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Tax Executives Institute--U.S. Department of Treasury Office of Tax Policy liaison meeting: February 25, 2003.

On February 25, 2003, Tax Executives Institute held its annual liaison meeting with Assistant Treasury Secretary Pamela Olson and other representatives of the Treasury's Office of Tax Policy. The agenda for the meeting is reprinted below. Minutes of the meeting will be published in a future issue of the magazine.

I. Introduction

II. The Bush Administration's Budget Proposals

On February 3, 2003, the Bush Administration released its proposed budget for fiscal year 2004, which includes significant tax provisions. Tax Executives Institute commends the Administration's goals of stimulating the economy and easing double taxation.

TEI is continuing its review of these proposals and may provide more detailed comments as the proposals evolve. Given the breadth of the provisions and their potential disparate effect--combined with the diversity of TEI's membership both in the United States and elsewhere--the Institute may ultimately be unable to develop a consensus position on certain aspects of the Budget proposals. Nevertheless, TEI will be pleased to work with the Treasury Department to highlight our members' concerns and to ensure that the final legislation is as effective and administrable as possible. During the liaison meeting, we invite a discussion of the following provisions.

a. Dividend Exclusion

* Effective for distributions on or after January 1, 2003, with respect to corporate earnings after 2000, public and private corporations would be permitted to distribute non-taxable dividends to their shareholders to the extent those dividends are paid out of income previously taxed at the corporate level. To calculate the amount that can be distributed to its shareholders without further tax, a corporation would compute an excludable dividend amount (EDA) for each year. As an alternative to distributing excludable dividends, corporations could allocate all or a portion of the EDA to provide non-taxable basis increases.

* TEI commends the Bush Administration for undertaking to ease the double taxation of dividend income. We believe that the policy objective of integrating the corporate and individual tax system is laudable, and stand ready to assist Treasury in reducing complexity--including the level of required recordkeeping--and developing a system that is equitable and administrable for both corporations and their shareholders.

b. ERSAs

* The proposed budget includes several new savings vehicles, including the establishment of an Employer Retirement Savings Account (ERSA). ERSAs would follow the existing rules for 401(k) plans, subject to certain modifications. A single test would apply for satisfying the nondiscrimination requirements with respect to contributions for ERSAs. For defined contribution plans, the top-heavy rules would be repealed. Disparity and cross-testing would no longer be permitted.

* The proposal will provide significant simplification to the extent that it leads to the elimination of the alphabet soup of current pension and retirement savings regimes. The savings provisions, however, raise myriad technical issues (especially as they interact with current rules) that potentially will make the Code more complicated.

c. Related Party Interest Deductions

* Section 163(j) of the Code would be revised to tighten the limitation on the deductibility of interest to related persons and to modify the applicable safe harbor. The current law 1.5 to 1 debt-to-equity safe harbor would be supplanted by a test that takes into account the types of assets owned by the corporation and the leverage typically associated with various broad classes of assets. Instead of a fixed debt-to-equity ratio, the safe harbor would be determined based on a series of debt-to-asset ratios identified for these asset classes.

* In the event a decision is made to revise section 163(j)'s safe harbor, TEI recommends several clarifications to the Treasury proposal. For example, the revised safe harbor would permit a level of indebtedness (the "safe harbor amount") based on the value of the corporation's assets in each identified class. "Value" is undefined. We recommend that taxpayers be afforded an election to choose either fair market value or tax basis to determine value.

* The proposal also states that "equity investments in foreign related parties (other than investments in subsidiaries) would not be taken into account" for purposes of the safe harbor. If this provision is aimed at companies that have undergone an inversion transaction, we suggest that it should be more targeted, perhaps by providing look-through treatment similar to section 1297(c) of the Code. Otherwise, it might operate to punitively restrict interest deductions.

d. Brownfields Remediation Costs and Research Tax Credit

* Under the Administration's proposal, the expensing of brownfield remediation expenditures would become permanent by eliminating the restriction that qualified expenditures must be paid or incurred before January 1, 2004.

* The Administration's proposal would also make the research tax credit permanent. This proposal recognizes that the constant expiration and adoption of tax provisions adds complexity to the law and undermines their intended incentive effect. If these provisions are to achieve their intended goals, they must be made permanent. TEI supports the adoption of these provisions.

* Does the Treasury Department anticipate proposing any other statutory changes to the research tax credit provisions?

e. Use of Private Collection Agencies

* Under the proposal, the IRS would be permitted to use private collection agencies (PCAs) to support IRS collection efforts by having the agencies locate and contact taxpayers with outstanding tax liabilities. The PCAs would be permitted to request payment of the liability, either in full or in installments, but would not be permitted to take any enforcement action against a taxpayer. The agencies would be governed by the same rules by which the IRS is governed.

