Deloitte Suggests Alternatives to Stewardship Rules in FTC Regs

Internal Revenue Service
Attn: CC:PA:LPD:PR (REG-105495-19)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Attn: David J. Kautter
Assistant Secretary for Tax Policy
U.S. Department of the Treasury

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

Charles P. Rettig
Commissioner
Internal Revenue Service

The Honorable Michael Desmond
Chief Counsel
Internal Revenue Service

Re: Request for Comments on the Proposed Expense Allocation and Apportionment Regulations (REG-105495-19)

Dear Sirs:

On December 17, 2019, the U.S. Department of the Treasury (the “Treasury Department”) and the Internal Revenue Service (the “Service”) issued proposed regulations (the “Proposed Regulations”)¹ relating to the allocation and apportionment of deductions, including deductions for stewardship expenses in Treas. Reg. § 1.861-8(e)(4).² The Preamble to the Proposed Regulations solicited comments on all aspects of the Proposed Regulations, including specifically comments regarding the definition of stewardship expenses and how to readily distinguish such expenses from supportive expenses that are allocated and apportioned under §1.861-8(b)(3). Further, the Treasury Department and the IRS requested comments on whether additional changes to the rules for allocating and apportioning stewardship and similar expenses are appropriate in light of the enactment of the Tax Cuts and Jobs Act (“TCJA”), and in order to better reflect modern business practices that are increasingly global and mobile in nature.³

Deloitte Tax LLP (“Deloitte”), a subsidiary of Deloitte LLP⁴, is pleased to have the opportunity to express our views regarding the allocation and apportionment of stewardship expenses. As discussed below, we believe the Proposed Stewardship Regulations raise significant concerns and recommend that consideration be given to three alternatives, ranging from a narrow clarification to a comprehensive change in approach.

I. EXECUTIVE SUMMARY

A. The proposed changes to Treas. Reg. § 1.861-8(e)(4) and Treas. Reg. § 1.861-14(e)(4) (the “Proposed Stewardship Rules,” which would modify the “Current Stewardship Rules”) broaden the classes of gross income of an affiliated group of domestic corporation to which stewardship expenses are definitely related, while appearing to retain the single corporation approach to affiliated group expenses in general. We believe new Example 18, as written, departs from the single corporation approach and therefore potentially introduces a significant change to current law that is not reflected in the text of the Proposed Stewardship Rules. We request that Treasury and the Service correct the Example to clarify that oversight performed for affiliated group members is not stewardship and thus not subject to the apportionment rules in Treas. Reg. § 1.861-8(e)(4)(ii).

B. As an alternative, if Treasury and the Service intend to treat oversight performed for affiliated group members as stewardship, we recommend revising the first sentence of Treas. Reg. § 1.861-8(e)(4)(ii) to clarify this approach. In addition, to reflect that stewardship expense may relate to both activities performed for U.S. and foreign corporations, we request that the regulation be revised to provide for allocation of stewardship expense (i) to all dividends and inclusions received or to be received from foreign corporations and non-affiliated domestic corporations, and (ii) to other gross income earned or to be earned directly by U.S. affiliated group members. to all gross income received or to be received by the U.S. affiliated group, and apportionment in the same manner as interest expense, i.e., based on the assets of the U.S. group and treating foreign corporation stock (and stock of unaffiliated U.S. corporations) as the relevant asset.

C. A third alternative acknowledges that compliance with the Current Stewardship Rules is very difficult for many multinational enterprises (“MNEs”) and the Proposed Stewardship Rules do nothing to ease that burden. To facilitate compliance in a way that continues to reflect the factual relationship between stewardship expenses and the assets benefiting from stewardship activities, we recommend eliminating the distinction between stewardship and supportive expenses under Treas. Reg. § 1.861-8. Instead, we recommend that all expenses not treated as beneficial expenses under Treas. Reg. § 1.482-9(l)(3) (and thus properly charged out to controlled corporations) be allocated and apportioned under the existing rules for supportive expenses in Treas. Reg. § 1.861-8(b)(3).

