[WPRT 109-6]
[From the U.S. Government Publishing Office]
109th Congress WMCP:
COMMITTEE PRINT
1st Session 109-6
_______________________________________________________________________
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
__________
WRITTEN COMMENTS
on
H.R. 3376, THE ``TAX TECHNICAL CORRECTIONS ACT OF 2005''
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13
AUGUST 31, 2005
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
E. CLAY SHAW, JR., Florida CHARLES B. RANGEL, New York
NANCY L. JOHNSON, Connecticut FORTNEY PETE STARK, California
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
PHIL ENGLISH, Pennsylvania WILLIAM J. JEFFERSON, Louisiana
J.D. HAYWORTH, Arizona JOHN S. TANNER, Tennessee
JERRY WELLER, Illinois XAVIER BECERRA, California
KENNY C. HULSHOF, Missouri LLOYD DOGGETT, Texas
RON LEWIS, Kentucky EARL POMEROY, North Dakota
MARK FOLEY, Florida STEPHANIE TUBBS JONES, Ohio
KEVIN BRADY, Texas MIKE THOMPSON, California
THOMAS M. REYNOLDS, New York JOHN B. LARSON, Connecticut
PAUL RYAN, Wisconsin RAHM EMANUEL, Illinois
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
DEVIN NUNES, California
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
C O N T E N T S
__________
Page
Advisory of Thursday, July 22, 2005, announcing request for
written comments on H.R. 3376, the ``Tax Technical Corrections
Act of 2005''.................................................. 1
______
Accenture, Palo Alto, CA, Douglas G. Scrivner, letter............ 2
AEGON USA, Inc., Cedar Rapids, IA, Arthur C. Schneider, letter... 4
Alticor Global Holdings, Inc., Linda Carlisle and Jonathan
Talisman, joint letter......................................... 8
American Apparel & Footwear Association, Arlington, VA, Kevin M.
Burke, statement............................................... 10
American Association of Port Authorities, Kurt J. Nagle, letter.. 11
American Bankers Association, Ed Yingling, America's Community
Bankers, Diane Casey-Landry, Independent Community Bankers of
America, Camden R. Fine, joint letter.......................... 13
American Council of Engineering Companies, Danielle Marks, letter 13
American Council of Life Insurers, Gregory F. Jenner, letter and
attachment..................................................... 15
American Electronics Association, Marie K. Lee, letter and
attachment..................................................... 17
American Forest & Paper Association, David G. Koenig, statement.. 20
American Ocean Enterprises, Inc., APL, Ltd., Central Gulf Lines,
Inc., Maersk Lines Limited, Waterman Steamship Corp., American
Maritime Congress, Maritime Institute for Research and
Development, The Transportation Institute, joint letter and
attachment..................................................... 22
American Petroleum Institute, Mark W. Kibbe, statement........... 24
Association of American Publishers, Inc., Patricia Schroeder,
letter......................................................... 28
Boies, Schiller and Flexner LLP, Miami, FL, Michael Kosnitzky,
letter......................................................... 30
Cigar Association of America, Inc., Norman F. Sharp, letter...... 32
Clark Consulting, Kenneth J. Kies, letter........................ 34
Financial Executives International, Committee on Taxation,
Michael Reilly, letter......................................... 37
Florida Institute of Certified Public Accountants, Federal
Taxation Committee, Tallahassee, FL, Ignacio J. Abella, letter. 37
Levin, Carl, a U.S. Senator from the State of Michigan, Richard
Neal, a Representative in Congress from the State of
Massachusetts, Lloyd Doggett, a Representative in Congress from
the State of Texas, Rosa DeLauro, a Representative in Congress
from the State of Connecticut, Marion Berry, a Representative
in Congress from the State of Arkansas, Louise Slaughter, a
Representative in Congress from the State of New York, John
Lewis, a Representative in Congress from the State of Georgia,
joint letter................................................... 38
Mcintire School of Commerce, Charlottesville, VA, David W. LaRue,
letter......................................................... 39
Nalco Co., Naperville, IL, Michael R. Bushman, letter and
attachment..................................................... 43
National Association of Home Builders, James Tobin, statement.... 45
National Association of Real Estate Investment Trusts, Tony M.
Edwards, statement............................................. 46
National Council of Farmer Cooperatives, Jean-Mari Peltier,
letter......................................................... 52
Nova Southeastern University Law Center, Fort Lauderdale-Davie,
FL, Gail Levin Richmond, J.D., statement....................... 55
Organization for International Investment, Todd M. Malan, letter. 56
Subpart F Shipping Coalition, Kenneth J. Kies, Clark Consulting,
Stephen Fiamma, Allen & Overy LLP, Warren Dean, Thompson Coburn
LLP, Alex Trostorff, Jones Walker, joint letter................ 59
Tailored Clothing Association, David Starr, letter............... 64
Terech, John, Milan, MI, letter.................................. 65
Williams & Jensen, LLC, David Starr, letter...................... 66
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
July 22, 2005
No. FC-12
Thomas Announces Request for
Written Comments on H.R. 3376, the
``Tax Technical Corrections Act of 2005''
Congressman Bill Thomas (R-CA), Chairman of the Committee on Ways
and Means, today announced that the Committee is requesting written
public comments for the record from all parties interested on H.R.
3376, the ``Tax Technical Corrections Act of 2005.''
BACKGROUND:
On Thursday, July 22, 2005, Chairman Bill Thomas introduced H.R.
3376, the ``Tax Technical Corrections Act of 2005.'' The legislation
contains technical corrections needed with respect to recently enacted
tax legislation.
``We hope the public will review the proposed text and provide
comments during the coming weeks on any amendments that may be
necessary so that Congress can send appropriate legislation to the
President as soon as possible,'' stated Thomas.
The bill includes technical corrections to provisions in the
``American Jobs Creation Act of 2005'' (P.L. 108-357), and other
legislation.
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Accenture
Palo Alto, California 94304
August 31, 2005
The Honorable Charles Grassley
Chairman
Senate Finance Committee
219 Dirksen Office Building
Washington, DC 20510
The Honorable Max Baucus
Ranking Member
Senate Finance Committee
511 Hart Office Building
Washington, DC 20510
The Honorable Bill Thomas
Chairman
House Ways and Means Committee
1102 Longworth Office Building
Washington, DC 20515
The Honorable Charlie Rangel
Ranking Member
House Ways and Means Committee
2354 Rayburn Office Building
Washington, DC 20515
Dear Chairmen Grassley and Thomas and Ranking Members Baucus and
Rangel:
On behalf of Accenture and its 120,000 employees, including the
28,000 U.S. employees of Accenture LLP, we thank you for the
opportunity to comment on recently introduced legislation, the Tax
Technical Corrections Act of 2005, pursuant to your press release of
August 8, 2005.
As we have discussed with you and your staff, the ``corporate
inversion'' provisions as passed in the Jobs Creation Act of 2004 are
broad in their scope. Accordingly, it could potentially lead to the
unintended application of the law to the transactions of a foreign
multinational company. Without further guidance or clarification,
taxpayers cannot be certain regarding a company's status under section
7874. Now, more than ever, public companies need certainty. Although we
believe that we are not impacted by the statute, we urge Congress to
provide a technical correction to provide greater certainty.
It is important to emphasize that Accenture did not engage in an
inversion transaction.
Prior to May 2001, Accenture operated as a series of
separate legal entities organized under the laws of more than 40
countries, including the U.S. Accenture, as a multinational enterprise,
has never operated under a U.S. parent corporation or partnership.
In May 2001, Accenture completed the transaction in which
the owners of U.S. and non-U.S. businesses each combined the separate
locally owned businesses into one global corporate structure.
In July 2001, Accenture successfully completed an initial
public offering.
Accenture did not engage in an inversion by moving its
place of incorporation from the U.S. to Bermuda. The U.S. General
Accounting Office (GAO) confirms this. A GAO report in October 2002 did
not include Accenture on a list of government contractors that
undertook corporate inversions. In media coverage of the report, the
GAO's Director of Tax Issues, James White, said: ``Since Accenture
didn't have a corporate structure to begin with, it didn't have a
corporate structure to invert.'' The GAO report provides a brief
history of Accenture's pre-incorporation operation, explaining that
Accenture was a series of locally owned partnerships coordinated
through a Swiss entity.
Accenture pays, and has always paid, tax in each of the
countries in which we generate income. Accenture LLP pays U.S. tax on
income generated by our U.S. operations, and the appropriate entities
pay tax on non-U.S. income in the countries in which that income is
generated. In fact, Accenture's annual effective tax rate as disclosed
in its Securities and Exchange Commission (SEC) filings is high
compared to those of most companies. As reported in our most recent
10K, our annual effective tax rate for the fiscal year ending August
31, 2004 was 32%.
Although Accenture did not engage in an inversion transaction, the
broad scope of the JOBS Act continues to create uncertainty.
Along with many other companies and commentators, we have
previously expressed our concerns regarding the legislation's broad
scope and its potential for misapplication to the various types of
restructurings of foreign multinational companies.
While transactions before March 4, 2003, and internal
restructurings are not among the transactions that the legislation was
apparently intended to target, a taxpayer cannot be certain given the
breadth of the statute.
The broad reach of the legislation is particularly a
concern to taxpayers where the legislation applies to a transaction
that was completed before March 4, 2003. As a result, every
multinational company must examine past transactions to determine if
the legislation applies.
The consequence to taxpayers of an unclear statute is,
for example, as reflected in our most recent 10K filing: ``We do not
believe this legislation applies to Accenture. However, we are not able
to predict with certainty whether the U.S. Internal Revenue Service
will challenge our interpretation of the legislation. Nor are we able
to predict with certainty the impact of regulations or other
interpretations that might be issued related to this legislation. It is
possible that certain interpretations could materially increase our tax
burden.'' The consequence of inappropriate or retroactive application
is to impose on non-U.S. operating income a U.S. income tax burden that
neither the multinational company nor the investment community could or
should have anticipated.
We as taxpayers, and our shareholders, need greater certainty. We
believe that by clarifying the proper scope of the legislation through
technical corrections legislation and guidance, Congress would be
providing the greater certainty that is appropriate in today's
environment.
We appreciate having the opportunity to provide our views on this
important matter.
Douglas G. Scrivner
General Counsel and Secretary
AEGON USA, Inc.
Washington, DC 20515
August 19, 2005
The Honorable William Thomas, Chairman
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515-6348
Dear Chairman Thomas,
On behalf of AEGON USA, I am writing to comment on the proposed
legislation to make technical changes in the tax code, H.R. 3376, the
Tax Technical Corrections Act of 2005. I appreciate the opportunity to
raise the following points with the Ways and Means Committee about the
potential inclusion of an additional technical correction related to
the identified straddle amendments included in H.R. 4520, the American
Jobs Creation Act of 2004 (the ``Act'').
The specific concern with this provision is that it could be
interpreted so as to result in a permanent disallowance of a loss
rather than a loss deferral. In addition, there is some question as to
the effectiveness of the provision prior to the promulgation of
guidance by the Secretary. Based on discussions with the staff of the
Ways and Means Committee, Finance Committee and Joint Committee of
Taxation, as well as with Treasury Department personnel, it does not
appear that the intent of the new provision was to eliminate losses
altogether or to delay the effective date of the new rules until
regulations are issued. As a result, we ask you to consider making
technical corrections to this provision to ensure it operates as
intended.
Background
Included in the Act was a provision revising the existing rules on
straddles, including a reform that was viewed as simplifying the law
for so-called identified straddles. To avoid abuses, the general
straddle rules require a taxpayer to defer losses incurred until gains
in offsetting positions are realized. Previous law provided an
exception to this rule for certain identified straddles. The new
statutory language replaced this exception with a basis adjustment rule
and appeared to provide more flexibility for taxpayers to use
identified straddles. This new provision is of interest to AEGON USA
and other insurers because, as insurance companies, we are in the
business of managing risks, including investment risks. We frequently
enter into offsetting positions in the ordinary course of our business
to conservatively manage such risks. As a result, we have transactions
that could be subject to the general straddle rules, absent the ability
to use alternatives such as identified straddles.\1\
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\1\ There are other potential exceptions to the straddle rules,
such as the tax hedging rules of IRC section 1221(a)(7) or other
hedging provisions (Treas. Reg. section 1.988-5 and Treas. Reg. section
1.1275-6). However, these hedging exceptions are narrowly drawn and are
not always available to an insurance company with a large, actively
managed investment portfolio.
---------------------------------------------------------------------------
The legislation passed last year was initially viewed by us and
others in the insurance industry as a welcome clarification and
simplification of the identified straddle rules. Unfortunately, recent
comments by Treasury and IRS personnel have suggested an interpretation
outside the apparent intent of Congress. As noted above, their
interpretation is that the new statutory language might result in the
permanent denial of a loss, rather than loss deferral. Such a dramatic
change in the straddle rules is not discussed in any of the legislative
history, nor does it fit with the simplification and clarification
theme of the provision.
Moreover, taxpayers who wish to use the identified straddle regime
need clarification that, until the Treasury Department issues
regulations, they may use reasonable methods to identify straddles.
Congress enacted the new identified straddle rules effective October
22, 2004, and taxpayers should not be forced to wait for Treasury to
issue regulations before being able to utilize the new rules.
It seems that these two issues should appropriately be addressed in
a technical corrections bill to ensure that the provision operates as
intended.
Identified Straddle Exception--Losses in Excess of Unrecognized Gains
The tax straddle rules (IRC section 1092) generally require
taxpayers to defer realized losses on a straddle position to the extent
the taxpayer has unrecognized gains on offsetting straddle positions.
Losses in excess of unrecognized gains, however, are not limited by the
straddle rules. In addition, losses that are deferred under the
straddle rules can be carried forward indefinitely and become available
to the taxpayer in a future year to the extent such deferred losses
exceed unrecognized gains on offsetting straddle positions. This can
occur, for example, when gains on an offsetting straddle position are
recognized upon a subsequent sale of the offsetting position.
Although the basic goal of the straddle rules can be easily
described, application of the rules can be problematic. The straddle
rules are written in a manner that assumes that the offsetting
positions in a tax straddle are readily determinable. While this may be
true for an investor with a limited number of positions, determining
the positions that make up a tax straddle is a difficult and uncertain
proposition for a taxpayer, such as an insurance company, holding and
managing a large investment portfolio in the ordinary course of its
business. When the tax straddle rules were originally enacted in 1981,
Congress directed the Secretary to promulgate guidance providing a
method to be used by taxpayers in the determination of the positions
making up a tax straddle. No such guidance, however, was ever provided
by the Secretary.
Section 888 of the Act significantly extended the availability of
the prior law exception for qualifying ``identified straddles.'' The
amendments made by the Act reflect Congress' frustration with the
failure of the Secretary to provide required guidance on the
application of the straddle rules to ``unbalanced'' straddle positions,
which the Secretary had been instructed to provide under the original
straddle legislation adopted in 1981.\2\
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\2\ In 2001, in a study of simplification alternatives for the tax
code, the Joint Committee on Taxation proposed several changes to the
straddle rules including what we believe is the first version of a
proposal to statutorily clarify the identified straddle regime; a
proposal that was ultimately enacted as Section 888 of the American
Jobs Creation Act of 2004 (P.L. 108-357). In the discussion by the
Joint Committee on Taxation, the staff noted that the Treasury
Department had not issued regulations since 1981, when Congress had
directed Treasury to issue regulations related to identified straddles
and unbalanced straddles. The staff recommended a new identification
regime as well as a capitalization regime that ultimately was included
in the American Jobs Creation Act of 2004 (Joint Committee on Taxation,
Study of the Overall State of the Federal Tax System and
Recommendations for Simplification, Pursuant to Section 8022(3)(B) of
the Internal Revenue Code of 1986 (JCS-3-02), pp. 339-342).
---------------------------------------------------------------------------
Under the new ``identified straddle'' rules, taxpayers are allowed
to identify the offsetting positions making up the straddle. The
positions making up an identified straddle are then excepted from the
general straddle loss deferral rules, and are instead subject to the
special rules for identified straddles. The identified straddle rules
are important in providing taxpayers some certainty over the positions
making up a tax straddle, thereby precluding such identified positions
from being arbitrarily considered a tax straddle with respect to other
positions on an after-the-fact basis.
In addition to exempting the offsetting positions of an identified
straddle from the general straddle loss deferral rules, the new
identified straddle rules also provide that realized losses from any
position included in an identified straddle are added to the tax basis
of those offsetting identified positions with ``unrecognized gain,''
but only to the extent of the amount of such unrecognized gain. For
purposes of the identified straddle rules, ``unrecognized gain'' is
defined as the excess (if any) of (1) the fair market value of a
position as of the date a loss on an offsetting position in the
identified straddle is realized (the ``determination date'') over (2)
the fair market value of the position on the date the identified
straddle was entered into. Realized losses that are added to the tax
basis of an offsetting identified straddle position are essentially
deferred until the offsetting position is subsequently disposed of.
Losses in excess of ``unrecognized gains'' are exempt from the straddle
rules.
Notwithstanding what appears to be clear Congressional intent to
provide an exception to the straddle rules for qualifying identified
straddles, the amendments made by the Act could be construed in a
manner that would permanently disallow realized losses on offsetting
positions in an identified straddle. Specifically, IRC section
1092(a)(2)(A)(ii) requires that the tax basis of each of the identified
offsetting positions in the identified straddle be increased ``by an
amount that bears the same ratio to the loss as the unrecognized gain
with respect to such offsetting position bears to the aggregate
unrecognized gain with respect to all such offsetting positions.'' IRC
section 1092(a)(2)(A)(iii) then states that ``any loss described in
clause (ii) shall not otherwise be taken into account for purposes of
this title.'' (Emphasis added.)
It seems clear that the ``not otherwise taken into account''
reference in IRC section 1092(a)(2)(A)(iii) was simply intended to
prevent taxpayers from attempting to ``double dip'' or utilize the same
loss twice. In other words, to the extent any portion of a realized
loss is added to the tax basis of an offsetting position included in an
identified straddle, that portion of the loss would not otherwise be
deductible. The legislative history to the Act confirms this intent by
stating that any loss with respect to an identified position that is
part of an identified straddle ``cannot otherwise be taken into account
by the taxpayer or any other person to the extent that the loss
increases the basis of any identified positions that offset the loss
position in the identified straddle.'' (Emphasis added.)
Notwithstanding this logical interpretation, some Administration
personnel have publicly stated that the modified identified straddle
rules can be interpreted to cause permanent denial of a portion of a
taxpayer's realized losses on positions included in an identified
straddle--a result that is contrary to both the normal straddle loss
deferral rules, as well as to the exception provided for qualifying
identified straddles. If such an interpretation were correct, the
modified identified straddle rules would actually result in a dramatic
shift in policy from deferring losses to permanently denying losses.
This would mean that an amendment that was intended to provide
taxpayers with relief from the general straddle rules would instead
result in identified straddles being subjected to more onerous rules.
This potential interpretation of the identified straddle rules, however
remote, makes the modified identified straddle rules a potential tax
trap.
Technical corrections to the amended identified straddle rules are
necessary to make it clear that realized losses resulting from an
offsetting position in an identified straddle that exceed unrecognized
gains on other positions included in the identified straddle do not
disappear, but are available in the year realized.
Example of Losses in Excess of Unrecognized Gains
Because a straddle involves ``offsetting positions,'' one might
wonder why a loss on one position would not be offset by unrecognized
gain in the other position. It is possible, however, for an identified
straddle to have a result in which there is no unrecognized gain on an
offsetting position. Such a result may occur, for example, when an
unrelated risk that is not offset causes the value in the offsetting
position to decrease.
For example:
In the ordinary course of its business, an insurance company buys a
corporate bond for $95 to back its insurance liabilities. Because the
company is concerned that interest rates will rise, it also enters into
an interest rate swap to hedge this risk. Assume that the company
properly and timely identified the bond and the swap as the positions
making up an ``identified straddle'' under new IRC Sec. 1092(a)(2).
If interest rates rise, the bond market value may drop to $92, but
the swap will be worth $3. If interest rates fall, the bond market
value may increase to $97, but the swap will be worth ($2). In both
situations, the company is economically in the same position. If the
swap were to be sold in the first instance, a $3 gain would be
recognized. Under the new identified straddle rule, if the swap were to
be sold in the second instance, the basis of the bond would be
increased by the $2 realized loss on the swap.
However, assume that interest rates fall as in the second scenario
and that the bond's credit rating also is downgraded. Assume that as a
result of these events, the bond's market value falls to $80, while the
swap value is ($2). If the swap were to be sold in this situation, the
treatment of the $2 realized loss is not clear under the new statutory
language because the loss exceeds the amount of unrecognized gain
(which is $0) on the offsetting position.
Under the Administration's potential interpretation of the new
identified straddle language, the taxpayer in the above example would
be permanently denied the $2 true economic loss on the swap if there is
not an equal amount of unrecognized gain on the offsetting bond. It
appears obvious that this result is not appropriate and was not
intended as part of the amendments to IRC Sec. 1092(a)(2).
Technical Correction Needed
Our concerns about the identified straddle language result from
public comments made by both Treasury and IRS officials who have stated
that a literal interpretation of the new language could result in loss
denial rather than loss deferral. One of the same Treasury officials
also indicated that clarifying the operation of this provision might
not be possible by way of regulations, noting that ``[f]rankly I don't
know how we in the administration would correct that.'' (``Officials
Cite Problems with Changes to the Straddle Rules,'' Tax Notes, June 6,
2005, p. 1229-30). The clear implication is that the statute must be
corrected by a technical correction.
Representatives from AEGON USA have met with the Joint Committee on
Taxation and the respective staffs of the tax writing committees. At
this stage, no one has suggested that Congress had intended (in the
straddle language adopted) to deny losses completely. The legislative
history does not suggest such an outcome either. As such, we believe
that this issue is appropriate for a technical correction to clarify
the application of the new identified straddle provision in cases where
losses from an identified straddle position exceed unrecognized gains
on identified offsetting positions.
The legislative history clearly supports the conclusion that
Congress did not intend to deny losses as is illustrated in the example
above. Further, as noted above, the relevant legislative history
indicates that losses in excess of unrecognized gains may be taken
immediately, by stating that ``Any loss with respect to an identified
position that is part of an identified straddle cannot otherwise be
taken into account by the taxpayer or any other person to the extent
that the loss increases the basis of any identified positions that
offset the loss position in the identified straddle.'' (H. Rpt. 108-
755, American Jobs Creation Act of 2004, Conference Report to Accompany
H.R. 4520, pp. 756-57) (emphasis added). To the extent the losses in
the example set out above do not increase the basis of any identified
offsetting positions in the straddle, the reasonable interpretation of
the new statutory language and the relevant legislative history is that
the taxpayer should be able to immediately deduct such a loss. This
legislative history is repeated in the Blue Book for the 108th
Congress. (Joint Committee on Taxation, ``General Explanation of Tax
Legislation Enacted in the 108th Congress'' (JCS-5-05), May 2005, p.
484).
Identified Straddle Exception--Effectiveness
Finally, Treasury officials have also suggested that the new
identified straddle provisions do not take effect unless and until the
Secretary prescribes regulations specifying, among other items, the
proper methods for clearly identifying a straddle as part of an
identified straddle.
The Administration's suggestion that the new identified straddle
rules are not effective unless and until regulations are promulgated by
the Secretary does not appear to have any support in the statute itself
or the accompanying legislative history. This interpretation also seems
wholly inconsistent with the rationale for amending IRC section
1092(a)(2) itself, namely the failure of the Secretary to have
prescribed regulations pursuant to the 1981 legislative mandate
obligating the Secretary to establish guidance for unbalanced straddle
positions.
The Joint Committee on Taxation, in explaining the reasons why the
identified straddle rules were changed, states ``While the prior-law
rules provided authority for the Secretary to issue guidance concerning
unbalanced straddles, the Congress was of the view that such guidance
was not forthcoming. Therefore, the Congress believed that it was
necessary to provide such guidance by statute.'' (Joint Committee on
Taxation, ``General Explanation of Tax Legislation Enacted in the 108th
Congress'' (JCS-5-05), May 2005, p. 483). In fact, Treasury has had the
opportunity to issue regulations for nearly 23 years, and it has chosen
not to do so. It may take significant time for any such future guidance
from Treasury. The statute's language, on its face, applies to
positions established on or after October 22, 2004. Therefore, we
suggest a technical correction making it clear that a taxpayer can use
a reasonable method to identify the positions making up an ``identified
straddle'' until such time as the Treasury issues regulations under IRC
section 1092(a)(2).
Proposed Technical Corrections
We respectfully submit the attached technical correction language
as a proposal that would ensure that the new identified straddle
provision operates as intended and cannot be interpreted to permanently
deny realized losses that exceed unrecognized gains.
The suggested language in subclause I is drawn directly from the
legislative history. (See, e.g., H. Rpt. 108-755, American Jobs
Creation Act of 2004, Conference Report to Accompany H.R. 4520, p.
756). We believe this approach--which confirms that losses from
identified straddle positions that exceed unrecognized gains on
offsetting positions are available in the year realized--is supported
by the legislative history and a fair reading of the statute.
Alternatively if the Committee determines that the intent of the
modified identified straddle rules was to parallel the general straddle
loss deferral rule, a second option would be to capitalize all losses
realized on positions included in an identified straddle, not just
losses up to the amount of ``unrecognized gain'' on offsetting
positions. We could support an interpretation that requires
capitalization of the full amount of realized losses on positions
included in an identified straddle since this alternative would at
least provide taxpayers with assurances as to the positions making up a
tax straddle. This clarification would in and of itself be valuable in
that it would provide taxpayers with certainty as to the operation of
the straddle rules and, as a result of the basis adjustments to
offsetting positions, the time at which losses would eventually be made
available. The attached proposed technical correction does not reflect
such a broad policy change and, if this approach were adopted, further
revisions to the proposed technical correction to IRC section
1092(a)(2) would be required.
We also suggest a clarification to explicitly allow taxpayers to
use any reasonable method to identify straddles unless and until the
Treasury issues regulations.
Conclusion
Thank you for the opportunity to comment on the H.R. 3376, the Tax
Technical Corrections Act of 2005. I hope you will look favorably on
including the requested technical corrections in the legislation.
Arthur C. Schneider
Senior Vice President and Chief Tax Officer
Alticor Global Holdings, Inc.
Washington, DC 20001
August 31, 2005
House Committee on Ways and Means
1102 Longworth House Office Building
Washington, DC 20515
To whom it may concern:
In response to the request for additional technical corrections
dated July 21, 2005, we would like to submit, on behalf of our client
Alticor Global Holdings Inc., the following request regarding the
treatment of wholly owned partnerships under new section 199. The
recently introduced technical corrections bill (H.R. 3376/S. 1447) adds
a provision that generally would treat a partnership and the members of
an expanded affiliated group (EAG) as a single taxpayer (for purposes
of determining domestic production gross receipts) where the
partnership is owned entirely by members of the EAG. For the reasons
described below, we respectfully request that a similar rule be applied
to situations where a partnership is wholly owned by entities that, in
turn, are owned entirely by a common parent. We see no policy reason to
distinguish between the two situations.
Applicable Facts
Alticor Global Holdings Inc. (AGHI) is a U.S. S corporation. It is
the common parent of several entities that are collectively engaged in
the business of manufacturing and selling a wide range of consumer
products. These products are sold in more than 60 countries under
trademarks and trade names owned by AGHI and its affiliates. AGHI owns
indirectly 100 percent of Alticor Enterprises Inc. (AEI), which, in
turn, is the common parent of Alticor Distribution Inc. (ADI) and
Access Business Group LLC (ABGL). AGHI intends to elect to treat AEI
and ADI as ``qualified subchapter S subsidiaries.'' ABGL is a
subchapter C corporation.
ADI and ABGL collectively own 100 percent of Access Business Group
International LLC (ABGIL), a Delaware limited liability company that is
treated as a partnership for Federal tax purposes. ABGIL was formed as
a partnership rather than as a corporation for local law purposes. (A
diagram of this corporate structure is attached to this letter.)
ABGIL owns title to the manufacturing intangibles for most of the
products produced by the group. It also performs the research and
development for the group. ABGIL does not itself manufacture the
products it distributes, but rather contracts with ABGL, the group's
manufacturer, to produce the products. Under the contracts, ABGL has
the right to use ABGIL's manufacturing intangibles and to affix ABGIL's
trademarks and trade names to the products. The products are
manufactured entirely in the United States.
Section 199
Section 199 was enacted under the American Jobs Creation Act of
2004 to encourage the domestic production of goods and to help replace
the export tax incentives. In general, Section 199 effectively provides
taxpayers with a deduction for a portion of their income derived from
property manufactured or produced ``by the taxpayer in whole or
significant part within the United States.''
To fully encourage domestic production, Congress has evinced a
policy that integrated producers should be able to treat both their
production income and their distribution income as subject to Section
199. This is true regardless of whether the distribution activity takes
place in the same entity as the production function, or is undertaken
by a related party. For example, by providing that the members of an
EAG are treated as a single taxpayer, Congress clearly intended that
the Section 199 production incentive apply to both the production
income and the distribution income of an integrated group. Similarly,
the example in the legislative history regarding the roasting of coffee
beans also indicates that distribution income qualifies for the benefit
of Section 199 in the case of an integrated producer. Finally, the
recently introduced technical corrections bill provides that a
partnership and the members of an EAG will be treated as a single
taxpayer if the partnership is wholly-owned for its entire taxable year
by the members of the EAG. Thus, if the partnership distributes
products produced by members of the EAG, the technical correction would
allow both the production income derived by members of the EAG and the
distribution income derived by the partnership to qualify for the
benefits of Section 199.
It is also important to note that tax incentives under both the
Foreign Sales Corporation regime and the Extraterritorial Income regime
would apply to the distribution income of an integrated production
group. Section 199 was a replacement for these two regimes and the
statutory scheme is similar in many respects.
The failure to adopt our requested technical correction may cause
anomalous results and provide some wholly owned corporate groups with a
competitive advantage over others. For example, distributor A is a
partnership owned by two C corporations, both of which are members of
the same EAG. One of A's corporate partners manufactures all of A's
products in the United States. Distributor B is a major competitor of
distributor A. Distributor B is a partnership that is owned by a QSS
and a C corporation, both of which are wholly owned by a common parent
S corporation. The C corporation partner manufactures all of B's
products in the United States. A and B both own all of the
manufacturing intangibles related to the production of their respective
group's products.
