Washington Tax Insight August 2015

 
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Background – Budget

The House and Senate have now both closed up shop for the August recess and are scheduled to return to Washington on September 8, 2015.  When they return, they will face a number of challenging issues and deadlines to be met before the end of 2015 with just 12 legislative workdays in September to come up with an agreement on how to fund the government when the new fiscal year starts on October 1st or face a government shutdown.  One month later, the short-term highway bill that was passed prior to the August recess will expire.  The extension of the Export-Import Bank must also be addressed because its charter expired at the end of June.  The President’s Iran nuclear deal will also be considered and there will be a need to raise the debt ceiling limit.  The contest for the Republican nomination for President, which includes several Senators, will add to the rhetoric around all of these issues and the challenge of achieving consensus on any of them. 

While both the House and Senate have passed all 12 FY 2016 appropriations bills through Committee, none of these bills have made it to the Floor of either chamber. House and Senate leadership have prevented Committee members from negotiating on individual spending bills with their counterparts in the other chamber and have refused to discuss raising the spending caps enacted as part of a deficit-reduction bill in 2011, which Senate Democrats are demanding.  A Continuing Resolution (CR) to fund the government appears to be inevitable as the October 1st deadline approaches, but it is unclear whether the Republican leadership will support a short-term CR with the goal of a bigger budget deal by the end of the year or opt for a longer term CR.

Congressional Activity

Tax extenders

On July 21, the Senate Finance Committee (SFC) voted to approve a two-year extension (through 2016) of more than 50 individual and business tax provisions.  No date has yet been set for consideration on the Senate Floor.  House Ways & Means Chair Ryan has stated that he would like his Committee to consider a tax extenders package in September, and it is expected that he will include permanent extensions of some of the now-expired provisions (e.g., the R&E credit, the state and local tax deduction, and section 179 expensing for small businesses, all of which have already been approved on the House Floor in other legislation.)

The SFC-approved bill does not include any permanent extensions because SFC Chair Hatch chose to defer consideration of permanence in order to move the bill forward now.  Ranking Member Wyden noted that the long-term goal of the Committee is comprehensive tax reform, which would moot the need to consider annual extensions of these provisions.  Although SFC bill includes 3 revenue-raising provisions providinmg $1.8 billion in revenue over 10 years, the $95 billion revenue loss from the bill is largely not offset based on the Republican view that extensions of current law do not need to be paid for. Key extenders in the bill include:

  • Research & Experimentation (R&E) credit
  • Exception under subpart F for active financing income
  • Bonus depreciation
  • Higher section 179 expensing limits
  • Lookthrough treatment of payments between related controlled foreign corporations under the foreign personal holding company rules
  • 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements

The Highway Trust Fund

The House and Senate have both approved, and the President has signed, a three-month funding extension of the Highway Trust Fund (which will expire October 29, 2015) after failing to agree on a long-term highway bill before the recess.  The Senate has approved a three-year extension of the highway bill and the House is expected to consider a long-term funding bill when it returns in September.  The Senate  bill would finance only three years of the shortfall between the Highway Trust Fund spending and the dedicated revenues that come from excise taxes. 

The 3-month extension legislation includes the following tax–related revenue offsets:

  • Require mortgage lenders to provide the IRS with additional information on outstanding loans including the origination date of the mortgage, outstanding principal balance, and property address;
  • Require estates with positive estate tax liability to provide the IRS with property value detail in order to ensure consistent basis reporting by beneficiaries for income tax purposes;
  • Clarify that a six-year statute of limitations for the IRS to reassess taxpayers who substantially understate their income applies in the case of overstatement of basis;
  • Adjust certain tax and information return filing deadlines so that passthrough entities would file before the filing date for C corporations;
  • Extend through 2025 a current-law provision (set to expire in 2021) that allows employers to transfer excess defined benefit plan assets to retiree medical accounts and group term life insurance.
  • Equalization of excise taxes on liquefied natural gas, liquefied petroleum gas, and compressed natural gas

Ways & Means Committee Chair Ryan supported a short-term extension because he wants to include an international tax reform package in a long-term highway bill extension.  This international tax reform package is likely to include a deemed repatriation tax on previously untaxed foreign-source income of US multinationals, a shift from a worldwide to a territorial/dividend-exemption regime, and an innovation box that would provide lower tax rates on income generated by certain intellectual property.  The SFC working group on international issues report that was issued in early July includes similar ideas, and there are ongoing discussions with the Administration about these ideas.

