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482 Services regulations and survey on LMSB "environment" command TEI's attention: institute engages in Canadian pre-budget consultations, addresses EU enlargement and on cost sharing.

Reflecting TEI's increasingly global nature, international issues dominated the Institute s technical activities this fall. TEI testified on the section 482 services regulations in the United States, submitted comments to the Canadian Standing Committee on Finance in respect of its pre-budget consultations, provided additional examples to the Internal Revenue Code and U.S. Treasury Department on the cost sharing rules, and commented to the European Union on issues relating to the most recent EU enlargement. In addition, TEI submitted member comments to the IRS Large and Mid-Size Business Division on the current "environment" in which LMSB personnel and taxpayers interact.

Section 482 Testimony

TEI's International Tax Committee chair, Janice L. Lucchesi, testified October 27 at an IRS hearing on the revised section 482 services regulations. Ms. Lucchesi began by commended the government for substantially redesigning regulations that had been originally proposed in 2003.

"[The 2003] regulations presented many challenges to taxpayers, particularly the elimination of the cost safe harbor and its replacement with the simplified cost-based method," she stated, "and TEI is gratified that the government responded to TEI's--and other groups'--concems 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."

Noting that two categories of covered services--"specified covered services" and "low margin covered services"--qualify for being billed at cost under SCM, Ms. Lucchesi referred to a restriction imposed on the use of the SCM that a taxpayer must reasonably conclude "in its business judgment" that the covered services are not core capabilities of the renderer or the recipient. She recommended that that this subjective "business judgment" qualifier 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.

Ms. Lucchesi also offered comments on Announcement 200650, which sets forth a proposed revenue procedure listing 21 areas with descriptions of 48 activities that qualify as specified covered services. She urged that the list of services be broadened by taking 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," she said. The organization committed to providing the government with a red-lined version of the proposed procedure.

Finally, the TEI chair recommended that the effective date of the regulations be delayed until taxable years beginning after December 31, 2007.

The Institute's testimony is reprinted in this issue on page 481. TEI's International Tax Committee is preparing more comprehensive comments on the regulations. Those comments will be published on the TEI website at and in the January-February 2007 issue of The Tax Executive.

LMSB Environment Survey

On November 1, TEI provided comments to LMSB Commissioner Deborah M. Nolan on the current "environment" in which LMSB personnel and taxpayers interact. The survey was undertaken in response to a request from LMSB to attempt to quantify some anecdotal information TEI had received about a perceived deterioration in the tone and professionalism of the relationship between LMSB examination personnel and taxpayers.

In response to the request, TEI polled its Board of Directors and IRS Administrative Affairs Committee for comments on--Whether there had been an increased issuance of Forms 5701 at later stages of the exam or surprise notices of proposed adjustments;

* Whether there had been an increase in referral of issues to Appeals. If so, to what do you attribute this behavior;

* Whether they had received unreasonable/unfocused IDR's or "kitchen sink" IDRs; and

* Whether there had been an overall change in tone of the examination.

TEI President David L. Bernard said the survey responses reflected a diversity of treatment around the country, with some members reporting good relationships and others suggesting that the level of trust and cooperation, as well as the focus on materiality, had deteriorated in recent years.

"That differences exist suggest opportunities for improvement," he stated. "They also suggest that taxpayers are experiencing--or could well experience--disparate treatment, audit experiences, and outcomes, because of the differing attitudes and perspectives of the LMSB personnel with whom they interact."

Noting that many respondents described a generally positive experience in dealing with the IRS, he expressed regret that "others found themselves at the other end of the spectrum and detailed particularly troublesome behavior by the agents and specialists." TEI's comments are reprinted beginning on page--of this issue.

Canadian Pre-Budget Consultations

In its October 26 statement to the Standing Committee on Finance of the Canadian House of Commons, TEI urged the committee to adopt the following recommendations in its next budget:

* Review the competitiveness of the Canadian corporate income tax structure, especially the tax rates, and encourage the provinces to follow suit with a review of their income, capital, and sales tax regimes; encourage the provinces to harmonize their sales tax systems with the GST;

* Abandon altogether or substantially narrow the Reasonable Expectation of Profit (REOP) test included in draft legislation clarifying the deductibility of interest and other expenses;

* Expeditiously negotiate and implement a new provision in the Income Tax Convention with the United States eliminating withholding on all dividends and interest for payments to both related and unrelated parties;

* Abandon draft legislation in respect of Foreign Investment Entities and Non-Resident Trusts; if perceived abuses of the Income Tax Act cannot be addressed by Canada Revenue Agency under the act's current provisions, adopt narrower, more targeted remedies; and

* Implement a corporate loss transfer system or group loss relief mechanism.

The Institute's comments are reprinted in this issue, beginning on page 477.

Cost Sharing Regulations

Following up on its August 4 meeting with the IRS and Treasury Department, TEI filed additional comments on the section 482 cost sharing regulations. Specifically, in a letter dated October 16, TEI provided examples on the use of a discount rate, alternatives to the geographic exclusivity requirement, proposed changes to the example of a workforce-in-place, and exceptions to the periodic adjustment requirement.

In determining the discount rate to be used to test whether a periodic adjustment is required, the Institute noted that the proposed regulations demonstrate a preference for using the overall weighted average cost of capital (WACC) of the company if it is publicly traded. During the August meeting, the IRS explained that the required use of the applicable discount rate for publicly traded companies is not intended to require an automatic adjustment, but simply to prompt the IRS examination team to scrutinize a transaction. In response to the government's invitation, TEI submitted three examples of the use of other discount rates such as risk-adjusted hurdle rates and risk-adjusted cash flows. The Institute also provided an example of unsuccessful research and development activities.

Referring to regulations' requirement that cost sharing participants must partition the world into exclusive territories to exploit their interests in cost-shared intangibles, the Institute suggested the addition of a new subsection to permit a division of rights other than on a territorial basis and included two examples demonstrating divisions based on field of use and manufacturing projections.

In the compliance area, TEI recommended that the time to sign the cost sharing agreement be changed to be within 90 days (rather than the current 60) of the occurrence of the first intangible development costs. The organization also suggested that the requirement to file an original CSA Statement with IRS no later than 90 days after first joining CSA should be eliminated. Instead, the CSA Statement should be filed with the tax return for the applicable year. In addition, the requirement that an officer of the controlled participant sign the CSA Statement should be amended to permit an officer of a controlled participant that is filing the U.S. income tax return to sign the statement.

The Institute's comments are reprinted in this issue, beginning on page 471. Its initial comments on the regulations were reprinted in the November-December 2005 issue of The Tax Executive.

EU Enlargement

On October 10, TEI submitted comments to the European Commission on the implications of the accession of Romania and Bulgaria into the European Union. The Institute recommended that the EC take steps to ameliorate the significant administrative burdens enlargement will impose on businesses during the transitional period preceding and following the accession.

Explaining that companies must assess the effect of the enlargement and the accompanying legal changes in Romania and Bulgaria across all facets of their operations, the Institute stated that "even the best organised business will be challenged to implement all the necessary changes in a timely manner." It recommended that the EC, the Member States, and the Acceding Countries develop transitional rules to ease the administrative burdens on businesses and minimize the potential disruption of cross-border trade by--:

* Adopting a "light touch" in respect of documentation requirements and penalties;

* Temporarily relaxing the requirement for validation of registration numbers through the VAT Information Exchange Services (VIES) database; and

* Encouraging post accession dialogue with businesses in the Acceding Countries.

The Institute's letter is reprinted in this issue, beginning on page 491.
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Publication:Tax Executive
Date:Nov 1, 2006
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