PwC Seeks ATI Computation Changes Under Interest Regs

February 26, 2019

CC:PA:LPD:PR (REG-106089-18)
Courier's Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Comments on proposed regulations implementing IRC section 163(j) (NPRM REG-106089-18)

Dear Sir or Madam:

Thank you for the opportunity to submit comments on the proposed regulations under section 163(j)¹ (“Proposed section 163(j) Regulations”) promulgated in the Notice of Proposed Rulemaking² by the Internal Revenue Service and the Department of the Treasury (hereinafter, collectively referred to as the “IRS” or the “Service”) on December 28, 2018. These comments are being submitted on behalf of a working group of companies engaged in manufacturing, production, and resale activities (“manufacturers and producers”) coming from a broad range of industries, such as manufacturing and production of industrial products, construction materials, consumer goods, oil and gas, minerals, and electricity (the “Working Group”). The operations of these companies are very capital-intensive and require significant investments in plants, equipment, infrastructure, and other property. The capital-intensive nature of operations and the need to make significant investments require funding from both equity and third-party debt as part of regular business practice. The investments increase productivity, leading to higher wages and providing American workers a competitive edge that keeps jobs in America.

The comments in this letter are specifically focused on the Proposed section 163(j) Regulations' interpretation of the rule under section 163(j) allowing taxpayers an addition in computing adjusted taxable income (“ATI”) for depreciation, amortization, or depletion (“DD&A”). Prop. Treas. Reg. § 1.163(j)-1(b)(iii) provides that DD&A expense that is capitalized to inventory under section 263A is not a DD&A deduction for purposes of adjusting ATI despite the language of the statute which encompasses “any deduction allowable for depreciation, amortization, or depletion.”

In the Working Group's view, the Proposed section 163(j) Regulations incorrectly interpret the DD&A addition rule set forth in section 163(j)(8)(A)(v) and should be revised. The proposed rule is in error as a matter of technical interpretation of the statute, fails to carry out congressional intent, and is not sound tax policy. It not only disregards the legislative intent in enacting section 163(j) in the Tax Cuts and Jobs Act (the “TCJA”),³ it would have the effect of significantly limiting the benefit the Working Group members receive from immediate expensing for their investments under amended section 168(k). The proposed interpretation inequitably narrows the DD&A addition for manufacturers and producers, effectively placing them immediately on the post-2021⁴ section 163(j) rules. For the reasons discussed at length in this letter, the Working Group requests that DD&A capitalized under section 263A be allowed as an addition in computing ATI.

Background

On December 22, 2017, Congress enacted the TCJA with a principal objective of increasing U.S. economic growth by making the United States the best place in the world to undertake new investments. Section 13301 (Limitation on Deduction for Interest) of the TCJA amended section 163(j), and significantly broadened the scope of taxpayers subject to a limitation on their interest expense deduction. Under amended section 163(j), a taxpayer's interest expense deduction for a taxable year is limited to the sum of (1) its business interest income for the taxable year, (2) 30 percent of its ATI for the taxable year, and (3) its floor plan financing interest for the taxable year.

Under section 163(j)(8), the term “ATI” means taxable income adjusted for certain specifically enumerated items. One of these adjustments is for any deduction allowable for DD&A.⁵ In other words, in computing ATI, taxpayers are allowed an addition to taxable income for DD&A deductions allowable. Notably, former section 163(j) contained identical statutory language in allowing an addition for DD&A.⁶ In addition to the statutorily provided adjustments under section 163(j)(8)(A), section 163(j)(8)(B) grants the Secretary authority to identify additional adjustments to arrive at ATI.

