Comments on T.D. 8257 and INTL-304-89: interest allocation - transition rules, March 16, 1990.

Comments on T.D. 8257 and INTL-304-89: Interest Allocation - Transition Rules

On March 16, 1990, Tax Executives Institute filed comments with the Internal Revenue Service on the temporary and proposed regulations relating to the transition rules for the allocation and apportionment of interest expense under section 864(e) of the Internal Revenue Code. The Institute's comments, which were prepared under the aegis of the International Tax Committee, are reprinted below.

On August 1, 1989, the Internal Revenue Service issued temporary (T.D. 8257) and proposed (INTL-304-89) regulations concerning the transition rules for the allocation and apportionment of interest expense under section 864(e) of the Internal revenue Code.

The 1989 temporary regulations represent a revision of proposed regulations that were originally issued by the IRS on September 1, 1987 (INTL-935-86). See 1987-2 C.B. 43. Because the 1989 regulations are generally effective for taxable years beginning after December 31, 1986, taxpayers that followed the 1987 proposed regulations can find themselves facing an increase in their prior years' tax liability. Thus, the regulations retroactively penalize those taxpayers that relied in good faith on the 1987 proposed regulations. TEI submits that such a result is wrong and recommends that the 1989 regulations be applied on a prospective-only basis.

Discussion

Temp. Reg. [Sub-section] 1.861-13T provides transitional relief from the expense allocation rules of section 864(e) (which require taxpayers to allocate interest expense on a consolidated, rather than a separate-company, basis). The regulation also provides transitional relief from the consolidated approach to interest allocation for taxpayers that experienced net increases in total indebtedness during certain time periods. The relief is phased in over a four- and five-year period, depending upon the time period in which the net increase in indebtedness occurred. The provision is generally applicable for taxable years beginning after 1986.

The temporary regulations require taxpayers to use an average monthly debt level in computing the percentage of interest expense that is subject to the pre-1987 allocation rules. This is in contrast to the transition rule set forth in the initial proposed regulations, which instructed taxpayers to use a year-end debt level. See Prop. Reg. [Sub-section] 1.861-11(e)(1)(iv) (issued September 1, 1987). TEI submits that the retroactive change in the operative rule - which can affect the level of transitional debt and, hence, a taxpayer's liability - is improper.

Stated simply, taxpayers should not be penalized for relying on the prior regulations, especially where the choice of month-end or year-end debt levels is not dictated by either the statute or the committee reports. Retroactively requiring the use of monthly debt levels will force taxpayers to recompute the amount of 1987 and 1988 interest expense subject to the post-1986 allocation rules, in some cases necessitating the filing of amended returns. Taxpayers that in good faith relied upon the prior regulations should not now be required to bear the cost and burden of recomputing their 1987 and 1988 tax liabilities.

TEI believes that the change from the use of year-end to month-end debt levels is an appropriate circumstance for the exercise of the authority granted under section 7805(b) of the Code. The temporary regulations should be amended to require the use of average month-end debt levels on a prospective-only basis.

Conclusion

Tax Executives Institute appreciates this opportunity to present our views on the proposed and temporary regulations relating to the transition rules under section 864(e) of the Code. If you have any questions, please do not hesitate to call Bernard J. Jerlstrom, chair of TEI's International Tax Committee, at [phone] (ext. 2163) or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey) at [phone].