Clinton administration budget proposals.

On May 9, 1997, Tax Executives Institute submitted the following comments to the tax-writing committees of Congress, with copies to the Department of the Treasury and the Internal Revenue Service, on the tax proposals contained in the Clinton Administration's fiscal year 1998 budget proposals. The comments were prepared under the aegis of the Institute's Federal Tax Committee chaired by David L. Klausman of Westinghouse Electric Corporation), International Tax Committee (chaired by Joseph S. Tann, Jr. of Ameritech Corporation), and IRS Administrative Affairs Committee (chaired by Robert L. Ashby of Northern Telecom Inc.). Other members of the Institute participating in the development of TEI's comments were the Michael D. Fryt of Federal Express Corporation; John A. Gurovich of US West, Inc.; and Philip G. Cohen of Unilever United States, Inc.

Tax Executives Institute is the principal association of corporate tax executives in North America. Our 5,000 members represent approximately 2,800 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and that taxpayers can comply with in a cost-efficient manner.

On February 6, 1997, President Clinton submitted his fiscal year 1998 budget proposals to Congress, including numerous proposals amending the Internal Revenue Code. Although the Administration and congressional leadership have announced an agreement on a general outline for the budget package, we understand that few specific proposals have been adopted. These comments focus on several Administration proposals affecting corporate taxpayers.

Domestic Tax Issues

Denial of Interest Deduction 

For Certain Debt Instruments

Administration Proposal. The Administration proposal provides that no deduction would be permitted for interest on an instrument issued by a corporation (or a partnership to the extent of its corporate partners) that either (i) has a maximum weighted average maturity date of more than 40 years, or (ii) is payable in stock of the issuer or a related party. The proposal would also modify the rules for indebtedness that is reflected as equity on the issuer's financial statements. The proposal would essentially reduce the facts-and-circumstances test for distinguishing between debt and equity to one factor: the term of the instrument.

TEI Recommendation. TEI opposes enactment of this provision. So-called supermaturity debt instruments are issued by corporate treasurers for legitimate business reasons, primarily to "lock in" attractive interest rates on long-term debt financing. The term of a financial instrument alone does not confer undue tax or financial reporting advantages to either party nor does it vitiate the economics underlying the traditional tax law distinctions between debt and equity financing. Indeed, both the issuer and holder understand well that what they have is a long-term debt obligation that provides the holder legal rights in bankruptcy that are superior to all classes of equity.

More than 25 years ago, Congress enacted section 385 of the Internal Revenue Code, giving the Treasury Department authority to address debt/equity interests. Although several sets of regulations have been issued under this provision, there are no current regulations that apply. Treasury's inability to craft workable regulations under that provision demonstrates that the issues to be resolved are complex and not subject to easy solutions. Asking Congress to enact an arbitrary rule, while facile, will not bring long-term stability to this area and adjusts what is in reality a market-based transaction. Indeed, as the Joint Committee's explanation admits, the effect of this provision may well be nothing more sophisticated than encouraging the issuance of 39-year debt. Joint Committee on Taxation, Description and Analysis of Certain Revenue-raising Provisions Contained in the President's Fiscal Year 1998 Budget Proposal (JCX-10-97), at 5 (March 11, 1997) (hereinafter cited as "Joint Committee Description"). We urge that the proposal be rejected.

Limitation of the

Dividends-Received Deduction for

Portfolio Stock

Administration Proposal. Under current law, a corporation receiving dividends from stock of a corporation of which it is less than a 20-percent owner may deduct an amount equal to 70 percent of the dividend. The Administration's proposal would decrease the dividends-received deduction to 50 percent of the amount received

TEI Recommendation. The proposal to constrict the dividends-received deduction constitutes an unjustified assault on longstanding and well-founded corporate tax policy. The dividends-received deduction is a mechanism to mitigate multiple taxation of income distributed through a chain of corporations. Stated differently, where one corporation, P, claims the dividends-received deduction for amounts received as dividends from another corporation, S, there is no evasion of the corporate tax by P since S has paid corporate income tax on the earnings before paying the cash dividend to P. Moreover, should P pay out the cash received from S as a further dividend to P's shareholders, P's shareholders will pay an additional level of tax on the business income generated by S. Thus, for every tier in the chain of income-producing corporations, the dividends-received deduction is not a loophole and does not constitute 'corporate welfare.' It is a proxy for integration and serves as a check against multiple taxation.

