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Notice 96-18: interest netting study.

On June 28, 1996, Tax Executives Institute submitted the following comments to the Internal Revenue Service on Notice 96-18, which invited public comments on the IRS and Treasury Department's study of issues surrounding the computation of interest where overpayments and underpayments of tax liabilities overlap. The Institute's comments were prepared under the aegis of TEI's IRS Administrative Affairs Committee, whose chair is Robert L. Ashby of Northern Telecom Inc. Frank J. Real of Consolidated Rail Corp. coordinated the preparation of the Institute's comments on the interest netting study, Robert H. Proehl of BellSouth Corporation also contributed materially to the project.

On March 20, 1996, the Internal Revenue Service issued Notice 96-18,(1) inviting public comment in connection with a study of issues surrounding the computation of interest where overpayments and underpayments of tax liabilities overlap. Tax Executives Institute is pleased to submit the following comments in response to that invitation.


Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 5,000 members represent more than 2,700 of the leading corporations in the United States and Canada. Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the interest-netting study.

Good Tax Policy Favors Comprehensive Interest Netting

Section 6402(a) of the Internal Revenue Code authorizes the IRS to credit overpayments and interest on overpayments against a taxpayer's liability for underpayments and interest on underpayments. Section 6601(f) provides that no interest will be imposed on the portion of an underpayment that is satisfied by crediting an overpayment. Prior to 1987, the same interest rate applied to underpayments and overpayments of tax. As part of the Tax Reform Act of 1986, however, Congress created an interest rate differential or "spread" by providing in section 6621(a) that the interest rate charged on underpayments be one percentage point higher than the interest rate paid on overpayments. Where both an underpayment and overpayment of tax exist at the same time, it will always be beneficial for the taxpayer to have interest calculated on the net balance rather than on the gross amount of deficiency and refund. To ameliorate the effect of the spread on taxpayers, Congress enacted section 1511(b) of the Tax Reform Act, which states:

The Secretary of the Treasury or

his delegate may issue

regulations to coordinate section

6621 of the Internal Revenue

Code of 1954 (as amended by

this section) with section

6601(f) of such Code. Such

regulations shall not apply to

any period after the date 3 years

after the date of enactment of

this Act.

Hence, Congress recognized the potential hardship flowing from the interest-rate differential for taxpayers who have both overpayments and deficiencies spanning several years. The purpose of section 1511(b) was to provide a transition period within which the IRS was to coordinate the interest-rate differential provisions with the offset rules of section 6601(f); after this period, comprehensive netting procedures were to be implemented. The Conference Committee Report on the 1986 Act explains:

Section 6601(f) provides that, to

the extent a portion of a tax due

is satisfied by a credit of an

overpayment, no interest is

imposed on that portion of the

tax. Consequently, if an

underpayment of $1,000 occurs

in year 1 and an overpayment of

$1,000 occurs in year 2, no

interest is imposed in year 2

because of the rule of section

6601(f). The IRS can at present

net many of these offsetting

overpayments and

underpayments. Nevertheless,

the IRS will require a transition

period during which to

coordinate differential interest

rates with the requirements of

section 6601(f). The Senate

amendment, therefore, provides

the Secretary of the Treasury

may prescribe regulations

providing for netting of tax

underpayments and

overpayments through the period

ending three years after the date

of enactment of the bill. By that

date, the IRS should have

implemented the most

comprehensive netting procedures

that are consistent with sound

administrative practice.(2)

Despite the unambiguous instruction that the IRS "should have implemented...comprehensive netting procedures" within three years, no such procedures were developed by the agency.(3) As a result, when Congress increased the interest rate for large corporate underpayments by two percentage points (thereby increasing the aggregate interest rate differential between overpayments and underpayments to three percentage points) in the Omnibus Budget Reconciliation Act of 1990, it affirmed its prior directive saying that "the Secretary should implement the most comprehensive crediting procedures under section 6402 that are consistent with sound administrative practice."(4)

Again in 1994, when the interest rate differential between certain large corporate underpayments and corporate overpayments was increased to four and one-half percentage points in the Uruguay Round Agreements Act (the so-called GATT interest rate), Congress urged the Secretary of the Treasury to "implement the most comprehensive crediting procedures under section 6402 that are consistent with sound administrative practice," adding (in a tone of exasperation that reflects both congressional and taxpayer frustration) that the Secretary "should do so as rapidly as practicable."(5) Thus, as Congress has ratcheted the interest-rate differential upwards, it has -- in increasingly ardent language -- directed the IRS to implement the most comprehensive procedures practicable that permits overpayments to be credited against underpayments.

