IRS Notice 97-7: draft revenue procedure on obtaining private rulings on environmental remediation issues.

On June 11, 1997, Tax Executives Institute submitted the following comments to the Internal Revenue Service on IRS Notice 97-7, which sets forth a draft revenue procedure on obtaining private rulings from the agency on the proper tax treatment of environmental remediation expenditures. The comments were prepared under the aegis of the Institute's Federal Tax Committee, whose chair is David L. Klausman of Intel Corporation. Margaret A. Satko of General Motors Corporations materially contributed to the preparation of TEI's submission.

The Internal Revenue Service published Notice 97-7 in the Internal Revenue Bulletin (1997-1 I.R.B. 8) on January 6, 1997. The Notice sets forth a draft of a proposed revenue procedure that will provide special procedures for obtaining private guidance on the proper tax treatment of environmental cleanup costs under sections 162 and 263 of the Internal Revenue Code. In response to the IRS's invitation in Notice 97-7, Tax Executives Institute is pleased to submit the following comments on the draft revenue procedure.

Background

Tax Executives Institute is the principal association of business tax executives in North America. The Institute's more than 5,000 members represent 2,800 of the largest companies 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 the 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.

TEI members 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 training of our members enable us to bring an important, balanced, and practical perspective to environmental cleanup issues generally and to the issues raised specifically by Notice 97-7 relating to a proposed revenue procedure providing guidance to taxpayers seeking to obtain private guidance concerning the treatment of environmental remediation expenditures.

Notice 97-7

In Notice 97-7, the IRS proposes a new special revenue procedure permitting taxpayers to obtain private guidance on the tax treatment of environmental cleanup costs. The purpose of the procedure is "to facilitate the resolution of issues involving the capitalization or deduction of environmental cleanup costs for both prior and future years of a single environmental cleanup transaction."(1)

Consequently, the new procedure will depart from current ruling practice by permitting taxpayers generally to (i) obtain a private letter ruling after filing a return for the year of the transaction, (ii) obtain technical advice covering all years of a transaction rather than just the years under examination, and (iii) in connection with settlement of an examination, obtain a ruling addressing the future tax treatment of expenditures where part of the costs will be incurred under a continuing plan for environmental cleanup.

TEI commends the IRS for its effort to implement procedures facilitating the resolution of issues, especially the proper tax treatment of environmental cleanup costs. Under some circumstances, the proposed procedure will prove salutary in resolving the deductibility of costs incurred in environmental cleanup transactions. Hence, the Institute supports the issuance of the procedure, but that support is tempered by our often expressed opinion that the resolution of capitalization issues generally, and environmental cleanup issues specifically, can and should be addressed more broadly and efficiently by the issuance of generally applicable guidance that can be relied upon by taxpayers and revenue agents alike.(2) Indeed, the number and extent of disputes over the deductibility of environmental remediation costs--and the rancor that is sometimes engendered during the disputes--have been exacerbated by the dearth of generally applicable formal guidance.

Issuing Private Letter Rulings and Technical Advice Memoranda Is Not an Effective Means of Providing Guidance on Capitalization Issues

TEI does not believe that the tax law governing environmental cleanup expenditures can be effectively developed through the issuance of piecemeal guidance in private letter rulings and technical advice memoranda. Private rulings involve the application of the law to the taxpayer's specific facts; hence, they are not designed to serve as general guidance. The rulings have no precedential effect and are not intended to be relied upon by anyone other than the taxpayer to whom the ruling is directed.(3)

The precedential effect of private rulings is limited for good reason. Many rulings, especially in their redacted form, are not detailed enough to provide useful precedent. In order to protect the confidentiality of the taxpayer, the discussion of the facts is frequently abbreviated. In addition, the factual patterns posed in many rulings are not representative of common circumstances or transactions. Moreover, important factual alternatives may be omitted or the factual question may be narrowly framed. Similarly, alternative legal theories may not be addressed in the ruling and the legal analysis may be attenuated. Finally, private rulings are not subject to the same level of review by policy makers within the IRS and Treasury. For the foregoing reasons, private rulings are an ineffective method for communicating tax policy.(4)

