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Comments on miscellaneous revenue issues considered at February 21-22, 1990, hearings, March 9, 1990.

Comments on Miscellaneous Revenue Issues Considered at February 21-22, 1990, Hearings March 9, 1990

On March 9, 1990, TEI filed comments with the Subcommittee on Select Revenue Measures of the House Committee on Ways and Means concerning three international tax proposals on which the Subcommittee held hearings on February 21 and 22, 1990. The Institute's submission took the form of a letter from Institute President William M. Burk to Representative Charles B. Rangel, Chairman of the Subcommittee. Mr. Burk's letter, which was prepared under the aegis of TEI's International Tax Committee, is reprinted below.

On behalf of Tax Executives Institute, I am pleased to provide the following comments on several revenue issues on which the Subcommittee on Select Revenue Measures held hearings on February 21 and 22, 1990.


Tax Executives Institute (TEI) is the principal association of corporate tax executives in North America. The Institute's 4,300 members represent approximately 2,000 of the largest companies in the United States and Canada, and are responsible for coping with the tax laws - from both a planning and a compliance perspective - on a day-to-day basis.

TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting uniform and equitable enforcement of tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayer and government alike. As a professional association, TEI is firmly committed to working with the government in developing and maintaining a tax system that works - one that is consistent with solid tax policy, taxpayers can comply with, and the Internal Revenue Service can audit.

Foreign Tax Credit: Carryback

and Carryforward Rules

(Item A.1.)

TEI supports the enactment of legislation to lengthen from 5 to 15 years the carryforward period in respect of foreign tax credits. As explained below, we further recommend that the carryback period in respect of such credits be lengthened from 2 to 3 years and that the ordering rules for foreign tax credits be modified to permit any carryover credit to be taken into account before the current year's credit.

1. Description of the Problem. Current law provides that any foreign tax credits (FTCs) not used against U.S. tax in the current year may be carried back 2 years and forward 5 years. The rules for the general business tax credit (section 39) and net operating losses (section 172(b)) provide, however, for a 3-year carryback and a 15-year carryforward. The effect of the shortened time periods has been to cause FTCs to expire unused, thereby frustrating the purpose of the credit - the prevention of double taxation.

There is no readily apparent policy reason for the harsher rules in the foreign tax credit area. In fact, when originally enacted as part of the 1954 Code, the carryback/carryforward provisions in respect of the net operating loss (NOL) and the FTC were identical - two years back and five years forward. Although the rules have been liberized several times for net operating losses since 1954 (most recently in 1981 as part of the Economic Recovery Tax Act), the FTC provisions have been ignored.

In addition, the ordering rules for FTCs require that the current year's credits be utilized before any carryovers are taken into account. By contrast, in respect of the general business tax credit, a carryover is to be used first, before the current year's credits, to afford the taxpayer the maximum opportunity for using the credit.

The current rules effectively penalize taxpayers that experience operating losses, thereby creating a windfall for the federal government that may "collect" a substantial portion (if not all) of the FTCs previously earned and claimed because of the unduly short carryback/carryforward period. Current law effects an especially harsh result in respect of taxpayers in cyclical industries whose ability to utilize FTCs is limited because of income fluctuations.

2. Response to the Treasury Department's Testimony. In its February 21 testimony, the Treasury Department opposed the proposal to conform the foreign tax credit carryforward period to that for net operating losses on the ground that the purpose of the foreign tax credit is more "limited" than the purpose of the Code's NOL provisions. TEI respectfully disagrees. The purpose of the foreign tax credit - to ensure that a second tax is not exacted on income already subject to taxation - is, or should be, of paramount importance as a matter of tax policy. Prevention of double taxation is especially important given Congress's well-founded concern over the effect of U.S. tax rules on the ability of American business to compete internationally.

3. TEI Recommendation. TEI recommends that the foreign tax credit carryback/carryforward periods be extended to conform with the periods allowed for net operating losses and general business tax credits (i.e., 3 years back and 15 years forward). In addition, the ordering rules for utilization of foreign tax credits should parallel the general business credit rules: any carryover credit should be taken into account before the current year's credit.

TEI submits that adoption of its recommendations would limit those situations where the purpose of the foreign tax credit - the elimination of double taxation - is frustrated by unrealistically short carryback and carryforward periods.

