NYSBA Tax Section Comments on Regs Targeted as Burdensome

August 7, 2017

The Honorable David Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable William M. Paul
Acting Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable John Koskinen
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Letter on Notice 2017-38

Dear Messrs. Kautter, Koskinen, and Paul:

This letter of the New York State Bar Association Tax Section responds to Notice 2017-38, which identified eight Department of Treasury ("Treasury") regulations issued in 2016 as potentially either imposing a substantial burden on taxpayers or adding undue complexity to the law. In light of the short time frame to provide comments pursuant to Notice 2017-38 and in an effort to assist Treasury in completing its analysis of the identified regulations, this letter generally summarizes and compiles the comment we have made previously.¹

The Tax Section is appreciative of the hard work and dedication of the professionals in the Treasury's Office of Tax Policy and the Internal Revenue Service (the "Service"). The tax guidance issued by Treasury and the Service is thoughtful and well developed, providing certainty for taxpayers and their advisors.

I. Background

Executive Order 13789 ("EO 13789"), signed by President Trump on April 21, 2017, called for Treasury to review all "significant tax regulations" issued on or after January 1, 2016, and to identify in an interim report those that impose undue financial burden, add undue complexity, or exceed statutory authority.

As a result of this study, Treasury issued Notice 2017-38 on July 7, 2017, identifying eight regulations issued in 2016 that Treasury believes may impose a substantial burden on taxpayers or may add undue complexity to the law.² No regulations were identified as exceeding statutory authority. Of the listed regulations, the Tax Section previously has commented on four: ³

• Proposed Regulations under Section 2704 on Restrictions on Liquidation of an Interest for Estate, Gift and Generation-Skipping Transfer Taxes (REG-163113-02)

• Temporary Regulations under Section 752 on Liabilities Recognized as Recourse Partnership Liabilities (T.D. 9788)

• Final and Temporary Regulations under Section 385 on the Treatment of Certain Interests in Corporations as Stock or Indebtedness (T.D. 9790)⁴

• Final Regulations under Section 367 on the Treatment of Certain Transfers of Property to Foreign Corporations (T.D. 9803)

As a general matter, our reports were drafted from the perspective that the regulations would be adopted in some form, after appropriate comment and review. The reports identify and discuss areas of concern that are consistent with those identified in Notice 2017-38. Therefore, set forth below is a summary of the relevant parts of the prior reports as compared to the Treasury's observations in Notice 2017-38.

II. Identified Regulations

A. Proposed Regulations under Section 2704

As explained in Notice 2017-38:

In NYSBA Tax Section Report 1358, Joint Report on Proposed Regulations under Section 2704 of the Code, we commended Treasury and the Service for exercising their regulatory authority to propose reform in connection with the tax valuation rules of Section 2704, and recommended changes to improve the administration of the rules and promote certainty. The Report observed that the Proposed Regulations provide almost no guidance regarding how an interest in an entity should be valued when certain "applicable restrictions" and "disregarded restrictions" are disregarded when determining fair market value of an interest in an entity, as required by the Proposed Regulations. To address this concern, the Report recommended that Treasury and the Service consider adopting one of the following standards to use in determining fair market value of an interest in an entity where a restriction is disregarded: (a) provide clear substitute assumptions that an appraiser must apply when valuing an entity interest; (b) provide that a gift occurs on formation of the entity; or (c) provide that the entity interest is not valued under the traditional willing-buyer-willing-seller test.

B. Temporary Regulations under Section 752

As explained in Notice 2017-38:

The Tax Section generally does not agree with the comments cited above. NYSBA Tax Section Report No. 1307, Proposed Regulations on the Allocation of Partnership Liabilities and Disguised Sales, recommended that, solely for purposes of the disguised sale rules of Section 707(a)(2)(B), partnership liabilities generally be allocated in accordance with a portion of the rules governing the allocation of nonrecourse liabilities under Section 752.⁵ This suggestion was generally adopted by the Temporary Regulations promulgated as part of T.D. 788. According to Notice 2017-38, commentators stated that this "rule was novel." Although the rule itself is novel, it is noteworthy that this rule simplifies the administration of the disguised sale rules and does not create a new regulatory framework; rather, it incorporates the well-understood rules under Treasury regulations section 1.752-3(a)(3) (relating to the allocation of "excess nonrecourse liabilities"). Moreover, we believe it was a reasonable change to the Treasury regulations in light of the development of commercial practices since the finalization of the original disguised sale regulations in 1992. The Notice also states that commentators claimed that this change "would negatively impact ordinary partnership transactions." What is "ordinary" is, of course, a matter of judgment and experience. While this rule has the effect of making it more difficult to use the partnership rules to extract cash from an asset on a tax-deferred basis, the disguised sale rules contain numerous exceptions and limitations that continue to provide taxpayers ample opportunity to combine their assets on a tax-deferred basis while appropriately limiting the ability to "cash out" of those assets without the recognition of gain.