The Need For General Guidance

In contrast with private rulings, the legal and policy analyses underlying regulations and revenue rulings are subject to a high level of scrutiny within the IRS (as well as the Treasury Department), which ensures that the articulated position is more likely to be sustained by the courts. Several benefits flow from this. First, taxpayers and agents generally give greater deference to published rulings, especially during the crucial phase of an examination where the facts are elicited and legal authorities reviewed to determine whether a proposed adjustment is warranted. Second, published rulings are less likely to be challenged by taxpayers or subsequently revoked by the national office. As a result, the stability of the law is enhanced. Moreover, the first two benefits often combine felicitously to diminish the contentiousness of examinations. Finally, since published rulings apply to all taxpayers, many more issues can be resolved and cases settled at the Examination and Appeals levels without resorting to technical advice. Where national office procedures in respect of technical advice memoranda are invoked, the lapse time for resolution of cases escalates, significantly increasing taxpayer administrative burdens and diminishing the rate of case resolution.

The fact-intensive nature of capitalization issues make them especially ripe for early and expeditious resolution at the Examination level--assuming sufficient guidance is given to permit such resolution. For example, the IRS's recent revenue rulings on advertising, repairs, and training costs(5) have substantially diminished unnecessary capitalization controversies. Hence, the promise inherent in Notice 97-7 is that it will result in generally applicable guidance on environmental remediation issues rather than be limited to the cases where the procedure is invoked.

Under section 5.03 of the draft procedure, the national office of the IRS will coordinate review of proposed letter rulings with a representative of the environmental cleanup costs specialization team prior to issuing a ruling. TEI believes that the review of proposed letter rulings may promote uniformity and consistency in the rulings issued. More important, even though cleanup issues are factual, it should be possible for the specialization team to develop authoritative guidance on typical remediation fact patterns. Accordingly, we recommend that the specialization team use the experience gained from the procedure to propose standards for deductibility or capitalization of cleanup costs that can be incorporated in regulations or, at a minimum, announced in published rulings at the close of the two-year trial period of the revenue procedure. Such guidance would advance the overall goals of efficient tax administration.

The Procedure in Notice 97-7 Should Supplement, Not Undermine, Existing Guidance

The only published guidance specifically addressing environmental remediation expenditures, Rev. Rul. 94 38,(6) permits an ordinary and necessary deduction for the costs of removing environmentally hazardous PCBs pursuant to soil and groundwater cleanups. Specifically, the ongoing costs for treating the groundwater and the costs of removing and replacing contaminated soil were determined to be deductible under section 162. The costs of constructing a special groundwater treatment facility in contrast were deemed to be capital expenditures under section 263A.

TEI sincerely hopes that the issuance of Notice 97-7 does not signal a stepping back from the challenge of providing general guidance similar to Rev. Rul. 94-38 on the proper treatment of various forms of environmental remediation costs. Such a retrenchment would be both mistaken and counterproductive to the averred purpose of the procedure to "facilitate the resolution of issues." As important, we are concerned that the publication of the procedure may cause revenue agents to question the vitality of Rev. Rul 94-38. Specifically, section 3.02 of the procedure includes soil and water contamination as among the environmental hazards for which rulings may be sought without any qualification or reference to the 1994 ruling. Hence, the procedure may spawn confusion by undermining the only generally applicable guidance currently addressing contaminated soil and groundwater cleanups. Is Rev. Rul. 94-38 to be limited to the costs incurred in cleaning up a single form of hazardous material--PCBs--while the costs of cleaning up other hazardous materials in soil and groundwater contamination are subject to review by the national office? We hope not and recommend that, in order to remove any shadow cast upon Rev. Rul. 94-38, the IRS incorporate in the procedure a reference to that ruling as providing the generally applicable guidance on the proper treatment of soil and groundwater cleanups.

Rev. Rul. 94-38 was developed in response to submissions by numerous commentators--including TEI--following the IRS's public announcement of an intensive study of the proper tax treatment of environmental cleanup costs. When issued, the ruling was hailed as an important touchstone because it provided bright-line rules in respect of the treatment of environmental remediation expenditures. TEI was among those that hoped that the ruling marked the first in a series on the treatment of environmental remediation expenditures.

