ABA Tax Section Members Suggest Change to Proposed Regs on Foreign Trusts With U.S. Beneficiaries

[1] I am enclosing comments on the above noted proposed rulemaking as prepared by members of the Committee on Exempt Organizations. Principal responsibility was exercised by Robert H.M. Feguson (sic), Patterson, Bellknap, Webb & Tyler, New York, New York. Substantive contributions were made by Victoria B. Bjorklund, Simpson Thacher et al., New York, NY; Betsy Buchalter Adler. Silk Adler & Colvin, San Francisco, CA, Milton Cerny, Caplin & Drysdale, Washington, DC.

[2] These comments represent the individual views of those members who prepared them and do not represent the position of the American Bar Association or of the Section of Taxation.

Sincerely,

COMMENTS ON NOTICE OF PROPOSED RULEMAKING PROP. TREAS. REGS. SECTIONS 1.679 AND 1.684

[3] The following comments and recommendations express the individual views of the members of the Section of Taxation who prepared them and do not represent the position of the American Bar Association or the Section of Taxation.

[4] These comments and recommendations were prepared by members of the Committee on Exempt Organizations. Primary responsibility was taken by Robert H. M. Ferguson, Chair of the Committee, with assistance from Victoria B. Bjorklund, Vice Chair of the Committee and Betsy Buchalter Adler and Milton Cerny, Co-chairs of the Subcommittee on International Philanthropy. These comments were reviewed by Carolyn M. Osteen of the Section's Committee on Government Submissions and by Douglas M. Mancino, Council Director for the Committee on Exempt Organizations.

[5] Although many of the members of the Section of Taxation who participated in preparing these comments and recommendations have clients who would be affected by the federal tax principles addressed, or have advised clients on the application of such principles, no such member (or the firm or organization to which such member belongs) has been engaged by a client to make a governmental submission with respect to, or otherwise influence the development or outcome of, the specific subject matter of these comments.

Contact Person: Robert H. M. Ferguson

[6] As members of the Committee on Exempt Organizations of the Section of Taxation of the American Bar Association, we welcome the opportunity to comment on one aspect of the regulations recently proposed under Internal Revenue Code sections 679 and 684 (the "proposed regulations"), which provide guidance on transfers by U. S. persons to foreign trusts. The aspect of the proposed regulations that we believe requires reconsideration is that which relates to the exception for transfers to charitable trusts described in section 501(c)(3) and specifically the portion of the proposed regulations that would limit the exception to those trusts that had actually received rulings or determination letters from the Internal Revenue Service. We believe the intent of the statutory provisions would be more than adequately fulfilled by requiring a transferor to notify the Service that he or she had made a transfer to a foreign trust that meets the requirements of section 501(c)(3).

II. SPECIFIC COMMENTS

[7] To prevent potential abuses arising from transfers to foreign trusts, section 679 provides, generally, that a U.S. transferor to such a trust is to be treated as the owner of the portion of the trust attributable to the property so transferred. In addition, section 684 of the Code provides that in those cases in which a U. S. person is not treated, or ceases to be treated, as the owner of the transferred property, then the transfer will be treated as a sale or exchange resulting in the recognition of gain to the transferor.

[8] Exceptions exist under both sections 679 and 684 for transfers to foreign charitable trusts. In the first case, the exception is found in section 679(a) of the statute, which provides that the section applies to a transfer to a foreign trust "(other than a trust described in section 6048(a)(3)(B)(ii))". Pertinent parts of this last cited section refer to "a trust which is . . . determined by the Secretary to be described in section 501(c)(3)." The exception in section 684 is found only in the proposed regulations, but the provisions governing both exceptions are substantially similar. Those provisions state that the exceptions for transfers to foreign charitable trusts will apply only to a transfer "to a foreign trust that has received a ruling or determination letter, which has been neither revoked nor modified, from the Internal Revenue Service recognizing the trust's tax exempt status under section 501(c)(3)." (Sections 1.679-4(a)(3) and 1.684-3(b) of the proposed regulations.) We respectfully suggest that requiring a charitable trust to obtain a ruling or determination letter in order to qualify for these exceptions is unreasonable. The statutory purpose would be more than adequately fulfilled by having the transferor notify the Service of the fact of the transfer, with the final decision on the issue of exempt status being left to the Service as part of its examination function.

[9] Foreign charitable trusts with no U.S. source income would normally have no reason to obtain rulings or determination letters as to exempt status, as their income is not subject to taxation in the United States and their United States contributors are not entitled to deductions under section 170, which applies only to contributions to entities organized in the United States. Although the receipt of a ruling or determination letter is one way of establishing that a trust has been "determined . . . to be described in section 501(c)(3)," it is certainly not the only way. Thus, in the case of a charitable gift or bequest that is deductible under section 2055 or 2522, all that is required is to disclose the fact of the transfer on the estate or gift tax return. And in the case of a grant by a private foundation, all that is necessary to establish that a payment is a qualifying distribution or other than a taxable expenditure under section 4942 or 4945, is that the private foundation make a "good faith determination" with respect to the transferee's status as a public charity. Consistent with these last described provisions, we suggest that all that ought to be required is that the U.S. transferor to a foreign trust disclose to the Service, at such time and in such manner as the Service may reasonably provide, that the transfer has been made and that the transferor believes that the transferee trust is an organization described in section 501(c)(3) of the Code. Such a procedure would be consistent with the approach taken under the estate and gift and private foundation provisions referred to above. To require that a transferee trust obtain a ruling or determination letter would merely add needless complexity to the process and could inhibit charitable contributions that sections 679 and 684 were actually intended to protect.

[10] Your attention to these matters is appreciated.