[Congressional Record Volume 145, Number 38 (Wednesday, March 10, 1999)]
[Senate]
[Pages S2503-S2506]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. BREAUX (for himself and Mr. Mack):
  S. 572. A bill to prohibit the Secretary of the Treasury from issuing 
regulations dealing with hybrid transactions; to the Committee on 
Finance.


                   SUBPART F OF INTERNAL REVENUE CODE

  Mr. BREAUX. Mr. President, today Mr. Mack and I are again introducing 
legislation to place a permanent moratorium on the Department of the

[[Page S2504]]

Treasury's authority to finalize any proposed regulations issued 
pursuant to Notice 98-35, dealing with the treatment of hybrid branch 
transactions under subpart F of the Internal Revenue Code. Our bill 
also prohibits Treasury from issuing new regulations relating to the 
tax treatment of hybrid transactions under subpart F and requires the 
Secretary to conduct a study of the tax treatment of hybrid 
transactions and to provide a written report to the Senate Committee on 
Finance and the House Committee on Ways and Means.
  By way of background, the United States generally subjects U.S. 
citizens and corporations to current taxation on their worldwide 
income. Two important devices mitigate or eliminate double taxation of 
income earned from foreign sources. First, bilateral income tax 
treaties with many countries exempt American taxpayers from paying 
foreign taxes on certain types of income (e.g. interest) and impose 
reduced rates of tax on other types (e.g. dividends and royalties). 
Second, U.S. taxpayers receive a credit against U.S. taxes for foreign 
taxes paid on foreign source income. To reiterate, these devices have 
been part of our international tax rules for decades and are aimed at 
preventing U.S. businesses from being taxed twice on the same income. 
The policy of currently taxing U.S. citizens on their worldwide income 
is in direct contrast with the regimes employed by most of our foreign 
trading competitors. Generally they tax their citizens and domestic 
corporations only on the income earned within their borders (the so-
called ``water's edge'' approach).
  Foreign corporations generally are also not subject to U.S. tax on 
income earned outside the United States, even if the foreign 
corporation is controlled by a U.S. parent. Thus, U.S. tax on income 
earned by foreign subsidiaries of U.S. companies--that is, from foreign 
operations conducted through a controlled foreign corporation (CFC)--is 
generally deferred until dividends paid by the CFC are received by its 
U.S. parent. This policy is referred to as ``tax deferral.''
  In 1961, President John F. Kennedy proposed eliminating tax deferral 
with respect to the earnings of U.S.-controlled foreign subsidiaries. 
The proposal provided that U.S. corporations would be currently taxable 
on their share of the earnings of CFCs, except in the case of 
investments in certain ``less developed countries.'' The business 
community strongly opposed the proposal, arguing that in order for U.S. 
multinational companies to be able to compete effectively in global 
markets, their CFCs should be subject only to the same taxes to which 
their foreign competitors were subject.
  In the Revenue Act of 1962, Congress rejected the President's 
proposal to completely eliminate tax deferral, recognizing that to do 
so would place U.S. companies operating in overseas markets at a 
significant disadvantage vis-a-vis their foreign competitors. Instead, 
Congress opted to adopt a policy regime designed to end deferral only 
with respect to income earned from so-called ``tax haven'' operations. 
This regime, known as ``subpart F,'' generally is aimed at currently 
taxing foreign source income that is easily moveable from one taxing 
jurisdiction to another and that is subject to low rates of foreign 
tax.
  Thus, the subpart F provisions of the Internal Revenue Code (found in 
sections 951-964) have always reflected a balancing of two competing 
policy objectives: capital export neutrality (i.e. neutrality of 
taxation as between domestic and foreign operations) and capital import 
neutrality (i.e. neutrality of taxation as between CFCs and their 
foreign competitors). While these competing principles continue to form 
the foundation of subpart F today, recent actions by the Department of 
the Treasury threaten to upset this long-standing balance.
  On January 16, 1998, the Department of the Treasury announced in 
Notice 98-11 its intention to issue regulations to prevent the use of 
hybrid branches ``to circumvent the purposes of subpart F.'' The hybrid 
branch arrangements identified in Notice 98-11 involved entities 
characterized for U.S. tax purposes as part of a controlled foreign 
corporation, but characterized for purposes of the tax law of the 
country in which the CFC was incorporated as a separate entity. The 
Notice indicated that the creation of such hybrid branches was 
facilitated by the entity classification rules contained in section 
301.7701-I through -3 of the Income Tax Regulations (the ``check the 
box'' regulations).
  Notice 98-11 acknowledged that U.S. international tax policy seeks to 
balance the objectives of capital export neutrality with the objective 
of allowing U.S. businesses to compete on a level playing field with 
foreign competitors. In the view of the Treasury and IRS, however, the 
hybrid transactions attacked in the Notice ``upset that balance.'' 
Treasury indicated that the regulations to be issued generally would 
apply to hybrid branch arrangements entered into or substantially 
modified after January 16, 1998, and would provide that certain 
payments to and from foreign hybrid branches of CFCs would be treated 
as generating subpart F income to U.S. shareholders in situations in 
which subpart F would not otherwise apply to a hybrid branch as a 
separate entity. This represented a significant expansion of subpart F, 
by regulation rather than through legislation.
  Shortly after Notice 98-11 was issued, the Administration released 
its Fiscal Year 1999 budget proposals which, among other things, 
included a provision requesting Congress to statutorily grant broad 
regulatory authority to the Treasury Secretary to prescribe regulations 
clarifying the tax consequences of hybrid transactions in cases in 
which the intended results are inconsistent with the purposes of U.S. 
tax law. . . . While the explanation accompanying the budget proposal 
argued that this grant of authority as applied to many cases ``merely 
makes the Secretary's current general regulatory authority more 
specific, and directs the Secretary to promulgate regulations pursuant 
to such authority,'' the explanation conceded that in other cases, 
``the Secretary's authority may be questioned and should be 
clarified.''

