Washington Tax Insight April 2019
Politics and Congressional Activity
The FY 2020 budget submission from the White House was released on March 11th. Treasury Secretary Mnuchin testified on the budget on March 14th before both the Ways & Means Committee and the Senate Finance Committee. The $4.7 trillion budget proposal for FY 2020 calls for a 5 percent reduction in non-defense spending and states that it balances revenue and spending within 15 years. The proposal includes increased spending for the IRS. In the past, the Treasury Department would typically issue a Green Book with more detailed explanations of the revenue proposals, but this practice has not been followed by the Trump Administration and this report is not expected this year. This budget proposal is not expected to be a focus for Democrats in the House, and, in fact, there is some support for not working on a budget resolution this year in the House on the assumption that there will be no cooperation on it from the Republican-controlled Senate.
The Senate Budget Committee has scheduled a markup for March 27-28th on a proposed FY 2020 budget resolution, which would set out the broad tax and spending goals for the next fiscal year. The non-binding plan includes a reconciliation bill that would include $94 billion in deficit reductions over five years, with more than half of that coming from Senate Finance Committee issues. The Democratic-controlled House Budget Committee has not yet scheduled action on a budget resolution and is likely to take a different approach. Even if agreement were reached between the two houses of Congress on this issue, budget resolutions are not submitted to the President for approval and therefore, they do not carry the force of law.
The House failed to override the President’s veto of a congressional resolution that would have prevented him from using a national emergency declaration to fund a border wall so the issue will now go the courts. Other issues being considered by the House include health care, equal pay, climate change, ethics and campaign reform, and investigations related to the Mueller report on Russian interference in US elections, while the Senate will consider the Green New Deal, which was approved by the House. House Democratic leadership introduced legislation that aims to update and strengthen the Affordable Care Act at the same time that the White House announced that it would move forward with efforts to repeal and replace the ACA with the Republican-controlled Senate unlikely to move on the House legislation. With Republicans in control of the Senate and action unlikely on issues of importance to Democrats, most of this activity is designed to provide messaging tools for Democrats going into the 2020 elections.
Treasury and the IRS
Treasury and the IRS – Regulatory Policy Announcement
Treasury and the IRS issued a joint policy statement announcing important changes to the tax regulatory process and clarifying their views on less-formal “sub-regulatory” guidance, which includes revenue rulings, revenue procedures, notices, and announcements. The new policy is more aligned with the established principles of the Administrative Procedure Act (APA) that historically has not always been applied to tax regulations. The key issue in the statement relates to the category of sub-regulatory guidance, which do not carry the force of law and therefore are interpretive rules that are not subject to the APA’s notice-and-comment requirements, but courts have held that the IRS is bound by these forms of guidance. The statement holds that sub-regulatory guidance should not be used to modify legislative rules or create new ones, and therefore the IRS will not receive deference from courts for its interpretations, based on the Auer and Chevron cases. The statement also addresses issues related to a commitment to notice-and-comment rulemaking, limited use of temporary regulations, and notices announcing the intent to propose regulations.
Treasury and the IRS have released a significant amount of guidance on the TCJA to date. Businesses should not delay in submitting comments on proposed rules. Treasury has until June 22, 2018, which is 18 months after the TCJA was enacted to issue final rules that can operate retroactively back to the enactment date. On several key regulatory projects, Treasury has issued proposed rules and received public comments, but it has not yet released final rules. The intention is to complete all final international rules by late summer before companies are required to file their 2018 returns.
Underpayment Penalties for Individuals: The IRS lowered the withholding underpayment threshold to 80 percent for the 2018 tax year, down from the 85 percent cutoff announced earlier this year and the 90 percent threshold usually in effect. That means that filers who paid at least 80 percent of what they owe will avoid underpayment penalties.
Foreign Tax Credit Rules: The IRS held a public hearing on March 14th on its proposed regulations regarding changes to the foreign tax credit (FTC) and related rules for allocating and apportioning expenses for determining the FTC limitation that were made by the TCJA. The proposed regulations were issued on December 7, 2018, and cover a number of issues including: (1) the allocation and apportionment of deductions under Code sections 861 through 865 and adjustments to the FTC limitation under Code section 904(b)(4); (2) transition rules for overall foreign loss, separate limitation loss, and overall domestic loss accounts under Codes sections 904(f) and (g), and for the carryover and carryback from unused foreign taxes under Code section 904(c); and (3) the determination of deemed paid credits under Code section 960 and the gross up under Codes section 78.
