Treasury Defends Regulatory Process to Wyden

February 11, 2020

The Honorable Ron Wyden
United States Senate
Washington, D.C. 20510

Dear Senator Wyden:

I write in response to your January 16, 2020 letter regarding the implementation of certain international tax provisions of the Tax Cuts and Jobs Act (TCJA).

Your letter appears to rely on a single, unbalanced New York Times story, which focuses on Treasury's regulatory process with respect to (i) regulations implementing Section 59A — the Base Erosion and Anti-Abuse Tax (BEAT) — that concern special capital requirements imposed by U.S. bank regulators, and (ii) proposed regulations to implement the high-tax exclusion under the TCJA's Global Intangible Low Tax Income (GILTI) regime.¹ Treasury's regulatory process related to implementation of these provisions has been open, transparent, and free from any improper influence by any particular company, individual, or group. Throughout the process, Treasury's goal has been to implement the TCJA in a manner consistent with the text of the statute and the purposes it reflects.

Consistent with departmental practice, as well as requirements under the Administrative Procedure Act, Treasury has taken part in extensive taxpayer engagement, internal meetings, and interagency process in developing rules and guidance implementing the TCJA generally and the international provisions about which you inquire in particular. Treasury officials, including the Secretary and Office of Tax Policy officials, have taken part in regular and frequent meetings regarding the implementation of the TCJA, including international tax law provisions. These regular meetings do not include representatives from the Office of Management and Budget (0MB) or the Office of Information and Regulatory Affairs (OIRA). As a part of the Executive Order (E.O.) 12866 regulatory review process, stakeholders may request meetings with OIRA.

As required by law, Treasury solicited, received, and considered public input through the statutorily mandated notice-and-comment period. Public comment is generally received in the form of letters submitted to Regulations.gov. In addition to written comments, meetings with commenters are a routine part of the notice-and-comment period, as they can provide taxpayers and job creators the opportunity to clarify or emphasize issues reflected in their written comments. We estimate that Treasury officials accepted more than a hundred meetings from various taxpayers and coalitions relating to BEAT and GILTI. Meetings requested of Treasury officials generally did not include OMB or OIRA officials, but if a stakeholder requested a meeting with OMB or OIRA personnel pursuant to E.O. 12866 section 6, those offices would have invited a Treasury official to participate and publicly docketed the meeting on OIRA's website.

As a result of these processes, Treasury has received hundreds of comments from taxpayers and other interested parties regarding BEAT and GILTI. Written comments can be found on Regulations.gov, where various proposed regulations under the TCJA remain open for public comment, including certain provisions related to GILTI.² It also is the longstanding practice of the Department's Office of Tax Policy to release letters it receives on tax policy to Tax Notes on a biweekly basis. All comments from taxpayers have been or are being considered, as required by law, and Treasury's consideration of comments received during the regulation's notice-and-comment period are detailed in the preamble to the respective final regulation.

Treasury officials have performed their duties in accordance with Executive Branch ethics obligations. The ethics laws and rules that govern employee conduct establish baseline legal standards to ensure that agency decision-making is carried out in a fair and impartial manner and that employees' relationships with persons who do business with Treasury are not tainted by employees' personal gain. For example, all Executive Branch employees are governed by the Standards of Conduct regulations concerning impartiality in the performance of official duties (5 C.F.R. § 2635.502). The impartiality provision generally prohibits employees, absent an authorization, from participating in specific party matters where a former employer or client (or other person with whom there is a covered relationship) is a party or represents a party, if participation in the matter would cause a reasonable person with knowledge of the facts to question the employee's impartiality. If an employee is concerned that other circumstances not specifically addressed by the regulation would raise impartiality concerns, the employee may use the same regulatory framework to determine whether to work on a particular matter. Additionally, all full-time political appointees must sign the Administration's Ethics Pledge as required by E.O. 13770, which further restricts employee participation in certain matters directly and substantially related to former employers and clients for a two-year period from date of appointment.³ Treasury employees who have ethics questions are encouraged to contact an ethics official for guidance. Moreover, all Treasury employees have access to the Treasury Ethics Handbook, posted on the Department's Intranet as a reference for day-to-day ethics questions.⁴ Finally, all Treasury employees receive ethics training within three months of appointment to the agency, and financial disclosure filers receive annual ethics training. The topics covered in these ethics trainings include, but are not limited to, financial conflicts of interest, impartiality, misuse of position, and gifts. Treasury also provides supplemental live training to senior agency employees on these topics.

