provisions applicable to regulated investment companies, which appear in supplement Q of the Internal Revenue Code, exempt from the corporation tax income which is currently distributed as dividends. Furthermore, the capital gains of a regulated investment company may be passed on to stockholders in the form of capital gains dividends, thus providing capital gains treatment to the stockholders.

The CHAIRMAN. Let me ask you a question there. The Treasury Department has given pretty careful consideration to this bill and there is nowhere in this bill that you or the Treasury Department see any attempt to interfere with private business, is there?

Mr. KIRBY. None that we are aware of.

The CHAIRMAN. You do not read in any section of this bill where we would have anybody believe they are going to get something for nothing; they have to put up collateral; is that the way you understand it? Mr. KIRBY. That is the way we understand the bill.

The CHAIRMAN. That is the way the Secretary understands it, too? Mr. KIRBY. That is correct.

The CHAIRMAN. In other words, it is a private enterprise small business bill?

Mr. KIRBY. That is correct.

The CHAIRMAN. And collateral must be put up for any loans?
Mr. KIRBY. As I understand it, that is correct.

The CHAIRMAN. And the Secretary understands it that way, too?
Mr. KIRBY. Yes, sir.

The CHAIRMAN. Some people made the statement here the other day they read in the paper that they were going to borrow money for small business, if this bill passed, without collateral and it would cost the taxpayers a lot of money. It was never the intention of those who drew the bill to have that occur, but I wanted to get the record clear as to what the Treasury Department understands.

Mr. KIRBY. I am not aware of any such intention.

The CHAIRMAN. And the Secretary feels the same way?

Mr. KIRBY. I am sure he does.

The CHAIRMAN. I wanted to ask you that question.

Will you proceed?

Mr. KIRBY. The tax treatment of the regulated company is based upon the theory that the companies are merely conduits for the flow of investment income which is currently taxable to the stockholders. In order to qualify for the special treatment provided under supplement Q, a regulated investment company must receive 90 percent of its gross income from dividends, interest, or capital gains, and must distribute 90 percent of its net income, other than capital gains, to stockholders during the taxable year.

It is further required under supplement Q that the investment portfolio of the company must be diversified both as to the number of separate corporate investments, and as to the size of the investment in any one company.

A regulated investment company is subject to the regular corporate rates on any amount of income which is not distributed during the taxable year. Any net capital gains retained by the company are subject to the usual 25 percent tax.

Under the proposed bill, national investment companies would be eligible for the conduit treatment provided under supplement Q now in our Internal Revenue Code. However, the technical requirements

as to the sources of income and diversification of assets would be liberalized with respect to the national investment companies.

In order to qualify under supplement Q, national investment companies would need to receive only 75 percent of their gross income from dividends, interest, and capital gains, instead of 90 percent required for other regulated investment companies.

The reduction in the percentage of income required to be derived from investment sources is intended to permit greater flexibility of operation. It is expected, particularly during the initial years, that the companies may derive a substantial portion of their income from the furnishing of technical or managerial services to eligible enterprises on a fee basis.

Under the bill, national investment companies may obtain as much as 25 percent of gross income from noninvestment sources.

The bill also provides, with respect to the asset diversification requirement, that the Federal Reserve Board may waive these requirements as to any national investment company if it determines that such action is necessary and appropriate to accomplishment of the purposes of the act. The waiver of such requirements presumably may be made as to any one or all national investment companies, and may be under such conditions and limitations as the board determines. It may be noted in this connection that section 206 of the bill also contains limitations on the aggregate amount of investment by a national investment company in any single enterprise, and that such limitations may be waived by the board.

The principal changes in supplement Q as applied to the national investment companies appear in section 208 (d) (1) and (2) of the

bill.

Under supplement Q, regulated investment companies are generally required to distribute substantially all their income and are fully subject to tax on any portion of income retained, not to exceed 10 percent of the income for the taxable year.

The provisions of supplement Q also operate in such a manner as to deny regulated investment companies the operating loss carry-over and the 85 percent dividends-received credit available to other corporations.

