Group Proposes Qualified Derivative Payment Reporting Method

QDP Identification Alternative

I. Introduction

We have previously made two recommendations to Treasury and the IRS with respect to the method of QDP reporting under Section 59A(h)(2)(B):

1. Reporting of Aggregate Amounts. If Treasury and the IRS require taxpayers to report the amount of their QDPs, they should be permitted to report the amount of QDPs made by the taxpayer in the aggregate to non-U.S. affiliated entities.

2. Alternative Identification Requirement. We have also recommended that, as an alternative to a requirement that taxpayers report the amounts of their QDPs, a taxpayer should be permitted to identify the payments reflected in its books and records that it is treating as QDPs (the “QDP Identification Alternative”), provided that the taxpayer retains the records necessary to establish what payments are QDPs and what are not.

This paper elaborates further on the proposed QDP Identification Alternative.

II. QDP Identification Alternative

A. Background

The rationale for the QDP Identification Alternative can be stated very simply: because payments that qualify for the QDP exception are not included in either the numerator or the denominator, the actual amounts of QDP payments are irrelevant to the operation of Section 59A. In light of this, the reporting requirement of Section 59A(h)(2)(B) is best understood as expressing a congressional intent that the IRS have the tools to determine whether a taxpayer inappropriately excluded an item from the numerator by categorizing it as a QDP (or inappropriately included in the denominator a payment that does qualify for the QDP exception). In this respect, it is important to note that nowhere does Section 59A(h)(2)(B) expressly require reporting of the amounts of QDPs; rather it requires only the reporting of “such information as is necessary to identify the payments to be so treated [as QDPs],” in addition to any other information the Secretary determines is necessary to carry out the provisions of Section 59A(h).

We submit that the best way to accomplish the purposes of Section 59A(h)(2)(B) is to require a taxpayer to give the IRS a “roadmap” as to which payments it treated as QDPs, and which payments it did not treat as QDPs. That “roadmap” will vary by taxpayer, depending on how the taxpayer tracks various categories or types of QDPs and non-QDPs in its books and records. In some cases, taxpayers will be able to point to specific accounts that contain certain QDPs or non-QDPs, or otherwise be able to clearly identify such payments on its general ledger. In other cases, especially with respect to items that do not have non-tax significance (e.g., payments described in Section 59A(h)(3)), tracking QDPs and non-QDPs via account listing or by reference to general ledger identifiers may not be a viable option. As a result, the identification method will likely vary by taxpayer and, even for a single taxpayer, may consist of a mix of both (i) identification of specific accounts or general ledger identifiers and (ii) a description of the process by which the taxpayer identified QDPs and non-QDPs in situations where such items are not capable of being easily separated into separate accounts or otherwise separately “tagged” on the taxpayer's books and records.

Because different taxpayers are not similarly situated, and no single method of complying with the QDP Identification Alternative is likely to be feasible for all taxpayers, we believe that a taxpayer should be permitted to satisfy the QDP Identification Alternative using any reasonable method.

It is important to note that whatever method of reporting is adopted, the failure to report any given QDP would generally cause that QDP not to be eligible for exclusion from the numerator, subject to the protections set forth in our original proposals (including, importantly, that only the non-reported QDP, and not all QDPs, be excluded from the numerator, and that taxpayers be allowed to correct a ministerial or other non-material failure or error in complying with the reporting requirement post-filing).

B. Illustrative Identification Methods

The following are illustrations of what we submit would be reasonable methods of satisfying the QDP Identification Alternative, and are analogous to certain methods by which Section 475 dealers can comply with the identification requirements in Section 475(b)(2) under existing IRS guidance.

1. Identification by QDPs by Inclusion. One reasonable method of complying with the QDP Identification Alternative would be to identify the specific ledgers or accounts that contain QDPs or the specific coding used to “capture” these items in the taxpayer's systems. Any payments reflected in this universe that are not eligible for the QDP exception would need to be specifically identified in some fashion. For example, taxpayers could maintain a Section 59A identification database and identify the code or description of these specified payments following the general ledger account number and description. Taxpayers could also show (e.g., by describing the relevant process) that the payments that are not eligible for the QDP exception have been properly taken into account in the base erosion percentage calculation.

2. Identification of QDPs by Exclusion. A second reasonable method of complying with the QDP Identification Alternative would be to do the reverse, and identify the “universe” of payments that do not qualify for the QDP exception (again, with the ability to identify payments reflected in this universe that are eligible for the QDP exception in some fashion).

As indicated above, there are cases where taxpayers may have substantial difficulty identifying with specificity the “universe” (e.g., the specific transactions, ledgers or accounts in which the payments are booked or the specific coding used to “capture” these items in the taxpayer's systems) of payments that are or are not eligible for the QDP exception without significant and burdensome system-build. When this is the case, taxpayers should be permitted to report the process by which they comply with the QDP Identification Alternative rather than the specific “universe” of these items.

C. Comparison to Section 475 Identification Requirements

Support for the proposition that taxpayers should be permitted to comply with the QDP Identification Alternative using any reasonable method and that the methods described above should be viewed as reasonable can be found in existing IRS guidance regarding methods by which Section 475 dealers can comply with the identification requirements in Section 475(b)(2).

1. Section 475(b)(1) generally provides that certain securities are not marked to market under Section 475 if they have been properly identified as (A) “held for investment,” (B) evidences of indebtedness (or an obligation to acquire evidence of indebtedness) that was acquired in the ordinary course of business and is not held for sale or (C) hedges of securities that are not marked to market under Section 475.

2. Section 475(b)(2) provides that to be properly identified as excluded from Section 475(a), a security must be clearly identified in the dealer's records as falling within Section 475(b)(1) by the close of the day the security was acquired, originated or entered into (or such other time as set forth in regulations). An analogy can be drawn between this requirement and the requirement in Section 59A(h)(2)(B) for taxpayers to report “such information as is necessary to identify the payments to be [treated as QDPs].”

3. Revenue Ruling 97-39, Issue 6, 1997-2 C.B. 63, provides that a Section 475 dealer may comply with the identification requirements under Section 475 using “any reasonable method.” The identification can be made by clearly identifying a specific security as exempt, or by identifying accounts that contain specific securities covered by a particular exception.

4. In addition, despite the statutory language in Section 475(b)(2) that expressly requires that a security that is exempt from marking to market under Section 475(a) be identified as such, the ruling provides that a Section 475 dealer may comply with this identification requirement by clearly indicating the specific securities or accounts that are not covered by a particular exception (that is, indicating that they are covered by some other exception or that they are not exempt from Section 475(a)) and globally identifying all other securities or accounts as being covered by a particular exception. For example, a dealer may place on its books and records a statement that, unless otherwise identified, all of its securities are exempt under a particular exception.

5. Section 475 represents a similar audit trail question for the IRS. Although taxpayers still need to prove in audit that a Section 475(c) identification is properly done, Rev. Rul. 97-39 allowed taxpayers to make the identification without pointing to specific ledgers or accounts.