Transcript Is Available of IRS Hearing on FDII, GILTI Regs

UNITED STATES DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

PUBLIC HEARING ON PROPOSED REGULATIONS
"DEDUCTION FOR FOREIGN-DERIVED INTANGIBLE INCOME
AND GLOBAL INTANGIBLE LOW-TAXED INCOME"
[REG-104464-18]

Washington, D.C.
Wednesday, July 10, 2019

PARTICIPANTS:

For IRS:

For U.S. Department of Treasury:

Speakers:

* * * * *

PROCEEDINGS

(10:06 a.m.)

MR. JERUCHIM:Welcome everyone. We're going to get started. This is a Public Hearing on Proposed Regulations on Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income. I'm going to introduce myself. I'm Kenneth Jeruchim, an attorney with the IRS Office of Associate Chief Counsel, International. I'm going to ask our government panel to introduce themselves, and then I'll give you some ground rules for the speakers and we'll get started.

MS. RENSEN:I'm Marissa Rensen, special counsel with IRS Office of Chief Counsel.

MR. DEWALD:I'm Joe Dewald. I'm a senior technical reviewer, Office of Associate Chief Counsel, International.

MR. DIAMOND-JONES:Austin Diamond-Jones with Chief Counsel, Corporate.

MR. YEN:I'm Jason Yen with the Treasury Department.

MR. JERUCHIM:We have seven speakers who are designated to speak today. Each speaker is going to have 10 minutes and there is a timer upon the podium, so when each speaker's turn comes, please come up to the podium. You'll see the time that will indicate how much time you have left.

We're going to go ahead and start with Catherine Schultz from the National Foreign Trade Council.

MS. SCHULTZ:The NFTC appreciates the opportunity to participate in this hearing on the proposed Foreign-Derived and Tangible Income Regulations.

When Congress enacted the Tax Cuts and Jobs Act they included two minimum taxes, BEAT and GILTI, and added a carrot to encourage companies to export from the United States, the FDII Provision.

When the proposed FDII Regulations were released many companies were surprised to find that they would not be able to access the carrot because many of the onerous documentation requirements.

I would like to explain just a few of the problems with the documentation requirements, and I suspect that other witnesses will explain their difficulties with these as well.

Under the proposed FDII regulations taxpayers are required to maintain documentation regarding whether the purchaser is a foreign person, and whether the property that has been sold is for foreign use, and/or the location of the person to whom the taxpayer provide services is outside the U.S.

Specific documentation requirements vary depending on the types of sales or services provided to the foreign person. However, in almost all cases the types of information that the proposed FDII Regulations require are the types of information the taxpayers cannot reasonably expect customers to provide, such as foreign IDs, potentially confidential information about where business are located, and U.S. foreign revenue splits.

Furthermore, the documentation requirements contemplate the collection of information that a taxpayer may not even be able to provide, such as three-year intended use of product, statements about which specific benefits — location benefit from services.

The documentation requirements relating to general services provide to business require a complex analysis of a location of businesses, of business operations receiving the benefits which, again, the contemplated taxpayer's ability to obtain information from third-party customers that cannot reasonably be expected to be obtained.

Finally, building the appropriate IT systems for the collection of any new information, not previously collected in the ordinary course in tracking — linking with transfer price and documentation process will require a long lead time to develop and implement.

The proposed FDII regulation documentation requirements are detached from business reality, because they require the cooperation of third-party counterparties that are under no legal obligation to do so, and who derive no benefit from doing so.

In the vast majority of the cases, third-party recipients will simply not comply with the taxpayer's request. His statements regarding the foreign status and the foreign use will not be available. The taxpayer's FDII deduction will be denied. They're going to lose the carrot.

This business reality does not well serve the government's purpose of wanting to incent U.S. taxpayers to bring their IP back onshore. And it does not well serve taxpayers' purposes who are seeking to comply in good faith.

As such, the FDII documentation requirements should be revised as follows: We recommend significantly expanding the qualifying documents to include materials that can be more readily obtained from a customer and that are utilized in the ordinary course of business, such commercial invoices, packing slips, purchase orders, and/or bills of lading.

The sale of general property is for foreign use if the property is subject to manufacture, assembly or other processing outside of the United States. To qualify as a manufacturer to assemble the process, general property must meet one of two tests. The subject of the physical material change or is incorporated into another product as a component.

In this regard we note that the two test periods to incorporate elements from the regulations under former section 199 and the regulations under 954.In each of these contexts the taxpayer is testing whether activities conducts itself constitute manufacturing, assembly, or other processing.

Accordingly, the taxpayer will have direct information regarding the extent of physical and/or material change to property.

In the case of section 250, a taxpayer may not know for certain or be able to demonstrate the extent of physical material change to the property being sold to an unrelated party.

The NFTC recommends that for general property sold to an unrelated party the regulations incorporate a rebuttable presumption test. By using documentation created in the ordinary course of business a taxpayer must be able to show reasonable documentation regarding the sale to person outside the United States.