The amendments to section 163(j) were first introduced in the version of the TCJA passed by the House of Representatives (“House”). Under the House version, DD&A deductions allowable were treated as an addition in computing ATI for all taxable years. The House Ways and Means Committee report⁷ accompanying the House bill did not make any distinction between DD&A capitalized under section 263A and DD&A not required to be capitalized under section 263A.⁸

Speaker of the House, Paul Ryan, explained the House version of section 163(j) in a televised interview:⁹

Most countries, and the [Organisation for Economic Co-operation and Development (“OECD”)] is doing this. They're doing what we call a thin cap rule. Yes, I know those industries that do a lot of leverage don't like this, but we are doing an interest limitation on 30 percent of EBITDA¹⁰ . . . Most of our foreign competitors are adopting what we call a thin cap rule. If you are thinly capitalized you can't deduct interest above a certain amount, and the typical amount is 30 percent of EBITDA. You can deduct up to 30 percent of your EBITDA, but not after 30 percent of your EBITDA.¹¹

Under the Senate version, DD&A was no longer treated as an addition in computing ATI with the result that the score from the Senate version of section 163(j) generated considerably more revenue.¹² The final version of section 163(j) represents a compromise in conference between the House and Senate versions of section 163(j) by providing an addition for DD&A deductions allowable for tax years beginning before January 1, 2022. Although the Conference Report,¹³ which notes that this modification was made in the conference agreement, does not provide further explanation for the change, it is clear that the elimination of the DD&A addback was necessary to meet budgetary scoring requirements.

It is important to note that the Conference Report makes no distinction between DD&A capitalized under section 263A and DD&A not required to be capitalized under section 263A.¹⁴ Notwithstanding this lack of distinction, as noted above, Prop. Treas. Reg. § 1.163(j)-1(b)(iii) provides that DD&A expense that is capitalized to inventory under section 263A is not a DD&A deduction for purposes of adjusting ATI. The preamble to the Proposed section 163(j) Regulations explains this provision as follows:

Additionally, to clarify an issue raised by a commenter in response to Notice 2018-28, the [IRS] note that an amount incurred as [DD&A], but capitalized to inventory under section 263A and included in cost of goods sold (“COGS”), is not a deduction for [DD&A] for purposes of section 163(j).

The Proposed section 163(j) Regulations' limited view of DD&A that should be added back to ATI is counter to the explicit aim of the TCJA to increase U.S. economic growth by making the United States the best place in the world to undertake new investment in job creating plants and equipment. It will have a particularly adverse effect on the Working Group members, who are capital-intensive manufacturers and producers required to capitalize the vast majority of their DD&A under section 263A. As such, this rule will have a significant negative impact on the Working Group members' businesses and their ability to deduct interest expense on the indebtedness funding their operations. While a particular focus of Congress in enacting the TCJA was increasing manufacturing jobs, the Working Group members instead will be disadvantaged in raising capital and undertaking investment relative to businesses that do not engage in production activities if the IRS maintains the limited interpretation of DD&A in the final Regulations.

The Proposed section 163(j) Regulations' treatment of capitalized DD&A would upset the balance Congress struck in enacting the TCJA between base-broadening and rate reduction. Part of the TCJA's base-broadening included the repeal of the “manufacturing deduction” of section 199, a tax benefit focused on domestic manufacturers and producers, including members of the Working Group. Section 199 translated to a corporate rate cut as high as 3 percentage points. The Ways and Means Committee, in discussing the decision to repeal section 199, noted the importance of this benefit in terms of after-tax cash flow. As noted in the discussion above and is made clear in the examples below, the Proposed section 163(j) Regulations' treatment of capitalized DD&A could have an effect opposite of former section 199. Rather than benefiting manufacturers and producers, they would be hit twice — first by the repeal of section 199 and then by a disproportionately large disallowance of interest expense with significant adverse after-tax cash flow consequences.

The following examples highlight the impact of the proposed rule on the Working Group members:

Example 1 — Manufacturer if DD&A capitalized under section 263A not allowed as an addition in computing ATI

