Washington Tax Insight January 2017
Politics and Congressional Activity
President-elect Trump will take office on January 20, 2017. Typically, a new President will deliver a policy and budget address to a joint session of Congress in late February that is similar in content to a State of the Union address, but a date for such speech by the President-elect has not been announced.
Congress convened on January 3, 2017. Based on comments from the Republican leadership and President-elect Trump, it is expected that the Congressional agenda in the early months of 2017 will include repeal of the Affordable Care Act (ACA), tax reform, and changes to environmental regulations, as well as the need to consider confirmation of several nominees for key positions in the Trump Administration and to address several foreign policy issues.
Budget Reconciliation and Tax Reform
Senate Majority Leader McConnell (R-KY) has announced that he plans to address tax reform and repeal of the ACA by using two budget resolutions and the budget reconciliation process. The budget reconciliation procedure involves the approval of a budget resolution that sets broad tax and spending goals and instructs committees to report legislative language to meet those goals. Budget resolutions are non-binding, but budget reconciliation legislation requires the President’s signature. Typically, there is one budget reconciliation bill that is subject to rules that limit Senate debate and bar filibusters and unrelated amendments with a simple majority needed for passage. Senator McConnell has stated that the first budget resolution will repeal the ACA, and a second in the spring will deal with tax reform
If tax reform is passed as part of the budget reconciliation process, it must be deficit-neutral and it will expire at the end of a 10-year period. If a narrow tax and infrastructure package is advanced, it is possible that Democratic support could be developed, but a more comprehensive tax reform package may face challenges getting the more than 60 votes needed in the Senate to prevent a filibuster. Another potential obstacle will be the position of key conservatives in Congress on the two budget resolutions since comments have indicated that they may be willing to allow the first resolution to advance but insist on the second resolution containing proposals of importance to conservatives.
House Speaker Paul Ryan (R-WI) has also stated that he believes the budget reconciliation process is the best way to proceed with advancing tax reform. Ways & Means Committee Chair Brady has stated that Democrats will be offered an opportunity to contribute their ideas and engage on tax reform, but he has acknowledged that Republicans will be willing to move tax reform using the reconciliation process.
The Senate Finance Committee
Senate Finance Committee Chair Hatch (R-UT) has indicated that he will turn his efforts from his corporate integration plan to a focus on comprehensive tax reform since Republicans will control the White House and the Congress. Hatch commented, “Given the current reality, any substantive tax reform proposal will need to be considered and evaluated in the context of what has quickly become a much broader discussion.” He has said that he continues to want to consider how integration fits into the tax reform debate. Chair Hatch has also signaled that he may be reconsidering his intention to retire in 2018. Under Senate rules, he is eligible to continue as Chair of the SFC through 2020.
Senator Claire McCaskill (D-MO) will take the SFC seat held by Senator Chuck Schumer, who becomes the new Senate Minority Leader. No replacement has been announced for the seat held by Senator Dan Coats (R-IN), who retired.
The Ways & Means Committee
W&M Committee Republicans held a two-day strategy session in December to “review the decision points on tax reform and health care” and to consider the feedback they received on the GOP tax reform blueprint. Chair Brady has downplayed the differences between the Trump tax reform proposals and the GOP blueprint by commenting that they will be the subject of discussion between the Congress and the White House and are “more than manageable.” A key variance is that Trump proposes a 15% corporate rate while the blueprint calls for a 20% rate, and Trump’s plan would use revenue from a deemed repatriation proposal for infrastructure spending, while Chair Brady prefers investing that revenue into offsetting the cost of the corporate rate cut.
W&M Committee Chair Brady and SFC Chair Hatch introduced identical bills in the House and Senate on December 6th that would make a variety of technical changes and clarifications to provisions included in recently enacted tax legislation. The bipartisan bills were cosponsored by W&M Ranking Democrat Neal and SFC Ranking Democrat Wyden. The technical corrections legislation includes clarifications to current law on bonus depreciation, the research credit, the American Opportunity Credit, the partnership audit rules, and REIT income testing rules. The introduction of the bills prior to Congress recessing for the year was done to lay groundwork for the changes to be made in the new Congress and to allow taxpayers an opportunity to comment on the language of the bills.
