Washington Tax Insight August 2017
Politics and Congressional Activity
The House began their several week August recess on July 28th but Senate Majority Leader McConnell (R-KY) kept the Senate in session for an additional week to focus on nominations and other legislative priorities. The Senate did not formally adjourn for the recess and will maintain a schedule of pro forma sessions, which means that the President will not be able to make any recess appointments to avoid the requirement of Senate confirmation.
The House Budget Committee approved a FY 2018 concurrent budget resolution, which summarizes broad spending cuts and revenue targets for the next fiscal year, but the full House did not vote on this prior to leaving for the August recess. The resolution includes reconciliation instructions for the Ways & Means Committee to report a comprehensive tax reform bill and a broad policy statement on tax reform calling for simplification, lower marginal rates for individuals and corporations, consolidation of tax brackets, repeal of the AMT, and a transition to a more competitive system of international taxation. A tax bill that is considered under the rules of budget reconciliation is protected during Senate debate from unrelated amendments and filibusters, and requires only a simple majority vote for passage. Without approval of this resolution by the House and Senate, Congress cannot move to advance tax reform using the budget reconciliation process.
Treasury Secretary Mnuchin faces a September target date for achieving an increase in the federal debt ceiling limit, since Congress has not yet acted on legislation and is unlikely to do so until they return from the August recess. Failure to raise the limit could lead to the US failing to pay its obligations and potentially defaulting on US debt. There continues to be uncertainty about whether the Administration’s position on this legislation will align with Mnuchin’s view that the legislation should be “clean” and not include spending cuts or align with Office of Management and Budget Director Mulvaney’s view that it should include additional spending cuts and budget changes.
Congress has also not made much progress on the 12 appropriations bills due to be approved by the start of FY 2018 on October 1st. The House approved a $789 billion defense spending package that includes what GOP leaders have called a $1 billion “down payment” for Trump’s border wall. The four-bill package now will go to the Senate, where it is unlikely to pass without changes. The Senate is moving even more slowly and has moved only two bills out of the Appropriations Committee.
In an effort to unite their party and re-energize their message to voters prior to the 2018 mid-term elections, House and Senate Democrats released a new economic agenda titled “A Better Deal” with the goals of attacking Republican tax reform goals as benefiting the wealthy, limiting large corporate mergers, controlling rising drug prices and increasing wages.
Ways & Means Committee/House
The House W&M Tax Policy Subcommittee held a hearing on small business growth and tax reform. In conjunction with the hearing, the Joint Tax Committee issued a report on the taxation of small businesses.
The House W&M Committee held a tax reform hearing focusing on individuals and families. One of the witnesses was former W&M Committee Chair Bill Archer (R-TX) who advised Committee members not to enact retroactive revenue provisions, which he suggested was one of the key failings of the 1986 Tax Reform Act. He also stated that tax reform should be bipartisan in order to be “long lasting” and permanent tax reform is important in order to give taxpayers certainty.
The House W&M Oversight Subcommittee held a hearing on IRS electronic record retention policies.
The Financial Accounting Standards Board (“FASB”) received two separate requests–one from a group of 16 House Democrats, led by Congressmen Doggett (D-TX) and Patch (D-WI) and the other from the Investor Advisory Committee of the SEC—for FASB to require multinational companies to disclose country-by-country tax reporting information in their public financial statements.
Senate Finance Committee/Senate
On July 20th, the Senate Finance Committee unanimously approved the nomination of David Kautter to be the Assistant Secretary for Tax Policy at the Treasury Department. A vote by the full Senate has not yet been scheduled. During the committee questioning, Kautter stated that “we can get tax reform over the finish line,” and that he believes that all issues should be “on the table.” He also commented that he believes that tax reform should be revenue-neutral using dynamic scoring; that eliminating the interest deduction altogether is not advisable; that there should be lower tax rates for pass-throughs while acknowledging the issue of taxing personal service income at a lower pass-through rate; and that the US should continue to participate in the OECD Base Erosion and Profit Shifting (BEPS) project.
SFC Republicans met on July 27th for presentations on the various issue areas that were recently assigned by Chair Hatch to members of the Committee. The discussion covered process and policy options.