The final FDII regulations might build off the place of used rules that appear elsewhere in the existing regulations. So the general property which is sold to an unrelated person will be presumed to have been sold for use, consumption, or disposition in the county of destination of the property sold, unless the taxpayer knows or has reason to know that the general property will be used in the United States.

Additionally, to address the first prong test we recommend the addition of language to further define a physical and material change.

Specifically we recommend that this test be satisfied where the general property is subject to processing, or assembly activities that are substantial in nature and generally considered to constitute the manufacturer production of property that is different than the property which was purchased, similar to the language in the regulations under section 954.

Turning to another issue that we have, the ordering rules: The ordering rules and interaction of section 163(j), 172 and 250, are illustrated under proposed reg section 1.250(a)(1)(f)2, example two.

Based on example two, the ordering rules in an interaction of section 163(j), 172 and 250 are performed in five steps.

The FDII amount in step one is redetermined in step four by considering that section 163(j) and 172(a) amounts, that were computed steps two and three, based on the tentative section 250, amount of step of one.

The example illustrates that section 163(j) and section 172(a) carryovers are included in the step four computation.

However, the example fails to note that interest expense and NOL carryovers arise in the prior years were already previously considered in the prior year FDII amounts and limited under section 252(a)(2) in the respective year.

As a result there are duplicative reduction — FDII with respect to carryovers, interest expense and NOLs in the respective prior year and current year.

Step four should be limited to current year activity and not consider — section 172(b) and 163(j) carryover and carrybacks.

Additionally, the section 250(a)(2) limitation to step five already ensures that FDII deduction is limited to taxable income, notwithstanding the elimination of section 172(b), 163(j) carrybacks in step four.

The NFTC recommends the Proposed reg section 1.250(a)-1(f)2, example two, step 4B rewritten so as to be limited to current year activity and not considered section 172(b) and 163(j) carryover and carrybacks.

In section 250(a) limitations step five already ensures that FDII is limited to taxable income notwithstanding the elimination of section 172(b) and 163(j) carryovers in step four.

The ordering rules in interaction section 163(j), 172 and 250, should be specifically called out in the operative provisions of the proposed section 250 Regulations, not only in an example.

And finally on the foreign branch rules: We believe the proposed section 1-250(b)-1(c)(11) and 1904-4(f)(2) should take a consistent approach on the categorization of foreign branch income. Direct and indirect sales of assets including gains from the disposition of an interest in a partnership or other pass-through entity, or disregarded entities that are not reflected in a separate set of books and records of the foreign branch, and not held in the originary course of active trade or business, should not be treated as foreign branch income. Proposed reg 1.250B-1(c)(11) subsection to proposed reg 190-4(f)(2), should be removed.

Thank you for your time, and we appreciate being able to testify.

MR. JERUCHIM: Thank you. All right. We now have Maureen Byam. OK. Is Stephen Comstock ready, from API?

MR. COMSTOCK:I am ready. Hi. Good morning. My name is Stephen Comstock, and I am the Director of Tax & Accounting Policy for the American Petroleum Institute, or API.API represents over 600-member companies involved in all aspects of the nation's natural gas and oil industry. Our members invest billions in the U.S. economy, support thousands of workers, and export millions of barrels of product every day.

On behalf of all of our members, I appreciate the opportunity to speak today regarding the issues associated with the proposed regulations under section 250 of the Internal Revenue Code addressing the Foreign-Derived Intangible Income deduction, or FDII.

Specifically I will address two main subject areas covered in the proposed regulations which API and its members believe should be amended.

The changes I advocate address products exported by our members that should qualify for FDII, and the administrative requirements to verify such qualification are not overly burdensome.

The first issue I will address is a determination of the Taxpayers Foreign-Derived Intangible Income, or FDII. And determining the proper FDII, Treasury and the IRS properly concluded that not all sales of goods and services to former purchasers should be eligible.

However, API believes that the scope of what was deemed eligible is too narrow and potentially excludes much of the oil and gas industry exports solely due to the type of contracts used to conduct these transactions.

The proposed Treasury Regulation section 1.250B-4(f) provides that sales of commodities as defined by section 475(e)(2)(b) through (d), do not qualify as FDII eligible sales.

Section 475(e)(2)(b) through (d) defines the commodity to include any notional principle contract with respect to any commodity, and interest in a forward contract future contract or short, or any other similar instrument.

Of great concern to API is the inclusion of forward contracts in this definition of excludable commodities. Crude oil and finished products are typically sold either as a stock price or by using privately negotiated forward contracts.

Forward contracts used by the oil and gas industry will include information such as price, date of delivery, and perhaps most importantly, place of delivery. Therefore, sales are settled by physical delivery of said products. This is a critical differentiating characteristic of oil and gas contracts as opposed to other financial contracts, and in API's view should make our industry exports eligible and outside the scope of the FDII's exclusion of commodity sales.

The preamble to the proposed regulations stated that the reason a commodity's exception was inserted was primarily due to the concern over sales of financial instruments, which cannot necessarily be verified to have been used abroad as required by the statute.