The Report supported the provisions of the Proposed Regulations addressing so-called bottom-dollar guarantees, with certain modifications. We also recommended that if the Service and Treasury determined that finalizing those provisions "would result in significant changes to the manner in which partnership deductions are allocated under Section 704(b) (applying traditional Section 704(b) principles)," consideration should be given to "seeking additional public comments before finalizing those provisions." Substantially all of our recommendations were adopted when the Proposed Regulations were issued as Temporary Regulations, although additional comments regarding the allocation of partnership deductions were not sought. The Notice states that commentators "were concerned that the bottom dollar payment obligation rules would prevent many business transactions compared to the prior regulations and suggested their removal or the development of more permissive rules." Although we do not have empirical data to support this assertion, we suspect that it is correct that the Temporary Regulations will prevent many transactions compared with the prior regulations. We, however, share the view of the government, as described in the preamble to the Temporary Regulations, that bottom-dollar guarantees "generally lack a significant non-tax commercial business purpose." Instead, in our experience, these types of guarantees were included in transactions to achieve tax-planning (i.e., tax-deferral) objectives. We do not believe this was what was intended by Congress when it instructed Treasury to adopt the "economic risk of loss" rules in 1984. Nevertheless, as is stated in the Report, we do not believe that the interaction between the rules addressing bottom-dollar payment obligations and the allocation rules under Section 704(b) is well addressed by the current regulations, including the Temporary Regulations. Therefore, we recommend that Treasury provide additional guidance in the near term to address these interactions.

C. Final and Temporary Regulations under Section 385

As explained in Notice 2017-38:

These final and temporary regulations address the classification of related-party debt as debt or equity for federal tax purposes. The regulations are primarily comprised of (i) rules establishing minimum documentation requirements that ordinarily must be satisfied in order for purported debt among related parties to be treated as debt for federal tax purposes; and (ii) transaction rules that treat as stock certain debt that is issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result. Commenters to the documentation rules criticized the financial burdens of compliance, particularly with respect to more ordinary course transactions. Commenters also requested a longer delay in the effective date of the documentation rules.⁶ Commenters to the final transaction rules criticized the complexity associated with tracking multiple transactions through a group of companies and the increased tax burden imposed on inbound investments

NYSBA Tax Section Report No. 1351, Report on Proposed Regulations under Section 385, addressed the Proposed Regulations under Section 385 and made similar comments to those included in the Notice. We have not commented on the Final and Temporary Regulations under Section 385. We are grateful for Treasury’s and the Service’s efforts in considering and responding to our and others' comments on the Proposed Regulations, and making revisions in the Final and Temporary Regulations. We believe, though, a number of our comments on the Proposed Regulations continue to be relevant and recommend further consideration of our earlier report.

D. Final Regulations under Section 367

As explained in Notice 2017-38:

In NYSBA Tax Section Report No. 1222, Report on Section 367(d), submitted in 2010, prior to the issuance of the Proposed Regulations, the Tax Section recommended that any revisions to the existing regulations should not subject foreign goodwill and going concern value to Section 367(d), stating, “we believe that the legislative history expresses the clear intention that goodwill and going concern value used in connection with a foreign trade or business should be eligible for non-recognition and that Section 367(d) should be administered to honor that intention unless and until superseding legislation has been enacted.” This recommendation was not adopted by Treasury in the Proposed Regulations that were released five years later, based on what the Preamble described as difficulties in administering the foreign goodwill and going concern value exceptions in the then applicable regulations.

NYSBA Tax Section Letter No. 1337, Proposed Section 367 Regulations: Elimination of the Foreign Goodwill Exception, commented on the Proposed Regulations and recognized the difficulties and noted: “All must acknowledge the correctness of the government’s position that significant differences in the tax treatment between goodwill and going concern value on the one hand, and other customer based intangibles on the other hand, seems a prescription for disagreement and potential litigation much like that which preceded the enactment of Section 197 of the Code.” The Report made comments similar to those cited in the Notice above. Under the Regulations, an incorporation of a foreign branch requires valuation of all branch assets as if they had been sold to an unrelated party, which can result in a burdensome valuation process. A taxpayer must elect to treat foreign goodwill as either a Section 367(a) asset (with current taxation) or a Section 367(d) asset (with a royalty taxation regime under Section 367(d)), and so the Report recommended “the introduction of some limited exceptions designed to preserve nonrecognition of foreign goodwill in demonstrably non-abusive contexts.” Further, the Regulations require asset appraisals and the potential for indefinite royalty treatment (previously limited to twenty years) on self-regenerating assets, where transferred value is difficult to distinguish from subsequently accruing value, and so the Report recommended that Treasury and the IRS consider restoring the 20-year useful life limit to any deemed royalty under Section 367(d).

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We hope that our comments are helpful to you. Please let us know if we can provide any further assistance.

Respectfully submitted,

Michael S. Farber, Chair
New York State Bar Association
Tax Section

cc:
Dana Trier
Deputy Assistant Secretary (Tax Policy)
Department of the Treasury

Thomas C. West
Tax Legislative Counsel
Department of the Treasury

Douglas Poms
Deputy International Tax Counsel
Department of the Treasury