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TEI comments on tax shelter disclosure regulations: January 28, 2003.

On January 28, 2003, TEI filed comments with the Internal Revenue Service relating to the temporary and proposed regulations under section 6011 and 6112 of the Internal Revenue Code. The temporary and proposed rules modify the rules for disclosure and reporting of certain transactions as well as the requirement to maintain and furnish lists of investors in tax shelter transactions.

The comments were prepared under the joint aegis of TEI's Federal Tax and IRS Administrative Affairs Committees, whose chairs, respectively, are Mitchell S. Trager of Georgia-Pacific Corporation and David L. Bernard of Kimberly Clark Corporation.

On October 17, 2002, the Treasury Department and Internal Revenue Service issued guidance under sections 6011 and 6112 of the Internal Revenue Code substantially modifying the rules relating to the disclosure and reporting of certain transactions under Temp. Reg. [section] 1.6011-4T and the requirement to maintain investor lists under Temp. Reg. [section] 301.6112-1T. Specifically, the government issued temporary and proposed rules (T.D. 9017) revising the temporary and proposed regulations released February 28, 2000 (and subsequently amended several times), requiring taxpayers to disclose their participation in "reportable transactions." In addition, temporary and proposed rules (T.D. 9018) were issued modifying the requirement for certain transaction promoters and their material advisers to maintain and produce lists of investors in "potentially abusive shelters." (1) The rules were published in the FEDERAL REGISTER on October 22, 2002 (67 Fed. Reg. 64799 and 64807, respectively), and in the Internal Revenue Bulletin (2002-45 I.R.B. 815 and 823, respectively). A hearing on the temporary and proposed rules was held on January 7, 2003.

Background

Tax Executives Institute is the preeminent association of business tax executives in North America. Our more than 5,300 members represent 2,800 of the leading corporations in the United States, Canada, and Europe. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply.

These goals can only be achieved through our members' adherence to the highest standards of professional competence and integrity. To ensure compliance with the law, TEI's Standards of Conduct exhort the members to "present the facts required in tax returns and all the facts pertinent to the resolution of questions at issue with representatives of the government imposing the tax." As important, the members "recognize an obligation to make an affirmative contribution to the sound administration of the laws, and to the adoption of sound legislation, by cooperation and consultation with the persons charged with those functions, having due regard for the interests of society, as well as the interests of the company and its employees." In short, TEI members agree that a balance must be struck between public duty and private right.

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 package of rules released by the government to address tax-motivated transactions. TEI members know all too well that the inherent complexity of the Internal Revenue Code make drawing the line between sound tax reduction strategies, on the one hand, and "tax shelters," on the other, difficult. Since TEI does not represent tax shelter promoters or their advisers, our comments relate, except for the definition of a "material adviser," primarily to the temporary regulations under section 6011(a) that require taxpayers to file statements with their returns disclosing "reportable transactions."

Overview of Temporary Disclosure Regulations

Under Temp. Reg. [section] 1.6011-4T(a), every taxpayer that participates directly or indirectly in a reportable transaction as defined in Temp. Reg. [section] 1.6011-4T(b) is required to attach a disclosure statement (on newly prescribed Form 8886) to its tax return "for each taxable year for which the taxpayer's Federal income tax liability is affected by the taxpayer's participation in the transaction." (2) In addition, a copy of the disclosure statement for the first taxable year for which disclosure is required must also be filed with the IRS's Office of Tax Shelter Analysis (OTSA). Moreover, if a transaction becomes a reportable transaction (e.g., the transaction subsequently becomes a listed transaction described in Temp. Reg. 1.6011-4T(b)(2) or there is a change in facts that causes a transaction to become reportable under paragraphs (b)(5) through (b)(7)) on or after the date the taxpayer has filed the return for the first taxable year for which the transaction affects the taxpayer's or a partner's (or S corporation shareholder's) tax liability, the disclosure statement must be filed as an attachment to the taxpayer's federal tax return next filed after the date the transaction becomes reportable regardless of whether the transaction affects the taxpayer's or any partner's or shareholder's tax liability for that year.

The temporary regulations set forth six categories of reportable transactions. The first category of reportable transactions, i.e., "listed transactions," includes those identified by the Treasury and IRS in published guidance as "tax avoidance" transactions. (3) Other reportable transactions include confidential transactions, (4) transactions affording taxpayers contractual protection, (5) loss transactions, (6) transactions with significant book-tax differences, (7) and transactions involving assets with brief holding periods. (8) In addition, Temp. Reg. [section] 1.6011-4T(c)(3)(ii) requires certain United States shareholders in controlled foreign corporations to report their "indirect" participation if the controlled foreign corporation directly participates in a reportable transaction described in Temp. Reg. [subsection] (b)(2) through (b)(5) or (b)(7) or participates in a transaction that reduces or eliminates an income inclusion under section 551, 951, or 1293. In effect, the definition implicitly creates a seventh broad category of reportable transactions for transactions undertaken by a controlled foreign corporation that reduce the shareholder's Subpart F income. The temporary regulations also enumerate specific categories of exceptions to the "book-tax difference" category and exclude from the definition of reportable transactions any transaction for which the Commissioner issues public guidance stating that a transaction is not reportable. (9) In the preamble to the temporary regulations, the IRS and Treasury invite comments on specific transactions that should not be subject to disclosure or that should be excluded from the various categories of reportable transactions (the so-called angel list). (10)

Overview of TEI Comments and Summary of Recommendations

A. Overview of Comments. Tax Executives Institute has long held that the most effective approach to addressing tax shelter transactions is to enhance tax return disclosures. By identifying and targeting indicia of transactions that are characteristic of "tax shelters" and requiring enhanced disclosure of such transactions, the IRS can properly focus its examination resources on questionable transactions. TEI's comments on the 2000 regulations noted that the definition of reportable transactions contained a number of nebulous concepts and unclear subjective tests. Thus, we commend the Treasury and IRS for revising the disclosure rules to emphasize objective criteria for the determination of reportable transactions.

The preamble to the temporary regulations explains that the revised disclosure tests were developed in part in reaction to a perception that "taxpayers are interpreting the five reporting characteristics in the 2000 regulations in an overly narrow manner and ... interpreting the exceptions in an overly broad manner." (11) As a result, the temporary regulations adopt not only objective criteria but also more expansive reporting requirements. TEI believes the requirements cast an unnecessarily wide net, requiring disclosure of many routine transactions. Notwithstanding our support for objective rules, we believe the temporary regulations overreach and will impose substantial administrative burdens on many business taxpayers. Moreover, the exceptions to disclosure are too narrow to afford taxpayers with meaningful relief and minimize the preparation and filing of excessive and unnecessary disclosure statements. Treasury officials have publicly acknowledged that the rules are so broad that they will affect compliant taxpayers as harshly as those that engage in "potentially abusive transactions." (12) Hence, many large companies (say, those involved in the Coordinated Industry Case program) will likely be required to provide detailed reports of hundreds (or, perhaps, thousands) of routine commercial transactions that occur in the ordinary course of their business. (13) Indeed, the disclosure rules will sweep in many more transactions than IRS agents can effectively examine or OTSA can timely review, analyze, and provide beneficial guidance for.

More specific comments and recommendations for improving the regulations, especially for narrowing the reporting requirements and categories, follow. TEI's overarching concerns with these regulations are the potential they pose for (1) substantially increasing compliance costs without a commensurate improvement in the quality of information supplied to the IRS, (2) increasing uncertainty for taxpayers, and (3) heightening the risk of underpayment penalties for foot faults relating to inadvertent failures to file disclosure statements for reportable transactions.

Some taxpayers report that they will likely be required to add staff positions simply to comply with the disclosure requirements. At a minimum, taxpayers must devote resources to reviewing their entire reporting and recordkeeping systems to determine whether changes are necessary in their tax information systems and record-retention procedures. Taxpayers have hardly had time to digest the rules sufficiently to make the necessary modifications to their information systems and record-retention procedures. Even though disclosure of reportable transactions is not required until a taxpayer files its federal income tax return for a taxable year in which its tax liability is affected by the transaction (which, in the case of calendar year taxpayers, may be as late as September 15, 2004, for the first transactions covered by the temporary rules), and even though the IRS suspended the effective date of the rules in Notice 2003-11, it is imperative for taxpayers to have systems and procedures in place to track relevant transactions (and, under the temporary regulations, communications relating to those transactions) as they occur.

As important, examining agents may, after reviewing the many unnecessary disclosures that these regulations require, miss the one or two key transactions that warrant additional scrutiny. Alternatively, agents may feel compelled to examine every disclosed transaction thereby consuming scarce resources and engendering delays in the examination process. Such a result would undermine the initiatives undertaken by the Large and Mid-Size Business Division to accelerate issue resolution and increase the currency of examinations. To assist the IRS in discovering transactions that warrant scrutiny, the temporary regulations should be tailored to apply to specific transactions that a taxpayer has planned and controlled in order to obtain specific tax benefits, that are not routinely disclosed on a tax return, and that have not already been reviewed by the IRS on examination. At a minimum, routine and recurring commercial transactions undertaken in the ordinary course of a taxpayer's business should not be the subject of additional reporting requirements.

