The CHAIRMAN. Yes; you may file your statement, if you wish, for the record.

Mr. CARROLL. Thank you, sir.

The CHAIRMAN. All right. Thank you very much.

(The statement referred to is as follows:)

AMENDMENT TO SECTION 131 OF THE INTERNAL REVENUE CODE PROPOSED FOR INCLUSION IN THE REVENUE BILL OF 1941 IN BEHALF OF THE NATIONAL FOREIGN TRADE COUNCIL, INC., 26 BEAVER STREET, NEW YORK, BY MITCHELL B. CARROLL, ESQUIRE

INTRODUCTORY STATEMENT

Mr. Chairman and members of the Committee on Finance of the United States Senate, the members of the National Foreign Trade Council are gratified that the House has adopted in the revenue bill of 1941 section 108 which provides for the reduction, in pursuance of treaties, of the rates of tax to be withheld from certain recurring items of income derived by nonresident alien individuals resident in, and corporations organized under the laws of, Western Hemisphere countries. This provision should indeed tend to accomplish the purpose set forth in the official report of the House Committee on Ways and Means (p. 9. par. 6), namely, that "the extension of this favorable treatment is a part of the program toward improving relations with our sister nations in the Western Hemisphere."

Therefore, the council heartily endorses this amendment and hopes that the Senate will concur in its adoption.

PROPOSED AMENDMENT TO ALLOW DEFERRING OF THE CREDIT FOR FOREIGN TAXES ON BLOCKED INCOME UNTIL RELEASE OF INCOME

You are doubtless aware that, just as you are considering the raising of taxes according to the criterion of the utmost capacity to pay, the legislatures of other countries are likewise engaged in augmenting their rates to about the highest point the traffic will bear. If an American enterprise carrying on business in any one of these countries realizes income there, which is subject to burdensome rates both in the foreign country and again in the United States, the resulting burden would be so great that American enterprises might have to withdraw and leave the field to competitors.

Many of you may recall that our commercial enterprises were faced with a similar situation along toward the end of the last war and, in the Revenue Act of 1918, the Congress wisely decided that if our enterprises were to continue to compete abroad with foreign companies which were receiving tax exemptions and other kinds of aid from their respective governments it would be necessary at least to allow a credit against the United States income tax for income taxes paid in foreign countries. The credit has justifiably been limited so that in no case the offset may reduce the United States tax on domestic income, and where the foreign rate is lower than the American rate, our Government collects the difference in rates on the foreign income. However. in recent years, and particularly at the present time, enterprises are being denied the benefit of this credit because of circumstances arising from the disruption of economic life abroad and the trends of foreign tax legislation. As you know, an increasing number of countries, including countries of the Western Hemisphere, are forced to adopt exchange restrictions in order to arrest the depletion of their national monetary resources, with the result that, in many cases, profits which have been earned abroad by American enterprises are blocked and cannot be availed of. The question has arisen whether such income, which cannot actually be enjoyed by the American enterprise, should be treated as income for tax purposes here, and the Board of Tax Appeals has ruled that such blocked income need not be treated as income until it is unblocked or becomes convertible into dollars. (International Mortgage and Investment Corporation v. Commssioner, 36 B. T. A. 187). However, if this unblocking takes place in a later year, the limitations in section 131 (b) prevent taking the credit for the tax paid abroad on such income.

Hence, we respectfully urge you to remove this inadvertent inequity by adopting our proposed amendment which, in substance, would treat the tax as following the income and would allow it to be taken as a credit in the taxable year when the income in question is brought into gross income.

TECHNICAL DISCUSSION OF AMENDMENT

The decision in the case of International Mortgage and Investment Corporation v. Commissioner (36 B. T. A. 187) to which the Commissioner has given his acquiescence, 1937-2 CB 15, permits the carrying forward for tax purposes of completely blocked income until it is released; and, if this interpretation of the law is generally applied, it may result in the loss of the credit for foreign taxes in a growing number of cases. This problem may become more serious for American export corporations in view of the probable increase in exchange restrictions on foreign currencies because of the war situation. The credit for foreign taxes on blocked income may be assured, however, by a simple amendment which merely states a principle inherent in section 131 of the Internal Revenue Code.

In the above-mentioned case the petitioner realized gain by purchasing at less than their face value mortgages which were paid off at their full value. The Board of Tax Appeals observed that, measured in marks, the petitioner had income from its business in Germany, but that income for our Federal income-tax purposes is measured only in terms of dollars. The marks received after a certain date were blocked and they could not therefore be removed from Germany either physically or by way of a credit during the remainder of the taxable year, nor could the dollar equivalent of the marks be obtained. The petitioner did not have unrestricted use and enjoyment of the marks, and could not use them to retire its bonds as planned. It could not have any of these marks released until a number of years later. The marks were seriously restricted and in no sense the equivalent of free marks. The Board therefore held it was improper to compute a gain to the petitioner from the repayment of the mortgages by translating the gain in marks received into dollars at the rate of exchange applicable to free marks.

