Today, the Treasury Department released “Second Report to the President on Identifying and Reducing Tax Regulatory Burdens,” (the “Report”) dated October 2. The Report was required by Executive Order (EO) 13789 and follows up on an interim report, issued on June 22 as Notice 2017-38, in which Treasury identified eight regulations for review under EO 13789. The EO directed the Secretary of the Treasury to identify significant tax regulations issued on or after January 1, 2016 that: (i) impose an undue financial burden on US taxpayers; (ii) add undue complexity to the federal tax laws; or (iii) exceed the statutory authority of the IRS. Treasury and the IRS received more than 140 comments (plus thousands of “form” comments) on the eight regulations identified in the interim report.
With respect to the eight regulations identified in the interim report, Treasury now recommends, consistent with law, that proposed regulations under sections 2704 and 103 be withdrawn entirely; the temporary or final regulations under sections 385, 707, 752, and 7602 be revoked in part and retained and revised in part; and the regulations under sections 367, 337, and 987 be revised.
The Report also notes that Treasury continues to analyze all recently issued significant regulations and is considering possible reforms of several regulations not identified in the interim report, including regulations under section 871(m) (relating to payments treated as US source dividends) and the Foreign Account Tax Compliance Act (FATCA). In addition, Treasury and the IRS initiated a comprehensive review of all tax regulations, regardless of when they were issued, to identify regulations that are unnecessary, create undue complexity, impose excessive burdens, or fail to provide clarity and useful guidance. Included in this review are longstanding temporary or proposed regulations that have not expired or been finalized. As part of this process, the IRS has already identified more than 200 regulations for potential revocation, most of which have been outstanding for many years. Treasury and the IRS expect to begin the rulemaking process for revoking these regulations in the fourth quarter of 2017. We anticipate that some or all of the regulations identified for revocation will appear on the Priority Guidance Plan, which Treasury expects to release this fall.
Proposed Regulations to be Withdrawn Entirely
Treasury and the IRS recommend to be withdrawn in their entirety:
- Proposed regulations under section 2704 on restrictions on liquidation of an interest for estate, gift, and generation-skipping transfer taxes. The goal of the proposed regulations was to counteract changes in state statutes and developments in case law that eroded section 2704’s applicability and facilitated the use of family-controlled entities to generate artificial valuation discounts, such as for lack of control and marketability, and thereby depress the value of property for gift and estate tax purposes. Specifically, the proposed regulations would have required an entity interest to be valued as if disregarded restrictions under section 2704 did not exist, either in the entity’s governing documents or under state law. Treasury and the IRS agree with commenters that the proposed regulations’ approach to the problem of artificial valuation discounts is unworkable and would result in an excessive compliance burden. Given the uncertainty surrounding the valuation, it is unclear whether the proposed regulations could have achieved their policy goal. Unlike with other recommendations contained in the Report, there is no indication that Treasury and the IRS plan to issue other guidance in this area.
- Proposed regulations under section 103 on the definition of a “political subdivision.” Treasury and the IRS recommended these regulations be withdrawn because they would have required costly and burdensome changes in existing entity structures. The proposed regulations would have required a “political subdivision” to possess not only significant sovereign power, but also to meet enhanced standards to show a government purpose and governmental control. Treasury and the IRS indicated that they believe enhanced standards may still be appropriate and may propose more targeted guidance in this area in the future.
Regulations to Consider Revoking in Part
Treasury and the IRS are considering:
- Revoking in part final and temporary regulations under section 385 on the treatment of certain interests in corporations as stock or indebtedness. The regulations are primarily comprised of: (i) rules establishing minimum documentation requirements that ordinarily must be satisfied in order for purported debt obligations among related parties to be treated as debt for federal tax purposes (the “documentation regulations”); and (ii) rules that treat as stock certain debt issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result (the “distribution regulations”). Treasury and the IRS agree with commenters that some requirements of the documentation regulations departed substantially from current practice and would have compelled corporations to build expensive new systems to satisfy the requirements imposed by the regulations. Consequently, Treasury and the IRS are considering a proposal to revoke the documentation regulations as issued. (Treasury and the IRS already announced in Notice 2017-36 that application of the documentation rules would be delayed until 2019.) In particular, Treasury and the IRS noted that the requirement to document a reasonable expectation to pay indebtedness and the treatment of trade payables would be reexamined. By contrast, Treasury and the IRS believe that proposing to revoke the existing distribution regulations before the enactment of fundamental tax reform could exacerbate current problems related to excessive earnings stripping. Treasury and the IRS note that if tax reform does not obviate the need for the distribution regulations, such rules will be reassessed.