Finally, the issues raised by the temporary regulations should be resolved (including the type and amount of information to be provided) before the effective date of the temporary regulations. TEI understands that the 2000 regulations may expire on February 28, 2003, but the interaction of these regulations with an already complex substantive tax law, with the myriad various transactions for which there are multiple financial and tax accounting and reporting treatments, and with the variety and complexity of taxpayers' business operations (and information systems) guarantees many unforeseen consequences and unanswered questions about the scope and effect of the rules. Correspondingly, to accomplish their intended purposes, and for taxpayers to be able to comply, the temporary regulations likely require additional guidance and clarification. Hence, we recommend that the effective date of the regulations be delayed, even beyond the anticipated release of revised regulations in February.

B. Summary of Principal Recommendations. TEI's principal recommendations for changes in the temporary regulations are, as follows:

1. Provide (or retain) a broad-based exception for recurring transactions in the ordinary course of business; clarify when "transactions" must (or may) be aggregated, especially where transactions (e.g., mergers and acquisitions) fall into multiple reporting categories; and clarify that certain studies are not "transactions" even though they affect the treatment of items on a return.

2. Establish a three-year time limit for the disclosure of transactions that become "reportable transactions" in a year subsequent to the year in which the transaction is undertaken or effected.

3. Provide exceptions or exclusions from the confidential transaction category, including a $10-million threshold for reportable transactions, an exception for M&A agreements (including letters of intent), and an exception for communications with the taxpayer's counsel. Clarify that boilerplate confidentiality statements included on routine electronic communications are not "conditions of confidentiality." Provide an exception clarifying that certain exclusivity agreements are not subject to disclosure. Clarify that confidential information supplied to obtain or maintain financing is not a "confidential transaction."

4. Provide a $10-million threshold for reporting transactions subject to contractual protection and clarify the treatment of many other standard forms of contractual protection, including tax "calls," gross-ups, etc.

5. Exempt all mark-to-market losses from the definition of a section 165 loss transaction; clarify the treatment of hedges and hedged transactions for purposes of the section 165 loss category; and, in addition to creating an exception for losses on sales of securities on an established securities market, consider creating an exception for section 165(g) losses.

6. Eliminate the significant book-tax difference category as a category of reportable transactions because it is overbroad and administratively unworkable. If the category is retained, the government should consider substantially increasing the dollar threshold or possibly establishing a reporting threshold that is based on a sliding scale with a threshold that increases with the size of a company's reported assets. If the category is retained in the regulations, the government should also permit taxpayers to report book income in accordance with the method used to report to shareholders and creditors. Finally, the list of exceptions to the significant book-tax difference reportable transactions category should be expanded.

7. Substantially clarify the application and operation of the indirect participation rules, especially for reporting shareholders of controlled foreign corporations (CFCs). Provide exceptions to the indirect participation reporting rule for certain transactions. Recognize that the burden of implementing the information system changes and document retention procedures is potentially greater at the CFC level than it is for U.S. operations, and hence narrow the required reporting and afford taxpayers substantially more time to implement system and document-retention procedures at the CFC level.

8. Narrow the document retention requirements generally because the requirement to retain all documents in respect of reportable transactions is overbroad and imposes a substantial administrative burden. At a minimum, streamline the documentation required for recurring transactions in the ordinary course of business.

9. Delay the effective date of the rules to afford taxpayers more time to analyze the rules, provide comments, and make changes to their information reporting systems and record-retention procedures. The administrative burden of establishing systems and document-retention procedures to comply with these rules is substantial and taxpayers should be afforded time to implement the changes before the effective date.

10. Delay the effective date of the proposed regulations limiting taxpayer defenses to the understatement penalty for failure to disclose reportable transactions. At a minimum, limit the effective date of the penalty regulations to "listed" transactions rather than "reportable" transactions.

11. Narrow the definition of material adviser to exclude employees of the taxpayer who provide advice in respect of their employer's reportable transactions. Narrow the definition of material adviser to exclude external company advisers selected by the taxpayer (not the promoter) and whose fees are usual, customary, and reasonable and increase the minimum fee to $1 million for taxpayers subject to Temp. Reg. [section] 1.6011-4T.

Definition of Transaction

Under Temp. Reg. [section] 1.6011-4T(b)(1), the term "transaction" "includes all of the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and includes any series of steps carried out as part of a plan, and any series of substantially similar transactions entered into in the same taxable year."

As written, the temporary regulations require reporting for many routine and recurring commercial transactions. Indeed, nearly all day-to-day business activities of taxpayers, including the collection of revenues from customers, payment of expenses, investments in plant and equipment, etc., are reportable if one of the tests is satisfied. We do not believe that requiring taxpayers to report many routine and recurring business transactions will assist the IRS in identifying transactions with "potential for tax avoidance or evasion." A broad, general exclusion of routine or recurring transactions undertaken in the ordinary course of business would be beneficial for both the IRS and taxpayers. Thus, TEI recommends that the regulations provide (or retain) an ordinary course of business exception similar to that set forth in the 2000 regulations.

In addition, while it is clear that the requirement to aggregate substantially similar transactions may be necessary, especially for purposes of testing whether the dollar thresholds for the section 165 loss and significant book-tax difference transaction categories are exceeded, it is unclear how the aggregation rules will apply in some cases. For example, large taxpayers frequently have multiple lines of business, each of which may have a separate method of accounting for similar transactions, e.g., a warranty reserve or deferred revenue account. On one hand, there is presumably no requirement to aggregate the warranty reserves or deferred revenues from separate trades or businesses for purposes of the book-tax reporting difference so long as the transactions reflected in the accounts are considered separate "items" for purposes of the tax accounting method rules. (14) On the other hand, would the taxpayer be permitted to aggregate? The different transactions reflected in the taxpayer's warranty reserves or deferred revenue accounts from the separate trades or businesses may be considered "substantially similar transactions entered into in the same taxable year" for purposes of Temp. Reg. [section] 1.6011-4T(b)(1) (especially where the taxpayer coincidentally employs the same accounting method for the items in the separate trades or businesses) and, hence, aggregation may be permitted or even required. We do not believe that aggregation is intended under these facts and circumstances, but we recommend that the regulations confirm when aggregation is permitted or required. (15)

As another example, in merger and acquisition "transactions" there are frequently multiple, related agreements that may constitute a "series of steps carried out as part of a plan." Is the M&A transaction a single transaction even though it may consist of, or spawn, different but related types of "reportable" transactions, such as "transactions" offered under conditions of confidentiality, (16) expected book-tax differences in excess of $10 million, expected section 165 (or similar) losses, or assets with brief holding periods? Also, an M&A agreement involving an "intermediary" may be a "listed" transaction. (17) Presumably, the label of the reportable transaction does not matter so long as the transaction is reported. On the other hand, with dollar thresholds in some but not all categories, a "transaction" may or may not be reportable.

Finally, taxpayers frequently engage advisers to undertake studies that indirectly affect the treatment of items on a federal tax return. For example, they may hire advisers to (1) perform cost-segregation studies, (2) study R&D expenditures in order to maximize the available section 41 credit, (3) review and improve transfer-pricing methodologies and documentation, or (4) develop state and local tax reduction strategies. These studies and reviews should not, in and of themselves, be considered "transactions" subject to the reporting requirement even though they may affect the tax treatment of items reported on the tax return or may prompt a taxpayer to file an amended return. TEI recommends that the regulations be clarified to exclude disclosure of these studies from the reporting requirements.

Definition of Tax Avoidance Transaction

Temp. Reg. [section] 311.6112-1T, which sets forth the rules that organizers and sellers of "potentially abusive tax shelters" and their material advisers must follow in preparing, maintaining, and furnishing lists of investors in such transactions, cross-references Temp. Reg. [section] 1.6011-4T(a) and the list of "reportable transactions" in Temp. Reg. [section] 1.6011-4T(b) for purposes of defining transactions that must be registered as "tax shelters" or have a "potential for tax avoidance or evasion." The preambles to both the disclosure and investor-list regulations state that the IRS and Treasury intend to revise the tax shelter registration regulations under section 6111 to adopt a similar definition when pending legislation is enacted.

Establishing a consistent definition for purposes of all three sections is commendable, for it provides a measure of simplification and clarification for taxpayers and the IRS. This approach, however, increases the concern that unifying the definition of these sections may create the perception that "reportable" transactions are equivalent to "potentially abusive tax shelter" transactions that warrant an automatic adjustment by a revenue agent. Although Temp. Reg. [section] 1.6011-4T cautions that "[t]he fact that a taxpayer files a disclosure statement for a reportable transaction shall not affect the legal determination of whether the tax benefits claimed with respect to the transaction are allowable," the loaded terms in the investor list (and ultimately the registration) regulations are so pejorative that revenue agents may ignore the cautionary statement included in the disclosure regulation. Hence, we recommend that the IRS reinforce the message that disclosure of "reportable transactions" is not indicative of whether the tax benefits are allowable and emphasize in training materials that the determination of the benefits of a transaction is independent of disclosure.