II. BACKGROUND

A. Stewardship Expenses within the General Framework of Section 861

Treas. Reg. §§ 1.861-8 through -14T and -17 (collectively, the “section 861 regulations”) prescribe specific guidance for assigning deductible expenses to income from a particular source or activity. A taxpayer must first allocate deductions to a “class” of gross income. Deductions that are factually related to a class of gross income are considered “definitely related” to such class and thus allocated directly to that income or class.⁵ The section 861 regulations provide that a deduction is “definitely related” to a class of gross income if it is “incurred as a result of, or incident to, an activity or in connection with property, which activity or property generates, has generated, or could reasonably have been expected to generate gross income.”⁶

Stewardship expenses, due to their nature as a special kind of supportive expense, are definitely related to only certain types of income. The Proposed Regulations retain the definition of stewardship expenses under existing law. The section 861 regulations define stewardship activities as “overseeing” functions undertaken for a corporation's own benefit as an investor in a related corporation.⁷ Stewardship expenses include, for example, expenses related to an activity “the sole effect of which is . . . to protect the [taxpayer's] capital investment in the related corporation.”⁸ In addition, stewardship expenses include deductions incurred to facilitate the taxpayer's compliance with reporting, legal, or regulatory requirements applicable specifically to the taxpayer.⁹ Because such stewardship functions are undertaken exclusively for the benefit of the taxpayer incurring the deduction, these expenses are not considered to confer a commercial benefit on the related corporation, and thus are allocated under the special rules for stewardship expenses.¹⁰

Deductions attributable to stewardship functions are considered definitely related and allocable to the type of income primarily received, or to be received, by an investor. Under current law this type of income is dividends from related corporations. The Proposed Regulations recognize that an investor's stock investment may also generate other types of income and expand the class of gross income to which deductions attributable to stewardship functions are factually related. Specifically, the proposed regulations would treat stewardship expense as factually related to Subpart F, GILTI, and PFIC inclusions and section 78 gross-up amounts, in addition to actual dividends.

By definition, stewardship expenses include deductions attributable to “duplicative activities” (as defined in Treas. Reg. § 1.482-9(l)(3)(iii)) and “shareholder activities” (as defined in Treas. Reg. § 1.482-9(l)(3)(iv)). Stewardship expenses explicitly exclude deductions related to day-to-day management activities or other activities that benefit or reduce the risk of a related corporation rather than the taxpayer itself.¹¹ Treas. Reg. § 1.482-9(l) provides the following examples of duplicative activities and shareholder activities incurred by a taxpayer:

• Treasury functions, such as arranging financing for corporate needs, and cash management, but only to the extent the taxpayer's functions duplicate the treasury functions carried out by its subsidiary.¹²

• Preparation and filing of financial statements for the worldwide group.¹³

• Expenses incurred related to internal audit of a subsidiary, to review the subsidiary's adherence to operating procedures issued by the taxpayer with respect to the taxpayer's compliance with U.S. anti-bribery laws.¹⁴

• Expenses incurred to retain a law firm and investment banking firm to propose changes to the capital structure of a foreign subsidiary, following the enactment of a new foreign exchange control law in the foreign jurisdiction.¹⁵

Treas. Reg. § 1.482-9(l) also provides several examples of types of expenses that do not constitute stewardship expenses:

• A taxpayer's expenses were not related to “shareholder activities” when incurred to retain a law firm and an investment banking firm to determine whether restructuring would increase the profitability of a foreign subsidiary, reduce the number of legal entities in the foreign jurisdiction, and enhance the efficiency of foreign operations.¹⁶

• A taxpayer's expenses were not considered related to “shareholder activities” when incurred to conduct a retreat for senior executives to refine the organization's long-term business strategy, with the strategy statement made available to its subsidiary.¹⁷

