Washington Tax Insight June 2017
The agenda and legislative schedule facing Congress in the months ahead continues to present significant challenges with uncertainty as to whether any major legislation can be passed in the near future. Congressional leadership must deal with the issue of increasing the debt limit ceiling and funding the government for FY 2018, which starts on October 1st. None of the 12 appropriations bills are finished, so it seems to be a real possibility that a short-term spending bill will be necessary. Health care reform legislation has passed the House, but is moving more slowly in the Senate, which has opted to draft its own legislation rather than work with the House bill. Hearings on tax reform have started in the House and Senate, but the White House has yet to produce any details of their plan outlined in April, and it is unclear who will effectively be taking the lead on the advancement of tax reform.
In addition, there are three major programs that are set to expire in September – the Federal Aviation Administration law, federal flood insurance, and a children’s health insurance initiative – as well as a number of smaller programs including Coast Guard laws, and various Medicare and Food and Drug Administration programs.
There is divided opinion in Washington about whether the firing of FBI Director Comey and the related investigations of Russian contacts with Trump campaign personnel will make tax reform and health care reform more difficult. In any event, the legislative agenda facing Congress was already highly ambitious, and the political issues that are now added to the mix will only make legislative achievements more difficult.
One procedural rule is complicating progress on the budget and tax reform. The current budget reconciliation instructions are being used for health care reform, and Congress must finish that effort or abandon it before passing a new budget. The plan has been to use the new budget to write reconciliation instructions that would include tax reform, allowing that legislation to pass by a simple majority in both the House and the Senate. Congress could informally agree on spending levels for FY 2018 and then proceed with consideration of the appropriations bills, but that has not yet been done.
Debt Ceiling Limit
Top economic aides from the White House are urging Congress to act on raising the debt ceiling by the beginning of August prior to the Congressional summer recess rather than waiting until fall. In addition, Treasury Secretary Mnuchin is pushing for a “clean” debt ceiling bill (i.e., with no additional items). But Congressional leadership had hoped to include the debt ceiling issue in a broader spending package that will need to be approved prior to the beginning of FY 2018 on October 1st.
Congressional Republicans are divided over whether to combine spending cuts with the debt ceiling increase, and Senate Democrats are considering whether they should push for concessions on key issues as part of the package. Democratic support will be needed in the Senate where a 60-vote majority will be required, and if House conservatives do not support a clean debt limit bill, Democratic support may also be necessary in the House. In addition, Congressional leadership had hoped to devote the June/July work period to consideration of health care reform and tax reform rather than becoming embroiled in a fight over the debt limit.
The White House FY 2018 Budget proposal
On May 23rd, the White House released its FY 2018 budget proposal, which includes $4.1 trillion of spending and a goal of balancing the budget over 10 years. The proposed budget does not include details on the President’s tax reform plan, which was released on April 26th, but it does assume that any adopted tax reforms will be revenue neutral.
Health Care reform
The non-partisan Congressional Budget Office (CBO) issued its cost estimate for the House-passed legislation to replace the Affordable Care Act (ACA), which is called the American Health Care Act (AHCA). CBO estimates that the bill would reduce the deficit by $119 billion over 10 years, as a result of $1.1 trillion in reduced spending and $992 billion in reduced revenues. The bill would reduce coverage by 23 million people by 2026 as compared to current law.
The spending savings are primarily a result of a phase-out of the ACA’s Medicaid expansion and the replacement of current-law refundable premium assistance tax credits, which subsidize coverage in the nongroup market for low-income individuals with less generous age-adjusted premium assistance credits. The revenue reduction comes from the bill’s elimination of most of the tax increases enacted by the ACA including the 3.8% net investment income tax, the additional 0.9% Medicare payroll tax on high-income taxpayers, and new industry taxes on medical device makers, health insurers, and manufacturers of branded drugs. The bill also further delays the effective date of the so-called “Cadillac” tax on high-cost employer-provided health plans.
The AHCA is being advanced through the budget reconciliation process, which allows it to be approved by a simple majority vote in both the House and the Senate (where Republicans hold 52 seats.) The Senate has indicated that it intends to draft its own legislation rather than use the House-passed bill, and a working group has been meeting frequently although no timetable has been set for consideration of their health care bill. Majority Leader McConnell (R-KY) has said that he is still not certain how he gets 51 votes for this type of legislation although that is his goal once a Senate bill is produced. Many Senators have concerns about the rollback of the Medicaid expansion, and some Senators object to the restructuring of the premium assistance tax credits.
Senate Finance Committee
SFC Ranking Member Ron Wyden (D-OR) introduced the Clean Energy for America Act (the “Act”) which “proposes a dramatically simpler set of long-term performance-based energy tax incentives that are technology-neutral and promote clean energy in the United States.” The Act includes proposed tax incentives including a technology-neutral tax credit for domestic production of clean energy, a technology-neutral tax credit for domestic production of clean transportation fuel, a performance-based tax credit for energy efficient homes, and a tax deduction for energy efficient commercial buildings.
