Tax Executives Institute - U.S. Department of Treasury liaison meeting: February 4, 2004.
On behalf of the U.S. Treasury Department's Office of Tax Policy, Assistant Secretary Pamela F. Olson welcomed TEI President Raymond G. Rossi and the other members of the delegation from Tax Executives Institute to the liaison meeting. Mr. Rossi thanked the Treasury representatives for taking time to meet with the Institute. He noted that Ms. Olson had announced her intention to resign as Assistant Secretary. He thanked her for her service as Assistant Secretary, especially her openness and willingness to listen and wished her well in her future endeavors.
The delegations for the Treasury Department and TEI at the liaison meeting are set forth below.
I. Regulatory Projects
a. Section 482 Services Regulations. Ms. Lange referred to the proposed section 482 services regulations, which were released in September. The Institute filed comments on the regulations and testified at the January hearing, expressing concern about several aspects, particularly the elimination of the cost safe harbor, its replacement with the simplified cost-based method (SCBM), and the effect of the statute of limitations in the examples relating to the contingent payment provisions. Ms. Lange noted that government spokespersons have expressed interest in the development of a periodic list of what the government considers "low-margin" services. She inquired about the status of the regulations and requested an update about the concerns raised in TEI's written comments.
Ms. Angus noted that the proposed regulations represent the first attempt to revamp the current regulations since 1968. The world has changed considerably in the last 35 years, she said and issuing final regulations is a high priority for Treasury.
Ms. Angus explained that the cost safe harbor in the current regulations has prompted many comments concerning what types of services fit within its borders. The new method was intended to have the same effect, but was structured to be self limiting, i.e., only low-margin services may qualify for its use. Treasury believes that the SCBM method is effective, she stated, but requested TEI's comments on the development of a per se list of low-margin services, including which services should be included and what form the list should take. She also asked for comments on the negative inference that may be drawn if an item were not included on the list.
In respect of the statute of limitations issue, Ms. Lange noted the current regulations provide that written contracts between controlled parties will generally be respected as long as the terms are consistent with the economic substance of the parties' conduct; if not, the IRS may impute terms consistent with economic substance. Significantly, two examples in the proposed regulations considerably expand this authority, permitting the IRS to rewrite agreements if the taxpayer rendering services is not adequately compensated. Moreover, the examples indicate that the IRS is not limited to making transfer pricing adjustments for the years under audit, but rather, may choose to make an adjustment in the current years to correct an "erroneous" methodology in past years. Did this not suggest that the agency may vitiate the operation of the statute of limitations?
Ms. Angus explained that the examples were intended to address a particular issue where a marketing company attempts to break into the U.S. market but receives no compensation for its efforts. When the market is established, the parties decide that the company is a distributor and there is only a small mark-up in its costs. The proposed regulations permit the IRS to re-cast the transaction to effect a fair allocation of income when a taxpayer has no documentation of the relationship and the relationship shifts to produce a different outcome. The rules are not intended as an end run around the statute of limitations. Mr. O'Connor said that TEI is concerned whether IRS agents will discern any temporal boundaries in reviewing transfer pricing issues. Ms. Angus stated that Treasury appreciates the issue. The government must have the ability to address abusive situations, she said, but clear rules are needed.
Ms. Lange suggested that the proposed services regulations should not be finalized before taxpayers have had an opportunity to review and comment upon the proposed cost-sharing regulations when they are issued. Ms. Angus said the government has not considered how the effective dates between the two sets of regulations should interact. She added that both the cost-sharing regulations and the services regulations are high priority items for the government.
b. Research Tax Credit Regulations. Mr. Rossi referred to the final regulations (T.D. 9104) on the definition of qualified research and computation of the research credit, as well as an Advance Notice of Proposed Rulemaking (ANPR) inviting additional comments on internal use software.
Mr. Traubenberg commended Treasury for the issuance of the much improved regulations, particularly the adoption of a more rational "discovery test" that simply distinguishes between technical and non-technical research based on the section 174 definition. He asked where Treasury is going with the definition of internal use software. Treasury has rejected all suggestions to date, he said. What are you looking for?