However, oil and gas sold via four contracts is easily distinguishable as they are settled by the fiscal delivery of said goods. As such Treasury and the IRS can readily confirm foreign use, in this physical settlement of our goods and possibly other commodities that's a key distinguishing characteristic from other contract arrangements, where there are no such determinations.

Furthermore, income or loss generated from the sale of a forward contract is not viewed as attributable to that forward contract itself, rather it is viewed as arising from the underlying physical product being exchanged.

Focusing on the character of the underlying income-generating item rather than the formal nature of the contract itself is not new and was adopted under section 199 regulations where Treasury and the IRS recognized that advanced payments could be qualifying provided the underlying property that was subject to the contract was qualifying production property.

We ask that the Treasury and the IRS narrow the definition — narrow the exclusion of certain financial instruments deemed eligible for FDII. For contracts subscribed under — in section 475(e)(2)(b) through (d), Treasury and the IRS should clarify the for sale or taxable transfer of a physical commodity occurs pursuant to say a forward contract.

Then the sale of the underlying fiscal commodity qualifies as FDII. We should also note that API member companies will execute financial derivative transactions to hedge against price movements with respect to the delivery of those underlying fiscal commodities.

This could arise due to a member company having to manage the price risk on a sale where the commodity may take weeks to be delivered for the physical possession due to shipping times.

During the several-week period the exchange price of the commodity will fluctuate. In order to guard against these price fluctuations a hedge maybe executed on the domestic contract market such the NYMEX, or on the foreign contract market.

Again, section 199 illustrates how best to approach this issue. Regulation section 1.199-3(i)(3) provides that if the risk being hedged relates to qualifying production property, if the transaction meets the definition of a hedging transaction and if the transaction is properly identified under section 1221 rules, then the hedging gain or loss should be allocated to the sale of the underlying qualifying property.

Applying this approach to the oil and gas export gains, losses on the hedging transactions related to the qualifying FDII export of fiscal commodities should be integrated with the value of the underlying exported fiscal commodity, provided that the hedge is timely identified under the requirements of 1221.87.

The second issue I wish to address the FDII documentation requirements. While API appreciates the government's need to ensure that the sales of goods and services has been sold and used abroad, some characteristics of the oil and gas industry fit poorly into the proposed regulation's requirements.

API believes that the proposed regulations create an administratively burdensome process which could be simplified and still achieve the same results. Our first suggestion in the proposal is that the small business exception be expanded to all businesses. Under the current proposed regulations large taxpayers will be required to research and document every foreign buyer's residence, or to attain a written statement from each foreign buyer confirming their status as being foreign.

However, the foreign counterparties are under no obligation to provide such information, and there is no monetary leverage to ensure foreign counterparty compliance with the documentary requirements. The shipping address of the foreign party should be sufficient to prove the buyer is foreign.

Similar to the documentation requirements to prove a foreign buyer is in fact foreign, large U.S. taxpayers will be required to obtain FDII representation in each contract written — obtain a written statement from the foreign buyer or review and retain shipping documentation for each transaction to prove foreign use.

Large U.S. taxpayers should be permitted to rely upon a shipping address similar to small U.S. taxpayers to prove foreign use of exported products.

Our second proposal related to the FDII documentation requirements has to do with fungible goods, the proposed regulations section 1.250B-4(d)(3)(i), requires the U.S. seller of fungible goods to perform market research including statistical sampling and economic modeling to demonstrate that at least 90 percent of the fungible goods are subject to foreign use to qualify for such foreign use.

Further, no portion of the sale will be treated as foreign use if the taxpayer cannot demonstrate that at least 90 percent of fungible goods sold are for foreign use. This documentation requirement is tremendously difficult for oil and gas companies to satisfy because oil and gas and petroleum products comingle and blend.

We cannot track molecules and there is no way for our members to determine whether some portion could be returned to the U.S. after they've been sold and delivered abroad.

API believes that the documentation rules for fungible goods be modified such that a rebuttable presumption exists that exported fungible goods are sold for foreign use, consumption or disposition unless the U.S. seller knows or has a reason to know a material amount of the previously exported goods will be sold back to U.S. purchasers.

The third documentation proposal I wish to address arises under the proposed regulations section 1.250B-(3)(d), which requires that for documentation to be acceptable, it must be obtained no earlier than one year before the date of sale or service.

For contracts longer than a year the U.S. taxpayers would need to obtain a written statement or other satisfactory documentation from foreign customers each and every year.

This one-year requirement should be replaced by a rule that the U.S. taxpayer must seek only a reconfirmation of a foreign buyer's status as foreign if it believes the original FDII documentation representation is no longer accurate.

I would like to thank the Panel for its time. And I encourage both the Treasury and the IRS to reach out to API with any question pertaining to my testimony today. Thank you.

MR. JERUCHIM: Thank you very much.

Thank you. We will now hear from Kevin Klein from the Organization for International Investment.

