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Oil Company Seeks ATI Computation Changes Under Interest Regs

FEB. 26, 2019

Oil Company Seeks ATI Computation Changes Under Interest Regs

DATED FEB. 26, 2019
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February 26, 2019

CC:PA:LPD:PR (REG-106089-18)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

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

Dear Sir or Madam:

Occidental Petroleum Corporation ("Oxy") appreciates the opportunity to comment on the proposed regulations regarding the section 163(j) business interest expense deduction limitation that were issued on November 26, 2018, by the Department of the Treasury ("Treasury") and the Internal Revenue Service ("IRS"). This comment letter discusses application of section 163(j), enacted as part of Public Law 115-97 ("Tax Cuts and Jobs Act"), and the methodology of computing adjusted taxable income ("ATI") for purposes of the proposed regulations. In section (1)(A)(iii) of the notice of proposed rulemaking, the Treasury clarifies that an amount incurred as depreciation, amortization, or depletion, but capitalized to inventory under section 263A and recovered through cost of goods sold ("COGS"), is not a deduction for depreciation, amortization, or depletion for purposes of section 163(j). For the reasons stated below, Oxy requests that the Treasury reconsider this position, and conclude that amounts incurred as depreciation, amortization, or depletion, whether or not capitalized under section 263A, is a "deduction allowable" for calculating ATI under the proposed regulations.

Sincerely,

Vincent Alspach
Vice President — Tax
Occidental Petroleum
Houston, TX
713-366-5693 (o)

cc:
The Honorable David J. Kautter, Assistant Secretary for Tax Policy, Department of the Treasury
The Honorable Charles Rettig, Acting Commissioner, Internal Revenue Service
The Honorable William M. Paul, Acting Chief Counsel, Internal Revenue Service
Mr. Krishna Vallabhaneni, Deputy Tax Legislative Counsel, Office of Tax Policy, Department of the Treasury
Mr. Christopher W. Call, Attorney-Advisor (Tax Legislation), Office of Tax Policy, Department of the Treasury
Mr. Brett York, Attorney-Advisor, Office of Tax Policy, Department of the Treasury
Mr. Zachary King, Office of the Associate Chief Counsel (Income Tax and Accounting), Internal Revenue Service
Mr. Charles Gorham, Office of the Associate Chief Counsel (Income Tax and Accounting), Internal Revenue Service
Ms. Susie Bird, Office of the Associate Chief Counsel (Income Tax and Accounting), Internal Revenue Service
Ms. Jaime Park, Office of the Associate Chief Counsel (Income Tax and Accounting), Internal Revenue Service
Ms. Sophia Wang, Office of the Associate Chief Counsel (Income Tax and Accounting), Internal Revenue Service
Mr. Kevin Jacobs, Office of the Associate Chief Counsel (Corporate), Internal Revenue Service


I. Introduction

Founded in 1920, Occidental Petroleum Corporation ("Oxy") is an international oil and gas and chemical company with operations primarily in the United States, Middle East, and Latin America. Oxy's principal three business segments are — (1) oil and gas exploration and production; (2) midstream and marketing, which purchases and sells oil, condensate, and natural gas; and (3) the chemical segment, which operates 22 manufacturing plants in the United States, primarily producing chlorine and caustic soda. Headquartered in Houston, Texas, Oxy is one of the largest U.S. oil and gas companies based on equity market capitalization, which was $46 billion as of December 31, 2018.

Oxy employs approximately 11,000 people worldwide with approximately 7,000 of those employees located in the United States. Fortune magazine has ranked Occidental among its Most Admired Companies in the Mining, Crude-Oil Production category every reported year since 2008, including the No. 1 ranking 10 times. At Oxy, social responsibility is fundamental to our success. We are committed to conducting our business in a manner that safeguards our employees, protects the environment, benefits neighboring communities, and strengthens local economics.

Oxy supports the Tax Cuts and Jobs Act, which more closely aligns U.S. corporate income taxes rates with our OECD trading partners, recognizes the IRS's hard work and diligence in issuing proposed regulations to provide taxpayers with additional guidance to help us meet our tax compliance responsibilities.