In the case of distributor A, both the production income earned by
A's corporate affiliate and the distribution income earned by A would
qualify as QPAI under the recently introduced technical corrections
bill (because the partnership and the members of the EAG would be
treated as a single taxpayer). By contrast, in the case of distributor
B, the manufacturing income earned by B's corporate affiliate may not
qualify as QPAI (under the benefits and burdens test of Notice 2005-
14). Obviously, if B were denied similar treatment to A, it would
provide A (and its corporate affiliates) a significant competitive
advantage over B (and its corporate affiliates). As with A, both the
production income and the distribution income derived by B and its
corporate affiliates should be eligible for treatment as QPAI.
Requested Technical Correction
In light of the foregoing issues, we respectfully request that a
technical correction be adopted clarifying the application of section
199 to situations where a partnership is wholly owned by entities that,
in turn, are owned entirely by a common parent. We suggest that either
of the following two alternatives would properly address our issues. We
believe either change is consistent with the legislative policy
underlying section 199.
Option 1
For purposes of determining domestic production gross receipts, if
a group of entities are wholly owned (directly or indirectly) by a
common parent corporation during the entire taxable year of such parent
corporation, each such entity and the common parent corporation shall
be treated as a single taxpayer.
Option 2
The definition of ``expanded affiliated group'' in section 199
could be amended to include S corporations by modifying the language of
section 199(d)(4)(B)(ii) to read as follows: ``without regard to
paragraphs (2), (4), and (8) of section 1504(b).''
We very much appreciate the opportunity to submit our comments
regarding proposed technical corrections. We would be happy to meet
with you to discuss these issues further. Also, if you have any
questions or need additional information, please call either of us.
Linda Carlisle
White & Case
Jonathan Talisman
Capitol Tax Partners
Statement of Kevin M. Burke, American Apparel & Footwear Association,
Arlington, Virginia
On behalf of the American Apparel & Footwear Association (AAFA), I
am pleased to submit comments to the Committee on Ways and Means
regarding some of the undefined issues contained in the American Jobs
Creation Act of 2004, P.L. 108-357. AAFA is the national trade
association representing over 400 companies in apparel, footwear and
other sewn products companies, and their suppliers. AAFA members
include American companies that produce clothing, footwear, textile
inputs, and related equipment in the United States and around the
world. Many of our domestic manufacturing members specialize in
supplying sewn products to the military. Our motto, ``We Dress the
World,'' accurately portrays the market our members represent, on the
commercial side and the military.
AAFA previously submitted comments to the Department of Treasury
regarding the promotion of two key points for consideration in
Treasury's interpretation of P.L. 108-357. Unfortunately, the Treasury
did not agree with AAFA's position on these issues; therefore, it is up
to the Committee to effect any change in the Treasury's current
interpretation.
Our main area of focus was having domestic contract manufacturing
arrangements considered as separate qualifying production activities
for the purposes of the manufacturing tax deduction. As design/
development is an integral part of the manufacturing process for
apparel and footwear production, it is our position that companies
investing in this domestic production should also benefit from the
manufacturing tax deduction proportional to the amount of production
completed domestically.
H.R. 3376 does not currently address either of the issues important
to AAFA. On behalf of our members I urge the committee to consider
providing Treasury with additional direction in these areas so that
small businesses that engage primarily in subcontracting and
multinational companies that perform their design and development
domestically can also benefit from these changes in the tax code. Under
the current interpretation of the Department of Treasury, contract
manufacturing is not eligible for the deduction as only the taxpayer
owning the tangible property during the manufacturing process is
considered the manufacturer.
Contract Manufacturing
Both domestic and multinational companies routinely contract
portions of the manufacturing process to other companies. Recognizing
domestic contract manufacturing arrangements as part of the
manufacturing process is paramount for apparel and footwear companies
and especially for the smaller companies as subcontract jobs can make
up a significant part of their business. Many AAFA domestic
manufacturers regularly accept subcontracts from larger companies and
also subcontract portions of the highly competitive government
contracts.
Government contracts for apparel and footwear, as with other
industries, typically span several years. The difficulties of
accurately predicting long-term work flow, the rise and fall of demand
and cost of supplier components among other factors, can contribute to
an overload on occasion. Rather than forfeit a contract, any company
will attempt to subcontract a portion of the original contract. In
addition, in most manufacturing processes and businesses, in order to
remain competitive, develop niche markets and specialized expertise.
This fosters an atmosphere ripe for subcontracting specific portions of
a program. There may be one or only a few companies that have the
capabilities to perform certain functions in the apparel and footwear
manufacturing process and thus contributing to the additional demand
for subcontracting particular portions.
Under current U.S. Code 26 Section 263A, production or the term
produce ``includes construct, build, install, manufacture, develop, or
improve.'' Also under this section, ``the taxpayer shall be treated as
producing any property produced for the taxpayer under a contract with
the taxpayer; except that only costs paid or incurred by the taxpayer
(whether under such contract or otherwise) shall be taken into account
in applying'' direct and indirect costs to the taxpayer. AAFA supports
the inclusion of this language in the interpretation of P.L. 108-357,
which would allow the producer or taxpayer, including subcontractors,
of the apparel and footwear manufacturing process to benefit from the
manufacturing tax deduction.
Under P.L. 108-357, the deduction is based on the lesser of the
qualified production activities (QPA) income of the taxpayer or taxable
income. The qualified production activities income is equal to the
excess of the domestic production gross receipts over the sum of (1)
the cost of goods sold allocable to such receipts, (2) other
deductions, expenses, or losses directly allocable to such receipts and
(3) a ratable portion of other deductions, expenses, and losses not
directly allocable to such receipts or another class of income.
Domestic production gross receipts, as it applies to AAFA members,
consists of the receipts for any lease, rental, license, sale,
exchange, or other disposition of qualifying production property which
was manufactured, produced, grown, or extracted by the taxpayer in
whole or in significant part within the United States. Qualifying
production property as it applies to AAFA members is the tangible
personal property--apparel and footwear.
The deduction is based on profit--the cost for producing the item
from a subcontract basis is included in the original taxpayer's overall
costs. Therefore, the deduction for the original taxpayer is not for
the same profit received by the subcontractor to make a portion of the
product. This allows for both the subcontractor and original taxpayer
to take advantage of the deduction. AAFA supports separately computed
deductions for the original taxpayer and the contractor.
Design and Development
An essential part of the process for manufacturers of apparel and
footwear and for most manufacturing is design and development. The
process of producing a design and parlaying that design into a sample
product is the beginning of the manufacturing process. In most
instances, without the design and development, there would be no
production. Many U.S. apparel and footwear companies complete all of
the design and development in the U.S. and under the current
interpretation of Treasury, packaging, design, and development are not
included in the consideration for the application of the ``significant
part'' test for the purposes of determining tangible personal property.
As the face of apparel and footwear manufacturing continues to
evolve due to the removal of quotas worldwide on January 1, 2005, the
current practice of completing the design and development in the U.S.
may change. Companies are consolidating their sourcing in fewer
countries and with the advent of manufacturing cities, which include
every component in the manufacturing process in one location--from the
supply of yarn, fabric, thread, buttons, zippers, cutting and sewing,
what is there to keep this part of the process in the U.S. Due to this
type of sweeping transformation in the way apparel and footwear
companies do business, an incentive to keep the design and development
in the U.S. could not come at a better time. The manufacturing
deduction would serve as incentive for companies to continue to make a
substantive investment in the people and process that make up this
important phase of the manufacturing process. The ability to take
advantage of a QPA deduction for this part of the manufacturing process
will contribute significantly toward keeping this element of the
process in the U.S. Therefore, as an integral part of the apparel and
footwear manufacturing process, AAFA strongly urges the Committee to
consider providing Treasury with more specific direction that would
allow companies performing their design and development in the U.S. to
benefit from the deduction in P.L. 108-357.
AAFA appreciates the opportunity to comment on the Committee on
Ways and Means regarding H.R. 3376. If you have any questions about
AAFA's position on any of the above comments, please feel free to
contact Felicia Cheek at 703.797.9039.
American Association of Port Authorities
Alexandria, Virginia 22314
August 31, 2005
The Honorable William M. Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, DC 20515
Dear Chairman Thomas,
I am writing to you today regarding your request for written
comments on H.R. 3376, the ``Tax Technical Corrections Act of 2005.''
Recently, Congressmen Dave Weldon and Christopher Shays introduced H.R.
3319 to amend the IRS Code to exempt domestic intermodal cargo
containers and cargo loaded on a vessel by means of wheeled technology
from the Harbor Maintenance Tax. The American Association of Port
Authorities (AAPA) urges you to include this provision in your
technical corrections bill. AAPA represents the leading public port
authorities in the Western Hemisphere, and these comments reflect the
position of our U.S. members. Most maritime trade that flows in and out
of the U.S. transits through AAPA member ports.
As the primary congressional committee dealing with trade, you are
well aware of the importance of trade to this nation and the
projections for increases in the coming years. Ports are looking
strategically at how to accommodate this growth, especially in terms of
transporting cargo out of the port facilities in a way that will not
overload our current highway and rail transportation systems. Road
congestion and projected increases in trade volumes have spurred many
in the maritime industry, including the Maritime Administration, to try
to encourage the use of short sea shipping to carry some of the
domestic load. This industry is well developed in Europe, and maritime
transportation is underutilized in the U.S. for domestic shipping.
In the United States, most cargo imported or exported through
seaports is transported by truck or rail. Congestion is evident at most
large U.S. ports, many of which are also located in heavily congested
urban areas. A March 2003 report from the U.S. Chamber of Commerce,
Trade and Transportation: A Study of North American Port and Intermodal
Systems, highlighted this growth in trade and the need to ``proactively
address the current crisis in the capacity of our intermodal system.''
Short sea shipping is one part of this solution.
Domestic short sea shipping would also allow this country to
accommodate the increase in cargo trade by providing an alternative to
the already overburdened highways and railroads. Unfortunately, the
Harbor Maintenance Tax has been identified by experts as a cost
disincentive to the development of this new industry. Trucking rates
and rail rates are very competitive with short sea shipping. Exempting
certain domestic cargo from the Harbor Maintenance Tax would encourage
the expansion of short sea shipping.
Established in 1986, the Harbor Maintenance Tax (HMT) is an ad
valorem tax on the value of commercial cargo. The tax is deposited into
a trust fund to pay 100% of maintenance dredging of harbors, which is
conducted by the U.S. Army Corps of Engineers. Unfortunately, Congress
has not allowed full use of this trust fund, and there is currently a
surplus of $2.6 billion.
There are currently several exemptions from the HMT, and we hope
your committee will endorse an additional exemption for certain
intermodal cargo shipped on coastal routes or rivers between U.S. ports
as outlined in H.R. 3319. The current law excludes ferries, cargo
moving to and from Alaska and Hawaii other than Alaskan crude oil, and
any cargo associated with vessel movements to and from most of the
inland waterways system. We are not encouraging a full domestic
exemption, only a tax law change that would impact containerized cargo
and cargo loaded on vessels by means of wheeled technology. Bulk cargos
would not be exempt, since much of this type of cargo already uses the
maritime system heavily.
As with any tax change, it is important to consider the cost.
Preliminary estimates put the cost of this new exemption at under $2
million a year. The Corps of Engineers reports that for FY'02 (the most
recent report on the Harbor Maintenance Trust Fund) the total of all
HMT domestic payments was $28 million. Also, total domestic cargo was
only 4.3% of the total HMT collected in 2002. This provision would only
be a small subset of the domestic total. With a $2.6 billion surplus in
the trust fund that continues to grow each year, adding this exemption
to the law would not harm the trust fund.
Short sea shipping is an exciting opportunity that shows great
promise for helping the U.S. address the cargo congestion brought on by
growth of trade in this country. By recommending a change in the tax
law to provide an additional exemption for certain domestic cargos,
your committee would be doing a great service to this nation by
promoting the transportation solutions for tomorrow.
The American Association of Port Authorities thanks you for your
consideration of this important maritime issue and would be very
interested in discussing this matter further as you develop changes to
the Tax Technical Corrections Act of 2005.
Kurt J. Nagle
President
American Bankers Association
Washington, DC 20036
August 30, 2005
The Honorable William M. Thomas
Chairman
House Ways and Means Committee
Washington, DC 20515
Dear Chairman Thomas:
The undersigned banking trade associations offer our support for
the Technical Tax Corrections Act of 2005 (H.R. 3376 and S. 1447). Late
last year, the enactment of the American Jobs Creation Act of 2004
(``AJCA'') provided many positive and pro-growth tax reforms, including
significant Subchapter S Corporation reforms. Fortunately, the
Technical Tax Corrections Act of 2005 will ensure that provisions
included in AJCA can be properly implemented as intended by Congress.
We support this important effort and urge lawmakers to quickly pass the
Technical Tax Corrections Act as introduced.
We are especially pleased to see that the Technical Tax Corrections
Act of 2005 includes several needed technical corrections to the S
Corporation reforms included in the AJCA.
Specifically, the Technical Tax Corrections Act helps clarify that
eligible Subchapter S shareholders include IRAs holding stock in a
bank, bank holding company, or thrift holding company. The legislation
will also make clear that the scope of the passive income exemption
provision encompasses thrift holding companies. Moreover, important
language is included that will clarify that a qualified Subchapter S
subsidiary is a separate entity for purposes of information returns.
This legislation will also ensure that the estate of a family member is
treated as a member of the family for purposes of determining the
number of shareholders. Finally this measure will verify that eligible
adopted and foster children will be treated as ``lineal descendants''
or ``common ancestors'' in the definition of ``members of the family''
in the tax code.
These crucial technical corrections to the Subchapter S reforms in
the AJCA will provide our membership with much-needed clarity. We
appreciate your efforts and urge speedy passage of this important
legislation.
Ed Yingling
President and CEO
Diane Casey-Landry
President and CEO of America's Community Bankers
Camden R. Fine
President and CEO of Independent Community Bankers of America
American Council of Engineering Companies
Washington, DC 20005
August 31, 2005
The American Council of Engineering Companies (ACEC) submits these
comments in regard to the Tax Technical Corrections Act of 2005. ACEC
is the business association of America's engineering industry,
representing approximately 5,500 independent engineering companies
throughout the United States engaged in the development of America's
transportation, environmental, industrial, and other infrastructure.
ACEC thanks the Ways and Means Committee for their work to ensure that
the implementation of the American Jobs Creation Act (P.L. 108-357) is
carried out smoothly and to solicit the input of the regulated
community on this process.
Definition of Engineering
The proposed definition in the Notice for ``engineering and
architectural services'' is consistent with IRS Regulation Section
1.924(a)-1T(e)(5) and -1T(e)(6):
(b) Engineering services. Engineering services in connection with
any construction project include any professional services requiring
engineering education, training, and experience and the application of
special knowledge of the mathematical, physical, or engineering
sciences to those professional services such as consultation,
investigation, evaluation, planning, design, or responsible supervision
of construction for the purpose of assuring compliance with plans,
specifications, and design.
While this definition is consistent with previous relevant IRS
definitions, it could be interpreted to exclude engineering services
that are related to a construction project, but occur after
construction is completed. ACEC suggests Congress include in the Tax
Technical Correction Act language to amend the definition to:
(b) Engineering services. Engineering services in connection with
any construction project include any professional services requiring
engineering education, training, and experience and the application of
special knowledge of the mathematical, physical, or engineering
sciences to those professional services such as consultation,
investigation, evaluation, planning, design, responsible supervision of
construction for the purpose of assuring compliance with plans,
specifications, and design or the inspection of the constructed
facilities after construction.
This amended definition would clarify that projects like bridge
inspections and other post-construction engineering studies,
evaluations and audits would qualify for the deduction. These
engineering services are crucial to ensuring the safety of construction
projects.
Accounting Burden
Engineering firms undertake an enormous volume of projects in a
given year. For our larger firms, the contracts associated with
engineering and construction/construction management annually number in
the thousands, and the projects associated with those contracts would
be more than ten-thousand for any given year. Additionally, projects
are further broken down into task and sub-tasks, significantly
expanding the level of detail. These facts are consistent throughout
the architectural and engineering industry.
The IRS Notice on Section 199 requires that the determination of
Qualified Production Activities Income be:
``On an item-by-item basis (and not, for example, on a division-by-
division, product line-by-product line, or transaction-by-transaction
basis) and is the sum of QPAI derived by the taxpayer from each item.''
The Notice also states that (emphasis added):
``The Engineering or architectural services must relate to real
property, must be performed in the United States, and the taxpayer
providing these services must be able to substantiate that the services
relate to a construction project within the United States.''
ACEC believes that the rigorous requirements for determining QPAI
``on an item-by-item basis'' will impose a substantial and unreasonable
burden to taxpayers which will overwhelm tax departments and result in
firms not taking advantage of the tax treatment that they are entitled
to. The ``item-by-item basis'' could result in each invoice and job
scope needing to be reviewed in order to determine whether the Section
199 requirements are met.
ACEC requests that Congress include in the Tax Technical
Corrections Act an instruction to the IRS and the Treasury to examine
methods that would reduce the accounting burden for engineering firms
who are affected by the item-by-item provision. These methods should
include the allowance of statistical sampling as already provided in
Rev. Procs. 2004-29, 2004-34 and Rev. Proc. 81-70.
Real Property Restriction
ACEC is concerned about troubling and restrictive language that
requires that ``engineering or architectural services must relate to
real property . . .'' which was contained in the Tax Technical
Corrections Act and also in Treasury Notice 2005-14, the Interim
Guidance on Income Attributable to Domestic Production Activities
[hereinafter, Notice]. The Notice defined real property as
``residential and commercial buildings (including items that are
structural components of such buildings), inherently permanent
structures other than tangible property in the nature of machinery,
inherently permanent land improvements, and infrastructure.'' Also, the
Notice defines construction to mean ``the construction of real
property. . . .'' Section 4.04(11). The Notice also states that
``tangible personal property (as defined under section 4.04(8)(b)) (for
example, appliances, furniture and fixtures) that is sold as part of a
construction project is not considered real property for this
purpose.''
ACEC recommends that the provision requiring that engineering
services ``must relate to real property'' in order to qualify for the
tax relief included in the American Jobs Creation Act (P.L. 108-357)
should be removed from the Tax Technical Corrections Act and that
Congress should instruct the Treasury Department to provide a more
inclusive definition for ``real property'' as related to construction
projects. This language, as written, will result in the non-
applicability of the provision to engineering work that Congress
intended the provision to apply to and will create an undue compliance
burden for engineering firms.
The real property restriction in its current form will create
difficulties for engineering firms in determining whether they qualify
for the benefit. In many cases, an engineering and/or architectural
design firm or a construction firm may design or build a project that
contains both real and personal property elements. With the many
projects that engineering firms undertake each year, the task of
determining what percentage of the project fee related to real property
and what percentage related to personal property will be extremely
complex and will require the firm to expend considerable resources.
This may result in many firms not taking advantage of the tax treatment
that Congress intended.
In addition to the compliance aspect, certain work that qualified
for the export tax deduction under Domestic International Sales
Corporation (DISC), the Foreign Sales Corporation (FSC), and the
Extraterritorial Income (ETI) would not qualify for the Domestic
Production Activities benefit if the proposed real property restriction
is included in the final regulation. For example, the design and
construction of clean rooms, power plants, steam generating units, and
oil refineries would not benefit for the deduction, which was not
Congress' intent. Congress intended for this legislation to provide
much needed tax relief and to ensure that U.S. business can remain
competitive in the global marketplace. The restriction for real
property would not fulfill those goals.
ACEC strongly recommends the current language relating to real
property should be removed from the Tax Technical Corrections Act and
that Congress should instruct the Treasury Department to reconsider
their definition of ``real property'' as related to construction
projects in any regulations that are promulgated.
ACEC and our member organizations stand ready to provide you with
any additional information necessary to help you implement the American
Jobs Creation Act. In addition, we realize that other issues of concern
may arise during the implementation of H.R. 4520 and look forward to
continuing this dialogue as needed.
Thank you in advance for your consideration of these matters.
Please do not hesitate to contact us with any questions.
Danielle Marks
Director, Finance and Regulatory Affairs
American Council of Life Insurers
Washington, DC 20001
August 31, 2005
Mr. Robert Winters
Chief Tax Counsel
Committee on Ways and Means
United States House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Mr. John Buckley
Minority Chief Tax Counsel
Committee on Ways and Means
United States House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Gentlemen:
Attached are the comments of the American Council of Life Insurers
regarding a technical correction that we feel is required to section
888(a) of the American Jobs Creation Act of 2005 (P.L. 108-357). The
ACLI is the principal trade association of life insurance companies,
representing 356 members that account for, in the aggregate, and 80
percent of the assets of legal reserve life insurance companies in the
United States.
In the course of conservatively investing company assets for the
benefit of their insurance customers, our companies will often engage
in hedging transactions to manage interest rate and other risks.
Therefore, they are keenly interested in seeing that the changes to
Internal Revenue Code section 1092 contained in section 888(a) of the
Jobs Act work correctly and clearly reflect Congressional intent. Our
comments below explain the issue and our proposed solution.
We appreciate the opportunity to provide our comments and would
welcome the opportunity to work with Congressional staff on this issue.
Gregory F. Jenner
------------
Proposed Technical Correction to Section 888(a) of the
American Jobs Creation Act
Issue_Section 888(a) of the Jobs Act amended Internal Revenue Code
Section 1092(a)(2), which sets forth the tax treatment of identified
straddles. Before the Jobs Act amendment, the identified straddle rule
provided an exception from the general loss deferral regime applicable
to straddles. The new rules now require that if a loss is realized on
an identified straddle position, the basis of the remaining offsetting
position(s) of the identified straddle shall be increased by the
realized loss. The new rules are effective for positions established on
or after October 22, 2004.
Importance_Life insurance companies often use hedging techniques to
manage interest rate and other risks. Because of this, life insurers
may have transactions that could be subject to the general straddle
rules (i.e., loss deferral) absent the ability to use narrowly crafted
relief provisions such as identified straddles.
Need for Correction_Initially the Jobs Act amendment was viewed as
a welcome simplification of the identified straddle rules. The straddle
rules are intended to provide a clear reflection of income by deferring
loss until gain in offsetting positions is recognized. However, recent
comments by Treasury and IRS officials have indicated that the new
statutory language could be interpreted to result in a permanent loss
denial or a loss deferral in amounts exceeding the losses that would be
deferred under the general straddle rules, a result that is contrary to
the clear reflection of income principle.
As enacted, the amendments to section 1092(a)(2) appear to assume
that, if one position of the identified straddle is disposed of at a
loss, there will be gain in the offsetting position. The new rules do
not provide what the result will be where there is no gain in the
offsetting position. The absence of a specific rule has prompted
Treasury and IRS officials to suggest that this may result in a
permanent denial of the loss, a result we believe would be entirely
inappropriate from a tax policy perspective.
Moreover, where there is insufficient unrecognized gain in the
remaining position(s) to offset the entire loss, the new rules appear
to result in a deferral of the entire loss, whereas the general
straddle rules would permit immediate deduction of the excess loss.
Nothing in the legislative history of the provision suggests that
Congress intended to enact a more onerous rule than prior law.
Finally, it has been suggested by certain Treasury and IRS
officials that regulatory guidance may be required before taxpayers can
take advantage of these new rules. While the statute, by its terms, is
clearly self-executing, we believe it is essential that this be
clarified by Congress in order to prevent frustration of Congressional
intent.
Specific Changes_
1. Section 1092 should be amended to specify the treatment of any
realized loss on a position in an identified straddle where such loss
exceeds the unrecognized gain in the offsetting position(s). One
possible approach is to allow the excess loss to be deductible
currently. This would be a simple extension of the general straddle
rules that defer losses on straddles only to the extent of the
unrealized gains in the offsetting positions.
2. If Congress concludes that no loss should be allowed until the
offsetting position is disposed of, a rule is still needed under
section 1092 to cover situations in which there is no gain in the
offsetting position. In those instances, the loss should not be
permanently denied. Instead, the loss should be allocated to the basis
of the offsetting position so that the loss would be recovered upon
disposition of the offsetting position. This could be done in several
tax neutral ways, including allocating based on fair market value or
basis. We would be happy to work with Congressional staff with respect
to this issue.
3. The provision relating to Treasury guidance should be amended
to provide that, until such time as there is any such guidance, any
reasonable identification method is sufficient. Alternatively,
legislative history with respect to the technical corrections bill
could provide a similar clarification for taxpayers and regulators.
American Electronics Association
Washington, DC 20004
August 31, 2005
The Honorable William Thomas, Chairman
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
The Honorable Charles Grassley, Chairman
The Honorable Max Baucus, Ranking Minority Member
Committee on Finance
United States Senate
219 Dirksen Senate Office Building
Washington, DC 20510
Dear Chairmen Thomas and Grassley and Senator Baucus:
On behalf of AeA (American Electronics Association), I am writing
to propose an additional provision be included in the foreign
repatriation-related provisions in the Tax Technical Corrections Act of
2005, H.R. 3376 and S. 1447.
AeA is the nation's largest high-tech trade association,
representing more than 2,500 member companies that span the high-
technology spectrum, from software, semiconductors, and computers to
Internet technology, advanced electronics, and telecommunications
systems and services. AeA members include small, medium, and large
high-tech companies.
Section 965 (often referred to as the ``Homeland Investment Act''
or ``HIA'') allows U.S. corporations to elect, for one year only, to
claim a dividends received deduction (``HIA DRD'') equal to 85 percent
of qualifying cash dividends (``HIA dividends'') received from
controlled foreign corporations (``CFCs''). The HIA DRD allows U.S.
corporations to receive HIA dividends subject to a 5.25% effective tax
rate, instead of the normal 35% tax rate. HIA is intended to encourage
U.S. corporations to repatriate cash from foreign subsidiaries for
investment in the United States.
As described below, currently there is uncertainty regarding the
portion of a distribution from a CFC that qualifies as a distribution
out of earnings and profits (``E&P'') attributable to previously taxed
income (``PTI'') as defined in section 959(c), i.e., the portion of the
distribution that is not a dividend. With respect to the year for which
the section 965 election is in effect (the ``HIA election year''), this
uncertainty complicates the calculation of the HIA DRD and therefore
discourages maximum repatriations of offshore cash to the United
States.
In order to eliminate this uncertainty, a technical correction
should provide that the portion of a distribution from a CFC made
during the HIA election year (``HIA distribution'') which is treated as
a PTI distribution will be based on the CFC's undistributed PTI for the
most recent taxable year ending on or before June 30, 2003, as reduced
by subsequent PTI distributions. This technical correction would be
consistent with other provisions of section 965, which provide for
computations based on amounts that are fixed prior to the HIA election
year.
Issue
There are three components of a distribution under section 965: (1)
the distribution of PTI; (2) the base period dividend distribution; and
(3) the HIA dividend distribution of deferred earnings. Section 965
currently allows taxpayers to determine with certainty some, but not
all, of the material elements of the required calculation. While the
statute allows taxpayers to determine the base period amount (as
defined in section 965(b)(2)(B)) and the deferred earnings amount (as
defined in section 965(b)(1)) with certainty, there is no certainty
with respect to the amount of a CFC's PTI that will have to be taken
into account to determine either (i) the dividends which are declared
to satisfy the base period dividend requirement, or (ii) the HIA
dividend itself. This lack of certainty may prevent taxpayers from
maximizing the amount of HIA distributions, and therefore prevent
taxpayers from maximizing the amount of offshore earnings reinvested in
the United States.
Absent further guidance, a CFC must distribute all of its PTI,
determined as of the end of the HIA election year, before it can
distribute a HIA dividend. The amount of the CFC's PTI as of the end of
the HIA election year, however, will not be known with certainty on the
date that it makes an HIA distribution. The tax return for the HIA
election year will not be filed until several months after the date of
the HIA distribution. The tax return for the prior taxable year also
may be filed after the date of the HIA distribution if the distribution
is made early in the HIA election year.
In addition, there may be amended returns or audit adjustments for
various open years up to and including the HIA election year that
affect PTI but which are not finally determined until after the date of
the HIA distribution. Despite the Service's laudable initiative to
bring large taxpayers current in their audit cycles, many large
taxpayers with offshore earnings which potentially could be reinvested
in the United States still have several taxable years open to
examination. Under the statute as currently drafted, any adjustment by
audit or amended return that increases PTI for any taxable year through
the HIA election year would retrospectively reduce the HIA dividend,
dollar for dollar, by recharacterizing a portion of the HIA
distribution as a PTI distribution. Similarly, changes to PTI may
affect whether the taxpayer received dividends in excess of the base
period amount.
This uncertainty complicates the calculation of the HIA dividend
and the tax accrual for that dividend. Corporate tax managers are under
increasing pressure to precisely quantify the amount of the income tax
accrual for all transactions. For many taxpayers, the decision whether
to make an HIA distribution is a very significant one, which can be
made only with a full understanding of the financial consequences. The
existing uncertainty makes that determination difficult, which
discourages maximum reinvestment of offshore earnings in the United
States.
Proposed Technical Correction
A technical correction should be enacted to provide taxpayers the
same certainty in determining the PTI amount for purposes of
calculating the HIA dividend that exists in determining the base period
amount and the deferred earnings amount. Both of those amounts are
determined as of June 30, 2003. The technical correction should provide
that, for purposes of determining the amount of HIA dividends and
dividends that are necessary to meet the base period amount, the amount
of the distributing CFC's PTI that is taken into account shall not
exceed the PTI amount as shown on the most recent return filed for the
most recent taxable year ending on or before June 30, 2003 (excluding
amended returns filed after that date) (``Fixed PTI Amount''), reduced
by actual PTI distributions made prior to the HIA election year.
This proposal would allow taxpayers to calculate their HIA dividend
with certainty and to distribute the maximum allowable HIA dividend.
Taxpayers would not be required to base their HIA calculations on
tentative estimates of a PTI amount that could change by the end of the
HIA election year or that could be affected by subsequent audit
adjustments.
Under this proposal, taxpayers will be required to distribute the
full Fixed PTI Amount prior to distributing an HIA dividend. That
distribution could occur in any taxable year after the year in which
the Fixed PTI Amount is determined, up to and including the HIA
election year. Therefore, if an amount equal to the Fixed PTI Amount
had been distributed prior to the HIA election year, distributions
would first be made from other E&P, rather than from PTI, up to the
applicable base period dividend amount (to the extent not paid by other
CFCs) and HIA dividend limits. The CFC's PTI account would remain
intact, and distributions in excess of the CFC's share of the base
period dividend and the HIA dividend would be attributable to the CFC's
PTI account under normal rules.
