Tax Executives Institute--U.S. Department of Treasury Office of Tax Policy liaison meeting: February 25, 2003.

On February 25, 2003, Tax Executives Institute held its annual liaison meeting with Assistant Treasury Secretary Pamela F. Olson and other representatives of the Treasury's Office of Tax Policy. The agenda for the meeting was published in the March-April 2003 issue of The Tax Executive. The minutes follow:

I. Introductory Comments

On behalf of the U.S. Treasury Department's Office of Tax Policy, Assistant Secretary Pamela F. Olson welcomed TEI President J. A. (Drew) Glennie and the other members of the delegation from Tax Executives Institute to the liaison meeting. Ms. Olson observed that the Treasury Department derives benefit from its meetings with the Institute, and confirmed the view that the meetings are only part of an ongoing dialogue. TEI thanked the Treasury representatives for taking time to meet with the Institute, especially during this hectic period. The delegations for the Treasury Department and TEI at the liaison meeting are set forth below.

II. The Administration's Budget Proposals

a. Dividend Exclusion 

TEI expressed support for the goal of eliminating the double taxation of corporate earnings and said that it is pleased that the Administration's 2004 Budget proposals focus on restoring economic growth. TEI noted that the dividend exclusion proposal will have far-reaching effects on many provisions of the Internal Revenue Code. Moreover, concerns have been expressed by some about the complexity of the proposal as well as the additional recordkeeping burdens imposed. In addition, company dividend payment policies are very stable, but operating earnings and reported tax liabilities can vary substantially from year to year. As a result, there may be considerable volatility in the excludable dividend account (EDA) and the retained earnings basis adjustments (REBA) reported to shareholders, especially for companies in cyclical industries.

Ms. Olson said that, since the proposal was released in early January, practitioners, taxpayers, and taxpayer groups have identified a number of technical issues that the Treasury Department has addressed through clarifications and revisions. A draft of the proposal's statutory language, which is expected to be released later in the week, is likely to incorporate additional minor revisions, but may not address the shareholder reporting concerns expressed by TEI. Ms. Olson noted that, because of business and economic conditions in 2001 and 2002, some groups have recommended that the Treasury Department modify the base tax year (or years) for computing the 2003 EDA. Adopting those recommendations, however, would add complexity.

TEI noted that large businesses are generally subject to examination, which may take several years for the IRS to initiate and conclude. In addition, where disputes arise about a company's reported tax liability, the taxes subsequently paid (or refunded) in order to resolve the dispute will be made well after the year to which the additional (or reduced) tax liability relates. TEI inquired whether the Treasury Department has considered the effect of tax appeals or litigation on the computation of EDA. Specifically, TEI noted, if the EDA is based on the amount of taxes paid in cash during a particular year, the proposal may affect a taxpayer's choice of forum for litigating tax matters. Ms. Hubbard said that the statutory language would likely address the specific questions posed by TEI in respect of the effects of subsequent payments and refunds. Generally, the Treasury intends that the EDA employ a straightforward arithmetic calculation based on the amount of taxes actually paid during a year in order to provide certainty to corporations and their shareholders. Ms. Olson said that TEI is the right group to raise and highlight the administrative issues posed by the proposal. After the statutory language is released, she said, the Treasury Department would be willing to discuss any issues identified by the Institute. TEI said it will work with the Treasury Department to highlight members' concerns and to ensure that the final legislation is as administrable as possible.

b. Employer Retirement Savings Accounts 

TEI noted that the Administration's 2004 Budget proposals include several provisions designed to enhance savings, including an Employer Retirement Savings Account (ERSA). ERSAs would follow the existing rules for 401(k) plans, subject to certain modifications. TEI noted that the proposal will provide significant simplification to the extent that it leads to the elimination of the alphabet soup of current pension and retirement savings regimes, but there are likely to be a number of transition issues.

Mr. Sweetnam said that the Treasury's current focus is on developing the economic growth package, including the dividend exclusion. The statutory language for the pension and savings provisions, he said, will be developed and released later. In the meantime, his staff is taking comments and responding to questions from various groups, especially from small business and tax exempt and government entities, about the effect of the proposals on various types of tax-deferred savings accounts. For 401(k) plans, he noted, the ERSA proposal is tantamount to a name change because the substantive differences between an ERSA and a 401(k) plan are minimal.

