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Comments on proposed tax simplification legislation July 23, 1991, and September 10, 1991.

Tax Executives Institute (TEI) is the principal association of corporate tax executives in North America, whose approximately 4,700 members represent more than 2,000 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 consistent with sound tax policy, one that taxpayers can comply with, and one in which the Internal Revenue Service can effectively perform its audit function. TEI is pleased to submit the following comments on H.R. 2777, the Tax Simplification Act of 1991, and H.R. 2775, a bill relating to additional tax simplification.

I. Overview

Tax Executives Institute commends the Committee on Ways and Means for recognizing that the tax laws are in desperate need of simplification. The Institute shares the Committee's commitment to developing and maintaining an administrable tax system. For far too long, a sincere but sometimes misguided desire to close "loopholes" and even "pinholes" in the Internal Revenue Code has led to the enactment of mind-numbingly complex "band-aids" on an already too complex tax law. For far too long, concerns about the substantive, transactional, and transitional complexity spawned by tax law changes have been given short shrift and cavalierly dismissed as self-serving smoke screens -- even where the concerns are voiced by taxpayers and IRS alike. For far too long, tax legislation has been drafted and enacted without adequate attention to the compliance burdens. For far too long, administrability has been little more than an afterthought.

The Committee's focus on simplification during the past year, together with the IRS's related initiatives, is testimony to a desire to build a "new tax order." Chairman Rostenkowski and the Committee are to be commended for acknowledging Congress's role in creating complexity and in recognizing their obligation to take steps to reduce the heavy compliance burden imposed by unduly complex tax laws. These hearings clearly represent a step in the right direction in elevating administrability and compliance concerns to their rightful position in the tax legislative process.

In announcing the hearings on H.R. 2777 and H.R. 2775, Chairman Rostenkowski articulated the following criteria (among others) for assessing the various proposals and developing the legislation: whether the proposal would significantly reduce mechanical complexity or recordkeeping requirements, whether the proposal would significantly reduce compliance and administrative costs, and whether the proposal, would preserve underlying policy objectives of current law.

Several provisions of H.R. 2777 clearly satisfy those criteria. For example, the provisions relating to the treatment of built-in losses for purposes of the corporate alternative minimum tax (AMT), the modification to the look-back method for long-term contracts, and the treatment of gain on certain stock sales by controlled foreign corporations (CFCs) under section 1248 of the Code would all fulfill the goal of simplification. There are, however, some curious and disappointing omissions. For example, we urge reconsideration of the decision not to include a proposal for creation of a single foreign tax credit (FTC) limitation "basket" for section 902 noncontrolled companies (so-called 10-to-5 companies). Even the Treasury Department has singled out the treatment of dividends from each 10- to 50-percent owned subsidiary as an area in need of simplification. The failure to include such relief in the proposal legislation leaves large multinational corporations to grapple with hundreds of separate FTC calculations for both regular tax and AMT purposes. (1)

In addition, certain proposals in H.R. 2777 would make substantive changes in the tax law and might actually increase taxpayer burden. For example, in the international tax area, H.R. 2777 would consolidate several anti-deferral regimes, which would at first blush provide some small measure of simplification. Upon analysis, however, the promise of simplification evaporates, for the bill would supplant the existing rules with a complex hybrid of the existing controlled foreign corporation, foregn personal holding company, and passive foreign investment company rules and would add a new "market-to-market" provision. In other words, the good intentions of the drafters notwithstanding, the proposed passive foreign corporation (PFC) scheme is anything but simple.

On the domestic side, H.R. 2777 endeavors to mitigate the appalling complexity of the AMT and adjusted current earnings (ACE) provisions. Rather than recognizing that the mere existence of two separate and independent taxing schemes breeds inordinate complexity, however, the bill opts for a "quick fix" in calculating depreciation under the AMT/ACE rules for newly acquired assets. It completely ignores the requirement that taxpayers comply with the ACe requirements beginning in 1990 and that, even under the bill, they must continue to "track" the various depreciation regimes for assets acquired before the effective date of the proposed simplified method. Frankly, the AMT proposal is an example of "too little, too late." Indeed, the operation of the provision is such that taxpayers would be required to establish and maintain still another depreciation system.

