-3

back three years and forward five years to offset profits in those years. On seven occasions in the past, the Congress has recognized the economic desirability of modifying this general averaging rule to provide greater flexibility and equity in averaging profitable and loss years.

A close examination of the prior Congressional action reveals that the underlying rationale for liberalizing carryback and carryover provisions in each case was identical: Congress simply decided that it was unfair to exact an income tax from a taxpayer when in economic fact that taxpayer had not realized any income. Stated otherwise, the prior legislation shows a definite Congressional recognition of the business fact that hard-hit losing industries have an acute need for funds immediately, while they are incurring losses, not in the future, when they are earning profits against which loss carryovers may be applied. In many cases, the immediate utilization of operating losses can be the difference between survival and insolvency. A more flexible operating loss carryback/carryover period would be in keeping with the policy intent behind the original enactment of the loss carryback and carryover provisions.

While a loss carryover does provide benefits, it is the loss carryback which yields the immediate benefit of a tax refund when the taxpayer is in urgent need of the cash at the time it is incurring the loss. Obviously, such refunds are immediately plowed back into business operations, thus permitting continued operations and preventing further deterioration of the economy.

It has been recognized that extending the carryback period is particularly useful since it promptly provides liquid funds for a business experiencing economic reverses. Statement of Senator Gaylord Nelson (see also Statement of Senator William Proxmire), Cong. Rec. 32089-32091 (November 9, 1967)).

(4) Effect on tax revenues would not be significant.

The immediate "overpayments" produced by an extended operating loss carryback period represent merely a refund of "overpayments" of prior year income taxes based upon the use of a more realistic business cycle for the determination of the true amount of net income.

At the time that the proposal to extend the net operating loss carryback period was considered by the Committee on Ways and Means, when it was considering the Tax Reduction Act of 1975, the Staff indicated that, while its immediate effect would be a reduction in current revenues, there would be

-4

an increase in tax revenues in future years, because there would be a decrease in the amount of net operating loss carryforwards. Under present law, carryforwards would be utilized directly by the taxpayer or indirectly through mergers.

(5) Importance of preserving the carryover of losses to properly reflect income resulting from business cycles.

As a matter of equity, full offset of losses treats alike those taxpayers who stand in like positions over a period of time. Carryovers ameliorate the harsh and somewhat arbitrary consequences of the annual accounting approach toward computing income. Carryovers are essential in the case of new businesses, fast growing businesses which suffer extraordinary losses, as well as for companies which have been marginal struggling businesses for a long period prior to incurring losses. It would be inequitable not to permit taxpayers to carryover operating losses in these situations.

In addition, as above noted, full offset of losses contributes to the counter-cyclical effect of taxes. An absence of loss offsets, or a limitation on their use, tends to increase cyclical instability.

(6) Appropriate safeguards would prevent trafficking in loss carryovers.

It is widely known that the complex and elaborate rules of sections 381, 382, 269 and 482, while they have substantially reduced the acquisition of loss companies by profitable companies, they have not eliminated the trafficking in loss carryovers in certain situations. Of course, the adoption of a more liberal carryback would reduce the trafficking in carryovers because there would be less of a loss to carry forward. By the same token the more extensive the carryback the more completely the carryover abuse possibility is eliminated. Since no trafficking abuse potential exists with respect to carrybacks this presents additional justification for a more flexible carryback period.

Possible safeguards for consideration might include:

Limitations on the deductibility of loss carryovers where a profitable business acquires a loss business; and in the reverse situation in cases where the shareholders of the profitable company receive a specified percentage of the stock of the loss company into which the profitable company

-5

is merged, e.g., none of the carryover of the loss company would be allowed where the shareholders of the profitable company receive at least 50% of the shares of the surviving company; where the shareholders of the profitable company receive less than 50% of the surviving company, the loss carryover of the losing company which could be offset against future profits of the profitable business would be reduced by two percentage points for each one percent of the shares received of the surviving company.

(7) Other arguments which may be amplified depending on particular industry.

(a) More flexible carryover and carryback provisions would preserve competition by refunding taxes to enable the smaller or harder-hit competitors in particular industries to develop products and facilities in greater competition with the industry leaders.

(b) Some industries, and supporting businesses, require huge amounts of capital at the present time to adapt to the new economic era into which we have recently been thrust. After earning negative profits and borrowing up to capacity, an extended loss carryback period would truly be badly needed "pennies from heaven".

(8) Recommendation

What may have been adequate anti-recessionary tax legislation in the Tax Reduction Act of 1975 to help stimulate the economy is not what is needed for structural long term tax reform purposes, particularly considering the extraordinary nature and causes of the economic problems created by the 1973 oil embargo and the huge price increases resulting therefrom, e.g.:

(a) The economic recession hit all developed countries who are
in any way dependent on other countries for oil.

(b) The price of oil has soared and is expected to continue to
increase.

(c) Not only the price of oil but the supply itself is not certain.

(d) Continued high prices will result in a decreased demand for goods for the indefinite future which will result in a continued high level of unemployment and depressed business activity for certain industries related to and dependent upon oil (e.g., automotive manufacturers and suppliers, utilities, recreational oriented businesses, transportation related businesses, etc.)

-6

The carryback/carryover period should be amended to provide any carryback/carryover period elected by the taxpayer not to exceed a total of ten taxable years which may consist of either the ten taxable years immediately preceding the taxable year of such loss, the ten taxable years immediately following the taxable year of such loss, or any combination of successive taxable years immediately preceding and successive taxable years immediately following the taxable year of such loss. This extended carryback/carryover period should be available to taxpayers with respect to loss years ending on or after the 1973 oil embargo.

Attached are several articles outlining problems confronting family farming in America. In many ways, these articles parallel the statement submitted by Gil Rohde earlier last month.

To supplement the record, if it's not too late, the Committee may want to include them.