Guidance priorities following enactment of the 1997 tax bill.
On behalf of Tax Executives Institute, I am pleased to respond to the invitation extended to stakeholders to provide comments on the provisions of the Taxpayer Relief Act of 1997 that should be the focus of immediate guidance from the Treasury Department and the Internal Revenue Service. Soliciting stakeholder views on guidance priorities will have a salutary effect on tax administration by enabling the Treasury Department and IRS to concentrate on matters where the uncertainty engendered by the legislation will either impede legitimate commercial transactions or hinder taxpayer efforts to timely comply with the new provisions. Hence, TEI appreciates the opportunity to provide this input. We urge the Treasury Department and IRS to consider routinely issuing such invitations whenever legislation is enacted just as it routinely solicits input on the annual business plan.
Tax Executives Institute is the principal association of corporate tax executives in North America. Our more than 5,000 members represent the 2,700 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 with which taxpayers can comply.
Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the Taxpayer Relief Act of 1997.
The ink was not dry on the Taxpayer Relief Act of 1997 (hereinafter "the Act") when taxpayers, practitioners, and pundits began tallying the flaws in this complex legislation -- the intricacies of which rival the Tax Reform Act of 1986 for mind-numbing, eyes-glaze-over complexity. Moreover, the final Act was hastily cobbled together from the competing House, Senate, and Administration versions thereby guaranteeing that corrective legislation rather than interpretative guidance is necessary to clarify important provisions. For example, Act section 224 -- relating to contributions of computer and technology equipment for elementary and secondary school purposes -- states that the provision expires for contributions made in tax years beginning after December 31, 1999, whereas the Statement of Managers on H.R. 2014 (Conference Report) explains that the provision will sunset after three years and be effective for contributions made in taxable years prior to January 1, 2001.
While the discrepancy may seem extreme (and that issue may be addressed by the staff of the Joint Committee on Taxation when it issues its Bluebook in connection with the Act), it underscores the need for prompt guidance from the Treasury and the IRS on the issues that can be addressed. Without doubt, there may be provisions where it is unclear whether ambiguous -- or even contradictory -- congressional directives should be addressed through technical corrections legislation or by means of interpretative guidance. In these cases, we urge the IRS to err on the side of administrative action.
Notwithstanding the substantial challenges that the legislation poses for the IRS and taxpayers alike to understand and administer -- and our initial guidance priority list highlights only a few key issues from among its many provisions -- we would be remiss if we did not point out the continuing need for the IRS to provide guidance on other issues. Whether as a result of previous tax acts (e.g., providing guidance to distinguish a product-line extension from a new trade or business in connection with the operation of a possessions corporation under the amendments to Code section 936 as revised by the Small Business Job Protection Act of 1996) or as a result of ongoing developments in the tax law (e.g., the need to clarify capitalization issues because of controversies in the after math of the INDOPCO decision), the IRS must tend to this important, though unfinished, business even as it shifts its resources to meet the pressing demands imposed by the 1997 legislation.
Summarizing the corporate taxpayer community's priorities for guidance is a daunting challenge because TEI members are engaged in an ongoing process of identifying and understanding the manifold implications of the Act. Moreover, merely cataloging the multiple delegations of authority to craft regulations is a challenge since, in far too many cases, Congress has shifted to the Secretary the burden of finishing what Congress could -- or would -- not. Finally, taxpayers and the tax administrator very likely will differ in their views of what constitutes a priority for guidance. Hence, it would be useful for taxpayers to know the IRS's own guidance priorities.
TEI's list of guidance priorities is by no means a comprehensive list of every delegation of authority to the Secretary. Indeed, it is necessarily incomplete. It reflects only our concern for aspects of the legislation where regulatory guidance has the potential for immediate -- perhaps even retroactive -- effect. Our list also reflects our traditional concern that taxpayers be afforded ample time to modify information systems and administrative procedures to comply with the new law.
The basic framework for setting our priorities parallels the effective dates in the Act. Category A guidance -- that which we believe should be issued within 90 days of enactment -- is important because (1) the provision is effective immediately, and (2) depending on the guidance supplied, high potential exists for either retroactive application (thereby upending taxpayer expectations for current or pending transactions) or imposing substantial administrative burdens. Category B guidance is similarly important and should be issued before a less immediate effective date, for example, tax year,4 beginning after December 31, 1997. Category C guidance, while important enough to warrant early attention from the IRS, may prudently be delayed until 1998 thereby according IRS time to study the provisions and develop clear and necessary rules. All other issues fall into a residual category that may be addressed as time and resources permit.