The Congressional Budget Office (CBO) issued a 316-page summary of spending and tax policy changes titled “Options for Reducing the Deficit: 2017 to 2026” for consideration by Congress to reduce the deficit. The options were collected from a number of sources including previously proposed legislation and budget proposals from prior administrations. The report includes several proposals targeting corporations, foreign income and business-related activities, including changes to the rules for R&D expensing, depreciation, LIFO, publicly traded partnerships, foreign tax credit pooling, and deferral, and new fees on large financial institutions, financial transactions, greenhouse gas emissions, and a Value Added Tax. The report includes an estimate of the effects of each proposal on the budget and a discussion of the pros and cons, but does not make recommendations.
Treasury and the IRS
The IRS issued proposed and temporary regulations that provide guidance on distributions of stock or securities of a controlled corporation without recognition of income, gain or loss. The regulations provide guidance on determining whether a corporation is a predecessor or successor of a distributing or controlled corporation for purposes of the exception under Code section 355(e) to the nonrecognition treatment afforded qualifying distributions. They also provide certain limitations on the recognition of gain in certain cases involving a predecessor of a distributing corporation. In addition, the regulations also contain rules regarding the extent to which Code section 355(f) causes a distributing corporation (and in certain cases its shareholders) to recognize income or gain on the distribution of stock or securities of a controlled corporation.
In Notice 2016-73, the IRS announced its intent to issue regulations modifying the “triangular reorganizations” rules under Code section 367 for foreign corporations where a subsidiary acquires its parent’s stock and uses that stock to acquire a target corporation. These rules will target transactions that repatriate earnings and basis of foreign corporations without incurring US tax by exploiting the Code section 367(a) priority rule. The regulations will also modify the “all earnings and profits” amount that must be included in income as a result of certain inbound asset acquisitions that repatriate “excess asset basis.”
Treasury and the IRS issued final regulations under Code section 367 regarding transfers of certain intangibles (foreign goodwill and going concern value) to foreign corporations through “nonrecognition transactions.” This rulemaking finalizes regulations proposed in September 2015 and finalizes parts of the temporary regulations issued in 1986. These final regulations eliminate the foreign goodwill and going concern value exception in Treas. Reg. §1.367(d)-1T(b) and narrow the scope of the Code section 367(a)(3) active trade or business exception to apply only to certain tangible property and financial assets. The final regulations do not take a position on whether goodwill and going concern should be characterized as a Code section 936(h)(3)(B) intangible, so taxpayers may elect to apply either Code section 367(a) or Code section 367(d) to transfers of such items.
Treasury and the IRS issued final regulations under Code section 6038A that treat a domestic disregarded entity that is wholly owned by a foreign person as a domestic corporation separate from its owner for the limited purposes of the reporting, record maintenance, and associated compliance requirements that apply to 25% foreign-owned domestic corporations. This guidance makes three changes to the proposed regulations that were issued in May 2016 including changing the effective date to apply to taxable years of entities beginning on or after January 1, 2017, and ending on or after December 13, 2017. The regulations also ease compliance with the filing of Form 5472 by providing that corporations have the same taxable year as their foreign owner if the foreign owner has a US return filing obligation, and they make it clear that the reporting should apply without regard to certain regulatory exceptions generally applicable under §1.6038-2(e)(3) and §1.6038A-2(e)(4).
The IRS issued three sets of guidance on the tax treatment of foreign currency gains or losses by subdivisions of taxpayers within a larger multinational company, known as “qualified business units (QBUs),” under Code Section 987. In final regulations, the IRS addressed the determination of the taxable income or loss of a corporation or an individual with respect to a QBU subject to Code section 987 as well as the timing, amount, character, and source of any Code section 987 gain or loss. Temporary and proposed rules address the recognition and deferral of foreign currency gain or loss of QBUs in situations where taxpayers terminate a QBU and situations involving partnerships. The IRS also issued Notice 2017-07 which modifies the effective dates for the deferral rule under these anti-abuse rules under Code section 987.
The IRS issuedd temporary and proposed regulations under Code section 901(m) addressing transactions that generally are treated as asset acquisitions for US income tax purposes but treated as stock acquisitions or disregarded for purposes of determining foreign income and the foreign tax credit. The regulations target certain “covered asset acquisitions” that the IRS has identified as abusive avoidance transactions using the foreign tax credit by limiting the ability of taxpayers who buy and sell foreign assets in such transactions to claim the foreign tax credit.
