Notice 98-11, relating to the treatment of hybrid arrangements under Subpart F.

• Position: IRS Notice 98-11, Internal Revenue Code Subpart F

On March 12, 1998, Tax Executives Institute submitted the following comments to the Internal Revenue Service on Notice 98-11, relating to the treatment of certain hybrid arrangements under subpart F of the Internal Revenue Code. The comments, which were submitted to Michael Danilack, Associate Chief Counsel (International), were prepared under the aegis of the Institute's International Tax Committee, whose chair is Joseph S. Tann, Jr. of Ameritech Corporation. The following members of the Institute contributed materially to the preparation of TEI's comments: Karen L. Hall of Komag, Inc. and R. Douglas Kyle of Weyerhaeuser Company.

On January 16, 1998, the Internal Revenue Service issued Notice 9811, announcing an intent to issue regulations relating to the use of certain hybrid branch arrangements. The notice was published in the INTERNAL REVENUE BULLETIN on February 9, 1998 (1998-6 I.R.B. 18). After the Notice was issued, the Clinton Administration released its 1999 budget proposals, which include a provision granting Treasury the authority to promulgate regulatory guidance to prevent "inappropriate results" from the use of hybrids. The proposal would be effective as of the date of enactment of the legislation.

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our 5,000 members represent nearly 2,800 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and that taxpayers can comply with in a cost-efficient manner.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by Notice 98-11, relating to the use of certain hybrid branch arrangements.

In Notice 98-11, the IRS announced its intention to issue regulations under Subpart F of the Internal Revenue Code "to prevent the use of hybrid branch arrangements to reduce foreign tax while avoiding the corresponding creation of subpart F income." According to the Notice, these arrangements involve the use of deductible payments to reduce the taxable income (and therefore foreign taxes) of a controlled foreign corporation (CFC) under foreign law, and the corresponding creation in another entity of low-taxed, passive income of the type to which Subpart F was intended to apply. The Notice states the regulations will be effective in respect of hybrid branch arrangements entered into on or after January 16, 1998, and payments made or accrued in respect of existing structures after June 30, 1998.

The Notice sets forth two examples of "abusive" transactions, which essentially involve a loan (and the attendant payment of interest) with a CFC in one country and a hybrid branch in another country.(1) The Notice would recast the branch in each example as a separate subsidiary (i.e., a CFC) and, accordingly, would treat the transactions as creating foreign personal holding company income taxable under Subpart F. That is, taxpayers would be denied the benefit of the same-country exception of section 964(c)(3) of the Code.

The Institute has grave concerns about the dramatic shift in tax policy evidenced by the Notice. Quite simply, we believe that the Notice is ill advised as a matter of both tax policy and economics. Concededly, maintaining capital export neutrality--the principle underlying the Notice--is a policy that spurred the enactment of Subpart F. It is not, however, the only policy. Congress was equally concerned about ensuring international competitiveness, yet that goal is given short shrift by the Notice. The lack of balance--indeed, the myopia--reflected in Notice 98-11 is unfortunate.

TEI is concerned about several specific aspects of the Notice. First, TEI questions the Treasury's authority to issue the Notice, which significantly distends the branch rule set forth in the Internal Revenue Code...