imporitio'ir of tax Paragraph (1) of section 882(a) provides that a foreign corporation which is engaged in trade or business within the United States at any time during the taxable year in respect of which the tax is be- ing determined is also subject to the regular corporate tax imposed' `by section 11 or 1201 (a) on its taxable income (whether derived from sources within or without the United States) which is effectively con- nected with t'he conduct of a trade or business within the United States. The determination of when income is effectively connected with the `conduct of `a trade or business within the United States, `and of' what income from *sources without the United States is taken into account for such purpose, is to be made in accordance with section 864(c), as added by section 2(d). of the bill. A foreign corpora- tion which is engaged in trade or business in the United States dur- ing the taxable year is also subject to the t'ax imposed by amended section 881 on its income from sources `within the United States which is `described in section 881 (`a) and `which' is not effectively connected with the conduct of a trade or business `within the United States. Paragraph (2) of section 882(a) provides that in determining the amount of taxable income for purposes of paragraph (1), gross' income includes only gross income which is effectively connected with the conduct of a trade or business within the United States. In de- termining the taxable income subject to tax under section 11 or 1201 (`a), no income is to be taken into account which is required to be taken into account in determining the tax under section 881. (b) Gross inco?me.-Subsection (b) of section 882 provides that in the case of a foreign corporation gross income includes only the' income from United' States sources which is not effectively connected with the conduct of a trade or business within the United States and all income (whether or not derived from sources within the United States) which is effectively connected with the conduct of a trade or business within the United States. 754 PAGENO="0765" FOREIGN INVESTORS TAX ACT OF 1966 89 Income from sourceswithin the United States which is not effectively connected with the conduct~ of a trade or business within the United States is taxable under section 881 of the code,, as amended by section' 4 (a) of the bill, if such income is described in sectioii' 881 (a). Any such income which is not described in section 881 (a), such as almost all capital gains, is not subject to U.S. income tax. (c) Allowance of dedu~ction8 and credits.-Subsectjon (c) of sec- tion 882 contains the rules applicable to the allowance of deductions and credits to a foreign corporation. Allocation of deduction$ Paragraph (1) (A). of section 882 (c) provides that generally the deductions allowed under subtitle A (relating to income taxes) of the code are allowed to a foreign corporation only if and to the extent tha't such deductions are connected with income which is effectively connected with the conduct of a trade or business within the United States; moreover, such deductions are allowed oniy for purposes of determining under section 882 (a) the tax on taxable income which is effectively connected with the conduct of a trade or business within the United States. The Secretary of the Treasury or his delegate is authorized to prescribe `by regulations the proper apportionment and allocation of the deductions for such purposes. The deductions al- lowed by section 882 (c) may: in no case be used to reduce amounts subject to the 30-percent takimposed by section 88L Paragraph (1) (B) of section 882(c) provides that, in determining the tax imposed pursuant to section 882 (a), a foreign corporation may take `the deduction for charitable contributions and gifts allowed by section 170 of the code whe'ther or not such deduction is connected with income which is effectively connected with the conduct of a trade or `business within the United States. In determining the limitations on the amount of the. ucti0i pp~rsu'ant to seet~iqii.i70~h), only the gross income which `is `~ffecti~ëly `connected with `the `conduct of a `trade or business wi'thin the United States is to be taken into account. For a more detailed discussion of the allowance of deductions, see `the comments on section 873, as amended by section 3(c) of the bill. The provisions of amended section 882 may be illustrated by the `following example: Ethampie , During the taxable yea'i~ foreign corporation M maintains a branch sales office in the United States and by reason of its activities therein `is engaged in business within the United States. The income which `is effectively connected with ,the business carried on through such `sales office is derived from sources within the United States. Cor- poration M also owns stock in a domestic corporation, and, by reason ~of the application of new section 864(c), the dividends on such stock, and a ôapital gain derived from, the sale of a part of the stock, are `not effectively connected with the conduct of the trade or business within the Uni'ted States. The tax under section 11 of the code is imposed on the taxable income which is effectively connected with the business carried on through such sales office, determined after allowance of all deductions connected with income which is effectively connected with the conduct of the trade or business within the United 755 PAGENO="0766" 90 - FOREIGN INVESTORS TAX ACT O:P 1966 States. The tax of 30 perent is imposed under section 881 on the gross amount of the dividend income. The gain realized from the sale of stock is not subject to U.S. income tax. Deductio~s azn»=l credits allowed only if return filed Paragraph (2) of section 882(c) continues the substance of the rule contained in section 882(c) (1) of existing law that a foreign corporation is to receive the benefit of the allowable deductions only by ffling a true and accurate return of* its total income (including income subject to tax under section 881 (a)); a technical amendment has been provided, however, to make clear that the return must also include the income derived from sources without the United States which is effectively connected with the conduct of a trade or business within the United States. This rule has also been extended to apply to credits against tax, such as the foreign tax credit, other than the credit provided by section 32 for tax withheld at the source or the credit provided by section 39 for certain users of gasoline and lubri- cating oil. As so amended, section 882(c) (2) is consistent with sec- tion 874(a) of the code, as amended by section 3(d) of the bill. Foreign tax credit Paragraph (3) of section 882(c) provides that a foreign corpora- tion will not be allowed the foreign tax credit allowed under section 901 of the code, except to the extent provided by section 906 of the code, as added by section 6(a) of the bill. Under existing law a foreign corporation is not allowed a foreign tax credit. Cross reference Paragraph (4) of section 882 (c) contains a cross reference to sec- tion 906(b) (1) of the code, as added by section 6(a) of the bill~ relating to the limitation on the amount of the credit under section. 906 (a) or, if applicable, the amount of any deduction under section 882(c), for income taxes paid or accrued to any foreign country or possession of the United States. (d) Election to treat real property income as income connected with United States business.-Subsection (d) of section 882 permits a foreign corporation deriving real property income from sources with- in the United States which is not effectively connected with the con- duct of a trade or business within the United States to elect to treat such income as income which is effectively connected with the conduct of a trade or business within the United States; the income which is so treated is taxable in accordance with the provisions of section 882(a). The election is available to all foreign corporations, whether or not engaged in trade or business within the United States during the taxable year for which the election is made or during taxable years for which the election is in effect. The provisions relating to the applicability of such an election, as well as the manner of making or revoking the election, are identical to the provisions of section 871(d), as amended by section .3(a) of the bill. . See the discussion of amended section 871 (d). (e) Returiu~ of tax by agent.-Subsection . (e) of section 882 con- tinues the rule of existing section 882(d). of the code, which provides that, if a foreign corporation has no office or place of business in the 756 PAGENO="0767" FOREIGN INVESTORS TAX ACT OF 1966 91 United States but has an agent in the United States, the corporation's return which is required by. section 6012 of the code is to be made by such agent. SECTION 4 OF BILL-CONTINuED (c) Withholding of tacz~ on foreign corporations.-Subsection (C) of section 4 of the bill amends section 1442 of the code (relating to withholding of tax on foreign corporations), effective with respect to taxable years beginning after December 31, 1966. Under existing law a foreign corporation not engaged in trade or business within the United States is generally subject to the withholding of tax under chapter 3 of the code in the same manner as a nonresident alien individual; and, subject to specified rules, such corporation is also subject to the withholding of tax under section 1451 (relating to interest on tax-free covenant bonds). A foreign corporation engaged in trade or business within the United States is presently not subject to withholding of tax under such sections. CODE SECTION 1442. WITHHOLDING OF TAX ON FOREIGN CORPORATIONS (a) General rule.-Subsection (a) of section 1442, as amended by section 4(c) of the bill, places foreign corporations engaged in a trade or business within the United States in the same status as nonresident a.lien individuals engaged in trade or business within the United States with respect to the withholding of tax provided by section 1441. Thus, foreign corporatiOns engaged in a trade or business within the * United States will be subject to withholding at the 30-percent rate of tax only on items of income from sources within the United States designated in section 1441(b), as amended by section 3(g) of the bill, which are not effectively connected .with the conduct of a trade or business within the United States. Income (other than income for services) which is effectively connected with the conduct of a trade or business within the United States is not subject to withholding of tax under section 1442(a) if a tax is imposed on such income for the taxable year of the recipient pursuant to amended section 882(a) (1), or, if applicable, pursuant to amended section 842. By reason of amended section 1441(c) (4), income for services performed by a for- eign corporation may be exempted from withholding under section 1442(a) pursuant to regulations prescribed by the Secretary .of the Treasury or. his delegate. No change is made in section 1451, with the result that only a foreign corporation not engaged in a trade or business in the United States is subject to the withholding of tax under such section from interest on tax-free covenant bonds, whether or not such interest is effectively connected with the conduct of a trade or business within the United States. (b) Exem~ption.-Subsection (b) of section 1442 provides that, sub- ject to such terms and conditions as may be provided by regulations, a. foreign corporation engaged in trade or business within the United States at some time during the taxable year may be exempted from withholding under subsection (a). if the Secretary of the Treasury or his delegate determines that the withholding requirements of sub- section (a) impose an undue administrative burden and that the col- lection of the fiat 30-percent tax imposed by amended section 881 757 PAGENO="0768" 92 FOREIGN INVESTORS TAX ACT OF 1966 (relating to income not connected with a U.S. business) on such c.orporatiqn will not be jeopardized by the exemption. The Secretary or his delegate is authorized to prescribe by regulations the terms and conditions pursuant to which `a foreign corporation may `be exempted from withholding under subsection (a). The terms and conditions so prescribed may be such as to insure that the tax imposed by section 881 on the income of the foreign corporation is returned and paid by the exempted foreign corporation, no later than the date such amounts would be returned and paid by the withholding agent if the exemption from withholding had not been granted. SECTION 4 OF BILIr-CONTINIJED (d) Dividends received from certain foreign co-rporatwns.-Sub- section (d) of section 4 of the bill amends section 245 of the code (relating to the allowance of a deduction for dividends received from a foreign corporation). The amendment is effective for taxable years beginning after December 31, 1966. Under existing law a corpora- tion, whether domestic or foreign, receiving dividends from a foreign corporation which, for the specified 36-month period, is engaged in trade or business in the United States and derives 50 percent or more of its gross income from sources within the United States is entitled, if the deduction is otherwise allowable, to take as a deduction a pro rata portion of 85 percent of the dividends received from the foreign corporation paying the dividends. The pro rata portion is based on the ratio which the paying corporation's gross income from sources within the United States `bears to its gross income from all sources. The amendments made by paragraphs (1), (2), and (3) of section 4(d) of the bill strike out of section 245 (a) all references to income from sources within* the United States and substitute references to income effet~t,ively~ eonne~t,ed with the conduct of a trade or business within the United States. These amendments are necessary to conform section 245 to the amended taxing provisions applicable to foreign corporations and operate to continue the principle of the existing provision. Thus, the deduction for dividends received from a for- eign corporation, when otherwise allowable, is to be allowed if 50 percent or more of the total gross income of such foreign corporation from all: sources. for the applicable period is effectively connected with tbe eonduct'of a trade or business within the United States. The amount of the deduction is determined as under existing law, but the pro rata portion is based upon the ratio which the gross income which is effectively connected with the conduct of a trade or business within the United States bears to such corporation's total gross income from all sources. Paragraph (4) of section 4(d) of the bill provides in effect that. to the extent aross income of the foreign corporation for any period before its first taxable year beginning after December 31, 1966. is required to be taken into account for purposes of applying amended section 245. the gross income of such corporation for such period from sources within the United States will be considered to be gross income effectively connected with the conduct of a trade or business within the United States. 758 PAGENO="0769" FOR1~1IGN INVESTORS TAX.. ACT: OF' 1968 93 (e) `Unrelated: business ta~vable `income.-Subsection (e) of section 4 of the bill amends section 512(a) of the code (relating to the defini- tion of "unrelated business taxable income") to provide that, in tbe case of a foreign organization of the type described in section. 511 of the code (relating to charitable, etc., organizations), the `unrelated business taxable ~income includes only the unrelated `business taxable income which is effectively connectea with the conduct of a `trade or business within the~ United States. The amendment is effective for taxable years be~inñing after Deóember 31,1966. .` (f) Corporations subject' to personal holding coimpan~y tax.-Sub- section (f) of section 4 of the bill amends section. 542(c) (7) of the code (relating to foreign corporations not subject to the personal holding company `tax) `by. deleting the 50-percent gross income test of existing paragraph (7) (A)... and by making' existing paragraph (7) (B), with certain modifications, paragraph' (7). The amend-' ment is. effective for taxable years beginning `after December 31, 1966. Under this `amendment, the term "personal holding company" does not `include a foreign corporation. all of whose `outstanding stock during the last half of the taxable year is owned by'nonresident alien individuals directly or indirectly through foreign estates, foreign' trusts, foreign partnerships, or other foreign cor.porations~ `For `this purpose, stock will be considered `as `owned by `nonresident alien mdi- vidualsindirectly through foreign estates; foreign trusts, `foreign part- nerships, or foreign- corporations if all of `thO beneficiaries (`having an interest with an actuarial value of 5 percent or more), partners, or shareholders of such estates, trusts, partnerships, or `corporations are nonresident alien individuals. . ` . ` ` (g) Amendments with respect to /oreign corporations carrying on insurance business' in United States.-Subsection (g) of section 4 of the bill amends those provisions of subchapter L of chapter 1' of the code (relating to insurance companies) that apply' toforeign corpora- tions. The' amendments are effective ~for `taxable years beginning' after December 31, 1968. . ` ` ` ` ` In general Paragraph (1) of section 4(g) of the bill deletes present section 842 of the code (relating to computation of gross income) and adds anew section 842. ` ` Existing section 842 provides, that the gross income of a life insur- ance company subject to the tax imposed by section 802, and of the mutual marine, etc., insurance companies subject `to the tax imposed by section 831, is not to be determined in the manner provided in sections 861 through 864 of the code, relating to the determination `of sources of income. CODE SECTION 842. FOREIGN CORPORATIONS CARRYING ON INSURANCE BUSINESS New section 842 replaces all of the existing provisions in parts I, II, and III of subchapter L which designate when and to what extent a foreign insurance company will be subject to the tax imposed pursuant to those parts. The coordinating amendments to conform to this change are embodied in the other paragraphs of section 4(g) 71-297 0-67-pt. 1-49 759 PAGENO="0770" 94 FOREIGN INVESTORS TAX ACT OF 1986 of the bill. Under new section 842, only those foreign corporations carrying on an insurance business in the United States are subject to the provisions of subchapter L which, were they domestic corpora- tions, would qualify for the taxable year under part I, II, or Ill of such subchapter without taking into account their income not effectively connected with the conduct of a trade or business within the United States. Each such corporation which would so qualify for the taxable year under either part I, II, Or III of subchapter L shall be taxable for such year under that part on its entire taxable income (whether derived from sources within or without the United States) which is effectively connected with its conduct of any trade or business (whether or not its insurance business) within the United States. In determin- ing such taxable income, only allowable deductions which are con- nected with income which is effectively connected with the conduct of a trade or business within the United States are to be allowed. Any income derived by such foreign corporation from sources with- in the United States which is not effectively connected with the conduct of any trade or business in the United States is taxed for such year as provided in section 881., as amended by section 4(a) of the bill. Each such foreign corporation which would not so qualify for the taxable year under part I, II, or III of subchapter L, and all foreign insurance companies not carrying on an insurance business in the United States, shall be taxable as provided in amended section 881 or 882 with respect to other foreign corporations. In deter- mining whether income is derived from sources within or without the United States for purposes of applying subchapter L, as amended by the bill, the provisions of sections 861 through 864 of the code shall apply. In determining for purposes of subchapter L whether a for- eign corporation is carrying on an insurance business in the United States, and whether income is effectively connected with the conduct of a trade or business within the United States, section 864 (b) and (c), as added by section 2(d) of the bifi,. shall apply. SECTION 4 OF BILL-CONTINUED ClericaZ amendment Paragraph (2) of section 4(g) of the bill amends the table of sec- tions for part IV of subchapter L of chapter 1. Life insurance companies Paragraph (3) of section 4(g) of the bill provides various amend- ments of section 819 .of the code (relating to foreign life insur- ance companies). Subparagraph (A) of paragraph (3) deletes sub- sections (a) (relating to foreign life insurance companies carrying on a life insurance business in the United States) and (d) (relating to foreign life insurance companies not carrying on an insurance business within the United States) from section 819 and redesignates subsec- tions (b) and (c) of such section as subsections (a) and (b). Sub- paragraphs (B) through (H), except for subparagraph (D), of para- graph (3) make clerical changes in section 819 to conform it tO the amendment made by subparagraph (A). Subparagraph. (I) of para- 760 PAGENO="0771" FOREIGN INVESTORS TAX ACT OF 1966 95 graph (3) adds a new subsection (c) to amended section 819 containing a cross reference to section 842. Subparagraph (D) of paragraph (3) adds a new paragraph (3) to section 819(a), as redesignated by subparagraph (A), which provides for the reduction of the tax, if any, imposed under section 881, as amended by section 4(a) of the bill, during a taxable year for which the adjustment required by section 819(a) (1), as so redesignated, is required to be made. Amended section 819 (a) (1), as does present law, provides for an adjustment in determining the tax imposed by part I (relating to life insurance companies) of subchapter L (secs. 801 et seq.) for taxable years during which the foreign corporation main- tains a surplus in the United States which is less than the special mini- mum figure determined in accordance with paragraph (2) of amended section 819(a). The section 819(a) (1) adjustment consists of a reduc- tion in the amount of policy and other contract liability requirements and in the amount of the required interest, thereby increasing the amount of tax imposed by part I of subchapter L. The provisions of new paragraph (3) of section 819 (a) provide, in effect, that in cases where the adjustment required by section 819(a) (1) is made with a resulting increase in the tax imposed by part I of subchapter L, a compensating adjustment shall be made by reducing the tax which is otherwise imposed by amended section 881 on the foreign corporation's income from sources within the United States which is not effectivdy connected with the conduct of a trade or busi- ness within the United States. This compensating reduction of the section 881 tax is accomplished by a formula which takes into account the fact that, by reason of exemptions and reductions in rate, the effec- tive rate of the tax imposed by that section may be less than 30 percent. In determining the reduction in the tax otherwise imposed by sec- tion 881 on the income of the foreign corporation which is required to make the section 819 (a) (1) adjustment, paragraph (3) of such sec- tion provides that there shall first be determined: (1) The total amount of income which would be subject to the tax imposed by section 881 if such income were being determined without regard to the exclu- sions from gross income provided by sections 103 and 894, and (2) the wrnount determined under section 819(a) (1) by which the amount of the policy and other contract liability requirements and the amount of the required interest is reduced. The tax otherwise actually im- posed by section 881 for the taxable year shall then be reduced by an amount which is the same proportion of such tax (before reduction) as such amount used for reduction purposes under section 819 (a) (1) bears to the total amount of income so determined to be subject to tax under section 881. In no case, however, shall the tax otherwise im- posed by section 881 be reduced below zero, nor shall the reduction in the tax otherwise imposed by section 881 exceed the increase in tax imposed by part I of subchapter L by reason of the reduction provided in paragraph (1) of section 819 (a). Mutual i~surance com~panies Paragraph (4) of section. 4(g) of the bill amends section 821 of the code (relating to the tax on mutual insurance companies to which pt. II of subch.. L applies). Subparagraph (A) of paragraph (4) strikes out subsection (e) of section 821 (relating. to~ foreign 761 PAGENO="0772" 96 FOREIGN INVESTORS TAX ACT OF 1966 ~rnutual insurance companies not carrying on an insurance business in the United States) and redesignates subsections (f) and (g) of such section as subsections (e) and (f). Subparagraph (B) of paragraph (4) adds a new paragraph (3), containing a cross reference to section :842, to newly designated section 821 (f). Paragraph (5) of section 4(g) of the bill amends section 822 (relating to the determination of taxable investment income) by strik- lug out subsection (e) (relating to foreign mutual insurance com- panies carrying on an insurance business in the United States) and by redesignatmg subsection (f) as subsection (e). Other i~n~rance eo~impani&i Paragraph (6) of section 4(g) of the bill amends section 831 of the code (relating to tax on mutual marine, etc., insurance companies) by striking out subsection (b) (relating to foreign mutuai marine, etc., insurance companies not carrying on an insurance business in the United States) , by redesignating subsection (c) as subsection (b), and by redesignating subsection (d) as subsection (c) and adding therein a cross reference to section 842. * Paragraph (7) of section 4(g) amends section 832 (relating to insurance company taxable income) by striking out subsection (d) (relating to foreign mutual marine, etc., insurance companies carry- ing on an insurance business in the United States) and by redesignat- lug subsection (e) as subsection (d). .Prot,i8i,oi~i of general application Parao'raph (8) of section 4(g). amends section 841 (relating to cred- it for foreign taxes) by makmg the definition of "taxable income" contained therein apply in the case of foreign corporations subject to tax under subchapter L which are entitled to the foreign tax credit dëtermined as provided in section 906 of the code, as added by section 6(a) of the bill. (h) Snb part F ineoin,e.-Subsection (h) of section 4 of the bill amends section 9.52(b) of the code (relating to the exclusion of U.S. sOurce income from subpart F income). The amendment is effective for~ taxable years beginning after December 31, 1966. Existing section 952 *(b) provides that income derived from sources within the United States by a controlled foreign corporation engaged in trade or busi- ness in the United States is excluded from subpart F income if such income from U.S. sources is includible in gross income of such corporation under any provisions (other than sees. 951 through 964) of chapter 1 of the code. The purpose of existing section 952 (b) is to exclude from the application of sections 951 through 964 in- come which is otherwise subject to U.S. income tax under section 11 or 1201(a) by reason of being derived from source~ in the United States. Amended section 952(b) retains the principle of existing section 952(b) by providing that income from sources within the United States which is effectively connected with the conduct of a trade or* business within the United States is excluded from subpart F income. Thus, for example, dividends received from sources within the United States by a foreign corporation engaged in trade or business within the United States, which are not effectively connected with the con- duct of a trade or business within the United States are not excluded 762 PAGENO="0773" FOREIGN INVESTORS TAX ACT :Op t96'6 97. from subpart F income under amended section 952(b), even though such dividends are subject to the tax imposed by amended section 881(a). Moreover if by reason of a treaty obligation of the United States the income from sources within the United States which is effec- tively connected with the conduct of a trade or business within the. United States is not subject to the regular U.S. corporate rate of tax, such income is not excluded from subpart F income under amended section 952(b). (i) Gain from certain sales or exchanges of stock in certain foreign corporations.-Subsection (i) of section 4 of the bill amends para- graph (4) of section 1248(d) of the code (relating to exclusions from earnings and profits of controlled foreign corporations for certam purposes). The amendment, which is effective with respect to sales or exchanges of stock occurring after December 31, 1966, contmues the principle of the existing provision by providing that for taxable years beginning before January 1, 1967, income which is derived from sources within the United States by a foreign corporation engaged m trade or business in the United States and is includible m the gross income of such corporation is to be excluded from the earnmgs and profits of such corporation for purposes of determining the amount. of tax imposed on a U.S. person pursuant to section 1248. For taxable years beginning after December 31, 1966, income which is effectively connected with the conduct of a trade or business within the United States by a foreign corporation, whether derived from sources within or without the United States, and which is includible in the gross income of such corporation is to be excluded from its earn~ ings and profits for purposes of applying section 1248 to a U.S. per~ son. The exclusions provided by amended paragraph (4) are not to apply to any item of income which is exempt from U.S. tax, or is sub~ ject to a reduced rate of U.S. tax, by reason of a treaty obligation of t.he United States. (1) Declaration of estimated income tax by corporatio~s.-Sub- section (j) of section 4 of the bill amends section 6016 of the code (re- lating to declarations of estimated income tax . by corporations) by redesignating subsection (f) as subsection (g) and by inserting a new*. subsection (f). The amendment is effective for taxable years begin-* fling after December 31, 1966. The new subsection (f) provides, in. effect, that a foreign corporation subject to taxation under section 11 or 1201 (a), or under subchapter L of chapter 1, must .treat the tax~ imposed under section 881 as a tax imposed by section 11 in deter- mining whether it must make a declaration of estimated tax and in determining the amount of the estimated tax. Thus, in cases where the income subject `to tax under section 881 has been withheld on pursuant to section 1442, as amended by section 4(c) of the bill, the credit imder section 32 of the code for the tax withheld which is taken into account for purposes of section 6016 will effectively remove the section 881 tax from consideration for purposes of section 6016. If, however, any income subject to tax under section 881 has not been fully withheld on, the tax imposed by section 881 which is in excess of the credit allowed by section 32 will be taken into account in determining whether a declaration is required and will increase the estimated tax for the taxable year. On the other hand, if the tax imposed by section 881 is determined to be less than the. credit allowed under section 32, such excess credit will be taken into* 763 PAGENO="0774" 98 FOREIGN INVESTORS TAX ACT OF 1966 account in determining whether a declaration is required and will reduce the estimated tax for the taxable year. The amendment made by this subsection also applies for purposes of section 6655 (relating to the addition to tax in the case of failure by a corporation to pay estimated tax). (le) Technical amenthn~ents.-Paragraph (1) of section 4(k) of the bill amends section 884 of the code (relating to cross references). Paragraph (2) of section 4(k) corrects an erroneous reference to section 832(b) (5) in section 953(b) (3) (F) of the code, as added by section 12(a) of the Revenue Act of 1962. The amended reference is to section 832(c) (5) of the code (relating to capital losses allowed in determining taxable income of an insurance company subject to the tax imposed by sec. 831). Paragraph (3) of section 4(k) corrects a clerical error in section 1249(a) of the code, as added by section 16(a) of the Revenue Act of 1962. The amendments made by section 4(k) of the bill are effective for taxable years beginning after December 31, 1966. (7) Effective dztes.-Subsection (I) of section 4 of the bill pro- vides that the amendments made by section 4, other than by subsection (i), apply with respect to taxable years beginning after December 31, 1966. The amendment made by subsection (i) applies with respect to sales or exchanges occurring after December 31, 1966. SECTION 5 OF BILL. SPECIAL TAX PROVISIONS (a) Income affected by treaty.-Subsection (a) of section 5 of the bill designates the provisions of existing section 894 of the code (relat- ing to income exempt under treaty) as new section 894(a) and adds a new subsection (b). The amendment is effective for taxable years beginning after December 31, 1966. CODE SECTION 894. INCOME AFFECTED BY TREATY (a) Income er~empt under treaty.-Subsection (a) of section 894, as amended by section 5 (a) of the bill, is identical to existing section 894. (b) Permanent establishment in United States.-Subsection (b) of section 894 provides that a nonresident alien individual or foreign cor- poration which is engaged in trade or business in the United States at any time during the taxable year is deemed not to have a permanent establishment within the United States during such year for purposes of applying any exemption from, or reduction in the rate of, any U.S. tax provided by any U.S. treaty with respect to income which is not effectively connected with the conduct of a, trade or business within the United States. This provision operates to extend such exemptions and reductions to nonresident alien individuals and foreign corporations even though they are engaged in trade or business in the United States through a permanent establishment situated therein; it will apply to all treaties entered into by the United States, whether entered into before, on, or after the date of enactment of the bill. Only those items of income derived from sources within the United States which are subject to the 30-percent tax imposed by section 871 (a) (in the case of a nonresident alien individual) or section 881 (in the case of a foreign corporation) 764 PAGENO="0775" FOREIGN INVESTORS TAX ACT OF 1966 99 are affected by this provision. The provisions of section 894(b) do not apply in the case of a nonresident alien individual subject to the tax imposed pursuant to section 877(b) (relating to expatriation to avoid tax), as added by section 3(e) of the bill. Without the amendment provided by sectjon 894(b) a nonresident alien individual, or a foreign corporation, having a permanent estab- lishment in the United States would be taxable at the flat 30-percent rate under amended section 871 (a) or 881 on the gross income from sources within the United States which is not effectively connected with the conduct of a trade or business within the United States. Under existing law such a nonresident alien individual or foreign corporation is taxable at graduated rates under section 1 (or section 11) or 1201 on such income and the flat 30-percent tax on gross income does not apply. Section 894(b) extends to such a nonresident alien individual or for- eign corporation the benefit of any exemption, or reduced rate of tax, under a treaty in the case of income from sources within the United States which is not effectively connected with the conduct of a trade or business within the United States. The provisions of section 894(b) may be illustrated by the follow- ing example: Example a corporation organized in foreign country Z, is engaged in busi- ness in the United States through a permanent establishment located therein. The United States and country Z are parties to an income tax convention. The convention provides that the United States will tax at a 15-percent rate dividends received from sources within the United States by a corporation of country Z not having a permanent establishment in the United States. Corporation M receives dividends from a domestic corporation all of whose income is from U.S. sources. The dividends are not effectively connected with the conduct of M corporation's business in the United States. The gross dividends are taxable under amended section 881, but the tax may not exceed the treaty rate of 15 percent. If the dividends were effectively connected with the conduct of M corporation's business in the United States, they would be taxable under section 882(a) after allowance of the divi- dends-received deduction under section 243 of the code. SECTION 5 OF BILL-CONTINUED (b) Application of pre-1967 income tax provi~io~s.-Subsection (b) of section 5 of the bill adds new section 89.6 to subpart C of part II of subchapter N of chapter 1 of the code (relating to miscellaneous provisions applicable to nonresident aliens and foreign corporations). The amendment is effective for taxable years beginning after De- cember 31, 1966. CODE SECTION 896. APPLICATION OF PRE-1967 INCOME TAX PROVISIONS (a) Imposition of more burdensome taxes by foreign country.- Subsection (a) of section 896 contains procedures whereby the Presi- dent can proclaim that the ~ax of certain nonresident alien individuals and foreign corporations will be determined under the provisions of subchapter N of chapter 1, and of chapter 3, of the code which were in effect immediately before the date of enactment of this bill. Before 765 PAGENO="0776" 100 FOREIGN INVESTORS TAX ACT OF 1966 making such i~ proclamation the President must. make three specified findings. Paragraph (1) of section 896(a) provides that the President must first find that a foreign country (taking into account taxes imposed by its political subdivisions) is imposing more burdensome taxes on income received from sources within that country by U.S. citizens not resident in that country or by' domestic corporations not domiciled in that country than the United States imposes on similar income derived from sources within the United States by nonresident alien individuals resident in that country or by corporations of that coun- try. This finding may be made with respect to individuals or corpora- tions or both. It may be made with respect to any particular item of income, any combination of types of income, or all income. Paragraph (2) of section 896(a) provides that the President must find that, after having been regues'ted by the United States to do so, the foreign country has not acted to revise or reduce the more burden- some taxes (with respect to which the finding under par. (1) has been made) so as to `alleviate the more burdensome taxes involved. Paragraph (3) provides that the President must.find that it is in the public interest to apply pre-1967 tax provisions to residents or cor- porations of that foreign country in accordance with this section. After making the appropriate findings, the President shall proclaim that the tax of the nonresident alien individuals or foreign corpora- tions involved will be determined in the manner provided by subsec- tion (a) for taxable years beginning after the date the proclamation is issued. The proclamation will be limited to the foreign country, tax- payers, and income with respect to which the findings under para- graphs (1), (2), and (3) have been made. (b) AZieviation of n-tore burde~'wome ta~res.-Subsection (b) of sec- tion 896 provides the procedure whereby the President may revoke a proclamation issued pursuant to the provisions of section 896(a). A proclamation issued under section 896(a) may be revoked completely or in part if the President finds that the conditions upon which the finding required by paragraph (1) of section 896 (a) was made have been sufficiently remedied to justify a complete or partial revocation~ If such a finding is made, the President may revoke the outstanding proclamation by so proclaiming. The revocation so made shall apply with respect to taxable years beginning after the date the revoking proclamation is issued, and for such taxable years the tax shall be de- termined under subtitle A without regard to section 896(a). (c) Notification, of Congress required.-Subsection (c) of section 896 requires the President to give Congress a 30-day notice of his in- tention to issue a proclamation under section 896 (a) or to revoke a proclamation under section 896(b). (d) Jn-tpZem~entation by reguZations~-Subsection (d) of section 896 authorizes the Secretary of ` the Treasury or his deiegate to prescribe regulations to implement the provisions of section 896. SECTION 5 OF BILL-CONTINUED (o) CZerical amendm~ents.-Subsection (c') of section 5 of the bill amends the table of sections for subpart 0 of part II of subchapter N of chapter 1 to conform to the amendments made by subsections (a) and (b) of sectionS of the bifi. 766 PAGENO="0777" FOREIGN INVESTORS TAX ACT OF 1966 101 (d) Effective date.-~-Subsection (d) of section 5 of the bill provides that the amendments made by section 5 of the bill apply to taxable years beginning after December 31, 1966. (e) El~ectio'ns by ?wn~resident United States citisen~ who are ject to foreign coimimv~ity property laws.-Paragraph (1) of section 5(e) of the bill adds a new section 981 (designated as new subpart H) to part III of subchapter N Of chapter 1 of the code (relating to income from sources without the United States). CODE SECTION 981. ELECTION AS TO TREAThtENT OF INCOME SUBJECT TO FOREIGN COMMUNITY PROPERTY LAWS (a) General rule.-Subsection (a) of new section 981 provides that for any taxable year beginning after December 31, 1966, an individ- ual who is (1) a citizen of the United States, (2) a bona fide resident of a foreign country or countries during the entire taxable year, and (3) married at the close of the taxable year to an individual who is a nonresident alien during the entire taxable year, may, together with such spouse, elect for such year to have subsection (b) apply to their income for any taxable year in which there is community income under the community property laws of a foreign country. If an election to have subsection (b) apply for a taxable year has been made, the elec- tion is to apply for all open taxable years (as defined in subsection (e) (2)) for which the requirements of subsection (a) (1) are met, unless the Secretary of the Treasury or his delegate consents to a ter- mination of the election. (b) Treatiment of com'imunity incoine.-Subsection (b) of new sec- tion 981 contains rules for determining the attribution of the com- munity income to the respective spouses for U.S. income tax purposes for taxable years beginning after December 31,1966, to. which the elec- tion made under subsection (a) applies. Community income for this purpose means community income as determined under the community property laws of the foreign country of jurisdiction. Earrted in.~,om1e Paragraph (1) of subsection (b) provides that wages, salaries, or professional fees, and other amounts received as compensation for per- sonal services actually performed which, under the foreign commu- nity property laws is treated as community income of the spouses, are to be treated as the income of the spouse who actually performed the personal services. This rule does not apply to community income derived by a spouse from a trade or business conducted by such spouse in which both personal services and capital are material income-pro- ducing factors, nor does it apply to a partner's distributive share of partnership income. Also this rule does not apply to any compensa- tion which represents a distribution of earnings or profits of a corpora- tion rather than a reasonable allowance for compensation for personal services actually performed. Trade or business i?wom~e and partnership income Paragraph (2) of subsection (b) contains a rule for the. attribution to the respective spouses of the community income derived from a trade or business and of community income which is a partner's dis- tributive share of partnership income. The rule follows the princi- 767 PAGENO="0778" 102 FOREIGN INVESTORS TAX ACT OF 1966 pies of section 1402(a) (5) of the code (relating to the definition of "net earnings from self-employment". For this purpose income de- rived from a trade or business includes the. full amount of any com- munity income realized from the conduct of a trade or business in. which both personal services and capital are material income-produc- ing factors, but does not include income realized from a trade or busi- ness carried on by a partnership. In accordance with the principles of section 1402(a) (5) (A), any of the community income realized from the conduct of a trade or business will generally be treated, for pur- poses of section 981(a), as the income of the husband. However, if it is shown that the wife exercises substantially, all of the management and control over the trade or business, all of the community income realized from the trade or business is to be treated as the income of the wife. In accordance with the principles of section 1409(a) (5) (B), any portion of a partner's distributive share of the income of a partnership which is community income is to be treated, for purposes of section 981(a), as the income of the spouse who is the partner entitled to re- ceive such share. Incom.e fro'im 8eparate propert7/ Paragraph (3) of subsection (b) provides that any community income which is not described in either paragraph (1) or (2) of such subsection and which is derived from separate property of one of the spouses (as determined under the community property laws of the for- eign jurisdiction) is to be treated as income of the spouse whose sep- arate property gave rise to such community income. Other coin1nw,nity income Paragraph (4) of subsection (b) provides that all income which is community income under the community property laws of the foreign jurisdiction and which is not described in either paragraph (1), (2), or (3) of such subsection (e.g., community income derived from com- munity property) is to be treated as the income of the spouse who is the owner of such income under the community property laws of such foreign jurisdiction. (c) Election for pre-1967 7/ears.-Subsection (c) of new section 981 contains provisions for the application of an elective procedure to tax- able years beginning before January 1, 1967. Election Paragraph (1) of subsection (c) provides that an individual who meets the requirements of subsection (a) (1) (A) and (C) for any taxable year beginning before January 1, 1967, may, together with his spouse, elect, for all open taxable years beginning before January 1, 1967 (as defined in subsection (e) (2)), for which the requirements of subsection (a) (1) (A) and (C) are met, to have the provisions of paragraph (2) of subsection (c) apply for purposes of determining their U.S. income tax liability. The election is to be made jointly and is applied to each open taxable year beginning before January 1, 1967. Except as provided in subsection (d) (3), an election to have sub- section (c) apply for open taxable years beginning before January 1, 1967, must be made by both spouses described in subsection (a) (1) 768 PAGENO="0779" FOREIGN INVESTORS TAX ACT OF 1966 103 (A) and (C). This is true whether or not the period, in the case of the nonresident alien spouse, for assessing a deficiency for a taxable year has otherwise expired at the time of the election. An election made pursuant to subsection (c) in no case is to be considered in effect for any taxable year beginning after December 31, 1966. Furthermore, an election under subsection (c) is not to apply for any taxable year for which the requirements of subsection (a) (1) (A) and (C) are not met. In determining or redetermining the U.S. income tax of the U.S. citizen spouse, or of the nonresident alien spouse, for any such taxable year for which the election under subsection (c) applies, the provisions `of the 1954 code, the 1939 code, or any earlier Revenue Act, whichever was applicable to such taxable year, is to apply. For purposes of subsections (a) and (c) if the spouses have different taxable years, the period for which the income of the nonresident alien spouse is to be determined in accordance with paragraph (2) of subsec- tion (c) is to be that period falling within 2 consecutive taxable years of the nonresident alien spouse which coincides with the period covered by the open taxable year of the U.S. citizen spouse. Effect of election Parag.raph (2) of subsection (c) contains rules for the attribution of the community income to the respective spouses for U.S. income tax purposes for all taxable years for which the election made under sub- section (c) applies. In general, income which is community income under the community property laws of the governing foreign juris- diction is to be attributed to the respective spouses in accordance with the rules of subsection (b), which are the rules applicable to elec- tions under subsection (a) for taxable years beginning after De- cember 31, 1966. However, for any taxable year to which the elec- tion under subsection (c) applies, the rule of paragraph (4) of subsec- tion (b) does not apply in the case of the election made under sub- section (c), but instead all of the community income other than that described in paragraphs (1), (2), and (3) of subsection (b) is to be treated as the income of the spouse who, for such taxable year, had a greater amount of gross income than the other. spouse, determined by adding to the amount of the gross income which is sep- arate income of the spouse under the foreign community property laws, the amount of gross community income which is attributed to that spouse by applying the rules of paragraphs (1), (2), and (3) of sub- section (b). (d) Tim.e for making eleotio'ns; period of limitations; etc.-Suh- section (d) of new section 981 contains rules applicable to the making of the elections allowed under subsection (a) and (c) and contains special rules relating to the limitation periods on assessment, credits, and refunds, as well as rules relating to the running of interest on over- payments and deficiencies. Time Paragraph (1) of subsection (d) provides that the election under subsection (a) or (c) may be made for a taxable year at any time such taxable year is open, and is to be made in such manner as the Secretary of the Treasury or his delegate prescribes by regulations. In the case of the U.S. citizen spouse, the term "open taxable year" is defined in paragraph (2) of subsection (e). 769 PAGENO="0780" 104 FOREIGN INVESTORS TAX ACT OF 1966 Exteneion of period /oi' assessing deficiencies an~l making refunds Paragraph (2) of si~bsection (d) provides in effect that the period for assessing a d~ficiency against either spouse for any taxable year * for which an election under subsection (a) or (c) applies, and the period within which a claim for credit or refund of an overpayment for such taxable year may be flied by either sp~use~ to the extent that such deficiency or overpayment is attributable to such election is not to expire before 1 year after the date of such election. TI~us ex- tension of the period of limitations applies to both spouses, since under paragraph (2) of subsection (e), discussed below, each taxable year of the nonresident alien spouse to which an election applies is an open taxable year for purposes of paragraph (2) of subsection (d). The extension of the period of limitations under paragraph (2) of subsec- tion (d) does not apply to taxable years of a nonresident alien spouse who is not required, by reason of paragraph (3) of subsection (d), to join in the election allowed by subsection (c). Alien spouse need not join in subsection (c) election in certain cases Paragraph (3) of subsection (d) provides two circumstances under which the nonresident alien spouse referred to in subsection (a) (1) (C) is not required to join with the U.S. citizen spouse in making the election allowed by subsection (c) in order to make such election valid. Pursuant to. subsection (d) (3), the nonresident alien spouse Is not required to join in the election made under subsection (c) by the U.S. citizen spouse if the Secretary of the Treasury or his delegate determines that (1) the election under subsection (c) would not affect the U.S. income tax liability of the nonresident alien spouse for any taxable year beginning before January 1, 1967, or (2) the effect of the election on the nonresident alien spouse's liability for U.S. income tax for any such taxable year cannot be ascertained and that to deny the * election under subsection (c) to the U.S. citizen spouse for open tax- able years beginning before January 1, 1~67, would be inequitable and cause undue hardship. Interest * Paragraph (4) of subsection (d) delays the running of interest on a deficiency or overpayment of tax attributable to the making of the election allowed under subsection (a) or (c), so that interest on such a deficiency or overpayment is not to be paid or allowed for any pe- riod before the day which is 1 year after the date of such election. * (e) Definitions and special ru2es.-Subsection (e) of new section * 981 contains definitions and special rules necessary for the application of the provisions of such section. Paragraph (1) provides that deductions allowable under the code are'to be treated in a maimer consistent with the manner provided by section 981 f.or the income to which such deductions relate. Paragraph (2) defines the term "open year" as used in section 981. Under this paragraph a taxable year of the U.S. citizen and his spouse is to be treated as "open" if the period for assessing a definciency against such citizen has not expired before the date of the making of the election allowed by subsection (a) or (c), whichever applies. Thus, if a taxable year of a nonresident alien spouse who has joined in an election either ends or begins within the open taxable year of his 770 PAGENO="0781" FOREIGN INVESTORS TAX~ ACT OF 1966 105 tT.S; citizen spouse, such taxable year of. the nonresident alien spouse is to be considered "open". for purposes of subsection (.d) (2), and the period for assessing a deficiency for such taxable year is not to expire before 1 year after the date of such election. This is true although prior to the filing of such election, the assessment period for the tax-: able year of the nonresident alien spouse had expired. Paragraph (3) provides that, in those cases where one spouse is deceased and such spouse is required to join in makmg the election under subsection (a) or (c), as the case may be, the executor, administrator, or other person charged with the property of such decedent may join in making the. election. Paragraph (4) provides that if one of the sponses dies, then the taxable year of the surviving spouse is to be treated as closing on the date of such death for the purpose of applying sections 981(a) (1) (0) and 981 (c) (2) to such year. SECTION 5 OF BILTj-~-CONTINtTED Clerical or conforming amendments Paragraph (2) of section 5(e) of the bill adds new subpart H to the table of subparts for part III of subchapter N of chapter 1 of the code. Paragraph (3) of section 5(e) amends section 911(d) of the code (relating to crOss-references in respect of earned income from sources. without the United States) to include therein a new paragraph con- taining a cross-reference to new section 981. SECTION 6 OF BILL. FOREIGN TAX CREDIT (a) Allowance of credit to certain nonre8ident aliens and foreign corporatione.-Paragraph (1) of section 6(a) of the bill amends sub- part A of part III of subchapter Nof chapter 1 of the code (relating to the foreign tax credit) by adding a new section 906 which allows certain nonresident alien individuals and foreign corporations a credit under section 901 for foreign income taxes. . Under present law non- resident alien individuals and foreign corporations are not allowed a foreign tax credit under section 901, except that a nonresident alien in- dividual who is a bona fide resident of Puerto Rico during the entire taxable year is allowed such a credit. The amendment is effective for taxable years beginning after December 31, 1966. The credit allowed pursuant to section 906 is determined in basically the same manner as the c.redit would be determined if the nonresident alien individual were a citizen of the United States, or the foreign corporation were a domestic corporation managed and controlled in the United States, and all of the income of such citizen or domestic corporation consisted of the alien's or foreign corporation's income which is effectively connected with the conduct of a trade or business within the United States. CODE SECTION 906. NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN CORPORATIONS (a) Allo-wance of oredit.-Subsection (a) of new section 906 ex- tends the foreign tax credit allowed under section 901 of the code to nonresident alien individuals and foreign corporations who are en- 771 PAGENO="0782" 106 FOREIGN INVESTORS TAX ACT OF 1966 gaged in trade or business in the United States at any time during the taxable year and have income for such taxable year which is effectively connected with the conduct of a trade or business within the United States and is subject to tax pursuant to section 871(b) or 882(a), as amended by the bill. A nonresident alien individual who is a bona fide resident of Puerto Rico during the entire taxable year; that is, an alien to whom section 876 of the code applies, is not allowed a foreign tax credit pursuant to section 906. A citizen of a possession of the United States who is tax- able pursuant to section 932(a) of the code, as amended by section 3(m) of the `bill, in the same manner as a nonresident alien individual is subject to tax pursuant to section 871(b), as amended by the bill, and is allowed a foreign tax credit pursuant to section 906. The amount of the credit under section 906 is based `on the income, war profits, and excess profits taxes, and taxes included in the term "income, war profits, and excess profits taxes" by reason of section 903 of the code, paid or accrued during the taxable year to a foreign coun- try or possession of the United States on or with respect to income which is effectively connected with the conduct of a trade or business within the United States. The credit is also allowed witti respect to such foreign taxes which are deemed paid or accrued during the taxable year under section 902 of the code if the dividends received upon which the section 902 credit is based are effectively connected wi'th the conduct of a trade or business within the `United States by the recipient of the dividends. (b) Special ~rules.-Subsection (b) of section 906 contains special rules concerning the allowance of the foreign tax credit to nonresident alien individuals and foreign corporations pursuant to section 906. It also provides a rule for determining the amount of foreign income taxes for which such persons may claim a deduction in determining the taxable income which, pursuant to amended section 871 (b) or 882(a), is subject to the tax imposed by section 1 or 11. This subsec- tion dOes not apply to a nonresident alien individual to whom section 876 of the code applies.' Foreign taxes for which credit or deduction is not allowed Paragraph `(1) `of section 906(b) provides that a credit against tax, or a deduction from gross income under amended section 873 (a) or 882 (~) (1) (A), is not to be allowed for income,~ war profits, or excess profit~ taxes paid or accrued to a foreign country or possession of the United `States on income which is effectively connected `with the conduct of a trade or business wi'thin the United `States if the taxes so imposed are imposed solely by reason of the fact that the nonresi- dent alien individual is a citizen or resident of that country or posses- sion or that the foreign corporation is created or organized under the law of that country or possession or has its domicile for tax purposes there. This provision, in effect, requires that the taxes paid or accrued to a foreign country or possession which taxes the worldwide income of the alien individual or foreign corporation be disregarded for pur- poses of the foreign tax credit, or of the deduction under section 873 (a) or 88~(c) (1) (A), if such country or possession would not have taxed such income (1) had the alien `individual been a citizen and resident 772 PAGENO="0783" FOREIGN INVESTORS TAX ACT OF 1966 107 of another country or (2) had the foreign corporation been created or organized under the law of another country and had its domicile in another country. In applying section 906(b) (1) to any foreign coun- try or possession of the United States the laws of such country or possession are to be used for purposes of determining whether an in- dividual is a resident of, or a corporation is domiciled for tax purposes in, such country or possession. The amount of the foreign taxes which is to be taken into account for purposes of section 906(a), 873 (a), or 882(c) (1) (A) is, if such amount cannot otherwise be specifically allocated to an item or class of income, generally to be that amount which bears the same ratio to the total income taxes payable to the foreign country of residence or domicile as the taxable income which is effectively connected with the conduct of a trade or business within the United States and is taxable by that foreign country for reasons other than the residence of the individual, or the domicile of the foreign corporation, therein bears to the total taxable income of such individual or corporation from all sources. The application of section 906(b) (1) may be illustrated by the following example: Eccam.ple a corporation organized under the law of foreign country Z, is engaged in trade or business within the United States during the taxable year through an office located in the United States. Upon the basis of the facts assumed, M Corporation is allowed to take into account under section 906(b) (1) in determining the credit against tax, or its deductions from income, the following amounts of foreign income taxes: 4~ross income (all effectively connected with the conduct of a trade or business within the United States) having the following source under the laws of the United States: Sources within United States $50.00 Sources within country Y - 50.00 Total gross income :100.00 Deductions allowable under the laws of the United States and country Z__ 25.00 Country Y tax for purpo.se,~ of sec. 906(a) or 882(c), assuming a 30-per- cent rate on gross income from Y sources ($50 times 30 percent) 15. 00 ~Jountry Z tax imposed at a 50-percent rate on $75 taxable income of M corporation solely because M corporation is created under the law of country Z 37.50 Total foreign income taxes taken into account for purposes of the foreign tax credit under sec. 900 (a), or for purposes of deductions allowable under sec. 882(e) (country Y tax) 15.00 Limitation on aiinount of credit Paragraph (2) of section 906(b) provides in effect that, in deterinin- ing under section 904 of the code the maximum foreign tax credit allow- able (pursuant to section 906(a)) for any taxable year, (1) the taxable income from sources within a foreign country or possession for pur- poses of section 904 (a) (1) is to be only the taxable income from such sources which is effectively connected with the conduct of a trade or business within the United States, (2) the taxable income from sources without the United States for purposes of section 904(a) (2) is to be only the taxable income from sources without the United States which 773 PAGENO="0784" 108 1~'OREIGN INVESTORS ~I'AX ACT OF 1966 is effectively connected with the conduct of a trade or business within the United States, and (3) the entire taxable income for purposes of section 904(a) is to be only the taxpayer's total taxable income which is subject to tax for the taxable year pursuant to section 871(b) or 882(a), as amended by the bill. None of the income for the taxable year which is subject to the tax imposed by section 871 (a) or 881, as amended by the bill, is to be taken into account for purposes of apply- ing section 904. In applying the provisions of section 904 to the credit allowable pursuant to section 906, no amount of excess tax paid may be carried from or to any taxable year beginning before January 1, 1967, and no such taxable year is to be taken into account. The appli- cation of section 906(b) (2) may be illustrated by the following example: Example The facts are the same as those given in the example illustrating the provisions of paragraph (1) of section 906(b). Foreign coun- try Z does not allow a credit against its tax for the amount of the United States income tax. Assuming that M corporation has elected to take a foreign tax credit and apply the overall limitation of sec- tion 904(a) (2), the limitation on the amount of the credit allowed pursuant to section 906 for the taxable year is determined as follows: Gross income for purposes of U.S. tax $100.00 Deductions allowable under sec. 882(c) 25.00 Taxable income for purposes of sec. 882(a) 75.00 Taxable income from sources without the United States, pro rata alloca- tion of deductions being assumed ($75 times $50/$100) -- 37.50 U.S. tax under sec. 882(a) before foreign tax credit (surtax exemption under sec. 11(d) of the code being disregarded for simplification) ($75 times 48 percent) 36.00 Limitation on foreign tax credit: $36 times $37.50/$75 equals $18, but not to exceed creditable tax of $15 15.00 U.S. tax payable 21.00 Tax against which credit may be taken Paragraph (3) of section 906(b) provides that the credit allowed pursuant to section 906 (a) is to be allowed only against the U.S. tax imposed pursuant to amended section 871(b) or 882(a) on the taxable income which is effectively connected with the conduct of a trade or business within the United States. For example, if in the above ex- ample under section 906(b) (1), M Corporation had any income from sources within the United States for the taxable year which was not effectively connected with the conduct of a trade or business within the United States and was subject to the tax imposed under amended secion 881 (a), such tax could not be reduced by the credit allowed pur- suant to section 906 (a) and such tax (and income) could not be taken into account in determining the limitation provided in section 904(a) on the amount of the foreign tax credit allowable for the taxable year against the tax imposed pursuant to amended section 882 (a). Treatment as a domestic corporation Paragraph (4) of section 906(b) provides that, for purposes of sections 902(a) and 78 of the code, a foreign corporation receiving dividends described in section 902(a) is to be treated as a domestic 774 PAGENO="0785" FOREIGN INVESTORS TAX ACT OF 1966 109 corporation if for the taxable year such corporation chooses the bene- fits of the foreign tax credit allowable pursuant to section 906(a). Pursuant to the provisions of paragraph (4) the benefits of section 902 with respect to the dividends received are allowed to foreign cor- porations choosing to take the foreign tax credit under section 901, and the gross-up requirement of section 78 is mad~ applicable with respect to the taxes deemed paid under section 902(a) (1) by reason of such credit. These provisions apply, however, only if the dividends which are described in section 902(a) and received by the foreign corporation which is subject to the tax imposed pursuant to amended section 882(a) are effectively connected with the conduct of a trade or business within the United States by such recipient foreign corporation. In applying section 902(a) to such foreign corporation owning at least 10 percent of the voting stock of the foreign corporation paying the dividends, the foreign corporation paying the dividends will be deemed under section 902(b) to have paid foreign income taxes by reason of the receipt of any dividends from another foreign corpora- tion 50 percent or more of whose voting stock it owns. It is not neces- sary to make any determination as to whether the dividends paid by such other foreign corporation are effectively connected with the con- duct of a trade or business within the United States. SECTION 6 OF BILL-CONTINUED Clerical or con/oriming amendments Paragraph (2) of section 6(a) of the bill adds new section 906 to the table of sections for subpart A of part III of subchapter N of chapter 1. Paragraph (3) of section 6(a) makes a conforming amendment in section 874(c) of the code (relating to the allowance of the foreign tax credit to nonresident alien individuals). Under existing section 874(c) a nonresident alien individual who is not described in section 876 of the code is never allowed the foreign tax credit under section 901. Paragraph (4) of section 6 (a) amends subsectiOn (b) of section 901 of the code (relating to the amount allowed as a credit) by redes- ignating paragraph (4) as paragraph (5) and by inserting a new paragraph (4) which provides that the amount of the foreign tax credit allowed under section 901 (a) in the case of a nonresident alien individual not described in section 876 of the code or of a foreign corporation is to be determined under new section 906. Since a nonresident alien individual who is a bona fide resident of Puerto Rico during the entire taxable year is, by reason of section 876, not subject to the tax imposed pursuant to section 871(b), such alien's foreign tax credit is not determined pursuant to new section 906. The credit against tax allowed in the case of such an alien described in section 876 is the amount allowed under existing section 901(b) (3) of the code. Paragraph (5) of section 6(a) makes a conforming amendment in paragraph (5) of section 901(b), as so redesignated. Effective date Paragraph (6) of section 6(a) provides that the amendments made by section 6(a) are to apply with respect to taxable years beginning after December 31, 1966. This paragraph also provides that, in ap- 775 71-297 0-67-pt. 1-50 PAGENO="0786" 110 FOREIGN INVESTORS TAX ACT OF 1966 plying section 904 with respect to the credit allo'wed pursuant to section 906, no excess tax may be carried from or to any taxable year beginning before January 1, 1967. Thus, in determining under sec- tion 906 foreign income taxes paid or accrued for a taxable year be- ginning after December 31, 1966, no taxes are to be deemed paid or ac- crued for such year by reason of a carryover under section 904 (d) or (e) from any taxable year beginning before January 1, 1967. Moreover, if in applying section 906 for any taxable year beginnin after December 31, 1966, the foreign income taxes paid or accrue for such year with respect to income effectively connected with the conduct of a trade or business within the United States exceed the applicable limitation under section 904(a) with respect to the tax * imposed pursuant to amended section 871(b) or 882(a), none of such excess taxes may be carried back and deemed paid or accrued in any taxable year beginnning before January 1, 1967. Computations in respect of a taxable year beginning before January 1, 1967, are in no way to serve to reduce a carryback or a carryover from a taxable year beginning after December 31, 1966, in respect of the foreign income taxes allowable as a credit pursuant to section 906 (a). (b) Alien residents of the United States or Puerto Rico.-Subsec- tion (b) of section 6 of the bill provides for the elimination, subject to specified safeguards, of the so-called similar credit requirement in respect of the income tax credit allowed by reason of section 901 (b) (3) of the code for certain foreign income taxes and in respect of the estate tax credit allowed by reason of section 2014(a) of the code for certain foreign death taxes. Under existing section 901 (b) (3) an alien individual who is a resident of the United States or who is a bona fide resident of Puerto Rico for the entire taxable year-is allowed the credit under section 901 for income, war profits, and excess profits taxes paid or accrued to any foreign country, only if the foreign country of which such alien is a citizen or subject provides a similar credit to citizens of the U.S. resident in the country of which such alien is a citizen or subject. Under existing section 2014(a) the estate of a decedent who was not a citizen of the United States but was a resident thereof is allowed the credit under section 2014 for estate, inheritance, legacy, or suc- cession taxes paid to any foreign country, only if the foreign country of which such decedent was a citizen or subject provides a similar credit to the estate of a citizen of the United States resident at the time of death in the country of which such alien was a citizen or subject. Deletion of the similar credit requirement in case of income taxes Paragraph (1) of section 6(b) of the bill deletes the similar credit requirement now contained in section 901 (b) (3) of the code. Para- graph (2) of section 6(b) makes existing subsections (c) and (d) of section 901 subsections (d) and (e) and adds a new subsection (c). New subsection (e) provides that the Président may reinstate such similar credit requirement if certain findings are.made. The findings required to be made by the President as a prerequisite to the reinstate- ment of such similar credit requirement are substantially the same as those required as a prerequisite for the reinstatement of pre-1967 in- come tax law under the authority of section 896, as added by section 776 PAGENO="0787" FOREIGN INVESTORS TAX ACT OF 1966 111 .~(b) of the bill. These amendments are effective for taxable years beginning after December 31, 1966. The President is to proclaim the application of the similar credit requirement with respect to resident alien individuals who are citi- :Z8nS or subjects of a particular foreign ~country if he finds (1) that :such foreign country does not allow a similar credit to citizens of the United States resident in such foreign country; (2) that such foreign country, after being requested by the United States, has not acted to provide a similar credit to such citizens of the United States; and (3) that it is in the public interest to allow the credit under section 901(b) (3) to citizens or subjects of such foreign country only on a reciprocal basis. For taxable years beginning while the President's proclamation is in effect, the credit under section 901(b) (3) is to be allowed to citizens or subjects of the foreign country with respect to which the proclamation is issued only if a similar credit is provided by such country to citizens of the United States resident in such country. Deletion of the sim1ilar credit reguireiment in case of death taxes Paragraph (3) of section 6(b) of the bill amends section 2014(a) of the code (relating to credit for foreign death taxes) by deleting the similar credit requirement contained therein and by adding a new subsection (h) authorizing the President to reinstate the similar credit requirement under prescribed conditions. The amendment is appli- * cable to estates of decedents dying after the date of the enactment of the bill. The provisions of new subsection (h) are essentially similar to the provisions of new subsection (c) of section 901, as added by paragraph (2) of section 6(b), except that new subsection (h) ap- plies to the Federal estate tax. Effective dates Paragraph (4) of section 6(b) provides that the amendments made by subsection (b) of section 6, other than by paragraph (3), apply with respect to taxable years beginning after December 31, 1966. The amendment made by paragraph (3) applies with respect to estates of decedents dying after the date of the enactment of the bill. (c) Foreign taco credit in case of certain overseas operations fund- ing subsidiaries.-Subsection (c) of section 6 of the bill amends section 904(f) of the code (relating to the application of limitations on the foreign tax credit in the case of certain interest income). In general, section 904(f) presently provides that, in determining the limitation on the amount of the foreign tax credit under section 904, interest from foreign sources is to be treated separately from other income from foreign sources and the per-country limitation is to be applied in computing the limitation on the foreign tax credit in the case of such interest. Paragraph* (2) of subsection (f), which de- scribes the interest to which subsection (f) applies, excepts from the application of that siThsection: (1) Interest derived from any transac- tions, directly related to the active conduct of a trade or business in a foreign country or U.S. possession; (2) interest derived in the conduct of a banking, financing, or similar business (such as an insurance company business); (3) interest received from a corporation in which the taxpayer owns at least 10 percent of the voting stock; and (4) interest received on obligations acquired as the result of disposition 777 PAGENO="0788" 112 FOREIGN INVESTORS TAX ACT OF 1966 of a trade or business actively conducted by a taxpayer in a foreign country or as a result of a disposition of stock or obligations of a corporation in which the taxpayer owns at least 10 percent of the votmg stock.. Paragraph (1) of subsection (c) amends paragraph (2) of section 904(f) by adding a new subparagraph (E) which excepts from the application of section 904(f) interest received by an overseas operations funding subsidiary on obligations of a related foreign corporation. Definitions necessary for the application of the new subparagraph (E) arecontained in a new paragraph (5) of section 904(f)., as added i by paragraph (2) of subsection (c). Subparagraph (A) of new paragraph (5) defines the term "overseas operations funding subsid. lary" to mean a domestic corporation which is a member of an af- ffliated group of corporations within the meaning of section 1504 of the code (other than the common parent corporation of such affiliated group) and whIch was formed, and is availed of, for the principal purpose of raising funds outside the United States through public offerings to foreign persons and of using such funds to finance the op- erations in foreign countries of one or more related foreign corpora- tions. For purposes of applying subparagraph (A), a foreign person is a person who is not a U.S. person within the meaning of section 7701 (a) (30) of the code. Funds are not to be considered to be raised in *the United States merely because negotiations essential to the raising of such funds have occurred, in whole or in part, in the United States. In determining for purposes of new subparagraph (E) of section. 904(f) (2) whether interest paid to a domestic corporation which is an overseas operations funding subsidiary is paid on obligations of a related foreign corporation and whether. such~ domestic subsidiary corporation's activities meet the principal purpose test of subpara- graph (A) of new section 904(f) (5), the term "related foreign cor- poration", as defined in subparagraph (B) of new section 904(f) (5), means a foreign corporation of which an aggregate of 50 percent or more of the voting stock is owned either directly by members of the affiliated group of which such domestic subsidiary corporation is a member or indirectly by .such member corporations through owner- ship of the voting stock of a single other foreign corporation. Thus, for example, if the members of the affiliated group together own directly 100 percent of the voting stock of foreign corporation N and foreign corporation N in turn owns directly 50 percent or more of the voting stock of foreign corporation M, then foreign corporation M is a related foreign corporation with respect to a domestic corporation which is an overseas operations funding subsidiary and a member of such affiliated group. However, if in turn foreign corporation Mowns directly 100 percent of the voting stock of foreign corporation R, foreign corporation R is not a related foreign corporation with respect to such overseas operations funding subsidiary. Where the members of the affiliated group so own stock in a for- eign corporation indirectly through separate other foreign corpora- tions, the aggregate indirect ownership is to be taken into account for determining whether the 50-percent ownership test of subparagraph (B) of new section 904(f) (5) is met. Paragraph (3) of subsection (c) provides that the amendments made by paragraphs (1) and (2) of subsection (c) are to be effective 778 PAGENO="0789" FOREIGN INVESTORS TAX ACT OF 1966 113 ivith respect to interest received by a domestic corporation after December 31, 1965, in taxable years of sudh recipient ending after that date. SECTION 7 OP BILL. AMENDMENT TO PRESERVE EXISTING LAW ON DEDUC- TIONS UNDER SECTION 931 (a) Dediu~ctio'n&-Subsecition (a) of section 7 of the bill amends section 931(d) of the code (relating to deductions available to U.S. citizens and domestic corporations entitled to the benefits of sec. 931) in order to preserve existing law for determining the taxable income of such persons. Section 931(d), as so amended, adopts the provisions of subsections (a),. (b), (c), and (e) of existing section 873 of the code and paragraphs (2) and (3) of existing section 882(c) of the code, except that under amended section 931 (d) (2) (c) the individual is allowed a deduction for contributions or gifts to or for a trust described in section 170(c) (~). This is consistent with the change made in paragraph (2) of section 873(b), as amended by section 3(c) of the bill. (b) Effective date.-Subsection (b) of section 7 of the bill provides that the amendment made by section (a) applies with respect to taxa- ble years beginning after December 31, 1966. SECTION 8 OP THE BILL. ESTATES OP NONRESIDENTS NOT CITIZENS (a) Rate of tax.-Subsection (a) of section 8 of the bill strikes out subsection (a) of section 2101 of the code (relating to tax imposed in case of estates of nonresidents not citizens) and substitutes in its place a new subsection (a). Under present subsection (a) of section 2101, the taxable estate of a nonresident not a citizen of the United States is subject to the tax com- puted in accordance with the table of rates contained in section 2001, ~which is the tax table used in computing the tax on estates of citizens or residents of the United States. These rates begin at 3 percent on. the first $5,000 of a taxable estate and reach a maximum of 77 percent on that part of a taxable estate in excess of $10 million. New subsection (a) of section 2101 contains a separate tax table of lower rates, ranging from 5 percent on the first $100,000 of a taxable estate to a maximum rate of 25 percent on that part of a taxable estate in excess of $2 million. The new subsection applies to estates of nonresidents not citizens, including certain citizens of the United States who were residents of a possession of the United States and who are considered nonresidents not citizens under section 2209 of the code, who die after the date of enactment of the bill. (b) credits against taa,.-Subsection (b) of section 8 of the bill amends section 2102 of the code (relating to credits allowed against estate tax). This amended section retains existing law in subsection (a), which provides that the estate tax imposed on the estate of a non- resident not a citizen of the United States is to be reduced by the credits prescribed in sections 2011 to 2013, inclusive, relating to State death taxes, gift tax, and estate tax on prior transfers, respectively. 779 PAGENO="0790" 114 FOREIGN INVESTORS TAX ACT OF 1966 New subsection (b) of section 2102 provides a special limitation ow the allowance of the credit provided by section 2011, relating to State' death taxes. Under this special limitation, the maximum credit allow- able for State death taxes is the amount which `bears the same ratio to the maximum credit computed as provided in section 2011(b) as the' value of the property (determined at the date of death or as provided in sec. 2032 of the code) upon which a State death tax was actually paid and which is included in the gross estate under section 2103 bears. to the value of the total gross estate under section 2103. (c) Property within the United States.-Subsection (c) of section 8 of the bill amends section 2104 of the code (relating to property within the United States) by adding at the end thereof a new subsec- tion (c) (relating to debt obligations). Section 2103 provides that the. value of the gross estate of every decedent nonresident not a citizen of the United States consists only of the value of that portion of the property otherwise includible in his gross estate which at the time of his death is situated in the United States. In the regulations under existing section 2104 of the code' a debt obligation the written evidence of which is treated as being the property itself (e.g., a bond) is considered to be situated in the United States only if the written evidence is located within the United States. Under existing section 2105(b) of the code deposits in the United States with any person carrying on the banking business are considered situated within the United States only if the decedent was engaged in `business in the United `States `at the time of his death. Any other d~bt obligation the written evidence of which is not treated as the property itself is considered, in the regulations under section 2104, to be situated within the United States if issued by or enforceable against a resident of the United States `or a domestic corporation Or' governmental unit. New subsection (c) of section 2104 provides that, with one exception, a debt obligation owned by a nonresident not a citizen of the United States is to be considered property within the United States, and thus includible in the gross estate of such a `decedent, if the primary obligor' with respect to such debt obligation is any of the following: (1) A U.S. person (as defined in sec. 7701 (a) (30)), `or (2) The United States, `a State or any political subdivision' thereof, or t'he District of `Columbia. This rule applies whether or not the written evidence of the debt obligation is treated `as being the property itself. Except as provided in section 2105(b) (relating to' deposits with a foreign branch of a domestic corporation), as amended by section 8(d) of the bill, this' rule also applies in the case of bank deposits. Currency is not a debt; obligation for purposes of subsection (c). The one exception to the rule is that a de'bt obligation of a domestic corporation is not to be' treated as property within the United States when owned by a non-. resident not a citizen in a case where any interest on such thligation, if it were received by the decedent at the time of his death, would be' treated by reason of the application of section 861 (a) (1) (B) of the code as income from sources without the United States. This exception applies whether or not interest is in fact paid ~ the obligation. Debt obligations of obligors not described in section' 2104(c) (1) and (2), as added `by this subsection, are not to be deemect 780 PAGENO="0791" FOREIGN INVESTORS TAX ACT OF 1966 115 property within the United States even though there is located in the United States the written evidence of such obligation which is treated as being the property itself. (d) Property withont the United States.-Subsection (b) of section section 2105 presently provides that, in the case of estates of non- residents not citizens of the United States who `were not engaged in business in the United States at the time of death, any moneys de- posited by or for such decedents with any person carrying on the banking business shall be considered to be property outside the United States (and thus not includible in the gross estates of such decedents). Subsection (d) of section 8 of the bill deletes subsection (b) of section 2105 and inserts a new subsection (b) which provides that deposits with a foreign branch of a domestic corporation shall be considered to be property outside the United States if such branch is engaged in the commercial banking business. The new provision applies whether or not the decedent was engaged in business in the United States at the time of his death, and whether or not the deposits, upon withdrawal, are payable in U.S. dollars. Any bank deposit made by or for a nonresident not a citizen of the United States with a U.S. person, other than a deposit to *which new subsection (b) of section 2105 applies, is considered under new subsection (c) of section 2104 to be property within the United States, if such deposit is not a `debt obligation to which the last sen- tence of subsection (c) of section 2104 applies. (e) Definition of taxable estate.-Subsection (e) of section 8 of the' bill amends paragraph (3) of section 2106(a) of the code (relating to the deduction of an exemption from the gross estate of nonresidents. * not citizens of the United States). Subparagraph (A) of this amended paragraph raises the exemption allowed in respect of the estate of a nonresident not a citizen of the United States from the existing $2,000 to $30,000. Subparagraph (B) provides that, in the case of decedents who were citizens of the United States and residents of a possession of the United States at the time of death but who are considered nonresidents not citizens of the United States by reason of section 2209, the exemption is to be the greater of either $30,000 or that proportion of `the exemption (now $60,000) authorized by section 2052 (relating to the exemption al- lowed in respect of estates of decedent ~citizens or* residents of the United States) which the value of that part of the decedent's gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated. If under an applicable estate tax convention to which the United States is a party `the estate tax exemption in the case of a nonresident decedent not a citizen of the United States is in excess of $30,000, such treaty exemption is to apply for purpose of determining the tax imposed by section 2101, as amended by section 8(a) of the bill, or by section 2107, as added by section 8(f) of:the bill. (f) Special imethods of co'irtpnting tax.-Subsection (f) of section 8 of the bill amends subchapter B of chapter U of the code (relating to estates of nonresidents not citizens) by adding new sections 2107 (relating to expatriation to avoid tax) and 2108 (relating to appli- cation of pre-1967 estate tax provisions). These new sections apply 781 PAGENO="0792" 116 FOREIGN INVESTORS TAX ACT OF 1966 with respect to estates of decedents dying after the date of the enact- ment of the bill. CODE SECTION 2107. EXPATRIATION TO AVOID TAX (a) Rate of ~a~.-New section 2107 provides a special tax computa- tion ~for the estates of decedent nonresidents not citizens of the United States, who lost U.S. citizenship after March 8, 1965, and within 10 years of death, and who had as a principal purpose for such loss the avoidance of U.S. income, estate, or gift tax. Subsection (a) of such section provides that the taxable estate of such a decedent shall be sub- ject to tax at the rates set out in section 2001, which are the rates used in the case of estates of U.S. citizens or residents. For this purpose, the taxable estate is determined as provided in section 2106 in the same manner as that provided for in the case of any other decedent nonresi- dent not a citizen of the United States, except that in determining such taxable estate the gross estate of such a decedent also includes, under subsection (b) of section 2107, a proportion of the fair market value of any stock owned by the decedent in a foreign corporation, if the corporation was controlled by the decedent and had assets situated in the United States. (b) Gross estate.-Subsection (b) of section 2107 provides that as a general rule the gross estate of a decedent to whom subsection (a) of section 2107 applies is determined as provided in section 2103 with re- spect to the estate of any other decedent nonresident not a citizen of the United States. Subsection (b) also provides an exception to this general rule which is designed to prevent a decedent to whom sub- section (a) of section 2107 applies from avoiding Federal estate tax by transferring to a foreign corporation under his control property which would otherwise be includible in his gross estate for Federal estate tax purposes if such property had not been transferred to such corporation. For purposes of the application of this exception, such a decedent is considered to have been in control of a foreigh corporation at the time of his death if the tests set out in paragraphs (1) and (2) of sub- section (b) are both met. The test contained in paragraph (1) is that the decedent must have owned, at the time of his death, either directly or indirectly (within the meaning of sec. 958(a) of the code and the regulations thereunder) through certain foreign entities, at least 10 percent of the total com- bined voting power of all classes of stock entitled to vote of the foreign corporation. The test contained in paragraph (2) is that the total of the stock which the decedent owned, either directly or indirectly as described in paragraph (1), and the stock which he was considered to have owned by applying any applicable constructive ownership rules, of section 958(b), at the time of his death, must have constituted more than 50 percent of the total combined voting power of all classes of stock en- titled to vote of the foreign corporation. For purposes of this sub- section (b) the decedent is treated as owning stock of a foreign corpora- tion at the time of his death if, at the time of a transfer (by trust or otherwise) within the meaning of section 2035,2036,2037, or 2038 of the code, he owned such stock. The same shares of stock may not be counted more than once in determining whether or not the 50-percent 782 PAGENO="0793" FOREIGN INVESTORS TAX ACT OF 1966 117 test contained in paragraph (2) is met, even though the decedent both is treated as having owned the shares (within the meaning of this subsection without reference to sec. 958(b)) and is considered to have owned the shares by applying the constructive ownership rules of section 958(b) ; as, for example, in a case where the decedent had given the shares to his wife in contemplation of death. If the ownership tests of paragraphs (1) and (2) of subsection (b) are bothmet, the gross estate of the decedent is to include, in addition to items includible therein under section 2103 of the code, that propor- tion of the fair market value of the stock of the foreign corporation owned by the decedent, at the time of his death, which the fair market value of any assets owned by the foreign corporation and situated in the United States at the time of his death bears to the fair market value of all of the corporation's assets, wherever situated, at such time. The fair market value of assets, wherever situated, of the foreign cor- poration shall be determined without reduction for any outstandin liabilities of such corporation. The alternate valuation date provide by section 2032 of the code may be used in determining the value of the gross estate under subsection (b) of section 2107, but the owner- ship tests of paragraphs (1) and (2) of such subsection must be deter- mined solely by reference to the time of death. The application of the provisions of subsection (b) of section 2107 is illustrated by the following example. Example.-H, a nonresident decedent to whom section 2107 applies, owned stock worth $50,000 which constituted 40 percent of the total combined voting power of all classes of stock entitled to vote of foreign corporation M. W, his wife, owned stock constituting 20 percent of the combined voting power. H transferred all of his stock in M corporation to W in contemplation of death within the meaning of section 2035. At the time of H's death, 30 percent of the fair market value of the assets of the corporation were situated within the United States. The test of paragraph (1) is met since H "owned" (within the meaning of that paragraph) 40 percent of the combined voting power at the time of `his death, and the test of paragraph (2) is met since, under that paragraph, H is treated as having owned 60 percent of the combined voting ~power (having constructive ownership of his wife's 20 percent of combined voting power, in addition to his own 40 percent of such power) at the time of his death. Accordingly, *an amount equal to 30 percent (the percentage of the fair market value of the corporation's assets which were situated within the United States at H's death) of $50,000 (the fair market value of the stock "owned" by H), or $15,000, is included in H's gross estate. (C) Credits.-Subsection (c) of section 2107 provides that in com- putmg the Federal estate tax on the transfer of the taxable estate of a decedent nonresident not a citizen of the United States which is subject to tax under the provisions of subsection (a), credits against the tax are to be allowed in accordance with the provisions of section 2102, as amended by section 8(b) of the bill, for State death taxes, gift tax, and estate tax on prior transfers. In applying section 2102(b) for this purpose the gross estate is to be determined in the manner pro- vided by subsection (b) of section 2107. (d) E~rception for loss of citizenship for certain ctneses.-Subsection (d) of section 2107 provides that the provisions of subsection (a) of 783 PAGENO="0794" 118 FOREIGN INVESTORS TAX ACT OF 1966 such section are not to apply to the transfer of the estate of a decedent whose loss of U.S. citizenship resulted from the application of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended. These sections are discussed in connection with section 877 (d), as added by section 3(e) of the bill. (e) Burden of proof..-Subsection (e) of section 2107 provides that, in determining whether a principal purpose for the loss of United States citizenship by an expatriate was the avoidance of U.S. income, estate, or gift taxes, the Secretary of the Treasury or his delegate must first establish that it is reasonable to believe that the decedent's loss of U.S. citizenship would, but for section 2107, substantially reduce his combined Federal and foreign death taxes (including death taxes im- posed by political subdivisions of foreign countries). In the absence of complete factual information, the Secretary or his delegate may make a determination, based on the information available, that the decedent's loss of U.S. citizenship would, but for section 2107, substantially reduce his combined Federal and foreign death taxes. Such tentative deter- mination is to be sufficient to establish that it is reasonable to so believe, in the absence of a showing by the executor of the decedent's estate of the actual reduction in such taxes resulting from the decedent's loss of U.S. citizenship. Such tentative determination may be based upon the fact that the laws of the country of which the decedent became a citizen and the laws of the country of which the decedent was a resident (including the laws of the political subdivisions of such countries) would ordinarily result, in tha case of an estate of a person of the decedent's citizenship and residence, in liability for death taxes substantially lower than the amount of tax imposed by subchapter A of chapter 11 of the code on estates of citizens of the. United States. Once the Secretary of the Treasury or his delegate has established that it is reasonable to believe that the decedent's loss of U.S. citizenship would, but for section 2107, substantially reduce his combined Federal and foreign death taxes, the executor of the decedent's estate must show that such loss did nothave for one of its principal purposes the avoid- ance of U.S. income, estate, or gift taxes. SECTION 8 OF EILL-CONTINUED CODE SECTION 2108. APPLICATION OF PRE-1967 ESTATE TAX PROVISIONS (a) Imposition of more burdensome tax by foreign country.-Sub- section (a) of section 2108 provides that whenever the President finds that (1) the tax system of any foreign country (including the tax systems of its political subdivisions) imposes a more burdensome tax on the transfer of estates of decedents who were United States citizens not residents of that country than the tax imposed by subchapter B of chapter 11 of the code, as amended (exclusive of this section), on the transfer of estates of decedents who were residents of such foreign country; (2) that such country has not revised or reduced its tax, when requested by the United States to do so, to make it no more burdensome than such U.S. tax; and (3) that it is in the public in- terest to apply pre-1967 estate tax provisions to estates of residents of such country who were not citizens or residents of the United 784 PAGENO="0795" FOREIGN INVESTORS TAX ACT OF 1966 119 States; then the President is to proclaim that the tax on estates of such residents of such foreign country who die after the date of such proc- lamation is to be determined under subchapter B of chapter 11 with- out regard to amendments made to sections 2101, 2102, 2106, and 6018 on or after the date of enactment of the bill. (b) Alleviation 0/n-tore burdensome tax.-Subsection (b) of section 2108 provides that, whenever the President finds that the laws of any foreign country with respect to which the President has made a procla- anation under subsection (a) have been modified so that the tax on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country is no longer more burdensome than the tax imposed by subchapter B of chapter 11, he is to proclaim that the tax on the transfer of the estates of residents of such foreign country (not citizens of the United States) dying after the date of such proclamation of revocation is to be determined under subchapter B without regard to subsection (a) of section 2108. (c) Notification of Congress required.-Subsection (c) of section 2108 provides that neither the proclamation authorized by subsection (a) nor that authorized by subsection (b) is to be issued unless, at least 30 days prior to such proclamation, the President has notified Congress of his intention to make such proclamation. (d) ln-tplementation by `regulations.-Subsection (d) of section 2108 provides that the Secretary of the Treasury or his delegate is to prescribe such regulations as may be necessary or appropriate to imple- ment section 2108. SECTION 8 or BILL-CONTINUED (g) Estate tax returns.-Subsection (g) of section 8 of the bill con- forms paragraph (2) of section 6018(a) of the code (relating to estate tax returns of estates of nonresidents not citizens) to the amendment made by subsection (e) of section 8 of the bill by striking out "$2,000" and inserting in lieu thereof "$30,000". The effect of amended para- graph (2) is to require an estate tax return in the case of a nonresident not a citizen of the United States only if that part of his gross estate which is situated in the United States exceeds $30,000. (It) Clerical amendrnent.-Subsection (h) of section 8 of the bill amends the table of sections for subchapter B of chapter 11 of the code to include new sections 2107 and 2108 of the code, as added by section 8(f) of the bill. (i) Effective date.-Subsection (i) of section 8 of the bill provides that the amendments made by such section is to apply with respect to estates of decedents dying after the date of the enactment of the bill. SECTION 9 OF BILL. GIFT TAX OF NONRESIDENTS NOT CITIZENS (a) Imposition of tax.-Subsection (a) of section 9 of the bill strikes out subsection (a) of section 2501 of the code and inserts in its place a new subsection (a). Existing subsection (a) of section 2501 of the code provides that a tax, computed as provided in section 2502, is im- posed on the transfer of property by gift by any individual, whether resident or nonresident, except transfers of intangible property by a 785 PAGENO="0796" 120 FOREIGN INVESTORS TAX ACT OF 1966 nonresident not a citizen of the United States who was not engaged in business in the United States during the calendar year of the gift. Paragraph (1) of new section 2501 (a) provides that a tax, com- puted as provided in section 2502, shall be imposed on the transfer of property by gift by any individual, whether resident or nonresident. Paragraph (2) contains an exception to paragraph (1) by pro- viding that no gift tax shall be imposed on the transfer of intangible property by gift by any nonresident not a citizen of the United States. This exception applies whether or not the nonresident is engaged in business in the United States during the calendar year and even though the property is situated in the United States. Paragraph (3) withdraws the exception contained in paragraph (2.) in the case of gifts by an expatriate who lost U.S. citizenship (other than as a result of the application of sec. 301(b), 350, or 355 of the Immigration and Nationality Act) after March 8, 1965, and within the 10-year period ending with the date of transfer if such loss of U.S. citizenship had for one of its principal purposes the avoidance of U.S. income, estate, or gift tax. Accordingly, in the case of such an expatriate, the tax provided in section 2502 is imposed on the transfer of intangible property by gift (subject to the limitation with respect to situs contained in sec. 2511 (a) of the code). The tax will be imposed in such case irrespective of whether the donor is engaged in business in the United States during the calendar year. Sections 301(b), 350, and 355 of the Immigration and Nationality Act are discussed in con- nection with section 877(d), as added by section 3(e) of the bill. Paragraph (4) provides that, in determining whether a principal purpose for the loss of U.S. citizenship by an expatriate donor was the avoidance of U.S. income, estate, or gift tax, the Secretary of th~ Treasury or his delegate must first establish that it is reasonable to believe that the donor's loss of U.S. citizenship would, but for para- graph (3) of this subsection, result in a substantial reduction in his combined Federal and foreign gift taxes for the calendar year. In the absence of complete factual information, the Secretary or his delegate may make a tentative determination, based on the infor- mation available, that the decedent's loss of U.S. citizenship would, but for paragraph (3) of this subsection, substantially reduce his combined Federal and foreign gift taxes for the calendar year. Such tentative determination shall be sufficient to establish that it is reasonable to so believe, in the absence of a showing by the donor of the actual reduc- tion in such taxes resulting from his loss of U.S. citizenship. Such tentative determination may be based upon the fact that the laws of the country of which the donor became a citizen and the laws of the country of which the donor is a resident would ordinarily result, in the case of gifts by a person of the donor's citizenship and residence, in liability for gift taxes substantially lower than the amount of tax imposed by chapter 12 of the code on gifts by citizens of the United States. Once the Secretary or his delegate has established that it is reason- able to believe that the donor's loss of U.S. citizenship would, but for paragraph (3) of . this subsection, result in a substantial reduction in his combined Federal and foreign gift taxes for the calendar year, such expatriate donor must show that avoidance of U.S. income, estate, or gift tax was not a principal purpose of his loss of citizenship. 786 PAGENO="0797" FOREIGN INVESTORS TAX ACT OF 1966 121 (b) Transfers in general.-Subsection (b) of section 9 of the bill amends subsection (b) of section 2511 of the code, relating to the situs rule for stock in a corporation, to provide situs rules for stock in a. corporation and debt obligations. Since, under new section 2501 (a) (2), transfers of intangible property by `nonresidents not citizens of the United States are no longer subject to the gift tax unless the donor is an expatriate to whom new section 2501 (a) (3) applies, these situs rules apply only to transfers by such expatriates. They are~ in general, the same as the situs ~rules provided for estate tax purposes by. section 2104, as amended by section 8(c) of the bill, except that there is in new section 2511(b) no exception similar to that contained in new section 2104(c) with respect to debt obligations of a domestic corporation the interest on which would be treated as income from sources without the United States by reason of section 861 (a) (1) (B) of the code. Moreover, no exception is provided in section 2511 of the code comparable to that contained in section 2105(b), as amended by section 8(d) of the bill, with respect to deposits in certain foreign branches of domestic corporations. Accordingly, for gift tax purposes in the case of sttch expatriates, bank deposits with a domestic corporation are considered debt obliga- tions situated within the United States even though deposited with a foreign branch of the domestic corporation. Shares of stock issued by a foreign corporation and debt obligations of persons not described in new section 2511(b) (2) shall in no case be considered to be property situated in the United States for purposes of determining the gift tax of such expatriates.. (c) Effective date.-The amendments made by section 9 of the bill apply with respect to the calendar year 1967 and all calendar years thereafter. SECTION 10 OF BILL. TREATY OBLIGATIONS Section 10 of the bill provides that, if the application of any pro- visiOn of the bill would be contrary to a treaty obligation of the United States in force on the date of enactment of the bill, the treaty obligation is to prevail. For example, if an income tax corwention to which the United States is a party provides that the United States wifi tax individual residents or corporations of the other country only on income from sources within the United States, then, in the case of such residents or corporations who are entitled to the benefit so accorded by that convention, the provisions of section 871 (b), as amended by section 3(a) of the bill, and of section 882, as amended by section 4(b) of the bill, is to apply only to that income effectively connected with the conduct of a trade or business within the United States which is from sources within the United States. In such case the income from sources without the United States, which in the absence of the convention would be taxable, is to be excluded from gross income by reason of the treaty obligation and the provisions of section 894(a), as amended by section 5(a) of the bill. Section 10 also makes clear that, for such purposes, the extension of any beuefit provided by any amendment made by the bill is not to be considered as being contrary to any treaty obligation of the United States. Thus, for example, the benefit accorded by section 894(b), as 787 PAGENO="0798" 122 FOREIGN INVESTORS TAX ACT OF 1966 added by section 5(a) of the bill, is to apply notwithstanding the firsl sentence of section 10 of the bill and notwithstanding the provisions~ of section 7852(d) of the code (relating to treaty obligations). VI. CHANGES IN EXISTING LAW MADE BY THE BILL,. AS REPORTED In compliance with clause 3 of rule XIII of the Rules of the House of Representatives, changes in existing law made by the bill, as re- ported, are shown as follows (existing law proposed to be omitted is enclosed in black bracketh, new matter is printed in italic, existing: law in which no change is proposed is shown in roman): * INTERNAL REVENUE CODE OF 1954 Subtitle A-Income Taxes * * * * * * * CHAPTER 1-NORMAL TAXES AND SURTAXES * * * * * * * Subchapter A-Determination of Tax Liability * * * * * * * PART I-TAX ON INDIVIDUALS * * * * * * * SEC. 1. TAX IMPOSED. (a) RATES OF TAX ON INDIVIDUALS.- * * * * * * * (ci) NONRESIDENT ALIENS.-hL the case of a nonresident alien mdi- vidual, the tax imposed by subsection (a) shall apply as provided by~ section 871 or 877. ((d)] (e) CRoss REFERENCE.- For definition of taxable income, see section 63. * * * * * * * PART lI-TAX ON CORPORATIONS Sec. 11. Tax imposed. Sec. 12. Cross references relating to tax on corporations. SEC. 11. TAX IMPOSED. (a) CoRroii~rIoNs IN GENERAL.-A tax is hereby imposed for each taxable year on the taxable income of every corporation. The tax shall consist of a normal tax computed under subsection (b) and a surtax computed under subsection (c). (b) NORMAL TAx.-The normal tax is equal to the following per-- centage of the taxable income: 788 PAGENO="0799" FOREIGN INVESTORS TAX ACT OF 1960 123 (1) 30 percent, in the case of a taxable year beginning before January 1, 1964, and (2) 22 percent, in the case of a taxable year beginning after December 31, 1963. (c) StmTAx.-The surtax is equal to the following percentage of the amount by which the taxable income exceeds the surtax exemption for the taxable year: (1) 22 percent, in the case of a taxable year beginning before January 1, 1964. (2) 28 percent, in the case of a taxable year beginning after December 31,1963, and before January 1, 1965, and (3) 26 percent, in the case of a taxable year beginning after December 31, 1964. (d) SURTAx Exi~MrnoN.-For purposes of this subtitle, the surtax exemption for any taxable year is $25,000, except that, with respect to a corporation to which section 1561 (relating to surtax exemptions in case of certain controlled corporations) applies for the taxable year, the surtax exemption for the taxable year is the amount determined under such section. (e) ExcErlIoNs.-Subsection (a) shall not apply to a corporation subject to a tax imposed by- * (1) section 594 (relating to mutual savings banks conducting life insurance business), (2) subchapter L (sec. 801 and following, relating to insurance companies), or (3) subchapter M (sec. 851 and following, relating to regulated investment companies and real estate investment trusts)'(, or]. ((4) section 881(a) (relating to foreign corporations not en- gaged in business in United States).] (f) Foi~io~ G0RF0RATI0NS.-In the case of a foreign corporation, the tacii imposed by snbsectio'm (a) shall apply only a~s provided by section 88g. * ** * * * * * Subchapter B-Computation of Taxable Income * * * * * * * PART Ill-ITEMS SPECIFICALLY EXCLUDED FROM GROSS INCOME * * * * * * * SEC. 116. PARTIAL EXCLUSION OF DIVIDENDS RECEIVED BY INDI- VIDUALS. (a) EXCLUSION FROM GROSS INCOME.-Effective with respect to any taxable year ending after July 31, 1954, gross income does not include amounts received by an individual as dividends from domestic corpo- rations, to the extent that the dividends do not exceed $100. If the dividends receive in a taxable year exceed $100, the exclusion pro- vided by the preceding sentence shall apply to the dividends first received in such year. * * * ** * * ** * (,d) `CERTAIN NONRESIDENT ALIENS INELIGIBLE `FOR EXCLUSION.- [Subsection (a) does not apply to a nonresident alien individual with respect to whom a tax is imposed for the taxable year under section 789 PAGENO="0800" 124 FOREIGN INVESTORS TAX ACT OF 1966 `871(a)] In the case of a `nonresident alien individual,"subsection (a) shall apply only-' (1) in determining the tax imposed for the taxable year pur- suant to section 871 (b) (1) and only in respect of dividends which are effectively connected with the conduct of a trade or busines8 within the United States, or (~) in determining the tax imposed for the taxable year pur suant to section 877(b). * * * * * ` *, * SEC. 15.4. CROSS REFERENCES. ` (1) For definitions of "husband" and "wife", as used in section 152 (b)(4), see section 7701(a)(17). (2) For deductions of estates and trusts, in lieu of the exemptions under section 151, see section 642(b). (3) For exemptions of nonresident aliens, see section [873(d)] 873(b) (3). (4) For exemptions of citizens deriving income mainly from sources within possessions of the United States, see section 931(e). * * * * * * * PART VIII-SPECIAL DEDUCTIONS FOR CORPORATIONS * *, * " * * * SEC. 245. DIVIDENDS RECEIVED FROM CERTAIN FOREIGN CORPORA- TIONS. (a) GENERAL Rui~n.-In the case of dividends received from a for- eign corporation (other than a foreign personal holding company) which is subject to taxation under this chapter, if, for an uninterrupted period of not less than 36 months ending with the close of such foreign corporation's taxable year in which such dividends are paid (or, if the corporation has not `been in existence for 36 months at the close of such taxable year, for the period the foreign corporation has been in existence as of the close of such taxable year) such foreign corporation has been engaged in trade or business within the United States f and has derived 50 percent or more of its gross income from sources within the United States,] and if 50 percent or more of the gross income of such corporation from all sources for such period is effectively con- nected `with the conduct of a trade or. business within the United States, there shall be allowed as a deduction in the case of a corpora- tion- (`1) An amount equal to the percent (specified in section 243 for the taxable year) of the dividençls received out of its earnings and profits specified in paragraph (2) of the first sentence of sec- tion 316(a), `but such amount shall not exceed an `an~ount `which bears the same ratio to such percent of such dividends received' `out of such earnings and profits as the gross income of such foreign corporation'for the taxable year (from sources within the United States] which is effectively connected with the conduct of a trade or business within the United States bears to its gross income from all sources for such taxable year, and (2) An amount equal to the percent (specified in section 243 for the taxable year) of the dividends received out of that part of its earnings and profits specified in paragraph (1) of the first sentence of section 316 (a) accumulated after the beginning of 790 PAGENO="0801" FOREIGN INVESTORS TAX ACT OF 1966 125 such uninterrupted period, but such amount shall not exceed an amount which bears the same ratio to such percent of such divi- dends received out of such accumulated earnings and profits as the gross income of such foreign corporation (from sources within the United States], which is effectively connected with. the conduct of a trade or business within the United States, for the portion of such uninterrupted period ending at the beginning of such taxable year bears to its gross income from all sources for such portion of such uninterrupted period. For purposes of this subsection, the gross income of the foreign corpo- ration for any periOd before the first taxable year beginning after December 31, 1966, which is effectively connected with the conduct of a trade or business within the United States is an amount equal to the gross income for such period from sources within the United States. * * * * * * * Subchapter F-Exempt Organizations * * * * * * * PART Il-TAXATION OF BUSINESS INCOME OF CERTAIN EXEMPT ORGANIZATIONS * * * * * * * SEC. 512. UNRELATED BUSINESS TAXABLE INCOME. (a) DErINrrioN.-The term "unrelated business taxable income"* means the gross income derived by any organization from ~ny un~re- lated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed by this chapter which are directly connected with the carrying on of such trade or business, both com- puted with the exceptions, additions, and limitations provided in sub- section (b). In the case of an organization described in section 511 which is a foreign organization, the unrelated business taxable income shall be its unrelated business taxable income (derived from sources within the United States determined under subchapter N (sec. 861 and following, relating tg tax based on mcome from sources withm or without the United States)] which is effectively connected with the conduct of a trade or business within the United States. * * * * * * Subchapter G-Corporations Used To Avoid Income Tax on Shareholders * * * * * * * * PART Il-PERSONAL HOLDING COMPANIES * * * * ** * SEC. 542. DEFINITION OF PERSONAL HOLDING COMPANY. * * * * ** * * (c), ExCEPTI0N5.-The term "personal holding company" as define~i in subsection (a) does not include- * * * * * ** -* * * 71-297 0-67-pt. 1-51 791 PAGENO="0802" 126 FOREIGN INVESTORS TAX ACT OF 1966 ((7) a foreign corporation if- ((A) its gross income from sources within the United States for the period specified in section 861 (a) (2) (B) is less than 50 percent of its total gross income from all sources, and ((B) all of its stock outstanding during the last half of the taxable year is owned by nonresident alien individuals, whether directly or indirectly through other foreign cor- porations;] (7) a foreign corporation, if all of its stock outstanding during the last half of the taxable year is owned by nonresident alien individuals, whether directly or indirectly through foreign estates, foreign trusts, foreign partnerships, or other foreign corporations; * * * * * * * Subchapter L-Insurance Companies * *. * * * * * PART I-LIFE INSURANCE COMPANIES * * * * * * * Subpart E-Miscellaneous provisions * * * ** * * * SEC. 819. FOREIGN LIFE INSURANCE COMPANIES. ((a) CAimYr~G ON UNITED STATES INSURANCE BU5INESs.-A for- eign life insurance company carrying on a life insurance business within the United States, if with respect to its United States business it would qualify as a life insurance company under section 801, shall be taxable on the United States business of such company in the same manner as a domestic life insurance company.] ((b)] (a) ADYIJSTMENT WHERE SIJTRPLUS HELD IN UNITED STATES Is LESS THAN SPECIFIED MINIMUM.- (1) IN GENERAL.-In the case of any (company described in subsection (a)] foreign corporation taxable under this part, if the minimum figure determined under paragraph (2) exceeds the surplus held in the United States, then- (A) the amount of the policy and other contract liability requirements (determined under section 805 without regard to this subsection), and (B) the amount of the required interest (determined under section 809 (a) (2) without regard to this subsection), shall each be reduced by an amount determined by multiplying such excess by the current earnings rate (as defined in section 805(b) (2). (2) DEmNrnoNs.-For purposes of paragraph (1)- (A) The minimum figure is the amount determined by multiplying the taxpayer's total insurance liabilities on United States business by- (i) in the case of a taxable year beginning before Janu- ary 1, 1959, 9 percent, and (ii) in the case of a taxable year beginning after De- cember 31, 1958, a percentage for such year to be deter- mined and proclaimed by the Secretary or his delegate. 792 PAGENO="0803" FOREIGN INVESTORS TAX ACT OF 1966 127 The percentage determined and proclaimed by the Secretary or his delegate under clause (ii) shall be based on such data with. respect to domestic life insurance companies for the preceding taxable year as the Secretary or his delegate con- siders representative. Such percentage shall be computed on the basis of a ratio the numerator of which is the excess of the assets over the total insurance liabilities, and the de- nominator of which is the total insurance liabilities, (B) The surplus held in the TJinted States is the excess of the assets held in the United States over the total insurance liabilities on United States business. For purposes of this paragraph and subsection [(c)] (b), the term "total insurance liabilities" means the sum of the total re- serves (as defined in section 801(c)) plus (to the extent not in- cluded in total reserves) the items referred to in paragraphs (3), (4), and (5) of sectiOn 810(c). (3) REDUCTIoN OF SECTION 881 TAX.-ifl the case. of any foreign corporation taxable under this part, there shall be determined- (A) the amount which would be subject to tax under sec- tion 881 if the amount taxable under such section were deter- mined without regard to sections 103 and 894, and (B) the amount of the reduction provided by paragraph (1). The tax under section 881 (determined without regard to this paragraph) shall be reduced (but not below zero) by an amount which is the same proportion of such tax as the amount referred to in subparagraph (B) is of the amount referred to in sub- paragraph (A); but such reduction in tax shall not exceed the increase in tax under this part by reason of the reduction provided by paragraph (1). ((c)] (.b) DIsmIBUTI0NS TO SHAREHOLDERS.- (1) IN GENERAL.-In applying sections 802(b) (3) and 815 (for purposes of subsection (a)] with respect to a foreign corporation the amount of the distributions to shareholders shall be deter- mined by multiplying the total amount of the distributions to shareholders (within the meaning of section 815) of the foreign ~life insurance company] corporation by whichever of the follow- ing percentages is selected by the taxpayer for the taxable year: (A) the percentage which the minimum figure for the taxable year (determined `under subsection ((b)] (a) (2)- (A)) is of the excess of the assets of the company over the total insurance liabilities; or (B) the percentage which the total insurance liabilities on United States business for the taxable year is of the com- pany's total insurance liabilities. (2) DISTRIBUTIONS PURSUANT TO CERTAIN MUTUALIZATIONS.- In applying section 815(e) (for purpose of subsection (a)] with respect to a foreign corporation- (A) the paid-in capital and paid-in surplus referred to in section 815(e) (1) (A) of a foreign (life insurance company] corporation is the portion of such capital and surplus deter- mined by multiplying such capital and surplus by the per- 793 PAGENO="0804" 128 FOREIGN INVESTORS TAX ACT OF 1966 centage selected for the taxable year under paragraph (1); and (B) the excess referred to in section 81~5 (e) (2) (A) (i) (without the adjustment provided by section 815(e) (2) (B)) is whichever of the following is the greater: * (i) the minimum figure for 1958 determined under subsection ((b) 3 (a) (2) (A), or (ii) the surplus described in subsection ((b)] (a) () * (B) (determined as of December 31, 1958). [(d) No UNITED STATES INSURANCE BuSINESS.-Foreign life in- surance companies not carrying on an insurance business within the' United States shall not be taxable under this part but shall be taxable as other foreign corporations.] (c) CRoss REFERENCE.- For taxation of foreign corporations carrying on life insurance business within the United State8, see section 842. ** * * * * * * PART Il--MUTUAL INSURANCE COMPANIES (OTHER THAN LIFE AND CERTAIN MARINE INSURANCE COMPANIES AND OTHER THAN FIRE OR FLOOD INSURANCE COMPANIES WHICH OPERATE ON BASIS OF PERPETUAL POLICIES OR PREMIUM DEPOSITS) * * * *. * * * SEC. 821. TAX ON MUTUAL `INSURANCE COMPANIES TO WHICH PART * II APPLIES. * ** * * * * * ((e) No UN1m1 STATES INSURANCE BUSINES5.-Foreign mutual insurance companies (other than a life insurance company and other than a fire, flood, or marine insurance company subject to the tax imposed by section 831) not carrying on an insurance business within the United States shall not be subject to this part but shall be taxable as other foreign corporations.] ((f)] (e) SPI,IAL TRANSITIONAL UNDERWRITING Loss.- * * * * * * *: ((g)] (f) CROSS REFERENCES.- * * * * * (1) For exemption from tax of certain mutual insurance companies, see section 501(c)(15). (2) For alternative tax in case of capital gains, see section 1201(a). (3) For taxation of foreign corporations carrying on an insurance business within the United States, see 8ection 842. * ** * * * * * SEC. 822. DETERMINATION OF TAXABLE INVESTMENT INCOME. * * * * * * * * ((e) FOREIGN MUTUAL INSURANCE `COMPANIES OTHER THAN Lm'E OR MARINE.-Ifl the case of a foreign mutual insurance company (other than a life or marine insurance company or a fire insurance 794 PAGENO="0805" FOREIGN INVESTORS TAX ACT OF 1966 129 company subject to the tax imposed by section 831), the taxable invest- ment income shall be taxable income from sources within the Umted States (computed without regard to the deductions allowed by sub- section (c) (7)), and the gross amount of income from the items de- scribed in subsection (b) (other than paragraph (1) (D) thereof) and net premiums shall be the amount of such income from sources within the United States. In the case of a company to which the preceding sentence applies, the deductions allowed in this section shall be allowed to the extent .provided in subpart B of part II of subchapter N (sec. 881 and following) in the case of a foreign corporation engaged m trade or business within the United States.] ((f)] (e) DEirn~ITIoNs.-For purposes of this part- (1) NET PREMItTM5.-The term. "net premiums" means gross premiums (including deposits and assessments) written or re- ceived on insurance contracts during the taxable year less return premiums and premiums paid or incurred for reinsurance. Amounts returned where the amount is not fixed in the insurance contract but depends on the experience of the company or the discription of the management shall not be included in return premiums but shall be treated as dividends to policyholders under paragraph (2). (2). DIVIDENDS TO P0LICYHOLDERS.-The term "dividends to policyholders" means dividends and similar distributions paid or declared to policyholders. For purposes of the preceding sen- tence, the term "paid or declared" shall be construed according to the method regularly employed in keeping the books of the insurance company. * * * *. * * * PART Ill-OTHER INSURANCE COMPANIES Sec. 831. Tax on insurance companies (other th~m life or mutual), mutual marine insurance companies, and certain mutual * fire or flood insurance companies. Sec. 832. Insurance company taxable income. SEC. 831, TAX ON INSURANCE COMPANIES (OTHER THAN LIFE. OR MUTUAL), MUTUAL. MARINE INSURANCE COMPANIES, * AND CERTAIN MUTUAL FIRE OR FLOOD INSURANCE COMPANIES (a) IMPOSITION or TAx.-Taxes are computed as provided in section~ 11 shall be imposed for each taxable year on the taxable income of- * (1.) every insurance company .(other `than. a life or mutual insurance company), ~. . .(2) every mutual marine insuri~nce company, and*. (3) every mutual fire or flood insurance company- (A) exclusively issuing perpetual policies, ~r (B) whose . principal, business is the issuance of policies for which the premium deposits are the same, regardless of the length of the term for which the, policies are written, if the unabsorbed portion of such premium deposits not 795 PAGENO="0806" :130 FOREIGN INVESTORS TAX ACT OF 1966 required for losses, expenses, or establishment of reserves is returned or credited to the policyholder on cancellation or expiration of the policy. ((b) No UNITED STATES INSURANCE BusINEss.-Foreign insurance companies (other than a life or mutual insurance company), foreign mutual marine insurance companies, and foreign mutual fire insurance companies described in subsection (a), not carrying on an insurance business within the United States, shall not be subject to this part but shall be taxable as other foreign corporations.] ((e)] (14 ELEcTION FOR MuUrIr~n LINE COMPANY To BE TAXED ON TOTAL INCOME.- (1) IN GENERAL.-Any mutual insurance company engaged in writing marine, fire, and casualty insurance which for any 5-year period beginning after December 31, 1941, and ending before January 1, 1962, was subject to the tax imposed by section 831 (or the tax imposed by corresponding provisions of prior law) may elect, in such manner and at such time as the Secretary or his delegate may by regulations prescribe, to be subject to the tax imposed by section 831, whether or not marine insurance is its predominant source of premium income. (2) EFFECT OF ELECTION.-If an election is made under paragraph (1), the electing company shall (in lieu of being sub- ject to the tax imposed by section 821) be subject to the tax im- posed by this section for taxable years beginning after December 31, 1961. Such election shall not be revoked except with the consent of the Secretary or his delegate. ((d) ALTERNATIVE TAX ON CAPITAL GAINS.- (For alternative tax in case of capital gains, see section 1201(a).] (c) Ciwss REFERENCES.- (1) For alternative tax in case of capital gains, see section 1201(a). (2) For taxation of foreign corporations carrying on an insurance business within the United States, see section 8~2. SEC. 832. INSURANCE COMPANY TAXABLE INCOME. *. * * * * * * ((d) TAXABLE INCOME OF FOREIGN INSURANCE COMPANIES OTHER THAN Li~r~ OR MIJTIJAL AND FOREIGN MUTUAL EARINE.-In the case of a foreign insurance company (other than a life or mutual insurance company), a foreign mutual marine insurance company, and a foreign mutual fire insurance company described in section 831(a), the taxable income shall be the taxable income from sources within the United States. In the case of a company to which the preceding sentence applies, the deductions allowed in this section shall be allowed to the extent provided in subpart B of part II of subchapter N (sec. 881 and following) in the case of a foreign corporation engaged in trade or business within the United States.] ((e)] (d) DOUBLE DEDtrci'ioNs.-Nothing in this section shall permit the same item to be deducted more than once. * * * * * * 796 PAGENO="0807" FOREIGN INVESTORS TAX ACT OF 1966 131 PART IV-PROVISIONS OF GENERAL APPLICATION Sec. 841. Credit for foreign taxes. (Sec. 842. Computation of gross income.] Sec. 842. Foreign corporations carrying on insurance business. Sec. 843. Annual accounting period. SEC. 841. CREDIT FOR FOREIGN TAXES. The taxes imposed by foreign countries or possessions of the United States shall be allowed as a credit against the tax of a domestic insur-. ance company subject to the tax imposed by section 802, 821, or 831, to the extent provided in the case of a domestic corporation in section 901 (relating to foreign tax credit). For purposes of the preceding sen- tence (and for purposes of applying section 906 with respect to a for- eign corporation subject to tax under this subchapter), the term "taxable income" as used in section 904 means- (1) in the case of the tax imposed by section 802, the life insur- ance company taxable income (as defined in section 802(b)), (2) in the case of the tax imposed by section 821(a), the mutual insurance company taxable income (as defined in section 821(b)); and in the case of the tax imposed by section 821(c), the taxable investment income (as defined in section 822(a) ), and (3) in the case of the tax imposed by section 831, the taxable income (as deflned.in section 832(a)).' [SEC. 842. COMPUTATION OF GROSS INCOME. ~The gross income of insurance companies subject to the tax im- posed by section 802 or 831 shall not be determined in the manner provided in part I of subchapter .N (relating to determination of sources of income).] SEC. 8~2. FOREIGN CORPORATIONS CARRYING ON INSURANCE BUSINESS. If a foreign corporation carrying on an insurance bnsine.ss within the United States would qualify under part I, II, or III of this subchapter for the taxable year if (without regard to income not effectively con- nected with `the conduct of any trade or business within the United States) it were a domestic corporation, such corporation s/tall be tax- able under such part on its income effectively conn~cted with its con- duct of any trade or bwsiness within the United States. With respect to the remainder of its income, which is from sources within the United States. such a foreign corporation shall `be taxable as provided in sec- tion 881. * * * * * * * Subchapter N-Tax Based on Income From Sources Within or Without the United States Part I. DetermInation of sources of income. Part II. Nonresident aliens and foreign corporations. Part III. Income from sources without the United States. PART I-DETERMINATION OF' SOURCES OF INCOME Sec. 861. Income from sources within the United States. Sec. 862. Income from sources without `the United States. Sec. 863. Items not specified in section 861 or 862. Sec. 864. Definitions. 797 PAGENO="0808" 132 FOREIGN INVESTORS TAX ACT OF 1966 SEC. 861. INCOME FROM SOURCES WITHIN THE UNITED STATES. (a) GROSS INco~ FROM SOURCES WITHIN UNITED STATES.-The followmg items of gross income shall be treated as income from sources within the United States: (1) JNTEREsT.-Interest from the United States, any Territory, any political subdivision of a Territory, or the District of Colum- bin, and interest on bonds, notes, or other interest-bearing obliga- gations of residents, corporate or otherwise, not including- ((A) interest on deposits with persons carrying on the banking business paid to persons not engaged in business within the United States,] (A) interest on amounts described in subsection (c) re- ceived by a nonresident aliert individual or a foreign corpora- tion, if such interest is not effectively connected with the conduct of a trade or business within the United States, (B) interest received from a resident alien individual, a resident foreign corporation, or a domestic corporation, when it is shown to the satisfaction of the Secretary or his delegate that less than 20 percent of the gross income of such resident payor or domestic corporation has been derived from sottrces within the United States, as determined under the privisions of this part, for the 3-year period ending with the close of the taxable year of such payor preceding the payment of such interest, or for such part of such period as may be applicable, (and] (0) income derived by a foreign central bank of issue from bankers' acceptances(.], and (D) interest on deposits with a foreign branch of a domestic corporatiov, if such branch is engaged in the com- mercial banking business. (2) DIVIDENDS.-The amount received as dividends- (A) from a domestic corporation other than a corporation entitled to the benefits of section 931, and other than a corporation less than 20 percent of whose gross income is shown to the satisfaction of the Secretary or his delegate to have been derived from sources within the United States, as determined under the provisions of this part, for the 3-year period ending with the close of the taxable year of such corporation preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence, or * (B) from a foreign corporation unless less than (50] 80 percent of the gross income from all sources of such foreign corporation for the 3-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was (derived from sources] effectively connected with the conduct of a trade or business within the United * States (as determined under the provisions of this part]; but only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period (derived from sources] which is effectively connected 798 PAGENO="0809" FOREIGN INVESTORS TAX ACT OF 1966 133 with the conduct of a trade or business within the United States bears to its gross income from all sources; but divi- dends from a foreign corporation shall, for purposes of sub- part A of part III (relating to foreign tax credit), be treated as income from sources without the United States to the extent (and only to the extent) exceeding the amount which is 100/85ths of the amount of the deduction allowable under section 245 in respect of such dividends, or (C) from a foreign corporation to the extent that such amount is required by section 243(d) (relating to certain dividends from foreign corporations) to be treated as divi- dends from a domestic corporation which is subject to taxa- tion under this chapter, and to such extent subparagraph. (B) shall not apply to such amount. For purposes of subparagraph (B), the gross income of. the for- eign corporation for any period before the first taxable year be- ginning after December 31, 1966, which is effectively connected with the conduct of a trade or business within the United States is an amount equal to the gross income for such period from sources within the United States. (3) PERSONAL sERvIcEs.-Compensation for labor or personal services performed in the United States; except that compensation for labor or services performed in the United States shall not be deemed to be income from sources within the United States if- (A) the labor or services are performed by a nonresident alien individual temporarily present in the. United States for a period or periods not exceeding a total of 90 days during the taxable year, (B) such. compensation does not exceed $3,000 in the ag- gregate, and (C) the compensation is for labor or services performed as an employee of or under a contract with- (i) a nonresident alien, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or (ii) an individual who is a citisen or resident of the United States, a domestic partnership, or a domestic corporation, if such labor or services are performed for an office or place of business maintained in a foreign country or in a possession of the United States by such individual, partnership, or corporation. (4) RENTALS AND RorArJrIEs.-Rentals or royalties from prop- erty located in the United States or from any interest in such property, including rentals or royalties for the use of or for the privilege of using in the United States patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and `other like property.. (5) SALE OF REAL PROPERTY.-GainS, profits, and income from the sale of real property located in the United States. (6) SALE OF PERSONAL PRoPErrrY.-Gains, profits, and inèome derived from the purchase of personal property without the United States (other than within a possession of *the United States) and its sale within the United States. 799 PAGENO="0810" 134 FOREIGN INYESTORS TAX ACT OF* 1966 (b) TAXABLE INCOME FROM SotmcEs WITHIN UNITED STATES.- From the, items of gross income specified in subsection (a) as being. income from sources within the United States there shall be deducted the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part `of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as taxable income from sources wi'thin the United States. (c) INTEREST ON DEPOSITS, ETC.-FOr purposes of subsection (a) (1) (A), the anwurtts described in this subsection are- (1) deposits with persons carrying on the banking business, (2) deposits or wit hdrawable accounts with savings institutions chartered and supervised as savings and loan or sim~ilar associa- tions under Federal or State law, but only to the extent that amounts paid or credited on such deposits or accounts are dedueti- ble wnder section 591 in ccnmputing the taxable income of such institutions, and (3) amounts held by an insurance company under an agree- ment to pay interest thereon. Effective with respect to amounts paid or credited after December 31, 1971, subsection (a) (1) (A) and~ this subsection shall cease to apply. SEC. 862. INCOME FROM SOURCES WITHOUT THE UNITED STATES. (a) GROSS INCOME FROM SouacEs WITHOUT UNITED STATES.-The following items of gross income shall be treated as income from sources without the United States: (1) interest other than that derived from sou'rces within the United Sta'tes as provided in section 8.61 (a) (1); (2) dividends other than those derived from sources within the United States as provided in section 861 (a) (2); (3) compensation for labor or personal services performed without the United States; (4) rentals or royalties from property located without the United States or from any interest in such proj~erty, including rentals or royalties for the use of or for the privilege of using without the United States patents, copyrights, secret processes and formulas, good will, trade-marks, trade brands, franchises, and other like properties; (5) gains, profits, and income from the sale of real property located without the United States; and (6) gains, profits, and income derived from the purchase of personal property within the United States and its sale without the United States. (b) TAXABLE INCOME FROM SOURCES WITHOUT UNITED STATES.- From the items of gross income specified in subsection (a) there shall be `deducted the expenses, losses, and other deductions properly apportioned or allocated thereto, and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be treated in full as taxable income from sources without the Unite.d States. 800 PAGENO="0811" FOREIGN INVESTORS TAX ACT. OF 1966 135. SEC. 863. ITEMS NOT SPECIFIED IN SECTION 861 OR 862. (a) ALLOCATION UNDER REGTJIATI0N5.-Ttems of gross income, expenses, losses, and deductions, other than those specified in sections 861 (a) and 862(a), shall be allocated or apportioned to sources within or without the United States, under regulations prescribed by the Secretary. or his delegate. Where items of gross income are separately allocated to sources within the United States, there shall be deducted (for the purpose of computing the* taxable income therefrom) the expenses, losses, and other deductions properly apportioned or allo- cated thereto and a ratable part of other expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. The remainder, if any, shall be included in full as taxable income from sources within the United States. (b) INCOME PARTLY FROM WITHIN AND PARTLY FROM WITHOUT THE UNITED STATEs.-In the case of gross income derived from sources partly within and partly without the United States, the taxable income may first `be computed by deducting the expenses, losses, or other deductions apportioned or allocated thereto and a ratable part of any expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income; and the portion of such taxable income attributable to sources within the United States may be determined by processes or formulas of general apportionment prescribed by the Secretary or his delegate. Gains, profits, and income-. (1) from transportation or other services rendered partly within and partly without the United States, (2) from the sale of personal property produced (in whole or in part) by the taxpayer within and sold without the United States, or produced. (in whole or in part) by the taxpayer without and sold within the United States, or (3) derived from the purchase of personal property within a possession of the United States and its sale within the United States, shall be treated as derived partly from sources within and partly from sources without the United States. SEC. 864. DEFINITIONS. (a) SALE, Erc.-For purposes of this part, the word "sale" includes "exchange"; the word "sold" includes "exchanged"; , and the word "produced" includes "created", "fabricated", "manufactured", "ex- tracted", "processed", "cured", or "aged". (b) TRADE OR BUSINESS WITHIN THE UNITED' STATES.-FOr pur- pose.s of this part, part II, and chapter 3, the termS "trade or business within the United States" includes the performance of personal sern'- ices within the United States at any tim;e within the taceable year, but does not include- (1) PERFORMANCE OF PERSONAL SERVICES FOR FOREIGN EM-' PLOVER .-Tlie performance of personal services- (A) for a nonresident alien individual, foreign partner- ship, or foreign corporation, not engaged in trade or business within the United States. or (B). for an offIce or place of business maintained in a for- eign country or in a possession of the United States by an 801. PAGENO="0812" 136 FOREIGN INVESTORS TAX ACT OF 1966 individual who is a citicen or resident of the United States or 1y a domestic partnership or a domestic corporations by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days dur- ing the taxable year and whose compensation for such services does not exceed in the aggregate $3,000. (2) TRADING IN SECURITIES OF COMMODITIES.- (A) Sroczs ANtD SECURITIES.- (i) Except in the case of a dealer in stocks or securities, trading in stocks or securities for the taxpayer's own ac- count, whether by the taxpayer or his employees or through a resident broker, commdssion agent, oustodian, or other agent, and whether or not any such agent has dis- cretionary authority to make decisions in effecting the transactions. This clause shall not apply in the case of a corporation (other than a corporation which is, or but for section 542(c) (7) would be, a personal holding company) the principal business of which is trading in stocks or securities for its own account, if its principal office is in the United States. (ii) In the case of a person who is a dealer in stocks or securities, trading in stocks or securities for his own as- count through a resident broker, commission agent, cus- todian, or other independent agent. (B) COMMODITIES.- (i) Except in the case of a dealer in commodities, trad- ing in commodities for the taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, cOmmission agent, custodian, or other agent, and whether or not any such agent has discretion- ary authority to make decisions in effecting the trans- actions. (ii) In the case of a person who is a dealer in com- modities,. trading in commodities for his own account through a resident broker, commission agent, custodian, or other independent agent. (iii) Clauses (i) and (ii) apply only if the commod- ities are of a kind customarily dealt in on aim or,qanieed commodity exchange and if the transaction is of a kind customarily consummated at such place. (CI) LIMITATION .-Subpara.qra phs (A)(ii) and (B)(ii) shall apply only if, at no time during the taxable year, the tax- payer has an office or place of business in the United States through which or by the direction of which the tratnsactions in stocks or securities, or in commocZities, as the case ma~j be are effected. (C)EFFECTIVELY CONNECTED INCOME, Erc.- (1) GENERAL RULE.-FOr purposes of this title-. (A) In the case of a nonresident alien individual or a for- eign corporation engaged in trade or business within the United States during the taxable year, the rules set forth in paragraphs (93) , (3), and (4) shall apply in determining the 802 PAGENO="0813" FOREIGN INVESTORS TAX ACT OF 1966 137 income, gain, or loss which shall be treated as effectively con- nected with the conduct of a trade or business within the United States. (B) E~vcept as provided in section 871(d) or section 882 (d), in the case of a nonresident alien individual or a foreign corporation not engaged in trade or business within the United States during the taceable year, no i'iwoir&e, gain, or loss shall be treated as effectively connected with. the conduct of a trade or business within the United States. (2) PEI~IoDIcAL, ETC., INCOME FROM SOURCES WITHIN UNITED STATES-FAcT0R5.-----In determining whether income from sources within the United States of the types described in section 871 (a) (1) or section 881 (a), or whether gain or loss from sources within the United States from the sale or exchange of capital assets, is effectively connected with the conduct of a trade or bwsi- ness within the United States, the factors taken into account shall include whether-. (A) the income, gain, or loss is derlived from assets used in or held for use in the conduct of suchtrade or business, or (B) the activities of such trade or business were a material factor in the realization of the income, gain, or loss. In determining whether, an asset is used in or held for `use in the conduct of such trade or business or whether the activities of such trade or business were a material factor in realizing an item :of income, gain, or loss, due regard shall be given to whether or not such asset or such income, gain, or loss was accounted for through such trade or business. In applying this paragraph and para- graph (4), interest referred to in section 861(a) (1) (A) shall be considered income from sources within the United States. - (3) OTHER INCOME FROM SOURCES WITHIN UNITED STATES .-All income, gain, or loss from sources within the United States (other than income, gain, or loss to which paragraph (2) applies) s/tall be treated as effectively contneoted with the cth-tduct of a trade or business within the United State~. (4) INCOME FROM SOURCES WITHOUT UNITED STATES.- (A) Except as provided in subparagraph (B) and (C), no income, gain, or loss from sources. without the United States shall be treated as effectively comioected with the `con- duct of a trade or business within the United States. (B) Income, gain, or loss from sources. without the United States shall be treated as effectively connected with the conduct of a trade or business within the United Stases by a nonresident alien -z~ndividual or a foreign corporation if such person has an office or other fixed plüee of business within the United States to which such income, gain, or loss is attributable and such income, gain, or loss- (i) consists of rents or royalities for the `use of or for the privilege of using intangible property described in section 862(a) (4) (including any gain or loss realized on the sale of such property) derived in the active conduct of such trade or business; (ii) consists of dividends or i~nterest, or gain or~ loss from the sale of exchange of stock or notes, bonds, 803 PAGENO="0814" 138 FOREIGN INVESTORS TAX ACT OF 1966 or other evidences of indebtedness, and either is derived in the active conduct of a banking, financing, or similar business within the United States or is re- ceived by a corporation the principal business of which is trading in stock or securities for its own account: or (iii) is derived from the sale (without the United States) through such office or fixed place of business of personal property described in section 1~321 (1), except that this clause shall not apply if the property is sold for use, consumption, or disposition outside the United States and an office or other fixed place of bw9i- ness of the taxpayer outside the United States parti- cipated materially in such sale. In the case of a sale described in clause (iii), the income which shall be treated as attributable to the office or other fixed place of business within the United States shall not exceed the income which would be derived from sources within the United States if the sale were made in the United States. (C) In the case of a foreign corporation taxable under part I of subchapter L, any income from sources without the United States which is attributable to its United States busi- ness shall be treated as effectively connected with the conduct of a trade or business within the United States. (D) No income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States i/it either- (i) consists of dividends, interest, or royalties paid by a foreign corporation in which the taxpayer owns (within the weaning of section 958(a)), or is considered as owning (by applying t4e ownership rules of section 958(b)), more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or (ii) is subpart F income within the meaning of sec- tion95~(a). PART Il-NONRESIDENT ALIENS AND FOREIGN CORPORATIONS Subpart A. Nonresident alien individuals. Subpart B. Foreigfi corporations. Subpart C.. Miscellaneous provisions. SUBPART A-NONRESIDENT ALIEN INDIVIDUALS Sec. 871. Tax on nonresident alien individuals. Sec. 872. Gross income. Sec. 873. Deductions. Sec. 874. Allowance of deductions and credits. Sec. 875. Partnerships. Sec. 876. Alien residents of Puerto Rico. sec. 877. Ecrpatriationto avoid tacv. Sec. [877] 878. Foreign educational, chartiable, and certain other exempt organizations. 804 PAGENO="0815" FOREIGN INVESTORS TAX ACT OF 1966 139 SEC. 871. TAX ON NONRESIDENT ALIEN INDIVIDUALS. ((a) No TIN ITED STATES BusINEss-30 PERCENT TAX.- ((1) IMPOSITION OF TAX.-ExCept as, otherwise provided in subsection (b) there is hereby imposed for each taxable year, in lieu of the tax imposed by section 1, on the amount received, by every nonresident alien individual not engaged in trade or business within the United States, from sources within the United States, as interest (except interest on deposits with persons carrying on the banking business), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits, and income (including amounts described in section 402(a) (2), section 403 (a) (2), section 631 (b) and (c), and section 1235, which are, considered to be gains from the sale or exchange of capital assets), a tax of 30 percent of such amount. ((2) CAPITAL GAINS OF ALIENS TEMPORARILY PRESENT IN THE UNITED sTAms.-In the case of a nonresident alien individual not engaged in trade or business in the United States, there is hereby imposed for each taxable year, in addition to the, tax imposed by paragraph (1)- ((A) if he is present in the United States for a period or periods aggregating less than 90 days during such taxable year-a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from sales or exchanges of capital assets effected during his presence in the United `States exceed his losses, allocable to sources within the United States, from such sales or exchanges effected during such presence; or ((B) if he is present in the United `States for a period or periods aggregating 90 days or more during such taxable year-a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from sales or exchanges of capital assets effected at any time during such year exceed his losses, allocable to sources within the United States, from such sales or exchanges effected at any time during such year. For purposes of this paragraph, gains and losses shall be taken into account only if, and to the extent that, they would be rec- ognized and taken into account if such individual were engaged in trade or business in the United States, except that such gains and losses shall be computed without regard to section 1202 (relating to deduction for capital gains) and such losses shall be determined without the `benefits of the capital loss carryover pro- vided in section 1212.] (a) INCOME NOT CONNECTED WITH UNITED STATES BUSINESS- 3OTPERCENT TAX.- (1) INCCME OTHERI THAN CAPITOL GAINS.-There is hereby im- posed for each taaiable year a ta.ci~ of 80 percent of t.e amount re- ceived from sources within the United States by a nonresident alien individual as- (A) interest, dividends, rents, salaries, wages, premium~s, anviuities, coni4pensations, remunerations, emolwments, and 805 PAGENO="0816" 140 FOREIGN INVESTORS TAX ACT OF 1966 other ficved or determinable annual or periodical gains, profits, and income, (B) gains described in section 401 (a) (2), 403(a) (2), or 631 (b) or (c), and gains on transfers described in section 1235, a,nd (C) amounts which under section 341, or under section 1232 (in the case of bonds or other evidences of indebtedness issued after September 28,1965, are treated as gains from. the sale or exchange of property which is not a capital asset. but only to the e~~vtent the amounts so received is not effectively connected with the conduct of a trade or business within the United States. (2) CAPITAL GAINS OF ALIENS PRESENT IN THE UNITED STATES 183 DAYS OR MORE.-In the. case of a nonresident alien individual present in the United States for a period or periods aggregating 183 days or more during the taxable year, there is hereby imposed for such year a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from the sale or exchange at any time during such year of capital assets exceed his losses, allocable to sources within the United States, from the sale or exchange at any time during such year of capital assets. For purposes of this paragraph, gains and losses shall be taken into account only if, and to the extent that, they would be recognized and taken into account if such gains and losses were effectively connected with the conduct of a trade or business within the United States, except that such gains and losses shall be deter- mined without regard to section 1202 (relating to deduction for capital gains) and such losses shall be determined without the benefits of the capital loss carryover provided in section 1212. Any gain or loss which is taken into account in determining the tax under paragraph (1) or subsection (b) shall not be taken into account in determining the tax under this paragraph. For pur- poses of the 183-day requirement of this paragraph, a nonresident alien individual not engaged in trade or business* within the United States who has not established a taxable year for any prior period shall be treated as having a taxable year which is the calendar year. ((b) No UNITED STATES BUSINESS-AEGULAR TAx.-A non-resident alien individual not engaged in trade or business within the United States shall be taxable without regard to subsection (a) if during the taxable year the sum of the aggregate amount received from the sources specified in subsection (a) (1), plus the amount by which gains from sales or exchanges of capital assets exceed losses from. such sales or exchanges (determined in accordance with subsection (a) (2) is more than $19,000 in the case of a taxable year beginning in 1964 or more than $21,200 in the case of a taxable year begiuning after 1964, except that- * ((1) the gross income shall include only income from the sources specified in subsection (a) (1) plus any gain (to the extent provided in subchapter P; sec. 1201 and following, relating to capital gains and losses) from a sale or exchange of a capital asset if such gain would be taken into account were the tax being determined under subsection (a) (2); 806 PAGENO="0817" FOREIGN INVESTORS TAX ACT OF 1966 141 [(2) the deductions (other than the deduction for charitable contributions and gifts provided in section 873(c)) shall be al- lowed only if and to the extent that they are properly allocable to the gross income from th6 sources specified m subsection (a), except that any loss from the sale or exchange of a capital asset shall be allowed (to the extent provided in subchapter P without the benefit of the capital loss carryover provided in section 1212) if such loss would be taken into account were the tax being de- termined under subsection (a) (2). [If (without regard to this sentence the amount of the taxes imposed in the case of such an individual under section 1 or under section 1201(b), minus the credit under section 35, is an amount which is less than 30 percent of the sum of- [(A) the aggregate amount received from the sources specified in subsection (a) (1) plus [(B) the amount, determined under subsection (a) (2), by which gains from sales or exchanges of capital assets exceed losses from such sales or exchanges, then this subsection shall not apply and subsection (a) shall apply. For purposes of this subsection, the term "aggregate amount received from the sources specified in subsection (a) (1)" shall be applied without any exclusion under section 116. ((c) TJ~m~ STATES Bus~~ss.-A nonresident alien individual en- gaged in trade or business within the United States shall be taxable without regard to subsection (a). For purposes of part I, this sec- tion, sections 881 and 882, and chapter 3, the term "engaged in trade or business within the United States" includes the performance of personal services within the United States at any time within the taxable year, but does not include the performance of personal services- [(1) for a nonresident alien individual, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or [(2) for an office or place of business maintained by a domestic corporation in a foreign country or in a possession of the United States, by a nonresident `alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year and whose compensation for such services does not exceed in the aggregate $3,000. Such term does not include the effecting, through a resident broker, commission agent, or custodian, of transactions in the United States in stocks or securities, or in commodities (if of a kind customarily dealt in on an organized commodity exchange, if the transaction is of the kind customarily consummated at such place, and if the alien, partnership, or corpo- ration has no office or place of business in the United States at any time during the taxable year through which or by the direction of which such transactions in commodities are effected).] (b) IivcloME CONNECTED WITH UNITED STATES BuSINESS-GRADu- ATED.RATE OF TAX.- (1) IMPOSITION OF TAI.-A nonresident alien individual en- gaged in trade or bvsivess within the United States during the taxable year shall be taxable as provided in section 1 or 1201(b) 807 71-297 0-67-pt. 1-52 PAGENO="0818" 142 FOREIGN INVESTORS TAX ACT OF 1966 on his taxable income which is effectively connected with the con- duct of a trade or business within the United States. (2) DETERMINATION OF TAXABLE INCOME.-In determining tax- able income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct of a trade `or business within the United States. ((d)] (c) PARTICIPANTS IN CERTAIN EXCHANGE OR TRAINING PROGRAMS.-FOr purposes of this section, a nonresident alien indi- vidual who (without regard to this subsection) is not engaged in trade or business within the United States and who is temporarily present in the United States as a nonimmigrant under subparagraph (F) or (J) of section 101 (a) (15) of the Immigration and Nationality Act, as amended (8 U.S.C. 1101 (a) (15) (F) or (J)), shall be treated as a nonresident alien individual engaged in trade or business within the United States, and any income described in section 1441(b) (1) or (2) which is received by such individual shall, to the extent derived from sources within the United States, be treated as effectively con- nected with the conduct of a trade or business within the United States. (d) ELECTION To TREAT REAL PROPERTY INCOME AS INCOME CON- NECTED WITH UNITED STATES BUSINESS.- (1) IN GENERAL.-A nonresident alien individual, who during the taxable year derives any income- (A) from real property held for the production of income and located in the United States, or from any interest in * such real property, including (i) gains from the sale or ex- change of such real property or an interest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and (B) which, but for this subsection, would not be treated as income which is effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or busi- ness within the United States. In such case, such income shall be taxable as provided in subsection (b) (1) whether or not such in- dividual is engaged in trade or business within the United States during the taxable year. An election under this paragraph for any taxable year shall remain in effect for all subsequent taxable years, except that it may be revoked with the consent of the Sec- reta~y or his delegate with respect to any taxable year. (2) ELECTION AFTER REVOCATION.-IJ an election has been made under paragraph (1) and such election has been revoked, a new election may not be made under such paragraph for any taxable year before the 5th taxable year which begins after the first tax- able year for which such revocation is effective, unless the Secre- tary or his delegate consents to such new election. (3) FORM AND TIME OF ELECTION AND REVOCATION.-A'fl election under paragraph (1), and any revocation of such an election, may be made only in such manner and at such time as the Secretary or his delegate may by regulations prescribe. (e) CROSS REFERENCES.-' 808 PAGENO="0819" FOREIGN INVESTORS TAX ACT OF 1966 143 ((2)] (1) For tax treatment of certain amounts distributed by the United States to nonresident alien individuals, see section 402(a) (4). (2) For taxation of nonresident alien individuals who are expatriate United States citizens, see section 877. ((1)] (3) For doubling of tax on citizens of certain foreign countries, see section 891. (ft) For reinstatement of pre-1967 income tax provisions in the case of residents of certain foreign countries, see section 896.. (5) For withholding of tax at source on nonresident alien individuals, see section 1~t11. (6) For the requirement of making a declaration of estimated tax by certain nonresident alien individuals, see section 6015(i). (7) For taxation of gains realized upon certain transfers to domestic corporations, see section 1250(d)(3). SEC. 872. GROSS INCOME. (a) GENERAL RULE.-ln the case of a nonresident alien individual, gross income includes only- (1) Ithe] gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade. or business within the United States, and (~) gross income which is effectively connected with the con- duct of a trade or business within the United States. (b) ExcbusIoNs.-The following items shall not be included in gross income of a nonresident alien individual, and shall be exempt from taxation under this subtitle: (1) SHIPs tTNDER FOREIGN FLAG.-Earmngs derived from the operation of a ship or ships documented under the laws of a foreign country which grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. (2) AIRCRAFT OF FOREIGN REGISTRY.-Earmngs derived from the operation of aircraft registered under the laws of a foreign country which grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. (3) COMPENSATION OF PARTICIPANTS IN CERTAIN EXCHANGE OR TRAINING FR0GRAMs.-Compensation paid by a foreign employer to a nonresident alien individual for the period he is temporarily present in the United States as a. nonimmigrant under subpara- graph (F) or (J) of section 101(a) (15) of the immigration and Nationality Act, as amended. For purposes of this para- graph, the term "foreign employer" means- (A) a nonresident alien individual, foreign partnership, or foreign corporation, or (B) an office or place of business maintained in a foreign country or in a possession of the United States by a domestic ~corporation] corporation, a domestic partnership, or an individual who is a citizen or resident of the United States. (4) Bozen INTEREST OF RESIDENTS OF THE RYUKYU ISLANDS OR THE TRUST TERRITORY OF THE PACIFIC ISLANDS.-Income derived by a nonresident alien individual from a series E or series if United States savings bond, if such individual acquired such bond while a resident of the Ryuleyu islands or the Trust Ter- ritorij of the Pacific Islands. 809 PAGENO="0820" 144 FOREIGN INVESTORS TAX ACT OF 1966 SEC. 873. DEDUCTIONS. ((a) GENERAL RtTLE.-In the case of a nonresident alien individual the deductions shall lie allowed only if and to the extent that they are connected with income from sources within the United States; and the proper apportionment and allocation of the deductions with re- spect to sources of income within and without the United States shail be determined as provided in part I, under regulations prescribed by the Secretary or his delegate. ((b) LOSSES.- ((1) The deduction, for losses not connected with the trade or business if incurred in transactions entered into for profit allowed by section 165(c) (2) (relating to losses) shall be allowed whether or not connected with income from sources within the United States, but only if the profit, if such transaction had resulted in a profit, would be taxable under this subtitle. ((2) The deduction for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c) (3), shall be allowed whether or not connected with income from sources within the United States, but only if the loss is of property within the United States. ((c) CHARITABLE C0NnanurloNs.-The deduction for charitable contributions and gifts provided by section 170 shall be allowed whether or not connected with inôome from sources within the United States, but only as to contributions or gifts made to domestic corpora- tions, or to community chests, funds, or foundations, created in the United States. ((d) PERSONAL ExEMPrI0N.-In the case of a nonresident alien individual who is not a resident of a contiguous country, only one exemption under section 151 shall be allowed as a deduction. ((e) STANDARD DEDUCTION.- (For disallowance of standard deduction, see section 142(b) (1).] (a) GENERAL RULE.-In the case of a nonresident alien individual. the dediuctions shall be allowed only for purposes of section 871(b) and (except as prorided by subsection (b)) only if and to the extent that they are connected with inco~ime wihich is effectirely connected wit/i- the conduct of a trade or business within the Unlted States; anti the proper apportionment and allocation of the deductions for this purpose shall be determ%ned as prorided in regulations prescribed by the Secretary o'rhis delegate. (b) ExcEPrIoNs.-The following deductions shall be allowed whether or not they are connected with income which is effectively connected with the conduct of a trade or business within the United States: (1) LOSSEs.-The deduction, for losses of property not con- nected with the trade or business if arising from~ certain casualties or theft, allowed by section 165(c) (3), but only if the loss is of property located within the United States. (~) (JEARITABLE C0NTRIBUTIONS.-The deduction for charitable contributions and gifts allowed by section 170. (3) PERSONAL EXEMPTI0H.-The deduction for personal ex- em1ptiorie allowed by section 151, except that in the case of a `non- 810 PAGENO="0821" FOREIGN INVESTORS TAX ACT OF 1966 145 resident alien individual who is not a resident of a contiguous country o~nk,' one exem~ption shall be allawed under section 151. (c) CRoss REFERENCES.- (I) For disallowance of standard deduction, see section 142(b)(l). (2) For rule that certain foreign taxes are not to be taken into ac- count in determining deduction or credit, see section 906(b)(1). SEC. 874. ALLOWANCE OF DEDUCTIONS AND CREDITS. (a) R~xnmu~ PIu~uIsrrE To ALLOWANCL-A nonresident alien in- dividual shall receive the benefit of the deductions and credits allowed to him in this subtitle oniy by filing or causing to be filed with the Secretary or his delegate a true and accurate return (of his total in- come received from all sources in the United States], in the manner prescribed in subtitle F (sec. 6001 and following, relating to procedure and administration), including therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. This subsection shall not be construed to deny the credits provided by sections 31 and 32 for tax withheld at [the] source or the credit provided by section 39 for certain uses of gasoline and lubricating oil. (b) TAX Wrriima~r~ AT Soui~oE.-The benefit of the deduction for exemptions under section 151 may, in the discretion of the Secretary or his ddegate, and under regulations prescribed by the Secretary or his delegate, be received by a nonresident alien individual entitled thereto, by filing a claim therefor with the withholding agent. (c) FOREIGN TAX CREDIT NOT ALLOWED.