Tax Executives Institute-Department of the Treasury liaison meeting: November 19, 1996.

On November 19, 1995, Tax Executives Institute held its annual liaison meeting with the acting Assistant Secretary of the Treasury for Tax Policy and other officials of the treasury Department's Office of Tax Policy. Reprinted below is the written agenda for the meeting, which was submitted to the Treasury in October. A full report on the liaison meeting will be published in a future issue of The Tax Executive.

I. Introductory Comments

Tax Executives Institute is pleased to have this opportunity to meet with Assistant Secretary Lubick and other representatives of the Treasury Department's Office of Tax Policy. TEI's liaison meetings with the Department of the Treasury have afforded each organization an opportunity to articulate technical, policy, and process concerns and to explore how these concerns can best be addressed. We are confident that this year's meeting, focusing on the items discussed below, will be candid and productive.

II. National Commission on

Restructuring the

Internal Revenue Service

As a new millennium approaches, the tax system is facing unparalleled challenges, including (1) the ongoing effects of a major reorganization of the Internal Revenue Service; (2) a proliferation of calls to "end the IRS as we know it" (and "to pull the tax system out by the roots"); and (3) the chartering of a National Commission on Restructuring the Internal Revenue Service.

As an association of tax professionals who deal with taxes on a daily basis, TEI has long been concerned about the corrosive effect that attacks on the agency's legitimacy can have on the level of voluntary compliance in the United States. We share the view that vigilant oversight of the IRS by Congress and others is absolutely necessary, but also acknowledge that the orderly collection of taxes and the efficient administration of the tax system are in the best interest of the entire country and, further, that adequate funding must be provided for those goals to be attained. Hence, we lament the sometimes virulent attacks that have been launched against the IRS and its employees. To be sure, there are flaws in the current tax system, and there are design and management issues (including those related to tax systems modernization) that must be addressed. TEI sincerely believes, however, that the focus should remain on correcting the problems, not undermining the basic legitimacy of - and hence the public's confidence in - the tax system.

During the past few months, TEI has voiced these sentiments in statements filed with Congress and comments released to the media, and in mid-November, the Institute will underscore its views in testimony before the National Commission on Restructuring the IRS.(1) During the liaison meeting, we request a report on the Treasury Department's involvement with the Restructuring Commission.

III. The Prospects for

Fundamental Tax Reform

Regardless of the outcome of the upcoming election, taxes and tax policy will continue to dominate the headlines. There will undoubtedly be renewed calls for fundamental reform of the Internal Revenue Code. Nothing will be resolved during the next few weeks, but during the liaison meeting, TEI welcomes Treasury's views on the short- and long-term future of the tax system and the role the Institute can play to ensure that in any reform effort, workable, administrable rules are adopted.

IV. Proposals for Reform of

the International Tax

Provisions

A. Treasury Conference on Formulary Apportionment. The Treasury Department has scheduled a conference on formulary apportionment for December 12. In announcing the conference, Deputy Secretary Summers stated that the decision to hold the conference should not be interpreted as a weakening of treasury's support for the arm's-length principle. He continued, however:

But if the arm's-length principle

were to become unworkable

in the future, we would

certainly cooperate with our

trading partners to develop a

consensus, multinational alternative.

Similar comments were made by Assistant Secretary Lubick during his recent presentation to TEI's 51st Annual Conference.

TEI awaits the Treasury conference with interest, and agrees that should the arm's-length principle be replaced, the need for a standardized alternative would be imperative. Indeed, such a system will work only if all of the United States' major trading partners agree upon the same formula; otherwise, multiple taxation - if not chaos - will reign. With respect to the conference, we wonder what type of follow-up actions the Department envisions. For example, does the Department anticipate congressional hearings on the relative merits of formulary apportionment and the arm's-length standard? Does the Department intend to contact our treaty partners concerning the possible use of formulary apportionment?

B. Prospects for International Tax Reform. Senator Pressler has introduced legislation that would provide for much needed simplification of the international tax provisions of the Internal Revenue Code. Among other things, the bill would permit the use of generally accepted accounting standards for purposes of computing Subpart F income, exempt foreign corporations from the uniform capitalization rules, expand the Subpart F de minimis rules, and treat the European Union as a single country for purposes of determining foreign base company sales and services income. Many of these provisions - such as the elimination of the overlap between the CFC and PFIC rules - are long overdue and have been the subject of previous legislative efforts (such as last year's Houghton-Levin bill).

TEI believes that the Pressler bill represents a step in the right direction by generally reducing the transaction costs and the costs of preparing and auditing U.S. corporate tax returns for American companies engaged in international trade. Enactment would not only decrease costs - thereby enhancing the country's competitiveness - but also signal a commitment to the simplification of the tax law generally. The bill would also bring much needed reform to the foreign tax credit area.

