David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Worldwide Tax Daily. This week: Regulatory power. With the role of regulations becoming more high profile as policymakers seek to implement the complex provisions of the Tax Cuts and Jobs Act, it seems like a good time to step back and take a look at the limits of the Treasury Department's authority to make those regulations. My guest this week has some thoughts on this issue. He is Ben Willis, the newest contributing editor at Tax Notes and author of the Willis Weighs In column. Ben, welcome to the podcast.
Ben Willis: David, thanks for having me. Very happy to be here.
David Stewart: So, let's start with the regulators themselves. How does the executive branch view its role in policymaking through regulations?
Ben Willis: Well, I believe the executive branch has multi layers and these different layers, which we'll talk about, each have a different view. And so we can start at the very top of the executive branch and focus on the policy agenda set by the executive and then work our way down into the Treasury Department, which is led by Secretary Mnuchin, who has reporting to him the commissioner of the IRS, Commissioner Rettig. And that relationship is an interesting one, because we like to think of the IRS as an unbiased agency who's fighting for fairness and equality and executing the tax laws. But we also know that there is an agenda that comes down from Treasury, part of the Cabinet, and that the president has the ability to fire the commissioner at will under the Internal Revenue Code. And so with that ability comes a lot of pressure, I believe, and the ability to impose political pressure on the IRS has been an issue for decades. We can take a look at the Lois Lerner incident or we could take a look at even before that with NAACP where senators were angrily calling in to the IRS about negative comments about President Bush at the time and questioning why they had tax-exempt status. And so both Democrats and Republicans have both had accusations about their bias and using the IRS as a tool to implement that bias. And so that's the higher end of the answer, and then at the lower end is you've got these drafters who are working away at these massively complex statutory provisions in writing regulations to help taxpayers interpret them. And we all know how important a task this is, because we need interpretation on the Tax Cuts and Jobs Act. It simply has too many holes, too many uncertainties, effective data issues, things that you've talked about before on other shows that require answers. And the question is if we're not going to be able to get the legislative branch to step in with technical corrections, can the Treasury Department and the IRS do anything to help taxpayers? And I really believe that that is what they're trying to do. But in doing so, some of these interpretations that have come out in recent regulations seem so focused on revenue raising, perhaps justifying the revenue estimates underlying the bill originally or to pay for certain political agenda expenses or what have you. But in any respect, if we're looking at these regulations, which are increasing the burden on what taxpayers thought it would be through the statutory provisions themselves, we have to question whether or not those drafters have the authority to write those regulations.
David Stewart: Now when you're saying that they’re looking to raise revenue, where would the pressure to raise revenue come from for the regulator?
Ben Willis: So, it would come from the executive branch and this is all, obviously, that's a broad answer. They're all part of the executive branch, but it would come from anywhere from the president all the way down through the commissioner and passing to his bosses. So if Secretary Mnuchin was given an order to ensure that a certain type of taxpayer receive a certain treatment, whether it be related to real estate activities or foreign investment or what have you, and that pressure is exerted on the commissioner and then thereby passed down through to the actual reg writers, I think you could wind up having some real pressure on those people to ensure that the provisions are taxing in a way that is desirable to the administration.
David Stewart: So what sort of regulations are we seeing where the Treasury is going beyond maybe what we expected under the statute in order to raise additional revenue?
Ben Willis: That's a great question, and I think it'll be something I'll be dealing with, along with many others, for months to come as all these regs come out. One of the most frequently cited examples of this is the definition of interest inside the 163(j) regulations. A lot of folks believe that the courts have a well-established definition of interest. It is not an ambiguous term. And when it was used in the statute and then later broadened in regulations, which pull in imputed interests, which pull in debt fees and commitment costs, loan obligation costs into the definition of interest, that this was broadening the statute much further than Congress had given the authority to do. And so I would say, interest is a prime example. Another large example is in the recent GILTI regulations where there are basis adjustments provided for in those regulations. They're worried about loss duplication concerns, at least that's what the preamble says. The problem is that those regulations, which are promulgated under 952(a), focus on GILTI and the basis provision in the statute is 961. And in fact, Congress chose to amend 961, the basis adjustment provision for the controlled foreign corporation rules, CFC rules for 245A dividends. These are excluded dividends that come up under the new hyperterritorial system. And so when those dividends come up, there is indeed under 961(d) a basis reduction for them, but Congress chose not to make any basis reductions for anything else. Here the IRS believed that they would make their own basis adjustment using another regulation, -6 and the 961(a) new regulations, and they cite Ilfeld, which is a very narrow consolidated return case principle, which is focused on double deductions created by a basis duplication system and investment adjustments system inside of those regulations. And so not only does the actual language in the regulation go well beyond the statute that was updated for these provisions, but the logic that the IRS provided for its reasoning is faulty. It doesn't relate to CFCs or the system which actually governs the application of these rules. And so I think these are just a couple of the issues that taxpayers are not only concerned about, but are likely to litigate cases, which is why I believe even though we're focused now on the executive branch, we're really going to be thinking about the entire government as a whole as we look at this further.