-(A nonresident] Except as provided in section 906, a nonresident alien individual shall not be allowed the credits against the tax for taxes of foreign countries and possessions of the United States allowed by section 901. SEC. 875. PARTNERSHIPS. For purposes of this subtitle, a nonresident alien individual shall be considered as being engaged in a trade or business within the United States if the partnership of which he is a member is so engaged. SEC. 876. ALIEN RESIDENTS OF PUERTO RICO. (a) No APPLICATION `10 CERTAIN ALIEN RLSIJYENTS OF Pm~ro Rroo.-This subpart shall not apply to an alien individual who is a bona fide resident of Puerto Rico during the entire taxable year, and such alien shall be subject to the tax imposed by section 1. (b) CROSS REFERENCE.- For exclusion from gross income of income derived from sources within Puerto Rico, see section 933. SEC. 877. EXPATRIATION TO AVOID TAX. (a) IN GENERAL.-Every nonresident alien individual who at any time after March 8, 1965, and within the 5-year period immediately preceding the close of the taxable year lost United States citisenship, unless such loss did not have for one of its principal pv~rposes the avoidance of taxes under this subtitle or subtitle B, shall be taxable for such taxable year in the manner provided in subsection (b) if the tax im~posed pursuant to such subsection exceeds the tax which, without regard to this section, is imposed pursuant to section 871. (b) ALTERNATIVE TAX.-A nonresident alien individual described in subsection (a) shall be taxable for the taxable year as provided in sec- tion 1 or section 19~01 (b), except that- 811 PAGENO="0822" 146 FOREIGN INVESTORS TAX ACT OF 1966 (1) the gross income shall include only the gross income de- scribed in section 872(a) (as modified by subsection (c) of this section), and (2) the deductions shall be allowed if and to the extent that they are connected with the gross income included under this section, except that the capital loss ca'rryoverprovided by section 1212(b) shall not be allowed; and the proper allocation and appor- tionment of the deductione for this purpose shall be determilned as provided under regulatione prescribed by the Secretary or his delegate. For purposes of paragraph (2), the deduetione allowed by section 873(b) shall be allowed; and the deduction (for losses not connected with the trade or business if incurred in transactione entered into for profit) allowed by section 165(c) (2) shall be allowed, but only if the profit, if such transaction had resulted in a profit, would be included in gross income under this section. (c) SPECIAL RULES OF SouRcE.-For purposes of subsection (b), the following item~s of gross income shall be treated as income from sources within the United States: (1) SALE OF PROPERTY.-Gains on the sale or exchange of prop- erty (other than stock or debt obligations) located in the United States. (2) STOCK OR DEBT OBLIGATIONS.-Gains on the sale or exchange of stock issued by a domestic corporation or debt obligations of United States persons or of the' United States, a State or political subdivision thereof, or the District of Columbia. (d) EXCEPTION FOR LOSS OF CITIZENSHIP FOR CERTAIN GA USES.- Subsection (a) shall not apply to a nonresident alien individual whose loss of United States citizenship resulted from the application of sec- tion 301 (b), 350, or 355 of tile Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). (e) BURDEN OF PR00F.-If the Secretary or his delegate establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction for the taxable year in the taxes on his probable income for such year, the burden of proving for such taxable year that such loss of citizen- ship did not have for one' of its principal purposes the avoidance of taxes under this subtitle or subtitle B shall be on such individual. SEC (877] 878. FOREIGN EDUCATIONAL, CHARITABLE, AND CERTAIN OTHER EXEMPT ORGANIZATIONS. For special provisions relating to unrelated business income of foreign educational, charitable, and other exempt trusts, see section 512(a). Subpart B-Foreign Corporations [Sec. 881. Tax on foreign corporations not engaged in business in United States.] [Sec. 882. Tax on resident foreign corporations.] Sec. 881. Income of foreign corporaticms not connected with United States bnsiness. Sec. 882. Income of foreign corporations connected with United States business. sec. 883. Exclusions from gross income. Sec. 884. Cross references. 812 PAGENO="0823" FOREIGN INVESTORS TAX ACT OF 1966 147 (SEC. 881. TAX ON FOREIGN CORPORATIONS NOT ENGAGED IN BUSI- NESS IN UNITED STATES. ((a) IMPosITION OF TAx.-In the case of every foreign corporation not engaged in trade or business within the. United States, there is hereby imposed for each taxable year, in lieu of the taxes imposed by section 11, a tax of 30 percent of the amount received from sources within the United States as interest (except interest on deposits with persons carrying on the banking business), dividends, rents, salaries, ~Vages, premiums, annuities, compensations, remunerations, emolu- ments, or other fixed or determinable annual or periodical gains, profits, and income (including amounts described in section 631 (b) and (c) which are considered to be gains from the sale or exchange of capital assets).] SEC. 881. INCOME OF FOREIGN CORPORATIONS NOT CONNECTED WITH UNITED STATES BUSINESS. (a) IMPosITIoN OF TAX.-There is hereby imposed for each taxable year a tax of 30 percent of the amount received from sources within the United States by a foreign corporation as- (1) interest, dividends, rents, salaries, icages, premiums, an- nuities, compensato?ng, remunerations, emoluments, and other freed or detez~minable annual or periodical game, profits, and income, (2) gains described in section 631 (b) or (c), and (3) amou'rtts which under section 341, or under section 1232 (in the case of bonds or other evidences of indebtedness issued after September 28, 1965), are~ treated as gains from the sale or exchange of property which is not a capital asset,. but only to the extent the amount so received is not effectively con- nected with the conduct of a trade or business within the United States. (b) DOUBLING OF TAX.- For doubling of tax on corporations of certain foreign countries, see section 891. SEC. 882. [TAX ON RESIDENT FOREIGN CORPORATIONS.] INCOME OF FOREIGN CORPORATIONS CONNECTED WITH. UNITED STATES. BUSINESS. (a) NORMAL TAX AND SURTAX.- (1) IMPOsITION OF TAX.-A foreign corporation engaged in trade or business within the United States during the taxable year shall be taxable as provided in section 11 or 1201 (a) on its tax- able income which is effectively connected with the conduct of a trade or business within the United States. (2) DETERMINATION OF TAXABLE INCOME .-In determining tax- able income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct of a trade or business within the United States. (b) GROSS TNCOME.-In the case of a foreign corporation, gross in- come includes only- 813 PAGENO="0824" 148 FOI~~~GN INVESTORS TAX ACT OF 1966 (1) (the] gross income which is derived from sources within the United States(.] and which is not effectively connected with the conduct of a trade or business within the United States, and (2) gross income which is effecti'vely connected with the con~ duct of a trade or business within the United States. (c) ALLOWANCE OP DEDUCTIONS AND Ciu~nITs.- [(2)] (1) ALLOCATION OP DEDUCTIONS.- (A) GENERAL RULE.-Irl the case of a foreign corporation the deductions shall be allowed only for purposes of subsection (a) and (except as provided by subparagraph (B)) only if and to the extent that they are connected with income which is effectively connected with (income from sources] the con- duct of a trade or business within the United States; and the proper apportionment and allocation of the deductions (with respect to sources within and without the United States] for this purpose shall be determined as provided in (part I, under] regulations prescribed by the Secretary or his dele- gate. ((3)] (B.) CHARITABLE C0NTmBUTI0NS.-The deduction for charitable contributions and gifts (provided] allowed by section 170 shall be allowed whether or not connected with income which is effectively connected with (income from sources] the conduct of a trade or business within the United States. ((1)] (2) DEDUCTIONS. AND CREDITS ALLOWED ONLY IF RE- TTJRN FILED.-A foreign corporation shall receive the benefit of the deductions and credits allowed to it in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true and accurate return [of its total income received from all sources in the United States], in the manner prescribed in subtitle F, includ- ing therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. This paragraph shall not be cortetrued to deny the credit provided by section 32 for tax withheld at source or the credit provided by section 39 for certain uses of gasoline and lubricating oil. ((4)] (3) Foim~IGN TAX CREDIT.-(Foreign] Except as pro- vided by section 906, foreign corporations shall not be allowed the (credits] credit against the tax for taxes of foreign countries and possessions of the United States allowed `by section 901. (4) CROSS REFERENCE.- For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b)(1). (d) ELECTION To TREAT REAL PROPERTY INCOME AS' INCOME CONNECTED WITH UNITED STATES BUSINESS.- (1) IN GENERAL.-A foreign corporation which during the tax- able year derives arty income- (A) from real property held for the production of income and located in the United States, or from any interest in such real property, including (i) gaivs from the sale or exchange 814 PAGENO="0825" FOREIGN INVESTORS TAX ACT OF 1966 149 of real property or an interest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and (B) which, but for this subsection, would not be treated as inccem,e effectively connected with the conduct of a trade or business within the United States, may elect for such. taxable year to treat all such income as income which is effectively connected with the conduct of a trade or busi- ness within the United States. In such case, such income shall be taxable as provided in subsection (a) (1) whether or not such corporation is engaged in trade or business within the United States during the taxable year. An election under this paragraph for any taxable year shall remain in effect for all subsequent tax- able years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. (~) ELECTION AFTER REVOCATION, ETC.-Paragraphs (~) and (3) of section 871(d) shall appliy in respect of elections under this sub- section in th same manner and to the same extent as they apply in respect of elections under section 871 (d). [(d)] (e) Ri~rui~s OF TAX BY AGENT.-If any foreign corporation has no office or place of business in the Tjnited States but has an agent in the United States, the return required under section 6012 shall be made by the agent. SEC. 883. EXCLUSIONS FROM GROSS INCOME. The following items shall not `be included in gross income of a for- eign corporation, and shall be exempt from taxation under this sub- title: (1) 5mm UNDER FOREIGN FLAG.-Earnrngs derived from the operation of a ship or ships documented under the laws of a for- eign country whióh grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. (2) AIRCRAPr OF FOREIGN REGISTRY.-Eaflllngs derived, from the operation of aircraft registered under the laws of a foreign country which grants an equivalent exemption to citizens of the United States and to corporations organized in the United States. SEC. 884 CROSS REFERENCES. ((4)] (1) Forspecial provisions relating to unrelated business income of foreign educational, charitable, and certain other exempt organiza- tions, see section 512(a). [(3)] (2) For special provisions relating to foreign (insurance com- panies], corporation carrying on an insurance business within the United States see (subchapter L (sec. 801 and following)] section 842. ((2)] (3) For rules applicable in determining whether any foreign corporation is engaged in trade or business within the United States, see section (871(c)] 861(b). (4) For reinstatement of pre-1967 income tax provisions in the case of corporations of certain foreign countries, see section 896. (5) For allowance of credit against the tax in case of a foreign corpor- ation having income effectively connected with the conduct of a trade or business within the United States, see section 906. ((1)] (6) For withholding at source of tax on income of foreign cor- porations, see section 1442. 815 PAGENO="0826" 150 FOREIGN INVESTORS TAX ACT OF 1966 Subpart C-Miscellaneous Provisions Sec. 891. Doubling of rates of tax on citizens and corporations of certain foreign countries. Sec. 892. Income of foreign governments and of international organizations. * Sec. 893. Compensation of employees of foreign governments or international organizations. (Sec. 894. Income exempt under treaty.] Sec. 894. Income affected by treaty. Sec. 895. Income derived by a foreign central bank of issue from obligations of the United States or from. baink deposits. Sec. 896. Application of pre-1967 income tae provisions. * * ** * * * * SEC. 894. INCOME AFFECTED BY TREATY. (a) INCOME EXEMPT UNDER TREATY.-Income of any kind, to the extent required by any treaty obligation of the United States, shall not be included in gross income and shall be exempt from taxation under this subtitle. (b) PERMANENT ESTABLISHMENT IN UNITED STATES.-For pur- poses of applying any exemption from, or reduction of, any tax pro- vided by any treaty to which the United States is a party with respect to i~ncome which is not effectively connected with the conduct of a trade or business within the United States, a nonresident alien individual or foreign corporation shall be deemed not to have a permanent establish- ment in the United States at any time during the taxable year. This subsection shall not apply in respect of the tax computed u'nder section 877(b). SEC. 895. INCOME DERIVED BY A FOREIGN CENTRAL BANK OF ISSUE FROM OBLIGATIONS OF THE UNITED STATES OR FROM BANK DEPOSITS. Income derived by a foreign central bank of issue from obligations of thQ United States owned by such foreign central bank of issue, or froin~ interest on deposits with persons carrying on the banking busi- ness, shall not be included in gross income and shall be exempt from taxation under this subtitle unless such obligations or deposits are held for, or used in connection with, the conduct of commercial banking functions or other commercial activities. For purposes of the pre- ceding sentence, the Bank for International Settlements shall be treated as a foreign central bank of issue with respect to interest on deposits with persons carrying on the banking business. SEC. 896. APPLICATION OF PRE-1967 INCOME TAX PROVISIONS. (a) IMPOSITION OF MORE BURDENSOME TAXES BY FOREIGN COUN- TRY.- Whenever the President finds that- (1) `wnder the laws of any.foreign country, considerMg the tax system of such foreign country, citisens of the United States not residents of such foreign couatry or don-testic corporations are being subjected to more burdensome taxes, on any item of income received by such citis ens or corporations from sources within such foreign country, than taxes imposed by the provisions of this sub- title on similar income derived from sources within the United States by residents or corporations of such foreign country, 816 PAGENO="0827" FOREIGN ~VESTORS' TAX ACT OF 1966 151 (2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such taxes so that the?, are no more burdensome than taxes imposed by the provisions of this subtitle on similar income derived from sources within the United States by residents or corporations of such foreign country, and (3) it is in the. public interest to apply pre-1967 tax provisions in accordance with the provisions of this section to residents or corporations of such foreign country, the President shall proclaim that the tax on such similar income derived from sources within the United States by residents or corporations of such foreign country shall, for taxable years beginning after such proclamation, be determined under this subtitle without regard to amendments made to this subchapter and chapter 3 on or after the date of enactment of this section. (b) AI1LEvIATION OF MORE BURDENSOME. TAXES.-Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have, been modified so that citizens of the United States not residents of such foreign country or domestic corporations are no longer sub- ject to more burdensome taxes on such item of income derived by such citizens or corporations from sources within such foreign coun- try, he shall proclaim that the tax on such similar income derived from sources within the United States by residents or corporations of such foreign country shall, for any taxable year beginning after such proclamation, be determined under this subtitle without regard to subsection (a). (c) NoTIFIcATIoN OF CONGRESS REQUIRED.-NO proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. (d) IMPLEMENTATION BY REGULATIONS.-Th Secretary or his dele- gate shall prescribe such regulations as he deems necessary or appro- priate to implement this section. PART Ill-INCOME FROM SOURCES WITHOUT THE UNITED STATES Subpart A. Foreign tax credit. Subpart B. Earned income of citizens of United States. Subpart C. Western Hemisphere' trade corporations. Subpart D. Possessions of the United States.. Subpart E. China Trade Act corporations. Subpart F. Controlled Foreign Corporations. Subpart G. Export Trade Corporations. Subpart H. Income of certain nonresident United States citizeuis subject to foreign comm~unity property laws. Subpart A-Foreign Tax Credit Sec. 901. Taxes of foreign countries and of possessions of United States. Sec. 902. Credit for corporate stockholder in foreign corporation. Sec. 903. Credit for taxes in lieu of income, etc., taxes. Sec. 904. Limitation on credit. Sec. 905. Applicable rules. Sec. 906. Nonresident alien individuals and foreign corporations. 817 PAGENO="0828" 152 FOREIGN INVESTORS TAX ACT OF 1966 SEC. 901. TAXES OF FOREIGN COUNTRIES AND OF POSSESSIONS OF UNITED STATES. (a) ALLOWANCE o~ Ciu~rr.-If the taxpayer chooses to have the benefits of this subpart, the tax imposed by this chapter shall, subject to the applicable limitation of section 904, be credited With the amounts provided in the applicable paragraph of subsection (b) plus, in the case of a corporation, the taxes deemed to have been paid under sections 902 and 960. Such choice for any taxable year may be made or changed at any time before the expiration of the period pre- scribed for making a claim for credit or refund of the tax imposed by this chapter for such taxable year. The credit shall not be allowed against the tax imposed by section 531 (relating to the tax on accu- mulated earnings), against the additional tax imposed for the tax- able year under section 1333 (relating to war loss recoveries), or against the personal holding company tax imposed by section 541. (b) AMOUNT AILowED.-Subject to the applicable limitation of section 904, the following amounts shall be allowed as the credit under subsection (a): (1) ()rrlzENs AND DOMESTIC c0RP0RATI0N5.-In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; and (2) RESIDENT OF THE UNITED STATES OR PUERTO iuco.-In the case of a resident of the United States and in the case of an individual who is a bona fide resident of Puerto Rico during the entir~e taxable year, the amount of any such taxes paid or accrued dui~ing the taxable year to any possession of the United States; and (3) Aui~ RESIDENT OF THE UNITED STATES OR PUERTO RICO.- In the case of an alien resident of the United States and in the case of an alien individual who is a bona fide resident of Puerto Rico during the entire taxable year, the amount of any such taxes paid or accrued during the taxable year to any foreign country(, if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country]; and (4) NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN CORPORA- TI0NS.-In the case of any nonresident alien individual i~ot described in section 876 and in the case of any foreign corporation, the amount deterin4ned jrar~uant to section 906; and ((4)](5) PARTNERSHIPS AND ESTATE5.-In the case of any in- dividual 4escribed in pargraph (1), (2), (or (3),] (3), or (4), who isa member of a partnership or a beneficiary of an estate or trust, the amount of his proportionate share of the taxes (de- scribed in such paragraph) of the partnership or the estate or trust paid or accrued during the taxable year to a foreign country or to any possession of the United States, as the case may be. (c) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN RESIDENTS.- Whenever the President finde that- (1) a foreign country, in iin~posing income, war profits, and excess profits taxes, does not allow to citizens of the United States 818 PAGENO="0829" FOREIGN INVESTORS TAX ACT OF 1966 153 residing in such foreign country a credit for any such taxes paid or accrued to the United States or any foreign country, as' the case may be, similar to the credit allowed under subsection (b) (3), (2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit to c'iti~ens' of the United States residing in such foreign country, and (3) it is in the public interest to allow the credit under sub- section (b) (3) to citizens or subjects of such foreign country only if it allows ,s'zwh a similar credit to citizens of the United States residing in such foreign country, `the President shall proclaims that, for taxable years beginning while the proclamation remains in effect, the credit under subsection (b) (8) shall be allowed to citizens or subjects of such foreign country only if such foreign country, in imposing income, war profits, and excess profits taxes, allows to citizens of the United States residing in such foreign country such a .similar credit. ((c)] (d) CoIuion~rIoNs TREATED AS FoIu~aaN.-For purposes of this subpart, the following corporations shall be treated as foreign cor- porations: (1) a corporation entitled to the benefits of section 931, by rea- son of receiving a large percentage of its gross incothe from sources within a possession of the United States; and (2) a corporation organized under the China Trade Act, 1922 (15 U.S.C., chapter 4), and entitled t6 the deduction provided in section 941. ((d)] (e) CROSS REFERENCE.- (1) For deductions of income, war profits, and excess profits taxes paid to a foreign country or a possession of the United States, see sections 164 and 275. (2). For right of each partner to make election under this section, see section 703(b). (3) For right of estate or trust to the credit for taxes imposed by foreign countries and possessions of the United States under this section, see section 642(a) (2). (4) For reduction of credit for failure of a United States person to furnish certain information with respect to a foreign corporation controlled by him, see section 6038. * * ` * * * * ` * SEC. 904. LIMITATION ON CREDIT. * * * * * * * (f) APPLICATION OF SECTION IN CASE OF CERTAIN INTEREST IN- COME.- (1) IN GENERAL.-The provisions of subsection (a), (c), (d), and (e) of this section shall be applied separately with respect to- (A) the interest, income described in paragraph (2), and (B) income other than the interest income described in paragraph'(2). (2) INTEREST INCOME TO WHICH APPLICABLE.-For purposes of this subsection, the interest income described in this paragraph is interest other than interest- (A) derived from any transaction which is directly related to the active conduct of a trade or business in foreign coun- try or a possession of the United States, 819 PAGENO="0830" 154 FOREIGN INVESTORS TAX ACT OF 1966 (B) derived in the conduct of a banking, financing, or similar business, (C) received from a corporation in which the taxpayer owns at least 10 percent of the voting stock, (or] (D) received on' obligations acquired as a result of the dis- position of a trade or business actively conducted by the tax- payer in a foreign `country or possession of the United States or as a result of the disposition of stock or obligations of a corporation in which the taxpayer owned at least 10 percent of the vdting stock (.],or ` (E) received by an overseas operations funding subsidiary on obligations of a related foreign corporation. (3) OvEI~&LL LIMITATION NOT TO APPLY.-The limitation pro- vided by subsection (a) (2) shall not apply with respect to the interest income described in paragraph (2). The Secretary or his delegate shall by regulations prescribe the manner of appli- cation of subsection (e) with respect to `cases in which the limita- tion provided by subsection (a) (2) applies with respect to income other than the interest income described in paragraph (s). * * * * * * * (5) DEFINiTIoNs FOR PURPOSES OF PARAGRAPH (1)(E) .-For pur- poses of paragraph (1) (Jfl- (A) the term "overseas operations funding subsidiary" means a domestic corporation which (i) is a member of an affiliated group (within the meaning of section L504) and is not the common parent corporation, and (ii) was form1ed and is availed of for the principal purpose of raising funds outside the United States ,through public offerings to for- eign persons and of using such funds to finance the operations in foreign countries of one or more related foreign corpora- tio'ns, and (B) a foreign corporation is, with respect to an overseas operations fu~ding subsidiary, a related foreign corporation if the affiliated group of which such subsidiary is a member owns 50 percent `or more of the voting stock of such foreign corporation either directly or through ownership of the vot- ing stock of another foreign corporation. * * .* * * * SEC. 906. NONRESIDENT ALlEN INDIVIDUALS AND FOREIGN COR.~ FORATIONS. , ` (a) ALLOWANCE OF GREDIT.-A nonresident alien indiridual or a foreign corporation engaged in trade or business within the United States during the taxable year shall be allowed a credit under section 901 for the amount of any income, war profits, and excess profits taxes paid or accrued during the taxable year (or deemed, vinder section 902, paid or accrued during the taxable year) to any foreign country or possession of the United States with respect to income effectively con- nected with the conduct' of a trade or business within the United States. 820 PAGENO="0831" FOREIGN INVESTORS TAX ACT OF 1966 155 (b) SPECIAL RULES.- (1) For purposes of subsection (a) and for purposes of deter- mining the deductions allowable under sections 873(a) and 882(c), in determining the amount of any tax paid or accrued to any foreign country or possession there shall not be taken into account any amowrtt of tax to the extent the tax so paid or accrued is im- posed with respect to income which would not be taxed by sue/i foreign country or possession but for the fact that- (A) ir~ the case of a nonresident alien, individual, such indi'viductl is a citizen or resident of such foreign country or possession, or (B) in the case of a foreign corporation, such corporation wa~ created or organized under the law of such foreign country or possession or is domiciled for tax purposes in such country or possession. (2) For purposes of subsection (a), in applying section 904 the taxpayer's taxable income shall be treated as consleting only of the taxable income effectively connected with the taxpayer's conduct of a trade or business within the United States. (3) The credit allowed pursuant to subsection (a) shall not be allowed against any tax imposed by section 871 (a) (relating to income of nonresident alien individual not connected with United States business) or 881 (relating to income of foreign corpora- tions not coivnected with United States business). (4) For purposes of sections 902(a) and 78, `a foreign corpora- tion choosing the benefits of this subpart which receives dividends shall, with respect to such dividends, be treated as a domestic corporation. Subpart B-Earned Income of Citizens of United States Sec. 911. Earned income from sources without the United States. Sec. 912. Exemption for certain allowances. SEC. 911. EARNED INCOME FROM SOURCES WITHOUT THE UNITED STATES. (a) GENERAL Ruiu~.-The following items shall not be included in gross income and shall be exempt from taxation under this subtitle: * (1) BONA FJDE RESIDENT OF FOREIGN COUNTRY.-Tn the case of an individual citizen of the United States who establishes to the sat- isfaction of the Secretary or his delegate that he has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) which constitute earned income attributable to services performed during such uninter- rupted period.' The amount excluded under this paragraph for any taxable year shall be computed by applying the special rules contained in subsection (c). (2) PRESENCE IN FOREIGN COUNTRY FOR 17 MONTHS.-In the case of an individual citizen of the United States who during any pe- riod of 18 consecutive months is present in a foreign country or 821 PAGENO="0832" 156 FOREIGN INVESTORS TAX ACT OF 1966 countries during at least 510 full days in such period, amounts receievd from sources without the United States (except amounts paid by the United States or any agency thereof) which consti- tute earned income attributable to services performed during such 18-month period. The amount excluded under this paragraph for any taxable year shall be computed by applying the special rules contained `in subsection (c). An individual shall not be allowed, as a deduction from his gross in- come, any deductions (other than those allowed by section 151, relat- ing to personal exemptions) properly allocable to or chargeable against amounts excluded from gross income under this subsection. (b) DEFINITION OP E~u~I~D INCOME.-For purposes of this section, the term "earned income" means wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are mate- rial income-producing factors. under regulations prescribed by the Secretary or his delegate, a reasonable allowance as compensation for the personal services rendered by the taxpayer, not in excess of 30 percent of his share of the net profits of such trade or business, shall be considered as earned income. * * * * * * (d) CRoss REFERENCE.- (1) For administrative and penal provisions relating to the exclusion provided for in this section, see sections 6001, 6011, 6012(c), and the other provisions of subtitle F. , ` (2) For elections as to treatment of income subject to foreign com- munity property laws, see section 981. * * * * * * Subpart D-Possessions of the United States. * Sec. 931. Income from sources within possessions of the United * States. Sec.'932. Citizens of possessions of the United States. Sec. 933. Income from sources within Puerto Rico. :,` Sec. 934. Limitation on reduction in income tax liability incurred to the Virgin Islands. SEC. 931. INCOME FROM SOURCES WITHIN POSSESSIONS OF THE UNITED STATES. (a) GENERAL RUEE.-In the case of citizens of the United States or domestic corporations, gross income means only gross income from sources within the United States if the conditions of both paragraph (1) and paragraph (2) are satisfied: (1) THREE-YEAR PERI0D.-If 80 percent or more of the gross income of such citizen or domestic corporation (computed without * the benefit of this section) for the 3-year period immediately pre- ceding the close of the taxable year (or for such part of such period immediately preceding the close of such taxable year as may be 822 PAGENO="0833" FOREIGN INVESTORS TAX ACT OF 1966 157 applicab1~ was derived from sources within a possesshrn of the United States; and (2) TRADE OR BUSINESS.-If- (A) in the ease of such corporation, 50 percent or more of its gross income (computed without the benefit of this sec- tion) for such period or such part thereof was derived from the active conduct of a trade or business within a possession of the United States; or (B) in the case of such citizen, 50 percent or more of his gross income (computed without the benefit of this sectioi~) for such period or such part thereof was derived from the active conduct of a trade, or business within a possession of the United States either on his own account or as an - employee or agent of another. (b) AMorn~s RECEIVED IN UNITED STATEs.-Not.withstanding sub- section (a), there shall be included in gross income all amounts re- ceived by such citizens or corporations within the United States, whether derived from sources within or without tbe United States. (c) D~'INITIoN.-For purposes of this section, theterm "possession of the United States" does not include the Virgin Islands of the United States, and such term when used with respect to citizens of the, United States does not include Puerto Rico. ((d) DEDUCTIONS.- ((1) Citizens of the United States entitled to the benefits of this section shall have the same deductions as are allowed by section 873 in the case of a nonresident alien individual engaged in trade or business within the United States. ((2) Domestic corporations entitled to the benefits of this section shall have the same deductions as are allowed by section 882 (c) in the case of a foreign corporation engaged in trade or business within the United States.] (d) DEDucTIoNs.- (1) GENERAL J2uLE.-Except as otherwise provided in this sub- section and subsection (e), in the case of persons entitled to the benefits of this section the deductions shall be allowed only if and to the extent that they are connected with income from sources wit hi n~ the United States; and the proper apportionment and al- location of the deductions with respect to sources of income within arid without the United States shall be deterirdrted as provided in part I, under regulations prescribed by the Secretary or his delegate. (2) EXcEPTI0N5.-The following deductions shall be allowed whether or not they are connected with income from sources within the United States: (A) The deduction, for losses not connected with the trade or bnsiness if incurred in transactions entered into for profit, allowed by section 165(c) (2), but only if the profit, if such transaction had resulted in a profit, would be taxable under this subtitle. (B) The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c) (3), but only if the loss is of property within the United States. 71-297 0-67-pt 1-53 823 PAGENO="0834" 158 FOREIGN INVESTORS TAX ACT OF 1966 (C) The deduction for charitable contributions and gifts allowed by section 170. (3) DEDUCTION DISALLOWED.- For disallowance of standard deduction, see section 142(b) (2). (e) DEDUCTION FOR PERSONAL ExEMPI'I0N.-A citizen of the United States entitled to the benefits of this section shall be allowed a deduc- tion for only one exemption under section 151. (f) ALLOWANCE OF DEDUCTIONS AND CREDFP5.-Persons entitled to t~he benefits of this section shall receiv~e the benefit of the deductions and credits allowed to them in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true and accurate return of their total income received from all sources in the United States, in the manner prescribed in subtitle F, including therein all the infor- matión which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. (g) FOREIGN TAX Ciu~rn~.-Persons entitled to the benefits of this sectiOn shall not be .allowed the credits against the tax for taxes of foreign countries and possessions of the United States allowed by section 901. (h) INTERNEES.-In the ease of a citizen of the United States in- terned by the enemy while serving as an employee within a possession of the United States- (1) if such citizen was confined in any place not within a pos- session of. the United States, such place of confinement shall, for purposes of this section, be considered as within a possession of. the United States; and (2) subsection (b) shall not apply to any compensation received within the United States by such citizen attributable to the period of time during which such citizen was interned by the enemy. (i) EMPLOYEES OF THE UNITED STATES.-FOr purposes of this sec- tion, amounts paid for services performed by a citizen of the United States as an employee of the United States or any agency thereof shall be deemed to be derived from sources within the United States. SEC. 932. CITIZENS OF POSSESSIONS OF THE UNITED STATES. (a) GENERAL Rui~.-Any individual who is a citizen of any posses- sion of the United States (but not otherwise a citizen of the United States) and who is not a resident of the United States shall be subject totaxation under this subtitle [only as to income derived from sources within the United States, and in such case the tax shall be computed and paid] in the same manner and subject to the same conditions as in the case of [other persons who are taxable only as to income de- rived from.such sources] a nonresident alien individual. This section shall have no application in the case of a citizen of Puerto Rico. (b) VIRGIN ISLAND5.-Nothing in this section shall be construed to alter or amend the Act entitled "An Act making appropriations for the naval service for the fiscal year ending June 30, 1922, and for other purposes", approved July 12, 1921 (48 U.S.C. 1397), relating to the imposition of income taxes in the Virgin Islands of the United States. 824 PAGENO="0835" FOREIGN INVESTORS TAX ACT OF 1966 159 (c) GUAM.- For applicability of United States income tax laws in Guam, see sec- tion 31 of the Act of August 1, 1950 (48 U.S.C. 1421i); for disposition of the proceeds of such taxes, see section 30 of such Act (48 U.S.C. 1421h). * * * ~* * * * Subpart F-Controlled Foreign Corporations Sec. 951. Amounts included in gross income of United States Shareholders. Sec. 952. Subpart F income defined. Sec. 953. Income from insurance of United States risks. * * * * * * * SEC. 952. SUBPART F INCOME DEFINED. (a) IN GENERAL.-FOr purposes of this subpart, the term "subpart F income" means, in the case of any controlled foreign corporation. the sum of- (1) the income derived from the insurance of United States risks (as determined under section 953), and (2) the foreign base company income (as determined under section 954). ((b) ExoLtrsloN OF UNITED STATES INc0ME.-Subpart F income does not include any item inc,ludible in gross income under this chapter (other than this subpart) as income derived from sources within the United States of a foreign corporation engaged in trade or business in the United States.] (b) ExcLusIoN OF UNITED STATES JNCOME.-ITt the case of a con-. trolled foreign corporation, subpart F income does not include any item of income from sources within the United States which is eff cc- tively conuccted with the conduct by such corporation of a trade or business within the United States unless such item is exempt from taxation (or is scubject to a reduced rate of taa~) pursuant to a treaty obligation of the United States. (c) LIMITATI0N.-For purposes of subsection (a), the subpart F income of any controlled foreign corporation for any taxable year shall not exceed the earnings and profits of such corporation for such yearreduced by the amount (if any) by which- (1) an amount equal to- (A) the sum of the deficits in earnings and profits for * prior taxable years beginning after December 31, 1962, plus (B) the sum of the deficits in earnings and profits for taxable years beginning after December 31, 1959, and before January 1, 1963 (reduced by the sum of the earnings and profits for such taxable years) ; exceeds (2) an amount equal to the- sum of the earnings and profits for prior taxable years beginning after December 31, 1962, al- located to other earnings and profits under section 959(c) (3). For purposes of the preceding sentence, any deficit in earnings and profits for any prior taxable year shall be taken into account under paragraph (1) for aily taxable year only to the extent it has not been taken into account under such paragraph for any preceding taxable year to reduce earnings and profits of such preceding year. 825 PAGENO="0836" 160 FOREIGN INVESTORS TAX ACT OF 1966 (d) SPECIAL RULE IN CASE OF INDIRECT OwNERsmP.-For pur- poses of subsection (c), if- (1) a United States shareholder owns (within the meaning of section 958 (a)) stock of a foreign corporation, and by reason of such ownership owns (within the meaning of such section) stock of ahy other foreign corporation, and (2) any of such foreign corporations has a deficit in earnings and profits for the taxable year, then the earnings and profits for the taxable year of each such for- eign corporation which is a controlled foreign corporation shall, with respect to such United States shareholder, be properly reduced to take into account any deficit described in paragraph (2) in such manner as the Secretary or his delegate shall prescribe by regulations. SEC. 953. INCOME FROM INSURANCE OF UNITED STATES RISKS. (a) GENERAL RULE.-FOr purposes of section 952 (a) (1), the term "income derived from the insurance of United S.tates risks" means that income which- (1) is attributable to the reinsuranco or the issuing of any insurance or annuity contract- (A) in connection with property itt, or liability arising out of activity in, or in connection with the lives or health of residents of, the United States, or (B) in connection with risks not included in subparagraph (A) as the result of any arrangement whereby another cor- poration receives a substantially equal amount of premiums * or other consideration in respect to any reinsurance or the issuing of any insurance or annuity contract in connection with property in, or liability arising out of activity in, or in connection with the lives or health of residents of, the United States, and (2) would (subject to the modifications provided by para- graphs (1), (2), and (3) of subsection (b)) be taxed under sub- chapter L of this chapter if such iiicome were the income of a domestic insurance corporation. This section shall apply only in the case of a controlled foreign corporation which receives, during any taxable year, premiums or other consideration in respect of the reinsurance, and the issuing, of insurance and annuity contracts described in paragraph (1) in excess of 5 percent of the total of premiums and other consideration received during such taxable year in respect of all reinsurance and issuing of insurance and annuity contracts. (b) SPECIAL Rur~s.-For purposes of subsection (a)- (1) In the application of part I of subchapter L, life insurance company taxable income is the gain from operations as defined in section 809(b). (2) A corporation which would, if it were a domestic insurance corporation, be taxable under part II of subchapter L shall apply subsection (a) as if it were taxable under part III of subchapter L. (3) The following provisions of subchapter L shall not apply: (A) Section 809(d) (4) (operations loss deduction). 826 PAGENO="0837" FOREIGN INVESTORS TAX ACT OF 1966 161 (B) Section 809(d) (5) (certain nonparticipating con- tracts). (0) Section 809(d) (6) (group life, accident, and health insurance). (D) Section 809(d) (10) (small business deduction). (E) Section 817(b) (gain on property held on December 31, 1958, and certain substituted property acquired after 1958). (F) Section (832(b) (5)]832(c) (5) (certain capital losses) (4) The items referred to in- (A) section 809(c) (1) (relating to gross amount of pre- miums and other considerations), (B) section 809(c) (2) (relating to net decrease in re- serves), (0) section 809(d) (2) (relating to net increase on re- serves), and (D) section 832(b) (4) (relating to premiums earned on insurance contracts), shall be taken into account only to the extent they are in respect of any reinsurance or the issuing of any insurance or annuity contract described in subsection (a) (1). (5) All items of income, expenses, losses, and deductions (other than those taken into account under paragraph (4)) shall be properly allocated or apportioned under regulations prescribed by the Secretary or his delegate. * * * * * * * Subpart H-Income of Certain Nonresident United States Citizens Subject to Foreign Communty Property Laws Sec. 981. Election as to treatment of income subject to foreign community property laws. SEC. 981. ELECTION AS TO TREATMENT OF INCOME SUBJECT TO FOREIGN COMMUNiTY PROPERTY LAWS. (a) GENERAL RuLE.-In the* case of any taxable year beginning after December 31, 1956', if- (1) a~n individual is (A) a citizen of the United States, (B) a bona fide resident of a foreign country or cou,ntries during the entire taxable year, and (C) n-tarried at the close of the taxable year to a spouse who is a nonresident alien during the entire tace- able year, and (2) such individual and his spouse elect to have subsection (b) apply to their comflnu'nity income under foreign comnwfnity pro- perty laws, then subsection (b)shall apply to such income of such individual and such spouse for the taxable year and for all subsequent tactiable years for which the requirements of paragraph (1) are met, unless the Secretary or MB delegate consents to a termination of the election. (b) TREATMENT OF COMMUNITY INCoME .-For any taxable year to which an election made under subsection (a) applies, the corn.- 827 PAGENO="0838" 162 FOREIGN INVESTORS TAX ACT OF 1966 munity income under foreign coinmu'nity property laws of the husband and wife making the election shall be treated as follows: (1) Earned income (within the meaning of the first sentence of section 911 (b) ), other than trade or business income and a part- ner's distributive share of partnership income, shall be treated as the income of the spouse who rendered the personal services. (2) Trade or business income, and a partner's distributive share of partnership income, shall be treated, as provided in section 1402(a) (5). (8) Comcniunity income not described in paragraph (1) or (2) which is derived from the separate property (as determined vinder the applicable foreign community property law) of. one spouse shall be treated as the income of such spouse. (4) All other such conwinunity income shall be treated as pro- vided in the applicable foreign community property law. (c) ELECTION FOR PRE-1967 YEARS.- (1) ELECTI0N.-If an individual meets the requirements of sub- section (a) (1) (A) and (C) for any taxable year beginning before January 1, 1967, and if such individual and the spouse ref erred to in subsection (a) (1) (C) elect under this subsection, then para- graph (2) of this subsection shall apply to their comm/unity in- come under foreign community property laws for all open taxable years beginning before January 1, 1967 (whether under this chap- ter, the corresponding provisions of the Internal Revenue Code of 1939, or the corresponding provisions of prior revenue laws), for which the requirements of subsection (a) (1) (A) and (C) are met. (2) EFFECT OF ELECTION.-FOr any taxable year to which an elec.. tion made under this subsection applies, the community income under foreign community property laws of the husband and wife making the election shall be treated as provided by subsection (b), except that the other community income described in paragraph (4') of subsection (b) shall be treated as the income of the spouse who, for such taxable year, had gross income under paragraphe (1), (2), and (8) .of subsection (b), plus separate gross income, greater than that of the other spouse. (d) TIME FOR MAKING ELECTIONS; PERIOD OF LIMITATIONS; ETC.- (1) TIME.-An election under subsection (a) or (c) for a tax- able year may be made at any time while such year is still open, and shall be made in such manner as the Secretary or his delegate shall by regulations prescribe. (2) EXTENSION OF PERIOD FOR ASSESSING DEFICIENCIES AND MAKING REFuNDS.-If any taxable year to which an election under * subsection (a) or (c) applies is open at the time such election is made, the period for assessing a deficiency against, and the period for filing claim for credit or refund of any overpayment by, the /thts- band and wife for such taxable year, to the extent such deficiency or overpayment is attributable to such an election, shall not e~cpire * before 1 year after the date of such election. (3) ALIEN SPOUSE NEED NOT JOIN IN SUBSECTION (c) ELECTION IN CERTAIN CASES.-If the Secretar~j or his delegate determines- 828 PAGENO="0839" FOREIGN INVESTORS TAX ACT OF 1966 163 (A) that an election under subsection (c) would not affect the liability for Federal income tax of the spouse re/erred to in subsection (a) (1) (C) for any taxable year, or (B) that the effect on such liability for tax cannot be ascer- tained and that to deny the election to the citisen of the United States would be inequitable and cause undue hard- ship, such spouse shall not be required to join in such election, and paragraph (2) of this subsection shall not apply with respect to such spouse. (4) INTEREST.-TO the extent that any overpayment or deficiency for a taxable year is attributable to an election made under this section, no interest shall be allo'wed or paid .f or any period before the day which is 1 year after the date of such election. (e) DEFINITIONS AND SPECIAL BuLES.-For purposes of this section- (1) DEDUCTI0N5.-Deductions shall be treated in a manner consistent with the manner p'rovided by this section for the in- corns to which they relate. (2) OPEN YEARS.-A taxable year of a citixen of the United States and his spouse shall be treated as "open" if the period for assessing a deficiency against such citisen for such year has not expired before the date of the election under subsection (a) or (c), as the case may be. (3) ELECTIONS IN CASE OF DECEDENTS.-If a husband or wife is deceased, his election under this section may be made by his ex- ecutor, administrator, or other person charged with his property. (4) DEATH OF SPOUSE DURING TAXABLE YEAR.-In applying sub- section (a) (1) (C), and indetermining under subsection (c) (2) which spouse has the greater income for a taxable year, if a hus- band or wife dies the taxable year of the surviving spouse shall be treated as ending on the date of such death. Subchapter P-Capital Gains and Losses * * * .* * * * PART IV-SPECIAL RULES FOR DETERMINING CAPITAL GAINS AND LOSSES * * * * * * * SEC. 1248. GAIN FROM CERTAIN SALES OR EXCHANGES OF STOCK IN CERTAIN FOREIGN CORPORATIONS. * * * * * * * (d) EXCLUSIONS FROM EAIu~INos AND PROFITS.-For purposes of this section, the following amounts shall be excluded, with resp~t to any United States person, from the earnings and profits of a foreign corporation: * * * * * * * (4) UNITED STATES INCOME.-Afly item includible in gross income of the foreign corporation under this chapter- 829 PAGENO="0840" 164 FOREIGN INVESTORS TAX ACT OF 1966 (A) for any taxable year beginning be/ore January 1, 1967, as income derived from sources within the United States of a foreign corporation engaged in trade or business [m] within the United States, or (B) for any taxable year beginning after December 31, * 1966, as income effectively connected with the conduct by such corporation of a trade or business within the United States. This paragraph shall not aptly with respect to any item which is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation of the United States. * * * * * * * SEC. 1249. GAIN FROM CERTAIN SALES OR EXCHANGES OF PATENTS ETC., TO FOREIGN CORPORATIONS. (a) GENERAL 1tur~E.-(Except as provided in subsection (c), gain] Gain from the sale or exchange after December 31, 1962, of a patent, an invention, model, or design (whether or not patented), a copyright, a secret formula or process, or any other similar property right to any foreign corporation by any United States person (as defined in section 7701 (a) (30)) which controls such foreign corpora- tion shall, if such gain would (but for the provisions of this sub- section) be gain from the sale or exchange of a capital asset or of property described in section 1231, be considered as gain from the sale or exchange of property which is neither a capital asset nor property described in section 1231. (b) C0Nm0L.-For purposes of subsection (a), control means, with respect to any foreign corporation, the ownership, directly or indirectly, of stock possessing more than 50 percent of the total combined voting power of all classes of stock entitled to vote. For purposes of this subsection, the rules for determining ownership of stock prescribed by section 958 shall apply. SEC. 1250. GAIN FROM DISPOSITIONS OF CERTAIN DEPRECIABLE REALTY. * * * * * * * (d) Exceptions and Limitations.- * * * * * * (3) CERTAIN TAX-FREE TRANSACTIONS.-If the basis of property in the hands of a transferee is determined by reference to its basis in the hands of the transferor by reason of the application of section 332, 351, 361, 371(a), 374(a), 721, or 731, then the amount of gain taken into account by the transferor under subsection (a) (1) shall not exceed the amount of gain recognized to the trans- feror on the transfer of such property (determined without re- gard to this section). This paragraph shall not apply to- (A) a disposition to an organization (other than a coopera- tive described in section 521) which is exempt from the tax imposed by this chapter, or * (B) a transfer of property by a nonresident alien indi- vidual, a foreign estate or trust, or a foreign partnership, to a 830 PAGENO="0841" FOREIGN INVESTORS TAX ACT OF 1966 165 domestic corporation in exchange for stock or securities in such corporation in a transaction to which sectwn 351 applies. * * * * * * * CHAPTER 3-WITHHOLDING OF TAX ON NON- RESIDENT ALIENS AND FOREIGN CORPORA- TIONS AND TAX-FREE COVENANT BONDS SUBCHAPTER A. Nonresident aliens and foreign corporations. SUBCHAPTER B. Tax-free covenant bonds. SUBCHAPTER 0. Application of withholding provisions. Subchapter A-Nonresident Aliens and Foreign Corporations Sec. 1441. Withholding of tax on nonresident aliens. Sec. 1442. Withholding of tax on foreign corporations. Sec. 1443. Foreign tax-exempt organizations. SEC. 1441. WITHHOLDING OF TAX ON NONRESIDENT ALIENS. (a) GENERAL Rtri~E.-Except as otherwise provided in subsection (c), all persons, in whatever capacity acting (including lessees or mortgagors of real or personal property, fiduciaries, employers, and all officers and employees of the United States) having the control, receipt, custody, disposal, or payment of any of the items of income specified in subsection (b) (to the extent that any of such items con- stitutes gross income from sources within the United States), of any nonresident~ alien individual, or of any partnership not engaged in trade or business within the United States and composed in whole or in part of nonresident aliens, shall (except in the cases provided for in section 1451 and except as otherwise provided in regulations pre- scribed by the Secretary or his delegate under section 874) deduct and withhold from such items a tax equal to 30 percent thereof, except that in the case of any item of income specified in the second sentence of subsection (b), the tax shall be equal to 14 percent of such item. (b) INco~n~ I~nlMs. -The items of income referred to in subsection (a) are interest ((except interest on deposits with persons carrying on .the banking business paid to persons not engaged in business in the United States)], dividends, rent, salaries, wages, premiums, an- nuities, compensations, remunerations, emoluments, or other fixed or determinable annual or periodical gains, profits and income,' (and amounts described in section 402(a) (2), `section 403 (a) (2), section 631 (b) and (c), and section 1235, which are considered to be gains from the sale or exchange çf capital assets.] and gains described in section 402(a) (2), 403(a) (2), or 831 (b) or (c), and gains on transfers described in section 1235. The items of income referred to in sub- section (a) from which tax shall be deducted and withheld at the rate of 14 percent are- (1) that portion of any `scholarship or fellowship grant which is received by a nonresident alien individual who is temporarily present in the United States as a nonilumigrant under subpara- 831 PAGENO="0842" 166 FOREIGN INVESTORS TAX ACT OF 1966 graph (F) or (J) of section 101(a) (15) of the Inimigration and Nationality Act, as amended, and which, not excluded from gross income under section 117(a) (1), solely by reason of section 117(b) (2) (B) ;and (2) amounts described in subparagraphs (A), (B), (C), and * (D) of section 117(a) (2) which are received by any such non- * resident alien individual and which are incident to. a scholarship or fellowship grant to which section 117(a)(1) applies, but only to the e~tent such amounts are includible in gross income. (c) EXCEPTIONS.- ((1) DIVIDENDS OF FOREIGN (JORPORATI0NS.-NO deduction or withholding: under subsection (a) shall be required in the case of dividends paid by a foreign corporation unless (A) such corpo- ration is engaged in trade or business within the United States, and (B) more than 85 percent of the gross income of such corpo- ration for the 3-year period ending with the close of its taxable year preceding the declaration bf such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under part I of subchapter N of chapter 1.] (1.) INcOME CONNECTED WITH UNITED STATES BUSINESS.-NO de- d~wctio#m or withholding under .snbsection (a) shall be reçpiired in the case of any . item of income . (other than compensation for personal services) which is effectively connected with the conduct of a trade or bv~siness within, the United States and on which a taxis imposed fOr the taxable pear pvrsuont to section 871 (b) (1). (2) OWNER tTNKN0WN.-The Secretary or his delegate may authorize the tax under subsection (a) to be deducted and with- held from the interest upon any securities the owners of~ which are not known to the withholding agt~nt. (3) BONDS WITH EX?~ENDFJ) MAT(TRITY DATE5.-The deduction and withholding in the case of interest on bonds, mortgages, or deeds of trust or other similar obligations of a corporation, within subsections~ (a)., (b), and (c) of section 1451 were it not for the * . fact that the maturity date of such obligations has been ex- tended on or after January 1, 1934, and the liability assumed by * the debtor exceeds 21/2 percent of the interest, shall not exceed the rate of 27i/2 percent per annum. (4) COMPENSATION OF CERTAIN ALIEN5.-Under regulations prescribed by the Secretary or his delegate, (there] cow~peneation for personal services may be exempted from deduction and with- * holding under subsection (a) (the compensation for personal services of- ((A) nonresident aiien individuals who enter and leave the United `States at frequent intervals, and ((B) a nonresident alien individual for the period he is temporarily present in the United States as a nonimmigrant under subparagraph (F) or (J) of section 101 (a) (15) of the Immigration and Nationality Act, `as amended]. (5) SPECIAL ITEMS.-In the case of (amounts described in section 402(a)(2), section 403(a) (2), section 631 (b) and (`c), and section 1235, which are considered to be gains from `the, sale or 832 PAGENO="0843" FOREIGN INVESTORS TAX ACT OF 1966 167 exchange of capital assets,] gains described in section 402(a) (2), 403(a) (2), or 631 (b) or (c), and gains i~'n tranfers described in section 1235, the amount required to be deducted and withheld shall, if the amount of such gain is not known to `the withholding agent, be such amount, not exceeding 30 percent of the (proceeds from such sale or exchange] amount payable, as may be necessary to assure that the tax deducted and withheld shall not be less than 30 percent of such gain. (6) PER DIEM OF CERTAIN ALIEN5.-No deduction or withhold- ing under subsection (a) shall be required in the case of amounts of per diem for subsistence paid by the United States Government (directly or by contract) to any nonresident alien individual who is engaged in any program of training in the United States under the Mutual Security Act of 1954, as amended. (d) ALIEN RESIDENT OF PUERTO Rioo.-For purposes of this section, the term "nonresident alien individual" includes an alien resident of Puerto Rico. SEC. 1442. WITHHOLDING OF TAX ON FOREIGN CORPORATIONS. (a) GENERAL RuLE.-In the case of foreign corporations subject to taxation. under this subtitle (not engaged in trade or business within the United States], there shall be deducted and withheld at the source in the same manner and on the same items of income as is provided in section 1441 or section 1451 `a' tax equal to 30 percent thereof; except that, in the case of interest described in section 1451 (relating to tax- free covenant bonds), the deduction and withholding shall be at the rate specified' therein. For purposes of the preceding sentence, the reference in section 1441(c) (1) to section 871(b) (1) shall be treated as referring to section 842 or section 882(a), as the case may be. (b) EXEMPTI0N.-Subject to such, terms and conditions as may be provided by regulations prescribed by the Secretary or his delegate, subsection (a) shall not apply in the case of a foreign corporation en- gaged in trade or business within the United States if the Secretary or his delegate determines that the requirements of subsection (a) imposes an undue administrative burden and that the collection of the tax imposed by section 881 on such corporation will not be jeopardised by the exemption. * * * * * * * Subchapter C-Application of Withholding Provisions * * * * * * * SEC. 1461. [RETURN AND PAYMENT OF] L!ABIL!TY FOR WITHHELD TAX. Every person required to deduct and withhold any tax under this chapter (shall, on or before March 15 of each year, make return thereof `and pay the tax to the officer designated in section 6151. Every such person] is hereby made liable for such tax and is hereby indemnified against the claims and demands of any person for the amount of any payments made in accordance with the' provisions of this chapter. * * * * * * * 833 PAGENO="0844" 168 FOREIGN INVESTORS TAX ACT OF 1966 Subtitle B-Estate and Gift Taxes * * * ** * *. * CHAPTER il-ESTATE TAX ``1 * * ~* * Subchapter A-Estates of Citizens or Residents * * * * * * * PART I-TAX IMPOSED Sec1 2001. Rate of tax. Sec. 2002. Liability for payment. SEC. 2001. RATE OF TAL A tax computed in accordance `with the' fOllowing table is hereby imposed on the transfer of the taxable estate, determmed as provided in `section 2051, of every decedent, citizen or resident of the United States dying after the date of enactment of this title: If the taxable estate is: The tax shall be: Not over $5,000 3% of the taxable estate. Over $5,000 but not over $10,000 $150, plus 7% of excess over Over $10,000 but not over $20,000 $500, pius 11% of excess over $10,000. Over $20,000 but not over $30,000 $1,600, plus 14% of excess over $20,000. Over $30,000 but not over $40,000 $3,000, plus 18% of excess over $30,000. Over $40,000 but not over $50,000 $4,800, plus 22% of excess over $40,000. Over $50,000 but not over $60,000 ` $7,000, plus 25% of excess over $50,000. Over $60,000 `but not over $100,000 $9,500, plus 28% of excess over * $60,000. Over $100,000 but not over $250,000 $20,700, plus 30% of excess over $100,000. Over $250,000 but not over $500,000 $65,700, plus 32% of excess over * " ` $250,000. Over $500,000 but not over $750,000 $145,700, plus 35% of excess over $500,000. Over $750,000 but not over $1,000,000 $233,200, plus 37% of excess over $750,000. Over $1,000,000 but not over $1,250,000..._... $325,700, plus 39% of excess over $1,000,000. Over $1,250,000 but not over $1,500,000~. $423,200, plus 42% of excess over $1,250 000. Over $1,500,000 but not over $2,000,000_.... $528,200, plus 45% of excess over $1,500,000. Over $2,000,000 but not over $2,500,000_.~ $753,200, plus 49% of excess over $2 000 000. Over $2,500,000 but not over $3,000,000_.... $998,200, plus 53% of excess over Over $3,000,000 but not over $3,500,000_.... $1~3,2ó0, plus 56% of excess over $3000000. Over $3,500,000 but not over $4,000,000_... $1,543,200, plus 59% of excesa over $3,500,000. 834 PAGENO="0845" FOREIGN INVESTORS TAX ACT OF 1966 1.9 If the taxable estate is-Continued The tax shall be-Continued Over $4,000,000 but not over $5,000,000___ $1,838,200, plus 63% of excess over $4,000,000. Over $5,000,000 but not over $6,000,000___ $2,468,200, plus 67% of excess over $5,000,000. Over $6,000,000 but not over $7,000,000___ $3,138,200, plus 70% of excess over $6,000,000. Over $7,000,000 but not over $8,000,000___ $3,838,200, plus 73% of excess over $7,000,000. Over $8,000,000 but not over $10,000,000_. $4,568,200, plus 76% of excess over $8,000,000. Over $10,000,000 $6,088,200, plus 77% of excess over $10,000,000. * * * * * * PART Il-CREDITS AGAINST TAX * * * * * * * SEC. 2014. CREDIT FOR FOREIGN DEATH TAXES. (a) IN GENERAL.-The tax imposed by. section 2001 shall be credited with the amount. of any estate, inheritance, legacy, or succession taxes actually paid to any foreign country in respect of any property situ- ated within such foreign country and included in the gross estate (not including any such taxes paid with respect to the estate of a person other than the decedent). (If the decedent at the time of his death was not a citizen of the United States, credit shall not be allOwed under this section unless the foreign country of which such decedent was a citizen or subject, in imposing such taxes, allows a similar credit in the case of a citizen of the United States resident in such country.]. The determination of the country within which property is situated shall be made in accordance with the rules ap- plicable under subchapter B (sec. 2101 and following) in determin- ing whether property is situated within or without the United States. * ** * .** * * * * "~ (h) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN RESiDENTS.- Whenever the President finds that- (1) a foreign country, in imposing estate, inheritance, legacy, or succession taxes, does not allow to citizens of the United States res- ident in such foreign country at the time of death a credit similar to the credit allowed under subsection (a), (2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, and (3) it is in the public interest to allow the credit under subsec- tion (a) in the case of citizens or subjects of such foreign country only if it allows such a similar credit in the case of citizens of the United States resident in such foreign country at the- time of death, the President shall proclaim that, in the case of citizens or subjects of ~such foreign country dying while the p'roclamation remains in effect, the credit under subsection (a) shall be allowed only if such foreign country allows such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death. * * * * * * * 835 PAGENO="0846" 170 FOREIGN INVESTORS TAX ACT OF 1966 Subchapter B-Estates of Nonresidents Not Citizens Sec. 2101. Tax imposed. Sec. 2102. Credits against tax. Sec. 2103. Definition of gross estate. Sec. 2104. Property within the United States. Sec. 2105. Property without the United States. Sec. 2106. Taxable estate. Sec. 2107. Expatriation to avoid tax. Sec. 2108. Application of pre-1967 estate tax provisions. SEC. 2101. TAX IMPOSED. [(a) IN GENERAL.-A tax computed in accordance with the table contained in section 2001 is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every de- cedent nonresident not a citizen of the United States dying after the date of enactment of this title.] (a) RATE OF TAX.-Except as provided in section 2107, a tax corn-. puted in accordance with the following table is hereby imposed on the transfer of the taceable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States: If the taxable estate is: The tax shall be: Not over $100,000 5% of the taxable estate. Over $100,000 but not over $500,000 $5,000, plus 10% of excess over $100,000. Over $500,000 but not aver $1,000,000---- $45,000, plus 15% of excess over $500,000. Over $1,000,000 but not over $2,000,000___ $120,000, plus 20% of excess over $1,000,000. Over $2,000,000 $320,000, plus 25% of excess aver ;~,ooo,ooo. (b) PROPERTY HELl) BY ALu~N PROPERTY CUSTODIAN.- For taxes ii connection with property or interests transferred to or vested in. the Alien Property Custodian, see section 36 of the Trading with the Enemy Act, as added by the Act of August 8, 1946 (60 Stat. 929; 50 U.S.C. App. 36). SEC. 2102. CREDITS AGAINST TAX. (a) IN GENE1w~.-The tax imposed by section 2101 shall be credited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), subject to the special limitation provided in subsection (b). (b) SPECIAL LIMITATI0N.-The maximum credit allowed under sec- tion 2011 against the taoi imposed by section 2701 for State death tacces paid shall be an amount which bears the same ratio to the credit corn- pitted as provided in section 2011(b) as the value of the property, as de- terirtined for purposes of this chapter, upon which State death taxes~ were paid a~nd which is included in the gross estate under section 210 bears to the value of the total gross estate under section 2103. For pur- poses of this subsection, the term "State. death taxes" means the tacce& described in section 2011(a). 836 PAGENO="0847" FOREIGN INVESTORS TAX ACT OF 1966 171 SEC. 2103. DEFINITION OF GROSS ESTATE. For the purpose of the tax imposed by section 2101, the value of the gross estate of every decedent nonresident not a citizen of the United States shall be that part of his gross estnte (determined as provided in section 2031) which at the time of his death is situated in the United States. SEC. 2104. PROPERTY WITHIN THE UNITED STATES. (a) STOCK IN C0RP0RATI0N.-For purposes of this subchapter shares of stock owned and held by a nonresident not a citizen of the United States shall be deemed property within the United States only if issued by a domestic corporation. (b) REVOCABLE TRANSFERS AND TRANSFERS IN CONTEMPLATION or DEATH.-FOr purposes of this subchapter, any property of which the decedent has made a transfer, by trust or otherwise, within the meaning of sections 2035 to 2038, inclusive, shall be deemed to be situated in the United States, if so situated either at the time of the transfer or at the time of the decedent's death. (c) DEBT OBLIGATI0NS.-For purposes of this subchapter, debt obligatio'ms of- (1) a United States person, or (2) the United States, .a State or any political subdivision thereof, or the District of Columbia, owned by a nonresident not a. citisen of the United States shall be deemed property within the United States. This subsection shall not apply to a debt obligation of a domestic corporation if any interest on such obligation, were such interest received by the decedent at the time. of his death, would be treated by reason of section 861 (a) (1) (B) as income from sources without the United States. SEC. 2105. PROPERTY WITHOUT THE UNITED STATES. (a) PROCEEDS OF Lin~ TNSURANcE.-For purposes of this sub- chapter, the amount receivable as insurance on the life of a nonresident not a citizen of the United States shall not be deemed property within the United States. ((b) BANK DEPOSITS.-For purposes of this subchapter, any moneys deposited with any person carrying on the banking business, by or for a nonresident not a citizen of the Tjnited States who was not engaged in business in the United States at the time of his death shall not be deemed property within the United States.] (b) DEPOSITS IN CERTAIN FOREIGN BRANCH ES.-FO? purposes of this subchapter, deposits with a fo~ign branch of a domestic corpora- tion, if such branch is engaged in the commercial banking buRiness, shall not be deemed property within the United States. (c) WORKS OF ART ON LOAN FOR ExrnBrrIoN.-For purposes of this subchapter, works of art owned by a nonresident not a citizen of the United States shall not be deemed property within the United States if such works of art are- (1) imported into the United States solely for exhibition purposes,: 837 PAGENO="0848" 1172 FOREIGN INVESTORS TAX ACT OF 1966 (2) loaned for such purposes, to a public gallery or museum, no part of the net earnings of which inures to the benefit of any * private stockholder or individual, and * (3) at the time of the death of the owner, on exhibition, or en route to or from exhibition, in such a public gallery or museum. SEC. 2106. TAXABLE ESTATE. (a) DEFINrrI0N OF TAXABLE ESTATE.-FOr purposes of the tax imposed by section 2101, the value of the taxable estate of every decedent nonresident not a citizen of the United States shall be de- termined by deducting from the value of that part of his gross estate which at the time of his death is situated in the United States- * * * * * .* * * (3) EXEMPTION.- (A) GENERAL RtLE.-Afl exemption of [$2,000] $30,000. * (B) RESIDENTS OF POSSESSIONS OF THE UNITED STATES.-Tfl the case of a decedent who is considered to be a "non-i~esident nQt a citizen Of the United States" under the provisions of section 2209, the exemption shall be the greater of (i) [$2,000] $30,000, or (ii) that proportion of the exemption authorized by section 2052 which the value of that part of * the decedent's gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated. (b) CONDITION OF ALLOWANCE OF DEDUCTION.-NO deduction shall be allowed under paragraphs (1) and (2) of subsection~ (a) in the case of a nonresident not a citizen of the United States unless the executor includes in the return required to be filed under section 6018 the value at the time of his death of that part of the gross estate of such non- resident not situated in the United States.. (c) UNITED STATES Bo*~s.-For purposes of section 2103, the value of the gross estate~ (determined as provided in section 2031) of a decedent who was not engaged in business in the United States at the time of his death- (1) shall not include obligations issued by the United States before March 1, 1941; and (2) shall include obligations issued by the United States on or * after March 1, 1941. SEC. 2107. EXPATRIATION TO AVOID TAX. (a) RATE OF TAX.-A tax computed in accordance with the table contained in section 2001 is hereby imposed on the transfer of the face- able estate, deter?mined as provided in section 2106, of every decedent `nonresident `not a citisen of the United States dying after the date of enactment of this section, if after March 8, 1965, and within the 10- ~year period ending with the date of death such decedent lost United States citisenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. (b) GRoss ESTATE.-FOr purposes of the tax imposed by subsection (a), the value of the gross estate of every decedent to whom subsec- tion (a) applies shall be deternlined as provided in section 2103, except that- 838 PAGENO="0849" FOREIGN INVESTORS TAX ACT OF 1966 173 (1) if such decedent owned (within the meaning of section 958(a)) at the time of his death 10 percent or more of the total combined voting po'wer of all classes of stock entitled to vote of a foreign corporation, and (2) if such decedent owned (within the meaning' of section 958(a)), or is considered to have owned (by applying the owner- ship rules of section 958(b)), at the time of his death, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of such foreign corporation, then that proportion of the fair market value of the stock of such for- .eign corporation owned (within the meaning of section 958(a)) by such decedent at the time of his death, which the fair market value of any c~sets owned by such. foreign corporation and situated in the United States, at the time of his death, bears to the total fair market value of all assets owned by such foreign corporation at the time of his death, shall be included in the gross estate of suck decedent. For pur- poses of the preceding sentence, a decedent shall be treated as owning stock of a foreign corporation at the time of his death if, at the time of a transfer, by trust or otherwise, within the meaning of sections 2035 to 2038, inclusive, he owned such stock. (c) CREDIT5.-The tax imposed by subsection (a) shall be credited with the amounts determined in accordance with section 2102. (d) EXCEPTION FOR Loss OF. GITIZENSHIP FOR GERTAIN GA USES.- Subsection (a) shall not, apply to. the transfer of the estate of a de- cedent w ose loss of United States citizenship resulted from the appli- cation of section 301 (b), 350, or 355 of the Immigration and National- ity Act, as amended (8 U.S.C. 1401(b) ,1482, or 1487). (e) BURDEN OF PRQoF~-If the Secretary or his delegate establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction in the estate, inheritance, legacy, and succession taxes in respect of the transfer of his estate, the burden of proving that such loss of citizen- ship did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A shall be on the executor of such individual's estate. SEC. 2108. APPLICATION OF PRE-1967 ESTATE TAX PROVISIONS. (a). IMPOSITION OF MORE BURDENSOME TAX BY FOREIGN COUNTRY.- Whenever the President finds that- (1) under the laws of any foreign country, considering the tax system of such foreign country, a more burdensome tax is imposed by such foreign country on the transfer of estates of decedents who were citizens of the United States. and not residents of such foreign country than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, (2) such foreign country, when `requested by the United States to do so, has not acted to revise or reduce such tax so that it is no n-tore burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, and 7 1-297 0-67-pt 1-54 839 PAGENO="0850" 174 FOREIGN INVESTORS TAX ACT OF 1966 (3) it is in the public interest to apply pre-1967 tax provisions in accordance with this section to the transfer of estates of dece- dents who were residents of such foreign country, the Presidejtt shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to amendments made to section 2101 (relating to tax imposed), 2102 (re- lating to credits against tax), 2106 (relating to taxable estate), and 6018 (relating to estate tax returns) on or after the date of enactment of this section. (b) ALLEVIATION OF MORE BUEDENSOME TAx.-TVhenever the Presi- dent finds that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that the tax on the transfer of `estates I of decedents who were citisens of the United States and not residents of such foreign country is no longer more burdensome that the tax imposed by this' subchapter on the transfer of estates of decedents who were residents' of such foreign country, he shall proclaim that the tax on the transfer of the estate of every decedent who was a `resident' of such foreign country at the time of his death shall, in the case of decedents dying' after the date of such proclamation, be determined under this sub- chapter without regard to subsection (a). (c) NOTIFICATION OF CONGRESS REQUIRED.-NO proclamation shalt be issued by the President pursuant to this section unless, at least 30' days prior to such proclamation, he has notified the Senate and the' House of Representatives of his intention to issue such proclamation. (d) IMPLEMENTATION BY REGULATIONS.-The Secretary or his dd.e- gate shall prescribe such regulations as may be necessary or appro- priate to implement this section. * * * * * * * CHAPTER 12-GIFT TAX Subchapter A. Determination of tax liability. Subchapter B. Transfers. Subchapter 0. `Deductions. Subchapter A-Determination of Tax Liability Sec. 2501. Imposition of tax. Sec. 2502. Rate of tax. Sec. 2503. Taxable gifts. Sec. 2504. Taxable gifts for preceding years. SEC. 2501. IMPOSITION OF TAX. (a) TAXABLE TRANSFERS.- (1) GE~an~L RULE.-For the calendar year 1955 and each, calendar year thereafter a tax, computed as provided in section 2502, is hereby imposed on the transfer of propexty by gift during such calendar year by any individual," resident or nonresident. [except transfers]. 840 PAGENO="0851" FOREIGN INVESTORS TAX ACT OF 1966 175~ (2) TRANSFERS OF INTANGIBLE PR0FERTY.-Except as provided in paragraph (3), paragraph (1) shall `not apply to the transfer of intangible property by a nonresident not a citizen of the United States (who was not engaged in business in the. United States during such caJendar year]. (3) EIcEPTI0NS.-Paragraph (2) shall not apply in the case of a donor who at any time after March 8, 1965, and within the 10- year period ending with the date of transfer lost United States citi- zenship unless-. (A) such donor's loss of United States citizenship resulted from the application of section 301 (b), 350, or 355 of the Immigration and Nationality Act, a~ amended (8 U.S.C. 1401 (b) 1482, or 1487), or (p3) such lossdid not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. (4) BURDEN OF PRO0F.-If the Secretary or his delegate estab-~ lie hes that it is reasonable to believe that an individual's loss of United States citizenship would, but for paragraph (3), result in a substantial reduction for the calendar year in the taxes on the transfer of property by gift, the burden of proving that such loss~ of citizenship did not have for one of its principal purposes the a'coidance of taxes under this subtitle or subtitle A shall be on such- individual. * . * * * * * * Subchapter B-Transfers * * * * *~ * * SEC. 2511. TRANSFERS IN GENERAL (a) SO0PE.-Subject to the limitations contained in this chapter,. the tax imposed. by section 2501 shall apply whether the transfer j5; in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible; but in the case- of a nonresident not a citizen of the United States, shall apply to a transfer only if the property is situated within the United States. ((b) STocK n~ C0RP0RATI0N.-Shares of stock owned and held by a nonresident not a citizen of the United States shall be deemed property within the United States only if issued by a domestic cor- poration.] (b) INTANGIBLE PR0PERTY.-For purposes of this chapter, in the case~ of a nonresident not a citizen of the United States who is excepted from the application of section 2501 (a) (2)- (1) shares of stocic issued by a domestic corporation, and (2) debt obligations of- (A) a United States person, or (B) the United States, a State or any political subdivision. thereof, or the District of Columbia, which are owned by such nonresident shall be deemed to be propert7~c situated within the United States. * * *. * * * * 841 PAGENO="0852" 176 FOREIGN INVESTORS TAX ACT OF 1966 `CHAPTER 24-COLLECTION OF INCOME TAX AT SOURCE ON WAGES Sec. 3401. Definitions. Sec. 3402. Income tax collected at source. Sec. 3403. Liability for tax. Sec. 3404. ~Return and payment by governmental employer. ~SEC. 3401. DEFINITIONS. (a) WAGES.-FOr purposes of this chapter, the term "wages" means ~all remuneration (other than fees paid to a public official) for services performed by an employee for his employer, including the cash value ~of all remuneration paid in any medium other than cash; except that ~such term shall not include remuneration paid- * * * * * * * ((6) for services performed by a nonresident alien individual, other than- ( (A) a resident of a contiguous country who enters and leaves the United States at frequent intervals; or ((B) a resident of Puerto Rico if such services are per- formed as an employee of the United States or any agency thereof; or ((C) an individual who is temporarily present in the United States as a nonimmigrant under subparagraph (F) or (J) of section 101(a) (15) of the immigration and Nation- ality Act, as amended, if such remuneration is exempt, under section 1441(c) (4) (B), from deduction and withholding un- der section 1441 (a), and is not exempt from taxation under section 872(b) (3) ; or] ((7)] (8) for such services, performed by a nonresident alien individual (who is a resident of a contiguous country and who enters and leaves the United States at frequent intervals], as may be designated by regulations prescribed by the Secretary or his * delegate; or * ** * * .:Subt t1 F-Procedure and Administration ** * * * * * * CHAPTER 61-INFORMATION AND RETURNS Subchapter A-Returns and Records * * * * * * PART 11-TAX RETURNS OR STATEMENTS * * * * * * Subpart B-Income Tax Returns * * * * * * * :SEC. 6015. DECLARATION OF ESTIMATED INCOME TAX BY INDI- VIDUALS. (a) REQ1IIREMJDNT OF DEcLAIt&TIoN.-(Evei~y] Except as otherwise yrovided in subsection (i), every individual ((other than a nonresi- ~dent `alien with respect to whose wages, as defined in section 3401 (a), * * * 842 PAGENO="0853" FOREIGN INVESTORS TAX ACT OF 1966 177 withholding under chapter 24 is not made applicable, but including every alien individ~xal who is a resident of Puerto Rico during the entire taxable year)] shall make a declaration of his estimated tax for the taxable year if- (1) the gross income for the taxable year can reasonably be expected to exceed- (A) $5,000, in the case of- (i) a single individual other than a head of a house- hold (as defined in section 1(b)(2)) or a surviving spouse (as defined in section 2(b)); (ii) a married individual not entitled under subsection (b) to file a joint declaration with his spouse; or (iii) a married individual entitled under subsection (b) to file a joint declaration with his spouse, but onJy if the aggregate gross income of such individual and his spouse for the taxable year can reasonably be ex- pected to exceed $10,000; or (B) $10,000, in the case of- (i) a head of a household (as defined in section 1(b)(2)); or (ii) `a surviving spouse (as defined in section 2(b)) ; or (2) the gross income can reasonably be expected to include more than $200 from sources other than wages (`as defined in section 3401(a) ). Notwithstanding the provisions of this subsection, no declaration is required if the estimated tax (as defined in subsection (~)) can reason- ably be expected to be less than $40. * * * * * * (i) NO1~RE5I~DENT ALIEH INDIVIDUALS.-NO declaration shall be required to be made under this section by a nonresident alien individual `u~n2ess- (1) withholding under chapter 934 is niade applicable to the wages, as defined in section 3401 (a), of such individual, (Z) such individual has income (other than com~pensation for personal services subject to deduction and withholding under section 1441) which is effectively connected with the conduct of a trade or business within the United States, or (3) such individual is a resident of Puerto Rico during the en- tire taxable year. ((i)] (J) AIrI4Ici~u3ILrrY.-This section shall be applicable only with respect to taxable years beginning after December 31, 1954; and sec- tions 58, 59, and~60 of the Internal Revenue Code of 1939 shall con- tinue in force with respect to taxable years beginning before January 1, 1955. SEC. 6016. DECLARATIONS OF ESTIMATED INCOME TAX BY COR- PORATIONS. (a) R]~txnu~ME~n~ op DEoI~&i~ATIoN.-Every corporation subject to taxation under section 11 or 1201 (a), or subchapter L of chapter 1 (relating to insurance companies)., shall make a declaration of esti- 843 PAGENO="0854" 178 FOREIGN INVESTORS TAX ACT OF 1966 mated tax under chapter 1 for the taxable year if its income tax im- posed by section 11 or 1201 (a), or such subchapter L,'.for such taxable year, reduced by the credits against tax provided by part IV of sub- chapter A of chapter 1, can reasonably be expected to exceed $100,000. (b) ESTIMATED TAx.-For purposes of this title, in the ease of a corporation, the term "estimated tax" means the excess of- (1) the amount which the corporation estimates as. the amount of the income tax imposed by section 11 or 1201 (a), or subchapter L of chapter 1, whichever is applicable, over (2) the sum of- (A) $100,000, and (B) the amount which the corporation estimates as the sum of any credits against tax provided by part IV of subchapter A of chapter 1. (c) CONTENTS OF DECLARATION.-The declaration shall contain such pertinent information as the Secretary or his delegate may by forms or regulations prescribe. (d) AMENDMENT OF DECLARATION.-A corporation may make amendments of a declaration filed during the taxable year under regu- lations prescribed by the Secretary or his delegate. (e) SHORT TAXABLE YEAR.-A corporation with a taxable year of less than 12 months shall make a declaration in accordance with regu- lations prescribed by the Secretary or his delegate. (f) CERTAIN FoREIGN C0RF0RATI0NS.-For purposes of this section and section 6655, in the case of a foreign corporation subject to taxa- tion under section 11 or 1201(a), or under subchapter L of chapter 1, the tax in~posed by section 881 shall be treated a~ a tax i~imposed by section 11. [(f)] (g) Ci~oss REFERENCE.- For provisions relating to the number of amendments which may be filed, see section 6074(b). . . * * * * * * * SEC. 6018. ESTATE TAX RETURNS. . (a) RETURNS BY ExEotrroR.- (1) CITIZENS OR RE5IDENTS.-In all cases where the gross estate at the death of a citizen or resident exceeds $60,000, the executor shall make a return with respect to the estate tax imposed by sub- title B. (2) NONRESIDENTS NOT CITIZENS OF THE UNITED STATES.-Tfl the case of the estate oF every nonresident not a citizen of the United States if that part of the gross estate which is situated in the United States exceeds [$2,000] $80,000, the executor shall make a return with respect to the estate tax imposed by sub- title B. (b) RETURNS BY BE 1FICIARIE5.-If the executor is unable to make a complete return as to any part of the gross estate of the decedent, he shall include in his return a description of such part and the name of every person holding a legal or beneficial interest therein. Upon notice from the Secretary or his delegate such person shall in like manner make a return as to such part of the gross estate. * ** * * * * * 844 PAGENO="0855" FOREIGN INVESTORS TAX ACT OF 1966 179 CHAPTER 79-DEFINITIONS * * * * * * SEC. 7701. DEFINITIONS. (a) When used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof- * * * * * * * (31) FomnoN ESTATE OR TRUST.-The terms "foreign estate" and "foreign trust" mean an estate or trust, as the case may be, the income of which [from sources without the United States] fron-~ sowrces withont the United States which is not effectivel7/ connected with the conduct of a trade or business within the United States, is not includible in gross income under subtitle A. * * * * * *. * 845 PAGENO="0856" PAGENO="0857" SECTION 18 HOUSE FLOOR DEBATE (From the daily Congressional Record) 847 PAGENO="0858" PAGENO="0859" [June 15, 1966] [P. 12669] PROVIDING EQUITABLE TAX TREATMENT FOR FOREIGN IN- VESTMENTS IN THE UNITED STATES Mr. MADDEN. Mr. Speaker, by direc- tion of the Committee on Rules, I call up the resolution (H. Res. 880) provid- ing for the consideration of H.R. 13103, a bill to amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States, and ask for its immediate consideration. The Clerk read the resolution, as fol- lows: H. RES. 880 Resolved, That upon the adoption of this resolution it shall be in order to move that the House resolve itself into the Committee of the Whole House on the State of the Union for the consideration of the bill (HR. 13103) to amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign Investment In the United States, and all points of order against said bill are hereby waived. After general debate, which shall be confined to the bill and shall con- tinue not to exceed three hours, to be equally divided and controlled by. the chairman and ranking minority member of the Committee on Ways and Means, the bill shall be con- sidered as having been read for amendment. No amendment shall be in order to said bill except amendments offered by direction of the Committee on Ways and Means, and said amendments shall be in order, any rule of the House to the contrary notwithstanding. Amendments offered by direction of the Com- mittee on Ways and Means may be offered to any section of the bill at the conclusion of the general debate, but said amendments shall not be subject to amendment. At the conclusion of the consideration of the bill for amendment, the Committee shall rise and report the bill to the House with such amendments as may have been adopted, and the previous question shall be considered as ordered on the bill and amendments thereto to final passage without intervening motion except one motion to recommit. The SPEAKER. The Chair recog- nizes the gentleman from Indiana [Mr. MADDEN] for 1 hour. Mr. MADDEN. Mr. Speaker, I yield 30 minutes to the gentleman from Cali- fornia [Mr. SMITH] and pending that yield myself such time as I may require. [Mr. MADDEN addressed the House. His remarks will appear hereafter in the Appendix.] (Mr. SMITH of California asked and was given permission to revise and ex- tend his remarks.) Mr. SMITH of California. Mr. Speak- er, I yield myself such time as I may use. As stated by the distinguished gentleman from Indiana, House Resolution 880 pro- vides a 3-hour rule for the consideration of H.R. 13103, the Foreign Investors Tax Act of 1966. It is a closed rule and points of order are waived. In addition to what the gentleman from Indiana stated, you will find that the committee has listed 23 principal changes in the law and these are sum- marized in the report on pages 2 through 5. A key to several changes in the bill is whether income is to be subjected to a fiat 30-percent rate or taxed sub- stantially the same as income earned here by a U.S. citizen or do~riestic corpo- ration. The decision turns oitwLhether or not the income is effectively connected with a U.S. business. If so, it is treated about the same as income from a domes- tic business. If not, it is subjected to the fiat 30-percent rate of taxation, or the lower treaty rate in some cases. I know of no objection to the rule and have no requests for time. Mr. MADDEN. Mr. Speaker, I move the previous question. The previous question was ordered. The resolution was agreed to. A motion to reconsider was laid on the table. [P. 12679] FOREIGN INVESTORS TAX ACT OF 1966 Mr. MILLS. Mr. Speaker, I move that the House resolve itself into the Com- mittee of the Whole House on the State of the Union for the consideration of the bill (HR. 13103) to amend the In- ternal Revenue Code of 1954 to provide equitable tax treatment for foreign in- vestment in the United States. The SPEAKER pro tempore. The question is on the motion offered by the gentleman from Arkansas. The motion was agreed to. IN THE COMMITTEE OF THE WHOLE Accordingly, the House resolved itself into the Committee of the Whole House on the State of the Union for the con- sideration of the bill H.R. 13103, with Mr. MADDEN in the chair. The Clerk read the title of the bill. By Unanimous consent, the first read- ing of the bill was dispensed with. The CHAIRMAN. Under the rule the gentleman from Arkansas [Mr. MILLS] will be recognized for 11/2 hours and the gentleman from Wisconsin [Mr. BYRNESJ will be recognized for 1 `/2 hours. The Chair recognizes the gentleman from Arkansas [Mr. MILLs]. Mr. MILLS. Mr. Chairthan, I yield myself 10 minutes. (Mr. MILLS asked and was given per- mission to revise and extend his re- marks.) Mr. MILLS. Mr. Chairman, the bill H.R. 13103, in my opinion represents a major revision of the U.S. tax laws with reference to the treatment of nonresident 849 PAGENO="0860" [P. 12680J aliens and foreign corporations. It is the first systematic reappraisal in this area of our tax law which has been un- dertaken, as I remember the record, for approximately 25 years. Mr. Chairman, although this bill will have only a slight effect on revenue and will not directly affect U.S. citizens or groups, in my opinion it represents a sub- stantial effort on the part of the Com- mittee on Ways and Means. PURPOSE AND BACKGROUND OF BILL Mr. Chairman, in October 1963, the President, as a part of his program to im- prove the U.S. balance of payments ap- pointed a task force on "Promoting In- creased Foreign Investment in United States Corporate Securities and In- creased Foreign Financing for United States Corporations Operating Abroad." Among the recommendations of the task force were a series of proposals de- signed to modify the U.S. taxation of for- eign investors. The Treasury Depart- ment studied the recommendations of the task force, and in March of 1965 sub- mitted to the Congress proposed legis- lation designed to increase foreign in- vestment in the United States. Public hearings were held on this leg- islation during 1965 and again in 1966. During this same period, your com- mittee extensively considered the pro- posal in executive session on numerous occasions. Your committee concluded that this area of the tax law was in need of change, but your committee altered the primary objective of the legislation suggested by the Treasury Department. The bill, as modified by your commit- tee, seeks as its primary objective the equitable tax treatment by the United States of nonresident aliens and foreign corporations. While, as I indicated, the initial proposals of the Treasury Depart- ment were concerned only with part of the tax provisions of the present law affecting nonresident aliens and foreign corporations-primarily those which could be modified to stimulate invest- ments by foreigners in the United States-your committee considered more broadly the appropriateness of all the provisions of the present law affecting these foreign persons. REVENUE ESTIMATES It is expected the bill will result in a revenue gain at current income and in- vestment levels of slightly over $1 mil- lion a year. In addition, the provision of the bill under which the Treasury is au- thorized to require quarterly payments of withheld taxes-instead of annual payments as now provided-is expected to increase collections on a one-shot basis in the fiscal 1967 by $221/I million. MAJOR PROVISIONS OF THE BILL Let me now talk about the major pro- visions of the bill. In this connection I ask unanimous consent, Mr. Chairman, to include at the end of my discussion a summary of these principal provisions of this bill. This summary reduces them, I believe, to as simple terms as it is pos- sible in view of the complexity of the matters involved here. The CHAIRMAN. Without objection, it is so ordered. There was no objection. 1. TAXABLE STATUS OF INCOME Mr. MILLS. Mr. Chairman, the first part of the bill deals with the taxable status of income. Undoubtedly, the most important proposal from the standpoint of tax policy is the amendment which separates the U.S. investment income from the U.S. business income of a non- resident alien or foreign corporation and taxes these two types of income on dif- ferent bases. Income of a foreigner derived from a U.S. business is to be taxed substantially in the same manner as if the business income were received by a U.S. citizen or a domestic corporation-that is, at the regular individual or corporate rates with all of the appropriate deductions. On the other hand, investment income of a nonresident alien or foreign cor- poration, unless it is related to a U.S. business, is to be taxed at a fiat rate of 30 percent or a lesser rate applicable where we have treaties with the foreign countries involved. Your committee believes this method of taxing nonresident aliens and foreign corporations is more equitable and rea- sonable than the present law which taxes these persons at the regular rates or a fiat 30 percent on their U.S. source in- come, depending on whether or not they are engaged in trade or business in the United States. In other words, under present law, investment income of a non- resident alien or foreign corporation is taxed at the regular rates, with the at- tributable reductions, if the recipient is engaged in business in the United States whether or not there is any relationship between the U.S. business and the U.S. investment income. Additionally, your committee's atten- tion was directed to the fact as a result of the interplay between the tax rules of certain foreign countries and the United States, foreign corporations which carry on substantial business activities in the United States, in some cases, have been able to cast their transactions in a form which may avoid all or most U.S. and foreign taxes on income generated from U.S. business activities. The provisions provided by this legislation will subject certain income generated by the U.S. business activities of these foreign cor- porations to U.S. tax. The benchmark used in determining whether or not income is related to a U.S. business and, therefore taxable at regular rates rather than at the fiat 30- 850 PAGENO="0861" percent rate, is whether or not the in- come is effectively connected with the U.S. business. In the case of investment and other fixed or determinable income and capital gains from U.S. sources the income is to be treated as effectively connected with the U.S. business if the income is derived from assets used, or held for use, in the conduct of U.S. business or if the activi- ties of the U.S. business were a material factor in the realization of the income. All other types of U.S. source income are to be considered to be effectively con- nected if there is a U.S. business. Income from sources without the United States will not be treated as effec- .tively connected with a U.S. business un- less the nonresident alien or foreign cor- poration has a fixed place of business In the United States and the income is at- tributable to that place of business. Moreover, even in such cases the only types of foreign source income which may be subject to U.S. tax under the bill are rents or royalties from licensing operations, income from banking. and similar type operations, or certain types of sales income. Moreover, neither "Sub- part F" income nor dividends, interest or royalties derived from a foreign cor- poration more than 50 percent owned by the nonresident alien or foreign cor- poration, will be considered effectively connected under any circumstances. 2. INCOME TAX SOURCE RULES The bill proposes an amendment with respect to the taxation of the interest paid to nonresident aliens and foreign corporations on their U.S. bank de- posits. Presently this type of interest income is subject to U.S. tax only. if the foreign recipient is engaged in trade or business in the United States. Your committee believes that it is questionable whether interest income of This type, which is so clearly derived from U.S. sources, should be treated as though derived from sources without the United States and thereby escape U.S. taxation. At the same time, however, your commit- tee realizes that immediate alteration of the present rule might have an adverse effect upon our balance of payments. To meet these two quite different objectives your commmittee's bill repeals this spe- cial foreign source rule, but postpones the repeal until after 1971. At that time your committee will have an opportunity to reconsider any balance of payments problem that then exists. The bill also provides that as long as bank deposit interest is treated as foreign source income, similar types of interest income are to be given the same treatment. On the other hand, the present rule with respect to interest paid to nonresi- dent alien individuals or foreign corpora- tions on deposits with foreign branches of U.S. banks would be changed. As amended, this type of interest would be treated as from sources without the United States, and therefore not subject to U.S. tax. Your committee believes that it was appropriate to treat this type of interest as from sources without the United States, since in reality that is what it is. Also it is believed that this amendment was necessary to place these foreign branches of U.S. banks in a com- petitive position with the other banks in the foreign countries in which they are located. 3. ESTATE TAX PROVISIONS Another major amendment -would modify the United States estate taxation of nonresident aliens. Although the U.S. estates of nonresident aliens are pres- ently, subject to the same estate tax rates as citizens or residents, the deductions, exemptions, and credit available to them are substantially less than those allowed to citizens or residents of the United States. Therefore, the estate of a non- resident alien frequently pays a heavier tax on its U.S. assets-and, in some in- stances, a much heavier tax-than would [P. 12681] be true in the case of a similar estate of a U.S. citizen or resident. In an effort to more closely equate the taxation of the U.S. estates of nonresident aliens with the estates of U.S. citizens or residents, the bill would establish a new scale of graduated estate `tax rates applicable to nonresident aliens, which would tax those estates in an amount which would be generally equivalent to the tax im- posed upon an~ estate of similar value of a U.S. citizen entitled to a martial de- duction. Also, the bill would raise the estate tax exemption of nonresident aliens from $2,000 to $30,000. The present rule, which excludes de- posits in U.S. banks from the gross U.S. estate of a nonresident alien, would be amended by this bill so as to include these assets in the gross estate of such a persons since they are includible in the estates of American citizens and resi- dents. Additionally, as in the case of the in- come tax amendments in this bill, a new provision is added to the estate tax pro- visions which excludes the deposits by foreigners in foreign branches of U.S. banks from the U.S. taxable estates of nonresident aliens. This is done for the simple reason that those assets never enter the United States. 4. EXPATRIATION PROVISIONS The bill also provides an amendment which establishes special tax treatment for U.S. citizens who expatriate in order to avoid U.S. taxes. Your committee con- siders such an amendment necessary since-although there are undoubtedly few Americans who would avail them- selves of such a maneuver-but for this provision, the bill does make such a scheme more advantageous. Therefore, 851 PAGENO="0862" we wish to foreclose the possibility that this bill would serve as an encourage- ment to such people. Generally, the ex- patriation provisions of this bill provide that U.S. source income and the effec- tively connected income of a citizen re- ceived within 5 years after expatriation i,~ to be taxed at the regular U.S. tax rates if a principal purpose of the ex- patriation was the avoidance of U.S. taxes. 5. OTHER AMENDMENTS The remaining amendments, which I will not discuss in detail, dO not, in my opinion, constitute major changes. In any event I would like to include in the RECORD at this point the summary of the principal changes and previously re- ferredto: SUMMARY OF PRINCIPAL PROVISIONS A; TAXATION OF FOREIGN CORPORATIONS 1. The regular corporate income tax is to apply to all Income of foreign corporations which is "effectively connected" with a U.S. business. Under present law, the regular corporate rate applies to all U.S. source in- come of a foreign corporation which is en- gaged In a trade or business in this country, whether or not the income In question Is connected with that business. 2. Income of a foreign corporation which is not "effectively connected" with a U.S. business is to be taxed at a flat 30 percent rate (or lower treaty rate). 3. In general, income is to be treated as "effectively connected" with a U.S. business If the underlying assets were used or held for use In a U.S. business or if the activities of the U.S. business were a material factor in producing the income. Income from for- eign sources will be treated as "effectively connected" only In the case of rents and royalties from licensing, certain banking In- come, and sales income, but only to the ex- tent that this income Is not "subpart F" in- come. 4. Foreign corporations carrying on a life insurance business in the United States are to be taxed as life insurance companies on income "effectively connected" with this U.S. business. Other income from U.S. sources is to be subject to the flat 30 percent rate (or lower treaty rate). B. TAXATION OF NONRESIDENT ALIENS 1. Investment and other fixed or determin- able income of nonresident aliens which is not "effectively connected" with a U.S. busi- ness is to be taxed at a flat 30 percent rate (or lower treaty rate). Under present law the regular rates generally apply with respect to this type of income where it is over $21,200. 2. Investment and other fixed or deter- minable income which ~Is "effectively con- nected" with a U.S. business Is to be taxed at the regular graduated individual rates. For purposes of determining whether the income is "effectively connected" the same rules apply as set forth above with respect to foreign corporations. 3. U.S. source capital gains which are not "effectively connected" with a U.S. business will be taxed to a nonresident alien only If he is in the United States for 183 days or more during the year. Presently capital gains are taxed if the nonresident alien is physically present when the sale is made or If he has been in the United States for 90 days or more during the year. Capital gains which are "effectively connected" with a U.S. business are to be taxed at the regular rates. C. ESTATE AND GIFT TAX PROVISIONS 1. A separate schedule of estate tax rates is to apply to estates of nonresident aliens. The rates are graduated from 5 percent on the first $100,000 to 25 percent on the excess over $2 million. The exemption is raised from $2,000 to $30,000. These changes ac- cord approximately the same tax treatment in the case of an estate of a nonresident alien as presently applies for a U.S. citizen eligible for the marital deduction. 2. Bonds of a U.S. person or corporation even though owned by foreigners are to be considered property within the United States and, therefore, subject to U.S. estate tax. 3. Bank deposits of nonresident aliens are to be treated as property within the United States and, therefore, subject to U.S. estate tax (except for deposits in foreign branches of U.S. banks). 4. Transfers of intangible property by nonresident aliens are not to be subject to gift tax whether or not they are engaged in a U,S. business. D. MISCELLANEOUS PROVISIONS 1. Interest on U.S. bank deposits of for- eigners is to be taxed after 1971; until then Interest on accounts with mutual savings banks, etc., and on deposits with insurance companies are to be treated as foreign source Income. 2. The Treasury Department is authorized to require payments of amounts withheld from nonresident aliens and foreign corpora- tions on a quarterly basis. 3. Except in the case of dealers and cer- tain Investmen1~ companies, trading in stocks or securities In the United States, for one's own account, whether by a foreign investor physically present In the United States, through an employee located here, or through a resident agent (whether or not the agent has discretionary authority) is not to con- stitute a trade or business in the United States for Income tax purposes. A parallel rule Is provided for those trading in com- modities. 4. U.S. source income and the effectively connected income of a citizen received for 5 years after expatriation is, in most cases, to be taxed at the regular U.S. tax rates if a principal purpose of the expatriation was the avoidance of U.S. income, estate, or gift taxes. CONCLUSION In conclusion, I would like to reiterate that this bill was primarily designed to provide equitable tax treatment for non- resident aliens and foreign corporations, treating them generally on a basis which is consistent with the tax treatmeht of American citizens and domestic corpora- tions. It is believed that this more equitable treatment will, to some extent, encourage foreigners to invest in the United States, but this is not the prin- cipal purpose of the legislation before the House. The bill was reported favorably by the committee. It is supported by the Treasury Department. I therefore urge the Members to support the measure here today. Mr. GROSS. Mr. Chairman, will the gentleman yield? 852 PAGENO="0863" Mr. MILLS. I yield to the gentleman from Iowa. Mr. GROSS. Mr. Chairman, if I un- derstood, did the gentleman say that the exemptions on estates were increased from $2,000 to $60,000? Mr. MILLS. The exemption is in- creased from $2,000 to $30,000 to treat them more nearly like U.S. citizens or residents. However, the American citi- zen is still better off since his exemption is $60,000, instead of $30,000. Mr. GROSS. That is a tremendous increase. The next question is: What are the foreigners doing by way of equal treat- ment for American investors in foreign countries? Mr. MILLS. Let me say to my friend that most foreign countries do not im- pose estate taxes on assets of Americans which are located in their countries. Those that dO usually impose relatively low rate taxes. In addition we have pro- visions in this bill which permit the Pres- ident to raise income or estate taxes with respect to citizens, or residents of foreign countries which impose more burdensome taxes on Americans with income or as- sets from sources within their countries. Mr. BATTIN. Mr. Chairman, will the gentleman yield? Mr. MILLS. I yield to the gentleman from Montana. Mr. BATTIN. Mr. Chairman, it seems to me that during the hearings on this matter it was pointed out that one of the compelling reasons to equate our taxes as we did-at least as recom- mended in this bill-was to put us more on a par with some of the foreign powers, so as to attract capital-rather than have capital go into their countries-be- cause they receive a fair tax treatment. Mr. MILLS. The gentleman is en- tirely correct. However, we also tried to make sure that the foreign country treated our citizens or residents fairly. Mr. CURTIS. Mr. Chairman, will the gentleman yield? [P. 12682J Mr. MILLS. I yield to the gentleman from Missouri. Mr. CURTIS. Mr. Chairman, I simply want to recall that this was a point a number of us made in the executive ses- sion with the Treasury Department. We hoped there would be real reciprocity in these tax concessions. I can assure the gentleman from Iowa that this. point was uppermost in the minds of the members `of the Ways and Means Committee. ]~ believe most of us were satisfied with `the results. Cer- tainly I was satisfied that under the bill we were moving toward more reciprocity. Mr. MILLS. I think my friend from Missouri would agree that even if we pass this bill, the estate tax we impose on the assets of these foreigners located in the United States would in most cases still be higher, in all probability, than the taxes we impose on our own citizens. Mr. CURTIS. I agree with the gentleman. Mr. GROSS. Mr. Chairman, will the gentleman yield? Mr. MILLS. I yield to the gentleman from Iowa. Mr. GROSS. I merely used that as an example. I did not mean to confine it to the estate tax. Mr. MILLS. On the income tax side, too, we will still be taxing foreigners at relatively high rates. Of course, we have treaties with some countries that fix the rate of tax on certain types of income at 15 percent or in some cases at lower rates. Those countries in turn, however, generally apply similar low rates to citi- zens of the United States deriving in- come from those countries. Mr. GROSS. Suppose an alien bought Government securities, such as E or H bonds, or something of that kind, ,or, as someone suggests, participation certificates under the legislation recent- ly enacted. What would happen under those circumstances? Would he pay tax to this country, or be exempt? Mr. MILLS. Those are not exempt. They are subject to U.S. tax. Mr. GROSS. None of them are ex- empt? Mr. MILLS. This is interest income developed within the United States, and it is subject to U.S. tax. If that is all the individual received from U.S. sources or if it is not effective- ly connected to a U.S. business, he would pay tax on that income at the fiat rate of 30 percent or lower applicable treaty rate. An American citizen would be likely to be taxed on similar income at, say, a 14-percent rate or a 20-percent rate, but a nonresident alien would be taxed at 30 percent, unless we had a treaty with his country making it less. If there were business income-if the individual had a business establishment developing business income in the United States-that business income would be taxed just as any other busi- ness income would be taxed in the United States. This would also be true of in- come effectively connected with this business income. Mr. GROSS. I thank the gentleman. Mr. DE LA GARZA. Mr. Chairman, will the gentleman yield? Mr. MILLS. I yield to the gentle- man from Texas. Mr. DE LA GARZA. I come from the border country, as the gentleman knows. There are commercial banks which de- rive deposits from both sides of the bor- der, in Mexico and the United States. `A nonresident alien might have a commercial banking account on' the U.S. side. Would interest income on that account be touched by this legislation? Mr. MILLS. If he had a bank ac- count in the United States, until after 853 PAGENO="0864" 1971 interest on this account would not be taxed by the United States. More- over, interest on deposits in U.S. branches in foreign countries by for- eigners will not be taxed under the bill at any time. I should also say that there are no special rules in this bill ap- plicable exclusively to Mexico. Mexico is treated the same as any other foreign country. Mr. DE LA GARZA. I understand what the bill does, and I am glad it does not tax interest on deposits of Mexican residents in U.S. banks until after 1971. I wish it did not do so after that time. Mexico is a matter of interest to me, since it is close to me. Mr. MILLS. I understand. Mr. BYRNES of Wisconsin. Mr. Chairman, I yield myself 5 minutes. (Mr. BYRNES of Wisconsin asked and was given permission to revise and extend his remarks.) Mr. BYRNES of Wisconsin. Mr. Chairman, the bill before us deals pri- marily with the taxation of the income derived from U.S. sources by nonresident aliens, both individuals and foreign cor- porations. The bill is largely technical in nature. Many of these matters are covered by tax treaty. However, the bill will provide rules to apply in the absence of treaty, and in areas which may not be covered with the foreign country if we have such a treaty. According to the estimates submitted by the Treasury Department and incor- porated in the committee report, you will note that the bill shows a net revenue gain when fully effective of about $1 million. In order to encourage investment in the United States, the bill seeks to elimi- nate progressive taxation of nonresident aliens not engaged in a trade or business in the United States and to place a ceil- ing on the estate tax rates applicable to the investments producing such an in- come. Added together, these provisions result in a revenue loss of about $3,- 800,000. This is largely offset by a provision modifying the rules for taxing the In- come of foreign life insurance companies doing business in the United States- mainly Canadian-which results in a revenue gain of about $3 million. This change cures an admitted deficiency in existing law in the taxation of foreign Life insurance companies. The bill further provides for the pay- ment on a quarterly basis, or more fre- quently If the Treasury should elect, of taxes withheld from foreigners. Under* present law, such taxes are paid to the Treasury only once each year. As you know, the Treasury has taken steps to have taxes withheld on American citi- zens paid over to the Treasury twice a month. I see no reason why taxes with- held on nonresident aliens and foreign corporations should not be turned over to the Treasury more often than once each year. If the Treasury collects these taxes quarterly, the provision will raise about $22,500,000 on a "one-shot" basis. In turn, the savings in interest on this amount is estimated at about $1,600,000 annually thereafter. Under existing law, interest derived by a nonresident alien on bank deposits in the United States is exempt from tax. However, interest on savings and loan deposits or on funds deposited with an insurance company are taxable. Under the bill interest from all three sources is treated in the same manner. Up to December 31, 1971, all such interest would be exempt from tax. After De- cember 31, 1971, all such interest would be taxable in the same manner as any other income derived by nonresident aliens from U.S. sources. When this provision goes into effect, it is estimated that an additional $300,000 in revenue will be realized. Admittedly, in terms of revenue loss or revenue gain, the bill has only minor significance. The bill is not designed, and is not intended either to grant any tax concession or incentives for invest- ments in the United States or to raise revenues by imposing additional taxes on the income derived from foreign in- vestments in the United States. After very careful study and review, and extensive hearings, the committee put together this bill primarily to do "equity" to foreign investors. You will note that the bill incorporates same 22 new tax rules dealing with investments from abroad. When taken together, it is hoped that the bill will provide a better climate-and more certainty and clarifi- cation-for those from abroad who are presently investing their funds in the United States, as well as new investors from abroad. As far as I know, everyone conversant with this field agrees that the bill is fair and equitable and deserves support. Mr. BYRNES of Wisconsin. Mr. Chairman, I yield 3 minutes to the gen- tleman from Missouri IMr. CURTIS]. Mr. CURTIS. Mr. Chairman, I only take this time to play a pleasant role, because I so often find myself playing an unpleasant role. I wish to say that not only am I in accord with the bill that has been presented here in detail, and it is a very technical bill, the result of considerable work, but also to point out that the procedures followed by the committee, in considering and drafting this bill in my judgment, were exem- plary. There were extensive public hear- ings. To those who are interested in the Congress exercising initiative, I would underline the remarks of the chairman of the committee that when this bill was presented to us it was on a policy of stimulating investments by foreigners in the United States. This 854 PAGENO="0865" policy was changed substantially so as to make the bill's primary objective the equitable tax treatment by the United States of alien investors vis-a-vis the U.S. ~P. 12683) investor. Tjndoubtedly this kind of equitable treatment provided in the bill will increase foreign investment in the United States. The only other observation I have to make relates to the reason I asked the chairman to yield during his presenta- tion. The reciprocity aspect of how foreign countries treat our citizens tax- wise was foremost in your committee's mind during our deliberations on this bill. I am satisfied a very fine j&' was done here. I certainly can commend this bill wholeheartedly for favorable action by the committee of~the whole House. Mr. MILLS. Mr. Chairman, I have no further requests for time. Mr. BYRNES of Wisconsin. Mr. Chairman, I have no further requests f or time. The CHAIRMAN. Under the rule, the bill is considered as having been read for amendment. The bill is as follows: H.R. 13103 Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SEcTION 1. SHORT TITLE, ETC. (a) SHORT TITLE-This Act may be cited as the "Foreign Investors Tax Act of 1966". (b) TABLE OF CONTENTS.- SEC. 1. Short title, etc. (a) Short title. (b) Table of contents. (c) Amendment of 1954 Code. SEC. 2. Source of income. (a) Interest. (b) Dividends. (c) Personal services. (d) Definitions. (e) Effective dates. SEC. 3. Nonresident alien individuals. (a) Tax on nonresident alien individuals: "SEC. 871. Tax on nonresident alien in- dividuals. "(a) Income not connected with United States business- 30 percent tax. `(b) Income connected with United States business-graduated rate of tax. "(c) Participants in certain ex- * change or training programs. `(d) Election to treat real prop- erty income as income con- nected with United States business. "(e) Cross references." (b) Gross income. (c) Deductions. (d) Allowance of deductions and credits. (e) Expatriation to avoid tax: "SEC. 877. Expatriation to. avoid tax. "(a) In general. `(b) Alternative tax. (c) Special rules of source. "(d) Exception for loss of citizen-. ship for certain causes. "(e) Burden of proof." (f) Partial exclusion of dividends. (g) Withholding of tax on nonresident aliens. (h) Liability for withheld tax. (I) Declaration of estimated income tax by individuals. (j) Gain from dispositions of certain de- preciable realty. (k) Collection of income tax at source on wages. (1) Definition of foreign estate or trust. (m) Conforming amendment. (n) Effective dates. SEC. 4. Foreign corporations. (a) Tax on income not connected with United States business: "SEC. 881. Income of foreign corpora- tions not connected with United States business. "(a) Imposition of tax. "(b) Doubling of tax." (b) Tax on income connected with United business: "SEc. 882. Income of foreign corpora- tions connected with United States business. "(a) Normal tax and surtax. `(b) Gross income. "(c) Allowance of deductions and credits. "(d) Election to treat real property income as income connected with United States business. "(a) Returns of tax by agent. `(f) Foreign corporations." (c) Withholding of tax on foreign corpo- rations. (d) DividendS received from certain for- eign corporations. (e) Unrelated business taxable income. (f) Corporations subject to personal hold- ing company tax. (g) Amendments with respect to foreign corporations carrying on insurance business in United States. (h) Subpart F income. (i) Gain from certain sales or exchanges of stock in certain foreign corpora- tions. (j) Declaration of estimated income tax by corporations. (k) Technical amendments. (1) Effective dates. SEC. 5. Special tax provisions. (a) Income affected by treaty. (b) Application of pre-1967 income tax provisions: "SEC. 896. Application of pre-1967 in- come tax provisions. "(a) Imposition of more burden- some taxes by foreign coun- try. `(b) Alleviation of more burden- some taxes. "(c) Notification of Congress re- quired. "(d) Implementation by regula- tions." (c) Clerical amendments. (d) Effective date. SEC. 6. Foreign tax credit. (a) Allowance of credit to certain non- resident aliens and foreign cor- porations. (b) Alien residents of the United States or Puerto Rico. SEc. 7. Amendment to preserve existing law on deductions under section 931. (a) Deductions. (b) Effective date. 71-297 0-67-pt. 1-55 855 PAGENO="0866" SEc. 8. Estates of nonresidents not citizens. (a) Rateof tax. (b) Credits against tax. (c) Property within the United States. (d) Property without the United States. (e) Definition of taxable estate. (f) Special methods of computing tax: "SEC. 2107. ExpatrIation to avoid tax. "(a) Rateof tax. "(b) Gross estate. "(c) Credits. "(d) Exception for loss of citizen- ship for certain causes. "(e) Burden of proof. "SEC. 2108. Application of pre-1967 estate tax provisions. "(a) Imposition of more burden- some tax by foreign country. "(b) Alleviation of more burden- some tax. "(c) Notification of Congress re- * quired. "(d) Implementation by regula- tions." (g) Estatetaxreturns. (h) Clerical amendment. (I) Effective date. SEC. 9. Tax on gifts of nonresidents not citizens. (a) Imposition of tax. (b) Transfers in general. (c) Effective date. SEC. 10. Treaty obligations. (c) AMENDMENT OF 1954 CoDE--Except as otherwise expressly provided, whenever in this Act an amendment or repeal is expressed in terms of an amendment to, or repeal of, a section or other provision, the reference Is to a section or other provision of the Internal Revenue Code of 1954. SEC. 2. SOURCE OF INCOME. (a) INTEREST.- (1) (A) Subparagraph (A) of section 861 (a) (1) (relating to interest from sources within the United States) is amended to read as follows: "(A) Interest on amounts described In subsection (c) received by a nonresident alien individual or a foreign corporation, If, such interest is not effectively connected with the conduct of a trade or business with- in the United States,". (B) Section 861 Is amended by adding at the end thereof the following new subsec- tion: `(c) INTEREST ON DEs'osITs, ETc-For pur- poses of subsection (a) (1) (A), the amounts described in this subsection are- "(1) deposits with persons carrying on the banking business, `(2) deposits or withdrawable accounts with savings Institutions chartered and su- pervised as savings and loan or similar as- sociations under Federal or State law, but only to the extent that amounts paid or credited on such deposits or accounts are de- ductible under section 591 in computing the taxable Income of such Institutions, and "(3) amounts held by an insurance company under an agreement to pay interest thereon. Effective with respect to amounts paid or credited after December 31, 1971, subsection (a) (1) (A) and this subsection shall cease to apply." (2) Section 861(a) (1) is amended by strik- ing out "and" at the end of subparagraph (B), by striking out the period at the en of subparagraph (C) and Inserting in liei. thereof ", and", and by adding at the en thereof the following new subparagraph: "(D) interest on deposits with a foreig branch of a domestic corporation, If suc branch is engaged in the commercial bankin business." (3) (A) Section 895 (relating to income de- rived by a foreign central bank of issue from obligations of the United States) Is amended- (I) by striking out "shall not be Includ- ed" and Inserting in lieu thereof ", or from interest on deposits with persons carrying on the banking business, shall not be Included"; (ii) by striking out "such obligations" and inserting In lieu thereof "such obliga- tions or deposits"; (lii) by adding at the end thereof the fol- lowing new sentence: "For purposes of the preceding sentence, the Bank for Interna- tional Settlements shall be treated as a for- eign central bank of issue with respect to interest on deposits with persons carrying on the banking business."; and (lv) by striking out the heading and In- serting In lieu thereof the following: [P. 12684) "SEC. 895. INCOME DERIvED BY A FOREIGN BANK OF ISSUE FROM OBLIGA- TIONS OF THE UNITED STATES o~ FROM BANK DEposrrs." (B) The table of sections for subpart C bf part II of subchapter N of chapter 1 Is amended by striking out the item relating to section 895 and Inserting In lieu thereof the following: "Sec. 895. Income derived by a foreign cen- tral bank of issue from obliga- tions of the United States or from bank deposits." (b) DivmEIms.- (1) Section 861(a) (2) (B) (relating to div- idends from sofirces within the United States) is amended to read as follows: "(B) from a foreign corporatiOn unless less than 80 percent of the gross Income from all sources of such foreign corporation for the 3-year period ending with the close of Its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been In exist- ence) was effectively connected with the conduct of a trade or business within the United States; but only In an amount which bears the same ratio to such dividends as the gross income of the corporation for such period which Is effectively connected with the conduct of a trade or business within the United States bears to its gross Income from all sources; but dividends from a for- eign corporation shall, for purposes of sub- part A of part III (relating to foreign tax credit), be treated as income from sources without the United States to the extent (and only to the extent) exceeding the amount which Is lOO/85ths of the amount of the deduction allowable under section 245 In respect of such dividends, or". (2) Section 861 (a) (2) Is amended by add- ing after subparagraph (C) the following: "For purposes of subparagraph (B), the gross Income of the foreign corporation for any period before the first taxable year beginning after December 31, 1966, which is effectively connected with the conduct of 856 PAGENO="0867" a trade or business within the United States is an amount equal to the gross income for such period from sources within the United States." (c) PERSONAL SERvIcEs-Section 861(a) (3) (C) (ii) (relating to income from personal services) is amended to read as follows: "(ii) an individual who is a citizen or resi- dent of the United States, a domestic part- nership, or a domestic corporation, if such labor or services are performed for an office or place of business maintained in a foreign country or in a possession of the United States by such individual, partnership, or corporation." (d) DEssNITI0N5.-Section 864 (relating to definitions) is amended- (1) by striking out "For purposes of this part," and Inserting in lieu thereof "(a) SALE, ETc-For purposes of this part,"; and (2) by adding at the end thereof the fol- lowing new subsections: "(b) TRADE OR BusINEss WITHIN THE UNITED STATES-For purposes of this part, part II, and chapter 3, the term `trade or business within the United States' Includes the performance of personal services within the United States at any time within the taxable year, but does not include- "(1) PERFORMANCE OF PERSONAL SERVICES FOR FOREIGN EMPLOYER-The performance of personal services- "(A) for a nonresident alien individual, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or "(B) for an office or place of business maintained In a foreign country or in a possession of the United States, by an in- dividual who is a citizen or resident of the United States or by a domestic partnership or a domestic corporation, by a nonresident alien individual tempo- rarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year and whose compensation for such services doss not ex- - ceed in the aggregate $3,000. "(2) TRADING IN SECURITIES OR COMMODI- TIES.- "(A) STOCKS AND SECURITIES.- `(i) Except in the case of a dealer in stocks or securities, trading in stocks or se- curities for the taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such agent has discretionary author- ity to make decisions in effecting the trans- actions. This clause shall not apply in the case of a corporation (other than a corpora- tion which is, or but for section 542(c) (7) would be, a personal holding company) the principal business of which is trading in stocks or securities for its own account, if its principal office is in the United States. "(ii) In the case of a person who is a dealer in stocks or securities, trading In stocks or securities for his own account through a resident broker, commission agent, custodian,. or other independent agent. "(B) COMMODITIES.- "(I) Except in the case of a dealer in com- modities, trading in commodities for the tax- payer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such agent has dis- cretionary authority to make decisions in effecting the transactions. "(ii) In the case of a person who is a dealer In commodities, trading In commodities for his own account through a resident broker, commission agent, custodian, or other inde- pendent agent. "(iii) Clauses (I) and (ii) apply only if the commodities are of a kind customarily dealt in on an organized commodity exchange and if the transaction is of a kind custom- arily consummated at such place. "(C) LIMITATION.-Subparagraphs (A) (ii) and (B) (ii) shall apply only if, at no time during the taxable year, the taxpayer has an office or place of business in the United States through which or by the direction of which the transactions in stocks or securi- ties, or in commodities, as the case may be, are effected. `(c) EFFECTIVELY CONNECTED INCOME, ETC. "(1) GENERAL RULE-For purposes of this title- "(A) In the case of a nonresident alien individual or a foreign corporation engaged in trade or business within the United States during the taxable year, the rules set forth in paragraphs (2), (3), and (4) shall apply in determining the income, ~aln, or loss which shall be treated as effectively con- nected with the conduct of a trade or busi- ness within the United States. "(B) Except as provided in section 871 (d) or section 882(d), in the case of a non- resident alien individual or a foreign cor- poration not engaged in trade or business within the United States during the taxable year, no income, gain, or loss shall be treated as effectively connected with the conduct of a trade or business within the United States. "(2) PERIODICAL, ETC., INCOME FROM SOURCES WITHIN UNITED STATES-FACTORS-In deter- mining whether income from sources within the United States of the types described in section 871(a) (1) or section 881(a), or whether gain or loss from sources within the United States from -the sale or exchange of capital assets, is effectively connected with the conduct of a trade or business within the United States, the factors taken into account shall include whether- "(A) the income, gain, or loss is derived from assets used in or held for use in the conduct of such trade or business, or "(B) the activities of such trade or busi- ness were a material factor in the realization of the income, gain, or loss. In determining whether an asset is used in or held for use in the conduct of such trade or business or whether the activities of such trade or business were a material factor in realizing an Item of income, gain, or loss, due regard shall be given to whether or not such asset or such income, gain, or loss was accounted for through such trade or busi- ness. In applying this paragraph and para- graph (4), Interest referred to in section 861(a) (1) (A) shall be considered income from sources within the United States. "(3) OTHER INCOME FORM SOURCES WITHIN UNITED STATES-All income, gain, or loss from sources within the United States (other than Income, gain, or loss to which para- graph (2) applies) shall be treated as effec- tively connected with the conduct of a trade or business within the United States. "(4) INCOME FROM SOURCES WITHOUT UNITED STATES.- "(A) Except as provided in subparagraph (B), no income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States. 857 PAGENO="0868" "(B) Income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or busihess within the United States by a nonresident alien individual or a foreign corporation if such person has an office or other fixed place of business within the United States to which such Income, gain, or loss is attributable and such Income, gain, or loss- `(i) consists of rents or royalties for the use of or for the privilege of using Intangible property described in section 862(a) (4) (In- cluding any gain or loss realized on the sale of such property) derived in the active con- duct of such trade or business; "(ii) consists of dividends or Interest, or gain or loss from the sale or exchange of stock or notes, bonds, or other evidences of indebtedness, and either Is derived in the active conduct of a banking, financing, or similar business within the United States or Is received by a corporation the principal business of which is trading in stock or securities for its own account; or "(iii) Is derived from the sale (without the United States) through such office or fixed place of business of personal property described in section 1221(1), except that this clause shall not apply if the property is sold for use, consumption, or disposition outside the United States and an office or other fixed place of business of the taxpayer outside the United States participated materially in such sale. In the case of a sale described In clause (iii), the income which shall be treated as attrib- utable to the office or other fixed place of business within the United States shall not exceed the income which would be derived from sources withill the United States if the sale were made in the United States. "(C) No income, gain; or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States if it either- "(1) consists of dividends, interest, or royalties paid by a foreign corporation in which the taxpayer owns (within the mean- ing of section 958(a)), or Is considered as owning (by applying the ownership rules of section 958(b)), more than 50 percent of the total combined voting power of all classes of stock entitled to vote, or "(ii) is subpart F income within the meaning of section 952(a) f P. 12685~ (e) EFFECTIVE DATES.- (1) The amendments made by subsections (a), (c), and (d) shall apply with respect to taxable years beginning after December 31, 1966. (2) The amendments made by subsection (b) shall apply with respect to amounts received after December 31, 1966. SEC. 3. NONRESIDENT ALIEN INDIvIDUALS. (a) TAX ON NONRESIDENT ALIEN INDIvID- UALS.- (1) Section 871 (relating to tax on non- resident alien Individuals) is amended to read as follows: "SEC. 871. TAX ON NONRESIDENT ALIEN IN- DIvIDUALS. "(a) INCOME NOT CONNECTED WrrH UNITED STATES Bu5INESs-30 PERCENT TAX.- "(1) INCOME OTHER THAN CAPITAL GAINS.- There is hereby imposed for each taxable year a tax of 30 percent of the amount re- 858 celved from sources within the United State by a nonresident alien individual as- "(A) Interest, dividends, rents, salaries wages, premiums, annuities, compensations remunerations, emoluments, and other fixe or determinable annual or periodical gains profits, and income, "(B) gains described In section 402(a) (2), 403 (a) (2), or 631 (b) or (c), and gains on transfers described in section 1235, and "(C) amounts which under section 341, or under section 1232 (in the case of bonds or other evidences of Indebtedness issued after September 28, 1965), are treated as gains from the sale or exchange of property which Is not a capital asset, but only to the extent the amount so re- ceived Is not effectively connected with the conduct of a trade or business within the United States. "(2) CAPITAL GAINS OF ALIENS PRESENT IN THE UNITED STATES 183 DAYS OR MORE-In the case of a nonresident alien Individual pres- ent In the United States for a period or periods aggregating 183 days or more during the taxable year, there Is hereby imposed for such year a tax of 30 percent of the amount by which his gains, derived from sources within the United States, from the sale or exchange at any time during such year of capital assets exceed his losses, allocable to sources within the United States, from the sale or exchange at any time during such year of capital assets. For purposes of this paragraph, gains and losses shall be taken into account only if, and to the extent that, they would be recognized and taken Into ac- count if such gains and losses were effec- tively connected with the conduct of a trade or business within the United States, except that such gains and losses shall be de- termined without regard to section 1202 (re- lating to deduction for capital gains) and. such losses shall be determined without the benefits of the capital loss carryover, pro- vided In section 1212. Any gain or loss which is taken Into account In determining the tax under paragraph (1) or subsection (b) shall not be taken into account In determining the tax under this paragraph. For purposes of the 183-day requirement of this para- graph, a nonresident alien Individual not engaged In trade or business within the United States who has not established a taxable year for any prior period shall be treated as having a taxable year which is the calendar year. `(b) INCOME CONNECTED WITH UNITED STATES BUSINESS-GRADUATED RATE OF TAX.- "(1) IMPOSITION OF TAX-A nonresident alIen individual engaged in trade or business within the United States during the txable year shall be taxable as provided In section 1 or 1201(b) on his taxable income which is effectively connected with the conduct of a trade or business within the United States. "(2) DETERMINATION OF TAXABLE INCOME.- In determining taxable income for purposes of paragraph (1), gross income includes only gross income which is effectively connected with the conduct of a trade or business within the United States. "(c) PARTICIPANTS IN CERTAIN EXCHANGE OR TRAINING PROGRAMS-For purposes of this section, a nonresident alien individual who (without regard to this subsection) is not engaged In trade or business within the United States and who is temporarily present in the United States as a nonimmigrant under subparargaph (F) or (J) of section 101(a) (15) of the Immigration and Nation- PAGENO="0869" ality Act, as amended (8 U.S.C. 1101(a) (15) (F) or (J)), shall be treated as a nonresident alien individual engaged in trade or business within the United States, and any income described in section 1441(b) (1) or (2) which is received by such Individual shall, to the extent derived from sources within the United States, be treated as effectively con- nected with the conduct of a trade or busi- ness within the United States. "(d) ELECTION To ~TREAT REAL PROPERTY INCOME AS INCOME CONNECTED WITH UNITED STATES BusiNEss.- "(1) SIre GENERAL-A nonresident alien in- dividual who during the taxable year derives any income- "(A) from real property located In the United States, or from any interest in such real property, Including (I) gains from the sale or exchange of real property or an inter- est therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and "(B) which, but for this subsection, would not be treated as income which is effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such Income as income which is effectively connected with the conduát of a trade or business within the United States. In such case, such income shall be taxable as pro- vided in subsection (b) (1) whether or not such individual Is engaged In trade or busi- ness within the United States during the taxable year. An election under this para- graph for any taxable year shall remain In effect for all subsequent taxable years, ex- cept that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. "(2) ELECTION AFTER REVOcATION-If an election has been made under paragraph (1) and such election has been revoked, a new election may not be made under such para- graph for any taxable year before the 5th taxable year which begins after the first taxable year for which such revocation is effective, unless the Secretary or his delegate consents to such new election. "(3) FORM AND TIME OF ELECTION AND REVO- CATION-An election under paragraph (1), and any revocation of such an election, may be made only In such manner and at such time as the Secretary or his delegate may by regulations prescribe. "(e) Caoss REFERENCES.- "(1) For tax treatment of certain amounts distributed by the United States to nonresi- dent alien individuals, see section 402(a) (4). "(2) For taxation of nonresident alien in- dividuals who are expatriate United States citizens, see section 877. "(3) For doubling of tax on citizens of certain foreign countries, see sectlpn 891. "(4) For reinstatement of pre-1967 In- come tax provisions in the case of residents of certain foreign countries, see section 896. "(5) For withholding of tax at source on nonresident alien individuals, see section 1441. "(6) For the requirement of making a declaration of estimated tax by certain non~ resident alien individuals, see section 6015(i). "(7Y For taxation of gains realized upon certain transfers to domestic corporations, see section 1250(d) (3)." (2) Section 1 (relating to tax on individ- uals) is amended by redesignating subsec- tion (d) as subsection (e), and by inserting after subsection (c) the following new sub- section: "(d) NONRESIDENT ALIENS-In the case of a nonresident alien individual, the tax im- posed by subsection (a) shall apply only as provided by section 871 or 877." (b) GROSS INCOME.- (1) Subsection (a) of section 872 (relat- ing to gross income of nonresident alien individuals) is amended to read as follows: "(a) GENERAL RULE-In the case of a non- resident alien individual, gross income in- cludes only- "(1) gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, and "(2) gross Income which is effectively con- nected with the conduct of a trade or busi- ness within the United States." (2) Subparagraph (B) of sectIon 872(b) (3) (relating to compensation of partici- pants in certain exchange or training pro- grams) is amended by striking out "by a domestic corporation" and Inserting in lieu thereof "by a domestic corporation, a do- mestic partnership, or an Individual who Is a citizen or resident of the United States". (3) Subsection (b) of section 872 (relating to exclusions from gross income) is amended by adding at the end thereof the following new paragraph: "(4) BOND INTEREST OF RESIDENTS OF THE RYUKYU ISLANDS OR THE TRUST TERRITORY OF THE PACIFIC ISLANDS-Income derived by a nonresident alien Individual from a series E or series H United States savings bond, if such individual acquired such bond while a resident of the Ryukyu Islands or the Trust Territory of the Pacific Islands." (c) DEDUCTIONS.- (1) Section 873 (relating to deductions allowed to nonresident alien Individuals) is amended to read as follows: "SEC. 873. DEDUCTIONS. (a) GENERAL RULE-In the case of a non- resident alien individual, the deductions shall be allowed only for purposes of section 871(b) and (except as provided by subsec- tion (b)) on)y If and to the extent that they are connected with Income which is effec- tively connected with the conduct of a trade or business within the United States; and the proper apportionment and allocation of the deductions for this purpose shall be deter- mined as provided In regulations prescribed by the Secretary or his delegate. "(b) EXCEPTIONS-The following deduc- tions shall be allowed whether or not they are connected with Income which Is effec- tively connected with the conduct of a trade or business within the United States: "(1) LoSSES-The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c) (3), but only if the loss is of property located within the United States. "(2) CHARITABLE CONTRIBUTIONS-The de- duction for charitable contributions and gifts allowed by section 170. "(3) PERSONAL EXEMPTION-The deduc- tion for personal exemptions allowed by sec- tion 151, except that In the case of a non- resident alien Individual who is not a resi- dent of a contiguous country only one ex- emption shall be allowed under section 151. "(c) Csoss REFERENCES.- 859 PAGENO="0870" [P. 12686J "(1) For disallowance of standard deduc- tion, see section 142(b) (1). (2) Section 154(3) (relating to cross ref- erences in respect of deductions for per- mining deduction or credit, see section 906(b) (1)." (2) Section 154(3) (relating to cross ref- erences in respect of deductions for per- sonal exemptions) is amended to read as follows: "(3) For exemptions of nonresident aliens, scc section 873(b) (3)." (d) ALLOWANCE OF DEDUCTIONS AND CRED- rrs.-Subsection (a) of section 874 (relating to filing of returns) is amended to read as follows: "(a) RETURN PREREQUISITE TO ALLOW- ANCE-A nonresident alien individual shall receive the benefit of the deductions and credits allowed to him in this subtitle only by filing or causing to be filed with the Sec- retary or his delegate a true and accurate re- turn, in the manner prescribed in subtitle F (sec. 6001 and following, relating to proce- dure and administration), including therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. This subsection shall not be construed to deny the credits provided by sections 31 and 32 for tax withheld at source or the credit provided by section 39 for certain uses of gasoline and lubricating oil." (e) EXPATRIATION To Avom TAX.- * (1) Subpart A of part II of subchapter N of chapter 1 (relating to nonresident alien individuals) is amended by redesignating section 877 as section 878, and by inserting after section 876 the following new section: "SEc. 877. EXPATRIATION To Avom TAX. "(a) IN GENERAL.-Every nonresident alLen individual who at any time after March 8, 1965, and within the five-year period Immediately preceding the close of the tax- able year lost United States Citizenship, un- less such loss did not have for one of its prin- cipal purposes the avoidance of taxes under this subtitle or subtitle B, shall be taxable for such taxable year in the manner provided in subsection (b) if the tax Imposed pursu- ant to such subsection exceeds the tax which, without regard to this section, is imposed pursuant to.section 871. `(b) ALTERNATIVE TAx-A nonresident alien individual described in subsection (a) shall be taxable for the taxable year as pro- vided in section 1 or section 1201(b), except that- "(1) the gross Income shall include only the gross income described in section 872(a) (as modified by subsection (c) of this sec- tion), and "(2) the deductions shall be allowed If and to the extent that they are connected with the gross income Included under this section, except that the capital loss carry- over provided by section 1212(b) shall not be allowed; and the proper allocation and apportionment of the deductions for this purpose shall be determined as provided un- der regulations prescribed by the Secretary or his delegate. For purposes of paragraph (2), the deduc- tions allowed by section 873(b) shall be al- lowed; and the deduction (for losses not connected with the trade or business if in- curred in transactions entered into for prof- it) allowed by section 165(c) (2) shall be allowed, but only if the profit, if such trans- action had resulted in a profit, would be in- cluded in gross income under this section. `(c) SPECIAL RULES OF SouRCE-For pur- poses of subsection (b), the following Items of gross income shall be treated as Income from sources within the United States: "(1) SALE OF PROPERTY-Gains on the sale or exchange of property (other than stock or debt obligations) located In the United States. "(2) STOCK OR DEBT OBLIGATIONS-Gains on the sale or exchange of stock issued by a domestic corporation or debt obligations of United States persons or of the United States, a State or political subdivision there- of, or the District of Columbia. "(d) EXCEPTION FOR Loss OF CITIZENSHIP FOR CERTAIN CAUsEs-Subsection (a) shall not apply to a non-resident alien individual whose loss of United States citizenship re- sulted from the application of section 301 (b) 350, or 355 of the Immigration and Na- tionality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). * "(e) BURDEN OF PR00F.-If the Secretary or his delegate establishes that it is reason- able to believe that an individual's loss of United States Citizenship would, but for this section, result in a substantial reduction for the taxable year in the taxes on his probable income for such year, the burden of prov- ing for such taxable year that such loss of Citizenship did not have for one of its prin- cipal purposes the avoidance of taxes under this subtitle or subtitle B shall be on such individual." (2) The table of sections for subpart A of part II of subchapter N of chapter 1 (re- lating to nonresident alien individuals) is amended by striking out the item relating to section 877 and inserting in lieu thereof the following: "Sec. 877. Expatriation to avoid tax. "Sec. 878. Foreign educational, charitable, and certain other exempt or- ganizations." (f) PARTIAL EXCLUSION OF DIvIDENDs-Sub- section (d) of section 116 (relating to cer- tain nonresident aliens ineligible for ex- clusion) is amended to read as follows: "(4) CERTAIN NONRESIDENT ALIENS INELI- GIBLE FOR ExCLu5I0N.-In the case of a non- resident alien individual, subsection (a) shall apply only- "(1) in determining the tax imposed for the taxable year pursuant to section 871(b) (1) and only in respect of dividends which are effectively connected with the conduct of a trade or business within the United States, or "(2) in determining the tax imposed for the taxable year pursuant to section 877 (b)." (g) WITHHOLDING OF TAX ON NONRESIDENT ALIENs-Section 1441 (relating to withhold- ing of tax on Zionresident aliens) is amended- (1) by striking out "(except interest on deposits with persons carrying on the bank- ing business paid to persons not engaged in business in the United States)" In subsec- tion (b); (2) by striking out "and amounts de- scribed in section 402(a) (2)" and all that follows in the first sentence of subsection (b) and inserting in lieu thereof "and gains de- scribed in section 402(a) (2), 403(a) (2), or 631(b) or (c), and gains on transfers ~1e- scribed in section 1235."; (3) by striking out paragraph (1) of sub- 860 PAGENO="0871" section (c) and inserting in lieu thereof the following new paragraph: "(1) INCOME CONNECTED WITH UNITED STATES BusINEss-No deduction or withhold- ing under subsection (a) shall be required in the case of any item of income (other than compensation for personal services) which is effectively connected with the con- duct of a trade or business within the Unit- ed States and on which a tax is imposed for the taxable year pursuant to section 871(b) (1)."; (4) by amending paragraph (4) of subsec- tion (c) to read as follows: "(4) COMPENSATION OF CERTAIN ALIENS.- Under regulations prescribed by the Secre- tary or his delegate, compensation for per- sonal services may be exempted from deduc- tion and withholding under subsection (a) ."; and (5) by striking out `amounts described in section 402(a) (2), section 403(a) (2), sec- tion 631 (b) and (c), and section 1235, which are considered to be gains from the sale or exchange of capital assets," in paragraph (5) of subsection (c) and inserting in lieu there- of "gains described in section 402(a) (2), 403 (a) (2), or 631 (b) or (c), and gains on trans- fers described in section 1235.", and by strik- ing out "proceeds from such sale or ex- change," in such paragraph and inserting in lieu thereof "amount payable,". (h) LIABILITY FOR WITHHELD TAx-Section 1461 (relating to return and payment of witheld tax) is amended to read as follows: "SEC. 1461. LIABILITY FOR WITHHELD TAX. "Every person required to deduct and with- hold any tax under this chapter Is hereby made liable for such tax and Is hereby In- demnified against the claims and demands of any person for the amount of any pay- ments made in accordance with the pro- visions of this chapter." (i) DECLARATION OF ESTIMATED INCOME TAX BY INDIvIDuAL5.-Section 6015 (relating to declaration of estimated income tax by in- dividuals) Is amended- (1) by striking out that portion of sub- section (a) which precedes paragraph (1) and inserting in lieu thereof the following: "(a) REQUIREMENT OF DECLARATIÔN.-Ex- ~ cept as otherwise provided in subsection (i), every individual shall make a declaration of his estimated tax for thetaxable year if-"; (2) by redesignating subsection (1) as subsection (j); and (3) by Inserting after subsection (h) the following new subsection: "(I) NONRESIDENT ALIEN INDIVIDUALS-NO declaration shall be required to be made under this section by a nonresident alien in- dividual unless- "(1) withholding under chapter 24Is made applicable to the wages, as defined In section 3401 (a), of such individual, "(2) such Individual has income (other than compensation for personal services sub- ject to deduction and withholding under section 1441) which is effectively connected with the conduct of a trade or business within the United States, or "(3) such individual is a resident of Puerto Rico during the entire taxable year." (j) GAIN FROM DISPOSITIONS OF CERTAIN DEPRECIABLE REALTY-The second sentence of paragraph (3) of section 1250(d) (relating to certain tax-free transactions) is amended to read as follows: "This paragraph shall not apply to- "(A) a disposition to an organization (other than a cooperative described In sec- tion 521) which is exempt from the tax imposed by this chapter, or "(B) a transfer of property by a non- resident alien individual, a foreign estate or trust, or a foreign psrtnership, to a domestic corporation in exchange for stock or secu- rities in such corporation in a transaction to which section 351 applies." (k) COLLECTION OF INCOME TAX AT SouRcE ON WAGES-Subsection (a) of section 3401 (relating to definition of wages for purposes of collection of income tax at source) is amended by striking out paragraphs (6) and (7) and inserting in lieu thereof the follow- ing: "(6) for such services, performed by a nonresident alien individual, as may be desig- nated by regulations prescribed by the Sec- retary or his delegate; or" (1) DEFINITION OF FOREIGN ESTATE OR TRuST-Section 7701(a) (31) (defining for- eign estate or trust) Is amended by striking out "from sources without the United States" and inserting in lieu thereof ", from sources without the United States which is not effectively connected with the conduct of a trade or business within the United States,". (m) CONFORMING AMENDMENT-The first sentence of section 932(a) (relatIng to citi- I~P. 12687] zens of possessions of the United States) Is amended to read as follows: "Any Individual who is a citizen of any possession of the United States (but not otherwise a citizen of the United States) and who Is not a resident of the United States shall be subject to tax- ation under this subtitle in the same manner and subject to the same conditions as in the case of a nonresident alien individual." (n) EFFECTIVE DATES.- (1) The amendments made by this section (other than the amendments made by sub- sections (h) and (k)) shall apply with re- spect to taxable years beginning after Decem- ber 31, 1966. (2) The amendments made by subsection (h) shall apply with respect to payments occuring after December 31, 1966. (3) The amendments made by subsection (k) shall apply with respect to remunera- tion paid after December 31, 1966. SEC. 4. FOREIGN CORPORATIONS. (a) TAX ON INCOME NOT CONNECTED WITH UNrrEp STATES BusiNEss-Section 881 (re- lating to tax on foreign corpoedtiOns not engaged in business in the United States) is amended to read as follows: "SEC. 881. INCOME OF FOREIGN CORPORATIONS NOT CONNECTED WITH UNITED STATES BUSINESS. "(a) IMPosITIoN OF TAx.-.There Is hereby imposed for each taxable year a tax of 30 percent of the amount received from sources within the United States by a foreign corporation as- "(1) Interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and Income, "(2) gains described in section 631 (b) or (c),and "(3) amounts which under section 341, or under section 1232 (In the case of bonds or other evidences of Indebtedness issued after September 28, 1965), are treated as gains from the sale or exchange of property which is not a capital asset, but only to the extent the amount so re- 861 PAGENO="0872" ceived is not effectively connected with the conduct of a trade or business within the United States. `(b) DOUBLING OF TAX.- For doubling of tax on corporations of certain foreign countries, see section 891." (b) TAX ON INCOME CONNECTED WITH UNITED STATES BusINEss.- (1) Section 822 (relating to tax on resident foreign corporations) is amended to read as follows: "SEC. 882. INCOME OF FOREIGN CORPORATIONS CONNECTED WITH UNITED STATES BUSINESS. "(a) NORMAL TAX AND SURTAX.- "(1) IMFOSITION OF TAX-A foreign cor- poration engaged in trade or business within the United States during the taxable year shall be taxable as provided in section 11 or 1201 (a) on its taxable Income which Is effec- tively connected with the conduct of a trade or business within the United States. "(2) DETERMINATION OF TAXABLE INCOME.- In determining taxable income for purposes of paragraph (1), gross income Includes only gross income which is effectively connected with the conduct of a trade or business within the United States. "(b) GRosS INCOME-In the case of a foreign corporation, gross income includes only- "(1) gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, and "(2) gross income which is effectively con- nected with the conduct of a trade or busi- ness within the United States. `(c) ALLOWANCE OF DEDUCTIONS AND CRED- ITS.- "(1) ALLOCATION OF DEDUCTIONS.- "(A) GENERAL RULE-In the case of a for- eign corporation, the deductions shall be al- lowed only for purposes of subsection (a) and (except as provided by subparagraph (B)) only if and to the extent that they are connected with income which is effectively connected with the conduct of a trade or business within the United States; and the proper apportionment and allocation of the deductions for this purpose shall be deter- mined as provided in regulations prescribed by the Secretary or his delegate. "(B) CHARITABLE c0NTRIBuTI0NS.-The de- duction for charitable contributions and gifts provided by section 170 shall be allowed whether or not connected with income which is effectively connected with the conduct of a trade or business within the United States. "(2) DEDUCTIONS AND CREDITS ALLOWED ONLY IF RETURN FILED-A foreign corporation shall receive the benefit of the deductions and credits allowed to it in this subtitle only by filing or causing to be filed with the Sec- retary or his delegate a true and accurate re- turn, In the manner prescribed in subtitle F, including therein all the information which the Secretary or his delegate may deem nec- essary for the calculation of such deductions and credits. This paragraph shall not be construed to deny the credit provided by sec- tion 32 for tax withheld at source or the credit provided by section 39 for certain uses of gasoline and lubricating oil. "(3) FOREIGN TAX CREDIT-EXCept as pro- vided by section 906, foreign corporations shall not be allowed the credit against the tax for taxes of foreign countries and pos- sessions of the United States allowed by section 901. "(4) CRoss REFERENCE.- "For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b) (1). "(d) ELECTION To TREAT REAL PROPERTY INCOME AS INCOME CONNECTED WITH UNITED STATES BUSINEss.- "(1) IN GENERAL-A foreign corporation which during the taxable year derives any income- "(A) from real property located in the United States, or from any interest in such real property, including (I) gains from the sale or exchange of real property or an In- terest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and "(B) which, but for this subsection, would not be treated as income effectively con- nected with the conduct of a trade or busi- ness within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. In such case, such income shall be taxable as pro- vided in subsection (a) (1) whether or not such corporation Is engaged in trade or busi- ness within the United States during the taxable year. An election under this para- graph for any taxable year shall remain in effect for all subsequent taxable years, ex- cept that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. "(2) ELECTION APIER REVOCATION, ETC.- Paragraphs (2) and (3) of section 871(d) shall apply in respect of elections under this subsection in the same manner and to the same extent as they apply in respect of elec- tions under section 871 (d). "(e) RETURNS OF TAX BY AGENT-If any foreign corporation has no office or place of business in the United States but has an agent In the United States, the return re- quired under section 6012 shall be made by the agent." (2) (A) Subsection (e) of section 11 (re.. lating to exceptions from tax on corpora- tions) is amended by inserting "or" at the end of paragraph (2), by striking out ", or" at the end of paragraph (3) and inserting a period in lieu thereof, and my striking out paragraph (4). (B) Section 11 (relating to tax on corpora- tions) Is amended by adding at the end thereof the following new subsection: "(f) FOREIGN CoRPoRATIoNS-In the case of a foreign corporation, the tax imposed by subsection (a) shall apply only as provided by section 882." (3) The table of sections for subpart B of part II of subchapter N of chapter 1 is amended by striking out the items relating to sections 881 and 882 and inserting in lieu thereof the following: "Sec. 881. Income of foreign corporations not connected with United States business. "Sec. 882. Income of foreign corporations Thonnected with United States business." (c) WITHOLDING OF TAX ON FOREIGN CoR- PORATIoNs-Section 1442 (relating to with- holding of tax on foreign corporations) is amended to read as follows: "SEC. 1442. WITHHOLDING OF TAX ON FOREIGN CORPORATIONS. "(a) GENERAL RuLE-In the case of foreign corporations subject to taxation under this subtitle, there shall be deducted and with- 862 PAGENO="0873" held at the source in the same manner and on the same items of income as is provided in section 1441 or section 1451 a tax equal to 30 percent thereof; except that, in the case of interest described in section 1451 (relating to tax-free covenant bonds), the deduction and withholding shall be at the rate specified therein. For purposes of the preceding sen- tence, the reference in section 1441(c) (1) to section 871(b) (1) shall be treated as re- ferring to section 842 or section 882(a) as the case may be. `(b) ExEMPTIoN-Subject to such terms and conditions as may be provided by regu- lations prescribed by the Secretary or his delegate, subsection (a) shall not apply in the case of a foreign corporation engaged in trade or business within the United States if the Secretary or his delegate determines that the requirements of subsection (a) imposes an undue administrative burden and that the collection of the tax imposed by section 881 on such corporation will not be jeopard- ized by the exemption." (d) DIVIDENDS RECEIVED FROM CERTAIN FOR- EIGN CoRPoRATIoNs-Subsection (a) of sec- tIon 245 (relating to the allowance of a de- duction in respect of dividends received from a foreign corporation) is amended- (1). by striking out "and has derived 50 percent or more of its gross Income from sources within the United States," in that portion of subsection (a) which precedes paragraph (1) and by inserting in lieu there- of "and if 50 percent or more of the gross income of such corporation from all sources for such period Is effectively connected with the conduct of a trade or business within the United States,"; (2) by striking out "from sources within the United States" in paragraph (1) and in- serting in lieu thereof "which is effectively connected with the conduct of a trade or business within the United States"; (3) by striking out "from sources within the United States" in paragraph (2) and in- serting in lieu thereof ", which is effectively connected with the conduct of a trade or business within the United States,"; and (4) by adding after paragraph (2) the fol- lowing new sentence: "For purposes of this subsection, the gross income of the foreign corporation for any period before the first taxable year beginning after December 31, 1966, which Is effectively connected with the conduct of a trade or business within the United States Is an amount equal to the gross income for such period from sources within the United States." [P. 12688J (e) UNRELATED BUSINESS TAxABLE IN. cossz.-The last sentence of section 512(a) (relating to definition) Is amended to read as follows: "In the case of an organization described in section 511 which is a foreign organization, the unrelated business taxable income shall be its unrelated business tax- able income which is effectively connected with the conduct of a trade or business within the United States." (f) CORPORATIONS SUBJECT TO PERSONAL HOLDING COMPANY TAx-Paragraph (7) of section 542(c) (relating to corporations not subject to the personal holding company tax) is amended to read as follows: "(7) a foreign corporation, if all of its stock outstanding during the last half of the taxable year is owned by nonresident alien individuals, whether directly or Indirectly through foreign estates, foreign trusts, for- eign partnerships, or other foreign corpora- tions;". (g) AMENDMENTS WrrH RESPECT TO FoR- EIGN CORPORATIONS CARRYING ON INSURANCE BusiNEss IN UNrrED STATES.- (1) Section 842 (relating to computation of gross income) is amended to read as follows: "SEc. 842. FOREIGN CORPORATIONS CARRYING ON INSURANCE BUSINESS. "If a foreign corporation carrying on an Insurance business within the United States would qualify under part I, II, or III of this subchapter for the taxable year if (without regard to income not effectively connected with the conduct of any trade or business within the United States) it were a domestic corporation, such corporation shall be tax- able under such part on Its income effectively connected with its conduct of any trade or business within the United States. With re- spect to the remainder of its income, which is from sources within the United States, such a foreign corporation shall be taxable as pro- vided In section 881." (2) The table of sections for part IV of subchapter L of chapter 1 is amended by striking out the Item relating to section 842 and inserting in lieu thereof the following: "Sec. 842. Foreign corporations carrying on insurance business." (3) Section 819 (relating to foreign life Insurance companies) Is amended- (A) by striking out subsections (a) and (d) and by redesignating subsections (b) and (c) as subsections (a) and (b), (B) by striking out "In the case of any company described in subsection (a) ," in subsection (a) (1) (as redesignated by sub- paragraph (A)) and inserting in lieu thereof "In the case of any foreign corporation tax- able under this part.", (C) by striking out "subsection (c)" in the last sentence of subsection (a) (2) (as redesignated by subparagraph (A)) and in- serting in lieu thereof "subsection (b) ", (D) byadding at the end of subsection (a) (as redesignated by subparagraph (A)) the following new paragraph: "(3) REDUCTION OF SECTION 881 TAX-In the case of any foreign corporation taxable under this part, there shall be determined- "(A) the amount which would be subject to tax under section 881 if the amount tax- able under such section were determined without regard to sections 103 and 894, and (B) the amount of the reduction provided by paragraph (1). The tax under section 881 (determined with- out regard to this paragraph) shall be re- duced (but not below zero) by an amount which is the same proportion of such tax as the amount referred to in subparagraph (B) is of the amount referred to In subparagraph (A); but such reduction In tax shall not ex- ceed the increase in tax under this part by reason of the reduction provided by para- graph (1).", (E) by striking out "for purposes of sub- section (a)" each place It appears in subsec- tion (b) (as redesignated by subparagraph (A)) and inserting in lieu thereof "with re- spect to a foreign corporation", (F) by striking out "foreign life Insurance company" each place It appears In such sub- section (b) and inserting in lieu thereof "foreign corporation", (G) by striking out "subsection (b) (2) (A)" each place It appears in such subsection 863 PAGENO="0874" (b) and Inserting in lieu thereof `subsection of a trade OtT business within the United. (a)(2)(A)", States. (H) by striking out "subsection (b) (2) This paragraph shall not apply with respect (B)" in paragraph (2) (B) (Ii) of such sub- to any item which is exempt from taxation section (b) and inserting In lieu thereof (~ Is subject to a reduced rate of tax) pur- "subsection (a)(2) (B)", and snant to a treaty obligation of the United (I) by adding at the end thereof the fol- States." lowing new subsection: (J) DECLARATION OF ESTIMATED INCOME "(c) Caoss REFERENCE.- TAX BY CoRpoRAs'~oNs.-Sectlon 6016 (relat- "For taxation of foreign corporations car- ing to declarations of estimated income tax rying on life insurance business within the by corporations) Is amended by redesignat- United States, see section 842." Ing subsection (f) as subsection (g) and by (4) Section 821 (relatIng to tax on mu- inserting after subsection (c) the following tual insurance companies to which part H new subsection: applies) Is amended- `(f) CERTAIN FOREIGN CORPORATIONS.-FOr (A) by striking out subsection (e) and by purpases of this section and sectIon 6655, redesignating subsections (f) and (g) as sub- in the case of a foreign corporation subject sections (e) and (f), and to taxation under section 11 or 1201 (a), or (B) by adding at- the end of subsection under subchapter L of chapter 1, the tax (f) (as redesignated by subparagraph (A)) imposed by Section 881 shall be treated as a the following: tax imposed by section 11." "(3) For taxation of foreign corporations (k) TECHNICAL AMENDMENTS.