If it is ultimately determined that, as of the end of the HIA
election year, a distributing CFC had PTI in excess of the Fixed PTI
Amount, that additional PTI would remain PTI of the CFC. Distributions
exceeding the CFC's share of the base period dividend and the HIA
dividend made during the HIA election year, or any distribution made in
a subsequent year, would be made out of such additional undistributed
PTI and other E&P under the normal ordering rules. Accordingly, any
uncertainty over the CFC's actual PTI amount would not affect the
calculation of the HIA dividend.
The Service may require taxpayers to attach a statement to the
return for the HIA election year designating the E&P pools from which
these distributions are made.
I have attached a draft of the proposed technical correction as an
exhibit.
Policy Reasons for Change
Congress enacted section 965 to encourage cash repatriation to fund
investment and job creation in the United States. The proposed
technical correction furthers this goal because it increases the
certainty with which taxpayers can calculate the HIA dividend, thereby
encouraging taxpayers to maximize repatriations to and investment in
the United States.
The proposal is consistent with other elements of section 965 which
provide certainty in computing the amount of the HIA dividend by
allowing taxpayers to rely on tax attributes that are fixed prior to
the beginning of the HIA election year.
All other existing limits under section 965 are preserved. The
amount of the HIA dividend still could not exceed the distributing
CFC's current or accumulated E&P in excess of undistributed PTI, as
determined after all audit adjustments for all years through the HIA
election year. In addition, this proposal does not affect the amount of
deferred earnings that are eligible for the HIA DRD, and it does not
alter the base period computation or the reinvestment plan requirement.
In light of the fact that some companies have already made an HIA
distribution, it may be appropriate to provide this resolution to
affected taxpayers by election.
This uncertainty is created by the unique situation that an HIA
distribution can be made for only one taxable year, while the
underlying elements that determine the amount of the HIA dividend may
cover several years. This proposed technical correction will eliminate
this unique uncertainty, and therefore will encourage maximum
reinvestment and job creation in the United States. Since it deals with
the one-time event of section 965, it will have no future impact on any
taxpayer after the completion of the HIA distribution.
Thank you for the opportunity to submit this proposed addition to
the Tax Technical Corrections Act of 2005. If you have any questions
about this letter, please feel free to contact me at (202) 682-4448.
Marie K. Lee
Tax Counsel
__________
Exhibit
New Section 965(c)(4). To be inserted between current Section 965(c)(3)
and Section 965(c)(4).
(4)
COORDINATION WITH SECTION 959.--Notwithstanding the rules of
section 959, distributions of earnings and profits made by a controlled
foreign corporation, which has a United States shareholder that has
made an election under this section, shall be applied for the year of
election in the following manner:
(A)
First, out of earnings and profits described in section
959(c)(1) and (c)(2), in the order specified in section 959(c), up to
the amount of such earnings and profits shown on the most recent return
filed for the most recent taxable year ending on or before June 30,
2003 (except that amended returns filed after June 30, 2003, shall not
be taken into account), reduced by the amount of distributions that
(i)
are excluded from gross income under section 959, and
(ii)
are distributed after the most recent taxable year ending
on or before June 30, 2003, and before the taxable year for which the
election under this section is in effect;
(B)
Second, out of earnings and profits described in section
959(c)(3), to the extent that dividends received by the United States
shareholder from other controlled foreign corporations during such year
are less than the amount stated in section 965(b)(2)(B);
(C)
Third, out of earnings and profits described in section
959(c)(3), to the extent of the amount distributed by such controlled
foreign corporation which qualifies for the deduction provided in
subsection (a)(1); and
(D)
Fourth, out of earnings and profits in the manner described
in section 959(c).
New Section 959(g).
(g)
COORDINATION WITH SECTION 965.--For special rules relating to the
application of this section in years for which an election is made
under section 965(f), see section 965(c)(4).
American Forest & Paper Association
Washington, DC 20036
August 31, 2005
The Honorable William Thomas
Chairman, Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas:
The American Forest & Paper Association is pleased to submit the
following comments on H.R. 3376, the Tax Technical Corrections Act of
2005.
The American Forest & Paper Association (AF&PA) is the national
trade association for the forest products industry. We represent more
than 200 companies and related associations that engage in or represent
the manufacturers of pulp, paper, paperboard and wood products.
America's forest and paper industry ranges from the state-of-the-art
paper mills to small, family owned sawmills and some 10 million
individual woodlot owners. The U.S. forest products industry is vital
to the nation's economy. We employ approximately 1.3 million people and
rank among the top ten manufacturing employers in 42 states with an
estimated payroll of $50 billion. Sales of the paper and forest
products industry top $230 billion annually in the U.S. and export
markets. We are the world's largest producer of forest products.
AF&PA very much appreciates the inclusion of technical corrections
clarifying the enhanced reforestation amortization (sec. 2(j)(2)(B) of
H.R. 3376) and the definition of open-loop biomass under IRC section 45
(sec. 2(t)(2) of H.R. 3376).
Our comments focus on section 2(t)(2) of H.R. 3376, which clarifies
the definition of open-loop biomass under IRC section 45:
(2) Clause (ii) of section 45(c)(3)(A) [definition of open-loop
biomass] is amended by inserting `or any nonhazardous lignin waste
material' after `cellulosic waste material.'
The description of H.R. 3376 indicates that this provision
``clarifies that open-loop biomass resources include both cellulosic
and lignin waste material.'' Joint Committee on Taxation, Description
of the ``Tax Technical Corrections Act of 2005,'' JCX-55-05, page 10.
Subsequent to the introduction of H.R. 3376, this technical
correction was enacted as part of the Energy Policy Act of 2005 (sec.
1301(f)(2) of H.R. 6).
AF&PA understands the legislative intent behind the word
``nonhazardous'' was to ensure that hazardous materials do not qualify
for the credit. Lignin is not a hazardous material. In the context of
our processes that produces steam and electricity from lignin, however,
we are concerned that there could be unintended confusion as explained
below. Similarly, we understand that ``waste'' was included to ensure
that the tax incentive did not create competition for woody-biomass
material that could be used to make paper or solid wood products.
However, as explained below, there could be unintended confusion
resulting from a previous IRS ruling that, in another context, found
lignin to not be considered ``waste.'' For these reasons AF&PA is
seeking further clarification of this language (see also ``Written
Statement for the Hearing Record,'' submitted by AF&PA to the
Subcommittee on Select Revenue Measures, on June 6, 2005, copy
attached).
Wood is composed primarily of cellulose (wood fibers) held together
by lignin (the fiber binding agent). The processing of wood for making
paper has several stages. The first stage involves the use of pulping
chemicals to dissolve wood into cellulose wood fibers and wood residues
(mostly lignin). The cellulose wood fibers then are separated and
further processed to become paper products. What remains is a
combination of pulping chemicals and wood residues or lignin. This
combination is referred to as pulping liquors. The next stage involves
a process to separate the pulping chemicals from the wood residues or
lignin. The pulping chemicals are recovered for reuse in the pulping
process. The wood residues (lignin) are burned to generate heat for
making steam and electricity.
AF&PA requests two clarifications. First, a clarification that the
wood residues are not considered hazardous because they are combined
with pulping chemicals prior to their use to generate steam and
electricity. Second, a clearer description of lignin to indicate it is
a ``by product'' of the pulping process, rather than ``waste''
material. This is important because, in a different context, there is
an interpretation by the Internal Revenue Service that lignin from the
pulping process is not ``waste'' material (see Technical Advice
Memorandum TAM 8722005, February 6, 1987).
AF&PA therefore suggests the following change to the Tax Technical
Corrections Act language cited above, with the changes noted in bold:
(2) Clause (ii) of section 45(c)(3)(A) is amended by inserting `or
any by product of wood or paper mill operations, including lignin in
pulping liquors,' after `cellulosic waste material.'
This clarification is consistent with the definition of biomass in
new IRC section 48B(c)(4)(A) (relating to a new tax credit for
qualifying gasification projects).
The description of this provision should be modified to read:
Open-loop biomass (including agricultural livestock waste
nutrients) facility
An open-loop biomass facility is a facility using open-loop biomass
to produce electricity. Open-loop biomass is defined as (1) any
agricultural livestock waste nutrients, or (2) any solid, nonhazardous,
cellulosic waste material or by product of wood or paper mill
operations, including lignin in pulping liquors, which is derived from
certain forest-related resources, solid wood waste materials, or
agricultural sources and which is segregated from other waste
materials. Eligible forest-related resources are mill residues,
precommercial thinnings, slash, and brush. Solid wood waste materials
include waste pallets, crates, dunnage, manufacturing and construction
wood wastes (other than pressure-treated, chemically-treated, or
painted wood wastes), and landscape or right-of-way tree trimmings.
Agricultural sources include orchard tree crops, vineyard, grain,
legumes, sugar, and other crop by-products or residues. However,
qualifying open-loop biomass does not include municipal solid waste
(garbage), gas derived from biodegradation of solid waste, or paper
that is commonly recycled. In addition, open-loop biomass does not
include closed-loop biomass or any biomass burned in conjunction with
fossil fuel (co-firing) beyond such fossil fuel required for start up
and flame stabilization. (Excerpt from Statement of Managers of H.R. 6,
page 17.)
AF&PA appreciates the opportunity to present you with these
comments. We would welcome the opportunity to discuss this issue with
you or to answer any questions you may have.
David G. Koenig
Director, Tax Policy
__________
The American Forest & Paper Association (AF&PA) is the national
trade association for the forest products industry. We represent more
than 200 companies and related associations that engage in or represent
the manufacturers of pulp, paper, paperboard and wood products.
America's forest and paper industry ranges from the state-of-the-art
paper mills to small, family owned sawmills and some 10 million
individual woodlot owners. The U.S. forest products industry is vital
to the nation's economy. We employ approximately 1.3 million people and
rank among the top ten manufacturing employers in 42 states with an
estimated payroll of $50 billion. Sales of the paper and forest
products industry top $230 billion annually in the U.S. and export
markets. We are the world's largest producer of forest products.
Today, the U.S. forest products industry is facing serious domestic
and international challenges. Since 1997, 101 pulp and paper mills have
closed in the U.S., resulting in a loss of 70,000 jobs, or 32% of our
workforce. An additional 67,000 jobs have been lost in the wood
products industry since 1997. New capacity growth is now taking place
in other countries, where forestry, labor, and environmental practices
may not be as responsible as those in the U.S.
Energy is the third largest operating cost for the forest products
industry. In the pulp, paper and paperboard sector of the industry,
energy makes up 10-15 percent of the total operating costs. Since 1972,
our industry has reduced its average total energy usage by 17 percent
through increased efficiencies in the manufacturing and production
process. In addition, we have reduced our fossil fuel and purchased
energy consumption by 38 percent, and increased our energy self-
sufficiency by 46 percent.
The American Jobs Creation Act (H.R. 4520) included a provision to
expand the Section 45 tax credit to include open-loop biomass. For
purposes of the credit, open-loop biomass is defined as any solid, non-
hazardous, cellulosic waste material which is segregated from other
waste materials and which is derived from forest-related resources,
solid wood waste materials, or agricultural sources. Eligible forest-
related resources are mill and harvesting residues, pre-commercial
thinnings, slash, and brush. The 2005 credit for electricity produced
from open-loop biomass facilities is 0.9 cents per kilowatt hour
compared with 1.9 cents per kilowatt hour of electricity generated from
closed-loop biomass facilities. To qualify for the credit for both open
and closed-loop biomass, the facility must be placed in service prior
to January 1, 2006.
The forest products industry is the largest user of biomass for
energy production, which is used largely to fuel our wood and paper
manufacturing facilities. In addition to biomass like bark, sawdust,
and other residues from the wood harvesting and product manufacturing
processes, the industry uses biomass in the form of ``spent pulping
liquors.'' Spent pulping liquors are created as a residual during the
pulping process, and the wood residuals (mostly lignin) are burned in a
process that separates and recovers the chemicals for reuse and
captures the heat value from the lignin to create steam and
electricity. In total, the forest products industry currently uses
biomass to generate 60% of its power needs. With continued research and
development of new technologies, and expanded tax incentives, the
potential exists to greatly increase our industry's capacity for energy
production.
Regarding Section 45, the placed in service date for facilities
that produce electricity from open-loop biomass needs to be extended
from January 1, 2006 to January 1, 2010. Such projects take several
years to complete and the industry needs the certainty of knowing that
the current tax credit will be available in the future to take the risk
of making the investment. At the very minimum, Congress should extend
the placed in service date to January 1, 2008 as the Administration
proposed in its FY 2006 budget.
Also, clarification is necessary to the Section 45 definition of
open-loop biomass to ensure inclusion of the lignin content from spent
pulping liquors used to produce electricity at new or expanded
facilities. Wood is composed primarily of cellulose (wood fibers) held
together by lignin. Wood bark is composed of hemicelluloses. Pulping
chemicals are used to dissolve the wood used for making paper. The
cellulose fibers become paper products, the pulping chemicals are
recycled from recovery boilers for reuse in the pulping process, and
the wood residues (mostly lignin) are used to generate heat for making
steam and electricity.
Finally, the current inflation adjusted tax credit of 0.9 cents per
kilowatt hour needs to be increased to 1.5 cents per kilowatt hour to
make the additional electricity produced competitive with other
traditional forms of electric generation. The increased tax credit
would provide a critical incentive for new investments in energy
production facilities connected to current paper mill infrastructure,
thus helping to improve the competitive position of the forest products
industry.
We appreciate the subcommittee's interest in our thoughts on the
need to extend and modify the Open-Loop Biomass component of the
Section 45 tax credit.
Washington, DC 20006
August 31, 2005
The Honorable William M. Thomas
Chairman
Committee on Ways and Means
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas:
The undersigned U.S. flag ocean carriers and associations are
writing to propose certain technical corrections to the tonnage tax
provisions (Subchapter R) of the American Jobs Creation Act. We would
like to express our sincere appreciation for your efforts and those of
the Congress to revitalize the U.S. shipping industry and to bring the
taxation of U.S. shipping into conformity with global practices
regarding the taxation of shipping. We note that H.R. 3376 as
introduced contains certain provisions relating to the tonnage tax and
we endorse those provisions. We have one additional suggestion that we
offer as follows.
The technical correction we propose would define the term
``operating agreement'' which was introduced in the tonnage tax
provisions late in the legislative process. The amendment would define
the term consistent with industry practices and provide that operating
agreement revenues received by a corporation otherwise eligible for
tonnage tax treatment would also be subject to the tonnage tax regime.
Whether a corporation meets the ``shipping activity'' requirement of
the Code would, however, be determined without regard to the
corporation's operating agreement. We enclose a more detailed
explanation of the proposed amendment and legislative language for your
consideration.
The amendment meets the standards of a technical correction in that
it defines terms not otherwise defined and clarifies the relation of
such terms to the structure of the tonnage tax regime. We urge that
these provisions be included in the Tax Technical Corrections Act.
American Ocean Enterprises, Inc.
APL, Ltd.
Central Gulf Lines, Inc.
Maersk Lines Limited
Waterman Steamship Corporation
American Maritime Congress
Maritime Institute for Research and Development
The Transportation Institute
__________
Legislative Language of Proposed Amendment
(a) Amendment Related to the American Jobs Creation Act of 2004.--
(1) Amendment related to section 248 of the act.--Paragraph (8) of
Subsection (a) of section 1355 of the Internal Revenue Code of 1986 is
amended by adding at the end the following: ``An `operating agreement'
means an agreement to provide vessel operating services in respect of a
qualifying vessel, such as crew, technical, commercial, or other vessel
management services or the provision of related equipment, tools,
provisions, and supplies by the person providing the operating
services. A vessel in respect of which an operating agreement exists
shall be treated as bareboat (or sub-bareboat) chartered to the person
providing services under the operating agreement and time chartered
back to the other party to the agreement. This paragraph shall apply
only in the case of a corporation that meets (or is a member of a
controlled group that meets) the shipping activity requirement in
subsection (c) without regard to this paragraph.''
General Explanation of Proposed Amendment
Congress believed operators of U.S. flag vessels in international
trade generally were subject to higher taxes than their international
competitors, who benefited from tonnage tax and other preferential
income tax regimes. Congress believed that this tax differential caused
a steady and substantial decline of the U.S. industry and its well-
paying, unionized U.S. jobs.
Therefore, Section 248 of the American Jobs Creation Act of 2004
(the ``Jobs Act''), added a tonnage tax regime for the taxation of
certain U.S. flag vessels. A provision stating that the term
``charter'' includes an ``operating agreement'' was added in the
conference. No definition of the term ``operating agreement'' was
provided or included in the legislative history, and neither this
provision nor the legislative history clarified the consequences of
treating an ``operating agreement'' as a charter to the parties to such
an agreement.
The technical correction provides a definition of the term
operating agreement that reflects customary practices in the industry,
and provides that an operating agreement would be treated as a bareboat
charter of the vessel to the operator and a time charter back to the
person owning the vessel. This definition applies only to a corporation
(or a member of a controlled group) that otherwise meets the statutory
shipping activity requirement.
An operating agreement is defined to include an agreement to
provide vessel operating services in respect of a qualifying vessel,
such as crew, technical, commercial or other vessel management services
or the provision of related equipment, tools, provisions, and supplies
by the person providing the operating services.
Under the amendment, both the owner and the person providing the
operating services qualify for tonnage tax treatment with respect to
earnings realized from the operation of the vessel in a qualified
trade.
Because the proposed amendment would treat a vessel subject to an
operating agreement as bareboat chartered to the person providing the
operating services, the operator is permitted to count the vessel that
is the subject of the operating agreement for purposes of meeting the
``Shipping Activity Requirement'' applicable to the operator as is the
other party to the operating agreement.
In summary, this technical correction is needed to clarify
application of the statute, reflect industry practices, and maintain
the competitiveness of U.S. industry.
Technical Explanation of Proposed Amendment
In the Conference on H.R. 4520, the American Jobs Creation Act of
2004 (the ``Jobs Act''), Paragraph (8) of Subsection (a) of new section
1355 of the Internal Revenue Code of 1986, as amended (the ``Code'')
was added and provided that the term ``charter'' includes an
``operating agreement.'' No definition of the term ``operating
agreement'' was provided or included in the legislative history, and
neither this provision nor the legislative history clarified the
consequences of treating an ``operating agreement'' as a charter to the
parties to such an agreement.
Section 1355 of the Code is part of the alternative tonnage tax
regime (Subchapter R) enacted by the Jobs Act, under which a
``qualifying vessel operator'' may generally elect to be subject to the
corporate income tax on certain notional shipping income in lieu of
actual amounts of income from ``qualifying shipping activities.'' A
``qualifying vessel operator'' is defined as any corporation who
operates one or more qualifying vessels and who meets the shipping
activity requirement of Subsection (c) of section 1355. For purposes of
the first prong of the test, a person is generally considered to
operate a qualifying vessel during any period that it either owns or
charters (including time charters) the vessel (the ``Operates
Requirement''). Although a person is generally not considered to
operate or use a vessel that it charters out on bareboat charter terms,
exceptions apply where the vessel is bareboat chartered to another
member of such person's controlled group, or where the vessel is
bareboat chartered to either a controlled group member or an unrelated
person who sub-bareboat charters or time charters the same vessel back
to the owner or another member of the controlled group (who ultimately
uses the vessel as a qualifying vessel). The second prong of the test,
the ``Shipping Activity Requirement,'' is met for any taxable year, if,
on average during such year, at least 25 percent of the aggregate
tonnage of qualifying vessels used by the corporation (or other members
of the corporation's controlled group) were owned by such corporation
or chartered to such corporation on bareboat charter terms.
The first sentence of the attached technical corrections amendment
provides a definition of an ``operating agreement'' that would cover
agreements typically used in the shipping industry for the provision of
vessel operating services in respect of a qualifying vessel.
The second sentence of the proposed amendment clarifies how both
parties to an operating agreement can qualify for the tonnage tax
provisions in respect of a vessel subject to an operating agreement,
assuming that the Shipping Activity Requirement and all of the other
requirements of this Subchapter are met. Since the proposed amendment
would treat such a vessel as bareboat chartered to the person providing
the services under an ``operating agreement,'' such person is treated
as satisfying the Operates Requirement. Furthermore, since the proposed
amendment treats the vessel in respect of which an operating agreement
exists as bareboat (or sub-bareboat) chartered to the person providing
the services under the operating agreement and time chartered back to
the other party to the agreement, such other party is also treated as
satisfying the Operates Requirement, regardless of whether the parties
to the operating agreement are members of the same controlled group.
The third sentence of this proposed amendment limits applicability
of this provision to corporations that meet (or are members of
controlled groups that meet) the Shipping Activity Requirement without
regard to the treatment of operating agreements as charters under this
paragraph. Thus, a corporation will not meet the Shipping Activity
Requirement and qualify for the tonnage tax provisions solely by reason
of an operating agreement. However, if a corporation (or its controlled
group) independently meets the Shipping Activity Requirement (by owning
or bareboat chartering sufficient tonnage of other qualifying vessels),
it will qualify for the tonnage tax provisions in respect of any
qualifying vessel that it is treated as operating by reason of
providing services under an operating agreement.
Statement of Mark W. Kibbe, American Petroleum Institute
I. INTRODUCTION
These comments are submitted by the American Petroleum Institute
(API) for consideration by the U.S. House Committee on Ways and Means
on H.R. 3376, the ``Tax Technical Corrections Act of 2005,''
specifically technical corrections to provisions contained in the
``American Jobs Creation Act of 2004'' (P.L. 108-357). API represents
more than 400 member companies involved in all aspects of the oil and
natural gas industry, including exploration, production,
transportation, refining, and marketing.
II. PROPOSED TECHNICAL CORRECTIONS
Item 1:
Elimination of Foreign Base Company Shipping Income
Prior Law
For tax years prior to 2005, the subpart F rules required U.S.
shareholders with a 10-percent or greater interest in a controlled
foreign corporation (``CFC'') to include currently in income for U.S.
tax purposes foreign base company shipping income (``FBCShI'') earned
by that CFC. FBCShI was income derived from the use of vessels in
foreign commerce and generally included the transportation of property
between a port in the U.S. and a foreign port, two ports in the same
foreign country or two ports in different foreign countries. Prior to
its elimination, income qualifying as FBCShI could not be considered
any other type of foreign base company income under section 954(a) of
the Internal Revenue Code \1\ (see section 954(b)(6)).
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\1\ All sections noted herein refer to the Internal Revenue Code of
1986, unless otherwise stated.
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The subpart F rules also require U.S. shareholders of CFCs to
currently recognize in income foreign base company oil related income
(``FBCORI''). FBCORI includes foreign oil related income as defined by
section 907(c) with certain specific exceptions. Section 907(c)(2)(B)
defines foreign oil related income as taxable income derived from
sources outside the U.S. from, among other items, the transportation of
minerals from oil and gas wells or their primary products.
Under section 904(d)(1)(D), taxpayers with shipping income are
required to separately calculate a foreign tax limitation on such
income. Under section 904(d)(2)(D), shipping income means any income
received or accrued by any person which is of a kind which would be
FBCShI (as defined by section 954(f)). Income currently recognized as
FBCORI is included in the general limitation basket for purposes of
section 904.
New Law
The American Jobs Creation Act of 2004 (the ``2004 Act'')
eliminated FBCShI as a category of subpart F income. No conforming
amendments were included to address the definition of shipping income
for purposes of section 904. However, the 2004 Act does reduce the
number of section 904 baskets from nine to two for tax years beginning
after December 31, 2006.
Treatment of FBCORI
Eliminating FBCShI allows many taxpayers to defer current
recognition of such income for U.S. tax purposes until the U.S.
shareholder repatriates it. However, some income earned by CFCs and
once qualifying as FBCShI (i.e., shipping income earned from
transporting crude from one country to another country) may now also
constitute FBCORI, as section 954(b)(6) is no longer operative.
Therefore, such income will still be recognized currently for U.S. tax
purposes. Further, for section 904 purposes, as the shipping basket in
section 904(d)(1)(D) remains in effect through the end of 2006, the
FBCORI would not be included in the general limitation basket but
would, instead, be recategorized as shipping income. Therefore, for
taxpayers incurring certain FBCORI, the current state of the law after
the 2004 Act is as if FBCShI were never eliminated.
This is not the same for all taxpayers that have shipping income.
Taxpayers with CFCs earning shipping income that is not otherwise
subpart F income are able to defer the inclusion of such income until
2007 when the section 904 shipping basket is eliminated. After that
date, the repatriation of such income will likely result in inclusion
in the general limitation basket for purposes of section 904.
It is not apparent why the policy behind the 2004 Act provision
eliminating FBCShI would allow it to essentially remain in effect for
taxpayers earning transportation income that also constitutes FBCORI.
Even though such income is not deferred due to other subpart F
provisions, it should not have to be recategorized as shipping income
for purposes of section 904.
Proposed Technical Correction
There is likely a need to retain section 904(d)(1)(D) to the extent
taxpayers with CFCs earning shipping income effectively chooses to
repatriate such income prior to 2007. However, the shipping basket
should be given a lower priority for purposes of section 904 than
income recognized as FBCORI. Thus, we recommend the following technical
changes to the current statutory language of section 904(d)(2)(D):
Section 904(d)(2)(D)--Proposed technical correction (changes
highlighted):
The term ``shipping income'' means any income received or accrued
by any person which is of a kind which would be foreign base company
shipping income (as defined in section 954(f) as in effect before its
repeal). Such term does not include any financial services income, and
does not include any foreign base company oil related income (as
defined in section 954(g)).
Section 904(d)(2)(D)--Proposed technical correction (clean version):
The term ``shipping income'' means any income received or accrued
by any person which is of a kind which would be foreign base company
shipping income (as defined in section 954(f) as in effect before its
repeal). Such term does not include any financial services income, and
does not include any foreign base company oil related income (as
defined in section 954(g)).
Item 2:
Sale of Partnership Interests
Prior Law
For tax years prior to 2005, the sale of a partnership interest
constituted passive income for U.S. foreign tax credit purposes
(sections 904(d)(1)(A) and 954(c)(1)(B) (ii)).
New Law
The 2004 Act adopted a ``look-thru'' rule for certain partnership
sales. Specifically, the 2004 Act added section 954(c)(4) which
provides that, in the case of any sale by a controlled foreign
corporation of an interest in a partnership with respect to which such
corporation is a 25-perecent owner, such corporation shall be treated
as selling the proportionate share of the assets of the partnership
attributable to such interest. In effect, the 2004 Act applies an
``aggregate'' approach (vs. an ``entity'' approach) in characterizing
gain on the sale of a partnership interest, i.e., it is treated the
same as a sale of an interest in a disregarded entity. This is similar
to the general approach of other international provisions relating to
partnerships. As a result, to the extent that the assets of a
partnership are used in a trade or business, the gain on the sale of
the interest in the partnership should not be foreign personal holding
company income under Subpart F. As a consequence, it should also not be
passive income for foreign tax credit purposes.
Ownership Attribution Issue
In order to qualify for the ``look-thru'' rule for partnership
sales, the seller must meet the 25-percent ownership requirement. The
Committee Report specifically refers to partners who meet this
requirement as ones ``owning directly, indirectly, or constructively at
least 25 percent of a capital or profits interest in the partnership''
\2\ [emphasis added]. Thus, if a U.S. company owns a 25% (or greater)
interest in a partnership through two ``sister'' CFCs, the
``constructive'' ownership principle would mean that the ownership
interests of the sister companies would be combined in testing the 25%
ownership level. Unfortunately, the statutory language did not follow
the Committee Report statements, in that no mention of constructive
ownership is included in new section 954(c)(4). There is no tax policy
reason for this omission, and it appears that it was simply a technical
oversight. We recommend a technical correction to conform the statutory
language to the stated legislative intent expressed in the Committee
Report.
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\2\ House Committee Report (Act Sec. 412, H.R. Rep. No. 108-548,
pt. 1). The Senate amendment was the same as the House bill, and the
conference agreement followed the House bill and the Senate amendment.
See Conference Committee Report (Act Sec. 412, H.R. Conf. Rep. No. 108-
755). The report language was the same as the language used by the
Staff of the Joint Committee on Taxation to describe this same
provision in H.R. 4520 (JCX-41-04, p. 90) and H.R. 2896 (JCX-72-03, p.
46).
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Proposed Technical Correction
The constructive ownership rules of section 958(b) apply for
purposes of most of the provisions of Subpart F, and applying these
rules for purposes of new section 954(c)(4) would properly allow look-
thru treatment where a 25% (or greater) ownership interest in a
partnership is split between two (or more) related entities. Thus we
recommend the following technical changes to the current statutory
language of sections 954(c)(4)(B) and 958(b):
Section 954(c)(4)(B)--Proposed technical correction (changes
highlighted):
25-PERCENT OWNER.--For purposes of this paragraph, the term ``25-
percent owner'' means a controlled foreign corporation which owns
directly, indirectly, or constructively (under the rules of section
958) 25 percent or more of the capital or profits interest in a
partnership.
Section 954(c)(4)(B)--Proposed technical correction (clean version):
25-PERCENT OWNER.--For purposes of this paragraph, the term ``25-
percent owner'' means a controlled foreign corporation which owns
directly, indirectly, or constructively (under the rules of section
958) 25 percent or more of the capital or profits interest in a
partnership.
Section 958(b)--Proposed conforming amendment (changes highlighted):
CONSTRUCTIVE OWNERSHIP.--For purposes of section 951(b),
954(c)(4)(B), 954(d)(3), 956(c)(2), and 957, section 318(a) (relating
to constructive ownership of stock) shall apply to the extent that the
effect is to treat any United States person as a United States
shareholder within the meaning of section 951(b), to treat a controlled
foreign corporation as a 25% owner of a partnership under section
954(c)(4)(B), to treat a person as a related person within the meaning
of section 954(d)(3), to treat the stock of a domestic corporation as
owned by a United States shareholder of the controlled foreign
corporation for purposes of section 956(c)(2), or to treat a foreign
corporation as a controlled foreign corporation under section 957,
except that . . .
Section 958(b)--Proposed conforming amendment (clear version):
CONSTRUCTIVE OWNERSHIP.--For purposes of section 951(b),
954(c)(4)(B), 954(d)(3), 956(c)(2), and 957, section 318(a) (relating
to constructive ownership of stock) shall apply to the extent that the
effect is to treat any United States person as a United States
shareholder within the meaning of section 951(b), to treat a controlled
foreign corporation as a 25% owner of a partnership under section
954(c)(4)(B), to treat a person as a related person within the meaning
of section 954(d)(3), to treat the stock of a domestic corporation as
owned by a United States shareholder of the controlled foreign
corporation for purposes of section 956(c)(2), or to treat a foreign
corporation as a controlled foreign corporation under section 957,
except that . . .
