TEI comments on providing additional capitalization guidance: November 7, 2001.

On November 7, 2001, TEI President Robert L. Ashby submitted the following letter to Assistant Treasury Secretary for Tax Policy Mark A. Weinberger, IRS Commissioner Charles O. Rossotti, and Acting Chief Counsel Richard W. Skillman, urging the government to follow through on the Priority Guidance Plan and issue much-needed guidance on capitalization issues. The letter was prepared under the aegis of TEI's Federal Tax Committee, whose chair is Mitchell S. Trager of Georgia-Pacific Corporation.

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The Treasury Department's 2001 Priority Guidance Plan lists "guidance under sections 162 and 263 regarding the deduction and capitalization of expenditures" as a priority for the year. Tax Executives Institute concurs with the government's assessment that capitalization issues remain a high priority.

As the preeminent association of corporate tax executives in North America, Tax Executives Institute 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. Our members are responsible for managing the tax affairs of their companies and must daily deal with the Internal Re, venue Service (primarily, but not exclusively, the Large and Mid-Size Business Division) and with the provisions of the tax law that define whether a particular expenditure should be capitalized or deducted.

Taxpayers, the IRS, and courts, have long struggled with the distinctions between costs that are deductible when incurred and those 'that should be capitalized. Since the Supreme Court's decision in INDOPCO v. Commissioner, 503 U.S. 79 (1992), whether a particular expense may be deducted currently or must be capitalized has become a particularly troublesome issue. (1) While the National Office has consistently said that INDOPCO did not alter the fundamental principles of capitalization, (2) the decision has been cited by IRS agents to justify adjustments capitalizing numerous expenditures, many of which have long been viewed as clearly deductible. As a result, the number, scope, and frequency of disputes between taxpayers and the IRS over such issues have escalated substantially. Indeed, the National Taxpayer Advocate identified capitalization issues as the most litigated issue for business taxpayers in the 1998 Report to Congress, and there is no sign the controversy has abated. In addition, the IRS's Large and Mid-Size Business Division has reported that more than 25 percent of its audit resources are devoted to capitalization issues in some industries.

The core inquiry under INDOPCO is whether an expenditure produces a "significant future benefit." Expenditures producing "incidental future benefits" remain deductible, but determining whether there is a future benefit and, if so, whether it is incidental is rarely obvious or easy. To quell disputes over such issues, TEI and other groups have, in the nearly ten years since the decision, submitted various analyses, recommendations, and proposals for guidance on specific expenditures. The government has responded with guidance that has been, at once, helpful and frustrating. Each ruling has been unique and hence bereft of broader principles that can be applied beyond the limited facts in the rulings. As a result, both taxpayers and the government continue to grapple for a "unified theory" of capitalization: rules that set forth objective, administrable principles that are less dependent on an analysis of the unique facts and circumstances of each case. The greater our experience with the INDOPCO framework, the more we become convinced that the "significant future benefit" standard is unadministrable. It consumes far too many taxpayer and IRS resources and robs the tax system of much needed certainty.

Recently, a group of companies and their advisers--the INDOPCO Coalition submitted a proposal to the Treasury Department and IRS outlining an approach to future capitalization guidance. According to the document, the proposal attempts to "set forth an administrable and practical framework for addressing capitalization issues by providing objective principles that draw lines between capital expenditures and deductible expenses." TEI has consistently advocated a similar approach. In addition, the proposal seeks to provide "safe harbors and rules of administrative convenience that may be applied in evolving business environments without intensive analysis of each taxpayer's particular circumstances.

The proposal is a highly professional and persuasive document that can provide a useful framework for future action. As a result, TEI's Federal Tax Committee has undertaken an analysis of the myriad rules, safe harbors, and recommendations offered by the Coalition. While TEI's analysis and conclusions may ultimately differ from the recommendations in the proposal in respect of one or more substantive rules, we applaud the Coalition for developing the proposal. The group's efforts will clearly contribute to the resolution of the issues.

We urge the government likewise to consider the proposal seriously as it moves forward to effect the capitalization guidance announced on the 2001 Priority Guidance Plan.

If you have any questions or need additional copies of these comments, please do not hesitate to call Jeffery P. Rasmussen of the Institute's professional staff at 202.638.5601.

(1) Indeed, concern about the excessive scope and lack of administrable standards in the circuit court's opinion in National Starch v. Commissioner (subsequently restyled INDOPCO v. Commissioner) prompted TEI to submit an amicus curiae brief on the appeal to the United States