- carrying on an insurance business within the (1) Section 884 is amended to read as United States, see section 842." follows: (5) Section 822 (relating to determination "SEC. 884. CRoss REFERENCES. of taxable investment income) is amended by striking out subsection (e) and by re- "(1) For special provisions relating to un- designating subsection (f) as subsection (e). related business Income of foreign educa- (6) Section 831 (relating to tax on certain tional, charitable, and certain other exempt other insurance companies) is amended- organizations, see section 512(a). (A) by striking out subsection (b) and by "(2) For special provisions relating to for- redesignating subsection (c) as subsection eign corporations carrying on an Insurance (b), and business within the United States, see sec- (B) by amending subsection (ci) to read as tion 842. follows: . "(3) For rules applicable In determining "(c) Caoss REFERENCES.- . whether any foreign corporation is engaged "(1) For alternative tax in case of capital in trade or business within the United States, gains, see section 1201(a). see section 864(b). "(2) For taxation of foreign corporations "(4) For reinstatement of pre-1967 income carrying on an Insurance business within the tax provisions in the case of corporations of United States, see section 842." certain foreign countries, see section 896. (7) Section 832 (relatIng to Insurance "(5) For allowance of credit against the company taxable Income) Is amended by tax in case of a foreign corporation having striking out subsection (d) and by redesig- income effectively connected with the con- flating subsection (e) as subsection (d). * duct of a trade or business within the United (8) The second sentence of section 841 States, see section 908. (relating to credit for foreign taxes) is "(6) For withholding at source of tax on amended by striking out "sentence," and income of foreign corporations, see section inserting in lieu thereof "sentence (and for 1442." purposes of applying section 906 wIth respect (2) Section 953(b) (3) (F) Is amended by to a foreign corporation subject to tax under striking out "832(b) (5)" and inserting in this subchapter) ,". . lieu thereof "832(c) (5) ". (h) SUBPART F INCOME.-SeCtiOn 952(b) (3) Section 1249(a) Is amended by strlk- (relating to~excluslon of United States in- Ing out "Except as provided In subsection come) Is amended to read as follows: (c), gain" and inserting in lieu thereof "(b) EXCLUSION OF UNITED STATES IN- "Gain". CoME-In the case of a controlled -foreign (1) EFFECTIVE DATES~-The amendments corporation, subpart F income does not In- made by this section (other than subsection elude any item of income from sources with- (i)) shall apply with respect to taxable in the United States which is effectively con- years beginning after December 31, 1966. nected with the conduct by such corpora- The amendment made by subsection (i) tion of a trade or business within the United shall apply with respect to sales or exchanges States unless such item Is exempt from taxa- occurring after December 31, 1966. tion (or Is subject to a reduced rate of tax) SEC. ~. SPECIAL TAX PROvISIoNs. pursuant to a treaty obligation of the United States." . (a) INCOME AFFECTED BY TREATY-Section (i) GAIN FROM CERTAIN SALES OR Ex- 894 (relating to income exempt under CHANGES OF STOCK ~ CERTAIN FOREIGN COR- treaties) is amended to read as follows: P0RATI0N5-Paragraph (4) of section 1248 "SEC. 294. INcOME AFFECTED BY TREATY, (d) (relating to exclusions from earnings "(a) INCOME EXEMPT UNDER TREATY-In- and profits) is amended to read as follows: come of any kind, to the extent required by "(4) UNiTED STATES INCOME-Any item in- any treaty obligation of the United States, cludible In gross Income of the foreign cor. shall not be Included In gross- income and poration under this chapter- shall be exempt from taxation under this "(A) for any taxable year beginning before subtitle. January 1, 1967, as income derived from . "(s) PERMANENT ESTABLISHMENT IN UNITED sources within the United States of a foreign STATES-For purposes of applying- any ex- corporation engaged In trade or business emption from, or reduction of, any tax pro- within the United States, or videci by any treaty to which the United "(B) for any taxable year beginning after States is a party with respect to income December 31, 1966, as income effectively con- - which Is not effectively connected with the neoted with the conduct by such corporation conduct of a trade or business within the 864 PAGENO="0875" United States, a nonresident alien individual or a foreign corporation shall be deemed not to have a permanent establishment in the United States at any time during the tax- able year. This subsection- shall not apply in respect of the tax computed under sec- tion 877(b) ." (b) APPLICATION OF PRE-1P67 INCOME TAX PRovIsIoNs-Subpart C of part II of sub- [P. 12689) chapter N of chapter 1 (relating to miscel- laneous provisions applicable to nonresident aliens and foreign corporations) Is amended by adding at the end thereof the following new section: "SEC. 896. APPLICATION OF PRE-1967 INCOME TAX PRovIsIoNs. "(a) IMPOsITION OF MORE BURDENSOME TAXES BY FOREIGN CouNTRY-Whenever the President finds that- "(1) under the laws of any foreign coun- try, considering the tax ~ystem of such for- eign country, citizens of the United States not residents of such foreign country or do- mestic corporations are being subjected to more burdensome taxes, on any item of in- come received by such citizens or corpora- tions from sources within such foreign coun-' try, than taxes Imposed by the provisions of this subtitle on similar income derived from sources within the United States by resi- dents or corporations of such foreign coun- try. "(2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such taxes so that they are no more burdensome than taxes imposed by the provisions of this subtitle on similar - income derived from sources within the United States by residents or corporations of such foreign country, and "(3) It Is In the public interest to apply pre-1967 tax provisions in accordance with the provisions of tills section to residents or corporations of such foreign country, the President shall, proclaim that the tax on such similar Income derived from sources within the United States by residents or corporations of such foreign country shall, for taxable years beginning after such procla- mation, be determined under this subtitle without regard to amendments made to this subchapter and chapter 3 on or after the date of enactment of this section. `(b) ALLEVIATION OF MORE BURDENSOME TAxEs-Whenever the President finds that the laws of any foreign country with respect to which the President has made a procla- mation under subsection (a) have been modi- fied so that citizens of the United' States not residents of such foreign country or domestic corporations' are no longer subject to more burdensome taxes on such item of income derived by such citizens or corporations from sources within such foreign country, he shall proclaim that the tax on such simi- lar income derived from sources within the United States by residents or corporations of such foreign country shall, for any taxable year beginning after such proclamation, be determined under this subtitle without re- gard to subsection (a). - "(c) NOTIFICATION OF CoNGREss RE- QUIRED.-NO proclamation shall be issued by the President pursuant to this section un- less, at least 30 days prior to such procla- mation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. "(d) IMPLEMENTATION ,BY REGULATIONS- The Secretary or his delegate shall prescribe luch regulations as he deems necessary or appropriate to implement this section." (c) CLERICAL AMENDMENTS-The table of sections for subpart C of part II of subchap- ter N of chapter 1 is amended- (1) by striking out the Item relating to section 894 and Inserting in lieu thereof "Sec. 894. Income affected by treaty.";" (2) by adding at the end of such table the following: "Sec. 896. Application of pre-1967 income tax provisions," (d) EFFEcTIVE DAVE-The amendments made by this section (other than subsection (e)) shall apply with respect to taxable years beginning after December 31, 1966. SEC. 6. FOREIGN TAX CREDIT. (a) ALLOWANCE OF CREDIT TO CERTAIN NoN- RESIDENT ALIENS AND FOREIGN CORPORA- TIONS.- (1) Subpart A of part IU of subchapter N of chapter 1 (relating to foreign tax credit) is amended by adding at the end thereof the following new section: "SEc. 906. NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN CORPORATIONS. "(a) ALLOWANCE OF CREDIT-A nonresident alien individual or a foreign corporation en- gaged in trade or business within the United States during the taxable year shall be al- lowed a credit under section 901 for the amount of any income, war profits, and ex- cess profits taxes paid or accrued during the taxable year (or deemed, under section 902, paid or acci~ued during the taxable year) to any foreign country or possession of the United States with respect to income effectively connected with the conduct of a' trade or business within the United States. "(b) SPECIAL RuLEs.- "(1) For purposes of subsection (a) and for purposes of determining the deductions allowable under sections 873(a) and 882(c) in determining the amount of any tax paid or accrued to any foreign country or pos- session there shall not be taken into account any amount of tax to the extent the tax so paid or accrued is Imposed with respect to income which would not be taxed by such foreign country or possession but for' the fact that- "(A) `in the case of a nonresident alien individual, such individual is a citizen or resident of such foreign country or pos- session, or "(B) in the case of a foreign corporation. such corporation was Oreated or organized under the law of such foreign country or possession or is domiciled for tax purposes in such country or possession. "(2) For purposes of subsection (a), In applying section 904 the taxpayer's taxable Income shall be treated as consisting only of the taxable income effectively connected with the taxpayer's conduct of a trade or business within the United States. "(3) The credit allowed pursuant to sub- section (a) shall not be allowed against any tax imposed by section 871 (a) (relating to income of nonresident alien individual not connected with United States business) or `881 (relating to Income of foreign corpora- tions not connected with United States busi- ness). "(4) For purposes of sections 902(a) and 78, a foreign corporation choosing the bene- fits of this subpart which receives dlvi- 865 PAGENO="0876" dends shall, with respect to such dividends, be treated as a domestic corporation." (2) The table of sections for such sub- part A is amended by adding at the end thereof the following: "Sec. 906. Nonresident alien individuals and foreign corporations." (3) Section 874(c) is amended by striking out `(c) FOREIGN TAX CREDIT NOT ALLOWED.- A non-resident" and inserting in lieut thereof the following: `(c) FOREIGN TAX CREDIT-Except as pro- vided In section 906, a nonresident." (4) Subsection (b) of section 901 (relat- ing to amount allowed) is amended by re- designating paragraph (4) as paragraph (5), and by inserting after paragraph (a) the fol- lowing new paragraph: "(4) NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN cORPoRATIONs-In the case of any nonresident alien individual not described in section 876 and in the case of any for- eign corporation, the amount determined pursuant to section 906; and". (5) Paragraph (5) (as redesignated) of section 901(b) is amended by striking out "or (3) ." and inserting in lieu thereof "(3), or (4),". (6) The amendments made by this sub- section shall apply with respect to taxable years beginning after December 31, 1966. In applying section 904 of the Internal Revenue Code of 1954 with respect to section 906 of such Code, no amount may be ~arried from or to any taxable year beginning before Janu- ary 1, 1967, and no such year shall be taken into account. (b) ALIEN RESIDENTS OF THE UNITED STATES oa PUERTO RIco.- (1) Paragraph (3) of section 901(b) (re- lating to amount of foreign tax credit allowed in case of alien resident of the United States or Puerto Rico) is amended by striking out ", if the foreign country of which such alien resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such coun- try". (2) Section 901 is amended by redesig- nating subsections (c) and (d) as subsec- tions (d) and (a), and by inserting after subsection (b) the following new subsection: "(C) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN RESIDENTS-Whenever the President finds that- "(1) a foreign country, In Imposing in- come, war profits, and excess profits taxes, does not allow to citizens of the United States residing in such foreign country a credit for any such taxes paid or accrued to the United States or any foreign country, as the case may be, similar to the credit allowed under subsection (b) (3), "(2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit to citizens of the United States residing in such foreign country, and "(3) it is in the public interest to allow the Credit under subsection (b) (3) to citi- zens or subjects of such foreign country only if it allows such a similar credit to citizens of the United States residing in such foreign country. the President shall proclaim that, for taxable years beginning while the proclamation re- mains In effect, the credit under subsection (b) (3) shall be allowed to citizens or subjects of such foreign country only if such foreign country, in Imposing income, war profits, and excess profits taxes, allows to citizens of the United States residing in such foreign coun- try such a similar credit." (3) Section 2014 (relating to credit for for- eign death taxes) is amended by striking out the second sentence of subsection (a), and by adding at the end of such section the follow- ing new subsection: "(h) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN REsIDENTs-Whenever the President finds that- "(1) a foreign country, in imposing estats. inheritance, legacy, or succession taxes, does not allow to citizens of the United States resident in such foreign country at the time of death a credit similar to the credit allowed under subsection (a), "(2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit in the case I of citizens of the Un(ted States resident in such foreign country at the time of death, anti "(3) it is in the public interest to allow the credit under subsection (a) in the case of citizens or subjects of such foreign country only if it allows such a similar credit in the case of citizens of the United States resi- dent in such foreign country at the time of death, the President shall proclaim that, in the case of citizens or subjects of such foreign coun- try dying while the proclamation remains in effect, the credit under subsection (a) shall be allowed only if such foreign country al- [P. 12690) lows such a similar credit in the case of citi- zens of the United States resident in such foreign country at the time of death." (4) The amendments made by this subsec- tion (other than paragraph (3)) shall apply with respect to taxable years beginning after December 31, 1966. The amendment made by paragraph (3) shall apply with respect to estates of decedents dying after the date of the enactment of this Act. SEC. 7. AMENDMENT To PREsERVE EXISTING LAW ON DEDUCTIONS UNDER SEcTIoN 931. DEDUcTIoNS-Subsection (d) of section 931 (relating to deductions) is amended to read as follows: "(d) DEDUCTIONS.- "(1) GENERAL RULE-Except as otherwise provided in this subsection and subsection (e), in the case of persons entitled to the benefits of this section the deductions shall be allowed only if and to the extent that they are connected with income from sources within the United States; and the proper ap- portionment and allocation of the deduc- tions with respect to sources of income within and without the United States shall be de- termined as provided in part I, under regu- lations prescribed by the Secretary or his delegate. "(2) ExcEPTIoNs-The following deduc- tions~ shall be allowed whether or not they are connected with income from sources within the United States: "(A) The deduction, for losses not Con- nected with the trade or business if Incurred in transactions entered into for profit, al- lowed by section 165(c) (2), but only If the profit, if such transaction had resulted In a profit, would be taxable under this subtitle. "(B) The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c) (3), but only if the loss is of property within the United States. 866 PAGENO="0877" "(C) The deduction for charitable contri- butions and gifts allowed by section 170. "(3) DEDUCTION DISALLOWED.- "For disallowance of standard deduction, see section 142(b) (2) ." (b) EFFECTIVE DATE.-The amendment made by this section shall apply with respect to taxable years beginning after December 31, 1966. SEC. 8. ESTATES OF NONRESIDENTS NOT Crri- ZENS. (a) RATE OF TAx-Subsection (a) of sec- tion 2101 (relating to tax imposed in case of estates of nonresidents not citizens) is amended to read as follows: "(a) RATE OF TAx-Except as provided in section 2107, a tax computed in accordance with the following table is hereby imposed on the transfer of the taxable estate, deter- mined as provided in section 2106, of every decedent nonresident not a citizen of the United States: "If the taxable estate is: Not over $l00,000~_ 5% of the taxable estate. Over $100,000 but not over $500,000_ $5,000 plus 10% of excess over $100,000. Over $500,000 but not over $1,000,- 000 $45,000, plus 15% of excess over $500,000. Over $1,000,000 but not over $2,000,- 000 $120,000, plus 20% of excess over $1,000,000. Over $2,000,000 $320,000, plus 25% of excess over $2,000,000." (b) CRsnrrs AGAINST TAx,-SectiOn 2102 (relating to credits allowed against estate tax) is amended to read as follows: "SEC. 2102. CRmrrs AGAINST TAX. "(a) IN GENERAL.-The tax imposed by section 2101 shall be credited with the amounts determined in accordance with sec- tions 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), subject to the special limitation provided in subs~ctlon (b). `(b) SPECIAL LIMrFATI0N.-The maximum credit allowed under section 2011 agaInst the tax Imposed by section 2101 for State death taxes paid shall be an amount which bears the same ratio to the credit computed as provided in sectIon 2011(b) as the value of the property, as determined for purposes of this chapter, upon which State death taxes were paid and which is included In the gross estate under section 2103 bears to the value of the total gross estate under section 2103. For purposes of this subsection, the term `State death taxes' means the taxes described In section 2011(a)." (C) PROPERTY WITHIN THE UNITED STATEs-Section 2104 (relating to property within the United States) Is amended by adding at the end thereof the following new subsection: "(c) DEBT OBLIGATIONS-For purposes of this subchapter, debt obligations of- "(1) a United States person, or "(2) the United States, a State or any political subdivision thereof, or the District of Columbia, owned by a nonresident not a citizen of the United States shall be deemed property with- in the United States. This subsection shall not apply to a debt obligation of a domestic corporation if any interest on such obliga- tion, were such interest received by the de- cedent at the time of his death, would be treated under section 862(a) (1) as income from sources without the United States." (d) PROPERTY WITH0D'r THE UNITED STATEs-Subsection (b) of section 2105 (re- lating to bank deposits) is amended to read as follows: `(b) DEPOSITS IN CERTAIN FOREIGN BRANCHES.-FOr purposes of this subchapter, deposits with a foreign branch of a domestic corporation, If such branch is engaged In the commercial banking business, shall not be deemed property within the United States." (e) DEFINITION OF TAXABLE EsTATE-Para- graph (3) of section 2106(a) (relating to de- duction of exemption from gross estate) Is amended to read as follows: "(3) EXEMPTION.- "(A) GENERAL RULE-An exemption of $30,000. "(B) RESIDENTS OF POSSESSIONS OF THE UNITED sTATEs-In the case of a decedent who is considered to. be a `nonresident not a citizen of the United States' under the pro- visions of section 2209, the exemption shall be the greater of (I) $30,000, or (Ii) that pro- portion of the exemption authorized by sec- tion 2052 which the value of that part of the decedent's gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated." (f) SPECIAL METHODS OF COMPUTING TAX.- Subchapter B of chapter 11 (relating to estates of nonresidents not citizens) is amended by adding at .the end thereof the following new sections: "SEC 2107. EXPATRIATION To AVOID TAX. (a) RATE OF TAX-A. tax computed In accordance with the table contained In sec- tion2001 is hereby imposed on the transfer of the taxable estate, determined as provided In section 2106, of every decedent nonresident not a citizen of the United States dying after the date of enactment of this section, If after March 8, 1965, and within the 10-year period ending with the date of death such decedent lost United States citizenship, unless such loss did not have for one of Its principal pur- poses the avoidance of taxes under this sub- title or subtitle A. "(b) GRoss ESTATE-For purposes of the tax Imposed by subsection (a), the value of the gross estate of every decendent to whom subsection (a) applies shall be determined as provided in section 2103, except that- "(1) if such decedent owned (within the meaning of section 958(a)) at the time of his death 10 percent or more of the total combined voting power of all classes of stock entitled to vote of a foreign corporation, and "(2) If such decedent owned (within the meaning of section 958(a)), or Is considered to have owned (by applying the ownership rules of section 958(b)), at the time of his death, more than 50 percent of the total com- bined voting power of all classes of stock entitred to vote of such foreign corporation, then that proportion of the fair market value of the stock of such foreign corporation owned (within the meaning of section 958(a)) by such decedent at the time of his death, which the fair market value of any assets owned by such foreign corporation and situated in the United States, at~ the time 867 PAGENO="0878" of his death, bears to the total fair market value of all assets owned by such foreign corporation at the time of his death, shall be Included In the gross estate of such decedent. For purposes of the preceding sentence, a decedent shall be treated as owning stock of a foreign corporation at the timeof his death If, at the time of a transfer, by trust or otherwise, within the meaning of sections 2035 to 2038, Inclusive, he owned such stock. `(c) CsEorrs.-The tax imposed by rub- section (a) shall be credited with the amounts determined In accordance with sec- tIon 2102. "(d) EXCLPTION FOR Loss o~ CITIZENSHIP FOR CERTAIN CAusEs-Subsection (a) shall not apply to the transfer of the estate of a decedent whose loss of United States citizen- ship resulted from the application of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401 (b), 1482, or 1487).. "(e) BURDEN OF Paoos.-If the Secretary or his delegate establishes that It Is reason- able to believe that an Individual's loss of United States citizenship would, but for this section, result In a substantial reduction in the estate, Inheritance, legacy, and succes- sion taxes In respect of the transfer of his estate, the burden of proving that such loss of citizenship did not have for one of Its principal pUrposes the avoidance of taxes undUr this subtitle or subtitle A shall be on the executor of such Individual's estate. "SEC. 2108. APPLICATION OF PRE-1967 ESTATE TAX PRovassoNs. "(a) IMPoSITIoN OF MORE BURDENSOME TAX BY FOREIGN CoUNTRY-Whenever the Presi- dent finds that- "(1) under the laws of any foreign coun- try, considering the tax system of such for- eign country, a more burdensome tax is im- posed by such foreign country on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country than the tax Imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, `(2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such tax so that It Is no more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, and "(3) It Is In the public Interest to apply pre-1967 tax provisions in accordance with this section to the transfer of estates of decedents who were residents of such foreign country, the President shall proclaim that the tax ei the transfer of the estate of every de- cedent Who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to amend- ments made to sections 2101 (relating to tax [P. 12691) imposed), 2102 (relatIng to credits against tax), and 6018 (relatIng to estate tax re- turns) on or after the date of enactment of this section. "(b) ALLEVIATION OF MoRE BURDENSOME TAx-Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclama- tion under subsection (a) have been modi- fied so that the tax on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country is no longer more burden- some than the tax imposed by this sub- chapter on the transfer of estates of de- cedents who were residents of such foreign country, he shall proclaim that the tax on the transfer of the estate of every de- cedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to subsec- tion (a). `(c) NoTIFIcATIoN OF CONGRESS REQUIRED.- No proclamation shall be issued by the Presi- dent pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his Intention to issue such proclamation. "(d) IMPLEMENTATION BY REGULATIONS.- The Secretary or his delegate shall prescribe such regulations as may be necessary or appropriate to implement this section." (g) ESTATE TAX RETuRNS-Paragraph (2) of section 6018(a) (relating to estates of nonresidents not citizens) Is amended by striking out "$2,000" and inserting in lieu thereof "$30,000". (h) CLERICAL AMENDMENT-The table of sections for subchapter B of chapter 11 (re- latIng to estates of nonresident-s not citi- zens) is amended by adding at the end thereof the following: "Sec. 2107. Expatriation to avoid tax. "Sec. 2108. Application of pre-1967 estate tax provisions." (I) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to estates of decedents dying after the date of the enactment of this Act. SEC. 9. TAX ON GIFTS OF NONRESIDENTS NOT ~ITIzzNs. (a) IMPOSITION OF TAX-Subsection (a) of section 2501 (relating to general rule for imposition of tax) is amended to read as follows: "(a) TAXABLE TRANSFERS.- "(1) GENERAL RULE-For the calendar year 1955 and each calendar year thereafter a tax, computed as provided in section 2502, is hereby imposed on the transfer of prop- erty by gift during such calendar year by any Individual, resident or nonresident. "(2) TRANSFERS OF INTANGIBLE PROPERTY.- Except as provided in paragraph (3), para- graph (1) shall not apply to the transfer of Intangible property by a nonresident not a citizen of the United States. "(3) ExcEPTIONS-Paragraph (2) shall not apply in the case of a donor who at any time after March 8, 1965, and within the ten-year period ending with the date of transfer lost United States citizenship unless- "(A) such donor's loss of United States citizenship resulted from the application of section 301(b), 350, or 355 of the Immigra- tion and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487), or "(B) such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. "(4) BURDEN OF PROOF-If the Secretary or his delegate establishes that it is reason- able to believe that an individual's loss of United States citizenship would, but for paragraph (3), result in a substantial reduc- tion for the calendar year In the taxes on the transfer of property by gift, the burden 868 PAGENO="0879" of proving that such loss of citizenship did not have for one of its principal purposes the avoidance of taxes under this subtitle or sub- title A shall be on such individual." (b) TRANSFERS IN GEN~ERAL.-Subsection (b) of section 2511 (relating to situs rule for stock in a corporation) is amended to rind as follows: `(b) INTANGI8LE PRoPERTY-For purposes of this chapter, in the case of a nonresident not a citizen of the United States who is excepted from the application of section 2501(a) (2)- "(1) shares of stock issued by a domestic corporation, and "(2) debt obligations of- "(A) a United States person, or "(B) the United States, a State or any political subdivision thereof, or the District of Columbia, which are owned by such nonresident shall be deemed to be property situated within the United States." (c) EFFECTIVE DATE.-T~e amendments made by this section shall apply with respect to the calendar year 1967 and all calendar years thereafter. SEC. 10. TREATY OBLIGATIONS. No amendment made by this Act shall apply in any case where its application would be contrary to any treaty obligation of the United States. For purposes of the preced- ing sentence, the extension of a benefit pro- vided by any amendment made by this Act shall not be deemed to be contrary to a treaty obligation of the United States. The CHAIRMAN~ No amendments to the bill are in order except amendments offered by direction c~f the Committee on Ways and Means. Mr. MILLS. Mr. Chairman, permit me to make a unanimous-consent re- quest. There are a number of amend- ments to this bill developed within the committee. As my friend the gentleman from Wisconsin [Mr. BYRNESI and my friend the gentleman from Missouri [Mr. CuRTIs] know, those amendments are printed In the report and they are also printed in the bill as reported by the committee. They are very technical and very numerous. I am going to ask unan- imous consent, Mr. Chairman, that these amendments be considered en bloc and that they be considered as read and printed in the RECORD at this point. The CHAIRMAN. Is there objection to the request of the gentleman from Arkansas? There was no objection. The committee amendments are as follows: Page 14, line 16, strike out "(B) ." and in- sert "(B) and (C)," Page 16, line 11, insert: "`(C) In the case of a foreign corporation taxable under part I of subchapter L, any income from sources without the United States which is attributable to its United States business shall be treated as effectively connected with the conduct of a trade or business within the United States." Page 16, line 17, strike "(C)" ~`ad insert "(D)". Page 17, line 11, after "1966" insert: "; ex- cept that in applying section 564(c) (4) (B) (iii) of the Internal Revenue Code of 1954 (as added by subsection (d)) with re- spect to a binding contract entered into on or before February 24, 1966, activities in the United States on or before such date in nego- tiating or carrying out such contract shall not be taken into account." Page 20, line 8, strike "taxable" and insert "taxable". Page 21, line 14, after "property" insert "held for the production of income and". Page 21, line 17, after "of" insert "such". Page 56, line 4, insert: * "(e) ELECTIONS BY NONRESIDENT UNITED STATES CITIZENS WHO ARE SUBJECT vo FOREIGN COMMUNITY PROPERTY LAwS.- "(1) Part III of subchapter N of chapter 1 (relating to income from sources without the Unted States.) is amended by adding at the end thereof the following new subpart: "SUBPART H-INCOME OF CERTAIN NONRESIDENT UNITED STATES CITIZENS SUBJECT TO FOREIGN COMMUNITY PROPERTY LAWS "`SEC. 981. Elections as to treatment of in- come subject to foreign com- munity property laws. "`SEC. 981. ELECTION AS TO TREATMENT OF IN- COME SUBJECT To FOREIGN C0M- MIJNITY PROPERTY LAWS. "(a) GENERAL RULE-In the case of any taxable year beginning after December 31, 1966, if- "`(1) an individual is (A) a citizen of the United States, (B) a bona fide resident of a foreign country or countries during the entire taxable year, and (C) married at the close of the taxable year to a spouse who is a nonresident alien during the entire tax- able year, and "`(2) such individual and his spouse elect to have subsection (b) apply to their com- munity income under foreign community property laws, then subsection (b) shall apply to such In- come of such individual and such spouse for the taxable year and for all subsequent tax- able years for which the requirements of paragraph (1) are met, unless the Secretary or his delegate consents to a termination of the election. ``(b) TREATMENT OF COMMUNITY IN- COME-For any taxable year to which an etlection made under subsection (a) applies, the community income under foreign com- munity property laws of the husband and wife making the election shall be treated as follows: "`(1) Earned income (within the meaning of the first sentence of section 911(b) ), other than trade or business income and a part- ner's distributive share of partnership in- come, shall be treated as the income of the spouse who rendered the personal services. "`(2) Trade or business income, and a partner's distributive share of partnership in- come, shall be treated as provided in section 1402(a) (5). `(3) Commuinty income not described in paragraph (1) or (2) which is derived from the separate property (as determined under the applicable foreign community property. law) of one spouse shall be treated as the income of such spouse. "`(4) All other such community income shall be treated as provided in the applicable foreign community property law. "(c) ELECTION FOR PRE-1967 YEARS.- "`(1) ELECTION-If an individual meets the requirements of subsection (a) (1) (A) and (C) for any taxable year beginning be- fore January 1, 1967, and if such individfial 869 PAGENO="0880" and the spouse referred to in subsection (a) (1) (C) elect under this subsection, then paragraph (2) of this subsection shall apply to their community income under foreign community property laws for all open taxable years beginning before January 1, 1967 (whether under this chapter, the correspond- ing provisions of the Internal Revenue Code of 1939, or the corresponding provisions of prior revenue laws), for which the require- ments of subsection (a) (1) (A) and (C) are met, "`(2) EFFEcT OF ELEcTION-For any tax- able year to which an election made under this subsection applies, the community in- come under foreign community property laws of the husband and wife making the election shall be treated as provided by subsection (b), except that the other community income described in paragraph (4) of subsection (b) [P. 12692) shall be treated as the income of the spouse who, for such taxable year, had gross income underparagraphs (1), (2),and (3) of subsec- tion (b), plus separate gross income, greater than that of the other spouse. `(d) TIME FOR MAKING ELECTIONS; PERsOn OF LIMITATION5 rdrc.- "`(1) TIME-An election under subsection (a) or (c) for a taxable year may be made at any time while such year is still open, and shall be made in such manner as the Secre- tary or his delegate shall by regulations prescribe. "`(2) EXTENSION OF PERIOD FOR ASSESSING DEFICIENCIES AND MAKING REFUNDS-If any taxable year to which an election under sub- section (a) or (c) applies is open at the time such election is made, the period for assessing a deficiency against, and the period for filing claim for credit or refund of any overpayment by, the husband and wife for such taxable year, to the extent such defi- ciency or overpayment is attributable to such an election, shall not expire before 1 year after the date of such election. "`(3) ALIEN SPOUSE NEED NOT JOIN IN SUB- SECTION (c) ELECTION IN CERTAIN CASES-If the Secretary or his delegate determines- "`(A) that an election under subsection (c) would not affect the liability for Federal income tax of the spouse referred to in sub- section (a) (1) (C) for any taxable year, or "`(B) that the effect on such liability for tax cannot be ascertained and that to deny the election to the citizen of the United States would be inequitable and cause un- due hardship, such spouse shall not be required to join In such election, and paragraph (2) of this subsection shall not apply with respect to such spouse. "`(4) INTEREsT-To the extent that any overpayment or deficiency for a taxable year Is attributable to an election made under this section, no interest shall be allowed or paid for any period before the day which is 1 year after the date of such election. "`(e) DEFINITIONS AND SPECIAL RtTLEs.- For purposes of this section- "`(1) DEDucTIoNs-Deductions shall be treated in a manner consistent with the manner provided by this section for the in- come to whicth they relate. "`(2) OPEN YEARS-A taxable year of a citizen of the United States and his spouse shall be treated as "open" If the period for assessing a deficiency against such citizen for such year has not expired before the date of the election under subsection (a) or (c), as the case may be. "`(3) ELECTIONS IN CASE OF DECENDENTS.- If a husband or wife is decreased his election under this section may be made by his ex- ecutor, administrator, or other person charged with his property. "`(4) DEATH OF SPOUSE DURING TAXABLE YEAR-In applying subsection (a) (1) (C), and in determining under subsection (c) (2) which spouse has the greater income for a taxable year, if a husband or wife dies the taxable year of the surviving spouse shall be treated as ending on the date of such death.' "(2) The table of subparts for such part III is amended by adding at the end thereof the following: `Subpart H. Income of certain nonresident United States citizens sub- ject to foreign community property laws.' "(3) Section 911(d) (relating to earned Income from sources without the United States) is amended- "(A) by striking out `For administrative' and inserting In lieu thereof the following: `(1) For administrative'; and "(B) by adding at the thereof the follow- ing: "`(2) For elections as to treatment of in- come subject to foreign community prop- erty laws, see section 981." Page 68, line 9, insert: `(c) FOREIGN TAX CREDIT IN CASE OF Cm- TAIN OvansEAs OPsmsATIoNs FUNDING SUB- SIDIAR5ES.- "(1) Section 904(f) (2) (relating to ap- plication of limitations on foreign tax credit in case of certain interest Income) is amended- "(A) by striking out "or" at the end of subparagraph (C), "(B) by striking out the period at the end of subparagraph (D)~ and inserting in lieu thereof ", or", and "(C) by adding at the end thereof the following new subparagraph: "`(E) received by an overeea operations funding subsidiary on obligations of a re- lated foreign corporation.' "(2) Section 904(f) is amended by adding at the end thereof the following new para- graph: "`(5) DEFINITIONs FOR PURPOSES OF PARA- GRAPH (1) (E) -For purposes of paragraph (1) (E).- "`(A) the term "overseas operations fund- ing subsidiary" means a domestic corpora- tion which (i) is a member of an affiliated group (within the meaning of section 1504) and is not the common parent corporation, and (ii) was formed and Is availed of for the principal purpose of raising funds outside the United States through public offerings to foreign persons and of using such funds to finance the operations in foreign coun- tries of one or more related foreign corpora- tions, and "`(B) a foreign corporation is, with re- spect to an overseas operations funding sub- sidiary, a related foreign corporation if the affiliated group of which such subsidiary is a member owns 50 percent or more of the vot- ing stock of such foreign corporation either directly or through ownership of the voting stock of another foreign corporation.' "(3) The amendments made by paragraphs (1) and (2) shall apply to interest received after December 31, 1965, in taxable years ending after such date." Page 73, line 20, strike "under section 862 (a) (1)" and insert "by reason of section 861 (a) (1) (B)". 870 PAGENO="0881" Page 78, line 15, after "tax) ," insert "2106 The SPEAKER pro tempore. Under (relating to taxable estate) ,". : the rule, the previous question is ordered. Is a separate vote demanded on any amendment? If not, the Chair will put them en gros. The amendments were agreed to. The SPEAKER pro tempore. The question is on the engrossment and third reading of the bill. The bill was ordered to be engrossed and read a third time, and was read the third time. The SPEAKER pro tempore. The question is on the passage of the bill. The bill was passed. .A motion to reconsider was laid on the table. The committee amendments were agreed to. The CHAIRMAN. Under the rule, the Committee rises. Accordingly, the Committee rose; and the Speaker pro tempore (Mr. ALBERT) having resumed the chair, Mr. MADDEN, Chairman of the Committee of the Whole House on the State of the Union, re- ported that that Committee, having had under consideration the bill (H.R. 13103) to amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States, pursuant to House Resolution 880, he reported the bill back to the House with sundry amendments adopted by the Committee of the Whole. 71-297 O-67-pt. 1-56 871 PAGENO="0882" PAGENO="0883" SECTION 19 BILL AS PASSED BY THE HOUSE AND REFERRED TO THE SENATE COMMITTEE ON FINANCE (See Section 21 of this document, page 887) 873 PAGENO="0884" PAGENO="0885" SECTION 20 PRESS RELEASE OF THE SENATE COMMITTEE ON FINANCE DATED JULY 29, 1966, ANNOUNCING HEARINGS ON FOREIGN INVESTORS TAX ACT OF 1966 875 PAGENO="0886" PAGENO="0887" PRESS RELEASE FOR IMMEDIATE RELEASE COMMITTEE ON FINANCE JULY 29, 1966 UNITED STATES SENATE 2227 New Senate Office Bldg. Phone: 225-4515 RUSSELL B. LONG (D., LA.), CHAIRMAN, COMMITTEE ON FINANCE, ANNOUNCES HEARINGS ON FOREIGN INVESTORS TAX ACT OF 1966 Chairman Russell B. Long today announced that the Committee on Finance has scheduled hearings on H. R. 13103, the Foreign Investors Tax Act of 1966. Hearings on this bill, he said, would begin at 10:00 a. m., Monday, August 8, Room 2221, New Senate Office Building. The Secretary of the Treasury, Henry H. Fowler, is to be the lead-off witness. Persons desiring to be heard on this important measure should submit requests to Tom Vail, Chief Counsel, Committee on Finance, no later than Friday, August 5. In order to facilitate the hearing, those with similar interests are urged to designate a single spokesman to preseot their testimony. Witnesses who are scheduled to appear are further urged to make their statements as brief as possible to conserve the time of the Committee. In order to further conserve time, the Committee will be pleased to receive from any interested person a written statement for inclusion in the printed record of the hearings in lieu of a personal appearance. These statements will be given the same full consideration as though they had been delivered orally. All statements should include a summary sheet and subject headings and should be received in the Finance Committee office the day prior to scheduled appearance. P. R. # 20 877 PAGENO="0888" PAGENO="0889" SE CTION 21 HEARINGS BEFORE THE SENATE COMMITTEE ON FINANCE 879 PAGENO="0890" PAGENO="0891" FOREIGN INVESTORS TAX ACT OF 1966 HEARINGS BEFORE THE COMMITTEE ON FINANCE UNITED STATES SENATE EIGHTY-NINTH CONGRESS SECOND SESSION ON H.R. 13103 AN ACT TO AMEND THE INTERNAL REVENUE CODE OF 1954 TO PROVIDE EQUITABLE TAX TREATMENT FOR FOREIGN INVESTMENT IN THE UNITED STATES AUGUST 8, 9, AND 10, 1966 Printe4 for the use of the Committee on Finance U.S. `GOVERNMENT PRINTING OFFICE WASHINGTON : 1966 881 PAGENO="0892" COMMITTEE ON FINANOB RUSSELL B. LONG, Louisiana, Chairnva~ GEORGE A. SMATHERS, Florida JOHN J. WILLIAMS, Delaware CLINTON P. ANDERSON, New Mexico FRANK CARLSON, Kansas PAUL H. DOUGLAS, illinois WALLACE F. BENNETT, Utah ALBERT GORE, Tennessee CARL T. CURTIS, Nebraska HERMAN E. TALMADGE, Georgia THRUSTON B. MORTON, Kentucky EUGENE J. McCARTHY, Minnesota EVERETT McKINLEY DIRKSEN, Illinois VANCE HARTKE, Indiana J. W. FULBRIGHP, Arkansas ABRAHAM RIBICOFF, Connecticut LEE METCALF, Montana ToM VAIL, Chief Counsel EVELYN R. THOMPSON, Assi8tant Chief Clerk II 882 PAGENO="0893" CONTENTS Page Textofll.R. 13103 I Departmental comments on H.R. 13103: Bureau of the Budget 25 Department of Commerce 26 Department of State 28 WITNESSES American Bankers Association, John H. Perkins 151 Arizona Bankers Association, Charles H. Bartlett, Jr 235 Bankers Association for Foreign Trade, William F. Ray, president; accompanied by Thomas Baer, counsel 135 Barth, Alfred W., executive vice president, the Chase Manhattan Bank; accompanied by Stuart E. Keebler, counsel 113 Bartlett, Charles H., Jr., representing the Arizona Bankers Association - 235 Chapman, Alger B., vice president, New York Stock Exchange; accom-' panied by Stanley West, research director 57 Chase Manhattan Bank, The, Alfred W. Barth, executive vice president; accompanied by Stuart E..Keebler, counsel 113 Finchell, A. Richard, president, Greater Miami Savings Center 237 Fowler, Hon. Henry H., Secretary of the Treasury; accompanied by Stanley S. Surrey, Assistant Secretary for Tax Policy; and Winthrop Knowlton, Assistant Secretary for International Affairs, Department of the Treasury 29 Greater Miami Savings Center, A. Richard Finchell, president 237 Henderson, Gordon D., Committee on International Taxation of the New York State Bar Association Tax Section 217 Institute on U.S. Taxation of Foreign Income, Inc., Paul D. Seghers, president 102 International Telephone & Telegraph Corp., John Seath, vice president and director of taxes 206 Kalish, Richard H., partner, Peat, Marwick, Mitchell & Co 171 National Foreign Trade Council, Inc., the, Robert M. Norris, president; accompanied by Charles R. Carroll, counsel to the board of directors - 64 New York Clearing House Association, Walter H. Page; accompanied by David Lindsay, counsel 106 New York State Bar Association Tax Section, Gordon D. Henderson, Committee on International Taxation 217 New York Stock Exchange, Alger B. Chapman, vice president; accom- panied by Stanley West, research director 57 Norris, Robert M., president, the National Foreign Trade Council, Inc.; accompanied by Charles R. Carroll, counsel to the board of directors. - - 64 Page, Walter H., representing the New York Clearing House Association; accompanied by David Lindsay, counsel 106 Peat, Marwick, Mitchell & Co., Richard H. Kalish, partner 171 Perkins, John H., representing the American Bankers Association 151 Ray, William F., president, Bankers Association for Foreign Trade; ac.. companied by Thomas Baer, counsel 135 Seath, John, vice president and director of taxes, International Telephone & Telegraph Corp 206 Seghers, Paul D., president, Institute on U.S. Taxation of Foreign Income, Inc 102 Surrey, Stanley S., Assistant Secretary for Tax Policy, Department of the Treasury 29 III 883 PAGENO="0894" IV CO~NTET~TS COMMUNICATIONS American Institute of Certified Public Accountants, statement submitted Pftge by Donald T. Burns, general chairman, committee on federal taxation.. 256 Appelmans, Jacques, vice chairman, Foreign Investment Committee, Investment Bankers Association of America, statement 166 Association of the Bar of the City of New York, the, statements submitted by Laurence F. Casey, chairman, committee on taxation 247 Banco de Ponce, statement of Roberto de Jesus Toro 177 Banco Popular de Puerto Rico, statementof R. Carrion, Jr., president._. 186 Bank of China, statement 193 Barclay's Bank D.C.O., letter and enclosure of E. W. Bithell, local director, to the chairman 200 Beaumont, Robert, agent in charge, Hongkong and Shanghai Banking Corp., statement 195 Bithell, E. W., local director, Barclay's Bank D.C.O., letter and enclosure, to the chairman 200 Brace, L. D., chairman, the First National Bank of Boston, letter to the chairman 145 Burns, Donald T., general chairman, Committee on Federal Taxation, American Institute of Certified Public Accountants, statement 256 Carrion, R., Jr., president, Banco Popular de Puerto Rico, statement - - - 186 Casey, Laurence F., chairman, Committee on Taxation, the Association of the Bar of the City of New York, statements. 247 Clark Equipment Co., letter of R. F. Sumerwell, tax manager, to the chairman 265 Danielian, N. R., president, International Economic Policy Association, statement 166 Decker, G. H., president, Manufacturing Chemists' Association, Inc., letter to the chairman 100 Derr, Charles I., senior vice president, Machinery & Allied Products Insti- tute, letter to the chairman 267 Dickinson, David E., Hubachek, Kelly, Miller, Rauch & Kirby, statement 168 Eaton, Fredrick M., letter to the chairman 244 First National Bank of Boston, The, letter and enclosures of L. D. Brace, chairman, to the chairman 145 Fitzpatrick, Patrick, president, World Trade Center in New England, Inc., statement 260 Funston, G. Keith, president, New York Stock Exchange, statement - - - 59 Fraser, John M., Jr., vice president and manager, Rhode Island Hospital Trust Co., letter to the chairman 164 Gleason, D. H., chairman, Subcommittee on International Taxation, NAM Taxation Committee, National Association of Manufacturers, letter to the chairman 100 Hongkong & Shanghai Banking Corp., statement of Robert Beaumont, agent in charge 195 Hubachek, Kelly, Miller, Rauch & Kirby, statement submitted by David E. Dickinson 168 Humphreys, Ward C., manager, Washington office, Kaiser Aluminum & Chemical Corp., letter to the chairman 272 International Economic Policy Association, statement submitted by N. R. Danielian, president 166 Investment Bankers Association of America, statement submitted by Jaques Appelmans, vice chairman, foreign investment committee 166 James, George F., senior vice president, Mobil Oil Corp., letter to the chairman 244 Kaiser Aluminum & Chemical Corp., letter of Ward C. Humphreys, man- ager, Washington office, to the chairman 272 Korth, John E., assistant secretary-treasurer, Star-Kist Food, Inc., letter to Tom Vail, chief counsel, Committee on Finance 149 Langer, Marshall J., attorney, Stone, Bittel, and Langer, letter to the chairman 240 Laredo National Bank, the, Max A. Mandel, president, letter with enclo- sures to the chairman 273 Leness, George J., chairman of the board, Merrill Lynch, Pierce, Fenner & Smith, Inc., letter to the chairman 245 McKenna, William F., general counsel, National League of Insured Savings' Associations, letter to the chairman 241 Machinery & Allied Products Institute, letter of Charles I. Derr, senior vice president, to the chairman 267 884 PAGENO="0895" COW~ENTS V Mandel, Max A., president, the Laredo National Bank, letter with enclo- Page sures to the chairman 273 Manufacturing Chemists' Association, Inc., letter of G. H. Decker, presi- dent, to the chairman 100 Merrill Lynch, Pierce, Fenner & Smith, Inc., letter of George J. Leness, chairman of the board, to the chairman 245 Mobil Oil Corp., letter of George F. James, senior vice president, to the chairman 244 Morgan Stanley & Co., letter to the chairman. 243 National Association of Manufacturers, letter of D. H. Gleason, chairman, Subcommittee on International Taxation, NAM Taxation Committee, to the chairman 100 National Foreign Trade Council, the, pamphlet of 67 National League of Insured Savings Associations, letter of William F. McKenna, general counsel, to the chairman 241 New York Stock Exchange, statement of G. Keith Funston, president_ - - 59 Rhode Island Hospital Trust Co., letter of John M. Fraser, Jr., vice president and manager, to the chairman 164 Star-Kist Foods, Inc., letter of John E. Korth, assistant secretary-treasurer, to Tom Vail, chief counsel, Committee on Finance 149 Stone, Bittel, and Langer, letter of Marshall J. Langer, attorney, to the chairman 240 Sumerwell, R. F., tax manager, Clark Equipment Co., letter to the chairman 265 Tarleau, Thomas N., of Willkie, Farr, Gallagher, Walton & Fitzgibbon, letters to the chairman: July 11, 1966 270 August 10, 1966 271 Toro, Roberto de Jesus, Banco de Ponce, statement 177 Wachovia Bank & Trust Co., statement of John F. Watlington, Jr., president 165 Watlington, John F., Jr., president, Wachovia Bank & Trust Co., state- ment 165 Wilikie, Farr, Gallagher, Walton & Fitzgibbon, letters of Thomas N. Tarleau, to the chairman: July 11, 1966 270 August 10, 1966 271 World Trade Center in New England, Inc., statement submitted by Patrick Fitzpatrick, president 260 Yarborough, Hon. Ralph, a U.S. Senator from the State of Texas, state- ment, with letter from the Department of the Treasury 245 ADDITIONAL INFORMATION "Revised Guidelines for Banks and Nonbank Financial Institutions," from the Federal Reserve Bulletin, December 1965 157 885 PAGENO="0896" PAGENO="0897" FOREIGN INVESTORS TAX ACT OF 1966 MONDAY, AUGUST 8, 1966 U.S. SENATE, COMMITTEE ON FINANCE, Washington, D.C. The committee met, pursuant to notice, at 10:10 a.m., in room 2221, New Senate Office Building, Senator Russell B. Long (chair- man) presiding. Present: Senators Long, Anderson, Talmadge, Ribicoff, Williams, Carlson, Curtis, and Dirksen. The CHAIRMAN. The hearing will come to order. This morning we begin 3 days of hearings on the Foreign In- vestors Tax Act of 1966. In 1963 President Kennedy appointed a task force on promoting increased foreign investment in TJ.S. corporate securities and in- creased foreign financing for U.S. corporations operating abroad. It was the hope of the administration that the task force would suggest additional measures to improve the U.S. balance of pay- ments. The report of the task force in 1964 recommended modifications in the U.S. tax law with regard to foreign investors. Based upon these recommendations legislation was submitted to Congress in 1965. After many months of working on the recommendations, the Ways and Means Committee of the House reported H.R. 13103. It passed the House on June 15. Rather than having as its purpose the encouragement of foreign investment in the United States though, the bill passed by the House is concerned with providing taxation of nonresident aliens and foreign corporations comparable to that of U.S. individuals and corporations. (The bill, H.R. 13103 follows:) [HR. 13103, 89th Cong., 2d sess.] AN ACT To amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled, SECTION 1. SHORT TITLE, ETC. (a) SHORT TITLE.-ThIS Act may be cited as the "Foreign Investors Tax Act of 1966". (2) TABLE OF CoN~NTs.- SEC. 1. Short title, etc. `(a) Short title. `(b)Table of contents. (c) Amendment of 1954 Code. 1 71-297 0-67-pt. 1-57 887 PAGENO="0898" 2 FOREIGN INVESTORS TAX ACT OF 1966 SEC. 2.. Source of income. (a) Interest. (b) Dividends. (c) Personal services. (d) Definitions. (e) Effective dates. SEC. 3. Nonresident alien individuals. (a) Tax on nonresident alien individuals: "SEC. 871. Tax on nonresident alien Individuals. "(a) Income not connected with United States business-3.O percent tax. "(b) Income connected with United States business-graduated rate of tax. "(c) Participants in certain exchange or training programs. "(d) Election to treat real property income as Income connected with United States business. (e) Cross references." (b) Gross Income. (c) Deductions. (d) Allowance of deductions and credits. (e) Expatriation to avoid tax: "SEC. 877. ExpatriatIon to avoid tax. "(a) In general. "(b) Alternative tax. "(c) Special rules of source. "(d) Exception for loss of citizenship for certain causes. "(e) Burden of proof." (f) Partial exclusion of dividends. (g) Withholding of tax on nonresident aliens. (h) Liability for withheld tax. (i) Declaration of estimated income tax by individuals. (i) Gain from dispositions of certain depreciable realty. 1(k) CollectIon .of income tax at source on wages. (1) Definition of foreign estate or trust. (rn) Conforming amendment. .(n) Effective dates. Szc. 4. ForeIgn corporations. (a) Tax on income not connected with United States business: ~`SEc. 881. Income of foreign corporations not connected with United States business. "(a). Imposition of tax. (b) Doubling of tax." (b) Tax on income connected with United States business: "SEC. 882. Income of foreign corporations connected with United States business. "(a) Normal tax and surtax. (b) Gross Income. "(c) Allowance of deductions and credits. "(d.) Election to treat real pro.perty Income as Income connected with United States business. "(e) Returns of tax by agent. `(f) Foreign corporations." (c) Withholding of tax on foreign corporations. (d) Dividends received from certain foreign corporations. (e) Unrelated business taxable income. (f) Corporations subject to personal holding company tax. (g) Amendments with respect to foreign corporations carrying on insurance business in United States. (h) Subpart F income. (1) Gain from certain sales or exchanges of stock in certain foreign corporations. (j) Declaration of estimated Income tax by corporations. (k) Technical amendments. (1) Effective dates. SEc. 5. Special tax provisions. (a) Income affected by treaty. (b) Application of pre-1967 income tax provisions: ~`SEc. 896. Application of pre-1967 income tax provisions. "(a) Imposition of more burdensome taxes by foreign country. "(b) Alleviation of more burdensome taxes. "(C) Notification of Congress required. (d) Implementation by regulations." (c) Clerical amendments. (d) Effective date. SEC. & Foreign tax credit. (a) Allowance of credit to certain nonresident aliens and foreign corporations. * (b) Alien residents of the United States or Puerto Rico. SEC. 7. Amendment to preserve existing law on deductions under section. 931. (a) Deductions. (b) Effective date. SEC. 8. Estates of nonresidents not citizens. (a) Rate of tax.. (b) `Credits against tax. (c) Property within the United States. (d) Property without the United States. * (e) Definition of taxable estate. (f) Special methods of computing tax: 888 PAGENO="0899" FOREIGN INVESTORS TAX ACT OF 1966 3 Ssc. 8. Estates of nonresidents not citizens-Continued (f) Special methods of computing tax-Continued "SEC. 2107. Expatriation to avoid tax. "(a) Rate of tax. "(b) Gross estate. "(c) Credits. "(d) Exception for loss of citizenship for certain causes. "(e) Burden of proof. "SEc. 3108. Application of pre-1907 estate tax provisions. "(a) Imposition of more burdensome tax by foreign country. "(b) Alleviation of more burdensome tax. "(c) Notification of Congress required. "(d) Implementation by regulations." *(g) Estate tax returns. (h) Clerical amendment. (i) Effective date. SEC. ~. Tax on gifts of nonresidents not citizens. (a) Imposition of tax. (b) Transfers in general. (c) Effective date. SEC. 10. Treaty obligations. (c) AMENDMENT OF 1954 CODE.-Except as otherwise expressly provided, when- ever in this Act an amendment or repeal is expressed in terms of an amendment to, or repeal of, a section or other provision, the reference is to a section or other provision of the Internal Revenue Oode of 1954. SEC. 2. SOURCE OF INCOME. (a) INTETiEST.- (1) (A), Subparagraph (A) of section 861 (a) (1) (relating to interest from sources within the United States) is amended to read as follows: "(A) interest on amounts described in subsection (c) received by a nonresident alien individual or a foreign corporation, if such interest is not effectively connected with the conduct of a trade or business within the United States,". "(c) INTEREST ON DEPOSITS, Erc.-For purposes of subsection (a) (1) (A), (B) Section 861 is amended by adding at the end thereof the following new subsection: the amounts described in this subsection are- "(1) deposits with persons carrying on the banking business, "(2) deposits or withdrawable accounts with savings institutions char- tered and supervised as savings and loan or similar association under Federal or State law, but only to the extent that amounts paid or credited on such deposits or accounts are deductible under section 591 in computing the taxable income of such institutions, and "(3) amounts held by an insurance company under an agreement to pay interest thereon. Effective with respect to amounts paid or credited after December 31, 1971, subsection (a) (1) (A) and this subsection shall cease to apply." (2) Section 861(a) (1) is amended by striking out "and" at the end of subparagraph (B), by striking out the period at the end of subparagraph (0) and inserting in lieu thereof ", and", and by adding at the end thereof the following new subparagraph: "(D) interest on deposits with a foreign branch of a domestic cor-. poration, if such branch is engaged in the commercial banking busi- ness." (3) (A) Section 895 (relating to income derived by a foreign central bank of issue from obligations of the United States) is amended- (i) by striking out "shall not be included" and inserting in lieu thereof ", or from interest on deposits with persons carrying on the banking business, shall not be included"; (ii) by striking out* "such obligations" and inserting in lieu thereof "such obligations or deposits"; (iii) by adding at the end thereof the following new sentence: "For purposes of the preceding sentence, the Bank for International Settle- ments shall be treated as a foreign central bank of issue with respect to interest on deposits with persons carrying on the banking business."; and 889 PAGENO="0900" 4 FOREIGN INVESTORS TAX ACT OF 1966 (iv) by striking out the heading and inserting in lieu thereof the following: "SEC. 895. INCOME DERIVED BY A FOREIGN CENTRAL BANK OF ISSUE FROM OBLIGATIONS OF THE UNITED STATES OR FROM BANK DEPOSITS." (B) The table of sections for subpart C of part II of subchapter N of chapter 1 is amended by striking out the itean relating to section 895 and inserting in lieu thereof the following: "See. 895. Income derived by a foreign central bank of issue from obligations of the United States or from bank deposits." (b) DIVIDENDS.- (1) Section 861 (a) (2) (B) (relating to dividends from sources within the United States) is amended to read as follows: "(B) from a foreign corporation unless less than 80 percent of the gross income from all sources of such foreign corporation for the 3-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was effectively connected with the conduct of a trade or business within the United States; but only in an amount which bears the same ratio to such dividends as the gross income of the corporation for such period which is effectively con- nected with the conduct of a trade or business within the United States bears to its gross income from all sources; but dividends from a foreign corporation shall, for purposes of subpart A of part III (re- lating to foreign tax credit), be treated as income from sources with- out the United States to the extent (and oniy to the extent) exceeding the amount which is 100/85ths of the amount of the deduction allow- able under section 245 in respect of such dividends, or". (2) Section 861(a) (2) is amended by adding after subparagraph (C) the following: "For purposes of subparagraph (B), the gross income of the foreign corporation for any period before the first taxable year beginning after December 31, 1966, which is effectively connected with the conduct of a trade or business within the United States is an amount equal to the gross income for such period from sources within the United States." (c) PERSONAL SERvICE5.-Section 861(a) (3) (0) (ii) (relating to income from personal services) is amended to read as follows: (ii) an individual who is a citizen or resident of the United States, a domestic partnership, or a domestic corporation, if such labor or services are performed for an office or place of business maintained in a foreign country or in a possession of the United States by such individual, partnership, or corporation." (d) DEFINITION5.-SectiOn 864 (relating to definitions) is amended- (1) by striking out "For purposes of this part," and inserting in lieu thereof "(a) SALE, ETc.-For purposes of this part,"; and (2) by adding at the end thereof the following new subsections: "(b) TRADE osi BUSINESS WITHIN THE UNITED STA~rxs.-For purposes of this part, part II, and chapter 3, the term `trade or business within the United States' includes the performance of personal services within the United States at any time within the taxable year, but does not include- "(1) PERFORMANCE OF PERSONAL SERVICES FOR FOREIGN EMPLOYERS.-The performance of personal services- "(A) for a nonresident alien individual, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or "(B) for an office or place of business maintained in a foreign country or in a possession of the United States by an individual who is a citizen or resident of the United States or by a domestit~ partner- ship or a domestic corporation, by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year and whose compensation for such services does not exceed in the aggregate $3,000. 890 PAGENO="0901" FOREIGN INVESTORS TAX ACT OF 1966 5 "(2) TRADING IN SECURITIES OR COMMODITIES.- "(A) STOCKS AND SECURITIES.- "(i) Except in the case of a dealer in stocks or securities, trading in stocks or securities for the taxpayer's own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such agent has discretionary authority to make de~ cesions in effecting the transactions. This clause shall not apply in the case of a corporation (other than a corporation which is, or but for section 542(c) (7) would be, a personal holding company) the principal business of which is trading in stocks or securities for its own account, if its principal office is in the United States. "(ii) In the case of a person who is a dealer in stocks or se- curities, trading in stocks or securities for his own account through a resident broker, commission agent, custodian, or other inde- pendent agent. "(B) COMMODITIES.- "(i) Except in the case of a dealer in commodities, trading in commodities for the taxpayer's own account, whether by the tax- payer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such agent has discretionary authority to make decisions in effecting the transactions. "(ii) In the case of a person who is a dealer in commodities, trading in commodities for his own account through ~ resident broker, commission agent, custodian, or other independent agent. "(iii) C1ause~ (i) and (ii) apply only if the commodities are of a kind customarily dealt in on an organized commodity ex- change and if the transaction is of a kind customarily consum- mated at such place.. "(C) LIMTPATI0N.-Subparagraphs (A) (ii) and (B) (ii) shall ap- ply only if, at no time during the taxable year, the taxpayer has an office or place of business in the United States through which or by the direction of which the transactions in stocks or securities, or in commodities, as the case may `be, are effected. "(c) EFFECTIVELY CONNECTED INCOME, ETC.- "(1) GENERAL RTJLE.-For purposes of this title- "(A) In the case of a nonresident alien individual or a foreign cor- poration engaged in trade or business within the United States during the taxable year, the rules set forth in paragraphs (2), (3), and (4) shall apply in determining the income, gain, or loss which shall be treated as effectively connected with the conduct of a trade or business with the United States. "(B) Except as provided in section 871(d) or section 882(d), in the case of a nonresident alien individual or a foreign corporation not en- gaged in trade or business within the United States `during the taxable year, no income, gain, or loss shall be treated as effectively connected with the conduct of a trade or business within the United States. "(2) PERIODICAL, ETC., INCOME FROM SOURCES WITHIN UNITED STATES- FACToRS-In determining whether income from sources within the United States of the types described in section 871(a) (1) or section 881(a), or whether gain or loss from sources within the United States from the sale or exchange of capital assets, is effectively connected with the conduct of a trade or business within the United States, the factors taken into account shall include whether- "(A) the income, gain, or loss is derived from assets used in or held for use in the conduct of such trade or business, or "(B) the activities of such trade or business were a material factor in the realization of the income, gain, or loss. In determining whether an asset is used in or held for use in the conduct of such trade or business or whether the activities of such trade or business were a material factor in realizing an item of income, gain, or loss, due regard shall be given to whether or not such asset or such income, gain, or loss was accounted for through such trade or business. In applying this paragraph and paragraph (4), interest referred to in section 861 (a) (1)(A) shall be considered income from sources within the United States. 891 PAGENO="0902" 6 FOREIGN INVESTORS TAX ACT OF 1966. "(3) OTHER INCOME FROM SOURCES WITHIN UNITED STATES.-A11 income, gain, or loss from sources within the United States (other than income, gain, or loss to which paragraph (2) applies) shall be treated as effectively con- nected with the conduct of a trade or business within the United States. "(4) INCOME FROM SOURCES WITHOUT UNITED STATES.- "(A) Except as provided in subparagraph (B) and (C), no income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a `trade or business within the United States. "(B) Income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States by a nonresident alien individual or a foreign corporation if such person has an office or other fixed place of business within the United States to which such income, gain, or loss is attributable and such income, gain, or loss- "(i) consists of rents or royalties for the use of or for the privilege of using intangible property described in section 862(a) (4) (includ- ing any gain or loss realized on the sale of such property) derived in the active conduct of such trade or business; "(ii) consists of dividends or interest, or gain or loss from the sale or exchange of stock or notes, bonds, or other evidences of in- debtedness, and either is derived in the active conduct of a banking, financing, or similar business within the United States or is received by a corporation the principal business of which is trading in stock or securities for its own account; or "(iii) is derived from the sale (without the United States) through such office or fixed place of business of personal property described in section 1221 (1), except that this clause shall not apply if the peoperty is sold for use, consumption, or disposition outside the United States and an office or other fixed place of business of the taxpayer outside the United States participated materially in such sale. In the case of a sale described in clause (iii), the income which shall be treated as attributable to the office or other fixed place of business within the United States shall not exceed the income which would be derived from sources within the United States if the sale were made in the United States. "(C) In the case of a foreign corporation taxable under part I of subchapter L, any income from sources without the United States which is attributable to its United States business shall be treated as effectively connected with the conduct of a trade or business within the United States. "(D) No income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States if it either- "(i) consist of dividends, interest, or royalties paid by a foreign corporation in which the taxpayer owns (within the meaning of section 958(a)), or is considered as owning (by applying the owner- ship rules of section 958(b)), more than 50 percent of the total com- bined voting power of all classes of stock entitled to vote, or "(ii) is subpart F income within the meaning of section 952(a)." (e) Er~oTIvE DATES.- (1) The amendments made by subsections (a), (c), and (d) shall apply with respect to taxable years beginning after December 31, 1966; except that in applying section 864(c) (4) (B) (iii) of the Internal Revenue Code of 1954 (as added by subsection (d)) with respect to a binding contract entered into on or before February 24, 1966, activities in the United States on or before such date in negotiating or carrying out such contract shall not be taken into account. (2) The amendments made by subsection (d) shall apply with respect to amounts received after December 31, 1996. 892 PAGENO="0903" FOREIGN INVESTORS TAX ACT OF 1966 7 SEC. 3. NONRESIDENT ALIEN INDIVIDUALS. (a) TAX ON NONRESIDENT AUXN INDIVIDUALS.- (1) Section 871 (relating to tax on nonresident alien individuals) is amended to read as follows: "SEC. 871. TAX ON NONRESIDENT ALIEN INDIVIDUALS. "(a) INCOME Nor CONNECTED WITH UNITED STATES BusINEss-30 PERCENT TAx.- "(1) INCOME OTHER THAN CAPITAL GAIN5.-There is hereby imposed for each taxable year a tax of 30 percent of the amount received from sources within the United States by a nonresident alien individual as- "(A) interest, dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or deter- minable annual or periodical gains, profits, and income, "(B) gains described in section 402(a) (2), 403 (a) (2), or 631 (b) or (c), and gains on transfers described in section 1235, and "(C) amounts which under section 341, or under section 1232 (in the case of bonds or other evidences of indebtedness issued after Sep- tember 28, 1965), are treated as gains from the sale or exchange of property which is not a capital asset, but only to the extent the amount so received is not effectively connected with the conduct of a trade or business within the United States. "(2) CAPITAL GAINS OF ALIENS PRESENT IN THE UNITED STATES 183 DAYS OR MORE.-In the case of a nonresident alien individual present in the United States for a period or periods aggregating 183 days or more during the taxable year, there is hereby imposed for such year a tax of 30 per- cent of the amount by which his gains, derived from sources within the United States, from the sale or exchange at any time during such year of capital assets exceed his losses, allocable to sources within the United States, from the sale or exchange at any time during such year of capital assets. For purposes of this paragraph, gains and losses shall be taken into account only if, and to the extent that, they would be recognized and taken into account if such gains and losses were effectively connected with the conduct of a trade or business within the United States, except that such gains and losses shall be determined without regard to section 1202 (relating to deduction for capital gains) and such losses shall be determined without the benefits of the capital loss carryover provided in section 1212. Any gain or loss which is taken into account in determining the tax under paragraph (1) or subsection (b) shall not be taken into account in de- termining the tax under this paragraph. For purposes of the 183-day re- quirement of this paragraph, a nonresident alien individual not engaged in trade or business within the United States who has not established a tax- able year for any prior period shall be treated as having a taxable year which is the calendar year. "(b) INCOME CONNECTED WITH UNITED STATES BUSINESS-GRADUATED RATE OF TAX.- "(1) IMPOsITION OF TAx.-A nonresident alien individual engaged in trade or business within the United States during the taxable year shall be taxable as provided in section 1 or 1201 (;b) on his taxable income which is effectively connected with the conduct of a trade or business within the United States. "(2) DETERMINATION OF TAXABLE INCOME.-In determining taxable in- come for purposes of paragraph (1), gross income includes only gross in- come which is effectively connected with the conduct of a trade or business within the United States. "(c) PARTICIPANTS IN CERTAIN EXCHANGE OR TRAINING PROGRAMS-For purposes of this section, a nonresident alien individual who (without regard to this subsection) is not engaged in trade or business within the United States and who is temporarily present in the United States as a nonimmigrant under subparagraph (F) or (J) of section 101(a) (15) of the Immigration and Na- tionality Act, as amended (8 U.S.C. 1101(a) (15) (F) or (J)), shall be treated as a nonresident alien individual engaged in trade or business within the 893 PAGENO="0904" 8 FOREIGN INVESTORS TAX ACT OF 1966~ United States, and any income described in section 1441(b) (1) or (2) which is received by such individual shall, to the extent derived from sources within the United States, be treated as effectively connected with the conduct of a trade or business within the United States. "(d) ELEcTIoN To TR.1t~r REAL PROPERTY INCOME AS INcoME CONNECTED WITH UNIT1~D STATES BUSINESS.- "(1) IN GENERAL-A nonresident alien individual who during the taxable year derives any income- "(A) from real property held for the production of income and located in the United States, or from any interest in such real property, including (1) gains from the sale or exchange of such real property or an interest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and "(B) which, but for this subsection, would not be treated as income which is effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. In such case, such income shall be taxable as provided in subsection (b) (1) whether or not such individual is engaged in trade or business within the United States during the taxable year. An election under this paragraph for any taxable year shall remain in effect for all subsequent taxable years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. "(2) ELlarrioN AFTER REvocATIoN.-If an election has been made under paragraph (1) and such election has been revoked, a new election may not be made under such paragraph for any taxable year before the 5th taxable year which begins after the first taxable year for which such revocation is effective, unless the Secretary or his delegate consents to such new election. "(3) FORM AND TIME OF ELECTION AND REVOCATI0N.-An election under paragraph (1), and any revocation of such an election, may be made only in such manner and at such time as the Secretary or his delegate may by regulations prescribe. "(e) CRoss REFERENCES.- "(1) For tax treatment of certain amounts distributed by the United States to nonresident alien individuals, see section 402(a) (4). "(2) For taxation of nonresident alien individuals who are ex- patriate United States citizens, see section 877. "(3) For doubling of tax on citizens of certain foreign countries, see section 891. "(4) For reinstatement of pre-1967 income tax provisions in the case of residents of certain foreign countries, see section 896. "(5) For withholding of tax at source on nonresident alien indi- viduals, see section 1441. "(6) For the requirement of making a declaration of estimated tax by certain nonresident alien individuals, see section 6015(i). "(7) For taxation of gains realized upon certain transfers to domestic corporations, see section 1250(d) (3)." (2) Section 1 (relating to tax on individuals) is amended by redesignating subsection (d) as subsection (e), and by inserting after subsection (c) the following new subsection: "(d) NONRESIDENT ALmN5.-In the case of a nonresident alien individual, the tax imposed by subsection (a) shall apply only as provided by section 871 or 877." (b) GRoss INCOME.- (1) Subsection (a) of section 872 (relating to gross income of nonresident alien individuals) is amended to read as follows: "(a) GENERAL RULE.-In the case of a nonresident alien individual, gross income includes only- "(1) gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, and "(2) gross income which is effectively connected with the conduct of a trade or business within the United States." (2) Subparagraph (B) of section 872(b) (3) (relating to compensation of participants In certain exchange or training programs) is amended by striking out "by a domestic corporation" and inserting in lieu thereof "by a 894 PAGENO="0905" FOREIGN INVESTORS TAX ACT OF 1966 9 domestic corporation, a domestic partnership, or an individual who is a citizen or resident of the United States". (3) Subsection (b) of section 872 (relating to exclusions from gross in- come) is amended by adding at the end thereof the following new paragraph: "(4) BOND INTEREST OF RESIDENTS OF THE RYUKYU ISLANDS on THE TRTJST TERRITORY OF THE PACIFIC ISLANDS.-IncOme derived by a nonresident alien individual from a series E or series H United States savings bond, if such individual acquired such bond while a resident of the Ryukyu Islands or the Trust Territory of the Pacific Island." (c) DEDUCTIONS.- (1) Section 873 (relating to deductions allowed to nonresident alien in- dividuals) is amended to read as follows: "SEC. 873. DEDUCTIONS. "(a) GENERAL RULE.-In the case of a nonresident alien individual, the deduc- tions shall be allowed only for purposes of section 871(b) and (except as pro- vided by subsection (b)) only if and to the extent that they are connected with income which is effectively connected with the conduct of a trade or business within the United States; and the proper apportionment and allocation of the deductions for this purpose shall be determined as provided in regulations pre- scribed by the Secretary or his delegate. "(b) ExcEPTI0N5.-The following deductions shall be allowed whether or not they are connected with income which is effectively connected with the conduct of a trade or business within the United States: "(1) LossEs-The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by section 165(c) (3), but only if the loss is of property located within the United States. "(2) CHARITABLE CONTRIBUTION s.-The deduction for charitable contribu- tions and gifts allowed by section 170. "(3) PERSONAL ExEMPTION.-The deduction for personal exemptions al- lowed by section 151, exceiit that in the case of a nonresident alien indi- vidual who is not a resident of a contiguous country only one exemption shall be allowed under section 151. "(c) CRoss REFERENCES.- "(1) For disallowance of standard deduction, see section 142(b)(1). "(2) For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b) (1)." (2) Section 154(3) (relating to cross references in respect of deductions for personal exemptions) is amended to read as follows: "(3) For exemptions of nonresident aliens, see section 873(b) (3)." (d) ALLOWANCE OF DEDUCTIONS AND CREDIT5.-Subsection (a) of section 874 (relating to filing of returns) is amended to read as follows: "(a) RETURN PREREQUISITE TO ALLOWANCE.-A nonresident alien individual shall receive the benefit of the deductions and credits allowed to him in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true and accurate return, in the manner prescribed in subtitle F (sec. 6001 and following, relating to procedure and administration) including therein all the information which the Secretary or his delegate may deem necessary for the calculation of such deductions and credits. This subsection shall not be construed to deny the credits provided by sections 31 and 32 for tax withheld at sOurce or the credit provided by section 39 for certain uses of gasoline and lubricating oil." (e) EXPATRIATION To AvOID TAX.- (1) Subpart A of part II of subchapter N of chapter 1 (relating to non- resident alien individuals) is amended by redesignating section 877 aa sec- tion 878, and by inserting after sedtion 876 the following new section: "SEC. 877. EXPAThIATION TO AVOID TAX. "(a) IN GENERAL.-EVery nonresident alien individual who at any time after March 8, 1965, and within the 5-year period immediately preceding the close of the taxable year lost United States citizenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle B, shall be taxable for such taxable year in the manner provided in subsection (b) if the tax imposed pursuant to such subsection exceeds the tax which, without regard to this section, is imposed pursuant to section 871. 895 PAGENO="0906" 10 FOREIGN INVESTORS TAX ACT OF 19 66 "(b) ALTERNATIVE TAx.-A nonresident alien individual described in sub- section (a) shall be taxable for the taxable year as provided in section 1 or section 1201(b), except that- "(1) the gross income shall include only the gross income described in ~ection 872(a) (as modified by subsection (c) of this section), and "(2) the deductions shall be allowed if and to the extent that they are con- nected with the gross income included under this section, except that the capital loss carryover provided by section 1212(b) shall not be allowed; and the proper allocation and apportionment of the dedudtions for this purpose shall be determined a~ provided under regulations prescribed by the Secretary or his delegate. For purposes of paragraph (2), the deductions allowed `by section 873(b) shall be allowed; and the deduction (for losses not connected with the trade or business if incurred in transactions entered into for profit) allowed by section 165(c) (2) shall be allowed, but only if the profit, if such transaction had resulted in a profit, would be included in gross income under this section. "(c) SPECIAL RULES OF SouRcE.-~For purposes of subsection (b), the follow- ing items of gross income shall be treated as income from sources within the United States: "(1) SALE OF PROP]rRTY.-Gaifls on the sale or exchange of property (other than stock or debt obligations) located in the United States. "(2) STocK OF DEBT 0BLIGATIONs.-Gains on the sale or exchange of stock issued by a domestic corporation or debt obligations of United States persons or of the United States, a State or political subdivision thereof, or the District of Columbia. "(d) EXCEPTION FOR LOSS OF CITIZENSHIP FOR CERTAIN CAU5E5.-Subsection (a) `shall not apply to a nonresident alien individu~al whose loss of United States citizenship resulted from the application of section 301(h), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487). "(e) BURDEN OF PR0OF.-If the Secretary or his delegate establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction for the taxable year in the taxes on his probable income for such year, the `burden of proving for such taxable year that such loss of citizenship did not `have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle B shall be on such individual." (2) The table of sections for subpart A of part II of subchapter N of chapter 1 (relating to nonresident alien individuals) is amended by striking out the item relating to section 877 and inserting in lieu thereof the following: "Sec. 877. ExpatriatIon to avoid tax. "Sec. 878. Foreign educational, charitable, and certain other exempt orga- nizations." (f), PARTIAL EXCLUSION OF DwIDENDs.-~Subsecti'on (d) of section 116 (relat- ing to certain nonresident aliens ineligible for exclusion) is amended to read as follows: "(d) CERTAIN NONRESIDENT ALIENs INELIGIBLE FOE EXCLU5I0N.-In the case of a nonresident alien individual, subsection (a) shall apply only- "(1) in determining the tax imposed for the taxable year pursuant to section 871(b) (1) and only in respect of dividends which are effectively connected withthe conduct of a trade or business within the United States, or "(2) in determining the tax imposed for the taxable year pursuant to section 877(b)." (g) WITHHOLDING OF TAX ON NONRESIDENT ALIENs.-~SectiOn 1441 (relating to withholding of tax on nonresident aliens) is amended- (1) by striking out "(except interest on deposits with persons carrying on the banking business paid to person's not engaged in business in the United States)" in subsection (b); (2) by striking out "and amounts described in section 402(a) (2)" and all that follows in the first sentence of subsection (b) and inserting in lieu thereof "and gains described in section 402(a) (2), 403(a) (2), or 631(b) or (c), and gains on transfers described in section 1235.";, (3) by striking out paragraph (1) of subsection (c) and inserting in lieu thereof the following new paragraph: "(1) INCOME CONNECTED WITH UNITED STATES BUSINESS-No deduction or withholding under subsection (a) shall be required in `the case of any item 896 PAGENO="0907" FOREIGN INVESTORS TAX ACT OF 1966 11 of income (other than compensation for personal services) which is effec- tively connected with the conduct of a trade or business within the United States and on which a tax is imposed for the taxable year pursuant to section 871(b) (1)."; (4) by amending paragraph (4) of subsection (c) to read as follows: "(4) COMPENSATION OF CERTAIN ALIENS.-Under regulations prescribed by the Secretary or his delegate, compensation for personal services may be exempted from deduction and withholding under subsection (a)."; and (5) by striking out "amounts described in section 402(a) (2), section 403(a) (2), section 631 (b) and (c), and section 1235, which are considered to be gains from the sale or exchange of capital assets," in paragraph (5) of subsection (c) and inserting in lieu thereof "gains described in section 402(a) (2), 403(a) (2), or 631 (b) or (c), and gains on transfers described in section 1235,", and by striking out "proceeds from such sale or exchange," in such paragraph and inserting in lieu thereof "amount payable,". (h) LIABILITY FOR WITHHELD TAx.-SectiOn 1461 (relating to return and payment of withheld tax) is amended to read as follows: "SEC. 1461. LIABILITY FOR WITHHELD TAX. "Every person required to deduct and withhold any tax under this chapter is hereby made liable for such tax and is hereby indemnified against the claims and demands of any person for the amount of any payments made in accordance with the provisions of this chapter." (I) DECLARATION OF ESTIMATED INCOME TAX BY INDIvIDUAL5.-Section 6015 (relating to declaration of estimated income tax by individuals) is amended- (1) by striking out that portion of subsection (a) which precedes para- graph (1) and inserting in lieu thereof the following: "(a) REQUIREMENT OF DECLARATION.-EXCept as otherwise provided in subsec- tion (i), every individual shall make a declaration of his estimated tax for the taxable year if-"; (2) by redesignating subsection (i) as subsection (j) and (3) by inserting after subsection (h) the following new subsection: "(i) NONRESIDENT AlIEN INDIVIDUALS-No declaration shall be required to be made under this section by a nonresident alien individual unless- "(1) withholding under chapter 24 is made applicable to the wages, as defined in section 3401(a), of such individual, "(2) such individual has income (other than compensation for personal services subject to deduction and withholding under section 1441) which is effectively connected with the conduct of a trade or business within the United States, or "(3) such individual is a resident of Puerto Rico during the entire taxable year." (j) GAIN FII0M DISPOSITIONS OF CERTAIN DEPRECIABLE REALTY.-The second sentence of paragraph (3) of section 1250(d) (relating to certain tax-free trans- actions) is amended to read as follows: "This paragraph shall not apply to- "(A) a disposition to an organization (other than a cooperative de- scribed in section 521) which is exempt from the tax imposed by this - chapter, or "(B) a transfer of property by a nonresident alien individual, a for- eign estate or trust, or a foreign partnership, to a domestic corporation in exchange for stock or securities in such corporation in a transaction to which section 351 applies." (k) COLLECTION OF INCOME TAX AT SOURCE ON WAGES.-Subsection (a) of sec- tion 3401 (relating to definition of wages for purposes of collection of income tax at source) is amended by striking out paragraphs (6) and (7) and inserting in lieu thereof the following: "(6) for such services, performed by a nonresident alien individual, as may be designated by regulations prescribed by the Secretary or his delegate; or". (1) DEFINITION OF FOREIGN ESTATE OR TRUST.-SectiOfl 7701(a) (31) (defining foreign estate or trust) is amended by striking out "from sources without the United States" and inserting in lieu thereof ", from sources without the United States which is not effectively connected with the conduct of a trade or business within the United States,". (m) CONFORMING AMENDMENT.-The first sentence of section 932(a) (relating to citizens of possessions of the United States) is amended to read as follows: "Any individual who is a citizen of any possession of the United States (but 897 PAGENO="0908" 12 FOREIGN INVESTORS TAX ACT OF 1966 not otherwise a citizen of the United States) and who is not a resident of the United States shall be subject to taxation under this subtitle in the same manner and subject to the same conditions as in the case of a nonresident alien indi- vidual." (n) EFFECTIVE DATES.- (1) The amendments made by this section (other than the amendments made by subsections (h) and (k)) shall apply with respect to taxable years beginning after December 31, 1966. (2) The amendments made by subsection (h) shall apply with respect to payments occurring after December 31, 1966. (3) The amendments made by subsection (k) shall apply with respect to remuneration paid after December 31, 1966. SEC. 4. FOREIGN CORPORATIONS. (a) TAx ON INCOME NOT CONNECTED WITH UNITED STATES BUSINESS.-Section 881 (relating to tax on foreign corporations not engaged in business in the United States) is amended to read as follows: "SEC. 881. INCOME OF FOREIGN CORPORATIONS NOT CONNECTED WITH UNITED STATES BUSINESS. "(a) IMPosITIoN OF TAx.-There is hereby imposed for each taxable year a tax of 30 percent of the amount received from sources within the United States by a foreign corporation as- "(1) interest, dividends, rents, salaries, wages, premiums, annuities, com- pensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income. "(2) gains described in section 631(b) or (c), and "(3) amounts which under section 341, or under section 1232 (in the case of bonds or other evidences of indebtedness issued after September 28, 1965), are treated as gains from the sale or exchange of property which is not a capital asset, but only to the extent the amount so received is not effectively connected with the conduct of a trade or business within the United States. "(b) DoUBLING OF TAX.- "For doubling of tax on corporations of certain foreign countries, see section 891." (b) TAX ON INCOME CONNECTED WITH UNITED STATES BUSINESS.- (1) Section 882 (relating to tax on resident foreign corporations) is amended to read as follows: "SEC. 882. INCOME OF FOREIGN CORPORATIONS CONNECTED WITH UNITED STATES BUSINESS. "(a) NORMAL TAX AND SURTAX.- "(1) IMPosITION OF TAX.-A foreign corporation engaged in trade or busi- ness within the United States during the taxable year shall be taxable as provided in section 11 or 1201(a) on its taxable income which is effectively connected with the conduct of a trade or business within the United States. "(2) DETERMINATION OF TAXABLE INCOME.-In determining taxable in- come for purposes of paragraph (1), gross income includes only gross in- come which is effectively connected with the conduct of a trade or business within the United States. "(b) Gnoss INc0ME.-In the case of a foreign corporation, gross income in- cludes only- "(1) gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, and "(2) gross income which is effectively connected with the conduct of a trade or business within the United States. "(c) ALLOWANCE OF DEDUCTIONS AND CREDITS.- "(1) ALLOCATION OF DEDUCTIONS- "(A) GENERAL RuLE.-In the case of a foreign corporation, the de- ductions shall be allowed only for purposes of subsection (a) and (except as provided by subparagraph (B)) only if and to the extent that they are connected with income which is effectively connected with the conduct of a trade or business within the United States; and the proper apportionment and allocation of the deductions for this 898 PAGENO="0909" FOREIGN INVESTORS TAX ACT OF 1966 13 purpose shall be determined as provided in regu1ations prescribed by the Secretary or his delegate. "(B) CHARITABLE CONTRIBUTIONS-The deduction for charitable contributions and gifts provided by section 170 shall be allowed whether or not connected with income which is effectively connected with the conduct of a trade or business within the United States. "(2) DEDUCTIONS AND CREDITS ALLOWED ONLY IF RETURN FILED.-A foreign corporation shall receive the benefit of the deductions and credits allowed to it in this subtitle only by filing or causing to be filed with the Secretary or his delegate a true and accurate return, in the manner prescribed in subtitle F, including therein all the information which the Secretary or his delegate may deem necessary for the calculation of sudh deductions and credits. This paragraph shall not be construed to deny the credit provided by section 32 for tax withheld at source or the credit provided by section 39 for certain uses of gasoline and lubricating oil. "(3) FOREIGN TAX CREDIT.-Except a~ provided by section 906, foreign corporations shall not be allowed the credit against the tax for taxes of foreign countries and possessions of the United States allowed by section 901. "(4) Cnoss REFERENCE.- "For rule that certain foreign taxes are not to be taken into account in determining deduction or credit, see section 906(b) (1). "(d) ELECTION To TREAT REAL PROPERTY INCOMR AS INCOME CONNECTED WITH UNITED STATES BUSINESS.- "(1) IN GENERAL.-A foreign corporation which during the taxable year derives any income- "(A) from real property located in the United States, or from any interest in such real property, including (i) gains from the sale or exchange of real property or an interest therein, (ii) rents or royalties from mines, wells, or other natural deposits, and (iii) gains described in section 631 (b) or (c), and "(B) which, but for this subsection, would not be treated as income effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. In such case, such income shall be taxable as provided in subsection (a) (1) whether or not such corporation is engaged in trade or business within the United States during the taxable year. An election under this paragraph for any taxable year shall remain in effect for all subsequent taxable years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. "(2) Eu~CTION AFTER REVOCATION, EPc.-Paragraphs (2) and (3) of section 871(d) shall apply in respect of elections under this subsection in the same manner and to the same extent as they apply in respect of elections under section 871(d). "(e) RETURNS OF TAX BY AGENT.-If any foreign corporation has no office or place of business in the United States but has an agent in the United States, the return required under section 6012 shall be made by the agent." (2) (A) Subsection (e) of section 11 (relating to exceptions from. tax on corporations) is amended by inserting "or" at the end of paragraph (2), by striking out ", or" at the end of paragraph (3) and inserting a period in lieu thereof, and by striking out paragraph (4). (B) Section 11 (relating to tax on corporations) is amended by adding at the end thereof the following new subsection: " (f) FOREIGN CORP0RATI0NS.-In the case of a foreign corporation, the tax imposed by subsection (a) shall apply only as provided by section 882." (3) The table of sections for subpart B of part II of subchapter N of chapter 1 is amended by striking out the items relating to sections 881 and 882 and inserting in lieu thereof the following: "Sec. 881. Income of foreign corporations not connected with United States business. "Sec. 882. Income of foreign corporations connected with tinited States business." 899 PAGENO="0910" 14 FOREIGN INVESTORS TAX ACT OF 1966 (c) WITHHOLDING OF TAX ON FOREIGN C0RP0RATI0Ns.-Section 1442 (relating to withholding of tax on foreign corporations) is amended to read as follows: "SEC. 1442. WITHHOLDING OF TAX ON FOREIGN CORPORATIONS. "(a) GENERAL RuLE.-In the case of foreign corporations subject to taxation under this subtitle, there shall be deducted and withheld at the source in the same manner and on the same items of income as is provided in section 1441 or section 1451 a tax equal to 30 percent thereof; except that, in the case of interest de- scribed in section 1451 (relating to tax-free covenant bonds), the deduction and withholding shall be at the rate specified therein. For purposes of the preceding sentence, the reference in section 1441(c) (1) to section 871(b) (1) shall be treated as referring to section 842 or section 882 (a) as the case may be. "(b) ExEMPTI0N.-Subject to such terms and conditions as may be provided by regulations prescribed by the Secretary or his delegate, subsection (a) shall not apply in the case of a foreign corporation engaged in trade or business within I the United States if the Secretary or his delegate determines that the require- ments of subsection (a) imposes an undue administrative burden and that the collection of the tax imposed by section 881 on such corporation will not be jeopardized by the exemption." (d) DIVIDENDS RECEIVED FROM CERTAIN FOREIGN C0RP0RATI0N5.-Subsection (a) of section 245 (relating to the allowance of a deduction in respect of divi- dends received from a foreign corporation) is amended- (1) by striking out "and has derived 50 percent or more of its gross income from sources within the United States," in that portion of subsection (a) which precedes paragraph (1) and by inserting in lieu thereof "and if 50 percent or more of the gross income of such corporation from all sources for such period is effectively connected with the conduct of a trade or business within the United States,"; (2) by striking out "from sources within the United States" in paragraph (1) and inserting in lieu thereof "which is effectively connected with the conduct of a trade or business within the United States"; (3) by striking out "from sources within the United States" in paragraph (2) and inserting in lieu thereof ", which is effectively connected with the conduct of a trade or business within the United States,"; and (4) by adding after paragraph (2) the following new sentence: "For purposes of this subsection, the gross income of the foreign taxable corpo- ration for any period before the first taxable year beginning after December 31, 1966. which is effectively connected with the conduct of a trade or business within the United States is an amount equal to the gross income for such period from sources within the United States." (e) UNRELATED BUSINESS TAXABLE INC0ME.-Tbe last sentence of section 512 (a) (relating to definition) is amended to read as follows: "In the case of an organization described in section 511 which is a foreign organization, the unre- lated business taxable income shall be its unrelated business taxable income which is effectively connected with the conduct of a trade or business within the United States." (f) CORPORATIONS SUBJECT TO PERSONAL HOLDING COMPANY TAX.-Paragraph (7) of section 542(c) (relating to corporations not subject to the personal hold- ing company tax) is amended to read as follows: "(7) a foreign corporation, if all of its stock outstanding during the last half of the taxable year is owned by nonresident alien individuals, whether directly or indirectly through foreign estates, foreign trusts, foreign partner- ships, or other foreign corporations ;". (g) AMENDMENTS WITH RESPECT TO FOREIGN CORPOI~ATIONS CARRYING ON INSURANcE BUSINESS IN UNIrIm STATES.- (1) Section 842 (relating to computation of gross income) is amended to read as follows: "SEC. 842. FOREIGN CORPORATIONS CARRYING ON INSURANCE BUSI- NESS~ "If a foreign corporation carrying on an insurance business within the United States would qualify under part I, II, or III of this subchapter for the taxable year If (without regard to income not effectively connected with the conduct of any trade or business within the United States) it were a domestic corpora- tion, such corporation shall be taxable under such part on its income effectively connected with its conduct of any trade or business within the United States. With respect to the remainder of its income, which is from sources within the 900 PAGENO="0911" FOREIGN INVESTORS TAX ACT OF 1966 15 United States, such a foreign corporation shall be taxable as provided in section 881." (2) The table of sections for part IV of subchapter L of chapter 1 is amended by striking out the item relating to section 842 and inserting in lieu thereof the following: "Sec. 842. Foreign corporations carrying on Insurance business." (3) `Section 819 (relating to foreign life insurance companies) is amended- (A) by striking out subsections (a) and (d) and by redesignating subsections (b) and (c) as subsections (a) and (b), (B) by striking out "In the case of any company described in sub- section (a)," in subsection (a)(1) (as redesignated by subparagraph (A)) and inserting in lieu thereof "In the case of any foreign corpora- tion taxable under this part,", (0) by striking out "subsection (c)" in the last *sentence of sub- section (a)(2) (as redesignated by subparagraph (A)) and inserting in lieu thereof "subsection (b) ", (D) by adding at the end of subsection (a) (as redesignated by sub- paragraph (A)) the following new paragraph: "(3) REDUCTION OF SECTION 881 TAx.-In the case of any foreign corpora- tion taxable under this part, there shall be determined- "(A) the amount which would be subject to tax under section 881 if the amount taxable under such section were determined without regard to sections 103 and 894, and "(B) the amount of the reduction provided .by paragraph (1). The tax under section 881 (determined without regard to this paragraph) shall be reduced (but not below zero) by an amount which is the same pro- portion of such tax as the amount referred `to in subparagraph (B) is of the amount referred to in subparagraph (A),; but such reduction in tax shall not exceed the increase in tax under this part by reason of the reduc- tion provided by paragraph (1).", (E) `by striking out "for purposes of `subsection (a)" each place it appears in subsection (`b) (as redesigna:ted by subparagraph (A)) and inserting in lieu thereof "with respect to a foreign corporation", (F), by striking out "foreign life insurance' company" each place it appears in such subsection (b) and inserting in lieu thereof "foreign corporation", (G) by striking out "subsection (ib) (2) (A)" each place it appears in `suth subsection (b) and inserting in lieu thereof "subsection (a)(2) (A)", (H) `by striking out "subsecti'on (b) (2) (B)" in paragraph (2) (B) (ii) of such subsection (b) and inserting in lieu thereof "subsection (a) (2) (B)",and (I) by adding at the end thereof the following new suhsection: "(c) CRoss REFERENCE.- "For taxation of foreign corporations carrying on life insurance business within the United States, see section 842." (4) Section 821 (relating to tax on mutu'al insurance companies to which part II applies), is amended- (A) by striking out subsection (e) `and by redesignating subsections (f) and (g) as subsections (e) `and (f), `a'nd (B) `by adding at `the end of subsection (f) (as redesignated by sub- paragraph (A)) the following: "(3) For taxation of foreign corporations carrying on an insurance business within the United States, see section 842." (5) Section 822 (relating to determination of taxable investment income) is amended by striking out subsection (e) and by redesign'ating subsection (f) as subsection (e). (6) Section 831 (relating to tax on certain other insurance companies) is amended- (A) `by `striking out subsection (b) and by redesignating subsection (c) as subsection (b),and 901 PAGENO="0912" * 16 FOREIGN INVESTORS TAX ACT OF 1966 (B) by amending subsection (d),to read as follows: "Cnoss REFEnENCEs.- "(1) For alternative tax in case of capital gains, see section 1201(a). "(2) For taxation of foreign corporations carrying on an insurance business within the United States, see section 842." (7), Section 832 (relating to insurance company taxable income) is amended by striking out subsection (d) and by redesignating subsection (e) as subsection (d). (8) The second sentence of section 841 (relating to credit for foreign taxes) is amended by striking out "sentence," and inserting in lieu thereof "sentence (and for purposes of applying section 906 with respect to a foreign corporation subject to tax under this subchapter) ,". (h) SUBPART F INcoME-Section 952(b) (relating to exclusinn of United States income) is amended to read as follows: "(b) EXCLUSION OF UNITED STATES INCOME-In the case of a controlled foreign corporation, subpart F income does not include any item of income from sources within the United States which is effectively connected with the conduct by such corporation of a trade or business within the LTnited States unless such item is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation of the United States." (i) GAIN FROM CERTAIN SALES OR EXCHANGES OF STOCK IN CERTAIN FOREIGN C0RP0RATI0N5.-Paragraph (4) of section 1248(d) (relating to exclusions from earnings and profits) is amended to read as follows: "(4) UNITED STATES INCOME-Any item includible in gross income of the foreign `corporation under `this chapter- "(A) for any taxable year beginning before January 1, 1967, as in- come derived from sources within the United States of a foreign corpora- tion engaged in trade or business within the United States, or "(B) for any taxable yehr beginning after December 31, 1966, as in- come effectively connected with the conduct by such corporation of a trade or business within the United States. This paragraph shall not apply with respect to any item which is exempt from taxation (or is subject to a reduced rate of `tax) ,pursuant to a treaty obligation of the United States." (j) DECLARATION OF ESTIMATED INCOME TAX BY C0RPORATI0N5.-Section 6016 (relating to declarations of estimated income tax `by corporations) is amended by redesignating subsection (f) as subsection (g) and by inserting after subsec- tion (e) the following new subsection: "(f) CERTAIN FOREIGN CORP0RATIONS.-FOr purposes of this section and section 6655, in the case of a foreign corporation subject to taxation under section 11 or 1201(a), or under subchapter L of chapter 1, the tax imposed by section 881 shall be treated as a tax imposition by section 11." (k) TECHNICAL AMENDMENTS.- (1) Section 884 is amended to read as follows: "SEC. 88'4. CROSS REFERENCES. "(1) For special provisions relating to unrelated business income of foreign educational, charitable, and certain other exempt orga- nizations,, see section 512(a). "(2) For special provisions relating to foreign corporations carry- ing on an insurance business within the United States, see section 842. "(3) For rules applicable in determining whether any foreign corporation is engaged in trade or business within the United States, see section 864(b). "(4) For reinstatement of pre-1967 income tax provisions in the case of corporations of certain foreign countries, see section 896. "(5) For allowance of credit against the tax in case of a foreign corporation having income effectively connected with the conduct of a trade or business within the United States, see section 906. "(6) For withholding at source of tax on income of foreign corpo- rations, see section 1442." (2) Section 953(b) (3) (F) is amended by striking out "832(b) (5)" and inserting in lieu thereof "832(c) (5)". 902 PAGENO="0913" FOREIGN INVESTORS TAX ACT OF 1966 17 (3) Section 1249 (a) is amended by striking out "Except as provided in subsection (c), gain" and inserting in lieu thereof "Gain". (1) EFFECTIVE DATES.-The amendments made by this section (other than subsection (i)) shall apply with respect to taxable years beginning after Decem~ ber 31, 1966. The amendment made by subsection (I) shall apply with respect to sales or exchanges occurring after December 31, 1966. SEC. 5. SPECIAL TAX PROVISIONS. (a) INCOME AFFECTED BY TREATY.-SectiOn 894 (relating to income exempt under treaties) is amended to read as follows: "SEC. 894. INCOME AFFECTED BY TREATY. "(a) INCOME EXEMPT UNDER TREATY.-Income of any kind, to the extent re- quired by any treaty obligation of the United States, shall not be included in gross income and shall be exempt from taxation under this subtitle. "(b) PERMANENT ESTABLISHMENT IN UNITEI~ STATES.-FOr purposes of apply- ing any exemption from, or reduction of, any tax provided by any treaty to which the United States is a party with respect to income which is not effectively con- nected with the conduct of a trade or business within the United States, a non- resident alien individual or a foreign corporation shall be deemed not to have a permanent establishment in the United States at any time during the taxable year. This subsection shall not apply in respect of the tax computed under section 877(b)." (b) APPLICATION OF PRE-1967 INCOME TAX PRovIsIoNs.-Subpart (3 of part II of subchapter N of chapter 1 (relating to miscellaneous provisions applicable to nonresident aliens and foreign corporations) is amended by adding at the end thereof the following new section: "SEC. 896. APPLICATION OF PRE-1967 INCOME TAX PROVISIONS. "(a) IMP05rrI0N OF MORE BURDENSOME TAXES BY FOREIGN C0UNTEY.-When- ever the President finds that- "(1) under the laws of any foreign country, considering the tax system of such foreign country, citizens of the the United States not residents of such foreign country or domestic corporations are being subjected to more burden- some taxes, on any item of income received by such citizens or corporations from sources within such forgign country, than taxes imposed by the provi- sions of this subtitle on similar income derived from sources within the United States by residents or corporations of such foreign country, "(2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such taxes so that they are no more burdensome than taxes imposed by the provisions of this subtitle on similar income derived from sources within the United States by residents or cor- porations of such foreign country, and "(3) it is in the public interest to apply pre-1967 tax provisions in accord- ance with the provisions of this section to residents or corporations of such foreign country, the President shall proclaim that the tax on such similar income derived from sources within the United States by residents or corporations of such foreign country shall, for taxable years beginning after such proclamation, be de- termined under this subtitle without regard to amendments made to this sub- chapter and chapter 3 on or after the date of enactment of this section. "(b) ALLEVIATION OF MORE BURDENSOME TAxE5.-Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that citizens of the United States not residents of such foreign country or domestic corpora- tions are no longer subject to more burdensome taxes on such item of income derived by such citizens or corporations from sources within such foreign coun- try, he shall proclaim that the tax on such similar income derived from sources within the United States by residents or corporations of such foreign country shall, for any taxable year beginning after such proclamation, be determined under this subtitle without regard to subsection (a). "(c) NOTIFICATION OF CONGRESS REQUIRED.-NO proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. 7 1-297 0-67-pt. 1-58 903 PAGENO="0914" 18 FOREIGN INVESTORS TAX ACT OF 1966 "(d) IMPLEMENTATION BY REGULATIONS-The Secretary or his delegate shall prescribe such regulations as he deems necessary or appropriate to implement this section." (c) CLERICA~L AMENDMENTS-The table of sections for subpart C of part II of subchapter N of chapter 1 is amended- (1) by striking out the item relating to section 894 and inserting in lieu thereof "Sec. 894. Income affected by treaty."; (2) by adding at the end of such table the following: "Sec. 896. Application of pre-1967. income tax provisions." (d) EFFECTIVE DATE.-The amendments made by this section (other than subsection (e)) shall apply with respect to taxable years beginning after December 31, 1966. (e) ELECTIONS BY NONRESIDENT UNITED STATES CITIZENS WHO Apji SUBJECT TO FOREIGN COMMUNITY PROPERTY LAWS.- (1) Part III of subchapter N of chapter 1 (relating to income from sources without the United States) is amended by adding at the end thereof the following new subpart: "Subpart H-Income of Certain Nonresident United States Citizens Subject to Foreign Community Property Laws "Sec. 981. Elections as to treatment of income subject to foreign community property laws. "SEC. 981. ELECTION AS TO TREATMENT OF INCOME SUBJECT TO FOREIGN COMMUNITY PROPERTY LAWS. "(a) GENERAL RULE-In the case of any taxable year beginning after Decem- ber 31, 1963, if- "(1) an individual is (A) a citizen of the United States, (B) a bona fide resident of a foreign country or countries during the entire taxable year, and (C) married at the close of the taxable year to a spouse who is a nonresident alien during the entire taxable year, and "(2) such individual and his spouseelect to have subsection (b) apply to their community income under foreign community property laws, then subsection (b) shall apply to such income of such individual and such spouse for the taxable year and for all subsequent taxable years for which the requirements of paragraph (1) are met, unless the Secretary or his delegate consents to a termination of the election. "(b) TREATMENT OF COMMUNITY INCOME-For any taxable year to which an election made under subsection (a) applies, the community income under foreign community property laws of the husband and wife making the election shall be treated as follows: "(1) Earned income (within the meaning of the first sentence of section 911 (b)), other than trade or business income and a partner's distributive share of partnership income, shall be treated as the income of the spouse who rendered the personal services. "(2) Trade or business income, and a partner's *distributive share of partnership income, shall be treated as provided in section 1402(a) (5). "(3) Community income not described in paragraph (1) or (2) which is derived from the separate property (as determined under the applicable foreign community property law) of one spouse ~hall be treated as the income of such spouse. "(4) All other such community income shall be treated as provided in the applicable foreign community property law. "(c) ELECTION FOR PRE-1967 YEARS.- "(1) ELEcTIoN-If an individual meets the requirements of subsection (a) (1) (A) and (C) for any taxable year beginning before January 1, 1967, and if such individual and the spouse referred to in subsection (a) (1) (C) elect under this subsection, then paragraph (2) of this sub- section shall apply to their community income under foreign community property laws for all open taxable years beginning before January 1, 1967 904 PAGENO="0915" FOREIGN INVESTORS TAX ACT OF 1966 19 (whether under this chapter, the corresponding provisions of the Internal Revenue Code of 1939, or the corresponding provisions of prior revenue laws), for which the requirements of subsection (a) (1) (A) and (C) are met. "(2) EFFECT OF ELECTIoN-For any taxable year to which an election made under this subsection applies, the community income under foreign community property laws of the husband and wife making the election shall be treated as provided by subsection (b), except that the other community income described in paragraph (4) of subsection (b) shall be treated as the income of the spouse who, for such taxable year, had gross income under paragraphs (1), (2), and (3) of subsection (b), plus separate gross income, greater than that of the other spouse. "(d) TIME FOR MAKING ELECTIONS; PERIOD OF LIMITATIONS; zrrc.- "(1) TIME.-An election under subsection (a) or (c) for a taxable year may be made at any time while such year is still open, and shall be made in such manner as the Secretary or his delegate shall by regulations prescribe. "(2) EXTENSION OF PERIOD FOR ASSESSING DEFICIENCIES AND MAKING RE- FUNDS.-If any taxable year to which an election under subsection (a) or (c) applies is open at the time such election is made, the period for assessing a deficiency against, and the period for filing claim for credit or refund of any overpayment by, the husband and wife for such taxable year, to the extent such deficiency or overpayment is attributable to such an election, shall not expire before 1 year after the date of such election. "(3) ALIEN SPOUSE NEED NOT JOIN IN SUBSECTION (C) ELECTION IN CER- TAIN CASES.-If the Secretary or his delegate determines- "(A) that an election under subsection (c) would not affect the liability for Federal income tax of the spouse referred to in subsection (a)(1) (0) foranytaxableyear,Or "(B) that the effect on such liability for tax cannot be ascertained and that to deny the election to the citizen of the United Sates would be inequitable and cause undue hardship. such spouse shall not be required to join in such election, and paragraph (2) of this subsection shall not apply with respect to such spouse. "(4) IN'rEREsT.-To the extent that any overpayment, or deficiency for a taxable year is attributable to an election made under this section, no in- terest shall be allowed or paid for any period before the day which is 1 year after the date of such election. "(e) DEFINITIONS AND SPECIAL RULES.-For purposes of this section- "(1) DEDUCTI0NS.-Deductions shall be treated in a manner consistent with the manner provided by this section for the income to which they relate. "(2) OPEN YEARS.-A taxable year of a citizen of the United States and his spouse shall be treated as `open' if the period for assessing a deficiency against such citizen for such year has not expired before the date of the election under subsection (a) or (c), as the case may be. "(3) ELECTIONS IN CASE OF DECEDENTS.-If a husband or wife is deceased his election under this section may be made by his executor, administrator, or other person charged with his property. "(4) DEATH OF SPOUSE DURING TAXABLE YEAR-In applying subsection (a) (1) (0), and in determining under subsection (c) (2) which spouse has the greater income for a taxable year, if a husband or wife dies the taxable year of the surviving spouse shall be treated as ending on the date of such death." (2) The table of subparts for such part III is amended by adding at the end thereof the following: Subpart H. Income of certain nonresident United States citizens subject to cforeign community property laws." (3) Section 911(d) (relating to earned income from sources without the United States) is amended- (A) by striking out "For administrative" and inserting in lieu thereof the following: "(1) For administrative"; and (B) by adding at the end thereof the following: "(2) For elections as to treatment of income subject to foreign community property laws, see section 981." 905 PAGENO="0916" 20 FOREIGN IN'VESTORS TAX ACT OF 1966 SEC. 6. FOREIGN TAX CREDIT. (a) ALLOWANCE OF CREDIT TO CERTAIN NONRESIDENT ALIENS AND FOREIGN CORPORATIONS.- (1) Subpart A of part III of subchapter N of chapter 1 (relating to for- eign tax credit) is amended by adding at the end thereof the following new section: "SEC. 906. NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN CORPO- RATIONS. "(a) ALLOWANCE OF CREDIT.-A nonresident alien individual or a foreign cor- poration engaged in trade or business within the United States during the tax- able year shall be allowed a credit under section 901 for the amount of any in- come, war profits, and excess profits taxes paid or accrued during the taxable year (or deemed, under section 902, paid or accrued during the taxable year) to any foreign country or possession of the United States with respect to income effectively connected w~ith the conduct of a trade or business within the United States. "(b) SPECIAL RULES.- "(1) For purposes of subsection (a) and for purposes of determining the deductions allowable under sections 873(a) and 882(c), in determining the amount of any tax paid or accrued `to any foreign country or possession there shall not `be taken into account `any amount of tax to `the extent the tax so paid or accrued is imposed with respect to income which would not be taxed by such foreign country or possession but for the fact `that- "(A) in the case of a nonresidential alien individual, such individual is a citizen or resident of such foreign country or possession, or "(B) tin the case of a foreign corporation, such corporation was cre- ated or organized under the law of such foreign country or possession or is domiciled for tax purposes in such country or possession. "(2) For purposes of subsection (`a), in applying section 904 the taxpayer's taxable income shall be treated as consisting only of `the taxable income effectively connected with the taxpayer's conduct of `a trade or business within the United States. "(3) The credit allowed pursuant to `subsection (a) shall not be allowed against any tax imposed by section 871 (`a) (relating to income of non- resident alien individual not connected with United States business) or 881 (relating to `income of foreign corj~orations not connected with United States `business). "(4) For purposes of sections 902(a) and 78, a foreign corporation choos- ing the benefits of this subpart which receives dividends shall, with respect to such dividends. be treated as a domestic corporation." (2) The table of sections for such subpart A is amended by adding at the end thereof the following: "Sec. 906. Nonresident alien individuals and foreign corporations." (3) Section 874(c) is amended by striking out "(c) FOREIGN TAX CREDIT NOT ALLOWED.-A nonresident" and inserting in lieu thereof the following: "(c) FOREIGN TAX CREDIT.-Except as provided in section 900, a nonresident". (4) Subsection (b) of section 901 (relating to amount allowed) is amended by redesignating paragraph (4) as paragraph (5), and by inserting after paragraph (3) the `following new paragraph: "(4) NONRESIDENT ALIEN INDIVIDUALS AND FOREIGN CORPORATIONS-In the case of any nonresident alien individual not described in `seCtion 876 and in `the case of any foreign corporation, the amount determined pursuant to section 906; and". (5) Paragraph (5) (as redesignated) of section 901(b) is amended by striking out "or (3)," `and inserting `in lieu `thereof "(3), or (4),". (6) The amendments made by this subsection shall apply with respect to taxable years beginning after December 31, 1966. In applying section 904 of the Internal Revenue Code of 1954 with respect to section 906 of such Code, no amount may be carried from or to any taxable year beginning before January 1, 1967, and no such year shall be taken into account. (b) ALIEN RESIDENTS OF THE UNITED STATES OR PUERTO Rico.- (1) Paragraph (3) of section 901(b) (relating to amount of foreign tax credit allowed in case of alien resident of the United States or Puerto Rico) is amended by striking out ", if the foreign country of which such alien 906 PAGENO="0917" FOREIGN INVESTORS TAX ACT OF 1966 21 resident is a citizen or subject, in imposing such taxes, allows a similar credit to citizens of the United States residing in such country". (2) Section 901 is amended by redesignating subsections (c) and (d) as subsections (d) and (e), and by inserting after subsection (b) the following new subsection: "(c) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN REsIDENTs-Whenever the President finds that- "(1) a foreign country, in imposing income, war profits, and excess profits taxes, does not allow to citizens of the United States residing in such for- eign country a credit for any such taxes paid or accrued to the United States or any foreign country, as the case may be, similar to the credit allowed under subsection (b) (3), "(2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit to citizens of the United States residing in such foreign country, and "(3) it is in the public interest to allow the credit under subsection (b) (3) to citizens or subjects of such foreign country only if it allows such a similar credit to citizens of the United States residing in such foreign country, the President shall proclaim that, for taxable years beginning while the proc- lamation remains in effect, the credit under subsection (b) (3) shall be allowed to citizens or subjects of such foreign country only if such foreign country, in imposing income, war profits, and excess profits taxes, allows to citizens of the United States residing in such foreign country such a similar credit." (3) Section 2014 (relating to credit for foreign death taxes) is amended by striking out the second sentence of subsection (a), and by adding at the end of such section the following new subsection: "(h) SIMILAR CREDIT REQUIRED FOR CERTAIN ALIEN RE5IDENT5.-Whenever the President finds that- "(1) a foreign country, in imposing estate, inheritance, legacy, or succes- sion taxes, does not allow to citizens of the United States resident in such foreign country at the time of death a credit similar to the credit allowed under subsection (a), "(2) such foreign country, when requested by the United States to do so, has not acted to provide such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, and "(3) it is in the public interest to allow the credit under subsection (a) in the case of citizens or subjects of such foreign country only if it allows such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death, the President shall proclaim that, in the case of citizens or subjects of such foreign country dying while the proclamation remains in effect, the credit under subsection (a) shall be allowed only if such foreign country allows such a similar credit in the case of citizens of the United States resident in such foreign country at the time of death." (4) The amendments made by this subsection (other than paragraph (3)) shall apply with respect to taxable years beginning after December 31, 1966. The amendment made by paragraph (3) shall apply with respect to estates of decedents dying after the date of the enactment of this Act. (c) FOREIGN TAX CREDIT IN CASE OF OERTAIN OVERSEAS OPERATIONS FUNDING SUBSIDIARIES.- (1) Section 904(f) (2) (relating to application of limitations on foreign tax credit in case of certain interest income) is amended- (A) by striking out "or" at the end of subparagraph (C), (B) by striking out the period at the end of subparagraph (D) and inserting in lieu thereof ", or", and (C) by adding at the end thereof the following new subparagraph: "(B) received by an overseas operations funding subsidiary on obligations of a related foreign corporation." (2) Section 904(f) is amended by adding at the end thereof the following new paragraph: "(5) DEFINITIONS FOR PURPOSES OF PARAGRAPH (1) (B) .-For purposes of paragraph (1) (B) "(A) the term `overseas operations funding subsidiary' means a domestic corporation which (i) is a member of an affiliated group (within the meaning of section 1504) and is not the common parent corporation, and (ii) was formed and is availed of for the principal purpose of raising funds outside the United States through public offer- 907 PAGENO="0918" 22 FOREIGN INVESTORS TAX ACT OF 1966 ings to foreign persons and of using such funds to finance the operationss in foreign countries of one or more related foreign corporations, and "(B) a foreign corporation is, with respect to an overseas operations funding subsidiary, a related foreign corporation if the affiliated group of which such subsidiary is a member owns 50 percent or more of the voting stock of such foreign corporation either directly or through owner- ship of the voting stock of another foreign corporation." (3) The amendments made by paragraphs (1) and (2) shall apply to interest received after December 31, 1965, in taxable years ending after such date. SEC. 7. AMENDMENT TO PRESERVE EXISTING LAW ON DEDUCTIONS UNDER SECTION 931. (a) DEDucTI0NS.-Subsection (d) of section 931 (relating to deductions) is amended to read as follows: "(d) DEDUCTIONS.- "(1) GENERAL RULE.-Except as otherwise provided in this subsection and subsection (e), in the case of persons entitled to the benefits of this section the deductions shall he allowed only if and to the extent that they are con- nected with income from sources within the United States; and the proper apportionment and allocation of the deductions with respect to sources of income within and without the United States shall be determined as provided In part I, under regulations prescribed by the Secretary or his delegate. "(2) ExOEPTIONS.-The following deductions shall be allowed whether or not they are connected with income from. sources within the United States: "(A) The deduction, for losses not connected with the trade or busi- ness if incurred in transactions entered into for profit, allowed by section 165(c) (2), but only if the profit, if such transaction had resulted in a profit, would be taxable under this subtitle. "(B) The deduction, for losses of property not connected with the trade or business if arising from certain casualties or theft, allowed by sections 165(c) (3), but only if the loss is of property with the United States. "(0) The deduction for charitable contributions and gifts allowed by section 170. "(3) Dlmuc'rIoN DISALLOWED.- "For disallowance of standard deduction, see section 142(b),(2)." (b) ErFncnvE DAm-The amendment made by this section shall apply with respect to taxable years beginning after December 31, 1966. SEC. 8. ESTATES OF NONRESIDENTS NOT CITIZENS. (a) RATE OF TAx.-~Subsection (a) of section 2101 (relating to tax imposed in case of estates of nonresidents not citizens) is amended to read as follows: "(a) RATE OF TAx.-Except as provided in section 2107, a tax computed in. accordance with the following table is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent non- resident not a citizen of the United States: "If the taxable estate is: The tax shall be: Not over $100,000 5% of the taxable estate. Over $100,000 but not over $500,000 $5,000, plus 10% of excess over $100,000. Over $500,000 but not over $1,000,000 $45,000, plus 15% of excess over $500,000. Over $1,000,000 but not over $2,000,000 $120,000, plus 20% of excess over $1,000,000. Over $2,000,000 $320,000, plus 25% of excess over $2,000,000." (b) CREDITS AGAINST TAx.-Section 2102 (relating to credits allowed agaitist estate tax) is amended to read as follows: "SEC. 2102. CREDITS AGAINST TAX. "(a) IN GENERAL.-The tax imposed by section 2101 shall be credited with the amounts determined in accordance with sections 2011 to 2013, inclusive (relating to State death taxes, gift tax, and tax on prior transfers), subject to the special limitation provided in subsection (b). "(b) SPECIAL LIMITATI0N.-The maximum credit allowed under section 2011 against the tax imposed by section 2101 for State death taxes paid shall be an amount which bears the same ratio to the credit computed as provided in section 908 PAGENO="0919" FOREIGN INVESTORS TAX ACT OF 1966 23 2011(b) as the value of the property, as determined for purposes of this chapter, upon which State death taxes were paid and which is included in the gross estate under section 2103 bears to the value of the total gross estate under section 2103. For purposes of this subsection, the term `State death taxes' means the taxes described in section 2011(a)." (c) PROPERTY WITHIN THE UNITED STATE5.-Section 2104 (relating to property wIthin the United States) is amended by adding at the end thereof the following new subsection: "(c) DEBT OBLIGATI0N5.-For purposes of this subchapter, debt obligations of- "(1) a United States person, or "(2) the United States, a State or any political subdivision thereof, or the District of Columbia, owned by a nonresident not a citizen of the United States shall be deemed prop. erty within the United States. This subsection shall not apply to a debt obliga- tion of a domestic corporation if any interest on such obligation, were such interest received by the decedent at the time of his death, would be treated by reason of section 861(a) (1) (B) as income from sources without the United States." (d) PROPERTY WITHOUT THE UNITED STATES.-Subsection (b) of section 2105 (relating to bank deposits) is amended to read as follows: "(b) DEPOSITS IN CERTAIN FOREIGN BRANOHES.-FOF purposes of this sub- chapter, deposits with a foreign branch of a domestic corporation, if such branch is engaged in the commercial banking business, shall not be deemed prop- erty within the United States." (e) DEFINITION OF TAXABLE ESTATE-Paragraph (3) of section 2106 (a) (re- lating to deduction of exemption from gross estate) is amended to read as follows: "(3) EXEMPTION.- "(A) GENERAL RULE-An exemption of $30,000. "(B) RESIDENTS OF POS5ESSIONS OF THE UNITED STATES-In the case of a decedent who is considered to be a `nonresident not a citizen of the United States' under the provisions of section 2209, the exemption shall be the greater of (i) $30,000, or (ii) that proportion of the exemp- tion authorized by section 2052 which the value of that part of the decedent's gross estate which at the time of his death is situated in the United States bears to the value of his entire gross estate wherever situated." (f) SPECIAL METHODS OF COMPUTING TAx.-Subchapter B of chapter 11 (re- lating to estates of nonresidents not citizens) is amended by adding at the end thereof the following new sections: "SEC. 2107. EXPATRIATION TO AVOID TAX. "(a) RATE OF TAx.-A tax computed in accordance with the table contained in section 2001 is hereby imposed on the transfer of the taxable estate, determined as provided in section 2106, of every decedent nonresident not a citizen of the United States dying after the date of enactment of this section, if after March 8, 1965, and wihin the 10-year period ending with the date of death such decedent lost United States citizenship, unless such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. "(b) GRoss ESTATE.-FOr purposes of the tax imposed by subsection (a), the value of the gross estate of every decedent to whom subsection (a) applies shall be determined as provided in section 2103, except that- "(1) if such decedent owned (within the meaning of section 958(a)) at the time of his death 10 percent or more of the total combined voting power of all classes of stock entitled to vote of a foreign corporation, and "(2) if such decedent owned (within the meaning of section 958(a)), or is considered to have owned (by applying the ownership rules of section 958 (b)), at the time of his death, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of such foreign corpora- tion, then that proportion of the fair market value of the stock of such foreign corporation owned (within the meaning of section 958(a)) by such decedent at the time of his death, which the fair market value of any assets owned by such foreign corporation and situated in the United States, at the time of his death, bears to the total fair market value of all assets owned by such foreign corporation at the time of his death, shall be included in the gross estate of such decedent. 909 PAGENO="0920" 24 FOREIGN INVESTORS TAX ACT OF 1966 For purposes of the preceding sentence, a decedent shall be treated as owning stock of a foreign corporation at the time of his death, if, at the time of a transfer, by trust or otherwise, within the meaning of sections 2035 to 2038, inclusive, he owned such stock. "(c) CREDITS.-The tax imposed by subsection (a) shall be credited with the amounts determined in accordance with section 2102. "(d) EXCEPTION FOR Loss OF CITIZENSHIP FOR CERTAIN CAUSES-Subsection (a) shall not apply to the transfer of the estate of a decedent whose loss of United States citizenship resulted from the application of section 301(b), 350, or 355 of the Immigration and Nationality Act, as amended (8 U.S.C. 1401(b) 1482, or 1487). "(e) BURDEN OF PR00F.-If the Secretary or his delegate establishes that it is reasonable to believe that an individual's loss of United States citizenship would, but for this section, result in a substantial reduction in the estate, inherit- ance, legacy, and succession taxes in respect of the transfer of his estate, the burden of proving that such loss of citizenship did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A shall be on the executor of such individual's estate. "SEC. 2108. APPLICATION OF PRE-1967 ESTATE TAX PROVISIONS. "(a) IMPosITIoN OF Moiu~ BURDENSOME TAX BY FOREIGN C0uNTRY.-Whenever the President finds that- "(1) under the laws of any foreign country, considering the tax system of such foreign country, a more burdensome tax is imposed by such foreign country on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, "(2) such foreign country, when requested by the United States to do so, has not acted to revise or reduce such tax so that it is no more burdensome than the tax imposed by this subchapter on the transfer of estates of dece- dents who were residents of such foreign country, and "(3) it is in the public interest to apply pre-1967 tax provisions in accord- ance with this section to the transfer of estates of decedents who were residents of such foreign country, the President shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be deter- mined under this subchapter without regard to amendments made to sections 2101 (relating to tax imposed), 2102 (relating to credits against tax), 2106 (relating to taxable estate), and 6018 (relating to estate tax returns) on or after the date of enactment of this section. "(b) ALLEVIATION OF MORE BURDENSOME TAx-Whenever the President finds that the laws of any foreign country with respect to which the President has made a proclamation under subsection (a) have been modified so that the tax on the transfer of estates of decedents who were citizens of the United States and not residents of such foreign country is no longer more burdensome than the tax imposed by this subchapter on the transfer of estates of decedents who were residents of such foreign country, he shall proclaim that the tax on the transfer of the estate of every decedent who was a resident of such foreign country at the time of his death shall, in the case of decedents dying after the date of such proclamation, be determined under this subchapter without regard to subsection (a). "(c) NOTIFICATION OF CONGRESS REQUIRED.-NO proclamation shall be issued by the President pursuant to this section unless, at least 30 days prior to such proclamation, he has notified the Senate and the House of Representatives of his intention to issue such proclamation. "(d) IMPLEMENTATION BY REGULATIONS.-The Secretary or his delegate shall prescribe such regulations as may be necessary or appropriate to implement this section." (g) ESTATE TAX RETURN5.-Paragraph (2) of section 6018(a) (relating to estate of nonresidents not citizens) is amended by striking out "$2,000" and inserting in lieu thereof "$30,000". (h) CLERICAL AMENDMENT.-The table of sections for subchapter B of chapter 11 (relating to estates of nonresidents not citizens) is amended by adding at the end thereof the following: "Sec. 2107. Expatriation to avoid tax. "Sec. 2108. Application of pre-1967 estate tax provisions." 910 PAGENO="0921" FOREIGN INVESTORS TAX ACT OF 1966 25 (i) EFFECTIVE DATE.-The amendments made by this section shall apply with respect to estates of decedents dying after the date of the enactment of this Act. SEC. 9. TAX ON GIFTS OF NONRESIDENTS NOT CITIZENS. (a) IMPOSITION OF TAx.-Subsection (a) of section 2501 (relating to general rule for imposition of tax) is amended to read as follows: "(a) TAXABLE TRANSFERs.- "(1) GENERAL RULE.-For the calendar year 1955 and each calendar year thereafter a tax, computed as provided in section 2502, is hereby imposed on the transfer of property by gift during such calendar year by any individual, resident or nonresident. "(2) TRANsFERS OF INTANGIBLE PR0PERTY.-Except as provided in para- graph (3), paragraph (1) shall not apply to the transfer of intangible property by a nonresident not a citizen of the United States. "(3) ExCEPTI0N5.-Paragraph (2) shall not apply in the case of a donor who at any time after March 8, 1965, and within the 10-year period ending with the date of transfer lost United States citizenship unless- "(A) such donor's loss of United Sta.tes citizenship resulted from the application of snction 301(b), 350, or 355 of the Immigration and Na- tionality Act, as amended (8 U.S.C. 1401(b), 1482, or 1487), or "(B) such loss did not have for one of its principal purposes the avoidance of taxes under this subtitle or subtitle A. "(4) BURDEN OF PROOF.-If the Secretary or his delegate establishes that it. is reasonable to `believe that an individual's loss of United States citizen- ship would, but for paragraph (3), result in a substantial reduction for the calendar year in the taxes on the transfer of property `by gift, `the burden of proving that such loss of citizenship did not have for one of its principal pur- poses the avoidance of taxes under this subtitle or subtitle A shall be on such individual." (b) `TRANSFER IN `GENERAL-Subsection (b) of section 2511 (relating to situs rule for stock in a corporation) is amended to read as follows: "(b) INTANGIBLE pR0PERTY.-For the purposes of this chapter, in the case of a nonresident not a citizen of the United States who is excepted from the applica- tion of section 2501(a) (2)- "(1) shares of stock issued by a domestic corporation, and "(2) debt obligations of- "(A) `a United States persons, or "(B) the United States, a State or any political subdivision thereof, or the District of Columbia, which are owned by such nonresidents shall be deemed to be property situated within the United States." (c) EFFECTIVE DATE-The amendments made by this section shall apply with respect to the calendar year 1967 and all calendar years thereafter. SEC. 10. TREATY OBLIGATIONS. No amendment made by this Act shall apply in any case where its application would be contrary to any treaty obligation of the United States. For purposes of the preceding sentence, the extension of a benefit provided by any amendment made by `this Act shall not be deemed to be contrary to a treaty obligation of the United States. Passed the House of Representatives June 15, 1966. Attest: RALPH R. ROBERTS, Clerk. (Departmental comments on H.R. 13.103 follow:) EXECUTIVE OFFICE OF THE PRESIDENT, BUREAU OF THE BUDGET, Washingten, D.C., A~ugust 10, 1966. Hon. RUSSELL B. LONG, Chairn~an, Committee on Finance, U.S. Senate, New Senate Office Building, Was1z~ington, D.C. DEAR Mn. CHAIRMAN: This is in response to your request for the views of the Bureau of the Budget on H.R. 13103, an act "To amend the Internal `Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States," and on `an amendment intended to be prOposed by `Mr. Dirksen to H.R. 13103. . . 911 PAGENO="0922" 26 FOREIGN INVESTORS TAX ACT OF 1966 ER. 13103 is a modified version of H.R. 5916, a bill introduced in March 1965, to carry out recommendations of the Treasury Department. H.R. 5916 was a part of the President's program to improve the United States balance of payments. We believe that H.R. 13103, `by providing more equitable tax treatment for for- eign investors, will tend to enhance the attractiveness of investment in the United States and thereby have a favorable effect on our balance of payments. Accordingly, the Bureau of the Budget recommends enactment of the bill. The proposed amendment to H.R. 13103 would give the President discretionary authority to impose or remove the interest equalization tax on dollar loans made by foreign branches of U.S. banks. We have no objection to this amendment. Sincerely yours, WILFRED H. ROMMEL, Assistant Director for Legislative Reference. GENERAL COUNSEL OF THE DEPARTMENT OF COMMERCE, Washington, D.C., Aagwst 18, 1966. Hon. RUSSELL B. LONG, Chairman, Committee on Finance, U.S. Senate, Washington, D.C. DRAR Mit. CHAIRMAN: This is in further reply to your request for the views of this Department concerning H.R. 13103, an act to amend the Internal Revenue Code of 1954 to provide equitable tax treatment for foreign investment in the United States. The act as passed by the House would reduce U.S. tax upon the estates of nonresident aliens, thereby providing more equitable tax treatment in line with that applied to estates of U.S. citizens. The `bill would also limit U.S. tax on nonresident aliens' investment income while taxing their trade and business income in the same manner that a U.S. citizen's trade and business income is taxed. The estate tax applied to estates of aliens domiciled abroad would be reduced considerably by increasing the current $2,000 exemption to $30,000 and by reflect- ing the new alien estate tax rate schedule a marital deduction of 50 percent of the taxable estate, which deduction currently is not allowed. The present high estate tax on nonresident aliens discourages many of them from investing in the United States. This reduction will make the United States more attractive as a place to invest one's savings and should increase foreign investment here. The act extends the income tax exemption presently given interest paid on bank deposits to nonresident aliens not engaged in trade or business in the United States to interest and dividends paid on share deposits `by savings and loan associations and interest paid `by insurance companies. However, beginning in 1972 all such payments would become subject to tax on U.S. source income. The act would restructure the income tax treatment accorded nonresident aliens and foreign corporations so as to tax their investment income at the flat rate of 30 percent or the lower treaty i-ate, and to tax their income effectively connected with the carrying on of a U.S. trade or business at the regular income tax rates applied to resident individuals and domestic corporations. Currently nonresident aliens not engaged in trade or business in the United States are taxed at either the 30-percent rate or higher graduated rates, whichever produces more tax, except that if a rate has been fixed by treaty, that rate will apply. Nonresident aliens and foreign corporations engaged in trade or business are taxed at the graduated rates on the net amount of all their U.S. source income. On the one hand this change would make investment in the United States more attractive to foreign investors not residents of tax treaty countries, since it limits the tax rate to 30 percent. Also, any foreign investor in the higher tax brackets engaged in trade or business here would benefit so far as his U.S. investment income is concerned since under present law this is taxed at the graduated rates regardless of whether a tax treaty is in effect. On the other hand the change would close the loophole allowed to foreign corporations that in reality are not engaged in business in the United States, but through a minimal amount of activity qualify for the 85-percent dividend deduc- tion accorded to foreign corporations engaged in business. This results in an effective tax rate of less than 7~ percent as opposed to a 15-percent treaty rate or 30-percent rate that would apply under this bill. At the same time, those 912 PAGENO="0923" FOREIGN INVESTORS TAX ACT OF 1966 27 foreign corporations carrying on substantial business activities would be simi- larly affected. At the end of 1964 foreigners held stocks in U.S. corporations valued at about $13.8 billion as portfolio investments. No data are available on the percentage of these holdings owned by foreign corporations. Approxi- niately 90 percent of the foreign investments in the United States are held by Western European and Canadian corporations or individuals. Most of these countries have income tax treaties with the United States limiting tax on U.S. source dividends to 15 percent. It is difficult to tell whether foreign corpora- tions would change their investment policy because of the additional 7'/2 cents tax on each dollar of dividend. However, where the foreign taxing authority's rate exceeds 15 percent and the U.S. source income is subject to the foreign tax there would be no reason for foreign withdrawal of investment in U.S. stocka, because this change would merely reallocate between taxing authorities the same total amount of tax. Nor would there be any change in investment policy of Swiss banks holding stock as nominees since they are now paying the treaty rate on 30-percent rate where applicable. As for the nonresident alien individual deriving more than $10,600 annual taxable income from trade or business in the United States, he would pay less tax on that portion of his income derived from investment. However, indi- viduals doing business in the United States with total U.S. income of less than $10,000, including investment income, would pay somewhat more because the 30-percent tax on investment income would be higher than the applicable gradu- ated rate. There are not many nonresident aliens not engaged in business in the United States paying the high graduated. rate of tax. Elimination of the graduated rate of tax on investment income should therefore attract consider- ably more investment on the part of these individuals. The U.S. source capital gains of a nonresident alien not engaged in trade or business in the Unitea States are to be taxed under the bill only if the alien was in the United States for 183 days or more during the year. Currently nonresident aliens engaged in trade or business in the United States, those not engaged in trade or business but present in the United States 90 days or more, and those present less than 90 days hut present at the time of sale, are taxable on their capital gains. The 183-day provision will be a strong inducement for nonresident aliens to invest in stocks and bonds of U.S. compa- nies, particularly since the bill also permits investors to grant U.S. agents the discretionary authority to buy and sell their holdings without thereby being considered as having engaged in trade or business in the United States; being engaged in trade or business in the United States would subject the capital gains to U.S. income tax. The bill would also give real estate investors an election to be treated as being engaged in trade or business so as to be taxed on net income rather than on gross income as is generally the case now. Currently a real estate investor can deduct interest, taxes, depreciation, etc., from his gross income in determining his taxable income only if he renders services to his tenants. These tax relief measures would considerably increase the effective rate of return on investments in the United States and therefore should attract addi- tional foreign investment here. The bill would introduce into law the concept of taxing a foreign corporation on worldwide income of the corporation effectively connected with carrying on the activity of the U.S. branch. This concept would be limited to income attrib- utable to an office in the United States conducting (1) licensing operations in the United States deriving income from the use of their licenses outside the United States; (2) banking or financing operations and some investment opera- tions; or (3) branches in the United States deriving income from the sale of goods except where a branch outside the United States materially participated in the sale of the product for use outside the United States. This taxing concept is equitable in that it would place the foreign corporation that is essentially a domestic corporation but for having been created in a foreign country, in the same tax position as its U.S. competitor.. This change would also prevent foreigners from using the United States as a tax haven. U.S. exports would probably not be affected by this provision. There apparently is a typographical error on page 69, line 4, in making refer- ence to paragraph (1) (e). The reference should b~ to paragraph (2) (e) which contains the expression "overseas operations funding subsidiary" that is being defined. . . . . We uaderstand that Objections have been raised that two provisions of H.R. 13103 may have some adverse effect upon the balance of payments or .U.S~. gold 913 PAGENO="0924" 28 FOREIGN INVESTORS TAX ACT OF 1966 holdings. One of these provisions is the amendment making interest received by foreign investors on bank deposits in the United States subject to income tax: after 1972. However, this provision would appear to have little immediate impact in view of the 1972 effective date. The other provision would subject to U.S. estate tax, U.S. bank deposits of deceased foreign investors. This provision would go into effect immediately upon enactment. It is difficult to determine the impact of this provision in view of the increased exemption and reduced rates provided in the bill for estates of foreign investors. Subject to your consideration of the possible adverse effect of the two bank. deposit provisions on the balance of payments and U.S. gold holdings, this. Department is of the view that the subject bill would attract foreign investment to the United States. The Department of Commerce therefore recommends enactment of H.R. 13103. We have been advised by the Bureau of the Budget that there would be no objection to the submission of our report to the Congress from the standpoint. of the administration's program. Sincerely, ROBERT B. GrLss, General Counsel. DEPARTMENT OF STATE, August 8, 196ff.. Hon. RUSSELL B. LONG, Chairman, Committee on Finance, U.S. Senate DEAR Ma. CHAIRMAN: This report on H.R. 13103, a bill "to amend the Internal' Revenue Code of 1954 to provide equitable tax treatment for foreign investors in. the United States," is submitted in response to your letter of June 17, 19643. H.R. 13103 would `substantially implement the 1964 proposals of the Presidential task.: force on "Promoting Increased Foreign Investment in U.S. Corporate `Securities. and Increased Foreign Financing for U.S. `Corporations Operating Abroad." The Department of State `believes that H.R. 13103, if enacted, would have a salutary effect on the U.S. balance of payments. By reducing certain existing tax: disincentives to investment in United States assets, the `bill would tend to en- hance their attractiveness to foreigners. Especially noteworthy in this regard: *are the provisions in the bill dealing with estate tax rates, exemptions and re- turns; with the application of `a separate tax rate for U.S. source income derived: from royalties and investments in U.S. corporate securities as against source income "effectively connected" with the conduct of a Uni'ted States trade or' `business; and with the uniform fiat rate on fixed or determinable income of non- resident alien individuals. The Department of `State supports the objectives of H.R. 13103 `and regards the proposed amendment to the Internal `Revenue Code as reasonable and prac- ticable steps for the accomplishment of those objectives. The Department re- gards Section 10 of the `bill, which provides that no amendment is to be applied, in contravention of any treaty obligation of the United States, as an essential part of the proposed legislation. The Bureau of the Budget advises that from the standpoint of the Adminis- tration's program there is no objection to the submission of this report. Sincerely yours, DOUGLAS MACA.ETHUR II, Assistant Secretary for Congressional Relations (For the Secretary of State). The CHAIRMAN. We are particularly happy to welcome as the first witness the Secretary of the Treasury, Hon. Henry H. Fowler. It was Mr. Fowler, before he became Secretary of the Treasury, who was asked by President Kennedy to serve as chairman of the task force and it was because of his strong and knowledgeable leadership that the 13-man group has come to be known universally as the Fowler task force. Mr. Secretary, we are glad to have you. We hope we can expedite your appearance here today. And we ask the other witnesses who will' follow you to observe the 15-minute limitation on oral testimony.. We do not propose to hold you to that limitation. 914 PAGENO="0925" FOREIGN INVESTORS TAX ACT OF 1966 29 STATEMENT OF HON. HENRY H. POWLER, SECRETARY OP THE TREASURY; ACCOMPANIED BY STANIEY S. SURREY, ASSISTANT SECRETARY FOR TAX POLICY; AND WINTHROP KNOWLTON, ASSISTANT SECRETARY FOR INTERNATIONAL AFFAIRS, DE- PARTMENT OF THE TREASURY Secretary FOWLER. Thank you. Mr. Chairman and members of the committee, I am appearing be- fore you to urge prompt and favorable action on H.R. 13103, legisla- tion which is intended to establish equitable tax treatment for foreign investment in the United States. Passage of this bill will serve an important national objective by providing a comprehensive and in- tegrated revision of our present system of taxing foreign individuals and foreign corporations on income derived from the United States. The revision is supportable on tax policy criteria and brings our sys- tem of taxing foreigners more into line with the rules existing gen- erally in the other developed countries of the world. A fundamental and enduring consequence of this revision will be increased interest on the part of foreigners generally in investment in the United States. This proposed legislation, therefore, is one of the important positive elements of our long-range balance-of-payments effort. BACKGROUND OF PROPOSALS In his balance-of-payments message of July 18, 1963, President Kennedy announced he was appointing a task force to review U.S. Government and private activities which adversely affect foreign pur- chases of the securities of U.S. companies. The group was composed of representatives of finance, business, and government. This task force, of which I had the' privilege of serving as chairman, studied various courses of action which could be adopted in both the private and public sectors to encourage foreign ownership of U.S. securities. In April 1964, the task force issued its report containing 39 recom- mendations, which called for a broad range of actions by U. S. interna- tional business organizations and financial firms, as well as by the Fed- eral Government, to bring about broader foreign ownership of U.S. corporate securities. Among the recommendations . directed toward the Government, those dealing with the taxation of foreign individuals and foreign corporations have the most significant and immediate im- pact. Issuance of the task force report prompted a broad and intensive review by the Treasury of rules governing taxation by the United States of foreign individuals and foreign corporations. This review considered these rules not only from the standpoint, of the balance of payments but also in view of conventional tax policy considerations. As a result of this review,, on March 8, 1965, the Treasury Department submitted to the Congress proposed legislation containing proposals in all of the tax areas dealt with in the task. force report,, and also in other areas where it appeared that change was desirable to make the present system more consistent with rational tax treatment of foreign investment. The House Ways and Means Committee then thoroughly considered that bill, as well as several areas not covered by the bill, and, following public hearings, a new version of the bill (H.R. 915 PAGENO="0926" 30 FOREIGN INVESTORS TAX ACT OF 19~6 11297) was introduced by Chairman Mills on September 28, 1965, and public comments on the revised bill were invited. The committee then further considered the matter in executive session and Chairman Mills introduced a revised version (H.R. 13103) on February 28, 1966. Fol- lowing public hearings on March 7, 1966, H.R. 13103 was favorably reported out of the Ways and Means Committee and passed by the House of Representatives without opposition on June 15, 1966. The Treasury Department agrees with the view expressed by the task force and in the House Ways and Means Committee report that many of the existing rules applicable to foreign investors in the United States are outmoded and inconsistent with sound tax policy and as a result deter foreign investment, to the detriment of our balance-of- payments position. These rules were enacted many years ago and do not reflect the changes in economic conditions which have occurred over the last 15 years. Examples of tax rules which impede foreign investment in this country are many: The present level of our estate tax-much higher on foreigners than on U.S. citizens-is completely out of line with the rates generally prevailing elsewhere in the world and acts as a signifi- cant deterrent to potential foreign investors. Also, the fact that we require income tax returns from foreigners who only mak.e passive investments here is inconsistent with international tax practice and hinders foreign investment in the United States. These and other aspects of our system of taxing foreigners contribute to the widely held view that investment in U.S. securities poses such serious tax problems for the foreign investor that it cannot be undertaken without the benefit of expensive tax advice. At the same time, some of these provisions are extremely difficult, if not impossible, to enforce, or are susceptible of relatively easy avoidance by the sophisticated foreign investor. Since they deter many foreign investors and are avoided by the rest, they give rise to almost no tax revenue. However, this bill is not intended to convert the United States into a tax haven nor divert investment capital to the United States from less developed counries. The purpose of this bill is to provide equitable tax treatment for foreign investment in the United States. At the same time we recognize that this purpose will not be served if the bill violates proper tax policies or international tax standards, thereby set- ting off a competitive contest among the developed nations of the world to attract foreign investors through tax devices. To attract foreign investors, the United States must offer not "tax breaks" or "tax gimmicks"-it must offer a growing and dynamic economy. We believe our record of economic growth over the last 6 years and our prospects for the future are sufficient to induce a substantial increase in foreign investment if our tax system does not act as a bar. Moreover, policies of this bill are consistent with the general policy of the United States which treats foreign capital on a basis of equality with domestic capital. Thus, there generally is no requirement that a foreign investor apply to U.S. authorities for permission to invest; the policy of the United States is to avoid inte.rference with the right of foreigners to engage in particular types of economic activity in the United States; there are no legal provisions requiring the participation of domestic. capital in foreign enterprises engaged in business in the United States; and the United States has no exchange controls, there 916 PAGENO="0927" FOREIGN INVESTORS TAX ACT OF 1966 31. are no restrictions on the remittance of business profits, or income from passive investments, and U.S. dollars are freely convertible in the mar-* ket for any currencies and for all purposes; and the U.S. economy offers foreigners a safe, ready, and diversified investment market which has an outstanding record of economic growth. The United States-with a GNP of $732 billion, personal consump- tion expenditures of $459 billion, business expenditures on new plant and equipment of $52 billion in 1965; an increase of $28 billion in GNP for the first half of 1966, the sixth year of our economic up- swing, an open-door policy under which President Johnson said: "The United States warmly invites businessmen from other industrial countries to explore the many promising investments and licensing opportunities in the U.S.A."-offers to foreign investors an oppor- tunity to take advantage of the potentials of investing in a great and growing marketplace. These investments will contribute to the long-range economic growth of the United States and the investing country. The bill should encourage such investments by removing certain tax obstacles involved in the present system. Enactment of H.R. 13103 will result in a revenue gain of about $1 million annually. In addition, in the fiscai year 1967 only, it is ex- pected that the bill will produce a revenue gain of approximately $22.5 million by reason of the provision requiring U.S. withholding agents to remit taxes withheld on payments to foreigners more fre- quently than on an annual basis, as is the case under present law. (See table I on p. 7 of the report of the Committee on Ways and Means on H.R. 13103, entitled "Estimated revenue changes resulting from the foreign investors tax bill.") IMPACT OF H.R. 13103 ON THE BALANCE OF PAYMENTS There is no way of estimating with any degree of precision the im- pact of the bill on foreign investment in the United States or the resulting benefit to our balance of payments. The factors governing securities investment, are many and complex. Even in purely domestic transactions, intangibles such as habit, convenience, and past expe- rience may be as important as yields, price-earnings ratios, and other economic indicators. Although difficult to quantify, there is ample evidence of a sizable potential for attracting foreign investment in U.S. corporate securi- ties, particularly stocks, by residents of the prosperous countries of continental Europe. After more than a decade of rapidly rising in- comes, Europeans have to a large extent fulfilled many of their most pressing consumer needs and are accumulating savings at a high rate. Individuals in Europe are turning increasingly toward securities in- vestment, as shown by the rising activity on European stock exchanges, the large number of new offices being opened in Europe by American securities firms, and rising sales of mutual fund shares. Yet, even now, in Europe only 1 person in 30 is a shareowner as compared to 1 in 11 in the TJnited States. At the end of 1965, foreiguers held an estimated $12.5 billion of U.S. corporate stocks valued at market prices. In every year since 1950 except three, foreign purchases of U.S. stocks have exceeded for- eign sales and in the 7 years between 1959 and 1965, net purchases 1y foreigners averaged $175 million (both excluding certain foreign 917 PAGENO="0928" 32 FOREIGN INVESTORS TAX ACT OF .1966 governmental transactions). These net figures are the residual of total transactions which in~ recent years have been about $21/2 billion to $3½ billion each year for both purchases and sales. A small per- centage increase in such purchases, therefore, could have had a sub- stantial effect on the net .balance of transactions. If the amount of additional investment expected to result from H.R. 13103 were merely a function of the amount of tax saved, there would be little improvement in the balance of payments. More important than any tax savings to foreigners, however, is the substantial effect which will result from the simplification and rationalization of our tax treatment of foreign investors. Our high estate tax on foreigners, for example, is widely considered by experts to be one of the biggest bar- riers to foreign investment. Existing estate tax rates almost certainly deter many foreigners from investing here at all. This is particularly SO because the exemption is limited to only $2,000-nearly any invest- ment whatsoever will subject the estate to tax and require filing of an estate tax return. It is not surprising under these complexities that the small foreign investor may avoid purchasing U.S. stocks because of the inconvenience of the estate tax; the big investor also may avoid such purchasing because of the size of the tax itself. Viewed in this light, it is clear that the changes contained in H.R. 13103 should in time materially increase the volume of foreign invest- ment in the United States. Based on the sizable potential for foreign purchases of U.S. corporate stocks which is known to exist, we expect that the legislation will eventually result in a meaningful additional capital inflow, other factors remaining unchanged. Some timer-per- haps 1 to 2 years or maybe more-will be required before foreigners can reorient their reactions to the U.S. tax system and complete the ad- justment of their portfolios to take advantage of ILIR. 13103, but a sub- stantial impact may be felt in the period ahead. Mr. Chairman, I would like to interject at this point to say that in addition to the half dozen or so recommendations dealing with tax barriers that were in the task force report, many of the other 39 recom- mendations had to do with activities carried on by the private se.ctor-=~-- industrial corporations marketing their securities abroad, securities firms opening up offices abroad, and many other things designed to further the purposes of this act. I think the committee would be in- terested in knowing that the private sector, since the report was made, has been very active in trying to implement the nontax recommenda- tions that lie within the report's purview. In the hearings before the House Ways and Means Committee a year ago last June, Mr. Robert Kinney, who was the executive director of the task force, included in the proceedings a detailed accounting of the efforts of the private sector to carry through these recommendations (beginning at p. 114 of the hearings). So we really come down in this bill to that part of the role of government which was considered most important in the task force report. SPECIFIC PROPOSALS CONTAINED IN H.R. 13103 I should like to review at this time the principal substantive changes embodied in H.R. 13103. Capital gain~.-The present system of taxing capital gains realized by foreigners has contributed to the view that investment in the 918 PAGENO="0929" FOREIGN INVESTORS TAX ACT OF 1966 33 nited States is something which should be approached cautiously because of the possibility of inadvertently becoming subject to tax. The Internal Revenue Code now provides for a general exemption from capital gains tax for nonresident foreigners not doing business in the United States with two exceptions. First, the foreigner's gains are subject to u.S. capital gains tax if he is physically present in the United States when the gain is realized, and second, all gains during the year are taxable if he spends 90 days or more in the United States during :that year. The physical presence restriction can be easily avoided by the ex- perienced foreign investor if he arranges to be `outside the country when the gain is realized, but is a potential trap to the foreigner who is nOt `aware of its existence. The bill would eliminate this restric- tion from the general capital gains exemption. In addition, the bill would extend the 90-day period which a for- eigner may spend here without `being subject th capital gains tax to 183 day's. This will make the provision more consistent with interna- tional standards governing the taxation `of foreigners residing in a country for a substantial period. It will also minimize a foreigner's fear `that `he will be taxed on capital gains realized at the `beginn'ing of a taxable `year if he later spends `a substantial amount of time in the tTnited States during that year. `Graduated income tax rates.