AICPA comments on "check-the-box" prop. regs.

At an IRS hearing, the AICPA expressed concerns about proposed regulations issued in November 1999 under Sec. 7701, imposing new limits on the "check-the-box" regime.

The proposed regulations, which focus on certain transactions occurring before or after a foreign entity elects to reclassify its status as disregarded, generally would operate to invalidate this election for tax purposes when an "extraordinary transaction" (such as a sale of an ownership interest), occurs either one day before or 12 months after the election. The IRS issued these regulations in response to perceived abuses occurring under the income source rules (Secs. 861-865), the foreign tax credit limit (Sec. 904), the disposition of ownership interests under Subpart F (Secs. 951-964) and outbound transfers (Sec. 367).

New Rules Unnecessary

The AICPA views these regulations as an attempt "to modify the generally applicable entity classification rules in order to address perceived problems relating to specific substantive rules." Because the Service already has a battery of anti-abuse rules at its disposal, the Code's relevant substantive provisions should be changed if additional measures are needed to combat inappropriate use of the check-the-box rules. As an example, the Sec. 865 regulations contain anti-abuse rules for losses, suggesting that the proposed regulations would be redundant.

According to the AICPA, the proposed regulations undermine the objectives of the original check-the-box regime of simplicity, certainty and administrative ease. For example, a taxpayer does not have to make a check-the-box election to achieve the same results by undertaking formal transactions and incurring additional legal, commercial and foreign tax costs. Consequently, these regulations appear to be in direct conflict with the underlying rationale of the check-the-box regime, essentially forcing taxpayers to divert resources toward unproductive activities in an effort to avoid punitive rules.

Given the ever-changing business environment, these regulations could create uncertainty. For instance, top management of a company could make restructuring decisions without consulting their tax advisers. Business reasons would clearly dominate a decision to divest ownership of a lower-tier entity, yet the transaction could be subject to punitive rules if a check-the-box election had been recently made. Thus, an election by a foreign eligible entity to be disregarded would not be final and certain under these regulations, until it was clear that no extraordinary transactions would occur during the 12 months following the election. Although the proposed regulations currently contain an exception for situations in which an election does not materially alter an extraordinary transaction's tax consequences, they do not adequately define the phrase "materially alter," nor do they outline specific procedures to obtain relief.

Role of Intent

The regulations would not address a taxpayer's intent, even though they address tax-motivated transactions. The AICPA's concern is that too many transactions that are not tax-motivated could fall under the punitive rules, unless a targeted anti-abuse rule is provided. In response, the IRS questioned whether the AICPA supports the use of an intent test to obtain a more targeted anti-abuse rule. Stating that subjective rules conditioned on the taxpayer's intent could cause additional uncertainty and administrative difficulties, the AICPA recommended that the regulations, if finalized, contain a statement of the specific abuse targeted, to alert taxpayers to potentially abusive situations. Further, including a provision that narrowly targets the abuse would remove uncertainty, providing taxpayers with enough guidance to allow them to assess whether a transaction would be subject to the new rules.

According to the Treasury's Office of International Tax Counsel, the proposed regulations seek to narrow the check-the-box rules of operation, to better reflect intent, rather than to counter abuse. Treasury believes the final regulations should provide more specificity so that it will be easier for taxpayers to identify the particular transactions under scrutiny. It does not believe, however, that an intent test is appropriate in the regulations, because they are not regarded as anti-abuse rules.

The AICPA also expressed concern that "the consequences of an invalidated election would extend beyond the tax treatment of the disposition itself." Payments and other transactions occurring between the entity and another related entity or their mutual owner generally are disregarded for tax purposes; however, these regulations could operate to retroactively recharacterize these transactions so that they have tax implications. In these circumstances, legitimate tax and financial planning could suffer.

AICPA Suggestions

To exclude transactions that are clearly not abusive, the AICPA suggested that certain explicit exceptions be included in the final regulations. First, extraordinary transactions undertaken to minimize foreign taxes (as opposed to U.S. taxes) should not be subject to the new rules. Restricting U.S. multinationals' ability to minimize their foreign taxes could cause them to operate at a distinct disadvantage relative to their foreign competitors. In addition, there should be an exception for transfers of disregarded entities by foreign corporations within a foreign-affiliated group. Neither of the proposed exceptions would affect situations that involve outbound transfers by U.S. persons in dispositions to third parties, a concern apparently underlying the promulgation of these regulations.

The AICPA also stated that retroactive application of the proposed regulations would cause significant, undue hardship. Thus, final regulations should apply only when all triggering events occur after the date the regulations are published in the Federal Register. However, the AICPA has continued to reiterate its belief that these regulations should be withdrawn rather than finalized.

FROM COLLEEN M. GREEN, CPA, WASHINGTON, DC

Robert Zarzar, CPA
Partner
Washington National Tax Services
PricewaterhouseCoopers
Washington, DC