Proposed revision of Revenue Procedure 65-17: adjustments required after a section 482 allocation.

• Position: Tax Executives Institute International Tax Committee

On January 16, 1996, Tax Executives Institute submitted the following comments to the Internal Revenue Service, concerning the proposed revision Of Revenue Procedure 65-17, which addresses the collateral consequences of transfer pricing adjustments under section 482 of the Internal Revenue Code. The Institute's submission was prepared under the aegis of its International Tax Committee, whose chair is Philip J. Bergquist of Apple Computer, Inc. The following members joined Mr. Bergquist in materially contributing to TEI's comments: Robert D. Adams of Halliburton Company and Lisa Norton of Ingersoll-Rand Company.

Revenue Procedure 65-17(1) addresses the collateral consequences of U.S. transfer pricing adjustments. Specifically, the procedure permits a qualifying U.S. taxpayer, whose taxable income has been increased by reason of an allocation under section 482 of the Internal Revenue Code, to receive payment from the related entity from (or to) which the allocation of income (or deduction) was made, without having the receipt of such payment considered a taxable distribution for federal income tax purposes. It is our understanding that the Internal Revenue Service is revising Rev. Proc. 65-17 to reflect both the 1986 changes to section 482 and the final section 482 regulations, which were issued in 1994. Tax Executives Institute is pleased to offer the following comments on, and recommendations concerning, the procedure.

1. Background

   Tax Executives Institute is the principal association of corporate tax executives in North America. Our more than 5,000 members represent approximately 2,700 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 - 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 issues of tax policy and administration.

   The past 30 years have seen a significant evolution in how foreign operations by U.S. multinational corporations are structured and in the technical rules for governing the U.S. tax consequences of international transactions. Foreign jurisdictions, too, have become increasingly active in the transfer pricing area, increasing the need for bilateral approaches to conflict resolution. In revising Rev. Proc. 65-17, the IRS has an opportunity to eliminate many ambiguities and bring a fuller measure of certainty to this area while advancing the goal of minimizing the potential for double taxation. We are pleased to have the opportunity to participate in this revision project and believe that it should be placed on the IRS and Treasury's 1996 business plan.

2. Introduction

   A substantial number of TEI members work for multinational companies that engage in international trade. Such companies often face the difficult issue of determining arm's-length transfer prices for goods and services that move between U.S. operations and foreign entities. When such prices are subsequently adjusted, taxpayers must reconcile the adjusted prices with the existing cash and economic situation. For the last 30 years, Rev. Proc. 65-17 has provided guidance to taxpayers in properly aligning their offshore cash situations with pricing adjustments. Given the changes in the law and the expanding global market, we agree that more guidance is needed.

   Rev. Proc. 65-17 essentially adopts the theory that section 482 adjustments will be treated as a loan from the entity to which the income properly belonged, to the entity that received the income.(2) This principle holds true whether the adjustment increases or decreases the taxpayer's reported U.S. taxable income.(3) Taxpayers may elect to establish "loan" accounts under prescribed IRS procedures. If such an election is not made, or if requests for relief are denied, then the taxpayer may face constructive dividend (or capital) treatment.

   Rev. Proc. 65-17 provides the mechanism for U.S. parent companies to establish and receive payment of the "loan" from a foreign subsidiary. The procedure addresses the situation in which a U.S. parent company was subject to a section 482 adjustment that increased its taxable income from a foreign subsidiary. Relief was provided not only to mitigate double taxation, but also to encourage future settlements of section 482 issues.(4)

   Rev. Proc. 65-17 provides the option of either offsetting dividends or repatriating cash to satisfy the receivable created by the section 482 adjustment.(5) In Rev. Rul. 82-80,(6) relief was extended to foreign-owned U.S. subsidiaries that are faced with a section 482 adjustment that increases their U.S. taxable income. The subsidiary may receive payment from its foreign parent of an amount not in excess of the increased taxable income. If Rev. Proc. 65-17 relief is granted, any original transaction that was adjusted is treated as if the correct amount had been paid. An example notes that where a U.S. subsidiary has paid more for services than an arm's-length amount, the foreign parent will not be considered to have received a dividend to the extent of the excess amount, and the withholding tax provisions of sections 881 and 1442 will not be applied. G.C.M. 38676 explains that any difference between the arm's-length charge and the amount actually transferred is to be established as an account receivable from the parent, pursuant to the general principles of Rev. Proc. 65-17.

   The IRS has recently endeavored to integrate Rev. Proc. 65-17 relief with its competent authority procedures.(7) Thus, the IRS has provided that "if a taxpayer intends to request competent authority assistance ... to resolve a double taxation matter in a treaty case, the taxpayer should request relief under Rev. Proc. 65-17 in conjunction with its request for competent authority assistance under the provisions of [Rev. Proc. 96-131, sec. 4 and sec. 10." These procedures properly place Rev. Proc. 65-17 within the bilateral...