[Congressional Record Volume 140, Number 70 (Wednesday, June 8, 1994)]
[Senate]
[Page S]
From the Congressional Record Online through the Government Printing Office [www.gpo.gov]


[Congressional Record: June 8, 1994]
From the Congressional Record Online via GPO Access [wais.access.gpo.gov]

 
   THE COMPREHENSIVE TAX RESTRUCTURING AND SIMPLIFICATION ACT OF 1994

  Mr. DANFORTH. Mr. President, yesterday I introduced S. 2160 and 
requested that it be printed in the Record along with accompanying 
technical explanation. I inadvertently did not submit such technical 
explanation along with the bill. Attached is the technical explanation 
I want printed in the Record directly after the printing of the bill.
  There being no objection, the explanation was ordered to be printed 
in the Record, as follows:

      Technical Overview--The Comprehensive Tax Restructuring and 
                       Simplification Act of 1994


   introduction to the technical explanation of the comphrensive tax 
              restructuring and simplification act of 1994

       The Comprehensive Tax Restructuring and Simplification Act 
     of 1994 eliminates over $400 billion of business and 
     individual income taxes and payroll taxes. To replace this 
     revenue, the package enacts a Business Activities Tax (BAT). 
     The BAT is a tax on all businesses that sell goods or 
     services in the U.S. economy. The tax is designed to be 
     simple to compute and to administer, and it allows a company 
     to use the sales and purchase data that it already keeps for 
     its own financial reporting purposes. Generally, a company 
     will determine its gross receipts from the sale of goods and 
     services and its gross purchases of goods and services that 
     it uses in its business. By subtracting purchases from sales, 
     the company computes the value of its business activity. A 
     single rate of 14.5 percent will be applied to that value to 
     determine the tax due.
       The BAT base therefore will equal the sum of the company's 
     payments for the labor services (wages, salaries, fringe 
     benefits, etc.) and the capital services (interest to 
     creditors and profits to owners) that allow the company to 
     convert its purchased inputs into the more valuable outputs 
     that it sells. Moreover, the BAT operates according to the 
     destination principle, that is, the tax applies only to goods 
     and services that are used or consumed in the United States. 
     Under the provisions of GATT, the BAT is a border-adjustable, 
     indirect tax that can be removed from U.S. exports before 
     they enter the stream of world commerce and that can be 
     levied on imports that come into our deomstic market.
       The BAT applies to a very broad base of producers of goods 
     and services so that it is as economically neutral as 
     possible. Neutrality is essential so that business decisions 
     are based not on the tax consequences of an action, but on 
     efficiency and productivity concerns. The tax is neutral as 
     well in its treatment of debt and equity financing; by 
     eliminating the deduction for interest, debt-financing is no 
     longer tax-favored.
       The BAT applies a single-rate of 14.5 percent and contains 
     virtually no exemptions. Multiple rates and exemptions 
     significantly increase the complexity of a tax system. For 
     example, a May 1993 IRS study on implementing a federal 
     value-added tax system concluded that the cost and difficulty 
     of administering a tax would be directly dependent on the 
     complexity of the system and urged that ``it is imperative to 
     the interests of both taxpayers and the government that 
     [such] legislation be kept as simple as possible.''
       Finally, it is important to note that the legislation 
     assumes that the BAT is fully phased in. The drafters have 
     not attempted to address the difficult transition questions 
     that such extensive reform necessarily entails. The intention 
     behind the Comprehensive Tax Restructuring and Simplification 
     Act of 1994 is to detail the changes in the current tax 
     system that are required to encourage savings and investment, 
     increase productivity and efficiency, and renew our ability 
     to compete internationally. Only after we have reached a 
     consensus as to the goal of tax reform, and the appropriate 
     means to achieve such goal, should we resolve the issues 
     raised by the transition to such a system. In other words, we 
     have to know where we are going, before we know the best way 
     to get there.


   technical explanation of the comprehensive tax restructuring and 
                       simplification act of 1994

              Title I.--Repeal of the corporate income tax

                               In general

       The bill generally would repeal the corporate income 
     tax.\1\ Unincorporated businesses would be allowed to elect 
     to be treated as a corporation. The bill would provide a 
     corporate-level passive investment tax to discourage the 
     avoidance of the individual income tax by amassing passive 
     investments in corporate form. In addition, in order to 
     provide simplification, the bill would change the income tax 
     treatment of distributions from corporations.

                Election to be treated as a corporation

       Under the bill, the earnings of both incorporated and 
     unincorporated businesses would be subject to both the 
     Business Activities Tax (``BAT'', described in detail below) 
     and the individual income tax. All businesses would be 
     subject to BAT as they engage in taxable business activities. 
     However, the timing of the imposition of the individual 
     income tax may vary depending on the form of entity. As under 
     present law, in the absence of the election described below, 
     the earnings of a business other than a C corporation would 
     be subject to the individual income tax as its taxable income 
     is earned, while the earnings of a C corporation would not be 
     subject to the individual income tax until such earnings are 
     distributed.
       So that the changes made by the bill do not distort an 
     individual's choice as to the form of entity through which to 
     conduct a trade or business, the bill provides an election 
     for a business that is not a C corporation to be treated as a 
     domestic C corporation. Under the election, each owner of an 
     equity interest in the business would be treated as a 
     shareholder of a corporation in proportion to such interest. 
     The Secretary of the Treasury would provide regulations for 
     the application of the appropriate subchapter C rules to 
     distributions, liquidations, organizations, and 
     reorganizations of electing unincorporated businesses. The 
     election to be treated as a corporation (and as shareholders 
     of a corporation) would not apply for purposes of determining 
     the treatment of employee fringe benefits.\2\
       The election to be treated as a corporation would be made 
     in the manner prescribed by the Secretary of the Treasury and 
     would remain in effect until revoked. Elections and 
     revocations would be required to be made within two and a 
     half months after the close of the taxable year for which 
     they would apply. If a business revokes its election to be 
     treated as a corporation, it must receive the consent of the 
     Secretary of the Treasury in order to once again make the 
     election.

                         Passive investment tax

                Operation of the passive investment tax

       The bill would impose a tax (the ``passive investment 
     tax'') on a C corporation for a taxable year if the 
     corporation has nonbusiness gross income in excess of a 
     threshold amount for the year.\3\ The amount of the passive 
     investment tax would be determined by multiplying the 
     nonbusiness gross income of the corporation by the highest 
     individual income tax rate for the taxable year.\4\ A 
     taxpayer would not be allowed to offset its passive 
     investment tax liability with any of the various tax credits 
     allowed under the income tax (other than the credit for the 
     overpayment of tax).
       For this purpose, ``nonbusiness gross income'' would mean 
     the gross income of the corporation other than gross income 
     from a business activity (determined in the same as under the 
     BAT).\5\ Thus, nonbusiness gross income generally would be 
     that gross income that is not subject to the BAT (as well as 
     gross income that is not subject to the BAT because it 
     relates to an export sale or certain nontaxable transactions) 
     and generally would be dividends, interest, capital gains and 
     other income from the corporation's passive investments.\6\ 
     Nonbusiness gross income for the taxable year would be 
     reduced by the aggregate amount of any distributions by 
     the corporation to its shareholders with respect to its 
     stock that are made: (1) during the taxable year and (2) 
     during the first 45 days after close of the taxable year, 
     so long as the distributions are designated by the 
     corporation as relating to the prior taxable year. Any 
     distribution described in (2) would: (1) not be treated by 
     the corporation as again reducing nonbusiness gross income 
     in the year of the actual distribution and (2) be treated 
     as received by the recipient shareholder for the 
     shareholder's taxable year that includes the last day of 
     the taxable year of the distributing corporation.
       A corporation would exceed the threshold amount for a 
     taxable year if the percentage determined by dividing the 
     corporation's nonbusiness gross income by its gross income 
     exceeds the applicable working capital percentage. The 
     ``applicable working capital percentage'' would be a 
     percentage determined by the Secretary of the Treasury that, 
     based on the best information available, represents the ratio 
     that the: (1) average nonbusiness gross income of 
     corporations that is derived from assets held to provide 
     reasonably required working capital bears to (2) average 
     gross income. The Secretary may prescribe more than one 
     applicable working capital percentage to reflect differences 
     in industries, size, or other factors that affect reasonably 
     required working capital. It is expected that a corporation 
     that conducts more than one trade or business would be 
     allowed to compute and apply its applicable working capital 
     percentage on a business segment or blended basis. In 
     addition, the Secretary may prescribe aggregation rules that 
     provide for the treatment of two or more persons as one 
     person to the extent necessary to carry out the purposes of 
     the passive investment tax.\7\
       The passive investment tax would not apply to start-up 
     companies or companies changing their businesses under 
     certain circumstances.\8\ Specifically, the passive 
     investment tax would not apply to a corporation for the first 
     taxable year it has gross income if: (1) no predecessor of 
     the corporation was subject to the tax; (2) it is established 
     to the satisfaction of the Secretary of the Treasury that the 
     corporation will not be subject to the tax for the first two 
     years following its first taxable year; and (3) the 
     corporation, in fact, is not subject to the tax for such two 
     years. In addition, the passive investment tax would not 
     apply to a corporation for any taxable year if: (1) neither 
     the corporation nor its predecessor was subject to the tax in 
     a prior year; (2) it is established to the satisfaction of 
     the Secretary of the Treasury that substantially all the 
     nonbusiness gross income of the corporation for the year is 
     attributable to proceeds from the disposition of one or more 
     active trades or businesses and that the corporation will not 
     be subject to the tax for the first two years following the 
     taxable year; and (3) the corporation, in fact, is not 
     subject to the tax for such two years.\9\
       Amounts subject to the passive investment tax would be 
     subject to the individual income tax when distributed to 
     individual shareholders. Accordingly, the bill would not 
     establish a ``previously taxed income'' account or a 
     shareholder credit mechanism to reflect the fact the 
     distributed income had been subject to the passive investment 
     tax.

