For Release Upon Delivery JOINT STATEMENT OF THE HONORABLE JOHN E. CHAPOTON THE HONORABLE ROSCOE L. EGGER COMMISSIONER OF INTERNAL REVENUE SERVICE Mr. Chairman and Members of the Subcommittee: We are pleased to appear before you today to discuss the proposed imputed interest regulations under sections 482 and 483. We would like to take this opportunity to present the results of the review by the Treasury Department and the Internal Revenue Service of these regulations. At the outset, however, we would like to correct a fundamental misunderstanding that has permeated all aspects of the debate over these regulations. The Internal Revenue Service has received a large number of comments on these proposed regulations from farmers and other groups. The majority of these comments are based on an erroneous understanding of how section 483 operates. The comments assume that by providing higher imputed interest rates for deferred payment sales for tax purposes, the proposed regulations would require higher amounts to be paid by purchasers of property. In fact, section 483 does not affect the amounts paid by the purchaser for property; it affects only the characterization of these amounts as principal or interest for Federal tax purposes. We would like to illustrate this point with a simple example. Assume A sells a farm to B for $1 million and that the contract of sale provides that B will pay A $100,000 each year for 10 years. The contract specifies that no interest will be charged. Section 493 provides that in this situation some R-146 32-821 0-81--6 portion of each $100,000 payment will be interest for Federal income tax purposes. The remaining portion will be considered to be a payment of principal. Notwithstanding the application of section 483, B still pays A $100,000 each year for 10 years or a total of $1 million. Section 483 does not require that B pay A more than the amount specified in the contract. To the extent interest is imputed, A will have interest income for Federal income tax purposes. B will have an interest deduction in this amount. A's gain on the sale and B's basis in the farm will be based on the portion of the $1 million representing principal, not the entire $1 million. Thus, A will have less gain (or more loss) and B will have a lower basis in the property than if no interest were imputed. Most of the specific criticisms of the proposed regulations arise from this misunderstanding. For example, it has been asserted (1) that the proposed rates would make it more difficult for young people to purchase farms or homes by increasing monthly amortization payments due to higher interest costs; (2) that the proposed rates are inflationary and would institutionalize higher interest rates; and (3) that the proposed rates would further depress the already seriously-depressed housing and real estate industries. These assertions are all based on the underlying assumption that section 483 actually increases the amounts to be paid under deferred-payment sales contracts. As I have indicated, section .483 affects only the characterization of these amounts as interest or principal for Federal tax purposes. Thus, these criticisms are misdirected. We would now like to explain the background of the proposed changes in the regulations under section 482 and 483 and to set forth the results of our review of these changes. The principle that the imputed interest rates under sections 482 and 483 should reflect market interest rates has long been a part of the law. The legislative history of section 483 indicates that its purpose is to prevent a seller of property from manipulating the tax consequences of the sale by increasing the amount of deferred payments for property in lieu of interest. Section 483 directs the Treasury Department to set an appropriate minimum interest rate for these deferred payment sales in order to prevent this abuse. The legislative history of section 483 anticipates that the rate will reflect the going rate of interest and will not be higher than the rate at which a person in reasonably sound financial circumstances and with adequate security could be expected to borrow from a bank. Set forth in the appendix are excerpts from the legislative history to 483 setting forth in more detail the purposes of this provision and guidelines for Treasury regulations. The general purpose of section 482 is to prevent taxpayers from avoiding tax by conducting transactions between commonly-controlled trades or businesses on non-arm's length terms. Specifically, the section 482 regulations have for years provided that taxpayers cannot avoid tax by charging an interest rate very different from the normal market rate on loans between commonly-controlled businesses. In view of the disparity between the current market interest rates and the 7 percent rates imputed under the existing regulations if at least 6 percent interest is not charged, we believe it is necessary to adjust the existing imputed interest rates to bring them more in line with current market rates. We have therefore concluded that the final regulations will provide, in general, that the minimum interest rate that must be charged under section 483 to prevent imputed interest is 9 percent and that the minimum rate that must be charged under section 482 is 11 