In addition, if the Administration's proposal is enacted, even greater pressure would be added to the trend to "disincorporate" U.S. businesses, which would trigger significant unintended consequences. Finally, the proposal would exacerbate the difference between U.S. corporate income tax policy and that of much of the rest of the world since most U.S. trading partners (such as Canada) provide full or partial integration of their corporate-shareholder income tax regimes and thereby mitigate multiple taxation. In the past, the Treasury Department has acknowledged that the current system of multiple taxation of corporate income is economically inefficient. It is ironic and unfortunate that the Administration now proposes to take a step backward and exacerbate the current system's shortcomings. TEI urges that the proposal to reduce the dividends-received deduction be rejected.

Modification of the Loss

Carryover Rules

Administration Proposal. Under current law, a taxpayer may carry back a net operating loss (NOL) for 3 years and may carry forward the loss for 15 years. The Administration's proposal would reduce the carryback to 1 year, and expand the carryforward period to 20 years,

TEI Recommendation. The current NOL carryover period is designed to "smooth out swings in taxable income and loss caused by the annual accounting period requirement." Joint Committee Description 43. See also Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, 99th Cong., 2d Sess. 288 (1987) (NOL carryover periods permit taxpayers to average income and losses "to reduce the disparity between the taxation of businesses that have stable income and businesses that experience fluctuations in income."). The proposal would increase the taxes of struggling businesses at the time they need it least: following a substantial loss. Tax refunds paid to companies experiencing temporary business reversals provide a vital infusion of cash. The refunds will often prove decisive in forestalling the company's bankruptcy, thereby preserving employee jobs and future tax revenues from both the company and its employees. Although increasing the carryforward would seemingly benefit taxpayers with expiring NOLs, as a practical matter NOLs normally do not expire because the 15-year carryforward is sufficient time in which to absorb the losses. Joint Committee Description 43. Increasing the carryforward period should not come at the expense of shortening the carryback period. As a commentator has noted, "Treasury says this proposal is about simplification, but it is a revenue grab -- pure and simple." Martin A. Sullivan, Tax Analysts Budget Briefing on Clinton Tax Proposals, 74 Tax Notes 695 (Feb. 10, 1997). The Administration's proposal to limit the use of carrybacks should be rejected.

Extension of Educational

Assistance Deduction and

Research Tax Credit

Administration Proposal. The employer-provided educational assistance exclusion under section 127 and the research tax credit under section 41 are due to expire -- again -- on May 31, 1997. The Administration's proposal would extend the educational exclusion through December 31, 2000, and the research tax credit until May 31, 1998.

TEI Recommendation. TEI supports the permanent extension of both the research tax credit and the income exclusion for employer-provided educational assistance. Both provisions represent important investments in America's future and both have enjoyed widespread support for many years. The transitory nature of the provisions, however, has imperiled their incentive effect. Indeed, since its enactment in 1978, the section 127 exclusion for educational assistance has been extended no fewer than eight times. The section 41 research credit provision has also been extended numerous times.

If sections 41 and 127 are to operate properly, they should be made permanent for the "sunsetting" of these provisions diminishes their vitality. In light of the planning horizon (generally at least five years) for research and development activities, the repeated short-term re-enactment of section 41 cannot help but engender uncertainty and impede the credit's incentive effect of encouraging companies to engage in incremental research projects in the United States. Because the credit is targeted primarily at wages paid to employees engaged in U.S.-based R&D activities, a permanent credit will support additional high-skilled, high-paying jobs for American workers.

The on-again, off-again, sometimes retroactive, other times restrictive nature of both provisions also imposes substantial administrative burdens on taxpayers. For example, with respect to employer-provided educational assistance, employers have been required to design and implement programs to tax and withhold the value of such assistance, only to modify (or undo completely) those programs after-the-fact. Employees too have been subject to confusion, financial hardship, and the administrative burden of filing amended returns from the see-sawing effect of extensions and retroactive legislation.

