Washington Tax Insight February 2017
Politics and Congressional Activity
Congressional Republicans held an annual retreat to discuss their agenda for 2017 with an appearance by President Trump who encouraged an aggressive agenda on health care, tax reform and new trade deals. House Speaker Paul Ryan (R-WI) outlined the legislative schedule for the “first 200 days” in the House stating the Affordable Care Act (ACA) would be repealed and replaced by April, followed by a funding plan for increased border and national security, and a comprehensive tax reform plan by August. Senate Majority Leader McConnell (R-KY), however, has commented that the Senate will not be able to move as quickly as the House and will likely require Democratic support for most legislation. Congressional Democrats also held a retreat in January.
McConnell said that there would be three parts to the ACA repeal process including legislation passed by Congress; administrative actions to stabilize the insurance market; and replacement legislation which will need 60 votes to pass in the Senate. Speaker Ryan has commented that the “Two Hundred Day Plan” may eventually take the entire year to complete, although he plans to have the bulk of the work completed before the August Congressional recess. The House and Senate both approved a Republican-sponsored budget resolution with reconciliation instructions to four specific committees to report out $1 billion in savings over the next 10 years – with the intention that this savings be the result of repeal of the ACA.
Congressional leaders have suggested that the border wall between Mexico and the US will be paid for initially through a supplemental appropriations bill, while the Trump Administration has proposed covering the cost of the wall through an import tax on Mexican goods. The current funding legislation for this fiscal year for the Federal government runs out at the end of April and the extension could serve as a vehicle for the supplemental appropriations bill, although 60 votes will be needed in the Senate for approval.
Congress will also be working on an infrastructure plan, which is a key part of the Trump agenda to boost the economy. A group of Senate Democrats introduced a $1 trillion infrastructure plan that would rely on direct federal spending and closing tax loopholes, and would cover not only bridges and roads, but the nation’s broadband network, hospitals and schools. Trump advisers have stated that their proposal will rely on federal tax credits and public-private partnerships rather than federal spending.
In the initial days of the new Administration, President Trump signed a number of executive orders that included several focused on the economy, trade and jobs. He also held a series of meetings with business leaders to discuss tax reform and job creation. He is also expected to release the name of his nominee for the Supreme Court, and he has suggested to Senate Majority Leader McConnell the idea of killing the filibuster rule in the Senate in order to achieve confirmation – a move McConnell may be reluctant to advance, since Senate rule changes can adversely impact a political party when they are not in control of the Senate.
President Trump has been invited to address a joint session of Congress on February 28th, and he is expected to release the outlines of his first budget in February, which will be a blueprint for his plans for government spending, which will then be developed further in March and April by Congress as part of the budget process. Disagreements within the Republican party over spending priorities are likely as the President has publicly stated that he will not cut entitlement programs, such as Medicare and Social Security, and he will support spending for infrastructure and defense – positions which could lead to bigger deficits.
Treasury and the IRS
White House Chief of Staff Priebus sent a memorandum to the heads of executive departments and agencies directing a temporary regulatory freeze pending review. The memorandum directs agency heads to refrain from sending regulations to the Office of the Federal Register (OFR) until a department or agency head appointed by President Trump reviews and approves the regulation. It also states that regulations that have been sent to the OFR but not yet published in the Federal Register are to be withdrawn from the OFR, and reg ulations that have been published in the Federal Register but have not yet taken effect are to be temporarily postponed for 60 days from the date of thememorandum for the purpose of reviewing any questions of fact, law and policy. Tax regulations that could be affected include final regulations relating to US-source dividend equivalents and final regulations relating to the qualifying income exception for publicly traded partnerships, while the proposed regulations relating to the new partnership audit regime have already been pulled by the IRS.
Also, the House has passed a bill that would repeal “Midnight Regulations,” which are defined as any regulations released in the last 60 days of the Obama Administration, but the bill is unlikely to get the 60 votes needed in the Senate to prevent a filibuster. Both Treasury and the IRS must agree to withdraw regulations, and some business groups are working on this effort directly with the Administration and through Congressional contacts targeting regulations issued under Code sections 367(d), 901(m) and 987.
