APPWP Suggests Modifications To Regs On Foreign-Funded Pension Plans.
APPWP Suggests Modifications To Regs On Foreign-Funded Pension Plans.
- AuthorsDudley, Lynn D.
- Institutional AuthorsAssociation of Private Pension and Welfare Plans
- Cross-ReferenceEE-14-81
- Code Sections
- Subject Area/Tax Topics
- Index Termspension plans, aliens, nonresident
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 94-10692 (21 pages)
- Tax Analysts Electronic Citation94 TNT 239-30
Lynn D. Dudley of the Association of Private Pension and Welfare Plans (APPWP), Washington, has supplemented the APPWP's previously submitted comments on the proposed regulations under section 404A concerning contributions to foreign-funded pension plans. (For a summary of the APPWP's prior comments, see Tax Notes, Oct. 18, 1993, p. 298.)
Generally, the APPWP continues to believe that Congress did not intend for section 404A to be the exclusive means for reducing the earnings and profits for deferred compensation with respect to foreign-funded plans. However, if the Service maintains its position on the issue, the APPWP asks that the proposed regulations be applied on a prospective basis only. It states that the prospect of retroactively eliminating reliance on section 964 is "unconscionable and unworkable."
The APPWP also renews its request that the Service modify the requirements imposed on funded plan trusts and trust equivalents to (1) provide for certain exceptions to the anti-reversion requirement; (2) use section 503(b) compliance, instead of section 4975(c)(1) compliance, as a factor in determining section 401(a)(2) compliance; (3) provide a special section 481 adjustment for situations where taxpayers must amend earlier returns to either increase deductions or reduce their earnings and profit; (5) permit the "150 percent of current liability factor" to be disregarded when determining if a foreign plan is fully funded; and (5) provide a three-year implementation period.
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November 22, 1994
J. Mark Iwry,
Deputy Benefits Tax Counsel
Department of the Treasury
1500 Pennsylvania Ave., N.W.
Washington, DC 20220
Re: Proposed Regulations under Section 404A, Deductions and
Reductions in Earnings and Profits (or Accumulated Profits)
with Respect to Certain Foreign Deferred Compensation Plans
Maintained by Certain Foreign Corporations or by Foreign
Branches of Domestic Corporations (58 F.R. 27219, May 7,
1993)
Dear Mr. Iwry:
I am writing on behalf of the Association of Private Pension and Welfare Plans (the "APPWP") in order to supplement comments that the APPWP previously submitted regarding the release of proposed regulations under Code section 404A (the "Proposed Regulations"). Those comments, included herein as Appendix One, were submitted to Internal Revenue Service ("IRS") Commissioner Margaret M. Richardson on September 30, 1993. As it is our understanding that Treasury and the IRS are currently focusing their efforts on finalizing the Proposed Regulations, we would like to take this opportunity to provide further support for certain points raised in our comments of September 30, 1993 (the "1993 Comments"), as well as raise some additional issues that have since come to the attention of our members.
As you know, the APPWP is a national trade association for companies and individuals concerned about federal legislation affecting all aspects of the employee benefits system. The APPWP's members represent the entire spectrum of the private pension and employee benefits community: Fortune 500 companies, banks, insurance companies, law, accounting, consulting, investment and actuarial firms. APPWP members either sponsor directly or administer employee benefit plans covering more than 100 million Americans.
CODE SECTION 404A AS THE EXCLUSIVE MEANS FOR REDUCING EARNINGS AND
PROFITS
Section 1.404A-1(a) of the Proposed Regulations states that Code section 404A provides the exclusive means by which an employer may reduce earnings and profits ("E&P") for deferred compensation outside of Section 404. This exclusive means provision was not included in the prior proposed regulations issued in 1985. In the 1993 Comments, the APPWP argued, among other things, that Congress did not intend for Code section 404A to be the exclusive means by which an employer may reduce E&P for deferred compensation with respect to a foreign funded plan. The APPWP continues to hold this position.