-At the present time, foreign mdi- viduls not doing business in the United States who derive more than "$21,200 of investment income from U.S. sources are subject to regular 11.5. income tax graduated rates on that income and are required to file returns. (Below that figure a fiat 30-percent rate applies.) These requirements have produced little revenue, in part because we have eliminated graduated rate taxation ,of investment income in almost `all of our treaties with the other industrialized countries and in part be- cause of the relative ease with which this provision is avoided. Blow- ever, the possibility of being subjected to graduated rate taxation and the accompanying return requirement may be a source of concern to ,foreigners and consequently act as a substantial deterrent to foreign investment in the United States. H.R. 13103 eliminates this form of taxation of nonresident for- eigners not doing business here and removes the requirement for filing `returns in such cases. The liability of foreign investors deriving U.S. `investment income would thus be limited to the, tax withheld at the statutory 30-percent rate or a lower'applicable treaty rate. The leg- islation would continue graduated rate taxation for foreigners who are doing business in the United States. These rules are consistent `with the practices of most other industrialized countries. Definition of "engaged in trade o'r business".-H.R. 13103 makes clear that nonresident alien individuals or foreign corporations are not engaged in trade or business in the United States-and thus are sub- ~ject to tax at the 30 percent withholding rate or lower treaty rate rather than at regular graduated rates-because of investment activi- ties here or because they have granted a discretionary investment power ~to a U.S. banker, broker or, adviser. This provision should have the effect of removing much of the uncertainty which now surrounds the question of what amounts to engaging in trade or business in the Tilinited States. Uncertainty of this type is undesirable as a matter of 71-297 0-67-pt. 1-59 919 PAGENO="0930" 34 FOREIGN INVESTORS TAX ACT OF 1966 tax policy and has the effect of limiting foreign investment in th~ United States. Many foreigners do not desire to invest in U.S. stock~ if they cannot give a U.S. bank or broker discretionary authority to ac for them. The bill also changes present law by giving foreign individuals and foreign corporations an election to compute their income from real property on a net income basis at regular U.S. rates rather than at the 30 percent withholding rate or lower treaty rate on gross income. This type of treatment is common in the tax treaties to which the United States is a party and is designed to deal with the problem which arises from the fact that the expenses of operating real property (e.g., taxes, interest, depreciation) may be high and cannot be taken as deductions if the recipient of the income from such real property is not engaged in trade or business in the United States. It is sometimes difficult for a foreigner to determine whether his U.S. real estate activities constitute engaging in trade or business in the United States. Thus, taxation at higher graduated rates on a net basis, i.e., after allowable deductions, frequently results in a lower tax liability than taxation at a 30-percent rate (or lower treaty rate) on gross income without any allowance for deductions. Segregation of investment and business income.-Under present law, if a foreign individual is doing business in the United States he is subject to tax on all his U.S. income, whether or not connected with his business operations, at regular graduated rates. }I.R. 13103 would separate the business income of a foreign individual engaged in busi- ness here from his investment income (e.g., dividends, interests, royal- ties), and would tax the investment income at the 30-percent statutory withholding rate or at the lower appropriate treaty rate. All business income would remain subject to tax at graduated rates. With respect to foreign corporations doing business in the United States (so-called resident foreign corporations), which also have iti~ vestments here, H.R.. 13103 would likewise separate the investment in- come from the business income of the foreign cOrporation. Under the legislation, a resident foreign corporation deriving such investment income from the United States would thus be taxable on such income at the statutory 30-percent rate or at the lower applicable treaty rate. The bill conforms our treatment of investment income to the general approach followed by many other nations. It also is in accord with the Organization for Economic Cooperation and Development Model In- come Tax Convention and the approach followed in our more recent treaties with the United Kingdom, Germany, and the Netherlands, and thus has the advantage of conformity to international practice. The bill offers guidelines, which are supplemented by the legis- lative history, to the application of the "effectively connected" con- cept. A foreigner who is receiving investment income from the United States, under the approach of the bill would no longer have to be concerned that some other activity in the United States will suddenly be considered as attributing to him a trade or business status in the United States, thus subjecting the investment income to business taxation. Instead, as long as the investment income is not effectively connected with the other activity, any uncertainty as~ to the status of the latter would not color or affect the investment income. The removal of such uncertainty should encourage invest- ments by foreigners in the United States. 920 PAGENO="0931" FOREIGN INVESTORS TAX ACT OF 1966 35 As a result of the above-described changes, the foreign corporation engaged in business in the United States and also receiving dividend income would no longer automatically receive on those dividends the deduction now afforded under the Internal Revenue Code to divi- dends received by one corporation from another corporation. The elimination of the dividends received deduction in certain cases as respects resident foreign corporations is in part designed to end an abuse which has developed. Frequently, a foreign corporation with stock investments in the United States engages in trade or business here in some minor way and then claims the dividends received de- duction on its stock investments-which results in the taxpayer pay- ing tax at a rate of only 7.2 percent on the dividends (48 percent corporate tax on 15 percent of the dividends). Thus, such a corpo- ration ends up paying far less than the 30 percent statutory or applicable treaty rate on its U.S. dividends, even though its position as respects its investment income is basically the same as a corpora- tion which is not doing business here but which also derives invest- ment income from the United States. In those cases where the applicable treaty rate is 5 percent (the rate set by certain treaties where subsidiary dividends are involved), the resident foreign corporation will benefit from this proposed change. Where the treaty rate is more than 7.2 percent and the dividend income is not effeëtively connected, the higher treaty rate will govern. TAXATION OF FOREIGN SOtTRCE INCOME OF CERTAIN FOREIGNERS The House noted that under present law certain foreigners can conduct business activities within the United States and not pay any tax to the United States (or frequently any other country) on the income derived from such activities. This is in contrast with the tax rules of other countries, which under comparable circumstances would tax active businesses with similar activities in their countries. To give the United States a parity of tax jurisdiction, and also to prevent the United States from being used in some cases as a kind of "tax haven" country because of the absence of that jurisdiction, the bill provides for the U.S. taxation of four limited kinds of in- come which are attributable to the conduct within the United States of a trade or business by a foreigner, even though the technical source of such income under our code rules is foreign. Under the circumstances covered, this provision is consistent with economic realities in attributing the profits to the U.S. business, and is in accordance with the practice of many member countries of the OECD. The bill provides that such limited kinds of foreign source income of foreigners can be subject to U.S. tax only if the foreigner has an office or other fixed place of business within the United States to which such income is attributable. Thus, for example, under the bill a U.S. tax would be imposed where a U.S. branch of a foreign enter- prise imports goods from abroad, solicits, negotiates, and performs other activities required in arranging the sale of such goods, and then resells the goods in the United States. Today the transaction may not be taxed by the United States if the sale is considered to take place outside the United States in view of the passage of title 921 PAGENO="0932" 36 FOREIGN INVESTORS TAX ACT OF I a66; outside the United States (and it may not be taxed by the' country o residence of the taxpayer if it does not tax its residents on incom arising outside that country under the source rules of that country). In accordance with this tax treatment, the `bill allows' a foreigner whose foreign source income is so taxed in the United States a for- eign tax credit for creditable foreign taxes paid on. such foreign source income if the foreign tax is levied on the basis of source jurisdiction by the foreign country. Personal holding companies and "second d'ivid~nd tax."-H.R.. 13103 changes the personal holding company provisions of the Inter- nal Revenue Code as applied to the U.S. investment income of foreigm corporations and also modifies the application of the so-called second, dividend tax. Under the bill, foreign corporations owned entirely by foreigners would be exempt from the personal holding company tax~ as respects their U.S. income. This is desirable because of' the elimi- nation of graduated rates as applied to individual foreigners which is~ contained elsewhere in the bill, and which makes the application of the' personal holding company provisions to corporations wholly owned, by foreigners no longer appropriate since a withholding tax on its~ income has already been collected. Under the bill, the "second dividend tax" (which under present' law is levied on dividends distributed by a foreign corporation to its~ shareholders (whether foreigners or U.S. citizens) if the corporation derives 50 percent or more of its gross income from the United States) would be applied only to the dividend distributions of foreign corpor- ations `doing business in the United States which derive' 80 percent or' more of their business income from their U.S. business. It is desir- able to retain this pare of the tax to cover those cases where a resident' foreign corporation has the great bulk of its business' operations in the United States, so as to treat dividends of such a corporation as' being from U.S. sources. These changes should have the effect of eliminating application of the personal holding company tax and "second dividend' tax" in many' cases where they now apply, and where they may now act as a deter-~ rent to foreign investment. Bank deposits.-Under present law, interest on deposits with U.S. banks paid to foreigners not doing business within the Unitedi States' is not subject to U.S. income tax and the deposit is not subject to estate" tax. This is an exception' to the general rule which subjects to U.S.. income tax all interest paid by residents of the United States, cor- porate or individual. The House saw from the standpoint of tax' equity no basis for such an exception but, because of balance-of-pay- ments considerations, deferred the repeal of this bank deposit interest' income tax exception until 1972. The repeal of the bank deposit estate tax exemption will become effective for decedents dying after the' date of the enactment of the bill. Where the interest is paid on a deposit of a foreigner in a foreign' branch of a U.S. bank, the House liberalized the present bank deposit' rule by providing that interest from such deposits with foreign' branches of U.S. banks shall no longer be subject to U.S. tax except under limited circumstances. Under present law such interest incomeS is subject to income tax when received by foreigners engaged' in busi- ness within the United States; and subject to U.S. estate tax in the~ hands of nonresidents not citizens. 922 PAGENO="0933" FOREIGN INVESTORS TAX ACT OF 1966 37 Senator TALMADGE. Mr. Secretary, would you yield at this point for question or would you prefer to finish your statement? Secretary FOWLER. Whatever the committee wishes. Senator TALMADGE. I have received several letters from individuals both inside and outside my State strenuously objecting to this par- ticular portion of the bill on the theory that at the end of 1965 we had. some $13 billion worth of bank deposits in the United States, and they claim that if we imposed this tax it will have a very adverse effect on our balance of payments which this bill is supposedly designed to correct. They say particularly since an inheritance tax would be imposed immediately that many of them would withdraw their funds immediately. As I understand this provision, these funds would be taxable under the House bill in the year 1971 which would result in a most serious effect on our balance of payments. I would like to hear your comment on that. Secretary FOWLER. Well, Senator Talmadge, as I indicated, the decision to terminate in 1972, the income tax exemption in the pres- ent law for bank deposit interest derived by foreigners not engaged in trade or business in the United States was made by the House Ways and Means Coimnittee. It was not dealt with in the task force report. The Ways and Means Committee felt, in effect, that no valid ta~ reason existed for continuing the exemption in. the case of foreigners when U.S. citizens and residents are required to pay U.S. income tax on such interest. As a matter solely of tax equity, I think the House Ways and Means conclusion appears to be correct. However, because that decision may have current balance-of-pay- ments implications-and recognizing that-the Ways and Means Com- mittee postponed the effective date of the income tax until 1972, and said that at that time it would have an opportunity to reconsider the balance-of-payments situation. It is our understanding, Senator, that representatives of the banking community will appear before your committee and testify on this provision of the bill. They are, of course, much closer and much more familiar with the actual impact of this 1972 provision, and the current impact of the estate tax provision, than we are. Therefore, we are going to listen very carefully to their testimony. I am sure that it will be helpful to all of us in considering just what the effect is of this change in the law. I do not have a concrete response to your question, except to urge that the committee give careful consideration to the testimony to be given by those who are more intimately familiar and directly con- cerned with this matter. Senator TALMADGE. If I understand your reply correctly, you are neither for nor against the House provision. Secretary FOWLER. Precisely. Senator TALMADGE. Thank you. Senator ANDERSON. Since there has been a pause here, where does this money come from in these banks? Secretary FowL1~. It comes from all over, Senator Anderson. Senator ANDERSON. Principally South America? Secretary FOWLER. I was going to give you what information we have on this.. I am now speaking of interest on deposits in U.S. banks paid to private foreigners as distinct from foreign central banks and foreign governmental institutions. 923 PAGENO="0934" 38 FOREIGN INVESTORS TAX ACT OF 1966 These time deposits, interest on which would become subject to in come tax, according to our information, amounted to $2.5 billion a the end of May 1966. Of that amount, about $1.3 billion was hel by Latin American residents. About half the Latin American hold ings are in three countries-Argentina, Mexico, and Venezuela-which have free foreign exchange systems allowing residents to hold deposits in the United States or elsewhere. Senator ANDERSON. Thank you. Senator CURTIS. May I ask one question? Senator ANDERSON. Surely, Senator Curtis. Senator CURTIS. If these foreign deposits, deposits by foreigners in American banks become subject to tax, and as a result the depositors remove their money to other countries to have it free of the tax, in what countries could they make their deposits? Secretary FOWLER. What are the other countries? Senator CURTIS. Yes. Venezuela deposits money in Switzerland. Will the interest be subject to a tax? Secretary FOWLER. The treatment varies. Our information indi- cates that in France they would be exempt from French tax if payable in a currency other than francs; in Germany, they would also be exempt; in Italy they would be taxable; in the Netherlands they would be exempt; in Switzerland they would be taxable. In the United Kingdom they would be- Senator WILLIAMS. May I ask at what rate would they be taxed? Secretary FOWLER. In Italy and Switzerland at a 27-percent rate. Senator WILLIAMS. What rate would be. proposed under the House bill? Secretary FOWLER. Sir? Senator WILLIAMS. What rate would the House bill propose? Secretary FOWLER. Thirty percent unless the rate was reduced by treaty. In some countries with which we have treaties, Senator Williams, the interest would be exempt from tax. Senator ANDERSON. Just a minute. What countries are principally treaty countries, then? Is Great Britain one? Senator WILLIAMS. Those are the exempt treaty countries you are speaking of? Senator ANDERSON. He put that in the answer so I thought it might all go in the answer at one time. Secretary FOWLER. If I may, I would like to complete the answer to Senator Curtis' question giving the tax rates in three other coun- tries and then answer the treaty question. In the United Kingdom, interest from bank deposits of foreigners are taxable at the rate of 41¾ percent, and in Canada at 15 percent-but I should note that in Canada when the deposit has been made in a foreign currency, and the interest is payable in a foreign courrency, no tax is w-ithheld. The last country is Japan where bank interest of foreigners would be tax- able at a 20-percent rate. So there are three major countries in which they are exempt, and five in which they are taxable. Now, as to the countries with which the United States has treaties. Interest on U.S. bank deposits would be exempt in the case of payments to residents of the United Kingdom and taxed at 5 percent in the case of payments to residents of Switzerland under our treaty with Switzerland. 924 PAGENO="0935" FOREIGN INVESTORS TAX ACT OF 1966 39 Senator WILLIAMS. Is that a reciprocal arrangement? Secretary FOWLER. Yes, sir. Senator WILLIAMS The same rate applies both ways? Secretary FOWLER. Yes, sir; 10 percent with Japan; 15 percent with elgium, France, and Canada; 30 percent with-well, 30 percent would pply to the Latin American countries, Argentina, Mexico, and. Venezuela. Senator WILLIAMS. Is it not true that- Secretary FOWLER. May I make one comment on the United King-j dom. I am told, and I will have to defer to Mr. Surrey for this, that the United Kingdom apparently exempts interest on bank deposits in practice although in theory under the law it appears to be taxable at a 41l/4-percent rate. Senator WILLIAMS. Is it not true that if, for example, the Latin American investments should be deposited in Switzerland rather than here, the interest rates that they would receive would be relatively low, maybe 1 or 2 percent. In some cases don't they actually pay for the privilege of depositing their money over there?. Secrecy is the point, not the interest rates. Secretary FOWLER. That. is my general understanding~ Senator Williams Senator ANDERSON- (presiding). Proceed, Mr. Secretary. Senator CURTIS. May I ask one more question. How longhas the exemption existed? Secretary FOWLER. I believe it was in the Revenue Act of 1921. According to the legislative history we have on it, it seemed to reflect concern for the competitive aspects-whether the banks here would be placed at a competitive disadvantage if it were not exempt. Senator CARLSON. Mr. Secretary- Senator ANDERSON. May I ask one question. iDid that have any- thing to do with the financial c.ondition in which this country found itself in 1921, with banks closing all over the country? Secretary FOWLER. I cannot really give you a good answer to that Senator; I do not know. The only thing we have found is a reflection of a concern for the competitive situation of the American banks. Senator ANDERSON. I know of one community which had six banks, and five of them closed. We kept the other one open by brute strength. Could that have had any effect, could that have played any part in this decision? Secretary FOWLER. It might well have. Senator ANDERSON. Senator Carlson. Senator CARLSON. Mr. Secretary, on this income we have from de- posits in banks, deposits from foreign countries, assuming we pass H.R. 13103, what would be the proposed rate? Secretary FOWLER. In the nontreaty countries it would be 30 percent. I have indicated the rates for the treaty countries. Five percent in the case of Switzerland, 10 percent in the case of Japanese depositors, 15 percent for Belgium, France, and Canada, United Kingdom, and certain other European countries would be exempt, and in Latin American countries the full 30-percent rate would apply. Senator CARLSON. The reason I bring that up, we, of course, have negotiated many treaties, but there are pending presently treaties before the Senate Foreign Relations Committee, and not only that, but 925 PAGENO="0936" 40 FOREIGN INVESTORS TAX ACT OF 1966 a great number of treaties are being negotiated, as I understand it all over the world at the present time. Assuming we in the Congress approved those treaties, would that not substantially change this 30-percent provision? Secretary FOWLER. I do not think it would because the so-called less- developed-country treaties do not normally carry an exemption o reduction `on interest. Senator CARLSON. They normally do not carry interest? Secretary FOWLER. They normally do not exempt interest from tax' in the source country or reduce the tax on interest. Senator CARLSON. My thought was if we approved this legislation that is pending and then enter into treaties with foreign countries we would actually vitiate what we thought we were doing on a 30-percent basis, was my point. Secretary FOWLER. Yes. You would with a certain number of the developed countries, as I have indicated. Senator CARLSON. That is all. Senator ANDERSON. You may proceed, Mr. Secretary. Secretary FOWLER. Estate tax. It is generally felt that our current system of taxing the U.S. estates (involving only the U.S. `assets) of foreign decedents is inequitable and constitutes a significant `barrier in our tax laws to increasing foreign investment in U.S. corporate securities. `Under present law, a foreign decedent is taxable at regular U.S. estate tax rates, ranging up to 77 percent, on U.S. property held at death. Moreover, the U.S. estates of foreign decedents are entitled only to a $2,000 exemption compared with a $60,000 exemption avail- able to U.S. citizen decedents. In addition, foreign decedents are not entitled to the marital deduction available to U.S. citizen decedents. As a consequence, a foreign decedent's estate must pay far heavier estate taxes on its U.S. assets than would the estate of a U.S. citizen owning the same assets. Moreover, `U.S. estate tax rates applied to nonresidents are in most cases considerably higher than those of other countries and therefore foreigners who invest in the United States suffer an estate tax burden. H.R. 13103 would increase the exemption for the U.S. estates of foreign decedents from $2,000 to $30,000 and would tax such estates on the `basis of a 5- to 25-percent rate schedule. With this significant increase in the exemption and sharp reduction in rates, `the effective U.S. estate tax rate on foreign decedents would `be generally compa- rable to the effective rate of tax of `a U.S. citizen who can utilize the $60,000 exemption and the marital deduction. This effective rate would no longer be considerably higher than most other countries, and would be more closely comparable to the rates prevailing elsewhere. Senator WILLIAMS. Would not that formula give foreign decedents a lower rate than U.S. citizen decedents when the reduction in the rates on the larger estates is taken into consideration. Secretary FOWLER. This would be on the higher- Senator `WILLIAMS. Yes; I am speaking of the 5- to 25-percent rate if we change that schedule. That would change it. Secretary FOWLER. Let us take a U.S. gross estate of $500,000. Un- der the proposed law the effective rate on a nonresident alien would be 7.4 percent. In the case of a U.S. citizen with a marital deduction the rate would be 8 percent. In the case of a U.S. citizen without a marital deduction the rate would be 22 percent. 926 PAGENO="0937" ~F1)REItN INVESTORS TAX ACT OF 1966 41 If the gross estate was $1 million, the effective rate of tax on a non- resident alien under the proposed law would be 10.1 percent. For the U.S. citizen with a marital deduction the rate would be 11.1 percent and for the U.S. citizen without a marital deduction the rate would be :26.7 percent. Senator WilLIAMs. As to the person with a gross estate of $5 mil- lion, I notice in the table on page 43 that this bill would cut the estate tax to about 30 percent of the existing rate, and would put it at about half of the rate paid by American citizens. Secretary FOWLER. Without the marital deduction. Senator WILLIi~rs. Yes. Secretary Fowi~a. A fair summary would be they are comparable where there is the marital deduction. The U.S. citizen without the marital deduction would pay a substantially higher rate. Senator WILLIAMs. There is not such a reduction in the smaller estates, but in the larger estates there is practically a 50- to 60-percent reduction under this bill. Secretary FOWLER. Yes; however, moving the exemption from $2,000 up to $30,000 would exempt the smaller estates. Senator WILLIAMS. Of course, there has been a suggestion, and I do not know but there may be an amendment offered here, to raise the exemption in this country from its present $60,000 to $120,000. When was the present $60,000 exemption put into effect? Secretary FowI~ER. I do not recall. Senator WILLIAMS. `There has been quite a change in the value of the dollar since that time. Senator ANDERSON. You would get a lot of support for that amend- :ment. Senator WILLIAMS. What would be the Treasury's position to the changing of that exemption, because I know that is going to be pro- posed to this bill? Secretary FOWLER. Senator, I do not know what it would be at. the moment. We have been engaged in a thoroughgoing study in the whole estate tax area, and we have not as yet arrived at a conclusion. Senator WILLIAMS. This has been mentioned for the last 2 or 3 years. I think you would admit, would you not, if $60,000 was fair when it was first initiated it is far out of date under the existing valuation of the dollar? Secretary FOWLER. I would prefer to say that I think that rather than deal with just one particular aspect of the estate tax, I think the Whole area justifies a thorough reworking. At least that is the con- clusion we have come to after about a year of fairly intensive study. That would be one aspect of it. Senator ANDERSON. That is not an answer to Senator Williams' question. Secretary FOWLER. No, sir. Senator WILLIAMS. I gather it is somewhat like the answer you gave to Senator Talmadge before, you are neither for nor against? Secretary FOWLER. That is right. Senator WILLIAMS. We will settle for that answer, no position. Secretary FOWLER. Well, I would be inclined to say that many other things ought to be taken into account before you act on one aspect of the estate tax. 927 PAGENO="0938" 42 FOREIGN INVESTORS TAX ACT OF 1966 Senator WILLI~~Ms. I think the whole rate structure of the estate tax should be studied carefully. Secretary FOWLER. We think so, too. Senator WILLIAMS. But I am not too sure it would be necessary to wait on that particular point because it is one that can very readily be understood and the merits can be appreciated on their own ir- respective of what we may do with the other phase of it. Secretary FOWLER. It could be quite expensive, and I am always concerned that when we remove some inequity we also try to corn- pensa.te wherever we can by getting back the revenue. That is one aspect of the problem that disturbs me. Senator WILLIAMS. I compliment you on the statement you just made. I only wish you felt the same way when we were cutting taxes. We would have been together then, too. Senator ANDERSON. Mr. Secretary, on the amount that is avail- able, by passing the marital reduction, didn't we substantially in- crease our $60,000? Secretary FOWLER. It is about. $120,000 as a practical matter now. Senator ANDERSON. Yes. Secretary FOWLER. And the marital deduction was adopted, I be- lieve, in 1948. Senator ANDERSON. 1948. Secretary FowI~ER. Since the war; yes, sir. To get back to my statement, the change in the estate tax rates on nonresident aliens should have an important effect on foreigners con- templating investment in U.S. securities. Where the gross U.S. estate would be less than $30,000, there would be no estate tax, and no need to file an estate tax return. In those instances where the estate is larger, the effective rates would be substantially reduced. Thus, the top rate would drop from 77 to 25 percent, and the effective rates would be only 3 percent on a U.S. estate of $100,000 (the present effec- tive rate is 17 percent), 7 percent on a U.S. estate of $500,000 (the present effective rate is 26 percent), 10 percent on a U.S. estate of $1 million (the present effective rate is 29 percent) and 18 percent on a U.S. estate of $5 million (the present effective rate is 43 percent). Expatriate Arn~erica'n citizens.-The provisions of H.R. 13103 which eliminate graduated income tax rates for foreign individuals and sub- stantially reduce the estate tax liability of foreign decedents may create a substantial tax incentive to U.S. citizens who might wish to surrender their citizenship in order to take advantage of these changes in the law. While it is doubtful whether there are many who would be willing to take such a step, still the incentive would be present and might be utilized. In 1936 when the Congress eliminated graduated rates of tax on the U.S. income of former citizens, this action was reversed within 1 year because it was believed that this change had provided an incentive for expatriation to avoid tax. IELR. 13103 deals with this problem by providing that in the future an individual who has surrendered his U.S. citizenship for tax reasons within a preceding 5-year period shall be subject to U.S. taxation with respect to his U.S. income and assets at the rates applicable to U.S. citzens. Such individuals will therefore not receive the benefits of this legislation during such 5-year period but will be taxed substantially as nonresi- dent foreigners are at present. These provisions will not apply unless 928 PAGENO="0939" FOREIGN INVESTORS TAX ACT OF 1966 43 the avoidance of U.S. taxes was one of the principal reasons for his surrender of citizenship. Retaining treaty bargaining position.-By unilaterally making the changes applicable to foreigners provided in I[LR. 13103, the United States could. be placed at a considerable disadvantage in negotiating similar rules in other countries for Americans with income from foreign sources. In order, therefore, to protect the bargaining posi- tion of the United States in international tax treaty negotiations, H.R. 13103 authorizes the President, where he determines such action to be in the public interest, to reapply present law to the residents of any foreign country which he finds has not acted to provide our citzens with substantially the same benefits for investment in that country as those enjoyed by its citizens on their investments in the United States as~ a result of this legislation. If this authority were invoked, it could be limited to those investment situations as to which U.S. citizens were not being given comparable treatment. This provision of the bill is patterned on provisions presently contained in the Inter- nal Revenue Code which attempt to assure U.S. persons appropriate tax treatment by foreign countries, e.g., section 891 which provides for doubling of U.S. rates on foreigners under certain circumstances; sec- tion 901(b) (3) which denies a foreign tax credit to alien residents of the United States unless a similar credit is allowed U.S. persons by their home countries. We believe that the presence of such a provi- SiOll will be a material aid in our securing appropriate provisions respecting these matters in our international tax treaties. In addition to the comments I have made on the existing bill I wish to recommend to the committee two amendments which will furth~r the purpose of this proposed legislation. The first of these would clarify the tax exemption on income from investments held by foreign central banks in securities or other obliga- tions issued or guaranteed by the various agencies of the U.S. Govern- ment. The present language of section 895 of the code which provides for tax exemption on income received by foreign central banks on "obligations of the United States" leaves in doubt the status of some obligations of Federal agencies other than those of the Treasury. Interest in such investments has been shown by various central banks and it is clearly desirable to provide the broadest possible spectrum of investment possibilities in the United States in order to attract and hold foreign dollars which otherwise might be converted into gold. Also from the standpoint of marketing such issues it is in our interest to broaden the market by making them attractive to this type of large investor. The second amendment would expand the authority of the Secretary of the Treasury to issue foreign currency denominated securities in the same range of maturities and interest rates as is authorized for regular dollar issues and in a manner which could benefit our balance of payments. The present legislation permits the sale of such foreign currency denominated issues only in the form of bonds and certificates of indebtedness whereas regular dollar issues may be offered in the form of certificates, bonds, and notes. Offerings in the 1- to 5-year maturity range are in the form of notes. The ability to issue notes in the foreign currency series of securities will make it possible for us to offer an attractive investment in the medium-term range of matu- rities since interest could be paid at rates comparable to that on regular 929 PAGENO="0940" 44 FOREIGN INVESTORS TAX ACT OF 1966 U.S. issues of similar maturity. I, therefore, propose that the word "notes" be added to present language of section 16 of the second Liberty Bond Act of 1917, as amended. The Treasury Department also recommends certain amendments to the bill developed jointly by our staff and the staff of the Joint Com- mittee on Internal Revenue Taxation. These proposals are described in a printed pamphlet entitled "Summary of House Bill and Suggested Technical Amendments," prepared for your use by these staffs, and therefore I will not describe them now. CONCLuSION Our current system of taxing foreign investors in the United States contains elements which are inconsistent with generally accepted inter- national tax policy principles and which, at the same time, act to discourage foreign investment in the United States. H.R. 13103 is designed to reshape our present system in order to make it a more rational and equitable vehicle for taxing foreign individuals and corporations. The legislation is an important element of the President's compre- hensive program for dealing with our balance-of-payments problem. Foreigners will invest in this country as long as our economy remains prosperous and stable. However, it cannot be expected that the level of foreign investment will reach its full potential so long as provisions exist in our tax laws which, while serving no sound tax purpose, dis- courage foreign investors. H.R. 13103 will eliminate or modify these provisions and provide an up-to-date system of taxing foreigners which is in accord with international tax standards. Adoption of H.R. 13103 will lead to a simpler, more rational, and more equitable method of taxing foreigners. It will also be an im- portant step in improving our balance-of-payments deficit and the strengthening of the international position of the dollar. Because this legislation will contribute to these two vital national objectives, I urge you to support it. Members of the committee, I have with me at the table Assistant Secretary Surrey, who has iaJbored long and hard both in preparing the Treasury recommendations and working in executive session with the House Ways and Means Committee and the staff of that commit- tee. This is a technical subject, and I will call upon Secretary Surrey from time `to time to deal with some questions. Assistant Secretary Winthrop Knowlton is here to assist in con- ne~Lion with questions that might involve balance-of-payments infor- mation. Senator ANDERSON. Thank you for your statement, Mr. Secretary. I think I can ask my questions by showing what Saturday's mail brought in on the subject. It is good reading, I might say. Have you seen these documents put out by the New York State Bar Association and various firms? Secretary FOWLER. No, sir, I have not. Perhaps Mr. Surrey is fa- miliar with some of them. Senator ANDERSON. it just seems to me that Mr. Surrey or somebody ought to go through some of these and try to decide whether their arguments are good or bad. I was quite impressed with the argu- ments. 930 PAGENO="0941" FOREIGN INVESTORS TAX ACT OF 1966 45 Mr. SURREY. Senator, our staff is going through those documents with the joint committee staff to see if there are any technical changes we would like to recommend `in addition to those listed in the pamphlet that has already been prepared for the committee. Senator ANDERSON. I thiuk that when somebody goes to the effort of preparing a 100-page pamphlet with what sounds like very good arguments in it, that the Treasury might supply us with a brief answer if `they wished to do so. Senator WILLIAMS. In line with that same question, it seems to me, Mr. Secretary, you are dealing here with a very far-reaching bill, and one which completely revises the present method of taxing foreign investment in `this country. It i's a complete revision, and a substan- tial reduction, for estate taxes, and income taxes as they will be paid by foreigners owning American `investments, and I am wondering if this particular reduction in the estate tax provision, and some of these other reducti'on's, should not be considered in light of what we are going to do in a revised tax proposal for our American citizens, and I- Secretary FOWLER. Senator, I would hope you would not defer ac- tion on this bill. This bill, it seems to me, i~s long overdue. It is one which is designed to deal with the balance-of-payments problem-not in an emergency way, but as one of the pat'hs to a long-term solution of the problem: The task force report was originally made in the spring of 1964. The House committee thoroughly considered the bill all last summer, and comments were invited. There were hearings in June of 1965. This bill has been around a good long time. I would certainly hope that for balance-of-payments reasons, if for no other reason, that you would deal with it fairly promptly. This does not mean that the estate tax problem as it applies to do- mestic persons is not an important one. As I have indicated `to you, we have been working fairly intensively on it over the past year or so. But if we are going to try to review all the provisions of the code that affect domestic taxpayers, and get into that `kind of a reform along with revising the tax on foreigners, we will never get this bill through. Senator WILLIAMS. I am not saying tha't we should postpone it in- definitely, but I think you have given an excellent argument for the position I just suggested, because you said yourself that your task force studied this extensively in 1964, and that the House studied it through- out last year, and the early part of this year. But in the Finance Committee and in the Senate we are being presented with it here in the middle of August, just ahead of what we hope is going to be an adjournment and I am wondering if this committee has the time to really study and understand exactly what is proposed. I was wondering if it would not be better if we worked out an agree- ment tha.t this proposal, perhaps substantially in the form in which it presently is, could be presented to us in the early part of next year when we could give it the study it deserves rather than for us just to rubber stamp the proposal on a lot of suggestions which we are not going to have time to analyze. Secretary FOWLER. Well, I really think that from the standpoint of the `balance of payments, as I indicated earlier in my testimony, the private sector has been very energetic in trying to carry out their 931 PAGENO="0942" 46 FOREIGN INVESTORS TAX ACT OF 1966 part of this task force report. Most of the comment that I get, quite frankly, is, "Why is the Congress holding this up ?" There seems to be no great. disagreement about it. There was no opposition to it in the House. As far as the estate tax matter, the task force report recommended a revision which I am sure the Congress would never come to in dealing with estate taxes of domestic citizens. It recommended that you eliminate U.S. estate taxes on intangible personal property of nonresident alien decedents, and the grounds for it are contained on page 24 of the task force Report, which are simply that the balance-of-payments benefits that would be achieved so far outweighs the questions of whether or not this is in the proper equity relationship to domestic citizens that the members of the task force unanimously felt that it ought to be eliminated. I signed that particular report feeling that way myself. Senator WILLIAMS. When did you sign it? Secretary FOWLER. That was in April 1964. Senator WILLIAMS. That is right. That is 2 years ago, over 2 years ago, and now, this is the first time that I have had anyone from the Treasury Department suggest to me that this was an important meas- ure to be dealt with this year. Secretary FOWLER. It was in the President's message of February of 1965, Senator Williams. I would like to bring your attention to the specific paragraph, because it- Senator WILLIAMS. That is the same message in which he said he was going to balance the budget; I think I remember the message. Secretary Fow~R. No, this was the one of February 10, 1965, which outlined the whole balance-of-payments program. It included the so- called voluntary program on direct investment, and on foreign bank loans. On page 7 of the report the President said: A truly worldwide market for capital among industrialized countries requires a two-way flow of investment in order to stimulate a greater inflow of capital from advanced industrial countries. The Secretary of the Treasury will shortly request legislation generally along the lines recommended by a Presidential task force to remove the deterrents to foreign investment in U.S. securities. This ac- tion will be reinforced and encouraged by the efforts of American business and finance to market U.S. stocks and bonds to foreign investors. This proposal has been a matter of very great responsibility on the part of the financial community, both here and abroad, and it is viewed as a key element in dealing long term with our balance-of-payments problem. Senator WILLIAMS. I do not question that the balance-of-payments problem is serious. In fact, I sometimes wonder if I am not more concerned than the Treasury, because one of my criticisms is that the Treasury does a lot of talking about the problem, but does little in the way of acting on the problem. Now, Treasury recommends this bill as the solution to the balance- of-payments problem, but as always, it seems too little, too late. This is not going to provide the solution to the problem of the balance of payments. Secretary FOWLER. There is not one solution. You have to deal with many facets of it, and this is an important facet. of a long-term treat- ment of the problem. It is one which, in my judgment, is overdue as far as the Congress is concerned, if I may speak quite frankly. The Treas- ury has been pushing this. We have been anxious to get it through. 932 PAGENO="0943" FOREIGN INVESTORS TAX ACT OF 1966 47 We have tried to do what we could to impress this upon the Congress. Obviously it was futile to ask this committee to hear it until the House finally acted. The House finally acted in June, and we have been urg- ing that it be scheduled as soon as possible for hearings before this cormnittee. Senator WILLIAMS. I will withhold further questions at this mo- ment. Senator ANDERSON. May I comment here for just a second once again. One of these documents I received is from Brown Bros. & Harriman, sent to me by a former very fine member of the Senate, Prescott Bush, ~nd I want to read just one part of it: We, therefore, urge that H.R. 13103 be amended by dropping the provisions of the tax on bank deposits; namely, that interest on such deposits will continue to remain exempt from Federal income tax and withholding and that such de- posits continue to remain exempt from Federal and estate taxation. That is the big item they have that is going to be the big fight before the committee before they report a bill out. Can you toll me what your attitude would be on this if the bill was reported out without that provision, would you be for it? Secretary FOWLER. Yes. Answering Senator Talmadge's comments on it, I made note of the fact that this was a decision of the House Ways and Means Committee *and that from the standpoiiit of tax equity the conclusion appears to be a correct one. But the decision also has very serious current balance- of-payments implications, according to the banking community who deal in this particular area.. I would hope, without taking a position one way or another-because I am not in a position to make a judg- ment about this matter-that this committee would pay very careful i~ttention t.o representations such as the one you referred to, and to the testimony which, I think, will be forthcoming from representatives of the banking community as to the impact of this deferred intention to remove the exemption which becomes effective in 1972. Senator ANDERSON. I understand that you do not violently object. Secretary FOWLER. No, sir; I,do not either object- Senator ANDERSON. If it should develop, Mr. Secretary, that we got stuck on these, you would not object. in regard to the rest of this bill? Secretary FOWLER. No, sir. Senator CARLSON. Mr. Secretary, in your statement you mentioned that. the Internal Revenue (1ode now provides for a general exemp- tion in capital gains tax for nonresident foreigners doing business in the United St.ates with two exceptions. These two excep.tions you mentioned are, first, the foreigners' gains are subject to the capital gains tax if he is physically present in the United States when t.he gain is realized and, second, all gains during the year are taxable if he has spent 90 days or more in the United States during that year. This raises a que.stion in my mind. You mentioned in your statement, too, that many invest in mutual funds, they pay capital gains. How does that fit in under this bill? Would they be subject to tax under mutual funds, investments in mutual funds? Secretary FOWLER. A foreigner investing in a mutual fund? Senator CARLSON. Mutual fund. Presently they are not. Mr. SURREY. Under this bill, if he is not present in the United States for 183 days during a taxable year he would not be subject to ta~. 933 PAGENO="0944" 48 FOREIGN INVESTORS TAX ACT OF 19 66 Consequently, a foreigner who lives abroad-one who does not come to the United States at all, which, I think, is the example you had in mind-would not be subject to tax. Senator CARLSON. In other words, a foreigner could continue to in-~ vest in mutual funds and receive capital gains without tax. Mr. SURREY. That is right. Senator WILLIAMS. But if he lived in the United States 183 days,. then he would be taxable under this bill. Mr. SURREY. That is right. Today, if he lived in the United States 90 days he would be subject to tax. Secretary FOWLER. If he were physically present when he sold out he would also be taxable under present law. Senator CARLSON. You have been stressing your interest in our bal- ance of payments, and I think we can all share this with you. But I was interested to read in the last issue of Business Week that- The Internal Revenue Service proposal to clarify tax laws affecting U.S. coni- panies and their foreign affiliates is expected to boost shipments abroad. And, of course, that is to boost exports which would be helpful in the balance of payments. Secretary FOwLER. Yes. Senator CARLSON (reading): The Treasury Department this week moved to clarify the hazy tax picture on transactions between a company and its domestic and foreign subsidiaries. The law, section 482 of this law, permits the Internal Revenue Service to adjust or allocate the incomes of various members of a group of firms under common con- trol in order to reflect accurately the true income of the members to prevent tax avoidance. What can you do, what have you done, under that particular section. of the tax law? Secretary FOWLER. We have announced and issued proposed regu- lations which will be subject to a hearing and comment over the weeks; ahead. The particular regulations that have been published for hearing and consideration are designed to deal with the concern that. many American companies who do business with affiliates abroad have. con- cerning the action of the Internal Revenue Service in levying an addi- tional tax on the domestic company on the ground that too much of `the profit, so to speak, has been passing over to the foreign affiliates. There has been a great deal of concern in the exporting community about section 482 and the proposed regulations are primarily designed. to give clarity to the situation, to avoid any rigid hard-and-fast rules,. and to provide guidelines for `areas which seem to be causing most of the trouble. We have tried in the regulations to stay clearly within the policy of law as the Congress intended, `and yet, at the same time, to interpret the law and apply it in such a way as to clear up the confusion and to en- courage the venturing out into the export field of American concerns and businesses. We will, `of course, hear the comments from those who specialize in those areas, and then, in the light of those coin- ments, the regulations will become effective. I should say also, Senator, that we have studied carefully in `this connection the report of the National Export Expansion Committee which is `a committee established by the Department of Commerce. It has made three very substantial reports on how to encourage ex- 934 PAGENO="0945" FOREIGN INVESTORS TAX ACT OF 1966 49 ports. We have taken the one dealing with this particular area very much into account. Senator CARLSON. Under existing law, then, you are authorized and permited to deal administratively with this particular section of the law? Secretary FOWLER. That is right-to allocate income and deduc- tions between the domestic seller and his foreign affiliate. Senator CARLSON. Then I get back just to one other question and that deals with treaties. Now, when we begin to negotiate treaties between countries, as we are doing and have done, does this section have any effect in this way, in a way that we will either take care of it; in a treaty- Secretary FOWLER. Not until fairly recently. Lately, however, it is my understanding that provisions have been included in our income tax conventions which in essence provides that the treaty countries will get together in an effort to prevent them from both taxing the same income if there is a section 482 type adjustment made which affects related companies. Senator CARLSON. That is all, Mr. Chairman. Senator ANDERSON. Senator Talmadge. Senator TALMADGE. Mr. Secretary, do you know how much money foreigners have on deposit in banks, savings and loan associations, and insurance companies in the United States ? Secretary FOWLER. We have the figure on time deposits, Senator Tal- madge, and that is two and a half billion dollars. Senator TALMADGE. Do you have figures for other type deposits? One of my correspondents said the sum total of the three was $13 billion. Secretary FOWLER. I think that includes all short-term banking liabilities to private foreigners, of which bank time deposits are only apart. Within that larger total the private time deposits are two and a half billion dollars. * Senator TALMADGE. Let us look further into this problem and see how it might affect our balance of payments. Assume that a citizen of South America has had deposits, for ex- ample in the Chase National Bank in certificates of deposit in the amount of $1 million. The interest rate now on this type deposit I think, is ~~/2 percent. Secretary FOWLER. Yes, sir. Senator TALMADGE. The interest on the $1 million over a period of I year would be $55,000,would it not? Secretary FOWLER. That is right. Senator TALMADGE. Now, if this bill passes in its present form it would be subject in 1971 to a 30-percent flat tax rate, would it not? Secretary FOWLER. In 1972, it would be subject to a 30-percent U.S. tax rate. That is correct, sir. Senator TALMADGE. That would be $16,500 he would pay on his certificate of deposit. Assuming a citizen did not want to pay that t.ax, what would prevent him from withdrawing his money in the New York bank and trans~ ferring it th the same bank in Paris, France? Secretary FOWLER. Nothing whatsoever. 7 1-297 0-67-pt. 1-60 935 PAGENO="0946" 50 FOREIGN INVESTORS TAX ACT OF 1966 Senator TALMADGE. In other words, that would mean if he were wise enough and had foresight enough and wanted to avoid this tax he would simply withdraw the $1 million he has on deposit in New York and transfer it to the Paris bank, t.hereby avoiding the tax and getting the same return, would he not? Secretary FOWLER. That is correct, and I think I should add to that that most banks in Europe do accept dollar deposits from foreigners and pay about the same rate as is paid in the Euro dollar market, as it is called. The interest rate over the past. year there has been ranging about a half percent higher than in the United States. Senator TALMADGE. In other words, he would earn $5,000 more and esc.ape the tax. Secretary FOWLER. That is right, and to carry out the mathematics of your questioning, according to our computation the net return on deposits in these countries, if it is equal to the gross interest, rate cur- rently payable would be about 61/2 percent on 3-month Euro dollar deposits compared to a gross yield in the United States of about 5~/2 percent. and a net yield to a foieigner after application of the withhold- ing tax, of about 3.85 percent.. Senator TALMADGE. Doesn't it seem to you logical that. this particu- lar foreigner would choose this course of action and increase his income by escaping the tax? Secretary FOwLER. From my own simple knowledge of the situation I think it does present a case. Senator WILLIAMS. Would the Senator yield at that point? Senator TALMADGE. Yes. Senator WILLIAMS. Assuming that the individual did that. and de- posited it in France, would he be subject to a tax in France, and would he have the same privileges of withdrawal and convertibility as he would have in this country or would he lose some of those. advantages? Secretary FOWLER. Insofar as the tax goes, Senator Williams, my earlier comments indicated that in France, Germany, and the Nether- lands, he would not be subject to a tax in the source country. Inso- far as convertibility goes, that is a much more complicated question. I do not want to hazard a comment on that., although my impression is that there is fairly free movement insofar as bank deposits are con- cerned. Senator TALMADGE. Assuming, Mr. Secretary, that he made that transfer from the New York bank to the Paris branch of the same bank, would not that $1 million certificate of deposit be a factor in the further drain of otir gold supply? Secretary FOWLER. That is one of the. consequences. There is a pos- sibility of a gold impact from shifted dollar deposits. Senator TALMADGE. Mr. Secretary, I listened to your testimony very carefully, and I think the main thrust of this bill would accomplish desirable ends, t.o increase investment in this country, and curtail our dollar drain. However, it seems to me that this particular provision of the bill which we have been discussing is calculated to do just exactly the opposite. Bank deposits are highly mobile in character. People are going to look for the highest possible short-range return, and if they can get a better return elsewhere and escape the tax, it is unquestionable that most foreigners would immediately transfer their deposits elsewhere to avoid the tax and get the higher return. 936 PAGENO="0947" FOREIGN INVESTORS TAX ACT OF 1966 51 This probability is fraught with very grave danger, and so far as our dollar deficit is concerned, I would hope the Treasury would look into that aspect of it very carefully and be prepared to recommend to this committee, one way or another, what we ought to do about it. *Secretary FOWLER. Well, I think, Senator, it is a question of weigh- ino~ the balance-of-payments consideration with the tax equity con- si~eration-two very valid considerations. The House Ways and Means Committee gave a preeminence to considerations of tax equity as between domestic citizens and the other- Senator TALMADGE. I would agree with that aspect of it completely. Certainly I would hate to see the United States of America grant preferential treatment to foreigners that is not given its own citizens. But the fact remains we have jurisdiction over American citizens and we do not over foreigners. Secretary FOWLER. That is the observation I was going to make. The foreigner has an option-he can leave his money here or he can take it someplace else. Senator TALMADGE. An American does not. Secretary FOWLER. The American has a much lesser option, shall we say and, therefore, looking at it from a balance-of-payments stand- point, I think one views this provision with a considerable amount of concern. Senator TALMADGE. Then you would have the further inequity that results from some American banks having foreign branches and some not. Secretary FOWLER. That is another aspect of the problem. Senator TALMADGE. So the American bank with foreign branches might not lose any deposits. It would merely shift from the Ameri- can branch to the foreign branch. The foreigner would get increased income on his deposit, and escape the tax at the same time. But if the American bank had no foreign branches it would lose the deposit, which would also further complicate the dollar deficit crisis. Secretary FOWLER. I think that is true. And I would imagine that one of the considerations that led the House to defer the effective date of this provision until 1972 was so that banks without foreign branches that were interested in this business could arrange to open foreign branches. Senator TALMADGE. Thank you, Mr. Secretary. Senator ANDERSON. Senator Dirksen. Senator DIRKSEN. Mr. Secretary, I have one question. All the rep- resentations and all the mail I have received concern section (2) (c) (1) on page 12. The words are "effectively connected." They point out that foreign corporations doing business in this country but, at the same time, out of their home office in their own country they do an investment business, but they permit their New York office to collect a return, interest and principal, on foreign loan repayments and so forth. They are uneasy about what the interpretation of the pro- posed "effectively connected" is going to be. I have had mail from Asia, Europe, and any number of people in this country, and I swear that all the letters deal with just that item. I understand tITlat it is on page 12 of the bill. Secretary FOWLER. Yes, Senator Dirksen, this has been a phrase that has given rise to some concern. I am going to ask Secretary Sur- rey if he would deal with it. My understanding is that in the legis- 937 PAGENO="0948" 52 FOREIGN INVESTORS TAX ACT OF 1966 lative history of the House bill an attempt has been made, in discussing this particular provision, to deal with many of the fears that might otherwise arise. Whether that has been effectively and adequately done in the legislative history, I do not know. I would defer to Mr. Surrey about that. But I would also think that in that connection the Senate report might well direct itself to an interpretation or a mean- ing of this phrase that would allay some of the concern that ought really not be there. Mr. SURREY. Yes. I think the Secretary's statement indicates the situation. In the case you gave where the foreign investor is doing business in the United States and is also investing in the United States, we were trying to achieve a device which would not subject his investment income to the higher rates of business tax except in those cases where that investment income was, as the bill says, tied in or effectively connected with his business. It is a phrase which we are now using in our treaties with the West- ern European countries in conformity with the model draft which the OEOD has written. We are extending it in this bill to all of the coun- tries without waiting for treaties on this particular point. Now, it is a new phrase in our tax language, and, consequently, there will be doubts at the borderline until some more experience is gained. If we could look at the particular problems that have been addressed to you, Senator, we could see whether there could be language put in the Senate committee report to further clarify this phrase. We would be glad to help in that regard, although we had thought that the House report had removed most of the difficulties. As I say, it is a rule which is now evolving in our treaties, as well as in European treaties, when those countries are dealing with each other. Senator DIRKSEN. Would it be advisable to expand the definition in the statute itself so that they would be fully on notice without hav- ing to depend on any Treasury regulations? Mr. SURREY. If the language could be found, Senator. It is like the situation today where, for example, we use the phrase "engaged in trade or business in the United States." It is rather hard to expand upon language of that nature. It takes time to gain experience with the borderline cases. The phrase "effectively connected" is defined to some extent in the statute on page 13, so that there are some guides there. We would not be adverse to improving the language in the bill or to adding language in the committee report if it would give people more guidance. Senator DIRKSEN. That is all. Senator AImER50N. Senator Curtis. Senator CURTIS. Mr. Secretary; is the provision inserted by the House with respect to bank deposits the only portion of H.R. 13103 which increases the tax burden? Secretary FOWLER. No. There are some other provisions, Senator Curtis. For example, one has to do with insurance. I think foreign insurance companies have enjoyed a considerable competitive advan- tage over U.S. insurance companies under present law and the bill at- tempts to equalize the competitive position of foreign insurance com- panies, primarily Canadian companies, with U.S. insurance companies. That results in some increased revenue. 938 PAGENO="0949" FOREIGN INVESTORS TAX ACT OF 1966 53 Senator CURTIS. Are there any others of significance? Mr. SURREY. There is one other situation where a foreign corpora- tion is engaged in business activities in the United States but because of our technical source rules the income is technically not within the present taxing jurisdiction of the United States. In three or four limited cases the United States under this bill will assert tax in these situations. It is impossible to estimate the revenue gain from that, but there will be some revenue gain. Senator CURTIS. What will be the revenue gain from the House provisions in reference to bank deposits? Secretary FOWLER. $300,000 is the only estimate currently. That has to do with the estate tax that now excludes bank deposits, but would, after the law is passed, include bank deposits. That is not an estimate of what would be the effect of the law in 1972 when the inter- est on bank deposits would become taxable. On page 7 of the House report the elements of gain are calculated: $300,000 from the estate tax on excluded bank deposits; $3 million from `taxation of foreign life insurance company income from non- trustee investments in the United States; and $1,593,000 from savings on interest costs to the U.S. Government resulting from the quarterly payment of withheld taxes. That last provision changes the rules on when taxes withheld from foreign persons are to be returned to the Treasury by the person collecting the tax. It accelerates that process. Senator CURTIS. Is that a one-time gain or reoccurring? Secretary FOWLER. Sir? Senator CURTIS. Is that a one-time gain? Secretary FOWLER. The interest costs each year are an annual gain. The one-shot benefit is about $22 million. Senator CURTIS. So the gain on the table on page 7 of $4,893,000, is the continuing gain. Secretary FOWLER. That is the continuing gain. Senator CURTIS. I guess that is all, Mr. Chairman. Senator ~WILLIAMS. I had one question. I passed before because the staff was working up a hypothetical case. But the question deals with this point, that under existing law a foreigner who has investments in this country is taxed pretty much at American individual tax rates, is he not? Secretary FOWLER. Yes; I think that is a fair statement, subject to treaty arrangements. Senator WILLIA~tS. That is right. A question has `been raised as to whether or not, if this bill is passed in the form in which it is presented, we would be inviting the extremely wealthy individual in this country who wished to escape some of his income taxes and inheritance taxes to give up his American citizen- ship, go `down to Nassau, spend 6 months of the year there, and return to the United States. Suppose such an individual had $100 million in investments in this country-and some of them do-with an annual income of $5 million from those investments. Instead of paying in- come tax at American rates, after he `had lived abroad 5 years, `he would be able to pay income tax at the lower rate under this bill. If he lived abroad for 10 years, his estate tax would be about one-tenth of what it i's under existing law. I have asked the staff to provide a hypotheti- cal case and to determine just how much difference it would mean on the annual tax rate, and on the estate tax for some individual. 939 PAGENO="0950" 54 FOREIGN INVESTORS TAX ACT OF 1966 Have you given any consideration to that point? Secretary FOWLER. Yes. Senator WILLIAMS. Now, there is a similar problem when an- in- dividual gives up his residence in one State and goe.s to another State to take advantage of a better tax climate. That is not so serious as an inducement for an American citizen to go abroad and to take ad- vantage of a provision that in effect creates a special tax haven in the United States for foreign investment. Would that be possible, t~ what extent, and have you given it any consideration? Secretary FOWLER. Yes, Senator Williams; we worried about this. considerably. As a. matter of fact, I think we, in executive sessions and in discussion of it, asked that the House committee provide 10 years in both cases. It is a matter of judgment as to what the appropriate period of years would be to be sufficient to meet this problem. The House committee came out with a recommendation that 5 years in the case of income tax, and 10 years in the case of the estate tax, would be the appropriate period. I have no particular quarrel with that judgment. I think the situation is as you presented it, and if this committee saw fit to make that period of time a longer period in order to deal with the problem, we certainly would not object. Senator WILLIAMS. For the moment, we will skip the. time element. As I understand the existing law it has no such loophole in it, but the adoption of this particular provision, in effect, creates a loophole where- by you are handing out an incentive for the wealthy of this country to give up their American citizenship and yet have the same protection of all their investments in this country without having to contribute toward the defense in the form of taxes. Do you think that is a wise policy for us to adopt for the first time here in America? Secretary FOWLER. Under present law you still have this particular problem, because now a person can give up his citizenship, renounce it, and rid himself, so to speak, of his responsibilities under present law. Senator WILLIAMS. Well, now, can he, assuming this same hypotheti- cal casc- Secretary FOWLER. Perhaps you will give me this hypothetical case. Senator WILLIAMS. This individual keeps his investments in this country and gives up his American citizenship under existing law, and say he complies with all the rules of living out of t.his country the specified time but when he dies, t.hat individual will be taxed. If he had a gross estate of $10 million, he would be taxed at 53.3 percent, whereas under this bill he would be taxed at 20 percent or have his taxes reduced by around 60 percent. Now, there is a difference here. I mean under existing law he would pay the higher tax, would he not? Secretary FOWLER. I would like to have Mr. Surrey answer that. Mr. SURREY. It is a question of degree, Senator. If he is so de- termined as to give up his American citizenship t.o save taxes, then he can go on and be sufficiently resourceful ~n all probability as to make it very difficult for us to effectively collect those taxes, because foreign- ers today can, through the formation of corporations, in large part escape our estate tax, and also, in large part, escape our progressive rates of tax above 30 percent. So if he is sufficiently resourceful today he can do it. 940 PAGENO="0951" FOREIGN INVESTORS TAX ACT OF 1966 55 This bill makes it harder for him to do it for 10 years in the case of an estate tax. It is harder for him to do it under this bill than it would be under present law in the estate tax cases. As I indicated, Senator, a foreigner today can escape our estate tax through a corpora- tion. Now if an American wants to become an expatriate, and wants to really give up his citizenship to avoid our tax, he can do it through a corporation. Under this bill it will be harder because for a period of 10 years we look through a corporation to the assets underlying the corporation in the case of expatriates. So in that sense it will be harder for him, rather than easier, under this bill for a 10-year period. Senator WILLIAMS. I agree with that, but I am speaking about the bill, that part of the bill which would make it easier. Now the staff has just furnished me the figures on this hypothetical case of an individual who has an estate of $100 million, entirely with investments here in this country. Now, according to the staff, under existing law this individual, even if he renounced his citizenship and died but with investments in this country, would pay an estate tax, with deductions of 10 percent and a ~2,000 exemption, $67.7 million. Under this bill that estate tax would be reduced to $22.3 million. Secretary FOWLER. If he had a good tax lawyer, Senator, he would form the foreign corporation that Mr. Surrey refers to, do it under present law, and be in better shape than he would be under this law. Senator WILLIAMS. But we are plugging that loophole as you just said. Mr. SURREY. For a 10-year period. Secretary FOWLER. For a 10-year period, right. Senator WILLIAMS. As we plug that loophole, w~iy open up another one, because, according to the staff, this same citizen-and we are assuming that this $100 million investment here produces an income of $5 million-would be taxed at $3.1 million annually. After 5 years, by giving up his U.S. citizenship, he could reduce his tax to $1.5 million. He could cut it in half under this bill. Is it wise to close one loophole and open another one at the same time? I form no opinion on it. I am just raising this question because it has been raised and the staff has just confirmed that we are, in effect, opening the possibility for wealthy individuals, and they are the only ones who change their residences from State to State, to give up their residence, live in Nassau, down in the islands, travel around the world for half the year, come back to this country half the time, and by so doing reduce their estate tax liability by approximately 70 percent and reduce their income tax liability by about half. I question the advisability of that at this time. Mr. SURREY. Senator, the difficulty is that that person would sub- ject himself to a 30-percent rate of withholding tax; It has been very difficult for us, in practice, to enforce our progres- sive rates of tax beyond that on foreigners. Wealthy foreigners who want to invest in the United States and want to avoid their obliga- tions to the United States have found ways through nominees, and through corporations and the like, to effectively reduce their U.S. income tax to 30 percent. It is doubtful if we can do better than that. So consequently today this person would likely find himself as a practical matter paying an effective 30-percent U.S. tax rate. This 941 PAGENO="0952" 56 FOREIGN INVESTORS TAX ACT OF 1966 bifi is likely for a period of 5 years to make us much more energetic and carefal with respect to the expatriate because he is the fellow we are looking for in particular, and on whom we would concentrate. As Secretary Fowler said, we suggested the period be 10 years in the House. All I am saying is that it is a conscious policy in this bill to do all that can be done within reasonable limits to reach the expatriate, but it is very difficult to go beyond a certain point. If people want to give up their citizenship, and in many cases wait for 5 or 10 years after that before they really receive a commensurate benefit, they are free to make that choice. I do not think there will be many who would want to do that. Senator WILLIAMS. I do not question that, and I agree fully, as I understand it, that the bill would provide that greater control for the 5-year period, but why open it after a 5-year period? That is the point that disturbs me. Secretary Fowi~m~. I think that- Senator WILLIAMS. Why dangle a carrot for them to use later. Secretary FOWLER. The whole purpose of the bill is to make it at- tractive for foreigners to invest in the United States. Now if you are going to achieve that particular objective, and if it is a desirable one, you have this incidental problem of the expatriate to deal with. We have tried to deal with it in the manner described because we think the advantage of the bill in terms of the authentic foreign investor far outweighs the disadvantage that might accrue by the fact that sporad- ically an American might renounce his citizenship in order to achieve some tax advantage. However, we have gone further than that and not just left it on that particular balance, but by these 10-year and 5-year provisions- 10-year for the estate tax and 5-year for the income tax-tried to weight the scales against that judgment. Now, if it is the judgment of this committee that these yearly periods do not put sufficient weight on the scale. I think the Trea- sury's instincts would be to extend the number of years. That was our position in the House. Senator WILLIAMS. That is the point. What years did you suggest or do you suggest? Secretary FOWLER. Ten and ten. Senator WrLLIAMS. Ten and ten. Secretary FOWLER. In the House, yes. Senator WILLIAMS. What about 10 and 20? Do you think you should leave any financial attraction at all to an American citizen to give up his citizenship? Secretary FOWLER. I certainly have no desire to propose that there be some limit. If the committee feels that the 10- and 5-year periods selected by the House are not adequate, I would not object and would go along with it if the committee wished to extend the period. Senator WILLIAMS. As I understand it, you recognize this could be a potential loophole and you would have no objections to it being tight- ened or closed if this committee saw fit. Secretary FOWLER. No, sir. Senator WILLIAMS. I appreciate that. Senator ANDERSON. Senator Curtis. Senator CURTIS. I have one question. 942 PAGENO="0953" FOREIGN INVESTORS TAX ACT OF 1966 57 Coming back to the increased revenue by taxing interest on deposits in U.S. banks, let us assume that the interest paid on deposits to for- eigners in the year 1962 remains at the present rate, at the present level, and that the tax rates remain the same. What would be the increase in revenue in 1972? Secretary FOWLER. About $22.5 million. That is if all the deposits remained here-I had better give you my assumptions-if all the deposits remained here and the rate of interest was 4 percent, the tax on such interest would total about $22.5 million. Senator Cuicris. Did I understand Senator Carlson to say that the return paid on mutual funds falls under this same provision of the bill? That is not regarded as interest, is it? Mr. SURREY. No, sir. Senator CURTIS. That is treated as an equity investment. Mr. SuRiu~Y. Yes. Secretary Fown~R. Thank you. Senator CURTIS. Thank you, Mr. Secretary. Senator ANDERSON. Mr. Chapman, I regret you waited so long, but we had a long examination of the Secretary. We have some import- ant bills on the floor. You go right ahead. STATEMLNT OP ALGER B. CHAPMAN, VICE PRESIDENT, ~EW YORK STOCK EXCHANGE; ACCOMPANIED BY STANLEY WEST, RE- SEARCH DIRECTOR Mr. CHAPMAN. Thank you, Senator Anderson. My name is Alger B. Chapman. I am a vice president of the New York Stock Ex- change. With me today is Stan West, research director of the exchange. I want to thank the committee for affording the exchange this op- portunity to appear on behalf of its membership in support of the pro-. posed Foreign Investors Tax Act of 1966. Unfortunately, when the committee's announcement of the hearings was received last week, Mr. Funston, president of the exchange, was on board ship between California and Hawaii, and his plans were such that it was impossible for him to be here today. He has asked me to make his personal apologies to the committee because if it had been possible, he would have wanted to deliver his statement in person. As a member of the Presidential task force on promoting foreign investment and increased foreign financing, Mr. Funston feels v~ry strongly that this bill should be enacted. But he also urges adoption of the amendments suggested in his statement, so that foreign invest- ment will be further encouraged in the United States with a resultmg beneficial effect on our balance of payments. I have filed for the committee's information, and ask that it be in- cluded in the record, copies of Mr. Funston's statement, and accord- ingly I do not plan to read it to the committee. However, I would like to take just a few minutes to summarize the various points it contains. First, the bill with the modifications we suggest can be a decisive factor in increasing the flow of foreign funds to this country. If U.S. taxation of foreign investors is eased, other inhibiting factors are alle- viated, and our private selling efforts are reinforced, the savings flow- ing here for investments from other countries should increase sub- stantially the benefits to our balance of payments.. 943 PAGENO="0954" ~58 FOREIGN INVESTORS TAX ACT OF 1966 A number of provisions in the bill remove barriers to increased foreign investments, and we urge that they be adopted. They are elimination of the requirement that foreigners file a tax return for income above $21,200; elimination of the risks that a foreigner may be treated as doing business in the United States if he gives power of at- tornev to a U.S. resident; application of capital gains taxation to a foreigner only if he is present in the United States for 183 days or more per year; and, finally, reduction of the estate t~x rates on foraigners. The comn dttee should be ale rted to the risk that some of the restric- tive provisions of the bill could lead to large withdrawals of foreign funds from U.S. banks, thus hurting our balance-of-payments position. The committee should also be aware that a number of provisions in the bill may act as a deterrent to foreign investment in the United States, rather than providing a stimulus which is intended to help our balance of payments. Certain changes would avoid these dangers. In the estate tax, the simplest and most effective step would be to eliminate the estate tax on foreigners completely. This would provide a much greater stimulus for foreign investment in the United States than a rate reduction, and it would help our balance of payments be- cause many people feel that elimination of an estate tax would open up the vaults of Europe, and would .produce a dramatic inflow of funds into the United States. Second, if estates continue to be taxed, retain the situs rule on bonds. Under the present law, bonds issued by U.S. persons are only subject to the estate tax if located in the United States. Under FLR. 13103, all debt obligations of a U.S. person, U.S. Government, or State or local governments and owned by foreigners, will be subject to the estate tax no matter where their physical location. Under the administration's voluntary program to reduce capital out- flow, American companies are being urged to finance their oversea in- vestments through local borrowing. During 1965 and in the first quarter of 1966, some $600 million of such borrowings were financed through bond issues outside of this country. The proposed changes in the situs rule would jeopardize this program by making foreign in- vestors reluctant to purchase these bonds, as well as others issued in the United States, if they will be subject to U.S. estate taxation. Third, exclude from property consuleration taxable customers' cash balances at brokerage houses awaiting investment or reinvestment. These balances are similar to deposits in banks and savings and loan associations and-for estate tax purposes-they should be treated in the same way. Fourth, exempt permanently bank deposits of foreigners. In the area of the income tax, delete the provisions of the bill which, after 1971, would impose income tax on deposits of foreigners not doing business in the United States. Fifth, reduce and consider discontinuing the withholding tax levied on interest and dividends paid to foreigners. As a minimum step, the committee should urge the administration to press for mutual re- ductions with other countries in the percentage~ withheld through treaty arrangements. Sixth, eliminate the tax imposed on foreign pension trusts and simi - lar institutional investors, such as charitable organizations, and at 944 PAGENO="0955" FOREIGN INVESTORS TAX ACT OF 1966 59 the very least urge the administration to ease the procedures involved in qualifying these organizations for tax exemption. The difficulty in qualifying for tax exemption, even though it is afforded under the tax laws, is such that many foreign institutions refrain from invest- ment in U.S. securities. Permit foreign bank branches in this country to treat income from investment portfolios of U.S. securities as effectively connected with the trade or business in the United States, so that they can continue to take the deductions they are permitted under current law. Failure to do this could lead to a substantial liquidation of their holdings of U.S. securities. The theme of Mr. Funston's statement is quite basic. The bill before the committee eliminates a number of tax deterrents to foreign invest- ment in the United States. However, at the same time, it creates some new deterrents. In order to obtain the maximum impact on our bal- ance-of-payments position, we recommend that the new deterrents to foreign investments should be eliminated from the bill and the addi- tional incentives we propose be incorporated in the bill. Thank you very much. If there are any questions, Mr. West and I will try to answer them. Senator ANDERSON. In the statement of Mr. Funston, he refers again to this "effectively connected." Mr. CHAPMAN. Yes. Senator ANDERSON. You heard some discussion of it. Did that satisfy you? Mr. CHAPMAN. Yes. Senator ANDERSON. You think we ought to get a definition so every- body could understand it. Senator Curtis? Senator CuRTIS. I think not. In light of the hour, I will refrain from questioning. Senator ANDERSON. Thank you very much, Mr. Chapman. It is a good statement and we will include Mr. Funston's statement in the record. Mr. CHAPMAN. Thank you very much. (Mr. Funston's statement referred to above follows:) STATEMENT OF G. KEITH FUNSTON, PRESIDENT, NEW YORK STOCK EXOHANGE, ON H.R. 13103 SUMMARY The New York Stock Exchange vigorously supports the basic philosophy of H.R. 13103-"The Foreign Investors Tax Act of 1966"-to increase incentives for foreigners to invest in the United States. The bill, with the modifications we suggest, can be a decisive factor in increasing the flow of foreign funds to this country. If U.S. taxation of foreigninvestors is eased, other inhibiting factors are alleviated, and our private selling efforts are reinforced, the savings flowing here for investment from other countries should increase substantially-to the benefit of our balance of payments. The bill, as originally introduced, embodied many of the recommendations of the Presidential Task Force (headed by now Secretary of the Treasury Fowler) on Promoting Foreign Investment and Increased Foreign Financing. One of the stated objectives of the Task Force was "to help establish conditions under which restraining influences on capital flows between the industrially advanced nations * * * can be removed, diminished or allowed to expire." The problem of these capital flows is forcefully demonstrated by what happened during the last two years. In 1964 and 1965, partly because of the 945 PAGENO="0956" 60 FOREIGN INVESTORS TAX ACT OF 1966 indirect effects of the Interest Equalization Tax, foreigners were net sellers of $635 million of U.S. corporate stocks and bonds. Even before imposition of the Interest Equalization Tax, however, the outflow of U.S. funds for invest- ment in foreign securities almost invariably exceeded the inflow of foreign funds for investment in U.S. securities. There is clearly a need, therefore, to take steps which will attract more foreign investment to the U.S. In general, II.R. 13103 simplifies the present complicated and sometimes unen- forceable tax law governing foreign individuals and corporations. This is accomplished in the bill by changing the existing law to: (1) Relieve foreigners of the need to file a return for income above $21,200. (2) Eliminate the risk that a foreigner may be treated as doing business in the United States by giving a power of attorney to a United States resident. (3) Exempt a foreigner from capital gains taxation unless he is present in the United States for at least 183 days. Although the Exchange applauds the bill in principle, we are impelled to point out serious reservations about a number of provisions which conflict with the bill's over-all objective-aiding our balance of payments position and stimulating foreign investment in the United States. The Oommittee should be alerted to the risks that some of the restrictive provisions of the bill could lead to large withdrawals of foreign funds from United States banks in favor of either of foreign branches of such United States banks or foreign banks. This could mean an outflow of dollars unfavorable to our balance of payments position. The Exchange, therefore, suggests the following deletions, amendments and additions to H.R. 13103: (1) Eliminate the estate tax on nonresident aliens completely, rather than providing only a rate reduction. (2) If estates continue to be taxed, retain the situs rule on bonds. (3) Exclude brokerage customers' cash balances awaiting investment or reinvestment from property considered taxable for estate tax purposes. (4) Permanently exempt from the estate tax bank deposits of foreigners and also delete the provision which would make interest on deposits of for- eigners not doing business in the U.S. subject to income tax after 1971. (5) Discontinue or reduce the withholding tax levied on interest and dividends paid to foreigners. As a minimum step, press for mutual reduc- tions with other countries in the percentage withheld through treaty arrange- ments. (6) Eliminate or ease taxes imposed on foreign pension trusts and similar institutional investors. (7) Permit foreign bank branches in this country to treat income from investment portfolios of U.S. securities as "effectively connected" with a trade or business in the U.S. The Exchange specifically endorses the language in Section 2 of the `bill referring to "Trading in Securities and Commodities," as revised from the orig- inal Administration proposals. The revised language of H.R. 13103 clarifies the intent of the legislation and eliminates any risk of misinterpretation. OBJECTIVES OF PENDING BILL H.R. 13103, "The Foreign Investors Tax Act of 1966," accepts the basic philosophy and recommendations of the Presidential Task Force on the Balance of Payments, of which I was a member. The Task Force recommendations were originally embodied in H.R.. 5916, submitted by the Administration to the Congress for consideration in 1965. In its statement on HR. 5916, the Exchange noted that: "Adoption of this legislation would do much to stimulate the long-term flow of foreign capital to the U.S., in part by removing archaic restrictions on the flows. The securities industry has long advocated removal of such restrictions. The Exchange applauds the fact that the proposed legislation will enhance the freedom of movement in the international flow of capital funds." The legislation, appropriately cast, should aid our balance of payments prob- lem. A~s the late President Kennedy observed in his last balance of payments message to the Congress, "Securities of U.S. private firms could be and should be one of our best selling exports." This proposed legislation, by removing some bothersome and complex restraints, should make the sale of American securities to foreign investors considerably easier. 946 PAGENO="0957" FOREIGN INVESTORS TAX ACT OF 1966 61 While the Exchange supports the basic philosophy of the bill, and the bill in- cludes a number of desirable features, we do have serious reservations about several provisions which are not consistent with the bill's over-all objective- aiding our balance of payments and stimulating foreign investment in the United States. The Committee should be aware of the possibility that some of the bill's restrictive provisions could lead to large withdrawals of foreign funds from United States banks in favor either of foreign branches of such United States banks or foreign banks. This could mean an outflow of dollars unfavorable to our balance of payments position. Therefore, if these provisions are not modified, the legislation might well produce unfavorable, rather than favorable, reactions in the financial markets of the world and on our balance of payments. SUGGESTED REVISIONS Although the unfavorable impact of the changes effected between the original bill (H.R. 5916) and its second version (H.R. 11297) has been softened in the current version, the legislation's basic purpose of stimulating foreign investment in the U.S. may well be blunted if further changes are not made. The legislation as written can be materially strengthened in several ways, as discussed below, and moved closer to its objective, as outlined by the Balance of Payments Task Force, of removing existing deterrents to foreign investment. In addition, the effectiveness of a program to encourage foreign investmer~t in U.S. securities may be enhanced by adoption of several measures not included in the tax bill. Consequen.tly, the Exchange suggests the following adjustments and additions: I. ELIMINATION OF ESTATE TAX ON NONRESIDENT ALIENS Under present law, the esta;tes of nonresident aliens are taxed at rates ranging from 3% to 77%, with a specific exemption of $2,000. Section 8 of the bill, by raising the specific exemption and lowering tax rates, reduces the estate tax rates to between 0% and 40% of present levels, thereby taxing nonresident aliens at about the same rates as U.S. citizens who claim a marital deduction. We feel the bill should go further and completely eliminate estate taxes on nonresident aliens. This would provide a much greater stimulus to foreign investment in the U.S. than a rate reduction, and be a much greater help to our balance of payments. Many feel elimination of estate taxes would open up the vault~ of Europe and produce a dramatic inflow of funds to the U.S. The reasons are twofold: First, many foreigners are discouraged from investing here by the existing requirement that they file estate tax returns. This deterrent would be removed if the tax were eliminated. Second, since even the proposed lower tax rates are higher than those now levied in many other countries, investment by residents of those countries would continue to be discouraged. The rates proposed in the bill are higher than the ones originally suggested by the Administration, and stop far short of the Task Force recommendation to "eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents." Though the proposed rates would be below those levied on resi- dent estates in the United Kingdom, Canada and Italy, they would be higher than those imposed in Switzerland, Germany, France and The Netherlands. Thus, the legislation favors the residents of some countries while discriminating against those of others. Elimination of the estate tax on nonresident aliens would lead to a very small revenue loss. The tax has produced revenues of $4 to $5 million annually in recent years, and would probably yield no more than $2 million under the pro- posed legislation. An additional revenue loss of $2 million would be a small price to pay for the removal of a major deterrent to foreign investment in the U.S. The benefits of the change to our balance of payments would be ample compensation for the revenue loss. II. RETENTION OF "SITUS RULE" ON BONDS Under the present law, bonds issued by United States persons are subject to the estate tax only if such bonds are located in the United States. Under H.R. 13103 all debt obligations (including bonds) of a United States person, the United States, state governments or any political subdivision of a state are deemed to be property within the United States independent of their physical location, and as such, are subject to the estate tax. 947 PAGENO="0958" 62 FOREIGN INVESTORS TAX ACT OF 1966 The stimulus given to foreign investment in the U.S. by the reductions in the estate tax rates could in part be negated by this change in the situs rule. The result of a change in the rule would be decidedly adverse to the U.S. balance of payments~. Therefore, the Exchange urges that the situs rule regarding bonds not be changed. Under President Johnson's voluntary program to reduce capital outflows, American companies are being urged to finance their overseas investment through local borrowing. About $600 million worth of bonds were floated abroad in 1965 and the first quarter of 1966 in response to the President's appeal. The proposed change in the situs rule could jeopardize this program by imped- ing the efforts of American firms to finance their overseas expansion in foreign capital markets. Foreign investors would clearly become reluctant to purchase bonds of American companies if this exposed `them to United States estate taxation. Moreover, it would be extremely difficult administratively to enforce this change in the law. Since bonds are generally issued in bearer form, we know of no practical way of identifying their owners for tax collection purposes. III. EXCLUSION OF CUSTOMER'S CASH BALANCES FROM ESTATE TAXATION Under present law, foreign customers' cash balances with brokers are subject to U.S. estate taxation. The Exchange suggests that, if foreigners remain sub- ject to the estate tax, Section 2105 of the Internal Revenue Code should be amended so that all funds awaiting investment not be considered property within the U.S. for estate tax purposes. This should `apply not only to deposits in banks and savings and loan associations, as discussed below, but also to the "counter- part" to such deposits in the securities industry-customers' cash balances held by brokers awaiting investment or reinvestment. IV. REVISED TREATMENT OF BANK DEPOSITS OF FOREIGNERS Under the present law, interest received by foreigners from funds on deposit in the U.S. with persons engaged in the banking business or with some state- chartered savings and loan associations is considered as non-U.S. income and is currently exempt from United States taxes. Similarly, the principal amount held for foreigners by all banking institutions is exempt from United States estate taxes. H.R. 13103 changes these provisions and makes such interest tax- able, whether or not the foreigner is engaged in business here, and also subjects the principal to the estate tax. But, in recognition of the current balance of payments problem, the bill defers the taxation of such interest until after De- cember 31, 1971. This recognition of the balance of payments problem, however, is not carried forward in the estate tax provision. Even though the interest collected is not subject to income tax until after 1971, the deposit itself becomes subject to estate tax on the effective date of H.R. 13103. Both of these changes would surely lead to a sizable outflow of foreign capital. Knowledgeable bank officials have estimated that several billion dollars of bank deposits would be potentially subject to either the estate tax or to annual taxa- tion of interest income if the proposed legislation becomes law. It seems rea- sonable to assume that a large part of these deposits would then be withdrawn over time from banks within the U.S. There is every reason to assume that these deposits would not be shifted to foreign branches of U.S. banks. Even if they were, the transfer would represent a capital outflow in the balance of payments. Consequently, the Exchange strongly urges that `the proposed legislation be revised to omit those sections which change the treatment of bank deposits of foreigners. An impediment to the free flow of internati'onal capital funds would thereby be avoided, and our balance of payments position remain unaffected. V. DISCONTINUATION OF WITHHOLDING TAXES ON INTEREST AND DIVIDEND PAYMENTS Present law requires the withholding of income tax on dividend and interest payments to foreigners. This acts as `a deterrent to foreign investment in U.S. securities. To remove this obstacle and help improve the balance of payments, the Exchange recommends that the pending `bill be amended to eliminate these withholdings taxes. If the potential revenue loss makes repeal undesirable, the U.S. should press through treaty arrangements for mutual reduction in the withholding tax with 948 PAGENO="0959" FOREIGN INVESTORS TAX ACT OF 1966 63 as many foreign countries as possible. Since transactions in outstanding securi- ties have generally produced an inflow of funds to the U.S., mutual reductions in the withholding rate could be expected to stimulate foreign purchases of U.S. securities to a greater extent than they would U.S. purchases of foreign securi- ties-even when the adverse effect of the Interest Equalization Tax is taken into account. VI. ELIMINATION OR EASING OF TAXES ON FOREIGN PENSION TRUSTS U.S. income taxes imposed on foreign pension trusts and ~similar investors should be eased. Domestic pension funds enjoy a tax exemption on their invest- ment income. Foreign pension funds, even though qualified for an exemption, can obtain it only by going through the difficult procedure of obtaining approval from numerous agencies of the U.S. government. As a result, these investors are discouraged from investing here, especially if they are exempt from taxes in their country of domicile. Pension funds in some foreign countries have grown dramatically in recent years. For example, the Joint Economic Committee study of European capital markets showed that pension funds in Great Britain have been one of the fastest growing institutions in that country's financial structure, and had investments of $10 billion at the end of 1962.1 Further growth is fully expected. It seems reasonable to assume that a considerable capital flow into the U.S. might be stimulated if foreign pension funds were accorded a tax treatment similar to that enjoyed by domestic funds. Further, the Treasury in its regulations can provide any safeguards necessary to prevent abuse of this legislation. Consequently, taxes on the income of foreign pension funds and similar institu- tional investors should be eliminated by law. As a minimum step, the U.S. should work with other countries toward the mutual elimination of taxes on these types of investors. VII. TREATMENT OF FOREIGN BRANCH BANKS' PORTFOLIO INCOME AS "EFFECTIVELY CONNECTPED" The present law generally taxes nonresident aliens and foreign corporations at the regular individual or corporate rates on all their U.S. source income, if they are engaged in trade or business in this country. If not so engaged, they are taxed at a flat 30% rate or tower treaty rate on all fixed or determinable income. The bill would generally subject the income of a nonresident alien or foreign cor- portation to the fiat 30% or lower treaty rate, if the income is not effectively con- nected with the conduct of a trade or business in the United States. Some foreign banks with branches in the United States may suffer adverse effects under the different tax treatment proposed for income "effectively con-. nected" and that "not effectively connected" with the conduct of a "trade or business" under Sections 881 and 882. The income from their investment port- folios of U.S. securities is usual and necessary to an ordinary commercial banking operation. If it is treated as "not effectively connected," the tax will be on the gross income without the allowance of any deductions properly allocable to such income. Such a tax on gross income could have a confiscatory effect upon the portfolio income of foreign banks, since there are generally significant deduc- tions which would otherwise be attributable to such income. The Exchange believes that foreign banks with branches in the U.S. should have the election of treating the income from their investment portfolios of U.S. securities as "effectively connected" with a trade or business, so that they can have the benefit of deductions which are allocable to such income. Unless an amendment of this type is included, treating such income as "not effectively con- nected" with the conduct of a trade or business would have a substantial adverse effect on the willingness of such foreign banks to have their U.S. branches hold domestic securities. CONCLUSION As noted in the Report of the House Ways & MeansCommittee, "H.R. 13103 is designed to provide more equitable tax treatment for foreign investment in the U.S." The purpose of the legislation, as initially introduced, was to "stimulate foreign investment in the United States by modifying existing tax rules which 1 U.S. Congress, Joint Economic Committee, A. Description and Analysis of Certain Euro- pean Capital Markets, 1964, page 238. 949 PAGENO="0960" 64 FOREIGN INVESTORS TAX ACT OF 19 66 are not consistent with sound tax policy and act as barriers to such investment." The Exchange, in endorsing the spirit of the bill, believes that our suggested changes, amendments, and additions would greatly enhance the effectiveness of the legislation. Through the adoption of these suggestions, the Congress would be better able to achieve the original objective of aiding our balance of payments position ~y removing pres~t deterrents and in addition providing positive in- centives for foreign investors. Senator ANDERSON. Robert Norris. STATEMENT OP ROBERT M. NORRIS, PRESIDENT, THE NATIONAL POREIGN TRADE COUNCIL, INC.; ACCOMPANIED BY CHARLES It. CARROLL, COUNSEL TO THE BOARD OP DIRECTORS Mr. Noiu~is. Senator, my name is Robert M. Norris, president, Na- tional Foreign Trade Council, and I am accompanied by Oharles R. Carroll, counsel to the board of directors. The National Foreign Trade Council appreciates your invitation to present its views on H.R. 13103 at these hearings. The National Foreign Trade Council has been engaged for 53 years in the promotion and protection of American foreign trade and invest- ment and therefore in recent years has been vitally concerned with the need to remedy the recurring deficits in the balance of payments of the United States. Consequently, the recommendations of the Fowler task force were welcomed as a step to end the im'balance by attracting foreign investment in U.S. securities. Implementing these recom- mendations could be an important factor in eliminating the deficit in our payments position and a significant move toward achieving the ultimate objective of greater freedom of international movement of capital. The council and its highly diversified membership considered the introduction last year of H.R. 5916 to implement the tax part of the Fowler Committee recommendations to be a most important forward step. The council favored the provisions of H.R. 5916 for encourage- ment of foreign investment in the United States and recommended its enactment with certain modifications. However, the introduction of H.R. 11297 and H.R. 13103, in turn, as substitutes for H.R. 5916 has presented matters of grave concern to the council. H.R. 13103, as now pending, has changed the original provisions of H.R. 5916 with regard to income and estate taxes on foreign corporations and nonresi- dent aliens, and is less favorable in this respect than the original bill- H.R. 5916. Furthermore, there `has been embodied in H.R. 13103 an~ objective which is in direct conflict with the purposes of the Fowler report; that is, a general revision and broadening of U.S. taxation of nonresident aliens and foreign corporations which would be treated as "effectively connected" with an office in the United States. The council believes that the adoption of this new taxing system would be unwise and in- equitable; that rather than raise additional revenue it would lead foreign corporations to reduce their investment and employment in the United States; that it would come into conflict with the prevailing pattern of taxation of international business by the principal trad- ing nations of the world; and that it would produce serious prob- lems of double taxation. Moreover, in our estimation, the enactment of these provisions would adversely affect the U.S. balance of pay- 950 PAGENO="0961" FOREIGN INVESTORS TAX ACT OF 1966 65 ents not oniy from reduction in business investment but also from he foreseeable liquidation of foreign holdings of American short- erm obligations and the liquidation of bank deposits of foreigners. he council has grave concern over the inclusion in the bill of these )rovisions which represent a radical departure from the objective )f the original bill, and which the council considers would defeat the very purposes of the Fowler committee's recommendations. The council, through its tax committee, has given thorough con-. ;ideration to H.R. 13103 and has prepared a detailed statement based ipon the results of their deliberations. Copies of this statement have een filed with your committee. It is requested that it be made a part )f the record of these hearings and that full consideration be given ;o the views of the council, particularly because of the importance of ;his legislation as it may affect the international balance-of-payments osition of the United States. Senator ANDERSON. Is this the document? Mr. NORRIS. Yes. Senator ANDERSON., It will be placed in the record. Mr. NORRIS. In summary, then, Senator, the council's principal reservations with respect to this legislation are: (1) Concern about the possible adverse effect of this legislation on international trade and commerce through the introduction of the "effectively connected" concept relating to taxation of foreign enterprises; and (2) The adverse effect to which I have alluded-and the filed statement more fully covers the subject-that certain portions of this legislation would have on the balance-of-payments position of the United States. I would merely like to conclude by saying that there have been in- troduced two `additional amendments in the Secretary's statement this morning, and also the report of the joint staff, and we would like the `opportunity, obviously, to examine these, and to have the oppor- tunity to present our views if they are indicated at the future time. Senator ANDERSON. We certainly will, Mr. Norris. . You take those with you, and if you have comments, send them to the committee as soon as possible because I understand we will be working on this bill within~the next week or 10 days. Mr. NORRIS. Thank you. Senator ANDERSON. Thank you. I am sorry the other members of the committee have gone, but I appreciate your coming very much. Mr. NomuS. Thank you. (The pamphlet referred to above follows:) 7 1-297 0-67-pt. 1-61 951 PAGENO="0962" PAGENO="0963" FOREIGN INVESTORS TAX ACT OF 1966 67 STATEMENT Of The NATIONAL FOREIGN TRADE COUNCIL, INC. With Respect To H.R. 13103 FOREIGN INVESTORS TAX ACT OF 1966 Presented to the Committee on Finance of the United States Senate August 8, 1966 NATIONAL FOREIGN TRADE COUNCIL, INC. 10 Rockefeller Plaza, New York, N. Y. 10020 953 PAGENO="0964" 68 FOREIGN INVESTORS TAX ACT OF 1966 SUMMARY A. Effectively Connected Concept. 1. Foreign Source Income. - The purposes stated by the Report of the Ways and Means Committee for taxing specified rents and royalties, specified dividends, interest, and gains, and certain income from sales of goods made through a U.S. office, if "effectively connected" with the conduct of a trade or business in the U.S., are to prevent the use of the U.S. as a "tax haven" with respect to certain types of transactions and to impose tax on "income generated from U.S. business activities." 2. "Tax Haven" Purpose. - This purpose appears to be specious in that (1) the scope of the bill goes beyond "tax haven" situations; (2) any abuses which exist could more appropriately be corrected by other countries; and (3) legislation by the U.S. would only drive the activities affected to countries which impose no taxes. 3. Purpose of Taxing "Income Generated from U.S. Business Activi-. ties". - The bill would change the U.S. method of taxing the income of foreign corporations from one which meshes well into the established international system which has been developed in the income tax laws of the principal trading nations into one which would conflict with that system and create unwarranted double taxation. Income tax laws of most countries do not seek to tax income from sources outside their borders merely because of incidental and ancillary activities within their borders. It still is in the self-interest of the U.S. to adhere to this generally recog- nized principle. Taxation based on the "effectively connected" concept would tend to discourage purchasing within the country and would prompt the removal of offices which now furnish investment and employ- ment in the country. The bill applies the "effectively connected" concept in a one-sided manner, and does not recognize the right of other countries to apply a similar rule, in that it does not permit U.S.-source income of foreign corporations to be exempt to the extent that foreign offices and activities help to generate the income and does not even modify the limitations on U.S. foreign tax credits so as to allow credit for foreign taxes imposed on U.S.-source income "effectively connected" with foreign business activ- ities. 4. Conflict with U.S. Tax Treaties. - The bill would come into con- flict with most, if not all, of the existing tax treaties to which the U.S. is a party. Some treaties prohibit the taxation of foreign source income as attributable to a U.S. office; two of the recently proposed treaties expressly embody our existing source rules. Others limit such taxation to cases where the office qualifies as a permanent establishment and then limit the amount 954 PAGENO="0965" FOREIGN INVESTORS TAX ACT OF 1966 69 of income which can be taxed to that which the activities would have earned if carried on by an independent corporation. The bill does not conform to these rules. 5. Effect on Controlled Foreign Corporations. - Congress in 1962 reviewed the "tax haven" possibilities of U.S.-controlled foreign corpo- rations and enacted subpart F of the Code, prescribing the types of income of such corporations which should be taxed immediately and deferring taxation of other classes of income until remitted to the share- holders. The bill would impose immediate U.S. tax on income as to which the policy of subpart F was to continue deferment. It is believed that consistency with the policy of subpart F should be maintained by making the new provisions inapplicable to income of controlled foreign corpora- tions which were excluded from subpart F. 6. Income of Banking and Similar Corporations. - The bill exempts dividends and interest from foreign sources, received by a foreign corpora- tion from corporations in which it has a 50% stock interest. It is suggested that a 10% stock ownership requirement would be more appropriate. 7. Sales to Foreign Customers. - The bill would not tax income from sales for use, consumption, or disposition outside of the U.S., even though the income would otherwise be "effectively connected" with a U.S. office, "if an office or other place of business of the taxpayer outside the U.S. participated materially in such sale." The Council is concerned that this language will not be construed to give proper recognition to foreign activ- ities other than selling-for example, manufacture,. extraction, or produc- tion of goods and purchasing and related activities. 8. Sales to Foreign Customers of U.S. Exports. - It is not believed that the U.S. should seek to tax any income of foreign corporations from sales outside the U.S. to foreign customers of goods purchased in the U.S., nor to tax more than the profit attributable to manufacture or production on such foreign sales of goods manufactured or produced here. Such taxation would run counter to our national policy of encouraging exports. 9. Sales to U.S. Customers. - In the case of foreign source income from sales to U.S. customers, it should be made clear that the income deemed to be "effectively connected" with a U.S. office will not exceed that which would be allocable to that office if its activities had been car- ried on by a separate subsidiary of the foreign corporation. 10. Foreign Sales with No Foreign Office. - Where a foreign corpo- ration has substantial foreign economic activities outside the U.S. but no office outside the U.S., the foreign source income deemed to be "effectively connected" with its U.S. office should be limited as suggested in para- graph 9 above. 11. Credit for Foreign Income Taxes. - Foreign corporations would suffer serious double taxation with respect to income "effectively con- 955 PAGENO="0966" 70. FOREIGN INVESTORS TAX ACT OF l96~ nected" with a U.S. office, because of failure of the bill to allow a credit against the U.S. tax for all foreign taxes imposed on the "effectively con- nected" income. Such credit should be given regardless of whether the taxing country is the country of source, the country of domicile, or both. 12. Rental and Royalty Income. - The bill appears to go much further in attributing rental or royalty income to U.S. offices than it does in the case of sales income, since it does not seem to give recognition to the activities of foreign offices in negotiating and making leases or licenses. It also seems unrealistic to regard royalties paid for the use of a valuable right as being generated entirely by the making of the contract. It is the making of the invention or its use in manufacturing which should be con- sidered to generate the income. 13. Section 245. - Under the bill, 15% of any dividends paid by a foreign corporation, out of its "effectively connected" foreign source in- come, to a U.S. corporate shareholder, would be subject to U.S. tax if 50% or more of the foreign corporation's gross income was "effectively connected" with its U.S. trade or business. However, no foreign tax credits would be allowed to reduce the U.S. income tax on such dividends. It is not believed that the bill should introduce double taxation in this situ- ation. B. Balance of Payments Considerations. 1. U.S. Estate Tax. - The bill gives some reduction in estate tax rates on estates of nonresident aliens, but does not give as great a reduc- tion as was proposed in H.R. 5916, the original bill introduced to imple- ment the Fowler Report. By including certain classes of intangible property which is excluded from the taxable estate under present law, the bill would have an adverse effect on foreign investment in the U.S. 2. Interest on U.S. Bank Deposits. - The bill proposes to terminate, effective at the end of 1971, the long-standing exemption of interest on bank deposits paid to nonresident aliens and foreign corporations, even though the recipient is not engaged in trade or business in the U.S. It is believed that this change will not actually produce additional revenue but that it will rather cause withdrawal of such deposits from the U.S., with a substantial adverse effect on our balance of payments. 3. Short-Term Promissory Notes. - Proposed section 881(a) (3) would tax foreign corporations not engaged in trade or business in the U.S. on amounts of original issue discount which are treated as ordinary income received on retirement or sale or exchange of bonds or other evi- dences of indebtedness issued after September 28, 1965 if held for more than six months. To subject such discount to U.S. income tax will cause foreign corporations not engaged in trade or business in the U.S. to cease to furnish a market for commercial paper, especially since it is feared by 956 PAGENO="0967" FOREIGN INVESTORS TAX ACT OF 1966 71 some that the new provision may be construed to apply whether or not.such commercial paper is held for more than six months. The annual market for short-term (9 months and under) commercial paper sold in the U.S. to nonresidents is estimated to be in excess of $1 billion. The loss of this market would have a severe adverse effect on ourbalance of payments. 4. Section 904(f). - The bill would make the special limitation on foreign tax credits with respect to interest income inapplicable to interest income received by an "overseas operations funding subsidiary" on obliga- tions of a "related foreign corporation." The Council supports the general purpose of this amendment, although it believes the exception in exist- ing 904(f) (2) (C) should be construed to apply where a U.S. parent uses a domestic affiliate to finance the operations of a foreign affiliate owned by such domestic parent to the extent of at least 10%, whether such ownership is direct or indirect. The proposed definition of the terms "overseas operations funding subsidiary". and "related foreign corporation" contained in the bill are unduly restrictive, and should be liberalized. The Council urges that section 904 (f) (2) (C) be clarified so as to exclude interest received from a corporation in which the recipient (or another member of the same affiliated group, as defined in section 1504) owns directly or indirectly 10% or more of the total combined voting power of all classes of stock. The present law also contains an exception of interest on obligations acquired on disposition of stock or obligations of a corporation in which the taxpayer owns at least 10%. This should be extended to obligations acquired as a result of disposition of stock of a wholly-owned subsidiary of such a 10% owned corporation. 957 PAGENO="0968" 72 FOREIGN INVESTORS TAX ACT OF 19 66 CONTENTS Page INTRODUCrION . 1 EFFECTIVELY CONNECTED CONCEPT . 2 Foreign Source Income 2 "Tax Haven" Purpose 2 Purpose of Taxing "Income Generated from U.S. Business Activities" 4 Conflict with US. Tax Treaties 6 Effect on Controlled Foreign Corporations 7 Income of Banking and Similar Corporations 7 Sales to Foreign Customers 8 U.S. Export Sales 10 Sales to U.S. Customers 10 Equitable Considerations 12 Objective of Ways and Means Committee 12 U.S. Tax Treaty Commitments 13 Foreign Sales With No Foreign Office 13 Credit for Foreign Income Taxes 14 Rental and Royalty Income 16 Section 245 17 BALANCE OF PAYMENTS CONSIDERATIONS 19 U.S. Estate Tax 19 Interest on U.S. Bank Deposits 19 Short-Term Promissory Notes 21 Section 904 (f) 22 Interest Received in Connection with Certain Dispositions 26 APPENDIX A 27 958 PAGENO="0969" FOREIGN INVESTORS TAX ACT OF 1966 73 INTRODUCTION In October of 1963 the President appointed a Task Force on "Promot- ing Increased Foreign Investment in U.S. Corporate Securities and In- creased Foreign Financing for U.S. Corporations Operating Abroad" (Fowler Conimittee) to stimulate investments in the United States by foreigners. The increased inflow of investment funds from abroad would have an immediately favorable effect on reducing the pressure on the U.S. balance of payments. For this reason the Council welcomed H.R. 5916 which was proposed by the Treasury Department to carry out several of the Fowler Committee recommendations. However, as stated in its Report on H.R. 13103, the House Committee on Ways and Means has modified considerably the objectives of the earlier bill. On Page 6 the Report states: "While . . . the initial bill proposed by the Treasury De- partment was designed primarily to stimulate investments by foreigners in the United States, your Committee considered more generally the tax provisions of present law affecting nonresident aliens and foreign corpo- rations." For equity reasons and because of the potential adverse effect on our balance of payments position the Council is deeply concerned over a number of provisions in the bill as presently drafted. These provisions include those relating to: 1) the taxation of foreign source income of foreign corporations under the "effectively connected" concept; 2) the inclusion of the U.S. bank deposits and U.S. debt obligations in the taxable estate of a nonresident alien; 3) the taxation of interest on bank deposits received after 1971 by non- resident aliens and foreign corporations even though not "effectively con- nected" with the conduct of a trade or business in the U.S.; 4) the taxation of certain evidences of indebtedness described in pro- posed sections 871 (a) (i) and 881 (a) (3); 5) the overly restrictive application of the provisions relating to the treatment of interest received by an "overseas operations funding sub- sidiary." * There follows a detailed presentation of these five areas of concern. 1 959 PAGENO="0970" 74 FOREIGN INVESTORS TAX ACT OF 1966 EFFECTIVELY CONNECTED CONCEPT Foreign Source Income H.R. 13103 as passed by the House of Representatives would amend the Internal Revenue Code to broaden the present rules for U.S. taxation of foreign corporations to include not only income from sources within the United States but also certain types of foreign source income "ef- fectively connected" with the conduct of a trade or business in the United States. These are: (i) Rents and royalties derived from the active conduct of a licensing business; (ii) Dividends, interest, or gain from stock or bond or debt obligations derived in the active conduct of a banking, financing, or similar business; and (iii) Certain income from sales of goods made through a U.S. office. The purpose of this feature of the bill is described in the Ways and Means Committee's Report primarily as prevention of the use of the United States as a "tax haven" with respect to certain types of transactions which might escape tax in other countries if certain activities are carried on in the United States. The Report states further (at P. 15) that "it is believed that foreign corporations should pay a U.S. tax on the income generated from U.S. business activities." "Tax Haven" Purpose The National Foreign Trade Council believes that the "tax haven" aspect of these purposes is specious in that: (a) any abuses which exist could more appropriately be corrected by other countries; (b) the scope of the bill goes beyond "tax haven" situations; and (c) legislation by the United States would only drive the activities affected to countries which impose no taxes. The Report of the Ways and Means Committee describes the "tax haven" purpose as relating to cases in which international sales, licensing and financial activities can be carried on with an office in the United States without payment of income taxes to any country because (1) the foreign corporation is organized in a country which does not tax its corporations on income derived from the conduct of business outside the country; (2) the income may not be taxed where the goods are sold because the corpora- tion does not have a permanent establishment there; and (3) the United States will not tax the income because under United States rules the in- come is not derived from sources within the United States. The Report 2 960 PAGENO="0971" FOREIGN INVESTORS TAX ACT OF 1966 75 does not state how widely this triple combination of circumstances has been found to exist. The Council does not believe that the elimination of the alleged abuses is properly a matter for legislative action by the United States. The ex- amples cited in the House Committee report could more appropriately be corrected by changes in the tax laws of other countries. Thus, the country of incorporation could adopt the long-standing U.S. practice of taxing locally-organized corporations on their world-wide income. Alterna- tively, the country in which the sale is made could logically impose a tax on the transaction. Finally, the country where the controlling share- holders reside could impose tax under provisions similar to subpart F en- acted as a part of the U.S. Revenue Act of 1962. However, the failure of these countries to act does not furnish a sound reason for the United States to reach out and tax income more properly within the jurisdiction of other countries. The fallacy of the "tax haven" purpose of the bill is indicated by the fact that its application would not be limited to cases in which income is escaping taxation by other countries. In fact, the question of whether some other country taxes the income would be given no effect in determining whether the new U.S. tax would apply. The only cases in which income of the three specified types, treated as "attributable" to a United States office, would not be taxed under the bill are those in which goods are sold for use outside of the United States and there is also a foreign office participating materially in the sale. However, no exceptions whatever are recognized with respect to "effectively con- nected" income from licensing operations, dividends and interest, or in- come from sales of goods for use in the United States. It is probable that in most cases the foreign source income which the bill subjects to United States tax will be taxed by the country of source of the income or the country of incorporation. The bill not only applies in these non-tax haven situations; it would not even give a foreign tax credit for a tax imposed by the country of incorporation unless it was also the source of the income and then not in all such cases.1 Even when credit is given for a tax imposed by the ccuntry of source of the income, the bill may still have the effect of imposing a residual U.S. tax on foreign source income in a non-tax haven situation. Even if the bill is enacted, the "tax haven" purpose will not be ac- complished, since the U.S. offices whose activities will be considered to generate United States taxable income can be removed to genuine "tax haven" countries which would impose no income taxes. Thus the bill would accomplish neither elimination of international tax avoidance nor an 1 Because of ill-chosen phraseology, the proposed statute may fail to allow a credit where the country imposing the foreign income tax is both the country of "source" and the country of domicile, unless a similar tax would have been imposed by that country if the corporation had been domiciled in another country. 3 961 PAGENO="0972" 76 FOREIGN INVESTORS TAX ACT OF 1966 increase,~the United States revenues. It would simply cause the United States economy and balance of payments to lose the benefit of the em ployment and expenditures of United States offices of foreign corporations. It is therefore apparent that, although H.R. 13103 uses the same "tax haven" label as a subpart F, its real thrust is in the opposite direction, i.e., to discourage foreign corporations from conducting activities within the United States rather than to discourage U.S. taxpayers from conducting activities in foreign countries. The foreign corporations that would be affected by HR. 13103 are not used to siphon off capital or employment from the United States. On the contrary, the use by such corporations of a U.S. office tends to augment both capital and employment in the United States. Purpose of Taxing "Income Generated from U.S~ Business Activities" On first impression it seems difficult to disagree with the statement that there should be a U.S. tax on the "income generated from U.S. business activities" conducted through an office located within the United States. However, on analysis, it will be seen that the real issue is as to what income is "generated" from U.S. activities. The bill as drafted would change the United States method of taxation of the income of foreign corporations from one which meshes well into the established international system which has been developed in the income tax laws of the principal trading nations into one which would conflict with that system and create unwarranted double taxation. It would detract from the degree of international harmony which now exists as to rules of source of income and provisions for foreign tax credits. Under existing tax systems, including the U.S. system, income of the types affected by the bill is generally treated as entirely taxable by a single country which is regarded as the source of the income. A country other than the country of source does not seek to tax a portion of the income simply because that portion might be regarded as "generated" by activities within its borders. General recognition of this principle is necessary to avert the double taxation that results from conflict between the laws of different countries. The income tax laws of most countries apply to income attributable to local manufacture and production of commodities. Income from selling is usually attributed by existing tax systems entirely to a single country, i.e., the place of title passage or the place of contract. Income from licen sing intangibles is generally considered to have its source in the country where the right is exercised or, under recent treaties, the domicile of the owner. Similarly, dividend or interest income is generally attributed to the situs of the payor or the source of the payor's income, except for some treaties which attribute it to the domicile of the owner of the shares of stock or the debt claim. 4 962 PAGENO="0973" FOREIGN INVESTORS TAX ACT OF 1966 77 There are many reasons why governments shoUld abstain from basing income taxes on incidental and ancillary activities occurring within their borders. For example, this policy prevents the taxation of a portion of income derived from foreign selling of goods which are purchased in the country, even though, from the "activity" point of view, the purchasing side of the business may be more substantial than the selling side of the business in terms of assets, personnel and skills devoted to it. Most govern- ments understand that it would not be in their own interest to attempt to levy income taxes which would burden the purchase of their products. As to local offices in charge of other ancillary activities such as warehousing, transportation, and technical assistance to suppliers in the country, and even offices for solicitation and negotiation of sales, governments gener- ally understand that such offices could readily be removed, if threatened with the burden of a tax on the income from sales. This is also true as to local offices engaged in the licensing of patents and other intangibles. It is still in the self-interest of the United States to adhere to the gen- erally recognized principle of not trying to derive revenue from offices and activities which are likely to be driven away rather than to pay tax. In addition, in the case of income from the licensing of such intangibles, the bill is particularly unrealistic in attributing the income to the activity of negotiating and concluding license contracts rather than to the owner- ship of the intangible or its actual use in operations, Substantial double taxation would also result from the imposition of the proposed tax by the United States on foreign source income "effec- tively connected" with a U.S. office. The situation would be chaotic if other countries also adopted a similar rule, unless entirely new apportion- ment formulas were consistently applied by all countries. It seems unlikely that international tax consistency could be ic-established until after years of international negotiations, if ever. As a geneEally accepted international rule, an "activities" test could work satisfactorily only,7~substitute for existing source rules. In the case of the United States, the bill does not propose such substitution. It uses the "activities" test to impose U.S. tax on income which is not now taxable under the existing source rules, but it does not permit the "activities" test to excuse from U.S. tax any U.S.-source income "effectively connected" with a foreign office. Moreover, the bill would thus tax a foreign corporation on U.S. source income generated by foreign business activities without, in most cases, giving a credit against the U.S. tax for the foreign tax on such U.S. source income. The bill also ignores the corollary of its stated purpose, i.e., that a foreign country would then be entitled to tax a U.S. domestic corporation on its U.S. source income "effectively connected" with an office located within the foreign country. The bill ignores this situation since it fails to 5 963 PAGENO="0974" 78 FOREIGN INVESTORS TAX ACT OF 1966 modify the existing limitations under section 904 which would normally disallow any U.S. credit for foreign taxes levied on U.S. source income. To summarize, the bill treats its new "activities" test as taking prece- dence over the existing source rules when the activities occur within the United States but not when the activities occur within a foreign country. This inconsistency is compounded by the bill's adherence, in determining the limitation on U.S. credits for foreign taxes, to existing source rules instead of using its new "activities" test to attribute income to a foreign country. The Council therefore submits that, if the purpose of the bill is to set a precedent for a reform of tax laws throughout the world, the bill should at least apply its new "activities" test in an even-handed manner, which might work if other countries were to follow this new concept, rather than on a one-sided basis which could only produce numerous cases of double taxation if other countries followed the lead of the United States. If the activities test as contained in the bill is not valid as a precedent far for other countries, the United States is not justified in adopting it. Conflict with U.S. Tax Treaties The United States has concluded numerous tax treaties which prohibit the taxation, as attributable to a United States office, of income from sources outside the United States. (Significantly, two of the most recently proposed treaties-with Israel and Thailand-specifically set forth our existing source rules for this purpose). It is true that other U.S. tax treaties do not expressly prohibit U.S. taxation of foreign source income attributable to an office in the United States, if that office qualifies as a "permanent establishment". But even those treaties expressly limit the amount of income which could be so attributed to the amount which the particular activities would earn if carried on by an independent corporation with no other activities. The bill, in contrast, would apply in many cases where there was no such permanent establishment and is ambiguous as to whether the amount of income which would be attributed to the U.S. office of the foreign corpo.. ration is limited to only the amount fairly allocable to the U.S. activities. The bill thus would come in conflict with most, if not all, of the exist- ing tax treaties to which the United. States is a party. While the proposed section 894 makes the bill inoperative to that extent, it nevertheless seems fair to question the need either (1) to renegotiate these numerous treaties or (2) to discriminate against foreign corporations belonging to the many non-treaty countries of the world, which include most of the "less devel- oped countries." These unfortunate alternatives would seem to be justi- fied. only by some inherently desirable and necessary policy. We submit that no such policy is furnished either: (1) by the idea that the United States is entitled to move into any vacuum created by supposed 6 964 PAGENO="0975" FOREIGN INVESTORS TAX ACT OF 1966 79 loopholes in foreign tax laws, or (2) by the idea that all income should be fragmented into as many pieces as there are countries in which some "activities" are performed. Much less does it seem a tenable position that the United States alone is entitled to apply these ideas, the uni- versal application of which could only result in years of conflict between the tax systems of the nations of the world. Effect on Confrolled Foreign Corporations The new provisions of H.R. 13103 would be particularly objection- able in their application to foreign corporations controlled by U.S. persons. In enacting the Revenue Act of 1962, the Congress conducted an extensive review of the "tax haven" possibilities of such controlled foreign corporations. Subpart F of the 1962 Act reflects the decision of Congress to tax certain types of income immediately and to allow the taxation of certain other classes of income to be deferred until such income is re- mitted to the shareholders. It would appear that the exclusion of all income of controlled foreign corporations would be appropriate since Congress has carefully prescribed just what income of such controlled foreign corporations should be currently taxed. It should also be noted that various classes of income are excluded from immediate taxation under subpart F, including: 1) Dividends, interest and gains realized by a corporation engaged in a banking, financing or similar business: 2) Dividends, interest and gains from qualified investments in less developed countries:~ 3) Income which would otherwise be subpart F income but which constitutes less than 30% of the foreign corporation's gross income: 4) Income of a foreign corporation not availed of to reduce taxes: 5) Royalty income derived in the active conduct of a trade or busi- ness which is received from unrelated persons. H.R. 13103 would in some cases impose an immediate U.S. tax on the above classes of income and thus appears inconsistent with the policies excluding those classes of income under subpart F. The Council believes that consistency with those policies would require a similar exemption of such classes of income from tax under H.R. 13103. The exclusion of such classes of income of controlled foreign corpora- tions from coverage under the bill would not be a discrimination in favor of U.S. controlled corporations because such exclusion would only miti- gate the existing discrimination against U.S. controlled foreign corpo- rations created by subpart F. Income of Banking and Similar Corporations The provisions of H.R. 13103 for taxing dividends and interest received 7 965 PAGENO="0976" 80 FOREIGN INVESTORS TAX ACT OF 1966 by foreign corporations engaged in banking, financing or similar business would exempt dividends and interest received by such corporations from corporations in which they have a stock ownership of more than 50%. A 10% ownership requirement would be consistent with the stock owner- ship requirement for qualified investments in less developed countries and with the realities of present-day foreign investment. Many countries do not permit 50% foreign ownership, and such a high percentage of foreign ownership would tend to discourage participation by local investors in necessary industries. It is noted that the bill does not define what is meant by "banking, financing, or similar business." Presumably this provision is intended to be correlated with the provision in section 954 (c) (3) (B). Sales to Foreign Customers If the foreign corporation maintains an office in the United States and a second office outside the United States, the proposed statute would exempt from U.S. tax the entire profit from the sale of goods arranged through the U.S. office "if the property is sold for use, consumption or disposition outside the United States and an office or other place of busi- ness of the taxpayer outside the United States participated materially in such sale." The Report of the Ways and Means Committee indicates (at P. 16) that the purpose of the phrase "participated materially in such sale" is to assure that "foreign source sales income will be attributed to the U.S. trade or business only when the U.S. office is the primary place of the activity giving rise to the income." The Council is concerned that the proposed statute will not be inter- preted to effectuate this purpose. This concern stems primarily from the ambiguity of the word "sale" as it is used in the phrase "office or other fixed place of business of the taxpayer outside the United States partici- pated materially in such sale." One possible interpretation is that the term "sale" refers solely to sell- ing activities. Under this interpretation, a foreign office or other place of business would be considered to have "participated materially in such sale" only if its activities were selling activities as contrasted with the performance of other economic activities essential to earn the ultimate profit, such as the manufacture, extraction, or production of the goods or their procurement by purchasing activities. The practical effect of this restrictive interpretation can be illustrated by the case of a Philippine corporation engaged in the business of pur- chasing hand-embroidered household linens, blouses, etc., for export to overseas customers. The Philippine corporation maintains its principal office in Manila, where a staff of employees places orders with numerous small Philippine factories to which the corporation furnishes technical 8 966 PAGENO="0977" FOREIGN INVESTORS TAX ACT OF 1966 81 and stylistic advice as well as working capital. The Philippine corporation takes title to the goods at the factory and arranges for temporary ware- housing, insurance, transportation to the dock, and all of the formalities required for exportation. Sales to customers in Canada as well as the United States are negotiated by a single employee working from a sales office maintained by the Philippine corporation in Seattle, Washington. Title to the merchandise normally passes to the customer at the time of shipment from Manila, so that none of the resultant profit is from a "source" within the United States. Under these facts, the Philippine corporation is clearly subject to what- ever income taxes the Philippine Government may see fit to impose. (Moreover, Philippine tax would also be imposed if the above described business were conducted by a Philippine branch of a Panamanian corpo- ration.) Thus, this case cannot properly be considered to involve the type of "tax avoidance" at which H.R. 13103 is said to be aimed. The Council therefore submits that the office in Manila should be con- siderëd as having "participated materially in [the] sale" of the goods sold through the Seattle office, so that the tax imposed by H.R. 13103 would not apply to profits from those sales made to Canadian customers.2 This interpretation of "sale" would be essential to carry out the stated objective of the Ways and Means Committee that "foreign source sales income will be attributed to the U.S. trade or business only when the U.S. office is the primary place of the activity giving rise to the income." In support of this position, it should be pointed out that, under the House version of H.R. 13103, it is clea~r that, where a foreign office of a foreign corporation participates materially in the selling activities, no U.S. tax would then be imposed on any profits from sales to foreign cus- tomers negotiated through its U.S. office.3 If selling activities by a foreign 2 This hypothetical example also serves to highlight the fact that H.R. 13103 could not impose U.S. tax on foreign source income of a Philippine corporation without renegotiation of the Income Tax Convention with the Philippines. Article 3(1) of that Convention (as submitted to the Senate on July 29, 1965) provides, in effect, that the United States may tax a Philippine corporation only on income derived from "sources" within the United States. As previously noted, however, H.R. 13103 does not recharacterize income "effectively connected" with a U.S. office as income having its "source" within the United States. On the contrary, it is clear from the proposed section 864 (c) (4) of the Code that no change in existing "source" rules is intended. Enactment of H.R. 13103 would therefore have one of the two undesirable conse- quences: (1) it would require renegotiation of the Income Tax Convention with the Philippines and 17 other countries, i.e., Australia, Austria, Denmark, Finland, Greece, Honduras, India (proposed), Ireland, Israel (proposed), Italy, Japan, Luxembourg, New Zealand, Norway, Pakistan (proposed), Switzerland, Thailand (proposed), or (2) it would not apply to foreign corporations having their domicile or seat of management in the foregoing countries and thus would create a capricious discrimina- tion in favor of those foreign corporations as distinguished from foreign corporations belonging to all of the other nations of the world. 3This is true both of goods exported from the United States and goods exported from one foreign country to another. 9 7 1-297 0-67-pt. 1-62 967 PAGENO="0978" 82 FOREIGN INVESTORS TAX ACT OF 1966 office furnish a valid reason for not imposing U.S. tax, it would be anomalous to impose U.S. tax where the activities of the foreign office (although not a sales office) are more substantial than those of the typical sales office, e.g., where the foreign activities are as extensive as* the Philippine activities of the Philippine corporation described above. It is believed that the foregoing analysis also leads to the conclusion that, where a foreign corporation engages in the manufacture, extraction, growth, or production of goods outside the United States, it should not be subject to any U.S. tax merely because it uses a U.S. office to arrange for sales of those goods to foreign customers. It is clear, therefore, that an office or other place of business outside the United States should be considered to have "participated materially in the sale" of goods in all cases where those goods have been procured by substantial purchasing or productive activities conducted by the foreign corporation at its office or other place of business outside the United States. U.S. Export Sales Different policy considerations lead to a similar conclusion where the goods sold to foreign customers are either produced by the foreign corpo- ration within the United States or purchased from suppliers within the United States. Here the imposition of any U.S. income tax by reason of selling activities of a U.S. office would clearly run counter to our national policy of encouraging U.S. exports, a policy essential to the strengthening of the U.S. balance of payments. The Council believes that the selling of goods to foreign customers through a U.S. office should not give rise to any U.S. tax on the sale by a foreign corporation which either produces those goods within the United States or purchases them from suppliers within the United States. As under existing law, the sale of such goods, if produced by the foreign corporation, would give rise to U.S. tax on the portion of the total profit treated as U.S.-source income from production (as distinguished from selling) activities. (See Regulation 1.863-3(b)). Sales to U.S. Customers The bill fails to specify any method for determining the portion of the total profit taxable by the United States with respect to sales made through a U.S. office to customers iccated within the United States. Thus it may not give effect to the intention expressed in the Report of the `Ways and Means Committee at P. 16: "In the case of foreign source income where the products are destined for the United States, the income will be treated as effectively connected with a U.S. business to the extent the sales activity is carried on by the U.S. office. 10 968 PAGENO="0979" FOREIGN INVESTORS TAX ACT OF 1966 83 "The amount of income attributable to the U.S. sales office is not to be more than would have been attributable to it if the sale had been made in this country.4 This gives assurance, for example, that the sales income attributable to a U.S. business will not include income properly attributable to manufacturing or any other activities (apart from sales) occurring outside the United States." (Emphasis added) The general intention is clearly to exempt "income properly attributable to . . . activities . . . occurring outside the United States." The Council is concerned, however, that the U.S. Treasury might try to tax the entire' profit, without allocation, in cases where the foreign corporation imports into the United States goods which it has purchased (rather than manufactured, extracted, grown or produced) through an office or place of business maintained by it abrOad, e.g., the case of the Philippine corporation using a Seattle office to sell hand-embroidered linens purchased through its extensive home-office facilities in the Philip- pines (described above). This concern stems from an existing Regulation5 which would, under present law, cause a foreign corporation* to be taxable upon its entire profit from the purchase and sale, if it were to pass title to U.S. customers when the goods arrive in the United States rather than when the goods are shipped from the foreign country. This Regulation might lead the U.S. Treasury to argue that under H.R. 13103 the same amount, i.e., the entire profit, should be taxed in cases where title to the goods passes to the U.S. customer in the foreign country rather than in the United States. It is submitted that any such interpretation would be unjustified: (a) on equitable grounds, (b) in view of the stated purposes of H.R. 13103, and (c) in view of the conflicting treaty obligations of the United States. 4 sentence appears to be directed to cases where the foreign corporation manu- factures, extracts, or produces outside the United States the goods marketed to U.S. customers through its U.S. sales office. There the foreign corporation would pay U.S. tax under existing law on only an allocated part of its total profit from such sales if it were to pass title to the goods within the United States. (The method of allocation is described in Regulation Sec. 1.863-3(b)). Since H.R. 13103 would extend U.S. taxation to cases in which title to such U.S. imports passes outside the United States, the above-quoted sentence assures that the amount taxable under H.R. 13103 would not exceed the allocated part of the profit taxable under existing law where title passes within the United States. ~ Regulation Sec. 1.861-7 provides: "(a) General. Gains, profits, and income derived frdm the purchase and sale of personal property shall be treated as derived entirely from the country in which the property is sold. Thus, gross income from sources within the United States includes gains, profits, and income derived frOm the purchase of personal property without the United States and its sale within the United States."... "(c) Country in which sold. For the purposes of part I (section 861 and follow- ing), subchapter N, chapter 1 of the Code, and the regulations thereunder, a sale of personal property is consummated at the time when, and the place where, the rights, title, and interest of the seller in the property are transferred to the buyer." (Emphasis added). 11 969 PAGENO="0980" 84 FOREIGN INVESTORS TAX ACT OF 1966 a. Equitable Considerations It would be highly inequitable for the United States-solely because the selling activities of the single employee stationed at the Seattle office- to attempt to tax the entire profit of the Philippine corporation from sales to U.S. customers. Such taxation would be unfair because it would ignore the much larger volume of activities and assets having their situs in the Philippines. The case of the Philippine corporation is very different from the type of case to which the existing Regulation is addressed. The latter may be illustrated by an English corporation operating a retail shoe store~in New York where it sells shoes purchased from suppliers in England. Here title to the shoes necessarily passes to U.S. customers within the United States, causing the entire profit from their sale to be taxable by the United States. This result is reasonable because the English corporation's business is substantially similar to that of a U.S. domestic corporation selling shoes from an inventory maintained within the United States. This type of business is very different, however, from the type of busi- ness to which H.R. 13103 is directed. Thus, the nature of the Philippine corporation's business does not require it to land and warehouse its goods within the United States. Accordingly, the fact that title to the goods passes to the U.S. customer when the goods are shipped from Manila (rather than when they arrive in Seattle) is no mere technicality. On the contrary, this fact flows from the nature of the business of the Philippine corpora- tion: that its economic "center of gravity" is in the Philippines rather than in the United States. There is, therefore, no valid reason for the United States to tax the Philippine corporation as if it had been required by busi- ness exigencies to defer passing title to the goods until their arrival in Seattle. b. Objective of Ways and Means Committee U.S. taxation of the entire profit of the foreign corporation would also conflict with the stated objective of the Ways and Means Committee to tax "income generated by U.S. business activities." Clearly, the aim of taxing "income generated by U.S. business activities" does not justify the taxation of profit from other activities performed by a foreign corporation outside the United States. As previously noted, the Report of the Ways and Means Committee is explicit "that the sales income attributable to a U.S. business will not include income attributable to manufacturing or any other activities (apart from sales) occurring outside the United States." (Emphasis added). This intention is stated even more emphatically at P. 64: if only a part of the income, gain, or loss from a transaction, or series of transactions, is properly considered attributable to such 12 970 PAGENO="0981" FOREIGN INVESTORS TAX ACT OF 1966 85 office, or other fixed place of business within the United States, only that part shall be treated as effectively connected with the conduct of a trade or business within the United States." (Emphasis added) While these statements of Congressional intent are helpful, it is be- lieved there should be no possible ground for a contrary interpretation. c. U.S. Tax Treaty Commitments A fair apportionment o' the foreign corporation's income is also re- quired by many of the income tax treaties to which the United States is a party. As indicated above under these treaties,6 the U.S. is clearly barred from taxing the U.S. branch office of a foreign corporation (having its domicile or seat of management in the treaty country) on more than that portion of the profit arising from its U.S. activities "which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm's length" with its home office in the treaty country. It is submitted that the United States should not attempt to tax a greater amount to those foreign corporations belonging to countries having no such tax treaty with the United States. Most of the non-treaty countries are the "less developed countries" of Latin America, Africa and Asia. It is the policy of the United States to assist the economic development of these "less developed countries." Consistency with that policy would pro- hibit the United States from imposing more stringent taxes on those countries' corporations engaged in importing their products into the United States than on corporate importers belonging to treaty countries. The Council believes that H.R. 13103 should provide that the amount of income of a foreign corporation attributable to sales to U.S. customers made through a U.S. office should not exceed the amount which would be allocable to that office if it had been maintained by a separate subsidiary corporation of the foreign corporation. Foreign Sales With No Foreign Office In addition, a similar allocation should be permitted with respect to sales by a foreign corporation, which has substantial economic activities outside the United States but no office outside the United States, of goods of foreign origin sold for use, consumption or disposition outside the United States. The corporation should not be subject to U.S. tax on its entire income from sales negotiated through its U.S. office if part of its income is economically attributable to other factors. For example, the foreign corporation may purchase goods in one for- 6 Provisions of this type appear, for example, in the U.S. Tax Treaties with Be!- gium, Germany, Netherlands, the United Kingdom, and South Africa. 13 971 PAGENO="0982" 86 FOREIGN INVESTORS TAX ACT OF 1966 eign country and transport them to another country for sale there. If part of its profit is fairly attributable to its transportation activities or other fac- tors, it should be subject to U.S. tax only on the portion of its profit attributable to the selling functions performed at its U.S. office. Credit For Foreign Income Taxes A major defect of the House version of H.R. 13103 is its failure to pro- vide adequate relief from international double taxation of income "effec- tively connected" with a U.S. office or other fixed place of business. This problem may also be illustrated by the example (set forth above) of the Philippine corporation purchasing hand-embroidered linens in the Philippines and selling them through a U.S. office to both U.S. and Cana- dian customers. In this typical case, the country of purchase (the Philippines) will impose its tax on the entire profit either: (i) because the corporation is domiciled or has its seat of management in that country or (ii) because the corporation passes title to the goods within the country of purchase. In addition, H.R. 13103 would cause the United States to tax the same profit. The resultant double taxation should be alleviated by allowing the for- eign corporation a credit against its U.S. tax for the foreign tax on the double-taxed income. Under H.R. 13103, such a credit would be allowed, however, only where the foreign tax is imposed by the country in which the income has its "source", i.e., the country in which title to the goods passes,7 but not where the foreign tax is imposed by the country in which the foreign cor- poration has its domicile or seat of management, i.e., by its home country.8 The apparent rationale of this distinction is that the right of the United States to tax income "effectively connected" with a U.S. office should take precedence over the right of the foreign corporation's home country to tax such income. Under this theory, double taxation would be averted by allowance by the home country of a credit against its tax for the U.S. tax (rather than by allowance by the United States of a credit against the U.S. tax for the home country's tax). While this new theory may at first appear plausible, there are several reasons why it is not likely, in practice, to avert double taxation. ~ As mentioned above, the proposed statute may fail to allow a credit where the country imposing the foreign income tax is. both the country of "source" and the country of domicile, unless a similar tax would have been imposed by that country if the corporation had been domiciled in another country. 8 Thus, for example, no credit would be allowed for the Philippine tax if the United States were to tax the Philippine corporation on sales to Canadian customers negotiated by its U.S. office and if those customers were to take title to the goods upon their arrival in Canada rather than upon their shipment from the Philippines. On those facts, credit would be denied because the foreign tax would be imposed by the country of domicile (the Philippines) rather than the country of "source" (Can- ada). 14 972 PAGENO="0983" FOREIGN INVESTORS TAX ACT OF 1966 87 A serious practical objection is that some foreign countries, such as Sweden, tax their local corporations on world-wide income without allow- ing appropriate credits for taxes paid to other countries. Moreover, even if the foreign corporation's home country does, in general, allow credit for income tax paid to other countries, it may well deny a credit in those cases where title to the goods passes at the point of shipment within the home country because the income would then have its "source" within that country (rather than within the United States where the sales office is located). Since the U.S. Treasury does not allow any credit to U.S. corporations for foreign taxes on domestic source in- come, how can it reasonably expect that foreign governments will allow credit to their corporations for a U.S. tax on their domestic source income? Finally, the foreign corporation's home country may restrict the credit allowed to its local corporations for taxes paid to other countries by means of a "per-country limitation" similar to that under the U.S. tax law. Such a "per-country limitation~' would often operate to eliminate the foreign country's credit for any U.S. tax imposed on profits from sales to foreign customers whenever the income would have its "source" in the customer's country, e.g., when title passes upon arrival of the goods. It is therefore apparent that foreign corporations would frequently suffer serious double taxation with respect to income "effectively con- nected" with a U.S. office, if the United States were not to allow a credit against its tax for all foreign taxes imposed on such income, regardless of whether the taxing country is the country of "source", the country of domi- cile, or both. In this connection, it is noted that H.R. 13103 would impose on for- eign corporations a greater tax burden than is borne by domestic corpo- rations. Since a domestic corporation is allowed a credit against its U.S. tax for foreign taxes on its income from sources outside the United States, a foreign corporation should, if taxed under H.R. 13103, likewise be allowed a credit against its U.S. tax for foreign taxes on its income from sources outside the United States (to the extent that such income is "effec- tively connected" with a U.S. office). Even if the United States were to allow a credit for income tax imposed by the home country, the foreign `corporation might still suffer a serious detriment from the new U.S. tax proposed by H.R. 13103. That is be- cause the credit would automatically be reduced to reflect any income tax benefits which the home country may see fit to grant. For example, the home country might well confer a variety of tax advantages on a local corporation engaged in activities promoting the expansion of local exports, e.g., construction of new warehouse facili- ties, by means of "tax holidays", deductions for reinvested profits, rapid depreciation, etc. The economic incentive afforded by these tax benefits would often be completely nullified by the concomitant increase in the 15 973 PAGENO="0984" 88 FOREIGN INVESTORS TAX ACT OF 1966 U.S. tax payable by the local corporation. The net result would be particu.~ Jarly harmful for corporations exporting goods from the many "less de- veloped" areas which offer such tax incentives, e.g., Ireland, Peru, Puerto Rico, Southern Italy, Trinidad, etc. These inadequacies of the credit approach thus furnish further support for the need: (1) to eliminate the proposed U.S. tax on profits from sales to foreign customers by foreign corporations conducting substantial oper- ations through a local place of business in a foreign country, and (2) to restrict any U.S. tax on profits from sales to U.S. customers to the amount which an independent sales agent would earn by performing services simi- lar to those performed by the U.S. branch office of the foreign corporation. Rental and Royalty Income The bill includes as one of the types of income from sources without the United States which will be treated as "effectively connected" income, if attributable to a U.S. office of a foreign corporation or nonresident alien individual, rents or royalties for the use of intangible property outside the United States. While the bill itself is silent as to the criteria to be used in determining whether such rents or royalties are to be attributed to a U.S. office, the Ways and Means Report indicates that the test is whether the lease or license is "made by or through" such office. This, in turn, is said to depend upon whether a U.S. office actively participates in soliciting, negotiating or performing other activities required to arrange the license. The place where the invention was developed is immaterial Under this test. The Council firmly believes that it is unrealistic to regard the royalties paid for the use of a valuable right as being generated entirely by the making of the contract. It is either the making of the invention or its use in manufacturing which generates the income; salesmanship or the mere negotiation of the lease or license is generally of minor importance. If the approach of the proposed statute is to tax rental and royalty income merely because of the presence of negotiating or related activities in the United States, the Council believes that modification of the bill is necessary to bring the rental and royalty provision into line with analogous portions of the bill and to avoid substantial inequity. As presently formulated, under the test indicated in the Ways and Means Report, rental or royalty income would be attributed to a U.S. office if activities (other than general supervision) incident to the lease or license are performed by or through such office, irrespective of the extent to which a foreign office also participates or where the activities are performed. Thus, for example, royalty income might conceivably be attributed to a U.S. office even though: (1) the intangible property being licensed was developed or acquired entirely outside the United States, (2) the license is negotiated principally by a foreign office, but a tech- 16 974 PAGENO="0985" FOREIGN INVESTORS TAX ACT OF 19 66 89 nician assigned to a U.S. office participates in the negotiations or the drafting of the license agreement, and (3) the negotiations* or other activities performed by personnel assigned to a U.S. office are performed entirely outside the United States. As discussed above (Sales to Foreign Customers) in the case of income from sales the approach of the Ways and Means Committee is to attribute foreign source income to a U.S. office only when the U.S. office is the primary place of the activity giving rise to the income. To effectuate this purpose, the proposed statute would exempt from U.S. *tax the entire profit from sales arranged through a U.S. office if the property is sold for use, consumption or disposition abroad and an office or other place of business of the taxpayer outside the United States participated materi.. ally in the sale. This approach should be equally applicable to income from the leasing or licensing of intangible property for use outside the United States. Thus no U.S. tax should be imposed where an office or other place of business of the taxpayer outside the United States has "participated materially" with respect to the lease or license, either through solicitation, negotiation or other activities related to the making of the lease or license, or through productive or purchasing activities directed toward the creation or acquisition of the intangible property by the taxpayer. Section 245 H.R. 13103 would amend section 245 to provide an 85% deduction for dividends received from a foreign corporation engaged in trade or business within the United States and having 50% or more of its gross income "effectively connected" with the U.S. trade or business. The deduction would be in proportion to the "effectively connected" income of the paying corporation. The Council wishes to point out potential double taxation which can occur under the bill where a U.S. corporate shareholder receives a dividend from a foreign subsidiary which has been subject to U.S. tax on its "effectively connected" income. The following situation should be considered: Assume a situation where a wholly-owned foreign subsidiary of a U.S. corporation has only foreign source income but is subject to U.S. income tax on 100% of its income as being "effectively connected" with a U.S. trade or business. Assume also that it pays foreign income tax at a rate greater than the U.S. income tax rate and that the foreign income tax is creditable under proposed section 906 against the sub- sidiary's U.S. tax. Under the bill, 15% of every dollar of dividends from the foreign sub- sidiary would be subject to U.S. income tax. Such taxation is generally referred to as an "upstream dividend tax." No foreign tax credit would be permitted to the U.S. parent under the revised provisions of section 17 975 PAGENO="0986" 90 FOREIGN INVESTORS TAX ACT OF 1966 861 (a) (2) (B) since this section would treat dividends from such a foreign corporation as being U.S. source income. Therefore, the section 904 limitation on the foreign tax credit would prevent any available foreign tax credits from being used to reduce the U.S. income tax payable on the dividends. Under existing law, the parent's U.S. income tax on dividends from such a foreign corporation could be offset by available foreign tax credits. It is submitted that to the extent that 15% of such dividends would be subject to the U.S. income taxation under the bill, this would constitute double taxation. It seems inconsistent with the purpose for which the changes regarding foreign source income which might be "effectively connected" were made to have this result. That is, such changes were intended to prevent tax avoidance by foreign corporations. The effect of this "upstream dividend tax" is to impose an additional tax on U.S. shareholders. The Committee Report submitted by the Committee on Ways and Means does not specific- ally recognize the possibility of creating an additional tax on U.S. share- holder corporations. It is hoped, therefore, that this is an unintended effect which the Senate will correct. 