Tax Executives Institute-U.S. Department of Treasury Office of Tax Policy Liaison meeting minutes.

February 8, 2006

On February 8, 2006, The Tax Executives Institute met with representatives of the Office of Tax Policy and of the Department of Treasury. Note: These minutes were prepared by Tax Executives Institute, and although reviewed by the Treasury Department, they have not been formally approved by the Department. The Treasury's and TEI's delegations to the meeting are listed on page 253.

I. Introductory Comments

On behalf of the U.S. Treasury Department's Office of Tax Policy, Acting Deputy Assistant Secretary for Tax Policy Eric Solomon welcomed TEI President Michael P. Boyle and the other members of the delegation from Tax Executives Institute to the liaison meeting. Mr. Solomon said that he was pleased to be able to meet with TEI. Mr. Boyle thanked the government representatives for taking time to meet with the Institute.

II. Pending Legislation

A. Budget Proposals and Extension of the Research Credit.

Mr. Boyle observed that the Administration's fiscal 2007 budget proposals were released two days prior to the meeting. The American Competitiveness Initiative announced during the President's State of the Union message includes a proposal to make the research credit a permanent part of the Internal Revenue Code. He said that TEI supports making the credit permanent. Mr. Solomon said that the Treasury Department looks forward to working with Congress on the President's proposal. He invited TEI to submit comments on the Administration's other budget proposals.

B. Codification of Economic Substance Doctrine.

Ms. Bauer said that TEI submitted a letter to the congressional tax-writing committees in January urging them to reject the proposal to codify the economic substance doctrine that is included in the Senate-passed version of the fiscal 2006 tax reconciliation bill (S. 2020). Ms. Bauer explained that in TEI's view codifying the economic substance doctrine is unnecessary and counterproductive. She observed that in the past the Treasury Department has expressed opposition to codification of the economic substance provision and inquired whether the Treasury Department remains opposed to the proposal. She also asked whether the Treasury Department is currently considering other regulatory initiatives to curb tax shelter transactions.

Mr. Solomon acknowledged that the Treasury Department remains opposed to the codification of the economic substance doctrine. [Note: On February 23, 2006, Treasury Secretary John Snow sent a letter to the chairs of the congressional tax-writing committees urging them, among other things, to reject the proposal to codify the economic substance doctrine.] In respect of other tax shelter initiatives, Mr. Desmond explained that the Treasury Department is working with the IRS to finalize regulations on the disclosure, penalty, and tax shelter registration provisions that were part of the 2004 Tax Act.

III. Tax Reform

Mr. Boyle noted that President's Advisory Panel on Tax Reform presented its recommendations to Treasury Secretary Snow on November 1, 2005. Mr. Boyle inquired about the Treasury Department's timetable relating to tax reform as well as the best avenue for TEI and others to submit input to the Treasury Department. Mr. Solomon said the Treasury Department is studying the recommendations submitted by the Advisory Panel and others. He acknowledged that the Treasury Department's tax reform activities have not been visible in the press, but assured the TEI group that tax reform is a very active topic within the Department. He invited TEI to submit its views on various tax reform issues, noting that the organization's diverse membership enables it to reflect the overall business community's reaction to various proposals. In addition, TEI can provide meaningful input on the administrability of the proposals. Mr. Boyle agreed that TEI is a broad-based business group with diverse views, especially on legislative issues. There is a strong consensus, though, that the business tax burden should not be increased to "pay for" individual tax relief. Mr. Solomon acknowledged that criticism is frequently expressed about the 1986 Tax Reform Act. Mr. Hicks said that a number of international tax provisions of the Code are ripe for reform because they are more than 40 years old and based on an outdated model of the U.S. and global economies.

