Washington Tax Insight September 2015

 
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Background – Budget

Presidential politics will have a significant impact on what happens in Congress this fall with the Republican presidential primary complicating matters for the Republican leadership, who are struggling to manage a number of critical issues and avoid a government shutdown.  Upon their return to Washington from the August recess, the House and Senate face a number of issues, with the most urgent being the need to fund the federal government when the new fiscal year starts on October 1st or face a government shutdown.  The growing controversy within the Republican Party about how to handle the issue of defunding Planned Parenthood is complicating decisions by the House and Senate Republican leadership on how to proceed since Republican conservatives have threatened to oppose any spending bill without defunding language, while Senate Democrats and the White House would surely oppose such legislation. 

The Congress is expected to proceed with funding the government with a short-term Continuing Resolution (CR), and it is increasingly clear that the Republican leadership may need Democratic votes to pass that legislation, so they will need to avoid inclusion of controversial provisions.  Senate Democrats have already demonstrated that they can successfully block appropriations bills with the intent to force increased spending for domestic programs above the budget caps set by the 2011 sequester deal’s automatic spending cuts.

Congress also returns to face a vote on the President’s Iran nuclear deal, an extension of the Export-Import Bank, an extension of the highway bill, and a need to raise the debt limit ceiling for the federal government by the end of the year.  Recent Congressional Budget Office projections indicate that Congress will likely have until early December to act on the debt ceiling limit issue, and the passage of a short term CR in September may result in a year end agreement that deals with all of the outstanding issues.

Congressional Activity

Tax Extenders, the Highway Bill and International Tax Reform

With respect to outstanding tax issues, Congress must address whether to complete the “tax extenders” legislation, how to fund the highway bill extension, and whether to advance international tax reform to fund other legislation, including an increase in the spending caps and the highway bill.  Prior to the August recess, the Senate Finance Committee approved a package of extenders through 2016.  House W&M Committee Chair Ryan (R-WI) plans to work on an extenders package in September but is expected to include some permanent extenders so the contrasting approaches on this issue may result in a delay in completion until the end of the year.

Senate Majority Leader McConnell (R-KY) has consistently opposed  the inclusion of international tax reform as an offset for a highway bill extension, choosing instead to negotiate $47 billion in other revenue offsets with Senator Boxer (D-CA).  Senator Schumer (D-NY), who is expected to be the next Democratic leader in the Senate, supports combining the highway bill extension and the government spending bill negotiations together and including international tax reform as a revenue offset along with the 3-year revenue offset package all of which could be used to pay for the highway bill extension, a reduction in tax rates, and an increase in domestic spending levels. 

Congress will have to address another extension of spending authority for the Highway Trust Fund before October 29th when the current short term extension expires.  House W&M Chair Ryan plans this fall to develop a package of international tax reforms including a “deemed repatriation” tax on previously untaxed foreign-source income of US multinationals and an “innovation box” applying a reduced rate of tax on income from patents and certain intellectual property (as set forth in the Boustany/Neal discussion draft).  On the Senate side, however, Senate Majority Leader McConnell will likely move to advance the multi-year bill approved by the Senate prior to the recess and funded in part by tax compliance provisions and spending cuts. 

Whether international tax reform advances to completion or not this fall, there will certainly be a debate in both the House and Senate about a comprehensive overhaul of the current international tax rules.

Senate Permanent Subcommittee on Investigations Hearing on Foreign Acquisitions of US Business

The Senate Permanent Subcommittee on Investigations held a hearing to examine the impact of US taxation on foreign acquisitions of US businesses and the ability of US businesses to expand by acquisition.  A PSI report that was issued in conjunction with the hearing reviewed several recent cross-border transactions and acquisitions of US firms, concluding that the high statutory US corporate tax rate encourages the merger of US companies with foreign corporations, with the new combined headquarters located abroad.  PSI Chairman Rob Portman (R-OH) also co-chaired with Senator Schumer the SFC Working Group report on international tax reform, which outlined several possible reforms including patent boxes, deemed repatriation, and a transition to a hybrid territorial type system.