In deference to the administrative difficulties confronted by the IRS in creating a comprehensive, automated computer system for calculating and crediting the proper amount of interest, Congress has tempered its calls for comprehensive netting with the acknowledgment that the procedures must be "consistent with sound administrative practice." Nonetheless, congressional impatience with IRS delays was signaled during the hearings in 1995 relating to the Taxpayer Bill of Rights 2 legislation. The IRS Oversight Subcommittee's report leaves no doubt that some in Congress perceive that deference to "sound administrative practice" has become a shield for bureaucratic intransigence:

The Subcommittee has become

increasingly disappointed

at the prolonged failure

of the IRS to implement

comprehensive interest netting

procedures. The Subcommittee

is uncertain

whether this prolonged delay

stems from genuine technical

difficulties in implementing

interest netting or whether

it stems primarily from

administrative hostility towards

interest netting.(6)

Indeed, a cynic might conclude that the interest-netting study, which was initially described in Announcement 96-5, Administrative Initiatives to Enhance Taxpayer Rights,(7) was initiated to forestall additional legislation such as the provision in the House version of the Taxpayer Bill of Rights 2 legislation that would have mandated an interest-netting study. If that was the objective, it was successful, for the provision was removed in the Conference Agreement on the subsequently vetoed Revenue Reconciliation Act of 1995.

Current IRS Netting Procedures

As summarized in Notice 96-18, the IRS has developed crediting procedures to implement netting in limited circumstances. For example, current practice is to consider all increases and decreases in a taxpayer's liabilities within a single tax year before applying the statutory interest rules to the year. Thus, in Rev. Proc. 94-60,(8) the IRS ruled that a taxpayer will not be charged the higher interest rate under section 6621 on an underpayment that is satisfied by credit of an overpayment arising in the same taxable year. Such netting is referred to as "annual interest netting." In other words, annual interest netting involves netting increases and decreases of a taxpayer's liabilities within a single year before applying the statutory interest rules for that year.

The IRS also permits crediting of overpayments against underpayments for the period of time when the underpayments and overpayments are both unpaid and outstanding, even if they are from different tax years or for different types of taxes. The IRS refers to the computation of interest netting under such circumstances as "offsetting." Offsetting involves crediting of overpayments against underpayments for the period of time when both the underpayment and the overpayment are unpaid and outstanding, even though they are from different tax years and represent different types of tax liability.

The IRS does not, however, permit interest to be computed on a net basis where a taxpayer realizes an overpayment in one year that overlaps a deficiency that the taxpayer has already paid for a different tax year. Similarly, the IRS will not net interest where an unpaid deficiency in one tax year overlaps with an overpayment that the IRS has already paid for a different tax year. Owing to the IRS's computer file structure, where a tax deficiency (or refund) is satisfied (paid) and aged off the taxpayer's Business Master File with a zero balance, the "module" becomes inaccessible. The netting of over- and underpayments in order to compute interest in such circumstances requires a "global" search of the IRS computer for inactive tax modules. Hence, the IRS parlance of "global interest netting."

The Eighth Circuit in Northern States Power Co. v. United States,(9) recently addressed whether the IRS is required to perform "global interest netting" computations. The court held that, where the taxpayer's liability was fully paid, there was no "outstanding liability" against which to net a subsequently determined overpayment. Hence, a taxpayer may not compel the IRS to apply the same, higher interest rate to contemporaneously extant overpayments and underpayments from different tax years. The court confirmed, however, that the IRS has discretion to credit overpayments against underpayments.