By restoring the educational assistance exclusion of section 127 and making it permanent, the administrative burden on employers and the financial burdens on employees will be ameliorated. As important, educational assistance programs provide job opportunities and advancement for lower-paid and unskilled workers. In addition, a permanent extension of the employee income exclusion will encourage more employers to establish such programs to enhance the knowledge and training of their workforces and otherwise hone employee skills that are required in a highly competitive global market.

Repeal of Components-of-Cost

Inventory Method

Administration Proposal. Under section 472 of the Code, taxpayers permitted or required to take inventories may elect the last-in-first-out (LIFO) method of accounting, pursuant to which the taxpayer is assumed to have sold the merchandise most recently bought. Once made, the election to use LIFO is irrevocable. Manufacturers electing LIFO generally use two methods of accounting for their inventories: (i) the total product cost (TPC) method, whereby ending inventory is determined by valuing the items in ending inventory by the base-year cost of producing such an item, and (ii) the components of cost (COC) method, whereby taxpayers treat the units of production (i.e., raw material, labor, and overhead) that were used to produce the inventory as separate items. The Administration's proposal would repeal the COC method.

TEI Recommendation. TEI opposes the repeal of the COC method. For financial reporting purposes, the COC method is considered "preferable" for manufacturers in certain circumstances, including those with little finished goods inventory or with substantial work-in-process inventories. For these taxpayers -- required to continue using COC under generally accepted accounting principles (GAAP) -- the repeal of the COC method would require the maintenance of two sets of inventory records. Such a recordkeeping burden is costly and unwarranted.

Moreover, without the COC method, many taxpayers would be unable to compute LIFO inventories -- effectively suffering an increase in tax based on "phantom" profits attributable to inflation because they would be precluded from matching their most recent costs with current income. Finally, taxpayers switching to the TPC method might be forced to reconstruct their base-year costs, which the Joint Committee staff notes may be "difficult and time-consuming." See Joint Committee Description 75. Indeed, in some cases, it would literally be impossible. Even if possible, the requirement would increase disputes between the IRS and taxpayers over the accurate measure of income. See Joint Committee Description 75. For all these reasons, the proposal should be rejected.

Recognition of Gain on

Certain Stock Distributions

Administration Proposal. Section 355 of the Code provides an exception from income recognition for certain distributions of stock in a controlled corporation, subject to certain restrictions prior to and subsequent to the distribution. In Commissioner v. Mary Archer W. Morris 7rust, 367 F.2d 794 (4th Cir. 1966), a corporation spun off a subsidiary and then merged with another corporation. The old shareholders of the distributing corporation received stock in the merged corporation that was more than 50 percent of the ownership of that corporation. The court held that the spin-off qualified for nonrecognition treatment under section 355 and that there was no inherent incompatibility between combined divisive and acquisitive reorganizations. The IRS subsequently agreed that section 355 was not per se incompatible with a contemporaneous acquisitive reorganization.(1) The current regulations generally comport with this principle.(2)

In the classic Morris Trust transaction, no gain or loss is recognized under current law since shareholders do not "cash out" their investments. Any corporate asset gain is built into the assets of the controlled and distributing corporation, and the shareholder's built-in gain continues in the stock of the merged corporation received in the transaction. Restrictions exist to protect against transactions that do not have a valid business purpose or are simply devices to effect a distribution of earnings and profits without tax.

The Administration's proposal would impose additional restrictions on historically tax-free transactions involving the stock of the distributing or controlled corporations. Under the proposal, the distributing corporation (but not its shareholders) would be required to recognize gain on the distribution of the stock of the controlled corporation unless the direct and indirect shareholders of the distributing corporation (as a group) control both distributing and controlled corporations at all times two years before and two years after the distribution.

TEI Recommendation. TEI believes that the Administration's proposal is an example of overreaction and overkill. While some modification in section 355 may be justified, the Administration's proposal represents a crude, meat-ax approach to a mechanism that has proven quite salutary in permitting corporate groups to reorder themselves.

