Proposed Transition Tax Regs Sweep Too Broadly, Jones Day Says

August 30, 2018

The Honorable Steven Mnuchin
Secretary
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, N.W.
Washington, D.C. 20220

The Honorable David J. Kautter
Acting Commissioner
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

The Honorable William M. Paul
Acting Chief Counsel and Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

CC:PA:LPD:PR
REG-104226-18
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments to Proposed Regulations under Section 965 of the Internal Revenue Code

Dear Sir or Madam:

We write to provide comments in response to the Notice of Proposed Rulemaking published in the Federal Register on August 9, 2018, 83 Fed. Reg. 39514, relating to proposed regulations (the “Proposed Regulations”) under section 965.¹

Jones Day advises U.S. multinational companies in all manner of transactions involving their foreign subsidiaries. Our clients have eagerly awaited guidance under section 965 because the mechanics of computing the transition tax may affect their ability to enter into legitimate business transactions and conduct their day-to-day operations. Based on our experience in advising our clients, we respectfully submit that the Proposed Regulations have exceeded their intended effect in a few areas, penalizing transactions that are consistent with congressional purpose or else not relevant to the policies of section 965.

Our recommendations are as follows:

1. Transfers of Cash Between Related SFCs With Different Taxable Years

In order to assess the transition tax on overseas earnings held as cash and cash equivalents at a 15.5% tax rate and all other overseas earnings at an 8% tax rate, Congress allowed a deduction for any taxable year of a U.S. shareholder in which the U.S. shareholder includes an amount under section 965(a) in income. Under section 965(c)(1), the deduction is equal to the sum of two amounts. The first is the excess, if any, of the section 965(a) inclusion amount over the amount of the U.S. shareholder's aggregate foreign cash position, multiplied by the percentage necessary to tax such excess at the 8% rate. The second is so much of the U.S. shareholder's aggregate foreign cash position as does not exceed the section 965(a) inclusion amount, multiplied by the percentage necessary to tax this amount at the 15.5% rate. Under section 965(c)(3)(B), the cash position of an SFC generally includes cash and certain cash equivalents.

In interpreting section 965(c)(1), the Proposed Regulations require a U.S. shareholder to determine its aggregate foreign cash position by reference to its pro rata share of the cash position of each of its SFCs on three separate “cash measurement dates.” Prop. Reg. § 1.965-1(f)(8)(i). The U.S. shareholder's aggregate foreign cash position generally is the greater of the U.S. shareholder's pro rata share of the cash position of each SFC determined as of the “first cash measurement date” and the average of such amounts determined as of the “first cash measurement date” and the “second cash measurement date.” Because SFCs likely have year ends that match or occur one month before the year end of their U.S. shareholders,² for calendar year U.S. shareholders, the first cash measurement date would typically be November 30 or December 31, 2015; the second cash measurement date would typically be November 30 or December 31, 2016; and the final cash measurement date would typically be December 31, 2017 or November 30, 2018.

Thus, the Proposed Regulations contemplate that, for any U.S. shareholder, each cash measurement date may actually encompass two (or more) actual calendar dates. Indeed, the final cash measurement date of one SFC will very often be months apart from the final cash measurement date of another SFC. Because of this discrepancy, cash earnings may often be counted twice. For example, suppose USP, a domestic corporation, owns all of the stock of CFC1 and CFC2, both foreign corporations. The taxable years of USP and CFC1 end on December 31, and CFC2's taxable year ends on November 30. On December 31, 2017, CFC1 has $100x in cash. On January 1, 2018, CFC1 transfers the $100x in cash to CFC2, which holds the cash through November 30, 2018. As a result, CFC1 and CFC2 would each hold the same $100x of cash on their respective final cash measurement dates. Under Prop. Reg. section 1.965-1(f)(8)(i), USP's aggregate foreign cash position could include the $100x twice, simply because the cash moved from one SFC to another.

