Tax Week in Review

Monday, May 8, 2000

OnLine

• Treasury Floats Proposal to Replace FSC Regime
• Extend Internet Tax Moratorium, House Subcommittee Urges
• House Approves Africa/CBI Trade Bill
• Will Roth Tax Shelter Bill Include Assumption of Liability Provision?
• Doggett to Introduce Tax Haven Bill
• Corporate AMT: Will Ways & Means Consider Relief?
• Supreme Court to Tackle Treatment of S-Corp Discharge of Indebtedness Income
• Rossotti: Success of IRS Modernization Depends on Congress
• The Numbers are In: JCT Scores Bush Tax Plan

Treasury Official Outlines FSC Alternative: Treasury Deputy Secretary Stuart Eizenstat outlined for tax practitioners and the press May 1 an alternative to the foreign sales corporation (FSC) tax regime that he described as an elective regime for "eligible" corporations with "qualifying" foreign income.

The alternative was developed in the wake of a World Trade Organization decision which held that the tax breaks the U.S. government offers FSCs violate the WTO's global trading rules. Failure to fix the problem by the October 1 deadline established in the WTO dispute body's initial decision would mean that European Union members can ask the WTO to impose duties on American imports equal in value to the tax benefits FSCs give American firms.

The proposal defines an eligible corporation as one that is organized in a foreign jurisdiction and elects to be subject to U.S. tax, Eizenstat explained. The proposal would also include as qualifying foreign income all foreign sales, not just "export property" sales. Under the current FSC regime, exporters may only claim an FSC benefit on export property -- property manufactured, produced, grown, or extracted in the United States with not more than 50 percent of the fair market value attributable to imported articles. Although U.S. taxpayers will no longer need to sell U.S.-manufactured property to obtain a benefit, they still will need to meet the 50 percent U.S. content rule.

The alternative would likely apply to eligible manufacturing companies. It is expected that these companies would be eligible for the lower tax rate on only the "sales portion" of their income. The foreign eligible corporation -- if its U.S. parent were willing to forgo deferral on its earnings -- would be subject to an effective tax rate of 12.17 percent (or 24.5 percent if certain safe harbor provisions are not met).

Eizenstat said the new alternative -- like the current FSC regime -- would rely on administrative pricing rules. Also, the U.S. parent would get a full dividends-received deduction for dividends paid by the eligible corporation. Eizenstat said nothing about how -- or if -- the combination of a special tax rate and dividends-received deduction would integrate with the foreign tax credit regime.

Unlike the FSC regime, the new alternative provides benefits to all corporations selling goods and services outside the U.S. -- not just those that sell export property. Because the alternative is not contingent upon export performance, Treasury expects the WTO will not oppose the alternative. However, Treasury also expects the EU to raise concerns about the new proposal, rather than endorsing it immediately.

Eizenstat said those concerns may be reflected in future changes to the alternative regime, although he also indicated in a May 2 news conference that Treasury had presented the proposal to the European Union as a take-it-or-leave-it proposition. EU Trade Commissioner Pascal Lamy, who also spoke at the press conference, said the EU would not make a decision on the proposal for several weeks.

Eizenstat has also indicated the proposal has the support of House Ways and Means Committee Chairman Bill Archer, R-Texas, who would like both houses to pass a bill by October 1. Eizenstat also appears confident the alternative has bipartisan support.

House Committee Urges Five-Year Extension of Internet Tax Moratorium: The House Judiciary Committee May 4 approved 29-8 the Internet Nondiscrimination Act (H.R. 3709) which would extend for five years the moratorium enacted by the Internet Tax Freedom Act as it applies to new, multiple, and discriminatory taxes on the Internet. The bill also would eliminate the grandfather clause that currently allows 10 states to collect taxes on Internet access.

"For those that think Congress is unwilling or uninterested in these issues, I can assure you nothing is further from the truth," said committee Chairman Henry Hyde, R-Ill. Ranking Democrat John Conyers, D-Mich., agreed saying, "virtually all interested parties think we should extend the moratorium, but we should keep it as tailored as we can."

Other Democrats disagreed, claiming the subject matter and timing of the hearing had not been properly thought out. Jerrold Nadler, D-N.Y., said, "I don't understand the rush of holding this markup today, without hearings. It's putting the cart before the horse."

"We are legislating on a subject on which there is no need to legislate," Rep. Barney Frank, D-Mass., said. "Maybe it's supposed to offset the fact that this Congress hasn't legislated in areas that it should have."

The committee defeated amendments that would have provided for a two-year extension or a permanent ban on Internet taxes. House Majority Leader Dick Armey, R-Texas, indicated that a floor vote on H.R. 3709 could take place the week of May 15. The Commercial and Administrative Law Subcommittee has scheduled a hearing on May 17 to address other Internet tax issues in the Advisory Commission on Electronic Commerce report.