percent. These rates are unchanged from the proposed regulations. In the event the literal terms of both sections 482 and 483 are met in the same transaction, section 483 will be controlling. The final regulations under section 482 will, in general, provide that the Internal Revenue Service can impute a 12 percent interest rate on loans between commonly-controlled trades or businesses unless the taxpayer charges a rate between 11 and 13 percent or establishes that a different rate would be an appropriate arm's length rate. Under the present regulations, the comparable rates are 7 percent and 6-8 percent. The final regulations under section 483 will, in general, provide that unless a contract for the sale of property provides for at least 9 percent simple interest on deferred payments, a rate of 10 percent, compounded semiannually, is imputed. Under the present regulations, the comparable rates are 6 and 7 percent. Many comments asserted that the proposed rates would have a negative and unfair impact on family farming and family businesses because higher interest rates would be required on loans for the sale of property to a family member than on loans for the sale of property to a non-family member. This is based on the assumption that such sales would be governed by section 482 and not section 483. The final regulations will eliminate any possible problem in this regard by providing that, in the event the literal terms of both section 482 and section 483 apply to a transaction, section 483 will override section 482. Thus, the 9 percent minimum interest rate will be sufficient for sales of property to a family member as well as for sales of property to a non-family member. Consistent with the letter to Senator Melcher last December from Donald C. Lubick, former Assistant Secretary for Tax Policy, we will not issue final regulations on these issues before July 1, 1981. We have decided, however, in view of the many taxpayer inquiries regarding the imputed interest rates, to announce our decision through this statement and through a news release. A copy of the news release, which is being issued today, is attached. We have carefully considered whether the final regulations should maintain the effective dates provided in the proposed regulations. These dates are August 29, 1980 for the regulations under section 482 and September 29, 1980 for the regulations under section 483. We believe it would have been consistent with Mr. Lubick's letter to maintain these effective dates. However, because there may have been some confusion about whether Mr. Lubick's letter portended a delay in the effective dates until July 1, 1981 and in order to extend to Congress every courtesy in its review of the issues raised by the proposed regulations, we have decided that, in general, the final regulations will be made effective as of July 1, 1981. The final regulations under section 482 will provide certain "grandfather" rules for interest paid pursuant to a non-demand loan or advance entered into on or after July 1, 1981 but pursuant to a binding contract entered into prior to August 29, 1980. Similarly, the final regulations under section 483 will provide certain "grandfather" rules for payments on account of a sale or exchange of property entered into on or after July 1, 1981 but pursuant to a binding written contract (including an irrevocable written option) entered into before September 29, 1980. However, there will be no such "grandfather" rules with respect to binding contracts entered into after these dates. Appendix Excerpts from the Legislative History to Section 483 (b) General reasons for provision. Your committee agrees with the House that there is no reason for not reporting amounts as interest income merely because the seller and purchaser did not specifically provide for interest payments. This treats taxpayers differently in what are essentially the same circumstances merely on the grounds of the names assigned to the payments. In the case of depreciable property this may convert what is in reality ordinary interest income into capital gain to the seller. At the same time the purchaser can still recoup the amount as a deduction against ordinary income through depreciation deductions. Even where the property involved is a non-depreciable capital asset, the difference in tax bracket of the seller and buyer may make a distortion of the treatment of the payments advantageous from a tax standpoint. The House and your committee believe that manipulation of the tax laws in such a manner is undesirable and that corrective action is needed. Senate Rep. No. 830, 88th Cong. 2d Sess., 101, 102 (1964). The interest rate to be used for purposes of this provision is to be a rate provided by regulations prescribed by the Secretary of the Treasury or his delegate. It is anticipated that any rate specified by the Secretary of the Treasury or his delegate will reflect the going rate of interest and will not be higher than the rate at which a person, in reasonably sound financial circumstances and with adequate security could be expected to borrow money from a bank. A rate of 5 percent, for example, would appear appropriate under existing circumstances. House Rep. No. 749, 88th Cong., 1st Sess., at 72-73 (1963); Senate Rep. No. 830, supra at 102. |