Washington Tax Insight July 2017
Politics and Congressional Activity
At the end of June, Congress left Washington for a week-long July 4th recess with no progress on the FY 2018 budget, the debt ceiling limit, health care reform or tax reform. Republican Members of the House and Senate appear to be increasingly concerned about the lack of legislative progress on their key agenda items for 2017 with very few legislative days left when they return before the month-long August recess. The Senate continued to focus on health care reform in an effort to move past that issue to tax reform, but leadership was unable to close out that issue before Congress left for the July 4th recess.
The House Budget Committee had hoped to release a budget plan for FY 2018 before the July 4th recess, but that action was delayed when several Committee chairs expressed opposition to plans to cut $50 billion from several mandatory programs, including entitlement programs, to fund an increase in defense spending. This budget resolution is intended to provide the framework for work to begin on tax reform in the House through budget reconciliation instructions, so the delay in scheduling a markup of the budget resolution presents another serious challenge to the advance of comprehensive tax reform.
Debt Ceiling Limit
The Congressional Budget Office (CBO) issued a report that stated that the federal government is likely to run out of cash in early to mid-October, which will necessitate Congressional action to increase the debt ceiling limit prior to that time. Since the debt limit expired in March, the Treasury Department has been taking “extraordinary measures” to avoid exceeding the debt ceiling, but without an increase, the government could default on its debt and be forced to delay payment for other federal spending.
Health Care reform
Senate Majority Leader McConnell (R-KY) released a discussion draft of a Senate version to repeal and replace the Affordable Care Act (ACA) on June 22nd, but he announced on June 27th that he would postpone Senate action on the bill until after the July 4th recess since he lacked the votes to pass the procedural motion needed to begin debate on the Senate Floor. The Senate bill generally follows the approach of the House-passed legislation but includes some key changes related to the Medicaid expansion provisions and the premium tax credit regime, which assists taxpayers who do not receive health care coverage from an employer or through a government program. The bill would eliminate the insurance coverage mandates and many of the taxes on businesses and wealthy individuals. W&M Committee Chair Brady stated publicly his position that if these taxes are not repealed as part of health care reform, they will not be repealed in any tax reform legislation but instead will remain in place.
The CBO score of the Senate bill shows a deficit reduction of $321 billion in the 10-year budget window and a $701 billion reduction in federal revenues. The CBO score also shows that the number of uninsured would increase by 22 million and that average premiums would rise through 2020 but decline after that time, with enrollment in Medicaid decreasing by 15 million. Senate leadership is continuing to work with individual Senators to make changes to the bill, including the possibility that one or more of the ACA’s taxes such as the 3.8 percent tax on investment income would be retained to pay for increased credits and programs to help lower-income individuals. In response to the opposition this draft has produced, there is renewed discussion from some Republicans of turning to the approach of repealing the ACA now and replacing it at some point in the future, although there is no indication that Senate leadership is considering this approach.
Ways & Means Committee/House
The House approved by voice vote legislation that would impose restrictions on when a state may tax nonresident employees who travel to that state to perform work and require employers to implement state income tax withholding and reporting with respect to wages or other remuneration earned by those employees. The Mobile Workforce State Income Tax Simplification Act is intended to simplify state income tax compliance by setting a national standard for taxing nonresidents and related employer withholding. The bill would exempt an employee from a non-resident state income tax if the individual works in the nonresident state for fewer than 31 days in a calendar year. The 31-day threshold is cumulative, not continuous. If the 31-day threshold is met, it would trigger withholding retroactive to the first day worked in the state.
The House approved by voice vote legislation that would expand the advanced nuclear power production tax credit by making it available to facilities placed in service beyond the current-law cut-off date and allowing public entities to transfer credits to an eligible project partner. An identical bill was introduced in the Senate by Senator Tim Scott (R-SC), but no markup has been scheduled.