* The outsourcing of core government functions, including the collection of tax liabilities, implicates important government policies relating to confidentiality, taxpayer rights and privacy, and due process. Thus, even though the proposal seemingly has no direct effect on LMSB taxpayers, TEI suggests that it represents poor tax policy, could lead to abuses such as those that triggered the 1998 IRS reforms, and would likely erode taxpayer confidence in the fairness of the tax system. We further suggest that the revenue estimates associated with the proposal represent an overstatement at best and fool's gold at worst. We also have a concern that outsourcing the function could easily lead to a loss of control and additional congressional scrutiny. Accordingly, we recommend that the Administration abandon the proposal.

f. Modification of Section 1203 of the IRS Restructuring and Reform Act

* Section 1203 of the IRS Restructuring and Reform Act of 1998 requires the Commissioner of Internal Revenue to terminate an employee for certain specifically enumerated violations committed by the employee in connection with the performance of the employee's official duties. The Administration proposes to modify section 1203 by (i) removing the late filing of refund returns from the list of violations; (ii) removing employee vs. employee acts (i.e., violation of an employee's, rather than a taxpayer's, constitutional or civil rights) from the list of violations; and (iii) adding the unauthorized inspection of returns or return information to the list of violations.

* Although arguably well intentioned, section 1203 may have undermined IRS morale and had the unintended effect of inhibiting IRS employees from effectively performing their duties. TEI therefore supports the proposed modification of this provision.

II. Tax Shelters

a. The Administration's Proposed Penalty for Abusive Tax Avoidance Transactions

* The Administration's proposal would add a new penalty in respect of 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% 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 their filings with the Securities and Exchange Commission, corporate taxpayers would be required to report any penalty for the failure to disclose a listed transaction and any accuracy-related penalty resulting from an undisclosed listed transaction.

* TEI has long supported the establishment of an effective disclosure regime in respect of taxpayers, promoters, and advisers who may be involved in the development and marketing of potentially abusive tax shelters. Nevertheless, we have significant reservations about certain aspects of the Treasury's proposals, which would layer another penalty on top of an already complex penalty regime. Specifically, TEI suggests that a new strict liability penalty is no substitute for strong, fair enforcement of the laws that are already on the books. In addition, given the ambiguity of the definition of reportable transactions--particularly in respect of transactions that are "substantially similar" to listed transactions--we are concerned that the penalty would impose substantial recordkeeping and reporting obligations on taxpayers, compelling them to disclose myriad ordinary business transactions in order to avoid the penalty.

b. The Grassley-Baucus Proposed Legislation

* The charity tax relief bill recently approved by the Senate Committee on Finance contains provisions relating to corporate tax shelters that are modeled after S. 2498, The Tax Shelter Transparency Act, which was introduced by Senators Grassley and Baucus last year. In its comments on S. 2498, TEI urged the Finance Committee to: (i) refrain from increasing the substantial understatement penalty to 30 percent for listed transactions or 25 percent for other reportable transactions; (ii) reject strict liability standards for nondisclosure and heightened substantial understatement penalties; (iii) replace the "a significant purpose of tax avoidance" filter for reportable transactions with a standard based on "the principal purpose" of tax avoidance; (iv) retain the current substantial authority standard for avoiding penalties for disclosed nonlisted transactions and undisclosed nonreportable transactions; and (v) eschew proposals requiring shareholder reporting of certain penalties. We continue to believe that the proposal is flawed.

* Economic Substance Test. The new bill would "clarify" the economic substance doctrine, but delays its effective date to transactions after Feb. 15, 2004. Although legislative language has not been released, TEI believes that proposals to codify the doctrine should be rejected. The economic substance doctrine was developed by the courts to complement, or provide a backstop, to the Internal Revenue Code's substantive provisions, not vitiate them. It is clear that, when abuses occur, the courts are generally willing to utilize existing doctrines or to create new ones to prevent abuse. Regrettably, codifying the economic substance doctrine would further complicate and confuse the system and undermine not only legitimate tax planning but also the courts' willingness and ability to apply other judicial doctrines in the event the codified rule does not reach a particular type of transaction.

* CEO Signature Requirement. The new bill would also require chief executive officers to sign corporate tax returns. Although TEI has consistently supported efforts to enhance the disclosure of transactions justifying scrutiny, the Institute believes the proposal to require a CEO to sign a corporate tax return misapprehends the role of the tax department as well as that of the CEO. It would force companies to devote substantial time and resources to educating CEOs about the intricacies of the company's tax affairs, distracting them (and the company's tax personnel) from activities that put their respective professional expertise to their best uses--including overarching issues of corporate governance and accountability.