IV. Circular 230

Ms. Twinem noted that the Treasury Department and IRS issued final regulations in May 2005 amending the rules governing practice before the IRS. The rules clarify that in-house tax practitioners are to be treated as a distinct category of tax professionals for purposes of Circular 230 and that written advice provided by in-house counsel to the employer for purposes of determining the employer's tax liability is excluded from the definition of a covered opinion under section 10.35 of Circular 230. She commended the Treasury and IRS for recognizing that the application of section 10.35 to in-house tax practitioners would have raised numerous issues and might have impaired the provision of sound and timely tax advice to the practitioner's employer. She said that regulations do not define the term "employer" and urged the Treasury Department to provide a broad definition. She explained that in-house counsel are often called upon to render advice for numerous entities beyond the W-2 employer, and invited the Treasury Department's views on TEI's recommended clarification of the scope of the term "employer" as well as an update on the timing of, and prospects for, changes to the Circular 230 regulations.

Mr. Solomon acknowledged that it would be helpful to clarify the meaning of the term "employer" in Circular 230. Numerous comments from members of the American Bar Association, the American Institute of Certified Public Accountants, and other professionals have stimulated a broad scope review of the effect of the final Circular 230 regulations on public practitioners. Clarifying the definition of employer is important, but of narrower interest overall. Moreover, given the scope of the review, it is unclear when additional guidance might be issued.

V. Other Regulatory Actions and Initiatives

A. Notice 2006-6.

Ms. Bauer said that at the previous day's liaison meeting, Internal Revenue Service officials said they would clarify that Notice 2006-6 applies to all book-tax differences reported on tax returns filed after the date of the notice even where the transaction takes place before the date of the Notice.

Mr. Solomon noted that, because of collaborative efforts with TEI and others, the IRS and Treasury Department were able to develop a workable Schedule M-3 for Form 1120 for disclosure of book-tax accounting differences. He said that the final form balances the government's need for information with the disclosure burden on taxpayers and represents an example of the consensus that can emerge in a give and take between government and business taxpayers. He expressed appreciation to TEI for its active participation in the project. Mr. McCormally said that Neil D. Traubenberg of Sun Microsystems chaired TEI's Schedule M-3 workgroup. Mr. Boyle noted that, while some members had questioned TEI's participation in shaping the form, the Institute was convinced that the end result was better because of its involvement. Mr. Solomon agreed. The final form represents a fair compromise among interests, he concluded.

B. Taxation of Cross-License Agreements.

Ms. Lucchesi said that the longstanding treatment of cross-licensing agreements (CLA) is that they constitute a netting arrangement that does not result in the recognition of income to the extent the rights exchanged between the parties are of equal value. She noted that the IRS is apparently working on a technical advice memorandum that may significantly alter the treatment of CLAs, especially in the cross-border context.

Mr. Hicks said the Treasury Department does not become involved in taxpayer-specific cases, and suggested it was appropriate to let the audit process run its course. He indicated that there is no longstanding tax policy with respect to cross licenses. If public guidance is ultimately issued in respect of cross-license agreements, he said, the Treasury Department will be involved and it is aware of the potentially unsettling effects a change in current policy might cause. He asked whether companies are receiving information document requests about their cross-license agreements. Ms. Lucchesi said that a number of taxpayers have received requests similar to the taxpayer involved in the TAM process. Mr. Solomon assured TEI that the Treasury Department is sensitive to the ramifications of the issues, adding that it will initiate a guidance project if a policy call is required. [Note: On March 15, 2006, the IRS issued Notice 2006-34 soliciting comments about various issues in respect of cross-license agreements.]

C. Cost-Sharing Arrangements.

Ms. Lucchesi referred to the proposed regulations under section 482 addressing cost-sharing arrangements (CSAs). She said that the current regulations treat the buy-in payment and ongoing cost-sharing payments as independent transactions. The proposed regulations, she said, inappropriately fuse the preliminary and contemporary transactions with the ongoing CSA payments. As a result, the proposed regulations understate the financial return to an entity that does not contribute intellectual property. CSAs, she concluded, are simply a method of sharing research and development costs.