Listed Transactions

Under Temp. Reg. [section] 1.60114T(b)(2), a transaction is a "listed transaction" if the transaction is the same as or substantially similar to one of the types of transactions that the IRS has determined to be an avoidance transaction identified by notice, regulation, or other form of public guidance as a listed transaction for purposes of section 6011. Except for the inherent difficulty of determining which transactions are "substantially similar" to listed transactions, TEI believes the concept of requiring disclosure for specifically identified transactions is workable. It would be beneficial for taxpayers and the IRS alike for the government to annually publish a comprehensive summary of listed transactions. (18)

Temp. Reg. [section] 1.6011-4T(c)(4) defines the term "substantially similar" to include any transaction that is expected to obtain the same or similar types of tax consequences and that is either factually similar or based on the same or similar tax strategy. Regrettably, the definition is tautological, i.e., a substantially similar transaction is one that obtains similar tax consequences and is either factually similar or based on a similar tax strategy. We appreciate that defining the phrase too narrowly poses a risk that taxpayers or promoters will parse the phrase unreasonably to limit the number of disclosures, but the definition injects subjective judgments into otherwise objective disclosure requirements. Thus, agents may apply hindsight to argue that an undisclosed transaction is based on a similar tax strategy as a listed transaction and thereby create a justification for seeking access to a taxpayer's tax accrual workpapers under IRS Announcement 2002-63.

Time Limit for Disclosure of Reportable Transactions

Temp. Reg. [section] 1.6011-4T(e) states that, where a transaction becomes a reportable transaction on or after the date the taxpayer has filed the return for the first taxable year for which the transaction affected the taxpayer's, partner's, or shareholder's federal income tax liability, a disclosure statement must be filed as an attachment to the taxpayer's next federal income tax return filed after the date the transaction becomes reportable. The disclosure is required regardless of whether the transaction affects the taxpayer's, partner's, or shareholder's federal income tax liability for that subsequent year.

This requirement is too broad and seemingly ignores the policy underlying the statute of limitations. Without a time limitation on the scope of the retrospective review, taxpayers are seemingly obliged to report participation in transactions notwithstanding that their returns may have been previously examined or that the statute of limitations has run on the year in which the transaction was undertaken. Moreover, if the statute of limitations has closed on a taxable year, a taxpayer may not have records available to determine whether it participated in a transaction "substantially similar" to a newly listed transaction. (19) Thus, we urge the Treasury and IRS to establish a time limit and require taxpayers to review no more than, say, three prior taxable years in order to identify and report whether they have engaged in "substantially similar" listed transactions undertaken prior to the date a transaction first becomes reportable. At a minimum, taxpayers should not have to review transactions in years closed to examination.

The challenge of complying with these rules and the attendant recordkeeping requirement of Temp. Reg. [section] 1.6011-4T(g) can be illustrated, as follows. Assume a calendar-year taxpayer enters transaction A in 2003 that is not then reportable and files its 2003 return by September 15, 2004. In October 2007, the IRS "lists" transaction A. Assuming the taxpayer filed its 2006 return by September 15, the taxpayer is presumably required to file Form 8886 with its 2007 tax return and under Temp. Reg. [section] 1.6011-4T(g) would be required to keep "all documents" material to the tax treatment of the 2003 transaction until 2010. (20) If the normal three-year statute of limitations on the tax-payer's 2003 return expired September 15, 2007, however, it is unlikely the taxpayer would have retained documents relating to the 2003 transaction. Hence, the taxpayer may well dispose of many records before a transaction becomes listed. (21) Additional comments on the recordkeeping burden imposed by the regulations are set forth below.

Confidential Transactions

Temp. Reg. [section] 1.6011-4T(a)(3) defines a "confidential transaction" as any transaction offered under conditions of confidentiality. All the facts and circumstances relating to a transaction are considered in determining whether a transaction is offered under conditions of confidentiality. The temporary regulations explain that a transaction is offered under conditions of confidentiality if "a taxpayer's disclosure of the structure or tax aspects of the transaction is limited in any way by an express or implied understanding or agreement with or for the benefit of any person who makes or provides a statement, oral or written, (or for whose benefit a statement is made or provided) as to the potential tax consequences that may result from the transaction."

The confidential transaction characteristic will be satisfied in many ordinary course of business transactions because taxpayers frequently sign "nondisclosure" or "confidentiality" agreements before engaging in substantive negotiations. For example, in most transactions that involve an extension of credit from one party to another, the creditor will require confidential information about the financial viability of the borrower that the borrower often will not supply without a confidentiality agreement. Also, most merger and acquisition agreements are negotiated pursuant to nondisclosure agreements. To avoid sweeping in myriad business transactions negotiated between principals, the regulations should be narrowed. Where no "promoter" is working for a fee, the regulations should not compel companies to choose between maximizing protection of intellectual property (i.e., the structure of the transaction between the two companies) and the risk of exposure to the tax disclosure regime. In addition, the rules seemingly require taxpayers to disclose confidential transactions even where the tax statements or structure relate to foreign or state and local taxes. TEI submits that the rules should be limited to the federal tax consequences of a transaction. (22)

In addition to the foregoing, TEI recommends the following specific limitations and exceptions for the "confidential transaction" disclosure requirement:

A. Establish a Dollar Threshold to Eliminate Reporting for Small, Routine Commercial Transactions. The reporting requirement for confidential transactions includes neither a dollar threshold for reportable transactions nor a measure of tax reduction that would limit taxpayers' disclosure reporting burdens. Thus, a taxpayer that engages in a small dollar transaction in which a statement is made about the tax structure or benefits of a transaction must disclose the transaction if it was offered under conditions of confidentiality. Indeed, the provision will require reports for routine commercial transactions regardless of whether tax planning is a material aspect of the transaction because many commercial transactions have an express or implied expectation of confidentiality. Specifically, most businesses expect that their customers and suppliers will not publicly disclose details about routine business transactions. For example, if during the course of negotiations a supplier suggests that the taxpayer consider leasing instead of purchasing equipment, the transaction may become reportable under this provision. A similar problem may arise in connection with any other routine transaction for which there is a means to structure the deal for a tax incentive through tax credits or deductions.

In addition, many day-to-day emails and faxes incorporate a standard privacy notice warning the recipient against nondisclosure of the information. Such boilerplate disclaimers, whether sent by corporate tax department employees discussing the tax consequences of routine transactions or sent by business decisionmakers negotiating transactions, should not constitute "conditions of confidentiality" that engender a disclosure requirement.

Administratively, most businesses will have difficulty implementing procedures to detect whether oral or written statements are made "under conditions of confidentiality" in connection with many routine commercial transactions. Potentially every transaction, email, and other communication of any nature, written or oral, must be scrutinized--and every employee interviewed--in order to determine whether tax consequences were discussed as part of the negotiations for routine transactions. In order to minimize over-reporting to the IRS and the imposition of an unreasonable compliance burden on taxpayers, TEI recommends that a $10-million threshold (based on the total amount invested or expended by a taxpayer in the transaction) be applied to "confidential transactions" undertaken by taxpayers subject to continuing examination in the Coordinated Industry Case program.

B. Exception for Nondisclosure of Pending Merger and Acquisition Transactions. Most merger and acquisition transactions are negotiated on a confidential basis. To protect sensitive business information (including tax return information) that is exchanged during negotiations from disclosure, taxpayers routinely enter into nondisclosure and confidentiality agreements. Confidentiality is paramount because of the potentially disruptive effects that disclosure may have on employee morale as well as supplier and customer relationships. In addition, the form of an M&A transaction (e.g., stock-for-stock merger, cash, or a combination of cash and stock) and whether the transaction will be structured as taxable or tax-free is often unclear at the outset and the negotiation of the tax aspects of the M&A agreement would likely create a disclosure requirement for one or all parties to the agreement. Thus, an exception from the disclosure requirement should be accorded to M&A transactions in order to permit companies to safeguard proprietary corporate information. (23)

C. Exceptions for Communications with Taxpayer's Counsel and for Communications Preceding the Discussion of Tax Consequences of Transactions. The temporary regulations limit the presumption set forth in the 2000 regulations that a transaction is not offered under conditions of confidentiality where a written authorization permitting disclosure is given to the recipient of the communication. Temp. Reg. [section] 1.6011-4T(a)(3)(iv) revises the presumption and accords a safe harbor from disclosure only where the written authorization is provided by every person who makes a tax-related statement and the authorization is effective from the commencement of discussions.

These revisions to the 2000 regulations seem unnecessarily limiting. First, while it is reasonable to require a written disclosure authorization from both the transaction promoter and the promoter's tax counsel, there is no reason to require that the taxpayer's counsel provide a disclosure authorization because that counsel would have no interest in whether or not its client keeps the transaction confidential. TEI recommends that the regulations be revised to clarify that the authorization from a taxpayer's adviser (whether internal or external) is unnecessary. Second, if a person makes a statement concerning the tax aspects of a transaction but had no involvement with the transaction when discussions were initiated, it would be impossible for that person to provide a disclosure authorization that is effective from the commencement of discussions. For companies of any size, there are likely multiple discussions and many individuals involved in the negotiation or approval of any given transaction. Thus, at a minimum, this provision should be revised to require that for the disclosure authorization to be effective it should be provided no later than the first date on which a person makes a statement about the tax treatment of an item.

