CPA Cites Concerns With, Seeks Withdrawal of Debt-Equity Regs

After 45 years of in the corporate tax field I am moving towards retirement, but I would like to offer some practical comments from an administrative perspective on the currently proposed Section 385 Regulations for your further consideration. For the past 18 years I have served as a chief tax officer with two large publically traded U.S. global manufacturing companies with revenues ranging between $10 and $18 billion. Both companies were headquartered in the U.S. with operations in 20 or more foreign countries and I have dealt first-hand with the debt/equity issues you are trying to address.

My comments are focused on improving tax administration, and reminding you of the challenges that U.S. companies have when competing against foreign companies that often have favorable tax advantages when compared to the U.S. tax programs. The impact of taxes on financial results is arguably more important to public companies than the cash burden; although, I can understand your perspective where financial reporting is not your focus. However, I would suggest that it should be. My experience over my 45 years with 6 publically traded companies is the senior management and the directors are focused on earnings, not cash taxes. For these companies, income taxes are viewed as an "operating expense" rather than a social obligation. Operating expenses include the cost of compliance as well as the related taxes. When companies have inverted they have done so to reduce these controllable expenses. Tax compliance costs in the U.S. are already the most expensive and extensive in the World. I can attest that since 1994, I have been with three manufacturing companies in the healthcare, packaging and electronics industries and for every one one of those tax returns the cost of U.S. compliance exceed the actual cash taxes paid to the U.S.! As hard as this statement may be for you to believe, it is the absolute truth.

In my opinion the proposed Section 385 regulation released by the Treasury Department on April 4, 2016, would add significantly greater complexity and administrative costs to US companies trying to compete on a worldwide basis. Ironically, the proposed regulations were motivated to stem the tide of U.S. multinationals "inverting" to foreign jurisdictions. However, these proposed regulations go far beyond that stated purpose and would impose additional significant administrative costs on U.S. companies to comply with as well as adding a new level of financial uncertainty for publically traded companies. In addition to saving U.S. taxes, these administrative burdens are exactly why companies have inverted!

Coordinate Current guidance and regulations with GAAP

The debt/equity debate has been in dispute between taxpayers and the IRS for years. These new documentation regulations will not change that. In fact, it will only add to the disputes, since documentation can be viewed as subjective. The SEC and US GAAP requirements also address the debt/equity issue, in addition to current IRS regulations. U.S. companies must disclose Uncertain Tax Positions (UTP) to the IRS when an inconsistent tax position is being taken on a tax return. In addition, globally there are now Base Erosion and Profit Shifting (BEPS) regulations going into place that will also address this area from both a tax and financial reporting perspective. I believe IRS tax writers need to become more familiar with the U.S. GAAP requirements and coordinate their regulations accordingly.

I am sure the government has some specific objectives and situations that they are focusing on, but addressing those concerns with onerous regulations, that significantly burdens both large and small U.S. companies is neither good tax administration or policy.

Administrative costs to comply

I can foresee significant administrative costs and financial uncertainty if these regulations are enacted in their current form. I am particularly concerned with the 30 day documentation requirements that would allow the IRS a 72-month window to challenge common corporate treasury transactions that occur regularly to respond quickly to an on-going business need, a global event or a customer opportunity. By restricting the use of foreign intercompany cash, the proposed regulations create a tremendous burden for U.S. companies, dramatically increasing their borrowing costs and would not encourage more repatriation of earning back to the US, if the funds are needed off-shore.

These regulations will also increase the cost and financial exposure for publically traded companies, as these companies would then need to demonstrate to its independent auditors that documentation is complete or financial reserves may be required. Since documentation is subjective we see a likely possibility for significant debates with the external auditors as well as the IRS auditors over what is adequate documentation, regardless if there is a debt/equity issue or not.

Cash Pooling

A key issue for many multinational corporations is to effectively manage cash is through cash pooling arrangements. Companies often fund day-to-day operating cash needs by internal "cash pooling" arrangements in which one member of an affiliated group acts as a central bank for daily cash transactions of group members. This allows companies to efficiently use group-wide cash and minimizes the cost and need for third-party borrowing. Under the proposal, the debt instruments issued in these cash pooling arrangements (also required by IRS regulations) could be numerous on any given day and the documentation required would be a significant burden with no beneficial business purpose. In fact, the documentation would likely overwhelm the field agents on exam.