The tax affairs of major corporations are extraordinarily complicated and their management is routinely delegated to the Chief Tax Officer (or similarly titled individual) who has been especially trained. In TEI's view, the senior tax official is the person in the best position to assess--and state affirmatively--that the return fulfills the company's legal obligations.

* During the liaison meeting, TEI requests the Treasury Department's view on the proposed legislation.

c. Temporary and Proposed Regulations on the Disclosure of Tax Shelters

* General. In October, the IRS and Treasury Department released temporary and proposed regulations modifying the rules for disclosure of "reportable" transactions. Other temporary and proposed regulations released the same day modify the rules for certain persons--promoters and material advisers--to maintain and furnish lists of investors in "potentially abusive shelters." In Notice 2003-11, the Treasury Department indicated that it anticipates releasing revised regulations by February 2003. In light of the imminent release of revised disclosure regulations, we invite a discussion of the new rules.

* Although TEI supports a disclosure approach based on objective criteria, we believe the reporting requirements are far too broad. Moreover, taxpayers have had little time to digest the new regulations and make the necessary modifications to their information systems and record-retention procedures. TEI therefore recommends that the effective date of the revised regulations be deferred for at least six months following the release of the revised rules.

* Recommendations to Minimize Taxpayer Burden. The administrative burden imposed on all taxpayers by the temporary rules is tremendous. In order to mitigate that burden, the triggers for reporting the various categories of transactions should be narrowed. Specifically, the regulations should (i) include an exception for routine or recurring transactions in the ordinary course of business, (ii) eliminate the significant book-tax difference as a category of reportable transactions, and (iii) narrow or substantially clarify the application of the "indirect participation" rule for transactions undertaken by controlled foreign corporations.

In their current form, the temporary rules will catch many routine and recurring transactions, including those that taxpayers have neither planned nor controlled for tax-reduction purposes. An exception for transactions undertaken in the ordinary course of business would minimize such over-reporting. In addition, transactions with book-tax differences are already disclosed on the return and are subject to scrutiny by revenue agents. Requiring additional disclosures of the same transactions on Form 8886 is extremely burdensome for taxpayers and any benefit from added disclosures will be diminished by the sheer number of extraneous reportable transactions. Hence, the category of reportable transactions should be eliminated. In the event that the book-tax reporting difference is retained as a category of reportable transactions, the list of exceptions for this category should be expanded in order to minimize duplicative reporting on Schedule M-1 and Form 8886. Some suggestions were included in TEI's January 2003 comments.

Finally, the indirect participation rules are potentially far-reaching. It is unclear, however, how--and when--a "reportable transaction" must "affect" an indirect participant's tax liability in order to trigger a reporting obligation. Key questions are when, and to what extent, the reporting rules apply if there is no current U.S. tax effect. Also, taxpayers frequently structure their business operations in order to minimize Subpart F income. These transactions have legal, economic, and business ramifications apart from the effect on a taxpayer's tax liability. As a result, the temporary rules should clarify that decisions about (i) whether to acquire assets or stock (on a deemed or actual basis), (ii) choice of entity (branch, corporation, partnership), (iii) number of legal entities employed, and (iv) location of assets or entities are not reportable transactions.

* Other Recommendations and Clarifications. TEI's comments made a number of other recommendations for modification or clarification of various aspects of the temporary rules. We request a status report or discussion of the prospects for modification or clarification of the rules, as follows:

* The adoption of a $10 million threshold for "confidential" transactions and "transactions with contractual protection";

* A requirement to review no more than three years of previously filed returns in order to determine whether a taxpayer engaged in a newly reportable transaction when a transaction is designated a "listed" transaction in a year subsequent to the year in which the taxpayer undertakes the transaction;

* Exceptions in respect of confidentiality for (i) M&A agreements (including letters of intent) and (ii) communications with the taxpayer's counsel.

* Clarification of the "confidential transaction" category that (i) certain "exclusivity" agreements are not subject to disclosure as confidential transactions; (ii) boilerplate confidentiality restrictions in many electronic communications do not trigger disclosure; (iii) non-disclosure agreements relating to intellectual property does not trigger disclosure; and (iv) information supplied to obtain or maintain debt or equity financing does not trigger a disclosure obligation;

* Clarification of the category of "transactions with contractual protection" so that common financial terms in preferred stock issues and gross-up provisions in derivatives, swaps, and notional principal contracts do not trigger a disclosure requirement;

* Clarification of the treatment of hedges and hedge accounting for purposes of the "section 165 loss transaction" category and the addition of an exception for section 165(g) losses.

* The December Proposed Regulations. The Treasury Department has also issued proposed regulations limiting defenses for the imposition of accuracy-related penalties where a reportable transaction is not disclosed. 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. Hence, the effective date of the proposed penalty regulations should be suspended or at least limited to listed transactions.

