United States

Treasury releases report recommending action on burdensome regulations

TAX ALERT  | 

As part of the executive order issued April 21, 2017, the Treasury Department was required to review all “significant tax regulations” issued during 2016 and 2017 and submit two reports to the President – one identifying regulations that impose undue financial burden, undue complexity, or exceed the statutory authority of the IRS, and another providing specific action to reduce or mitigate the burden imposed by the identified regulations. The first report, contained in Notice 2017-38, identified eight regulations that met the criteria specified in the executive order, but did not recommend specific action. 

The Treasury Department recently released its second report (see Second Report to the President on Identifying and Reducing Tax Regulatory Burdens) to the President recommending specific action to reduce or mitigate the burden imposed by 8 significant tax regulations previously identified in Notice 2017-38. In sum, the Second Report recommends that the administration take the following significant actions:

Proposed Regulations to be Withdrawn Entirely:

  • Proposed Regulations under Section 2704 on Restrictions on Liquidation of an Interest for Estate, Gift and Generation Skipping Transfer Taxes (REG-163113-02)
  • Proposed Regulations under Section 103 on Definition of Political Subdivision (REG-129067-15)

Regulations to Consider Revoking in Part

  • Final Regulations under section 7602 on the Participation of a Person Described in Section 6103(n) in a summons interview (T.D. 9778)
  • Regulations under Section 707 and Section 752 on Treatment of Partnership Liabilities (T.D. 9788)
  • Final and Temporary regulations under Section 385 on the Treatment of Certain Interests in Corporations as Stock or indebtedness (T.D. 9790)
  • Final Regulations under Section 367 on the Treatment of Certain Transfers of Property to Foreign Corporations (T.D. 9803)
  • Temporary Regulations under Section 337(d) on Certain Transfers of Property to Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITS) (T.D. 9770)
  • Final Regulations under Section 987 on Income and Currency Gain or Loss with respect to a Section 987 Qualified Business Unit (T.D. 9794)

RSM Observations regarding the proposed actions in the Second Report

The Second Report recommends the following actions with respect to the 8 regulations identified in the First report:

  • Final and Temporary Regulations under Section 385 regarding the Treatment of Certain Interests in Corporations as Stock or Indebtedness.  (See T.D. 9790; 81 F.R. 72858)

The final and temporary regulations under Section 385 provide rules related to the classification of certain related party debt as equity or indebtedness, as well as provide generally applicable minimum documentation requirements necessary for companies to meet in order to avoid default equity treatment for certain related party debt. Treasury issued these rules to stem the tide of corporate inversions, after a series of high profile inversion transactions. However, the regulations have been extremely controversial, so much so that a proposal to repeal them under the Congressional Review Act has been introduced in Congress, so we are not surprised to see these regulations slated for review under the President’s executive order.

Treasury and the IRS recommended action: Revoke in part

In the Second Report, the Treasury and the IRS propose two different approaches for the two main components of the 385 regulations. With respect to the “documentation” rules of the 385 regulations, Treasury has already taken action by announcing a one year effective date delay. (See Notice 2017-36). The Second Report notes they may even completely revoke the documentation regulations and replace them with new rules that would greatly reduce the administrative burdens of the current regulations.

However, Treasury and the IRS do not intend to revoke the “distribution” rules of the 385 regulations. Instead, the administration will work with Congress to remedy the concerns addressed by the distribution regulations through tax reform. If legislation addresses the concerns of the distribution regulations, then Treasury and the IRS will revoke those regulations, but if not, the regulations may still be revised to reduce taxpayer burden. 

For more information on final and temporary regulations, see our article: US Treasury's much-anticipated debt-equity regulations

  • Temporary Regulations under Section 337(d) regarding Certain Transfers of Property to Regulated Investment Companies (RIC) and Real Estate Investment Trusts (REIT).  (See T.D. 9770; 81 F.R. 36793)

These temporary regulations provide that a spin-off involving a REIT generally may qualify as tax-free only if both corporations, the one that was spun off (Controlled) via distribution of its stock, and the one that distributed the stock of Controlled (Distributing), are REITs immediately after the distribution. REITs may also spin off certain taxable REIT subsidiaries. Separate legislation passed in 2015 also imposed a 10-year prohibition on making REIT elections for corporations that have been involved in tax-free spin-offs, but these regulations apply in addition to what this legislation provides. In addition, the temporary regulations extended the post-spin-off REIT conversion tax trigger to corporations other than the two directly involved in the spin-off—Distributing and Controlled. Finally, these temporary regulations that provide tax is also triggered by REIT conversions by predecessors or successors of these corporations, or by other members of their respective separate affiliated groups.