The tax treatment of national investment companies proposed in the bill would enable these companies to be treated as regulated investment companies for the purposes of amounts distributed to stockholders, while at the same time allowing such companies to retain and accumulate a substantial fund of earnings designated as a "national investment company reserve." National investment companies would be granted a tax deduction as to certain additions to the reserve and the dividends received credit with respect to further additions to the reserve.

In general, it is contemplated that the reserve would be available to offset operating losses or capital losses. Any other withdrawals from the reserve would be required to be distributed to the stockholders and would be taxable as a dividend to them or, in the case of liquidation, as a short-term capital gain.

The mechanics of the reserve are set forth in section 208 (d) (2) of the bill. It is there provided that any national investment company which meets the requirements of Supplement Q may, under regulations prescribed by the Commissioner of Internal Revenue with the

approval of the Secretary of the Treasury, establish and maintain a reserve. This reserve must not at any time exceed 50 percent of the invested capital of the company.

It is also provided that the reserve shall not exceed the actual amount of accumulated earnings and profits of the company.

A national investment company electing to establish such a reserve may deposit therein all or any portion of its earings up to the allowable maximum of the reserve and to the extent of such deposits, is relieved of the requirement of distributing such income to its stockholders.

Deposits in the reserve up to 20 percent of invested capital are allowed as a tax deduction without regard to the source of such income. Further additions to the reserve up to the maximum of 50 percent of the invested capital qualify for the dividends-received credit of 85 percent, provided the company actually has dividend income from domestic corporations equal to the amount of such deposits.

Any deposits in the reserve which do not qualify for the deduction or the dividends-received credit would be subject to tax at the regular corporate rate.

The CHAIRMAN. Have you discussed this matter at all with Mr. Stam of the Joint Committee on Internal Revenue Taxation?

Mr. KIRBY. No, I have not.

The CHAIRMAN. Have you discussed it with anybody in the Finance Committee?

Mr. KIRBY. No, I have not, Mr. Chairman.

Senator SPARKMAN. While you are stopped, may I ask a question? Mr. KIRBY. Yes, indeed.

Senator SPARKMAN. Are these things you are mentioning now applicable to the investment companies proposed in this bill? Mr. KIRBY. That is right.

Senator SPARKMAN. And not to corporations generally?

Mr. KIRBY. That is correct. This would be applicable to the national investment companies that would be set up under the provisions of the bill.

Senator SPARKMAN. And they are, in many respects, different from conditions that apply to ordinary corporations?

Mr. KIRBY. That is right. Yes, this reserve is unusual.

Senator SPARKMAN. That is what prompted the question. It seemed to me that is much more liberal than it is with ordinary corporations, is it not?

Mr. KIRBY. That is correct. It is more liberal. It permits these national investment companies to set up reserves up to 50 percent of their total invested capital, which includes all their borrowings as well. The first 20 percent of that would be permitted as a tax deduction. The next 30 percent would be given the dividends received credit to the extent that they receive dividends, and that results in quite a low tax. It amounts to about 5.7 percent tax.

Senator SPARKMAN. This thought occurs to me, and I think this might be as good a place as any for me to state it or ask it. The Select Committee on Small Business of the Senate has had several days of hearings, as you know, Mr. Chairman. I believe that every witness who came before our committee during those days-and Senator Benton will check me on this-made the statement that the greatest single relief that small business needed was in the field of taxation.

So the thought occurs to me: If this is good for these investment companies, why would not some such program be good for small business generally?

Mr. KIRBY. That is quite a difficult question to answer.

Senator SPARKMAN. I realize it is, but I think it is something we need to turn our thinking to quickly and very strongly.

Mr. KIRBY. A lot of thinking has been done along the lines of small business. Studies have been made. The Department has studied the problems very carefully. There are many, many proposals that have been advanced by various sources for the aid of small business, even in the area of tax treatment.

Senator SPARKMAN. I may say, Mr. Chairman, in all fairness, that we have not yet had the Treasury Department before us because they were not ready to come at the time we asked them but, after we have finished with these hearings, we do hope to have representatives of the Treasury Department up to discuss fully this question of tax relief for small business.