                Rationale for the passive investment tax

       Because the bill would repeal the corporate income tax but 
     retain the individual income tax, individuals would have an 
     incentive to avoid or defer a portion of their income tax 
     liability by placing passive investments in corporate form or 
     by having corporations re-invest (rather than distribute) 
     business earnings in passive investments. The passive 
     investment tax is intended to address these situations by 
     applying an individual income tax-based tax (the ``passive 
     investment tax'') upon corporate passive earnings when such 
     earnings are in amounts in excess of the reasonable business 
     needs of the corporation. The bill directs the Secretary of 
     the Treasury to develop appropriate working capital ratios in 
     order to determine when a corporation has amassed too many 
     passive investments. Although the development of these ratios 
     may be difficult and may be criticized as not applicable to 
     any particular case, it is believed that this ``working 
     capital approach'' is superior to similar approaches 
     contained in the present-law income tax.\10\ For example, the 
     accumulated earnings tax applies a tax based on the 
     individual income tax on corporate earnings and profits 
     that are accumulated beyond the reasonable needs of the 
     business, unless the taxpayer proves that such 
     accumulation was not done for tax avoidance purposes. 
     Thus, the accumulated earnings tax generally is applied on 
     a case-by-case basis; such application creates 
     administrative complexity. Conversely, the passive foreign 
     investment company (PFIC) rules apply mechanical tests to 
     determine when a corporation has excessive passive 
     investments in order to remove the benefits of deferral of 
     U.S. tax on income earned through certain foreign 
     corporations. The PFIC rules apply if: (1) 75 percent or 
     more of the gross income of the foreign corporation is 
     passive income or (2) 50 percent or more of the average 
     value of the corporation's assets produce, or are held to 
     produce, passive income.\11\ The bill tries to strike a 
     balance between a tax that is administered on a case-by-
     case basis and one that provides a ``one size fits all'' 
     approach. We invite comments on the need to develop, and 
     the ability to administer, a corporate-level tax on 
     excessive passive investment.

                  Treatment of corporate distributions

       The bill changes the treatment of distributions with 
     respect to corporate stock. In general, all distributions 
     made by a corporation to a shareholder with respect to its 
     stock would be treated as ordinary income by the shareholder. 
     This general rule would not apply to any distribution: (1) 
     that is pursuant to a plan of full or partial liquidation of 
     the corporation; (2) that is in complete redemption of all a 
     shareholder's stock in the corporation; (3) that does not 
     constitute a dividend because of insufficient corporate 
     earnings and profits, in the case of a corporation that 
     maintains an adequate account of its earnings and profits; or 
     (4) that represents a return of capital to the extent the 
     distribution does not exceed the shareholder's contributions 
     to capital during the 60-day period ending with the date of 
     the distribution. These exceptions do not apply to the 
     special post-yearend distribution that a corporation 
     designates as being made in its prior year.
       These changes to the treatment of distributions with 
     respect to corporate stock are intended to provide 
     simplification. For a corporation, the bill replaces the 
     corporate income tax with the BAT. The corporate income tax 
     and the BAT have as their bases different measures of 
     economic activity\12\ and many of the records that a 
     corporation must maintain under the income tax may become 
     unnecessary under the BAT. One such recordkeeping 
     requirement relates to ``earnings and profits.''\13\ Thus, 
     the bill generally repeals the present-law earnings and 
     profits requirement.\14\ A corporation could electively 
     retain the present-law earnings and profits requirement by 
     maintaining the records necessary to determine its 
     earnings and profits. It is expected that the Secretary of 
     the Treasury would provide guidance so that a corporation 
     may determine when it has met its burden for maintaining 
     the required earnings and profits records.
       The bill would also repeal the ``not essentially equivalent 
     to a dividend'' and disproportional distribution exceptions 
     of sections 302(b)(1) and (2) of present law. Although the 
     replacement of the corporate income tax with the BAT does not 
     implicate these exceptions, the repeal of these rules will 
     provide simplification because it: (1) eliminates what under 
     present law are difficult determinations and (2) allows the 
     treatment of corporate distributions to be determined and 
     reported at the corporate, rather than the individual 
     shareholder, level (other than with respect to distributions 
     that are in complete redemption of the shareholder's interest 
     in the corporation).
       Despite the desire to achieve simplification and uniformity 
     with respect to corporate distributions, it may be considered 
     unfair to apply ``per se'' dividend treatment in certain 
     cases. Thus, the bill does not treat all corporate 
     distributions with respect to stock as dividends. 
     Distributions received in full or partial liquidation of a 
     corporation\15\ and distributions that result in the full 
     redemption of the shareholder's interest in the 
     corporation would continue to be treated as under present 
     law.\16\ In addition, a distribution to a shareholder 
     within a reasonable time of the shareholder's contribution 
     of capital to the corporation would be treated as a non-
     taxable return of such capital.
       Further, the bill is not intended to change present law as 
     to whether or when distributions are taxable. Thus, for 
     example, proportionate stock distributions would continue to 
     be excluded from gross income (sec. 305(a)), while certain 
     redemption premiums would continue to be taken into account 
     on an accrual basis (sec. 305(c)).

                  Technical and conforming amendments

       The bill would require the Secretary of the Treasury to 
     submit to Congress such technical and conforming changes as 
     are necessary to implement the amendment made by this title 
     of the bill. The submission would be due no later than six 
     months after the date of enactment of the bill and would 
     include legislation implementing these changes. Examples of 
     technical and conforming changes could include repeal of 
     subchapter S of the Code and those provisions of the 
     alternative minimum tax that apply to corporations. Other 
     income tax rules that currently apply to both corporations 
     and individuals (e.g., the Modified Accelerated Cost Recovery 
     System of sec. 168 of the Code) generally would be retained 
     since the bill would not repeal the individual income tax.

                 Title II.--Tax Relief for Individuals

                  Reduction in OASID payroll tax rate

       The bill would reduce the payroll tax rate for both 
     employers and employees for Old-Age, Survivors and Disability 
     Insurance from 6.2 percent to 3.1 percent. In the case of 
     self-employed individuals, the corresponding tax rate would 
     be reduced from 12.4 percent to 6.2 percent. Some portion of 
     revenues from the BAT would be transferred to the old-age and 
     survivors insurance and disability insurance trust funds to 
     compensate for the reduction in trust fund revenues caused by 
     the reduction in the payroll tax rates.

                        Extra standard deduction

       The bill would allow an extra standard deduction for 
     individuals who do not itemize their deductions. The extra 
     standard deduction would be $8,650 for married individuals 
     filing joint returns, $7,600 for heads of household, $5,200 
     for single individuals, and $4,325 for married individuals 
     filing separate returns. This extra standard deduction would 
     be allowed in addition to the basic standard deduction and 
     the additional standard deduction for the aged and the blind. 
     For a taxpayer claiming both the basic standard deduction and 
     the extra standard deduction, the total standard deduction at 
     1994 levels would be $15,000 for married individuals filing 
     joint returns, $13,200 for heads of household, $9,000 for 
     single individuals, and $7,500 for married individuals filing 
     separate returns.
       The extra standard deduction would be phased out ratably 
     for taxpayers with adjusted gross income (AGI) in the 
     following ranges: $45,000-$88,250 for married individuals 
     filing joint returns, $37,000-$75,000 for heads of household, 
     $27,000-$53,000 for single individuals, and $22,500-$44,125 
     for married individuals filing separate returns.
       The amount of the extra standard deduction and the phaseout 
     ranges are expressed in 1994 dollars and would be indexed for 
     inflation.

                     Business activities tax credit

                               In general

       The bill would allow individuals a refundable credit 
     against the income tax equal to the rate of the BAT times the 
     individual's AGI (up to certain limits). The maximum amount 
     of AGI eligible for the credit would be $9,500 for married 
     individuals filing joint returns, $7,900 for heads of 
     household, $5,700 for single individuals, and $4,750 for 
     married individuals filing separate returns. With a BAT rate 
     of 14.5 percent, the maximum credit would be $1,378 for 
     married individuals filing joint returns, $1,146 for heads 
     of household, $827 for single individuals, and $689 for 
     married individuals filing separate returns.
       The credit would be phased out at a 20 percent rate for 
     taxpayers with ``modified AGI'' in excess of the following 
     amounts: $15,000 for married individuals filing joint 
     returns, $13,200 for heads of household, $9,000 for single 
     individuals, and $7,500 for married individuals filing 
     separate returns. With a BAT rate of 14.5 percent, the credit 
     would be phased out ratably for taxpayers with ``modified 
     AGI'' in the following ranges: $15,000-$21,888 for married 
     individuals filing joint returns, $13,200-$18,928 for heads 
     of household, $9,000-$13,133 for single individuals, and 
     $7,500-$10,944 for married individuals filing separate 
     returns. Modified AGI would be defined as AGI determined (1) 
     without regard to deductions for individual retirement 
     arrangements (IRAs), simplified employee pension plans (SEPs) 
     or Keogh plans, or to exclusions for foreign income, income 
     from the possessions and educational savings bonds, and (2) 
     by adding in tax-exempt interest and the portion of Social 
     Security benefits not otherwise included in AGI.
       The AGI limits and the beginnings of the phaseout ranges 
     are expressed in 1994 dollars and would be indexed for 
     inflation.

                            Advance payment

       An individual would be eligible to receive the business 
     activities tax credit on an advanced basis similar to that 
     available for the earned income tax credit. An individual 
     would be required to provide a BAT eligibility certificate to 
     his or her employer that (1) certifies he or she is eligible 
     for the BAT credit, (2) certifies that he or she does not 
     have a BAT eligibility certificate in effect for that year 
     with another employer, (3) states whether the individual's 
     spouse has a BAT eligibility certificate in effect, (4) 
     estimates the individual's AGI and modified AGI.

                  Title III.--Business Activities Tax

                  In general; definitions of key terms

       In the case of any person engaged in business activities, 
     the bill imposes a tax (the ``Business Activities Tax,'' or 
     ``BAT'') equal to 14.5 percent of the taxable amount for the 
     taxable period. The ``taxable amount'' generally is the 
     amount by which the taxpayer's gross receipts from business 
     activities exceed the taxpayer's business purchases for the 
     taxable period. If the taxpayer's business purchases exceed 
     its gross receipts for the taxable period, the taxpayer 
     generally would be entitled to a refund equal to 14.5 percent 
     of the excess.

                         ``Business activity''

       ``Business activity'' means` (1) the sale of property or 
     services in the United States by any person in connection 
     with a business;\17\ (2) the import of property or services 
     into the United States (whether or not in connection with a 
     business); and (3) the export of property or services from 
     the United States in connection with a business.\18\ 
     ``Business activity'' would also include the provision of 
     financial intermediation services.\19\ ``Business'' includes 
     any activity carried on continuously or regularly, whether or 
     not for profit, that involves or is intended to involve the 
     sale of property or services. The ``sale of property'' means 
     the transfer of ownership of property from a seller to a 
     purchaser for consideration.\20\ The ``sale of services'' 
     means the performance of any service, including the 
     granting of the right to use tangible or intangible 
     property for consideration and the granting of a right to 
     the performance of services or to reimbursements 
     (including the granting of warranties, insurance, and 
     similar items) for consideration. The following are not 
     ``business activities'': (1) the performance of services 
     by an employee for an employer and (2) any import of an 
     article that is free of duty under chapter 98 of the 
     Harmonized Tariff Schedule of the United States.

