Conduit rules under section 7701(l) of the Internal Revenue Code.

• Position: Tax Executives Institute International Tax Committee

On June 17, 1994, Tax Executives Institute submitted the following comments to the Internal Revenu regulations under section 7701(l) of the Internal Revenue Code. The Institute's comments on the so-c was prepared under the aegis of TEI's International Tax Committee, whose chair is Lisa Norton of Ing The following members of the Institute also contributed materially to the preparation of the Institu Bergquist, Apple Computer Co.; Joseph E. Bernot, AT&T Global Information Solutions Co.; Lester D. Ez Co.; Stephen H. Finnegan, McDonald's Corporation; Matthew H. Paull, McDonald's Corporation; and Raym Rossi, Intel Corporation.

The Omnibus Budget Reconciliation Act of 1993 added section 7701(l) to the Internal Revenue Code which authorizes the Secretary of the Treasury to issue regulations recharacterizing certain "multiple-party financing transaction[s]." In response to the government's request for taxpayer guidance before the regulations are issued, Tax Executives Institute submits the following comments on the scope of the impending regulations under section 7701(l).

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our approximately 5,000 members represent 3,000 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 ae one that is administrable and with which taxpayers can comply.

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 the anti-conduit regulations contemplated by section 7701(l) of the Code.

Overview

Section 7701(l) provides that --

The Secretary may prescribe

regulations recharacterizing

any multiple-party financing

transaction as a transaction

directly among any two or

more of such parties where

the Secretary determines

that such recharacterization

is appropriate to prevent

avoidance of any tax imposed

by this title. Although [section 7701(l)'s] grant of rulemaking power is broad, it is not without limit. The statute circumscribes the grant of regulatory authority in two ways: (i) the rules under section 7701(l) must address themselves to a multiple-party financing arrangement, and (ii) the exercise of the IRS's authority under the statute must be premised on a determination that the particular arrangement must be recharacterized to prevent tax avoidance. If these conditions are met, the IRS may recharacterize the transaction as a transaction between two or more entities, in order to reverse the unwarranted tax benefits.

Section 7701(l) was enacted in 1993 to address Congress's concern that taxpayers may be avoiding U.S. tax by intricately structuring financial transactions that utilize multiple entities, where the use of one or more of those entities serve no commercial purpose. See H.R. Rep. No. 103-213, 103d Cong., 1st Sess. 185 (1993) (Conference Report); H.R. No. 103-11, 103d Cong., 1st Sess. 729 (1993) (House Report). The legislative history cites several cases and rulings as examples of three-party arrangements that were to fall within the ambit of the provision, including Aiken Industries v. Commissioner, 56 T.C. 925 (1971), acq. on another issue, 1972-2 C.B. 383(1)(*); Rev. Rul. 87-89, 1987-2 C.B. 195(2); and Technical Advice Memorandum 9133004 (May 3, 1991)(3). Congress intended the provision to apply not only to back-to-back loan transactions, but also to multiple-party transactions involving debt guarantees or equity investments. Conference Report at 186. Section 7701(l) is thus a statutory arrow in the government's quiver to attack financing arrangements that exalt form over substance. See, e.g., Commissioner v. Court Holding Co., 324 U.S. 331 (1945).

TEI recognizes the government's need to address, somehow, abusive efforts by taxpayers to exalt form over substance by structuring financing arrangements. Such arrangements may involve only related parties, or they may involve an unrelated party acting in concert with the taxpayer. Section 7701(l), however, does not add to the authority already vested in the Treasury and IRS to attack sham arrangements. Rather, the provision is intended to facilitate the government's enforcement efforts by undergirding administrative guidance on the kinds of arrangements that will be disregarded for U.S. tax purposes. The grant of authority is so vague--and therefore potentially broad--however, that taxpayers understandably view the new statute with concern. Absent reasonable guidance, section 7701(l) will hang over taxpayers like a sword of Damocles, threatening to crash down on sound, as well as abusive, arrangements. In other words, we are concerned that examining agents may, without guidance, equate legitimate "tax planning" with impermissible "tax avoidance." See, e.g., Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934) (Hand, J. ("A transaction, otherwise within an exception of the tax law, does not lose its immunity, because it is actuated by a desire...