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THE
ADMINISTRATION'S FY 2001 BUDGET:
A CRITIQUE OF KEY TAX PROVISIONS
INTRODUCTION
The
Tax Council commends the Administration for its positive tax
proposals. In particular, the provision accelerating
look-through treatment for dividends from 10/50 Companies will
go a long way toward improving the competitiveness of U.S.
companies. However, in devising many of its other tax proposals, the
Administration has abandoned tax policy principles in order to
tap new revenue sources. The
federal budget surplus in FY2001 will be larger than at any time
since 1951. A strong economy and substantial corporate tax payments have
contributed to this budgetary success.
It makes little sense to consider approximately $175
billion in gross tax increases ($96 billion in income tax and
$79 billion in Superfund and tobacco excise taxes), many of
which are aimed directly at the largest employers in America, at
a time when we should be pursuing all reasonable means to
bolster our current economic achievements.
The Tax Council recommends that Congress reject a number
of these proposals, many of which could conceivably provide
Treasury with the ability to attack legitimate tax planning by
U.S. companies.
Many
of the revenue raisers found in the FY2001 Budget proposals
introduced by the Administration lack a sound policy foundation.
Although some of them may be successful in raising
revenue, they do nothing to achieve the objective of retaining
or expanding U.S. jobs and making the U.S. economy stronger.
For example, provisions are found in the FY2001 Budget
that (1) provide the Treasury Secretary with blanket authority
to issue regulations in the international area that could
conceivably allow it to attack legitimate tax planning by U.S.
companies, (2) arbitrarily change the sourcing of income rules
on export sales by U.S. based manufacturers, (3) impose new
complex rules on business operations in certain "tax
haven" countries, (4) limit the ability of so-called
"dual capacity taxpayers" (i.e., multinationals
engaged in vital petroleum exploration and production overseas)
to take credit for certain taxes paid to foreign countries, (5)
extend Superfund taxes without attempting to improve
environmental remediation programs, (6) severely and
retroactively impact the economics of transactions entered into
in reliance on present law by, for example, imposing changes to
the deductibility of future interest payments that are made to
related foreign entities on previously issued debt, modifying
the treatment of distributions as dividends on previously issued
self-amortizing stock, and imposing new capitalization
requirements regarding future interest accruals for previously
entered into straddles transactions, and (7) restrict taxpayers
from having the ability to deduct legitimate amounts paid to
satisfy civil punitive damage awards.
In its efforts to raise revenue, the Administration has
unwisely targeted publicly held U.S. multinationals doing
business overseas. The Tax Council urges that such proposals be seriously
reconsidered. The
predominant reason that businesses establish foreign operations
is to serve local overseas markets so they are able to compete
more efficiently. Investments
abroad provide a platform for the growth of exports and
indirectly create jobs in the U.S., along with improving the
U.S. balance of payments. The
creditability of foreign income taxes has existed in the
Internal Revenue Code for over 70 years and is necessary to
prevent the double taxation of foreign income.
Replacing foreign tax credits with less valuable
deductions will result in international double taxation and
greatly increase the costs of doing business overseas, putting
U.S. multinationals at a competitive disadvantage vis-à-vis
foreign-based companies.
In order that U.S. companies can better compete with
foreign-based multinationals, the Administration should do all
it can to reform the international provisions of the U.S. Tax
Code, making it more friendly, and consistent with the
Administration's more enlightened trade policy. Rather than making proposals that would reward some
industries and penalize others, the Administration's budget
should be written with the goal of reintegrating sounder tax
policy into decisions about the revenue needs of the government.
Provisions that merely increase business taxes by
eliminating legitimate business deductions should be avoided.
Ordinary and necessary business expenses are an integral
piece of our current income based system, and arbitrarily
denying a deduction for such expenses will only distort that
system. Higher
business taxes impact all Americans, directly or indirectly.
For example, they result in higher prices for goods and
services, stagnant or lower wages paid to employees in those
businesses, and smaller returns to shareholders.
Those shareholders are often employees of that company,
or the pension plans of other middle class workers.