MR. KLEIN:Good morning. My name is Kevin Klein. I'm the director of tax policy for the Organization for International Investment, or OFII.

OFII's business association will represent the U.S. subsidiaries of international companies headquartered outside the U.S.S.R. have about 200 members and on average they employ roughly 12,000 Americans each, some of the largest companies in the country.

OFII, we noted that supported the Tax Cuts and Jobs Act, and would like to thank both Tresury and IRS for your efforts in implementing tax reforms so far. One stated goal the TCJA was to make the U.S. tax regime more competitive for attracting foreign direct investment, and we believe that the FDII deduction is part of achieving that goal.

We would like to take this opportunity to raise administrative issues regarding the documentation requirements specifically surrounding the FDII proposed regs. Treasury and the IRS has stated that in forming the documentation requirements you aim to propose rules that would not alter economic decisions. However, under the proposed regulations, many taxpayers and their customers would need to produce documentation which serves no purpose other than regulatory compliance.

OFII would therefore recommend the following to help you reach your stated goal. Rather than a narrow list of documentation that could be difficult to obtain, OFII believes that any document typically created in the ordinary course of the taxpayers' business should be sufficient as long as it establishes to the satisfaction of the secretary that the relevant property is for foreign use.

We note that the proposed regulations already recognize that documents created in the ordinary course of business is a reasonable standard because it applies that standard for taxable years prior to March 4, 2019.

The proposed regs also establish a special rule for small businesses and small transactions and we would — believe the standard should be applied to all taxpayers and would provide a simple administrable rule for other companies.

OFII would specifically note that standard invoices contain the necessary information to determine foreign use and if there is a concern about the use of invoices for this purpose, the secretary could include in the final regulations boilerplate language that could be added to include certifying that property purchases or service recipients are foreign.

Further, OFII members would point out that we already deal with withholding rules that effectively determine foreign status of taxpayers. Rather than new rules or forms, OFII contends that taxpayers should be able to use withholding certificates or other forms of governmentally approved substantiation such as Form W8 to document foreign use by a foreign person.

Taxpayers should also be able to establish a foreign location of business service for a service recipient with a statement from the recipient that it does not have a U.S. place of business. This would be in contrast to the proposed regulations provision requiring specification of all places of business that benefit from the service.

Customers will likely reject your request to provide information on the allocation of benefits among business operations because this is likely sensitive business intelligence. If the Treasury and the IRS are concerned about abuse, they can include a rebuttable presumption specifically regarding if the taxpayer has any reason to note the service benefits a U.S. person or that the property will be for U.S. use.

Next issue we would like to highlight is that regardless of what type of documentation is required, the proposed regs require the documents themselves meet a reliability standard. One rule is that only documents obtained no earlier than one year before the date of the sale or service is considered reliable.

We understand the intent here to be preventing old and cold or stale documentation. However, normal business practice is to have long-term contracts. Many of these have been in place for longer than one year and some precede the TCJA. These contracts on their face identify a buyer and purchaser and should be sufficient on their own to meet a reasonable documentation standard. Requiring an annual update is unnecessary and burdensome.

Other sections of the code and regulations allow taxpayers to update information pertaining to foreign status or ownership every three years and in certain cases only require updates if a change in circumstances makes the information unreliable or incorrect. And that from Form W8 under section 1441.

We encourage the Treasury Department and the IRS to adopt the reliability standard utilized for withholding purposes. This would be familiar to our members and would reduce their compliance burden.

Finally, if taxpayers do not have required documentation at the time of filing a return, there should be an option to claim the benefit on the return provided the documentation is obtained within the three years of return filing. If the taxpayer does not provide the necessary documentation within that three-year period, the deduction would prospectively — would be prospectively recaptured in the following year.

Again, OFII would like to thank you for your work in this area and we would invite any questions or future comments. Thank you.

MR. JERUCHIM:Thank you very much. Jeff Maydew from Baker & McKenzie.

MR. MAYDEW:Thanks for having me here. I'm Jeff Maydew. I'm a partner at Baker McKenzie. I'm going to make a few comments . I think there will be echoes of themes that have emerged today a bit, it's going to be focused on documentation. So thanks for the opportunity to testify.

I would like to commend Treasury and IRS for providing the much needed guidance on FTI provisions. Especially in light of all of the need for regulatory guidance generally.

In the interest of time my comments will focus on three aspects of the foreign use documentation requirements and a more detailed discussion of these comments is included in one of the Baker & McKenzie letters that have been submitted.

The first and most important comment is that the regulations ought to take a broader approach to the types of information that can prove or disprove that property is sold for foreign use. The proposed regulations should allow taxpayers to use ordinary course business documentation to satisfy the test.

The statute asks whether property is sold for any use, consumption, or disposition outside of the United States. That sort of test will always be more administrable when taxpayers, IRS examiners, judges, and other decision makers are allowed to look at a broad range of sources of information.

The proposed regulations in contrast limit the types of the documentation that can be used to inform a decision maker that a — as to whether a particular good is sold for foreign use.

