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Tax simplification and reform.

On March 25, 1997, Tax Executives Institute submitted the following proposals for tax simplification and reform to the US. Department of the Treasury, the Senate Committee on Finance, the House Committee on Ways and Means, the Joint Committee on Taxation, and the Internal Revenue Service. The comments were also filed with the National Commission on Restructuring the Internal Revenue Service.



Simplification Issues

Repeal of AMT Depreciation: In the absence of the repeal of the entire alternative minimum tax (AMT) regime, the AMT depreciation method should be conformed to the regular tax method.

Filing of Forms 3115: Taxpayers that are required to change their method of accounting under a statutory mandate should be relieved from the burden of filing separate Forms 3115 for each subsidiary.

Charitable Contribution Substantiation Exemption: Corporations should be exempted from the charitable contribution substantiation rules.


Simplification Issues

Passive Foreign Investment Company Rules: Controlled foreign corporations should be exempted from the reach of the PFIC provisions.

Use of GAAP for E&P Calculations: Taxpayers should be generally permitted an election to use U.S. GAAP in computing the E&P of foreign corporations.

Same-Country Exception: EU Countries and Hong Kong/China: Countries in the European Union should be treated as a single country for purposes of the same-country exception of the Subpart F rules. Moreover, Congress should clarify that after July 1, 1997, Hong Kong and China will also be treated as a single country.

Translation of Foreign Taxes: Foreign taxes should be translated at the average exchange rate in effect for the year that the foreign taxes accrue for foreign tax credit purposes.

Dividends from Noncontrolled Foreign Subsidiaries: All dividends from noncontrolled section 902 corporations should be aggregated and placed in a single basket for purposes of the foreign tax credit limitations.

Increase in Filing Thresholds: The ownership requirement for filing under section 6046(a) of the Code should be increased from five to ten percent.

Capitalization of Interest in the Foreign Context: Section 263A(f) and section 263A(i) should be amended to specifically exempt controlled foreign corporations from the reach of the related-party rules (and the IRS's rulemaking authority).

Sourcing of the ACE Adjustment: The alternative minimum tax rules should be amended to provide a simplifying rule with regard to the adjusted current earnings preference, similar to that provided in respect of the BURP preference of former section 59(a)(1)(C).

Reform of the

Foreign Tax Credit Rules

Extension of FTC to Lower-Tier CFCs: In recent years, there have been several legislative proposals to expand the foreign tax credit to sixth-tier subsidiaries. TEI endorses these proposals, but suggests that there is no sound policy reason for not expanding the indirect credit to encompass indefinite tiers.

Expansion of FTC Carryovers: The foreign tax credit carryover rules should be conformed to those allowed for net operating losses (i.e., three years back and fifteen years forward).

"Quickie" Refunds Attributable to FTC Carrybacks: Section 6411 should be amended to treat foreign tax credit carrybacks in the same manner as other loss and credit carrybacks for purposes of the "quickie" refund procedures.

As the premier organization of corporate tax professionals in North America, Tax Executives Institute has long been concerned about the complexity of the tax law. The process of simplifying the Internal Revenue Code is overwhelming -- so much so that many would shrink from undertaking the task. Although TEI recognizes that provisions relating to consolidated returns of affiliated groups of corporations, mergers and acquisitions, and the foreign operations of U.S. corporations will never be truly simple, Congress can take action to ease recordkeeping and compliance burdens. On a project-by-project basis, strides can be made. Discrete issues can be attacked and victories achieved. It is with this in mind that we offer the following recommendations to simplify and bring more equity to the Internal Revenue Code.


Tax Executives Institute is the principal association of corporate tax executives in North America. Our 5,000 members represent more than 2,700 of the leading corporations in the United States and Canada. 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 that taxpayers can comply with in a cost-efficient manner.