II. Analysis

a. Statutory Framework

Section 163(j) limits the amount of business interest expense that an entity can deduct. The amount allowed as a deduction for business interest expense cannot exceed the sum of:

1. The taxpayer's business interest income for the taxable year;

2. 30 percent of the taxpayer's ATI for the taxable year, or zero if the taxpayer's ATI for the taxable year is less than zero; and

3. The taxpayer's floor plan financing interest expense for the taxable year.1

The ATI calculation contemplates taxable income without regard to certain adjustments including, for taxable years beginning before January 1, 2022, any deduction allowable for depreciation, amortization, or depletion ("DD&A").2 However, the proposed regulations specify that DD&A expense capitalized to COGS under section 263A is not an addback to taxable income for purposes of determining ATI.3

i. Mechanics of §263A Capitalization to Inventory

Section 1.263A-1(e)(3)(ii) mandates that depreciation is an indirect cost which must be bifurcated between capitalized inventory costs and currently deductible expenses using a reasonable method as directed under the regulations. Further, section 1.263A-2(b)(3)(ii) requires that indirect section 263A costs be allocated to ending inventory. Consequently, depreciation expense that is subject to section 263A will be partially reflected as a section 167 or 168 deduction, and the remaining portion will be capitalized to inventory and deducted as part of cost of sales.

Technical Argument

ii. The language of the proposed regulations does not track that of the statute.

ATI is computed without regard to, in the case of taxable years beginning before January 1, 2022, any deduction allowable for depreciation, amortization, or depletion.4 However, the proposed regulations state for taxable years beginning before January 1, 2022, any deduction for depreciation5, any deduction for the amortization of intangibles and other amortized expenditures6, and any deduction for depletion under section 6117 are added to taxable income to determine adjusted taxable income. Regulations are intended to clarify the statute. In this case, the omission of the word "allowable" is a departure from the statute. As a matter of regulatory procedure, this omission is improper and conveys different treatment.

iii. Section 163(j) should consider DD&A allowances as "allowable" deductions under the Code, which would be consistent with the statutory interpretation of other Code provisions

Section 1016(a)(2) mandates that a property's basis must be adjusted, in all instances, by amounts allowed as deductions in computing taxable income and stipulates that these adjustments must be made in amounts not less than an amount allowable under the Code or prior tax laws.8 "Allowable" deductions are deductions that are permitted under the Code and are not otherwise forbidden to be taken, regardless of whether they result in a tax benefit to the taxpayer.9 Therefore, for purposes of calculating tax basis adjustments under section 1016(a)(2), taxpayers must determine whether the amounts are allowable deductions per the Code.

Under section 263A(a)(2), only amounts which are allowable in computing taxable income may be properly capitalized to inventory.10 Indirect costs that must be capitalized include DD&A allowances taken on property that is produced by the taxpayer and on property that is used in the taxpayer's manufacturing processes.11 Because DD&A costs must be capitalized to inventory, they are considered "allowable" amounts in computing taxable income under section 263A(a)(2). Additionally, DD&A costs that are capitalized to inventory and recovered through COGS must also be included as adjustments to a property's basis under section 1016(a)(2) because they are "allowable" deductions permitted under the Code.

Section 163(j)(8) contains similar statutory language to section 1016(a)(2) and section 263A. For tax years beginning before January 1, 2022, a taxpayer's ATI is calculated without regard to any deduction allowable for DD&A.12 Consistent with the statutory interpretation of section 263A(a)(2), DD&A costs that are capitalized to inventory and deducted as a part of cost of sales should be recognized as "allowable” amounts that affect the ATI calculation under section 163(j). This result is also consistent with the statutory interpretation of section 1016(a)(2) because that provision recognizes DD&A costs that are capitalized to inventory under section 263A as "allowable" deductions under the Code that must be included as adjustments to a property's basis. It would be inconsistent to interpret section 163(j)(8) in a way that precludes the ATI calculation from accounting for DD&A amounts that are capitalized to COGS because this deprecation is an "allowable" deduction under other provisions of the Code.

iv. A.M. 2008-12 supports considering section 263A costs as "allowable" deductions under section 163(j)

In A.M. 2008-12, the IRS reached a result that is consistent with the interpretation that DD&A should be added back to taxable income to arrive at ATI, regardless of whether the depreciation is reported as part of COGS. In A.M. 2008-12, the Large and Mid-Size Business Operating Division ("LMSB”) identified manufacturing taxpayers that paid workers compensation or incurred costs to remediate environmental contamination. The taxpayers properly capitalized the remediation costs and workers compensation payments to inventory under section 263A. Part of the capitalized amounts were properly accounted for in current year gross income as COGS, and the remaining portion was properly included in ending inventory.