Also the proposed regulations require taxpayers to create brand new documents for the sole purpose of satisfying the foreign use requirement.

In particular, in the case of international transportation property, taxpayers have only two narrow and challenging paths to travel down in order to establish foreign use. One, a taxpayer may obtain a written statement from the buyer that the buyer will use or intends to use the property outside the U.S. Or two, the taxpayer may enter into a full-biding contract with the buyer to that same effect.

The challenge with both of these requirements first is that they don't serve any non-tax purpose and that they ignore commercial realty. Customers have no incentive to comply with the rules that support the seller's ability to claim a U.S. tax benefit.

In the case of transportation property, customers may simply refuse to provide a written statement or enter into a biding agreement to this effect. This is particularly the case given the forward looking three year period test and the 50 percent time spent and miles traveled test for transportation property in particular. It's a difficult test for customers to try and project out and include they'll satisfy.

The customers that do agree to provide a written statement or enter into a binding contract to that effect may ask for compensation before doing so. Put differently, if you write documentation rules that require the consent to foreign buyers you give the foreign buyers' market power. In the end, this results in a transfer of some of the incremental tax savings from the FDI rules from the intended beneficiaries, the U.S. manufacturers to the domestic — to the foreign buyers.

The challenge posed by satisfying the foreign use requirement in the transportation property area also can be contrasted with the comparatively more flexible rules for establishing foreign use of intellectual property.

When the property sold as IP, taxpayers are instead empowered to look to information appearing in audited financial statements and a wide range of other documents. The documentation rules for IP have their own challenges but they strike a better balance than the more restrictive rules for sales of goods.

The documentation rules should provide similar flexibility across different industries and categories of transactions point that will be returned to later today.

To avoid all these concerns the final regulations should provide that any document typically created in the ordinary course of the taxpayer's or the recipient's business which established to the satisfaction of the commissioner that the relevant property is for foreign use is sufficient.

It's also worth noting here that some types of international transportation property by their nature and by regulation are going to be sold for use outside the U.S. Whenever the buyer happens to be a foreign person.

Consider as an example commercial airplanes. Under the U.S. cabotage rules, foreign airlines generally cannot register an aircraft in the U.S. In turn, a foreign registered commercial aircraft generally cannot travel between two points within the U.S. other than a part of a thru trip involving travel to or from a foreign destination.

An illustration of how the cabotage rules work will be helpful here. If an aircraft owned by a foreign airline carries passengers from, say Frankfurt to Washington, D.C., it may discharge passengers in D.C. and accept new passengers in D.C. But if the aircraft then continues on to Chicago, the passengers that boarded the aircraft in Washington must be transported to a final destination that is in a foreign country. They can't deplane in Chicago.

This is why you don't see foreign commercial airlines competing heavily in the domestic market. The world is already carved into different jurisdictions by the airline — by the rules that relegate air traffic.

Commercial aircraft sold to airlines simply are not being sold for use in the U.S. If it's a twin aisle jet, it's going to be flown over international water. If it's a single aisle jet it's going to be flown point to point outside the U.S. most often.

In such cases, it should be unnecessary to have the foreign buyer attest to foreign use in a written statement or binding contract. Instead the parties should be allowed to rely on other documentation such as an export certificate of air worthiness to satisfy the foreign use requirement.

The second comment is on the date of sale rule which has been touched on earlier today. The proposed regulations provide that a document is only considered reliable in part if it is obtained no earlier than one year before the quote date of sale. The date of sale rule can be especially problematic for manufacturers of transportation property and other high value equipment. Such manufacturers often enter contracts with their customers years before the date of sale.

In such cases, this requirement alone could effectively prevent entire categories of sales from qualifying for the FDII deduction. Thus we would recommend that the final regulations eliminate the date of sale rule or at a minimum revise their requirement by trying the one year time limit to the date of contract execution as opposed to the date of sale itself.

The third and final comment relates to the documentation requirements for services. In the services contracts — in the services context, generally services provided to a business recipient only constitute FDII qualifying services where the income is allocable to such recipients quote office or other fixed place of business located outside the U.S.

While this rule may work in many circumstances, it unfortunately may prevent general services provided with respect to mobile property such as ships or naval aircraft from qualifying as FDDEI services because by its very nature, mobile property has no office or fixed place of business.

Therefore, FDDEI services should include general services that benefit a customer's mobile operations outside the U.S.

On a related note, the preamble to the proposed regulations asks for comments regarding property that is temporarily located in the U.S. for maintenance and repair type services.

If property is otherwise used in a manner that constitutes foreign use, repair, and maintenance services performed on the property while it's temporarily in the U.S. should still produce FDII. Such a rule would be consistent with the purposes of section 250 and statements in the preamble to the proposed regulations.

The preamble to the proposed regulations helpfully notes appropriately that overly burdensome documentation requirements might shift transactions to sellers that do not need or cannot use the FDII deduction or it may discourage foreign persons from transacting with the U.S. seller or renderer.

