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

Minutes November 19, 1996

On November 19, 1996, Tax Executives Institute held its annual liaison meeting with the Assistant Secretary of the Treasury for Tax Policy and other senior representatives of the Treasury Department's Office of Tax Policy. The minutes of the meeting are set forth below.

Introduction

On behalf of the U.S. Treasury Department's Office of Tax Policy, Acting Assistant Secretary Donald C. Lubick welcomed the delegation from Tax Executives Institute. On behalf of TEI, TEI President James R. Murray thanked the Treasury representatives for meeting with the Institute. The Treasury's and Institute's delegations to the meetings are set forth in the box on the following page.

(The order of the items listed in TEI's agenda for the meeting was changed to accommodate the schedules of the Treasury Department representatives. For convenience sake, these minutes follow the Institute's written agenda.)

National Commission on Restructuring the Internal Revenue Service

Mr. Murray summarized his November 8, 1996, testimony before the National Commission on Restructuring the Internal Revenue Service. He explained that his testimony focused on the burdens imposed by current laws and the steps that can be taken to reduce those burdens. Specifically, Mr. Murray's testimony made the following points:

* The Desirability of Establishing an Administrability Index. The tax-writing committees should ask the IRS -- as well as the public -- to testify on the compliance burdens posed by all proposed tax legislation. Ideally, this testimony would be designed to ensure that clear, administrable, and cost-sensitive rules are enacted into law.

* Instability in the Tax Law. Congress needs to keep in mind that change itself is a complicating factor. In 1996 alone, six bills were passed that effected major changes in the Internal Revenue Code. The magnitude and rapidity of change only compound the already complicated nature of the law.

* The Search for More Revenue Without Raising Tax Rates. Each "revenue enhancer" or "loophole closer" that the Administration proposes and Congress enacts adds complexity to the tax law. Each time a legitimate deduction is curtailed, a new set of recordkeeping requirements is imposed. And each time the Code deviates from generally accepted accounting principles that business taxpayers employ for financial reporting purposes, there is a layer of complexity added to the tax law.

* The Use of the Tax Code to Promote Social and Economic Policies. Whether the goal of special provisions is to encourage home ownership through the mortgage interest deduction, to provide an incentive for research by means of the R&D credit, to aid low income Americans by the Earned Income Tax Credit (or Work Opportunity Tax Credit), to spur investment in Puerto Rico, or to enhance capital formation through the adoption of special provisions relating to capital gains, each provision -- regardless of its merits -- spawns tremendous compliance and planning burdens.

* The Alternative Minimum Tax. The decision to impose a "backstop" creates a horrifically complex alternative minimum tax scheme.

Assistant Secretary Lubick stated that Treasury is compiling a list of particular measures that need to be addressed in legislation; none of these items may be "earth shaking," he said, but in the aggregate the changes will reduce the tax law's complexity. He added that Congress needs to decide the priority to be assigned to tax simplification proposals. He invited the Institute's suggestions on what items should be addressed, though noted that there would be only a limited amount of revenue available to "pay for" simplification. He added that Treasury is well aware of the problems related to the alternative minimum tax (both the general "dual system" complication and the ensuing "train wreck" attributable to the interaction of the indexed regular tax exemption and brackets and the AMT regime).

Prospects for Fundamental Tax Reform

Mr. Murray referred to recent proposals to restructure the tax laws, for example, by adopting a flat or consumption tax. He asked for the Administration's views on the likelihood of fundamental tax reform. Although the diversity of its membership prevents TEI from taking a position on the various proposals, he said, the Institute believes it has a role to play in determining whether any particular proposal is administrable. Mr. Murray offered the Institute as a resource for sounding out new ideas, particularly in respect of administrative and transitional issues raised by the various proposals. Mr. Lubick thanked the Institute for its offer. He said that the Treasury Department does not view prospects for fundamental reform of the Code as great, but reiterated his earlier statement that some incremental "reforms" may overlap with simplification proposals.

Proposals for Reform of the International Tax Provisions

A. Treasury Conference on Formulary Apportionment. Mr. Rossi referred to the Treasury conference on formulary apportionment, which was scheduled for December 12. He stated that Mr. Cherecwich will attend the conference on behalf of the Institute. Noting that the speakers' list includes many proponents of a formulary approach, Mr. Rossi asked whether the conference will fully explore the problems with an apportionment-based system. For example, current-day formulae tend to focus on tangible property and generally ignore intangibles. In contrast, the arm's-length standard, as reflected in section 482 of the Code, applies to transfers of intangible property.