For more than 15 years, the budget rules and political imperatives have placed a premium on tax law changes that raise revenues without raising rates. Hence, recent legislation has added penalties and engrafted other compliance provisions on to the Internal Revenue Code to raise money. Congress has also chosen to change the Code's accounting rules, not necessarily to achieve a better tax policy result, but to satisfy the insatiable appetite to raise revenue. For example, the 1980s saw a greater separation of the tax law concepts of income and expenses from the related financial accounting principles. Deviations between financial accounting (GAAP) definitions of income and expenses and income tax definitions of the same terms concededly may generate additional tax dollars in the short term, but often the increases are transitory in nature. Hence, the added revenue is fleeting, whereas the increased complexity is forever.

One way to ensure more administrable tax laws in the future would be to place greater emphasis on the administrability of particular provisions during the legislative process. Thus, TEI recommends that the Internal Revenue Service be asked to testify before Congress to address specifically the administrative aspects of proposed legislation, including the cost of compliance for both the government and the taxpayer. In addition, the IRS should be requested whenever possible to develop necessary tax forms and schedules before a proposal is enacted. Finally, the IRS should be required to prepare -- and Congress review -- so-called administrability impact statements in respect of pending legislative proposals. Congress, the IRS, the affected taxpayers, and the public at large should have the opportunity to assess the consequences of proposed tax law changes before it is too late. Minimizing complexity should no longer be an afterthought.

TEI recognizes that Congress and the Clinton Administration are in the midst of a debate on the basic structure of the U.S. tax system. We also recognize that, in light of the impetus for a major overhaul, some may question the efficacy of proceeding with targeted, incremental changes. The Institute believes, however, that the prospects for major reform -- however real or remote -- should not detract from the important and attainable goal of bringing immediate and constructive reform to the tax code.


Simplification Issues


Over the past decade, the Code's departure from accounting concepts has required the creation and maintenance of separate accounting systems and different sets of books, the need to reconcile the multiple systems, and the consequent expenditures of additional funds. For example, section 263A imposes complex capitalization rules for all costs incurred in manufacturing or constructing tangible property. These "uniform capitalization" rules are fictive in nature. In respect of interest, for example, they require the application of "avoided cost" principles, whereby any interest expense that the taxpayer would have avoided if the production expenditures had been used to repay debt of the taxpayer is treated as allocable to the production of property.

Another example of excessive complexity is the alternative minimum tax (AMT), which is, in effect, a separate and independent tax system that not only operates parallel to, but also undermines tax and economic decisions reflected in the regular tax system. The dual systems engender horrendous administration and compliance burdens. To the extent the AMT rules are justified, they are a confession that the (regular) tax system does not work: The AMT regime takes away with one hand the tax treatment given by the other. Well, confession may be good for the soul, but it is absolutely terrible in terms of tax policy and administration. The AMT imposes myriad additional burdens on taxpayers, requires them to maintain at least two sets of books for tax purposes, and has the perverse effect of taxing struggling or cyclical companies at a time when they can least afford it. TEI strongly believes that any true reform of the Code must include the repeal of the alternative minimum tax.

Moreover, the tax law often imposes burdens that are far out of proportion to any legitimate legislative purposes. A prime example of this phenomenon is the lobbying disallowance rules. Enacted in 1993, section 162(e) denies a deduction for certain lobbying expenditures that otherwise meet all requirements of the Code for deductibility of ordinary and necessary expenses. The rules impose tremendous recordkeeping burdens, require taxpayers to split hairs, and make compliance virtually impossible. The regulations only make the statute worse by failing to implement reasonable de minimis rules. In our view, these rules stand as a monument to what can happen to good tax administration when the tax laws are called upon to do a non-tax job.(1)

Another area where a laudable purpose has been undermined by complexity is section 42 of the Code, which provides a tax credit for owners of residential rental property that is used to provide low-income housing. The purpose of the credit is to increase the availability of affordable housing for low-income individuals by encouraging companies to invest in projects that they otherwise would not undertake. The credit was introduced in 1986 in order to streamline and expand the existing tax incentives for housing projects. See Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, 99th Cong., 2d Sess., 152-53 (1987) (hereinafter cited as "1986 General Explanation"). The credit itself, however, is anything but streamlined; indeed, it is incredibly complicated. Because the production of low-income housing is unrelated to the specific business operations of many taxpayers, the credit's very complexity may encourage taxpayers to decline to participate in the program. Those taxpayers that try to provide such housing may find themselves in an avalanche of paperwork.(2) Even where Congress has tried to lighten taxpayers' burdens -- for example, in 1993 when the IRS was given the authority to exempt 100-percent low-income housing projects from the onerous re-certification rules -- taxpayers have seen no relief The rules are in desperate need of simplification.