POSITIVE
TAX PROPOSALS
The
Administration has proposed a number of tax provisions that will
positively impact the economy. The most significant one affecting multinational businesses
is the provision that accelerates the effective date of a
"10/50 Company" change made in the 1997 Tax Relief
Act. The 1997 Act provision affected foreign joint ventures owned
between ten and fifty percent by U.S. parents, and allowed such
so-called 10/50 Companies to be treated just like controlled
foreign corporations. It
did this by allowing "look-through" treatment for
foreign tax credit purposes for dividends from these joint
ventures. The 1997
Act, however, did not make the change effective for 10/50
Company dividends unless they were received after the year 2002.
Even then, it required two sets of rules to apply for
dividends from earnings and profits ("E&P")
generated before the year 2003, and dividends from E&P
accumulated after the year 2002.
The Administration's proposal will, instead, apply the
look-through rules to all 10/50 Company dividends received in
tax years after 1999, no matter when the associated E&P was
accumulated.
This
change will result in a tremendous reduction in complexity and
compliance burdens for U.S. multinationals doing business
overseas through foreign joint ventures.
It will also reduce the competitive bias against U.S.
participation in such ventures by placing U.S. companies on a
much more level playing field from a corporate tax standpoint.
This proposal epitomizes the favored policy goal of
simplicity in the tax laws, and will go a long way toward
helping the U.S. economy by strengthening the competitive
position of U.S. based multinationals.
Two
other positive changes for business should also be mentioned
briefly. One
provision expands the exclusion for employer-provided
educational assistance to include graduate level courses.
Such a change would undoubtedly lead to a better educated
workforce, which should assist companies in today's rapidly
changing and ever more technological workplace. A second positive provision would make permanent a taxpayer's
ability to currently deduct the costs of certain environmental
remediation expenditures (so-called "brownfields"
remediation under Code § 198).
Permanently extending this expensing treatment promotes
our national interest in a cleaner environment by removing any
taxpayer doubts as to the future deductibility of these costs.
PROVISIONS
THAT SHOULD BE RECONSIDERED
The
Tax Council offers the following comments on certain specific
tax increase proposals set forth in the Administration's budget:
REPEAL OF THE 50/50 SOURCE RULE
Since 1922, regulations under Code § 863(b) and its
predecessors have contained a rule that allows the income from
goods that are manufactured in the U.S. and sold abroad, with
title passing outside the U.S., to be treated as 50% U.S. source
income and 50% foreign source income ("50/50 source
rule"). Because
the U.S. tax law sometimes restricts the ability of companies to
receive credit for the foreign taxes that they pay (e.g.,
through the interest and R&D allocations), many
multinational companies face double taxation on their overseas
operations, i.e., taxation by both the U.S. and the foreign
jurisdiction. The
50/50 source rule helps alleviate this double taxation burden.
The Administration, as it has done the last several
years, again proposes to eliminate the 50/50 source rule and
replace it with an "activities based" test.
This new test would require exporters to allocate income
from exports to foreign or domestic sources based upon how much
of the activity producing the income takes place in the U.S. and
how much takes place abroad.
The justification continually given by the Administration
for eliminating the 50/50 source rule is that it provides U.S.
multinational exporters operating in high tax foreign countries
a competitive advantage over U.S. exporters that conduct all
their business activities in the U.S.
The Administration also notes that the U.S. tax treaty
network protects export sales from foreign taxation in countries
where we have treaties, reducing the need for the 50/50 source
rule.
Both of these arguments are seriously flawed, however. The 50/50 source rule does not provide a competitive
advantage to multinational exporters vis-à-vis exporters with
"domestic-only" operations.
Exporters with only domestic operations never incur
foreign taxes and, thus, cannot be subject to the onerous
penalty of double taxation.
Also, domestic-only exporters are able to claim the full
benefit of deductions for U.S. tax purposes for all their U.S.
expenses, e.g., interest on borrowings and R&D costs,
because they do not have to allocate any of those expenses
against foreign source income.
Thus, the 50/50 source rule does not create a competitive
advantage; rather, it helps to "level the playing
field" for U.S.-based multinationals.
Our tax treaty network is certainly no substitute for the
50/50 source rule.
Exports are fundamental to our economic growth and our
future standard of living.
Over the past three years, exports have accounted for
about one-third of total U.S. economic growth.
The 50/50 source rule permits companies to continue to
produce their goods in their U.S. plants rather than in their
foreign facilities. Repeal
or cutbacks in the export source rule will reduce U.S. exports,
further worsening our huge current trade deficit, and will also
jeopardize many high paying jobs in the United States.