The issue in Northern States Power may ultimately be resolved by the Supreme Court, since the Eighth Circuit's decision seemingly involves a distorted interpretation of the interplay of the crediting provisions of section 6402 and the netting provisions of section 6601(f). In the absence of a definitive decision by the Supreme Court in Northern States Power, further litigation on this issue is probable since taxpayers will continue challenging a result at odds with economic reality and common sense. What's more, unless the Northern States Power decision is reversed or more comprehensive netting is implemented by legislative clarification or administrative action, taxpayers will be subject to untenable whipsaws in a variety of factual circumstances. As a result, TEI commends the Department of the Treasury and IRS for undertaking the interest-netting study. The study will provide a wide range of commentary and afford the opportunity to craft an administrable solution to an intolerable and inequitable situation.

Eliminating Whipsaws Arising from the Interest-Rate Differential Is the Goal Regardless of the Label

The decision in Northern States Power Co. is cited by the IRS in Notice 96-18 for the proposition that the government is not required to perform global interest netting. The decision, however, does not preclude the IRS from performing global interest netting. Hence, the Institute urges the Department of the Treasury and IRS to reconsider their administrative interpretations of sections 6402 and 6601(f) to permit comprehensive netting in a much wider variety of situations to eliminate the whipsaws that taxpayers may face from the interest-rate differential.

The Institute concurs with the principle that "[t]he underlying objective [of the interest provisions] is to determine in a given situation whose money it is and for how long the other party had the use of it."(10) The IRS and Treasury Department should keep this firmly in mind as they move forward in the development of the government's netting policy. In addition, we urge the government to disavow the Rambo-like, litigate-to-win position espoused in Northern States Power.(11) Stated simply, the government's policy on interest netting should be driven by the desire to achieve an equitable result. Tax policy should not be a byproduct of a hypertechnical statutory interpretation that distorts the "plain language" meaning of what Congress intends, as reflected in the legislative history to the 1986, 1990, and 1993 Acts.

In the Institute's view, an equitable tax policy demands that mutually offsetting overpayments and underpayments be netted before the application of the statutory interest rates. Alternatively, a comparable result can be achieved mathematically by applying the same interest rate to both overpayments and deficiencies for the period of time during which they overlap. From a tax policy perspective, the government or the taxpayer should be compensated with interest only for the time the government has the use of the taxpayer's money or vice-versa. Where concurrent overpayments and underpayments exist, there simply is no deficiency against which interest should be assessed. This is especially true in the case of corporations where, owing to the vagaries of the business cycle, the annual determination of tax liability is partially mitigated by loss and credit carryback and carryforward provisions in order to measure and average over time the corporation's true economic income. For large corporations subject to the IRS's Coordinated Examination Program (CEP), the boundaries of the annual determination of tax liability are further blurred by the IRS's administrative practice in joining multiple tax years into a single examination cycle and, on occasion, the joining of such examination cycles.

More important, the examination of a complex corporate income tax return and the resolution of issues through the administrative appeals process or litigation can, especially in the CEP program, require many years to resolve. Often the issues involve large timing adjustments that "turn around" (or reverse) within the examination cycle.

Consider the following example: An examination results in additional deductions being permitted in a taxpayer's calendar-year 1990 return, thereby generating an overpayment of $5 million for the year and a corresponding underpayment of $5 million for the later year 1991. If the over--and underpayments for the years are not netted, the interest expense arising solely from the four-and-a-half percent interest differential would be approximately $170,000 through the end of a two-year examination, $815,000 through the end of an additional two-year appeals process, and a whopping $2.8 million if the issue is not resolved until four more years elapse during the course of litigation. The cost is attributable entirely to the spread between the overpayment and underpayment interest rates when applied separately to the overpaid and underpaid tax amounts pending resolution of the issue. The taxpayer could be charged $2.8 million of additional interest simply because it paid $5 million in the earlier -- though incorrect -- year, despite having "prepaid" its entire tax liability for the combined period.

