Re: Collection of Information under notice of proposed rulemaking (IRC Section 385 REG )

Transcription

1 June 7, 2016 VIA Office of Management and Budget Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs Washington, DC Re: Collection of Information under notice of proposed rulemaking (IRC Section 385 REG ) Dear Sir/Madam, In response to the collection of information requirements contained in the notice of proposed rulemaking USCIB provides the comments set forth below. The preamble states that the Office of Management and Budget has estimated that the paperwork burden associated with these regulations is 35 hours per respondent with 21,000 annual respondents, for an annual total burden of 735,000 hours. OMB has also estimated that the total annual cost of the burden this regulation imposes at approximately 13 million dollars. 1 These estimates grossly understate the burden associated with the regulations as proposed. USCIB has asked members for input on the potential costs associated with implementing the regulations as proposed. The costs could run to hundreds of millions or even billions of dollars across all persons affected by the regulations. This is in part because the documentation requirements are so broad with no exception for small or ordinary course loans, thereby potentially applying to hundreds of thousands or millions of loans per corporate group. The OMB estimates do not include the cost just to build the IT systems to do the required tracking and reporting. Many taxpayers will have to prepare new IT systems. Those systems will cost millions of dollars for each taxpayer that has to build one (preliminary estimates indicate that the costs could run between 5 and 30 million dollars) and could easily take 24 months to complete. Once these systems are developed, they would need to be maintained at a further cost of hundreds of thousands of dollars per year. Additional compliance staff would need to be hired. Initial estimates indicate that companies would need to hire between two to 1 Accepting OMB s numbers and assuming all the costs of complying with the documentation requirements are labor (which of course they will not be), then the cost of labor is estimated to be $18.00 an hour. This number itself is absurdly small.

2 four additional compliance staff per company, not just in the tax departments but also in treasury and accounting. 2 Some initial estimates indicate that the documentation costs associated for each loan could be between 35,000 and 50,000 dollars. The costs would be so high because of the transfer pricinglike analysis that would have to be performed to determine the ability to pay. Given the potentially dire consequences, companies might hire outside advisors to perform the analysis. Implementation would be so expensive because these regulations affect multiple aspects of corporate management including: the treasury, legal and accounting functions. The consequences of failing to provide documentation are punitive; therefore, companies need to be certain that they have satisfied all of the documentation requirements. The penalty for failing to comply with the documentation requirements 3 is the treatment of the instrument as equity, regardless of how the instrument ought to be characterized. If the instrument should be characterized as debt, then this mischaracterization results in denial of an interest deduction for 100% of the otherwise deductible interest expense. Further, the mischaracterization of the debt as equity could have significant collateral consequences that are out of proportion to the failure. No penalty should be so disproportionate to the underlying failure. USCIB is not in a position to determine whether the estimate of 21,000 annual respondents is accurate; but this figure seems low, based on the findings by the IRS own Statistics of Income division that over 1.6 million C corporation returns were filed in tax year 2012 (the most recent year for which data appears to be available). 4 The difficulty of ensuring documentation that is sufficient and timely especially with respect to cash pooling arrangements will result in some businesses using third party banks to manage liquidity even though they have cash elsewhere in their groups. Some initial estimates indicate that this might add 350 basis points to the cost of cash management. One member would strongly consider using a third-party bank as an intermediary for all cash-flow movements and has estimated that leading option to cost up to $20 million dollars annually. This increased interest expense would be fully deductible because it is third party debt. Although this is not a cost of reporting, it should be taken into account because it will be a cost of adopting these regulations. As a result, the effective cost of investing in future activities will increase for businesses affected by these regulations compared to businesses that are not affected. Additionally, to the extent that businesses use third party borrowing at the local 2 If OMB s estimate is entirely labor costs associated with implementation, then the cost of labor is approximately $18.00 per hour. Personnel with treasury, tax and accounting expertise cannot be hired for this amount. 3 Assuming there is not reasonable cause for the failure. Proposed regulation section (c)(1). The reasonable cause standard of section may be difficult to meet especially given that the documentation requirements apply globally to routine transactions with no de minimis threshold. 4 View Table 1, Number of Returns, Total Receipts, Business by Form of Business, Tax Years The regulations may also apply to entities that are not C corporations, including S corporations, partnerships and foreign corporations.