In our view, the goal of E&P calculations is primarily to measure the dividend-paying capacity of a foreign subsidiary. The application of U.S. tax principles is often a convenient method to calculate that capacity, but it is merely a means of accomplishing the main goal, i.e., the calculation of dividend-paying capacity. It is not used in every E&P situation. If the taxpayer is paying out amounts that it never expects to see again and views as an irretrievable labor cost, then a reduction of E&P should be allowed on the grounds that cash deposited in a pension fund is a legitimate reduction of the dividend-paying capacity of the subsidiary. An exception to this general rule would be appropriate if the facts and circumstances indicate there is an intent to manipulate the taxpayer's U.S. tax liability.
The APPWP also stated in its 1993 Comments, however, that if the IRS and Treasury maintained their position on the exclusive means issue, such position should be applied prospectively only. As written, the Proposed Regulations would apply the exclusive means provision of Section 1.404A-1(a) retroactively to all years. As it now appears likely that the final regulations will retain the exclusive means position taken in the Proposed Regulations, the APPWP renews its request that the exclusive means provision be applied prospectively only.
The APPWP finds the prospect of retroactively eliminating reliance on Code section 964 to be both unconscionable and unworkable. Reductions in E&P under Code section 964 were clearly provided for in Section 1.404A-1(e) of the prior proposed regulations issued in 1985. Moreover, it is now too late for many taxpayers that reasonably relied on the prior proposed regulations (as well as similar prior announcements) to make the necessary elections under Code section 404A for years in the transition and retroactive periods. Therefore, if the exclusive means provision is retained, the final regulations should also provide that good faith compliance with prior announcements and regulations will be sufficient to support a reduction in E&P for prior years. /1/
REQUIREMENTS IMPOSED ON FUNDED PLAN TRUSTS OR TRUST EQUIVALENTS
The APPWP's 1993 comments urged the IRS and Treasury to modify the positions taken in the Proposed Regulations with respect to prohibitions on reversions of excess assets in funded plans and the use of the prohibited transaction rules under Code section 4975(c)(1) as an important factor in determining whether a funded plan has complied with Code section 401(a)(2). Based on feedback from our members and the results of a recent survey conducted by the international actuarial and consulting firm of Milliman & Robertson, the APPWP renews its request for modifications in the requirements imposed on funded plan trusts and trust equivalents as outlined below. In our view, the requested modifications would assist in aligning the final regulations with the economic and legal realities that exist in most foreign countries.
BACKGROUND
The Proposed Regulations provide that contributions under a qualified funded plan must be paid to a trust or the equivalent of a trust. See Proposed Regulation section 1.404A-2(a). Generally, such contributions must be segregated from the general assets of the employer, must not be subject to the claims of the employer's creditors, must not revert to the employer prior to the satisfaction of all liabilities with respect to employees covered under the plan, and must be held by a person who has a duty to operate the fund prudently. See Proposed Regulation section 1.404A-1(e).
Even the possibility of a reversion of excess assets in an overfunded plan will result in the disallowance of a deduction or a reduction in earnings and profits. See Proposed Regulation section 1.404A-2(b)(4). Moreover, contributions to a trust or the equivalent of a trust must have substance, and the trust or its equivalent must generally avoid transactions (including loans to plan sponsors) that would violate the provisions Code section 4975(c)(1) if the plan were subject to those provisions. See Proposed Regulation section 1.404A- 2(b)(2).
MILLIMAN & ROBERTSON SURVEY
Milliman & Robertson, a member of the APPWP, has conducted a survey of its international affiliates regarding 17 countries to determine whether the applicable laws of such countries would allow a retirement fund to be treated as the equivalent of a trust (including whether reversions of excess assets would be allowed in such countries). The results of this survey are included herein as Appendix Two. Countries such as Germany and Luxembourg have not been included in Milliman & Robertson's survey because such countries are generally not considered "funded" countries (i.e., plans in such countries are overwhelmingly maintained through book entries alone).
