tion to be available. Also, the deduction is limited to 85 percent of the same proportion of the dividend as the foreign corporation's gross income, which is effectively connected with a U.S. trade or business, is of that corporation's total gross income from all sources.

Your committee added an amendment to the House bill which in certain situations provides a 100 percent dividends-received deduction to a domestic corporation for dividends received from a wholly owned foreign subsidiary which has a 100 percent effectively connected income. In such a situation a foreign corporation is subject to U.S. tax on all of its income, just as is a domestic corporation.

The bill also contains a transitional rule which makes it unnecessary to apply the effectively connected income concept when any of the years which is taken into account for the 50-percent test is a pre-1967 year. This rule provides that, for purposes of computing this deduction, all of a foreign corporation's U.S. source income, for any period before its first taxable year beginning after December 31, 1966, is to be considered to be effectively connected income.

Effective date. These amendments apply for taxable years beginning after December 31, 1966.

d. Unrelated business taxable income of certain foreign charitable organizations (sec. 104(g) of the bill and sec. 512(a) of the code) Under present law the unrelated business taxable income of foreign charities is subject to tax if it is derived from sources within the United States.

The bill conforms this provision to the effectively connected concept by providing that the unrelated business taxable income of a foreign charity is to be subject to tax only if it is effectively connected with the conduct of a trade or business in the United States.

This amendment applies for taxable years beginning after December 31, 1966.

e. Foreign corporations subject to personal holding company tax (sec. 104(h) of the bill and sec. 542 (c), 543(b), and 545 (a) and (d) of the code)

Present law. Under present law any foreign corporation with U.S. investment income, whether or not doing business here, may be taxed as a personal holding company unless all its outstanding stock is owned (directly and indirectly) by nonresident alien individuals and its U.S. source gross income is less than 50 percent of its total gross income for that year. If taxable as a personal holding company the foreign corporation is subject to a special 70-percent tax on its undistributed U.S. source personal holding company income in addition to the flat rate 30-percent tax (or possibly the regular corporate tax). Also, if a foreign corporation is determined to constitute a personal holding company and the foreign corporation has not filed a return or that which was filed was not a true and accurate return, the 70-percent personal holding company tax is assessed without allowance of the dividend paid deduction. In such cases, the combination of the regular 30-percent tax and the 70-percent personal holding company tax can constitute a tax of about 80 percent of the income of the foreign corporation.

Reason for provision. The primary reason for applying the U.S. personal holding company tax to foreign corporations owned by non

resident aliens has been to prevent the avoidance of the graduated rates of U.S. tax applicable to certain nonresident alien individuals by utilizing foreign holding companies as the recipients of their U.S. source investment income. Generally the graduated rates presently apply when a nonresident alien's U.S. gross income exceeds $21,200 or when he is engaged in a trade or business in the United States. However, under your committee's and the House bill nonresident aliens are not to be subject to the graduated rates of tax unless their income is effectively connected with a trade or business in the United States. In view of this the retention of the personal holding company tax would appear to serve no purpose where all of the shareholders are nonresident aliens.

Explanation of provision.-The House bill modifies the provision in present law excluding from the personal holding company definition only those foreign corporations which meet two tests; namely, where their U.S. source gross income is less than 50 percent of their total gross income and all of their stock is held directly or indirectly by nonresident aliens. In place of this the House bill substitutes a broader exemption which applies to any foreign corporation all of whose outstanding stock during the last half of its taxable year is owned by nonresident alien individuals (directly or indirectly through foreign estates, trusts, partnerships, or other foreign corporations). Your committee has adopted three amendments in this area. The first amendment provides that the general exclusion from the personal holding company provision provided in the House bill is not to be available to a foreign corporation which is a personal holding company if it has income from personal services which is personal holding company income described in section 543 (a) (7). In such a case the personal holding company tax is to be assessed on that personal service income. The second amendment provides a deminimus rule, in addition to the general exception provision provided in the House bill. Under the amendment, in the case of foreign corporations with only 10 percent or less U.S. ownership the personal holding company tax is to be assessed only on the corporation's undistributed personal holding company income attributable to the U.S. shareholders' interest. The final amendment adopted by your committee provides that a foreign corporation can claim all appropriate deductions in computing its personal holding company tax notwithstanding the general rule disallowing deductions where no return is filed. However, a 10-percent addition to taxes otherwise due is to be assessed. Effective date. This amendment applies with respect to taxable years beginning after December 31, 1966.