FOREIGN OIL AND GAS INCOME TAX
CREDITS
The
Tax Council's policy position on foreign source income is
clear--A full, effective foreign tax credit should be restored
and the complexities of current law, particularly the
multiplicity of separate "baskets," should be
eliminated. The
President's budget proposal dealing with foreign oil and gas
income, again a repeat of last year, moves in the opposite
direction by limiting the availability of the foreign tax credit
on foreign oil and gas income.
This selective attack on a single industry's utilization
of the foreign tax credit is not justified.
U.S. based oil companies are already at a competitive
disadvantage under current law because most of their foreign
based competition pay little or no home country tax on foreign
oil and gas income. This
proposal increases the risk of foreign oil and gas income being
subject to double taxation, which will severely hinder U.S. oil
companies in the global oil and gas exploration, production,
refining and marketing arena.
“CORPORATE TAX SHELTERS”
Another
proposal that appears in substantially the same form as last
year, but continues to cause serious concern among ordinary tax
professionals, is the Administration's collection of provisions
attacking so-called "corporate tax shelters".
Under these proposals, the penalty for tax
understatements attributable to “corporate tax shelters"
would be increased from 20 percent to 40 percent; the existing
reasonable cause exception would be severely limited; and a 25
percent excise tax would be imposed on fees charged for such
"tax shelters". Corporate
"tax shelters" would be defined as any entity, plan or
arrangement, to be determined based on all the facts and
circumstances, where an attempt is made to reduce taxes through
a "tax avoidance transaction".
The IRS would be authorized to disallow deductions,
credits, etc., obtained in "tax avoidance
transactions", i.e., where the reasonably expected pre-tax
profit is insignificant in relation to the expected tax
benefits. Income
attributable to a "tax indifferent" party (for
example, foreign persons, tax-exempt organizations, and domestic
corporations with expiring losses or credit carryforwards) would
be taxed to that party.
The
Administration's sweeping attack on corporate tax planning is
both alarming and unwarranted.
Its attempt to impose a harsh new penalty regime based
largely on IRS judgments about legitimate business transactions
is disturbing. The
Administration's proposals are overly broad and would bring
within their net many corporate transactions that are clearly
permitted under existing law.
Legitimate tax planning to conform to domestic and
foreign non-tax legal or regulatory requirements may be subject
to confiscatory penalties for failure to satisfy these overly
broad standards. If
an IRS agent finds a transaction to be uneconomic, the fact that
the taxpayer acted reasonably or in good faith, or had a
substantial business purpose for the transaction, would not
matter. Moreover,
since 1982, the Code has been littered with penalties,
disclosures, confiscatory rates of interest, and endless amounts
of reporting. The
Treasury already has sufficient weapons at its disposal to
attack any perceived threats in this area.
IDENTIFIED TAX HAVEN COUNTRIES
A
new provision that is of great concern to The Tax Council is one
that would impose complex new rules on operations in so-called
"tax haven countries". These are defined as countries
that impose no or nominal tax, either generally or on specific
classes of income, and have strict confidentiality rules or
ineffective information exchange practices.
A list of such countries would be compiled by Treasury
based on such criteria. The proposal would disallow foreign tax credit treatment for
taxes paid in black-listed countries, and require a separate
foreign tax credit "basket" and imputation of income
earned there. In
addition, the proposal would require that all payments over $10k
to entities located in such havens be reported annually on the
taxpayer's return, subject to a penalty of 20% of the payment
amount if unreported.
The
Administration's proposal attempts to force these countries to
reform their bank secrecy laws and to adopt more open
information sharing regimes, by imposing, on U.S.-based
companies, harsh tax rules that are ordinarily reserved for
countries which repeatedly support international terrorism.
This blatant attack on business operations in countries
with low tax rates is just one further attempt by the
Administration to assuage its pre-occupation with tax-planning
that reduces foreign (as opposed to U.S.) tax payments. What is even more worrisome is that the Treasury would be
able to characterize a country as a "tax haven" even
though its only "sin" may be a low rate on a specific
(as opposed to general) class of income.