B. Other Supportive Expenses

The Current Stewardship Rules and Proposed Stewardship Rules draw a sharp distinction between stewardship expenses and expenses that are supportive in nature, like overhead, general and administrative, and supervisory expenses.¹⁸ Supportive expenses do not directly produce income; rather, such expenses indirectly contribute to the production of income. Accordingly, deductions for supportive functions may be combined with and allocated and apportioned along with other deductions to which they relate.¹⁹ Alternatively, the section 861 regulations deem it equally acceptable to allocate supportive expenses to all classes of income of the taxpayer using a reasonable method that reflects the factual relationship of the deduction to the relevant class(es) of gross income.²⁰

The section 861 regulations include examples that illustrate the application of the allocation (and apportionment) rules for deductions attributable to supportive functions. Example 21 involves a foreign corporation that incurs general and administrative expenses related to its sales of certain machinery in the United States and foreign countries. As a result, the foreign corporation's general and administrative expenses are definitely related (and thus allocable) to income from the sales of the machines.²¹

In Example 19, a domestic corporation earns income from domestic and foreign sales and incurs personnel, training, general and administrative, and salary expense in connection with its worldwide sales business. Domestic and foreign sales are not divided into separate departments in the organization. Accordingly, the example concludes that the domestic corporation's deductions are definitely related and allocable to all of the corporation's gross income.²²

C. Expenses Related to Exempt Income

The section 861 regulations provide special rules for allocation and apportionment of expenses related to exempt income. For purposes of apportioning expenses based on gross income, gross income is reduced to the extent it gives rise to a partial dividends-received deduction under either section 243(a) or 245(a).²³ Example 24 illustrates how this adjustment can affect the treatment of stewardship expenses.²⁴ In the example, X owns a 25-percent interest in two domestic corporations and three foreign corporations. In the current year X receives $100 dividend from each corporation and also incurs $100 of stewardship expenses with respect to these five investments. The dividends from the two domestic corporations qualify for an 80-percent DRD under section 243(a). The stewardship expense is allocable to the class of income consisting of the dividends collectively. X properly apportions the expense based on the relative amount of dividend income in the statutory grouping (foreign-source general) and residual grouping (U.S. source). In order to reflect the partially exempt status of the dividend income from the domestic corporations, however, only 20 percent of the domestic dividends are counted. As a result, $88 ($100 x $300/$340) of the stewardship expense is apportioned to the foreign dividends, and $12 ($100 x $40/$340) is apportioned to the U.S. dividends.

Dividends from affiliated domestic corporations or CFCs making a valid section 953(d) election, which give rise to a 100-percent DRD under section 243(a)(3) and the stock that gives rise to them are not covered by the above rule for exempt assets. Instead,

In the above example if the domestic corporations were wholly owned by X and the exempt asset rule applied, we would apportion $100 x 300/300 of the stewardship expenses to the foreign dividends and $100 x 0/300 to the US dividends. But that is not the correct result. Treas. Reg. § 1.861-14T applies a different approach that follows logically from the notion that affiliates do not hold stock in one another and do not receive dividends from one another. In our view, and as explained further below, this approach requires the oversight expense to be bifurcated and the portion attributable to stewardship for the domestic corporations removed before apportioning the remaining stewardship expense based on foreign corporation stock.

D. Expenses within an Affiliated Group

In the case of an affiliated group, section 864(e)(6) requires certain expenses other than interest that are not directly allocable to specific income producing activities to be allocated and apportioned “as if all members of the affiliated group were a single corporation.” Treas. Reg. § 1.861-14T provides rules for allocating and apportioning supportive expenses that are not directly allocable to specific income-producing activities conducted, or property held, solely by the member of the affiliated group that incurs the expense. Such expenses must be allocated and apportioned as if all members of the affiliated group were a single corporation, and for this purpose income from intercompany transactions, including dividends, are disregarded.²⁶ Stewardship is one of the supportive expenses covered by these rules.

