Washington Tax Insight August 2019
Politics and Congressional Activity
The Senate and the House approved legislation called the Bipartisan Budget Act of 2019 that would suspend the statutory debt limit until mid-2021 and lift the statutory caps on discretionary spending for the next two years (the “sequester”). The President has said that he will sign the bill. The budget deal does not include any tax measures, such as tax extenders, technical corrections, or retirement security legislation.
The bill would lift the sequester caps on annually appropriated spending by a total of $320 billion over the next two fiscal years (2020 and 2021), split equally between defense and non-defense spending. As compared to 2019 spending, this represents for 2020 an increase of $22 billion for defense accounts and $27 billion for non-defense with additional increases for 2021. The legislation also suspends the statutory debt limit through July 2021 – the issue that created the urgency for completing this deal prior to the Congressional August recess. Since the suspension of the debt limit had ended on March 2nd, the Treasury Department had been using “extraordinary measures” to manage the government’s borrowing authority, but those actions were likely to be exhausted prior to the return of Congress on Sept. 9th.
There were objections from both sides of the aisle to the agreement. Conservatives complained about the fact that the bill, which includes more than $2.7 trillion in spending, was for the most part not paid for, and progressives complained about the amount of authorized defense spending. Only $75 billion of the agreement is offset, and that is done by “budget gimmicks” that have been used in the past, including the collection of customs user fees. In the end, however, the threat of a government shutdown and a government default helped get the deal finished.
Although the budget deal represents good news, there is still opportunity for drama when Congress returns in September. By the start of FY 2020 on October 1st, Congress will need to have approved appropriations legislation that specifies the funds allocated for the various departments and functions of the federal government. The 2019 budget deal does not include appropriations at the program level.
House/Ways & Means Committee: The Ways & Means Committee has filed suit in federal court against the Treasury Department and the IRS for access to President Trump’s tax returns asking the court to enforce subpoenas that have been issued. A DC federal judge later added President Trump and several of his business entities to the lawsuit after they asked to intervene in the case.
The House voted overwhelmingly in favor of legislation that would repeal the excise tax on high-cost health insurance plans – the “Cadillac tax.” The bill has been sent to the Senate, but it is unclear if they will take it up for action anytime soon, although there are reports that leadership is open to Floor action. The tax was included in the 2010 Affordable Care Act but is not scheduled to take effect until 2022. Repealing the law would create a $197 million revenue loss over 10 years, but the current legislation does not cover this revenue loss.
Democrats in the House and Senate introduced joint resolutions of disapproval in an effort to invalidate recently issued final regulations from the Treasury Department and IRS that stop actions by certain states to allow their residents to minimize the impact of the $10,000 cap on the federal deduction for state and local taxes (SALT), which was included in the TCJA. The resolutions are authorized by the Congressional Review Act, which allows Congress to review certain rules before they take effect and disapprove them. Such resolutions only require a simple majority vote, which is important in the Senate where the Republicans hold only a slim margin of control. Becoming law is still unlikely, however, because it would require the President’s signature, but this issue is likely to be included in political discussion connected to the 2020 elections.
Senate/Senate Finance Committee: Fifteen Senate Democrats sent a letter to Treasury Secretary Mnuchin on July 12th urging him not to pursue administrative action to index capital gains to inflation. The letter was sent because of press reports that the Administration is considering bypassing Congress and using regulatory action to make this policy change. The letter questions whether the Administration has the legal authority to act unilaterally on the issue.
Retirement Savings Legislation: The House-passed versions of retirement legislation – the Setting Every Community Up for Retirement Enhancement Act (“SECURE” Act) – remains blocked in the Senate due to the objections from Senator Cruz (R-TX) to the removal of the Code section 529 programs for education savings expansion and potential objections from a handful of other Senators. It remains unclear if Senate leadership will be able to resolve these objections in order to move the bill under unanimous consent or whether they will have to go through the more time-consuming process of bringing it to the Senate Floor for debate.
Tax Treaties: The Senate approved protocols to four tax treaties that have been waiting for ratification for years including treaties with Japan, Luxembourg, Spain, and Switzerland. The pending treaties with Chile, Poland, and Hungary are still pending in the Senate Foreign Relations Committee as the Treasury Department seeks to clarify how provisions in those agreements interact with the base erosion and anti-abuse (BEAT) provision enacted in the TCJA.