The SFC held a hearing on “Comprehensive Tax Reform: Prospects and Challenges,” which featured a panel of former Assistant Treasury Secretaries for Tax Policy including Mark Mazur (2012-2017), Eric Solomon (2006-2009), Pam Olson (2002-2004) and Jon Talisman (2000-2001). In connection with this hearing, the Joint Tax Committee issued a pamphlet that includes an overview of federal taxation and discusses how to evaluate various tax systems for efficiency, fairness, and simplicity. SFC Chair Hatch was asked whether the SFC would hold a hearing once a specific tax reform plan has been released, and he responded, “I would like to but I don’t know.”
SFC Chair Hatch (R-UT) delivered a speech on tax reform on the Senate Floor in which he argued for the need to move to a territorial system for foreign income. In connection with his remarks, the SFC issued a briefing paper on the benefits of a territorial system.
Treasury and the IRS
The IRS issued Notice 2017-36, which delayed the effective date of the debt-equity documentation rules under Treas. Reg. section 1.385-2 by a year; under the Notice, the documentation requirements will only apply to interests issued or deemed issued after December 31, 2018.
The IRS issued Notice 2017-38, which identifies eight regulations that the Treasury Department intends to modify or repeal, including regulations on debt-equity, property transfers to foreign corporations, and certain estate tax rules. This action followed from Executive Order 13798, issued on April 21st that instructed the Treasury Secretary to review all “significant tax regulations” issued on or after January 1, 2016 and to submit a 60-day interim report identifying regulations that impose an undue financial burden on US taxpayers, add undue complexity to the federal tax laws, or exceed the IRS’s statutory authority. Out of the 105 temporary, proposed and final regulations issued during that period, 52 were deemed to be potentially significant, and 8 were targeted for action, although none were deemed to exceed the IRS’s statutory authority.
A final report recommending specific actions to mitigate the burden imposed by the regulations identified in the interim report is required by September 18, 2017. Comments regarding whether the regulations should be rescinded or modified (and how they should be modified) are due by August 7, 2017. The full list of regulations to be modified, replaced or removed is:
- Proposed regulations under Code section 103 on the definition of political subdivision
- Temporary regulations under Code section 337(d) on certain transfers of property to regulated investment companies (RICs) and real estate investment trusts (REITs)
- Final regulations under Code section 367 on the treatment of certain transfers of property to foreign corporations
- Final and temporary regulations under Code section 385 on the treatment of certain interests in corporations as stock or indebtedness
- Temporary regulations under Code section 752 on liabilities recognized as recourse partnership liabilities
- Final regulations under Code section 987 on income and currency gain or loss with respect to a section 987 qualified business unit
- Proposed regulations under Code section 2704 on restrictions on liquidation of an interest for estate, gift, and generation-skipping transfer taxes
- Final regulations under Code section 7602 on the participation of a person described in Code section 6103(n) in a summons interview
Treasury and the IRS withdrew 2005 proposed regulations under Code sections 332, 351 and 368 on certain corporate transfers of no net value. The proposed regulations generally would have provided that the non-recognition rules in subchapter C do not apply unless there is an exchange or distribution of net value. The IRS explained that current law under Code section 351 and the reorganization regulations finalized in 2008 (TD 9434) and 2016 (TD 9759) are sufficient to readjust continuing property interests held in modified corporate form.
The IRS released an International Practice Unit (IPU) on determining whether Forms 5471 and 5472 are substantially complete for penalty purposes. The IPU states that if the specific information or requirement at issue is determined to be related to the “substance or essence” of the statute or regulation, then strict compliance is necessary. If the requirement, however, is viewed as “procedural or directory,” then substantial compliance will apply. IPUs are internal IRS documents used by IRS staff as job aids and training materials in compliance activities.
The IRS issued Revenue Procedure 2017-41, which streamlines the process for seeking pre-approvals for retirement savings plans under Code sections 401, 403(a), and 4975(e)(7).
The IRS issued corrections to information reporting and withholding regulations issued in January 2017. The first set of corrections is to IRS Regulation TD 9808, related to withholding of tax on certain US source income paid to foreign persons, information reporting and backup withholding with respect to payments made to certain US persons, and portfolio interest paid to nonresident alien individuals and foreign corporations. The IRS also issued correcting amendments to final and temporary regulations TD 9809, which provide instructions to foreign financial institutions (FFIs) on reporting US accounts and withholding on payments to FFIs and other foreign entities. The IRS stated that several portions of TD 9808 and 9809 which were published in the Federal Register on January 6th could not be incorporated due to inaccurate amendatory instructions.