Former Congressman Barber Conable was known for saying that fairness is the enemy of simplicity -- that the laws are complicated because life is complex and that efforts to make the law fair will invariably lead to complexity. TEI does not deny this, but we believe that reasonable steps can be taken to minimize burdens without undermining the Code's legitimate policy goals. Below are our recommendations for changes in the domestic area. Adoption of these changes will not only ease taxpayers' administrative burdens, but will also permit the IRS to audit returns more efficiently.

Repeal of AMT Depreciation

Present Law. Corporations must adjust their regular tax depreciation deductions in computing their alternative minimum taxable income (AMTI). Under the AMT, depreciation on property placed in service after 1986 must be computed by using the class lives prescribed by the alternative depreciation system of section 168(g) and either (1) the straight-line method in the case of property subject to the straight-line method under the regular tax, or (2) the 150-percent declining balance method in the case of other property. Under the regular tax, depreciation on such property is generally determined using shorter recovery periods and more accelerated recovery methods.

Requiring AMT depreciation to be calculated using depreciation methods that are slower than the regular tax depreciation presents a disincentive to investment. Moreover, the multiple systems create tremendous compliance burdens. For example, for an ordinary piece of office equipment, depreciation must be calculated for regular tax purposes (200-percent declining balance method over 7 years), AMT purposes (150-percent declining balance method over 10 years), and adjusted current earnings (straight-line method over 10 years).

Recommendation. In the absence of the repeal of the entire AMT regime, the AMT depreciation method should be changed to conform with the regular tax method. In addition, to eliminate the need to continue accounting for the assets placed in service prior to the effective date of the provision, taxpayers should be permitted to accumulate the difference between the net tax value of their assets under the regular and AMT depreciation regimes as of the bill's effective date and depreciate cumulative differences over a prescribed time period (no more than 5 years) for AMT purposes.

Filing of Forms 3115

Present Law. Statutory changes often trigger an obligation by taxpayers to file a separate Form 3115 (Application for Change in Accounting Method) for each corporate affiliate. For large multinationals (which may have hundreds of subsidiaries), such a requirement is burdensome and unnecessary.

Recommendation. Taxpayers that are required to change their method of accounting under a statutory mandate should be relieved from the burden of filing separate Forms 3115 for each subsidiary. At a minimum, taxpayers should be permitted to file one Form 3115 for all subsidiaries. In addition, in the case of a change from one permitted method to another permitted method, taxpayers should be allowed to make the change on their return and attach the Form 3115, with a copy to the National Office. Although the IRS may possess the regulatory authority to effect this recommendation, the inclusion of a congressional mandate to do so would demonstrate Congress's seriousness about simplification.

Charitable Contribution

Substantiation Exemption

Current Law. Section 170 of the Code imposes contemporaneous substantiation rules for charitable contributions over $250. Section 170(f)(8)(E) gives the Treasury Department the authority to "prescribe such regulations as may be necessary or appropriate to carry out the purposes of this paragraph, including regulations that may provide that some or all of the requirements of this paragraph do not apply in appropriate cases."

The provision was enacted as part of the Omnibus Reconciliation Act of 1993 (OBRA). The legislative history of the 1993 Act explains that Congress was concerned with quid pro quo donations' that, while deducted as charitable contributions, in reality constituted a payment for goods and services. See H.R. Rep. No. 103-213, 103d Cong., 1st Sess. 63-64 (1993). Moreover, although the broad language of the statute sweeps in contributions made by corporations, the substantiation requirement was clearly aimed at individuals.(3)

Large corporations often have extensive charitable donation programs. Contributions by a company can aggregate millions of dollars a year, spread over scores of locations and thousands of different charities throughout the country. The congressional concern that donors may receive goods or services in return for their "contributions" does not resonate in the corporate setting because the purchase of goods or services by a corporation will generally be deductible under section 162.(4) Therefore, the substantiation requirements impose needless corporate recordkeeping burdens and may prompt some companies to reduce their level of giving without furthering any legitimate legislative goal.

