The House and Senate have completed their September legislative session and will now be in an extended recess until after the November 8th elections. On September 28th, Congress approved and sent to President Obama a continuing resolution to fund the federal government from the beginning of the new fiscal year on October 1st through December 9th. In light of the fact that Congress will have to act on additional legislation to fund the government beyond that date in a lame duck session, there is a possibility that issues such as tax extenders and technical corrections could be included in such legislation.
Congress is expected to return to work on November 14th, take a one-week break for Thanksgiving, and complete their work for 2016 by December 16th.
Extenders/energy provisions: Leadership in both the Senate and House have suggested that they will consider renewing several alternative energy provisions that will expire at the end of 2016, but there is no certainty of action, and it may depend on the outcome of the elections. There are also a number of other provisions that will expire at the end of 2016 including breaks for mortgage forgiveness, energy-efficient homes, racehorse owners, and film productions.
House/Ways and Means: Prior to recessing, the House Ways & Means Committee approved several targeted tax bills covering nuclear production tax credits, student loan debt issues, tax-exempt water cooperative rules, stock options for start-up businesses, and tax relief for citrus groves hit by a bacterial infection. House leadership has indicated that they will schedule these bills for House Floor action during the lame duck session. The House approved legislation that would reduce the threshold for claiming the itemized deduction for medical expenses to 7.5 percent of adjusted gross income (AGI) for all taxpayers, reversing a provision in the Patient Protection and Affordable Care Act of 2010 that increased the threshold for claiming the deduction to 10 percent of AGI. The Senate is not expected to consider this bill, which would likely be vetoed by President Obama.
Senate/Senate Finance Committee: The Senate Finance Committee voted unanimously to approve legislation aimed at expanding access to retirement account savings and simplifying plan administration for small businesses and multiemployer plans. The Retirement Enhancement and Savings Act of 2016 includes provisions recommended last year by the bipartisan Finance Committee working group on savings and investment as well as certain provisions included in the discussion draft of retirement account reform legislation released by ranking Democrat Wyden (D-OR) in September. The bill’s largest tax benefit would ease administrative burdens for small employers participating in multiple employer pension plans (MEPs) by providing that a MEP defined contribution plan will not become disqualified or lose other tax-favored status because one or more participating employers fails to take certain required administrative actions with respect to the plan. It is unclear whether the Senate will act on this legislation during the lame duck session, but these bills are also likely to be under consideration when another continuing resolution is addressed.
Democratic presidential nominee Hillary Clinton and Republican presidential nominee Donald Trump provided few new details on tax policy during the presidential debate on September 26th. Trump’s focus was on offering companies an incentive to keep jobs in the US (alluding to his repatriation proposal) and providing individual tax cuts that would encourage company owners to expand their businesses, thereby creating jobs. Clinton’s focus was on higher taxes on the wealthy with the resulting revenue to be used to “invest” in the middle class through education, infrastructure spending, affordable child care, and advanced manufacturing, while she also discussed eliminating corporate loopholes.
House Judiciary Chairman Goodlatte (R-VA) has released a new online sales tax draft bill which proposes a system using the tax base of an online retailer’s state, a tax rate set by the buyer’s state, and collection by the seller’s state. This bill varies from his previous draft legislation which set up a system where retailers would have charged sales tax based on their own state and local rates. The framework for sales taxes the Supreme Court affirmed in 1992 resulted in no taxes being applied on sellers that lack a physical presence in the state, but the growth of internet commerce has complicated this issue. Internet retailers have a price advantage by shipping goods into states without opening physical locations there – with local retailers losing business to the competition and states losing tax revenue. A bipartisan coalition formed to support the idea of letting states tax those sales, and the Senate passed legislation in 2013, but it has stalled in the House. It is unlikely that this issue can be resolved prior to the end of the year, however, due to the short legislative calendar and the continuing controversy surrounding the issue.
The Treasury Department sent final 385 regulations to the Office of Information and Regulatory Affairs within the Office of Management and Budget. These regulations are designated as “under review” with the text of the regulations not to be made public until the interagency review process is completed. The window for that review is 90 days, but it can be expedited. Treasury has sent signals that they expect the regulations to be finalized very soon and that many of the business community’s concerns will have been addressed. Unconfirmed reports indicate that the regulations package could extend to about 550 pages.