Milliman & Robertson generally categorizes the countries listed on page one of the survey as "First-Tier Countries" based on the prevalence and size of funded plans maintained in such countries. The countries listed on pages two through four of the survey are generally categorized as "Second-Tier Countries" because, in its experience, funded plans maintained in those countries are smaller than in First-Tier Countries. Milliman & Robertson has noted, however, that countries such as South Africa and the Netherlands could be considered First-Tier Countries by some U.S. multinational companies.
The Milliman & Robertson survey focuses on the four elements required for a plan fund to be considered the equivalent of a trust: funds are segregated from company assets, funds are protected from company creditors, asset reversion is prohibited before all obligations are settled, and funds are subject to a prudent investment requirement. The survey also provides insight regarding other applicable laws that are designed to protect fund assets, such as minimum funding requirements, restrictions on investments in sponsoring employers, restrictions on loans to sponsoring employers, and employee representation requirements.
It is important to note that reversions are allowed in all First-Tier Countries prior to the satisfaction of all plan liabilities, but only from surplus assets. Most of the First-Tier Countries would meet the remaining requirements for the equivalent of a trust. Moreover, most First-Tier Countries also impose a minimum plan funding requirement, and limit investments in, as well as loans to, plan sponsors.
Most of the Second-Tier Countries listed in the survey also allow reversions, but the remaining requirements for the equivalent of a trust are generally met where reversions are allowed. Overall, most countries in the Milliman & Robertson survey also allow loans from funded plans to plan sponsors, as well as investments by funded plans in plan sponsors (on at least a limited basis).
APPWP'S PROPOSED MODIFICATIONS TO EXISTING FUNDED PLAN
REQUIREMENTS
Anti-reversion Requirement
The APPWP's 1993 Comments pointed to the need for the IRS and Treasury to provide for deemed compliance with the Code section 401(a)(2) reversion prohibitions where local laws actually require a reversion of excess pension assets prior to the satisfaction of all obligations to participants. Additionally, based on the Milliman & Robertson survey, the APPWP understands that, while reversions may not actually occur in certain countries, no legal impediments exist in those countries to prevent such reversions. In our view, the opportunity to maintain qualified funded plans can be extended under certain circumstances to employers in the types of countries described above (even if reversions are required or the potential for reversions may otherwise exist) without violating the intent of Code section 404A.
The APPWP proposes that, as a general rule, the current reversion prohibitions be maintained for funded plans in the final regulations. However, the final regulations should provide two exceptions to the general rules of non-reversion. First, a reversion should be allowed if local law requires an immediate reduction in excess assets where a pension plan is overfunded. Such a reversion would presumably lead to income or to an increase in earnings and profits for the company involved, so there would be a corresponding tax increase. Moreover, a local law exception would not generally be subject to manipulation by taxpayers and would not significantly undermine the principles behind Code section 401(a)(2). Timely disclosure of such an action, along with adequate documentation of the local law requirement, should be sufficient to prevent abuse.
Second, even though local law may allow a reversion of funded plan assets, the possibility of a reversion should not be a bar to funded plan treatment where: 1) the possibility of a reversion is remote and 2) the plan has otherwise fully complied with all other requirements imposed on funded plans. For purposes of this exception, the possibility of a reversion should be deemed remote where no reversions have occurred during the preceding five-year period (or, if less than five years, during the period in which the plan has been a funded plan).
APPLICATION OF CODE SECTION 4975(c)(1) PRINCIPLES
The APPWP's 1993 Comments also asked the IRS and Treasury to reconsider using Code section 4975(c)(1) compliance as an important factor in determining whether funded plans have complied with the Code section 401(a)(2) requirements. In our view, such a standard is far too harsh. As it appears from the Milliman & Robertson survey that most countries allow plan loans and limited investments by plans in plan sponsors, the application of Code section 4975(c)(1) principles is likely to result in the exclusion of many plans from funded treatment under Code section 404A. A far more appropriate standard is provided under Code section 503(b), which prohibits transactions between a plan and a plan sponsor only if such transactions are for less than adequate consideration, if insufficient security or interest is provided for in a loan, if unreasonable compensation is paid, or if the transaction would otherwise result in a substantial diversion of income or corpus.