At a May 3 hearing, members of the House Commerce Subcommittee on Telecommunications, Trade, and Consumer Protection debated the merits of the Internet Access Charge Prohibition Act of 1999 (H.R. 1291), and the Internet Services Promotion Act of 2000 (H.R. 4202). Both bills prohibit Federal Communications Commission (FCC) fees on Internet access. H.R. 4202 also extends the current moratorium on taxes on Internet access and multiple and discriminatory taxes on the Internet.

Subcommittee members questioned whether Internet telephone service requires the protection from taxation that is currently extended to Internet access. In effect, local and long distance phone service customers are subsidizing Internet phone service, said the subcommittee's ranking Democrat Ed Markey of Massachusetts. He also discussed the future subsidy of rural phone service, which is supported by taxes on traditional phone service. A per-line charge could be used to support rural Internet subscribers for instance, Markey said.

The author of H.R. 1291, Rep. Fred Upton, R-Mich., said his bill was designed to protect Internet data transmission -- not telephone transmission -- from taxation, adding that he would accept more specific language to that effect.

Subcommittee member Christopher Cox, R-Calif., warned that the FCC might read the committee debate as an encouragement to impose fees on Internet phone service. But Chairman Billy Tauzin, R-La., responded that perhaps in the future, traditional phone companies would compete equally on the Internet, giving them the same tax advantages that Internet companies have in their phone offerings. Traditional phone companies now operate at a disadvantage compared to their Internet competitors, Tauzin added.

Subcommittee members were also concerned that a moratorium on e-commerce taxation could cause state and local revenues to dry up as consumers abandon traditional retail stores in favor of on-line shopping.

Markey asked how long it would take for state and local governments to simplify their sales tax systems to permit an effective solution to the growth of tax-free Internet sales.

According to witness Peter Lowy, founding chairman of the E-Fairness Coalition, which represents 1.5 million retail stores, it would take about three years for the states to simplify their sales tax systems and develop a coordinated approach to the problem.

The coalition opposes both H.R. 1291 and H.R. 4202, partly because "the states are currently working on simplifying sales tax rules nationwide," Lowy said. "An extension of the moratorium will stop the momentum gained in solving the complex issue."

House Approves Africa/CBI Trade Bill: The House on May 4 voted 309-100 to approve the conference report on the Africa Trade/Caribbean Basin Initiative legislation, after conference members earlier in the week stripped out revenue offsets. The legislation will be paid for with non-Social Security surplus funds.

The report includes two tax-related measures. One would allow the president to waive the section 901(c) denial of foreign tax credits for certain foreign countries, when such a waiver would expand trade and investment opportunities for U.S. companies in the affected country. Under the Senate version, this would apply on or after February 1, 2001.

The second tax provision would accelerate last year's measure to increase the amount of rum excise tax channeled to Puerto Rico and the U.S. Virgin Islands. (The level was boosted from $10.50 to $13.50 per proof gallon).

Among the revenue raisers dropped from the legislation are limits on pre-funding of employee benefits; an increase to 15 percent in the optional withholding rates for nonperiodic payments from deferred compensation plans; limits on the use of the non-accrual experience method of accounting on amounts to be received for qualified professional services; measures to prevent duplication of loss through assumption of certain liabilities; and measures that require consistent treatment of and provide basis allocation rules for intangible transfers in certain nonrecognition transactions.

The trade bill would grant countries in the Caribbean, Central America, and sub-Sahara Africa greater duty-free access to U.S. markets. The decision to drop the revenue raises does not mean they won't turn up again in another bill, but the move makes that possibility less likely.

Roth May Add Assumption of Liability Measure to Tax Shelter Bill: Senate Finance Committee Chairman William V. Roth, R-Del., is considering including in a bipartisan bill targeting corporate tax shelters a section 358(b) provision that would prevent the duplication of loss on the assumption of certain liabilities. Roth is in the process of developing the legislation with ranking Democrat Daniel Patrick Moynihan of New York.

The duplication of loss provision was originally slated to serve as a revenue offset in the Africa/CBI trade bill before being dropped during conference. Roth said he was "very disappointed" that the measure was not included.

The tax shelter bill is likely to focus on three major areas: enhanced disclosure, reforming the opinion letter standard, and bringing tax shelter promoters into the penalty system. According to Finance Committee staff, the legislation is unlikely to codify the economic substance doctrine, a judicial concept that attempts to quantify the tax-versus-business purpose equation.

To date, House Ways and Means Committee Chairman Bill Archer, R-Texas, has been unwilling to report similar legislation due to his concern that it would stifle legitimate business transactions. It remains to be seen whether the Finance Committee bill may move him or other House leaders to add anti-corporate tax shelter provisions to House legislation.

Doggett to Introduce Tax Haven Bill: House Ways and Means Committee member Rep. Lloyd Doggett, D-Texas, will introduce a bill next month to restrict the tax benefits on income that flows through tax haven countries, an aide told & May 5. The bill will be modeled after revenue proposals in the Clinton administration's FY 2001 budget request.