Mr. Hicks said that regulation writers should in general be on guard against writing regulations to prevent the worst cases of abuse because it can make the regulations very complex. He added that the government is very concerned about writing regulations that might undermine legitimate cost-sharing agreements. A number of complaints about the rules revolve around fears that the government would kill cost-sharing agreements, he said. The current cost-sharing regulations have a number of holes in them and many taxpayers are engaging in sophisticated tax planning to circumvent the rules. Mr. Hicks acknowledged the criticism of the proposed transition rules and indicated that the Treasury is open-minded about modifying the rules. One significant ancillary benefit of the proposed regulations, he said, is that taxpayers have been compelled to reexamine their transfers of intellectual property and have come forward to the Treasury Department to discuss how their CSAs are affected by the new rules. (In that sense, the CSA rules are different from the proposed section 482 services regulations, which affect nearly every taxpayer in the same fashion.) He explained that taxpayers who have supplied information to the Treasury Department about how their CSAs are affected by the proposed rules have made recommendations that will assist the Treasury Department improve the regulations.

Mr. Hicks acknowledged that new rules intentionally require a greater return to the party contributing intangibles to a CSA. The rules were drafted to rein in some of the abuses in the allocation of benefits to noncontributing entities that the Treasury Department and IRS encountered. He urged taxpayers to work with the Treasury Department by developing a list of the top 10 or 12 changes that the Treasury Department can adopt to improve the proposed rules. Retaining the current regulations' approach, he said, is not feasible. Ms. Lucchesi said that she would contact the members who contributed to TEI's comments to assess interest in a follow-up meeting with the Treasury Department. Mr. Hicks said that any follow-up meeting should be held soon since the IRS and Treasury Department would like to issue final regulations by the end of the calendar year.

Ms. Lucchesi inquired whether the Treasury Department has other ongoing guidance projects on the treatment of intellectual property. Mr. Hicks said that the top three international projects in this area are finalizing the proposed section 482 services regulations, finalizing the proposed CSA regulations, and issuing new proposed regulations under section 367(d). He said the current section 367(d) regulations are out of date, especially for transfers of foreign goodwill and going concern value. The issue, he said, is what transfers of intangible rights should be taxable or exempt. He noted that transfers of foreign goodwill and going concern value would likely remain exempt under section 367(d), but the question is whether the value transferred offshore is attributable to the exempt items. For example, is a workplace-in-force intangible inside or outside the foreign goodwill exception? Mr. Dilworth noted that the current 367(d) regulations were issued before the enactment of section 197, relating to the amortization of goodwill and other intangible property.

Mr. Hicks said the Treasury Department hopes to move forward this year on regulations governing CSAs. Proposed section 367(d) regulations, he said, would likely be issued by the end of the calendar year. The section 482 services regulations would likely be issued by the end of the current guidance priority plan year (i.e., by August), but the Treasury Department has made no decision whether to re-propose those regulations or issue them as temporary or final regulations.

Ms. Lucchesi noted that TEI and others have recommended that the Treasury Department issue an angel list of simplified services for which no (or a minimal) markup over cost would be required. She asked whether the Treasury Department would issue such a list. Mr. Hicks replied that the cost method has its appeal in the services area and there is interest in the Treasury Department in restoring some form of cost method to the regulations. The issue is still under discussion.

Mr. Dilworth inquired whether the Institute has considered what the proper treatment of CSAs should be under a territorial tax system, which was one of the recommendations the President's Advisory Panel on Tax Reform included in its simplified income tax proposal. He explained that under such a system deductions for CSA payments would likely be disallowed. Ms. Norton replied that most taxpayers likely have not considered the implications of a territorial system on CSAs. Mr. Boyle said that there are a number of other open issues under a territorial system such as what is in or out of the territorial system and whether royalties would be considered active or passive income. The Institute is studying those proposals, he said.