D. Exception for Certain "Exclusivity" Agreements. The temporary regulations do not address whether "exclusivity agreements" (i.e., agreements requiring the offeree to pay a fee to a promoter if the offeree engages in the transaction regardless of whether the offeree uses the promoter's services) are considered to be offered under "conditions of confidentiality." Upon their release, the 2000 regulations did not address exclusivity agreements, but in August 2000, the IRS issued T.D. 8896 and clarified, among other issues, that transactions subject to "exclusivity" agreements are not considered to be "confidential" so long as the promoter provides an express written authorization of disclosure of the arrangement. (24) TEI recommends that the regulations clarify that certain transactions offered under "exclusivity agreements" are not considered offered under "conditions of confidentiality." (25) As with the 2000 regulations, there should be an exception where the offeree is authorized to disclose the structure of the transaction to others.

E. Exception for Confidential Company Information Supplied in Connection with Loans, Credit Arrangements, or Potential Security Offerings. Companies often supply substantial amounts of information to banks or trade creditors on a confidential basis in order to obtain or maintain financing arrangements. (26) In addition, companies supply confidential information to investment banks on a preliminary basis in order to permit the investment bank to decide whether to participate in a securities offering. The regulations should clarify that information provided under "confidentiality" or "nondisclosure" agreements in such circumstances are not "confidential transactions" within the meaning of the temporary regulations.

Transactions with Contractual Protection

Under Temp. Reg. [section] 1.6011-4T(b)(4), transactions with "contractual protection" must be disclosed. A transaction has "contractual protection" if the taxpayer obtains contractual protection against the possibility that all or part of the intended tax results of a transaction will not be sustained. The regulations expressly enumerate certain contractual protections requiring disclosure, including rescission rights, the right to a refund of fees, fees contingent upon realization of the transaction's tax benefits, and tax indemnifications and similar agreements.

As with the confidential-transaction category, the contractual-protection category includes neither a dollar threshold for reportable transactions nor a measure of tax reduction that would limit taxpayers' disclosure reporting obligations. Thus, a tax-payer that engages in a small-dollar transaction in which contractual protection is provided must disclose the transaction. In order to avoid over-reporting to the IRS and the imposition of an unreasonable compliance burden on taxpayers, TEI recommends that a $10-million threshold (based on the total amount invested or expended by the taxpayer) be accorded to transactions with contractual protection for taxpayers subject to the Coordinated Industry Case program.

In addition, it is unclear whether transactions with certain standard contractual provisions (e.g., those permitting one of the parties to rescind or terminate a transaction as a result of a change in tax law) will be considered to have contractual protection. The temporary regulations provide an explicit exception for gross-up and call provisions included in "debt" instruments that protect the holder from new or increased withholding tax liabilities. (27) The explicit exception for debt instruments, however, may create an inference that "call" provisions in other contexts or instruments are considered a form of contractual protection requiring disclosure of the underlying transaction. For example, preferred stock issuances typically permit a holder to require redemption if the dividends received deduction is reduced or eliminated because of a change in law or on account of the payer's earnings and profits being insufficient to support dividend treatment. Because such provisions are common financial terms, their presence should not trigger a reporting obligation. Similarly, standard gross-up provisions in other agreements should not result in a transaction being considered to have contractual protection. For example, swaps and notional principal contracts are not "debt" instruments per se. Such transactions are typically documented on forms issued by the International Swaps and Derivatives Association (ISDA) and the gross-up and "call" provisions in the forms would likely subject such transactions to a disclosure requirement. TEI recommends that the regulations clarify by example or rule that other standard "tax call" or "gross-up" provisions do not constitute contractual protection requiring disclosure of the pertinent transaction. (28)

In addition, there are many customary tax-related provisions (representations, warranties, indemnities, tax-sharing agreements, audit protection agreement, withholding protection, and gross-up provisions) incorporated in M&A agreements, employment agreements, and vendor contracts. The agreements may address state and local and foreign taxes in addition to federal income or excise taxes. We recommend that the current exception in the parenthetical language of Temp. Reg. [section] 1.6011-4T(b)(4) for a "customary indemnity provided by a principal" be clarified to ensure that such provisions and agreements do not trigger a reporting requirement.

Loss Transactions

Temp. Reg. [section] 1.6011-4T(b)(5)(i) defines a "loss transaction," in the case of a corporate taxpayer, as any transaction resulting in, or that is reasonably expected to result in, a taxpayer claiming a loss under section 165 of $10 million in any single taxable year or $20 million in any combination of taxable years. Lower thresholds apply for purposes of determining whether loss transactions of partnerships, S corporations, and individuals are reportable. Under Temp. Reg. [section] 1.6011-4T(b)(5)(ii), the amount of the loss may be adjusted for salvage, insurance, or other similar compensation. Other income or offsetting gains, however, are not taken into account in determining whether a transaction satisfies the dollar threshold.

This provision will require large companies to provide separate annual disclosures for many transactions for recurring, routine commercial transactions. Reporting of these transactions, however, will provide little useful information to the IRS that is not already reported on Form 1120 and related schedules. We have three recommendations to reduce the amount of unnecessary reporting created by the loss transaction rules. First, for some categories of transactions, and for some financial businesses, the dollar threshold will be satisfied even without a disposition because section 475(a) requires losses to be taken into account on a mark-to-market basis without actual sales. Mark-to-market losses, however, are similar in nature to the exceptions that are provided in Temp. Reg. [section] 1.6011-4T(b)(5)(iii) for losses that are outside of the control of the taxpayer, such as losses from theft, fire, casualty, or other involuntary conversions. In other words, mark-to-market losses occur because of market forces and the taxpayer cannot control the timing of the recognition event. Thus, we recommend exempting mark-to-market losses from the definition of a loss transaction.

Second, many losses that occur from derivative transactions used as financial hedges are substantially offset by income from the items that are hedged as required by Treas. Reg. [section] 1.446-4. Moreover, with respect to hedges, financial accounting rules contain a matching requirement that requires the amount of gain or loss on the transaction to be netted in determining the amount of book income or expense. As a result, it is unclear how a taxpayer is to determine whether the minimum dollar threshold for hedged loss transactions is satisfied. The disclosure regulations seemingly require that the gross, unhedged book and tax amounts be compared, but that would require the taxpayer to ignore the temporary regulation requiring the use of U.S. GAAP for purposes of determining the reported book amount. TEI suggests that a matching rule similar to that applicable for book treatment apply in the context of hedging transactions.

Third, the preamble to the disclosure regulations invites comments on whether the regulations should include a broad exception for losses resulting from the sale of securities on an established securities market, but only where the taxpayer's basis is equal to the amount of cash paid for the securities. TEI agrees that such an exception should be adopted in order to minimize over-reporting. In addition, we encourage the government to consider adding an exception for worthless stock deductions claimed under section 165(g). Business taxpayers frequently establish new subsidiaries in order to introduce new products or services or to expand an existing trade or business into a new geographic market. Such investments are made with an intent to make a profit, but sometimes result in losses. Moreover, nearly every section 165(g) loss claimed by taxpayers in the Coordinated Industry Case program (including amounts less than the section 165 loss disclosure triggers) is scrutinized by the IRS. As a result, a separate disclosure requirement under the temporary regulations would not seem warranted.

Transactions with Significant Book-Tax Differences

Temp. Reg. [section] 1.6011-4T(b)(6) requires publicly held companies and entities with $100 million or more in gross assets to disclose any transaction where the federal income tax treatment of any item or items differs, or is reasonably expected to differ, by more than $10 million from the treatment of the transaction under U.S. generally accepted accounting principles (GAAP). In addition, offsetting items are not permitted to be netted for book or tax purposes.

