Comments on proposed foreign recordkeeping regulations under Section 6038A.

• Author: Ashby, Robert L.

Comments on Proposed Foreign Recordkeeping Regulations under Section 6038A

On December 4, 1990, the Internal Revenue Service issued proposed regulations under section 6038A of the Internal Revenue Code, relating to the information reporting and agency designation requirements for foreign-owned corporations. The regulations were published in the Federal Register on December 10, 1990 (55 Fed. Reg. 50706), and in the December 31, 1990, issue of the Internal Revenue Bulletin (1990-53 I.R.B. 45). The IRS held a public hearing on the regulations on February 22, 1991.

For simplicity's sake, the proposed regulations are referred to as the "proposed regulations"; specific provisions are cited as "Prop. Reg. [section]." References to page numbers are to the proposed regulations (and preamble) as published in the Internal Revenue Bulletin.

EXECUTIVE SUMMARY

The Omnibus Budget Reconciliation Act of 1989 amended section 6038A of the Internal Revenue Code by expanding the class of corporations subject to that information reporting provision to include corporations with at least 25-percent foreign ownership and by imposing additional recordkeeping requirements on those corporations. As enacted, these rules applied only to taxable years beginning after July 10, 1989, but in 1990 Congress extended the section 6038A amendments to cover all open years. With respect to summonses for records, however, the 1990 amendments are effective only if the records were in existence on March 20, 1990. See Omnibus Budget Reconciliation Act of 1990, Public Law No. 101-508, [subsection] 11314, 11315.

TEI filed pre-regulation comments on the 1989 Act amendments with the IRS on May 24, 1990. Although the Institute commends the IRS for incorporating several of our recommendations,(1) TEI believes that refinements are necessary to ensure that the recordkeeping and agency designation requirements do not become unworkable and overly burdensome. For example, while we welcome the inclusion of a safe harbor and de minimis exceptions, these mechanisms should be expanded to encompass more related party transactions.

The proposed regulations correctly recognize that section 6038A is a powerful new tool to obtain access to foreign-based books and records and, accordingly, that its application must be measured and consistent. On its face, the statute could be invoked to impose enormous administrative burdens for businesses of all sizes. Fortunately, the proposed regulations contain several provisions to ameliorate those potentially harsh burdens, including authorizing the negotiation of taxpayer-specific record maintenance agreements, the use of reasonable estimates on Form 5472, and the filing of one consolidated Form 5472 for all members of a consolidated group. The proposed regulations represent a good first step. More is needed, however, to ensure that the statute is applied judiciously and that its enforcement mechanisms are used only as a last resort. To achieve these objectives, we recommend that the proposed regulations provide that the imposition of penalties under section 6038A(e) (3) must be approved by the Assistant Commissioner (International). The prudent exercise of such authority is essential given Congress's decision to limit judicial review of the penalty determination.

With respect to the record maintenance requirements, we agree that the general recordkeeping requirements of section 6001 constitute the foundation on which the requirements of section 6038A are built. We strongly disagree, however, that section 6001 necessarily extends to records of any foreign related party that may be "relevant" to transactions between the reporting corporation and foreign related parties, including "indirectly related records." In our view, the regulations stretch section 6001's recordkeeping requirements and the Code's admittedly broad definition of "relevance" practically to their breaking point and should be circumscribed.

With respect to the agency designation, we agree that such designation does not, on its own, constitute a U.S. trade or business or a permanent establishment. The regulations should be clarified to state unequivocally that the agency designation is not evidence that may be considered in determining whether the related party is engaged in a U.S. trade or business under the Code, or has created a permanent establishment or fixed base for purposes of an income tax treaty.

SPECIFIC COMMENTS

1. Prop. Reg. [section] 1.6038A-1(h): De Minimis Rule

   Prop. Reg. [section] 1.6038A-1 provides the general rule that certain foreign-owned corporations engaged in a trade or business in the United States (a "reporting corporation") must furnish certain information annually on an information return (Form 5472) and maintain records relating to transactions between the reporting corporation and a foreign related party. Prop. Reg. [section] 1.6038A-1(h) provides an exemption from section 6038A's recordkeeping and agency requirements for certain de minimis transactions. The exemption applies to a reporting corporation (i) that has an aggregate value of not more than $2 million of gross payments made to (or received from) foreign related parties, and (ii) for which the aggregate value of the gross payments made to (or received from) foreign related parties is less than 10 percent of its U.S. gross income. In the preamble to the proposed regulations, the IRS requests comments on this de minimis rule. 1990-53 I.R.B. at 46.

   TEI strongly endorses the concept of a safe harbor for reporting corporations whose foreign related party transactions are insubstantial in relation to their aggregate business operations. We suggest, however, that the two-part test in the proposed regulations can operate to require the reporting of relatively insubstantial transactions. Consistent with the de minimis reporting exception set forth in Prop. Reg. [section] 1.6038A-2(b)(7), the regulations should provide that insubstantial transactions (measured by a dollar amount) not be taken into account in detemining whether the reporting corporation meets the two-part test. (2)

   Moreover, we recommend the final regulations adopt a straight percentage test. At a minimum, the regulations should provide that the exemption applies to a reporting corporation (i) that has an aggregate value of not more than $2 million of gross payments made to (or received from) foreign related parties, or (ii) for which the aggregate value of the gross payments made to (or received from) foreign related parties is less than 10 percent of its U.S. gross income. Alternatively, should the two-part test be retained, the de minimis ceiling on gross payments should be increased to $5 million and adjusted periodically for inflation.

   We also recommend that the IRS expand this exemption to encompass the Form 5472 information-reporting requirements, as well as section 6038A's record maintenance and agency-designation rules. We believe that such changes will ease the administrative burdens for both taxpayers and the government without doing violence to the policies underlying section 6038A.

2. Prop. Reg. [section] 1.6038A-1(i): Consolidated Filings

   In the preamble, the IRS requests comments on ways in which foreign corporations may file a single agency designation similar to the consolidated Form 5472 that may be filed under Prop. Reg. [section] 1.6038A-1(i). 1990-53 I.R.B. at 46.

   We recommend that the controlling foreign entity be permitted to file one agency designation on behalf of itself and its affiliates (as listed in the authorization document) without obtaining powers of attorney or similar authorization from each affiliate. The designation could be based on the Form 851 (Affiliations Schedule) which is filed with the consolidated return. Proof of such designation should not be required in advance of the time the underlying books and records are requested by the IRS during the audit.

   In addition...