D. Section 199 Domestic Manufacturing Deduction.

1. Item-by-Item Determination and Shrink-Back Rule. Ms. Twinem referred to the proposed regulations under section 199. She noted that as taxpayers implement the requirements in their compliance information systems, they have begun to focus on the complexity of the proposed rules. Moreover, in some cases, the benefit of applying the rules is attenuated relative to the cost of implementing the rules and documenting the benefit. Even worse, there seemed to be no way to elect out of the provision and claim no deduction. A simpler compliance method might be beneficial, she said, especially where the shrink-back method must be applied to determine whether receipts for an item qualify as domestic production gross receipts (DPGR). Mr. Solomon inquired whether Ms. Twinem was asking for an "opt-out" provision. Ms. Twinem responded that taxpayers should be permitted not to claim a section 199 deduction.

Mr. Manousos said that the legislative history of the section 199 deduction is clear that Congress intended to create a shrink-back rule, explaining that the coffee footnote in the committee report concerning the distinction between the qualifying production activity of coffee-bean roasting and brewing and selling coffee at a retail store demonstrated that congressional intent. This interpretation, he added, was confirmed in the Joint Committee on Taxation's explanation of the 2004 Tax Act, which clarifies that the shrink-back rule applies throughout section 199.

Mr. Manousos said the Treasury Department is sympathetic to the compliance burden and is considering alternatives to simplify compliance with the shrink-back rule. An option to elect out of the provision on an item-by-item basis, however, is likely not viable because it might introduce a transaction-by-transaction approach that in the Treasury Department's view was not intended by Congress. As an example of a rule of administrative convenience, he said, the Treasury Department is considering the cost-to-cost ratio suggested in TEI's agenda. In other words, taxpayers might be permitted to elect to apportion their gross receipts between the qualified and nonqualified components of their items based on the relative cost of a qualified item incorporated in the property sold. Another possibility, he said, would be to create a reverse safe harbor. In this case, if a de minimis percentage of an item's gross receipts, say five percent or less, were qualified DPGR, the taxpayer might be permitted to treat the entire amount of the item's sales as non-DPGR. Mr. Manousos described a sympathetic example of a case where the shrink-back rule might lead to a compliance burden exceeding the benefit of the deduction. Applied strictly, he said, the shrink-back rule would require a steel manufacturer (company A) that sells a company A owned vehicle, which is used in A's business by A's employees and was manufactured by automobile manufacturer (company B) using steel purchased from company A, to obtain a certification from B of the amount of steel manufactured by company A that was included in the manufacture of the car sold by Company A. That certification would permit A to calculate the DPGR attributable to the steel in the vehicle that is sold.

2. Exclusion of Freight Receipts from DPGR. Ms. Twinem inquired about the requirement in the proposed rules to exclude freight from DPGR where the freight (or other incidental service) exceeds five percent of the gross receipts from the sale of the item. Most companies, she said, provide shipping as a convenience to their customers and make little or no profit (or loss) from their freight receipts. Mr. Manousos acknowledged that the Treasury Department has received comments on the treatment of freight receipts and that it is considering modifying the treatment of ancillary services in the final regulations. A "no-profit" test, however, may be too nebulous and difficult to administer. One way to address taxpayer's concerns, he said, might be to increase the de minimis threshold percentage for ancillary services like freight and installation costs.

3. Attribution of Partnership Activities and Income to Partners for Determination of QPAI. Ms. Twinem referred to an exception in the proposed rules that would permit attribution of partnership manufacturing activities to a partner in certain cases, i.e., for partnerships involved in the production or extraction of oil and gas. She inquired whether the Treasury Department is considering expanding the rules to address other cases where property is manufactured, produced, grown, or extracted (MPGE) by partnerships and joint ventures and distributed in kind to the partners. She said that chemical manufacturers and electric power companies frequently use joint ventures for the production of their products and also distribute the property in kind.

Mr. Solomon said that the Treasury Department has also heard from the mining industry on the issue. Mr. Manousos explained that the exception accorded to oil and gas companies is based on the historical industry practice of in-kind distribution of the extracted products. Absent the in-kind distribution rule, clearly qualified MPGE activity and items would result in no DPGR upon eventual sale of the items by the partners. Mr. Manousos said that a number of underlying principles were used to accord the exception to the oil and gas industry. The Treasury Department is refining those principles, 2he said, and may publish them in the final regulations; the Treasury Department is also considering the comments requesting attribution of partnership activities in a wider variety of eases. Industry norms may be one of the guiding principles.

