Evening star., 1937-01-01
DEBTS ARE FROZEN
BY TAX ON PROFITS.
Arrangements Tempted to
Preserve Obligations
to Avoid Levy.
BY Cambridge Associates.

tration and the general pubic alike,
Is that 1t tends to freeze corporate
debts at present levels. although in
many cases it appears imperative for
the future well-being of many cor
porations to reduce fixed charges in
times of good earnings.
Except in instances we're generous
sinking fund provisions were in effect
previous to May 1. 1896. the tax cost
of devoting more than 10 per cent OF
net income to the retirement of funded
debt is practically prohibitive. Fur
thermore, the retirement of this debt
reduces the proportion of future profits
which are exempt from the tax and
therefore tempts arrangements to pre-
serve funded debts as q means OF
avoiding taxes.
/ Corporations in receivership are
naturally prohibited from paying out
earnings. not only to shareholders, but
also to all but the most firmly estab-
]jshed of bondholders. Thus we have
the peculiar condition where a COM
pany which cannot legally pay profits
ITO bondholders must turn over to the
Government large portion Of these
revenues, so delaying the advent of
reorganization further and adding to
the general uncertainty. And COM
panies Of uncertain financial strength
ranging from those actually graphing
with problems bequeathed by huge de-
preston deficits to those who merely
sacrificing business to competitors be-
nf ut ol nit oil
may certainly question the theory of
taxation which enforces a burdensome
penalty on the restoration of conserva-
tive balance-sheet ratios. 1t is the
belief of those close to the situation
that these conditions will be corrected
to degree through system of ex-
emptions, which may or may not be
accompanied by stiffening of the
Gates to make up for lost income.
No Chance of Repeal Seen.
These are by no means the only
charges against the present law. In
fact, most business men would revel
in the opportunity to denounce it al
most from beginning to end. But
there is little possibility of question
less than no chance at all of repeal
President Roosevelt's original concep-
tion Of the undistributed profits tax
was. in some respects similar to the
English system, except that he pro-
posed to apply a sliding scale rather
than a normal tax. Broadly. he sug-
gested in his message of March 8,
1886. that the capital stock and excess
profits tax and the corporate income
tax be eliminated: that undistributed
profits be taxed on a sliding scale of
sufficient magnitude to produce the
same income which would theoretical
1y result from distribution of such
profits if no exemption of dividends
were allowed on individual incomes,
and that this exemption. which now
exists, be repealed The principles
involved in the resulting tax system
are simply stated:
l. Profits paid out in dividends
are exempt from taxation at the
source, but are taxable as individ-
ual income at normal plus Surtax
rates
2 Profits not paid out are tax
able on a sliding scale depending
on the percentage of total profits
retained
3. Dividend income from sub
sidiaries is regarded as regular in
come.
The last provision is aimed at hold
ing compa anies. Unfortuna tely. the
workings of these principles are far
from being as simple as they sound
Less Simple In Actual Draft.
They are even less simple in tine
actual draft. Normal corporate in
come tax was not repealed. but rates
were lowered for net income of less
than $4,000, in Difference to little
business. The capital stock and sur
plus profits tax was likewise retained,
and the basis on which net income is
stated for normal tax purposes is diff
ferent from that used for the undis-
fributed profits tax The resulting
confusion and duplication of levies
will provide many hours of labor for
legal minds.
In addition to stabilizat ton of cor
porate debt levels. duplication of taxa
ton and more complicated tax pro-
visions, there are other bad effects
OF lesser importance. One of the re-
form theories behind this tax is to
deter managemenls from unwiSely in
creasing productive facilities beyond
The need by virtually forcing them to
conduct expansion through the issue
Of securities rather than through use
OF undistributed profits Needless to
say. in smaller com panies with close
control by stockholders, the decIara-
ton of large dividends will not pre-
vent the plowing of profits back into
the business, since by common agree
ment these dividends will be rein
vested in the business. Likewise with
large corporations of strong financial
condition and stock listed on the
large exchanges there will be little
difficulty in issuing rights or new
stock. But the intermediate COM
panies will be restricted on the one
hand by lack of centralized control
and on the other by poor market
ability of their securities from ex-
pansion which may be justified
Budgetary operation of business is
likely to become more and more neces-
sary. demanding an increase in cleri-
cal staffs. Whether or not this is good
and to what degree it should be car
ried are matters OF conjecture, but
the passage of this tax legislation can
only be credited with augmenting the
pressure for such procedure. Happily
the imposing technical advance in bus
mess machinery simpliies many OF
these tasks for those who are able to
afford them.
New Practice in Evidence.
During the latter months of 1886
an entirely new practice of dividend
declaration was In evidence. For
relatively few companies can it be
said that regular dividend rate has
been established, following the food
Of extras and special dividends which