Concededly, the Morris Trust holding has recently come under attack because of several highly publicized transactions where new debt is incurred and the entity incurring the debt is subsequently separated from the funds derived from the new debt. In contrast, a classic Morris Trust transaction permits a corporate taxpayer to distribute unwanted assets to its shareholders in order to facilitate a merger, acquisition, or restructuring; the spin-off does not result in a "cashing out" by either the shareholders or the company disposing of the business. The shareholders continue to hold the same interest in the same assets; only the form is different. As a result, the continuity of the shareholder's interest, as well as control over the assets, is maintained.

TEI submits that the wholesale repeal of Morris Trust would be detrimental to U.S. multinational companies' competitiveness in the global marketplace and impose a chilling effect on the efforts of businesses to refine their focus as the companies move into the 21st century. We respectfully submit that Morris Trust is an essential tool in today's ever-changing business environment: It is used by American corporations to efficiently reorganize corporate groups, especially in industries that are undergoing dramatic competitive changes. The repeal would cause the multiple taxation of a single transaction: The target corporation would recognize gain built into the new company stock; the shareholder would not receive a stepped-up basis in the new stock; and the new company would not receive a stepped-up basis of its assets.

The Institute recognizes that Congress and the Administration have a legitimate interest in circumscribing the use of the Morris Trust doctrine to prevent de facto sales from escaping taxation.(3) By the same token, there are numerous non-abusive spin-offs that do not result in the cashing out of any interests, but rather are simply restructurings of businesses within the corporate solution. Unfortunately, the Administration's proposal and two related bills (H.R. 1365 and S. 612) ensnare numerous non-abusive transactions within their scope. The Administration's proposal should be rejected.

Substantial Understatement

Administration Proposal. Section 6662 of the Code imposes a 20-percent penalty for understatements of income tax that are "substantial," i.e., the amount of the understatement for the taxable year exceeds the greater of (i) 10 percent of the tax required to be shown on the return, or (ii) $10,000. Under the Clinton Administration's proposal, any understatement of tax that exceeds $10 million would be considered "substantial" for purposes of the penalty.

TEI Recommendation. TEI believes that the proposed revision of section 6662 reflects a failure to learn from Congress's extensive reform of the penalty provisions less than a decade ago. The Improved Penalty and Compliance Tax Act -- enacted as part of the Omnibus Budget Reconciliation Act of 1989 -- revised and streamlined several penalty provisions of the Code, consolidating many of them into a new section 6662. The changes were made because Congress concluded that the Code's myriad penalties caused confusion among taxpayers and led to difficulties in administration by the IRS. H.R. Rep. No. 101-247, 101st Cong., 1st Sess. 1388 (1989). Underlying the new statutory scheme was a philosophy that civil tax penalties should exist for the purpose of encouraging voluntary compliance and not for other purposes, such as the raising of revenue.

TEI wholeheartedly endorses the philosophy that penalties should be assessed only to punish culpable behavior. The tax law should not punish "foot faults" or good faith efforts to comply with tax rules that are hopelessly complex and, in many instances, ambiguous. Taxpayers -- especially large, multinational enterprises that are subject to constant IRS scrutiny -- struggle to comply with vague statutes and regulations, and despite their best efforts either sometimes substantially underpay -- or overpay -- their taxes. These companies do not play the audit lottery (because they are audited year after year), and they should not be subjected to still another penalty where, after audit, they must pay additional taxes (plus interest). We acknowledge that the dollar threshold in the Administration's proposal seems high in the abstract, but in today's global economy the threshold could be exceeded by a multinational business acting entirely in good faith. That good faith, non-culpable errors are possible is evidenced by the IRS's own mistakes in asserting huge tax deficiencies. Even with the benefit of hindsight denied taxpayers when they filed their returns, the IRS frequently loses multi-million dollar cases.(4) We therefore oppose the knee-jerk reaction to use penalties, apparently as a revenue-raising measure. The Administration's proposal should be rejected.