The Assistant Secretary emphasized that the purpose of the conference is to give proponents of formulary apportionment a "fair hearing." The Administration's support for the arm's-length standard and correlative opposition to formulary apportionment has not changed. He said the implementation and administration of a formulary apportionment scheme would likely be problematic and might well create more problems than it solves. He repeated that the purpose of the conference is to explore the issues, adding that he does not anticipate that it will prompt any change to the United States' fealty to an arm's-length standard.

In response to a question about the role of U.S. trading partners in any debate over formulary apportionment, Mr. Lubick agreed that international agreement would be necessary in order for any system to work. Mr. West added that collateral issues (such as the retention of deferral) would have to be addressed under a formulary apportionment system.

B. Prospects for International Tax Reform. Mr. Tann referred to S. 2086, which Senator Pressler had introduced in the 104th Congress to provide much needed simplification of the international tax provisions of the Code. He asked about the prospects for passage of such legislation in 1997, noting that Senator Pressler had not been reelected.

Mr. Lubick responded that he hopes the Administration's 1998 budget will include a large number of simplification proposals (including several dealing with international taxation); he added that it is unclear what proposals will be included. Mr. West noted that Treasury has previously testified about several proposals in the Pressler bill. Mr. Rossi asked about the prospects for eliminating the overlap between the rules for controlled foreign corporations and the passive foreign investment company rules, which the Administration previously supported. Mr. West stated that with the recent repeal of section 956A, the Administration's view may change because there is now no mechanism for policing the accumulation of passive assets. Treasury needs to study whether the elimination of the CFC/PFIC overlap should be opposed, he said.

C. Treasury Discussion Paper on Electronic Commerce. The Assistant Secretary reported that Treasury's discussion paper on electronic commerce will be released within the next few days. He invited the Institute's comments on the issues raised in the paper, adding that the report will not propose any new taxes on electronic commerce transactions. Rather, the report will address how current tax law principles apply to electronic commerce and whether they need to be clarified or recalibrated in light of technological developments. Mr. West described the discussion paper as the first step in the identification and analysis of the tax issues raised by electronic commerce. The United States and its trading partners must continue to refine their thinking about the taxation of electronic commerce, Mr. Lubick said, adding that the United States, Canada, and Australia have thus far done the most work on these issues. [Note: The Treasury's discussion paper was issued on November 21, 1996.]

Distinguishing Between Capital Expenditures and Ordinary and Necessary Expenses

Mr. Murray explained that TEI members continue to be concerned about the IRS and Treasury's actions in respect of the capitalization of expenditures and, in particular, about agents' invoking the Supreme Court's decision in INDOPCO v. United States, 503 U.S. 79 (1992), to justify the capitalization of heretofore currently deductible expenses. The uncertainty caused by this process -- which often produces deviations from U.S. generally accepted accounting principles -- creates complexity, he stated. Mr. Klausman remarked that tax executives are involved with determining the treatment of certain expenses on a day-to-day basis; we cannot wait for guidance but must make decisions, he stated. He explained that the problem areas are not those associated with mergers and acquisitions (which is what INDOPCO was concerned with) but with ordinary, recurring expenditures.

Mr. Klausman noted that in March the Institute filed extensive comments in response to IRS Notice 96-7, which requested taxpayer comments on the need for further capitalization guidance. At the Institute's liaison meeting with the IRS earlier in the day, Chief Counsel Stuart Brown remarked that the breadth and diversity of taxpayer comments demonstrates that there is no "magical solution" to whether an expenditure should be capitalized or currently deducted. Mr. Klausman lamented that IRS agents are essentially writing tax policy in the absence of National Office guidance. He added that such guidance was preferable to congressional micromanaging of the tax system; he cited the recent outcry over the release of TAM 9618006, which holds that a taxpayer must capitalize the costs of periodic airline maintenance expenses, as an example of what can happen in the absence of generally applicable guidance.

As an example of an area where taxpayers need guidance, Mr. Klaus man cited expenses for the modification of computer systems to deal with the Year 2000. Costs are being currently incurred -- the issue is percolating now -- and taxpayers cannot wait until, say 2005 for the IRS to determine whether the expenses are capital in nature, he said. He asked when taxpayers may expect guidance clarifying the IRS's position.

Assistant Secretary Lubick stated that guidance on the treatment of asbestos remediation and airline maintenance expenses is now under consideration by the Treasury Department. The Department has not been involved in this issue until recently, he explained, and is now reviewing the issues that have gained the most prominence. He asked for patience while the government works through the deliberative process. Treasury representatives have met with the IRS, as well as with aircraft industry representatives, to discuss the issues raised by TAM 9618006, he added.

