In 1979, the Supreme Court held in Thor Power Tool Co. v. Commissioner of Internal Revenue, 439 U.S. 522, that a taxpayer must value inventory for tax purposes at cost unless market (replacement cost) is lower. As a result of the Supreme Court's decision, the taxpayer can value inventory below market or replacement cost in only two instances: 1) where the taxpayer in the normal course of business has actually offered merchandise for sale at prices lower than replacement cost, and 2) where the merchandise itself is defective.

In March, 1980 the Internal Revenue Service issued Revenue Ruling 80-60 which requires that, pursuant to the Supreme Court's Thor Power Tool decision, taxpayers using a method of inventory valuation for "'excess" inventory that is not in accordance with IRS regulations must change their method of inventory valuation retroactive to taxable year 1979.

The Supreme Court's requirement that a taxpayer value his inventory at less than cost, only if, in the normal course of business, he actually offers merchandise for sale at prices lower than replacement cost, is unrealistic and threatens to bring about the destruction of automobile replacement parts, parts for machinery used in factories, stores, and homes. In addition, publishing houses plan to destroy or "remainder" millions of books in the next few months because they can no longer depreciate inventories for tax purposes. Publishers expect to print fewer books in the future to avoid the chance of overstocking and to permit titles to go out of print sooner. Fewer contracts for "noncommercial" books are also likely. Other industries will have useful equipment forced into early obsolescence because replacement parts will be unavailable.

Moreover, the IRS Revenue Ruling which makes the decision retroactive to 1979 will be unduly burdensome to small businessmen who will be required to reassess their method of inventory write-downs for

taxable year 1979, the books for which have already been closed. In an era when small businesses have become an "endangered species," it is untenable for the Internal Revenue Service to add an additional burden to those already facing this segment of industry. In fact, the White House Conference on Small Business found that many of the problems faced by small businesses are caused by the federal government.

The added cost of employing the businessman's accountant full-time or of seeking advice from a large, independent accounting firm to reasses its method of inventory accounting will further enhance the problems many small businessmen have in remaining viable entities in these inflationary times. The additional time and money spent in determining a permissible accounting method for 1979 could be better spent in making the determination prospectively, thus avoiding duplication of effort and the tying up of essential personnel. Thus, the IRS Revenue Ruling 80-60 should be applied only prospectively, beginning with taxable year 1980.

The Senate Finance Committee must implement plans to make a complete study of the implications for future years on suppliers who must maintain spare parts to service their customers, and to businesses and consumers who must rely on these replacements. The Committee has recognized that the Thor Power Tool decision could cost the economy millions of dollars in coming years by shortening the lives of thousands of everyday items in more than 50 commodity lines, including automobiles, scholarly books, industrial machinery and equipment, and household appliances.

Legislation must be enacted to facilitate prospective application of the Thor decision, and, more importantly, to define a valid inventory write-down formula that accurately reflects existing conditions in industries producing these commodities.

RESOLVED

The Small Business Legislative Council urges and supports enactment of legislation to prevent implementation of the IRS Revenue Ruling 80-60 which would apply the Thor Power Tool decision retroactively to taxable year 1979. Moreover, the Small Business Legislative Council urges that legislation be

promulgated to substantively overrule the Supreme Court's decision in Thor, and to define a valid inventory write-down formula to avoid the destruction of usable property. Such legislative action will eliminate the unfairness of applying the Thor decision retroactive to 1979 and will save useful equipment, replacement parts and books from forced obsolescence.

The lack of available debt or equity capital has been identified as a universal concern of small businesses. Historically, commercial banks have supplied the most significant amounts of outside capital to the small business community and it is expected that this trend will continue in the future. However, it has often been said that this source of capital is not adequate for the long-term needs of smaller firms.

Additionally, there are other roadblocks for a firm seeking capital. For example, direct investments by employees or others in small independent businesses are difficult to attract as the rewards associated with these investments are rarely equal to the related risks. The small business owner is hesitant to sell an equity interest in the business because of the desire to maintain independence and the competitive advantage of confidentiality. Moreover, an equity interest in a small business is often difficult to liquidate for the intermediate-term investor.

A partial solution is a new, hybrid security for use by small businesses who need capital but in amounts less than those generally provided by venture capital companies. The new hybrid security is called a Small Business Participating Debenture (SBPD). It would combine certain debt characteristics (such as an interest rate and a maturity date) with existing equity characteristics (such as a share in the net profits of the issuing enterprise). The significant characteristics of the SBPD concept are its tax consequences. The total interest paid by the SBPD issuer would be treated as an interest expense and deductible by the company. This would include the interest due through the stated rate and any "premium" interest payments made that represent a share of net income.

The tax benefits and incentives to the investor in SBPDs include taxing "premium" interest earned as if it were a long-term capital gain and, when possible, allowing capital formation credits to flow through to the investor in a manner similar to the investment tax

credit for an investment in equipment. In the event that the investor does not recover his full investment, SBPD legislation would allow him an ordinary loss deduction.

In summary:

Advantages to Small Business Borrowers

Entire cost of borrowing is tax deductible.

Avoids giving up equity.

No necessity for additional bureaucratic controls. Potentially, the total of borrowing could be reduced as a result of tax benefits of the investors.

Advantages to SBPD Investors

Receives tax credits as incentive for making invest

ment.

Portion of interest (share of profits) is taxable as a capital gain.

Losses on SBPD investments would be offset by ordinary income.

The administration of the SBPDs would be relatively inexpensive as no government involvement is required nor is there any risk of loss to the government. Unlike several pieces of legislation aimed at small business, this one has only a nominal cost to the Treasury; acordingly, this solution is a practical one.

