Railroad Group Recommends Changes, Clarifications to Proposed 'Repair' Regs

Dear Ms. Feldstein:

This letter is submitted on behalf of the Tax Policy Committee of the Association of American Railroads ("the AAR"), a trade association representing the North American railroad industry, to provide comments on the 2011 Proposed Regulations. The AAR's membership includes freight railroads that operate 77 percent of the line-haul mileage, employ 94 percent of the workers, and account for 97 percent of the freight revenue of all railroads in the United States, as well as passenger railroads that operate intercity passenger trains and provide commuter rail service. The Tax Policy Committee, comprised of the chief tax officers from AAR's member railroads, addresses a broad spectrum of tax-related issues on behalf of the Association.

As the AAR has stated to the Government on several previous occasions, the issues addressed in the regulations are of paramount importance to the railroad industry given its highly capital intensive nature. The freight railroad industry is the most capital intensive industry in America. The industry's capital expenditures as a percentage of revenue over the past ten years (i.e., 18 percent) far exceeds the comparable percentage for other capital intensive industries where the percentages range from around 3 percent to 10 percent. A consequence of the railroads' high capital outlays is the related need to expend high amounts to maintain that property, plant, and equipment. Given that the railroads and the Government have a joint interest in ensuring that the regulations are workable, with sound legal support, the AAR has participated actively throughout this regulatory process. This activity includes providing the Government extensive comments and suggestions in response to the 2008 Proposed Regulations, the 2006 Proposed Regulations, Notice 2004-6, and meeting with the Treasury team to discuss the industry's proposals. Moreover, in anticipation that the Government would be requesting input from taxpayers on this subject, the AAR submitted comments in December 2002 addressing the need for regulations in this area and providing a framework as to how such regulations should be drafted to achieve their objective.

As with the 2008 and 2006 Proposed Regulations, the AAR has evaluated the Proposed Regulations and offers the following comments. Please note that the AAR's comments are limited to the language and application of Reg. § 1.263(a)-3T (sometimes referred to as the Repair Regulations).¹

Use the "Modified Cut-Off Method" for Section 481 Adjustments

Section VIII of the Preamble to the 2011 Proposed Regulations explains that "a change to conform to the proposed regulations upon finalization will be considered a change in method of accounting under section 446(e)" and "a taxpayer seeking a change in method of accounting to comply with these temporary regulations must take into account an adjustment under section 481(a)." By imposing the requirement for a section 481(a) adjustment, the Government rejected the entreaties of commentators -- including the AAR -- for use of the cut-off method.

The AAR is concerned that the Government understates the administrative burden faced by many taxpayers -- including railroads -- that may be forced to make section 481(a) adjustments arising from expenditures made many years ago. This is not necessary to achieve the Government's objectives and creates greater potential for disagreements between the IRS and taxpayers over how the section 481(a) adjustments should be calculated.

It appears the Government proposes an unmodified section 481(a) adjustment in reaction to taxpayers that attempted to change their capitalization methods based on the 2008 Proposed Regulations. The government could still achieve its objective to put all taxpayers on an equal footing and reduce the administrative burden of the 481 adjustment by using a modified cut-off approach. This modified cut-off approach is the same one the Government used in the final intangible regulations (Treas. Reg. §§ 1.263(a)-4 and -5). Under the modified cut-off basis for the intangible regulations, only amounts paid or incurred on or after the January 24, 2002 publication date of the advance notice of proposed rulemaking in the Federal Register were taken into account under section 481(a). The equivalent date for the 2011 Proposed Regulations is August 21, 2006. (See 71 FR 48590-01.)

The Government's adoption of the modified cut-off method was premised on the avoidance of administrative burdens on both taxpayers and the IRS. If the modified cutoff method represented a suitable balance for the intangible regulations, it is hard to see why it would not be equally suitable for the 2011 Proposed Regulations -- especially the Repair Regulations. Accordingly, the AAR urges adoption of the modified cut-off basis requiring a section 481(a) adjustment only for expenditures made on or after August 21, 2006.

Clarification that Safe Harbor is Not Exclusive

Both the 2011 Proposed Regulations and 2008 Proposed Regulations contain routine maintenance safe harbor provisions under the Repair Regulations. But only the Preamble to the 2008 Proposed Regulations contains the following language:

The AAR is concerned that the omission of this language from the Preamble of the 2011 Proposed Regulations may lead -- in practice -- to the field's unwarranted conclusion that expenditures not meeting the safe harbor are presumptively capital expenditures. For the sake of clarity, this language should be reinserted into the Preamble to the 2011 Proposed Regulation to ensure no inference is drawn that expenditures falling outside the safe harbor are presumed to be capital expenditures.