The IRS's current netting practices may provide relief for a taxpayer where the overpayment and underpayment years are part of a single examination cycle. In the foregoing example the 1990 and 1991 years may have been part of a single examination cycle (or "module" in IRS netting parlance), or separate examination cycles may ultimately be joined together. Hence, where an earlier examination cycle -- say the taxpayer's 1989 and 1990 tax years -- require three to four years to resolve, the later 1991 and 1992 examination cycle may "catch up" in Appeals or litigation and ultimately be joined with the earlier cycle for resolution. In either case, the IRS's current basic "netting" practice may ameliorate the interest-rate whipsaw. If the taxpayer is unsuccessful in joining separate examination cycles, however, it will incur a substantial, and undeserved, interest penalty.(12) Numerous other examples may be constructed where, as a result of the interest rate differential, taxpayers are harmed by the failure to net.(13)

Legal and Policy Issues in "Global" Interest Netting

In Notice 96-18, the IRS poses five numbered questions about the legal and policy issues relating to global netting. We address the questions seriatim.

1. In view of the policy generally favoring the finality of tax determinations, should a rule concerning the finality of global interest netting computations be adopted, and, if so, what should that rule be? What effect, if any, should the statute of limitations hate on global interest netting, particularly considering the language in section 6402 regarding the applicable period of limitations? Should the statute of limitations be kept open longer in light of global interest netting?

TEI recommends that comprehensive interest netting procedures be implemented as soon as possible. In particular, a procedure should be developed to permit offsets of overpayments and deficiencies (1) from different years and (2) among different types of taxes. Moreover, we recommend that the procedures be developed and implemented in that order.

As a derivative liability flowing from the determination of tax liability, interest should be recomputed whenever the tax liability is redetermined for a particular taxable year for which the statute of limitations is open. Thus, whenever there is an appropriate "triggering" event, such as a filing date, refund claim, notice of deficiency and demand for payment, or full or partial payment pursuant to a settlement, interest should be computed in respect of the redetermined liability.

TEI does not believe that there is any need or requirement to extend the statute of limitations in order to implement a comprehensive interest netting regime. Taxpayers should not be subject to the risk of additional tax assessments in exchange for an interest computation that properly takes account of "mutual indebtedness" between the taxpayer and the government. Mutual indebtedness should be defined as any concurrent period of time during which the taxpayer has a liability to the government and the government has a liability to the taxpayer. Mutual indebtedness occurs where (1) a taxpayer has previously received interest on an overpayment (or would have received interest but for the application of the overpayment to a deficiency for a different tax period or tax) or paid interest on a deficiency (or would have paid interest on a deficiency but for the application of an overpayment from a different period or tax) and (2) there is a subsequent transaction involving interest (i.e., a triggering event).

Under limited and unusual circumstances, the proper rate of interest to apply to the net over- or underpayment may be affected by the closing of the statute of limitations in respect of the year to which an overpayment or underpayment is applied. For example, if the statute of limitations for filing suit for recovery of an erroneous refund by the IRS has expired and the taxpayer was overpaid interest on such refund, the taxpayer should not be assessed underpayment interest in excess of the amount that would have been assessed on such underpayment at the statutory underpayment rate.

Another example involves the situation where the statute of limitations for filing a claim for refund on an underpayment year has expired and the amount of underpayment interest was overassessed and overpaid; in such a case, the taxpayer would not receive overpayment interest in excess of the amount that would have been paid on the overpayment at the statutory underpayment rate.

2. When would it be appropriate for the Service to net interest globally for a particular tax year or period? For example, would it be appropriate to net interest globally before the final decision of an appeal or court decision for a tax period overlapping with the period at issue that might affect the interest calculations for such period? Would it be appropriate to net interest globally before the final decision of an appeal or court decision for a tax period that does not overlap with the period at issue, if such decision could produce an adjustment, such as a net operating loss or credit, that

might affect the interest calculation for such period?

As summarized in the response to question 1. TEI recommends that interest be computed every time a taxpayer's tax liability in respect of a particular year changes, irrespective of future events such as examinations, appeals, or court decisions. In appropriate cases, taxpayers with complex tax histories (including carryovers, refund claims, etc.) and multiple examination cycles at varying stages of review (examination, appeals, or litigation) will likely enter closing agreements or extend the statute of limitations for interim tax years between the years at Appeals (or subject to court jurisdiction) and subsequent tax years. Moreover, where the statute of limitations is closed, the IRS may consider adopting a rule, similar to that set forth in our response to question 1, that conditions the manner in which comprehensive interest netting is calculated. In the case of loss or credit carrybacks, however, only the loss or excess credit year need be open.