Item 3:
Redesignation of Reference to Qualified Activity
In section 952(c)(1)(B)(ii)
Prior Law
Prior to the passage of the 2004 Act, under the flush language in
section 952(c)(1)(B)(ii), a qualified deficit that taxpayers could use
to offset FBCORI of a CFC included deficits attributable to qualified
FBCORI activities arising from 1983 forward. Shipping income, though,
could only be offset by shipping deficits arising 1987 forward.
New Law
With the elimination of the shipping income under 954 in the 2004
Act, a conforming amendment was included that eliminated shipping
income as a qualified activity under section 952(c)(1)(B)(iii). The
remaining activities in that section were also redesignated. However,
the flush language in section 952(c)(1)(B)(ii) was never amended to
address the redesignation. Accordingly, this section now currently
provides that FBCORI deficits prior to 1987 can not be used to offset
CFC FBCORI. This was clearly not the intention of the changes adopted
by the 2004 Act and, as such, the flush language in 952(c)(1)(B)(ii)
should be changed.
Proposed Technical Correction
To address the proper redesignation of which qualified deficits may
be used prior to 1986 we propose the following:
Section 952(c)(1)(B)(ii) flush language--Proposed conforming amendment
(changes highlighted):
In determining the deficit attributable to qualified activities
described in clause (iii)(II) or (III), deficits in earnings and
profits (to the extent not previously taken into account under this
section) for taxable years beginning after 1962 and before 1987 also
shall be taken into account. In the case of the qualified activity
described in clause (iii)(I), the rule for the preceding sentence shall
apply, except that ``1982'' shall be substituted for ``1962.''
Section 952(c)(1)(B)(ii) flush language--Proposed conforming amendment
(clean version):
In determining the deficit attributable to qualified activities
described in clause (iii)(II) or (III), deficits in earnings and
profits (to the extent not previously taken into account under this
section) for taxable years beginning after 1962 and before 1987 also
shall be taken into account. In the case of the qualified activity
described in clause (iii)(I), the rule for the preceding sentence shall
apply, except that ``1982'' shall be substituted for ``1962.''
Item 4:
Treatment of Wholly Owned Partnerships for Purposes of Domestic
Manufacturing Deduction
Section 2(a)(7) of the Tax Technical Corrections Act of 2005
(``H.R. 3376'') would amend section 199(c) by adding in relevant part:
(D) Partnerships Owned by Expanded Affiliated Groups--For purposes
of this paragraph, if all of the interests in the capital and profits
of a partnership are owned by the members of a single expanded
affiliated group at all times during the taxable year of such
partnership, the partnership and all members of such group shall be
treated as a single taxpayer during such period.
Because the proposed correction is limited to section 199(c), it is
unclear how partnerships that are wholly owned by members of a single
expanded affiliated group should be treated for all other purposes of
section 199. Therefore, further guidance is needed to ensure that
partnerships that are wholly owned by members of a single expanded
affiliated group are treated in the same manner as corporations that
satisfy the definition of expanded affiliated group under section
199(d)(4)(b).
In addition, the proposed correction requires the partnership to be
wholly owned by the members of a single expanded affiliated group at
all times during its taxable year. This does not reflect the realities
of the business environment where an interest in a wholly owned
partnership might be transferred to an entity that is not a member of
the same expanded affiliated group without causing a termination of the
partnership's taxable year. In such instances, the partnership should
be treated as a member of the expanded affiliated group prior to the
transfer.
To this end, we propose that for purposes of clarifying section
199, the language cited above in Section 2(a)(7) of H.R. 3376 be
deleted from the bill. We further suggest that in addition to the
changes proposed in H.R. 3376 to section 199(d)(4), the following
language be added:
Sec. 199(d)(4) is amended by adding at the end the following new
subparagraph:
(D) Partnerships Owned by Expanded Affiliated Groups--If all of the
interests in the capital and profits of a partnership are owned by the
members of a single expanded affiliated group, the partnership shall be
treated as a member of such expanded affiliated group for purposes of
this section.
Association of American Publishers, Inc.
Washington, DC 20001
August 31, 2005
The Honorable William Thomas
Chairman
Committee on Ways & Means
United States House of Representatives
Washington, DC 20515
Dear Messrs. Thomas, Grassley and Baucus:
On behalf of The Association of American Publishers (``AAP''), I
want to thank you for including book publishing within the definition
of ``qualifying production property'' in Section 199 of the Internal
Revenue Code of 1986, as amended (``Code''). As you know, the AAP is
the principal trade association of the U.S. book publishing industry,
with over 300 members. Book publishing is very labor intensive so the
inclusion of book publishing clearly promotes the purposes of the
American Jobs Creation Act of 2004.
On February 14, 2005, the Treasury Department issued Notice 2005-
14, I.R.B. 2005-7 (``Notice''), in an effort to resolve certain
interpretive issues that have arisen under Code Section 199. The
Treasury Department invited comments regarding the Notice and the AAP
submitted comments to the Treasury Department on the Notice on March
22, 2005 (copy of our comments are attached for your review).
An issue of specific interest to the publishing industry concerns
gross receipts derived from the distribution of books, journals, and
similar materials irrespective of the physical or electronic or other
medium used to effectuate such distribution to the customer. Our
members' publications are increasingly being made available in
electronic or other medium in addition to, or in lieu of, traditional
printed copies, leaving open the question of whether receipts from the
distribution of these materials in electronic or other medium also
constitute ``domestic production gross receipts'' as defined in Code
Section 199(c)(4). We have reviewed your letter to the Honorable John
W. Snow, Secretary of the Treasury, dated July 21, 2005, where you note
near the end ``. . . that gross receipts from the provision of services
are not treated as domestic production gross receipts, regardless of
the fact that computer software may be used to facilitate such service
transactions.'' We do not believe that the mere provision of a book or
journal in electronic or other medium should be considered a service.
The Notice uses Treasury Regulations (``Regs.'') Section 1.48-1(c)
as the basis to determine what is included in the definition of
``tangible personal property.'' The provisions of Regs. Section 1.48-
1(c) were drafted to maximize the benefits available to taxpayers
eligible to claim the investment tax credit. It is understandable that
the provisions of Regs. Section 1.48-1(c) focus more on the distinction
between real and personal property than the distinction between
tangible and intangible property. The investment tax credit was
available only with respect to qualified investment in depreciable
tangible personal property. Accordingly, the investment tax credit was
generally available with respect to the purchase of machinery used to
manufacture or produce inventory. It was generally not available with
respect to the inventory itself. As a result, the distinction between
real and personal tangible property was of critical importance for many
taxpayers; the distinction between tangible and intangible personal
property was much less often of critical importance.
By contrast, the provisions of Code Section 199 deal with gross
receipts from the sale of tangible personal property. In few cases will
the tangible personal property that falls within the provisions of Code
Section 199 be depreciable. In the vast majority of instances, it will
constitute inventory or property held for sale to customers in the
ordinary course of business. As a result, the context in which the
distinction between tangible and intangible property is to be made is
dramatically different from that existing for purposes of Regs. Section
1.48-1(c). Consequently, the flexibility brought to bear in making the
distinction between tangible and intangible personal property for
purposes of Code Section 199 should be the same as that brought to bear
in making the distinction between real and personal tangible property
for purposes of Regs. Section 1.48-1(c).
The provisions of Code Section 263A and the Regs. adopted there
under which are also used as a basis in the Notice. The principal focus
of the provisions of Code Section 263A is on the production of
inventory (or other property held for sale to customers) and is thus
similar to the principal focus of Code Section 199 which is on the
generation of gross receipts from the sale of inventory (or property
held for sale to customers). In each case, it is inventory (or property
held for sale to customers) that is at issue. The focus of the analysis
as to what distinguishes tangible from intangible property for purposes
of Code Section 199 should therefore be similar to that embodied in the
Regs. adopted under Code Section 263A.
Regs. Section 1.263A-2(a)(2)(i) confirms that, in general,
``section 263A applies to the costs of producing tangible personal
property.'' Regs. Section 1.263A-2(a)(2)(ii), which is cited with
approval in Section 3.04(8)(b) of the Notice, includes in the term
``tangible personal property'' videocassettes, computer diskettes,
books, and similar items. Regs. Section 1.263A-2(a)(2)(ii)(A)(1) deals
specifically with books. It provides that Code Section 263A applies to
various categories of prepublication costs, including the costs
incurred by publishers in writing, editing, compiling, illustrating,
designing and developing a book. Regs. Section 1.263A-2(a)(2)(ii)(A)(1)
explicitly states that these prepublication costs are required to be
capitalized as costs of producing tangible personal property.
If we were permitted to borrow and rephrase the well-known
utterance of Gertrude Stein, we would suggest that what Regs. Section
1.263A-2(a)(2)(ii) in essence provides is that ``a book is a book is a
book'' for purposes of Code Section 263A regardless of the medium by
which it is transmitted to the customer, and that, as such, it is
treated as tangible personal property for purposes of Code Section
263A. We respectfully submit that the same non-technical line of
analysis should apply for purposes of determining whether a book or
journal constitutes tangible or intangible inventory for purposes of
Code Section 199. We believe that a book transmitted electronically to
the customer should be classified as a tangible item of inventory for
purposes of both Code Section 199 and Code Section 263A.
Clearly, the proper focus of Code Section 199 should be on the
treatment of the qualification of a publisher's prepublication costs
rather than the method of delivery selected by the customer. The
majority of the production activities and costs involved in the
publishing of a book, journal or magazine occur before the activities
associated with the determination of the medium of presentation.
Finally, we note that applying a more expansive, non-technical
analysis to the definition of the term ``tangible personal property''
for purposes of Code Section 199 would not be inconsistent with the
provisions of Federal copyright law or recent judicial decisions issued
interpreting such law. In this regard, 17 U.S.C.A. Section 102(a)
provides,
``Copyright protection subsists, in accordance with this title, in
original works of authorship fixed in any tangible medium of
expression, now known or later developed, from which they can be
perceived, reproduced, or otherwise communicated, either directly or
with the aid of a machine or device.''
Thus, copyright protection depends on some degree of embodiment in
a tangible medium of expression. The policy behind the Copyright Act
was to foster the creation of original works of authorship in an era of
rapid changes in the technology of delivery, and it has worked very
well. We submit that the same policy considerations are applicable in
this instance.
While we hope that the Treasury Department will adopt our comments
when regulations are issued, our members wanted to voice their concerns
now in the event that some corrections may be needed as a result of the
issuance of regulations which may occur within the next month.
Patricia Schroeder
President & CEO
Boies, Schiller and Flexner LLP
Miami, Florida 33131
August 25, 2005
The Honorable Bill Thomas
Chairman of the Committee on Ways and Means
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas:
We are pleased to submit our written public comment in response to
your request for comments related to the ``Tax Technical Corrections
Act of 2005'' (H.R. 3376, S. 1447) (the ``Technical Correction''). We
believe the bill clarifies certain aspects of the Jobs Creation Act of
2004 (the ``Act''), and offers both practitioners and taxpayers a more
reliable framework for the application of the Act. Although the bill is
certainly an improvement, we believe that an additional clarification
in the Technical Correction would further enhance the reliability of
the Act.
PRE-ACT RULES
Of particular concern is the repeal of the ``stock exception to the
straddle rule.'' In their day-to-day operations, our clients, and a
multitude of other taxpayers, enter into long and short positions, some
of which are structured to minimize risk. Section 1092(a)(1)(A) of the
Internal Revenue Code, in pertinent part, provides that a loss with
respect to a position shall be taken into account only to the extent
that the amount of such loss exceeds the unrecognized gain with respect
to one or more offsetting positions. This is referred to as the ``loss
deferral'' straddle rule; this rule defers losses on the unwinding of
the loss leg of a straddle. The straddle rule has other implications as
well, including suspension of the holding period on property for
purposes of determining long-term or short-term holding periods.
Interest costs incurred on a straddle position must also be capitalized
rather than being deducted as a current expense.
For these rules to apply, there, first and foremost, must be a
straddle. Section 1092(c)(1) defines a ``straddle'' as an ``offsetting
position with respect to personal property.'' In general, before the
adoption of the Act, the term ``personal property'' did not include
stock except under certain limited circumstances. One such
circumstance, resulting in a ``straddle'' under old section 1092(d)(3),
was a position in stock, the offsetting position of which was one with
respect to substantially similar or related property (other than
stock). The aforementioned circumstance, also known as the ``stock
exception to the straddle rule,'' was interpreted by many practitioners
to mean that a position in stock would not constitute ``personal
property'' as long as such position was offset by another position in
respect to the same or similar stock. This meant, for example, that if
a taxpayer held a position in stock and an offsetting position in a
short equity swap in the same or a similar stock, the stock would not
be treated as ``personal property.'' This notion, however, changed with
the introduction of proposed regulations section 1.1092(d)-2(c), which
narrowed the initial interpretation of the statute to apply only to
offsetting positions that were directly in stock or a short sale of
stock. Consequently, if a taxpayer established a position in stock and
an offsetting position in an equity swap in respect to the same stock,
the stock would be treated as ``personal property'' because the
offsetting position was not directly in stock or a short sale of stock.
POST-ACT RULES
The Act modified section 1092(d)(3)(A)(i) to read as follows: ``In
the case of stock, the term `personal property' includes stock only
if--(i) such stock is of a type which is actively traded and at least 1
of the positions offsetting such stock is a position with respect to
such stock or substantially similar or related property'' (emphasis
added). The presumed intended effect of this provision was to repeal
the ``stock exception to the straddle rule.'' The conference report and
the JCT 2004 explanations (the 2004 Blue Book) supports this intention,
that ``[t]he Act also eliminates the exception from the straddle rules
for stock (other than the exception relating to qualified covered call
options).'' Problematically, footnote 867 of the Conference Report
states that, ``[it] is intended that Treasury regulations defining
substantially similar or related property for this purpose will
continue to apply subsequent to repeal of the stock exception and
generally will constitute the exclusive definition of a straddle with
respect to offsetting positions involving stock. See Prop. Treas. Reg.
sec. 1.1092(d)-2(b).''
NEED FOR CLARIFICATION
The language of the new provision in the Act itself suggests that
the ``stock exception to the straddle rule'' is repealed in its
entirety. As such, a long position in stock offset by a short position
in the same stock, or a short position in a similar stock, should
presumably lead to the classification as ``personal property'' and,
hence, to a straddle. However, the underlying history behind the
provision may lead to a different interpretation. As we suggest below,
footnote 867 may be interpreted to stand for the proposition that the
Act repeals only the stock exception in respect to short positions in
the same stock, but not short positions in stock that is
``substantially similar or related property'' (``SSRP'').
The straddle rule was enacted in 1981 for the principal purpose of
defeating certain shelter arrangements proliferating at that time by
prohibiting the selective realization of losses. To accomplish this,
the provision treats two ostensibly separate transactions as if they
were one because of the interdependency of the economic relationships
and because the taxpayer, but for the loss deduction, would not have
changed his underlying economic position.
We believe the failure to clarify the scope of the repeal of the
stock exception in the Technical Correction will create unnecessary
burden and unintended consequences to taxpayers engaged in non-abusive
transactions. For example, a taxpayer holding a long position in GE
stock and a short position in a non-grantor trust regulated investment
company (a ``RIC'') holding some GE stock will have to determine under
the SSRP regulations (Reg. Sec. 1.246-5, Prop. Regs. Sec. 1.1092(d)-2)
whether the RIC is SSRP with respect to the GE stock, and based on that
determination, whether the positions constitute a straddle under
section 1092. Conceivably, for example, at the time the long GE
position and the short RIC position were established, the RIC might not
have held any GE stock, but might later acquire such GE stock in the
ordinary course of business, under which circumstances the taxpayer may
then be deemed to have an ``unintended'' or ``unexpected'' straddle. A
RIC should not be treated the same as a synthetic hedging product.
Rather, a RIC is a common non-abusive investment product which, because
of its investment objectives and the independence of its investment
advisors, makes it an unlikely candidate for tax arbitrage. The
additional burden imposed by the Act on taxpayers holding short
positions in RICs will outweigh the limited potential for abuse
resulting from a taxpayer's limited ability to selectively realize
losses under these circumstances.
Footnote 867 also states that proposed regulations section
1.1092(d)-2 will constitute the exclusive definition of a straddle.
Apart from the fact that the proposed regulations do not contain a
definition of a straddle, the proposed regulations expressly provide
that ``a position with respect to substantially similar or related
property (other than stock) does not include direct ownership of stock
or a short sale of stock but includes any other position with respect
to substantially similar or related property.'' If, as the footnote
suggests, the proposed regulations continue to be applicable, a short
position in a ``similar stock''(e.g. a short position in a non-grantor
RIC) or a direct position in a ``similar stock'' would not be a
position in respect to ``substantially similar or related property''
for purposes of section 1092(d). Accordingly, the offset stock would
not be ``personal property.''
Because the proposed regulations do not provide an exception for
short sales in the same stock, the new statute in combination with the
proposed regulations should be interpreted to only repeal the stock
exception in respect to short sales in the same stock, and to preserve
the stock exception for short sales in ``similar or related'' stock. To
interpret the legislative history and the statute otherwise would
unduly burden taxpayers such as those holding short positions in RICs,
with the duty to verify whether each long position they sell at a loss
is a part of a straddle with respect to any such short RIC positions.
Additionally, any position in a RIC provides limited, if any, potential
for abuse through the selective realization of losses.
For the reasons discussed above, we believe footnote 867 should be
construed such that the Act repeals only the stock exception in respect
to short positions in the same stock, and not short positions in stock
that is ``substantially similar or related property.''
RECOMMENDATION
We believe that Congress intended to resolve the previous ambiguity
stemming from the old statute and the proposed regulations, and also
intended to repeal the stock exception to the straddle rule with
respect to short sales in the same stock, but not short sales in
similar or related property such as stock similar to the offset stock.
Thus, section 1092(d)(3)(A)(i) should be corrected to unambiguously
reflect the intent of Congress. We suggest the following language
clarification be included in the Technical Correction (clarification in
bold):
(3) Special Rules For Stock--For purposes of paragraph (1)----
(A)
In General--In the case of stock, the term `personal
property' includes stock only if----
(i) such stock is of a type which is actively traded and at
least 1 of the positions offsetting such stock is a position with
respect to such stock or substantially similar or related property
(other than stock), or
(ii) such stock is of a corporation formed or availed of to
take positions in personal property which offset positions taken by any
shareholder.
This language, in conjunction with the proposed regulations,
unambiguously states that if the offsetting position is in the same
stock, or similar or related property other than a direct ownership of
stock or a short sale of stock, the stock will be treated as ``personal
property.''
We are pleased to have been able to offer this comment, and we hope
that it will help in clarifying the intent of Congress in respect to
the repeal of the stock exception in section 1092. Please do not
hesitate to contact us should you have any questions regarding this
comment.
Michael Kosnitzky
Cigar Association of America, Inc.
Washington, DC 20006
August 31, 2005
The Honorable Bill Thomas
Chairman
Committee on Ways and Means
United States House of Representatives
Washington, DC 20515
Dear Chairman Thomas:
In response to your request for comments on H.R. 3376, the Cigar
Association of America would urge you to make a technical correction to
the American Jobs Creation Act of 2004 (``AJCA''), specifically to the
provisions under Title VI, the Fair and Equitable Tobacco Reform Act of
2004 (``FETRA''), providing for the buyout of tobacco quota owners and
growers. The members of the Cigar Association of America account for
more than 96 percent of cigars manufactured, imported, and sold in the
United States.
Our comments relate to AJCA section 625, which provides for
imposition of assessments as a source for the payments to tobacco quota
owners and growers. Section 625(b) requires the Secretary of
Agriculture to impose quarterly assessments (during the FY 2005-14
period) on tobacco product manufacturers and importers selling products
in the United States, including manufacturers and importers of
cigarettes, cigars, snuff, roll-your-own tobacco, chewing tobacco, and
pipe tobacco. Section 625(c) provides rules for allocating shares of
the total assessment to these different classes of tobacco products.
Cigars erroneously subjected to assessments
From a policy perspective, it was a clear mistake for cigars to be
included in the AJCA tobacco buyout assessment regime. The apparent
policy justification for the tobacco buyout assessments was that the
manufacturing beneficiaries of the Federal tobacco quota/price support
program should bear the cost of retiring that program.
That policy does not argue for imposition of the assessments on
cigars. The cigar industry simply does not make use of quota tobacco.
In 2002, the cigar industry's use of quota tobacco was just 0.025
percent of the total 905 million pounds of quota tobacco grown in the
United States. In fact, domestic quota tobacco was used by only one
small company in Scranton, Pennsylvania that makes only 0.3 percent of
all cigars sold in the United States. By way of comparison, we believe
the amount of quota tobacco used by the cigar industry is about the
same as the amount used in medical research programs.
Nor does the cigar industry use any significant amount of imported
quota-type tobacco. When imported quota-type tobacco is added to
domestic quota tobacco, the cigar industry's use of such tobacco
remains de minimis--just 0.14 percent of the total used by the entire
tobacco industry in 2002. The fact is, cigars sold in the United States
are made from a completely different class of tobacco than that at
issue in the quota buyout program.
The inclusion of cigars in the AJCA buyout program has much to do,
we suspect, with the speed in which the AJCA conference negotiations
were concluded. Neither the House-passed nor the Senate-passed buy-out
provisions included any buyout assessments with respect to cigars. The
House-passed bill included no buyout assessment scheme, while the
Senate version's buyout assessment provisions specifically (and
correctly) exempted cigars. The assessment regime included in the
conference report was wholly new, and developed without the benefit of
a full and open airing of views that we believe would have led
lawmakers to exempt cigars.
Cigar industry's assessment allocation is miscalculated
A further injustice to the cigar industry is the fact that the
industry's allocated share of the total buyout assessment is
overstated.
The AJCA initial allocation percentages were determined by
reference to 2003 excise tax data. Specifically, the assessment
allocations were calculated by multiplying tobacco products (both
domestic and imported) ``removed'' (i.e., subject to tax) in 2003 by
the maximum excise tax rate for each class of tobacco. The AJCA
methodology resulted in an estimate that cigars accounted for 2.783
percent of total tobacco excise taxes in 2003.
This methodology erroneously assumes that all large cigars were
taxed at the maximum rate of $48.75 per 1,000 cigars. In reality,
however, a sizable number of cigars are sold at a price that yields a
tax per 1,000 that is significantly lower. Furthermore, final
Department of Agriculture regulations implementing the assessment
regime compound this problem by providing that the same flawed
methodology will apply for purposes of determining class allocations
for all subsequent years. Accordingly, absent the appropriate exercise
by the Department of Agriculture of its regulatory authority to base
future assessments on actual tax collections, the allocation percentage
for cigars will continue to be misstated going forward.
Actual excise tax data for imported and domestic tobacco shows
conclusively that the 2.783 percent share for the cigar industry was
grossly overstated. Consider the following:
U.S. Customs and Border Protection, in an April 21, 2005,
letter to the Honorable Jim McCrery (R-LA) (attached), estimated that
cigars accounted for 1.5 percent of a total $475.278 million in FY 2003
excise taxes collected on imported tobacco products. Thus, a total of
$7.129 million in excise taxes was collected in FY 2003 on cigar
imports.
The Treasury Department Alcohol and Tobacco Tax and Trade
Bureau, in a February 11, 2005, letter to Representative McCrery
(attached), stated that cigars in FY 2003 accounted for $156.181
million (2.076 percent) of total domestic tobacco excise tax liability
of $7,521.707 million. The Treasury letter stated that product class
statistics are not maintained with respect to collections.
Total FY 2003 domestic tobacco excise tax collections
were $7,435.498 million, according to Alcohol and Tobacco Tax and Trade
Bureau Statistical Release TTB S 5630-FY-2003. If one simply applies
the 2.076 percent cigar share of total tobacco excise tax liability to
this aggregate collection amount, one can reasonably estimate that
total cigar domestic excise tax collections were $154.361 million in FY
2003.
The government data therefore indicates that cigars accounted for
$161.490 million ($154.361 million domestic plus $7.129 million
imported) of total FY 2003 tobacco excise tax collections of $7,910.776
million ($7,435.498 million domestic plus $475.278 million imported),
or 2.04 percent.
Thus, if cigars must be assessed under the buyout program, and the
assessment must be based on excise taxes, the industry's allocation
should be 2.04 percent--not 2.783 percent as enacted under AJCA.
Unfortunately, the situation only will get worse for the industry
over the 2005-14 life of the assessment program. Because the large
cigar excise tax is the only ad valorem tobacco excise tax, the cigar
industry's share of total industry excise taxes will continue to climb
as large cigar prices increase--even if cigar use (relative to other
products) remains constant. As the cigar industry's share of taxes
rises, its assessment allocation likewise will increase. Based on our
projections, the cigar industry's share of total assessments will climb
from 2.783 percent to more than 5 percent before the assessments
terminate. Looked at another way, the cigar industry's share of
assessments will increase from $282 million over 10 years (if the
first-year assessment were held constant) to nearly $400 million.
Recommendation
It remains the strong view of the Cigar Association of America that
cigars should be removed from the tobacco-buyout assessment regime, for
all of the reasons discussed above. Accordingly, we urge you to
consider an AJCA technical correction that would accomplish this
result.
If a decision is made not to remove cigars from the buyout regime,
the alternative technical correction would be to set allocations by
reference to the actual share of tobacco excise taxes paid (i.e., 2.04
percent in 2003). Further, in light of the unfair application of the
assessment regime to the cigar industry, we would urge that the
industry's allocation be frozen at that level for the duration of the
assessments.
Norman F. Sharp
President
Clark Consulting
Washington, DC 20001
August 25, 2005
The Honorable William M. Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, DC 20515
Dear Chairman Thomas:
I am writing in response to your request for comments on the
technical corrections legislation (H.R. 3376) you introduced on July
21, 2005. These comments relate to section 965 of the Internal Revenue
Code, enacted as part of the American Jobs Creation Act of 2004, and
certain H.R. 3376 technical corrections provisions relating to section
965. As discussed below, clarifications to section 965 may be necessary
to allow foreign-owned U.S. companies to repatriate earnings in
accordance with the policy intended by Congress in enacting this
provision.
Section 965(b)(3) concerns
By way of background, section 965 generally allows an 85-percent
dividends-received deduction for cash dividends received by a U.S.
shareholder from a controlled foreign corporation (``CFC'') in the U.S.
shareholder's 2004 or 2005 taxable year.
Section 965(b)(3) sets forth a limitation based on a CFC's related-
party indebtedness. Specifically, the amount of dividends eligible for
the deduction is reduced by any increase in CFC indebtedness to related
persons between October 3, 2004, and the close of the taxable year for
which the deduction is being claimed. Section 965(b)(3)(A) defines a
``related person'' for this purpose by reference to section 954(d)(3),
which defines a related person of a CFC broadly to include any entity
that controls the CFC and any entity that is controlled by the same
entity that controls the CFC. Section 965(b)(3) treats all CFCs of a
U.S. taxpayer as a single corporation for purposes of the borrowing
limitation.
The AJCA conference agreement explains that the section 965(b)(3)
related-party borrowing limitation is intended to prevent a deduction
from being claimed when a U.S. shareholder lends to a CFC in order to
finance the payment by the CFC of the dividend. In that case, there
would be no net increase in cash in the United States.
The section 965(b)(3) limitation on related-party indebtedness does
not appear to have contemplated situations in which a foreign owned
U.S. corporation repatriates foreign earnings. While not the
prototypical fact pattern, many foreign-owned U.S. companies own a CFC
that may be in a position to bring earnings back to the United States.
As is the case with CFCs of U.S.-owned multinational corporations, such
a CFC may need to access funds in order to pay a dividend. Potential
sources could include the foreign parent of the U.S. shareholder and
foreign subsidiaries of the foreign parent itself.
[GRAPHIC] [TIFF OMITTED] T3731A.001
As drafted, however, the section 965(b)(3) limitation will deny the
CFC the ability to borrow from these non-CFC related foreign persons in
order to fund the payment of a dividend that otherwise would qualify
for the repatriation provision deduction. This result may have been
inadvertent, since payment of a dividend funded by borrowing from a
related foreign entity would indeed bring cash to the United States.
Funds would move from the foreign entity to the CFC and then to the
U.S. shareholder for investment in the United States. This movement of
cash is fully consistent with the repatriation provision's intent.
These additional potential sources of borrowing (i.e., the ultimate
foreign parent and foreign subsidiaries of the foreign parent)
available to foreign-owned U.S. companies do not exist for CFCs of
U.S.-owned multinational corporations that may have been the prototype
for drafters of the provision.
Concerns re: H.R. 3376
H.R. 3376 would expand on the 965(b)(3) related-party debt rule by
providing Treasury with explicit regulatory authority to reduce the
amount of eligible dividends in certain instances in which dividends
are funded by cash transfers from a related party. Specifically,
section 2(q)(3) of the bill provides:
The Secretary may prescribe such regulations as may be necessary or
appropriate to prevent the avoidance of the purposes of this paragraph,
including regulations which provide that cash dividends shall not be
taken into account under subsection (a) to the extent such dividends
are attributable to the direct or indirect transfer (including through
the use of intervening entities or capital contributions) of cash or
other property from a related person (as so defined) to a controlled
foreign corporation.
The Joint Committee on Taxation (``JCT'') summary (JCX-55-05)
explains that this regulatory authority ``supplements existing
principles relating to the treatment of circular flows of cash.'' The
JCT summary further states that this regulatory authority is to be
exercised ``only in cases in which the transfer is part of an
arrangement undertaken with a principal purpose of avoiding the
purposes of the related-party debt rule of Code section 965(b)(3).''
The summary further discusses certain transfers (e.g., cash
contributions for purposes of working capital) that would not be
considered as having been undertaken to avoid section 965(b)(3).
The H.R. 3376 cash-transfer rule raises the same policy concerns as
are raised by the underlying section 965(b)(3) limitation. That is, the
amount of eligible dividends may be reduced when cash is transferred
from a related foreign person to a CFC that pays an otherwise-eligible
dividend to the U.S. shareholder. This is the result even though such
transactions do not involve a circular cash flow (i.e., from the United
States to the CFC and back to the United States) and will result in a
net increase in cash for domestic investment which is fully consistent
with the intent of Congress.