18 976 PAGENO="0987" FOREIGN INVESTORS TAX ACT OF 19 66 91 BALANCE OF PAYMENTS CONSIDERATIONS US. Estate Tax As compared with H.R. 5916, this bill would increase estate tax rates on estates of nonresident aliens to a maximum of 25%, thus giving less incentive for foreign investment in the United States than was given by H.R. 5916. H.R. 13103 would include in the taxable estate of a nonresident alien certain intangible personal property which is excluded from the estate under present law. Such property includes: (a) bank deposits in the United States of a nonresident alien not engaged in business in the United States, and (b) debt obligations of a U.S. person (including a U.S. corporation), the United States, a State or political subdivision of a State, or the District of Columbia, even though such obligations are physically located abroad. There is no doubt that these provisions will have an adverse effect on foreign investment in the United States. Interest on U.S. Bank Deposits Since the Revenue Act of 1921, interest on deposits with persons carry- ing on the banking business paid to persons not engaged in trade or busi- ness within the United States has been treated as foreign source income and consequently not subject to U.S. income tax. In considering the merits of this exclusion from taxable income, the House Ways and Means Corn.. mittee Report (67th Cong., 1st Sess.) indicated that "the loss of revenue which would result if this deduction were allowed would be relatively small in amount, while the exemption of such interest from taxation would be in keeping with the action of other countries and would encourage non- resident alien individuals and foreign corporations to transact financial business through institutions located in the United States." H.R. 13103 would completely change this long-standing rule of law in that interest paid on bank deposits in the United States to nonresident aliens and for- eign corporations after December 31, 1971, will become subject to income tax even though the recipient may not be doing business in the United States. The technical change in source definitions made by the bill af- fecting bank interest during the interim period 1966 through 1971 is not objectionable since it is not less favorable than existing law in its treatment of U.S. bank interest paid to foreigners. It is submitted that the factors prevailing in today's economy are even more compelling than in the 1920's in requiring that interest paid on U.S. bank deposits to nonresident alien individuals and foreign corpora- tions not doing business in the U.S. continue to be exempt from U.S. taxa- tion. The U.S. balance of payments problem would be made more acute 19 977 PAGENO="0988" 92 FOREIGN INVESTORS TAX ACT OF 1966 if this interest were taxed since it seems reasonable to believe that a sub- stantial part of the underlying deposits would be transferred to foreign banks: If this were to happen there would be an increased likelihood of these dollars shifting from private to public hands and then becoming a claim on our gold. In addition, it is evident there would be no gain in U.S. tax revenue but in fact a loss, since the shifting of these deposits to foreign banks not subject to U.S. taxation would reduce taxable income otherwise generated by U.S. banks on these deposits. The House Committee on Ways and Means recognized in its Report that an alteration of this source rule might have a substantial adverse effect on our balance of payments. For this reason the Report indicates that the effective date of this change is being postponed until after 1971 at which time there will be an opportunity to reconsider the balance of payments situation. For the reasons noted above, the Council is in complete agreement that the proposed change' in the source of income rules can have a substantial adverse effect on our balance of payments and that they should not be changed in the context of our present balance of payments difficulties. Indeed, the Council believes that the proposed change would be contrary to the best interest of the United States as a world financial center even in the absence of a balance of payments problem. Furthermore, the Council does not believe that the present Congress should insert in the law a future date on which the long-standing exemp- tion from tax will be automatically terminated, in view of its recognition that such termination can have serious economic consequences. It would seem that sound. legislative procedure dictates that if this exemption is to be terminated at all, despite the continued validity of the reasons for which it was made a part of our law by the Revenue Act of 1921, it should be terminated by positive action of the Congress at the time of termination only after giving thorough consideration to the effect of the change in the light of the then current economic conditions; a situation should not be legislated by the present Congress under which a change in tax law having potentially serious economic consequences can become effective in 1972 by a combination of mere passage of time and inaction on the part of a future Congress. Moreover, the Council believes that insertion in the law of a termina- tion date for the present exemption will inadvertently negate at least in part the obvious intention of the Congress to reconsider the balance of payments situation before withdrawal of foreign-owned deposits from financial institutions in the United States is induced by taxation of the interest on such deposits. The existence of this date in the law will create a psychological barrier to further deposits and induce withdrawal of existing deposits even before the effective date of the tax, thus having a potential adverse balance of payments effect prior to essential Congres- sional reconsideration of the situation. Accordingly, the Council strongly 20 978 PAGENO="0989" FOREIGN INVESTORS TAX ACT OF 19 66 93 urges that this date be deleted from the bill. The Council agrees that foreign-owned funds on deposit with savings~ and loan associations and insurance companies should receive similar treatment to that given to bank deposits in the United States. Short-Term Promissory Notes Section 881 of the Internal Revenue Code imposes a tax on fixed or determinable income from sources within the United States of foreign corporations not engaged in the conduct of a trade or business within the United States. Presently, section 881, in addition to taxing fixed or determinable in- come, imposes a tax on types of income described in section 631 (b) and (c), which relate to gains on the disposal of timber, coal and iron with a retained economic interest. Except as provided in section 631, foreign corporations not engaged in trade or business in the United States are not presently subject to tax on capital gains from United States sources. The Committee on Ways and Means in House Report No. 1450, Page 87, recognized this when it said: "Gains from the sale or exchange of a capital asset (other than amounts to which amended sec. 881 (a) (2) and (3) applies) are subject to tax only if they are received by a foreign corporation which is engaged in trade or business within the United States at some time during the taxable year for which the tax is being determined and are effectively connected with the conduct of ~ trade or business within the United States." The proposed amendment to section 881 retains the types of income ~pecified under present law as being taxable, but with two additions: (1) gains with respect to the sale of stock of a collapsible corporation, treated as ordinary income (section 341), and (2) amounts of original issue discount which are treated as ordinary income received on retirement or sale or exchange or bonds or other evidences of indebtedness issued after September 28, 1965 (section 1232). Certain United States corporations, principally finance companies, in the ordinary course of business sell to nonresident aliens short-term (nine months and under) promissory notes (commercial paper) issued in bearer form at a discount without interest. With regard to these sales, the discount on the non-interest bearings notes has, under Revenue Rulings L. 0. 1024, 2 CV 189 (1920); I. T. 1398, 1-2 CB 149 (1922); I. T. 3889, 1948-1 CB 78 (1948), been considered to be not fixed or deter- minable and, therefore, not subject to tax. To subject such discount to Federal income tax will, as explained below, have substantial and lasting adverse effect on the United States balance of payments. Proposed section 881 (a) (3), by reference to section 1232, specifi- 21 979 PAGENO="0990" 94 FOREIGN INVESTORS TAX ACT OF 1966 cally taxes income which, under section 1232, is treated as a gain from the sale or exchange of property not considered to be a capital asset and to the extent the amount received is not effectively connected with the conduct of a trade or business within the United States. Under section 1232, any gain realized to the extent of original issue discount from evidences of indebtedness held by the taxpayer more than six months is considered as gain from the sale or exchange of property which is not a capital asset. Thus, by including a reference to section 1232, proposed section 881 would, in effect, be taxing a nonresident alien corporation on a gain from the sale or exchange of a capital asset which is not effectively con- nected with the conduct of business in the United States. It is the Council's understanding that certain nonresident alien corpo- rations which have in the past purchased substantial amounts of such commercial paper fear that the U.S. Treasury might interpret erroneously the proposed section 881 (a) (3) to the effect that the discount on all commercial paper sold to nonresident alien corporations will be taxable, without regard to whether or not such paper is held for more than six months. Thus, if the proposed section 881 (a) (3) is enacted, such corpo- rations will cease to furnish a market for commercial paper. This would have a severe, adverse effect on the United States balance of payments. It is estimated that the annual market in this short-term (nine months and under) commercial paper sold in the United States to nonresidents is in excess of $1 billion. The possibility that the gain on this short-term paper might be subject to United States income tax will result in the permanent loss of a substantial part of such investment in the United States by nonresident foreign corporations. The Council believes the proposed section 881 (a) (3) should not be enacted. Section 904 (f) H.R. 13103 proposes to amend section 904 (f) of the Internal Reve- nue Code by making the present separate "per country" limitation with respect to interest income inapplicable to interest received by an "over- seas operations funding subsidiary" on obligations of a "related foreign corporation." While the Council supports the general purpose of the proposed amend- ment (set forth in the Report of the Ways and Means Committee at pages 39-40), it wishes to first point out that it believes that the exception in section 904 (f) (2) (C) of the present law should be construed to apply where a U.S. parent uses a domestic affiliate to borrow foreign funds to finance the operations of its (the parent's) foreign subsidiary, despite the doubt expressed on this point on page 40 of the Committee Report. In addition, the Council wishes to point out that, contrary to the state- ment on page 40 of the Report to the effect that this exception under 22 980 PAGENO="0991" FOREIGN INVESTORS TAX ACT OF 1966 95 904 (1) (2) (C) is only provided in cases where the U.S. taxpayer receiv- ing this interest directly owns 10% of the borrowing foreign affiliate, it believes that the intent of present law is that such a foreign affiliate may be either directly or indirectly owned by the U.S. company to come within the exception. It will be recalled that when Secretary Dillon was examined by Senator Long with respect to his recommendation for a separate foreign tax credit limitation for certain investment income, he made it very clear that this provision was directed specifically to passive short-term funds that were invested abroad. This will be seen from the following questions and answers appearing on pages 4259 and 4260 of the record of Senate Hear- ings on the Revenue Act of 1962: Senator Long. Mr. Secretary (Dillon), . . . You cited a flow of short- term funds to Canada and I believe you are correct in what you recom- mended with regard to that. According to your testimony contained on p~ges 103 and 104 of the recOrd, [attached hereto as Appendix A] and in greater detail at page 243, this change is intended to cover short-term investments abroad. Am I correct in my understanding you do not intend this change to apply to dividends received by a U.S. corporatiOn from another cor- poration, domestic or foreign in which it owns at least 10 percent of the voting stock? Secretary Dillon. That is correct. No, it would not. It is only meant to handle this one specific short-term problem which I described in my April 2 statement. Senator Long. Would I also be correct in understanding that you do not intend this change to apply to interest received from investments in such affiliates? Secretary Dillon. No, it would not apply to interest received from such affiliates. Senator Long. Now, do you intend this change to~ apply to interest re- ceived on a loan made to a foreign customer to secure an outlet for prod- ucts to be sold to the lender? Secretary Dillon. No. This was only meant to apply, in effect, to passive funds that were transferred abroad for the specific purpose of taking ad- vantage of this situation in the law where there is an unused credit which allows totally tax-free treatment of the income from such passive funds by investment abroad. Senator Long. I have been informed by some corporations occasionally that they are required to buy bonds in a Latin American country. They are not particularly anxious to buy them, but while they have no enthusi- asm for the purchase, as a matter of good will in the country they are 23 981 PAGENO="0992" 96 FOREIGN INVESTORS TAX ACT OF 1966 more or lesss compelled to do so. And I take it that you would not intend your recommendation to apply to that either? Secretary Dillon. No. Senator Long. As long as it is limited to that, I think the recommenda- tion should receive complete support. At least I would expect to support it. However, to completely resolve these points, the Council urges that 904 (f) (2) (C) be clarified so as to exclude interest received from a corporation in which the recipient (or one or more includible corpora- tions in an affiliated group, as defined in section 1504, of which such recipient is a member) owns directly or indirectly 10% or more of the total combined voting power of all classes of stock. This wording is similar to that in section 4915 of the Code whereby direct foreign investments are excluded from the imposition of the Interest Equalization Tax. Direct foreign investments are spelled out by statute as investments of 10% or more of the total combined voting power of all classes of stock held either directly or indirectly by members of an affili- ated group of corporations. While this recommendation would eliminate the need for the special amendment to section 904 (*f) for interest received by an "overseas operations funding subsidiary" on obligations of a related foreign corpo- ration, the Council wishes to express its concern over the unduly restric- tive proposed definitions of the terms "overseas operations funding sub- sidiary" and "related foreign corporation" contained in H.R. 13103. The definition of the term "overseas operations funding subsidiary" as contained in the proposed section 904 (f) (5) (A) requires that such a subsidiary raise its funds through "public offerings." The Council is at a loss to understand why there should be a requirement that the offerings be public. The objectives of the balance of payments program will be satisfied if the funds are raised outside of the United States from foreign persons whether the offerings are public or private. The definition of a "related foreign corporation" in proposed section 904 (f) (5) (B) requires that at least 50% of the voting stock of the foreign corporation must be owned either directly or through ownership of only one other foreign corporation included in the affiliated group of which the "overseas operations funding subsidiary" is a member. First, it is felt this definition is too restrictive insofar as it requires the affiliated group to own at least 50% of the voting stock of the foreign corporation from which the interest income is received. This 50% require- ment is to be contrasted with the 10% requirement of the existing section 904 (f) (2) (C) which makes the separate "per country" limitation in- applicable to interest income "received from a corporation in which the taxpayer owns at least 10% of the voting stock." The apparent rationale of this 10% rule is that an interest-bearing loan 24 982 PAGENO="0993" FOREIGN INVESTORS TAX ACT OF 1966 97 to a corporation (earning all or most of its income abroad) is likely to be prompted by legitimate business considerations if the lender owns as much as 10% of the voting stock of the borrowing corporation. If this is the rationale of the present 10% stock ownership requirement, it should apply regardless of whether the loan comes from the 10% shareholder or from another U.S. corporation, such as an "overseas operations funding subsidiary," which is a member of an affiliate group of corporations (as defined in section 1504) to which the 10% shareholder belongs. There does not appear to be any logic in raising the stock ownership require- ment from 10% to 50% simpiy because the loan and the stock are not held by the same member of the affiliated group. Unless - the proposed new 50% requirement is modified to conform to the present 10% requirement, a U.S. taxpayer owning at least 10% but less than 50% of the voting stock of a foreign corporation will find it advantageous to lend U.S. funds to the foreign corporation rather than to utilize an "overseas operations funding subsidiary" to lend foreign funds to the foreign corporation, thus adversely affecting the balance of pay- ments position of the United States. Second, the Council believes that the proposed amendment is too re- strictive insofar as it specifies that the required voting stock of the foreign borrowing corporation be held by a member of the affiliated group either "directly or through ownership of the stock of another foreign corpora- tion." According to the Report of the Ways and Means Committee at Page 41, "This latter requirement, in effect, means that the borrowing subsidiary may be either a first or second tier foreign subsidiary." The Council can see no logical basis for denying the benefit of the pro- posed amendment to interest income received from third or fourth tier foreign subsidiaries. While it is true that dividends received from third or fourth tier foreign subsidiaries do not carry "deemed paid" credits under section 902, this does not afford a persuasive analogy because only interest income (and not dividend income) is affected by the separate "per coun- try" limitation imposed by section 904 (f). It is arbitrary to give effect to stock ownership in first and second tier subsidiaries and to ignore the same percentage of stock ownership in third and fourth tier subsidiaries. Incidentally, the Council has recently indicated its support of H.R. 15139, introduced by Congressman Secrest, which would amend section 902 of the Internal Revenue Code to reduce the 50% ownership re- quirement to 25% between the first and second levels and extend the bene- fits of section 902 to dividends received from a third level foreign corpora- tion if the 25% test is met. As stated above, the 10% stock ownership requirement appears to be premised on the view that an interest-bearing loan to an affiliate is likely to be motivated by genuine business considerations (rather than tax-saving considerations) if the lender is at least a 10% stockholder. If this assump- tion is valid (as the Council believes it to be), it is equally valid regardless 25 71-297 O-67-pt. 1-63 983 PAGENO="0994" 98 FOREIGN INVESTORS TAX ACT OF 1966 of whether the 10% stock interest is held directly or through any number of intermediate subsidiaries. Interest Received In Connection With Certain Dispositions Under present law an exception to section 904 (f) is provided where the interest received is on an obligation acquired as a result of disposition of stock or obligations of a corporation in which the taxpayer owned at least 10%. However, in the case of a disposition of stock of a wholly- owned subsidiary of a corporation in which the taxpayer owns a 10% interest the latter exception may not apply under present law. It appears that the limitation on the foreign tax credit should apply in the same man- ner if the obligation is acquired as a result of disposition of the stock of a corporation owned at least 10% whether directly or indirectly. 26 984 PAGENO="0995" FOREIGN INVESTORS TAX ACT OF 1966 99 APPENDIX A Eliminating Artificial Tax Incentives To Capital Movements Arising Out Of Foreign Tax Credit Computation9 Last summer Canada revised its tax laws to provide a 57½ % effective rate of Canadian tax applicable to income going to United States corpo- rations operating in branch or subsidiary form in Canada. This Canadian tax rate in excess of the U.S. 52% rate has highlighted the operation of the existing method for computing the foreign tax credit as an artificial inducement to the outflow of short-term U.S. capital. This is harmful to our monetary stability and to our balance of payments position. Under existing rules, a U.S. company deriving income from business abroad through a branch or a subsidiary may have an unused foreign tax credit where the foreign rate of tax on the income exceeds the U.S. rate. If, however, additional foreign source investment income can be generated which is subjected to a foreign tax rate lower than the U.S. rate, the two kinds of income can be lumped together under the existing foreign tax credit rules. In this way the U.S. tax on the income from such investment funds can be completely eliminated by the excess credit from the tax on the business income of the company. For example, the 57½ % effective rate of Canadian tax applicable to income going to U.S. corporations operating in~ branch or subsidiary form in Canada leaves an excess credit of 5½ % over the U.S. 52% rate. The Canadian rate of tax on interest income flowing to such corporations is only 15%. Consequently, some of these U.S. corporations have transferred to Canada short-term funds, such as bank deposits, which ordinarily would be held in the United States. Since the excess credit from the business income will eliminate the U.S. tax on the interest income, the effect is to leave that income taxable at only a 15% Canadian rate, as compared with the 52% U.S. rate that would apply if the funds were held in the United States. Thus the existence of this situation serves as an artificial inducement to the movement of U.S. capital abroad. In my report to the President on the balance of payments, transmitted to the Congress on March 28, 1962, I recommended that this situation be corrected. I suggest that the foreign tax credit for certain investment income be computed apart from the foreign tax credit for all other foreign income. In this way a foreign tax credit will be allowed against investment income only for the actual foreign taxes paid on such income. This will result in the same tax rate being paid with respect to short-term investment income of U.S. companies whether it is earned at home or abroad. We believe that this is an effective and fair way to correct this tax-induced disruptive monetary situation. A more detailed explanation of~ this recom- *mendation and the proposed statutory language is submitted as exhibit III E. ~ Excerpt from testimony of Secretary Dillon at Hearings before Senate Finance Committee on the Revenue Act of 1962 (Part 1, pages 103 and 104). 27 985 PAGENO="0996" 100 FOREIGN INVESTORS TAX ACT OF 19 66 (By direction of the Chair, the following communications are made a part of the record at this point:) NATIONAL ASSOCIATION OF MANUFACTURERS, Washington, D.C. August 9, 1~966. Hon. RUSSELL B. LONG, Chairman, Committee on Finance, U.S. Senate, Washington, D.C. DEAR MR. CHAIRMAN: This letter is in response to your Committee's invitation to submit written statements on H.R. 13103, the Foreign Investors Tax Act of 1966. This legislation has been the subject of continued study, by the NAM Sub- committee on International Taxation since the original version was first in-* troduced. Our concern with H.R. 13103 is focused largely on the "effectively connected income" test. On March 4, 1966, we told the House Committee on Ways and means, "~ * * that unless this new concept is carefully drawn and applied, it invites a host of questions and uncertainties in the existing U.S. source rules." These "questions and uncertainties" still exist and indeed further study re- affirms our doubts. The basic purpose of H.R. 13103, with which we have no quarrel, is to attract foreign investment capital to the U.S. The collateral purposes with which we also agree in principle are: (a) To prevent the U.S. from being used as a tax haven by foreign cor- porations, and (b) To impose a U.S. tax on income generated from U.S. business activi- ties-otherwise not taxed-. It is the implementing provisions to effect these latter purposes about which we have serious doubts The "effectively connected income" test is a jurisdic- tional test which would be imposed on and would supplement our present source of income rules. It is subjective and fuzzy in its measurements and application. Taxes would turn on such concepts as: material participation in-activities attributed to-etc. Practical questions of proof are consequently raised. Fur- ther, materiality and taint would, in a number of instances lead to multiple taxa- tion. * The present rules, while being jurisdictional themselves, are well understood both here and abroad. The proposed rules seriously lack the precision of the old, and were they superimposed, in many instances, would lead to controversy as to which would apply or, perhaps, to a situation where all would apply. Other troublesome areas immediately come to mind. What would be done, for example, in the tax treaty area? The proposed rule conflicts with the jurisdic- tional tests in a number of our tax treaties with other countries. How are the resulting conflicts and inconsistencies to be corrected? These provisions of the bill, H.R. 13103, are not expected to increase revenues. However, they would add imprecision and confusion to our present well-tested and precise rules of source and jurisdiction. Any changes in these existing rules for any purpose should be the subject of more careful consideration as to their ultimate effect in areas not contemplated or presently considered in the drafting of the bill now before your Committee. We respectfully request that this letter be made part of the official record of the Committee's hearings. Sincerely, D. H. GLEASON, Chairman, Subcommittee on International Taxation, NAM Taxation Committeec. 1~L&NUFACTURING CHEMISTS' ASSOCIATION, INC., Washington, D.C., August 10, 1966. Hon. RUSSELL B. Loxo, Chairman, Committee on Finance, U.S. Senate, Waahington, D.C. DEAR Ma. CHAIRMAN: Reference is made to your Committee's announcement of public hearings on H.R. 13103, The Foreign Investors Tax Act of 1966. The purpose of this letter is to present the views of the Manufacturing Chemists As- sociation (MOA) concerning this bill. For your information, MCA. is a non- profit trade association with 192 U.S. member companies, large and small, which 986 PAGENO="0997" FOREIGN INVESTORS TAX ACT OF 1966 101 together account for more than 90% of the productive capacity of the chemical industry in the United States. This Association is opposed to the provisions contained in H.R. 13103 which embody the concept of "effectively connected" so as to impose United States tax on foreign source income of foreign corporations doing business in this country. It is our beliof that sufficient documentation has not been developed as to the necessity of introducing this new and novel concept into the tax laws and that the resulting confusion and burdens would be substantially disproportionate to the abuses which are sought to be remedied. Our specific objections to these pro- visions are set forth below. 1. The terms "effectively connected" and "participated materially" embothed in H.R. 13103 remain vague and ambiguous despite attempts to clarify them. The numerous issues which will be raised and the extensive litigation which will follow in interpreting their meaning and scope will create undue and un- necessary burdens on taxpayers and the Govermnent alike. 2. Adoption of the present version of H.R. 13103 would create insurmountable accounting and auditing problems for taxpayers and the Internal Revenue Serv- ice. For instance, where goods are manufactured by a corporation abroad and sold for consumption abroad through use ot a sales office in the United States, the selling profit must be allocated to and taxed in the United States. Since all of the personnel and records of such corporation probably are abroad, except for possibly one salesman, considerable difficulty will be experienced by the Internal Revenue Service in any audit. Even where such audit is conducted, it will be an impossibility to determine the proper income attributable to the United States sale since advertising, selling expenses, etc. incurred at some previous time during the year might have to be allocated to this sale under conditions where no rules have been established. 3. it has been pointed out that H.R. 13103 is designed to tax certain foreign source sales solely because the income therefrom escapes tax completely. How- ever, the net result of the proposal will unnecessarily harm the United States balance of payments since to avoid such tax, a foreign corporation need only move its sales office to a more receptive counitry, thereby eliminating the present flow of funds into the United States to pay for the sales office and the employ- ees' salaries. 4. While the Association commends the exclusion of subpart F income from being considered "effectively connected" with the conduct of a trade or business in the United States, there is need for further clarification of this relief. For example, if a foreign base company is not subject to subpart F because less than 30% of the gross income of the corporation is subpart F income, does the relief granted under Section 954(b) (3) become nullified through the "effectively con- nected" provisions of H.R. 13103? It would seem that the intent of the bill is to grant the exclusion under these circumstances, but this should be indicated more clearly. 5. H.R. 13103 brings within its new concept of "effectively connected", rents or royalties derived for use or for the privilege of using intangible property located outside the United States. This is another example where the criterin to be used in determining whether the "effectively connected" concept applies are vague and unclear. Although the House Ways and Means Committee report sets out some general principles, taxpayers will continue to be uncertain as to whether the activities performed in the~TJnited States are such as to require these items to be attributed to the United States office. MCA believes that it would be desirable to provide a rent and royalties requirement similar to that which is applicable to foreign income from sales, namely, that rents and royalties will not be considered effectively connected to a United States office where the taxpayer has an office outside of the United States which "participates mate- rially" in the negotiation of the leases and licenses or participates in the servicing of the rights thereunder. For the above stated reasons, this Association recommends the complete deletion of the "effectively connected" provisions referred to above from HR. 13103. On the assumption, however, that your Committee may deem it advisable to continue to include these provisions in the bill, it is suggested that the bill be limited to its original purpose of dealing with foreigners by a simple amendment which would exclude from the bill those foreign corporations now subject to United States scrutiny because they are controlled `by United States persons. This can be done simply by deleting the present language of Section 864(c) (4) (D) (ii) and substituting the following language: "(ii) is derived by a foreign corporation more than 50% owned directly or indirectly, by United States persons". 987 PAGENO="0998" 102 FOREIGN INVESTORS TAX ACT OF 1966 The Association also strongly recommends that H.R. 13103, if enacted, be revised so as to extend a foreign tax credit for foreign income taxes imposed by the home country of the taxpayer on foreign income "effectively connected" with the conduct of a trade or business within the United States. For example, if the country in which a foreign corporation is organized imposes an income tax on foreign income which under H.R. 13103 is considered "effectively connected" with a trade or business in the United States, a foreign tax credit for those taxes should be allowed. It is well known that many nations tax income of their taxpayers whether derived from sources within or without the country. In such cases. H.R. 13103 would cause double taxation by requiring United States taxation of the same income taxes by the home country of the taxpayer. MCA believes that where income under these circumstances is doubly taxed, the United States should grant a fQreign tax credit. We appreciate this opportunity to present our views for your consideration and request that they be made a part of the printed record of the Committee's hearings. Sincerely, 0. H. DECKER. Senator ANDERSON. Mr. Seghers. STATEMENT OF PAUL D. SEGHERS, PRESIDENT, INSTITUTE ON U.S. TAXATION OP FOREIGN INCOME, INC. Mr. SEOHERS. Thank you for the opportunity to appear. For the record, my name is Paul D. Seghers, appearing as president of the Institute on U.S. Taxation of Foreign Income, Inc. I am not reading from my written statement that was filed. We thank you for this opportunity to present our views regarding the Foreign Investors Tax Act of 1966. Before commencing my oral presentation, I wish to mention the magnificent report on this bill submitted by the Interstate Tax Committee, New York State Bar Association. It clearly and dispassionately states the facts regard- ing the objectionable features of this bill, penalizing exports of U.S. products, and theharmful effects it would have on our economy and our relations with friendly nations. This is presented in 108 pages of text and 11 pages of summary. This is fortunate, as it would be impossible to begin to deal adequately with these extremely complicated and confusing provisions in an oral presentation. Very few of us would be here today if this bill were the same as originally introduced, H.R. 5961. In fact, I have a feeling that many of us would not be here today, if the effect of this bill were as stated, in its behalf. However, even the brightest picture reveals clearly that it would impose new burdens on the export and sale abroad of U.S. products. Limit its effect to foreign investors, and foreign-owned corpora- tions and opposition to this bill would evaporate. We offer no comments regarding the provisions of this bill which are in harmony with its title and stated purpose and are in fact intended to accomplish its purpose as originally stated by the Treas- ury, the increased foreign investment in the United States. We are concerned with those provisions that have nothing to do with the stated purpose of this bill but would place further burdens of harass- ment as well as taxes on U.S.-owned foreign corporations, particu- larly those selling abroad U.S. products of U.S. parent companies. Just why such sales are the special target of attack by the Treasury we cannot understand. These sales already have been singled out for 988 PAGENO="0999" FOREIGN INVESTORS TAX ACT OF 1966 103 special attack under subpart F of the 1962 revenue act and this bill would impose additional burdens, difficulties and harassment on for- eign corporations making such sales abroad. H.R. 13103 would tax corporations on income earned abroad, on income heretofore believed beyond the taxing power of tho United States not even attempted in the 1962 Revenue Act. Yet the Ways and Means Committee report on H.R. 13103, at page 7, shows that these burdensome provisions would produce no tax revenue for the United States. Then why do we protest against them? Because even if they did not extract one penny of taxes these provisions would place heavy burdens of accounting, reporting, and vouchering upon all for- eigncorporations with any employees or agents in this country. How complicated and how burdensome these requirements would be are set forth in many pages of the bar association report to ~which reference has been made. This bill would not conform to foreign tax systems but would add to the present maze of U.S. tax rules other foreign rules and radical new theories. Business does not want to be forced to depend on legislative history to explain theories too difficult to explain in the statute. It is not necessary to say. "effectively connected" to make clear our objection. To sum up: It is our hope that your committee will make a thorough study of the provisions of this bill which go beyond its stated pur- pose. We ask that you give careful consideration to the many ex- cellent statements filed with you regarding the defects and harmful features of this bill as it affects U.S. exports. The provisions of H.R. 13103 which are aimed at U.S.-owned foreign corporations selling U.S. products abroad would further dis- criminate against export of U.S. products. It is vastly complicated; unworkable tests applicable to income of foreign corporations from their sales abroad of U.S. products would result in confusion and end- less dispute, and to what end? We again emphasize that the Ways and Means Committee report shows no tax revenue from these o'b- jectionable provisions. If it is clear that it will have a harmful effect on our economy and will produce no revenue, why should they be enacted? The Foreign Investors Tax Act of 19f36 could accomplish its stated purpose with- out these provisions as was done in the original bill H.R. 5918. If your committee weighs the facts and arguments against the radical new theories which these provisions would implant in our tax law, we believe you will conclude that they are not desirable and should not be enacted. U.S. tax incentives for exports are needed, not U.S. tax penalties on U.S. exports. Thank you. (Mr. Seghers' prepared statement follows:) STATEMENT OF PAUL D. SEGHERS, PRESIDENT, INSTITUTE ON U.S. TAXATION OF FOREIGN INCOME, Ixo. SUMMARY OF COMMENTS AND RECOMMENDATIONS 1. This institute heartily agrees with the oft-stated purpose of this Bill-to afford tax incentives for investment in the United States by foreigners. 2. Our objection is to the provisions in this Bill which would impose further U.S. tax burdens on U.S. foreign trade, especially U.S. manufacturers exporting their products for sale through foreign subsidiaries. 989 PAGENO="1000" 104 FOREIGN INVESTORS TAX ACT OF 19 66 3. Despite the substantial improvements in the language of the latest Bill con- cerning foreign income "effectively connected" with business activities in the United States, we insist that that theory is wrong in principle and will have ad- verse effects on the U.S. economy. 4. To avoid further handicapping U.S. concerns engaged in foreign trade, it is essential, if the "effectively connected" theory is retained, to provide that this theory is not to be applied to foreign corporations majority-controlled by U.S. persons. We make no alternative recommendations for improving these very complicated and troublesome provisions, as the one change we recommend will be sufficient to eliminate the harm to U.S. business engaged in foreign trade. 5. The House Ways and Means Committee report on HR. 13103 (p. 7) shows that its "effectively connected" provisions would produce no tax revenue. Hence, there is no revenue barrier to deter eliminating this complicated source of un- certainty and endless disputes and difficulties. 6. The proposed radically new provisions for disallowance of credit for foreign income taxes would, in certain circumstances, result in severe and unjustifiable hardship through double taxation, even if the "effectively connected" provisions were limited as recommended above. 7. We are convinced that the stated objectives of this Bill could be achieved by the use of very much simpler and more direct language, and doubt that the present provisions of H.R. 13103 regarding U.S. income and activities of foreign~ owned foreign corporations would go far towards accomplishing its stated purpose. 1. Stated purpose of H.R. 13103 is heartily appreced * This institute heartily approves of the oft-repeated purpose of H.R. 13103 (and its predecessors, H.R. 5916 and H.R. 11297)-"to increase foreign investment in the United States," as expressed in the Treasury Department's March 8, 1905, statement. This purpose was again stated in the report on H.R. 11297 published by the House Ways & Means Committee for the use of its members, as follows: "4' * * to modernize the present U.S. tax treatment of foreigners and to en- courage foreign investment in the United States * * * by removing tax barriers to such investment." In its report on the present version of this proposed legislation (H.R. 13103) the House Ways & Means Committee is less specific in stating the purpose to encourage foreign investment in the United States and has restated the modified purpose of the bill as: - "u * * designed to increase the equity of the tax treatment accorded foreign investment in the United States." With both stated purposes we are thoroughly in accord. What concerns us is the provisions in the present bill which would place new and previously believed to be impossible burdens of U.S. income tax on income earned abroad by foreign corporations, particularly those selling abroad U.S. products of U.S. parent com- paities. fust why such sales are the special target of attack, we can not under- stand. 2. Objection to use of Hil. 13103 to burden our foreign trade H.R. 11297 would have constituted an oppressive burden on U.S. foreign trade. While H.R. 13103 goes far to avoid this evil, it still presents a threat to all U.S.- owned foreign subsidiaries engaged in foreign trade, especially in the case of U.S. manufacturers exporting and selling theii~ products abroad through such subsidiaries. Such added burden is in no wise consistent with the purpose of affording incentives for foreign investment in the United States, nor with efforts to encourage export of U.S. manufactured products. Comments regarding specific ways in which this Bill would imposu added bur- dens on U.S. businesses engaged in foreigh trade are given in statements filed with your Committee by other organizations. We make no comments or recommendation herein regarding the possibly ad- verse effects of H.R. 13103 on foreign-owned foreign corporations. We are con- cerned here only with its adverse effects on U.S. business and the U.S. economy. 3. The radical new "effectively connected" theory is wrong in principle The feature of H.R. 11297 which led to a storm of protest against that version of the proposed legislation was the fact that it would have subjected foreign cor- porations to U.S. tax on income earned by them outside the United States by broadly applying the radical new "effectively connected" theory. That theory seems to be that every foreign corporation should pay U.S. tax on all ipeome 990 PAGENO="1001" FOREIGN INVESTORS TAX ACT OF 1966 105 it earns anywhere in the world o~utside the United States, if such income is "effectively connected" with business activities by it in the United States. Although H.R. 13103 has substantially modified and restricted the application of this "effectively connected" theory, it still pervades the Bill, the phrase being repeated scores of times throughout the first 63 of its 82 pages. The exact mean- ing of this phrase defies definition. It is so vague that it would cause endless uncertainty, confusion and disputes. This is one point on which all who have examined this Bill and its predecessor agree. We believe that no amount of "legislative history" could adequately cure this defect. One of the serious defects in this respect is that H.R. 113103 apparently would tax all of any item of income earned abroad which was "effectively connected" with certain United States activities of a foreign corporation, without regard to the e~vtent that such income was "attributable" to those activities. This is contrary to the intention clearly expressed in the House Ways & Means Committee report, to limit the application of the "effectively connected" theory so as to tax only so much of the foreign earned income as is attributable to activities in the United States. (p. 16) However, in its present form, H.R. 13103 makes no provision for any allocation, but would levy the tax on an "all- or-nothing basis. This will be confirmed in statements filed by others with your Committee. 4. Recommended limitation of application of the "effectively connected" theory so as to ceclude U.S. controlled corporations In order for this Bill `to afford U.S. tax incentives to foreign investment in this country, application of the radical new "effectively connected" theory to U.S. owned and controlled corporations is not necessary; would be harmful; and should be eliminated. This could be accomplished by `substituting for the presently proposed new IRC Sec. 882(b) the following: "SEC. 882. IuvoME OF FOREIGN C0RP0nATI0N5 CONNECTED WITH UNITED STATES BUSINESS.- * * * * * (b) Gnoss INCOME.- 1. In the case of foreign corporation 50 percent or more of the stock of which is owned, directly or indirectly, by United States persons (as defined in Section 957(d)), gioss income includes only gross income from sources within the United States and, 2. In the case of all other foreign corporations, gross income also shall in- clude gross `income from sources~ without the United States which is ef- fectively connected with the conduct of a trade or business within the United States. The foregoing proposed provision would take away from foreign investor- owned foreign corporations no benefits which they would be able to obtain under the present provisions of H.R. 13103. Another, simpler method to accomplish exactly the same purpose, with fewer changes in wording and cross-references, would be to reword the proposed new Sec. 864(c) (4) (*C) (page 16 of `the Bill a's introduced) as follows: "(C) No income, gain, or loss from sources withOut the United States shall be treated as effectively connected with the conduct of a trade or business within the United States if it either-(i) is derived by a foreign corporation, more than 50% owned, directly or indirectly, by 15.5. persons, or (ii) is subpart F income within the meaning of section 952(a)." 5. No revenue considerations to bar elinvi'nation of the "effectively connected" prorision~ of H.R. 13103 The Ways & Means Committee report on H.R. 13103 (p. 7) shows that its "ef- fectively connected" provisions would produce no tax revenue. Hence, the need for tax revenue can not be used as an argument against the elimination of this complicated source of uncertainty and endless disputes and difficulties, with all its undesirable features. 6. Proposed disallowance of credit for uncertain foreign income ta~res H.R. 13103 would disallow credit (or deduction)' for foreign income taxes im- posed on a foreign corporation if- (1) Such taxes were imposed by reason of its place or organization or domicile, or 991 PAGENO="1002" 106 FOREIGN INVESTORS TAX ACT OF 1966 (2) Such taxes were incurred as a result of steps taken for tax saving reasons. A mere statement of these tests should be sufficient to condemn them. The first test would penalize the payment of foreign taxes imposed by a foreign government on a foreign corporation on the same basis as the United States has always claimed jurisdiction to tax corporations organized in this country. The second test is purely subjective and would subject a foreign corporation to double taxation on the basis of what it might have done, rather than what it did. Others will present to this Committee more specific comments and recommenda- tions regarding this proposed foreign tax credit disallowance, which would be in addition to all existing restrictions and limitations on the amount allowable as `a foreign tax credit. We ask this question: In what way would this provision for the disallowance of credit (or deduction) for uncertain foreign income taxes, operate as an in- centive for foreign investment in the United States? 7. Desirability of simplification of language and coincepts. Doubt as to attrac- tiveness to foreign investors of proposed income tan proDinions We believe that `the stated objectives of this Bill could be attained more satisfactorily by the use of much simpler and well-recognized principles. If it is desired to make radical changes in the half-century old'principle of source of income, that should be considered separately, on its merits. We doubt that, on balance, the income taw provisions of H.R. 13103 will afford much incentive to foreign investors. It is beyond the scope of this statement to labor further these points. We will only add that no U.S. business man relishes the need for a legal opinion as to the possible tax consequences of every export shipments of goods to or by a subsidiary. Senator ANDERSON. Thank you very much. I am sorry we were so late. Mr. Page, do you want to testify tomorrow or now ~ Come right ahead. Mr. Seghers, I was glad to hear you refer to that New York docu- ment. I read it yesterday, and I thought it was a very good piece of work. STATEMENT OP WALTER H. PAGP~ REPRESENTING THE NEW YORK CLEARING HOUSE ASSOCIATION; ACCOMPANIED BY DAVID LIND- SAY, OOUNSEL TO MORGAN GUARANTY TRUST CO., OP NEW YORK Mr. PAGE. Senator Anderson, my name is Page, Walter Page. I am executive vice president of the Morgan Guaranty Trust Co., of New York, in charge of their international business. My bank is a member of the New York Clearing House Association, and I am rep- resenting the clearinghouse here. I have with me Mr. David Lindsay, counsel to my bank. The New York Clearing House is made up of 10 banks which are listed as an `appendix to this statement I have filed. Senator ANDERSON. I will just say to you, Mr. Page, you did well to bring Mr. Lindsay along. He was with the Treasury for many years and was very kind to this committee and we have great respect for him. Mr. PAGE. Thank you. I am very glad he is here. Senator, I will not read my statement here. I `do want to emphasize that the New York Clearing House very strongly opposes `the two provisions which will impose taxes on bank deposits. One is the estate tax which would be effective immediately upon enactment of 992 PAGENO="1003" FOREIGN INVESTORS TAX ACT OF 1966 107 this bill, and second is the income tax which will become effective as recommended in this bill in 1972. Senator ANDERSON. Did you hear the questions that I raised earlier today? Mr. PAGE. I did indeed, sir. Senator ANDERSON. Would you think, if those two items were taken out, there still would be a bill worth passing? Mr. PAGE. I do not know that I am qualified to answer the major questions which Mr. Seghers has just detailed or summarized to you. Senator ANDERSON. Well, the problem comes to this: Should the Finance Committee of the Senate try to bring out a bill without those two sections in it, since there is a great deal of objection to it, and consider those more thoroughly at a later date? Mr. PAGE. Yes, I think that the Finance Cominittee, perhaps, should look at this bill very carefully. Certainly the original purpose of this bill to increase foreign investment in the United States is something that I, myself, representing my own bank, would be very much in favor of. I do know that these two taxes on bank deposits can have a very bad effect on our balance of payments. I am not sure I have fully followed your question there, Senator, fully answered it. Senator ANDERSON. In politics sometimes you have to take the best solution you can find. Mr. PAGE. Yes. Senator ANDERSON. If a great many people are opposed to H.R. 13103 because of these two items you have mentioned, and they were to be taken out of the bill, would there still be something worth salvag- ing in the bill? Mr. PAGE. For myself and my own bank, I would say we would be in favor of its passage, of taking out these provisions I mentioned and a further look at this "effectively connected" concept. Senator ANDERSON. Is your manuscript there in such shape that the reporter can handle it and put it in `the record as if read? Mr. PAGE. I am not sure I heard. Senator ANDERSON. Can the reporter take your manuscript and put it in the record as if read? Mr. PAGE. We have already filed it with the committee. I would like to expand on one thing. Senator Talmadge earlier mentioned the figures of bank deposits and Secretary Fowler mentioned a figure of $2.5 billion as the bank deposits from foreigners in the United States which would be affected `by this bill. The New York Clearing House, the 10 member banks, have each reported confidentially to the clearinghouse their own figures. These total approximately $1.9 bil- lion. Of that $1.9 billion, $1 billion is of individuals, foreign indi- viduals, deposited in these 10 banks in New York on which interest is paid. Another $400 million is the demand deposits from foreign in- dividuals in New York banks on which no interest is paid, of course. A further half a billion dollars, $500 million, is from foreign corpora- tions and other private entities abroad, not foreign central banks or official institutions. That makes up the $1.9 billion in these 10 banks in New York. We have no firm figures on the total for the country, but obviously it is going to be considerably in excess of the figures in New York. I do want to. make one other point, Senator, which is in my mem- orandum, but which has not been mentioned this morning. Senator 993 PAGENO="1004" 108 FOREIGN INVESTORS TAX ACT OF 196.6 Dirksen has proposed an amendment to this bill which would ef- fectively amend the Interest Equalization Tax Act. This would en- able th~ foreign branches of American banks to make dollar loans without regard to the interest equalization tax. Today, whether we make-an American bank-makes a dollar loan from the United States or from its foreign branch, it is subject to the interest equaliza- tion tax in the same way. But American banks have a considerable amount of dollars deposited in their branches abroad which are for- eign source dollars. We feel that it would be of benefit to the balance of payments if we were allowed, in foreign branches of American banks, to make dollar loans of a year or more where the interest equalization tax would not affect it, so that we would be in full competitive stance with our foreign bank competitors. We feel that this would also help the balance of payments because ~ck~e have a very heavy demand from the foreign subsidiaries of American companies for 2-, 3-, or 4-year term loans abroad which we cannot now make without being subject to the additional tax penalty of the JET. We feel this is a step which would help the balance of payments today, and enable the American-owned subsidiaries abroad to further de- velop without any drain on our balance of, payments, and in fact, by that development, send further earnings back here. This is detailed in our statement here. We have a lot of figures. I might mention one other point. Senator Talmadge particularly asked Secretary Fowler, or perhaps you did also, sir, as to what coun- tries the theoretical depositor from Latin American countries might move his deposit to avoid estate and income tax. ` There are many in this world. Perhaps we should really concentrate on the developed countries because I do not believe that the depositor would put his money in a very small country which had no stability. But effectively we be- lieve that the taxes are such in the United Kingdom, in Belgium, in France, and in Germany that he would not be subject to income tax or estate tax if he `held his deposit in dollars in those countries which certainly opens a big field for him. Senator ANDERSON. Yes, I know. Mr. PAGE. I believe that is all I need to say. (Mr. Page's prepared statement follows:) SUMMARY STATEMENT OF WALTEN H. PAGE, FOR THE NEW YORK CLEARING HOUSE AsSocIATIoN ON H.R. 13103 1. Bank Deposits.-Two provisions of H.R. 13103 relating to bank deposits are not believed to be in the best interests of the United States. One would subject bank deposits held here by non-resident alien individuals to United States estate taxes, effective upon enactment. The other would subject interest earned on bank deposits held here by non-resident aliens to income tax with- holding, effective in 1972. These provisions seem irreconcilable with present day international financial policies, would, it is believed, have a detrimental effect on the United States Balance of Payments and are not likely to produce significant revenue or achieve meaningful tax equity. 2. Feceign Bra'voh~ Loa7vs.-The New York Clearing House Association sup- ports the Dirksen Amendment, amendment No. 717 to H.R. 13103, which would allow the President to exempt dollar loans made by foreign branches of United States banks from the interest equalization tax. The amendment would sup- port the Administration's balance of payments program that encourages the financing of foreign subsidiaries of U.S. corporations out of funds located abroad. 994 PAGENO="1005" FOREIGN INVESTORS TAX ACT OF 1966 109 STATEMENT OF WALTER H. PAGE, FOR THE NEW YORK CLEARING Housn ASsocIATIoN ON H.R. 13103 Mr. Chairman, and gentlemen of the Committee, my name is Walter H. Page. I am Executive Vice President of the Morgan Guaranty Trust Company of New York, a member of the New York Clearing House Association. I have with me Mr. David A. Lindsay, counsel to my bank. We are appearing for the New York Clearing House Association which consists of ten member banks, listed at appendix A, attached to my prepared statement. I. PROVISIONS AFFECTING BANK DEPOSITS-ESTATE AND INCOME TAX H.R. 13103, the Foreign Investors Tax Act of 1966, contains two provisions relating to bank deposits held in the United States by non-resident aliens which: (1) Represent a reversal in long standing policy; (2) Are irreconcilable with the urgent present day international financial policies and interests of the United States; and (3) Are inconsistent with the purposes underlying the administration's original impetus for the Bill and are not likely to accomplish effectively their present purpose. 1. Provisions described and stated purpose One of these provisions would be subject bank deposits held here by non- resident alien individuals to United States estate taxes on the death of such non-resident alien individuals. This provision is proposed to have immediate effect upon enactment. The other provision would subject interest earned on bank deposits held here by non-resident aliens, individual, corporate and institutional (excepting foreign central banks and governments and international institutions) to income tax withholding, effective in 1972. The Congress deliberately exempted such in- terest from tax (and the bank deposits from the estate tax) in the case of non- resident aliens in the Revenue Act of 1921. The proposed changes are made in the name of "tax equity." One can under- stand their appealing logic. Residents are~ taxed on these items. Why exempt non-resident aliens? The difficulty is that bank deposits can be readily moved out of the United States or even if kept here can be insulated (in ways beyond the control of domestic banks) from the reach of the Commissioner of Internal Revenue. The proposed new tax provisions affecting bank deposits simply will not catch the sophisticated dollar holder. They will, on the other hand, have detrimental effects on the balance of payments and the control of the U.S. authorities on our own currency. 2. Effect of provisions on dollar deposits The estate tax provisions would have the most immediate impact. According to a confidential survey by the New York Clearing House Association its ten member banks hold almost $1.4 billion of deposits for non-resident alien in- dividuals of which about $1 billion are on a time deposit and about $400 million on a demand deposit basis. The aggregate for all banks in the United States is considerably higher. All of these deposits would be potentially affected by the estate tax provisions. Because of the threat of the present bill some such deposits have already been removed and steps have been taken to move addi- tional ones. The removal of these deposits can be accomplished simply and quickly. It is, therefore, hard to imagine that this estate tax provision will produce significant revenue to the United States or achieve meaningful tax equity. The proposed delayed tax on interest earned on domestic dollar deposits of non-resident aliens potentially affects all interest bearing savings and time deposits (including certificates of deposit) in the U.S. exclusive of so-called "official" accounts. As far as the ten member banks of the New York Clearing House are concerned, the total of these deposits is about $1.5 billion and, again, the total for all U.S. banks is considerably higher. The delay was no doubt adopted in light of problems concerning our balance of payments and gold problem. The provisions, therefore, may be characterized as a red flag or warning to foreign depositors of the present intent of this country as to future action. Again, because of the fluid nature of bank deposits, the income tax pro- visions would probably have little or no revenue impact even if effective imme- diately upon enactment. The delayed impact is most difficult to measure, but certainly any movements thereby induced will be in the wrong direction, and increasingly so, as the deadline approaches. 995 PAGENO="1006" 110 FOREIGN INVESTORS TAX ACT OF 1966 3. Effect of provisions on U.S. balance of payments and monetary policy One direction which these domestic dollar deposits may go because of these tw.o provisions in the proposed Act is into investments abroad in other cur- rencies. This would involve the sale of dollars in foreign exchange markets with the bulk of them ending up in the dollar holdings of those central banks that are gaining reserves. In this manner they become a potential claim against the United States gold reserve. Another direction which the domestic dollar deposits may go is the Eurodollar pool. This would remove these dollars effectively from the control and reporting procedures of the United States and their employment would, thereafter, not necessarily be in accord with U.S. monetary policy. Also some of the funds in the Eurodollar pool are used in a manner involving temporary conversion into foreign currencies. This could create a claim against the U.S. gold reserve as in the case of foreign currency investments that I mentioned before. 4. Conclusion We feel that these two provisions of the Bill are not in the best interests of the United States. The delay in the income tax provisions only slightly mitigates its adverse effect. Capital in this world is notoriously timid; it very sedlom goes where it is not wanted. With the warning of future action advertised to the world very little new money will enter and we think a lot will leave well before the end of Decmeber, 1971. Both of the taxes proposed are new in concept, not in accordance with the Fowler Committee Report, and would, we think, have a detrimental effect on the United States balance of payments. TI. AMENDMENT NO. 717 TO H.R. 13103-LOANS BY FOREIGN BRANCHES OF COMMERCIAL BANKS REPAYABLE IN DOLLARS The New York York Clearing House Association supports the Dirksen Amend- ment, amendment No. 717 to H.R. 13103, which would allow the President to exempt dollar loans made by foreign branches of United States banks from the interest equalization tax. In the present situation where United States business abroad in cooperation with the Department of Commerce is exploring every avenue to finance expansion without a drain on the United States balance of payments it seems obvious that this source of foreign financing should not be severely handicapped by a 1% tax penalty. The Voluntary Restraint Program as applied to banks by the Federal Reserve as well as the reports made weekly and monthly by foreign branches of United States banks to the Federal Reserve ensure that this exemption will not be abused. Extending and expanding the principle of flexibility originated in the Gore Amendment to the lET which allows the Executive to move quickly in this fluid area, seems appropriate. We, therefore, feel that this amendment should be adopted as part of H.R. 13103. A detailed memorandum on its purposes is attached. MEMORANDUM EXEMPTION FROM INTEREST EQUALIZATION TAX FOR DOLLAR TERM LOANS FROM FOREIGN BRANCHES OF U.S. BANKS We feel it is in the best interests of the United States to exempt from the Interest Equalization Tax U.S. dollar loans made by the foreign branches of U.S. banks regardless of maturities involved. We believe that this exemption should be attained because it would' be of considerable net benefit to the U.S. balance of payments. The present application of this tax restricts the activities of American bank branches in a business that is desirable from a balance of pay- ments point of view and it shifts this business to their foreign competitors. It limits the ability of the American branches to provide a type of financing that the Department of Commerce recommends the U.S. corporations as being in the interest of its balance of payments program. These dollars are, of course, those deposited in the foreign branches of U.S. banks by foreign owners. In the past some authorities have worried that ex- empting foreign branch dollar loans from the lET would mean that the head offices of American banks would channel some of their domestic funds to tb~r foreign branches to make these loans. This channel is now blocked by the ~4- eral Reserve Voluntary Restraint Program and the weekly reports to the Treasury made on form 3953. On the positive side, we feel that the foreign branches of U.S. banks are one of the primary sourees looked to by U.S. corporations to finance their operations and 996 PAGENO="1007" FOREIGN INVESTORS TAX ACT OF 1966 111 expansions abroad. The foreign branches of U.S. banks have been confronted during the past year with a heavy demand for Eurodollar loans with maturities of up to five years. This demand has come primarily from U.S. corporations and their European subsidiaries because of the Department of Commerce Restraint Program. Would-be borrowers have been looking for these loans because these maturities best fitted their cash flow from foreign earnings; because of the ease and often lower cost of making bank loans as compared to public bond issues; and their reluctance to sell convertible bond issues. The foreign branches of U.S. banks have been unable to meet this demand in a meaningful way because the Interest Equalization Tax represented too much of an additional cost. To some extent their place has been taken by foreign banks that are not subject to the tax. Earnings on such loans have .accrued to these foreign banks instead of to the U.S. banks and the U.S. balance of payments. There is another way in which increased ability to make dollar, bank loans out of foreign branches would be beneficial to the U.S. balance of payments. In the Eurodollar area the foreign branches of U.S. banks do not in general lend for long maturities against short deposits. Therefore, the ability to make long loans would be an important incentive to induce depositors to lengthen, their maturities with the foreign branches. This in turn would delay the point where these funds could become a claim on U.S. gold. It is true that foreign branches may now make loans, in foreign'currencies free of the lET. -However, the banks have not been able to, make effective use of this exemption for foreign currency loans. Deposits in branches of U.S. banks are largely in dollars and it is not possible to swap these dollars into foreign currencies for sufficiently long maturities. American branch banks, overseas attract only limited amounts of longer term foreign currency deposits because: 1) the majority of clients are subsidiaries of U.S. companies operating to a large extent in borrowed funds and remitting dividends, now in larger percentages, to parent companies; 2) truly international, non-U.S. sources tend to hold their excess funds in U.S. dollars, and 3) local companies, except as they have exten- sive dollar oriented business, tend to deal with native banks. We would like to mention also that the ability of U.S. subsidiaries to obtain medium-term Eurodollar loans could become even more important if local cur- rency loans in developed countries become further restricted by market condi- tions or government restrictions. As an example, the Bank of England has restricted the sterling borrowing of foreign owned companies but at the same time has indicated permission for Eurocurrency borrowings under certain conditions. APPENDIX A. THE Nnw YORK CLEARING HousE ASSOCIATION MEMBER BANKS The Bank of New York. The Chase Manhattan Bank. First National City Bank. Chemical Bank New York Trust Company. Morgan Guaranty Trust Company of New York. Manufacturers Hanover Trust Company. Irving Trust Company. Bankers Trust Company. Marine Midland Grace Trust Companyof New York. United States Trust Company of New York. Senator ANDERSON. Thank you very much. Do you have any comment to make, Mr. Lindsay? * Mr. LINDSAY. No comment. Senator ANDERSON. Thank you. I am sorry you had to wait so long. We will recess until 10 o'clock tomorrow morning. (Whereupon, at 12:35 p.m., the committee recessed, to reconvene at 10 a.m., Tuesday, August 9, 1966.) 997 PAGENO="1008" PAGENO="1009" FOREIGN INVESTORS TAX ACT OF 1966 TUESDAY, AUGUST 9, 1966 U.S. SENATE, COMMITrEE ON FINANCE, Washington, D.C. The committee met, pursuant to recess, at 10 a.m., in room 2221, New Senate Office Building, Senator Russell B. Long (chairman) presiding. Present: Senators Long, Douglas, Talmadge, Williams, and Carison. The CHAIRMAN. This hearing will come to order. Most of the witnesses scheduled to appear today have decided to submit statements for the record instead of appearing personally. Others have had difficulty with air transportation, and that leaves only two witnesses to be heard today. Our first witness is Mr. Alfred W. Barth, executive vice president of the Chase Manhattan Bank in New York. Mr. Barth, we are happy to welcome you here today, and we will be pleased to hear your statement. Senator CARLSON. Mr. Chairman, I would like to state that I had some difficulty with air transportation. I was supposed to speak in Boston at the National Association of Postal Supervisors at 11 o'clock. I got to the airport and the flight was canceled because they could not land at Boston this morning, so here I am at the hearing where I am happy to be. The CHAIRMAN. After reading some of your writings on the bal- ance-of-payments problem, Mr. Barth, I must say that I felt as though I was much better informed. I am not sure that you succeeded in informing me completely, but I am a lot better informed than I was before I read your writings. STATEMENT OF ALFRED W. BARTH, EXECUTIVE VICE PRESIDENT, THE CHASE MANHATTAN BANK; ACCOMPANIED BY STUART E. KEEBLER, COUNSEL Mr. BARTH. Thank you, Mr. Chairman. Mr. Chairman and members of the committee, my name is Alfred W. Barth, I am an executive vice president of the Chase Manhattan Bank in New York. I have with me Mr. Stuart E. Keebler, counsel to my bank. I am appearing here in my capacity as chief executive officer of the international department of that bank. While H.R. 13103 has many excellent features, I believe my deep concern over certain provisions of the proposed Foreign Investors Tax Act of 1966 is shared by many others with experience in international banking. 113 71-297 0-67-pt. 1-64 PAGENO="1010" 114 FOREIGN INVESTORS TAX ACT OF 1966 I understand that ot.her witnesses have already testified before this committee in connection with the provisions of ELR. 13103 concerning income taxation of bank deposit interest earned by nonresident f or- eigners and estate taxation of such deposits. My full statement has already been filed with the committee. In order to conserve the time of the committee I propose this morning to summarize the portion of my prepared statement regarding deposits. Thereafter, I would like to return to my prepared statement to invite the committee's attention to a matter involving the application of the interest equalization tax to U.S. dollar loans of foreign branches of U.S. banks. My general conclusion as to the proposals on bank deposits is a simple one-these deposits can easily be withdrawn from U.S. tax juris- diction, therefore escaping the tax burden, and such withdrawal un- doubtedly will harm our international financial position, add to the strain on our gold stock, and hurt our domestic economy. We are dealing with large amounts. The proposed change in tax treatment would, in our estimate, directly affect $2 to $21/2 billion of deposits. Once these deposits are shifted to a foreign bank abroad, that bank will, in turn, almost surely lend them to foreigners. The foreign borrowers are all too likely to convert the dollars into local currency. The dollars thus will end up in the hands of foreign cen- tral banks which can turn them in to the U.S. Treasury for gold. I know from personal conversations with customers abroad that our foreign banking competitors are already seizing upon the provisions of H.R. 13103 as a lever for encouraging the transfer of deposits to them. I cannot forecast precisely the time and volume of deposit with- drawals, but I do feel certain that significant withdrawals will occur. I would like heartily to endorse the proposal that the provisions relating to bank deposits of nonresident foreigners not doing business in this country be deleted from the bill. I would like now to direct your attention to the interest equaliza- tion tax matter and turn to my prepared statement starting at the bottom of page 7. Under the terms of an Executive order issued on February 10, 1965, the interest equalization tax was extended not only to certain foreign loans made by banks in the United States, but also to loans in U.S. dollars with maturities of 1 year or more made by branches of U.S. commercial banks abroad to foreign obligors. The extension of the interest equalization tax to these foreign branch loans not only impairs the competitive position of those branches, but, at present, demonstrably works at cross-purposes to the President's overall bal- ance-of-payments program. I understand that the Treasury Depart- ment has taken the position that this matter can only be resolved by legislation, since `under the terms of the Interest Equalization Tax Act the `terms of the existing Executive order cannot be appropriately relaxed. Our foreign branches, in competition with foreign banks, have ac- cess to foreign funds in the form of Euro-dollars, or more properly called external dollars. The acquisition of these deposits already in foreign hands does not affect our balance of payments. The trouble is these potential deposits cannot at present be utilized by our branches to their best advantage-or to the best advantage of the United States. 1000 PAGENO="1011" FOREIGN INVESTORS TAX ACT OF 1966 115 American-owned business enterprises abroad are understandably unwilling to incur the additional cost of reimbursing our branches for the interest equalization tax on dollar loans maturing in 1 year or more. As a result, our branches are in effect prevented from mak- ing such loans to these firms, which in the normal course of events would be the prime customers of these branches. Naturally, a bank can accept deposits and pay competitive interest rates thereon only if the funds so deposited can be loaned to customers at a proper rate of return. Consequently, the effect of the interest equalization tax on foreign branch loans is to cause our foreign branciies to refuse to accept certain dollar deposits from foreigners which, in the absence of tax, could be used to make term loans to the subsidiaries of U.S. businesses. My own experience is that many millions of U.S. dollar deposits ~from foreign sources for maturities ranging to a year or more have had to be turned down-despite the needs of U.S.-owned firms for fore.ign money-because of the inability to use these medium- term deposits to make loans for which there is a heavy arid unfulfilled demand. The existing exemption from interest equalization tax for foreign branch loans made in foreign currency is not of practical significance, since our branches abroad normally can attract only limited amounts of foreign currency deposits. Moreover, because of the impossibility of covering the foreign exchange risk over a series of years, it is not feasible for our foreign branches to take U.S. dollar deposits from foreigners and to convert such dollars to foreign currency for the purpose of making loans, even if the potential borrrower itself is willing to borrow in a foreign currency. As a result, U.S. subsidiaries, urged by the Government to finance their foreign operations to the maximum extent feasible from foreign sources of funds, have been forced to turn elsewhe1~e. As you know, European capital markets are poorly developed and very congested, and indigenous foreign banks are already unable to meet fully the needs of their own domestic customers. The consequence is growing doubts over the ability of U.S. firms to complete their foreign borrow- ing programs. Branches of American banks could make a significant contribution toward breaking this impasse if they are freed from the interest equalization tax. Removal of the tax would permit us to seek medium- term dollar deposits from foreigners freely in competition with indi- genous banks, and to place those funds at the disposal of our borrow- ing customers, who are primarily U.S.-owned concerns. As a result, without any transfer of funds from the United States, the total financ- ing available to U.S. firms abroad would undoubtedly increase, to t.he direct benefit of our balance of payments. I should emphasize that removal of this tax from our foreign branches would be fully consistent with the voluntary balance-of- payments program. The Federal Reserve System, in conducting the voluntary restraint program for banks, has fully and repeatedly rec- ognized that the loaning by our foreign branches of dollars already located abroad is not detrimental to this country. More than that, to the extent these loans enable businesses to reduce transfers from the United States, the balance of payments will be improved. Presumably, the tax was originally extended to foreign branches to provide assurance that U.S. banks did not themselves transfer funds 1001 PAGENO="1012" 116 FOREIGN INVESTORS TAX ACT OF 1966 abroad to make loans taxable in the United States. That theoretical possibility has now been effectively closed by the fact that U.S. com- mercial banks can make advances to their foreign branches only within. the restrictive limits of the Federal Reserve balance-of-payments guidelines. Frequent and periodic reports provide positive protection against any possible abuse. In conclusion, I would like to express my strong approval of the proposed amendment to H.R. 13103 which was presented to the com- mittee on August 2, 1966, amendment No. 717. The amendment to be proposed would permit the President to exempt from interest equali- zation tax U.S. dollar loans made at foreign branches of our banks. I understand that this proposed amendment would grant discretion to the President to reimpose the tax should he feel, contrary to all ex- pectations, that the exemption is in any way abused. I feel confident that in view of the sizable potential benefits to the balance of pay.- ments, the President will in fact permit this exemption, and I respect- fully urge that this proposed amendment be adopted. Thank you, Mr. Chairman. (The prepared statement of Mr. Barth follows :`) SUMMARY STATEMENT OF ALFRED W. BARTH, IN REGARD I'O H.R. 13103 I. The provisions of H.R. 13103 which would impose income tax and with- holding on bank deposit interest earned by foreigners not doing business in the United States (Sees. 2(a) (1) and 3(g) of the Bill) and estate tax on such de- posits (Sec. 8(d) of the Bill) will have adverse consequences on the financial position of the United States, and should be deleted from the Bill. II. Approval is expressed for a proposed amendment to H.R. 13103 which would authorize the President to exempt from Interest Equalization Tax U.S. dollar loans made at foreign branches of U.S. banks. STATEMENT OF ALFRED W. BARTH, IN REGARD ro H.R. 13103 Mr. Chairman, members of the Committee, my name is Alfred W. Barth; I am an Executive Vice President of The Chase Manhattan Bank (NA.) in New York. I am appearing here in my capacity as Chief Executive Officer of the International Department of that Bank, but I believe my deep concern over cer- tain provisions of the proposed Foreign Investors Tax Act of 1966 on which I will comment is shared by many others with experience in international banking. I would like heartily to urge that the provisions of H.R. 13103 relating to income taxation of bank deposit interest earned by nonresident foreigners and to estate taxation of such deposits be deleted from the bill, and, on the basis of my practical banking experience, to comment as to the adverse consequences which they would have on the financial position of the United States. In addi- tion, I would like to invite the Committee's attention to a closely related matter involving the application of the Interest Equalization Tax to U.S. dollar loans by foreign branches of U.S. banks. I believe an appropriate amendment to the bill now before you would significantly facilitate the current efforts of U.S. businesses to finance their operations abroad, to the benefit of our balance-of- payments position. Adverse consequences of taxation of bank deposits of foreigners in the United E3~tates (sees. 2(a) (1) and 3(g)) of the bill My general conclusion as to the proposals on bank deposits is a simple one- these deposits can easily be withdrawn from U.S. tax jurisdiction, therefore escaping the tax burden, and such withdrawal undoubtedly will harm our inter- national financial position, add to the strain on our gold stock, and hurt our domestic economy. We are dealing with large amounts. The proposed change in tax treatment would directly affect $2 to $2½ billion of deposits. But more significant is the fact that we are dealing with an amount of funds equivalent to 15 to 18% of 1002 PAGENO="1013" FOREIGN INVESTORS TAX ACT OF 1966 117 our entire remaining gold stock, and an amount equal to almost 50% of our remaining gold free of pledging requirements against Federal Reserve notes. Even these figures may understate the problem to the extent that shifts of these accounts may affect other banking relationships as customers move to consolidate their accounts abroad. It is important to note that the amount of deposits directly affected is as large as our entire loss of $2~ billion of gold over the past three years. To the extent that these foreign owned dollars (other than those owned by central banks) are held at offices of U.S. banks here and abroad they cannot be a claim on our gold. However, once these deposits are shifted to a foreign bank abroad, the foreign bank recipients of the dollar deposits will in turn almost surely lend them to foreigners. The foreign borrowers are all too likely to convert the dollars into local currency. As a result of that conversion process a good part of the additional supply of dollars so released is certain to end up in the hands of foreign central banks. The central banks, in turn, can turn them in to the U.S. Treasury for gold. The effect of the proposed tax will be artificially to stimulate the growth of the Eurodollar market at the expense of the dollar deposit accounts now main- tamed by foreigners with U.S. banks. In other words, the tax will stimulate the shift of deposits to foreign banks abroad. Once this occurs there is no way to prevent conversion of the dollars to foreign currency and the possible call on our gold which can result when the dollars come into the hands of foreign central banks. A bank executive responsible for extensive day-to-day international opera- tions, I am made aware continually that U.S. banks no longer are in a unique position to compete for dollar deposits of foreigners. My foreign competitors in important financial centers throughout the world are ready, willing and able to compete for this busiñess. The force of their competition is illustrated by the fact that banks in ten leading foreign countries at the end of 1965 already held some $11~,4 billion of gross dollar jleposits from non-Americans who were not resident in the country of deposit. That total is already several times the volume of time deposits of foreigners in theUnited States. Included among these foreign banks are the foreign branches of U.S. banks. To the extent these branches of U.S. banks recapture the funds shifted from the U.S. the damage will be minimized, for these funds ai~e likely to be transferred back to this country or to be employed in lending to ~thsidiaries of U.S. companies, indirectly helping the balance of payments. But, of course, these branches only account for a fraction of the total, and we can certainly not count on deposits shifted from the U.S. being transferred to those branches. I would hope some of them would be, but, from the standpoint of the national interest, the objective should be to encourage rather than discourage the retention of existing deposits within the United States. I should also point out that, in many instances, foreign banks already benefit from some competitive advantages, such as more liberal regulatory treatment. I am not aware that anyone familiar with international banking contests the conclusion that the proposed taxation will tend to drive the deposits abroad. The Committee on Ways and Means of the House of Representatives itself pointed out in its report on H.R. 13103 that immediate income taxation of bank interest could have "a substantial adverse effect on our balance of payments." The postponement of the effect of the income and withholding tax until aftel 1971 will not solve the problem since it fails to recognize the sensitivity of foreigli depositors to the kind of strong expression of Congressional intent embodied in the bill. I know from personal conversations with customers abroad since the House action that our foreign banking competitors are already seizing upon these new provisions of the bill as a lever for encouraging the transfer of deposits to them. In particular, they are pointing out to our foreign depositors the desirabil- ity of acting promptly to establish and solidify new banking relationships abroad well in advance of the effective date. In the process, the foreign banks naturally have no incentive to emphasize that the proposed income tax effective date is some distance off. Confusion on that point will tend to accelerate transfers, and inevitably some of our foreign customers will interpret the action, whatever its effective date, as a harbinger of a less hospitable climate for these funds in the United States. The application of the estate tax without delay means, of course, that individual depositors have every incentive to move their funds promptly. Naturally, in response to urgent inquiries from foreign depositors contemplat- ing an early transfer, we are doing what we can to dispel confusion and 1003 PAGENO="1014" 118 FOREIGN INVESTORS TAX ACT OF 1966 maintain these relationships, but I fear that, if the Senate supports the House action, our success in this effort is not assured, to say the least. I should also note, in this connection, that our analysis of our own deposit composition offers little or no basis for a belief that tax treaties or foreign tax credits abroad will substantially ease the impact. I cannot forecast precisely the time and the volume of deposit withdrawals. But I do feel certain that significant withdrawals will occur. The situation presented would be analogous to, say, an attempt by one of our states to extend its income tax to interest paid on nonresident bank deposits. The banks in that state would simply lose those deposits. But, of course, the impact of this tax is worse since the consequences are international and not solely internal. The adoption of these provisions would have most unfortunate and unnecessary repercussions on our international gold position, on the position of the United States as a world financial center, and even on our internal economy. The Interest Equalization Ta~r Act sho~ukZ be amended by H.R. 13103 to authorize the President to ezempt dollar loans made at foreign branchea of U.$. banks I would like now to turn to an important Interest Equalization Tax matter, which I believe should appropriately be changed by an amendment to H.R. 13103. Under the terms of an Executive Order issued on February 10, 1965, the In- terest Equalization Tax was extended not only to certain foreign loans made by banks in the U.S., but also to loans in U.S. dollars with maturities of one year or more made by branches of U.S. commercial banks abroad to foreign obligors. The extension of the Interest Equalization Tax to these foreign branch loans not only impairs the competitive position of those branches, but at present demonstrably works at cross purposes to the President's over-all balance-of-pay- ments program. I understand that the Treasury Department has taken the position that this matter can only be resolved by legislation, since under the the terms of the Interest Equalization Tax Act the terms of the existing Execu- tive Order cannot be appropriately relaxed. Our foreign branches, in competition with foreign banks, have access to foreign funds in the form of Euro-dollars. The acquisition of these deposits already in foreign hands does not affect our balance of payments. The trouble is these potential deposits cannot at present be utilized by our branches to their best advantage-or to the best advantage of the United States. American-owned business enterprises abroad are understandably unwilling to incur the additional cost of reimbursing our branches for the Interest Equaliza- tion Tax on dollar loans maturing in one year or more. As a result, our branches are in effect prevented from making such loans `to these firms, which in the normal course of events would be the prime customers of these branches. Naturally, a bank can accept deposits `and pay competitive interest rates thereon only if the funds so deposited can be loaned to customers at a proper rate of return. (Jonse- quently, the effect of the Interest Equalization Tax on foreign branch loans is to cause our foreign branches to refuse to accept certain dollar deposits from foreigners which, in the absence of tax, could be used to make term loans to the subsidiaries of U.S. businesses. My own experience is that many millions of U.S. dollar deposits from foreign sources for maturities ranging to a year or more have `had to `be turned down-despite `the needs of U.S.-owned firms for foreign money-because of `the inability to use these medium-term deposits to make loans for which there is a heavy `and unfulfilled demand. The existing exemption from Interest Equalization Tax for foreign branch loans made in foreign currency is not of practical significance since our branches abroad normally can attract only limited amounts of foreign currency deposits. Moreover, `because of the impossibility of covering the foreign exchange risk over a series of years, it is not feasible for our foreign branches to take U.S. dollar deposits from foreigners and to convert such dollars to foreign currency `for the purpose of making loans, even if the potential borrower itself is willing to borrow in a foreign currency. As a result, U.S. subsidiaries, urged by the Government to finance their foreign operations to the maximum extent feasible from foreign sources of funds, have been forced to turn elsewhere. As you know, European capital markets are poorly developed and very congested, and indigenous foreign banks are already unable to meet fully the needs of their own domestic customers. The consequence is growing doubts over the ability of U.S. firms to complete their foreign borrow- ing programs. Branches of American banks could make a significant contribution toward breaking this impasse if they are freed from the Interest Equalization Tax. 1004 PAGENO="1015" FOREIGN INVESTORS TAX ACT OF 1966 119 Removal of the tax would permit us to seek medium-term dollar deposits from foreigners freely in competition with indigenous banks, and to place those funds at the disposal of our borrowing customers, who are primarily 1J.S.-owned con- cerns. As ~ result, without any transfer of funds from the U.S., the total financing available to U.S. firms abroad would undoubtedly increase, to the direct benefit of our balance of payments. I should emphasize that removal of this tax from our foreign branches would be fully consistent with the voluntary balance-of-payments program. The Fed- eral Reserve System in conducting the voluntary restraint program for banks has fully and repeatedly recognized that the loaning by our foreign branches of dollars already located abroad is not detrimental to this country. More than that, to the extent these loans enable businesses to reduce transfers from the U.S., the balance of payments will be improved. Presumably, the tax was originally extended to foreign branches to provide assurance that U.S. banks did not themselves transfer funds abroad to make loans taxable in the U.S. That theoretical possibility has now been effectively closed by the fact that U.S. commercial banks can make advances to their for- eign branches only within the restrictive limits of the Federal Reserve balance- of-payments guidelines. Frequent and periodic reports provide positive protec- tion~against any possible abuse. In conclusion, I. would like to express my strong approval of the proposed amendment to H.R. 13103 which was presented to the Committee on August 2, 196~3.' The amendment to be proposed would permit the President to exempt from Interest Equalization Tax U.S. dollar loans made at foreign branches of our banks. I understand that this proposed amendment would grant discretion to the President to reimburse the tax should he feel, contrary to all expectations, that the exemption is in any way abused. I feel confident that in view of the sizable potential benefits to the balance of payments, the President will in fact permit this exemption, and I respectfully urge that this proposed amendment be adopted. Thank you, Mr. Chairman. The CHAIRMAN. Let me just ask you this: If we give you this exemption you are asking for here, Mr. Barth, is there something in such an amendment to keep you from transferring money overseas from your parent bank into the branch and then lending it out from the foreign branch bank? Mr. BARTH. Mr. Chairman, the transfer of money from here to the branch is controlled under the guidelines. We have to make a monthly report to the Federal Reserve Board, the Board of Governors of the Federal Beserve, and it is within our present 107 or 108 percent. We cannot exceed that. The CHAIRMAN. So, if I understand your argument on this, you contend that if you are not permitted through your foreign branches to lend the dollars that come into those branches in those European areas, then those dollars are simply not going to come into those branches, for the most part. They will go to someone else's bank, rather than go to your branches. Mr. BARTH. That is right. The CHAIRMAN. And banks of other nations will loan it out. Mr. BARTH. And they will loan it out. - The CHAIRMAN. So that in the last analysis about all that the restric- tion on your branches is doing is just taking business away from Amer- ican branches- Mr. BARTH. And giving it to foreign banks. The CHAIRMAN (continuing). And putting it in foreign banks where this country has no say about what happens to those same dollars. Mr. BARTH. That is correct. ~ Amendment No. 717. 1005 PAGENO="1016" 120 FOREIGN INVESTORS TAX ACT OF 1966 The CHAIRMAN. That term Euro-dollars is a term I had not used a lot. You are talking about American dollars in Europe that are used as American dollars over there? Mr. BARTH. Euro-dollars is a name that was adopted in the late forties when the Russian bank in Paris started *to keep its dollar deposits outside of the United States, and the word "Euro-dollars" really came from the cable address of the Russian bank in Paris, and the cable address is Eurobank. I think a more correct description of Euro-dollars would be to say external dollars, dollars which are out- side of the jurisdiction of the United States. The CHAIRMAN. Are those paper dollars and coins or part of them just credits that somebody writes down on a sheet o~f paper? In other words, I am beginning to learn enough about banking to know that many times what you talk about as dollars is just a number that you write down on one of those ledger sheets in your bank. Does having that many dollars abroad mean that somebody actually has that many dollars in terms of paper ones and paper one hundreds out or does it mean that they have that many dollars overseas in terms of simply credits? Mr. BARTH. Well, Mr. Chairman, the size of the so-called Euro- dollar market according to estimates made by my bank and by the Bank for International Settlements at Basle, the gross dollar deposits in 10 major countries of nonresidents and non-Americans went from $7 billion in 1963 to $11,750 million in 1965. The CHAIRMAN. So those are dollars-let me get this straight in my mind now. That is $11 billion? Mr. BARTH. That is right. The CHAIRMAN. That is in 10 major countries overseas. Does that include Japan or just European countries? Mr. BARTH. This will include Japan, because Japan is a big user of Euro-dollars in the London market. The CHAIRMAN. Yes. So $11 billion held by non-U.S. citizens, citizens of countries other than the United States, citizens of Japan and nine European countries, dollars which could be converted into gold claims in the event that they were taken into the central banks of those countries. Mr. BARTH. That is absolutely right. The CHAIRMAN. I take it that it is to our advantage, however, that *they continue to be used as dollars rather t.han going into the central bank? Mr. BARTH. I should think so, Mr. Chairman. The CHAIRMAN. Now, those countries do have the power to call all those dollars into the central banks, do they not? Mr. BARTH. I do not believe that all countries have, because in Germany, Switzerland, Holland, and Belgium, I believe you have great freedom. in foreign exchange, no foreign exchange restrictions, and I believe for the central banks to call these dollars in they would have to have legislation, but that could be arranged. The CHAIRMAN. Yes. It would take legislation. It would prob- ably be complicated to administer, but most of that they can call into their central banks. Of course, Switzerland would have to drastically change its banking practices to do that, I take it, because they have all sorts of ways of doing business in Switzerland where you just do not know who has 1006 PAGENO="1017" FOREIGN INVESTORS TAX ACT OF 1966 121 the money; is not that about the size of it? The bankers know it, but they do not require the banker to tell the Government. Mr. BARTH. Well, Mr. Chairman, your question is very difficult to answer in this particular case. Obviously, all governments have the right to ask their citizens to turn, in the dollars to the central bank if they want to do that. But I do not think anything would be accom- plished out of that. The CHAIRMAN. In other words, it could be done, but you do not think it will be done by any of these governments. Mr. BARTH. It could be done, but I do not think it will be done. The CHAIRMAN. And, if I understand the burden of your argu- ment, it is that the way the law applies to your foreign branches creates an impact that you doubt we considered when we passed that legislation because it tends to run these U.S. dollars that exist in these European countries and in Japan into other people's banks rather than to let them come into the branches of American banks. Mr. BARTH. Well, far be it from me to say that the law did not get the proper consideration, but I believe conditions have changed since, and the Euro-dollar h'as become much `more important in not only international but American banking business since `1964, and most American banks with branches `abroad have drawn upon their deposits generated by the London office to feed New York, so that New York could make loans to `aid the domestic economy; and, obviously, if we are not `competitive in quoting intere'st rates in London as compared to British or French or Japanese or other banks, we will not get these dollars, not only to aid American subsidiaries abroad, `but to aid ourselves. The CHAIRMAN. I recall very well how we voted the amendment to give `the President the power to extend the interest equalization tax to bank loans. It occurred the same night `that the President made the decision `to strike `back at t'he North Vietnamese in the Gulf of Tonkin, which was a rather important occasion. Most of the Senators were down there at the White House talking with the President about the situation in Vietnam while we were debating the interest equalization tax problem. I do n'ot think their vote ~would have been any different, but the argument h'ad been made for d'ays that the interest equalization `tax was a fraud, and that it was ju'st a gesture, it would not succeed because anybody could evade the interest equalization tax by going through bank loans. After `th'at `argument had been made for awhile, some of us ~ho h'ad been hearing the argument began to say if that i's the case why don't we just close that loophole and say that in `the event that that device is used, then `the President would extend the tax to cover bank loans. But, the problem you `are presenting here, Mr. Barth, was never discussed at all. I do not think it `was discussed. Mr. BARTH. If you will permit me, Mr. Chairman, I would like to give you another example. The CHAIRMAN. Yes. Mr. BARTH. There are many American concerns that have gone into the London Euro-dollar market to float debentures, either straight debentures or convertible debentures, and these debentures are for 10, 15, 18 years. 1007 PAGENO="1018" 122 FOREIGN INVESTORS TAX ACT OF 1966 The financial houses selling these debentures are using the very same dollars that I propose to use to make loans of a lesser duration, and the American subsidiary abroad does not like to be obligated to pay a high rate of interest ad infinitum for 15 or 20 years because it really does not need the money for 15 or 20 years. But we are stopped from helping it for 3, 4, or 5 years, which is really the requirement that it had, because of the interest equalization tax, and yet we are using the same dollars. The CHAIRMAN. `So you would be able to give better treatment to Americans doing business overseas through American branch banks overseas- Mr. BARTH. That is right. The CHAIRMAN. If you were not foreclosed from doing this. Mr. BARTH. That is right. The CHAIRMAN. And it would be better for the American business interests and, of course, it would be better for your bank because you like to do business with those Americans over there. Mr. BARTH. We like to pay taxes, too. The CHAIRMAN. Are you sure about that now, Mr. Barth? Mr. BARTH. Yes, sir. The more business we do the more we can pay. The CHAIRMAN. Thanks so much. Senator Williams. Senator WILLIAMS. In the foreign branches are you allowed to hold gold? Mr. BARTH. I beg your pardon? Senator WILLIAMS. Can you hold gold in your reserves in your for- eign branches? - Mr. BARTH. In the foreign branches we do not; no. We are not allowed by law, but there are certain exceptions made. For instance, we have an affiliated bank in Peru, and they have for years and years and years put their reserves in gold, and we have a license from the Treasury Department to continue that. Then there is another exception in the Persian Gulf where banks are permitted to trade in gold, also under license of the Treasury, but not for their own account. Senator WILLIAMS. I did not understand. Mr. BARTH. They are not allowed to trade in gold for their own account. They are only allowed to finance the trading of gold. Senator WILLIAMS. And, as I understand it, through your branch banks you would not be allowed to arrange a program where you could convert any of these dollars into gold if you wished. Mr. BARTH. No, no; because the gold regulations of the Treasury Department do not apply only in the United States. They touch every American or every American corporation wherever they are. Senator WILLIAMS. That was my understanding. Are you permitted in yäur investment portfolio abroad to buy these bonds that the Treasury is issuing in the foreign countries that are payable in marks or francs or whatever they may be? Mr. BARTH. In our investment portfolio abroad or here? Senator WILLIAMS. Abroad. I know you are not here. Mr. BARTH. Abroad in Germany we will buy some German mark bonds, yes. In France we have to buy French. In Britain we have to buyBritish for reserve requirements or capital requirements. Senator WILLIAMS. I did not q~iite mean that. 1008 PAGENO="1019" FOREIGN INVESTORS TAX ACT OF 1966 123 The Treasury, in order to stop the conversion of dollars into gold, has done some of its financing by borrowing the money, that is, our Government, the U.S. Government, has borrowed, this money abroad, payable in the respective currency of the country over there and, of course, that currency is more or less pegged to the $35 gold. Are you permitted to buy that type of a security through your branches? It is not available to American citizens, I understand. Mr. BARTH. Are we permitted to buy bonds in a foreign currency? Senator WILLIAMS. The Government, the U.S. Government obliga- tions which are issued abroad payable in the currency of their respec- tive countries. Mr. BARTH. Senator, I believe you are referring to the Roosa bonds. We do not. We are not buying those. Senator WU4LIAMs. You are not permitted to buy them? Mr. BARTH. No. Senator DouGLAs (presiding). Senator Talmadge. Senator TALMADGE. Mr. Barth, you state on page 2 of your prepared statement dealing with taxation of bank deposits of foreigners that the proposed change in tax treatment would directly affect $2 to $2i/~ billion of deposits. Mr. BARTH. Yes, sir. Senator TALMADGE. Now, are those the deposits only in State and national banks or does that also include total deposits in State and national banks, mutual savings banks, and the~ savings and loan associations? Mr. BARTH. Senator, as of-I have the official statistics of the Fed- eral Reserve Bulletin of May 1966, and this $2 to $21/2 billion is made up as follows: Unfortunately it is not the deposits only with the Chase Manhattan Bank. These are the deposits in the United States. Time deposits of nonofficial, nonbank foreigners, $1,633 million; time deposits of foreign commercial banks, $740 million; CD's, Certificates of Deposit, of nonofficial2 nonbank foreigners, $100 million; and demand and time deposits subject to possible estate tax proposals estimated at $150 million; which makes a total of $2,473 million. This does not include deposits with savings banks or savings and loan associations, as there may be some. Senator TALMADGE. Would you have any idea how much the total would be in those two instances? Mr. BARTH. I am sorry I do not have that figure. Senator TALMADGE. Would it be a considerable amount or would it be inconsequential? Mr. BARTH. I should think that among the border States it may be considerable. - Senator TALMADGE. Well, then, that would add to the $21/2 billion that you mentioned in your statement. Mr. BARTH. Yes, sir. Senator TALMADGE. And would add to the total possible flight of dollars in the American market. Mr. BARTH. It could well, yes, sir. Senator TALMADGE. Do you have any idea how much of this money might be transferred in the event it was to be taxed immediately under the terms of this bill? 1009 PAGENO="1020" `124 FOREIGN INVESTORS TAX ACT OF 1966 Mr. BARTH. This is very difficult to estimate, but I can tell you of my own experience during the past 2 months, that I have lost two clients to European banks because of the impending legislation. Senator TALMADGE. In your case you could simply let that custonrier transfer his deposits in New York to the Paris bank, without losing `his deposit? Mr. BARTH. No. Unfortunately this went to a bank, a commercial * bank, in another country. Senator TALMADGE. But it could have been withdrawn from your bank and deposited in your branch bank in Paris, could it not? Mr. BARTH. It could have, yes. Senator TALMADGE. However, banks without branch banks such as yours would not have that advantage. Mr. BAWrn. That is right, sir. Senator TALMADGE. Are bank deposits highly mobile in their na- ture; do t.hey seek the highest return at the immediate moment? Mr. BARTH. They are very mobile because they seek higher return and they change, particularly in the external dollar market they change, for a fraction of a percentage point. Senator TALMADGE. Let us take a mythical account. now. Assume some foreigner has $1 million on deposit in your principal bank in New York, and at present you pay him 5½ percent. Mr. BARTH. That is the maximum extent allowed. Senator TALMADGE. That would give him `an income of $55,000 an- nually on his $1 million deposit, would it not? Mr. BARTH. Yes, sir. Senator TALMADGE. Under the terms of this act as passed by the House, if it is adopted, he would pay in 1972, $16,500 in withholding taxes on that $55,000, would he not? Mr. BARTH. That is right. Senator TALMADGE. Assume that he decides to avoid that tax. Could he take that $1 million and transfer it to a bank in Paris? Mr. BARTH. Senator, are you speaking about an American ctitzen or- Senator TALMADGE. A foreign citizen, because this is not applicable to Americans, since it only applies to foreigners. Mr. BARTH. A foreign citizen will most likely move the money out of here. Senator TALMADGE. Then he could take his $1 million out of. your bank in New York and put it in a Paris bank, could he not? * Mr. `BARTH. A foreign citizen could; yes. Senator TALMADGE. What would he get on his certificate of * deposit in the foreign bank? Mr. BARTH. We do not issue certificates of deposit in Paris. Senator TALMADGE~ But do other banks do so? Mr. BARTH. Not in Paris. Certificates of deposit so far have only been issued in London. Senator TALMADGE. Well, what could he do, assuming he wants the highest retrrn he could get, to avoid the tax, assuming he was financially wise? Mr. BARTH. Are we again talking about $1 million for 1 year? * Senator TALMADGE. TTsing the $1 million as a practical example be- cause you can easily figure the interest on it, and what it amounts to. 1010 PAGENO="1021" FOREIGN INVESTORS TAX ACT OF 1966 125 Mr. BAImI. That is right. Well, he could go to a British bank, he could go to a Swiss bank, he could, go to other banks. Senator TALMADGE. Assuming he desires to transfer it to London, what would his interest rate be there? Mr. BARTH. He could do that in London and with a foreign bank, not an American `bank, he cOuld probably get today, instead of 51/2 percent, he probably could get for 1-year money close to 71/4 percent, whereas he would not get this from an American bank operating in London. Senator TALMAIJGE. That would be $72,500, he could earn on his money for 1 year. Mr. BARTH. That is right. Senator TALMADGE. Would that be tax free? ..." Mr. BARTH. This would be tax free; yes, sir. Senator TALMADGE. In other words, if he started off with $55,000 in income, he would be subject to the American tax of $16,500. But by switching his business to a foreign bank in London he could have an income of $72,000; is that correct? Mr. BAImI. That is about right under today's interest rates. Senator TALMADGE. Is that the reason why you state that a sub- stantial portion of this $2½ billion might leave the American banks? Mr. BARTH. Yes, sir. Senator DOUGLAS. Will the Senator yield? Senator TALMALXm. Certainly, I am delighted to yield. Senator DOUGLAS. Mr. Barth, do these foreign countries `have in- come taxes? Mr. BARTH. They do have. Based upon information we have been, able to obtain, the return is not taxable for a nonresident in France nor in Germany. There is no withholding and, in practical effect, no tax in the United Kingdom; Italy and Canada-where in other than Canadian dollars-in Switzerland and Japa.n interest is taxable. Senator DOUGLAS. It is taxable? Mr. BARTH. Yes; in Switzerland, but it is not in London. Senator DOUGLAS. Would the same provisions apply for foreign depositors as for domestic depositors? Mr. BARTH. These are for foreign depositors, Senator. Senator DOUGLAS. Pardon? Mr. BARTH. These are for foreign depositors. Senator DOUGLAS. For foreign. Do you know the rates of taxation in Switzerland and Japan? Aren't they quite heavy? Mr. BARTH. I believe in Switzerland the withholding tax on interest earned by nonresidents is 27 percent. In Japan I am not certain, but I believe it is 20 percent. Senator DOUGLAS. You say, however, in England this is not taxable~ Mr. BARTH. No, sir. Senator DOUGLAS. Is the income of the individual taxable so that while there would not be withholding at the source there would be taxation of the individual, of the recipient? Mr. BARTH. To the best of my knowledge, if a nonresident of Eng- land has an account in England, the interest is not taxable. Senator DOUGLAS. I wonder if you would consult your legal depart- ment on that. Mr. BARTH. We have. lOll PAGENO="1022" 126 FOREIGN INVESTORS TAX ACT OF 19 66 Senat.or DOUGLAS. You have? Mr. BARTH. We have. It is rather a little confusing. I believe the legal department informed us that there are laws on the books but they apparently are not taxing nonresidents, nor withholding tax, and no tax. Senator Douor~&s. I did hear the first part of your statement. Mr. BARTH. Our legal department informed us that the British situ- ation is a little confusing. There are certain laws on the books, but apparently they are not being enforced as far as nonresidents are concerned. Senator DOUGLAS. That is very unusual for the British not to enforce their laws. They are, on the whole, the most law-abiding people that we have, and laws which are on the books tend to be enforced. What about France, where the chief danger for the gold run may come? Mr. BARTH. Not taxable. Senator DOUGLAS. Not taxable in France. What did you say about Italy? Mr. BARTH. No withholding tax in Italy for nonresident aliens. Senator DOUGLAS. What about the low countries, Belgium and Holland? Mr. BARTH. I do not have this information here, but, Senator Douglas, if you would like to have it, I would be glad to have our legal department write a memorandum. Senator DOUGLAS. Do you have any material on the Scandinavian (countries? Mr. BARTH. No. The Scandinavian countries do not enter into this particular aspect because the Scandinavian countries borrow more than-there are very few foreign deposits in Scandinavian countries. Senator DOUGLAS. Let me put it this way: While the situation is mixed, is it not true in some cases if the depositors abroad withdrew their funds, they would be jumping from the frying pan into the fire? Mr. BARTH. Well, I do not know how to answer that. People still have a lot of faith in foreign banks, particularly in London, and some European countries; and whether or not your statement is cor- rect, I am not here-I cannot answer it. Senator DOUGLAS. Well, it would not seem at the moment that there would be great alacrity, on the part of foreign depositors to deposit in British banks. On the contrary, the movement is the other way, unfortunately. Mr. BARTH. Well, when I say deposit m British banks, Senator, I mean deposit dollars in British banks, not the conversion into pounds, and the British banks have an awful lot of dollar deposits in the so-called external dollar deposits. Senator DOUGLAS. Which they will not exchange mto pounds. Mr. BARTH. Oh, no, no. They are used in dollars to finance world trade, to finance modernization of factories, to finance all kinds of things not necessarily in Britain but worldwide. Senator WILLIAMS. If there were a devaluation, those dollars de- posited in the British banks would not be affected at all? Mr. BARTH. Oh, no, no. You see, one of the strengths of -the London market has `been that even though you had devaluations and 1012 PAGENO="1023" FOREIGN INVESTORS TAX ACT OF 1966 127 foreign exchange restrictions for the British, foreign currency de- posits by nonresidents in London banks have never been affected. That is the strength of the London market. Senator DOUGLAS. Senator Carison. Senator CARLSON. Mr. Barth, just one or two questions. I was interested in what I believed to be the substantial increase, I t1'~nk you said in 1963 there were between seven and seven point something billion; and in 1965 or 1966 it is $11 billion. What is responsible for this great increase in these 2 or 3 years? Mr. BARTH. Well, I suppose the proper answer to your question is that the increase represents an increase of dollars held outside of the jurisdiction of the United States. In other words, they have not been permitted to come back as American dollars, and these $11,750 million are outside of the jurisdiction of the United States today. Senator CARLSQN. Well, I assume that this, which would be, approx- imately $4 billion in the last 3 years, which is a substantial movement of dollars, have they gone over for investment purposes and because interest rates are higher? Have they gone over- Mr. BARTH. Well, the obvious reason is, when I say it is not subject to the jurisdiction of the United States, the European banks are not subject to the jurisdiction of regulation Q, and I will give you an ex- ample of what money market rates are inLondon today. I am speak- ing of dollars. Senator CARLSON. That is right. Mr. BARTH. It may interest you to hear this. Call money, that is, sight deposit, 5¾ percent; 7-day fixed, 6~4~; 1 iñorith, 6i~; 2 months, 6% percent; 3 months, 6~/1fi; 6 months, 613/io; and 12 months, 71/4 to 7%, compared to your maximum here of 51/2. Senator CARLSON. In other words, our citizens just show they have good business acumen, and put their money where they can get good interest and good rates. Mr. BARTH. Well, Senator, I believe no branch bank of an American bank will accept abroad a dollar deposit from a citizen of the United States except if he is a resident of London. We would not accept an account from any citizen of the United States who is a resident in the United States, either in London or Paris or Beirut. We have an un- derstanding along those lines with the Federal Reserve Bank. Senator CARLSON. That is what I was going to get to next. You state in your statement, you say, "The U.S. commercial banks can make advances to their foreign branches only within the restrictive limits of the Federal Reserve balance-of-payments guideline." As a member of the committee you would help me if you would tell me what are some of those restrictions. Mr. BARTH. Well, that means that we cannot transfer money to London to let London loan the money to foreign individuals. What we propose is to let London generate its own deposits to make these loans. Senator OARLSON. In other words, these restrictions then evidently are not too effective, are they? Mr. BARTH. They are very, very effective. Senator CARLSON. You say they are very effective? Mr. BARTH. Yes. Senator CARLSON. Well, I was just interested in what is happening to our dollars, and I am also cognizant of the balance-of-payments 1013 PAGENO="1024" 128 FOREIGN INVESTORS TAX ACT OF 1966 problem, and we are all concerned about that. I appreciate very much your responses. Senator WILLIA1~rs. Primarily from where did this $4 billion come from; out of what was it generated? Mr. BARTH. Yes. The $4 billion increase presumably comes from, in the main, from foreign banks that want to utilize the-foreign banks and individuals that want to utilize-their dollars in invest- ments outside of the United States at a higher return. Senator WILLIAMS. I understand that. But if we had about $7 billion in that category in 1963 and it increased to $11 billion- Mr. BARTH. That is right. Senator WILLIAMS (continuing). What is the primary source of it? It just does not grow- Mr. BARTH. Well, the increase in the money supply between 1963 and 1965 has something to do with that, and I believe this almost matches the increase in the money supply. Senator WILLIAMS. How does it get out of this country to get over there in the AID programs and various other programs? Mr. BARTH. Well, to answer your question, let me finish answering your first question. I believe the U.S. balance-of-payments deficit has something to do with the increase. Senator WILLIAMS. That is what I was getting at. Mr. BARTH. I should have answered that before. The CHAIRMAN (presiding). Senator Talmadge. Senator TALMADGE. Thank you, Mr. Chairman. Mr. Barth, as I understand it, this bill is designed to provide equita- ble tax treatment for foreign investments in the United States, and to particularly try to correct the balance-of-payments deficit. Do you believe in its present form it will aid in correcting the balance of pay- ments or will it worsen it? Mr. BARTH. In its present form? Senator TALMADGE. Yes, sir. Mr. BARTH. In its present form I cannot help but say that I believe it will worsen it. Senator TALMADGE. Do you consider a gold drain in the dollar defi- cit at the present time a very serious problem affecting our country? Mr. BARTH. Yes, I consider this a very serious problem. Senator TALMADGE. If you had a completely free hand to correct the gold drain, what corrective measures would you take? Mr. BARTH. Well, if I had a completely free hand I would consider * that the banking fraternity as such has reduced the balance-of-pay- ments outgo considerably; business has also done so, and I would be- lieve that we could help our balance-of-payments deficit considerably if we would permit the opulent and affluent society of Western Europe to kind of look out for themselves, and to bring some of our troops * back, reduce some of the expenses. Senator TALMADGE. I have heard various reports from a very senior member of the Appropriations Committee that our six divisions in Western Europe caused a dollar deficit of $21/2 billion, but the Secre- tary of the Treasury testified when he was before this committee that it contributed a dollar deficit in the amount of $750 million. I think that if some arrangements whereby Germany would buy certain arms from us this would have some countereffect on the $21/2 billion. Do 1014 PAGENO="1025" FOREIGN INVESTORS TAX ACT OF 1966 129 you have any idea how much our troop maintenance at the present time contributes to our true dollar deficit? Mr. BARTH. I have no accurate knowledge. But last week, while I was down in Washington, I heard that our sales of dollars to Ger- many alone, I believe, is in the neighborhood of $1.1 billion to $1.2 billion annually. Senator TALMADGE. All right, we agree if some of the troops are brought home this would cut down on the dollar deficit. What else would you do? Mr. BARTH. Right now, in addition to that, I think the most im- portant thing for us to do would be to stimulate exports more. Senator TALMADGE. How would you proceed to do that? Mr. BARTH. I would try to induce the Export-Import Bank to become an insurer rather than a lender. Senator TALMADGE. Has any proposal along that line been recom- mended to Congress? Mr. BARTH. Well, I believe it has been talked about for 1 or 2 years, but you will have heard from Chairman Linder, quite properly, that under the law the Export-Import Bank is authorized to make collec- tible loans, and, therefore, the head of the Export-Import Bank must, as such, see to it that the loans are collected. Senator TALMADGE. What countries operate by insuring rather than lending? Mr. BARTH. In most countries it is on an insurance basis. It is quicker and less troublesome. Senator TALMADGE. What else would you do besides that? What do you think about foreign aid? How much does that contribute to our dollar deficit? Mr. BARTH. Well, I think wiser men than myself have been talking about foreign aid down here for quite some time, and I would like to beg off that. Senator TALMADGE. How about tourists? Mr. BARTH. Well, we seem to have an insatiable appetite to see the world. Britain had to cut down. But, you notice, Britain only cut it as of November 1, when summer is over. It seems to be difficult to legislate against people and their desires to travel. But the outflow from tourism is terrific. Senator TALMADGE. What is the true dollar deficit on tourism, about $2 billion annually? Mr. BARTH. I believe it is about between $1.7 billion and $2 billion. Senator TALMADGE. Thank you, Mr. Barth. I think you have been one of the most knowledgeable witnesses I have seen before this com- mittee since I have had the privilege of sitting on it. Mr. BARTH. Thank you very much, sir. The CHAIRMAN. Mr. Barth, if we are going to reduce the outgo through tourism, it seems to me we can do several things. Of course, one is to advertise; we are doing some of that; advertise the American sights better to encourage people to see more things over here. But if we are going to increase tourism, it seems to me we must do a couple of other things: We have either got to raise the cost of American tourism abroad by putting taxes on passports or some such thing as that so as to make it cost Americans more to go overseas or else we must subsidize the citizens of foreign countries moving to the United States to see what we have. I just wondered what thoughts you 71-297 0-67-pt. 1-65 1015 PAGENO="1026" 130 FOREIGN INVESTORS TAX ACT OF 1966 might be able to offer on that subject, as just a businessman who is worried about banking problems but sees how this cash moves. Mr. BARTH. Mr. Chairman, you have just given me an idea. I am not prepared to explore it here. But, you know, you have counterpart funds all over the world. You have none in Western Europe today. But, perhaps, some thought ought to be given to the creation of some counterpart funds so that the people in spending-instead of spending dollars which are redeemable at the Bank of France or the. Bundes- bank, that they will be redeemable against the fund which belongs either to the Treasury Department or somebody else, and I would like to make a study of this, and I will submit a report to you. The CHAIRMAN. You say you might create some sort of counterpart fund. Would you mind explaining that again? Mr. BARTH. Well, let us say if France wants to have our tourists they ought to put some French francs at the disposal of this fund' which ultimately could be used only to buy American goods; in other words, to compensate for it. But I would like to think that out a little more. The CHAIRMAN. I would appreciate it if you would just give us your thoughts along that line, because somewhere along the line I think we are going to- Mr. BARTH. For instance, I do not understand why any American- I am speaking about private people going to places like India or Pakistan or wherever we have counterpart funds-why they should be allowed to spend any dollars. He should buy the counterpart funds from somebody here before he goes, and spend `them freely, and leave the dollars here in the United States. The CHAIRMAN. Then that being the case, I take it, they would have that available to them to spend in the United States, to buy American products with. Mr. BARTH. No. Their counterpart funds, Mr. Chairman, belong to you, the Government. of the United States, and the dollars that the American tourist would spend abroad will be paid to `the Government of the United States. For instance, you have $1.5 billion worth of rupees. Came the de- valuation and you lost $400 million. The CHAIRMAN. Would you' mind giving me that again, because that is something that really merits consideration. You said that we had $1.5 billion in rupees- Mr. BARTH. That is right. .The CHAIRMAN. Available to us in India. * Mr. BARTH. Isolated, they are isolated in India because you are not allowed to use them without the consent of the Indian Government. Then, in addition to that, you have Public Law 480 rupees. The CHAIRMAN. You said though in the exchange, in the currency exchange, we lost $400 million. `Mr. BARTH. When the rupee was devalued 2, 3, 4 weeks ago by 36.5 percent you lost the equivalent of $400 million. `The CHAIRMAN. So we lost the equivalent of $400 million, did you say? Mr. BARTH. Yes. The rupee was devalued against the dollar by 36.5 nercent. The CHAIRMAN. I would appreciate it if you would just give us your thoughts which you have along that line. Frankly, it does occur to 1016 PAGENO="1027" FOREIGN INVESTORS TAX ACT OF 1966 131 me that the way we are accepting these foreign currencies, at least we ought to try to make the maximum use possible of them rather than have them simply pinned down in those countries where we can- not do anything with them, except to use them in a way that those countries tell us we can use it. If they tell us we cannot use it at all, it just means we might as well not have it over there, because we cannot use it, we cannot do anything with it. Mr. BARTH. That is right. Senator WILLIAMS. The expansion of the foreign tourism in this country has been something that we have been working on for quite a while, but is it not getting a setback with this airline strike because we are getting some complaints-I have had a few in my office-of foreign visitors over here who cannot complete the tour for which they were booked? I was wondering what impact you think that this airline strike may be having on our balance of payments or our economy in general by having to use the foreign airlines for trans- portation. Mr. BARTH. Well, you know that stranded Americans are estimated to be somewhere between 25,000 and~ 30,000 in Western Europe alone, and they have to find ways and means of getting home. I know of several of them who left Rome to go to Madrid feeling that they could come here more readily. From Madrid they went to London, and now they were assured of passage back to the United States around August 28 or 29, on a forthgn airline. Now, if you add this up, multiply that by 30,000, and also figure out what each American spends abroad just to live, it certainly has an impact on our balance of payments. Senator Wn~LIAMs. Thank you. Would you care to comment also on what impact you think it is having on our domestic economy? Mr. BARTH. Well, I have gone through the airport here in Wash- ington this morning or last night; I was here last Wednesday, and I saw the LaGuardia Airport, and it is half empty. I feel very sorry for the people who have the stores andrestaurants in there and obvi- ously all you have to do is talk to a cab driver who drives out to. the airport and he will tell you his story, too. Senator WILLI~isis. Thank you. Senator DOUGLAS. Mr. Chairman, I would like to make a request of the Treasury-is there a representative of the Treasury here-I would like to ask that the Treasury prepare a comparative statement on. the rates of taxation of deposits by foreigners and citizens in the banks of various countries so as to get a comparison of the comparative advantages and disadvantages in taxation matters which these various countries have, and, as the Senator from Georgia suggests, not merely including withholding on current income but inheritanèe taxes as well. (Pursuant to the above discussioi~ the following material was received for the record:) TREASURY DEPARTMENT, Washington, D.C., August 16, 1966. Hon. PAUL H. DOUGLAS. U.S. Senate, Washin~qton, D.C. DEAR SENATOR DoUGLAs: Pursuant to your request at the public hearings held August 9, 1966, On H.R. 13103, I enclose three copies each of tables which describe the estate tax and income tax treatment of bank deposits and the interest derived therefrom in nine major foreign countries. 1017 PAGENO="1028" 132 FOREIGN INVESTORS TAX ACT OF 1966 If you or your staff have any further questions concerning the enclosed, I will be happy to try to answer them for you. Sincerely yours, STANLEY S. Sumuiy, Assistant Eecretary. OFFICE OF THE SECRETARY OF THE TImASURY Treatment of bank deposits heW by nonresidents under the estate taa~ laws of selected countries Treatment of Taxing country: deposit8 France - Exempt. Germany - DO.' Italy Taxable.' Netherlands Not available. Switzerland Exenipt.8 United Kingdom Taxable.4 Do.5 Japan . Do. Belgium Exempt.6 1 The exemption in Germany Is conditioned upon the fact that the recipient Is a non- resident of Germany. 2 Apparently taxable, though available sources do not note this fact specifically. `There are no Federal, estate, or succession taxes imposed by Switzerland. Although cantonal estate tax duties are imposed, bank deposits are not subject to such cantonal estate taxes. ` Our information indicates that as a practical matter, while bank deposits are tech- nically subject to U.K. estate tax, no tax actually is Imposed. A 15 percent Canadian estate tax is imposed on that portion of bank deposits of for- eigners which exceed ~5.000. 6 exemption In Belgium is conditioned upon the fact that the decedent was not domiciled in, and did not have his "siege de sa fortune" in Belgium. Treatment of interest on bank deposits held by nonresidents under income taa~ laws of selected countries Source country: Withholding rate France . 25 percent.' Germany - Exempt. Italy 27 percent plus local surcharges.2 Netherlands - Exempt. Switzerland 27'/2 percent.' United Kingdom . 411,4 percent.' Canada 15 percent.5 Japan 20 percent.° Belgium Exempt.' `As of Jan. 1, 1905, France imposes a Z5~-percent withholding tax on interest derived by foreigners from deposits with French banks. However, no such tax Is Imposed if the deposit is made in a "foreign currency," e.g., U.S. dollars. 2 total rate varies, but averages about 32.4 percent. `The 2'T'~~,-percent withholding rate will be raised to 30 percent beginning Jan. 1, 1907. However, because Swiss banks frequently do not pay interest on deposits (indeed there Is often a charge for depositing money in a so-called "numbered account") the rate of Swiss withholding tax Is of no practical importance. 4 interest derived by foreigners from bank deposits In U.K. banks technically is subject to U.K. standard tax of 41¼ percent, there is no withholding of such tax on "short Interest," i.e., interest derived from deposits of less than 1 year's duration (U.K. authorities state that the overwhelming majority of deposits in U.K. banks by foreigners generate "short Interest"). - 5 the deposit has been made In a foreign currency and the interest is payable in a foreign currency no tax Is withheld. 6 This rate Is temporarily reduced to 10 percent in some cases, but will apparently revert back to 2.0 percent in 1067. `Pursuant to a law enacted In 1962., a withholding tax applicable to foreigners deriving interest from bank deposits In Belgium was to become effective Jan. 1, 1OW5L However, the effective date of such tax was postponed first to Jan. 1, 10(16, and subsequently to Jan. 1, 1007. Senator DouGr~s. Does your bank have that information, Mr. Barth? Mr. BARTH. We will try to put it together. We have been working on it for some time, but unfortunately, we have not got the complete information, but we will get it. 1018 PAGENO="1029" FOREIGN INVESTORS TAX ACT OF 1966 133 Senator DOUGLAS. Would you submit such material as you have and then we can make a comparison between the two. Mr. BARTH. Yes, sir. Senator DOUGLAS. Thank you very much. (The information referred to follows:) THE OHASE MANHATTAN BANK, New York, N.Y., August 11, 196G. Hon. PAUL H. DOUGLAS, U.S. Senate, Washington, D.C. DEAR SIR: Please permit me to express appreciation for the opportunity to appear before the Oommittee on Finance of the U.S. Senate on August 9, 1906, in connection with H.R. 13103. I am most grateful for the kind attention you and the other members of the committee afforded to me at the bearing. As agreed, I transmit for your information and that of the committee a sched- isle prepared by bank counsel which sets forth our understanding of the foreign income taxation of interest on bank deposits and the death taxation of bank deposits themselves held by nonresident aliens and foreign corporations not doing business in certain countries. The information contained in the schedule is the best that we have. been able to obtain. The schedule does not cover the low countries (Holland and Belgium), but we are compiling that data and will for- ward it to you. I should mention that as to the income taxation of such bank deposit interest in the United Kingdom, it is our understanding that while the British tax law does by its terms apply a 41.25-percent rate, there is no withholding thereon. Further, the United Kingdom takes the position that they do not have tax juris- diction to assess the tax against a nonresident. Thus, there is a technical lia- bility but under the British concept of taxing jurisdiction, as we understand it, collection of the tax is not undertaken where there is no withholding. 1 trust that the enclosure will prove useful to you and to the other members of the committee. I am taking the liberty of transmitting herewith 25 copies of the enclosure. ~Naturally, if I can be of any assistance in connection with this mat- ter, I will be most delighted to do so. Very truly yours, ALFRED W. BARTH, Evecwtive Vice President. Taaxltion by leading financial nati-ms of bank deposits of nonresident aliens and foreign corpo~ratioivs not doing bnsiness there PART I-TAXATION OF INTEREST ON BANK DEPOSITS. OF NONRESIDENT ALIENS AND FOREIGN CORPORATIONS NOT DOING BUSINESS IN THE SUBJECT COUNTRY' Country Tax applicable Rates Withholding France No (if deposit in dollars or other foreign currency). Germany Italy Japan Spain Switzerland No Yes (practice of Italian banks to bear tax, as permitted by law). Yes do do 27 percent (plus local collec- tion charges up to 5 percent). 20 percent 24percent2 27 percont (plus 3 percei~t cou- pon tax); 30percent (overall) effective Jan. 1, 1967. Yes. Do. Do.2 Yes (unless rede- posited by Swiss bank on a fidu- ciary basis). United Kingdom -- Yes (generally, however, the nonresident cannot be 41.25 percent No. Canada 2 assessed). No (if deposit in dollars or other foreign currency). See footnotes at end of table. 1019 PAGENO="1030" 134 FOREIGN INVESTORS TAX ACT OF 1966 PART Il-DEATH TAXES IN RESPECT OF BANK DEPOSITS OF NONRESIDENT ALIENS NOT DOING BUSINESS IN THE SUBJECT COUNTRY! Country Tax applicable Rates France . Germany Italy Japan Yes 2 No (unless resident beneficiaries) Yes do Graduated (ta relationship dent). Do. Do. x will vary depend of beneficiaries to ing on dece- . Spain Switzerland do No Do. United Kingdom~.. Canada2 No (unless operation of account directed or withdrawals made in United King- dom, or unless nonresident depositor physicallymade deposits or withdraw- ale in United Kingdom. Yes Graduated. 15 percent. 1 General source: Information obtained through CMB (through foreign branches and representative offices). 2 Source: Generalreference works and/or interpretation of statutes and treaties. THE CHASE MANHATTAN BANK, New York, N.Y., August 19, 1966. HON. PAUL H. DOUGLAS, U.S. Senate, Washington, D.C. Dasie SENATOR DOUGLAS: The schedule forwarded to you by my letter of August 11, 1966, did not cover the tax treatment of bank deposits in the Neth- erlands and Belgium since we did not at that time have the necessary information. We have now been informed that no income tax and no withholding are im- posed on bank deposit interest in the Netherlands and Belgium earned by non- resident aliens and foreign corporations not doing business in those two countries. Likewise, no death taxes are imposed on such deposits. Agaiu permit me to express my sincere appreciation for your kind attention and that of the committee at the hearing on August 9, 1966, in connection with H.R. 13103. Sincerely yours, ALFRED W. BARTH, Eaecutive Vice President. Senator WILLIAMS. Mr. Barth, you have be,en most cooperative this morning and I hesitate to delay you further, but could you tell us gen- erally what residence is claimed by these so-called rovmg depositors? Mr. BARTH. I could not hear you, Senator. Senator WILLIAMS. I say, generally speaking- Mr. BARTH. Yes. Senator WILLIAMS. What residence is taken or claimed by these so-called roving depositors or are they just referred to generally as being scattered around among various countries? Mr. BARTH. By far the majority of these deposits are in Western Europe, and I believe that the largest holdings are in London, England. I am speaking of dollar deposits, not sterling; London, England, has become the center of the external or Euro-dollar operations because, as I have explained to you, even during the war the Bank of England never interfered with any foreign exchange operation that involved a non-Britisher, and London has been the financial headquarters of the world for a long, long time; and, as you will notice from these gross deposits, the majority is kept in London because people still have faith in the British banks. Senator WILLIAMS. And they are mostly British citizens then? Mr. BAImI. British banks. 1020 PAGENO="1031" FOREIGN INVESTORS TAX ACT OF 1966 135 Senator Wu~IAMs. The citizenship of the depositor is what I was interested in. Mr. BARTH. The citizenship .of the depositor, Middle East, Swiss, French, Italian, South American, Canadian, Scandanavian, all over the world. Senator WIUaAMs. Thank you. The CHAIRMAN. You are going to furnish us with a thought or two that you had on this subject in writing, and I would appreciate it if you would do that. Mr. BARTH. Yes, sir; gladly. The CHAIRMAN. At your convenience we would like to see it. Thank you very much, Mr. Barth. We appreciate your testimony here today. Mr. BARTH. Thank you very much, Mr. Chairman, and members of the committee. The CHAIRMAN. The next witness is Mr. William F. Ray of the Bankers' Association for Foreign Trade, who is accompanied by his counsel, Mr. Thomas Baer. Mr. Ray and Mr. Baer, we are happy to have you here. STATEMENT OP WILLIAM P. RAY, PRESIDENT, BANKERS' ASSO- CIATION FOR FOREIGN TRADE, ACCOMPANIED BY THOMAS BARR, COUNSEL Mr. RAY. Thank you, Senator Long. My name is William F. Ray. I am president of the Bankers' Association for Foreign Trade, and I want to express our appreciation for the opportunity to come here and be heard. May I say, Senator Carlson, that I can sympathize with your airline difficulties. I had to make that trip in reverse last night, and I did not think I would make it. The Bankers' Association for Foreign Trade includes among its membership 128 American banks. We were founded in 1921 by a small group of bankers from Buffalo, Cleveland, and Detroit, and our organization has now grown to include nearly every bank in the United States which has a fully organized foreign department. At our annual meeting which took place on April 27, our organiza- tion unanimously adopted a resolution which opposed certain sections of H.R. 13103 as passed by the House. The text of the resolution is a supplement to our statement. While we generally endorse the objectives of H.R. 13103, our mem- bership is concerned about the sections of the bill which impose an income and estate tax on foreign-owned bank deposits in the United States. We point out in our statement that the exemption of such deposits from such taxation goes back to the Revenue Act of 1921, and when that act was being considered, the Congress recognized that the loss of revenue which would result if this deduction were allowed would be relatively small in amount, while the exemption of such interest from taxation would be in keeping with the action of other countries and would encourage nonresident alien individuals and foreign cor- porations to transact financial business through institutions located m the United States. And, in our opinion, the reasons which were persuasive to the Congress in 1921 are equally valid today. 1021 PAGENO="1032" * 136 FOREIGN INVESTORS TAX ACT OF 1966 It is our understanding that many leading foreign cOuntries, includ- ing England, Germany, the Netherlands, and Sweden also do not impose a withholding tax on interest paid on deposits of nonresident ahens, so that our domestic banks would be placed at a disadvantage with respect to competition on this point from these important financ- ing countries. May I take a little time to point out the experience of Germany, which, when it was concerned over an excessive inflow of capital, took a step that was somewhat analogous to placing a tax on the interest on money deposited in banks. The German Government proposed and later enacted a tax on bond coupons paid to foreigners. This experi- ence is described in the monthly bulletin of the German Central Bank for June 1965. It may be summarized as follows: The mere publication of the proposed German coupon tax in March 1964, in accordance with which interest paid on German bonds owned by foreigners was to be subject to a withholding tax, reduced foreign purchases of such bonds to about 50 percent of the amount that had been purchased by foreigners in each of the preceding months of that year. The parliamentary approval of the tax bill in January of 19~5 and February of 1965 again resulted in an excess of sales over pur- chases. All in all, 550 million deutschemarks of foreign funds were withdrawn from Germany through the excess of sales over purchases of forei-gt~-üwned German bonds in the 14-month period beginning with the publication of the proposed tax, and ending in April 1965. This spectacular figure must be compared with that of the net pur- chases by foreigners in the 14-month period immediately preceding the publication of the proposed tax act. In this period the purchases of German bonds by foreigners totaled 2.36 billion deutschemarks. The German Central Bank article further points out that following the enactment of the coupon tax, there was a rise of more than 1 percent per annum in the interest rate level prevailing in Germany. The * coupon tax is cited by the Central Bank as one of the contributing causes. Do we need this kind of upward pressure on interest rates in this country? We point out that the proposed tax on interest affects a larger deposit * total than the proposed estate tax, for it includes time deposits of banks, corporations and others, as well as individuals and apparently it was recognized that a potentially undesirable effect existed when the bill was drafted to defer the application of this withholding tax until * January1972. How~ver, in our opinion, substantiated by the German experience with the interest withholding taxj cited above, the mere existence of the provisions in the law will itself result in withdrawal of deposits, as I believe was mentioned by Mr. Barth. Our member banks have advised us that this process has already begun following passage of H.R. 13103 by the House. It is clear that the anticipation of action, even as distant as that presently proposed by 1972, can become an active force in the sensitive international money market. On the matter of estate tax, the provisions would become imme- diately effective. Our member banks have advised us again that some deposits have already been withdrawn, and that steps have been taken 1022 PAGENO="1033" FOREIGN INVESTORS TAX ACT OF 1966 137 to move additional deposits. This experience seems to illustrate the fact that the proposed estate tax is contrary to one of the purposes of FIR. 13103, to encourage the investment of foreign funds in the United States. The facts are that it is too easy to move such funds to dollar accounts in foreign banks outside the control of the United States, or to have the deposit made through a closely held foreign corporation and, therefore, the estate tax revenues from this source to our Government would be miniscule-the Treasury estimate, I believe, is $300,000 per year-and not worth the risk of potential loss of dollar deposits. The tax changes affecting bank deposits of foreigners as proposed in H.R. 13103 could be particularly damaging to 115 of our American members that have no branches abroad, which might be able to acquire some of the deposits shifted from this country. The loss of these deposits would do serious damage to such banks. Large banks with foreign branches may be able to attract some of these departing deposits back into these branches, and the depositor would then be free of tax. Some of us without foreign branches may have to consider opening such branches in order to avoid the extinction of our foreign business. Others simply cannot do that and the loss of these deposits would do serious damage to these banks. Business related to these deposits would presumably also be lost when the deposits were transfererd to other banks or branches abroad or simply repatriated. Many of these smaller banks have spearheaded in their communities the U.S. Government's export promotion drive, in many cases through newly established or revitalized international banking divisions built around export financing. Their abilty to make these efforts self-supporting has necessarily been reduced by the pres- ent tightness of money and by the foreign lending guidelines of the Federal Reserve System, which include loans to finance exports. The tax provisions of H.R. 13103 affecting time deposits will hamper the ability of some of these banks to develop their facilities for export financing by reducing the earnings and the deposit base of their international banking divisions. We believe that the shift in deposits which will take place if H.R. 13103 is enacted in its present form will seriously diminish the func- tions of the U.S. banking system as a depository of dollar holdings of foreigners. We recognize that some of the deposits now on the books of American banks in the name of nonresident foreign individuals will simply be shifted to the accounts of foreign banks, and thus remain deposited in the United States. However, the effect of moving these deposits to dollar accounts of banks outside t.he control of the United States is to intensify the danger to our monetary reserves. The foreign bank would not have the same obligation that an Amer- ican bank would feel for taking part in any program of the United States for voluntary cooperation and restraint, and the foreign bank, moreover, is not subject to our laws and regulations. Consequently, the foreign bank will seek the best return available on its funds consistent with safety and liquidity wherever that may be, and it will have no hesitation in selling the dollars it holds for other foreign currencies. Dollars thus sold are likely to wind up in the hands of foreign central banks, where they constitute a direct claim on our gold supply. 1023 PAGENO="1034" 138 FOREIGN INVESTORS TAX ACT OF 1966 Under, currently prevailing practice a substantial portion of the net new reserves acquired by foreign central banks is converted into gold. The concern both here and abroad about the continuing dram on our gold reserves needs no comment. Moreover, some foreign holders of dollars would not be prepared to hold these dollars on deposit with a bank outside the United States for various reasons, including transfer risks political risks, and credit risks. Faced with a tax liability, such owners of dollars may decide to re- patriate them. That means to convert them into their own domestic currency by selling them. The ultimate purchaser of these dollars is often a foreign central bank, so that the end effect of this transac- tion is again a potential drain on our gold supply. We believe that these provisions of }II.R. 13103 proposing to tax bank deposits do not recognize that the dollar is a major international reserve currency; that a major portion of international trade is done in dollars and that, as a result, the United States has become the financial center of the world. Since this is the case, and because foreign deposits have always provided an important part of the financing of our own foreign trade, any action to force foreign holdings of dollar deposits to accounts at foreign banks is clearly contrary to our national interests. There can be no doubt that the provisions with regard to bank deposits in E[.R. 13103 adversely affect the status of foreign dollar holdings. In summary, we believe that the present exemptions from income and estate tax on bank deposits granted to nonresident aliens should be continued for (1) the taxes proposed by H.R. 13103 on such de- posits will create a less favorable climate for foreign investment in the United States; (2) they will drive foreign deposits out of the United States and thus yield only negligible tax revenue; (3) they will lead to a potential further drain on the U.S. gold stock of menac- ing proportions; and (4) they are particularly damaging to the normal business operations of those U.S. banks, including many smaller banks which have no foreign branches. Thank you, Mr. Chairman. (The prepared statement of Mr. Ray follows:) STATEMENT OF WILLIAM F. RAY, ON BEHALF OF THE BANKERS' ASSOcIATION FOE FOREION TRADE, ON H.R. 13103 TABLE OF CONTENTS AND SUMMARY SHEET Page 1: (Who BAFT Represents. Cooperation of BAFT with Government Agencies. Page 2: BAFT Resolution at Annual Meeting re H.R. 13103. Forty-five Year History of Tax Exemptions for Foreign-Owned Bank Deposits. Page 3: Practice of Other Countries. Page 4: Proposed Income and Withholding Tax on Interest on Foreign-Owned Bank Deposits. Page 5: Proposed Estate Tax on Foreign-Owned Bank Deposits. Effect of Interest and Estate Tax Provisions of HR. i3i03 on Small Banks. Page 6: Effect on Deposits and on Our Gold Supply. Page 8 : Summary of Conclusions: We believe that the exemptions from income and estate tax on bank deposits granted to nonresident aliens in the Revenue Act of 1921 should be continued for (1) the taxes proposed by H.R. 13103 on such deposits will create a less favorable climate for foreign investment in the United States; (2) will drive foreign deposits out of-the United Etates and thus yield only negligible tax revenue; (3) will lead to a potential further drain on the United States gold stock of menacing proportions, and (4) are particularly damaging to the normal business operations of those United States banks, including many smaller banks, which have no foreign branches. 1024 PAGENO="1035" FOREIGN INVESTORS TAX ACT OF 1966 139 WHO BAFT REPRESENTS The Bankers' Association for Foreign Trade includes among its membership 128 American banks from all parts of the United States as shown on the at- tached list (Appendix A). Our organization was founded in 1921 by a small group of bankers from Buffalo, Cleveland and Detroit, and now has grown to include nearly every bank in the United States having a fully organized foreign or international department. The purposes of the BAFT, as stated in its by-laws, are "to promote inter- national banking and foreign trade by doing all things appropriate to the stimu- lation of public interest therein and to the improvement of existing practices and the development of new techniques thereof." COOPERATION OF BAFT WITH GOVERNMENT AGENCIES The BAFT has cooperated closely with the representatives of the various government departments and financing agencies concerned with international trade and financing. As examples of this cooperation, for some time the Ex- port-Import Bank has appointed our President to serve on its Advisory Com- mittee during his term of office and, more recently, our President has also been named to the National Export Expansion Council. Many of the officers of our member banks have served as chairmen or members of the various Regional Export Expansion Councils. BAFT RESOLUTION AT ANNUAL MEETING BE H.R. 13103 At the annual meeting of our Association on April 27, a resolution was adopted unanimously opposing certain sections of H.R. 13103 as passed by the House of Repersentatives (see Supplement B). While generally endorsing the objectives of H.R. 13103, our membmership is concerned about the sections of this Bill which impose an income and estate tax on foreign owned bank deposits held in the United States. We believe (1) that these provisions are contrary to one of the stated objectives of H.R. 13103, namely, to attract foreign investment in the United States, (2) that they will affect unfavorably the ability of American banks to do a foreign business and, (3) they will not accomplish the revenue purposes for which they were designed; business will merely be shifted from American banks to their foreign competitors and the pay- ment of an important part of the proposed taxes will be avoided. We, therefore, urge that H.R. 13103 be amended by dropping the privisions that would tax foreign owned bank deposits so that the law would continue as at present, namely: (a) that interest on such deposits would continue to remain exempt from Federal income tax and withholding; (b) that such deposits would continue to remain exempt from Federal estate taxation. FORTY-FIVE YEAR HISTORY OF TAX EXEMPTIONS FOR FOREIGN-OWNED BANK DEPOSITS To fail to accord such exemptions would be to reverse a long-standing policy of the United States established in the Revenue Act of 1921. In considering the merits of this exclusion from taxable income over 40 years ago, the House Ways and Means Committee recognized that the loss of revenue which would result if this deduction were allowed would be relatively small in amount, while the exemption of such interest from taxation would be in keeping with the action of other countries and would encourage non-resident alien individuals and foreign corporations to transact financial business through institutions located in the United States. In our opinion, the reasons which were per- suasive to the Congress in 1921 are equally valid today. PRACTICE OF OTHER COUNTRIES Furthermore, it is our understanding that many leading foreign countrh~s mcluding England, Germany and the Netherlands, do not impose a withholding tax on interest paid on deposits of non-resident aliens so that our domestic banks would be placed at a disadvantage with respect to competition on this point in these important financing countries. It is instructive that Germany, when concerned over an excessive inflow of capital, took a step that was some- 1025 PAGENO="1036" 140 FOREIGN INVESTORS TAX ACT OF 1966 what analogous to a tax on depositing money in banks. The German govern- ment proposed, and later enacted, a tax on bond coupons paid to foreigners. This experience is described in the monthly bulletin of the German Central Bank for June, 1965, and may be summarized as follows: The mere publication of the proposed German Coupon Tax in March, 1964 (according to which interest paid on German bonds owned by for- eigners was to be subject to a withholding tax) reduced foreign purchases of such bonds to about 50% of the amount that had been purchased by foreigners in each of the preceding months. The parliamentary approval of the tax bill on January 27, 1965, and February 12, 1965, again resulted in an excess of sales over purchases. All in all, 550 milion DM of foreign funds were withdrawn from Germany through the excess of sales over purchases of foreign-owned German bonds in the fourteen-month period beginning with the publication of the proposed tax act and ending in April 1965. This spectacular figure must be compared with that of the net pur- chases by foreigners in the fourteen-month period immediately preced- ing the publication of the proposed tax act. In this period, the purchases of German bonds by foreigners totalled 2.36 billion DM. The German Oentral Bank article further points out that, following the enactment of the Coupon Tax, there was a rise of more than 1% per annum in the interest rate level prevailing in Germany; the Coupon Tax is cited by the Central Bank as one of the contributing causes. Do we need this kind of added upward pressure on interest rates in this country? PROPOSED INCOME AND WITHHOLDING TAX ON INTEREST ON FOREIGN-OWNED BANK DEPOSITS The proposed tax on interest affects a larger deposit total than the proposed e~ate tax, for it includes time deposits of banks, corporations, trusts and other entities as well as those of individuals. Apparently the draftsmen of H.R. 13103 recognized a potential undesirable effect of this proposed tax which they sought to mitigate by deferring the application of this withholding tax until January 1, 1972. However, in our opinion, substantiated, by the German experience with the bond interest withholding tax cited above, the mere ex- istence of the provisions in the law will itself result in withdrawal of deposits. Our member banks have advised us that this process has already begun following passage of H.R. 13103 by the House. It is clear that the anticipation of action, even as distant as that presently proposed for 1972, can become an active' force in the sensitive international market. PROPOSED ESTATE TAX ON FOREIGN-OWNED BANK `DEPOSITS Under the proposed law, the estate tax provisions would become immediately effective. Our member banks advise us that some individual `deposits have already been withdrawn and that steps have been taken to move additional de- posits. This experience seems to illustrate the fact that the proposed estate tax on bank deposits is contrary to the purpose of H.R. 13103 to encourage the investment of foreign funds in the United States. The facts are that it is too easy to move such funds to dollar accounts in foreign banks outside the control of the United State's or to have the deposit made through a closely held foreign corporation and, therefore, the estate tax revenues from this source to our government would be minusule (Treasury estimate $300,000 per year) and no't worth the risk' of potential loss of dollar deposits. EFFECT OF INTEREST AND ESTATE TAX PROVISIONS OF HR 13103 ON SMALLER BANKS The tax changes affecting `bank deposits of foreigners as proposed in HR 13103 could be particularly damaging to approximately 115 of our American mem- bers that have no branches abroad which might be able to acquire some of the deposits shifted from this country. The loss of these deposits would do serious damage to such banks., Large banks with foreign branches may be able to at- tract some of these departing' deposits back into their branches, `and, the depositor would then be free of tax. `Some of us without foreign branches may have to consider opening such branches in order to avoid extinction `of' an important source of our foreign' business. Others simply cannot do that and the loss of these deposits would do serious `damage to such `banks. Business related to these deposits would presumably al$o be lost when the deposits were transferred to other banks or branches abroad or simply repatriated. Many of these banks have spearheaded in their communities the U.S. Government's export promotion 1026 PAGENO="1037" FOREIGN INVESTORS TAX ACT OF 1966 141 drive of recent years, in many cases through newly established or revitalized International Banking Divisions built around export financing. Their ability to make these efforts self-supporting has necessarily been reduced by the present tightness of money and the foreign lending guidelines of the Federal Reserve System (which include loans to finance exports). The tax provisions of HR 13103 affecting time deposits will hamper the ability of some of these `banks to develop their facilities for export financing by reducing the earnings and the deposit base of their International Banking Divisions. EFFECT ON DEPOSITS AND ON OUR GOLD SUPPLY We believe that the shift in deposits which will take place if hR 1310~ is enacted in its present form will seriously diminish the functions of the United States banking system as a depository of dollar holdings of foreigners. We recognize that some of the deposits now on the books of American banks in the name of nonresident foreign individuals will simply be shifted to the accounts of foreign banks and thus remain deposited in the United States. However, the effect of moving these deposits to dollar accounts. of banks outside the control of the United States is to intensify the danger to our monetary reserves. The foreign bank would not have the same obligation that an American bank would feel for taking part in any program of the United States for voluntary cooperation and restraint and the foreign bank is moreover not subject to our laws and regula- tions. Consequently, the foreign `bank will seek the best return available on its funds consistent with safety and liquidity wherever that may be and it will have no hesitation in selling dollars it holds for other foreign currencies. Dol- lars thus sold are likely to wind up in the bands of foreign central banks where they constitute a direct claim on our gold supply. Under currently prevailing practice, a substantial portion of the net new re- serves acquired by foreign central banks is converted into gold. The concern both here and abroad about the continuing drain on our gold reserves needs no comment. Moreover, some foreign holders of dollars would not be prepared to hold these dollars on deposit with a `bank outside the United States for various reasons, including traflsfer risks, political risks and `credit risks. . Faced with a tax liability, such owners of dollars may decide to `repatriate them, that is, to con- vert them into their own domestic curreney `by selling them. The ultimate purchaser of these dollars is often a foreign central bank, so that the end effect of this transaction is again a potential drain on our gold supply. In addition, these provisions of. `HR 13103 proposing to tax bank deposits do not seem to recognize that the dollar is a major international reserve cur- rency, that a major portion of international trade is done in dollars, and that, as a result, the United States has become the financial center of the world. Since this is the case-and because foreign deposits have~ always provided an important part of .the financing of, our own foreign trade-any action to force foreign holdings of dollar deposits to accounts at foreign banks is clearly con- trary to our national interest. There can be no doubt that the provisions with regard to bank deposits in HR 13103 do adversely affect the status of foreign dollar holdings. SUMMARY OF OONCLUSIONS In sunimary, we believe that the exemptions from income and estate tax on bank deposits granted to non-resident aliens in the Revenue Act of 1921 should be continued for (1) the taxes proposed by HR 13103 on such deposits will create a less favorable climate for foreign investment in the United States; (2) will drive foreign deposits out of the United States and thus yield only negligible tax revenue; (3) will lead to a potential further drain on the United States gold stock of menacing proportions, and, (4) are particularly damaging to the normal business operations of those United States banks, including many smaller `banks, which have no foreign branches. UNITED STATES MEMBERS, BANKERS' Assocu~rmox FOR FOREIGN TRADE, JULY 21, 1966 APPENDIX A Akron, Ohio: First National Bank of Akron Atlanta, Georgia: The Citizens & Southern National Bank First National Bank of Atlanta The Trust Company of Georgia 1027 PAGENO="1038" 142 FOREIGN INVESTORS TAX ACT OF 1966 UNITED STATES MEMBERS, BANKERS' ASSOCIATION FOR FOREIGN TRADR, JULY 21, 196(~-Continued APPENDIX A-continued Baltimore, Maryland: First National Bank of Maryland Maryland National Bank Union Trust Company of Maryland Boston, Massachusetts: First National Bank of Boston The National Sbawmut Bank of Boston The New England Merchants National Bank of Boston State Street Bank & Trust Company Buffalo, New York: Manufacturers and Traders Trust Company Marine Midland Trust Company of Western New York Charlotte, North Carolina: North Carolina NationalBank Chicago, Illinois: American National Bank & Trust Co. of Chicago Central National Bank of Chicago Continental Illinois National Bank and Trust Company of Chicago First National Bank of Chicago Harris Trust and Savings Bank LaSalle National Bank Northern Trust Company Cincinnati, Ohio: The Central Trust Company Fifth-Third Union Trust Company First National Bank of Cincinnati Cleveland, Ohio: Central National Bank of Cleveland The Cleveland Trust Company The National City Bank of Cleveland Society National Bank of Cleveland Union Commerce Bank Dallas, Texas: First National Bank of Dallas Mercantile National Bank at Dallas Republic National Bank of Dallas Denver, Colorado: Denver United States National Bank Detroit, Michigan: Bank of the Commonwealth City National Bank of Detroit Detroit Bank & Trust Manufacturers National Bank of Detroit National Bank of Detroit Forth Worth, Texas: First National Bank of Fort Worth Forth Worth National Bank Hartford, Connecticut: Connecticut Bank and Trust Company Hartford National Bank & Trust Company Honolulu, Hawaii: Bank of Hawaii The First National Bank of Hawaii Houston, Texas: Bank of the Southwest National Association The First City National Bank of Houston Texas National Bank of Commerce of Houston Indianapolis, Indiana: American Fletcher National Bank & Trust Co. The Indiana National Bank of Indianapolis Kansas City, Missouri: City National Bank & Trust Company Commerce Trust Company First National Bank 1028 PAGENO="1039" FOREIGN INVESTORS TAX ACT OF 1966 143 UNITED SPATES MEMBERS, BANKERS' AsSoCIATIoN FOR FOREIGN TRADE, JULY 21, 1966-Continued APPENDIX A-COfltinued Los Angeles, California: First Western Bank and Trust Company Manufacturers Bank Security First National Bank Union Bank United California Bank Memphis, Tennessee: First National Bank of Memphis National Bank of Commerce in Memphis Union Planters National Bank - Miami, Florida: The First National Bank of Miami Milwaukee, Wisconsin: First Wisconsin National Bank of Milwaukee Marshall & Ilsley Bank Minneapolis, Minnesota: First National Bank of Minneapolis Northwestern National Bank of Minneapolis Mobile, Alabama: First National Bank of Mobile Merchants National Bank of Mobile Newark, New Jersey: National Newark & Essex Banking Company New Orleans, Louisiana: Hibernia National Bank in New Orleans National American Bank of New Orleans The National Bank of Commerce in New Orleans Whitney National Bank of New Orleans New York, New York: American Express Company The Bank of New York Bankers Trust Company Brown Brothers Harriman & Co. The Chase Manhattan Bank Chemical Bank New York Trust Company Empire Trust Company The First National City Bank Franklin National Bank Irving Trust Company Laidlaw & Company Manufacturers Hanover Trust Company Marine Midland Grace Trust Company of New York The Meadow Brook National Bank Morgan Guaranty Trust Company of New York Sterling National Bank and Trust Company Norfolk, Virginia: Virginia National Bank Oakland, California: Central Valley National Bank Omaha, Nebraska: The Omaha National Bank Paterson, New Jersey: New Jersey Bank and Trust Company Philadelphia, Pennsylvania: Central-Penn National Bank of Philadelphia Fidelity-Philadelphia Trust Company First Pennsylvania Banking & Trust Company Girard Trust Bank The Philadelphia National Bank Provident National Bank Phoenix, Arizona: First National Bank of Arizona Valley National Bank Pittsbflrgh, Pennsylvania: Mellon National Bank & Trust Company Pittsburgh National Bank Ponce, Puerto Rico: Baco Credito y Ahorro Ponceno Banco de Ponce 1029 PAGENO="1040" 144 FOREIGN INVESTORS TAX ACT OF 1966 UNITED STATES MEMBERS, BANKERS' ASSOCIATION FOR FOREIGN TRADE, JuLY 21, 1966-Continued' APPENDIX A-Continued Portland, Oregon: The First National Bank of Oregon Providence, Rhode Island: Industrial National Bank of Rhode Island Rhode Island Hospital Trust Company St. Louis, Missouri: First National Bank in St. Louis Mercantile Trust Company San Diego, California: First National Bank of San Diego San Francisco, California: Bank of America, N.T. & S.A. Bank of California, N.A. Crocker-Citizens National Bank Pacific National Bank of San Francisco Wells Fargo Bank San Juan, Puerto Rico: Banco Popular de Puerto Rico Seattle, Washington: The National Bank of Commerce of Seattle Pacific National Bank of Seattle Peoples National Bank of Washington Seattle-First National Bank Tacoma, Washington: National Bank of Washington Tampa, Florida: Marine Bank & Trust Company Toledo, Ohio: First National Bank of Toledo Tucson, Arizona: Southern Arizona Bank and Trust Company Washington, D.C.: American Security and Trust Company The Riggs National Bank of Washington, D.C. Winston-Salem, North Carolina: Wachovia Bank & Trust Company Worcester, Massachusetts: Worcester County National Bank SUPPLEMENT B-RESOLUTION ADOPTED BY THE BANKERS' ASSOCIATION FOR FOREIGN TRADE AT THEIR ANNUAL MEETING-~APRIL 27, 1966 We support the general objectives of H.R. 13103, the "Foreign Investors Tax Act of 1966", and the section which classifies as foreign source income interest paid on accounts of all types of depositors in foreign branches of United States banks. We do, however, strongly oppose the provisions of the bill which would impose income and inheritance taxes on certain foreign owned deposits `in the United States and on certain debt obligations located outside the United States and owned `by non-residents. We are convinced `that these provisions will have a detrimental "effect on the United States `balance of payments and on the position of the United States as a financial center' of the world, and that they are in direct conflict with the stated objectives of H.R. 13103. The CHAIRMAN. Have you had the: opportunity to present these arguments of the Bankers' Association for Foreign Trade against this provision of the House bill prior to the time that the House provision was agreed to? Mr. RAY. We did not `have that~ opportunity. Were hearings held at that time, Senator Long? The `OHAIRMAN. Well, I would assume that if v~i did ndt i'~ve the opportunity `to testify, the House simply met on H.R. 13103 after the hearings had been concluded and the amendment ~as offered in execu- tive session without your `having `had `a chance to present your arguments. Mr. RAY. This is the first presentation that we `have made of these arguments. The CHAIRMAN. I am informed that there was opportunity to be heard on it, but that it was on very short notice and there was little 1030 PAGENO="1041" FOREIGN INVESTORS TAX ACT OF 1966 145 time between the announcement of hearings on the subject and the time when the House had an executive session on it. Thank you very mudh. I will see that your statement and your arguments are further considered by the committee. Mr. RAY. Senator Long, may I add one further item. I understand that the Treasury is proposing an amendment which would exempt discount `on bankers' `acceptances of a maturity o'f 6 months or less from the imposition of withholding `or income taxes. We `are very pleased that they have introduced this suggestion. We believe it recognizes the importance of bankers' acceptances which `are a very old but not very well understood means of supplying funds to the banking system for the financing for foreign trade. Currently I believe there are outstanding $832 million of banker's acceptances which were created to finance exports. The CHAIRMAN. Yes. I understand that the Treasury proposes that we have clarifying language in our committee report. Well, thank you very much, sir. We will see that your arguments here are considered. I think you made a very fine argument. Mr. RAY. Thank you, Senator. The CHAIRMAN. We have a statement of Mr. L. P. Brace, chair- man of the First National Bank of Boston, who decided to file his statement in lieu of a personal appearance and because his position was being stated by Mr. Ray. (The statement referred to follows:) Tnz FIRST NATIONAL BANK OF BOSTON, Boston, Mass., August 3, 1966. Hon. RUSSELL B. LONG, Chairman of the Benate Finance Committee, New ~~enate Office BuIlding, Wa$hin.gton, D.C. DEAR SENATOR LONG: In our ietter of June 30, 1966, we requested the privilege of testifying before your committee. during the hearings on the "Foreign In- vèstors Tax Act of 1966" (H.R. 13103). Since then we have agreed with other United States banks affected by this bill to have Mr. William Ray, President of the Bankers Association for Foreign Trade, represent our joint interests before your committee. Therefore, we shall not have anyone appear at the hearings on our behalf. However, we take this opportunity to submit in writing our views concerning this bill. We are opposed to the provisions of H.R. 13103 which: 1. Subject interest paid on U.S. bank deposits of nonresident aliens and foreign corporations to a U.S. withholding tax commencing January 1, 1972. 