Senator Wyden also introduced the Modernization of Derivatives Act of 2017, which would require recognition of gains on derivatives each year (mark-to-market) and apply ordinary tax treatment to those gains. His purpose is to “prevent wealthy investors from using complex financial tools as a way to avoid paying their fair share of taxes.”
Senator Tammy Baldwin (D-WI) and Congressman Sander Levin (D-MI) have introduced legislation called the “Carried Interest Fairness Act” that would require carried interest to be taxed as ordinary income rather than at the capital gains rate.
Treasury and the IRS
The IRS issued two pieces of guidance related to the issuance of rulings on two common spin transactions – transactions implicating so-called “north/south” issues and transactions involving debt “issued in anticipation” of a leveraged spin. In 2013, the IRS had announced that it would no longer issue rulings with respect to these types of transactions as well as transactions that were recapitalizations into control in conjunction with spin-offs. In July 2016, the IRS removed the “no-rule” designation for recapitalizations into control and provided two limited safe-harbors where the IRS would not challenge an unwind of a high/low voting structure.
In May, the IRS issued Revenue Ruling 2017-9 offering guidance on the north/south transactions in which certain distributions of stock and securities of a controlled corporation are made to subsidiaries. The IRS noted that Revenue Procedure 2017-3 would be amended to allow the issuance of private letter rulings and determinations in this area with the caution that the IRS might decline to issue a letter ruling addressing the integration of steps when appropriate in the interest of sound tax administration or on other grounds when warranted by the facts or circumstances of a particular case. The guidance addressed two specific situations, ruling that (i) the transfer of the assets of an active trade or business to a controlled subsidiary followed by the distribution of the stock of that subsidiary will be tax free, and (ii) the contribution of cash to a controlled subsidiary made in furtherance of a plan of reorganization under §§ 368(a)(1)(D) and 355 will be governed by § 361.
The IRS also issued Revenue Procedure 2017-38, which states that the IRS will begin to issue new private letter rulings on deals involving debt issued in anticipation of a spinoff, although it continues to study matters concerning deals involving debt for a distribution. Specifically, the guidance states that the IRS will resume determinations on whether Code sections 355 or 361 apply to a distributing corporation’s distribution of stock or securities of a controlled corporation in exchange for, and in retirement of, any putative debt of the distributing corporation if such distributing corporation debt is issued in anticipation of the distribution.
The Government Accounting Office (GAO) issued a report to Congress on the IRS’s issue-based examinations and compliance campaigns that focus on certain areas of risk. The IRS Large Business and International (LB&I) division announced the launch of 13 issue-focused campaigns in January. The GAO was asked to review how the IRS selects returns and to evaluate the implementation of this new compliance initiative. The findings were that there are several areas of concern and areas that needed improvement, including gaps in the IRS selection method procedures and policies related to six internal control principles, flaws in the process to monitor field staff’s audit selection decisions, and other problems in its planning principles for implementation of the new compliance approach. The GAO report makes 14 specific recommendations, including that the IRS address documentation gaps in policies and procedures for internal control principles for its audit selection methods. The IRS has stated that it agrees with all of the GAO’s recommendations and is identifying specific actions to be taken to implement them.
The President signed an Executive Order (EO) that directs government agencies with respect to activities involving religious expression and liberties, but does not appear to change current law. The EO instructs the Treasury Department not to pursue “adverse action” against persons, churches or religious organizations for speaking about political issues from a religious perspective. “Adverse action” is defined as “the imposition of any tax or tax penalty; the delay or denial of tax-exempt status; the disallowance of tax deductions for contributions made to entities exempted from taxation under section 501(c)(3) of title 26, United States Code; or any other action that makes unavailable or denies any tax deduction, exemption, credit or benefit.” Because the IRS has almost never enforced this limitation, the EO should have little practical effect.
The European Parliament voted to adopt proposed amendments to the EU Anti-Tax Avoidance Directive (EU Directive 2016/1164) that would expand the directive’s current hybrid mismatch provisions, which generally apply to certain hybrid mismatches between two EU member states that are attributable to differences in the legal characterization of a financial instrument or entity. If the amendments are approved by the European Council, they would extend these provisions to certain hybrid mismatches involving an EU member state and a non-EU jurisdiction and to certain reverse hybrid mismatches, permanent establishment mismatches, tax residency mismatches, and “imported” mismatches. EU member states would then have until the end of 2019 to adopt laws, regulations, and administrative provisions necessary to implement the new provisions, and until the end of 2021 to implement the provisions relating to reverse hybrid mismatches.