From a practical perspective, the H.R. 3376 cash-transfer rule is
creating significant uncertainty in some situations. While the JCT's
list of ``good'' cash transfers is helpful, it is not exhaustive. For
example, there may be uncertainty when a CFC sells assets to a related
foreign person for cash and pays an otherwise-eligible dividend to the
U.S. shareholder.\1\ While the taxpayer might argue that such a cash
transfer was not made with the principal purpose of avoiding the
section 965(b)(3) limitation, both the proposed statutory language and
the JCT explanation are sufficiently broad to create uncertainty
regarding the ultimate interpretation of this provision. The risk
(i.e., the difference between a 35-percent tax rate and a 5.25-percent
effective tax rate) would discourage payment of a dividend to the U.S.
shareholder in this instance.
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\1\ I am aware of one proposed repatriation transaction viewed now
(i.e., after introduction of H.R. 3376) with at least some uncertainty
that involves a sale of CFC assets that is required by a foreign
regulatory authority and whose planning began prior to enactment of
section 965--hardly the type of transaction that should be viewed as
abusive in connection with a CFC's payment of a dividend to the United
States.
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Solution
The solution to the concerns discussed above would be to amend
section 965(b)(3) to clarify that funding via a loan or cash transfer
from a CFC's ultimate foreign parent or a foreign subsidiary of the
foreign parent does not disqualify otherwise-qualifying repatriation
transactions from the benefits of section 965(a). This could be
accomplished by a technical correction excluding foreign related
persons from the definition of related persons for purposes of the
section 965(b)(3) related-party borrowing limitation:
SEC. __. AMENDMENT RELATED TO THE AMERICAN JOBS CREATION ACT OF 2004.
(a) AMENDMENT RELATED TO SECTION 422 OF THE ACT--Section
965(b)(3)(A) of the Internal Revenue Code of 1986 is amended by
striking `(as defined in section 954(d)(3))' and inserting in its place
`(as defined in section 954(d)(3), except that related persons for this
purpose shall not include any foreign persons).'
Thus, the section 965(b)(3) limitation would disregard any
borrowing by a CFC from its ultimate foreign parent or a foreign
subsidiary of the foreign parent. This definition of ``related
persons'' also would apply, by extension, for purposes of the H.R. 3376
cash-transfer rule, which ``piggybacks'' off of the section
965(b)(3)(A) definition.
To avoid any potential abuse from a circular flow of cash, the
legislative history would provide that Congress expects Treasury would
treat any back-to-back funding or cash transfer (e.g., a loan from a
U.S. related party to a foreign related party coupled with a loan from
the foreign related party to the CFC) as a direct cash transfer from a
U.S. related party to the CFC for purposes of the related-party
indebtedness rule.
A narrower solution, at least for some taxpayers contemplating
repatriation transactions, would be to clarify that a cash transfer to
a CFC as a result of the sale of assets by the CFC to a foreign related
party or a transfer of cash by a foreign related party to repay a bona
fide debt owed to a CFC would not be considered as having been
undertaken primarily to avoid section 965(b)(3).
In either case, because repatriation transactions generally must be
completed by the end of 2005, it would be necessary to communicate this
clarification as quickly as possible if technical corrections
legislation cannot be enacted in an expeditious manner.
Sincerely,
Kenneth J. Kies
Financial Executives International
Washington, DC 20005
August 25, 2005
The Honorable Bill Thomas
Chairman
Committee on Ways and Means
United States House of Representatives
Washington, DC 20515
Dear Chairman Thomas:
On behalf of the Financial Executives International's (FEI)
Committee on Taxation (COT), I am writing to suggest some important
revisions to H.R. 3376, the ``Tax Technical Corrections Act of 2005.''
Specifically, we would like to propose some changes to Section 2(a) of
the bill, which includes corrections and amendments to Section 199 of
the ``American Jobs Creation Act of 2004'' (Public Law No: 108-357).
FEI is a professional association representing the interest of more
than 15,000 CFOs, treasurers, controllers, tax directors, and other
senior financial executives from over 8,000 major companies throughout
the United States and Canada. FEI represents both providers and users
of financial information. The FEI Tax Committee formulates tax policy
for FEI in line with the views of the membership. This letter
represents the views of the Committee on Taxation.
As drafted, Section 2(a)(7) of the technical corrections bill would
amend I.R.C. Section 199(c) by adding in relevant part:
(D) Partnerships Owned by Expanded Affiliated Groups--For purposes
of this paragraph, if all of the interests in the capital and profits
of a partnership are owned by the members of a single expanded
affiliated group at all times during the taxable year of such
partnership, the partnership and all members of such group shall be
treated as a single taxpayer during such period.
Because the proposed correction is limited to I.R.C. Section
199(c), it is unclear how partnerships that are wholly owned by members
of a single expanded affiliated group should be treated for all other
purposes of IRC Section 199. Therefore, further guidance is needed to
ensure that partnerships that are wholly owned by members of a single
expanded affiliated group are treated in the same manner as
corporations that satisfy the definition of expanded affiliated group
under subsection (d)(4)(b).
In addition, the proposed correction requires the partnership to be
wholly owned by the members of a single expanded affiliated group at
all times during its taxable year. This does not reflect the realities
of the business environment where an interest in a wholly owned
partnership might be transferred to an entity that is not a member of
the same expanded affiliated group without causing a termination of the
partnership's taxable year. In such instances, the partnership should
be treated as a member of the expanded affiliated group prior to the
transfer.
To this end, we propose that for purposes of clarifying I.R.C.
Section 199, the language cited above in Section 2(a)(7) be deleted
from the bill and the following be added to Section 2(a)(10):
Sec. 199(d)(4) is amended by adding at the end the following new
subparagraph:
(D) Partnerships Owned by Expanded Affiliated Groups--If all of the
interests in the capital and profits of a partnership are owned by the
members of a single expanded affiliated group, the partnership shall be
treated as a member of such expanded affiliated group for purposes of
this section.
Thank you for your consideration of our views regarding the tax
technical corrections bill. Should you or your staff wish to discuss
this matter in further detail, please contact Mark Prysock of FEI's
Washington office at (202) 626-7804.
Michael Reilly
Chairman, FEI Committee on Taxation
Florida Institute of CPAs
Tallahassee, Florida 32314
August 29, 2005
The Honorable Bill Thomas
U.S. House of Representatives
Chairman, Committee on Ways and Means
2208 Rayburn
Washington, DC 20515
Dear Chairman Thomas:
On behalf of the Federal Taxation Committee of the Florida
Institute of Certified Public Accountants (FICPA), we offer the
following comments on the Tax Technical Corrections Act of 2005 (H.R.
3376):
Section 231 of the American Jobs Creation Act of 2004, which deals
with members of a family being treated as one shareholder for the
number of shareholders limit on S corporations, should be amended so
that the treatment is automatic and does not require an election to be
made by any family member.
We believe that the requirement for an election to be made by a
family member was carried forward from previous versions of this
section which would have limited the number of families permitted to be
treated as one shareholder for the number of shareholders limitation.
Since any number of families can now be subject to this provision,
there no longer seems to be a need for an election to be made. The
provision for members of a family to be counted as one shareholder
should be parallel to the provision that treats a husband and wife as
one shareholder without any requirement for one of the spouses to make
an election.
Thank you for this opportunity to submit these comments to you.
Ignacio J. Abella
Chair
Washington, DC 20515
August 31, 2005
Dear Chairmen Grassley and Thomas and Ranking Members Baucus and
Rangel:
We are pleased to note that H.R. 3376, the ``Tax Technical
Corrections Act of 2005'' does not include a special provision to
shield Accenture from the anti-inversion provisions passed as part of
last year's international tax law. Please continue to keep such
provisions out. Writing new rules with the specific purpose of allowing
Accenture to avoid paying millions of dollars in U.S. taxes on its
international profits would be extremely unfair to U.S. companies who
pay their fair share. We urge you not to incorporate these
controversial measures into the bill as it proceeds through the
legislative process.
When Congress passed the American Jobs Creation Act last year, it
specifically condemned the practice of corporate expatriation. The
House report accompanying the legislation states, ``The Committee
believes that certain inversion transactions are a means of avoiding
U.S. tax and should be curtailed.'' The Committee had it right last
year: Accenture's inversion transaction was obviously a means of
avoiding U.S. taxes and it should be curtailed--not condoned and
rewarded.
This is a question of responsibility. Hard-working Americans, Mom
and Pop small businesses, and thousands of corporations with integrity
meet their responsibilities by paying their fair share of taxes.
Accenture chose a different path: pushing its share of the burden onto
others. The Finance Committee and the Ways and Means Committees both
have responsibilities of their own: to protect the taxpayers who play
by the rules. We appreciate the responsible approach these committees
have taken to date by rejecting Accenture's unworthy efforts to flout
the laws that bind everyone else.
Please continue to exclude any provisions designed to shield
specific companies from existing anti-inversion laws.
Carl Levin
U.S. Senator
Richard Neal
Member of Congress
Lloyd Doggett
Member of Congress
Rosa DeLauro
Member of Congress
Marion Berry
Member of Congress
Louise Slaughter
Member of Congress
John Lewis
Member of Congress
Mcintire School of Commerce
Charlottesville, Virginia 22947
August 27, 2005
The Honorable William Thomas
Chairman, Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas:
I am writing to request that the Committee on Ways and Means
consider technical corrections to Internal Revenue Code Sections
1371(c) and 1367(a)(2)(D) that are, in my opinion, required for the
proper and equitable treatment of the incremental taxes incurred by a
LIFO-method S corporation under Section 1363(d).
LIFO Recapture under Section 1363(d)
Section 1363(d), which was enacted as part of the Revenue Act of
1987, requires any C corporation that uses the ``last-in, first-out''
[``LIFO''] method to account for one or more of its inventories and
that elects S status,\1\ to recognize the ``LIFO recapture amount''
built into its LIFO inventories as of the end of its last tax year as a
C corporation. The ``LIFO recapture amount'' [``LRA''] is the excess,
if any, of the inventory's value determined under the ``first-in,
first-out'' [``FIFO''] method over its actual LIFO value.\2\ This
amount is included in the converting corporation's ordinary gross
income on its final C corporation income tax return, and the resulting
incremental income tax is payable in four interest-free annual
installments, commencing with the due date for its final C corporation
return.\3\
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\1\ In 1993, the Treasury Department extended the scope of the
application of Section 1363(d) to any C corporation that transfers LIFO
inventory to a new or pre-existing S corporation in an otherwise
nontaxable carryover-basis transaction (e.g., certain corporate
reorganizations described in Section 368(a) and certain corporate
divisions described in Sections 368(a)(1)(D)/355). Reg. Sec. 1.1363-
2(a)(2) (proposed August 19, 1993 and finalized October 6, 1994).
\2\ Stated differently, the ``LIFO recapture amount'' is the
cumulative net amount of gross income that the converting corporation
(i.e., a C corporation converting to S status) has deferred by using
the LIFO method, rather than the FIFO method, to account for its
inventory.
\3\ The statute also provides for the converting corporation to
increase the tax basis of its LIFO inventories to reflect its
recognition of this income. LIFO recapture under Section 1363(d) does
not terminate the converting corporation's LIFO election.
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Adjustments to ``Earnings and Profits'' and to Stockholder Basis for
the Incremental Tax Imposed on the Section 1363(d) Inclusion
Background. The statute variously requires that the earnings and
profits [``E&P''] of a C corporation, the ``accumulated adjustment
account'' [``AAA''] of an S corporation,\4\ and the basis the
shareholders of an S corporation have in their stock \5\ be reduced by
nondeductible, noncapital expenses. Federal income taxes, and more
specifically, the corporate-level income taxes imposed on the income
recognized under Section 1363(d), are nondeductible, noncapital
expenses. Since the converting corporation will be a C corporation at
the time the taxes resulting from the recapture of the LRA become
``fixed and determinable,'' \6\ but it (or, following a nontaxable
carryover-basis transaction, its successor) will be an S corporation at
the time these taxes are actually paid,\7\ questions arise as to
whether the corporation's E&P, AAA, and/or its shareholders' stock
basis are to be adjusted for them, and, if so, when the adjustment is
to be made (i.e., immediately on the recapture date or as the
installments are actually paid).
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\4\ I.R.C. Sec. 1368(e)(1)(A); Reg. Sec. 1.1368-2(a)(3)(i)(C)(1).
\5\ I.R.C. Sec. 1367(a)(2)(D); Reg. Sec. 1.1367-1(c)(2).
\6\ As of the last day of the converting corporation's last C year,
all events will have occurred which determine the fact of its liability
under Section 1363(d) and the amount of that liability will have become
determinable with reasonable accuracy. See I.R.C. Sec. 461(h)(4).
\7\ This assumes, of course, that the converting corporation's S
election (or the S election of its successor corporation) does not
terminate prior to the payment of the final installment.
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The statute expressly provides that in computing an S corporation's
AAA, no reduction is to be made for federal taxes ``attributable to''
any tax year in which the corporation was a C corporation.\8\ Although
neither the statute nor the regulations define the phrase
``attributable to,'' the incremental tax imposed on the converting
corporation's LRA clearly falls within its scope.
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\8\ I.R.C. Sec. 1368(e)(1)(A); Reg. Sec. 1.1368-2(a)(3)(C)(1).
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The effect of the incremental tax on the converting corporation's
E&P \9\ and on the stock basis of its (or its successor's) shareholders
is not, however, predicated upon whether or not this tax is
``attributable to'' a C-corporation tax year of the converting
corporation. The touchstone for making these determinations is,
instead, whether the incremental tax is deemed to have been
``incurred'' in the converting corporation's last C year or,
alternatively, in a subsequent S year. Simply put, any portion of the
incremental tax that is incurred in a C year will reduce the converting
corporation's E&P and will have no effect on the stock basis of its (or
its successor's) stockholders. Conversely, any portion of the
incremental tax that is incurred in the converted corporation's S years
will have no effect on its E&P and will reduce its shareholders' stock
basis.
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\9\ The accumulated E&P of a C corporation does not disappear upon
its conversion to S status or upon the transfer of its assets to an S
corporation in a nontaxable carryover-basis transaction. Instead, the
converting corporation's E&P reside in the S corporation (either the
converting corporation itself or the transferee of the converting
corporation's assets (Sections 381(c)(2) or 312(h))) until they are
distributed to its shareholders (as a dividend under Section
1368(c)(2), in redemption of stock, or in complete liquidation), or
until they are transferred to another corporation under Section
381(c)(2) or Section 312(h). I.R.C. Sec. Sec. 1371(c)(2) and (3).
Unfortunately, the converting corporation's E&P has the potential
to create significant tax liabilities for the S corporation and/or its
shareholders. First, nonliquidating, nonredemption distributions of an
S corporation's E&P will be taxable to its shareholders as dividend
income. I.R.C. Sec. Sec. 1368(c)(1) and (2). Second, if the S
corporation has any E&P as of the end of any tax year and it has
passive investment income in excess of 25% of its gross receipts for
the year, it may be liable for a flat 35% corporate-level tax under
Section 1375. Finally, if the corporation has E&P and excess passive
investment income for three consecutive tax years, its S election will
generally terminate as of the beginning of the fourth tax year. I.R.C.
Sec. 1362(d)(3).
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The ``Economic Performance'' Test. An accrual-method corporation's
liability for federal, state, and local income taxes is ``incurred''
(and therefore ``recognized'') for any and all federal income tax
purposes \10\ only when the ``all-events'' test of Section 461(h)(4) is
met.\11\ The all-events test is met no earlier than when the ``economic
performance'' occurs.\12\ For liabilities in the form of ``taxes,''
economic performance does not generally occur until the tax in question
is actually paid.\13\
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\10\ I.R.C. Sec. 461(h)(1) reads as follows:
``In general. For purposes of this title, in determining whether an
amount has been incurred with respect to any item during any taxable
year, the all events test shall not be treated as met any earlier than
when economic performance with respect to such item occurs.'' [Emphasis
supplied.]
\11\ ``All events test. For purposes of this subsection, the all
events test is met with respect to any item if all events have occurred
which determine the fact of liability and the amount of such liability
can be determined with reasonable accuracy.'' See also Reg.
Sec. Sec. 1.446-1(c)(1)(ii)(A) and 1.451-1(a).
\12\ I.R.C. Sec. 461(h), which generally applies to amounts
incurred on or after July 18, 1984. See also Reg. Sec. 1.461-
1(a)(2)(i).
\13\ Reg. Sec. 1.461-4(g)(6). (An exception to this requirement is
available under Section 461(c), which allows an accrual method taxpayer
to elect to accrue certain real property taxes ratably over the period
to which they relate, regardless of when those taxes are actually
paid.)
See also P.L.R. 199904036 (Feb. 1, 1999), where the taxing
authority allowed the taxpayer to pay a sales tax liability resulting
from an asset acquisition over a period of years. The I.R.S. held that
payment, and therefore economic performance, occurred as each payment
was made and not when the asset was acquired.
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An exception to the ``payment'' requirement is available to accrual
method taxpayers that adopt the ``recurring item exception'' of Section
461(h)(3).\14\ Under this exception, taxes will be treated as having
been incurred during a particular taxable year if and only if (i) the
all-events test is satisfied before the close of that taxable year,
(ii) payment of the tax is made within the shorter of a ``reasonable
period'' after the close of such taxable year or 8\1/2\ months after
the close of such taxable year, and (iii) the taxes are recurring in
nature and the taxpayer consistently treats taxes of the kind in
question as incurred in the taxable year in which the all-events test
is satisfied.\15\
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\14\ An accrual-method taxpayer may generally adopt the recurring
item exception as method of accounting for one or more types of
recurring liabilities that it incurs during a taxable year. Reg.
Sec. 1.461-5(a). See Reg. Sec. 1.461-5(d) for the time and manner of
adopting the recurring item exception.
\15\ I.R.C. Sec. 461(h)(3); Reg. Sec. 1.461-5(b). For most
liabilities, the recurring item exception also requires that either (i)
the amount of the liability in question is not ``material,'' or that
(ii) the accrual of that liability in the taxable year in which the
all-events test is met results in a better ``matching'' with the income
to which it relates than would result from accruing that liability in
the taxable year in which economic performance occurs. This requirement
is automatically satisfied where the liability at issue is a tax
liability. Reg. Sec. 1.461-5(b)(5)(ii).
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With respect to the incremental tax on the Section 1363(d)
inclusion, the converting corporation will have been a C corporation at
the time the all-events test of Section 461(h)(4) was satisfied, but it
(or its successor) will be an S corporation at the time these taxes are
actually paid.\16\ A converting corporation that has adopted the
recurring item exception, and that pays the incremental tax in
installments as they become due, should be permitted to treat the tax
paid with the first installment as having been incurred in the
recognition year--while it was still a C corporation.\17\ The taxes
paid with the last three annual installments, however, will be treated
as having been incurred in years during which the converted corporation
was an S corporation.
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\16\ This assumes, of course, that the converting corporation does
not prepay the entire incremental tax in the recognition year and that
its S election (or the S election of its successor corporation) does
not terminate prior to the payment of the final installment.
\17\ See, for example, Reg. Sec. 1.461-4(g)(8), Ex. 8.
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Earnings and Profits. The E&P of an accrual method C corporation
are reduced by accrued federal income taxes. Section 1371(c), however,
provides that no adjustments are to be made to the E&P of an S
corporation except (i) where those earnings are distributed out to the
shareholders as dividends under Section 1368(c)(2), (ii) where the
corporation redeems its stock or liquidates, or (iii) where the
corporation acquires, disposes, or allocates E&P as a result of the
application of a subchapter C provision to a reorganization or
division.\18,19\ Section 1371(d)(3) provides another exception that
permits an S corporation to reduce its E&P for any additional taxes for
which it is liable under the investment credit recapture provisions of
Sections 49(b) or 50(a).
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\18\ Consequently, for example, neither the recognition of built-in
gains and losses under Section 1374, nor the payment of corporate-level
taxes on net recognized built-in gains will have any effect on an S
corporation's E&P. Nor will the recognition of ``excess net passive
income'' or the payment of corporate-level taxes thereon under Section
1375 have any affect on an S corporation's E&P.
\19\ I.R.C. Sec. 1371(c) was enacted as part of the Subchapter S
Revision Act of 1982.
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Read literally and together, Sections 1371(c) and 461(h) preclude a
reduction in the converting corporation's E&P for any amount of the
incremental tax not deemed to have been incurred while it was still a C
corporation--notwithstanding the fact that such tax is ``attributable
to'' a C year of that corporation. Consequently, a converting
corporation that has not adopted the recurring item exception will not
reduce its E&P for any amount of the incremental tax paid after the
close of the recognition year. A converting corporation that has
adopted the recurring item exception and that pays the incremental tax
in installments as they become due will reduce its E&P by the amount of
the first installment, but no reduction will be permitted for any of
the three remaining installments. However, a converting corporation
that has adopted the recurring item exception should be permitted to
reduce its E&P by any prepayments on the final three installments that
are made within a ``reasonable period'' (or 8\1/2\ months, whichever is
shorter) following the close of the recognition year.\20\
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\20\ Since the converting corporation's liability for the
incremental tax on the Section 1363(d) inclusion becomes ``fixed and
determinable'' in the recognition year, and since the statute expressly
authorizes the prepayment of this tax, it seems clear that, for a
converting corporation that has adopted the recurring item exception, a
prepayment of all or part of any or all of the last three installments
within a ``reasonable period'' (or 8\1/2\ months, whichever is shorter)
following the close of the recognition year, will result in those taxes
being ``incurred'' in the recognition year. I.R.C. Sec. 1363(d)(2)(B)
(``. . . the 3 succeeding installments shall be paid on or before the
due date . . . for the corporation's return for the 3 succeeding
taxable years.'' [Emphasis supplied.]
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The failure of the statute or regulations to permit the converting
corporation to reduce its E&P by the full amount of the incremental tax
in the recognition year is clearly at odds with the whole concept of
corporate E&P, i.e., that the before-tax corporate-level earnings and
profits of a C corporation should be reduced by the corporate-level
taxes attributable to them. In a closely analogous situation, Congress
belatedly ``clarified'' the treatment of federal income taxes paid by
an S corporation upon the recapture of investment tax credits
previously claimed by the corporation in a prior C year. As noted
above, Section 1371(d)(3) permits an S corporation to reduce its E&P by
the full amount of such taxes.\21\
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\21\ ``The Act clarifies that an S corporation's accumulated
earnings and profits will be reduced by the amount of investment credit
recapture tax . . . imposed on the corporation with respect to these
credits, since the earnings and profits were not previously reduced by
the amount of tax savings attributable to the credit.'' [Emphasis
supplied.] Staff of Joint Comm. on Taxation, 98th Cong., 2d Sess.,
General Explanation of the Revenue Provisions of the Deficit Reduction
Act of 1984 (1984): pp. 1019-1025.
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The failure of the current statute to permit a converting
corporation to reduce its E&P by the full amount of the incremental tax
also conflicts with the legislative purpose that triggered the
enactment of Section 1363(d): to ``eliminate this potential disparity
in treatment'' between FIFO-method and LIFO-method converting
corporations.\22\ As of the date of its conversion to S status, a FIFO-
method C corporation would have already reduced its E&P by the income
taxes attributable to its inventory profits.
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\22\ H.R. Rep. No. 100-391, Part 2 (1987):
``The committee is concerned that taxpayers using the LIFO method
may avoid the built-in gain rules of section 1374. It believes that
LIFO method taxpayers, which have enjoyed the deferral benefits of the
LIFO method during their status as a C corporation, should not be
treated more favorably than their FIFO (first-in, first-out)
counterparts. To eliminate this potential disparity in treatment, the
committee believes it is appropriate to require a LIFO taxpayer to
recapture the benefits of using the LIFO method in the year of
conversion to S status.'' (At p. 1098.)
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Shareholder Stock Basis. Failure to adjust the converting
corporation's E&P by the incremental tax is an inequity that is
exacerbated by Section 1367(a)(2)(D), which requires, without
qualification, that the shareholders of an accrual-method S corporation
reduce their stock bases by their pro rata share of the nondeductible,
noncapitalizable expenses incurred during the year.\23\ It seems clear
that this requirement extends to any amount of the incremental tax that
is deemed, under the rules discussed above, to have been incurred
during an S year of the converted corporation, notwithstanding the fact
that such tax is, in its entirety, attributable to a C year of the
converting corporation.\24,25\
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\23\ Reg. Sec. Sec. 1.1367-1(c)(2) and -1(d)(2).
\24\ Although Reg. Sec. 1.1367-1(c)(2) does not include the
incremental tax on the Section 1363(d) inclusion in its listing of the
types of nondeductible, noncapitalizable expenses that fall into this
category, that regulation expressly states that the listing is
illustrative, not exclusive. See also Section 1368(e)(1)(A), which
directs that AAA is computed by making adjustments that are ``similar
to the adjustments under Section 1367,'' but that ``no adjustment shall
be made for Federal taxes attributable to any taxable year in which the
corporation was a C corporation.'' This language seems to confirm that
federal income taxes attributable to taxable years in which the
corporation was a C corporation are taken into account in making basis
adjustments under Section 1367 when they are incurred in an S year.
See also Preamble, T.D. 9210 (July 11, 2005), which states that
``[t]he issues raised by the payment by an S corporation of taxes
attributable to a taxable year in which the corporation was a C
corporation are not unique to a payment of the LIFO recapture tax. . .
.'' (T.D. 9210 extended the application of Section 1363(d) to LIFO
inventory held indirectly by a converting corporation through a
partnership.)
In my opinion, the Section 1363(d) incremental tax is unique and
this uniqueness warrants the special treatment described below.
\25\ Note that the income taxes payable by a converted corporation
under Section 1374 also reduce stock basis. I.R.C. Sec. Sec. 1366(f)(2)
and 1367(a)(2)(B) and (C). However, unlike Section 1363(d), stock basis
is also increased by the net recognized built-in gain on which the tax
is imposed.
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Technical Corrections Needed. The literal application of these
current provisions creates the potential for substantial distortions in
the amount, timing, and character of the income ultimately recognized
by the shareholders of the converted corporation. For the reasons
stated above, Sections 1371 and 1367 should, in my opinion, be revised
to require the accrual of the entire amount of the Section 1363(d)
incremental tax on the recapture date--i.e., at the time the liability
for that tax becomes ``fixed and determinable,'' without regard to when
economic performance ultimately occurs. These revisions would be
consistent with the concept of E&P, with the legislative purpose that
prompted the enactment of Section 1363(d), with the treatment of
corporate-level recapture taxes under Section 1371(d)(3), and with the
regulations under Section 1374 (which apply the all-events test without
regard to the economic performance requirement in distinguishing
deductions that were built-in as of the last day of the converting
corporations last tax year as a C corporation, and those that accrued
subsequent to the start of the Section 1374 recognition period).\26\
These changes would also be consistent with the legislative purposes
that inspired the changes made to Subchapter S by the American Jobs
Creation Act of 2004.\27\
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\26\ Reg. Sec. 1.1374-4(b)(2), which reads, in part, as follows:
``Deduction items. Except as otherwise provided in this Section,
any item of deduction properly taken into account during the 10-year
recognition period is recognized built-in loss if the item would have
been properly allowed as a deduction against gross income before the
beginning of the 10-year recognition period to an accrual method
taxpayer. . . . In determining whether an item would have been properly
allowed as a deduction against gross income by an accrual method
taxpayer for purposes of this paragraph, Section 461(h)(2)(C) and
Section 1.461-4(g) (relating to liabilities for . . . taxes . . .) do
not apply.'' [Emphasis supplied.]
Note also that the corporate-level tax imposed under Section 1374
is treated as a loss sustained by the S corporation for the taxable
year in which the built-in income or gain is recognized and the tax is
imposed, regardless of the year in which the tax is actually paid.
I.R.C. Sec. 1366(f)(2) and Reg. Sec. 1.1366-4(b).
\27\ P.L. 108-357. The revisions to Subchapter S were designed to
``modernize the S corporation rules and eliminate undue restrictions on
S corporations in order to expand the application of the S corporation
provisions so that more corporations and their shareholders will be
able to enjoy the benefits of subchapter S status.'' H. Rep. No. 108-
548, 108th Cong. 2nd Sess. 128 (2004).
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Thank you for your time and consideration.
David W. LaRue, Ph.D.
Nalco Company
Naperville, Illinois 60563
August 29, 2005
The Honorable William M. Thomas
Chairman
U.S. House Committee on Ways and Means
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas and Committee Members:
On behalf of Nalco Company, I submit the attached proposed
amendment to H.R. 3376 to clarify the circumstances under which tax
credits may be earned under Section 45 of the tax code, as added under
provisions of the American Jobs Creation Act of 2004 (the ``Act''). The
attached clarifying language, provided in draft bill form, relates to
Section 710 of the Act.
Among other water treatment and process improvement services, Nalco
Company supplies coal preparation and related environmental materials
and consulting services. We believe that ambiguous definitions in the
Act raise enough uncertainties to limit its potential value. In our
view, clarifying language would help ensure that benefits are realized
from the Act's intended support for waste coal re-mining and related
site reclamation, as well as for technologies to create energy from
waste coal with lower sulfur dioxide, nitrogen oxide and/or mercury
emissions.
The Internal Revenue Service took more than a decade and hundreds
of Private Letter Ruling precedents to implement Section 29.
Ambiguities in the Act as it exists for Section 45 today, when combined
with the limited size of the credit, could well result in similar
delays or complete avoidance of the technology development needed to
enable waste coal re-mining and emission reductions from coal
preparation technologies.
Additional legislative clarity is needed to provide reasonable
assurance that interpretations of legislative intent will remain stable
as companies decide whether or not to invest in research and
development to support the Act's legislative objective. The attached
proposed language represents our best efforts to further clarify
several key points. Specifically, the language is intended to clarify
that:
Impoundment waste coal is included in the definition of
``feedstock.''
The per-ton credit applies to only the energy-producing
coal tonnage left after the waste coal is refined to eliminate non-
energy-producing materials.
Refined waste coal may be blended with newly mined coal
in energy production, while applying the credit only to the refined
coal.
Any positive market value for refined waste coal should
meet the 50 percent market value improvement criteria, as this waste
coal has no value or a negative value in situ.
An average of 20 percent emission reductions of two of
the three pollutant sources discussed in the Act--nitrogen oxide,
sulfur dioxide and/or mercury--to enhance the potential producers'
ability to meet the Act's intended environmental benefits.
We appreciate the Committee's consideration of our proposal and
would be happy to respond to any questions.
Michael R. Bushman
__________
DRAFT BILL
To amend the Internal Revenue Code of 1986 to make technical
corrections, and for other purposes.