IRS and Treasury recommended action: Substantial revision

According to the Second Report, the Treasury and the IRS are looking to reduce the application of the regulations through various changes which include a revision limiting the potential gain recognized in certain spin-off transactions involving REITs. The reduction in scope, coupled with the limitation on potential taxable gain recognition, will provide much needed relief for taxpayers that are involved in transferring property to RICs or REITs.

For more information on these temporary regulations, see our tax alert: New regulations imposing tax on spin-offs followed by REIT conversions

  • Final Regulations under Section 987 regarding Income and Currency Gain or Loss With Respect to a Section 987 Qualified Business Unit.  (See T.D. 9794; 81 F.R. 88806)

These final regulations provide rules governing the translation of income from foreign branch operations into a branch owners’ functional currency, as well as rules for calculating foreign currency gain or loss associated with the financial assets and liabilities of a foreign branch. In addition, the final regulations provide rules for calculating foreign currency gain or loss upon a transfer of property from a branch to its owner. The regulations set forth an extremely complex approach to calculating foreign exchange gains and losses that deviates significantly from the approach taken for financial statement purposes and would also impose significant recordkeeping burdens.

IRS and Treasury recommended action: Substantial revision 

According to the Second Report, the IRS and Treasury expect to issue guidance (which they issued in Notice 2017-57) that would allow taxpayers to defer the effective date of the regulations until at least 2019, depending upon the starting date of taxpayer’s taxable year. The Second Report also states the IRS and Treasury intend to propose modifications to the final regulations to allow taxpayers to elect a simplified method of calculating Section 987 gain or loss including a mark to market method of accounting that would be more consistent with financial accounting rules. In addition, Treasury and the IRS are considering alternative loss recognition timing limitation that would apply to electing taxpayers. The Second Report also states the IRS and Treasury are considering alternatives to the transition rules in the final regulations.

For more information on these final regulations, see our tax alerts: IRS issues key foreign currency tax regulations; IRS delays effective date of key foreign currency rules by one year

  • Final Regulations under Section 367 regarding the Treatment of Certain Transfers of Property to Foreign Corporations.  (See T.D. 9803; 81 F.R. 91012)

The final regulations under Section 367 generally provide for the immediate or future recognition of U.S. income tax on transfers of property, either tangible or intangible, to a foreign corporation. Most notably, these regulations eliminate the favorable tax treatment (i.e. no immediate or future U.S. income tax) previously afforded to transfers of foreign goodwill and going concern value to a foreign corporation.

IRS and Treasury recommended action: Substantial revision

According to the Second Report, the Treasury and the IRS are working on proposed regulations that would increase the scope of the active trade or business exception.  This increase of scope would provide reprieve for outbound transfers of foreign goodwill and going concern value to a foreign corporation. Although no time table has been established for the proposed regulations, the Treasury and the IRS have indicated that they will be issued in the near term.

For more information on these final regulations, see our tax alert: Treasury finalizes regulations relating to foreign goodwill

  • Temporary Regulations under Section 752 regarding Liabilities Recognized as Recourse Partnership Liabilities.  (See T.D. 9788; 81 F.R. 69282)

These temporary regulations address the rules pertaining to disguised sales of property and some of the corresponding rules regarding the allocation of certain partnership liabilities under Section 752. Additionally, these temporary regulations provide rules for determining whether certain partner guarantees, specifically so-called ‘bottom dollar’ guarantees, are to be taken into consideration when allocating certain partnership liabilities.

Treasury and the IRS recommended action: Revoke in part  

According to the Second Report, Treasury and the IRS have determined that the regulations addressing disguised sales of property and the corresponding liability allocations under Section 752 should be further studied. Accordingly, based on the Second Report, Treasury and the IRS are considering whether to revoke the proposed and temporary regulations regarding disguised sales and reinstate the prior regulations.  Treasury and the IRS go on to state that they believe the regulations regarding ‘bottom dollar’ guarantees, however, should be retained.

