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Treasury report recommends action on eight significant tax regs

As directed by President Trump’s Executive Order 13789, the Treasury Department has released a report on planned upcoming actions that it believes would reduce the burden of eight tax regs identified earlier this year. Treasury also announced its comprehensive review has already identified over 200 regs that it believes should be repealed, which will begin in the fourth quarter of 2017.

Background. On Apr. 21, 2017, President Trump issued Executive Order 13789 which instructed the Treasury Secretary to review all “significant tax regulations” issued on or after Jan. 1, 2016, and submit two reports, followed promptly by concrete action to alleviate the burdens of regs that meet criteria outlined in the order.

The Treasury Secretary, in consultation with the Administrator of the Office of Information and Regulatory Affairs, was to submit a 60-day interim report identifying regs that: (1) impose an undue financial burden on U.S. taxpayers; (2) add undue complexity to the Federal tax laws; or (3) exceed IRS’s statutory authority. The Treasury Secretary was directed to submit a final report to the President by Sept. 18, 2017, recommending “specific actions to mitigate the burden imposed by regulations identified in the interim report.”

In July of 2017, Treasury in its first report described its review of significant tax regs as directed by President Trump’s Executive Order 13789 and identified eight regs that met at least one of the criteria specified by Executive Order 13789. (Notice 2017-38, 2017-30 IRB 147, see Weekly Alert ¶  24  07/13/2017)

Treasury has now, somewhat late, released its second report.

Final report. In its second and final report, Treasury recommends that of the previously identified eight regs, two proposed regs be withdrawn entirely, three temporary or final regs be revoked in substantial part, and the remaining three regs be substantially revised.

The Treasury Report notes that IRS is considering withdrawing the following regs:

…Proposed Code Sec. 2704 regs (REG-163113-02, see Weekly Alert ¶  36  08/04/2016) on restrictions on liquidation of an interest for estate, gift and generation-skipping transfer taxes. Code Sec. 2704(b) provides that certain non-commercial restrictions on the ability to dispose of or liquidate family-controlled entities should be disregarded in determining the fair market value of an interest in that entity for estate and gift tax purposes. The proposed regs would create an additional category of restrictions that also would be disregarded in assessing the fair market value of an interest.

The proposed regs would have narrowed long-standing exceptions and dramatically expanded the class of restrictions that are disregarded under Code Sec. 2704; no exceptions would have been allowed for interests in active or operating businesses. Treasury and IRS now believe that the proposed regs’ approach to the problem of artificial valuation discounts is unworkable. Commenters warned that the valuation requirements of the proposed regs were unclear and that their effect on traditional valuation discounts was uncertain. In particular, commenters argued that it wasn’t feasible to value an entity interest as if no restrictions on withdrawal or liquidation existed in either the entity’s governing documents or state law; a legal vacuum in which there is no law relevant to an interest holder’s right to withdraw or liquidate is impossible, commenters asserted, and, so, could meaningfully be applied as a valuation assumption. Commenters also argued that the proposed regs could have produced unrealistic valuations. For example, the lack of a market for interests in family-owned operating businesses is a reality that, commenters argued, should continue to be taken into account when determining fair market value.

…Proposed Code Sec. 103 regs (REG-129067-15, see Weekly Alert ¶  23  02/25/2016) on the definition of a “political subdivision” of a State (e.g., a city or county) that is eligible to issue tax-exempt bonds for governmental purposes. The proposed regs would require a political subdivision to possess three attributes: (i) sovereign powers; (ii) a governmental purpose; and (iii) governmental control.

Treasury and IRS continue to believe that some enhanced standards for qualifying as a political subdivision may be appropriate. However, after careful consideration of the comments on the proposed regs, Treasury and IRS now believe that regs having as far-reaching an impact on existing legal structures as the proposed regs are not justified.

The Treasury Report identifies the following regs to consider for partial revocation:

…Final Code Sec. 7602 regs (T.D. 9778, see Weekly Alert ¶  30  07/21/2016) on the participation of a person described in Code Sec. 6103(n) in a Summons Interview, which would provide that persons described in Code Sec. 6103(n) and Reg. § 301.6103(n)-1(a) with whom IRS contracts for services—such as outside economists, engineers, consultants, or attorneys—may receive books, papers, records, or other data summoned by IRS and, in the presence and under the guidance of an IRS officer or employee, participate fully in the interview of a person who IRS has summoned as a witness to provide testimony under oath.

When IRS enlists outside attorneys to perform the investigative functions ordinarily performed by IRS employees, the government risks losing control of its own investigation. Under the proposed changes to these regs that Treasury is considering, attorneys who are private contractors would be prohibited from assisting IRS in the auditing of taxpayers, including in the interview process. The revised regs would continue to allow outside subject-matter experts to participate in summons proceedings.

…Temporary Code Sec. 752 and Code Sec. 707 regs (T.D. 9788, see Weekly Alert ¶  4  10/06/2016) on liabilities recognized as recourse partnership liabilities which generally would provide: (i) rules for how liabilities are allocated under Code Sec. 752 solely for purposes of disguised sales under Code Sec. 707; and (ii) rules for determining whether “bottom-dollar payment obligations” provide the necessary “economic risk of loss” to be taken into account as a recourse liability.