  Notice 98-11 and the accompanying budget proposal generated 
widespread concerns in the Congress and the business community that the 
Treasury was undertaking a major new initiative in the international 
tax arena that would undermine the ability of U.S. multinationals to 
compete in international markets. For example, House Ways and Means 
Committee Chairman Bill Archer wrote to Treasury Secretary Rubin on 
March 20, 1998 requesting that ``Notice 98-11 be withdrawn and that no 
regulations in this area be issued or allowed to take effect until 
Congress has an appropriate opportunity, to consider these matters in 
the normal legislative process.'' The Ranking Democrat on the 
Committee, Charles Rangel, wrote to Secretary Rubin expressing strong 
concerns about the Treasury's increasing propensity to ``legislate 
through the regulatory process as evidenced by Notice 98-11.''
  Despite these concerns, on March 23, 1998, the Treasury department 
issued two sets of proposed and temporary regulations, the first 
relating to the treatment of hybrid branch arrangements under subpart 
F, and the second relating to the treatment of a CFC's distributive 
share of partnership income. As Notice 98-11 had promised, the 
regulations provided that certain payments between a controlled foreign 
corporation and a hybrid branch would be recharacterized as subpart F 
income if the payments reduce the payer's foreign taxes.
  The week after the temporary and proposed regulations were issued, 
the Senate Finance Committee considered H.R. 2676, the Internal Revenue 
Service Restructuring and Reform Act of 1998. A provision was included 
in the bill prohibiting the Treasury and IRS from implementing 
temporary or final regulations with respect to Notice 98-11 prior to 
six months after the date of enactment of H.R. 2676. The Senate bill 
also included language expressing the ``sense of the Senate'' that 
``the Department of the Treasury and the Internal Revenue Service 
should withdraw Notice 98-11 and the regulations issued thereunder, and 
that the Congress, and not the Department of the Treasury or the 
Internal Revenue Service, should determine the international tax policy 
issues relating to the treatment of hybrid transactions under subpart F 
provisions of the Code.''
  Opposition to Notice 98-11 and the temporary and proposed regulations