Ways & Means Committee – “Innovation Promotion Act of 2015”

Congressmen Boustany and Neal, who released a discussion draft in late July that includes an “innovation box” proposal and special rules for transfers of intangible property from controlled foreign corporations to US shareholders, have requested feedback from taxpayers who would be affected by the draft.  They are specifically interested in:

  • whether the definition of qualified property is appropriate
  • how gross receipts from services directly related to a product using qualified property should be included in qualified gross receipts
  • what the appropriate approach should be for allocating expenses to innovation profits
  • how the innovation box deduction should be coordinated with the current research credit and section 199 deduction

No revenue estimate and no details about how the expected revenue loss from the bill would be offset have been released.  It is expected that strong base erosion and minimum tax subpart F rules would have to be included.

Treasury and the IRS

The IRS issued Revenue Procedure 2015-40, which provides guidance on the process for requesting and obtaining assistance under US tax treaties from the US Competent Authority, acting through the Advance Pricing and Mutual Agreement Program and the Treaty Assistance and Interpretation Team of the Deputy Commissioner (International) Large Business and International Division of the IRS.  This revenue procedure supersedes Revenue Procedure 2006-54 and will generally be effective for competent authority requests filed on or after October 30, 2015.  The IRS also issued Revenue Procedure 2015-41, which provides guidance on the process for requesting and obtaining an Advance Pricing Agreement (APA) and guidance on the administration of executed APAs.

The IRS published twelve new International Practice Units (IPUs), which serve as training and reference materials for IRS employees but are not an official pronouncement of law and may not contain a comprehensive discussion of issues.  One IPU addresses “Branch-Level Interest Tax Concepts” under Code section 884, while another IPU addresses a transaction that compares and contrasts the tax treatment of effectively connected income (ECI) and non-services fixed or determinable annual or periodical income (FDAP).  Several of the IPUs address issues related to the tax treatment of individuals.

The IRS and Treasury issued their priority guidance plan for 2015-2016 with 277 projects for the period from July 2015 through June 2016.  The Plan includes 39 international projects, most of which are carried over from the prior year plan.  The new projects relate to: (1) inversions (2) allocation by partnerships of foreign income tax (3) relinquishment of US citizenship and (4) country-by-country reporting of income, earnings, taxes paid, and certain economic activity for transfer pricing risk assessment.  Treasury commented that the Plan will be updated and reissued periodically to reflect other priority items and to respond to developments during the plan year.

The IRS issued Notice 2015-54 announcing coming regulations under Code section 721(c) to address property transfers to partnerships with foreign partners.  The Notice also stated that the IRS is considering issuing regulations under sections 482 and 6662 applicable to controlled transactions involving partnerships to ensure the appropriate valuation of such transactions.

The IRS issued two regulations regarding the determination of a partner’s distributive share of a partnership’s assets under Code section 706.  The IRS finalized regulations on the determination of a partner’s distributive share of partnership items of income, gain, loss, deduction, and credit when a partner’s interest varies during a partnership year.  The IRS also issued proposed regulations regarding the determination of a partner’s distributive share of certain allocable cash basis items and items attributable to an interest in a lower-tier partnership during a partnership taxable year in which a partner’s interest changes.

International - OECD Base Erosion and Profit Shifting (BEPS) project

The OECD Base Erosion and Profit Shifting (BEPS) project is sponsored by the G20 countries and is designed to formulate a set of international tax rules and principles to combat BEPS, which can then be implemented by individual countries.  When international tax planning became a political issue in many countries, the G20 tasked the OECD in 2012 with designing a policy framework for international corporate tax that eliminates inappropriate double non-taxation, whether it arises from the actions of taxpayers or from the tax policies of national governments.  Fifteen key areas for action were identified in the OECD action plan, and the full BEPS package is to be distributed in time for the G20 finance ministers’ meeting in October 2015.  The OECD sought to deepen involvement of developing countries, so there are now 61 countries involved.