While Treasury and IRS believe that the temporary regs’ novel approach to addressing disguised sale treatment merits further study, they agree that such a far-reaching change should be studied systematically. Accordingly, they are considering whether the proposed and temporary regs relating to disguised sales should be revoked and the prior regs reinstated. By contrast, Treasury and IRS currently believe that the second set of regs relating to bottom-dollar guarantees should be retained.

…Final and temporary Code Sec. 385 regs (T.D. 9790, see Weekly Alert ¶  29  10/20/2016) on the treatment of certain interests in corporations as stock or indebtedness, which address the classification of related-party debt as debt or equity for federal tax purposes. The regs are primarily comprised of (i) rules establishing minimum documentation requirements that ordinarily must be satisfied in order for purported debt among related parties to be treated as debt for federal tax purposes (documentation rules); and (ii) transaction rules that treat as stock certain debt that is issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result (distribution rules).

Treasury and IRS now agree with commenters that some requirements of the documentation regs departed substantially from current practice and would have compelled corporations to build expensive new systems to satisfy the numerous tests required by the regs. Treasury and IRS do not believe that taxpayers should have to expend time and resources designing and building systems to comply with rules that may be modified to alleviate undue burdens of compliance. Accordingly, shortly after issuing the June 22 Report, Treasury and IRS announced in Notice 2017-36, 2017-33 IRB, that application of the documentation rules would be delayed until 2019. After further study of the documentation regs, Treasury and IRS are considering a proposal to revoke the documentation regs as issued and are actively considering the development of revised documentation rules that would be substantially simplified and streamlined in a manner that will lessen their burden on U.S. corporations, while requiring sufficient legal documentation and other information for tax administration purposes.

Treasury believes that proposing to revoke the existing distribution regs before the enactment of fundamental tax reform could make existing problems worse. If legislation does not entirely eliminate the need for the distribution regs, Treasury will reassess the distribution rules and Treasury and IRS may then propose more streamlined and targeted regs.

The Treasury report identified the following regulations to consider for substantial revision:

…Final Code Sec. 367 regs (T.D. 9803, see Weekly Alert ¶  29  12/22/2016) on the treatment of certain transfers of property to foreign corporations.Code Sec. 367 generally imposes immediate or future U.S. tax on transfers of property (tangible and intangible) to foreign corporations, subject to certain exceptions. The final regs eliminate the ability of taxpayers under prior regs to transfer foreign goodwill and going concern value to a foreign corporation without immediate or future U.S. income tax.

After considering the comments and studying further the legal and policy issues, Treasury and IRS have concluded that an exception to the current regs may be justified by both the structure of the statute and its legislative history. Thus, to address taxpayers’ concerns about the breadth of the regs, the Office of Tax Policy and IRS are actively working to develop a proposal that would expand the scope of the active trade or business exception to include relief for outbound transfers of foreign goodwill and going-concern value attributable to a foreign branch under circumstances with limited potential for abuse and administrative difficulties, including those involving valuation. Treasury and IRS currently expect to propose regs providing such an exception in the near term.

…Temporary Code Sec. 337(d) regs (T.D. 9770, see Weekly Alert ¶  43  06/09/2016) on certain transfers of property to regulated investment companies (RICs) and real estate investment trusts (REITs), which would amend existing rules on transfers of property by C corporations to REITs and RICs generally. The regs would also provide additional guidance on certain provisions of the Protecting Americans from Tax Hikes (PATH) Act of 2015, that were intended to prevent certain spin-off transactions involving transfers of property by C corporations to REITs from qualifying for nonrecognition treatment.

Treasury and IRS agree that the temporary regs may produce inappropriate results in some cases. In particular, Treasury and IRS agree that the regs may cause too much gain to be recognized in certain cases. Thus, they are considering revisions that would limit the potential taxable gain recognized in such situations.

…Final Code Sec. 987 regs (T.D. 9794, see Weekly Alert ¶  2  12/15/2016) on income and currency gain or loss with respect to a Code Sec. 987 qualified business unit, which provide rules for (i) translating income from branch operations conducted in a currency different from the branch owner’s functional currency into the owner’s functional currency, (ii) calculating foreign currency gain or loss with respect to the branch’s financial assets and liabilities, and (iii) recognizing such foreign currency gain or loss when the branch makes a transfer of any property to its owner.

Treasury and IRS believe that the regs have proved difficult to apply for many taxpayers. To address these difficulties, Treasury and IRS currently expect to issue guidance that would permit taxpayers to elect to defer the application of Reg. § 1.987-1 through Reg. § 1.981-10 until at least 2019, depending on the beginning date of the taxpayer’s tax year. In addition, Treasury and IRS also intend to propose modifications to the final regs to permit taxpayers to elect to adopt a simplified method of calculating Code Sec. 987 gain and loss and translating Code Sec. 987 income and loss, subject to certain limitations on the timing of recognition of Code Sec. 987 loss.

Second Report to the President on Identifying and Reducing Tax Regulatory Burdens.