A. General. The Internal Revenue Code is replete with provisions creating book-tax accounting differences. Hence, it is somewhat a paradox that the more scrupulous taxpayers are in complying with the underlying tax law (in reporting those book-tax differences), the greater the likelihood of having to file additional disclosure statements. Corporations that participate in the IRS's Coordinated Industry Case program generally disclose hundreds (in some cases, thousands) of book-tax differences on their returns and the difference in the book and tax amount frequently exceeds $10 million. TEI submits that this category of reportable transactions imposes a substantial and duplicative reporting burden on taxpayers that is not administrable and will not provide the IRS with useful information to detect abusive tax-motivated transactions. TEI's principal recommendation is that this category of reportable transactions should be eliminated because the reported information duplicates what is already disclosed on the tax return. If the significant book-tax difference reporting category is retained, the government should, at a minimum, consider substantially increasing the dollar threshold or possibly establishing a sliding scale for the reporting threshold that increases as an entity's assets grow beyond the $100 million asset threshold of Temp Reg. [section] 1.6011-4T(b)(6)(ii)(A)(2). (29)

In addition, if this category of reportable transactions is retained, we have three preliminary, overriding concerns about the challenges it poses for taxpayers to comply with and the IRS to administer. First, many companies keep their books on a basis other than U.S. GAAP. Foreign-owned U.S. companies, for example, may keep their books in accordance with their parent companies' foreign GAAP or international accounting standards. In addition, many regulated companies, such as banks and insurance companies, keep their primary books and records on the basis of regulatory accounting requirements. For companies that do not employ U.S. GAAP in their books and records, the book-tax reporting requirement seemingly requires the taxpayers to redesign their tax information systems to convert their book accounting amounts to U.S. GAAP and then compare those amounts to U.S. tax amounts. TEI believes that a requirement to convert the taxpayers books to U.S. GAAP amounts is unnecessary and should be eliminated from the regulations. Companies should be permitted to measure their significant book-tax differences by comparing the tax treatment of an item with the regular method of computing book income for the item and reporting to shareholders and creditors.

Second, most companies do not prepare a "consolidated" U.S. GAAP financial statement for the companies that constitute the affiliated group included in the consolidated tax return. (30) Specifically, public and large, private companies that follow U.S. GAAP include many entities--such as 50- to 80-percent-owned domestic affiliates and more than 50-percent owned foreign affiliates--in their consolidated financial statements, but not in their consolidated U.S. tax returns. Also, taxpayers with partnership entities (whether foreign or domestic) within the group may follow section 704(b) for their book method of accounting for the partnership rather than prepare U.S. GAAP statements at the entity level. To avoid the numerous and confusing adjustments necessary to reconcile between U.S. GAAP reporting requirements and tax reporting requirements, the regulations should be clarified to permit taxpayers to follow their method of computing book income for purposes of reporting to shareholders and creditors. (31)

Third, the book and tax accounting systems for large companies are fundamentally different and are sometimes served by separate computer systems. Absent an exception for transactions incurred in the ordinary course of business, taxpayers will need to substantially redesign their accounting systems to permit comparisons of book and tax treatment on an item-by-item basis. Specifically, as drafted, the regulations would require a taxpayer to (1) group its "substantially similar" transactions, (2) determine the book income on a U.S. GAAP basis for the transactions in which members of the federal consolidated tax return participated, (3) exclude transactions in which members of the financial reporting group that are not part of the consolidated return engaged (subject, however, to the exception for "indirect participation" rule of Temp. Reg. [section] 1.6011-4T(c)(3)(ii) for reporting shareholders), and (4) compare the resulting book income or expense with taxable income or expense. We regret that the information contemplated by the temporary regulations is simply not available today. As a result, taxpayers should not be required to comply with these rules--or worse, be subject to an increased risk of underpayment penalties for failure to disclose "reportable" transactions--until they have been given sufficient time to digest the rules and make the attendant changes to information systems and record-retention procedures.

B. Additional Exceptions for Temp Reg. [section] 1.6011-4T(b)(6)(iii). TEI commends the government for recognizing the reporting burden imposed on taxpayers and for including the list of exceptions for the book-tax difference reporting rule. We also commend the government for soliciting comments in order to expand the list, not only for book-tax differences, but for other categories of reportable transactions as well. As the IRS gains experience with these rules and the transactions that taxpayers report, we urge it to supplement the exceptions and exclusions. (32)

To diminish the burden of duplicative reporting of the same transactions (on Schedule M of Form 1120 and on Form 8886), TEI recommends that the Treasury and IRS consider adopting additional exceptions to the list set forth in Temp. Reg. [section] 1.6011-4T(b)(6)(iii), as follows: (33)

* Inventory valuation differences, whether attributable to differences in book and tax LIFO computation differences, (34) section 263A, or obsolescence reserves.

* Lease transactions (insofar as applicable regulations and IRS ruling requirements are satisfied, e.g., for "true" operating leases or "leveraged" leases).

* Differences in the book and tax treatment of life insurance policies, including the treatment of the policies' inside build-up, death benefits, and surrender proceeds.

* Amounts deducted pursuant to the dividends received deduction.

* Foreign sales corporation commissions (and extraterritorial income exclusions) and subsequent adjustments.

* Tax credits for low-income housing, historic preservation, and alternative energy sources.

* Service income deferred under Rev. Proc. 71-21 and advance payments for goods deferred under Treas. Reg. [section] 1.451-5.

* Like-kind exchanges under section 1031.

* "True-up" or post year-end book adjustments made in order to comply with section 482 or advance pricing agreements.

* All differences in reporting pension and profit-sharing expenses (including post retirement benefits such as medical benefits for retirees).

* Imputed interest income and expense.

* Interest expense deferred under section 163(j).

* Related-party payments deferred under section 267.

In addition, we recommend that examples be added to clarify the general rule in Temp. Reg. [section] 1.6011-4T(b)(6)(iii)(A). For example, post-employment benefit accruals, interest expense deferred under section 163(j), and related-party payments under section 267, which are listed above, are seemingly amounts that represent a "book loss or expense" accrued for financial statement purposes that are generally "reported before or without a loss or deduction" and for which there is no reportable transaction. (35) Similarly, accrued book liabilities deferred for tax purposes under the economic performance rules of section 461(h) might be covered under Temp. Reg. [section] 1.6011-4T(b)(6)(iii)(A) as would disallowed deductions for meal and entertainment expenses under section 274, but it would be helpful to clarify that result. In addition, contingent losses accrued for financial statement purposes under the "probable," "possible," or "remote" criteria for financial statement accrual purposes should be specified.

Further, many of the items for which the deduction is deferred under Temp. Reg. [section] 1.6011-4T(b)(6)(iii)(A) will ultimately reverse, i.e., the liability will be paid and an amount will be deducted for tax purposes under the economic performance rules. Hence, we recommend the regulations include an additional broad rule excluding disclosure of items, especially cash payments, that are deducted under the economic performance rules of section 461(h).

The exception in Temp. Reg. [section] 1.6011-4T(b)(6)(iii)(L) for gains and losses arising under section 475 or section 1296 should be expanded to include book-tax differences that are attributable to any mark-to-market adjustment for book or tax purposes. For example, exceptions for mark-to-market adjustments under section 1256 should be considered. In addition, positions that are marked to market for book purposes but not for tax purposes (and vice versa) should not be reportable.

An exception should be considered for book-tax differences attributable to transactions that are treated as sales for tax purposes but financing transactions for book purposes, and vice versa.

The exception in Temp. Reg. [section] 1.6011-4T(b)(6)(iii)(C) for amortization should apply to amortization of items such as premium and discount on debt instruments.

The exception in Temp. Reg. [section] 1.6011-4T(b)(6)(iii)(C) relating to depreciation should be clarified to include adjustments attributable to amounts recorded in the taxpayer's books for salvage value. In addition, there should be a related exception for the difference in gain or loss reported on the sale or disposition of assets where the difference in basis is attributable to different book and tax depreciation methods, lives, or conventions. Similarly, U.S. GAAP may prescribe purchase accounting treatment for certain tax-free reorganizations. The difference in gain or loss on the disposition of assets with a different book basis attributable to purchase accounting adjustments should be excluded.

The exception in Temp. Reg. [section] 1.6011-4T(b)(6)(iii)(H) encompasses only charitable contributions of cash or tangible property. We recommend expanding the list to include contributions of intangible property. Marketable securities, for example, are frequently contributed and are easily valued.

The term "compensation" in Temp. Reg. [section] 1.6011-4T(b)(6)(iii)(F) should be clarified to include grants and vesting of restricted stock awards (and dividends paid on restricted stock prior to vesting), accruals and payments of deferred compensation, and any amount includible in a Form W-2 or 1099-MISC for nonemployee compensation.

Transactions Involving Assets with Brief Holding Periods

Under Temp. Reg. [section] 1.6011-4T(b)(7), a transaction resulting in or reasonably expected to result in a tax credit of $250,000 or more is a reportable transaction if the asset giving rise to the credit is held by the taxpayer for less than 45 days. There are no exceptions for this reporting category.

Since they are frequently subject to withholding taxes, routine day-to-day intercompany royalty and interest payments may engender a reporting requirement. Indeed, short-term related-party loans are a commonplace financing mechanism within multinational groups. To minimize unnecessary reporting, Treasury and IRS should consider providing an exception for foreign tax credits arising from withholding tax on short-term ordinary course financing.

Companies also frequently invest in overnight or other short-term debt instruments issued by unrelated parties with a term of less than 45 days that may be subject to withholding tax. The regulations would require reporting such investments even though the company held the debt instrument for its entire term. To minimize unnecessary reporting, Treasury and IRS should consider providing an exception for foreign tax credits arising from withholding tax on debt instruments of less than 45 days duration as long as the investment is held for the entire term of the debt instrument.

