Firm Requests Guidance on Treatment of NOL Carryforwards for BEAT Purposes

July 23, 2018

Mr. David J. Kautter
Assistant Secretary for Tax Policy, and Acting Commissioner of the Internal Revenue Service
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Mr. Lafayette G. "Chip” Harter III
Deputy Assistant Secretary
International Tax Affairs
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Mr. William M. Paul
Acting Chief Counsel and Deputy Chief (Technical)
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Mr. Douglas Poms
International Tax Counsel
U.S. Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

Re: Section 59A — Net Operating Loss Carryforwards

Dear Sirs:

The new base erosion and anti-abuse tax (“BEAT”) is unclear in some respects, including its application to net operating loss (“NOL”) carryforwards. Treasury regulations clarifying how to apply NOL carryforwards under BEAT can have significant economic impacts on taxpayers. We recommend that the Treasury Department promulgate regulations ensuring that taxpayers receive one (and only one) benefit, at the regular corporate income tax rate, for an NOL carryforward. As discussed below, Treasury has the authority to do so because the statute's literal terms can reasonably be interpreted to provide more than one full tax benefit for the same carryforward, but the Supreme Court's Ilfeld doctrine forbids a taxpayer to take more than one full benefit from a single loss, and the Court's Aluminum Goods decision requires that the taxpayer receive one full benefit from the loss. This letter explains the statute's operation, summarizes the Ilfeld doctrine and the Aluminum Goods decision, suggests an administrable method for regulations to apply these authorities to NOL carryforwards from both pre-2018 and post-2017 periods, and provides numerical examples.

Specifically, we suggest that:

I. Statutory Rules

Sec. 59A(c) defines modified taxable income (“MTI”) as “the taxable income of the taxpayer computed under this chapter for the taxable year, determined without regard to — (A) any base erosion tax benefit with respect to any base erosion payment, or (B) the base erosion percentage of any net operating loss deduction allowed under section 172 for the taxable year.” Consequently, taxpayers must compute MTI in the same manner as taxable income with the sole exception of disregarding those two specified items.

Sec. 172(a) provides a net operating loss deduction for an NOL carryforward. The deduction applies even if “the taxpayer has no income from a trade or business for the taxable year.”¹ Secs. 172(a) and (b)(1)(A)(ii) require the continuing deduction of an NOL carryforward every year until it is absorbed by positive taxable income (or, in the case of pre-2018 losses, expires).² Congress explicitly acknowledged that NOL carryforwards reduce MTI because the statute disregards a portion of them for that purpose,³ and the statute's legislative history clearly states that “[t]he provision allows for a reduction of liability for this anti-abuse tax for a certain percentage of the U.S. corporation's net operating loss carryforwards . . .”⁴ Consequently, the statute permits NOL deductions against a greater amount of MTI than taxable income. In addition, the statute might be interpreted to provide serial deductions against MTI for the same NOL carryforward until it is absorbed by positive taxable income (or expires). A single carryforward could reduce MTI multiple times and then reduce taxable income, providing more than a 21% tax benefit from a single loss.⁵ For an example, see Scenario 1 below.

On the other hand, the statute might be interpreted to limit the benefit of NOL carryforwards to the lower BEAT tax rate if they offset MTI before taxable income. For an example, see Scenario 2 below.

Finally, the statute might be interpreted to reduce the value of an NOL carryforward below the regular statutory tax rate when it reduces both regular and modified taxable income in the same year. Sec. 59A(b)(1) imposes a minimum tax equal to (A) a tentative minimum tax (the product of MTI and the minimum tax rate), reduced by (B) the taxpayer's regular tax liability for the year.⁶ If Sec. 59A(b)(1)(B) refers to regular tax liability after the NOL deduction then the taxpayer can lose some of the carryforward's benefit. The year's pre-carryforward taxable Income would absorb the NOL deduction. But the formula would not reduce the tentative minimum tax by the otherwise-applicable regular tax on that same income. As a result, the taxpayer would both use up the carryforward and pay the unreduced minimum tax, depriving it of some of the value of the NOL carryforward. Other taxpayers would not suffer the same detriment. For an example, see table below:

II. The Ilfeld Doctrine

The taxpayer in Ilfeld interpreted a revenue act to provide a second tax benefit for a previously deducted loss.⁷ The Supreme Court relied on the Aluminum Goods precedent requiring the use of "equitable principles of accounting” in statutory construction to reject the claim.⁸ The Court found that the taxpayer properly benefits from a loss deduction the first time that the law provides for it,⁹ but cannot benefit from it again at a later time: “[i]n the absence of a provision of the Act definitely requiring it, a purpose so opposed to precedent and equality of treatment of taxpayers will not be attributed to lawmakers.”¹⁰ The Internal Revenue Service recognizes that “Ilfeld is a doctrine of statutory construction that is properly applied . . . where the duplicative tax benefit is not expressly authorized by statute or regulation.”¹¹

