The consensus is that an omnibus spending bill will be considered by the House and Senate prior to the end of the year that will address several other key issues. With the current government funding extension due to expire on December 11th, there is increasing pressure to reach agreement on the government spending issues and a decision as to what riders will be included. House and Senate Republican leadership view the omnibus spending bill as the best vehicle for achieving some of their top policy priorities this year. Some of the areas being considered for inclusion are: (1) curbs on the Syrian resettlement program; (2) rollbacks of the President’s environmental and financial regulations; and (3) campaign finance regulations. Congressional negotiators are also working to reach a compromise on the tax extenders package.
Congressman Kevin Brady (R-TX) was elected to be the new Chair of the powerful House Ways & Means Committee by the House Republican Conference on November 5th, replacing newly-elected House Speaker, Paul Ryan (R-WI). Congressman Charles Boustany (R-LA) will chair the newly renamed Subcommittee on Tax Policy, which previously was called the Subcommittee on Select Revenue Measures. Chair Brady now becomes one of the Republican Party’s top voices on tax, trade and health policy, and he quickly took command of his new position on taxes by stating that he plans an active agenda to move forward on tax reform. Current priorities include negotiations on the expired “tax extenders”, and he stated that then he will move on to action on international tax reform in 2016 as Speaker Ryan has confirmed that it will not be included in the highway spending bill. Chair Brady said he is committed to working on additional tax reform in 2017, including lowering the rates for both corporations and pass-through entities and simplification for individuals. He will have an enthusiastic partner in this effort in Speaker Ryan, who has already made it clear that tax reform is one of his priorities as Speaker.
The negotiations over the fate of some 50 business tax provisions which expired at the end of 2014 continue as the two chairs of the tax-writing committees search for enough common ground to approve legislation prior to the end of the year. Chair Brady has said that the extension of these provisions is his current top priority, and SFC Chair Hatch agrees, with both stating that they would aim for two-year extensions if necessary (2015-16). In a recent meeting with W&M Committee Democrats, Treasury Secretary Lew reconfirmed the Administration’s preferences stating that the White House would not support a permanent extension of 50 percent bonus depreciation due to its revenue cost and that permanent extension of business incentives must be paired with permanent extension of certain refundable credits, including the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC). Reportedly Secretary Lew said that the White House would consider permanent extension of the R&D credit and enhanced section 179 expensing if equal treatment is provided for the EITC, CTC and the American Opportunity Tax Credit for higher education costs.
The House and Senate both passed a $305 billion, 5-year bill to reauthorize federal highway spending and funding, and the President signed the legislation on December 4th. The law also re-opens the Export-Import Bank which closed in July due to lack of funding. Most of the funding comes from provisions related to the Federal Reserve Bank but there are a handful of tax provisions, including, for example, denial of passports to tax delinquents and allowing the use of private debt collectors to pursue unpaid taxes.
The Senate approved reconciliation legislation that would repeal and revise certain key parts of the Affordable Care Act (ACA). The bill includes a provision defunding Planned Parenthood and an amendment to repeal the so-called “Cadillac tax,” which is a 40 percent excise tax on health plans that offer benefits above the industry standards. The House has already passed similar legislation but the President has stated that he will veto the bill.
On November 10th, the Senate Foreign Relations Committee voted to report several pending tax agreements, including a protocol with Japan, which now must be approved by the full Senate prior to ratification by President Obama. Senator Rand Paul (R-KY) continues to withhold his consent for Senate Floor consideration based on his objection to treaty provisions authorizing the exchange of tax information between treaty countries without evidence of fraud.
On November 19th, the Treasury Department and the IRS issued Notice 2015-79 announcing their intention to issue regulations that will expand the application of the anti-inversion rules under Code section 7874 and limit the tax benefits associated with inversion transactions. The Notice states that it will now be more difficult for US companies to invert by: (1) Strengthening the requirement that the former owners of a US company own less than 80 percent of the new combined entity and (2) strengthening the substantial business activities exception. The Notice reduces the tax benefits of inversions by preventing inverted companies from transferring foreign operations “out from under” the US tax net without paying current US tax.