The IRS issued a set of final, temporary and proposed regulations under the Foreign Account Tax Compliance Act (FATCA) regarding the information reporting of, and withholding on, transactions between certain US persons and foreign financial institutions (FFIs).
- Final and temporary regulations (TD 9809) address information reporting by FFIs for US accounts and withholding on certain payments made to FFIs and other foreign entities. These regulations clarify that foreign branches of US banks will be considered US withholding agents and may be treated as FFIs in some cases.
- Final regulations (TD 9808) finalize temporary regulations issued in March 2014 regarding the withholding of tax on certain US source income paid for foreign persons, information reporting and backup withholding with respect to payments made to certain US persons, and the treatment of portfolio interest paid to nonresident alien individuals and foreign corporations.
- Proposed and temporary regulations (TD 9808) revise final regulations regarding the withholding tax on certain US source income paid to foreign persons and requirements for certain claims for refund or credit of income tax made by foreign persons.
- Proposed and temporary regulations address the verification and certification of compliance requirements for entities that agree to perform FATCA due diligence, withholding, and reporting requirements on behalf of certain FFIs.
The IRS also issued new guidance under FATCA that includes an updated model agreement for FFIs and a new agreement for qualified intermediaries (QIs). Rev. Proc. 2017-15 provides a final QI withholding agreement that allows foreign persons to enter into an agreement with the IRS to simplify their withholding obligations for amounts paid to their account holders. Rev. Proc. 2017-16 sets forth the agreement entered into by an FFI with the IRS to be treated as a participating FFI under section 1471(b), known as the FFI agreement. The revenue procedure also provides guidance to FFIs under an applicable Model 2 intergovernmental agreement on complying with the terms of the FFI agreement.
The IRS issued final regulations that define and set the annual reporting rules for shareholders of Passive Foreign Investment Companies (PFICs). The regulations assist in determining ownership of a PFIC and the requirements that shareholders file Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.” They also provide guidance on an exception to the requirement for shareholders of foreign corporations to file Form 5471, “Information Return of US Persons with Respect to Certain Foreign Corporations.” The regulations finalize with some changes proposed regulations that had been issued in December of 2013.
The IRS and Treasury issued Notice 2017-09 providing guidance regarding the de minimis error safe harbor for information reporting penalties under Code sections 6721 and 6722. Under the safe harbor, an error on an information return or payee statement is not required to be corrected, and no penalty is imposed, if the error relates to an incorrect dollar amount and the error differs from the correct amount by no more than $100. The notice clarifies that the de minimis error safe harbor does not apply in the case of an intentional error or if a payor fails to file an information return or furnish a payee statement. Treasury and the IRS intend to issue regulations on these provisions.
The IRS issued an International Practice Unit (IPU) titled “Section 367(d) Transactions in Conjunction with Cost Sharing Arrangements (CSAs),” covering the outbound transfer of certain intangibles in conjunction with CSAs. IPUs are drafted by the IRS’s Large Business and International Division and are intended to serve as job aids and training materials. The IPU focuses on transactions in which a US taxpayer may enter into a CSA arrangement with its controlled foreign corporation (CFC) in a low or no tax jurisdiction and contribute high value intangibles to the CSA, and it includes an example with a fact pattern where a US firm takes a number of steps that allow it to move certain intellectual property to a CFC in a low-tax jurisdiction.
The IRS issued final and temporary inversion regulations (TD 9812) under Code section 7874. The final regulations adopt prior temporary regulations issued in 2014 and 2016 with certain amendments. They are intended to address cases structured to avoid Code section 7874 where the assets of domestic corporations or partnerships are directly or indirectly acquired by a foreign corporation. The regulations identify certain stock of a foreign corporation that is disregarded in calculating ownership of the foreign corporation for purposes of determining whether it is a surrogate foreign corporation. The final regulations also provide guidance on the effect of transfers of stock of a foreign corporation after the foreign corporation has acquired substantially all of the properties of a domestic corporation or of a trade or business of a domestic partnership.