So for example, if you sell mobile property and you offer to provide services that are repair and maintenance to that property and your facilities to do so are located in the U.S., then you need a rule like this to get the FDII benefit. If you don't then likely a foreign provider of those services will get the work.

I greatly appreciate the opportunity to speak with you today. At this point I would be happy to answer any questions you may have. OK, thank you.

MR. JERUCHIM:Thanks very much. Next we will hear from Sharon Heck from the Semiconductor Industry Association.

MS. HECK: OK. Thank you for the opportunity to speak with you today about the Semiconductor Industry Association's views on the proposed FDI regulations.

The board of SIA is comprised of 20 member companies, including Intel Corporation. As the vice president of global tax at Intel Corporation and a co-chair of the SIA Tax Committee, I am pleased to speak on behalf of SIA.

SIA represents the leading U.S. companies engaged in the research, design, and manufacture of semiconductors. Semiconductors as enabling technology of modern electronics have transformed virtually all aspects of our economy. Information technology, telecommunications, healthcare, transportation, energy, and national defense.

Innovations in semiconductor design and manufacturing have resulted in increasingly smaller and more powerful, less expensive, and more energy efficient semiconductors. Additionally, U.S. semiconductor companies have increased growth, jobs, and productivity here in the U.S.

Over 80 percent of the revenue of U.S. semiconductor companies is derived from sources outside of the U.S. as semiconductors are America's fourth largest export. In addition, U.S. semiconductor companies on average invest approximately 20 percent of their revenue into research and development, among the highest percentage of any industry.

We would like to discuss four areas of concern with the proposed regulations for the semiconductor industry. First, the definition of physical and material change. Second, the documentation requirements, not surprising. Third, R&D expense allocation and apportionment and fourth, foreign use of intangible property. Please refer to our original submission for additional details.

The first issue I want to discuss is the determination of whether the sale of general property is for foreign use. If the property is subject to manufacturer, assembly, or other processing outside the U.S., it meets the foreign use requirement.

To qualify as manufactured, assembled, or processed, general property must meet the first of two tests. First is subject to physical and material change, or second it is incorporated into another product of the component.

We believe semiconductor chips fall under the first test requiring physical and material change. Semiconductors are substantially transformed in the manufacturing processes performed by unrelated parties.

For example, a semiconductor may be manufactured by a taxpayer in the U.S. and incorporated by an unrelated party into a new consumer device such as a smartphone or a computer. This new device has a name, character use, and a tariff code that is different from all the rest of its constituent materials including the semiconductor. In short, it has been physically and materially changed through the manufacturing process.

Therefore, semiconductors satisfy this first test as the property is subject to processing or assembly activities that are substantial in nature and generally considered to constitute the manufacturer or production of property that is different than the property which was sold to the consumer.

To reaffirm this understanding, we request that a simple example be considered for inclusion in the final regulations. We have provided you with such an example in our original submission.

Furthermore, while in — while some cases taxpayers will have direct information regarding the extent of physical and material change to the property, a taxpayer may not always be able to demonstrate the extent of physical or material change to the property being sold to an unrelated party.

As a result, we believe the proposed regulations could be enhanced by incorporating a rebuttable presumption test.

More specifically, the regulations could build off the place of use rules that appear elsewhere in existing regulations. These rules could allow general property which is sold to an unrelated person to have the presumption of foreign use if the country of destination of the property sold is outside the U.S. unless the taxpayer knows or has reason to know that the property will be used in the U.S.

Our second point relates to documentation requirements outlined in the proposed regulations. As a key enabling technology for all electronics, semiconductors are mounted on circuit boards that are incorporated into a broad range of products. Each of these end products have complex and globally integrated supply chains.

Unlike other industries, semiconductors currently do not nor would they be likely to track where the unrelated party sells its finished products. A semiconductor manufacturer's transaction ends when it makes its sale to an unrelated party.

The documentation requirements, particularly those around establishing the status of a customer as a foreign person, could be a very significant administrative burden. The requirements needed to establish foreign status for all foreign customers could be especially challenging given the large volume of sales done through purchase order rather than individual specific contract.

For the transition period, companies are required to provide additional documentation. Unfortunately, several of the items listed in the proposed regulations would not be attainable by the taxpayer in the ordinary course of business. Nor would they be provided by the recipient.

Additionally, for taxpayers with longer term contract cycles greater than one year, the requirement to provide documentation such as a binding contract no earlier than one year before the date of the sale or service would be impossible to meet.

Therefore, we recommend that the list of qualifying documents be expanded to include additional documents more readily obtainable from the customer and utilized in the ordinary course of business. Such documents can include purchase orders, commercial invoice, contracts, Form W8 ben, packaging slips, shipping or billing documents, or any equivalent documentation from which the residents of the foreign person can be established.

Identify and potentially implementing new documentation requirements will take time particularly for business models with longer term contracts.

