Exxon Mobil Suggests Changes to Proposed Debt-Equity Regs

Exxon Mobil Corporation ("ExxonMobil") submits this letter in response to the request for comments on the proposed regulations (REG-108060-15) under section 385 of the Internal Revenue Code (the "proposed regulations").

ExxonMobil's day-to-day cash management operations will be severely disrupted as a result of these regulations. ExxonMobil estimates the proposed regulations will cost around $30 million in implementation costs and $100 million in annual operating costs. Most of those amounts will be paid to banks in the form of interest or foreign exchange spreads. The proposed regulations will also put ExxonMobil at a competitive disadvantage compared to foreign-based competitors. The burdens these regulations will impose on non-targeted taxpayers are disproportionate to any potential benefits.

We therefore respectfully request that the proposed regulations be reissued with significant modifications in proposed form. These modifications will not eliminate disruption to ExxonMobil's operations, but they will improve the operating flexibility of the proposed regulations.

ExxonMobil's U.S. Cash Management

ExxonMobil is engaged in the business of oil and gas production, refining and marketing, and chemicals. It has operated for over 130 years as a U.S.-based corporation and does business in approximately 90 countries. In 2015, ExxonMobil's consolidated revenue and other income was $269 billion. Cash flow from operations and assets sales was $33 billion. The company seeks to minimize global cash balances and routinely repatriates cash to the U.S. to fund distributions to shareholders and capital expenditures. Last year, ExxonMobil distributed $1S billion to our shareholders and invested $11 billion in the U.S.

ExxonMobil's cash management operations have characteristics typical of a large multinational corporation. The company has three cash pooling centers located in the U.S., Netherlands, and Singapore. We also maintain cash pooling arrangements in about a dozen countries to manage funds for multiple affiliates in each of those countries.

ExxonMobil seeks to centralize cash in the U.S. and minimize cash levels. Recent cash levels of $4-5 billion globally are the result of these efforts. Minimizing cash avoids maintaining funds in low-return assets and limits external debt needs. Centralizing external debt in the U.S. allows ExxonMobil to utilize the liquid and competitive U.S. debt markets while maintaining its superior credit rating.

Pooling is a key tool for reducing the group's cash balances and ensuring adequate liquidity for our operations. We use a combination of physical pooling, notional pooling, and target balances, depending on jurisdiction, regulations, and banking industry norms. Pooling across multiple currencies reduces cash balances and avoids an estimated $185 billion of foreign currency transactions each year by allowing affiliates to net foreign exchange needs.

Effect of the Regulations

ExxonMobil processes over 70,000 cash movements per year across 600 intercompany agreements with over 400 affiliates. It will be impossible to analyze each transaction for possible equity treatment. The only practical response to the proposed regulations is to replace our current intercompany network with third-party banks at considerable cost.

ExxonMobil estimates an increase to annual operating costs of around $100 million, mostly in payments to banks, and $10-20 billion of increased cash balances. The increase in cash balances would cost ExxonMobil the interest rate spread between ExxonMobil's deposits and the charges for borrowing by the company. We would also pay a spread from selling a currency in one location while buying the same currency elsewhere. In total the company estimates an increase to annual operating costs of around $100 million, mostly in payments to banks. We would also bear higher operating costs from the additional staff needed for expanded operations.

ExxonMobil will need to build systems to ensure remaining intercompany loans are not inadvertently converted to equity. Systems projects of similar scope have cost as much as $30 million to design and implement. The company estimates that execution of the changes will take approximately 2 years. Execution will also require expenditures for hiring and training staff to implement new procedures.

ExxonMobil understands that Treasury has expressed interest in evaluating ideas to reduce the burden of the regulations on cash pooling. Even with a carve-out, the company estimates that annual compliance costs would increase by $20 million plus implementation costs.

The proposed regulations put ExxonMobil at a competitive disadvantage relative to non-U.S. companies. More than 80% of ExxonMobil's 2015 operating segment earnings were from outside the U.S. Unlike ExxonMobil, many of ExxonMobil's foreign competitors are taxed only in the country of operations. The proposed regulations deny ExxonMobil interest expense deductions and cause the company to recognize dividend income without the benefit of a foreign tax credit for any local taxes paid. This results in double taxation and undermines our ability to compete against other multinationals.