Moreover, in several instances H.R. 2777 eschews Congress's responsibility to effect meaningful simplification by simply delegating authority to the Department of the Treasury. For example, the bill would grant the Secretary authority to issue regulations under section 986 that would allow foreign tax payments made by a foreign corporation to be translated into U.S. dollar amounts using an average exchange rate for a specified period. Although we commend the drafters for recognizing that something must be done to ease the burdens that the Tax Reform Act of 1986 places on taxpayers with respect to such translations, the approach taken in H.R. 2777 does not make sense. U.S. taxpayers find it difficult, if not literally impossible, to comply with the statutory requirements for translating their myriad foreign tax payments. Rather than ceding the authority to correct a well-documented and agree-upon problem, Congress should forth-rightly recognize that the enactment of section 986 was misguided and amend the statute to provide a statutory rule that taxpayers can comply with and that the IRS can audit.

A similar flaw underlies the bill's provision on establishing a "simplified method" for applying the uniform capitalization rules. The proposal acknowledges the need for a simplified method for determining the cost of each administrative, service, or support function or department that is allocable to production or resale activities. Rather than establishing such a method, the bill would delegate authority to the Treasury Department to issue regulations allowing the use of a simplified method -- the details of which would be "fleshed out" later. The simplified method, moreover, could not be used until such regulations were promulgated. Simplification deferred, however, is simplification denied: even if coupled with the injunction that the Treasury act with "all deliberate speed," the bill not only prevents taxpayers from commenting on the specifics of a proposed statutory change (because there are no specifics), but would also effectively sentence taxpayers to regulatory limbo, requiring them to wait months (or even years) to avail themselves of any such method. What's more, there is no guarantee that any regulations issued by the Treasury Department would truly promote the goal of simplification. (2)

Finally, we wish to comment on the process used in developing H.R. 2777 and H.R. 2775 and scheduling these hearings. TEI applauded the Committee last year when it announced its simplification study and requested assistance in developing proposals. That the Committee struck a responsive chord is evidenced by the more than 200 responses received from congressional staffs, the Treasury Department, and the tax community, including the Institute. Taxpayers were heartened by the process that the Committee indicated would be followed: the release of legislation followed by a reasonable period for review and analysis before the scheduling of hearings and mark-up sessions. That process, however, has been compromised by the truncated time period taxpayers were given to prepare for this hearing.

In our February 1990 testimony before the Committee, we stated that the most effective safeguard against complexity would be the allotment of ample time in which to analyze the administrability of specific proposals. Although we commend the Committee for tackling the complexity conundrum, we agree with the staff of the Joint Committee on Taxation that "prevention rather than cure is the ideal way to deal with excessive complexity." The Joint Committee staff was referring to the development of substantive tax rules, but its statement rings equally true with respect to simplification legislation. Indeed, we believe that the importance of affording taxpayers and the Committee itself ample time to review proposed statutory language cannot be overstated. Time is needed for affected taxpayers to discern the import of proposed legislation and to advise Congress not only whether they agree with the policy underlying the proposals, but also whether that policy would be served by the legislative language. Time is needed to gauge whether the proffered scheme is not only wise but administrable. Inadequate time will often result in the enactment of foolish, incomprehensible, and technically flawed legislation. (3)

In other words, notwithstanding the critical need for simplification, the Institute believes that reasonable time is needed to solicit purposeful reactions to the bills and to consider reasonable alternatives. TEI sincerely believes that by scrutinizing proposals in advance on the grounds of administrability, compliance problems can be minimized, true simplification can be achieved, and U.S. corporations can operate more efficiently and effectively at home and abroad. Thus, we believe a more deliberate time frame would benefit taxpayers and the government alike, and we trust that the speed with which these hearings were scheduled does not signal any long-term retrenchment from the orderly process embraced by the Committee in commencing its simplification initiative.