Treasury and the IRS
Treasury and the IRS have released a significant amount of guidance on the TCJA to date. Treasury had until June 22, 2018 (18 months after the TCJA was enacted) to issue final rules that would operate retroactively back to the enactment date.
Global Intangible Low-Taxed Income (GILTI) & Foreign-Derived Intangible Income (FDII): The IRS released proposed regulations that would expand the exception to the global minimum tax, with respect to global income that has already been taxed by foreign jurisdictions with a proposal to exempt income where 90% of the US tax rate has been paid — i.e. 90% of 21% or 18.9%. Because it was not included in the final regulations issued before June 22nd, this change will not be available for taxpayers retroactively to the date of enactment of the 2017 legislation. Although the IRS provides some relief with this proposed rule, many believe that Congress intended the fundamental top global rate to be 13.25%, above which residual US GILTI taxation would no longer apply, and clearly the 18.9% is significantly above that rate. Also, several states have passed legislation that excludes GILTI income from full taxation on the state level, including New York which excludes 95% of GILTI from the New York State income tax base. Other states that have addressed the issue include Massachusetts, Connecticut, and Pennsylvania with legislation in Florida and Oregon awaiting signature by the governors of those states.
Opportunity Zone regulations: The IRS updated its FAQs for Opportunity Zones. In the updated FAQs, the IRS now poses, and answers in the affirmative, the question of whether a taxpayer can still make a valid deferral election based on an investment that was lower than the total Code section 1231 gain but realized within the 180-day period after the last day of the 2018 tax year under proposed regulations.
Other Issues and Guidance
PFIC Regulations: The IRS issue proposed regulations under Code section 1298 regarding passive foreign investment company (PFIC) ownership and “the treatment of certain income received or accrued by a foreign corporation and assets held by a foreign corporation for purposes of section 1297.” The guidance clarifies the rules for determining if a US taxpayer holding stock in a PFIC is treated as a shareholder and whether a foreign entity is a PFIC.
New Compliance Campaigns: The IRS Large Business and International (LB&I) Division announced the launch of six new compliance campaigns covering the following areas: (1) Corporations’ Built in Gains Tax; (2) Post Offshore Voluntary Disclosure Program Compliance; (3) Expatriation; (4) High Income Non-filer; (5) US Territories – Erroneous Refundable Credits; and (6) Section 457A Deferred Compensation Attributable to Services Performed before January 1, 2009.
Partnerships/Allocation of Foreign Income Taxes: The IRS issued final regulations under Code section 704 on the allocation by a partnership of foreign income taxes. The rules aim to “improve the operation of an existing safe harbor rule that determines whether allocations of creditable foreign tax expenditures are deemed to be in accordance with the partners’ interests in the partnership.
Partnerships/Disregarded Entities: The IRS issued final regulations that clarify the employment tax treatment of partners in a partnership that owns a disregarded entity. The new rules “explicitly provide that the owner of a disregarded entity who is treated as a sole proprietor for income tax purposes is subject to self-employment taxes,” according to the IRS. “These regulations do not address the application of Revenue Ruling 69-184 in tiered partnership situations, but rather clarify that a disregarded entity owned by a partnership is not treated as a corporation for purposes of employing any partner of the partnership.” The regulations also do not address the application of Revenue Ruling 69-184 to publicly traded partnerships, but the IRS says it welcomes additional input on the “exception to the principles” of the revenue ruling for publicly traded partnerships. The final regulations also clarify the applicability date.
Miscellaneous: The IRS announced that updated instructions for Form 8975 and Schedule A on country-by-country reporting for large multinationals were published on July 1st.
The IRS announced a public hearing on its proposed rules regarding withholding of tax and information reporting of interests in partnership scheduled for August 26, 2019.
The IRS posted a page for General Section 965 Questions and Answers, providing informal guidance on complying with Code section 965 regarding the taxation of foreign earnings deemed repatriated under the TCJA. The guidance includes a discussion of making successive installment payments, filing transfer agreements as a result of certain acceleration or triggering events, and other matters related to S corporation shareholders making the Code section 965(i) election.
The IRS issued its third quarter update to its 2019 priority guidance plan which sets out tax regulatory projects the agency will work on during the year. No new international regulatory projects were announced in this update.