Ms. Olson explained that the ANPR identifies the problems Treasury has encountered with the extant internal use software rules, which were proposed in 2001. Mr. Rossi noted the gulf between taxpayers' views and those of the government. The area is particularly difficult, which is the reason we separated it from the final regulations, Ms. Olson stated.
Mr. Kim remarked that Treasury is concerned that the proposed regulations do not facilitate resolution of issues at the examination level. Treasury does not want to issue regulations that increase administrative controversies, he remarked. Ms. Hubbard likened the definition of internal use software--particularly in respect of enterprise resource planning (ERP) systems--to a bowl of spaghetti, noting that it was hard to separate a single piece. If the definition picks out certain pieces and stops, she said, it merely moves the controversy to a different level.
Mr. Traubenberg noted some ambiguity about the effective date of the final regulations. Mr. Kim explained that the definition of gross receipts--which was part of the section 1.41-3 of the regulations issued in T.D. 8930--is effective for taxable years beginning on or after January 3, 2001. The section 1.41-8 regulations--relating to the alternative incremental credit and also in T.D. 8930--are effective for taxable years ending on or after January 3, 2001. The most recent regulations (T.D. 9104) are effective for taxable years ending on or after December 31, 2003. Treasury needs to clarify the effective dates, he acknowledged.
Ms. Zelisko referred to the retroactive nature of the broad definition of gross receipts, which creates a difficult burden for companies to reconstruct gross receipts in the base period. This interpretation seems at odds with Notice 2001-19, which stated that the provisions of T.D. 8930--including the definition of gross receipts--"would be effective no earlier than the date when the completion of the Treasury Department and the IRS review of T.D. 8930 was announced." That date should be either the date the final regulations were issued (December 22, 2003) or the date they were published in the Federal Register (January 2, 2004).
Mr. Kim explained that the definition of gross receipts is unchanged from the one proposed in 1998. Treasury believes that the definition is derived from the language of the statute and should not be changed, he concluded.
c. Capitalization Regulations. Mr. Traubenberg commended Treasury for the issuance of the final regulations addressing the capitalization of costs incurred to acquire or create intangibles, particularly--
* The retention of the presumption in favor of deducting costs relating to the creation of intangibles and the 12-month rule set forth in the proposed regulations;
* The limitation on the use of the "significant future benefit" test only to capitalized expenditures that are expressly listed in guidance issued by the government;
* The adoption of de minimis rules; and
* The modification of the definition of "separate and distinct intangible asset" to exclude package design costs, computer software, and income streams derived from the performance of services.
He said that the reaction to the final regulations in the taxpayer community has generally been positive. One issue TEI has identified is that the final regulations do not permit capitalized acquisition costs to be amortized. TEI believes that these costs should be amortized and suggested that a 15-year amortization of the costs for both the target and the acquirer be adopted. Such a rule would reduce controversy in this area and be consistent with section 197. The cliff effect of the rules (i.e., the expenditure is either fully deductible or capitalized and often never recovered) exacerbates the problem, he explained.
Ms. Hubbard responded that Treasury is grappling with the issue of defining the amortizable costs. Rather than hold up the issuance of the entire package, the department decided to release the regulations without addressing the matter. Given the wide disparity of treatment of the costs under the tax law, the issue warrants further study, she said.
Mr. Solomon explained that Treasury will move to clarify the rules in respect of acquisition costs. More consistency is needed between the treatment of costs incurred by the target and the acquiror, as well as those relating to successful vs. non-successful takeovers. Even if Treasury determines that the costs should be amortized over a 15-year period, he stated, it must still define the costs to be included in the amortization period. He called the costs associated with a "B" reorganization particularly difficult to characterize.
d. Tax Shelter Disclosure Regulations. Mr. Traubenberg referred to the final tax shelter disclosure regulations issued in December that narrow the "confidential transaction" category of reportable transactions to be disclosed under section 6011. The new regulations also remove the presumption against confidentiality for transactions containing a provision for a "tax confidentiality" waiver.
Mr. Traubenberg commended Treasury for working with taxpayers to narrow the confidentiality filter to something more manageable for taxpayers and field agents. He urged Treasury to consider further refinements to the filters by recognizing that transactions to reduce foreign taxes should be exempted from the scope of the regulations, similar to the exemption for transactions to reduce state taxes.