Finally, the United States Council for International
Business, the American tax trade association responsible for
providing advice to the Business and Industry Advisory Committee
to the OECD, has already recorded its disagreement with any
efforts to formulate a list of "bad" counties based on
tax rates: "[T] he suggestion that the exemption of tax on
income from low or lower tax jurisdictions be selectively
eliminated by OECD members--however effected--is
inappropriate".
ELIMINATING THE DEDUCTIBILITY OF
PUNITIVE DAMAGES
One of the Administration's repeat proposals from last
year's budget, which is clearly lacking in any policy foundation
but is apparently included for revenue raising purposes, is the
proposal to deny all future payments associated with
"punitive" damages incurred in civil law suits.
The proposal would apply whether the damages were paid
pursuant to a judgment or the settlement of a claim.
It would be effective for damages paid or incurred after
the date of enactment, irrespective of when the claim was
litigated. This new
rule would apply even where the claim arose in the ordinary
course of the taxpayer's business.
The proposal is based on a premise that punitive damages
are imposed only in egregious cases where the company violates
public policy. This
is demonstrably not true. Civil punitive damages are a risk that
virtually all companies are susceptible to in our present
litigious society. The
randomness of American juries is evident in recent cases where
tens of millions of dollars have been awarded as punitive
damages for such corporate misbehavior as selling hot coffee or
firing an employee who had sexually harassed a co-worker.
Punitive damage awards are often based on arbitrary and
capricious jury awards and should be distinguished from the
primarily criminal-type punitive damages currently denied
deductibility under the Code.
Civil punitive damages are ordinary and necessary
expenses of doing business and should continue to be deductible
from gross revenues to arrive at a proper net taxable income
amount. Thus, we
adamantly oppose what would be a material change in the tax law,
and we support the continued deductibility of civil punitive
amounts.
FOREIGN
BUILT-IN LOSSES
Another foreign proposal addresses the Administration's
concern that when certain tax attributes are imported into the
U.S., they can lead to purposeful tax avoidance by taxpayers
through manipulation of foreign tax credit positions or
avoidance of income tax, capital gains, or subpart F inclusions.
The Administration argues that although there are rules
in the Code that limit a U.S. taxpayer's ability to avoid paying
U.S. tax on built-in gain (e.g., Code §§ 367(a), 864(c)(7),
and 877), similar rules do not exist that prevent built-in
losses from being used to shelter income otherwise subject to
U.S. tax and, as a result, taxpayers are avoiding Subpart F
income inclusions or capital gains tax. Thus, the provision
would require that when a corporation or asset becomes subject
to U.S. tax jurisdiction, it must have its tax basis
"marked-to-market".
The Administration also asks that the IRS be granted
regulatory authority to prevent "trafficking" in
favorable tax attributes among commonly owned foreign
corporations. Finally,
the Administration has proposed following up a change from the
1997 Tax Act covering only dividends to domestic
shareholders, by also preventing taxpayers from generating
losses through basis shift transactions involving foreign
shareholders.
We believe that each of these directives, which are
written extremely broadly, are unnecessary due to the existence
of rules already available in the Code, e.g., the anti-abuse
provisions of Code §§ 269, 382, 446(b), and 482. They add needless complexity and uncertainty.
ALTER THE
CONTROL TEST FOR TAX-FREE REORGANIZATIONS
The Administration has re-proposed a provision, which was
included in the Administration’s Budget last year but not
acted on by the Congress, to alter the definition of
“control” for purposes of Section 368(c) to an
“80%-by-vote-and-value” test.
In view of the Administration’s failure to show any
overwhelming policy reason for altering the control test, The
Tax Council opposes elimination of statutory rules that have
existed for more than 76 years, particularly in light of the
potential effect on the competitiveness of U.S. businesses.
MODIFY
TAX TREATMENT OF DOWNSTREAM MERGERS
This proposal deals with situations where a target
corporation owns less than 20% of the acquiring corporation, or
the reverse. The
target or the acquiring corporation in reorganization would be
required to recognize gain (but not loss) as if stock was sold
immediately prior to the reorganization.
The Tax Council opposes elimination of the longstanding
and previously well-recognized ability to reorganize in a
tax-free manner.
TAX EXEMPT BONDS
The
Administration seeks to disallow a portion of interest expense
deductions for certain entities that earn tax-exempt interest.
Under the proposal, financial intermediaries such as
securities dealers and finance companies would lose a portion of
their interest expense deduction based on the ratio of
tax-exempt investments to total assets.