This new hybrid security has been discussed extensively and has received widespread support. In the 96th Congress and again in the 97th, Senator Lowell P. Weicker (R. Conn.) and others introduced a bill to amend the Internal Revenue Code to create SBPDs.

RESOLVED

In 1979, the Supreme Court held in Thor Power Tool Co. v. Commissioner of Internal Revenue, 439 U.S. 522, that a taxpayer must value inventory for tax purposes at cost unless market (replacement cost) is lower. As a result of the Supreme Court's decision, the taxpayer can value inventory below market or replacement cost in only two instances: 1) where the taxpayer in the normal course of business has actually offered merchandise for sale at prices lower than replacement cost, and 2) where the merchandise itself is defective.

In March, 1980 the Internal Revenue Service issued Revenue Ruling 80-60 which requires that, pursuant to the Supreme Court's Thor Power Tool decision, taxpayers using a method of inventory valuation for "'excess" inventory that is not in accordance with IRS regulations must change their method of inventory valuation retroactive to taxable year 1979.

The Supreme Court's requirement that a taxpayer value his inventory at less than cost, only if, in the normal course of business, he actually offers merchandise for sale at prices lower than replacement cost, is unrealistic and threatens to bring about the destruction of automobile replacement parts, parts for machinery used in factories, stores, and homes. In addition, publishing houses plan to destroy or "remainder" millions of books in the next few months because they can no longer depreciate inventories for tax purposes. Publishers expect to print fewer books in the future to avoid the chance of overstocking and to permit titles to go out of print sooner. Fewer contracts for "noncommercial" books are also likely. Other industries will have useful equipment forced into early obsolescence because replacement parts will be unavailable.

Moreover, the IRS Revenue Ruling which makes the decision retroactive to 1979 will be unduly burdensome to small businessmen who will be required to reassess their method of inventory write-downs for

taxable year 1979, the books for which have already been closed. In an era when small businesses have become an "endangered species," it is untenable for the Internal Revenue Service to add an additional burden to those already facing this segment of industry. In fact, the White House Conference on Small Business found that many of the problems faced by small businesses are caused by the federal government.

The added cost of employing the businessman's accountant full-time or of seeking advice from a large, independent accounting firm to reasses its method of inventory accounting will further enhance the problems many small businessmen have in remaining viable entities in these inflationary times. The additional time and money spent in determining a permissible accounting method for 1979 could be better spent in making the determination prospectively, thus avoiding duplication of effort and the tying up of essential personnel. Thus, the IRS Revenue Ruling 80-60 should be applied only prospectively, beginning with taxable year 1980.

The Senate Finance Committee must implement plans to make a complete study of the implications for future years on suppliers who must maintain spare parts to service their customers, and to businesses and consumers who must rely on these replacements. The Committee has recognized that the Thor Power Tool decision could cost the economy millions of dollars in coming years by shortening the lives of thousands of everyday items in more than 50 commodity lines, including automobiles, scholarly books, industrial machinery and equipment, and household appliances.

Legislation must be enacted to facilitate prospective application of the Thor decision, and, more importantly, to define a valid inventory write-down formula that accurately reflects existing conditions in industries producing these commodities.

RESOLVED

The Small Business Legislative Council urges and supports enactment of legislation to prevent implementation of the IRS Revenue Ruling 80-60 which would apply the Thor Power Tool decision retroactively to taxable year 1979. Moreover, the Small Business Legislative Council urges that legislation be

promulgated to substantively overrule the Supreme Court's decision in Thor, and to define a valid inventory write-down formula to avoid the destruction of usable property. Such legislative action will eliminate the unfairness of applying the Thor decision retroactive to 1979 and will save useful equipment, replacement parts and books from forced obsolescence.

Small business is one of the sectors of our economy hardest hit by inflation. Government-mandated cost increases are the most burdensome and proportionately more costly to small business since small businesses rarely have easy access to the administrative capacity or technical expertise to comply with complex regulations. The resultant increases in cost must, in many cases, be absorbed by the profits of small businesses, primarily because they are least able to increase prices and hope to remain competitive. Increases in minimum wages, also mandated by federal and state law, as well as increased Social Security taxes and unemployment taxes, impose a burden on small businesses which must be absorbed or passed on to paying customers. Their competitive stance is thus further weakened.

No program of wage and price controls, either voluntary or mandatory, can succeed if the entire business and labor communities do not participate and cooperate (including small business). Despite small business' natural desire to de exempted, it is a fact that the control program of 1972 failed because the Pay Board exempeed 10% of the small business community. The resulting increases in wages and prices put the squeeze on larger business that used small firms as sources for suppões, as well as resulting in increased prisves to many small businesses' customers. Since

all Nouses in this country account for some 39% of the GNP and have created 95% of the new

private-sector jobs in the past decade, their inclusion and full participation is essential. The competitive edge of the small business community keeps all prices relatively low.

It is essential that the government avoid mandatory controls--the least desirable method of dealing with economic problems.

It is commendable that the Administration has recognized that one of the most elemental sources of inflationary pressures is government policy. Through the creation of a regulatory council within OMB, proposed regulations will be monitored and analyzed for their potential cost-increasing (or cost decreasing) impact. Also, the President's proposed crackdown on federal spending may begin to ease the deficits that have plagued previous administrations and added fuel to further heat up inflation.

Another commendable new focus is the government's attention to ways to increase productivity. Wage increases greater than productivity increases cause unit costs to rise, with the increases being passed on to consumers. As a way of retarding this adverse cycle, fundamental economic principles call for awarding wage increases only with accompanying increases in productivity. The resulting rise in consumer and production cost is offset by a greater labor yield and a greater supply of goods and services.