Mr. Kim remarked that a reduction in foreign taxes will generally have no U.S. tax effect and thus should not come within the definition of a reportable transaction. Mr. Traubenberg agreed that there is no direct effect, but noted that the reduction will affect the calculation of earnings and profits. Mr. Kim suggested that the government would want to review the transactions if there were an effect on the U.S. tax return. Mr. Solomon stated that Treasury is generally interested in only the ripple effect of foreign taxes. Mr. Murray noted that the reduction in foreign taxes will lower the foreign tax credit. Mr. Solomon stated that in his personal opinion the transaction would not have to be reported. Ms. Olson stated, however, that carving out an explicit exception in this area may not be feasible.
e. Schedule M-3 Project. Mr. Traubenberg referred to the project to revise the Form 1120, Schedule M to provide more information at the time of filing. The goal of the revised schedule is to permit the agency to screen returns for audit (or non-audit) issues within 90 days of filing. The intent is to be more selective in choosing returns to be audited; some returns that are now routinely audited will not be selected for audit. This will permit the IRS to review returns that have been rarely looked at in the past. A draft Schedule M-3 was issued on January 29.
Mr. Traubenberg commended Treasury for reaching out to stakeholders in revising Schedule M. The transparency effort has the potential of serving both the IRS's and taxpayers' needs, he added. He suggested, however, that the level of detail required in Parts 3 and 4 of the Schedule M-3 has caused some concern. Breaking out discrete items at the book level may not be possible, he said, adding that changes to the general ledger system will be extremely costly. For example, taxpayers cannot map from the ledger to charitable contributions of intangible property--one item required to be broken out on the schedule--because that is not a discrete account within the ledger.
Mr. Traubenberg also noted that a question in Part 1 of the draft inquires about any restatements of earnings. There are different reasons for restating earnings, he explained. What information is the government seeking?
Ms. Hubbard suggested that a taxpayer is required to know the amount of the charitable contributions of intangible property for tax deduction purposes, as well as the amount of the Schedule M adjustment. Isn't the book number just the difference between the two? Mr. Traubenberg replied that the software is not configured to pick up the difference. The general ledger does not include the book amount for intangible property, he said.
Mr. Solomon suggested a separate meeting to discuss TEI's concerns about the Schedule M-3. Mr. Manousos added that the draft instructions for the new schedule will be available soon.
Mr. Rossi expressed concern about taxpayers' ability to use the revised form in respect of 2004. The form will need to be issued soon because many taxpayers have already begun mapping data for the current year, he explained. Mr. Solomon stated that Treasury recognized that speed is of the essence.
Mr. Rossi asked to what extent, if any, the new schedule may eliminate the filings now required under the book-tax difference filter in the tax shelter disclosure regulations. Mr. Solomon stated that although the first step is to complete the Schedule M-3, Treasury is open to considering modifications to the disclosure regulations. Ms. Zelisko noted that frequent changes in the form will create systems problems. Ms. Olson stated that although the Schedule M should probably be updated more than once every 40 years, Treasury recognizes that annual updates cause problems for both the IRS and taxpayers. A balance is needed, she said, as the IRS tries to move to a better way of auditing companies. The government would like to have the new schedule in place for 2004, but we may not be able to complete the review in time. We intend to try, she added.
II. APA Program
Mr. Rossi referred to the IRS's advance pricing agreement (APA) program, which permits taxpayers to work with the IRS to determine the appropriate price for transferring goods and services across international borders between related entities. A recent study found that 86 percent of parent companies identified transfer pricing as the most important international issue they face, he said. He expressed concern about a recent request to the IRS from the Senate Finance Committee to turn over more than 400 APAs and their underlying documentation, the names of all professionals employed by the APA unit in the last 10 years, and a summary of all disciplinary actions brought against APA and competent authority personnel for the last three years. He expressed concern about the future of the program and asked what role Treasury is playing in this process.
Ms. Olson reported that Ms. Angus has been in discussions with the IRS concerning the inquiry. The program is a good one, she said, adding that care must be taken that the scrutiny does not chill the decisionmaking process.
Ms. Lange stated that the inquiry has slowed down the APA process considerably, noting that her company's request for an APA with Japan has been placed in limbo because the APA staff is gathering data to respond to the congressional inquiry.