Assume that a corporate taxpayer has gross receipts of $20,000,000, a depreciation deduction allowable of $10,000,000, interest expense of $5,000,000, and other deductions of $3,000,000 for 2018. (We assume that the taxpayer does not meet the $25 million gross receipts exception for purposes of this and further examples.) The taxpayer is a manufacturer that has no inventories on hand at year-end, and 100 percent of its depreciation deduction allowable is capitalized under section 263A. The taxpayer's taxable income (before the application of section 163(j)) is $2,000,000 (gross receipts of $20,000,000 less depreciation deduction allowable in COGS of $10,000,000, interest expense of $5,000,000, and other deductions of $3,000,000), and its ATI is $7,000,000 (taxable income (before the application of section 163(j)) of $2,000,000 plus interest expense of $5,000,000). Accordingly, the taxpayer is only allowed to deduct interest expense of $2,100,000 (lesser of $5,000,000 or 30 percent of ATI, or $2,100,000) for 2018. The remaining interest expense of $2,900,000 will be allowed as a carryforward in future years. Assuming static taxable income and interest expense, the taxpayer may never be able to utilize its section 163(j) carryforward.

Example 2 — Manufacturer if DD&A capitalized under section 263A is allowed as an addition in computing ATI

Assume the same facts as Example 1, but that the taxpayer is allowed to add back its depreciation capitalized under section 263A. The taxpayer's ATI is $17,000,000 (taxable income (before the application of section 163(j)) of $2,000,000 plus interest expense of $5,000,000 plus depreciation deduction allowable in COGS of $10,000,000). Accordingly, the taxpayer is allowed to deduct the full amount of its interest expense of $5,000,000 (lesser of $5,000,000 or 30 percent of ATI, or $5,100,000) for 2018. Under this example, the manufacturer is placed on equal footing with taxpayers that do not engage in business activities subject to section 263A.

The Working Group's Recommendation

The current interpretation of section 163(j)(8)(A)(v) in the Proposed section 163(j) Regulations puts capital-intensive manufacturers and producers at a significant disadvantage. Because the vast majority of their DD&A is capitalized under section 263A, it would severely constrain their ability to deduct their interest expense. In effect, the Proposed section 163(j) Regulations accelerate the application of the post-2021 section 163(j) rules to 2018 for the Working Group members. The result is that the Proposed section 163(j) Regulations disproportionately increase the Working Group members' cost of capital, and discourage further job creating investment in the United States.

Accordingly, the Working Group respectfully requests that the rule under Prop. Treas. Reg. § 1.163(j)-1(b)(iii) be modified. Specifically, the Working Group requests that, for purposes of computing ATI under section 163(j), DD&A be allowed as an addition regardless of whether the DD&A is capitalized under section 263A.

The Working Group believes that its recommendation provides a result that is truer to the statutory language, more sensible and equitable, that does not discriminate against manufacturers and producers, and that aligns with legislative intent in enacting section 163(j). The analysis supporting the Working Group's recommendation is discussed further below.

Analysis Supporting the Working Group's Recommendation

The Proposed section 163(j) Regulations should interpret section 163(j) consistent with the statute

The Proposed section 163(j) Regulations violate the rules of statutory construction in four areas: 1) the Proposed section 163(j) Regulations' interpretation is inconsistent with the general application of section 263A; 2) the treatment of depletion under the Proposed section 163(j) Regulations' interpretation would be nonsensical; 3) Code provisions should be interpreted in a manner consistent with their purposes; and 4) the proposed rule could lead to irrational results in other areas.

The Proposed section 163(j) Regulations' interpretation is inconsistent with the general application of section 263A

As discussed above, section 163(j)(8)(A)(v) provides an addition for “any deduction allowable for depreciation, amortization, and depletion.” (Emphasis added.) Accordingly, the flush language in section 263A(a) and Treas. Reg. § 1.263A-1(c)(2) support the Working Group's recommendation. Specifically, this language provides that an amount is not subject to capitalization under section 263A unless it is first allowable as a deduction.¹⁵ Regardless of its subsequent capitalization under section 263A, DD&A is first allowable as a deduction and fits squarely within section 163(j)(8)(A)(v) as a “deduction allowable for depreciation, amortization, or depletion.” Thus, DD&A capitalized under section 263A should be added back to ATI under the statutory language of section 163(j)(8)(A)(v).

Furthermore, section 263A was originally enacted to better match expenses to their related income. While better matching is achieved by converting DD&A into COGS, it does not change the critical point that a taxpayer has incurred DD&A expense. Failing to allow an addition to ATI for DD&A based on its geography on a tax return will subject taxpayers to a limitation that has no logic or policy support.