Where taxpayers are subject to continuous examination, it is not unusual for one cycle to result in a net refund and another, later cycle to produce a net deficiency. (This frequently arises in large corporate cases because items of income, deduction, gain, loss, or credit shift from one year to another.) Hence, in addition to developing a procedure for comprehensive netting, the IRS should develop a procedure to permit a taxpayer to defer receipt of a refund from an earlier cycle and to apply the net overpayment to subsequent periods for which a taxpayer reasonably believes a deficiency will exist. In other words, a taxpayer should not be compelled to accept a refund with overpayment interest applied and then pay a subsequent deficiency at the underpayment rate.

3. What would be the effect of carrybacks and carryforwards (e.g., net operating losses, various credits, etc.) on the global interest calculation for a certain period? Would carrybacks and carryforwards always require a recalculation of interest for such period ? Or should global interest netting calculations only be made after carryforwards and carrybacks that might affect the period at issue are determined finally? How would the analysis be affected by the restricted interest provisions of Section 6601(d) and Section 6611 (f)?

As explained in our responses to question 1 and 2, the interest computation should occur at the time of the deficiency or refund payment. For example, where a loss or credit carryback claim is filed, the interest computation should be made by the IRS when it has determined that the claim is proper (as under current procedures) and is ready to pay a refund. The interest calculation should not be deferred pending an examination of the year the loss or excess credit arises. Should examination adjustments be made that diminish (or increase) the amount of the loss or credit carryback, interest should be recomputed at the proper under (or over) payment rate.(14)

4. Does global interest netting present any unique implications for taxpayers filing consolidated returns?

The rules governing the filing of consolidated tax returns by affiliated groups currently supply guidance on (1) the application of estimated tax payments by individual members for the group's consolidated tax liability, (2) joint and several liability of members for the group's tax liability, (3) the application of loss and credit carrybacks to, and carryovers from, separate return years, and (4) other administrative issues affecting the determination and allocation of tax liability of an affiliated group filing a consolidated return.

Inasmuch as the consolidated return rules treat the affiliated group as a single taxpayer for purposes of calculating and settling the tax liability owed to the government and inasmuch as interest liability is derived from tax liability, we do not perceive a need for additional guidance on the calculation of interest on those tax liabilities. To the extent that the current rules supply the proper answer for determining the group's (or member's separate) tax liability and the payment history is properly attributed and credited, we see no added complications in connection with the computation of comprehensive interest netting on over- or underpayments by the group.(16) Nonetheless, the Institute will continue to study whether additional guidance may be necessary under the consolidated return rules to implement an interest-netting regime.

One possible detriment for consolidated taxpayers under a global interest netting regime is an increase in administrative costs. Every time interest is recomputed, the amount due to (from) the parent corporation from (to) each subsidiary for previous tax payments or refunds could change. Thus, subsequent assessments or refunds could result in additional interest due to or from a subsidiary corporation without a corresponding change in tax liability. We do not, however, view this as an impediment to implementation of interest netting.

5. How would global interest netting affect Section 861 allocations or interact with other U.S. international tax provisions?

Under section 861, interest paid on tax deficiencies is allocated between U.S.- and foreign-source income in the year paid. Hence, net foreign-source taxable income is decreased whenever tax deficiencies are paid, resulting potentially in the additional "penalty" of a deferral or permanent loss (through the expiration of unused foreign tax credit carryforwards) of creditable foreign taxes. On the other hand, when overpayment interest is received by a taxpayer, such income is treated as entirely U.S.-source. Hence, there is no corresponding increase in foreign-source taxable income upon the receipt of refund interest that permits the use of additional foreign tax credits. This whipsaw against taxpayers is exacerbated to the extent of the interest-rate differential on underpayments and overpayments. While a comprehensive netting regime will not eliminate the whipsaw, it will mitigate the potential loss of foreign tax credits and, hence, minimize the adverse economic effect to U.S. taxpayers. We believe that this is an added reason to proceed with dispatch to establish comprehensive interest netting procedures.