II. H.R. 2777:

A. International Provisions

1. The Passive Foreign Corporation (PFC) Regime. The passive foreign investment company (PFIC) provisions of the Internal Revenue Code were enacted as part of the Tax Reform Act of 1986. Almost from the date of enactment, TEI and others have pointed to the PFIC provisions as a prime example of legislative overkill. The goals of the PFIC provisions -- to remove the economic benefit of tax deferral in certain perceived abuse situations and to prevent conversion of ordinary passive income into capital gain -- were compromised by their excessive breadth. The definition of a PFIC is so broad that it has resulted in the classification of many corporations with active businesses (and substantial passive income or assets) as PFICs (even in situations where the foreign corporation is subject to high rate of foreign tax). Thus, whereas the target of the PFIC provisions was traditional investment companies, many other companies have become ensnared in the PFIC trap -- one replete with tremendous administrative burdens.

TEI's proposed solution to this problem is simplicity embodied: exclude controlled foreign corporations (CFCs) from the reach of the PFIC provisions. A U.S. shareholder owning 10 percent or more of a CFC (i.e., a foreign corporation that is more than 50-percent owned by U.S. shareholders) is already subject to immediate tax on passive income under Subpart F of the Code. (4) Within the context of the Committee's simplification initiative, TEI does not quarrel with the basic concept of Subpart F. We do, however, dispute the need to overlay another regime on top of Subpart F. The beauty of the Institute's proposal to exempt CFCs from the PFIC rules lies in its operational clarity: taxpayers could deal with an established set of rules, and need not undertake to unravel and comply with another regime that, in terms of tax policy, is wholly redundant and, indeed, never intended to apply to CFCs.

Regrettably, sections 301 to 304 of H.R. 2777 reflect a different approach to the Code's overlapping anti-deferral regimes. Under the proposed "unified" anti-deferral scheme, a passive foreign corporation (PFC) will still include a U.S. controlled corporation. In fact, the PFC regime is broader in scope -- and more complicated -- than the PFIC provisions it would supplant in the name of simplification. Thus, we believe that the PFC proposal violates one of Chairman Rostenkowski's criteria for simplification legislation by effecting substantive tax law changes.

Under the bill, the PFIC 50-percent assets test would be retained for PFC purposes and the threshold 75-percent gross income test would be reduced to 60 percent. The high-tax exception to current inclusion of passive income under Subpart F would not carry over the PFC rules because, according to the Technical Explanation (at page 50) prepared by the staff of the Joint Committee on Taxation, that exception does not apply to PFICs and, hence, the bill's "modification to the application of a controlled foreign corporation rule [i.e., elimination of the high-tax exception of section 954(b)(4) to passive income] preserves present law." (5) The bill would subject a U.S. person holding 25 percent or more of the shares in a PFC that is not U.S. controlled to the same mandatory inclusion rule. In addition, U.S. persons with less than 25-percent ownership in PFCs could elect current, full inclusion; in the absence of such an election, the less than 25-percent shareholders are subject to tax under either a new "mark-to-market" regime or an interest-charge method adapted from the present PFIC rules. (6)

TEI objects to changes in the law that subject a greater proportion of non-"tainted," active business income to current taxation. The Technical Explanation of H.R. 2777 is silent on why the PFC rules ought to apply to CFCs governed by current Subpart F rules. The 60-percent passive gross income threshold is proposed for PFCs apparently because such a threshold is contained in the foreign personal holding company (FPHC) rules, which are targeted at ending tax deferral by individuals. Such a gross income test, however, will in some circumstances cause CFCs with active operating businesses to be subject to the PFC rules. (The same is true under the 75-percent PFIC gross income test.) Assuming the absence of an explicit CFC exemption, TEI believes that the better, more targeted way of removing the effective penalty on active subsidiaries without vitiating the policy goals of the FPHC rules is to adopt a gross receipts test. Although the need for such a test would not be as pronounced as under current law given the concomitant proposal to repeal the generally applicable "once a PFIC, always a PFIC" rule, we nevertheless urge the Committee's careful consideration of such a provision.

