United States: Treasury Identifies Eight Regulations Subject To Modification And Potential Repeal

The Treasury Department on July 7 issued Notice 2017-38 which identifies eight regulations — including those issued under Section 385 — that could be subject to some reform, including modification, streamlining, or potential repeal.

Executive Order (EO) 13789, which was issued on April 21 by the president, ordered Treasury to review all "significant tax regulations" issued on or after Jan. 1, 2016, and to submit a report within 60 days that identifies those regulations that either (1) impose an undue burden on U.S. taxpayers, (2) add undue complexity to federal tax laws or (3) exceed the statutory authority of the IRS.

The eight regulations identified in the notice meet at least one of the first two criteria, meaning Treasury does not believe that the IRS has exceeded its statutory authority for any of those regulations. The eight regulations have been narrowed down from a universe of 105 total regulations issued after Jan. 1, 2016. The notice states that of those regulations, 53 were "minor or technical in nature," and that after treating the remaining 52 as potentially significant, a re-examination identified the eight regulations described in the notice.

Notably, several regulatory projects failed to make the cut, including:

• Final and temporary regulations under Section 7874 related to corporate inversions
• Temporary regulations under Section 901(m) related to covered asset acquisitions
• Temporary regulations under Section 721(c) related to transfers to partnerships with related foreign partners
• Final regulations under Section 956, related to foreign partnerships

Wide variety of tax regulations

The eight regulations identified in the notice cover a wide variety of subject matter and, for the most part, do not come as much of a surprise. Certain regulatory projects, such as the final and temporary regulations under Section 385, final regulations under Section 367 and proposed regulations under Section 2704, have generated considerable comment and criticism from taxpayers and practitioners as being overly burdensome. Other projects identified in the notice appear to be more targeted to specific transactions or other considerations, including final regulations under Section 7602 related to the participation of certain contractors of the IRS in litigation, and temporary regulations under Section 337(d) related to spinoffs involving transfers of property by a C corporation to a real estate investment trust (REIT).

 A list of the eight regulations follows:

• Proposed regulations (REG-129067-15) under Section 103 on the definition of a political subdivision: The proposed regulations require a political subdivision to possess (i) sovereign powers, (ii) a governmental purpose and (iii) governmental control. Commenters believe that this test imposes additional, unnecessary limitations and would disrupt the status of numerous existing entities.

• Temporary regulations (T.D. 9770) under Section 337(d) on certain transfers of property to regulated investment companies and REITs: The final regulations provided additional guidance on newly enacted provisions of the Protecting Americans from Tax Hikes (PATH) Act of 2015, and commenters expressed concern that the REIT spinoff rules could result in over-inclusion of gain in some cases.
• Final regulations (T.D. 9778) under Section 7602 on the participation of certain independent contractors in a summons interview: While the IRS has long relied on certain outside experts in tax litigation, the regulations allow attorneys as contractors to participate in certain litigation activities, including conducting depositions, which certain commenters objected to. Treasury indicated in the notice that it will "review these regulations as they concern the outside attorneys under contract with the IRS to participate in the taking of compulsory testimony under oath," which is the only mention in the notice of some specific action by Treasury with regard to any of the eight regulations.

• Proposed regulations (REG-163113-02) under Section 2704 related to restrictions on liquidation of an interest for estate, gift or generation-skipping transfer (GST) taxes: The regulations would restrict certain discounts from applying to the fair market value of certain interests related to family-controlled entities for estate, gift or GST tax purposes, which many commenters and taxpayers found concerning.

• Temporary regulations (T.D. 9788) under Section 752 related to recourse partnership liabilities: The temporary regulations generally provide rules for how certain liabilities are allocated under Section 752 solely for purposes of disguised sales, and whether "bottom-dollar payment obligations" provide for the necessary economic risk of loss to be taken into account as a recourse liability for a partnership. Final and temporary regulations (T.D. 9790) under Section 385 related to treatment of interests in corporations as equity or debt: Arguably the most prominent of the regulations issued during the time period specified by the EO, the regulations under Section 385 provide for minimum documentation standards related to purported debt instruments between related parties and for reclassification of debt as stock in certain situations. Taxpayers have long complained that the regulations would impose greater compliance burdens and have asked for a delay in the effective date of the documentation rules.

•   Final and temporary regulations (T.D. 9790) under Section 385 related to treatment of interests in corporations as equity or debt: Arguably the most prominent of the regulations issued during the time period specified by the EO, the regulations under Section 385 provide for minimum documentation standards related to purported debt instruments between related parties and for reclassification of debt as stock in certain situations. Taxpayers have long complained that the regulations would impose greater compliance burdens and have asked for a delay in the effective date of the documentation rules.

•   Final regulations (T.D. 9794) under Section 987 related to income and currency gain or loss with respect to qualified business units: The regulations provide rules for translating income from branch operations from a foreign country's functional currency to the owner's functional currency, calculating foreign currency gain or loss with respect to the branch's assets and liabilities, and recognition of such gain or loss when the branch makes a transfer to its owner.
• Final regulations (T.D. 9803) under Section 367 on the treatment of transfers of property to foreign corporations: The regulations eliminate the so-called "foreign goodwill exception" and limit the scope of the active trade or business exception related to certain transfers of property by U.S. persons to foreign corporations.

Impact and analysis

It is not yet clear what actions Treasury will take with regard to each of these regulations, though the notice states Treasury intends to propose reforms to mitigate the burdens identified by Treasury and described above. Such modifications may include full repeal of the regulation. For now, Treasury is requesting comments on whether these regulations should be rescinded or modified, and if the latter, how the regulations should be modified to reduce burdens and complexity. Those comments are due Aug. 7.

The EO requires Treasury to submit a final report by Sept. 18, 2017, to the president that should describe specific actions to address the regulations identified in the notice. At that point, Treasury will still need to take affirmative steps to implement the modifications or repeal the identified regulations.