Should the CEO be required to sign the corporate tax return? Should the economic substance doctrine be codified? TEI resoundingly responds "no" institute offers views on transfer pricing, DISC/FSC, and several state, local, and provincial matters. (Recent Activities).

The proposal to require a company's chief executive officer to sign its corporate tax return misapprehends the role of the tax department as well as that of the CEO, TEI President Drew Glennie recently wrote the chairman and ranking minority member of the Senate Finance Committee. In an August 22 letter to Senators Max Baucus and Charles Grassley, Mr. Glennie expressed TEI's opposition to section 511 of S. 1971, the National Employee Savings and Trust Equity Guarantee (NESTEG) bill, which would amend section 6062 of the Internal Revenue Code to require that the income tax return of a corporation be signed by its chief executive officer. A similar provision was included, as the "sense of the Senate," in the Sarbanes-Oxley corporate accountability bill, which was signed into law last July.

Mr. Glennie's letter explained that the proposal would not meaningfully advance any legitimate tax policy, and would be burdensome and possibility counterproductive. It also argued that less intrusive, but more effective, alternatives were available. "If Congress determines that the integrity of corporate income tax returns warrants an expanded scope and higher level of internal scrutiny than is currently required," the TEI president stated, "TEI suggests requiring a company's independent audit committee to annually authorize the chief tax officer to sign the corporate income tax return."

"Although TEI shares Congress's and the Administration's shock and disappointment over recent financial reporting failures," Mr. Glennie said, "TEI does not believe the CEO signature proposal will advance the goal of minimizing such failures." While CEOs and other senior corporate officers remain ultimately responsible for the company's compliance with the tax laws, TEI's president explained, "it would be rare that a CEO could be personally involved in, or knowledgeable about, the plethora of tax rules that apply to literally thousands of transactions that are reflected in the company's tax returns." Indeed, Mr. Glennie continued, "the level of detail and specialized knowledge demanded in the preparation and submission of complex corporate tax returns demands that the responsibility for signing the return--and affirming under penalties of perjury the completeness and accuracy of the return--be delegated to an employee with a significant level of professional tax expertise, training, and experience." In TEI's view, the senior tax official is the person in the best position to assess that the return fulfills the company's legal obligations.

"In summary, the proposal to require CEOs to sign corporate tax returns would impose a burden on CEOs that most are ill-trained to bear, would unnecessarily saddle companies with additional compliance costs, and represents a step backward for efficient tax administration since the person signing the return would not be the employee in the best position to ensure the accuracy or completeness of a complex multinational tax return. TEI urges that the proposal either be abandoned or revised substantially," Mr. Glennie concluded.

The provision is reminiscent of proposals that were previously considered during the debate over abusive tax shelters. For example, a senior officer tax return attestation proposal was set forth in the Senate Finance Committee's preliminary draft of proposed legislation to curb abusive tax shelter transactions. After criticism by TEI and others, the proposal was subsequently removed from pending tax shelter legislation. In the organization's view, the proposal will be no more effective in curbing misleading financial reporting practices than the senior officer attestation would have been in curbing abusive tax shelters.

TEI's letter is reprinted in this issue, beginning on page 458.

Economic Substance Doctrine

Early in August, TEI wrote to House Ways and Means Committee Chairman Bill Thomas and Ranking Democratic Member Charles Rangel to oppose the proposed codification of the judicially developed economic substance doctrine and a corresponding proposal to establish a penalty for understatements attributable to transactions lacking economic substance. The proposals are set forth in H.R. 5095, The American Competitiveness Act of 2002.

In its August 2 letter, TEI noted that the proposals mark a significant departure from our rules-based system, apply to an extraordinarily broad range of transactions, and involve the application of vague and undefined subjective tests. "They would make it extremely difficult for taxpayers to enter into their everyday business decisions with necessary clarity and certainty," the Institute stated, "and for the IRS to examine their returns in an even-handed, objective, and consistent manner." Adopting the proposals will both ensnare and severely punish taxpayers for wholly legitimate transactions and fail to catch some abuses that should be stopped.

The Institute explained that the proposed filter for other reportable transactions--"a significant purpose of tax avoidance or evasion"--is overbroad. "In our view, it should be changed to envelop transactions only where "the principal" purpose of a transaction is tax avoidance." TEI said. Otherwise, the bill will not provide a meaningful basis for distinguishing legitimate tax planning for ordinary commercial transactions from potentially abusive transactions.

TEI urged Congress to abandon the current proposals, which it described as burdensome, ill-founded, and unnecessary. The Institute's comments are reprinted in this issue, beginning on page 432.