The current Subpart F rules require full inclusion of a CFC's income by U.S. shareholders where Subpart F income comprises 70 percent or more of gross income. FPHC income is one category of Subpart F income and, with modifications, serves as the definition of passive income for the PFC provisions. Under H.R. 2777, however, the threshold for full inclusion of CFC income would be reduced to 60 percent when a single category of Subpart F income -- passive income -- is involved. Reducing the threshold would not only increase the number of U.S. shareholders of CFCs subject to full inclusion of both tainted and non-tainted income, but would also create a dichotomy between the groups of tainted Subpart F income that trigger mandatory full inclusion. Thus, by reducing the PFIC gross income test from 75 percent -- a figure greater than Subpart F's 70-percent full inclusion rule -- to a 60-percent gross income threshold with mandatory full inclusion, the PFC provisions would broaden the tax base of U.S. corporations with CFCs. Such a result cannot be justified as "simplification."

Finally, the bill would retain the 50-percent average passive assets test contained in the PFIC provisions. Such a test could unfairly trap foreign sales or distribution subsidiaries with high ratios of working capital to total assets. We believe this result would be improper where virtually all of the CFC's gross income arises from active business activities. Thus, absent a CFC exemption, the PFC assets test should be eliminated or the threshold percentage substantially increased. (7)

By retaining the assets test, lowering the gross-income test's threshold, eliminating the high-tax exception for passive income, and reducing the percentage of "tainted" income to total gross income triggering full inclusion, the PFC provisions would increase the number of U.S. corporate shareholders operating active business CFCs subject to current taxation. Subjecting active operating earnings (or an even greater percentage of such earnings) to potential current taxation is at odds with longstanding tax policy to defer current taxation of active foreign-earned income. Doing so under the guise of simplification is inconsistent with Chairman Rostenkowski's ground rules for the simplification bills. If Congress is to wash away the deferral principle, it should do so openly and forthrightly; the concept should not be steadily eroded by a stream of muddy simplification bills.

One positive aspect of the new PFC provisions is the elimination of the permanent stain of PFIC status for CFCs (or PFCs deemed to be CFCs under proposed section 1292.) (8) Under H.R. 2777, the "once a PFIC, always a PFIC" rule would be replaced by an annually applied test. Thus, even if a CFC became a PFC in one year (thereby subjecting both active and passive income to full inclusion to the U.S. shareholder), the subsequent year's active income would not necessarily be taxed under the PFC regime (though the passive income would be currently taxed under the Subpart F rules). Another positive features, though too limited to provide relief to a substantial number of taxpayers, is the provision that would allow leased facilities to be included in base for determining the existence of 5-percent average passive assets.

Although the PFC regime arguably better integrates the Code's antideferral provisions than current law, the simplifying nature of the proposal should not be exaggerated, especially in light of the substantive (on balance, taxpayer-adverse) changes the proposals would work, as well as the complexity inherent in the proposed new mark-to-market rules. True simplification could be accomplished by adding a single sentence to the Code that eliminates the overlap of PFIC and Subpart F rules.

2. Treatment of Foreign Sales Corporations. Under the current PFIC rules, it is unclear whether those rules apply to foreign sales corporations (FSCs) whose passive income is already subject to current U.S. taxation. Section 302 of the bill clarifies that the passive income of a PFC does not include a FSC's foreign trade income. Although the IRS has informally suggested that the PFIC rules do not apply to FSCs, the proposed change would bring some certainty to this area.

