Proposed regulations under Section 404A of the Internal Revenue Code.

On January 6, 1994, Tax Executives Institute filed the following comments with the Internal Revenue Service on proposed regulations under section 404A of the Internal Revenue Code, relating to limitations on deductions and adjustments to earnings and profits with respect to certain foreign deferred compensation plans. The comments were prepared under the aegis of TEI's International Tax Committee, whose chair of the committee is Lisa Norton of Ingersoll-Rand Company, and its Employee Benefits Subcommittee, whose chair is David L. Klausman of Westinghouse Electric Corporation. The following TEI members also contributed materially to the preparation of the submission: Robert J. Arthur of Johnson & Johnson, Anne M. Maher of General Motors Corporation, Susan A. Williams of Hewlett-Packard Company, R. Douglas Kyle and David Crawford of Weyerhaeuser Company, and Joseph W. Tierney and Joyce Fukami of Digital Equipment Corporation.

On May 6, 1993, the Internal Revenue Service issued proposed regulations under section 404A of the Internal Revenue Code, relating to limitations on deductions and adjustments to earnings and profits with respect to certain foreign deferred compensation plans. The notice withdraws proposed regulations that were issued on April 8, 1985. The new proposed regulations were published in the Federal Register on May 7, 1993 (58 Fed. Reg. 27219), and in the Internal Revenue Bulletin on May 24, 1993 (1993-21 I.R.B. 10). On October 5, 1993, the IRS held a public hearing on the proposed regulations.(1)

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our approximately 4,900 members represent 2,400 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 as 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 proposed regulations under section 404A, relating to limitations on deductions and adjustments to earnings and profits with respect to certain foreign deferred compensation plans.

Overview

Section 404A of the Internal Revenue Code permits taxpayers to elect to deduct from earnings and profits (E&P) contributions to certain foreign pension plans designed for nonresident aliens who work outside the United States, even though the plans do not meet the requirements of U.S. law. The deduction is generally limited to the lesser of the amount allowed under foreign law or the amount allowable under standards comparable to those applied to U.S. retirement plans.

Section 404A was enacted in 1980 and essentially blends complex technical concepts involving employee benefits, international taxation, and tax accounting. A "qualified foreign plan" is defined under section 404A(e) as a written plan of an employer (who elects to apply section 404A) for deferring the receipt of compensation, if (i) the plan is for the exclusive benefit of the employer's employees or their beneficiaries; and (ii) 90 percent or more of the amounts taken into account for the taxable year are attributable to services performed by nonresident aliens whose compensation is not subject to U.S. tax. There are two types of qualified foreign. plans under section 404A: qualified reserve plans and qualified funded plans.(2)

With respect to qualified reserve plans, the proposed regulations generally follow prior IRS announcements. The proposed regulations' treatment of qualified funded plans, however, is seriously flawed, and raises significant compliance problems for taxpayers. The administrative burdens imposed by the proposed regulations (e.g., the requirement for filing amended returns at least back to 1980 and possibly before) are substantial. Rather than redressing taxpayers' concerns about the treatment of foreign deferred compensation plans, the proposed regulations constitute a dramatic and unjustified shift from the IRS's prior announced positions and they raise more questions than they answer. This situation is untenable--the statute was passed more than a decade ago and taxpayers have been struggling in the interim to comply as best they can. To mitigate the confusion and burden caused with respect to section 404A, TEI recommends that taxpayers be permitted to compute their contributions to foreign pension plans in accordance with U.S. generally accepted accounting principles.

Moreover, because of the drastic changes and reversals of position set forth in the proposed regulations, the Institute strongly recommends that the final regulations apply with respect to qualified funded plans only on a prospective basis--with sufficient lead time to permit taxpayers to gather the necessary data to ensure compliance. Our comments on the specific provisions of the proposed regulations document the need for this prospective-only treatment and are set forth below.

Use of U.S. GAAP Rules to Compute E&P

The legislative history of section 404A specifically recognizes that U.S. employers should be permitted to take deductions and make adjustments to E&P in respect of their obligations under their foreign plans. S. Rep. No. 96-1039, 96th Cong., 2d Sess. 12 (1980) (hereinafter referred to as the "Senate Report"). Congress also acknowledged that, except as necessary to prevent distortion of income or the allowable foreign tax credit, "[i]t is unnecessary to burden qualification for these tax benefits with many of the provisions intended to protect employees and their beneficiaries applicable to domestic plans." Id.

In 1992, the IRS issued proposed regulations under sections 952 and 964 of the Code that expressly recognized the need to reduce the administrative burdens associated with computing E&P for foreign corporations. Those regulations eliminated the need to adjust financial statements prepared in accordance with U.S. generally accepted accounting standards (GAAP) to reflect the Internal Revenue Code's uniform capitalization and depreciation rules. In the Institute's October 8, 1992, comments on these GAAP E&P regulations, we expressed the belief that the regulations represented "the first step in the development of a simplified method for computing E&P that will significantly reduce the existing compliance burden." We also said that more needed to be done.

TEI believes that the GAAP E&P method should be broadened beyond the limited items enumerated in the proposed section 964 regulations. Specifically, taxpayers should be permitted to use U.S. GAAP rules as an alternative to making book-to-tax adjustments for foreign pension plan contributions. Statement of Financial Accounting Standards (FAS) No. 87 provides comprehensive rules for contributions to foreign pension plans. The use of the GAAP E&P method would therefore represent a major simplification of this area. At a minimum, the U.S. GAAP rules should be adopted with respect to noncontrolled foreign corporations. Such an approach would substantially reduce complexity and result in a significant decrease in compliance burdens for the taxpayer and government alike.

Prop. Reg. § 1.404A-l(a): Exclusive Means for Deduction

1. In General. Prop. Reg. § 1.404A-l(a) provides that, if an employer's plan does not satisfy the requirements of section 404, section 404A provides the exclusive means by which an employer may take a deduction or reduce E&P in respect of contributions to foreign pension plans.(3) The proposed regulations stand in stark...