Section 172(f)(1)(B)(i) specifies that workers compensation payments and remediation costs should be considered "allowable as [] deduction[s]" under the Code, and section 172(f)(1)(B)(i)(IV)-(V) identifies workers compensation payments and environmental remediation costs as specified liability losses. However, the LMSB questioned whether these costs failed to qualify as specified liability losses; and therefore, as "allowable" deductions under the Code, because they were included as inventoriable costs under section 263A.

The IRS concluded that the phrase "allowable as a deduction" should be interpreted to include amounts that are considered in computing taxable income. Since Congress used the phrase "allowable as a deduction" in the statute, the IRS concluded that Congress did not intend to distinguish COGS from "deductions." Because workers compensation payments and remediation costs are considered "allowable" deductions under section 172(f)(1)(B)(i), the IRS reasoned that they qualified as specified liability losses even though they were capitalized to inventory under section 263A and subsequently recovered through COGS.13 This statutory interpretation is consistent with section 263A because only amounts that may be accounted for in computing taxable income can be treated as inventoriable costs.14

The IRS also justified its conclusion from a policy standpoint. It reasoned that interpreting section 172(f)(1)(B)(i) in a manner that prohibited environmental remediation costs and workers compensation payments allocable under section 263A from qualifying as specified liability losses unreasonably limited application of the provision to taxpayers that were not subject to section 263A, such as service providers. If Congress meant to limit application of section 172(f)(1)(B)(i) to such taxpayers, it would have done so explicitly.

The statutory language in section 163(j) is similar to the language in section 172(f), because section 163(j) also specifies that only DD&A amounts which are "allowable" deductions may affect the ATI calculation.15 Thus, section 163(j) should be interpreted to include DD&A costs that must be capitalized to inventory under section 263A as "allowable" deductions that should be added back to calculate ATI. Any deduction allowable for depreciation, amortization, or depletion includes any deduction allowable for any amount treated as depreciation, amortization, or depletion under present law.16 Similar to the situation in A.M. 2008-12, the legislative history behind section 163(j) does not indicate that Congress intended for COGS to be distinguished from "allowable" deductions for purposes of calculating ATI.17 Because DD&A costs capitalized to inventory under section 263A are treated as "allowable" deductions under the Code, they should be included as "any deduction allowable" under section 163(j).

v. With respect to any deduction allowable for depletion, the proposed regulations as drafted nullify the statute.

Section 163(j)(8)(v) allows for any deduction allowable for depletion to be added back to taxable income in order to calculate ATI. The regulations of Section 263A require that depletion, whether or not in excess of cost, is properly allocable to property that has been sold.18 Further, the proposed regulations further state that depletion expense that is capitalized to inventory under section 263A is not a depletion deduction for purposes calculating ATI.19 Thus, when a corporate taxpayer owns a working interest in an oil and gas mineral lease, the amount of depletion expense should be capitalized to inventory under section 263A. If the corporate taxpayer, such as Oxy, is required to capitalize its depletion expense to inventory, and depletion expense that is capitalized to inventory under 263A is not a depletion deduction for purposes of calculating ATI, then the statute allowing for any deduction allowable for depletion is nullified. Surely, IRS regulations should not be inconsistent with the clear legislative intent to allow an addback for depletion expense in calculating ATI.

b. Policy Argument

i. The proposed regulations do not align with Congressional intent

The Tax Cuts and Jobs Act aimed to promote the success of American businesses so that they may, in turn boost the American economy through increased wages and more job opportunities.20

