[WPRT 109-10]
[From the U.S. Government Publishing Office]
109th Congress WMCP:
COMMITTEE PRINT
2nd Session 109-10
_______________________________________________________________________
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
__________
WRITTEN COMMENTS
on
H.R. 6264, THE ``TAX TECHNICAL CORRECTIONS ACT OF 2006''
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13
OCTOBER 31, 2006
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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 JOHN S. TANNER, Tennessee
J.D. HAYWORTH, Arizona XAVIER BECERRA, California
JERRY WELLER, Illinois LLOYD DOGGETT, Texas
KENNY C. HULSHOF, Missouri EARL POMEROY, North Dakota
RON LEWIS, Kentucky 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 Friday, September 29, 2006 announcing request for
written comments on H.R. 6264, the ``Tax Technical Corrections
Act of 2006''.................................................. 1
American Council of Life Insurers, statement..................... 2
API, statement................................................... 5
Citigroup Inc., statement........................................ 7
Crowe Chizek and Co. LLC, statement.............................. 16
Cubeta, David B., Miller and Chevalier Chartered, letter......... 17
Cuno, James, Eloise Martin, and Julia Getzels, The Art Institute,
Chicago, IL, joint letter...................................... 20
Davis, Jonathan R., Massachusetts Bay Transportation Authority,
Boston, MA, letter............................................. 22
Duffy, Tom, Wubbels and Duffy, letter............................ 23
Dwyer, Edward K., Lousiana District Export Council, New Orleans,
LA, letter..................................................... 24
Edwards, Tony, National Association of Real Estate Investment
Trusts, letter................................................. 26
Englert, Joseph G., Export Assist, San Francisco, CA, letter..... 34
Fleming, Michael, Equipment Leasing Association, Arlington, VA,
letter......................................................... 35
Fontaine, Monita, National Marine Manufacturers Association,
Chicago, IL, letter............................................ 36
Food Donation Connection, Knoxville, TN, statement............... 36
Gaudieri, Millicent Hall, and Anita M. Difanis, Association of
Art Museum Directors, joint letter............................. 40
Geelan, Sara, Solomon R. Guggenheim Foundation, New York, NY,
letter......................................................... 42
Goldstein, Fred, Los Angeles County Museum of Art, Los Angeles,
CA, letter..................................................... 45
Government Finance Officers Association, National Association of
Counties, National Association of State Auditors, Comptrollers
and Treasurers, and National League of Cities, joint statement. 47
Hand, Ivan L. Jr., Money Management International, Inc., Houston,
TX, letter..................................................... 51
Hendricks, Jeff, Alaska Ocean Seafood, Anacortes, WA, letter..... 53
Ickert, David, Air Tractor, Inc., Olney, TX, letter.............. 54
Jones, Laura Ellen, Hunton & Williams LLP, Richmond, VA, letter.. 56
Kercheval, Nancy, Cascade Fishing, Inc., Seattle, WA, letter..... 57
Levenson, Dana, City of Chicago, letter.......................... 58
Lipman, Deborah, Washington Metropolitan Area Transit Authority,
letter......................................................... 58
Margro, Thomas, Beverly Scott, Roger Snoble, Nathaniel Ford, Sr.,
Michael Scanlon, and Michael Burns, California Transit
Agencies, joint letter......................................... 59
McCrillis, Richard J., Metropolitan Atlanta Rapid Transit
Authority, Atlanta, GA, letter................................. 61
McMahon, Tom, S Corp. Association, letter........................ 61
Metropolitan Transportation Authority, New York, NY, statement... 62
Metz, Michael, RSM McGladrey, statement.......................... 63
Misey, Robert, Jr., Federal Tax Committee of the Wisconsin
Institute of Certified Public Accountants, Brookfield, WI,
letter......................................................... 64
Morrison, James, Small Business Exporters Association, letter.... 66
National Association of Manufacturers, statement................. 68
Olchyk, Samuel, and E. Ray Beeman, Extended Stay, Inc., joint
letter......................................................... 69
Paul, William, U.S. Securities Markets Coalition, letter......... 72
Quitmeyer, Gordon, LI-COR, Inc., letter.......................... 74
Real Estate Roundtable, statement................................ 75
Rebar, Robert, Rebar & Associates, PLLC, letter.................. 84
Riley, Thomas, New York State Society of Certified Public
Accountants, New York, NY, letter.............................. 85
Schlect, Christian, Northwest Horticultural Council, Yakima, WA,
letter......................................................... 88
Schreckhise, Carol, Moore Fans, LLC, Marceline, MO, statment..... 89
Serota, Susan P., American Bar Association, letter............... 89
Starr, David, Williams & Jensen, P.C. on behalf of Church
Alliance, letter............................................... 107
Sullivan, Thomas, U.S. Small Business Administration, letter..... 109
Swartz, Peter, NH Research, Irvine, CA, letter................... 110
Wahlin, Donald, Stoughton Trailers, Stoughton, WI, letter........ 110
Wasch, Kevin, Software and Information Industry Association,
letter......................................................... 111
Wessel, Thomas F., KPMG LLC, letter.............................. 112
Williams & Jensen PLLC, on behalf of Houston Firefighters' Relief
and Retirement Fund, statement................................. 114
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
September 29, 2006
FC-26
Thomas Announces Request for
Written Comments on H.R. 6264, the
``Tax Technical Corrections Act of 2006''
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 in H.R.
6264, the ``Tax Technical Corrections Act of 2006.''
BACKGROUND:
On Friday, September 29, 2006, Chairman Thomas introduced H.R.
6264, the ``Tax Technical Corrections Act of 2006.'' The legislation
contains technical corrections needed with respect to recently enacted
tax legislation.
``H.R. 6264 includes important corrections intended to make
Congressional intent clear regarding crucial components of recent tax
legislation,'' said Chairman Thomas. ``We are asking the public to
review the proposed text and provide comments during the coming weeks
so that Congress can send appropriate legislation to the President as
soon as possible. Although the Tax Technical Corrections Act of 2006
does not include any technical corrections to the Pension Protection
Act of 2006, we are interested in receiving any proposals for technical
corrections to this important legislation.''
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Statement of American Council of Life Insurers
1. Investment Advice
Need for change
The provision requires that an eligible investment advice program
either be based on a computer model or that the fees of the fiduciary
adviser, including commissions, not be affected by the advice (i.e.,
fee leveling). The provision was intended to apply the fee leveling
requirement solely to the individual actually providing such advice;
however, the term used in the section is ``fiduciary adviser'' which is
defined to include the entity employing the individual providing the
advice, rather than simply the individual. In addition, the provision
was intended to require an eligible investment advice arrangement to
take into account all designated investment vehicles under the plan
(excluding brokerage windows). Finally, a typographical error in
section 601(b)(3) of the Act is corrected.
Statutory Change
Amend section 408(g)(3)(B)(v) of ERISA by deleting the word
``options'' and insert in lieu thereof ``investments designated''.
Amend section 4975(f)(8)(C)(ii)(V) of the Code by deleting the word
``options'' and insert in lieu thereof ``investments designated''.
Amend section 601(b)(3)(A)(i) by deleting the words ``subparagraphs
(B) through (F) (and so much of subparagraph (G) as relates to such
paragraphs) of'' and inserting after the word ``1986'' the following:
``which are not covered by Part 4 of Title I of ERISA''
Amend section 601(b)(3)(C)(i)(I) by inserting at the beginning
thereof the following: Except as the Secretary may otherwise provide by
regulation, general notice on its website, or otherwise, ``
Amend section 601(b)(3)(C)(ii)(I) by striking the following: ``and
section 4975(f)(8) (other than subparagraph (C) thereof)''.
Amend section 601(b)(3)(C)(ii) by deleting subclauses (I) and (II),
striking the words ``and as are necessary to --'' and inserting in lieu
thereof a period.
Although we understand that there is some dispute among the
conferees as to who they meant to apply the fee-leveling requirement
to, we would like to take this opportunity to state that our members
strongly indicate that the only way to make this requirement workable
is to apply it to an individual providing advice. Otherwise, applying a
fee-leveling requirement would be impractical, applying the entire
audit and fee requirement to the corporation or affiliate offering the
advice. It is only practical that the adviser's fee be leveled, which
would disincent conflicted advice, and could be easily and readily
audited.
2. Scope of IRA Class Exemption
Need for change
The provision clarifies that the IRA class exemption may apply to
self-directed accounts are similar to IRAs, including Keogh plans.
However, Keogh plans covered by Title I of ERISA would continue to be
subject to the exemption for qualified plans.
Statutory Change
Amend section 601(b)(3)(A)(i) by deleting the words ``subparagraphs
(B) through (F) (and so much of subparagraph (G) as relates to such
paragraphs) of'' and inserting after the word ``1986'' the following:
``which are not covered by Part 4 of Title I of ERISA.''
3. Clarify Department of Labor Authority to Issue Exemptions for Advice
Need for change
There is concern that the directive by Congress in the Act could
prejudice the ability of DOL in the future to issue exemptions for
other advice arrangements.
Statutory Change
Amend section 601(b)(3)(C)(i)(I) by inserting at the beginning
thereof the following: ``Except as the Secretary may otherwise provide
by regulation, general notice on its website or otherwise,''
4. Clarify Department of Labor Authority Regarding IRA Class Exemption
Need for change
As currently drafted, subclauses (I) and (II) have been interpreted
to limit the class exemption's application to the type of guidance
permitted under Interpretive Bulletin 96-1. The following change is
intended to clarify the authority of the Secretary of Labor in granting
a class exemption for IRAs if a computer model is determined not to be
feasible.
Statutory Change
Amend section 601(b)(3)(C)(ii)(I) by striking the following: ``and
section 4975(f)(8) (other than subparagraph (C) thereof)''.
Amend section 601(b)(3)(C)(ii)(I) by striking the following: ``and
as are necessary to --'' and inserting in lieu thereof a period.
In the alternative, the following correction deleting subparagraph
(C) is necessary to remove the fee leveling requirement should the IRA
study determine that a computer model for IRAs is not feasible:
Amend section 601(b)(3)(C)(ii)(I) by striking the following: ``and
section 4975(f)(8) (other than subparagraph (C) thereof)''.
5. Long-term Care Exchange Effective Date
Need for change
The Act specifies that long-term care i nsurance contracts are
covered under section 1035 of the Code for exchanges occurring on or
after January 1, 2010. Various transactions commonly take place today
under group contracts, such as replacements of coverage (either between
carriers or within the same carrier), that often are accompanied by a
transfer or reallocation of reserves to reduce the premiums that
otherwise would apply under the new coverage. These transactions are
subject to various provisions of the Code and state law regarding
continuation and conversion of coverage rights and replacements. See,
e.g., section 7702B(g)(2)(A)(i)(IV) and (V) of the Code.
There are also situations where individual long-term care insurance
policyholders exchange their contracts for new contracts with improved
features, e.g., pursuant to state law rules requiring insurers to make
new improved products available to existing policyholders. In addition,
an exchange may occur in order to allow a policy or certificate to be
treated as a ``partnership'' policy under the Medicaid laws, in
accordance with the recently enacted Deficit Reduction Act of 2005 and
the express intention of the conferees with respect to such exchanges
(see H.R. Conf. Rep. 109-362, at 294).The replaced contract does not
have a cash surrender value and, unlike an annuity, endowment or life
insurance contract, income on the contract is not realized on its
exchange that would be recognized if not deferred under Code section
1035. In each of the above cases, the ``exchange'' serves only to
reduce premiums under the new qualified long-term care insurance
policy, compared with the premiums that would apply without regard to
the prior coverage.
The suggested language would clarify that such transactions do not
result in any current taxation to the certificate holder or
policyholder. In particular, the acceleration of the effective date
would address any concerns that transactions between enactment and the
otherwise applicable effective date would be adversely affected.
Statutory Change
Add the following provision to any technical corrections
legislation to address this issue:
SEC. xxx--Technical Correction to Effective Date of Tax-Free
Exchange Provisions.
(a) Correction of Effective Date.--Section 844(g) of the Pension
Protection Act of 2006 is amended by striking paragraph (2) (regarding
the effective date of amendments made to section 1035 of the Internal
Revenue Code of 1986) and inserting in lieu thereof the following new
paragraph:
``(2) Tax-Free Exchanges.--
``(A) In General.--Except as otherwise provided in subparagraph (B)
of this paragraph, the amendments made by subsection (b) shall apply
with respect to exchanges occurring after December 31, 2009.
``(B) Exchanges of Qualified Long-Term Care Insurance Contracts.--
The amendment made by paragraph (4) of subsection (b) shall apply with
respect to exchanges occurring on or after the date of enactment of
this Act.
(b) No Inference.--Nothing in the amendments made by this section
or by section 844(b)(4) of the Pension Protection Act of 2006 shall be
construed to create an inference with respect to the treatment of
exchanges of qualified long-term care insurance contracts under the
Internal Revenue Code as in effect before such amendments.
(c) Effective Date.--The amendments made by this section shall take
effect as if included in section 844 of the Pension Protection Act of
2006.
6. Section 1322 Treament of Death Benefits From Company-Owned Life
Insurance
Need for change
Section 1322 of the Act adds a new section, section 101(j) to the
Code. The general rule of section 101(j) limits the amount excluded
from income under section 101(a) to the amount of premiums and other
amount paid by the policyholder. Section 101(j)(2) provides exceptions
to this rule. Under section 101(j)(2), the policyholder may exclude all
death benefits received under a company-owned life insurance policy if
certain notice and consent requirements are satisfied. Section
101(j)(2)(A)(ii)(II) provides an exception for employees who are highly
compensated within the meaning of section 414(q) of the Code. Under
section 414(q)(1)(B), whether an employee is highly compensated is
determined by applying a test that considers whether the employee was
highly compensated for the preceding year.
While the look back rule of section 414(q)(1)(B) can be applied
readily in those situations where the employee was employed in the
preceding year, a problem arises if the insured is a new employee of
the policyholder. This is because there is no prior year salary history
applicable to a newly-hired employee. The look-back rule essentially
disqualifies those employees hired in the same year an employer is
considering purchase of a company owned life insurance policy. This
means they cannot be considered as part of the eligible pool of highly
compensated employees. The impact of this look-back rule is
particularly harsh on small employers seeking to purchase insurance on
newly-hired key employees and on start-up companies. We do not believe
that Congress intended this result when it enacted section 101(j).
Statutory Change
Therefore, we propose the following amendment to section
101(j)(2)(A)(ii)(II):
(II) a highly compensated employee within the meaning of section
414(q) (without regard to paragraph (1)(B)(ii) thereof, and, for
purposes of this subsection only, by adding the words ``current or''
before ``preceding year'' in section 414(q)(1)(B)), or
We believe that this change will mitigate the problem created by
the look-back rule that arises in the case of newly-hired key employees
without changing the intent of Congress to limit the definition of
highly compensated employees to those employees describe in either
section 414(q) or section 105(h)(5).
7. Typographical Errors
Need for change
The following items involve errors in the nature of incorrect
cross-references, etc.
Statutory Change
Amend section 4975(f)(8)(A) of the Code by deleting ``subsection
(b)(14)'' and inserting in lieu thereof ``subsection (d)(17)''.
[Subsection (b)(14) does not exist in the Code.]
Amend section 408(g)(3)(D)(ii) of ERISA by deleting subsection
``(b)(14)(B)(ii)'' and inserting in lieu thereof ``subsection
(b)(14)(A)(ii)''. [(B) does not exist; we believe the drafters intended
the reference to be (b)(14)(A).]
Amend section 4975(f)(8)(D)(iv) of the Code by deleting
``(b)(14)(B)(ii)'' and inserting in lieu thereof ``subsection
(d)(17)(A)(ii)''. [Conforming previous change in the Code.]
Statement of API
I. INTRODUCTION
These comments are submitted by API, the national trade association
of the U.S. oil and gas industry, in connection with U.S. House of
Representatives Committee on Ways and Means request for comments from
parties interested in H.R. 6265, the ``Tax Technical Corrections Act of
2006.'' API represents nearly 400 member companies involved in all
aspects of the oil and gas industry, including exploration, production,
transportation, refining, and marketing.
API is proposing two technical corrections. The first concerns
I.R.C. section 4082(a)(2) and the dyeing of untaxed diesel fuel. The
second technical correction concerns I.R.C. section 6427(l)(4) and fuel
used in commercial aircraft engaged in foreign trade.
II. Mechanical Dye Injection Equipment
Present and Prior Law
Federal excise tax generally is imposed on gasoline, diesel fuel
and kerosene when the fuel is removed from a refinery or terminal rack.
However, tax is not imposed on rack removals of diesel fuel and
kerosene if, among other things, the fuel is indelibly dyed in
accordance with regulations prescribed by Treasury. The presence of dye
in the fuel indicates that the fuel is destined for a nontaxable use.
Regulations have been issued that specify the allowable types and
concentration of dye. The regulations do not specify the method of
adding dye to the fuel.
New Law
Public Law 108-357 (the American Jobs Creation Act of 2004) amended
I.R.C. Section 4082(a)(2) (relating to the exemptions from tax for
diesel fuel and kerosene) to provide that tax will not be imposed on
removals of diesel and kerosene if, among other things, the fuel is
indelibly dyed by mechanical injection. In addition, the law added new
I.R.C. Section 6715A which imposes penalties on persons who tamper with
a mechanical injection system and on the operator of a mechanical dye
injection system who fails to maintain security standards for such
system as established by Treasury.
The reason for this change in the law, as stated by the Joint
Committee on Taxation, was that ``Congress remained concerned, however,
that tax could still be evaded through removals at a terminal of undyed
fuel that had been designated as dyed. Manual dyeing was inherently
difficult to monitor. It occurred after diesel fuel had been withdrawn
from a terminal storage tank, generally required the work of several
people, was imprecise, and did not automatically create a reliable
record. The Congress believed that requiring that untaxed diesel fuel
be dyed only by mechanical injection will significantly reduce the
opportunities for diesel fuel tax evasion.'' (Emphasis added.) (Joint
Committee on Taxation, General Explanation of Tax Legislation Enacted
in the 108th Congress (JCS-5-05), May 2005, at page 437-438.)
Technical Correction
The new law as written may be interpreted to apply to dyeing which
occurs today within the bulk distribution system (such as dyeing by
pipeline operators that routinely occurs as fuel is pumped out of
intermediate tankfarm facilities to shipper terminals), whereas the
legislative intent was to address the opportunity for evasion at the
terminal rack. Therefore, the new law under section 4082(a) should be
clarified as follows (omissions are struck out and additions are
underlined):
SEC. 4082. Exemptions for Diesel Fuel and Kerosene.
(a) In General.--The tax imposed by section 4081 . . . shall not
apply to diesel fuel and kerosene--
(2) which is indelibly dyed in accordance with regulations which
the Secretary shall prescribe, and
(3) which meets such marking requirements (if any) as may be
prescribed by the Secretary in regulations.
In the case of fuel that is dyed coincident with the removal from a
terminal as described in section 4081(a)(1)(A)(ii), the
requirement of paragraph (2) shall be satisfied only if the
fuel is dyed by mechanical injection. Such regulations
prescribed under this subsection shall allow an individual
choice of dye color approved by the Secretary or chosen from
any list of approved dye colors that the Secretary may publish.
III. Fuel Used in Commerical Aircraft Engaged in Foreign Trade--Refunds
and LUST
Present Law
Excise tax is imposed on jet fuel (kerosene) when the fuel is
removed from a registered pipeline or barge terminal (I.R.C. section
4081). Except in the case of airports directly served by such a
terminal and which the Internal Revenue Service (``IRS'') determines to
be a ``secure'' airport, tax is imposed at a rate of 24.4 cents per
gallon. At secure airports directly served by registered terminals, tax
is imposed at 4.4 cents per gallon on jet fuel sold for use in
commercial aviation (21.9 cents per gallon on noncommercial, or
general, aviation use) when aircraft are fueled. Registered commercial
airlines are liable for the tax on jet fuel taxed at 4.4 cents per
gallon. In other cases, the position holder in the terminal is liable
for payment of the tax. Commercial aviation is defined as
transportation of persons or property for hire.
The jet fuel excise tax rates are comprised of two components: 4.3
cents per gallon (commercial aviation) or 21.8 cents per gallon
(general aviation) dedicated to the Airport and Airway Trust Fund
(``AATF''), and 0.1 cent per gallon dedicated to the Leaking
Underground Storage Tank (``LUST'') Trust Fund. Jet fuel removed for
use in commercial aircraft engaged in foreign trade (sec. 4221(d)(3))
is exempt from the AATF, but not the LUST, portion of the tax.
The 24.4-cents-per-gallon rate (and the 4.4--or 21.9-cents-per-
gallon rates on otherwise exempt jet fuel) exceed actual liability.
Refunds of excess tax imposed under section 4081 are claimed under
section 6427(l)(4) or section 6427(l)(5). Section 6427(l)(4) applies to
commercial aviation while section 6427(l)(5) applies in all other
cases.\1\ Section 6427(l)(4) allows airlines to claim the refund
directly (e.g., by crediting the excess tax against the airline's
passenger or property excise tax liability) or to assign the refund to
their ultimate vendors (if the vendors are registered with the IRS).
Section 6427(l)(5) limits refunds to registered ultimate vendors.
---------------------------------------------------------------------------
\1\ The heading to section 6427(l)(5) states that the paragraph
applies to fuel used in ``noncommercial aviation.''
---------------------------------------------------------------------------
New Law
As enacted by SAFETEA,\2\ section 6427(l)(4) creates an ambiguity
as to the proper treatment of refunds for jet fuel sold as supplies for
aircraft engaged in foreign trade. The ambiguity arises because of a
parenthetical exclusion in the introductory language of section
6427(l)(4)(A) for jet fuel used as ``supplies for vessels or aircraft
within the meaning of section 4221(d)(3).'' The exclusion reflects the
fact that this fuel, unlike jet fuel used in domestic commercial
aviation, is not subject to the 4.3-cents-per-gallon AATF tax rate.
However, the exclusion should not be interpreted to preclude comparable
refund treatment for jet fuel sold for commercial use in foreign trade
and identical fuel sold for use in domestic commercial aviation.\3\ The
IRS has issued rules denying commercial airlines the right to claim
these refunds directly (by treating the fuel as described in section
6427(l)(5) rather than section 6427(l)(4)).
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\2\ ``SAFETEA'' stands for the Safe, Accountable, Flexible,
Efficient Transportation Equity Act: A Legacy for Users. SAFETEA was
enacted on August 10, 2005 as Public Law 109-59.
\3\ Airlines eligible for the section 4221(d)(3) exemption are
commercial airlines that, like their domestic counterparts, currently
collect the AATF excise taxes under section 4261 (in this case, the
international arrival and departure excise taxes).
---------------------------------------------------------------------------
Technical Correction
Section 6427(l)(4) should be amended to clarify that excess tax
collected under section 4081 on jet fuel sold for use as supplies for
aircraft engaged in foreign trade may be refunded either to registered
airlines or their ultimate vendors. The amendment may be accomplished
by deleting the current parenthetical ``(other than supplies for
vessels or aircraft within the meaning of section 4221(d)(3))'' in
section 6427(l)(4)(A), and adding a new flush sentence at the end of
that subparagraph, as follows: ``Clause (ii) shall not apply in the
case of kerosene used as supplies for vessels or aircraft within the
meaning of section 4221(d)(3).''
Contacts
For further information, please contact Anne Price Warhola, Mark
Kibbe, or Teresa Dondlinger Trissell.
Statement of Citigroup Inc.
I. Introduction.
Citigroup Inc. is pleased to offer its comments on proposed Section
6 of H.R. 6264 and S. 4026, the Tax Technical Corrections Act of 2006
(the ``TTCA''). Section 6 would revise section 470 of the Internal
Revenue Code (as added to the Code by the American Jobs Creation Act of
2004, P.L. 108-357), principally by adding a new section 470(e),
addressing the application of section 470's principles to partnerships.
Citigroup appreciates the importance of section 470 as it applies
to leasing, and we also understand and accept the importance of
ensuring that the Code does not countenance the development of highly-
structured partnership arrangements that replicate all or most of the
tax benefits of ``LILO'' and ``SILO'' lease structures. At the same
time, Citigroup remains concerned that an overbroad provision aimed at
forestalling the development of structured partnership successors to
``LILOs'' and ``SILOs'' could cause adverse unintended consequences for
many operating partnerships--partnerships that actively conduct one or
more trades or businesses--that have nothing in common with ``LILO''
and ``SILO'' leasing practices.
This issue is particularly important to Citigroup because one of
our largest overseas affiliates is organized as a partnership for U.S.
tax purposes, with a majority U.S. partner and minority foreign
partners (which in turn are Citigroup subsidiaries that are taxed as
``controlled foreign corporations''). The affiliate has thousands of
employees, billions of dollars in annual revenue, in capital, and in
assets (comprised predominantly of securities positions, but also
including property described in section 470(c)(2)), and thousands of
customers. At worst, an overbroad prophylactic partnership provision
would deny Citigroup a deduction for depreciation and amortization of
the affiliate's section 470(c)(2) assets, despite the fact that the
partnership is actively engaged in a customer-driven business that
bears no resemblance to LILO/SILO fact patterns. At best, an overbroad
provision would introduce difficult interpretational and compliance
issues for the IRS, for Citigroup, and for thousands of other operating
partnerships across the U.S. economy.
The comments that follow are designed to honor the concerns that
motivated Congress to introduce section 470 in 2004, and to preserve
the general framework of Section 6 of the TTCA, as it is currently
drafted. The overall purpose of our comments is to focus the language
of Section 6 as it applies to operating partnerships more closely on
the nature of the relationship between taxable and tax-exempt partners
that can give rise to the same concerns that Congress addressed in
section 470 with respect to a taxable lessor and a tax-exempt lessee.
Section II of this memorandum describes our overall theme in a
little more detail. Section III then lays out our specific suggestions,
and briefly summarizes our reasoning. Finally, we have attached for
your convenience a copy of current Section 6 of the TTCA, marked to
show our suggested changes.
II. Translating Section 470 Principles into the Partnership Context.
We believe that section 470, as it applies to its core subject
(leasing), is premised on three principles that together define a
``true'' lease. Section 470 then develops rules to ensure that the
relationship between a tax-exempt lessee and a taxable lessor does not
to any significant extent vitiate any of these principles.
The three principles that section 470 uses to define a ``true''
lease when the lessee is a tax-exempt entity are as follows. First, the
lessor must make a substantial investment of capital in the leased
property. Second, the lessor must look to the lessee's rental
obligations for one significant portion of the lessor's economic
returns. And third, the lessor must also look to the residual value of
the leased property for another significant portion of its economic
returns.
Section 470(d) responds to these three principles with three basic
operating rules. First, the lessor must make and maintain a significant
investment in the leased property. (Section 470(d)(2).) Second, the
lessee must not ``monetize'' (beyond relatively insignificant levels)
its obligation to pay rent to the lessor, or its option to repurchase
the leased property.\1\ (Section 470(d)(1).) Third, the lessee must not
assume any significant risk of loss relating to the residual value of
the leased property (whether through a lessor ``put'' option or
otherwise). (Section 470(d)(3).)
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\1\ As a strictly logical matter, the inclusion of the monetization
of a lessee option to purchase the leased property probably does not
necessarily follow from the three principles summarized earlier. The
inclusion is best explained as reflecting a deep skepticism on the part
of Congress that a tax-exempt lessee would ever not exercise a
``defeased'' purchase option, given the importance of the leased
property in many cases to the lessee's operations.
---------------------------------------------------------------------------
We believe that these principles and operating rules help put the
operation of section 470(d)(1), in particular, into context, as can be
illustrated by some common LILO/SILO fact patterns. To take one
example, a loan from a tax-exempt lessee to a taxable lessor might be
viewed as undercutting the first principle outlined above (that the
lessor have an at-risk investment in the leased property); section
470(d)(1) accordingly addresses this fact pattern. A tax-exempt
lessee's ``defeasance'' of its rental obligations to the taxable lessor
might be viewed as undercutting the second principle (that the lessor
look to the lessee for a significant portion of its return); section
470(d)(1) therefore addresses this fact pattern as well. And finally, a
lessee fixed price option to purchase the leased property, combined
with a ``defeasance'' arrangement, was seen by Congress as putting too
much practical pressure on the third principle (that the lessor look to
the residual value of the leased property for a significant portion of
its return); section 470(d)(1) therefore also addresses this case.
Despite all the complexity of the ``LILO'' and ``SILO''
arrangements that impelled Congress to enact section 470, those
transactions, like all leases, essentially boil down to simple
bilateral agreements between a (taxable) lessor and a (tax-exempt)
lessee. Accordingly, section 470(d)(1)(A) applies, first, to set-asides
or other arrangements that run directly to the benefit of the lessor,
or to any lender to the lessor (because that is what it means to be a
``lender'' in a leveraged lease transaction). The party providing these
set-asides of course is the tax-exempt lessee, because that is the
counterparty to the lessor (and the lessor's lender). Similarly,
section 470(d)(1)(A) also applies to set-asides by the lessee that
directly satisfy its own obligations under the lease--but again those
obligations (and the destination of the lease rental payments) are to
the lessor (the only counterparty to the lease), or to the lessor's
lender. In either case, the presupposition is that there is a lessor
investment or a lessee obligation to pay rent, the economic
significance of which to the lessor is undercut by the arrangements
entered into by the lessee.\2\
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\2\ In the case of a fixed-price lessee purchase option, the
lessee's collateralization of that option was viewed by Congress as
undercutting the economic uncertainty of the exercise of the option.
---------------------------------------------------------------------------
Section 470(e)(2)(A), as proposed by the TTCA, is patterned closely
on current section 470(d)(1)(A), but we believe that partnerships are
much more complex bundles of agreements than are leases. As a result,
the partnership analogy to section 470(d)(1)(A) is more complex (and
less inclusive) than how Section 6 of the TTCA in its current form
might be read. First, partnerships that operate businesses engage in a
wide range of transactions with suppliers, customers, counterparties,
lenders and other third parties that have no direct analogy to the
narrower sphere of activity embodied in a lease. Second, a partnership
is simultaneously an entity (conducting business with third parties,
for example) and a multilateral agreement among its partners (through
partnership allocations). Third, a lender in a leasing arrangement is
by definition lending to the owner of the property--the lessor. By
contrast, a lender to a partnership indirectly is lending to all
partners, including tax-exempt as well as taxable partners. Some
aspects of this complex web of relationships can be analogized to a
tax-exempt lessee monetizing its lease obligations, but many others
cannot.
The difficulty, then, is to identify within the complex web of
relationships that define a modern partnership (relationships between
the partnership and its suppliers, customers and counterparties;
relationships among the partners in allocating the returns from the
partnership's business; relationships between a partnership and its
lenders, etc.) those relationships that are analogous to a tax-exempt
lessee setting aside ``funds'' for the benefit of the lessor, or the
lender to the lessor. For example, we submit that, if a partnership
borrows money from a third party to acquire depreciable property that
the partnership operates directly in a manufacturing business, and
posts collateral to the lender to secure the loan, that partnership is
not, without more, engaged in a transaction that should fall within the
scope of new section 470(e)(2)(A), regardless of the nature of the
collateral, because the loan is made indirectly to tax-exempt as much
as taxable partners.
Our suggested language seeks principally to clarify the application
of new section 470(e)(2)(A) by focusing on those relationships that in
fact are analogous to a tax-exempt lessee monetizing its obligations to
a taxable lessor. As revised, the language looks to whether a tax-
exempt partner has an obligation to a taxable partner (either directly
or indirectly through the partnership), which obligation in turn has
been ``monetized'' through any set-aside or similar arrangement. We
believe that this clarification focuses new section 470(e)(2)(A) on the
correct problem, while preserving its broad application (e.g., through
fungibility of money principles) to prevent abuse.
III. PROPOSED REVISIONS TO STATUTORY LANGUAGE.
[All references to page and line numbers are to the official print
of H.R. 6264 S. 4026]
1. Amend page 14, line 6, to read:
``such property is not described in paragraph (A) or (B), and,
except as provided in regulations prescribed . . .''
Reason: New section 470(e)(2) is difficult to parse because the
operative tests do not clearly relate back to the depreciable
property described in new section 470(e)(1)(C). This amendment,
and the following one, clarify this relationship. Neither
changes the fungibility of money concept embodied in new
section 470(e)(2)(A): that is, the ``set aside'' rule applies
with respect to any set aside, even if the set aside serves as
collateral (for example) for non-depreciable property, so long
as there exists some obligation on the part of the tax-exempt
partner relating to depreciable property (as described below).
The consequence of failing the test, however, is relevant only
to depreciable property described in new section 470(e)(1)(C).
2. Amend page 14, line 14, to read as follows:
``respect to any property described in subparagraph (1)(C) owned by
the partnership . . .''
Reason: See above.
3. Page 14, strike lines 22 through 25, and Page 15, strike lines 1
and 2. Replace with the following:
``if the purpose or effect of the transaction described in clause
(i) or (ii) is directly or indirectly to satisfy any obligation
(whether current, future or contingent) of a tax-exempt partner
relating to such property and owed to the partnership, any taxable
partner of the partnership, any lender to the partnership, or any
lender to a taxable partner of the partnership . . . ''
Reason: This suggestion is designed to implement the fundamental point
made in Part II, which is that the analogy to section 470(d)(1)
here requires identifying an obligation that a tax-exempt
partner has to a taxable partner that relates to property
described in section 470(e)(1)(C), which obligation is directly
or indirectly satisfied through the monetization transaction
described in section 470(e)(2)(A)(i) or (ii). (Options are
addressed in proposed section 470(e)(3), below.) The idea here
is that simple co-ownership, even with preferred returns or the
like, does not by itself give rise to an ``obligation'' of the
tax-exempt partner (the lessee equivalent) that is being
directly or indirectly monetized for the benefit of the taxable
partner (the lessor equivalent).
It is intended, for example, that a simple purchase-money mortgage
by which a partnership acquires property from a third party seller
would in general fall outside the scope of revised section
470(e)(2)(A), both because there would be no set-aside of, similar
arrangement with respect to ``funds'', and because the obligation of
both partners to repay the purchase money indebtedness to the third
party is not an obligation of one partner to the other partner. On the
other hand, a tax-exempt partner's obligation (whether contingent or
current) to fund a capital account deficit, for example, is an
obligation that indirectly runs to the benefit of the taxable partner;
if the parties require the tax-exempt partner to monetize that
obligation, then section 470(e)(2)(A) would be triggered.
4. Page 16, strike lines 1 through 6, and replace with the
following:
``(C) ARRANGEMENTS.--The arrangements referred to in this
subparagraph include:
(i) a loan by a tax-exempt partner to the partnership, any taxable
partner, or any lender to the partnership or a taxable partner,
(ii) to the extent of all tax-exempt partners' share thereof, a
loan by the partnership to any taxable partner or any lender to a
taxable partner, and
(iii) any arrangement referred to in subsection (d)(1)(B) that has
the effect of a transaction described in clause (i) or (ii).''
Reason: This revision, like item 3, above, is intended to focus section
470(e)(2)(A) on those partnership arrangements that in fact are
analogous to section 470(d)(1)(A)--that is, transactions in
which a tax-exempt partner monetizes, whether directly or
indirectly through the partnership vehicle, an obligation of
that tax-exempt partner to a taxable partner. In addition,
section 470(e)(2)(C) as currently written is difficult to
parse, as it appears to contemplate, for example, a loan by a
partnership to itself. The discussion in Part II and under item
3, above, applies with equal force here.
5. Strike page 16, line 18 through page 17, line 3 and substitute
the following:
``TEST.--Funds shall not be taken into account in applying
subparagraph (A) to property described in subparagraph (1)(C) if such
funds bear no connection to the economic relationships among the
partners (whether reflected in the partnership agreement or otherwise)
with respect to items of income, gain, loss, expense or credit
attributable to such property. For this purpose, funds described in
section 956(c)(2)(J) or section 956(c)(2)(K) shall be deemed not to
bear any connection to the economic relationships among the partners
with respect to property described in subparagraph (1)(C).''
Reason: New section 470(e)(2)(D)(ii) is very difficult, if not
impossible, for a taxpayer to apply, because as currently
drafted it simply provides that a taxpayer shall not take into
account funds if those funds ``bear no connection to the
economic relationships among the partners.'' But everythingthat
a partnership does bears some connection to the economic
relationships among the partners: every item of income, or
deduction, etc. is shared on some basis among the partners. We
believe that a more useful way to reformulate the test would be
that funds should be excluded if they do not affect the
economic deal with respect to the depreciable property being
tested. The proposed replacement language reflects this
understanding. Clause (ii) was dropped, because it was believed
that the phrase ``(whether reflected in the partnership
agreement or otherwise)'' more succinctly makes the same point.
Finally, the last sentence of the proposed revision addresses
explicitly the ``self-funding'' transactions that all financial
institutions employ to acquire ownership or possession of
securities in the ordinary course of business. Because the
financial institution gives and receives equivalent value (or
posts collateral on commercial terms directly in connection
with a financial transaction), the transactions cannot be used
to accomplish any of the monetization results that are the
purpose of section 470(d) and new section 470(e).
As reformulated, this test will be useful primarily for any
operating partnership in respect of the funding of its ongoing day-to-
day operations. It would be very extraordinary, for example, for
partners to be able to demonstrate that a funding arrangement in place
at the outset of a partnership, or contemplated by the partnership
agreement (or other operative documents), did not affect the economic
relationships of the partners in respect of the partnership's section
470(e)(1)(C) property. This relatively narrow scope is appropriate, in
light of the fact that new section 470(e)(2)(D)(ii) is intended as an
exception from an anti-abuse rule.
For the reasons summarized above, we believe that the reformulated
test will apply only in clearly delineated cases. If, however, there is
residual concern that the contours of the proposed test need to be
defined more sharply, consideration could be given to limiting the
application of the test only to funds used by a partnership in
connection with the conduct of an active trade or business. The
Internal Revenue Code contains several ``active trade or business''
tests that might serve as a model. For example, one could fashion a
rule that permitted partnerships to rely on the ``no connection'' test
only in cases where no more than 20 percent of the partnership's gross
income constituted ``foreign personal holding company income'' under
the principles of section 954(c) (as modified by sections 954(h) and
(i)) if the partnership hypothetically were organized as a controlled
foreign corporation.\3\
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\3\ Because section 954(c) and its implementing Treasury
regulations address different concerns than does section 470, care
would need to be taken to ensure that a cross-reference to the
principles of section 954(c) would not bring with it rules and
limitations that would be irrelevant to the test suggested in the text.
For example, in applying the hypothetical ``if the partnership were a
controlled foreign corporation,'' what should be done about same-
country limitation? Similarly, section 954(c)(1)(D) (dealing with
foreign currency gains) probably is unnecessary in the section 470
contest. And finally, section 954(c) includes a number of temporary
provisions, including section 954(h) and (i), both of which modify
section 954(c)(1), and section 954(c)(6). To preserve the intended
application of the cross reference here, we would suggest that the
principles of section 954(c) would be defined as those principles that
would apply in 2006 to a hypothetical controlled foreign corporation
that was a calendar year taxpayer.
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6. Examples. If our understanding of the purpose and scope of new
section 470(e)(2)(D)(ii) is correct, then the revised statutory
language can be illustrated in the legislative history with examples
along the following lines:
Example 1. Partnership ABC has two partners, T (a taxable partner) and
TE (a tax-exempt partner). Partnership ABC has been engaged in
an active trade or business for many years, and owns many
properties, both depreciable and nondepreciable. All items of
partnership income are allocated 50-50 between T and TE. In
2007, Partnership ABC arranges for long-term nonrecourse
financing, secured by a revolving pool of receivables generated
by Partnership ABC in the ordinary course of its business, and
guaranteed by a third-party financial guarantor. The lenders in
the nonrecourse financing are unrelated third parties.
Partnership ABC does not amend its partnership agreement in
light of the nonrecourse financing, and there is no
understanding between T and TE with regard to the sharing of
the economics from their respective investments in Partnership
ABC that is not reflected in the partnership agreement.
Under these facts, the nonrecourse financing does not affect the
economic relationships among the partners with respect to any item of
depreciable property owned by the Partnership. Accordingly, and without
regard to whether the arrangement otherwise would be described in
section 470(e)(2)(A), the nonrecourse financing is not taken into
account for purposes of section 470(e)(2)(A), by virtue of section
470(e)(2)(D)(ii).
Example 2. Partnership DEF has two partners, T (a taxable partner) and
TE (a tax-exempt partner). Partnership DEF is engaged in an
active trade or business that it has conducted for many years.
Under the DEF partnership agreement, TE has an obligation to
invest additional funds in Partnership DEF under certain
defined circumstances. To ensure that TE performs its
obligation, the DEF partnership agreement provides that DEF
will withhold 50 percent of the profits otherwise distributable
to TE and set those funds aside in a portfolio of U.S. Treasury
securities, the interest income on which will be allocated to
TE and distributed currently to TE. DEF is permitted to
withdraw assets from the portfolio and apply them to TE's
capital contribution obligations if TE does not otherwise
satisfy its obligation within 10 days of the obligation's
arising.
Under these facts, the portfolio of Treasury securities constitutes
a set-aside of funds that bears a connection to the economic
relationships among the partners, because the existence of the
portfolio gives T security that TE in fact will satisfy its contingent
``capital call'' obligation. Accordingly, partnership DEF may not rely
on section 470(e)(2)(D)(ii). Moreover, under these facts the
partnership has monetized an obligation that TE has to the partnership;
accordingly, if the value of the portfolio of Treasury securities
exceeds Partnership DEF's allowable partnership amount, the
requirements of section 470(e)(2)(A) will not be satisfied, and section
470 will apply to Partnership DEF.
Example 3. Partnership GHI has two partners, T (a taxable partner) and
TE (a tax-exempt partner). Partnership GHI has been engaged for
many years in an active trade or business as a full-service
investment banking firm, including dealing in a wide range of
securities. Partnership GHI therefore is a dealer in
securities, within the meaning of section 475(c)(1). In the
conduct of its business, Partnership GHI maintains large
positions in securities (as defined in section 475(c)(2)), the
identity and quantities of which fluctuate daily, in response
to customer demands and Partnership GHI's hedging and other
business requirements. Partnership GHI also owns substantial
depreciable and amortizable assets described in section
470(c)(2).
To finance its purchases of U.S. Treasury securities in the
ordinary course of its activities as a dealer in securities,
Partnership GHI engages in ``sale-repurchase'' (``repo'') transactions,
in each of which Partnership GHI ``sells'' a Treasury security to a
``buyer'' for cash in an amount equal to or slightly less than the fair
market value of the Treasury security, and Partnership GHI
simultaneously agrees to ``repurchase'' that Treasury security the next
business day, for a price equal to the cash received on the first day,
plus an additional amount equal to one day's interest on that amount.
(The arrangement might also be defined to cover a specified longer
term.) The ``buyer'' might be either a third party or an affiliate of
GHI that in either case seeks to invest cash on a short-term basis. The
``repo'' arrangement is documented under industry-standard
documentation. Under the terms of their repo agreement, Partnership GHI
and the ``buyer'' of the Treasury securities agree to roll over the
financing from day to day, unless and until either party terminates the
transaction. The value of the Treasury securities is marked to market
daily, and the net amount of cash transferred to Partnership GHI in
turn is adjusted daily, such that the cash held by Partnership GHI in
respect of the repo transaction never exceeds the fair market value of
the Treasury securities ``sold'' to the repo ``buyer.''
Under these facts, the repo arrangement between Partnership GHI and
the repo ``buyer'' constitutes a transaction described in section
956(c)(2)(K). Partnership GHI raises funds through the repo
transaction, but at the same time Partnership GHI gives up possession
of marketable securities having an equal or greater value. Because
Partnership GHI employs the repo transaction in the ordinary course of
its trade or business as a dealer in securities, for example to finance
its purchases of U.S. Treasury securities, and because the conditions
of section 956(c)(2)(K) are satisfied, therefore, without regard to
whether the arrangement otherwise would be described in section
469(e)(2)(A), the repo financing is not taken into account for purposes
of section 470(e)(2)(A), by virtue of section 470(e)(2)(D)(ii).
Example 4. The facts are the same as those of Example 3, except that,
in addition to the financing described therein, Partnership GHI
and TE enter into an arrangement described as a one-year sale-
repurchase transaction, but in which TE extends $2 million to
Partnership GHI in exchange for $1 million in Treasury
securities, and Partnership GHI unconditionally promises to
repurchase those securities one year in the future for $2
million, plus interest thereon. The arrangement falls outside
the scope of section 956(c)(2)(K), because the cash received by
Partnership GHI exceeds the value of the Treasury securities
delivered by Partnership GHI. Moreover, the arrangement is not
consistent with market practices among participants in the
active repo financing markets.
Under these facts, the arrangement will be viewed as a $1 million
sale-repurchase transaction, and an unsecured loan of $1 million by TE
to Partnership GHI. The unsecured loan by TE falls outside the ordinary
course of Partnership GHI's business and presumptively affects the
economic relationships among the partners. Accordingly, unless
Partnership GHI can otherwise demonstrate that the funds in fact do not
affect the relationship between T and TE, Partnership GHI cannot rely
on section 470(e)(2)(D)(ii) to exclude those funds from the possible
application of section 470(e)(2)(A).
7. Amend page 17, line 14, to read as follows:
``respect to any property described in subparagraph (1)(C) owned by
the partnership--''
Reason: This revision clarifies that those options to which new section
470(e)(3)(A) is addressed are options that relate to
depreciable property owned by the partnership. Financial
institutions routinely employ options over financial assets in
the ordinary course of their trade or business. If a financial
institution is organized as a partnership, it would be common
for that partnership to enter into such financial options with
its partners, as well as other customers. We believe that such
options over financial assets, by way of example, have no
relationship to the intended scope of new section 470(e)(3)(A).
The proposed language confirms this result.
8. Amend p. 18, line 24, by removing the period and adding at the
end thereof:
``, other than a tax-exempt controlled entity (as defined in
section 168(h)(6)(F)).''
Reason: A tax-exempt controlled entity is itself a taxpayer. Whatever
the purpose for the inclusion of such entities in determining
the scope of section 168, in light of the fact that they are
taxpayers, there does not appear to be any reason that we can
determine for including these entities as possible devices by
which a partnership could be employed to accomplish LILO/SILO-
type results.
9. Remaining Issues. The suggestions made above do not address a
fundamental issue with the current draft of new section 470(e), which
is the consequence of failing the two-part test. Imagine, for example,
that a tax-exempt partner in a $1 billion partnership improperly
monetizes a $100 obligation to a taxable partner outside the
partnership. What consequence should follow from that $100
monetization? As currently drafted, new section 470(e) appears to
contemplate that all of the $1 billion partnership's depreciable assets
would be tainted. We respectfully submit, however, that this
consequence is wholly disproportionate to the problem. The issue does
not arise in the context of actual leases, because there section 470 is
applied on a lease-by-lease basis. As a result, the improper
monetization of one lease taints only the property subject to that
lease. We believe that some sort of proportionality rule is required in
the partnership context. That rule need not be a dollar-for-dollar
tainting. One can imagine, for example, a rule that provides that every
$1 of improper monetization requires that $5 of depreciable property be
subject to section 470. A similar issue arises in respect of the
differing interests of taxable and tax-exempt partners in partnership
property. Improper monetization of a lease implies that the taxable
lessor has an impermissibly small true economic interest in the leased
property; as a result, section 470 applies to the entirety of the
leased property. In the partnership context, by contrast, a taxable
partner might (by way of example) bear 90 percent of the economic risk
and reward with respect to the depreciable property accrued by the
partnership. If a tax-exempt partner impermissibly monetizes an
obligation to the taxable partner, the consequence of that monetization
should be limited to the tax-exempt partner's interest in partnership
property (in this example, 10 percent), because that represents the
greatest extent to which the monetization might fairly be said to shift
the attributes of the partnership's property to the taxable partner.
These two issues--the ``cliff effect'' of the current draft of new
section 470(e), and the failure to recognize a taxable partner's
genuine investment in partnership property--go to the same ultimate
point, which is that the consequence of failing the monetization test
needs to be linked in at least an approximate manner to the extent of
that monetization. Without such a limitation, new section 470(e) could
be criticized as imposing tax liabilities wholly disproportionate to
any possible abuse.
IV. CONCLUSION
Citigroup appreciates the opportunity to submit these comments.
Please find on the following pages a marked up version of the
legislation that includes our proposed edits.
Sincerely
Jeffrey R. Levey
Vice President, Director
______
[Citigroup Inc. Suggested Revisions]
SEC. 6. AMENDMENTS RELATED TO THE AMERICAN JOBS CREATION ACT OF
2004.
(a) AMENDMENTS RELATED TO SECTION 710 OF THE ACT.--
(1) Clause (ii) of section 45(c)(3)(A) is amended by striking
``which is segregated from other waste materials and''.
(2) Subparagraph (B) of section 45(d)(2) is amended by inserting
``and'' at the end of clause (i), by striking clause (ii), and by
redesignating clause (iii) as clause (ii).
(b) AMENDMENTS RELATED TO SECTION 848 OF THE ACT.--
(1) Section 470 is amended by redesignating subsections (e), (f),
and (g) as subsections (f), (g), and (h) and by inserting after
subsection (d) the following new subsection:
``(e) EXCEPTION FOR CERTAIN PARTNERSHIPS.--
``(1) IN GENERAL.--In the case of any property which would (but for
this subsection) be tax-exempt use property solely by reason of section
168(h)(6), such property shall not be treated as tax-exempt use
property for purposes of this section for any taxable year of the
partnership if--
``(A) such property is not property of a character subject to the
allowance for depreciation,
``(B) any credit is allowable under section 42 or 47 with respect
to such property, or
``(C) such property is not described in paragraph (A) or (B), and,
except as provided in regulations prescribed by the Secretary under
subsection (h)(4), the requirements of paragraphs (2) and (3) are met
with respect to such property for such taxable year.