However, the Board held that taxable gain had been realized in marks which were received previous to the time of the imposition of the exchange restrictions and because those earlier funds had been freely negotiable, convertible, and transferable. They could have been removed from Germany when received but had been allowed to remain there until they were blocked.

There may be a great many situations in which an American taxpayer will receive foreign currency income in the forms of dividends, interest, royalties, trading profits, or otherwise, which is blocked, and only in a later year susceptible of conversion or of realization through use.

Although the International Mortgage and Investment Corporation decision involved only a very limited class of income, its basic reasoning may well apply in determining what shall be included in gross income in many other blocked currency situations. It would be very difficult to draft legislation to cover the facts of all these situations, and perhaps it may be best to leave to determination in audit whether, under the facts of each case, blocked foreign income should be regarded as realized in terms of dollars and included in gross income, or should be regarded as not realized until a later year. In the former case, the amount of foreign taxes thereon would be converted into dollars at the same rate and taken as a credit under section 131. However, if foreign income were not included in gross income until a year or more after it arises abroad, then any foreign income taxes paid or accrued with respect to such income should be carried forward for the purposes of the credit for foreign taxes in section 131 until the foreign income is included in gross income.

Only such a procedure would be consistent with the underlying principle of the foreign tax credit. The law presupposes that foreign income will be subjected to the United States tax for the year in which it is realized and, under section 131 (a), only taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States may be taken as a credit. Furthermore, under section 131 (b) (1), the credit for the taxes of any particular foreign country may not exceed the same proportion of the United States tax against which it is taken, which the income from such country bears to the entire net income, in the case of a taxpayer other than a corporation, or to the normal tax net income, in the case of a corporation, for the same taxable year (sec. 131 (b)).

Strictly speaking, therefore, under the language of subsection (a), the foreign tax paid on blocked income can be credited only in the taxable year in which it is

paid or accrued. If the taxpayer regularly takes credit on the accrual basis, and if the blocked income involved is not brought into gross income in the given year, no credit would be allowed in that year because the numerator of the limiting fraction would be zero. Situations might also arise where taxpayers could not take credit for the foreign tax on a paid basis for similar reasons. Furthermore, when, in a subsequent year, the funds are freed for conversion into dollars or utilization, they would be subjected to the United States tax, but ordinarily no credit could be taken against the United States tax for the foreign tax which was paid or accrued during an earlier taxable year. Hence, in such cases the income would be doubly taxed and the purpose of the credit for foreign taxes would be frustrated. The original intent of section 131 could be realized if the section were amended so as to incorporate specifically the principle that the foreign tax would not be deemed to have been paid or accrued until the taxable year when the income is included in gross income. This might be accomplished by inserting at the end of subsection (d), entitled "Year in Which Credit Taken," the following language printed in italic :

SUGGESTED LANGUAGE OF AMENDMENT

SEC. 131. TAXES OF FOREIGN COUNTRIES AND POSSESSIONS OF UNITED STATES. (a) Allowance of credit.-If the taxpayer signifies in his return his desire to have the benefits of this section, the tax imposed by this chapter, except the tax imposed under section 102, shall be credited with:

(1) Citizen and domestic corporation.—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

* ** *

(d) Year in which credit taken.-The credits provided for in this section may, at the option of the taxpayer and irrespective of the method of accounting employed in keeping his books, be taken in the year in which the taxes of the foreign country or the possession of the United States accrued, subject, however, to the conditions prescribed in subsection (c) of this section. If the taxpayer elects to take such credits in the year in which the taxes of the foreign country or the possession of the United States accrued, the credits for all subsequent years shall be taken upon the same basis, and no portion of any such taxes shall be allowed as a deduction in the same or any succeeding year. In any case, for the purposes of subsection (a) of this section, taxes paid or accrued to any foreign country or any possession of the United States shall be deemed to have been paid or accrued during the taxable year when the income upon or with respect to which they are imposed is included in gross income for purposes of the tax imposed by this chapter.

If the above location of the new language seems inappropriate, the amendment might be added to section 131 as a new subsection, as follows:

() Definition of taxes paid or accrued.-For the purposes of subsection (a) of this section, taxes paid or accrued to any foreign country or any possession of the United States shall be deemed to have been paid or accrued during the taxable year when the income upon or with respect to which they are imposed is included in gross income for purposes of the tax imposed by this chapter.

DEDUCTION OF FOREIGN TAX

The carrying forward of the foreign tax for the purpose of taking it as a deduction under section 23 (c) (2), if the taxpayer prefers, might also be covered, as follows:

SEC. 23. DEDUCTIONS FROM GROSS INCOME.-In computing net income there shall be allowed as deductions:

(c) Taxes generally.-Taxes paid or accrued within the taxable year, except— (2) Income, war-profits, and excess-profits taxes imposed by the authority of any foreign country or possession of the United States; but this deduction shall be allowed in the case of a taxpayer who does not signify in his return his desire to have to any extent the benefits of section 131 (relating to credit for taxes of foreign countries and possessions of the United States), and in such case, taxes paid or accrued to any foreign country or possession of the United

States shall be deemed to have been paid or accrued within the taxable year when the income upon or with respect to which they are imposed is included in gross income.