The case for the proposals outlined above is bolstered by the existence of the overriding "substance" requirement set forth in Proposed Regulation section 1.404A-2(b)(2). For example, if the IRS determines that taxpayers have abused their ability to enter into arm's length transactions with the plans they sponsor (as would be allowed under Code section 503(b)), the IRS could find that contributions to the offending plans lack substance. Such an "anti- abuse" rule also supports the relaxation of the anti-reversion rules because contributions that are made by an employer with an eye toward receiving such contributions back as a reversion of excess assets would also lack substance.
CODE SECTION 481 ADJUSTMENTS
Our members have expressed concern that because many of the tax years for which a number of companies used Method 2 (as provided under IRS Announcement 81-114) are now closed, taxpayers seem to have lost their ability to go back and amend their returns to increase deductions or to reduce E&P. In our view, the final regulations should provide for a special Code section 481 adjustment to address such situations. Thus, if a taxpayer elected Code section 404A and used Method 2 for a closed year, then the amount that could have been deducted or used to reduce E&P should be carried over to the taxpayer's next open year. The sum of such amounts should be established as a Code section 481 adjustment in the first open year and amortized over five years. The final regulations should clarify that there is no need to amend any returns for closed years.
A similar Code section 481 adjustment should be available to taxpayers who used Method 1 during a closed year and determine, after the issuance of final regulations, that the amounts that could have been taken into account under Code section 404A differ from the amounts reflected on tax returns for the closed years.
The APPWP's 1993 Comments also pointed out that a Code section 481 adjustment should not be required for preexisting funded plans that make a prospective election under Code section 404A for the first time. See Proposed Regulation section 1.404A-6(e). We again wish to emphasize that because a 404A election in such a case would not result in the duplication of tax claims for prior contributions, a Code section 481 adjustment would be unnecessary.
FULL-FUNDING LIMITATION
The prospect of having the Code section 412(c)(7) full-funding limitation applied to foreign deferred compensation plans (as is currently provided under Proposed Regulation section 1.404A-5(c)) has also generated a great deal of concern among our membership. As pointed out in the 1993 APPWP Comments, the 150% full-funding limit conflicts with sound actuarial practice in many countries. Moreover, application of the full-funding limit may not be practical in countries with highly inflationary currency.
We would like to stress once again that the prior proposed regulations did not even address the application of Code section 412(c)(7). In our view, this was because the version of Code section 412(c)(7) in effect at the time those regulations were issued did not provide for a 150% limit and therefore did not prove to be a significant limitation for deductibility purposes. We note that the 150% limit was not added to Code section 412(c)(7) until seven years after Code section 404A was enacted. Moreover, the amendment to Code section 412(c)(7) was intended to limit perceived overfunding in small defined benefit plans. The legislative history simply does not reveal a desire by Congress to extend the 150% limit to foreign plans. Therefore, the Proposed Regulations should relax the application of Code section 412(c)(7) to foreign plans by allowing the "150% of current liability" factor to be disregarded in determining whether such plans are fully funded.
IMPLEMENTATION PERIOD
We again urge that a three-year period be provided after final regulations are issued in order to allow taxpayers to make, perfect, or revoke elections under Code section 404A. The one-year period currently provided under the Proposed Regulations is simply not realistic in light of the magnitude of the decisions that plan sponsors will face after the issuance of final regulations. In our view, a three-year period would allow for a much more orderly implementation of the final regulations.
We appreciate the opportunity to work with Treasury and the IRS on these important regulations. Please call me if you have any questions, or if you wish to set up a meeting with your staff and our members.
Sincerely,
Lynn D. Dudley
Director of Retirement Policy
APPWP
Washington, D.C.
cc: Margaret M. Richardson
Randolf H. Hardock
Harlan Weller
FOOTNOTE
/1/ We suggest including this relief as part of a more general grant of relief for taxpayers who, in good faith, reasonably relied on the prior proposed regulations in addressing a number of issues that were unclear over the years, as well as those issues with respect to which the IRS and Treasury have now changed direction in the Proposed Regulations.