Transfer Pricing Documentation

In September, the Institute turned to the proposed transfer pricing documentation requirements developed by the Pacific Association of Tax Administrators (PATA), which includes Australia, Canada, Japan, and the United States. The Institute's comments were solicited by the taxing authorities in both Canada and the United States.

In its September 5 letter to Carol Dunahoo of the IRS's Large and Mid-Sized Business Division and Tom Crowe of CCRA's International Tax Operations Division, TEI commended PATA for recognizing the need to develop guidance to enable multinational taxpayers to satisfy the PATA countries' transfer-pricing documentation requirements. "The multiple, highly nuanced, and sometimes conflicting, interpretations of the arm's-length standard reflected in the substantive transfer-pricing rules and administrative requirements of various jurisdictions impose significant compliance burdens on taxpayers," the Institute stated.

TEI urged PATA to work toward the goal expressed in the OECD guidelines and to recalibrate the balance struck in the current draft of the documentation package. The Institute also stressed the need for standardization of the underlying substantive transfer-pricing rules.

"We encourage PATA to coordinate with the OECD in respect of uniform and consistent multilateral guidance in respect of transfer-pricing rules, documentation requirements, and penalty standards," TEI stated. "The OECD guidelines were developed in consultation with taxpayers and governments and, while not wholly satisfactory, reflect a balance among myriad competing interests and demands." The development of cost-effective standards will require a careful balance among the needs of taxpayers and tax administrators, especially because of taxpayers' reluctance to support more burdensome multilateral requirements.

Although the package aims to avoid imposing "legal requirements greater than those imposed under the local laws of PATA members," the scope and amount of information required to be produced and maintained under the proposal is seemingly more extensive than that required under either section 6662 of the U.S. Code or section 247 of the Canadian Income Tax Act, TEI noted. In addition, neither the introductory material nor the detailed schedule of documents sets forth a limitation on the scope of taxpayer recordkeeping obligations. "Specifically, there is no statement limiting taxpayers' obligations to retain and produce only material information related to significant controlled transactions," the Institute stated. The organization recommended that PATA adopt a cost-benefit limitation on documentation requirements similar to the OECD's.

Overall, TEI stressed that "the development of consistent, fair, and reasonable substantive transfer-pricing rules, penalty standards, and administrative practices will not only minimize taxpayer burdens but also reduce transfer-pricing controversies generally." A reduction in controversies, in turn, will diminish the resources devoted to the resolution of such cases. "Thus, we urge PATA to move forward and provide balanced and harmonized guidance on substantive transfer-pricing rules and standards for evaluation of `reasonable efforts,' as well as reasonable standards of relevance and materiality documentation requirements," the Institute said.

Specific areas addressed in the Institute's comments include the inability of taxpayers to comply with all the principles discussed in the package, the open-ended list of documentation required, the difficulty of subsidiaries' producing a world-wide group structure, and the need for clarification of the contemporaneous documentation requirement.

The Institute's comments are reprinted in this issue, beginning on page 464.

Boeing: Interpreting the DISC/ FSC Rules

On August 9, TEI filed a brief amicus curiae with the Supreme Court of the United States in support of the taxpayer in Boeing Company v. United States. The case involves the allocation for DISC and FSC purposes of Boeing's research and development expenses to the revenues generated by the export sales of commercial aircraft. The issue arises because Treas. Reg. [section] 1.861-8(e)(3) requires taxpayers to allocate R&D expenditures according to a two-digit SIC code, whereas the DISC regulations permit taxpayers greater flexibility, for example, to group transactions along product lines.

In determining its combined taxable income during 1979 through 1987, Boeing exercised its right to elect product groupings under the DISC and FSC regulations, grouped its export sales by airplane program, and determined its costs, including R&D costs, for each airplane program. "Boeing's determination properly allocated definitely related expenses to its export sales," TEI averred, "and was also consistent with the general rule of the section 861 regulations that `allocations and apportionments are made on the basis of the factual relationship of deductions to gross income.'"

Although the district court held that the regulation was invalid as applied to the CTI calculation, the Ninth Circuit concluded that in computing the company's net income, the Commissioner "properly applied Treas. Reg. [section] 1.861-8(e)(3) to allocate Boeing's R&D costs to its export sales." TEI explained that the "court's conclusion is wrong as a matter of law."

TEI stressed that the regulation's requirement that a taxpayer allocate R&D expenses to sales revenues within a single two-digit SIC code "vitiates the flexibility taxpayers have" to claim congressionally provided tax benefits. "The section 861 regulations were tailored for the purpose of allocating and apportioning income and expenses between foreign and domestic sources under the foreign tax credit provisions of the Code," the organization stated. "The mechanical rules of Treas. Reg. [section] 1.861-8(e)(3) impermissibly conflict with the more specific DISC regulations, which accord taxpayers a choice in grouping sales according to product lines. Because Treas. Reg. [section] 1.861-8(e)(3) cannot be harmonized with the purposes of the DISC provisions, it is invalid as applied to DISCs."