                           ``Taxable amount''

       The ``taxable amount'' is the amount by which the 
     taxpayer's gross receipts from business activities exceed the 
     taxpayer's business purchases for the taxable period. In the 
     case of imported property or services, the ``taxable amount'' 
     is the sum of: (1) the amount paid or incurred for the 
     property or services, plus (2) any amounts paid or incurred 
     for the transportation of imported property (if such costs 
     are not included in the amount paid for the property).

                           ``Gross receipts''

       ``Gross receipts'' means all receipts from a business 
     activity. The amount treated as gross receipts from the 
     exchange of property or services is the fair market value of 
     the property or services, plus any money, received. Gross 
     receipts includes: (1) any excise tax, sales tax, customs 
     duty, or other separately stated levy imposed by the Federal, 
     a State, or a local government on property or services sold 
     in a business activity and received and collected by the 
     seller in connection with the sale, other than Federal excise 
     taxes imposed by chapters 31, 32, 33, 34, 35, 36, 39, 51, 52, 
     or 53 of the Internal Revenue Code of 1986; and (2) the 
     proceeds of property and casualty insurance for losses in 
     connection with business property or services.
       If a taxpayer issues a post-sale price adjustment 
     attributable to a sale, the gross receipts from which were 
     taken into account in a prior taxable period, then the amount 
     of the adjustment would be treated as a reduction in gross 
     receipts for the taxable period in which the adjustment is 
     issued.\21\ For this purpose, ``post-sale price 
     adjustment'' means a refund, rebate, or other price 
     allowance attributable to a sale of property or services. 
     If the reduction in gross receipts for the period exceeds 
     the amount of gross receipts for the period, such excess 
     would be treated as a business purchase.
       ``Gross receipts'' would not include any gross receipts 
     from an applicable nontaxable transaction except to the 
     extent attributable to money or other property (i.e., 
     ``boot'') received in the transaction. ``Applicable 
     nontaxable transaction'' means any transaction: (1) to which 
     sections 332, 351, 368, or 721 applies, or (2) which is 
     specified by the Secretary of the Treasury and with respect 
     to which gain would not be recognized in whole or in part for 
     Federal income tax purposes.\22\

                         ``Business purchases''

       ``Business purchase'' means any amount paid or incurred to 
     purchase property or services for use in a business activity 
     other than: (1) any amount paid or incurred as current or 
     deferred compensation to employees, or employee benefits; (2) 
     interest or insurance premiums (other than premiums for 
     property or casualty insurance); or (3) other implicit 
     financial intermediation fees; and (4) amounts the payment 
     of which is unlawful under Federal, State, or local law. 
     Business purchases include any excise tax, sales tax, 
     customs duty, or other separately stated levy imposed by 
     the Federal, a State, or a local government on property or 
     services purchased for use in a business activity. Under a 
     special rule, business purchases would include certain 
     implicit intermediation services provided by a financial 
     intermediary for which the purchaser receives notice of 
     the amount of these services.\23\ The amount treated as 
     paid or incurred for business purchases in connection with 
     the exchange of property or services is the fair market 
     value of the property or services exchanged, plus any 
     money paid.
       If a taxpayer receives a post-sale price adjustment 
     attributable to a business purchase that was taken into 
     account in a prior taxable period, then the amount of the 
     adjustment would be treated as a reduction in business 
     purchases for the taxable period in which the adjustment is 
     received. If the reduction in business purchases for the 
     period exceeds the amount of business puchases for the 
     period, such excess would be treated as a gross receipt.

Treatment of imported and exported goods and services and international 
                        transportation services

                               In general

       The BAT generally is based on the destination principle. 
     That is, goods and services are subject to tax in the country 
     in which they are used rather in their country of origin. 
     Under the destination principle, imported goods and services 
     are subject to tax while exported goods and services are not. 
     In this way, all locally-consumed goods and services bear the 
     same tax burden, regardless of their origin. Likewise, 
     locally-produced goods and services may be exported free of 
     local tax, but may face tax in the country of destination if 
     such country also operates under the destination principle.

                Treatment of imported goods and services

       Under the bill ``business activity'' includes the import of 
     property or services into the United States for use or 
     consumption within the United States, whether or not in 
     connection with a business. The taxable amount with respect 
     to imported property or services is the sum of: (1) the 
     amount paid or incurred for the property or services, plus 
     (2) any amounts paid or incurred for the transportation of 
     imported property (if such costs are not included in the 
     amount paid for the property).\24\ Thus, individual (non-
     business) consumers that import property or services into 
     the United States would be subject to the BAT on such 
     import (unless such property was an article that would be 
     free of duty under chapter 98 of the Harmonized Tariff 
     Schedule of the United States).
       Taxpayers that import property or services into the United 
     States for use in a business activity would be allowed to 
     deduct, as a business purchase, the taxable amount described 
     above with respect to the imported property or services, plus 
     the amount of BAT payable with respect to the import of the 
     property or services.\25\ A business purchase deduction would 
     not be allowed for a property or service that is imported for 
     use other than in a business activity.
       The taxation of imported property and services raises 
     certain administrative concerns. Procedures must be 
     established to ensure that taxpayers report the importation 
     of goods and services as taxable business activities and that 
     the Federal tax authorities can trace such activities. These 
     issues are of less concern with respect to taxpayers that are 
     otherwise subject to the BAT with respect to a trade or 
     business conducted in the United States because such 
     taxpayers: (1) should be familiar with the operation of 
     the tax; (2) would generally file periodic BAT returns 
     subject to review; and (3) would be expected to maintain 
     the documentation that discloses the import activity in 
     order to claim a business purchase deduction for the 
     imported good or service. However, taxpayers that import 
     goods or services but are not otherwise subject to the BAT 
     (i.e., non-business consumers) present deeper concerns. 
     Such taxpayers may not be aware of their BAT 
     responsibilities or may attempt to evade the tax. Taxation 
     of imported property may be enforced by levying the BAT at 
     the place of import through the U.S. Customs Service. 
     Imported services may be more difficult to identify and 
     subject to tax. Other countries that impose consumption-
     based value-added taxes based on the destination principle 
     have also confronted these issues and have responded in 
     various ways. We invite comments on how to best administer 
     the BAT with respect to goods and services imported by 
     both businesses and consumers.

                Treatment of exported goods and services

       Under the bill, ``business activity'' includes the export 
     of property or services from the United States in connection 
     with a business. However, the gross receipts of a taxpayer 
     engaged in an exporting business activity would not include 
     amounts received by the taxpayer for property or services 
     exported from the United States for use or consumption 
     outside the United States.\26\ Thus, taxpayers that engage in 
     the export of goods or services generally would receive BAT 
     refunds because such taxpayers would not have taxable gross 
     receipts but would have deductible business purchases with 
     respect to such activity. Under a special rule, if property 
     or services are sold for export to a governmental entity or 
     exempt organization and are exported other than in a business 
     activity of such entity or organization, then the seller of 
     the property or service to the entity or organization would 
     be treated as the exporter.
       Under the BAT, taxpayers have an incentive to classify 
     their sales of goods or services as nontaxable exports. As in 
     the case of imports, it may be appropriate to elicit the 
     services of the U.S. Customs Service in the determination of 
     which goods are being exported and by whom. However, the 
     determination of the extent to which services performed by 
     taxable persons within the United States are being used 
     outside the United States presents difficulties of 
     identification and allocation (where the services are used 
     both within and without the United States). We invite 
     comments on to this issue.

           Treatment of international transportation services

       ``Gross receipts'' would not include receipts from the 
     transportation of property: (1) exported from the United 
     States or (2) imported into the United States. Transportation 
     related to exported goods are not subject to the BAT for the 
     same reason exported goods are not subject to BAT under the 
     destination principle. The provision of transportation 
     services with respect to imported goods would not be subject 
     to the BAT because such services are considered to be a 
     portion of the taxable amount of the underlying good (i.e., 
     the person importing a good is subject to the BAT with 
     respect to the related transportation cost rather than the 
     person who performs the transportation service).
       ``Gross receipts'' would include receipts from the 
     transportation of passengers from outside the United States 
     to a destination in the United States, but would not include 
     receipts from the transportation of passengers from the 
     United States to a destination outside the United States. 
     ``Business purchases'' would include amounts paid or incurred 
     in a business activity for the transportation of passengers 
     from outside the United States to a destination in the United 
     States, but would not include amounts paid or incurred in a 
     business activity for the transportation of passengers from 
     the United States to a destination outside the United States.
       ``Business purchases'' would not include amounts paid or 
     incurred for the transportation of property exported from the 
     United States. ``Business purchases'' also would not include 
     amounts paid or incurred for the transportation of property 
     imported to the United States unless such receipts are not 
     taken into account in computing the taxable amount with 
     respect to the imported property.\27\