END OF FOOTNOTE
* * *
September 30, 1993
Ms. Margaret M. Richardson,
Commissioner
Internal Revenue Service
P.O. Box. 7604
Ben Franklin Station
Attn: CC:CORP:T:R (EE-14-81)
Room 5228
Washington, DC 20044
Re: Proposed Regulations under Section 404A, Deductions and
Reductions in Earnings and Profits (or Accumulated Profits)
with Respect to Certain Foreign Deferred Compensation Plans
Maintained by Certain Foreign Corporations or by Foreign
Branches of Domestic Corporations (58 F.R. 27219, May 7,
1993)
Dear Commissioner Richardson:
I am writing on behalf of the Association of Private Pension and Welfare Plans (the "APPWP") regarding the release of proposed regulations under Code section 404A (the "Proposed Regulations"). The APPWP is a non-profit organization founded in 1967 to protect and foster the growth of this country's private employer-sponsored employee benefits system. The over 400 members of the APPWP include both large and small plan sponsors, and also include plan support organizations, such as consulting and actuarial firms, investment firms, banks, insurers and other professional benefit organizations. Collectively, the APPWP's members have substantial experience in the entire spectrum of issues relating to all types of benefit plans, and sponsor or provide services to plans covering over 100 million participants.
The APPWP appreciates the opportunity to make comments on these regulations. Our membership is generally pleased with the addition of a safe harbor for purposes of the 90-percent test and the treatment of certain termination indemnity plans as plans that provide deferred compensation. As a whole, however, the Proposed Regulations still tend to be complicated, burdensome, and unnecessarily harsh. Our specific comments follow.
COMPETITIVENESS OF U.S. BASED MULTINATIONAL COMPANIES
If finalized in their current form, the Proposed Regulations would place an enormous administrative burden on multinational companies based in the United States. For example, the Proposed Regulations require companies to attach extensive documentation to their tax returns in order to substantiate their positions on deductions or reductions in earnings and profits. (Section 1.404A- 5(b)). The Proposed Regulations also require separate actuarial valuations in countries where there are sound actuarial practices already in place. (Sections 1.404A-2(d)(1)(ii) and 1.404A-5(c)(1)).
The Internal Revenue Service has estimated that affected companies will spend up to 1,000 hours per year collecting data and making the calculations required by the Proposed Regulations. (The Preamble to the Proposed Regulations). This estimate does not include the amount of time that it will take for the necessary personnel to familiarize themselves with the requirements imposed by the Proposed Regulations.
This allocation of resources is enormous. Many multinational companies will have to hire an additional person to spend half of his or her time keeping data required for these regulations alone. The effect on the international competitiveness of American companies is apparent; however, the alternative of eliminating deferred compensation plans would result in an even greater competitive disadvantage by diminishing such companies' ability to attract qualified employees. We believe that the regulations can and should be simplified.
SECTION 404A AS THE EXCLUSIVE MEANS FOR REDUCING EARNINGS AND PROFITS
The Proposed Regulations provide that Code section 404A is now "the exclusive means by which an employer may reduce earnings and profits for deferred compensation" with respect to a funded foreign plan, other than situations in which such a reduction would be allowed under Code section 404. (Section 1.404A-1(a)). This change in position from the prior proposed regulations will seriously disadvantage taxpayers who relied on the statement that earnings and profits could be reduced under Code sections 312, 901, 902, 960, and 964 if a plan were not allowed a deduction under Code section 404 or 404A. (Section 1.404A-1(e) of the prior proposed regulations). This reversal is attributed to a "reexamination of the Congressional intent underlying the enactment of section 404A." (Preamble to the Proposed Regulations).
We disagree that the legislative history under Code section 404A requires this result. In our view, historical support for the position that Code section 404A is the exclusive source for a reduction in earnings and profits is ambiguous at best. Rather, the overriding Congressional concern in the enactment of Code section 404A was that, for timing purposes, reductions in earnings and profits for contributions to foreign plans should be given some degree of parity with corresponding reductions for contributions to U.S. plans. Thus, it appears that Congress intended to expand, not limit, available options for reducing earnings and profits.