Amendment of Passive Foreign

Investment Company Rules

(Item A.5)

TEI supports legislation to amend the passive foreign investment company (PFIC) rules of the Internal Revenue Code. Specifically, we believe that controlled foreign corporations (CFCs) subject to taxation under Subpart F of the Code should be exempted from the reach of the PFIC provisions. Alternatively, the so-called asset test for determining PFIC status should be refined to ameliorate the heavy compliance burdens imposed by the unexpectedly broad PFIC rules.

1. Description of the Problem. The PFIC rules, which were enacted as part of the Tax Reform Act of 1986, were intended to remove the economic benefit of tax deferral and the ability to convert ordinary income to capital gain which was available to U.S. investors in foreign investment funds. In addition, in enacting the PFIC rules Congress was also concerned that the tax rules not provide incentives to make investments outside the United States (current taxation is the order of the day for passive investments in the United States).

a. Source of the Problem: The Definition of a PFIC. The definition of a PFIC is so broad that many corporations with active businesses have been classified as PFICs, even in situations where the foreign corporation is subject to high rates of foreign tax. More fundamentally, foreign subsidiaries of U.S. companies (CFCs) are already subject to Subpart F of the Code, which governs when the income of foreign subsidiaries will be currently taxed even though such income is not repatriated by the U.S. parent company.

Under current law, a foreign corporation is a PFIC if, for any taxable year, either -

* 75 percent of its gross income

consists of passive income, or

* at least 50 percent of the average

value of its assets produce,

or are held to produce, passive


In addition, a look-through rule provides that if a foreign corporation owns 25 percent of the value of the stock of another corporation, that foreign corporation is treated as if it held its proportionate share of the assets of such other corporation and received directly its proportionate share of the income of such other corporation.

Combined with the look-through rule, the gross-income and assets test creates a tremendous compliance burden for corporate taxpayers. First, corporate taxpayers must analyze both the income and assets of their active foreign subsidiaries. In addition, because of the look-through rule, the income and assets of lower-tier subsidiaries must be attributed to higher-tier subsidiaries, thereby compounding and complicating the analysis process.

There are also definitional problems with respect to both test. For example, the income test is based upon gross income. An operating company could realize a loss from operations but, because it has passive income, be classified as a PFIC. The asset test is cumbersome because corporate taxpayers must periodically analyze the assets of their foreign subsidiaries to see if such subsidiaries meet the definitional test. Since the test is one of "average percentage," this analysis cannot be done on a year-end basis.

b. The Result: Enormous Administrative Burdens. Even a corporation with a modest number of active subsidiaries is required to devote substantial time to analyzing the applicability of the PFIC rules. For example, one TEI member, with only 30 active subsidiaries, devotes between 300 and 400 hours per year to such analysis. Obviously, the larger the number of a company's foreign subsidiaries, the larger and more complex its compliance burden. More to the point, such a compliance burden is unwarranted, particularly in connection with CFCs whose shareholders must currently include the CFCs' Subpart F income in their income. The PFIC rules stand as an excellent example of overkill - taxing not only passive income but also the operating income of foreign corporations.

2. Response to the Treasury Department's Testimony. In its February 22 testimony, the Treasury Department opposed the two specific PFIC reform proposals before the Subcommittee. At the same time, however, the Treasury expressed its continuing "concern about the scope and operation of PFIC regime." We respectfully submit it is time to translate the Treasury Department's long-expressed concern into concrete proposals for reform. Thus, in view of the Treasury Department's reservations about the proposals before the Subcommittee, the Treasury should be asked to comment on other alternatives (such as those set forth below) or develop its own proposal.

3. TEI Recommendation. TEI recommends that the PFIC rules be amended to exempt CFCs, thereby reinstating an exemption originally included in the Senate version of the 1986 Act. Alternatively, Congress could eliminate the assets test altogether, narrowly crafting anti-deferral rules in respect of those companies that are not subject to Subpart F. One approach would be to couple elimination of the asset test with the adoption of a modified income test (possibly paralleling that contained in the Code's foreign personal holding company provisions.) Adoption of the Institute's recommendations will ameliorate substantial compliance burdens without doing violence to the congressional intent underlying the PFIC provisions.