TEI noted that many of the proposed changes for ERSAs, e.g., to the top-heavy, safe harbor, and nondiscrimination rules, would simplify the rules for plan administration inquired whether the revisions might cause shifts in pension coverage. Mr. Sweetnam said that the proposals focus on simplifying the rules for defined contribution plans, whereas the rules for defined benefit plans have been unaltered. The Treasury Department, he said, is reviewing the scope and nature of the effect of the ERSA definitional provisions, e.g., for highly compensated employees, on defined benefit plans. Ms. Olson said that implementation of the package of proposals for Retirement and Lifetime Savings Accounts is secondary to the enactment of the dividend exclusion and the acceleration of the individual tax cuts. She noted that the principal benefits of the proposals for Lifetime Savings Accounts and Retirement Savings Accounts are simplification and standardizaton of the conditions under which participants may withdraw the funds. Financial institutions, she noted, would welcome the simplification and standardization and would likely re-double their marketing efforts to attract savings to such accounts.

c. Section 163(j) Related Party Interest Provisions

TEI requested a status report on legislative proposals affecting the treatment of related-party interest payments. Ms. Angus said that the Treasury Department believes that legislative changes are necessary in order to address corporate inversions. She noted that inversion activity has slowed substantially since the Treasury Department and Congress announced proposals to address inversions. Despite the slowdown in inversions, the Treasury Department believes that certain proposals should be enacted to ensure that inversion activity does not reemerge. One such step is to tighten the rules in section 163(j). Ms. Angus said that the Budget proposals reflect the Treasury Department's conclusion that it is appropriate to include a safe harbor in the interest-stripping rules. The Budget proposal, she said, provides a tailored safe harbor that would afford protection to the vast majority of companies, but would still tighten the rules sufficiently to inhibit companies from adopting unusual or excessive debt structures. Ms. Angus invited TEI to submit comments elaborating on any technical concerns that it may have about the Budget proposal.

II. Tax Shelters 

TEI noted that it has long supported establishing a disclosure-based regime for combating the development and marketing of tax shelters. Enhanced disclosure, TEI said, will aid the IRS in identifying transactions that are potentially abusive. Nevertheless, TEI is concerned that recent Treasury Department and congressional proposals that would add a penalty regime to enhance compliance with the disclosure requirement. A new strict liability penalty, TEI said, is no substitute for measured enforcement of substantive tax rules. Indeed, the provision could result in taxpayers' incurring substantial monetary penalties for inadvertent noncompliance with overbroad disclosure rules. Imposing penalties for disclosure "foot faults," especially for transactions that are clearly disclosed elsewhere on the return--e.g., on Schedule M-1--would neither encourage compliance with the disclosure rules nor deter abusive transactions.

Ms. Olson said that the current perception in the press and among some in Congress is that many corporations view their tax compliance obligations in the same fashion as Enron did. That unfavorable perception is driving the political and legislative response to tax shelters specifically and to corporate governance issues generally. She suggested that TEI take its message directly to legislators. Ms. Olson explained that, before releasing the tax shelter proposals in March 2002, the Treasury Department and IRS concluded that without a nondisclosure penalty taxpayers would have insufficient incentive to comply with disclosure requirements.

Ms. Olson said that the Treasury Department worked with the staff of the Senate Finance Committee to develop portions of the tax shelter bill that the Committee passed last summer. A separate bill was developed by Representative Bill Thomas, Chairman of the House Ways and Means Committee. The Senate bill would increase the risk that taxpayers might incur a heavy penalty for for nondisclosure of reportable transactions and would also eliminate IRS discretion to waive certain tax shelter related penalties. Mr. Solomon noted that, of the various legislative proposals to codify the economic substance test, the one included in legislation pending in the Senate is quite stringent.

TEI inquired whether the report released by the staff of the Joint Committee on Taxation in respect of various tax shelter transactions undertaken by Enron would influence the substance of either the disclosure regulations or pending tax shelter legislation. Ms. Olson noted that the JCT report recommended a number of substantive changes in the law that the Treasury Department and IRS are studying. In addition, the Treasury Department anticipates releasing the disclosure regulations in final form by the end of the week. She noted that the regulations have been revised to respond to a number of requests for clarification. Mr. Solomon noted that the current political environment (which is clearly affected by the JCT's Enron Report) may impel codification of the economic substance doctrine.

