Capitalization rules top TEI's spring agenda: IRS funding, role of Taxpayer Advocate, debt collection, and options withholding also prompt responses. (Recent Activities).

An advance notice of proposed rulemaking on the treatment of expenditures in acquiring, creating, or enhancing intangible rights was the subject of comments submitted on April 24 by Tax Executives Institute to the U.S. Treasury Department and Internal Revenue Service. Issued in January, Announcement 2002-9 sets forth rules the government is likely to propose this year to provide a framework for expensing or capitalizing these expenditures.

In its comments, TEI commended the Treasury and IRS for seeking public comments on the issues. "The consultative process will enable the government to issue rules that will reduce compliance and administration costs and minimize uncertainty and controversy for the benefit of both taxpayers and the government," TEI President Bob Ashby wrote. "Indeed, to minimize resources devoted to unproductive controversies, we recommend that the final rules not only be effective immediately, but also that guidance be issued stating that the government will not challenge a taxpayer's treatment of expenditures in prior years to the extent such treatment is consistent with the new rules."

The advance notice generally describes categories of expenditures for which capitalization will be required. The government stated it anticipates "that other expenditures to acquire, create, or enhance intangible assets or benefits generally will not be subject to capitalization under section 263(a)." In its comments, the Institute urged the adoption of a formal rule of "general deductibility." The organization explained that, during the past 10 years, a number of revenue rulings have been issued that were intended to quell controversies by according taxpayers deductions for specific expenditures. "Regrettably, revenue agents have narrowly construed the rulings by characterizing many routine expenditures as `rare and unusual' and thus outside the scope of the ruling's general rule of deductibility." An explicit statement that expenditures--other than those identified--are deductible is needed, TEI stated.

In addition, the Institute supported the adoption of a 12-month rule. "Where the future benefit or life of an asset is 12 months or less," TEI said, "it is unlikely that taxable income will be materially distorted by permitting a current deduction." For purposes of applying the rule, the organization recommended that the expected economic life of an intangible asset be the basis for measuring the period of the benefits. In respect of prepaid items, TEI supported the application of the 12-month rule to permit an immediate deduction for amounts prepaid for goods, services, or other benefits (such as insurance) to be received in the future, but suggested guidance to illustrate the rule's interaction with section 461(h)'s economic performance rules may be necessary.

TEI also supported the government's proposal to adopt a de minimis rule permitting deductions for all expenditures of $5,000 or less per vendor (or provider) per transaction for intangible assets or benefits. "We question, however," the Institute stated, "whether a $5,000 threshold affords meaningful simplification for larger taxpayers and urge the government to consider adopting a higher dollar amount." In addition, TEI urged the government to consider adopting a flexible threshold by permitting taxpayers to employ the minimum capitalization threshold adopted for financial statement reporting. The Institute also urged the government to expand the de minimis threshold concept to tangible property.

Other subjects touched on in TEI's comments include amount paid to terminate certain contracts or in connection with tangible property owned by another, defense of title, transaction costs, book-tax accounting conformity, and safe harbor cost recovery periods.

The Institute's comments are reprinted in this issue, beginning on page 262.

IRS Activities

During the last few months, the Institute also submitted comments on a wide variety of IRS activities, ranging from funding to the role of the National Taxpayer Advocate.

On May 15, TEI President Bob Ashby urged the chairman and ranking member of the Senate Appropriations Committee's Subcommittee on Treasury and General Government to ensure that the IRS receives adequate funding for its 2003 operations.

"Much has been accomplished under the IRS Restructuring and Reform Act," Mr. Ashby stated. Improving customer satisfaction was a mandate of the 1998 act and the IRS is making progress. "Indeed, two recent surveys show a strong turnaround in IRS public approval."

"If the IRS is to succeed in reinventing itself as a modern, customer-focused agency, it must have adequate funding for its service initiatives," TEI's president said, citing in particular the need to maintain the momentum of the modernization initiative. The organization recommended that the Administration's funding request for the IRS be approved and that any pay raise for employees be fully funded.