Foreign-Derived Intangible Income (FDII): The IRS issued proposed regulations under Code section 250 on the deduction for foreign-derived intangible income (FDII), which is income earned in the US through the sale of products or services to foreigners for use abroad. FDII provides a 37.5 percent deduction on intangible income held domestically, resulting in a rate of 13.125 percent available only for foreign sales (as opposed to the regular corporate 21 percent rate). The proposed rules outline a series of rules and tests that companies have to satisfy to verify that their income is from foreign sales, and also include exemptions to some of the documentation rules for small businesses (less than $10 million in annual sales or less than $5000 from an individual customer), which were not included in the TCJA statute. Treasury also indicated that there would be distinction between sales and services, which received different treatment in the statute, based on the “overall predominant character of the transaction.” This is a categorization area that could present challenges for taxpayers in interpretation and administration. The proposed rules cover applicability of the rules to partnerships, individuals, consolidated groups, and tax-exempt corporations. Written comments were due by March 6th.
Global Intangible Low-Taxed Income (GILTI): The proposed regulations issued on March 4th also covered issues related to the global intangible low-taxed income deduction in Code section 250, which requires a US shareholder of a controlled foreign corporation for any taxable year to include in gross income the shareholder’s GILTI for the year and is designed to restrict a company’s ability to shift profits offshore. The proposed rules allow individuals owning foreign corporations to use Code section 962 to be treated as if they were corporations, allowing them benefit from GILTI’s 50 percent deduction, which under the statue was only available to corporations. Both FDII and GILTI are key elements of the international framework of the TCJA.
Base Erosion and Anti-Abuse Tax (BEAT): The IRS scheduled a hearing for March 25th on proposed regulations relating to the Base Erosion and Anti-Abuse Tax which were issued on December 31, 2018. The tax is designed to serve as a minimum tax on certain taxpayers that reduce their overall tax liability by making deductible payments to related foreign parties. Requests to testify were due March 15th.
Hybrid Entities: The IRS scheduled a March 20th public hearing on proposed regulations on hybrid entities and transactions under Code section 267A, which were issued on December 20, 2018.
Opportunity Zones: The Office of Information and Regulatory Affairs at OMB received the second set of regulatory guidance for review from the IRS concerning the Opportunity Zone (OZ) incentive. These rules are expected to address what type of property qualifies as qualified OZ business property, steps an OZ business must take to be qualified, and the penalty for a qualified opportunity fund’s failure to meet the 90% investment standard.
Miscellaneous TCJA Issues
Other Issues and Guidance
The IRS Advance Pricing and Mutual Agreement Program issued an announcement that described a process for valuing assets contributed by more than one affiliate in an advance pricing agreement (APA), called the “functional cost diagnostic” model. Provided in an Excel workbook, the model guides the user in entering various costs incurred by members of a related group carrying out core functions of the business that are covered by the agreement with the calculations allowing “a pro forma split of residual profits,” stated the announcement. Some transfer pricing experts saw this as a signal to taxpayer to consider a residual profit split method, with some commenting that recent OECD guidance also appeared to favor this approach. An agency spokesman, however, said that profit split methods are used in a minority of cases and that hasn’t changed — the IRS is not prescribing or mandating the use of the method, but rather they are making available a model used by companies and accepted by the IRS and foreign governments in the past.
The IRS announced that it is withdrawing rules on allocation and basis recovery in corporate stock transactions that were first proposed in 2009. The IRS statement said that it is still studying issues addressed in the proposed rules with a focus on issues surrounding Code sections 301(c)(2) and 304, and section 1.302-2(c) of the Income Tax Regulations.
The IRS issued Revenue Ruling 2019-09, which suspends two long-standing rulings pending the completion of a study on the active conduct of a trade or business under Code sections 355(a)(1)(C) and 355(b). The suspended rulings are Revenue Ruling 57-464 and Revenue Ruling 57-492. The IRS states that it is conducting a study “to determine, for purposes of section 355, ‘whether a business can qualify as an ATB [active trade or business] if entrepreneurial activities, as opposed to investment or other non-business activities, take place with the purpose of earning income in the future, but no income has yet been collected.” The IRS noted that the ATB analysis underlying the holdings in these rulings focuses on the lack of income generated by the activities under consideration, and thus they could be interpreted as requiring income generation for a business to qualify as an ATB.
The IRS issued final regulations under Code sections 1471-1474 on the requirements and verification procedures for certain entities complying with the Foreign Account Tax Compliance Act (FATCA). These rules affect foreign financial institutions (FFIs) and certain nonfinancial foreign entities (NFFEs), trustees of certain trustee-documented trusts, registered deemed-compliant FFIs, and financial institutions that implement consolidated compliance programs (compliance FIs). The IRS stated that the final rules adopt the 2017 proposed regulations with only limited modifications.
The IRS issued proposed regulations to prevent a corporate partner from avoiding corporate-level gain through transactions with a partnership involving equity interests of the partner or certain related entities.