Recommendation. Corporations should be exempted from the special charitable contribution substantiation rules. Such a change would not, of course, relieve corporations from their current obligations to substantiate their charitable contributions under Treas. Reg. [section] 1.17OA-13.


Simplification Issues


The international provisions of the Internal Revenue Code have grown enormously in length and complexity during the past 15 years. Change has been piled upon change, with inadequate attention being paid to the administrative burdens spawned by the cumulative changes. The Code's foreign provisions are in dire need of fundamental simplification and reform. In order for U.S. corporations to remain competitive in the worldwide marketplace, the costs of complying with the tax law and of preparing U.S. corporate tax returns must be reduced. Adoption of the following proposals will not only reduce compliance costs -- thereby enhancing the country's competitiveness -- but will also signal Congress's commitment to simplifying the tax law generally.

Passive Foreign Investment

Company Rules

Present Law. When enacted in 1986, the passive foreign investment company (PFIC) rules were intended to limit the economic benefit of tax deferral available to U.S. investors in foreign investment funds, as well as to restrict the ability of such investors to convert ordinary income into capital gain. In addition, Congress was concerned that the tax rules not provide undue incentives to make investments outside the United States. See 1986 General Explanation 1023.

Unfortunately, even at the time, the PFIC provisions were flawed. Specifically, the definition of a PFIC was so distended that it resulted in the classification of many corporations with active businesses as PFICs. Thus, the PFIC rules not only tax passive income, but also impose a financial toll charge on the operating income of controlled foreign corporations (CFCs), which are already subject to tax on their passive income under Subpart F of the Code.(5) Even a corporation with a modest number of active subsidiaries is required to devote substantial time to analyzing the applicability of the PFIC rules and engaging in activity to minimize their punitive intent. These burdens are not warranted, particularly in connection with CFCs whose U.S. shareholders must independently include the CfCs' passive income in their taxable income under the rigorous rules of Subpart F. A provision to exclude CFCs from the PFIC rules was included as part of the Balanced Budget Act of 1995, which was passed by Congress, but vetoed by President Clinton for reasons unrelated to its merits.

Recommendation. Controlled foreign corporations should be excepted from the reach of the PFIC provisions. Such a move would ameliorate substantial compliance burdens without undermining the congressional intent underlying the PFIC provisions.(6)

Use of GAAP for

E&P Calculations

Present Law. The concept of "earnings and profits" (E&P) has relevance in the foreign tax area for several reasons. For example, E&P is used in measuring the amount of Subpart F inclusions, the portion of a distribution from a foreign corporation that is taxable as a dividend, the amount of foreign taxes deemed-paid for purposes of section 902's deemed-paid foreign tax credit, and the amount of section 1248 gain taxable as a dividend.

The Code currently provides that the E&P of a foreign corporation is to be computed in accordance with rules substantially similar to those applicable to domestic corporations. As a practical matter, however, a foreign corporation is frequently unable to compute E&P in the same manner as a domestic corporation. Although a domestic corporation generally calculates E&P by making adjustments to U.S. taxable income, a foreign corporation necessarily must use foreign book income as its starting point. The required adjustments become especially difficult -- as well as time-consuming and expensive -- in the case of noncontrolled foreign corporations since the U.S. shareholder of such companies may be unable to obtain all the information required to compute E&P.

Although foreign corporations do not compute U.S. taxable income, they frequently do adjust foreign book income to conform with U.S. generally accepted accounting principles (GAAP) for financial reporting purposes. There are numerous differences between GAAP and E&P, but most relate to timing differences and have at most a transitory and nominal effect on a company's U.S. tax liability, especially in light of the requirement of the Tax Reform Act of 1986 that taxpayers compute their deemed-paid credit on the basis of a "pool" of post-1986 undistributed earnings.

