Proposed adjusted current earnings regulations.

Proposed Adjusted Current Earnings Regulations

On May 2, 1990, the Internal Revenue Service issued proposed regulations under section 56 of the Internal Revenue Code (concerning the computation of adjusted current earnings for purposes of the alternative minimum tax) and proposed amendments to the temporary regulations under section 926 (concerning foreign sales corporations). The regulations were published in the Federal Register on May 3, 1990 (55 Fed. Reg. 18626) and in the May 29, 1990, issue of the Internal Revenue Bulletin (1990-22 I.R.B. 18).

For simplicity's sake, the proposed regulations are referred to as the "proposed regulations" and the temporary regulations as the "temporary regulations"; specific provisions are cited as "Prop. Reg. [section]" or "Temp. Reg. [section]." References to page numbers are to the proposed and temporary regulations (and preamble) as published in the Internal Revenue Bulletin.

BACKGROUND

Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 4,500 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 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 proposed regulations relating to adjusted current earnings and the temporary regulations relating to foreign sales corporations.

1. Prop. Reg. [section] 1.56(g)-1(e):

Computation of Deductions

Under Prop Reg. [section] 1.56(g)-1(c), adjusted current earnings (ACE) include all income items that are not taken into acount in computing preadjustment alternative minimum taxable income (AMTI), but are taken into account in determining earnings and profits (E&P). An item is generally not deductible in computing ACE, however, unless it is deductible in determining both pre-adjustment AMTI and current E&P. See Prop. Reg. [section] 1.56(g)-1(e). Thus, no deduction is allowed in computing ACE for charitable contributions in excess of the limitations of section 170, losses limited by section 277, or amounts in excess of the separate return limitation year (SRLY) limitations. See 1990-22 I.R.B. at 19.

In the preamble, the IRS states that ACE is a separate and distinct tax system. 1990-22 I.R.B. at 18. Thus, under section 59(h) of the Code, (1) it would seem that separate limitation amounts should be computed for deductible items such as charitable contributions, section 277 losses, and the SRLY limitations. Although recomputation of the limitations would result in a lower taxable income for taxpayers under ACE, the recomputation would serve only to further complicate the AMT system. TEI therefore recommends that the Treasury permit taxpayers an election to compute such limitations under regular tax principles, thereby eliminating the administrative burden of recomputing the limitations in calculating AMTI.

2. Preamble: Integration

Election

In the preamble, the IRS requests comments regarding the desirability of an election that would allow taxpayers to determine certain items for purposes of computing pre-adjustment AMTI in the same manner as these items are determined for purposes of computing ACE. As an example, the IRS suggests an election to permit taxpayers to use the slower ACE depreciation for purposes of computing pre-adjustment AMTI. 1990-22 I.R.B. at 21.

TEI generally supports such integration elections as enabling taxpayers to reduce their workload burdens without adverse revenue effect. In addition, we recommend that a similar election be accorded with respect to Prop. Reg. [section] 1.56(g)-1(a)(4) which provides that, in applying the capitalization provisions of section 263A, the amount of depreciation to be capitalized is based on the amount of depreciation allowed in computing ACE. To minimize taxpayer compliance burdens, taxpayers should be permitted to elect to compute the amount of depreciation to be capitalized based on the amount of depreciation allowed in computing regular tax, rather than the amount allowed in computing ACE. Permitting such an election would eliminate much of the complexity inherent in a separate AMT/section 263A calculation. Under such an election, the amount of depreciation to be capitalized in the example set forth in Prop. Reg. [section] 1.56(g)-1(a)(4)(ii) would be increased, but the administrative burden on taxpayers would be lessened.

TEI also recommends that the IRS permit taxpayers to elect that cost of goods sold for purposes of AMT and ACE be the same as under regular tax, thereby eliminating entirely the need for additional section 263A calculations. Again, such an election would generally tend to increase a taxpayer's taxable income, but the reduction in workload would be sufficient to prompt many taxpayers to make the election.

3. Preamble: Controlled

Foreign Corporations

In the preamble, the IRS invites comments on the application of ACE to foreign corporations. 1990-22 I.R.B. at 21.

TEI strongly recommends that the ACE adjustment not be made applicable to controlled foreign corporations (CFSs). Applying the ACE adjustment to the computation of a CFC's earnings and profits (2) would add significant complexity to the foreign area. For example, a recomputation of a CFC's E&P under ACE would require: (i) every ACE adjustment to be placed in the proper "basket" for purposes of the look-through rules; (ii) the recomputation of expenses to be allocated and apportioned at the CFC level under Treas. Reg. [section] 1.561-8; (iii) the adjustment of the look-through rules to reflect the differing amounts of income or allocated expense in each basket; and (iv) most important, the recomputation of expenses to be allocated and apportioned under Treas. Reg. [section] 1.861-8 at the U.S. taxpayer level to the extent relevant items at the CFC level were adjusted. (3) TEI questions whether the revenue potential of the adjustment, if any, warrants this added taxpayer compliance burden. Indeed, in some cases it may actually decrease revenues.

Moreover, for assets placed in service after December 31, 1986, the method of depreciation for computing a CFC's E&P is the same as under ACE. Thus, applying ACE in the foreign context will have a progressively diminishing revenue impact attributable to depreciation in future years.

For the above reasons, we suggest that at a minimum Treasury permit taxpayers an election to apply regular tax concepts to the computation of a CFC's E&P.

4. Preamble: Sourcing for

Section 904 Purposes

In the Preamble, the IRS invites comments on integration approaches that would alleviate the recordkeeping burden without departing from the purposes of the ACE adjustment. 1990-22 I.R.B. at 21.