Consequently, we recommend lengthening the transition period to at least five years to accommodate different business models and ease the ability to get new compliant systems up and running and contacts in place. New contract terms in place if necessary.

Our third point relates to R&D expense allocation and apportionment. R&D is a core part of the semiconductor industry as I mentioned earlier. Therefore how R&D expenses must be allocated and apportioned are of a critical importance to us.

As proposed, taxpayers must allocate R&D expenses against FDII income and correspondingly GILTI without regard to exclusive geographic apportionment rule that allows such expenses to be allocated to the geographic area where research is performed.

Although Treasury is generally applying reasonable and consistent methodology, this mechanical allocation may discourage taxpayers from performing R&D and discourage them from retaining or cause them to transfer — or transferring IP rights back to the United States.

By reducing the potential FDII deduction and also reducing any potential foreign tax credit associated with foreign or GILTI income, tax payers that hold IP rights in the U.S. may be incentivized to increase R&D activities offshore which runs counter to the policy intent of the provision.

To address this concern, we recommend that the regulations provide the taxpayer with additional flexibility to better align with the GILTI rules. As the FDII and GILTI were designed to work in conjunction with one another providing an elective option to utilize an exclusive apportionment would allow for a similar approach that would further ensure that a consistent methodology is applied between the two provisions.

Our final concern is with a foreign use of intangible property. For the purposes of determining whether the sale of intangible property is for foreign use under the proposed regulations, use is generally determined based on the location of the end user customers of the licensee that manufacturer's products, which include the intangible property.

This approach and the proposed regulations is inconsistent with the rule for tangible property, also referred to as general property. The approach in the proposed regulations is also inconsistent with the principles of patent law, which generally determine that an infringement occurs when and where the first use of intangible property occurs. If the first use occurs when the manufacturing occurs that should be the point when and where use is determined for tax purposes.

The preamble asks for comments on whether a similar rule for intangible property is appropriateness believes it is appropriate for both tangible and intangible property used in the manufacturer of products to be considered used, or the manufacturing of the product takes place.

SIA believes the final regulations should specify that intangible property used in products manufactured outside the U.S. should be considered used outside the U.S. for the purposes of FDII. By their nature, semiconductors are substantially transformed in the manufacturing process performed by unrelated parties. We appreciate the challenge ahead of you as you — in balancing the need to minimize abuse with the ability to practically implement and ease compliance with the law.

Thank you for the opportunity to provide this feedback on behalf of SIA and your efforts in this area.

MR. JERUCHIM:Thank you. We will now hear from Gary Sprague from The Software Coalition.

GARY SPRAGUE:Thank you. My name is Gary Sprague, I'm with Baker and Mackenzie in Palo Alto, and speaking to you today on behalf of The Software Coalition. Now The Software Coalition is comprised of 24 of the country's largest software companies, all of which have significant exports.

So, first, we want to compliment Treasury and the Service for the thoughtful work you've put into these challenging issues. The purpose of our comments is to suggest some changes to the documentation requirements, in particular reference to software transactions, that we believe would allow proper recognition of the exports of products and services by our software companies that don't disrupt customer relationships, but still protect the interests of — of the government.

To understand our comments, I think it's worth a few minutes to describe to you the general way that U.S. software companies distribute their goods and services around the world. Single B2C transactions are pretty easy to understand, the more complex ones are the global enterprise agreements, because that's how our software companies distribute to large number of users around the world.

And there are three main ways this happens. One is through global enterprise licenses, where the software supplier will grant a license to an enterprise that allows the enterprise to install software throughout the global enterprise.

Second our global SAS, Software as a

Service, arrangements where there's no installation at the user location, but users all around the world can access software that's hosted on the software company's own infrastructure.

And then the third is reproduction licenses for regional VARs, value added resellers or distributors, where reproduction licenses granted in a territory and the VAR reproduces and distributes.

So, all three of those accomplish exactly the same thing of getting the software functionality into the hands of users around the world. In essence, they're all like mass sales, they'll come back to the fungible, you know, mass concept here. But those three transactions are treated differently under the FDII regulations, the reproduction license, the enterprise license and the service. And our basic proposition is that those three economically similar transactions should not be treated differently under the — under the FDII regulations.

So, let me start with a — a technical point that's specific to software. We believe that there is a conflict in the regulations definition of intangible property that conflicts with the basic rule in Treasury 1.861-18 that classifies software transactions between copyrighted article transactions and copyright right transactions.

As you well know, examples four and five in the section dealing with sales and intangible property, deal with software, limited term licenses. Despite the license term, those transactions are clearly described in dash 18 as transactions and copyrighted articles, not transactions in intangible property.

Dash 18 is, from the software industry's perspective, the single most important regulation in the Treasury regulations, because it does set out the difference. That's the fundamental distinction between royalty transactions, for transactions in intellectual property, versus property transactions akin to sales of goods.

And the significance is beyond software because most practitioners believe that the dash 18 rules apply to content transactions, data transactions, all transactions and copyrighted articles.

