Washington Tax Insight February 2019
Politics and Congressional Activity
The 116th Congress convened on January 3rd as divided government returned to Washington with the Democrats in control of the House, and Republicans in control of the Senate and the White House. Nancy Pelosi (D-CA) was elected Speaker of the House, and Kevin McCarthy (R-CA) was elected House Minority Leader. Top Senate leadership remained the same as in the prior Congress with Senator McConnell (R-KY) as Senate Majority Leader and Senator Schumer (D-NY) as Senate Minority Leader, although Senator Thune (R-SD) assumed the position of Senate Majority Whip from Senator Cornyn (R-TX).
The government reopened January 26th with a short-term deal reached to fund those government operations without approved fiscal year spending until February 15th. If the bipartisan Congressional negotiating team cannot reach an agreement that is accepted by the White House, the President has stated that the government could be shut down again or he could bypass Congress by declaring a national emergency to get funding for a border wall.
The State of the Union address was originally scheduled for January 29th, but it was postponed due to the government shutdown and has now been rescheduled for February 5th. The FY 2020 budget submission from the White House is required by law to be released by the first Monday in February, but typically that deadline is missed with a release later in the month. Last year, the President’s budget proposal was released one week after the due date.
In February of 2018, Congress suspended the debt ceiling, which is the federal government’s borrowing limit, until March 2, 2019. According to an estimate from the Bipartisan Policy Center, the government may be able to continue to operate until mid-summer without further action. As part of their rule changes, House Democrats approved a new rule that streamlines the process of raising the statutory debt limit by allowing the House to suspend the debt ceiling with a vote on the annual budget, thereby avoiding a separate vote on the issue, although the Senate must still hold a separate vote. Other issues on the agenda for 2019 include the new trade deal with Mexico and Canada and the future of the Affordable Care Act. Finally, Democrats are reportedly planning to use their oversight powers in the House aggressively with respect to a number of issues involving the Trump Administration.
Treasury and the IRS
Code section 199A – Deduction for Qualified Passthrough Income: The IRS issued final regulations and new guidance under Code section 199A on the deduction for qualified passthrough business income covering how to define and compute the deduction along with an anti-abuse rule under Code section 643 to prevent taxpayers from using multiple trusts to avoid tax and/or improperly claim the deduction. Some of the key differences between the proposed and final regulations include: (1) 3-year look-back rule imposed on independent contractors; (2) rules on “crack-and-pack” strategies, whereby ineligible service firms separate functions in order to qualify, were eased by deleting the 80 percent threshold; (3) health care is defined more broadly so that health care professionals are assessed on the basis of facts and circumstances; (4) aggregation is allowed at the entity level; and (5) triple net leases are not covered by the real estate safe harbor. The IRS also issued: (1) Notice 2019-07 related to regulated investment companies (RICs) and real estate investment trusts (REITs); (2) Revenue Procedure 2019-11 providing methods for calculating W-2 wages; and (3) proposed regulations providing guidance on the treatment of previously suspended losses that constitute qualified business income.
Repatriation Tax/Code Section 965: Treasury and the IRS issued final rules on the Code section 965 transition tax on certain foreign earnings deemed repatriated under the TCJA, covering calculating and reporting a US shareholder’s inclusion amount and how to make elections. The regulations “retain the basic approach and structure of the proposed regulations, with certain revisions,” according to the IRS. The final rules did include a narrow exception for some commodities and derivatives contracts from the 15.5 percent transition tax. Despite the fact that there were many issues identified by taxpayers and other exceptions requested, the final regulations follow the proposed rules fairly closely.
The IRS has faced criticism over its policy of denying corporate refunds on 2017 tax returns by applying them to installments of the one-time repatriation tax, which can be paid in eight interest-free installments. An IRS memorandum in August 2018 from the Office of the Chief Counsel was issued to address taxpayer questions about this matter but has drawn opposition from taxpayers who want the decision reversed. Technical corrections legislation introduced by former W&M Committee Chairman Brady includes a provision that appears to address this issue, but the bill is not expected to advance under Democratic control.