``(2) AVAILABILITY OF FUNDS.--
``(A) IN GENERAL.--The requirement of this paragraph is met for any
taxable year with respect to any property described in subparagraph
(1)(C) owned by the partner ship partnership if (at all times during
the taxable year) not more than the allowable partnership amount of
funds are--
``(i) subject to any arrangement referred to in subparagraph (C),
or
``(ii) set aside or expected to be set aside,
to or for the benefit of any taxable partner of the partnership or
any lender, or to or for the benefit of any tax-exempt partner of the
partnership if the purpose or effect of the transaction described in
clause (i) or (ii) is directly or indirectly to satisfy any obligation
of such tax-exempt partners (whether current, future or contingent) of
a tax-exempt partner relating to such property and owed to the
partnership, any taxable partner of the partnership, any lender to the
partnership, or any lender to a taxable partner of the partnership.
``(B) ALLOWABLE PARTNERSHIP AMOUNT.--For purposes of this
subsection, the term `allowable partnership amount' means, as of any
date, the greater of--
``(i) the sum of--
``(I) 20 percent of the sum of the taxable partners' capital
accounts determined as of such date under the rules of section 704(b),
plus
``(II) 20 percent of the sum of the taxable partners' share of the
recourse liabilities of the partnership as determined under section
752, or
``(ii) 20 percent of the aggregate debt of the partnership as of
such date.
``(iii) NO ALLOWABLE PARTNERSHIP AMOUNT FOR ARRANGEMENTS OUTSIDE
THE PARTNERSHIP.--The allowable partnership amount shall be zero with
respect to any set aside or arrangement under which any of the funds
referred to in subparagraph (A) are not partnership property.
``(C) ARRANGEMENTS.--The arrangements referred to in this
subparagraph include:
``(i) a loan by a tax-exempt partner or the partnership to the
partnership, any taxable partner, the partnership, or any lender to the
partnership or a taxable partner,
``(ii) to the extent of all tax-exempt partners' share thereof, a
loan by the partnership to any taxable partner or any lender to a
taxable partner, and
``(iii) any arrangement referred to in subsection (d)(1)(B) that
has the effect of a transaction described in clause (i) or (ii).
``(D) SPECIAL RULES.--
``(i) EXCEPTION FOR SHORT-TERM FUNDS.--Funds which are set aside,
or subject to any arrangement, for a period of less than 12 months
shall not be taken into account under subparagraph (A). Except as
provided by the Secretary, all related set asides and arrangements
shall be treated as 1 arrangement for purposes of this clause.
``(ii) ECONOMIC RELATIONSHIP TEST.--Funds shall not be taken into
account under subparagraph (A) if such funds--in applying subparagraph
(A) to property described in subparagraph (1)(C) if such funds bear no
connection to the economic relationships among the partners (whether
reflected in the partnership agreement or otherwise) with respect to
items of income, gain, loss, expense or credit attributable to such
property. For this purpose, funds described in section 956(c)(2)(J) or
section 956(c)(2)(K) shall be deemed not to bear any connection to the
economic relationships among the partners with respect to property
described in subparagraph (1)(C).
``(I) bear no connection to the economic relationships among the
partners, and
``(II) bear no connection to the economic relationships among the
partners and the partnership.
``(iii) REASONABLE PERSON STANDARD.--For purpose of subparagraph
(A)(ii), funds shall be treated as set aside or expected to be set
aside only if a reasonable person would conclude, based on the facts
and circumstances, that such funds are set aside or expected to be set
aside.
``(3) OPTION TO PURCHASE.--
``(A) IN GENERAL.--The requirement of this paragraph is met for any
taxable year with respect to any property described in subparagraph
(1)(C) owned by the partnership if (at all times during such taxable
year)--
``(i) each tax-exempt partner does not have an option to purchase
(or compel distribution of) such property or any direct or indirect
interest in the partnership at any time other than at the fair market
value of such property or interest at the time of such purchase or
distribution, and
``(ii) the partnership and each taxable partner does not have an
option to sell (or compel distribution of) such property or any direct
or indirect interest in the partnership to a tax-exempt partner at any
time other than at the fair market value of such property or interest
at the time of such sale or distribution.
``(B) OPTION FOR DETERMINATION OF FAIR MARKET VALUE.--Under
regulations prescribed by the Secretary, a value of property determined
on the basis of a formula shall be treated for purposes of subparagraph
(A) as the fair market value of such property if such value is
determined on the basis of objective criteria that are reasonably
designed to approximate the fair market value of such property at the
time of the purchase, sale, or distribution, as the case may be.''.
(2) Subsection (g) of section 470, as redesignated by paragraph
(1), is amended by adding at the end the following new paragraphs:
``(5) TAX-EXEMPT PARTNER.--The term `tax-exempt partner' means,
with respect to any partnership, any partner of such partnership which
is a tax-exempt entity within the meaning of section 168(h)(6), other
than a tax-exempt controlled entity (as defined in section
168(h)(6)(F)).
``(6) TAXABLE PARTNER.--The term `taxable partner' means, with
respect to any partnership, any partner of such partnership which is
not a tax-exempt partner.''.
(3) Subsection (h) of section 470, as redesignated by paragraph
(1), is amended--
(A) by striking ``, and'' at the end of paragraph (1) and inserting
``or owned by the same partnership,'',
(B) by striking the period at the end of paragraph (2) and
inserting a comma, and
(C) by adding at the end the following new paragraphs:
``(3) provide for the application of this section to tiered and
other related partnerships, and
``(4) provide for the treatment of partnership property (other than
property described in subsection (e) (1) (A)) as tax-exempt use
property if such property is used in an arrangement which is
inconsistent with the purposes of this section determined by taking
into account one or more of the following factors:
``(A) A tax-exempt partner maintains physical possession or control
or holds the benefits and burdens of ownership with respect to such
property.
``(B) There is insignificant equity investment in such property by
any taxable partner.
``(C) The transfer of such property to the partnership does not
result in a change in use of such property.
``(D) Such property is necessary for the provision of government
services.
``(E) The deductions for depreciation with respect to such property
are allocated disproportionately to one or more taxable partners
relative to such partner's risk of loss with respect to such property
or to such partner's allocation of other partnership items.
``(F) Such other factors as the Secretary may determine.''.
(4) Paragraph (2) of section 470(c) is amended--
(A) by striking ``and'' at the end of subparagraph (A), by
redesignating subparagraph (B) as subparagraph (C), and by inserting
after subparagraph (A) the following new subparagraph:
``(B) by treating the entire property as tax-exempt use property if
any portion of such property is treated as tax-exempt use property by
reason of paragraph (6) thereof.'', and
(B) by striking the flush sentence at the end.
(5) Subparagraph (A) of section 470(d)(1) is amended by striking
``(at any time during the lease term)'' and inserting ``(at all times
during the lease term)''.
(c) AMENDMENTS RELATED TO SECTION 888 OF THE ACT.--
(1) Subparagraph (A) of section 1092(a)(2) is amended by striking
``and'' at the end of clause (ii), by redesignating clause (iii) as
clause (iv), and by inserting after clause (ii) the following new
clause:
``(iii) if the application of clause (ii) does not result in an
increase in the basis of any offsetting position in the identified
straddle, the basis of each of the offsetting positions in the
identified straddle shall be increased in a manner which--
``(I) is reasonable, consistent with the purposes of this
paragraph, and consistently applied by the tax payer, and
``(II) results in an aggregate increase in the basis of such
offsetting positions which is equal to the loss described in clause
(ii), and''.
(2)(A) Subparagraph (B) of section 1092(a)(2) is amended by adding
at the end the following flush sentence:
``A straddle shall be treated as clearly identified for purposes of
clause (i) only if such identification includes an identification of
the positions in the straddle which are offsetting with respect other
positions in the straddle.''.
(B) Subparagraph (A) of section 1092(a)(2) is amended--
(i) by striking ``identified positions'' in clause (i) and
inserting ``positions'',
(ii) by striking ``identified position'' in clause (ii) and
inserting ``position'', and
(iii) by striking ``identified offsetting positions'' in clause
(ii) and inserting ``offsetting positions''.
(C) Subparagraph (B) of section 1092(a)(3) is amended by striking
``identified offsetting position'' and inserting ``offsetting
position''.
(3) Paragraph (2) of section 1092(a) is amended by redesignating
subparagraph (C) as subparagraph (D) and inserting after subparagraph
(B) the following new subparagraph:
``(C) APPLICATION TO LIABILITIES AND OBLIGATIONS.--Except as
otherwise provided by the Secretary, rules similar to the rules of
clauses (ii) and (iii) of subparagraph (A) shall apply for purposes of
this paragraph with respect to any position which is, or has been, a
liability or obligation.''.
(4) Subparagraph (D) of section 1092(a)(2), as redesignated by
paragraph (3), is amended by inserting ``the rules for the application
of this section to a position which is or has been a liability or
obligation, methods of loss allocation which satisfy the requirements
of subparagraph (A)(iii),'' before ``and the ordering rules''.
(d) EFFECTIVE DATE.--The amendments made by this section shall take
effect as if included in the provisions of the American Jobs Creation
Act of 2004 to which they relate.
Statement of Crowe Chizek and Company LLC
Proposed
Sec. 7. AMENDMENT RELATED TO THE JOBS AND GROWTH TAX RELIEF
RECONCILIATION ACT OF 2003.
(a) AMENDMENT RELATED TO SECTION 302 OF THE ACT.--Clause (ii) of
section 1(h)(11)(B) is amended by striking ``and'' at the end of
subclause (II), by striking the period at the end of subclause (III)
and inserting ``, and'', and by adding at the end the following new
subclause:
``(IV) any dividend received from a corporation which is a DISC or
former DISC (as defined in section 992(a)) to the extent such dividend
is paid out of the corporation's accumulated DISC income or is a deemed
distribution pursuant to section 995(b)(1).''.
(b) EFFECTIVE DATE.--The amendment made by this section shall apply
to dividends received on or after September 29, 2006, in taxable years
ending after such date.
General Comments
Congress has a history of stimulating the export of goods from the
United States. In the past, Congress attempted to increase exports by
providing incentives to U.S. exporters by enacting the foreign sales
corporation (``FSC'') and its successor, the extraterritorial income
exclusion (``ETI'') legislation. However, because the World Trade
Organization's (``WTO'') challenge of the FSC and ETI regimes resulted
in the repeal of both pieces of legislation, the only remaining export
incentive for U.S. exporters is the domestic international sales
corporation (``DISC'').
Originally adopted in 1971, the DISC regime was intended to induce
an increase in export activities for U.S. companies by allowing them to
receive a deferral on a portion of the income attributable to their
export activity. Under the DISC regime, a portion of the income
attributable to the export activity was segregated in a separate legal
entity, namely the DISC, which was not subject to U.S. income tax. U.S.
foreign trading partners contended that the DISC regime was an illegal
export subsidy because it allowed a portion of the DISC earnings to be
retained tax free without an interest charge. In response, the U.S.
introduced the ``Interest Charge DISC.'' In order to comply with
General Agreements on Tariffs and Trade requirements, the U.S. added an
interest charge component to the DISC in 1984.
For federal income tax purposes, the DISC is classified as a
domestic corporation whose income is derived almost exclusively from
U.S. export-related activities. The DISC itself is not subject to
income tax; however, DISC shareholders can be taxed on the DISC's
income for actual or deemed distributions. Despite shareholders'
taxation on DISC distributions, they still receive limited tax deferral
on income from export sales and certain other services.
Under section 1(h)(11) created by the Jobs Growth Tax Relief
Reconciliation Act of 2003 (``JAGRTA''), certain dividends earned by
individual taxpayers are taxed at long-term capital gain rates. Section
1(h)(11) applies to virtually all dividends paid by domestic
corporations and certain qualified foreign corporations. Further, this
section provides that the reduced rate is rendered unavailable for
certain excluded dividends listed under Section 1(h)(11)(B)(ii). A DISC
is a domestic corporation by definition, and because DISC dividends are
not listed on the excluded dividends list, they would qualify for
capital gains rate treatment under the current law. If Congress enacts
the proposed amendment, dividends from DISCs or former DISCs would be
considered ineligible for capital gains rate treatment. DISC
shareholders will no longer be able to take advantage of the favorable
capital gains rate on the dividend payment from DISCs or former DISCs,
which will ultimately be detrimental to the U.S. export industry.
Without the incentive of favorable capital gains rates on dividends
from DISCs or former DISCs, exports will go down thus having a negative
impact on the U.S. economy.
Since the enactment of JAGTRA, two Tax Technical Corrections Acts
have been submitted to Congress, both of which have not included an
amendment to change the tax treatment of dividends from a DISC or
former DISC under section 1(h)(11)(B). Congress' omission of this
amendment in prior Tax Technical Corrections Acts was generally viewed
by taxpayers as an indication that Congress had no intention of
changing the language under section 1(h)(11)(B) to specifically exclude
dividends received from a DISC or former DISC as qualified dividends
subject to capital gains rate treatment. Many taxpayers opted to use
the benefits originally provided under the Interest Charge DISC regime
and spent considerable sums to
utilize this business entity form. Their reliance on this structure has
helped to build the economy and stimulate growth in the export
industry. By taking no prior action, perhaps Congress was acknowledging
that dividends from DISCs or former DISCs should be qualified under
section 1(h)(11)(B).
If Congress pushes forward with the proposed amendment to section
1(h)(11)(B), we propose the following changes to the amendment:
Effective Date
At the very least, Congress should consider modifying the effective
date to allow taxpayers to transition out of the structure. Enacting
the amendment effective September 29, 2006, will affect taxpayers
estimated tax payments because under the current law, DISC dividends
and deemed dividends would still be qualified. By delaying the
effective date, Congress will give taxpayers time to transition their
business structures. We propose an effective date for years ending on
or after January 1, 2008.
Taint Earnings and Profits
Congress should consider rewording the amendment so that dividends
from pre-enactment earnings and profits (``E&P'') are still eligible
for capital gains rate treatment, while those dividends from post-
enactment E&P fall under the proposed change as unqualified dividends
under section 1(h)(11)(B). In essence, this will taint the E&P rather
than the dividend stream and will allow taxpayers to take advantage of
the benefits under the law as originally written. Currently, the
amendment is written such that dividends from a DISC or former DISC
will no longer be qualified under section 1(h)(11)(B). Any pre-
enactment E&P of the DISC or former DISC, if distributed after the
effective date, will be considered unqualified dividends taxed as
ordinary income even though the E&P was created before the effective
date. Taxpayers will not be able to take advantage of the lower tax
rates to which they were initially entitled on the pre-enactment E&P,
thereby making the proposed legislation, in effect, retroactive rather
than prospective. A proposed solution is to apply the amendment to the
E&P created after the effective date, and not to the dividend stream.
Making these proposed changes to Section 7 of the Tax Technical
Corrections Act of 2006 will allow taxpayers the time to transition
their business structures as well as take advantage of the benefits
under the law as originally written.
Miller and Chevalier Chartered
October 31, 2006
Committee on Ways and Means U.S. House of Representatives Longworth
House Office Building Washington, DC 20515-6348
We are writing to propose, as an addition to the pending technical
corrections bill, a new technical correction to the provision of the
American Jobs Creation Act of 2004 that extended the application of
section 108(e)(8) of the Internal Revenue Code to partnerships. We have
proposed this technical correction previously and have had discussions
with the staff of the Joint Committee on Taxation with regard to the
proposal. We would like to follow up on those discussions shortly.
As part of the American Jobs Creation Act of 2004, section
108(e)(8) was expanded to cover certain partnership contributions of
debt in exchange for equity. As explained in more detail in the
attached document we submitted to the Treasury Department last year, we
are proposing that section 108(e)(8) be clarified to provide comparable
scope to both partnerships and corporations. Currently, section
108(e)(8) does not apply to the contribution of debt to corporate
equity when the company does not issue shares, such as when the
shareholders make pro rata contributions of debt and the issuance of
shares has no economic consequence. The proposed technical correction
would make it clear that section 108(e)(8) similarly does not apply to
pro rata debt contributions to partnerships, even though the
partnership may make capital account adjustments pursuant to the
section 704(b) safe harbor regulations. The proposal is described in
more detail in the attached memorandum. We would also be open to
discussing other alternatives to resolve this problem, such as the
application of an exception for partnerships among members of a
consolidated group.
We will follow up with the Joint Committee on Taxation staff to
request a meeting to discuss this proposal. In the meantime, please
call David Zimmerman (202-626-5876), Steven Schneider (202-626-6063) or
me (202-626-5828) with any questions or comments.
Sincerely,
David B. Cubeta
______
Proposed Technical Correction to Section 108(e)(8)--Recognition of
Cancellation of Indebtedness Income Realized on Satisfaction of
Indebtedness with a Partnership Interest
Background
In the American Jobs Creation Act of 2004 (the ``2004 Jobs Act''),
Congress extended the application of section 108(e)(8) to acquisitions
of indebtedness by a partnership from a partner in exchange for a
capital or profits interest in the partnership.\1\ Prior to this
amendment, section 108(e)(8) had by its terms only applied to
corporations. As is discussed more fully below, because the safe harbor
provisions of the section 704(b) regulations require that an adjustment
be made to the partners' capital accounts when the partners contribute
debt to the creditor partnership, the partnership may be deemed to have
issued a capital interest for purposes of section 108(e)(8) even if the
partnership does not formally issue a partnership interest in exchange
for its indebtedness. As a result, the partnership will be unable to
avoid the application of section 108(e)(8) in situations where the
partners contribute their indebtedness to the partnership on a pro rata
basis and no partnership interest was actually issued in exchange. In
similar cases in the corporate context, a corporation has the ability
to choose whether to be subject to section 108(e)(8) or section
108(e)(6) by the simple expedient of issuing, or refraining from
issuing, stock. Because a corporation will generally recognize less
cancellation of indebtedness income if section 108(e)(6) applies to the
cancellation of the debt rather than section 108(e)(8), pro rata
cancellations of shareholder debt, including acquisitions of debt from
a sole shareholder, are usually structured as capital contributions.
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\1\ All section references are to the Internal Revenue Code of
1986, as amended.
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Proposal
Amend section 108(e)(8) to clarify that this section will not apply
to a pro rata contribution of indebtedness by partners to a
partnership.
Specifically, we would recommend that the following sentence be
added to section 108(e)(8):
If a debtor partnership acquires its indebtedness from its partners
proportionate to the manner in which the partners share future profits
and there have been no changes to any partner's profit sharing as a
result of such contribution, then this paragraph shall not apply.
Current Law
If a corporation acquires its indebtedness from its sole
shareholder or from each of its shareholders on a pro rata basis, the
corporation and its shareholders will be indifferent as to whether
additional shares are issued in the transaction. In such circumstances
if the form of the transaction is respected, section 108(e)(8) will
apply if the corporation issues its stock in satisfaction of the
indebtedness and section 108(e)(6) will apply if the shareholders
contribute the indebtedness to the corporation as a contribution to
capital. If section 108(e)(6) applies, the corporation is treated as if
it satisfied the indebtedness for an amount of money equal to the
shareholder's adjusted basis in the debt. If section 108(e)(8) applies,
the corporation will be treated as if it satisfied the indebtedness for
an amount of money equal to the fair market of the stock issued in the
exchange. The corporation will generally either realize the same or a
lesser amount of cancellation of indebtedness income under section
108(e)(6) because the shareholder's adjusted tax basis in the
indebtedness typically will be equal to or greater than the fair market
value of the debt.
Although the IRS does not appear to have a formal ruling policy
with respect to pro rata cancellations of debt in the corporate arena
in ``overlap'' cases where the issuance of stock by the corporation in
exchange for the debt would be economically meaningless and either
section 108(e)(6) or section 108(e)(8) could be construed to apply to
the cancellation, the private letter rulings that have been issued to
date appear to have followed the taxpayer's form in every case.\2\ In
effect, the IRS does not apply the authorities that might otherwise
deem stock to be issued based on the ``meaningless gesture'' doctrine
to section 108(e)(8) in situations where the taxpayer did not issue
stock.\3\ On the other hand, the IRS does not ignore the issuance of
stock in situations where the taxpayer in form issued stock. This gives
a corporation the flexibility to avoid having section 108(e)(8) apply
to the cancellation.
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\2\ See, e.g., PLR 9018005 (Nov. 15, 1989) (applying section
108(e)(8) to contribution of debt to a wholly owned subsidiary in
exchange for subsidiary stock); PLR 9024056 (Mar. 20, 1990)
(contribution of debt to a wholly owned subsidiary respected as capital
contribution subject to section 108(e)(6) in accordance with form); PLR
8606032 (Nov. 8, 1985) (same); PLR 9215043 (Jan. 14, 1992) (same); PLR
9623028 (March 7, 1996) (same); cf. TAM 9822005 (May 29, 1998) (noting
that there was a potential issue as to whether section 108(e)(6) or
section 108(e)(8) should be the controlling authority in situations
where both could apply; ruling did not resolve the issue because either
section would give equivalent results under the assumed facts of the
ruling).
\3\ In certain circumstances, such as for purposes of section 351,
the IRS and the courts will deem an exchange requirement to have been
met even though no shares were issued in circumstances where the
issuance of the shares would have been a ``meaningless gesture.'' See,
e.g., Rev. Rul. 64-155, 1964-1 C.B. 138 (contribution to 100% owned
corporation); Lessinger v. Commissioner, 872 F2d 5 19 (2d Cir. 1989)
(section 351 applies to transfer by 100% shareholder); and Warsaw
Photographic Associates v. Commissioner, 84 T.C. 21 (1985) (pro rata
transfer by multiple shareholders).
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Reasons for Change
The proposed amendment affords partnerships the same ability to
avoid the application of section 108(e)(8) as is allowed to
corporations under the Internal Revenue Service's informal ruling
policy, and it would limit this flexibility to fact patterns where it
would be a matter of economic indifference to the partnership and the
partners whether to issue additional partnership interests in exchange
for the indebtedness. This would be the case if the debt contribution
is in proportion to each partner's interest in profits and there is no
change in the profit allocations of any partner as a result of the
contribution. In such circumstances, while capital account credit must
still be assigned to the contributing partner to satisfy the section
704(b) safe harbor,\4\ the capital account credit will be in proportion
to each partner's profit sharing ratio and merely represents the same
amount that the partners otherwise would receive as profits if the
capital account were not adjusted. Thus, when coupled with the absence
of any change to the partners' future profit sharing ratios as a result
of the contributions, the capital account adjustment would be a matter
of economic indifference to the partners (as in the pro rata case for
corporations), and there would be no tax policy reason to require
income recognition as a result of the contribution. Absent
clarification, it is unclear whether a partnership is afforded
comparable flexibility because the requisite adjustment to the capital
account may properly be regarded as the issuance of a capital interest
and, if so treated, would cause section 108(e)(8) to apply even in the
case of a pro rata contribution of indebtedness. This change is
consistent with the clear intent of the 2004 Jobs Act's revision as a
whole--to treat corporations and partnerships in a like manner for
purposes of section 108(e)(8). When Congress extended the application
of section 108(e)(8) to partnerships it is reasonable to assume that
Congress did not intend to disadvantage partnerships as compared to
corporations. Nor, in the pro rata case, would there appear to be any
tax policy justification for requiring a greater amount of cancellation
of indebtedness income recognition, because there would be no
meaningful change in the partners' economic sharing arrangement by
reason of the contributions of debt. Consequently, in the pro rata
case, the imposition of section 108(e)(8) on the partnership would
create the potential for a tax ``whipsaw'' on the partners (ordinary
income allocated to each partner with a corresponding capital loss
incurred by each partner in its capacity as creditor) in a circumstance
presenting no underlying economic change of any substance.
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\4\ Treas. Reg. Sec. 1. 704-1(b)(2)(iv)(b).
---------------------------------------------------------------------------
The following examples will help clarify this point.
Example 1. Pro rata contribution in corporate context. A and B are
shareholders in Corporation. Each originally contributed $2,000 in
exchange for 100 shares of stock and loaned $4,000 to Corporation. At a
time when the fair market value of Corporation's assets is $12,000 and
the liabilities are $8,000, A and B each contribute their debt to
Corporation and do not receive any additional stock in return.
Immediately before the contribution, the Corporation stock was worth
$4,000 and immediately after the contribution the stock was worth
$12,000. The value of each shareholder's equity interest has increased
from $2,000 to $6,000 as a result of the contribution. If Corporation
had instead issued an additional 200 shares to each shareholder in
exchange for the contribution of the indebtedness, the value of an
individual share would be unchanged, but the value of each
shareholder's total equity interest would have increased from $2,000 to
$6,000. In this example, the act of issuing additional stock would have
been a meaningless gesture because A and B each will share in the
$8,000 net value increase in the same 50:50 ratio whether new stock is
issued in a 50:50 ratio or whether their historical stock, also held in
a 50:50 ratio, increases in value.
Example 2. Pro rata contribution in LLC context--not liquidating in
accordance with capital accounts. Same as Example 1 except that the
entity is an LLC that liquidates and shares profit in accordance with
relative outstanding units. Like Example 1, it would be a meaningless
gesture to issue additional units because the ``profit'' to each member
from the increased net value of LLC would be the same whether reflected
in an increased value of the historical units or in additional units
with a constant value.
Example 3. Pro rata contribution in LLC context--liquidating in
accordance with capital accounts. Same as Example 2 except that the LLC
follows the section 704(b) safe harbors and liquidates in accordance
with positive capital accounts. The LLC shares profits in accordance
with the relative outstanding units, or 50% each to A and B. In this
example, it would be a meaningless gesture for the LLC to issue
additional units since they would be issued in the same ratio as the
existing outstanding units and the issuance of the additional units
would not affect the relative profit percentages. However, because the
LLC follows the section 704(b) safe harbors, it must credit the member
capital accounts in an amount equal to the net fair market value of
their contributions. In this case, similar to Example 2, this credit
increases the liquidation rights of the existing units by $4,000 each,
which is in proportion to both the contributed debt and the members
relative profit sharing percentages.
The results would be the same for an entity organized as a state
law partnership rather than an LLC.
The progression shown by these examples demonstrates three
identical economic fact patterns where the issuance of additional stock
or LLC units would be a meaningless gesture. In all three cases, the
contributions of debt and any corresponding section 704(b) capital
account increases were ``pro rata'' to the manner in which the existing
outstanding shares/units shared in the benefit of the increased net
value of the entity resulting from the contribution. In other words,
when the contribution of debt was pro rata to the owners' profit
sharing percentages, the issuance or non-issuance of additional stock/
units would be a meaningless gesture and would fit within the
constraints of the proposed technical correction.
By providing a rule that defines pro rata based on the sharing of
future profit, any existing partnership special allocations are already
incorporated into the rule as part of the future profit sharing
percentages. Similarly, the rules regarding partnership liabilities in
section 752 would operate as they do under current law, and the manner
in which the partners share liabilities for purposes of those rules
would not impact the application of section 108(e)(8) because those
sharing rules do not reflect the economic and tax policy analysis
above.
The proposed technical correction is limited to excluding pro rata
contributions of indebtedness by partners to partnerships from section
108(e)(8) treatment. We recognize that it may be logical to apply
section 108(e)(6) in such circumstances. As section 108(e)(6) by its
terms applies only to corporations, a further technical correction
would be necessary to apply section 108(e)(6) in this context. We would
be happy to provide you with additional input in this regard.
The Art Institute
Chicago, Illinois 60603
October 31, 2006
Honorable Charles E. Grassley, Chairman
Honorable Max Baucus, Ranking Member
Committee on Finance
U.S. Senate
219 Dirksen Senate Office Building
Washington, DC 20510
Honorable William M. Thomas, Chairman
Honorable Charles B. Rangel, Ranking Member
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Gentlemen:
We are writing to request that certain corrections be included in
the Tax Technical Corrections Act of 2006 (S. 4026 and H.R. 6264). Our
requests relate to the provisions on fractional interest gifts found in
Section 1218 of the Pension Protection Act of 2006 (the ``Act'').
Background
The Art Institute is deeply concerned that the fractional gift
provisions of the Act will curtail or even end partial interest gifts
to museums and will thus deprive the public of the opportunity to see
great works of art. Like many American museums, the Art Institute has
received significant works as fractional gifts. Objects we have
received as partial interest gifts--and that as a result are on public
view at the museum--include works by Monet, Picasso, Van Gogh, and
Cezanne, among others.
Museums rely on gifts to acquire such works for the public; in
today's art market, museums cannot realistically expect to have the
funds to purchase such major works on a regular basis. It is the public
that gains when a museum receives gifts of art, since these
masterpieces can now be viewed by anyone who visits the museum rather
than being passed down in families or being sold to other private
owners.
Given the critical importance of gifts of art, including fractional
interest gifts, we are seeking the corrections described below.
Requested Corrections
1. Discrepancy Between Tax Liability and Deduction
Under Sections 2031 and 2512 of the Internal Revenue Code of 1986,
as amended (the ``Code''), estate and gift taxes are based on the fair
market value of an object on the date of death or the date of the gift.
Under Section 1218 of the Act, however, after a donor makes a gift of a
fractional interest in an object, the deduction for all subsequent
fractional interest gifts in the same object is limited to the
appraised value at the time of the first gift. As a result, if a donor
makes a gift of a 30% interest in an object in Year 1, the work
appreciates in value, and he then dies in Year 8 with the remaining 70%
interest going to the museum at that time, the estate tax will be based
on the fair market value of the object in Year 8 but the deduction will
be based on the lower appraised value from Year 1. A similar result
occurs under the gift tax laws.
This discrepancy does not seem to promote any policy goal and
produces a harsh result for individuals who are attempting to make
charitable gifts. Not surprisingly, perhaps, donors have already
informed us that because of this discrepancy, they will no longer make
partial interest gifts. We therefore seek corrections that will
eliminate this concern.
2. Gifts in Progress
When museums receive gifts of art, including fractional interests,
they take the new work into account in developing exhibition and
programming plans. In addition, they adjust their acquisition plans and
priorities; having received an interest in a work by a particular
artist, which brings with it the right to possess that work for some
period and the expectation of eventually receiving full ownership, a
museum will focus its acquisition plans on works by other artists or
works from other periods. Unfortunately, in light of the uncertainty
created by the Act and the new penalties contained in the Act, donors
are suspending gifts that were in progress before the new law was
enacted. Museums, in turn, are facing disruption to plans and a delay
in receiving gifts that donors long intended to give. To avoid this
result, the Act should not apply to fractional interest gifts in an
object if the donor had made at least one fractional interest gift in
the same object before the law was enacted.
3. Recapture Provision
The Act provides for recapture of income and gift tax deductions,
plus a penalty, if the remaining interest in a work has not been
contributed to the donee ``before the earlier of
(I) the date that is 10 years after the date of the initial
fractional contribution, or (II) the date of the death of the donor. .
. .'' One reading of this language is that the final interest has to
have been contributed before the date of the donor's death, making it
impossible for the gift to be completed upon death by way of a will,
trust, or other instrument without recapture. If the donor dies within
ten years of making the initial fractional gift, and if the work is in
fact transferred to the donee upon the donor's death, recapture and
penalties seem inappropriate.
4. Valuation of Subsequent Gifts
We are particularly troubled by the provision of the Act stating
that subsequent gifts must be valued based on the lesser of the fair
market value at the time of the initial gift or the fair market value
at the time of the additional contribution. First, of course, this
provision gives rise to the discrepancy discussed above between the
deduction and the potential gift and estate tax liability. Second,
faced with the likelihood of having to take a deduction in the future
that does not represent the actual market value of the gift, donors may
choose either not to give the gift at all or to delay and give the
object as a bequest at death. From the museum's perspective, even a
delay in making a gift poses a risk; a donor may change his mind about
making the donation, the work could suffer damage, or the donor's
circumstances may change such that he is forced to sell the work.
The concern reflected in this provision appears to be that donors
are using inaccurate appraisals. Rather than requiring donors to use
out-of-date valuations, however, an approach generally disfavored in
other contexts, it would seem more appropriate to focus on assuring
that appraisals are accurate. We therefore recommend that donors be
permitted to deduct the current fair market value, but in any case in
which the work as a whole is valued at $1 million or more, even if the
gift in question is just a fractional interest, the appraisal should be
reviewed by the IRS Art Advisory Panel.
5. Ten-Year Recapture Period
We also recommend a change to the provision in the Act requiring
recapture and imposing penalties if the gift is not completed by the
earlier of ten years from the date of the initial contribution or the
death of the donor. Donors may wish to spread out a gift over more than
ten years for legitimate reasons such as financial planning or personal
attachment to the object. A ten-year time limit will likely deter
donors from making gifts; a collector who owns an object valued at tens
of millions of dollars may feel he simply cannot donate such a work
over only ten years, given the contribution limit for gifts of tangible
personal property, and thus may not give the work at all, while another
collector may wish to have possession of a particularly treasured
object for at least some periods throughout his life and therefore may
decide simply to keep the object until his death. So long as the museum
ultimately ends up with the object and meets the possession
requirements during the course of the gift, the period of the gift
should not matter. To assure that these goals are met, donees could be
required to file information returns with the Internal Revenue Service
in the event the gift is not completed or the possession requirements
are not met. If either event occurs, prior income and gift tax
deductions could be recaptured.
6. Possession
Under the Act, donors are subject to recapture and penalties if the
donee does not have substantial physical possession of the work during
the period of the gift. We suggest a clarification that the recapture
and penalties do not apply in the event the donor dies before the donee
has taken possession. In addition, we recommend the adoption of
exceptions to the possession requirement for exceptional circumstances,
such as a significant construction project at the museum that requires
deinstallation of galleries or because of unique factors relating to
the particular work of art in question.
We appreciate your consideration of our suggestions and your
attention to the important role that fractional interest gifts play in
allowing museums to build art collections for the benefit of the
public.
Very truly yours,
James Cuno
President
Eloise W. Martin
Director
Julia E. Getzels
Executive Vice President, General Counsel and Secretary
Massachusetts Bay Transportation Authority
Boston, Massachusetts 02110
October 31, 2006
The Honorable Bill Thomas
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
Dear Chairman Thomas:
On behalf of the Massachusetts Bay Transportation Authority (MBTA),
I wish to submit these formal comments pursuant to your request for
written comments in connection with H.R. 6264, the ``Tax Technical
Corrections Act of 2006.'' These comments specifically regard the newly
enacted section 4965 of the Internal Revenue Code. The MBTA is very
concerned that this new law, depending on interpretation, could impose
a retroactive and financially damaging excise tax on public sector,
tax-exempt agencies which have taken part in ``lease in-lease out''
(LILO) and ``sale in-lease out'' (SILO) transactions.
The MBTA is the fifth largest mass transit system in the United
States, serving over 1.1 million passengers daily. We operate the
oldest continually operating subway system in the country and seven
other modes of transit.
The MBTA's annual operating budget exceeds $1.3 billion and is
funded from fare revenues, non-fare revenues generated by the MBTA,
dedicated revenues pledged by the Commonwealth of Massachusetts and its
communities as well as federal funds. The MBTA is in the midst of a
fiscal crisis, including a potential $70 million budget shortfall for
the MBTA's fiscal year ending June 30, 2007. This is mainly due to
increased fuel costs, high debt service expenses and lower than
anticipated sales tax revenues. The MBTA has taken appropriate steps to
address this shortfall by reducing costs and increasing revenues with
such actions as a fare increase anticipated to take effect in January
of 2007. Even with these aggressive actions, the MBTA will not have the
wherewithal to fund a substantial regressive federal excise tax that
could be imposed on us.
The MBTA participated in four LILO transactions between 1996 and
1998, which is prior to the IRS including LILOs as listed tax shelters.
In each case, the transactions were not only approved by the Federal
Transit Administration but promoted by that agency as an innovative
financing tool. The proceeds from these transactions were received by
the MBTA as upfront payments and have been used to invest in the
infrastructure of our system and to provide service to our customers.
The imposition of a retroactive excise tax would have a profoundly
negative impact on our ability to provide expected service to the
public.
The central problem is that section 516 of the Tax Increase
Prevention and Reconciliation Act does not provide clear definitions of
``net income'' and ``proceeds'' and, as a result, the Treasury and IRS
have insufficient guidance in defining those terms as they proceed
through the regulatory process. The MBTA, along with many other transit
agencies, is very concerned that this lack of guidance may result in
regulations with overly broad definitions which will make the MBTA
subject to a substantial retroactive excise tax.
Mr. Chairman, as you and your Committee consider this issue, we
respectfully request that you include in H.R. 6264 a provision which
would clarify the meaning of the terms ``net income'' and ``proceeds''
and the appropriate allocation of such items to ensure that the new
excise tax is not applied on a retroactive basis to public agencies
like the MBTA.
Thank you for your consideration of our views. For a more detailed
explanation of the issue, we have attached a copy of our comment letter
to the Treasury Department and IRS. If you have any further questions,
please feel free to contact me.
Very truly yours,
Jonathan R. Davis
Deputy General Manager and Chief Financial Officer
Wubbels and Duffy
November 3, 2006
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
Re: Written Comments on H.R. 6264.
Dear Sir or Madam,
With regard to H.R. 6264, we are writing to express our
disagreement with the amendment related to the Jobs and Growth Tax
Relief Act of 2003. Included in Section 7 of H.R. 6264 is an amendment
to Section 302 of the Jobs and Growth Tax Relief Act of 2003 which
effectively excludes from the definition of qualified dividends ``any
dividend received from a corporation which is a DISC or former DISC . .
.''.
Because the intent of the DISC is to encourage U.S. companies to
export domestically produced products, this amendment seems contrary to
the original intent of the DISC. Essentially, this proposed amendment
specifically singles out exporters for exclusion from qualified
dividend treatment.
Why would Congress want to hurt U.S. Exporters?
We would appreciate your reconsideration of this amendment. We
believe this amendment should be removed and that dividends paid by
U.S. manufacturer/exporters using the DISC should receive at least
equal treatment to that of other U.S. dividend paying companies.
Sincerely,
Tom Duffy
Lousiana District Export Council
New Orleans, Lousiana 70130
October 26, 2006
The Committee on Ways and Means
U. S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Chairman Thomas and Committee Members:
This submission is being made on behalf of the Louisiana District
Export Council, Inc. (``LADEC''), a non-profit organization
incorporated under the laws of Louisiana. The purpose of LADEC is to
promote and encourage U.S. exports from Louisiana by: (1) supporting
Louisiana based businesses and/or Louisiana produced goods and services
so as to strengthen individual companies, stimulate U.S. economic
growth, and create Louisiana based export related jobs; (2) supporting
the activities of the U.S. Commercial Service (``USCS'') at the Delta
U.S. Export Assistance Center located in New Orleans, LA; and (3)
initiating or supporting such other export related activities as the
LADEC Board of Directors with the concurrence by a majority of its
Members may decide from time to time. We appreciate this opportunity to
express our views on a matter of great concern to a significant number
of Louisiana's small business exporters.
On September 29, 2006, H.R. 6264, the ``Tax Technical Corrections
Act of 2006'' (``the Bill'') was introduced by Chairman Bill Thomas. On
the same date, Chairman Thomas requested written public comments for
the record from all parties interested in H.R. 6264. The Website of the
Committee on Ways and Means advises that such comments must be
submitted by the close of business on Tuesday, October 31, 2006. This
submission is being made within that time period.
Concerns re: H.R. 6264, Section 7
Included within its proposed ``corrections'' H.R. 6264 includes
Section 7, which dramatically affects the tax treatment of dividends
received by non-C corporation shareholders of Interest-Charge Domestic
International Sales Corporations (``IC-DISCs''). This class generally
includes those small business taxpayers receiving their IC-DISC
dividends through an S corporation, or a partnership-owned IC-DISC. As
proposed, Section 7 would deny ``qualified dividend'' treatment under
Internal Revenue Code of 1986, as amended (``Code''), Section
1(h)(11)(B), for all IC-DISC dividend distributions.\*\ Section 7
provides that such changed treatment be effective with respect to such
``dividends received on or after September 29, 2006, in taxable years
ending after such date.''
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\*\ The practical effect of this provision would be to more than
double the taxation of such affected individuals by taxing their IC-
DISC dividends at as high as a 35 percent marginal rate rather than at
the 15 percent rate currently in effect for qualified dividends.
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It is respectfully submitted that Section 7 is not a ``technical'',
but rather a substantive, change in the tax law treatment of all
affected individuals receiving dividends from an IC-DISC. A change with
such a substantial impact, although on an admittedly small segment of
taxpayers, should neither be part of a ``technical corrections'' Bill,
nor should it bear an effective date that, although stated as
prospective from the date of introduction,has the practical effect of
retroactivity to January 1, 2006.
Affected taxpayers have structured their eligible export
transactions for calendar year 2006 in reliance on the law as it has
existed for over three years, with the reasonable expectation that
their IC-DISC tax transactions and dividend distributions for the
calendar year 2006 would be taxed in accordance with existing law.
In accordance with the applicable IC-DISC transfer pricing rules of
the Code, the applicable U.S. Treasury regulations, and IC-DISC related
pronouncements of the Internal Revenue Service, these calculations are
made, inter-company transaction are effected, and IC-DISC dividends are
paid, generally only at or near the end of the calendar year concerned,
when the required information is first available with reasonable
certainty. Indeed, the IC-DISC ``gross receipts'' and ``assets tests''
of Code section 992(a) (1) (A) and (B) for DISC qualification can only
be made at the end of the year. The practical consequence of enacting
Section 7 of the Bill with its currently stated effective date would
therefore be to impose a significant tax increase, in a retroactive
fashion, on all those affected taxpayers.
Current Law Provisions
The IC-DISC provisions of Code sections 991-997, as now in effect,
provide tax incentives for small businesses with respect to their
export of U.S. manufactured goods and certain export related services,
by permitting them to defer paying income tax on a limited amount of
export profits. They may accumulate within the IC-DISC otherwise
taxable profits attributable to qualified export receipts not exceeding
$10 million per calendar year, but only if substantially all such
accumulated DISC profits are reinvested in expanded export assets. The
price of such deferral is the payment of an interest charge at an
attractive Treasury Bill rate. Code section 995(f).
Alternatively, the IC-DISC may distribute some or all of such
export profits as dividends to the IC-DISC's shareholders. Under
current law such shareholders who are individuals, including those
owning their interests in an IC-DISC through a flow-through entity, are
taxed at a maximum rate of 15 percent on such dividends. Export profits
of an IC-DISC on its export receipts in excess of $10 million per year
are deemed distributed to the IC-DISC shareholders, who are taxed on
such distributions as dividends. Code section 995(b) (1). If such
shareholders are individuals, the current maximum rate of 15 percent
also applies to such ``deemed distributions''.
Many U.S. manufacturers, particularly those with expanding
businesses, may not be overly burdened by the reinvestment requirement
for accumulating export profits within their IC-DISC subsidiaries. Such
taxpayers should also now be deriving benefits from the domestic
production deduction provided by Code section 199.
Need for a Different Approach to Solving the Perceived Problem
Many architectural and engineering firms, and small wholesalers and
retailers that find foreign markets for, and then buy and immediately
export, U.S. manufactured goods on a C.O.D. or short-term Letter of
Credit basis, have neither a significant investment in export
inventories nor require warehouses, nor are they eligible for the Code
section 199 domestic production deduction with respect to their export
sales or services. In addition, some ``manufacturers'' may not require
significant investments in materials, or bricks and mortar type export
assets, yet incur substantial additional costs in developing an export
market for their wares. So these taxpayers, due to the peculiar
circumstances of their export businesses, and although included within
the intended recipients of the IC-DISC export tax incentives, are often
unable to meet the reinvestment requirements and will be effectively
shut out from all export tax incentives unless some form of meaningful,
if limited, small business exception is made in the Bill's Section 7.
It is respectfully submitted that a responsible way to deal with
the unintended consequences to the U.S. Treasury from granting access
to the 15 percent qualified dividend rate for individuals would be to
curtail access to this preferential treatment on unlimited amounts of
deemed distributions from an IC-DISC, preferably on a truly prospective
basis.
Recommended Solutions
The preferred 15 percent dividend rate would be retained, but only
with respect to a very limited amount of dividends to benefit those
small businesses that would otherwise be left out of the IC-DISC export
tax incentive. This could be accomplished by retaining the preferred 15
percent rate on distributions of ``DISC income'' under Code section
995(f)(1), but denying it with respect to ``deemed distributions''
under Code section 995(b)(1).\\
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\\ The sole remaining beneficiaries of this limited access
to the 15 percent qualified dividend rate would be individuals, and the
amounts of tax benefits derived, in the aggregate, would be quite small
in macroeconomic terms. Nevertheless, such treatment would still
provide a limited but meaningful export tax incentive for those
originally intended beneficiaries of the IC-DISC provisions. This class
of taxpayers was certainly not the object of the World Trade
Organization complaints concerning export tax incentives given to major
U.S. corporations, and it is anticipated that there should be no
reprisals within the WTO from the retention of such limited benefits to
an even more limited group of individuals.
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The effect of such a limited change would be to provide for
continuation of the 15 percent rate with respect to annual dividends of
the IC-DISCprofits from no more than $10 million of qualifying export
receipts of the IC-DISC and its related supplier(s) within a modified
controlled group. See Code section 995(b) (4).
For the typical small business exporter with, say, a 4% net-to-
gross ratio, this would have the maximum effect of a 20 percentage
point rate reduction in dividends of $400,000 of annual export profits,
or an aggregate group tax reduction of $80,000. All export profits on
the group's receipts in excess of $10 million each year would then be
subject to the full ordinary income tax rate of up to 35 percent. Of
course for many, indeed most, affected small businesses the actual
benefit would be considerably less: their actual export sales volumes,
the profits on which the beneficial rate would apply, would be
considerably less than the annual maximum of $10 million.
These changes should be made prospective in a meaningful way, by
making them applicable to dividends paid in taxable years of IC-DISCs
beginning after the date of introduction (or, more preferably, after
the date of enactment).
In order to accomplish these recommended changes,
(1) The indented sub-clause in paragraph (a) of Section 7 could be
changed to read:
`(IV) any dividend received from a corporation which is a
DISC or a former DISC, as defined in section 992(a), to the
extent such dividend is not paid out of its DISC income for
such year (as defined in section 995(f) (1)).'
And,
(2) Paragraph (b) of Section 7 should then be changed to read:
`(b) Effective Date-The amendment made by this section shall
apply to dividends paid in IC-DISC taxable years beginning after the
date of enactment.'
On behalf of the Louisiana District Export Council, Inc., and the
small business exporters of Louisiana who are attempting to recover
from the ravages of Hurricane Katrina, we earnestly solicit your
adoption of the proposed changes as discussed above, if it is found
necessary to make any change to the existing rules regarding the tax
treatment of IC-DISC dividends. Thank you for your consideration of
these views.
Of course, if you have any questions or would consider further
discussion helpful, the undersigned is available to your Staff at the
above e-mail address or by phone at 251-625-4603.
Respectfully submitted,
Edward K. Dwyer, CPA
LADEC Member
The Honorable William M. Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
The Honorable Charles B. Rangel
Ranking Member
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas and Ranking Member Rangel:
In response to Advisory Release No. FC-26 (September 29, 2006), the
National Association of Real Estate Investment Trusts'
(NAREIT) is submitting these comments regarding TTCA 2006, and in
particular, the modifications to section 470,\1\ which limits the
deductions allocable to property used by governmental or other tax-
exempt entities. NAREIT is the representative voice for U.S. 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.
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\1\ For purposes of this letter, ``section'' refers to the Internal
Revenue Code of 1986, as amended (Code), unless otherwise indicated.
Also, ``section 470'' refers to section 470 as enacted by the American
Jobs Creation Act of 2004 (AJCA), and ``TTCA 2006, proposed section
470'' refers to the proposed revisions to section 470 under section
6(b) of TTCA 2006.
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As further described below, NAREIT has two specific comments.
EXCUTIVE SUMMARY
First, NAREIT requests a statutory change or legislative history
demonstrating that REITs should not be considered ``pass-thru
entities'' for purposes of sections 168(h)(6)(E) and 470. This request
is consistent with federal tax law's general treatment of REITs (with
rare exceptions) as C corporations and not as pass-thru entities.
The second comment relates to the umbrella partnership (UPREIT)
structure utilized by over 60% of the publicly traded REIT industry, by
many private REITs and by some non-REIT C corporations. As further
described below, an UPREIT owns and operates its entire property
portfolio through an operating partnership (OP), the ownership units in
which are held by the REIT and third parties who, typically after one
year, have the right to exchange their partnership units for the fair
market value equivalent of REIT stock or cash (at the REIT or OP's
option). Because this exchange right does not protect the unitholders
from risk of loss, but rather is a means to provide them with
liquidity, NAREIT requests guidance that the existence or funding of
this redemption right by the REIT or OP in the ordinary course of
business, by itself, is not considered a ``set aside'' or
``arrangement'' resulting in the unintended application of the loss
disallowance rules of section 470.
NAREIT also supports the more general comments to TTCA 2006
submitted by The Real Estate Roundtable.
DISCUSSION
I. Background
As enacted by the AJCA, and proposed to be amended by TTCA 2006,
section 470 was designed to prevent taxpayers from claiming tax
benefits generated in ``Sale-In Lease-Out'' (SILO) transactions,\2\
which the IRS declared to be abusive tax avoidance arrangements.\3\
Presumably to prevent SILO-like transactions from being replicated
through special allocations made by partnerships, Congress extended
section 470 to losses attributable to property owned by a ``pass-thru
entity'' with one or more tax-exempt or foreign owners. Section 470
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.'' \4\
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\2\ H.R. Rep. No. 548, pt. 1, 108th Cong., 2d Sess. 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. 192, 108th
Cong., 1st Sess. at 198 (2003) (same).
\3\ Notice 2005-13, 2005-9 I.R.B. 1 (designating SILOs as a listed
transaction).
\4\ Section 470(a).
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The term ``tax-exempt use property'' is defined by reference to
section 168(h), which includes: 1) tangible property leased to tax-
exempt entities; \5\ and, 2) 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.\6\ Thus, under section 168(h) and, in turn, section 470,
tax-exempt use property includes not only property leased to tax-exempt
entities, but also the proportionate amount of other property,
regardless of its use, owned by a pass-thru entity and attributable to
a tax-exempt or foreign owner.\7\ Neither sections 470 and 168(h) nor
the accompanying legislative history define a pass-thru entity for this
purpose, and, furthermore, neither does TTCA 2006 address this issue.
Adding to the uncertainty is the fact that, notwithstanding the general
tax treatment of a REIT as a corporation,\8\ there are a few instances
in the Code in which a pass-thru entity is defined to include a
REIT.\9\
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\5\ Id. Sec. 168(h)(1).