In
a related proposal, the Administration seeks to increase from 15
percent to 25 percent the portion of a property casualty
insurance company’s tax-exempt income that is effectively
subjected to tax through special pro-ration rules.
This would effectively eliminate the tax exemption for
interest paid to property casualty insurance companies on
tax-exempt bonds.
The
Tax Council strongly opposes the Administration’s proposals to
increase the tax cost of state and municipal bond investments.
Financial intermediaries and property casualty insurance
companies play an important role in the markets for municipal
leases, housing bonds, and student loan bonds.
By eliminating this significant source of demand for
municipal securities, the Administration’s proposal would
force state and local governments to pay higher interest rates
on the bonds they issue, significantly increasing their costs of
capital. The cost
of public facilities, such as school construction and housing
projects, would be increased.
This proposal is entirely inconsistent with tax incentive
programs for some of the same state and local projects.
At a time when state and local governments are asked to
do more, Congress should not make it more costly for them to
achieve their goals.
TRACKING
STOCK
“Tracking
stock” is an economic interest that is intended to relate to,
and track the economic performance of, one or more separate
businesses of the issuing corporation.
Although the Congress did not act on the
Administration’s proposal to tax the issuance of tracking stock in the President’s Budget for FY2000,
the Administration has proposed a new tax on a shareholder’s
receipt of tracking stock as a distribution or in a
recapitalization or similar exchange of stock or securities for
tracking stock. In
effect, this proposal would increase the cost of capital to
corporations by inhibiting the use of “tracking stock” as a
financing option.
The
issuance of tracking stock is not an appropriate time to impose
a tax on a shareholder, to the extent that a taxpayer’s
investment remains in corporate solution, and the stock
represents merely a new form of participation in a continuing
enterprise. Moreover,
Tracking stock serves many valuable business purposes that
enhance shareholder value, such as raising capital efficiently,
enabling companies to obtain lower financing costs based on a
stronger, unified balance sheet of the parent company and the
“tracked” subsidiary, facilitating acquisitions, and
promoting the recruitment and retention of key employees.
The Tax Council strongly opposes yet another attempt to
increase the corporate income tax on capital.
MODIFY AND CLARIFY THE STRADDLE RULES
The Administration’s FY2001 Budget proposals to modify
and “clarify” the tax straddle rules would increase the cost
of capital to corporations by inhibiting the use of certain
financing options. Moreover,
one of the proposed “clarifications” (relating to the
capitalization of interest) would be applied retroactively,
even though the “clarification” relates to a statute that
has been on the books for 19 years.
Again, The Tax Council strongly opposes yet another
attempt to increase the corporate income tax on capital.
ACCRUAL
OF MARKET DISCOUNT
Another
Administration proposal would require accrual method taxpayers,
who acquire outstanding debt that is trading in the marketplace
for less than its original issue price, to include the market
discount in income as it accrues over the remaining life of the
debt.
The
Tax Council opposes this acceleration of the taxation of market
discount income. The
provision would greatly complicate the tax rules for many
investors, particularly those holding debt instruments with both
original issue discount and market discount.
Further, it would inject new asymmetries in the tax
treatment of similarly situated taxpayers, even while aiming to
correct others. Congress
has wisely chosen to keep complexity within bounds, while
treating cash and accrual method investors uniformly under the
current market discount rules.
SUPERFUND
TAXES
The
taxes that fund the Superfund Trust Fund (corporate
environmental tax, petroleum, chemicals, and imported substances
excise tax all expired on December 31, 1995.
The Administration's budget would reinstate the excise
taxes at their previous levels for the period after the date of
enactment through September 30, 2010.
The corporate environmental tax would be reinstated at
its previous level for taxable years beginning after December
31, 1999 and before January 1, 2011.
Moreover, the funding cap for the Oil Spill Tax would be
increased from the current $1 Billion amount to the level of $5
Billion.
However,
Congress has not reauthorized Superfund programs.
Therefore, taxes that were previously dedicated to
Superfund and the Oil Spill Liability Trust Fund would instead
be used to generate revenue for the General Fund.
This use of taxes, when historically dedicated to funding
specific programs, should be rejected.
The decision whether to re-impose these taxes should
instead be made as part of a comprehensive examination of
reforming the entire Superfund program.
