TEI urges Treasury to permit companies to "check the box" (Notice 95-14).
This letter follows up on our recent meeting concerning Notice 95-14, which asks whether a simplified method of classifying unincorporated business organizations should be adopted (commonly referred to as the "check-the-box" procedure). During that meeting, you asked TEI to address three issues relating to the international aspects of the procedure: (i) the feasibility of using a list of per se corporations; (ii) the designation of "default' corporate status for entities that fail to make an election; and (iii) the mechanics of making the election.
The Institute wholeheartedly supports the expansion of the check-the-box procedure to the international area and is eager to assist the Treasury in ironing out the "nits" in the system. We have completed a survey of the members of our Executive Committee and International Tax Committee on this issue. The following comments are based on that survey.
Automatic Classification of
Under Notice 95-14, domestic, state-law corporations are automatically treated as corporations for federal tax purposes. You asked whether there are foreign entities that should be excluded from an elective check-the-box regime because they are always treated as corporations by U.S. taxpayers.
You specifically requested comments on the treatment of an altiengesellschaft (AG) in Germany, a societe anonyme (SA) in France, and a public limited company (PLC) in the United Kingdom and Australia. Although the majority of our responding members treat these entities as corporations, the survey revealed that some members treat each of these enterprises as flow-through entities under the Morrissey regulations.
Given the IRS and Treasury's historical resistance to the use of lists in other areas (e.g., in respect of the high-tax country exceptions to Subpart F income inclusion), we are surprised that Treasury is considering designating certain enterprises unequivocally as corporations. The Government has also resisted having foreign law concepts drive U.S. tax consequences. See, e.g., United States v. Goodyear Tire & Rubber Co., 493 U.S. 132 (1990) (foreign accumulated profits computed under U.S., not British, law); Procter & Gamble v. United States, 961 F.2d 1255 (6th Cir. 1992) (Commissioner argued, albeit unsuccessfully, that the IRS had authority to reallocate royalty payments restricted by foreign law).
The use of a list of foreign entities that would constitute per se corporations raises several practical issues. First, what criteria are used in determining which entities should be placed on a list of per se corporations? Should the Morrissey factors remain the criteria or should other factors (such as a separate juridical person requirement) be used? In addition, what is the process by which the list will be developed? Will it be established only after a notice-and-comment period and will it be regularly updated?
More fundamentally, what happens if the foreign jurisdiction amends the governing statute (e.g., the United Kingdom changes the legal requirements for establishing a PLC) after the foreign entity is placed on the per se list? Presumably, good faith reliance on the list will not be upset. Thus, until the IRS issues a notice to modify the list (which could take months, perhaps even years), a taxpayer should be able to establish an entity with confidence that its initial and on-going treatment as a corporation will not be challenged. If the taxpayer did not enjoy such assurance - if it must worry that any change in the foreign stature could vitiate its reliance - the certainty offered by the check-the-box regime would evaporate. Finally, an issue arises concerning the effect of the per se list on entities formed before the new procedure becomes effective.
Notice 95-14 provides that if an election is not made for a foreign entity, then that entity will be classified as a corporation. In contrast, the default mechanism in the domestic area is a partnership. You asked whether TEI members are comfortable with such a bifurcated approach. Alternatively, you asked whether taxpayer concerns would be assuaged by a default mechanism that treats an entity as a corporation if all of the equity owners have limited liability.
There is no consensus among our members concerning the use of a default mechanism. Although the majority of our responding members would be satisfied with a corporate default, a sizeable minority expressed a preference for partnership or other flow-through status. Several members pointed out that imposing corporate classification for non-electing entities could upset taxpayers' intent and spawn significant adverse tax consequences, for example, by adding tiers for foreign tax credit purposes or requiring withholding on certain transfers.
Our responding members were evenly split in their responses to the alternative suggestion. A typical criticism was that the limited liability test is too mechanical and arbitrarily ignores the other three Morrissey criteria.
If the proposed regulations do provide for a default mechanism, then there is a critical need to provide for meaningful relief from the inadvertent effects of that default. Quite simply, taxpayers should not be penalized for procedural foot faults. Section 9100 relief should be available for taxpayers that inadvertently find themselves subject to the default treatment because they neglected to make an election under the new procedure. Thus, if the taxpayer completes its tax return and computes its tax liability on the basis of making the election, the failure to check the appropriate box or attach the right form should not preclude an election. In such a case, there can be no reasonable question that the taxpayer intended to treat the entity as a partnership or a corporation and no possibility that the decision to make the election came only with hindsight. Moreover, there would be no detriment to the government in providing for the relief. We therefore recommend that the proposed regulations specifically provide that section 9100 relief will generally be available in such cases.(1)
Election of Classification
One of the areas still open is how the taxpayer should effect the "check-the-box" election. You suggested several ways in which the election could be made: (i) on the Form SS-4 when the taxpayer applies for an identification number; (ii) on the quarterly estimated tax form; (iii) on the first return filed after the formation of the entity; or (iv) on a new, separate form.
Our responding members overwhelmingly endorsed making the election on the first return filed after the formation of the entity. For controlled foreign corporations, a line could easily be added to the Form 5471 or 5472; for foreign partnerships that file a Form 1065, a line could be added to that form. Indeed, the filing of a Form 5471, 5472, or 1065 could, in and of itself, act as the election of corporate or partnership status. Several members noted that many foreign entities do not file a Form SS-4 or make estimated tax payments. The use of a separate form only increases the paperwork burden for the taxpayer and the IRS.
TEI is pleased to be able to assist the Treasury Department in refining the check-the-box procedure. If you have any questions concerning the Institute's comments, please feel free to contact Philip J. Bergquist, chair of the Institute's International Tax Committee, at (408) 974-1531, or Mary L. Fahey of the Institute's professional staff at (202) 638-5601.
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|Title Annotation:||Tax Executives Institute|
|Date:||Mar 1, 1996|
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