Finally, the application of the 45-day holding period should be clarified in respect of low-income housing tax credits (and possibly other tax credits as well) where the credits are generated by assets held by a partnership in which the taxpayer is an investor. Specifically, TEI does not believe that a credit generated through an investment in a partnership within 45 days of the taxpayer's year end should be a reportable transaction so long as the holding period is ultimately satisfied. Unless the regulations are clarified, issues may arise under the regulations in respect of what "the underlying asset" is to which the 45-day holding period applies (i.e., the partner's partnership interest or the partnership's asset), especially where the taxpayer's holding period for the partnership interest straddles taxable years.

Other Exceptions

Under the 2000 version of Temp. Reg. [section] 1.6011-4T(b)(3)(ii), notwithstanding that a transaction possessed two or more of the factors triggering disclosure, a transaction was not reportable if one of four enumerated exceptions was satisfied. Two of the exceptions related to transactions undertaken in the "ordinary course of business"; one exception was for transactions where there was "no reasonable basis under Federal tax law for denial of any significant portion of the tax benefits"; and the fourth exception was for transactions identified in published guidance.

In our comments on the 2000 regulations, TEI acknowledged that such rules were necessary but recommended that the IRS and Treasury clarify their application. Regrettably, rather than clarifying the exception, the temporary regulations eliminate all but the last of the exceptions. In order to alleviate the administrative and compliance burdens that the temporary rules may spawn, TEI urges the Treasury and IRS to reconsider the elimination of the broad-based exceptions, especially for transactions in the ordinary course of business.

In nearly all commercial transactions, tax benefits are routinely considered. This is especially so where the tax benefits accruing to one or both parties to a transaction affect the price of an ordinary commercial transaction between them (e.g., leases or other financing transactions and allocations of purchase price). More broadly, absent unusual facts and circumstances that arise in connection with, or as part of a series of related transactions as the "reportable transaction," a transaction that otherwise comports with customary commercial practice should be accorded a presumption as being undertaken in the ordinary course of business.

In addition, the IRS should consider adding exceptions for transactions that are subject to an independent reporting requirement. For example, tax-free reorganizations are subject to very specific reporting requirements under Treas. Reg. [section] 1.368-3. Similarly, like-kind exchanges are reportable on Form 8824. Such reporting requirements provide sufficient disclosure of the transactions and should obviate additional reporting.

Indirect Participation in Reportable Transactions

Under Temp. Reg. [section] 1.6011-4T(c)(3)(i), a "taxpayer will have indirectly participated in a transaction if the taxpayer's federal tax liability is affected ... by a transaction even if the taxpayer is not a direct participant." Under Temp Reg. [section] 1.6011-4T(c)(3)(ii), a "taxpayer that is a shareholder in a foreign corporation will not be considered to have participated indirectly in a transaction to which the foreign corporation is a direct party merely because the taxpayer is a shareholder in the foreign corporation unless the taxpayer is a reporting shareholder ... and the transaction either is described in any of the paragraphs (b)(2) through (b)(5) or in paragraph (b)(7), or reduces or eliminates an income inclusion that otherwise would be required under section 551, 951, or 1293." (Emphasis in the original.) Thus, reporting shareholders of controlled foreign corporations (CFCs) must seemingly disclose the CFC's participation in "listed transactions," transactions offered under conditions of confidentiality, transactions with contractual protection, transactions generating section 165 losses, and transactions involving brief asset holding periods. (36) In addition, reporting shareholders must seemingly disclose transactions involving significant book-tax differences (in paragraph (b)(6)) if the transaction reduces or eliminates Subpart F (or QEF) income inclusions. Temp. Reg. [section] 1.6011-4T(b)(6)(F) provides indirect confirmation of this interpretation by providing that "to the extent that a taxpayer is considered under paragraph (c)(3)(ii) ... to have indirectly participated in a transaction in which a foreign corporation is a direct party, all items from the transaction that otherwise are considered items of the foreign corporation for Federal tax or book purposes shall be considered items of the taxpayer for purposes of [the significant book-tax difference reporting rule]." The preamble explains that "where a taxpayer is considered to participate in a transaction indirectly through a partnership or a foreign corporation, items of the partnership or foreign corporation (for tax or book purposes) are treated as items of the taxpayer (to the extent of the taxpayer's allocable share)." (37)

A. Clarification of the Scope of the Rules is Essential. The manner in which the foregoing rules apply is far from clear. Specifically, it is unclear how reportable transactions must "affect" an indirect participant's tax liability in order to trigger a reporting obligation. Many transactions at the foreign corporation level have no current effect on the shareholder's U.S. tax liability (because there is no dividend or Subpart F inclusion), but to the extent that earnings and profits are affected (e.g., by a section 165 loss) or the deemed paid or other foreign tax credits claimed at a later date by the shareholder are affected, the reporting rules seemingly would apply. Key questions are when, and to what extent, the reporting rules apply if there is no current U.S. tax effect. Hence, TEI recommends that the operation of these rules, especially the book-tax difference reporting rule, be clarified and amplified with examples.

Moreover, read literally, the rules apply to transactions that indirectly "affect" a reporting shareholder through a reduction of the CFC's foreign tax liabilities. It seems odd that the reporting rules would apply to transactions that reduce foreign taxes. If this result is intended, TEI recommends that it be confirmed explicitly and that the regulations include examples to clarify when and to what extent a reduction of a CFC's foreign taxes constitute reportable transactions. (38)

B. Income Inclusions under Subpart F. For a reporting shareholder to be considered an indirect participant in a foreign corporation's direct transactions, a transaction must be (a) reportable and (b) reduce or eliminate income includible by the shareholder as a deemed dividend under section 551, 951, or 1293. To trigger an income inclusion under, for example, the Subpart F rules of section 951, a number of key definitions and operating rules must be satisfied and companies generally structure their foreign operations, entities, and income and expense flows in a tax-efficient fashion that minimizes such inclusions. Indeed, since the "same-country" rule of section 954(c)(3) expressly excludes otherwise includible income from the reach of Subpart F, a critical decision that taxpayers face in structuring their foreign operations is where to establish (or reincorporate) an entity. Equally important are decisions about the form of the legal entity (partnership, corporation, branch, hybrid, or reverse hybrid) employed in each country. Making use of the "same-country" rules of section 954(c)(3) to limit Subpart F income is clearly contemplated by the Code and there should be no "reportable transaction," as such, triggered by transactions employing that exception. We recommend that the temporary rules clarify that choice-of-entity decisions or tax planning to employ the same-country or other exceptions that minimize Subpart F inclusions are not reportable.

Moreover, even more so than in the domestic tax arena, there are a number of provisions that trigger independent shareholder-reporting requirements that will bring entity structuring or restructuring or potentially includible Subpart F amounts to the attention of the IRS. Indeed, the foreign reorganization provisions are replete with shareholder-reporting requirements. Since the purpose of the temporary regulations is to promote the identification of transactions that otherwise might not be reported, the regulations should provide exceptions that clarify when taxpayers may structure or restructure their operations to "reduce or eliminate" Subpart F income without triggering a reporting obligation under the temporary regulations. For example, when entering into a new country through an acquisition of an existing business, a U.S. taxpayer may structure the transaction as either a stock or asset purchase. If a pre-existing CFC acquires the assets in the new country it may operate the business as a branch in order to avoid Subpart F income. The decision to purchase assets rather than stock of a foreign corporation from the seller should not be reportable. Alternatively, a taxpayer may choose to purchase the stock of a foreign target and make a section 338 election in order to eliminate earnings and profits and other tax attributes of the acquired entity. In TEI's view, decisions about (1) whether to acquire assets or stock (on an actual or deemed basis), (2) choice of entity (e.g., branch, partnership, corporation), (3) number of legal entities employed, (4) location of legal entities, and (5) location of assets used in an active trade or business should not give rise to reportable transactions.

C. Reporting Burden. Finally, we note that any expense item at the CFC level--even amounts for which book and tax reporting is consistent--that is allocable to, and reduces the taxpayer's Subpart F income, is potentially a reportable transaction where one of the other categories of reportable transaction is implicated (i.e., confidential transactions, transactions with contractual protection, loss transactions, and assets with brief holding periods generating tax credits.) Thus, the burden of implementing the information system changes and document retention procedures necessary to capture data relating to reportable transactions at the foreign-entity level (whether corporation, partnership, or disregarded entity) is potentially greater than it is for domestic U.S. operations. Since the rules affect many ordinary business transactions, companies will have to train foreign-based personnel, including operating personnel that may make tax statements in connection with negotiating business agreements, in the intricacies of the rules so that they may recognize, document, and report the transactions. This compliance challenge underscores the need to delay the effective date of the regulations. Additional comments on the effective date are set forth below.

Other Issues

Under Temp. Reg. [section] 1.6011-4T(e), a disclosure statement for a transaction must be filed every year for which the transaction "affects" the taxpayer's tax liability for that year. Hence, a taxpayer that participates in a transaction that generates a book-tax difference in excess of the dollar threshold in the first year must disclose the transaction in all subsequent taxable years, even if the taxpayer subsequently reports taxable income equal to (or in excess of) book income. TEI recommends limiting the requirement to disclose a reportable transaction to the taxable year in which the relevant event occurs (e.g., only in taxable years in which the taxpayer recognizes a section 165 loss or a significant book-tax difference).