As provided in Treas. Reg. § 1.861-8(e)(4)(ii), in general, stewardship expenses are considered to be definitely related and allocable to dividends received or to be received from related corporations. When a dividend is received from a group member, it is eliminated because the members are treated as a single corporation. Under Treas. Reg. § 1.861-14T, however, a dividend received by a group member from a nonmember, must be taken into account by other group members because all members are treated as a single corporation.²⁷ This distinction is illustrated in one of the examples in the current regulations:

If P's stewardship activities related to both X and Y, then we believe the current regulations would require a bifurcation of this analysis. For stewardship activities relating to nonmember Y, P and X are treated as a single corporation that receives dividends from a related corporation. P and X are a single shareholder of Y, and the stewardship expenses of P and X are definitely related and allocable to the dividend from related corporation Y. On the other hand, P's stewardship expenses vis-à-vis its investment in fellow member X is not definitely related to dividends from X, because such dividends are disregarded, as is the stock investment that P has in X.

Under the current regulations, the example that comes closest to dealing with the expenses to oversee other affiliated group members is Treas. Reg. § 1.861-8(g), Example 17. In Example 17, X, a domestic corporation, wholly owns M, N, and O, which are members of X's consolidated group. X incurs expenses to oversee its subsidiaries. All the income of X and O is from U.S. sources, while all of M's and N's income is from foreign sources. The example states that X receives no dividends from M, N, or O. Apparently for this reason, the example states that “X's deductions * * * are definitely related and thus allocable to the types of gross income to which they give rise,” which is, in the case of M and N, foreign source general limitation income and, in the case of O, U.S. source income.

Example 17 was included in the first comprehensive 861 regulations issued in 1977.²⁹ The facts were largely the same as they are in the current regulations, although there were additional facts that were relevant to calculations specific to the law in effect at the time. The example's conclusion is still more or less correct under current law because, in general, oversight and other supportive expenses incurred with respect to other members of an affiliated group are now allocated and apportioned as if all members were a single corporation under Treas. Reg. § 1.861-14T. These expenses cannot be allocated to dividends from other affiliated group members because the intercompany shareholdings and dividends are disregarded. But Example 17 makes no mention of Treas. Reg. § 1.861-14T or the single corporation principle.³⁰ It also does not appear to be applying the stewardship rules of Treas. Reg. § 1.861-8(e)(4)(ii) as the stewardship expenses are allocated based on the income of each corporation rather than dividends received.

In some respects the allocation and apportionment rules were the same in 1977 as they are today and in some respects they were quite different, and that limits the value of the example as guidance.³¹ To understand how Example 17 reached its conclusion, one needs to reconstruct the law in effect in 1977.³² One important difference under the prior regulations was that dividends within a consolidated group were counted as items of income to which expenses could be allocated. In addition, each member of the group was required to allocate and apportion its expenses on the basis of its own income.

The Proposed Regulations remove existing Example 17 with no explanation of why it does not reflect current law. The Proposed Regulations also revise Example 18 to illustrate how the amendments to Treas. Reg. § 1.861-8(e)(4)(ii).³³

The treatment of an affiliated group as a single taxpayer under Treas. Reg. § 1.861-14T requires expenses incurred to support investment in most domestic subsidiaries to be segregated from the stewardship analysis described in Treas. Reg. § 1.861-8(e)(4)(ii).³⁴ Expenses to oversee affiliated group members do not fall within the definition of stewardship expense in the Current or Proposed Regulations as they are oversight expenses incurred for the group's own account and not to support investment in a related corporation. New Example 18, however, apparently equates oversight for affiliates with oversight for non-affiliated related corporations (generally foreign subsidiaries) but apportions all oversight expenses based on assets of only non-affiliated related corporations. Below we suggest alternatives to either revise the example to take this distinction into account or more broadly reconsider the approach to stewardship expense apportionment.