2. Subject bank deposits of nonresident aliens to U.S. estate taxes; and 3. Employ, the "effectively connected" concept as a means to subject cer- lain foreign source income to U.S. taxation. As a result of our inquiries, we received letters from prominent European bankers indicating the serious effect H.R. 13103 will have on the U.S. balance of payments problem. These letters are enclosed with the request that they, to- gether with this statement, be included in the printed record of the hearings. A discussion of each of the provisions of H.R. 13103 to which we object follows: 1. H.R. 13103 would subject interest on bank deposits paid to nonresident aliens and foreign corporations to United States withholding tax beginning January 1, 1972. Under present law foreigners are exempt from U.S. income and estate tax on their U.S. deposits if they are not engaged in trade or business within the United States. Accordingly, if enacted this bill, entailing withholding of interest at the rate of 30 percent would diminish the net earnings on foreign-owned deposits to about one-half of what the same investor could obtain in the European Euro- dollar market. In view of this grea.t dllspa.rity of interest rates, which is largely due to the fact that many of the developed European countries, such as England, 71-297 0-67-pt. 1-66 1031 PAGENO="1042" 146 FOREIGN INVESTORS TAX ACT OF 1966 Germany, France, Holland and Sweden, do not impose a similar tax, it seems certain that the enactment of this provision would not only discourage prospec- tive foreign investors from depositing their money with United States banks, but would drive present foreign deposits out of this country and into the hands of foreign banks. Such a development would be neither in the interest of the American banking industry nor of the national economy as a whole as this would result in an outflow of dollars, which would constitute a potential further drain on the gold reserves of the United States. It has been alleged that withdrawn deposits would return to the United. States in some other form. Such an allegation is pure speculation. A foreign investor, who elected to invest his funds in the form of tax exempt U.S. bank deposits and at the same time to receive the benefits of a politically and economically stable country, might well decide to forego these latter advantages for a higher return by depositing his funds in another country where they would be tax exempt. That the United States would sustain a dollar drain is indicated in the opin- ions of Mr. Gustav Glueck, the managing director of the Dresdner Bank AG and that of the Comme.rzbank, two leading German publicly owned banks. (Ap- pendixes A and B.) In his letter of July 27, 1966, Mr. Glueck states that the provisions of H.R. 13103 affecting foreign owned bank deposits would substan- tially reduce the willingness of foreigners to deposit funds with American banks. He then draws an analogy to the German withholding tax imposed in 1964 on interest paid on German bonds held by nonresident aliens. He points out that~ such withholding tax not only stopped the further influx of foreign capital into Germany but also was a decisive factor in the deterioration of the German capital market. Support for Mr. Glueck's statement is found in the June, 1965, issue of "Monatsberichte der Deutschen Bundesbank" ("Monthly Bulletins of the German Centralbank"), Appendix O,* indicating that sales of German bonds by foreign investors exceeded purchases by 550 million DM in the fourteen months' period starting with the publication of the proposed law in March, 1964, and ending in April, 1965. This figure is all the more significant when coni- pared with the 2.36 billion DM of German bonds which foreigners had purchased in the fourteen months' period preceding the publication of this proposed with- holding tax law. The graph attached to Appendix C) clearly reflects this trend, the red "balance" curve showing a varying excess of sales over purchases of. German bonds by foreigners in the period of March, 1964, through May, 1965. Particularly important in today's economy is the fact that a substantial with- drawal of foreign owned bank deposits would further restrict the already tight money supply of U.S. banks. This, in turn, would increase the pressure for loans from the Federal Savings and Loan institutions and other lending agencies. The net result, of course, would be further pressure to increase domestic interest rates. This, in itself, would be contrary to the present policies of the Federal Reserve Bank, embodied in the latest supplement of the Federal Reserve Bank of Boston to Regulation Q, Par. 217.6 of July 20, 1966. By way of comparison, it may be noted that the interest rate of German bonds rose by more than one percent following the enactment of the German withholding tax (cf. chart 2 of appendix 0). The adverse practical effects of subjecting bank deposits of foreigners to with- holding tax appear clearly to outweigh and abstract equitable considerations of treating nonresident aliens on a tax parity with residents and citizens of the Tjnited States. This is especially true when such equitable considerations could well be repudiated on the ground that nonresident aliens do not receive the same benefits from the United States as do residents and citizens. In addition, the proposed withholding tax would not affect all nonresident aliens uniformly since United States tax treaties with developed countries, such as Germany and the United Kingdom, frequently specifically exempt such interest payments from income taxation. In view of this discrimination, it is all the more difficult to accept the purely formalistic argument in support of this provirion which seeks to justify this change because "interest income of this type is so clearly derived from United States sources." (See Ways and Means Committee Report, P.7) 2. H.R. 13103 would subject bank deposits owned by nonresident aliens to the Federal Estate tax effective immediately upon enactment of this bill. 4Appendix C, referred to, may be found in the official files of the Committee. 1032 PAGENO="1043" FOREIGN INVESTORS TAX ACT OF 1966 147 Virtually the same objections, set forth above, to the proposed imposition of a withholding tax on interest apply to the proposed estate tax on U.S. bank deposits of nonresident alien individuals. The obvious reason for the withholding on interest provision not to become effective until January 1, 1972, was the belief that the immediate enactment of the income tax provision would do serious harm to the United States balance of payments. The proposed estate tax by contrast would take effect immediately presumably because of the assumption that such a tax would not cause an outflow of dollars from the United States. This reasoning may well prove to he fallacious as it seems unlikely that an individual nonresident alien who, having *the intention of withdrawing his deposits after 1971, would leave his money with a United States bank during the next five years and thus run the additional risk of falling within the ambit of the estate tax provision. 3. H.R. 13103 employs the "effectively connected" concept as a means of sub- jecting certain foreign source income to U.S. taxation. H.R. 13103 introduces the novel concept of "effectively connected" (a) to dis- tinguish between business and investment income and (b) to determine the amount of business income that should be subject to progressive United States income tax rates. According to the Report of the Ways and Means Committee, at page 14, the latter function of this concept was intended to curb the abuse of the existing U.S. source rules by foreign. taxpayers engaged in trade or busi- ness within the United States. According to the bill, specified types of foreign source income, namely, (a) rents and royalties, (b) dividends and interest derived from the active conduct of a banking business and (c) certain sales income, would be subject to United States taxation if such income were "effec- tively connected" with the taxpayer's United States trade or business and if such taxpayer maintained a fixed place of business within the United States. This new concept is meant to supersede a very important segment of the tradi- tional source rules and should be as easy to apply as the rules that it would replace. However, it is submitted that the "effectively connected" concept would be far more difficult to administer than existing rules because there are no general guidelines for the future application of this term. This uncertainty about the administrative and judicial interpretation of this concept would, if enacted, tend to discourage prospective foreign investment in the United States. It might also lead to withdrawal of deposits because interest paid on foreign owned U.S. bank deposits, including interest paid by foreign branches of U.S. banks, might be deemed "effectively connected" with a foreign taxpayer's United States trade or business and thus be subject to United States income taxation prior to January 1, 1972. This possibility would in particular discourage foreign banks which maintain United States branches from depositing dollars with United States banks, including their foreign branches. Finally, the "effectively connected" concept would require our bank, acting as a withholding agent, to determine whether or not the interest it pays on foreign-owned bank deposits is "effectively connected" with the United States business of the depositor. This requirement would not only impose an extremely heavy administrative burden on the clerical staff of our bank but also would necessitate it either to pass upon intricate legal questions exceeding its profes- sional capabilities or to obtain legal opinions. Apart from these difficulties, it even seems doubtful whether we would be able to collect all the necessary fact- ual data from our clients to reach a decision in a specific case. In view of the personal liability and severe penalties applicable to withholding agents, it would theerfore seem likely that United States banks would deem most of the interest paid on foreign-owned bank deposits as not "effectively connected" with the de- positor's United States business and thus subject them to the United States withholding tax provided for by H.R. 13103. Such a course of action would, hbwever, not only greatly increase the administrative worklOad of United States banks but at the same time also defeat the proper and reasonable application of the new "effectively connected" concept. For these reasons, we submit that the "effectively connected" concept be elimi- nated from H.R. 13103 altogether, or at least be limited in its application to United States source income. Based on these considerations, we respectfully request that your Committee eliminate the provisions of H.R. 13103 indicated above. Sincerely yours, L. D. BRACE, Chairman. 1033 PAGENO="1044" 148 FOREIGN INVESTORS TAX ACT OF 1966 GALLTJSANLAGE 7, July 27, 1966. Mr. J. WARREN OLMSTED, Executive Vice President, The First National Bank of Boston, Boston, Mass. DEAR Mn. OLMSTEAD: On return from a business trip abroad I found upon my ~lesk your letter of July 6th, 1960 pertaining to "The Foreign Investors Tax Act of 1966". The proposed provisions (1) in the tax bill entitled "The Foreign Investors Tax Act of 1966" .(}LR. 13103) would certainly not be favorably received by inter- national bankers. The proposed 30 per cent withholding-tax to be levied on in- tere~t paid by United States banks on deposits of foreigners, I am afraid, would substantially reduce the willingness to deposit funds with American banks, of investors, such as banks, commercial enterprises and private individuals. Even though a double taxation treaty concluded with the depositor's home country may permit full reimbursement of the taxes withheld or at least a partial set off against domestic taxes, it seems to me that the necessary procedures of getting full or partial compensation for the withheld taxes would of necessity cause delays and losses of interest income to potential depositors. In this context, I believe, the experiences gained subsequent to the enact- ment of the 25% withholding-tax on interest paid on German bonds held by non~ residents, which became law on March 28th, 1965 and effective firstly on the July 1st, 1965 coupon, may be of interest. The main aim of this so-called 4'coupon-tax" was to discourage foreign money to flow at the same rapid pace as in the previous months into Germany, where the then prevailing interest level was considered internationally very attractive. While the law proved quite effective in stopping the influx of funds into Germany, it has shaken the con- fidence of foreign investors and thus became a contributing factor to the de- terioration of the German capital market which has been noticeable in the last two years. I would have no objection to your submitting the above opinion to the Senate Finance Committee. Yours sincerely, GUSTAV GLUECK. DtiSSELDORF, July 27, 1966. TMr. J. WARREN OLMSTED, Executive Vice President, The First National Bank of Boston, International Divi- sion, Boston, Mass. DEAR Mn. OLMSTED: Your letter to Mr. G. Fuchs, Deputy General Manager, of July 6, 1966, has been referred to us for answering. We are rather surprised that the United States Congress should consider to subject interest on foreign deposits with US-banks to United States income tax and the deposits themselves to United States estate tax. As you are aware, banks in this country are at the present time not permitted to pay interest on foreign held deposits with the exception of savings deposits (restricted to individuals) and L/C cover accounts. No tax whatsoever is levied on these deposits and interest thereon. But the interest regulations have had a similar effect as would have had a tax. They have naturally caused non- residents-bankers as well as non-bankers-to keep their credit balances in Ger- many at the minimum required for their current operations and invest funds beyond this level elsewhere. * One may compare the problem with the German coupon tax, i.e. the withhold- ing tax on interest paid by German debtors to non-resident bond owners. If the bond owner declares his income properly at home, he would normally be per- niitted to deduct there the tax paid in Germany. In case of the existence of a double taxation convention the German Internal Revenue would upon his pro- ducing proof of proper tax declaration at home reimburse him for the tax with- held in Germany. The explicit purpose of the coupon tax has been to discourage foreign investors to import into Germany certain black moneys which had added to our increasing and undesired balance of payments surplus. The result has been disappointment among all foreign investors who very heavily have withdrawn from bond invest- ments in Germany. 1034 PAGENO="1045" FOREIGN INVESTORS TAX ACT OF 1966 149 * To what extent this development has contributed to the great change in our balance of payments during the last two years is difficult to assess, but the tend- *ency as such has been quite obvious. We ought to repeat that this was exactly what the German legislator wanted. What he did not want, of course, was the very undesired contribution which this withdrawal of foreign investors made to the present deplorable condition of our capital market. It would seem quite clear that taxes of the before-mentioned kind cannot but discourage foreign investors who would look for more friendly havens. Large foreign funds invested with US-banks, particularly with those heavily engaged in world-wide transactions, would certainly disappear and foreign holdings would shrink to working balances, thus reducing the flexibility and scope of their inter~ national operations. It seems difficult to understand, therefore, why a country suffering from complex structural balance of payments problems should take siction to increase the deficit rather than to attract foreign capital. Admittedly, there are always various aspects to a problem and, unfortunately, they are some- times conflicting. We hope to have been of assistance to you. You may use these comments as yofi deem appropriate, although we do not think that we have produced big news. Very truly yours, COMMERZBANK, AKTIENGESELLSCHAFT. The CHAIRMAN. Mr. Anthony Nizetich will not be able to appear here today. He canceled his appearance and sent us a letter signed by John E. Korth, assistant secretary-treasurer, and we will see that the letter is printed. (The letter referred to follows:) STAR-KIST Foons, INC., Terminal Island, Calif., August 11, 1966. Re H.R. 13103. COMMITTEE ON FINANCE, U.S. Senate, New Senate Office Bnilding, Washington, D.C. (Attention of Mr. Tom Vail, chief counsel). GENTLEMEN: We believe that H.R. 13103 is ambiguous with respect to the "effectively connected" concept as embodied in proposed sections 864(c) (4) and section 882. We believe that enactment of these provisions as they are presently written would add to the uncertainties of tax compliance which already exist because of the Revenue Act of 1962 and the delays in issuing regulations under section 482 of the Internal Revenue Code. We believe that the 1962 Revenue Act together with sections 367 and 482 of the Internal Revenue Code give the Internal Revenue Service ample authority to control the shifting of income and expenses outside of the United States. We believe that the entire area of taxa- tion of foreign source income has been thoroughly reviewed and resolved by the recently enacted Revenue Act of 1962. As businessmen and taxpayers we need clearly defined tax rules and regula- tions on which to rely in making business decisions. Otherwise, we cannot stay competitive either at home or abroad. The proposed sections of H.R. 13103 as above cited will, in our opinion, accomplish just the opposite. Aside from need- less record keeping and accounting requirements, they will create confusion and litigation for many years to come. As always in situations such as this, it is the small businessman who will suffer most. In the case of small taxpayers in particular, we believe this proposed legisla- tion would create undue hardships for two reasons. First, the small taxpayer will usually be compelled to concede in favor of the Revenue `Service's position with respect to the "effectively connected" concept because he will find it too expensive to litigate the issues. Secondly, under the proposed legislation the larger taxpayers will `be able to avoid its application in some instances by estab- lishing an office or other `fixed place of business outside the United States for their foreign subsidiaries. This tends to disfavor the small taxpayer who cannot economically support a separate foreign-based office location in order simply to avoid the "effectively connected" concept. 1035 PAGENO="1046" 150 FOREIGN INVESTORS TAX ACT OF 1966 We must through necessity search out all of the seas of the world for an ade- quate supply of raw fish in our business. This proposed legislation would hinder this search and penalize our industry only because of the nature of our opera- tions. In our opinion, this proposed legislation would place the U.S. tuna fishing industry at a competitive disadvantage with other countries of the world. There- fore, we strongly recommend that the "effectively connected" concept of H.R. 13103 be deleted. Very truly yours, JOHN E. KouTH, Assistant Secretary-Treasurer. The CHAIRMAN. That concludes this morning's hearing. We will resume tomorrow morning at 10 o'clock. (Whereupon, at 11:25 a.m., the committee recessed to reconvene at 10 a.m., Wednesday, Aug. 10, 1966.) 1036 PAGENO="1047" FOREIGN INVESTORS TAX ACT OF 1966 WEDNESDAY, AUGUST 10, 1966 U.S. SENATE, COMMITTEE ON FINANCE, Wa8hington, D.C. The committee met, pursuant to recess, at 10 a.m., in room 2221, New Senate Office Building, Senator Clinton P. Anderson presiding. Present: Senators Long (chairman), Anderson, McCarthy, Wil- hams, Carlson, Morton, and Dirksen. Senator ANDERSON. This committee will come to order. This morning we have a rather lengthy list of witnesses and I would hope the 15-minute time limitation to testify will be honored. The first witness is Mr. John H. Perkins of the American Bankers Association. Will you come forward and proceed, sir. I am sorry other members of the committee are not here as yet, but we all have double assignments today. But we will be glad to have you go ahead. STATEMENT OP J~OHN H. PERKINS, REPRESENTING~ THE AMERICAN BANKERS ASSOCIATION Mr. PERKINS. My name is John H. Perkins. I am senior vice presi- dent of the Continental Illinois National Bank & Trust Co. of Chi- cago. I am appearing here today to present the views of the Ameri- can Bankers Association on H.R. 13103, the Foreign Investors Tax Act of 1966. This act carries out a number of the recommendations contained in the Fowler task force report for the purpose of encourag- ing foreign investment in the United States. Secretary Fowler em- phasized this objective again Monday, and we support this. However, the act contains two provisions of vital concern to commercial banks, and to the well-being of our country. These provisions do not have any bearing upon taxes paid by commercial banks under our tax laws, and are not based on recommenda,tions of the Fowler task force. In fact, they run counter to the objectives of the task force report. The act proposed to amend the Internal Revenue Code to subject to the U.S. income tax, interest paid to nonresident aliens and foreign corporations on their U.S. bank deposits. This tax would become effective after 1971. The act also would include deposits in U.S. banks in the gross estate of nonresident aliens and subject such deposits to the U.S. estate tax. Presently, interest paid to nonresident aliens and foreign corporations not doing business in the United States on U.S. bank deposits is not subject to the U.S. income tax and neither are the deposits of nonresident aliens subject to the U.S. estate taxes. 15~ 1037 PAGENO="1048" 152 FOREIGN INVESTORS TAX ACT OF 1966 In presenting H.R. 13103 to the House of Representatives for its con- sideration, the chairman of the Committee on Ways and Means reported that the original purpose of this legislation was to improve the U.S. balance of payments, but the committee concluded that the tax laws needed change. The bill as modified by the Ways and Means Com- mittee was primarily designed to treat nonresident aliens and corpora- tions generally on a basis which is consistent with the tax treatment of American citizens and domestic corporations. We believe that enactment of the two provisions in the act referred to above will do irreparable injury to the economic position of the United State.s. If these provisions are enacted, undoubtedly there will be a widespread withdrawal of foreign dollar balances from this country. Tl1is will add to the problems brought on by our balance- of-payments position and will result in substantial additional outflow of gold from the United States. Any assumption that delay in the effective date in the imposition of income taxes until after 1971, post- pones immediate concern is erroneous. I think I would like to empha- size that, that the very passing of that act will trigger a reappraisal of banking relationships by the nonresident aliens affected. This reappraisal will lead to near-term action in many cases. As a matter of fact, commercial banks already are receiving inquiries from their foreign depositors concerning the pending legislation. Also, the estate tax on foreign held deposits would be effective at once, that is, with respect to taxable years beginning after December 31, 1966. Conse- quently, if the legislation is enacted there could possibly be a massive outflow of funds before the end of the year which could seriously affect our international financial position for this year. On the basis of transactions during the first half of this year, our payments position, without taking into consideration any movement of funds that may result under this legislation, will be much more unfavorable than originally anticipated at the beginning of the year. I might add too any outflows triggering from the passage of this act would take effect immediately, whereas the benefits from the other parts of the act would take some time to affect our position. The action proposed in the pending legislation is inconsistent: with previous action by the Congress in dealing with foreign bank deposits in this country. The importance of retaining such funds in this country from the standpoint of our balance of payments and U.S. gold position was considered an important factor by the Banking and Cur- rency Committee in its report on H.R. 5306, 89th Congress, 1st session (IRept. No. 336), a bill to continue the authority of domestic banks to pay interest on time deposits of foreign governments at rates differ- ing from those applicable to domestic depositors. The committee, in recommending passage of H.R. 5306, stated that."the object of the bill is `to extend existing provisions of law designed to encourage foreign governments and monetary authorities to maintain dollar accounts in this country rather than convert these dollar accounts directly into gold or to transfer the funds to other financial centers, whereupon they could be acquired by official institutions of `other countries and be converted into gold." Bringing our international payments into balance is difficult, par- ticularly in light of the present magnitude of U.S. Government com- mitments in support of world peace and development. As an emer- 1038 PAGENO="1049" FOREIGN INVESTORS TAX ACT OF 1966 153 gency expedient, American businessmen and bankers have been enlisted in a voluntary program of restraints on U.S. capital outflow to elimi- nate the deficits. This effort should not be undermined by introducing penalties on foreign deposits with American banks. The original proposal of tax legislation in this area at this time was to create a more attractive' climate for foreign investments in the United States. Even the threat of the contemplated action is harmful, affecting for- eigners' decisions to Open or maintain accounts with American banks. In addition to `the effect which the withdrawal of foreign balances could exert on our balance-of-payments position, there is also the effect on our general economic position. Balances in U.S. banks maintained by nonresident aliens represent assets that have been voluntarily brought into this country for one reason or another, `but usually from the standpoint of safety. The U.S. dollar is, and has been for many years, the strongest currency in the world, and this has lead foreigners to transfer' part of: their wealth to the United States for safekeeping. This has been encouraged because such assets in the form of bank deposits have not been subject to our estate taxes; the income on such deposits has not been subject to our income taxes, and there are no impediments to the withdrawal of the deposits from the United States. We. do not have precise figures available which show the aggregate amount of the' fun,ds currently on deposit, but it is conservatively esti- mated that they amount to several billions of dollars, which I think our figures are consistent with those which have been given in the last few days here.' Senator ANtERSON. It is substantially higher, isn"t it? We had testimony earlier of about a billion nine-hundred million dollars. Mr. PERKINS. As I understand it., Senator~ that was in reference to New York: City alone. Senator ANDERSON. Most of the money is there, isn't it? Mr. PERKINS. Well, I think `there is quite a bit more, as we point out here, wherethese funds are not only held in the large banks in the principal money centers of the country, which do an extensive business in support of our foreign trade, but they are also held by many of `the smaller banks throughout the country, and especially. by. the banks in the border States. ` ` ` ` ` In the last few days, incidentally,, we made some checks around on an informal basis and we found deposits of this type while admittedly not `quitethe biggest dollar amounts but spread all over,Atianta, Bôs- ton, Chicago, Cincinnati, Cleveland, Dallas, El Paso, Fort Worth, Houston, Jacksonville, Phoenix, Philadelphia, St. Louis. It is very widespread. ` ` ` We know `for. a fact that a number of Texas banks, for example, especially those located near the border, have substantial deposits from residents in Mexico. One such bank reports that one-quarter of. its total deposits' of $40 million would be included in t.his category. So again in, answer to your question, it is very important to these banks even though the dollar amounts are quite different in magnitude. Senator. ANDERSON. Iwant you to testify on this point because that is a question we will face very shortly. I talked to Sam Young of the bank in El Paso-I have known him for many years; a very fine man and a very fine bank-and he tells me that he has substantial deposits from across the border. That is true clear across the Mexican 1039 PAGENO="1050" 154 FOREIGN INVESTORS TAX ACT OF 1966 borderline and I think that was an important fact which had not been brought out the other day in the testimony. It isn't confined to the New York banks, in other words. Mr. PERKINS. I couldn't agree with you more. That is what I am trying to emphasize, that while the very large dollar amounts may be in some of the New York banks and one or two others around the country, in Chicago and San Francisco, there are very important dollar amounts elsewhere and to the individual banks elsewhere, par- ticularly in along both the borders, these are very important amounts to those banks and I think would have a very substantial effect on the operations of those banks. Senator CARLSON. Mr. Chairman, right on that point, Mr. Perkins, who represents The American Bankers here, we disputed this figure of $1.9 billion, $1.9 billion in New York. Would you be willing to estimate a guess as to what we have in this country? Mr. PERKINS. I think it would be very hard to guess. We are try- ing, through the Reserve City Bankers Association to get some more accurate figures, but we don't have those available yet. I understand Secretary Fowler used a figure of about $2.5 billion as the total dollar amount. This would presumedly then say there is roughly $600 mil- lion of this type of money spread elsewhere. I don't think this is an unreasonable figure. My own guess would be that if we added not only the nonresident alien deposits, but we got into some of these estate matters and others, my guess would be it would be larger than the $600 million, if we got all the figures together, but I just don't know. Senator CA.nLsoN. Larger than $600 million, in addition to the $1.9 billion? Mr. PERKINS. Yes, sir. Senator C~uiLsoN. That would be $3.5 billion, a little better than that. Senator ANDERsoN. Senator Carlson, all along the border there are banking institutions that do business in Mexico. I know the El Paso banks do a lot of business. Mr. PERKINS. For example, Senator, taking this one bank I refer- red to, a $40 million bank. He has got $10 million in his $40 million bank alone. Well, you can imagine what the impact would be on his bank of such a tax bite. Also I think that is indicative of the kind of money that is around that is not normally thought of. This particular bank is in a little Texas town where you would not expect this kind of money at all, of that size. Senator ANDERSON. I am glad you cleared up that point because it was bothering some people. Mr. PERKINS. Well, I have been impressed in our informal survey just how many cities this does affect. It is not just Miami and New Orleans and a few of the larger cities but it is widespread, and even in areas like Pittsburgh that have this kind of deposit. I go on. Many of the resources of agencies in the United States are being utilized to encourage the expansion of our export business in order to strengthen our balance-of-payments position. Our American banks and industry have wholeheartedly supported efforts of the ad- ministration to increase our exports and to reduce the amount of American investments abroad. Withdrawal of balances of nonresi- 1040 PAGENO="1051" FOREIGN INVESTORS TAX ACT OF 1966 155 dent aliens might well exert some indirect adverse effect on our export; trade. Although it is obviously difficult to pinpoint this with cer- tainity. We believe that on balance, the United States has a great deal more to lose than can ever be gained from what little taxes that might be collected under the pending legislation from these sources because, as pointed out above, owners of these funds are free to move them else- where. Legislation of this character is apt to have an unwholesome immediate effect on investor psychology and we can look to a prompt outflow of funds seeking investment outlets in other countries. It is recognized that the act provides that the amendments made by it are not to apply where application would be contrary to any treaty obliga- tion of the United States and' that there is a 5-year period before the in- come tax would be effective on bank deposits. However, this is offset by the in-imediate imposition of the estate tax. And I would like to add it is offset by the immediate psychological effect on these foreigners who already are concerned about this and who will not wait, in our opinion, until 1971 at all to make their moves. Accordingly, we strongly recommend that the committee amend the act and rebtin the present provisions of the Internal Revenue Code which exempts from the U.S. estate and income taxes deposits held by nonresident aliens in U.S. banks and the interest paid thereon. Senator ANDERSON. Thank you, Mr. Perkins. Is there any possi- bility that the banks might feel differently if the estate tax provision was postponed until 1972? Mr. PERKINS. I don't believe so, Senator. Our feeling, and we have talked to a number of bankers about this in a number of areas, our feel- ingis quite strong that the banking relationship is built up over a long period of years. When a new tax comes in, whether it is the estate tax Or the deposit tax, the people owing the funds and their lawyers and their financial advisers and all start; looking at this, start worrying about it and they don't think of waiting until that day in 1971. They start trying to analyze whether or not they ought to change their bank- ing relationships because of this tax, and if they conclude to do that, they will go ahead and start making these moves now. So, I don't think the idea of an effective date really has as much bear- ing as might seem from the date it is. In other words, we feel that this would trigger a certain amount of action immediately and not post- pone action until 1971 when we could get another look. Obviously, there would be those who would wait until 1971 to make a move, I grant you that, but we think there would be some effects immediately and then over the next few years, month by month. Senator ANDERSON. Sinèe the House bill does not alter the present law permitting interest to be earned on income in foreign branches of U.S. banks without a tax `being due, are there any large banks with foreign branches which might support this provision of the House bill? In other words, perhaps there is a divergence of opinion among your own people. Mr. PERKINS. No; I think I can answer that unequivocally. Those `who have foreign branches, the New York banks primarily, obviously they support that provision. We have foreign branches in our bank, we would not; we feel very strongly on this. I just don't see that at 1041 PAGENO="1052" 156 FOREIGN INVESTORS TAX ACT OF 1966 all. I think, incidentally, this is one point that needs making, that while those banks having foreign branche.s maybe could conteract some of the impact of this, the fact is that is a very small group of banks, and the banks we were talking about along the border and elsewhere throughout the country do not have foreign branches and would have no way to recoup any of these funds through a branc~ii operation. Senator ANDERSON. I referred a while ago to Mr. Young and has bank in El Paso. He has been a longtime friend and director of Mr. Hilton's hotel operations. Because he came out of that country and I would have thought that Mr. Young's interests were in oil and cotton and some hotel business. But he was very definite in the amount of money that his bank had and other banks along the bordcr had, and he thought this was a great disservice to those banks. You think your membership will so testify ~ Mr. PERKINS. Yes. Senator ANDERSON. Senator Carlson. Senator CARLSON. Mr. Perkins, yesterday when Mr. Barth testi- fied, in his statement he had a paragraph or two that dealt with some of the restrictions that are placed on the movement of this money by the Federal Reserve, and he mentioned, his direct statement was, there were some very rigid, I believe, restrictions on the handling of this foreign credit. I have here before me the Federal Reserve Bulletin of December 1965, and in it, page 1683, there is an article entitled "Revised Guide- lines," and I shall read one or two paragraphs and then ask permis- sion to put it in-it is just a short article-in the record of the hearings. The main feature of the guidelines for 1965 has been a percentage limitation on increases in foreign credits from the base date of December 31, 1964. In general each bank was requested to restrict its foreign credits outstanding to an amount not in excess of 105 percent of the amount outstanding at the end of 1964, and each non-bank financial institution was requested to operate within~ a framework roughly similar to that suggested for the banks. Now I assume the bankers have been following this, and- Mr. PERKINS. I think the bankers have been following it very well. As a matter of fact, I think the total amount of this credit is actually below the maximum permitted by the guidelines, and I think the banking industry, in response to the Government's volun- tary restraint program, of which these guidelines are a part, have had complete conipliance. I think Governor Martin and Governor Robertson have so testified at a number of House and Senate hearings. I think their record is very good on this. Senator CAI~I1soN. For the record, the next one paragraph: Continued restraint on the increase in foreign credits is a basic objective of the bank program for 1966. Generally speaking, commercial banks are requested to restrain any expansion in foreign credits to such an extent that the amount outstanding at year end will not exceed 109 percent of the amount outstanding on December 31, 1964. I wanted this as a part of the record. Senator ANDERSON. It will be put in the record. Senator OARLSON. Thank you very much. 1042 PAGENO="1053" FOREIGN INVESTORS TAX ACT OF 1966 157 (The article referred to follows:) [From the Federal Reserve Bulletin, December 1965] BALANCE OF PAYMENTS PRoGRAM-REvIsED GUIDELUcE5 FOR BANKS AND NONBANK FINANCIAL INSTITUTIONS Since the inception of the voluntary foreign credit restraint effort, immediately following announcement by the President of his balance of payments program in February 1965, commercial banks and other financial institutions have con- tributed substantially to the improvement in the nation's payments position. This has been accomplished by the high degree of cooperation and statesmanship exhibited by the financial community in restraining the growth of (and in some instances reducing) claims on foreigners in accordance with guidelines issued by `the Board of Governors of the Federal Reserve System. Although considerable progress has `been made and although the voluntary restraint program is temporary in nature, perseverance by financial institutions `in the program through 1966 is necessary to `attain the goal `of equilibrium in the nation's `balance of payments and represents `the appropriate response to the President's message of February 10, 1965, in which he issued a personal "call on American `businessmen and bankers to enter a constructive partnership with their Government to protect and strengthen the position of the dollar in the world today." The main feature of the guidelines for 1965 has been a percentage limitation on increases in foreign credit's from `the base date of December 31, 1964. In general, each hank was requested to restrict its foreign credits outstanding to an amount not in excess `of 105 per cent of the amount outstanding at the end of 1964, and each nonbank financial institution was requested to operate within a framework roughly similar to that `suggested for banks. For the year 1966 the guidelines for both banks `and nonbank financial institu- tions h'ave `been revised to suggest limitations on expansion of foreign credits that are comparable to the limitations suggested for 1965. These will permit some further expansion in such credits, and provide for variations to remove certain inequities inherent in the 1965 program. Nothwithstanding the fact that the banking system as a whole is presently well below the suggested target for 1965, this additional expansion has been al- lowed for two reasons: (1) it is believed that banks will continue to cooperate with the spirit as well as the letter of the program and will utilize the expansion `suggested only to the extent needed to meet priority credit requirements; and (2) it is intended to make certain that export financing is available in adequate amounts, and that the bona `fide credit needs of less developed countries will con- tinue to be met. Continued restraint on the increase in foreign credits is the basic objective of the bank program for 1906. Generally speaking, commercial banks are re- quested to restrain any expansion in foreign credits to such an extent that the amount outstanding at year-end will not exceed 109 per cent of the amount outstanding on December 31, 1964. Further, in order to spread throughout the year any outflow necessary to meet priority credit requirements, it is requested that the amount outstanding not exceed 106 per cent of the 1964 base during i he first quarter, 107 per cent during the second, and 108 per cent during the third quarter. Special consideration for banks with small bases will add 1 per cent or less to the total, bringing the potential amount outstanding at the end of 1966 for the banking system as a whole to about 110 per cent of the 1964 base us compared with the 105 per cent target for 1965. The guidelines for 1966 for nonbank financial institutions have been revised to reflect provisions broadly comparable with those of the bank guidelines. In- vestments of liquid funds abroad are to be held to minimum practicable levels and ordinarily should not be permitted to exceed the reduced September 30, 1965, total. Investments in credits maturing in 10 years or less `and in foreign branches and financial subsidiaries are subject to the same ceiling as suggested for the banks. Long-term investments in developed countries other than Oanada and Japan are subject to a ceiling of 105 per cent of the September 30, 1965, amounts during 1966; this base was selected because retroactive use of a 1964 year-end base might have been inequitable for some institutions. As in 1965, financial institutions are requested to give priority to export credits and credits to less developed countries. In instances where the special base and 1043 PAGENO="1054" 158 FOREIGN INVESTORS TAX ACT OF 1966 ceiling calculations for banks with small bases result in a ceiling in excess of 109 per cent, it is requested that the amount in excess of 109 per cent of a bank's base be used exclusively for such priority credits. The leeway for additional foreign credits provided by the 1966 guidelines plus the funds available from repayments on outstanding credits will provide larger resources than last year to finance an expanded volume of exports and to satisfy credit requirements ~f -less developed countries. The guidelines for banks and nonbank financial institutions follow.' GUIDELINES von BANKS (1) BASE, CEILING, AND REPORTING ~(a) Base 1. The base is a bank's total claims on foreigners for own account, including ~foreign long-term securities, on December 31, 1964, except for the exclusion in (a) 3 below. 2. Meaning of terms: (A) "Foreigners" include individuals, partnerships, and corporations domi- `cued outside the United States, irrespective of citizenship, except their agencies *or branches within the United States; branches, subsidiaries, and affiliates of U.S. banks and other U.S. corporations that are located in foreign countries; and any government of a foreign country or official agency thereof and any official international or regional institution created by treaty, irrespective of location. (B) "Long-term securities" are those issued without a contractual maturity or with an original maturity of more than 1 year from the date of issuance. (0) "Other claims" include all long-term claims other than Securities, real assets, net investment in and advances to foreign branches and subsidiaries, and all short-term claims (such as deposits, money market instruments, cus- tomers' liability on acceptances; and loans). 3. Specific inclusions and exclusions: (A) Claims on foreigners should be included withdut deduction of any offsets. Foreign customers' liability for acceptances executed should be included whether or not the acceptances are held by the reporting bank. Participations purchased in loans to foreigners (except participations in loans extended by the Export-Import Bank) also should be included. (B) Contingent claims, unutilized credits, claims held for account of cus- tomers, acceptances executed by other U.S. banks, and participations in loans arranged by or guaranteed by the I6xport-Import Bank or insured by the Foreign Credit Insurance Association shthild be excluded. (b) Ceiling 1. The 1906 ceilings, with respect to the amount of foreign credits outstand- irig by a bank with a base of $5 million or more are as follows: (A) In the first calendar quarter, 106 per cent of its base; (B) In the second calendar quarter, 107 per cent of its base; (0) In the third calendar quarter, 108 per cent of its base; (D) In the fourth calendar quarter, 109 per cent of its base. 2. In. lieu of the ceiling prescribed in (b) 1 above, a bank with a base of ~500,000 but less than $5 million, may use the following special ceiling: (A) In the first calendar half, its base plus $225,000; `(B) In the second calendar half, its base plus $450,000. ~3. The `ceiling for a bank with a base below $500,000 is 150 per cent of its base. However, any such bank, or a bank which had no foreign credits out- `standing `on December 31, 1964, may discuss with the Federal Reserve Bank `of the Reserve district in which it is located the possibility of adopting a ceiling that `wo~uId permit expansion up to $450,000 above the bank's base. 4. In `discussing the ceiling of a bank described in paragraph 3, the Federal 1~eserve Bank will ascertain the bank's previous history in foreign transac- tions, including acceptance of foreign deposits or handling foreign collections, and the reasons why the hank èonsiders it should have additional leeway. `Previous Guidelines for Banks and Nonbank Financial Institutions were published in `the following BULLETINS this year: March, pp. 3l~1-76; April, p. 532; May, p. G85; July, pp.944-46; and August, p. 1105. 1044 PAGENO="1055" FOREIGN INVESTORS TAX ACT OF 1966 I59~ Prior to a decision, the Federal Reserve Bank will obtain clearance from the Board of Governors. 5. Any expansion under paragraphs 2 or 3 that is in excess of 109 per cent of the bank's base should be limited to loans or acceptance credits that finance exports of U.S. goods or services or that represent credit extended to less~ developed countries. Export credits should be limited to transactions orginated by the bank's regular customers or by residents of its normal trade territory~ Such expansion should not involve (A) participations in loans originated by other banks or purchases of such loans, (.B) investments in foreign securities~ (C) deposits in foreign banks, or (1)) investments in foreign short-term money market instruments. (c) Reporting 1. Banks that report on Treasury Foreign Exchange Form B-2 or B-3 should file a Monthly Report on Foreign Claims (Form P.R. 391) with the Federal Reserve Bank of the Reserve district in which the bank is located. 2. Banks that have claims on foreigners in an amount of $100,000 or more and do not report on Treasury Foreign Exchange Form B-2 or B-3 should file a Quarterly Report on Foreign Claims (Form P.R. 391a) with the Federal Reserve Bank of the Reserve district in which the bank is located. 3. Copies of Forms F.R. 391 and 39i a are available at the Reserve Banks. (2) LOANS INVOLVING EXPORT-IMPORT BANK Participations in individual export loans arranged by the Export-Import Bank, loans with Export-Import Bank guarantees or insurance, and holdings of "Ex- port-Import Portfolio Fund" participations are excluded from the ceiling. The role of the Export-Import Bank within the framework of the President's pro- gram is coordinated by the National Advisory Council for International Mone- tary and Financial Problems. (3) CREDITS IN EXCESS OF CEILING A bank would not be considered as acting in a manner inconsistent with the program if it at times exceeds its ceiling as a result of the (a) drawdown of binding commitments entered into before February 11, 1965; or (b) extension of priority export credits. The bank should, however, reduce its claims on foreigners to an amount within the ceiling as quickly as possible. It should also take every opportunity to with- draw or reduce commitments, including credit lines, that are not of a firm nature and to assure that drawings under credit lines are kept to normal levels and usage. At time of renewal, each credit line should be reviewed for consistency with the program. A bank whose foreign credits are in excess of the ceiling will be invited peri- odically to discus with the appropriate Federal Reserve Bank the steps it has taken and proposes to take to reduce its credits to a level within its ceiling. (4) LOAN PRIORITIES Within the ceiling, absolute priority should be given to bona fide export credits~ Credits that `substitute for cash sales or for sales customarily financed out of nonbank or foreign funds are not entitled to priority. With respect to nonexport credits, banks should give the highest priority to loans to less developed countries and should avoid restrictive policies that would place an undue burden on Canada, lapan, and the United Kingdom. It is expected that the outstanding amount of nonexport credits to developed countries in continental Western Europe would not be increased during 1966 but rather would be reduced to the extent needed to meet bonn fide requests for priority credits within the over-all ceiling. Without attempting to specify all types of loans that should be restricted, it is obvious that credits to developed countries that can be cut back with benefit to our balance of payments and with the least adverse side-effects include: credits to finance third-country trade, credits to finance local currency expenditures outside the United States, credits to finance fixed or working capital needs, and all other nonexport credits to developed countries that do not suffer from balance of payments difficulties. 1045 PAGENO="1056" 160 FOREIGN INVESTORS TAX ACT OF 1966 45) BANKS WHOSE FOREIGN CREDITS CONSIST ALMOST ENTIRELY OF EXPORT CREDITS A bank whose foreign credits are consistently composed almost entirely of export credits usually should keep its credits within its ceiling. If such a bank exceeds its ceiling from time to time, it would not be considered as acting in a manner inconsistent with the program if the amount of such excess is reasonable and the bank makes every effort to bring the amount of its credits back within the ceiling at the earliest practicable date. (6) TRUST DEPARTMENTS Trust departments of commercial banks should follow the guidelines with respect to nonbank financial institutions. (7) TRANSACTIONS FOR THE ACCOUNT OF CUSTOMERS A bank should bear in mind the President's balance of payments program when acting for the account of a customer. Although the bank must follow a custom- er's instructions, it should not encourage customers to place liquid funds outside the United States. A bank should not place with a customer foreign obligations that, in the absence of the voluntary credit restraint program., it would have acquired or held for its own account. * (8) FOREIGN BRANCHES The voluntary credit restraint program is not designed to restrict the exten- sion of foreign credits by foreign branches if the funds utilized are derived from foreign sources and do not add to the outflow of capital from the United States. Total claims of a bank's domestic offices on its foreign branches (including permanent capital invested in as well as balances due from such branches) represent bank credit to nonresidents for the purposes of the program. (9) "EDGE ACT" CORPORATIONS "Edge Act" and "Agreement" corporations are included in the voluntary credit restraint program. Foreign loans and investments of such corporations may be combined with those of the parent bank or a separate ceiling may be adopted for the parent bank and each such subsidiary corporation. If such corporation is owned by a bank holding company, its foreign loans and investments may be combined for purposes of the program with any one or all of the banks in the holding company group. An "Edge Act" corporation established before February 10, 1965, that had not made any Significant volume of loans and investments before December 31, 1964, may take as a base, alone and not in combination with its parent, its paid-in capital and surplus, up to $2.5 million. (10) U.S. BRANCHES AND AGENCIES OF FOREIGN BANKS Branches and agencies of foreign banks located in the United States are re- ~quested to act in accordance with the spirit of the domestic commercial bank voluntary credit restraint program. (1 1) LOANS TO U.S. RESIDENTS AND SUBSTITUTION OF DOMESTIC CREDIT FOR CREDIT FROM FOREIGN SOURCES There are a number of situations in which loans to domestic customers may be detrimental to the President's balance of payments program. These include: (A) Loans to U.S. companies which will aid the borrower in making new foreign loans or investments inconsistent with the President's program. Banks should avoid making new loans that would directly or indirectly enable borrowers to use funds abroad in a manner inconsistent with the Department of Commerce program or with the guidelines for nonbank financial institutions. (B) Loans to U.S. subsidiaries and branches of foreign companies which otherwise might have been made by the bank to the foreign parent or other foreign affiliate of the company, or which normally would have been obtained abroad. 1046 PAGENO="1057" FOREIGN INVESTORS TAX ACT OF 1966 161 (0) Loans to U.S. companies with foreign activities that take the place of ~oredit normally obtained abroad. Even though such loans are made to domestic Ifirms or those domiciled here, the impact on the U.S. balance of payments is the same as if the bank had made loans to foreigners in the first instance. To the extent possible, banks should also avoid making loans to domestic borrowers that have an effect similar to that of the loans described in para- ~graphs (B) and (C) above. (12) MANAGEMENT OF A BANK'S LIQUID FUNDS A bank should not place its own funds abroad for short-term investment purposes, whether such investments are payable in foreign currencies or in U.S. ~dollars. This does not, however, `call for a reduction in necessary working bal- ances held with foreign correspondents. GUIDELINES FOR NONBANK FINANCIAL INSTITUTIONS The types of financial institutions to which these guidelines on foreign lending and investing are applicable include domestic life, fire and casualty insurance companies; corporate noninsured pension funds and State-local retirement sys- tems; mutual savings banks, mutual funds and investment companies; con- sumer, sales and commercial finance companies; college endowment funds and charitable foundations. Also covered by the program are the U.S. branches of foreign insurance companies and of other foreign financial corporations. Trust companies and trust departments of commercial banks are expected to observe the guidelines in the investment of funds entrusted to them or for which they `serve as investment advisor. Investment underwriting firms, security broker and dealers, and investment counseling firms are also covered with respect to foreign assets held for their own account, and are requested to inform customers of the guidelinesc and to enlist their support in cooperating with the Presi- dent's program. Any nonbank financial institution holding $500,000 or more in foreign loans, investments, or other foreign financial assets is requested to file a statistical report (Form P.R. 392) at the close of each calendar quarter with the Federal Reserve Bank of the Reserve district in which its principal office is located. Lending institutions not receiving copies of the reporting form may obtain them from the Federal Reserve Bank. SPECIFIC GUIDELINES (1) Investment of liquid funds abroad should be reduced to minimum practica- ~ble levels consistent with the operating needs of the institution. Such holdings ordinarily should not be permitted to exceed the September 30, 1965, total, ex- cept for temporary seasonal excesses. This category includes all deposits held with foreign banks or foreign branches of U.S. banks, whether denominated in U.S. dollars or a foreign currency and regardless of maturity. It also includes all liquid money market claims on foreign obligors with an original maturity of 1 year or less, whether such claims are denominated in U.S. dollars or a foreign currency. The term "liquid money market claims" is interpreted broadly to include the securities of Governments and their instrumentalities, commercial paper, finance company paper, bankers' acceptances, and other readily marketable paper. This guideline is not applicable to short-term business credits that are not readily marketable (covered under ~guideline (2)). (2) Investments and credits maturing in 10 years or less at date of acquisi- tion, except for liquid investments covered under guideline (1), are subject to a percentage guideline based on the total of such holdings at the end of 1964. The aggregate amount of these investments, and of net financial investment in -foreign branches, financial subsidiaries and affiliates (described below), should `not exceed 105 percent of the 1964 base date amount as of the end of 1965, and `should not exceed 106 per cent of the base date amount during the first quarter of 1966, 107 per cent during the second quarter, 108 per cent during the third quarter, and 109 per cent in the final quarter of the year. This category includes all bonds, notes, mortgages, loans, and other credits -carrying maturities at date of acquisition of 10 years or less. The date of final 71-297 O-67-pt. 1-67 1047 PAGENO="1058" 162 FOREIGN INVESTORS TAX ACT OF 1966 maturity is to be taken in classifying individual credit transactions, except that a credit transaction should not be classified as "long term" (and hence subject to guideline (3) below) unless 10 per cent or more of the amount to be repaid is scheduled to be repaid after 10 years. Loans guaranteed or arranged by the Export-Import Bank or insured by the Foreign Credit Insurance Association are not to be considered foreign credits for purposes of this program. Net financial investment in foreign branches, financial subsidiaries and affili- ates, if any, is included among the assets subject to the percentage ceilings of this guideline. Such financial investment includes payments into equity and other capital accounts of, and net loans and advances to, foreign corporations engaged principally in finance, insurance, or real estate activities, in which the U.S. institution has an ownership interest of 10 per cent or more. Earnings of a foreign affiliate that are reinvested in the business are not included among assets subject to the guideline ceiling, although institutions are requested to repatriate such earnings to the fullest extent feasible. In administering restraint in foreign lending and investing, institutions are requested to observe the following priorites or guides: 1. Credits and investments that represent bona fide U.S. export financing should receive absolute priority. 2. Nonexport credits and investments in the less developed countries, and in- vestments in the securities of international institutions, are to be given priority consideration second only to bona fide export financing. 3. The flow of investment funds to Canada and Japan, which are heavily de- pendent on U.S. capital markets, need be restricted only to the extent necessary to remain under the guideline ceiling. It is recognized that some individual institutions may temporarily exceed the guideline ceiling, because of investments made under the first two priorities above, or the taking down of firm commitments to lend or invest entered into prior to June 22, 1965, the effective date of the previous guidelines. In any such case, ~an institution that exceeds its target should consult with the Federal Re- serve Bank of the Reserve district in which it is located regarding a program for moving back within the ceiling in a reasonable period of time. (3) Long-term credits (exceeding 10 years in maturity) and stock investments in foreign companies are not subject to an aggregate ceiling for 1966. This category includes bonds, notes, mortgages, loans, and other credits maturing more than 10 years after date of acquisition, as well as preferred and common stocks. (Loans and investment in certain subsidiaries and affiliates, however, are covered by guideline (2).) !Perm loans and serial-payment notes and bonds are included in this category only if 10 per cent or more of the total amount of the credit is scheduled for repayment to the. lender after 10 years beyond date of acquisition. No percentage ceiling is suggested on long-term credits and investments in the priority categories relating to export financing and to less developed countries (including international institutions) as described in guideline (2). Long-term investment in Canada and Japan also is not subject to a percentage ceiling, in view of inter-Governmental agreements affecting the net amount of financing done by these countries in U.S. financial markets. Lending institutions are re- quested, however, to limit in 1966 the total of credits and investments in other developed countries to an amount not in excess of 105 per cent of the amount of such holdings on September 30, 1965. Within this category, institutions are ex- pected to avoid any increase in long-term investments in the developed countries of continental Western Europe. The attention of lending institutions is directed to the need to refrain from making loans and investments inconsistent with the President's balance of pay- ments program. Among these are the following: 1. Long-term credits covered by guideline (3) which substitute for loans that commercial banks would have made in the absence of the voluntary foreign credit restraint effort administered by the Federal Reserve System. 2. Credits to U.S. borrowers which would aid in making new foreign loans or investments inconsistent with the voluntary restraint program administered by the Department of Commerce. 3. Credits to U.S. subsidiaries and branches of foreign companies which other- wise might have been made to the foreign parent, or which would substitute for funds normally obtained from foreign sources. 1048 PAGENO="1059" FOREIGN INVESTORS TAX ACT OF 1966 163 4. Credits to U.S. companies with foreign activities which would take the place of funds normally obtained abroad. Reasonable efforts should be made to avoid accommodating credit requests of these types, regardless of specific guideline targets detailed in this circular. Notes 1. None of the guidelines in this circular are intended to apply to the reinvest- ment of reserves on insurance policies sold abroad in assets within the country involved, in amounts up to 110 per cent of such reserves. 2. Developed countries other than Canada and Japan are: Abu Dhabi, Aus- tralia, Austria, the Bahamas, Bahrein, Belgium, Bermuda, Denmark, France, Germany (Federal Republic), Hong Kong, Indonesia, Iran, Iraq, Ireland, Italy, Kuwait, Libya, Liechtenstein, Luxembourg, Monaco, Netherlands, Neutral Zone, New Zealand, Norway, Portugal, Qatar, Republic of South Africa, San Marino, Saudi Arabia, Spain, Sweden, Switzerland, and the United Kingdom. Also to be considered "developed" are the following countries within the Sino- Soviet bloc: Albania, Bulgaria, any part of China which is dominated or con- trolled by international communism, Cuba, Czechoslovakia, Estonia, Hungary, any part of Korea which is dominated or controlled by international commu- nism, Latvia, Lithuania, Outer Mongolia, Poland (including any area under its provisional administration), Rumania, Soviet Zone of Germany and the Soviet sector of Berlin, Tibet, Union of Soviet Socialist Republics and the Kurile Islands, Southern Sakhalin, and areas in East Prussia which are under the pro- visional administration of the Union of Soviet Socialist' Republics, `and any part of Viet Nam that is dominated or controlled by international communism. Senator ANDERSON. Senator Dirksen. Senator DIRKSEN. Mr. Perkins, how are you? My attention was directed yesterday to the fact that the President's Task Force recommended that the tax on the estates of decedents, foreign decedents, be eliminated. Well, evidently, they also struck out two exemptions in the bill that go along with it. One of those made an exemption of corporate bonds, and the other made an exemp- tion of cash in banks. Well, if that is the case, I can see very readily that they would want to haul their money out of the banks and they would want to liquidate their corporate bonds. Now I believe somewhere along the line, although I have not seen it, that Secretary Fowler may have said that probably it would not amount to more than $5 million. Well, I have a letter which points out there has been a recent withdrawal in a Chicago bank of over $500,000, and one other withdrawal in which over $20 million would certainly be driven from this country if we didn't continue these exemptions in the law. Do you have a theory about it? Mr. PERKINS. I really wonder whether the Secretary maybe was thinking of the amount of revenue from the tax, because clearly the amounts would be very large. This has been our position, Senator, particularly adding in the corporate bonds, but with the deposits, these are just large amounts of money, and these people are very responsive to taxes, and while some of them perhaps would, regardless of the tax, would keep their money in the United States for one reason or another, an awful lot of them would take some kind of steps to avoid the tax and the amounts involved I think clearly are just of very large mag- nitude, nothing like the $5 million you mentioned. Senator DIRKSEN. Yes. Mr. PERKINS. I had a call from one Chicago lawyer, as a matter of fact, who pointed out just one estate they were handling in their firm where there was $5 million of corporate bonds involved that would be moved. 1049 PAGENO="1060" 164 FOREIGN INVESTORS TAX ACT OF 1 ~6'6 Senator DIRKSEN. Another case that came to my attention was one~ from Latin America involving a very substantial sum. Mr. PERKINS. I think in many ways, too, we are dealing-it is hard to pinpoint any of this. It is kind of a feel because we are dealing- with areas where there are not precise figures available, where there are confidential relationships between banks and their customers, so it is hard to pinpoint, but what checking we can do indicates we are talking about large amounts of money. Senator DIRKSEN. But it could be fairly assumed if that were the case and those two exemptions were eliminated, there would be every inducements to take their money out and also liquidate the bonds. Mr. PERKINS. ~There would be every inducement to do it and it would be very easy to do it, particularly with bank deposits and even with the bonds that are well known bonds; that is riotht. Senator DnuisEN. And that, of course, woi~id aggravate our bal- ance-of-payments problem rather than help it. Mr. PERKINS. This we feel very strongly and, as a matter of fact, I was trying to make the point earlier that the beneficial effects on the- balance of payments to which the Secretary addressed himself Mon- day, would take time to develop because these are special technical provisions. On the other hand, the immediate impact on the balance of payments,. adverse impact, would be very sharp and very large because these people are free to move in many cases. Senator DIRKSEN. Yes. Thank you. Senator ANDERSON. Thank you very much, Mr. Perkins, for your- statement. Mr. PERKINS. Thank you. (By direction of the Chair, the following communications are made a part of the record at this point:) RHODE ISLAND HOSPITAL TRUST Co., Providence, 1~J., July 7, 1966. Hon. RUSSELL B. LONG, Chairman of the Senate Comm4ttee on Finance U.S. Senate, Washington, D.C. DEAL SENATOR LONG: I understand that the "Foreign Investors Tax Act of 1966" HR 13103, is about to receive the active consideration of the Senate Com~ mittee on Finance. Speaking for myself personally, as well as the Rhode Island Hospital Trust Company, we strongly oppose those provisions of the Bill which would impose income and inheritance taxes on certain foreign owned deposits in the United~ States, as there is no question in our minds that these provisions will seriously discourage non-residents from depositing in the U.S. Banking System. The loss of such deposits will, in our estimation, further compound the balance of pay- ments position of the United States and, at the same time, impede our ability to serve as the financial center of the world. These provisions, we think, work more to the disadvantage of the inland banks in the United States, that those large banks located principally in New York which maintain overseas branches, in that a loss of such deposits in the United States must certainly flow to banks in other- countries where we maintain no branches. We at the Hospital Trust Company have vigorously supported the U.S. Govern- ment's Export Expansion efforts and have cooperated fully with the more recent Foreign Lending Guide Lines of the Federal Reserve System. Both of these programs are being specifically designed to represent the banking industry's con- tributions to a favorable solution of our balance of payments deficits. It would, therefore, be especially disturbing to us in the industry to see the benefits of our cooperation along these lines mitigated by the introduction of taxes whose end~ result must be detrimental to our international financial position. 1050 PAGENO="1061" FOREIGN INVESTORS TAX ACT OF 1966 165 Beyond this it seems to me that if the. U.S. Government adopts the position provided for in the Foreign Investors Tax Act of 1966, we are adopting a position which is totally inconsistent with the role of the U.S. Dollar as a key World Currency. I would appreciate your recognizing our views as your Committee considers the Foreign Investors Tax Act of 1966. Thank you for your consideration. Sincerely yours, JOHN M. FRASER, Jr., Vice President and Manager~ WACHOVIA BANK & TRUST Co., Winston-SaZem, N.U., August 4, 1966. Re H.R. 13103-Foreign Investors Tax Act of 1966. Hon. RUSSELL B. LONG, Chairman, Committee on Finance, U.S. Senate, Washington, D.C. DEAR MR. CHAIRMAN: We understand that hearings on this bill are scheduled August 8 and 9. We submit this statement in lieu of a personal appearance and support the statements presented in person by representatives of the Bankers Association for Foreign Trade and the American Bankers Association. Our International Department, established six years ago, has been successful not only in building business and earnings for the bank but also in assisting domestic companies to expand their export activities as a part of the Govern- ment's export promotion effort. As examples of the cooperation and assistance we have afforded the Government, the officer in charge of our International Department is a member of the Regional Export Expansion Council of the Department of Commerce, and our export promotion efforts won one of the first "B for Export" citations from President Kennedy. Although the foreign lending guidelines of the Federal Reserve System have reduced our potential for growth of business and earnings in export financing, we have recognized their need and have kept our foreign lending within the guidelines. Estate and income taxes on foreign-owned deposits, as proposed in H.R. 13103, would, in our judgment, make the dollar a less desirable currency for foreign nationals and cause a great portion of these deposits to be transferred outside the United States. This flight would, without a doubt, reduce the deposit base, restrict the potential expansion of deposits and limit the earnings of our Inter- national Department, and we know of a number of other banks in similar circum- stances. Inevitably and unfortunately, this reduction would hamper further the ability of Wachovia and the other banks to expand the export financing activi- ties that are vital to the Nation, particularly in view of the serious balance of payments problem which plagues the U.S. economy. We are further concerned because the proposed taxes can so easily be avoided by transfer of the deposits to other countries. It seems to us unwise to impose taxes that not only will not accomplish the revenue purposes for which they are designed but will also drive business to foreign competitors of United States enterprises. The transfer of deposits to avoid the taxes would be to the particular disad- vantage of Wachovia and other banks like us which have no branches abroad to which our customers could move their deposits. The loss of these deposits would be further aggravated by the fact that business related to these deposits presumably would also be lost. The transfer of deposits to avoid the taxes could, in itself, adversely affect the U.S. balance of payments and increase potential claims against the dwindling U.S. gold reserve. The purpose of this bill, as we understand it, is to create a more attractive climate for foreign investments in the United States; therefore, the deposit tax provisions would be contrary to the stated purpose of the bill of which they are a part. They would also appear to be inconsistent with pre- vious actions' by this Congress to encourage foreign dollar accounts in this country. Our balance of payments and gold reserve problems are of such sig- nificance and are so sensitive that we feel that our domestic economy would also suffer under the strains that these taxes would cause. The transfer of deposits would also reduce a source of capital valuable to United States enterprises; less capital would mean reduced sources of domestic deposits and, consequently, a reduction in income already subject to tax. 1051 PAGENO="1062" 166 FOREIGN INVESTORS TAX ACT OF 19 66 For these reasons, therefore, we are opposed to H.R. 13103 as it passed the House of Representatives. We urge that the provisions imposing income and estate taxes on foreign-owned deposits in domestic offices of U.S. banks be elim- inated from the bill. In our opinion, the present exemptions from these taxes are in the national interest and should be continued. Respectfully, WACHOVIA BANK & TRUST Co. JOHN F. WATLINGTON, Jr., President. INTERNATIONAL ECONOMIC POLICY ASSOCIATION, Washington, D.C., August 5, 1966. Hon. RUSSELL B. LONG, Chairman, Senate Finance Committee, U.S. Senate, Washington, D.C. DEAR Mn. CHAIRMAN: We submit this statement for the consideration of your Committee's hearings on H.R. 13103, the Foreign Investors Tax Act of 1966. We wish to speak particularly to section 2(a) (1) (A) which extends the exemp- tion from U.S. taxation on interest earned on foreign-held deposits in U.S. banks to savings and loan institutions and insurance companies, but provides that the exemption will cease to apply after December 31, 1971. We are concerned about the balance of payments implications of removing this exemption. The International Economic Policy Association has made a detailed study of the United States balance of payments problem which was published June 13. 1966. The United States has had a deficit in its balance of payments in every year since 1950 with the single exception of 1957. These continuing deficits reached serious proportions in 1958 and have averaged more than $3 billion a year through 1964. Early in 1965 the Administration took steps to correct this problem which involved a program of voluntary restraints on U.S. private invest- ment abroad. This resulted in some improvement in 1965 when the deficit was reduced to $1.3 billion. However, there is every reason to believe that the deficit ~this year will exceed the 1965 figure. This serious problem results from the fact that the United States Government has assumed substantial commitments of an. economic and military nature throughout the world. Meeting these obligations under those commitments requires the United States Government to expend huge sums abroad. These have consistently over the years exceeded the net amounts of foreign exchange earned by the private sector by substantial amounts. Given the long-range character of these commitments abroad, one cannot readily assume that this situation will change at an early date and our balance of payments improve. Any action sug- gested which may further aggravate the balance of payments deficits should be considered in this light. The United States Government has, under the voluntary restraint program, asked U.S. companies with affiliates abroad to have the deposits of such affiliates brought back to the United States. The United States is also attempting to attract foreign capital to the United States. This is the original purpose of H.R. 13103. The proposal to tax foreign-held deposits in U.S. institutions would dis- courage efforts to attract foreign capital. Some capital might be withdrawn even prior to December 31, 1971. Certainly, thereafter, there will be a powerful disincentive to foreigners to hold their capital in U.S. banks. In view of the seriousness of the balance of payments problem, and its long- range nature, we respectfully submit that this is not an appropriate time to withdraw the tax exemption from foreign-held deposits even prospectively after December 31, 1971. If, by 1970 or 1971, our balance of payments deficits should have been eliminated and we can anticipate no further serious difficulty, that would seem to us the time to consider such action. Respectfully yours, N. R. DANIELIAN, President. STATEMENT SUBMITTED TO THE SENATE COMMITTEE ON FINANCE BY JACQUES APPEL- MANS, VICE CHAIRMAN, FOREIGN INVESTMENT COMMITTEE OF THE INVESTMENT BANKERS Assoora~TIoN OF AMERICA The Investment Bankers Association of America is comprised of approxi- mately 717 organizations which underwrite, deal and act as brokers in all types of securities. The business of its members is primarily the raising of capital 1052 PAGENO="1063" FOREIGN INVESTORS TAX ACT OF 1966 167 funds for industry, for new enterprises, and for governmental agencies by selling securities to investors both in this country and abroad. Its members also play a significant part In the secondary market for all such securities, both on the* stock exchanges and over the counter. Their relations with foreign customers give them frequent opportunities to help improve the United States balance of payments by encouraging investment by foreign persons in securities issued by businesses or governments in the United States. H.R. 13103 as passed by the House of Representatives on June 15, 1966, while eliminating some of the tax barriers to foreign investment in the United States, would continue one of the most serious barriers to investment in securities of U.S. issuers, namely, the imposition of estate taxes on nonresident aliens who die owning such securities. This is contrary to the recommendation of the Presidential task force headed by Henry H. Fowler before he became Secretary ~f the Treasury. The Association can emphatically affirm, based on the experience of its mem- bers, the finding of the Fowler task force that U.S. estate taxes are "one of the most important deterrents in our tax laws to foreign investment in the United States." The task force recommended the elimination of au U.S. estate taxes on intangible personal property of nonresident alien decedents. Unfortunately, this important recommendation is not reflected in H.R. 13103 in its present form. Most persons engaged in the securities business would agree that there are two features of the present tax laws which seriously deter investment in U.S. secu- rities by foreign individuals, trusts and estates. These are (1) the progressive income tax rates applicable to nonresident aliens and foreign trusts and estates if the income derived from United States sources is greater than a certain amount ($21,200 beginning in 1965), and (2) the application of the Federal estate tax to nonresident alien decedents solely because of their ownership of U.S. securities. The Fowler task force report recommended the elimination of both ~f these obstacles. H.R. 13103 in its present form would only eliminate the progressive income tax rates, but the Federal estate taxes would be retained. While the rate of the estate tax would be limited to a maximum of 25%, at the same time the estate tax base would be broadened by making bonds and other indebtedness of U.S. issuers, the certificates of which are physically located outside the United States, and deposits in U.S. banks subject to the estate tax for the first time. Thus H.R. 13103 would not only retain the existing estate tax barrier to foreign investments in U.S. stocks, but would extend it to bonds, debentures and other forms of indebtedness. As explained in the Report of the Ways and Means Committee of the House, the 25% maximum estate tax rate was recommended primarily because nonresi- dent aliens are not entitled to the 50% marital deduction. Any increase in for- eign investment in this country would be only an incidental benefit. However, since the Federal estate tax is one of the two principal tax obstacles to inveStment by foreign persons in this country, the complete elimination of the estate tax provision should be seriously considered. The elimination of progressive income tax rates alone will not encourage foreign persons to invest in U.S. securities unless this barrier is also eliminated. No tax avoidance loophole would be created by the elimination of intangibles from the estate tax provisions applicable to nonresident aliens. `Since the pres- ent tax only applies to investments in U.S. securities, it can easily be avoided by the timely sale of U.S. securities owned `by a foreign investor, except in the un- fortunate cases where the investor meets death unexpectedly. Furthermore, as the Fowler task `force report recognized, the present estate tax can legally be avoided, `by foreign investors who can afford the proper advice and planning, by simply having their `U.S. securities owned `by a personal `holding company which is incorporated abroad. Accordingly, while the reduction of the maximum Federal estate tax rate in the case of foreign persons owning U.S. property other than securities may be desirable for the reasons `stated in the `House Ways and Means `Committee report, a complete exemption of securities and other in- tangibles `from the Federal estate tax provisions applicable to nonresident aliens should also be enacted in order to encourage foreign investment. The policy of not taxing intangibles owned by nonresidents has long been fol- lowed by many states of the United States. In the State of New York, this policy has been incorporated into the State. Constitution for the specific purpose of encouraging nonresidents to use the investment facilities that exist in New York. This policy has helped greatly to make New York the financial center of the United `States. The adoption of a similar policy in the U.S. Internal Revenue 1053 PAGENO="1064" 168 FOREIGN INVESTORS TAX ACT OF 1966 laws could assist in attracting investments to the United States and making the United States the flanancial capital of the world. A great many foreign countries, developed as well as underdeveloped, refrain from attempting to impose death taxes on securities issued by local companies which are owned by nonresidents, especially if the securities are transferable abroad, such as bearer securities physically located abroad. `Some of these countries do not tax intangibles owned by nonresidents at all, regardless of where they are transferable or where they are physically located. A similar policy by the United States to encourage investment in this country is not out of line with the policy of other countries, but indeed only extends equal treat- ment to the residents of such countries. Furthermore, the small amount of U.S. estate tax collections attributable to intangibles owned by foreign persons sug- gests that the attempt to tax intangibles is not really effective. The removal of this deterrent to the use by foreign investors of the investment facilities offered by U.S. institutions would undoubtedly result in increased use of these facilities and have beneficial effects on the balance of payments. The proposed extension of the estate tax to bonds and other debt instruments seems particularly inappropriate at the present time. Debt obligations of U.S. issuers are becoming more competitive in the international bond market due to the substantially increased yields that have developed recently, and this could attract new foreign investment to the United States which has previously been attracted to higher yielding foreign securities. The U.S. balance of payments could be improved significantly by such investment. While U.S. securities are already at a disadvantage because of the interest withholding tax, the imposi- tion of the proposed estate tax would certainly make such securities unattractive to foreign investors. The top 25% rate is higher than the taxes imposed by some foreign countries on their own residents. Because of the conflict with the U.S. balance of payments program, the estate tax should not be applied to debt instruments. As an affirmative step toward encouraging investment in U.S. securities, the elimination or reduction of withholding taxes on interest payments, and possibly also dividends, should be considered. Precedent for the complete elimination of withholding taxes on interest and the reduction of withholding taxes on dividends may be found in many of the income tax treaties that the United States has with other countries. CHIcAGo, ILL., Angust .5, 1966. Re H.R. 13103. Hon. RussuLL B. LONG, Chairman, Committee on Finance, United States Senate, Washington, D.C. DzAa SENATOR LoNa: We respectfully request that this statement be incor- porated in the hearings of the Finance Committee on H.R. 13103. H.R. 13103 is "a part of the President's program to improve the U.S. balance of payments. The changes included in the proposed legislation were designed to stimulate foreign investment in the United States by modifying existing tax rules which are not consistent with sound tax policy and act as barriers to such investment." See House Report No. 1450,89th Cong., 2d Sess. A review of the provisions of H.R. 13103, coupled with an understanding of international financial practices, makes it clear that far from removing tax barriers to foreign investment, H.R. 13103 creates new barriers which are apt to result in an over-all worsening of the climate for foreign investment in the United States. H.R. 5916, the predecessor of H.R. 13103, while a move in the right direction, fell somewhat short of its goal. H.R. 5916 was the Administration's original response to the published 1964 report of the President's Task Force on Promoting Increased Foreign Invest- ment in United States Corporate Securities, which Task Force was headed by the then Under Secretary of the Treasury, Henry H. Fowler. The Task Force made its recommendations to the U.S. financial community and the U.S. Govern- ment for action to reduce the deficit in the U.S. balance of payments and de- fend U.S. gold reserves. The key recommendation for U.S. Government action calls for a revision of U.S. taxation of foreign investors. Recognizing that such revision is "one of the most immediate and productive ways to increase the flow of foreign capital to this country", the Task Force recommends the removal of "a number of elements in our tax structure which unnecessarily complicate and 1054 PAGENO="1065" FOREIGN INVESTORS TAX ACT OF 1966 169 ~inhibit investment in U~S. corporate securities without generating material tax -revenues". The Task Force's two key tax recommendations `are (1) elimination (with re- .npect to income not connected with the conduct of a trade or business) of grad- uated taxation of U.S. source income of nonresident alien individuals and (2) elimination of U.S. estate taxes on all intangible personal property of nonresi- `dent alien decedents. With respect to the estate tax recommendation, the Task Force has this to say.: "U.S. estate taxes, especially as applied to shares of U.S. corporations owned -by nonresident alien `decedents (which are subject to U.S. estate taxes Irre- spective of whether they are held in this country or abroad) are believed to be *one of the most important deterrents in our tax laws to foreign investment in the United States. U.S. estate tax rates are materially in excess of those existing in many countries of the world and, despite the treaties in effect with several countries, the taxes paid on a nonresident alien decedent's estate, some portion of which is invested in `the United States, generally would be greater ~than those paid on a nonresident alien decedent's estate, no portion of which is invested in the United States. We understand that the revenues received by `the United States as a result of estate taxes levied on intangible personal property in estates of nonresident alien decendents are not large." H.R. 5916, introduced on March 8, 1965, was the administration's initial tax proposal based upon the Task Force recommendations. While proposing elimi- nation of the graduated income tax on nonbusiness income of nonresident aliens, IH.R. 5916 failed to follow the Task Force recommendation for complete elimi- nation of the estate tax on intangible personal property. Instead, § 8 of HR. :5916 substituted a new 5-10-15% rate schedule applicable to nonresident alien deceder~ts. At the same time, however, § 8 made two adjustments to `the non- resident alien decendent's estate tax base `by (1) requiring the inclusion in `the gross estate of all U.S. corporate and Government bonds and (2) treating all U.S. savings and loan deposits in the same manner as U.S. bank deposits, `which under `~ 2105(b) of the Code are persently excluded from the nonresident alien decedent's gross estate. Following hearings on H.R. 5916, at which the Treasury urged the Ways `and Means Committee to support the bill and taxpayers argued for substitu- tion of the Task Force estate tax `recommendation for § 8, Congressman Mills introduced H.R. 11297 and then H.R. 13103, `both of which were new versions of ER. 5816. Incredibly enough, ER. 13103 might well be more appressive to nonresident aliens than is the case under existing law. While § 8 of H.R. 13103 proposes a new set of graduated estate tax rates for nonresident alien decendents ranging from 5% up to 25%, it also drastically broadens the estate tax base by requir-. ing the inclusion, not only of U.S. corporate and Government bonds as pro- `posed in H.R. 5916, but all U.S. bank deposits as well. The net results of H.R. 13103 would undoubtedly be the reduction of incentive to future foreign Investment in the United States plus a withdrawal `by nonresident aliens of substantial assets already invested here. These results would be the exact -opposite'of the stated purpose `of the proposed legislation. RATE SCHEDULE It was made abundantly clear in the Task Force report and in Treasury testi- mony before the Ways and Means Committee on H.R. 5916 that the high U.S. estate tax rates currently in effect are a major deterrent to foreign investment in this country. Certainly nonresident aliens are not encouraged to invest in U.S. securities so long as U.S. estate tax rates are substantially higher than those prevailing in their own countries. Even the rates proposed by H.R. 5916 were con- ceded by the Treasury to be somewhat higher than those imposed upon resident estates in Switzerland, France, Germany, and the Netherlands. Any rate struc- ture as high as the one proposed in HR. 13103 would do little, if anything, to induce foreign investment, particularly from residents of the four countries men- tioned above-4he most prosperous countries in continential Europe. Foreigners `are able to avoid high U.S. estate taxes entirely by not investing in this country or by investing indirectly through holding companies or foreign investment com- panies.. If the goal of the Fowler Task Force is to be achieved, we must think in terms of inducing a substantial flow of capital to this country with less estate `tax receipts per dollar of investment (though with substantially more capital paying a modest tax, the total estate tax receipts could well be higher). Trying 1055 PAGENO="1066" 170 FOREIGN INVESTORS TAX ACT OF 1966 to think in terms of whether a foreigner pays estate taxes at rates higher or lower than a U.S. citizen is unrealistic because the foreigner has the option of avoiding the tax entirely. As matters now stand, the effective U.S. estate tax rates on estates of non- resident alien decedents are substantially higher than the corresponding rates on U.S. citizens utilizing the marital deduction. Mere reduction of the rates on nonresident alien decedents to a level comparable to those on U.S. citizens, such as ER. 13103 proposes, provides no incentive to foreign investment. If Con- gress is unwilling to follow the Task Force recommendation for complete elimina- tion of an estate tax on intangible personal property of nonresident alien dece- dents, then at the very least H.R. 13103 should be revised to provide an estate tax rate schedule certainly no higher than the 5-10-15% schedule proposed by H.R. 5916. This is the only way that the United States can hope to attract substantial investment by nonresident alien individuals. The annual estate tax revenue loss if the U.S. estate tax were made inapplicable to nonresident alien decedents' estates was estimated by the Treasury at $5,000,000. The annual revenue loss under HR. 5916 was estimated by the Treasury at $3,000,000. These sums are negligible in comparison with the tremendous boost in foreign invest- ment which could be expected by reason of elimination of the estate tax with respect to nonresident aliens' estates or a reduction of the rates to the levels of HR. 5916. THE LIKELY IMPACT OF ENLARGING THE ESTATE TAX EASE Under the present law a nonresident alien may place his U.S. dollars in a U.S. bank account or place them in a foreign bank account and have the same estate tax consequences. If such deposits should become subject to estate taxes, it would be a simple matter indeed for the foreign depositor to avoid the tax by a transfer of funds. Undoubtedly this has been a principal reason why the exemption has existed since 1921. The international financial community has done business for years under the bank account estate tax exemption and the exemption of bonds located outside the country. Very large cash and bond balances have `built up under these exemptions. `Their elimination would cer- tainly cause a dramatic exodus of capi'tal from this country by simple transfers in the case of bank accounts and by tax-free sales and transfers of proceeds in the case of bonds. Removal of these long~standing exemptions would easily result in `an `immediate gold drain of hundreds of millions of dollars. Furthermore, it cannot be the intention of H.R. 13103 to discourage foreign investment in U.S. bonds and savings accounts. This, `however, is i'ts effect. By removing the existing tax incentive, the efforts of the U.S. financial com- munity to interest foreigners in such investments, to say nothing of retaining what is already invested `here, would `be seriously impaired. It should be `noted, incidentally, that H.R. 13103 purports to make one con- cession in determining the nonresident `alien decedent's estate tax base. There would `be excluded for an unlimited time "deposits in' a foreign branch of a domestic corporation, if such branch is engaged in the commercial banking busi- ness and if such deposits are payable only in foreign currency". Correspond- ingly, interest income on such deposits would be treated as income from sources without the United States. These rules would apply regardless of whether the nonresident alien was engaged in business here. The significance, if any, of these provisions in attracting foreign investment has not been revealed ei'ther by the Ways and Means Committee or the Treasury. If it is believed that the provisions constitute such a marked liberalization of existing law as to require the severe estate tax rules of H.R. 13103 as a revenue loss counterbalance, then their revenue impact should' be spelled out. It would appear, however, that these rather peculiar "concessions" have no real substance. OTHER CONSIDERATIONS The Task Force, in addition to recommendations for U.S. Government action, made a number of suggestions for action by the U.S. financial community. Testi- mony on H.R. 5916 `brought out that the response by the private sector of the U.S. economy to `th'e Task Force suggestions had been extremely encouraging. Failure by the Federal Government to respond directly and effectively to its challenge would create an extremely unfortunate picture. Enactment of § 8 of H.R. 13103 as now drafted would clearly indicate the Government's lack of confidence `in the Task Force recommendations and a total failure to support 1056 PAGENO="1067" FOREIGN INVESTORS TAX ACT OF 1966 171 the U.S. financial community in its renewed effort to attract foreign investment to this country. The Task Force report cautioned that its tax recommendations were intended and conceived as a package and that the primary impact of the recommendations could be obtained only by adoption of the package. "To the degree that the pack- age approach is discarded and the package is broken down into its components, some being accepted and others rejected, more of the potential impact will be lost than might necessarily be expected by analysis of the financial effect of any par- ticular proposal." See Task Force report, p. 23. H.R. 5916 and H.R. 13103 propose to do exactly what the Task Force warned not to do. Failure to adopt the Task Force's estate tax recommendation and substituting a provision which, in the case of § 8 of H.R. 13103, could well have a detrimental net effect on our balance of payments, cuts the heart out of the Task Force's package of recommendations. CONCLUSION The Task Force has made well-considered proposals for revision of U.S. tax laws to encourage investment by nonresident aliens in U.S. securities. These proposals as a package represent a direct and dramatic effort to improve our balance-of-payments position. The revenue cost would be minimal. If the Task Force program is worth doing at all, it should be done completely and well. H.R. 5916 fell somewhat short of the Task Force recommendations, and H.R. 13103 is an essential failure in this respect. Except for § 8, H.R. 13103 is a step in the right direction to provide added incentive for foreign investment in the United States through removal of U.S. tax deterrents to such investment. § 8, however, should be redrafted to provide for elimination of U.S. estate taxes on all intangible personal property of non- resident alien decedents. In other words, the Task Force estate tax recommenda- tions should be adopted. If, on the other hand, Congress is unwilling to follow this recommendation in every detail, then rates comparable to or less than those incorporated in H.R. 5916 should be adopted, and § 8(c) and § 8(d) of H.R. 13103, which broaden the estate tax base, should be dropped. Respectfully submitted. HUBACHEK, KELLY, MILLER, RAUCH & KIRBY, By DAVID E. DICKINSoN. Senator ANDERSON. Mr. Kalish. STATEMENT OP RICHARD IL KALISH, PARTNER, PEAT, MARWICK, MITCHELL & CO. Mr. KALISH. Mr. Chairman, Senator Carlson, Senator Dirksen, my name is Richard Kalish. I am a partner in the firm of Peat, Marwick, Mitchell & Co. We represent many firms doing business in the United States. My testimony is being made on behalf of our clients and also on behalf of Mr. James Burke, also a partner in the firm of Burke & Burke, attorneys for clients having a common cause with that of our clients. Senator ANDERSON. Just a second, Mr. Counsel. Do you plan to present all this testimony here? Mr. KALISH. Pardon? Senator ANDERSON. We are trying to hold these to 15 minutes. Will you stay under that? Mr. KALISH. Yes; I am not reading from the testimony, statements that I have submitted, because they are too long. I have geared a presentation for about 12 minutes. You see we have submitted state- ments on behalf of about five or six different foreign agency banks, including the Puerto Rican bank, so it would be impossible to have them all. I am here to speak about two matters under the proposed Foreign Investors Tax Act of 1966, affecting the foreign agency and branch banks in the United States. 1057 PAGENO="1068" 172 FOREIGN INVESTORS TAX ACT OF 19 66 The first issue concerns the taxation of interest on U.S. Government obligations at a fiat rate of 30 percent without any deduction for ordinary and necessary business expenses where these securities are held by Puerto Rican branches of Puerto Rican banks rather than by U.S. branches of such banks. If these securities were held by a U.S. branch of these banks there would be little question that these expenses would be deductible. Under present law a Puerto Rican bank doing business in the United States is taxed on its U.S. source income, even though such U.S. source income may be earned in Puerto Rico. It is taxed at the regular cor- porate rates after the allowance of all applicable business expenses. Under H.R. 13103 only income which is effectively connected with the conduct of the trade or business in the United States will be taxed at the regular corporate rates after the allowance of all related business expenses. Interest income from U.S. Government obligations earned by Puerto Rican branches will suffer a tax at 30 percent on the gross amount re- ceived without any deduction for ordinary and necessary business ex- penses. A gross income tax at 30 percent would be confiscatory since a Puerto Rican bank could not earn a profit after deducting all appli- cable expenses plus the U.S. gross income tax. This is due to the fact that a Puerto Rican bank must borrow money from depositors in order to obtain the funds to acquire these Govern- ment securities. The net income, after deducting the interest costs of borrowed moneys plus investment department's expenses, leaves a profit margin considerably less than 30 percent of the gross amount of interest income received on these U.S. Government obligations. Therefore, as demonstrated in the statement prepared and filed by Banco Popular de Puerto Rico, substantial losses would have resulted from these investments over the past 5 years if this bank were taxed at 30 percent on the gross interest income received through these in- vestments. Banco Popular would have paid a tax on this income at an effective rate between about 152 and 177 percent. The same situa- tion would also hold true for Banco de Ponce whom we are also rep- resenting in this testimony. Furthermore, Puerto Rican banks will be treated less favorably under H.R. 13103 than most foreign banking institutions earning in- terest income from U.S. obligations. Many, if not most, foreign banks doing business in the United States are resident in countries having income tax treaties with the United States where the withholding rate is reduced from 30 percent to either 15, 10, 5 percent, or even zero. This fact is fully documented in the statements we have submitted. Because of these income tax treaties, H.R. 13103 would be treating more favorably a truly foreign corporation rather thon one who is only considered foreign for tax purposes by a fiction of law. Puerto Rican banks must invest in the U.S. Government obliga- tions because they are part of the U.S. banking community, and are faced with the same problems and conditions as domestic banking `institutions. Although they are organized under the laws of Puerto Rico, they are nevertheless subject to certain U.S. banking laws. For example, `all Puerto Rican banks are insured by the Federal Deposit Insurance Corporation, which subjects them to Federal reg- ulation on their financial operations. 1058 PAGENO="1069" FOREIGN INVESTORS TAX ACT OF 1966 173 Federal regulation requires sound asset liquidity, and investments in U.S. Government obligations are customarily used to provide the re- quired security for Federal deposits. By way of illustration, mvest- ments in U.S. Government obligations are necessary for the per- formance of the following activities: Acting as depositories for the U.S. Government and its Federal agencies, including the collection of Federal withholding taxes in Puerto Rico; 2, selling and redeem- ing U.S. savings bonds in Puerto Rico; 3, operating facilities at Army, Navy, and Air Force installations, just to name a few. It is respectfully submitted that the U.S. source investment income of resident Puerto Rican banking corporations be .treated as effec- tively connected with the conduct of their trade or business in the United States, even though such income is earned by a branch outside of the United States such as in Puerto Rico, so as to insure a deduc- tion for all applicable ordinary., and necessary business expenses related to earning this income. The second issue on which I am testifying which concerns all f or- cign banks including the two mentioned Puerto Rican banks, and, in particular, the Hongkong & Shanghai Banking Corp., Barclay's Bank, and Bank of China, for whom we have also submitted state- ments on their behalf. The second issue concerns all foreign banks having U.S. branches or agencies and deals with the proposed rule that a U.S. place of business of a foreign bank is to be taxed by the United States on its foreign source dividends, interest, and gains from the sales of securities attributed thereto under the so-called effectively connected concept. Under present law a foreign bank engaged in trade or business in the United States is taxed only on its income from sources within the United States. It is not taxed on its income derived from sources outside of the United States, regardless as to whether or not such foreign source income is attributed to its U.S. place of business. Interest received from foreign obligors, including interest on secu- rities issued by foreign governments, is exempt from U.S. income tax inasmuch as it is income derived from sources outside the United States. Under H.R. 13103 foreign source interest income or dividend income will be subject to U.S. income tax if it is attributable to a U.S. office; that is, a domestic agency or branch of a foreign banking corporation. The object of this provision is to treat the U.S. branch of a foreign. banking corporation the same for tax purposes as the U.S. branch of a domestic bank. At first appearances it may seem equitable to tax a U.S. branch o~ a foreign bank on its foreign source dividends, interest, and gains from the sales of securities since a U.S. branch of a domestic bank is also taxed on that same basis. However, closer investigation reveals that domestic banks enjoy certain income tax privileges which are not accorded to foreign banking institutions engaged in trade or business in the United States. What are these privileges accorded to domestic but not foreign banks? A domestic bank may claim a deduction for an addition to a reserve for bad debts `based upon a fixed formula without regard to its actual bad debt experience. The U.S. branch of a foreign bank may only claim a deduction based upon its actual bad debt experience 1059 PAGENO="1070" 174 FOREIGN INVESTORS TAX ACT OF 1966 and is not permitted to use the special formula available to domestic banks. Second, to the extent that losses from the sale of securities exceed the gains therefrom, a domestic bank may claim such excesses as an ordinary deduction applicable against income taxed at 48 percent. A resident foreign bank may only carry such excess loss forward for a period of 5 years to be offset against gains taxed at 25 percent. To the extent that the resident foreign bank does not have capital gains to offset against such losses the carryovers can be lost forever. Thirdly, a domestic bank is permitted to deduct interest paid on deposits and other expenses incurred in earning tax exempt interest income from State and municipal securities. A resident foreign bank may only deduct those expenses related to earning taxable income from sources within the United States. This means that any expenses in~ curred in earning tax-exempt interest income from State and munici- pal bonds is not deductible by a resident foreign bank. It is, therefore, submitted that taxing the U.S. office of a foreign hank on its foreign source dividends, interest, and gains from the sales of securities will not achieve the stated purpose of the bill to provide equitable tax treatment for their investments in the United States. Furthermore, a provision taxing a U.S. branch or agency of a for- eign bank on foreign source income attributable thereto is in conflict with practically all of our income tax treaties of the United States which are presently in effect. A foreign bank organized in a treat.y country can only be taxed on its U.S. source income which is attributable to a permanent establish- ment in the United States. A foreign bank organized in a nontreaty country would be taxed on United States and foreign source income attributable to its U.S. place of business under H.R. 13103. Thus, this provision would also provide inequitable U.S. tax treat- ment even between foreign banks doing business in the United States. Lastly, it has always been fundamental to American democrat philos- sophy that the Federal Government's right to tax is based upon the protection of life and property, and that the income to be levied upon is the income which is created by activities and property protected by the Government. The mere fact that a bond or a security or bill of exchange is physically located in the United States or is accounted for by the U.S. branch or agency does not mean that the United States is: protecting the property represented by this document. The foreign resident's country, the obligor upon the bond or bill of exchange, protects the property rights represented by the security, and properly exercises the jurisdiction to tax the foreign bank which holds the obligation. By the same token, the country of organization of the foreign bank, which holds the obligation, may also choose to tax the income because it offers worldwide protection to that foreign bank. It seems it is unconscionable for the United States to attempt to tax such transactions where the securities and negotiable instruments are not governed by the laws of the United States, none of the parties han- dling the transactions are located in the United States, and all trans- fers of currency concerning principal and interest take place outside the United States, simply because the physical document, the docu- ment may be physically held in the U.S. office of the resident foreign 1060 PAGENO="1071" FOREIGN INVESTORS TAX ACT OF 1966 175 bank may be accounted for through the U.S. office or because the funds may have been advanced by the U.S. office. In view of the fact that the taxation of a foreign source income attributable to a U.S. place of business does not provide equitable tax treatment between domestic and foreign banking institutions, nor, for that matter, between foreign banks organized in treaty countries and those organized in nontreaty countries, it is difficult to understand why this group of taxpayers should be selected for such discriminatory treatment when the effectively connected concept was restricted severely by the House Ways and Means Committee in its application to foreign source income. It should be noted that House Report No. 1450 attached to H.R. 13103, which goes into considerable detail to explain the objectives of each of these provisions of the proposed bill, fails to indicate the reason for placing resident foreign banking institutions in this inequitable situation. It is respectfully submitted that U.S. taxation of foreign source dividends, interest and gains from sales of securities attributable to a U.S. place of business of a foreign bank will not fulfill the stated objectives of H.R. 13103 to provide more equitable tax treatment for their investments in the United States. If Congress wishes to fulfill this objective, then it should consider either not taxing resident foreign banks on such foreign source in- income or else extend to them the same privileges accorded to domestic banks. It is respectfully recommended that U.S. offices of foreign banks not be taxed on their foreign source income which might be attributed thereto. Thank you. Senator ANDERSON. Well, thank you. We know there are some problems with respect to this matter, and the staff is trying to work out an amendment that might be offered on this question of the pay- ment of taxes on bonds, and so forth. Senator Carison. Senator CARLSON. Just one thing, Mr. Kalish. Did you appear before the House Ways and Means Committee when this legislation was under consideration? Mr. KALI5H. No, I did not. As I understand, there was only one hearing as I recall. It was March 7. We were notified the Friday before at 3 o'clock that all requests had to be in by 12 o'clock, and it was impossible to have attended that meeting. Otherwise, I would have tried to have appeared. Senator CARLSON. I share the chairman's views in regard to this, and that is the reason I wondered whether you had appeared before the committee. Mr. KALI5H. Thank you. Senator CARLSON. That is all. Senator ANDERSON. Senator Dirksen. Senator DIBKSEN. Doesn't your trouble spring essentially from that one clause, "effectively connected"? Mr. KALISH. Yes, with respect to the foreign source income. There is a provision in the bill which states that, generally, it is only U.S. source income which will be effectively connected with the conduct of the U.S. trade or business e~cept for three exceptions where for- 1061 PAGENO="1072" 176 FOREIGN INVESTORS TAX. ACT OF 196 Q eign source income is considered to be effectively connected in a U.S. trade or business. It is that particular clause that we are con- cerned about on this second issue which would attract foreign source income to U.S. tax. In the other case, on the U.S. Government obligations, it is also the "effectively connected" concept which creates the problem. Under present law, this income, U.S. source income, earned in Puerto, is taxed in the United States at the regular corporate rates with a deduc- tion for all the related expenses. It is the "effectively connected" concept that, affects that item a little more pointedly than the other issue that we have, but it affects both. Senator DIRXSEN. The Treasury has worked with that phrase- Mr. KALISH. Yes. Senator DIRXSEN. At least, so they said the other day. Mr. KALISH. Yes. Senator DIRK5EN. I made a point that I thought in the bill itself there ought to be a more adequate definition so that you do not leave it to a whole range of interpretations and never know quite where you are because different people will interpret that in different ways. So it there were a clear definition set out in the statute itself, you would know pretty well where you stand? Mr. KALI5H. Right. Except, of course~ the "effectively connected" concept is really a subjective concept which is very, very difficult to `define to cover all situations, unfortunately. It does not really- if it set an objective standard that would be a lot more helpful, I would say. Senator DIRKSEN. Well, they discovered exactly that effect by now. Mr. KALISH. Yes. Thank you. Senator DIRKSEN. That is all. Senator ANDERSON. The members of the committee received a state- ment from the Bank of Puerto Rico. Was your statement largely drawn from this? `Mr. KALISH. Banco Popular de Puerto Rico? Senator ANDERSON. Yes. Mr. KALISH. Actually, we submitted-I will speak for myself, I and for Mr. Burke-we submitted three statements to each of the Senators and yourself, Senator Anderson, one on Banco Popular de Puerto Rico another one on Hongkong & Shanghai Banking Cor- poration, and another one on Barclay's Bank, which should be corn- in~ in if you have not received it already. Mr. Burke of Burke & Burke has submitted a statement for the Banco de Ponce, and on the Bank of China, and I have stated here basically what our feelings are and our reasons for believing that not only the Puerto Rican banks, but the foreign agency banks, that the bill should be corrected so as to relieve the one on taxation on U.S. Government obligations at a fIat 30 percent rate, and the other not to tax foreign source inrorne to the domestic operations of the foreign agency banks as a whole. Seretor ANDEP50N. I wanted to know if you desired to have these placed in full in the record?, 1062 PAGENO="1073" FOREIGN INVESTORS TAX ACT OF 1966 177 Mr. KALISH. Oh, yes; I would like each of the statements, if pos- sible, to be inserted. Senator ANDERSON. I have not seen the Shanghai one. Mr. KALISH. The Hongkong statement is also there, too. I belie~re it should `have been submitted. There will be one on Barclay's Bank, which you may not have received yet. We had a little difficulty in typing, and that should be coming down either today or tomorrow, I would say, if it has not arrived yet. Senaitor ANDERSON. Thank you very much. (The documents previously referred to follow:) STATEMENT OF BANCO DR PONCE, SUBMITTED BY ROBERTO DE JESUS ToRo Impact of Proposed "Foreign Investors Tax Act of 1906" (H.R. 13103) on Puerto Rican Banking Corporations having Branches in the United States INTRODUCTION This memorandum is addressed specifically to the impact on Banco de Ponce of certain provisions of H.R. 13103, the proposed Foreign Investors Tax Act of 1966, (hereinafter sometimes referred to as "the Bill"), as recently passed by the House of Representatives. Banco de Ponce is a Puerto Rican banking corpora- tion having its head office in the City of Ponce and operating branches through- out the Island of Puerto Rico and in the continental United States, where it has three branches in the City of New York. Inasmuch, however, as neither the Internal Revenue Code nor the Bill differentiates between corporations incor- porated in Puerto Rico and those incorporated in foreign countries, the defects in the Bill here `considered and the remedies proposed below are not restricted in their application to this one bank nor to Puerto Rican banks generally, and although, as will be shown below, there are special considerations applicable to Puerto Rican banks which do not apply to others, the following discussion nevertheless illustrates problems of widespread application. I. EXISTING LAW 1. For income tax purposes, corporations organized under the laws of Puerto Rico are deemed "foreign" and are dealt with in the Internal Revenue Code in the same manner as corporations organized under the laws of any foreign coun- try. See Code Sees. 7701(a) (4), (5) and (9) and 7701(e). 2. Foreign corporations not engaged in trade or~business within the United States are taxed under and `only to the extent provided in Sec. 881 of the Internal Revenue Code, which imposes a tax at a fiat rate of 30% on income received from U.S. sources as interest, dividends and other types of "fixed or determinable annual or periodical" income. This tax is in lieu of the tax imposed on domestic corporations under Sec. 11 of the Code. It reaches only these types of income and is based on the gross amount of such income, without the allowance of any deductions or credits. 3. Foreign corporations `which are engaged in trade or business within the United States, on the other hand, are taxed under See. 882 of the Code, which provides that such corporation's shall be taxable in the same manner as domestic corporations, i.e., on their net income at the rates prescribed by Sec. 11 (current maximum, 48%), with the exception that their gross income includes only gross income from sources within the United States and deductions are allowed, in general, only to the extent that they are connected with such income. 4. Sections 881 and 882 are thus mutually exclusive, a foreign corporation `being taxable under one or the other depending solely on whether or not it is engaged in the conduct of a trade or business in the United States, but never under both of these sections at the same time. Banco de Ponce, being deemed a foreign corporation as stated in ¶1 and being engaged in business within the United States through its New York `City branches, is taxable under Sec. 882. 5. The application of Sec. 882 may be illustrated by the example set forth in `the `annexed Schedule I, based on figures which, while not actual, closely approxi- mate in essential particulars the magnitude and nature of the Bank's income and 1063 PAGENO="1074" 178 FOREIGN INVESTORS TAX ACT OF 19 66 expense for a typical taxable year. On the basis of these figures, the Bank's tax under existing law on $2,000,000 of gross income from U.S. sources would amount to $233,500. IT. EFFECT OF H.R. 13103 1. The new bill makes many changes in the Code provisions dealing with the taxation of non-resident aliens and foreign corporations, but the particular points that concern us here are: (a) The provisions of Sec. 4 of the Bill amending Code Sees. 881 and 882 so that these two sections would no longer be mutually exclusive, but instead would tax the foreign corporation under either or both of these sections de- pending on whether its income is or is not "effectively connected with the conduct of a trade or business within the United States"; and (b) The provisions of Sec. 864(c) (4) as added to the Internal Revenue Code by Sec. 2(d) of the Bill which have the effect of including in the defini- tion of the term "income which is effectively connected with the conduct of a trade or business within the United States" certain types of income derived from sources outside the United States. In other words, under these provisions of Bill, all income not deemed effec- tively connected with the conduct of a trade or business within the United States, to the exten.t that it is taxable at all, would be taxable under Sec. 881 at the 30% rate on the gross amount received, while all income which is deemed so connected would be taxable under Sec. 882 at regular domestic corporate rates on the net amount received after the allowance of related deductions and this will be so, in the case of the interest income of a bank, even though it is derived from sources outside the United States. Thus, the Bill, while making no change in the case of a bank having no branch or agency here, completely changes the approach in the case of the Bank which does have branches or agencies here, so that unless the interest received can be made to meet the test of being "effectively connected" with the United States operation, it will be taxed on the gross amount of such interest at the 30% rate without any offsets for expenses or losses, as if it had no United States business operations at all, while the rest of its United States operations, inclifiding any interest or capital gains income from sources outside the United States that can be deemed "effectively connected" with the United States operations, will be taxed at domestic rates on net income. 2. The effect of these changes in the law are illustrated in the annexed Sched- ule II, from which it will be seen that on the basis of the same income and ex- pense figures as those used in Schedule I, the Bank's tax computed under the Bill would be $421,300 as compared with $233,500 under existing law, an increase of $187,800 or more than 80%. III. PROVISIONS OF H.R. 13103 REQUIRING REVISION 1. The severity of the Bill's impact on taxpayers in Banco de Ponce's position as disclosed in the preceding paragraph raises the question of whether this result is consistent with what the Bill Is intended to accomplish. Obviously any pro- vision of the Bill which operates in specific factual situations so as to defeat its basic purposes is defective and requires revision. These purposes are indi- cated in general terms by its title: "A bill to provide equitable tax treatment for foreign investment in the United States," and are clearly described in the Ways and Means Committee Report on the Bill, in which the Committee in discussing the background of the Bill (House Report No. 1450, pp. 5 and 6) points out that the proposed legislation was originally prepared by the Treasury Department and introduced in Congress as H.R. 5916, a bill "designed to increase foreign investment in the United States . . . as part of the President's program to improve the balance of payments." In the course of its consideration of this Bill, the Committee decided to expand the scope of the legislation to include a general overhaul of the taxation of non-resident aliens and foreign corpora- tions, as the result of which H.R. 5916 was ultimately superseded by the present Bill, H.R. 13103, a bill designed, as the Report states (p. 8), "to increase the equity of the tax treatment accorded foreign investment in the United States." it is, however, made clear throughout the Report that the original, more limited objective of encouraging foreign investments in the United States through an amelioration of unduly severe tax burdens is still contemplated by H.R. 13103. For example, in giving the reasons for the provisions of Sees. 2 and 4 of the Bill already referred to (pp. 2 and 3, above), the Committee Report criticizes existing law as deterring foreign businessmen and corporations from investing in the 1064 PAGENO="1075" FOREIGN INVESTORS TAX ACT OF 1966 179 United States and indicates that these provisions are intended to remedy this situation. (House Report No. 1450, ¶ B-2 on p. 14 and ¶ D-1(b) on p. 27.) The climate of the Bill is thus definitely one of amelioration, of relief from inequities and the removal of discriminatory treatment. It is clearly not intended as a revenue measure since it is not expected to increase annual revenues to any significant degree. (Report No. 1450, p. 6.) 2. "The equity of the tax treatment accorded foreign investment in the United States" is obviously not increased by provisions which increase the tax burdens imposed on such investment by as much as 80 or 90 per cent. The existing provisions of Code Sec. 881, in imposing a tax at the fiat rate of 30% on the gross amount of a foreign taxpayer's income, is already imposing a far heavier tax burden than most domestic taxpayers have to bear. The only grounds on which such a tax on gross income can reasonably be justified are: (a) the purely pragmatic ground that such a tax is readily collectible at the source, reducing to a minimum the administrative difficulties inherent in the collection of taxes from alien taxpayers whose persons and business affairs are physically outside the territorial jurisdiction of the United States and (b) the more equitable argu- ment that the tax is imposed only on such types of income as interest, dividends, rents, royalties and the like, and therefore, in most cases at least, reaches only the income derived from resources not tied up in the current operations of the taxpayer's business, and does not really impose a heavier burden than most domestic taxpayers would have to bear on the same types of income. (See Appendix for a note on the legislative history of Code Secs. 881 and 882.) The first of these grounds for justifying a 30% gross income tax on foreign taxpayers ceases to have any force, of course, in the case of a taxpayer actively engaged in business in the United States. Such a taxpayer is just as completely subject to the jurisdiction of the United States as a domestic taxpayer insofar as the filing and examination of tax returns, the collection of tax deficiencies and all the other apparatus of income tax administration are concerned. The validity of the second argument fails with the first, for once it becomes administratively feasible to require complete tax returns, there is no longer any necessity or excuse for treating a foreign taxpayer's income from U.S. sources in a sort of vacuum, without reference to the nature of the taxpayer's over-all business or other income-producing activities. It can then be deter- mined with adequate precision whether and to what extent there are expenses or other deductions which should fairly be attributed to the taxpayer's U.S. income and there ceases to be any reason at all for taxing the foreign taxpayer at any different rates or by any different methods than the domestic taxpayer. These principals, which lie at the root of the distinction made by the existing provisions of Code Sees. 881 and 882 between the taxation of corporations which do not conduct any trade or business in the United States and those which do, may seem too self-evident to he stated, but the Bill, by dividing the income of a foreign corporation carrying on business in the United States into two classes depending on whether or not such income is deemed effectively connected with the conduct of the U.S. business and taxing the income not so connected under Sec. 881 at 30% of the gross amount, violates these principals and definitely dis- criminates against the foreign taxpayer engaged in business here as compared with the domestic taxpayer. Furthermore, when the foreign taxpayer in question is an ordinary commer- cial `bank operating branches in the United States, the effect of the Bill would be absolutely confiscatory, as `becomes obvious when one considers the case of Banco de Ponce, a quite typical commercial bank. More than 90% of its entire gross income consists of interest. Its net. profit before taxes from all of its operations everywhere averages far less than 30% of its entire gross income. To stay in `business it obviously must have some margin of profit left after taxes, which means that on the average the effective rate of tax on all of its interest income can `be no more than a small fraction of 30% of the gross amount of the interest received. Why, then, should it invest any of its funds in se- curities subject to a 30% gross income tax if it can possibly avoid it? To ask the question is to answer it. 3. Put another way, the money which a bank invests does not constitute mere surplus or excess funds that would otherwise lie idle; `for the most part it is depositor's money, obtained only at substantial cost in interest paid and banking services performed. If the bank's interest income is taxed in an amount greater than the excess of such income over the cost, in interest and other expense, of the money invested to produce it, the result is confiscation. Domestic banks do not 1065 PAGENO="1076" 180 FOREIGN INVESTORS TAX ACT OF 1966 face this problem. because they are taxed only on net income. Most foreign banks can avoid the problem (and defeat the original purpose of the Bill) by refraining from investing any funds in the United States other than those directly involved in the operation of their U.S. business. Puerto Rican banks, however, cannot resort to this expedient, because for reasons indicated later in this memorandum, they have no choice but to invest a substantial portion of their Puerto Rican funds in U.S. securities regardless of the tax consequences. For them the dis- criminatory and confiscatory aspects of the Bill are not only harsh and self- defeating; they are unconscionable as well. 4. We have considered above the effect of singling out the income from U.S. sources not "effectively connected" with a U.S. trade or business for taxation at 30% of the gross amount, without allowing any offset or deduction for the ex- pense incurred in earning such income or the results of the taxpayer's U.S. business activities. *We have now to consider the effect of the provisions of the Bill dealing with the taxation of income which is deemed "effectively connected" with the U.S. trade or business, with particular reference to the provisions of Code Sec. 864(c) (4) as added by the Bill and the resultant taxation under Sec. 882 of income from sources outside the United States. Presumably the concept underlying these provisions is that two otherwise identical businesses conducted in the United States should bear the same tax burdens even though one of them is operated by a foreign corporation and the other by a domestic corporation; that as the domestically owned business pays a tax based on the entire net income of the business, regardless of the geographical source of its income, so also should the foreign-owned business, and that the in- come of the foreign corporation effectively connected with its U.S. business should therefore be taxed in the same manner as the income of a domestic cor- poration, regardless of whether the income is derived from sources inside or out- side the United States. The difficulty is that however reasonable this concept may seem in the ab- stract, the Bill fails to implement it with any degree of consistency. The re- sultant mixture of mutually contradictory concepts could not help but give rise to extreme hardship and gross inequity in many cases and so defeat the objec- tives the Bill was intended to achieve. (a) In the first place, there is a basic conflict between the concepts underly- ing Secs. 881 and 882 as revised by the Bill. If the determinative factor in de- ciding whether income is to be taxed in the United States is not the geographical source of the income but the fact that such income is "effectively connected" with the business conducted within the United States, then it would seem to follow that if such income can be shown to be effectively connected with the con- duct of a trade or business outside the United States, such income should not be taxed in the United States. Yet the Bill, in dealing with interest and the other classes of income covered by Code Sec. 881, not only retains the old concept of the geographical source of the income as the determinative factor but enlarges the scope of the section so as to impose the `burdens of a 30% gross income tax on resident foreign corporations which have heretofore been taxed only on their net income from U.S. sources even when the income can be readily shown to be effectively connected with the conduct of the taxpayer's trade or business out- side the United `States. (b) In the second place, perhaps in an effort to deal with some of the untoward consequences of this conflict, the Bill's proposed Code Sec. 864(c) (4) (A) and (B) limits the ex~tent to which income from outside sources is to be deemed "effec- tively connected" with a U.S. trade or business (and hence taxable here) to only the three specific classes described in clauses (i), (ii) and (iii) of Sec. 864(c) (4) (B), thereby creating yet another basis for discriminatory tax treatment between otherwise comparable taxpayers. The merits of clauses (i) and (iii) are not germane to this discussion, but clause (ii) relates specifically to interest, dividends and certain capital gains income from sources outside the United States that are to be deemed effectively connected with the U.S. trade or business and therefore taxable under Sec. 882. As to these types' of income, therefore, the Bill carries water on both shoulders, taxing interest from U.S. sources under Code Sec. 881 as revised if nt effectively connected with the U.S. business and taxing interest from non-U.S. sources as well as from U.S. sources under Code Sec. 882 if it is so connected. Furthermore, to make matters worse, it does so only in the case of certain specific types of business, one of which is the banking business. It is not apparent from the Ways and Means Committee Report why banks were singled out along with the very limited group of other taxpayers specified 1066 PAGENO="1077" FOREIGN INVESTORS TAX ACT OF 1966 181 in See. 864(e) (4) (B) for the application of the concept that income from sources outside the United States should be taxed if connected with income derived from the conduct of a U.S. business. Report No. 1450, p. 65, contains, the statement that "in general, income described in Clause (ii) of subparagraph (B) does not include income from . . . securities purchased for investment purposes only . . ." If this is meant to apply in the case, for example, of a U.S. branch of the Puerto Rican bank investing its funds (derived, of course, principally from customers' deposits) in Puerto Rican mortgages or other non-continental U.S. securities, it is simply not true. Without investing its funds profitably in interest-bearing securities it could not perform its essential banking services. There is surely no more justification for singling the banking business out for the taxation of income from non-U.S. sources than there is in the case of any other taxpayer regularly engaged in the sale of goods or services to the public. (c) In the third place, if the purpose of these provisions is indeed to accord more equitable tax treatment to foreign taxpayers, and if in so doing it is deemed appropriate to equate the tax treatment of the U.S. branches of foreign banks with that of domestic banks to the extent of taxing the foreign-source income attributable to their U.S. business operations, then the Bill should also take into account the privileged tax position enjoyed by the domestic banks as against their foreign competitors in other areas and make some provision to equate the tax treatment of domestic and foreign banks in these respects also, e.g.: (1) The provisions of Code Sec. 582(c), under which banks (defined by Sec. 581 to include only domestic banks) are allowed to treat losses from the sale of corporate and government bonds as ordinary losses fully deductible against ordinary income (taxable at 48%) rather than as capital losses which may be offset only against capital gains (taxable at 25%); (2) The similar provisions of Code See. 582(a) in dealing with losses due to securities becoming worthless; (3) The right accorded only to domestic banks to take advantage of the special rules promulgated by the Treasury Department for determining the amounts allowable as deductions for additions to the reserve for bad debts. (Rev. Rul. 65-92, 1965-I C.B., p. 112); (4) The right accorded to domestic, but not to foreign, banks of deducting interest expense even though the funds on which such interest is paid are invested in tax-exempt state and municipal bonds (cf. Rev. Rul. 61-222, 1961-2 C.B. p. 58), whereas foreign banks may deduct only expenses attrib- utable to the earning of ta~vable income from sources within the United States. (Cf. Code Sec. 882(c) (2), Treas. Regs. Sec. 1.882-3(b) and 1.873- 1(a)(1)). By including banks in the category of foreign taxpayers to be taxed on in- tome from foreign sources under clause (ii) of Cede Sec. 864(c) (4) (B) while making no attempt to change such discriminatory features of existing law as those listed above, the Bill merely compounds existing inequities. 5. Except as international tax conventions may alter the picture, the fore- going considerations apply equally to all, corporations deemed "foreign" for tax purposes, whether incorporated in a foreign country or in Puerto Rico. In the case of a banking corporation incorporated in Puerto Rico, however, there are additional and even more cogent reasons why some modification of the pro- visions of the Bill here under discussion is required. The constitutional status of Puerto Rico is, of course, historically anomalous. Puerto Rico has never enjoyed the clearly defined and well-understood status of a "territory" such as Alaska and Hawaii were before they achieved state- hood. Nevertheless, like them, or like any State, Puerto Rico falls wholly within the monetary system of the United States and its sole currency is United States currency. Its banks, including Banco de Ponce, are members of and regulated by the Federal Deposit Insurance Corporation and are eligible for membership in the Federal Reserve System. As depositories of Federal funds, the Puerto Rican banks as such must maintain the required liquidity and to do so, must invest in U.S. government securities. The employees of such banks, whether employed in the United States or in Puerto Rico, are covered by the Social Security and Unemployment Insurance Laws of. the United States and the banks must file reports and pay taxes accordingly. In short, for almost every conceivable purpose other than income taxation, the status of Banco de Ponce as a Puerto Rican bank is identical with that of a bank organized under the laws of the United States. Obviously, therefore, the original purpose of the Bill-that of improving the balance of payments position of the United States-has no application whatever 1067 PAGENO="1078" 182 FOREIGN INVESTORS TAX ACT OF 1966 to Puerto Rican banks, except perhaps in the negative sense of making it at- tractive to them to invest in Canadian government securities, on which there would be no taxation at the source. The inequitable, discriminatory, and in some cases confiscatory, effects of the Bill as it affects a foreign bank with branches in the United States are doubly unfair and illogical in the case of Puerto Rican banks, which are not really "foreign" in the fiscal sense and have no choice `but to invest heavily in U.S. government securities. iv. SUGGESTED REMEDIES 1. Inasmuch as this memorandum is concerned with the impact of the Bill on foreign banking corporations regularly engaged in business in the United States, and more particularly with Puerto Rican banks having branches in the United States, we shall limit our suggestions to this area. We would like to point out, however, that the adverse effects of some of the provisions of the Bill extend over a much broader field and might well justify a thorough restudy of the basic concept reflected in this very complex and in some respects revolutionary piece of legislation. Our preferred remedy, therefore, would be to make no changes in Code Sees. 881 and 882 insofar as the provisions discussed on pp. 2 and.3 above are concerned. This would entail the deletion from the Bill of all the pro- visions thereof utilizing the "effectively connected" concept as applied to foreign corporations. 2. If, however, it is felt that the general effect of the Bill is desirable and would be too greatly compromised by following the suggestion made in the pre- ceding paragraph, it nevertheless remains true, as shown above, that it is not the purpose or intention of the Bill to impose substantially heavier tax burdens *on the U.S. income of foreign corporations than those imposed on domestic cor- porations, but rather to alleviate excessive tax burdens on foreign investment in the United States where they exist and generally accord more equitable tax treatment to such foreign taxpayers than heretofore. Yet in the case of foreign banks with offices here the Bill does in fact impose such burdens, and at levels amounting in some cases to confiscation. A simple solution. and the one which does perhaps the least violence to the plan of the Bill as a whole, while solving the problem of taxpayers like the foreign banks, is to allow each foreign bank to elect whether or not its investment income from U.S. sources (otherwise tax- able under the proposed new language of Code Sec. 881) is to be deemed effec- tively connected with its U.S. business and therefore taxable under Code Sec. 882. Such an election is already provided by the Bill in the case of certain real property income, and parallel language and similar safeguards against abuse could easily be provided for investment income. For example, there might be added to Sec. 882 as revised by the Bill a new subsection (e) similar to subsec- tion (d) as contained in `Sec. 4(b) of H.R. 13103 reading somewhat as follows: "(e) ELECTION To TREAT U.S. SotnicE INVESTMENT INCOME AS INCOME CON- NECTED WITH UNITED STATES BUSINESS. "(`1) IN GENERAL.-A foreign corporation engaged in the active conduct of a banking business which during the taxable year derives any income from sources within the United States. " (A) which consists of dividends, interest or gain or loss from the sale or exchange of stock, notes, bonds, and other evidences of indebted- ness. and "(B) which, but for this subsection, would not be treated as income effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. In such case, such income shall be taxable as provided in subsection (a) (1) whether or not such corporation is engaged in trade or business within the United States during the taxable year. An election under this paragraph for any taxable year shall remain in effect for all subsequent taxable years, except that it may revoked with, the consent of the Secretary or his delagate with respect to any taxable year. "(2) ELECTION Air'rim REVOCATION, INC.-Paragraphs (2) and (3) of Section 871(d) shall apply in respect of elections under this subsection in the same manner and to the `same effect as they apply in respect of elections under Section 871(d)." 3. This language would cover aU foreign banking corporations, thereby not only obviating the grossly discriminatory effect of the Bill on Puerto Rican banks with branches in the United States as compared with domestic banks but also, in 1068 PAGENO="1079" FOREIGN INVESTORS TAX ACT OF 1966 183 the case of other resident foreign banking corporations, encouraging the invest- ment of surplus funds in U.S. securities. If, however, it is felt that only Puerto Rican banks, because of their anomalous status as insiders in the U.S. monetary and banking structure but outsiders for tax purposes, should receive this relief, then for the words, "foreign corporation . . . business" in the first sentence of subsection (e) (1) as proposed above, there could be substituted the words: "A corporation organized under the banking laws of Puerto Rico." Such special treatment for Puerto Rico is not without precedent. In fact the effect of such a provision would merely be to place a Puerto Rican bank on a parity in respect of the right to be taxed only on net income from U.S. sources with the individual citizen and resident of Puerto Rico under Section 876 of the Code as presently in effect. 4. It will be noted that all of the suggested language of the new subsection (e) as quoted above beginning with the words "may elect" is taken verbatim from new subsection (d) of Code Sec. 882 as set forth in Sec. 4(b) of H.R. 13103, including this phrase at the end of the second sentence: "whether or not such corporation is engaged in trade or business within the United States during the taxable year." The inclusion of this phrase would have the effect of making the right of election available to a non-resident foreign banking corporation, pro- vided, of course, that it ified proper income tax returns and otherwise complied with the requirements of Code Sec. 882(c). This seems desirable to avçid unfair ~1iscrimination between Puerto Rican banks which do not operate branches in the continental United States, but which are nevertheless under the same com- pulsion to invest heavily in U.S. securities, and those which do operate such branches. 5. As already pointed out (pp. 7-10), there is no apparent reason why the Bill should single out banks for the taxation of interest and capital gains income from ~sources outside the United States and it is respectfully submitted that Clause (ii) of Code Sec. 864(c) (4) (B) as added by Sec. 2(d) of the Bill should be revised by deleting the words: "banking, financing, or similar business", and substituting therefor the words: "financing or similar business, other than banking." If there is thought to be any ambiguity as to what is meant by the term "banking" in the phrase "other than banking", a definition could be added to *Subparagraph (B) of Sec. 864(c) (4). Such a definition might adapt the lan- *guage of Code Sec. 581 and read somewhat as follows: "For the purpose of clause (ii) the term "banking" means the business con- ~ducted within the United States by a bank or trust company, a substantial part of the business of which consists of receiving deposits and making loans and discounts, or of exercising fiduciary powers similar to those permitted to national banks under the authority of the Comptroller of the Currency, and which, with respect to the business conducted by it within the United States, is subject by law to supervision and examination by State, Territorial or Federal authority `having supervision over banking institutions." CONCLU5ION5 In conclusion, it is submitted that the changes made by the Bill in the pro- visions of Code Sees. 881 and 882 discussed above do not "increase the equity of the tax treatment accorded foreign' investment in the United States"; that on the contrary, in many cases, and particularly in the case of foreign banking corporations, they impose drastic and unfair new burdens on such investment wholly at variance with the stated purposes of the Bill; that the best solution `for the present would be to make no change in existing law insofar as these provisions of Secs. 881 and 882 are concerned; but that if the new concepts im- ported into the Code `by the Bill are felt to represent progress toward more *equitable treatment of foreign taxpayers in other areas, then it is urged most strongly that for `the reasons set forth in this memorandum, foreign banking corporations carrying on business in the United States, and especially the Puerto Rican banks, should be given the option suggested above of electing whether to be taxed by the old methods or the new and should also be excluded from the special group of ta~payers singled out by See. 864(c) (4) (B) for the :novel experiment of taxing foreign corporations on income derived from sources ~outside the United States. Respectfully submitted. BANCO DE PONCE. Dated: July 27, 1966. 1069 PAGENO="1080" 184 FOREIGN INVESTORS TAX ACT OF 1966 SCHEDULE I Computation of taa~ under ecristing law on Puerto Rican banking corporation with U~S. branches Assume that the gross income of the bank as a whole from all sources is $10 million, consisting of: (1) Income from sources within the United States: (a) Interest on U.S. Government bonds held by head office in Puerto Rico $1,200, 000 (b) Interest on commercial loans by Puerto Rican branches to U.S. residents 50, 000 (c) Interest on U.S. Government bonds held by U.S. branches 200,000 (d) Interest on commercial loans by U.S. branches to U.S. residents 500, 000 (e) Miscellaneous income of U.S. branches from U.S. sources 50, 000 Total income from U.S. sources 2, 000, 000 (2) Income from sources outside the United States: (a) Interest income of head office and Puerto Rican branches from sources outside the United States 6, 450, 000 (b) Interest income of U.S. branches on FHA guaranteed mortgages and commercial loans to residents of Puerto Rico 600, 000 (c) Miscellaneous income of head office and Puerto Rican branches from sources outside the United States 950, 000 Total income from non-U.S. sources 8, 000, 000 Assume expenses allowable as deductions in computing net income from sources within the United States under Code section 882(c) as follows: Expenses directly attributable to operation of U.S. branches $700, 000 Allocation of general overhead and interest expense of the bank as a whole ($4,000,000) which cannot be attributed to any particular source of income, apportioned in ratio of gross income from each source to total gross income in accordance with Code Sec. 882(c) (2) and Regs. Sec. 1.873-1(a) (1) and 1.882-3(b) (2): 4,000,000X2,000,000 - 800 000 10,000,000 - Total allowable deductions 1, 500, 000 COMPUTATION OF TAX Gross income from U.S. sources 2, 000,000 Deductions attributable thereto 1, 500, 000 Net taxable income 500,000 Taxable at 22 percent $25,000 5, 500. Taxable at 48 percent $475,000 228,000 Total tax 233, 500 SCHEDULE II Computation of ta~v under H.R. 13103 based on same facts and figures as schedule I A. Tax on income not effectively connected with U.S. business, section 881: (1) Interest on U.S. Government bonds held by head office in Puerto Rico-schedule I, item (1) (a) $1, 200, 000 (2) Interest on commercial loans made by Puerto Rican branches to U.S. residents, schedule I, item (1) (b) 50,000 Total income taxable under section 881 1, 250, 000 Tax at 30 percent 375, 000 1070 PAGENO="1081" FOREIGN INVESTORS TAX ACT OF 1966 185 Computation of tao under H.R. 13103 based on same facts and figures as schedule I-Continued B. Tax on income effectively connected with U.S. business, section 882: (1) Gross income: (a) Interest on U.S. Government bonds held by U.S. branches, schedule I, item (1) (c) 200,000 (b) Interest on commercial loans made by U.S. branches to U.S. residents, schedule I, item (1) (d) 500, 000 (c) Interest income of U.S. branches on PITA guar- anteed mortgages and commercial loans to res- idents of Puerto Rico, schedule I, item 2(b) - 600, 000 (d) Miscellaneous income of U.S. branches, schedule I, item (1)(e) 50,000 Total gross income for section 882 1, 350, 000 (2) Deductions applicable to gross income taxable under section 882: (a) Expenses directly attributable to U.S. branches as in schedule I 700, 000 (b) Deductions apportioned on basis of figures in schedule TI-B per formula as in schedule I: 4,000,000X_1,350,000_ 540 000 10,000,000 -______ Total allowable deductions 1,240, 000 COMPUTATION OF TAX, SECTION 882 Gross income connected with U.S. business 1, 350, 000 Deductions attributable thereto 1,240, 000 Net income taxable under section 882 110, 000 Taxable at 22 percent: $25,000 5, 500 Taxable at 48 percent: $85,000 40, 800 Total tax, section 882 46,300 The total tax liability under H.R. 13103 is the sum of the taxes computed under sections 881 and 882 as follows: Section 881, as per A, above $375, 000 Section 882, as per B, above 46,300 Total tax liability - -- 421, 300 APPENDIX. LEGISLATIVE HISTORY OF INTERNAL REVENUE CODE SECTIONS 881 AND 882 The substance of Sections 881 and 882 of the Internal Revenue Code of 1954 as now in effect was derived from Sections 231 (a) and (b) of the Internal Revenue Code of 1939. Section 231 of the 1939 Code, along with the correspond- ing provisions relating to non-resident alien individuals found in Section 211, first appeared in the income tax law in the Revenue Act of 1936. In explaining Sections 211 and 231 of the Revenue Act of 1936, which super- seded a system under which all foreign taxpayers were taxed on net income and capital gains like domestic taxpayers with reliance placed on the filing of returns instead of withholding at the source, the House Ways and Means Committee bad this to say in its Report (74th Congress, 2nd Sess., H. Report No. 2475, pp. 9 and 10). "In the case of a foreign corporation not engaged in trade or business within the United States and not having an office or place of business therein, it is proposed to levy a fiat rate of tax . . . on the grass income of such corporation from interest, dividends . . . and other fixed and determinable income (not including capital gains) . . . to be collected at the source. "It is believed that the proposed revision of our system of taxing nonresident aliens and foreign corporations will be productive of substantial amounts of 1071 PAGENO="1082" 186 FOREIGN INVESTORS TAX ACT OF 1966 additional revenue, since it replaces a theoretical system impractical of adminis- tration in a great number of cases." [Italics added.] The rate of tax imposed by Sec. 231(a) of the Revenue Act of 1936 on the gross amount of interest income was 15%, equal to the maximum tax rate appli- cable to domestic. corporations under that Act. The following table shows the comparable tax rates in each category for all subsequent years: Years ~ Flat rate of tax on interest income, nonresident foreign corporations (percent) Top bracket domestic corporations I 1930-40 1941 15 273/i 30 15 percent (19 percent for 1939; 24 per. cent for 1940). 31 percent. 40 percent (through 1945; thereafter varying between 38 percent and 52 percent; now 48 percent.) 1942 to date I Exclusive of excess profits tax. STATEMENT OF R. CARRION, JR., PRESIDENT, BANCO Po~ui~&a DR PUERTO Rico INTRODUCTION Banco Popular de Puerto Rico, a corporation organized under the laws of The Commonwealth of Puerto Rico, is engaged in the commercial banking business. This taxpayer has forty-one branches and its Head Office located in this Commonwealth, in addition to three branches in New York City, which service the local Puerto Rican population with general banking services, includ- ing the making of loans, and the maintenance of checking and savings accounts for depositors. All excess available funds of the entire bank are kept at the Head Office in San Juan, Puerto Rico, where they are invested under the direc- tion of the Investment Officer. Currently, the bank has approximately $35,000,000 invested in United States Treasury and other Federal Agency obligations, which yield the bulk of its U.S. Source income. PRESENT EDIES Under the tax rules presently in effect, the bank is taxable in much the same manner as a domestic corporation since it is engaged in trade or business in the United States. However, under Section 882 of the 1954 Internal Revenue Code as amended, it is only taxable on its gross income from sources within the United States less the applicable deductions. It is not taxable on income derived from sources without the United States. Interest income derived from a foreign government or foreign resident entity is generally excluded from U.S. income tax unless such entity derives 20% or more of its gross income from U.S. sources (Section 861 (a) (1) (B)). Interest received from securities of the United States Government is treated as income from sources within the United States under Section 861(a) (1) of the Code regardless of where received, and is combined with the other taxable U.S. source income (including that generated by the New York branches) for Federal income tax purposes. All expenses, losses and other deductions properly apportioned or allocated to the items of taxable gross income and a ratable part of any other expenses, losses and other deductions which cannot definitely be allocated to some item or class of taxable gross income, but which are related thereto, are allowable in com- puting taxable income (Section 861(b) and 882(c) (2) of the Code; Treasury Regulation Section 1.882-3(b) (2) and 1.873-1(a) (1)). Such expenses, to the extent allowable under the above rules, may be claimed regardless of whether they are incurred by the New York or Puerto Rican offices of the bank. ffn other words, the bank is taxed as a single entity regardless of whether the U.S. taxable income is earned by the New York branches or by a Puerto Rican office of the bank. 1072 PAGENO="1083" FOREIGN INVESTORS TAX ACT OF 1966 187 PROSPECTIVE RULES UNDER H.R. 13103 Though, the Foreign Investors Tax Act, according to the Report of the Com- mittee on Ways and Means, House of Representatives, accompanying H.R. 13103, is designed to "stimulate foreign investment in the United States" and provide "equitable tax treatment by the United States of nonresident aliens and foreign corporations," it proposes to change the present tax rules radically and will have a serious and arbitrary effect on this taxpayer. Under the bifi in its present form (H.R. 13103), the gross income, of a resident foreign corporation would be divided into two categories: (1) gross income which is effectively connected with the conduct of a trade or business within the United States. (H.R. 13103, Section 4(b)). (2) gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business in the United States. (H.R. 1103, Section 4(a)). The first category of income would be taxed at the regular corporate rates under Section 11 of the Code after an allowance for the appropriate deductions (H.R. 13103, Section 4(b) amending Section 882(a) and (c)), or at the capital gain rate under Section 1201(a) of the Code. In this category foreign source income will be treated as "effectively connected" with the U.S. business if the foreign entity conducts such business through an office or other fixed place of business within the United States, such income is attributable thereto, and it consists of dividends, interest or gains from the sale of stock, securities or notes derived in the conduct of a banking business. (Section 2(d) of the Bill and proposed Sec- tion 864(c) (4) (B) (ii) of the Code). The second category of income would be taxed at a fiat rate of 30 per cent upon the gross amount received without any deduction for applicable business expenses (H.R. 13103, Section 4(a) amending Section 881(a)), subject to withholding at source (H.R. 13103, Section 4(c) amending Section 1442(a)). INTEREST INCOME ON U.S. OBLIGATIONS The bill, as currently drafted, would levey a confiscatory 30 per cent gross income tax on the interest income earned by the Head Office in San Juan from investments in U. S. obligations since such income is not effectively connected with the conduct of the banking business by the New York branches. The funds used to acquire these obligations are generated by the forty-one branches of the bank in Puerto Rico. The decisions as to when and how these funds should be invested are made by the Investment Officer in San Juan; and lastly, the invest- nients and income dervied therefrom are accounted for through the Head Office in Puerto Rico. Nevertheless, considerable expenses are incurred to earn this income. The taxpayer's primary sources of excess available capital are deposits and other borrowings. The bank incurs expenses attributed to these funds, such as interest and business overhead, inasmuch as a banking operation is continu- ously concerned with the borrowing, lending and investing of funds. A tax on gross income, without a deduction for allocable expenses would result in a tax at an effective rate in excess of 100 per cent of net income. This is clearly mdi- (ated from the illustration set forth on Exhibit A-i and A-2 attached to and made a part of this statement. Based on the investment income earned by the bank and other financial information taken from its Federal and Puerto Rican income tax returns for the past five years, we have computed the U. S. income tax applicable under present law after the allowance of deductible expenses in accordance with Section 882(c) (2). (See also Tretts. Reg. Sec. 1.882-3(b) (2) and 1.873-1(a) (1)). We have also computed the U. S. income tax liability assuming that the provisions of Sections 4(a) and 4(b) of H.R. 13103 were in effect for each of these years. The confiscatory nature of H.R. 13103 is quite evident from the fact that in ~ach case the applicable expenses plus the 30 per cent tax on the gross interest income received far exceed the gross amount of interest income from U. S. obligations. The effective rate of Federal income tax on U. S. source interest income ranges from 152% to 177, creating a substantial loss in each case. It is also submitted that Puerto Rican banks will be treated less favorably than most foreign banking institutions earning interest income from U.S. obligations. In the absence of a tax treaty provision, Section 4(a) of HR. 13103 imposes a flat 30 per cent tax on such income of a foreign banking institution earned by an office outside the United States. Many, if not most, of the foreign banks earning income from sources within the United States are resident in 1073 PAGENO="1084" 188 FOREIGN INVESTORS TAX ACT OF 1966 countries with whom the United States has an income tax treaty containing a provision reducing the rate of withholding to 15 per cent or less. For example, Article VII of the United Kingdom Income Tax Treaty exempts interest from any withholding tax, as do many of the income tax conventions concluded by the United States with other foreign countries. Article VI of the Japanese Income Tax Treaty imposes a tax of only 10 per cent on interest income derived from sources within the United States, and Article VII of the Swiss Treaty reduces such withholding rate to 5 per cent. The French and Belgium Income Tax Treaties impose a 15 per cent tax on U.S. source interest income as provided in Article 6A and Article VIII A respectively. Even though a foreign banking institution may be engaged in trade or business in the United States through a permanent establishment, if the interest income is not effectively connected with the conduct of a trade or business within the United States, then the reduced rate of tax or exemption from tax under the treaty, applicable where there is no permanent establishment, shall be applicable in such case. (Section 5(a) of H.R. 13103 amending Section 894 of the Cede). This means that a foreign banking institution resident in a treaty country would only be subject to a maximum withholding tax of 15 per cent, and frequently exempt, in lieu of the 30 per cent rate applicable to Puerto Rican banks. Because of these treaty provisions, the United States is inadvertently treating more favorably a truly foreign corporation rather than one who is only considered foreign for tax pur- poses by a fiction of law. Politically a Puerto Rican bank is a U.S. entity and one against which the U.S. has not discriminated but has generally sought to help as other U.S. banks. Therefore, it would seem that Puerto Rican banking institutions should not be treated less favorably than banking institutions located in foreign countries. Because of the close political and economic ties with the United States, Puerto Rican banking institutions are faced with the same problems and conditions as domestic U.S. banking institutions. Although they are organized under the laws of Puerto Rico, they are, nevertheless, subject to certain U.S. banking laws. For example, all banks in Puerto Rico are insured by the Federal Deposit Insuraric Corporation. This means that the taxpayer's overall operation is subject to Federal regulation. `Such regulation requires sound asset liquidity, and, spe- cifically, investments in U.S. obligations to provide the required security for Federal deposits (6 U.S.C. § 15). Moreover, Puerto Rican banks are approved depositories for the U.S. Government, and a good many of the Federal Agencies carry accounts in Puerto Rican banks, such as the well-known Tax and Loan Account of the U.S. Treasury. Puerto Rican banks also sell and redeem U.S. Savings Bonds, and operate branches and facilities at various Army, Navy. and Air Force installations in Puerto Rico. As a result of these activities, and also following generally accepted and required banking principles, Puerto Rican banks carry a secondary reserve for their total deposits in Puerto Rico, consist- ing chiefly of bonds and notes of the U.S. Government and its agencies. Thus, the penalty it must pay for complying with U.S. bank rules and sound American banking practice as to asset liquidity, is a tax penalty which is confiscatory and unrelated to the realities of the banking business. If interest income from U.S. obligations were earned by one of the New York branches of the bank, there would be no question that the cost of borrowing the funds to purchase these obligations would be deductible as well as other investment overhead expenses. The mere fact that interest income from U.S. Government securities is earned by a Puerto Rican operating branch rather than a U.S. branch of the bank does not provide a sufficient basis in logic and reason for distrinction. In either case, the taxpayer is operating a banking business requiring the incurrence of the above expenses to earn such income, regardless of whether or not such taxable U.S. source of income is effectively connected with the conduct of the trade or business by the New York branches. There are a number of ways in which H.R. 13103 can be amended so as to avoid this problem and, in addition, further the objectives of this legislation. Several of them are outlined below and are submitted for your consideration: 1. Permit a resident foreign banking corporation, or a Puerto Rican banking corporation in particular, to elect to treat U.S. source investment income, or income from U.S. obligations, as effectively connected with the conduct of the trade or business in the United States. By so doing, a deduction could be claimed for these expenses which are connected with earning such income, and an allocable share of those expenses which are attributable to earning such 1074 PAGENO="1085" FOREIGN INVESTORS TAX ACT OF 1966 18~ income but the amount of which cannot be specifically identified, regardless. of where these expenses are incurred. A provision could be inserted in Section 882 similar to subsection (d) "Elec- tion to Treat Real Property Income as Income Oonnected with United States Business.-" as set forth in Section 4(b) of H.R. 13103, and might read as follows: "(e) ELECTION To ThEAT U.S. SOURCE INVESTMENT INCOME AS INCOME CON- NECTED WITH UNITED STATES BUsINEss.- "(1) IN GENERAL.-A corporation organized under the banking laws of Puerto Rico (or a foreign country) which during the taxable year derives any income- "(A) from investment in bonds, notes or other securities issued by the United States, any territory, any political subdivision or agency of the United States or of a territory, or the District of Columbia, and any obligations guaranteed as to interest and principal by any of them, and (B) which, but for this subsection, would not be treated as in- come effectively connected with the conduct of a trade or business within the United States, may elect for such taxable year to treat all such income as income which is effectively connected with the conduct of a trade or business within the United States. In such case, such income shall be taxable as provided in subsection (a) (1) whether or not such corporation is engaged in trade or business within the United States during the taxable year. An election under this paragraph for any taxable year shall remain in effect for all subse- quent taxable years, except that it may be revoked with the consent of the Secretary or his delegate with respect to any taxable year. "(2) ELECTION Airrnn. REVOCATION, ETC.-Paragraphs (2) and (3) of section 871(d) shall apply in respect of elections under this subsection in the same manner and to the same extent as they apply In respect of elec- tions under section 871(d)." The above provision, as in the case of income from real property, would treat this U.S. source interest income as effectively connected with the conduct of a trade or business within the United States and taxed at the regular corporate rates as provided in Section 11 of the Internal Revenue Code together with the income of the bank which is effectively connected with the conduct of its bank- ing business in the United States. Such special treatnient for Puerto Rico would not be unique under U.S. concepts of taxation. By way of analogy, Section 87~l of the Code provides that Section 871 through 875 (dealing with the taxation of U.S. source income of non-resident alien individual) does not apply to a citizen and bona fide resident of Puerto Rico for an entire taxable year. Thia means that a Puerto Rican individual coming within this section may claim all ordinary and necessary business expenses incurred in connection with earning taxable income, including U.S. source income, even though such expenses are in- curred in Puerto Rico. Inasmuch as the proposed Bill would treat taxable interest income not effectively connected with the conduct of the U.S. trade or business as being earned by a non-resident foreign corporation, and since Section: 876 recognizes the deductibility of related expenses by Puerto Rican resident: individuals not available to non-resident foreigners, this principle should be ex- tended to Puerto Rican banking corporations as recommended above. 