Washington Tax Insight May 2016

 
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Background

While the focus on the Presidential primaries continues to heat up, Congress continues to work on budget and spending issues, a Puerto Rico debt crisis bill and important issues such as the Federal Aviation Administration reauthorization – with questionable success.  There is increasing uncertainty about the likelihood that the Republican leadership in Congress will be able to produce a budget agreement this year, with the House continuing to have challenges finding a majority for a budget agreement and the Senate unwilling to move without cooperation from the House.  As a practical matter, however, a budget agreement is unnecessary this year because of the agreement late in 2015 on spending targets for a 2-year period.  The Senate appears willing to move ahead with appropriations bills using those targets, while there is disagreement in the House over the spending levels.  A continuing resolution that would keep the government operating past the end of the fiscal year on September 30th seems nearly inevitable at this point.

Tax Reform

House Ways & Means Committee

Ways & Means Committee Chair Brady announced that he plans to produce a consensus blueprint for comprehensive tax reform in June.

The W&M Tax Policy Subcommittee held a hearing on April 13th to review tax reform bills introduced by House lawmakers that make fundamental reforms within the context of an income-based system, including the comprehensive reform bill that was introduced by former Chairman Camp in late 2014.

Senate Finance Committee

The Senate Finance Committee held a hearing titled “Navigating Business Tax Reform” on April 26th, which is the first hearing this year on tax reform in the Committee.  SFC Chair Hatch began work in 2015 on a corporate tax integration reform proposal, which he has said will be a first step to broader tax reform, while also decreasing incentives for inversions.  He is currently working with the Joint Tax Committee on a comprehensive analysis and revenue estimate of his proposal, which is expected to be released in June. On the day of the hearing, SFC Ranking Member Wyden (D-OR) released a discussion draft of legislation that would replace the current cost recovery system with a revised set of depreciation rules and fewer schedules. We will provide additional details on this proposal in the June issue.

Miscellaneous

W&M Committee Chair Brady and SFC Chair Hatch introduced identical technical corrections bills in the House and Senate that would make a number of technical changes and clarifications to seven previously enacted tax laws.  The majority of the changes address the Consolidated Appropriations Act of 2016/Protecting Americans from Tax Hikes Act of 2015 (PATH Act), which was the appropriations and extenders legislation enacted late in 2015.  Included in the legislation are changes to the permanent research credit and the bonus depreciation rules.  There was some discussion of adding this legislation to the current work on the Federal Aviation Administration (FAA) reauthorization legislation, but no deal to do so was reached.

The SFC approved a bill that would require the IRS to increase security measures to combat identity theft and refund fraud, but rejected a Wyden amendment that would have imposed minimum standards of competence on paid tax return preparers, removed the IRS from the regulatory process, and placed the authority under Treasury’s Office of Professional Responsibility.  The Wyden amendment would have overturned the US Court of Appeals decision in the case of Loving v. Internal Revenue Service that blocked an effort to certify and regulate tax return preparers.  Chair Hatch said he supported the concept of regulating tax return preparers but several Senators were concerned about the broad authority to be given to the Treasury.  He promised to work with Senator Wyden on a more acceptable compromise.

Senate Minority Leader Reid and Ranking SFC Democrat Wyden spearheaded an effort to add several alternative energy extenders that are due to expire at the end of 2016 to the FAA reauthorization legislation, but the effort ultimately failed when it was determined that the FAA bill became “must-pass” legislation.  Due to the fact that it appeared to be one of the few bills that would advance in 2016 to which tax provisions could be attached, lawmakers began attaching a variety of tax issues to it, which threatened failure so Senate leaders opted to move a “clean” FAA bill.

The SFC held a hearing titled “Cybersecurity and Protecting Taxpayer Information.”  The hearing focused on safeguarding taxpayer information and what improvements can be made by the IRS to protect taxpayers from cybercriminals.

Treasury and the IRS

Treasury and the IRS issued proposed regulations providing guidance on the amount and timing of a deemed distribution under section 305(c) that result from adjustments to rights to acquire stock.  The proposed regulations state that the value of a deemed distribution would be the excess of (1) the FMV of the right to acquire the stock immediately after the applicable adjustment over (2) the FMV of the right to acquire the stock without the applicable adjustment.  The proposed regulations also provide additional guidance to withholding agents regarding their current withholding and information reporting obligations with respect to these deemed distributions.

In Notice 2016-26, the Treasury and IRS invited public input on the coming year’s Priority Guidance Plan (covering July 1, 2016 through June 30, 2017), which annually lists regulations and other tax guidance that the IRS sees as the most important to taxpayer and tax administrations.  Recommendations from taxpayers are due by May 16, 2016.  For taxpayers, this Plan provides useful information about where the IRS will devote its resources, and the addition of new items to the Plan gives an early signal of new priorities for the IRS.