Senate Finance Committee/Senate
The Senate Finance Committee held a hearing to consider the following nominations for the Department of Treasury: David Malpass to serve as Under Secretary for International Affairs, Andrew Maloney to serve as Assistant Secretary for Legislative Affairs, and Brent MacIntosh to serve as General Counsel.
Treasury and the IRS
The IRS reissued proposed regulations intended to implement a new centralized partnership audit regime enacted by the Bipartisan Budget Act of 2015. The new regime replaces the audit structure put in place by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) with a process that assesses and collects tax at the partnership, rather than at the partner level. The new regime applies to returns filed for partnership taxable years beginning after December 31, 2017, and to returns filed by partnerships that elect application of the new regime for tax years between November 2, 2015 and January 1, 2018.
The proposed regulations provide procedures for electing out of the centralized partnership audit regime, filing administrative adjustment requests, and determining amounts owed by a partnership or its partners attributable to adjustments that arise out of an examination of the partnership. The proposed regulations also address the scope of the centralized partnership audit regime and provide definitions and special rules that govern its application, including the designation of a partnership representative. Open issues remain including issues related to tiered partnership structures.
The Treasury Department issued a request for comments on Treasury regulations that can be eliminated, modified, or streamlined under Executive Order 13771, which directs agencies to eliminate two regulations for each new regulation issued. A task force is being developed as directed by the EO to evaluate existing regulations and make recommendations to the Treasury Secretary to prioritize their possible repeal, replacement or modification. Comments are due by July 29th.
In Chief Counsel Advice 201724026, the IRS advised that the taxpayer was not entitled to the domestic production activities deduction under Code section 199 for its online software. The IRS characterized the online software as a service through which the taxpayer’s customers can interface with the taxpayer’s products, rather than the software itself being the product. They also took issue with the taxpayer’s allocation of gross receipts based on development time, stating that regulation section 1.199-3(d)(1) requires that gross receipts be allocated for domestic production gross receipts on an item-by-item basis, and not on a transaction or product-line basis.
On June 7th, the Multilateral Convention to Implement Tax Treaty-Related Measures to Prevent Base Erosion and Profit Shifting (MLI) was signed by 68 countries (not including the United States); eight additional countries expressed their intent to sign the MLI and many more countries are expected to sign in the future. The MLI is designed to implement efficiently the tax treaty-related measures arising from the G20/OECD BEPS project. “Minimum standard” changes to the functioning of existing bilateral tax treaties in the areas of treaty abuse, mutual agreement procedures (MAPS,) and treaty preambles will be implemented through the MLI. In addition, optional changes to modify tax treaties in respect of permanent establishments (PEs), transparent entities, residency tiebreakers, double tax relief, minimum shareholding periods, capital gains derived from immovable property, and a jurisdiction’s right to tax its own residents will be facilitated. A subgroup of 26 jurisdictions, including 16 EU member states, have opted into the mandatory binding arbitration provisions based on the principles set forth in the final report on BEPS Action 14 (making dispute resolution mechanisms more effective).
The OECD has released the key document which will form the basis of the peer review of the BEPS Action 6 minimum standard on preventing the granting of treaty benefits in inappropriate circumstances. There are four BEPS minimum standards, each of which is subject to peer review to ensure timely and accurate implementation and to safeguard the level playing field. The new document includes the criteria for assessing implementation of the Action 6 minimum standard as well as the procedural mechanism for conducting the review. OECD Working Party 1 and all jurisdictions that are members of the inclusive framework will conduct the peer reviews starting in 2018. Annual reports will outline whether and how the minimum standard on treaty shopping has been incorporated into the existing bilateral treaties of each jurisdiction and will include any jurisdictions that fail to implement relevant measures. The first report is expected in January 2019.
The OECD released a discussion draft which provides guidance on the implementation of the approach to pricing transfers of hard-to-value intangibles (HTVI) described in Chapter VI of the OECD Transfer Pricing Guidelines. The OECD noted that comments are not requested on the approach to pricing HTVI agreed under BEPS Action 8, but instead commentators should concentrate solely on the proposed guidance contained in the discussion draft for implementing the approach. Comments were due by June 30th.