The IRS issued final regulations on the time period that a Regulated Investment Company (RIC) or a Real Estate Investment Trust (REIT) may be required to pay corporate taxes on certain transfers of property. One key change addressed an issue raised in a letter from the Chairs and Ranking Members of the Ways & Means Committee and SFC. The letter stated that the proposed regulations deviated from Congressional intent and the general practice of treating REITs and RICs as having the same five-year built-in gain recognition period as S corporations, and the letter urged the IRS to modify the rules.
The IRS issued guidance in Internal Revenue Bulletin 2017-1 that outlines the procedures by which the IRS will issue rulings (and information letters), determination letters, and technical advice memoranda (TAMs), and the areas on which the IRS will and will not rule. The guidance covers large businesses, employee plans, passthroughs, financial institutions, international corporations and tax exempt organizations.
The OECD released an updated version of the BEPS Action 4 Final Report that sets out a common approach to addressing BEPS involving interest and payments economically equivalent to interest. The update includes further guidance on two areas included in the 2015 version of the report: (1) the design and operation of the “group ratio rule,” which allows an entity to claim higher net interest deductions based on a relevant financial ratio of its worldwide group, and (2) approaches to dealing with risks posed by the banking and insurance sector. The update examines regulatory and commercial requirements that constrain the ability of groups to use interest for BEPS purposes and limits on these constraints. The OECD previously published a discussion draft on approaches to addressing BEPS involving interest in the banking and insurance sectors in July of 2016.
The OECD released for public comment a discussion draft under its BEPS initiative on the treaty entitlement of non-collective investment vehicle (CIV) funds. The OECD report focuses on the interaction between the tax treaty provisions of the Action 6 Final Report (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances) and the treaty entitlement of non-CIV funds. The draft includes the conclusions reached at the May 2016 meeting of Working Party 1 and the subsequent work on the development of examples related to the application of the principal purposes test (PPT) rules included in the Report on Action 6 with respect to some common transactions involving non-CIV funds. The paper requests public input on three draft examples under consideration by the Working Party for inclusion in the Commentary on the PPT rule.
On January 1st, Switzerland began the collection of information under the International Convention on the Automatic Exchange of Information (AEOI) developed by the OECD. The convention provides for the mutual exchange of information on financial accounts between the almost 100 states that have agreed to the AEOI. These new rules will change the historic “secrecy” of Swiss bank account information and bring Switzerland in line with international standards for exchange of financial information. The financial data will begin being exchanged with partner states in 2018.
Tax Reform Update
House Speaker Ryan has stated that Congress will work on tax reform between April and August this year finishing prior to the August Congressional recess. Whether this ambitious schedule can be met may depend in part on whether the Administration and Congressional taxwriters can agree on key issues including the border adjustment tax plan. Both the Speaker and Chair Brady have made high-profile public appearances in recent weeks and defended the House GOP tax reform blueprint and the border adjustable provision that would exempt exports and tax imports.
W&M Committee Republican members have formed informal working groups to examine and develop consensus around certain questions raised by the GOP tax reform blueprint covering issues such as passthrough issues, retirement taxation, education incentives, the treatment of carried interest, tax deductions for mortgage interest and charitable deductions, and energy tax incentives, and Chair Brady has said they will be expected to make their recommendations soon. Ranking Member Neal (D-MA) is viewed as a more business-friendly Democrat than his predecessor and has created a new staff position to increase outreach to the business and advocacy community.
Chair Hatch (R-UT) met with President Trump to discuss tax reform and other issues that will be handled by the SFC.
Border Adjustment Tax Proposal
In connection with comments about increasing border security through a wall between Mexico and the US, President Trump and his advisers suggested paying for the wall with a 20% border tax on Mexican imports, which appears to be consistent with the proposal in the GOP tax reform blueprint for a border adjustment tax – but the Administration later stated that this was only one of many options being considered.