The project is creating uncertainty in the global tax environment for multinational companies as some countries have already begun to make changes to their tax laws and administration based on BEPS documents and discussion drafts.  Companies can expect to face changes in the future as a result of this project and would be wise to begin assessing the impact of the changes on their business in order to be prepared to align their business models and tax planning to the new global rules.

Recently, the tax writing committees have also increased their attention to the BEPS project.  SFC Chair Hatch delivered remarks on the Senate Floor outlining his concerns about the BEPS initiative and citing his letter (to the GAO) requesting an analysis of the potential economic impact of BEPS on US companies and the US economy.  He state that the Treasury Department is negotiating the BEPS action items—which may attempt to commit the US to make changes to our domestic tax laws—without any substantive input from Congress or its tax-writing committees.

Senate Finance Committee Report of the Business Income Tax Working Group

The report of the SFC Business Income Tax Working Group was released in early July by co-chairs Senator John Thune (R-SD) and Senator Ben Cardin (D-MD) and submitted to the SFC leadership on behalf of the entire working group.  The report focuses on two threshold issues: lowering the corporate tax rate and the equitable treatment of pass-through businesses.  The report includes a discussion of the challenges of lowering the corporate tax rate in a revenue neutral manner and details options for base broadening.  The report in summary does not endorse one specific business tax reform plan, but notes that comprehensive tax reform is long overdue and will require bipartisan cooperation for success. 

The report states that the following four principles should drive business tax reform:

  • Create an internationally competitive and modern business tax code that lowers business tax rates and encourages job creation and economic growth
  • Address structural biases and promote investment
  • Promote American innovation
  • Remove complexity, encourage certainty, and improve the taxpayer experience

Lowering Business Tax Rates

The report cites the general support for lowering the corporate tax rate but acknowledges that doing so within the “constraints of revenue-neutral 1986-style tax reform” will require significant base broadening.

Pass-through Businesses

The consideration of the treatment of pass-through businesses necessitates a consideration of individual tax reform, which was not within the scope of the working group’s mandate, but the report discusses several options that would address the issue of equitable treatment of these businesses if the corporate tax rate should be lowered but individual tax rates are not.  The working group could not reach consensus on one option to recommend.  The options include:

  • Business equivalency, which would tax all active business income, regardless of business form at the same rate
  • Enhanced targeted tax benefits for pass-through entities to offset an unchanged statutory rate
  • A new deduction that would apply only to active business income of pass-through entities

Structural biases and double taxation

The report does not endorse any specific corporate integration proposal, but it references the SFC report issued in December of 2014 on Comprehensive Tax Reform and recommends to SFC leadership that the issue of corporate integration be explored.  The report discusses a “partial corporate integration” proposal, whereby undistributed income is taxed at the corporate level and income distributed to shareholders is taxed only once.  The report also raises the issue of the consideration of a consumption tax, acknowledging that this would be a fundamental shift that would take long-term consideration but noting that an income tax system has an inherent bias against saving and toward current consumption.

Promote American innovation

The report provides a review of current R&E credit reform proposals and existing innovation box regimes, but it does not endorse any specific proposal.  A permanent R&E credit is recommended while the report cautions against using an innovation box proposal as a substitute for lowering rates.  The report includes a review of current energy tax policies with no consensus reached as to whether and how the government should favor certain types of energy development.

Remove complexity and encourage certainty

While noting that tax simplification measures could be moved separately from comprehensive tax reform, the report does recommend consideration of tax administration and simplification proposals which may reduce non-compliance and improve taxpayer interactions with the IRS.

Download this article. 

For further information or to discuss providing feedback to Congress on the “innovation box” proposals, contact:

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

 

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