For global companies with foreign subsidiaries the documentation requirement will be an enormous burden with absolutely no benefit to the IRS for the majority of the transactions. As an analogy, the proposed regulations are similar to asking corporate treasury departments to document each time they go for a cup of coffee, and did they add cream, sugar or sweetener to their cup and then challenging them years later to prove that they didn't gain weight because of it.

Here again, existing IRS regulations, transfer pricing reports, BEPS and U.S. GAAP reporting should be coordinated and consistent. The proposed safe harbor rule relying on current E&P regulations is not workable as the required information cannot be determined with the time frames required. It's impossible and totally impractical under current E&P guidance.

Retroactive Effective Dates and Look-Back Rules

I believe that that the subjective rules will make normal business operations much more difficult and uncertain. Of particular concern are the recharacterization rule that would apply to instruments issued after April 4, 2016, and the three-year look-forward/look-back rule, which will create even more uncertainty for companies in the United States trying to effectively deploy their cash.

The proposed date of April 4^th, is neither practical or in keeping with good policy. Requiring companies to comply with unknown regulations on a retroactive date is abusive to U.S. taxpayers. Good regulations should embrace good business practices. Companies cannot operate under retroactive rules and regulations.

Broad 72 Month Per Se Funding Rule

The proposed regulations also provide a presumption that a debt instrument is treated as stock if it is issued during the 72-month period beginning 36 months before the date of a distribution or acquisition that recharacterizes debt as equity. Manufacturers believe that the per se rule impedes effective cash management because it is excessively broad and administratively burdensome, linking transactions from multiple tax years that are factually unrelated.

Current case law guidance and coordination with U.S. GAAP, UTP and BEPS disclosures would better serve the government's objective. This 72 month window will hold up valid business decisions as well as IRS audits. The government would be better served by focusing on the business purpose of transactions. I believe the government is focusing on a few transactions and making an assumption that such transactions are wide spread. I don't believe this to be the case.

Administrative burden

As discussed above the administrative burden on U.S. companies if the proposed regulations are enacted in their current form will be huge. In addition, I will point out that the IRS would also need to staff up to take on another administrative review such as this. Again, because of the subjective nature of documenting business purposes, these issues will likely lead to protracted tax appeals that will also mean greater uncertainty for public companies with their financial statements. From the government's perspective, the 72 month look back/forward provisions will almost certainly cause significant delays and complications in closing tax audit years. I urge you to focus on the administrative burden and costs that are being proposed on U.S. taxpayers. It's going to be a much larger burden than I believe you are anticipating. If these documentation regulations are enacted I will expect that the U.S. Treasury will eventually realize that these regulations will actually cost them far more revenue than they generated. These are far too broadly bureaucratic, rather than thoughtful and practical. I urge you to consider the practical.

Conclusion

I believe that the US Tax Code and good tax policy needs to be understandable and predictable. The key is business purpose. Companies do not retroactively change their business purposes. These regulations and the required documentation will further complicate the US tax laws by adding subjective documentation that will certainly lead to extended audits, appeals and tax court cases. In short, these documentation regulations do not provide any meaningful guidance to U.S. companies. Rather, they are another burden for still being a U.S. company.

In addition, my recollection is these are the most wide-ranging section 385 regulations proposed since the Tax Reform Act of 1986, when those proposals helped lead to a disastrous financial market reaction in 1987. U.S. companies need help to compete in the global markets, not more putative regulations to deal with. These regulations will only help our foreign competitors and the companies that have already inverted.

Given the significant negative impact the proposed regulations will have on a wide range of global and domestic manufacturers in the United States, I respectfully request that the Treasury Department withdraw these proposed regulations until there can be a thoughtful and open discussion that would include practical considerations of and coordination with U.S. GAAP (Generally Accepted Accounting Principles), SEC and BEPS requirements already in place.

Thank you in advance for your consideration of our comments and concerns.