\6\ Id. Sec. Sec. 168(h)(6)(A), (E).
\7\ Id. Sec. 168(h)(6)(A). TTCA 2006, proposed section 470(c)(2)(B)
would change section 470 from limiting deductions proportionately based
on the ownership interests of a tax-exempt or foreign partner in a
partnership to being completely disallowed. NAREIT opposes this change
and agrees with the comments of The Real Estate Roundtable which
discuss this opposition in more detail.
\8\ Treas. Reg. Sec. 1.856-1(e) (stating that, to the extent not
inconsistent with the REIT provisions of the Code, other provisions of
chapter 1 of the Code, such as sections 301 (property distributions);
302 (distributions in exchange for stock), and 316 (definition of a
dividend), apply to a REIT and its shareholders ``in the same manner
that they would apply to any other organization which would be taxable
as a domestic corporation.'' See also Treas. Reg. Sec. 1.368-2 (tax-
free reorganization rules apply to REITs as corporations); Rev. Rul.
66-106, 1966-1 C.B. 151 (``provisions of subchapter C pertaining to
corporate distributions, are applicable with respect to both REITs and
their shareholders in the same manner that they would apply to any
other unincorporated trust which would be taxable as a domestic
corporation'').
\9\ Sec. Sec. 1(h)(10)(B); 860E(e)(6)(B); 1260(c)(2).
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II. Guidance Requested That REITs Are Not ``Pass Thru Entities'' Under
Section 470
Much of the discussion below was set forth in a February 25, 2005,
letter to Treasury Department and IRS officials requesting regulatory
guidance on this issue. NAREIT understands that regulatory guidance may
not have been issued in the past given the expectation of technical
corrections to section 470. Recognizing the difficulty in applying
section 470 to pass-thru entities in an appropriate manner, the IRS
issued Notice 2005-29, 2005-13 I.R.B. 796, and then Notice 2006-2,
2006-2 I.R.B. 278, which provide that in the case of partnerships and
pass-thru entities described in Sec. 168(h)(6)(E), for taxable years
that began before January 1, 2006, the IRS will not apply Sec. 470 to
disallow losses associated with property that is treated as tax-exempt
use property solely as a result of the application of Sec. 168(h)(6).
Because TTCA 2006 now has been proposed without addressing the issue of
a REIT being treated as a pass-thru entity for purposes of section 470,
and the moratoria have expired, now would be the appropriate time to
provide certainty to REITs and their investors by resolving this issue.
This issue is particularly important because, as further described
below, TTCA 2006 attempts to provide an exception from the application
of section 470 for certain ``partnerships.'' However, ``REITs'' neither
would be included in the definition of ``partnerships'' for purposes of
this exception, nor excluded from the general definition of ``pass thru
entities'' under the general application of section 470. As a result,
it is still possible that section 470 could apply to REITs, even under
TTCA 2006's proposal and without the benefit of the proposal's
exceptions from section 470). This clearly would be an inappropriate
result; section 470 simply should not apply at the REIT level.
The statutory language and legislative history clearly indicate
that REITs were not the target of this provision. First, a REIT by
definition is required to be taxable as a domestic corporation.\10\
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 or credits to their shareholders.\11\ 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.
---------------------------------------------------------------------------
\10\ Section 857(a)(3).
\11\ 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 (e.g., partnerships), REIT-level losses
or credits do not flow through to shareholders regardless of whether
the REIT issues a single class of stock or multiple classes of stock.
Further, a REIT generally has little or no taxable income or tax
liability to offset with something like SILO deductions or credits
because it may deduct dividends paid to shareholders, and it must
distribute most of its taxable income as dividends.\12\ Given the tax
treatment of REITs, there was no benefit to its shareholders for a REIT
to acquire tax deductions or credits through a SILO arrangement.\13\
The only practical way that a REIT shareholder could offset its REIT
taxable income or associated tax liability would have been to enter
into a SILO transaction on its own outside of--and separate and apart
from--the REIT.
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\12\ Id. Sec. 561.
\13\ To the extent that it could be argued that preferred shares of
REITs could be issued to tax-exempt investors as some way to
approximate SILO transactions, the existing fast pay preferred stock
regulations of Treas. Reg. Sec. 1.7701(1)-3(c)(2) prohibit such abuse
and is a more targeted anti-abuse method than channeling all REITs into
the definition of ``pass-thru entity'' under section 470. See C.
Kulish, J. Sowell, and P. Browne, Section 470 and Pass-thru Entities: A
Problem in Need of a Solution, 7 Bus. Entities 12, 25-26 (2005), for a
more detailed explanation of this issue.
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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.\14\ 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. REITs had (and have) little incentive to enter into SILO-
like arrangements because they already receive a deduction for
dividends paid and expend significant resources in order to comply with
the REIT rules in order to receive this deduction. Thus, SILO
transactions are unattractive to REITs because they would generate less
cash to REITs and their investors compared alternative investments such
as leasing transactions with real economics that are the basis on which
REIT investors evaluate REIT management.
---------------------------------------------------------------------------
\14\ 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.
In order to avoid the unintended application of the loss limitation
rules of section 470 to REITs with tax-exempt or foreign shareholders,
NAREIT respectfully requests that Congress provide guidance (by
statutory changes to TTCA 2006 or in its legislative history) stating
that a REIT is not pass-thru entity for purposes of sections 470 and
168(h)(6)(E). Note that even under such guidance, a REIT's lease of
property to a tax-exempt lessee still could be subject to section 470
if it uses a partnership; however, the REIT itself would not be a
``pass thru entity'' subject to section 470.
III. Guidance Requested that the Typical UPREIT Redemption Right Does
Not, By Itself, Cause REIT OPs to Be Subject to Section 470
Recognizing that ``[t]he manner of application of section 470 in
the case of property owned by a partnership in which a tax-exempt
entity is a partner is unclear,'' \15\ TTCA 2006 proposes a number of
changes to section 470's application to partnerships.
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\15\ Joint Committee on Taxation, Description of the Tax Technical
Corrections Act of 2006 (JCX-48-06), October 2, 2006, at page 6.
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A. TTCA 2006 Proposals
As relevant to NAREIT's comments, the loss limitation provisions
under section 470 as amended by TTCA 2006 generally would not apply to
a partnership if two requirements are met: the ``no set asides''
requirement, and the ``no fixed price option'' requirement.\16\ First,
under the ``no set asides'' requirement, proposed section 470 would not
apply to a partnership with a tax-exempt/foreign partner so long as
there are no ``arrangements'' \17\ or ``set asides'' \18\ to, or for
the benefit of (among others) a taxable or tax-exempt partner of the
partnership. Although a limited amount of partnership funds could be
aside with no time limit \19\ or an unlimited amount of partnership
funds could be set aside for up to 12 months \20\ (with ``related''
set-asides and arrangements treated as one arrangement),\21\ no amount
could be set aside or expected to be set aside by an entity outside of
the partnership (such as by another partner) to or for the benefit of,
among others, a taxable or tax-exempt partner of the partnership.\22\
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\16\ TTCA 2006, proposed section 470(e)(1)(C).
\17\ TTCA 2006, proposed sections 470(e)(2)(A)(i) and 470(e)(2)(C);
section 470(d)(1)(B).
\18\ TTCA 2006, proposed section 470(e)(2)(A)(ii).
\19\ TTCA 2006, proposed section 470(e)(2)(B).
\20\ TTCA 2006, proposed section 470(e)(2)(D)(i).
\21\ Id.
\22\ TTCA 2006, proposed section 470(e)(2)(B)(iii).
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In addition to this requirement, under the ``no fixed price
option'' requirement, no tax-exempt partner could have an option to
purchase or compel the distribution of partnership property or any
interest in the partnership for other than at fair market value.\23\
Similarly, neither the partnership nor any taxable partner could have
an option to sell or compel distribution of partnership property or any
interest in the partnership to a tax-exempt partner for other than at
fair market value.\24\
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\23\ TTCA 2006, proposed section 470(e)(3)(A)(i).
\24\ TTCA 2006, proposed section 470(e)(3)(A)(ii).
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While funds would be treated as set aside only if a reasonable
person would conclude, based on the facts and circumstances, that funds
are set aside or expected to be set aside, no such ``reasonable
person'' test applies to an ``arrangement,'' which is defined to
include, among other things, ``a defeasance arrangement, a letter of
credit collateralized with cash or cash equivalents, a payment
undertaking agreement, and any similar arrangement.'' \25\
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\25\ Section 470(d)(1)(B).
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B. Application of TTCA to UPREITs
Arguably, this rule could result in loss disallowance to partners
in OPs owned in part by REITs in an UPREIT structure, which is utilized
by over 60% of the publicly traded REIT industry, by many private REITs
and by some non-REIT C corporations \26\.
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\26\ The discussion herein should apply to a parallel structure
known as ``DownREITs''. A DownREIT is similar to an UPREIT except that
in a DownREIT, the REIT may own property directly (in addition to an
interest in a lower-tier partnership), while in an UPREIT, virtually
all of the REIT's holdings are through the OP. Our data indicates that
approximately 10% of publicly traded REITs (by equity market
capitalization) are DownREITs.
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As further described below, because third party partners of the OP
have the ability to require the OP or REIT to repurchase at fair market
value of their partnership units for cash or REIT stock, it is possible
this structure could prevent the UPREIT structure from satisfying the
``no set asides'' requirement. Because section 470 could apply to these
non-tax shelter transactions conducted in the ordinary course of the
REIT's business, NAREIT requests statutory language or legislative
history clarifying that these transactions are not set-aside/
arrangements contemplated by TTCA 2006.\27\
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\27\ While these concerns also apply to the application of existing
section 470, they are even more valid here given the attempt to clarify
section 470's application to partnerships.
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A general overview of the UPREITs format is below. While the
structure of specific UPREITs may vary in the details, most will be
very similar in most, if not all, respects with respect to the matters
outlined in this overview.
Characteristics of an ``UPRIET''
An UPREIT generally consists of a publicly traded REIT that owns
substantially all of its assets and conducts substantially all of its
operations through an ``operating partnership.'' As a general rule, the
REIT will own a number of ``common units'' in the OP equal to the
number of shares of common stock that the REIT has outstanding. If the
REIT has preferred stock outstanding, the REIT will own ``preferred
units'' in the OP that correspond to the shares of preferred stock the
REIT has outstanding.
The limited partnership interests held by partners in the OP other
than the REIT also are denominated as ``units.'' Because the REIT owns
substantially all of its assets and conducts substantially all of its
operations through the OP, and because the REIT owns a number of OP
units equal to the number of shares of common stock that it has
outstanding, there is effectively an economic identity of interest
between the units in the OP that are owned by the outside limited
partners and the shares of common stock outstanding in the REIT.
Typically, the REIT acquires its interest in the OP in one of two
ways, both evidencing a substantial equity investment in the OP. First,
the REIT may sell its shares in an initial public offering and
contribute the cash proceeds to the OP. Alternatively, the REIT may
contribute real property or partnership interests in partnerships that
own real property to the OP. Then, the REIT (or a subsidiary) typically
acts as the sole general partner of the OP, and has the exclusive right
to manage the affairs of the OP, subject to limitations intended
primarily to: 1) preserve the effective economic identity of interest
that exists between the units and the REIT shares; and, 2) avoid the
REIT or OP taking actions that would eliminate or adversely affect the
redemption/exchange right for unitholders described below.
The third party unitholders typically acquire their interests in
the OP in one of two ways: 1) contributing their direct interests in
real property to the OP in exchange for OP units, or, 2) contributing
their interest(s) in pass through entities that own real property to
the OP in exchange for OP units.
If new partners are admitted to the OP, the REIT's interest in the
OP diminishes over time, typically not below 50%. Conversely, as a REIT
issues secondary offerings and contributes cash to the OP (probably the
norm), the REIT's interest in the OP increases. The REIT's interest
also may increase as unitholders exercise their redemption/exchange
rights described below.
See the diagram below for the basic structure of an UPREIT
[GRAPHIC] [TIFF OMITTED] T1495A.001
Reasons for UPREIT Formation
The UPREIT structure was developed to facilitate the desire of real
estate owners to be able to access the public capital markets while
deferring the immediate recognition of taxable gain that would result
if they were to transfer their properties or property-owning
partnership interests directly to the REIT in exchange for REIT shares,
rather than to the OP in exchange for units.\28\ This tax gain can be
deferred if the property owner instead receives OP units, rather than
REIT shares. The IRS has indicated that it does not consider the UPREIT
structure abusive. See Example 4 of Treas. Reg. Sec. 1.701-2 (the
partnership anti-abuse regulations). Further, the IRS has issued dozens
of rulings involving UPREITs.\29\ Since much of the real estate
industry holds real estate in partnership form, the use of an UPREIT
structure does not represent a significant departure from that of the
structures used by non-REIT real estate investors.
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\28\ Under Section 351(e) of the Internal Revenue Code, a transfer
of property to a REIT in exchange for REIT shares in connection with
the formation of the REIT and an IPO by the REIT often will result in
the recognition of gain for tax purposes, even though most business
owners who transfer their businesses to a corporation in connection
with an IPO would not recognize gain. Nevertheless, the IRS has ruled
that in certain circumstances property transfers to an existing REIT do
not trigger income under section 351(e). See, e.g., PLRs 200450018,
200011036, 199915030, 9801016.
\29\ See, e.g., PLRs 200011036, 199952071, 9832022.
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In general, tax-exempt entities generally do not own OP units
directly. As noted above, the principal reason for the UPREIT structure
is to permit a property to defer the recognition of gain through the
receipt of a partnership interest, rather than shares of REIT stock,
typically a non-issue for a tax-exempt entity. With that said, there
may be situations when a tax-exempt (or foreign) entity does own OP
units.\30\ If tax-exempt entities are unitholders, their redemption/
exchange rights (described below) are likely to be virtually identical
to those of taxable entities.
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\30\ The most likely situation would be where a tax exempt entity
is an investor with taxable entities in a fund or partnership that
transfers property to an OP for units, with the fund or partnership
retaining the units that it received for a period of time.
---------------------------------------------------------------------------
Publicly traded REIT shares typically are held in ``street name,''
and although publicly traded REITs monitor the ownership of more than
5% shareholders through Forms 13D and 13G filed with the SEC, a
publicly traded REIT may not always be aware of tax-exempt investors
that own relatively small indirect interests in its OP, meaning the
REIT may face uncertainty in whether section 470 may apply in the first
instance and may even be forced to assume it might apply.
Redemption/Exchange Right Provides Liquidity/Does Not Limit Risk of
Loss
In the typical UPREIT structure, the holder of OP units generally
have the right to require the REIT or the OP to redeem all or some of
its units for an amount of cash equal to the agreed upon ``value'' of
those units. Under the typical partnership agreement for an UPREIT, the
``value'' of a unit is defined as equal to the value of a common share
of stock of the REIT so long as the stock of the REIT is publicly
traded. Typically, the value of a share of the common stock is in fact
the best approximation of the value of an OP unit.\31\
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\31\ Because the REIT generally does not own significant assets
other than its interest in the OP, and because it owns a number of OP
units equal to the number of common shares that it has outstanding, the
value of a share of the common stock is in fact the best approximation
of the value of an OP unit. In fact, NAREIT assumes that because the
purchase price of the OP unit would be at fair market value, the ``no
fixed price purchase option'' requirement would be met.
---------------------------------------------------------------------------
Although the unitholder's redemption/exchange right is typically
expressed as the right to receive cash equal to the value of a REIT
share, the OP and/or the REIT normally have the right, in lieu of
paying cash, to satisfy the redemption obligation with one share of
REIT common stock for each OP unit that is redeemed. It is generally
the parties' expectation that the REIT will elect to satisfy the
redemption rights with shares of REIT stock, rather than cash, but this
is not typically required. In some cases, the unitholder will have a
contractual right directly with the REIT to exchange the units for
shares of common stock on a one-for-one basis.
In the typical UPREIT, the common unitholder does not have the
right to get a fixed amount of cash or notes that is predetermined at
the time the unit is acquired. Rather, the common unitholder only has a
right to receive cash in an amount (or at the election of the REIT or
OP, REIT shares with a value) equal to the agreed upon value of the OP
units at the time the redemption/exchange right is exercised. The
redemption/exchange right most typically is set forth in the
partnership agreement for the OP, although in some cases there will be
a separate contractual agreement between the unitholder and the REIT
and/or OP.
Typical UPREIT Does Not Provide For Defeasance/Collateralization of
``Redemption/Exchange'' Right for OP Unitholders
As described below, in the typical UPREIT, there is no
collateralization or other similar arrangement with respect to the
unitholders' redemption or exchange right. With that said, because
either the REIT or OP stands ready to fund the redemption/exchange
right, practitioners have expressed a concern that there is ambiguity
as to whether the ``no set aside'' requirement to avoid application of
section 470 would be met.
We are not aware of any REIT that has (or is required to) set aside
cash to provide for payment of the redemption price when the
unitholders exercise their redemption right. If, and to the extent
that, the REIT elects to pay cash in connection with the exercise of
the redemption right, it generally will fund that cash with operating
cash flow, borrowings on an existing line of credit or other debt
arrangement (available and used for other cash needs as well), or the
proceeds of a new equity issuance. Thus, the REIT may use the cash
proceeds on hand after sale of a particular property (or after the
sales of multiple properties) with which to fund a repurchase request.
The REIT, however, is under no contractual obligation to maintain cash
on hand, a line of credit or other similar credit facility to permit
the payment of cash upon exercise of the redemption/exchange right.
If the REIT (or OP) elects (or is required) to issue shares of REIT
stock in connection with the exercise of a unitholder redemption/
exchange right, the REIT generally will use ``newly issued'' shares of
REIT stock. The unitholder typically will want to ensure that the REIT
has the ability to issue these shares of REIT stock and that the
unitholder has liquidity for the REIT shares that it receives. This
objective most typically is achieved by requiring that, once the OP
units become redeemable or exchangeable, the REIT register with the SEC
under the Securities Act of 1933 the shares to be issued on redemption/
exchange of the OP units. The registration of these shares merely
ensures that when the unitholder exercises the redemption or exchange
right, 1) the REIT will be legally permitted under the securities laws
to deliver the shares of REIT stock that it has the option to deliver;
and, 2) that the unitholder receiving those shares of REIT stock will
be permitted under the securities laws to resell the shares without
significant restrictions. This registration is accomplished by filing a
registration statement with the SEC in accordance with the applicable
SEC rules.\32\
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\32\ In some cases, rather than registering the shares when the
redemption/exchange right first becomes exercisable, the REIT will
agree to register the shares for ``resale'' when they are actually
issued, but this alternative is more cumbersome and much less common.
---------------------------------------------------------------------------
There generally is no obligation for the REIT or the OP to
repurchase any shares of REIT stock from the unitholder that are issued
pursuant to the redemption/exchange right. Furthermore, because the
exercise of the redemption/exchange right is a taxable transaction, and
its availability provides the OP unitholder with the flexibility of
deferring taxation until such time that the unitholder has the cash or
the liquid publicly traded company stock with which to pay the
corresponding tax liability, neither the OP nor REIT typically has the
right to require redemption of the unitholder.
Guidance Requested to Prevent Inadvertent TTCA 2006 Proposed Section
470 From Applying to Typical UPREIT Structures
There is ambiguity as to whether proposed section 470 under TTCA
2006 could apply inadvertently to typical UPREIT structures for the
following reasons. First, while unusual, it is possible that a REIT's
OP could have at least one tax-exempt or foreign partner, resulting in
the potential treatment of all of the OP's property as ``tax-exempt
property'' subject to section 470's loss limitation provisions absent
satisfaction of the ``no set asides'' and no ``fixed price purchase
option'' provisions. Second, the ``no set asides'' requirement to avoid
application of section 470 could apply inadvertently to the typical
UPREIT structure (or, at the very least, cannot be considered by the
publicly traded REIT clearly not to apply, resulting in the potential
of having to account for uncertain tax positions and having to disallow
certain deductions) to the typical UPREIT structure if either the OP or
REIT's standing ready to fund a theoretical tax-exempt or foreign
partner's repurchase request with REIT stock (marketable securities) or
cash could be viewed as either: i) a set aside if it is impossible to
determine that a reasonable person would not so conclude; or, ii) as an
``arrangement'' (regardless of a reasonable person's conclusion that it
was not) despite that the IRS already has viewed this structure as non-
abusive in the partnership anti-abuse regulations.
The absence of clear guidance in this area raises serious tax,
accounting, and capital market-related issues for the publicly traded
REIT industry and REIT shareholders. For this reason, NAREIT
respectfully requests statutory language or legislative history
providing that the redemption/exchange right present in the typical
UPREIT structure is not considered to be a set-aside or arrangement
causing the operating partnership in such structure to be subject to
section 470.
NAREIT would welcome the opportunity to discuss our comments with
you or others in more detail. Please contact me at (202) 739-9408 or
Dara Bernstein at (202) 739-9446 if you have further questions. Thank
you.
Respectfully submitted,
Tony M. Edwards
Executive Vice President & General Counsel
Export Assist
San Francisco, California 94104
October 30, 2006
The Honorable Bill Thomas
Chairman, Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas,
Export Assist, Inc. has provided export finance management services
to over 2000 U.S. exporters, most of whom are small to medium-sized
companies. We appreciate this opportunity to comment on Section 7 of
the Tax Technical Corrections Act of 2006 (HR6264 and companion S4026).
Section 7 repeals the 15% Interest Charge Domestic International
Sales Corporation (IC-DISC) dividend rate as of September 29, 2006.
This provision could adversely impact privately-held exporters, many of
whom operate small businesses and work hard to compete in the global
marketplace. These individuals have invested time, effort and money to
set up and operate an IC-DISC based upon the legality of the 15%
dividend rate, as legislated in the Jobs and Growth Tax Relief
Reconciliation Act of 2003, and the fact that the IC-DISC conforms with
the GATT findings adopted in 1981. To abruptly remove this tax benefit
from them without warning not only creates a financial hardship but
could threaten the success of their export business. Many of these
small to medium-sized exporters with IC-DISCs are growers in
California's San Joaquin Valley.
In order to maintain the ability of U.S. exporters to effectively
compete worldwide, we propose removing Section 7 from the Bill. If the
Committee wishes to address the 15% IC-DISC dividend rate, they should
do so in a way that gives exporters time to debate the ramifications of
this change in the legislation. These small to medium-sized exporters
have planned and acted in good faith. We can understand your
Committee's action but it seems too short a time frame for them to
adequately respond.
In addition, please keep in mind that at year-end all export tax
benefits end except the IC-DISC. More than ever, U.S. exporters and
Congress need to work together. It is important to have export tax
benefit legislation that enables exporters to effectively compete
internationally which in turn helps to reduce the U.S. trade deficit
which is rapidly approaching $1 trillion a year.
In the interest of our small and medium-sized export clients,
Export Assist urges the Committee, before it votes on Section 7, to
consider the immediate financial hardship that these exporters would
experience should the Bill pass with Section 7 included. We are
available to answer any questions that you might have.
Sincerely,
Joseph G. Englert
President
Equipment Leasing Association
Arlington, Virginia 22203
September 30, 2005
The Honorable William Thomas
Chairman
House Ways and Means Committee
1102 Longworth House Office Building
Washington, DC 20515
The Honorable Charles Rangel
1106 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas and Congressman Rangel,
The Equipment Leasing Association of America (ELA), the trade
association for the equipment leasing and finance industry, commends
you for taking the lead in the enactment of bipartisan emergency tax
relief for the victims of Hurricane Katrina. We also look forward to
working with you as you examine other tax incentives designed to
encourage rebuilding and reconstruction in the areas that were
devastated by Hurricanes Katrina and Rita.
The availability of leasing capital will be an important component
of any plan for rebuilding and reconstruction in the areas affected by
Katrina and Rita. For example, through the use of lease financing,
businesses in the affected areas will be able to finance 100% of the
cost of new and replacement equipment, as compared to debt financings
that normally requires a down payment of some amount.
For this reason, ELA would urge you to consider the following
proposals that would enhance the utility of lease financings.
Eliminate the Mid-quarter Depreciation Convention for the
Current Year
Under current law, taxpayers are discouraged from placing
substantial property in service during the last three months of the
current taxable year, because the ``mid-quarter depreciation
convention'' could apply to reduce the first year's depreciation
deduction. After 9/11, the Internal Revenue Service recognized that the
mid-quarter convention distorts decisions about the timing of equipment
acquisitions, and provided a one-time election to ignore this
depreciation convention for property placed in service in the tax year
that included September 11, 2001(See, IRS Notice 2001-70). As the staff
of the Joint Committee on Taxation recommended in its 2001
simplification report, the permanent elimination of the mid-quarter
convention would reduce complexity in the tax code. ELA agrees with
this recommendation and strongly supports the current year elimination
of the mid-quarter depreciation convention as a means to encourage
investment at this crucial time.
Enhance the New Markets Tax Credit. On September 9, 2005,
Treasury Secretary Snow announced changes to the New Markets Tax Credit
(NMTC) program to assist recovery efforts in areas affected by
Hurricane Katrina. ELA supports this initiative and recommends the
following additional modifications to the NMTC program: (1) the program
should be more amenable to investments structured as leases (as
mentioned above, lease financing allows for 100% financing of new and
replacement equipment); and (2) The NMTC program should be streamlined
to reduce and eliminate the existing cumbersome application process
that now applies.
In the case of these and any other tax incentives for
reconstructing after Katrina and Rita, it will be important to allow
the incentives to be used for both regular and alternative minimum tax
purposes.
Thank you for considering these important proposals as part of your
initiative to provide tax incentives to encourage rebuilding and
reconstruction in the aftermath of Hurricanes Katrina and Rita. Please
feel free to contact me or ELA's Vice President of Federal Government
Relations, David Fenig, if you have any questions or would like to
discuss this proposal further. We can be reached at (703) 527-8655.
Sincerely,
Michael Fleming, CAE
President
National Marine Manufacturers Association
Chicago, Illinois 60601
October 30, 2006
The Honorable Bill Thomas
Chairman, House Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas:
The National Marine Manufacturers Association (NMMA) appreciates
the opportunity to offer comments regarding H.R. 6264, the Tax
Technical Corrections Act of 2006.
NMMA is the nation's largest recreational marine industry
association, representing over 1,600 boat builders, engine
manufacturers and marine accessory manufacturers. NMMA members
collectively produce more than 80 percent of all recreational marine
products made in the United States. Recreational boating is a popular
American pastime and a major economic engine, with almost 71 million
boaters nationwide and some 13 million registered boats. In 2005 alone,
annual expenditures on marine recreational products and services
totaled over $37 billion.
Although NMMA supports efforts to clarify the tax code through
technical corrections, we are concerned that Section 7 of H.R. 6264,
which deals with interest charge-Domestic International Sales
Corporations (IC-DISC), is a substantive rather than a technical change
to the law. Currently, under provisions implemented in the Jobs and
Growth Tax Relief and Reconciliation Act of 2003, small and medium,
privately-held American exporting companies may defer a portion of
their export-related income by paying a tax-free commission to a DISC,
reducing their overall tax liability and paying dividend taxes on
shareholder income at the capital gains rate of 15 percent. In 2005,
the American boat and engine export market increased by double digits,
with exports totaling about $2.2 billion.
As you know, American manufacturers face substantial and increasing
structural costs, including the rising price of health care and energy,
unfair foreign competition, unnecessary and cumbersome regulation and
an overly-complex tax code. Given a level playing field, American
producers can compete with any company in the world. However, reducing
the overall cost of doing business in America is important,
particularly for small--to medium-sized companies.
NMMA respectfully urges the Committee to reconsider its inclusion
of Section 7 regarding the tax treatment of dividends from IC-DISCs in
H.R. 6264, since we believe this is a substantive change in the tax
code and that a technical corrections bill is not the appropriate
vehicle for such a modification.
Again, NMMA appreciates the opportunity to share its views with the
Committee. Please do not hesitate to contact Mathew Dunn, Manager,
Natural Resources and Economic Policy, with any questions or if you
need additional information.
Respectfully Submitted,
Monita W. Fontaine, Esq.
Vice President and Senior Counsel
Statement of Food Donation Connection, Knoxville, Tennessee
These comments call attention to a technical correction needed to
the charitable giving incentives created by recent tax legislation
found in H.R. 4, the Pension Protection Act of 2006, Section 1202--
``Extension of Modification of Charitable Deduction for Contributions
of Food Inventory''. This correction would bring the provision in line
with the original intent of Congress to encourage food donations by all
business entities.
Food Donation Connection (FDC) coordinates the donation of
wholesome prepared food from restaurants and other food service
organizations to local non-profit agencies that help people in need.
Federal tax code (IRC Section 170(e)(3)) has provided incentive for C
corporations to donate their food inventory since 1986. Since its
founding in 1992, FDC has been involved in the effort to pass
charitable giving incentives for food donations for all business
entities and is currently working with several restaurant companies
that have agreed to donate food if this issue is resolved. FDC has
coordinated the donation of over 80 million pounds of prepared food for
companies like Yum! Brands (Pizza Hut, KFC, Taco Bell, Long John
Silver's, A&W) and Darden Restaurants (Red Lobster, Olive Garden,
Smokey Bones). We currently coordinate donations from 6,300 restaurants
to 3,200 non-profit agencies nationwide.
In our discussion with Yum! Brands franchisees about the charitable
giving incentives contained in H.R. 4 (Pension Protection Act of 2006,
which extended the provision of H.R. 3768 (KETRA) to December 31, 2007)
we discovered an issue in the tax code that negate the tax savings for
S corporations that donate food. Individual S corporation shareholders
may not be able to take the deduction for the donation of food
inventory, depending on their basis in the corporation. In working with
S corporations we have learned the following:
S corporation income is distributed to each shareholder
based on each shareholder's ownership percentage and therefore the
deductibility of the deduction depends on each shareholder having
sufficient basis (i.e. at IRS risk rule) in the company to permit
deduction at the individual level.
S corporations make ongoing distributions to shareholders
rather then retain excess funds in the company and therefore S
corporation shareholders have no basis (i.e. distributions reduce
basis).
As a result, S corporation shareholders do not believe
they are entitled to a tax deduction and do not benefit from recent tax
law changes and are therefore not motivated to donate.
Under this current situation, the shareholder basis rule trumps the
intention of Congress to extend the special rule for certain
contributions of food inventory to S corporations (H.R. 4 extension of
H.R. 3768 Sec.305, which modified IRC section 170(e)(3)).
To remedy this situation, a technical correction could be made to
the language of H.R. 4, the Pension Protection Act of 2006. The
following wording would be added to H.R. 4 section 1202:
(c) In General--Section 170(e)(3)(C) of the Internal Revenue Code
of 1986 (relating to special rule for certain contributions of
inventory and other property) is amended by redesignating (iv) as (v)
and inserting after (iii) the following new paragraph:
`(iv) S corporation BASIS LIMITATION--In the case of food
contributions from S corporations, limitations on individual
shareholder's deductions due to shareholder basis (section 1366(d)(1))
on stock and debt do not apply. However, shareholder's basis continues
to be adjusted consistent with section 1367(a).'
The immediate impact of this change would mean that over 721
restaurants in 26 states would be eligible for this deduction for
donating food, and therefore willing to donate. See the list below for
additional details.
It is the intent of Congress to address the needs of Americans by
providing valuable resources to charitable organizations. This
technical correction would fulfill the original intent of the
legislation by allowing S corporations to take advantage of this
charitable deduction for contributions of food inventory.
Thank you for considering these comments.
Sincerely,
Jim Larson
Program Development Director
______
Yum! Brand Franchisees Willing to Donate with S Corp Basis Cost
Resolution
The passage of H.R. 4 has roused the interest of many Yum! Brands
franchisees to donate food. A number of franchised operators of Pizza
Hut, KFC and Long John Silver's restaurants that have told Food
Donation Connection they would start a Harvest food donation program if
the issue with S corporation basis costs can be corrected.
The following chart lists the number of new restaurants and the
pounds of food donations that can be projected from these restaurants.
The poundage projections are based on averages from Yum! Brands
operated restaurants. These donations include cooked prepared pizza,
breadsticks, chicken, fish, mashed potatoes, vegetables, biscuits and
other items that have been properly saved, packaged and chilled or
frozen. The saved food would be picked up on a regular basis by local
food banks and hunger relief agencies and used in the local community.
Yum! Brands has been donating surplus food from its restaurants
since 1992. In 2005, over 1,800 local hunger relief agencies received
about 12 million pounds of prepared food from 3,926 company-operated
restaurants. This food has been a tremendous help for these agencies,
as donated food frees up their limited resources for other needs.
The list of 721 restaurants represents a broad spectrum of
communities across 26 states and 140 congressional districts. These
restaurants are operated by 15 different franchised groups. Since the
Yum! Brands system is over 75% franchised, resolution of the S
corporation tax deduction issue will result in many more opportunities
to encourage donation of wholesome prepared food.
#
State District Representative Restaurants Lbs per Year
AL 05 Robert E. (Bud) Cramer Jr. 2 10,350
AZ 01 Rick Renzi 6 17,197
AZ 03 John B. Shadegg 2 5,732
AZ 07 Raul M. Grijalva 11 31,529
AZ 08 Jim Kolbe 14 40,127
CA 24 Elton Gallegly 1 5,175
CA 26 David Dreier 2 10,350
CA 27 Brad Sherman 5 25,875
CA 28 Howard L. Berman 4 20,700
CA 29 Adam B. Schiff 2 10,350
CA 30 Henry A. Waxman 4 20,700
CA 31 Xavier Becerra 2 10,350
CA 32 Hilda L. Solis 2 6,511
CA 33 Diane E. Watson 4 20,700
CA 35 Maxine Waters 1 5,175
CA 36 Jane Harman 1 5,175
CA 38 Grace F. Napolitano 4 16,861
CA 46 Dana Rohrabacher 1 1,336
CO 03 John T. Salazar 4 20,700
CO 05 Joel Hefley 1 5,175
DC Delegate Eleanor Holmes Norton 1 5,175
FL 03 Corrine Brown 1 5,175
FL 05 Ginny Brown-Waite 5 14,331
FL 07 John L. Mica 3 15,525
FL 08 Ric Keller 2 10,350
FL 12 Adam H. Putnam 1 5,175
FL 13 Katherine Harris 2 10,350
FL 15 Dave Weldon 6 31,050
FL 16 Vacant 3 15,525
FL 17 Kendrick B. Meek 5 25,875
FL 18 Ileana Ros-Lehtinen 4 20,700
FL 20 Debbie Wasserman Schultz 2 10,350
FL 21 Lincoln Diaz-Balart 2 10,350
FL 22 E. Clay Shaw Jr. 5 25,875
FL 23 Alcee L. Hastings 2 10,350
FL 24 Tom Feeney 5 25,875
FL 25 Mario Diaz-Balart 1 5,175
GA 09 Charlie Norwood 4 11,465
GA 10 Nathan Deal 2 5,732
IA 05 Steve King 8 22,930
IL 12 Jerry F. Costello 1 2,866
IL 15 Timothy V. Johnson 3 8,599
IL 19 John Shimkus 4 11,465
IN 01 Peter J. Visclosky 2 5,732
IN 02 Chris Chocola 4 11,465
IN 03 Mark E. Souder 1 2,866
IN 04 Steve Buyer 1 2,866
IN 05 Dan Burton 5 16,640
IN 08 John N. Hostettler 2 5,732
IN 09 Michael E. Sodrel 1 2,866
KY 01 Ed Whitfield 2 5,732
KY 02 Ron Lewis 2 5,732
KY 04 Geoff Davis 3 8,599
KY 05 Harold Rogers 7 20,064
LA 01 Bobby Jindal 6 31,050
LA 02 William J. Jefferson 8 41,401
LA 03 Charlie Melancon 1 5,175
LA 06 Richard H. Baker 9 46,576
MD 01 Wayne T. Gilchrest 5 23,567
MD 02 C. A. Dutch Ruppersberger 4 20,700
MD 03 Benjamin L. Cardin 3 15,525
MD 04 Albert Russell Wynn 1 5,175
MD 05 Steny H. Hoyer 7 36,226
MD 07 Elijah E. Cummings 1 5,175
MI 01 Bart Stupak 9 25,796
MI 02 Peter Hoekstra 2 5,732
MI 03 Vernon J. Ehlers 16 45,860
MI 04 Dave Camp 3 8,599
MI 05 Dale E. Kildee 1 2,866
MI 06 Fred Upton 7 20,064
MI 07 John J. H. ``Joe'' Schwarz 8 22,930
MI 10 Candice S. Miller 2 5,732
MS 01 Roger F. Wicker 11 56,926
MS 02 Bennie G. Thompson 10 51,751
MS 03 Charles W. ``Chip'' Pickering 10 51,751
MS 04 Gene Taylor 19 98,326
NC 01 G. K. Butterfield 2 5,732
NC 02 Bob Etheridge 7 31,608
NC 04 David E. Price 25 106,846
NC 05 Virginia Foxx 14 53,980
NC 06 Howard Coble 9 46,576
NC 10 Patrick T. McHenry 5 14,331
NC 11 Charles H. Taylor 23 65,924
NC 12 Melvin L. Watt 5 25,875
NC 13 Brad Miller 29 122,371
NE 01 Jeff Fortenberry 11 31,529
NE 02 Lee Terry 14 40,127
NE 03 Tom Osborne 12 34,395
NJ 05 Scott Garrett 5 25,875
NJ 06 Frank Pallone Jr. 1 5,175
NJ 07 Mike Ferguson 3 15,525
NJ 09 Steven R. Rothman 6 31,050
NJ 10 Donald M. Payne 5 25,875
NJ 11 Rodney P. Frelinghuysen 4 20,700
NJ 12 Rush D. Holt 1 5,175
NJ 13 Vacant 8 41,401
NY 07 Joseph Crowley 1 5,175
NY 13 Vito Fossella 3 15,525
NY 16 Jose E. Serrano 8 41,401
NY 17 Eliot L. Engel 3 15,525
NY 18 Nita M. Lowey 2 10,350
NY 20 John E. Sweeney 1 2,866
NY 23 John M. McHugh 16 52,786
NY 24 Sherwood Boehlert 7 36,226
NY 25 James T. Walsh 8 41,401
OH 02 Jean Schmidt 2 5,732
OH 08 John A. Boehner 1 2,866
OH 10 Dennis J. Kucinich 11 56,926
OH 11 Stephanie Tubbs Jones 16 82,801
OH 13 Sherrod Brown 10 51,751
OH 14 Steven C. LaTourette 7 36,226
OH 16 Ralph Regula 2 10,350
OH 17 Tim Ryan 2 10,350
PA 01 Robert A. Brady 1 5,175
PA 05 John E. Peterson 2 5,732
PA 06 Jim Gerlach 1 5,175
PA 09 Bill Shuster 1 5,175
PA 10 Don Sherwood 2 5,732
PA 13 Allyson Y. Schwartz 1 5,175
PA 16 Joseph R. Pitts 4 20,700
PA 17 Tim Holden 4 20,700
PA 19 Todd Russell Platts 8 41,401
SC 01 Henry E. Brown Jr. 12 34,395
SC 02 Joe Wilson 14 40,127
SC 03 J. Gresham Barrett 3 8,599
SC 04 Bob Inglis 6 17,197
SC 05 John M. Spratt Jr. 6 17,197
SC 06 James E. Clyburn 5 14,331
TN 04 Lincoln Davis 1 2,866
TN 07 Marsha Blackburn 4 20,700
TN 08 John S. Tanner 1 5,175
VA 01 Jo Ann Davis 3 8,599
VA 02 Thelma D. Drake 2 5,732
VA 05 Virgil H. Goode Jr. 3 10,908
VA 06 Bob Goodlatte 2 5,732
VA 07 Eric Cantor 1 2,866
VA 09 Rick Boucher 13 37,261
WI 03 Ron Kind 7 20,064
WI 07 David R. Obey 1 2,866
WV 03 Nick J. Rahall II 6 17,197
Totals 721 2,930,650
Supplemental Sheet to H.R. 4 Technical Tax Comments
Food Donation Connection (FDC) administers the Harvest Program to
coordinate the distribution of excess food from restaurants and other
food service organizations to qualified local non-profit organizations
that help people in need. FDC has coordinated prepared food donation
programs since 1992 involving the donation of over 80 million pounds of
quality surplus food. We currently coordinate donations from 6,300
restaurants to 3,200 non-profit agencies nationwide.
Association of Art Museum Directors
October 30, 2006
Honorable Charles E. Grassley, Chairman
Honorable Max Baucus, Ranking Member
Committee on Finance
U.S. Senate 219
Dirksen Senate Office Building
Washington, DC 20510
Honorable William M. Thomas, Chairman
Honorable Charles B. Rangel, Ranking Member
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Gentlemen:
The Association of Art Museum Directors, founded in 1916,
represents 170 art museums nationwide. On behalf of the membership, we
write to express concern about the amendments to the Internal Revenue
Code of 1986, as amended (the ``Code'') dealing with gifts of
fractional interests contained in the Act. As we review the
legislation, we believe that Congress's intention was to permit
fractional gifts to be made, but to curb perceived abuses under the old
law. Unfortunately, we hear from our members that various provisions in
the law will effectively end fractional gifts, thereby depriving
museums of a means to acquire great works of art for the benefit of the
public. The loss will be to the public, to the nation's art museums and
to the communities that they serve in all states. In order to avoid
this result, certain technical corrections should be made as soon as
practicable to avoid what appear to be unintended consequences that
will paralyze the completion of gifts in progress.
1. Grandfather existing gift programs. To avoid the disruption of
pre-existing acquisition, program and development plans by museums, the
new law should not apply to subsequent gifts of fractional interests in
property if the donee institution already owned a fractional interest
in such property on the effective date.
Because the exception would apply only to works in which fractional
interests were given prior to enactment, there is no risk that the
recommended provision will give rise to a pre-effective date flurry of
fractional gifts. Without this change, donors who have already made
gifts of fractional interests will be unlikely to give additional
interests out of fear of becoming subject to the new law's
uncertainties and harsh penalties, which means that the next
installment of fractional gifts already in process will most likely not
come to the museum until the death of the donor.
2. Correct the mismatch between the estate and gift tax
consequences. The Act restricts a decedent's charitable deduction for
subsequent fractional interest gifts (after the first such gift) in a
work of art to the initial value at the time of the first fractional
gift, but Sections 2031 and 2512 of the Code provide that for purposes
of computing the estate tax and the gift tax, the valuation will be the
fair market value on the date of death or date of the gift. The result
is a limitation on the amount of the charitable deduction which,
assuming that the work of art has increased in value from the time of
the first fractional gift, will be significantly less than the
valuation for estate or gift tax purposes.
For example:
For purposes of the gift tax, a donor could conceivably give the
entire interest in a work of art to a museum during his/her lifetime
(and within the 10 years provided by the statute) and incur a gift tax
because the value of the work increases between the first fractional
gift and any subsequent fractional gift;
For purposes of the estate tax, a donor could donate fractional
interests during his/her lifetime and complete the transfer as part of
his/her estate plan (and within the 10 years provided by the statute),
i.e., as part of a disposition by will or trust, and incur an estate
tax because the value of the work increases between the first
fractional gift and the donation after death.
Many have indicated to us that this potential mismatch, because it
could result in an unintended estate or gift tax, will preclude
fractional gift giving in the future because the risk is simply too
great.
3. Eliminate the recapture of income and gift tax deductions and
recapture penalty when property is transferred to a charity at death.
The new statute provides that any income or gift tax deductions are
recaptured if the remaining interest in the work is not transferred
before the earlier of 10 years of the initial fractional contribution
or the date of death. In addition, there is a 10% recapture penalty on
the amount recaptured. This language could be construed to mean that
the gift must be completed before death and would not allow a gift of
the remainder interest by will or trust after death.
For example:
If a donor is on schedule to complete a gift in 10 years, but dies
in year eight, his/her estate could be responsible for recapture,
interest and penalties because the gift was not completed BEFORE the
death of the donor.
We suggest in such circumstances there be no recapture since the
work of art ultimately is owned by the museum.
We are mindful of concerns that have been expressed that fractional
gifts could result in a current income tax deduction without the museum
receiving the ultimate benefit of a work of art. We support the concept
in the legislation that a fractional gift should be coupled with a
commitment to transfer the entirety of the work, ultimately, to the
museum. Nevertheless, the legislation as drafted (even with the
corrections to the unintended consequences identified above) would
continue to discourage generous donors from supporting museums by
transferring their private wealth to the common good. In order to
encourage donors in their philanthropy and at the same time increase
enforcement we recommend the following corrections.
4. Eliminate the mandatory 10-year period for recapture purposes.
There does not appear to be any specific policy advanced by requiring
recapture of deductions and penalties if the remaining interests in the
property are not transferred prior to the earlier of 10 years from the
initial transfer or death. Donors, who willingly give partial interests
in a valuable museum quality work of art, should be able to avail
themselves of the flexibility of giving their gift over their lifetimes
if that best suits their financial and personal needs and desires. So
long as the possession requirements are met, taxpayers should be
permitted to make fractional interest gifts over any period of time
without risking recapture of the deductions.
In place of a limited time period, we suggest that a donor be
required to pledge at the time of the initial fractional contribution
that the balance of the interest will be transferred either during
lifetime or at death. In addition, if the donor failed to complete the
gift of the entire interest or failed to provide physical possession as
suggested below, the donee would provide an information return to the
Internal Revenue Service and, in such event, all prior income and gift
tax deductions would be recaptured. A binding contract with reporting
provisions would help ensure that any work for which a deduction was
taken will ultimately go to the donee museum.
5. Provide limited exceptions to recapture where required
possession and use is not practical. The new statute requires recapture
where the donee does not take physical possession of the property. We
support the concept that substantial physical possession should occur
during each 10-year period until the gift is completed (this assumes
that the mandatory 10-year gifting period is eliminated). As a
practical reality, however, very fragile, very large, or very rare
works often should not be subject to travel or frequently moved. We
suggest that physical possession can be waived if: (a) the donee museum
certifies that physical possession would not be in the best interest of
the work of art, the museum or the public because (i) the museum's
construction commitments would prevent possession of the work during
the period, or (ii) packing and transporting the work may damage the
work because of its fragility; or cause serious financial hardship to
the museum because of the cost of transporting and assembling a large
work of art, or (b) the donor dies before the donee has an opportunity
to possess the work.
6. Restore the fair market value deduction. With the addition of
enhanced protections to the appraisal process in Section 170(f)(11)(E)
of the Code and the recently issued guidance in Notice 2006-96, 2006-46
IRB, the possibility for abusive appraisals is significantly reduced.
Furthermore, we recommend that appraisals of works with a total value
(not just the proposed gifted interest) exceeding $1,000,000 be subject
to automatic review by the IRS Art Advisory Panel. With these changes,
the donors should be allowed to use the actual value of a donated
interest rather than the historic and potentially unrealistic value as
now required by the Act. Furthermore, there seems little logic or
policy justification to continuing to allow a fair market deduction for
gifts of fractional interests in real estate to charities and yet
disallow such a deduction for gifts of works of art.
The suggested changes will ensure that one of the most significant
sources for great works of art will continue to come into the public
domain. We appreciate your willingness to consider these changes.
Very truly yours,
Millicent Hall Gaudieri
Executive Director
Anita M. Difanis
Director of Government Affairs
Solomon R. Guggenheim Foundation
New York, New York 10128
October 31, 2006
Honorable William M. Thomas, Chairman
Honorable Charles B. Rangel, Ranking Member
Committee on Ways and Means
United States House of Representatives
Washington, DC 20515
Gentlemen:
Although the current provisions of the Technical Corrections Act of
2006 (H.R. 6264, S.4026) (the ``Technical Corrections Act'') do not
apply to the PPA, we understand that you are accepting comments for
technical corrections to the PPA. We therefore are writing at this time
to express our general concerns with respect to the impact on museums
of Section 1218 of the PPA regarding Contributions of Fractional
Interests in Tangible Personal Property (``Section 1218''), and to
highlight two issues that we believe would be most appropriately
addressed in the Technical Corrections Act.
The Solomon R. Guggenheim Foundation (the ``Guggenheim'') was
founded in 1937 for the ``promotion and encouragement and education in
art and the enlightenment of the public.'' It has fulfilled this goal
through the establishment of an international network of museums and
exhibition spaces around the world. The Guggenheim currently
administers museums in Venice, Bilbao, Berlin, and Las Vegas, as well
as its landmark Frank Lloyd Wright-designed museum in New York. Its
museums attract over 2.5 million visitors per year, nearly 40 percent
of whom are visitors to the flagship New York museum. Each year, the
Guggenheim mounts between 20 and 30 original exhibitions, which are
usually displayed in one of its United States museums, and may travel
within the Guggenheim's network and to other museums throughout the
world.
The Guggenheim's renowned collection began with gifts from its
founder, Solomon R. Guggenheim and has been expanded in large part by
gifts received from art collectors over the years. In the current era
of formidable and rapidly escalating prices for art, the Guggenheim and
many other museums have had to rely heavily on gifts and bequests from
generous donors to allow them to continue to build their collections.
The prior law governing fractional gifts of art provided museums with
an effective vehicle to encourage donors to make gifts of art,
particularly those significant (and valuable) works of art that are so
difficult for museums to acquire by purchase. We are concerned that
Section 1218 of the PPA will have a chilling effect on such gifts and,
therefore, on the ability of museums to acquire works of art for the
benefit of the public.
I. Overview of the Tax Law Applicable to Fractional Gifts
Under prior law, donors of fractional interests in tangible
personal property were allowed to deduct a pro rata share of the fair
market value of the property proportionate to the percentage interest
of the gift, based on an appraisal at the time of each fractional gift.
There was no requirement regarding the amount of time over which the
gift had to be completed; and many donors reserved the right to retain
their remaining interest in the property until the later death of the
donor and the donor's spouse. With each fractional gift, the donee
institution received the right to possession of the work for a fraction
of each year proportionate to its ownership interest in the work;
although case law determined that the institution did not have to
exercise such right each year, so long as it had the unfettered right
to possession.
