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23 A.B.A. J. 759 (1937)
The Loophole - Closing Revenue Act of 1937

handle is hein.journals/abaj23 and id is 785 raw text is: THE LOOPHOLE-CLOSING REVENUE ACT OF 1937 New Act Is not a Measure of Wide Scope, but Viewed for What It Is, as Strictly Ad Hoc Legislation, It is a Very Competent Piece of Work-General Outline of New Law Is Commend- ably Clear and Understandable-Probably the most Important Changes, in Economic Effect, Are those Relating to Domestic Personal Holding Companies, Embodied in Title I-New Types of Income Added under This Head-Most Revolutionary Portion of Law Embodied in Title II, Relating to Foreign Personal Holding Companies-Constitutional Questions in This Connec- tion-Miscellaneous Changes in Law, etc. By GEORGE F. JAMES, JR. Member of the Chicago Bar HE President's message to Congress of June 1, 1937, pointing out the wide-spread use of devices within the letter of the revenue laws for the pur- pose of avoiding taxes, the two weeks or more of public bearings before the Congressional Joint Committee on Tax Evasion and Avoidance, and the labors of Treas- ury experts and special counsel, have borne fruit in the Revenue Act of 1937, commonly known as the loop- hole-closing bill. The new Act is not a measure of wide scope. No effort was made to write a blanket provision by which all devices designed for the avoidance of tax could be outlawed or nullified, although several suggestions for such a blanket provision were made. The Act merely carries on the attempt to plug various specific loopholes in the law with specific legislation, which has been made, always with partial success and partial failure, in every revision of the revenue laws since 1913. Viewed for what it is, strictly ad hoc legislation, the Revenue Act of 1937 is a very competent piece of work. The general outline of the new law is commend- ably clear and understandable. Five principal subjects are covered, the first two at some length and three more briefly: (a) Substantial changes are made in the tax established by the Act of 1934 on personal holding companies. (b) A new tax is levied upon foreign personal holding companies. (c) Certain previously allowable deductions from income are disallowed, and the non-deductibility of certain other items is clarified. (d) The personal exemption of trusts to accumu- late is eliminated. (e) An additional tax is placed upon non-res- ident alien individuals. A. DOMESTIC PERSONAL HOLDING COMPANIES Probably the most important changes in the law, in economic effect, are those applicable to domestic per- sonal holding corporations, embodied in Title I of the Act. The basic structure of this tax has not been altered. In the new Act as in the old. personal hold- ing companies are defined so as to include corporations which derive most of their income from investments as distinguished from operations. and which are effectively controlled by not more than five unrelated individuals. A tax, in addition to the regular corporate income tax and surtax on undistributed profits, is then placed on the undistributed net income of such corporations in order to make it unprofitable to accumulate income in a personal holding corporation instead of paying it over to shareholders. But although the structure of the law has not been altered the existing provisions have been considerably tightened and the tax rate tremend- ously increased. Under the 1936 Act a corporation to be taxed as a personal holding company had to derive at least 80% of its gross income from royalties, dividends, in- terest, annuities and gains from the sale of stock or securities. To these types of income, referred to as personal holding company income, the new Act has added (a) profits on the exchange of stocks, (b) gains from dealing in commodity futures (except hedging transactions by a producer, processor, merchant or handler), (c) income from estates or trusts in which the holding company might be interested, (d) income from personal service contracts, (e) compensation for the use of property by a person owning directly or in- directly 25% of the stock of the corporation, (f) rents (unless they constitute 50% or more of the gross in- come of the company), and (g) mineral, oil or gas royalties (unless they constitute 50% of the gross in- come and unless deductions for expense allowable under Section 23 (a) of the 1936 Act constitute 15% or more of the gross income). Of these changes the addition of profits on the ex- change of stocks or securities was merely clarifying. Inclusion of profits on grain futures was designed to meet a specific case presented to the Joint Committee in which a holding company went into the grain market to secure a source of income not classed as personal holding company income under the 1936 Act. (Joint Committee Report, s 1, par. 9). The provision including income to a personal hold- ing company from an estate or trust is apparently one provision in the Act in which the Treasury experts have anticipated private tax counsel. Under the Act as it was drawn taxes might be avoided by mounting a trust upon a personal holding company, so that the trust would hold dividend or interest bearing securities, and avoid tax by paying out all of its income to a corporate beneficiary which in turn might be regarded as falling out side the provisions of the personal holding company tax, unless income from a trust or estate was expressly 59

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