TEI inquired whether the effective date of the disclosure regulations might be delayed in order to give taxpayers time to comply with and comment on the revised regulations. Ms. Olson said that the current regulations expire at the end of the week and any lapse in the disclosure regulations might result in an adverse political reaction. Specifically, Congress might adopt legislation that would make it more difficult for the Treasury Department and IRS to respond promptly and appropriately to either the overbreadth or underbreadth of the rules. She said that the regulations might be modified by putting certain exceptions relating to the loss and book-tax accounting difference reporting filters in revenue procedures to enable the IRS and Treasury Department to revise the exceptions as quickly as circumstances warrant. She invited TEI to submit additional comments on the regulations and revenue procedures.

TEI next referred to a provision in the Senate's pending tax shelter legislation that would require chief executive officers (CEOs) to sign the corporate tax return. TEI said it believes the proposal to require a CEO to sign a corporate tax return misapprehends the role of the tax department as well as that of the CEO. It would force companies to devote substantial time and resources to educating CEOs about the intricacies of the company's tax affairs, distracting them (and the company's tax personnel) from activities that put their respective professional expertise to their best uses--including overarching issues of corporate governance and accountability. TEI inquired about the Treasury Department's view of the proposed provision. Ms. Olson said that the Treasury Department has not taken a position on the CEO signature proposal, but acknowledged the difficulty of explaining the intricacies of a complex corporate tax return to the CEO.

TEI referred to a letter from Senator Charles Grassley to the Treasury Department and the Securities and Exchange Commission inquiring whether disclosure of corporate tax returns in whole or in part would be beneficial in combating tax shelters that are based on differences between book and tax accounting and reporting. TEI said that it had written to the Treasury Department and the SEC urging both to support retention of current law restrictions against disclosure of confidential tax return information.

Ms. Olson said that the Treasury Department opposed the tax return disclosure proposal. Proprietary company information disclosed in tax returns would aid a company's competitors, she said, but likely would not enhance the quality of information available to the IRS for examination. Likewise, the SEC said in its response that additional public disclosure of book-tax accounting differences in financial statement footnotes or other schedules would likely create confusion for investors rather than enhance their understanding of the company's financial position. The IRS, she added, is working on a revision to Schedule M-1 of Form 1120 in order to enhance its examination of book-tax differences, but the Treasury Department opposes public release of such information because its release could adversely affect rather than improve disclosure. Ms. Olson concluded by noting that a revision of Schedule M-1 may hold greater promise for increasing the transparency of corporate tax returns and enhancing compliance and examinations than public disclosure of tax returns. TEI observed that IRS agents will generally request all of a taxpayer's Schedule M-1 workpapers in the first information document request of an examination. The workpapers, TEI said, provide more detailed information than even a revised Schedule M1 can provide. Ms. Olson acknowledged the point, but said that a revised Schedule M-1 would provide the IRS with an improved risk assessment tool that would aid the IRS in focusing limited examination resources on specific issues. TEI noted that it has responded to the IRS request for assistance on the Schedule M revision project.

III. Simplification and Tax Reform

TEI inquired about the prospects for simplification of the international tax provisions of the Code and also asked for an update on the government's initiatives to resolve the issues posed by the WTO's adverse decision against the FSC/ETI provisions. Ms. Angus said that the United States must comply with the WTO's decision soon; more than $4 billion per year in trade sanctions could be applied by the European Union should the United States fail to comply. The Administration, she said, has concluded that compliance with the WTO decision will require repeal of the ETI provisions and the Budget proposals include a recommendation for their repeal. At the same time, the Treasury Department has identified a number of provisions in the current tax laws that are either outdated or out of step with changes in the global economy or the tax policies of the United States' trading partners. The Treasury Department, she said, will work with Congress to ensure that a balanced package is enacted that ensures compliance with the WTO decision and preserves the competitiveness of U.S. companies and the U.S. tax system.