The IRS issued final regulations effective March 28th that limit the importation of net built-in losses under sections 334(b)(1)(B) and 362(e)(1) of the Code.  The final regulations adopt proposed regulations issued in September 2013, with a few changes.  These regulations apply to certain non-recognition transfers of loss property to corporations subject to certain taxes, and they affect corporations receiving such loss property.  The regulations also modify certain rules previously issued under sections 332 and 351 of the Code (in proposed regulations issued in March 2005), affecting certain corporations “that transfer assets to, or receive assets from, their shareholders in exchange for the corporation’s stock. 

IRS Announcement 2016-16 announced that the IRS is withdrawing certain parts of a regulation proposed in January regarding nondiscrimination requirements applicable to qualified retirement plans under section 401(a)(4) of the Code.

BEPS and International Issues

BEPS Update

The OECD issued its standard electronic format for sharing information under the Country-by-country (CbC) reporting regime approved as part of the BEPS initiative.  CbC reports will be electronically transmitted between Competent Authorities in accordance with the CbC XML Schema, included in the released material along with a User Guide. 

The OECD issued a consultation draft under the BEPS initiative Action 6 (covering the use of tax treaties) on the tax treaty entitlement of non-Collective Investment Funds (non-CIVs).  The draft covers a range of issues relating to the effect a limitation on benefits (LOB) provision would have on non-CIV funds.

The OECD has also announced that the following consultations are upcoming:

  • Attribution of profit to permanent establishment in early fall;
  • BEPS Action 2 (hybrid mismatches) with the discussion draft published June 30th for comments by August 10th: branch mismatch arrangements
  • BEPS Action 4 (interest deductions) with the discussion draft published June 22nd for comments by July 20th: elements of the design and operation of the group ratio rule;
  • BEPS Action 4 (interest deductions) with the discussion draft published July 6th for comments by August 17th: approaches to address BEPS involving interest in the banking and insurance sectors.

EU/State Aid investigations:  Margrethe Vestager, European Commissioner for Competition, met with several Members of Congress, including SFC Chair Hatch, Ranking SFC Democrat Wyden and Treasury Secretary Lew, to discuss the EU’s state aid investigations of US companies.  Senators Hatch and Wyden made it clear to her that they believe the EU has gone too far with the investigations, while Commissioner Vestager responded that while she takes their concerns very seriously, she does not agree with them.  She did promise US officials that the EU would be more open with them in the hope of avoiding “misunderstandings” about the inquiries.

EU/Tax Disclosure Rules:  The European Commission issued a proposal that would require multinationals operating in the EU with global revenues exceeding EUR 750 million a year to publish key information on where they make their profits and where they pay their tax within the EU on a country-by-country basis.  Affected companies would also have to publish an aggregate figure for total taxes paid outside the EU.  The EU was already looking at this type of rule in light of the BEPS project, and the release of the so-called Panama Papers helped to accelerate the release.

G20 and Tax Havens:  The G20 Finance Ministers called on the OECD to report by July on the countries and jurisdictions that have not yet signed up to international standards on tax transparency and information sharing.  This issue has been a G20 priority for several years but has gained more prominence of late due to the leak of the so-called Panama Papers.  The exchange of tax information request was first issued in 2009, and there is a new standard of automatic exchange of information scheduled to go into effect in 2017-18 as part of the Global Forum on Transparency and the Exchange of Information for Tax Purposes.

IMF/OECD/UN/World Bank cooperation – Platform for Collaboration on Tax:  The International Monetary Fund (IMF), Organization for Economic Development (OECD), United Nations (UN) and World Bank announced a new joint effort to intensify their cooperation on tax issues: the Platform for Collaboration on Tax.  The Platform will not only formalize regular discussions between the four international organizations on the design and implementation of standards for international tax matters, it will strengthen their capacity-building support, deliver jointly developed guidance, and share information on operational and knowledge activities.  Among the Platform’s first tasks will be the delivery of a number of “toolkits” designed to help developing countries implement the measures developed under the G20/OECD BEPS project.

Inversions, Earnings Stripping and the new 385 Regulations

Treasury and the IRS issued temporary and proposed regulations to further reduce the benefits of and limit the number of corporate tax inversions including by addressing earnings stripping.  (See True Alert, issue no. 2016-2, dated April 11, 2016, for a detailed summary of the new regulations.)  Treasury Secretary Lew announced that the new rules will have an important effect on but cannot stop these transactions, so he urged Congress to move ahead with anti-inversion legislation this year.  Treasury believes that inversions are not driven by genuine business strategies and economic efficiencies, but rather a desire to shift the tax residence of a parent entity to a low-tax jurisdiction in order to reduce or avoid US taxes.

The new rules will limit inversions by disregarding foreign parent stock attributable to recent inversions or acquisitions of US companies, thereby preventing a foreign company from using the resulting increase in size to avoid the current inversion thresholds for a subsequent US acquisition.  The regulations implement new rules not previously included in the prior notices, including a rule to address so-called “serial inversions,” where a foreign corporation combines with a series of US corporations and where section 7874 would otherwise have applied if the acquisitions had been made at the same time or pursuant to a plan or series of related transactions.