The IRS issued final rules on reportable transaction penalties under Code section 6707A, which imposes penalties for failing to disclose information regarding a reportable transaction under Code section 6011. The final regulations were necessary to clarify the amount of the penalty, which was changed by the Small Business Jobs Act of 2010, from a dollar amount to a percentage of the decrease in tax shown on the return as a result of the reportable transaction.
The IRS issued revised proposed rules on transactions where C corporation property is transferred to a Real Estate Investment Trust (REIT). The IRS stated it was partially withdrawing a 2016 proposed rulemaking that would have provided guidance for transactions in which property of a C corporation becomes the property of a REIT following certain corporate distributions of controlled corporation stock since this issue is covered in the revised rules.
The IRS issued Notice 2019-20, which provides penalty relief to certain partnerships for missing negative tax basis capital account information. The guidance waives penalties under Code section 6722 (failure to furnish correct payee statements) and Code section 6698 (failure to file partnership return). The relief affects partnerships that file Schedule K-1 that fail to report information about partners’ negative tax basis capital accounts for the partnerships’ 2018 tax year. The penalty relief is contingent on the partnerships providing the missing information by March 15, 2020.
The IRS issued final regulations that remove nearly 300 regulations deemed unnecessary because they no longer apply under the current tax code. Most of the changes targeted various reporting and recordkeeping requirements.
Brexit: The U.K. Parliament voted on March 13th to rule out the possibility of leaving the European Union without a withdrawal agreement, which eased fears that Britain would crash out of the EU’s legal and regulatory framework without a transition period. This followed a vote on March 12th which saw the Government’s proposal for a withdrawal agreement overwhelmingly defeated. The Parliament voted on March 14th on a delay of three months from the March 29th departure date to gain more time for reaching a deal, which will require EU agreement. Voting continues in the Parliament in an effort to find a way forward on this issue with a plan that can be approved by Parliament and agreed to by the EU. EU officials have stated that no delay will be approved without an explanation from the UK of what will be accomplished with the extra time. If an extension is granted by the EU, the focus shifts to determining what kind of deal can gain the approval of both the Parliament and the EU with an additional option of a second referendum that could result in the cancellation of Brexit.
Digital Services Taxes: The OECD announced on January 29th that it is working toward a consensus plan to taxing digital commerce as part of the BEPS initiative. A Consultation Document was issued on February 13th, and interested parties were invited to comment by March 1st. A public consultation meeting was held on March 13-14th in Paris as part of the meeting of the Task Force on the Digital Economy. A detailed program of work will be considered at the Inclusive Framework meeting in May and presented to the G20 Finance Ministers meeting in June with a goal of a consensus-based long-term solution in 2020.
The OECD released more than 200 comment letters received in response to the public consultation, which began with the focus on the tax challenges of the digitalization of the economy but has now broadened to a general discussion of countries’ right to tax multinational group profits in all sectors. Proposals under debate include a minimum tax on multinational profits and proposals that would allocate more taxing rights to market jurisdiction or jurisdictions where the users of digital services live. Some commentators have questioned why the broader issue of a global anti-base erosion proposal was included in the consultation document and the OECD discussions.
EU Action on Digital Tax: EU Finance Ministers dropped their effort to adopt a proposal for an immediate, temporary, EU-wide digital tax on large global companies, which had been intended to be a stop-gap measure until a global consensus was reached on a long-term solution. The digital services tax and an advertising tax were opposed by several EU countries including Sweden, Denmark, Finland, and Ireland. The EU will focus on the discussions proceeding at the OECD and G20 level, and only revisit the issue on the EU level if consensus is not reached in 2020. The EU has called on France and other countries pursuing unilateral measures, including Belgium, Spain, the UK, Italy, and Austria, to focus their efforts on reaching consensus at the EU level and at the OECD.
France: After the failure to adopt an EU-wide digital tax, the French government published a draft bill proposing a new 3 percent tax on the revenue of large digital companies applying retroactively to January 1, 2019. The bill was presented to the cabinet and is expected to be presented to the Parliament in early April. The tax would apply to online marketplaces, the sale of data for targeted advertising, and the sale of targeted online advertising. France has said that it would terminate its tax once an OCED solution has been agreed. Treasury Secretary Mnuchin has expressed his opposition to a unilateral French proposal, and Chip Harter, Treasury’s Deputy Assistant Secretary for International Tax Affairs called the new tax “highly discriminatory,” stating that Treasury, the US Trade Representative’s office and US lawmakers are studying whether the discriminatory impact would give the US rights under trade agreements, WTO and treaties. During a hearing on the Administration’s budget proposal, Ways & Means Committee Chair Neal (D-MA) commented on the OECD work on the taxation of digital commerce stating, “That work has the potential to affect a wide range of US businesses and taxpayers, and the US tax base.” He said he intends to pay close attention to those developments, especially in light of France’s recent unilateral imposition of a digital services tax, and he asked Secretary Mnuchin to keep him fully informed on the issue as the OECD works on a consensus plan.