Mr. Kohl noted that the IRS issued Notice 96-7 because of the debate over the expense versus capitalization of various items. The comments filed in response to the notice have been good, he stated, but do not address the fundamental issue of when a generic expense should be capitalized. Items that are not covered by a specific ruling create problems, he noted. Taxpayers and the government may have no choice but to engage in a fact-by-fact analysis of specific items, he stated.

Mr. Murray suggested that IRS agents have become more aggressive in their treatment of certain items, such as the cost of removal, that have long been currently deductible. The Assistant Secretary asked whether capitalization issues are a major focus of most audits. Mr. Murray answered affirmatively, adding that the majority of significant issues raised in a recent audit of his company centered on the capitalization of items. (Mr. Murray explained that with the capital gains differential and investment credit eliminated from the Code, capitalization issues are one of the "biggest games in town.")

Mr. Kohl inquired whether capitalization issues would still be raised, even if INDOPCO had not been decided. Mr. Wheeler remarked that the case has served to shift the spotlight onto capitalization issues. Mr. Murray agreed, saying the Supreme Court's decision seems to have "whetted the appetite" of field agents, though both he and Mr. Wheeler acknowledged that capitalization issues have always been present. Agents will seek to capitalize an item unless the taxpayer can produce a ruling specifically permitting expensing, Mr. Wheeler added.

Mr. Lubick asked whether taxpayers have resolved capitalization issues with the IRS's Appeals function and, if so, on what basis. Referring to the technical advice memorandum on asbestos costs, Mr. Murray noted that the taxpayer in respect of which the TAM was issued had won "99 percent" of the issue at Appeals. Mr. Kohl asked rhetorically whether the solution may lie with legislation similar to section 197, which resolved the issue of the appropriate amortization period for purchased intangibles. A systemic solution may be preferable, he added.

Mr. Lubick referred to TEI's submission on the treatment of environmental remediation expenses, commenting specifically on the myriad variations of fact patterns. Mr. Murray suggested that the government may be able to rely on the judgment of a taxpayer's independent auditor, perhaps requiring a certified statement similar to the one required for filings with the Securities and Exchange Commission. Mr. Thomson said, however, that reliance on audited financial statements may create a perception that the IRS is adopting a simpler rule for big business, while leaving smaller businesses (which may not have certified financial statements) grappling with the issues. Mr. Murray concluded the discussion by urging the Treasury Department to issue generic guidance soon.

Congressional Review of Regulations/Line Item Veto 

Mr. Tann referred to the recent enactment of legislation that 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; non-major rules are also subject to review (on an after-the-fact basis). 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. Mr. Tann asked about the effect of the legislation on tax guidance.

Mr. Thomson stated that Treasury has always believed it appropriate to give Congress a "heads up" concerning major regulatory guidance. The legislation formalizes a process that is already in place in respect of tax regulations, he explained. He added that the legislation was not aimed at the IRS, but rather at regulatory agencies such as the Occupational Safety and Health Administration and the Environmental Protection Agency whose regulations were viewed as potentially intrusive or burdensome. Congress, however, could not very well exempt the agency with the largest volume of regulations. Mr. Thomson predicted that the legislation will rarely be used to abrogate tax regulations.

Mr. Tann suggested that few Treasury regulations will constitute "major rules" under the law. Mr. Thomson agreed, but added that virtually all regulations (plus revenue rulings and procedures) will be referred to Congress for review. He added that the new legislation will have no effect on effective dates because IRS guidance will not be considered major rules. The review, however, will increase the workload of the staff of the Joint Committee on Taxation who will have to review and summarize the regulations. Mr. Thomson said the process will keep Congress better informed about IRS policies.

Mr. Miller stated that the congressional review of rules under the new legislation has been streamlined and should not interfere with the release of Treasury and IRS guidance. Mr. Thomson agreed, adding that Treasury has always found its discussions with the Joint Committee staff about regulatory projects to be productive. Mr. Miller predicted that the recent requirements for review of IRS regulations under the Regulatory Flexibility Act to determine the effect of rules on small business may have a greater effect on how guidance is issued. For example, including an election in regulations will require an analysis under the Act to determine the paperwork burden.