                           Accounting methods

       In computing its taxable amount under the BAT, a taxpayer 
     generally may use the cash receipts and disbursements method, 
     an accrual method, or any other method permitted by the 
     Secretary of the Treasury. All persons that are members of 
     the same controlled group would be required to use the same 
     method of accounting. It is expected that the taxpayer's 
     method of accounting must be consistently applied and may 
     only be changed with the permission of the Secretary.
       The BAT departs from several income tax concepts. 
     Principally, under the income tax, the cost of property that 
     has a useful life that extends beyond one year must be 
     capitalized and amortized; under the BAT, such costs are 
     ``expensed''. Thus, a taxpayer's method of accounting under 
     the BAT primarily will be used to determine in which taxable 
     periods the taxpayer's sales and purchases took place and 
     should be taken into account.
       Except as described below, the BAT allows taxpayers a 
     choice of accounting methods so as not to impose potential 
     recordkeeping burdens that the required use of a single, 
     specified method may entail. It is expected that most 
     taxpayers would use a method of accounting for the BAT that 
     corresponds to a method that is used for non-tax purposes, 
     primarily for financial accounting purposes.\28\ However, the 
     Secretary of the Treasury will be allowed to change a 
     taxpayer's method of accounting if such method does not 
     clearly reflect the taxpayer's gross receipts or business 
     purchases.\29\
       The BAT provides specific accounting method rules in two 
     instances. First, taxpayers may not use the installment 
     method to report gross receipts from the sale of property. 
     Thus, even if a taxpayer that sells property pursuant to an 
     installment plan elects the cash receipts and disbursements 
     method as its overall method of accounting for BAT purposes, 
     the taxpayer will be required to report gross receipts from 
     such sales on an accrual method.
       The denial of the use of the installment method and the 
     fact that the BAT generally is not imposed on interest 
     received by a business (unless that business is a financial 
     intermediary, as described below) raises certain concerns. A 
     taxpayer that sells property pursuant to an installment plan 
     should not be able to avoid the BAT by characterizing a 
     significant portion of the installment payments it receives 
     as non-taxable interest. Rules similar to those contained in 
     the present-law income tax system may be necessary to reach 
     this result under the BAT.\30\ A similar issue of 
     characterization relates to the fact that interest 
     receipts are treated differently depending on whether the 
     taxpayer's business activity is treated as a financial 
     intermediation service. Sellers of goods on the 
     installment plan may derive a significant portion of their 
     ``profit'' from the provision of credit to their 
     customers. An issue that arises in these cases is whether 
     these taxpayers should be treated as engaging in two 
     separate business activities--the sale of goods as well as 
     financial intermediation services. Similar questions arise 
     with respect to retailers that issue their own credit 
     cards to consumers.
       The BAT also provides special accounting method rules with 
     respect to property produced pursuant to long-term contracts 
     (as defined in section 460(f) of the Code). A seller of 
     property would be required to use the percentage-of-
     completion method in computing its gross receipts.\31\ The 
     purchaser of property produced pursuant to a long-term 
     contract would compute its business purchases with respect to 
     the property by using the cash receipts and disbursements 
     method of accounting (i.e., the business would be allowed 
     deductions as it makes payments pursuant to the contract).
       The nature of long-term contracts requires the special 
     rules described above. The cash method does not properly 
     reflect the amount of ``value added'' by the producing seller 
     in any accounting period. Allowing producers to report gross 
     receipts under the cash method could allow for a significant 
     deferral of BAT when payments under the contract are back-end 
     loaded. Theoretically, purchasers under long-term contracts 
     should be allowed business purchase deductions as value is 
     added to the property produced under the contract. However, 
     synchronizing the accrual treatment of buyers and sellers 
     under long-term contracts would require the sharing of the 
     seller's cost information with the buyer. Thus, the BAT would 
     prescribe the use of an accrual method by the seller and the 
     cash method by the buyer.

                    Treatment of financial services

                               In general

       The bill would impose the BAT on the provision of financial 
     intermediation services. Special rules would apply to 
     determine the taxable amount derived from financial 
     intermediation services. In addition, the bill would permit 
     the business user of financial intermediation services to 
     deduct as business purchases any stated fees for such 
     services and any implicit fees allocated and reported to it 
     by the financial intermediary. This would prevent the 
     cascading of BAT when financial intermediation services are 
     used in connection with a business.\32\ The bill would 
     provide a method (and reporting mechanism) for allocating the 
     value of financial intermediation services among users of the 
     services.

                     The need for a special regime

       Like other services, financial intermediation services add 
     value to the economy. Unlike other services where the price 
     is often clearly specified, however, the value of financial 
     intermediation services is not easily determined. Typically, 
     the charge for financial intermediation services is blended 
     with other elements of the transaction. For example, 
     financial institutions provide financial intermediation 
     services by pooling the funds provided by depositors\33\ and 
     making them available to borrowers. These institutions often 
     do not charge explicit fees to the depositors and borrowers; 
     rather, the institutions are compensated for the financial 
     intermediation services by the spread between the interest 
     rates charged on loans and the interest rates paid to 
     depositors. For other financial services, financial 
     institutions may charge separate fees, but such fees do not 
     necessarily represent the actual value of the particular 
     services rendered. For example, banks often offer low or no 
     cost checking services to customers who maintain a minimum 
     balance in their checking accounts.
       Similarly, a life insurance provider generally charges no 
     explicit fee for its services. Instead, the provider receives 
     premiums, generally only a small part of which comprises a 
     fee to the provider.\34\ Investment returns on the premiums 
     also may cover a portion of the cost to policyholders of 
     the insurance service (as evidenced by a lower rate of 
     return being credited to policyholders and the remaining 
     return on investment going to the insurance provider).\35\ 
     Thus, the value of the financial intermediation services 
     that should be subject to tax is the ``spread'' between 
     the premiums and financial earnings of the provider and 
     the claims and cash surrender values paid by the provider.
       These difficulties in ascertaining the actual cost to 
     consumers of financial intermediation services have led most 
     countries that impose a consumption-based value added tax to 
     exempt financial intermediation services.\36\ Recently, for 
     two principal reasons, this exemption has been widely 
     criticized by both commentators and the providers of 
     financial services.
       First, for reasons of economic efficiency and equity, 
     commentators argue that financial services should be included 
     in the base of any consumption-based value added tax and 
     should be taxed at the rate that generally applies to 
     ordinary goods and services.\37\ This treatment would 
     maintain economic neutrality and prevent the tax system from 
     favoring or disfavoring financial services over other goods 
     and services. If one type of service is subject to tax, but 
     another is not, the tax system distorts the relative values 
     of the services to consumers, which, in turn, distorts the 
     consumers' choices.
       Second, exemption may be disadvantageous to taxpayers 
     where financial intermediation services are provided to 
     business customers. Under the value added tax systems in 
     other countries, exempting financial services from tax 
     means that financial institutions are not considered 
     taxpayers, and consequently may not claim any refunds of 
     the tax they may have paid on business purchases. Business 
     customers of exempt financial institutions, in turn, are 
     not allowed to treat as a business purchase any amounts 
     paid to the exempt financial institution. This generally 
     results in cascading (multiple imposition) of tax with 
     respect to the business purchases of the provider.\38\
       Thus, to maintain neutrality and avoid distorting the 
     behavior of consumers and to minimize any cascading of tax, 
     we believe that the value of financial intermediation 
     services should be included in the BAT base and that business 
     customers generally should be entitled to a business purchase 
     deduction for the cost of such services.

            Definition of financial intermediation services

       Under the bill, a business activity generally includes the 
     sale of property or services in connection with a business. 
     Financial institutions provide numerous services to 
     customers, including: (1) intermediation between borrowers 
     and lenders; (2) risk-pooling; (3) pooling of savings, which 
     provides economies of scale; (4) transactional services, such 
     as credit cards and checking; and (5) market-making. Many of 
     these services, however, would not be treated as a sale of 
     property or services under the bill. For example, the term 
     ``property'' generally would be defined in the bill to 
     exclude money and financial instruments,\39\ and therefore, 
     market-making through buying and selling financial 
     instruments would not be a business activity under the 
     general BAT rules. Thus, absent special rules, financial 
     intermediaries often would not be treated as engaged in a 
     business activity, and no BAT would be imposed on the 
     services they provide.
       To ensure that financial intermediation services are 
     subject to the BAT, the bill specifically treats the 
     provision of financial intermediation services as a business 
     activity. For this purpose, financial intermediation services 
     would be defined to include lending services, insurance 
     services, market-making and dealer services, and certain 
     other services.
       The bill would define ``lending services'' as the regular 
     making of loans and providing credit to, or taking deposits 
     from, customers. For example, a financial institution 
     generally would provide lending services. In addition, a 
     consumer finance company, credit card issuer, or other 
     provider of credit would be treated as rendering lending 
     services, even if the business did not also accept deposits. 
     Installment or delayed credit arrangements, however, would 
     not be treated as lending services under the bill if no 
     interest was charged in connection with the arrangements, 
     other than fees or additional charges for late payments.\40\ 
     Thus, a business would not be treated as providing lending 
     services merely because it allowed customers to pay for goods 
     on a layaway plan, or to defer payments for goods to a future 
     date, provided the business did not charge interest to 
     customers utilizing such a layaway or deferred payment plan.
       The bill does not define ``insurance services.'' We would 
     expect that a person providing common forms of insurance 
     services, such as risk shifting and risk distribution 
     services, and reinsurance, would be treated as providing 
     insurance services under the bill.
       ``Market-making and dealer services'' would be defined 
     under the bill to mean services performed by a person who 
     regularly, in the ordinary course of its trade or business, 
     either (1) purchases financial instruments from customers or 
     sells financial instruments to customers, or (2) offers to 
     enter into, assume, offset, assign, or otherwise terminate 
     positions in financial instruments.\41\ For example, an 
     underwriter who buys securities from an issuer at a 
     discount and sells the securities to its customers would 
     be treated as providing dealer services. By contrast, a 
     securities broker who acts only as a conduit between 
     buyers and sellers, or as the buyers' or sellers' agent, 
     might not qualify as rendering market-maker or dealer 
     services.\42\
       Under the bill, ``financial intermediation services'' also 
     would include services rendered by a person that acts as an 
     intermediary in the transfer of property, services, or 
     financial assets, liabilities, risks or instruments among two 
     or more persons, or in the pooling of economic risks among 
     other persons, and that derives gross receipts from streams 
     of income or expense, discounts or other financial flows 
     associated with the matter with respect to which such person 
     is acting as an intermediary. For example, a person engaged 
     in factoring receivables might not meet the definition of 
     providing lending services under the bill, but generally 
     would be considered to be rendering financial intermediation 
     services under this definition.
       Finally, we would expect that the Secretary of the Treasury 
     will furnish guidance on other business activities that 
     constitute financial intermediation services.