Moreover, the disclosure rules should apply only to situations where a taxpayer can plan and control the transaction to obtain expected tax benefits. Thus, no disclosure should be required where a transaction that was not a reportable transaction when executed subsequently becomes a reportable transaction due to a subsequent change in law or relevant rule. For example, where a book-tax difference arises after a transaction is executed because of a change in tax law or financial accounting treatment, no disclosure should be required because taxpayers cannot plan or control such an event. TEI recommends that an exception be provided for changes in tax law or accounting principles.

Administrative Issues

A. Reporting on Form 8886. In certain circumstances, the temporary regulations require a series of substantially similar transactions to be treated as a single transaction. In such circumstances, it is unclear whether the taxpayer should disclose each transaction in the series on a separate Form 8886 or, instead, may file a single disclosure statement reflecting aggregate information for the entire series of transactions. We believe it would be consistent with the regulations to permit taxpayers to file a single statement aggregating the series of related transactions and recommend that the regulations be clarified.

B. Document Retention. Temp Reg. [section] 1.6011-4T(g) requires taxpayers to retain all documents "that are material to an understanding of the facts of the transaction, the expected tax treatment of the transaction, or the taxpayer's decision to participate in the transaction." Examples of documents required to be retained include: "marketing materials related to the transaction; written analyses used in the decision-making related to the transaction; correspondence and agreements between the taxpayer and any advisor, lender, or other party to the transaction; [and] documents discussing, referring to, or demonstrating the tax benefits arising from the reportable transaction." Absent an exemption for transactions undertaken in the ordinary course of a taxpayer's business, compliance with this requirement for thousands of potentially reportable recurring transactions will be challenging, if not impossible. Business decisionmakers generate volumes of print and email correspondence and other materials with respect to transactions that have no tax motivation. It would be impractical for the tax department to suggest that the business people retain all records, correspondence, analyses, etc., relating to routine or recurring transactions until the tax department determines which transactions must be disclosed under the temporary regulations. Accordingly, we recommend that the proposed documentation requirements not apply to recurring transactions. If it is necessary to have a reporting requirement for recurring transactions, taxpayers should be afforded a more streamlined approach for record retention relating to such transactions.

C. Ruling Procedures. Under Temp. Reg. [section] 1.6011-4T(f), if a taxpayer is uncertain whether a transaction must be disclosed it may file a "protective disclosure" statement or "submit a request to the IRS for a ruling ... whether the transaction is subject to the disclosure requirements of this section." TEI believes that both provisions are helpful. In addition, we recommend that the temporary regulations (1) provide examples to illustrate where such rulings will be granted and (2) permit taxpayers to obtain rulings that, on a case-by-case basis, may be contrary to the general disclosure rules. (39) In other words, transactions that are a "potentially abusive tax shelter" or have "potential for tax avoidance transaction" for one taxpayer may not be so for another taxpayer. For example, it would be proper to permit limited or no disclosure with respect to otherwise reportable transactions where an examining agent (or OTSA) has reviewed and approved such transactions for the taxpayer or where a taxpayer frequently engages in the transactions in the ordinary course of business. Indeed, as the government gains more experience in the "reportable" transaction rules, it should consider developing an expedited guidance process to permit taxpayers whose disclosed transactions have been examined and found not to be tax avoidance transactions of concern to the IRS to discontinue filing the reports.

Effective Date

A. General. The temporary regulations were released on October 17, 2002, with a request that comments be submitted by December 2, 2002, and an effective date of January 1, 2003. The hearing date was postponed from December 11, 2002, to January 7, 2003, because of inclement weather. In Notice 2003-11, the Treasury and IRS indicated that they are studying the comments that have been submitted and will likely revise the regulations in order to minimize unnecessary reporting. The government expects to publish revised regulations in February and taxpayers would be accorded an election to apply the revised disclosure regulations (rather than the October 2002 regulations) from January 1, 2003.

TEI submits that the six- to ten-week period afforded to taxpayers, practitioners, professional organizations, and other interested parties to study these rules is insufficient to evaluate their full scope and effect, especially the differences between tax and financial accounting for the myriad transactions subject to disclosure. In addition, while some taxpayers report that they will be able to develop systems and procedures to comply with these rules immediately (or will be able to identify reportable transactions after they have been booked), others have expressed doubt about their ability to timely redesign their accounting systems and document-retention procedures to capture all reportable transactions. As a consequence, TEI recommends that the effective date of the disclosure regulations be delayed for a minimum of six months following the release of revised disclosure regulations. Taxpayers should be afforded time to understand the rules, modify their information systems, and develop the document-retention procedures.

B. Transitional Rules or Relief. Transitional rules are likely necessary in a number of circumstances. For example, a taxpayer may have a fiscal year that straddles the effective date. Where substantially similar transactions occur both prior and subsequent to the effective date within the same taxable year, it is unclear whether the transactions should be aggregated. Guidance should be provided for such taxpayers.

In addition, a transaction may close after December 31, 2002, pursuant to an agreement or offer made prior to January 1, 2003, (or the revised elective effective date). Under Temp. Reg. [section] 1.6011-4T(b)(3)(iv), a written disclosure authorization agreement executed at any time after the commencement of discussions will not satisfy the safe harbor presumption. TEI submits that where there are no confidentiality provisions that apply to a transaction that occurs on or after January 1, 2003, a transaction should not be a reportable "confidential transaction." Transitional relief should be provided.

Penalties

On December 30, 2002, the IRS and Treasury released proposed regulations limiting defenses for the imposition of accuracy-related penalties where taxpayers fail to disclose reportable transactions. (40) TEI submits that, before crafting new or additional penalties or limiting taxpayers' penalty defenses, the government should determine whether the new disclosure rules are having the intended salutary effect on taxpayer behavior and encouraging disclosures. Indeed, given the broad scope of the revised disclosure regulations and the excessive number of transactions likely caught by the expansive rules, the government should fine tune its information requirements before considering the application of the revised penalty standards. Moreover, taxpayers should be afforded an opportunity to revise their information systems and review other document-retention systems and procedures in order to comply with the rules. Hence, we urge the government to withdraw (or suspend) the proposed penalty regulations. At a minimum, until taxpayers are afforded sufficient time to develop systems and procedures to comply with the disclosure regulations, the proposed penalty regulations should be limited to a taxpayer's failure to disclose listed transactions. TEI believes it is premature for the IRS to assert penalties for all reportable transactions where the scope and effect of the revised disclosure rules are not fully comprehended.

Material Advisers and List Maintenance

Section 6112(a)requires any person who "organizes" or "sells an interest" in a potentially abusive tax shelter to maintain a list identifying each person to whom an interest was sold. The preamble to Temp Reg. [section] 301.6112-1T states that a material adviser is any person who (i) receives, or expects to receive, at least a minimum fee in connection with a transaction that is a potentially abusive tax shelter, and (ii) who makes or provides any statement, oral or written, to any person about the potential tax consequences of that transaction. (41) The minimum fee is either $250,000 for a transaction where all the participants are C corporations or $50,000 for any other transaction.

These rules are far too broad. If the minimum fee threshold is satisfied, a taxpayer's independent counsel, including potentially a company's employees who act as in-house advisers, is treated as though it were a tax shelter promoter or a promoter's adviser and subject to the investor-list requirements. In the case of many large, commercial transactions where fees may reasonably be expected to exceed $250,000 (e.g., M&A transactions), taxpayers may be dissuaded from seeking independent advice about their transactions. TEI submits that neither voluntary compliance nor disclosure of questionable transactions will be enhanced by a system that potentially penalizes a taxpayer for seeking independent advice in respect of their transactions. Moreover, the regulations are, arguably, unsupported by the current statute, especially as they apply to a taxpayer's seeking a second opinion from an independent adviser that is neither "organizing" nor "selling" the potentially abusive tax shelter transaction.

TEI recommends that the temporary regulations be revised to exclude from the definition of material adviser all officers, directors, or employees of a taxpayer who provide advice to their employer in respect of their employer's reportable transactions. Such a distinction would recognize that the relationship between in-house advisers and their client, i.e., employer-employee, is different from that of promoters and promoters' advisers. (42) In addition, TEI recommends that the scope of the definition of material adviser be narrowed to exclude external advisers who are unconnected to the promoter. For example, material advisers should not include those (1) who are selected solely by the taxpayer and not the promoter and (2) whose fees for legal opinions are based on usual, customary, and reasonable hourly rates.

Finally, where all participants to a transaction are corporations subject to the reportable transaction rules of Temp. Reg. [section] 1.6011-4T, TEI recommends increasing the minimum fee to $1 million.

Conclusion

Tax Executives Institute appreciates this opportunity to present its views on the temporary and proposed regulations issued under section 6011, relating to the disclosure of reportable transactions. The Institute's comments were prepared under the joint aegis of its IRS Administrative Affairs and Federal Tax Committees, whose chairs are David L. Bernard and Mitchell S. Trager, respectively. If you have any questions, please do not hesitate to call Mr. Bernard at 920.721.2230, Mr. Trager at 404.652.2690, or Jeffery P. Rasmussen of the Institute's professional staff at 202.638.5601.