- Revoking in part regulations under section 707 and section 752 regarding the treatment of partnership liabilities. These partnership tax regulations include: (i) proposed and temporary regulations governing how liabilities are allocated for purposes of disguised sale treatment; and (ii) proposed and temporary regulations for determining whether so-called “bottom-dollar” guarantees create the economic risk of loss necessary to be taken into account as a recourse liability. The first rule would effectively apply the rules relating to nonrecourse liabilities to recourse liabilities upon the formation of a partnership. Treasury and the IRS believe that while the first set of rules adopt a novel approach that merits further study, they are considering whether such rules should be revoked in the interim (given the far-reaching change that would result under the rules) and the prior regulations reinstated. By contrast, Treasury and the IRS believe the second set of regulations relating to bottom-dollar guarantees do not meaningfully increase regulatory burdens for taxpayers and should be retained to prevent taxpayer abuses.
- Proposing a prospectively effective amendment to final regulations under section 7602 on the participation of a person described in section 6103(n) in a summons interview. The regulations permit private contractors to participate in IRS interviews of taxpayers or witnesses and to receive and review documents in response to a summons. The regulations were prompted by the need to allow outside subject-matter experts, such as transfer pricing economists, to participate in the examination process more effectively. However, the regulations were broad enough to permit the IRS to hire outside lawyers to participate in examinations, which concerned both taxpayers and members of Congress. The amendment contemplated by Treasury and the IRS would narrow the scope of the regulations by prohibiting the IRS from enlisting outside lawyers to participate in an examination, but would continue to allow outside subject-matter experts to participate in a summons proceedings.
Regulations to Consider Substantially Revising
Treasury and the IRS are considering substantially revising:
- Final regulations under section 367 on the treatment of certain transfers of property to foreign corporations. They are considering expanding the scope of the active trade or business exception to include relief for outbound transfers of foreign goodwill and going-concern value attributable to a foreign branch under circumstances with limited potential for abuse and administrative difficulties, including those involving valuation. The final regulations had eliminated an exception under section 367(d) for transfers of foreign goodwill and going-concern value.
- Temporary regulations under section 337(d) on certain transfers of property to regulated investment companies (RICs) and real estate investment trusts (REITs). The temporary regulations closed a perceived gap in the provisions of the Protecting Americans from Tax Hikes (PATH) Act of 2015 prohibiting a spin-off followed by a REIT election. The temporary regulations would have effectively required gain recognition if a spin-off was followed by a transfer of assets to a REIT. Treasury and the IRS agree that the temporary regulations are overly broad in certain limited circumstances—specifically where a small corporation engages in a spin-off and then is acquired by a large company that is or elects to become a REIT—and is considering revisions to limit the potential taxable gain recognized in these situations to the assets of the smaller corporation. In addition, other technical changes to further narrow the application of the rules are being considered.
- Final regulations under section 987 on income and currency gain or loss with respect to a section 987 qualified business unit. The final regulations provide rules for: (i) translating income from branch operations conducted in a currency different from the branch owner’s functional currency into the owner’s functional currency; (ii) calculating foreign currency gain or loss with respect to the branch’s financial assets and liabilities; and (iii) recognizing such foreign currency gain or loss when the branch makes certain transfers of any property to its owner. On October 2, Treasury and the IRS issued Notice 2017-57, which defers by one year the applicability of the final regulations. Treasury and the IRS also intend to propose modifications to permit taxpayers to elect to adopt a simplified method of calculating section 987 gain and loss and translating section 987 income and loss, subject to certain limitations on the timing of recognition of section 987 loss. Treasury and the IRS are also considering alternative loss recognition timing limitations that would apply to electing taxpayers, as well as alternatives to the transition rules in the final regulations.
It is possible that the 200 additional regulations identified for potential revocation could help alleviate concern about Executive Order 13771 (the 2-for-1 EO), which requires any new incremental costs associated with new regulations be offset by the elimination of existing costs associated with at least two prior regulations. While the impact of the 2-for-1 EO on Treasury regulations is not certain at this point, if these revoked regulations are able to count against the cost of issuing new regulations, that could at least postpone some of the concern that the 2-for-1 EO could force Treasury to eliminate guidance taxpayers rely on or that the government needs to prevent avoidance of various Code provisions.
Treasury expects to issue additional reports on reducing tax regulatory burdens, including, as directed in Executive Order 13789, the status of Treasury’s actions recommended in the Report.