3 country levels this will result in additional internal resources including increased internal controls due to the decentralization of cash management. Alternatively, businesses will be forced to make equity contributions that will trap cash in high-risk jurisdictions. These burdens are especially questionable given that the authority cited for the collection of this information does not support the collection of the requested information. Section 385(c)(3) provides: The Secretary is authorized to require such information as the Secretary determines to be necessary to carry out the provisions of this subsection. This subsection is the subsection pertaining to consistent classification by the issuer and the holders of any instrument. The legislative history is short and contains only one sentence on the scope of the regulatory authority. That sentence provides: The Secretary of the Treasury is authorized to require such information as is deemed necessary to implement the provision. 5 The more natural reading of the regulatory authority is that it pertains only to whether the issuer and the holder have treated the instrument consistently as either debt or equity at the time the instrument was issued; and therefore the information that should be required to be provided should be limited to that determination of whether the issuer and holder have taken inconsistent positions, not the basis for those positions. In order to understand why USCIB believes the burden is grossly underestimated, an explanation of some of the documentation requirements are included in this letter. Documentation is Excessive The level of documentation is excessive. There is no sense that the documentation burden is proportionate to the value of the debt instrument or the amount of deductible interest. In negotiating the terms of a debt instrument, an issuer and creditor are more likely to extensively document the terms if the amount of the debt obligation is greater. In order to address this lack of proportionality USCIB suggests three changes. First, there should be a de minimis rule per obligation, such that the proposed rules do not apply to any obligation with a face amount below a certain level. 6 Second, the regulations should provide that if the expanded group can demonstrate that the level of documentation is equivalent to the documentation provided in a similar transaction between unrelated parties, then the requirements of section would be considered satisfied and not lead to treatment of an instrument as stock. The regulations should not demand more documentation than a lender would get from an unrelated party. Third, the documentation should not apply to any transaction that is within the ordinary course exception of proposed regulation (b)(3)(iv)(B)(2). The way in which the ordinary course exception is drafted, it only applies for purposes of the funding rule of proposed section A multi-national group could have millions of intercompany debt obligations if these ordinary course obligations are taken into account. This is also true for businesses that have numerous entities that participate in a cash pooling structure where daily or weekly cash 5 Energy Policy Act of 1992, Conference Report at The de minimis threshold would not prevent the IRS from challenging the character of an instrument as debt, it would simply mean that the rules of and -3 would not apply.

4 movements between the participants and the cash pool leader occur. Applying the documentation requirements to all of these ordinary course obligations would be impossible and attempting to do so would be extremely costly. An example of this excessive documentation is the rule concerning whether the creditor has a reasonable expectation of repayment (section (b)(2)(iii)). 7 While documenting an expectation of repayment is not in and of itself unreasonable, the level of documentation required, particularly in light the lack of any sense of proportionality and materiality, is unreasonable. In determining whether there is a reasonable expectation that the issuer has the ability to repay the debt obligation, written documentation must be prepared that establishes that as of the date of the issuance and taking into account all the relevant circumstances (including all other obligations incurred by the issuer as of the date of issuance or reasonably anticipated to be incurred after the date of issuance of the applicable instrument) the issuer s financial position supported a reasonable expectation that the issuer intended to, and would be able to, meet its obligations. This is too unclear and too broad. What is an obligation? Is it only other debt obligations? Is a draw-down on an existing debt obligation an obligation that warrants additional documentation, including a new assessment of the creditworthiness of the borrower? If interest on an existing obligation is capitalized, is the capitalized amount considered an obligation that warrants additional documentation, including a new assessment of the creditworthiness of the borrower? Does it include obligations to pay rents and royalties? Is a non-recourse obligation an obligation of an issuer? How would an issuer prove that it had taken into account all of its obligations? Would all of the obligations have to be identified in the written documentation? Do these obligations include trade payables? How would a business document that it took into account reasonably anticipated obligations? Many obligations are not material and would not have any impact on the ability of an issuer to repay a debt obligation. Non-material obligations should not be required to be considered. (Outstanding obligations would also clearly be a better standard than incurred, since an obligation that has been incurred but satisfied ought not to be considered.) The burden of complying with these documentation requirements for a single instrument could easily exceed OMB s total annual estimate of 35 hours per respondent. Some initial estimates indicate the cost of compliance per obligation could be between 35,000 and 50,000 dollars. It is also common for a prior-in-time related party interest to be subordinated to new unrelated party debt. Would subordinated debt need to be re-documented in order to avoid the potentially punitive result of being treated as equity? That is, if a new obligation was not reasonably anticipated at the time the EGI was entered into and therefore was not taken into account in determining whether there was a reasonable expectation that the issuer could meet its repayment obligation, then the obligation would be tested under section (e)(4)(vi) to determine whether there was a modification. Under that standard, subordination would not 7 Generally, the first two requirements that the documentation indicate an unconditional obligation to pay and the documentation establish the existence of creditor rights are not problematic.