Section 1218 has changed the law to require a donor to complete a
fractional interest gift within ten years after the initial fractional
interest gift (or upon the donor's earlier death); and limits the
income, estate and gift tax deductions that the donor is entitled to
receive for each fractional gift to the lesser of a proportionate share
of (i) the fair market value of the work at the time of the initial
gift, and (ii) the fair market value at the time of each fractional
gift. Section 1218 also requires that the donee institution take
``substantial physical possession'' of the property during the period
of co-ownership by the donor and the donee institution. If the property
is not used for the donee's tax-exempt purpose, the gift is not
completed within ten years, or the donee fails to take substantial
physical possession of the work during the period of co-ownership,
Section 1218 provides for the recapture of all income, estate and gift
tax deductions the donor has taken with regard to the gift of the
property, with interest and a 10% penalty tax on the amount of
deductions previously taken.
We fear that the rigidity of these rules and the harsh penalties to
which donors may become subject will drastically reduce the number of
gifts museums receive through the very useful charitable giving vehicle
of fractional gifts. With fewer incentives to give works of art to
museums, more donors are likely to delay making commitments to museums.
As a result, more works will remain in private hands or be sold upon
the death of the collector, rather than be given to museums for the
enjoyment of the public.
II. Importance of Fractional Gifts to Museums
Fractional gifts have been very useful to museums, in part because
they allowed the institution to encourage a donor to begin giving a
work of art, even if the donor was not yet willing to commit to giving
up all possession of the art during her lifetime. A donor of a
particularly valuable work of art would often choose to give a fraction
of the work the proportionate value of which was an amount the donor
would be able to deduct for income tax purposes, taking into account
the contribution limit for gifts of tangible personal property
(approximately 30% of the donor's adjusted gross income), and the five-
year carry-forward for the value of the gift in excess of the
contribution limit. The donor had to relinquish dominion and control of
the art to the museum only for the portion of the year equal to its
ownership interest in the work. The promise of additional fair market
value tax deductions was incentive to encourage the donor to make
additional fractional interest gifts once she had exhausted the carry-
forwards from her initial gift. With each subsequent fractional
interest gift, the institution would gain increasing rights of
possession, and greater decision-making power over the location, care
and treatment of the work. Even if the museum chose not to take
possession of a work for its fractional share of a given year, because
it would not be able to display the work that year, or because frequent
packing and shipping of the work might damage it or be prohibitively
costly, the curators knew that the museum would be entitled to
possession of the work when it ``needed'' it, for inclusion in
exhibitions.
The ability to take possession of a fractional interest gift when
needed means that a museum can truly rely on such a gift in its
collecting strategy, and does not have to continue to seek to acquire a
similar work by gift or purchase. This distinguishes fractional gifts
importantly from ``promised gifts,'' in which the museum gets no
ownership interest until the donor decides to give the work (usually
upon death). For these reasons, it is appropriate that donors of
fractional interests receive income tax deductions for the very real
present-interest they give in works of art, while no income tax
deduction is available to those who make promised gifts, or give
future-interests.
If there were abuses under the prior law, instances where
institutions had side agreements with donors that they would not take
possession of the works during the donors' lifetimes, they were not
widespread, and could be curbed by less drastic means than those of
Section 1218. By taking away the incentive of fair market value
deductions for subsequent fractional interest gifts (after the initial
fractional interest), and the flexibility of allowing a donor to choose
his or her own schedule for giving, we fear that the PPA has stripped
fractional gifts of the attributes that made them attractive to donors
and a key vehicle for museums to start a dialogue with donors,
encouraging them to begin to give important works of art.
Although we are hopeful that Congress will consider these concerns
and modify Section 1218 in the next Congress, we realize that
addressing some of these issues is beyond the scope of a technical
correction. There are however, two matters of a technical nature, which
we hope will be addressed in the Technical Corrections Act.
III. Proposed Technical Corrections
A. Charitable Gifts Should Not Trigger Estate or Gift Taxes
Section 1218(b) and (c) provides for caps on the estate and gift
tax deductions available for ``additional contributions'' of fractional
interests, after an initial contribution, at the lesser of a
proportionate share of (i) the fair market of the property at the time
of the initial contribution, and (ii) the fair market value of the
property at the time of the additional contribution. While these
provisions mimic Section 1218(a), which limits the income tax
deduction, they would produce, in most cases, the clearly unintended
result of creating gift or estate tax liability for contributions of
additional fractional interests to a museum, if the work of art has
appreciated in value since the initial contribution. In fact, in some
instances, the resulting estate and gift tax liabilities could exceed
the value of the income tax deductions to the donor, resulting in a net
cost to a donor to make a charitable gift.
An example of the application of Section 1218(b) would be a donor
who gave an initial 10% fractional interest in a work of art worth $1
million, and gave the remaining 90% of the work to the museum as a
bequest in his will when he died five years later. If at the time of
the donor's death the work of art was worth $2 million, the $1.8
million dollar value of the donor's 90% interest in the work would be
includable in his estate for estate tax purposes. However, his estate
tax deduction for the gift of his 90% interest in the work would be
limited to $900,000 (90% of the $1 million value at the time of the
initial contribution). Therefore, the donor's estate would be liable
for estate tax on $900,000 (the $1.8 million value, less the $900,000
deduction), despite an entirely charitable transfer of the art. This
result occurs despite the fact that the donor is not responsible for or
able to manipulate the market value of the work of art, and the fact
that the donor has complied with the time requirements for completing
the gift under Section 1218, and had allowed the institution to enjoy
substantial possession of the work during the period of co-ownership.
Section 1218(c) would cause a similar result in the gift tax
context. If the donor in the example above did not die, but gave an
additional contribution of 10% of the work five years after the initial
gift, his income tax deduction would be limited to $100,000 (10% of the
fair market value on the date of the initial gift), and so would his
charitable gift tax deduction. However, the donor would incur gift tax
on the $200,000 value of the gift on the date of the additional
contribution, offset only by the $100,000 deduction. There is no policy
reason served by causing a donor to pay gift tax (or use up his
lifetime exemption from gift tax) for making the second charitable
transfer, which resulted in an increase in the donee museum's ownership
interest in the work and greater rights of possession.
We have already heard from counsel for donors that they will advise
their clients not make any new fractional gifts, for fear of such
illogical and unjust results. Thus, unless this technical correction is
made, the enactment of Section 1218 is likely to have the unintended
consequence of eliminating the ability of museums to receive fractional
gifts entirely.
B. Fractional Gifts in Progress Should be Grandfathered
Donors who made one or more fractional interest gifts to a museum
prior to the enactment of the PPA should be allowed to give their
remaining interest in those works under the rules of the prior law.
Without this change, it appears that donors of such gifts-in-progress
will ``freeze'' their gifts, to avoid having them come under the PPA,
and the potential for harsh penalties under Section 1218. Museums would
then have to wait until the death of the donor to receive the remaining
fractional interest in the work, although that may not have been the
intention of the donor when he or she began giving fractional
interests. We do not believe that the intention behind this new law is
served by slowing-down the process of giving to institutions; it would
be an unfortunate consequence of the law if museums had to endure
longer periods with smaller ownership interests in works of art than
either the institution or the donor had intended when the initial
fractional gift was made. Since the proposed exception could be drafted
to apply only to the defined group of donors who have made documented
fractional interest gifts prior to the effective date of the PPA, there
would be no potential for abuse or a ``flood'' of gifts in avoidance of
the new law if such gifts were ``grandfathered'' under the prior law.
* * *
We urge you to include in the Technical Corrections Act corrections
that (i) would ensure that charitable donors would not incur any estate
or gift taxes as a result of any contribution of a fractional interest
in tangible personal property, and (ii) grandfather gifts-in-progress,
so that donors will receive the benefits of the law prior to the
enactment of the PPA with respect to their additional contributions of
such property. We also hope that other changes to Section 1218 will be
considered by the 110th Congress that will restore incentives for
charitable giving of works of art, while ensuring that those incentives
are not abused.
We would be pleased to discuss these comments with you or members
of your staff at any time. We appreciate your consideration of the
needs of museums and the important benefits to the public that result
from fractional interest gifts.
Sincerely yours,
Sara Geelan
Associate General Counsel
Los Angeles County Museum of Art
Los Angeles, California 90036
October 31, 2006
On behalf of the Los Angeles County Museum of Art (``LACMA''), I
urge you to include in the Technical Corrections bill (S. 4026 and H.R.
6264) the following changes to the provisions on fractional gifts in
the recently enacted Pension Protection Act of 2006 (Section 1218) (the
``Act''). Without these technical corrections, the Act will have a
substantial chilling effect on such fractional gifts, on which the
LACMA and, indeed, all of our museums rely.
Here at LACMA, we regularly receive fractional interests in donated
art works which in fact do become 100% acquisitions. In just the last
three years, such fractional donations, now 100% owned by LACMA,
include: 39 etchings by David Hockney, 6 paintings by other artists
(Matt Mullican, Tim Ebner, Simon de Vlieger, Aelbert Cuyp, Jacob van
Ruisdael, and Jan van Huysum); an assemblage by Franois
Morellet;sculptures by Keith Haring and Allen Ruppersberg; 43
photographs by Robert Stivers and Garry Winogrand, prints by Sam
Francis and Johann Friedrich Overbeck;and aJapanese screenof Kinoshita
Itsuun (Shōsai). In addition, LACMA currently owns a fractional
interest in well more than 100 significant works of art, under gift
agreements entered into before HR 4 was enacted. Each of these
agreements will be negatively impacted by the provisions of the Act, if
it is permitted to apply retroactively.
Specifically, the following provisions on fractional interests in
the Act would have a significant, unfavorable effect on LACMA's
programs:
1. Estate and Gift Tax Consequence. If a donor were to initiate a
fractional gift after the effective date of the Act, or if he or she
were to donate additional fractions of gifts already in progress, each
successive fraction would trigger either gift tax (during the donor's
life) or estate tax consequences (after the donor's death), because of
the difference between the deduction permitted under the Act and the
actual fair-market value.
To correct the problem: all fractions should be allowed at the fair-
market value after a qualified appraisal.
2. Transitional clarification. The new law should not apply to
subsequent gifts of fractional interests in property if the donee
institution already owns a fractional interest in such property. This
would avoid disrupting pre-existing acquisition, program, and
development plans by museums that were put in place in reliance on
continuing acquisition of additional fractions of already partially-
owned gifts. Because this clarification would apply only to works in
which fractional interests were given prior to enactment, there is no
risk that this change would give rise to a pre-effective date flurry of
fractional gifts. Without this clarification, donors who have already
made gifts of fractional interests in works will be unlikely to give
additional interests out of fear of becoming subject to the new law's
uncertainties and harsh penalties. Thus the next installment of
fractional gifts already in process will most likely not come to the
donee museum until the death of the donor.
To correct the problem: only fractional gifts begun after the effective
date should be subject to the new law.
3. Eliminate the requirement for gifts to be given within 10 years
or donor's death whichever is sooner. This provision would likely
result in the postponement, and in some cases, outright elimination of
some gifts of fractional gifts in artwork to LACMA. Rather than
surrender a work in so short a time, a potential donor might well
prefer to wait until later in life. The gift postponed could then
become the gift denied, if plans change or if the donor dies before
making the gift. It would be fairer and still encourage giving to
require that the museum take actual possession for a period of time
proportional to the fractional gift, rather than imposing an arbitrary
maximum ten-year period on a donor and donee museum. We do agree that
the donor should be required to provide for the gift of the remainder
of the work at or prior to the date of death of the donor (or the
donor's spouse), which is generally the practice of most museums.
To correct the problem: allow donors to give the gift over the
period of time that suits their needs. To ensure the charitable
disposition of fractional gifts and proper disclosure of such
donations, the new law should require binding contracts with mandatory
reporting and recapture of deductions plus interest. This would mark a
significant change for some institutions and would ensure that any work
for which a tax deduction is taken will ultimately go to the donee
museum for the benefit of taxpayers. Such a contract should require:
a) A donor of an undivided fractional interest in a work of art to
evidence his or her gift in writing and pledge the remainder of the
work to the same donee on or before his or her death (or the later
death of the donor's spouse);
b) Museums to give written acknowledgment of receipt of fractional
interest gifts;
c) Museums, under penalty, to inform the IRS, similar to reporting
required by IRS Form 8282, if donors fail to give a remaining
fractional interest, fail to comply with the possession requirements
detailed above, or fail to honor any other contract requirement;
d) The recapture of deductions plus interest for donors who fail to
comply with the terms of fractional gift contracts.
4. To ensure accurate appraisals. The provision that the donor must
use the original appraisal, if lower, for each fractional gift is
simply unfair to the donor and thus a disincentive to giving, since
donors would not be able to take the full measure of the value of an
appreciated gift. The more rigorous rules for the appraisal of donated
personal property should be sufficient to address any perceived abuses.
In lieu of the punitive requirement that donors use the lower of the
appraisal at the time of the initial fractional gift or any subsequent
fractions of the gift, donors should be allowed to use a current,
accurate, fair-market value appraisal, provided that appraisals for
fractional gifts in which the value of the work as a whole exceeds $1
million automatically would be subject to review by the IRS Art
Advisory Panel. The US Treasury has confirmed the reliability and
efficacy of the IRS Art Advisory Panel. The technical correction could
include a requirement directing the IRS to require taxpayers to
identify such works by checking a box on the appropriate tax form.
To correct the problem: submit all works the whole of which exceeds $1
million to the IRS Art Advisory Panel.
5. Physical possession requirement and exceptions to create a safe
harbor. Under the Act, the donee institution must take physical
possession of the work of art for a substantial period within the 10-
year period or before the fractional gift is complete. We don't
disagree that some requirement of proportional possession be included
prior to the time the gift is completed, but believe that (1) for
purposes of determining ``physical possession,'' credit will be given
for any exhibition of the work to the public at another institution;
(2) the donee's possession should be proportional over the life of the
loan (exercised, perhaps, within each 10 year period); and (3) in
certain cases, physical possession may be waived if either:
a) The donee museum certifies that physical possession within a 10-
year period would not be in the interest of the work of art, the museum
or the public because either:
i) The museum's permanent collection, exhibition, planning,
educational, or construction commitments would prevent showing the work
to the public during the period, or
ii) Packing and transporting the work may damage the work because,
for example, of its fragility; or cause a serious financial hardship to
the museum because, for example of the cost of transporting and
assembling an overly large work of art; or
b) The donor dies within a 10-year period before the donee has an
opportunity to possess the work.
To correct the problem: create exceptions in the rare case a museum
cannot accommodate a work or the work would risk damage or
extraordinary costs to move.
The mission of LACMA is to serve the public through the collection,
conservation, exhibition and interpretation of significant works of art
from a broad range of cultures and historical periods, and through the
translation of these collections into meaningful educational,
aesthetic, intellectual and cultural experiences for the widest array
of audiences.
To carry out this mission, LACMA relies in substantial part on the
generosity of donors to increase its permanent collection by the
donation of works of art. In general, the tax code recognizes and
supports this activity through its long-standing incentives fostering
such private philanthropy. Unless these technical corrections are
adopted, the Act's changes on fractional interests will discourage and
place significant negative limits on donors wishing to so contribute.
In turn, this could detrimentally impact LACMA's operations. To ensure
that the Act does not harm legitimate charitable activity, it is
important that the Technical Corrections bill eliminate altogether or
at least modify these harmful provisions in the Act.
We would appreciate your attention to these suggested technical
corrections and thank you for your consideration of this request and
for supporting charitable organizations.
Yours truly,
Fred Goldstein
General Counsel
Joint Statement of Government Finance Officers Association, National
Association of Counties, National Association of State Auditors,
Comptrollers and Treasurers, and National League of Cities
U.S. Conference of Mayors
October 31, 2006
The Honorable Bill Thomas
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
Dear Chairman Thomas:
The Government Finance Officers Association; the National
Association of Counties; National Association of State Auditors,
Comptrollers and Treasurers; the National League of Cities; and the
U.S. Conference of Mayors appreciate the opportunity to provide
suggestions to H.R. 6264 the Technical Corrections Act of 2006, with
regard to Section 512 of the Tax Increase and Prevention Act of 2005
(TIPRA).
Section 512 of TIPRA, imposes an excise tax on financing
transactions, such as sale-in-lease-out (SILOs) and lease-in-lease-out
(LILOs), that state and local governments and their agencies entered
into until the American Jobs Creation Act labeled them as ``listed
transactions'' in 2004. Prior to the JOBS Act state and local
governments, and especially transit authorities, had entered into these
financings with the encouragement and approval of the U.S. Department
of Transportation.
TIPRA allows for a retroactive application of an excise tax penalty
on transactions that were completed years ago with the full knowledge
of the Department of Transportation and Treasury Department. The
retroactive imposition of a substantial excise tax could have
substantial negative repercussions to many governments, and ultimately
the citizens that they serve.
We believe that a remedy for this retroactive application in TIPRA,
is a clear definition of the term ``proceeds'' and ``net income.'' We
are concerned that the Treasury and the IRS have insufficient guidance
in defining these terms and may promulgate regulations with overly
broad definitions that would be detrimental to governments and transit
authorities. Therefore, we respectfully request that a provision be
added to H.R. 6264 that would clarify the meaning of ``proceeds,'' as
well as ``net income.'' This would allow guidance to be written which
would provide for the allocation of both ``net income'' and
``proceeds'' to avoid substantial retroactive consequences.
Allowing for this technical correction, and subsequent regulations
from the Department of the Treasury, these transactions would be in
parity with the exact same type of transit agency SILO financing
transactions that were ``grandfathered'' by both the JOBS Act and
TIPRA. Under the current application of the law, the same type of SILO
transaction receives potentially different treatment, solely due to the
date when the transaction was pending approval by the Department of the
Transportation. We believe that this is unfair and should be rectified
so that all of the financings receive the same treatment as the
grandfathered deals. As we have stated, this could be accomplished with
a consistent application of the terms ``proceeds'' and ``net income.''
Another item worth noting is that Section 512 casts a shadow over
all future financial transactions entered into by state and local
governments. Because the legislation is written so broadly, the
Treasury has the power at any time in the future to administratively
impose an excise tax retroactively on state and local governments by
designating a type of transaction as a ``listed transaction.'' Thus,
transactions that close today could be listed in the future, with no
debate or public hearing, resulting in state and local governments
incurring a tax liability with no means of challenging the
determination. This allows the IRS to tax state and local governments
without specific Congressional approval, and could adversely affect the
tax-exempt bond marketplace. Although the IRS can already challenge the
tax-exempt status of state and local bonds, the potential application
of Section 4965 creates another avenue for the IRS to weaken the bond
market, without the possibility of judicial review.
Mr. Chairman, we again very much appreciate the opportunity to
comment on the Technical Corrections Act of 2006, and encourage
inclusion of a provision to clarify the terms ``proceeds'' and ``net
income'' with regard to Section 512 of TIPRA. A more detailed letter
that was sent to Treasury by the GFOA regarding this provision is
attached for your review.
If you have any questions about our comments, please contact Susan
Gaffney, Director of GFOA's Federal Liaison Center at 202-393-8020
x209.
Sincerely,
Government Finance Officers Association
National Association of Counties
National Association of State Auditors, Comptrollers and
Treasurers
National League of Cities
U.S. Conference of Mayors
______
Dear Sir or Madam:
On behalf of the 16,500 members of the Government Finance Officers
Association (GFOA), we appreciate the opportunity to comment on the
newly created IRC Section 4965 as requested under Treasury notice 2006-
65. The GFOA is a professional association of state and local
government finance officers dedicated to the sound management of
government financial resources. Many of our members will be impacted by
these regulations.
Based on our analysis, this provision would impose an excise tax on
state and local governments and their agencies that have entered into
many types of transactions such as Sale In/Lease Out or Lease In/Lease
Out (SILOs or LILOs) transactions prior to the date of enactment of the
Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA)
(P.L.109-222). TIPRA also allows a retroactive excise tax to be applied
to future state and local government and governmental agency financings
if they become listed transactions by the U.S. Department of the
Treasury and the Internal Revenue Service.
To combat tax shelter concerns with SILO and LILO transactions,
both Congress and the IRS have acted to abolish these types of
transactions from occurring. This includes the 2004 American Jobs
Creation Act (JOBS), which eliminated the tax incentives for SILO and
LILO transactions. Additionally, the U.S. Department of the Treasury
issued two Revenue Rulings on this issue that curtailed these
transactions--the 1999 IRS Revenue Ruling 1999-14 which disallowed the
depreciation and interest deductions for LILOs and the 2002 IRS Revenue
Ruling 2002-69 that listed LILO transactions as abusive tax shelters or
transactions.
Despite complying with evolving standards on lease-related
transactions, Section 4965 imposes a new punitive excise tax on state
and local governments and their agencies that entered into these
transactions in good faith before such transactions were prohibited.
Additionally, many SILO and LILO transactions were entered into by
transit authorities and municipalities with the encouragement and
approval of the U.S. Department of Transportation. Depending on
forthcoming regulatory guidance, many of the affected state and local
governments and their agencies could face significant tax liabilities,
in some cases in the millions of dollars, even though the proceeds of
these transactions were typically invested in the capital and operating
budgets of these public agencies long ago.
Beyond the retroactive application of Section 4965, we are also
very concerned about its open-ended nature that will allow an excise
tax to be applied to future transactions that may become listed by the
Treasury and the IRS. This creates an ominous cloud over current state
and local government and governmental agency financings by imposing
great uncertainty regarding what could become a listed transaction in
the future. While we believe Congress, the Treasury, and the IRS should
do everything possible to rid the marketplace of abusive transactions,
we are concerned that future application of this provision may cause
unintended consequences, and disrupt the most commonly used market for
the state and local government financing, the tax-exempt bond arena.
To deter unfair application of Section 4965 on state and local
governments and their agencies, we would like to make the following
suggestions with respect to forthcoming regulatory actions of the
Department of the Treasury.
1. Retroactive application of an excise tax on transactions that
were completed prior to enactment of TIPRA, should not be imposed. Due
to the fact that most SILO/LILO transactions closed before the 2004
JOBS Act, and were done in good faith, generally adhering to U.S.
Department of Transportation guidelines (Innovative Financing
Techniques for America's Transit Systems--1998), and other accepted tax
practices, Treasury should consider these transactions completed with
no net income/proceeds outstanding. As was suggested at our meeting
with Treasury and IRS officials on July 21, if net income and gross
proceeds are defined consistently with existing Code, there is
currently no project income to which the excise tax could apply.
Alternatively, these transactions could simply be delisted, as is the
case for nearly a dozen transactions noted in TIPRA. Those delisted
transactions were originally grandfathered in the JOBS Act, due to the
fact that they were awaiting approval from the Department of
Transportation at the time the legislation was introduced in 2003. The
types of grandfathered/delisted financings are no different than the
types of transactions that occurred prior to 2003, thus none of the
SILO/LILO transactions that were completed prior to 2004 should be
penalized by an excise tax.
2. Uniform definitions of net income and proceeds should be
applied. Treasury should seek to define `net income' and `gross
proceeds' in a manner that is consistent with current IRS Code, and
reflective of the true nature of SILO/LILO transactions. Below are some
technical suggestions.
Net Income
The IRS takes the position that lessors must be taxed in
accordance with the substance of the LILO/SILO transaction and such
substance is (i) an up-front payment by the lessor to the lessee and
(ii) a loan by the lessor to the lessee (the ``Deemed Loan'') in the
amount that the lessee sets aside to purchase highly-rated securities
(the ``Equity Collateral'') that defease certain obligations of the
lessee under the LILO/SILO or, alternatively, in the case of a LILO, a
purchase of a future leasehold interest in the leased property. The IRS
takes the position that cash flows in respect of the debt financing
must be disregarded as circular because the lessee uses the debt
proceeds to defease the debt-portion of its obligations with an entity
related to the lender.
The lessee would have income on receipt of the up front
payment in the year the LILO/SILO closes and, in the case of a SILO,
income in respect of earnings on the Equity Collateral that would be
offset, in timing and amount, by interest deductions attributable to
the Deemed Loan throughout the term of the transaction. In the case of
a LILO, the lessee would have either on-going interest income offset by
an interest deduction, as is the case in SILO transactions, or,
alternatively, income in the year of closing with respect to the sale
of a future interest in the property. The only net income from the
transaction is the Accommodation Fee received by the lessee on closing
of the transaction, and under an alternative IRS argument with respect
to LILOs, the payment for the future interest in the property. Under
normal tax accounting rules, these up-front payments would be taken
into income on closing of the transaction and would not be allocable to
subsequent years. In the absence of legislative direction to apply
different tax accounting principles, normal tax accounting rules should
apply.
Proceeds
Section 4965 and its legislative history are silent on
how the ``proceeds'' of a transaction to which the excise tax applies
are to be determined. The proper approach would be to treat the up
front payment as the proceeds of the transaction. The up front payment
represents the lessee's ``free cash'' from the transaction after
payment of transaction costs and provision for the defeasance of the
lessee's obligations and purchase option payment.
Under the proceeds prong of the measure of the excise
tax, the tax-exempt entity's tax for a particular year is measured by
reference to ``the proceeds received by the entity for the taxable
year,'' and then only to the extent the proceeds received for that year
are attributable to the transaction. The predicate to the proceeds
prong is that an amount must be received by the tax-exempt entity for
the year in question; if no amount is received by the tax-exempt for
the year, the inquiry stops: no tax is imposed under the proceeds
prong. In the context of LILO/SILO transactions, no amounts are
received by the lessee for any year, other than the year the
transactions closed.
Additionally, creating uniform definitions will also assist the
Department of the Treasury with their workload by not having to produce
new regulations every time a listed transaction is established.
3. Future application of Section 4965 should only be applied
prospectively. Procedures should be developed regarding how the Section
would apply to future transactions. This includes creating a procedure
so that the excise tax is not automatically applied to newly listed
transactions. Instead, penalties should only be applied prospectively
to transactions or at the very least, state and local governments and
their agencies should be able to provide comments on the newly listed
transactions and then only in extreme circumstances have the excise tax
apply to these transactions in a retroactive manner. An independent
judicial review mechanism should also be sought.
4. Section 4965 should not apply to tax-exempt bond transactions. A
regime for compliance in the tax-exempt bond marketplace currently
exists at the IRS. This includes the relatively recently (1999) created
``Tax-Exempt Bond Office'' which focuses solely on tax-exempt bond
transactions with an emphasis on abusive practices. It is unlikely that
Congress intended the Section to apply to tax-exempt bond financings,
and it unduly places the potential for substantially greater penalties
to be imposed upon state and local governments than currently exist, or
that are in line with possible purported abuses. State and local
governments and their agencies have little recourse in the tax-exempt
bond audit program, because of a lack of independent judicial review,
which is a problem in and of itself, without the further added threat
of an excise tax penalty regime being imposed upon the same
transaction, again without an independent judicial review mechanism.
5. Guidance is needed with respect to the disclosure requirements
in Section 4965. While the Section requires state and local governments
and governmental agencies to disclose existing transactions, the
legislative language does not provide for the specific timing and form
such disclosure must be made (``in such form and manner and such time
as determined by the Secretary.''). Ample time and guidance should be
provided for governments to fulfill this requirement, and Treasury
should consider exempting the disclosure requirement from applying to
transactions where there is no current income or proceeds subject to
the excise tax.
Conclusion
We are very concerned with the application of Section 4965 on state
and local governments and governmental authorities. This provision from
TIPRA creates a turning point in long standing federal/state/local
government relations, by having a federal excise tax imposed upon state
and local governments in the manner of a penalty, specifically in a
retroactive manner. Many governments entered into LILO and SILO
transactions from the late 1990's through 2004, most with the approval
of the U.S, Department of Transportation. Having these past
transactions now taxed is an unfair application of the penalty, and
could cost state and local governments and agencies millions of dollars
even though the proceeds of these transactions were generally spent at
the time the transactions were closed on public infrastructure and
services. By creating an atmosphere where an excise tax can be applied
to governments and agencies at any time in the future on transactions
that occur in the past, the ability of governments to enter into
financing transactions will be undermined and become more costly, as
tax lawyers strive to protect the transactions from possible--and
currently undefined--tax exposure. Clear guidance from Treasury is
imperative in order for governments to continue to provide the
essential infrastructure and services that the public demands.
Thank you for the opportunity to comment on the forthcoming
guidance.
Sincerely,
Susan Gaffney
Director, Federal Liaison Center
Money Management International, Inc.
Houston, Texas 77096
October 31, 2006
The Hon. William M. Thomas, Chairman
House Committee on Ways and Means
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas:
Money Management International, Inc. (``MMI'') would like to thank
you for the opportunity to submit comments on the recently enacted
credit counseling provisions of the Pension Protection Act of 2006 (the
``Pension Protection Act''), as requested pursuant to the recent
introduction of House Rule 6264, the Tax Technical Corrections Act of
2006.
The Pension Protection Act of 2006 adopted a new section 501(q) of
the Internal Revenue Code (``Code''), which establishes standards that
a credit counseling organization must satisfy in order to qualify for
exemption under Code Section 501(c)(3) or 501(c)(4). We believe that a
number of technical corrections are necessary in order to make
Congressional intent clear with respect to the important changes made
concerning credit counseling organizations.
I. Background.
MMI is the largest, tax-exempt, non-profit credit counseling
organization (``CCO'') in the nation and operates six telephone contact
centers and 135 in--person counseling offices in 22 states and the
District of Columbia. MMI provides professional financial guidance,
counseling, community-wide educational programs, and debt management
assistance. We are licensed in all states that require it of CCOs and
have been approved by the Executive Office for U.S. Trustees to provide
both pre-filing bankruptcy counseling and pre-discharge bankruptcy
education programs in all judicial districts. MMI has been reaccredited
by the Council on Accreditation after an extensive self-study and
onsite review process. MMI is a member of, and has taken leadership
roles in, the two well-regarded and reputable industry trade
associations, the National Foundation for Credit Counseling (``NFCC'')
and the Association of Independent Consumer Credit Counseling Agencies
(``AICCCA''), both of which have strict standards of operation as a
condition of membership. In the first nine months of 2006, nearly
500,000 consumers contacted MMI looking for financial education and
guidance on a wide range of issues, including credit card debt,
budgeting problems, debt prioritization, housing counseling, bankruptcy
counseling, and pre-discharge bankruptcy education.
II. Comments.
Below are our specific comments on the provisions of the Pension
Protection Act of 2006. In some instances, we propose new text that is
indicated by double underlines and deletions are indicated using
strikethroughs.
A. Prohibited ``credit repair activities'' section 1220(a) amendment to
Code Section 501(q)(1)(A)(iii).
We suggest section 1120(a) creating Code Section 501(q)(1)(A)(iii)
be revised to state ``provides services for the purpose of improving a
consumer's credit record, credit history, or credit; provided, however,
that if such services involve only educating a consumer as to how the
consumer can improve the consumer's credit record, credit history, or
credit rating, and not acting as an agent on behalf of the consumer to
do so (such as the organization contacting credit bureaus to correct
inaccurate items on a consumer's credit record), then such services
shall be considered the provision of educational information within the
definition of ``credit counseling services'' and not covered by the
restrictions of Section 501(q)(1)(A)(iii) or (iv), and''.
During the credit counseling process, consumers recognize the
importance of their financial health, often for the first time, and
numerous questions arise concerning the consumer's credit record,
credit history and credit rating. While MMI counselors have the
consumer's attention, it is important to educate them as much as
possible on the financial issues affecting their lives. Although CCOs
would like to be able to offer all education assistance free of charge,
education related to credit history and credit reports is expensive to
provide, as credit reports with credit scores are not provided to CCOs
free of charge. With decreasing contributions from creditors and others
which in the past have covered most of the agency's costs, CCOs should
be able to offer services related to credit reports and credit scores,
and collect modest fees to cover their costs, when appropriate.
It is important to note that it is not MMI's intention to offer
``credit repair'' advocacy services. By making the suggested changes to
the Act, we only wish to be able to provide consumers the information
needed to understand their credit report which will allow them to
contest any inaccuracies themselves. The intent of our proposed change
is to clearly distinguish between ``credit repair'' advocacy services
and traditional credit counseling education services.
B. Referrals section 1220(a) amendment to Code Section 501(q)(1)(F).
Section 1220(a) of the Pension Protection Act amends Code Section
501 to require CCOs to adhere to a number of operating requirements,
including that:
The organization receives no amount for providing referrals to
others for debt management plan services, and pays no amount to others
for obtaining referrals of consumers.
We believe Code Section 501(q)(1)(F) is unnecessarily restrictive.
Moreover, the Internal Revenue Service has already published on its web
site an FAQ that we believe incorrectly interprets this provision.\1\
In doing so, the IRS appears to ignore that the referral prohibition
applies to ``debt management plan services'' and not ``credit
counseling services.'' These terms are expressly defined in Code
Section 501(q)(4).
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\1\ An Internal Revenue Service FAQ states:
May I buy lists of potential customers from the Internet site that
carries my ads?
No. You cannot purchase leads of customers from third party vendors
and you cannot sell the names of your customers to other providers.
Internal Revenue Service Web Site, available at http://www.irs.gov/
charities/article/0,,id=163193,00.html (visited on Oct. 27, 2007).
Notably, in this FAQ the question asked and the answer provided appears
to address two different issues. The question asks about advertising
initiated by the CCO while the question addresses whether a tax-exempt
nonprofit CCO can purchase ``leads'' of customers from third party
vendors.
---------------------------------------------------------------------------
We suggest Code Section 501(q)(1)(F) be revised to state:
The organization receives no amount for providing referrals to
others for debt management plan services, and pays no amount to others
for obtaining referrals of consumers for debt management services who
do not consent to such referrals. For purposes of this provision, a
referral shall not include when a consumer seeks debt management plan
services from an organization that is connected to a credit counseling
organization. If a credit counseling organization pays or receives a
fee, for example, for using or maintaining a locator service for
consumers to find a credit counseling organization, such a fee is not
considered a referral under this provision. Further, nothing herein
shall be construed to prohibit a credit counseling organization from
paying fees for advertising and marketing services rendered.
We believe it is reasonable to consider the referral prohibition as
intended to prevent consumers from being diverted from one kind of
service provider to another, without their consent, for a referral fee,
bonus or commission and not to prohibit marketing and advertising.
However, we believe that consumers should not be prevented from being
connected to CCOs by a source that has their permission to do so.
We believe that Congress intended to adopt a narrow view of what
constitutes a ``referral.'' For example, the Joint Committee on
Taxation made clear that the Code Section 501(q)(1)(F) referral
prohibition should be interpreted as meaning that ``If a credit
counseling organization pays or receives a fee, for example, for using
or maintaining a locator service for consumers to find a credit
counseling organization; such a fee is not considered a referral.'' \2\
To keep costs down for both the agency and consumers, CCOs often
contract with other organizations that represent a pool of consumers
(employers, employee assistance programs, creditors, etc.) who may need
the CCO's services and may provide reimbursement to these organizations
for their marketing and related costs of making the referral.
---------------------------------------------------------------------------
\2\ See Joint Committee on Taxation, Technical Explanation of H.R.
4, page 318, n.436.
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We believe CCOs should be able to participate in locator services
provided by trade associations and other credit counseling industry
servicing organizations since it clearly improves operating
efficiencies when offering their services to consumers. These types of
locator services connect consumers seeking credit counseling and
financial education with CCOs. This type of service should be
acceptable to the Congress. Without the continuation of this service,
consumers may turn to predatory companies, those without strict
operating standards, as well as companies engaged in unlawful practices
and not operating in full compliance with applicable laws and
regulations.
Finally, as with other organizations, CCOs often engage in
advertising and marketing campaigns to keep consumers informed of the
availability of financial counseling and education, the vast majority
of which is offered at no cost to the consumer. Congress should make
clear that the referral prohibition is not intended to prevent this
practice.
C. Internal Revenue Service Disclosures to Third Parties Section
1224(a) amendment to subsection (c) of Code Section 6104.
We suggest section 1224(a) amendment to subsection (c) of Code
Section 6104 be revised to add the following after paragraph (5):
``(6) NOTIFICATION OF DISCLOSURE.--If a State officer receives or
seeks disclosures pursuant to these provisions (2), (3), (4) or (5),
the organization shall be included in all correspondence between the
Secretary and the State officer;
``(67) DEFINITIONS.--''
In the same spirit of disclosure and openness, CCOs should be
included in the correspondence surrounding the disclosures now
authorized under the Act. Such notification of disclosure would provide
CCOs the opportunity to open a dialogue with the States most concerned
about the CCO industry so that services may be better improved for our
consumers.
Please do not hesitate to let me know if you have any questions or
would like to discuss the comments outlined above. Thank you for your
consideration of these proposed technical corrections.
Sincerely,
Ivan L. Hand, Jr.
President and CEO
Alaska Ocean Seafood
Anacortes, Washington 98221
October 31, 2006
Dear Congressman:
I am writing to alert you to a pending tax law development that I
believe will be detrimental to small and mid-sized exporters. While I
am writing this letter on my Company's behalf, I believe many fellow
exporters share my views on this subject.
The Technical Corrections Bill Increases the Foreign Trade Deficit.
Section 7(b) of the Tax Technical Corrections Act prevents dividends
received from an IC-DISC from obtaining the same maximum 15% federal
tax rate as qualifying dividends from other types of corporations.
Passage of the bill would cause the IC-DISC regime to revert to its
status prior to 2003. Rapidly growing companies who needed capital to
expand export operations often came to the conclusion that they could
not use the IC-DISC structure because the deferral of tax wasn't worth
the interest charge or the soft costs of implementing the structure.
But when the tax rules changed in 2003 to allow IC-DISC dividends to
enjoy a permanent tax savings that the exporter never had to pay back
to the federal government, the IC-DISC structure came within the reach
of many companies with export activities.
One-Time Dividends Received Deduction Did Not Help Most Privately-
Held Companies. Various sources have quoted figures suggesting that
small businesses represent the vast majority of new jobs created in the
U.S. My view is that the one-time dividend received deduction available
for most taxpayers in their 2005 tax year benefited those U.S.
multinationals who had already exported jobs and who had already built
up significant foreign infrastructures. There was no corresponding
reward for those U.S. enterprises that built their businesses at home.
The Tax-Sophisticated Company Still Obtains Permanent Tax Benefits.
The Technical Corrections Bill does not eliminate the availability of
the 15% maximum federal rate on dividends from qualifying foreign
corporations or qualifying corporations formed in possessions of the
United States. Therefore, my competitors who happen to have operations
in China or Switzerland or Puerto Rico or Guam who have hired tax
advisors to help them manage their tax liabilities outside the U.S. can
still benefit from the 15% tax rate after passage of the Technical
Corrections Bill. This result seems unfair.
The ``Foreign-Owned'' Company Still Benefits. The Technical
Corrections Bill does not address technical rules that continue to
allow foreign corporate owners of an IC-DISC to obtain an effective
U.S. tax rate of 15% or less on profits derived from exporting
activities. It doesn't seem fair that Congress would enact a Technical
Correction that seemingly aids the foreign-owned U.S. company at the
expense of a U.S.-owned, U.S.-based company, both competing in the
global marketplace.
WTO Accepts IC-DISC. Congress has sought over years to provide tax
benefits to U.S. exporters. The original DISC provisions were replaced
with FSC provisions, and those were eventually replaced with the
Extraterritorial Income Exclusion (EIE). All have been met with various
objections from the WTO and the EU. EIE finally phases out at the end
of 2006, leaving no export incentive except the IC-DISC. This last
incentive was addressed by the WTO and accepted as not being an unfair
advantage to U.S. exporters. Now, instead, it is our own government
that is threatening to take away the only export incentive accepted by
our trading partners.
Conclusion:
Section 7(b) the Technical Corrections Bill eliminates
the ability of most privately-held U.S. companies to obtain a
permanently reduced federal tax rate on profits attributable to export
activities.
Section 7(b) has a disproportionately negative effect
upon small to mid-sized companies owned by U.S. individuals.
Section 7(b) can be defeated by taxpayers who can afford
sophisticated tax advice.
I therefore urge you to recommend removal of Section 7(b) from the
pending Tax Technical Corrections Act of 2006. After years of promoting
exports through DISC, FSC and then EIE legislation, it is difficult to
accept that the IC-DISC structure that is finally acceptable to the WTO
risks being struck down by our own government.
Thank you for your consideration of this letter. I appreciate your
leadership on this important issue to all U.S.-owned exporters.
Very truly yours,
Jeff Hendricks
CEO
Air Tractor, Inc.
Olney, Texas
October 27, 2006
The Honorable Bill Thomas
Chairman
House Ways and Means Committee
1102 Longworth House Office Building
Washington, DC 20515
The Honorable Charles Grassley
Chairman
Senate Finance Committee
219 Dirksen Senate Office Building
Washington, DC 20510
Dear Chairmen Thomas and Grassley:
Air Tractor, Inc. (``AT'') is a small business located in Olney,
TX. AT manufactures agriculture and forestry fire bombing airplanes and
has been in business since 1972. We are a small business with
employment of approximately 180 people. In addition to selling our
products domestically, AT also sells aircraft internationally.
We urge the Committee to reconsider Sec. 7 of the proposed
legislation, which addresses the tax treatment of IC-DISCs. This
section as written would bring about substantive (and we believe
negative) changes to the areas of small business, U.S. trade policy,
U.S. trade deficit, job creation and operates as a tax increase. In
view of the wide spectrum of categories impacted, Sec. 7 as currently
proposed is much more than a technical correction. Since we believe
that Sec. 7 is much broader than a technical correction, we request
that it be pulled from the technical corrections legislation. If
consideration of this section is something that Congress desires to
undertake, then we respectfully submit that this consideration should
be careful and in-depth deliberation afforded new legislation, and that
affected companies like ours be given more opportunity for input.
Our comments on the major issues that make this section much more
than a technical correction are as follows:
--Small Business. Since many of the IC-DISC mechanisms operate
through a Subchapter S corporation, by definition Sec. 7 is for the
most part a small business issue. Exporting for small business is an
important but expensive proposition. Sec. 7 would make this proposition
more expensive.
--U.S. Trade Policy. Through WTO rulings, U.S. exporters have lost
the availability of DISCs, FSCs, and ETI. The IC-DISC remains the lone
mechanism that the WTO has not ruled against and in fact, has
specifically let stand. Sec. 7 effectively neuters this remaining,
approved WTO mechanism.
--U.S. Trade Deficit. In the month of August 2006, the U.S.
Department of Commerce announced a record monthly trade deficit of
$69.9 Billion (second straight monthly ``record''). Our country is on
target for an annual trade deficit in excess of $800 Billion--
unfortunately another ``record''. The IC-DISC by definition applies to
small-medium enterprises (``SME'') that engage in exporting. Our
country should be working hard to reduce the trade deficit. Enactment
of Sec. 7 takes away another tool of the exporter and works
counterproductive to trade deficit reduction.
--Job Creation. Research indicates that companies that began
trading internationally between 1993 and 2001 had about five times the
employment growthof other companies. Companies that stopped trading
during this period actually lost jobs. Additionally, virtually all of
the Fortune 1000 companies are active international traders already,
but less than 10% of the nation's small companies export. With 96% of
the world's consumers living outside of the U.S., with global
communications rapidly shrinking the world community, and with trade
deficits threatening our future economic stability, this disappointing
overall export performance by smaller companies is something our nation
can no longer afford. Sec. 7 is a negative impact on SMEs that are
exporting or wish to export. Legislation should be enacted to stimulate
job growth--not the opposite.
--Tax Increase. Sec. 7 does not appear to address any specific,
perceived abuse or situation that would give rise to a need for a
technical correction. Sec. 7 operates as a straight tax increase.
Sec. 7 negatively impacts the issues noted above. Each issue alone
has substantive economic effects. Collectively, the economic effects
are amplified (in a negative way). Sec. 7 of the bill addresses
``technical corrections'' to the Jobs and Growth Tax Relief
Reconciliation Act of 2003. In that context it is instructive to
examine the House committee reports for that 2003 legislation. House
Committee Report (H.R. Rep. No. 108-94) as related to Code Sec. 1(h),
Code Sec. 163(d), Code Sec. 854 and Code Sec. 85c states in the Reason
For Change, ``The Committee believes it is important that tax policy be
conducive to economic growth. The Committee believes that reducing the
individual tax on dividends lowers the cost of capital and will lead to
economic growth and the creation of jobs.''
Further in the Reasons For Change, the Committee reached the
following conclusion, ``It is through such investment that the United
States' economy can increase output, employment, and productivity.''
Sec. 7 of the current proposed legislation was classified as a
technical correction. However, as noted above the enactment of Sec. 7
would have a negative impact across a broad economic range. The Reasons
For Change of the legislation that Sec. 7 are proposing to
``technically correct'' is very clear that the 2003 Act was keyed to
increasing economic growth and creation of jobs. This puts Sec. 7
directly opposed to the reasons for enactment of the 2003 and renders
the term ``technical correction'' dubious relative to the original
legislation.
In the Description of the Tax Technical Corrections Act of 2006
prepared by the staff of the JOINT COMMITTEE ON TAXATION (dated October
2, 2006, page 10), a justification for the proposed change is linked to
IRC 246(d). Sec. 246(d) references ``dividend from a corporation which
is a DISC or former DISC . . .'' Sec. 246(d) was added to the law in
1971. Much has changed in the economic and exporting landscape in the
ensuing 35 years. As noted, the WTO recently ruled against DISCs, FSCs
and ETI. The IC-DISC (which was created in 1984) is one of the few
mechanisms to stimulate exporting left standing today. Fundamentally,
the operation of today's IC-DISC (which was created 13 years after
246(d) was added) in the current economic environment is much different
than the DISCs addressed in 1971. This further reinforces our assertion
that today's Sec. 7 is much more than a technical correction. Sec. 7
has broad (and negative) impacts. We urge that Sec. 7 be eliminated
from a technical corrections bill.
Thank you for your consideration.
Sincerely,
David Ickert
Vice President--Finance
Hunton & Williams LLP
Richmond, Virginia 23219
October 31, 2006
Dear Chairman Thomas and Ranking Member Rangel:
In response to Advisory Release No. FC-26 (Sept. 29, 2006), Hunton
& Williams LLP is submitting this comment letter regarding TTCA 2006 on
behalf of one of its clients. Specifically, our comments relate to
Section 48A of the Internal Revenue Code (``Section 48A'') as enacted
by Section 1307 of the Energy Policy Act of 2005.
Section 48A provides a 20 percent investment tax credit for
certified qualifying advanced coal projects using integrated
gasification combined cycle technology (``IGCC'') and a 15 percent
investment tax credit for projects using an advanced coal-based
generation technology other than IGCC. The Secretary of Treasury is
authorized to allocate a maximum of $800 million in tax credits for
IGCC projects under Section 48A ($267 million to projects using
bituminous coal, $267 million to projects using subbituminous coal and
$266 million to project using lignite) and a maximum of $500 million in
tax credits for project using an advanced coal-based generation
technology other than IGCC. In order to qualify, a project must (i) be
certified by the Department of Energy (``DOE''), (ii) receive an
allocation of tax credits from the Internal Revenue Service (the
``IRS''), and (iii) meet certain requirements set forth in Section 48A.
One such requirement is that the generating unit must be ``designed to
meet'' certain emission performance requirements, including 99 percent
removal of sulfur dioxide.
In order to be considered in the initial round of tax credit
allocations, a taxpayer must have submitted an application for DOE
certification to DOE by June 30, 2006. DOE was required to notify the
IRS as to which projects received DOE certification by no later than
October 1, 2006. Taxpayers were required to submit an application to
the IRS for an allocation of Section 48A tax credits by no later than
October 2, 2006. The IRS is expected to notify taxpayers by November
30, 2006 as to whether they received an allocation.
We understand that companion bills have been introduced in the
House and the Senate (the ``Bills'') which would amend the sulfur
dioxide requirement to provide that such requirement will be satisfied
if the unit is designed to achieve either 99 percent sulfur dioxide
removal or the achievement of an emission limit of 0.04 pounds of
sulfur dioxide per million Btu, on a 30-day average. H.R. 6173 (Sept.
25, 2006); S. 3883 (Sept. 11, 2006). This revised requirement would be
applicable to all Section 48A projects and take effect as if included
in the Energy Policy Act of 2005. Although TTCA 2006 does not currently
contain the amendment to Section 48A proposed by the Bills, if such
amendment is included and enacted, it would result in an increase in
sulfur dioxide emissions beyond those contemplated by Section 48A as
originally enacted.
In addition, the deadlines for application for DOE certification
and for application for a tax credit allocation from the IRS for the
initial round of allocations has passed (June 30, 2006 and October 2,
2006, respectively). Because the amendments made by the Bills would
take effect as if included in the Energy Policy Act of 2005, certain
taxpayers may not have filed applications due to a belief that they did
not meet the sulfur dioxide removal requirement as originally enacted.
These taxpayers would be prejudiced by a retroactive amendment.
Similarly, projects that meet the sulfur dioxide removal requirement as
originally enacted may also be prejudiced by a retroactive amendment.
Accordingly, we respectfully request that the amendment to Section
48A provided in the Bills not be included in TTCA 2006 as it would
increase sulfur dioxide emissions and prejudice certain taxpayers that
did not meet the initial Section 48A deadlines and those that met the
deadlines and the sulfur dioxide removal requirement as originally
enacted. However, if the tax writing committees believe the amendment
is appropriate to be included in TTCA 2006, we respectfully recommend
that the amendment be effective on a prospective basis after the date
of enactment. Thus, projects that meet the new alternative sulfur
dioxide removal requirement would be eligible to participate in
subsequent tax credit allocation rounds.
Finally, we understand that the DOE did not certify any of the
Section 48A IGCC projects using subbituminous coal based on an
assumption that such projects could not meet the 99 percent sulfur
dioxide removal requirement. This assumption is incorrect. Although
subbituminous coal is a low-sulfur coal, 99 percent removal (or more)
of sulfur dioxide is possible, for example, when additional processes
are incorporated to further remove pollutants such as sulfur from the
synthesis gas. Moreover, Section 48A(f)(1) of the Code provides that an
electric generation unit uses ``advanced coal-based generation
technology'' if the unit ``is designed to meet'' certain performance
requirements including a ``design level for the project'' of 99 percent
sulfur dioxide removal. Thus, if a taxpayer presented technical and
engineering information demonstrating that the project was designed to
meet this requirement, the project should be certified by DOE. If the
project, when completed and operational, does not meet the performance
characteristics, the IRS can appropriately address this issue on audit.