Finally, reinstating the corporate environmental tax as
of January 1 would amount to retroactive taxation, forcing
taxpayers to adjust their book earnings after the fact, an event
not warmly received by current shareholders.
USER
FEES
Another Administration proposal converts what was
previously the "harbor maintenance tax" into what it
calls a "user fee".
However, no matter what it calls the levy, the
Administration is extending the life of a tax that was declared
by the U.S. Supreme Court to be unconstitutional as applied to
exports. In fact,
the Administration specifically proposes that the new levy
"be designed to withstand challenge under the Export Clause
of the Constitution".
The Tax Council objects to such thinly veiled efforts to
extend or impose additional taxes on businesses by labeling
proposals as "user fees".
TAXING
INVESTMENT INCOME OF TRADE ASSOCIATIONS
Under the proposal, trade associations, including
chambers of commerce, business leagues, and other similar
not-for-profit entities organized under Code § 501(c)(6),
generally would be subject to tax on their net investment income
in excess of $10,000. The
Tax Council opposes this $3.6 billion (over 10 years) tax
increase on trade associations.
The current law purpose of imposing unrelated business
income tax ("UBIT") on associations and other
tax-exempt organizations is to prevent such organizations from
competing unfairly against for-profit businesses.
Subjecting trade association investment income to UBIT is
counter to this legislative purpose.
The proposal mischaracterizes the benefit that trade
association members receive from such earnings.
Moreover, if these earnings on a trade association's
assets did not exist, members would have to pay larger
tax-deductible dues. There
simply is no tax abuse here, and Congress should leave the
present rules as they are.
INCREASE
EXCISE TAXES ON TOBACCO
The Administration also proposes new tobacco legislation
that would provide for net revenues approaching $66 billion over
the ten-year period from October 1, 2000 through September 30,
2010. We oppose any
excise tax increases on tobacco because these higher taxes would
clearly fall on those least able to pay them (predominantly
lower income individuals).
With such large surpluses projected over the next 10
years, Congress should not even consider increasing taxes on
individuals.
BUSINESS
LIFE INSURANCE
The
Administration proposes to raise the DAC tax on annuities and
life insurance. The
Administration's proposed additional tax would apply
retroactively to existing life insurance contracts.
Life insurance and annuities are the only private sector
products that allow individuals to protect their families
against premature death and to guarantee that they will not
outlive their income. Raising
taxes on the premiums companies receive for these products will
lead to higher prices for these important retirement products,
making them less accessible to those who need it most.
POLICYHOLDERS'
SURPLUS ACCOUNTS
The
Administration proposes to force life insurance companies with
policyholder’s surplus accounts (PSAs) to include those
accounts in income and pay tax on that amount over a five-year
period. The
policyholder’s surplus account is a tax accounting fiction in
the practical operations of life insurance companies.
There are no special untaxed assets set aside and
available to pay this unanticipated tax.
In fact, accountants have concluded that under GAAP
accounting rules that govern shareholder-owned life insurance
companies, Section 815 accounts would very rarely, if ever, be
triggered, and, thus that the potential tax liability under
Section 815 should be disregarded for accounting purposes.
Further, no reserves are required under the statutory
accounting rules used for regulatory purposes. Taxing PSAs will
affect the return to current policies since this is a tax that
must be paid from current operations.
BUSINESS
LIFE INSURANCE
The
Administration proposes to place an additional tax on companies
that borrow for any purpose if those companies also own life
insurance, including key employee insurance.
The proposal would also increase taxes on companies that
borrow directly against life insurance policies covering key
employees. Further
changes in the tax treatment of business life insurance are
unnecessary and would unfairly disrupt the fundamental
protection and benefit plans of many businesses.
Business life insurance is a product that protects
businesses, especially small businesses, and allows all
businesses to provide employee benefits, including retiree
health benefits. The
proposal would eliminate the use of business life insurance in
providing those protections and benefits.
419A
PLANS
The
Administration’s proposal that seeks to shut down the
ten-employer exception for 419A plans providing life insurance,
severance and unemployment benefits is an unnecessary approach
to curb some potential misuses of this welfare benefit fund when
regulators — the IRS — already have all the necessary
regulatory tools to deal with any real problems in this area.