The legislation would give Treasury the authority to list tax haven countries, deny foreign tax credits to U.S. taxpayers who conduct transactions in those countries, and provide countries on the list a one-year grace period to improve their transparency rules, according to published reports.

Doggett also is the author of anti-corporate tax shelter legislation that is modeled after another administration proposal.

House Ways and Means Committee Chairman Bill Archer, R-Texas, has so far been unwilling to support broad anti-corporate tax shelter legislation for fear of stifling legitimate business transactions. (See also previous story.)

Ways and Means May Address Corporate AMT Before End of Session: The House Ways and Means Committee may address corporate alternative minimum tax (AMT) relief at some point during the remainder of the current congressional session, an aide to committee Chairman Bill Archer, R-Texas, told .

In a May 2 speech before the U.S. Chamber of Commerce, Archer outlined other items the committee hopes to address, including depreciation issues and further capital gains relief. "Because taxes are at an all-time high and the economy is strong, the non-Social Security surplus will continue to grow and there will be pressure to spend the money," Archer said. "Clearly, we have to get the money out of Washington and back to the American people who earned it, or the politicians will surely spend it."

Archer said the committee is also considering tax relief in the areas of community renewal, Social Security benefits, estate tax repeal, telephone excise tax repeal, and individual retirement account contribution limits.

The budget resolution Congress approved April 13 calls for $175 billion in tax relief over five years, but the House already has approved five-year tax cuts totaling $111 billion. That leaves only $64 billion to accommodate any additional reductions.

The Tax Court held in 1998 that income excluded under section 108 does not pass through to the shareholders. The Tenth Circuit affirmed in two separate cases, including Gitlitz, holding that tax attribute reduction occurs at the corporate level, before the excluded DOI income is passed through to the shareholders.

Taking a contrary position, the Third Circuit and one district court in the Ninth Circuit have recently held that the excluded DOI income does pass through to the shareholders. The Third Circuit in United States v. Farley, 202 F.3d 198 (3d Cir. 2000), relied on statutory language providing that the attribute reduction does not occur until the year following the year in which the corporation's indebtedness is discharged.

The Seventh Circuit took yet another approach, concluding in Witzel v. Commissioner, 200 F.3d 496 (7th Cir. 2000), that the shareholder could not currently deduct suspended net operating losses because those losses were offset by the excluded DOI income at the corporate level, but that the excluded income did pass through to increase the shareholder's stock basis for use against future losses.

Success of IRS Modernization Depends on Congress, Rossotti Says: With the Internal Revenue Service at the crossroads in implementing its modernization plans, congressional approval of its fiscal 2001 budget will determine the agency's success or failure, IRS Commissioner Charles Rossotti said May 3.

Addressing a hearing of the Joint Committee on Taxation, Rossotti acknowledged that the agency is "not yet meeting the legitimate service expectations of the vast majority of compliant taxpayers," and that examination and collection enforcement activity has declined. Those problems, he said, can be solved by hiring more people to handle the agency's increasing workload and by modernizing the agency's computer systems.

But getting Congress to approve a budget increase for the IRS will be difficult for Rossotti. The recently approved Republican budget provides little for domestic spending. Democrats and some Republicans have expressed concern that there are insufficient funds in the budget for key domestic programs such as education, health care, medical research, and other priorities.

Senate GOP appropriators have tentatively agreed to boost spending for some programs -- including Treasury and postal operations -- but the budget still falls short of the administration's spending targets.

Bush Ecstatic Over JCT Cost Estimate of Tax Plan: Presumptive Republican presidential nominee Texas Gov. George W. Bush received good news May 1 when the Joint Committee on Taxation (JCT) scored his tax plan as costing $460 billion over five years and $1.3 trillion over 10 years. The campaign had arrived at similar figures when it unveiled the plan last December and had actually projected the five-year cost to be $23 billion more. The JCT released the figures in a May 1 letter from Chief of Staff Lindy Paull in response to an inquiry by House Ways and Means Committee Chairman Bill Archer, R-Texas.

Hailing freshly calculated budget projections, Bush said May 2 that his proposed 10-year, $1.3 billion tax reduction can be financed without dipping into the Social Security surplus. The Bush campaign released new budget and economic projections based on updated Treasury data and a recalculated CBO budget baseline that project non-Social Security surpluses to total $1.8 trillion over 10 years.

Bush hopes to fend off criticism from likely Democratic presidential nominee Vice President Al Gore, who claims the Bush tax plan costs $2.1 trillion over 10 years and relies on Social Security surpluses for financing. Gore contends that the Bush campaign has failed to account for interest costs. Elaine Kamarck, Gore's policy advisor, has said Bush "can't do all these things while balancing the budget and paying down the debt."

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