Tax Reform Update
Timing and Update
White House officials have stated that the Administration will send Congress a detailed tax reform plan after lawmakers return to work in early September following the August recess. National Economic Director Cohn and Treasury Secretary Mnuchin have been meeting regularly with House and Senate leadership (including Speaker Ryan, W&M Chair Brady, Senate Majority Leader McConnell and SFC Chair Hatch) in an attempt to agree on a single tax reform plan that could be approved by both the House and Senate. These negotiations are expected to continue through the summer including during the August recess.
Reports are that key issues where agreement has not yet been reached include the issue of revenue neutrality for a tax reform package and inclusion of the border adjustment tax.
Ways & Means Committee/House
On June 20th, Speaker Paul Ryan (R-WI) gave a key speech to the National Association of Manufacturers’ annual conference on tax reform in which he predicted passage of comprehensive tax reform by the end of 2017. He stated, “I am here to tell you: We are going to get this done in 2017. You know why we’re going to get this done in 2017? Because we have to get this done in 2017.”
The speech generally aligned with the GOP House Blueprint with the Speaker calling for a lower corporate tax rate and a transition to a territorial system, but he did not express support for the border adjustment proposal (BAT), which has drawn significant opposition. The Speaker was asked about the BAT following the speech, and he said that the SFC Republicans are working on an alternative, noting that dropping the proposals creates a “revenue hole” (of more than $1 trillion) and makes it necessary for lawmakers to find another way to address the US tax base erosion problem. Senate Republicans are reportedly looking at the proposal in the Camp draft tax reform legislation that would create a bifurcated minimum worldwide effective tax rate of 15% on foreign base company intangible income and 12.5 % on sales income.
With respect to policies on individuals, Ryan called for the elimination of the estate tax and the alternative minimum tax, the reduction of the number of individual tax brackets from seven to three, and the retention of the mortgage interest, charitable contribution, and retirement savings deductions. He emphasized that the tax reforms/tax cuts must be permanent, although the following day, he stated to reporters that “there are also provisions in tax reform that don’t have to be permanent. But the key ones like rates, the things that businesses plan on, those things require the certainty of permanence, and that’s where you get economic growth.”
In an interview on the same day as the Speaker’s comments, Treasury Secretary Mnuchin said he was aligned with GOP leaders in Congress, saying “The speaker, myself, the Senate leadership, we are all 100 percent committed to getting it done this year.”
Permanency is a key issue relating to whether GOP leadership decides to continue to advance comprehensive tax reform or settle for tax cuts, which might be less challenging. Tax cuts without tax revenue offsets, however, would have to be temporary to comply with budget reconciliation rules, which do not allow legislation that increases the deficit beyond the 10-year budget window. One suggestion for working around these rules is to lengthen the budget window, a proposal which picked up support from Chair Hatch but is opposed by Speaker Ryan and W&M Chair Brady.
Chair Brady announced that the W&M Committee will hold two hearings in July on the benefits of tax reform for small businesses and the need for tax code simplification for individuals and families.
Senate Finance Committee/Senate
In June, SFC Chair Hatch (R-UT) publicly provided an update on the status of tax reform noting that bipartisan support is still possible and remains his goal, and that he intends that there be an open debate with “full process” in the SFC and on the Senate Floor. He commented that the BAT faces challenges in the Senate, but he is not yet ruling any revenue offsets out. He stated that he has not committed to any specific tax rates for individuals or businesses, noting that rate reductions will depend on the results of base broadening and which preferences and credits are eliminated. He stated that major changes to the international tax system are needed, suggesting “a conversion to a territorial system with safeguards in place to prevent base erosion.”