MODIFYING
THE "SUBSTANTIAL UNDERSTATEMENT" PENALTY
The
Administration proposes to make any tax deficiency greater than
$10 million "substantial" for purpose of the Code §
6662 substantial understatement penalty, rather than applying
the existing test that such tax deficiency must exceed ten
percent of the taxpayer's liability for the year.
The penalty is twenty percent of the tax underpayment,
unless the taxpayer had "substantial authority" for
the position producing the underpayment, or the relevant facts
are disclosed on the return and there is a reasonable basis for
the position.
There
is no basis for the Administration's assertion that large
corporate taxpayers are "playing the audit lottery"
because of the purportedly high threshold amount at which the
substantial understatement penalty applies.
Instead, it will simply mean that the enhanced penalty
will automatically apply to large corporations, which is
manifestly unfair. The
IRS already subjects large publicly held corporations to
continuous audits. These
corporations spend enormous amounts on tax related advice and,
for security law and other reasons, generally document the basis
for every major tax return position.
Unfortunately, because of the complexity of both modern
business transactions and the tax laws, as well as the frequent
absence of regulatory or other guidance, the proper tax
treatment of many items in a large corporation's return is far
from clear. Furthermore,
it is unclear whether the "substantial authority"
standard is met where a position is supported by well-reasoned
legal analysis but there are no relevant cases, rulings, or
other precedents, a situation encountered all too frequently by
the corporate taxpayers targeted by this proposal.
Indeed, the standard's vagueness is evidenced by the
continuing failure of Treasury to comply with the mandate of
Code § 6662(d)(2)(D), requiring it to publish and periodically
update a list of positions for which it is believes substantial
authority is lacking.
The
result of expanding the substantial understatement penalty will
be lengthy and costly litigation to properly interpret the
substantial authority standard.
Taxpayers seeking protection from this penalty by
disclosing uncertain positions will face almost certain proposed
adjustments from IRS agents, no matter how reasonable their
position, resulting in lengthy administrative appeals and
litigation. We
believe there is no evidence that the existing penalty and
interest provisions are inadequate, so we strongly urge Congress
to reject this ill-advised proposal.
INCREASED
PENALTIES FOR FAILURE TO FILE RETURNS
The Administration proposes to increase penalties for
failure to file information returns, including all standard 1099
forms. IRS
statistics bear out the fact that compliance levels for such
returns are already extremely high.
Any failures to file on a timely basis generally are due
to the late reporting of year-end information or to other
unavoidable problems. Under
these circumstances, an increase in the penalty for failure to
timely file returns would be unfair and would fail to recognize
the substantial compliance efforts already made by American
business.
GENERAL COMMENTS ON RETROACTIVITY
It
appears that many of the Administration's proposals will
retroactively impact the economics of transactions entered into
in good faith reliance on present law.
These transactions, some of which were entered into well
prior to the issuance of the Treasury proposals, of necessity
involve future settlements, payments or other activities
reasonably assumed and required as part of the underlying
economics involved and permitted under present law.
Unless they are fully grandfathered, the Treasury's
proposals will have the economic effect of undermining these
transactions. For
example, the Treasury proposes to change the rules with regard
to deductions for interest payments made to related foreign
CFCs, PFICs or FPHCs accruing on or after the date of first
committee action on debt instruments involving original issue
discount, notwithstanding when the debt instrument involved was
entered into. Similarly, Treasury proposes to modify the rules regarding
treatment as a dividend for distributions with respect to
self-amortizing stock, notwithstanding when the stock was
issued. Yet another
example is Treasury's proposal to impose new expense
capitalization rules on interest accruals occurring after the
date of enactment with regard to straddles transactions entered
into at any time before or after the date of enactment.
Such retroactive proposals are unfair to taxpayers who
legitimately relied on the tax rules in effect when entering
into various business transactions.
CONCLUSION
In
summary, The Tax Council strongly urges the Administration to
reconsider the tax policy wisdom of these revenue-raising
proposals in its budget. Many
such proposals will make it difficult for taxpayers to engage in
legitimate transactions. This
will ultimately hurt the ability of U.S. multinationals to
operate economically and to compete effectively against their
foreign-based competitors.
In considering the Administration's budget, Congress
should elevate sound tax policy over revenue needs.
Revenue can be generated consistent with sound tax
policy, and that is the approach that should be followed as the
budget process moves forward.
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