The proposed regulations exacerbate other tax policy concerns. To avoid debt-to-equity conversions, ExxonMobil will, of necessity, reduce inter-affiliate dividends. The reduction will strand funds offshore and suppress our U.S. taxable income. This, in turn, will increase borrowing in the U.S. to meet U.S. cash needs, including the dividend to ExxonMobil's shareholders. ExxonMobil considers such steps costly due to the spread between debt and bank deposits. The additional leverage also poses a cost to the U.S. government in the form of additional tax deductions. This is the same behavior the regulations are seeking to discourage in foreign entities.

The comment period for these regulations has been short. ExxonMobil therefore has not had time to consider all of the implications of the proposed regulations. In the next section, we recommend changes to the proposed regulations that would reduce the financial and compliance burden of the regulations. However, ExxonMobil has not identified a solution other than complete withdrawal of the regulations that would bring its costs to a reasonable level.

Recommended Changes

ExxonMobil believes the proposed changes in this section will reduce the risk of an inadvertent debt-to-equity conversion, lessen the operational costs and compliance burdens, and mitigate the consequences of a debt-to-equity conversion.

Recommended Changes to -3

First, the company recommends that the current-year E&P exception in Prop. Treas. Reg. § 1.385-3(c)(l) be expanded to cover the greater of current-year E&P or the sum of current-year E&P plus the two prior-years' E&P.

Current-year E&P alone is not a sufficient solution, as it is not determinable until after the year is closed. Unforeseen circumstances, such as a plant outage or a swing in commodities pricing, can sharply alter actual E&P relative to anticipated E&P. This makes any distribution under the current rule risky. Further, in many countries current-year E&P cannot be distributed until after the year is closed and the statutory books have been audited and certified sometime in the following year.

A rule covering multiple years of earnings better matches taxpayers' cash management needs. Cash flow and current-year E&P are different. ExxonMobil operates in a capital intensive industry and non-cash charges to E&P, such as depreciation, amortization and FIFO inventory adjustments, create significant differences between cash flow and current-year E&P. Expanding the exception to cover three years does not bring those differences into alignment, but it does give taxpayers increased flexibility to remit available cash flow.

Second, ExxonMobil suggests that CFC-to-CFC transactions be excluded from the scope of the regulations. These transactions cause no net loss of income to the U.S. Carving them out of the regulations significantly reduces the compliance burden, but does not eliminate it. ExxonMobil would still have significant compliance costs for activities in its U.S. treasury center and for U.S. entities with foreign operations that might use the Singapore or Netherlands treasury centers.

ExxonMobil also recommends that loans from U.S. corporations to foreign entities be excluded from the regulations. Since the income from these loans is immediately recognized in the U.S., these loans at best result in net revenue generation in the U.S. and at worst are neutral to the U.S. Excluding these loans would further reduce the burden of the proposed regulations.

Third, ExxonMobil recommends shortening the per se rule in Prop. Treas. Reg. § 1.385-3(b)(3)(iv)(B)(1) from 36 months prior to and 36 months after a distribution to 12 months prior to and after a distribution. If a distribution does not clearly fall into the current-year E&P exception, the six-year window imposes material due diligence and forecasting burdens before any distribution is made. First, the rule requires a review of the three years prior to the distribution. The review must incorporate not just the execution of the loan agreement, but must test for loan draws and for any capitalized interest that could represent an additional loan draw. Loan balances must be reviewed on a daily basis. Once the history of the affiliate has been reviewed, ExxonMobil must forecast the cash needs of the affiliate for the following three years. Forecasts are often imprecise by material amounts as external events play a significant role in ExxonMobil's earnings. For example, three years ago, crude oil was trading in excess of $100 per barrel. Today's operating environment, with crude oil trading for less than $50 per barrel, would not have been anticipated. Shortening the per se rule reduces the risk of an inadvertent debt-to-equity conversion due to an inability to forecast cash needs.

Fourth, the company asks that any carve-out for short-term cash pooling be drafted simply to make it readily administrable. Specifically, the company proposes a rule that excludes all debt instruments with a committed tenor of one year or less. These loans have lower interest rates than longer-term debt instruments and, therefore, do not raise a significant risk of stripping earnings from the U.S.

Fifth, ExxonMobil requests that intercompany trade payables settled through a clearing house or other netting arrangement be covered by the ordinary course of business exception in Prop. Treas. Reg. § 1.385-3(b)(3)(iv)(B)(2), even after the payable becomes an obligation to the clearing house. For most large affiliates, intercompany billing is handled through a clearing house located in Exxon Mobil Corporation, the parent company. This allows affiliates to net intercompany receivables and payables and simply settle a net amount. Without coverage for the clearing house, Exxon Mobil estimates that roughly 72,000 intercompany transactions each month would need to be included in any debt-to-equity conversion analysis.