Notice 2015-79 supplements Notice 2014-52 in which Treasury and the IRS also announced their intention to issue new anti-inversion regulations, but no such regulations have yet been issued, and the new Notice makes certain changes and clarifications to the rules in the previous Notice. In general, Notice 2015-79 applies prospectively to acquisitions and post-inversion planning occurring on or after November 19, 2015, although in the case of certain post-inversion planning, the guidance applies only to taxpayers that have undertaken inversion transactions on or after September 22, 2014.
At a background briefing on the Notice, a senior Treasury official stated that it is not too late for Congress to enact legislation to fully address inversion issues. Notice 2015-79 does not include new limitations on interest deductions or earnings stripping by expatriated entities, but he commented that additional inversion guidance is expected in the coming months, including the possibility of new Treasury rules directed at earnings stripping under Code section 163(j).
In Revenue Procedure 2015-53, the IRS announced the tax schedules and inflation adjustments for more than 50 tax provisions for 2016.
In Notice 2015-73, the IRS clarified guidance on basket contracts describing them as a deferred income recognition scheme that “may attempt to convert short-term capital gain and ordinary income to long-term capital gain through a contract denominated as an option, notional principal contract, forward contract, or other derivative contract.” In Notice 2015-74, the IRS clarified guidance on basket option transactions describing them as an attempt to “defer income recognition and convert short-term capital gain and ordinary income to long-term capital gain using a contract denominated as an option contract.”
The IRS Large Business and International (LB&I) Division posted several new International Practice Units (IPUs) that serve as both job aids and training materials on international tax issues including on the following topics: (1) Foreign Partnership – Taxation; (2) Determination of US Shareholder and CFC Status and (3) Overview of Subpart F Income for Individual Shareholders.
The IRS and several other governmental agencies issued final regulations on several issue areas and policies under the Affordable Care Act (ACA). The 379 pages of regulations affect “grandfathered health plans, preexisting condition exclusions, lifetime and annual dollar limits on benefits, rescission, coverage of dependent children to age 26, internal claims and appeal and external review processes, and patient protections under the ACA.”
In United States v. Microsoft Corp., 116 AFTR 2d 2015-XXXX (W.D. Wash., Nov. 11, 2015), the district court upheld an IRS attempt to enforce summonses against Microsoft in connection with a transfer pricing dispute. Microsoft had argued that the summonses should not be enforced because the IRS had hired a private law firm to assist in its examination of the company. The court held that Microsoft had not met its burden to demonstrate that enforcement of the summonses would abuse the court’s process.
Two different district courts took opposite views on the validity of structured advantaged repackaged securities (STARS) transactions. In Wells Fargo & Co. v. United States, 2015 TNT 219-11 (D. Minn., Nov.10, 2015), the court held that the transaction had no economic substance and was thus invalid, while in Santander Holdings USA, Inc. v. United States, 116 AFTR 2d 2015-6795 (D. Mass., Nov. 13, 2015), the court rejected the IRS attempt to apply the economic substance doctrine and upheld the transaction.
On October 5th, the Organization for Economic Cooperation and Development (OECD) released the 2015 Final Reports on the OECD/G20 Base Erosion and Profit Shifting (BEPS) project two years after its launch in 2013 at the request of the G-20 leaders. The G-20 Finance Ministers approved the Final Reports at their meeting on October 8th, and the G-20 Leaders endorsed the BEPS package of measures at their annual summit on November 15-16th.
The G20 leaders committed to the implementation of the BEPS project and called on the OECD to monitor progress and to develop by early 2016 an inclusive framework including the participation of developing economies on equal footing. The leaders also welcomed progress toward greater transparency and fairness in the global tax system and reaffirmed their commitments to implement automatic exchange of information by 2017.
Congressional hearings on the BEPS project took place in both the House Ways & Means Committee and the Senate Finance Committee for December 1st. In announcing the SFC hearing, Chair Hatch (R-UT) commented that “many nations, including the United States, are facing tax base erosion as multinational companies shift profits, activities and property from high-tax to low-tax jurisdictions. With the OECD’s BEPS project, the Obama Administration and the international community have sought to find solutions to address taxation challenges in an increasingly globalized and digital economy. And while such efforts are laudable, the recommendations contained in the OECD’s BEPS reports raise a number of serious concerns about taxpayer confidentiality and the Treasury Department’s statutory authority to implement regulations as envisioned by the project.”