The IRS issued Revenue Procedure 2016-45, which lifts the IRS’s “no-rule” policy on significant legal issues under Code section 355 relating to (1) the corporate business purpose requirement and (2) the device test. The changes will apply to all requests received on or after August 26, 2016, and will apply to requests that relate to distributions occurring after August 26th, the date of the revenue procedure. The IRS also issued Revenue Procedure 2016-40 that provides two safe harbors under which the IRS will not assert that a corporation lacks the control required under Code section 355(a) when a corporation acquires control of another corporation through the target’s issuance of stock followed by certain transactions that reverse the effect of the stock issuance.
The IRS issued Revenue Procedure 2016-48, which provides guidance on changes to the depreciation rules under Code sections 179 and 168 that were enacted in December 2015 by the Protecting Americans from Tax Hikes Act (PATH Act). The covered provisions include: (1) the extension of the Code section 179(f) election to expense certain qualified real property used in an active trade or business from any taxable year beginning after 2009 and before 2015 to any taxable year beginning after 2009 and before 2016; (2) the extension of the placed-in-service date for property to qualify for the 50-percent additional first year depreciation deduction; and (3) an election under Code section 168(k)(4) to increase the AMT credit limitation under Code section 53(c) in lieu of bonus depreciation. The guidance includes procedures for making certain elections and filing amended returns.
Treasury and the IRS issued final regulations under Code section 5000C relating to the two percent tax on payments made by the US government to foreign persons pursuant to a contract for goods or services if the goods are manufactured or produced or the services are provided in any country that is not a party to an international procurement agreement with the US. The regulations also include rules under Code section 6114 with respect to foreign persons claiming an exemption from the two percent tax under an income tax treaty.
The IRS issued final regulations on the Code section 148 arbitrage investment restrictions applicable to tax-exempt bonds and other tax-advantaged municipal bonds that amend the current rules to address market developments, simplify certain provisions, and improve ease of administration.
The IRS posted an International Practice Unit (IPU) that provides internal advice to auditors on the Foreign Investment in Real Property Tax Act (FIRPTA), which governs the disposition of a US real property interest (USRPI) by nonresident aliens and foreign corporations and the withholding on such transactions. IPUs are drafted by the Large Business and International (LB&I) Division and are intended to serve as both job aids and training materials on international tax issues. Legislation was enacted in December 2015 that raised from 10 percent to 15 percent the withholding rate on Real Estate Investment Trust (REIT) stock, REIT distributions and dispositions of any other USRPI, effective for transactions on or after February 17, 2016. The IRS plans to issue additional IPUs on related topics covering US real property holding corporations (USRPHC).
The IRS finalized regulations that clarify the definition of certain real property under a Real Estate Investment Trust (REIT). The IRS issued revenue rulings from 1969 to 1975 and then relied on private letter rulings to address taxpayer-specific inquiries on the real property status of certain assets. These regulations address these issues in published guidance and also include regulations initially proposed in 2014 that address issues related to renewable energy.
The OECD released a discussion draft on “branch mismatch structures” under Action 2 (Neutralizing the Effects of Hybrid Mismatch Arrangements) of its BEPS action plan. Branch mismatches occur where the jurisdictions in which the head office and a branch office of a taxpayer are located take a different view as to the allocation of income and expenses between the head office and branch office and include situations where the branch jurisdiction does not treat the taxpayer as having a taxable presence in that jurisdiction. The discussion draft identifies five types of branch mismatches and makes recommendations intended to address each type. Comments were required by September 19th.
The OECD Secretary General delivered his report to the G20 leaders at the fall meeting in China. The two-part report addressed the following: the BEPS project, tax transparency, tax policy tools to support sustainable and inclusive growth, tax and development, as well as a progress report on transparency and exchange of information for tax purposes. The report noted that the Global Forum on Transparency and the Financial Action Task Force would be issuing a report in October 2016 on the provision of beneficial ownership information, essentially as part of the automatic exchange of information under FATCA and the common reporting standard. The Secretary General also noted that it will provide details to the G20 leaders’ meeting in 2017 of “uncooperative” jurisdictions, i.e. jurisdictions that essentially are not participating in the automatic exchange of information.
The OECD released a working paper titled “Fiscal Incentives for R&D and Innovation in a Diverse World.” The working paper recommends that fiscal incentives, including tax policies be directed at specific barriers, impediments or synergies to facilitate the desired level of investment in research and development (R&D) and innovations. The working paper concludes that “[m]ore research is needed to determine the extent to which R&D fiscal incentives in one country increase overall R&D, the quality of that R&D, and its positive spillovers to other sectors of the economy and other countries.”