                    Determination of taxable amount

       Under the general BAT rules, the taxable amount for 
     business activities would be gross receipts less business 
     purchases. Many of the items necessary to determine the value 
     of financial intermediation services, however, are expressly 
     excluded from the general definitions of gross receipts and 
     business purchases under the bill. For example, the bill 
     would define gross receipts to exclude receipts of interest, 
     income from financial instruments, and proceeds from the 
     disposition of financial instruments. Similarly, monetary 
     outflows associated with financial transactions such as 
     payments of principal and interest, payments under option, 
     forward and futures contracts and notional principal 
     contracts, and payments to purchase financial instruments 
     generally would not constitute business purchases. The bill 
     would therefore apply special rules to determine the 
     taxable amount for financial intermediaries.
       The bill provides that ``financial receipts'' would replace 
     ``gross receipts'' in the calculation of the taxable amount 
     for providers of financial intermediation services. Under the 
     bill, ``financial receipts'' would be defined as all receipts 
     properly allocable to the financial intermediation services 
     activity, other than contributions of capital. Thus, 
     ``financial receipts'' would include all amounts that qualify 
     as gross receipts under the general provisions of the bill, 
     such as stated fees and proceeds from the sale of property 
     used in the business. Moreover, financial receipts would 
     include virtually all other inflows of value that would not 
     be treated as gross receipts by other types of businesses. 
     For example, a financial intermediary would treat the receipt 
     of proceeds from borrowings made in connection with its 
     business as a financial receipt.\43\ Amounts received by a 
     financial intermediary from the sale of stock or securities 
     in connection with its business also would be included in 
     financial receipts. Financial receipts would not, however, 
     include any funds a financial intermediary received from the 
     sale of its own equity, or funds or property otherwise 
     contributed to its own capital.
       Similarly, for purposes of the BAT, the bill provides that 
     ``adjusted business purchases'' would replace ``business 
     purchases'' with respect to the providers of financial 
     intermediation services. Under the bill, ``adjusted business 
     purchases'' would include all expenditures that qualify as 
     business purchases under the general BAT rules, such as the 
     cost of office supplies, equipment and machinery, travel 
     expenses, and the cost of real property used in the business. 
     In addition, certain financial outflows that are not 
     deductible by other businesses would be ``adjusted business 
     purchases''. These would include: (1) payments of principal 
     and interest on borrowings associated with the financial 
     intermediation services business;\44\ (2) the cost of 
     financial instruments, and any payments made under financial 
     instruments, other than the cost of, or payments made 
     under, instruments that represent equity interests in the 
     person engaged in the financial intermediation services 
     business; (3) claims and cash surrender values paid in 
     connection with insurance or reinsurance services; and (4) 
     payments for reinsurance.
       For example, a typical bank would include in its financial 
     receipts the stated fees it charges customers for services 
     during a period, such as safety deposit box fees, all 
     deposits received from its customers during the period, all 
     receipts of interest and principal from borrowers, any 
     dividends and other financial flows such as receipts from 
     swaps, options and foreign currency contracts, and the 
     proceeds from dispositions of such assets as stocks, bonds 
     and other evidences of indebtedness, or from assumptions or 
     assignments of notional principal contracts and other 
     financial contracts. To obtain its taxable amount, a bank 
     would deduct its adjusted business purchases, including 
     business purchases deductible under the general BAT rules, as 
     well as most payments of interest and principal, costs of 
     acquired financial instruments such as stock, bonds and other 
     evidences of indebtedness, and payments made under financial 
     instruments, which would include upfront payments it might 
     make under notional principal contracts or the amounts it 
     might pay to assign such a contract.
       An insurance company would calculate its taxable amount in 
     a similar fashion. The insurance company would, in addition, 
     include in its financial receipts the insurance premiums it 
     receives from customers, and would deduct as an adjusted 
     business purchase net insurance claims, payments of cash 
     surrender values, and payments for reinsurance.\45\
       A person that provides financial intermediation services 
     and engages in other businesses would be required to 
     determine which part of its monetary inflows and outflows are 
     allocable to its financial intermediation services business. 
     Monetary inflows and outflows not associated with the 
     financial intermediation services would be subject to the 
     general BAT rules. Any item, such as a borrowing, a loan or 
     other financial instrument, must be consistently treated. 
     Thus, a person could not deduct as an adjusted business 
     purchase the payment of principal and interest on a loan 
     unless the person previously included the amount it 
     borrowed under the loan in financial receipts. Similarly, 
     if a business deducted the purchase of a share of stock as 
     an adjusted business purchase, the business would have to 
     include the proceeds of the sale of the stock in financial 
     receipts.
       We would expect that the Secretary of the Treasury will 
     furnish guidance on the determination of financial receipts 
     and adjusted business purchases.

        Business purchases of financial intermediation services

       To avoid cascading of the tax,\46\ the bill would permit 
     business users of financial intermediation services to claim 
     appropriate business purchase deductions for the cost of such 
     services. Stated fees charged by financial intermediaries 
     would be deductible under the general BAT rules. Where the 
     cost of the service is not stated (and therefore typically 
     cannot be determined by the customer), the bill would require 
     financial intermediaries to determine the implicit fee for 
     the service and to allocate and report the implicit fee to 
     the users of the services. A business purchase deduction 
     would generally be allowed for any implicit fees allocated 
     and reported to a person by a financial intermediary that are 
     related to the person's business use of such services.\47\ No 
     deduction would be permitted with respect to implicit fees 
     that are not reported.

               Allocation and reporting of implicit fees

       The bill would require each financial intermediary to 
     allocate the amount of the implicit fees it derives from 
     financial intermediation services among the recipients of the 
     services. The allocable implicit fees of a financial 
     intermediation services business should equal the aggregate 
     amount charged by the intermediary for financial 
     intermediation services, other than the services provided for 
     a stated fee and property and casualty insurance 
     services.\48\ Thus, it is anticipated that a 
     financial intermediary's allocable implicit fees generally 
     would constitute (1) its financial receipts, less (2) 
     amounts that would be treated as gross receipts under the 
     general BAT rules, such as any stated fees and property 
     and casualty insurance premiums, less (3) the excess of 
     its adjusted business purchases over the amounts that 
     would be treated as business purchases under the general 
     BAT rules.\49\
       The bill would require businesses to allocate implicit fees 
     from financial intermediation services among recipients of 
     the services for each taxable period. The allocation would 
     have to be made on a reasonably consistent basis. It is 
     anticipated that financial intermediaries would allocate 
     their implicit fees based on a number of factors. These 
     factors could include the interest paid or received by a 
     customer, the amount insured or the insurance premium payment 
     under a customer's policy, the labor expended by the 
     financial intermediary in connection with a transaction, and 
     other relevant considerations. It would generally not be 
     reasonable for a financial intermediary to allocate a 
     disproportionate amount of its implicit fees to business 
     recipients of services. For example, if a business customer 
     and a household customer engaged in substantially similar 
     transactions with a bank, it would generally be unreasonable 
     for the bank to allocate a larger amount of its implicit fees 
     to the business customer than to the household customer.
       We would expect the Secretary of the Treasury to issue 
     regulations regarding the requirements for reasonably 
     allocating implicit fees among the recipients of financial 
     intermediation services. These regulations could provide 
     general rules for allocating fees for different types of 
     financial intermediaries or specific rules for certain 
     financial intermediaries.
       The bill requires financial intermediaries to report to 
     each recipient of services the amount of the implicit fees 
     allocated to the recipient for the taxable period. The report 
     must be provided within 45 days after the close of the 
     taxable period to which the report relates. The bill provides 
     that the Secretary of the Treasury should establish rules 
     allowing a financial intermediary not to report to persons 
     receiving the services other than in connection with a 
     business activity. A business purchase deduction for an 
     implicit fee, to the extent allowable, shall be taken by the 
     recipient of services in the taxable period in which the 
     notice from the financial intermediary is received.

                    Treatment of nonprofit entities

       The BAT would provide the following rules for governments, 
     charities, and other nonprofit entities:

                              Governments

       Government entities (Federal, State, and local) would be 
     fully subject to BAT only with respect to the following 
     activities: (1) Public utility services; (2) mass transit 
     services; (3) postal services; and (4) any activity not 
     involving an ``essential governmental function'' within the 
     meaning of present-law section 115.\50\ Other government 
     activities would not be subject to tax, with the exception of 
     certain ``self-consumption'' activities made subject to BAT 
     by regulation (as described below). The amount of government 
     revenues subject to BAT would be computed by subtracting from 
     gross receipts derived from taxable activities by amounts 
     incurred by governments to purchase goods or services used in 
     such activities. The Secretary would have authority to 
     prescribe by regulation methods for allocating government 
     purchases of goods or services between taxable and nontaxable 
     activities.
       If a government entity did not separately charge customers 
     for the taxable service (e.g., if utility services were not 
     separately charged but were included with property taxes), 
     then gross receipts subject to BAT would be determined on the 
     basis of the fair market value of the taxable service.
       Government entities would be partially subject to the BAT 
     with respect to their ``self-consumption'' of goods or 
     services, to the extent so provided by regulations in order 
     to discourage vertical integration by governments in a manner 
     that distorts competition.\51\ If so provided by regulation, 
     ``self-consumption'' goods or services--meaning certain 
     goods or services produced and consumed by the government 
     itself as part of offering a final, nontaxable good or 
     service--would be subject to the BAT. In such cases, the 
     taxable amount would be calculated by subtracting from the 
     fair market value of the self-consumed goods or services 
     the cost of inputs with respect to such self-consumed 
     goods or services.
       Government entities would be limited with respect to the 
     refunds they may claim, because any loss from a taxable 
     activity would be reduced by: (1) the value of property or 
     services used in the activity for which no amount was paid or 
     incurred by the consumer and (2) amounts appropriated to the 
     taxable activity from general government revenues.

                               Charities

       Charities described in present-law section 501(c)(3) would 
     be fully subject to the BAT only with respect to their 
     business activities that would be subject to the unrelated 
     business income tax (``UBIT'') under present law. The taxable 
     amount for a charity conducting a ``UBIT activity'' would be 
     determined in the same manner as the taxable amount for any 
     other person subject to the BAT.
       Charities (like governments) would be partially subject to 
     BAT with respect to their self-consumption of goods and 
     services, to the extent so provided by regulations, based on 
     the fair market value of the self-consumed goods or services. 
     In contrast to the BAT rules for government entities, no 
     special rule would be provided to limit refunds in cases 
     where charities offer subsidized taxable services.

                        Other nonprofit entities

       Nonprofit entities (other than charities) would be fully 
     subject to the BAT on their transfers of property or 
     furnishing of services. Thus, a nonprofit that is not a 
     charity generally would be subject to BAT on all its 
     activities, even if such activities are substantially related 
     to what historically has been considered to be the exempt 
     purposes of the organization.
       If there were no separately stated charge by the nonprofit 
     entity when it transfers property, or furnishes services, to 
     others (e.g., goods or services furnished by a social welfare 
     organization), then gross receipts would be determined on the 
     basis of fair market value of the property transferred or 
     services furnished. In contrast to the BAT rules governing 
     government entities, no limit would be imposed on refunds in 
     cases where noncharities offer subsidized goods or services.
       Because the activities of nonprofit entities that are not 
     charities (e.g., social welfare organizations) are taxable 
     but not subject to a special refund rule (as are certain 
     enumerated government activities), activities of 
     nonprofits will be eligible for BAT refunds (assuming that 
     contributions to the nonprofit are not treated as ``gross 
     receipts'' from the sale of property or services). This 
     could result in favorable tax treatment for activities 
     conducted by social welfare organizations or other 
     nonprofit entities compared to the tax treatment of the 
     same (or similar) activities conducted by charities, which 
     generally are not subject to BAT or eligible for BAT 
     refunds. Thus, it may be desirable to extend the special 
     refund limitation applicable to government taxable 
     activities to taxable activities of all nonprofit 
     entities.