David Stewart: So if these interpretations were not affirmatively authorized by Congress or even left ambiguous, where's Treasury finding the authority to make these rules?
Ben Willis: So 7805(a) of the Internal Revenue Code provides the IRS with the general authority to provide rules, and a lot of people refer to these as interpretive regulations, and this provision is limited, however, which we must appreciate. It's limited in that the rules must be needful to the enforcement of provisions within the code. And so this grant which Congress gave them through the code ensures that the IRS follow what the intent of Congress was by relying solely on the provisions within it. And so the IRS believes that it is following this statute in interpretations that it's making, and I think that they may believe that they are experts in this area, which certainly the IRS has more expertise in tax than other government agencies, but does that expertise justify going well beyond what was provided for by Congress? I don't think so, and I could envision a situation where the IRS would argue that there is Chevron deference and they should be granted a level of deference in promulgating these regulations. But in reality, that provision or that case only applies where the statute is unclear, and the instances that I'm talking about with you, and in fact, the majority of the concerns that folks have about overly broad regulations fall well outside Chevron and relate to statutes that are very clear. And in fact, there is a litany of case law on this topic where the IRS has lost, where they've made regulations trying to prevent double benefits and the IRS has been told by these courts, including the Supreme Court, that they must respect the code as written, even if it provides an unexpected windfall to the taxpayer, as the court states.
David Stewart: We've talked a lot about the statutes, so let's turn now to the Congress itself. And on the one hand, they create these gaps in statutes that are the areas that need regulations, but how do they view the authority of the regulators?
Ben Willis: I think that's an excellent question, particularly since over the past year numerous bills have been pushed forward by members of Senate and the House to reduce the authority of the IRS and provide more protection to taxpayers. One of the famous acts that came out last year is the Taxpayer First Act of 2018, H.R. 7227, which provides that a number of penalty provisions inside of the Internal Revenue Code shall be altered to provide the taxpayer with more benefits and protections that the Congress believes those taxpayers are entitled to. And so in 98, we had a reorganization of the IRS. This is really an attempt to redo that, and Congress has cited a lot of things for this. They've looked at, again, the Lois Lerner and other perceived abuses that have gone on within the executive branch. But in putting forward this new legislation, I think the majority of Congress right now believes that there needs to be a lot of changes made within the IRS and within its authority, and I think that this is on par with the same concerns that we've been talking about throughout our discussion today, which is making sure that the IRS doesn't overstep. And now that we know that Congress is clearly on board with altering the rules that the IRS are required to follow because they believe that the current ones are not either sufficient to protect taxpayers or the IRS is not following them, then this new taxpayer first legislation, I think, will hopefully provide a level of protection that will prevent the concerns that you and I are talking about, like with respect to these regulations.
David Stewart: I guess while the Congress is attempting to reign in the authority of the IRS, isn't it true that they could write the statutes more tightly in order to basically preempt things that the IRS could do by regulation?
Ben Willis: I think they have done that, and that's why I believe that the IRS has overreached in writing its current regulations. And so the case law is clear in that the IRS can't expose a taxpayer to taxes beyond the authority granted to it by the Internal Revenue Code. And so when these rules are written, the IRS to me is directly violating not only the statute, which only allows regulations to go so far in interpreting them where there's the need for interpretations such as where an ambiguity exists, but also the fact that the courts have been very explicit in a number of rulings and instances, the IRS is overstretched. And I think just a few months back, a case called Illinois Tool Works came out where an argument was made that a conduit provision inside of the 956 regulations with a principal purpose threshold, which basically was getting at transactions where taxpayers were using a conduit to funnel E&P up into the U.S. And this provision basically said, if they have a principal purpose of doing that, then it'll be treated as a direct investment in the U.S. as opposed to going through the conduit entity in between the U.S. and the actual entity with the earnings and treated as a dividend. And in that case, the court found in favor of the taxpayer and said that the regulation was not applicable. And there's also other case law out there focusing on this exact same point — that when the courts try to create some sort of a penalty provision, which often uses these type of wrongdoing thresholds, these scienter thresholds, to use a term of art or legalese. When they insert them into regulations just like they are in the code, willful evasion of tax, for example, and other provisions that really get at the intent of a taxpayer trying to avoid an outcome that they're going to strictly construe that language in favor of the taxpayer. And so I believe that the IRS is actually doing itself a disservice often times in creating these rules and ensuring that they will be looked at with greater scrutiny, and with no deference to the agency at all.