The IRS issued Notice 2016-76 providing for the phased-in application of the Code section 871(m) regulations issued in 2015 related to compliance with dividend equivalent payment regulations. The guidance states that changes to these regulations are expected with an explanation of several compliance challenges including the creation of systems for withholding and reporting for dealers, issuers, and other withholding agents; implementing new system requirements for paying agents and clearing organizations; and enhancing and developing data sources for determining whether transactions are Code section 871(m) transactions.
The IRS issued proposed regulations providing new guidance on the fractions rule and the application of Code section 514(c)(9)(E) to partnerships that hold debt-financed real property and have one or more tax-exempt qualified organization partners as well as other partners. The fractions rule limits the ability of such partnerships to allocate a disproportionate amount of income to the tax-exempt qualified organizations.
The IRS issued proposed regulations under Code section 472 dealing with the establishment of dollar-value last-in, first-out (LIFO) inventory pools by taxpayers that use the inventory price index computation (IPIC) pooling method. The proposed regulations amend the IPIC pooling rules to clarify that manufactured or processed goods and resale goods may not be included in the same dollar-value LIFO pool.
The IRS issued final regulations to increase user fees for those who seek to pay their liabilities through installment agreements effective on January 1, 2017. The fee for an installment agreement plan will be $225 (increased from $120) with the fee for low-income taxpayers continuing at $43. The IRS is also introducing two new online installments subject to separate user fees including an online payment agreement at $149 and a direct debit online payment agreement at $31.
Treasury and the IRS issued final regulations relating to the health insurance premium tax credit under Code section 36B. The final regulations affect (1) individuals who enroll in qualified health plans through Health Insurance Exchanges and claim the premium tax credit and (2) Exchanges that make qualified health plans available to individuals and employers. These regulations expand the intentional or reckless disregard for the facts exception to the section 36B safe harbor for household income below 100% of the federal poverty level.
In Notice 2016-79, the IRS set the business mileage rates for taxpayers for 2017, which will be 53.5 cents per mile (a half-cent decrease from 2016), and sets the driving rates for medical, moving and charitable purposes. The IRS also issued Revenue Procedure 2010-51, which provides rules for “using optional standard mileage rates in computing the deductible costs of operating an automobile for business, charitable, medical, or moving expense purposes.”
In Revenue Procedure 2017-12, the IRS issued guidance stating that it will treat as debt an instrument that provides total loss-absorbing capacity (TLAC). The covered TLAC is issued by an intermediate holding company of a foreign global systemically important bank (GSIB) pursuant to Federal Reserve regulations and will be treated as indebtedness for federal tax purposes “to the extent that the internal TLAC has not been subject to a debt conversion order.” The purpose of this guidance is to help foreign banks address certain Federal Reserve Board loan requirements.
The Organization for Economic Cooperation and Development (OECD) issued new guidance to assist in the implementation of the BEPS initiative regarding country-by-country (CbC) reporting. Under the BEPS Action 13 Final Report on “Transfer Pricing Documentation and Country-by-Country Reporting,” the OECD is setting the reporting standards for multinational enterprises (MNEs) with cross border operations. This guidance addresses the “parent surrogate filing,” the application of CbC to investment funds and partnerships, and CbC reporting notification requirements for MNE Groups during the transitional phase.
Under BEPS Action 15, the OECD released the text of a multilateral instrument to implement tax treaty-related measures that was negotiated by more than 100 jurisdictions with a signing ceremony set for June 2017. The new multilateral convention is expected to introduce results from the BEPS project into more than 2000 tax treaties globally.
A summary of the arguments included in Ireland’s appeal filed in November 2016 to overturn the August decision by the European Commission to recoup nearly $14 billion in unpaid taxes from Apple Inc. as part of its state aid investigations were publicly released. The central issue is whether two Irish tax rulings in 1991 and 2007 gave a form of special treatment to Apple. Ireland has argued that the rulings did not depart from “normal” taxation because they followed a part of the Irish tax code that states that nonresident companies should not pay income tax on profit that isn’t generated in Ireland. Apple Inc. has also filed an appeal to the decision but did not release the text of its appeal. The US Treasury issued a statement about the case noting that the EU’s decision is “retroactively applying a sweeping new State aid theory that is contrary to well-established legal principles, calls into question the tax rules of individual countries, and threatens to undermine the overall business climate in Europe.” The General Court of the European Union will render the decision on the appeal and whether the tax must be collected.