We would welcome the opportunity to discuss our comments with you
in more detail. Please contact me at (804) 788-8746 if you have any
questions or require further information.
Respectfully submitted,
Laura Ellen Jones
Cascade Fishing, Inc.
Seattle, Washington 98199
October 31, 2006
I am writing to you to express my concerns with Section 7 of the
Technical Corrections Act of 2006 and specifically with the changes
proposed to the treatment of dividends paid by an IC DISC corporation.
We oppose the proposed changes to the treatment of dividends paid
by an IC DISC. First, this change does not seem fitting as a
``technical correction''. Rather it is a fundamental change in the
treatment of dividends as paid by an IC DISC. We believe any such
fundamental change in tax law should be addressed the same way in which
any other fundamental changes in tax law are addressed, which is
through the tax approval process and not as a technical correction.
Second, the suddenness of the enactment date of the proposed change
undermines basic business planning. As a small business whose sales are
substantially foreign, we rely on the values the current tax laws allow
as an important part of our business success for the year. For the tax
laws on which we rely to suddenly change undermines a good portion of
our fiscal success. If it is the committee's belief that this major
change in stance regarding the treatment of dividends is within the
technical corrections process, we would respectfully request that such
enactment date be effective December 31, 2006 so as to not undermine a
planned portion of our business success. It is our understanding the IC
DISC rules were put in place to help businesses like ours who provide
U.S. based employment and who export to foreign countries. This sudden
change in the tax law will have the opposite effect.
We are a small US based business providing jobs in the US. Where
specifically provided by our tax code we plan for and rely on the
benefits this code provides us. These benefits are an integral part of
our success and the suddenness of changes like it proposed in this area
of the technical corrections act undermines the basis for our planning
and success.
We request you either eliminate this provision in the technical
corrections act or change the enactment date of this provision to
December 31, 2006.
Respectfully submitted,
Nancy Kercheval
President
City of Chicago
Chicago, Illinois 60602
October 31, 2006
The Honorable Bill Thomas
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
Dear Chairman Thomas:
On behalf of the City of Chicago, I welcome this opportunity to
submit comments on H.R. 6264, the ``Technical Tax Corrections Act of
2006''. Our comments discuss issues relevant to the application to the
City of a new excise tax enacted by Section 516 of the Tax Increase
Prevention and Reconciliation Act of 2005 (``TIPRA''). I will first
mention some general concerns about the excise tax and then suggest
some technical corrections to Section 516 which would alleviate a
portion of our concerns. We respectfully request that these corrections
be included in H.R. 6264.
In general, the City is concerned that the excise tax enacted by
Section 516 of TIPRA may be applied retroactively to transactions that
were entered into prior to the Internal Revenue Service issuing any
guidance or stating any concern that certain transactions may be tax
shelters. Such retroactivity can be inherently unfair given that state
and local governments have endeavored to enter into financial
transactions in accordance with the law. Furthermore, the excise tax
appears to be a way of taxing state and local government income, which
is contrary to long-established practice and may invoke constitutional
issues.
To turn to more technical concerns and some possible technical
corrections, the Act and its legislative history do not provide a clear
definition of ``proceeds,'' on which the excise tax imposed under
Section 516 of TIPRA is partly based. As a result, the City is
concerned that the Treasury and the Internal Revenue Service have
insufficient guidance in defining this term during the regulatory
process and may promulgate regulations with an overly broad definition
of this key term. Therefore, the City asks the Committee to focus on
the economics of the transaction to the City and provide a technical
clarification of the definition of proceeds that is consistent with the
fact that the City's only economic benefit from the transaction is
received on the closing date of the transaction. Similarly, the City
requests that the Committee consider adding a provision to H.R. 6264
that would clarify the meanings of ``net income'' and ``proceeds'' as
such terms are used in Section 516 of TIRPA, and would provide guidance
on the allocation of both ``net income'' and ``proceeds'' that is
consistent with the fact that the City's only economic benefit from the
transaction is received on the closing date of the transaction.
Thank you for your consideration of our views. If you have any
further questions, please feel free to contact me.
Sincerely,
Dana Levenson
Chief Financial Officer
Washington Metropolitan Area Transit Authority
October 31, 2006
The Honorable William M. Thomas
Chairman
Committee on Ways & Means
United States Senate
1102 Longworth House Office Building
Washington D.C. 20515
Dear Chairman Thomas:
The Washington Metropolitan Area Transit Authority (WMATA) is the
largest public transportation provider in the Washington, D.C.
metropolitan area and the second largest subway and fifth largest bus
system nationally. On average, we provide 720,000 rail trips, 439,000
bus trips, and 4,400 paratransit trips every weekday, and almost half
of Metrorail's peak period riders are federal employees. Pursuant to
your request for written comments on September 29, 2006, WMATA is
pleased to submit formal comments on H.R. 6264, the ``Tax Technical
Corrections Act of 2006.'' Specifically, our comments relate to the
application of a new section 4965 of the Internal Revenue Code
following the enactment of the Tax Increase Protection and
Reconciliation Act (TIPRA) in May of 2006 (P.L. 109-222).
WMATA believes that neither TIPRA nor its legislative precedents
provide a clear definition of the term ``proceeds'' and ``net income,''
particularly for the application of Internal Revenue Code Sec. 4965
(excise taxes). As a result, the U.S. Department of the Treasury and
the Internal Revenue Service (IRS) may have insufficient guidance to
define these terms during the regulatory process and could promulgate
regulations with an overly broad definition of these key terms.
WMATA is deeply concerned that unless these terms are defined with
more precision, the IRS may impose an excise tax on proceeds of Sale
In/Lease Out (SILO) or Lease In/Lease Out (LILO) transactions completed
by WMATA prior to the passage of TIPRA. Between 1998 and 2003, WMATA
was the lessee in several LILO and SILO transactions. Consequently, if
these terms are not clearly defined, the IRS could impose substantial
excise tax on those transactions, which could have a material adverse
impact on WMATA's ability to serve our riding public, including over
360,000 federal employees.
Therefore, WMATA respectfully requests that the Ways & Means
Committee include in H.R. 6264 a technical clarification of the
definitions of ``proceeds'' and ``net income'' that are also consistent
with the position taken by the IRS in revenue rulings and court
filings. Specifically, WMATA suggests that for purposes of assessing
excise taxes, all proceeds and net income be considered to have been
received at the closing of the transaction when the tax exempt entity
received a cash payment.
Thank you for introducing H.R. 6264 and for allowing those affected
by TIPRA to submit comments. If you or your staff have any further
questions, please do not hesitate to contact me at 202-962-1003 or Mark
R. Pohl, WMATA Associate General Counsel at 202-962-2541.
Sincerely,
Deborah S. Lipman
Director, Office of Policy and Government Relations
California Transit Agencies
October 24, 2006
The Honorable Charles Grassley
Chairman
Senate Finance Committee
219 Dirksen Senate Office Building
Washington, DC 20510
The Honorable Max Baucus
Ranking Member
Senate Finance Committee
219 Dirksen Senate Office Building
Washington, DC 20510
The Honorable Bill Thomas
Chairman
House Ways and Means Committee
1102 Longworth House Office Building
Washington, DC 20515
The Honorable Charles B. Rangel
Ranking Member
House Ways and Means Committee
1106 Longworth House Office Building
Washington, DC 20515
Dear Chairmen and Ranking Members:
On behalf of transit agencies around the country, California
transit agencies appreciate your introduction of H.R. 6264, the Tax
Technical Corrections Act of 2006. Enactment of this measure will
resolve numerous ambiguities in the Tax Increase Prevention and
Reconciliation Act (TIPRA), the American Jobs Creation Act of 2004
(Jobs Act) and other significant tax legislation, improving compliance
while providing certainty.
Per the Committees' request for comments on the proposed
legislation, we respectfully request that an additional technical
correction relating to the treatment of Sale In/Lease Out transactions
under Section 4965 be included in the enacted legislation. The
correction would clarify that TIPRA does not impose an excise tax on
transit system transactions lawfully entered into before such
transactions were prohibited under the Jobs Act.
Enactment of the Jobs Act effectively ended tax-advantaged leasing
transactions, and none have been entered into since its effective date.
However, for years prior to the enactment of the Jobs Act, the U.S.
Department of Transportation (DOT) and its Federal Transit
Administration (FTA) encouraged transit systems to employ innovative
financing mechanisms as a means to raise revenue for public transit,
and in fact heavily promoted the use of tax-advantaged leasing
transactions to that end. This is evidenced in the 1998 FTA publication
entitled ``Innovative Financing Techniques for America's Transit
Systems,'' which specifically encouraged the use of these transactions.
As such, public transit systems relying not only on DOT's
encouragement but with the FTA's review and approval acted entirely in
good faith when entering into these transactions. As intended, the
proceeds earned under such transactions were long ago used to meet
critical public transit needs.
Our concern is that, as currently written, IRC Section 4965 could
be interpreted to impose an excise tax on transactions involving
transit systems that were entered into in good faith long before the
effective date of the Jobs Act. While we believe this interpretation to
be wrong, it could mean a retroactive application of an excise tax to
transactions that were not only lawfully entered into, but were
recommended and approved by the federal government.
Such an application of Section 4965 would appear to be inconsistent
with the approach to these leasing transactions taken under the Jobs
Act. The language of the Jobs Act makes clear that Congress did not
intend to target benefits received by state and local government
entities. We believe this Congressional intent is further underscored
by the Joint Committee on Taxation revenue estimate for TIPRA, which
does not appear to anticipate taxation of these transactions. Rather,
the JCT score shows an estimate which does not reflect collections from
potentially affected transit entities.
Moreover, the transactions that were pending during consideration
of the Jobs Act were specifically ``grandfathered'' and are not subject
to the excise tax as per Section 4965. As a result applying Section
4965 to past leasing transactions would result in a 100 percent excise
tax retroactively applied to older transactions, while more recent
transactions are held harmless. This result would appear to be
arbitrary and inequitable.
In light of the foregoing, we respectfully request that the
technical correction clarify that the excise tax as enacted under TIPRA
does not apply to transit agency transactions lawfully executed before
the effective date of the Jobs Act.
Again, thank you for the opportunity to comment on H.R. 6264, the
Tax Technical Corrections Act of 2006. We hope that this comment will
help in clarifying the intent of Congress with respect to the
applicability of Section 4965. We welcome the opportunity to answer any
questions or discuss this issue further. Thank you for your
consideration.
Sincerely,
Thomas E. Margro
General Manager
San Francisco Bay Area Rapid Transit District
Beverly A. Scott
General Manager
Sacramento Regional Transit District
Roger Snoble
Chief Executive Officer
Los Angeles County Metropolitan Transportation Authority
Nathaniel P. Ford Sr.
Executive Director/CEO
San Francisco MTA
Michael Scanlon
Executive Director
Peninsula Corridor Joint Powers Board (PCJPB) / Caltrain
Michael J. Burns
General Manager
Santa Clara Valley Transportation Authority
Metropolitan Atlanta Rapid Transit Authority
Atlanta, Georgia 30324
October 24, 2006
The Honorable Bill Thomas
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
Dear Chairman Thomas:
The Metropolitan Atlanta Rapid Transit Authority (MARTA) welcomes
this opportunity to submit formal comments pursuant to your request for
comments on September 29, 2006. Our comments discuss issues relevant to
the application of a newly enacted section of the Internal Revenue Code
to the Metropolitan Atlanta Rapid Transit Authority as a result of
MARTA's role as a lessee in transactions commonly referred to as LILOs
and SILOs.
MARTA is concerned that the excise tax (The Tax Increase Protection
and Reconciliation Act, Section 516) may be applied retroactively to
transactions that were entered into prior to the IRS issuing any
guidance or stating any concern that certain transactions may be tax
shelters. MARTA was the lessee in several LILO and SILO transactions
involving assets with an appraised fair market value in excess of $2.2
billion. Retroactive imposition of a substantial excise tax could have
a material adverse impact on MARTA's ability to serve our riding
public.
The Tax Increase Protection and Reconciliation Act and its
legislative history do not provide a clear definition of ``proceeds.''
As a result, MARTA is also concerned that the Treasury and the IRS have
insufficient guidance in defining this term during the regulatory
process and may promulgate regulations with an overly broad definition
of this key term. Therefore, MARTA asks the Committee to focus on the
economics of the transaction and provide a technical clarification of
the definition of proceeds that is also consistent with the position
taken by the IRS in Revenue Rulings and court filings. Additionally,
MARTA requests that the Chairman consider adding a provision to the
recently introduced Tax Technical Correction bill (H.R. 6264) that
would clarify the meaning of net income and proceeds and would provide
guidance on the allocation of both net income and proceeds that is
consistent with the treatment of net income and proceeds by the IRS.
Thank you for your consideration of our views. For a more detailed
explanation of the issue, we have attached a copy of our comment letter
to the Treasury Department and IRS. If you have any further questions,
please contact me at 404-848-5377.
Sincerely,
Richard J. McCrillis
General Manager/CEO
S Corporation Association
October 24, 2006
The Honorable Bill Thomas
Chairman
House Ways and Means Committee
1102 Longworth House Office Building
Washington, DC 20515
The Honorable Charles Grassley
Chairman
Senate Finance Committee
219 Dirksen Senate Office Building
Washington, DC 20510
Dear Chairmen Thomas and Grassley:
On behalf of the members of the S Corporation Association and the
3.2 million S corporations nationwide, we appreciate your introduction
of H.R. 6264 and S 4026, the Tax Technical Corrections Act of 2006.
Enactment of this measure will resolve numerous ambiguities in the Tax
Code, improving compliance while providing certainty.
Per the Committee's request for comments, I would like to raise
serious concerns regarding Section 7 of the Act which, if enacted,
would significantly increase taxes on small and closely-held U.S.
manufacturing exporters.
Since the 1970s, the EU has successfully challenged a number of
U.S. tax provisions--DISC, FSC, and ETI--designed to mitigate the harm
caused by their use of border-adjustable taxes and to assist U.S.
exporters competing in the global marketplace. In each of these cases,
the U.S. has been forced to comply with the EU challenge by eliminating
the pro-export provision.
The IC-DISC (Interest Charge Domestic International Sales
Corporation) was created in 1984 to allow the deferral of tax on IC-
DISC income until it is repatriated as a dividend. The IC-DISC is
different from DISC in that IC-DISC shareholders must pay interest on
any deferred taxes. Because it requires shareholders to pay interest on
any deferred tax liability, the EU has never challenged its legality
under GATT or WTO.
Under the IC-DISC, a U.S. exporter pays the IC-DISC an annual
``commission'' equal to a percentage of its export income. This income
accumulates untaxed within the IC-DISC. When the IC-DISC income is
repatriated, it is distributed to the IC-DISC shareholders in the form
of a dividend. Since the repeal of FSC/ETI and the reduction in the
dividend tax rate to 15 percent, the IC-DISC has become a very popular
tool for small and closely held manufacturers seeking to increase their
exports.
Section 7 of the Tax Technical Corrections Act of 2006 would
increase the tax on IC-DISC dividends by making these payments
ineligible for the lower 15-percent tax rate for dividends. This change
would apply to dividends paid after September 29, 2006. Our objections
to this provision are two-fold.
First, we believe this provision does not qualify as a technical
correction. It is substantive, controversial, and would significantly
impact revenues. The question of whether IC-DISC dividends should be
taxed at 15 or 35 percent is a policy matter for Congress to determine
through the normal legislative process, not as part of a bill reserved
for technical and non-controversial adjustments to the tax code.
Second, Congress should oppose raising taxes on domestic exporters.
While U.S. exports are on the rise, particularly from smaller
manufacturers, it is critical that this growth continue for the Untied
States to continue making progress toward addressing our current trade
imbalance. Following the repeal of the most recent RSC/ETI regime, the
IC-DISC provisions are the sole remaining tax provisions targeted
directly at U.S. exporters. Given the current size of the U.S. trade
deficit, it makes little sense for Congress to act unilaterally to harm
small and closely-held manufacturers and other exporters.
Based on these concerns, we urge you to support America's small and
closely-held exporters and remove this provision from the Tax Technical
Corrections Act.
Thank you for your consideration of our comments and we would be
pleased to discuss this matter further with you as you work to complete
this bill.
With best regards,
Tom McMahon
Vice President/Operations
Statement of Metropolitan Transportation Authority, New York, New York
The Metropolitan Transportation Authority (``MTA''), a public
benefit corporation and public authority of the State of New York,
welcomes this opportunity to submit formal comments pursuant to your
request for comments to the Tax Technical Correction bill (H.R. 6264).
MTA is concerned that the newly created IRC section 4965 excise tax
(The Tax Increase Protection and Reconciliation Act, Section 516) may
be applied retroactively to transactions that were entered into prior
to the IRS issuing any guidance or stating any concern that certain
transactions may be tax shelters or enactment of any legislation
effecting certain leasing transactions. Between 1997 and 2003, the MTA
was the lessee in several LILO and SILO transactions involving assets
with an appraised fair market value of approximately $2.9 billion.
Retroactive imposition of a substantial excise tax could have a
material adverse impact on MTA's ability to serve our riding public.
The Tax Increase Protection and Reconciliation Act and its
legislative history does not provide a clear definition of
``proceeds.'' As a result, MTA is also concerned that the Treasury and
the IRS have insufficient guidance in defining this term during the
regulatory process and may promulgate regulations with an overly broad
definition of this key term. Therefore, MTA asks the Committee to focus
on the economics of the transaction and include a provision that would
provide a technical clarification of the definition of proceeds and
would provide guidance on the allocation of both net income and
proceeds that is also consistent with the position taken by the IRS in
Revenue Rulings and court filings.
Thank you for your consideration of our views. For a more detailed
explanation of the issue, we have attached a copy of our comment letter
to the Treasury Department and IRS. If you have any further questions,
please feel free to contact me.
Statement of RSM McGladrey
Introduction
RSM McGladrey is a leading professional services firm providing
accounting, tax and business consulting to midsized companies. When
considered together with McGladrey & Pullen (a partner-owned CPA firm),
the two companies rank as the fifth largest accounting, tax and
business consulting firm in the United States. Our client list
represents some of the top names in manufacturing and distribution,
construction, real estate, health care, financial services and the
public sector. RSM McGladrey focuses on the middle market because it
represents the heart of U.S. commerce and industry, with more than
500,000 businesses contributing more than 30 percent of the nation's
gross domestic production and representing one third of all American
workers. Companies in the middle market are a vital sector of our
economy and we appreciate the opportunity to comment on legislation
that affects them.
Overview
We applaud the efforts of the Committee to promote the pro-growth
tax relief that is critical to the competitiveness of American
exporters. Similarly, we appreciate the efforts of the Committee to
advance legislation (H.R. 6264) that makes needed technical corrections
to recent tax relief legislation.
In response to your request for comments on H.R. 6264, we are
extremely concerned about how Section 7 will change the tax treatment
of dividends paid from Interest-Charge Domestic International Sales
Companies (IC-DISCs). If enacted, this provision would make a
substantive change in the current tax code, resulting in a significant
hidden retroactive tax increase on many privately-held manufacturing
companies that export. As H.R. 6264 moves through the legislative
process, we strongly urge you to drop Sec. 7 from the technical
corrections bill.
Background
Continued export growth is critical to addressing our current trade
deficit. While the U.S. trade deficit is large--on a seasonally
adjusted basis, the August 2006 deficit in manufactured goods was at an
annual rate of $536 billion--it has stayed at essentially the same
range since January 2006. Export growth is stabilizing the balance.
According to the Commerce Department, August 2006 was the 10th month in
a row in which manufactured goods exports rose more rapidly than
imports.
United States manufacturers play a major role in U.S. exports,
exporting more than $60 billion in goods every month. In addition,
exports from the United States have increased by 57 percent over the
past ten years. Nonetheless, in order for the manufactured goods trade
imbalance to shrink, it is critical that export growth continue since
import value is about 50 percent larger than manufactured goods exports
value.
While manufacturers of all sizes are exporters, the increase in
exports by midsized companies has increased significantly in recent
years. According to the Commerce Department, 97 percent of all
exporting manufacturers have fewer than 500 employees.
Potential Impact of Tax Law Change
If enacted, the proposed change in the tax treatment of IC-DISCs
likely would have a negative impact on U.S. exports. Under current tax
rules, privately-held companies that export can set up an IC-DISC that
allows the deferral of taxes on certain income from export activities,
as long as interest is paid on the deferred tax.
In addition, when the income is distributed to noncorporate
shareholders as a dividend, it is taxed at a 15 percent rate. The
amount of deferral is capped at gross annual export receipts of $10
million.
The proposed change in the IC-DISC rules would increase taxes for a
number of midsized companies in the United States that export
manufactured goods, making it more difficult for them to compete in the
global marketplace. Over 90% of the businesses whom we represent have
1,000 or fewer employees. Most of our clients are privately held and a
great many of these companies are exporters. A recent survey conducted
by the National Association of Manufacturers is consistent with our
experience serving midsized businesses. More than two thirds of
privately, family or individually owned companies responding to the
survey said that they export products.
Section 7 Is a Substantive Law Change
While the stated purpose of H.R. 6264 is to ``make Congressional
intent clear regarding crucial components of recent tax legislation,''
Section 7 of the bill goes well beyond a clarification. We believe the
statutory language of the Jobs and Growth Tax Relief Reconciliation Act
(2003 Act) is unambiguous as it applies to IC-DISCs. However, Section 7
would significantly increase the tax rate on dividends paid by IC-DISCs
without any public debate or discussion of the policy ramifications,
and with no public analysis on the proposal's impact to midsized
businesses. For this reason we think it is not proper to attempt to
enact such a change as a ``technical correction.''
We note that in 1984, and again in 2000 when the FSC regime was
under challenge, the World Trade Organization (WTO) commented that the
IC DISC was not to be viewed as an illegal export subsidy. Thus, we
believe that a repeal of the IC-DISC regime would have been improper
during consideration of the 2003 Act as this section wasn't one of the
offending sections that the WTO had highlighted. Obviously, a repeal
now based upon a ``technical correction'' to the 2003 Act makes no
sense without a public debate on export tax policies impacting midsized
businesses.
Many midsized businesses have made decisions to repatriate earnings
or expand internationally based upon the laws in effect at the time. In
addition, midsized businesses are currently making decisions to
increase exports based upon tax laws applicable to such transactions.
Changes to the IC-DISC regime need to be carefully considered because
midsized businesses can't avail themselves of the variety of
restructuring options available to larger businesses with more
resources and larger scale. We respectfully believe such changes need
to be done outside the ``technical corrections'' process.
Conclusion
The proposed change to the IC-DISC rules in H.R. 6264 represents a
substantive change to current tax law that would have a negative impact
on the ability of midsized businesses to export. Thank you in advance
for considering our request to remove this anti-growth provision from
the Technical Corrections Act of 2006.
If you have questions concerning these comments, please contact
Bill Major, Managing Director, International Tax, RSM McGladrey, at
1.847.413.6236.
Sincerely,
Michael L. Metz
Executive Vice President, Tax Services
Federal Tax Committee of the Wisconsin Institute of Certified
Public Accountants
Brookfield, Wisconsin 53005
October 23, 2006
The Honorable Senators Chuck Grassley and Max Baucus
U.S. Senate Committee On Finance
219 Dirksen Senate Office Building
Washington, DC 20515
The Honorable Bill Thomas, Chairman
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Gentlemen:
As an attorney for numerous small manufacturers and on behalf of
the Federal Tax Committee of the Wisconsin Institute of Certified
Public Accountants, I am responding to requests for comments to the Tax
Technical Corrections Act of 2006 (H.R. 6264/S. 4026).
If signed into law, section 7 of the Tax Technical Corrections Act
of 2006 would eliminate the incentive aspect of IC-DISCs for tens of
thousands of closely-held manufacturers, a sector of the economy
crucial to long-term growth and prosperity. This comment explains why
the proposed legislation is inappropriate and would go against the
longstanding policy of aiding domestic manufacturers of exported goods.
1. The Proposed Legislation Hurts U.S. Manufacturers of Exported
Products. Manufacturers are the bedrock of a prosperous economy.
Manufacturing jobs generally pay higher wages and have more generous
benefits than jobs in other sectors. Furthermore, manufacturing jobs
are considered especially valuable because they import wealth from
around the world. Through their interactions with others, manufacturers
spur demand in the retail, service and not-for-profit sectors. Now,
however, with manufacturers closing U.S. plants and moving production
to less expensive foreign locations, this ripple effect is working in
reverse, magnifying the economic disruption caused by manufacturer
exodus. The proposed legislation would effectively eliminate a key
export incentive that helps put domestic manufacturers in an economic
position closer to that of their foreign counterparts. Eliminating the
incentive aspect of IC-DISCs will negatively effect domestic
manufacturers, leading to reduced exports, lower productivity and fewer
jobs.
2. The Proposed Legislation is Unnecessary. More than merely
providing a ``technical correction,'' the proposed legislation would
work a substantive change by eliminating an export benefit that has
existed without question. Nothing in the text or legislative history of
the Jobs and Growth Tax Relief Reconciliation Act of 2003 suggests that
the current tax rate on dividends paid from an IC-DISC is something
that requires correction.
Furthermore, the Joint Committee's description of the Tax Technical
Corrections Act of 2006 tries to argue that the proposed legislation is
similar to the denial of a dividends received deduction on dividends
received from an IC-DISC found in Code section 246(d). That section
does deny the dividends received deduction with respect to dividends
received from IC-DISCs because those dividends have not yet been
subject to corporate-level tax. Code section 246(d)'s sole purpose is
to prevent corporate shareholders of IC-DISCs from avoiding corporate-
level tax on IC-DISC dividends altogether. However, this problem does
not exist with respect to non-corporate IC-DISC shareholders because
there is no corporate-level tax to avoid.
3. The Proposed Legislation Goes Against the Longstanding Policy of
Aiding Domestic Manufacturers of Exported Goods. A review of the
history of export incentives shows that Congress has a longstanding
policy of aiding domestic manufacturers of exported goods and has only
abandoned this policy after significant pressure from our foreign
trading partners. Our foreign trading partners have not objected to the
rate of tax paid by individuals on dividends received from IC-DISCs,
making abandonment of this policy through the proposed legislation
inappropriate.
In 1971, Congress enacted the domestic international sales
corporation (``DISC'') regime in an attempt to stimulate U.S. exports.
A DISC afforded U.S. exporters some relief from U.S. tax on a portion
of their export profits by allocating those profits to a special type
of domestic subsidiary known as a DISC. In the mid-1970s, foreign
trading partners of the United States began complaining that the DISC
regime was an illegal export subsidy in violation of the General
Agreement on Tariffs and Trade (``GATT'').
In 1984, Congress enacted the foreign sales corporation (``FSC'')
regime as a replacement for the DISC regime in response to the GATT
controversy. The FSC regime required U.S. exporters to establish a
foreign corporation that performs certain activities abroad in order to
obtain a U.S. tax benefit. Rather than repeal the DISC regime, Congress
modified it to include an interest charge component, making all DISCs
from that point forward IC-DISCs. Manufacturers often did not take
advantage of the IC-DISC because until recently other regimes, such as
the FSC and ETI exclusion, were more attractive.
In 1998, the European Union filed a complaint with the World Trade
Organization (``WTO'') asserting that the FSC regime, similar to the
original DISC regime that preceded it, was an illegal export subsidy in
violation of the GATT. In 1999, the WTO released its report on the
European Union's complaint, ruling that the FSC regime was an illegal
export subsidy that should be eliminated by 2000.
In 2000, Congress responded to the WTO's ruling by enacting the FSC
Repeal and Extraterritorial Income Exclusion Act of 2000. The new
extraterritorial income (``ETI'') exclusion afforded U.S. exporters
essentially the same tax relief as the FSC regime. Consequently, the
ETI exclusion did not end this trade controversy as the WTO
subsequently ruled that the ETI exclusion was an illegal export subsidy
that should be eliminated.
In 2004, Congress enacted the American Jobs Creation Act of 2004
(``2004 Act''), which phased out the ETI exclusion while phasing in a
domestic production deduction (``DPD''). With the elimination of the
ETI exclusion, the only remaining incentive for exports was the IC-
DISC. Rather than encouraging exports, the DPD allows a deduction for
certain domestic production activities. While exporting manufacturers
may take advantage of the DPD, the tax relief (and concomitant
incentive to export) of the DPD is far less than that afforded by the
IC-DISC.
As the foregoing history shows, Congress has only removed export
incentives under significant pressure from our foreign trading
partners. As our foreign trading partners have not objected to the tax
rate on dividends received from IC-DISCs, it is inappropriate for
Congress to abandon its longstanding policy of aiding domestic
manufacturers of exported goods.
4. The Proposed Legislation Unfairly Impacts Exporters. The
proposed legislation unfairly impacts exporters who have relied on
current law to arrange their affairs by applying retroactively to all
dividends paid from IC-DISCs since the date of its introduction. Even
in the face of challenges and discontent by the European Union, the
transition periods for each of the FSC and ETI regimes began several
months after the dates of their introduction and lasted at least two
years.
Here in the Midwest, America's heartland, we are home to more than
one-third of all manufacturing jobs in the United States and generate
more than $100 billion in revenue from exports each year. The proposed
legislation will harm tens of thousands of hard-working small
businesses whose value to the economy cannot be overstated.
Furthermore, the proposed legislation has no basis in the text or
legislative history of the Jobs and Growth Tax Relief Reconciliation
Act of 2003 and penalizes exporters who reasonably relied on the law.
Accordingly, section 7 of the Tax Technical Corrections Act of 2006
should not be enacted into law.
Yours very truly,
Robert J. Misey, Jr., Esq.
Small Business Exporters Association
October 27, 2006
Hon. Bill Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, DC 20515
Dear Chairman Thomas,
On behalf of the more than 22,000 small and mid-sized exporting
companies that belong to the Small Business Exporters Association of
the United States and its affiliated nonprofit organization, the
National Small Business association, SBEA would like to comment on H.R.
6424, the Tax Technical Corrections Act of 2006.
We appreciate the conscientious work that went into this
legislation, as well as its companion bill S.4026, by the members and
staff of the House Ways and Means Committee, the Senate Finance
Committee, and the Joint Committee on Taxation. We know that many
provisions of the bill will help clarify the tax code for taxpayers,
tax practioners, and Congress itself.
However, we do wish to draw the attention of the Ways and Means
Committee to one section of the bill that we believe requires a more
extensive analysis and more public input than it is likely to receive
in this bill.
Section 7 of the bill would significantly change the tax treatment
of Interest Charge Domestic International Sales Corporations (IC-
DISC's). We believe these changes would unnecessarily harm small U.S.
exporters, notably those who manufacture their products.
Change would disrupt businesses. The IC-DISC form of business
organization is best suited for privately-held companies with few
shareholders, such as smaller C corporations and pass-through entities
like S Corporations. Consequently, nearly all of the companies
utilizing the IC-DISC are small. Our members who use IC-DISC's tell us
that they spent tens of thousands of dollars, and considerable amounts
of time, structuring their companies so as to utilize the IC-DISC
format, on the basis of assurances from attorneys and CPA's that this
form of organization was approved by Congress and the World Trade
Organization.
Not only would a change in the tax treatment of IC-DISC's expose
these companies to much greater than anticipated federal taxes, but it
would require them to yet again restructure their companies, yet again
spend tens of thousands of dollars on attorneys and accountants, and
yet again divert precious management time to all of this.
For a larger company, spending tens of thousands of dollars and
many hours of management time is not inconsequential, but it can at
least be spread over tens or hundreds of millions of dollars in sales
and dozens of managers. Not so a smaller company. For them, this would
be a real blow.
The sudden decision by the tax-writing Committees, in the closing
hours of the last session of Congress, to focus on this provision means
that almost none of these affected companies are prepared for this
change. Indeed, the American Institute of Certified Public Accountants
has just finished holding two programs, in Chicago and San Francisco,
advising accountants and companies on how to structure IC-DISC's. (Two
more such programs are planned soon.)
Legal under the WTO. The IC-DISC is qualitatively different from
other forms of business organization by exporters that have been
invalidated by WTO decisions. In the first place, IC-DISC shareholders
pay interest on any deferred taxes. Secondly, the type of taxation and
the tax rates levied on IC-DISC income (dividend income taxation and
rates) are available not only to exporters, but to a broad swath of
U.S. taxpayers. Thus, the IC-DISC has never been challenged, and indeed
the WTO has specifically exempted it from its earlier decisions
affecting DISC's and FSC-ETI. So we see no external reason to tamper
with it.
Would increase taxes. An upward revision in the tax rates on IC-
DISC revenue would affect, at a bare minimum, many hundreds of
companies and many millions of dollars in revenues. This is a tax
increase; there is no other way to view it. Historically, and as a
matter of fairness, Congress has allowed those affected by tax
increases ample opportunity to express their views to their elected
representatives. That process has included the commissioning of
economic studies and the debating of alternatives. It has also included
allowing ample lead time for those affected to plan and adapt.
None of that has occurred in this situation. With no advanced
warning or publicity, a significant tax increase has been proposed for
a whole swath of taxpayers--in the closing moments of a Congressional
session just before an election. It is further proposed that Congress
approve this tax increase a week or two after the election, in a ``lame
duck'' session that may last only a few days. Most of those affected
are small companies who aren't ``plugged in'' to Washington and have no
idea what could be coming their way. This isn't right or fair.
A substantive change. Sometimes, what seems like a modest tweak to
analysts who concentrate closely on the tax code will seem far more
sweeping to those who experience the change. We can understand how the
IC-DISC proposal might seem small to some, and therefore end up in a
``Technical Corrections'' bill. IC-DISC's have grown quietly over a
period of years, and those outside the manufacturing and exporting
communities are probably not that familiar with them. But perhaps more
than any other provision in the ``Tax Technical Corrections'' bill,
this one has far-reaching ramifications. It is truly a substantive
change. It deserves careful deliberation. We ask the Committees to
refrain from acting on this provision until that more careful
deliberation has occurred.
Trade policy considerations. Changing IC-DISC's is not simply a
matter of tax policy. It is also a matter of trade policy. How can the
U.S. best deal with a trade deficit that is rapidly ascending to $1
trillion a year? What needs more emphasis--and less emphasis? Engaging
American small and mid-sized enterprises in international trade would
seem to be a crucial piece of the puzzle. Virtually all of our
country's largest companies are fully globalized, but fewer than 10% of
U.S. companies that have less than one hundred employees export. How
can we address the cost of entry hurdles that keep smaller companies
out of the international marketplace?
How, too, can we address the global price advantage that border-
adjustable taxes give to countries that offer them? Shall we wait years
or decades for an overhaul of the U.S. tax system--as trade deficits
continue rising unimpeded--or shall we do something sooner?
SBEA urges the Committee to take the time to explore these issues
before acting on the IC-DISC proposal.
Regards,
James Morrison
President
______
The Small Business Exporters Association of the United States
SBEA is the nation's oldest and largest nonprofit organization
exclusively representing small and mid-size companies in international
trade. SBEA is proud to serve as the international trade council of the
National Small Business Association, the nation's oldest nonprofit
advocacy organization for small business.
Statement of National Association of Manufacturers
Overview
The National Association of Manufacturers--the nation's largest
industrial trade association--represents large, mid-size and small
manufacturers in every industrial sector and in all 50 states. The
NAM's mission is to enhance the competitiveness of manufacturers by
shaping a legislative and regulatory environment conducive to U.S.
economic growth and to increase understanding among policymakers, the
media and the general public about the vital role of manufacturing to
America's economic future and living standards.
NAM members applaud the efforts of the Committee to promote the
pro-growth tax relief that is critical to the competitiveness of
American manufacturers. Similarly, we appreciate the efforts of the
Committee to advance legislation (H.R. 6264) that makes needed
technical corrections to recent tax relief legislation.
In response to your request for comments on H.R. 6264, the NAM is
extremely concerned about a provision (Section 7) included in the bill
that would change the tax treatment of dividends paid from interest-
charge Domestic International Sales Companies (IC DISCs). If enacted,
this provision would make a substantive change in the current tax code,
resulting in a tax increase on many privately-held manufacturing
companies that export. As H.R. 6264 moves through the legislative
process, we strongly urge you to drop Sec. 7 from the technical
corrections bill.
Background
Continued export growth is critical to addressing our current trade
deficit. While our trade deficit is large--on a seasonally adjusted
basis, the August 2006 deficit in manufactured goods was at an annual
rate of $536 billion--it has stayed at essentially the same range since
January 2006. Export growth is stabilizing the balance. According to
the Commerce Department, August 2006 was the 10th month in a row in
which manufactured goods exports rose more rapidly than imports.
U.S. manufacturers play a major role in U.S. exports, exporting
more than $60 billion in goods every month. In addition, exports from
the United States have increased by 57 percent over the past ten years.
Nonetheless, in order for the manufactured goods trade imbalance to
shrink, it is critical that export growth continue since import value
is about 50 percent larger than manufactured goods exports value.
While manufacturers of all sizes are exporters, the increase in
exports by smaller companies has increased significantly in recent
years. According to the Commerce Department, 97 percent of all
exporting manufacturers have fewer than 500 employers. The NAM has
tracked the exporting experience of smaller manufacturers for more than
a decade. Based on a recent NAM survey, current export activity among
smaller companies has doubled since 2001.
Potential Impact of Tax Law Change
If enacted, the proposed change in the tax treatment of IC-DISCs
likely would have a negative impact on U.S. exports.
Under current tax rules, a U.S. manufacturing company that exports
can set up a small IC-DISC that allows the deferral of taxes on certain
income from export activities, as long as interest is paid on the
deferred tax. In addition, when the income is distributed to
noncorporate shareholders as a dividend, it is taxed at a 15 percent
rate. The amount of deferral is capped at gross annual receipts of $10
million.
The proposed change in the IC-DISC rules would increase taxes for
privately-held companies in the United States that export manufactured
goods, making it more difficult for them to compete in the global
marketplace. Roughly 90% of NAM's small and medium size companies
(SMMs)--generally those with 1,000 or fewer employees--are privately
held and many of these companies are exporters. In a recent survey of
NAM's smaller members, more than two thirds of privately, family or
individually owned companies responding to the survey said that they
export products.
A Substantive Change
While the stated purpose of H.R. 6264 is to ``make Congressional
intent clear regarding crucial components of recent tax legislation,
``Section 7 of the bill goes well beyond a clarification. Specifically
Section 7 would significantly increase the tax rate on dividends paid
by IC-DISCs, a substantive change to existing law, rather than a
``technical correction.''
Conclusion
In sum, the proposed changed to the IC-DISC rules in H.R. 6264
represents a substantive change to current tax law that would have a
negative impact on the ability of some U.S. companies to export. Thank
you in advance for considering our request to remove this anti-growth
provision from the Technical Corrections Act of 2006. The NAM looks
forward to continuing to work with Congress, the Administration and
others to promote progrowth tax relief that encourages broad based
economic growth and U.S. competitiveness.
Extended Stay, Inc.
October 31, 2006
The Honorable William M. Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
The Honorable Charles B. Rangel
Ranking Member
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C. 20515
Dear Chairman Thomas and Ranking Member Rangel:
In response to the Committee's request, dated September 29, 2006,
for comments on the Tax Technical Corrections Act of 2006 (H.R. 6264)
and proposals for additional technical corrections, we respectfully
request that you consider including in the bill a new provision that
would clarify the application of the ``transient basis'' test that is
used to define a ``lodging facility'' in section 856(d)(9)(D)(ii) for
purposes of the real estate investment trust (``REIT'') rules regarding
taxable REIT subsidiaries (``TRS'').\1\
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\1\ Unless otherwise noted herein, all references to ``section''
are to the Internal Revenue Code of 1986, as amended (the ``Code'').
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We are submitting this request on behalf of Extended Stay, Inc.
(``ESI''), which is a hospitality industry REIT with over 600 lodging
properties located across the United States--approximately 550 of which
are owned by ESI and leased to TRSs. As its name suggests, ESI
specializes in a hospitality market segment that consists of longer
term (but nevertheless temporary) occupancies. As discussed more fully
below, a clarification of the TRS transient basis test would address an
area of significant uncertainty for all hospitality industry REITs that
utilize a TRS structure.
Background
To qualify as a REIT, an entity must derive at least 95 percent of
its gross income from sources listed in section 856(c)(2) and at least
75 percent of its gross income from sources listed in section
856(c)(3). Although rents from real property generally are treated as
qualifying income for purposes of these tests, income from providing
hotel accommodations to guests is not treated as qualifying income due
to the service element associated with providing hotel accommodations.
However, the REIT rules provide that a REIT's gross income derived from
a hotel property can be treated as qualifying income if the REIT leases
the hotel property to a third party operator or a TRS (which, in turn,
must contract with a third party to operate the property).
The lease payments from a TRS to the REIT under such an arrangement
are treated as rents from real property (i.e., qualifying income under
the REIT income tests), provided the leased property constitutes a
``lodging facility'' (among other requirements). Section
856(d)(9)(D)(ii) defines a ``lodging facility'' as a ``hotel, motel, or
other establishment more than one-half of the dwelling units in which
are used on a transient basis.'' The term ``transient basis'' is not
defined in section 856 or any regulations thereunder, notwithstanding
the fact that a failure to satisfy the transient basis test could
result in a loss of REIT status.
In the aftermath of Hurricanes Katrina and Rita last year, the
hospitality industry provided (and continues to provide) lodging for
evacuees, employees of displaced businesses, and relief workers for
extended periods of time. To assist hospitality industry REITs in
meeting these critical housing needs without impacting their compliance
with the transient basis test, the Internal Revenue Service (the
``IRS'') issued two notices providing a limited and temporary
clarification of the transient basis test.
The IRS announced in Notice 2005-89, 2005-49 I.R.B. 1077, that, for
purposes of the ``lodging facility'' definition under section
856(d)(9)(D)(ii), it would treat a dwelling unit within a property as
being used on a transient basis if the unit was used to provide shelter
to evacuees, displaced employees or relief workers during the 6-month
period beginning on August 28, 2005 (the date of the President's first
major disaster declaration resulting from Hurricane Katrina). Due to
the magnitude of the damage resulting from Hurricanes Katrina and Rita,
the IRS later extended and modified this guidance with the issuance of
Notice 2006-58, 2006-28, I.R.B. 59. In both Notices, the IRS
acknowledged that ``Section 856 and the regulations thereunder do not
define the term transient basis'.''
Permanent Clarification of the Transient Basis Test
While the IRS Notices provided welcome and needed clarification of
the section 856(d)(9)(D)(ii) transient basis test under extenuating
circumstances, this clarification is only temporary and limited to
occupancies related to Hurricanes Katrina and Rita. As an addition to
the pending technical corrections bill, we respectfully request that
the application of the section 856(d)(9)(D)(ii) transient basis test be
clarified permanently and generally, either by providing a 6-month
quantitative standard for the test (Alternative #1) or by clarifying
that the transient basis test does not apply to properties that are
hotels or motels (Alternative #2).
Alternative #1_Clarify that the transient basis test is applied using a
six (6)-month period.
While other Code sections employ variations of the transient basis
test,\2\ there is no consistent definition of what constitutes a
transient basis. In fact, we are aware of only a few instances in which
such a definition has been provided.\3\
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\2\ For example, under the investment credit recapture rules of
section 50(b)(2)(B), property used for lodging is not eligible for the
credit except for ``property used by a hotel or motel in connection
with the trade or business of furnishing lodging where the predominant
portion of the accommodations is used by transients.'' Another example
of the transient basis test can be found in the accelerated cost
recovery system depreciation rules of section 168. In distinguishing
between an apartment lodging facility, which qualifies as residential
rental property with a 27.5-year recovery period, and a hotel/motel,
which does not qualify as residential rental property (and has a 39-
year recovery period), section 168(e)(2)(A)(i) provides that the term
``residential rental property'' means any building or structure if 80
percent or more of the gross rental income from such building or
structure for the taxable year is rental income from dwelling units.
For this purpose, section 168(e)(2)(A)(ii)(I) provides that the term
``dwelling unit'' means a house or apartment used to provide living
accommodations in a building or structure, but does not include a unit
in a hotel, motel, or other establishment more than one-half of the
units in which are used on a transient basis.
\3\ See, e.g., former Treas. Reg. section 1.167(k)-3(c) and Treas.
Reg. section 1.48-1(h)(2)(ii). These regulations provide (or provided)
that a facility is treated as used on a transient basis if the facility
is used more than 50 percent of the time for occupancies of less than
30 days. Although section 48 itself was repealed in 1990, the Treasury
regulations under section 48 (including Treas. Reg. section 1.48-
1(h)(2)(ii)) have never been removed.
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The term ``transient basis'' is used in section 42(i)(3)(B)(i)
which, for purposes of the low-income housing credit, defines a ``low-
income unit'' as any unit that (among other things) is ``used other
than on a transient basis.'' As is the case with regard to section
856(d)(9)(D)(ii), neither section 42 nor the regulations thereunder
define the term ``transient basis''. However, legislative history
discussing the low-income housing credit indicates that transient basis
use of a unit refers to occupancy periods of less than six months:
``Generally, a unit is considered to be used on a nontransient basis if
the initial lease term is six months or greater.'' H.R. Conf. Rep. No.
99-841, at 4183 (1986).
We believe that the uses of the term ``transient basis'' in the
section 42 low-income housing credit and in the section 856 REIT TRS
rules serve the same purpose. In both cases, the term is intended to
distinguish between property which is used to provide temporary lodging
for guests and property which is used to provide permanent housing for
residents. Therefore, if a quantitative standard is used to clarify the
application of the transient basis test in determining whether property
constitutes a ``lodging facility'' under section 856(d)(9)(D)(ii), we
would suggest using the same 6-month standard that is used in
determining whether a unit is a low-income unit for purposes of the
low-income housing credit. This clarification also would be consistent
with the temporary and limited clarification that was provided in the
IRS Notices relating to Hurricanes Katrina and Rita, which itself
presumably found support from the low-income housing credit for using a
6-month period.
Proposed language--Under Alternative #1, Section 856(d)(9)(D)(ii)
would be amended to read to as follows:
``(ii) LODGING FACILITY.--The term lodging facility' means a hotel,
motel, or other establishment more than one-half of the dwelling units
in which are used by persons who occupy the unit for less than 6
months.'' \4\
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\4\ The proposed language eliminates any reference to the term
``transient basis'' because a quantitative standard would supplant the
need to use the term, thereby avoiding any unintended interpretive
consequences for other Code sections that use the term. A further
refinement to the proposed language also might eliminate the terms
``hotel'' and ``motel'' as surplusage if the transient basis test
applies to all ``establishments'' without regard to whether they are
hotels or motels.
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Alternative #2_Clarify that the transient basis test applies only to
establishments other than hotels and motels.
Beyond the absence of a definition of the term ``transient basis'',
the scope of application of the transient basis test for purposes of
section 856(d)(9)(D)(ii) is unclear with regard to whether the test
even applies to properties that are hotels or motels. The relevant
statutory language of section 856(d)(9)(D)(ii)--``hotel, motel, or
other establishment more than one-half of the dwelling units in which
are used on a transient basis''--could be interpreted as providing that
the transient basis test only applies to ``other establishment[s]'' and
not to hotels or motels, particularly since the terms ``hotel'' and
``motel'' would appear to be surplusage if, instead, the transient
basis test applies to all properties without regard to whether they are
``hotels'', ``motels'' or ``other establishment[s]''.\5\
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\5\ See Lawrence Filson, The Legislative Drafter's Desk Reference,
Congressional Quarterly, Inc. (1993), at 234 (``When setting forth a
series of items in a sentence either in conjunctive or disjunctive
form, the last two items in the series, like the earlier items, should
be separated by a comma. . . . The omission of the final comma in the
series--a common practice in expository writing--sometimes invites the
misreading that the last item is part of the preceding one. . . .'').
---------------------------------------------------------------------------
Such an interpretation does place some definitional pressure on the
terms ``hotel'' and ``motel''. However, these terms are used in several
other Code sections, often without any accompanying definitional
detail.\6\ With regard to whether a property constitutes a ``lodging
facility'' under section 856(d)(9)(D)(ii), we believe that the plain
meaning of these terms is sufficiently clear in the vast majority of
circumstances without the need for further statutory definition. Even
in the handful of cases in which there might be some factual question
concerning whether a particular property constitutes a hotel or motel,
there are certain distinctive features of hotels and motels that can be
identified and an analysis of the property in question performed to
determine whether the property possesses the requisite characteristics
of a hotel or motel.
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\6\ See former section 48(a)(3)(B) and sections 50(b)(2)(B),
168(e)(2)(A)(ii)(I), 179D(f)(2)(C)(i), 280A(f)(1)(B), 1202(e)(3)(E),
and 3121(d)(3)(D).
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For example, hotels and motels may be subject to applicable local
occupancy taxes that do not apply to residential property, and their
sites generally are zoned specifically for use by a hotel or motel. In
addition, the nature of the contractual relationship between the
provider and occupant of the dwelling units in question (i.e., guest
registration versus negotiated lease) may be determinative of this
issue.
While there may be a few isolated situations in which the terms
``hotel'' and ``motel'' by themselves are somewhat ambiguous and pose
some interpretive difficulty, the statutory language of section
856(d)(9)(D)(ii) at least should be more clear about whether properties
that are hotels or motels also must satisfy the transient basis test.
If hotels and motels are required to satisfy the transient basis test,
then we believe that the transient basis test itself needs to be more
clearly defined, as proposed by Alternative #1 above. If not, then we
believe that section 856(d)(9)(D)(ii) needs to be restated to clarify
that the transient basis test applies only to ``other
establishment[s]'' and not to ``hotels'' or ``motels''. The proposed
language below would accomplish this by simply dividing the clause into
separate subclauses.
Proposed language--Section 856(d)(9)(D)(ii) would be amended to
read as follows:
``(ii) LODGING FACILITY.--The term `lodging facility' means--
(I) a hotel or motel, or
(II) any other establishment more than one-half of the dwelling
units in which are used on a transient basis.''
We appreciate your consideration of our request to clarify the
section 856(d)(9)(D)(ii) transient basis test in the pending technical
corrections legislation. We would be happy to meet with you to discuss
this issue further. Please feel free to contact us at (202) 344-4034
(Sam Olchyk) or (202) 344-4406 (Ray Beeman).