Increase in Penalties for

Failure To File Correct

Information Returns

Administration Proposal. The Administration's proposal would increase the general penalty for the failure to file correct information returns before August 1 of a given year from $50 to the greater of $50 or 5 percent of the total amount required to be reported. The increased penalty would not apply if the aggregate amount that is timely and correctly reported is at least 97 percent of the amount required to be reported.

TEI Recommendation. The Administration contends that this increase in the information-reporting penalty is needed to encourage "taxpayers to assure both the accuracy and timeliness of information on each return and in the aggregate." Other than this bromide, no evidence has been offered to show that the current provisions are inadequate to ensure compliant behavior.

The proposal constitutes an abandonment of the principle that penalties should not be enacted or increased simply to raise revenue.(5) In addition, in many cases it would unfairly penalize taxpayers for reporting late or incorrect information provided by unrelated parties over which the taxpayer has no control. Finally, the proposal disproportionately affects businesses that must report the gross proceeds of a transaction.(6) It should be rejected.

Corporate Tax Shelter 

Registration

Administration Proposal. Under current law, an organizer of a tax shelter is required to register the shelter with the Internal Revenue Service. The Administration's proposal would expand registration requirements to include shelters for corporate taxpayers when the promoters earn fees in excess of $100,000, and require participants to sign an agreement not to disclose how the shelter works. Where the promoter is not a U.S. person, or if a required registration is not made, then any U.S. participant would be required to register the shelter. Registration would be required no later than the next business day after the day the tax shelter is first offered to potential users. For purposes of this provision, a corporate taxpayer that ultimately determines not to participate in the transaction may be required to register the shelter, unless, within 90 days of the date discussions began, the taxpayer sends a written notice to the promoter of the taxpayer's decision not to participate in the shelter. The penalty for failure to register a corporate tax shelter is the greater of $10,000 or 50 percent of the fees payable to any promoter with respect to offerings prior to the date of late registration. Intentional disregard of the registration requirement raises the penalty to 75 percent of the fees.

TEI Recommendations. TEI has grave doubts about the proposal. Congress took great strides in 1989 to streamline and improve the Internal Revenue Code's penalty provisions. The tax law is replete with provisions aimed at forcing disclosures of questionable positions, curtailing improper "tax shelters," and punishing taxpayers who unduly "push the envelope" in completing their tax returns through explicit penalties (in section 6662) or enhanced interest rates (in section 6621(c)).

TEI appreciates the policy concerns underlying the proposal -- the aggressive use of confidentiality agreements to market tax shelter arrangements and the effect such agreements have on the IRS's ability to identify and staunch unacceptable tax shelter activities. The Institute submits, however, that the proposal is seriously flawed because it would misguidedly and redundantly impose burdens on taxpayers. It is doubly objectionable to impose the registration requirement on corporate taxpayers that discuss participation in the shelter but ultimately choose not to participate in the shelter.

We submit that more appropriate targets of the registration requirement are available -- namely, any U.S. person who serves as an adviser to the promoter. Experience teaches that "plans or arrangements" marketed on conditions of confidentiality are unfailingly accompanied by legal opinions or other analyses attesting to the attendant tax consequences. Where the promoter is not a U.S. person, it is quite likely that one or more of the advisers whose opinions are used in marketing the shelter will be subject to U.S. tax jurisdiction. Hence, we believe that the "backstop" should be those advisers, rather than the taxpayer. Expanding the definition of promoter to include advisers would properly target the proposal to those who market (or whose views are used in marketing) tax shelters. This would be accomplished by including a sentence such as the following:

For purposes of this section,

the term "promoter" also

includes any attorney,

accountant, investment banker, or

other adviser whose identity

and views concerning the tax

treatment of the tax shelter

are disclosed in any

materials provided to any person

with whom participation in

the shelter is discussed.