A similar letter was sent to the chairman and ranking member of the Subcommittee on Treasury, Postal Service, and General Government of the House Appropriations Committee. The Senate letter is reprinted in this issue, beginning on page 274.

In June, the Institute wrote to Treasury Secretary Paul O'Neill concerning recent IRS testimony on the proposed use of private agencies to collect delinquent taxes. Echoing concerns expressed at an April hearing by the IRS National Taxpayer Advocate, TEI noted that such an action would constitute a radical change in the way federal taxes are collected. We believe that the proposal represents poor tax policy, could imperil taxpayer rights, and would likely erode taxpayer confidence in the fairness of the tax system, the Institute cautioned. It strongly recommended that the proposal be rejected. The June 12 letter is reprinted in this issue, beginning on page 275.

In response to a request from the IRS Oversight Board, TEI submitted comments in March on the organization and operation of the IRS Office of the Taxpayer Advocate. The organization stated that, although the National Taxpayer Advocate has not previously focused on or provided resources to business taxpayers, large corporations could provide assistance in identifying areas of the law requiring attention.

For example, the Taxpayer Advocate submits an annual report to Congress on the most significant problems faced by taxpayers. Although the Advocate has in the past recommended the repeal of the alternative minimum tax for corporate and individual taxpayers, in 2001 the recommendation was limited to the repeal of the individual AMT. National Taxpayer Advocate Nina Olson has explained that her office was created to focus on individuals and smaller businesses. In its March 27 letter, the Institute expressed disappointment that the Advocate viewed her role as so limited. TEI urged the Oversight Board to encourage the office to use its resources to identify systemic solutions and resolve problems for all taxpayers. The Institute's letter is reprinted in this issue, beginning on page 261.

Finally, in May the Institute submitted TEI members' responses to a survey by the IRS Large and Mid-Sized Business Division on ways in which to streamline the audit process. These responses are reprinted in this issue on page 277.

Canadian Taxes: Regulation 105

On May 30, TEI submitted a letter to Brian Ernewein of the Canadian Department of Finance expressing concern about the withholding tax required under Regulation 105. In a letter signed by President Bob Ashby, TEI characterized the regulation as "a significant impediment to the competitiveness of Canadian companies because it erects artificial barriers that inhibit access to the expertise of non-resident service providers, especially those in the United States."

Issued prior to the adoption of the North American Free Trade Agreement, Regulation 105 imposes withholding tax on fees paid to non-residents for services rendered. During liaison meetings and roundtable discussions with Canada Customs and Revenue Agency and the Department, TEI has noted that the policies underlying the statute and the regulation are outmoded in the post-NAFTA environment. Mr. Ashby urged the Department to work with TEI and CCRA to devise an effective legislative or regulatory remedy to eliminate the anachronistic effects of Regulation 105.

Referring to the waiver procedure administered by CCRA, Mr. Ashby noted that "it is impractical in many cases for a non-resident to utilize" the process. To obtain a waiver, the non-resident must apply directly to CCRA 30 days prior to the start of the performance of services in Canada or 30 days prior to the first payment for services. A non-resident is frequently unaware of either the withholding tax or the waiver process until the Canadian payer draws attention to it, he explained.

Mr. Ashby called CCRA's administration of the waiver procedure "far too restrictive." The default choice for most non-resident suppliers is simply to add approximately 18 percent to the normal service price, he stated.

In light of the administrative and economic costs to Canadian taxpayers of complying with Regulation 105, the TEI president questioned whether the provision should be retained. He recommended that the Department of Finance repeal Regulation 105 in its entirety or amend it to apply solely to artistes and athletes. Alternatively, he urged the Department to eliminate the withholding tax for service providers resident in countries with which Canada has free-trade agreements.

The Institute's comments are reprinted in this issue, beginning on page 270.

Treasury Minutes

Included in this issue of The Tax Executive are the minutes of the Institute's most recent liaison meeting the Treasury Department's Office of Tax Policy. These minutes are reprinted in this issue, beginning on page 257.