The bill fails, however, to provide FSCs with an exemption from the 50-percent assets test for purposes of the PFC provisions. Thus, FSCs that invest their foreign trade income might become subject to the PFC rules because the earnings on that income would be treated as passive income. Because the FSC provisions already subject a FSC's passive income to current U.S. taxation, this oversight could result in double taxation of such income. Therefore, we recommend that a specific exemption from the PFC rules to provided for FSCs. At a minimum, an exemption from the assets test (if it is retained) should be included in H.R. 2777.

3. Repeal of Sections 960(a)(3) and (b). Section 312 of the bill would repeal sections 960(a)(3) and (b) of the Code, which permit an indirect foreign tax credit (FTC) and an increased FTC limitation upon certain distributions by a controlled foreign corporation (CFC) of previously taxed income (PTI). Under the bill, foreign taxes paid by a foreign corporation on a distribution of PTI would be added to the pool of indirect FTCs.

When the Joint Committee staff first advanced this proposal in its simplification recommendations, it averred that no real substantive change would be effected by its enactment because most taxpayers are in excess credit limitation and could not use the credits that would be lost by the repeal of the statute. Staff of Committee on Ways and Means, 101st Cong., 2d Sess., Written Proposals on Tax Simplification, WMCP 101-27, at 33 (May 25, 1990) (recommendations of staff of the Joint Committee on Taxation). We suggest, however, that the Joint Committee staff misapprehended the effect of its proposal, since many taxpayers continue to rely on the mitigating provisions of section 960 to avoid double taxation of earnings. Distributions of PTI are frequently subject to foreign withholding taxes when they are remitted to the U.S. shareholder and, without sections 960(a)(3) and (b), there would be no specific mechanism to credit the additional taxes. TEI believes that the tax policy against double taxation far outweighs any nominal simplification that may be achieved through the repeal of the statute. Thus, sections 960(a)(3) and (b) should be retained.

4. Translation of the Deemed-Paid Foreign Tax Credit. Section 321 of the bill would grant the Secretary of the Treasury authority to issue regulations permitting foreign tax payments to be translated into U.S. dollar amounts using an average U.S. dollar exchange rate for a specified period. The bill thus adheres to section 986's requirement that foreign taxes be translated at a rate in effect during the year the taxes were paid.

Although the approach taken in the bill represents a minor simplification of the translation of foreign tax payments, the proposal still fails to meet head-on the substantial administrative burdens engendered by the Tax Reform Act of 1986's year-of-payment rule. Multinational corporations may have numerous foreign subsidiaries operating in foreign jurisdictions requiring, in the aggregate, hundreds of income tax payments. In addition, some countries require the payment of a given year's income tax to be paid over a three- or four-year period. A year-of-payment rule -- even as modified by H.R. 2777 -- would still require taxpayers to "track" the year in which all those tax payments were made. TEI submits that the compliance burdens associated with section 986 are totally disproportionate to any practical or policy purpose that may be served by the provision.

Stated simply, the Code's foreign tax translation rules are in desperate need of simplification. Fortunately, administrable alternatives are clearly available. One is to return to pre-1987 law, which was relatively simple for both taxpayers and the IRS to administer. Another is to translate foreign taxes at a rate in effect in the year in which the taxes are accured; an average of the exchange rates in effect on the first and last days of the corporation's taxable year could be used. Such a rule would substantially reduce the administrative burdens on taxpayers without sacrificing any sound tax policy or revenue goal.

5. Simplified Method for FTC/AMT Calculation. In computing its FTC limitation, a taxpayer is required to allocate and apportion deductions between U.S. and foreign source income. This limitation must be separately computed for both regular tax and AMT purposes. In essence, taxpayers that have allocated and apportioned deductions for regular tax purposes must re-allocate and re-apportion those same deductions for AMT foreign tax credit (FTC) purposes, using assets and income that reflect the AMT adjustments made in computing alternative minimum taxable income.