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continued to mount. On April 23, 1998, 33 Members of the House Ways and 
Means Committee wrote to Secretary Rubin expressing concern about the 
Treasury's decision to move forward and issue regulations pursuant to 
Notice 98-11 without an appropriate opportunity for Congress to 
consider this issue in the normal legislative process, urging Treasury 
to withdraw the regulations.
  In the face of these and other pressures from the Congress and the 
business community, on June 19, 1998, the Treasury Department announced 
in Notice 98-35 that it was withdrawing Notice 98-11 and the related 
temporary, and proposed regulations. According to Notice 98-35, 
Treasury intends to issue a new set of proposed regulations to be 
effective in general for payments made under hybrid branch arrangements 
on or after June 19, 1998. These regulations, however, will not be 
finalized before January 1, 2000, in order to permit both the Congress 
and Treasury Department the opportunity to further study the issues 
that were raised following the publication of Notice 98-11 earlier this 
year.
  While we applaud the Treasury's decision to withdraw Notice 98-11 and 
the temporary regulations, we believe that additional legislative 
action is needed to prevent the Treasury from finalizing the 
forthcoming regulations until Congress considers the issues involved. 
We believe that only the Congress has the authority to achieve a 
permanent resolution of this issue. Notice 98-35, like its predecessor, 
Notice 98-11 continues to suffer from a fatal flaw; it is the 
prerogative of Congress, and not the Executive Branch, to pass laws 
establishing the nation's fundamental tax policies. Simply put, Notice 
98-35 adds restrictions to the subpart F regime that are not supported 
by the Code's clear statutory language, and there has been no express 
delegation of regulatory authority to the Treasury that relates 
specifically to the issues presented in the Notice.
  More importantly, we question the policy objectives to be achieved by 
Notice 98-35 and the accompanying proposed regulations. We do not 
understand the rationale for penalizing U.S. multinational companies 
for employing normal tax planning strategies that reduce foreign (as 
opposed to U.S.) income taxes. Moreover, Notice 98-35 is contrary to 
recent Congressional efforts to simplify the international tax 
provisions of the Code. For example, the Congress reduced complexity 
and ridded the code of a perverse incentive for U.S. companies to 
invest overseas by repealing the Section 956A tax on excess passive 
earnings in 1996. Again in 1997, the Congress repealed the application 
of the Passive Foreign Investment Company regime to U.S. shareholders 
of controlled foreign corporations because of the complexity involved 
in applying both regimes, in addition to enacting a host of other 
foreign tax simplifications. The Senate Finance Committee will hold a 
hearing on March 11, 1999 to further investigate the reforms needed in 
the international tax arena that not only reduce complexity, but also 
encourage U.S. global economic competition. I fully expect Notice 98-35 
to be discussed at this hearing.
  In order for Congress to gain a better understanding of the Treasury 
Department's position on this matter, our bill would require the 
Treasury to conduct a thorough study of the tax treatment of hybrid 
transactions under subpart F and to provide a report to the Senate 
Committee on Finance and House Committee on Ways and Means on this 
issue.
  If the forthcoming regulations are permitted to be finalized by the 
Treasury, U.S. multinational businesses will be placed at a competitive 
disadvantage vis-a-vis foreign companies who remain free to employ 
strategies to reduce the foreign taxes they pay. Clearly, such a result 
should be permitted to take effect only if Congress, after having an 
opportunity to fully consider all of the tax and economic issues 
involved, agrees that the arguments advanced by the Treasury are 
compelling and determines that additional statutory changes to subpart 
F are necessary and appropriate.
  Mr. President, I ask unanimous consent that the text of the bill be 
printed in the Record.
  There being no objection, the bill was ordered to be printed in the 
Record, as follows:

                                 S. 572

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. HYBRID TRANSACTIONS UNDER SUBPART F.