Base Erosion and Anti-Abuse Tax (BEAT): The new proposed regulations provide help with some calculation issues, but the rules also clarify that noncash transactions, such as transfers of property and stock, may be base erosion payments, and there is no exception for transfers of assets from a foreign company to a US affiliate without recognition of gain or loss. The regulations clarify how the BEAT applies to services transactions. Services charged at cost are exempt; the cost portion for services subject to a markup continues to be exempt while the markup portion goes into the BEAT calculation.
Miscellaneous Issues: The IRS issued Revenue Procedure 2019-12, which provides safe harbors under Code section 162 for payments made by C corporations or specified passthroughs “to or for the use of an organization described in section 170(c) if the C corporation or specified pass-through entity receives or expects to receive a state or local tax [SALT] credit in return for such payment,” according to the IRS.
The IRS issued Notice 2019-11, which waives the tax penalty under Code section 6654 for the underpayment of estimated income tax for certain individuals who are required to make 2018 payments by January 15, 2019. The IRS said it would not penalize individuals who paid at least 85 percent of the required tax liability (rather than 90 percent previously).
The IRS issued Notice 2019-09, which provides preliminary guidance under Code section 4960 and announces forthcoming proposed regulations. Code section 4960 imposes a 21 percent excise tax on the excess remuneration and parachute payments paid by an applicable tax-exempt organization to a covered employee. The Notice defines several key terms and includes guidance on how to report and pay the excise tax.
The IRS issued informal guidance on excess business loss limitations and net operating losses (NOLs) that reflects changes made by the TCJA. The guidance on excess business loss limitations defines an “excess business loss,” provides information about what losses can be included in the calculation, and explains how disallowed business losses are treated. The guidance on NOLs explains the new rule that does not allow NOL carrybacks, gives guidance on deduction calculations, and discusses exceptions.
Other Issues and Guidance
The IRS issued Revenue Procedure 2019-9, which updates its annual adequate disclosure revenue procedure. The guidance identifies circumstances where a tax return disclosure satisfies the accuracy penalty of Code section 6662 and return preparer penalty under Code section 6694. This guidance updates Revenue Procedure 2018-11 with no substantive changes but only minor revisions.
The IRS issued final comprehensive regulations to implement the centralized audit regime for partnerships. The final rules cover partnerships for taxable years beginning in 2018 and those with tax years ending after August 12, 2018. The IRS also stated that the rules cover partnerships “that make the election to apply the centralized partnership audit regime to partnership taxable years beginning on or after November 2, 2015, and before January 1, 2018.” The IRS issued Notice 2019-6, which announces that the agency will propose regulations that will set out special enforcement guidelines for partnership audits under Code section 6241(11). The IRS explains that the proposed rules will provide that “the IRS may determine that the centralized partnership audit regime will not apply to adjustments to partnership-related items in certain limited circumstances and that partnerships with a qualified subchapter S subsidiary (QSub) are not eligible to elect out of the centralized partnership audit regime except by applying a rule similar to the rules for S corporations under section 6221(b)(2)(A) to the QSub partner.” Comments must be filed by February 22, 2019.
The IRS issued a statement that exempted from sequestration tax refunds gained through collecting corporate alternative minimum tax (AMT) credits for fiscal year 2019. The corporate AMT was repealed by the TCJA, but credits that companies received for payments already made would have been hit by a roughly 6 percent automatic cut. In December, the Trump Administration had said that it would not subject tax refunds that corporations had collected over the years to sequestration but until now had not issued anything officially.
Michael Desmond was re-nominated to be the IRS Chief Counsel. His confirmation was held up in the Senate last year by Senator Menendez (D-NJ) over the issue of the TCJA cap on state and local tax deductions, and the Senator has indicated he is willing to block the nomination again this year.
Brexit: On January 15th, the U.K. Parliament overwhelmingly rejected the government’s draft agreement for leaving the European Union by a margin of 230 MPs, throwing the Brexit plans into crisis and raising questions about whether the March 29 departure date can still be met. The range of possible outcomes broadly includes no deal, a “managed” no deal, a second referendum, a General Election – or a second vote of some kind, perhaps after a renegotiation phase with Europe.