IRS New Large Corporate Compliance Program
The Large Business and International Division (LB&I) recently announced that it will roll out a new program, the Large Corporate Compliance (LCC) program, to replace the Coordinated Industry Case (CIC) program which selects the largest and most complex taxpayers. The primary objective of the LCC program will be to “efficiently focus its resources on noncompliance” by using data analytics to identify which large corporate taxpayers to audit, beginning with the 2017 tax year. The elimination of the CIC program was first suggested in 2015, when the IRS moved toward more “risk-based” audits. Some of the key features of the LCC program’s use of data analytics will be in identifying case-pointing criteria such as gross assets and gross receipts, which allows for a more “objective determination” of which taxpayers properly belong in the category of the largest and most complex corporate taxpayers. LB&I will then use the data analytics to identify which tax returns are vulnerable to the highest compliance risk, regardless of whether the taxpayer has been under audit. For calendar year taxpayers, 2017 returns could include the Code section 965 transition tax. Pending CIC cases will be completed and closed as CIC cases. Businesses would be well advised to perform an audit risk assessment especially if they have not been under continuous audit.
Brexit: Boris Johnson has assumed the position of UK Prime Minister and has declared that the UK will leave the European Union by October 31st, with or without a new deal. There are reports that PM Johnson may be preparing for a general election at some point, in order to address the fact that he now leads a minority government. The UK will leave the EU without a deal unless one of three steps is taken: agreement to a deal, a request for a further delay, or a decision to cancel Brexit. Under the agreement with the EU, the UK may reconsider their entire Brexit strategy, but the extension agreement precludes reopening the withdrawal agreement.
Adoption of a Global Minimum Tax & Digital Taxation
The OECD continues working on a plan to tax digital commerce as part of the BEPS initiative along with a general discussion of global tax rules. The G20 leaders endorsed the plan developed by the Inclusive Framework on BEPS following their June 28-29 meeting with the goal of a final report by the end of 2020.
Finance Ministers and central bank governors from the G-7 agreed to endorse the direction of the international consensus project on digital taxation at the OECD, despite the fact that the US and France are currently at odds over the new French unilateral proposal. The Chair’s summary released after the July 17-18 meeting stated, “Considering the need to improve the current international tax framework, without undermining its principles, Finance Ministers agreed that it is urgent to address the tax challenges raised by the digitalization of the economy and the shortcomings of the current transfer pricing system.” Chip Harter, the US Treasury Deputy Assistance Secretary for International Affairs commented during the same period of time that the US must balance its interests, stating “We do want to show that the United States objects in a robust way against such unilateral actions,” while also noting “At the same time, we do want to maintain a positive atmosphere for going forward in the OECD to reach a multilateral consensus.”
The US vs. France (and the UK)
The French Parliament has approved a new 3% digital service tax on revenue from some digital activities, such as targeted advertising and running a digital marketplace, by large companies in France. The current version of the tax, which is modeled on a tax proposal that several EU countries had supported at the EU level, would apply to companies with worldwide digital revenue of at least $845 million and at least $25 million in France, retroactive to January 1, 2019. It will apply to gross revenue, similar to a sales tax, rather than applying to a company’s profits after expenses. France will repeal the new tax once a “credible agreement” is reached at the OECD for a global tax. Although France has been accused of targeting large US companies such as Google, Apple, Facebook and Amazon, the tax would reportedly affect US, British, Chinese, German and Spanish businesses and one French company.
The UK also published draft legislation based on the EU proposal that will be part of the next finance bill which would impose a 2% digital services tax in April 2020 unless a global agreement is reached by then. The UK digital tax would be payable annually and assessed on a global basis. The treatment of cross-border transactions will vary if the transaction involves a country that levies a tax that is similar to the UK’s. The UK proposal was first announced in the 2018 budget, and it is targeted at large digital businesses with exemptions for small businesses or businesses with UK losses.
Other countries which are moving ahead with country-specific digital services taxes include Austria, the Czech Republic, Italy, Poland, Portugal, and Spain. Opposition of countries such as Ireland and Luxembourg, which have been successful in attracting high tech companies, prevented unanimous agreement at the EU level.