Section 322 of the bill would accord taxpayers an election to use as their AMT foreign tax credit limitation the ratio of foreign-source regular taxable income (rather than foreign-source AMT income) to their entire AMT income. TEI commends the Committee for acknowledging the comlexity inherent in requiring taxpayers to allocate and apportion the same deductions for both regular and AMT purposes. The proposed election, however, would clearly operate to the taxpayer's detriment because foreign-source regular taxable income will invariably be less than foreign-source AMT income.

TEI questions the rationale set forth in the Technical Explanation (at page 69) that "the differences between regular taxable income and alternative minimum taxable income are often relevant primarily to U.S. source income." Indeed, any section 56 or 57 expense (such as depreciation) that is apportionable under Treas. Reg. (Section) 1.861-8 will reduce foreign-source income. We believe that an alternative exists that is not skewed toward benefiting either the government or the taxpayer. Specifically, we recommend that taxpayers be permitted to elect to use their regular section 904(a) limitation fraction, i.e., the ratio of foreign-source regular taxable income to their entire regular taxable income. This is the approach adopted by Congress in former section 59(a)(1)(C), regarding the allocation and apportionment of the book income preference.

6. Treatment of Gain on Certain Stock Sales. Section 311 of the bill would provide that gain from the sale of stock of a foreign corporation by a CFC will be treated as a dividend to the same extent it would be under section 1248(a) of the Code if the CFC were a U.S. person. The modification clearly satisfies the simplification criteria, and TEI endorses it. We question, however, the rationale underlying the proposal to exclude such deemed dividends from the scope of the same-country exception that the Code provides for actual dividends.

B. Corporate Provisions

1. Simplified Method for Applying Uniform Cost Capitalization Rules. Section 412 of the bill would grant the Treasury Department the authority to issue regulations that allow taxpayers to use a base-period percentage in determining the costs of any administrative, service, or support function or department that are allocable to production or resale activities.

The Institute finds it difficult to comment on this proposal because the particulars of the simplified method are for the most part left for Treasury to determine. The Technical Explanation does state (at page 86) that the base period would begin no earlier than four years prior to the taxable year, but it leaves many questions unanswered. For example, the explanation does not address the length of the base period. Will it be a four-year rolling period? A one-year period that would be used for the four succeeding years? If the base period is a four-year rolling period, simplification will be achieved only in the first year. Moreover, the proposed statutory requirement that the costs be capitalized on a department-by-department, function-by-function basis is far from simple. A better method would be to permit taxpayers an election to use a specific percentage based on an average capitalization rate determined from a four-year base period.

In addition, we note that the Technical Explanation states (at page 85) that the bill "authorizes (but does not require)" the Treasury Department to issue regulations providing for the simplified allocation method. The proposed statutory language, however, would clearly require the Treasury to issue such regulations. The obligatory nature of the grant of authority should be confirmed in the committee report.

2. Depreciation for AMT/ACE Purposes. Section 421 of the bill would apply a 120-percent declining balance method (switching to straighline at a point maximizing depreciation deductions) for personal property (other than transition property to which the ACRS system in effect before the Tax Reform Act of 1986 applies) for determining the alternative minimum taxable income of a corporation. No further adjustment for this property would be required for purposes of the adjusted current earnings (ACE) provision.

The proposal would provide a simpler method of determining depreciation for newly acquired property. It would not, however, permit taxpayers to use the same method with respect to assets acquired prior to 1991. Thus, the provision may actually increase a taxpayer's compliance burden by forcing it to maintain one more depreciation system (for property placed in service after December 31, 1990). TEI recommends that taxpayers be accorded an election to apply the simplified method retroactively for all years to which ACE applies.

3. Built-In Losses for Purposes of the Corporate Alternative Minimum Tax. Section 422 of the bill would repeal the adjusted current earnings (ACE) rule relating to the treatment of built-in losses after a change in ownership (current section 56(g)(4)(G) of the Code). Thus, under the bill, the treatment of built-in losses would be the same for ACE, AMT, and regular tax purposes -- a significant simplification of current law. TEI endorses enactment of this provision.