Sincerely yours,
Samuel Olchyk
E. Ray Beeman
U.S. Securities Markets Coalition
November 8, 2006
The Honorable William M. Thomas
Chairman
House Committee on Ways & Means
1102 Longworth House Office Building
Washington, DC 20515
The Honorable Charles E. Grassley
Chairman
Senate Committee on Finance
219 Dirksen Senate Office Building
Washington, DC 20515
The Honorable Charles B. Rangel
Ranking Member
House Committee on Ways & Means
1102 Longworth House Office Building
Washington, DC 20515
The Honorable Max S. Baucus
Ranking Member
Senate Committee on Finance
219 Dirksen Senate Office Building
Washington, DC 20515
Gentlemen:
This letter and the attached memorandum set forth the comments of
the U.S. Securities Markets Coalition (the ``Coalition'') regarding the
Tax Technical Corrections Act of 2006 (H.R. 6264 and S. 4026) (the
``Bill''). The members of the Coalition include the American Stock
Exchange, the Boston Options Exchange, the Boston Stock Exchange, the
Chicago Board Options Exchange, the Chicago Stock Exchange, Depository
Trust & Clearing Corporation, the International Securities Exchange,
the NASDAQ Stock Market, the National Stock Exchange, NYSE Arca, the
Options Clearing Corporation, and the Philadelphia Stock Exchange. All
trading in listed equity options in the United States takes place on
exchanges that are members of the Coalition.
The Coalition's comments relate to section 6(c) of the Bill, which
contains amendments to the ``identified straddle'' provisions of Code
section 1092. Those provisions were substantially revised by the
American Jobs Creation Act of 2004 (``AJCA''). The Coalition generally
supports the approach reflected in the proposed amendments and believes
that they will eliminate the uncertainty created by AJCA with respect
to the treatment of losses on positions in identified straddles when
there are no gains on offsetting positions.
There is, however, one aspect of the proposed changes that we
believe warrants further consideration. As explained in the attached
memorandum, the Bill would expand the requirements for making a proper
identification of an identified straddle to include the requirement
that the taxpayer identify which positions in the identified straddle
are offsetting with respect to one another. Under the Bill, this change
would apply retroactively to the effective date of the AJCA provisions.
As explained in the attached memorandum, we question whether this
additional requirement is necessary or appropriate and recommend that
Congress leave to Treasury's regulatory authority the issue of whether
and under what circumstances such additional information would be
useful. In addition, taxpayers could not have known of this new
requirement prior to the introduction of the Bill, and it is highly
likely that many taxpayers, including individuals, did not immediately
become aware of the expanded requirement upon introduction of the Bill.
Accordingly, we suggest that if this amendment is preserved in the
final version of the Bill, its effective date should be tied to the
date the Bill is enacted.
Sincerely yours,
William M. Paul
______
Tax Technical Corrections Act of 2006 (H.R. 6264, S. 4026)
Expanded Identification Requirement for ``Identified Straddles'' Under
Code section 1092(a)(2)
Code Section 1092(a)(2) provides special rules for identified
straddles. These rules were substantially revised by the American Jobs
Creation Act of 2004 (``AJCA''). In order for these special rules to
apply, a taxpayer must identify the straddle as an identified straddle
by the close of the day on which the straddle is acquired (or such
earlier time as Treasury may specify by regulation). Treasury has
authority to specify, by regulations or other guidance, the proper
methods for clearly identifying a straddle as an identified straddle
and for identifying the positions comprising such straddle.\1\
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\1\ See Code Sec. 1092(a)(2)(C).
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Section 6(c)(2) of the Tax Technical Corrections Act of 2006 (the
``Bill'') would expand the identification requirement by requiring
taxpayers not only to identify the positions making up the identified
straddle but also to identify ``the positions in the straddle which are
offsetting with respect [to] other positions in the straddle.'' The
Joint Committee Staff's description of this provision states as
follows:
``Under present law, a straddle is treated as an identified
straddle only if, among other requirements, it is clearly identified on
the taxpayer's records as an identified straddle before the earlier of
(1) the close of the day on which the straddle is acquired, or (2) a
time that the Secretary of the Treasury may prescribe by regulations.
The provision clarifies that for purposes of this identification
requirement, a straddle is clearly identified only if the
identification includes an identification of the positions in the
straddle that are offsetting with respect to other positions in the
straddle. Consequently, taxpayers are required to identify not only the
positions that make up an identified straddle but also which positions
in that identified straddle are offsetting with respect to one
another.'' \2\
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\2\ Joint Committee on Taxation, Description of the Tax Technical
Corrections Act of 2006 (JCX-48-06) at 9-10.
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This change, as well as the other changes that the Bill would make
to Code section 1092(a)(2), would take effect as if included in
AJCA.\3\
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\3\ See section 6(d) of the Bill.
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The U.S. Securities Markets Coalition (the ``Coalition'') questions
whether this additional requirement is necessary or appropriate. In the
vast majority of straddles, it will be evident which positions in the
identified straddle are ``long'' positions and which positions are
``short'' positions. This will certainly be true for identified
straddles that consist of stock and options with respect to such stock.
For example, if a taxpayer identifies 1,000 shares of stock and put
options on those shares as an identified straddle, it is perfectly
clear that the put options are offsetting positions to the stock.
Treating identification of such an identified straddle as invalid for
failure to state expressly that the put options offset the stock will
needlessly cause a taxpayer who inadvertently omits such a statement to
be subject to the general loss deferral rule of section 1092(a)(1).\4\
Accordingly, the Coalition recommends that any rules along these lines
be left to Treasury regulations. Such regulations could, for example,
describe some subset of identified straddles with respect to which
imposing the additional requirement would result in providing the
Internal Revenue Service with useful information.
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\4\ Alternatively, there may be uncertainty as to whether section
1092(a)(2) would nevertheless apply to such a straddle. Under section
1092(a)(2), Treasury has authority to specify the rules for applying
section 1092 to taxpayers who fail to comply with the identification
requirements. Until Treasury exercises that authority, taxpayers who
fail to satisfy the proposed new requirement might be in a position to
whipsaw the government.
---------------------------------------------------------------------------
We also note that the requirement that taxpayers identify which
positions in the identified straddle are offsetting with respect to one
another is a new requirement that taxpayers could not have been aware
of or anticipated prior to the introduction of the Bill. While the
introduction of the Bill may be viewed as putting taxpayers on notice
of the new requirement, as a practical matter many taxpayers, including
individuals, who are likely to avail themselves of the identified
straddle rules would not immediately become aware of the requirement on
September 29, 2006, the day the Bill was introduced. Accordingly, if
the new requirement is retained in the final version of the Bill, the
Coalition recommends that it not apply with respect to identified
straddles entered into before the date the Bill is enacted.
We recognize that technical corrections typically have the same
effective date as the provisions they amend. However, that is not
always the case. For example, section 7 of the Bill would amend the
2003 legislation relating to ``qualified dividend income'' eligible for
the 15% rate by excluding certain dividends paid by a DISC or former
DISC. This change would apply to dividends received on or after
September 29, 2006, the date the Bill was introduced. In addition, the
change made by section 5(d)(3) of the Bill, relating to certain 2005
amendments to the LUST tax provisions, would apply to fuel sold after
the date the Bill is enacted. Similar examples of delayed effective
dates for technical corrections can be found in prior technical
corrections legislation.\5\ Thus, while there is a presumption that the
effective date of a technical correction should relate back to the
effective date of the provision being amended, a later effective date
may appropriately be adopted where, as here, there is reason to do so.
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\5\ See, e.g., Tax Technical Corrections Act of 2005, enacted as
part of the Gulf Opportunity Zone Act of 2005, Sec. 402(m)(3).
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LI-COR, Inc.
October 31, 2006
To Whom It May Concern:
I am writing with respect to Section 7. of H.R. 6264 and companion
S. 4026--Tax Technical Corrections Act of 2006.
I am VERY confused. After decades of doing continual battle with
World Trade Organization accusations of unfair trade practices and
multiple varieties of legislation (DISC, FSC, ETI, etc.) enacted in a
conscientious effort to appease the WTO and yet encourage export
activities, we have finally found a vehicle, the IC-DISC, which serves
the purpose and is also apparently acceptable to the WTO. And what do
we do? Potentially ``shoot ourselves in the foot'' by introducing the
above referenced legislation!
At $35 million of Sales (70% export) and 230 employees, LI-COR is
not a major player in world economic markets. But I do believe
companies our size and legions of even smaller companies do
collectively comprise an extremely large constituency for whom export
tax incentives DO make a difference. We established a DISC back in the
early 1980's and have taken advantage of this legislation and
successors since that time. It has meant hundreds of thousands of
``incremental'' investment dollars available, by virtue of reduced
taxes, that has financed the growth LI-COR has experienced and
therefore has been plowed right back into our local and national
economies. In the economic circle, this reinvestment of tax-saved
dollars has, of course, resulted ultimately in substantially increased
tax dollars coming back to numerous government units as a consequence
of higher employment levels, goods and services purchased, etc. etc.
There are a variety of legislative measures Congress could consider
to continue encouraging export activities. I'm sure the appropriate
legislative parties are aware of all of them and I am confident they
will all be given due consideration. At the same time and particularly
since the impetuous behind the above referenced legislation did not
come from external sources (i.e. the WTO), it seems perfectly
reasonable that current law remain in effect as is, including the 15%
tax rate on IC-DISC dividend distributions.
If this country is to remain competitive in the world marketplace,
it is IMPERATIVE export incentives be preserved. And it is cumbersome
and problematic in a variety of ways to us as ``the players'' to
continually be changing the playing field. Fair and reasonable
legislation needs to be in place and it needs to be consistent in
application from year to year. Significant plans are built around
existing tax legislation at any point in time, and it is one thing to
``tweek' things but it is an entirely different matter to alter
fundamental structure!
Thank you for your consideration, and I urge you in the STRONGEST
terms to reconsider the ramifications of Section 7. of H.R. 6264 and
companion S. 4026 as it currently stands. Please remove this
``correction'' from the Bill in its entirety so that the full
ramifications of any potential changes can be properly and thoughtfully
considered at a more appropriate and later date.
Respectfully,
Gordon Quitmeyer
Treasurer
Statement of Real Estate Roundtable
Section by Section Analysis
1. Section 470(e)(1) and (4)(B)--General Exceptions and All-Or-Nothing
Tax-Exempt Use Property Rule
Bill Language
Section 470(e)(1)_
``(1) IN GENERAL.--In the case of any property which would (but for
this subsection) be tax-exempt use property solely by reason of section
168(h)(6), such property shall not be treated as tax-exempt use
property for purposes of this section for any taxable year of the
partnership if--
(A) such property is not property of a character subject to the
allowance for depreciation,
(B) any credit is allowable under section 42 or 47 with respect to
such property, or
(C) except as provided in regulations prescribed by the Secretary
under subsection (h)(4), the requirements of paragraphs (2) and (3) are
met with respect to such property for such taxable year.''
Section 470(e)(4)_
``(B) by treating the entire property as tax-exempt use property if
any portion of such property is treated as tax-exempt use property by
reason of paragraph (6) thereof.''
Commentary
We interpret revised section 470(e)(4)(B) to mean that, if a
partnership's interests are owned even a de minimis amount by a tax-
exempt partner, then all partnership section 470 losses would be
subject to 470 limits if the partnership cannot satisfy an applicable
exception, not just the losses attributable to the tax-exempt partner's
share. This fundamentally alters the application of section 168(h)(6),
which otherwise limits losses based on the proportional interest of the
tax-exempt partner. We believe strongly that this change does not
constitute a technical correction. While Congress may not have fully
appreciated the breadth of section 168(h)(6) when it incorporated those
rules into section 470 in 2004, Congress did understand how section
168(h)(6) operates--and would operate within the context of section
470--particularly with regard to its more visible features such as the
proportionate disallowance rule. Therefore, we respectfully submit that
the change reflected in revised section 470(e)(4)(B) represents a
substantive change to section 470 and that would be wholly
inappropriate for inclusion in technical corrections legislation.
We also believe that revised section 470(e)(4)(B) is ill-advised.
The legislation goes well beyond what is necessary to defeat SILO
transactions and any variants involving partnership structures. Given
the series of technical--and, in many places, vague--rules that
partnerships must satisfy under the legislation in order to maintain
loss allowance, a foot fault under these rules does not justify
complete loss disallowance, particularly where there might be only de
minimis tax-exempt participation. We consider this an overreach
inconsistent with section 168(h)(6) and the intent of Congress in
enacting Section 470.
This provision also may not be in the government's own interest.
Section 470 operates by storing up deferred losses which are then
released when the tax-exempt partner sells its interest to a taxable
partner. The greater the amount of losses that are deferred, the
greater the income sheltering potential upon sale.
Also, one hallmark of a SILO transaction is the fact that the
taxpayer/lessor is insulated from the economic risk associated with
true ownership of the property. A SILO is nothing more than a title
flipping arrangement between taxable and tax-exempt entities for
purposes of transferring tax benefits. The taxable party's investment,
plus a pre-determined rate of return, is virtually guaranteed by the
terms of the lease and side agreement terms. The tax-exempt entity is
economically compelled to re-purchase the property and sets aside the
funds to ensure its ability to do so. The proposed language in section
470(e)(2) and (3) addresses only the set aside part of the SILO
arrangement. We believe the economic risk side of the arrangement is
equally relevant and should also be used in testing whether a
partnership should be subject to section 470. If the taxable partner
has economic risk with respect to its interest, the partnership is not
being used to replicate a SILO and should not be subject to the
application of section 470. An exception based on the taxable partner
having economic risk would be consistent with the objectives of section
470(d) (i.e., the exception for ``legitimate'' leases).
Further, a clear, objective, and easily administrable way to remove
a segment of real estate partnerships that are not engaged in, or being
used to replicate, SILOs from the inappropriate application of section
470 is to define qualified allocations by reference to the ``fractions
rule.'' A partnership that complies with the fractions rule cannot be
used to replicate a SILO. Therefore, we strongly believe that using the
fractions rule as the touchstone for determining if a partnership's
allocations are qualified cannot have any impact on the revenue score
associated with the proposal or with the proposal's classification as a
technical correction. Further, a reference to the fractions rule could
be ``updated'' to the extent any future legislation modifies that rule.
Thus, although the fractions rule is not perfect, we are unaware of any
tenable reason why it should not be used in defining qualified
allocations, particularly given that the use of such rule would provide
thousands of legitimate real estate partnerships with certainty that
they are not subject to section 470.
Finally, it is not clear whether the exception for non-depreciable
property applies to non-amortizable property. While the bill language
only refers to non-depreciable property, the Joint Committee on
Taxation (``JCT'') description of the bill (JCX-48-06) refers to both
non-depreciable and non-amortizable property as being covered by the
exception. We see no reason why non-amortizable property should not be
excluded as well from the application of section 470.
Recommendation
(i) Apply Section 470 only to losses attributable to the tax-exempt
partner(s) interest(s) in the partnership.
(ii) Add an ``Economic Risk'' test as a fourth (mutually exclusive)
exception. For example: ``(D) each taxable partner has economic risk
with respect to its partnership interest, as evidenced by the
investment having a meaningful probability that the after-tax internal
rate of return to the taxable partner could vary by at least a pre-
defined and reasonable range.'' We have suggested in the prior meetings
a range of 300 basis points of the projected partnership returns as
represented by the partnership sponsor. We encourage that this, or a
similar approach, be adopted.
(iii) A carve-out is necessary for ``pure'' preferred interests.
Such preferred interests often will not provide for significant
economic risk evidenced by a projected variable return. At the same
time, such interests will not present the opportunity for producing
SILO-like results, since the interests will not provide for loss
allocations, except in situations where the partnership has experienced
losses at a level that have caused the elimination of the capital of
all other partners.
(iv) Clarify that non-amortizable assets are not subject to section
470.
(v) Provide that, for purposes of section 470, section 168(h)(6)(A)
shall be applied by disregarding section 168(h)(6)(B) and instead
treating an allocation as a ``qualified allocation'' if it satisfies
the rules of section 514(c)(9)(E). All tax-exempt partners would
qualify for this allocation treatment. The definition of ``qualified
organization'' in section 514(c)(9)(C) would not apply for purposes of
section 470. [See comments above].
2. Section 470(e)(2)(A) and (C)--The ``Arrangement and Set Aside''
Requirement.
Bill Language
Section 470(e)(2)(A) subjects to section 470 loss limits an
arrangement or set aside:
(i) to or for the benefit of any taxable partner of the partnership
or any lender, or
(ii) to or for the benefit of any tax-exempt partner to satisfy any
obligation of the tax-exempt to the partnership, any taxable partner,
or any lender.
Section 470(e)(2)(C) provides that an arrangement includes a loan
by a tax-exempt partner or the partnership to any taxable partner, the
partnership, or any lender. (Technically, these concepts should be
broken apart, as there cannot be a loan by the partnership to the
partnership.)
Commentary
While the comprehensive scope of the ``benefit of any lender'' rule
may be appropriate for leasing transactions, we believe that it needs
to be narrowed and tailored as applied to partnerships. Implicit in the
existing rule for leases is the notion that such an arrangement or set
aside is designed to eliminate or significantly mitigate the economic
risk of the beneficiary of the arrangement or set aside. Because not
all arrangements or set asides in the partnership context are intended
to eliminate or reduce the economic risk of taxable partners, we
believe that the rule for partnerships and their partners should be
limited explicitly to arrangements or set asides that do, in fact,
reduce or eliminate the economic risk of the beneficiaries (perhaps in
lieu of our recommendation above regarding a fourth general exception
from section 470 and/or the economic relationship test in the bill
language discussed below).
For example, without such a limitation the rule effectively would
prevent partnerships from defeasing loans that may not be prepaid. Many
commercial real estate loans are put into conduits, such as REMICs.
These loans may not be pre-paid because doing so would frustrate the
expected return to conduit investors. A partnership interested in
selling the property subject to the conduit loan must defease the
collateral with U.S. securities expected to provide a similar cash flow
as the property. In this regard, the ``benefit of any lender'' language
would put partnerships at a significant economic disadvantage vis-a-vis
other entities.
Also, loans by a tax-exempt partner to the partnership could be
very common. If a partnership encounters economic difficulty, it is not
at all unusual for partners to begin funding operations through debt
rather than equity in order to preserve claims for repayment vis-a-vis
other creditors. Letters of credit, etc. are used to support guarantee
obligations of tax-exempt partners with respect to partnership debt.
Credit support arrangements are used to fund capital calls. Also,
partnerships sometimes borrow money relying on the credit of the tax-
exempt partner.
More generally, advancing funds to a partnership through a
combination of debt and equity is very common. In addition, loans by a
partnership to taxable partners are quite common. Also, tax-exempts may
loan money to employee/service providers to acquire interests in a
partnership. As another example, management companies often lend money
to managers to allow the managers to acquire interests as a means of
incentive-based compensation.
Partner to partner loans also come into play where there is a
default on a capital contribution obligation. Where one partner fails
to fund a capital call, another partner can contribute for that
partner, with the operative documents considering the advance to be a
loan between the partners. As is explained below, the proposed language
appears to have ``zero tolerance'' for such an arrangement, even though
the arrangement has nothing to do with a SILO.
Finally, we would note that the application of section 470 would
not be limited only to those taxable partners which are the
beneficiaries of an arrangement or set aside, so we would be interested
in better understanding how the Government anticipates applying section
470 to a particular taxable partner on the basis of a loan among other
partners--of which the taxable partner may not even be aware.
Recommendations
(i) Problems created by the proposed language relative to partner
loans causing legitimate arrangements to be covered could be alleviated
to some extent by limiting the language to arrangements or set asides
that reduce or eliminate economic risk of their beneficiaries or,
similarly, by adopting the ``Economic Risk'' exception discussed above
(and the other modifications discussed below).
(ii) We understand that that lender arrangements and set asides are
included as types of defeasance in section 470(d) primarily to prevent
loans to lessors that will be either (1) forgiven or (2) satisfied
through payment by the lessee to the lender. If this is correct, then
the partnership rule for lender arrangements and set asides should be
narrowed so as to only capture situations where the loan arrangement is
intended to serve as a device to ensure the return of the taxable
partner's investment in the partnership (e.g., repayment of a loan to a
taxable partner is contingent upon the return of the partner's
investment).
3. Section 470(e)(2)(B)--Allowable Partnership Amount.
Bill Language
``Allowable partnership amount'' is defined to be the greater of:
(i) (a) the sum of 20 percent of the sum of the taxable partners'
capital accounts, plus
(b) 20 percent of the sum of the taxable partners' share of
recourse liabilities of the partnership, or
(ii) 20 percent of the aggregate debt of the partnership.
Commentary
Given the breadth of arrangements and set asides that would be
subject to section 470, the allowable partnership amount clearly should
be higher than 20%, although it really is somewhat doubtful that any
amount will be sufficient to adequately exempt non-abusive
partnerships. The need for a higher allowable amount is particularly
acute when a partnership is in the liquidation phase. In the
liquidation phase, which can take a year or more depending on market
conditions, the last sale or last few sales realistically may put a
partnership over the 20% threshold (e.g., last asset is worth $100;
sell it and hold proceeds for distribution; the $100 awaiting
distribution is above the 20% threshold). This problem is made even
more acute by the fact that, when in the liquidation phase, a
partnership may not be able to take advantage of the 12-month rule
(described below) due to the continuing sales and holding of cash.
Furthermore, the 20% threshold by reference to taxable partners'
capital accounts and recourse debt share may not give much help where a
partnership has de minimis taxable partners participating, especially
in light of the fact that revised section 470(e)(4)(B) (discussed
above) would eliminate the section 168(h)(6) proportionate disallowance
rule. A partnership with minimal participation by taxable partners is
not an unusual arrangement. In numerous investment partnerships, the
tax-exempt partner(s) provide(s) the overwhelming amount of the
capital. They are the ``finance'' partners. The taxable partner is
often the real estate company sponsor that is putting in some capital
along side the tax-exempt but its primary contribution is its real
estate management, development, and investment expertise.
The alternative allowable amount of 20% of aggregate partnership
debt also will not give much help where partnership is not highly
leveraged. This is a particularly likely scenario in liquidation phase
when debt is being paid off.
Recommendations
(i) The allowable amount should be increased to at least 50
percent. Most SILO arrangements had defeasance levels for taxable
partners of nearly 100 percent. The 50 percent threshold further makes
sense since section 470(d) already permits the Treasury Secretary to
increase the threshold to 50% for leases under certain circumstances.
(ii) Section 470 should not apply when a partnership is in the
liquidation phase, perhaps pursuant to a plan of liquidation. There is
little, if any, opportunity to transfer tax benefits and defease a
taxable partner's risk in this relatively short period. Moreover, any
deferred losses likely will be released in any case during liquidation
upon disposition of the tax-exempt use property (see present-law
section 470(e)(2)).
(iii) Similarly, Section 470 should not apply to funds in escrow or
otherwise held due to litigation.
(iv) Another allowable amount standard should be the aggregate at
risk amounts of the partners as determined under Section 465 since this
represents the amount of economic risk the partners have invested. At-
risk amounts under Section 465 are cash, basis of property contributed,
recourse debt and qualified non-recourse financing.
4. Section 470(e)(2)(B)(iii)--No Allowable Partnership Amount for
Arrangements Outside the Partnership.
Bill Language
This section provides that the allowable partnership amount shall
be zero with respect to any set aside or arrangement under which any of
the funds referred to in subparagraph (A) are not partnership property.
Commentary
Given the broad definition of arrangement, the absolute prohibition
on arrangements and set asides outside the partnership will sweep many
partnerships, not just the involved partners, into Section 470 with
absolutely no means of relief. A common example of outside defeasance
would be a situation in which an employer loans an employee money to
buy a partnership interest in a fund sponsored by the employer and the
employee puts up a letter of credit as part of the repayment terms.
As another example, if a partner guarantees partnership debt, the
lender often may require that partner to post collateral to secure the
loan in a manner that constitutes an impermissible arrangement; given
the absolute prohibition on defeasance outside the partnership, this
legitimate arrangement would cause the partnership to fall outside the
scope of the exception and to be subject to section 470 with respect to
depreciable property. Further, as was mentioned above, legitimate loans
among partners and between partners and partnerships also could cause
partnerships to fall outside the scope of the exception.
Again, since the application of section 470 would not be limited
only to those taxable partners which are the beneficiaries of an
arrangement or set aside, we would be interested in better
understanding how the Government anticipates applying section 470 to a
taxable partner on the basis of transactions among other partners--of
which the taxable partner may not even be aware--particularly in light
of the absolute prohibition against arrangements outside the
partnership.
Recommendation
Outside partnership defeasance should be allowed the same relief
allowed inside partnership defeasance. We are not aware of any reason
why outside partnership defeasance is more pernicious than inside
partnership defeasance such that no allowable amount of defeasance
should be permitted, particularly with the heightened potential that
section 470 could apply to taxable partners who simply are unaware of
arrangements that might exist among other partners and that are
unrelated to the partnership.
5. Section 470(e)(2)(D)(i)--Exception for Short Term Funds
Bill Language
This provision provides that funds which are set aside, or subject
to any arrangement, for a period of less than 12 months shall not be
taken into account under subparagraph (A). Except as provided by the
Secretary, all related set asides and arrangements shall be treated as
1 arrangement. The JCT description of the bill states that a series of
multiple set asides or arrangements which combine to exceed the 12-
month threshold will not be eligible for the exception. It goes on to
say that the exception should not be interpreted to permit taxpayers to
effectively extend the 12-month threshold by use of separate and
fungible set asides or arrangements.
Commentary
While we welcome any safe harbor relief from the application of
section 470, the exception for short-term funds raises several
interpretive and operational questions that create doubts as to its
usefulness to non-abusive partnerships. For instance, what does the
term ``related'' mean in this context? Cash and certain types of
securities are completely fungible. Would the following example be
considered a related multiple set aside which combines to exceed the 12
month threshold?
Partnership sells a non-leveraged asset for $100 and holds the
proceeds in the partnership's bank account for 90 days before
distributing them. On day 60, the partnership sells another non-
leveraged asset for $200 and holds the proceeds in the same account
until they are distributed 11 months later. It's clear that the sale
proceeds from each of the two sales, if viewed completely separately,
are distributed within the allotted 12 months. But, is the intention of
this language such that the $100 of proceeds from the first sale
actually is considered set aside for 13 months since there is at least
$100 in the partnership bank account for that period?
If this interpretation is correct, partnerships that are frequently
selling property and distributing proceeds will be left to rely solely
on the allowable amount for relief. When a partnership hits liquidation
phase, the problem is exacerbated as properties will be sold on a
continuous basis.
Recommendations
(i) The term ``related'' needs to be clarified beyond the
discussion in the JCT description of the bill.
(ii) At a minimum, funds held by the partnership should be deemed
not to be set aside once the partnership has adopted a plan of
liquidation, with some reasonable period of time, such as two years,
allowed for the partnership to carry out its liquidation.
6. Section 470(e)(2)(D)(ii)--Economic Relationship Test
Bill Language
The provision provides an exception for funds subject to an
arrangement, or set aside or expected to be set aside, that bear no
connection to the economic relationships between and among the partners
and that bear no connection to the economic relationships between the
partners and the partnership. Any funds that bear a connection either
to the economic relationship between two or more partners or to the
economic relationship between the partnership and any partner do not
meet the exception and must be taken into account.
Commentary
Again, while we welcome any efforts to narrow the application of
section 470 with regard to non-abusive partnerships, it is unclear what
this provision means. We understand that this provision may have been
included given that the bill does not designate who can (or cannot) set
aside funds or be subject to an arrangement to or for the benefit of a
partner, the partnership, or any lender. Nonetheless, the ``no
connection'' language could be interpreted in a very restrictive manner
such that it would not apply in certain common situations in which
parties may have some relationships, but not of a nature that could
give rise to SILO concerns.
For example, a taxable and tax-exempt party may be partners in one
partnership, with the tax-exempt partner lending funds to the taxable
partner in a wholly different context. Although the loan has nothing to
do with the joint investment of the parties in the partnership, the
loan does bear a clear connection to the economic relationship of the
taxable partner and tax-exempt partner.
Recommendation
This provision is in need of elaboration, which we hope would
clarify that it exempts from the application of section 470
arrangements and set asides that do not, in a real and substantial way,
affect the relationships of the relevant parties in a capacity that
relates to the partnership being analyzed under section 470. Also, the
provision needs to explain how lenders are taken into account--for
example, by clarifying that arrangements or set asides with respect to
lenders are only taken into account where such arrangements affect the
economic relationships among the partners or among the partners and the
partnership.
We believe that the recommendation provided above (with regard to
section 470(e)(2)(A) and (C)--the ``arrangement and set aside''
requirement) to limit the definition of defeasance to arrangements or
set asides that reduce or eliminate the risk of loss for the
beneficiaries of such arrangements or set asides would largely remove
the need for the ``no economic connection'' exception. The
recommendation also would provide a much clearer and more useful
expression of the underlying principle of section 470 as it applies to
partnerships.
7. Section 470(e)(2)(D)(iii)--Reasonable Person Standard
Proposed Language
For purposes of subparagraph (A)(ii), funds shall be treated as set
aside or expected to be set aside only if a reasonable person would
conclude, based on the facts and circumstances, that such funds are set
aside or expected to be set aside.
Commentary
In a SILO transaction, any amount set aside would seem to be for
the purpose of defeasing the taxable lessor. There are not many reasons
in a lease arrangement to set aside cash other than to protect the
economic interest of the lessor. In reality, the reasonable person test
most likely was not envisioned by lawmakers to be applied in the lease
context since Section 470 was designed as a deterrent to SILO
transactions. In the partnership context, however, Section 470 is an
operational statute. Further, given the nature of a partnership, all
funds are held for the benefit of those with an economic stake in the
venture, including lenders and partners. Presumably, the ``reasonable
person'' standard was intended to identify only a subset of partnership
funds that are segregated and are not available for general use in
connection with the business of the partnership.
Therefore, the reasonable person test needs definition so it can be
applied with greater certainty. Further, consideration needs to be
given as to how partnerships could establish with certainty the
purposes for which funds are set aside in a manner that is not
overwhelmingly administratively burdensome, given fungible money and
tracing concerns.
Recommendation
We recommend limiting the application of defeasance to ``set asides
that a reasonable person would conclude, based on facts and
circumstances, are made to provide distributions to the taxable
partner, (or payment to a lender who has advanced funds in an
arrangement designed to support return of the taxable partner's
investment), so as to reduce the partner's economic risk of loss.''
This would tie in with the Economic Risk test discussed above. Further,
given the subjectivity that always will be inherent in a ``no set
aside'' requirement, using the fractions rule to measure whether
allocations are qualified at least would provide an objective means by
which real estate partnerships could be certain that section 470 is not
applicable.
8. Section 470(e)(3)(A)--Option to Purchase.
Bill Language
(A). In General. The requirement of this paragraph is met for any
taxable year with respect to any property owned by the partnership if
(at all times during such taxable year)--
i. Each tax-exempt partner does not have an option to purchase (or
compel distribution of) such property at other than fair market value.
ii. Each tax-exempt does not have an option to purchase any direct
or indirect interest in the partnership at other than fair market
value.
iii. Each taxable partner does not have an option to sell (or
compel distribution of) such property to a tax-exempt partner at other
than fair market value.
iv. Each taxable partner does not have an option to sell a direct
or indirect interest in the partnership to a tax-exempt partner at
other than fair market value.
v. The partnership does not have an option to sell (or compel
distribution of) such property to a tax-exempt partner at other than
fair market value.
vi. The partnership does not have an option to sell a direct or
indirect interest in the partnership to a tax-exempt partner at other
than fair market value.
Commentary
The bill language above is dissected into the transactions between
the parties and properties described in this portion of the bill: We
find the transaction described in (iii) to be confusing.
With respect to (iii), the taxable partner does not own the
property held by the partnership and thus seemingly could not be under
any obligation to transfer such property to a tax-exempt partner. If
there is a concern about a tax-exempt partner taking a distribution of
property and then selling such property, that series of transactions
should be specifically described.
Regarding the tax-exempt partner's option to purchase property at
fair market value, the statute only addresses fair market value with
respect to the partnership property. Presumably, the Government also is
concerned that the credit given to the tax-exempt partner for the
interest that is redeemed reflects the fair market value of that
interest. This raises the difficult issue of how one determines the
fair market value of a partnership interest. Taxpayers and the
Government have wrestled with this issue in the past. In the proposed
regulations regarding ``partnership interests for services,'' the IRS
decided to allow taxpayers to choose between liquidation value and a
``willing buyer--willing seller'' approach.
Also, would there be a difference in the measurement of fair market
value with respect to the partnership interest where a partner is
receiving a distribution of property from the partnership (i.e., the
regulations under section 704(b) generally look for such distributions
to be in accordance with positive capital accounts) as compared to when
one partner is selling its interest to another partner (i.e., such
transactions generally take into account factors such as control in
management, liquidity of the investment, etc., and rarely focus on
positive capital accounts in determining the purchase price)? Such a
disparity in analysis seems difficult to justify, although something
would have to be done to bridge the gap between these two situations.
Non-fair market value options in the context of employee/service
provider interests present another issue. Partnership agreements often
allow the partnership to reacquire a partnership interest when a
service provider partner leaves for the amount paid for the interest,
book value, or some other amount that does not reflect fair market
value. This is meant to establish a penalty element for leaving the
employ of the sponsor. This is not addressed in the proposed language.
An exception should be provided for these re-acquisitions.
In general, note that it may not be economically feasible for
partnerships to renegotiate existing option agreements with employees
and option holders in order to ``satisfy'' the bill's exception,
particularly given the leverage of the option holder and changes in
economic circumstances since the option was put in place. This raises
effective date concerns, discussed below.
9. Section 470(e)(3)(B)--Option For Determination of Fair Market Value
Bill Language
Under regulations prescribed by the Secretary, a value of property
determined on the basis of a formula shall be treated for purposes of
subparagraph (A) as the fair market value of such property if such
value is determined on the basis of objective criteria that are
reasonably designed to approximate the fair market value of such
property at the time of the purchase, sale, or distribution, as the
case may be.
Commentary
The statute appears to only grant regulatory authority. There are
numerous purchase and sale options in partnerships based on formulas
designed to approximate fair market value. These partnerships are
operational now and cannot wait for regulations to be issued.
Additionally, there are numerous types of arrangements designed to
approximate fair market value that are not based on an objective
criteria formula. An example of one such arrangement is where one
partner can name a price to buy another partner's interest. The offeree
can accept or has a right to buy the offering party out at the offered
price. This method of determining sales price seemingly would
approximate fair market value, but the interest is not being offered to
the broader public, so one cannot be sure. The price determination is
not made pursuant to a ``formula'', and it may not even meet the
``objective criteria'' requirement since, it is a proffer, not a
criterion. There clearly is substance though, given that the offering
partner presumably is not going to offer to buy out the other partner
for an amount that they are not willing to accept themselves.
Finally, a right of first refusal arrangement at a named price is
not really formula based, although it seemingly should achieve a fair
market value price. No appraisal would be undertaken but you would have
a willing buyer-seller situation.
Recommendations:
(i) Statutory guidance should be provided, not merely regulatory
authority.
(ii) Statutory language and regulatory authority should provide for
a formula or arrangement that is designed to approximate current fair
market value at the time of option exercise. The language ``determined
on the basis of objective criteria that are'' should be deleted since
not every arrangement is, or must be, based on objective criteria in
order to achieve fair market value
(iii) Where the price for the interest or partnership property is
determined by reference to a bona fide offer from an unrelated third
party bargaining at arms' length or on the basis of adverse interests,
such price should be conclusively presumed to represent fair market
value.
10. Section 470(g)(5)--Tax-Exempt Partner Definition
Proposed Language
The term `tax-exempt partner' means, with respect to any
partnership, any partner of such partnership which is a tax-exempt
entity within the meaning of section 168(h)(6).
Commentary
The definition of tax-exempt entity under section 168(h)(6)
provides in (F)(1) that a tax-exempt controlled entity shall be treated
as a tax-exempt entity. As a result, a tax-exempt partner cannot
relieve a partnership from section 470 by owning its interest through a
taxable ``blocker'' corporation and thereby agreeing to fully subject
itself to tax. A blocker corporation is often used to ensure that the
tax-exempt does not incur UBTI.
We believe that this is a substantive change to section 168(h)(6)
and not a technical correction. Congress did not address, or express an
intention to address, the operation of section 168(h)(6) when it
enacted section 470.
Recommendation
An exception should be included in the proposed definition of tax-
exempt entity to exclude tax-exempt controlled entities.
11. Section 470(h)(C)(3)--Tiered and Other Partnership Regulatory
Authority--
Proposed Language
The language grants regulatory authority to ``provide for the
application of this section to tiered and other related partnerships.''
Commentary
A large number of partnerships are part of tiered structures. Clear
and comprehensive tiered partnership rules are necessary given the
broad reach of the proposed statute before section 470 is applied to
defer losses of any partnership by reason of section 168(h)(6).
Otherwise, it will be extremely difficult, if not impossible, to apply
section 470 in the context of tiered partnerships or even to figure out
whether or not section 470 applies to an entity in a tiered structure.
Is it correct to presume that arrangements and set asides anywhere in
the tiered structure will give rise to application of section 470? If
not, will section 470 apply only to the partnership(s) in the tiered
structure that have taxable and tax-exempt partners?
How is the 20% allowable amount rule applied in a tiered
arrangement? Is an arrangement or set aside in existence at any level
other than the level at which property subject to section 470 is held
treated as ``inside'' defeasance (with the 20% allowable amount rule
available) or ``outside'' defeasance'' (with no allowable amount rule
available)?
Also, as discussed earlier, options moving property or partnership
interests up one or more tiers may not be considered fair market value
and thus could give rise to application of section 470. It seems like
it would only be a problem if the property is moving in a way that tax-
exempt participation is increasing. But, how is this determination made
if the ultimate make-up of the most upper-tier partners is unknown? How
do lower-tier partnerships report out on K-1s when they do not know
what is going on above them? Does this create the same situation that
existed with respect to section 199 where every partnership arguably
had to report relevant information for section 199 on the off-chance
that a partner might want to take advantage of section 199?
Recommendation
There are no easy answers to questions dealing with how to apply
Section 470 in the context of tiered partnerships. Nonetheless,
taxpayers are entitled to arrange their business affairs in a manner
such that tax results accompanying such affairs are reasonably
determinable. The tiered partnership rules would be of much less
concern if an exception to section 470 were adopted which could be
readily applied at the partnership level where the property that is
subject to section 470 is held.
We, along with numerous other groups representing a variety of
industries, have previously endorsed a regime that would except
property from section 470 so long as a tax-exempt partner does not use
or have operational control with respect to property held by the
partnership. We continue to believe that, in the vast majority of
cases, this rule provides a sound indicator of partnerships that might
engage in a SILO-like transaction. This rule also has the benefit of
applying by reference to information that would be available at the
level of the partnership that holds property subject to section 470. We
respectfully urge reconsideration of this approach, even if the
approach is utilized in the context of less than all property classes
that might be held by a partnership.
10. Section 470(b)(C)(4)--Regulatory Catch All Authority
Proposed Language
The proposed language grants regulatory authority to provide for
the treatment of partnership property (other than property described in
subsection (e)(1)(A)) as tax-exempt use property if such property is
used in an arrangement which is inconsistent with the purposes of this
section determined by taking into account one or more of the following
factors:
(A) A tax-exempt partner maintains physical possession or control
or holds the benefits and burdens of ownership with respect to
suchproperty.
(B) There is insignificant equity investment in such property by
any taxable partner.
(C) The transfer of such property to the partnership does not
result in a change in useof such property.
(D) Such property is necessary for the provision of government
services.
(E) The deductions for depreciation with respect to such property
are allocated disproportionately to one or more taxable partners
relative to such partner's risk of loss with respect to such property
or to such partner's allocation of other partnership items.
(F) Such other factors as the Secretary may determine.
Commentary
This grant of regulatory is unacceptably broad and vague. Further,
only ``one or more'' of the factors may be all that is required. Items
(B), the insignificant equity for taxable partners factor and (E), the
disproportionate allocations of depreciation to taxable partners
relative to risk of loss factor, are extremely troubling. Item (E), in
particular, seems to be an indirect attempt to permit the Treasury
Department to alter the operation of the section 465 at-risk rules with
respect to a limited category of partnerships.
Item (F) is also troubling given the lack of clear guidance as to
what kinds of partnership arrangements Congress did, and did not,
intend to be covered by section 470. This item resembles the broad
grant of regulatory authority that was contained in the
Administration's proposed SILO legislation but was soundly rejected by
Congress on the grounds that it would have been an inappropriate
delegation of legislative authority to the Treasury Department.
Given the lack of clear definition as to what the purpose of the
section is, this appears to grant very broad authority to the
Government to address by regulation issues not within the statutory
construction or Congressional intent of Section 470. This would be even
more troubling if the regulations could be retroactive.
Recommendation
This regulatory authority should be eliminated. At a very minimum,
it should be clarified, narrowed significantly and made more neutral
(e.g., include regulatory authority to exclude transactions from
section 470 that do not exhibit one or more of these factors). Indeed,
as we previously suggested, partnerships that do not qualify for any of
the bill's exceptions should be provided a mechanism by which they can
establish that they are not engaged in the kind of SILO-replication
abuse that Congress intended to prevent in enacting section 470. These
factors would seem to do the opposite.
13. Effective Date
Proposed Language
The amendments made by this section shall take effect as if
included in the provisions of the American Jobs Creation Act of 2004 to
which they relate.
Commentary
This language would sweep in losses for property acquired after
March 12, 2004, with respect to taxable years beginning after 12/31/05.
Given the moratoria provided in Notices 2005-29 and 2006-2, taxpayers
and advisors have justifiably anticipated that section 470 would be
narrowed in the partnership context so as to more effectively target
SILO-like transactions. Partnerships never saw the particular
requirements of the bill's exceptions (or the expansion of the amount
disallowed) coming and should not be bound by the particular
requirements and rules. It will not be possible to unwind many
arrangements that will throw into section 470 partnerships that do not
meet the ``set aside'' and ``option'' exception (i.e., defeasance with
respect to loans that could not be prepaid; options that are an
integral part of the partners' economic deal, etc.). Thus, partners
often will not be able to use self-help to get out of section 470.
Recommendation
Section 470 (in its current form and as amended) should not be
applied to defer losses of any partnership with respect to property
acquired before the date the Technical Corrections bill was introduced
(or is re-introduced). Further, grandfather relief should be provided
for options, set asides, and other arrangements put into place (or
subject to a binding commitment) before such date. Providing such an
effective date should not cause the bill to lose revenue or open the
door to SILO abuses given that the enactment of section 470 in 2004
should have deterred the promotion of partnerships as vehicles to
circumvent the application of section 470. It also would be consistent
with effective date relief provided in certain other sections of the
bill.
Rebar & Associates, PLLC
October 31, 2006
I am writing to you to express my concerns with Section 7 of the
Technical Corrections Act of 2006 and specifically with the changes
proposed to the treatment of dividends paid by an IC DISC.
We oppose the proposed changes to the treatment of dividends paid
by an IC DISC. First, this change does not seem fitting as a
``technical correction''. Rather it is a fundamental change in the
treatment of dividends as paid by an IC DISC. We believe any such
fundamental change in tax law should be addressed the same way in which
any other fundamental changes in tax law are addressed, which is
through the tax approval process and not as a technical correction.
Second, the suddenness of the enactment date of the proposed change
undermines basic business planning. We are a CPA firm who provides
services to closely held businesses. These businesses for the most part
are under $25mm in annual sales and owned by less than five people. All
are US companies who provide US jobs and export their goods. These
businesses plan annually and as a part of that planning take into
consideration tax costs and benefits when making their decisions. Most
all of the business that avail themselves of the treatment of IC DISC
dividends make such payments at the end of the year. This is because
most small businesses do not know where their profitability will come
out until late in the year. To suddenly adversely change the tax law
will have a very negative effect on many small business owners
undermining solid business planning and harming the small business
owner.
I respectfully request you eliminate this provision from the
technical corrections act leaving it to be addressed through the tax
writing process. If it is the committee's belief that this major change
in tax treatment of dividends is within the technical corrections
process, I respectfully request that such enactment date be effective
December 31, 2006 so as to not damage small businesses that have
planned for and relied upon this area of tax law. The IC DISC rules
were put in place to help small businesses who provide U.S. based
employment and who export to foreign countries. This sudden change in
the tax law late in the year will have the opposite effect.
Respectfully submitted,
Robert J. Rebar
Managing Member
New York State Society of Certified Public Accountants
New York, New York 10016
October 31, 2006
House Ways and Means Committee
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
Ladies and Gentlemen:
The New York State Society of Certified Public Accountants,
representing 30,000 CPAs in public practice, industry, government and
education, submits the following comments to you regarding the
technical corrections bill captioned above.
The NYSSCPA thanks Ways and Means for the opportunity to comment on
this proposed legislation.
The NYSSCPA International Taxation Committee deliberated the bill
and prepared the attached comments. If you would like to discuss the
comments further with the Committee, please contact Cristina N. Wolff,
CPA, Chair, International Taxation Division Committee at 212-682-1600
or Ernest J. Markezin, CPA or William Lalli, CPA, NYSSCPA staff, at
212-719-8300.
Sincerely,
Thomas E. Riley, CPA
President
TAX TECHNICAL CORRECTIONS ACT OF 2006 HR6264--SECTION 7, AMENDMENT
RELATED TO THE JOBS AND GROWTH TAX RELIEF RECONCILIATION ACT OF
2003 (REPEAL OF 15% IC-DISC)
Principal Drafter
Mitchell Sorkin, CPA
NYSSCPA 2006-2007 Board of Directors
Thomas E. Riley, President
David A. Lifson, President-elect
Mark Ellis, Secretary
Neville Grusd, Treasurer
Sharon S. Fierstein, Vice President
Richard E. Piluso, Vice President
Robert E. Sohr, Vice President
Louis Grumet, ex officio
Edward L. Arcara
Deborah L. Bailey-Browne
Thomas P. Casey
Debbie A. Cutler
Anthony G. Duffy
David Evangelista
Joseph M. Falbo, Jr.
Myrna L. Fischman, PhD.
Daniel M. Fordham
Phillip E. Goldstein
Scott Hotalen
Don A. Kiamie
Lauren L. Kincaid
Stephen F. Langowski
John J. Lauchert
Kevin Leifer
Elliot A. Lesser
Howard B. Lorch
Beatrix G. McKane
Mark L. Meinberg
Ian M. Nelson
Jason M. Palmer
Robert A. Pryba Jr.
Robert T. Quarte
Judith I. Seidman
C. Daniel Stubbs, Jr.
Anthony J. Tanzi
Edward J. Torres
Liren Wei
Ellen L. Williams
Margaret A. Wood
Richard Zerah
NYSSCPA 2006-2007 Tax Division Oversight Committee
Susan R. Schoenfeld, Chair
Scott M. Cheslowitz
Robert L. Goldstein
Richard L. Hecht
Janice M. Johnson
Alan D. Kahn
Stephen A. Sacks
David Sands
Theodore J. Sarenski
P. Gerard Sokolski
Neil H. Tipograph
Stephen P. Valenti
Maryann M. Winters
Cristina N. Wolff
NYSSCPA 2006-2007 International Taxation Committee
Cristina N. Wolff, Chair
Paul R. Allutto
Nancy L. Berk
William B. Blumenthal
Ben J. Bogdanowicz
James P. Booth
Sheila Brandenberg
Jerry K. Brockett
Susan L. Brown
Thomas A. Butera
Ronald Carlen
Peter G. Chen
Jude Coard
Itzhak Cohen
Paul Dailey
Steven Davis
Alan R. Deutsch
Thomas J. Flattery
Alfred Floramo
Melissa S. Gillespie
Kadir R. Karabay
Norman A. Levine
Antonio Malavasi
Richard W. Margaroli
Richard D. Nichols
Gerard P. O'Beirne
Lawrence A. Pollack
Monica A. Rannige
Donald Reisinger
Gentiana Shameti
Stanley G. Sherwood
Lawrence E. Shoenthal
Mitchell Sorkin
Jonathan Tierney
Philip Van Schuyler
Ann-Christine Westerlund
Paul Zambito
General Comments
The International Taxation Committee (the Committee) of the New
York State Society of Certified Public Accountants has reviewed the
above-referenced technical corrections bill and has the following
comments:
If this legislation is passed, it may force taxpayers who have
established Interest Charge-Domestic International Sales Corporations
(IC-DISCs) to open up facilities abroad to avoid increased taxes which
will ultimately cost the United States in jobs and growth.
As part of the Jobs and Growth Tax Relief Reconciliation Act of
2003, Congress introduced the 15% long-term capital gains tax along
with the 15% rate on qualified dividends. The purpose of this change
was to reduce income tax on investment income and provide an incentive
for investing in corporate America.
The proposed section of the bill to exclude application of the
lower 15% dividend rate to IC-DISC distributions appears not to be a
technical correction, but rather a significant shift in policy with
repercussions throughout the small and mid-sized business community,
especially having a negative impact on the small domestic manufacturer
who exports.
Many domestic manufacturers who export their goods have a difficult
time competing in world markets where wages and related production
costs are less expensive than they are in the U.S. Congress tried to
redress this business segment by passing the Extraterritorial Income
Exclusion Act in 2000. As a result of pressure from the European Union,
Congress was forced to repeal this law with a phase out, but retained
some grandfathering provisions that have now also been repealed.
Congress then decided to pass the Domestic Production Activity
Deduction that would help U.S. manufacturers and qualified industries.
However, this law falls short compared to the earlier Extraterritorial
Income Exclusion.
Many smaller companies have found some refuge in utilizing an IC-
DISC to reduce their costs and stay competitive by taking advantage of
distributions received from IC-DISCs that are taxed at the 15% rate.
Although the use of IC-DISCs was no longer beneficial to large
American corporations due to the inability to defer the tax on the
income attributed to sales in excess of the $10 million threshold (the
gross income limitation) and the interest charge relating to the
deferral below this threshold, many smaller manufacturers saw
opportunities to reduce their operating costs and compete more
effectively abroad when the 15% rate for dividends came into effect.