David Stewart: So if the courts are providing less deference toward IRS rulemaking, what's the point of going beyond the statute and pushing these extra provisions?
Ben Willis: I think the point is similar to taxpayers who engage in transactions and take on audit risk. And so for example, if a taxpayer engages in a transaction that they think might be abusive, but believe there's less than a 1 percent chance they'll be audited, then they're more likely to engage in that transaction because even though they think it's likely to violate certain principles, it's also even less likely that the IRS will find out about it and bring them to court. On the IRS side, however, to your point, I think the IRS is betting that the likelihood that somebody will call them on this regulation as being in violation of a principle is something that they can avoid, something they can settle out before it needs to go to court if they believe they're in a weak position and is simply unlikely to go to court and get overturned. And so there's a level of risk assessment, I believe, that's involved when the IRS takes a look at its power to make these regulations and say, hey, do I really have the ability to force a taxpayer to call something interest that's really fees and costs unrelated to the actual term “interest” and the cost of borrowing? They believe that they can escape any overturning of that through, like I said, either one, not getting the taxpayer to call their bluff, or settling out before it goes to court. So again, I think there’s a risk minimization strategy, but at the same time, I think they believe that some of these are risks are just not that great. And so they are willing to take them.
David Stewart: So I guess that brings us next to the point of the people who will challenge these inevitably, the taxpayers themselves. How are taxpayers responding to these broad regulations?
Ben Willis: Well, I think they're getting bolder and bolder all the time with respect to this issue and that's why the IRS needs to be concerned. And so Illinois Tool, which we've already mentioned is a recent example of that. But I think with respect to provisions inside of the Tax Cuts and Jobs Act, there's even more concern that the IRS should be having. Because there is this mounting resistance or view against their regulations that they are an overreach. And so as taxpayers continually see this administration pushing the boundaries of legislation and ignoring the words that Congress provided inside of its statute, they're willing to bring them to court. And so I believe that a number of these regulations, if finalized, will eventually be overturned and held in favor of the taxpayer that they're overly broad, and therefore, null and void.
David Stewart: Well, Ben, this has been fascinating. I'm sure there's going be a lot to watch play out over the next several years as all these regulations come up. Speaking of things to be playing out over the next few years, you are a new columnist here at Tax Notes. Can you tell me about what you are planning on writing about and where do you come from?
Ben Willis: Sure. So I have a column, Willis Weighs In, that I am bringing back. Before I went to government, I did have the column in Tax Notes and I'm going to be focusing largely on the same issues I did then, which are controversial cross-border tax issues like the ones that we're discussing today.
David Stewart: Right.
Ben Willis: And so I want to bring a fresh perspective, having spent time at the Treasury Department, the IRS, the Senate Finance Committee and in the big firms, helping taxpayers interpret guidance just like that being issued all the time. So I think we'll be continuing the same theme in the Willis Weighs In column when it first started, and I look forward to hopefully inciting some good debate and discussion. And I more than welcome any comments or disagreement with my points of view, and I look forward to talking more about it with you.
David Stewart: Alright, excellent. Well, for any listeners that want to disagree with you in person, do you have a social media presence where they can go straight at you?
Ben Willis: Absolutely. I just opened up an account last night for the first time on Twitter. My handle is @willisweighsin, the name of my column, and I look forward to folks reaching out to me there.
David Stewart: Alright, well, listeners who are interested in reading more about what we talked about today should check out Ben’s first column. It will be appearing in the January 28th edition of Tax Notes. Ben, thank you for being here.
Ben Willis: Thank you for having me.
David Stewart: And now, Coming Attractions. Each week, we preview commentary that will be appearing in the next issue of the Tax Notes magazines. We're joined by executive editor for commentary, Jasper Smith. Jasper, what will you have for us?
Jasper Smith: In Tax Notes, Brian Hamano examines existing guidance on block chain transactions and Adam Wallwork discusses recently issued regulations on tax-exempt private activity bonds and how they affect related public approval procedures.
In State Tax Notes, Billy Hamilton examines states’ legislative priorities for 2019, while Roxanne Bland addresses the development of zapper software and its role in defrauding states of sales tax.
And in Tax Notes International, a Brazilian practitioner examines how changes in U.S. controlled foreign corporation and constructive ownership rules would affect a multinational entity with a Brazilian parent company, and Aleksandra Bal discusses the EU's efforts to revamp the VAT system and how they compare to the 2016 VAT action plan.
David Stewart: You can read all that and a lot more in the January 28th editions of Tax Notes, State Tax Notes, and Tax Notes International.
That's it for this week. You can follow me on Twitter @TaxStew. That's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave us a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
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