Notice 96-18: interest netting study.

• Position: Tax Executives Institute IRS Administrative Affairs Committee

On June 28, 1996, Tax Executives Institute submitted the following comments to the Internal Revenue Service on Notice 96-18, which invited public comments on the IRS and Treasury Department's study of issues surrounding the computation of interest where overpayments and underpayments of tax liabilities overlap. The Institute's comments were prepared under the aegis of TEI's IRS Administrative Affairs Committee, whose chair is Robert L. Ashby of Northern Telecom Inc. Frank J. Real of Consolidated Rail Corp. coordinated the preparation of the Institute's comments on the interest netting study, Robert H. Proehl of BellSouth Corporation also contributed materially to the project.

On March 20, 1996, the Internal Revenue Service issued Notice 96-18,(1) inviting public comment in connection with a study of issues surrounding the computation of interest where overpayments and underpayments of tax liabilities overlap. Tax Executives Institute is pleased to submit the following comments in response to that invitation.

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 5,000 members represent more than 2,700 of the leading corporations in the United States and Canada. 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 interest-netting study.

Good Tax Policy Favors Comprehensive Interest Netting

Section 6402(a) of the Internal Revenue Code authorizes the IRS to credit overpayments and interest on overpayments against a taxpayer's liability for underpayments and interest on underpayments. Section 6601(f) provides that no interest will be imposed on the portion of an underpayment that is satisfied by crediting an overpayment. Prior to 1987, the same interest rate applied to underpayments and overpayments of tax. As part of the Tax Reform Act of 1986, however, Congress created an interest rate differential or "spread" by providing in section 6621(a) that the interest rate charged on underpayments be one percentage point higher than the interest rate paid on overpayments. Where both an underpayment and overpayment of tax exist at the same time, it will always be beneficial for the taxpayer to have interest calculated on the net balance rather than on the gross amount of deficiency and refund. To ameliorate the effect of the spread on taxpayers, Congress enacted section 1511(b) of the Tax Reform Act, which states:

The Secretary of the Treasury or

his delegate may issue

regulations to coordinate section

6621 of the Internal Revenue

Code of 1954 (as amended by

this section) with section

6601(f) of such Code. Such

regulations shall not apply to

any period after the date 3 years

after the date of enactment of

this Act.

Hence, Congress recognized the potential hardship flowing from the interest-rate differential for taxpayers who have both overpayments and deficiencies spanning several years. The purpose of section 1511(b) was to provide a transition period within which the IRS was to coordinate the interest-rate differential provisions with the offset rules of section 6601(f); after this period, comprehensive netting procedures were to be implemented. The Conference Committee Report on the 1986 Act explains:

Section 6601(f) provides that, to

the extent a portion of a tax due

is satisfied by a credit of an

overpayment, no interest is

imposed on that portion of the

tax. Consequently, if an

underpayment of $1,000 occurs

in year 1 and an overpayment of

$1,000 occurs in year 2, no

interest is imposed in year 2

because of the rule of section

6601(f). The IRS can at present

net many of these offsetting

overpayments and

underpayments. Nevertheless,

the IRS will require a transition

period during which to

coordinate differential interest

rates with the requirements of

section 6601(f). The Senate

amendment, therefore, provides

the Secretary of the Treasury

may prescribe regulations

providing for netting of tax

underpayments and

overpayments through the period

ending three years after the date

of enactment of the bill. By that

date, the IRS should have

implemented the most

comprehensive netting procedures

that are consistent with sound

administrative practice.(2)

Despite the unambiguous instruction that the IRS "should have implemented...comprehensive netting procedures" within three years, no such procedures were developed by the agency.(3) As a result, when Congress increased the interest rate for large corporate underpayments by two percentage points (thereby increasing the aggregate interest rate differential between overpayments and underpayments to three percentage points) in the Omnibus Budget Reconciliation Act of 1990, it affirmed its prior directive saying that "the Secretary should implement the most comprehensive crediting procedures under section 6402 that are consistent with sound administrative practice."(4)

Again in 1994, when the interest rate differential between certain large corporate underpayments and corporate overpayments was increased to four and one-half percentage points in the Uruguay Round Agreements Act (the so-called GATT interest rate), Congress urged the Secretary of the Treasury to "implement the most comprehensive crediting procedures under section 6402 that are consistent with sound administrative practice," adding (in a tone of exasperation that reflects both congressional and taxpayer frustration) that the Secretary "should do so as rapidly as practicable."(5) Thus, as Congress has ratcheted the interest-rate differential upwards, it has -- in increasingly ardent language -- directed the IRS to implement the most comprehensive procedures practicable that permits overpayments to be credited against underpayments.

In deference to the administrative difficulties confronted by the IRS in creating a comprehensive, automated computer system for calculating and crediting the proper amount of interest, Congress has tempered its calls for comprehensive netting with the acknowledgment that the procedures must be "consistent with sound administrative practice." Nonetheless, congressional impatience with IRS delays was signaled during the hearings in 1995 relating to the Taxpayer Bill of Rights 2 legislation. The IRS Oversight Subcommittee's report leaves no doubt that some in Congress perceive that deference to "sound administrative practice" has become a shield for bureaucratic intransigence:

The Subcommittee has become

increasingly disappointed

at the prolonged failure

of the IRS to implement

comprehensive interest netting

procedures. The Subcommittee

is uncertain

whether this prolonged delay

stems from genuine technical

difficulties in implementing

interest netting or whether

it stems primarily from

administrative hostility towards

interest netting.(6)

Indeed, a cynic might conclude that the interest-netting study, which was initially described in Announcement 96-5, Administrative Initiatives to Enhance Taxpayer Rights,(7) was initiated to forestall additional legislation such as the provision in the House version of the Taxpayer Bill of Rights 2 legislation that would have mandated an interest-netting study. If that was the objective, it was successful, for the provision was removed in the Conference Agreement on the subsequently vetoed Revenue Reconciliation Act of 1995.

Current IRS Netting Procedures

As summarized in Notice 96-18, the IRS has developed crediting procedures to implement netting in limited circumstances. For example, current practice is to consider all increases and decreases in a taxpayer's liabilities within a single tax year before applying the statutory interest rules to the year. Thus, in Rev. Proc...