f. Foreign corporations carrying on insurance business in the United States (sec. 104(i) of the bill and secs. 819, 821. 822, 831, 832, 841 and 842 of the code)

Present law.-Present law taxes a foreign life insurance company carrying on a life insurance business in the United States on all its income attributable to that business in substantially the same manner as a domestic life insurance company. Foreign insurance companies carrying on life insurance businesses in the United States gen

A foreign life insurance company that is not carrying on a life insurance business in the United States is taxable under the provisions applicable to foreign corporations generally.

erally have interpreted this as providing they were not taxable on U.S. source income which is not income of the U.S. life insurance business of the company.

As is indicated above, with respect to their life insurance company business, foreign life insurance companies are taxed, under present law, in substantially the same manner as domestic life insurance companies. However, a special rule is provided where the surplus of a foreign life insurance company held in the United States is less than a specified minimum figure. This figure is expressed as the same percent of the foreign life insurance company's liabilities on U.S. business as the average surplus of domestic corporations is of their total liabilities. The Secretary of the Treasury determines this ratio each year. If the foreign insurance company's surplus held in the United States is less than this proportion of the taxpayer's total insurance liabilities on U.S. business, then the policy and other contract liability requirements, and the required interest for computing gain from operations, are reduced by this deficiency multiplied by the rate of earnings on investments. This provision is designed to prevent foreign insurance companies doing business in the United States from avoiding tax that they would otherwise have to pay to the United States merely by not holding a sufficient amount of surplus attributable to the U.S. business. Reason for, and explanation of provisions.-Your committee agrees with the House that foreign insurance companies-life insurance companies and other insurance companies, including both mutual and stock companies should, in general, be taxed on their investment income in the same manner as other foreign corporations. For this reason, the bill provides that a foreign corporation carrying on an insurance business within the United States is to be taxable in the same manner as domestic companies carrying on a similar business with respect to its income which is effectively connected with the conduct of a trade or business within the United States. The remainder of the U.S. source income of this type of a corporation is to be taxed in the same manner as income of other foreign corporations which is not effectively connected with a U.S. trade or business; that is, at a flat 30 percent (or lower treaty) rate. The determination of whether a foreign insurance company qualifies for the special domestic insurance treatment is to be made by considering only the income of the corporation which is effectively connected with the conduct of its insurance business carried on in the United States. In making this change vour committee intends no inferences as to the requirements of existing law with respect to investment income of foreign insurance companies.

For purposes of determining whether or not income of a foreign life insurance company is effectively connected with the conduct of its U.S. life insurance business, the annual statement of its U.S. business on the form approved by the National Association of Insurance Commissioners will usually be followed. It has been brought to the attention of your committee that certain foreign casualty insurance companies also use this form to indicate their U.S. business connected investment income. The committee does not intend to imply by negative inference that these companies will be precluded from using this form in the future. It is noted that all the income effectively connected with the foreign life insurance company's U.S. life insurance business, from whatever source derived, comes within the ambit of this provision. This a continuation of present law which subjects to U.S.

tax all the income attributable to the U.S. life insurance business from whatever source derived.

In the case of insurance companies other than life-both mutual and stock-present law provides that if these companies have income from U.S. sources but are not engaged in an insurance business here, they are taxed in the same manner as other foreign corporations. Where mutual insurance companies (other than life or marine) are carrying on an insurance company business in the United States, they are taxable on their income derived from sources within the United States in the same manner as similar domestic mutual companies. Stock casualty, fire, flood, and so forth, insurance companies carrying on an insurance business in the United States, also are taxed in the same manner as domestic stock insurance companies with respect to the portion of their taxable income from sources within the United States.