III. DISCUSSION

A. Alternative 1 — Conform Example 18 to Current Law

1. Example 18 appears to inconsistent with the single corporation treatment of members of an affiliated group under existing law

According to the Example, USP incurs a total of $540 of expenses in the supervision of its four subsidiaries — three CFCs and one domestic affiliate. The language of paragraph (i)(B) consistently refers to the four subsidiaries collectively in explaining the purpose for the $540 of expenses. In the Analysis, Section (ii)(C)(iv) refers to the entire $540 as “stewardship” expenses and reiterates that this amount is attributable to the investment in all four subsidiaries. In acknowledgement of the fact that USSub is a member of the same affiliated group as USP, the investment in USSub's stock is disregarded. It is clearly correct to remove affiliate stock from the apportionment, because USSub and USP are properly treated as a single corporation rather than as related corporations. But the Example does not remove the portion of the expenses incurred to oversee USP's investment in USSub. Instead the expenses attributable to USSub are apportioned along with the rest of the “stewardship” expenses only to foreign source income based on the categories of income that the CFCs' stock generates, as if the entire $540 of expenses were attributable to USP's investment in the CFCs' stock.

Based on the regulations described in Section II (Background), the treatment of expenses related to USSub as stewardship and the way these expenses are allocated reaches a result that is inconsistent with current law.

Treasury Reg. § 1.861-8(b) sets out the general principle underlying the section 861 regulations that an expense should be allocated to the class of gross income to which it factually relates. Expense incurred to oversee U.S. based activities of affiliated corporations, which by definition are U.S. corporations, bears no factual relationship to stock, assets or income from foreign subsidiaries. In contrast, where a U.S. group member performs oversight functions for a foreign subsidiary of a related corporation, that expense factually relates to foreign subsidiary stock, assets or income. Example 18, however, does not distinguish between the two. The absence of this distinction would be easier to understand if USSub were a pure holding company for the CFCs. But it is clear from the facts presented that the CFCs are owned by USP rather than by USSub. Thus, oversight of USSub is not indirectly stewardship of the CFCs.

Further, Treas. Reg. § 1.861-8(d)(2)(ii) provides that stock of another member of an affiliated group and the dividends thereon are “eliminated from consideration in the apportionment of interest expense under the consolidation rule set forth in § [1.861-11T(c)], and in the apportionment of other expenses under the consolidation rules set forth in Treas. Reg. § 1.861-14T.” If stewardship expense must be allocated to income from stock and, as between group members, there is no stock or income from the stock, then Treas. Reg. § 1.861-8(e)(4)(ii) would not apply by its terms. Instead this type of stewardship expense would fall within the provisions of Treas. Reg. § 1.861-8(c)(3) and (e)(9), addressing deductions that are not definitely related to any gross income. In that case the stewardship deduction would be ratably apportioned to all gross income.

2. Clarifying and Reconciling the Rules Applied in Example 18

We recommend revising Example 18 to reconcile it with the factually related standard for expense allocation and the single corporation treatment for affiliated group members under section 864(e)(6) and Treas. Reg. § 1.861-14T. To do so, Treasury and the Service could also revise the first sentence of Treas. Reg. § 1.861-8(e)(4)(ii) to expressly state that it applies only to stewardship activities undertaken directly or indirectly with respect to foreign subsidiaries and non-affiliated domestic subsidiaries. Further, specific language could be added to confirm that stewardship activities undertaken with respect to a U.S. corporation's oversight of other affiliated group members would not be treated as stewardship, and instead would be allocated and apportioned to all income producing activities of affiliates other than investment in foreign subsidiaries under the rules for supportive expenses in Treas. Reg. § 1.861-8(b)(3).

The allocation of stewardship expenses to dividends and inclusions from foreign subsidiaries then would be consistent with the factual relationship standard in Treas. Reg. § 1.861-8(b)(1). Example 18 could be revised to illustrate this rule by stating as a fact that USS has no foreign subsidiaries and removing the portion of stewardship related to USSub before applying Treas. Reg. § 1.861-8(e)(4)(ii). Alternatively, the example could posit that one of the two CFCs is owned by USSub. To the extent USP performs stewardship for its wholly owned CFC and USS's CFC, Treas. Reg. § 1.861-8(e)(4)(ii) would apply. To the extent USP's stewardship relates to USSub's U.S. based activities or assets, the regulation would not apply.