Recommendation. Taxpayers should be generally permitted an election to use U.S. GAAP in computing the E&P of foreign corporations.(7)

Same-Country Exception:

EU Countries and

Hong Kong/China

Present Law. In 1992, the European Union created a single market now comprised of 15 countries that led to the consolidation of many European business opportunities. The resulting reduction of operating costs enhanced the competitiveness of EU-based corporations, often to the detriment of U.S.-based companies that are subject to Subpart F.

Under the current Subpart F rules, certain sales and services income that is earned outside a CFC's home country is taxable, whereas income earned inside the home country is exempt from current taxation. Section 954(c)(3)(A) provides that dividends and interest received from a related person who has a substantial part of the assets used in an active trade or business within the same country as the CFC is not included in Subpart F income (the "same-country exception").

Computing Subpart F income significantly increases the administrative costs for U.S.-based companies, but because of generally high European tax rates, the exercise frequently does not generate increased revenues for the U.S. fisc. Thus, U.S. multinationals may be forced to choose between the potential for cost-efficient consolidation of operations in Europe (which could well generate increased tax revenue in the future) and higher administrative costs. Moreover, the Subpart F rules constitute a major hurdle to the use of the EU Parent/ Subsidiary Directive, which permits the tax free movement of dividends within the EU.

In addition, later this year the British lease on Hong Kong will expire and that country will become part of the Republic of China. It is uncertain how this reversion will be treated for purposes of the same country exception.

Recommendation. The EU countries should be treated as a single country for purposes of the same-country exception. This would permit the efficient consolidation of U.S. multinationals' European operations, thereby enhancing their ability to compete in the European Union. Moreover, Congress should clarify that after July 1, 1997, Hong Kong and China will also be treated as a single country.

Translation of Foreign Taxes

Present Law. Prior to the enactment of the Tax Reform Act of 1986, deemed-paid foreign taxes arising with respect to dividends from foreign corporations were translated at the exchange rate in effect on the date of the dividend distribution, in accordance with the seminal decision in Bon Ami Co., 39 B.T.A. 825 (1939). Accumulated profits were translated using the spot rate on the dividend date. By using the same rate to translate foreign taxes and accumulated profits, the Bon Ami approach preserved the historical ratio between those two items.

Section 986(a)(1) was added to the Code in 1986 to address a perceived inconsistency between the rules applicable to taxpayers operating through branches and the rules applicable to taxpayers operating. through foreign subsidiaries. Hence, although foreign taxes are now translated using the exchange rates in effect on the date such taxes were paid, accumulated profits are still translated using the spot rate on the dividend date. This change exponentially increased a U.S. corporation's administrative burdens in respect of translating foreign taxes. Taxpayers must collect and analyze the information on foreign tax payments necessary to compute the dollar values for each tax payment and refund using multiple exchange rates. For example, companies operating in Japan pay three separate creditable income taxes, and Japanese corporate income tax payments and adjustments generally occur throughout the year. In addition, foreign tax returns and receipts often do not evidence a time of payment. The administrative burdens engendered by section 986 are disproportionate to any practical or policy purpose that may be served. Indeed, multinational corporations now find it difficult, if not impossible, to comply literally with the statutory requirements for translating their myriad foreign tax payments.

Recommendation. The simplest and easiest way to remedy this problem would be to return to the Bon Ami rule -- a solution that would translate taxes in the same manner as all other elements of the section 902 fraction. An alternative approach would be to translate foreign taxes at the average exchange rate in effect for the year that the foreign taxes accrue for FTC purposes. Such a proposal has been included in several bills during the last few years. While not perfect, this approach marks a significant improvement over current law.(8)

Dividends from


Foreign Subsidiaries

Present Law. Under section 904(d)(1)(E) of the Code, dividends from each 10-percent to 50-percent owned foreign subsidiary ("noncontrolled section 902" companies) must be separately calculated and placed in a separate foreign tax credit (FTC) limitation basket' (which thereby limits the taxpayers' ability to utilize the credit to minimize double taxation). Consequently, taxpayers face hundreds (or, in some instances, perhaps even thousands) of separate FTC calculations for both corporate and minimum tax purposes in respect of their noncontrolled foreign corporations.