Arguably, individuals, not necessarily businesses, were meant to be
the primary beneficiaries of the 15% dividend rate. Nevertheless, a 15%
rate for IC-DISC dividends is in correlation to that principle since
IC-DISCs are utilized by small businesses that are owned by individuals
or by pass through entities in which individuals are the stakeholders,
as opposed to publicly traded companies.
Under the present law, smaller exporting companies are able to
receive distributions from their IC-DISCs, pay their applicable taxes
and reinvest the after-tax proceeds into the economy. This translates
into more jobs, more production, and ultimately more revenue for the
Government.
In summary, the Committee considers that this proposed section of
the bill seems less a technical correction and more a policy shift,
which might have an adverse impact on taxes, U.S. competitiveness, U.S.
jobs and the U.S. economy, and, therefore, should not be included in
the bill.
Northwest Horticultural Council
Yakima, Washington, 98901
October 27, 2006
The Honorable Bill Thomas, Chairman
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth Office Bldg.
Washington, DC 20515
Dear Chairman Thomas:
We oppose a provision--Section 7--in the ``Tax Technical
Corrections Act of 2006'' (TTCA) that if approved by Congress would
counteract efforts ongoing for over two years in the Pacific
Northwest's tree fruit industry to utilize an important tax savings
tool created by the ``Jobs and Growth Tax Relief Reconciliation Act of
2003'' (JGTRRA).
The Northwest Horticultural Council is a trade association, located
in Yakima, Washington, representing the policy interests of growers and
shippers of such deciduous tree fruits as apples, pears, and cherries.
Our membership covers the states of Idaho, Oregon, and Washington.
Competing with foreign producers of fruits, such as fresh apples,
in key export markets has been a difficult one in recent years for the
small privately-held companies that comprise our industry.
Determinations of the World Trade Organization have resulted in the
repeal of two important tax incentives for these exporters: Foreign
Sales Corporations (repealed in 2000 by P.L. 106-519) and
Extraterritorial Income (repealed in 2004 by P.L. 108-357). As of
January 1, 2007, Export DISCs will represent the sole remaining tax
savings vehicle for small business exporters to utilize as a means of
approaching parity with foreign trade competitors who enjoy a
competitive advantage over U.S. producers due to direct government
subsidization, lower production cost structures (especially wages),
and, in the case of the People's Republic of China, these and soaring
production increases. (China now grows more apples than any other
country.) This lone remaining export incentive will be nearly useless
to our industry if Congress approves Section 7 of the TTCA.
Section 7 of the TTCA is a significant policy change
inappropriately and unfairly characterized as a simple and routine
corrective measure. It arbitrarily disqualifies dividends received from
an Export DISC for the 15% tax rate established under Sec. 303 of the
JGTRRA. Those harmed by this arbitrary change are not large
corporations but shareholders of small companies fighting an uphill
battle to compete in increasingly competitive export markets.
Further contributing to the unfairness and arbitrary nature of
Section 7 of H.R. 6264 and S. 4026 is the proposed date of the change.
The repeals of Foreign Sales Corporations and Extraterritorial Income
were accompanied by either multi-year transition periods or an
immediate and effective successor benefit. This legislation establishes
the effective date as the date the bill was introduced to Congress
(September 29, 2006) and offers no successor proposal or remedy. The
effective date as proposed pays no regard to the substantial
investments made by our small business exporters to establish Export
DISCs and comply with requirements of their administration for the
current tax year. This is a very real expense that has been incurred in
good faith.
We respectfully ask that the Committee remove Section 7 of the
TTCA. Its excision will not provide a permanent benefit--it will only
maintain the current benefit through its scheduled expiration in 2010.
Eliminating Section 7 will grant our small business exporters an
appropriate amount of time to plan for the phase-out of the current tax
benefit. At worst, the fate of Section 7 should be set aside for
further hearings in the next Congress to give ample time for this
serious policy proposal by the Committee to be thoroughly debated. This
would allow for the possibility of a more targeted corrective action
next year alleviating any actual problem (now unknown to us) with this
particular tax provision.
We would be happy to provide additional information on the impact
of this legislation to our industry upon your request. Thank you for
this opportunity to provide comment.
Sincerely yours,
Christian Schlect
President
Statement of Carol Schreckhise, Moore Fans, LLC, Marceline, Missouri
We are a small business in Missouri and are writing to ask you to
vote against HR6264 AND COMPANION S4026 that were introduced on
September 29, 2006. These bills deal with the taxation of dividends
from Domestic International Sales Corporatons (DISCs).
According to the Jobs and Growth Tax Relief Reconciliation Act of
2003, these dividends were taxed at the 15% Federal income tax rate in
the same manner as capital gains. To be more competitive in the global
marketplace, our company has undertaken to make use of this incentive
at considerable time and expense.
HR6264 AND COMPANION S4026, if approved, would make these dividends
taxable at ordinary Federal income tax rates. This will raise the tax
rates for the individuals who own shares in DISCs making them a less
attractive investment and eventually costing Missouri jobs due to a
decrease in products exported outside the United States.
The use of DISCs will increase the volume of exports from Missouri.
It is also the only export incentive that has not been attacked by the
World Trade Organization.
Not only do HR6264 AND COMPANION S4026 take away the tax benefit,
they also backdate the date of the tax increase to the date the bill
was introduced on September 29, 2006.
Thank you for allowing us to express our concerns and we hope you
will examine HR6264 AND COMPANION S4026 and decide not to vote in favor
of their passage.
If you wish to discuss this further, I can be reached at my work
number or by E-Mail.
American Bar Association Section of Taxation
October 31, 2006
The Honorable Charles E. Grassley
Chairman
Senate Committee on Finance
219 Dirksen Senate Office Bldg.
Washington, DC 20510
The Honorable Max S. Baucus
Ranking Member
Senate Committee on Finance
219 Dirksen Senate Office Bldg.
Washington, DC 20510
The Honorable William M. Thomas
Chairman
House Committee on Ways and Means
1102 Longworth House Office Bldg.
Washington, DC 20515
The Honorable Charles B. Rangel
Ranking Member
House Committee on Ways and Means
1106 Longworth House Office Bldg.
Washington, DC 20515
Dear Gentlemen:
Enclosed are comments on the proposals included in H.R. 6264 and
S.4026 related to the application of Code section 470 to partnerships
and proposed clarification of the term ``separate affiliated group'' in
section 355(b)(3). These comments represent the views of the American
Bar Association Section of Taxation. They have not been approved by the
Board of Governors or the House of Delegates of the American Bar
Association and should not be construed as representing the policy of
the American Bar Association.
Sincerely,
Susan P. Serota
Chair, Section of Taxation
______
EXECUTIVE SUMMARY
I. Comments on Proposed Technical Corrections to Code Section 470
The Tax Technical Corrections Act of 2006 (``Technical Corrections
Act'') would amend section 470 \1\ to provide rules regarding the
application of section 470 to partnerships. As is explained below, we
commend the drafters of the Technical Corrections Act for excluding
some legitimate partnerships that are not engaged in the abuses that
Congress intended to prevent from the application of section 470. We
also commend the drafters for recognizing the need to exclude non-
depreciable partnership property. Importantly, however, we believe that
the legislation does not go far enough in excluding legitimate
arrangements that have nothing to do with SILO transactions from being
subject to the loss deferral regime. We also believe that the approach
taken by the legislation will engender substantial uncertainty
regarding whether and to what extent common business arrangements are
subject to section 470, in contravention of sound tax policy. As is
explained in more detail below:
---------------------------------------------------------------------------
\1\ Except to the extent specified otherwise, all section
references are to the Internal Revenue Code of 1986, as amended, or to
the Treasury regulations promulgated thereunder.
We believe that the legislation's retroactive expansion
of the portion of a pass-thru entity's property that can be subject to
the loss deferral rules is inappropriate and inconsistent with sound
tax policy.
The legislation provides an exception for partnerships
that meet certain objective requirements (relating to funds not being
set aside or subject to certain arrangements and to the lack of certain
types of options). Because the economic arrangements that exist with
respect to partnerships are so diverse, we believe that focusing on the
economic relationship of the partners, partnership, and lenders in the
manner specified will apply the loss deferral rules to far more
partnerships than can be justified on policy grounds. Accordingly, we
believe that, if this approach is pursued, an additional exception
should be provided for property that is not subject to ``use'' or
``control'' by a tax-exempt partner and that ``qualified allocations''
should be determined by reference to section 514(c)(9)(E), rather than
section 168(h)(6)(B). We also believe that consideration should be
given to a more general anti-abuse rule for the application of section
470 to partnerships and to providing anexception when all taxable
partners satisfy a threshold projected variance in their investment
return with respect to the partnership. We also have highlighted
significant problems with, and made suggestions regarding, the
arrangement, set aside, and options rules.
Numerous practical and technical issues exist that are
fundamental to whether and how section 470 applies with regard to
tiered partnerships. Given the large number of tiered arrangements, we
believe it is inappropriate to leave resolution of these issues to
regulations.
We believe that the broad regulatory authority to expand
the scope of section 470 with respect to partnerships should be
narrowed significantly so as to potentially capture only those
situations where the arrangement truly resembles a SILO.
We believe that certain additional exceptions and
definitions need to be provided.
Given the inability of taxpayers to have predicted the
details of the technical correction, we believe that consideration
should be given to applying section 470 only to partnership property
acquired after the date the Technical Corrections Act was introduced
(in non-leasing situations) and to providing appropriate transition
relief for arrangements entered into before the Technical Corrections
Act was introduced that may be difficult or impossible to modify.
If appropriate legislation cannot be enacted expeditiously, we
strongly believe that the existing moratoria should be extended to
taxable years beginning before January 1, 2007.
II. Comments on Proposed Technical Corrections to Code Section 355
The Tax Increase Prevention and Reconciliation Act of 2005 amended
the active trade or business requirement of section 355(b) by adding
paragraph (3), providing that all members of a corporation's ``separate
affiliated group'' (``SAG'') are treated as one corporation for
purposes of the active trade or business requirement. In the Technical
Corrections Act, Congress has proposed to clarify that the term SAG
would not include any corporation that became an otherwise qualifying
member of the SAG within the five-year period ending on the date of the
distribution by reason of one or more transactions in which gain or
loss was recognized in whole or in part.
This proposed change would undermine the so-called ``expansion''
doctrine embodied in Treasury Regulation Sec. 1.355-3(b)(3)(ii) that
permits a corporation to acquire a business in a taxable acquisition
during the five-year period, provided that the business is an expansion
of a pre-existing active business. The expansion doctrine is regularly
relied upon by taxpayers to satisfy the active business requirement of
section 355.
We recommend that the proposed technical correction not be enacted
without modification to make clear that any such change will not
interfere with the law that has developed to allow an expansion of a
historic business. This could be accomplished by making clear that the
expansion doctrine will be applied on an affiliated group basis,
without regard to the SAG membership and providing examples to
illustrate the principle.
ABA SECTION OF TAXATION
COMMENTS ON H.R. 6264 AND S.4026: THE TAX TECHNICAL CORRECTIONS ACT OF
2006
I. Comments on Proposed Technical Corrections to Code Section 470
A. Introduction
Section 6 of the Technical Corrections Act would amend the ``anti-
SILO'' rules of section 470 of the Internal Revenue Code to provide
rules regarding the application of section 470 to partnerships. The
amendment would expand the portion of a partnership's losses and
deductions that could be deferred, but would provide new exceptions for
(1) non-depreciable property and (2) certain property that meets two
specific requirements that are based on certain leasing rules contained
in section 470(d). The amendment also would provide the Treasury
Department (``Treasury'') and the Internal Revenue Service (``IRS'')
with extremely broad regulatory authority based on certain vague
concepts to subject partnerships to section 470, even if those entities
would otherwise be excepted from the application of section 470. The
amendment would apply retroactively to property acquired after March
12, 2004.
The application of section 470 to pass-thru entities is a critical
issue to thousands of taxpayers in a variety of industries, as well as
to those practitioners who advise pass-thru entities and their owners
regarding compliance with the tax laws. We commend the drafters of the
Technical Corrections Act for their efforts in attempting to limit the
application of section 470 in the context of partnerships that are not
engaged in ``SILO'' transactions and for recognizing the need to
exclude non-depreciable partnership property. As is explained in more
detail below, however, we have significant concerns regarding both the
general direction and the particular details of the amendment contained
in the Technical Corrections Act.
Very generally, we are concerned that, notwithstanding the
provisions of the Technical Corrections Act, many partnerships will be
subject to section 470 even though they are not engaged in, or being
used to replicate, the kinds of transactions that Congress intended to
subject to section 470. We also are concerned that the amendment will
engender considerable uncertainty regarding how, whether, and to what
extent section 470 applies to many common business arrangements. We
also have concerns with respect to other compliance and policy issues,
including effective date concerns.
Before elaborating upon our concerns regarding the amendment, we
believe it is useful to provide some brief background regarding current
law and the comments we previously submitted regarding the application
of section 470 to pass-thru entities.
B. Background Regarding Current Law
Section 470 is a loss deferral provision that was enacted as part
of the American Jobs Creation Act of 2004 (P.L. 108-357, the ``2004
Act''). Section 470 was primarily designed to address concerns with
certain SILO (i.e., sale-in, lease-out) transactions the Government
considers abusive. These transactions typically involved a sale of
property (such as a subway system) by a tax-exempt entity (such as a
municipal transit authority) to a taxable entity that, in turn, leased
the property back to the tax-exempt entity. The taxable entity
benefited from the cost recovery deductions associated with the
property, while the tax-exempt entity typically received an implicit
fee for participating in the arrangement and continued to control the
operation of the property.
Section 470 suspends the deduction of losses related to ``tax-
exempt use property'' in excess of the income or gain from that
property. Tax-exempt use property includes property that is leased to a
tax-exempt entity. Importantly, however, as a result of the application
of section 168(h)(6), tax-exempt use property also includes property
(whether or not leased) owned by a partnership that (1) has as partners
both taxable and tax-exempt entities (including foreign persons) and
(2) makes allocations to the tax-exempt partners that are not
``qualified.'' As a result, a partnership that has a combination of
taxable and tax-exempt (including foreign) partners and that makes
nonqualified allocations is potentially subject to section 470, even if
the partnership does not lease any property and even if the partnership
is not engaged in a SILO-like transaction.
In the pass-thru context, section 470 applies to property acquired
after March 12, 2004. The IRS and Treasury, however, have indicated
that, for tax years beginning before January 1, 2006, the IRS will not
apply section 470 to disallow losses associated with property that is
treated as tax-exempt use property solely as a result of the
application of section 168(h)(6).\2\
---------------------------------------------------------------------------
\2\ See Notice 2006-2, 2006-2 I.R.B. 278, and Notice 2005-29, 2005-
1 C.B. 796.
---------------------------------------------------------------------------
C. Previous Submission by the Tax Section
In June 7, 2005, the Tax Section of the American Bar Association
submitted a letter to the distinguished Chairs and Ranking Members of
the House Committee on Ways and Means and the Senate Finance Committee
expressing concerns regarding the application of section 470 to pass-
thru entities.
In our previous submission, we expressed our strong concern that
section 470 applied in the partnership context far more broadly than
necessary to achieve the Government's ``anti-SILO'' objective. Our
previous submission provided support for why we did not believe
Congress intended section 470 to apply so broadly, as well as examples
of the kinds of common business arrangements that could be
inappropriately subject to the loss deferral regime.
In our previous submission, we made a number of recommendations
that were intended both (1) to protect the Government's interest in
preventing the ``next generation'' of SILO transactions through
partnerships and (2) to allow taxable and tax-exempt parties to
continue to undertake legitimate business transactions through
partnerships without inappropriately being subject to the loss deferral
rules of section 470. Although there were numerous aspects to the
recommendations, the core recommendation focused on excluding
partnerships from the application of section 470 where a tax-exempt
partner did not ``use'' or ``control'' the property following
acquisition of the property by the partnership. While we recognize that
there are difficulties in applying the concepts of ``use'' and
``control'' in the context of certain limited types of properties, we
continue to believe that this basic approach is most effective in
distinguishing legitimate arrangements from those that resemble SILOs.
Further, from a tax policy perspective, it provides an objective
standard that, in most cases, can easily be administered.
D. Section 6 of the Technical Corrections Act
Section 6 of the Technical Corrections Act takes a different
approach to addressing how section 470 applies to pass-thru entities
that are not engaged in covered leasing transactions. This approach
would exclude some legitimate business arrangements from the
application of the loss deferral regime. In this regard, we commend the
drafters for recognizing the need to narrow the application of section
470. Nonetheless, we are very concerned that the Technical Corrections
Act does not go far enough in excluding those entities that are not
engaged in the kinds of SILO transactions Congress considers to be
abusive. We also are concerned that the approach reflected in the
Technical Corrections Act will engender tremendous uncertainty as to
both the scope and operation of section 470 in the pass-thru context,
in contravention of sound tax policy. Thus, we respectfully encourage
the drafters to reconsider the suggested approach that we described in
our previous submission.
We appreciate, however, the interest in securing expeditiously a
legislative solution to the problems associated with the application of
section 470 to pass-thru entities. We also understand that the drafters
of the Technical Corrections Act would like this solution to ``mirror''
the exceptions contained in section 470(d) for ``legitimate'' leases to
the extent possible and are appreciative of the opportunity to provide
comments on the Technical Corrections Act before it moves further in
the legislative process. Thus, while the discussion below summarizes
significant problems with the approach reflected in the Technical
Corrections Act, it also contains suggestions as to how that approach
could be modified so as to protect the Government's interests in
deterring ``synthetic'' SILOs, while not inappropriately subjecting a
large number of legitimate arrangements to the loss deferral rules.
1. Scope of Loss Deferral
The Technical Corrections Act would amend section 470 to expand the
portion of a pass-thru entity's property that can be subject to the
loss deferral rules. Section 168(h)(6) treats only the tax-exempt
entity's ``proportionate share'' of the entity's property as tax-exempt
use property. The Technical Corrections Act would eliminate the
``proportionate share'' rule and treat all property of a pass-thru
entity (not otherwise excepted from section 470) as tax-exempt use
property for purposes of section 470 if any portion is treated as tax-
exempt use property for purposes of section 168(h)(6). This approach
has the practical effect of causing all of the losses with respect to a
particular property to be deferred, even if the tax-exempt partner's
share of partnership items with respect to such property is extremely
small. This result is unduly harsh, particularly to the extent that
section 470 continues to apply to many legitimate pass-thru entities
that are not involved in SILO arrangements. Further, expanding the
scope of the disallowance retroactively (as the Technical Corrections
Act proposes to do) would be inconsistent with sound tax policy. Thus,
we recommend that only the tax-exempt entity's share of property be
treated as tax-exempt use property.
2. Exception for Non-Depreciable Property
The Technical Corrections Act also provides two new exceptions to
the definition of tax-exempt use property in situations in which
property would otherwise be considered tax-exempt use property solely
by reason of section 168(h)(6). One of these exceptions is for property
that is not of a character subject to the allowance for depreciation.
We strongly support this exception for the reasons set forth in our
previous submission. We note, however, that the Joint Committee on
Taxation's description of the Technical Corrections Act (JCX-48-06)
(the ``JCT Description'') indicates that, to qualify for the exception,
property must be both non-depreciable and non-amortizable. Presumably,
the reference to property that is subject to amortization is intended
to capture amortizable section 197 intangibles, which is consistent
with the inclusion of such property in section 470(c)(2)(B)(ii). This
reference, however, also raises questions with respect to other
property that may be subject to amortization, such as bonds with
amortizable bond premium under section 171. Bonds with amortizable bond
premium generally are not thought to be of a character subject to the
allowance for depreciation and should not be subject to section 470.
For this reason, clarification as to the scope of the reference to
``amortizable property'' in the JCT Description would be helpful.
3. Exception Based Upon the Economic Characteristics of the Partnership
The second new exception (the ``Two-Part Exception'') is for
partnerships that meet both of two fairly complex requirements--the
``no set aside'' requirement and the ``no option to purchase at other
than value'' requirement--with respect to the property for the taxable
year. The Two-Part Exception is the exception upon which many thousands
of legitimate pass-thru entities that hold depreciable property would
have to rely in order to escape the application of the anti-SILO loss
deferral rules.
a. General Concerns
As is explained below, the Two-Part Exception focuses on the
economic characteristics of the arrangements among partnerships,
partners, lenders, and potentially others. As the Government has
previously recognized in another context, ``[s]ubchapter K is intended
to permit taxpayers to conduct joint business (including investment)
activities through a flexible economic arrangement without incurring an
entity-level tax.'' \3\ This statement gives explicit recognition to
the flexibility of the partnership entity and the fact that taxpayers
may engage in a myriad of diverse economic arrangements through
partnerships. We cannot emphasize enough the difficulty in anticipating
the economic terms that taxpayers may enter into, or may have entered
into, in advancing legitimate business interests in connection with a
partnership. Thus, any rule that focuses exclusively on the economic
characteristics of partnership arrangements, such as the Two-Part
Exception, will inevitably capture many legitimate partnerships that
have nothing to do with SILOs. For this reason, we believe that, if
such an approach is employed, it needs to be combined with a
consideration of other characteristics of the arrangement. Otherwise,
numerous legitimate taxpayers will be subject to loss deferral rules
that Congress intended to apply only to abusive arrangements. We
discuss alternative approaches and rules for consideration after the
discussion of issues arising in connection with the Two-Part Exception.
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\3\ Treas. Reg. Sec. 1.701-2(a).
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b. Particular Concerns Regarding the ``No Set Aside'' Requirement
The ``no set aside'' requirement focuses on whether, at any time
during a taxable year with respect to any property owned by the
partnership, funds are (1) subject to certain arrangements (such as a
defeasance arrangement, a letter of credit collateralized with cash or
cash equivalents, or a loan by a tax-exempt partner or the partnership
to any taxable partner, the partnership, or any lender, among others)
or (2) set aside or expected to be set aside, to or for the benefit of
a taxable partner or any lender, or to or for the benefit of any tax-
exempt partner to satisfy any obligation of the tax-exempt partner to
the partnership, any taxable partner, or any lender. In the case of
funds outside of the partnership (i.e., funds held by a party other
than the partnership that are set aside to satisfy an obligation
described in the prior sentence), the ``no set aside'' requirement
requires that no amount be subject to an arrangement or set aside in
this manner at any time during a taxable year. With respect to funds
held by the partnership, it would be permissible for funds to be
subject to an arrangement or set aside (or expected to be set aside) by
the partnership to or for the benefit of a partner or lenderas of any
date during the year in an amount equal to the greater of:
(1) 20 percent of the ``aggregate debt of the partnership'' (which
term is not defined); or
(2) the sum of (a) 20 percent of the taxable partners' capital
accounts determined under the rules of section 704(b) and (b) 20
percent of the taxable partners' share of the recourse liabilities of
the partnership determined under section 752.
The Technical Corrections Act provides that funds that are set
aside for less than 12 months would not be taken into account in
determining whether the ``no set aside'' requirement is met. It further
provides that funds would not be treated as ``set aside'' if such funds
``(I) bear no connection to the economic relationships among the
partners, and (II) bear no connection to the economic relationships
among the partners and the partnership.''
The ``no set aside'' requirement appears designed to mirror the
``no defeasance'' rule set forth in section 470(d) with respect to
leases. Section 470(d) provides that a lease that has certain
characteristics is not subject to the loss deferral rules, presumably
because those characteristics are inconsistent with SILO transactions.
One of these characteristics is that the tax-exempt lessee has not
monetized more than an allowable amount of its lease obligation
(including any purchase option) pursuant to an arrangement, set aside,
or expected set aside that is to or for the benefit of the taxpayer or
any lender, or is to or for the benefit of the tax-exempt lessee. While
looking to a lack of defeasance may make sense in distinguishing a
``good'' leasing arrangement from a SILO leasing arrangement, such an
approach is inherently difficult to apply in the partnership context
and cannot be structured in such a manner so as to accurately separate
legitimate pass-thru entities from those that might be structured in
the future as synthetic SILOs.\4\ Specific concerns and suggestions
with regard to this requirement include the following:
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\4\ As was indicated in our previous submission, we are not aware
of any pass-thru entities that have been used to replicate the
economics of a SILO transaction.
The exception establishes a ``reasonable person''
standard for determining when funds are set aside or expected to be
``set aside for the benefit'' of one of the relevant parties. In the
context of leases, money set aside for the benefit of the lessor must
be ``targeted'' towards the lessor in some way in order for a
reasonable person to determine that the funds are impermissibly set
aside. By contrast, all partnership funds are held for the eventual
benefit of those with an economic stake in the partnership--including
partners and lenders. Thus, in undertaking the required analysis for
funds held by the partnership, the ``for the benefit of'' portion of
the test does not meaningfully affect the inquiry. Instead, the primary
question will relate to what it means for funds to be ``set aside.''
Given that partnerships may hold significant cash for many purposes, it
is imperative that taxpayers have detailed guidance allowing them to
determine when funds are considered to be set aside in a manner that
violates the ``no set aside'' requirement. Presumably, the ``no set
aside'' requirement, as applied to funds held by a partnership, is
intended to capture only funds that have been isolated, such that they
will not be available for use in connection with the business of the
partnership, and that are earmarked either for distribution to partners
or payment to creditors.\5\ Clarifying the meaning of the requirement
would help both the taxpayers and the IRS apply this provision. In
fact, given the stakes of loss deferral for all partners, pass-thru
entities need immediate clarity as to how they can establish with
certainty that funds are not considered to be set aside for an
impermissible purpose.
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\5\ As is discussed below, we similarly believe that, if the
reference to ``lenders'' is retained in section 470(e)(2), the statute
should apply only with respect to ``arrangements'' and ``set asides''
where the loan serves to support repayment of the investment of the
taxable partner. Also, sinking funds to redeem partners are common
business structures used in many legitimate arrangements. Thus, the
existence of a sinking fund should not necessarily be viewed as
determinative of a SILO arrangement. Nonetheless, we understand that
the presence of a sinking fund, in conjunction with other factors,
could be troubling to the Government. This illustrates the problems
with subjecting a partnership with depreciable property to section 470
merely because it fails the ``no set aside'' requirement, without
examining the totality of the arrangement.
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Establishing the purpose for which particular funds are
set aside raises tracing and fungibility concerns and could impose
tremendous administrative burdens on both taxpayers and the Government.
The blanket inclusion of partnership lenders as parties
for whom ``arrangements'' and ``set asides'' are prohibited sweeps in
numerous legitimate partnership arrangements.
We assume that lender arrangements are included to address two
primary situations. In one situation, a taxable partner would
contribute significant cash to the partnership and simultaneously would
borrow a like amount of funds. The tax-exempt partner would bear the
risk with respect to the debt, either by lending the funds directly to
the taxable partner or by guaranteeing debt advanced to the taxable
partner by a third-party lender. Repayment of the debt by the taxable
partner would be contingent on the taxable partner receiving back its
investment in the partnership.\6\ In a second situation, the taxable
partner may advance minimal funds to a partnership, with the majority
of the acquisition proceeds for the property being borrowed by the
partnership from an unrelated lender. In order to accrue significant
deductions in this situation, the taxable partner would be required to
enter into a guarantee or some similar arrangement with respect to the
debt. To counteract the risk associated with the guarantee, however,
the partnership would set aside significant funds for repayment of the
debt so as to ensure that the taxable partner is never called upon to
satisfy its guarantee obligation.
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\6\ In the third-party lender situation, the tax-exempt partner
would repay the debt pursuant to the guarantee.
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As an initial matter, we do not think that the second situation
should create any concern for the Government. Treas. Reg. Sec. 1.752-
2(j)(3) provides that ``[a]n obligation of a partner to make a payment
is not recognized if the facts and circumstances evidence a plan to
circumvent or avoid the obligation.'' It is hard to see how a scenario
that satisfies the ``set aside'' requirement in section 470(e)(2) would
not run afoul of this provision.\7\
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\7\ As a result, the taxable partner would not have sufficient
adjusted basis under section 705 to take into account significant
losses, as section 704(d) would limit the allowance of such losses.
Similarly, with minimal capital invested by the taxable partner, and
presumably significant capital being contributed by the tax-exempt
partner to provide for the funds that would be set aside and that would
secure the partnership debt, it would not seem possible to allocate
significant losses to that taxable partner under section 704(b). First,
the taxable partner would not have contributed significant capital to
justify the allocation of losses. Similarly, it would not seem possible
to generate nonrecourse deductions under Treas. Reg. Sec. 1.704-2(c)
that might be allocated to the taxable partner in this situation. If
both the property and the funds secured the debt, the total basis (or
book value) of all property securing the debt would not fall below the
amount of the debt (i.e., because the funds would retain their basis
(or book value)). Thus, no nonrecourse deductions would result from
depreciation of the property. See Treas. Reg. Sec. 1.704-2(b)(2)
(``partnership minimum gain'' is the amount by which a nonrecourse
liability exceeds the adjusted basis (or book value) of partnership
property that the debt encumbers); Treas. Reg. Sec. 1.704-2(c)
(``nonrecourse deductions'' must be attributable to a net increase in
partnership minimum gain during the year).
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We also believe that existing authority provides the Government
with significant weapons to attack the first situation. Depending on
the facts, the lending arrangement may be disregarded altogether, so
that the tax-exempt party would be treated as the person contributing
the funds.\8\ Of equal or greater significance, the regulations under
section 704(b) would certainly take such an arrangement into account in
determining the allocation of losses under the partnership agreement.
We think it is highly unlikely that section 704(b) would permit a
partner to be allocated losses where the partner is protected from loss
as a result of a lender arrangement.\9\
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\8\ See Rev. Rul. 72-135, 1972-1 C.B. 200 (nonrecourse loan by
general partner to limited partner for limited partner to purchase
partnership interest recast as a contribution to capital by general
partner). Cf. Knetsch v. U.S., 364 U.S. 361 (1960) (no valid
indebtedness in deferred annuity savings investment where annual
borrowings kept net cash value at a de minimis amount; lending was, in
substance, a rebate of a substantial part of the interest payments);
Bussing v. Commissioner, 88 T.C. 449 (1987) (loan disregarded in sham
leasing arrangement where note payments and rental obligation offset
each other), supplemental opinion, 89 T.C. 1050 (1987); HGA Cinema
Trust v. Commissioner, 950 F.2d 1357 (7th Cir. 1991) (same), cert.
denied, 505 U.S. 1205 (1992); Compare VanRoekel v. Commissioner, T.C.
Memo 1989-74 (note in sale-leaseback transaction determined to be valid
where debtor was unconditionally liable for payments and the form was
respected in early years of the arrangement; court noted this was a
``close case'').
\9\ Treas. Reg. Sec. 1.704-1(b)(2)(ii)(f) states that, for purposes
of section 704(b), the partnership agreement includes all agreements
among the partners, or between one or more partners and the
partnership, concerning the affairs of the partnership and
responsibility of partners, whether oral or written, and whether or not
embodied in a document referred to by the partners as the partnership
agreement. Thus, in determining whether distributions are required in
all cases to be made in accordance with the partners' positive capital
account balances . . ., and in determining the extent to which a
partner is obligated to restore a deficit balance in his capital
account . . ., all arrangements among partners, or between one or more
partners and the partnership relating to the partnership, direct and
indirect, including puts, options and other buy-sell agreements, and
any other `stop-loss' arrangement, are considered to be part of the
partnership agreement. (Thus, for example, if one partner who assumes a
liability of the partnership is indemnified by another partner for a
portion of such liability, the indemnifying partner (depending on the
particular facts) may be viewed as in effect having a partial deficit
makeup obligation as a result of such indemnity agreement.)
Under Treas Reg. Sec. 1.704-1(b)(2)(ii)(a), in order for an
allocation to be respected as having economic effect, ``it must be
consistent with the underlying economic arrangement of the partners.''
In other words, any economic benefit or economic burden that
corresponds to an allocation must inure to the benefit or detriment of
the partner to whom the allocation is made. If the lender arrangement
is taken into account as part of the partnership agreement, so that the
taxable partner is considered to be protected from loss with respect to
its investment for purposes of analyzing allocations, the section
704(b) regulations would not permit an allocation of losses to the
taxable partner. We note that, in Van Roekel v. Commissioner, T.C. Memo
1989-74 (discussed supra note 8), the court found that, although the
indebtedness in that case would be respected for federal tax purposes,
the taxpayer would be viewed as protected from loss with respect to
such indebtedness.
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Given the means already available to the Government to deal with
lender arrangements and set asides, the inclusion of such arrangements
seems unnecessary. Further weighing against the inclusion of these
lender arrangements and set asides is the multitude of legitimate
lender arrangements that occur everyday in the partnership context
which would unfairly subject a partnership to loss deferral under
section 470. For instance, many loans that are subject to
securitization may not be prepaid.\10\ The only way to effectively pre-
pay such a loan is to defease the obligation. It appears, however, that
if a partnership utilizes ``in substance'' defeasance or ``legal''
defeasance, the partnership will fail section 470 unless it can satisfy
one of the 20-percent safe harbors for ``inside'' defeasance.\11\ As
another example, where a partner guarantees debt of a partnership, it
is not at all unusual for the lender to require that the guarantor post
some amount of collateral to secure its guarantee obligations. This
often will take the form of a letter of credit or some other
arrangement that would be impermissible under the terms of the
amendment. Because this arrangement would relate to funds held outside
the partnership, the 20-percent safe harbor would not be available. The
universe of analogous arrangements that raise troubles in this regard
is too numerous to catalogue.
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\10\ See B. Rubin, A. Whiteway, and J. Finkelstein, Tax Planning
for Conduit Loan Defeasance Transactions, Including Like Kind
Exchanges, 9 J. of Passthrough Entities 15 (2006).
\11\ Significantly, even though the partnership would no longer be
treated as the borrower for federal tax purposes with respect to debt
that it legally defeases, section 470 may nevertheless be applicable.
This is because the reference to ``lender'' in the amendment does not
refer only to a lender of the partnership, as determined for federal
tax purposes. Instead, the provision literally seems to apply where the
partnership provides for the defeasance of an obligation of anyborrower
to any lender. As is discussed below, proposed new section
470(e)(2)(D)(ii) provides the only limitation on arrangements with
respect to lenders; under this provision, such arrangements are ignored
only if the funds bear no connection to the economic relationship (1)
of the partners or (2) among the partners and the partnership. See
infra text accompanying note 12.
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Because the references to ``lenders'' sweeps in numerous legitimate
transactions in situations where the Government's interest already is
significantly protected by existing rules and authority, we believe
that the references to ``lenders'' in section 470(e)(2) should be
eliminated. If these references are not eliminated, we believe that the
situations in which lender arrangements are considered should be
significantly limited so as to refer only to situations where the
principle purpose of the loan is to support repayment, directly or
indirectly, of the investment of the taxable partner.
``Arrangement'' includes a loan by a tax-exempt partner
or the partnership to any taxable partner, the partnership, or any
lender. These kinds of arrangements are very common. For example, if a
partnership is having financial difficulty, partners often will fund
operations through debt rather than equity so as to preserve claims for
repayment in bankruptcy or other collection actions. Partners
(including tax-exempt partners) also may lend funds to employees or
service providers of a partnership in order to allow such persons to
acquire interests in partnerships and thereby ``incentivize'' such
persons to contribute to the success of the business. Loans by
partnerships to partners also are extremely common. (Indeed, the
Treasury regulations contain specific rules to address such loans.\12\
) Further, where one partner fails to fund a capital call, it is very
common for another partner to contribute funds for that partner, with
the operative documents treating the advance as a loan between the
partners. Where the partner making the advance is a tax-exempt partner
and the partner who failed to make the advance is taxable, presumably
the arrangement would constitute impermissible ``outside'' defeasance,
thereby subjecting the partnership to section 470. Consistent with our
recommendation above, we believe that, if loans continue to be treated
as ``arrangements,'' such treatment should follow only where the
principal purpose of the loan is to support repayment, directly or
indirectly, of the investment of the taxable partner.
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\12\ See, e.g., Treas. Reg. Sec. 1.752-2(c)(1) (partner generally
bears ``economic risk of loss'' with respect to loans made by such
partner or related person); Treas. Reg. Sec. 1.752-2(d) (de minimis
exception applicable to loans made or guaranteed by a partner or
related person); and Treas. Reg. Sec. 1.704-2(i) (providing that
``partner nonrecourse deduction,'' i.e., deductions arising from
otherwise nonrecourse loans made by partners or related persons, must
be allocated to the partner that bears the economic risk of loss with
respect to such loans).
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Where a partnership sells property and does not
instantaneously distribute such amounts, the sales proceeds seemingly
would be treated as set aside for the benefit of the partners
(including taxable partners). The amendment includes a 12-month safe
harbor rule to help alleviate this problem. This rule, however, may not
apply when a partnership repeatedly sells assets. In this situation,
the ``set aside'' amount may never fall to zero in a 12-month period
because, by the time that the proceeds from one sale are distributed,
the proceeds from the next sale have already been received.\13\ This is
of particular concern where a partnership is in the process of winding
up its affairs and liquidating. Thus, consideration should be given to
deeming a partnership to satisfy the ``no set aside'' requirement if it
has adopted a plan of liquidation and distributes all of its assets
within a few years of adopting such plan.\14\ A partnership that is
near the end of its life would not be an attractive vehicle for a SILO,
given the limited period during which deductions would be generated.
Nonetheless, even with such an exception, it is important to recognize
that entities that frequently sell assets but that are not in the
process of winding down still could be inappropriately subject to the
loss deferral regime.
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\13\ In order to qualify for the safe harbor, funds cannot be set
aside, or subject to an arrangement, for 12 months or more. Thus,
questions are raised as to the availability of the safe harbor when a
partnership sells multiple properties over a period of time; even
though the partnership may distribute funds from each property sale
within a relatively short period of time following the sale, it may
have a positive amount ``set aside'' for a period of more than 12
months.
\14\ Cf. section 332(b)(3) (permitting a corporate shareholder to
receive assets from a subsidiary corporation tax free in connection
with the liquidation of the subsidiary if, among other things, the
subsidiary distributes all of its assets within 3 years of the close of
the taxable year during which the first liquidating distribution is
made).
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At a minimum, the ``20-percent'' allowable partnership
amount should be increased to a much higher percentage. Much larger
amounts (approaching 100 percent) were ``defeased'' in the SILO
transactions with which Congress was concerned in enacting section 470
because substantial defeasance was necessary in order to make the
transactions attractive. It is hard for us to point to a specific
benchmark for what would be a reasonable allowable partnership amount.
The fact that a partnership has a significant amount of liquid assets
is in no way determinative that it is being used to replicate a SILO;
indeed, many current joint ventures and other pass-thru entities have
significant funds on hands for a variety of reasons, yet we are not
aware of any such entities that have been used to replicate a SILO
arrangement.
Given the extremely broad parameters for what is caught by the
amendment, we view the allowable partnership amount as a ``rough
justice'' provision designed to give a chance to those innocent parties
who, for legitimate reasons, enter into (or have entered into) an
otherwise impermissible arrangement or set aside. Whether a situation
falls below or above any allowable partnership amount necessarily will
be ``luck of the draw,'' depending on the characteristics of the
partners and the partnership.\15\ Given the extremely broad parameters
of what constitutes an impermissible arrangement or set aside and the
numerous legitimate partnerships that will fall within these
parameters, we strongly urge the Government to consider how high this
threshold could go before the Government's interests are realistically
compromised. Similar thought should be given in the context of outside
defeasance, as the provisions defining what constitutes outside
defeasance also are so broad as to encompass many very common
partnership arrangements. In many situations, the allowable partnership
amount will serve as the only way for legitimate partnerships to avoid
loss disallowance under section 470.
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\15\ Because, under one test, the ``allowable partnership amount''
is measured by reference to taxable partners' capital accounts and
their share of recourse debt, the test may not assist legitimate
partnerships from escaping the inappropriate application of section 470
when there are insignificant taxable partners participating. Similarly,
because, under the other test, the ``allowable partnership amount'' is
measured by reference to partnership debt, partnerships that are not
highly leveraged would have little leeway accorded by this test.
Separately, defeasance of a loan relating to a single property in a
large multi-property partnership may not create problems under the 20-
percent safe harbor, whereas defeasance of a loan relating to a single
property in a single-property partnership is much more likely to give
rise to an arrangement that falls outside of the 20-percent safe
harbor.
The meaning of the rule that provides that funds would
not be treated as ``set aside'' if they bear no connection to the
economic relationships among the partners or to the economic
relationships among the partners and the partnership is unclear. We
understand that this rule is viewed as necessary due to the lack of any
designation as to who can hold funds pursuant to an arrangement or set
aside for the benefit of (1) a taxable partner, the partnership, or any
lender or (2) a tax-exempt partner to satisfy any obligation of such
tax-exempt partner to the partnership, any taxable partner, or any
lender. For example, without this rule, a partnership could become
subject to section 470 by virtue of an unrelated third party taking out
a letter of credit to secure a loan to a taxable partner of the
partnership, even though the loan has absolutely nothing to do with the
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partnership.
The ``no connection to economic relationships'' language obviously
is very restrictive and seemingly would not apply in situations in
which a party may have a very tangential connection to the economic
relationship among the partners or the partners and the partnership. In
addition, the language would not appear to apply to an arrangement or
set aside that has a connection to the economic relationship among the
partners, but in a context that is wholly unrelated to the partnership.
In today's investment world, investors may come together in numerous
transactions and in a multitude of circumstances. For example, a
taxable party and a tax-exempt pension fund may come together as
partners in one deal, while, in another deal, the taxable party (or an
affiliate) may undertake syndicated financing for a project where the
same tax-exempt pension fund participates as a lender. The loan has
nothing to do with the joint investment of the parties in the
partnership, but the loan does bear a clear connection to the economic
relationship of the taxable party and tax-exempt pension fund. There
are an endless number of similar scenarios that have nothing to do with
SILOs.
In order to prevent such arrangements from causing legitimate
partnerships to be subject to loss deferral under section 470, it is
necessary to more specifically define the arrangements and set asides
that do not, in a real and substantial way, implicate the relationships
among the relevant parties ``in a capacity'' that relates to the
partnership.
In addition, the rule relating to arrangements and set
asides contemplates relationships with lenders, although the exclusion
gives no indication as to how lenders are taken into account.
Presumably, arrangements or set asides with respect to lenders are only
taken into account where such arrangements affect the economic
relationships among the partners or among the partners and the
partnership.\16\ Nonetheless, the existing rule engenders significant
uncertainty and confusion. For instance, suppose that a tax-exempt
partner owes significant funds to a bank, and a taxable partner in the
same partnership owns a small number of shares of that bank. The bank
requires that collateral be set aside for the loan. The loan is of such
a size that, if it were to become uncollectible, it could affect the
price of the bank's stock, thereby indirectly affecting the economic
well-being of the taxable partner. Without further guidance, this
arrangement could be viewed as having some (albeit de minimis) effect
on the economic relationship of the partners (assuming that the parties
could even detect that this arrangement exists).
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\16\ See supra note 11.
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Finally, the amendment operates with respect to ``funds''
that are subject to an ``arrangement'' or that are ``set aside.'' We
note, however, that the amendment does not define ``funds'' for
purposes of this provision. While ``funds'' would seem to denote cash,
we anticipate that the drafters may also intend that marketable
securities fall within the definition of ``funds.'' The inclusion of
marketable securities could create problems in a number of situations
that in no way implicate the concerns present with respect to SILOs.
One situation in particular exists with respect to REITs and their
``umbrella'' partnerships (``UPREIT partnerships'').\17\ Most REITs
hold their property through an UPREIT partnership that has unrelated
third-party partners. The partners may be either taxable or tax-exempt.
An outside investor in an UPREIT partnership generally is entitled to
have its partnership interest redeemed either for cash or stock of the
REIT that is equal to the fair market value of the partnership
interest. The REIT generally will stand ready to issue stock to satisfy
the redemption obligation. A REIT obviously has a virtually unlimited
ability to issue its own stock, so it is quite easy to see how the
Government might argue that the arrangement with respect to UPREIT
partners gives rise to an impermissible ``set aside.'' Nonetheless,
such arrangements in no way create concerns implicated by SILOs.\18\
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\17\ Also, analogous structures (typically referred to as ``Public
LLCs'' or ``Pubco'' structures) have become increasingly commonplace in
corporate America, with a number of companies having gone public in the
last year using this structure.
\18\ We note that there also could be significant problems
presented where a partnership holds, along with property that is
subject to an allowance for depreciation, stock in a corporation whose
stock becomes publicly traded. If a partnership decides that it will
not immediately distribute such publicly-traded stock to the partners
(possibly because it is prohibited from doing so for regulatory
reasons), but also determines that it will ultimately distribute,
rather than sell, the stock, this action seemingly could create an
impermissible ``set aside.''
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c. Particular Concerns Regarding the ``No Option to Purchase at Other
Than Value'' Requirement
In order to meet the ``no option to purchase at other than value''
requirement, no tax-exempt partner can have, at any time during a
taxable year, an option to purchase (or to compel distribution of)
partnership property or a direct or indirect interest in the
partnership other than at the fair market value of such property or
interest at the time of the purchase or distribution. In addition, the
partnership and the taxable partners cannot have an option to sell (or
to compel distribution of) partnership property or a partnership
interest to any tax-exempt partner at any time other than at the fair
market value of such property or interest as determined at the time of
the sale or distribution. Treasury would have the authority to issue
regulations allowing the fair market value of partnership property or a
partnership interest to be determined by formula ``when the value is
determined based on objective criteria that are reasonably designed to
approximate the fair market value of such property at the time of the
purchase, sale, or distribution.''
The ``no option to purchase at other than value'' requirement
appears to be based upon concerns that, in the typical SILO
transaction, a tax-exempt lessee is assured that it can purchase the
property it previously had sold for a predetermined amount at the end
of the lease term. Although looking to a tax-exempt entity's ability to
purchase property for an amount other than value may make sense in
attempting to distinguish a ``good'' leasing arrangement from a SILO
leasing arrangement, such an approach is more problematic in the pass-
thru entity context, given that pass-thru entities utilize different
kinds of option arrangements for a variety of different business
reasons. Further, it may be very difficult, if not impossible, for
pass-thru entities to restructure existing options, puts, and other
similar agreements, given that this involves renegotiating and
modifying the economic agreement among the parties. Specific concerns
and suggestions with regard to the ``no option to purchase other than
at value'' requirement include the following:
Many options determine the fair market value of property
at the time of exercise based upon formulae. Further, there are many
different kinds of formulae that are used. Although the Technical
Corrections Act provides Treasury with authority to ``allow'' the use
of formula options, it is unclear at this point what kinds of formulae
will be acceptable. Clear rules as to what kinds of formula options
satisfy the ``no option to purchase at other than value'' need to be
provided before section 470 is applied to any pass-thru entity that is
not engaged in a covered leasing transaction. Deferring resolution of
this issue until such time as regulations may be issued will create
considerable uncertainty as to what extent taxpayers are subject to
section 470, will engender significant compliance concerns, and is
inconsistent with the sound administration of the tax laws.
The application of the fair market value analysis is
unclear in many contexts relating to partnerships. The amendment makes
reference to fair market value only in the context of the property
being acquired from the partnership or the partnership interest being
acquired from another partner. The analysis, however, in the
partnership context is more complicated than this. Unlike in the
leasing context, where the consideration that will be conveyed in
exercising the option almost always will be cash, for partnerships, a
partner often will transfer its partnership interest in exchange for
property received in redemption. In this situation, the Government
presumably will want to ensure that (1) the amount of property being
distributed is determined by reference to fair market value, and (2)
the credit given to the partner for the partnership interest being
redeemed similarly is fair market value. Manipulation of either side of
the equation could upset the protection that the Government is looking
to obtain. This raises the very difficult question, however, as to how
one determines the fair market value of a partnership interest. That
is, does one look to what a willing buyer would pay to a willing seller
when bargaining at arm's length, or does one instead look to the
liquidation value of the interest that is being redeemed? The
Government has previously struggled with this analysis, and, in one
context, has given taxpayers the ability to choose either method.\19\
While ``liquidation value'' often (although not always) is used to
measure economic entitlement in a liquidating distribution,\20\ this
amount rarely will reflect the fair market value that parties would
derive where a willing buyer and seller are negotiating for the sale of
a partnership interest, as these parties will consider factors like
voting control, liquidity of the investment, etc., and the Government
has recognized this fact.\21\ Would this dichotomy result in taxpayers
being required to undertake a different fair market value analysis for
the partnership interest depending on how the interest is transferred?
Such an analysis would seem to undercut the conclusion that taxpayers
really can determine the ``fair market value'' of a partnership
interest. Guidance with respect to this issue obviously would be of
great importance in applying section 470.
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\19\ Prop. Reg. Sec. 1.83-3(l); Notice 2005-43, 2005-24 I.R.B.
1221.
\20\ In determining whether a partnership's allocations have
economic effect, the regulations generally require that liquidating
distributions with respect to a partner must be in accordance with that
partners' positive capital accounts. Treas. Reg. Sec. 1.704-
1(b)(2)(ii)(b)(2). This requirement, however, is not violated if ``all
or part of the partnership interest of one or more partners is
purchased (other than in connection with the liquidation of the
partnership) by the partnership or by one or more partners... pursuant
to an agreement negotiated at arm's length by persons who at the time
such agreement is entered into have materially adverse interests and if
a principal purpose of such purchase and sale is not to avoid'' the
principle that partners must receive the economic benefit and bear the
economic burden relating to allocations. Treas. Reg. Sec. 1.704-
1(b)(2)(ii)(b) (flush language).
\21\ See supra note 19.
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Problems also could arise in the context of preferred
partnership interests that are not redeemable for a period of time
without payment of a penalty. Suppose that a foreign (i.e., tax-exempt)
partner is the general partner of a partnership. Taxable partners hold
nine-percent cumulative preferred partnership interests that are
mandatorily redeemable in ten years. The partnership, which is managed
by the foreign general partner, may redeem the preferred interests
earlier by paying a penalty equal to an additional one-percent percent
cumulative return to the partners determined through the redemption
date. Would the payment of the penalty cause the foreign partner to be
treated as acquiring an indirect interest in the partnership at other
than fair market value (i.e., the value of a nine percent preferred
partnership interest) or is the penalty provision taken into account in
determining the value of the partnership interest? One would hope that
the answer is the latter, given that the penalty provision is an
inherent feature of the partnership interest, but this answer is by no
means clear under the statute.\22\
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\22\ Note that this question also raises issues that relate to the
discussion immediately above. That is, from a willing buyer/willing
seller valuation perspective, some discount for the penalty provision
likely would be taken given the probability that the interest will not
be redeemed prior to the end of ten years. Presumably, no such discount
would be applied once it became clear that the redemption option would
be exercised early, so that penalty provision clearly would apply.
