Use of GAAP to compute the earnings and profits of controlled foreign corporations.

On September 2, 1998, Tax Executives Institute submitted the following comments to the Internal Revenue Service in connection with the IRS's request for information on the collection of information under sections 952 and 964 of the Internal Revenue Code. The comments were prepared under the aegis of the Institute's International Tax Committee whose chair is Michael P. Boyle of Microsoft Corporation. TEI's previous comments on this subject -- which are referred to in the following submission -- were reprinted in the November-December 1992 issue of The Tax Executive.

This letter responds to the Internal Revenue Service's recent request for comments on the collection of information under the proposed section 952 and 964 regulations, relating to the computation of the earnings and profits of foreign corporations. The regulations were issued on June 30, 1992, and would eliminate the need to adjust financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) with respect to uniform capitalization (UNICAP) and depreciation for purposes of computing the earnings and profits (E&P) of a foreign corporation. Because the regulations would significantly reduce paperwork burdens for taxpayers and the government, Tax Executives Institute strongly urges that the final regulations be issued as soon as possible.

TEI and others have long been interested in the development of a simplified method of computing the E&P of foreign corporations. The proposed regulations mark a commendable first step in that development. In prior written comments and during meetings with IRS and Treasury representatives, the Institute wholeheartedly endorsed the concept. We continue to believe that, by allowing taxpayers to use GAAP financial information gathered for non-tax reasons, the Treasury Department and IRS can substantially reduce reporting burdens.

Indeed, TEI advocates the development of a much broader, elective, GAAP-based rule, i.e., one that goes beyond eliminating the computation of depreciation and UNICAP adjustments. We recommend that the GAAP E&P method permit taxpayers to start with their financial statements and limit those adjustments to those items that are likely to be material. Even if this recommendation is not adopted, we believe that the proposed regulations will materially ease the administrative burdens of taxpayers and the government alike without violating sound tax policy. Thus, the Subpart F carve-out in the proposed regulations notwithstanding, taxpayers will enjoy a significant reduction in the compliance burden, particularly where (1) the taxpayer's Subpart F income consists solely of foreign personal holding company income, or (2) the taxpayer has not elected the U.S. ratio method for purposes of the UNICAP rules.

We do wish to note, however, that many taxpayers will continue to face a significant compliance burden unless the GAAP E&P method is also available for purposes of calculating Subpart F income, particularly foreign base company sales and services income. Our analysis of the Internal Revenue Code and other applicable authorities convinces us that the use of the GAAP E&P method for such income is permissible under current law. In the event the Internal Revenue Service concludes that a legislative change is required to effect GAAP-conformity simplification in respect of Subpart F, TEI still believes that the proposed GAAP E&P regulations should be promulgated in final form this year.

For your information, we are enclosing a copy of the Institute's October 8, 1992, comments on the proposed regulations which discuss the effect of the regulations on Subpart F. If you have any questions concerning the Institute's comments on this or any other issue, please feel free to contact Michael P. Boyle, chair of the Institute's International Tax Committee, at [phone], or Mary Lou Fahey of the Institute's professional staff at [phone].