The treatment of depletion under the Proposed section 163(j) Regulations' interpretation would be nonsensical

If the Proposed section 163(j) Regulations' interpretation of section 163(j)(8)(A)(v) were correct, it would lead to an irrational treatment of depletion. Pursuant to Treas. Reg. § 1.263A-1(e)(3)(ii)(J), depletion is an indirect production cost that must be capitalized under section 263A¹⁶ and thus would not be treated as a “deduction” for purposes of computing ATI for the vast majority of taxpayers. For example, corporate taxpayers with a working interest in mineral properties (i.e., extracting the mineral and selling to third parties) that generate depletion expense in their trades or businesses will not benefit from the addition in computing their ATI.

Disallowing the addition for depletion for taxpayers with a working interest in mineral property could not be the intention of Congress given that they explicitly referenced depletion under section 163(j)(8)(A)(v) as one of the items allowed as an addition. The Proposed section 163(j) Regulations clearly lead to a nonsensical and irrational result with respect to the treatment of depletion.¹⁷ This result is made even more illogical by the fact that depletion is allocated to property that has been sold. Thus, Congress could not have envisioned that the application of section 263A would or should have an impact on the DD&A addition.

Code provisions should be interpreted in a manner consistent with their purpose

It is a recognized rule of statutory construction that the same word or phrase appearing in different places in Code provisions may have different meanings depending upon the context and legislative purposes involved.¹⁸ As discussed further below, it is clear that the House version of section 163(j) was modeled after OECD principles in limiting interest expense to 30 percent of EBITDA. While the final version of section 163(j) only allows a DD&A addition for tax years beginning before January 1, 2022, it is evident that the House version was the foundation for this rule. Thus, the legislative purpose in allowing DD&A as an addition in computing ATI was to limit interest expense based on 30 percent of EBITDA, which represents a cash flow and is a well-established measure of an enterprise's ability to service its debt. Further, it is clear that Congress intended for the interest limitations to apply broadly to all taxpayers and certainly did not intend to disproportionately disadvantage capital-intensive manufacturers and producers.

The importance of interpreting Code provisions in light of their context and legislative purposes is highlighted in former section 172(f).

Former section 172(f)

Former section 172(f), which allowed a 10-year carryback for net operating losses (“NOL”) attributable to specified liability losses, similarly supports the Working Group's recommendation. Included in the definition of items eligible for the 10-year carryback were amounts “allowable as a deduction” for environmental remediation costs and workers compensation claims. However, manufacturers are generally required to capitalize these types of costs as indirect costs under Treas. Reg. § 1.263A-1(e)(3)(i). If the term “allowable as a deduction” was interpreted in the same manner as the Proposed section 163(j) Regulations, a large population of the types of taxpayers (i.e., manufacturers and producers) that were intended to benefit from section 172(f) would not be eligible.

This precise issue was addressed by the IRS National Office in Advice Memorandum (“AM”) 2008-012.¹⁹ In AM 2008-012, the IRS' Large and Mid-Size Business Operating Division requested advice on whether environmental remediation and workers compensation costs capitalized under section 263A were “deductions” eligible for the 10-year carryback. In response, the IRS National Office concluded that these costs were eligible for the 10-year carryback as long as they were taken into account in computing the NOL for the taxable year. That is, as long as the inventory to which the costs were capitalized had been sold, the COGS attributable to environmental remediation and workers compensation would be allowed as a “deduction.” In arriving at this conclusion, the IRS National Office stated:

In our view, Congress used the phrase 'allowable as a deduction' in section 172(f)(1)(B)(i) to mean amounts that may be taken into account in computing taxable income. Congress did not mean to distinguish 'deductions' from '[COGS].'

