TEI urges rejection of budget proposal to end deductibility of interest on corporate tax underpayments.

TEI Urges Rejection of Budget Proposal to End Deductibility of Interest on Corporate Tax Underpayments

Tax Executives Institute urges the rejection of any budget proposal to deny a deduction to corporations for interest paid on income tax underpayments. The proposal, which apparently is based on H.R. 5557 -

* threatens to disrupt the orderly administration of federal, state, and foreign tax audit systems;

* is punitive;

* is inappropriately retroactive with respect to interest accumulated prior to its stated effective date;

* is at odds with longstanding and legitimate tax law principles; and

* represents the type of gimmickry that both the Administration and Congress have pledged to avoid in crafting realistic and reasonable deficit reduction legislation.

Background

Tax Executives Institutes (TEI) is the principal association of corporate tax executives in the United States and Canada. The Institute's more than 4,500 members are employed by 2,000 of the leading corporations in North America and represent a cross-section of the business community. TEI is dedicated to maintaining a tax system that works - one that is fair and administrable and with which taxpayers can comply.

Discussion

From press reports, TEI understands that consideration is being given to a proposal to deny a business deduction for interest paid by corporations on income tax underpayments. According to published reports, such a proposal (which would be effective with respect to interest payments made after December 31, 1990) is estimated to raise $4.5 billion during the 1991-1995 budget period.

TEI opposes the inclusion of the proposal to deny a deduction for interest paid on income tax underpayments for the following reasons:

1. The proposal threatens to disrupt the orderly administration of federal, state, and foreign tax audit systems. Currently, the Internal Revenue Service, state, local, and foreign tax administrators are unable to conduct timely audits of many corporations and consequently regularly seek extensions of the statute of limitations from the affected taxpayers. Denying corporate taxpayers a deduction for interest paid on income tax underpayments would harden taxpayers from giving such extensions because it would postpone the ultimate determination of the amount of the taxpayer's liability that would be owing plus accrued interest. This could lead to either the expiration of the statute of limitations before an audit is complete (which would reduce government revenues) or the precipitous issuance of deficiency notices or jeopardy assessments (which would clog an already overburdened Tax Court and require substantial additional taxpayer and government resources to sort out). An unavoidable consequence of the ensuing disruption of the audit process would be to heighten tensions between taxpayers and the IRS (or state or foreign tax administrators).

In addition, the proposal could prompt taxpayers to overpay their taxes, file administrative claims for refund, and ultimately file refund suits in the courts. This process would deny taxpayers access to the Tax Court and impose additional burdens and demands on both taxpayers and the government.

2. The proposal is punitive. The proposal would apply in respect of all interest paid on all income tax underpayments, without regard to either the good faith of the taxpayer or the fact that high interest charges in respect of corporate tax disputes are frequently attributable to government-caused audit delays. At a time when the tax laws are changing constantly and tax returns must be filed frequently before final regulations are issued and other necessary guidance provided under new and often ambiguous statutes, the proposal would be especially punitive. Indeed, delayed guidance may retroactively increase a taxpayer's tax liability - giving rise to an interest charge attributable not to taxpayer culpability but to the tax administrator's prior inaction.

That the proposal is punitive and without a legitimate tax policy basis is underscored by the absence of a reciprocal provision stating that interest received on tax overpayments will be excluded from the taxpayer's gross income. The one-sided nature of the proposal cannot help but foster taxpayer cynicism and distrust.

3. The proposal is inappropriately retrocative with respect to interest accumulated prior to its stated effective date. A particularly objectionable aspect of the proposal is its retroactive application to interest accumulated prior to the proposed effective date. Frequently, tax disputes are not resolved because of good faith disagreements about the requirements of the tax law or because of delays attributable not to the taxpayer but to the courts or the administrative appeals process. To deny the deductibility in 1991 of interest that has already accrued is to inequitably penalize taxpayers that have endeavored in good faith to resolve their tax disputes through the administrative process or that have legitimately availed themselves of their due process rights in the courts.

4. The proposal is at odds with longstanding and legitimate tax law principles. Under current law, taxpayers are properly accorded a deduction for ordinary and necessary business expenses. Interest paid on business-related indebtedness is one such expense. Thus, if a company borrows to purchase equipment that is used in its business, the interest on the loan is deductible as a cost of doing business.

Interest on income tax underpayments (whether to the IRS, state or local governments, or foreign governments) represents the identical type of business-related expense. There is absolutely no reason why interest on tax underpaments should be distinguished for federal tax purposes from other interest payments. To deny corporate taxpayers a deduction for interest paid on income tax underpayments would be to deny them a deduction for a legitimate cost of operation - a violation of a basic principle underlying the federal net income tax system. Thus, the proposal would mark an unwarranted departure from longstanding tax law principles without any legitimate tax policy basis.

5. The proposal represents the type of gimmickry that both the Administration and Congress have pledge to avoid in crafting realistic and reasonable deficit reduction legislation. The proposal is estimated to raise $4.5 billion during the 1991-1995 budget period. (Specifically, the proposal is estimated to raise $4.8 billion in 1991, to lose $0.5 billion in 1992 and $0.7 billion in 1993, and to raise $0.5 billion in both 1994 and 1995.) The revenue estimate apparently anticipates a rush by taxpayers to pay accumulated interest before the end of 1990 to avoid the draconian disallowance of deductions for such interest.

Although denying a business deduction for interest paid on tax underpayments would exact real, permanent, and deleterious cost from taxpayers, the proposal would increase government revenues in the first fiscal year primarily by virtue of its pre-effective date, in terrorem consequences and, thus, represents little more than a "quick fix" budget gimmick. Not only does such legislative legerdemain undermine taxpayer confidence in the fairness of the tax system, but it does little to foster an environment in which meaningful deficit reduction can be accomplished.

Conclusion

For the foregoing reasons, Tax Executives Institute recommends the rejection of the proposal to disallow a deduction for interest paid by corporations on income tax underpayments. If you should have questions about the Institute's position, please do not hesitate to call either Timothy McCormally, TEI's Tax Counsel, at [phone] or me at [phone].