Mr. Tann asked about the effect of the Regulatory Flexibility Act on the "check-the-box" regulations under section 7701. Mr. Thomson replied that the law will not affect the release of the simplified procedure for entity classification. Treasury is comfortable with its decision that the new procedure will not materially affect small businesses, he said. He referred to the recently announced review of the entity classification regulations by the Joint Committee staff; Treasury has previously discussed the regulations with the staff and will work with the staff to resolve any open questions. The Joint Committee review will not affect the release of final regulations, he added. [Note: The final entity classification regulations were issued on December 17, 1996.]

Mr. Thomson noted that the regulatory approach embodied by the check-the-box regime represents an effort to "push the edges" to ease administrative burdens (subject to fiscal constraints). The simplified election is not a universal solution, however, and has fostered a useful debate about the Treasury's authority, he said. Mr. Tann inquired about the effect of a determination by the Joint Committee staff that the IRS and Treasury lack the authority to issue the regulations. Mr. Thomson said he doubted such a determination would be forthcoming but that Congress clearly had the prerogative to pass a statute invalidating the regulations. Treasury would, of course, abide by the law. He added that in Treasury's view the check-the-box proposal merely shines a spotlight on the state of the current law of entity classification -- enabling taxpayers to achieve the same results without all the transaction costs. Treasury feels strongly that its regulatory approach is valid, he said.

Extention of Section 127

Mr. Cherecwich explained that 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 (subsequently vitiated) expiration of the income exclusion. The Institute recognizes that it was Congress that made the policy decision to extend section 127 retroactively, but taxpayers are frustrated over the administrative burdens spawned by that decision. Although the position set forth in IRS Information Release 96-36 (requiring the filing of amended Forms W-2 and 1040) can be justified under the statute, Mr. Cherecwich said, 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 -- to minimize the adverse consequences for compliant employers, employees, and the fisc while obviating the filing and processing of amended returns. He asked, how can this be prevented in the future?

Mr. Iwry called the process used in ending section 127 "regrettable," particularly because the final legislation caused good tax citizens more problems than it did for non-compliant ones. He explained that the Treasury and IRS had studied the issue carefully, but concluded that their options were limited by the statutory language.

Mr. Cherecwich stated that the tax system should encourage voluntary compliance, and reiterated that the process used in extending section 127 actually discourages compliance. Mr. Rossi added that the provision is set to expire again in 1997. He asked whether the Clinton Administration's 1998 budget will propose making the exclusion permanent. Mr. Iwry stated that the Administration had proposed a permanent extension of the educational assistance exclusion in 1996, but was unsuccessful in persuading Congress to enact it. Messrs. Thomson and Iwry agreed that an administrable solution to the retroactive extension of section 127 should be included in future legislation, but explained that there are several policy issues to be considered before permitting taxpayers to "mix" income and expenses in different taxable years. TEI offered its assistance in helping the Treasury Department develop alternatives that minimize administrative burdens.

Referring to his testimony before the IRS Restructuring Commission, Mr. Murray observed that the Institute has proposed the development of a so-called administrability index to measure both (1) the ability of the IRS to administer proposed provisions and the estimated cost of doing so and (2) the ability of taxpayers to comply with the provision and the estimated cost of doing so. The section 127 extension and the lobbying expense disallowance rules are prime candidates for the use of such an index, he remarked. In response to questions, Mr. Murray explained that the index should be developed and released early in the legislative process to heighten awareness of the administrative burdens imposed by certain legislative proposals. Mr. Murphy added that Congress should also look to the IRS before legislation is enacted to determine whether a provision is administrable.

Mr. Weller referred to the release of the proposed section 671 regulations, relating to the use of grantor trusts, especially in respect of their application to foreign deferred compensation plans. It was a difficult project, he explained, requiring a knowledge of accounting, trust, and pension rules. He stated that there has been little reaction to the proposed rules and asked for the Institute's comments. Mr. Murray stated that a request for comments has been posted on TEI On-Line, the Institute's electronic communications system, but few comments have been forthcoming. Mr. Weller reiterated the Treasury's desire for the Institute's help, especially in respect of the interaction of section 671 with the section 404A rules. [Note: The Institute's International Tax Committee and the Federal Tax Committee's Employee Benefits Subcommittee subsequently undertook drafting comments on the regulations.]

Status Report on Regulatory Projects

A. Technical Corrections. Assistant Secretary Lubick reported that Treasury has identified several technical corrections in the pension provisions enacted during the last year. Mr. Shewbridge asked if the issues will be clarified in the Joint Committee's general explanation of 1996 tax legislation ("bluebook"). Mr. Lubick believed that the better approach is to clarify issues through administrative guidance, such as regulations.