The conclusion reached by the IRS National Office in AM 2008-012 is consistent with the Working Group's recommendation. It is the Working Group's view that Congress similarly did not mean to distinguish “deductions” from “COGS” in the case of section 163(j)(8)(A)(v). An interpretation of section 163(j)(8)(A)(v) that prohibits manufacturers and producers from treating their DD&A capitalized under section 263A as DD&A for purposes of computing ATI would significantly limit, and in many cases eliminate, their ability to benefit from the DD&A addition. If Congress had intended this result, then it would have explicitly so stated. However, as discussed below, there is no indication from the legislative history of section 163(j) that a limited view of DD&A added back was Congress' intent. Instead, all indications are that Congress intended the TCJA provisions to encourage more manufacturing investment.

The proposed rule could lead to irrational results in other areas

The Proposed section 163(j) Regulations' interpretation of section 163(j)(8)(A)(v) could lead to unintended consequences with respect to sales or exchanges of depreciable or amortizable property. Specifically, a literal reading of sections 1016(a)(2) and 1245 could lead to taxpayers asserting that they never reduce their basis in depreciable or amortizable assets used exclusively in an activity subject to section 263A.

Section 1016(a)(2) generally provides, in part, that proper basis adjustments must be made to property for exhaustion, wear and tear, obsolescence, amortization, and depletion to the extent of the amount allowed as a deduction in computing taxable income, but not less than the amount allowable. Put simply, a taxpayer must reduce the basis in an asset by the greater of the amount of the depreciation or amortization deduction claimed on its federal income tax return or the amount of depreciation or amortization deduction that it was eligible to claim under the Code. Thus, an asset's basis is reduced regardless of the amount of depreciation or amortization claimed on a federal income tax return. Similarly, section 1245 requires taxpayers to recapture as ordinary income gain attributable to deductions allowed or allowable.

Notwithstanding these sections' references to depreciation or amortization deductions, it is universally accepted that an asset's depreciation or amortization that is capitalized under section 263A should reduce the asset's adjusted basis for purposes of sections 1016(a)(2) and 1245. However, the IRS' interpretation of section 163(j)(8)(A)(v) could lead taxpayers to believe that they may not be required to reduce the adjusted basis in their depreciable or amortizable assets to the extent that the assets' related depreciation or amortization is capitalized under section 263A. Under such an interpretation, taxpayers would be able to recover the basis in their assets twice (once through COGS and again upon sale or exchange of the asset) and would never be subject to ordinary income recapture under section 1245. The Working Group does not agree with this irrational result, but believes that the IRS' current interpretation of section 163(j)(8)(A)(v) is inconsistent with the predominant interpretation of sections 1016(a)(2) and 1245. The Working Group's recommendation would lead to sound results and would be consistent with the interpretation of the term “deduction” in sections 1016(a)(2) and 1245.

Section 163(j) should be interpreted consistent with legislative intent

Section 163(j) should be interpreted consistent with legislative intent in enacting the provision. First and foremost, ATI should be computed on an EBITDA basis based on the genesis of the provision in the House version of the TCJA. Second, section 163(j) should be interpreted in a manner that furthers, not frustrates, the legislative intent. To that end, the Proposed section 163(j) Regulations' interpretation of section 163(j)(8)(A)(v) should be reversed because, as proposed, it would have the effect of significantly limiting the benefit of the TCJA's expanded bonus depreciation provision under section 168(k).

EBITDA should be the measure for computing ATI

As discussed above, Speaker Ryan acknowledged that most countries and the OECD utilize 30 percent of EBITDA in determining the amount of interest expense that is deductible. In its report, Limiting Base Erosion Involving Interest Deductions and Other Financial Payments Action 4 — 2016 Update, the OECD explains at Paragraph 78 the rationale for using EBITDA as the measure for limiting interest expense deductibility:

EBITDA is the most common measure of earnings currently used by countries with earnings-based tests. By excluding the two major non-cash costs in a typical income statement (depreciation of fixed assets and amortisation of intangible assets), EBITDA is a guide to the ability of an entity to meet its obligations to pay interest. It is also a measure of earnings which is often used by lenders in deciding how much interest expense an entity can reasonably afford to bear.