                        Small business exemption

       The bill would provide an exemption from the BAT for 
     certain small businesses. The exemption would apply for any 
     taxable period if the person's aggregate gross receipts for 
     the taxable period\52\ and the three preceding taxable 
     periods did not exceed $100,000. The exemption would not 
     apply if the person (or a predecessor of the person) was not 
     exempt for all preceding taxable periods.\53\ An otherwise 
     exempt person may elect to be subject to the BAT.\54\

                     Administration of the BAT\55\

       The person engaging in a business activity (i.e., the 
     selling of goods or services in the United States, importing 
     of property or services to the United States or exporting of 
     property or services from the United States) would be liable 
     for the BAT (or eligible for a refund).\56\ The liable person 
     would be required to file a tax return before the sixteenth 
     day of the second calendar month after the close of each 
     taxable period. ``Taxable period'' means a calendar quarter, 
     except that if a taxpayer has a taxable year other than a 
     calendar year, then ``taxable period'' means a calendar 
     quarter of such year. In addition, to the extent provided in 
     regulations, ``taxable period'' includes a period selected by 
     a person other than a calendar quarter. The Secretary of the 
     Treasury would have the authority to shorten the length of a 
     person's taxable period to the extent the Secretary deems 
     such action necessary to protect the revenue.
       Refunds of BAT (e.g., a refund may be due because a 
     taxpayer has business purchases for the taxable period in 
     excess of gross receipts for the period) would be made by the 
     Secretary of the Treasury within 45 days of the taxpayer 
     filing a return requesting the refund. The 45-day period 
     would allow the Secretary an opportunity to make a limited 
     examination of the return to discover omissions and errors of 
     computations, determine the amount of the refund (if any) for 
     the period to which the refund relates, and refund the amount 
     to the person who filed the return.

                  Other special rules--Related parties

       Except to the extent provided in regulations: (1) an 
     affiliated group of corporations (as defined in present-law 
     section 1504(a) without regard to paragraphs (2), (4), and 
     (7) of section 1504(b)) or (2) two or more businesses 
     (whether or not incorporated) under common control within the 
     meaning of present-law section 52(b) and the regulations 
     thereunder), would be treated as one person. In addition, a 
     controlled group of corporations (as defined in present-law 
     section 1563(a), but determined without regard to the second 
     sentence of section 1563(a)(4) and section 1563(e)(3)(C)) may 
     elect to be treated as one person.
       Transactions in the United States between corporations or 
     other businesses treated as one person shall not be taken 
     into account in computing the gross receipts or business 
     purchases of either corporation or business.

              Certain transactions between related parties

       Any transfer of property or services to a related person 
     would be treated as a sale of the property or services for an 
     amount equal to the fair market value of the property or 
     service. For this purpose, ``related person'' means: (1) in 
     the case of an employment relationship, an employer and 
     employee; (2) in the case of an entity, an owner of the 
     entity; (3) any other person specified in regulations; and 
     (4) any member of a family (as defined in sec. 267(c)(4)) of 
     an individual described in (1), (2), or (3) above. ``Owner'' 
     means a proprietor of a sole proprietorship or any other 
     holder of a beneficial interest in a corporation, 
     partnership, trust, or other entity. Thus, if a corporation 
     transfers property in lieu of cash compensation to an 
     employee, the transaction would be treated as a sale of the 
     property, subject to the BAT, for its fair market value and a 
     payment of the sales proceeds to the employee as 
     nondeductible compensation. Similar rules would apply to 
     sales of property to employees at a discount. As a further 
     example, if an owner of a business uses business property for 
     personal use, such use would be treated as a sale of the 
     property subject to the BAT (or a sale of the right to use 
     the property if the use is for a temporary period) at its 
     fair market value and a distribution of the proceeds to the 
     owner.
       Similarly, if a person ceases to engage in any business 
     activity, any business property or services of the person 
     would be deemed to have been sold at their fair market value 
     in a business activity immediately before the cessation. 
     However, except as provided in regulation, such rule would 
     not apply to the extent the property or service is 
     transferred to another person as part of the transfer of 
     going concern. For example, if a business owner liquidates 
     his business and uses the distributed business property as 
     personal use property, the liquidation would be treated as 
     a taxable sale under the BAT. However, if the business 
     owner uses the property in a different business, the 
     liquidation generally would not be a taxable transaction 
     under the BAT.

               Other conversions of property or services

       Any conversion of a property or service from use in a 
     business activity to use in any other activity (or from use 
     in any other activity to use in a business activity) shall be 
     treated as a sale (or acquisition) of the property or service 
     for its fair market value. For example, the paragraphs above 
     describe the treatment that results when a business owner 
     converts business property to personal use (i.e., the 
     transaction would be treated as taxable sale of property at 
     its fair market value). Conversely, if a business owner 
     contributes what is personal property in her hands to her 
     business for use in a business activity, the receipt of the 
     property would be treated as a business purchase by the 
     business in an amount equal to the fair market value of the 
     property.
       The bill does not preclude a business from holding 
     nonbusiness property.\57\ Thus, property can be converted 
     from business use to nonbusiness use (or vice versa) within a 
     business. The bill provides that in these cases, the 
     conversion would be treated as a taxable sale (if the 
     property leaves business use) or as a business purchase 
     (if the property enters business use).

      Treatment of transfers in satisfaction of debt and bad debts

       The transfer of business property or services by a debtor 
     to a creditor in exchange for a reduction of debt generally 
     would be treated as a sale of the property or services in a 
     business activity for an amount equal to the amount by which 
     the debt is reduced. The transfer of personal property in 
     satisfaction of a business debt would be treated as a 
     contribution of such property to the business immediately 
     prior to the transfer in satisfaction. The transfer of 
     business property in satisfaction of a personal debt of a 
     business owner would be treated as a distribution of such 
     property to the owner immediately prior to the transfer in 
     satisfaction. The transfer of personal use property in 
     satisfaction of a personal debt should have no BAT 
     consequences to the transferor.
       If an amount owed to a seller of business property or 
     services that was taken into account as gross receipts in a 
     prior period becomes wholly or partially uncollectible during 
     a subsequent period, then the seller would treat the 
     uncollectible amount as a reduction in gross receipts in the 
     subsequent period. In such cases, the seller would be 
     required to notify the purchaser of the amount the seller is 
     treating as uncollectible. The notice must set forth with 
     specificity the purchase or purchases to which the write-off 
     relates and must be sent to the purchaser at the purchaser's 
     last known address within 10 days after the close of the 
     period in which the write-off occurs. If a purchaser receives 
     a notice from a seller with respect to a write-off of an 
     amount owed for business property or services that the 
     purchaser treated as a business purchase in a prior period, 
     then the purchaser must treat such amount as a reduction in 
     business purchases for the taxable period in which the notice 
     is received.
       If a seller receives payment for a bad debt amount that 
     was treated as a reduction in gross receipts in a prior 
     taxable period, then the seller must treat the recovery as 
     a gross receipt in the period in which it is received. 
     Similarly, if a purchaser pays all or part of an amount 
     treated as a bad debt reduction in business purchases in a 
     prior taxable period, then such payment would be treated 
     as a business purchase for the taxable period in which the 
     payment is made.
       These rules would not apply if a debt becomes worthless in 
     the taxable period that the underlying sale took place (or if 
     a recovery occurs in the taxable period a debt is written 
     off). In these cases, the gross receipts from the sale is 
     written off). In these cases, the gross receipts from the 
     sale and the bad debt deduction (or the bad debt deduction 
     and the recovery) would be netted against each other in 
     determining the taxable amount for the period.

                         Treatment of gambling

       In determining the taxable amount with respect to legal 
     gambling, lotteries, and other games of chance, gross 
     receipts would include (but are not limited to) amounts 
     received from wagers and ticket purchasers and business 
     purchases would include amounts paid to winners.

                              Regulations

       The Secretary of the Treasury would be authorized to 
     prescribe such regulations as may be necessary to carry out 
     the provisions of the BAT.