TEI recognizes that Congress is in the midst of a debate on the basic structure of the U.S. tax system. We believe, however, that the prospects of fundamental reform should not detract from the important goal of bringing immediate and constructive reform to the international arena. During the liaison meeting, we invite the treasury's views on this legislation and the prospects for revising the Code's international provisions, including whether Treasury supports interim international tax simplification. In addition, we welcome comments on possible alternative tax systems including a discussion of treasury's position on territorial systems and the attendant effects on the foreign tax credit system.

C. Treasury White Paper on Electronic Commerce. During last year's liaison meeting, Treasury representatives briefed us on a forthcoming "White Paper' on issues raised by the continuing expansion of electronic commerce and other technology issues. The White Paper has generated widespread interest in the international tax community and the release of the discussion draft is eagerly awaited. What is the status of this project? What will be the process following the release of the White Paper? For example, will briefings be held on the paper and will public comments be solicited? Is it anticipated that the White Paper will lead to any legislative proposals or regulations?

V. Distinguishing Between

Capital Expenditures and

Ordinary and Necessary

Expenses: The Need for

More Guidance

TEI does not wish to sound like a broken record, but our members continue to be concerned about the IRS's initiatives in respect of the capitalization of expenditures and, in particular, about the penchant of agents to invoke the Supreme Court's decision in INDOPCO v. United States, 503 U.S. 79 (1992), to justify the capitalization of heretofore currently deductible expenses. We are also concerned about the IRS's apparent decision to let the INDOPCO drama unfold through the private letter ruling and technical advice memorandum process rather than to issue published guidance in this area. We have raised this issue directly with the IRS, but given Treasury's involvement in the project - as well as the interest expressed by several members of Congress - we believe it appropriate to discuss it once again during our November 19 meeting.

Our concerns about INDOPCO are grounded in fact. Despite frequent public assurances from the IRS National Office (in Rev. Rul. 94-12, 1994-1 C.B. 36, and elsewhere) that "INDOPCO did not change the law regarding capitalization," agents continue to seize upon that decision's broadest statements to justify novel and distended capitalization theories. In many cases, agents have cast aside well-settled law and practice supporting the deduction of many business expenditures. Regardless what authority the agents cite - whether section 263 or 263A or, more baldly, the INDOPCO decision - the same burden is imposed on taxpayers: the need to defend against unwarranted proposed adjustments.

The latest blip on the INDOPCO radar scope relates to the proper treatment of certain airline maintenance expenditures, which were the subject of Technical Advice Memorandum 9618006. The technical advice memorandum, which held that a taxpayer must capitalize the costs of periodic major inspections, has prompted a firestorm of protests, not only from the airline industry but from key congressional leaders. Our concern is not so much with the legal conclusion set forth in the technical advice memorandum - though much fault can be found with that conclusion - but with the process the IRS is using to develop post-INDOPCO law.

TEI recognizes that technical advice memoranda and private letter rulings formally have no precedential effect. We also recognize that they technically involve the proper application of law to a taxpayer's specific set of facts. In the absence of published guidance, however, examining agents have imbued such documents with significant weight, and the result is what some have called 'secret law' that imposes a substantial hidden tax. Hence, while the IRS'S National Office attempts to insulate the technical advice memorandum from congressional criticism on the ground it reflects no change in law and affects only a single taxpayer, revenue agents are interpreting the memorandum as yet another green light to capitalize a whole range of expenses that heretofore have been currently deducted.

In its letter to House Ways and Means Committee Chair Archer, the IRS stated a goal of "providing additional guidance to assist both taxpayers and the Service in resolving these issues and minimizing further controversy." TEI shares that goal. We submit, however, that. it can be best attained by the issuance of public, generally applicable guidance. Such guidance can be held up to the light of day, by both taxpayers and the IRS. Such guidance provides a basis for challenge, clarification, or - if need be - congressional oversight. Where the private ruling process is used, however, the facts are obscured, the legal analysis is shielded from scrutiny, and taxpayers as a whole are disadvantaged. Taxpayers are technically denied the ability to rely on favorable rulings, whereas agents are free to apply 'the reasoning' of the ruling in other situations. (Taxpayers can invoke "the reasoning" of private rulings, too, but their success in doing so may depend on their willingness to pursue matters to litigation. See Rowan Cos. v. United States, 452 U.S. 247 (1981).) More fundamentally, the dearth of generally applicable guidance places taxpayers in the position of having to seek clarification of any challenged expense deduction, and may well open the door to Congress's micromanaging the IRS'S interpretation of the tax law.(2)

TEI renews its recommendation that the IRS National Office provide more generally applicable guidance on the capitalization issue in order to reduce the number of protracted, and expensive, disputes between taxpayers and the IRS. During the liaison meeting, we invite the Treasury's comments on this proposal to bring clarity to the capitalization area.