Therefore, the House bill allowed an addition for DD&A based on a principled approach to limiting the deduction according to metrics applicable to commercial transactions as recommended by the OECD in its base erosion and profit shifting reports. Companies often use EBITDA to measure management's performance, especially leveraged capital-intensive companies, and communicate the operational performance to their board of directors, investors, lenders, and other stakeholders. Further, EBITDA is commonly used for lending assessment and is a key loan covenant. Moreover, EBITDA is one of the key factors used for valuation of a company.

For the Working Group members, it is common for the vast majority of their DD&A to be capitalized for financial reporting purposes. Notwithstanding its inclusion in inventory costs, it is widely accepted in the commercial setting that DD&A is still treated as an addition in computing EBITDA. The geography of the DD&A on the income statement is irrelevant in computing EBITDA, and similarly should be irrelevant in computing ATI.

Furthermore, there is no indication in the legislative history to section 163(j) that Congress intended taxpayers subject to section 263A to be treated any differently than those taxpayers not subject to section 263A for purposes of computing ATI. Given the vast difference in the computation of ATI for these two classes of taxpayers, Congress would have made an intent to treat them differently clear. Instead, it is far more likely that Congress used the term “deduction allowable” to mean DD&A taken into account in reducing taxable income, whether as DD&A or as a reduction to gross income as COGS.

Former section 163(j)(6)(A)(i)(IV) similarly allowed an addition for “any deduction allowable for depreciation, amortization, or depletion” in computing ATI. The proposed Regulations issued under former section 163(j) (“Prior Proposed Regulations”) did not make any distinction for DD&A capitalized under section 263A. The preamble to the Prior Proposed Regulations did not address this distinction either, but clarified that the purpose of the adjustments to taxable income under Prop. Treas. Reg. § 1.163(j)-2(f) was to “modify taxable income to more closely reflect the cash flow of the corporation.”²⁰ By contrast, the preamble to the Proposed section 163(j) Regulations specifically states that a cash flow approach was not adopted by the IRS. Instead, the Proposed section 163(j) Regulations only include the adjustments specified in section 163(j)(8)(A) and additional adjustments to prevent double counting and other distortions of items. Thus, the new interpretation of ATI departs from the guiding principle of the Prior Proposed Regulations. This is inconsistent with footnote 445 of the Ways and Means Committee report which states: “[a]ny deduction allowable for depreciation, amortization, or depletion includes any deduction allowable for any amount treated as depreciation, amortization, or depletion under present law.” (Emphasis added.) The Committee report language following the footnoted sentence states the “[t]he Secretary may provide other adjustments to the computation of adjusted taxable income.” Nothing suggests that the Ways and Means Committee sought a narrower definition of ATI, nor does any of the legislative history that followed the Ways and Means Committee report.

Regardless of whether the IRS believes that a cash flow approach is appropriate, EBITDA is inherently a cash flow concept which Congress clearly intended to mimic in its computation of ATI. The IRS should interpret ATI accordingly. The statutory text is identical under former section 163(j)(6)(A)(i)(IV) and current section 163(j)(8)(A)(v) in allowing an addition for DD&A. The IRS never provided that DD&A capitalized under section 263A should not be allowed as an addition in the Prior Proposed Regulations, and thus the final section 163(j) Regulations should similarly remove this distinction.

Impact on immediate expensing provision

The result of the IRS' interpretation of section 163(j)(8)(A)(v) is that manufacturers and producers are significantly disadvantaged as compared to those taxpayers that do not engage in activities subject to section 263A. This result is neither equitable nor sensible. Taxpayers should not be penalized for investing in critical trade or business assets merely because those assets may be used in a function that requires capitalization under section 263A. Given that Congress also amended section 168(k) to allow for immediate expensing of much of the property that the Working Group members acquire, this result is even more incongruous.

It is counterproductive to allow manufacturers and producers to immediately expense property used in a manufacturing or production activity, but also disallow an addition for DD&A on the property so expensed. Manufacturers and producers will be inherently disincentivized from claiming immediate expensing on their critical investments in plants, equipment, and similar property because the Proposed section 163(j) Regulations make it considerably more costly by disproportionately limiting the interest deduction. This is true even where the incremental new investment is financed entirely with equity because, under the Proposed section 163(j) Regulations, the expensing of new investments reduces ATI and the ability to deduct interest on existing debt levels.

