Firm Asks IRS to Reconsider Nonqualified Deferred Compensation Plan Guidance

Dear Sir or Madam:

We respectfully submit the following comments on § 457A of the Internal Revenue Code and Notice 2009-8 regarding nonqualified deferred compensation. We write to emphasize, and lend support to, certain previous comments. These issues are important and of common interest to many multinational companies. U.S. employees in foreign countries could be directly impacted by these rules, as well. We are concerned that Notice 2009-8 significantly broadens the scope of § 457A and fails to address the norms of modern international business practices.

Section 457A provides that any compensation that is deferred under a nonqualified deferred compensation plan of a nonqualified entity is includible in gross income when there is no substantial risk of forfeiture of the rights to that compensation. A nonqualified entity means any foreign corporation unless substantially all of its income is effectively connected with the conduct of a trade or business in the U.S. or subject to a comprehensive foreign income tax. A comprehensive foreign income tax means, with respect to any foreign person, the income tax of a foreign country if that person is eligible for the benefits of a comprehensive income tax treaty between that foreign country and the U.S., or that person demonstrates to the satisfaction of the IRS that the foreign country has a comprehensive foreign income tax.

The statute does not define what it means for "substantially all of a foreign corporation's income to be subject to a comprehensive foreign income tax." The Notice states:

Many multinational corporations could fail to satisfy the Notice's stringent 20 percent excluded income standard even though these corporations may not have derived much or any of their income from non-treaty countries and they are not tax indifferent with respect to deferred compensation. The 20 percent exception developed in the Notice is overbroad, can be difficult to calculate, and is not conceptually related to the focus of § 457A. The 20 percent exception seems effectively to override the comprehensive income tax exception for most multinationals. It also would seem to override the statutory exception for foreign corporations that are eligible for the benefits of a comprehensive income tax treaty.

True, there is a dividend exception that applies if the dividends are received from a corporation which meets the "substantially all of whose income is subject to a comprehensive foreign income tax" exception. This raises its own issues and compliance (and audit) complexities. It might be compliance proof (and audit proof) in some situations, meaning compliance may be impossible in those situations, and it may be impossible for IRS examining agents to audit in those situations. There are many uncertainties surrounding the application of all of the exceptions and exclusions. As the New York State Bar Association ("NYSBA") report² notes, "the Notice is vague and ambiguous as to what may constitute an 'exclusion' of income."

In seconding comments made in the excellent NYSBA report, we suggest that to enhance the practical applicability of the nonqualified deferred compensation rules in § 457A, the 20 percent excluded income exception proposed in Notice 2009-8 not be adopted. A foreign corporation that exceeds the 20 percent excluded income exception should not automatically be considered a nonqualified entity and, thus, as a result have its U.S. employees be potentially subject to an accelerated current year nonqualified deferred compensation gross income inclusion.

The U.S. check-the-box rules also seem largely ignored by the Notice. Many foreign entities are treated as disregarded entities for U.S. tax purposes. Many multinationals have utilized the check-the-box rules, often to reduce their foreign tax liabilities. Under the 80 percent test proposed by the Notice, many foreign corporations will automatically be considered nonqualified entities because the non-residence source income earned through their "branches" constitutes more than 20 percent of their gross income. The Notice clearly needs to clarify the treatment of income earned through disregarded entities.

Consider for example a structure with a so-called super holding company with many subsidiaries that have made check-the-box elections to be treated as disregarded entities. It is unlikely that any foreign corporation in such a structure would satisfy the 20 percent excluded income exception proposed by the Notice. This makes no sense. They might all be in treaty countries and pay full income tax in those countries. Yet, the Notice would taint all of them.

The Notice also introduces a new concept, the "materially more favorable regime" requirement. This is not in § 457A, but rather was introduced by the Notice. There is no definition of "any regime or arrangement" for purposes of determining whether a controlled foreign corporation is subject to a comprehensive foreign income tax. We agree with the NYSBA that the term a "materially more favorable tax regime" should be defined and should not take into account any regime or arrangement that is generally available to U.S.-based multinational corporations.

If a foreign company locates its factory in a favorable area or obtains special benefits with respect to building or locating a factory (which are common for multinationals both inside and outside the U.S.), this should not be held against the taxpayer or its U.S. employees working there. This is simply international competitiveness and has nothing to do with the purpose of § 457A.

We believe the provisions in Notice 2009-8 need serious reconsideration and revisions before these rules are set forth in regulations. It is imperative that the deferred compensation rules be clear and not overbroad. The extra-statutory provisions in the Notice, such as the "20 percent exception" and the "any regime or arrangement," could effect many multinationals with controlled foreign subsidiaries in territorial countries, and these provisions need to be eliminated or substantially improved. These provisions would seem to completely override the statute and make § 457A a far more broad provision than the statutory language and congressional intent suggest.

² New York State Bar Association Tax Section comment letter to Department of U.S. Treasury and Internal Revenue Service, 2009 TNT 191-15 (Oct. 5, 2009).