The Proposed Regulations contain two rules for avoiding double-counting, but neither contemplates any relief for U.S. shareholders that find themselves in USP's position. First, Prop. Reg. section 1.965-3(b)(1) disregards accounts receivable, accounts payable, short-term obligations, and derivative financial instruments between related SFCs, to the extent of the U.S. shareholder's overlapping ownership percentage. Second, Prop. Reg. section 1.965-3(b)(2) disregards net accounts receivable, actively traded property, and short-term obligations of an SFC, to the extent attributable to amounts taken into account in determining a U.S. shareholder's pro rata share of the cash position of another SFC on the same cash measurement date, provided the U.S. shareholder attaches a statement to its timely filed return for its inclusion year that explains why there would otherwise be double-counting. Neither of these rules would provide relief to USP or similarly situated U.S. shareholders because cash does not fall within their scope.

We recommend that Prop. Reg. section 1.965-3(b)(2) be expanded to cover all assets constituting the cash position of an SFC, including actual cash. Under this formulation, a U.S. shareholder can disregard an SFC's cash (or any other asset described in section 965(c)(3)(B)) on a cash measurement date to the extent attributable to amounts already taken into account in determining the U.S. shareholder's pro rata share of the cash position of another SFC on such cash measurement date. We recommend that Prop. Reg. section 1.965-3(b)(2) be expanded — rather than a new rule created — because we acknowledge that the IRS needs regulations that are administrable. If required to provide sufficiently detailed explanations in their timely filed returns, U.S. shareholders would have the burden of demonstrating, even if not subject to examination, that double-counting would otherwise occur.

Without this change, the aggregate foreign cash position of many U.S. multinational companies will be overstated and, as a result, their liquid foreign earnings will be taxed at a rate greater than Congress intended. Transactions between SFCs with November 30 year ends and related SFCs with December 31 year ends are commonplace. In the context of a multinational company, transactions for cash and cash-like consideration by and among its foreign subsidiaries, including those with different year ends, are a routine, everyday occurrence. The issue also arises when SFCs dispose of all their assets pursuant to a reorganization, liquidation, or other transaction in furtherance of legitimate business purposes. For instance, a multinational company may wish to integrate newly acquired foreign subsidiaries by merging them with and into existing foreign subsidiaries. Indeed, it is quite common for a target group to have SFC year ends different from the acquiring group's historical SFCs.

Further, before the Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97, 131 Stat. 2054, many multinational companies held their SFCs in structures that did not permit efficient repatriations of cash. Optimizing those structures so that such cash can be efficiently repatriated is consistent with congressional intent behind the Tax Cuts and Jobs Act, but may require merging foreign subsidiaries with and into each other in light of local law restrictions on dividend distributions. If the acquiring foreign subsidiaries have November 30 year ends and the target foreign subsidiaries have December 31 year ends, then the mergers could, by happenstance, increase the aggregate foreign cash position of the company without increasing the actual amount of cash. Similar concerns also arise with liquidations and other reorganizations undertaken for legitimate business planning.

We believe that the Secretary of the Treasury plainly has the authority to broaden the scope of Prop. Reg. section 1.965-3(b)(2). As a general matter, section 7805(a) authorizes the Secretary to “prescribe all needful rules and regulations for the enforcement” of the Code. And section 965(o), in particular, grants the Secretary the authority to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of' section 965. Construing similar language, the Supreme Court has repeatedly held that such a broad delegation of rulemaking power triggers deference under Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc., 461 U.S. 837 (1984). See, e.g., Nat'l Cable & Telecommc'ns Ass'n v. Brand X Internet Servs., 545 U.S. 967, 980-81 (2005) (applying Chevron deference to FCC action where statute authorized regulations “as may be necessary . . . to carry out the provisions”); Sullivan v. Everhart, 494 U.S. 83, 87-89 (1990) (granting Chevron deference to HHS regulation where statute authorized promulgation of rules “which are necessary or appropriate to carry out such provisions [of this subchapter]”). And, of course, the Chevron framework applies equally to Treasury's tax regulations, as the Supreme Court has confirmed. See Mayo Found, for Med. Educ. & Research v. United States, 562 U.S. 44, 57 (2011).

Applying Chevron's two-step framework, the first question is whether Congress “directly addressed the precise question at issue.” 467 U.S. at 842-43. Congress did not do so. The “precise question at issue” is whether cash held by one SFC on its cash measurement date should be counted again if it is subsequently transferred to another SFC and remains held by the latter on its (different) cash measurement date. Nothing in section 965 “directly” speaks to that fact pattern, which is unlikely to have been at the forefront of the congressional mind.