2. Exempt resident foreign banking corporations, or Puerto Rican banks in particular, from Federal income tax on U.S. source investment income. Such action would not set a novel precedent for granting Puerto Rican persons a spe- cial status under the Internal Revenue Code. Section 931 of the Code already grants a special tax status to U.S. corporations operating in Puerto Rico, ex- empting them from U.S. income tax if they meet certain statutory requirements. Furthermore, although Puerto Rican corporations are treated as foreign cor- porations, for purposes of the controlled foreign corporation provisions of the 1962 Revenue Act, Section 957(c) of the Code provides an exclusion from this. status for most Puerto Rican corporations, again recognizing the unique posi- tion of such entities with respect to the United States and to Federal taxation.. Thus, the above exceptions recognize that Puerto Rico has a special position with respect to the United States and is not to be considered in the same light as: a foreign country despite the fact that it administers its own tax laws. 1075 PAGENO="1086" 190 FOREIGN INVESTORS TAX ACT OF 19 66 3. The second alternative suggestion could be restricted exclusively to interest from obligations of the United States Government or its agencies. Puerto Rico is a Commonwealth by act of Congress and is subject to Federal legislation that applies to all the States of the Union. The. relations between Puerto Rico and the United States are completely different and unique when compared to those of a foreign country with the United States. Puerto Rico is part of the United States, using the same currency, same postal service, under the same customs regulations, etc. The economic ties between the United States mainland and Puerto Rico are closely interrelated by all the Federal agencies which have jurisdiction in Puerto Rico, such as the Armed Forces, the Federal Bureau of Investigation, the Federal Housing Administration, the Department of Agriculture, the Department of Commerce, the Federal Aviation Agency, the Department of the Interior, the Department of Labor, the Treasury Department, and many others. In Puerto Rico there is even a Federal District Court, and its decisions, as well as those of the Commonwealth Courts, can be appealed to the Court of Appeals (First Circuit) and then to the United States Supreme Court. Puerto Ricans are United States citizens and have all the rights, privileges, and duties of a U.S. mainland citizen. It is, therefore, submitted that the position of Puerto Rican banks, such as this taxpayer, is unique and different from foreign investors. Substantial invest- ments in United States Government obligations (currently $35,000,000) are necessitated because of the relationship of this Commonwealth to the United States in conducting its banking business as outlined above. To subject the gross income derived therefrom to a confiscatory gross income tax of 30 per cent is not only contrary to a major purpose of this Bill to encourage foreign invest- ment in the United States, but also reflects an apparently unintended discrimi- nation against Puerto Rican banks in relationship to mainland banking institu- tions. This Bill also defeats to some extent the fundamental objective of Congress in providing this Commonwealth with its separate taxation autonomy by subject- ing interest income to a Federal tax on the gross amount. TAXATION OF FOREIGN SOURCE INCOME EFFECTIVELY CONNECTED WITH THE CONDUCT OF A U.S. BANKING BUSINESS A second provision of the Foreign Investors Tax Act for which the bank seeks amendment is Section 864(c) (4) (B) (ii). This subsection added by Sec- tion 2(d) of the Bill provides, in effect, that foreign source income will be treated as "effectively connected" with the U.S. business if the foreign entity~ conducts such business through an office or other fixed place of business within t~e United States, such income is attributable thereto, and it consists of dividend~, interesi or gains from the sale of stock, securities or notes derived in the coi~duct of a banking business. / The object of the Bill is "to provide more equitable tax treatment for foreigr investment in the United States" as stated on page 1 of Report No. 1450 of thE Committee on Ways and Means of the House of Representatives to accompany H.R. 13103. We submit that the taxation of foreign source interest incomE earned by a foreign corporation engaged in the banking business is th derogatioz of this purpose of the Bill as set forth below: /- 1. At first appearances, it may seem equitable to tax foreign banking insti- tutions on their foreign source interest income if such income i~ attributablE to activities of an office or place of business in the United States since a domestic bank is taxed on its world-wide income including that derived from sources outside of the United States. However, upon closer analysis it becomes apparent that domestic banking institutions have certain Federa] income tax privileges which are denied resident foreign banks~ For example, a domestic bank may claim annual deductions for additions to its reserve for bad debts until the reserve equals 2.4 per cent of loan~ outstanding at the close of the taxable year, regardless of whether its bad debt experiencE indicates that any losses, in fact, did result. (Rev. Rul. $5-92, 1965-1 C.B 112). / A resident foreign bank, ~n the other hand, may only claim a deductioz for those bad debts actually incured, or a deduction fOr an addition to a reserve for bad debts based upon a reasonable expectation that a percentage of loans will default under the normal rules set forth in Section 166. If, 1076 PAGENO="1087" FOREIGN INVESTORS TAX ACT OF 1966 191 based on subsequent experience, such bad debts do not materialize, the addi- tion to the reserve must be restored to income by the resident foreign bank. Since the primary source of earning income for any bank is the loaning of funds, a resident foreign bank is at a distinct disadvantage in comparison to a domestic banking institution. 2. However, the inequitable tax treatment between domestic and foreign banks goes much further. As a general rule, where a taxpayer corporation disposes of a capital asset at a gain, such gain is taxed at the reduced rate of 25 per éent. Any losses derived from the sale or exchange of capital assets are first offset against the gains from such sales and any excess may be carried forward for a period of five years and utilized against future gains from the sale of capital assets (Section 1212(a)). Any excess of losses over gains from the sale or exchange of capital assets may not be offset against so-called ordinary income taxed at the regular corporate tax rates. In the case of a domestic bank, however, if the losses of the taxable year from sales or exchanges of bonds, debentures, notes, or certificates, or other evidences of indebtedness, issued by any corporation (including one issued by a government or political subdivision thereof), exceed the gains of the taxable year from such sales or exchanges, no such sale or exchange shall be considered a sale or exchange of a capital asset. (Section 582 (c), Treas. Reg. Sec. 1.582-1(c)). This means that if the losses exceed the gains from the sale or exchange of such capital assets, a domestic bank se- cures the benefit of an ordinary deduction applicable against income taxed at the 48 per cent rate. A resident foreign bankS may only deduct capital losses against capital gains taxed at the 25 per cent rate and any excess may only be carried forward for five years and charged against capital gains. If it does not have capital gains within such period or not sufficient gains to absorb such losses, the carryover can be lost forever. No deduction for capital losses is permitted against ordinary income. 3. A further area of inequitable treatment stems from the fact that do- mestic banks are allowed to deduct interest paid on deposits and other ex- penses incurred in earning tax-exempt interest. Interest income earned on obligations issued by any of the fifty states or their municipalities is exempt from U.S. income tax (Section 103). Section 265(2) sets forth the general rule that no deduction shall be allowed for interest on indebtedness incurred or continued to purchase or carry obligations, the interest from which is wholly exempt from Federal income tax. However, this rule does not apply to domestic banks. The provisions of Section 265(2) have no application to interest paid on indebtedness represented by deposits in banks engaged in the general banking business since suéh indebtedness is not considered to be "indebtedness incurred or contirn~ed to purchase or carry obligations . . within the meaning of Section 265. (Rev. Rul. 61-222, 1961-2 C.B. 58). Even though a domestic bank may use a portion of its deposits to purchase tax-exempt state or municipa~ bonds, the interest expense paid on such de- posits is fully deductible without any allocation to the tax-exempt interest income. A resident foreign bank, on the other hand, is not accorded this same privilege. It may only claim a deduction for those expenses which are connected with earning taxatile gross income from sources within the United States. (Section 882(e) (2), Treas. Reg. Sec. 1.882-3(b) and 1.873-. 1(a) (1)). Section 861 (a) which defines income from sources within the United States limits this concept t~ "items of gross income." Municipal and state bond interest is not included in "gross income" (Section 103). Thus, to the extent that comparable interest expense on deposits and other ex- penses are attributable to tax-exempt bond interest income, they are not deductible by a resident foreign banking corporation, although a domestic banking institution can claim such deductions. In the light of the foregoing we submit that to tax resident foreign banking ~orporations on their foreign source dividends, interest, and gains from the sale f securities does not achieve equitable tax treatment for their investments ~.n the United States but serves to aggravate an inequity which exists under resent law and would continue under the proposed legislation. In addition, this novel concept of taxing foreign enterprises on their foreign source income is directly contrary to three-quarters of the Income Tax Treaties concluded by the United States with foreign countries which specifically limit U.S. taxation of foreign enterprises to their U.S. source income. (e.g., Australia- 1077 PAGENO="1088" 192 FOREIGN INVESTORS TAX ACT OF 1966 Article III, Italy-Article III). The U.S. Treasury Department Regulations applicable to those few tax treaties whose provisions allow Federal taxation on all income allocable to a U.S. "permanent establishment", limit this rule to income from sources within the United States, thus evidencing the intent of even these treaties not to tax foreign source income. (e.g., Canada-Regulation Section 519.104, France-Regulation Section 514.105). Since Section 10 of the Bill provides that no amendment made by H.R. 13103 shall apply in any case where its application would be contrary to any treaty obligation of the United States, this motive to tax foreign source income would not apply to those countries with whom the United States has an income tax treaty, thus discriminating severely against those nations with whom the United States has not yet con- cluded a treaty. Since the United States has not concluded an income tax treaty with Puerto Rico, investments in Puerto Rican or other foreign obligations would be seriously affected under the proposed Bill in a manner not contem-' plated at the time these tax treaties were negotiated. In conclusion, it is submitted that the Foreign Investors Tax Act will further aggravate the present discrimination against Puerto Rican and other resident foreign banking institutions instead of providing more equitable tax treatment for their investments in the United States. If Congress wishes to fulfill its stated objective, then it should choose between either not taxing resident foreign banks on their foreign source dividends, interest and gains from the sale of securities or else extend to them the same tax privileges accorded to domestic banks. It is recommended that this inequity be corrected by excluding resident foreign banks from Section 864(c) (4) (B) (ii) added to the Internal Revenue Code by Section 2(d) (2) of HR. 13103. This may be accomplished statutorily by deleting the word "Banking" from the phrase. ". . . and either is derived in the active conduct of a (banking), financing, or similar business . . ." set forth in Section 864(c) (4) (B) (ii). CONCLUSION Accordingly, it is respectfully requested that H.R. 13103 be amended to pro- vide relief covering the taxation of U.S. interest income earned in Puerto Rico and foreign source interest income effectively connected with the conduct of a U.S. banking business by Puerto Rican banking institutions. It is also respect- fully requested that, at such time as the Senate Finance Committee may hold a public hearing on the Foreign Investors Tax Act, the Banco Popular de Puerto Rico be given an opportunity to orally express its views through its representa- tive, Richard H. Kalish, Partner in the firm of Peat, Marwick, Mitchell & Co. (Certified Public Accountants). R. CARRION, JR., President, Banco Popular de Puerto Rico. EXHIBIT A-i Effect of the Foreign Investors Taa' Act 1961 1962 1963 Present law: Interest. U.S. Government obligations Less: Allocable share of expenses on gross to gross ratio Net income- Less tax thereon I Income after taxes Foreign Investors Tax Act: Interest, U.S. Government obligations Less: 30 percent tax Income Less: Expenses Net income (loss) Effective tax rate (percent) $827, 715. 54 687,559.89 $1,307,024.27 1,048,591.19 $1,855,879. 96 1,511,361.59 140,155.65 72, 880.94 258,433.08 134,385. 20 344,518.37 179, 150.27 67,274.71 124,047. 88 165.368. 10 827,715.54 248.314. 66 1,307,024.27 392. 107.28 . 1, 855, 879.96 556, 763.99 579,400.88 687, 559. 89 914,916.99 1, 048, 591. 19 1, 299, 115. 97 1, 511, 361. 59 (108, 159.01) (133. 674. 20) (212,245.62) 177 152 162 `Assuming other income exceeds $25,000 used 52 percent rate. 1078 PAGENO="1089" FOREIGN INVESTORS TAX ACT OF 1966 193 EXHIBIT A-2 Effect of the Foreign Investors Taa' Act 1964 1965 Present law: Interest, tr.s. Government obligations Less allocable share of expenses on gross to gross ratio Net income Less tax thereon 1 Income after taxes Foreign Investors Tax Act: Interest, U.S. Government obligations Less 30 percent tax Income Less expenses Net income (loss) $1, 756,823. 80 1, 423,818. 11 $1, 589, 261. 14 1, 299, 823. 60 333, 005. 69 166, 502. 85 289, 437. 54 138, 930. 02 166, 502.84 150, 507.52 1, 756,823.80 527, 047. 14 1, 589, 261. 14 476, 778. 34 1, 229, 776. 66 1, 423, 818. 11 1, 112, 482. 80 1, 299,823. 60 (194, 041. 45) (187, 340. 80) Effective tax rate 158 165 1 Assuming other income exceeds $25,000 1964, 50-percent rate; 1965, 48-percent rate. STATEMENT SUBMITTED IN BEHALF OF THE BANK OF CHINA AS TO EFFECT OF THE F01uIIGN INvicsPOEs TAX ACT OF 1966 (H.R. 13103) ON FOREIGN BANKS HAVING AGENCIES IN THE UNITED STATES This statement is submitted on behalf of Bank of China, a banking corporation organized in 1912 under the laws of the Republic of China with its head office in Taipei, Taiwan, and agencies in many of the major cities of the world, including two in the City of New York, one at No. 40 Wall Street and the other at No. 225 Park Row. The bank is duly authorized under the New York State Banking Law to do business in this State through these two agencies and is, of course, subject to the supervision to the New York State Superintendent of Banks. Under the existing provisions of the Internal Revenue Code the Bank has the status of a foreign corporation engaged in the conduct of trade or business within the United States and is therefore taxed under `Sec. 882 of the Code at the ordi- nary rates applicable to domestic corporations on all of its net income from sources within the United States including both the income of the N'ew York agencies and the income derived from investments by Head Office in the U.S. government and corporate securities. The Bank's taxable net income for U.S. tax purposes is arrived at by deducting from the total amount of all its gross income from U.S. sources, both Agency and Head Office, all of the allowable de- ductions related thereto. Such deductions consist of the direct expenses of the New York Agencies and an allocation of Head Office general overhead expense prorated under Code Sec. 882(c) (2) and Treasury Regs., Sees. 1.873-1(a) (1) and 1.882-3(b) (2). The Bank's New York Agencies also derive income from sources outside the United States, including interest on Canadian government bonds, discount of bills drawn on foreign banks, interest on loans to foreign banks and firms, and other foreign sources, mostly in Japan. This foreign-source income is not taxable under the present provisions of the Code, however, and the expenses related thereto (including both direct New York agency expenses and the allocation of Head Office overhead expenses) are not deductible. If H.R. 13103 should be enacted in its present form, this would be drastically altered as follows: 1. Under Code Sec. 882 as amended by Section 4 of the Bill, all income from interest and dividends received from U.S. sources held in the Head Office portfolio, together with the related deductions, would be excluded from the computation of the tax based on net income as income not "effectively con- nected with the conduct of a trade or business within the United States." 2. Under Code Sec. 881 as amended by Sec. 4 of the Bill the income excluded from tax under Sec. 882 as income from U.S. sources not effectively con- nected with the U.S. business of the Bank, would become taxable at a rate of 30% on the gross amount thereof, without any offsetting deductions or credits 71-297 0-67-pt. 1-69 1079 PAGENO="1090" 194 FOREIGN INVESTORS TAX ACT OF 19~6 whatever. (There is no income tax treaty between :the United States and th National Government of the Republic of China. 3. In addition, by virtue of the provisions of Sec. 864(c) (4) (B) of the Code as added by Sec. 2(d) of the Bill, `there would be included in the gross income of the New York agencies all of the income of the agencies derive from sources outside the United States, such as the Canadian and Japanes interest items referred to above, because this income would be deemed effec tively connected with the U.S. business of the Bank. (Of course at the sam time the related deductions, now disallowed, would become `allowable so tha only the net income from these sources would be taxed at normal domesti corporate rates.) 4. New Code Sec. 906 `as added by Sec. 6(a) of the Bill allows foreig corporations to credit `against their U.S. tax the foreign income `taxes pai on the foreign-source income referred to in ¶3 above, subject to the limita tions of the existing foreign tax credit provisions of the Code. According t subsec. (b)'(l) of the new Code Sec. 906, this credit will not be allowed, how ever, with respect to any tax imposed by the country of the corporation' domicile unless the income is derived from sources in that country. Thi means, in the case of the foreign source income of the U.S. agencies of th Bank of China, `that no credit would be allowed for any Chinese taxes an that to the extent that income from sources in other countries are subject t `lower rates of tax than those paid in the United States, or `to no tax at a] the Bank will pay the full U.S. tax on such income as in the case of incom from sources within the United States. By making the question of whether income is or is not "effectively connecte with the conduct of a trade or business within the United States" the decisiv factor in determining whether the income of a foreign corporation is to be taxe on its net income under Sec. 882 on its gross income under Sec. 881, and b including foreign source income in the measure of the tax under Sec. 882, tI Bill reflects a fundamental change in the basic concepts heretofore applicab tothe taxation of foreign corporations. According to its title the purpose of the Bill is "to provide equitable tax trea ment for foreign investment in the United States" or, as stated in the report~ the House Ways and Means Committee on the Bill (2d Session, 89th Congres House Report No. 14~0, p. 8,) "to increa'se the equity of the tax treatment a corded foreign investment in the United States." Whether or not these new concepts: are reasonably calculated to achieve the stated purposes of the Bill if consistently carried out and implemented in II Code in the majority of eases, it clearly appears that in the case of foreign ban] with agencies or branches in the United States there is no apparent equity changes which result in drastic increases in a foreign bank's tax liabilities in tl United States and it is submitted that as the Bill is drawn, it fails to recognh certain obvious facts generally applicable in the case of ordinary ban'ks ar furthermore contains provisions which, in certain cases at least, result in mo: discriminatory treatment rather than less for the foreign banks and therefo: lessens rather than increases the equity of the tax treatment accorded foreii investment in the United States. In the first place, interest constitutes by far th'e more important source of i: come of such a `bank and the funds invested by such a bank to produce ~m income con'sist mainly of borrowed funds, including customers' deposits ar other obligations. `Substantial expenses are necessarily incurred by the bar in obtaining the funds invested to produce its interest income. If these expens are not taken into account in determining the measure of the tax and if the ra of tax is higher than the ~bank's margin of profit, the result is simply co: fiscatory. Such `a system of taxation, far from encouraging foreign investme] in the United States, will effectively prohibit it in the case of more forei~ banks, `but this is the inevitable effect of taxing interest income from norm banking operation's at 30% of the gross amount thereof. In the second place, the inclusion of income from' sources outside the Unit States in determining the tax of the local agency of the foreign ban represents a radical departure from any previous concepts embodie in our income tax law. Whatever logic this concept might have if ai plied generally, it has been restricted in its application under this Bill so as 1 apply only to the extremely limited groups of taxpayers referred to in new Cod See. 864(c) (4) (B) (i). (ii) and (iii) and to no other class of taxpayers. Tb banking business is included in clause (ii). By `singling out banks, havin agencies or branches in the United States for this treatment when other foreig 1080 PAGENO="1091" FOREIGN INVESTORS TAX ACT OF 1966 195 corporations are not so treated appears to be purely discriminatory, and the inequity of this treatment is more evident when it is considered that there are a number of other provisions of the existing Internal Revenue Code which al- ready discriminate to a substantial extent against such banks, e.g.: the pro- visions of Sec. 582(c) of the Code under which domestic banks are allowed to treat losses on the sale of bonds and other government and corporate obliga- tions as ordinary losses fully deductible from ordinary income while foreign banks having agencies or branches in the United States are not; the similar provisions of Code Sec. 582(a) dealing with losses due to worthless securities; the disallowance of the right to deduct additions to a reserve for bad debts under Rev. Rul. 65-92 1965-1, C.B., 112, and the right to deduct interest and other ex- pense notwithstanding the investment of the bank's funds in tax exempt state and municipal bonds whereas under Sec. 882(c) (2) of the Code and the applica- ble regulations, foreign banks may deduct only expenses attributable to the earning of taccable income from sources within the United States. It is therefore respectfully submitted that in furtherance of the stated pur- poses of the Bill and to avoid its present harsh and discriminatory operation in the case of the foreign banks with branches or agencies in the United States, the Bill should be changed so as to permit such banks to treat all interest and dividend income derived from sources within the United States as effectively connected with its U.S. trade or business and to eliminate banks from the oper- ation of the provisions of Sec. 864(c) (4) (b) (ii). These changes can readily be accomplished in various ways. For example, Sec. 864(c) of the Code, as added by Sec. 2(d) çf the Bill might be revised (1) by adding at the end of Code Sec. 64(c) (2) the following sentence: "This paragraph shall not apply to any income derived from sources within he United States in the active conduct of a banking business by a foreign cor- oration having one or more branches or agencies in the United States which are ubject by law to supervision and examination by State, Territorial or Federal uthority having supervision over banking institutions." nd (2) by deleting the word "banking" from Clause (ii) of Code Sec. 04(c) (4) (B). As an alternative to the foregoing proposed revision of Sec. 864(c) (2), the ame result might be accomplished by adding to Sec. 882 as amended by the Will new subsection (e) allowing to foreign banks having branches or agencies in he United States the same option to elect to have all their income of the types pecified in Sec. 864(c) (2) treated as effectively connected with the conduct of heir U.S. business as that granted in the case of real estate income under sub- ection (d) of Sec. 882 as added by the Bill. TATEMENT or ROBERT BEAUMONT, AGENT-IN-CHARGE, THE HONGKONG AND SHANGHAI BANKING CORPORATION The Hongkong and Shanghai Banking Corporation, organized under the laws f Hong Kong, isengaged in the commercial banking business. In addition to its ~lead Office located in Hong Kong, and branches in the Far East, it maintains an gency located at 80 Pine street, New York City which is licensed to do business n New York State, and one at 180 Sansome Street, San Francisco which is icensed to do business in California. The vast majority of stock in the corpora- ion is owned by foreign nationals, and under chapter 70 of the laws of Hong tong no single shareholder can own more than approximately 3% of the issued Lnd outstanding capital stock. Its banking business in the U.S.A. consists of ervicing export and import operations, providing the necessary financing thereof, md offering many of the general `banking services of a domestic bank. Under the tax rules presently in effect, the bank is taxable in much the same nanner as a domestic corporation since it is engaged in trade or business in the united States. However, under `Section 882 of the 1954 Internal Revenue Code ~is amended, it is only taxable on its gross income from sources within the United States, less the applicable deductions. Interest received from securities issued by foreign governments is treated as income from sources without the United States under Section 861(a) (1) and 862(a) (1) of the Code regardless of vhether or not such interest is received by the New York Agency or a foreign office of the bank. Thus, for example, if this banking corporation purchases bonds issued by the Government of Australia, the interest earned thereon is not taxed by the United States. 1081 PAGENO="1092" 196 FOREIGN INVESTORS TAX ACT OF 1966 The Foreign Investors Tax Act (H.R. 13103) will depart radically from the foregoing principle inasmuch as it will tax certain income from sources without the United States if it is "effectively connected" with the conduct of a trade or business within the United States. Foreign source income will be treated as "effectively connected" with the U.S. business if the foreign entity conducts such business through an office or other fixed place of business within the United States, such income is attributable thereto, and it consists of dividends, interest or gains from the sale of stock, securities or notes derived in the conduct of a banking business. (Section 2(d) of the Bill and proposed Section 864(c) (4) (B) (ii) of the Code). At present, the Honkong and Shanghai Banking Corporation maintains its investment portfolio of Australian, New Zealand and Union of South Africa government bonds in New York. Since the interest is derived from sources out- side the United States it is not presently taxed in the United States. These bonds are retained in New York and may be included as New York assets in setting credit limitations by the New York State banking authorities. Although the proposed legislation and Committee Report (No. 1450) are not entirely clear, it would appear that since these bonds are recorded on the books of the New York Agency in a memorandum account for control purposes only, and since they are considered to be qualifying assets by the New York State banking authorities; they might be attributable to the New York Agency. As a result, under the above stated rule, the interest derived therefrom might be treated as taxable income which is "effectively connected" with the conduct of a trade or business within the United States under the proposed amendments to Section 882 (Section 4(b) of the Bill). In addition to foreign source interest income derived from Commonwealth investments, which is of great concern to us at the present time, the New York Agency also earns from its commercial banking function other types of interest income from foreign borrowers which, in fact, constitute the greater part of its earnings. It will be appreciated that the Agency is not permitted under New York State law to take deposits from U.S. residents, and consequently it operates entirely on foreign source funds lodged by overseas branches and by customers of those branches. Since the derivation of these funds is foreign and the banks sphere of operations is in the Far East and Middle East it follows that a large percentage of loans and other forms of advances are made by `the New York Agency to foreigners. This interest, which is foreign source interest on these loans and advances, would include: (1) Interest on dollar bills purchased, drawn on `a foreigner abroad (no letter of credit involved)-this might be a bill for collection which the New York Agency purchases from the U.S. exporter. The New York Agency will advance the full face amount of the bill to the U.S. exporter and instruct the foreign branch to collect the interest from the foreign importer and remit the proceeds plus interest to the New York Agency. (2) Interest earued by the New York Agency on overdrafts or loans made to foreigners abroad. (3) Interest on loans to a foreign borrower in which the New York Agency participates with another bank. (4) Interest earned by the New York Agency where it participates with the World Bank on `loans in countries in which The Hongkong and Shanghai Banking Corporation has branches, such as loans for construction of dams, electrical plants, etc. The seriousness of the impact of the proposed legislation is apparent for there is little doubt that such income would :be considered to `be "effectively con- nected" with the conduct of the U.S. banking business where: (1) the funds loaned are those of the U.S. place of business, or (2) the New York Agency or branch participates in effectuating the transaction between the exporter and importer (e.g., handles the correspondence, transmits `documents, inspects docu- ments, opens and advises letters of credit, makes payments, etc.). Furthermore, the fact that the foreign `source interest income is accounted for through the New York `branch or agency will be given considerable weight in determining whether the income is "effectively connected" with the conduct of a U.S. trade or business. (Section 864(c) (2) and (4) (B)). The object of the Bill is "to provide more equitable tax treatment for foreign investment in the United :States~~ as stated on page 1 of Report No. 1450 of the `Committee on Ways and Means of the House of Representatives to accompany ER. 13103. We submit that the taxation of foreign source interest income 1082 PAGENO="1093" FOREIGN INVESTORS TAX ACT OF 1966 197 earned by a foreign corporation engaged in the banking business is in derogation of this purpose of the Bill as set forth below: 1. At first appearances, it may seem equitable to tax foreign banking in- stitutions on their foreign source interest income if such income is attribut- able to activities of an office or place of business in the United States since a domestic bank is taxed on its world-wide income including that derived from sources outside of the United States. However, upon closer analysis, it `becomes apparent that domestic banking institutions have certain Federal income tax privileges `which are denied resident foreign banks. For ex- ample, a domestic `bank may claim annual deductions for additions to its reserve for `bad debts until the reserve equals 2.4 per cent of loans out- standing at the close of the taxable year, regardless of whether its bad debt experience indicates that any losses, in fact, did result. (Rev. Rul. 65-92, 1965-1 C.B.: 112). A resident foreign bank, on the other band, may only claim a deduction for those bad debts actually incurred, or a deduction for an addition to a reserve for bad debts `based on a reasonable expectation that a percentage of loans will default under the normal rules set forth in Section 166. If, based on subsequent experience, `such bad debts do not materialize, the addition to the reserve mus't be restored to income by the resident foreign `bank. `Since the primary source of earning income for any bank is the loaning of funds, a resident foreign `bank is at a distinct dils- advantage in comparison to a domestic banking institution. 2. However, the inequitable tax treatment between domestic and foreign banks goes much further. As a general rule, where a taxpayer corpora- tion disposes of a capital asset at a gain, such gain is taxed at the reduced rate of 25 per cent. Any losses derived from the sale or exchange of capital assets are first offset against the gains from such sales and any excess may be carried forward for a period of five years and utilized against future gains from the sale of capital assets (Section 1212 (a)). Any excess of losses over gains from the sale or exchange of capital assets may not be offset against so-called ordinary income taxed at the regular corporate tax rates. In the case of a domestic bank, however, if the losses of the taxable year from sales or exchanges of bonds, debentures, notes, or certificates, or other evi- dences of indebtness, issued by any corporation (including one issued by a government or political subdivision thereof), exceed the gains of the tax- able years from such sales or exchanges, no such sale or exchange shall be considered a sale or exchange of a capital asset. (Section 582(c), Treas. Reg. Sec.' 1.582-1(c)). This means that if the losses exceed the gains from the sale or exchange of such capital assets, a domestic bank secures the benefit of an ordinary deduction applicable against income taxed at the 48 per cent rate. A resident foreign bank may only deduct capital losses against capital gains taxed at the 25 per cent rate and any excess may only be carried forward for five years and charged against capital gains. If it does not have capital gains within such period or not sufficient gains to absorb such' losses, the carryover can be lost forever. No deduc- tion for capital losses is permitted against ordinary income. 3. A further area of inequitable treatment stems from the fact that domestic banks are allowed to deduct interest paid on deposits and other expenses incurred in earning tax-exempt interest. Interest income earned on obligations issued by any of the fifty states or their municipalities is exempt from U.S. income tax (Section 103). Section 265(2) sets forth the general rule that no deduction shall be allowed for interest on indebted- * ness incurred or continued to purchase or carry obligations, the interest from which is wholly exempt from Federal income tax. However, this rule does not apply to domestic banks. The provisions of Section 265(2) have no application to interest paid on indebtedness represented by de- posits in banks engaged in the general banking business since such in- debtedness is not considered to be "indebtedness' incurred or continued to purchase or carry obligations . . ." within the meaning of Section 265. (Rev. Rul. 61-222, 1961-2 C.B. 58). Even though a domestic bank may use a portion of its deposits to purchase tax-exempt state or municipal bonds, the interest expen~e paid on such deposits is fully deductible without any allocation to the tax-exempt interest income. A resident foreign bank, on the other hand, is not accorded this same privilege. It may only claim a deduction for those expenses which are connected with earning taxable gross income from sources within the United States (Section 882(c) (2), 1083 PAGENO="1094" 198 FOREIGN INVESTORS TAX ACT OF 1966 ~Preas. Reg. Sec. 1.882-3(b) and 1.87&-1(a) (1). Section 861 (a) which defines income from sources within the United States limits this concept to "items of gross income." Municipal and state bond interest is not in- cluded in "gross income" (Section 103). Thus, to the extent that comparable interest expense on deposits and other expenses are attributable to tax-exempt bond interest income, they are not deductible `by a resident foreign banking corporation, although a domestic banking institution can claim such deductions. In the light of the foregoing we submit that to tax resident foreign banking corporations on their foreign source dividends, interest, and gains from the sale of securities does not achieve equitable tax treatment for their investments in the United States. In addition, this novel concept of taxing foreign enterprises on their foreign source income is directly contrary to three-quarters of the Income Tax Treaties. concluded by the United States with foreign countries which specifically limit U.S. taxation of foreign enterprises to their U.S. source income. (E.g., Aus- tralia-Article III, Italy-Article III.) ~Phe U.S. Treasury Department Regu lations applicable to those few tax treaties whose provisions allow Federal taxation on all income allocable to a U.S. "permanent establishment," limi this rule to income from sources within the~ United States, thus evidencing th intent of even these treaties not to tax foreign source income. (E.g., Canada- Regulation Section 519.104, France-Regulation Section 514.105). Since Sectio 10 of the Bill provides that no amendment made by H.R. 13103 shall apply i any case where its application would be contrary to any treaty obligation of th United States, this motive to tax foreign source income would not apply to thos countries with whom the United States has an income tax treaty, thus discrimi nating severely against those nations with whom the United States has not ye concluded a treaty. Since the United States has not concluded an income ta treaty with Hong Kong, our bank would be seriously affected under the propose Bill in a manner not contemplated at the time these tax treaties were negotiated United States taxation of foreign interest income attributable to a U.S. plac of business could result in multiple taxation under the Bill without a compen sating offset for a foreign tax credit. Let us assume that the resident foreig: bank is organized in country A having a corporate income tax rate of 48 pe cent. Let us assume it earns interest income of $10,000 in country B wh imposes a 15 per cent withholding tax thereon. The interest income is ala attributable to the office in the United States and is taxed at 48 per cent. Fo purposes of simplification, we will assume that there are no deductible expense and that the total taxable income subject to tax in country A is $110000, includ ing the $10,000 bond interest. We will also assume that country A has a pe country limitation for foreign tax credits but no overall limitation. In othe words, the amount of any credit for foreign taxes paid or accrued to any foreig country is limited to the ratio of taxable income from sources within that countr: to entire taxable income applied to the tax due before credit in country A. Th following calculation sets forth the taxes paid to the respective countries afte the suitable credits. . Country A Country B United States Taxable income Tax comnuted thereon Less foreign tax credit Net tax due $110, 000 $10, 000 $10, 00 52, 800 1,500 1,500 4, 80 1, 50 51,300 1, 500 3,30 The effective rate of tax on the $10,000 of interest income is 81 per cent (i.e. 33% in country A, 15% in country B, plus 33% in the United States) instead of 48 per cent due to the fact that the credits are limited to the tax imposed b3 the country of source. From the foregoing illustration, it is evident that the resident foreign bank will not secure a foreign tax credit in its home land for net United States incomt. taxes paid. Furthermore, while Section 6 of the Bill permits a credit for foreign taxes paid or accrued on income from sources without the United States which is "effectively connected" with the conduct of a trade or business within the 1084 PAGENO="1095" FOREIGN INVESTORS TAX ACT OF 1966 199 United States, such credit is only allowed for the foreign tax levied by the country of source and not the country of organization. Therefore, no credit would be allowed in the United States for taxes paid to country A since the income is sourced in country B. As a result there would be multiple taxation duo to the inability to claim full foreign tax credits. Finally, it has always been fundamental to American democratic philosophy that the Federal government's right to tax is not based upon mere physical force but on the underlying theory that the consideration given for taxation is the protection of life and property, and that the income rightly to be levied upon to defray the burdens of government is that income which is created by activities and property protected by the government or obtained by persons enjoying such protection. (Mertens, Section 4527). This basic tenet of tax philosophy is' violated by the provisions of the Foreign Investors Tax Act that propose to tax foreign source, income of a foreign corporation controlled by non-U.S. persons erely because it is deemed to be attributable to a United States place of busi- ess. The fact that a bill of exchange, promissory note, or bond, the instrument videncing a debt, is physically located in the United States or is accounted for ~n the U.S., does not mean that the United States is protecting the property epresented by that document. The residence of the obligor determines the location of the property right, nd it is that country who properly exercises the jurisdiction to tax the income .arned thereon since it protects the property rights represented by the security. y the same token, `the country of organization of the obligee may also choose o tax the income because it offers world-wide protection to the taxpayer entity. `his latter country will generally allow a foreign tax credit for income taxes aid to the country of source, if it also chooses to tax the same income. Let us ake the case of a typical resident foreign banking institution such as this tax- )ayer. It negotiates the purchase of overseas bonds through its Head Office in [ong Kong and the funds for the purchase are provided by the Head Office and ot by the U.S. branches. The bonds are not governed by the laws of the U.S., lone of the parties to the transaction are located in the United States, and all ransfers of currency concerning principal and interest take place outside of he United States. Nevertheless, the resident foreign bank could be taxed in `he United States on the interest income earned from these bonds simply because hey are utilized in the United States as New York assets in setting credit limita- ions by the New York State banking authorities. Yet, the foreign bank cannot se the United States courts to enforce the property rights represented by these onds, such as the payment of principal or interest. It must turn to the courts utside the U.S. for redress and protection. Furthermore, since the United `tates is not the country of organization, it does not offer world-wide protection o this entity, which is fundamental to the philosophy for taxing a U.S. entity n foreign source income. To illustrate the principle, if the bonds were `to be used to secure loans made n the United States, it would seem that the proper income to tax is the income enerated by utilizing such loan funds, not the foreign source income earned by he security provided for such loans. In other words, it is the U.S. source income rom such loans which is properly attributable to the U.S. place of business, not he foreign source income from the bonds used as security to obtain the loans. 1herefore, it would seem that to tax the interest income derived from such bonds rould be an undue extension of the authority of the Federal government in xercising its taxing jurisdiction. It can also be seen that `the above argument applies to any ether evidence of ndebtedness, such as a bill of exchange or a promissory nOte, where the obligor nd obligee are foreign individuals or foreign entities and the income earned herefrom is foreign source income. In conclusion, it is submitted that the Foreign Investors Tax Act will dis- riminate against resident foreign banking institutions instead of providing aore equitable tax treatment for their investments in the United States. If ~ongress Wishes to fulfill its stated objective, then it should choose between `itber not taxing resident foreign banks on their foreign source dividends, nterest and gains from the sale of securities or else extend to them the same ax privileges accorded to domestic banks. It is recommended that this inequity be corrected by excluding resident foreign ~anks from Section 864(c) (4) (B) (ii) added to the Internal Revenue Code by ~3ec~tion 2(d) (2) `of H.R. 13103. It is respectfully requested that, at such time a~ the Senate Finance Committee nay hold a public hearing on the Foreign Investors Tax Act, The Hongkong and 1085 PAGENO="1096" 200 FOREIGN INVESTORS TAX ACT OF 1966 Shanghai Banking Corporation be given an opportunity to orally express its views through its representative, Richard H. Kalish, partner in the firm of Peat, Marwick, Mitchell & Co. (Certified Public Accountants). BARCLAY'S BANK D.C.O., New York, AugEst 9, 1966. H.R. 13103-Foreign Investors Tax Act of 1966. Hon. RUSSELL B. LONG, Ch.a4rman, U.E. Senate Committee on Finance, Washington, D.C. DEAR SENATOR LONG: As a resident foreign bank, you can appreciate our inter- est and concern with the provisions of The Foreign Investors Tax Act which will affect the taxability of agencies and branches in the United States. Our pri- mary concern is the provision of the Bill which would tax foreign source interest income attributable to a United States place of business under the "effectively connected" concept. Initially, it seemed quite equitable to tax foreign banking institutions on such foreign source interest income where it is earned through an office in the United States since a domestic bank is taxed on its world-wide in- come including that derived from spurces without the United States. Upon a closer analysis of this proposed legislation in the light of other provisions of the U.S. tax law, however, it became quite evident to us that tO tax a U.S. branch or agency of a foreign banking corporation would not, in fact, achieve the stated objective of the Bill "to provide more equitable tax treatment for foreign invest- ment in the United States." While a domestically incorporated U.S. bank is taxed on its foreign source income, it nevertheless enjoys certain tax privileges regarding the deductibility of additions to reserves for bad debts, capital losses and expenses related to the purchase of state and municipal securities which or" not available to resident foreign banks. Furthermore, where the country of organization or primary residence of the foreign banking corporation doing busi- ness in the U.S. does not permit a foreign tax credit for income which is taxed in the United States but not sourced here, the foreign bank will be subjected to a multiplicity of income taxes without tax credit relief. This would be true for any foreign nation which has a per-country limitation similar to that in the United States. Accordingly, we requested our tax accountants, Peat, Marwick, Mitchell & Co., to prepare a statement for submission to your Committee outlining in detail the reasons for which we feel a resident foreign bank should not be taxed on its foreign source dividends, interest, and gains from the sale of securities which might be attributed to a U.S. branch or agency. It is, therefore, respectfully requested that the Senate Finance Committee give careful consideration to the views expressed in the Statement which we are submitting herewith. We should also be pleased to have Mr. Richard Kalish, Partner in the firm of Peat, Marwick, Mitchell & Co. (Certified Public Accountants) discuss this mat- ter with you and other members of your committee and staff as you may see fit in the circumstances. Yours very truly, B. W. BITHELL, Local Director. STATEMENT OF BARCLAY'S BANK D.C.O. INTRODUOTION Barclay's Bank D.C.O. is a corporation organized under the laws of the United Kingdom in 1836, with its head office located at 54 Lombard Street, London B. C. 3, England. It is engaged in the commercial bankhig business with offices located throughout the world. In the United States it maintains branches in New York City at 300 Park Avenue and at 120 Broadway in addition to an office at 111 Pine Street, San Francisco, California. The bank is licensed to do business in New York State and the State of California. The stock of the corpo- ration is widely held by foreign persons. Its banking business consists of servic- ing export and import operations, providing the necessary financing thereof, and offering many of the general banking services of a domestic bank. Since it operates through branch offices, it is permitted to accept deposits from cus- tomers whereas an agency cannot do so, although it may solicit them for its head office. 1086 PAGENO="1097" FOREIGN INVESTORS TAX ACT OF 1966 201 PRESENT LAW A foreign corporation engaged in trade or business in the United States is taxed under section 882 of the Internal Revenue Code, which provides that such corporation shall be taxable in the same manner as a domestic corpora- tion (that is, on its net income at the rates prescribed by Section 11 of the Code), except that it is only taxable on its income from sources within the United States. It is not taxable on income derived from sources without the United States. Those business expenses which are directly identifiable with United States source income are allowable deductions plus the allocable share of other expenses which are related to earning United States source income, but the amount of which cannot be specifically determined. In this latter case, the expenses are deductible in the ration of gross income from sources within the United States to the total income of the bank from all sources. (Section 861 (b) and 882(c) (2) of the Code; Treasury Regulation Section 1.882-3(b) (2) and 1.873-1(a) (1)). Interest income derived from a foreign government, a nonresident alien individual, a foreign corporation or other entity not engaged in trade or busi- ness in the United States is income from sources without the United States and is exempt from United States income tax. (Section 861(a) (1) and 862 (a) (1)). Furthermore, interest income received from a resident alien individual, a resident foreign corporation (i.e. one engaged in trade or busi- * ness in the United States), or a domestic corporation is also exempt from Fed- eral income tax when such person derives less than 20% of its gross income from sources within the United States for the three preceding years or for the period of its existence if less than three years. (Section 861 (a) (1) (B)). PROPOSED LAW The proposed Bill departs to a considerable extent from the foregoing princi- ples and will have a serious and arbitrary effect on this taxpayer. Under the Bill in its present form, the gross income of a resident foreign corporation would be divided into two categories (H.R. 13103, Section 4(b)) (1) Gross income which is effectively connected with the conduct of a trade or business within the United States; (2) Gross income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business in the United States. The first category of income would be taxed at the regular corporate rates or 22% and 48% under Section 11 of the Cede after an allowance for the permitted deductions (HR. 13103, Section 4(b) amending Section 882 (a) and (e)), or at the capital gain rate of 25% under Section 1201(a) of the Code. The factors to be taken into account in order to ascertain whether an item of income is "effectively connected" with the conduct of a trade or business in the United States are (H.R. 13103, Section 2(d)): (1) The income gain or loss is derived from assets used in or held for use in the conduct of such trade or business, or (2) The activities of the trade or business were a material factor in the realization of the income, gain or loss. In determining whether either of these factors are present to render income as being effectively connected with the conduct of a United States trade or business, due regard shall be given as to whether or not the assets, income, gain or loss is accounted for through the United States place of business. (Proposed Section 864(c) (2) as set forth in Section 2(d) of H.R. 13103). While income from sources within the United States may be effectively con- nected with the conduct of a United States trade or business, only certain specified types of income from sources without the United States can be so treated. Of particular concern in this latter instance to Barclays Bank D.C.O. is the provision that dividends, interest, and gain or loss from the sale or ex- change of stock, notes, bonds, or other evidences of indebtedness derived in the a~~tiv~ (`orl((I.'t o? a banking business within the United States would be sub~ ject to Federal income tax, if such income is "effectively connected" with an office or other fixed place of business within the United States. (Proposed Section 882(b) (2) as contained in Section 4(b) of H.R. 13103). Income from sources within the United States, which is not "effectively connected" with the conduct of a trade or business in the United States, would be taxed at a fiat 30% rate (or applicable treaty rate). As under present law applying tn nonresident foreign corporations, no deductions would be permitted even though there may be expenses related to earning such income. 1087 PAGENO="1098" 202 FOREIGN INVESTORS TAX ACT OF 1966 EFFECT OF H.R. 13103 ON U.S. BRANCH OPERATIONS Most interest income earned by the U.S. branches of the bank, which could be subject to U.S. income tax, consists of interest on loans, overdrafts, invest- ments and bills. Interest is also earned by way of discount which is, of course, another term for interest. By way of illustration, foreign source interest income attributable to a U.S. place of business might arise in the foUo~ving manner: 1. A U.S. company (an exporter) draws a bill of exchange (i.e., a demand draft) on a United Kingdom company abroad. It presents the draft and documents (e.g. commercial invoice, bill of lading, consular invoice, certificate of origin, etc.) to the New York branch of the bank. The New York branch wil type the details on covering schedules; instruct the London branch as to th manner in which the bill should be collected and what to do if the Unite Kingdom importer does not honor and pay the bill; and will remit the bill documents and instructions to the London branch. The documents are place in the hands of the drawee on the bill (the United Kingdom importer) onl upon the instructions of the drawer of the bill (the U.S. exporter). Ph London branch will notify the United Kingdom importer, who examines th draft, and documents, and, if all is in order, he will pay the amount of th draft~ to the London `branch. The proceeds will be remitted `to the New Yor branch for payment to the exporter. Sometimes the foreign importer is not in position to pay the amount of the draft drawn by the U.S. exporter and th New York branch will advance the proceeds to the U.S. exporter charging th foreign importer with interest on the loan. In this case, the foreign sourc interest income would be effectively connected with the conduct of the U. banking business subject to Federal income tax under the Foreign Investo Tax Act. 2. A company organized in India (an exporter) might draw a bill of exchan payable in U.S. dollars (i.e. a 90 day `time draft) on a Turkish importer. P steps in the transaction are similar to those set forth in the first case. T Indian company needs cash immediately and discounts the draft with the Ne York branch of the bank who remits the funds to its Bombay office. At maturit the New York branch will collect the face amount of the bill and retain t proceeds, the discount earned representing interest income on the transactio Since the proceeds of the draft are paid by the Turkish importer, the intere income is earned from foreign sources. It would be taxable in the United Stat since the assets of the New York branch were utilized to discount the bill f the foreign exporter. 3. A French `shoe manufacturer not engaged in business in the United Stat might import raw `hides from the United States. He opens a letter of cre through the Paris office of the bank in favor of the U.S. exporter. The letter credit provides that upon presentation of the required draft and documents accordance with the terms of the letter of credit, the exporter will be paid f the shipment. However, the French importer does not have the cash to coy the letter of `credit and borrows the necessary funds from the bank. Whe the New York branch pays the U.S. exporter, it is in effect making a loan to t French importer. The interest earned by the New York branch of the ba: from this transaction is foreign source income since the payor is a foreign enti not engaged in trade or business in the United States. 4. Dollar loans might be made by the New York branch of the bank to a forei government to be used to finance the construction of dams, electrical plan schools and other facilities. The interest thereon would be foreign source incoi attributable to the U.S. place of business and subject to Federal income tax. While there may be other types of transactions generating foreign source come attributable to a U.S. place of business, the foregoing illustrations point the fact that there are many cases in which a foreign banking corporation e gaged in trade or business in the United States can be subject to U.S. income t on foreign source income under proposed Section 864(c) (4) (B) (ii). Whiles agree that this is undoubtedly one of the objectives of the Foreign Investors T~ Act, it is our view that such income should not be subjected to Federal incoi tax for the reasons cited below. CONSIDERATIONS FOR EXCLUDING FROM TAX FOREIGN SOURCE INTEREST INCO] OF AGENCY AND BRANCH BANKS The object of the Bill is "to provide more equitable tax treatment for forei: investment in the united States" as stated on page 1 of Report No. 1450 of t Committee on Ways and Means of the House of Representatives to accompa: 1088 PAGENO="1099" FOREIGN INVESTORS TAX ACT OF 1966 203 H.R. 13103. We submit that the taxation of foreign source interest income earned by a foreign corporation engaged in the banking business is in derogation of this purpose of the Bill as set forth below: 1. At first appearances, it may seem equitable to tax foreign banking institu- tions on their foreign source interest income if such income is attributable to activities of en office or place of business in the United States, since a domestic bank is taxed `on its world-wide income including that derived from sources outside of the United States. However, upon closer analysis, it becomes apparent that domestic banking institutions have certain Federal income tax privileges which are denied resident foreign banks. For example, a domestic bank may claim annual deductions for additions to its reserve for bad debts until the reserve equals 2.4 per cent of loans outstanding at the close of the taxable year, regardless of whether its bad debt experience indicates that any losses, in fact, did result. (Rev. Rul. 65-92, 1965-1 C.B. 112). A resident foreign bank, on the other hand, may only claim a deduction for those bad debts actually incurred, or a deduction for an addition to a reserve for bad debts based upon a reason- able expectation that a percentage of loans will default under the normal rules set forth in Section 166. If, based on subsequent experience, such bad debts do not materialize, the addition to the reserve must be restored to income by the resident foreign bank. Since the primary source of earning income for any bank is the loaning of funds, a resident foreign bank is at a distinct disadvantage `n comparison to a domestic banking institution. 2. However, the inequitable tax treatment between domestic and foreign banks oes much further. As a general rule, where a taxpayer corporation disposes f a capital asset at a gain, such gain is taxed at the reduced rate of 25 per cent. ny losses derived from the sale or exchange of capital assets are first offset gainst the gains from such sales and any excess may be carried forward for a eriod of five years and utilized against future gains from the sale of capital ssets. (Section 1212 (a)). Any excess of losses over gains from the sale or xchange of capital assets may not be offset against so-called ordinary income axed at the regular corporate tax rates. In the case of a domestic bank, owever, if the losses of the taxable year from sales or exchanges of bonds, ebentures, notes, or certificates, or other evidences of indebtedness, issued by fly corporation (including one. issued by a government or political subdivision hereof) exceed the gains of the taxable year from such sales or exchanges, rio uch sale or exchange shall be considered a sale or exchange of a capital asset Section 582(c), Treas. Reg. Sec. 1.582-1(c)). This means that if the losses .xceed the gains from the sale or exchange of such capital assets, a domestic ank secures the benefit of an ordinary . deduction applicable against income axed at the 48 per cent rate. A resident foreign bank may only deduct capital sses against capital gains taxed at the 25 per cent rate and any excess may nly be carried forward for five years and charged against capital gains. If it oes not have capital gains within such period or not sufficient gains to absorb uch losses, the carry-over can be lost forever. No deduction for capital losses permitted against ordinary income of a resident foreign bank. 3. A further area of inequitable treatment stems from the fact that domestic anks-are allowed to deduct interest paid on deposits and other expenses incurred i earning tax-exempt interest. Interest income earned on obligations issued by ny of the fifty states or their municipalities is exempt from U. S. income tax Section 103). Section 2(15(2) sets forth the general rule that no deduction iall be allowed for interest or indebtedness incurred or continued to purchase r carry obligations, the interest from which is wholly exempt from Federal tax. [owever, this rule does not apply to domestic banks. The provisions of Section 65(2) have no application to interest paid on indebtedness represented by eposits in banks engaged in the general banking business since such indebted- ess is not considered to be "indebtedness incurred or continued to purchase r carry obligations . . ." within the meaning of Section 265 (Rev. Rul. 61-222, 961-2 C.B. 58). Even though a domestic bank may use a portion of its deposits o purchase tax-exempt state or municipal bonds, the interest expense paid on uch deposits is fully deductible without any allocation to the tax-exempt in- erest income. A resident foreign bank, on the other hand, is not accorded his same privilege. It may only claim a deduction for those expenses which re connected with earning taxable gross income from sources within the United tates (Section 882(c) (2), Treas. Reg. Sec. 1.882-3(b) and 1.873-1(a) (1)). ection 861(a) which defines income from sources within the United States imits this concept to "items of gross income." Municipal and state bond interest s not included in "gross income" (Section 103). Thus, to the extent that corn- 1089 PAGENO="1100" 204 FOREIGN INVESTORS TAX ACT OF 1966 parable interest expense on deposits and other expenses are attributable to tax-exempt bond interest income, they are not deductible by a resident foreign banking corporation, although a domestic banking institution can claim such deductions. In the light of the foregoing, we submit that to tax resident foreign banking corporations on their foreign source dividends, interest, and gains from the sale of securities does not achieve equitable tax treatment for their investments in the United States but serves to aggravate an inequity which exists under present law and would continue under the proposed legislation. In addition, this novel concept of taxing foreign enterprises on their foreign source income is directl~t contrary to three-quarters of the Income Tax Treaties concluded by the United States with foreign countries which specifically limit U. S. taxation of foreign enterprises to their U.S. source income (e.g., Australia- Article III, Italy-Article III). The U. S. Treasury Department Regulations applicable to those few tax treaties whose provisions allow Federal taxation on all income allocable to a U. S. "permanent establishment," limit this rule to income from sources within the United States, thus evidencing the intent of even these treaties not to tax foreign source income (e.g., .Canada-Regulation Section 519.104, France-Regulation Section 514.105). Since Section 10 of the Bill provides that no amendment by H.R. 13103 shall apply in any case where its application would be contrary to any treaty obligation of the United States, this motive to tax foreign source income would not apply to those countries with whom the United States has an income tax treaty limiting its taxing juris- diction, thus discriminating severely against those nations with whom the United States has not yet concluded a treaty. Furthermore, even though the United States may have an income tax treaty with the country of residence of a foreign banking corporation engaged in trade or business within the United States providing that only U. S. source income can be attributed to a permanent establishment in the United States (e.g. such as Article III of the 1946 United States-United Kingdom Income Tax Treaty in conjunction with Section 10 of H.R. 13103 allowing treaties. to prevail; see also Houses Report No. 1450, page 121), a provision in the Internal Revenue Code which attempts to tax foreign source income of resident foreign banks in non- treaty countries could set the stage for future abrogation of the treaties presently in force. United States taxation of foreign source interest income attributable to a U.S. place of business could result in multiple taxation under the Bill without a com- pensating offset for a foreign tax.credit. Let us assume that the resident foreign bank is organized in country X and pays tax at an effective corporate rate of 60 per cent. Let us assume it earns interest income of $500,000 in country Y which imposes a 15 per cent withholding tax thereon. The interest income is also attributable to the office in the United States and is taxed at 48 per cent. Fos purposes of simplification, we will assume that there are no deductible expenses and that the total taxable income subject to tax in country X is $1,500,000 includ ing the $500,000 bond interest. We will also assume that country X has a pei country limitation for foreign tax credits bet no over-all limitation. In othei words, the amount of any credit for foreign taxes paid or accrued to any foreigr country is limited to the ratio of taxable income from sources within that countr~ to entire taxable income applied to the tax due before credit in country X. Th following calculation sets forth the taxes paid to the respective countries aftei the suitable credits: Country X Country Y United States Taxable Income Tax computed thereon Less foreigntax credit $1, 500, 000 $500, 000 $500, 00 900, 000 75,000 75, 000 240,00 75,00 Net tax due 825,000 75,000 165,00 The effective rate of tax on the $500,000 of interest income is 93 per cent (i.e. 45 per cent in country X, 15 per cent in country Y, plus 33 per cent in the United States) instead of 60 per cent due to the fact that the credits are limited to the tax imposed by the country of source (Section 6(a) of the Bill adding Section 906, House Report No. 1450 at pages 37 and 38). 1090 PAGENO="1101" FOREIGN INVESTORS TAX ACT OF 1966 205 From the foregoing illustration, it is evident that the resident foreign bank will not secure a foreign tax credit in its home land for net United, States income taxes paid since the interest income is not from U.S. sources: Furthermore, while Sec- tion 6 of the Bill permits a credit for foreign taxes paid or accrued on income from sources without the United States which is effectively connected with the conduct of a trade or business within the United States, such credit is only allowed for the foreign tax levied by the country of source and not the country of organization. Therefore, no credit would be allowed in the United States for taxes paid to country X since the income is sourced in country Y. As a result, there would be multiple taxation due to the inability to claim full foreign tax credits. Finally, it has always been fundamental to American democratic philosophy that the Federal government's right to tax is not based upon mere physical force but on the underlying theory that the consideration given for taxation is the protectiOn of life and property, and that the income rightly to be levied upon to defray the burdens of government is that income which is created by activities and property protected by the government or obtained by persons enjoying such protection (Mertens, Section 45.27). This basic tenet of tax philosophy is vio- lated by the provisions of the Foreign Investors Tax Act that propose to tax foreign source income of a foreign corporation controlled by non-United States persons merely because it is deemed to the attributable to a United States place of business. The fact that a bill of exchange, promissory note or bond, the instru- ment evidencing a debt, is physcially located in the United States, is accounted for in the United States, or the United States office acquired it does not mean that the United States is protecting the property represented by that document. The residence of the obligor determines the location of the property right, and it is that country who properly exercises the jurisdiction to tax the income earned thereon since it protects the property rights represented by the security. By the same token, the country of organization of the obligee may also choose to tax the income because it offers world-wide protection to the taxpayer entity. This latter country will generally allow a foreign tax credit for income taxes paid to the country of source, if it also chooses to tax the same income. Let us take the case of a Lebanese resident foreign banking institution. It negotiates the purchase of Chilean bonds through its head office in Lebanon. The loan is governed by the laws of Chile or Lebanon; the currency in which the bonds are payable is Chilean escudos; none of the parties to the transaction are located in the United States; and all transfers of currency concerning principal and interest take place outside of the United States. Nevertheless, the resident foreign bank could be taxed in the United States on the interest income earned from these Chilean government bonds simply because they might be held in the United States to secure additional lines of credit under the New York State banking laws or because the funds of the New York branch or agency were used to make the pur- chase. Yet, the foreign bank cannot use the United States courts to enforce the property rights represented by these bonds, such as the payment of principal or interest. It must turn to the courts in Chile or Lebanon for redress and protec- tion. Furthermore, since the United States is not the country of organization, it does not offer world-wide protection to this entity, which is fundamental to the philosophy for taxing a U.S. entity on foreign source income. If the bonds are being used to secure loans made in the United States, it would seem that the proper income to tax is the income generated by utilizing such loan funds, not the foreign source income earned by the security provided for such loans. In other words, it is the U.S. source income from such loans which is properly attributable to the U.S. place of business, not the foreign source income from the bonds used as security to obtain the loans. Therefore, it would seem that to tax the interest income derived from such Chilean bonds would be an undue extension of the authority of the Federal government in exercising its taxing jurisdiction. A similar situation exists with respect to other evidences of indebtedness, such as bills of exchange, drafts and promissory notes, where the obligor and obligee are foreign individuals or entities and the income earned therefrom is foreign source income. In conclusion, it is submitted that the Foreign Investors Tax Act will further aggravate the present discrimination against resident foreign banking institu- tions instead of providing more equitable tax treatment for their investments in the United States. `If Congress wishes to fulfill its `stated objective, then it should choose between either not taxing resident foreign banks on their foreign source dividends, interest and gains from the sale of securities or else extend to them the same tax privileges accorded to `domestic banks. 1091 PAGENO="1102" 206 FOREIGN INVESTORS TAX ACT OF 1966 Such treatment would provide a reasonable solution to this inequitable situa- tion, especially in view of the contribution made to the U.S. business community by foreign banking institutions as expressed in "Economic Policies and Prac- tices-Paper No. 9-Foreign Banking in the United States" which is part of the materials prepared for the Joint Economic Committee Congress of the United States (Joint Committee Print, 89th Congress, 2nd Session) "The recommendation for free entry and equal access for foreign banks ap- pears to be supported by past performance. Especially in the States whose foreign banking laws are most liberal, both bankers and supervisory officials argue that the advantages gained by the States and the country as a whole far outweigh the disadvantages. The foreign *banks have contributed to the de- velopment of New York and San Francisco as centers of international finance and trade. A by-product of this development has been the expansion of trade in which U.S. firms have been important participants and which several domes- tic banks have financed to an increasing degree. The foreign banking institu- tions have introduced new financial instruments in the trade financing field, and, thus, have complemented the activities of domestic banks. There has been little evidence or complaints of competitive developments unfavorable to the domestic banks, and most banks report improved correspondent relations since the estab- lishment of foreign banking institutions here. In certain instances, the foreign banks have provided personal banking services to ethnic groups who otherwise would have been denied these services and who probably would have held some of their money outside the banking system. Finally, it has been noted that the existence of foreign banks here and branches and subsidiaries of U.S. banks overseas probably has had favorable payment effects." It is recommended that this inequity be corrected by excluding resident for eign banks from Section 864(c)(4)(B) (ii) added to the Internal Revenue Cod `by `Section 2(d) (2) of H.R. 13103. This may be accomplished statutorily b deleting the word "banking" from the phrase "and either is derived in the activ conduct of a (banking), financing, or similar business. . ." set forth in Sectio. 864(c) (4) (B) (ii), added by Section 2(d) (2) of H.R. 13103. It is respectfully requested that, at such time as the Senate Finance Committe may hold a public hearing on the Foreign Investors Tax Act, Barclays Ban: D.C.O. be given an opportunity to orally express its views through it representa tive, Richard H. Kalish, partner in the firm of Peat, Marwick, Mitchell & Co (Certified Public Accountants). Senator ANDERSON. Mr. Seath. STATEMENT OP J~OHN SEATH, VICE PRESIDENT AND DIRECTO] OP TAXES, INTERNATIONAL TELEPHONE & TELEGRAPH CORP. Mr. SEATH. Mr. Chairman and members of the committee, my nam is John Seath. I am vice president and director of taxes of the Inter national Telephone & Telegraph Corp. I appreciate this opportunity to appear before you to express m: views on certain aspects of H.R. 13103. The initial bill proposed by the Treasury Department as the fore runner of H.R. 13103 had as its primary objective the encouragemen of foreign investment in the United States. This was, and is, a] objective that merits the full support of your committee. To the cx tent that the United States can create a favorable climate for foreig investment within its shores, to that extent can we expect foreig countries to create a favorable climate for American investmen abroad. It seems to me that the original purpose of the bill, to encourag foreign investment in the United States, has become obscured in ai attempt to extend U.S. income taxation to foreigners who have n U.S.-source income under the rules long established by the Congress This can have little or no effect on our balance-of-payments situation My company has one of the largest U.S. investment abroad. It i deeply concerned with the U.S. balance-of-payments problems. 1092 PAGENO="1103" FOREIGN INVESTORS TAX ACT OF 1966 207 Senator ANDERSON. Where are you on your statement? Mr. SEATH. I have submitted a longer statement and I am reading from a short statement which I thought you would prefer me to do rather than to read the long one. Senator ANDERSON. We would like to have you do that, but we would like to know where you are. Have you any copies of that? Your full statement can .go in the record. Mr. SEATH. Yes, that was my thought. Senator ANDERSON. Go ahead. Mr. SEATH. We believe that this bill, to the extent that your com- mittee can restore it to its original purpose of encouraging foreign investment to come to the United Stateg, will significantly aid our balance-of-payments situation. But to accomplish this, I repeat, the bill has to be restored to its original objective. Only if that is done, can we reasonably expect this bill to increase the inflow of investment funds from abroad. However~ I should like to call the attention of this committee to What I believe is another significant aspect of our balance-of-pay- ~ients problem. The foreign tax sections of the Revenue Act of 1962 vere designed to encourage the repatriation of income derived by U.S. orporations from foreign sources. At the same time, the cost of re- atriating that income was increased through the so-called "gross up" rovisions. Section 904 of the Internal Revenue Code imposes a limit ~n the credit against the U.S. tax on foreign-source income which may e claimed by a U.S. taxpayer against his U.S. income tax for foreign axes paid on the same income. Section 862 describes the method of ilocating U.S. expenses against U.S.-source and foreign-source in- ome. In 1944 the U.S. courts decided that the expense allocation ules of section 862 must be followed in determining the limits on al- Owable foreign tax credits under section 904. The net effect of this nterplay is that many U.S. corporations operating with subsidiaries broad are not receiving the foreign tax credits that we believe Con- ress originally intended. The result is that such corporations build p unused credits, are thereby encouraged not to repatriate earnings, nd the U.S. balance-of-payments situation is not helped at all. The Treasury Department, which recognized that there is an inequity .ere, a few days ago, aft.er many months of promises, issued proposed evised regulations under section 862 which were supposed to ease the roblems of excess foreign tax credits of U.S. corporations. We have analyzed these proposed regulations and it is our opinion iat, if it was their intent to ameliorate present harsh rules, they are dismal failure. They do not ameliorate. They merely substitute omplicated rules for simple rules without offering any relief at all. 1his harsh limitation on the utilization of foreign tax credits places I.S. corporations in a position of picking and choosing those foreign ubsidiaries from which dividends will be paid on an annual basis in rder to. avoid the accumulation of unused and unusable foreign tax redits. The solution is a simple amendment to section 904 of the ode providing that only expenses directly related to the production f the foreign income will be allocated against foreign income in de- ~rmirnng the limitation on the foreign tax credits. This avoids omplicated or unnecessary rules proposed by the Treasury. And it rings dollars back t.o the United States. 1093 PAGENO="1104" 208 FOREIGN INVESTORS TAX ACT OF 1966 I have prepared a more detailed statement which I have submitted to the clerk of the conimittee as I do not wish to burden the committee with a lengthy oral presentation. Thank you. I have submitted a more detailed statement. (The document referred to above follows:) STATEMENT OF JOHN .SEATH, VICE PRESIDENT AND DIRECTOR OF TAXES OF INTERNATIONAL TELEPHONE & TELEGRAPH CORP. Mr. Chairman and members of the Committee, my name is John Seath and I am Vice President and Director of Taxes of International Telephone and Tele- graph Corporation. You are holding hearings today on H.R. 13103, the Foreign Investors Tax Act of 1966, which is subtitled "A bill to provide equitable tax treatment for foreign investment in the United States." I am certain that from all the testimony you have heard and will hear on this bill, some doubts will be created whether the bill does, in fact, accomplish this objective. The Treasury Department which strongly supports the bill has repeatedly stated that the bill is part of the President's program to improve the United States balance of payments. I am here to urge consideration by your Committee of an amendment which will, I submit, substantially encourage repatriation by domestic corporations of earnings of foreign subsidiaries and thereby directly improve our balance of payments situation. As your Committee may well know, many U.S. corporations are already in difficulties because they have foreign tax credits currently unusable in part because of the interpretation of the present foreign tax credit pro~~isions of the Internal Revenue Code. Understandably, these corporations are reluctant to withdraw from foreign subsidiaries further dividends which carry with them a high foreign tax liability not currently creditable in full against U.S. tax liability. This potential excess tax liability serves severely to inhibit dividend repatriation, and the U.S. balance of payments situation is thereby adversely affected. I respectfully urge your Committee to consider an amendment to the bill which will eliminate this impediment to the withdrawal of dividends from foreign sub- sidiaries. Not only would such an amendment restore the foreign tax credit limitation to the interpretation followed by the Internal Revenue Service prior to two court decisions some twenty years old, but it would give substantial assist- ance to taxpayers seeking to support the economic policies of the United States. It is believed that any loss in revenue to the Treasury will be far outweighed by the increased flow of foreign earnings to the United States. A basic principle of the foreign tax credit is that a taxpayer is allowed a credit against U.S. tax not to exceed the ratio that its foreign taxable income bears to its entire taxable income, both foreign and domestic. However, an unintended quirk in the interpretation of the tax law cuts down the maximum foreign tax credit allowable by reducing the numerator of the limiting ratio. This results because indirect expenses (expenses not allocable to a specific class of income) must be allocated to dividends received from foreign subsidiaries, even though no portion of the expenses is properly applicable to such dividend income. In spite of our treaty program, this leads to double taxation since the foreign country imposing the tax properly allows no deduction for such expenses. The effect of this rule is not limited to dividend income; it applies to all foreign income, but its most extreme application is against foreign dividend income. As a result, many U.S. corporations, if they wish to rapatriate earnings from their foreign subsidiaries, have to pay an aggregate U.S. and foreign tax liability substantially in excess of the tax paid on the same amount of income by corpora- tions operating entirely in the United States. This can easily be illustrated by the following examples: Assume a domestic corporation realizes gross income of $150 from sources within the United States and $100 from sources without the United States (either foreign royalties of $100 on which $48 of foreign taxes were paid, or dividends of $52 from its foreign subsidiary which amount, after gross-up, is treated as $100 of foreign dividend income since the subsidiary paid $48 of foreign taxes with respect to the dividends). (It shohld be noted here that the gross-up provisions of the 1962 Revenue Act substantially increase the tax distortion caused by the present foreign tax credit computation rules.) Assume, further, that the foreign income was received without any expense and that the domestic corporation 1094 PAGENO="1105" FOREIGN INVESTORS TAX ACT OF 1966 209 has $30 of overhead expenses (concededly not incurred in respect of the foreign royalties or dividends). Under present law, the United States tax (at 48% rate) would be computed as follows: Foreign Domestic Total Income Allocated deductions $100 12 $150 18 $250.0 30. 0 Taxable income U.S. tax before credit ($220 at 48 percent) Amount of foreign taxes ($48 available) creditable after limi- tation (~~x$1o5.6o) U.S. tax after credit Total taxes paid: $48 foreign, plus $63.4 United State& or Total taxes on same amount of U.S. income Excess taxes paid . 88 132 220. 0 - 105. 6 42. 2 63. 4 111.4 105.6 . 5.8 Thus, $250 of gross income from domestic and foreign sources bears a signifi- cantly higher tax than the same amount of income would have borne if entirely from domestiè sources. This problem is further compounded by the effect of foreign withholding taxes on dividends paid to U.S. taxpayers. When such withholding rates are added to already high foreign tax rates, the foreign tax burden in many countries is substantially greater than the U.S. tax burden. The Treasury position on ex- pense allocations substantially increases this burden, with the result that the withdrawal of foreign earnings is discouraged by the high tax cost. Under an amendment which would require that foreign income be reduced only be expenses directly related thereto the U.S. tax would be computed as follows: Foreign Domestic Total Income . Deductions Total - $100 $150 30 $250. 0 30. 0 100 120 220.0 U.S. tax before credit ($220 at 48 percent) Amount of foreign taxes ($48 available) creditable after limita- tion (~~x$1o5. 6) . U.S. tax after credit . Total taxes paid: $48 foreign, plus $57.6 United States or Total taxes on same amount of U.S. Income 105. 6 48. 0 ~__ . ~7. 6 105. 6 105.6 . It is submitted that the latter result reached under the proposed amendment is the proper one. The total tax paid by the U.S. corporation is equal to the tax that would be paid by a domestic corporation with the same amount of taxable income arising from operations solely in the United States. This result is one of equitable tax treatment, the basic objective underlying both the long~standing foreign tax credit provisions of the Internal Revenue Code, the foreign inco~'xe provisions of the Revenue Act of 1962, and the provisions of the billnow befure your Committee. That the present rule is unfair and capricious has even been recognized by the U.S. Treasury Department which has given repeated assurances that new income tax regulations would be issued to correct the admitted inadequacies of the present regulations. On August 2, 1966, the new regulations were issued in proposed form. An analysis of the proposed rules indicates that they in no way to resolve the prob- lems. To the extent that they were intended to alleviate an admittedly unfair situation, they fail completely. The new proposed rules spell out in broad gen- 7 1-297 0-67-pt. 1-70 1095 PAGENO="1106" 210 FOREIGN INVESTORS TAX ACT OF 1966 eral language standards to be used in determining which deductions are to be apportioned to U.S. and foreign income on some form of "reasonable basis" and which deductions are to be apportioned across the board to U.S. and foreign income based on mechanical gross income ratios. But this amplification of lan- guage appears to be a mere gloss on the existing regulations. No ameliorative changes have been made. To the extent that a taxpayer wishes to show that his directly incurred U.S. expenses relate to U.S. income and not to foreign income, there is little in the regulations to aid him. Expenses not directly connected with foreign income are still to be allocated to such income, and the inequities of the existing regulations continue substantially unchanged. In the typical situation where a domestic parent performs services for a for- eign subisdiarey, the proposed regulations tie in to the new Section 482 regulations and state that expenses are to be apportioned to the gross income that the tax- payer gets or should get under the new regulations under § 1.482-2 for perform- ing such services. Under § 1.482-2(b) (3) of the new proposed regulations, the cost of the services is equal to the arm's length charge for such services which must be taken into account by the person rendering the services. Presumably, if the expenses of the services are greater than the amount charged, the taxpayer will have to take into account additional taxable income against which income there will be applied, for foreign source taxable income determination, the expenses incurred. While it is difficult to follow the reasoning involved in the proposed rule re- quiring allocation of expenses incurred by a domestic corporation for its sub- sidiary to some sort of imputed reimbursement received from the subsidiary for the services rendered, two examples given in the proposed regulations indicate the impossibility of applying the proposed rule to the affairs of a large corporation. In Example (1), a domestic corporation is said to have incurred $60,000 of direct selling expenses and $40,000 of indirect expenses (executive salaries, rents, utilities, expenses of staff departments, etc.) on behalf of its foreign subsidiary which amount is reimbursed by the foreign subsidiary which also pays a divi- dend of $90,000. According to Example (1), the $100,000 of expenses is allocated to the $100,000 of reimbursement and none of this $100,000 is allocated to the dividend income. However, whatever reason and sense there may be in Exam- ple (1) is completely nullified by Example (3) which points out that Example (1) does not take into account other significant corporate expenses. Under Exam- pie (3), the president's salary and other indirect expenses related thereto, as well as interest expense on general indebtedness, must be apportioned to foreign income on "some reasonable basis," while expenses for U.S. income tax return preparation and expenses for meetings of the U.S. parent's board of directors and shareholders must be apportioned to foreign income on the basis of gross income ratios. The net effect of all this, it is respectfully submitted, is that the taxpayer has been taken up the hill and down the hill and back to the old rule. The new examples and the confusing complex generalities of language that the new regu- lations contain merely perpetuate the old, admittedly inequitable rule which, at least, had the advantage of simplicity: direct expenses are allocated to items of income to which they directly relate and indirect U.S. expenses are allocated on the basis of gross income ratios to foreign source income. The basic question is whether this old rule is right or wrong, fair or unfair, in limiting available foreign tax credits to U.S. corporations operating abroad. These corporations have maintained that the old rules are unfair, hurt the tax- payer and, indirectly, the United States. And the Treasury Department has, in large measure, stated that it agrees with the taxpayer's complaints. If this be so, it is submitted that the basic rule needs to be changed by legis- lation and not perpetuated by confused, camouflaged regulatory language which, by design or accident, serves merely to perpetuate admitted inequities. Gentlemen, I respectfully urge your consideration of an amendment to the bill to accomplish this objective. Thank you for the opportunity to appear before you. Senator ANDERSON. Senator Carison. Senator CARLSON. Just this, Mr. Chairman. Mr. Seath, you mentioned this proposed revised regulation or these revised regulations under section 862 which were supposed to ease the 1096 PAGENO="1107" FOREIGN INVESTORS TAX ACT OF 1966 211 problems of excess foreign tax credits of U.S. corporations, and then you come down to the point and suggest that we amend section 904 of the code providing- Mr. SEATH. That is right, sir. Senator CARLSON (continuing). That only expenses directly re- lated to the production of. the foreign income will be allocated against foreign income in determining the limitation on the foreign tax credits. Now, that is not, of course, in the pending House bill, but it is your suggestion that we do that as we act on this legislation, is that it? Mr. SEATH. That is right, sir. The point is that if you try to amend section 862 you get into other ramifications of the code because it would hurt in other areas or do damage that should not be done. But section ~i04 is the section that governs the limitation of foreign tax credits and, by simply amending that to provide that only expenses directly allocated, directly related, to the earning of the income should be allocated against the income, then you do not do any damage to any other section of the code. Senator CAiu~soN. It sounds very simple, so I suppose we had better look at it when we get to it. Mr. SEATH. Thank you. Senator ANDERSON. Senator Dirksen. Senator DIRKSEN. Do you make the point that the Internal Revenue Code does discourage the repatriation of foreign income? Mr. SEATH. Very definitely, sir; very definitely, sir. You see, when you have to allocate, for example, the cost of the general headquarters in New York against a dividend from some country, foreign country, in determining the amount of the foreign tax credit allowable, then you have to examine how much dividends you should bring in; so, you would have to balance the tax rate in count.ry A, the tax rate in country B, versus the tax rate in country X, so that you can work out an aver- age tax rate which will permit you to bring in a certain amount of in- come and not allocate so much expense against it that your foreign tax credits are lost. Senator DIRKSEN. How does your proposed amendment operate to obviate that? Mr. SEATH. What I propose, sir, is that we change the section of the code, 904, which governs the limitation on foreign tax credits, to pro- vide that oniy expenses directly related to the production of the for- eign income be allocated against foreign income in setting the limit on foreign tax credits. Senator DIRKSEN. You think that the complicated rules to which you refer also discourage repatriation of foreign income? Mr. SEATH. Well, they do not change what is the present rule. You see, in 1944 the courts decided that you should allocate all expenses against both domestic and foreign income, and ever since then that has been the rule. These new proposed regulation-s of the Treasury that I referred to do not chang~m the rule as far as we can understand them. Senator DIRKSEN. Aside from this, what other provisions are there in the code that make it difficult for income to come back? Mr. SEATH. Well, it is a pretty lengthy thing. The limitation is the primary one. The other thing that is more of a harassment than 1097 PAGENO="1108" 212 FOREIGN INVESTORS TAX ACT OF 1966 anything else, the information sections of the code, in effect, cost the United States money. I file with my returns each year a stack of paper, information on foreign subsidiaries, about that high, which is completely useless. Senator DIRKSEN. You better say how high because the reporter cannot put that gesture down. Mr. SEATH. About a foot to a foot and a half high, which is com- pletely useless. What has happened is, in the Revenue Act of 1962-and I have no brief for evaders of our tax or avoiders of our taxes-we set up a mon- ster in the subpart F section of the code and, in order to try to effec- tuate that monster, they had to get information sections of the code and, as I say, I file a stack of paper about a foot and a half high that is of absolutely no use because our subsidiaries are primarily suppliers of equipment to their' local government. A supplier of equipment to a local government cannot be a tax haven. Senator DIRKSEN. In proportion to foreign earnings that do not come back, it would actually have an adverse, rather than a beneficial, effect on the balance-of-payments problem. Mr. SEATH. Very definitely, sir. One example-I was talking about the balancing of credits-Chile, for example, has a tax rate of 30 percent, but they have a withholding rate of 3 ~`/2 percent. When you put that together that exceeds the U.S. rate. When you also allocate expenses against that income you increase the effective Chilean rate to something way up in the 60- to 70-percent rate against a 48-percent U.S. rate, so it makes it quite a mess. The CHAIRMAN (presiding). What do you think about these Treas- ury regulations on section 482, the allocation of income and deduc- tion on taxpayers? The Treasury has been asking for a long time that they have more time to study the problem you raise about the repatria- tion of some of this money earned overseas. Does that help you with your problem? Mr. SEATH. No, sir: it certainly does not. They are long, they are complicated and, to the best of our study and our ability to analyze them, they have not. done. a thing. All they have done is to create complications, but they have not helped a bit. The CHAIRMAN. You do not find that to be helpful then? Mr. SEATH. Not a bit. The CHAIRMAN. You have said the Internal Revenue Code discour- ages repatriation of foreign earnings. Will you be a little more explicit as to how that works out in your case? Mr. SEATH. Yes, sir. I was starting to speak to that point just a minute ago. I used the example of Chile which has an income tax of 30 percent and a withholding tax of ~ percent. When you put those two together, you have got an effective rate that is pretty high. When you have to ailocate- The CHAIRMAN. It is 67.1/9 if you add them. Mr. SEATH. Straight addition. For a non-gross-up country, which Chile is, that is the way it works out. If it were a gross-up country, it. would not quite work out that way. But. when you have to allocate TJ.S. expenses against that income, `the net income decreases, the tax does not decrease. 1098 PAGENO="1109" FOREIGN INVESTORS TAX ACT OF 1966 213 Therefore, the effective rate of tax goes up again so you wind up with an effective rate of tax up in the seventies. Now, when you bring money in from Chile at this very high rate you are discouraged from bringing it from another country with a high rate because you have to look around all of your subsidiaries to find a low rate, such as Switzerland, which is a low rate, to bring some in from Switzerland to balance them so you do not wind up with excessive credits which you cannot use and probably will never use. The CHAIRMAN. In other words, you have money overseas that you would like to bring in but in one respect or another you cannot earn. enough credits? Mr. SEATH. We have got lots of credits, but their usability is de- stroyed by this allocation of U.S. expenses against the foreign-source income. The CHAIRMAN. I see. Mr. SEATH. This indiscriminate allocation of U.S. expenses against foreign-source income. The O~HAIRMAN. So the way the law is written you have a lot of credits that you cannot use because of the way they make you allocate your costs. Mr. SEATH. That is right. The CHAIRMAN. That being the case, you are just forced to leave the money over there until you are in a position to use those credits because they are worth something to you if you can use them. Mr. SEATH. That is right. The CHAIRMAN. If you bring the money in, and you have to pay the tax on it, you cannot use those credits, what tax do you pay here ? Mr. SEATH. You do not pay any tax when you have excess credits, Senator. The CHAIRMAN. No, I mean when you cannot use them. You have excess credits. Mr. SEATH. That is right. The CHAIRMAN. You cannot use them. Mr. SEATH. That is right. The CHAIRMAN. So you are just sitting around waiting until some day when you can use them. Mr. SEATH. That is correct. The CHAIRMAN. Suppose you went ahead and brought the money in and left the credits behind you. Mr. STEATH. Yes. The CHAIRMAN. What tax would you pay here then? Mr. SEATH. I would not pay any tax here. What I would do is to create a situation if and when these credits expired, and I had a time when I did not have enough credits, I would have to pay a tax that I should not have had to pay. The CHAIRMAN. Well, ~ll I am asking, is why you do not bring the money back. Mr. SEATH. That is exactly the point I was making. The CHAIRMAN. All I want to know is what would happen to you if you did. You are not going to bring it back, I presume, because you would pay a lot of taxes against which you would not get the benefit of your credits. 1099 PAGENO="1110" 214 FOREIGN INVESTORS TAX ACT OF 1966 Mr. SL&~rII. No, that is not quite the point. The point is that if you bring it back you will not pay any tax to the United States now, but you will create a situation where these foreign tax credits will expire, and when they have expired you will be in a situation very possibly where you will have to pay taxes that you would not have to pay if you did not bring the money home. The CHAIRMAN. You mean pay taxes here then? Mr. SEATH. Yes; yes, sir. - The CHAIRMAN. That you would not have to pay if you had not brought the money home. Mr. S~rH. Yes. Senator MCCARTHY. So you do not bring it back. Mr. SEATH. That is right, so we do not bring it back. The CHAIRMAN. What rate of tax would that be that you would pay, that you otherwise would not have to pay if you did not bring the money back? Mr. SEATH. Well, the U.S. rate is 48 percent now. The question- The CHAIRMAN. It is less than that against Chile, is it not? Mr. SEATH. Well, the U.S. rate is 48 percent. Now, Chile, with credits running up to 70 percent, you do not pay anything. Senator MCCARTHY. If you can use the credits. Mr. SEATH. If you can use the credits- Senator MCCARTHY. The point is when you did have to pay, the credits that you might otherwise have used would be canceled, and you would have to pay the regular rate on whatever the difference was. Mr. SEATH. That is right. It depends entirely on timing. The CHAIRMAN. Well, now, are there any other provisions of the code that discourage repatriation, to your knowledge? Mr. SEATH. I do not think there are sections that really discourage repatriation. They are more, as I said to Senator Dirksen, they are harassing sections, but not really discouraging sections.. In other words, we have to file tremendous volumes of information, which costs us a lot of money, and which is useless except for statistical purposes. It does not produce any revenue for the United States. The principal thing, in my opinion, is to put the foreign tax credit situation in a usable st.ate, a useful state, and eliminate some of the uncertainties. We never know exactly what is~ going to happen to us where we have things like these new regulations which are exceed- ingly complicated. There are many revenue agents around the country, and no two of them think . the same way. You give them something t.hat is exceedingly complicated, and you never know where you are going to come out, and that is why I think something simple like this amendment would do the job. The CHAIRMAN. Senator Anderson. Senator ANDERSON. I was just curious as to why you appear. here on this hearing; what do you want us to do with the bill? Mr. SEATH. I think you ought to amend the bill for what I was talking about here, and I also think you ought to put t.he bill back in the original shape the Treasury proposed it. In other words, you ought to be going back to the original proposal of the Treasury which would encourage foreign investment in the United States. 1100 PAGENO="1111" FOREIGN INVESTORS TAX ACT OF 1966 215 Senator ANDERSON. Specifically, which section then would you change? Mr. SEATH. For one, I would eliminate this "effectively connected" language completely from the bill. The "effectively connected" is a new concept. It is, again, indefinite; it is a subjective test, it is not an objective test; and when you put language like "effectively con- nected" into the hands of the many revenue agents there are around the country, you are going to get almost as many interpretations of the words "effectively connected" as there are revenue agents. Senator ANDERSON. Well, on a matter of this nature, wouldn't it be much better around the country if it all came into one place? Mr. SEATH. Around the country, it would be all over the country, sir. All these provisions in this bill will ultimately be in the hands of the thousands of revenue agents around the country who audit tax- payers' returns, and it is their job to apply that language. Senator ANDERSON. But they have to concern themselves with only one type income, do they not, which is foreign income? Mr. SEATH. Yes, sir. They examine all different kinds of tax returns. They just do not limit themselves to one type of income. Senator ANDERSON. I am trying to think what the average agent would do with your tax account. Mr. SEATH. Pardon me, sir? Senator ANDERSON. I am wondering what the average agent would do with your tax account that would not get them involved in my State or his State? What are you worried about? Mr. SEATH. That is right. We get an agent; one agent will take one position, and another agent will take another position. The court case in 1944 which changed the interpretation of the Internal Revenue Service which it had put in the rules for `many, many years prior to that time was the thought of one revenue agent. It was not a thought of the Internal Revenue Service, but he bulled it through, and it became the law of the land, and even today, sir, this allocation of expenses against foreign source income is not uniformly applied. There are many corporations today which have foreign-source income, and when they are determining the utilization of the foreign tax credits under limitation they do not allocate U.S. expenses against the foreign-source income because it is an abstruse provision of the code and not a well understood one. The- CHAIRMAN. Senator McCarthy. Senator MCCARTHY. I have no questions. The CHAIRMAN. Senator Morton. Senator MORTON. Sir, I think it is clear that the Treasury Depart- ment wants to recapture as much foreign earnings as we can for rea- sons of balance of payments. Mr. SEATH. Right. Senator MORTON. And your point is that their regulation today fails to recapture as much? Mr. SEATH. They fail to encourage it. Senator MORTON. Encourage the recapture. Mr. SEATH. That is right; that is right. Senator MORTON. Do you think that it would require an amendment to this bill to see that we recapture or encourage to recapture these foreign earnings? Has your experience been with regulation that 1101 PAGENO="1112" 216 FOREIGN INVESTORS TAX ACT OF 1966 you are not getting it and that now you need positive legislation from the Congress? Mr. SEATH. That is my experience, sir; yes, sir. I think we very definitely need, as I stated-we have been promised by the Treasury that they would amend their regulations to give the help we need. Now, we have seen the proposed regulations and they just abso- lutely do not do anything. They just substitute complicated rules to say the same thing `as the old simple rules say. It is just another way of saying "No." The only way we are going to get what we need is by legislation. Senator MORTON. It strikes me this is one of the most serious prob- lems that we face today, this question of balance of payments and if, indeed, and I know you are knowledgeable on this subject, if indeed, by regulation we are discouraging the recapture of funds earned abroad, which is bound to help our balance of payments, it seems to me if we could capture them, if we `indeed `are discouraging them, perhaps this committee should take some action along the lines of your proposal. Mr. SEAm. Well, that is my position. I think we are discouraging the repatriation of foreign earnings by this present situation. I think if we changed the law to this extent it will definitely encourage the repatriation of foreign earnings. I have talked with a number of taxpayers around the country, and I think the sentiment is unanimous that such a change would en- courage additional repatriation of foreign earnings. Senator MORTON. I do not like to ask you to speak for others, but is the position which you have taken today supported by other in- dustries and businesses that are in your situation? Mr. SEATH. Yes, sir; that is very definitely true. Senator MORTON. I apologize for not being here during your direct testimony. It is understandable that sometimes constituent problems in `a State like mine, politically balanced as it is, take a little bit of my time. Mr. SEAm. I believe that, sir. Senator MORTON. I have read it, and I commend you for it, and I think you have made a significant point t.hat this committee certainly should consider because here we are worried today about this balance- of-payments thing more than anything else, and you say, and you speak with authority and knowledge on this subject, that the regula- tioñs of our own Treasury Department are discouraging the recapture of these earnings. Mr. SEATH. That is correct, sir. Senator MORTON. I trust and hope, and I know the committee will take this very seriously, consider it very seriously. I thank you. Mr. SEATH. Thank you. Senator CARLSON. Mr. Chairman, I have a suggestion. Mr. Seath has mentioned we should amend section 904. I would appreciate very much if-this is somewhat of a technical amendment that someone will probably work with-if he would come up with a suggested amend- ment, at least let us look at it. Mr. SEATH. All right, sir; I will do that. Senator OARLSON. I, for one, would like to see it. Mr. SEATH. I will get it up here as quickly as I can. 1102 PAGENO="1113" FOREIGN INVESTORS TAX ACT OF 1066 217 (The suggested amendment referred to, follows:) PEoPosn~ AMENDMENT SECTION -. LIMITATION ON FOREIGN TAX CREDIT Effective with respect to taxable years ending after December 31, 1965, sub- section (c) of section 904 (relating to limitation on foreign tax credit) is amended to read as follows: `(c) Ta~vable income for purposes of computing limitations.-For purposes of computing the applicable limitation under subsection (a)- "(1) In generai.-The taxable income from sources within a foreign country or possession of the United States or from sources without the United States shall be computed under section 862(b), except that no expenses, losses, or other deductions shall be deducted from gross income from such sources unless such expenses, losses, or other deductions can directly be allocated to some item or class of such gross income, and "(2) Perscmal e~vemptions.-The taxable income in the case of an individual, estate, or trust shall be computed without any deduction for personal exemptions under section 151 or 642(b)." The CHAIRMAN. Mr. Seath, the best I can say is you have a good argument. It is not your fault. that the law is so complicated. We made it that way, with an assist of the Treasury Department. . If we can understand it enough to see just precisely what we are doing, I think there is a prospect that we might really give you some relief. Mr. SEATH. Thank you, sir. The CHAIRMAN. The next witness is Mr. Gordon Henderson, New York State Bar Association Tax Section. STATEMENT OP GORDON D. HENDERSON, COMMITTEE ON INTER- NATIONAL TAXATION, NEW YORK STATE BAR ASSOCIATION TAX SECTION Mr. HENDERSON. Mr. Chairman and members of the committee, my name is Gordon Henderson. I am a partner in the law firm of Root, Barrett, Cohen, Knapp & Smith in New York City. I am appearing before you today on behalf of t.he Committee on In- ternational Taxation of the New York State Bar Association Tax Section. Mr. David Simon, chairman of the committee, had planned to be here to testify before you today. He is presently in the West, how- ever, and because of the airline strike has been unable to get here. The CHAIRMAN. What, I ask, is the matter with railroads? I used to be able to get on a train in New York and get down here in 4 or 41/2 hours. Mr. HENDERSON. As I say, Senator, he is out in the West, and he lS about a 3-day train ride away. The CHAIRMAN. I see. He is out in the West. I did not under- stand it. Mr.-HENDERSON. So I am here today to testify in his place. The CHAIRMAN. Senator Anderson says that a 3-day train ride sounds like it must be somewhere out on the ocean. Mr. HENDERSON. It is out West. - Senator ANDERSON. The westerners on the committee know you can get to the committee in less than 3 days if you have good luck. 1103 PAGENO="1114" 218 FOREIGN INVESTORS TAX ACT OF 1966 Mr. HENDERSON. On the train? Senator ANDERSON. Yes. Mr. HENDERSON. Gentleman, the Committee on International Tax- ation has focused its attention on that portion of H.R. 13103 which ex- tends the Federal income tax t.o certain foreign source income of foreign corporations having offices in the United States. On August 2, the chairman of the tax section forwarded ~o you a detailed report of our committee on this aspect of H.R. 13103. That is the report I am holding here in my hand, copies of which you have all received. I shall today only briefly comment on some of the major overall issues raised in that report, but I would like to request that the complete report be included in the printed record of these hearings. The CHAIRMAN. Well, that is kind of hard to do. You are bring- ing us something that I am sure is a well-thought-out document. But it is-I'm just trying to find where you quit numbering these pages- you get up to 108 pages and then you start numbering all over again. [Laughter.] As I understand it, you have 19 more pages. Senator MCCARTHY. They have some in Roman numerals in the * beginning. The CHAIRMAN. Couldn't you just make a number of extra copies available to the committee so there would be copies for those who wanted to read it? It seems to me this would be a lot easier reading if we can keep it with our files. You know, most Senators get to where their eyesight is not too good after they reach a certain age, and your print is a lot superior to what we would get if it, were put into the printed hearings. There is a lot more white space to look at now than if we put it in the printed record. I would suggest that we print your summary, which is about 9 pages, and then those who wanted to read this 125-some-odd-page brief, could get the rest of it from the committee files. We will have it here for them. Mr. HENDERSON. That would be fine. The CHAIRMAN. I am sure it provides a lot of fine information. Mr. HENDERSON. All I can say is it took a great deal of work to prepare. The CHAIRMAN. We might be able to find a few members of this committee who can take time to do it justice. I myself intend to take the report home and read it, for it does look very impressive and worth while. Mr. HENDERSON. I hope I can provide just a brief summary of some of the highlights of it here. The `CHAIRMAN. Right. Mr. HENDERSON. Then members of the committee and the staff can go into the portions of it that they wish to study further. The CHAIRMAN. We will print the summary of it, and for those Senators who would like to read the rest of it, we will make it avail- able to them. I am sure a lot would rather sit down and read your printing of the report than to look at it in the committee record, be- cause t;he size of the type in the committee record makes for awfully tough reading. 1104 PAGENO="1115" FOREIGN INVESTORS TAX ACT OF 1966 219 (The summary referred to above follows:) [From the report "Analysis of Proposed U.S. Taxation of Foreign-Source Income of Foreign Corporations" by the Committee on International Taxation of the New York State Bar ~Association Tax Section] SUMMARY OF REPORT AND MAJoR RECOMMENDATIONS The principal features of our Committe~'s Report are presented below in capsulated form. A. INTRODUCTION Under existing law, foreign business corporations are taxable by the United States only on income from U.S. sources. Relatively objective tests have evolved for determining the "source" of specific categories of income (see pp. 2-3). The Bill would also tax three categories of foreign~source income: (1) rents or royalties for the use abroad of patents, copyrights and other intangibles; (2) certain banking and financing income received from foreign issuers and obligors; and (3) income from certain sales of goods, title to which passed out- side the United States. The test in each case it whether the particular item of foreign-source income was "attributable" to a U.S. office. However, in the case of non-import sales of goods, no U.S. tax would be imposed if a foreign office "par- ticipated materially in such sale". No additional revenue is expected to result from the proposed tax on foreign- source income. B. POLICY QUESTIONS PRESENTED The Report of the House Ways and Means Committee* gives two policy reasons for the proposed tax on foreign-source income: (1) to prevent the United States from being used as a "tax haven" by foreign corporations which avoid both all U.S. tax and most foreign tax, and (2) to impose a U.S. tax on "income generated from U.S. business activities". Our analysis of the Bill in relation to these policy objectives raises doubts as to whether they have been consistently applied in the Bill in the form enacted by the House on June 15, 1966. In particular, there are no exceptions in the Bill to assure that its application would be limited solely to those foreign corporations which are substantially availed of to reduce foreign taxes. Our Committee be- lieves that consistency with the Bill's "tax haven" theory would require pro- visions equivalent to various exceptions contained in Subpart F (see pp. 13-14). The Bill also fails to implement in consistent fashion its theory that, for tax purposes, income is "generated" by office activities. If the theory is valid, it would seem to require changing the sourc&of-income rules to treat as foreign- source income the portion which is "generated" by foreign office activities. The Bill does not do this, and our Committee urges that further consideration be given this question (see pp. 14-17, 65-6). There is also a question as to whether, under the Bill, the income taxed by the United States would be limited to the portion fairly allocable to the services ren- dered by the U.S. office. Our Committee recommends `that for this purpose the equivalent of a Section 482 type of allocation be employed, in order to allocate to the U.S. office an amount equal to the fee or commission for the services ren- dered in the United States which it would have earned at arm's length if it had been a separate entity (see pp. 18, 55-7,61, 65,84-5). Serious policy questions are also raised by conflicting U.S. income tax treaties with eighteen countries, which would bar the proposed tax on foreign-source income (see pp. 19-20). Treaties with other countries would allow the tax, but only if a Section 482 type of allocation was employed to determine the amount of income subject to the tax (see pp. 20, 57-9). Our Committee recommends further study of these treaty problems in order to assure that the proposed new tax would not operate in a disparate manner among different countries (see pp. 21, 63). C. PRACTICAL PROBLEMS Of special importance are the difficult problems of proof raised by the Bill (see pp. 22-8, 49-51, 73-4, 77). Tracing the "activities" of offices in the United States and abroad could be interpreted to require detailed records of negotiations and *~H. Rep. No. 1450, 89 Cong.. 2d Sess. (April 26, 1966). 1105 PAGENO="1116" 220 FOREIGN INVESTORS TAX ACT OF 1966 other matters not ordinarily reflected in branch books. Under that interpreta- tion, it would seem necessary for foreign corporations to maintain records of office "activities" for each separate transaction of sale, lease, license, loan, etc., or run the risk of being taxed on worldwide income in these categories. This novel record keeping could prove exceedingly burdensome for such corporations, even though little or no tax is involved. Another difficulty is the problem of double taxation, which arises from the fact that the foreign-source income proposed to be subjected to U.S. taxation would often be taxed by the country of source or by the country of incorporation. The Bill would limit the type of foreign tax for which a tax credit, or a deduction, would be permitted. Our Committee recommends that this limit on use of the credit be removed (see pp. 86-9). The creation of these practical problems and burdens might compel foreign corporations either to alter, or eliminate, their present office arrangements in the United States (see pp. 30-3). Our Committee questions whether this is the intended result and, if so, whether it has real policy advantages for the United States. D. SALE OF GOODS This important category is considered first in regard to foreign-to-foreign sales (pp. 35-43) and next in regard to export and import sales (pp. 43-66). In the case of foreign-to-foreign sales, the Bill is not clear as to whether the proposed new tax is intended to apply where a foreign office or other foreign fixed place of business has "participated materially" either by producing the goods abroad or by performing abroad other substantial economic activities essential to the foreign-to-foreign sale. Our Committee recommends that in both instances the Bill be clarified to confirm that there would be no U.S. tax, since the economic "center of gravity" is located abroad. (A suggested draft amendment is set forth at pages 42-3.) In the case of export and import sales, the proposals in the Bill would interlace in complex fashion with existing law (see the Tables at pp. 45-6). Our Com- mittee recognizes that any recommendations in this area must be premised on the larger policies which Congress seeks to pursue in regard to U.S. export and im- port trade. Should such trade be burdened by new taxes and, if so, to what extent? Does uniform application of the new rules require that their enactment be deferred until conflicting tax treaties have been revised? Assuming that immediate enactment is considered advisable, however, our Committee strongly urges a number of major changes to mitigate difficult prob- lems of proof, avoid serious inequities and anomalies, and simplify administra- tion. These recommendations are set forth in detail at pages 64-66. E. BANKING AND FINANCE INCOME Foreign banks perform important functions in the United States, utilizing branches, agencies, representatives and correspondents (see pp. 68-70). The pro- posed tax on banking and financing income "attributable" to a U.S. office is ambiguous in its application to foreign banking operations in the United States. As a result of the close intertwining of foreign and U.S. banking arrangements, the Bill may deter foreign banking activities that are essential to our domestic economy (see pp. 71-7). It also raises problems as to foreign banks held by domestic Edge Act subsidiaries of domestic banks (see pp. 77-9). Our Committee believes that the proposed new rules have not received adequate study and should not be enacted in their present form. If they are to be enacted, our Committee urges that an exception be made where a foreign banking office materially participated in the transaction; suggestions are also made for simpli- fying the determination as to such material participation by a foreign office (see pp. 79-80). F. ROYALTIES FROM PATENTS AND OTHER INTANGIBLES It appears that the proposed tax would turn on whether negotiation Of the license took place in the United States, with no allocation for the economic values represented by the development, acquisition, ownership and management of the licensed property (see pp. 82, 84). In our Committee's view this rule-if we understand it correctly-would produce unwarranted economic results because it would allocate to the United States far more royalty income than was actually "generated" here. Our Committee believes that in no event should the U.S. tax consequences of a business transaction performed by a U.S. branch of a foreign 1106 PAGENO="1117" FOREIGN INVESTORS TAX ACT OF 1966 221 corporation be more onerous than would be the case if such U.S. branch were separately incorporated. Accordingly our Committee recommends here-as elsewhere-that a Section 482 method of allocation be used to determine the fee or commission that would have been paid at arm's length for the services rendered by the branch if it were a separate entity (see p. 84). This would avoid an inconsistency with many existing treaty obligations which require that this method of allocation be followed (see p. 85). G. FOREIGN TAX CREDIT With respect to the foreign tax credit, our Committee makes a number of technical suggestions intended to minimize the risk of double taxation inherent in the Bill as presently framed (see pp. 86-94). H. PROPOSED LIBERALIzATION OF SECTION 904 (f) The Bill proposes some liberalization, subject to narrow restrictions, with respect to the present limitation on foreign tax credit treatment of interest income from foreign sources. Our Committee urges that further liberalization is needed in order to prevent arbitrary treatment of interest income derived by domestic corporations from indirect as well as direct investments in foreign corporations (see pp. 95-103). I. RETROACTIVE APPLICATION OF PROPOSED "U.S. OFFICE" TEST Our Committee recommends that if the proposed "U~S. office" test is to be adopted, the Bill should be amended to make it clear that no tax would be imposed by reason of any U.S. office "activities" occurring prior to the Bill's effective date, January 1, 1967. Mr. HENDERSON. Our committee focused on this one aspect of the bill because we felt it presented particularly serious problems which the Congress should èonsider, but which did not appear previously to have been analyzed in depth. One of the reasons for the previous lack of analysis would appear to be a widespread unawareness of the existence of these provisions in the bill. I might tidd that it is the experience of our committee members that even today few in the business community and even few tax lawyers appear to be aware of the existence of these provisions. They know that H.R. 13103 is intended to carry out the Fowler task force recom- mendations of liberalizing and simplifying the tax treatment of for- eign investors, particularly individuals, but they have not examined the bill with care and have not become aware that it contains these complex provisions which would add a new tax on certain foreign business activities in the United States. These new provisions would impose a tax on three categories of foreign-source income deemed "effectively connected" with the U.S. office of foreign taxpayers. The policy reasons given for these provisions in the House report are, first, to prevent the United States from being used as a "tax haven" and, second, to impose a U.S. tax on income "generated" from U.S. business activities. As explained in detail in our report, the new tax would apply, how- ever, even where no tax haven situation is involved. Nor does the bill apply in a consistent or equitable fashion its theory that the described income should be taxed where it is "generated." For example, the bill would subject, to U.S. tax, income it considers "generated" by U.S. office activities-but would not allow taxpayers to exclude from U.S. tax, or even to claim a foreign tax credit for, income similarly "gen- erated" by a foreign office. 1107 PAGENO="1118" 222 FOREIGN INVESTORS TAX ACT OF 1966 There is also a serious question whether the inc~me taxed by the United States under this new provision would, under the bill, be limited to the portion fairly allocable to the services performed in the U.S. office. Indeed, unless a section 482 type of allocation formula were added to the provision, this aspect of the provision might simply become a trap for t.he unwary, `and for the small taxpayer, since it could perhaps be avoided in many cases by the formation of a separate subsidiary to conduct the activities of the U.S. office. Serious policy questions are also presented by the fact that the new provision is in direct conflict with most of the present U.S. tax treaties with foreign countries. The new tax would be prohibited by 18 per- cent or proposed treaties, and treaties with 8 other countries would prohibit the new tax unless a section 482 type allocation formula were employed to determine the tax. This conflict with our tax treaties is nowhere mentioned in the House report. Since most of our treaties are with developed countries, the effect of this conflict would be to cause the new tax to apply primarily to taxpayers from the less-developed countries-unless and until the existing treaties were amended. You had a concrete example of this pointed out to you earlier this morning by Mr. Kalish when he talked about the problems of banks in Puerto Rico. An important policy question is, therefore, presented whether the Congress should adopt a provision which would apply in such a dis- criminatory fashion and against less-developed countries. So far as we are aware, however, this policy question has not yet been examined. Of particular importance are the very great recordkeeping and compliance `burdens which the new provision would place on taxpayers. First, the provision contains many vague terms which would present difficult interpretative problems in applying them to concrete business situations. In addition, taxpayers would have to keep complicated and exten- sive records, records which are not presently necessary for business reasons, in order to comply with the new provision. I might point out for your consideration that this recordkeeping and compliance aspect is described in concrete detail with factual examples on pages 22 to 28 of our report, and I think that portion `you might find par- ticularly interesting to read. Senator ANm~soN. Senator McCarthy just pointed out to me the items on pages 26 and 27, one, two, three, four, up to eight, and two, three, five, two, three, six, eight and on down. Can you explain that to us? Mr. HENDERSON. That is the example that I was referring to, Sen- ator; yes, indeed. Senator ANDERSON. What does it mean in connection with this bill? Mr. HENDERSON. It means in connection with this bill that any for- eign taxpayer who would have to determine whether a U.S. tax would apply to his foreign-source income effectively connected with his U.S. office would have to keep a whole new set of records in order to permit his counsel and his accountants and auditors to determine what portion of his income was taxable under this new bill. It means enormous 1108 PAGENO="1119" FOREIGN INVESTORS TAX ACT OF 1966 223 recordkeeping problems for taxpayers, enormous new complications which are not now present. We have tried to illustrate this by this concrete example. It shows, when sales of goods are made and a U.S. office may be involved, that under the present system of the tax code there are only two code numbers you would have to put on an invoice. One is for "Did the title pass in the United States?" Two is for the reverse, "Did title pass abroad?" But under this new bill you would have to code eight different factors on your invoices, most of which involve very difficult ques- tions of judgment. These are the eight factors listed on page 26. Some clerk would have to make a determination as to which of the,se factors applied to the particular sale, and that is a very difficult prob- lem. The CHAIRMAN. In the absence of a computer it would take almost forever to do that, would it not? In other words, you have to decide, one, did title pass in the United States, and you mark that down. Then, two, did the title pass abroad? Well, if title passed here, it did not pass there, so let us say you are under No. 1 on that. No. 3 is the trade attributable to the U.S. office. Mr. HENDERSON. Senator, I would like to stop you there because I would like you to think of the practical problem of instructing a clerk in an office how to decide whether the sale was "attributable" to a U.S. office. I am afraid we lawyers could write reams of memorandums and documents trying to interpret what the word "attributable" means and there would be just an enormous problem of properly communicating this to a clerk who is going to have to apply it. He is going to have to decide what is attributable. The CHAIRMAN. So, as a practical proposition, if you had to hire a lawyer and pay lawyer's wages to make all these judgments, it would not be worth making a sale to begin with. Now, if you are going to hire a clerk to do it, it is almost impossible to train a person working at clerk's wages to understand all of this well enough to make these decisions, I would take it. Mr. HENDERSON. That is right, Senator. This imposes a real prob- lem for taxpayers and their counsel and auditors because auditors and lawyers are going to insist that the clients have well-trained people who can handle this determination because tax returns have to be prepared and they have to be prepared properly. The CHAIRMAN. You mean this bill we have before us would require all these decisions? Mr. HENDERSON. Yes, sir; that portion of the bill which would tax "effectively connected" foreign-source income; that is the provision we are talking about. The CHAIRMAN. "Effectively connected foreign-source income." Mr. HENDERSON. Foreign-source income. The CHAIRMAN. All right. Now, would you mind showing me how a clerk would do these requirements under pages 26 and 27; how you would go about making up, arriving at these decisions? I just want to understand what you have to do in order to comply with it so I can decide on that section. Mr. HENDERSON. Yes, sir. Well, let me start with an example. 1109 PAGENO="1120" 224 FOREIGN INVESTORS TAX ACT OF 1966 The CHAIRMAN. First, you have to decide whether the title passed in the United States, I take it? Mr. HENDERSON. That is normally a very simple question of prop- erty law. Taxpayers do that now, and one of the great attributes of that provision is that it is simple. You can understand it. The CHAIRMAN. That one is. So title passed abroad, you can decide whether it passed that way, 1 or 2. Mr. HENDERSON. 1 or 2 is very simple. The CHAIRMAN. How about the next one? Mr. HENDERSON. The clerk would have to decide whether the sale was "attributable" to the U.S. office. To know that, you cannot nor- mally tell it from a piece of paper. He would have to talk to the officer of the company or the salesman, whoever had made the sale, and ask him how the sale was made, where did the property come from, how did it arise, where did it go, who in the organization worked on the sale, did someone from the U.S. office work on the sale. If someone from the U.S. office worked on the sale, what did he do with respect to the sale; did he simply send the paper record of the sale on Hong Kong to Great Britain after it had stopped here in the mail or did he talk to a customer who passed through the United States? Just what did he do? What were his activities? After he finds out these facts, which we lawyers know are not al- ways easy to assemble completely, he would then- The CHAIRMAN. That is the kind of a thing that causes a salesman in an ordinary retail store to fall out with the boss and two salesmen to fall out with each other. If you go into a store, are waited on by one salesmen and then the regular salesman gets into the act, and you finally buy a necktie, and you wind up with the question of who is en- titled to the commission for making that sale. Mr. HENDERSON. Yes, sir. The CHAIRMAN. Oftentimes it is left in dispute among the people as to who is responsible for the sale or maybe the manager comes up and gives you a discount or the question comes up of what part did each person play in making that, sale. That is one which is very diffi- cult to decide. Mr. HENDERSON. That is right. I would like to point out, Senator, that this problem would apply even to foreign-to-foreign sales. In other words, take, for example, a Philippine corporation making sales into Canada and also into the United States, which has an office, let us say, in Seattle in which there is a salesman. Let us take a sale made from the Philippines to Canada shipped di- rectly by ship from the Philippines to `Canada. The clerk would have to find out whether the salesman in the U.S. office had anything to do with that foreign-to-foreign sale. If he did there would then have to be a value judgment as to whether his activity made the sale "attribut- able" to the United States and subject it to this new U.S. tax. *That is the practical problem on that. The CHAIRMAN. All right. Let us take the next one, item 5, des- tination United States. I guess that is easy enough to determine. Mr. HENDERSON. Well, there is a question under the bill of what the test "destination" means. We have used that word "destination" here to simplify it, but the question under this bill would be whether the 1110 PAGENO="1121" FOREIGN INVESTORS TAX ACT OF 1966 225 product was coming into the United States to rest here, to be consumed here, to be used here, and, you know, there are problems today under subpart F of determining whether goods are received for consump- tion in a particular country or whether they may be reshipped and resold out of the country. That is a problem under items 5 and 6. The CHAIRMAN. Destination abroad, then, would be in there. Now, No.7, material participation by office abroad. Mr. HENDERSON. The problem with that factor is, Senator, that un- der the bill it is unclear whether participation by the office abroad in anything but a salesman's sense is important. For example, assume you manufacture goods in the Philippines and your only salesman is in the Seattle office. He handles all sales to Canada as well as to the United States. Since there is no salesman in the Philippines, there is a question under the bill whether the manufacturing activity in the Philippines is deemed a "material" participation in the "sale," which would exempt a Philippines-to-Canada sale from U.S. tax. That is the first question of interpretation, and it is a very serious ouestion. I think that the view of the Treasury may be that only the sales activity is the important activity; that manufacturing activity or substantial trading activity in the foreign country will not be deemed a material participation in the "sale." So the first question about the material participation in the sale factor that would have to be determined by regulations or by the statute is what the statute means by the word "sale." Let us assume the statute means that oniy a sales activity is a ma- terial activity abroad. If that is what it means then our clerk would have to decide, if we now add to our example a salesman in the Philippines office, whether the activity by the salesman in the Philip- pines office as opposed to the activity of the salesman in the U.S. office in Seattle was a material aspect in the sale. I think you can understand that this is not a very simple question to decide. We can easily state the general phraseology, but if you put yourself in the lawyer's position or the clerk's position you have to make the decision of what, in fact, is "material." Senator MCCARTHY. You are talking i~ow about something that was manufactured primarily in the United States? Mr. HENDERSON. Outside the United States. But there are also problems where you have trading rather than manufacturing corpora- tions abroad. For example, take the case of a corporation located abroad which does not manufacture abroad but which provides designs and so .forth to subcontractors there which manufacture goods for it. It buys the goods with title passing abroad, say in the Philippines or any other country you want to name, and then sells those goods to another foreign country or, in part, to the United States, and it has an office here. In the case of sales to a foreign country~ you would have the question of what is material participation. Is it only sales activity, as mentioned before, or can it include other activities? Whether or not it includes other activities, what is material? Do you gage this by a time factor? By a salary factor? By a property factor? What is the factor or factors that determines whether it is material? It is simply not an easy question to decide. To get clerks to make these decisions is not going to be very easy. 71-297 0-67-pt. 1-71 1111 PAGENO="1122" 226 FOREIGN INVESTORS TAX ACT OF 1966 Senator MCCARTHY. Do you know where this amendment came from? Has it been around in academic circles or have lawyers beéii using it in international tax problems for some time? Mr. HENDERSON. I do not know, Senator, what the origin was. Senator MCCARTHY. Are there courses in international taxation ui Harvard which have `been given through the years, do you know? Mr. HENDERSON. This provision, has it been considered? Senator MCCARTHY. This proposition of money earned in inter- national trade-did it come to you as a complete surprise when it was put into the House bill? Mr. HENDERSON. This particular language and particular provision' is new, but down through the years there has been discussion at the tax bar and Treasury staff and Congress staff and elsewhere about the source-of-income rules-which are the present rules in our code which determine what income is taxable here and what income is not taxable here-and people have various ideas and have had through the years about whether there ought to be amendments to the source- of-income rules. The American Law Institute, when the 1954 code was being adopted, as we mention in an appendix here to our report, gave some consider- ation to possibly changing our source-of-income rules, and they finail: decided after 2 years of study of the problems involved that they would not recommend any change in them. The source-of-income rules have been in the code, I think, sine 1917. This provision which is in here dealing with "effectively connected' focign-source income properly sshould be considered as an amendmen to the source rules. The CHAIRMAN. May I just say this to you, sir? My impression i that there is no greater economic waste and no greater waste of gooi brainpower in this country than the unnecessary complexity of Amer ican tax laws. I suppose we probably sop up more of America' brains with needless complications in these tax laws than with any thing else. For what we gain in income on taxation of foreign in come, the fantastic amounts of executive, legal, accountant, and den `cal talent that we put to work on it, is probably a prime example o economic waste. Think of all the fantastic amount of brainpower it takes to won all these kinds of things out when there must be some simple way t do it. Mr. HENDERSON. I have always thought, Senator, when the Treas ury makes computations of the collection costs of tax moneys, am determines what the percentage of the collection costs is to tax money received, that we really ought to add the private taxpayers' expense in getting tax advice and handling the paperwork involved, `befor we really know what the effective cost of tax collection is. This partic ular provision `here would cause an enormous amount of additiona complexity. But it would not produce additional revenue. Senator ANDERSON. And would we not have a lot of lawyers unem- ployed if we simplified the code? Mr. HENDERSON. Well, I suppose they would have less to do, Sena tor; that is right. But it would nonetheless have a good effect on th economy if we simplified it. 1112 PAGENO="1123" FOREIGN INVESTORS TAX ACT OF 1966 227 The CHAIRMAN. Some of them might be capable of being air space mechanics or something like that, areas of employment where there is & shortage. Mr. HENDERSON. That is right. Senator ANDERSON. Well, you, for example, are worried about the word "attributable." Mr. HENDERSON. Yes, sir. Senator ANDERSON. Is "attributable" in the code of taxes anywhere else? Mr. HENDERSON. It may be, Senator. I cannot remember. Senator ANDERSON. Has it caused any crisis? Mr. HENDERSON. Well, every time you have a word that is vague dealing with allocations- Senator ANDERSON. You think "attributable" is vague? Mr. HENDERSON. Yes, sir; absolutely. Senator ANDERSON. Then you said. "destination" was vague. Mr. HENDERSON. Well, "destination" in the concept used in the bill; yes, sir. Senator ANDERSON. You do not think they would know where they would ship everything? Mr. HENDERSON. Everybody knows where goods start to be shipped. The next question is what does the consignee of the goods intend. Does he intend to use them in that country, or is he going to take them and sell them out of the country? Senator ANDERSON. Have you ever had a problem arise on the que&. tion of destination in the filing of an income tax return? Mr. HENDERSON. Personally I have not dealt with the destination problem but I have dealt with allocation problems. Senator ANDERSON. Do you know of a lawyer who has dealt with the destination problem? Mr. HENDERSON. I cannot specifically name a lawyer, but I am sure here have been. There are problems under subpart F, if you read the regulations, which deal with destination. It is a concept which is very difficult as a concept to work out. When you ship an automo- )ile, for example, to Seattle from Germany, is it clear that the auto- mobile is going to be used in the United States or is it possible that it might be traded off-before it is `sold for retail-to a Canadian lealer in British Columbia. Senator ANDERSON. Most people who have enough money to send an Lutomobile from Germany to Seattle will know where to use it. Mr. HENDERSON. I am sorry, I did not hear that. Senator ANDERSON. I say most people who have enough money to have a car shipped from Germany to Seattle would know where it is ~oing to be used. Mr. HENDERSON. But the shipper may not know it. Let us take the ~ase of the German distributor who ships from Germany to Seattle. If he were to carry through the destination for use in U.S. concept, he would at least have to ask the dealer in Seattle whether the car was to `be sold at retail in Seattle or sold at wholesale to a Canadian dealer before he could determine whether or not he would owe U.S. tax on that car. Senator ANDERSON. How would a Canadian dealer be able to deter- mine what would be the shipment from Seattle? 1113 PAGENO="1124" 228 FOREIGN INVESTORS TAX ACT OF 1966 Mr. HENDERSON. There are many cases where goods come from abroad and are temporarily stored in the United States and then shipped abroad. These kinds of problems come up and there are many litigated cases involving this problem in connection with import taxes and State taxes, and this happens quite frequently. Senator ANDERSON. I have listened to many hearings where enor- mous problems are outlined, and then somehow the bill would get passed and not a thing would happen. Mr. HENDERSON. I do not know that this would be true of this provision. Senator ANDERSON. You think this might be subject to some con- fusion? Mr. HENDERSON. Yes, sir. These pages 22 to 28 we have just been talking about are one example. The CHAIRMAN. I would just instruct the clerk to insert in the record, starting at subsection (c) on page 25 in this presentation through the middle of page 28. I think that illustrates the problem. (The section referred to follows:) (c) EXAMPLE OF RECORDKEEPING DIFFICULTIES As a hypothetical example, take the ease of a Spanish corporation which pur-. chases sherry from Spanish vintners through an office in Spain, and sells it to customers throughout the world. Some orders are solicited `and accepted by the Spanish headquarters office. Others are solicited by branch offices in major cities throughout the world, forwarded to Spain, and accepted or rejected there. Shipment is made_either from Spain or from warehouse stocks in other coun- tries. The New York branch office solicits orders in the eastern half of the United States, Canada and Mexico, but certain large accounts deal directly with the office in Spain. The consequence of this operation under existing law would be the taxation of the net profits of those sales in which title passed in the United States. Rec- ord keeping would involve coding invoices with the numbers 1 or 2 to designate whether title passed in the United States or abroad. Under H.R. 13103, it would be necessary to use a coding system that would reflect much more information. Perhaps the simplest system would involve coding each invoice with a four digit number, such as 1357, 2368, or 2457, which would convey the following information: 1-Title passage in United States. 2-Title passage abroad. 3-Attributable to United States office. 4-Not attributable to United States office. 5-Destination United States. 6-Destination abroad. 7-Material participation by office abroad. 8-No material participation by office abroad. The four-digit numbers made up from these code would indicate taxability or nontaxability according to the following schedule: Taxable: 1--- 235- 2368 Nontaxable: 24-- 2367 The codes would be placed on the invoices by clerks in the sales offices, work- ing from instructions issued by the tax department. Those instructions would require a review by the coding clerk of all "activities" in each office of the foreign corporation to determine whether that office conducted substantial "ac- tivities" with respect to the sale being coded. At return filing time, the tax deparment would call for a report of all invoices coded 1-, 235-, and 2368, together with information about the cost of the goods sold, and the "expenses, 1114 PAGENO="1125" FOREIGN INVESTORS TAX ACT OF 1966 229 losses, and other deductions properly apportioned or allocated thereto * * ~" Reg. § 1.861-1(a) (1). The tax department would then develop further informa- tion and, in some fashion, determine "a ratable part of any other expenses, losses, or deductions which cannot definitely be allocated to some item or class of gross income." Reg. § 1.861-8(a). The taxable income would be that computed from these figures. The decisions required in coding the invoices point up the practical book- keeping problems presented by H.R. 13103. As explained earlier, the most troublesome choices would be in deciding whether a sale is to be coded 3 (attributable to a United States office) or 4 (not so attributable), and whether there is (7) material participation by a foreign office or (8) no such participation. In practice it would also be most difficult-and perhaps im- possible-to determine whether the ultimate "use, consumption, or disposition" of the goods (5) is in the United States or (6) abroad, since goods consigned to a purchaser located in the United States could be reconsigned or reshipped by him to a destination in Canada or elsewhere; unless the taxpayer has un- usual sources of information, be might be taxed on the income from such transactions even though the law does not require it. For further discussion of problems of proof, see pages 50-51, infra. For rec- ommendations to mitigate these problems, see pages 64-65. The CHAIRMAN (reading): As a hypothetical example, take the case of a Spanish corporation which purchases sherry from Spanish vintners through an office in Spain, and sells it to customers throughout the world. Some orders are solicited and ac- cepted by the Spanish headquarters office. Others are solicited by branch offices in major cities throughout the world, forwarded to Spain, and ac- cepted or rejected there. Shipment is made either from Spain or from ware- house stocks in other countries. The New York branch office solicits orders in the eastern half of the United States, Canada, and Mexico, but certain large accounts deal directly with the office in Spain. The consequence of this operation under existing law would be the taxation of the net profits of those sales in which title passed in the United States. Record keeping would involve coding invoices with the numbers 1 or 2 to designate whether title passed in the United States or abroad. Under HR. 13103, it would be necessary to use a coding system that would reflect much more information. Perhaps the simplest system would involve coding each invoice with a four-digit number, such as 1357, 2368, or 2457, which would convey the following information: And then it is broken down in eight ways, and then a four-digit number would be made up from these codes to indicate taxability or nontaxability according to the following schedule which I will let the record show. The code would be placed for use by that depart- ment. This is iio effort just to confuse. What you are saying here is that to try to arrive at a proper answer to a tax problem this would appear to be the simplest way that your people think that they could administer this particular provision of the law. This is not a matter of unduly confusing. This is just how they think they could best go about complying with this particular section of the bill before us. Mr. HENDERSON. That is right, Senator. We tried to go through the mechanical steps in determining, if the bill were enacted, what the taxpayer would have to do in order to comply with the bill; how could he mechanically collect the data on the basis of which a tax return could be prepared; and it was our feeling this had to be done, this amount of detail had to be gone. into. The CHAIRMAN. That sounds like a complicated version of the problem we had with entertainment expenses. We came up with the conclusion that people were properly entitled to deduct certain enter- tainment expenses. Most folks, and that includes myself, do not 1115 PAGENO="1126" 230 FOREIGN INVESTORS TAX ACT OF 1966 like to carry a pad in their pockets to try to keep up with everything they spend on entertainment. So there had been accepted in years gone by the so-called Cohan rule permitting a taxpayer to estimate what he was paying out, and as long as he could appear to substan- tiate the estimate on a reasonable basis, the Internal Revenue Service would accept that. But there were a lot of people cheating on this, so the Treasury then said, "We want everybody to itemize it." So what we came up with, to save any deduction at all for very legitimate expenses, was a proposition where each taxpayer would be expected to carry around a notebook and pad to note down who he entertained, where he entertained, what was the business rela- tionship, and whether he entertained in a situation where there was music entertainment or whether he entertained in a situation where there was no music, no entertainment, where the discussion of busi- ness would be more appropriate. Of course, you would have to take each one of those items and analyze each one of them individually to decide whether each one was deductible, and that is a simple ver- sion of the kind of problem you are posing here applied to individual transactions. Mr. HENDERSON. That is right, Senator. There are some areas in the tax law where, you know, additional complications have to be put in from time to time to produce fairness or proper tax revenue, and so on. It is not easy to have a completely simple code, but it is im- portant that we not add complicating provisions that we do not really need. And we feel that because of the practical and policy questions raised by these provisions that we have just been discus- sing, that they should be considered very carefully by your com- mittee before any action is taken. I won't go into any more detail on our report.. The detail is there, but I think, what I have said, and what the detailed analysis in the report contains, indicate that there are very important questions raised by this portion of t.he bill-the portion which would impose a new tax on the so-called "effectively connected" foreign source in- come of foreign corporations-regarding its standing under the gen- eral policy objectives which Secretary Fowler has stated for the bill as a whole. First, for example, this provision would not seem to create an ad- ditional simplification of the tax on foreigners. This is the point we have just discussed. Rather it would make such taxation more complex and burdensome. There are other provisions of the bill which would, of course, sim- plify the tax treatment of foreigners, and this is an important goal because it does encourage foreign investment in a country if the tax rules applied to foreigners are simple and easy to understand. Second, the new provision would not seem to create a more rational or equitable treatment for foreigners, either. Rather, the provision would apply in inconsistent and discriminatory ways. Third, it would not seem to eliminate barriers to investment. in the United States and to encourage new foreign investment and business activities here. Rather it would seem to impose a new barrier and to discourage new and even existing foreign investment and business activities in the United States. Thus, this provision would seem to have a harmful rather than a helpful effect on our balance-of-payments position. 1116 PAGENO="1127" FOREIGN INVESTORS TAX ACT OF 1966 231 Despite these negative aspects, the new provision would not appear to offer any positive contribution of tax revenue. The revenue esti- mates in the House report indicate that no additional revenue is actually expected to be produced by this new proyision. We believe these practical and policy questions should be fully explored and considered before this portion of the bill is enacted into law. We hope our detailed report will be of assistance to you in this connection. I might note that Secretary Fowler has urged this committee to see that this bill is adopted at this session of Congress, because of the salutary portions of it which would help our balance-of- payments situation. Because of the time pressure which immediate enactment would present to this committee and to the Congress, however, we would like to suggest that the committee consider eliminating from the bill, the portion we have just discussed, namely the portion that would put a new tax on foreign-source income o~ certain U.S. tax- payers, and the putting of that provision over for a later and more thorough consideration. Thank you. The CHAIRMAN. Senator Anderson. Senator ANDERSON. Is it possible under our present tax laws for a foreign corporation to establish a sales office in the United States, employ U.S. sales representatives, carry on a very active sales cam- paign in the United States, sell the goods to U.S. citizens in compe- tition with U.S. industry, and yet pay no U.S. tax because of arrangements for title to pass outside of the United States? * Mr. HENDERSON. Yes, sir. Senator ANDERSON. It can happen? Mr. HENDERSON. It is equally possible, Senator, for a taxpayer th iave all of the activities you just mentioned abroad, but pass title to he goods in the United States, in which case he is subjected to a 1.5. tax, and the U.S. tax code does not say that that income becomes ~ttributable to the foreign office. Now, this bill would attach a new 1.5. tax- Senator MCCARTHY. Not many people are doing that, are they? Mr. HENDERSON. On sales of goods because of the title passage rule t is usually possible to avoid that kind of situation. But in other ituations covered by the bill it may not be easy to avoid that kind f situation. Senator ANDERSON. Sometimes Congress feels like taking .a chance lthough all taxpayers say it is bad. Mr. HENDERSON. I am sorry, I could not hear it, Senator. *Senator ANDERSON. I say sometimes U.S. institutions and indus- ries take a law of this nature and find out how it works. We went hrough a long series of hearings on a subject very close to my heart, cLedicare, and all the newspapers told about how many people were going tobe standing in line trying to get to the doctor on July 1st, that he hospitals were gomg to become jammed and that they would have to have traffic cops in the corridors. I went to a hospital that day, and there was not a soul there. Those things happen sometimes. I think this bill might be enacted and probably not very many busi- nesses in the country would go broke. 1117 PAGENO="1128" ~232 FOREIGN INVESTORS TAX ACT OF 1966 Mr. HENDERSON. I am not sure that very many would go broke. I ~am sure it would help business for tax lawyers. On the other hand, I am equally sure it may well discourage business activity in the United States that now occurs here, because many, I think, sales offices may be moved out of the United States as a result of this, many licensing offices may be moved, many foreign bank operations that now occur in the United States through agencies and represent- atives and correspondents may change as a result of this bill. We tried to explain in detail how this may occur. It is a policy question for the Congress to determine whether the possible problems this portion of the bill presents, which we have tried objectively to state in this report, are such that the enactment of this portion of the bill should be more thoroughly considered than it has been until now. The CHAIRMAN. Senator McCarthy. Senator MCCARTHY. Well, it is possible now to have a substantial operation in the United States and pay no tax at all on the profits earned, is it not? A company could manufacture in one country, sell in a second and distribute to a third, and pay no tax to any of the three. Mr. HENDERSON. Senator, that is theoretically possible, if you can find a combination of three countries each of which has a source of income rule which so works that the company can avoid total tax. That is the reason why the bill talks about possible tax haven use in the United States. I would like to make the following comment on that, however. First, if the United States is being used as an enormous tax haven of this kind, then I think it would be desirable to have an objective record of fact. What are the facts as to the amount of use in the United States as a tax-haven country? I would think the pro- ponents of a provision like this ought to come up with a factual proof of the extent to which the United States is being used as a tax haven even in this fashion. Secondly, Senator, this bill would apply even where there is no tax haven element at all. Where a taxpayer simply engages in this activity here; but pays plenty of tax abroad. There is no ex- ception in this bill for non-tax-avoidance situations. In non-tax- avoidance situations the taxpayer would nonetheless have to go through all this complicated recordkeeping and so forth. So if tax-haven abuse is the focus of this bill, I should think there ought to be a! better factual foundation laid for the necessity of acting in that area, and, secondly, there ought to be appropriate exemptions written in the bill, as there were in subpart F, to prevent the bill from causing an undue burden where there is no tax-haven situation at all. Now, this tax-haven problem, where the taxpayer is a foreign citizen, a foreign corporation or a foreign resident, is the reverse of the situation we dealt with in subpart F. In subpart F, the 1962 Revenue Act, we tried to avoid having foreign tax systems en- courage U.S. taxpayers to export jobs and money into foreign markets because of differentials between the United States and the foreign tax rate. Now, we solved that problem for U.S. taxpayers. If a foreign government does not care whether its citizens export jobs to the 1118 PAGENO="1129" FOREIGN INVESTORS TAX ACT OF 1966 233 United States and money to the United States and does not have a provision like our subpart F-or like our basic tax code which taxes the worldwide income of our citizens and resident corporations and domestic corporations-then why should the United States care? That basically is a problem Of the foreign government. They have power to extend their taxing jurisdiction to their citizens, as we did in our code when we taxed all Our citizens' income and as we did when we taxed certain of their income from foreign corporations under subpart F. So this is basically not, I think, our problem. It is* basically the foreign country's problem. Senator MCOARTHY. I could not completely agree to that. It would certainly give them a competitive advantage in the American market against American taxpayers. We have costs around the world which have to be paid for in some way, and the only way we have of raising money is through the imposition of taxes. So you could have all American business giving its business over to foreign firms. You say, "Don't tax them because their own country does not care." Mr. HENDERSON. Senator, if that is happening to American firms something should be done about it. Senator 1~{CCARTHY. Certainly it should be done. But even if it is on a small scale something should be done about it. You do not have to wait until it is 90 percent of the American market. It is an inequity. The general rule we have is that people who make money should pay taxes in this country. We are not going to get foreign countries to make ~a reasonable contribution to the costs which this country is now bearing around the world in defense and in economic development by imposing tribute or demanding tribute from foreign countries. That has not worked since the Roman Empire,. and it did not work very well then. The only way we can get it is by taxing foreign corporations on the basis of the business they do in this country and taxing Amer- ican corporations on the basis of profits they make in foreign coun- tries. This is the, way in which you can get the revenue to pay for the worldwide expenses this country is bearing today. Mr. HENDERSON. Senator, the basic question is will the imposition of this tax help the position of the United States. Senator MCCARTHY. Well, that is correct. Mr. HENDERSON. If the only effect of this tax is to remove offices from the United States and force them into different countries, then I do not think we have helped the position of American business, and we certainly have not helped our balance-of-payments situation. That is a basic question of principle that ought to be examined by the Congress, and there. is not enough fact in the prior record of this bill to determine whether there is any real problem here at all or whether it is just a theoretical problem, and if there is a real problem, whether this bill will solve it, or simply hurt us. Senator MCCARTHY. I have no further questions. The CHAIRMAN. Senator Morton. Sen.ator MORTON. You discussed this question of a simple rule like the woj'd "destination," which is on page 26 of your report. 1119 PAGENO="1130" 234 FOREIGN INVESTORS TAX ACT OF* 1966 Of course it is a simple one now and anybody knows destinatioia is where the product goes. But, as you pointed out, transshipment is always possible, so destination and ultimate destination or place. of consumption could be entirely different; is that not correct? Mr. HENDERSON. Yes, sir; and that is the problem. That is diffi- cult to determine. As you know, this question became a very substantial issue of liti- gation earlier in our history under the Constitution. The Supreme. Court had to deal with the original package doctrine, and all the questions presented by goods landed here for transshipment to an- other country or for possible transshipment. Senator MORTON. Even more recently we have had* a problem which has caused a lot of litigation in this country, the so-called. Battle Act, which most of us voted for some 18 years ago here in the. Congress, which brings in the question of ultimate destination. You can ship a strategic material to France, but there is a res~on- sibility to see that it does not go to Russia, and we have had all kinds of problems in the enforcement of the so-called Battle Act which, I think, are indicative of the problems that we might get under the language of the section of the bill to which you refer. Certainly I think all of us want to see that the US. national, with a U.S. business is not unfairly-does not encounter unfair competition because a foreign national might have an office in the. same building and avoid certain taxes. But, as you say, the extent of this problem we do not know. If, in trying to cure that we throw out the baby with the bath water, and we lose business, that is here giving employment to people, to Nassau or Trinidad or wherever it might be with communication and trans- portation what it is today, they could easily operate in, across the border, or across the seas. Mr. HENDERSON. That is right; and also if the main purpose were to benefit American business then it would seem essential to put this "effectively connected" concept in also where it would directly bene- fit an American taxpayer, to permit him to treat activities effectively connected in this sense with a foreign office as being foreign source income so he could get a foreign tax credit for it, which he cannot. get under the present source rules. Senator MORTON. You do agree that if a case can be made, Ameri- can business is losing business because of a tax break that we give to a foreign operation, that this is a matter of concern to the Congress ? Mr. HENDERSON. Yes, sir. Senator MORTON. If it can be shown. Mr. HENDERSON. Absolutely. That is one of these major policy things that really should be fully explored, and that is all we are urging here, that this provision not be enacted until all of the facts and the issues it presents are really fully explored, and they have not been as yet. Senator MORTON. You also agree that these features of this bill which tend to discourage the recapture by this country of foreign earnings by American companies operating abroad, in view of our balance-of-payments dilemma, that this is a matter of major concern. to this committee and the Congress? 1120 PAGENO="1131" FOREIGN INVESTORS TAX ACT OF 1966 235 Mr. HENDERSON. It is of concern. We ought not to have pro- visions which artificially discourage repatriation; yes sir. Senator MORTON. Thank you, Mr. Chairman. The CHAIRMAN. Thank you very much, Mr. Henderson. Our next witness is Mr. Charles Bartlett of the Arizona Banking Association. STATEMENT OP CHARLES H. BARTLETT, JR., REPRESENTINO THE ARIZONA BANKERS ASSOCIATION Mr. BARTLETT. My name is Charles H. Bartlett, Jr. I am as- sistant vice president and manager of the International Department of the Valley National Bank of Arizona, and I am appearing here today as a representative of the Arizona Bankers' Association. This committee has heard testimony regarding the damaging effects of the imposition of U.S. income and estate taxes on foreign- owned deposits in banks located within the United States. Previ- ous witnesses have stressed the balance-of-payments implications of the provisions of H.R. 13103 which would apply to those taxes, and they have explained the inconsistency between those provisions and the stated objectives of the bill. I do not want to repeat the positions that have already been pre- sented to the committee, but there are a few points that are of im- portance to banks in my State and to others similarly located along an international boundary line. The same factors apply, though perhaps to a less extent, to banks in other interior points whose volume of foreign business is not on the scale enjoyed by banks in our larger financial centers, but is nevertheless of importance to themselves. The amount of deposits attracted by Arizona banks from foreign corporations is quite limited. For the most part, our foreign de- posits come from individuals who are attracted by this country's record of political stability and very excellent reputation for pre- serving the value of money in comparison with that of most other parts of the world. Higher after-tax yields can be obtained in mahy other countries. But there is a limit to the price foreigners will pay to keep money in our country. This year, we have noticed a loss of deposits to other countries because of their higher interest rates. If to this we add a 30-percent tax rate, there can be no question but that the flow of money to other countries would be accelerated. Many countries with favorable political climates now have strong financial insti- tutions which actively solicit U.S. dollar deposits. It is interesting to note that foreign depositors who transfer money out of the United States for the most part do not. repatriate it to their own countries, but rather place it where they can best attain their deposit objectives. The imposition of income taxes will most definitely cause the loss of important deposits by the banks in Arizona. Contrary to the House report, the effect will be noticed immediately and not in 1971. Anyone who has himself wrestled with the intricacies of our own tax laws can appreciate the. problems in trying to explain them to people living perhaps hundreds or even thousands of miles away. 1121 PAGENO="1132" 236 FOREIGN INVESTORS TAX ACT OF 1966 I know of no more frustrating experience than trying to explain a point of law or taxation on the telephone in a foreigh language to a person not familiar with our legal concepts. I recently tried un- successfully to translate into verbal Spanish the new Federal Re- serve regulations on multiple maturity time deposits, and, I am sure, that would be rather simple compared to what ELR. 13103 would require. We can be sure that the new tax measures would be given wide publicity and the mere fact of taxability, once brought to the attention of our foreign customers, would cause an immediate outflow of funds. Some bankers report it has already started. Our banker friends abroad are strong competitors, and know how to make good use of any advantages they have. There really can't be much doubt about what an income tax would do to foreign-owned deposits; but an estate tax would be absolutely deadly. I don't think any conscientious banker could fail to acquaint his foreign customers with the imposition of an estate tax. The bank I work for would most definitely do so. In this context, it should be remembered that some countries do not have any estate or inheritance taxes whatsoever. Certainly, people in those countries cannot be expected to invite loss of even a small part of their capital by leaving their funds in the United States. We have certain attractions, as I mentioned, but our mar- gin of advantages is not as wide as it was 20 years ago. It does not permit us to impose a charge for safekeeping. This bill will effectively destroy a very major share of the de- posits which enable the banks in my State to support international departments. None of us have foreign branches or subsidiaries and, while our foreign business is growing, we do not have the volume of transactions which would normally be required to serve as the bases for foreign operations of one type or another. The enact- ment of H.R. 13103 in its present form would force important de- posits to move to foreign banks and foreign branches of other Amer- ican banks. The growth of our foreign banking activities would be dealt a blow from which it would take us many years to recover. We would be at a competitive disadvantage both at home and abroad. The Arizona Bankers Association urges the elimination from H.R. 13103 of those provisions which would subject foreign-owned de- posits to income and estate taxes. The CHAIRMAN. Thank you very much. Mr. BARTLErr. Thank you, gentlemen. The CHAIRMAN. Senator Anderson. Senator ANDERSON. The Valley Bank has a number of branches in the State of Arizona, does it not? Mr. BARTLETT. Yes, sir. Senator ANDERSON. And the First National Bank also has? Mr. BARTLETT. Yes, sir. Senator ANDERSON. Both of these banks feel this is a dangerous piece of legislation? Mr. BARTLETT. Yes, sir. Senator ANDERSON. I only want to testify that these are two very fine and highly respected institutions and very w~ll regarded in the Southwest. 