Tax Reform Update

Senate Finance Committee Working Groups

After six months of work, five tax reform hearings, and the submission of over 1400 taxpayer comments, the five SFC tax reform working groups filed their reports with SFC Chair Hatch and Ranking Member Wyden and released their reports to the public.  In this issue, we will summarize briefly each of the reports with a more detailed summary of the International Tax Reform group report below.  More details on the other Working Group reports will be included in future issues.

  • Business Income Tax Working Group (chaired by Senators Thune (R-SD) and Cardin (D-MD)):  This report was submitted on behalf of the entire working group, and it cited two threshold issues as key: lowering the corporate tax rate and treating passthrough businesses equitably.  The report does not suggest a specific corporate tax rate but instead discusses the challenges of lowering the rate in a revenue neutral way and the options for base broadening.  The report does specify three options to address the equitable treatment of passthrough businesses as well as the topic of corporate integration (preventing double taxation).  The report suggests considering a shift toward a consumption-based system; R&E incentives (including making the incentive for R&E permanent and an “innovation box” regime), energy tax policy, and tax simplification.
     
  • Community Development and Infrastructure (chaired by Senators Heller (R-NV) and Bennet (D-CO)):  This report was submitted on behalf of the Chairs but not the entire working group; the report noted that they may release bipartisan legislative proposals in the future.  The report offers both an “interim option” for funding a six-year infrastructure/highway spending bill and a long-term option.  The interim option includes a “deemed repatriation tax” but does not specify the rate or the timeline for paying the tax.  The long-term option proposes a nationwide vehicle miles traveled (VMT) tax which would be implemented initially through a pilot program.
     
  • Savings and Investment (chaired by Senators Crapo (R-ID) and Brown (D-OH):  This report was submitted on behalf of the entire working group and focuses solely on tax policy issues related to private retirement savings, although their remit included defined benefit plans and the tax treatment of capital gains and dividends.  With respect to private retirement plans, the report identifies three key areas of focus: increasing access; increasing participation and contribution levels; and preserving savings that will last through retirement.
     
  • Individual income tax (chaired by Senators Grassley (R-IA), Enzi (R-WY) and Stabenow (D-MI)):  This report focuses on only three areas of individual income tax policy – charitable giving, higher education, and tax administration, noting that these were the only areas with the potential for bipartisan agreement.  The report noted the interaction with the work on passthrough businesses by the Business Income Tax Working Group.

House Ways & Means Committee

On July 29th, two senior members of the Ways & Means Committee released a bipartisan legislative proposal (including proposed legislative language and a technical explanation), titled the “Innovation Promotion Act of 2015”, which includes an “innovation box” proposal and special rules for transfers of intangible property from controlled foreign corporations to US shareholders.  Rep. Boustany (R-LA) and Rep. Neal (D-MA) also issued a list of questions seeking input on the bill from taxpayers.  As noted above, it is expected that the Ways & Means Committee will consider this type of legislation as part of the long-term highway funding bill this fall.

The “innovation box” proposal establishes a deduction for innovation box profits, which has the effect of lowering the income tax rate on profits that qualify for the deduction.  The deduction is equal to 71% of the lesser of the (i) “innovation tax profit” of the taxpayer for the taxable year or (ii) taxable income (determined without the 71% deduction) for the taxable year, which results in an effective tax rate of 10.15% on innovation box profits.  For purposes of computing innovation box profit, all members of an expanded affiliated group are treated as a single corporation.

Treasury and the IRS

On July 22nd, the Treasury Department and the IRS published proposed regulations under section 707(a)(2)(A)(REG-115452-14) that treat certain arrangements, including private equity fund management fee waiver arrangements, as payments by partnerships for services. This could have the effect of accelerating the timing and changing the character of partners’ income.