III. H.R. 2775:

A. Payroll Tax Deposit Safe Harbor. Section 301 of H.R. 2775 would replace the entire payroll tax deposit system with a new system consisting of three basic deposit timetables. The most generally applicable timetable requires deposits twice a week on Tuesdays and Fridays. For small depositors, the bill provides that if the amount required to be deposited was $3,500 or less per quarter for a previous two-year base period, deposits must be made only once a quarter. For large depositors, the next-day deposit rule of current law is retained. In addition, an employer would be treated as having deposited the required amount of employment taxes in any deposit if the shortfall does not exceed the greater of $150 or two percent of the amount of employment taxes due. Although the Technical Explanation fails to mention it, the bill thus lowers the current regulatory safe harbor for deposits from five percent to two percent.

As the bill rightly recognizes, the current payroll deposit system is extremely complex for both large and small employers. We believe the proposed Tuesday/Friday rule would bring a modicum of stability and certainty to payroll tax procedures. We must object, however, to the proposed tightening of the payroll tax safe harbour rule. The next-day deposit rule, which regrettably the bill would not moderate, places significant pressure on large taxpayers to accurately compute and pay over their payroll taxes. Indeed, many employers are effectively compelled to overpay their payroll tax obligations because of the difficulties associated with accurately calculating and depositing payroll taxes, especially where multiple payrolls (generated from varying locations) are involved. In these circumstances, we oppose the proposal to reduce the safe harbour, and we recommend that the five-percent safe harbor contained in Treas. Reg. (Section) 31.6302-1(a)(1)(b)(1) be codified in order to insulate from penalties taxpayers who make a good faith effort to comply with the Code's payroll tax deposit rules.

With respect to the small depositor rule, we believe the $3,500 ceiling is unreasonably low and would sweep more small businesses within its scope than current law. We suggest that the limit be raised (say, to $10,000). (9) In addition, we recommend that the two-year base period be reduced to one year. As a practical matter, the quarter that pushes the taxpayer's tax deposits over $3,500 (thereby requiring the taxpayer to adhere to the Tuesday/Friday deposit rule) will most likely be a recent quarter. Thus, a four-quarter base period should be sufficient.

B. Interest Rate under Section 6621(c). Section 321 of the bill would provide that, for purposes of determining the period to which the large corporate underpayment rate applies under section 6621(c) of the Code, any letter or notice will be disregarded if the amount of the deficiency, proposed deficiency, assessment, or proposed assessment set forth in the letter or notice is not greater than $100,000 (without regard to any interest, penalty, or addition to tax). The bill would thus clarify that a notice relating to a minor mathematical error by the taxpayer will not be sufficient to trigger the higher interest rate imposed by section 6621(c).

Although TEI continues to disagree with the policy underlying the so-called hot interest provision, we commend the Committee for clarifying that a notice of a minor adjustment to tax will not trigger the higher interest rate. We believe, however, that the bill should go further to make the provision more administrable and fair. Specifically, we recommend that the bill be amended to provide for the mandatory abatement of "hot interest" during the period attributable to a delay by the Internal Revenue Service in considering taxpayer's administrative appeal of proposed adjustments. (10) In addition, the bill should also make some provision for Tax Court review of adjustments paid by taxpayers to stop the running of interest; taxpayers should not be denied access to the Tax Court's expertise in resolving tax controversies when they act as Congress intended for them to act. Finally, the Committee should reaffirm its unequivocal instruction to the Treasury Department to implement a comprehensive netting procedure to ameliorate the unfair effects of section 6621(c). No such procedure has been forthcoming from the Treasury or IRS even though the congressional mandate dates back to 1986.