US Activity: US Trade Representative Robert Lighthizer announced that the US has launched an investigation of the French digital services tax under Section 301 of the 1974 Trade Act. The Act gives the President broad powers to investigate and respond to a foreign country’s unfair trade practices and take appropriate action, including retaliation. The issue to be reviewed is whether the French law targets US companies while excluding French ones, because it imposes the tax on large companies and the types of services subject to tax are limited. A hearing has been scheduled for August 19th. Possible outcomes of the USTR action, which could take up to year, could be new tariffs or other trade restrictions on French goods. Both SFC Chair Grassley (R-IA) and Ranking Democrat Wyden (D-OR) publicly stated their opposition to the French tax and their support for the USTR investigation. They also sent a joint letter to Treasury Secretary Mnuchin urging him to “consider all available tools under US law to address such targeted, discriminatory taxation.” The letter encouraged the Secretary to “take all steps necessary to convince the French government to abandon its unilateral DST provision,” and they specifically detailed punitive measures available under US law, including Code section 891, under which a double rate of US tax can be imposed on citizens and corporations of foreign countries engaging in discriminatory taxation of Americans.
OECD: The OECD announced that its Multilateral Instrument (MLI) matching database has been expanded to include information on entry into effect dates. The database is intended to help users understand how specific bilateral tax treaties are expected to be modified under the MLI mechanisms. Russia and India have deposited their instruments of ratification, and Canada and Morocco have signed the MLI. A total of 89 jurisdictions have now signed the MLI with 28 jurisdictions having deposited instruments of ratification.
The OECD has released new transfer pricing profiles for Chile, Finland, and Italy, which brings the total number of countries covered to 55. The country profiles reflect the current state of legislation and practice in each country regarding the application of the arm’s length principles and other key transfer pricing aspects.
European Union: After a recent meeting of EU Finance Ministers, it was reported by Germany’s official that the EU will likely reach a deal on a proposed financial transaction tax by this fall. The tax was first proposed in 2011 but stalled for years until France and German devised a plan to levy a French-style financial transaction tax with a rate of no less than 0.2%.
United Nations: The UN issued a new version of its tax treaty negotiation manual, which is designed to be a practical manual to assist developing countries in negotiating tax treaties and reflects the current UN Model Treaty.
The Netherlands: The Dutch government announced its priorities in the area of tax policy, including how the Netherlands intends to deal with tax evasion and tax avoidance and improve the Dutch investment climate. The Dutch priorities include the implementation of the EU anti-tax avoidance directive II, which targets hybrid mismatches; the introduction of a conditional withholding tax on interest and royalties; renewing the Dutch tax ruling practice; and implementing the EU mandatory disclosure directive. The legislative proposal on hybrid mismatches was released on July 2nd with effect as of December 31, 2019 and is intended to prevent cases where a payment is deductible in the Netherlands but not taxed elsewhere or where one payment is deductible twice. The other measures are expected to be proposed in 3Q 2019. On June 28th, the Dutch State Secretary of Finance published the final decree on the Dutch tax ruling practice pertaining to tax rulings relating to cross-border structures, with effect as of July 1, 2019. The new decree is not intended to reflect a change in the long-standing investor-friendly approach in the Netherlands.
The Tax-Writing Committees: Tax Extenders & Technical Corrections
The House Ways & Means Committee has approved legislation that would extend several temporary tax provisions, but the legislation has not yet made it to the House Floor for a vote. The 2-year budget deal that was agreed to by bipartisan House and Senate leadership does not include any tax measures, such as an extenders package. Supporters are looking for other potential vehicles that could move prior to the end of the year, but opportunities appear to be few, if any. Senator Thune (R-SD) did comment after the budget deal was announced that he believes there will be a tax vehicle that moves later this year that could carry some of the outstanding tax legislation.
In comments on the Senate Floor, SFC Chair Grassley (R-IA) discussed tax extenders legislation and the expected submission of recommendations by six task forces he appointed to assess the extenders prior to the August recess. The Joint Committee on Taxation issued a report on the temporary tax provisions stating that the revenue cost would be $920 billion over a 10-year period, including the cost to extend several of the individual tax provisions that were included in the TCJA. He has stated that the fact that the bill that repealed the “Cadillac tax” was approved by the House without a revenue offset suggests that there may be support for the same approach with an extenders package, which he would prefer to move through the Senate with revenue offsets. There is bipartisan support at the SFC for this approach, but Democrats on the Ways & Means Committee have resisted the idea of not paying for the extenders package.
Technical corrections legislation continues to be a low priority for tax-writers in Congress, and it is hard to see how this legislation moves forward this year if Democrats continue to take the position that they do not want to help Republicans correct errors in legislation that passed without Democratic input. A handful of technical corrections have been considered including the “grain glitch,” which was corrected in budget legislation in 2018 and the Kiddie Tax changes, which are being considered as part of the bipartisan retirement legislation moving in Congress.