The European Commission announced a series of proposals to improve the Value Added Tax (VAT) environment for e-commerce businesses in the European Union. The proposals will be submitted to the European Parliament for review and consultation, and then to the European Council for adoption. The proposals include new rules that allow companies to sell goods online to manage all their EU VAT obligations in one place, rules on actions against VAT fraud from outside the EU, and simplification of VAT rules for startups and micro-businesses selling online with cross-border sales under 10,000 euros.
Tax Reform Update
As President, Donald Trump will have significant authority over tax law and regulations, and it is expected that the new Administration and the new Congress will consider comprehensive changes to the current tax code and regulations. Although tax policy was a topic for debate and discussion during the election campaign and a Trump tax proposal was issued in September of 2015, there remains a great deal of uncertainty as to how tax legislation will develop in the first few months of the Trump Administration and what the details of that legislation will be.
Republicans control both the House and the Senate in the next Congress, which will help advance the cause of tax reform, since Republican leadership has made tax reform a priority for several years and a GOP tax reform “blueprint” was released in 2016. It should be noted, however, that proposals from the President-elect and Congressional leadership have not aligned in all areas.
Secretary of the Treasury Nominee, Steve Mnuchin
Steve Mnuchin, a former Wall Street executive who served as the Trump campaign finance manager, has been selected as the nominee for Secretary of the Treasury, and he has submitted tax returns and the required questionnaire to the Senate Finance Committee in preparation for his confirmation hearing. W&M Committee Chair Brady praised the nomination citing his private sector experience and stated that he is looking forward to working with him on policy development to help business create jobs and grow the US economy.
In an interview after his nomination was announced, Mnuchin commented that tax reform will be his number one priority stating that it is “something that happens absolutely within the first 90 days of this presidency.” He has focused on the importance of cutting the corporate tax rate, which he believes will encourage multinationals to repatriate accumulated offshore earnings and bring jobs back to the US. He believes that the revenue needed for the corporate tax rate cut as proposed by President-elect Trump to 15% will be raised by economic growth and increased personal income.
He has stated that the Trump Administration will rely on dynamic scoring to measure the revenue impact of its tax reform proposals. Dynamic scoring takes into account certain macroeconomic feedback effects of the plan on the economy and federal revenue levels. The House adopted rules in 2015 that require the Joint Committee on Taxation staff and the Congressional Budget Office to use dynamic scoring for major fiscal legislation. The Tax Foundation has estimated the revenue loss under the Trump plan to range from $2.64 trillion to $3.93 trillion using dynamic scoring, while the Tax Policy Center estimates the loss to be in the range of $6 trillion.
One of the most hotly debated issues in tax reform is the proposal in the GOP blueprint that calls for replacing the corporate income tax with a border adjustable, destination cash-flow tax that would eliminate US tax on products, services, and intangibles exported abroad, regardless of their production location, but impose a US tax on products, services, and intangibles imported into the US, regardless of their production location. Several commentators have questioned whether such a tax might not comply with WTO rules.
W&M Committee Chair Brady continues his support for the proposal commenting that he is happy to listen to retailers, oil refiners and other critics of the plan but “it’s important though for them to understand that we cannot leave in place any tax policies that encourage our companies to move their operations overseas just to sell back in the United States – those won’t stay.” He stated that “industries will have to adjust.”
There is opposition developing to this proposal including from some factions of the Republican party, some of whom argue that border adjustments would distort the market in the long term, although some economists have suggested that adjusting exchange rates would modify the adverse effects. A letter signed by more than 75 business groups including retailers, auto dealers, toy makers and apparel makers was sent to Chair Brady and stated that the proposal would lead to “huge business challenges caused by increased taxes and increased cost of goods, which would in turn likely result in reductions in employment, reduced capital investments and higher prices for consumers.”
Analyses by investment banks Goldman Sachs and RBC Capital have raised concerns about the impact on corporate profits and increased prices for consumers. The National Foreign Trade Council has reserved comment stating that they want to give Republicans the opportunity to elaborate on their tax reform plans.
Democratic staff of the SFC have called the House GOP blueprint regressive and fiscally irresponsible with specific criticism of the “destination-based cash flow tax” calling it “risky, untested and especially vulnerable to unforeseen consequences.” The comments also stated that the proposal could cause consumer prices to spike, give a boost to Wall Street and have an unpredictable impact on trade.