Tax Executives Institute appreciates this opportunity to present its views on H.R. 2777 and H.R. 2775 and would be pleased to answer any questions you may have about its positions. In this regard, please do not hesitate to call either Raymond G. Rossi, Chair of the Institute's International Tax Committee, who is testifying on the Institute's behalf at the Committee's July 23 hearing, at (408) 765-1193, or Timothy J. McCormally of the Institute's professional staff at (202) 638-5601.

(1) We recognize that the Committee does not wish to reopen "fundamental decisions" and further that "simplification" should not be invoked as a shibboleth to cloak truly substantive changes in the tax law. At the same time, we sincerely believe the complicated nature of some provisions (e.g., the FTC separate limitation rules) should give their advocates paus with respect to the wisdom of the policy justification for a provision can truly collapse under the weight of the administrative costs and compliance burdens attendants to its application.

(2) Much of the complexity under current law is undeniably the result of the Treasury's quest for theoretical purity or its zeal to prevent real or perceived abuses. For example, the interest sourcing regulations under section 864(e), including the controversial "CFC netting" rule, are horrendously complex (from both a mathematical and administrative perspective) and are derived from a simple grant of authority, which in our view the Treasury has construed in a manner inconsistent with the basic thrust of the statute.

(3) H.R. 2775 and H.R. 2777 clearly contain provisions that will benefit from taxpayer scrutiny. For example, section 302 of H.R. 2777 sets forth new Code section 1292(a), the last sentence of which would read, "Except as provided in regulations, stock in the preceding sentence shall also apply for purposes of section 904(d)." We are uncertain about the reference to "stock" in this sentence. Is it intended to provide a look-through rule for purposes of section 904? The sentence could even be read to classify PFC income as entirely passive for purposes of section 904. The Technical Explanation of the bill provides no guidance on the meaning or purpose of the garbled provision. See Technical Explanation of S. 1394 and H.R. 2777, at 56 (June 26, 1991) (hereinafter referred to as "Technical Explanation")

(4) Continued deferral of U.S. tax on passive income under Subpart F is limited to either de minimis amounts or income highly taxed in the foreign country (such that residual U.S. tax after the foreign tax credit is negligible).

(5) Unfortunately, the Technical Explanation glosses over the fact that, under present law, a shareholder in a PFIC (that is also a CFC) making the Qualified Electing Fund (QEF) election is provided a high-tax exception. Thus, making the QEF election prevents the full inclusion of highly taxed passive income.

(6) We note that the bill would also eliminate the option of CFC shareholders subject to the current PFIC scheme to continue deferral under the current law interest-charge method for excess distributions. Such a modification change would constitute a substantive, adverse change for those taxpayers that rely on the alternative excess distribution method to cope with the complexity of the PFIC and CFC overlap. In addition, those taxpayers would have to deal with the concomitant transitional complexity engendered by the change.

(7) Moreover, the bill pays inadequate heed to the substantial problems that minority shareholders may experience in obtaining information from foreign subsidiaries concerning the character of the income. The data-collection challenge confronting less-than-50-percent shareholders was one of the concerns expressed by Congress in denying, even on an elective basis, the application of a look-through rule to dividends from non-controlled section 902 companies for purposes of the limitation "baskets." See Staff of the Joint Committee on Taxation, 99th Cong. 2d Sess., General Explanation of the Tax Reform Act of 1986, at 868 (1987).

(8) The "once of PFIC, always a PFIC" rule would remain in effect for a limited category of U.S. shareholders of PFCs.

(9) Because a majority of the companies represented by TEI's membership are subject to the large depositor next-day rule, they would be unable to avail themselves of even the enhanced small depositor rule.

(10) For example, the abatement of the higher interest rate could commence 180 days after the taxpayer files its protest with the IRS Office of Appeals and end on the date of a "final determination" -- i.e., the issuance of a statutory notice of deficiency when the case is unagreed, or a Form 870 or Form 870-AD when the case is agreed.
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Title Annotation:Tax Executives Institute
Publication:Tax Executive
Date:Sep 1, 1991
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