TEI inquired about the timing of the proposed package of changes. Ms. Angus said that complying with the WTO's decision is a matter of some urgency because the country is facing an immediate threat of sanctions. Hence, the issues must be addressed quickly. She urged TEI to quickly provide comments and recommendations to the Treasury Department in respect of these proposals.

IV. Status Reports

A. Proposed Regulations on Capitalization of Expenditures

TEI noted that proposed regulations on the capitalization of expenditures for intangible assets were issued in December. Although TEI is still reviewing the proposed rules, the general reaction to the bright line rules has been favorable. TEI added that it would likely file comments on several areas in the proposed regulations, including transaction costs, the de minimis rules, and the aggregation of various costs. TEI inquired when the IRS might issue regulations in respect of the treatment of costs related to tangible assets or repairs. Ms. Olson said that additional guidance on capitalization issues would likely be issued, but the resources are not currently available for such a project. Mr. Solomon said that comments on the treatment of transaction costs would be especially helpful for the IRS and Treasury Department.

B. Section 482 Regulations

TEI noted that the Treasury Department and IRS are nearing completion of a revision of Treas. Reg. [section] 1.482-2, which deals with services. The Treasury and the IRS have issued proposed regulations that would include stock-based compensation as an expense that must be charged in intercompany services agreements--a position, TEI said, that violates the arm's-length principle. TEI requested a status report on the regulations. In addition, TEI said, reports suggest that the Treasury Department and the IRS will issue proposed regulations clarifying cost sharing under Treas. Reg. [section] 1.482-7 in early summer. TEI inquired what changes are contemplated beyond the inclusion of stock-based compensation in a qualified cost-sharing arrangement. For example, are changes to address issues associated with buy-ins contemplated?

Ms. Angus said that a project for revising the service regulations under section 482 was included on the business plan. The current regulations, she said, were implemented in 1968. Business practices, technology, and the global economy have changed substantially since then. Services used to be ancillary to manufacturing activities, but now services are a substantial component of the global economy. The project is intended to bring the regulations up to date, especially in respect of the changes in transfers of technology. Elements of the current service regulations that have been helpful in minimizing disputes will likely be included, she said, perhaps as a form of safe harbor.

In respect of the cost-sharing regulations, Ms. Angus noted that proposed regulations have been released that would require companies to include stock-based compensation and stock options in the pool of shared costs charged to the participants in a cost-sharing arrangement. In addition, another project has been initiated to address the treatment of cost sharing more generally, including buy-ins. The Treasury Department and IRS are reviewing the regulations to ensure that the rules are not used to disguise transfers of valuable intangible assets. Ms. Angus said that the Treasury Department and IRS believe that the proposed regulations addressing the treatment of stock options in cost-sharing agreements are consistent with the arm's-length principle. The proposed regulations include clear rules regarding when and how to value the stock options that should be included as compensation under the cost-sharing agreement. TEI noted that most companies with arm's-length cost-sharing agreements ignore stock option costs. TEI also said that the proposed rules on the treatment of stock options are out of step with the OECD's cost-sharing rules and, thus, create significant risks of disputes with foreign tax authorities as well as double taxation. Ms. Angus said that the Treasury is always receptive to additional comments and invited TEI to submit its comments and recommendations.

C. Tax Treatment of Stock Options

1. General. TEI noted that the divergent treatment of stock options for tax and financial accounting purposes continues to spawn much discussion and inquired whether the Treasury Department anticipates proposing any changes in the tax treatment of stock options. Mr. Sweetnam said that the Treasury Department is looking at various rules that address the treatment of stock options. The regulations under section 280G relating to golden parachute payments, for example, are under review. Treasury is also reviewing why section 83 treats stock options differently from other property transferred in connection with the performance of services. Although there is no current regulation project, he said, the Treasury Department is considering whether optionees should be taxed on the value of stock options under a different paradigm. The Black-Scholes formula and other option valuation models, he noted, were not available when the current regulations under section 83 were issued. Even though such models and formulas are available, he said, the Treasury Department is considering whether it would be appropriate to use such models to tax the value of stock options and, if so, when the value should be determined for tax purposes. In response to a question, Mr. Sweetnam said that consistency of the book and tax treatment of stock options is not necessarily a hallmark of good tax policy.