More importantly, taxpayers have relied on the Internal Revenue Service's prior position for over a decade. In many cases it may be too late for taxpayers that relied on Code section 964 to make the necessary elections under Code section 404A for years in the transition and retroactive periods. At the very least, the regulations should make this change applicable prospectively only and should state specifically that good faith compliance with prior announcements and regulations will be sufficient to support a reduction in earnings and profits for prior years.
APPLICATION OF PROHIBITED TRANSACTION RULES TO FOREIGN FUNDED PLANS
Code section 404A(b)(5) provides that a trust (or the equivalent of a trust) used to accumulate amounts payable under a qualified funded plan must meet the requirements of Code section 401(a)(2). The Proposed Regulations state that compliance with the prohibited transaction rules of Code section 4975(c) will now be "an important factor in determining whether the trust is not (or is) considered to be operated in accordance with the requirements of section 401(a)(2)." (Section 1.404A-2(b)(2)).
In light of the statutory scheme surrounding Code section 4975(c), we believe that its application in a context that would "disqualify" a funded plan trust is extraordinarily harsh. Code section 4975 was originally enacted as an alternative to the disqualification of qualified retirement plan trusts under Code section 503(b). In lieu of disqualification, Code section 4975 imposes monetary penalties and requires the correction of specified prohibited transactions. However, Code section 4975 covers a vast number of transactions that would not ordinarily endanger the soundness of a plan trust. This is why Congress provided procedures for grants of exemptions from the application of Code section 4975.
If a standard other than that provided by current case law and rulings under Code section 401(a)(2) is required, the provisions of Code section 503(b) are far more appropriate than Code section 4975. Code section 503(b) prohibits transactions between a plan and a plan sponsor only if such transactions are for less than adequate consideration, if insufficient security or interest is provided for in a loan, if unreasonable compensation is paid, or if the transaction would otherwise result in a substantial diversion of income or corpus. These provisions applied to all qualified retirement plans before ERISA was enacted, and still apply to governmental and church plans, as well as certain other tax-exempt arrangements.
The regulations should also provide a narrow exception to foreign plans' compliance with Code section 401(a)(2) if local law requires a specific act which would give rise to a technical violation of the exclusive benefit rule. For example, some of our members inform us that certain countries require an immediate reduction in excess assets if a pension plan is overfunded. Such a reversion would presumably lead to income or to an increase in earnings and profits for the company involved, so there would be a corresponding tax increase. Moreover, a local law exception would not generally be subject to manipulation by taxpayers and would not significantly undermine the principles behind Code section 401(a)(2). Timely disclosure of such an action, along with adequate documentation of the local law requirement, should be sufficient to prevent abuse. In any event, the regulations should at least allow a taxpayer to seek a letter ruling from the Internal Revenue Service allowing such a transaction upon a showing that a binding duty under local law will make strict compliance with Code section 401(a)(2) (or, if retained, Code section 4975) impossible.
ACTUARIAL MANDATES
The Proposed Regulations show little flexibility with regard to actuarial practices for foreign deferred compensation plans. It is important to note that in setting forth actuarial limitations for foreign deferred compensation plans, Code section 404A(g)(3) states that "principles similar to those set forth" in Code sections 412(c)(3) and 412(c)(7) should be applied. The Proposed Regulations simply impose these Code sections verbatim. (Section 1.404A-5(c)).
We believe that Congress did not intend for Treasury to require strict adherence to the Code sections 412(c)(3) and (c)(7) rules. For example, the imposition of the 150% full-funding limit may be inconsistent with sound actuarial practice in many countries. Furthermore, adherence to a strict interest corridor which is based on U.S. Treasury securities may cause significant underfunding in some countries. In fact, the Code section 404A(g)(3)(B) permissible interest rate range in the case of reserve plans (i.e., 80% to 120% of the applicable country's average long-term corporate bond rate) is evidence of a realization by Congress that the strict application of U.S. funding requirements would often be unreasonable.