Ms. Angus said the Finance Committee had also requested information about the Competent Authority program. Noting that it is important to prevent double taxation of income, Ms. Angus predicted that the responses will tell a strong story about the success of the APA and Competent Authority programs. She added that the programs also add value to U.S. treaty negotiations, as well as regulatory projects.
Mr. Rossi expressed appreciation for Treasury's strong support for the two programs.
III. Legislative Proposals
a. Simplification Proposals. Mr. Rossi referred to the Bush Administration's recent budget proposals, which contain several simplification provisions aimed at individual taxpayers, including the establishment of a uniform definition of child, simplification of the earned income tax credit and education provisions, and elimination of the household maintenance test for single parents. He commended Treasury for seeking simplification of the tax law, adding that significant simplification could also be achieved by repealing the alternative minimum tax (AMT) for both individuals and corporations.
Ms. Olson noted that although the Administration's budget does not call for the repeal of the AMT, the proposal is included in the list of items to be considered at a later time.
b. Use of Private Debt Collection Agencies. Mr. Bernard noted that the budget proposal would permit the IRS to use private collection agencies (PCAs) to support IRS collection efforts. Although the proposal would likely not affect TEI members, he explained, the Institute is concerned that outsourcing core government functions implicates important government policies relating to confidentiality, taxpayer rights and privacy, and due process.
Ms. Olson stated that Treasury has carefully reviewed the use of PCAs at the state level. Under the Administration's proposal, the PCAs would have only limited authority to collect unpaid taxes. The use of collection agencies is necessary because the IRS lacks the resources to collect these taxes, she said. The intent is to permit the PCAs to call and remind taxpayers about the taxes owed, permitting the IRS to focus its resources on more difficult issues.
Mr. Bernard expressed the Institute's concerns about the possible snowball effect of the proposal. Ms. Olson stated that Treasury is cognizant of the "slippery slope" issue, but insisted the current situation called for determining other ways to collect the unpaid revenues. Mr. McCormally noted particular concern about the use of contingent fees to compensate the PCAs. Mr. Kim responded that the IRS conducted a pilot program in the mid-1990s that faltered because the agency lacked the technology to identify appropriate cases for collection efforts; that situation has since changed. In addition, the proposal is structured with various safeguards such as the involvement of the National Taxpayer Advocate to ensure that the collection agencies do not overreach. We believe we have taken steps to protect taxpayer rights, he concluded.
c. Tax Shelters. Mr. Bernard next referred to the provisions in the budget proposal for combating tax shelters, including a new penalty for the failure to disclose potentially abusive transactions. A taxpayer failing to disclose a reportable transaction on a return would be subject to a penalty for each failure in the following amounts: (i) for corporate taxpayers with respect to listed transactions, $200,000 and 5 percent of any underpayment resulting from the listed transaction; (ii) for corporate taxpayers with respect to other reportable transactions, $50,000; and (iii) for partnerships, S corporations, and trusts, $200,000 with respect to listed transactions and $50,000 with respect to other reportable transactions. In addition, corporate taxpayers would be required to report any penalty for the failure to disclose to the Securities and Exchange Commission a listed transaction and any accuracy-related penalty resulting from an undisclosed listed transaction.
Mr. Bernard expressed reservations about the proposal, which would layer another penalty on top of an already complex penalty regime. He also encouraged Treasury to oppose ill-advised proposals such as the codification of the economic substance doctrine and the requirement to have a CEO sign the corporate tax return.
Ms. Olson stated that the CEO signature requirement--which has been championed primarily by one Senator--is not on Treasury's list of ways to address the tax shelter problem. She observed that the House of Representatives does not seem as interested in the proposal. She predicted that some form of tax shelter legislation will be enacted this year, perhaps as part of the repeal of the FSC/ETI regime. Although the CEO signature proposal may be dropped in conference, the new penalties will likely be included in the final bill.
Ms. Olson noted that the increase in penalties is intended to deter transactions. She added that the government recognizes that harsher penalties may well put the underlying tax liability at risk because agents may feel uncomfortable in proposing penalties that are viewed as unfair. A balance between encouraging compliance and punishing wrongdoing must be achieved, she concluded. Mr. Jenner added that the penalties are intended to have an in terrorem effect.