For more information on these temporary regulations, see our tax alert: New IRS rules for disguised sales and partnership liabilities

The proposed regulations under Section 103 provide the definition of a “political subdivision” of a State for the purposes of determining eligibility to issue tax-exempt bonds. These regulations generally require a “political subdivision” to possess three attributes; sovereign powers, a governmental purpose, and governmental control. 

Treasury and the IRS recommended action: withdraw

After careful review Treasury and the IRS have determined that, while the legal issues associated with political subdivision should continue to be studied, the proposed regulation’s far-reaching impact on existing legal structures is unjustified and the proposed regulations should be completely withdrawn. 

Proposed Regulations under Section 2704 regarding Restrictions on Liquidation of an Interest for Estate, Gift and Generation-Skipping Transfer Taxes.  (See REG-163113-02; 81 F.R. 51413)

The proposed regulations under Section 2704 address certain perceived shortcomings in the effectiveness of Section 2704 and are designed to prevent taxpayers from using various structural artifices to discount the value of interests in family-controlled entities for gift, estate and generation-skipping transfer tax purposes. The proposed regulations were met with considerable technical skepticism on the part of estate planners and valuation professionals as well as considerable concern from taxpayer groups around the country. What’s more, various members of Congress have expressed concern about the proposed regulations and recently, the House’s fiscal 2018 IRS appropriations bill would prohibit the IRS from using funds to “finalize, implement, or enforce amendments to the controversial estate tax rules under tax code Section 2704 or any substantially similar amendments to such regulations”. It is therefore no surprise to see that these proposed regulations have been identified as “burdensome”.

Treasury and the IRS recommended action: withdraw

According to the Second Report, upon further review Treasury and IRS do not believe that the approach taken by the proposed regulations to address the issue of artificial valuation discounts is workable. Moreover, the burden of complying with the proposed regulations would be excessive. Accordingly, the regulations will be withdrawn and no mention is made of any potential future regulations on this topic.

For more information on these proposed regulations, see our tax alert: Treasury releases proposed regulations to section 2704

  • Final Regulations under Section 7602 regarding the Participation of a Person Described in Section 6103(n) in a Summons Interview.  (See T.D. 9778; 81 F.R. 45409)

The final regulations under Section 7602(a) permit outside professionals – such as economists, engineers, consultants and attorneys to receive books, papers, records or other information that was summoned by the IRS. These regulations also allow for such outside professionals to participate fully in the interview of a person who the IRS has summoned as a witness to provide testimony under oath.

Treasury and the IRS recommended action: Revoke in part

According to the Second Report, the Treasury and the IRS have proposed a prospective amendment to the regulations which would diminish their scope by barring outside attorneys to participate in examinations. However, the regulations would still allow the IRS to use other subject matter experts in examinations as needed.

The Path Forward

We expect Treasury to issue additional reports regarding the reduction of tax regulatory burdens, including reports regarding the status of the Treasury’s actions on the recommendations contained in the Second Report.  We note that the recommendations contained in the Second Report are precisely that: recommendations.  Based on conversations with Treasury officials, the White House has yet to make final decisions regarding these recommendations and White House personnel could overrule or modify them.

With respect to temporary or final regulations that Treasury will revise or revoke, Treasury must follow the extensive notice-and-comment procedures of the Administrative Procedures Act. Under this process, Treasury will need to hold a hearing to give interested parties an opportunity to voice their concerns and will have to publish a reasoned explanation for any amendment of any final or temporary regulation.

Congress could bypass the APA notice-and-comment procedure if it rescinds a regulation under the Congressional Review Act (CRA) – a process that, most notably, does not involve the lengthy notice-and-comment period required under the APA. Currently, however, it is unclear which path policy makers may take.

We expect a final decision regarding these recommendation to be published shortly and taxpayers should closely monitor the situation to assess the impact of any final actions on their particular situation.

For more information on the CRA, see our tax alert: House resolution would revoke controversial debt/equity regulations

For more information on Notice 2017-38, see our tax alert: Treasury identifies eight regulations for review under executive order

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