Category A -- Guidance Within 90 Days
1. Extension of Statute of Limitations for Foreign Transfers. Under Act section 1145, the statute of limitations for assessment of any tax will be suspended where a taxpayer fails to supply any information required to be reported under Code section 6038, 6038A, 6038B, 6046, 6046A, or 6048. Since the new provision applies to information returns (including Forms 5471 and 5472) due after August 5, 1997, the statute of limitations in respect of calendar-year 1996 tax returns may be suspended even for omissions of immaterial items or amounts. We believe that guidance should be issued immediately to clarify that the statute of limitations remains open only in respect of taxes that relate to, and arise specifically from, the omitted item of information for that period. Otherwise, the provision hangs like a Damoclean sword above every multinational taxpayer's return. We urge that regulations confirming taxpayers' understanding of these provisions be issued as soon as possible.
2. Modifications to Substantial Understatement Penalty. Section 1028(c)(1) of the Act modifies the substantial understatement penalty for corporations by adding new flush language to subparagraph (B) of Code section 6662(d)(2) to provide that ". . . in no event shall a corporation be treated as having a reasonable basis for its tax treatment of an item attributable to a multiple-party financing transaction if such treatment does not clearly reflect the income of the corporation." In addition, section 1028(c)(2) of the Act revises the standard for defining a tax shelter from a partnership, entity, investment, plan, or arrangement having a "principal" purpose of tax avoidance to a partnership, entity, investment, plan, or arrangement having a "significant" tax avoidance purpose.
If the punitive effect of the substantial understatement penalty is to have a deterrent to prevent culpable and purposeful taxpayer behavior, taxpayers (and revenue agents alike) must know what transactions are considered as giving rise to the penalty. Otherwise taxpayers will view the provision as another tax increase, albeit one with an unpredictable -- even arbitrary -- incidence. Since the modifications apply to transactions (Partnership, entity, et al.) entered into after August 5, 1997, TEI believes that taxpayers deserve early guidance on key definitional phrases in these provisions including "multiple-party financing transaction" and "clearly reflect the income of the corporation," and particularly explaining how the term "significant" will apply in the case of a corporate tax shelter.
3. Repeal of Excise Tax on Transfers to Foreign Entities. Act section 1131 generally repeals the excise tax provisions of Code sections 1491 through 1494 on transfers of property to foreign entities. Those provisions, however, were replaced with amendments to other sections of the Code to ensure that the policies underlying sections 1491 through 1494 continue to apply in respect of transfers to foreign trusts, corporations, and partnerships. The new provisions accord broad authority to the Secretary to issue regulations to effectuate those policies. TEI believes that regulations implementing the provisions governing transfers of property to foreign entities are critical for the planning and day-to-day operations of multinational businesses. We recommend that the rules be issued as soon as practicable. Moreover, we urge the Treasury Department and IRS to eschew any position involving retroactive recognition of gain.
4. Holding Period for Certain Foreign Taxes. Under Act section 1053, taxpayers are precluded from claiming foreign tax credits in respect of withholding taxes imposed on, or deemed-paid taxes arising from, dividends received from foreign corporations unless the stock is held during certain measurement periods for, in the case of common stock, 16 days, and, in the case of preferred stock, 46 days. We believe that guidance should be issued to permit planning for acquisitions and restructurings by multinational corporations.
5. Limitation on Exception for Investment Companies Under Code Section 351. Except for transactions completed pursuant to a written binding contract in effect on June 8, 1997, Act section 1002(a) expands the scope of the definition of investment companies for which gain is recognized on transfers of property in exchange for stock. Hence, regulations issued pursuant to Code section 351(e)(1)(B), as amended by the Act, could be applied retroactively to disqualify transactions consummated after June 8, 1997. We recommend that guidance be issued immediately confirming that, for transactions completed after June 8, 1997, but before temporary or proposed regulations are issued, taxpayers may employ a reasonable, good-faith interpretation of revised Code section 351(e)(1)(B).
6. Constructive Sales of Appreciated Financial Positions. Act section 1001(a) pertaining to constructive sale treatment for appreciated financial positions applies to constructive sales or exchanges after June 8, 1997. The IRS and Treasury Department, however, will likely require a substantial period of time in order to develop comprehensive regulations to render this extraordinarily complex provision workable. Hence, we have two recommendations in respect of possible interim guidance.
First, the IRS and Treasury Department should issue immediate guidance that either limits the retroactive effect of forthcoming regulations or, at a minimum, defines the scope of "abusive" transactions that may be challenged retroactively. Second, to the extent that the IRS and Treasury Department are able to identify non-abusive transactions that would likely be exempted from these far-reaching provisions, we urge that such guidance be issued by the end of the current year. In many instances where new regulations affecting financial instruments are proposed, the IRS and Treasury Department have taken a similarly cautious approach in order to avoid substantial market disruptions. We believe that such caution is warranted here and recommend that, until the proposed regulatory scheme under section 1259 is developed (and taxpayers have had an opportunity to comment on the proposed rules), the IRS should issue interim guidance confirming that taxpayers may apply a reasonable, goodfaith interpretation of the constructive-sale provisions.