Repeal of Rev. Rul. 89-73:

Treatment of Short-Term Loans

under Section 956 (Item A.3)

TEI supports legislation that would preclude the Internal Revenue Service from applying Rev. Rul. 89-73, 1989-1 C.B. 258, which relates to the treatment of short-term loans under section 956 of the Internal Revenue Code, on a retroactive basis.

1. Description of the Problem. Section 956 of the Code provides that U.S. shareholders of controlled foreign corporations are taxable on their prorata shares of the CFC's annual increase in its "investment in U.S. property," which includes debt obligations of U.S. persons. Temporary regulations issued by the IRS in June 1988 eliminate a longstanding "one-year" rule which provided that, for purposes of determining the amount of a CFC's earnings invested in "United States property," the definition of such property does not include a debt obligation of a related domestic corporation that either (a) is collected within one year from the time it is incurred, or (b) matures within one year from the time it is incurred (but is not collected within such period solely by reason of the inability or unwillingness of the debtor to make payment within such period). The regulations apply in respect of investments made on or after June 14, 1988 - the day after the regulations were issued.

In Rev. Rul. 89-73, the IRS sets forth two examples addressing the circumstances under which a loan from a CFC will be deemed to be outstanding on the last day of the taxable year (even if the loan has been repaid). Specifically, the ruling considered when successive loans - neither of which was outstanding at the end of the year - should be collapsed for purposes of section 956. Because the ruling did not specify that it would be applied on a prospective-only basis, it applies to all open tax years.

The effect of Rev. Rul. 89-73 is to disregard the language of section 956, which measures an investment in U.S. property "at the close of the taxable year." In addition, the ruling ignores Congress's intent - evidenced by the legislative history of the Revenue Act of 1962 - to provide an exception from taxation for "normal commercial practices," which we submit includes short-term loans undertaken as a legitimate debt management tool. We submit that such loans are a far cry from the indefinite, long-term repatriation of earnings envisioned by Congress in enacting section 956. Finally, we believe the ruling can be properly criticized as a back-door repeal of the one-year rule for years prior to the stated effective date of the 1988 regulations.

The legislative proposal before the Subcommittee addresses not the IRS's authority to change its interpretation of section 956 (though we suggest such an issue is properly within Congress's purview), but rather the propriety of doing so on a retroactive basis. TEI submits that the retroactive application of Rev. Rul. 89-73 - to years even before the issuance of the 1988 temporary regulations - is improper.

2. Response to the Treasury Department's Testimony. In its February 22 testimony, the Treasury Department opposed the legislation, arguing that the ruling represents a correct interpretation of section 956 and, further, that the ruling is essential to prevent significant taxpayer abuses. The Treasury Department acknowledged, however, that section 956 had been a matter of dispute for some years and recommended that Congress consider whether a statutory clarification is necessary. We submit that such an acknowledgement undercuts the Treasury's position that the Rev. Rul. 89-73 is correct. More fundamentally, we submit that retroactive application of the ruling cannot, by its very nature, deter perceived abuses; the transactions to which the retroactive ruling would apply have already occurred.

3. Recommendation. Absent a Treasury and IRS decision to apply Rev. Rul. 89-73 on a prospective-only basis, TEI recommends that legislation prohibiting the retroactive application of the ruling be enacted.

Tax Executives Institute appreciates the opportunity to present its views on the issues under consideration by the Subcommittee on Select Revenue Measures and would be pleased to answer any questions you may have about its position. In this regard, please do not hesitate to call either Bernard J. Jerlstrom, chair of TEI's International Tax Committee, at (216) 943-4200 (ext. 2163) or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey) at (202) 638-5601.

PHOTO : 1990 Midyear Conference: TEI Treasurer Bob Perlman visits with Congressman William Coyne of Pennsylvania before the Sunday night banquet.
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Title Annotation:letter to Charles B. Rangel, Chairman of Subcommittee on Select Revenue Measures of House Committee on Ways and Means
Author:Burk, William M.
Publication:Tax Executive
Date:Mar 1, 1990
Previous Article:Tax Executives Institute-Department of the Treasury Liaison Meeting agenda February 16, 1990.
Next Article:Recommendations concerning electronic funds transfer procedures.

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