December 18, The Honorable John Koskinen Commissioner Internal Revenue Service 1111 Constitution Avenue, NW Washington, DC 20224

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1 Commissioner Internal Revenue Service 1111 Constitution Avenue, NW Washington, DC Dear Commissioner Koskinen: The U.S. Chamber of Commerce ( Chamber ), the world s largest business federation represents the interests of more than three million businesses and organizations of every size, sector, and region. The Chamber supports regulatory and tax policies that provide an even playing field and promote the efficient capital markets needed to grow and create jobs. We write to you today because we are concerned that the Internal Revenue Service ( IRS ) is considering a new interpretation of IRC Section 305(c) that may have adverse consequences upon capital formation. Accordingly, we believe that a change in the application of IRC Section 305(c) would effectively create a new regulatory regime and accordingly respectfully request that the IRS release a notice for public comment, as well as economic analysis as required under the Administrative Procedures Act and compliance with Executive Orders 12866, and to identify adverse impacts on capital formation and prevent any harm to the economy from the expanded application of this provision Background It is our understanding, that a new interpretation of 305(c) is being contemplated for convertible securities in which fair value adjustments would be treated as taxable deemed dividend distributions. This would result in a change in method of accounting for taxable income for US investors and require federal withholding tax on foreign investors. Such a change demonstrates a lack of understanding of the use of the product.

2 Page 2 Convertible fair value adjustments are not dividend substitutes, rather they are a form of protection since dividends erode the value of the embedded call options in the convertible security. The potential new interpretation would create a tax on phantom income and place significant burdens on investors. This will make convertible securities a less competitive form of financing for American businesses harming capital formation. While some have estimated that this new interpretation would generate $10 million in new revenue, we believe that the adverse consequences to capital formation will wipeout those gains and harm revenue collection. 1. Adverse Impact on Capital Formation for American Businesses American businesses have benefited from the most diverse, innovative, and deepest capital markets. This has allowed small businesses to use non-traditional forms of debt, such as home-equity loans, or large businesses to use multiple forms of capital, such as debt and equity instruments, to acquire the resources needed to operate on a daily basis and grow over the long-term. Corporate treasurers decide what instruments are best suited to meet the needs and fit the financial capabilities of businesses. Therefore, it is not unusual to see public companies with multiple gradations of equities, hundreds of different issuances of corporate bonds, or the use of convertible bonds and structured notes. At the same time, businesses must manage risk and insure the acquisition of raw materials to produce goods at a stable price. These activities not only benefit the business, but their customers as well. In suggesting changes to 305 (c), it appears that the IRS may make some of these capital formation and risk management devices less attractive to businesses. This will harm the ability of businesses to raise capital, manage risk, and ultimately harm the ability of the IRS to raise revenue. The Chamber believes that corporate access to the convertible market could decrease if investors are uncertain about the tax treatment of these instruments. As a result, convertibles will be a less attractive device used by corporate treasurers, investor demand will diminish, and the cost of capital will increase for companies. The potential new interpretation of 305 (c) may undermine the bedrock of innovation and efficiency that our financial markets have been built upon. Open, diverse capital markets have allowed Main Street businesses to grow and prosper. Because of the new withholding requirements, we believe it will be less likely that foreign investors will participate in American financial services markets. This will raise the costs of capital for Main Street

3 Page 3 businesses, harming the efficiencies of those capital markets reducing the amount of capital available to fuel economic growth and job creation. 2. Need for an Enhanced Economic Analysis The Chamber believes that a new interpretation of 305(c) would in essence create a new regulation and in fact should be considered an economically significant rulemaking. This would require a full public notice and comment period that should include an economic analysis subject to public scrutiny. i. Compliance with Executive Orders 12866, and on Regulatory Reform Changes to 305(c) must follow the requirements of the Administrative Procedures Act ( APA ), as well as the Regulatory Flexibility Act ( RFA ), the Paperwork Reduction Act ( PRA ), and the Small Business Regulatory Enforcement Fairness Act ( SBREFA ). The RFA requires assessment of the economic effect of regulations on small business and consideration of less burdensome alternatives. The PRA requires assessment of the paperwork burden on small entities and ways to reduce or mitigate it. Among other things, the portion of SBREFA known as the Congressional Review Act states that rulemaking agencies must submit to GAO, and make available to each house of Congress, a complete copy of any cost-benefit analysis prepared for a final rule for which such an analysis is performed. 1 While the next section of the letter will deal with the economically significant standard, it is also important to note that Treasury and the IRS are also subject to the common baseline for cost-benefit and economic analysis by using the blueprint established by Executive Orders and 13563, in addition to other requirements they must follow. Doing so would allow meaningful, cumulative analysis that would result in a more coherent final rule with fewer harmful, unintended consequences for the American economy. Executive Order places upon agencies the requirement, when promulgating rules to: 1 5 U.S.C. 801(a) (1) (b) (i).

4 Page 4 1) Propose or adopt a regulation only upon a reasoned determination that its benefits justify its costs (recognizing that some benefits and costs are difficult to justify); 2) Tailor regulations to impose the least burden on society, consistent with obtaining regulatory objectives, taking into account, among other things, and to the extent practicable, the costs of cumulative regulations; 3) Select, in choosing among alternative regulatory approaches, those approaches that maximize net benefits (including potential economic, environmental, public health and safety and other advantages; distributive impacts; and equity); 4) To the extent feasible, specify performance objectives, rather than specifying the behavior or manner of compliance that regulated entities must adopt; and 5) Identify and assess available alternatives to direct regulation, including providing economic incentives to encourage the desired behavior, such as user fees or marketable permits, or providing information upon which choices can be made to the public. 2 Additionally, Executive Order states that [i]n applying these principles, each agency is directed to use the best available techniques to quantify anticipated present and future benefits and costs as accurately as possible. Conducting the rulemaking and its economic analysis under this unifying set of principles will facilitate a better understanding of the rulemaking and its impact and give stakeholders a better opportunity to provide regulators with informed comments and information. ii. Failure to Provide an Appropriate Cost-benefit Analysis as Required Under the Unfunded Mandates Reform Act As stated earlier, the Treasury and IRS should determine if a rulemaking will cost state, local, or tribal governments or the private sector more than $100 million, using cost of living increases as permitted under UMRA. The threshold is now $141 million. 2 Executive Order 13563, Section 1(b)

5 Page 5 We believe that the adverse impacts on capital formation, upon a convertible market in the United States that is $230 billion, will exceed this threshold and should be considered to be an economically significant rulemaking. Therefore, the IRS should submit the rulemaking for an enhanced review and provide estimates of future compliance costs, impacts upon the economy including data on productivity, jobs, and international competitiveness. 3 To our knowledge, this enhanced review under UMRA has not been performed. Accordingly, the Chamber urges that an UMRA enhanced cost-benefit analysis should be undertaken and released for public comment before and changes to 305 (c) are finalized. Conclusion Accordingly, the Chamber respectfully requests that a new interpretation of 305(c) be released for public notice and comment and subject to an enhanced economic analysis to better understand the ramifications this regulatory action will have on the $230 billion convertible market and capital formation for American businesses. We hope that you take these concerns under consideration and are willing to discuss our concerns with you in greater detail. Sincerely, David Hirschmann President Center for Capital Markets Competitiveness U.S. Chamber of Commerce Dr. Martin Regalia Senior Vice President and Chief Economist Economic Policy U.S. Chamber of Commerce 3 See 2 USC 1501, et. seq.