VI. Congressional Review of

Regulations/line Item

Veto

In March of this year, President Clinton signed legislation (Public Law No. 104-21) that not only increased the public debt limit (which was the principal purpose of the bill) but also changed the process for developing federal regulations, including those issued by the IRS. Under the legislation, no regulation constituting a "major rule" can go into effect until at least 60 days after the regulation is submitted to Congress. Within the 60-day window period, Congress will have the opportunity to review and, if it is so inclined, block the implementation of the regulation by passage of a joint resolution. During the liaison meeting, we invite a report on how the legislation has affected the development, processing, and review of regulatory projects, as well as the procedures that are being developed by the Joint Committee - including procedures for ensuring a role for taxpayers - to implement the legislation. We also welcome a discussion of Treasury's role in determining whether an item constitutes a targeted tax benefit for purposes of the line-item veto.

VII. Extension of

Section 127

Congress's retroactive extension of the educational assistance exclusion of section 127 left taxpayers (employers and employees alike) who complied with the law in a worse position than taxpayers who disregarded the expiration of the income exclusion. TEI recognizes that it was Congress that made the policy decision to extend section 127 retroactively, and acknowledges that the position set forth in IRS Information Release 96-36 - requiring the filing of amended returns - can be justified under the statute. We continue to believe, however, that it should have been possible to craft a creative solution - such as permitting an adjustment to 1996 wages where the individual remained on the employer's payroll - that minimizes the adverse consequences for compliant employers, employees, and the fisc while obviating the filing and processing of amended returns. During the liaison meeting, we invite Treasury's comments on the process used to extend section 127, Treasury's role in the process, and how taxpayers may become more effective in focusing Congress's attention on the need for timely action and practical transition rules.

VIII. Request for Status

Reports

Time permitting, we request status reports on the following projects.

A. Technical Corrections. Kenneth J. Kies, Chief of Staff of the Joint Committee on Taxation, has reported that work is underway both on a general explanation ("bluebook") on the various tax bills that were enacted in the 104th Congress and on technical corrections legislation on those bills. Has the treasury Department identified any provisions affecting the business community that especially require either clarification in the bluebook or technical correction?

B. Interest Netting. On June 28, TEI filed comments on Notice 96-18, relating to issues surrounding the computation of interest where overpayments and underpayments of tax liabilities overlap. The Institute also testified at the IRS'S September 4 public hearing on Notice 96-18. During the liaison meeting, we request an update on the interest netting project, including a projected date for the release of the study.

C. Check-the-box Regime for Entity Classification. On August 9, TEI filed comments with the IRS on proposed regulations under section 7701, relating to the simplification of the Internal Revenue Code's entity classification rules; the Institute also testified at the IRS'S August 21 public hearing on the proposed regulations. During the liaison meeting, we request a status report on the regulations, especially on whether there are any open questions that TEI can help resolve. We particularly welcome Treasury's view of any congressional oversight of these regulations.

D. Section 482 Service Regulations. On July 24, TEI issued comments to the IRS on possible changes to the regulations under section 482, relating to intercompany services. During the liaison meeting, we request a status report on when such proposed regulations under section 482 may be issued.

E. CFC GAAP E&P Regulations. On June 30, 1992, the IRS issued proposed regulations under sections 952 and 964, relating to the use of generally accepted accounting principles (GAAP) to compute earnings and profits of foreign corporations. TEI filed comments the proposed regulations in October of that year, and in February of 1995 renewed our recommendation that final regulations be issued as soon as possible. During the on meeting, TEI requests a report the status of the GAAP E&P regulations.

F. Section 1494(c) Excise Tax. Section 1902 of the Small Business Job Protection Act added a new subsection (c) to section 1494, relating to the requirement that a return be filed by persons making a transfer described in section 1491. Although the legislative history of the provision discusses the penalty only in terms of the reporting requirements of foreign trust, there have been reports that the 35-percent penalty may also apply to property transferred to a foreign corporation as paid-in surplus or as a contribution to capital, or to any transfer of property to a foreign partnership. Given the August 20, 1996, effective date of the provision, the penalty represents a potentially harsh trap for the unwary. When can taxpayers expect guidance clarifying the reach of section 1494(c)? What form will that guidance take?

VI. Conclusion

TEI appreciates the opportunity to present its views and looks forward to its liaison meeting with the Department of the Treasury's Office of Tax Policy.

(1) This agenda is being prepared before the Institute appears at the National Commission's November 8 public hearing, but the liaison meeting is scheduled to follow that hearing. (2) See, e.g., "Omnibus Funding Bill Contains Clarification that SAIF Fee Is Fully Tax Deductible," BNA Daily Tax Report, DTR No. 191 (Oct. 2, 1996), at G-3.