There is significant opposition to this tax idea from many groups in the business sector including retailers, oil refiners and other industries who are significant importers, but this new tax provides $1 trillion in revenue over a 10-year period, which would be hard to replace in the GOP blueprint were this proposal to be dropped. Also, there are factions of the business community who would benefit from a plan that exempts exports from taxes, and they have formed a new group to lobby in support of the proposal. Note that a border adjustment is different from the tax the President has described as a targeted levy on firms that outsource production and import products back into the US.
The Office of Tax Analysis in the Treasury Department issued a working paper examining a destination-based cash flow tax concluding that the proposed style of reform was “promising” but outlining a long list of issues that need to be resolved.
Budget Reconciliation & Revenue Neutrality
There are reports that some Administration officials and Congressional members have discussed the possibility of a tax reform package that is not “revenue neutral,” but Speaker Ryan and Chair Brady have both stated that the tax reform package will be “revenue neutral” so that it will pay for itself and not add to the deficit.
If the budget reconciliation process is used to advance tax reform including tax cuts, the legislation is not permitted to increase budget deficits in years after the time period covered by the budget resolution, which is typically 10 years, but legislators can avoid this rule by sunsetting the tax provisions that would cause the revenue loss so that they expire at the end of the 10-year period even if the intention is that the cuts would be extended at that time. The Congressional Budget Office (CBO), which is the nonpartisan office that provides official budget information to Congress, would then likely have to issue two different budget outlooks, which would include a standard baseline in which temporary laws expire as scheduled and an alternative fiscal scenario in which many of the laws are permanently extended. This type of “fiscal ambiguity” existed at the time of the Bush tax cuts in 2001 and 2003 and resurfaced during the Obama Administration when there was debate and legislation to address the expiration of the tax cuts. The use of a single budget baseline provides clarity about the future impact on budget deficits, but the use of the budget reconciliation process to advance tax legislation may inject uncertainty into the budget debate with respect to baseline issues.
Secretary of the Treasury Nominee, Steve Mnuchin
Steve Mnuchin, who is nominated to be the Secretary of the Treasury, was questioned for several hours at his SFC confirmation hearing on January 19th. He was questioned on his past business experience including his involvement in OneWest, a bank he led during the financial crisis. Although his confirmation vote in Committee and on the Senate Floor has not been scheduled, it appears likely that he will be confirmed.
He stated that he would be in charge of tax reform for the Administration. In his comments on tax reform, he aligned himself with the GOP position of simplifying the tax code by lowering rates and broadening the base leading to economic growth that would benefit taxpayers at all income levels. He also stated that lowering the corporate rate would make US businesses more competitive on the global playing field and would help stop inversions.
With respect to the Trump proposal to allow certain passthrough entities to elect to be taxed as corporations (subject to a proposed 15% tax rate) rather than as individuals (subject to a proposed 33% tax rate), he was not specific about the mechanics but he said that anti-abuse rules would be developed to prevent passthrough businesses from gaming the system by recharacterizing wage income as more lightly taxed business income.
In response to a question about transition rules related to changes that would be included in tax reform, he commented that phase-out rules are necessary when changes are made. When asked about tax complexity and the tax gap, he noted that reductions in IRS staff and funding have contributed to the tax gap, and that he expects President Trump to support increasing IRS staff while stating that tax simplification and fewer deductions are “absolutely critical.” He was asked specifically whether international tax reform would be a priority, and he responded yes, noting that President Trump wants to see rates lowered and the money held offshore by companies return home to the US.
On the issue of dynamic scoring, he endorsed the need for it in order to accurately reflect the effects of positive tax changes, but he stated, “I think we want to make sure that tax reform doesn’t increase the size of the deficit.” He clarified that the President’s 35% import tax is only for certain companies who move jobs out of the US and not intended to be applied broadly – and he distinguished it from the GOP blueprint border adjustability proposal.
On most other issues including the border adjustability proposal, the Treasury Secretary nominee offered few details in written responses to Congressional questions, instead offering to work with Congress on the specifics. His confirmation could be further delayed due to a request by SFC Democrats to resubmit questions for the record because they found his responses inadequate.