Be it enacted by the Senate and House of Representatives of the
United States of America in Congress assembled,
SECTION 1. SHORT TITLE.
This Act may be cited as the ``[Renewable Credit and Refined Coal
Credit] Tax Technical Corrections Act of 2005.''
SEC. 2. TECHNICAL CORRECTIONS.
(a) AMENDMENTS RELATED TO THE AMERICAN JOBS CREATION ACT OF 2004.--
(1) Amendments Related to Section 710 of the Act.--
(A) Clause (i) of section 45(c)(7)(A) of the Internal Revenue Code
of 1986 is amended to read as follows:
``(i) is a liquid, gaseous, or solid synthetic fuel produced from
coal (including lignite and waste coal) or high carbon fly ash,
including such fuel used as a feedstock.''
(B) Clause (iv) of section 45(c)(7)(A) of such Code is amended to
read as follows:
``(iv) is produced in such a manner as to result in an increase of
at least 50 percent in the market value of the refined coal (excluding
any increase in heat value caused by materials combined or added during
the production process), as compared to the value of the feedstock
coal.''
(C) Subparagraph (B) of section 45(c)(7) of such Code is amended to
read as follows:
``(B) QUALIFIED EMISSION REDUCTION.--
The term `qualified emission reduction' means a reduction of at
least 20 percent of the total emissions of nitrogen oxide and either
sulfur dioxide or mercury released when burning the refined coal
(excluding any dilution caused by materials combined or added during
the production process), as compared to the emissions released when
burning the feedstock coal or comparable coal predominantly available
in the marketplace as of January 1, 2003.''
DESCRIPTION OF THE [RENEWABLE CREDIT AND REFINED COAL CREDIT] TAX
TECHNICAL CORRECTIONS ACT OF 2005
TAX TECHNICAL CORRECTIONS
The draft bill includes technical corrections to the recently
enacted American Jobs Creation Act of 2004 (the ``Act''). The
amendments made by the technical corrections contained in the draft
bill take effect as if included in the Act.
Clarifications relating to tax credit for production and sale of
refined coal (Act sec. 710).--The provision clarifies that waste coal
(including coal fines) is a qualifying feedstock which may be converted
into qualified refined coal, the production and sale of which generally
qualifies for a tax credit of $4.375 per ton of qualified refined coal,
subject to adjustment and phase-out. As a consequence, it is against
this waste coal feedstock that the 20 percent total emission reduction
and 50 percent value increase requirements are applied. If the waste
coal has no value, the 50 percent value increase requirement thus will
be satisfied to the extent that the synthetic coal has a positive
value. This clarification is supported by one of the legislative
purposes underlying the enactment of this provision, i.e., encouraging
the reclamation and use of waste coals.
The provision also clarifies that the 50 percent value increase
requirement should not take into account any value increment resulting
from heat value increases due to materials combined or added during the
production process. However, the 50 percent value increase requirement
should take into account any value increase resulting from the addition
of materials in order to obtain a ``qualified emission reduction.'' A
significant legislative purpose underlying this provision is the
achievement of a ``qualified emission reduction.'' This legislative
purpose should not be undercut by excluding value increases
attributable to the introduction of materials necessary to achieve a
``qualified emission reduction.''
The provision clarifies the definition of a ``qualified emission
reduction.'' A ``qualified emission reduction'' is tied to a reduction
of the emissions of three substances--nitrogen oxide, sulfur dioxide,
and mercury. The provision clarifies that a ``qualified emission
reduction'' is achieved if the process results in a average 20 percent
reduction of the total emissions of two of these pollutants, with one
of the reduced substances being nitrogen oxide. Achieving 20 percent
reduction in the total emissions of two of these pollutants will
satisfy the policy of a significant improvement to air quality.
Moreover, the 50 percent value increase fundamentally operates to
further ensure that the achieved emission reduction is considered
valuable by the market, which value inherently is driven by achieving
targeted emission reductions and other environmental goals.
Statement of James Tobin, National Association of Home Builders
Thank you for the opportunity to submit comments presenting the
views of the National Association of Home Builders (NAHB) on H.R. 3376,
the Tax Technical Corrections Act of 2005, and the impact the
legislation may have on homeowners and the home building industry. NAHB
represents more than 220,000 member firms involved in home building,
remodeling, multifamily construction, property management, housing
finance, building product manufacturing and other aspects of
residential and light commercial construction. The success of the home
building industry and the benefits of homeownership have been clearly
evident in recent years with the housing sector continuing to be an
engine of economic growth.
In 2004, in response to World Trade Organization rulings that
declared the foreign sales corporation (FSC) regime and the
extraterritorial income (ETI) regime prohibited export subsidies,
Congress enacted the American Jobs Creation Act of 2004. The American
Jobs Creation Act replaced the FSC/ETI regimes with new tax provisions
to aid domestic manufacturers. By reducing the tax burden on domestic
manufacturers, the American Jobs Creation Act sought to improve the
cash flow of domestic manufacturers and increase investment in domestic
manufacturing.
The American Jobs Creation Act created a new deduction for domestic
production activities, which is limited to fifty percent of the wages
(i.e. wages reported on Form W-2) paid by the taxpayer. Included in the
definition of ``qualified production activities income'' was domestic
production gross receipts generated from construction activities
performed in the United States. For this purpose, construction
activities are activities directly related to the erection of
residential and commercial buildings and infrastructure, including
substantial renovation. The new deduction will be a real tax benefit
for most home builders and, because the deduction is calculated using
wages paid, could represent a substantial deduction for home builders
who have a significant number of employees. The deduction will help
home builders maintain their role as an engine of economic growth by
offsetting some of the escalating costs of developing and constructing
a home. For homeowners and potential new home buyers, the deduction
will help reduce the cost of owning a new home.
Inevitably, major tax legislation requires technical corrections to
ensure the implementation of the new law reflects the intent of the
Congressional authors, and the American Jobs Creation Act of 2004 is no
exception. H.R. 3376, the Tax Technical Corrections Act of 2005,
contains technical corrections with respect to the American Jobs
Creation Act. NAHB's comments address a specific provision in H.R. 3376
that seeks to clarify that ``domestic production gross receipts''
exclude gross receipts derived from the lease, rental, license, sale,
exchange or other disposition of land (Sec. 2(a)(6)).
The construction of a home, or any structure, begins with the
improvement of raw land. Many of NAHB's members purchase land and later
sell the land to another builder to complete the final phase of
construction. Under the proposal contained in Section 2(a)(6) of H.R.
3376, any income derived from the passive holding of land would be
excluded from ``domestic production gross receipts'' for the purpose of
computing the domestic production deduction. This exclusion is unfair
and unnecessarily burdensome to home builders.
Excluding land holdings, the raw material on which home
construction depends, is unfair to businesses whose livelihood depends
upon land acquisition as the basis for their construction activities.
Excluding gross receipts derived from the lease, rental, license, sale,
exchange or other disposition of land, fails to recognize the true
costs, and business, of constructing a home. The passive holding of
land is a legitimate business activity and represents a small portion
of the income of a home builder. By far, home builders earn the largest
part of their income from the construction and sale of homes, an
approved activity under the American Jobs Creation Act, not from the
buying and selling of land. NAHB believes that this reality makes the
exclusion unnecessary.
Further, excluding the lease, rental, license, sale, exchange or
other disposition of land would require an overly burdensome accounting
of gross receipts; complex calculations attempting to divine permitted
construction activities from excluded passive land holdings. A large
percentage of the 70,000 builder members of NAHB would be required to
create land values for each parcel of land in their inventories. For
NAHB's members, the majority of which are small businesses and who
build only a few homes each year, the information required to identify
and separate the gross receipts of a permitted construction activity
and an excluded passive land holding is burdensome. For our large-
volume members, which potentially have thousands of transactions each
year, these calculations are complex and the costs are enormous.
Given the small percentage of gross receipts that home builders
derive from passive land holdings and the overly burdensome
requirements of computing passive land holdings, NAHB urges you to
eliminate the proposed exclusion for the lease, rental, license, sale,
exchange or other disposition of land.
Again, thank you for the opportunity to comment on H.R. 3376, the
Tax Technical Corrections Act of 2005. NAHB looks forward to working
with you and the members of the House Committee on Ways and Means as
you continue to develop legislation designed to ensure that the new
domestic manufacturing deduction reflects your intent.
Statement of the Tony M. Edwards, National Association of Real Estate
Investment Trusts
As requested in Press Release No. FC-12 (July 22, 2005), the
National Association of Real Estate Investment Trusts (``NAREIT'')
respectfully submits these comments in connection with the Committee on
Ways and Means' review of H.R. 3376, the ``Tax Technical Corrections
Act of 2005'' (the TTCA). As stated in Press Release No. FC-12, the
TTCA includes technical corrections to, among other things, the
American Jobs Creation Act of 2004, Pub. L. No. 108-357 (the Jobs Act)
including certain provisions relating to real estate investment trusts,
which was signed into law on October 22, 2004. NAREIT thanks the
Chairman and the Committee for the opportunity to share its views on
several important, but technical, issues relating to the Jobs Act's
effect on real estate investment trusts.
NAREIT is the representative voice for United States real estate
investment trusts (REITs) and publicly traded real estate companies
worldwide. Members are REITs and other businesses that own, operate and
finance income-producing real estate, as well as those firms and
individuals who advise, study and service these businesses.
EXECUTIVE SUMMARY
By way of background, the Jobs Act contains all three titles of the
NAREIT-supported REIT Improvement Act (RIA), which was introduced as
H.R. 1890. First, Title I of the RIA includes a number of provisions,
including one that allows a REIT to make certain loans in the ordinary
course of business without the risk of losing REIT status and another
that permits timberland dispositions to qualify for a new safe harbor
from the 100% prohibited transactions tax. Second, Title II of the RIA
substantially conforms the treatment under the FIRPTA rules of foreign
shareholders in publicly traded REITs to that of foreign shareholders
in other publicly traded U.S. companies. Finally, Title III of the RIA
(the REIT Savings provisions) allows companies to avoid REIT
disqualification for unintentional REIT test violations either by,
among other things, paying a monetary penalty if the violation was due
to reasonable cause or, for certain de minimis violations, by bringing
themselves into compliance with the REIT rules.
Because certain provisions of the Jobs Act could have resulted in
retroactive REIT disqualification and/or considerable additional
expense, NAREIT submitted written comments to the tax-writing
Committees suggesting certain clarifications to the REIT-related
provisions in the Jobs Act. NAREIT would like to thank the Ways and
Means Committee for favorably addressing these RIA-related changes.
However, we have been informed by practitioners that there still may be
some potential ambiguity concerning the application of a few of the
TTCA provisions concerning effective date issues. Accordingly, as
further described below, we have requested further clarification either
in statutory language or legislative history. In addition and as
further described below, we respectfully request that cross-references
be updated in connection with the new safe harbor from the 100%
prohibited transactions tax for timberland dispositions. Finally,
NAREIT requests the Committee to clarify that REITs are not considered
``pass-thru entities'' for purposes of Sec. 470 of the Internal Revenue
Code, as amended (the Code).\1\
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\1\ Unless otherwise provided, all ``section'' or ``Sec. ''
references in this submission shall be to a section of the code.
Sec. 470 was added by the Jobs Act.
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The specific RIA-related items are as follows:
1. A clarification to the transition rule concerning the
calculation of ``safe harbor securities'' under Sec. 856(m)(1) in order
to prevent retroactive disqualification of REITs that had held
qualifying securities and other securities in compliance with the
provisions of pre-Act Sec. 856(c)(7) but did not continue to hold such
securities on the date of enactment of the Jobs Act (or shortly
thereafter);
2. Clarification either to the statutory language or the
legislative history of the REIT Savings procedures, so that it is clear
that it applies to failures of the REIT tests (including those with
respect to taxable years prior to date of enactment of the Jobs Act)
that are discovered and satisfied after October 22, 2004;
3. A clarification either to the statutory language or the
legislative history of the ``deficiency dividend'' procedure, so that
it is clear that statements filed with the IRS in taxable years
beginning after October 22, 2004 can relate to distribution errors that
occurred in earlier taxable years as well;
4. A clarification of the effective date of the new FIRPTA
provisions of the Jobs Act to include ``deficiency dividends'' of
capital gains attributable to pre-Jobs Act years; and,
5. An update of a cross reference in the REIT provisions of the
Internal Revenue Code concerning the new safe harbor from the 100% tax
for timber sales, to clarify that, based on all the surrounding facts
and circumstances, a sale can avoid characterization as a ``prohibited
transaction'' even if all of the requirements of the new safe harbor
are not satisfied.
DISCUSSION
A. Transition Rule for Expansion of ``Straight Debt'' Safe Harbor
1. Background
In general, a REIT may not own more than 10% of the value of any
other entity's securities other than those of a taxable REIT subsidiary
(TRS) or another REIT. Prior to enactment of the Jobs Act, an exception
to this rule existed for securities that met the definition of
``straight debt,'' and, in the case of ``straight debt'' securities
issued by a partnership, the exception required (at least for REITs
that held non-straight debt and equity partnership securities) that the
REIT own at least a 20% profits interest in a partnership.
Unfortunately, this straight debt exception did not apply to many
situations in which individuals and/or businesses owed some debt to a
REIT, including non-abusive loans issued in the ordinary course of
business.
2. Jobs Act Change and Technical Issue
The Jobs Act exempted from the 10% test categories of loans that
are non-abusive and presented little or no opportunity for the REIT to
participate in the profits of the issuer's business. The Jobs Act also
eliminated the requirement that a REIT hold a 20% profits interest in a
partnership, but included a limitation that could disqualify from the
new ``straight debt'' safe harbor otherwise qualifying debt securities
if the REIT owned non-qualifying securities in the partnership with a
value in excess of 1% of the partnership's outstanding securities.
Sec. 856(m)(2)(C). The Jobs Act also included a new safe harbor for
partnership debt securities that prospectively treats them as
qualifying ``safe harbor'' securities if at least 75% of the
partnership's gross income is from the ``real estate-related'' sources
described in Code section 856(c)(3) (such as mortgages and rents).
NAREIT applauds Congress' leadership in enacting these changes and
appreciates greatly that they were made on a retroactive basis to 2001,
in recognition of the fact that prior to the amendment the ``straight
debt'' rules did not reflect the regulatory regime Congress had
originally intended.
Nevertheless, several practitioners have raised the concern that
the Jobs Act's retroactive change concerning partnership debt could
have resulted in retroactive failures of the asset test for certain
REITs that had complied with the provisions of the prior ``straight
debt'' safe harbor, and, accordingly, NAREIT submitted comments to the
tax-writing committees expressing this concern. For example, under the
Jobs Act, a REIT that owned the following securities in a partnership
prior to the enactment of the Act would have been in full compliance
with prior law but would fail the 10% value test retroactively after
the Jobs Act: (a) at least a 20% profits interest in the partnership;
(b) ``straight debt'' securities under Sec. 856(c)(7) (and under
Sec. 856(m)(1) prior to the application of Sec. 856(m)(2)(C)) with an
aggregate value in excess of 10% of the partnership's outstanding
securities; and (c) non-``straight debt'' securities with an aggregate
value greater than 1%, but less than 10%, of the partnership's
outstanding securities that do not qualify for the ``real estate
partnership'' exception.
3. TTCA Creation of a Transition Rule
In general, the TTCA evidences the intent to make the Jobs Act's
revisions to the prior law ``straight debt'' safe harbor apply
prospectively when the Jobs Act provisions are stricter than prior law.
The TTCA 2005 would clarify that securities of a partnership that are
held by a REIT on or after October 22, 2004, and that would have
qualified and continue to qualify as straight debt of that partnership
under prior law rules that required a REIT (that held any partnership
equity) to hold at least 20% of the partnership equity, will continue
to so qualify while held by that REIT (or successor) until the earlier
of the disposition or the original maturity date of the securities.
4. Potential Issues Raised by TTCA Statutory Language
a. REIT Disposed of Pre-Jobs Act Qualifying Securities Prior
to October 22, 2004
One potentially outstanding issue regarding the TTCA ``straight
debt'' change is that the TTCA requires that the securities have been
held by the REIT on October 22, 2004, and continuously thereafter.
However, the TTCA did not otherwise change the Jobs Act's retroactive
amendment to the prior law ``straight debt'' exception. As a result, it
would appear that it still may be possible for a REIT that held a 20%
profits interest in a partnership, along with other qualifying and non-
qualifying debt securities, and which met the pre-Jobs Act ``straight
debt'' safe harbor prior to its retroactive change by the Jobs Act on
October 22, 2004, but which disposed of the non-qualifying securities
prior to October 22, 2004 to face retroactive disqualification because
it would not be holding the 20% profits interest in the partnership on
October 22, 2004.
b. REIT Disposed of Pre-Jobs Act Partnership Equity Interest
Shortly After October 22, 2004
Another potential issue stems from the fact that the TTCA appears
to require a REIT that potentially faced retroactive disqualification
under the Jobs Act due to its ownership of a 20% profits interest in a
partnership in which it also held ``straight debt'' securities to
continue to own a 20% profits interest following the enactment of the
Jobs Act in order for its previously qualifying straight debt
securities to continue to be considered ``straight debt.''
Following enactment of the Jobs Act on October 22, 2004, REITs that
faced this retroactive disqualification may have disposed of their
partnership profits interest bringing themselves into compliance on a
going-forward basis and hoping that any modification to the
retroactivity issue raised by NAREIT would be solved only
retroactively. Unfortunately, this action appears to eliminate their
ability to meet the TTCA 2005's transition rule. Once the REIT no
longer holds at least a 20% profits interest, its ownership of other
partnership securities may result in the REIT's retroactive
disqualification because the REIT would not meet the TTCA's requirement
that it continue to comply with the pre-Jobs Act ``straight debt'' safe
harbor.
5. Recommended Solution
We suggest essentially the same solution that we proposed in our
earlier comments on this issue. Specifically, we suggest that any
technical corrections legislation treat the specific securities held by
a REIT (or a successor under Sec. 381) on or prior to October 22, 2004,
that qualified as ``straight debt'' as continuing to qualify for the
Sec. 856(m)(1) safe harbor (without requiring continued compliance with
the pre-Jobs Act safe harbor following October 22, 2004). By enacting
such a rule, a REIT that held both straight debt and non-straight debt
partnership securities and a 20% partnership profits interest pre-Jobs
Act (in compliance with the then-existing safe harbor), but which
disposed of any of the securities before October 22, 2004, would not be
retroactively disqualified. Similarly, the REIT that held a similar
portfolio of debt securities of a partnership's outstanding securities,
along with a 20% profits interest (in compliance with the pre-Jobs Act
safe harbor), but disposed of some or all of the profits interest
between October 22, 2004 and January 1, 2005, also would not be
disqualified retroactively. In the latter case, the REIT would have met
the pre-Jobs Act safe harbor for taxable years beginning before October
22, 2004, and the post Jobs Act safe harbor for subsequent taxable
years.
B. Clarification That REIT Savings Procedures Apply to Failures of
the REIT Tests Both Before and After October 22, 2004 That Are
Discovered and Satisfied After October 22, 2004
1. Violation of REIT Tests Under Prior Law
Prior to the Jobs Act change, a REIT could lose REIT status by
failing to satisfy a myriad of tests relating to its organizational
structure, its sources of gross income, its assets, the distribution of
its income, its compliance with various procedures, the transferability
of its shares, etc.
2. Jobs Act Change
The Jobs Act allows a REIT that fails the asset tests to avoid
disqualification by bringing itself into compliance with the asset
tests, and in certain cases, paying a penalty. In addition to
provisions relating to failures to satisfy the asset tests, the Jobs
Act also imposes a monetary penalty of $50,000 in lieu of
disqualification for each reasonable cause failure to satisfy the other
REIT tests. Intentional violations continue to result in REIT
disqualification.
3. Effective Date of Jobs Act Change
The effective date of the REIT Savings provisions in the Jobs Act,
both for violations of the REIT asset tests and for other REIT test
violations, was for ``taxable years beginning after the date of
enactment.'' This language could be interpreted to mean that if, for
example, in 2006, a REIT found a problem with respect to any of REIT
requirements relating to 2004 or earlier, the REIT Savings provisions
would not apply. Accordingly, NAREIT requested that the REIT Savings
provisions be clarified to apply to failures ``discovered'' in taxable
years after date of enactment of the Jobs Act.
4. TTCA 2005 Change to the REIT Savings Effective Date
The TTCA 2005 would amend the effective date for the REIT Savings
provisions of the Jobs Act to apply to failures of the REIT tests with
respect to which the requirements of the new rules are satisfied after
October 22, 2004 (that is, meets the reasonable cause standard if
applicable, pays the penalty if applicable, and disposes of assets or
otherwise brings itself into compliance). Specifically, in the case of
non-de minimis failures of the REIT asset tests, the TTCA would modify
Sec. 243(g)(4)(A) of the Jobs Act so that it applies to ``failures with
respect to which the requirements of subparagraph (A) or (B) of section
856(c)(7) . . . are satisfied after date of enactment [October 22,
2004].'' (emphasis added).
This change appears to mean, for example, that the new REIT Savings
provisions apply starting as early as October 23, 2004, when a REIT
discovers an asset test violation and then undertakes to cure it, which
is what NAREIT had requested. Because asset test violations only can
occur on the last date of each calendar quarter, in such a case, the
asset test violation must have occurred no later than the last testing
date, or September 30, 2004. Nevertheless, some practitioners had
expressed concern that the TTCA would not appear to include errors that
may have occurred before October 22, 2004, but that were discovered
after such date, and requested clarification of this point.
The concern is that because Sec. 856(c)(7)(A)(ii) requires that the
asset test failure be ``due to reasonable cause and not willful
neglect,'' technically, a pre-date of enactment asset test failure
would have been due to reasonable cause pre-date of enactment, and the
TTCA requirement that the requirements of Sec. 856(c)(7)(A) be
satisfied after the date of enactment would not be met. A further
source of confusion is that the Joint Committee pamphlet (JCS-55-05)
describing this provision in the TTCA states on page 5 that ``the new
rules that permit the curing of certain REIT failures apply to failures
with respect to which the requirements of the new rules are satisfied
in taxable years of the REIT beginning after date of enactment''
(emphasis added). This language is inconsistent with the statutory
language, which allows for satisfaction of the new rules presumably
immediately after date of enactment, rather than in the next taxable
year.
5. Proposed Solution: Clarification in Legislative History or
Statutory Language
NAREIT urges that the legislative history clarify (or the statutory
language be modified) to make clear that the REIT Savings procedures
apply to relevant failures of the REIT tests satisfied in taxable years
beginning after date of enactment of the Jobs Act (but the failures
that are remedied may have occurred prior to such date). At the very
least, the legislative history should use language similar to that
contained in the statute and should include an express statement that
the intention is to apply the new relief rules to all failures
discovered after October 22, 2004.
C. Clarification That Statements Concerning ``Deficiency Dividends''
Can Relate to Distribution Errors That Occurred in Earlier
Taxable Years
Similarly to section B above, the TTCA provision concerning
``deficiency dividends'' should clarify that the change to Sec. 860
applies to determinations made in taxable years beginning after date of
enactment of the Jobs Act and, thus, to errors that may have occurred
prior to such date. At the very least, the legislative history should
use language similar to that contained in the statute.
D. Clarification of the Effective Date of the New FIRPTA Provisions
of the Jobs Act to Include ``Deficiency Dividends'' of Capital
Gains Attributable to Pre-Jobs Act Years
1. Jobs Act Provisions
Prior to the Jobs Act, the ``Foreign Investment in Real Property
Tax'' (FIRPTA) required a foreign investor who received a REIT capital
gain distribution to file a U.S. tax return as though the investor were
doing business in the U.S. and, if the investor was taxable as a
corporation for U.S. tax purposes, possibly to pay a ``branch profits
tax.'' Furthermore, the REIT was required to withhold a 35% tax on such
distribution. The Jobs Act modified this rule to treat a capital gain
distribution of a publicly traded REIT to a non-U.S. investor as an
ordinary dividend so long as the investor owns 5% or less of the
distributing REIT ``at any time during the taxable year.'' The change
applied to taxable years beginning after October 22, 2004.
2. Technical Issues Under the Jobs Act
Because deficiency dividends are treated as deductions in the year
in which they relate (that is, the year in which the REIT failed to
satisfy the distribution test), it is theoretically possible that a
REIT could make a deficiency dividend including capital gain
distributions in a taxable year beginning after October 22, 2004, that
relates to a taxable year that began prior to October 22, 2004. In such
a case, the TTCA's change to the FIRPTA rules would not apply because
the deduction would relate to a taxable year prior to date of
enactment. Certain practitioners have informed us that this issue is
substantial enough that could prevent a ``clean'' opinion to be issued
about the non-FIRPTA status of REIT capital gains distributions paid
starting in 2005.
3. Proposed Solution
The TTCA clarifies that the FIRPTA change applies to any
distribution of a REIT that is treated as a deduction of a REIT for
taxable years beginning after date of enactment. NAREIT suggests that
this provision be modified so it also applies to capital gain
deficiency dividends that are paid after October 22, 2004.
E. Update Cross References in the REIT Provisions of the Code
Concerning the New Safe Harbor from the 100% Prohibited
Transactions Tax for Timber Sales
1. Jobs Act Created Safe Harbor from 100% Tax For Timberland
Dispositions
The Jobs Act establishes a new safe harbor from the 100% prohibited
transactions tax on gains attributable to the sale of ``dealer
property'' for sales of timberland. This change is accomplished by
adding a new subparagraph to Sec. 857(b)(6). Under previous law, which
was not amended, Sec. 857(b)(6)(C) provided for a safe harbor from the
prohibited transaction tax from sales of rental property if certain
requirements were met (the Rental Safe Harbor). Rules of application
relating to the Rental Safe Harbor were contained in Sec. 857(b)(6)(D).
Further, Sec. 857(b)(6)(E) specifically provided that the Rental Safe
Harbor was merely a safe harbor, and a REIT that failed to meet the
safe harbor still could avoid the 100% tax by applying a facts and
circumstances test as though the Rental Safe Harbor and the attendant
rules of application had not been enacted.
Section 321 of the Jobs Act, entitled ``Modification of Safe Harbor
Rules for Timber REITs,'' (emphasis added), added a new subparagraph
(D) to Sec. 857(b)(6) that establishes a safe harbor for property held
for the production of timber (the Timber Safe Harbor). It did so merely
by redesignating Sec. Sec. 857(b)(6)(D) and (E) as
Sec. Sec. 857(b)(6)(E) and (F) and inserting new subparagraph (D).
2. Omission of Cross References Including Rules of Application of
Timber Safe Harbor and Specific Treatment of Timber Safe Harbor as a
Safe Harbor
Although the Jobs Act created the Timber REIT Safe Harbor, it made
no other changes to the provisions that referenced subparagraph (C) of
Sec. 857(b)(6), the Rental Safe Harbor. As a result, the rules of
application contained in former Sec. 857(b)(6)(D) (redesignated
Sec. 857(b)(6)(E)) were not extended to the Timber Safe Harbor. Perhaps
more importantly, the rules of former Sec. 857(b)(6)(E) (redesignated
Sec. 857(b)(6)(F)), allowing a REIT to treat the Rental Safe Harbor as
merely a safe harbor, were not extended to the Timber Safe Harbor. As a
result, one could make the negative inference that a timber REIT, which
under prior law could avoid the 100% prohibited transaction tax if its
sold property was not ``dealer property'' after application of a facts
and circumstances analysis, could not do under post-Jobs Act law if it
failed to meet the specific Timber Safe Harbor.
3. Proposal
Both the rules of application and the provision treating the Rental
Safe Harbor as merely a safe harbor should be extended to apply to
timberland sales. Specifically, both subparagraphs (E) and (F) to
Sec. 857(b)(6) should be amended to make reference to subparagraph (D)
after the reference to subparagraph (C). As a result, property sales by
timber REITs, like property sales by REITs that own rental property,
will be judged based on the rules of application of Sec. 857(b)(6)(E).
Furthermore, adding the reference to subparagraph (D) (the Timber Safe
Harbor) in Sec. 857(b)(6)(F) will make clear that the Timber Safe
Harbor is in fact merely a safe harbor to avoidance of the 100%
prohibited transactions tax, rather than the only way for a transaction
to not be considered a prohibited transaction.
F. Clarification that REIT is not ``Pass-Thru Entity'' Under New
Section 470
1. Background
Section 470, added by the Jobs Act, prohibits a taxpayer from
claiming a deduction in excess of the taxpayer's gross income with
respect to the lease of ``tax-exempt use property.'' \2\ The term
``tax-exempt use property'' is defined by reference to section 168(h),
which includes: (i) tangible property leased to tax-exempt entities;
\3\ and, (ii) any property owned by a pass-thru entity with a tax-
exempt entity as an owner if the pass-thru entity's allocation of items
to the tax-exempt does not constitute a qualified allocation.\4\ Thus,
under section 168(h) and, in turn, section 470, tax-exempt use property
includes not only real property leased to tax-exempt entities but also
all other real property, regardless of its use, owned by a pass-thru
entity with a tax-exempt or foreign owner.\5\
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\2\ Section 470(a).
\3\ Id. Sec. 168(h)(1).
\4\ Id. Sec. Sec. 168(h)(6)(A), (E).
\5\ Id. Sec. 168(h)(6)(A).
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2. Issue
Our concern arises from the fact that neither sections 470 and
168(h) nor the accompanying legislative history defines a pass-thru
entity for this purpose. Adding to the uncertainty is the fact that,
notwithstanding the general tax treatment of a REIT as a corporation,
there are a few instances in the Code in which a pass-thru entity is
defined to include a REIT.\6\
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\6\ Id. Sec. Sec. 1(h)(10)(B); 860E(e)(6)(B); 1260(c)(2).
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The statutory language and legislative history clearly indicate
that REITs were not the target of this provision. Instead, section 470
was designed to prevent taxpayers from claiming tax benefits generated
in ``Sale-In Lease-Out'' (``SILO'') transactions,\7\ which the IRS
recently declared to be abusive tax avoidance arrangements.\8\ First, a
REIT by definition is required to be taxable as a domestic
corporation.\9\ Further, section 1361(a)(2) states that ``[f]or
purposes of this title'' the term ``C corporation'' is defined as a
corporation that is not an S corporation. Thus, REITs are C
corporations for all purposes of the Code unless a Code section
otherwise expressly provides. As you know, widely held C corporations
rarely are considered pass-thru entities for federal income tax
purposes because they cannot pass through losses to their
shareholders.\10\ In fact, we are not aware of any IRS guidance holding
that a REIT is a pass-thru entity in the absence of express statutory
direction. Unlike other Code sections, neither section 168 nor section
470 provides that REITs are pass-thru entities rather than C
corporations.
