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‘Badly Flawed’ Tax Law Blamed for Rules Democrats Call Giveaways

Feb. 3, 2020, 9:46 AM

The U.S. Department of Treasury has come under fire from Senate Democrats for giving away too much to companies in its regulations implementing the 2017 tax law’s international changes. The retort: blame your colleagues.

More than two years after the law passed, Treasury officials say they still have about 100 pieces of guidance to complete on how to interpret parts of it. Some are needed to resolve gaps, poor writing and conflicts in the legislation.

Remaining items include guidance on changes to carried interest, a big issue for the compensation of private equity and hedge-fund managers, and final regulations carving out exceptions to a new tax on global intangible low-taxed income, or GILTI. The GILTI rules address one of several problems with the law that Treasury officials raised to congressional staff before it was passed, seven people involved in the drafting process told Bloomberg Tax. They asked to remain anonymous in order to talk freely about private discussions.

Republican lawmakers didn’t address those issues partly because they were under tremendous pressure from the administration to get the bill passed by Christmas that year, said Ryan Ellis, a Republican tax lobbyist who had discussions with congressional staff while the law was being drafted. The tax law was the last chance to get a major legislative win for President Donald Trump during his first year of office, following a failed attempt to repeal the Obama administration’s Affordable Care Act.

In addition, Republicans’ use of the fast-tracked budget process, known as reconciliation, to pass the bill required them to keep its net cost to $1.5 trillion over a 10-year period—a tough feat given the magnitude of the tax cuts in the legislation. Clearly flawed provisions were left as-is if changing them would have jeopardized the $1.5 trillion target, one of the people said.

“They had to put 12 pounds of shit in a 10-pound bag,” Ellis said.

Members of Congress and staffers who drafted the provisions Treasury warned about are often the ones asking the department to fix them, said several of the people involved in the drafting.

Lawmakers and their staffs knew the law’s shortcomings would need to be addressed in regulations or another bill. In those types of situations, “you can’t do everything,” Ellis said. “There are only so many seats on the life boat.”

All Eyes on Treasury

The question now is whether Treasury’s regulations are giving up too much revenue, and increasing the odds that the tax law will end up being far more expensive than originally thought.

Senate Finance Committee Democrats including ranking member Ron Wyden (D-Ore.) recently criticized regulators for their apparent use of guidance on new international provisions to give more tax cuts to the very wealthy and large corporations.

“We are well aware of the numerous glitches, mistakes, and unintended consequences contained within the hastily written tax law,” the senators said in a Jan. 16 letter to Treasury Secretary Steven Mnuchin and acting Office of Management and Budget Director Russell Vought. “The Treasury Department’s willingness to rewrite the law at the behest of the largest corporations and their lobbyists only serves to compound these harms.”

Treasury’s Assistant Secretary for Public Affairs Monica Crowley in a Dec. 30 tweet said the department met with many taxpayers and their representatives as part of the rulemaking process but wasn’t influenced by any particular company or group.

Mnuchin has been directly involved in much of the regulatory process, holding almost-daily meetings on tax law implementation at the beginning of 2018, according to his calendar for the first quarter.

A Treasury spokesperson said Jan. 30 that the department “was actively engaged in the entire legislative process in both the House and Senate, and we have maintained our strong working relationships with tax writers and their staffs in both chambers.”

Concerns Raised

One issue, identified by Treasury officials before the law’s passage as an error, is referred to by tax professionals as the downward attribution glitch. It would subject more U.S. investors to reporting obligations and taxes on previously exempt foreign interests. Private equity firms and large multinationals like Coca-Cola Co. would later write to Treasury complaining about the change.

In addition, the department flagged concerns over the drafting of the GILTI tax, aimed primarily at pharmaceutical and tech companies that aren’t already taxed at a rate of at least 13.125% overseas.

Treasury officials told congressional staff that the tax would hit some companies paying more than that rate, because of the way the provision interacted with existing rules requiring U.S. businesses to allocate certain expenses to their taxable foreign income, reducing the foreign tax credits they can claim.

It’s unclear if lawmakers and staff knew the full extent of that issue at the time, one of the people involved in the drafting process said. But it became clear shortly after the law’s passage, as Treasury ended up holding about 50 meetings with companies and trade groups on that provision alone, said one of the people familiar with the situation.

Lawmakers like Senate Finance Committee member Rob Portman (R-Ohio) also took an interest in the drafting of the GILTI regulations.

Getting Creative

Legislators and their staffs attempted to address the problems with the two international provisions, without altering the law itself, by describing in the law’s conference report how they intended the provisions to work.

Republicans, including former Senate Finance Committee Chairman Orrin G. Hatch (R-Utah), have urged the Internal Revenue Service and Treasury to adhere to those explanations when drafting regulations, arguing that that’s well within their authority. But department officials have often been reluctant to rely on the conference report.

On the two international provisions, Treasury yielded to some of lawmakers’ and taxpayers’ demands but hasn’t gone as far as some have asked.

The department eased reporting requirements for U.S. investors and addressed some of the consequences of the downward attribution glitch in proposed rules (REG-104223-18) and a revenue procedure released in October, but it didn’t fix the underlying problem.

Proposed regulations from June (REG-101828-19) would allow companies to exclude from GILTI income that’s already taxed overseas at a rate of at least 18.9%—equal to 90% of the new 21% U.S. corporate tax rate.

Business groups, like the American Council of Life Insurers and the Alliance for Corporate Taxation, and companies, including Goodyear Tire & Rubber Co., have requested that Treasury provide an even more generous exception in the final rules to be released in the coming months.

‘Badly Flawed’ Law

Some flaws in the legislation were brought up by lower-level staff in early meetings with House aides, one of the people involved in the drafting said. The most pressing issues were later raised again by Treasury in written comments circulated among congressional staff in both chambers and the Joint Committee on Taxation before the Senate introduced its version of the law.

Yet the Treasury Department didn’t see the final text of the Senate bill until after it was introduced and had undergone the so-called Byrd Bath—at which point it becomes much harder for changes to be made in a bill, one of the people involved in the drafting said. The Byrd Bath is the process of removing provisions in a reconciliation bill that fail to meet the requirements of the Byrd Rule, which prohibits the legislation from increasing the federal deficit after a decade.

That rule adds an element of complexity to reaching final agreement in a reconciliation package, one former Republican congressional aide said, adding that many of the points Treasury raised came very late in the process.

Mark Mazur, who was assistant secretary for tax policy at Treasury during the Obama administration, said the tax law has placed Treasury in the tough position of implementing novel and complicated provisions that don’t always work well together.

But to a certain extent, it’s not up to Treasury to fix problems with the law, said H. David Rosenbloom, a member in Caplin & Drysdale Chartered’s Washington office who worked at Treasury in the 1970s and 1980s.

The department should address “egregious errors,” but its desire to use regulations to make the system work more coherently has, at times, led them to push the bounds of what might historically have been deemed appropriate, he said.

“That is problematic because, to the extent they go too far to the detriment of taxpayers, they will be challenged in court and may well lose but to the extent they are overly favorable there is no one to raise objection,” Rosenbloom said.

“That seems reason enough for them to curb their impulses to ‘correct’ a badly flawed statutory text,” he said.

To contact the reporter on this story: Allyson Versprille in Washington at aversprille@bloombergtax.com

To contact the editors responsible for this story: Patrick Ambrosio at pambrosio@bloombergtax.com; Bernie Kohn at bkohn@bloomberglaw.com

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