B. Alternative 2 — Retain the Distinction Between Stewardship and SG&A, But Revise Allocation and Apportionment Method for Stewardship

An alternative approach would be to include oversight performed by one member of an affiliated group with respect to the U.S. activities of another member as stewardship expense. If Treasury and the Service believe this is the correct approach, we recommend revising the first sentence of Treas. Reg. § 1.861-8(e)(4)(ii) to so provide. To reflect the factual relationship between stewardship expense and income, this approach would require conforming changes to the allocation and apportionment methodology in the proposed regulations. Specifically, stewardship expense would first be allocated (i) to all dividends and inclusions received or to be received from foreign corporations and non-affiliated domestic corporations; and (ii) to other gross income earned or to be earned directly by U.S. affiliated group members. Next, stewardship expense would be apportioned in the same manner as interest expense, i.e., based on the assets of the U.S. group and treating foreign corporation stock (and stock of unaffiliated U.S. corporations) as the relevant asset.

This approach retains the investor paradigm for viewing stewardship activity by continuing to define stewardship expenses as those resulting from overseeing functions undertaken for a corporation's own benefit as an investor. At the same time, it recognizes the global nature of a MNE's operations (discussed more in Alternative 3), and that stewardship performed for one corporation (foreign or domestic) may be necessary to preserve the value of the group as a whole.

C. Alternative 3 — Treat Stewardship Expenses Like Other Supportive Expenses

In our experience, taxpayers who have substantial global operations face significant challenges trying to comply with the Current Stewardship Rules, and the Proposed Stewardship Rules do nothing to alleviate these challenges. We respectfully request that Treasury and the IRS consider an alternative approach eliminating the distinction between stewardship and supportive activities. Under this approach, expenses that do not provide a direct benefit as defined in Treas. Reg. § 1.482-9(l)(3) and thus are not required to be charged out to controlled corporations would be treated as supportive expenses and allocated and apportioned under Treas. Reg. § 1.861-8(b)(3).

1. Approach in Current and Proposed Regulations is Subjective and Accuracy Is Affected

Both the Current and Proposed Regulations cross-reference Treas. Reg. § 1.482-9(l). Under Treas. Reg. § 1.861-8(e)(4)(i), expenses attributable to controlled services transactions, defined in Treas. Reg. § 1.482-9(l)(3), are considered definitely related and allocable to amounts charged to the controlled party. Current and Proposed Reg. § 1.861-8(e)(4)(ii) define stewardship expenses as expenses from oversight activities, which are duplicative and shareholder activities as defined in Treas. Reg. § 1.482-9(l)(3).

Treas. Reg. § 1.482-9(l)(3) distinguishes between expenses that provide a measurable benefit to a controlled corporation and those that do not. The former must be charged out to the controlled corporation and thus are no longer treated as expenses of the U.S. group. Treas. Reg. § 1.482-9(l)(3) recognizes four categories of activities/benefits that do not provide a measurable benefit to a controlled corporation and thus are not required to be charged out; activities providing an indirect or remote benefit, duplicative activities, shareholder activities, and passive association benefits arising from membership in a controlled group. Treas. Reg. § 1.861-8(e)(4)(ii) incorporates only two of these categories, shareholder and duplicative activities, into the definition of stewardship expense. Activities that provide an indirect or remote benefit or passive association benefit are not charged out but are not included in the definition of stewardship under the section 861 regulations, apparently because they do confer a commercial benefit on the related corporation, but not one that is measurable. Although not expressly stated, expenses that provide an indirect, remote or passive association benefit presumably would be characterized as supportive expenses under Treas. Reg. § 1.861-8(b)(3).