The proposed regulations have a punitive impact section 263A. Effectively, taxpayers who incur costs subject to the inventory capitalization rules of section 263A are required to calculate their ATI on an "EBIT" basis four years sooner than Congress intended. The conference committee report accompanying the Tax Cuts and Jobs Act strongly suggests that Congress intended for taxpayers to benefit from a four-year transition period to adjust from calculating ATI on an EBITDA21 basis to an EBIT basis. The House version of the Tax Cuts and Jobs Act defined ATI to be computed without regard to "deductions allowable for depreciation, amortization, or depletion."22 However, the Senate version provided an EBIT-based definition of ATI that did not account for "deductions allowable for depreciation, amortization, or depletion" as adjustments that should be made to taxable income.23 The conference agreement shows a compromise between the two definitions, and specifies that ATI should be calculated on an EBITDA basis by permitting deductions allowable for DD&A to be added back as adjustments to taxable income only for tax years beginning before January 1, 2022.24 Because the proposed regulations preclude the ATI calculation from accounting for DD&A costs that are capitalized under section 263A as adjustments to taxable income, they violate congressional intent that all taxpayers benefit from calculating ATI on an EBITDA basis during the four-year transition period25

III. Conclusion

The proposed regulations should be revised to provide that DD&A allowances that are capitalized to inventory and recovered through COGS are considered allowable deductions for purposes of section 163(j) and, therefore, may be included as adjustments to ATI for tax years beginning before January 1, 2022. Obtaining this result would be consistent with legislative intent and the statue as enacted in section 163(j)(8)(A)(v).

FOOTNOTES

1I.R.C. § 163(j)(1) (2018).

2I.R.C. § 163(j)(8)(A)(v) (2018).

3Prop. Treas. Reg. § 1.163(j)-1(b)(iii) (emphasis added).

4I.R.C. § 163(j)(8)(v) (2018).

5Prop. Treas Reg. § 1.163(j)-1(b)(i)(D).

6Prop. Treas. Reg. § 1.163(j)-1(b)(i)(E).

7Prop Treas. Reg. § 1.163(j)-1(b)(i)(F).

8I.R.C § 1016(a)(2) (2018).

9Sharp v. U.S., 14 F.3d 583, 588 (Fed. Cir. 1993).

10I.R.C. § 263A(a)(2) (2018).

11Treas. Reg. § 1.263A-1(e)(3)(ii)(I)-(J).

12I.R.C. § 163(j)(8) (2018).

13The IRS clarified that such costs constituted specified liabilities losses "to the extent they are taken into account in computing a net operating loss for the taxable year." Costs remaining on hand at the end of the taxable year (i.e. ending inventory) may be treated as specified liability losses for the year that they are recovered through COGS, assuming the taxpayer has a net operating loss for that year.

14Treas. Reg. § 1.263A-1(c)(2)(i).

15I.R.C. § 163(j)(8).

16H.R REP. No. 115-466, at 387 n.689 (2017) (Conf. Rep.).

17Id.

18Treas. Reg. § 1.263A-1(e)(3)(ii)(J).

19Prop. Treas Reg. § 1.163(j)-1(b)(iii).

20See H.R. Rep. of the Comm. on Ways & Means No. 115-409, at 112 (2017).

21EBITDA is a company's "earnings before interest, tax, depreciation and amortization.” It is a common measure of a company's operating performance. It is a common metric often used by the Organisation for Economic Co-operation and Development ("OECD") to determine whether or not a company is thinly-capitalized. EBITDA does not consider whether or not a deduction for DD&A is a below the line deduction or a reduction to gross sales to arrive at gross income. As such, the proposed regulations that eliminate the addback of DD&A to the extent those deductions are capitalized to inventory will improperly distort a company’s EBITDA.

22H.R. Rep. No. 115-466, at 387 (2017) (Conf. Rep.)

23Id. at 390.

24Id. at 392.

25Prop. Treas. Reg § 1.163(j)-1(b)(1) (clarifying that the adjusted taxable income of a taxpayer accounts for any depreciation, amortization, or depletion deductions incurred only during tax years that begin after December 31, 2017 and prior to January 1, 2022).

END FOOTNOTES

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