The National Taxpayer Advocate, Nina Olson, released her mid-year report to Congress, which includes a review of the 2017 filing season. The report identifies the priority issues the Taxpayer Advocate Service will address during FY 2018 and includes the IRS response to the 93 administrative recommendations included in her 2016 Report to Congress. Priority issues included in this report are private debt collection implementation, US passport revocations and denials for seriously delinquent tax debts, and transparency in the offshore voluntary disclosure programs.
The IRS announced the launch of country-by-country reporting pages on their website, www.irs.gov. The new pages include background information on country-by-country reporting, frequently asked questions, and a list of jurisdictions that have concluded competent authority arrangements with the United States.
The OECD released the 2017 edition of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations primarily reflecting changes resulting from the OECD BEPS project. The document also includes the revised Recommendation of the OECD Council on the Determination of Transfer Pricing between Associated Enterprises.
The OECD Committee on Fiscal Affairs released the draft contents of the 2017 update to the OECD Model Tax Convention prepared by the Committee’s Working Party 1. The update has not yet been approved the Committee on Fiscal Affairs or by the OECD Council, although significant parts of the 2017 update have been previously approved as part of the BEPS package. It will be submitted for the approval of the Committee and the Council later in 2017. Comments are requested with respect to certain parts of the 2017 update that have not been previously released for comments and should be submitted by August 10, 2017.
The OECD released revised discussion drafts on the attribution of profits to permanent establishments (PEs) and transfer pricing guidance on the profit split method. Both replace earlier drafts published in July 2016, and comments are due by September 15th. The PE discussion draft is in response to Action 7 of the BEPS plan and includes examples of how to analyze PE issues when a multinational enterprise uses a commissionaire structure, an online advertising sales structure, and a procurement structure involving a related intermediary. This draft also examines the interaction between Article 7 of the OECD Model Treaty (attribution of profits to PEs) and Article 9 (associated enterprises with respect to dependent agent PEs). The second discussion draft on profit splits outlines when the method is the most appropriate transfer pricing method and how profits should be split.
The OECD released its OECD Secretary-General Report to G20 Leaders highlighting progress made by the OECD and the G20 in addressing tax avoidance and tax evasion during the last year. The Report describes 2017 as the “year of implementation,” covering movement toward automatic exchange of information between tax authorities (starting in September 2017) and key measure to address tax avoidance by multinationals.
The European Commission released a proposal for a council directive that would require reporting and disclosure of aggressive cross-border tax planning schemes that will be submitted to the European Parliament for consultation and to the European Council for adoption. The directive requires lawyers, accountants, banks and other financial consultants, called intermediaries, to report international arrangements they design or promote within five days of advising their clients on the arrangements. The reporting obligation to tax authorities falls to the taxpayers themselves if the advisers are either outside the EU or are bound by professional rules protecting client confidentiality. The types of planning arrangements covered include those that (1) involve a cross-border payment to a recipient resident in a no-tax country; (2) enable the same income to benefit from tax relief in more than one jurisdiction; or (3) do not respect EU or international transfer pricing guidelines.
The European Parliament released a briefing providing an overview of the OECD Base Erosion and Profit Shifting (BEPS) project including information on progress made with respect to several of the BEPS Action reports.
The Failure of Health Care Reform and the Prospects for Tax Reform
In the run-up to the August recess, Senate Republican leadership committed to a series of votes on the Senate Floor on health care reform – an effort that failed after several Republican Senators opposed the various bills that were broadly described. Why would Senate Majority Leader McConnell go through this exercise?
Some in Washington suggest that his goal is to get past health care reform as an issue so that he can move on to tax reform while demonstrating that he responded to the White House and others in the Republican party that an attempt was made to deal with the health care reform issue before abandoning it. It has been suggested by some Republicans that tax reform will be easier with the failure of health care reform because the party will have to show success on some key issue prior to the end of the year.