The distinctions between the four types of activities that are not treated as beneficial and thus are not charged out are highly subjective and often difficult to discern. Because the section 861 regulations rely on the section 482 regulations, the line between stewardship and other supportive expenses also is difficult to draw.

2. The Investor Paradigm Needs to Be Updated to Fit the Way MNE's Are Managed

As discussed above, the Proposed Regulations provide an investor paradigm for viewing stewardship activity. “Stewardship expenses result from 'overseeing' functions undertaken for a corporation's own benefit as an investor in a related corporation.” The “investor paradigm” that underlies the concept of stewardship activities and their allocation and apportionment in the regulations may no longer be an appropriate way of understanding the relationship between global headquarters and subsidiaries for multi-national enterprises (“MNEs”). The investor paradigm presupposes a clear separation between ownership and operational control, which forms the basis of the classic corporate governance structure. For an increasing number of MNEs, that paradigm is now largely obsolete.

The data that MNEs collect and maintain with respect to their cost centers for business purposes typically does not track expenses with the level of detail that the regulations require to distinguish stewardship (duplicative and shareholder activities) from supportive (remote or passive association benefit activities) expenses. Once the amount to be charged out to controlled corporations is determined, the section 482 regulations do not require a further subdivision of the remaining expenses into the four categories of expenses not charged out, and MNEs thus do not do so. Reconstructing from the available data which expenses are properly characterized as shareholder or duplicative rather than remote or passive association is an arduous and subjective exercise. Oversight of the financial records of one CFC, for example, may meet the definition of duplicative activities, but it also provides a remote benefit to other members of the group in assuring that the worldwide group's financial statements are correct.

In addition, it is difficult for many MNEs to distinguish oversight expenses for foreign corporations from similar expenses incurred for domestic affiliates, because MNEs often organize their administrative activities by business division rather than by legal entity. It is difficult for them to distinguish between oversight expenses for CFCs from similar expenses for foreign disregarded entities, because for all purposes other than US federal income tax both types of entities are foreign related group companies.

Enterprise resource planning (ERP) systems have tightly integrated supply chains of related corporations and permitted centralized management of operational data. Centralized management of information from all business units within an MNE changes the nature of “oversight” of related corporations. Monitoring the financial performance of a subsidiary using the same or a coordinated ERP system can be done in real-time rather than waiting for the subsidiary to provide documentation. The real-time monitoring of most aspects of performance of related companies throughout the world gives the headquarters of the MNE opportunities to simultaneously perform oversight and business planning. Thus, expenses that may previously have been characterized entirely as a shareholder expense also contribute to business planning that is better viewed as a supportive expense.

3. Stewardship Activities Have Correlative Benefits for the Entire MNE Group

The headquarters of an MNE provides various supportive services for the group companies, both U.S. and foreign. Many of those services provide a direct quantifiable benefit for a particular group company. The cost of those services should be charged back to the company that derives the benefit. But there are also headquarters expenses that cannot be charged back, because the group companies already perform the activities that the headquarters performs and/or the benefit to the group companies is not sufficiently clear and quantifiable to sustain a deduction for an intercompany charge under local transfer pricing principles. These expenses may be duplicative or shareholder expenses, but also may be remote or passive association expense.

As defined in the Current and Proposed Stewardship Regulations, stewardship expenses include shareholder and duplicative expenses as defined in Treas. Reg. § 1.482-9(l)(3). These are expenses related to an activity “the sole effect of which is . . . to protect the [taxpayer's] capital investment in the related corporation,” [emphasis added] and expenses incurred to facilitate the taxpayer's compliance with reporting, legal, or regulatory requirements applicable specifically to the taxpayer. These expenses are distinguishable from other supportive expenses insofar as they do not confer a commercial benefit on any related corporation.

This view of stewardship expenses misses an important part of the function and motivation for these activities in a modern global commercial enterprise. While it is still true that the headquarters of a global MNE performs stewardship activities to protect its investment in particular subsidiaries, these activities have become broader and aim to protect more than the value of its investment in particular subsidiaries. As such, they may be better viewed as expenses provide a remote or passive association benefit to group members.