Treasury's regulations are consistent with governing law, in substance as well as process. Any legal analyses pertaining to the provisions about which you inquire were reviewed and approved by IRS Chief Counsel, as well as by Treasury's International Tax Counsel (on questions of international tax law) and the Tax Legislative Counsel (on all other tax law questions), prior to final review by the Office of General Counsel. Information regarding the legal authority for the international tax provisions at issue is available in the preambles to the relevant rulemaking notices. We have provided a summary of these analyses in the enclosed Appendix, which we hope assists your review of this matter.

Finally, your letter seeks information on the potential impact of international tax regulations under the TCJA. Treasury has released more substantial analyses of the TCJA regulations than any other set of regulations adopted by any previous Administration, and the regulatory impact analyses of economically significant rules have been extensive. Several illustrative examples can be found online.⁵ Treasury does not analyze the impact of a regulatory provision on a specific company or coalition of companies, but a regulatory impact analysis may discuss effects on various types of taxpayers, industries, and sectors as appropriate. Because different parties are situated differently, one regulation often will have a large effect on one industry but a very small effect on another industry. For example, the section 163(j) interest expense limitation proposed regulations describe why regulated investment companies and real estate investment trusts (REITs) exclude the dividends paid deduction when calculating adjusted taxable income in order to be treated similarly to other corporations. Similarly, the Passive Foreign Investment Company regulations include a separate discussion of their application to insurance companies since insurance companies must hold significant amounts of investment assets. Further, the section 250 foreign-derived intangible income regulations analyzed the proposed rules for defining a foreign military sale or service eligible for the deduction.

With respect to federal revenues and the President's Fiscal Year 2021 Budget, modeling any tax provision over a ten-year period involves many assumptions, and in some instances, the assumptions that informed the Joint Committee on Taxation's baseline may not match the Administration's initial assumptions. The President's Budget is updated each year based on remodeling and technical adjustments, which could include revised assumptions about current law, as clarified by regulations. Ultimately, although it does not reflect the impact of individual regulations, the Budget Baseline does incorporate the effects of all current laws, including proposed and final regulations.

If you have further questions, please direct your staff to contact the Office of Legislative Affairs.

Frederick W. Vaughan
Deputy Assistant Secretary
Office of Legislative Affairs

Identical letter sent to:
The Honorable Sherrod Brown
The Honorable Robert P. Casey, Jr.
The Honorable Sheldon Whitehouse
The Honorable Catherine Cortez Masto

cc:
The Honorable Charles E. Grassley

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APPENDIX

According to the New York Times article cited in your letter, “some tax experts” have disputed the statutory basis for the portion regulations of the implementing Section 59A — the Base Erosion and Anti-Abuse Tax (BEAT) — that concern special capital requirements known as Total Loss-Absorbing Capacity (TLAC), to which certain financial institutions are subject. The article also appears to suggest that Treasury improperly considered “congressional intent” in adopting regulations to implement the high-tax exclusion to the TCJA's Global Intangible Low Tax Income (GILTI) regime.

As noted, the legal basis for the regulatory provisions addressing these issues was discussed in the relevant published rulemaking notices. With respect to the treatment of TLAC under the BEAT, the preamble included in the rulemaking notice explains:

The Federal Reserve requires that certain global systemically important banking organizations (GSIBs) issue TLAC securities as part of a global framework for bank capital that has sought to minimize the risk of insolvency. In particular, the Board of Governors of the Federal Reserve (the Board) has issued regulations that prescribe the amount and form of external TLAC securities that domestic GSIBs must issue and internal TLAC securities that certain foreign GSIBs must issue. In the case of internal TLAC securities, the Board regulations require the domestic intermediate holding company of a foreign GSIB to issue a specified minimum amount of TLAC to its foreign parent. Section 59A(i) provides that the Secretary shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of section 5 9A, including regulations addressing specifically enumerated situations. The Treasury Department and the IRS have determined that because of the special status of TLAC as part of a global system to address bank solvency and the precise limits that Board regulations place on the terms of TLAC securities and structure of intragroup TLAC funding, it is necessary and appropriate to include an exception to base erosion payment status for interest paid or accrued on TLAC securities required by the Federal Reserve.¹