                               footnotes

     \1\The bill would repeal all chapter 1 taxes on corporations, 
     other than the tax on income of foreign corporations not 
     connected with United States business (sec. 881) and the 
     branch profits tax (sec. 884).
     \2\Under present law, sole proprietors, partners, and certain 
     shareholders of subchapter S corporations generally are not 
     treated as employees for purposes of determining the 
     treatment of certain fringe benefits provided to them.
     \3\The tax would not be imposed on any foreign corporation 
     unless the corporation is exempt from the branch profits tax 
     of section 884.
     \4\Even though the bill would repeal the corporate income 
     tax, corporations would be required to maintain a taxable 
     year for purposes of the passive investment tax. It is 
     expected that such year generally would be the year the 
     corporation had, or would have, maintained for income tax 
     purposes.
     \5\Gross income for the taxable year would be reduced by 
     returns and allowances made during the year and bad debt 
     deductions for the year. In addition, in determining gross 
     income and nonbusiness gross income, a corporation that 
     directly or indirectly holds an interest in passive foreign 
     investment company will be deemed to have made an election 
     described in sec. 1295(b).
     \6\As described in detail below, pursuant to a special rule, 
     certain dividends, interest, and capital gains of financial 
     intermediaries generally would be subject to the BAT and thus 
     would not be considered to be nonbusiness gross income 
     subject to the passive investment tax. This treatment is 
     appropriate because the assets that give rise to these types 
     of income (i.e., stocks, bonds, loans, etc.) are trade or 
     business assets in the hands of a financial intermediary, 
     even though such assets would be considered to be passive 
     investments in the hands of a non-financial service business, 
     such as a manufacturer. However, it is possible that a 
     financial intermediary may amass an unreasonably excessive 
     amount of such assets. In such case, it would be appropriate 
     to subject the financial intermediary to the passive 
     investment tax.
     \7\Among the issues involved in treating two or more persons 
     as one taxpayer for purposes of the passive investment tax 
     include the treatment of foreign subsidiaries. The passive 
     investment tax is intended to discourage corporations from 
     amassing passive investments in order to avoid or defer the 
     imposition of the individual income tax on earnings from such 
     assets. The foreign personal holding company rules (sec. 551, 
     et seq.), the subpart F income rules (sec. 951, et. seq.) and 
     the passive foreign investment company rules, (sec. 1291 et 
     seq.) of present law address similar concerns with respect to 
     passive income earned by foreign corporations the stock of 
     which is owned by U.S. persons. However, the operation of 
     these present-law income tax rules may differ from the 
     operation of the passive investment tax (e.g., the thresholds 
     for determining when the various rules apply may differ). We 
     invite comments as to the appropriate treatment of foreign 
     earnings under the passive investment tax, the appropriate 
     measurement of the threshold amount in the case of a 
     controlled group of corporations that includes foreign 
     subsidiaries, and the possible coordination between the 
     passive investment tax and the present-law anti-deferral 
     regimes with respect to foreign earnings.
     \8\These exceptions are similar to those applicable to 
     passive foreign investment companies under present law (sec. 
     1297(b)(2) and (3)).
     \9\In general, it is unclear how the gain on the sale of 
     stock of a controlled member of the group should be treated 
     under the bill. All transactions of a corporation generally 
     should be subject to the BAT or potentially to the passive 
     investment tax. One could argue that the gain should not be 
     subject to the BAT because a stock sale normally would not be 
     considered to be a business activity. Alternatively, one 
     could argue that the ownership of the stock of a controlled 
     subsidiary is not a passive investment that the passive 
     investment tax is designed to discourage. Creating further 
     difficulty for the resolution of the resolution of the issue 
     is the fact that if the group had sold the assets rather than 
     the stock of the target member, the resulting gain would be 
     subject to the BAT and the acquiring group would be allowed a 
     matching business purchase dedication under the BAT. However, 
     such deduction may be claimed only if the acquirer is itself 
     subject to the BAT. If the acquirers are individuals, as may 
     be the case with respect to stock sales, the BAT deduction 
     may be not allowable.
     The bill partially addresses this issue by providing that a 
     corporation generally will not be subject to the passive 
     investment tax if it sells a trade or business and does not 
     reinvest the sales proceeds in passive investments that would 
     subsequently subject the corporation to the passive 
     investment tax. However, this solution does not resolve all 
     the issues raised in the paragraph above and we invite 
     comments on how dispositions of trades or businesses (either 
     through asset sales, stock sales, or reorganizations that do 
     not give rise to recognition under subchapter C of present 
     law) should be treated under the proposed framework of an 
     interacting BAT, passive investment tax, and individual 
     income tax.
     \10\Under the present-law income tax, these concerns are 
     addressed by the accumulated earnings tax (sec. 531), the 
     personal holding company tax (sec. 541), the foreign personal 
     holding company rules (sec. 551, et seq.), and the passive 
     foreign investment company rules (sec. 1291, et. seq.).
     \11\In the case of a foreign corporation that is a 
     ``controlled foreign corporation,'' and any other foreign 
     corporation that so elects, assets for this purposes are 
     measured by adjusted basis.
     \12\One of the principal differences between the corporate 
     income tax and the BAT is that the latter does not require 
     the capitalization of costs that benefit future periods.
     \13\Under the present-law corporate income tax, distributions 
     with respect to corporate stock are treated as dividends only 
     to the extent the distributions are from the corporation's 
     earnings and profits. In general, the earnings and profits of 
     a corporation is its taxable income, adjusted for certain 
     items in order to more accurately reflect the economic income 
     of the corporation.
     \14\It should be noted that some commentators have suggested 
     the repeal of the earnings and profits requirement even in 
     the context of the corporate income tax. See, Senate 
     Committee on Finance. Report on the Reform and Simplification 
     of the Income Taxation of Corporations, 77-78 (Comm. Print 
     1983); the Earnings and Profits Work Group of the American 
     Bar Association Section on Taxation, Elimination of 
     ``Earnings and Profits'' from the Internal Revenue Code, 39 
     Tax Lawyer 2, 285 (1986); William D. Andrews, ``Out of its 
     Earnings and Profits'': Some Reflections on the Taxation of 
     Dividends, 69 Harvard Law Review 1403 (1956); and Walter J. 
     Blum, The Earnings and Profits Limitation on Dividend Income: 
     A Reappraisal, 53 Taxes 2, 68 (1975).
     \15\We recognize that the determination of what constitutes a 
     partial liquidation often is difficult.
     \16\Theoretically, liquidating distributions and 
     distributions in full redemption of a shareholder's interest 
     in a corporation could be treated as part dividend (to the 
     extent of the shareholder's pro rata share of corporate 
     earnings and profits) and part sale or exchange (to the 
     extent of it excess of earnings and profits). However, 
     adoption of such a regime would: (1) complicate the treatment 
     of corporate distributions and (2) treat liquidations and 
     redemptions differently than sales of stock.
     \17\For purposes of determining where a sale occurs, a sale 
     of property would be treated as occurring in the United 
     States if the property is located in the United States at the 
     time of the sale. A sale of services would be treated as 
     occurring in the United States to the extent the services 
     are: (1) provided from a place of business in the United 
     States; (2) provided with respect to property in the United 
     States; or (3) incidental to the provision of services within 
     the United States.
     For purposes of the BAT, ``United States,'' when used in a 
     geographic sense, includes the customs territory of the 
     United States (as defined in General Headnote 2 of the 
     Harmonized Tariff Schedules of the United States) and any 
     area seaward of the States lying within the outer boundaries 
     of the outer continental shelf (as defined in sec. 1331 of 
     title 43, U.S. Code).
     \18\See the discussion below for a more detailed description 
     of the treatment of imports and exports.
     \19\See the discussion below for the special rules that apply 
     with respect to financial intermediation services.
     \20\For purposes of the BAT, the exchange of property for 
     property or services would be treated as a sale of property 
     and the exchange of services for property or services would 
     be treated as a sale of services. If there is an incidental 
     sale of services in connection with the sale of property 
     (e.g., the provision of transportation or installation 
     services in connection with the sale of major appliance), 
     such sale of services would be treated as a sale of the 
     property. Likewise, if there is an incidental sale of 
     property in connection with the sale of services (e.g., the 
     sale of a de minimis amount of parts in connection with a 
     major repair of property), such sale of property would be 
     treated as a sale of services.
     \21\Post-sale price adjustments that are made by a taxpayer 
     in the same taxable period as the original sale occurred 
     would be netted against the gross receipts from the sale.
     \22\In general, it is thought that transactions in which the 
     mere form of the business changes (or if business property is 
     transferred from one business to another in a transaction 
     other than a sale) should not be subject to the BAT. In all 
     cases, ``boot'' received in a nontaxable transaction should 
     be includible in gross receipts (unless received other than 
     in connection with a business activity). The bill 
     specifically describes some of these transactions (i.e., 
     those transactions described in secs. 332, 351, 368, or 721 
     of present law). Other transactions that meet this test may 
     include: (1) certain transfers of possession of, or security 
     interest in, property or services by a debtor to a creditor 
     or a representative of creditors; (2) any transfer of 
     possession of, or incidents of ownership, of property or 
     services to a fiduciary who represents the interests of an 
     owner; or (3) any transfer of ownership of property or 
     services by a debtor to a trustee in a bankruptcy, receiver, 
     or other fiduciary appointed to marshall, manage, or 
     liquidate a debtor's property for the benefit of creditors. 
     However, any service provided by a transferee in such cases 
     would be subject to BAT. We seek comments as to what other 
     transactions should be included as nontaxable exchanges under 
     the BAT.
     \23\Special rules apply to implicit financial intermediation 
     fees as described in detail below.
     \24\In addition, a special rule applies to any imported 
     property that is returned to the United States after export; 
     (1) for repairs or alterations abroad or (2) to undergo 
     assembly, processing, manufacture or other changes in 
     condition abroad. In such cases, the taxable amount with 
     respect to the property would be the net cost to the importer 
     of such repairs, alterations, assembly, processing, 
     manufacture or other changes in condition. This special rule 
     would only apply to property that the importer acquired 
     before export and as to which there has been no transfer of 
     ownership between the time of export and import.
     \25\A business purchase deduction with respect to BAT levied 
     on imported property would be allowed to equalize the 
     treatment of property produced domestically and 
     internationally. For example, assume a manufacturer has the 
     choice of acquiring a machine produced in the United States 
     or produced abroad. Further assume for purposes of the 
     example that: (1) the price of either machine is $1,000 
     before tax and (2) U.S. providers of goods and services will 
     increase their sales prices to reflect the BAT imposed on 
     their business activities. Under these assumptions if the 
     manufacturer acquires the machine from the U.S. producer, it 
     could be expected to pay $1,145 (the $1,000 pre-tax price for 
     the machine, plus $145 of BAT borne by the U.S. producer and 
     assumed to be passed-through to the buyer) and would be able 
     to claim a business purchase deduction of $1,145. If the 
     manufacturer acquires the machine from the foreign producer, 
     it would pay $1,145 ($1,000 to the producer and $145 to BAT 
     to the Federal Government) and thus should be allowed to 
     claim a business purchase deduction of $1,145.
     \26\Therefore, ``gross receipts'' generally would not 
     include: (1) receipts from the sale of rental property 
     located outside the United States; (2) fees from the use of 
     patents, trademarks, copyrights, know-how, or licenses to the 
     extent such rights are used or consumed outside the United 
     States; and (3) royalties or other similar fees received with 
     respect to sales of goods or services used or consumed 
     outside the United States. As described herein, however, the 
     determination of use or consumption outside the United States 
     with respect to these or similar activities may be difficult.
     \27\The in-bound transportation services should be taken into 
     account as taxable imports under the destination principle. 
     This can be accomplished by either: (1) including 
     transportation costs as a portion of the taxable amount with 
     respect to imported property or (2) separately taxing 
     transportation as an imported service. The bill selects the 
     former option with respect to imported property that itself 
     is subject to the BAT. However, certain property transported 
     into the United States may not be considered to be imported 
     property under the bill. For example, international postal or 
     other carrier services may involve the transfer of mail or 
     other items into the United States that are not considered to 
