An executive order issued by the Trump Administration last Friday has set the stage for a needed debate within government on whether the burden and complexity imposed by tax regulations is justified by the prevention of tax avoidance or by enhanced clarity in the application of tax law.
While opponents of the earnings stripping and inversion tax regulations, issued mid to late last year, are jumping at the newfound opportunity to remove those regulations, other forces at play may make it unlikely that they will get their wish. Meanwhile, several other recently issued tax regulations appear to be excellent candidates for review.
Trump’s tax regulation order
The stated purpose of the new executive order, entitled “Identifying And Reducing Tax Regulatory Burdens,” is to review all “significant” tax regulations issued on or after January 1, 2016, to determine which, if any, of those regulations impose an undue financial burden on US taxpayers, add undue complexity to the federal tax law, and/or exceed the statutory authority of the Internal Revenue Service.
In assessing which regulations are “significant” and, thus, subject to this review process, the executive order explicitly states that the prior executive orders dating back to executive order 12866 on September 30, 1993, are not controlling.
This means that the informal understanding that has existed since that time on tax regulations generally being exempt from OMB review (because of the view that tax regulations merely interpret the law and do not make the law) is no longer controlling.
An interim report by the Treasury Secretary is due on or before June 20 (60 days from the date of the executive order, on April 21) and a final report to the President is due on or before September 18 (150 days from the date of the executive order).
In addition, the executive order states that a summary of actions taken in response to the report to the President is to be published in the Federal Register within 10 days of the finalization of the actions set forth in the presidential report.
If those actions have not been finalized by March 17, 2018 (180 days from the date of the report to the President), an interim report is to be published in the Federal Register.
Trump’s tax regulation order states that, among the actions that may be taken in response to the Treasury Secretary’s recommendations, are to delay or suspend the effective date of the regulations, or to modify or rescind the regulations, all through appropriate regulatory notice and comment procedures.
As we all know (and no offense intended), the Treasury Secretary is not trained or skilled in the nuances and technicalities of the Internal Revenue Code and its existing regulations and will need to rely on others in making his recommendations to the President.
It should also be apparent that no Treasury Office of Tax Policy or IRS National Office Chief Counsel attorney will acknowledge that any tax regulation put out on their watch since January 1, 2016, exceeded the statutory authority of the IRS. To admit this would be tantamount to admitting an unethical act. It will just not happen.
And, since the regulation preambles of all of the regulations issued since that date will have statements in them about any burden and complexity of those regulations being justified for one reason or another, it is hard to see how those attorneys will or could acknowledge that the very regulations they approved for publication impose either an undue financial burden or add undue complexity to the law.
Even those in the current government positions would be hard pressed to form such an adverse judgment on their predecessors, who may have been involved in those prior regulation projects.
And so, I have a hard time seeing how the goal of the executive order will be effectively administered.
Earnings stripping, inversions
Now, there are going to be exceptions to the rule noted immediately above due to the highly political and controversial nature of particular regulation projects that cannot be hidden from public view.
For example, the section 385 final regulations on debt documentation and earnings stripping are well known to the public and the Congress and it is no secret that those regulations will be very burdensome, complex, and perhaps even be beyond the authority of the IRS to issue in the first place. And so, many believe that those regulations will have a short shelf life.
Another regulation that fits the description in the executive order are the most recent set of regulations under section 7874 relating to corporate inversions. There is no doubt that those regulations are very burdensome, are very complex, and most likely exceeded the government’s authority to issue in the first place. And so, once again, many believe those regulations will likely also have a short shelf life.
However, these two sets of regulations may not end up getting delayed, suspended, modified, or rescinded because of one countervailing theme that I am sure will be prevalent in the internal government debate on this issue: that the regulations at issue serve an important public service in preventing tax avoidance and abuse and/or provide needed guidance to the public on how to apply the statute and, therefore, should be retained even though they could very well fit within one or more of the three criteria that the executive order lays out for examination of post-January 1, 2016, regulations.