Chair Hatch has assigned certain SFC members to lead the development of tax reform policies in certain areas including: (1) Enzi and Portman on international tax issues; (2) Thune on the business tax system and estate tax; (3) Heller and Cassidy on energy tax policy; (4) Grassley on individual tax issues; and (5) Roberts on agriculture tax issues.
SFC Chief Tax Counsel Mark Prater has stated publicly that the Committee is still considering a corporate integration plan that would lower the effective tax rate for corporations by combining a dividends received deduction and a withholding tax on corporate dividend and interest payments. Although SFC Chair Hatch has never released a discussion draft of a proposal, Prater commented that the Committee continues to see this work as a valuable tool for tax reform.
Chair Hatch has requested feedback from stakeholders by July 17th on how to improve the American tax system, specifically in these areas:
- Providing tax relief to middle-class individuals
- Lowering tax rates and broadening the tax base for businesses
- Removing disincentives for savings and investment in the tax code
- Making the international tax system more competitive and preserving the tax base
Treasury and the White House
National Economic Council Director Cohn focused recent public comments on the difficulties of dealing with the issues affecting pass through entities. He also stated that there is consensus among the White House and Congressional leadership on the need to adopt a territorial system for taxing foreign-sourced income of US multinationals, although he said that other issues in the international space remain unresolved. He restated the Administration position in favor of base broadening to achieve significant tax rate cuts.
Border Adjustment Tax
In mid-June, W&M Committee Chair Brady outlined possible changes to the GOP House Blueprint relating to the border adjustment tax. He suggested a 5-year phase-in for the border adjustment tax, which would tax all imports into the US at 20 percent and exempt all exports from taxation. He explained the proposed phase-in stating “Businesses need plenty of time to assess their current supply chain and decide what, if any, can return to the United States. And they want plenty of time to see how the dollar adjusts and at what level.”
Chair Brady and Speaker Ryan have argued that implementation of the border adjustment tax would result in a stronger US dollar, which would make it less expensive to import goods and effectively cancel out the higher tax on imports, but opponents are concerned that exchange rates won’t adjust enough to offset the tax.
Initial reactions from taxpayers and groups who oppose the BAT indicated that the phase-in was not enough to gain their support, and some members of Congress who have voiced concerns about the proposal said they would need more details on the phase-in before they could support it. The non-partisan Tax Foundation released a revenue estimate showing that a 5-year phase-in would raise $1 trillion in revenue over a 10-year period while immediate imposition of the tax would raise more than $1.2 trillion.
Chair Brady also suggested that he is considering special treatment for certain business sectors including financial services, shipping, communications, insurance, and digitally-focused businesses, where cross-border transactions are more challenging to identify. To date, he and Speaker Ryan have resisted consideration of exemptions but the opposition to the BAT has created the need to change it or find a revenue substitute.
Net Interest Deductibility
Another provision in the House GOP Blueprint that has raised controversy is the proposal to eliminate the current-law deduction for net interest expense paired with a provision that allows full expensing of business investments. W&M Committee Chair Brady has also suggested a possible change to this proposal to make it more palatable to critics by describing an exemption for small businesses from the repeal of the interest expense deduction but still allowing the full expensing of business investments.
Infrastructure and Welfare Reform – Additions to a Tax Reform Bill?
Although White House suggestions early in 2017 that they might pursue coupling a tax reform package with infrastructure legislation have receded of late, a bipartisan group of 250 lawmakers have sent a letter to W&M Committee Chair Brady and Ranking Member Neal to support inclusion of a long-term plan to deal with the solvency of the Highway Trust Fund in tax reform legislation.
The conservative House Freedom Caucus plans to play a key role in the debate on tax reform this year with two of their key members, Caucus Chair Meadows (R-NC) and Congressman Jordan (R-OH) urging that welfare reform be addressed during the tax reform debate. Other members of the Caucus are not on board with combining the two issues, however, and Chair Brady has also stated that he feels the two issues should be dealt with separately.