The CHAIRMAN. I made a statement last Friday that we hoped, when your hearings are printed-there is no use in duplicating the hearings by having them printed in this record, but we want those two records together. The reason I asked this tax question was that I have been very careful in this committee to make certain if there are any tax questions concerned, we should certainly have the advice of Mr. Stam. We concur in what the Secretary has said, but I am going to ask the clerk to have a statement from Mr. Stam as to how he interprets this, and also to ask him if the joint committee has any ideas as to how this could be further carried on, as you suggest, to have small business covered generally.

So I will ask the clerk to get that statement, and without objection, it will be placed in the record.

(The statement referred to will be found in the files of the committee.)

The CHAIRMAN. Go ahead, sir.

Mr. KIRBY. The maximum amount of the reserve is determined by reference to the invested capital of the company. As defined in the bill, it is stated that invested capital includes the amount of paid-in capital, paid-in surplus, contributions to capital, and any indebtedness of the company other than unpaid interest. The indebtedness may be represented by a bond, debenture, or any other certificate of indebtedness. If the indebtedness is not represented by a bond or debenture, however, it is only included in an amount equal to the average of such indebtedness for the taxable year.

Section 203 of the bill provides that the total amount of obligations of a national investment company outstanding at any one time shall not exceed the amount of capital stock in surplus. Accordingly, if a national investment company issues the maximum amount of obligations, the total of additions to the reserve could equal 100 percent of the paid-in capital.

The CHAIRMAN. Just for the record, what would you consider to be the maximum amount? You have been talking about a maximum but we have not any specific figures. What I want to get are a few figures that might be comparable to small business in this other study.

Mr. KIRBY. For example, if the company starts out with a paid-in capital of $5,000,000, as I understand it the bill permits the company

also to issue bonds or debentures to the extent of $5,000,000. That results in an invested capital for the purpose of the bill of $10,000,000. Then they can create, during the course of their existence, these reserves of earnings up to an amount of $5,000,000, 50 percent of their invested capital.

The CHAIRMAN. And then the 20 percent applies on that?
Mr. KIRBY. That is right.

The CHAIRMAN. Will you place that in the record, please?

Mr. KIRBY. With respect to the reserve, the first 20 percent of that reserve may consist of tax-exempt income; in other words, income that constitutes a deduction for tax purposes; and then the balance of the 50 percent, the 30 percent, may consist of dividends with respect to which the companies will be given a dividends received credit.

The CHAIRMAN. The Treasury Department believes these terms are liberal enough to attract private capital? I mean, to make it really attractive for private investors?

Mr. KIRBY. We do not pass judgment on that, Mr. Chairman. We are sure that these provisions are liberal and, as indicated, they are more liberal than the ordinary investment or other business corporations.

The CHAIRMAN. You would not have any further suggestions to make, other than what we have?

Mr. KIRBY. No, we do not have, but we want to work with the committee to provide appropriate tax treatment in connection with these national investment companies.

The CHAIRMAN. And also for small business?

Mr. KIRBY. Yes.

The CHAIRMAN. That is the main thing.

Mr. KIRBY. Very definitely, when I speak of the national investment companies, their purpose is only for the servicing of small business and it is to that extent that they are useful.

The bill also provides that national investment companies, unlike other regulated investment companies, shall be entitled to the net operating loss carry-back and carry-forward. At the present time the net operating loss provisions permit a 2-year carry-back and a 2-year carry-forward of losses. The Treasury has recently recommended that these provisions be modified so as to permit a 1-year carry-back and a 5-year carry-forward. If this recommendation is adopted, and it is now in the House bill that is being argued on the floor today, national investment companies

The CHAIRMAN. You speak of the House bill but, of course, you are talking of the tax bill?

Mr. KIRBY. Yes. It is now in the House tax bill, which is being discussed on the floor of the House today and will be on the Senate side shortly.

Senator BENTON. Did the President recommend changing the 2-year carry-back to 1 year at the same time he recommended changing the 2-year carry-forward to 5 years?

Mr. KIRBY. Yes.

Senator BENTON. This is his recommendation?

Mr. KIRBY. That, I believe, is his recommendation.
The CHAIRMAN. And that is in the House tax bill?
Mr. KIRBY. Yes, sir.

The CHAIRMAN. All right.