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\7\ H.R. Rep. No. 108-548, pt. 1, at 313-14 (2004) (noting that the
prior law was ineffective in curtailing the ability of a tax-exempt
entity to transfer tax benefits to a taxable entity through certain
leasing arrangements); S. Rep. No. 108-192, at 198 (2003) (same).
\8\ Notice 2005-13, 2005-9 I.R.B. 1 (designating SILOs as a listed
transaction).
\9\ Section 857(a)(3).
\10\ See, e.g., section 469(a)(2), which applies the passive loss
rules only to individuals, estates, trusts, personal service
corporations, and closely held C corporations.
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Second, even prior to the enactment of section 470, REITs generally
had no incentive to engage in a SILO-type transaction because, unlike
traditional pass-thru entities (i.e., a partnership), REIT-level losses
or credits do not flow through to its shareholders. Further, a REIT
generally has little or no taxable income because it may deduct
dividends paid to shareholders, and it must distribute most of its
taxable income as dividends.\11\ Given the tax treatment of REITs,
there was no benefit to its shareholders for a REIT to create
deductible losses through a SILO arrangement. In fact, one of the most
attractive features of investing in a REIT is earning positive income
through the high dividend yield that results from the requirement that
a REIT must distribute at least 90 percent of its taxable income
annually.\12\ In most cases, investing in a SILO arrangement actually
would have an adverse effect on a REIT because the losses associated
with a SILO would decrease REIT taxable income, which, in turn, would
decrease the all-important dividend yield of the REIT's stock. Further,
presumably the promoters of SILOs price into the transaction tax
benefits that investors receive from artificial losses or credits.
Thus, SILO transactions should generate less cash to REITs and their
investors compared to the economic leasing transactions that are the
basis on which REIT investors evaluate REIT management.
---------------------------------------------------------------------------
\11\ Id. Sec. 561.
\12\ Id. Sec. 857(a)(1).
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A REIT is principally evaluated by the public markets based on the
consistency of its income generating capacity and its ability to grow
the income stream over time. Thus, a REIT property usually does not
generate deductions in excess of income, other than when it is newly
constructed or renovated and has not yet ``stabilized'' its tenant
base. Yet, even though section 470 would rarely operate to suspend
losses for a REIT property, an SEC-registered REIT would be compelled
to undertake substantial verification procedures to document each
property's profitability. Public REITs already are expending millions
to comply with section 404 of the Sarbanes-Oxley Act, and to layer on
top of this extensive review procedure additional inquiries for the
rare instance when a property generates a net loss that cannot even be
allocated to a REIT shareholder is excessive, unnecessary, and
unproductive both for the REIT and the IRS. This waste of resources is
particularly acute with respect to transactions entered into in 2004,
for which REITs are currently preparing SEC filings.
3. Proposal
For these reasons, NAREIT respectfully requests that the TTCA
clarify that, for purposes of sections 470 and 168, a REIT is not pass-
thru entity within the context of section 168(h)(6)(E).
NAREIT thanks the Committee for the opportunity to comment on this
important legislation.
National Council of Farmer Cooperatives
Washington, DC 20001
August 31, 2005
United States House of Representatives
Committee on Ways and Means
1102 Longworth House Office Building
Washington, DC 20510
Dear Chairman Thomas:
The National Council of Farmer Cooperatives (NCFC) respectfully
submits the following comments on H.R. 3376, the Tax Technical
Corrections Act of 2005 (the Act). NCFC would like to commend you for
your leadership on the passage of the ``American Jobs Creation Act''
(AJCA). We believe the new Internal Revenue Code Section 199 deduction
for qualified production activities income, created by the AJCA, will
spur economic growth and will help farmer cooperatives and their
members realize greater income potential.
Farmer cooperatives provide over 300,000 jobs in the United States,
with a total payroll in excess of $8 billion, and contribute
significantly to the economic well-being of rural America. Since 1929,
NCFC has been the voice of America's farmer cooperatives. Our members
are regional and national farmer cooperatives, which are in turn
comprised of more than 3,000 local farmer cooperatives across the
country.
Our comments address several issues relating to the implementation
of the Section 199 deduction.
Clarify Language Regarding Denial of Deduction for Portion of Qualified
Payments
The Act proposes the language of Code Section 199(d)(3)(B) as
follows:
``(B) COOPERATIVE DENIED DEDUCTION FOR PORTION OF QUALIFIED
PAYMENTS.--The taxable income of a specified agricultural or
horticultural cooperative shall not be reduced under section 1382 by
reason of that portion of any qualified payment as does not exceed the
deduction allowable under subparagraph (A) with respect to such
payment.''
Our understanding of the meaning and purpose of the language is
illustrated by the following example:
Assume a ``specified agricultural or horticultural cooperative''
has net earnings of $1 million for its fiscal year ended September 30,
2006, from marketing the agricultural or horticultural products of its
members. All of the net earnings are qualified production activities
income by reason of Section 199(d)(3)(D). The cooperative markets its
members' products on a buy/sell rather than a pooling basis.
On December 15, 2006, the cooperative pays a patronage dividend of
$1 million to its members and notifies its members that it is passing
through $30,000 of Section 199 deductions. Patron A, whose products
account for 1 percent of the products marketed by the cooperative for
the year, receives a $10,000 patronage dividend and is notified that
$300 of Section 199 deductions has been passed through to him or her.
In this example, it is our understanding that the ``qualified
payment'' (i.e., the portion of the patronage dividend ``attributable
to qualified production activities income with respect to which a
deduction is allowed to such cooperative under subsection (a)'') is
$30,000. In this case, since the cooperative passed through the full
amount of its Section 199(a) deduction for the year, the ``portion of
any qualified payment as does not exceed the deduction allowable under
subparagraph (A) with respect to such payment'' is also $30,000. This
language refers to the deduction allowable to members of the
cooperative and the members as a group are entitled to deduct $30,000
under Section 199(a).
Under Section 199(d)(3)(B), the cooperative is entitled to claim a
patronage dividend deduction of $970,000 (i.e., its patronage dividend
reduced by the amount of Section 199 deduction passed through) and to
claim a Section 199 deduction of $30,000 on its 9/30/2006 return. The
members (assuming that they are all calendar year taxpayers) are
required to include $1,000,000 of patronage dividends in income and are
entitled to deduct $30,000 under Section 199(a) on their 2006 income
tax returns.
Absent any special language in Section 199, the cooperative in the
example would have been entitled to both a Section 1382 patronage
dividend deduction of $1 million and a Section 199(a) deduction of
$30,000. The language of Section 199(d)(3)(B) is obviously intended to
prevent both the cooperative and its members from claiming the benefit
of the portion of the Section 199(a) deduction passed through.
However, the approach taken in the Technical Correction, namely
reducing the cooperative's patronage dividend deduction, while allowing
both the cooperative and its members to claim a Section 199 deduction
in the amount of $30,000, is counter-intuitive. We are concerned that
the IRS might some day argue that both the cooperative's patronage
dividend deduction and its Section 199(a) deduction should be reduced
by the amount passed through, a clearly incorrect result. There is no
clear statement in the Technical Correction that the cooperative
remains entitled to the full Section 199(a) deduction.
We assume that the language was drafted as it was in order to leave
the cooperative (and not the members) accountable if it is later
determined on audit that the proper amount of the Section 199 deduction
for the year was less than $30,000. We do not disagree with that
approach to treating audit adjustments.
At a minimum, we suggest that an explanation (and perhaps an
example) should be set forth in any committee report that accompanies
the Tax Technical Corrections Act of 2005 so that the language of
Section 199(d)(3)(B) will not later be misconstrued.
We also question why the phrase ``as does not exceed'' is used in
this section instead of simply stating that the patronage dividend will
be reduced by an amount ``equal'' to the Section 199(a) deduction
passed through. Are there instances where the adjustment to the
patronage dividend can be less than the amount of the Section 199(a)
deduction passed through? The language seems to suggest that might be
the case.
Clarify Timing of the Deduction
The statutory language as proposed in the Act (Code Section
199(d)(3)(A)) provides that any person who receives a Section 199
``qualified payment'' from an agricultural or horticultural cooperative
will be allowed a deduction ``for the taxable year in which such
payment is received'' so long as the amount is ``identified by such
cooperative in a written notice mailed to such person during the
payment period described in section 1382(d).''
It is likely that many cooperatives, particularly those that pay
patronage dividends relatively soon after year end, will not yet know
the precise amount of their Section 199 deduction for a year when
patronage dividends are paid. To determine the amount of the Section
199 deduction, a cooperative's tax return will need to be substantially
complete. However, Section 6072(d) provides cooperatives with a due
date (without extensions) for their tax returns that is eight and one-
half months after year end.
Consequently, the effect of the provision as written is to require
taxpayers to take the deduction at the time they receive their
patronage payment (part of which is the ``qualified payment''), even
though they may be notified of the pass-through of the Section 199(a)
deduction after they file their returns. This result would require
taxpayers to file amended returns. A more efficient solution would be
to allow taxpayers to take the deduction in the tax year in which they
receive notice from the cooperative.
To illustrate our concern with the timing of the deduction, we
offer the following example:
Assume the facts are the same as the prior example except that the
cooperative also engages in other nonmember/nonpatronage activities
which result in net nonmember/nonpatronage income for the year of
$500,000. At the time the cooperative pays its $1 million patronage
dividend deduction (December 15, 2006), the cooperative has not yet
completed its tax return and is uncertain as to the precise amount of
its qualified production activities income and its Section 199(a)
deduction. When the cooperative pays its patronage dividend, it passes
through $25,000 of Section 199(a) deductions, determined based upon a
conservative estimate. When the cooperative completes its 9/30/2006 tax
return for filing in June 2007, the cooperative determines that it is
entitled to a $30,000 Section 199 deduction for the year with respect
to the business it conducts with its members. The cooperative sends
notices to its members before June 15, 2007, notifying them that an
additional $5,000 of Section 199(a) deductions passes through to them.
Must members amend their 2006 income tax returns if they want to
claim the benefit of the additional Section 199(a) deductions passed
through to them on June 15, 2007? That is what the statute seems to
require. Given that many agricultural and horticultural cooperatives
have thousands of members, that does not seem to us to be a practical
result.
Clarify Deduction Applies to Goods Manufactured, Produced, Grown, or
Extracted within the United States
Code Section 199(c)(4)(A)(i)(I) provides that income attributable
to domestic production activities is income derived from ``qualifying
production property which was manufactured, produced, grown, or
extracted by the taxpayer in whole or in significant part within the
United States . . .'' (emphasis added).
However, the language of Section 199(d)(3) leaves out these
critical words in several places. The first is in the definition
confirming that supply cooperatives can qualify as ``specified
agricultural and horticultural cooperatives.'' Section 199(d)(3)(F)(i)
provides that it applies to cooperatives engaging ``(i) in the
manufacturing, production, growth, or extraction in whole or in
significant part of any agricultural or horticultural products.'' In
addition, Section 199(d)(3)(D) states that cooperatives ``shall be
treated as having manufactured, produced, grown, or extracted in whole
or significant part any qualifying production property marketed by the
organization which its patrons have so manufactured, produced, grown,
or extracted.''
We recommend that the phrase ``within the United States'' be added
to Sections 199(d)(3)(D) and 199(d)(e)(F)(i).
Eliminate Ambiguity Regarding Supply Cooperatives
The statutory language as proposed in the Act (Code Section
199(d)(3)(F)(i)) provides that the pass-through provisions apply to
Subchapter T cooperatives engaged ``in the manufacturing, production,
growth, or extraction in whole or significant part of any agricultural
or horticultural product . . .''
This language is intended to include supply cooperatives, as was
made clear in Footnote 33 of the Managers' Report to the AJCA (H. Rept.
108-755):
``33. For this purpose, agricultural or horticultural products also
include fertilizer, diesel fuel and other supplies used in agricultural
or horticultural production that are manufactured, produced, grown, or
extracted by the cooperative.''
See also Notice 2005-14, 2005-7 I.R.B. 498 (February 14, 2005),
Section 4.07 (last sentence), which repeats this language.
Clearly, Congress intended that supply cooperatives be eligible for
the pass-through provision. We recommend that the statute be clarified
as follows (clarifying language is italicized):
``(F) SPECIFIED AGRICULTURAL OR HORTICULTURAL COOPERATIVE.--For
purposes of this paragraph, the term `specified agricultural or
horticultural cooperative' means an organization to which part I of
subchapter T applies which is engaged----
``(i) in the manufacturing, production, growth, or extraction in
whole or significant part in the United States of any agricultural or
horticultural products (including any supplies used in agricultural or
horticultural production), or
``(ii) in the marketing of agricultural or horticultural
products.''
Clarify Treatment of Wage Limitation
The statute should clarify that the Section 199 deduction of a
cooperative is subject to the W-2 wages limitation at the cooperative
level only and that it is not subject to a second W-2 wages limitation
at the patron level if it is passed through to the patron.
We recommend that the statute be clarified by adding the following
sentence at the end of Section 199(d)(3)(A): ``The limitation of
Section 199(b) does not apply to the amount received from an
organization to which part I of subchapter T applies.''
We appreciate the opportunity to make comments with respect to the
application of Section 199 to farmer cooperatives and their members. We
would be happy to answer any questions you may have regarding our
comments; please direct your questions to Marlis Carson, General
Counsel, at 202-879-0825.
Jean-Mari Peltier
President and CEO
Statement of Professor Gail Levin Richmond, Nova Southeastern
University Law Center, Fort Lauderdale-Davie, Florida
This statement is submitted with regard to Act section 2(ee), which
would amend section 121(d)(10), as added by section 840 of the American
Jobs Creation Act of 2004. In my comments, which relate to Act section
2(ee)(2), I refer to the Code section involved as section 121(d)(11) (a
correction I assume will pass as introduced).
The proposed change to section 121(d)(11) is an improvement over
the version enacted in the American Jobs Creation Act of 2004. But, as
I discuss below, it may not fully solve problems caused by the current
statutory language.
The American Jobs Creation Act of 2004 added a new requirement to
section 121. Property acquired in a section 1031 like-kind exchange is
ineligible for the section 121 exclusion if it is sold within five
years of the exchange. That provision had a worthy purpose. Given the
increase in land prices, a taxpayer could avoid significant gain
recognition with respect to unimproved land held for investment by
exchanging it for improved real estate on which a house was situated.
The taxpayer could rent the house (or merely hold it for future
appreciation) for the minimum period needed to convince the tryer of
fact that a section 1031 like-kind exchange actually occurred. (Because
both the property transferred and the property received must be held
for business or investment use, a taxpayer could not qualify for like-
kind exchange treatment by exchanging investment land for a principal
residence.) After the obligatory waiting period, which might be as
short as a year, the taxpayer could move into the house, live in it for
two years as a principal residence, and sell it.
By following that path, a married couple could shelter up to
$500,000 of gain, much of which could be attributable to investment
land (whose basis carried over to the home) that was never used as a
residence, much less a principal residence. Because section 121(c)
relief was available if unforeseen circumstances triggered an earlier
sale, taxpayers might still exclude a significant portion of their gain
even if the sale occurred before two years of residence.
In attacking that potential abuse, current section 121(d)(11)
failed to use precise language. It applied the five-year wait period if
``a'' taxpayer acquired the property in a section 1031 transaction. The
current language is:
If a taxpayer acquired property in an exchange to which section
1031 applied, subsection (a) shall not apply to the sale or exchange of
such property if it occurs during the 5-year period beginning with the
date of the acquisition of such property.
As worded, the five-year taint applies to anyone, even a good faith
purchaser for value, if ``a'' taxpayer acquired the property in a
section 1031 exchange. A taxpayer who purchased the property from the
person who entered into the exchange would have a five-year wait for
section 121 eligibility even if he or she had never been involved in
the type of transaction the section was enacted to discourage.
H.R. 3376 would change the language to eliminate the indefinite
reference to. It substitutes the following language:
If a taxpayer acquires property in an exchange with respect to
which gain is not recognized (in whole or in part) to the taxpayer
under subsection (a) or (b) of section 1031, subsection (a) shall not
apply to the sale or exchange of such property by such taxpayer (or by
any person whose basis in such property is determined, in whole or in
part, by reference to the basis in the hands of such taxpayer) during
the 5-year period beginning with the date of such acquisition.
The proposed language removes the potential taint applied to a good
faith purchaser. It does not, however, solve every potential problem.
Before the Committee finalizes the language of section 121(d)(11), I
hope it will consider whether two groups of individuals should be
exempted from the five-year taint:
1. Taxpayers who inherit the property. If section 1014 remains the
law, they will be exempt from section 121(d)(11) because they do not
take the basis used by the taxpayer who entered into the exchange. But,
if section 1014 is repealed and replaced by section 1022 carryover
basis (currently scheduled for 2010), the recipient will be unable to
use section 121 until the full five-year taint expires. This could work
a significant hardship in the situation of an unexpected death.
2. Taxpayers who receive the home in a divorce and must sell for
unforeseen circumstances related to health or finances. If the marriage
occurred after the exchange, it is possible the recipient spouse
received no benefit from the original section 1031 tax deferral. But,
because of the section 1041 carryover basis rules, that spouse will be
burdened by the full built-in gain and will be subject to the taint
period. Even if both spouses benefited from the exchange, only the
recipient spouse bears the five-year taint. Perhaps this result could
be improved if section 121(d)(11) allowed a recipient spouse to qualify
for section 121(c) relief based on unforeseen circumstances. Section
121(d)(11) currently appears to preclude such relief. As written,
section 121(d)(11) is a trap for unwary domestic relations lawyers.
I have previously discussed problems with the current version of
this Code section. See, e.g., Gail Levin Richmond, Section 121(d)(10):
An Article Addressing An Article, Tax Notes, February 14, 2005, at 797;
Mona L. Hymel, Roberta Mann & Gail Richmond, The American Jobs Creation
Act's Impact on Individual Investors: A Monster of Complexity?, 22
Journal of Taxation of Investments 187, 198-204 (2005). I do not
represent any client or other party in making these comments or in my
other writings on this topic.
Organization for International Investment
Washington, DC 20036
August 31, 2005
The Honorable Bill Thomas
Chairman of the Ways and Means Committee
2208 Rayburn House Office Building
United States House of Representatives
Washington, DC 20515
The Honorable Charles Grassley
Chairman of the Finance Committee
135 Hart Senate Office Building
United States Senate
Washington, DC 20510
The Honorable Max Baucus
Ranking Minority Member of the Finance Committee
511 Hart Senate Office Building
United States Senate
Washington, DC 20510
Dear Chairmen Thomas and Grassley and Senator Baucus:
The Organization for International Investment (``OFII'')
appreciates your introduction of the Tax Technical Correction Act of
2005 in July. The enactment of this legislation will resolve a number
of ambiguities in the American Jobs Creation Act of 2004 (``AJCA''),
permitting taxpayers to move ahead with their tax compliance and
planning. OFII offers the following comments.
OFII respectfully requests that an additional technical correction
relating to the repatriation provision in section 422 of the AJCA be
included in the enacted legislation. The correction would clarify that
loans from foreign parent companies and their foreign affiliates to
related controlled foreign corporations (``CFCs'') are not related
person indebtedness (``RPI'') within the meaning of section 965(b)(3)
and that other cash transfers from foreign parent companies and their
foreign affiliates to CFCs are not subject to the anti-abuse provision
to the RPI limitation contained in the proposed technical corrections
legislation. This clarification is essential so that the RPI limitation
reduces section 965 benefits solely for the U.S.-funded dividends
Congress intended and U.S. multinationals with foreign parents are
treated in the same manner under section 965 as U.S. multinationals
with U.S. owners.
Section 965 is intended to benefit net remittances of cash from
CFCs to their U.S. shareholders. No net remittance of cash occurs if a
CFC dividend is funded by a loan from its U.S. shareholder. To ensure
that dividends eligible for the section 965 dividends received
deduction are not funded by a U.S. shareholder, Congress included the
RPI limitation in section 965(b)(3). The Conference Report for the AJCA
is very clear on the RPI limitation's purpose:
This [RPI] rule is intended to prevent a deduction from being
claimed in cases in which the U.S. shareholder directly or indirectly
(e.g., through a related party) finances the payment of a dividend from
a controlled foreign corporation. In such a case, there may be no net
repatriation of funds, and thus it would be inappropriate to provide
the deduction.
Under the RPI limitation, to the extent that a majority U.S.
shareholder has indebtedness outstanding to CFCs at the end of the year
of a section 965 election in amounts greater than its indebtedness
outstanding to CFCs as of October 3, 2004, the eligible dividend amount
is reduced dollar-for-dollar.\1\ To define ``related person''
indebtedness for purposes of the RPI limitation, Congress incorporated
by cross-reference the related person definition routinely used for
U.S. shareholders and CFCs for subpart F purposes. That definition, in
section 954(d)(3), was drafted long before foreign-parented U.S.
multinationals were common. The related person definition in section
954(d)(3), read literally, unfortunately encompasses not only majority
U.S. shareholders of CFCs but their foreign parents and foreign
subsidiaries of those foreign parents as well. The implication of this
literal reading, which we believe was unintended, is that loans
originating abroad--made by foreign parents and their foreign
subsidiaries--to related CFCs are swept into the RPI definition and
therefore may reduce section 965 benefits.
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\1\ The statutory language is: ``The amount of dividends which
would (but for this paragraph) be taken into account under subsection
(a) shall be reduced proportionately for each shareholder by the excess
(if any) of--(A) the amount of indebtedness of the controlled foreign
corporation to any related person (as defined in section 954(d)(3)) as
of the close of the taxable year for which the election under this
section is in effect, over (B) the amount of indebtedness of the
controlled foreign corporation to any related person (as so defined) as
of the close of October 3, 2004. All controlled foreign corporations
with respect to which the taxpayer is a United States shareholder shall
be treated as 1 controlled foreign corporation for purposes of this
paragraph.'' The initial measurement date may now be the nearest
quarter-end to October 3, 2004, by taxpayer election. See Notice 2005-
38, section 7.01(b)(vi).
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As indicated above, the RPI limitation is intended to police CFC
borrowing from U.S. persons, not foreign persons. Just as CFC-to-CFC
loans are generally excluded from the RPI definition, so too should
loans from foreign parents (or their foreign subsidiaries) to CFCs
generally be excluded since neither category of loan normally
originates in the United States and, therefore, reduces net CFC
remittances to the United States.
As drafted, the proposed technical corrections legislation would
add an anti-abuse provision to the RPI limitation. The legislation
would grant Treasury regulatory authority to prevent the avoidance of
the purposes of the RPI limitation, including regulations providing
that cash dividends shall not be eligible for section 965 benefits to
the extent such dividends are attributable to the direct or indirect
transfer (including through the use of intervening entities or capital
contributions) of cash or other property from a related person to a
CFC. Like loans from foreign parents or their foreign subsidiaries to
CFCs, transfers of cash or other property from foreign parents or their
foreign subsidiaries to CFCs, as long as not originating in the U.S.,
should not limit section 965 benefits.\2\ The same is true for deemed
capital contributions under the Plantation Patterns \3\ doctrine from
foreign parents (or their foreign subsidiaries) that have guaranteed
CFC debt. Such deemed capital contributions should be considered to go
directly from the guarantor to the borrowing CFC and not through the
intermediary U.S. parent.\4\
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\2\ The proposed technical corrections legislation grants ample
discretionary authority to the Service and Treasury to address any
abuses that may arise involving loans and other property transfers from
foreign parents to related CFCs. Specifically, the legislation allows
the Service and Treasury to limit section 965 benefits in the case of
indirect as well as direct funding of CFC dividends by U.S.
shareholders. Under this authority, the Service and Treasury may, on a
discretionary basis, subject, for example, a foreign parent-to-CFC loan
to the RPI limitation if it is funded indirectly by a U.S. shareholder
via a loan or distribution from the U.S. shareholder to the lending
foreign parent.
\3\ Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th
Cir. 1972).
\4\ We recommend the points discussed in the last three sentences
of this paragraph be included in the committee reports as examples of
how Congress intends the grant of regulatory authority to be exercised
by the Service and Treasury.
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Many foreign-parented multinationals have CFCs with substantial
earnings the repatriation of which section 965 was intended to
encourage. The domestic reinvestment plan rules (at section 965(b)(4))
ensure that the amount of those repatriated earnings will be spent on
permitted investments in the United States. As drafted, the RPI
limitation will discourage foreign members of foreign-owned
multinational groups from funding related CFC dividends otherwise
eligible for section 965 treatment and, thus, thwart the purpose of the
repatriation incentive and treat such groups unfairly.
In summary, the technical corrections legislation and accompanying
explanatory language, should clarify that, when the parent company of a
multinational group to which a CFC belongs is foreign: (1) the RPI
limitation generally does not apply when CFC dividend funding is
provided by a related foreign person; and (2) funding for CFC dividends
may be provided by a related foreign person. The following technical
correction language would accomplish this result:
Paragraph (3) of section 965(b) is amended by inserting ``, except
that no foreign person shall be considered a related person for
purposes of this paragraph'' after ``section 954(d)(3).''
Re: Suggested Technical Correction Regarding Anti-Inversion Legislation
(New Section 7874 of the Code)
OFII requests a technical correction to the American Jobs Creation
Act of 2004 with regard to new section 7874. We note that the Senate
Conference Report included an exception from the application of section
7874 for the direct or indirect acquisition of the properties of a U.S.
corporation no class of the stock of which was traded on a public
exchange for the preceding four year period. We further note that this
exception was not included in the final legislation and understand that
you are not entertaining technical corrections to include such an
exception. The language that we propose is not intended to include such
an exception. We suggest adding the following language in bold italics
to section 7874(g):
(g) Regulations.--The Secretary shall provide such regulations as
are necessary to carry out this section, including:
(1) regulations providing for such adjustments to the application
of this section as are necessary to prevent the avoidance of the
purposes of this section, including the avoidance of such purposes
through----
(i) the use of related persons, pass-through or other noncorporate
entities, or other intermediaries, or
(ii) transactions designed to have persons cease to be (or not
become) members of expanded affiliated groups or related persons; and
(2) regulations as are necessary to exempt certain transactions
from the application of this section that do not involve the relocation
of a top-tier U.S. parent company as a top-tier foreign parent company,
including exemptions for internal company restructuring transactions.
Thank you for your consideration of these matters. If your staff
has questions about this letter or we can otherwise be of further
assistance, please have them call us.
Sincerely,
Todd M. Malan
President & CEO
Subpart F Shipping Coalition
Washington, DC 20001
August 31, 2005
The Honorable William M. Thomas
Chairman
Committee on Ways and Means
1102 Longworth Building
Washington, DC 20515
Dear Mr. Chairman:
We are submitting these comments regarding the technical
corrections legislation (H.R. 3376) on behalf of the Subpart F Shipping
Coalition and certain additional shipping companies (the ``Shipping
Coalition''), a group of the United States (``U.S.'') controlled
foreign-flag shipping companies that are affected by U.S. international
taxation policy. The Coalition supports strongly the shipping
provisions of the American Jobs Creation Act of 2004 (the ``Act'').
PROPOSED TECHNICAL CORRECTION RELATING TO REPEAL OF SUBPART F FOREIGN
BASE COMPANY SHIPPING INCOME RULES
Section 415 of the Act repealed the subpart F rules with respect to
``foreign base company shipping income'' to restore the competitiveness
of U.S.-owned foreign subsidiaries engaged in shipping operations.
Despite the repeal, the income of many of these U.S.-owned foreign
shipping companies could (depending on the future shape of Treasury
regulations) still become subject to subpart F's rules as ``foreign
base company services income,'' thereby frustrating Congress's
expressed intent. In a similar fashion, dividends, interest, or gains
that would have been foreign base company shipping income under prior
law could still become subject to subpart F taxation as ``foreign
personal holding company income,'' equally frustrating Congress's
intent. We propose that Congress adopt a technical correction,
described below, clarifying that (i) income that would have been
foreign base company shipping income prior to the Act will not be
treated as foreign base company services income and (ii) certain
dividends, interest, and gains that would have been foreign base
company shipping income under prior law, will not be treated as foreign
personal holding company income, after the effective date of the Act.
Background
The American Jobs Creation Act of 2004 (the ``Act'') represents the
most far reaching and significant effort in recent history to restore
the international competitiveness of U.S. shipping. This industry has
experienced a significant and steady decline over the last twenty-five
years, and the nation's technical and support capabilities for this
important sector have been eroded as a result. In its 2002 Report on
Corporate Inversion Transactions, Treasury specifically identified the
current taxation on income earned by U.S.-owned foreign shipping
subsidiaries as a competitive disadvantage relative to foreign-owned
corporations. The repeal of subpart F's rules concerning foreign base
company shipping income in Section 415 of the Act (accompanied by the
enactment of a tonnage tax system in subchapter R of the Act) was
intended to reverse this decline and to restore the competitiveness of
the industry for both economic and national security reasons.
In repealing the foreign base shipping company rules, Congress
sought to end the competitive disadvantage of the U.S.-owned shipping
subsidiaries that fell within anti-deferral rules of subpart F. The
House Ways and Means Committee noted: \1\
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\1\ H. Rpt. 108-548 at 209.
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In general, other countries do not tax foreign shipping income,
whereas the United States imposes immediate U.S. tax on such income.
The uncompetitive U.S. taxation of shipping income has directly caused
a steady and substantial decline of the U.S. shipping industry. The
Committee believes that this provision will provide U.S. shippers the
opportunity to be competitive with their tax-advantaged foreign
competitors.
Unfortunately, there are several regulations that if applied
without deference to the intent of Congress in the Jobs Act could
frustrate the realization of the objective of the Jobs Act. The first
of those, involving the potential application of Treasury's regulations
under Section 883 of the Code, was addressed constructively by Treasury
earlier this month. These regulations govern the exclusion from gross
income of the income derived from the international operation of ships
and aircraft by certain corporations organized in qualified foreign
countries. In a recent notice, Treasury stated that the regulation's
anti-abuse provision (commonly referred to as the income inclusion
test) would be applied without regard to the repeal of the foreign base
shipping income rules by the Jobs Act, so that U.S.-owned foreign
subsidiaries would not be unfairly penalized under those regulations.