The CHAIRMAN. Mr. Alfred L. Smith.

STATEMENT OF ALFRED L. SMITH, ELKHART, IND., CHAIRMAN, COMMITTEE ON TAXATION, NATIONAL ASSOCIATION OF BAND INSTRUMENT MANUFACTURERS

Mr. SMITH. Mr. Chairman and gentlemen of the committee, my name is Alfred L. Smith. I am executive vice president of C. G. Conn, Ltd., Elkhart, Ind., manufacturers of band and orchestra instruments, and I am speaking on behalf of the National Association of Band Instrument Manufacturers. This association is composed of the manufacturers of band and orchestra instruments.

This is a separate and distinct industry within the general music industry, manufacturing the instruments of the symphony orchestra; that is, the wind, percussion, and string instruments. Our great market is the public-school system and the children in the system who take instrumental instruction and our secondary and much smaller market is the professional musician who uses these instruments as the tools of his trade.

We are very small industry. I suppose I have the distinction, if it is a distinction, of representing the smallest group of any industry that has appeared before this committee. If you eliminate the small shops employing less than 25 people each, we have only about 15 manufacturers, and we employ only about 2,000 men, but on this tiny industry there depends entirely the development of the musical art in this country.

Also I might say that in no group of employees of this size, or any size, could you find, perhaps, a greater proportion of men who are very highly skilled, who have devoted their entire lifetime to one job. Throughout the entire industry, the employees are old. Probably the average is way over 50 years. These men are not of the type, they have not had the experience, and they are not of the age that they can be transferred to defense work, and they are dependent, and their families are, for their livelihood on this industry. For that reason, I ask your careful consideration of some of the problems of this industry which are affected by this tax.

Senator BROWN. Mr. Smith, you are now taxed at 52 percent, are you not?

Mr. SMITH. We are not taxed at all now. We are proposed to be taxed 10 percent on the manufacturers' price in the bill.

Senator BROWN. The House report, section 3404, emphasizes the tax on sales, manufacturing certain radio components at the rate of 512 percent of the sales price. Section 545 amended this to impose a tax of 10 percent on radio receiving sets and certain other instruments, including musical instruments.

Mr. SMITH. Yes; that added the musical instruments, but the musical instruments were not taxed at all.

Senator BROWN. Now it is proposed that you be taxed 10 percent? Mr. SMITH. That is right.

Senator DAVIS. Mr. Smith, what portion of the instruments are purchased for the young people of this country, especially those in the schools?

Mr. SMITH. Well, as between the children in the schools and the professional musicians who constitute the great market, I should say it is, roughly, in value-about 80 percent goes to the school children and 20 percent to the professional musician. That is not taking into account purchases by village bands, of which there are a few, and the lodge bands, and individual instruments of people for enjoyment; but I presume that between the school children and professionals, they account for 95 percent of the production, and that 95 percent, I should say, is divided about 80 percent between the children in the schools and 20 percent to the professionals.

When it comes to the number of instruments, the percentage to the schools is much larger, because, obviously, the professionals have to use the highest grade, the highest-priced instruments, whereas the children start with the third or lowest-grade instruments; and if they continue their instructions, as many of them do, they get the medium grade, and finally they purchase the highest grade. As a matter of fact, more of the very highest, finest instruments are purchased by the children in the schools than there are purchased by the professional musicians.

Senator DAVIS. If you pass this 10-percent tax on, how much will that increase the price to those youngsters that buy these instruments?

Mr. SMITH. It will increase the price by 10 percent to the consumer. That will mean in dollars to the beginner from about $5 to perhaps $15 or $20, and to the child who has progressed beyond the beginning stage and buys the better instrument, it will probably run from $10 to $25, depending on whether it is a trumpet, for instance, which is a relatively inexpensive instrument, or, we will say, an alto or bass clarinet, which is the expensive type of instru

ment.

Senator DAVIS. It is going to be difficult for them to buy the instrument. I recall when I was quite a youngster I got 50 cents a day, and I had to pay 50 cents a week on my clarinet. It was a difficult thing to get that half dollar. I presume there has not been much of a change since that time.

Mr. SMITH. Senator, you know parents may endure a lot of privation to give their children an enducation, whether it is a musical education or any other type of education. We know that they do go a long way in the poorer families. We also know these increased prices will curtail sales. They will have to, because our sales are primarily to the poorer people.

In other words, our market is primarily in the rural districts. in those States from Wisconsin down through to Texas and in the poorer sections of the industrial States, like in your State of Pennsylvania, Senator, and the State of Ohio, and our poorest markets are in the better suburbs of the big cities. In other words, music is the poor man's art, and he is the one that wants his children to take instrumental music. It is true that you will find the biggest, finest symphony orchestras and bands in the smaller towns and rural schools and in the workingmen's sections of the cities. The consolidated school has been