III. Simplification and Tax Reform

a. Repeal of the Alternative Minimum Tax

* Major simplification could be achieved by repealing the alternative minimum tax for both corporate and individual taxpayers. The Administration's budget proposal extends the temporary waiver of the AMTI limitation on net operating loss carrybacks to those originating in taxable years ending in 2003, 2004, and 2005, as well as for NOLs carried forward into those years. Although this is a step in the right direction--and one which the Institute supports--we urge the Treasury Department to continue to work for the full repeal of the AMT.

b. International Tax Reform

* In response to the adverse decision of the WTO's Dispute Settlement Body concerning the FSC/ ETI provisions, the Bush Administration has indicated it expects the United States to comply with its obligations under the WTO agreements. We also believe the Administration shares our concern about the adverse effect of trade retaliation. The exact form of that compliance has not yet been decided, but the repeal of these provisions will have a significant adverse effect on many U.S. companies. At the same time, many other Code provisions that affect international transactions go beyond the norm established by major U.S. trading partners or are significantly out of date. These problems also adversely affect the competitiveness of U.S. companies, farmers, and workers. TEI members are concerned that the Administration and Congress take effective action to address these issues. Moreover, any action resulting in the repeal of the FSC/ETI provisions should not be taken without correlative benefits to U.S. companies, farmers, and workers who suffer the loss of the FSC/ETI provisions and others significantly affected by the U.S. system of international taxation. During the liaison meeting, TEI would like an update on Administration efforts to address these problems.

IV. Status Reports

a. IRS Budget

* Whether the promise of the reorganization can be realized depends in large measure on the IRS's securing sufficient funds to do its job. TEI has consistently supported both adequate funding for the IRS. TEI is concerned about reports that funding for programs such as the modernization program may be substantially cut back. Does Treasury anticipate that the IRS will receive the funding it needs for this program, as well as for the recruitment and training of personnel?

b. Proposed Regulations on Capitalization of Expenditures

* Proposed regulations on the deduction and capitalization of expenditures were issued in December. TEI is still reviewing the proposed rules, but during the liaison meeting we request a status report on what, if any, changes are contemplated in the final regulations.

c. Section 482 Regulations

* We understand that the Treasury Department and IRS are nearing completion of a revision of Treas. Reg. [section] 1.482-2, which deals with services. IRS Chief Counsel B. John Williams stated recently that Treasury and the IRS are considering the inclusion of stock-based compensation as an expense that must be charged in intercompany services agreements--a position that violates the arm's-length principle. Mr. Williams also stated that the IRS is examining whether there should be safe harbors with regard to services. Is the Treasury Department coordinating the development of the proposed regulations with the Orgaanisation for Economic Cooperation and Development? During the liaison meeting, please provide a status report on the regulations.

* Treasury and the IRS will reportedly issue proposed regulations clarifying cost sharing under Treas. Reg. [section] 1.482-7 in early summer. Are changes contemplated beyond the inclusion of stock-based compensation in a qualified cost-sharing arrangement? For example, will any changes address the issues associated with buy-ins?

d. Research Tax Credit Regulations

* We understand that the Treasury Department and IRS are nearing completion of the final research tax credit regulations. During the liaison meeting, we invite a discussion of the status of these regulations, including what, if any, changes are contemplated.

e. Circular 230

* TEI filed comments last year on the effect of Circular 230 on in-house tax professionals. During the liaison meeting, we request a report on the status of these regulations.

f. Tax Treatment of Stock Options

* The divergent treatment of stock options for tax and financial accounting purposes continues to spawn much discussion. Does the Treasury Department anticipate proposing any changes in the tax treatment of stock options?

g. Deferred Compensation

* In its proposed budget, the Bush Administration recommends a repeal of section 132 of the Revenue Act of 1978, the effect of which would be to authorize the Treasury Department to issue rules to address inappropriate nonqualified deferred compensation arrangements. Should section 132 be repealed, what type of guidance is contemplated? In addition, does Treasury contemplate issuing rules in respect of nonqualified deferred compensation plans similar to the May 2002 regulations issued under section 457, which would liberalize the rules relating to monthly deferral elections, redeferral elections, and distribution/method of payment elections?

h. Disclosure of Corporate Tax Returns

* Last year a proposal was made to require the disclosure of corporate tax returns. TEI believes that the suggestion is ill-advised. Does the Treasury Department anticipate suggesting any changes in this area? Has Treasury had any discussions with congressional representatives concerning the issue?

i. Internet Tax Freedom Act

* What is the status of the extension of the Internet Tax Freedom Act?

V. Conclusion
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Publication:Tax Executive
Date:Mar 1, 2003
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