       (a) Prohibition on Regulations.--The Secretary of the 
     Treasury (or his delegate)--
       (1) shall not issue temporary or final regulations relating 
     to the treatment of hybrid transactions under subpart F of 
     part III of subchapter N of chapter 1 of the Internal Revenue 
     Code of 1986 pursuant to Internal Revenue Service Notice 98-
     35 or any other regulations reaching the same or similar 
     result as such notice,
       (2) shall retroactively withdraw any regulations described 
     in paragraph (1) which were issued after the date of such 
     notice and before the date of the enactment of this Act, and
       (3) shall not modify or withdraw sections 301.7701-1 
     through 301.7701-3 of the Treasury Regulations (relating to 
     the classification of certain business entities) in a manner 
     which alters the treatment of hybrid transactions under such 
     subpart F.
       (b) Study and Report.--The Secretary of the Treasury (or 
     his delegate) shall study the tax treatment of hybrid 
     transactions under such subpart F and submit a report to the 
     Committee on Ways and Means of the House of Representatives 
     and the Committee on Finance of the Senate. The Secretary 
     shall hold at least one public hearing to receive comments 
     from any interested party prior to submitting such report.

  Mr. MACK. Mr. President, today Senator Breaux and I introduce a bill 
reaffirming that the lawmaking power is the province of the Congress, 
not the executive branch. Our bill prohibits the Treasury Department 
from issuing regulations that would impose taxes on U.S. companies 
merely because one of their subsidiaries pays money to itself.
  As a general rule, U.S. corporations pay U.S. corporate income tax on 
the earnings of their foreign subsidiaries only when those earnings are 
actually distributed to the U.S. parent companies. An exception to this 
general rule is contained in subpart F of the Internal Revenue Code, 
which accelerates the income tax liability of U.S. parent companies 
under certain circumstances. The Treasury Department has announced, in 
Notice 98-35, an intention to issue regulations that will accelerate 
income tax liability for U.S. companies--not based on the specific 
circumstances enumerated in subpart F, but instead on a new 
``interpretation'' of the ``policies'' that Treasury infers from that 
36-year-old provision. This action crosses the line between 
administering the laws and making the laws, and cannot be allowed by 
Congress.
  Notice 98-35 concerns so-called ``hybrid arrangements.'' These 
involve business entities that are considered separate corporations for 
foreign tax purposes, but are viewed as one company with a branch 
office for U.S. purposes. U.S. companies organize their subsidiaries in 
this manner to reduce the amount of foreign taxes they owe. 
Transactions between a subsidiary and its branch have no impact on U.S. 
taxable income of the parent, as its subsidiary is merely paying money 
to itself. But the Treasury Department intends to impose a tax on the 
U.S. parent to penalize it for reducing the foreign taxes it owes.
  This effort is wrong for several reasons. First, the Treasury 
Department possesses only the power to issue regulations to administer 
the laws passed by Congress. New rules based on Congressional purpose 
are known as laws, and under the Constitution laws are made by 
Congress.
  Second, the Treasury Department is elevating one policy underlying 
subpart F--taxing domestic and foreign operations in the same manner--
over the other policy of maintaining the competitiveness of U.S. 
companies in foreign markets. This proposed tax would put U.S.-owned 
subsidiaries at a competitive disadvantage.
  Finally, the Treasury Department should not impose a tax on U.S. 
companies to force these companies to reorganize in a way that 
increases the taxes they owe to foreign countries. The Treasury 
Department is not the tax collector for other nations. And by raising 
the foreign tax bills of U.S. companies, the Treasury Department is 
also increasing the size of foreign tax credits and thereby reducing 
U.S. tax revenues.
  The Treasury Department is not only making policy that it has no 
right to make, it is also making bad policy. Our bill places a 
moratorium on this lawmaking. It also directs the Treasury

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Secretary to study these issues and submit a report to the tax-writing 
committees of Congress. Many people and organizations, including the 
Treasury Department, desire changes in the tax laws. But only Congress 
has the power to make these changes, and this is a power we intend to 
keep.
                                 ______