Firm Seeks Changes to Effective Dates of Proposed Regs on Gain Recognition Agreements

These comments are submitted on behalf of MMS Holdings, Inc., indirect subsidiary of Publicis Groupe, S.A., and are in response to the Notice of Proposed Regulations, RIN 1545-BK65, 78 Fed. Reg. 6772 (Jan. 30, 2013) (the "Notice"), which proposes amending the Treasury Regulations to relax the standards for accepting late filed "gain recognition agreements" under section 367 of the Code.

Firstly, we would like to express wholehearted approval of the contemplated change to the Regulations' standard for relief. Section 367 stands as an exception to the general rule of deferral of gain associated with certain corporate transactions that are recognized as not working a substantive change in ownership. The section limits the application of nonrecognition provisions of the Code in the case of corporate transactions involving foreign corporations, reflecting the concern that deferral might otherwise become exemption if taxpayers could "export" the potential gain outside U.S. taxing jurisdiction. In certain cases, the availability of deferral is conditioned on on the taxpayer's undertaking (in a "gain recognition agreement") to report gain upon the occurrence, within the term of the agreement, of certain triggering events deemed inconsistent with the policy underlying deferral. Taxpayers are thus afforded an election, as they can choose not to execute a gain recognition agreement and instead report the related gain upon the initial transfer.

The Deficit Reduction Act of 1984 ("DEFRA") added Code section 6038B, which requires that taxpayers report cross-border nonrecognition transactions. This reporting is done on Form 926. DEFRA also added Code section 6501(c)(8), which provides that the statute of limitations does not begin to run on the assessment of any related deficiency until the reporting requirements are met. These provisions were designed to require taxpayers to bring to the Service's attention transactions to which section 367 might apply. RIN 1545-BK65, 78 Fed. Reg. at 6773, citing authorities. The requirement to file Form 926 is waived if "[t]he transferor [or one or more successors] properly entered into a gain recognition agreement," or if the transferor properly reported the income from the transfer on a timely filed return. Treas. Regs. § 1.6038B-1(b)(2)(B).

If no exception applies, section 603 8B imposes a 10% penalty (measured by reference to the market value of the transferred property, and capped at $100,000 per exchange) for failure to timely report a transaction as required. The penalty may also be waived if the taxpayer establishes reasonable cause and a lack of willful neglect, the well-established standard for waiver of penalties for failure to file tax returns under section 6651, and other penalties. Taxpayers may be be deemed to lack "reasonable cause" if they fail to demonstrate "ordinary business care and prudence"¹ -- that is, an absence of negligence.

Somewhat anomalously, however, the current Regulations under section 367 effectively extend the penalty standard to computation of the tax liability on the underlying transaction. Gain recognition agreements are supposed to be filed with the tax return for the taxable year of the transfer. The Regulations provide that a taxpayer that fails to timely file a gain recognition agreement or one of the other associated documents "shall be considered to have satisfied the timeliness requirement" upon promptly amending its return to include the missing information, but only if it can demonstrate that its initial failure was "due to reasonable cause and not to willful neglect." Treas. Reg. § 1.367-8(p). Otherwise, the taxpayer must recognize all the gain that results from treating the transfer as a taxable exchange. The additional tax liability imposed by disallowing nonrecognition, which potentially applies in addition to the penalty,² may be nominal, but more commonly will be wildly disproportionate to the statutory penalty, which Congress capped at $100,000.

The proposed regulations would require taxpayers to demonstrate only that their initial failures to file had not been "willful" in order to avoid recognition of gain. Prop. Treas. Reg. § 1.367(a)-8(p), 78 Fed. Reg. at 6776. The preamble notes that the IRS and the Treasury Department believe that reporting and compliance are sufficiently encouraged by the statutory penalty imposed by section 6038B. The sanction of enforced recognition of gain is more appropriately reserved for preventing taxpayers from whipsawing the fisc with the assistance of "20/20 hindsight"³ and other abusive situations, and the new standard is better suited for that purpose than its predecessor.

Our comments relate only to the effective dates of the proposed regulations. The new standard is proposed to be effective for requests for relief on or after the date of publication of final regulations. Prop. Treas. Reg. § 1.367(a)-8(r).

The current regulations require a taxpayer that discovers a failure to file to promptly file an amended return and request relief, and generally allow the Service 120 days to make a determination. These events will frequently play out relatively shortly after the return is filed; moreover, the determination may occur during, or trigger, an audit. In any event, a taxpayer that has to pay additional tax as a result of an adverse determination will ordinarily have two years thereafter to file a refund claim, while section 6501(c)(8) will ordinarily ensure that the Service has at least three years from the date of disclosure to assess a related deficiency. If Examination makes an adverse determination, the related administrative proceedings may extend over several years.

In light of these facts, we respectfully suggest that the exclusively prospective application of the new regulations is unnecessarily restrictive. Furthermore, it opens the way to disparate treatment of similarly situated taxpayers, to the detriment of taxpayers that acted promptly to bring their failure to the attention of the Service. We recommend instead that the regulations allow taxpayers that have previously filed applications for relief under the old standard a compliance "window" during which they may request that their cases be considered, or reconsidered, under the new standard, provided, first, that the pertinent statutes of limitations remain open; and secondly, that the request not prejudice the interests of the government for any reason. Whether there was prejudice to the interests of the government could be determined by reference to the principles long applied to requests for relief with respect to late elections under Treas. Regs. § 301.9100-3. Such a transition rule would be fair, and would conserve resources by avoiding unnecessary debates about the proper interpretation of a standard that the Service believes no longer appropriate.

Thank you for your consideration. We would, of course, be happy to discuss the issue with you if you think that would be helpful.

² RIN 1545-BK65, Preamble, 78 Fed. Reg. at 6773.

³ Prop. Treas. Reg. § 1.367(a)-8(p)(3) (Ex. 4), 78 Fed. Reg. at 6778; cf. Treas. Reg. § 301.9100-3(b)(3).