After failure to approve any of the bills on health care reform as detailed below, Senate Majority Leader McConnell said, “This is clearly a disappointment. It’s time to move on.”
Health Care Reform
On July 25th, the Senate voted 51-50 in favor of a motion to begin debating the repeal of the Affordable Care Act, with two Republican Senators – Susan Collins (R-ME) and Lisa Murkowski (R-AK) — voting against the motion and Vice President Pence casting the tie-breaking vote. The Senate then began to take a series of votes on various proposals in an effort to pass some form of legislation that would allow the Senate to move to conference with the House on this issue.
The Senate voted 43-57 against the Better Care Reconciliation Act, which was the Republican leadership’s reform bill with additional language from Senator Cruz (R-TX) and Senator Portman (R-OH). It is notable that this version of the bill retained the 3.8 percent net investment income tax on high income households. On July 26th, the Senate voted 45-55 against an amendment to repeal major parts of the Affordable Care Act in two years without a replacement. The Senate then moved to vote on the “skinny repeal” bill that included repeal of the individual and employer mandates and the medical device tax, but that also went down to defeat late on July 27th when Senator McCain (R-AZ) joined Senators Collins and Murkowski in voting against the bill.
During debate on this issue, the Senate did adopt an amendment to permanently repeal the “Cadillac tax” on expensive employer-provided health insurance, which is scheduled to go into effect in 2020. Although the vote was along party lines, there is opposition to this tax in both parties, and it is expected to be repealed at some point.
In a joint statement issued July 27th, the White House and Congressional leaders outlined several broad tax policy goals and stated that “the time has arrived” for the tax-writing committees to draft legislation with the goal of “a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas.” The controversial Border Adjustment Tax (BAT) proposal which would have imposed a 20 percent tax on all imports while exempting exports has been dropped from consideration.
The “Big Six” tax reform meetings have involved Treasury Secretary Mnuchin, National Economic Director Cohn, Senate Majority Leader McConnell (R-KY), House Speaker Paul Ryan (R-WI), SFC Chair Hatch (R-UT) and W&M Committee Chair Brady (R-TX), and all signed the joint statement. The intention of this statement is clear – the White House wanted to pivot attention from the failed health care reform effort in Congress and show progress on a key issue that is important to the business community before Congress leaves for the August recess.
The joint statement was designed to show a unified commitment to achieving tax reform in 2017, but after weeks of meetings attended by Congressional leadership and key Administration officials, the document was even shorter than the 1-page set of principles released in April. There are still no details or policy specifics other than the abandonment of the BAT, which leaves a huge question about how to pay for the significant tax cuts that have been promised.
The statement indicated that the process has now been handed back to the two tax-writing committees by stating “our expectation is for this legislation to move through the committees this fall, under regular order, followed by consideration on the House and Senate floors.” It is expected that committee and Treasury staff will be working in August to draft legislation that will include policy specifics that will emerge in September when Congress returns as a unified product to be addressed by both the House and Senate.
A public campaign to energize support for tax reform is planned for August with House Republicans planning to talk about the issue in their home districts during the recess while a range of conservative grassroots groups has been meeting with the Administration communications and political staff. The Business Roundtable is planning a multi-million-dollar national television and radio campaign in favor of tax reform.
The joint statement states that permanent tax changes are a priority, but this may leave room for the tax reform package to be more limited than comprehensive reform and focus on tax cuts resulting in a bill that is not deficit-neutral. This approach could, however, run into problems with respect to the current House budget resolution, budget reconciliation rules, and Senate pay-as-you-go rules.
White House officials are considering an alternative strategy of pursuing a short-term tax cut if the effort to pursue comprehensive tax reform is not able to advance in the fall – an idea that has been advocated for by Trump campaign advisors, Lawrence Kudlow and Steven Moore. The three components of their package include a corporate rate of 15%, a doubling of the individual standardized deduction, and a proposal to allow companies to repatriate foreign earnings without penalty.
Treasury Secretary Mnuchin and National Economic Council Director Cohn still appear to prefer a broader plan that would lower rates while eliminating certain tax breaks to offset the cost. Reportedly, the Administration has made no decision on whether tax reform must be revenue neutral and whether the tax cuts would be permanent or temporary, and the joint statement does not clarify these issues.