We note that the prior proposed regulations did not even address the application of principles similar to Code section 412(c)(7). This was probably because the version of Code section 412(c)(7) in effect at the time those regulations were issued did not provide for a 150% limit and therefore did not prove to be a significant limitation for deductibility purposes. A very good case could be made that Congress did not intend for the 150% limit to apply to foreign plans since that provision was not added to Code section 412(c)(7) until seven years after Code section 404A was enacted. Moreover, the amendment to Code section 412(c)(7) was intended to limit perceived overfunding in small defined benefit plans. The legislative history does not reveal a desire by Congress to extend the 150% limit to foreign plans.
For these reasons, the Proposed Regulations should relax the application of Code section 412(c)(7) to foreign plans by allowing the "150% of current liability" factor to be disregarded in determining whether such plans are fully funded. The Proposed Regulations should also relax the application of Code section 412(c)(3) by making it clear that the standard of reasonableness for actuarial purposes will take into account local actuarial practices, especially in countries where such practices are well established.
In the event the provisions of Code section 412(c)(7) are fully applied to foreign plans, the testing for purposes of such limits should not be required more often than every three years (as is the case with the performance of actuarial valuations under the Proposed Regulations). If necessary, the Commissioner could retain authority to intervene in abusive situations (as is also the case with the frequency of actuarial valuations).
We also believe that Treasury should exercise its authority under Code section 404A(c)(1) to provide alternatives to the unit credit method for purposes of determining the reserve under a qualified reserve plan. An issue of primary concern is the inability of plan sponsors to take into account salary increases under the unit credit method. This requirement seems especially restrictive in countries with high inflation (and correspondingly high annual salary increases).
TIME FOR MAKING ELECTIONS
If the changes made by the Proposed Regulations are retained (especially the change making Code sections 404A and 404 the exclusive means for reducing earnings and profits), plan sponsors realistically will need more than one year to analyze the final regulations, seek advice, collect necessary data (some of which may span two decades), review alternatives, make final decisions, file amended returns, and make, perfect, or revoke necessary elections. Many companies will have to make decisions that will impact tax items which are over 20 years old. Furthermore, the failure to act in a timely manner could result in the loss of prior protective or retroactive elections. (Section 1.404A-7(b)(2)).
Our experiences over the past few years with the nondiscrimination regulations under Code section 401(a)(4) have revealed that, in the case of complicated, data specific regulations, a more gradual transition period is often necessary, both from the perspective of taxpayers and the Internal Revenue Service. Taxpayers that are in a position to take action sooner should be allowed to do so. Taxpayers with more complicated situations, however, should be given every opportunity to seek competent advice and to examine their alternatives. Members of the Internal Revenue Service should also be given time to become familiar with the final regulations, especially since taxpayer questions on the topic are likely to be numerous. Therefore, we recommend that a three year period be provided after final regulations are issued in order to allow taxpayers to make, perfect, or revoke elections under Code section 404A.
CHANGES TO ELECTIONS
The Proposed Regulations impose a six year waiting period on changes to elections and re-elections during the retroactive and transition periods. (Sections 1.404A-7(c)(4) and 1.404A-7(e)(3)). The prior proposed regulations did not provide such a requirement.
We are unable to find a statutory or policy basis for this limitation. Since the Code section 481(a) adjustment period under Proposed Regulation section 1.404A-6 must be complied with regardless of the number of years an election is in place, this added limitation seems unduly restrictive. Furthermore, the Commissioner always has the authority under Code section 446(b) to disallow deductions in truly abusive situations.
We note that the Proposed Regulations allow taxpayers to seek relief via a private letter ruling if extraordinary circumstances exist. If the six year waiting period is retained, we believe that the final regulations should provide a list of factors, which, if met, would warrant the automatic approval of a reduction in the six year waiting period. This procedure would be much less burdensome than requiring a plan sponsor to go to the time and expense of seeking a private letter ruling.