Netherlands rulings: The Netherlands has announced plans for broad reform that will tighten the requirements for tax rulings on international structures with a “no-ruling” policy for structures involving tax havens. The European Commission opened an in-depth investigation into the tax treatment of Nike in the Netherlands to determine whether Dutch tax rulings violated EU State aid rules.
European tax unanimity requirement: The European Commission (EC) launched a debate on reforming decision-making for areas of the EU taxation policy, which currently requires unanimity among Member States. The EC Communication recommends a roadmap for a progressive and targeted transition to qualified majority voting (QMV) under the ordinary legislative procedure in certain areas of shared EU taxation policy, as is already the case with most other EU policy areas. The EC is not proposing any changes to the rights of Member States to set personal or corporate tax rates as they see fit. The EC asks that the EU leaders, the EU Parliament, and other stakeholders assess the possibility of a gradual, four-step progression towards decision-making based on QMV with the suggestion that Steps 3 and 4 be developed by the end of 2025. Issues that have challenged the EU and could be affected by this change in policy include the development a digital services tax agreement and the taxation of financial transactions.
Digital Services Taxes: A European Commission proposal for a digital services tax (DST) was released in March of 2018, but unanimous agreement was not reached within the EU. The EU’s digital tax proposal called for a 3 percent tax on the turnover of large digital companies with over €750 million in global revenue and over €50 million in EU revenue and would have applied to gross revenues earned from multilateral interfaces, advertising, and selling user data but not intragroup revenues. In December, the EU announced a revision limiting the scope to apply only to online advertising thereby dropping the user interface aspect, although there is no guarantee of that limited scope ultimately prevailing.
With the failure to reach a unanimous EU agreement on this proposal (DST) before the end of 2018, several EU members are now adopting unilateral DST proposals that could raise issues for global companies who may not be the intended target of the laws but are caught by the scope of the rules and their intra-group activities. A DST similar to the EU proposal has been approved as part of Italy’s 2019 budget, but there have been criticisms of the proposal which reportedly was not drafted with input from the digital service companies. France has also released a DST proposal effective January 1, 2019, and it would tax revenue from advertising, selling user data, and online marketplaces, i.e., intermediation services. Spain is also developing a DST plan, which would impose a 3 percent tax on income derived from advertising, online intermediation services, and selling user data, similar to the EU proposal. The draft originally did not explicitly exclude intragroup payments from the scope of the tax, but the bill introduced to parliament has now removed a clause that would have caught transactions within a company group.
OECD announcement: The OECD announced on January 29th that it is working toward a consensus plan for taxing digital commerce as part of the BEPS initiative. A Policy Note on the issue outlines a path forward with the goal of reaching a consensus by the end of 2020. Renewed international discussions will focus on two central pillars identified in the Policy Note, which was released after the Inclusive Framework’s January 23-24 meeting, which included 264 delegates from 95 member jurisdictions and 12 observer organizations.
The first pillar will focus on how the existing rules that divide up the right to tax the income of multinational enterprises among jurisdictions, including traditional transfer pricing rules and the arm’s length principle, could be modified to take into account the changes that digitalization has brought to the world economy. This will require a re-examination of the so-called ‘nexus’ rules – namely how to determine the connection a business has with a given jurisdiction – and the rules that govern how much profit should be allocated to the business conducted there. The Inclusive Framework will look at proposals based on the concepts of marketing intangibles, user contribution, and significant economic presence and how they can be used to modernize the international tax system to address the tax challenges of digitalization.
The second pillar aims to resolve remaining BEPS issues and will explore two sets of interlocking rules designed to give jurisdictions a remedy in cases where income is subject to no or only very low taxation. A consultation document will be issued in mid-February, and a public consultation meeting will be held on March 13-14th in Paris as part of the meeting of the Task Force on the Digital Economy. An elaboration of 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 the intended target completion date of the end of 2020 for implementation.
This represents a major initiative on the part of the OECD that could have far-reaching implications for some current tax rules including the arm’s length standard. The Policy Note states “some of these proposals would require reconsidering the current transfer pricing rules as they relate to non-routine returns, and other proposals would entail modifications potentially going beyond non-routine returns. In all cases, these proposals would lead to solutions that go beyond the arm’s length principle.”