Moreover, regardless of whether one agrees where the lines are drawn in Rev. Rul. 94-38, it provides substantive guidance on a common type of environmental cleanup cost. Similar rulings should be developed by the IRS to address other situations, including those involving the remediation of leaking underground storage tanks, asbestos removal, and lead-paint removal.

Specific Comments on Revenue Procedure

In addition to the foregoing remarks on the process for providing guidance to taxpayers on capitalization issues generally and environmental remediation specifically, we offer the following comments on the draft procedure.

Terminology; Definition of "Single" or "Entire" Environmental Cleanup "Transaction" and "Completed Transaction"

1. Scope of Rulings Should be Expanded Beyond a "Single" Transaction

As a hybrid of the wholly prospective transaction-based private ruling approach of Rev. Proc. 97-1 and the wholly closed, completed, and reported transaction-based technical advice approach of Rev. Proc. 97-2, the draft procedure utilizes terminology that is adapted from both progenitors Consequently, the procedure employs the term "transaction" as though environmental cleanup "transactions" have a standard usage and meaning. They do not. More important, environmental remediation projects are not as discrete as the procedure assumes because they often do not have definitive start and stop times or circumscribed geographic boundaries. Hence, the amorphous nature of cleanup activities with respect to which a taxpayer may seek rulings issued pursuant to the procedure _ i.e., a "single" environmental cleanup transaction -- may inhibit the number of requests filed.

By way of explanation, section 1 of the draft procedure states that "the purpose of the ruling is to facilitate the resolution of issues [related to] a single environmental cleanup transaction." Building on this statement, section 3.01 states that the ruling procedure applies to "continuing transactions (e.g., occurring over prior and future taxable years)." In order for the new procedure to be useful, of course, it must be flexible enough to address alternative "plans" of remediation. Section 3.04 permits this, however, without defining what an alternative "plan" or "continuing plan" of environmental cleanup or remediation is, perhaps on the assumption that a "plan" for federal or state EPA requirements is a "plan" for purposes of the procedure. Finally, section 3.05 restricts taxpayers from obtaining rulings for "excluded situations." Specifically, a taxpayer may not request a ruling where (i) the "entire" environmental cleanup transaction is "completed" and the time for filing the returns has passed, (ii) the "entire" environmental cleanup transaction is a proposed transaction in respect of which the taxpayer may request a ruling under Rev. Proc. 97-1, or (iii) the "identical" environmental cleanup "issue" is in the taxpayer's return for an earlier period and that "issue" is pending in litigation.(7)

Just as environmental damage is amorphous and occasionally latent, the contours of a "single" or an "entire" cleanup "transaction" may not be as precise as assumed by the draft procedure. In order to clarify the procedure, TEI recommends that it be revised throughout to refer to environmental cleanup projects or plans rather than cleanup transactions. A transaction may be as narrow as a single expenditure. Projects or plans of remediation, however, generally encompass a plethora of activities and expenditures in connection with a particular site, a hazardous waste, or a multitude of cleanup initiatives. A taxpayer should not be required to seek a separate ruling on each and every activity within a remediation project or plan. On the other hand, the IRS should be able to know with some certainty what it is being asked to rule on. As a result, TEI recommends that the procedure be revised to permit taxpayers to define, within the ruling request or at the presubmission conference pursuant to Announcement 97-22,(8) the scope of the cleanup activities for which a ruling is sought.

As important, rather than limit the scope of the draft procedure to a "single" environmental "transaction" (or project or plan), we believe that the IRS should permit taxpayers to obtain a "global" ruling in respect of the different expenditures affecting a single type of hazard. For example, a taxpayer may be required to clean up multiple sites that share a common environmental hazard, such as abatement of fire-retardant asbestos in multiple floors of the same building or in similar buildings at different locations.(9) Without a means to address a single type of repeated cleanup procedure at different locations (i.e., a single issue), taxpayers may view the procedure as too costly, time-consuming, and too narrow to undertake.(10)

Similarly, as with the soil and groundwater cleanup in Rev. Rul. 94-38, multiple cleanup procedures may be required in respect of a single site. Where multiple cleanup activities are undertaken at a single site for a particular hazard, the ruling should be broad enough to incorporate all of the activities to be conducted. Likewise, where multiple hazards -- say, lead and other toxic chemical waste contaminants -- are discharged at a single manufacturing site that also includes a leaking underground storage tank -- say, fuel to power the equipment or heat the manufacturing facility -- the scope of the procedure should be broad enough to permit a ruling on all hazard types and activities at a single location.