Category B -- Guidance Critical by Year-end
1. Certain Preferred Stock Treated as Boot -- Treatment of Non-qualified Preferred Stock Under Other Provisions. Act section 1014(a) delegates to the Secretary broad authority to prescribe regulations (under new Code section 351(g)(4)) affecting the treatment of nonqualified preferred stock under multiple Code sections for transactions completed after June 8, 1997. Since preferred stock is a common form of currency used to effectuate corporate mergers and acquisitions, we recommend that regulations be provided sooner rather than later.
2. Constructive Sales Treatment of Appreciated Financial Positions. Act section 1001 expands the number of taxpayers that may elect mark-to-market accounting under Code section 475. Taxpayers making the election face a formidable undertaking identifying. The securities and positions subject to the new provisions. We recommend that the IRS issue guidance soon confirming whether taxpayers will continue to be eligible to identify positions retroactively in accord with Notice 97-37.
3. U.S. Shareholders of Controlled Foreign Corporations Not Subject to PFIC Inclusion. Act section 1121 repeals the overlap between the PFIC and Subpart F income inclusion provisions for U.S. shareholders of controlled foreign corporations (CFCs). Certain transition issues exist with respect to CFCs that may have been PFICs in years prior to the effective date of this provision, and for which a Qualified Electing Fund (QEF) (or other deemed E&P inclusion) election may have been made or may have been planned for future years. Given the complexity and significance of these issues, transition guidance is necessary.
Category C -- Guidance May be Deferred Until 1998 or After
1. Estimates of Shrinkage for Inventory. Act section 961 permits taxpayers, under prescribed conditions, to use estimates of inventory shrinkage to determine year-end inventory balances and the related deduction for cost of goods sold. The Conference Report expresses congressional intent that the Secretary of the Treasury issue guidance establishing one or more safe harbor methods for the estimation of inventory shrinkage that will be deemed to result n clear reflection of income. We urge the development of such safe harbor rules before the close of taxable years beginning in 1998. Also, we urge that the regulations clarify the availability of safe harbor estimates for manufacturers as well as the specific safe harbors for the retail trade.
2. Definition of Foreign Personal Holding Company Income. Act section 1051(a)(1) expands the categories of foreign personal holding company income (FPHCI) constituting Subpart F income to include net income from notional principal contracts. Hedges of other categories of FPHCI, however, are taken into account under the other category. In order to permit taxpayers to revise the information collected from CFCs in respect of their Subpart F income, TEI recommends that regulations defining the scope of the net income inclusion for notional principal contracts be issued in early to mid-1998.
3. Application of Communications Tax to Prepaid Telephone Cards. Act section 1034(a) prescribes new rules to determine the amount of communications services acquired by means of prepaid telephone cards. The amendments apply to amounts paid in calendar months beginning more than 60 days after August 5, 1997 (i.e., for November 1997). The Secretary is granted broad authority to issue regulations prescribing how the face amount of the prepaid telephone card shall be determined in the absence of a specified dollar amount of use. The communications tax is an important factor in decisions affecting the pricing, distribution, and use of prepaid telephone cards among card issuers, service providers, distributors, and users. In order to facilitate timely compliance with the provision, the regulations should be issued sometime in 1998.
4. Foreign Tax Credit Treatment of Noncontrolled Section 902 Corporation Dividends. Under Act section 1105, dividends from all noncontrolled section 902 corporations (10/50 companies) out of earnings and profits accumulated in taxable years before 2003 will be aggregated in a single basket for purposes of computing the applicable foreign tax credit limitation. For distributions from earnings and profits from tax years beginning after December 31, 2002, the look-through rules applicable to CFCs generally apply. Even though the provision is not effective for several years, this provision will have significant effect on the foreign tax credit position and information reporting of many U.S. corporate taxpayers. In order to provide ample time to taxpayers to plan for the transition (many of whom plan dividends up to five years in advance of actual distribution), guidance should address a number of transition issues including the treatment of accumulated E&P for existing 10/50 company investments and earnings and profits accumulated in years prior to acquisition of an interest in the 10/50 company.
If you should have any questions concerning the comments, please do not hesitate to contact Timothy J. McCormally or Jeffery P. Rasmussen of the Institute's legal staff at (202) 638-5601.
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