TEI comments on dual consolidated loss rules: August 22, 2005.

• Author: Herson, John J.
• Position: Tax Executives Institute

On August 22, 2005, TEI filed the following comments with the Internal Revenue Service and U.S. Department of Treasury, relating to the proposed regulations on dual consolidated losses under section 1503(d) of the Internal Revenue Code. The comments were prepared under the aegis of TEI's International Tax Committee, whose chair is John J. Herson of Neenah Paper, Inc. Alan Richer and George Abowd of General Electric Company and Amy Behroozi of FedEx Services contributed materially to the preparation of the comments.

Section 1503(d) of the Internal Revenue Code provides that, except to the extent provided in regulations, the dual consolidated loss of a domestic corporation cannot be used to offset the income of a domestic affiliate in the year of the loss or any other taxable year. In May 2005, the Internal Revenue Service and U.S. Department of Treasury issued proposed regulations substantially revising the temporary and final regulations issued in 1989 and 1992. The proposed regulations were published in the May 19, 2005, issue of the Federal Register (70 FED. REG. 29867), and the June 20, 2005, issue of the Internal Revenue Bulletin (2005-25 I.R.B 1297). A hearing on the new rules is scheduled for September 7, 2005.

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. TEI has approximately 5,400 individual members who represent more than 2,800 of the leading corporations in the United States, Canada, Europe, and Asia. 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, because it provides certainty, that taxpayers can comply with in a cost-efficient manner.

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 1503(d) of the Code, relating to dual consolidated losses.

The Dual Consolidated Loss Rules

1. In General

   Section 1503(d)(1) of the Internal Revenue Code precludes the dual consolidated loss (DCL) of any corporation from reducing the taxable income of any other member of the affiliated group for that or any other taxable year. Originally enacted as part of the Tax Reform Act of 1986, section 1503(d) was intended to prevent a single economic loss from being used to reduce the tax on two separate items of income, one of which is subject to current tax in a foreign country but not the United States and the other of which is taxed in the United States but not in the foreign jurisdiction (the so-called double dipping of losses). The provision was targeted at dual resident corporations because the ability of such corporations to use the same loss against both foreign and U.S. income taxes was perceived as giving undue tax advantage to foreign investors who could utilize the structure to make U.S. investments. (1) Two years later, section 1503(d) was amended to apply to unincorporated separate business units (i.e., foreign branches, partnerships, and hybrid entities). See Technical and Miscellaneous Revenue Act of 1988, [section] 1012. Under section 1503(d)(3), the government is authorized to issue regulations providing that any loss of a separate business unit is subject to the DCL rules in the same manner as if such unit were a wholly owned subsidiary.

   The term "dual consolidated loss" is defined in Treas. Reg. [section] 1.1503-2(c)(5)(i) to mean the net operating loss of a domestic corporation incurred in a year in which the corporation is a dual resident corporation (DRC). The latter term is defined under Treas. Reg. [section] 1.1503-2(c)(2) as a separate unit of a domestic corporation or a domestic corporation that is subject to the income tax of a foreign country on its worldwide income or on a residence basis. To restrict the deduction of a dual consolidated loss, the regulations apply the separate return limitation year (SRLY) rules. Treas. Reg. [sub section] 1.1503-2(b)(1), (d)(2) (referring to Treas. Reg. [section] 1.1503-21(c)). (2)

   In the preamble, the IRS and Treasury Department state that the new regulations address three concerns: (i) minimizing the cases of potential over-and under-application, (ii) taking into account updated U.S. entity classification regulations and rules so that the rules can be applied with greater certainty, and (iii) reducing administrative burdens imposed on taxpayers and the IRS. 2005-25 I.R.B. at 1298-99.

   The current DCL rules are incredibly complex and difficult to understand and administer. With the advent of the check-the-box regime, these regulations have taken on added significance for taxpayers. We agree with the IRS and Treasury Department that a revision of the current rules is warranted.

2. Reducing Administrative Burden

   The proposed regulations make several changes to make the rules more administrable.

   1. Seeking Section 9100 Relief. The current regulations require various filings to be made on a timely filed return; upon discovery, taxpayers failing to make these filings in a timely manner must request an extension of time to file under Treas. Reg. [section] 301.9100-3. Because of the complicated nature of the DCL rules, many taxpayers may be unaware that they have a DCL compliance issue when they file their returns, leaving the burdensome and often protracted section 9100 relief process as their only option.

      Prop. Reg. [section] 1-1503(d)-1(c) substitutes a reasonable cause standard whereby a taxpayer failing to make a required filing will be considered to have satisfied the timeliness requirement if the taxpayer can demonstrate--to the satisfaction of the Director of Field Operations (DFO)--that the failure was due to reasonable cause and not willful neglect. Perhaps as important, the proposed regulations will give the taxpayer more certainty by...