They also address “earnings stripping,” which Treasury posits is often used after a corporate inversion to minimize US taxes by the US subsidiary taking a loan from the foreign parent and paying interest that is deducted from the US company’s taxable income to their new foreign parent in a low-tax country.  Review of the new rules, however, shows that they go well beyond inversions and are also intended to apply to a broad range of related-party transactions, so that they would impact many ordinary business transactions and operations of domestic and foreign corporations, including cash management and pooling arrangements.

Congressional Reaction and Activity

W&M Chairman Brady called the new rules “punitive regulations that will make it even harder for American companies to compete and will further discourage businesses from locating and investing in the US.”  He has suggested that he believes that Treasury overstepped its authority, stating that the W&M Committee continues to review the regulations.  House Minority Leader Pelosi responded that Chair Brady and his fellow Republicans should “stop enabling corporate inversions and stop preserving special interest tax handouts that do nothing but increase the deficit.”  She went on to say, “The Treasury Department’s measures are no substitute for long-overdue Congressional action.  It is long past time for tax reform that would lower the corporate rate, close special interest loopholes, end costly tax expenditures, and ensure all Americans are paying their fair share.”

SFC Chair Hatch commented that the “Administration continues to tinker along the regulatory edges with unilateral proposals to address the symptoms of inversions, but not the disease.”  He stated that a comprehensive tax overhaul that reduces the rate, transitions to a territorial system with base erosion protections, and addresses earnings stripping is a better course to follow.

Congressman Levin (D-MI), the senior Democrat on the W&M Committee, has introduced a bill targeting “earnings stripping” and corporate inversions called the “Stop Corporate Earnings Stripping Act of 2016” (HR 4581).  Senators Brown (D-OH) and Schumer (D-NY) have introduced bills targeting inversion transactions, and Senator Wyden (D-OR) continues drafting an inversions bill covering hopscotch loans and “spinversions” (spinning off parts of a US company into a foreign entity).

Treasury Activity

In conjunction with the issuance of the new proposed rules, the White House and Treasury Department also issued an updated version of the President’s Framework for Business Tax Reform.  The April 2016 updated report reviews developments since the issuance of the original Framework in 2012, and details specific administration tax proposals without changing the key elements of the Framework.

In a statement to the International Monetary Fund (IMF), Secretary Lew said that the Obama Administration is finalizing new rules that take aim at shell companies by proposing a regulation that would require the beneficial owners of single-member limited liability companies to identify themselves to the IRS, thus closing a loophole that Treasury posits some have been able to exploit.

Robert Stack, Deputy Assistant Secretary for International Affairs, recently commented publicly about the new anti-inversion rules stating that Treasury is open to suggestions about how to tweak the rules, but that Treasury does not feel that it overstepped its authority in this area.  He also added that he believes that corporate executives should pay more attention to what the G20 and other international organizations are doing on international tax matters, suggesting that the business community is giving up too much influence on tax issues to nongovernmental organizations.

Business Community Reaction and Activity

The reaction from the business community and business trade groups to the new rules was swift with the rules being criticized by groups such as the Chamber of Commerce and the Business Roundtable as counter-productive and ultimately self-defeating.  Business leaders called the rules “punitive” and likely to result in driving companies out of the US.  The new rules are affecting the number of deals moving ahead including the proposed Pfizer/Allergan transaction, which has now been abandoned.

Business groups and corporate boardrooms were surprised at the scope of the earnings stripping rules, which they believe to be too broad — arguing that they penalize foreign companies with long histories in the US for using legitimate intra-company loans to pay for investments in the US.

Several business trade groups, including the National Foreign Trade Council (NFTC), the Organization for International Investment (OFII), Tax Executives Institute (TEI), US Council for International Business (USCIB) and many others, are forming a coalition on the new section 385, related-party financing rules. They will try to persuade the Treasury Department to defer the public comment date past July 7th  --arguing that the proposed rules are significant changes and will require extensive review and analysis before comments can be submitted, although Treasury has said that it plans to issue the final rule quickly.  Although foreign-owned companies may appear initially to be more severely impacted, US-owned companies will also be affected and will join the effort to work with Treasury on these rules.

A group of former Treasury officials, including former Treasury Secretary George Shultz, sent a letter to Treasury urging them to reconsider the April 4th release of temporary and proposed regulations.  The letter stated, “Current rules regarding corporate inversions don’t need revision.  Instead, we urge you to focus your attention on addressing the competitive disadvantages that are harming capital investment, employment, and economic growth in the United States.”  The letter concludes that “the only sustainable remedy is to reform the US tax code and create a level playing field with international competitors.”

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Robert M. Gordon
Managing Director & Assistant General Counsel
Robert.Gordon@tpctax.com
312-235-3321


 

 

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