I would also expect that the government attorneys will argue, in the case of some regulations, that it is the fault of the statute that the regulations are complex because the regulations merely interpret the statute (in other words, blame the statute writer and not the regulation writer).
Those government personnel who will make those arguments may very well have a legitimate point because there were reasonable and thoughtful reasons for the issuance of the two regulations first mentioned above (and others that I will mention below).
This tension between preventing taxpayer avoidance and abuse and/or providing needed guidance on how to apply the statute that Congress wrote versus undue complexity, burden, and arguable or questionable authority will be the prevailing theme, I would think, in this upcoming internal debate.
One can easily defend or attack a particular regulation depending on which camp you find yourself in: either you believe the burden and complexity is justified or you do not, and this judgment is a subjective one and is not generally capable of objective quantification.
Others for review?
What other regulations, then, are likely to be debated and end up potentially being subject to future regulatory rebuke in one form or another?
Here is a partial list of potential targets for Trump’s tax regulation order:
- Final outbound intangible section 367(a) and (d) regulations. These regulations dealt with the transfer of foreign goodwill and going concern value by a US person to a foreign corporation in certain outbound section 351 and related transactions. The regulations eliminated the exception for foreign goodwill on outbound transfers to corporations that existed in the prior version of the regulations and were hotly contested in terms of authority to issue the regulations, as well as their scope.
- Section 707 and 752 proposed, temporary and final liability allocation regulations. These regulations dealt with the allocation of liabilities from a partnership to a partner under the partnership disguised sale rules of section 707 and the liability allocation rules of section 752. The regulations completely upset the allocation scheme for liabilities in disguised sales by treating all liabilities as nonrecourse liabilities and by eliminating so-called bottom dollar guarantees. They also propose a new facts and circumstances test for determining the allocation of recourse liabilities and create uncertainties and ambiguities in current law. The regulations were issued with questionable authority in a number of instances and will have a significant and adverse effect on the economy.
- The section 721(c) temporary regulations. These regulations involve the outbound transfer of appreciated property by a US person to a partnership with a related foreign partner where the US and foreign partner control the partnership. The rules compel the adoption of an allocation method where the built-in gain on the contributed assets by the US person will remain within U.S. taxing jurisdiction. These rules were issued with a questionable effective date going back to an earlier notice and add considerable complexity to the tax law given a limited targeted abuse which could be dealt with under existing anti-abuse regulations and authority.
- The section 2704(b) proposed regulations. These proposed regulations deal with certain restrictions on the ability to control a family owned entity to prevent the reduction of the value of the assets owned by the entity for estate tax purposes. They were hotly debated in terms of authority and regulatory overreach when issued. These proposed regulations, when and if finalized, could have a significant negative effect on certain segments of the economy.
- The final CFC-foreign partnership section 956 regulations. These regulations impose a complex series of rules on foreign partnerships with CFCs or related parties as partners that treat a loan by a CFC to a related foreign partnership as a US asset in applying the subpart F rules of the Internal Revenue Code even though the loan proceeds may not be repatriated into the US. The regulations arguably exceed statutory authority given the literal status of a foreign partnership as a foreign person and the abuse targeted by these regulations could have been dealt with by existing anti-abuse rules and authority.
- Section 987 foreign currency final and temporary regulations. These regulations deal with the computation of foreign exchange gains and losses of remittances from qualified business units of US taxpayers that use a functional currency other than the U.S. dollar. They are extraordinarily complex and can have a significant economic impact on the economy as a whole.
- Section 901(m) temporary regulations on covered asset acquisitions. These regulations deal with tax basis mismatches between US tax basis and foreign tax basis in computing the foreign tax credit by “hyping up” foreign taxes without a corresponding increase in US taxable income of the US taxpayer. These regulations are very complex and address a limited subset of potential abuse that arguably could be dealt with under existing anti-abuse rules and authority. Although statutorily authorized, the regulations are a classic case of regulatory overkill where detailed rules are written for a limited abuse and can be understood only by highly specialized tax experts.