2. Payroll Tax Deposits. TEI next said that taxpayers have been threatened with penalty assessments for failing to timely deposit withholding and payroll taxes on the day after an employee exercises a stock option. The next-day deposit rule, TEI said, is nearly impossible for companies to comply with in the context of broker-assisted stock option exercises. In addition, TEI said, there is a question whether a deposit of withholding taxes on behalf of the employee in advance of the employee's receipt of the cash or stock from the broker would constitute a prohibited loan under the Sarbanes-Oxley Act of 2002. Mr. Sweetnam said that he has been meeting with the IRS LMSB Division in respect of the employment tax deposit issue. He said that the Treasury Department might be willing to provide rules of administrative convenience relating to the timing of deposits of payroll and withholding taxes on stock options, but it is unwilling to provide a general regulation that would treat options exercised with cash differently from so-called cashless option exercises. He invited TEI to submit comments on the tax policy and administrative issues relating to the timing of employment tax deposits on stock option exercises. [Note: The IRS issued a Field Directive on March 14, 2003, which states that LMSB Employment Tax Specialists should not challenge the timeliness of employment and withholding tax deposits on the exercise of stock options if the deposits are made the next day after settlement date, as long as that date is within three days of the trade date.]

D. Deferred Compensation

TEI noted that in its proposed budget, the Bush Administration recommends repeal of section 132 of the Revenue Act of 1978, which currently limits the Treasury Department's authority to issue rules that address nonqualified deferred compensation arrangements. TEI requested an update on the type of guidance contemplated and whether rules in respect of nonqualified deferred compensation plans would be similar to the May 2002 regulations issued under section 457.

Mr. Sweetnam said that if the Treasury Department is given the requested authority it will look at the timing rules relating to deferrals and re-deferrals of nonqualified deferred compensation. For example, he said, the Enron bankruptcy demonstrated that in some circumstances a 10-percent haircut for immediate access to deferred compensation may not constitute a substantial restriction on an employee's right to receipt of the deferred compensation. One of the goals of the guidance would be to provide consistency between the rules applicable to corporate nonqualified deferred compensation plans and governmental plans subject to section 457.

V. Conclusion

TEI thanked the Treasury Department representatives for their participation in the meeting. On behalf of the Treasury Department, Ms. Olson expressed her appreciation for the time and effort the TEI representatives devote to preparing for the meeting and urged the Institute to continue to bring issues to the attention of the Treasury Department.

Department of Treasury Delegation

Pamela F. Olson, Assistant Secretary (Tax Policy)

Gregory F. Jenner, Deputy Assistant Secretary (Tax Policy)

Eric Solomon, Deputy Assistant Secretary (Regulatory Affairs)

Drew Lyon, Deputy Assistant Secretary (Tax Analysis)

Helen M. Hubbard, Tax Legislative Counsel

Barbara M. Angus, International Tax Counsel

William F. Sweetnam, Jr., Benefits Tax Counsel

Jeffrey H. Paravano, Senior Advisor to the Assistant Secretary

Jodi B. Cohen, Attorney-Advisor

John F. Kelly, Jr., Special Assistant to the Assistant Secretary

TEI Delegation

J.A. (Drew) Glennie, Shell Canada Limited, TEI President

Raymond G. Rossi, Intel Corporation, TEI Senior Vice President

Judith P. Zelisko, Brunswick Corporation, TEI Secretary-Treasurer

Michael P. Boyle, Microsoft Corporation, TEI Executive Committee

Deborah A. Lange, Oracle Corporation, TEI Executive Committee

Neil D. Traubenberg, Storage Technology Corporation, TEI Executive Committee

Glenn G. Wickerson, BP Canada Energy Company, TEI Executive Committee

David L. Bernard, Kimberly-Clark Corporation, Chair, TEI IRS Administrative Affairs Committee

Bruce R. Maggin, IBM Corporation, Chair, TEI International Committee

Mitchell S. Trager, Georgia-Pacific Corporation, Chair, TEI Federal Tax Committee

Timothy J. McCormally, TEI Executive Director

Fred F. Murray, TEI General Counsel and Director of Tax Affairs

Mary L. Fahey, TEI Tax Counsel

Jeffery P. Rasmussen, TEI Tax Counsel

Gregory S. Matson, TEI Tax Counsel