Taxation Committee Meeting Washington, D.C.

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Taxation Committee MeetingWashington, D.C.
Tax Counsels Report James Atkinson
Lori Wittlin November 7, 2005
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Agenda

• The Current Environment
• In Washington
• In the Field
• FAS 109
• Update on Repair Regulations
• Update on Production Deduction
• Presidents Tax Reform Panel

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The Current Environment The View from Washington

• Treasury
• Severe staffing shortages at senior levels
• Guidance plans affected by this and by need for
  disaster relief
• The IRS National Office

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The Current Environment In The Field

• Focus on compliance
• Big push for currency
• Protracted dispute process
• Encouraging self-regulation
• SOX as a backstop
• A combination of carrots and sticks

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The Carrots

• Pre-Filing Agreement Program
• LIFE Audit Program
• CAP Program
• Early Referral to Appeals
• Fast Track Appeals
• Skip audit cycles or survey years for
  compliant taxpayers

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The Sticks

• Disclosure Rules
• Increased Use of Penalties
• Penalties are becoming routine
• Enactment of new Section 6662A
• SEC Disclosure Requirements
• Changes to Circular 230
• Tax Accrual Workpaper Rules

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The Outlook

• Eversons promise IRS will return 8 for every
  additional dollar invested in the IRS.
• Unlikely that IRS budget will be
  increased significantly in the near future.
• Continued pressure on IRS to raise more with
  fewer resources.

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FAS 109

• FASB expects to issue a final Interpretation,
  which would include amendments to Statement 109,
  in the first quarter of 2006.
• Posted to FASB website on October 12,
  2005.

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Update on Repair Costs

• The Sixth Circuit affirmed the district courts
  FedEx decision on February 16, 2005.
• FedEx Corp. v. United States, 412 F.3d 617
  (6th Cir. 2005), affg 291 F. Supp. 2d 699
  (W.D. Tenn. 2003).

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Repair Regulations

• Second step of trying to rationalize the
  capitalization area. The INDOPCO Regulations
  dealing with intangibles was the first step.
• Notice 2004-6 asked for public comment on a
  number of issues.

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Unit of Property

• IRS and Treasury have agreed on a definition of
  unit of property.
• Wont be pure facts and circumstances and wont
  be functional interdependence test.
• Likely to resemble multi-factor test of FedEx.
• Wont address long stringy assets such as
  transmission lines and pipelines.

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Life, Use, Value

• Likely to remain the fundamental standard due to
  amount of case law and taxpayer familiarity with
  standard.
• Life. Likely to be similar to current definition
  in section 167 regulations.
• Value.
• Struggling to define disfavors fair market
  value.
• Safe harbor likely, based on percentage of some
  benchmark.
• Use. No real discussion of this factor.

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Plan of Rehabilitation

• Applied aggressively by Exam, despite National
  Office attempts to curtail broad application.
• Only applies to specific unit of property.
• Only applies if there is at least one capital
  activity.
• Absolute cost of project is not determinative.
• Definition of unit of property will play a key
  role.

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Repair Allowance

• Strong sentiment in ITA to provide elective
  repair allowance but there are practical
  problems it is less clear how Treasury views it.
• One difficulty is determining the correct
  percentages IRS not confident about accuracy of
  most recent percentages and does not have
  resources to determine new ones. IIR approach?
• Also not sure what to do with excess repair
  costs. Considering treating as separate
  intangible.

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De Minimis Rules

• IRS seems conflicted. Appears to want to allow
  de minimis rule but not sure how to do so.
• Concern with horizontal equity.
• Concern with negative implication if dont
  provide one.
• Not sure whether to provide flat dollar amount or
  based on a percentage of some benchmark.

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Timetable

• Goal is to have proposed regulations out by end
  of calendar year.
• Actual timing may be affected by Treasury
  staffing shortages, need for disaster relief
  guidance, tax reform activities, or other
  unexpected priorities.

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Method Change Requests

• Some taxpayers are being advised to file
  protective accounting method change requests in
  anticipation of the new regulations.
• The chances of ultimately receiving a favorable
  response depend largely on how similar the
  requested method is to the position ultimately
  taken by Treasury and whether the guidance is
  seen as a change in the law.
• Consider the treatment of the 12 month rule
  changes filed prior to the final intangibles
  regulation.

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One final point about repairs . . .

• Environmental Cleanup Costs
• Rev. Rul. 2004-18. Environmental cleanup costs
  are subject to section 263A if related to
  production activities.
• Rev. Rul. 2005-42. Cleanup costs must be
  included in the production costs of whatever is
  produced in the year in which the cleanup occurs
  they dont relate back to the year in which the
  contamination occurred.

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Production Deduction

• Section 199 permits a deduction for certain
  qualifying production activities.
• Notice 2005-14 issued in January proposed
  regulations issued October 20.
• Generally applies to receipts relating to the
  production of natural gas only up to the point at
  which the natural gas becomes pipeline quality.

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Production Deduction

• What is pipeline quality?
• Is injecting the smell into the natural gas a
  qualifying production activity?
• Is liquefaction enough to constitute
  manufacturing?
• Is re-energizing gas that has been stored for
  some period of time a production activity?

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Production Deduction

• In general, government is interpreting section
  199 extremely narrowly.
• Doubts generally resolved against taxpayers be
  cautious in asking for clarifications.

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Presidents Tax Reform Panel

• Two reform proposals that share a common set of
  goals and rely on similar principles
• Moving as far as possible to eliminate the
  double taxation of corporate earnings, encourage
  business investment, and provide a more level
  treatment of debt and equity financing.
• Updating international tax rules to reduce
  economic distortions and create a more level
  playing field that promotes U.S.
  competitiveness.
• Eliminating individual and corporate AMT.

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2 Approaches to Tax Reform

• Simplified Income Tax Plan
• Top corporate tax rate lowered to 31.5.
• Would overhaul current depreciation system by
  collapsing the number of asset classes and
  methods.
• Would provide a full exclusion for individual and
  corporate taxpayers of dividends paid by
  U.S. corporations out of domestic earnings.
• Would exclude 75 of capital gains on the sale of
  stock of U.S. corporations.

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2 Approaches to Tax Reform

• Growth and Investment Tax Plan
• Top corporate tax rate lowered to 30.
• Would replace current depreciation system with
  immediate write-offs for purchase of new assets.
• No deduction for payments of interest and
  dividends.
• Would impose a flat 15 tax on all interest,
  dividends, and capital gains received by
  individuals.

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Other Tax Reform Options Considered

• VAT
• Panel could not reach a consensus on a VAT.
• National Sales Tax
• Rejected by Panel as regressive.

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Contact Information

• James Atkinson
• [phone]
• jatkinson_at_milchev.com
• Lori Wittlin
• [phone]
• lwittlin_at_milchev.com
• www.millerchevalier.com