Administrative Issues

Notice 96-18 also poses two additional numbered questions relating to administrative issues arising from the implementation of global interest netting. We address each seriatim.

1. To the extent that taxpayers or practitioners currently make global interest netting calculations for themselves or their clients, the Service would like to receive a detailed description of how those calculations are performed, the cost of performing those calculations, and the reasons why the method used by particular taxpayers or practitioners would be appropriate for the Service to apply to large numbers of taxpayers without requiring significant additional Service resources.

There is likely no single, simple computer "fix" that will address all the facets of global interest netting. All interest computations involving corporate account histories with examination adjustments, carrybacks, carryforwards, partial payments, and transfers of taxes between years and types of taxes are complex. Hence, some form of human intervention (or "manual" intervention in IRS parlance) will likely be necessary for corporate taxpayers. Such intervention is required for the offsetting and interest netting calculations performed today. Indeed, we doubt that the IRS would ever wish to eliminate human analysis fully from the computation of interest in complex cases.

The steps involved in comprehensive interest netting are arguably no more complex or burdensome than the annual interest and offsetting procedures that the IRS currently performs. Global netting may necessitate additional steps to ensure that all of the taxpayers accounts (or modules) are accessed, but the analysis is no more complicated. The additional steps of combining the data found in the account history of more than one year are comparatively easy once a time-line analysis has been performed. Moreover, after the time-line analysis is sketched out, inexpensive PC-based computer software will perform the interest calculations with and without netting.

2. How should the Service fulfill its obligations to verify the accuracy and completeness of all taxpayer data relevant to make a global interest netting calculation for a particular period, given the Service's computer data storage limitations?

Certainly, the IRS's computers have the capability to store and retrieve a taxpayer's historical tax transcript that details assessments, payments, and refunds for each year on a stand-alone basis. Where multiple years are involved in an interest-netting computation, the separate-year transcript data can be loaded into a PC-based software program to complete the interest calculation. This would require the expenditure of little time or additional resources over that required today, particularly in respect of larger, more complex corporate tax histories. In unusual circumstances where the tax payment data is not directly available in the IRS files, the IRS should be able to verify a taxpayer's independent records of its tax payments and refunds. Moreover, should the calculations and record retrieval prove too burdensome, taxpayers would likely be more than willing to lend assistance in the

Fairness to taxpayers demands that comprehensive interest-netting procedures be adopted. Since taxpayers must divert scarce budget resources from their revenue-generating activities in order to comply with complex tax laws, they may well be unsympathetic to pleas that the IRS either lacks the resources to implement netting or that implementation is administratively infeasible. More important, continued delays by the IRS in implementing comprehensive netting because of the administrative burden involved or the "lack" of resources will be counterproductive and undermine taxpayer confidence in the fairness of the system. Nonetheless, since computer limitations or IRS budget resources may hinder the speed with which the IRS is able to implement netting across all types of taxes, TEI recommends that global interest netting be implemented initially for each separate type of tax (income, payroll, excise, etc.) and then across tax types. Indeed, many taxpayers prefer that the automatic offsets that occur in the Business Master File offset program be "turned off." In such circumstances, the netting calculation might temporarily produce inequities where a taxpayer has overpayments of income taxes but underpayments of other types of taxes, but the overall result would be better than not permitting more comprehensive interest netting.


TEI appreciates this opportunity to comment on Notice 96-18, relating to the IRS's study of interest netting. These comments were prepared under the aegis of the Institute's IRS Administrative Affairs Committee whose chair is Robert L. Ashby of Northern Telecom, Inc. If you should have any questions concerning the Institute's comments that should be directed to Mr. Ashby at (615) 734-4621 or to Jeffery P. Rasmussen of the Institute's professional staff at (202) 638-5601.