In order to clarify the procedure in the manner suggested, we recommend that section 1 be revised to define the purpose of the procedure as "permitting rulings for environmental cleanup costs incurred for a particular type of hazard (e.g., leaking underground storage tanks), a particular site or source of environmental contamination (e.g., the leaking underground storage tanks in State `X'), or a combination of types of hazards, sites or sources of contamination, or methods of remediation spanning one or more taxable years, pursuant to a plan of remediation defined by the taxpayer."

2. Excluded Situations

Section 3.05(2) provides that where "the entire environmental cleanup transaction is a proposed transaction, and the taxpayer may request a letter ruling under Rev. Proc. 97-1," the new revenue procedure does not apply. Similarly, section 4.01 of the proposed procedure directs taxpayers who are not under examination or before the appeals office to use the private letter ruling procedure set forth in Rev. Proc. 97-1. Under section 4.02, taxpayers under examination or before an appeals office must, except to the extent modified by the special procedure, comply with the instructions for obtaining technical advice contained in Rev. Proc. 97-2. In addition, under subsection 3.05(1) a taxpayer may not request a ruling where the "entire" environmental cleanup transaction is "completed" and the time for filing the returns has passed. Finally, where the "identical" environmental cleanup issue is in the taxpayer's return for an earlier period and the "identical" issue is pending in litigation with the taxpayer (or certain related taxpayers), the taxpayer may not avail itself of the procedure.

TEI appreciates that the IRS intends that taxpayers that will incur costs related to wholly future environmental cleanup activities should obtain rulings pursuant to the procedures set forth in Rev. Proc. 97-1. Similarly, we appreciate that, where the cleanup activities are entirely "completed" and returns filed reporting the costs of such activities, taxpayers should generally employ procedures similar to the technical advice process of Rev. Proc. 97-2. Nonetheless, the use of the adjectives "entire" and "identical" in section 3.05 to preclude taxpayers from invoking the new procedure in excluded situations is problematic and will severely limit the utility of the procedure.

The determination whether all the remediation activities related to an "entire" transaction are "completed" or whether an "identical" cleanup "issue" exists (because of similar remediation activities) is heavily dependent on the facts and circumstances. For example, assume that multiple hazards, toluene (a paint-removing agent) and lead paint, have been discharged at the same site. Assume the taxpayer is aware of one hazard, removes it without benefit of a ruling, and subsequently discovers that the site contains the second hazard requiring additional cleanup work. Under these facts, is the taxpayer precluded from seeking a ruling in respect of the first hazard (because the entire hazard is removed), the second, or both? Alternatively, assume that the first attempt to remove or remediate a single hazard is unsuccessful and, as a result of continued monitoring, the hazard is rediscovered. Is the taxpayer precluded from seeking a ruling in respect of either the first or second attempts at remediating the site or hazard?

Likewise, determining when remediation activities are "completed" is extremely difficult since many, if not most, cleanups require continued monitoring (as in Rev. Rul. 94-38) to ascertain whether the cleanup is successful. Hence, the completion of a particular environmental remediation is also dependent on the facts and circumstances. Moreover, the issue whether the environmental cleanup is "completed" may not be relevant. Instead, the issue is whether there is an issue in any open taxable year that is attributable to cleanup costs involved in the project or plan of remediation that has been submitted to the IRS for a ruling. TEI's recommended approach of permitting the taxpayer, with the agreement of the national office, to define the scope of the site, hazard, and cleanup procedures involved in the ruling request will prove more workable.

Concededly, where an "identical" issue is being litigated in a previous tax year with the same taxpayer, the IRS may not wish to issue a ruling that potentially undermines its litigation strategy. Nonetheless, the last excluded transaction of subsection 3.05(3) (no ruling where the identical issue is in the taxpayer's return and the issue is in litigation) seemingly precludes the use of the procedure where it is most warranted: when an issue has resulted in substantial controversy. Moreover, TEI questions how identical a transaction must be to qualify as an excluded situation under subsection 3.05(3). For example, if the taxpayer remediated asbestos in certain machinery and equipment in an earlier year and that issue is now in litigation, will the taxpayer be precluded from seeking a ruling in respect of asbestos used as a fire retardant in the taxpayer's corporate headquarters? In such a case, we believe that either the activities performed in the remediation attempt or the differing use of the asset may compel a different answer. The draft procedure is unclear.

