Comment letter on ESOP dividend deductions 112205

Comment letter on ESOP dividend deductions 112205

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November 22, 2005 Via Electronic Filing CC:PA:LPD:PR (REG-133578-05) Courier’s Desk Internal Revenue Service 1111 Constitution Avenue, NW Washington, DC 20044 Re: Proposed Rule on Dividends Paid Deduction for Stock Held in ESOP Dear Sir or Madam: The American Benefits Council (Council) appreciates the opportunity to comment on the proposed regulations concerning which corporation is entitled to the deduction for applicable dividends under Internal Revenue Code Section 404(k). The Council is a public policy organization representing principally Fortune 500 companies and other organizations that assist employers of all sizes in providing benefits to employees. Collectively, the Council’s members either sponsor directly or provide services to retirement and health plans that cover more than 100 million Americans. In addition to our comments below, we respectfully request that a hearing be scheduled on this issue and the Council would appreciate testifying at this event. The Council is very concerned that the regulations, as proposed, would discourage employers with a foreign parent from establishing or maintaining an Employee Stock Ownership Plan (ESOP), resulting in harm to their American employees. The proposed regulations would harm these workers by denying the tax deduction to American employers that have a foreign parent, effectively eliminating one of the primary motivations for employers to establish ESOPs for employees. ...

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November 22, 2005
Via Electronic Filing
CC:PA:LPD:PR (REG-133578-05)
Courier’s Desk
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20044
Re:
Proposed Rule on Dividends Paid Deduction for Stock Held in ESOP
Dear Sir or Madam:
The American Benefits Council (Council) appreciates the opportunity to
comment on the proposed regulations concerning which corporation is entitled
to the deduction for applicable dividends under Internal Revenue Code Section
404(k).
The Council is a public policy organization representing principally
Fortune 500 companies and other organizations that assist employers of all sizes
in providing benefits to employees.
Collectively, the Council’s members either
sponsor directly or provide services to retirement and health plans that cover
more than 100 million Americans. In addition to our comments below, we
respectfully request that a hearing be scheduled on this issue and the Council
would appreciate testifying at this event.
The Council is very concerned that the regulations, as proposed, would
discourage employers with a foreign parent from establishing or maintaining an
Employee Stock Ownership Plan (ESOP), resulting in harm to their American
employees.
The proposed regulations would harm these workers by denying the
tax deduction to American employers that have a foreign parent, effectively
eliminating one of the primary motivations for employers to establish ESOPs for
employees.
This contradicts the expressed intent of Congress to encourage
employers to establish ESOPs.
2
The proposed rule directly reverses the position previously taken by the Internal
Revenue Service (the Service) in a private letter ruling that the domestic
subsidiary of the foreign parent is entitled to the dividend deduction even
though the dividends are paid by the foreign parent.
Although private letter
rulings can only be used by the recipient company and cannot be cited as
precedent, it is reasonable and common for other companies to look to the
Service’s stated position when implementing such plans in the absence of any
other guidance since 404(k) was first enacted 21 years ago. The Council is also
concerned that the proposed rule is inequitable to those companies that had not
yet received a written private letter ruling but, in some cases, had been told
informally that they would receive a favorable ruling.
Further, the Service’s statement in the preamble to the proposed rule, to the
effect that the statutory language of Section 404(k) can be clearly read only one
way – to support its new position that only the direct payor of the applicable
dividend (in this case, the foreign parent) and not the employer is entitled to the
deduction under 404(k) – is not only contradicted by the prior ruling, but by the
legislative history of Section 404(k).
Section 404(k) was introduced in section 542(a) of the Tax Reform Act of 1984,
P.L. 98-369 (TRA ’84). Although Section 404(k) has been amended a number of
times since 1984, the relevant part of the statutory language has continued to
read substantively the same.
The legislative history of several bills supports the
Service’s prior position that the employer sponsor of the ESOP is the corporation
entitled to the dividend deduction.
For example, the Senate Committee report to
TRA ’84, which was generally followed by the Conference Committee report,
states:
“Because such dividends are deductible to the employer corporation, they
do not qualify for the partial exclusion from income otherwise permitted
under Code section 116.” [Emphasis added].
Similarly, the General Explanation of the Revenue Provisions of the Tax Reform
Act of 1984 prepared by the Staff of the Joint Committee on Taxation states that
“[u]nder the Act, an employer is entitled to deduct the amount of any dividends
paid in cash during the employer’s taxable year with respect to stock of the
employer….” [Emphasis added].
Legislative history of subsequent amendments to Section 404(k) also reflects the
view that it is the employer corporation that receives the deduction rather than
the non-employer:
3
“Under prior and present law, an employer is entitled to deduct the
amount of any dividends paid in cash during the employer’s taxable year
with respect to stock of the employer that is held by an ESOP.”
General Explanation of the Tax Reform Act of 1986 Prepared by the Staff of the
Joint Committee on Taxation, at 843.
[Emphasis added].
“Present Law.
Dividends paid deduction.
In certain circumstances,
present law permits an employer to deduct dividends paid on securities
held by an ESOP to the extent the dividends are (1) paid out currently to
plan participants or (2)used to repay a loan used to acquire employer
securities (sec. 404(k))…. The present-law tax incentives for ESOPs were
designed to encourage employers to establish ESOPs…”
Committee Report to the Omnibus Budget Reconciliation Act of 1989, P.L. 101-
239.
[Emphasis added].
We do not believe that this repeated reference to the employer as receiving the
deduction under 404(k) can be disregarded.
For example, the definition of
“applicable employer security” with respect to which dividends are deductible
under Code Section 404(k)(3)(B) is by statute determined on a controlled group
basis.
Yet the Service’s narrow interpretation in the proposed regulations
effectively makes that statutory provision meaningless if a parent corporation is
foreign.
Rather, the legislative history indicates that, in the controlled group
context, it is the employer of the employees participating in the ESOP who
receives the deduction for the dividends paid.
The words of the statute
“dividends paid in cash by such corporation” should not be narrowly interpreted
as “dividends paid in cash DIRECTLY by such corporation”.
To give full effect
to the statute, it should include dividends paid in cash by a member of the
controlled group of corporations of which the corporation that employs the
ESOP participants is a member.
Such dividends should be treated as indirectly
paid by the employer corporation.
Furthermore, the proposed regulation contradicts fundamental principals of tax
law, which treat the service recipient as the entity entitled to the deduction.
The
mere fact that parent stock is used to provide the compensation is irrelevant.
In
this regard, for example, the Section 1032 regulations explicitly reconstruct
transactions of this type as a transfer of stock from the parent to the subsidiary,
followed by a compensatory payment to the subsidiary’s employee.
See also
Revenue Ruling 80-76, Internal Revenue Code Section 83(h) and Treas. Reg.
Section 1.83-6, as well as numerous private letter rulings where the person for
whom the services were performed (i.e., the subsidiary-employer) is entitled to a
deduction with respect to the transfer of property by a shareholder or parent
company to an employee of the employer.
4
For these reasons, the Council recommends that the Service and the Department
of Treasury revise this portion of the proposed regulations to allow the
sponsoring employer to take the deduction under 404(k).
In the alternative, the
Council recommends that the Service simply withdraw this portion of the
proposed regulations.
Again, we appreciate the opportunity to comment on the regulations relating to
deduction of ESOP dividends.
We believe that the American Benefits Council
offers an important and unique perspective of the employer sponsors of
retirement plans and we would be pleased to make this perspective and
additional information available to the Service.
If this would be helpful, please
call me at 202-289-6700.
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Director, Retirement Policy
American Benefits Council