(1) 1996-14 I.R.B. 27. (2) H. R. Rep. No. 841 (Part II), 99th Cong., 2d. Sess. 785 (1986) (emphasis added). (3) During liaison meetings with TEI, IRS officials offered assurances that the ability to net overpayments and underpayments would come with Tax Systems Modernization, but callously dismissed calls for interim procedures as more trouble than they were worth. Taxpayers, of course, disagreed. (4) H. R. Rep. No. 964, 101st Cong., 2d. Sess. 1101 (1990). (5) S. Rep. No. 412, 103d Cong., 2d. Sess. 144 (1994) (emphasis added). (6) Oversight Initiative Report on Need for Taxpayer Bill of Rights 2 Legislation and Reform of the Internal Revenue Service, Subcommittee on Oversight of the Committee on Ways and Means, WMCP 104-8, 104th Cong., 1st. Sess. 19 (Sept. 14, 1995). (7) 1996-4 I.R.B. 99, 101. (8) 1994-2 C.B. 774 (9) 73 F.3d 764 (8th Cir. 1996). (10) Rev. Proc. 60-17, 1960-2 C.B. 942. See also Avon Products, Inc. v. United States, 588 F.2d 342 (2d Cir. 1978) (interest is intended to compensate the government for delay in the payment of tax). (11) The government's position in Northern States Power is to be contrasted with that espoused in Pettibone Corp. v. United States, 34 F.3d 536 (7th Cir. 1994). In Pettibone, the IRS clearly argued for "continuous netting of overpayments, underpayments, and interest on the balance," whereas the taxpayer argued that overpayments and underpayments and interest thereon should be tallied separately. Id. at 538. Notwithstanding the Eighth Circuit Court's artful distinction between a bankruptcy "set off" issue and interest "netting" in dicta in Northern States Power, the fact remains that government counsel advocated starkly inconsistent positions in the different cases. The government's embrace of such win-at-any-price tactics without a proper regard for good tax policy -- or the equities -- is truly troubling. Although TEI does not endorse the "IRS bashing" that is becoming more and more prevalent, we do believe that the actions of the agency in cases such as Northern States Power can feed taxpayer frustration with the fairness of the system and, hence, contribute to a "tear it out by the roots" mentality. (12) For example, assume that as a result of a relocation of its headquarters following a corporate split-up, a taxpayer has open examination cycles in different IRS regions that are served, in turn, by different IRS Service Centers. Assume further that the taxpayer's earliest examination cycle generates a large refund, whereas the later cycle results in a net deficiency. We understand that, as a result of the separate examination cycles being assigned to different Service Centers, the IRS is unable to join the cycles in order to "offset" the over- and underpayments for purposes of calculating interest on the net balance. Hence, a taxpayer in this situation faces an interest-rate whipsaw that another taxpayer may avoid. (13) The various reports concerning interest netting that have been made to the Commissioner's Advisory Group are replete with illustrations. (See, in particular, the Reports of December 9 and 10, 1992; June 23 and 24, 1993; January 9, 1994; and January 18, 1995, on the need for interest netting.) The reports generally focus on the detriment to individual taxpayers who receive taxable "credit" interest at a lower rate of interest and are assessed deficiency (debit) interest at a higher rate. In the case of individuals, not only is there a whipsaw from the interest-rate spread, but taxpayers are generally unable to deduct the interest assessment to the extent that it constitutes nondeductible personal interest. (14) To the extent that pre-1982 tax years are affected by loss or credit carrybacks or other adjustments, different interest rules will apply since compound interest (interest on interest) was not permitted. (15) Drafting contractual provisions that address the accounting for, and allocation of tax liabilities among, different taxpayers when members leave or join affiliated groups through mergers, acquisitions, and divestitures is admittedly a complex matter requiring careful attention and planning to avoid unintended results between the parties. The derivative interest liability associated with changes in tax liability necessarily complicates that process further. Those complications, however, should not impede the development of comprehensive interest netting governing the settlement of liabilities between the government and taxpayers. (16) Indeed, taxpayers often find the current system for calculating and charging (crediting) interest frustrating because they are unable to verify independently the interest computation performed by the IRS Service Centers. Discrepancies in computations are generally resolved only after substantial discussions between the taxpayer's representative and the interest "specialist" at the Service Center or the District Office.
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Title Annotation:Tax Executives Institute IRS Administrative Affairs Committee
Publication:Tax Executive
Date:Jul 1, 1996
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