Regardless of the registration requirement imposed on promoters (however that term is defined), TEI recommends that the provision be amended to extend the time period within which taxpayers are required to register the shelter. The proposal practically begs noncompliance for it would require registration even before the taxpayer is required to provide a notice of nonparticipation to the promoter in order to vitiate the registration requirement. Such a "mechanical" defect in the application of the registration requirement underscores why taxpayers should not be required to register the shelter, especially where they choose not to participate in the shelter. Indeed, in its explanation of the Administration's proposals, the staff of the Joint Committee on Taxation notes, "[B]ecause in some instances it may be necessary to exercise judgment as to whether a transaction must be reported, there may develop disagreements between the private sector and the government as to the proper extent of reporting required by the statute." Joint Committee Description 80.

Should a registration requirement be retained in respect of taxpayers that participate in confidential tax shelters, TEI recommends that the time period for such registration be linked to the filing of the taxpayers' returns. Hence, we recommend that registration be required not sooner than the due date (including extensions) of the return for the year in which the taxpayer participates in the tax shelter. If nonparticipating taxpayers remain subject to the registration requirement, the deadline for their registration should similarly be linked to the due date of the return for the year in which the tax shelter discussions occur.

Use of Average Basis

for Securities

Administration Proposal. The Administration proposal would require that the basis of substantially identical securities be determined using the average of all holdings in the securities, effective 30 days after enactment. Under current laws, taxpayers may specifically identify the portion of their holdings that are being disposed of for purposes of determining the gain or loss.

TEI Recommendation. TEI is especially concerned about the administrative and recordkeeping burdens that the Administration's proposal would impose on companies that maintain stock purchase and stock option plans for their employees. (These companies routinely assist employees in determining the taxable gain realized when stock acquired pursuant to these plans is sold.) Because the Administration's plan would require that an average basis be determined each time an employee exercises an option or sells securities, the basis of stock acquired pursuant to a company plan would be affected by the cost of any stock acquired or sold independently by the employee. Hence, if an employee holds company stock outside the plan (which is common), it would be impossible for plan administrators to determine the average basis of the employee's holdings without obtaining -- and verifying -- information from the employee about additional holdings. Satisfying this prerequisite would not only be burdensome, but would also compromise the employee's right of privacy.

The practical effect of the Administration's proposal is illustrated by the following simple example: An employee, who already owns one share of stock with a basis of $41, receives an option for another share whose fair market value at grant is $50. She later exercises the option when the share has a fair market value of $75 and immediately sells the share at that price. Under current law, the employee has compensation income of $25 [$75-$501 and no capital gain. Under the Administration's proposal, she would have compensation income of $25 [$75-$501 plus capital gain of $17 [$75 -- ($41+$75)[divided by] 2)], or a total taxable gain of $42! The company, however, would not be able to determine this result unless the employee provided information about the basis of her independently acquired stock.

Moreover, many companies maintain stock purchase plans that permit employees to elect to purchase shares of company stock through the use of payroll withholding. In addition, companies commonly provide dividend reinvestment plans for their shareholders. The proposal greatly complicates the recordkeeping requirements for these plans.

For the foregoing reasons, TEI recommends that the Administration's proposal be rejected. Alternatively, stock sold following the exercise of a stock option, stock purchased by employees through company plans, or stock purchased by shareholders through dividend reinvestment plans should be excepted from the proposal's scope.

Foreign Tax Issues

Repeal of Export-Source Rule

Administration Proposal. Section 863 of the Internal Revenue Code provides a simple rule for determining the source (whether foreign or domestic) of a taxpayer's income. Treas. Reg. [sections] 1.863-3(b) permits taxpayers to apportion 50 percent of the income derived from the sale outside the United States of products manufactured within the United States on the basis of the location of the assets held to produce the income; the other 50 percent of the income is sourced under the title-passage rule (i.e., where title to the goods shifts to the purchaser and hence where the place of sale is determined to occur).

The Administration would replace this export-source rule with an activity-based rule. Thus, income from the sale or exchange of inventory produced in the United States and sold or exchanged abroad, or produced abroad and sold or exchanged in the United States, would be apportioned between production activities and sales activities based on actual economic activity.