Recommendation. All dividends from noncontrolled section 902 corporations should be aggregated and placed in a single basket. Alternatively, only two baskets should be required in respect of such dividends: one for dividends from noncontrolled section 902 corporations whose underlying earnings are subject to a local country statutory rate equal to or greater than 90 percent of the U.S. rate on ordinary income and another for all other noncontrolled section 902 corporation dividends.

Increase in Filing Thresholds

Present Law. Section 6046(a) of the Code requires U.S. shareholders of five percent or more of the stock of a foreign corporation to file such information returns as are required by the Secretary of the Treasury. The low reporting threshold is quite burdensome for U.S. corporations.

Recommendation. To lessen the administrative burden on U.S.-based companies, TEI recommends that the ownership requirement for filing be increased from five to ten percent. Such a change would not materially affect the IRS'S ability to ensure compliance with U.S. tax rules.

Capitalization of Interest

in the Foreign Context

Present Law. Section 263A(f) of the Code provides that interest paid or incurred during the production period of certain property that is allocable to the production of such property must be capitalized as part of the cost of such property. Property subject to this rule generally includes real property, property with a depreciation class life of 20 years or more, and property with an estimated production period of more than two years one year if the cost of the property exceeds $1 million). Section 263A(i)(1) provides for "regulations to prevent the use of related parties ... to avoid the application of [section 263A]." Pursuant to section 263A(i)'s grant of authority, the IRS issued Notice 88-99, which requires the application of section 263A(f) to the interest expense of all parties related to the taxpayer, including foreign subsidiaries outside the consolidated group.

The expansion of section 263A(f) to sweep foreign subsidiaries into the net of 'related parties" creates tremendous administrative and compliance burdens for U.S. companies, principally in the computation of indirect foreign tax credits under section 902 of the Code. Because all post-1986 earnings are pooled for purposes of this section -- and capitalization only defers the deduction temporarily -- the section 263A(f) inclusion amount becomes increasingly insignificant over time. The existence of excess foreign tax credits has a further averaging effect. Thus, the application of the interest capitalization rules in the foreign context produces relatively insignificant revenue -- certainly not enough to justify the increased cost of compliance on taxpayers.

The calculations required under section 263A(f) -- especially for multinational corporations that may have dozens (or even hundreds) of construction projects and debt instruments in myriad countries -- cannot be accomplished with a mere flick of a computer switch. The compliance burden imposed on these companies under Notice 88-99 is tremendous. Finally, the movement of cash between CFCs and between a CFC and its U.S. parent is independently subject to significant U.S. and foreign tax consequences that serve to prevent abuse. Thus, the extension of section 263A(f) to foreign subsidiaries is unwarranted.

Recommendation. Section 263A(f) and section 263A(i) should be amended to exempt controlled foreign corporations from the reach of the related-party rules (and the IRS's rulemaking authority).

Sourcing of the

ACE Adjustment

Present Law. In 1986, Congress enacted the book unreported profits (BURP) adjustment requiring an addition to minimum tax based on a corporation's book income. The BURP adjustment was effective for 1987-1989. Beginning in 1990, it was replaced by the adjusted current earnings (ACE) adjustment, which relied, in part, on a corporation's earnings and profits rather than book income. In calculating ACE, a corporation uses its E&P as calculated under section 312 of the Code and then makes the adjustments set forth in section 56(g). The corporation next compares its ACE to alternative minimum taxable income (AMTI). If the ACE exceeds the AMTI, the corporation adds 75 percent of that excess to its AMTI.

Former section 59(a)(1)(C) (relating to the BURP adjustment) provided that, for purposes of the alternative minimum foreign tax credit, the book income preference must --

still have the same proportionate

source (and character)

as alternative minimum

taxable income determined

without regard to [the book

income preference].

A similar rule, however, does not apply to the ACE preference. Consequently, under ACE, a taxpayer is required to source all items of income and allocate and apportion all items of expense under the principles of sections 861 and 862. Such complexity is unwarranted and unduly burdensome, particularly in years when the net negative adjustment rules of section 56(g)(2) apply.

Recommendation. The AMT rules should be amended to provide a simplifying rule with regard to the ACE preference similar to that provided in respect of the BURP preference of former section 59(a)(1)(C).