It has been pointed out that the special rule in present law referred to above with respect to foreign life insurance companies-where these companies hold a lower ratio of surplus for their U.S. business than that held by the average domestic companies may lead to what in effect is a double tax. This results from the interaction of this provision with the effectively connected rule. Thus for example, a company may find its deductions reduced (because of the minimum surplus requirement) while, at the same time, it is taxed at a flat 30 percent (or lower treaty rate) on investment income in this country not effectively connected with the U.S. business which, in effect, also includes the income subject to the minimum surplus adjustment.

To meet the problem referred to above, your committee's and the House bill adds a paragraph to the provision described above which has the effect of reducing the income subject to the flat 30-percent tax (or lower treaty rate) by the amount by which the deductions under this special provision are reduced as the result of the application of the Secretary's ratio. This is accomplished by allowing a credit against the 30-percent tax (or lower treaty rate) for the tax levied on the hypothetical income attributed to the U.S. life insurance company business. Effective date. These amendments apply with respect to taxable years beginning after December 31, 1966.

g. Subpart F income (sec. 104(j) of the bill and sec. 952(b) of the code)

Present law. Under present law certain portions of the undistributed income of a controlled foreign corporation are taxed currently to its U.S. shareholders having a 10 percent or greater voting interest. This undistributed income so taxed is termed "subpart F income." In determining "subpart F income," there is excluded income of a foreign corporation from U.S. sources which already is taxed by the United States because the corporation is engaged in trade or business in the United States. Present law is interpreted in the income tax regulations as not excluding from "subpart F" income, income exempt from U.S. tax, or subject to a reduced rate of tax, in accordance with a treaty.

The bill modifies existing law to conform this provision with the effectively connected concept and to clarify the language of existing law with respect to income affected by treaties.

Explanation of provision. The bill amends present law to provide that in determining "subpart F income" there is to be excluded only

those items of income effectively connected with the conduct by the foreign corporation of a trade or business within the United States. It also makes it clear that "subpart F" income includes items exempt from U.S. tax or subject to a reduced rate of tax pursuant to a treaty. Effective date. This amendment applies with respect to taxable years beginning after December 31, 1966.

h. Gain from certain sales or exchanges of stock in certain foreign corporations (sec. 104(k) of the bill and sec. 1248 (d) of the code) Present law. Present law treats the gain realized by a 10-percent U.S. shareholder from the sale or exchange of stock of certain foreign corporations as a dividend, to the extent the post-1962 earnings and profits of the corporation are attributable to the shares being sold or exchanged. In determining the earnings and profits to be taken into account in determining this gain, present law excludes U.S. source income of a foreign corporation engaged in a U.S. trade or business. Consistent with the interpretation of similar language applicable to the determination of "subpart F income" explained above, these earnings and profits have been construed by the regulations as including income exempt from U.S. tax or subject to a reduced rate by treaty.

Explanation of provision.-The amendment provides that for taxable years beginning on or after January 1, 1967, the earnings and profits of the foreign corporation (for purposes of sec. 1248) is not to include income effectively connected with the conduct of a trade or business within the United States. In addition, the amendment makes it clear that the exclusion does not apply to income which is exempt from tax, or subject to a reduced rate of tax, pursuant to a treaty. Effective date. This amendment applies to sales or exchanges occurring after December 31, 1966.

5. MISCELLANEOUS INCOME TAX PROVISIONS, ETC.

a. Income affected by treaty (sec. 105 (a) of the bill and sec. 894 of the code)

Present law. Existing income tax treaties generally provide that the exemptions from tax, or the reduction in rates of tax, provided for in its provisions apply only to persons who do not have a permanent establishment in the United States. The "permanent establishment" concept of the treaties serves a purpose similar to the "engaged in a trade or business in the United States" concept of U.S. tax law. The effect of such a provision in a treaty, therefore, is to deny the benefits of a treaty exemption or reduced rate to a nonresident alien individual, or a foreign corporation, engaged in a trade or business in the United States through a permanent establishment.

Explanation of provision. Under the tax treatment provided for such persons by the bill, the "engaged in trade or business in the United States" criterion is no longer the sole determinant of the method of taxing particular items of a nonresident alien individual's, or a foreign corporation's, U.S. source income. The bill seeks to tax all such persons alike on their noneffectively connected U.S. source income whether or not they also are engaged in a trade or business in the United States. This result would not be achieved under treaty provisions if some aliens or foreign corporations because of having a