5 be considered a modification of a debt instrument unless there is a substantial impairment of the obligor s capacity to meet the payment obligations under the debt instrument. So, if the issuer concludes there is no substantial impairment, there would be no modification and the documentation requirements would not apply. Nevertheless, businesses may be forced to redocument the transaction even if they conclude that there is not a modification -- in order to avoid the penalty of converting debt to equity, doubling the cost of documentation in this common case. Time for Preparation of Documentation is Inadequate The deadlines for preparation of the documentation are too short and could lead to anomalous results. The regulations generally provide that the documentation is treated as timely prepared if it is prepared no later than 30 days after the relevant date, in the case of documenting the obligation to repay, the existence of creditor rights and the reasonable expectation of repayment. Documentation is considered as timely prepared if it is prepared no later than 120 days after the relevant date in the case of documenting payment or the exercise of creditor rights on default. These rules would require businesses to implement systems to track these dates because the penalty, as described above, for failing to meet them is so onerous. A better rule would be to require the documentation to be finalized by the time the tax return (including extensions) for the relevant year is required to be filed. This approach would permit companies to address such documentation as part of the annual compliance process to allocate resources more effectively. Furthermore, the information would be available to the government when needed. Indeed, the proposed regulations provide that if a taxpayer fails to provide the documentation and information described in paragraph (b)(2) of this section upon request by the Commissioner, the Commissioner will treat the requirements of this section as not satisfied. 8 So, in all cases the taxpayer will need to have the documentation prepared in time for the Commissioner to review the documentation and if the documentation is provided when requested, it is not clear why there should be a disproportionate penalty associated with completing the documentation say 35 days after the loan was entered into. Timing with Respect to Ordinary Course Transactions To the extent that documentation relates to ordinary course transactions, many businesses complete their sub-ledger calculations on a quarterly basis, not on a monthly basis. For those businesses, a 30-day documentation requirement would either require massive changes to their accounting systems 9 or would cause every intercompany trade payable or receivable to be treated as equity. Payment of the intercompany trade payable or receivable would apparently be a repurchase of equity. Both of these would trigger massive downstream tax consequences 8 Proposed section (b)(1)(ii). 9 Given the very short time frame for submitting comments on this regulation, we do not have cost estimates of how much these types of changes would cost, but these costs alone would not be orders of magnitude higher than the OMB estimate of total costs.

6 for the taxpayer. There is no discernable policy reason for forcing these business changes and expenses. Again, there are millions of ordinary course transactions, so ordinary course obligations (however defined) should be excluded from the requirement that they satisfy these documentation requirements. Nevertheless, there will always be a line between ordinary course and non-ordinary course as defined in the regulations and flexibility on the timing of documentation would make the consequences of being on one side or the other of that line less onerous and reduce the costs of complying with the documentation rules. Timing with Respect to Payment Documentation and Exercise of Default Rights The relevant date for documentation of payment and exercise of default rights leads to confusing and perhaps absurd results. It seems as if there could be multiple relevant dates for a single payment or an event of default. For example, the regulations provide that each date on which a payment of interest or principal is due, taking into account all additional time permitted under the terms of the EGI before there is (or holder can declare) an event of default for nonpayment, is a relevant date. 10 What does this mean? If a payment is due on January 1, but the holder cannot declare an event of default until February 1, and the issuer pays on time on January 1 st, when does the documentation concerning that payment need to be prepared. Is it 120 days after the actual payment date, January 1 st? Or 120 days after the date a default could have been declared if there had been a default even though there wasn t a default? Further, if the issuer does not pay on time, but pays more than 120 days after an event of default could have been declared, is it impossible to timely document that payment because the payment itself occurs outside of the deadline for providing the documentation? This is an absurd answer; but seems to be the result under the proposed regulation. All of these issues would be cleared up by a rule that permits documentation by the extended due date of the relevant tax return and costs would be correspondingly reduced. An additional point on documenting the exercise of creditor rights in the event of default is that there may be overlapping events of default that result in multiple relevant dates. If a company is in a difficult financial situation, there may be different triggers in different obligations. Creditors also may not be aware that a trigger has occurred. It is common for a default on one instrument to trigger defaults on other instruments; the creditor might not be immediately aware of an occurrence of such a default. If the occurrence of a default triggering event is not immediately obvious to the creditor, then it may not begin to take steps let alone document those steps -- within the 120 period. Creditors also may be more concerned about pursuing their creditor rights than documenting all the steps they have taken, essentially in real time, and therefore miss the 120-day deadline. Ambiguity Concerning the Person Responsible for Documentation 10 Proposed section (b)(3)(C).

7 The regulations do not provide any rules concerning who is supposed to prepare and maintain the required documentation. The relevant rules are clearly structured in the passive voice 11 if the documentation and information described in paragraph (b) (2) of this section are not prepared, documentation and information that must be prepared and maintained to satisfy the requirements of this section, [t]here must be written documentation prepared by the time required in paragraph (b)(3) of this section, among others. Presumably this structure is intentional; that is, the Treasury and IRS are deliberately not identifying the entity that must prepare the documentation. In most cases the issuer should be able to document the transaction and this would seem to be appropriate because the issuer is the party that will be claiming the interest deduction. In the case of the exercise of creditor rights, however, it is unlikely that the issuer would be able to prepare and maintain the required documentation without cooperation from the creditor. Thus, the issuer s interest deduction will depend on the compliance of the creditor with the documentation requirements including that the documentation is prepared timely. Even in the context of an expanded group where there is significant stock ownership, it may be difficult to compel the timely preparation of these documents by the creditor. This is another case where a significant difficulty would be reduced or eliminated by permitting the documentation to be prepared by the time (including extensions) that the return is due to be filed. Conclusion For the above reasons, USCIB believes that the OMB estimate grossly underestimated the cost and time required to comply with the documentation requirements under Proposed Regulation section Sincerely, William J. Sample Chair, Taxation Committee United States Council for International Business (USCIB) 11 Proposed regulation sections (b)(1)(i) and (b)(2).