Reform of the Foreign Tax

Credit Rules

Because the United States taxes U.S. corporations on their worldwide income, the Internal Revenue Code permits the U.S. parent to claim a credit against U.S. tax for any income tax paid to a foreign government up to the U.S. tax liability on that type of income. A foreign tax credit (FTC) is allowed for foreign taxes paid not only on income derived from direct operations (conducted through a branch office), but also on dividends from foreign subsidiaries paid out of earnings that have been subject to to foreign taxes (the deemed-paid or indirect credit). The goal of the FTC is simple: to avoid double taxation of the same income by the country of origin and the United States.

In recent years, U.S. tax laws have eroded the effectiveness of the FTC in alleviating double taxation. The Tax Reform Act of 1986 substantially restricted the availability of the FTC by requiring certain types of income to be separated into several "baskets" for purposes of calculating the FTC limitation. The use of multiple baskets has diminished the ability of taxpayers to utilize the FTC to eliminate -- or, at least minimize -- double taxation. In addition, the separate limitations have increased the complexity of calculating the FTC, therby substantially increasing the burden on U.S. corporations to comply with the law. Significant reforms are necessary in this are not only to lessen compliance burdens, but to make U.S. companies more competitive. Our specific recommendations for reform are set forth below.

Extension of FTC to

Lower-Tier CFCs

Present Law. Under sections 902 and 960 of the Code, the deemed-paid FTC applies only to dividends paid by (or the Subpart F income of) a first-tier corporation, 10 percent or more of the voting stock of which is owned by a U.S. corporation. The credit also applies to second-and third-tier subsidiaries, as long as the product of the percentage ownership of voting stock at each level equals at least 5 percent.

The "three-tier" limitation on the deemed-paid FTC was adopted more than two decades ago as a matter of administrative.(9) There is no tax policy reason fore restricting the indirect credit to tiers. Indeed, sound tax policy favors expansion: It would further the goal of alleviating the double taxation of U.S. companies operating abroad. Moreover, it would not increase the administrative burden on "CFCs, which are already required to provide this information for Subpart F purposes. Finally, the adoption of the proposal would simplify the FTC system because taxpayers would no longer be required to effect complex structures to escape the effect of the three-tier limitation.

Recommendation. In recent years, there have been several lagislative proposals to expand the FTC to sixth-tier subsidiaries. TEI endorses these proposals, but suggests that there is no sound policy reason for not epanding the indirect credit to encompass unlimited tiers.

Expansion of FTC Carryovers

Present Law. Section 904?(c) of the Code currently provides that any FTCs not used against U.S. tax in the current year may be carried back two years and forward five. In contrast, the rules for net operating losses in section 172(b) provide for a three-year carryback and a fifteen-year carryforward.

Recommendation. The FTC carryover rules should be conformed to those allowed for net operation losses (i.e., three years back and fifteen years forward). Such a change will not only further the goal off simplifying the Code, but also limit the situations where the purpose of the FTC -- the elimination of double taxation -- is frustrated by unrealistically short] carryover periods. We recognize that in his 1998 fiscal budget,. President Clinton proposed that the FTC carryback be shortened from two years to one and that the carryforward be expanded from five years to seven. Enactment of his revenue raiser would only serve to exacerbate the double taxation caused by expiring FTCs; carryforwards should be lengthened, but not at the expense of the carryback.

"Quickie" Refunds

Attributable to FTC


Present Law. Under normal administrative procedures, tax refunds resulting from a carryback of net operation losses (NOLs), research credits, capital losses or FTCs cannot usually be made until a considerable period of time has elapsed after the close of the taxable year in which the carryback arose. Under section 6411(a) of the Code, however, a taxpayer may file an application for a tentative carryback adjustment of the tax (a "quickie" refund) for a prior taxable year affected by an NOL carryback, a research credit carryback, or a capital loss carryback. The goal of the procedure is the expeditions refund of monies to a taxpayer that -- as a result of subsequent economic events -- has overpaid its taxes and may have a heightened need for the funds. The Code's special "quickie" refund procedure is not currently available with respect to FTC carrybacks, though no sound policy or administrative reason has been articulated for the limitation.