TEI Recommendation. The Administration's proposal constitutes a giant step backward in efforts to simplify the Code. One need only consider the facts-and-circumstances test of section 482 to understand that replacing the export-source rule with the Administration's apportionment scheme would pawn countless disputes between taxpayers and the IRS and require the expenditure of time and resource$ as taxpayers and the IRS retain experts to perform a functional analysis of the taxpayer's export activities. Administratively, this proposal is far beyond the pale.

Moreover, the proposal would adversely affect U.S. companies that manufacture in the United States and use a foreign subsidiary to market their exports in two ways -- it would negate the title-passage rule and would unnecessarily increase uncertainty and complexity. By increasing the potential for double taxation, the repeal of the export-source rule could tip the scales in a company's decision whether to locate a manufacturing facility in the United States or abroad.

In 1986, the Senate Finance Committee considered changes to the title passage rule that would have adversely affected the export-source rule. The committee ultimately rejected these changes, finding that "with the substantial trade deficits of the United States, [the Committee] does not want to impose any obstacles on U.S. businesses that may exacerbate the problems of U.S competitiveness abroad." S. Rep. No. 99-313, 99th Cong., 2d Sess. 329 (1986). The reservations expressed in 1986 are just as valid today.

It is, indeed, ironic that the Administration's proposal is included in the same budget package that seeks to expand the use of another export-favorable provision for foreign sales corporations. The export-source rule has been part of the Treasury regulations for 75 years. It should not be cavalierly discarded. The Administration's proposed repeal should be rejected.

Modification of Foreign

Tax Credit Carryback

Administration Proposal. Section 904(c) of the Code currently provides that any foreign tax credits (FTCs) not used against U.S. tax in the current year may be carried back two years and forward five. The Administration's proposal would limit the carryback to one year and extend the carryforward to seven years.

TEI Recommendation. The Administration's proposed restriction of the carryback rules would undermine the very purpose of the FTC, which was adopted almost 80 years ago to mitigate double taxation that arises because the United States taxes corporations on their worldwide income. This purpose is frustrated by unrealistically short carryover periods, which cause credits to expire unused. Enactment of this revenue raiser would only serve to exacerbate the double taxation caused by expiring FTCs; carryforwards should be lengthened, but not at the expense of the carryback. Indeed, the carryover should be expanded to mirror other Code provisions.

Conclusion

Tax Executives Institute appreciates this opportunity to present its comments on the Administration's fiscal year 1998 budget proposals. If you have any questions, please do not hesitate to call James R. Murray, TEI's International President, at [phone] or Timothy J. McCormally, the Institute's General Counsel and Director of Tax Affairs, at [phone].

(1) Rev. Rul. 68-603, 1968-2 C.B. 148 (IRS will follow Morris Trust). See also Rev. Rul. 75-406, 1975-2 C.B. 125 (treating the continuing stock interest in the acquirer in a valid reorganization as satisfying the continuity requirement); Rev. Rul. 78-251, 1978-1 C.B. 89; Rev. Rul. 83-114, 1983-2 C.B. 66.

(2) Treas. Reg. [sections] 1.355-2(d)(2)(iii)(e) generally exempts post-distribution tax-free exchanges from the income recognition rules.

(3) The chairmen of the tax-writing committees recently introduced legislation (H.R. 1365 and S. 612) that effectively shuts down all Morris Trust-type spin-offs after April 1, 1997. The legislation also proposes to tax intra-group spin-offs. TEI opposes the legislation, particularly because it applies to intra-group spin-offs. Companies should be permitted to effect an efficient restructuring of their business operations for legitimate, non-tax reasons. These bills do not permit such a reorganization.

(4) Consider, for example, the IRS's multi-million dollar loss in the Aramco Advantage cases.

(5) The arbitrary nature of the Administration's proposal is underscored by the proposed exclusion when the taxpayer correctly reports 97 percent of the amounts required to be reported. Why 97? Why not 96? The absence of any justification for the percentage only reinforces the view that the proposal owes itself -- not to principle or to any empirical results -- but solely to a money grab.

(6) Some of the information returns subject to the proposed penalty report income items, such as interest and dividends; other returns (such as proceeds of a sale of stock or real estate) report gross proceeds.