(1) In addition, conforming changes were made to the temporary regulations under section 6111 relating to registration of transactions. For convenience' sake, the temporary and proposed rules released in October 2002 will hereinafter be referred to as the temporary rules or temporary regulations and cited as Temp. Reg. [section]. Since these temporary regulations supersede and substantially revise the temporary and proposed regulations that were issued in February 2000 (and amended subsequently several times), the pre-October 2002 disclosure rules are referred to as the "2000 regulations."

(2) Temp. Reg. [section] 1.6011-4T(e).

(3) Temp. Reg. [section] 1.6011-4T(b)(2).

(4) Temp. Reg. [section] 1.6011-4T(b)(3).

(5) Temp. Reg. [section] 1.6011-4T(b)(4).

(6) Temp. Reg. [section] 1.6011-4T(b)(5).

(7) Temp. Reg. [section] 1.6011-4T(b)(6).

(8) Temp. Reg. [section] 1.6011-4T(b)(7).

(9) Temp. Reg. [subsection] 1.6011-4T(b)(6)(iii) and (b)(8).

(10) 2002-45 I.R.B. 815, 817.

(11) Id., 816-817.

(12) Daily Tax Report (October 22, 2002), G-11.

(13) The compliance burden imposed by the temporary regulations, in terms of the estimated number of reportable transactions for taxpayers' domestic U.S. operations, varies widely from taxpayer to taxpayer and across industries. For U.S. taxpayers with foreign operations, the compliance burden arising from the indirect participation rule of Temp. Reg. [section] 1.6011-4T(c)(3) is unclear, but taxpayers share consistent concerns that the vague rules have a potentially broad scope and effect that will require significant modifications in their recordkeeping and reporting systems as well as their document-retention procedures.

(14) Temp. Reg. [section] 1.6011-4T(b)(6) refers to "items" without a definition or cross-reference. Presumably, the term "item" in the disclosure regulations has the same meaning as the term is used in Treas. Reg. [section] 1.446-1 and includes income, expense, gain, loss, etc., that enters into the determination of taxable income.

(15) The example is straightforward, but the facts and circumstances in taxpayers' businesses, information systems, and compliance procedures are complex and varied.

(16) The purchase-and-sale agreement or related agreements, such as a letter of intent, non-compete arrangements, employment agreements, or severance packages may include confidentiality agreements.

(17) See Notice 2001-16, 2001-9 I.R.B. 730.

(18) For example, in Notice 2001-51, 2001-34 I.R.B. 190, the IRS published a summary of listed transactions as of August 3, 2001. A number of Notices have been issued subsequently identifying new listed transactions.

(19) The purpose of the rule requiring taxpayers to retrospectively identify transactions that subsequently become "reportable" is seemingly intended to prevent the "first taxpayer in line" or "early adopters" of listed transactions from escaping detection. TEI submits that the "net of disclosures" that Treasury and IRS have constructed will cause tax-shelter transactions to surface far sooner than in the past. Hence, there is no need for such an open-ended lookback and disclosure requirement. Moreover, although the application of the reporting rule to transactions that subsequently become listed seems clear even without the example in Temp. Reg. [section] 1.6011-4T(e)(2), the application of the reporting rule to transactions for which there is a "change in facts" such that a nonreportable transaction subsequently becomes reportable as a section 165 loss, significant book-tax difference, or asset with a brief holding period is unclear. We recommend that the regulations provide examples to illustrate how a "change in facts" would trigger a reporting obligation under paragraphs (b)(5) through (b)(7) in a year subsequent to the year a transaction is first reported. Even with examples, it is unclear how a taxpayer's information reporting and recordkeeping system could be designed to ensure that a reporting obligation is satisfied.

(20) In addition to creating confusion about when taxpayers may properly destroy old records, the disclosure regulations will heighten the tension for timely completion of the examination and appeals process in order to close tax years. Taxpayers that routinely cooperate with IRS requests for extensions of the statute of limitations in order to facilitate examinations may find that the advantages of doing so outweighed by the risk of additional reporting and recordkeeping burdens that the open-ended disclosure regulations pose.

(21) Since the disclosure regulations do not specify a time limit on the disclosure requirement, the requirement to file the statement (and maintain records) is presumably the same if the IRS "lists" the transaction in 2010.

(22) Many provisions in the temporary regulations refer to "taxes" or "tax purposes." We believe the rules should be clarified throughout to refer to federal taxes.

(23) The "securities law exception" in Temp. Reg. [section] 1.6011-4T(b)(3)(iii) may not be broad enough to cover many such transactions, especially for private companies.

(24) 2000-2 C.B. 249.

(25) M&A transactions frequently involve brokers, venture firms, and investment advisers that employ "exclusivity" agreements. In the M&A context, exclusivity agreements are not tax-motivated; rather, they provide the broker with a means of securing a fee for arranging the transaction and provide buyers with a window of opportunity for exclusively negotiating a deal with the seller.

(26) The information may be supplied periodically, say, annually, or on a transaction-by-transaction basis.

(27) Although not stated explicitly in the regulations, this provision is likely intended to cover indemnifications as well. We recommend that the regulations be clarified.

(28) Royalty and service agreements commonly have tax gross-up provisions as well. The presence of such terms, however, should not cause a transaction to be reportable.

(29) For example, an entity with $250 million in assets may be subject to a $20 million book-tax difference.

(30) Most U.S. companies will have legal-entity financial statements or general ledgers for corporate entities (including controlled foreign corporations) that account for various items of income, expense, assets, and liabilities on a U.S. GAAP basis. Even so, where multiple entities are part of the group, adjustments and eliminations are often necessary to present the information in conformity with GAAP. Hence, the statement that, for purposes of the significant book-tax difference, "book income is determined by applying U.S. GAAP for worldwide income" is too vague to describe the multi-step process that companies employ to produce financial statements; to prepare federal, foreign, state, or local tax returns; or to reconcile among the different reporting requirements.

(31) The complexities inherent in reconciling the differences between book income of a reporting entity for consolidated financial statement purposes and for consolidated tax return purposes became apparent when the IRS was compelled by legislation to draft regulations for the book unreported profits (BURP) adjustment for purposes of computing alternative minimum tax. Treas. Reg. [section] 1.56-1 sets forth page after page of rules, priorities, and adjustments for determining book income for purposes of computing the BURP adjustment. Congress subsequently revised the AMT computation, but the complexity of that regulation underscores TEI's concern about the administrability of the proposed book-tax difference reporting requirement.

(32) In addition, we commend the IRS for including Temp. Reg. [section] 1.6011-4T(b)(8) as a means of providing additional future exceptions for all categories of reportable transactions.

(33) We appreciate that the Treasury and IRS included in the list many of the recommendations that were discussed informally with government representatives on September 18, 2002. Some recommendations that we made then are repeated here, others are modified, and some are new.

(34) Book and tax LIFO amounts are often not the same. Treas. Reg. [section] 1.472-2(e)(8) expressly permits differences in reported LIFO amounts for book and tax purposes. Such amounts should not be reportable transactions.

(35) Without a clarification or adoption of the recommendation in the next paragraph of the text, however, the deduction in a subsequent year for the deferred item may engender a reportable book-tax difference for the subsequent year. It is unclear why that would be a concern to the government or whether the "to the extent" language of Temp. Reg. [section] 1.6011-4T(b)(iii)(A) is intended to include the deduction for the subsequent payment.

(36) Under Temp. Reg. [section] 1.6011-4T(c)(3)(ii)(B), a reporting shareholder is a "United States shareholder" in a foreign personal holding company or a controlled foreign corporation (as defined in section 551(a) or 951(b), respectively) or is a 10-percent shareholder in a passive foreign investment that is a qualified electing fund (as specified in sections 1293 and 1295).

(37) 2002-45 I.R.B. 815, 817.

(38) Alternatively, the disjunctive "or" in Temp. Reg. [section] 1.6011-4T(c)(ii) joining the phrase "described in any of the paragraphs (b)(2) through (5) or in paragraph (b)(7)" and the phrase "reduces or eliminates an income inclusion...." could be a conjunctive "and." That interpretation, however, would raise questions about the purpose and scope of Temp. Reg. [section] 1.6011-4T(b)(6)(ii)(F).

(39) To be effective, the IRS must issue the rulings on an expedited basis.

(40) REG-126016-01, Reprinted in 2002 TNT 251-1 (December 31, 2002).

(41) T.D. 9018, 2002-45 I.R.B. 823, 824.

(42) In addition, this would minimize disputes about whether an in-house adviser has received a minimum "fee" of $250,000 in respect of a transaction. If TEI's recommendation is not accepted, there will be questions about (1) what forms of compensation (salary, commissions, bonuses, stock options, benefits, etc.) are included in the determination of the "fee" amount and (2) how to allocate the "fee" to the transaction.
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