Recommendation. Section 6411 should be amended to treat FTC carrybacks in the same manner as other loss and credit carrybacks. no valid policy reason exists for treating FTC carrybacks less favorably than NOl, capital loss, research credit, and general business credit carrybacks for quickie refund purposes.


Tax Executive Institute appreciates this opportunity to present our simplification and reform proposals. If you have any question, please do not hesitate to call me [James R. Murray, International President,] at (503) 731-17 or Timothy J. McCormally, the Institute's General Counsel and Director of Tax Affairs, at (20) 638-5601.

(1) Another example of needless complexity is the international boycott provisions of section 999, which generally duplicate the Export Administration Act and impose an unnecessary burden on U.S. taxpayers.

(2) Consider, for example, some of the requirements: The credit is generally claimed over a 10-year period in an amount equal to the present value of (i) 70 percent of the qualified basis of new buildings that are not federally subsidized, or (ii) 30 percent of the qualified basis of existing buildings or new buildings that are federally subsidized. A building qualifies for the credit if (i) 20 percent of the units are occupied by individuals with incomes of 50 percent or less of the area median income, or (ii) at least 40 percent of the units are occupied by individuals with income of 60 percent or less of the area median income. The rent charged to the tenants may not exceed 30 percent of the imputed income limitation applicable to the unit. These requirements must be satisfied over a 15-year period (the "compliance period"). In addition, there are complex requirements concerning the rental of the units to students, the amount of project costs that must be incurred in a year to obtain the credit, certification by state housing offices, and bonding.

(3) See, e.g., H.R. Rep. No. 103-213, supra, at 63, which refers to [a]n individual taxpayer who itemizes deductions' and notes that a taxpayer is not required to provide specific information "on his or her return" regarding claimed charitable contributions made by cash or check.

(4) Moreover, corporations making such large contributions will invariably have adequate accounting systems and internal controls; their accounts will most likely be audited by certified public accountants. These factors should ensure that only qualified charitable contribution deductions will be claimed.

(5) U.S. tax law generally allows corporations to defer paying tax on a subsidiary's income earned abroad until that income is repatriated. Under Subpart F, however, certain types of income received by CFCs are currently taxed as a constructive dividend to U.S. shareholders. Subpart F income is generally income that is considered relatively "movable" from one taxing jurisdiction to another and that is subject to low rates of tax. There are elective exceptions from taxation under Subpart F, for example, for income that is subject to a high rate of tax in the foreign country (the "high-tax" exception).

(6) The PFIC rules also impose a look-through rule where a foreign corporation owning 25 percent of the stock of another corporation must include a proportionate share of that other corporation's assets and income in their PFIC calculation. I.R.C. [section] (1296(c) (1986). At a minimum, to reduce administrative burdens this look-through requirement should be reduced from 25 percent to 10 percent.

(7) Regulations proposed in 1992 would eliminate the need to adjust financial statements prepared in accordance with GAAP, but only with respect to uniform capitalization and depreciation for purposes of computing a foreign corporation's E&P. More critically, the proposed regulations do not address the computation of E&P for Subpart F purposes because the IRS and Treasury officials at the time were unsure whether they have the authority to effect such a change by regulation. Although the Institute believes that section 964(a) provides the Treasury Department and IRS with adequate authority to prescribe such rules, we recommend that Congress clarify that such authority exists.

(8) Prior iterations of the proposal to use an average exchange rate have included a two-year rule whereby any foreign income tax paid after the date two years after the close of the taxable year to which such taxes relate would be required to translate taxes at the payment date exchange rate. TEI believes that this two-year rule is an unnecessary complication that should not be adopted.

(9) In the early 1970s, the deemed-paid credit was expanded to domestic corporations claiming a foreign tax credit for foreign taxes paid through a third-tier subsidiary. In making this change, Congress concluded that expanding the credit through the third tier would not create administrative problems for the IRS because of the reporting requirements and the imposition of the burden of proof on taxpayers to substantiate the credits. See S. Rep.
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Publication:Tax Executive
Date:Mar 1, 1997
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