B. Interest Netting. Mr. Cherecwich referred to the Institute's June 28, 1996, comments on Notice 96-18, relating to issues surrounding the computation of interest where overpayments and underpayments of tax liabilities overlap. He requested an update on the interest netting project, including a projected date for the release of the joint IRS-Treasury study on interest netting.

Mr. Thomson stated that Treasury is uncomfortable about expanding the scope of interest netting under current law, in spite of the legislative history of the Tax Reform Act of 1986. He added that the Department does not object to the concept of netting, but is concerned about the legal authority to implement netting and the administration of such a system. Mr. Cherecwich inquired whether any legislative fix will be subject to "scoring" for budget purposes. Mr. Thomson said yes. He added that the IRS-Treasury report will be released by January 31, 1997. [Note: TEI sent a follow-up letter on interest netting to Treasury Secretary Rubin on December 30, 1996.]

C. Check-the-Box Regime. Mr. West stated that the final regulations under section 7701 of the Code, relating to the simplification of the entity classification rules, will be issued before the end of the year. [Note: The final regulations were issued on December 17, 1996.]

D. Section 482 Service Regulations. Ms. Walker requested the status of possible changes to the regulations under section 482, relating to intercompany services. Mr. West referred to the Institute's July 24, 1996, comments and said he is unsure whether the project will be included on the 1997 business plan. Mr. Kohl added that the definition of what constitutes "services" is an important concept for many aspects of the Code.

E. CFC GAAP E&P Regulations. Five years ago, in June 1992, the IRS issued proposed regulations under sections 952 and 964, relating to the use of generally accepted accounting principles (GAAP) to compute the earnings and profits of foreign corporations. Mr. Ezrati stressed the importance of the project and asked the status of the regulations. Mr. West agreed that the regulations represent a significant simplification of the area. Referring to his recent employment by Treasury, he stated that he would inquire about the reasons the final regulations have not been issued. [Note: TEI sent a follow-up letter on the GAAP E&P regulations to Mr. West on December 4,1996.]

F. Section 1494(c) Excise Tax. Mr. Tann referred to section 1902 of the Small Business Job Protection Act, which added section 1494(c), relating to the requirement that a return be filed by persons making a transfer described in section 1491 and imposing a significant penalty for noncompliance. Although the legislative history of the provision discusses the penalty only in terms of the reporting requirements of foreign trusts, there have been suggestions 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. He commended Treasury for issuing Notice 96-60, which suspended enforcement of the excise tax until further guidance is issued and inquired about the status of that guidance. Mr. West stated that Treasury is currently reviewing the issue. One approach under consideration is to require filings on only an annual basis.

Conclusion

The Treasury representatives expressed their appreciation for the time and effort put into the meeting by TEI and urged the Institute to continue to bring issues to Treasury's attention. Mr. Murray then thanked the Treasury representatives for meeting with the Institute.

RELATED ARTICLE: Treasury Delegation

Donald C. Lubick, Acting Assistant Secretary (Tax Policy) Glen A. Kohl, Deputy Assistant Secretary Michael D. Thomson, Tax Legislative Counsel J. Mark Iwry, Benefits Tax Counsel Victoria Judson, Deputy Benefits Tax Counsel Robert H. Miller, Deputy Tax Legislative Counsel Philip R. West, Deputy International Tax Counsel Harlan M. Weller, Government Actuary 

TEI Delegation

James R. Murray(*) (PacifiCorp), TEI President Paul Cherecwich, Jr.(*) (Thiokol Corporation), TEI Senior Vice President Lester D. Ezrati(*) (Hewlett-Packard Company), TEI Secretary Charles W. Shewbridge, III(*) (BellSouth Corporation), TEI Treasurer Susan M. Murray(*) (ENRON Oil & Gas Company) Raymond G. Rossi(*) (Intel Corporation) Donna Lee Walker(*) (PPG Industries, Inc.) Roger M. Wheeler(*) (General Motors Corporation) Robert L. Ashby (Northern Telecom Inc.),

Chair, TEI IRS Administrative Affairs Committee David L. Klausman (Westinghouse Electric Corp.),

Chair, TEI Federal Tax Committee Joseph S. Tann, Jr. (Ameritech Corporation),

Chair, TEI International Tax Committee Michael J. Murphy, TEI Executive Director Timothy J. McCormally, TEI General Counsel and Director of Tax Affairs Mary L. Fahey, TEI Assistant Tax Counsel Jeffery P. Rasmussen, TEI Assistant Tax Counsel

(*)Indicates Member of TEI Executive Committee