1122 PAGENO="1133" FOREIGN INVESTORS TAX ACT OF 1966 237 Mr. BARTLETT. We feel every bit as strong as Mr. Young in El Paso. The CHAIRMAN. Thank you very much, sir. I think your views are very precise. Senator MCCARTHY. I have no questions unless he has some views on the other provisions of the bill which he would like to express. You are concerned only with the interest? Mr. BARTLErr. Those are the two points I am here to represent my State association on, Senator, yes. The CHAIRMAN. Thank you. Next is Mr. A. Richard Finchell of the Greater Miami Savmgs Center. STATEMENT OF A. RICHARD FINCHELL, PRESIDENT, GREATER MIAMI SAVINGS CENTER Mr. FINCHELL. Good morning, Senators Long, McCarthy, Ander- son, and Morton. I come here as president of the savings and brokerage firm called Greater Miami Savings Center, and also presi- dent of a direct-mail advertising company which serves as a co- ordinator of overseas direct mail advertising for deposits by a group of 25. insured savings and loan associations of Californio. My attorney has filed with Chairman Long a letter dated August 8, in which he sets out the technical points to House bill 13103 which we feel are objectionable, despite the purposes of the act, and which would be injurious, we believe, to more than 99 percent of the U.S. commercial banks, the entire mutual savings bank industry, and the entire U.S. savings and loan industry. The CHAIRMAN. We will print the whole statement in the record. You can read it if you want to, or summarize it. Mr. FINCHELL. No. If you do not mind, Senator, I would preTer to make just a few points of a background nature of my experience in the business which you may find helpful, which are not included in my attorney's submission. The CHAIRMAN. As you know, you can sit here in this room and hear some of these points made two or three times. What we are especially interested in is what you can add to it because I notice- Mr. FINCHELL. Yes. The CHAIRMAN. I notice you object to this House amendment just as the previous witness did. Do you think it would tend to run foreign deposits out of American banks? Mr. FINOHELL. The only point I think would be novel to you and, possibly of interest to you, would be how it would affect, presently affect, the U.S. savings and loan industry. I do not think that voice has been heard yet. The CHAIRMAN. Yes. Mr. FINCHELL. And the nature of the depositors who would be driven out or would be discouraged from bringing their money into the United States. In 1958, the Internal Revenue Service ruled that interest-paying savings and loan associations rather than mutual-type savings and loan associations were, for the purposes of the Internal Revenue regulations or the statutes governing interest paid to foreigners, per- 1123 PAGENO="1134" 238 FOREIGN INVESTORS TAX ACT OF 1966 Sons carrying on the banking business in the United States and, there- fore, the exemptions from interest on estate tax were extended to de- positors or savings account holders with certain types of savings and loan associations primarily located in California and Ohio, State-chartered institutions, most of them federally insured. This extension of the exemption was extended 4 years prior to 1958 to the entire mutual savings bank industry in the United States. So, in effect, what you have today is not only deposits that would possibly be driven out of the United States if this bill were enacted as proposed, but also from mutual savings banks and from savings and loan associations. Since 1958 we have forwarded close to $80 million foreign sav- ings deposits to California savings and loan associations where for- eigners have enjoyed exemption from U.S. income tax and U.S. estate tax, and most of these people are middle-class people, they are people who would, for the most part, not know how to go about establishing a foreign-situs corporation to avoid the U.S. estate tax. These are middle-class people engaged in commerce primarily with the United States and they find it expedient and desirable for their own peace of mind to keep a part of their earnings from the * United States in the United States in the form of savings deposits, all of which are insured by permanent agencies of the U.S. Govern- ment, because these are little people depositing $10,000 in a number of savings institutions. I would estimate that there are a quarter of a billion dollars on deposit in California savings and loan associations today by for- eigners who are enjoying these tax exemptions, exemptions from income and estate tax, and although I do not have any figures either on the New York mutual savings banks in particular, I would esti- mate that approximately a like amount is on deposit in mutual sav- ings banks in the Tjnited States. In other words, approximately half a billion of foreign deposits in the United States are presently with tax-exempt savings banks and savings and loan associations. I will not go into the-I think it is needless at this late stage to go into the reasons why this money would be driven out of the coun- try. I think it has been amply and eloquently explained. I think it is also worthy of note that the average individual who has deposits in the United States, a foreigner, from my experience, probably has a checking account, certificates of deposit and savings account approximately of $50,000, so that he would be consuming his $30,000 estate tax exemption immediately, and this would not take into account any equity investment that he had in the United States. There is a discriminatory feature in this bill which I am sure also has been brought `to your attention, that effective immediately with January 1, 1967, only deposits by foreigners in foreign branches of U.S. commercial banks would be exempt from the U.S. estate tax, and after 1971, only those branches of U.S. banks abroad could offer foreigners exemption from U.S. income tax. There are two points I think the committee should take into ac- count on why this discrimination should not hold in the final bill and that is, No. 1, if all the foreign deposits presently in the United States gravitate to these foreign branches, there would be so much 1124 PAGENO="1135" FOREIGN INVESTORS TAX ACT OF 1966 239 money going to these foreign branches that the interest they pay to a foreigner may not be sufficient to hold all the money that had been exited from the United States and would be going back onto othe'~ investments in other countries. The CHAIRMAN. We have been complaining about tight money in the United States, and that would make it a lot tighter because that would be pulled out from investment here. Mr. FINOHELL. Yes. Senator MCCARTHY. Did you say you ran a direct-mail appeal? Mr. FINCHELL. Yes. Senator MCCARTHY. What is the nature of that? Mr. FINOHELL. It is a group of 25 California savings and loan as- sociations as a group advertising by direct mail abroad. Senator MCCARTHY. Which countries, primarily? Europe? Mr. FINCHELL. Europe, Latin America, the Middle East, and other areas of the world where there has been an outflow, to which there has been a heavy outflow, of all U.S. money. In effect, we are trying to bring it back, and that is the easiest type of money to bring back into the United Stat~s. Senator MCCJARTHY. Do you emphasize the fact that their interest earnings are not taxable? Mr. FINCIIEr414. Oh, yes; it is one of the prime attractions to a for- eigner, which is the interest and estate exemption. Senator McCARTHY. And estate tax. Mr. FINCHELL. Definitely, sir. The CHAIRMAN. So what you have been doing is advertising that you have a good deal here for foreigners to invest money in the United States. You had been attracting quite a bit of U.S. dollars back into American investment, and then here comes a bill which originally is intended to encourage foreigners t~i bring this money in, but by the time you see a House amendment you are convinced that the money will be flowing out instead of in, as far as you are concerned. Mr. FINCHELL. Yes; a crazy quilt. The CHAIRMAN. One of the Senators who sat through the first 2 days of hearings told me yesterday that he was firmly convinced this bill started out as a bill to attract foreign investments over here, and by the time it came from the House they would run more dollars out of here thairthey would bring in. I think your statement is one more piece of evidence along that line. Mr. FINCHELL. There is one final point I would like to make. This bill extended the tax exemptions or at least the interest tax exemptions to 4,400 other savings and loan associations in the United States of a mutual nature, including savings and loan associations in Minnesota, New Mexico, Louisiana, and Kentucky, which are of the mutual type or semimutual type. But there is wording in that extension which makes it very difficult, which will make it very difficult, for the savings managers of these institutions to properly tell the story to the foreign investor because it states that only savings institutions which meet a certain section, and it is rather obscure for a foreigner, and it is the recommendation of my attorney as well as ourselves that an easier identification be made as to what type of savings institution does qual- ify, and I think that the most simple one would be an institution whose accounts were insured by either the FDIC or the FSLIC. 1125 PAGENO="1136" 240 FOREIGN INVESTORS TAX ACT OF 1966 Senator ANDERSON. That would take them all, would it not? Mr. FINOHELL. Yes. That would take virtually all of them. The CHAIRMAN. Thank you very much. Mr. FINOHELL. Thank you, sir. (The letter dated August 8, 1966, referred to above, follows:) STONE, BITTEL, AND LANGER, Miami, Fla., August 8, 1966. Re bearings on H.R. 13103. Hon. RUSSELL B. LONG, Chairman, Committee on Finance, U.S. Senate, Washington, D.C. DE~a 1~fn. CHAIRMAN: Some of the provisions of the proposed Foreign In- vestors Taco Act of 1966 (H.R. 13103) are inconsistent with President Johnson's balance-of-payments program. These provisions deal with the taxation of deposits by foreign investors in U.S. banks and savings institutions. As pres- ently written, they are likely to drive away existing funds now on deposit in the U.S. and to discourage foreign investors from making new deposits. The Bill would broaden the income tax exemption granted foreign investors on their deposits in U.S. savings institutions by increasing the number of insti- tutions whose interest payments are income tax-free. The exemption would now apply to dividends and interest paid on accounts in virtually all savings and loan associations. In the past it applied only to earnings paid by a limited number of such associations. However, the Bill eliminates, effective immediately upon enactment, the estate tax exemption which has historically been accorded to such deposits. We have several overseas clients who maintain substantial amounts on de- posit in U.S. savings institutions. Often, in making deposits totaling hun- dreds of thousands of dollars, they deposit only $10,000 each in numerous dif- ferent savings institutions so as to make certain that all such deposits are fully insured by either the FDIC or FSLIC. We believe that many of such deposits will be withdrawn if they might become subject to a potential U.S. estate tax. Many foreign investors will not be willing to keep money on de- posit in the U.S. in the face of an estate tax which will take from one to five times theamount of the annual earnings from such deposits. It is not likely that substantial revenue can be raised by such a provision. A knowing investor could legally avoid the estate tax on such deposits by making them through a foreign corporation whose shares would not have a U.S. situs for estate tax purposes. We believe that consideration should be given by the Congress to the following suggested changes in the Bill: 1. The estate tax exemption for deposits by foreign investors in U.S. savings institutions should be continued concurrently with the income tax exemption. Thus, if the income tax exemption expires in 1972, the estate tax exemption should expire at the same time. 2. The estate tax exemption, as in the past, should cover all deposits and accounts in banks and savings institutions which will be covered by the income tax exemption. 3. The scheduled elimiliation in 1972 of the income tax exemption for deposits, by foreign investors in U.S. savings institutions appears unwarranted. This exemption has been in force for 45 years, since the Revenue Act of 1921. It was enacted in the first place to discourage foreigners from withdrawing their bank deposits from the U.S. Such a goal is even more important now than it was then. The proposed elimination of such exemption is therefore directly con- trary to the avowed purpose of this Bill, which is to remove tax barriers to foreign investment in the U.S. Moreover, it represents a premature guess that the U.S. balance-of-payments problem will have been completely solved by 1972. Many foreign investors may begin pulling out their deposits long before the scheduled termination date rather than worry about keeping track of the situation. Even if the Congress feels inclined to remove this exemption in 1972, we believe it should wait until at or near that time to take such action. 4. The present version of the Bill would give a monopoly with respect to bank deposits and savings accounts to those few U.S. banks with over- seas branches. Interest paid to foreign investors on deposits in a foreign branch of a U.S. bank would be exempt from income tax even after 1971. Moreover, the foreign investor could get tax-free interest from a foreign branch of a U.S. bank whether or not such interest is effectively connected with the conduct o~ 1126 PAGENO="1137" FOREIGN INVESTORS TAX ACT OF 1966 241 a U.S. trade or business. Thus, beginning in 1972, a foreign investor can either get tax-free interest from a foreign branch of one of the few large U.S. banks operating overseas or fully taxable interest from any of the many thousands of other domestic banks and savings and loan associations. An earlier version of the Bill would have allowed this exemption only to foreign currency deposits in foreign branches of U.S. banks. Although foreign currency deposits would be less likely to compete with U.S. Dollar deposits in domestic banks and savings institutions, such a limitation would not materially improve the situation. The limitation could be avoided too easily by a foreign investor making his deposits in a foreign branch of a U.S. bank in some foreign currency which is closely tied to the U.S. Dollar. It is even possible that the amount payable by the bank could be tied to the U.S. Dollar by insurance or hedging transactions. Thus, such a rule would also unduly favor those few U.S. banks having foreign branches. While the provision would undoubtedly strengthen the competitive position of those U.S. banks having foreign branches as against foreign banks, it would also unduly strengthen their competitive position as against all other domestic banks and savings institutions. 5. The Bill provides that for estate tax purposes, hereafter only a deposit with a foreign branch of a U.S. bank will be deemed non-U.S. property. A decedent nonresident alien will be exempt from U.S. estate tax on such a deposit whether or not he was engaged in business in the U.S. at the time of his death. Thus, the Bill would further favor the few U.S. banks having foreign branches in two additional ways. It would immediately remove the existing estate tax exemption accorded deposits by foreign investors in all other domestic banks and some other savings institutions. In addition, the exemption to be continued only for deposits in foreign branches of U.S. banks would be per- mitted whether or not the foreign investor was engaged in business in the U.S. at the time of his death. This immediate withdrawal of the estate tax exemption now accorded most deposits by foreign investors in domestic banks and savings institutions may well prove disastrous to the President's balance-of-payments program. The money pulled out in fear of the potential estate tax will go to foreign banks and to the foreign branches of U.S. banks. In either case, it will no longer be subject to the guidelines limiting lending abroad and similar restrictions designed to improve our balance-of-payments situation. Most of such funds will no longer be a part of the U.S. economy. 6. A foreign investor cannot reasonably be expected to determine the income tax status of the U.S. savings institutions in which he deposits his money in order to determine his own tax status. Therefore, we suggest elimination of the words (page 5 of the Bill, lines 13-16): "* * * but only to the extent that amounts paid or credited on such deposits or accounts are deductible under section 591 in computing the taxable income of such institutions, * * It is probably sufficient to require that the association be "chartered and supervised". If a further limitation is deemed necessary, it should be one which the foreign investor can more readily determine, for example, a requirement that the association be insured by either the FSLIO or FDIO. We appreciate the opportunity of presenting these views On H.R. 13103 and we request that this letter be made a part of the record of the hearings on the Bill. Sincerely yours, MARSHALL 3~. LANGER. (By direction of the Chair, the following letter is made a part of the record at this point:) NATIONAL LEAGUE OF INSURED SAVINGS ASSOCIATION, Washington, D.C., August 8, 1966. Hon. RUSSELL B. LONG, Chairman, Committee on Finance, U.S. Senate, Washington, D.C. DEAR MR. CHAIRMAN: It is respectfully requested that this letter be included in the record of the hearings on H.R. 13103, the Foreign Investors Tax Act of 1966. The National League of Insured Savings Association is a nationwide trade association representing Savings and loan associations having accounts insured by the Federal Savings and Loan Insurance Corporation. Our membership consists of some members having a permanent stock form of organization and others having a mutual form of organization. 71-297 0-67-pt. 1-72 1127 PAGENO="1138" 242 FOREIGN INVESTORS TAX ACT OF 1966 Under current rulings of the Internal Revenue Service, it is our understanding that the income on all mutual and some stock savings and loan association sav- ings accounts held by non-resident aliens not engaged in business in the United States is subject to Federal income, withholding and estate taxes. Such aliens who hold like accounts in other domestic stock savings and loan associations are not subject to these taxes under current IRS interpretations. With reservations as noted, the National League supports the following provi~ Lions in H.R. 13103 that pertain to this problem. Income Tax. Section 2(a) (1) (A) would amend Section 861 of the Internal Revenue Code to provide that there be excluded from the category of income from sources in the United States "interest" ondeposits or withdrawable accounts in savings institutions chartered and supervised as savings and loan or similar associations under Federal or State law, to the extent the amounts paid or ~redited are deductible under Section 591 of the Internal Revenue Code in computing taxable income of the savings institution. The exclusion would *cease to apply to amounts paid or credited after December 31, 1971. These provisions would remove the present difference in tax treatment given earnings distributed to savers in some stock savings and loan associations, when compared with other stock savings and loan associations and all mutual savings and loan associations, as long as the word "interest" continues to have a broad enough connotation to include dividends or similar distribution of earnings on a savings account in a savings and loan association, as it has under current law. Naturally the savings and loan industry would prefer that the exemption be con- tinued beyond 1971, in order to hold and attract more savings from non-resident aliens not engaged in business with the United States. It appears to us that this would help to increase foreign investment in the United States. Withholding Tax. It is our understanding that until the end of 1971, the bill would require no withholding of tax by virtue of interest received by a non- resident alien from a savings account in a savings and loan association located in the United States. `Section 3(g) amending section 1411 of the Internal Revenue Code would still appear to exempt any need for withholding any tax on income that does not con- stitute gross income from sources within the United States. Section 3(i) proposes to amend section 6105 of the Internal Revenue Code by adding a new subsection (i) to the effect that no declaration of estimated tax would be required from a non-resident alien for income not effectively connected with the conduct of a trade or business in the United States (other than a resi- dent of Puerto Rico). Section 2(d) would amend section 864 of the Internal Revenue Code by adding a paragraph (c) (4) headed Income From Sources Without United States which provides, among other things, that no income from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States, except for situa- `tions outlined that would not normally apply to income received from a savings account in a domestic' thrift institution. As previously noted, until the end of 1971, Section 2(a) (1) (A) of the bill would not include dividends from savings accounts in savings institutions in the category of income from sources within the United States. Estate Tax. It is our understanding that section 8(e) of H.R. 13103 would increase to $30,000 from $2,000 the exemption from gross estate of a non-resident alien. This would encourage an individual non-resident to place savings with thrift institutions in the United States as well as investing in other media to the total amount of $30,000, without incurring a Federal estate tax, and hence is preferable to a flat $2,000 exemption. Again, of course, the potential estate tax liability for estate in excess of the $30,000 per taxpayer would serve as a deter- rent to the investment of more than that amount in the United States by a non- resident alien individual. But the provision does avoid any problem of distinc- tion based on whether the investment is held in a particular type of savings and loan association and in that regard, is deserving of our support. Conclusion. If our interpretations of the effect of the provisions above noted (dealing with income tax liability, withholding tax liability, and estate tax liability) agree with that of the Committee, the National League supports the pro- visions insofar as they treat all domestic savings and loan associations alike. As noted, it is hoped the Committee will give further consideration to the limita- tions of time and amount above noted in weighing whether a liberalization would be desirable in the public interest In order to attract more investment funds to the United States. Sincerely, WILLIAM F. MCKENNA, General Counsel. 1128 PAGENO="1139" FOREIGN INVESTORS TAX ACT OF 1966 243 The CHAIRMAN. That conclules the hearings on the bill. I have announced that we will hold some hearings on proposed amendments that will be offered to the bill, such as the amendment relatmg to campaign contributions. So I would hope we could study what we have here-Senator Williams had planned to offer an amendment and I had promised hearings on the subject, and I thought we ought to hold them before we voted on the bill. The committee will prmt as part of the hearings a number of communications received from parties. Particularly, the published hearings should contain the sev- eral letters received from gentlemen who served as members of the Presidential task force along with Secretary Fowler, the task force whose recommendations prompted legislation along the lines of this bill. (The letters referred to follow:) MORGAN STANLEY & Co., New York, N.Y., August 5, 1966. Re Foreign Investors Tax Act (H.R. 13103). Hon. Senator RUSSELL B. LONG, Ckairmcm, Sena*e Finance Committee, Senate Office Building, Wa~1tington, D.C. DEAR SENATOR LONG: Morgan Stanley & Co. has followed with considerable' interest the actions taken by both `the private `and public sectors which would have an effect on the United States Balance of Payments. Our partner, John M. Young, was a member of the Fowler Task Force, and since the recommendations of this Task Force were given to President Johnson we have been particularly interested in supporting measures which would implement these recommenda- `tions. We are therefore writing to respectfully urge you and your Committee to give favorable consideration to the Foreign Investors Tax Act, which we understand will be before your Committee n~xt week. Although this Bill in its present form implements many of `the recommenda- tions of the Task Force, it is our understanding that H.R. 13103 still contains provisions which will continue the imposition of estate taxes on holdings of U.S. securities by foreigners, although `at a reduced `rate, and in addition imposes new taxes on other forms of investment, including U.S. `bank deposits, which will make investment in the U.S. even less attractive to foreign investors. It was the opinion of the Task Force that the estate tax on foreign `holdings of U.S. secu- rities has `been one of the primary deterrents to investment by foreigners in this country, and should therefore be eliminated. The elimination of this tax would seem even more `appropriate in view of the fact that this area of taxation is expected to produce annual revenue of less than $5 million. Implementation of the Task Force recommendations is long overdue, `and we therefore urge you `and your Committee to expedite passage of the Bill, `at the `same time taking the necessary action to correct those provisions of the Bill which impose taxation which will adversely affect foreign investment in the United States `and thus further impede improvement in our Balance of Payments. We `are enclosing additional copies of this letter for the members of the Committee. Respectfully yours, MORGAN STANLEY & Co. Enclosure. TWENTY EXCHANGE PLACE, New York, N.Y., August 3, 1966. Re Foreign Investors Tax Act (H.R. 13103). Hon. Senator RUSSELL B. LONG, Chairman, Senate Finance Committee, Senate Office Building, Wa,slthvgton, D.C. DEAR `SENATOR LONG: As the member of the Fowler Task Force most heavily concerned with the preparation of its tax recommendations, I urge your favorable consideration of the Foreign lilvestors Tax Act. With `the excej~tion of its recommendations in respect of estate taxes, the Act, in general, carries out the recommendations of the Task Force. In certain respects, the Act goes `beyond these recommendations in that it incor- porates new provisions, which I am informed, might constitute a deterrent lx> 1129 PAGENO="1140" 244 FOREIGN INVESTORS TAX ACT OF 1966 foreign investment and result in an `adverse effect upon our `balance of payments. Among these'are: 1. the provision for the `withholding of taxes on interest paid on `bank deposits; and 2. the provision which would impose U.S. income t'axes on foreign `source income of foreign corporations and individuals under certain circumstances. I will not go into `the reason's for these conclusions as they undoubtedly will be advanced before your Committee by others more familiar with the problems. `The recommendation of the Task Force for elimination `of `all estate taxes on foreign holdings of securities was considered to be one `of `its most important recommendations. The `bill `as passed by `the House not only continues `the imposition `of a tax, although at a reduced rate, on `securities presently subject to `tax, but imposes new taxes on certain other securities and, more particularly, on U.S. bank deposits. The report `of `the Committee on Ways `and Means would indicate that the total revenue involved in these various estate tax provisions is in the neighbor- hood of 2 to 5 `million dollars. `If the Task Force is correct in `its judgment, the adverse effect upon the `balance of payments of these estate tax provisi'ons w'ould have far grea'te.r significance. Although I have not had an opportunity to determine the views of the mem- bers `of the Task Force with respect `to the A'ct, I believe `that `they would not be inconsistent with the foregoing. I, therefore, respectfully recommend that the Adt be approved with `the exceptions referred to above. Respectfully yours, FREDERICK M. FIATON. MOBIL OIL CORP., NEW YORK, N.Y., August 5, 1966. Re Foreign Investors Tax AcL Hon. Russ1~iL B. LONG, Chairman, Committee on Finance, U.s. ~S'enate, Washington, D.C. DEAR Mn. CHAIRMAN: As as member of the Fowler Task Force on "Promoting Increased Foreign Investment and Increased Foreign Financing", I have been following with interest the progress of the Foreign Investors Tax Act, now pending before your Committee as HR. 13103. This measure was originally introduced in March 1965 as H.R. 5916. As then introduced, it would have substantially though not completely implemented the tax recommendations of the Task Force. At the end of September 1965, HR. 11297 was introduced as a modified version of H.R. 5916. Two modifications, a provision, for the inclusion of U.S. bank deposits owned `by non-resident alien decedents not engaged in trade or business in the' United States in the U.S. estates of such aliens dying after the enact- ment of the Bill and a provision which after five years would subject interest on U.S. bank deposits of non-resident aliens or foreign corporations to U.S. income tax, work directly against the basic objective of improving U.S. Balance of Payments through increased foreign investment ill the United States. These provisions are still included in the present version of the Bill, H.R. 13103; in my opinion they should be eliminated. A third important change would have subjected foreign corporations and non- resident aliens engaged in trade or business in the United States to U.S. income tax on their world-wide income (not restricted to U.S. sources) "effectively con- nected" with the United States trade or business. This highly objectionable section was greatly modified and improved by the present provisions of H.R. 13103. There remain, however, certain problems under the "effectively con- nected" concept, including an apparently unintended upstream dividend tax on certain distributions of foreign corporations to' U.S. shareholder corporations. I understand that these problems and possible amendments to meet them have been presented to you or will be developed by technical witnesses before your Committee. ` The Foreign Investors Tax Act will provide a significant aid to the improve- ment of our national Balance of Payments. In my opinion, therefore, the meas- 1130 PAGENO="1141" FOREIGN INVESTORS TAX ACT OF 1966 245 nrc is in the national interest and should be enacted, but hopefully with the changes suggested above. Respectfully yours, GEORGE F. ifAMES. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., August 9, 1966. lion. RUSSELL B. LONG, Chairman, Senate Finance Committee, 17.5. Senate, Senate Office Building, Washington, D.C. DEAR SIR: As a member of the Task Force appointed by the late President Kennedy to investigate ways of promoting increased foreign investment in United States securities, I would like to recommend prompt and favorable consideration ~f the Foreign Investors Tax Act of 1966 (H.R. 13103), which I understand is now before your Committee. Amendment of the tax inequities with respect to foreign investors was one of the several important recommendations made by the Task Force. The For- eign Investors Tax Act of 1966, in general, incorporates the recommendations of the Task Force and remedies and corrects many of these tax inequities. The Act, in its present form, however, contains certain provisions which, in my opinion, might well serve as deterrents rather than inducements to foreign investment. I refer, among others, to the provisions regarding the imposition of estate taxes, albeit at a reduced rate, on foreign holdings of securities, the with- holding of taxes on interest paid on bank deposits, and the imposition of United States income taxes on income which is "effectively connected" with the con- ~luct of a trade or business in the United States. I do not intend to dwell upon these items, as I am certain they will receive detailed and thoughtful examina- tion by you and your Committee. Not withstanding the foregoing, 1 feel that the Foreign Investors Tax Act of 1966 is a positive step towards righting the tax inequities in our present laws and with the reservations noted above I strongly urge its approval and endorsement. Respectfully yours, GEORGE J. LENE5S. The CHAIRMAN. That concludes the hearing on this part. (Whereupon, at 12 :10 p.m., the committee adjourned.) (By direction of the chairman, the following communications are made a part of the record:) STATEMENT OF RALPH YARBOROUGII Mr. Chairman and members of the Senate Committee on Finance, I appreciate the privilege of submitting testimony to this distinguished committee. I wish today to submit my views on HR. 13103, the Foreign Investors Tax Act of 1966. In particular, I wish to direct the committee's attention to a provision in the bill which would impose a U.S. income tax on interest paid by U.S. banks to nonresident aliens on time deposits held in U.S. banks. This provision was added by the House Committee on Ways and Means. It was not included in the original administration proposal. Nor was it a part of the report of the Fowler Task Force, which was the basis for the bill. I under- stand that the administration has taken no position on the provision. It is opposed by the American Bankers Association and by bankers in my State. In an effort to arrive at an estimate of the effect of the bill, I wrote Mr. Stan- ley S. Surrey, Assistant Secretary of the Treasury, on August 2, 1966, asking for the amount of the deposits which would be affected, the amount of deposits that would be withdrawn if the provision were enacted, and the additional revenue that would be generated by enactment. Mr. Surrey replied that the total amount of time deposits covered is approxi- mately $2,250 million. In reply to my second question Mr. Surrey replied, that "We do not feel that we are in a position to give you any such estimate because of the uncertainty as to the reaction which foreigners may have to such tax and the fact that a large number of bank deposits are held as working balances by corporations which do not bear interest and hence would not be affected by the bill." In response to the third question Mr. Surrey replied that, making numerous assumptions, a rough estimate of the total revenue which would be derived from 1131 PAGENO="1142" 246 FOREIGN INVESTORS TAX ACT OF 196.6 taxing the interest would be $22,500,000. However, inasmuch as one of the assumptions he made was that foreigners' time deposits held in 1972 (the date when the provision would go into effect) would be equal to those held by them today, and he had already stated that the effect on foreigners' holdings of time deposits was unknown, this estimate would appear to be of little reliability. Let us, then, examine what we know. We know that the amount of deposits affected totals $2,250 million. But we do not know how much additional revenue would be generated, nor how many dollars worth of deposits would be with- drawn. It would seem, then, that we are legislating in the dark. We can speculate on human nature, however. It is obvious that if a country suddenly imposes an income tax on the interest received by someone who is neither a citizen nor a resident of that country, he is going to look for another place to put his money. So we can most surely assume that there will be large- scale withdrawals of funds. At a time when we are still in a period of difficulty over our balance of payments, it is unwise to look for new troubles in this regard. This money from foreign countries on deposit in American banks is used in America; this capital helps relieve our money shortage. Its withdrawal would worsen our tight money problems. In my opinion, it is fiscally unsound to drive this money out of the country. Many other countries would welcome these deposits within their boundaries. As a Senator. from Texas I have a concern for the welfare of all the people in the communities of my State. This bill would hurt not only bankers, it would hurt everyone in the community, because the banks would have less money to loan and the economic activity of the community would thus be diminished. One bank in my State indicates that one-fourth of its deposits of $40 million would be affected. At a time when interest rates are high because of a shortage of loanable funds, this is no time to diminish loan funds still further. I respectfully suggest to the committee that since we have so little hard evidence as to the effects of the change, and since commonsense would seem to indicate that funds would probably be withdrawn in large amounts, that we are running a risk of enacting a law which will raise only a little extra revenue and scare away large amounts of funds. The purpose of the Fowler Task Force was to study ways of increasing foreign investment in the United States. This seems a peculiar way to do it. For these reasons I urge the committee to delete this section from the House- passed bill. I ask unanimous consent that the letter to me of August 9 from Assistant Secretary of the Treasury, Stanley S. Surrey, be printed at the conclusion of my remarks. TREASURY DEPARTMENT, Washington, DXI., August .9, 1966. Hon. RALPH YARBOROUGH, U.S. Senate, Washington, DXI. DEAR SENATOR YARBOROUGH: This is in reply to your letter of August 2. 19643, requesting information concerning the effect of those provisions in H.R. 13103 dealing with the taxation of bank deposits of foreigners in the United States. You first ask the amount of deposits which would be affected by these pro- visions in the United States and in Texas. Unfortunately, we do not have figures available on a State-by-State basis, and consequently we cannot give you any information on the amount of such deposits in the State of Texas. In the United States as whole there are total bank deposits to foreigners of approxi- mately $91/2 billion. Of this total, only those which are time deposits, $2.5 billion, and which bear interest would be affected by the provision in H.R. 13103 taxing such interest. In addition, deposits of foreigners who are residents in certain countries with which we have a tax treaty exempting interest would not be affected. As a result, the total number of time deposits on which interest sub.ject to tax would be paid is approximately $2240 million. The estate tax would only be levied on deposits held by individuals. Unfor- tunately, our figures do not discriminate between deposits of individuals and private companies other than commercial banks, and consequently we are not in a position to give you any figures as to the amounts of such deposits which would be affected by. the estate tax provisions of H.R. 13103, though of course it would only be a small part of the total deposits. Your second question relates to the anticipated change in the amount of such deposits that would be brought about by the enactment of H.R. 13103 in its pres- ent form. We do not feel that we are in a position to give you any such estimate 1132 PAGENO="1143" FOREIGN INVESTORS TAX ACT OF 1966 247 because of the uncertainty as to the reaction which foreigners may have Ito such tax and the fact that a large number of bank deposits are held as working bal- ances by corporations which do not bear `interest and hence would not be affected by the bill. lit was our feeling when the Ways and Means Committee considered the matter that the bill would not have a substantial current impact in view of the postponement until 1972 of tax on the interest on these deposits. Your third question asked the additional revenues that would result from passage of the act. As `indicated above, we are not in any position to estimate the estate tax revenues which might result if the bill were passed though the figure is not a large one. In 1963, our figures indicate that estates of nonresident aliens filed eState tax returns showing a total of less than $5 million in U.S. bank deposIts. However, some aliens whose only U.S. assets were bank deposits which were exempt from estate tax may `not `have filed a return. Any estimate of `the income tax which might result from the imposition of this tax must necessarily be based on numerous assumptions. These assumptions in- clude `the amount of time deposits which would be held by foreigners in 1972 when the.tax went into effect., the interest rate that would then be paid on such deposits, and the rate of tax which would be levied on such income. At the present `time, our statutory rate of withholding tax is 30 percent, but this is modified in many cases by treaty. If it is `assumed `that foreigners' time deposits in 1972 were to equal those held by `them today, `that the interest rate on such de- posits is 4 percent, and that the same percentage of such deposits `are `held by foreigners subject to reduced rates of tax by reason of our tax treaties, the total revenue which would `be derived from taxing such interest would `be approx'i- inately $22,500,000. We trust that `this answers your questions. Sincerely yours, STANLEY S. SURREY,' Assistant t~ecretary. STATEMENT OF THE ASSoCIATION OF THE BAR OF THE CITY OF NEW Yonx, SuB- MITTED BY LAWRENCE F. CASEY, CHAIRMAN, COMMITTEE ON TAXATION SECTION 2(d). DETERMINATION OF INCOME "EFFECTIVELY CONNECTED" WITH A UNITED STATES TRADE OR BUSINESS H.R. 13103 would bring about two important new Federal income tax conse- quences affecting the income of nonresident aliens and foreign corporations: First, certain income from sources without the United States would, for the first time, be subjected to United States taxation. Second, the traditional "force of attraction" of a trade or business con- ducted by a nonresident alien or a foreign corporation in the United States, resulting in the taxation of nonbusiness as well as business income from United States sources at regular rates-meaning progressive rates for indi- viduals and regular corporate rates for corporations-would no longer apply. Nonbusiness, or "passive," income would be subject, instead, to a fiat 30% rate of tax (or a lower treaty rate if applicable). H.R. 13103 would accomplish both foregoing results by introducing into the Code a new concept, derived from recent income tax conventions-that of "income effectively connected with the conduct of a trade or business within the United `States." This Committee strongly urges that the first of these effects-erosion of the `traditional limitation of United States income tax to income from United States sources in the case of a nonresident alien or a foreign corporation-be eliminated from H.R. 13103. This Committee concurs in the elimination of the "force of attraction" doctrine as it affects passive income from United States sources. A. Income from 8ources without the United states One `of the stated purposes of the original Foreign Investors Tax Bill was to promote and encourage investments in the United States. The adoption of a rule `taxing non-United States source income is at cross-purposes with this purpose. The Bill would introduce into the Internal Revenue Code complexities which would seem to outweigh any additional revenue which the concept might produce.1 1 note that the Report of the Ways and Means Committee does not In Its estimate of the revenue erects of the Bill reflect any Increase of revenues due to the introduction of these particular provisions. 1133 PAGENO="1144" 248 FOREIGN INVESTORS TAX ACT OF 1966 These complexities will discourage foreign businessmen who are considering engaging in business here because it will make it more difficult for them to deter- mine the extent to which they will be subject to United States tax. Moreover, we question the desirability of a legislative provision whose real purposes and effects are completely unclear without the extensive exegesis contained in the Committee Report. Some of the ambiguities present can be seen if we examine the Bill's treat- ment of sales of personal property outside the United States-proposed section 864(c) (4)(B) (iii). Income "attributable" to an "office or fixed place of `busi- iiess" in the United States derived from the sale outside the United States of personal property will be subject to tax in the United States. The term "office or fixed place of business" has been the subject of litigation in the past. The Committee Report uses the terms "relatively sporadic and infrequent," "merely," "on occasion" and "absent other circumstances" (Report, p. 03) in explaining the -intended meaning of the term. The term "attributable" is itself obviously vague and the Report does little to remedy this by stating that income will he attributable to the United States office if that office is the "primary place" (Report p. 19) of activity giving rise to the sale. An exception is made to this rule if the property is sold for "use, disposition or consumption outside the United States" and an office or other fixed place of business of the taxpayer outside the United States makes a "material" contribution to the sale. What is a "material" contribution? Each of the terms quoted in this paragraph will require interpretation over many years before its meaning is known. We sub- mit that the creation of this much ambiguity and complexity is hardly calculated to encourage foreign persons to engage in business in the United States. Many examples of undesirable results arising under proposed section 864(c) (4) (B) might be given. `For present purposes, one example will be noted with respect to each of the three categories of foreign source income which H.R. 13103 would `subject to the United States tax. (i) Rental or royalty income.-A'ssume that a foreign-owned Dutch corpora- tion develops know-'how and patents in Holland and licenses rights thereto in Mexico. The Dutch corporation `has a United States office which participates in the negotiation of licenses of such know-how and patent rights. Under HR. 13103 the United `States would claim tax upon all royalties paid from Mexico to the Dutch corporation. `One alternative open to the Dutch corporation quite obviously would be to abandon its office within the United `States and `locate its licensing activities exclusively outside of the United States. (ii) Dividends, interest, gains or losses-Assume that a `foreign underwriter has a New York office and participates in an underwriting of the securities of a United `States corporation. Under proposed Section 864(c) (4) (B) (ii) it would seem that underwriter income arising from the sale of such securities by the foreign underwriter outside the United' States would be fully subject to taxation in the United States. (iii) Income from sales of personal property-Assume that a foreign-owned Canadian corporation manufactures a chemical in Canada for sale to European markets. The company establishes a sales office in New York City from which point it solicits and negotiates sales of the chemical. The Canadian manu- facturing plant is the sole supplier of the chemical, arranges for its shipment and if requested provides the European purchasers with certain services connected with the use of the chemical. The legislative history of HR. 13103 suggests that if an office outside the United States performs "significant services incident to such sale which were necessary to its consummation and were not subject to a separate agreement between the seller and the buyer," such office will be considered "to have participated materially" in the sale so as to exclude the income from capture under Category (iii). The only activities specifically referred to in the legislative history as constituting "material" participation in the sale are solicitation and negotiation of sales which, in the present ex- ample, would be taking place through the United States sales office. Certainly the risk of tax in the foregoing example would discourage establishment of a sales office in the United States. It should be noted that under the Bill the general effect of a finding that income from without the United States falling in one of these specified classes is "effectively connected" with a United States trade or business, will be to impose United States tax upon all of such income. This would seem a com- 1134 PAGENO="1145" FOREIGN INVESTORS TAX ACT OF 1966 249 pletely untoward result since not infrequently the activities carried on by the United States place of business will, in an economic sense, have generated only a fraction of the income in question. For instance, in example (i), above, the ownership of the patent rights in the particular country will have been the principal source of such income viewed in an economic sense. Therefore, if Section 864(c) (4) (B) is to be retained in something resembling its present form, provision should be made for allocating tO the United States place of business only that portion of the income in question which is economically attributable to the United States place of business. This might be done by adopting prin- ciples of allocation under section 482 of the Code such that the U.S. office would be taxed upon the portion of the income in question attributable to its selling or negotiating function. Effectire Date. Excluded from consideration in determining whether in- come from non-United States sources is to be treated as effectively connected income are activities attributable to a binding contract entered into on or before February 24, 1966, carried out "in the United States on or before such date in negotiating or carrying out such contract." It is suggested that the descrip- tion of excluded activities parallel the statutory language contained in proposed Section 864(c) (4) (iii), just discussed, as follows: "activities conducted through an office or other fixed place of business within the United States." B. Income from S'ources within the United States As noted above, we agree in principle with the use of the "effectively con- nected" concept to free from~ regular rate taxation investment income of foreign taxpayers notwithstanding their being engaged in trade or business in the United States. The statutory "effectively connected"- test is necessarily vague, and, as a result, it will be difficult in many instances to advise nonresident aliens with any degree of specificity whether or not passive income will be con- sidered "effectively connected." One of the difficulties arises from the use of an accounting factor in determin- ing whether income is "effectively connected." This is a carryover, somewhat modified, from the definition of "effectively connected" in HR. 11297. Under the proposed statute, the determination of whether investment and other fixed or determinable income and capital gains from United States sources is "effectively connected" with a United States business is made on the basis of whether (a) the income is derived from assets used, or held for use in the conduct of a United States business, or (b) the activities of the United States business were a material factor in the realization of the income. In determining whether factor (a) or factor (b) is present in a particular case, the statute provides that "due regard shall be given to whether or not such asset or such income, gain or loss was accounted for through such trade or business." In HR. 11297, this "accounting" factor was on. a par with the other two factors, (a) and (b), in determining whether income was effectively connected with a trade or business. The use of an accounting factor in the statutory definition does not in the first instance seem desirable, although it is certainly better to reduce it from its status under HR. 11297 where the presence of such factor alone might have resulted in treatment of income as effectively connected income. The basic definition in the statute of what constitutes "effectively connected" income is followed by a catchall definition of other types of income to be treated as effectively connected income, irrespective of whether so connected in fact (proposed Section 864(c) (3)) "(3) OTHER INCOME FROM SOURCES WITHIN UNITED STATES.-All income, gain, or loss from sources within the United States (other than income, gain, or loss to. which paragraph (2) applies) shall be treated as effectively connected with the conduct of a trade or business within the United States." The income, gain, or loss "to which paragraph (2) applies" (that is, Section 864(c) (2)) is, in turn, described by cross-reference to other sections of the Code. It is suggested that the same cross-references be made in Section 864(c) (3) So that the parenthetical portion of Paragraph (3) would read as follows: "* * * (other than income from sources within the United States of the types described in section 871 (a) (1) or section 881 (a) or gain or loss from sources within the United States from the sale or exchange of capital assets)" 1135 PAGENO="1146" 250 FOREIGN INVESTORS TAX ACT OF 196.6 THE ASSOCIATION OF THE BAR OF THE CITY OF NEW YORK COMMITTEE ON TAXATION ~ on H.R. 11297: "Foreign Investors' Tha, Act of 1965" Members of the Committee Laurence F. Oasey, Chairman James A. Olascock, Jr. Robert Arum Donald H. Kailman Joseph E. Bachelder, III Saul Duff Kronovet John C. Baity James A. Levitan John L. Cady Donald R. Osborn Wallace J. Olarfield James R. Rowen John A. Oorry David G.. Sacks Willis L. Ensign David Simon John W. Fager Orrie P. Stevens, secretary Aithur A. Feder Robert W. Wales Wilbur H. Friedman David E. Watts Set forth below are the comments of the Committee on Taxation of the As- sociation of the Bar of the City of New York on H.R. 11297. According to the Ways and Means Committee's Summary, a principal purpose of the bill is to encourage foreign investment in the United States-thereby beneficially affecting the United States balance of payments-by removing tax barriers to such investment. The Committee believes that certain changes made under the bill will have precisely the contrary effect. For instance, the elimination of the income and estate tax exemptions relating to United States bank deposits must lead to withdrawals of substantial existing deposits from, and discourage potential deposits in, this country. One further aspect of the bill may well serve to discourage investment in the United States. Under present law, it is possible to give fairly definite advice to a foreign corporation or partnership wishing to establish a branch in this country as to what part of its income will be treated as income from sources within the United States and subject to tax here. H.R. 11297 would abandon the use of these clearly defined "source" rules and instead subject to United States tax all income that is "effectively connected" with a United States branch operation. The "effectively connected" concept is vague and ill-defined. To the extent that the bill substitutes an unclear standard of taxability for a clear one, making it more difficult for a foreign investor to determine what United States tax he will pay, it will, in the Committee's opinion, serve to dis- courage investment in the United States. Our detailed comments are submitted under six principal headings, as follows: &urce of Income ~ection2(a). Interest The general effect of this provision is to extend the present exclusion of in- terest on bank deposits from U.S. source income to interest paid by savings and loan associations and to interest paid on amounts held by an insurance company under an agreement to pay interest thereon. However, with one minor exception described below, the present exclusion of bank deposit interest from U.S. source income as well as the proposed extension will terminate on December 31, 1970. Thus, all such interest paid or credited after December 31, 1970 will be sub- jected to a 30 percent withholding rate (or to any lower treaty withholding rate). It it believed that such change, even though deferred to 1970, will tend to dis- courage new deposits of substantial sums with U.S. banks, as well as encouraging the withdrawal of substantial deposits presently held by foreigners. Section 2(a) of the bill adds a new subparagraph to the Code excluding from "U.S. source income" interest paid on foreign currency deposits in foreign branches of U.S. banks, a change which is necessary because of the proposed termination of the present exclusion of bank interest from TLS. source inéome. This provision is desirable but should be extended to cover all interest paid by foreign branches of U.S. banks. If interest on dollar deposits in foreign branches of U.S. banks is subject to U.S. withholding taxes, such branches will be non- competitive with local foreign banks. The resulting reduction in their earnings may tend to worsen the U.S. balance of payments. Should the above restriction induce the incorporation of their foreign branches by U.S. banks, the balance of payments may be further worsened by the accumulation of their earnings free of U.S. tax in such incorporated branches. 1136 PAGENO="1147" FOREIGN INVESTORS TAX ACT OF 1966 251 Section 2(b). Dividends from foreign corporations This section modifies present Code section 861(a) (2) (B) to provide that dividends from a foreign corporation are to be considered income from U.S. sources only if 80 percent of the corporation's gross income for the preceding 3-year period consisted of income effectively connected with the conduct of a trade or business within the United States. This change represents a marked liberalization of the present requirements for exclusion of dividends of foreign corporations from U.S. source income and the Committee questions the necessity therefor. Presumably the change is designed to eliminate the `so-called "second dividend tax", particularly with respect to investment income. However, where a foreign corporation is carrying on activities here which are effectively con- nected with a U.S. trade or business, there would seem to be no reason why the withholding tax should not apply. Accordingly, it is suggested that the present requirement be retained, or more appropriately, reduced below 50 percent. In any event, in the interest of clarity, the word "total" should be `added before the words "gross income" where they first `appear in the subparagraph and the words "from all sources" should be added after the words "gross income". Since under the bill provisions (Sec. 4(b)) amending section 882(b), the "gross in- come' of a foreign corporation would be limited to income from sources within the United States plus "effectively connected" income, Section 861(a) (2) (B), as proposed, would produce an unintended result. Section 2(c). Personal services This provision desirably `broadens the present exclusion from U.S. source in- come of the earnings of employees of (1) foreign corporations or (ii) foreign branches of U.S. corporations who earn less than 3 thousand dollars and are present here for less than 90 days, the exclusion being extended to employees of foreign offices of U.S. partnerships or individuals. No change has been made in the basic 3 thousand dollar exclusionary test. Since this fignre has been part of the Code at least since 1939 (and apparently has its genesis in § 201(c) of the Revenue Act of 1917), and since wage levels have increased materially in that period, consideration might be given to increasing this amount. The exclusion presently applies to employees of foreign corporations, etc. where the employer is not engaged in trade or business in the United States if the employee is employed by a foreign office of the foreign employer. There would seem. to be no basis for putting employees of a foreign branch of a foreign employer engaged in trade or business here in a worse position than that of employees of a foreign branch of a U.S. corporation. Section 861(a) (3) (C) (i) of the Code and proposed section 864(b) (1) (A) should be amended to extend this exclusion to employees of a foreign branch of a foreign employer engaged in business in the United States. Section 2(d). Definition of "trade or business within the United States" Proposed Code section 864(b) (.)(A) would provide that trading in stocks or securities through a resident broker custodian or other agent having discretionary authority would not constitute the carrying on of a trade or business within* the United States. This is a desirable amendment which should aid in effectuat- ing the purposes of the bill. The Treasury Department release of March 8, 1965, accompanying H.R. 5916, stated that no legislative change is necessary to provide that the volume of transactions is not material in determining whether an inves- tor is engaged in trade or business in the United States since this is the rule under existing law. It is not believed that existing law in this regard is as clear as the Treasury release would indicate and it is therefore suggested that a specific clause be inserted in the proposed section 864(b) (2) affirmatively stating that the volume of securities or commodities transactions is not material in the deter- mination of whether an investor is engaged in trade or business within the United States. Income "effectively connected" with a U.S. trade or business The bill actually utilizes the "effectively connected" concept for two purposes. First, the concept is used to determine whether dividends, interest, royalties and other ordinarily "passive" types of income which are admittedly subject to United States tax are part of the income of a U.S. trade or business and properly subject to full rates of U.S. income tax or subject only to normally lower withholding tax rates. This use of the "effectively connected" concept parallels its use in the recent protocol to the U.S.-German Income Tax Convention and in the O.E.C.D. Draft Double Taxation Convention. To this extent the use of the concept is 1137 PAGENO="1148" 252 FOREIGN INVESTORS TAX ACT OF 1966. proper, and desirable, even recognizing the areas of question which underlie its interpretation. However, the bill then uses the "effectively connected" concept in a way in which it is not used in U.S. tax conventions or in the O.E.C.D. Draft. It is this second use of the concept which the Committee believes represents a serious and undesirable departure from present law. Under present law if a foreign corporation or nonresident alien is engaged in trade or business in the United States, then United States tax is imposed on the industrial and commercial income1 of that trade or business to the extent that it is "from sources within the United States." I.R.C. §~ 872(a), 882(b). The Code and Regulations contain fairly precise definitions of what is and is not income from sources within the United States and the case and other authority is now sufficiently clear so that definite answers can be given to the bulk of source of income questions arising in connection with industrial and commercial income. However, the bill would discard all of these established and well-understood rules and would treat as income of the foreign person's U.S. trade or business atl income "effectively connected" with that trade or business without reference to its "source". Proposed section 864(c) would provide a series of fairly amorphous "factors" which are to be "taken into account" in determining whether income is "effec- tively connected" with a United States trade or business. These "factors" provide no answers to the following everyday questions that will necessarily arise in applying the "effectively connected" concept. If goods are processed here and then shipped to a foreign country where they are sold through stores, with the benefit of extensive advertising, what part of the profit on sale is "effec- tively connected" with the trade or business carried on in the United States? What portion of the income from a sale of goods is effectively connected with the U.S. trade or business if goods are processed both here and abroad and then sold abroad? Suppose that the foreign corporation holds foreign patents, with- out which goods manufactured here could not be sold abroad. Does this affect the amount of income "effectively connected" with the U.S. trade or business? Suppose that a foreign corporation managed in this country operates oil fields throughout the world. What portion of its income is "effectively connected" with its U.S. trade or business? There would seem to be only two alternative solutions in each of the forego- ing cases. Either the entire income from the entire industrial and commercial income producing activity here and abroad is subject to U.S. tax or only part is so subject. If it is intended to subject all of such `income to tax, this certainly represents a drastic and questionable change in our tax system. If only part of the income from the entire profit-making activity is subject to U.S. tax then "source" rules will have to be provided and the bill simply becomes a vehicle for the rewriting of the source of income rules; and if this' is what is intended, the rules should be set forth specifically in the bill and should not be left to Com- mittee Reports or "guidelines." The Committee believes that this second and novel use of the "effectively con- nected" concept should not be adopted. Well-defined principles provided by the present source rules should be retained for purposes of determining what part of the industrial or commercial profits of a foreign person engaged in trade or business in the United States are to be taxed by the United States. This can be done by adding the words "from sources within the United States" after the words "gross income" in proposed section 882(b) (2) and after the words "gross income" the second time that they appear in proposed section 872(a) (2). Sim- ilar changes would be required in other provisions of the bill where the "effec- tively connected" phrasing appears. Adoption of the "effectively connected" concept will mean the imposition of United States taxes on income of foreign corporations not presently subject thereto; and as this occurs, the risk `of double taxation of the same include will increase notwithstanding the foreign tax credit and extension thereof proposed in section 6 of the bill. This provision would allow to foreign taxpayers engaged in trade or business in the United States a credit not presently allowed for foreign taxes imposed upon income "effectively connected" with the U.S. trade or business. The credit would not be allowed with respect to taxes which would not be imposed by the foreign jurisdiction but for the fact that the taxpayer was a citizen or resident of such country or was incorporated in that country. The Committee believes that it will be extremely difficult in many cases for taxpayers l The Code does not use the term industrial or commercial income. The term as used here provides a convenient description of the types of income which will be affected by this change in present law. PAGENO="1149" FOREIGN INVESTORS TAX ACT OF 1966 253 to demonstrate that a particular tax would not have been assessed but for the fact of the taxpayer's citizenship, residence or incorporation in the foreign jurisdiction. Non-resident aliens Section 3 would establish new rules for the application of the income tax to non-resident aliens. 1. The Committee believes that the following substantive changes are sound and are appropriately carried out by the proposed bill. (a) Non-resident aliens would be taxed separately on income effectively con- nected with a United States trade or business and income not so connected. Under the proposed bill, income not effectively connected with United States trade or business will be taxed at a 30 percent rate (or at a lower treaty rate, if applicable), and income which is effectively connected with a United States trade or business will be taxed at the regular graduated rate applicable to individuals. Under present law, the graduated rates apply only if non-resident aliens are engaged in trade or business in the United States or if their income exceeds $21,200. (b) A non-resident alien is not to be subject to United States tax on capital gains unless he is. here for more than 183 days during the year or unless such gains are effectively connected with a United States business. (c) Every non-resident alien, irrespective of w-hether he is engaged in busi- ness here, may elect to treat certain real property and mineral income as con- nected with a business in order to obtain deductions (such as depreciation and depletion) attributable to such income. 2. A majOr change proposed by the bill is that, in determining the taxation of a non-resident alien engaged in business here, an alien is to be taxed on his taxable income which is effectively connected with the trade or business con- ducted in the United States. While precise rules are not spelled out, it appears that the concept is intended to be broader than the present concept of gross income from United States sources. For the reasons stated in the discussion of Section 2 of the bill, it is believed that this change is inadvisable. 3. The withholding rules are amended to eliminate withholding on any item of income (other than compensation for personal services) which is effectively connected with conduct of a trade or business in the United States. It is believed that withholding should continue to be governed by the source of income rules, as these provide a much more objective and practicable standard for a withholding agent. At least, withholding should continue to be required with respect to dividends and interest. Under the proposed changes, there would be too great an incentive for persons to file false information with the withholding agent. 4. The definition of periodic income from United States sources (income sub- ject to 30% tax) would be expanded to include income from the sale or liquida- tion of a collapsible corporation (Section 341) and from original issue discount (Section 1232). The Committee believes that this extension of the definition of "periodic income" is inadvisable. The change would not result in any appreciable increase in tax collections, since the tax could easily be avoided by selling outside of the United States. Since it is sometimes difficult to know whether or not Section 341 or Section 1232 is applicable in the first instance, this expansion would tend to increase the uncertainty of taxation of non-resident aliens, which the proposed bill is supposedly designed to reduce. 5. As noted above, a non-resident alien may elect to treat income from certain real property as connected with a business in order to obtain the benefit of deductions attributable to such income. This election is equally applicable to a foreign corporation and the following comments are pertinent both to the election available to a non-resident alien individual and the election available to a foreign corporation. The Committee recommends that the election be extended to include personal property "associated" with the real property involved. For example, if a non- resident makes the election with regard to .a hotel subject to a net lease, such election would also relate to all personal property in the hotel subject to the lease, so that the non-resident woud not have one rule applying to the hotel lease and another rule applying to the lease of the personality associated with the hotel. Also, it is not clear whether the election would extend to interest from mortgages on real property. Under the various tax conventions mortgage interest, more often than not, is specifically excluded from the concept of "income from real property." It is therefore recommended that proposed Section 871 (d) (A) be amended to make it clear that interest from mortgages on real 1139 PAGENO="1150" 254 FOREIGN INVESTORS ~AXACT~ OF~I.~6:6 property is not "income from real property". A similar change should be made in proposed Section 882(d). Proposed Sections 873 (a) and 882(c) (1) (A), in providing for th.e allowance of deductions and credits in respect of United States income, limit the deductions to circumstances in which they are "effectively connected with the conduct of a trade or business within the United States." It is recommended that these proposed sections be changed by inserting "attributable to income" which is immediately preceding the phrase quoted in the preceding sentence, so that it is clear when an election is made to treat real property income as income connected with a United States business that such election effectively permits the non- resident to obtain the offsetting deductions, the purpose of the election in the first instance. Finally, the Committee questions whether the election under lections 871(d) and 882(d) should extend to gains described in present Code Section 631 (b) or (c). Since such gains are also defined as periodic income, it would appear that a nonresident individual or corporation would always make the election in order to obtain a lower effective tax rate and possible use of such deductions against other business income. Foreign corporations Under Section 4, a foregoing corporation engaged in trade or business in the United States, like a non-resident alien similarly so engaged, would be taxed as if it were a resident on its taxable income which is effectively connected with the trade or business conducted here. Again, it appears that the concept of "effec- tively connected with the trade or business" is intended to be broader than the present concept of gross income from United States sources. For the reasons stated in the discussion of section 2 of the bill it is believed that this change is inadvisable. Section 4(a). Taco on income not connected with United States business The title suggested for proposed Code section 881, "Income of Foreign Cor- porations not Connected with United States Business," fails to indicate, as it should, that a tax is imposed by that section. Accordingly, it is recommended that the section's title be amended by the addition of "Tax on" at the beginning thereof. Proposed *section 881(a) (1), reflecting changes made in proposed section 861(a) (1) (A), would eliminate from the category of nontaxable interest, inter- est on deposits with persons carrying on the banking business. For the reasons stated in the discussion of section 2(a) of the bill, it is believed that this change is inconsistent with the purpose of the bill to encourage foreigners to invest in the United States. Proposed section 881(a) also would expand the definition of periodic income from United States sources (income subject to 30% tax) to include income from the sale or liquidation of a collapsible corporation (section 341) and from original issue discount (section 1232). For reasons stated in the discussion of section 3 of the bill it is believed that this extension of the definition of "periodic income" is inadvisable. Section 4(b). Taco on income not connected with United States business It is recommended that the title to proposed section 882 be changed by adding at the beginning thereof the words "Tax on." It is recommended that sub- section (a) of proposed section 882 be changed to read as follows: "(a) Imposition of tax-A foreign corporation engaged in trade or business within the United States during the taxable year (or during any preceding tax- able year beginning after December 31, 1965) shall be taxable as provided in section 11 or 1201 (a) on its taxable income determined on the basis of its gross income as described in subsection (b) (2) ." The caption, "Imposition of Taxes," would be consistent with the caption to proposed section 881(a) and the intended limitation of taxable income can be accomplished without a separate paragraph. Proposed section 882(c) (1) (A), in providing for allowance of deductions and credits in respect of United States business income, limits the deductions to circumstances in which they are "effectively connected with the conduct of a trade or business within the United States." For reasons already given in respect of the similar provision affecting non-resident alien individuals in section 3 of the bill, it is recommended that the proposed section 882(c) (1) (A) be changed by inserting "attributable to income" immediately preceding the phrase quoted in the preceding sentence. 1140 PAGENO="1151" FOREIGN INVESTORS TAX ACT OF 1966 255 Proposed section 882(d) (1) (A) permits a foreign corporation to treat gains described iü present Oode section 631 (b) or (c) as income connected with a United States business. For reasons stated in the discussion of section 3, in respect of the simliar election granted to non-resident aliens, it is believed that this election in respect of section 631 (b) Or (c) income is not desirable. Proposed section 882(e) would seem to prohibit a direct filing of a return by a foreign corporation in the circumstances there described. It is recoin- mended that, in order to assure that the foreign corporation may itself file the return, the words "unless such return is made by such foreign corporation" be added at the end of the sentence. The withholding rules are amended to eliminate withholding on any item of income (other than compensation for personal services) which is effectively connected with the conduct of a trade or business in the United States. As stated in respect of section 3 of the bill it is believed that withholding should continue to be governed by the source of income rules. Section 4(b) (3) of the bill, containing proposed changes in the table of sec- tions for subpart B of part II of subchapter N of chapter 1, should be changed to reflect the above-recommended changes in the titles to sections 881 and 882. Thus, the words "Tax on" should be inserted at the beginning of the titles given for sections 881 and 882. Section 4(d). Dividends received from certain foreign corporations It is recommended that the amendment of section 245 (a) of the Code, as proposed in section 4(d) (1) of the bill, be changed by adding "total" before "gross income." Compare present Code section 542(c) (7) (A). The addition of "total" would seem to negate any. argument that the various statutory exclu- sions applicable to gross income of foreign corporations, see, for example, present Code section 883, should be taken into account in determining gross income for this purpose. Section 4(f). Corporations subject to personal holding company taa~ The proposed section 542(c) would change the present rule for excluding certain foreign corporations from classification as a personal holding company. Under the proposed rule indirect ownership by non-resident alien individuals through foreign estates, foreign trusts, foreign partnerships as well as through other foreign corporations would be taken into account. It is unclear why attribution through partnerships is limited to foreign partnerships. It is rec- ommended that the word "foreign" immediately preceding "partnerships" be deleted. Section 4(g). Foreign corporations carrying on insurance business in the United States It is recommended that the title to proposed section 842 be changed by adding at the beginning thereof the words "Tax on". A corresponding change would be required in paragraph (2) of section 4(g) of the bill, which would amend the table of sections for Part IV of subchapter L of chapter 1 of the Code. Estate and gift tacees The Task Force recommended the elimination of the federal estate tax on intangible property of nonresident alien decedents. It is widely believed that the estate tax is a significant deterrent to foreign investment in United. States securities. Nonetheless, the Treasury decision in presenting. H.R.. 5916 to retain an estate tax with relatively large exemption ($30,000) and with relatively low rates (a maximum of 15% and only 5% on the first taxable $100,000) was proba- bly warranted. The Committee takes no position regarding the desirability, from the standpoint of encouraging United States investments, of the proposed maximum 25% rate instead of the 15% maximum rate proposed in H.R. 5916. Section 8(b) would provide a new technical limitation on the credit for state death taxes. Though arguments can be made as to a limitation keyed to the kind of limitation that a domiciliary of the United States might have, in the context of a bill designed to reassure foreigners with respect to the low impact of death duties in this country, the introduction of any such limitation seems undesirable. In addition, the limitation may operate somewhat unevenly depend- ing upon how many intangible assets the decendent had which were not assign- able to any state of the United States. Section 8(c) would amend Section 2104 to make it clear that:where a debt obligation of a United States obligor is owned by a non-resident alien, the obliga- tion shall be treated as property within the United States no matter where it Is 1141 PAGENO="1152" 256 FOREIGN INVESTORS TAX ACT OF 1966 located. However, it should also be made clear that a foreign obligation phy- sically located in the United States will not be treated as property within the United States, a result which would be only a logical extension of the proposal with respect to United States obligations. The same comment can be made respecting section 9(b) which would amend section 2511(b) to set forth similar situs rules in the gift tax area. Ea~patriation Sections 3(e), 8(f) and 9(a) contain alternative provisions designed to penalize for income, estate and gift tax purposes, certain persons who sur- render their United States citizenship for the purpose of reducing their U.S. taxes. The Task Force on Promoting Increased Foreign Investments did not recommend such penalties and it may be questioned whether, on the one hand, the position of nonresident aliens is so greatly improved by the bill that U.S. citizens not otherwise prcmpted to expatriate themselves for tax reasons will now be induced to do so or, on the other hand, whether the penalties themselves are severe enough to prevent significant tax advantage from being gained for such surrender-as to justify adding these complexities and uncertainties to an already overburdened Code. How, for example, can the Commissioner, with any semblance of uniformity of treatment, proceed to establish that "it is reasonable to believe" that an expatriate would have gained, but for proposed section 877, a "substantial" reduction of taxes on "probable income" for the year? In the case of e$tate tax on expatriates, would the "substantial" reduc- tion in taxes be computed by reference to assets owned at expatriation or those owned at death, possible ten years later? Enforcement of such a provision can hardly be uniform; and lack of uniformity is further suggested in the exception provided for cases of dual citizenship. Moreover, it seems questionable whether, from a national policy standpoint, the United States should undertake such measures against persons willing to surrender their citizenship. Section .3(e). Expatriation to avoid tax It is recommended that the title of proposed section 877 be changed to "Tax on Certain Expatriates". Compare titles of other sections in part II of sub- chapter N of chapter 1, particularly sections 871, 881 and 882. The clause starting with "if the tax" in the last two lines of subsection (a) of section 877 should be changed to read as follows: "if the tax for the taxable year computed pursuant ot such subsection exceeds the tax for the taxable year computed without regard to this section." In making computations to determine the applicability of an alternative tax it would not seem appropriate to speak of a "tax imposed". See, e.g., section 1341 (a) of the Code. In the second line of subsection (c) (1) of proposed section 877, "debt obliga- tions" (in the title and text) should be changed to "evidences of indebtedness", in order to conform to the terminology used in other areas of the Code, e.g., sections 164 and 1232. Section 8(f). Special methods of computing estate tax It is recommended that the title of section 2107 be changed to "Tax on Estates of Certain Expatriates". Section 9(b). Gift tax transfers In subsection (b) (2) of section 2511 "debt obligations" should be changed to read "evidences of indebtedness". STATEMENT OF THE COMMITTEE ON FEDERAL TAXATION OF THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, SUBMITTED BY DONALD T. BURNS, GENERAL CHAIRMAN OF THE COMMITTEE COMMENTS AND RECOMMENDATIONS REGARDING H.R. 13103, FOREIGN INVESTORS TAX ACT OF 1966 General Comments HR. 13103 is a modified version of H.R. 11297 which, in turn, was a modified version of H.R. 5916. Frankly, we believe that the previous successive modifi- cations have overly diluted the original intent of the legislation, which was to encourage foreign investment in the United Stales, and thereby improve the U.S. balance of payments. 1142 PAGENO="1153" FOREIGN INVESTORS TAX ACT OF 1966 257 H.R. 5916 was designed to stimulate foreign investment in the United States by removing existing tax barriers to such investment. It would have revised or eliminated many of the provisions in the present law which tended to complicate or inhibit investment in U.S. securities. For this reason, the Institute's coin- mittee on federal taxation favored the proposed legislation, although in its com- ments submitted to the Committee on Ways and Means of the House of Repre- sentatives on June 25, 1965 it recommended certain changes and clarifications. The new version of the bill, H.R. 11297, differed dramatically from its predeces- sor. It introduced an entirely new idea of taxing foreign source income under an elusive "effectively connected" concept, provided for the income and estate taxation of deposits in U.S. banks, and provided for higher estate tax rates on nonresident alien decedents. The specific factors which led to the adoption of such changes were not made clear. The Institute's committee on federal taxa- tion opposed such changes In comments submitted to the House Ways and Means Committee on January 12, 1966. H.R. 13103 modified considerably the objectives of the initial bill. On page 6 of the report of the House Ways and Means Committee it is stated, "While the initial bill proposed by the Treasury Department was designed primarily to stimulate investments by foreigners in the United States, your Committee con- sidered more generally the tax provisions of present law affecting nonresident aliens and foreign corporations." H.R. 13103 as presently constituted does eliminate some of the objectionable provisions of H.R. 11297; however, H.R. 13103 still contains proposed amend- ments to the current law that we feel are highly questionable: 1. The introduction of an entirely new concept, that non-resident aliens and foreign corporations engaged in trade or business in the United States would be taxed on certain foreign source income as well as U.S. source income "effectively connected" therewith. Current law taxes such persons on their United States source income only. 2. After 1971, interest on United States bank deposits would be subject to United States tax although paid to persons not engaged in business here. 3. United States bank deposits would be included in the gross estate of non- resident alien decedents even though not engaged in business in the United States. Introduction of these new concepts and other changes and the uncertainties created thereby will have the effect of: a. Forcing foreign controlled businesses with operations in the U.S. to re- locate those operations outside the Uinted States, thus resulting in the loss of commercial contacts in the U.S., possible loss of exports, jobs, etc. b. Causing foreign businesses to change plans for opening operations in the U.S. due to the complexity of U.S. tax laws. c. Forcing the withdrawal of foreign deposits in U. S. banks, and stopping the further flow of funds to the U.S., thus aggravating our cur~rent serious balance of payments problem. We are aware of the many complex problems inherent in the preparation of this legislation, but we strongly feel that many of the proposed changes in existing law will adversely affect the U;S. economy. Specific Comments and Recommendations Bill section 2 1. Proposed code section 861 (a) (1) (A) and 861(c) Interest on U. S. bank deposits (page 4, lines 9-14; page 5, lines 1-21): The effect of the proposed amendments would be to broaden the exemption from U.S. tax for certain interest income for a five year period, but would subject interest on U.S. bank deposits and similar amounts to withholding of tax at source with respect to payments after December 31, 1971. There are two obvious reasons for questioning the proposed withdrawal of the exemptions: 1. The basic exemption which has been in force since 1921, has been considered desirable to encourage the use of U.S. banks by foreign persons for deposits and financial transactions. 2. The nexus of such taxation of income from U.S. bank deposits' is so slender as to raise doubts as to the rationale for the change. While the imnosition of tax would be delayed for several years, it is not con- sidered desirable because it creates another complication regarding investment in the United States. Such complications certainly act as a current psychological deterrent to U.S. investment by nonresident aliens, even though the actual im- pact of U.S. withholding tax will not occur until 1971. 71-297 0-67-pt. 1-73 1143 PAGENO="1154" 258 FOREIGN INVESTORS TAX ACT OF 19 66 Bill section 3 2. Proposed code section 871 (a) Subject of the tax on non-resident alien individuals (page 18, lines 3 and 17) In proposed Section 871 (a) (1), the words "gross" income should replace the words "amount received." In Regulations Section 1.871-7(b) (1) there is the following clarification: "For the purpose of Section 871(a) (1) `amount received' means `gross income'." 3. Proposed code section 871 (a) (Page 18, lines 5-7) : This proposed subsection describes the kinds of income not connected with a United States business which shall be subject to tax at the rate of 30 per cent. It repeats the enumeration of the types of income presently described in Section 871 (a) (1), including the words "salaries," "wages," "compensations," "remunerations," and "emoluments." Under pro- posed Section 864(b) the performance of personal services within the United States will constitute engaging in a trade or business within the United States except under certain limited circumstances. Remunerations for such personal services, therefore, would be taxed at graduated rates under proposed Section 871 (b) as income effectively connected with the c nduct of a trade or business within the United States. Accordingly, proposed Section 871 (a) should be revised to exclude the terms cited above which are descriptive of payments for personal services. 4. Proposed code section 871 (a) (2) Determination of capital gains of aliens present in the United States 183 days or more (page 18, lines 20-24; page 19, lines 1-24) : It is assumed that the intent of the Bill is to subject nonresident aliens who `are present in the U.S. for 183 days or more during a year to a 30% rate of tax. This provision places such an alien in a disadvantageous position in comparison with a domestic investor, because under the provisions of lines 11-15, page 19 the capital gain deduction and capital loss carryover provisions are not to be allowed. While the 183 days is a liberalization of current law, there should be further relief. We recommend that the rate of tax be 25 per cent and that consideration be given to allowing the deduction of capital loss carryovers. 5. Proposed bill section 871 (b) and 882 Income "effectively connected" with a U.S. trade or business (page 20, lines 3-8, and page 37, lines 8-13): It is proposed that nonresident aliens and foreign corporations engaged in trade or business within the United States would be subject to regular rates of tax on certain foreign source as well as U.S. source income "effectively connected" with such trade or business. This is the most questionable provision in the bill because it represents a drastic extension of U.S., taxing jurisdiction and unduly complicates U.S. taxation of foreign persons. Heretofore foreign corporations and nonresident alien individuals engaged in trade or business here have been subject to U.S. income tax only on U.S. source income. It has been said that the adoption of the "effectively connected" concept is in accord with the OECD Model Income Tax Convention and with our new treaty approach as evidenced by the recent protocol with Germany. Our study of these documents and of the reports of the Department of State and of the staff of the Joint Committee on Internal Revenue Taxation on the German protocol has disclosed no indication, that foreign source income would be taxed. Article III of the Convention with Germany as amended, dealing with the tax- ation of the industrial or commercial profits of an enterprise, does not even use the term "effectively connected" and Article XV, dealing with the avoidance of double taxation, limits the allowable tax credits and/or exclusions from taxable income to' income having its source in the other country. We believe that enactment of H.R. 13103 could lead to serious problems of double taxation, particularly with. regard to foreign siib~sidiaries of U.S. corpora- tions. If such foreign subsidiary were subjected to U.S. taxes under this prin- ciple, double taxation would result when the U.S. parent corporation receives dividends from the subsidiary since no credit is permitted for U.S. income taxes paid by a foreign corporation. (Relief under the proposed Section 245 would in most cases be wholly inadequate.) It is recognized `that a motivating factor in this proposal to tax foreign persons engaged in trade or business in the United States on certain of their foreign source income is concern that otherwise tax avoidance may be permitted. We do not believe that major U.S. tax avoidance 1144 PAGENO="1155" FOREIGN INVESTORS TAX ACT OF 1966 259 does result under the existing provisions for taxation of such foreign persons. The Treasury has various ways of dealing with efforts to avoid U.S. income taxes, such as Section 482, arrangements under various income tax treaties, and its ability to challenge such devices as the mere arrangement of title passage out- side the United States for tax avoidance purposes. The majority of our existing tax treaties contain provisions which limit the imposition of tax to income from sources within the taxing country. These include Australia, Austria, Denmark, Finland, Greece, Honduras, Ireland, Italy, Japan, Luxembourg, New Zealand, Norway and Switzerland. Since H.R. 13103 provides that the changes which it would make in U.S. tax law would not con- travene any existing treaties, the treaties with the above-named countries would require amendment before the foreign source income of their corporations could be taxed by the United States. The foreign tax credit proposed under new Section 906 would not be allowed for taxes paid to a country solely by reason of the foreign person being domiciled there for tax purposes. This can obviously result in double taxation where the country of domicile imposes limitations on allowable credits for foreign taxes which are similar to the United States rules. In such a case, where the United States taxes income which is derived from a third coimtry, the country of domicile would not permit a foreign tax credit for the U.S. taxes paid on income derived from the third country. It should be noted that the foreign source income which may be taxed under the "effectively connected" provisions may be greater than that actually com- mensurate with the functions performed by the office in the United States. The uncertainties and possible tax inequities resulting from the "effectively connected" concept will most likely discourage U.S. portfolio investment by for- eign persons engaged in trade or business here, because in many cases they could not be sure of obtaining the generally lower rates of tax on investment income. For the foregoing reasons we believe that it would be preferable to provide that a foreign corporation or a nonresident alien individual engaged in trade or busi- ness in the United States be taxed at regular rates only on its U.S.-source income "effectively connected" with the U.S. trade or business. Bill section 4 6. Proposed code section 882(c) (2) * Softening of provision disallowing all deductions for failure to file a return (page 39, lines 1-12) : The disallowance of all deductions and most credits for failure to file a return under proposed Section 882(c) (2), is an unusually harsh provision. Even though this provision is a part of the present law, the purposes of the Bill would seem to indicate that the provision should be softened. 7. Proposed code section 245(a) Dividend received deduction (page 43, lines 5-24; page 44, lines 1-9) : Consid- eration should be given to permitting a 100 per cent dividends received deduction to U.S. corporations with respect to an 80% or more owned foreign subsidiary to the extent that the distribution is entitled to a dividend received deduction, other- wise an up-stream dividend tax will be unjustly imposed. It should also be ob- served that the qualifying period under proposed Section 861 (a) and amended Section 245 continue to be different. We also urge that Code section 245 be amended to substitute the term "10 per cent" wherever the term "50 per cent" presently is used. This would permit a fractionalized dividends received credit in the majority of cases and would ameliorate, atihough not eliminate, the double taxation problems which we have described above. Bill section 6 8. Proposed code section90l(c) and 2014(k) Consistency in provisions requiring thirty-day notice prior to Presidential proclamation (page 66, line 15, and page 67, line 19; ef. page 55, lines 8-12 and page 79, lines 8-12: To be consistent with proposed Section 896 and 2108, pro- posed Sections 901(c) and 2014(h) should require a thirty-day notice to Con- gress before a proclamation is made by the President. 9. Proposed code section 904(f) (2) Foreign tax credit in case of certain overseas operations funding subsidiaries (page 68, line 9 through page 70, line 2): The amendment would make the present "per country" limitation with respect to interest income inapplicable to interest 1145 PAGENO="1156" 260 FOREIGN INVESTORS TAX ACT OF 1966 received by an "overseas operations funding subsidiary" on obligations of a "related foreign corporation." The provisions of this section are too restrictive. It is recommended instead *that the provisions of Section 904(f) (2) (c) be amended to provide an exception for interest received from a corporation in which the taxpayer or an affiliated corporation owns directly or indirectly at least 10% of the voting stock. Bill section 8 10. Proposed code section 2101 (a) Rate of estate tax on nonresident alien decedents (page 71, lines 19-21 and page 72, lines 1-2): The Fowler Task Force Report contained a recommendation to "eliminate U.S. estate taxes on all intangible personal property of nonresident alien decedents." We believe this recommendation should be followed. As pointed out in the report: "Under existing U.S. tax law, a foreigner willing to go therough the expense and trouble of establishing a personal holding company, incorporated abroad, and assuring himself that this personal holding company does not run afoul of the U.S. penalty taxes or undistributed personal holding company income, can already legally avoid estate taxes." The possibility of using such a holding company would be made even easier due to a provision in the bill which would exempt from the personal holding company tax a foreign corporation if all of its stock is owned by foreigners. Sophisticated investors may take advantage of this means of escaping estate tax; others will reject the complications and additional costs. It would seem preferable to enable both types of investors to acquire U.S. securities without concern for a substantial U.S. estate tax. 11. Proposed code section 2105(b) Inclusion of bank deposits in the gross estate (page 74, lines 3-7) : The bill would remove the existing exemption from the gross estate for U.S. bank deposits owned by a nonresident alien decedent who was not engaged in business in the United States at the time of his death. This provision should be eliminated from the bill since, if enacted, it is likely to have an immediately adverse effect on the U.S. balance payments. The exclusion of bank deposits from the gross estate would also result from the adoption of the recommendation in item 9 above. In any event, as far as bank deposits are concerned, the proposed inclusion in the gross estate is clearly in the wrong direction. COMMENTs OF THE WORLD TRADE CENTER IN NEW ENGLAND, INC. ON HR. 13103 SUBMITTED BY PATRICK FITZPATRICK, PRESIDENT I. SUGGESTIONS FOR TECHNICAL CHANGES IN H.R. 13103 1. H.R. 13101 proposed to substitute for the term "resident foreign corpora- tion" in section 882 of the Internal Revenue Code the new concept "effectively connected with the conduct of a trade or business within the U.S." Consequently, sections 861 (a) (1) and 861 (a) (1) (B) which still refer to "resident foreign corporations" require conforming amendments. 2. H.R. 13103 provides for the addition of section 896 to the Internal Revenue Code which, under appropriate circumstances, makes the existing provisions in Subchapter N and Chapter 3 of the Code applicable. Due to the fact that H.R. 13103, however, does not limit itself to the revision of rules within these men- tioned areas of the Code, but also proposes changes of provisions that fall out- side of Subchapter N and Chapter 3 (for example, section 542 relating to per- sonal holding companies), it seems likely that it was not intended to restrict the application of this new section 896 to Subchapter N and Chapter 3. Moreover, other Code provisions outside of this area which are changed by this bill, such as section 245 relating to the dividends received deduction, could not be applied reasonably in their revised form if other related rules such as section 861 (a) (2) (B) are applied in their present form. For these reasons, we respectfully sug- gest that section 896 be appropriately amended. 3. H.R. 13103 proposes to add a new subsection (c) to section 2104 of the Code which refers to "debt obligations owned by a nonresident alien." This should be contrasted with the langpage of section 2104(a) dealing with the situs of stock "owned and held by a mionresident alien." As it seems doubtful that it was in- 1146 PAGENO="1157" FOREIGN INVESTORS TAX ACT OF 1966 261 tended to attract different meanings to these two subsections, we respectfully suggest a conforming amendment. 4. Similarly, HR. 13103 and a new subsection b to section 2105 of the Code and a new subsection D to section 861 exempting "deposits with a foreign branch. * * * If such branch is engaged in the commercial banking busi- ness * * i" from U.S. estate and income taxation. As the present subsection 2105(b) simply requires that the money be deposited with any person "carrying on the banking business", it is not clear whether any change was intended by this new language. The Report of the Committee on Ways and Means is silent in this respect. 5. According to the proposals of H.R. 13103 the revised section 952(b) of the Code would include in Subpart F income an "effectively connected" item of income "exempt from taxation (or * * * subject to a reduced rate of tax) pursuant to a treaty obligation of the United States." In view of the fact that a number of U.S. tax treaties, e.g. U.S. tax treaties with the United Kingdom, Germany and Switzerland, subject income from real property to reduced tax rates both because the statutory rate may be reduced and because the effective rate may be lowered by changing the tax base from gross to net income, and in view of the possible election under section 871(d) and 882(d), this type of income would still fall within the ambit of Subpart F. As there is no apparent reason for this discrimination, it seems probable that it was not intended to except this category of income from the Subpart F exclusion. If this assump- tion is correct, another reference would have to be added to section ~52 (b) such as: "Subpart F income also does not include income from real property for which an election is made under section 871(d) or 882(d) or which is subject to net income taxation under a comparable provision in any treaty of the United States." 6. According to the Report of the Committee on Ways and Means (p. 1), H.R. 13103 is intended to revise systematically the U.S. tax treatment of non- resident aliens and foreign corporations. For this reason the meaning of section 872(b) (1) and (2) as well as section 883 should be clarified with respect to the "reciprocity" requirement in view of the fact that two possible criteria are applicable, namely, (a) place of incorporation (or perhaps fiscal residence of a corporation) and (b) place of documentation. The ambiguous state of the present law can best be illustrated by the following example, which assumes that foreign corporation A owns ships documented under the laws of country X and country X grants a tax exemption to U.S. corporations with respect to income from the operation of ships documented in the U.S. As applied to these facts, it is not clear whether section 883 provides that the U.S. on the basis of reciprocity ~vill grant an exemption to corporation A only if A is incorporated under the laws of X or regardless of where it is incorporated? Furthermore, Congress should review the policy objectives of these provisions and then determine how the U.S. would interpret the reciprocity concept if country X in our above example were, for instance, to expand the exemption it grants to U.S. corporations to cover income from the operation of ships regardless of where documented. Would the U.S. want to reciprocate by granting an ex- emption to corporation A regardless of where it is incorporated or would it rather deny any exemption to corporation A on the theory that the U.S. only wants foreign countries to exempt U.S. corporations with respect to income from the operation of ships documented in the U.S.? Based on present law, these questions cannot be satisfactorily answered so that we respectfully suggest that Congress use this opportunity to clarify these problems. 7. Finally, it is submitted that section 864(b) (2) (A) (ii) should be recirafted so that.the statute itself explicitly clarifies the tax treatment of foreign invest- ment companies having their principal office within the U.S. This would make it unnecessary to refer to the legislative history which, at present, is the only source dealing with this problem. II. SUGGESTIONS FOR SUBSTANTIVE CHANGES IN H.R. 13103 1. "Effectively ccmnected" concept H.R. 13103 introduces the new concept of "effectively connected" income as a means to- (1) distinguish between business and investment income, and (2) determine the amount of business income that is subject to the regular progressive 15.5. tax rates. According to the legislative history of this bill, the first purpose was to encourage foreign investment in the U.S. by having investment, income taxed at only 30 1147 PAGENO="1158" 262 FOREIGN INVESTORS TAX ACT OF 1966 per cent (or the lower applicable treaty rate) whether or not the foreign owner is engaged in business in the United States. The second purpose was to prevent abuse of the American source rules by foreign corporations which use the U.S. as a tax haven. An analysis of the origin of the "effectively connected" concept reveals that this is no term of art. This expression, which did not appear in any of the Model Tax Conventions of the Fiscal Committee of the League of Nations, was appar- ently used for the first time in art. 10, para. 4, art. 11, para. 4 and art. 12, para. 3 of the Draft Double Taxation Convention on Income and Capital of 1963 pre- pared by the Fiscal Committee of the Organization for Economic Cooperation and Development (OEOD). In recent times this expression has also been used in the income tax treaties of the U.S. with Germany, the Netherlands and the United Kingdom in connection with the allocation of earnings and profits to a permanent establishment.' It appears that the expression "effectively connected" is the English translation of the prevailing European concept concerning the attribution of dividends, in- terest and royalties to a permanent establishment. This is confirmed by the fact that the OECD Draft Convention, which first made use of this term and pre- dominantly reflects the views of its European members states, also employs this concept for delimiting certain categories of income, namely, dividends, interest and royalties to be attributed to a permanent establishment. If such dividends, interest and royalties are not "effectively connected" with the permanent estab- lishment and, therefore, do not constitute "business profits" of the permanent establishment within the ambit of art. 7 of the OECD Draft Treaty, they are not taxable in the state in which they arise (i.e. in the state of the permanent estab- lishment) but rather in the state of the recipient. This same rule is also to be found in the U.S. income tax treaties with Germany and the United Kingdom. In the light of this historical background it appears that H.R. 13103 proposes to incorporate the existing treaty law with regard to the distinction between business and investment income into domestic tax law. This transposition is apt to cause increased complexities because of its effect upon the traditional source rules in the U~S. Code. The distinction between business and investment income means that one type of income, e.g. royalties, may have two different sources depending upon whether in the particular facts it is business income effectively connected with a permanent establishment or investment income not effectively connected with a permanent establishment. It is this relation to the traditional source rules that could lead to unnecessary theoretical and practical difficulties. Such difficulties may arise if the provisions of HR. 13103 according to which the President may under certain circumstances cancel the benefits of this bill prove effective in causing other countries to adopt this system of taxing foreigners. Thus it is conceivable that two foreign countries might tax someone who is a "foreigner" as to both of those countries on the same income. For example, the royalty income of a U.S. citizen may be taxed by France and Switzerland because it has its source in France as business income of a permanent establishment in France and also has its source in Switzerland as investment income paid by a resident of Switzerland. If this occurs, double taxation can only be avoided, if France agrees to adopt something like a sect. 906 credit which is unlikely in view of its present tax system. In addition, it is hard to understand why H.R. 13103 limits the application of the "effectively connected" concept to three specific types of foreign source income, namely rents and royalties, dividends and interest derived in the active conduct of a banking or similar business and certain sales income attributable to a U.S. sales office. In the interest of maintaining a logically structured tax system, we therefore recommend that Congress abolish the "effectively connected" concept altogether or else at least limit its application to U.S. source income. It should then consider possible changes in the domestic source rules with regard to dividends, interest, royalties and sales income. In this respect it is to be observed that the Report of the Ways and Means Committee does not explain why these source rules cannot be revised so as to prevent their present abuse. One such revision, for instance, might be to substitute the "destination" test for the `Cf. art. 6~ para. 7; art. 7~ para. 3; art. 8, para. 4; and art. 16A, para. 2 of the treaty with Germany, art. 7, para. 3; art. 8, para. 2, and art. 9, para. 3 of the Suppi. Prot. of December 30, 19S5, to the treaty with the Netherlands; art. 6, para. 4 and 5; art. 7. para. 3 and art. 8, para. 3, of. the Suppl. Prot. of March 17, 1956, to the treaty with the United Kingdom. 1148 PAGENO="1159" FOREIGN INVESTORS TAX ACT OF 1966 263 present "passage of title" test in the case of sales income. Such a change would not only present abuse of the source rules but would also favor exports and discourage imports thereby alleviating to some extent the present balance of payments problem. Another objection against the "effectively connected" concept is that it provides no answer to the question whether a foreign corporation could be engaged in more than one "trade or business". If, for instance, a foreign corporation selling merchandise to other foreign countries through a U.S. sales office is deemed to have realized sales income "effectively connected" with its U.S. place of business and at the same time also earns U.S. source service income through another one of its U.S. offices, it is not clear whether H.R. 13103 would allow the separate taxation of income from each "business activity", or `require an aggregate taxa- tion of both the sales and services profits. Apart from the above-mentioned objections, which alone would justify the elimination of the "effectively connected" concept, the practical application of this concept also presents formidable difficulties. Due to the fact that this concept had its origin in various international tax treaties which have been in existence for some time, it was possible for the Report of the Ways and Means Committee to lay down rather specific guidelines, which presumably would be incorporated in regulations, for determining `when U.S. source income would be "effectively connected" with a business and when it would be derived from investments. By contrast, it apparently was not possible for the Ways and Means Committee to lay down guidelines for application of the "effectively connected" concept `to foreign source income. This may be due to the ~act that there is to our knowledge no other tax system which allows the "effectively connected" concept to supersede or conflict with domestic source rules. This in turn may be the reason why the Committee Report limit's itself to the statement (p. 63) that one or another factor alone will not suffice to subject certain foreign source income to U.S. taxation and failed to give any general rules that could serve as guidelines for future judicial or administrative interpretation. This, of course, makes it impossible to foresee `the future implications of this concept to foreign source income. For these reasons it is respectfully submitted that the "effectively connected" concept should `be eliminated from HR. 13103 altogether, or at least limited in its application *to U.S. source income. Under no circumstances should it be permitted to conflict with or supersede traditional U.S. source rules which could well be amended to prevent abuses from the use of the U.S. as a tax haven. 2 Tacoation of interest paid on deposits of foreigners H.R. 13103 would subject currently exempt interest on U.S. bank deposits of nonresident aliens and foreign corporations to U.S. income taxation. Such tax would go into effect on January 1, 1972, and would be collected by withholding at source. Legal, economic and administrative considerations militate against the enact- ment of this provision. The Report of the Ways and Means Committee states that the primary reason for the proposed change of this source rule was "that it is questionable whether interest income of this type, which is so clearly de- rived from U.S. sources should be treated as though derived from sources; with- out the U.S. and `thereby escape U.S. taxation" (Report p. 7). In view of the fact that the majority of the developed European Countries, such as France,2 Holland,3 Sweden and the United Kingdom,5 which play an important role in the capital markets of the world, `do not, impose similar taxes, there is an over- riding economic argument against the tax, namely, tha't of a free flow of capital. There can be no doubt that the enactment of this proposed provision would create a barrier against the inflow of capital into the U.S. and encourage the withdrawal of substantial bank deposits from this country. It seems strange for the United States, with its serious balance of payment deficit, to change a long existing source rule which now conforms to that of many of the developed countries of the world, for purely formalistic reasons. Furthermore, such a change does not even seem justifiable from an equitable point of view as `there is no reason why residents and citizens should be treated in the same manner as nonresident aliens since they do not receive the same measure of benefits from the United `States government. ~ World Tax Series, Taxation in France, p. 753 and chapt. 9/1.2e. Amended Income Tax Law of 1941, Part V, Chapt. 1. World Tax Series, Taxation In Sweden, chapt. 11/4.10, p. 487. 6 Revenue Act 19~2. 1149 PAGENO="1160" 264 FOREIGN INVESTORS TAX ACT OF 19 66. By imposing this proposed tax the average net return on U.S. bank deposits owned by foreign corporations and nonresident aliens will be reduced by 30 per cent (or lower applicable treaty rate). If the tax were to be 30 per cent, the return on the deposits in the U.S. would equal about half of the return that could be earned on the European Euro~do11ar market. This fact, as well as the loss of secrecy due to the information requirements that are necessarily con- nected with the imposition of a withholding tax, will undoubtedly drive a great number of foreign investors out of U.S. banks and into the hands of foreign institutions, a development which is neither in the international interest of the balance of payments nor in that of the domestic U.S. economy. Although the delay in the effective date of this provision would alleviate the problem, it is to be expected that new U.S. bank deposits of foreigners would be greatly reduced and that existing deposits gradually withdrawn because of this provision. Whether the withdrawn funds would reappear in other forms of U.S. investments is highly speculative. Certainly the proposed tax would be an important unfavorable factor in our balance of payments problem. Finally, H.R. 13103 would require U.S. banks, acting as withholding agents, to determine whether or not the interest they would pay on foreign owned de- posits would be "effectively connected" with the U.S. business of the depositor. Not only would this requirement impose an extremely heavy administrative burden on U.S. banks but it would necessitate their clerical staff to pass upon an intricate and difficult legal question exceeding their professional capabilities, or obtaining expensive legal opinions. Furthermore, it seems doubtful whether these banks would be able to collect the necessary factual data to enable them to reach a decision in a specific case. There can be no doubt, therefore that this proposed change of U.S. source rules is neither necessary nor justified, but on the contrary would cause severe economic damage to the economy of this country. 3. Estate taxation of foreign bank deposits In addition to taxing the interest paid by U.S. banks on deposits of non- resident aliens and foreign corporations, H.R. 13103 if enacted would subject such deposits to the U.S. estate tax. In view of the fact that this bill was originally intended to encourage foreign investment in the U.S., it is difficult to understand why this provision is included in the bill. As contrasted with the postponement of the effective date of the income taxation of interest on U.S. bank deposits of foreigners (to avoid an im- mediate adverse effect on the balance of payment problem) the estate tax on such bank deposits would go into effect immediately upon the enactment of this bill. This immediate effect would at least neutralize any advantages resulting from the delay in the income taxation of the interest on bank deposits. Most foreign investors who will be looking for new investment possibilities for the period after 1971 would certainly not be willing to run the risk of being subject to the estate tax during this transitional period. It would be desirable, there- fore, to eliminate this provision. 4. Net tas'ation of nonresident alien individitals H.R. 13103 finally provides for a flat 30 per cent withholding tax on the invest- ment incom.e of nonresident aliens and also gives such taxpayers the option of elected to be taxed on a net bas.is with regard to their income from real property. Apart from the fact that it seems difficult to justify taxing the income of non- residents at a higher rate than that of people living in this country who enjoy the benefits of citizenship and residence, there also seems to be lititle merit in limit- ing the optional net taxation of nonresident alien individuals to real property income. For these reasons we respectfully suggest amending H.R. 13103 so that nonresident alien individuals* could elect to have all their U.S. source income taxed on a net basis. This amendment would furthermore be consistent with the present withholding system on all fixed or determinable income and all other income described in section 1441 (a) and (b) of the Code inasmuch ~s it would require the affected taxpayer who wished to be taxed on a net base to apply for a refund. In addition, the newly created section 896 providing for reinstatement of present rules if a foreign country proves recalcitrant could always serve as a means of avoiding any unfavorable effects of such a provision. 1150 PAGENO="1161" FOREIGN INVESTORS TAX ACT OF 1966 265 CLARK EQUIPMENT Co., Buchanan, Mich., August 5, 1966. Subject: H.R. 13103 ("Foreign Investors Tax Act of 1966"). Hon. RUSSELL B. LONG, Chairman, &~nate Committee on Finance, $enate Office Building, Washington, D.C. Sia: I am taking this opportunity to protest to you certain provisions cur- rently incorporated in H.R. 13103 ("Foreign Investors Tax Act of 1966") which is now before your Committee for consideration and recommendation. I would first call to your attention the language found in Sec. 2, subsection (d) paragraph (4), subparagraph (D) of such Bill (beginning on page 16, line 16 of the June 16, 1966 printing of HR. 13103) as follows: "(D) No income, gain, or loss from sources without the United States shall be treated as effectively connected with the conduct of a trade or business within the United States if it * * * (ii) is subpart F income within the meaning of section 9520a ~." In analyzing such exclusion from the "effectively connected" income category, House Report No. 1450 states, at page 68 thereof: "Clause (ii) of subparagraph (D) provides for the exclusion of any income from sources without the United States which is subpart F income within the meaning of section 952(a) of the code. Under that section a foreign corporation can have subpart F income Only if it is a controlled foreign corporation within the meaning of section 957. `In general, the subpart F income of a controlled foreign corporation is includible in the income of its shareholders who are U.S. shareholders within the meaning of section 951(b). However, exceptions to this general rule are provided by sections 951 (c) and (d) and 963 of the code * * However, income of a controlled foreign corporation will not be considered subpart F income for purposes of clause (ii) of subparagraph (D) if it is ex- cluded from subpart F income by any provision of subpart F of part III of subchapter N of chapter 1 of the code." (My emphasis.) Insofar as the above-quoted language might `be construed to exclude from the relief of clause (ii) of said subparagraph (D) sums excluded from gross income "with respect to the subpart F income of a controlled foreign corporation" by eason of its making an appropriate minimum distribution `pursuant to the pro- `isions of Section 963 of the code (found in subpart F of part III of subchapter N of chapter 1 of `the Code), it is respectfully requested that your Committee clarify the intent of the Congress as to the applicability `Of clause (ii) of said ubparagraph (D) to a Section 963 situation. I `would, at this time, respectfully submit that income which is otherwise sub- tart F income should not lose its character as such merely because of a minimum distribution under section 963, and the `Congress should not allow the well easoned and appropriately based relief extended `to U.S. shareholders `by section 63 of the Code to be effectively extinguished by permitting a harsh and unduly strictive interpretation of clause (ii) of said subparagraph (D) to be adopted. Were such an interpretation to be permitted, a situation might well develop therein a controlled foreign corporation made a minimum distribution of say 100% of its earnings and profits only `to find that it has a tax liability due and owing to the Federal Government. `Moreover, with respect to the same above-quoted language it is submitted that the following language of section 954(b) (4) of the code should not be deemed to exclude from `the relief provision of clause (ii), of said subparagraph (D), income which would otherwise be characterized as subpart F income: "For purposes of subsection (a), foreign base company income does not include any item of income received `by a controlled foreign corporation if it is estab- lished to the satisfaction of the Secretary or `his delegate with respect `to such item that the creation or organization of the controlled foreign corporation receiving such item under the laws of the foreign country in which it is incor- porated does not have the effect of substantial reduction of income, war profit's, or excess `profits taxes or similar taxes." Were such a limitation not placed upon the use of section 954(b) (4), a con- trolled foreign corporation would be placed in the dilenima of possibly making a minimum distribution of, say, 100% of its earnings and profits only to find that 1151 71-297 0-67--pt. 1-74 PAGENO="1162" 266 FOREIGN INVESTORS TAX ACT OF 19 66 the Secretary or his delegate has determined that a certain item or items of income of such controlled foreign corporation do not constitute foreign base company income-as with respect to such item or items of income the creation of the controlled foreign corporation does not have the effect of a substantial reduction of income taxes (i.e., such income will be taxed as income "effectively connected with the conduct of a trade or business within the United States" and thus such controlled foreign corporation has an outstanding tax liability due and owing to the Federal Government). Indeed, one wonders whether all "effectively connected" income couldn't be excluded from foreign base company income under the above theory, merely at the discretion of the Secretary or his delegate so as to completely nullify the relief granted by the Congress in clause (ii) of said subparagraph (D) or at least subject the availability of such relief to the discretion of the Secretary or his delegate. The minimum distribution provisions of section 963 of the code were carefully drafted in an effort not to penalize legitimate U.S. investment abroad which seeks to repatriate-and not hoard-foreign income earned on such investments. Insofar as the provisions of clause (ii) of said paragraph (D) are susceptible to an `interpretation which would penalize and/or make uncertain and confusing the status of such legitimate U.S. investments abroad, it is respeetfuly requested that your Committee act to reaffirm the Congressional intent in this area. Cer- tainly the relief provisions of section 963 of the code have proven themselves to be the guiding light for legitimate U.S. investments abroad in this highly complex and sometimes dimly lit area of our Federal tax structure. The relief provisions of section 963 of the code should not be permitted to become ineffectual or circumscribed by this Bill. The following language is submitted for your consideration as a possible amendment to the Bill by inserting as an addition thereto immediately `after said subparagraph (D) the following language: "(E) In determining ~What constitutes subpart F income for purposes of (D) (ii) above, neither the provisions of section 963 of the code nor the provi- sions of section 954(b) (4) of the code shall be deemed to exclude any income from being characterized as subpart F income." A second major problem area involves the unnecessarily restrictive provisions relating to an "overseas operations funding subsidiary" found in subsection (C) of section 6 of the Bill (beginning on page 68, line 9, of the June 16, 1966. printing of H.R. 13103). Thus, in compliance with requests by the President of the United States and the Secretary of Commerce to voluntarily aid in alleviating an adverse balance of payments situation, Clark Equipment Company recently organized a wholly owned domestic subsidiary for the purpose of raising necessary funds abroad to finance the expanding operations of foreign affiliated corporations. Such newly formed corporation sold $15,000,000 worth of debentures in Europe to raise the necessary investment capital. Pursuant to oral instructions from I.R.S. staff personnel, a request for necessary tax rulings stated that such newly organized subsidiary planned to invest at least 85% of the proceeds from the sale of the aforementioned debentures in stock or debt obligations of foreign corporations in which Clark owned or would own 10% or more of such corpora- tions' total combined voting power at the time of the investment. It is my understanding that this language was also given other U.S. corporations setting up similar foreign financing subsidiaries by personnel of the I.R.S. Now, however, despite the verbal direction given United States taxpayers by representatives of the Internal Revenue Service, paragraph 1 of subsection (c) of section 6 of HR. 13103 adds to the type of interest which is excluded from the special per country foreign tax credit limitation prescribed by section 904(f) (3) of the code, interest received by an "overseas operations funding subsidiary" on obligations of a "related foreign corporation." Paragraph 2 of subsection (c) of section 6 of the bill then defines the term "overseas operations funding subsidi- ary" as a domestic corporation which (i) is a member of an affiliated group within the meaning of section 1504 and is not the common parent corporation of such group, and (ii) was formed AND is availed of for the principal purpose of raising funds outside the United States through public offerings to foreign per- sons and of using such fñnds to finance the operations in foreign countries of one or more related corporations. A "related foreign corporation" is then de- fined as a foreign corporation owned 50% or more by the affiliated group of which the "overseas operations funding subsidiary" is a member, either directly or through the ownership of the voting stock of another foreign corporation. 1152 PAGENO="1163" FOREIGN INVESTORS TAX ACT OF 1966 267 Thus, it would appear that the "principal purpose" test must be met on two occasions: (1) the time such overseas operations funding subsidiary was formed and (2) during the current operations of such overseas operations funding sub- sidiary. If the "principal purpose" test was thus to be strictly applied to Clark Equipment Company and similarly situated United States corporations which have already acted in response to the call for voluntary action made by the Administration and within the guidelines then promulgated by the Internal Revenue Service, such corporations may be deprived of standing as an "overseas operations funding subsidiary" in that their stated principal purpose for being formed was to finance 10% or more owned foreign affiliated companies and not 50% or more owned foreign affiliated companies as the proposed legislation re- quires. It is respectfully submitted that those United States corporations which were quick to respond to the pleas of our Administration in regard to limiting the outflow of U.S. dollars abroad should not now be penalized for the celerity of their response. Moreover, it should be noted that in the absence of the "overseas operations funding subsidiary" exclusion set forth in H.R. 13103, the interest received by corporations which generally meet those prescribed characteristics could be said to have been previously excluded from the separate per country limitation by the language already contained in section 904(f) (2) (B) as a corporation receiving interest "derived in the conduct of a banking, financing or similar business." With the enactment of H.R. 13103 the general rules of statutory con- struction would appear to require the conclusion that the Congress, by creating an additional exclusion encompassing interest received by an "overseas opera- tions funding subsidiary" was acting to fill a void and that corporations gener- ally meeting the definition of an "overseas operations funding subsidiary" must thus look to the requirements of that exclusion for relief or come within the per country limitation of section 904(f) (3). To correct this apparent inequity it is suggested that the 50% figure used on page 69, line 19 of the Bill should be deleted and the figure 10% inserted in lieu thereof. Such change would tend to equate the relief provisions granted an "over- seas operations funding subsidiary" with the relief provisions already found in section 904(f) (2) (C) which deletes from the per country limitation "interest received from a corporation in which the taxpayer owns at least 10% of `the vot- ing stock." As previously stated, a "related foreign corporation" is defined as a foreign corporation owned 50% or more by the affiliated group of which the "overseas operations funding subsidiary" is a member, either directly or through the ownership of the voting stock of "another" foreign corporation. Thus, a "related foreign corporation" is by definition restricted to a first or second-tier foreign corporation. It is respectfully submitted that this restrictive definition should be liberalized by deleting "another foreign corporation" on page 69, line 22 of the Bill and inserting in lieu thereof the phrase "one or more other foreign corporations." Very truly yours, CLARK EQUIPMENT Co., By R. P. SUMERWELL, Taa Manager. MACHINERY & ALLIED PRODUCTS INsTITUTE, Washington, D.C., August 1, 1966. Hon. RussEr~ B. LONG, Chairman, Committee on Finance, U.S. Senate, Washington, D.C. DEAR SENATOR LONG: We have just learned of the Finance Committee's plans to hold public hearings on H.R. 13103, the proposed Foreign Investors Tax Act. This bill is of very considerable interest and concern to a number of members of the Machinery and Allied Pi~oducts Institute, a national organization of capital goods and allied product manufactu.reri with extensive foreign opera- tions. Consistent with your inrttation for the submission of written statements re- specting this bill, we have set out herein a statement of our suggestions and recommendations for amendment and clarification of H.R. 13103 and ask that it be included in the printed record of the hearings. 1153 PAGENO="1164" 268 FOREIGN INVESTORS TAX ACT OF 1966 SOME GENERAL OBSERVATIONS It is our conviction that there would be an adverse economic impact from application to foreign source income of the proposed "effectively connected" concept. Under Section 2(d) of the bill, rental and royalty income derived by a foreign corporation from the use outside the United States of patents, copyrights, trade- niarks and other intangible property, and attributable to an office or other fixed place of business in the United States would be deemed to be "effectively connected" with the conduct by the foreign corporation of a trade or business in the United States and consequently subject to U.S. taxation even though such income is also deemed to be derived from foreign sources. The same rule would apply to sales income attributable to a U.S. business location of the for- eign corporation; however, such sales would not be deemed "effectively con- nected" if the goods in question are sold for use, consumption, or disposition outside this country, and an office or other fixed place of business~ of the for- eign corporation outside the U.S. "participated materially" in the sale. The 1)111 would include any foreign corporation without regard to its ownership- thus it would cover foriegn corporate subsidiaries of American parent corn- lanies. The basic purpose of this legislation, at least in its initial stages, was to stimulate foreign investment in the United States. The subsequent addition of the "effectively connected" concept and its application to extend U.S. taxa- tion to certain foreign source income of foreign subsidiaries of U.S. companies, is, we submit, unrelated to this legislative objective and, moreover, it is incom- patible with a number of other basic national economic objectives. There are many instances when it is desirable for commercial nontax reasons relating to the expansion of foreign markets to establish a U.S. business location for the foreign subsidiary or to have certain functions connected with this foreign busi- ness performed by parent company personnel located in the United States. To the extent that thi~ legislation permits U.S. taxation of income from the use of patents and trademarks abroad and income from the sale of goods used or consumed abroad, it is obviously a deterrent to expansion of this type of foreign business. Thus, it hinders the basic governmental policy of strengthening the overall U.S. position in respect to the international balance of payments. There are a number of ways in which this problem can be ameliorated. One would be to insert a proviso in the bill that its separate provisions are not to be construed in such a way as to either impose a U.S. tax liability when none has existed in the past or increase an already existing tax. Another alternative, already suggested to the Ways and Means Committee, would be to provide that the "effectively connected" provisions are not to apply to foreign source income of a foreign corporation when the latter is a "controlled foreign corporation" under, Subpart F of the Internal Revenue Code, that is, when it is a foreign subsidiary of a U.S. company. In addition to these fundamental methods of insuring that application of the "effectively connected" concept does not injure American business abroad, we have some additional suggestions relating to the specifics of Section 2(d) of the bill. The parenthetical references indicate provisions of the Internal Revenue Code which would be affected by Section 2(d). PERFORMANCE OF NONMANAGEMENT TASKS BY THE U.S. PARENT COMPANY (CODE SECTION 864(C) (4) (B)) The Ways and Means Committee report on the bill makes it clear that a foreign subsidiary will not be deemed to have a business location in the United States merely because its U.S. parent company exercises genecal supervision and control over the policies of the subsidiary.' We note, however, that under Example (3) following the statement of this general rule in the report, if orders received by *the subsidiary are subject to review by an officer of the parent company before acceptance, the subsidiary will be deemed to have a business office in the United States. Such a review policy is a common operating practice-and good business practice-with respect to orders received by a foreign subsidiary and' we think it is perfectly compatible with the exercise of "general supervision and control" by the parent company. We urge that Example (3) be amended to conform with this interpretation. 1 House Report No. 1450, 89th Congress, 2d Session, p. 63. 1154 PAGENO="1165" FOREIGN INVESTORS TAX ACT OF 1966 269 In addition, the "general supervision and control" rule needs to be broadened so that it would clearly not affect the performance by parent company personnel of services for the subsidiary that might be deemed to be nonmanagement in nature (e.g., clerical services). We think that when (as is normally the case) the performance of such "nonmanagement" services is clearly only a minor or incidental part of the parent company's overall activity with respect to the sub- sidiary, the subsidiary should not be deemed to have a business location in the United States. BENTS OR ROYALTIES (CODE SECTION 804 (C) (4) (B) (i)) This provision, as amplified in the report, would permit rents and royalties to be "effectively connected" with the United States if a business location of the foreign subsidiary in this country "either actively participates in solicting, negotiating, or performing other activities required to arrange, the lease or license * * * or performs significant services incident to such lease or license." 2 It is clear then that U.S. tax can be imposed even though the lease or license arrangements are negotiated from a foreign business location of the foreign subsidiary so long as the U.S. business location is deemed to have performed "significant" services incident to the lease or license. It seems to us that this provision is unsound because it would permit U.S. taxation in cases where the activities of the U.S. business location, even though admittedly "substantial," are obviously subordinate to or minor in comparison with the activities per- formed by the foreign business location with respect to the lease or license. This provision should be amended to provide that U.S. tax will not be imposed so long as a foreign business location of the subsidiary or of a related company "par- ticipates materially" in the activities relating to the lease or license. SALES INCOME (CODE SECTION 864(c) (4) (B) (iii)) As noted earlier, sales income of a foreign subsidiary which is deemed to have a U.S. business location may be considered "effectively connected" unless the goods in question are sold for use, consumption, or disposition outside this country, and a foreign business location of the subsidiary has "participated materially" in the transaction. This provision seems to us more logical than the related provision respecting rental and royalty income because it would exempt the sales income from U.S. taxation providing there is material participation by a foreign business location of the subsidiary in the transaction. However, there is a problem which we think should be corrected; this relates to multiple foreign subsidiaries. In many cases, a capital goods manufacturer in this country will have one foreign subsidiary take care of the sales transaction itself while another subsidiary is charged with the responsibility of providing necessary services in connection with that sale. There is no question that, as a practical matter, a foreign busi- ness location of the foreign sales operation (considered as a whole) has mate- rially participated in the sales transaction. Yet the bill, as currently worded, would exempt sales income only if the material participation abroad is by a foreign business location of the foreign subsidiary which is deemed to be doing business in the United States. We suggest that this might be corrected by providing for exemption when there is material participation in the sales trans- action by a foreign business location of the subsidiary or a related corporation. EXCLUSION FOR SUBPART F INCOME (CODE SECTION 864 (C) (4) (D) (II)) The bill would exempt from the reach of the "effectively connected" concept any income of the foreign subsidiary which is deemed to be Subpart F income within the meaning of Code Section 9~2 (a). A question arises as to whether this exclusion would also apply to foreign subsidiary income which would be Con- sidered Subpart F income but for the operation of one or more of the exclusions to Subpart F itself, such as, for example: 1. A minimum distribution under Code Section 963; 2. Export trade income under Code Section 970; 3. Foreign base company income which constitutes less than 30 percent of the total gross income of the foreign subsidiary; and 2 Ibid., p. 64. 1155 PAGENO="1166" 270 FOREIGN INVESTORS TAX ACT OF 1966 4. Foreign base company income when it is established, with respect to that income, that the organization of the foreign subsidiary does "not have the effect of substantial reduction [of taxes]." We think that the reasons for these specific exemptions from Subpart F were considered at great length by Congress during its prolonged deliberation on the Revenue Act of 1962 and we feel that it would be most unwise to change these de- cisions and now permit the use of the proposed "effectively connected" concept to reach such items of income. Accordingly, we urge that the Subpart F exclusion included in the bill be amended to make it clear that it applies to all Subpart F income and also income of the foreign subsidiary which would be considered Sub- part F income but for one or more of the exclusions contained in Subpart F itself. This concludes our comments on the "effectively connected" concept included in the proposed Foreign Investors Tax Act. We appreciate this opportunity of commenting on H.R. 13103. If the Institute or its staff can be of further assist- ance in the Committee's consideration of the bill we trust that you will not hesi- tate to call on us. Respectfully, CHARLES I. DERR, Senior Vice President. WILLKIE FARR GALLAGHER WALTON & FITzGIBB0N, New York, N.Y., July 11, 1966. Re Foreign Investors Tax Act of 1966 section 2(d) (2). Hon. RuSsELL B. LONG, Chairman, Co'mmittee on Finance, U.S. Senate, Washington, D.C. SIR: I am writing to you concerning the Foreign Investors Tax Act of 1966. More specifically I am concerned with section 2(d) (2) of the Act which adds proposed new section 864(b) (2) to the Internal Revenue Code. This new section of the Internal Revenue Code would permit a taxpayer who is not a dealer in stocks or securities to trade in stocks or securities for his own account directly or through an employee or a discretionary agent located in the United States without being treated as being engaged in a trade or business in the United States. The House Ways and Means Committee report indicates that this proposed amendment of the Internal Revenue Code is intended to amend section 871(c) of the Code and expand the scope of activities in the United States in which a foreign taxpayer trading in stocks or securities may engage without being classified as being engaged in trade or business in the United States. As section 2(d) (2) of the Act now stands, it applies to a "taxpayer" trading for taxpayer's own account. I believe that the use in the section of the term "taxpayer"-i.e., a person subject to internal revenue tax (I.R.C. § 7701 (a) (14) )-unduly and probably unintentionally, restricts the application of the provision. Thus, for example, if a nonresident alien individual were a limited parter in a partnership whose only activity in the United States involved trad- ing in stocks or securities, the new provision would not apply to that indi- vidual since trading in stocks or securities did not take place for the taxpayer's own account, but rather for the partnership's account. This produces the rather anomalous result that a nonresident alien individual who is a limited partner in a partnership trading in stocks or securities may be considered to be engaged in a trade or business in the United States because of the partnership's trading activities in the United States, although he, as a limited partner, cannot even participate in the trading activities of the partnership; in contrast, that same nonresident alien individual could be personally present in the United States or have an employee or discretionary agent here and not be considered to be engaged in a trade or business in the United States because of the trading activi- ties carried on by the taxpayer, his employees or his agents. Not only is this result anomalous, but I believe it may operate to deter some foreign investment in the United States by foreign investors who want to invest in United States' securities and derive the benefits of diversification of invest- ment and professional management which an investing partnership can produce. I represent several persons who are presently engaged in forming a partnership, which includes a substantial number of foreigners, for the purpose of investing in United States stocks and bonds. My clients have found that a great many foreign investors have indicated a desire to be able to be investors in such a 1156 PAGENO="1167" FOREIGN INVESTORS TAX ACT OF 1966 271 limited partnership and my clients believe that use of this type of investment vehicle will be very attractive to potential foreign inv~"tors. I would respectfully suggest that section 2(d) (2) of the Foreign Investors Tax Act of 1966 could be amended so as to solve the problem which I have raised by use of the term "person"-i.e., an individual, a trust, estate, partnership, assbcia- tion, company or corporation (I.R.O. § 770(a) (1) )-in place of the term "tax- payer." Alternatively, I would suggest that the section of :the Act could be amended by adding the following sentence as clause (iii) in proposed section 864 (b) (2) (A) (iii) Except in the case of a partnership which is a dealer in stocks or securities, in the case of a limited partner, trading in stocks or securities for the partnership's own account by the partnership or through a resident broker, commission agent, custodian or other agent, and whether or not any such agent has discretionary authority to make decisions in effecting the transaction. I would very much appreciate your consideration of the matters raised in this letter. If I may be of any assistance to you in obtaining additional information for you as to the points raised, please communicate with me. I would also appreciate being notified as to when Committee on Finance hearings are scheduled to commence on the Foreign Investors Tax Act of 1966. Very truly yours, THOMAS N. TARLEAU. WILLKIE FARE GALLAGHER WALTON & FITZGIBBONS, New York, N.Y., August 10, 1966. Re Foreign Investors Tax Act of 1966, section 2(d) (2). Hon. RUSSELL B. LONG, Chairman, Committee on Finance, U.S. Senate, Washington, D.C. DEAR SENATOR: I have received your letter of August 1, 1966 inviting me to testify before your Committee. Although I sin unable to personally appear, I would like to take this opportunity to communicate to you some comments on the proposed legislation. I had previously written to you on July 11, 1966 with respect to the proposed legislation. I am especially concerned about the unfortunate, and perhaps unintended, effect of Sec. 2(d) (2) in view of stated Congressional design to encourage, by introduction of the Foreign Investors Tax Act of 1966, the investment of foreign capital in this country with consequent improvement in the balance of pay- meats. Sec. 2(d) (2), which adds proposed Sec. 864(b) (2) *to the Internal Revenue Code, would permit a non-residen1~ alien other than a dealer in stocks and securities to grant discretionary authority to a United States broker or other agent to carry out transactions in the United States with respect to stocks, securities or commodities without the non-resident alien being considered engaged in carrying on a trade or business in this country. Under present law the granting of such discretionary authority would expose* the non-resident aliOn to tax on grounds of doing business. Section 2(d) (2) of the proposed Act applies to a "taxpayer" trading for his own account in the United States through an employee or agent in the United States w-ho may or may not have discretionary authority. It seems to me that the proposed legislation unnecessarily and inequitably inhibits the attrac- tion of foreign capital by restricting the change in the law to a taxpayer trading for his own account. In general, a foreigner who desires professional manage- ment of his money in United States securities has two operating vehicles avail- able, namely, to give an agent in the United States discretionary authority to buy and sell, or to become a limited partner in a domestic private investment partnership. In such a partnership the general partners are professional money managers, and the limited partners are, in effect, investors. The limited part- nership route is similar in nature to the agent who has broad discretionary power in terms of achieving the desired effect of professional personnel man- aging funds; however, a foreigner who wishes to invest substantial sums of money may desire the private investment partnership route for the following reasons: 1. It affords the foreigner greater diversification of risk since his money is being pooled with monies of other limited partners to purchase a bigger and more diversified portfolio. 1157 PAGENO="1168" 272 FOREIGN INVESTORS TAX ACT OF 1966. 2. The general partners, who manage money in much the same way as the private agent with broad discretionary powers, have greater market leverage and may be able to obtain better brokerage services and advice since more money is available on a pooled basis. 3. Since a private investment partnership would be the receptacle for larger amounts of money than the private agent might attract, the company can afford to retain more and better professional managers. 4. A discretionary agent is necessarily limited as to the number of separate accounts he can efficiently manage. The pooling of funds in a limited partnership permits him to accommodate a greater number of accounts. For the reasons above expressed, it seems to me that a domestic private in- vestment partnership is more likely to attract and capture substantial sums of foreign capital than would the private agent with discretionary authority. Such private investment partnerships have proven popular and successful in the United States in the past fifteen years. I have been told that their total assets now approximate $250,000,000. Under current tax law, such private investment partnerships have not been able to attract foreign capital since a non-resident alien who becomes a limited partner therein would be exposed to United States tax on his allocable share of the capital gains on grounds that the trade or busi- ness of the partnership would be attributed to him. Failure to attract foreign capital is especially unfortunate since it is my understanding that foreigners are very interested in investing in private investment partnerships and would invest substantial sums if the tax laws were more accommodating. In my opinion, there exists no reason to continue to insist that a non-resident limited partner in a private investment company is considered to be carrying on a trade or business if a non-resident alien is not considered to be engaged in the carrying on of a trade or business by the effecting of securities transactions through a domestic agent with broad discretionary powers. As indicated above, the management of money by a private investment partnership and )y a private agent with discretionary power is essentially similar in nature and, if it is stated Congressional design to encourage foreign capital by liberalizing the law with respect to the private agent with discretionary power, such liberalization logically should extend to the limited partnership situation in view of the fact that the private investment partnership route is, as a practical matter, the most attrac- tive investment vehicle for substantial sums of foreign capital. If you agree with the above recommendation, I would respectfully suggest that section 2(d) (2) of the Foreign Investors Tax Act of 1966 could be amended so as to solve the problem which I have raised by use of the term "person"-i.e. an individual, a trust, estate, partnership, association, company or corporation (I.R.O. § 770(a) (1) )-in place of the term "taxpayer." Alternatively, I would suggest that the section of the Act could be amended ~y adding the following sentence as clause (iii) in proposed section 864(b) (2) (A) (iii) Except in the case of a partnership which is a dealer in stocks or secu- rities, in the case of a limited partner, trading in stocks or securities for the partnership's own account by the partnership or through a resident broker, commission agent, custodian or other agent, and whether or not any such agent has discretionary authority to make decisions in effecting the tramis- action. Very truly yours, THOMAS N. TARLEAU. KAIssa ALUMINUM & CHEMICAL Coar., Washington, D.C., Avgust 8, 1966. Hon. RUSSELL B. LONG, Chairman, Senate Finance Committee, U.S. Senate, TVashington, D.C. DEAR Ma. CHAIRMAN: We wish to submit for consideration a technical amend- ment to HR 13103, the Foreign Investors Tax Act of 1966, that is now pending before your Committee. As you know, this Act deals compr~hensively with cer- tain income and other tax aspects. of foreign `taxpayers, including foreign corpo- rations in which United States investors may have a `substantial interest. Direct investment in foreign subsidiaries (that is, Investment in debt obliga- tions or stock of foreign corporations `in which the U.S. parent has ~ voting stock interest of 10% or more) is exempt from interest equalization tax if the parent U.S. company makes the investment with no present intent to sell the security or other evidence of ind~btedness. In order to provide flexibility in the manner by 1158 PAGENO="1169" FOREIGN INVESTORS TAX ACT OF 1966 273 which U.S. companies may finance the development of foreign ores and minerals in short supply in the U.S., the Interest Equalization Tax Act also exempts under Section 4914(d) of the Internal Revenue Code_~as the equivalent of direct in- vestment-loans made by U.S. institutional lenders to foreign subsidiaries produc- ing such ores and minerals where the financing is secured by so-called "take or pay" contracts entered into between the foreign subsidiary and `the U.S. parent. However, such loans become subject to tax under Section 4914 (j) (1) (a) when and if they are `subsequently transferred by the lender to another person, regard- less of intent at the time `of acquisition. This "recapture" of `tax on subsequent transfer of indebtedness applies generally to a number `of exempted transactions in order to prevent abuse of the exemptions beyond their i'ntended purpose, which `might result from a transfer to a third party lender; but it is `inappropriate to apply such "recapture" to the financing of "take or pay" mineral production `contracts the exemption for which contem- plated tha't a third party lender would participate in the transaction from the outset. In fact, "recapture" in the case `of the "take or pay" exemption serves to defeat the purpose of `the exemption-which wa's intended to facilitate loan's from financial institutions for purposes consistent with the raw material requirements of the United States-since such institutional lenders always acquire negotiable instruments and may in fact subsequently sell them to `other lenders, even though they have no present intent at the time of acquisition to do so. Accordingly, we respectfully `suggest `that Section 4914(j) (1) should `be amended to provide that subsequent transfers of indebtedness `originally exempted under Section 4914 ( d) should not be subject to tax where such indebtedness was ac- quired without an intent to `sell it t'o other U.S. persons. Respectfully, WARD `C. HUMPHREYS, Manager, Washington Office. THE LAREDO NATIONAL BANK, Laredo, Tex., June 28, 1966. Senator RussELL LONG, Chairman, Senate Finance Committee, Senate Office Building, Washiagton, D.C. DEAR SENATOR LONG: We are itiiterested in. the hearings that your committee may conduct in connection with the Foreign Investors Tax Act (H.R. 13103), and particularly the provisions of the bill which propose `to impose the U.S. income tax on interest paid by U.S. commercial banks to nonresident aliens and the U.S. estate tax on deposits in U.S. commercial banks of nonresident alien individuals. Therefore, we respectfully request that you advise us when such hearings will be conducted by your committee, and whether it will be possible for a repre- sentative of this bank to submit a written statement. Yours very truly, MAX A. MANuEL, President. THE LAREDO NATIONAL BANK, Laredo, Tex., April 14, 1966. The SECRETARY OF THE TREASURY, Washington, D.C. DEAR Sm: I would appreciate it if you will send me a copy of H.R. 11297 referred to as the Foreign Investors' Tax Act. I understand this legislation has been proposed by the Treasury Department and provides that in the future non- resident aliens will be required to pay income tax to the United States for interest received on time deposits in U.S. cpmmercial banks. As you know, for many years the Internal Revenue Code h~:s specifically exempted such income from the payment of income tax. It occurs to us that if `such legislation is enacted, it will result in the with- drawal of large snms now on deposit, and obviously this will be detrimental' to the United States and increase its balance of payments problem. Kindly send me a copy of the proposed bill and a statement of the Treasury's position with respect to the legislation. Yours very truly, MAX A. MANDEL, President. 1159 PAGENO="1170" 274 FOREIGN INVESTORS TAX ACT OF 1966 TREASURY DEPARTMENT, Washington, D.C., April 29, 1966. Mr. MAx A. MANDEL, President, the Laredo National Bank, Post Office Boa No. 59, Laredo, Tea. DEAR Mn. MANDEL This is in reply to your letter of April 14, 1966, to Secretary Fow-ler relating to the Foreign Investors Tax Act (H.R. 13103). Your letter expresses concern about a provision appearing in this legislation which imposes tax on interest payments made after December 31, 1971, on bank deposits of non- resident aliens and foreign corporations not engaged in trade or business in the United States. Consideration of the proper method of taxing nonresident aliens and foreign corporations deriving income from the United States was prompted by the report of the Fowler Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securities. As a consequence of this report, the Treasury Department engaged in a detailed analysis of the present system of taxing nonresident aliens and foreign corporations and submitted to the Congress legislation embodying its recommendations. This bill, H.R. 5916, was introduced on March 8, 1965, by Chairman Mills of the House Ways and Means Committee. The only change con- tained in H.R. 5916 relating to the taxation of bank interest received by nonresi- dent aliens and foreign corporations was to extend the exemption now contained in the Internal Revenue Code for such interest to savings and loan associations and mutual savings banks. The House Ways and Means Committee held public hearings on H.R. 5916 and considered the bill at length in executive sessions. In the course of its con- sideration, the committee was concerned with assuring the equitable tax treat- itient by the United States of nonresident aliens and foreign corporations. With regard to bank interest derived by foreigners from U.S. banks, the committee concluded that it was questionable whether interest income of this type. which is SO clearly derived from U.S. sources, should be treated as being derived from non- U.S. sources and thereby not subject to U.S. tax. The committee, however, recog- nized that to eliminate the present source rule on bank deposit interest might have an adverse effect on the U.S. balance-of-payments position, and consequently. the effective date of its change was postponed until after December 31. 1971. This result is embodied in HR. 11297 and its successor bill, H.R. 13103, which was recently reported by the committee to the House. In accordance w-ith your re- quest. I enclose a copy of H.R. 13103. Thank you very much for your interest in writing on this matter. Sincerely yours, STANLEY S. SURREY, Assistant Secretary. THE LAREDO NATIONAL BANK, Laredo, Tea~., May 4, 1966. Hon. STANLEY S. SURREY, L4ssistan t Secretary of the Treasury, Washington, D.C. DEAR MR. SURREY: I have your letter of April 29, 1966, in which you refer to the Foreign Investors Tax Act (HR. 13103), and the fact that it results from the report of the Fowler Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securities. It is my understanding that the original report did not apply to the taxation of bank interest received by nonresident aliens, and this provision was an afterthought by others. Since 1921, Congress has recognized that it is good for this country to encourage deposits of foreign funds in U.S. banks, and this policy has continued uninter- ruptedly during the many years when he had no balance-of-payments problem. No'w we have a real balance-of-payments problem and yet someone seems to advocate that the small amount of tax that can be generated is more important than the several billions of dollars of foreign funds that are now on deposit here. If the great majority of the funds are withdrawn, and I understand that this can be assumed, we will neither have the tax income nor the badly needed funds. Your letter states that the House Ways and Means Committee recognizes that the new provision might have an adverse effect on the U.S. balance-of-payments position, and, for that reason has postponed the effective date of its change until after December 31, 1971. If it is admitted that the bill is harmful and its. effect 1160 PAGENO="1171" FOREIGN INVESTORS TAX ACT OF 1966 275 should be postponed, would it not be more practical and beneficial to eliminate it completely? The mere fact that serious consideration is being given to its enactment has already caused a considerable amount of anxiety among Mexicans who have deposits here now. I will appreciate a frank statement advising just how much revenue the Treasury expects the new tax to generate, the amount of deposits~of nonresident aliens and foreign corporations not engaged in trade or business in the United States presently in U.S. banks, and the amount of such deposits that will probably be lost upon the enactment of the proposed legislation. I respectfully request that the Treasury reconsider this important legislation and convey the recommendation to the committee that it is to the best interest of the United States that the present law continue in effect. Yours very truly, - MAX A. MAND~L, President. TREASURY DEPARTMENT, Washingtoii, D.C., May 24, 1966.. MAX A. MANDEL, President, the Laredo National Bank, Post Office Boce No. 59, Laredo, Te~v. Dn:&R MR. MANDEL: Thank you for your letter of May 4, 1966, relating: to the' Foreign. Investors Tax Act (H.R. 13103) and more specifically, the provision in that bill subjecting to tax interest paid by U.S. banks to nonresident aliens~ and~ foreign corporations not engaged in trade or business in the United States. As you know, this aspect of the bill does not come into effect until after December 31, 1971. Your letter indicates that consideration of this provision by the Congress has caused considerable anxiety among foreign depositors in: your' bank. We would be interested in learning why foreigners would consid~r thern withdrawal of funds from U.S. banks at this time since the provision: is: not to go into effect for 5 years. We very much appreciate receiving your views on this matter. Sincerely yours, STANLEY S. SURREY.. TilE LAREDO NATIONAL BANK, Laredo, Tece., June 1, 1966.. lion. STANLEY S. SURREY, Assistant Secretary of the Treasury, Treasury Department, Washington, D.C. DEAr. Mn. SURREY: I appreciate your letter of May 24, 1966, relating to the Foreign Investors Tax Act (HR. 13103), and I am glad to respond to your inquiry. Actually, prior to the receipt of your letter, I had an opportunity to talk in person and by telephone to a number of our Mexican customers, and I might point out that at least half of the conversations were initiated by our customers. As you know, the matter of keeping money in a bank is one that is based on confidence and habit, and it takes many years for banks to develop long-lasting relationships. Our records show that we first began accepting savings and time accounts by the issuance of certificates of deposit around the turn of the century. At that time, our foreign customers were not numerous, but in subsequent years, particularly after World War I, our ties with Mexico began to develop, and during the past 20 years they increased at a rapid pace for a bank this size. Although Mexico is a developing nation and needs all of the savings of its people for its own expansion, you are well acquainted with the fact that many persons and corporations in Mexico, as elsewhere in Latin America, feel that it is good business for them to place some of their reserves in another country with a stable currency. It is true that at home they could receive a return of two or three times the amount they can get at our bank (our top rate on certificates of deposit at this time is 4% percent), but they do not want to put all of their eggs in one basket, and they believe that it is prudent for them to put a portion of their re- serves in a U.S. bank. Some of our customers tell us that if the proposed legislation is enacted w'ith the provision that the tax will not become effective until after December 31. 1971, they will not immediately draw out the money but that they will immediately be- gin "to look around." These were the exact words that' several persons used. 1161 PAGENO="1172" 276 FOREIGN INVESTORS TAX ACT OF 1966 Two of them pointed out that `in prior years they woulu not have considered put- ting their surplus funds in any country other than the United States. but now- they believe the situation is somewhat different: they are not unaware of our balance- of-payments problem, and the interest rates that they can obtain elsewhere are l~igher thaii what they can obtain in the United States. One of our customers stated that if the legislation is enacted even though the tax provision would not go into effect until a later date, it was like a "sword hanging over" his head, and he would want to move his funds as quickly as possible. One customer stated that he has already begun to look around so that he can act promptly if and when the bill is enacted. As a matter of fact, I believe that this is one of the detrimental features concerning the mere consideration of this legislation-it causes a number of people who previously were content with leaving deposits in U.S. banks to investigate alternative investments elsewhere. We must remember that a cash deposit in a bank outside of Mexico is not the only alternative that a Mexican investor can consider. I have gained the im- pression. when talking to some of our customers, that they may be considering other forms of investment since they must withdraw from U.S. banks anyway. You can understand that any form of investment requires more investigation and analysis than a cash deposit, and the investor must capitalize upon an opportunity when it presents itself rather than wait for a deadline. In answer to your ques- tion, this is one of the reasons foreigners are considering the withdrawal of funds from U.S. banks at this time, even though the provision is not to go into effect for 5 years. I realize that no one can state exactly the proportion of funds that will be moved and how quickly they will be moved. Bu.t I believe that it is obvious that large amounts will be moved, and, therefore, serious consideration should be given to the problem: What is the amount of such foreign deposits in U.S. banks at this time, what stable countries that exempt interest paid to foreigners can expect to benefit from the anticipated loss, and. what tax can the United States hope to collect on deposits that are now withdrawn? I have not touched upon the imposition of the estate tax. Of course, our corpo- rate customers were not concerned about this matter, but two individuals were more anxious about this provision than the proposed income tax. I honestly feel that this is a situation where we will be earning pennies and losing dollars, and our entire economy, not ju~t the banking industry, will be better off if we refuse to tamper with a provision that has been so effective since 1021 and make this decision without delay. I hope that I may hear from you again concerning this matter. Yours very truly, MAX A. MANDEL, President. TREASt~RY DEPARTMENT, Washington, D.C., Jnne 10, 1966. Mr. MAX A. MANDEL, President, T1~e Laredo National Bank, P.O.BosNo.59, Laredo, Te~. DEAR MR. MANDEL: Thank you for your letter of June 1 in which you discuss t.he provision appearing in the Foreign Investors Tax Act (H.R~ 13103) subjecting to tax interest paid by U.S. banks after December 31, 1971, to nonresident aliens and foreign corporations not engaged in trade or business in the United States. We were most interested in your comments as to why you believe that foreigners holding deposits in U.S. banks will remove these deposits as a result of this pro- vision in the legislation. As I indicated to you previously, we are giving this matter our most careful consideration. We are pleased to have received the benefit of your views in this regard. Sincerely yours, STANLEY S. SURREY. 1162