The industry faces a comparable challenge through the potentially
inappropriate application of IRS regulations designed to capture
services income. In order to compete effectively, U.S. shipping
companies provide certain services to their foreign subsidiaries. For
instance, while the principal asset generating income is the ship owned
by the foreign subsidiary, the U.S. parent often assists in providing
or arranging for legal, engineering, marketing and other similar
services with respect to the vessel's operation. That should not lead
to the taxation of the vessel's operating income under subpart F
through the recharacterization of that income as services income. Just
like Treasury's approach to the Section 883 regulations, U.S.-owned
shipping subsidiaries benefitting from this assistance should not be
penalized merely because of the Jobs Act's changes. This is
particularly the case where the foreign subsidiary has procured those
services through an arms-length arrangement with its parent.
For limited liability and other purposes, shipping companies
generally conduct their shipping operations through the use of multiple
subsidiary corporations that own and register the vessels. In some
cases, these companies are joint ventures where one of the owners is a
foreign subsidiary of a U.S.-based shipping company. An additional
challenge to the industry is the inappropriate possible application of
the foreign personal holding company income rules to dividends,
interest, and gains attributable to shipping income that foreign
subsidiaries of U.S.-based shipping companies may receive or realize
with respect to the lower-tier subsidiaries.
The overall purpose of the Jobs Act was to create jobs in the
United States, particularly in sectors where sophisticated and high
technology U.S. workers could be competitive in international markets.
It would be contrary to the purpose of the Act to tax the ship
operating income of foreign corporations under subpart F merely because
U.S. workers from affiliated companies are able to provide technical
and managerial assistance to those corporations, or because of the fact
that ships are held in lower-tier subsidiaries.
Foreign Base Company Services Income
Foreign base company services income of a controlled foreign
corporation (``CFC'') is defined as income (whether in the form of
compensation, commissions, fees, or otherwise) derived in connection
with the performance of technical, managerial, engineering,
architectural, scientific, skilled, industrial, commercial, or like
services which (1) are performed for or on behalf of any related person
and (2) are performed outside the country under the laws of which a CFC
is created or organized.\2\
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\2\ Code section 954(e).
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Under Treasury regulations, services subject to the foreign base
company services income rules include services performed by a CFC where
``substantial assistance'' contributing to the performance of such
services has been performed by a related person or persons.\3\ For this
purpose, assistance furnished by a related person or persons to the CFC
includes, but is not limited to, direction, supervision, services,
know-how, financial assistance (other than contributions to capital),
and equipment, material, or supplies.\4\ This has the effect of
subjecting all of the CFC's operating income to taxation under subpart
F merely because of the activities of its parent or other affiliates.
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\3\ Treas. reg. sec. 1.954-4(b)(1)(iv).
\4\ Treas. reg. sec. 1.954-4(b)(2)(ii)(a).
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Assistance furnished by a related person or persons to a CFC in the
form of direction, supervision, services, or know-how is generally not
considered to be ``substantial'' unless either (1) the assistance
provides the CFC with skills which are a principal element in producing
the income from the performance of such services by the CFC or (2) the
cost to the CFC of the assistance equals 50 percent or more of the
total cost to the CFC of performing the services performed by the
CFC.\5\ Also, assistance furnished by a related person or persons to a
CFC in the form of direction, supervision, services, or know-how is not
taken into account unless the assistance assists the CFC directly in
the performance of the services performed by the CFC.\6\ The
regulations contain various examples demonstrating the potential
application of these rules in cases where a parent corporation provides
assistance to its CFC.\7\
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\5\ Treas. reg. sec. 1.954-4(b)(2)(ii)(b).
\6\ Treas. reg. sec. 1.954-4(b)(2)(ii)(e).
\7\ See, Treas. reg. sec. 1.954-4(b)(3). See, also, GCM 38065, TAM
8127017, and PLR 8114015.
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Prior to the Act, the Code statutorily provided that foreign base
company shipping income would not be considered foreign base company
income under any other category of such income.\8\ That provision was
repealed as a ``conforming amendment'' in connection with the Act's
repeal of the foreign base company shipping income rules.\9\
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\8\ Code section 954(b)(6) (as in effect prior to the Act).
\9\ Act section 415(c)(2)(b).
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Foreign Personal Holding Company Income
The foreign personal holding company income (``FPHCI'') rules
subject to immediate subpart F taxation a CFC's dividends, interest,
royalties, rents, and annuities, and its gains (net of losses) from the
sale or exchange of property giving rise to such income.\10\ Prior to
the Act, dividends, interest, and gains relating to foreign shipping
income were treated as foreign base company shipping income and not as
foreign personal holding company income.\11\
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\10\ Code section 954(c)(1)(A), (B).
\11\ Code section 954(f) (as in effect before the Act) provided
that foreign base company shipping included:
(1) dividends and interest received from a foreign corporation in
respect of which taxes are deemed paid under section 902, and gain from
the sale, exchange, or disposition of stock or obligations of such
foreign corporation to the extent that such dividends, interest and
gains are attributable to foreign base company shipping income, and
. . . Except as provided in paragraph (1), such term shall not
include any dividend or interest income which is foreign personal
holding company income (as defined in subsection (c)).
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The Potential Problems
The foreign base company services income rules, as they have been
expansively interpreted by the Treasury ``substantial assistance''
regulations, raise a concern regarding their potential application to
CFC shipping income. U.S.-owned shipping operations may have
involvement of the U.S. parent corporation in the operation of foreign
shipping subsidiaries. This involvement by the parent company is also
the case for foreign-based competitors.
Prior to the Act, the Code clearly provided that foreign base
company shipping income would not be treated as foreign base company
income under any other potentially applicable category of such income.
But for the current regulatory provision discussed below, the Act's
conforming amendment could open the possibility that shipping income
will become subject to immediate subpart F taxation as foreign base
company services income in the future.
Current Treasury regulations provide that foreign base company
services income does not include, for taxable years beginning after
December 31, 1975, foreign base company shipping income (as determined
under Treas. reg. sec. 1.954-6).\12\ However, there is a concern that
in light of the ``conforming amendment'' discussed above, the Treasury
Department may consider modifying this regulatory provision.
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\12\ Treas. reg. sec. 1.954-4(d)(3).
---------------------------------------------------------------------------
This concern results from the fact that international shipping
operations are generally global in scope, and may involve the services
of many related and unrelated companies. Vessel owners typically employ
the assistance of brokers, agents, technical managers and economic
managers. They should not be prohibited from employing the assistance
of related U.S. companies that may be engaged in those services, since
the purpose of the Jobs Act was to restore those capabilities in the
United States. Obviously, the goal of Congress in repealing the subpart
F shipping income rules would be frustrated if U.S. shipping companies
remained subject to immediate subpart F taxation on their shipping
income under some other provision of the foreign base company income
rules.
The FPHCI rules may present a problem with respect to foreign
shipping income earned through lower-tier foreign subsidiaries. The use
of lower-tier subsidiaries for conducting shipping operations is
typical in the industry. When lower-tier foreign subsidiaries pay to
the CFC that owns them dividends or interest attributable to shipping
income, the FPHCI rules, absent a technical correction, could, in
certain circumstances, cause the dividend or interest income to become
subject to immediate federal income taxation even though it has not
been paid to the ultimate U.S. parent. Similarly, when the CFC sells or
disposes of a lower-tier subsidiary, the FPHCI rules could subject the
gain to immediate federal income taxation. It should be noted that
these foreign personal holding company income problems would not arise
if foreign shipping operations were conducted through a single CFC
entity rather than through lower-tier subsidiaries. Obviously, the goal
of Congress, in repealing the subpart F shipping income rules would
also be frustrated if U.S. shipping companies remained subject to
immediate taxation under the FPHCI rules because of the corporate
structure they have typically used.
The proposed technical correction below would clarify that income
that a CFC can show would have been foreign base company shipping
income prior to the Act, will not be treated as foreign base company
services income. This change will protect the operating income of the
CFC from recharacterization. It is without prejudice to the ability of
the Service by regulation or otherwise to require the related U.S.
company to recognize income reflecting the value of any assistance it
may provide to its foreign shipping subsidiary. The proposed technical
correction would also clarify that dividend, interest, and gain income
that would have been foreign base company shipping income under prior
law will not be treated as foreign personal holding company income.
Draft Technical Correction
AMENDMENT RELATED TO SECTION 415 OF THE AMERICAN JOBS CREATION ACT OF
2004----
Section 954(b) is amended by adding at the end thereof the
following new paragraph:
(7) Special Rules for Certain Shipping Income.--Income of a
corporation that would have been foreign base company shipping income
under paragraph (4) of subsection (a) (as in effect before its repeal
in the American Jobs Creation Act of 2004) shall not be considered
foreign base company income of such corporation under paragraph (3) of
subsection (a) and income that would have been foreign base company
shipping income under paragraph (1) of subsection (f) (as in effect
before its repeal in the American Jobs Creation Act of 2004) shall not
be considered foreign base company income under paragraph (1) of
subsection (a).
PROPOSED TECHNICAL CORRECTION RELATING TO INCENTIVES TO REINVEST
FOREIGN EARNINGS IN THE UNITED STATES
The Act creates a one-time opportunity for U.S. companies to
repatriate earnings from their foreign subsidiaries at a reduced rate
of tax. In order to qualify for this one-time opportunity, U.S.
companies must utilize such repatriated earnings as part of a
``domestic reinvestment plan'' designed to encourage domestic
employment. With the exception of certain related party indebtedness,
increased leverage is an accepted method of raising funds to facilitate
the repatriation of the benefited foreign earnings. Certain foreign
corporations engaged in international shipping, however, are severely
limited in the amount of indebtedness that they may efficiently incur
due to the application of an historic tax provision that has little, if
any, further relevance. We propose that Congress adopt a technical
correction, described below, clarifying that distributed amounts
related to previously excluded subpart F income withdrawn from foreign
base company shipping operations will qualify for the reduced tax rate,
thereby expanding the potential domestic reinvestment of foreign
earnings, in accordance with Congressional intent.
Background
Domestic corporations generally are taxed on all income, whether
derived in the United States or abroad. Income earned by a domestic
parent corporation from foreign operations conducted by foreign
corporate subsidiaries generally is subject to U.S. tax when the income
is distributed as a dividend to the domestic corporation. Until such
repatriation, the U.S. tax on such income generally is deferred, and
U.S. tax is imposed on such income only when repatriated. However,
under certain anti-deferral rules, the domestic parent corporation may
be taxed on a current basis in the United States with respect to
certain categories of passive or highly mobile income earned by its
foreign subsidiaries, regardless of whether the income has been
distributed as a dividend to the domestic parent corporation. One of
the main anti-deferral provisions in this context is the CFC rules of
subpart F. The U.S. tax owed on foreign-source income, whether earned
directly by the domestic corporation, repatriated as a dividend from a
foreign subsidiary, or included in income under the anti-deferral
rules, may be reduced through foreign tax credits, if any.\13\
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\13\ Code sections 901, 902, 960, 1291(g).
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Dividends received by a domestic corporation from its foreign
corporate subsidiaries are ordinarily not eligible for a dividends-
received deduction. Under section 965 of the Code, however, certain
cash dividends received by a United States corporate shareholder of a
CFC which are to be reinvested in the United States by such shareholder
are eligible for an 85-percent dividends-received deduction.\14\
Section 965 of the Code was introduced by the Act as an incentive to
repatriate and reinvest domestically foreign earnings that would
otherwise likely remain offshore. The deduction provided by section 965
of the Code is available only for a limited time.\15\ The deduction
does not apply to items that are not included in gross income as
dividends, such as subpart F inclusions or deemed repatriations under
section 956 of the Code. Further, cash dividends excluded from gross
income under section 959(a) of the Code are ineligible for the 85-
percent dividends-received deduction of section 965. The deduction is
allowed, however, for cash distributions excluded from gross income
under section 959(a) of the Code to the extent of subpart F income
resulting from dividends received by the CFC or a lower tier CFC.\16\
Without this exception, a U.S. shareholder of a second tier or lower
CFC would generally be unable to avail itself of section 965 of the
Code simply because the distributions themselves generated subpart F
income.
---------------------------------------------------------------------------
\14\ Code section 965(a)(1).
\15\ Code section 965(f).
\16\ Code section 965(a)(2).
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The Problem
U.S. shareholders of foreign shipping companies who wish to
reinvest their foreign earnings in the United States under section 965
of the Code may be prohibited from doing so because a distribution of
those earnings can result in non-qualifying subpart F income. As
described below, the subpart F income can result from a reduced ``net
investment in qualified shipping assets'' which may occur as a result
of this dividend.\17\ In such a case, the distribution is excluded from
gross income under section 959(a) of the Code and will not benefit from
the 85-percent dividends-received deduction provided by section 965.
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\2\ Code section 955; Treas. Reg. sec. 1.955A.
---------------------------------------------------------------------------
For taxable years beginning after 1975 and before 1987, the subpart
F income of a CFC generally did not include foreign base company
shipping income to the extent that such shipping income was reinvested
during the taxable year in certain qualified shipping investments.\18\
To the extent that, in a subsequent year, a net decrease in qualified
shipping investments occurred, however, the amount of previously
excluded subpart F income equal to such decrease was itself considered
subpart F income.\19\ For taxable years beginning after 1986, the
exclusion for reinvested foreign base company shipping income was
repealed.\20\ The provisions relating to the pre-1987 net investment in
qualified shipping assets, however, were retained. These rules continue
to apply even after the Act's repeal of the subpart F rules applicable
to foreign base company shipping income.
---------------------------------------------------------------------------
\18\ Former Code section 954(b)(2).
\19\ Code section 955(a).
\20\ Section 1221(c)(1) of the Tax Reform Act of 1986.
---------------------------------------------------------------------------
As a consequence of these rules, qualified shipping investments are
a category of earnings permanently invested abroad which, uniquely, are
potentially ineligible for the benefits of section 965 of the Code if
repatriated. Further, and again uniquely, a CFC which maintains such
investments may be prevented from borrowing from third-party sources to
fund a dividend which qualifies under section 965 of the Code, since
such a borrowing will, post-dividend, result in a decrease in the
amount of such investments. We believe that this result was not
intended by Congress, since it is caused by the residue of a statutory
scheme which was repealed almost 20 years ago and which has been
largely forgotten since. As a result, we believe that it is an
appropriate candidate for a technical correction.
The proposed technical correction below clarifies that a United
States shareholder of a CFC will be allowed to qualify for the 85-
percent dividends-received deduction for cash distributions that are
excluded from gross income under section 959(a) of the Code to the
extent of any amount included in the United States shareholder's income
for the taxable year under the rules relating to the inclusion of
previously excluded subpart F income withdrawn from foreign base
company shipping operations (section 951(a)(1)(A)(iii) of the Code). It
tracks the mechanics of existing section 965 of the Code, which
addresses a similar problem which could have arisen in the case of
dividends paid up a multi-tiered chain of CFCs.
Because of the short remaining time to bring dividends back under
section 965 (i.e., until December 31, 2005), we would urge an extension
through December 31, 2006, of the period to repatriate earnings covered
by this shipping income technical correction.
Section 965 Draft Technical Correction
AMENDMENT RELATED TO SECTION 422 OF THE AMERICAN JOBS CREATION ACT OF
2004
Section 965(a)(2) is amended to read as follows:
(2) DIVIDENDS PAID INDIRECTLY FROM CONTROLLED FOREIGN CORPORATIONS
AND PREVIOUSLY EXCLUDED SUBPART F INCOME WITHDRAWN FROM FOREIGN BASE
COMPANY SHIPPING OPERATIONS.--If, within the taxable year for which the
election under this section is in effect, a United States shareholder
receives a cash distribution from a controlled foreign corporation
which is excluded from gross income under section 959(a), such
distribution shall be treated for purposes of this section as a cash
dividend to the extent of
(A) any amount included in income by such United States shareholder
under section 951(a)(1)(A) as a result of any cash dividend during such
taxable year to----
(i) such controlled foreign corporation from another controlled
foreign corporation that is in a chain of ownership described in
section 958(a), or
(ii) any other controlled foreign corporation in such chain of
ownership, but only to the extent of cash distributions described in
section 959(b) which are made during such taxable year to the
controlled foreign corporation from which such United States
shareholder received such distribution; and
(B) any amount included in income for such taxable year by such
United States shareholder under section 951(a)(1)(A)(iii) (relating to
previously excluded subpart F income withdrawn from foreign base
company shipping operations).
An amount included in income under section 951(a)(1)(A)(iii) in
respect of a controlled foreign corporation in a chain of ownership
described in section 958(a) other than the controlled foreign
corporation from which the United States shareholder receives the cash
distribution shall be taken into account for purposes of subparagraph
(B) only to the extent of cash distributions described in section
959(b) which are made during such taxable year through such chain of
ownership to the controlled foreign corporation from which the United
States shareholder receives the cash distribution.
Kenneth J. Kies
Clark Consulting
Stephen Fiamma
Allen & Overy LLP
Warren Dean
Thompson Coburn LLP
Alex Trostorff
Jones Walker
Tailored Clothing Association
Washington, DC 20036
August 22, 2005
The Honorable Clay Shaw
Chairman
Subcommittee on Trade
Committee on Ways and Means
U.S. House of Representatives
1104 Longworth House Office Building
Washington, DC 20515
Dear Chairman Shaw:
On behalf of the Tailored Clothing Association, I would request
that the Committee consider making a technical corrections in Title V
of P.L. 108-429. The Association represents the interests of the men's
and boys' suit industry and has worked with the Committee on tariff
relief measures for imported worsted wool fabrics.
Last year Congress extended the wool tariff relief program by two
additional years as part of Miscellaneous Trade and Technical
Corrections Act of 2004 (Title V of P.L. 108-429). The original tariff
relief would have ended at the end of 2005. However, the sunset date
for two tariff line (9902.51.15 and 9902.51.16) were unintentionally
extended by only one year (through 12/12/2006). Other tariff lines
extended as part of the wool relief extension package received the
proper extension through the end of 2007.
The Conference Committee Report language describing the extension
clearly indicates that the tariff lines were to be extended by two
years. In addition, Senator Baucus inserted a Senate floor statement
into the Congressional Record flagging the fact that a technical
corrections was needed for purposes of this tariff line. The wool
tariff relief package contains several tariff lines, and all items in
the package have always had the same sunset dates.
We would appreciate consideration of making this technical
corrections this year, so that pricing and fabric selection decisions,
which are made far in advance of actual imports, can properly factor
potential duty rate levels.
We appreciate your consideration of our request.
David Starr
Counsel
Milan, Michigan 48160
August 31, 2005
Honorable John D. Dingell
U.S. House of Representatives
15th District, Michigan
19855 W. Outer Drive
Suite 103-E
Dearborn, MI 48124
Dear Representative Dingell:
I had the good fortune of meeting with you in person during an open
meeting in Dearborn, Michigan on Tuesday, August 30, 2005. The purpose
of my letter is to better inform you of the specifics regarding a
rather large AMT tax debt that I incurred on ``phantom'' gains due to
the application of the Alternative Minimum Tax to incentive stock
options (ISOs). This letter also comes as a result of your personal
recommendation during our brief meeting.
The issue with the AMT and ISOs is very complicated. The table
below has been added to assist in detailing the financial woes that
myself, and many others, have learned about ``the hard way.''
In 2000, I took out a Home Equity loan to cover costs associated
with the exercise of 13,166 stocks options with my current employer. At
the time of the sale, the stock was trading at $7.50. My exercise price
was $3.10 per share, and I chose to ``hold'' the stocks for a minimum
of one year in order to take advantage of the lower capital gains tax
rate of 20%. What I did not know at the time of exercise was that my
unrealized, or ``phantom'' gain of $57,930.40 was subject to a form of
taxation (the AMT) even though the stocks were not actually sold. As
such, I incurred a very large, unexpected tax liability when my 2000
tax returns were completed. At this point, I also ``earned'' an AMT
credit of $12,403 which could be applied to future taxes, or at least
that was what I thought.
Unfortunately, the stock price continued to fall and in 2004 I
actually sold the securities and realized a gain of $2,399.00. This was
a far cry from the ``phantom'' gain of $57,930.40 which formed the
basis of my AMT in 2000. While preparing for my 2004 tax return, I
assumed that the complete $12,403 tax credit would be refunded to me
based upon the fact that my realized gain was only a mere 5% of the
``phantom'' gain. However, after much consultation with my tax advisor,
I soon learned that this event (the actual sale of the securities) was
not an adequate event to trigger the complete release of the tax credit
per our current tax code. The resultant AMT credit carried forward was
reduced to $11,397.00. Further, my research has shown me that the AMT
remaining credit is not likely to be refunded over the course of my
life using conventional means.
[GRAPHIC] [TIFF OMITTED] T3731A.002
I would like to ask for your active support and co-sponsorship of
H.R. 3385. This important legislation was recently introduced by Reps.
Johnson (TX), Neal, McCrery, Jefferson, Ramstad, Lofgren, Shaw, Honda
and Johnson (CT), to provide relief for taxpayers subjected to unfair
and unjust tax treatment due to the AMT treatment ISOs. In addition to
unfairly affecting me, this serious problem has impacted many employees
of small and large companies across America, often resulting in taxes
up to and exceeding 300 percent of these employees' annual salaries.
Workers are being forced to pay tens of thousands, hundreds of
thousands, and even millions of dollars in tax overpayments on income
they will never receive.
Please join the groundswell of support for remedying this serious
injustice through this ISO AMT legislation. This bi-partisan effort is
building support in Congress, the Press, Corporate America, the
Taxpayer Advocate's office. Grassroots organizations like the ReformAMT
www.reformamt.org and the Coalition for Tax Fairness www.fair-iso.org
are actively supporting this important legislation, and may be
contacting your office to secure your support.
Again, it was a pleasure to meet with you and have the opportunity
to touch on this issue one on one. I am hopeful that you will see the
injustice with the portion of the tax code affecting ISOs and take the
appropriate countermeasures. Should you have any additional questions
or comments regarding my testimony, please feel free to contact me at
734-681-1080
Best Regards,
John Terech
Williams & Jensen, LLC
Washington, DC 20036
August 19, 2005
The Honorable William Thomas, Chairman
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515-6348
Dear Chairman Thomas:
On behalf of potential applicants for allocations of tax-exempt
financing authority under section 701 of H.R. 4520, the American Jobs
Creation Act of 2004 (P.L. 108-357) I am writing to comment on the
proposed legislation to make technical changes in the tax code, H.R.
3376, the Tax Technical Corrections Act of 2005. I appreciate the
opportunity to raise the following points with the Ways and Means
Committee about the potential inclusion of a technical correction
related to the ``Brownfields Demonstration Program for Qualified Green
Building and Sustainable Design Projects'' in H.R. 4520, the American
Jobs Creation Act of 2004.
Background
Section 701 of the American Jobs Creation Act of 2004 (P.L. 108-
357) (hereinafter the ``Jobs Act''), creates a new category of exempt-
facility bond under IRC section 142, the qualified green building and
sustainable design project bond (``qualified green bond'').
The qualified green bond legislation sets an aggregate limitation
of $2 billion of qualified green bonds that the Secretary may allocate
to qualified green building and sustainable design projects. Projects
were to be nominated within 6 months of enactment, with allocations
made within 60-days thereafter. The IRS extended this deadline for
applications in Notice 2005-28 until the date that is 120 days after
the date it publishes guidance on the subject. The authority to issue
qualified green bonds terminates after September 30, 2009.
Under the new IRC section 142(l)(4)(A)(v), the tax benefits of
qualified green bonds are to be allocated toward financing one or more
of the following:
(I) The purchase, construction, integration, or other use of energy
efficiency, renewable energy, and sustainable design features of the
project.
(II) Compliance with certification standards cited under [Section
142(l)(4)(A)(i)] (i.e., the United States Green Building Council's LEED
certification).
(III) The purchase, remediation, and foundation construction and
preparation of the brownfields site.
The inclusion of specific first-stage development costs in the
language of the qualified green bond legislation clearly contemplated
that the qualified green bond proceeds would be used for such purposes.
All of the projects that worked with the Committees in developing the
demonstration program had already acquired and remediated their
brownfields sites.
Reimbursement Regulations
Under current federal regulations (Sec. 1.150-2), the proceeds of
private activity bonds described in section 142 (including qualified
green bonds) may be used to reimburse an issuer for capital
expenditures incurred prior to the date of issuance of such bonds
(``original expenditures''), provided that, not later than 60 days
after the payment of the original expenditures, the issuer adopted an
official intent resolution indicating that it reasonably expected to
reimburse itself for such original expenditures with the proceeds of a
subsequent bond issue. In addition, under the current regulations, the
issuer must allocate (in writing) the proceeds of its bonds to the
original expenditures within 18 months of the later of (i) the date the
original expenditure is paid or (ii) the date the project is placed in
service--but in no event more than three years (five years in the case
of certain long-term construction projects) after the original
expenditure is paid. The regulations provide certain minor exceptions
to these rules.
In the case of a refinancing of interim debt for an exempt
facility, current federal regulations (Sec. 1.142-4) provide that the
foregoing rules are applied to the use of the proceeds of the interim
obligations, except that if the interim obligation is not a state or
local bond (e.g., a construction loan from a bank to the developer),
the foregoing rules are applied to the refunding bonds.
Impossibility to Comply with Regulations
In the case of potential qualified green bonds projects already
underway, a significant amount of the expenditures that are required to
make such projects eligible for an allocation from the Secretary under
the qualified green bond legislation--including, but not limited to,
the expenditures relating to the purchase, remediation and preparation
of the brownfield sites--were incurred prior to the adoption of the
qualified green bond legislation by Congress in October 2004. However,
prior to the adoption of the qualified green bond legislation by
Congress, an issuer could not have adopted an official intent
resolution relating to expenditures for a qualified green bond project.
Absent a technical correction, the Internal Revenue Service is
unwilling to waive the requirement for an official intent resolution or
the timing rules in connection with the reimbursement of expenditures
related to a qualified green bonds project. Therefore, absent a
technical correction to the qualified green bond legislation, the
potential qualified green bonds projects will not be eligible for the
reimbursement of certain expenditures which Congress clearly envisioned
as being eligible for qualified green bond financing under section
142(l) when it adopted the qualified green bonds legislation.
Program Incentives Are Furthered By Refinancing
In addition, the reimbursement regulations are intended to prevent
the replacement of taxable financing with tax-exempt financing without
changing the character of the project financed. In the instant case,
such a result is impossible. Any project awarded tax-exempt financing
authority must make significant investments in non-conventional energy
sources. The projects awarded bonding authority must, in the aggregate:
Reduce peak rate of consumption of electricity from the
grid by 150 megawatts through the use of renewable energy, on-site
power generation, and energy efficiency--equivalent to the peak rate of
power consumption for approximately 20 million square feet of
commercial office space or approximately 60,000 homes;
Install 900,000 square feet of solar panels, or more than
20 acres;
Install 10.9 megawatts of fuel cell electric generation,
which would represent a 27% increase in installed fuel cell electricity
generating capacity in U.S.; and
Through the use of renewable energy, on-site power
generation, and energy efficiency, reduce daily sulfur dioxide
emissions by at least 10 tons per day compared to coal generation
power.
The estimated cost of these investments alone, including design,
purchase, and installation exceeds $265 million. Thus, the cost of
deploying these technologies exceeds the financing benefits of $2
billion in tax-exempt financing. The mandatory expenditures for
qualification are rigorous and substantial. The capacity to manage cash
flow for these projects given the tremendous costs of the technologies
involved is important.
Finally, the projects must demonstrate that the net tax benefit of
the tax-exempt financing was used for the purposes described above
(including brownfields remediation). In essence, Congress inserted into
the Code a specific rule that displaces the need for a conflicting
regulatory requirement that restricts refinancings to avoid windfall
net tax benefits from tax exempt bonds.
Congress and the Implementing Rules Envision a Look Back
As stated above the projects that worked on developing the language
of the demonstration program described their progress in detail to the
tax writing Committees. Even the implementing rules under IRS Notice
2005-48 reflect the fact that projects envisioned to compete for
allocation had already been well underway. For example, the Code
provision requires state and local government resources of at least $5
million to be contributed towards the project to become eligible. The
Notice allows such resources to be counted to the extent provided ``at
any time during the period beginning on October 22, 2001 (three years
prior to the enactment of the Act). . . .''
The Jobs Act apparently does not provide sufficient guidance for
Treasury/IRS to determine how Congress intended the reimbursement
regulations to interplay with projects already underway. Without such
guidance, projects that have already made significant expenditures and
yet have to alter construction and investment plans are disadvantaged
as opposed to early stage projects that have more flexibility in timing
a tax-exempt issue to maximize cash flow needs. In Title VIII (entitled
``Energy Policy Tax Incentives'') of the recently enacted Domenici-
Barton Energy Policy Act of 2005 (H.R. 6, Signed by the President on
August 8, 2005, Public Law number unavailable), Congress provided more
specific guidance on how the IRS should treat the refinancing rules
with respect to newly authorized category of tax credit bonds, Clean
Renewable Energy Bonds. The new IRC section 54(d)(2)(B) specifically
discusses conditions under which the bonds may and may not be used to
refinance existing indebtedness. No similar guidance is included in the
Jobs Act for the green bonds provision.
Extension of Time
Because the IRS has delayed the date for submission of project
nominations beyond the originally contemplated statutory time frames,
the deadline for issuing qualified green bonds should be extended by
one year to ensure that the projects can reasonably utilize the
qualified green bonds. The overall maximum amount of bonds that may be
issued will not be changed, so the scope and revenue impact will not
increase.
Technical Correction Language
To address these technical correction issues related to the
reimbursement of expenditures for potential qualified green bonds
projects incurred prior to the issuance of qualified green bonds, the
following should be enacted as an off-Code provision:
``For purposes of the reimbursement allocation regulations
(including Reg. Sec. Sec. 1.142-4 and 1.150-2), a project described in
section 142(l) shall be deemed to be a long-term construction project
as described in Reg. Sec. 1.150-2(d)(2)(iii) and to have had an
official intent resolution which satisfies the requirements of Reg.
Sec. 1.150-2 covering the project adopted by an issuer prior to the
date of the earliest expenditure of any cost described in section
142(l)(4)(A)(v).''
To address the reduced time in which a project will have to secure
financing as a result of current implementation delays, and to maintain
the five year window to issue bonds as originally contemplated by the
qualified green bonds legislation, the following Code amendment should
be enacted:
``Section 142(l)(8) and (9) are amended by striking `2009' each
place it appears and inserting in lieu thereof `2010'.''
We appreciate the Committee's consideration of our request for
technical corrections, and we stand prepared to provide additional
information as you may request.
David Starr