At least as important is the motive to protect a global brand. Consider two examples of classic stewardship activities in Treas. Reg. § 1.482-9(l) regulations: preparation and filing of financial statements for the worldwide group (Example 7), and an internal audit of a subsidiary to review the subsidiary's adherence to operating procedures issued by the taxpayer with respect to the taxpayer's compliance with U.S. anti-bribery laws (Example 9). The potential cost to the organization of inaccurate financial reporting is a restatement of financials filed with a regulatory agency and the serious reputational fallout for the MNE as a whole that often accompanies such restatements. The potential cost of noncompliance with the Foreign Corrupt Practices Act is the reputational damage for the MNE as a whole that often accompanies disclosure of bribery of foreign officials. If the violation of U.S. anti-bribery laws by a subsidiary is disclosed in the media, the damage is likely to affect not just the value of the U.S. parent's capital investment in the local subsidiary company; it can taint the company in numerous countries and result in serious loss of business throughout the world.

For a modern MNE, global brand or reputation is a very valuable intangible. All companies in the group derive a benefit from protection of this intangible. Therefore, all companies in the group benefit from the headquarters' oversight of their financial statements and their compliance with laws. The problem is that the benefit that any one company in the group derives from these stewardship activities is indirect and hard to quantify, and therefore none of the group companies may be able to claim their allocable share of the headquarters' costs as a deductible expense of their own individual business. In other words, these types of oversight activities may be better viewed as providing a remote or indirect benefit to group members, which would not be stewardship within the meaning of Treas. Reg. § 1.861-8(e)(4)(ii).

Another significant motivation for headquarters activities is global competitiveness for the MNE overall. An example is a study of how to change the capital structure of the group to take advantage of loosening of foreign currency exchange controls in a particular country (Example 10). The regulations characterize this as an activity benefiting only the shareholder because it facilitates payment of dividends out of that country. But freeing up trapped cash inures to the benefit of multiple companies in the group by facilitating redeployment of cash in other foreign locations. A globally competitive structure has intangible value for the group as a whole. The benefit, however, is not readily measurable and thus may be viewed as an indirect or remote benefit which is not required to be charged out.

4. Allocation and Apportionment Suited to Stewardship in the New Business Environment

As argued above, stewardship activities in the new global business environment have outgrown the traditional investor paradigm and become a tool of managing an integrated global enterprise. Moreover, the function of stewardship in an integrated global enterprise includes the protection of valuable group intangibles which provide indirect benefits for every member of the group. From this perspective, it follows that stewardship promotes the global business and should be allocable to all income of the U.S. consolidated group and apportioned on a global basis.

To better align the stewardship and supportive expense allocation and apportionment rules with the new global business environment and eliminate the need to distinguish among remote benefit, passive association benefit, shareholder and duplicative activities under Treas. Reg. § 1,482-9(l)(3) as well as the category of subsidiary to which the expense relates, we respectfully request that you consider a broad change to the section 861 regulations. Specifically, we request that you consider treating all expenses not properly charged out to controlled corporations under Treas. Reg. § 1.482-9(l)(3) as supportive expenses to be allocated and apportioned under the rules for supportive expenses in Treas. Reg. § 1.861-8(b)(3).

IV. CONCLUSION

We commend the Treasury and the IRS for taking steps to reconcile the Current Stewardship Rules with the extensive changes brought about by TCJA and for considering the views of industry and practitioners about how to facilitate and improve the transition to the new regime. We have proposed three alternatives to addressing what we perceive to be significant practical and theoretical problems with the Proposed Stewardship Regulations.

Thank you for your consideration of these comments. We would be happy to discuss them further with you at your convenience.

Respectfully submitted,

Robert Rothenberg, Managing Director

Caren Shein, Managing Director

DELOITTE TAX LLP
Washington, DC