EU Rules to Limit Corporate Tax Avoidance—Now in Force: Legally binding rules that were first proposed in 2016, known as ATAD (Anti-Tax Avoidance Directive), came into force on January 1, 2019, and require all EU member countries to apply new anti-abuse measures that target the main forms of tax avoidance practiced by large global companies with additional rules on hybrid mismatches coming into force on January 1, 2020.
- A tax on profits moved to low-tax countries where the company does not have any genuine economic activity (controlled foreign company rules)
- Limits on the amount of net interest expenses that a company can deduct from its taxable income (interest limitation rules)
- A general anti-abuse rule to allow member nations to address tax avoidance schemes in cases where other anti-avoidance provisions cannot be applied.
The Tax-Writing Committees: Tax Reform, Technical Corrections & Tax Extenders
House Ways & Means Committee: Chair Neal (D-MA) held an organizational meeting for the Ways & Means Committee during which he stated that the Committee would be closely examining the “Republicans’ tax law and its various problems,” commenting “So we’ll be conducting thorough oversight of this law – oversight that frankly is well overdue.” His key tax priorities for this Congress include: (1) strengthening Americans’ retirement security; (2) protecting pre-existing conditions protections from the ACA and lowering health care costs, including prescription drug prices; (3) ensuring the tax system benefits middle-income Americans and small businesses; (4) ensuring that infrastructure systems are both safe and efficient; and (5) examining problems with the Tax Cuts & Jobs Act (TCJA). The membership of the Committee was finalized with a total of 42 members – 25 Democrats and 17 Republicans. Subcommittee assignments have been made with Congressman Mike Thompson (D-CA), the new Chair of the Select Revenue Measures Subcommittee (reverting to its original name after being called the Tax Policy Subcommittee under Republican control) and Adrian Smith (R-NE), the Ranking member.
Chair Neal will undertake oversight with respect to the TCJA by holding a series of hearings over the next year. It would be difficult to legislate on a major rewrite of the TCJA in 2020, which is an election year, but the hearings will ensure that all Committee members are well informed on the TCJA and any problems with it so that the Chair could consider proposing changes, including to the new international rules, after he gets input from his Committee members.
Although former Ways & Means Committee Chair Brady (R-TX) gained approval of a tax bill before the end of the last Congress, Chair Neal is not expected to reintroduce this bill. He may consider technical corrections legislation after Committee hearings including consideration of some of the technical corrections suggested in the JCT Blue Book on the TCJA, but this process may prove to be challenging if Democrats also pursue substantive changes to the TCJA.
Chair Neal has promised that his Committee will address the expired tax extenders provisions quickly this year, but it is unclear what approach he favors, i.e., the continuation of short-term extensions or consideration of making some extenders permanent and phasing out others. The extension of renewable energy sources is a Democratic priority with some support among Republican senators, including SFC Chair Grassley with the focus possibly expanding to cover subsidies for technologies beyond solar and wind, such as energy storage technology.
Any new tax provisions that result in a revenue cost will have to be offset or contribute to the deficit, which is something that Democrats have repeatedly opposed. For example, infrastructure legislation has been a key priority for Democrats and Republicans, but there are no easy answers to paying for new programs.
The looming 2020 Presidential election will begin to have an impact on the Congressional agenda early in 2019. The White House will be focused on re-election, and Congressional Republicans will be focused on preserving the legislative gains they have made including the tax cuts in the TCJA. Democratic Presidential hopefuls running from the Senate will be challenged on their positions on legislation that may advance if it gives a “win” to the Republicans.
Senate Finance Committee: Both parties have named new members to the SFC including three new Republicans senators and two new Democratic senators for a total committee roster of 28 members with Chair Grassley (R-IA) taking over the gavel. He has told reporters that his priorities for the Committee include IRS reform, retirement security, US competitiveness, renewable energy incentives, oversight of tax-exempt entities and tax shelters, and permanency of the individual and business tax provisions of the TCJA. He has also said that tax extenders that expired at the end of 2017 are a priority, but action was not taken prior to the beginning of the tax filing season on January 28th. At this point, Congress would have to extend them retroactively for more than a year with a probability that most of them would only be extended through 2018.