Tax Executives Institute - U.S. Department of Treasury liaison meeting: February 4, 2004.

On February 4, 2004, Tax Executives Institute held its annual liaison meeting with the Office of Tax Policy of the U.S. Department of Treasury. The agenda for the meeting was published in the January-February 2004 issue of The Tax Executive. The minutes follow:

Introductory Comments

On behalf of the U.S. Treasury Department's Office of Tax Policy, Assistant Secretary Pamela F. Olson welcomed TEI President Raymond G. Rossi and the other members of the delegation from Tax Executives Institute to the liaison meeting. Mr. Rossi thanked the Treasury representatives for taking time to meet with the Institute. He noted that Ms. Olson had announced her intention to resign as Assistant Secretary. He thanked her for her service as Assistant Secretary, especially her openness and willingness to listen and wished her well in her future endeavors.

The delegations for the Treasury Department and TEI at the liaison meeting are set forth below.

1. Regulatory Projects

   1. Section 482 Services Regulations. Ms. Lange referred to the proposed section 482 services regulations, which were released in September. The Institute filed comments on the regulations and testified at the January hearing, expressing concern about several aspects, particularly the elimination of the cost safe harbor, its replacement with the simplified cost-based method (SCBM), and the effect of the statute of limitations in the examples relating to the contingent payment provisions. Ms. Lange noted that government spokespersons have expressed interest in the development of a periodic list of what the government considers "low-margin" services. She inquired about the status of the regulations and requested an update about the concerns raised in TEI's written comments.

      Ms. Angus noted that the proposed regulations represent the first attempt to revamp the current regulations since 1968. The world has changed considerably in the last 35 years, she said and issuing final regulations is a high priority for Treasury.

      Ms. Angus explained that the cost safe harbor in the current regulations has prompted many comments concerning what types of services fit within its borders. The new method was intended to have the same effect, but was structured to be self limiting, i.e., only low-margin services may qualify for its use. Treasury believes that the SCBM method is effective, she stated, but requested TEI's comments on the development of a per se list of low-margin services, including which services should be included and what form the list should take. She also asked for comments on the negative inference that may be drawn if an item were not included on the list.

      In respect of the statute of limitations issue, Ms. Lange noted the current regulations provide that written contracts between controlled parties will generally be respected as long as the terms are consistent with the economic substance of the parties' conduct; if not, the IRS may impute terms consistent with economic substance. Significantly, two examples in the proposed regulations considerably expand this authority, permitting the IRS to rewrite agreements if the taxpayer rendering services is not adequately compensated. Moreover, the examples indicate that the IRS is not limited to making transfer pricing adjustments for the years under audit, but rather, may choose to make an adjustment in the current years to correct an "erroneous" methodology in past years. Did this not suggest that the agency may vitiate the operation of the statute of limitations?

      Ms. Angus explained that the examples were intended to address a particular issue where a marketing company attempts to break into the U.S. market but receives no compensation for its efforts. When the market is established, the parties decide that the company is a distributor and there is only a small mark-up in its costs. The proposed regulations permit the IRS to re-cast the transaction to effect a fair allocation of income when a taxpayer has no documentation of the relationship and the relationship shifts to produce a different outcome. The rules are not intended as an end run around the statute of limitations. Mr. O'Connor said that TEI is concerned whether IRS agents will discern any temporal boundaries in reviewing transfer pricing issues. Ms. Angus stated that Treasury appreciates the issue. The government must have the ability to address abusive situations, she said, but clear rules are needed.

      Ms. Lange suggested that the proposed services regulations should not be finalized before taxpayers have had an opportunity to review and comment upon the proposed cost-sharing regulations when they are issued. Ms. Angus said the government has not considered how the effective dates between the two sets of regulations should interact. She added that both the cost-sharing regulations and the services regulations are high priority items for the government.

   2. Research Tax Credit Regulations. Mr. Rossi referred to the final regulations (T.D. 9104) on the definition of qualified research and computation of the research credit, as well as an Advance Notice of Proposed Rulemaking (ANPR) inviting additional comments on internal use software.

      Mr. Traubenberg commended Treasury for the issuance of the much improved regulations, particularly the adoption of a more rational "discovery test" that simply distinguishes between technical and non-technical research based on the section 174 definition. He asked where Treasury is going with the definition of internal use software. Treasury has rejected all suggestions to date, he said. What are you looking for?

      Ms. Olson explained that the ANPR identifies the problems Treasury has...