Chair Hatch further commented that “the EU has launched investigations into American multinationals that have resulted in increased uncertainty and foreign tax liabilities for our businesses abroad. Given these concerns and developments, I expect a robust discussion at this hearing on what the OECD BEPS project means for US taxpayers and our tax system moving forward, as well as how the EU State Aid investigations could potentially affect tax revenues paid to the US Treasury.” Witnesses included Robert Stack, Deputy Assistant Secretary for International Tax Affairs, US Department of Treasury.
The House Ways & Means Subcommittee on Tax Policy held a similar hearing “on the OECD BEPS Project final recommendations and its effect on worldwide American companies. Witnesses included Deputy Assistant Secretary Stack and representatives from the National Foreign Trade Council and Tax Notes.
In this issue, we will provide additional detail on Actions 2-4, which relate to cross-border taxation. In future issues, we will provide additional detail on other Actions.
Achieving consensus among the countries which participated in the BEPS project was challenging and is reflected in the fact that the recommendations in the Final Reports indicate one of three possible levels of endorsement. “Minimum standards” indicates commitments to consistent implementation of standards laid out in final reports, and agreements to be subject to monitoring by the OECD during and after implementation. “Common approaches” indicate agreement as to “general tax policy direction,” with the aspiration that they will become “minimum standards” over time. “Best practices” are provided where the negotiators failed to reach a consensus that countries must adopt legislation on the specific topic in question.
Action 2: Neutralize the Effects of Hybrid Mismatch Arrangements
The Action 2 Report provides a “common approach” which is intended to neutralize the effects of hybrid mismatch by providing recommendations on the design of domestic rules arrangements (Part I) and by making changes to the model tax convention (Part II) to prevent hybrids from being a source of “double non-taxation.” Part 1 addresses mismatches in tax outcomes where they arise in respect of payments made under a hybrid financial instrument or payments made to or by a hybrid entity. It also addresses indirect mismatches that arise when the effects of a hybrid mismatch arrangement are imported into a third jurisdiction. The recommended primary rule is that countries deny the taxpayer’s deduction for a payment to the extent that it is not included in the taxable income of the recipient in the counterparty jurisdiction. If the primary rule is not applied, then the counterparty jurisdiction can generally apply a defensive rule, requiring the deductible payment to be included in income or denying the duplicate deduction depending on the nature of the mismatch. Part II is aimed at ensuring that hybrid instruments and entities, as well as dual resident entities, are not used to obtain inappropriately the benefits of tax treaties, and that tax treaties do not prevent the application of the changes to domestic law recommended in Part I.
Action 3: Strengthen CFC rules
The Action 3 Report sets forth “best practices” regarding the design and strengthening of controlled foreign corporation (CFC) rules to address concerns over the potential of creating affiliated non-resident taxpayers and routing income of a resident enterprise through the non-resident affiliate to reduce or avoid taxation. The Report sets out six “building blocks” for the design of effective CFC rules including: (1) Definition of a CFC; (2) CFC exemptions and threshold requirements; (3) Definition of income; (4) Computation of income; (5) Attribution of income; and (6) Prevention and elimination of double taxation.
Action 4: Limit Base Erosion via Interest Deductions and Other Financial Payments
Action 4 aims to limit base erosion via interest deductions and other financial payments through recommendations for domestic law limitations on tax deductions for both related and unrelated party interest expense and economically equivalent payments. The Action 4 Report suggests a “common approach” based on a fixed ratio rule with a potential range of ratios to take into account that not all countries are in an equivalent position. The fixed ratio approach can be supplemented by a worldwide group ratio rule as well as certain targeted rules. The Report does not cover the transfer pricing aspects of financial transactions, which will be addressed in a separate project in 2016-17. Additional work in 2016 will cover groups that are highly leveraged or in the banking or insurance fields.
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Robert M. Gordon
Managing Director & Assistant General Counsel