As a result of (i) the facts and circumstances nature of the inquiry and (ii) the substantial interpretative difficulties inherent in determining whether a cleanup project is "entire," "identical," or "completed," we recommend that the IRS delete subsection 3.05(3) and consider any environmental cleanup project eligible for the private ruling procedure.

Change In Accounting Method

Under section 9 of the procedure, a taxpayer receiving a ruling may be required to seek the Commissioner's consent for a change in accounting method. In such cases, the national office will inform the taxpayer of the procedures for obtaining consent. TEI recommends that taxpayers be able to obtain the change in method by supplemental submission to the ruling request under the new revenue procedure rather than by separate submission.

Temporary Nature of the Procedure

Section 13 states that the special ruling procedure will be available on a trial basis for a two-year period, beginning on the date the procedure is finalized. We believe that the IRS's caution in establishing the procedure on a temporary basis is warranted. The very nature of environmental remediation expenditures may diminish a taxpayer's desire to invoke the procedure inasmuch as expenditures for assessment or remediation of environmental hazards are unlikely to produce future income or to result in the construction of a tangible asset (or an improvement or betterment in the parlance of section 263, or the production of assets used in the trade or business as in section 263A). Moreover, taxpayers will likely resist strained arguments requiring capitalization of environmental cleanup costs. In other words, since remediation costs, standing alone, rarely meet one of the recognized tests for capitalization of repairs (an increase in the value or life of an asset), taxpayers may be reluctant to consider the procedure except as a last administrative recourse to resolve a contentious examination. Should taxpayers be unwilling to utilize the procedure, the IRS should discontinue it.

Conclusion

TEI is pleased to have the opportunity to present its views on Notice 97-7. These comments were prepared under the aegis of TEI's Federal Tax Committee whose chair is David L. Klausman. If you have any questions concerning these comments, please call either Mr. Klausman of Intel Corporation at [phone], or Jeffery P. Rasmussen of the Institute's professional tax staff at [phone].

(1) 1997-1 I.R.B. 8.

(2) See the Institute's comments on the tax treatment of environmental remediation expenses, dated June 15, 1993; comments with respect to expenditures to adopt just-in-time manufacturing, dated September 21, 1995; comments in response to Notice 96-7, dated March 20, 1996; comments submitted for the November 19, 1996, TEI-IRS liaison meeting; and our follow-up comments to Notice 96-7, dated April 1, 1997.

(3) Section 6 of the draft procedure recognizes this limitation and, in accord with section 6110(j)(3), parallels Rev. Proc. 97-1 and Rev. Proc. 97-2 in limiting its holdings to the specific transactions and taxpayer involved.

(4) Despite the limited precedential effect of private rulings, revenue agents and taxpayers frequently cite the "reasoning" employed in the ruling in support of the outcome either seeks. Should the draft procedure supplant public guidance, tax administration will suffer as the national office steps into more and more cases to resolve disputes.

(5) Revenue Rulings 92-80, 94-12, and 96-62, respectively.

(6) 1994-1 C.B. 35

(7) The change in terminology from environmental cleanup "transactions" to environmental cleanup "issues" within the same section underscores the need for consistency and clarification of the terminology. If the difference in terminology within section 3.05 of Notice 97-7 is unintended it should be eliminated; if it is purposeful, it should be explained. We recommend that the section be modified for consistency or the difference be explained.

(8) 1997-12 I.R.B. 1.

(9) The definition of "continuing transactions" may permit a ruling on repeated cleanup procedures at a single site. For example, the removal of asbestos insulation from different floors of a single building that requires several years to complete may be viewed as a continuing transaction." Should the IRS agree with this view, we recommend that a clarifying example be added.

(10) Section 3.05(3) precludes a taxpayer from obtaining a ruling where the "identical" issue is being litigated in other taxable years of the taxpayer or certain related taxpayers. While the meaning of "identical" issue is unclear, it presumably includes repeated cleanup activities for a particular hazard at different sites.