Mr. Rossi asked whether proposals to codify the economic substance doctrine will be enacted. Ms. Olson noted that, unlike the CEO signature requirement which is revenue neutral, the codification of the economic substance doctrine is scored to raise revenue. House Ways and Means Committee Chairman Bill Thomas, however, is skeptical about enacting a statutory definition of the doctrine, she added.
d. Expiring Tax Provisions. Ms. Zelisko noted that several tax provisions--such as the work opportunity tax credit and the expensing of "brownfields" remediation expenses--expired at the end of 2003. In addition, the research tax credit is due to expire on June 30, 2004. These provisions cannot effectively serve their legislative purpose if taxpayers do not know whether they will remain in effect from year to year. Moreover, in respect of the research tax credit, the retroactive extensions and gaps in coverage not only impair the provision's incentive effect, but also spawn significant administrative burdens on taxpayers. She asked for a status report on efforts to extend the provisions.
Mr. Jenner stated that it is unclear when such legislation will be considered, although the Administration supports early enactment of the extensions. Congress is working on the legislation, he said, but at the same time it is also trying to deal with the repeal of the FSC/ETI regime and its replacement. Ms. Zelisko noted that, in the absence of legislation repealing the FSC/ETI provisions, WTO sanctions on U.S. exports are scheduled to begin March 1. She expressed concern that some commentators have suggested that the level of trade sanctions is relatively low and therefore insignificant.
Mr. Jenner explained that Treasury has been directed to study the research tax credit provision, which he characterized as "broken." The current R&D regime creates significant controversies, he said. He referred to a proposal to create a third base-period test, calling it awkward at best. In addition, the definition of internal use software must still be addressed.
Mr. Rossi asked whether the Treasury study of the credit will affect its extension. Mr. Jenner stated that the goal of the study is not to interfere with the extension of the current credit, adding that the Administration supports a permanent extension of the credit.
In respect of the FSC/ETI regime, Ms. Angus explained that the threat of WTO sanctions must be taken seriously. Mr. Jenner emphasized the Administration's support for finding a solution to the problem before the sanctions are imposed. Ms. Angus added that Treasury will work with Congress to resolve the issue.
Mr. Rossi thanked the Treasury Department representatives for their participation in the meeting. On behalf of the Treasury Department, Mr. Jenner expressed his appreciation for the time and effort the TEI representatives devote to preparing for the meeting and urged the Institute to continue to bring issues to the attention of the Treasury Department.
Department of Treasury Delegation
Pamela F. Olson, Assistant Secretary (Tax Policy)
Gregory F. Jenner, Deputy Assistant Secretary (Tax Policy)
Eric Solomon, Deputy Assistant Secretary (Regulatory Affairs)
Helen M. Hubbard, Tax Legislative Counsel
Barbara M. Angus, International Tax Counsel
William F. Sweetnam, Jr., Benefits Tax Counsel
Julian Kim, Acting Deputy Legislative Counsel-Regulatory Affairs
George Manousos, Tax Specialist
John F. Kelly, Jr., Special Assistant to the Assistant Secretary
Raymond G. Rossi, Intel Corporation, TEI President
Judith P. Zelisko, Brunswick Corporation, TEI Senior Vice President
Michael P. Boyle, Microsoft Corporation, TEI Secretary
David L. Bernard, Kimberly-Clark Corporation, TEI Treasurer
Deborah A. Lange, Oracle Corporation, TEI Executive Committee
Lisa Norton, Amazon.com Inc., TEI Executive Committee
Mitchell S. Trager, Georgia-Pacific Corporation, TEI Executive Committee
Terilea J. Wielenga, Allergan, Inc., TEI Executive Committee
Paul O'Connor, Millipore Corporation, Chair, TEI IRS Administrative Affairs Committee
Nell D. Traubenberg, Storage Technology Corporation, Chair, TEI Federal Tax Committee
Timothy J. McCormally, TEI Executive Director
Fred F. Murray, TEI General Counsel and Director of Tax Affairs
Mary L. Fahey, TEI Tax Counsel
Jeffery P. Rasmussen, TEI Tax Counsel
Gregory S. Matson, TEI Tax Counsel
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|Date:||May 1, 2004|
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