Clinton administration budget proposals.

• Position: Tax Executive Institute's comments submitted May 9, 1997

On May 9, 1997, Tax Executives Institute submitted the following comments to the tax-writing committees of Congress, with copies to the Department of the Treasury and the Internal Revenue Service, on the tax proposals contained in the Clinton Administration's fiscal year 1998 budget proposals. The comments were prepared under the aegis of the Institute's Federal Tax Committee chaired by David L. Klausman of Westinghouse Electric Corporation), International Tax Committee (chaired by Joseph S. Tann, Jr. of Ameritech Corporation), and IRS Administrative Affairs Committee (chaired by Robert L. Ashby of Northern Telecom Inc.). Other members of the Institute participating in the development of TEI's comments were the Michael D. Fryt of Federal Express Corporation; John A. Gurovich of US West, Inc.; and Philip G. Cohen of Unilever United States, Inc.

Tax Executives Institute is the principal association of corporate tax executives in North America. Our 5,000 members represent approximately 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.

On February 6, 1997, President Clinton submitted his fiscal year 1998 budget proposals to Congress, including numerous proposals amending the Internal Revenue Code. Although the Administration and congressional leadership have announced an agreement on a general outline for the budget package, we understand that few specific proposals have been adopted. These comments focus on several Administration proposals affecting corporate taxpayers.

Domestic Tax Issues

Denial of Interest Deduction

For Certain Debt Instruments

Administration Proposal. The Administration proposal provides that no deduction would be permitted for interest on an instrument issued by a corporation (or a partnership to the extent of its corporate partners) that either (i) has a maximum weighted average maturity date of more than 40 years, or (ii) is payable in stock of the issuer or a related party. The proposal would also modify the rules for indebtedness that is reflected as equity on the issuer's financial statements. The proposal would essentially reduce the facts-and-circumstances test for distinguishing between debt and equity to one factor: the term of the instrument.

TEI Recommendation. TEI opposes enactment of this provision. So-called supermaturity debt instruments are issued by corporate treasurers for legitimate business reasons, primarily to "lock in" attractive interest rates on long-term debt financing. The term of a financial instrument alone does not confer undue tax or financial reporting advantages to either party nor does it vitiate the economics underlying the traditional tax law distinctions between debt and equity financing. Indeed, both the issuer and holder understand well that what they have is a long-term debt obligation that provides the holder legal rights in bankruptcy that are superior to all classes of equity.

More than 25 years ago, Congress enacted section 385 of the Internal Revenue Code, giving the Treasury Department authority to address debt/equity interests. Although several sets of regulations have been issued under this provision, there are no current regulations that apply. Treasury's inability to craft workable regulations under that provision demonstrates that the issues to be resolved are complex and not subject to easy solutions. Asking Congress to enact an arbitrary rule, while facile, will not bring long-term stability to this area and adjusts what is in reality a market-based transaction. Indeed, as the Joint Committee's explanation admits, the effect of this provision may well be nothing more sophisticated than encouraging the issuance of 39-year debt. Joint Committee on Taxation, Description and Analysis of Certain Revenue-raising Provisions Contained in the President's Fiscal Year 1998 Budget Proposal (JCX-10-97), at 5 (March 11, 1997) (hereinafter cited as "Joint Committee Description"). We urge that the proposal be rejected.

Limitation of the

Dividends-Received Deduction for

Portfolio Stock

Administration Proposal. Under current law, a corporation receiving dividends from stock of a corporation of which it is less than a 20-percent owner may deduct an amount equal to 70 percent of the dividend. The Administration's proposal would decrease the dividends-received deduction to 50 percent of the amount received

TEI Recommendation. The proposal to constrict the dividends-received deduction constitutes an unjustified assault on longstanding and well-founded corporate tax policy. The dividends-received deduction is a mechanism to mitigate multiple taxation of income distributed through a chain of corporations. Stated differently, where one corporation, P, claims the dividends-received deduction for amounts received as dividends from another corporation, S, there is no evasion of the corporate tax by P since S has paid corporate income tax on the earnings before paying the cash dividend to P. Moreover, should P pay out the cash received from S as a further dividend to P's shareholders, P's shareholders will pay an additional level of tax on the business income generated by S. Thus, for every tier in the chain of income-producing corporations, the dividends-received deduction is not a loophole and does not constitute 'corporate welfare.' It is a proxy for integration and serves as a check against multiple taxation.

In addition, if the Administration's proposal is enacted, even greater pressure would be added to the trend to "disincorporate" U.S. businesses, which would trigger significant unintended consequences. Finally, the proposal would exacerbate the difference between U.S. corporate income tax policy and that of much of the rest of the world since most U.S. trading partners (such as Canada) provide full or partial integration of their corporate-shareholder income tax regimes and thereby mitigate multiple taxation. In the past, the Treasury Department has acknowledged that the current system of multiple taxation of corporate income is economically inefficient. It is ironic and unfortunate that the Administration now proposes to take a step backward and exacerbate the current system's shortcomings. TEI urges that the proposal to reduce the dividends-received deduction be rejected.

Modification of the Loss

Carryover Rules

Administration Proposal. Under current law, a taxpayer may carry back a net operating loss (NOL) for 3 years and may carry forward the loss for 15 years. The Administration's proposal would reduce the carryback to 1 year, and expand the carryforward period to 20 years,

TEI Recommendation. The current NOL carryover period is designed to "smooth out swings in taxable income and loss caused by the annual accounting period requirement." Joint Committee Description 43. See also Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, 99th Cong., 2d Sess. 288 (1987) (NOL carryover periods permit taxpayers to average income and losses "to reduce the disparity between the taxation of businesses that have stable income and businesses that experience fluctuations in income."). The proposal would increase the taxes of struggling businesses at the time they need it least: following a...