In addition, in its notice of the regulations establishing U.S. TLAC requirements, published in early 2017, the Federal Reserve Board noted that “[i]n response to comments by a number of foreign banks, the Board consulted with the U.S. Department of the Treasury on the possibility that internal [TLAC] could be considered equity — rather than debt — for purposes of U.S. tax law” and had accordingly made four specific modifications to earlier proposed TLAC regulations in order to ensure debt characterization.² In implementing the BEAT, Treasury and the IRS appropriately took account not only of the fact that TLAC could not be used to engage in abusive base erosion, but also of the importance of harmonization with carefully crafted federal banking regulations and the international regulatory efforts to combat systemic risks to the global financial system. Treasury also considered concerns expressed by numerous commenters, including multiple foreign finance ministers, that a failure to harmonize these regulations would impose an unintended confiscatory tax regime on the U.S. operations of foreign banks, causing foreign-parented banks to become noncompetitive and materially weakening the banking sector. Other aspects of TLAC issues, including treatment of TLAC issued to comply with foreign laws and regulations, is set forth in the preamble to the final regulations.³

The authority for the proposed regulations implementing GILTI's high-tax exclusion is also discussed in published regulatory notices. By way of background, under provisions of the Internal Revenue Code that pre-date the TCJA, U.S. shareholders must include as taxable income, known as “subpart F income,” certain income earned by controlled foreign corporations (CFCs).⁴ Subpart F income includes “foreign base company income” (FCBI) and “insurance income.”⁵ Section 954(b)(4) establishes an “exception for certain income subject to high foreign taxes.” Under that exception, FCBI and insurance income “shall not include any item of income received by a controlled foreign corporation” subject to a foreign effective tax rate greater than 90 percent of the maximum U.S. corporate tax rate.

The TCJA modified the Internal Revenue Code to allow certain other earnings of foreign corporations to be repatriated to U.S. shareholders without tax.⁶ Because this could otherwise create incentives to allocate income — in particular, mobile income from intangible property — that would otherwise be subject to the full U.S. corporate tax rate to CFCs operating in low- or zero-tax jurisdictions, the TCJA also established the GILTI regime, set forth in section 951 A, to subject intangible income to U.S. tax in a manner similar to the treatment of subpart F income.⁷ The GILTI regime is triggered using a calculation based in part on computation of “gross tested income.”⁸ Section 951A expressly excludes from this amount “any gross income” that is excluded as FCBI and insurance income subject to tax under subpart F “by reason of Section 954(b)(4),” thereby importing the high-tax exclusion created under the subpart F regime.⁹

The relevant proposed regulations implementing the GILTI provisions would permit taxpayers to elect to apply the section 954(b)(4) high-tax exclusion without regard to whether income would be excluded as subpart F income for additional reasons besides section 954(b)(4). The preamble to the rulemaking notice explains:

Before the [TCJA], such an election would have had no effect with respect to items of income that were excluded from FBCI or insurance income for other reasons. Nevertheless, section 954(b)(4) is not explicitly restricted in its application to an item of income that first qualifies as FBCI or insurance income; rather, the provision applies to “any item of income received by a controlled foreign corporation.” Therefore, any item of gross income, including an item that would otherwise be gross tested income, could be excluded from FBCI or insurance income “by reason of' section 954(b)(4) if the provision is one of the reasons for such exclusion, even if the exception under section 954(b)(4) is not the sole reason. Any item thus excluded from FBCI or insurance income by reason of section 954(b)(4) would then also be excluded from gross tested income under the GILTI high tax exclusion, as modified in these proposed regulations.

The legislative history evidences an intent to exclude high-taxed income from gross tested income. See Senate Explanation at 371 (“The Committee believes that certain items of income earned by CFCs should be excluded from the GILTI, either because they should be exempt from U.S. tax — as they are generally not the type of income that is the source of base erosion concerns — or are already taxed currently by the United States. Items of income excluded from GILTI because they are exempt from U.S. tax under the bill include foreign oil and gas extraction income (which is generally immobile) and income subject to high levels of foreign tax.”). The proposed regulations, which permit taxpayers to electively exclude a CFC's high-taxed income from gross tested income, are consistent, therefore, with this legislative history. Furthermore, an election to exclude a CFC's high-taxed income from gross tested income allows a U.S. shareholder to ensure that its high-taxed non-subpart F income is eligible for the same treatment as its high-taxed FBCI and insurance income, and thus eliminates an incentive for taxpayers to restructure their CFC operations in order to convert gross tested income into FBCI for the sole purpose of availing themselves of section 954(b)(4) and, thus, the GILTI high tax exclusion.¹⁰