Ilfeld is a doctrine of statutory construction. Sec. 59A(i) authorizes Treasury to prescribe regulations “as may be necessary or appropriate to carry out the provisions of” the BEAT. Therefore Treasury has the authority to prescribe regulations denying more than one full tax benefit unless the statute “definitely” and "expressly” provides it. The regulations would reflect a principle of statutory construction rather than create a new legislative rule. Where the statute's plain terms require a result, however, those terms control even against contrary policy arguments under the Supreme Court's Gitlitz decision.¹²

For the same reason, Treasury has the authority to prescribe regulations interpreting the statute to provide the full benefit of an NOL carryforward. As the Court stated in Aluminum Goods, “[w]hile equitable principles of accounting applied to the calculation of the net income of the business unit do not permit deduction of the loss twice, they do require its deduction once.”¹³ Although Aluminum Goods refers to one deduction, it did so in the context of a single tax (rather than two taxes as here), and the Internal Revenue Service recognizes that the relevant measure is the tax benefit of the deduction.¹⁴ Congress only plainly intended to take away the minimum tax benefit of the base erosion percentage of the carryforward. It did not definitely or expressly take away any other value of an NOL carryforward in either the statute's text or legislative history. In contrast, when Congress intended to deprive taxpayers of other tax benefits it expressly covered them in the statute (e.g., tax credits covered by Sec. 59A(B)(1)(b)). Under Ilfeld. Treasury should not attribute to Congress an intent so opposed to equality of taxpayers as depriving some of the full benefit of their NOL carryforwards, because no provision in the statute definitely requires it.

Other legal principles also counsel against interpreting the statute to deprive taxpayers of the full benefit of their NOL carryforwards, particularly those from years before the BEAT'S effective date. Statutes generally should not be interpreted to implicitly defeat vested interests, even if an expressly retroactive provision would not violate due process or represent a taking.¹⁵ For example, courts have held in other circumstances that NOL carryforwards are property whose value should be preserved.¹⁶ The Supreme Court held in Reo Motors that an NOL must be computed on the basis of the tax laws applicable to the year of the loss rather than under the law in effect in a later year when the loss is deducted.¹⁷ In the specific context of BEAT, Congress clearly intended to treat pre-2018 NOL carryforwards more favorably than later ones because it capped the deduction of the latter at 80% of taxable income.

We are aware of some arguments that have been made that the reduction of the corporate tax rate from 35% to 21% resulted in a loss of tax benefit. This argument is incorrect, however, because the NOL still provides the same proportionate relief from income tax going forward that it provided in prior periods. In the case of NOLs and BEAT, action is justified because of a potential genuine economic loss of value, which would run contrary to these long-standing principles.

III. Suggested Interpretation for Administrable Regulations

Sec. 172 provides a regular tax benefit, currently at a 21% rate, for an NOL carryforward. Consequently, interpretive regulations implementing Ilfeld, Aluminum Goods and Gitlitz should provide taxpayers a 21% benefit (i.e., the current corporate tax rate) for an NOL carryforward — no more, and no less. Regulations should provide for calculating MTI and taxable income according to general Code provisions, deducting the NOL carryforward from both modified and regular taxable income each year until it is absorbed by regular taxable income, subject to two modifications.

A. In order to prevent an unintended duplication of tax benefits, regulations should provide that when an NOL deduction reduces either regular or modified taxable income the taxpayer must reduce the NOL carryforward by the resulting tax benefit grossed up at the regular tax rate. This proposal would eliminate that portion of the carryforward and definitively prevent a subsequent duplicate benefit from that amount of loss.

The Ilfeld, Aluminum Goods and Gitlitz decisions preclude an alternative proposal to allow NOL deductions against MTI only in years in which they also offset otherwise positive taxable income. Congress definitely granted the NOL deduction against MTI both in the statute and its legislative history, and the Ilfeld Court held that the taxpayer properly takes the loss deduction in the first year available under the statute and that equitable accounting principles only forbid the later duplicate deduction.

B. In order to prevent an unintended deprivation of tax benefits, the regulations should allow the taxpayer to defer the deduction of any part of an NOL carryforward that does not generate any tax benefit. This proposal would ensure that the taxpayer pays a minimum tax for the year in cash without depriving it of the full benefit of the carryforward.

Numerical examples of the proposal are attached.

This proposal is only one of several that regulations might adopt. For example, regulations could prevent duplication by permitting serial deductions of the NOL carryforward but capping the cumulative minimum and regular tax benefits of those deductions at 21% of the carryforward. Regardless of the alternative chosen, we believe that the Treasury Department has the authority to prevent unintended duplication and deprivation of tax benefits in this context and should properly exercise that authority in regulations. We would be happy to discuss this proposal and other alternatives with you at your convenience.

Sincerely,

Robert E. Glennon
Partner
Hogan Lovells
robert.glennon@hoganlovells.com
D 202-637-5458