With hundreds of pages of proposed regulations released and final regulations starting to appear, some overarching themes are beginning to emerge from Treasury and the IRS’s interpretation of the Tax Cuts and Jobs Act.
Treasury and IRS efforts in providing guidance have yielded considerable fruit over the past six months. Since last summer, Treasury has released proposed regulations on the section 163(j) business interest deduction limitation (REG-106089-18), foreign tax credits (REG-105600-18), global intangible low-taxed income (REG-104390-18), the section 59A base erosion and antiabuse tax (REG-104259-18), hybrid entities and transactions under section 267A (REG-104352-18), and section 199A (REG-134652-18). The first set of final rules published under the TCJA was on the section 965 transition tax.
Those guidance packages and others under the TCJA elicited a predictably large number of comments from taxpayers and their representatives. The rules generally demonstrate a valiant attempt by Treasury and the IRS to respond to taxpayer and practitioner concerns, perhaps in part because of the combined effects of Altera Corp. v. Commissioner, 145 T.C. 91 (2015), and greater involvement by the Office of Management and Budget’s Office of Information and Regulatory Affairs in reviewing new rules. But this new batch of rules, in concert with the statute that gave rise to them, adds considerable complexity to the tax law.
Dana L. Trier of Davis Polk & Wardwell LLP said one of the dilemmas Treasury faces is that it must give taxpayers rules to follow that they can rely on, but also keep the process open because it will take more than the 18 months Treasury had set as a goal for final regulations to clean up and rationalize the provisions of the new law. He noted that the guidance process after the Tax Reform Act of 1986 was effectively iterative and therefore extended several years past the 18-month time frame.
Trier said there’s good reason for the Trump administration to oppose temporary regs, but that even final regulations may end up being somewhat temporary as a practical matter. “Even though they’ll say ‘final regs,’ they need to be viewed as temporary — they’re law, but over a four-to-five-year period what needs to happen is a continuous rationalization,” Trier said. That rationalization could include making different regulations and different parts of individual rules conceptually consistent, such as the consolidated return treatment of GILTI and the section 163(j) treatment of GILTI.
The push for speedy guidance and the choice to do proposed and final regulations without temporary rules involve trade-offs, said John L. Harrington of Dentons. Proposed regulations generally take longer to write and review than other forms of guidance, such as notices. Few notices have been released on TCJA issues, perhaps because of the changes to the guidance process to include greater OMB involvement. With more participants in the approval process, there could be greater uncertainty that positions taken in a notice would continue in proposed and final regs, Harrington said.
Harrington said Treasury and the IRS have been good about identifying issues that they want comments on, but that the choice to proceed with mostly proposed regulations, followed quickly by final regulations, means there’s only one chance to address comments. And there are trade-offs in the depth of the rules and the number of issues addressed in the regulations, which affect Treasury’s willingness to adopt more taxpayer-friendly rules. “There is a certain cautiousness that comes with proposed regs and finalizing them quickly,” Harrington said.
Complexity
Congress is responsible for much of the complexity added by the TCJA, but some of Treasury’s choices in the subsequent guidance have increased it. The substantive decisions in the regulations on the treatment of interest, GILTI, and foreign tax credits are understandable, but collectively result in a “regime of mind-boggling complexity,” Trier said. The GILTI rules were perhaps necessarily complicated because they had to address the layering of a new regime on top of the old international regime. The same pattern of increasing complexity occurred in the passthrough deduction regime, although Trier noted that he was generally pleased with the passthrough regulations.
Treasury’s focus on implementing the policies in the TCJA as closely as possible to what Congress seems to have intended resulted in some additional complexity, Harrington said. Particularly in the international area of the statute, with its complicated, difficult-to-apply provisions, Treasury has tended to set forth rules to make the legislative provisions work as drafted instead of using its regulatory discretion to take a simpler approach or provide an elective alternative, he said. Examples include the definition of interest for purposes of section 163(j) and the hybrid rules and BEAT. Reading the statute fairly literally and using regulatory authority to deal with abusive situations or tighten the statute, but not to relax it, is probably correct as a literal reading, but historically taxpayers have expected Treasury to use its authority to make the statute more workable, Harrington said.
