Notice 2007-17 announced a controversial IRS program to allow regulated parties to write the regulations that govern their activities along with policy memorandums explaining their rationales. IRS According to the BNA RealTime of 10/23/07, Commissioner Korb defended this proposal today at the Tax Executives Institute, indicating that it would get guidance to taxpayers faster than the IRS can otherwise do, especially in highly technical areas where taxpayers have considerable expertise.
Of course, that is just the problem with the proposal. The wolves will be guarding the henhouse. Korb's first go at the controversial mechanism for writing regulations is issuance, slated for October 29th, of proposed new regulations to permit REMICs to become more active financial vehicles able to modify commercial mortgage loans in the conduits in ways beyond those permitted now under the tightly restrained REMIC regulations.
Here's the problem with this proposal. First, there are very few tax lawyers in the country who even know what REMICs are (real estate mortgage investment conduits), much less understand the restrictions set out in the Code and regulations governing the kinds of interests that REMICs are permitted to issue without becoming subject to a corporate tax. Very few tax lawyers are able to recognize whether and how a REMIC sponsor may be "playing" the system--whether in underdetermining the amount a REMIC residual holder is required to take into income, writing into mortgage loans swaps and other features that are not permitted to be entered into directly by the REMIC, or creating new classes of interests issued by a REMIC that may well result in the REMIC holding assets it is not permitted to hold or issuing interests it is not permitted to issue. That means that the practitioner community that can comment knowledgeably on regulations is very limited, and it means that the IRS has limited expertise to draw on in its own behalf.
Second, because the IRS is suggesting this procedure be used most in the technical areas of the Code (such as REMICs), the tax administration will be subject to capture by the highly technical and specialized financial services industry that is most knowledgeable in this area. This is a problem when the financial services industry is already able to game the system through innovative new derivatives and application of old rules to new financial products in ways that suit the tax-avoidance proclivities of customers rather than the revenue-generating needs of the Treasury. While many tax lawyers do play an important public service role through their commentary as members of bar associations (the New York State Bar Association Tax Section comes to mind), this process removes the filtering role of working through a bar association, where the accepted importance of the role of lawyers in developing the law in accord with the public interest helps to restrain zealous advocate impulses on behalf of client positions. The government's process doesn't retain those professionalism constraints. Practitioners may propose regulations that directly benefit their clients.
Third, if the practitioner community is invited to write regulations, one can expect that it will be tempting to overlook problems the practitioner community is aware of (but which the tax administration may not be aware of) that involve either overly aggressive interpretations of existing provisions or clearly abusive practices that have been undertaken by some practitioners. In fact, the temptation will be to draft regulations in such a way as to condone practices that the practitioner community has some doubts about or wants to have blessed because it will permit more REMIC activity, whether or not it is sound policy to do so.
Fourth, with the tax administration taking a back seat in the development of the proposed regulations, it is not clear how the primary concern for the public interest will be expressed. The current process involves a praiseworthy give-and-take, with the tax administration proposing regulations, various bar groups and private practitioners commenting, tax media discussing the pros and cons, and ultimately finalization of regulations based on consideration of the full commentary. With practitioners writing the regulations and the tax administration stepping back to a facilitator role, there will, I think, be inadequate consideration of the public's perspective.
All in all, the only thing favoring this procedure is the possibility of more rapid guidance. That's too small a gain for the high price of quasi-privatization of the regulatory process.
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