To be sure, Congress did speak directly to a related question: whether to double-count certain other SFC assets. And, there, Congress said no. Specifically, section 965(c)(3)(D) provides that net accounts receivable, marketable securities, and short-term obligations are not “taken into account by a [U.S.] shareholder” in determining its aggregate foreign cash position “to the extent that such [U.S.] shareholder demonstrates to the satisfaction of the Secretary that such amount is so taken into account by such [U.S.] shareholder with respect to another [SFC].” But no negative inference can be drawn from section 965(c)(3)(D)'s omission of cash. As the D.C. Circuit has consistently recognized, the usual expressio unius canon is a “feeble helper in an administrative setting, where Congress is presumed to have left to reasonable agency discretion questions that it has not directly resolved.” Cheney R.R. Co. v. ICC, 902 F.2d 66, 69 (D.C. Cir. 1990). Where an agency is expected to fill any statutory gaps, “the contrast between Congress's mandate in one context with its silence in another suggests . . . simply a decision not to mandate any solution in the second context, i.e., to leave the question to agency discretion.” Id. And particularly “when countervailed by a broad grant of authority contained within the same statutory scheme, the canon is a poor indicator of Congress' intent.” Adirondack Med. Ctr. v. Sebelius, 740 F.3d 692, 697 (D.C. Cir. 2014). Indeed, if anything, section 965(c)(3)(D)'s (admittedly limited) directive against double-counting supports a similar regulatory protection for actual cash; “a congressional prohibition of particular conduct may actually support the view that the administrative entity can exercise its authority to eliminate a similar danger.” Tex. Rural Legal Aid, Inc. v. Legal Servs. Corp., 940 F.2d 685, 694 (D.C. Cir. 1991); see also Mobile Commc'ns Corp. of Am. v. FCC, 77 F.3d 1399, 1405 (D.C. Cir. 1996).

The inapplicability of the expressio unius canon is further heightened here because, in exempting certain SFC assets from double-counting, Congress also imposed a heightened burden on taxpayers seeking to benefit from that exemption. Congress required a demonstration “to the satisfaction of the Secretary” that the cash position was already taken into account with respect to another SFC. Congress thus evidently believed that the circumstances surrounding SFCs' net accounts receivable, marketable securities, and short-term obligations would be sufficiently intricate to require the Secretary to consider them on a taxpayer-by-taxpayer basis, subject to extra scrutiny. That says nothing about how Congress wanted to handle actual cash that was transferred from one SFC to another; perhaps no demonstration “to the satisfaction of the Secretary” is necessary or appropriate for such straightforward assets. The point is simply that — as with a number of other key details for computing the section 965(c) deduction amount — Congress left the issue to the Secretary to address through “appropriate” regulations.³

That brings us to Chevron's second step: whether the agency's construction of the statute is a “reasonable” one, reflecting “a reasonable policy choice.” 467 U.S. at 843-45. And surely the elimination of double-counting satisfies that test, because it carries out the congressional intent found in section 965(c) that only liquid earnings be taxed at a 15.5% rate. Accord H.R. Rep. No. 115-466, at 620 (2017) (Conf. Rep.). Counting the same cash twice would effectively raise that congressionally mandated rate.

We note that Congress chose the word “provisions” in section 965(o) rather than the more typical “purposes.” However, we cannot discern any limitation on the Secretary's authority from Congress's word choice. Indeed, it would be odd to construe the Secretary's authority to carry out the “provisions” of a statute more narrowly than his authority to carry out the “purposes” of a statute, because the provisions of a statute are usually thought to embody its purposes. See Am. Ass'n of Retired Persons v. EEOC, 823 F.2d 600, 604 (D.C. Cir. 1987) (“[T]he best guide to the purposes of a statute is the language of the statute itself.”); L.A. Lakers, Inc. v. Fed. Ins. Co., 869 F.3d 795, 803 (9th Cir. 2017) (“To find a statute's purpose, we must look to see if Congress has clearly stated it in the text of the statute itself.”). Congress also appears to have understood section 965(o) this way. The Conference Report says that section 965(o) gives the Secretary “regulatory authority to carry out the intent" of section 965, seemingly using the word “intent” as a synonym for “provisions.” H.R. Rep. No. 115-466, at 617 (emphasis added).⁴