Not all of the guidance decisions increased the complexity of the new law. In the passthrough regime, Treasury took a blunter approach to preventing “crack-and-pack” strategies for avoiding the restriction on specified service trades or businesses in the section 199A rules, but it was, on balance, the right approach, Trier said. He said some strategies for avoiding specified service trade or business classification are probably consistent with the policy of section 199A, but that a more nuanced approach in the regulations would have added complexity.
Definitions and Calculations
Trier said the broad definition of interest was a policy error. As Treasury deputy assistant secretary for tax policy, Trier asked Congress on behalf of the administration for broad regulatory authority to define interest. But Trier said he never thought it was necessary or appropriate to exercise that authority to its limits, and he said so to congressional staffs. “There is a real question whether they have authority,” he said. Other practitioners have voiced that concern because the definition treats items that may not be compensation for the use or forbearance of money as interest, and the antiavoidance rule could pose problems for taxpayers. (Prior coverage: Tax Notes, Jan. 21, 2019, p. 326.) The broad definition puts the onus on taxpayers to analyze transactions for elements related to interest, and there should be a good reason to include that level of complexity in the rules, Trier said.
Echoes of the broad definition of interest in section 163(j) are found in other regulation packages, including the BEAT and the dividends received deduction rules, making it a developing theme in the regulations, said Carol P. Tello of Eversheds Sutherland (US) LLP. The preamble to the section 163(j) rules explains that the broad definition of interest largely comes from reg. sections 1.861-9T and 1.954-2. Tello noted that the definition of interest in the proposed hybrid regulations is similar to the definition under the section 163(j) rules but that the former explains that interest is an amount “not treated as stock under section 1.385-3.” That reference suggests that at least for now, the regulations under section 385 other than the documentation rules are alive and well, she said.
A major theme of the new international rules is that they depend heavily on calculations, and that has implications for planning, Tello said. GILTI, BEAT, and the interest deduction limitation are all predicated on formulas prescribed by Congress, and the accompanying rules help flesh out the definitions so that taxpayers know how to do the calculations. Tello said the foreign tax credit rules are more principles-based, but that overall, the calculation-driven rules mean that tax planning will likely change from planning for a specific industry or taxpayer profile to more individualized planning.
Preventing Abuse
A theme across the recent regulations is that Treasury has reacted to prevent abuse of the new provisions, Trier said. He noted that there were concerns from commentators shortly after the TCJA was enacted about areas ripe for abuse, but that the government “has stepped up big-time” in response to them. Trier said Treasury may have overreacted in one or two places, but that a common element of the guidance issued so far is to respond to the core situations in which provisions could be stretched too far by taxpayers. Some areas in which Treasury did so include preventing crack-and-pack strategies and adding presumptions to prevent employees from calling themselves independent contractors under the section 199A rules, and responding to tax planning that could have occurred in moving from old law to the transition tax of section 965.
Trier said he had no doubt that Treasury would respond to potential issues, but that it was unfortunate that Congress didn’t give specific grants of regulatory authority in several places. That left Treasury to navigate difficult authority questions. He said it would be ideal for Democrats in Congress to cooperate with Republicans to give Treasury specific grants of authority to write antiabuse rules.
Consistency Is an Ongoing Project
Maintaining consistency in the regulatory approach across various areas covered by the TCJA is difficult. “There is some evidence both with the regulations and across them of a somewhat different approach to what are the same problems,” Trier said. He pointed to the interaction between section 163(j) and the GILTI regime as being conceptually distinct from the consolidated returns portion of the section 163(j) proposed regulations.
Despite the size of the task, Treasury has done a remarkable job of providing guidance, according to practitioners. Tello praised the level of detail in the preambles to the proposed regulations. “These are very complicated provisions with new ideas,” and the detailed discussions provided by Treasury are helpful, she said. She noted that in addition to addressing the TCJA changes, Treasury officials tackled issues that had lingered from pre-TCJA law regarding foreign tax credits and hybrids, which made for comprehensive regulation packages. “So far, I’m awfully proud of them as friends and former colleagues,” Trier said.