Finally, Exxon Mobil recommends that the effective date of the regulations be extended to January 1, 2019, or the first tax year 24 months after final regulations are issued, whichever is later. Due to the high volume of transactions with in Exxon Mobil, the company will need to rely on systems both to modify business activity to avoid debt-to-equity conversions as well as to identify any inadvertent conversions and to report the differences in tax consequences on the tax return. The design, testing, and implementation of these systems will take time and can not be started until the final rules are known. It is likely that many taxpayers will be seeking fixes from the same vendors, and the vendors will not be able to accommodate all taxpayers immediately. An extension of the effective date for 24 months will give taxpayers a bare minimum of time to put systems and processes into place.

Recommended Changes to -2

Exxon Mobil strives to maintain high-quality documentation with respect to its intercompany loans, consistent with the arm's-length nature of these loans. However, there are certain circumstances where the company feels that that the documentation requirements are unreasonable and inconsistent with commercial practices. We request that the regulations exclude those circumstances.

It is consistent with commercial practices to document a loan at the time the agreement is issued. Such documentation includes an assessment of ability to pay. However, it is not reasonable or commercial to re-document each time the loan is drawn upon or interest is capitalized into the note. Exxon Mobil requests that the regulations specifically exclude these loans draws and interest capitalization events from all of the documentation requirements.

Second, Exxon Mobil requests clarity around the documentation requirements for trade payables. At yea r-end 2015, the company had outstanding intercompany trade payables of $8.3 billion. A large portion of these trade payables are settled through a clearing house which nets intercompany payables and receivables to minimize cash movements and intercompany billing. As mentioned above, the clearing house processes more than 72,000 intercompany payables transactions each month. Another 60,000 transactions are directly billed or settled via netting of receivables and payables.

The proposed regulations require documentation of a reasonable expectation of ability of repay. Prop. Treas. Reg. § 1.385-2(b)(2)(iii). Virtually all of Exxon Mobil's intercompany payables are settled promptly. Exxon Mobil has more than 1,200 affiliates, each of which receives some level of services from other affiliates. Evaluating the creditworthiness of each affiliate would require a significant increase in internal administrative costs and effort without significantly furthering Treasury's purpose in crafting these regulations.

Exxon Mobil understands that Treasury's primary concern is that intercompany trade payables not be used as an alternative for longer-term financing. The company suggests that intercompany trade payables be excluded from the documentation requirements if the payables are settled on or before the first day of the fourth month following the month in which the payable is incurred, consistent with Treas. Reg. § 1.482-2(a)(1)(iii)(C). Should an intercompany payable remain outstanding beyond the permitted time period, the intercompany item would become a debt instrument subject to -2 and -3 and be deemed incurred for purposes of the proposed regulations on that first day after the fourth month.

Should Treasury elect not to provide an exception for trade payables as outlined above, Exxon Mobil asks that Treasury include an example in the regulations showing that the contracts providing for these trade payables meet the documentation requirement in Prop. Treas. Reg. § 1.385-2(b)(2)(i). Unlike inter-company loans, individual trade payables are not documented as loans. Rather, documentation typically consists of a master agreement. In the case of a service agreement, this may outline a slate of available services; a product supply agreement might simply state an agreement to supply product and provide terms for nominating volumes for delivery. The documents are legally enforceable but will rarely state a fixed sum certain as charges will vary based on the benefit received in the billing cycle.

Recommended Changes to Section 902 of the Internal Revenue Code

When debt is converted to equity, the new shareholder is unlikely to have a 10% voting interest in the borrowing affiliate. As a result, the shareholder-lender will not be eligible for a deemed paid credit under section 902. The foreign tax credits associated with any dividends paid to the shareholder-lender will disappear per Treas. Reg. § 1.902-1(a)(S)(i). Not only interest payments, but loan repayments on a recast instrument can be characterized as dividends. As a result, the lost foreign tax credits have the potential to become a material cost to Exxon Mobil, even though we are not a target of the regulations. Further, it is a material cost foreign competitors do not have to bear.

To avoid this outcome, Exxon Mobil recommends that the section 902 regulations be amended to allow a deemed paid credit for distributions with respect to debt instruments converted under section 385, so long as the expanded group owns 10% of the voting stock.

In closing, Exxon Mobil appreciates you r consideration of our comments and suggestions. If you have any questions or comments on this letter, please feel free to contact us.