Accordingly, in order to carry out the provisions of section 965, we recommend that the final regulations under section 965 allow a U.S. shareholder to disregard cash (or any other asset described in section 965(c)(3)(B)) on a cash measurement date to the extent attributable to amounts already taken into account in determining the U.S. shareholder's pro rata share of the cash position on such cash measurement date. To this end, Prop. Reg. section 1.965-3(b)(2) could be revised as follows:

For purposes of determining the aggregate foreign cash position of a section 958(a) U.S. shareholder, the section 958(a) U.S. shareholder's pro rata share of the cash position of a specified foreign corporation on a cash measurement date is reduced by amounts of net accounts receivable, actively traded property, and short term obligations to the extent such amounts are attributable to amounts taken into account in determining the section 958(a) U.S. shareholder's pro rata share of the cash position of another specified foreign corporation on such cash measurement date and to the extent not disregarded pursuant to paragraph (b)(1) of this section.

2. Meaning of “Such Cash Measurement Date” in Prop. Reg. Section 1.965-3(b)(2)

Prop. Reg. section 1.965-3(b)(2) contains an ambiguity as to the proper time period for comparing the cash position of two SFCs. Consider the example described above, but suppose that CFC1 has $100x in marketable securities (instead of cash) on December 31, 2017, and on January 1, 2018, CFC1 transfers the $100x in marketable securities to CFC2, which holds the marketable securities through its final cash measurement date, November 30, 2018.

Would the $100x in marketable securities be counted twice in determining USP's aggregate foreign cash position? The answer depends on the meaning of the word “such.” Under Prop. Reg. section 1.965-3(b)(2), the cash position of an SFC with respect to a U.S. shareholder “on a cash measurement date” is reduced by amounts of net accounts receivable, actively traded property, and short-term obligations to the extent such amounts are attributable to amounts the U.S. shareholder takes into account in determining the cash position of another SFC “on such cash measurement date.”

If “such” refers to whether an SFC's cash measurement date is its first, second or final cash measurement date, USP could claim relief from double-counting. In this interpretation, as of CFC2's final cash measurement date, USP has already taken into account the $100x in marketable securities on the corresponding (final) cash measurement date of another SFC (namely, CFC1). USP would thus be entitled to reduce its share of the cash position of CFC2 by $100x. However, if “such” refers to the actual calendar date, USP could not claim double-counting relief. On November 30, 2018 (the actual calendar date of CFC2's final cash measurement date), USP takes into account the $100x in marketable securities only with respect to CFC2. It previously took into account the $100x in marketable securities with respect to CFC1, but on a different calendar date (namely, December 31, 2017). Prop. Reg. section 1.965-3(b)(2) would not be available.

We believe the first interpretation is more consistent with congressional intent. The plain language of section 965(c)(3)(D) allows relief from double-counting whenever a U.S. shareholder can establish that an amount is “taken into account . . . with respect to another [SFC].” The statute contains no requirement that the amount must have been taken into account by another SFC on the same day. And, as described above, double-counting assets in determining a U.S. shareholder's aggregate foreign cash position would frustrate the congressional purpose of taxing only liquid earnings at a 15.5% rate.

Accordingly, regardless of whether Recommendation No. 1 is adopted, we recommend that section 1.965-3(b)(2) of the final regulations provide relief from double-counting with respect to an SFC when an amount is taken into account in determining the U.S. shareholder's pro rata share of the cash position of another SFC on such other SFC's corresponding cash measurement date. To this end, Prop. Reg. section 1.965-3(b)(2) could be revised as follows:

For purposes of determining the aggregate foreign cash position of a section 958(a) U.S. shareholder, the section 958(a) U.S. shareholder's pro rata share of the cash position of a specified foreign corporation on a cash measurement date is reduced by amounts of net accounts receivable, actively traded property, and short-term obligations to the extent such amounts are attributable to amounts taken into account in determining the section 958(a) U.S. shareholder's pro rata share of the cash position of another specified foreign corporation on such the corresponding cash measurement date of such other specified foreign corporation and to the extent not disregarded pursuant to paragraph (b)(1) of this section.