So, we would like to avoid the implication in the FDII regs that software product transactions are classified as intangible property. And there are three ways that that we can suggest this.

First is to eliminate the distinction between intangible property and general property, and I think we've heard at least one other speaker make the same suggestion, and apply the same documentation requirements to all transfers of — of property.

The second, is if you choose to retain the distinction between general property and intangible property, then we would like that distinction to align with dash 18 So, that software product transactions, like you have now and examples four and five, would fall on the general property side, not the intangible property side of the line.

We make that suggestion with some hesitation because examples four and five do come to the right result and the foreign use rules for intangible property are generally more in line with how software companies think about their user base than the documentation rules for general property.

So, if you do continue to make this distinction, we also would prefer that the documentation rules for both types of property default to the transition rule that you have now of using any reasonable business record generating the ordinary course of business to establish foreign use.

If, as our third alternative, if you retain the distinction between intangible property and general property and, for whatever reason, want to include software user licenses in intangible property, then we very much need a statement that that classification is for purposes of FDII only, and not for general purposes of the law.

The second technical point, I would like to compliment you on the predominant character rule. That is a big issue in the software industry. You can imagine many transactions where you acquire a copy of software with cloud enabled features. That's a combo product service transaction. Because we very much like the predominant character rule — except in some cases — GAP does require companies to bifurcate transactions. This usually is in the context of sales of hardware, with software loaded on the hardware and accompanying maintenance obligations, GAP does require us to bifurcate the maintenance part. So, that is the one example where we would propose a difference from the predominant character rule.

Getting back to my description of the general ways that U.S. software companies distribute their products around the world, as I noted, there's discontinuities in these rules between enterprise licenses, which involve the actual transmission of a software copy to user and SAS agreements. And we submit that those discontinuities should be eliminated. There's no good policy reason for asymmetrical treatment between the global enterprise license and a SAS license, or SAS access agreement.

The discontinuities arise because the enterprise license is a transaction in property, either general or intangible, while the SAS transaction is a transaction in the services. So, we have different documentation rules for those two transactions.

There's also a discontinuity between a global enterprise license that's extended to a U.S. contracting party, that then can install software around the world, and a foreign contracting party, which then can install software around the world. And we don't think that there ought to be a discontinuity based on who the contracting party is. So, we would propose essentially a look-through rule that allows software companies to look through the contracting party to where that contracting party installs its software, regardless whether that contracting party is a U.S. person or a foreign person.

Now, we certainly appreciate the challenges you have because there is a statutory difference in 250(b)(4)(a) and (b) for sales of property and services. We think there are a couple different solutions that could work for software.

One is to reflect on the fact that all of those distribution models that I've described, whether it's a global enterprise license, a SAS access transaction, or a reproduction license for a foreign DAR, are sales of fungible masses of software. Every single software copy is the same as the original.

So, we believe that there's room for you to use the fungible mass concept to allow look through to all users of all enterprise licenses, regardless whether the named counterparty is a U.S. customer or a foreign customer. And if you need a contractual hook in order to establish that direct transaction between the U.S. supplier and the foreign part of the enterprise user, we believe that that hook does exist in the end user license agreement.

In every case of an enterprise license, there will be an agreement between the U.S. supplier and all users in the enterprise that restrict the user's use of the software. This is a true contractual restriction and I think you could rely on that.

And finally, I do note that there were similar statutory interpretation issues in the section 199 area, where the Treasury wanted to provide 199 benefits to SAS services, even though 199 applies on its face to sales of tangible property and the Treasury was able to come to the right result there for SAS, and we think the Treasury has a similar flexibility in this case.

So, I see my time is up. We do appreciate the opportunity to provide these comments. And I do endorse the comments of most of the other speakers about using the transition rule to allow taxpayers to rely on any documentation generated in the normal course of business would be the best rule to apply here.

A reasonable documentation rule is not a no documentation rule, an exam and courts are always able to test the reasonableness of a taxpayer's reliance on whatever reasonable documentation the taxpayer is proffering as its basis for determining its own FDII calculations. So, appreciate again the opportunity to provide these comments.

MR. JERUCHIM:Thank you. I want to thank all the speakers for your comments today, as well as all of you who've provided written comments. We appreciate your submissions and your speaking today. Your input is very helpful as we move to finalize the — those regulations. Thank you very much and have an nice day.

(Whereupon, at 11:02 a.m., the PROCEEDINGS were adjourned.)

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I, Thomas Watson, notary public in and for the State of Maryland, do hereby certify that the forgoing PROCEEDING was duly recorded and thereafter reduced to print under my direction; that the witnesses were sworn to tell the truth under penalty of perjury; that said transcript is a true record of the testimony given by witnesses; that I am neither counsel for, related to, nor employed by any of the parties to the action in which this proceeding was called; and, furthermore, that I am not a relative or employee of any attorney or counsel employed by the parties hereto, nor financially or otherwise interested in the outcome of this action.

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Notary Public, in and for the State of Maryland My Commission Expires: December 2, 2021 Commission No. 127812