Testimony on revised section 482 services regulations.

On October 27, 2006, JANICE L. LUCCHESI, Vice President of Tax for Akzo Nobel Inc., testified at an IRS hearing on behalf of TEI on The Proposed Regulations Relating to the Treatment of Services Under Section 482, The Allocation of Income and Deductions From Intangibles, and Stewardship Expense. TEI's detailed comments on the services regulations will be reprinted In the January-February 2007 issue.

Good morning. I am Janice Lucchesi, Vice President of Tax for Akzo Nobel Inc. in Chicago. I am here today as the chair of Tax Executives Institute's International Tax Committee. Thank you for the opportunity to present TEI's views on the revised section 482 services regulations.

TEI commends the government for substantially redesigning the 2003 proposed regulations. Those regulations presented many challenges to taxpayers, particularly the elimination of the cost safe harbor and its replacement with the simplified cost-based method, and TEI is gratified that the government responded to TEI's--and other groups'--concerns by, among other things, replacing the SCBM method with a services cost method under which covered services may be charged out at cost and proposing a revenue procedure detailing "specified covered services" eligible for the SCM.

First, I want to focus on the business judgment rule.

Under the revised regulations, two categories of covered services--"specified covered services" and "low margin covered services"--qualify for being billed at cost under SCM. (1) Specified covered services are those listed in a revenue procedure to be issued from time to time; low margin covered services are those for which the median comparable mark-up does not exceed seven percent. In addition, SCM may not apply to a specific list of excluded services. (2)

The regulations impose a restriction on the use of the SCM by requiring the taxpayer to "reasonably conclude in its business judgment that the covered services do not contribute significantly to key competitive advantages, core capabilities, or fundamental risks of success or failure in one or more trades or businesses of the renderer, the recipient, or both. In evaluating the reasonableness of the conclusion required by section (b)(2) consideration will be given to all the facts and circumstances." (3)

TEI recommends that this subjective "business judgment" qualifier on the use of the SCM be replaced with one that considers whether the taxpayer is in the business of providing the service. If so, the taxpayer may not treat the service as a specified covered service. The service may, however, still qualify as a low margin service under subparagraph (b)(4)(ii). If a taxpayer is in the business of rendering a service and comparable service providers earn a markup of seven percent or less on the rendering of that service, there is no reason to preclude the taxpayer from using SCM so long as it is not an excluded service.

Under TEI's recommended approach, a taxpayer would employ a three-step process to determine if it could use the SCM:

* Step 1: Determine whether the service is an excluded service. If it is, SCM may not be used. If it is not an excluded service, go to Step 2.

* Step 2: Determine whether the service is listed as a specified covered service. If it is not, go to Step 3. If it is, and taxpayer is not in the business of rendering the service, then SCM may be used. If it is, and taxpayer is in the business of rendering the service, go to Step 3.

* Step 3: Determine whether the service is a low-margin service. If it is, SCM may be used. If it is not, SCM may not be used.

We believe this approach is consistent with the examples under SCM--such as those involving high-end entertainment recruitment and sophisticated legal services--where it is evident that the government is concerned primarily with high-margin services. (4)

In addition, the provision of intercompany services within many corporate groups may be done by an affiliated group member with the sole function of providing intercompany services. In such a case, the service provider would fail to qualify for SCM because its sole business would be the providing of such services. TEI recommends that the determination of a taxpayer's trade or business for purposes of SCM be performed on a controlled group basis, including all members of the worldwide group. We understand that guidance on this issue will be issued by year-end.

If our alternative is not adopted, the regulations should at least clarify the business judgment standard. Helpful language is contained in the preamble, which provides: "Exact precision is not needed and it is expected that the taxpayer's judgment will be accepted in most cases." TEI requests that the language be included in the text of the regulation. In addition, TEI recommends that the regulation clarify the meaning of a taxpayer's business judgment, including who in the organization must make the judgment and how and when the judgment must be documented.

Our next series of comments will address Announcement 2006-50.

Two years ago, TEI urged the development of a per se list of low-margin and non-integral services that would qualify for a cost safe harbor. The bulk of back-office services C including finance, treasury, controller, accounting, legal, tax, human resources, and procurement C are routine, low-margin services for which charging cost is reasonable and requiring a mark-up would raise serious issues about double taxation. We are pleased the government accepted our recommendation to develop a more administrable solution.

Announcement 2006-50 sets forth a proposed revenue procedure listing 21 areas with descriptions of 48 activities that qualify as specified covered services.

To the extent a service is listed in this procedure, compliance burdens will be significantly reduced. TEI urges, however, that the government substantially broaden the criteria for inclusion on the list. This may be accomplished in several ways, but the approach should take into account the ways in which taxpayers customarily account for and bill their costs. Any structure designed independently of taxpayers' practices runs the risk of increasing compliance burdens because of the need to realign billing practices to fit the structure required by the revenue procedure. This severely limits the efficacy of the revenue procedure. Such a misalignment may force taxpayers to perform comparables studies for substantially all of their back-office services, thereby neutralizing the exception.

Our 2004 comments highlighted 12 categories of back-office services that should qualify for a cost safe harbor. Intended as illustrations of functions performed by corporate departments, these categories represent a structure more aligned with those used by many corporate taxpayers. TEI's list was based on general functions; in contrast, the proposed revenue procedure's list is based on specific activities. Thus, taxpayers would be required to keep track of their employee's time between activities that fall within the proposed list and those that do not. For example, the only tax services that are covered are payment of taxes and preparation of returns.

TEI urges the government to expand the list to broaden its approach to cover department-level services This could be done by expanding the list of activities covered in the 21 areas in the revenue procedure. For example, activities listed under Human Resources could include those most commonly performed by a human resources department, such as the list previously proposed in TEI's 2004 submission. Further, the revenue procedure should clarify that the listed activities are not exhaustive and similar services may also be included, provided they are topically related. This approach is consistent with the desire expressed in the announcement to minimize the compliance burdens applicable to such services.

Finally, because intercompany pricing may be set prior to "bill-outs" for services and taxpayers may not be able to delay billings, we recommend that the revenue procedure be issued in the fourth quarter of the year preceding the tax year for which the revenue procedure is effective.

Finally, the regulations propose to take effect for taxable years beginning after December 31, 2006. (5) TEI urges that the effective date of the regulations be delayed to taxable years beginning after December 31, 2007.

TEI appreciates this opportunity to testify on the proposed services regulations. We commend the Treasury and IRS for its willingness to consider recommendations for clarifying the proposed regulations to make them more administrable. TEI is continuing its review of the revised rules and will submit substantive written comments next month.

I would be pleased to respond to any questions you may have.

(1.) Temp. Reg. [subsection] 1.482-9T(b)(4)(i) & (ii).

(2.) Temp. Reg. [section] 1.482-9T((b)(3)(iii).

(3.) Temp. Reg. [section] 1.482-9T(b)(2) (emphasis added).

(4.) Temp. Reg. [section] 1.482-9T(b)(6), Exs. 4 &11.

(5.) Temp. Reg. [section]. 1.482-9T(n).