On July 27th, the Tax Court in Altera Corp. v. Commissioner struck down final IRS regulations issued in 2003 that required stock-based compensation to be shared between participants in cost-sharing arrangements, stating that the regulations violate the arm's-length standard. This decision could have potentially far-reaching consequences for all companies who have entered into cost-sharing arrangements.

On July 8th, the Treasury and IRS issued two notices relating to “basket option contracts” (also known as “barrier options” or “accreting strike price options”) and designated them as “listed transactions” (Notice 2015-47) and “transactions of interest” (Notice 2015-48).  These designations create significant reporting obligations for holders of the options, writers of the options, and persons who provided tax advice on these transactions.

The US and Vietnam have signed the first treaty between the two countries, a move which demonstrates the deepening of US-Vietnam bilateral economic relations.  The treaty must now be ratified by the US Senate, which will be difficult as the Senate has been in a period of delay on tax treaty ratification due to the objection of Senator Rand Paul to the normal unanimous consent procedure.  There are eight other treaty instruments currently awaiting consideration in the Senate.

SFC International Working Group Report (chaired by Senators Portman (R-OH) and Schumer (D-NY))

The report of the International Working Group has gained significant attention since the release of the reports in early July because international tax reform is being considered as part of a long-term highway funding bill, which is expected to be enacted by the end of 2015.  This lengthy report primarily discusses current law and the challenges lawmakers face in advancing tax reform, but the report also includes a “Bipartisan Framework” that includes several recommendations.  The proposals are presented as being supported by the two co-chairs but it is not clear whether all of the members of the Working Group also support all of the recommendations.  There is considerable similarity between these recommendations and the proposals included in the 2014 Camp tax reform legislation and the international section of the Obama FY 2016 budget proposal.

Territorial System and the Dividend Exemption Regime

The report recommends the adoption of a dividend exemption system but does not specifically recommend any exemption rate (such as the 95% rate that was in the Camp proposal).  The report suggests pairing the exemption  with a reduction in the corporate tax rate but does not specify what the rate should be.

Base Erosion and a Minimum Tax

The report states the need for “robust and appropriate base erosion rules” but with no specifics.  It discusses a minimum tax on foreign earnings of CFCs, but generally only states that the rate and type of income to which it applies should prevent base erosion while ensuring the competitiveness of US multinationals.

Deemed Repatriation

The report endorses a one-time transition toll charge on foreign earnings such as suggested by the 2014 Camp draft and the Obama FY2016 budget proposal, but those proposals differ significantly with respect to rate and application to specific assets.

Innovation Box

The report recommends the implementation of an innovation box regime, which would provide a substantially reduced tax rate on certain forms of intangible business income to encourage the development and ownership of intellectual property in the US and combat other countries’ efforts to attract highly mobile US corporate income.  The Working Group continues to work on the details of eligibility criteria, nexus, and domestication of offshore intellectual property. The report notes the OECD’s BEPS (Base Erosion and Profit Shifting) project, which includes a review of innovation and patent box regimes of various countries.

Interest Expense

The report does not make specific recommendations in this area, but indicates that the Working Group continues to review proposals to “determine the appropriate net limitation necessary for legitimate intra-group lending while at the same time stopping disproportionate leveraging to avoid US taxation and gaming of interest expense limits in place.”   They also continue to consider rules to maintain a level playing field for inbound and outbound companies as well as whether additional limits should be placed on domestic companies that choose to invert.

Subpart F Exceptions

The report states that it may be necessary to retain current rules on foreign personal holding company income in order to prevent certain types of passive income from qualifying for exemption from US tax, and in that case, CFC lookthrough and active financing exceptions might also need to be retained.

FIRPTA

The report suggests reforms to FIRPTA to encourage foreign investment in the US, and it states support for the Real Estate Investment and Jobs Act (H.R. 2128), which would increase the ownership stake a foreign investor can take in a US REIT and exempt foreign pension funds .

Other Issues

The Working Group is also looking at these issues: foreign affiliate reinsurance; taxation in Puerto Rico and other US possessions; and the taxation of US citizens living abroad, primarily with respect to issues with FBAR and FATCA reporting.

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For further information, please contact:

Robert M. Gordon, Managing Director
Robert.Gordon@tpctax.com
312-235-3321

 

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