OECD: The OECD released a report assessing whether the 127 members of the “Inclusive Framework on BEPS” are following through on their commitments to add provisions to their tax treaties to stop a practice known as “treaty shopping,” which allows multinational businesses to avoid tax on cross-border transactions. The report finds that 82 of the 116 members as of June 30, 2018, have either some agreements that are already compliant with the standards or that are expected to be compliant soon.
EU Tax Haven Report and Black-List Additions: The European Parliament issued a report naming 7 jurisdictions as tax havens including Belgium, Cyprus, Ireland, Hungary, Luxembourg, Malta, and the Netherlands. The report urged the EU to implement stricter rules to battle tax evasion and avoidance stating that these seven countries helped facilitate aggressive tax planning. The EU Council on March 12th adopted a revised list of non-cooperative jurisdictions for tax purposes adding 10 additional jurisdictions, including Aruba, Barbados, Belize, Bermuda, Dominica, Fiji, Marshall Islands, Oman, United Arab Emirates, and Vanuatu for a total of 15 jurisdictions on the list (including American Samoa, Guam, Samoa, Trinidad and Tobago, and US Virgin Islands). Inclusion on the list results in potential consequences including increased monitoring and audits and the prohibition against EU funds being channeled through entities in those countries.
The Tax-Writing Committees: Tax Reform, Technical Corrections & Tax Extenders
House Ways & Means Committee: The Committee held a hearing on infrastructure on March 6th with the discussion focused on what kinds of infrastructure should be prioritized and how to pay for the program. The Subcommittee on Select Revenue Measures also held a hearing on March 12th on extending expired tax incentives, many of which affect green energy and biofuels.
The Committee held a hearing on March 27th that focused on taxpayers who did not benefit from the TCJA. Republican members of the Committee argued that the TCJA has resulted in major capital business investments, historic wage growth and increased employment. Democratic members disagreed with these conclusions stating that the law has created disparities between income levels and between capital investments in the US and abroad. Congressman Doggett (D-TX) suggested that large multinational companies continue to be incentivized to invest in their overseas operations rather than repatriating that money to the US. American Action Forum President Douglas Holtz-Eakin, who is a former CBO director, testified that nearly $1 trillion from corporate earnings overseas has been repatriated, but it is unclear how much more of the $2.5 trillion in the Joint Tax Committee estimate of the repatriation proposal would return to the US. Democrats also highlighted the 199A pass-through business income deduction and the disparities between the kinds of service-based entities that can claim the benefit.
Two members of the Committee introduced legislation that would end capital gain treatment for income from carried interests, which has a companion bill in the Senate. Two members of the House introduced legislation that would impose a financial transactions tax on the sale of stocks, bonds, and derivatives with a companion bill in the Senate.
Senate Finance Committee: SFC Chair Grassley and Ranking Democrat Wyden released legislation that would retroactively extend through 2019 several temporary tax deductions, credit, and incentives that expired at the end of 2017 and 2018, but no action has been taken in the Committee.
Joint Committee on Taxation (JCT): The JCT issued an overview of the deduction for qualified passthrough business income under Code section 199A, which was enacted as part of the TCJA and is effective for tax years starting in 2018. The new qualified business income deduction allows certain passthrough owners to deduct up to 20 percent of their qualified business income, plus 20 percent of the aggregate amount of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. The IRS issued final regulations in February. JCT also issued a new report called the “Overview of the Federal Tax System as in Effect for 2019.” It does not include provisions that are scheduled to take effect after 2019, and it does not discuss termination dates for provisions that are due to sunset after 2025.
Extenders: The Ways & Means Committee is expected to hold a markup in April to consider an extender package dealing with several tax code provisions that have expired. A hearing was held on March 12th with a Joint Committee on Taxation report issued. There is some speculation that other issues might also be considered for inclusion in the bill including IRS reform, retirement savings issues, , disaster relief, and refundable tax credits. Senate Minority Leader Schumer (D-NY) made recent statements that suggested that concessions might be needed from Republicans not only with respect to agreement on technical corrections to the TCJA, but also to agreement on certain extenders. One question as yet unanswered is whether the Ways & Means Committee will decide that offsets are needed for an extender package, which is an issue that appears to be less likely to come up at the Senate Finance Committee. In any event, it is unlikely that an extenders package would move forward in Congress until this fall when a number of issues are typically considered prior to adjournment for the year.