4, Intercompany Interest Payments. Mr. Manousos explained that within an affiliated group filing a consolidated return there should be no net interest income or expense on the intercompany payment, but the manner in which qualified production activity income (QPAI) is calculated and allocated among the members of an affiliated group is controlled by section 1502.

5. Timing of Final Regulations and Effective Dates. Mr. Manousos said that the Treasury Department has received more than 80 sets of comments on the proposed rules. He added that there are only a handful of policy issues (such as in-kind partnership distributions, the item-by-item calculation, and the treatment of fees for online use of software) that need to be addressed. He added that more than 350 technical issues were raised in the comment letters and the IRS and Treasury Department have addressed about 300 of them. The final regulations are targeted for release around April 30. The government is acting quickly, he said, because taxpayers have expressed a desire for expeditious guidance in order to reflect the tax benefit properly in their financial statements.

Mr. Manousos said the effective date of the final regulations is unclear. It is unlikely that the regulations would be retroactive to January 1, 2005; most likely, he said, the regulations would either be prospective or possibly retroactive to January 1, 2006.

E. Section 965 Dividends Received Deduction.

Mr. Solomon inquired whether taxpayers are seeking additional guidance on residual issues under section 965. He gave kudos to the Office of International Tax Counsel and the Office of the Associate Chief Counsel (International) for developing comprehensive guidance in the three Notices addressing the provision. Mr. Hicks noted that the rules were largely taxpayer favorable. Mr. Dicker suggested that any remaining issues under section 965 would likely be specific to a taxpayer's facts and circumstances and not susceptible to broad-based guidance. He expressed the hope that common sense would prevail in respect of audit issues. For example, a minor foot fault on the Board's adoption of the repatriation plan should not result in the entire amount of the distribution failing to qualify for the deduction. Mr. Hicks said that if taxpayers play it straight, the IRS likely would not nit pick issues on examination. Ms. Lucchesi said that because of the large sums of money and tax benefits involved, taxpayers were very conservative in applying the guidance in the Notices.

F. Status of Reports Mandated by the 2004 Tax Act.

Ms. Lucchesi noted that the 2004 Tax Act directed the Treasury to conduct studies and report back to Congress in respect of (1) the effectiveness of the section 482 regulations, especially in respect of the treatment of intangible property; (2) the effect of the section 163(j) earnings stripping rules on the tax base and jobs in the United States; (3) U.S. tax treaties, including the effectiveness of anti-abuse provisions; and (4) the effect of section 7874 on corporate inversions. She inquired about the status of the four studies.

Mr. Hicks said that the Treasury Department has devised a work plan to finish the first three studies by December 2006. The final study, relating to the effect of section 7874 on corporate inversions, will likely be deferred until the guidance about that provision has been issued and in effect for awhile. Ms. Lucchesi offered TEI as a resource for input on the Treasury Department's studies. Mr. Hicks thanked Ms. Lucchesi for the offer, saying taxpayer input on all the studies would be beneficial.

G. Tax Treaties.

Mr. Alicandri requested a general update on the status of various tax treaties and inquired specifically about the prospects for nil or reduced withholding tax rates for dividends and interest under the Canadian tax treaty. Mr. Hicks noted that the Senate Foreign Relations Committee held hearings the previous week on new tax treaties with Sweden, Bangladesh, and France. He added that negotiations with Germany and Canada are ongoing but close to a final agreement. In addition, the Treasury Department is in active discussions with another half dozen countries. If negotiations are concluded on several more treaties, another hearing may be scheduled this year. In all treaty negotiations, he said, the Treasury Department looks for opportunities to (1) reduce double taxation, (2) improve or add articles relating to the exchange of information, (3) enhance limitations on benefits, and (4) incorporate zero or reduced rates of withholding taxes. Mr. Hicks noted that the U.S. Model Tax Treaty likely would not include a zero rate withholding tax because that would reduce or eliminate the country's flexibility in treaty negotiations. Mr. Hicks said that he has not been directly involved in the negotiations with Canada, but Germany has expressed interest in reducing the rates of some withholding taxes.