     be imported property. These services should be subject to the 
     BAT, but may be difficult to identify. Similar issues arise 
     with respect to the international transfer of information 
     (i.e., through telephone lines, via satellite or otherwise).
     \28\Most businesses use an accrual method of accounting for 
     financial accounting purposes. However, under generally 
     accepted accounting principles, even an accrual method 
     business must provide a statement of cash flows that 
     essentially utilizes the cash receipts and disbursements 
     method of accounting. See, Statement of Financial Accounting 
     Standards No. 95.
     \29\Under present law, a taxpayer generally must compute its 
     taxable income pursuant to the method of accounting that the 
     taxpayer regularly uses in keeping its books. Permissible 
     methods of accounting include the cash receipts and 
     disbursements method, an accrual method, any other permitted 
     method, or any combination of methods permitted under 
     regulations by the Secretary of the Treasury. In addition, 
     the Secretary may change a taxpayer's method of accounting if 
     that method does not clearly reflect the taxpayer's income. 
     The ``clear reflection of income'' standard has been used to 
     change what otherwise would be a permissible method of 
     accounting (sec. 446).
     A ``clear reflection of income'' standard is inapplicable to 
     the BAT, which does not attempt to measure income. by 
     allowing the ``expensing'' of capital goods when acquired, 
     the taxable base of the BAT more closely resembles the net 
     cash flow of a firm than does an income tax (with adjustments 
     for items such as imports and exports and interest and 
     compensation expense). The BAT does not mandate the use of 
     the cash receipts and disbursements method because of a 
     desire to allow a business to utilize a method of accounting 
     that generally corresponds to a method that it utilizes for 
     nontax purposes. However, use of an accrual method may result 
     in significant BAT deferral when payment of a liability 
     satisfying the ``all events'' test is significantly delayed. 
     (For example, see Ford Motor Co. v. Comm., 91 T.C. No. 6, (1/
     31/94); and Mooney Aircraft v. Comm., 420 F.2d 400 (5th Cir. 
     1969); where income tax deductions were denied for deferred 
     payments despite the fact that the underlying liability may 
     have satisfied the ``all events'' test.) The present-law 
     income tax addresses this issue, in part, through the 
     ``economic performance'' rules of section 461(h). The BAT 
     would not adopt such rules, but rather would provide the 
     Secretary of the Treasury the authority to adjust a 
     taxpayer's method of accounting in the appropriate 
     circumstances. The drafters invite comments on how to best 
     address this issue.
     \30\See section 483 and sections 1271 through 1275 of the 
     Code. However, these provisions were enacted because of a 
     concern that taxpayers were understating the interest 
     component of payments made pursuant to installment plans. As 
     described above, under the BAT, the concern would be that 
     taxpayers may overstate the interest component.
     \31\For this purpose, the percentage of completion generally 
     would be determined pursuant to rules similar to those 
     provided in present-law section 460(b). However, because the 
     income tax rules require the capitalization of certain costs, 
     adjustments for adaptation to the BAT may be necessary. For 
     example, percentage of completion for BAT purposes could be 
     determined by using percentages that (1) are developed for 
     financial accounting purposes; (2) only take into account 
     direct production costs; or (3) are developed using the BAT 
     treatment of the contract expenditures, with an adjustment 
     for labor costs.
     \32\See footnote 38 and accompanying text.
     \33\The bank provides a depositor with the services of 
     intermediation (i.e., reinvesting the deposit in a loan to a 
     different customer) and risk pooling (e.g., assuring that the 
     deposit can be withdrawn even if borrowers from the bank 
     default).
     \34\The remaining premium amount generally would cover the 
     actuarial risk of payment under the policy, including any 
     investment element.
     \35\An insurance company may provide other financial services 
     for which a portion of policy premiums and investment returns 
     constitutes compensation. For example, an insurance company 
     may furnish intermediation services similar to a financial 
     institution because it pools the premiums it receives and 
     makes these funds available to others through investments or 
     loans.
     \36\It should be noted that most countries that impose a 
     value added tax utilize the credit invoice method. Under the 
     credit invoice method, tax is imposed on a transactional 
     basis, with the amount of tax disclosed on an invoice. 
     Taxable businesses may reduce the amount of tax on their 
     sales by the amount of tax imposed on their business 
     purchases.
     \37\See, e.g., Alan Schenk and Oliver Oldman, ``Analysis of 
     Tax Treatment of Financial Services Under a Consumption-Style 
     VAT: A Report of the American Bar Association Section of 
     Taxation committee on Value Added Tax,'' 44 Tax Lawyer 181 
     (1991).
     \38\Generally, the provider will attempt to pass the cost of 
     taxes paid on its purchases to customers (possibly harming 
     its competitive position with respect to potential customers 
     who might alternatively self-finance or might purchase other 
     goods or services). In such a case, the failure to allow the 
     customer a deduction for the cost (including the taxes passed 
     thru by the provider) will result in cascading of the tax. 
     Alternatively, the provider could decide to bear the cost of 
     the tax itself, thereby depressing its profits.
     \39\Financial instruments would be defined under the bill as: 
     (1) corporate stock; (2) ownership interests in certain 
     partnerships and trusts; (3) notes, bonds, debentures and 
     other evidences of indebtedness; (4) interest rate, currency 
     and equity notional principal contracts; (5) evidence of an 
     interest in, or a derivative financial instrument in, any 
     financial instrument described in (1)-(4) above, or any 
     currency, such as options, forward contracts, short positions 
     or similar interests in such a financial instrument or 
     currency; and (6) any other instrument that is not otherwise 
     defined as a financial instrument, but that is an identified 
     hedge of any of the foregoing categories of financial 
     instruments.
     \40\This exception would not apply if the seller of property 
     adjusts the price of the property according to the deferred 
     payment arrangement with the buyer, or otherwise charges the 
     buyer interest disguised in the price of the property.
     \41\This is substantially the same as the definition of a 
     dealer in securities contained in present law sec. 475(c)(1).
     \42\Similarly, such a broker would not qualify as providing 
     financial intermediation services under the definition in the 
     following paragraph because a broker's commission charged to 
     a buyer or seller of securities generally would not qualify 
     as a associated with the securities for which it acted as a 
     broker. Such a person, however, would be subject to the 
     general BAT rules regarding the sale of services.
     \43\Financial receipts would not include amounts borrowed 
     allocable to employee compensation, employee benefits, or to 
     purchases of goods and services that would be business 
     purchases under the general BAT rules. For a similar rule 
     with respect to deductions of ``adjusted business 
     purchases'', see footnote 44.
     \44\No deduction would be allowed with respect to principal 
     or interest payments allocable either to employee 
     compensation, employee benefits, or business purchases as 
     determined under the general BAT rules. For example, a bank 
     borrows money to purchase a building used in its business. 
     The bank would be entitled to a business purchase deduction 
     for the cost of the building, but would not take into account 
     the borrowing, and any payments of principal and interest, in 
     determining its financial receipts and adjusted business 
     purchases. See footnote 43 regarding treatment of borrowings 
     as financial receipts.
     \45\Because an insurance provider, like other financial 
     intermediaries, may deduct (as an adjusted business purchase) 
     the cost of its investments allocable to the financial 
     intermediation business, it is believed that a deduction for 
     reserves would be largely duplicative and therefore 
     unnecessary. We invite comments regarding this issue.
     \46\See footnote 38 and accompanying text.
     \47\A person would not be able to deduct an implicit 
     financial intermediation fee reported to it which has 
     otherwise been taken into account under the bill. Thus, a 
     financial intermediary who borrows money and deducts the 
     interest cannot deduct any implicit financial intermediation 
     fee reported to it relating to the interest.
     \48\Property and casualty insurance is excluded because 
     business purchasers are entitled to deduct premiums for such 
     insurance under the general BAT rules.
     \49\The rule in (3) is necessary to prevent cascading of the 
     tax.
     \50\In general, these activities are subject to the BAT 
     primarily because: (1) these governmental activities are 
     similar to services provided by non-governmental persons who 
     normally would be subject to the BAT and (2) governments 
     often charge fair market value fees for the provision of such 
     services.
     \51\As an example of the self-consumption of goods or 
     services, assume a local government normally would provide 
     refuse collection for its citizens by contracting with an 
     outside trash collector and the government is not subject to 
     the BAT with respect to the provision of such service. 
     Further assume that the trash collector is subject to the BAT 
     and increases the price it charges the government in order to 
     recoup all or a portion of its BAT liability. As a result, 
     the government may decide to hire its own employees to 
     provide the refuse collection rather than continue to 
     contract with the outside firm. The hiring of the additional 
     employees is an example of ``self-consumed'' services.
     \52\As described in detail in the section below, a ``taxable 
     period'' means a calendar quarter. The $100,000 exemption 
     amount would be adjusted to the extent a person's taxable 
     period is not calendar quarter or if the person is not 
     engaged in business for an entire taxable period.
     \53\The ``once-big-always-big'' rule may be viewed as being 
     overly harsh. However, the primary purpose of the small 
     business exemption is to relieve small businesses of 
     recordkeeping requirements. Once a person or business has 
     developed the requisite BAT reporting procedures, maintaining 
     the same or similar procedures and records after a change in 
     the size of the person's business activity should not prove 
     to be an overwhelming burden.
     \54\A small business with business purchases in excess of 
     gross receipts (e.g., a start-up business) may wish to forego 
     its exemption in order to claim a BAT credit for such excess. 
     Once the election is made, that person would no longer be 
     able to claim a future BAT exemption.
     \55\The bill provides a minimum set of rules regarding the 
     administration of the BAT. More explicit rules would be 
     developed once the more substantive issues regarding the BAT 
     are resolved. Among the rules to be developed would include 
     those regarding requests for extensions to file returns, 
     interest on overpayments and underpayments of BAT, penalties, 
     notices of deficiency, statutes of limitations, judicial 
     procedures, liens, etc.
     For a general discussion of administrative costs associated 
     with a consumption-based tax, see General Accounting Office, 
     Value-Added Taxes: Administrative Costs Vary With Complexity 
     and Number of Businesses, Report to the Joint Committee on 
     Taxation, GAO-GGD-93-78, May 1993.
     \56\Rules would be required to determine who is the liable 
     person in the case of related parties treated as one person 
     (as described below). Similar rules would be required for the 
     passive investment tax described in title I of the bill.
     \57\For example, a business can invest in stocks, bonds, or 
     other passive investments. Such property generally would be 
     viewed as investment property not subject to the BAT, unless 
     the business involved the provision of financial services. 
     However, business may hold certain other types of property 
     (e.g., undeveloped land, collectibles such as artwork, 
     durable commodities such as gold, etc.) that could be viewed 
     as investment property not subject to the BAT or as business 
     property subject to the BAT. In many cases, property is 
     acquired for a specifically intended purposes and the 
     appropriate treatment of property may be determined by the 
     nature of the trade or business acquiring or holding the 
     property. For example, gold bullion acquired by a jeweller 
     generally would be considered to be business property subject 
     to the BAT, while gold acquired by an accounting firm 
     generally would be considered to be an investment. 
     Undeveloped land may require more difficult determinations. 
     For example, an individual may acquire a parcel of land to 
     use as his or her own personal hunting reserve, but may later 
     decide to convert the land to investment or business use by 
     merely holding, rezoning, subdividing, or developing it.
     Other types of property may be held for both business and 
     nonbusiness use at the same time. For example, a landlord may 
     live in his own apartment complex. These situations involve 
     allocations between the business and nonbusiness use rather 
     than determining the nature of the use or the conversion from 
     one use to another.
     The situations presented above raise issues of tax 
     administration and tax avoidance. For example, a taxpayer may 
     be able to generate BAT business purchase deductions by 
     transferring investment or personal use property to his 
     controlled business and claiming the property to be business 
     property. The inability to identify conversions to personal 
     use (e.g., the use of the company car by a business owner) 
     also raises concerns (as it does under the present-law income 
     tax). We invite comments as to the appropriate treatment of 
     property where the intended use of the property is not clear, 
     where property may be easily converted, and where property is 
     of mixed use.

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