Section 59(a)(1)(C) of the Code provides that for purposes of the alternative minimum foreign tax credit any increase in AMTI resulting from the book income preference "shall have the same proportionate source (and character) as alternative minimum taxable income determined without regard to" the book income preference. No similar statutory provision is provided with respect to the ACE adjustment. Consequently, under ACE a taxpayer is required to source all items of expense under the principles of sections 861 and 862. Such complexity is unwarranted and unduly burdensome, particularly in years when the net negative adjustment rules of section 56(g)(2) apply.

TEI believes that an election should be permitted whereby a rule similar to section 59(a)(1)(C) applies for purposes of both sourcing and characterizing the ACE preference. We believe that this is consistent with Congress's desire to minimize the amount of recordkeeping required under ACE and the AMT. See H.R. Rep. No.99-841, 99th Cong., 2d Sess. II-278 (1986); Staff of the Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1986, at 461 (1987. We recognize, however, that the legislative history of the Tax Reform Act of 1986 states that the ACE preference is to be sourced on an item-by-item basis. H.R. Rep. No. 99-841, at II-282; General Explanation at 465. Accordingly, to the extent that the IRS finds a legislative solution is needed to effectuate this recommendation, we ask the IRS's support for the change.

5. Prop. Reg. [section] 1.56(g)-1(d):

Section 939 Corporations

Prop. Reg. [sections] 1.56(g)-1(d)(2)(ii)(B) and 1.56(g)-1(d)(3)(iii) provide that dividends received from section 936 corporations are added to AMTI to determine ACE. Under section 56(g)(4)(C)(iii) of the Code (by cross reference to section 56(f)(1)(F)), the section 936 dividend to be added to AMTI must include both Puerto Rican witholding and income taxes paid by the section 936 corporation to the extent such taxes would be treated as paid by the recipient of the dividend "under rules similar to the rules of section 902." (Emphasis added.)

An issue arises concerning to which section 904 "basket" the dividends and Puerto Rican taxes should be allocated. TEI suggests that the IRS apply the look-through rules of section 904(d)(3) for these purposes. Although there is no provision explicitly permitting the application of these rules to dividends received from a section 936 corporation, we believe that the statutory language (underlined above) encompasses the rules of section 904.

In addition, the Treasury Department has been given broad authority under section 904(d)(5) to prescribe "such regulations as may be necessary or appropriate" for purposes of the look-through rules of section 904(d). Applying the look-through rules to dividends from section 936 corporations falls squarely within this statutory authority. Moreover, this approach would essentially treat a section 936 corporation as a foreign corporation for purposes of section 904. Thus, the suggestion would provide consistency in this area since the ACE adjustment rules treat section 936 corporations as foreign corporations in applying section 902. See I.R.C. [section] 56(g).

6. Temp. Reg. [section] 1.926(a)-1T:

Foreign Sales Corporations

The U.S. tax on the income of a foreign sales corporation (FSC) is generally determined by dividing the FSC's foreign trading income (FTI) into exempt and noe-exempt portions. The non-exempt portion essentially constitutes the FSC's taxable gross income. The proposed amendments in the temporary regulations set forth ordering rules to determine the portion of dividends received from a FSC that would be attributable to the non-exempt portion of FTI and therefore deductible under ACE. Temp. Reg. [section] 1.926(a)-1t(b)(1)(ii)(C) provides that a distribution from a FSC to its shareholders will be deemed to be made from both non-exempt and exempt foreign trade income (FTI) n specific percentages (8/23 and 15/23, respectively).

The recently issued temporary regulations fail to take into account the special FSC rule in respect of military property. Under section 923(a)(5) of the Code and Temp. Reg. [section] 1.923-1T(b)(3), 50 percent of otherwise exempt FTI attributable to military sales is reclassified as non-exempt FTI for purposes of determining a FSC's taxable gross income. Working together, the FSC and AMT provisions effectively whipsaw taxpayers by : (1) re-classifying and taxing 50 percent of this otherwise exempt income as non-exempt FTI in the FSC under section 923(a)(5), and then (2) taxing the same income as exempt FTI to the shareholder under the alternative minimum tax rules provided in Prop. Reg. [section] 1.56(g)-1(d)(2)(ii)(A). Such a result is contrary to the sound tax and trade policies underlying the enactment of the FSC provisions. TEI therefore recommends that the ordering percentages set forth in Prop. Reg. [section] 1.926(a)-1T(b)(1)(ii)(C) be amended to prevent a FSC's non-exempt FTI attributable to sales of military property from being classified as exempt FTI when distributed to its shareholders.

CONCLUSION

Tax Executives Institute appreciates this opportunity to present our views on the proposed regulations relating to adjusted current earnings and the temporary regulations relating to foreign sales corporations. If you have any questions, please do not hesitate to call Lester D. Ezrati, chair of TEI's Federal Tax Committee, at [phone] or the Institute's professional staff (Timothy J. McCormally or Mary L. Faher) at [phone].

(1) Section 59(h) authorizes the Treasury to apply the limitations of such provisions as may be specified in regulations for purposes of computing AMTI.

(2) The application of ACE in the foreign context may also affect the computation of a taxpayer's Subpart F income with respect to foreign base company sales income.

(3) Indeed, TEI submits that it is inappropriate to apply any AMT concepts to the computation of a CFC's E&P. It would be incongruous to assume that Congress intended a recomputation of a CFC's E&P or the section 902 deemed paid credit be made for purposes of the AMT/foreign tax credit (FTC). To do so would introduce the anomaly of allowing faster depreciation for AMT/FTC purposes under section 56(a)(1)(A)(ii) (150-percent declining balance) than for regular tax/FTC purposes under section 168(g) (straight-line).