Ireland has filed a formal appeal to the European Commission’s state aid decision that cited Ireland’s tax laws as illegally benefiting Apple. Treasury Secretary Lew has been publicly and privately vocal in expressing US criticism of this decision stating that it would undercut multilateral efforts such as the BEPS project. A Treasury Department white paper issued days before the EC decision was announced argued that the EC could be dangerously transformed into a “supra-national tax authority.”
EC State Aid Ruling – Will it Provide a New Impetus to Tax Reform?
Treasury Secretary Lew commented in a Wall Street Journal editorial in mid-September that the EC’s ruling that Ireland provided illegal tax benefits to Apple could further erode the US corporate tax base noting that the bipartisan opposition in Congress to the ruling “may present a new opportunity to make [tax] reform a reality.” He agrees with the EC on the broader issue of global tax avoidance, but states that the EC decision imposes “unfair retroactive penalties, is contrary to well-established legal principles, calls into question the tax rules of individual countries, and threatens to undermine the overall business climate in Europe.” He states that the Administration will continue to make the case to Congress for action on tax reform noting that attention being paid to the EC decision may help to move Congress to act on tax reform early in the next administration.
Treasury White Paper on EC State Aid Investigations
The Treasury Department released a white paper titled “The European Commission’s Recent State Aid Investigations of Transfer Pricing Rules,” which outlines concerns with the investigations and the targeting of US companies. The paper also suggests that the investigations could “undermine and reverse international progress” in developing transfer pricing rules and the OECD BEPS initiative.
The paper states that the investigations have caused the “Commission to second-guess Member State income tax determinations” and were “an unforeseeable departure from the status quo.” It criticizes the retroactive recoveries sought by the EC stating that this departs from prior practice, would be inconsistent with EU legal principles, and would undermine the G20’s efforts to improve tax certainty setting a bad precedent for tax authorities in other countries.
A major consequence of the ruling is that recoveries ordered “will be considered foreign income taxes that are creditable against US taxes owed by the companies in the United States.” The paper notes that in that case, “the companies’ US tax liability would be reduced dollar for dollar by these recoveries when their offshore earnings are repatriated or treated as repatriated as part of possible US tax reform.” The paper comments that this would effectively transfer tax revenue to the EU from US taxpayers.
Finally, the paper concludes that the EC’s actions “undermine the international consensus on transfer pricing standards, call into question the ability of Member States to honor their bilateral tax treaties, and undermine the progress made under the OECD/G20 Base Erosion and Profit Shifting (‘BEPS’) project.” The paper states: “The US Treasury Department continues to consider potential responses should the Commission continue its present course.”
Treasury and the IRS issued Notice 2016-52, which announces forthcoming regulations related to certain transactions conducted in anticipation of foreign-initiated income tax adjustments (i.e. EC state aid rulings). The regulations will treat these transactions as foreign tax credit splitter arrangements under Code section 909 applicable to foreign income taxes paid on or after September 15, 2016. Treasury representatives have indicated that the new notice would “close another tax loophole that contributes to the erosion of our tax base,” ensuring that corporations can only claim foreign tax credits when they repatriate foreign earnings. Treasury finalized rules in 2015 but have indicated that there were some gaps in the framework. Treasury has not explicitly stated that taxes required by EC state aid cases would be eligible for the foreign tax credit, but if they are, it appears that Treasury believes some corporations would use splitting arrangements to decrease their US tax liability.
Section 909 is intended to prevent the separation of creditable foreign taxes from related income by, in general, deferring the right to claim credits until the related income is included in US taxable income. The IRS explains in the Notice that a corporation facing such a ruling from the EC may make a pre-emptive move to change its ownership or initiate a large distribution “so that the subsequent tax payment creates a high-tax pool of post-1986 undistributed earnings that can be used to generate substantial amounts of foreign taxes deemed paid, without repatriating and including in US taxable income the earnings and profits to which the taxes related.”
Notice 2016-52 states that the regulations will “identify two new splitter arrangements relating to section 902 corporations that pay foreign income taxes pursuant to foreign-initiated adjustments.” The regulations will apply similar rules to taxpayers that take the position that taxes paid by a US person pursuant to a foreign-initiated adjustment to the tax liability of a section 902 corporation are eligible for a direct foreign tax credit under section 901. The IRS says the new regulations will treat these transactions as foreign tax credit splitter arrangements under Code section 909. Treasury and the IRS have requested comments on the rules described in the Notice.
Robert M. Gordon, Managing Director