3. Consolidated Group Aggregate Foreign Cash Position

The Proposed Regulations generally treat all members of a consolidated group that are U.S. shareholders of an SFC as a single U.S. shareholder. See Prop. Reg. § 1.965-8(e)(1). However, Prop. Reg. section 1.965-8(e)(3) provides that this general rule does not apply “to treat all members of a consolidated group as a single [U.S. shareholder] for purposes of determining the amount of any member's section 965(c) deduction amount.” Instead, the Proposed Regulations lay out a hybrid approach: the aggregate foreign cash positions of all U.S. shareholders in the consolidated group are added together, including members without any section 965(a) inclusions, and then reallocated only among members with section 965(a) inclusions.

Because Prop. Reg. section 1.965-8(e)(3) instructs that the determination of the section 965(c) deduction amount is made on a separate-member basis, it appears that relief from double-counting under Prop. Reg. section 1.965-3(b)(1) and (2) cannot be applied on a consolidated basis. This result is inappropriate. Suppose USP owns two domestic subsidiaries, USS1 and USS2, and USP, USS1, and USS2 elect to file a consolidated return. USS1 owns CFC1 and USS2 owns CFC2. All entities have December 31 year ends. As of December 31, 2017, CFC2 holds a short-term obligation of CFC1 in the amount of $100x. Must this short-term obligation be included in the determination of the USP consolidated group aggregate foreign cash position?

Prop. Reg. section 1.965-3(b)(1) provides relief from double-counting for short-term obligations between related SFCs, but only on a U.S. shareholder-by-U.S. shareholder basis. The rule does not treat members of a consolidated group as a single U.S. shareholder. Further, Prop. Reg. section 1.965-8(e)(3) does not permit members of a consolidated group to be treated as a single U.S. shareholder for purposes of determining any member's section 965(c) deduction amount, a determination as to which Prop. Reg. section 1.965-3(b)(1) is directly relevant. Accordingly, it appears that the Proposed Regulations require the short-term obligation between CFC1 and CFC2 to be counted as part of CFC2's cash position, even though it does not truly represent a cash amount. Cf. Notice 2018-07, § 3.01(b). A similar issue would arise under Prop. Reg. section 1.965-3(b)(2).

We believe that a consolidated group should be treated as a single U.S. shareholder for purposes of Prop. Reg. section 1.965-3(b)(1) and (2). Intercompany accounts and obligations held across separate chains of SFCs are commonplace. So, too, are cross-chain transfers among SFCs. Indeed, multinational companies have generally presumed that the tax laws will respect the “single entity” approach of the consolidated return rules and have structured their holdings of foreign subsidiaries accordingly. It would be unfair to deny these companies double-counting relief simply because they hold their SFCs under multiple members.

Accordingly, we recommend that the final regulations adopt the position that members of a consolidated group be treated as a single U.S. shareholder for purposes of applying Prop. Reg. section 1.965-3(b)(1) and (2).

* * *

We appreciate the opportunity to comment on the Proposed Regulations. If you would like to discuss any of the recommendations in this letter, please contact Joseph A. Goldman at (202) 879-5437 orjagoldman@jonesday.com or Scott M. Levine at (202) 879-3437 or smlevine@jonesday. com.

Sincerely,

Joseph A. Goldman

Scott M. Levine

Jones Day
Washington, DC

cc:
Lafayette “Chip” G. Harter III
Deputy Assistant Secretary (International Tax Affairs)
Department of the Treasury

Douglas L. Poms
International Tax Counsel Department of the Treasury

Brian Jenn
Deputy International Tax Counsel
Department of the Treasury

Brenda L. Zent
Special Advisor on International Taxation
Department of Treasury

Marjorie A. Rollinson
Associate Chief Counsel (International)
Internal Revenue Service

Daniel M. McCall
Deputy Associate Chief Counsel (International)
Internal Revenue Service

Raymond J. Stahl
Senior Counsel, Office of Associate Chief Counsel (International)
Internal Revenue Service

John J. Merrick
Special Counsel, Office of Associate Chief Counsel (International)
Internal Revenue Service