Issues such as this, however, create significant confusion.
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It is common for a partnership or partner promoting a
partnership to reacquire a partnership interest from a service provider
partner when the service provider ceases to provide services for the
partnership. The acquisition price may be the amount the service
provider paid for its interest, book value, or some other amount that
does not reflect the fair market value of the interest. The service
provider partner does not receive the full fair market value simply
because the arrangement was structured so as to deter the service
provider partner from terminating the employment relationship. Although
this kind of arrangement does not present SILO concerns, it arguably
violates the fair market value option requirement because a tax-exempt
partner's indirect interest (or direct, where a tax-exempt partner
acquires directly the interest) may be increased as a result of the
exercise of the option to reacquire the partnership interest from the
service provider.
The fair market value option requirement also provides
the potential for partners to use section 470 to their benefit. For
instance, assume that two small partners, one taxable and one tax-
exempt, are bargaining to have their partnership interests redeemed. In
order to inflate the redemption price, the taxable partner threatens to
issue a non-fair market value option to the tax-exempt partner to
acquire the taxable partner's interest. Such an option could cause the
partnership to become subject to loss deferral under section 470, which
would adversely affect all of the taxable partners. This possibility
could force the partnership to succumb to the economic blackmail of the
partners who are bargaining for redemption, such that the partnership
would pay those partners an inflated amount for their partnership
interests. This result obviously is not one that the tax system should
encourage.
4. Issues Regarding Tiered Partnerships
The amendment grants regulatory authority to ``provide for the
application of [section 470] to tiered and other related
partnerships.'' The issues regarding the application of section 470 in
the tiered partnership context are so significant that we believe that
the provision literally will be impossible to apply in many, if not
most, situations involving partnerships with taxable and tax-exempt
partners.
A very significant portion of the universe of partnerships with
taxable and tax-exempt partners involves investment partnerships where
the tax-exempts are merely passive financial investors in a ``fund''
partnership that is managed by a third-party promoter. The ``fund''
partnership often will invest in the underlying property or business
that is the subject of its investment through one or more tiers of
partnerships.\23\ It is not unusual for one fund to joint venture with
another fund with respect to a particular investment. This may occur
from the inception of an investment or during the life of an
investment, where the original fund wants to diversify its risk or
capture part of its return with respect to the investment. Also, many
times, one fund will actually invest as a partner in another fund.
There often will be different properties and partners involved at each
tier in the investment structure.
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\23\ The exception in the Technical Corrections Act for
nondepreciable property will not remove the partnership from the
application of section 470 to the extent (as is common) the fund
invests in non-corporate entities that hold operating businesses or
other property (such as real estate) that is subject to the allowance
for depreciation.
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Numerous additional reasons exist for tiered partnerships,
including a desire to isolate certain properties in a portfolio for
partial investment by a different group of investors, structural, as
opposed to legal, subordination in lending and equity arrangements,
regulatory reasons, and state and foreign tax planning, just to name a
few. Given the frequency with which taxable and tax-exempt partners
join together in tiered partnership arrangements, it is absolutely
imperative that parties have clear guidance in any enacted legislation
as to how the rules of section 470 should apply in this context. Some
of the problems arising in the tiered context--for both taxpayers and
the Government--are as follows:
It is not clear how a lower-tier partnership will obtain
the information necessary to determine whether and how section 470
applies. Under the amendment, section 470 applies on a property-by-
property basis, so the partnership that holds the direct interest in
the property will have to determine the extent of loss disallowance.
Often, this partnership will have no access to information regarding
the ultimate partners, whether there is a non-fair market value option
at any level in the tiered partnerships, whether an arrangement or set
aside exists at any level in the tiered partnerships, and whether non-
qualified allocations exist at any level in the tiered partnerships.
Lower-tier partnerships could take the conservative position that
section 470 applies to all property and include information on the
Schedule K-1s to this effect. This obviously would be a reporting
nightmare. Similarly, if there are multiple chains of partnerships
flowing from the ultimate properties, and section 470 applies because
of a violation in one of the chains, how will partners in another chain
know to apply section 470 where all parties in that chain have arranged
their affairs so as to comply with section 470?
It is not clear how the no ``arrangement'' or ``set
aside'' requirements apply in a tiered partnership structure. For
instance, is the 20-percent safe harbor available in a tiered
arrangement where funds may be set aside for distribution or for the
benefit of a lender in one or more upper-tier partnerships? The 20-
percent safe harbor is not available in ``outside defeasance
arrangements'' where the funds set aside are not ``partnership
property.'' Does ``partnership property'' refer only to funds held by
the partnership where the property that potentially is subject to 470
resides, or does it refer to property anywhere in the chain between the
property and the ultimate partners? If the 20-percent safe harbor
cannot apply in this situation, the safe harbor will be of very little
use in escaping the inappropriate application of section 470,
particularly where ``arrangements'' and ``set asides'' with respect to
lenders must be considered. If the safe harbor can apply, how does one
accomplish the 20-percent calculations where there is a different mix
of partners, properties, and creditors at each tier in the structure?
The Joint Committee Description contemplates that regulations ``may
permit or require the aggregation of tiered or related partnerships for
purposes of any or all determinations required under section 470.''
Obviously, one can reach very different results depending on whether
aggregation applies. Until regulations are promulgated, are taxpayers
left to apply section 470 on both an aggregate and tier-by-tier basis,
taking the worst of the two results? Similarly, if aggregation applies,
how would it apply where there are different properties at each tier?
If one were allowed to aggregate all properties and partnerships, it is
possible to see how a SILO-replicating arrangement could ``slip through
the cracks.'' That is, suppose that a SILO-replicating arrangement is
created between a taxable and tax-exempt partner in a lower-tier
partnership, but the parties bring into that partnership for a small
interest an upper-tier partnership that, itself, holds significant
property and has significant taxable partners or debt. By bringing in
the upper-tier partnership, the base against which the 20-percent safe
harbor is applied would grow to a level that could permit complete
defeasance of the taxable investor's investment at the lower-tier
partnership.
Assuming that more limited aggregation must apply to prevent such
arrangements, how would it apply? In order to prevent parties from
``growing the base'' against which the 20-percent safe harbor applies,
would the parties have to apply the 20-percent safe harbor on a
property-by-property basis? Seemingly, such an analysis would require
that the parties determine the ultimate proportionate ownership of each
property by each partner and then take a proportionate amount of each
partner's section 704(b) capital account and recourse debt, allocating
such debt and capital to such portion of the property. This amount then
would be combined for every taxable partner with respect to every
property. Obviously, with different partners at each tier, economic
sharing ratios that vary for partners at each tier, and different loans
in place at each tier, this analysis would be inordinately complex,
even assuming that perfect information were available.
Similarly complicated questions arise in trying to apply the ``20
percent of partnership debt'' prong of the ``allowable partnership
amount'' test, given that debt with respect to partnership property may
be incurred at different levels in the structure. Presumably this
analysis would require an analysis of the test again on a property-by-
property basis and would require liability tracing rules akin to those
used for purposes of section 163 or 265.
Similar complications arise with respect to options in
tiered partnership arrangements. The options rules contained in the
amendment essentially operate with respect to arrangements whereby the
tax-exempt can purchase, or can be forced to purchase, partnership
property or interests for an amount other than fair market value.
Questions arise in determining how the rules apply where options exist
between tiers of partnerships or between a partner and a middle-tier
partnership. Apart from the issue as to how the lowest tier partnership
would know that such options even exist, an issue arises as to how such
options fit into the scheme of section 470. Such options are not
actually putting a direct interest in the property or partnership
interest in the hands of a tax-exempt partner. However, such options
may be increasing one or more tax-exempt partners' indirect interests
in partnership property. On the other hand, depending on the mix of
partners in the various tiers, the options may operate so as to
decrease indirect tax-exempt ownership in the property. Or, the
calculus may change from year to year based upon transfers of
partnership interests among taxable and tax-exempt partners in upper-
tier partnerships. Again, even with perfect information, making this
determination would be extremely time consuming and difficult. It may
be that the Government would decide that any option at other than fair
market value anywhere within the tiers would give rise to loss deferral
under section 470. Such a result, however, would unfairly subject many
legitimate arrangements to a loss deferral regime that Congress
intended to apply only to SILO-replicating partnership structures.
5. Need for Other Exceptions/Rules
As was indicated above, we believe that, under the Technical
Corrections Act, many legitimate pass-thru entities would not be able
to consistently satisfy both parts of the Two-Part Test and would be
subject to section 470, even though they are not engaged in the kinds
of activities with which Congress was concerned in enacting that
section. Therefore, we continue to believe, as stated in our prior
submission, that section 470 should not apply to the pass-thru entity's
property if no tax-exempt partner has significant operational control
over the property or uses the property to a significant extent.\24\ In
addition, as explained in our prior report, we believe that
partnerships satisfying the allocation rules in section 514(c)(9)(E)
(i.e., the ``fractions rule'') should be excluded from section 470. The
``qualified allocation'' rules in section 168(h)(6) are so restrictive
as to be virtually useless in sophisticated partnerships like those
that typically have tax-exempt partners, and there would be no
potential for undertaking a SILO-like arrangement where the
partnership's allocations comply with section 514(c)(9)(E).\25\
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\24\ As was explained in depth in our previous submission, the tax-
exempt partner's continued control over, or use of, the property is a
critical ingredient in a SILO transaction. Also, note that this
approach has the added benefit in the tiered partnership context of
being capable of analysis by the partnership that holds the property
that could be subject to section 470. By permitting analysis with
respect to the property itself, the partnership that is required to
report under section 470 could more easily determine whether section
470 applies to property that it holds.
\25\ We recognize that the fractions rule has been criticized in
the past and that there may be some hesitancy to reference a rule that
ultimately may be modified. Nonetheless, if the fractions rule is
modified in the future, consideration could be given at that time to
whether and how such modification would (or would not) apply in the
context of section 470.
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Alternatively, we believe that a more general anti-abuse rule for
the application of section 470 to partnerships, which incorporates an
analysis of taxpayer intent and the facts and circumstances taken as a
whole, warrants consideration, in lieu of an approach that, in effect,
broadly sweeps legitimate partnerships ``into'' section 470 and then
relies on specific exceptions to attempt to remove legitimate
arrangements. We generally have not favored such a subjective analysis,
given the problems inherent in planning in the face of uncertain
standards. Nonetheless, if the law (or legislative history) contains
appropriate specificity regarding the characteristics of the SILO
transactions with which Congress is concerned, we think that such an
approach could distinguish abusive transactions from those that are
legitimate business transactions in a manner that is more accurate than
the standards contained in the Two-Part Exception.
Nonetheless, if the drafters remain committed to an approach that
relies primarily on identifying economic aspects of a partnership
arrangement that bear some relationship to a SILO, we believe it
imperative that an additional, mutually exclusive, economic factor be
adopted that would allow many legitimate partnerships to escape loss
deferral under section 470. As one option, a factor could be adopted
that would except from section 470 partnerships where all taxable
partners satisfy a threshold projected variance in their investment
return with respect to the partnership. Given that one of the hallmarks
of a SILO transaction is that the taxable purchaser of the property
undertakes no meaningful risk and has no meaningful upside with respect
to the property, it seems that the Government could safely assume that
a partner whose return is projected to vary by some reasonable amount
is not engaging in a SILO-like transaction. Taxable partners with pure
preferred interests (i.e., interests that accrue only a fixed return
and that are allocated losses only after partners of all other classes
have depleted their capital) would have to be excluded from the
analysis, but, being in a last-loss position, such partners would not
represent candidates for replicating a SILO transaction.
We do not believe that this factor is an ideal means of excluding
legitimate partnerships from the reach of section 470, as there are
difficult issues of proof in showing variability in projected returns,
and issues relating to the exclusion of partners with pure preferred
interests in tiered partnership arrangements would be difficult.
Nonetheless, this exception would be generally consistent with the
approach taken in the Two-Part Exception and would offer an additional
way out of section 470 for the many legitimate partnerships that would
be unable to satisfy the Two-Part Exception.
6. Concerns Regarding Regulatory Authority
Even if a partnership's property falls outside the scope of section
470 by virtue of the exceptions currently included in the Technical
Corrections Act, the bill would provide the Government with broad
authority to issue regulations treating partnership property as tax-
exempt use property ``if such property is used in an arrangement which
is inconsistent with the purposes'' of section 470, determined by
reference to certain factors. These factors include that:
(1) a tax-exempt partner maintains physical possession or control,
or holds the benefits and burdens of ownership, with respect to such
property;
(2) there is ``insignificant'' equity investment in such property
by any taxable partner (with the term ``insignificant'' not being
defined);
(3) the transfer of property to the partnership does not result in
a change in use of such property;
(4) the deductions for depreciation with respect to such property
are allocated disproportionately to one or more taxable partners
relative to such partner's ``risk of loss'' with respect to such
property or to such partner's allocation of other partnership items;
and
(5) such ``other factors as the Secretary may determine.''
We are very concerned with this extremely broad grant of regulatory
authority and the vagueness of certain of the factors described above,
particularly given the possibility that the IRS might attempt to issue
regulations with retroactive application. Although we agree that the
IRS should have the authority to issue regulations to subject those
pass-thru entities that truly are being utilized to replicate SILO
arrangements to section 470, we are concerned that the IRS might
utilize this regulatory authority to challenge allocations and other
arrangements that have nothing to do with the SILO-concerns Congress
was trying to address in enacting section 470. This is particularly
likely given the vagueness of certain of the factors and the lack of
clear definition, in the statute and the JCT Description, of the
particular kind of transaction with which Congress was concerned in
enacting section 470.
Thus, we strongly recommend that this broad grant of regulatory
authority be narrowed to delete factors 2, 4, and 5, above; that factor
1 be modified so as to allow de minimisuse by a tax-exempt partner; and
that the parameters of a SILO-transaction and the purposes of section
470 be defined more objectively (in the legislative history if not in
the statute).\26\ Such modifications would provide more certainty for
both the Government and taxpayers as to whether various arrangements
are subject to section 470, while ensuring that any regulations that
ultimately may be issued are appropriately focused upon the abuses with
which Congress was concerned in enacting section 470.
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\26\ Among other things, we note that, relying on factors 2 and 4,
the IRS and Treasury seemingly could, in effect, eliminate the
exception under section 465(b)(6) of the ``at risk'' rules for
qualified nonrecourse financing without obtaining legislative approval.
We respectfully question whether Congress intended such a result in
enacting legislation aimed at eliminating SILO transactions.
---------------------------------------------------------------------------
We also are very concerned that the Technical Corrections Act
seemingly would not provide the IRS with authority to exclude from the
scope of section 470 those partnerships that fail to qualify for one of
the objective exceptions, but that are not being used to replicate SILO
transactions. Although we believe that the drafters of the Technical
Corrections Act can significantly reduce the number of legitimate
arrangements that would be inappropriately subject to section 470 by
adopting appropriate standards, there still likely will be some
legitimate arrangements that fail to fall within an exception as a
result of a ``foot-fault.'' Such regulatory authority is even more
critical if the additional exceptions we suggested are not added, given
that more legitimate arrangements will be exposed to the application of
section 470.
7. Other Technical Issues
The definition of ``tax-exempt partner'' in the Technical
Corrections Act still encompasses tax-exempt controlled entities. For
the reasons set forth in our previous submission, we believe that
taxable corporations and foreign persons that are taxed adequately in
foreign jurisdictions should not be treated as tax-exempt entities for
purposes of section 470.
Section 470 generally applies on a property-by-property basis. The
JCT Description provides that regulations ``may permit or require the
aggregation of partnership property.'' As was indicated in our previous
submission, we believe the property-by-property application presents a
host of problems. Thus, we support the ability to aggregate property in
appropriate cases.
For the reasons set forth in our previous submission, RICs, REITs,
and S corporations are not suitable vehicles for SILOs. Therefore, we
suggest that it be clarified that none of these entities is treated as
a pass-thru entity for purposes of applying section 470.\27\
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\27\ See C. Kulish, J. Sowell, and P. Browne, Section 470 and Pass-
thru Entities: A Problem in Need of a Solution, 7 Bus. Entities 12, 25-
26 (2005) (discussing why a REIT should not be treated as pass-thru
entity for purposes of section 470).
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8. Concerns Regarding Effective Date
Section 6 of the Technical Corrections Act appears to apply to
property acquired after March 12, 2004. As was indicated above, the IRS
and Treasury have indicated that the IRS will not apply section 470 to
disallow losses associated with property that is treated as tax-exempt
use property solely as a result of the application of section 168(h)(6)
in tax years beginning before 2006. The JCT Description indicates that
the technical correction is not intended to supersede the rules set
forth in the two regulatory moratoria that previously have been issued.
Nonetheless, this concept is not reflected in the bill language. In
addition:
Given that the Technical Corrections Act was introduced
in October of 2006, pass-thru entities would not have been able to even
attempt to comply with the Two-Part Test for their 2006 tax years.
Taxpayers may not be able to restructure arrangements
that were put in place after March 12, 2004, in order to comply with
the Two-Part Test in future years.
As was indicated above, we believe it is inappropriate
for the Technical Corrections Act to expand the portion of property
with respect to which losses are disallowed retroactively.
To this end, we recommend that section 470 not be applied by reason
of section 168(h)(6) to any property of a pass-thru entity acquired
before the date the Technical Corrections Act was introduced. The
amendments to section 470 similarly should apply only to property
acquired on or after the date the Technical Corrections Act was
introduced.\28\ Nonetheless, even this effective date will produce an
inequitable result where property is acquired after such date by
partnerships that have an existing ``arrangement'' or ``set aside'' or
an option at other than fair market value that cannot be modified or
eliminated. Thus, we respectfully submit that ``arrangements'' or ``set
asides'' or options at other than fair market value that are in place
as of the effective date should be grandfathered, such that they do not
cause a partnership to fail the Two-Part Exception.
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\28\ We recognize that the effective date of a technical correction
traditionally is the same as the effective date of the legislation to
which the technical correction relates. We note, however, that section
7 of the Technical Corrections Act, relating to dividends received by a
corporation that is a DISC or former DISC, breaks from this tradition
and applies only to dividends received on or after September 26, 2006
(the date that the Technical Corrections Act was introduced), in
taxable years ending after such date. We respectfully submit that the
tax policy concerns justifying such a delayed effective date are
extremely compelling in the context of section 470, such that the
effective date of section 470 and the amendment thereto similarly
should be adjusted.
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We do not believe that such modifications present an opportunity
for abuse (or should cause the legislation to lose revenue) insofar as
we are not aware of any partnerships that have been structured to
replicate the economics of a SILO arrangement. Indeed, the enactment of
section 470 in the 2004 Act should have deterred the promotion of any
such partnership arrangements.
V. Extension of Moratorium
As explained above, Congress intended for section 470 to apply only
to those pass-thru entities that are engaged in, or being used to
replicate, SILO transactions. As noted, we are not aware of any pass-
thru entities that, in fact, have been structured or utilized so as to
replicate SILO transactions. Nonetheless, a large number of pass-thru
entities in a variety of different industries are potentially subject
to the loss deferral rules merely because of the characteristics of
their partners and their allocations. While section 6 of the Technical
Corrections Act is a step in the right direction, it does not go far
enough in exempting from the application of section 470 those entities
that are not engaged in the abuses Congress intended to prevent.
Further, given the vagaries of the legislative process, it is unclear
whether technical corrections legislation will be enacted this year.
Therefore, if appropriate legislation is not enacted this year that
removes legitimate arrangements from the application of section 470, we
strongly encourage the Government to extend the moratorium on the
application of section 470 to pass-thru entities that are not engaged
in covered leasing transactions to tax years beginning before 2007.
Failing to extend the moratorium in this situation not only would
subject a large number of legitimate taxpayers to a loss deferral
regime in contravention of Congressional intent, but also would create
a compliance nightmare for both the Government and taxpayers given the
lack of operating rules for the application of section 470 to
partnerships. Further, extending the moratorium in late 2006 would not
open the door for synthetic SILOs to be implemented in 2006 given both
that most of 2006 already has transpired and that legislation is
pending that would subject any synthetic SILOs structured in late 2006
to the loss deferral rules.
II. Comments on Proposed Technical Corrections to Code Section 355
A. Current Law
The Tax Increase Prevention and Reconciliation Act of 2005 amended
the active trade or business requirement of section 355(b) by adding
paragraph (3). Under section 355(b)(3), all members of a corporation's
``separate affiliated group'' (determined under section 1504(a) and
without regard to section 1504(b)) (``SAG'') are treated as one
corporation for purposes of the active trade or business requirement.
Section 355(b)(3) applies to distributions made after May 17, 2006, and
on or before December 31, 2010.
B. Proposed Technical Correction
In the Tax Technical Corrections Act of 2006 (the ``Act''),
Congress has proposed to clarify that the term ``separate affiliated
group'' in section 355(b)(3) would not include any corporation that
became an otherwise qualifying member of the SAG (or of any SAG to
which the active business rule of the provision applies for the same
distribution) within the five-year period ending on the date of the
distribution by reason of one or more transactions in which gain or
loss was recognized in whole or in part. Additionally, the Act would
provide that a business conducted by the corporation at the time it
became a qualifying member will not be included. The Act also would
clarify that Treasury shall prescribe regulations that provide for
proper application of section 355(b)(2)(B), (C), and (D) to
distributions to which section 355(b)(3) applies.
The Joint Committee on Taxation's description of the Act
illustrates the proposed amendment as follows: Distributing spins off
Controlled. Within the five-year period ending on the date of the spin-
off, Distributing acquires, in a transaction in which gain or loss was
recognized, stock ownership of Corporation such that Corporation would
otherwise qualify as a member of Distributing's SAG. Corporation will
not be considered a member of the SAG of Distributing if it is retained
by Distributing in the spin-off. Moreover, if Distributing transfers
the stock of Corporation to Controlled prior to the distribution,
Corporation will not be considered a member of the SAG of Controlled.
Likewise, a business conducted by Corporation will not be includable in
either relevant SAG, regardless of whether such business is held by
another corporation that otherwise is included in either relevant SAG.
C. Analysis of Proposed Technical Correction
Historically, the requirements for section 355 treatment were based
on the definition of ownership as provided in section 368(c) (at least
80 percent of the voting stock and at least 80 percent of all other
classes of stock). For example, section 355(b)(2)(D) provides that if
control of a corporation, as defined in section 368(c), is acquired in
a transaction in which gain or loss is recognized, the business of that
corporation may not be relied upon to satisfy the active trade or
business requirement of section 355(b). New section 355(b)(3), however,
is based on the definition of ownership contained in section 1504(a)
without regard to section 1504(b) (at least 80 percent of the voting
power and value of all stock). Section 355(b)(3) as enacted by TIPRA
did not address the interaction of the affiliated group test of section
355(b)(3) and the control test of section 368(b)(2)(D), creating
certain anomalies.
In one such anomalous example, which may have been the impetus for
the proposed technical correction, it seems possible to satisfy the
section 355(b)(3) active trade or business requirement in contravention
of the policy (but not the language) of section 355(b)(2)(D) by
acquiring stock of a corporation that satisfies the section 1504
ownership requirement, but not the section 368(c) ownership
requirement. For example, if Distributing has an active business but
Controlled does not, Controlled could purchase the common stock of
Corporation, that represents 80 percent of the voting power and value
of Corporation, but not acquire any of Corporation's non-voting
preferred stock. As a technical matter, Controlled would satisfy the
active business requirement of section 355(b)(3) because Corporation
would be a member of Controlled's SAG. The proposed technical
correction would provide that Corporation could not be treated as part
of Controlled's SAG because it was purchased within the last five
years. It seems appropriate to ensure that the principle of section
355(b)(2)(D) should continue to apply to members of a corporation's SAG
that were acquired in a transaction in which gain or loss was
recognized.
The proposed technical correction seems to go further, though.
Excluding Corporation from the SAG seems to indicate that the
``expansion'' doctrine would not apply to an acquisition of stock in a
transaction in which gain or loss is recognized. Treasury Regulation
Sec. 1.355-3(b)(3)(ii) permits a corporation to acquire a business in a
taxable acquisition during the five-year period, provided that the
business is an expansion of a pre-existing active business (i.e., a
business that qualifies as an active business under section 355(b)(2)).
An expansion requires that the acquired business is in the same line of
business as the old-and-cold business. It is wholly consistent with the
operation and policy of section 355(b)(3), providing that all members
of a corporation's separate affiliated group are treated as one
corporation, that a taxable acquisition of a business by any member of
the separate affiliated group potentially could qualify as an expansion
regardless of whether by stock or asset acquisition. In fact, even
without the enactment of section 355(b)(3), the Internal Revenue
Service had determined that it was possible to rely on the expansion
doctrine for a business acquired in a taxable acquisition of stock.
D. Recommendation
The American Bar Association Section on Taxation strongly
recommends that the proposed technical correction not be enacted
without modification to make clear that any such change will not
interfere with the law that has developed to allow an expansion of a
historic business. This could be accomplished by making clear that the
expansion doctrine will be applied on an affiliated group basis,
without regard to the SAG membership and providing examples to
illustrate the principle.
We note that there are other anomalies created by the disparate
ownership definitions that could be addressed by modifications to
section 355. For example, assume Controlled (with no business of its
own) historically has owned all of the voting common stock of
Corporation representing 80 percent of the value of Corporation, but
does not own the nonvoting preferred stock, Corporation is part of
Controlled's SAG and thus satisfies section 355(b)(3). If Controlled
then purchases Corporation's nonvoting preferred stock prior to the
spin-off, section 355(b)(2)(D) technically would apply. Presumably,
Controlled should still be treated as satisfying the affiliated group
test of section 355(b)(3), but it is unclear how to reconcile the two
provisions and whether satisfying section 355(b)(3) would be dependent
on arguing that the purchase is an expansion of a pre-existing business
in Controlled or the Corporation itself (which does not seem sensible).
Clarification on this interaction would be welcome.
Williams & Jensen, P.C.
on behalf of Church Alliance
October 27, 2006
Chairman William Thomas
Ranking Member Charles Rangel
Committee on Ways and Means
1102 Longworth House Office Building
Washington, D.C. 20515
Dear Chairman Thomas and Ranking Member Rangel:
On behalf of the Church Alliance, an organization representing the
church benefits programs of a wide variety of denominations, I am
submitting the attached proposed technical correction to the Pension
Protection Act of 2006, for consideration to be included in the Tax
Technical Corrections Act of 2006.
Thank you for the opportunity to comment.
Sincerely,
David Starr
Counsel
Technical Correction for PPA, Section 867
Providing Relief on Section 415 Percentage Limits for Lower Paid
Participants of Church Plans
Certain defined benefit church plans provide benefit formulas that
favor certain lower-paid employees/ministers. For example, some plans
provide that benefits are calculated using a denomination's average
wage for those who earn less than the average amount. These plans are
finding that they are exceeding the tax law limitation under section
415(b) that prohibits paying benefits that exceed the average of the
highest three years of compensation. The Pension Protection Act of 2006
(H.R. 4, P.L. 109-280) addresses this issue in section 867 for certain
non-highly compensated participants in church plans. The enacted
language of the law reads as follows:
``SEC. 867. CHURCH PLAN RULE.
(a) In General--Paragraph (11) of section 415(b) of the Internal
Revenue Code of 1986 is amended by adding at the end the following:
``Subparagraph (B) of paragraph (1) shall not apply to a plan
maintained by an organization described in section 3121(w)(3)(A) except
with respect to highly compensated benefits. For purposes of this
paragraph, the term highly compensated benefits' means any benefits
accrued for an employee in any year on or after the first year in which
such employee is a highly compensated employee (as defined in section
414(q)) of the organization described in section 3121(w)(3)(A). For
purposes of applying paragraph (1)(B) to highly compensated benefits,
all benefits of the employee otherwise taken into account (without
regard to this paragraph) shall be taken into account.''
(b) Effective Date--The amendment made by this section shall apply
to years beginning after December 31, 2006.'' [emphasis added]
The JCT technical description of H.R. 4 (JCX-38-06) explains that
``[t]he provision provides that the 100 percent of compensation limit
does not apply to a plan maintained by a church or qualified church
controlled organization defined in section 3121(w)(3)(A) except with
respect to highly compensated benefits''' [emphasis added].
The Church Alliance believes the Code citation that is highlighted
in the text of the PPA is contrary to the JCT description and is a
technical drafting error, for the following reasons:
1. The language in the bill does not reflect the description
contained in the Joint Committee description. The description provides
that Qualified Church Controlled Organizations (QCCOs) were intended to
be covered under the provision. The actual citation to Code section
3121(w)(3)(A) omits QCCOs.
2. The language creates a distinction between churches and certain
Qualified Church Controlled Organizations (QCCOs) that exists nowhere
else in the pension provisions of the Code to our knowledge. Non-QCCOs
were intentionally excluded from the provision (for example, church
controlled hospitals). Distinctions between churches and QCCOs on the
one hand, and non-QCCOs on the other hand, have been made for church
plans in several cases in the Code. However, there is no policy reason
for protecting the pension benefits of lower-paid workers in a church,
but not the pensions of lower-paid workers of a qualified church
controlled organization (e.g., charity, church camp, mission, etc.).
We believe that the source of the technical error was that in the
final drafting process for H.R. 4, Congress used language originally
included in H.R. 1776 (Portman-Cardin) as introduced in the 108th
Congress. Section 906 of that bill included the Sec. 415 change, but
mistakenly limited it only to churches as described in the Code section
3121(w)(3)(A). That mistake was subsequently corrected when Rep.
Portman reintroduced his next version of the bill in the 109th Congress
(H.R. 1960, sec. 405). Moreover, the language was also correct in S.
2193 introduced this year by Senator Hutchison.
On behalf of the Church Alliance, we urge Congress to correct this
technical error in the language of section 867.
Proposed Language:
Section 867(a) of the Pension Protection Act of 2006 (P.L. 109-280)
is amended by striking `section 3121(w)(3)(A)' wherever it appears and
inserting `section 3121(w)(3)'.
October 31, 2006
The Honorable Bill Thomas
Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, DC 20515
The Honorable Charles Grassley
Chairman
Committee on Finance
U.S. Senate
Washington, DC 20510
Chairman Thomas and Chairman Grassley:
I am writing to convey the interests of small business advocacy
organizations that have contacted me regarding H.R. 6264 and its Senate
counterpart S. 2026, the Technical Corrections Act of 2006.
Specifically, trade and membership organizations that represent small
businesses have expressed concern with how Section 7 may impact their
operations.
Congress established the Office of Advocacy at the U.S. Small
Business Administration (SBA) to represent the views of small
businesses before Federal agencies and Congress. Public Law 94-305
requires that the Office of Advocacy, ``determine the impact of the tax
structure on small businesses and make legislative and other proposals
for altering the tax structure to enable all small business to realize
their potential for contributing to the improvement of the Nation's
economic well-being.'' \1\
---------------------------------------------------------------------------
\1\ 15 U.S.C. Sec. 634(b)(4).
---------------------------------------------------------------------------
The Office of Advocacy is an independent office within the U.S.
Small Business Administration, so the views expressed in this letter do
not necessarily reflect the views of the SBA or the Administration.
This letter was not circulated to the Office of Management and Budget
for comment prior to its submittal to Congress.
First, I must commend the Committee for soliciting review and
comment, for working in consultation with the Joint Committee on
Taxation, and for working with the U.S. Department of the Treasury
prior to finalizing technical corrections. The technical corrections
legislation will be better written due to your inclusiveness and your
commitment to make comments publicly available after the comment period
has ended.
I feel that it is my responsibility to convey that some small
business groups have concerns with Section 7. The small business groups
that have contacted me believe Section 7 will prevent Interest Charge
Domestic International Sales Corporation (IC-DISC) dividends from being
taxed at the lower 15-percent tax rate.
I pointed out the positive impact that recent tax legislation has
had on small business when I testified before the Small Business
Committee in the House of Representatives in 2003.\2\ More recently,
dynamic analysis conducted by the U.S. Department of Treasury,
documents the economic benefits of lower tax rates on dividends for
small business and the economy in general.\3\ The tax relief
legislation drafted by your Committee and enacted in 2001 and 2003
demonstrates an appreciation for how legislative changes to the tax
code impact small business. I would like to work with the Committee to
ensure that small business views are fully vetted prior to finalizing
the Tax Technical Corrections Act of 2006 so that small business can
continue to benefit from tax relief passed by the 108th and 109th
Congresses.
---------------------------------------------------------------------------
\2\ Testimony of Thomas M. Sullivan, Chief Counsel for Advocacy,
U.S. Small Business Administration before the Committee on Small
Business, U.S. House of Representatives, Assisting Small Business
Through the Tax Code--Recent Gains and What Needs to be Done (July 23,
2003), http://www.sba.gov/advo/laws/test03_0723.html
\3\ U.S. Department of the Treasury, Office of Tax Analysis, A
Dynamic Analysis of Permanent Extension of the President's Tax Relief
(July 25, 2006), http://www.ustreas.gov/press/releases/ reports/
treasurydynamicanalysisreporjjuly252006.pdf
---------------------------------------------------------------------------
If you have questions about the content of this letter, please do
not hesitate to contact me or my office's tax counsel, Candace Ewell.
Sincerely,
Thomas M. Sullivan
Chief Counsel for Advocacy
NH Research
Irvine, California 92606
October 31, 2006
The Honorable Bill Thomas
Chairman, Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Congressman Thomas,
NH Research is a privately-owned, $8-million-per-year manufacturer
of automated test equipment for electronic power supplies.
Approximately 1/3 of our business is international. This percentage,
however, is growing rapidly due to the mass exodus of domestic
electronics manufacturing to lower-cost Asian countries. In order to
compete for business abroad we must invest heavily in local sales and
service offices. For example, we have had to established offices in
Shenzhen and Suzhou, China, where 70% of the world's electronic power
supplies are now manufactured.
NH Research has only been able to accomplish this through the
benefits afforded by the IC-DISC, which we have had in place since
1986.
To suddenly repeal this benefit is both unfair and hardship to our
export sales efforts. In addition, it is disruptive to our 2006 year-
end tax planning. Small private companies like us need all help they
can get to compete in the global marketplace.
We urge you to delay enactment of this ``technical correction''
until more discussion is held about the unintended consequences on
small manufacturers increasingly dependent on export sales.
Thank you for considering our comments.
Sincerely,
Peter Swartz
President
Stoughton Trailers
Stoughton, Wisconsin 53589
October 30, 2006
Hon. Bill Thomas Chairman House Ways and Means Committee
Dear Hon. Thomas and Committee:
We are a truck trailer, container and chassis manufacturer
employing 1,300 people in Stoughton Wisconsin, Evansville Wisconsin and
Brodhead Wisconsin. This year, within a six-month period, the Chinese
have put our Evansville facility out of business. The Evansville
facility was dedicated to manufacturing domestic containers and
chassis. We have employed approximately 300 people there since 1991.
This year the Chinese have put U.S. manufacturers out of business,
including Hyundai, Inc., a manufacturer of the same product in Tijuana,
Mexico. The Chinese are importing both the chassis and the container to
the West Coast cheaper than we can buy the materials for. Even Hyundai,
Inc. of Tijuana, Mexico with their $7/hour labor fully burdened cannot
compete. They are already making inroads into the U.S. over-the-road
freight trailer market. I can foresee that within a few years they will
import the bulk of truck trailers manufactured in this country. We also
manufacture a large amount of trailers for export to Canada. I want to
bring your attention to another pending disadvantage we will have if a
Tax Technical Correction is enacted.
This letter is to alert you to a pending tax law development that
we believe will be very harmful to U.S. based small and mid-sized
manufacturers. The proposed change will increase taxes on U.S.
manufacturers, making it even harder to compete against manufacturers
located in other countries that offer incentives (i.e. China
manufacturing tax holidays or India software exportation holidays.)
The Technical Corrections Bill introduces a Policy Change. Section
7 of the Tax Technical Corrections Act of 2006 prevents dividends
received form an IC-DISC from obtaining the same maximum 15% federal
tax rate as qualifying dividends from other types of corporations. Such
a substantial change in tax law would seem to merit open consideration
by House members and the public.
The One-Time Dividends Received Deduction Did Not Help Most
Privately-Held Manufacturers. Various sources have quoted figures
suggesting that small businesses represent the vast majority of new
jobs created in the U.S. But, the one-time dividend received deduction
available last year mostly benefited those U.S. multinationals who had
already exported jobs and who had already built up significant foreign
infrastructures. There was no corresponding reward for those U.S.
enterprises that built and maintained their businesses at home.
The Tax-Sophisticated Manufacturer Still Obtains Offshore Tax
Benefits. The Technical Corrections Bill does not eliminate the
availability of the 15% maximum federal rate on dividends from
qualifying foreign corporations or qualifying corporations formed in
possessions of the United States. Therefore, competitors who choose to
locate operations outside of the U.S. can still benefit from the 15%
tax rate after passage of the Technical Corrections Bill. This result
seems unfair.
The Foreign-Owned Manufacturer Still Obtains Export Benefits. The
Technical Corrections Bill applies only to U.S. non-corporate
taxpayers. It doesn't seem fair that Congress would enact a Technical
Correction that appears to aid the foreign-owned U.S.-owned, U.S.-based
manufacturer, both of whom are competing in the global marketplace.
Thank you for your consideration of this letter. I appreciate your
leadership on this important issue to U.S.-owned manufacturers.
Very truly yours,
Donald D. Wahlin
CEO
Software and Information Industry Association
October 31, 2006
The Honorable Charles Grassley
Chairman
Committee on Finance
U.S. Senate
Washington, DC 20510
The Honorable Bill Thomas
Chairman
House Committee on Ways and Means
U.S. House of Representatives
Washington, DC 20515
Dear Chairmen Thomas and Grassley,
On behalf of the Software & Information Industry Association
(SIIA), I appreciate the opportunity to provide feedback on the Tax
Technical Corrections Act of 2006. As a representative of many small
and medium-sized technology companies, I am concerned about the
potential effects of the amendments related to dividends from IC-DISCs,
specifically, the amendments to Sec. 302 of the Jobs and Growth Tax
Relief Reconciliation Act of 2003 (JGTRRA).
SIIA appreciates the efforts that you have taken in drafting the
tax technical corrections legislation to ensure that the effects of
Section 302 are not retroactive to the date of enactment of the JGTRRA.
However, because a clear, simple reading of JGTRRA could have led many
companies to utilize the IC-DISC for obvious reasons, we are concerned
that any effective date of Section 302 other than a prospective date
would present harmful consequences for many companies utilizing IC-
DISCS--consequences that we believe are unintended and unjustified by
this legislation.
Companies, in creating an IC-DISC, have a choice about when to
structure the commission payment and resulting dividend. Some taxpayers
choose to do this monthly, some quarterly, some semi-annually. Many
choose to declare the commission and the dividend annually--at the end
of the year--to minimize administration and financial charges that
result from the transaction. As the amendment to Section 302 is
proposed, these companies would be prohibited from engaging in an IC-
DISC transaction for calendar year 2006. Effectively, the retroactive
nature of this proposed amendment punishes these taxpayers for creating
a transaction that was perfectly lawful. Furthermore, the retroactive
amendment treats similarly situation taxpayers differently for no other
reason than the choice of administrative mechanics, and it does so
without notice or a chance to make other decisions before the rules
would be amended.
In light of the unintended consequences of choosing September 29,
2006 as the effective date, I respectfully request that the drafters
change the effective date so that all similarly situated taxpayers are
treated similarly. Thus, we would urge the drafters to choose tax years
beginning after December 31, 2006 as a more equitable effective date.
Sincerely,
Ken Wasch
President
KPMG LLC
October 25, 2006
Hon. Bill Thomas, Chairman
Committee on Ways & Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington D.C. 20515
Dear Chairman Thomas,
This letter is being submitted in response to your September 29,
2006 request for comments regarding the ``Tax Technical Corrections Act
of 2006,'' introduced on September 29, 2006, in the House of
Representatives as H.R. 6264 (the ``Act''). See Committee on Ways &
Means, Press Release, September 29, 2006. In particular, this letter
requests that the Committee expressly confirm the intent of the
proposed clarification of the active trade or business definition of
section 355 by section 2(b) of the Act, particularly as discussed in
the related Joint Committee on Taxation report. See Joint Committee on
Taxation, Description of the Tax Technical Corrections Act of 2006, p.
3 (JCX-48-06), October 2, 2006 (the ``JCT Report'').
As I understand it, the proposed clarification is intended to
ensure that a taxable stock acquisition does not result in section
355(b) being satisfied if it would not have resulted in section 355(b)
being satisfied prior to the enactment of section 355(b)(3). It is my
further understanding that the proposed clarification, however, is not
intended to limit the Department of the Treasury or the Internal
Revenue Service from interpreting the application of section 355(b)(2)
in the context of stock acquisitions as they had prior to the
legislative enactment of section 355(b)(3) or, as appropriate, from
altering such interpretations.
For example, the otherwise qualifying active trade or business
conducted by a corporation acquired in a taxable stock acquisition from
an affiliate within the five-year period prior to the distribution may
continue to satisfy section 355(b)(2)(D) in circumstances in which the
``purchase'' basis is eliminated. See Treas. Reg. Sec. 1.355-3(b)(4)
(applicable to acquisitions prior to the Revenue Act of 1987 and
Technical and Miscellaneous Revenue Act of 1988) and related private
letter rulings; see also Treas. Reg. Sec. 1.355-6(b)(2)(iii)(A)-(C).
Similarly, to the extent the ``business expansion'' doctrine, as
reflected in Treas. Reg. Sec. 1.355-3(b)(3)(ii) and the related
legislative history (see Conf. Rep. No. 2543, at 38 (1954)), sanctioned
a taxable stock acquisition prior to the enactment of section
355(b)(3), such acquisition may continue to be sanctioned. See PLR
200545001 (March 10, 2005).
If this understanding of the intent of Section 2(b) of the Act is
correct, it is respectfully requested that the Committee include
language confirming such understanding in any Committee Report that may
accompany the Act's enactment. For that purpose, included below for
your reference is proposed clarifying language for the JCT Report which
is marked to show the proposed revisions (``Appendix A'').
Respectfully submitted,
Thomas F. Wessel
Principal
______
Appendix A_Proposed Clarifying Language Highlighted
DESCRIPTION OF THE TAX TECHNICAL CORRECTIONS ACT OF 2006
Prepared by the Staff
of the
JOINT COMMITTEE ON TAXATION
OCTOBER 2, 2006
JCX-48-06
INTRODUCTION
This document,\1\ prepared by the staff of the Joint Committee on
Taxation, provides a description of the Tax Technical Corrections Act
of 2006, as introduced on September 29, 2006, in the House of
Representatives as H.R. 6264, and in the Senate as S. 4026.
I. TAX TECHNICAL CORRECTIONS
[p. 2] The bill includes technical corrections to recently enacted
tax legislation. Except as otherwise provided, the amendments made by
the technical corrections contained in the bill take effect as if
included in the original legislation to which each amendment relates.
Amendments Related to the Tax Increase Prevention and Reconciliation
Act of 2005
[. . .] [p. 3] Modification of active business definition under
section 355 (Act sec. 202).--The provision clarifies that, for purposes
of the special rule in section 355(b)(3) relating to the active
business requirement, the term ``separate affiliated group'' does not
include any corporation that became an otherwise qualifying member of
such separate affiliated group (or of any other separate affiliated
group to which the active business rule of the provision applies with
respect to the same distribution) within the 5-year period ending on
the date of the distribution by reason of one or more transactions in
which gain or loss was recognized in whole or in part., or in part, if
such transaction(s) would have precluded such corporation from
qualifying as being engaged in the active conduct of a trade or
business prior to the enactment of section 355(b)(3). Also, a business
conducted by such a corporation at the time it became such an otherwise
qualifying member shall not be included. Thus in determining the
satisfaction of the active business requirement if, prior to the
enactment of section 355(b)(3), it could not have been so included.
Therefore, as one example, if a parent corporation spins off a
subsidiary and, within the 5-year period ending on the date of the
spin-off the parent corporation had acquired, in a transaction in which
gain or loss was recognized, stock ownership of a third corporation
such that the third corporation would otherwise qualify as a member of
a separate affiliated group in the spin-off, then that third
corporation shall not be considered a member of the separate affiliated
group of the parent corporation if it is retained by the parent
corporation in the spin-off. Also, that third corporation shall not be
considered a member of the separate affiliated group of the spun-off
subsidiary, even if the parent corporation has dropped the stock of
that third corporation down to the subsidiary in a tax-free transaction
prior to the spin-off. Similarly, a business conducted by the acquired
third corporation at the time that corporation would otherwise have
qualified as a member of a relevant separate affiliated group (but for
the transaction in which gain or loss was recognized) also will not be
includable in either relevant separate affiliated group, regardless of
whether such business is held by another corporation that otherwise is
included in either relevant separate affiliated group.
The conclusions in the foregoing examples that the acquired
corporation and its business are not included in the relevant separate
affiliated group are based on an assumption that such corporation or
business could not have been relied upon to satisfy section 355(b)
prior to the enactment of section 355(b)(3). Thus, for example, no
implication is intended as to whether section 355(b) is satisfied in
the case of a corporation whose stock was acquired in a taxable
transaction from (i) an affiliate after the Revenue Act of 1987 and the
Miscellaneous Revenue Act of 1988 (see Treas. Reg. section 1.355-
3(b)(4)), or (ii) a non-affiliate where a direct taxable asset
acquisition could satisfy such requirement under the ``business
expansion'' doctrine.
The provision also clarifies that the Treasury Department shall, as
appropriate, prescribe regulations that or otherwise interpret section
355(b)(3) to provide for the proper application of sections
355(b)(2)(B), (C) and (D) to distributions to which the provision
applies.
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\1\ This document may be cited as follows: Joint Committee on
Taxation, Description of the Tax Technical Corrections Act of 2006
(JCX-48-06), October 2, 2006.
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Statement of Williams & Jensen PLLC, on behalf of Houston Firefighters'
Relief and Retirement Fund
The Pension Protection Act, Section 828
SEC. 828. WAIVER OF 10 PERCENT EARLY WITHDRAWAL POENALTY TAX ON CERTAIN
DISTRIBUTIONS OF PENSION PLANS FOR PUBLIC SAFETY EMPLOYEES.
(a) In General.--Section 72(t) of the Internal Revenue Code of
1986 (relating to subsection not to apply to certain distributions) is
amended by adding at the end the following new paragraph:
``(10) Distributions to qualified public safety employees in
governmental plans.--
``(A) In general.--In the case of a distribution to a qualified
public safety employee from a governmental plan (within the meaning of
section 414(d)) which is a defined benefit plan, paragraph (2)(A)(v)
shall be applied by substituting `age 50' for `age 55'.
``(B) Qualified public safety employee.--For purposes of this
paragraph, the term qualified public safety employee' means any
employee of a State or political subdivision of a State who provides
police protection, fire-fighting services, or emergency medical
services for any area within the jurisdiction of such State or
political subdivision.''.
(b) Effective Date.--The amendment made by this section shall
apply to distributions after the date of the enactment of this Act.
Explanation of Section 828
According to the Joint Committee on Taxation's Technical
Explanation of the Pension Protection Act (JCX-38-06, p. 177), Section
828 provides that ``the 10-percent early withdrawal tax does not apply
to distributions from a governmental defined benefit pension plan to a
qualified public safety employee when separated from service after age
50.''
Questions Following Enactment
(1) Whether the Section 72(t)(4) recapture tax would apply if a
qualified public safety employee began a series of substantially equal
periodic payments before or after enactment of Section 828 and then
changed the series to utilize the new Section 828 exception?
(2) Whether a qualified public safety employee who begins a series
of substantially equal periodic payments before or after enactment of
Section 828 is precluded from utilizing the new exception provided
under Section 828?
Discussion of Questions
Question 1--Prior to or following enactment of Section 828 some
qualified public safety employees reached age 50, separated from
service, and began taking a series of substantially equal periodic
payments. These payments may have been necessitated by their children's
education expenses or their own health expenses. Meanwhile, other
public safety employees reached age 50, separated from service, but
were in a financial situation that allowed them to defer distributions.
While the latter group may begin taking penalty-free distributions
following enactment of Section 828, the former group cannot change its
series of substantially equal period payments without triggering the
recapture tax under Section 72(t)(4). The former group finds itself
disadvantaged under the revised statute.
The final months or years of a public safety employee's life may be
ones of catastrophic illness brought about by the on-the-job hazards
they faced for years while protecting the public. Through enactment of
Section 828 Congress demonstrated its belief that public safety
employees who have reached age 50 should be given the flexibility to
receive pension distributions without being penalized. Unfortunately, a
small class of public safety employees stand to be denied this tax
relief because they began a series of periodic payments.
The first sentence of the proposed technical correction language
below provides that those qualified public safety employees who find
themselves caught between the recapture tax and the new Section 828
exception will not be subject to the additional tax.
Question 2--A question has been raised within the governmental plan
community over whether a qualified public safety employee who
began a series of substantially equal periodic payments would
be precluded from taking advantage of the new Section 828. The
second sentence of the language below provides that commencing
a series of substantially equal periodic payments does not
preclude a qualified public safety employee from subsequently
taking a penalty-free distribution under Section 828.
Proposed Technical Correction Language
Section 72(t)(10) is amended by adding a new subparagraph:
``(C) APPLICATION TO SERIES OF SUBSTANTIALLY EQUAL PERIODIC
PAYMENTS.--Section 72(t)(4) shall not apply if a change in a series of
substantially equal periodic payments is made after the date of
enactment of this paragraph to a qualified public safety employee,
provided the qualified public safety employee met the requirements of
subparagraph (A) at the time the substantially equal periodic payments
commenced. Additional tax under this section is waived as to
distributions to which subparagraph (A) applies, regardless of whether
prior distributions were made pursuant to section 72(t)(2)(A)(iv). ''