NEW REQUIREMENT FOR 90-PERCENT TEST IN THE CASE OF RESERVE PLANS
Code section 404A(f) provides that a qualified foreign plan may be either a "funded plan" or a "reserve plan." The Proposed Regulations provide that, for purposes of determining whether a reserve plan is a qualified foreign plan under Code section 404A(e)(2), "90 percent or more of the actuarial present value of the total vested benefits (i.e., BENEFITS NOT SUBJECT TO A SUBSTANTIAL RISK OF FORFEITURE) accrued under the plan" must be attributable to services performed by nonresident aliens. (Section 1.404A-1(b)(1), emphasis added). This is a significant departure from the prior proposed regulations, which based the 90-percent test for reserve plans on "the present value of the total benefits accrued under the plan" irrespective of whether such benefits were vested. (Section 1.404A-1(b)(1) of the prior proposed regulations). Moreover, this change is neither supported by Code section 404A(e)(2), nor the legislative history.
The proposed change could prevent many existing qualified reserve plans with vesting schedules from meeting the 90-percent test if the companies sponsoring such plans have high turnover rates among nonresident alien employees. This is because an increase in newly hired non-vested nonresident alien employees, regardless of the levels of benefits they accrue, will often result in a corresponding increase in the percentage of benefits attributable to vested U.S. citizen employees. If legally allowable, the solution for many companies may be to exclude all U.S. citizens regardless of income level, from foreign reserve plans in order to ensure compliance with Code section 404A. Thus, in addition to raising questions of competitiveness, the proposed change could have a detrimental impact on many U.S. citizens working abroad. In countries where the exclusion of expatriates from plans is not allowed, affected reserve plans will simply be unable to comply with Code section 404A.
We believe that the proposed change to the 90-percent test is largely superfluous as far as the enforcement of Code section 404A is concerned. Code section 404A(c)(3) already denies a deduction for nonvested benefits under a qualified reserve plan and Code section 404A(g)(1)(A) denies a deduction for benefits attributable to highly compensated U.S. citizen employees. Thus, the only possible policy furthered by the addition of a vested benefit factor to the 90-percent test would be that of reducing the number of foreign reserve plans that may qualify under Code section 404A.
OTHER ISSUES
A Code section 481 adjustment should not be required for preexisting funded plans that make a prospective election under Code section 404A for the first time. (Section 1.404A-6). In our view, making a 404A election in such a case would not result in the duplication of a tax claim for a contribution that was paid in the past.
The Proposed Regulations require a "carve out" for foreign plan benefits attributable to services performed in the United States. (Section 1.404A-5(a)(2)(ii)). Our members inform us that it is common for foreign plans to take into account all years of service with a multinational company and its affiliates (including years of service performed in the United States), and then offset the benefits provided under the foreign plan by the benefits accrued under a corresponding U.S. plan which has taken into account the same years of service performed in the United States. In our view, the administrative burden of running separate "carve out" calculations for such offset plans would substantially outweigh any marginal effect on the amount of allowable deductions or reductions in earnings and profits attributable to such plans. Therefore, we believe that the "carve out" rules under the final regulations should provide a specific exemption for these types of offset plans.
We also encourage Treasury to consider simplified methods for determining earnings and profits reductions for noncontrolled foreign corporations. We note that U.S. shareholders of noncontrolled foreign corporations are often not in a position to demand additional actuarial valuations or other extensive documentation from such corporations.
We look forward to working with you to resolve these important issues, and we hereby renew our previous request to testify at the hearings to be held on October 5, 1993. The enclosed comments will serve as our updated outline for comments to be made at the hearing.
Sincerely,
Lynn D. Dudley
Director of Retirement Policy
Association of Private Pension and
Welfare Plans
Washington, D.C.
[Appendix Two omitted]
- AuthorsDudley, Lynn D.
- Institutional AuthorsAssociation of Private Pension and Welfare Plans
- Cross-ReferenceEE-14-81
- Code Sections
- Subject Area/Tax Topics
- Index Termspension plans, aliens, nonresident
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 94-10692 (21 pages)
- Tax Analysts Electronic Citation94 TNT 239-30