Proposed intercompany transaction regulations under section 1502.

• Position: Tax Executives Institute Federal Tax Committee

On February 21, 1995, Tax Executives Institute submitted the following comments to the Internal Revenue Service on proposed regulations under section 1502 of the Internal Revenue Code, relating to the rules for intercompany transactions among corporations that join in filing a consolidated return. The comments were prepared under the aegis of the Institute's Federal Tax Committee, whose chair is Michael A. DeLuca of Household International, Inc. Also contributing materially to the Institute's efforts were the following TEI members: Philip G. Cohen of Unilever United States, Inc., Lester D. Ezrati of Hewlett-Packard Company, Charles J. Greene of Unisys Corporation, Douglas M. Hess of General Motors Corporation, Gerald K. Howard of GTE Corporation, Douglas M. Jerrold of Reynolds Metals Company, and Theresa A. Orlaske-Rich of General Motors Corporation.

On April 11, 1994, the Internal Revenue Service issued proposed regulations under section 1502 of the Internal Revenue Code, concerning the rules for intercompany transactions among corporations that join in filing a consolidated return.

The proposed regulations (CO-11-91) were published in the Federal Register on April 15, 1994 (59 Fed. Reg. 18011), and in the Internal Revenue Bulletin (1994-18 I.R.B. 48).(1)* Public hearings on the proposed rules were held on May 4, and August 8, 1994. Tax Executives Institute is pleased to submit the following comments on the proposed regulations.

Background

Tax Executives Institute (TEI) is the principal association of business tax executives in North America. The Institute's approximately 5,000 members represent more than 2,700 of the largest companies 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 the 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.

TEI members 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 training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed regulations relating to intercompany transactions among members of affiliated groups filing consolidated tax returns.

Overview

The proposed regulations on intercompany transactions represent the third part of a series of regulation projects initiated in February 1991 to overhaul the core of the consolidated return rules. The first project (CO-132-87 CO-78-90) revamps the separate return limitation year (SRLY) rules affecting loss carryovers under section 382. The second project (CO-30-92), finalized in T.D. 8560(2), revises the investment adjustment and earnings and profits rules contained generally in Treas. Reg. [sub-sections] 1.1502-32 and -33. This project completes the 1991 trilogy. The proposed intercompany transaction regulations expand the shift from the separate-entity theory of the 1966 consolidated return regulations to the single-entity theory. Under the proposed rules, transactions between the separate members of a consolidated group are treated as though they occur between divisions of a single entity for purposes of timing, character, source, and other tax attributes. "Only the amount and location of items remain on a separate entity basis."(3)

The proposed rules substantially alter the theoretical and conceptual framework and terminology governing the treatment of intercompany transactions for corporate groups filling consolidated returns. In many circumstances, the proposed rules produce the same result on taxable income as the current regulations. Consequently, the recognition of gain or loss from intercompany transactions will be generally deferred until a subsequent event or transaction occurs. Consistent with the current philosophy governing the promulgation of tax regulations, the framework of the proposed rules is set forth in general principles, supplemented by, in this case at least, a staggering number of examples illustrating the operation of the rules in specific cases. Finally, in keeping with the trend in regulatory guidance, the proposed rules are back-stopped by a general anti-abuse rule of broad and uncertain scope.(4)

Prefatorily, TEI observes that the general principles of the proposed rules are as dauntingly abstruse to apply as they are simple to state. The myriad examples, while providing concrete guidance in the specific fact patterns presented, provide precious little aid for transactions falling outside of their restricted scope. Moreover, in some examples the longstanding tax treatment of certain transactions has been upended by a seemingly purposeful result-oriented view that is inconsistent with sound economic or tax policy. In addition, the opaque nature of the general rules will prove confusing or even contradictory where the non-consolidated tax principles underlying the basic examples change. At a minimum, the IRS should develop additional guidance to fill in the regulatory interstices and should continue to revise or refine the intercompany transaction examples as the Code and regulations evolve.(5)

Change in Method

of Accounting

Prop. Reg. [sections] 1.1502-13(a)(3) states that "[t]he timing rules of this section are a method of accounting that overrides otherwise applicable accounting methods." The preamble explains that the "proposed regulations are a method of accounting to the extent they determine the timing of items" and adds that "[a] group's ability to change its manner of applying the final intercompany transaction regulations will be subject to the generally applicable rules for accounting method changes."[6]

These statements represent a radical departure from the current consolidated return regulations, the applicable case law (both pre- and post-1966), private rulings that consistently hold that the consolidated return regulations establish methods of reporting...