The Institute's brief also addressed the legislative history of the DISC and FSC provisions. Congress enacted these provisions, TEI emphasized, to provide a more level playing field for U.S. companies competing in foreign markets. The DISC provisions were enacted at a time when the economy was doing poorly. The changes were designed not only to stimulate spending but also to provide more jobs in the United States. Congress stressed the importance of providing tax incentives for U.S. firms to increase their international business not only because of their stimulative effect, but also to remove a disadvantage to U.S. businesses engaged in export activities through domestic subsidiaries. The provisions of the Revenue Act of 1971 were intended to provide a broad incentive program for taxpayers.

"In establishing the DISC regime," TEI stated, "Congress created a statutory scheme that was clearly intended to permit DISCs to earn profits in excess of those earned under the arm's-length pricing rules otherwise used between related parties. Thus, Congress established a unique regime under which taxpayers using DISCs were to obtain benefits not ordinarily then available."

There are two primary reasons why Treas. Reg. [section] 1.861-8(e)(3) should not be applied to the calculation of CTI, the Institute explained. "First, Congress intended only that the general principles of section 861 should apply in the DISC context. Second, the special allocation rule of Treas. Reg. [section] 1.861-8(e)(3) does not further those principles in this context."

TEI concluded that it is consistent with the section 861 principles for the allocation of R&D expenses to yield to the DISC and FSC rules. "By mandating the use of a special allocation rule for R&D expenses in respect of DISCs, the Treasury Department does violence to the statutory scheme. Treas. Reg. [section] 1.861-8(e)(3) is invalid as applied by the government to the computation of CTI," the Institute stated.

The Boeing case will likely be argued before the Supreme Court this winter, and a decision in the case is expected by next June. TEI's brief is reprinted in this issue, beginning on page 444. (The Institute's brief in support of Boeing's petition for a writ of certiorari was published in the March-April 2002, issue of The Tax Executive.)

State & Local Activities

On August 23, TEI submitted comments to the Multistate Tax Commission on the MTC's uniformity proposed for a factor-presence nexus standard for apportioned and income and franchise taxes. While the Institute embraced the goal of crafting a "simple and certain standard for income and franchise tax nexus," it urged the MTC to abandon its uniformity proposal. Alternatively, TEI urged that the MTC substantially revise the proposal to require some physical presence within a state.

In its comments, the Institute argued that the proposal was unconstitutional because it deviated from the substantial nexus standard adopted by the Supreme Court in 1977 in the Complete Auto Transit case. TEI also noted that the nexus standard set forth in the Quill case--which applies to sales and use taxes--is no less appropriate for income and other types of taxes. "Indeed, ample grounds exist for concluding that the nexus requirement for income tax purposed, if different, should be more demanding than the requirement for sales and use tax purposes," TEI stated.

"The formulaic approach to nexus determinations embodied in the Commission's proposal would create nexus even in circumstances where it constitutionally cannot exist," TEI concluded.

In other state and local news, the Institute has taken issue with a July 2002 notice by the District of Columbia's Office of Tax and Revenue requiring taxpayers to submit a copy of any letter ruling they rely on before December 31, 2002, or have that ruling revoked. On September 26, TEI called the notice "a step in the wrong direction" and urged OTR to withdraw it.

The Institute questioned the legal sufficiency of a blanket revocation of letter rulings through a notice posted solely on the OTR website, arguing that the such an approach likely violated the due process protections of the Constitution. It also noted that other means are available to review outstanding rulings and their effects on D.C. tax revenues.

The Institute's comments to the MTC and to OTR are reprinted in this issue, beginning on pages 462 and 470, respectively.

Toronto Chapter Submission

In an August 30 letter to Brenda Kershaw of the Ontario Ministry of Finance, Toronto Chapter President Robert Westlake commented on draft legislation and administrative rules in respect of Ontario's retail sales tax on software and related services.

Mr. Westlake commended the Province for adopting a de minimis rule for software-related services where vendors generally provide non-taxable services with an incidental supply of taxable services--a recommendation made by TEI in December 2001 comments to the Ministry. "The de minimis rule will help those vendors (and purchasers of these services) who supply what is for the most part a non-taxable service, but includes a nominal component of taxable services," Mr. Westlake stated, adding that the use of the word "cost" in the regulations describing this rule could be problematic.

The chapter president also suggested that any records used by a business in the development of its pricing, cost-tracking, or billing activities be considered acceptable documentation in determining the value of taxable vs. non-taxable services.

The chapter submission is reprinted in this issue, beginning on page 454.