TEI--treasury department--office of tax policy liaison meeting agenda.

June 5, 2014

2014 Priorities and Challenges

We invite a discussion of the Office of Tax Policy's (OTP) priorities, as well as the challenges OTP is facing in the current environment of declining budget and staffing resources and increasing workloads.

Capitalization Issues

Final regulations on the treatment of expenditures for tangible property include many helpful revisions and clarifications. Among the changes is the addition of an elective $5,000 per item (or per invoice) AFS safe harbor de minimis rule in Treas. Reg. [section] 1.263(a)-1(f), the elimination of the ceiling rule on such expenditures, and the extension of the repair and maintenance safe harbor to buildings under Treas. Reg. [section] 1.263(a)-3(i). We commend the IRS and Treasury Department for these changes. Contemporaneously with the final capitalization rules, re-proposed regulations on dispositions of tangible depreciable property [REG-110732-15] were issued. TEI invites a discussion of two issues and invites an update on the re-proposed disposition rules.

First, although many taxpayers will be able to avail themselves of the new AFS de minimis safe harbor rule to minimize or eliminate examinations of de minimis expenditures for tangible property, some taxpayers may have an AFS dollar threshold that exceeds the regulations' cap on the AFS de minimis policy. As with the temporary regulations, the preamble to the final regulations notes that the de minimis threshold for deductions of expenditures for tangible property is not intended to prevent a taxpayer and examining agents from reaching an agreement that certain items will not be reviewed. Taxpayers must be prepared to show that their AFS policy clearly reflects income. Have there been any discussions between the IRS and Treasury about what taxpayers must show to demonstrate that their policies "clearly reflect income"? Is the issue solely one for taxpayers and IRS examiners to work out administratively or will the Treasury Department actively monitor administration of the $5,000 AFS cap?

Second, some taxpayers have executed closing agreements with the IRS in respect of methods of accounting for capitalization, repairs, dispositions or other items affected by the final tangibles regulations or the re-proposed disposition regulations. Are methods subject to closing agreements also subject to the new rules and the transition guidance for automatic changes in the revenue procedures? In some cases, taxpayers may have "traded" a closing agreement on an accounting method to resolve another significant issue. The binding agreement and issue resolution that taxpayers thought they had achieved may now be mooted.

More generally, what is the status of the re-proposed regulations on dispositions (and any related guidance to implement the rules)? Will there be any significant changes to the re-proposed rules?

Research Expenditures

1. Research Credit--Intragroup Gross Receipts

   In December 2013, the IRS and Treasury Department issued proposed rules creating an "exception" to the "single taxpayer" rule of the research credit regulations. Under the proposed rule, U.S. taxpayers would be required to include gross receipts from transactions between U.S. controlled group members and foreign group members where there is a subsequent transaction between a foreign group member and a third party involving the same property or services sold by a U.S. group member and that sale does not give rise to effectively connected gross receipts.

   The proposed rules are contrary to the statute (1) and would overturn the result in Procter & Gamble Co. and Subsidiaries v. United States, 733 F. Supp. 2d 857 (S.D. Ohio, 2010); No. 1:08-cv-00608-TSB (Jun. 25, 2010), which decided that the plain language of section 41(f) requires the exclusion of sales to foreign affiliates from gross receipts. Specifically, the court said that section 41(f)(1)(A) plainly requires that "in determining the amount of the credit ... all members of the same controlled group shall be treated as a single taxpayer...." The court also relied on U.S. Treasury Department regulations which provided: "[b]ecause all members of a group under common control are treated as a single taxpayer for purposes of determining the research credit, transfers between members of the group are generally disregarded." (The court cited Treas. Reg. [section] 1.41-6T(i) (2005); see also Treas. Reg. [section] 1.41-6(i) (2010)).

   Given the plain language of the statute and the court's interpretation of that statute in Proctor & Gamble, it is surprising that the government is proposing a rule that can only limit the availability of the research credit for taxpayers using the traditional method of calculating the research credit. Congress has repeatedly re-enacted the section 41 credit as an incentive to support domestic research and experimentation activities without any change to the single taxpayer rule or to rule excluding foreign corporations' gross receipts. The proposed rule will undermine that incentive because the inclusion of intra-group sales in the gross receipts factor will directly and significantly impair the research credit claimed by many domestic companies. We believe that by enacting section 41(f)(1)(A) Congress purposefully provided the "single taxpayer" rule to preclude domestic and foreign sales within the controlled group from reducing the research credit. We invite a discussion of the Treasury Department's view of the proposed rule and especially whether it undermines the incentive effect that Congress intends for the research credit.

2. Section 174 Proposed Regulations

   On September 6, 2013, the IRS and Treasury Department issued proposed regulations affecting taxpayers that incur section 174 research and experimental (R&E) expenditures. The proposed regulations primarily address the eligibility of pilot model costs and whether the subsequent sale or business use of the pilot model created to resolve design uncertainties affects the eligibility of the costs for section 174 treatment. In addition, a "shrinking-back" rule similar to Treas. Reg. [section] 1.41-4(b) (2) is added where the research requirements of [section] 1.174-2(a)(l) are met only with respect to a component part and not with respect to the overall product of which the component is a part.

   The proposed rules are generally helpful in resolving the treatment of pilot model costs, however, TEI is concerned about the application of the "shrinking back" rale of Prop. Reg. [section] 1.174-2(a)(5). Prop. Reg. [section] 1.174(a)(5) states, "[t]he presence of uncertainty concerning the development or improvement of certain components of a product does not necessarily indicate the presence of uncertainty concerning the development or improvement of other components of the product or the product as a whole." While true, the line between components or subcomponents and the product is not always clear. Indeed, the performance of the product or other components can be significantly affected by the redesign or changes to one component. Hence, the language may be cited by IRS examiners using hindsight to challenge expenditures incurred to test whether an improved, refined, or re-designed component can be successfully integrated with other components or sub-systems, or the product as a whole.

   In many complex products, such as automobiles...