H. Withholding on Personal or Entertainment Use of Corporate Aircraft.

Mr. San Juan said that the Treasury Department is interested in issuing regulations on withholding related to the personal or entertainment use of corporate aircraft by the end of the current calendar year.

I. Dual Consolidated Loss Regulations.

Ms. Lucchesi inquired about the status of the proposed dual consolidated loss regulations issued in May 2005. Mr. Hicks replied that final regulations under section 1503(d) are a significant priority for the Treasury Department and the goal is to issue final rules during the current calendar year. He said that the guidance team has begun meeting again and there will likely be significant changes in the final regulations.

Ms. Lucchesi referred to Notice 2006-13, which was issued during the preceding week. The Notice permits taxpayers that fail to timely file statements and other notifications under section 1504(d) to seek relief under the reasonable cause procedures specified in the proposed regulations. In cases where a taxpayer fails to timely file a closing agreement under Treas. Reg. [beta] 1.1502-2(g)(2) upon the occurrence of a triggering event, though, taxpayers must still seek relief under section 9100. She asked why the reasonable cause procedures were not available in this circumstance. Mr. Hicks said the Notice is a product of a compromise with the field and the Treasury Department is still studying how or whether the Notice procedure would be incorporated in the final regulations. Mr. Hicks invited TEI to comment on the Notice.

In another issue under the dual consolidated loss rules, Mr. Hicks said that the United States is hoping to reach an agreement with the United Kingdom in respect of the treatment of dual consolidated losses under the mirror legislation rule of section 1503(g)(1). He said he has concerns about the mirror legislation rule because its effect is to deny the use of the loss in every jurisdiction; on the other hand, the United States does not wish to be the jurisdiction absorbing the loss in every case and situation. Hence, an agreement process will provide an avenue to share such losses with other jurisdictions. Mr. Dilworth inquired if TEI is aware of other jurisdictions--apart from the United Kingdom, Australia, New Zealand, and Germany--where mirror legislation dual consolidated loss disallowance rules have been adopted. After discussion, TEI said it is unaware of any other jurisdictions with a similar rule.

VI. Conclusion

Mr. Boyle thanked the Treasury Department representatives for their participation in the meeting. On behalf of the Treasury Department, Mr. Solomon expressed his appreciation for the time and effort the TEI representatives devoted 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

Eric Solomon

Acting Deputy Assistant Secretary

(Tax Policy)

Michael J. Desmon

Deputy Tax Legislative Counsel

Harry J. (Hal) Hicks III

International Tax Counsel

W. Thomas Reeder

Acting Benefits Tax Counsel

Robert H. Dilworth

Senior Advisor 

David Emick

Attorney-Advisor

Andrew Frobert

Attorney-Advisor

Eric San Juan

Attorney-Advisor

George Manousos

Tax Specialist

Donald Kiefer

Director, Office of the Deputy Assistant

Secretary (Tax Analysis)

TEI Delegation

Michael P. Boyle

Microsoft Corporation 

TEI President

David L. Bernard

Kimberly-Clark Corporation

TEI Senior Vice President

Vincent Alicandri

Hydro One Networks, Inc.

Tei Treasurer

Lisa Norton

Amazon.com, Inc.

TEI Executive Committee

Carita R. Twinem

Briggs & Stratton Corporation

TEI Executive Committee

Susan A. Bauer

Arby's Restaurants, Inc.,

Chair, TEI Federal Tax Committee

Janice L. Lucchesi

Akzo Nobel, Inc.

Chair, TEI's International Committee

Kelly A. Nall

Electronic Data Systems Corp.,

Chair, TEI IRS Administrative Affairs Committee

Timothy J. McCormally

TEI Executive Director

Eli J. Dicker

TEI Chief Tax Counsel

Mary L. Fahey

TEI General Counsel

Jeffery P. Rasmussen

TEI Tax Counsel