To demonstrate this, consider the following example. Assume a corporation has ATI of $1 million and interest expense of $350,000 due to interest relating to prior investments. (For purposes of this example, assume all prior year investment has been fully depreciated, so ATI is the same whether or not DD&A on prior year investment is added back in computing ATI.) The application of section 163(j) would result in the loss of $50,000 of interest deductions in the year (the amount of interest expense exceeding 30 percent of ATI of $1 million). Now consider an incremental $100,000 investment in equipment financed with retained earnings that is placed in service mid-year that can be immediately expensed under section 168(k). Suppose in the first half-year of service this new investment is used to produce $15,000 of goods that enter inventory and are sold in that year, generating $15,000 of revenue. If ATI is computed by adding back all DD&A capitalized under section 263A as recommended by the Working Group, ATI will increase to $1.015 million, and the additional $15,000 of ATI will permit an additional $4,500 of pre-existing interest expense to be deducted in the year (30 percent of the $15,000 increase in ATI). The taxpayer will receive the full benefit of section 168(k) expensing as intended by Congress and — by choosing to equity finance the marginal investment — will be permitted to deduct an additional $4,500 of interest expense.

Now consider the impact on the taxpayer if DD&A capitalized under section 263A is not permitted to be added back in computing ATI. In this case, ATI will decline by $85,000 (the $100,000 of section 168(k) expensing less the $15,000 of incremental revenues). The decline in ATI will cause the taxpayer to lose an additional $25,500 of interest deductions (30 percent of the $85,000 decrease in ATI), even though the incremental investment was completely financed with retained earnings. This will cause corporate income taxes to increase by $5,355 (21 percent of $25,500). It causes the after-tax cost of this investment to rise from $79,000 ($100,000 cost to purchase less $21,000 after-tax savings from expensing) to $84,355 — a 6.8% increase in the after-tax cost of the investment in the first year. The $5,355 increase in corporate income taxes also represents more than 25 percent of the tax savings from expensing relative to not claiming any depreciation on the asset ($5,355 / $21,000). Contrary to the intent of Congress to provide robust incentives for capital investment in the United States through section 168(k) expensing and the section 163(j) addition for DD&A in the computation of ATI in 2018 through 2021, the treatment of DD&A capitalized under section 263A in the Proposed section 163(j) Regulations would result in a significant increase in the cost of new investment. Given that immediate full expensing is available through 2022 and DD&A is allowed as an addition in computing ATI through 2021, it is unlikely that Congress intended such irrational results.

Conclusion

In conclusion, the Working Group recommends that the rule under Prop. Treas. Reg. § 1.163(j)-1(b)(iii) be modified. For purposes of computing ATI under section 163(j), the Working Group recommends that DD&A be allowed as an addition regardless of whether the DD&A is capitalized under section 263A. For the reasons addressed above, the Working Group believes that this recommendation reflects the proper interpretation of the statute, is consistent with legislative intent, and results in sound tax policy. Furthermore, the Working Group's recommendation ensures that all taxpayers are treated equitably in applying the DD&A addition rule of section 163(j)(8)(A)(v). Finally, if the Working Group's recommendation is adopted, manufacturers and producers would be able to benefit from immediate expensing of their qualifying property used in their trades or businesses as contemplated by Congress.

We appreciate the opportunity to comment on these important proposed Regulations implementing section 163(j) of the TCJA. We would be happy to discuss any questions you have in respect of this letter or otherwise to assist you in your efforts with respect to this important issue. Feel free to call me at 202-414-1401 if you have any questions. We would welcome the opportunity to meet with you to further discuss our comment letter.

Very truly yours,

Pamela F. Olson
Principal, PricewaterhouseCoopers LLP

cc:
Krishna Vallabhaneni, Acting Tax Legislative Counsel, U.S. Treasury Department
Brett York, Attorney — Advisor, U.S. Treasury Department
Ellen Martin, Tax Policy Advisor, U.S. Treasury Department
Scott Dinwiddie, Associate Chief Counsel (Income Tax & Accounting), Internal Revenue Service