As part of the ongoing efforts to maintain the integrity of the OECD Common Reporting Standard (CRS), the OECD is launching a disclosure facility on the Automatic Exchange Portal which allows interested parties to report potential schemes to circumvent the CRS. This facility is part of a wider three-step process the OECD has put in place to deal with schemes that purport to avoid reporting under the CRS. The three-step process to deal with CRS avoidance schemes complements the ongoing peer reviews carried out by the Global Forum on Tax Transparency and Exchange of Information for Tax Purposes to ensure the effective implementation of the CRS in all jurisdictions.
The OECD released a discussion draft related to the implementation of the approach to pricing transfers of hard-to-value intangibles described in Chapter VI of its Transfer Pricing Guidelines. The final reports on Actions 8-10 of the BEPS project mandated the development of guidance in this area. The discussion draft presents the principles that should underline the implementation of the approach to hard-to-value intangibles, provides examples illustrating the application of this approach, and addresses the interaction between the approach to such intangibles and the mutual agreement procedure under an applicable treaty. Comments on the draft are due June 30th.
Tax Reform Update
There is growing concern in corporate America and on Wall Street that one of the President’s key legislative initiatives to enact comprehensive tax reform is facing increasing challenges this year and that the White House and Congress will be unable to deliver on their promises to cut corporate and individual tax rates in 2017. A crowded legislative calendar for the remainder of this legislative session present procedural challenges to moving tax reform, while resistance to key revenue raisers in the House GOP blueprint including the border adjustment tax (BAT) present substantive challenges to moving a comprehensive package of tax cuts and base broadeners. GOP leadership continues to consider the option of a temporary tax cut to avoid issues with the long-term deficit rules of the budget reconciliation process with Secretary Mnuchin quoted as saying: “Permanent is better than temporary, and temporary is better than nothing.”
The White House
The White House has nominated David Kautter to be the Assistant Secretary of Treasury for Tax Policy, which is a key position with respect to the advancement of tax reform in the Administration and requires Senate confirmation. Most recently, Mr. Kautter was partner-in-charge of RSM’s Washington National Tax Practice and an Adjunct Instructor at American University, and previously he served as Managing Director of the Kogod Tax Center at American University and was Director of National Tax at E&Y. The office of the Assistant Secretary for Tax Policy includes four Deputy Assistant Secretaries: Tax Policy, Tax Analysis, International Tax Affairs, and Tax, Trade and Tariff Policy.
The Administration budget for FY 2018 did not include new details about the tax reform plan released in April, but it does include arguments that make the case for comprehensive tax reform, stating:
“The Administration has articulated several core principles that will guide its discussions with taxpayers, businesses, Member of Congress, and other stakeholders. Overall, the Administration believes that tax reform, both for individuals and businesses, should grow the economy and make America a more attractive business environment.”
In a recent interview, the President stated that he is willing to increase the deficit in the short term in order to get the longer-term economic growth and revenues that he believes will result from an improved tax system. He continues to support a reciprocal import tax on products made by manufacturers that have moved production outside of the US. He also expressed support for a Value Added Tax (VAT) but commented that he does not believe Americans would accept that type of system.
Ways & Means Committee
On May 18th, the W&M Committee held the first in a series of hearings on tax reform focusing on economic growth and job creation. In his opening statement, Chair Brady repeated his position that comprehensive reform is necessary to stimulate the economy, which was echoed by several corporate executives testifying at the hearing. Ranking Member Richard Neal (D-MA) stated that Democrats will “oppose any tax plan that helps the rich get richer and … oppose any tax reform that results in the middle class carrying even more of the tax burden.”
On May 24th, the W&M Committee held a hearing on the pros and cons of the border adjustment tax (BAT) included in the House GOP tax reform blueprint with corporate executives and economic experts testifying. A detailed study of the BAT was issued by the Joint Committee on Taxation in conjunction with the hearing. The provision, which would tax all imports at 20 percent and exempt exports, is estimated to raise more than $1 trillion over 10 years and thereby is one of the key revenue offsets in the GOP blueprint.
Testimony at the hearing demonstrated the lack of consensus on the effects of the proposal. Economist Lawrence Lindsey testified that supply and demand “will lead to a currency adjustment” under a BAT and strengthen the dollar, while other economic experts stated that there are serious uncertainties about the effect of the plan on currency values and noted that the World Trade Organization is likely to rule against the BAT.
Executives from the retail industry stated that the proposal would more than double their tax rate. Two lobbying coalitions on opposite sides of this issue have actively been working this issue on Capitol Hill – the American Made Coalition, which supports the BAT, and the Americans for Affordable Products which opposes the BAT.
In recent public comments, Treasury Secretary Mnuchin has been careful not to completely reject the BAT, but he has taken issue with the contention that it would level the playing field for US companies. In a W&M Committee hearing on the Administration’s FY 2018 budget, he stated that he does not support the BAT as currently drafted, and he is looking to work with the Congress on changes. In that hearing, the Secretary also commented that he believes the business deduction for net interest expense should be retained, but he is willing to consider this issue with other options. He also stated that tax rate parity between corporations and pass through entities must include anti-abuse measures that prevent the wealthy from using pass through entities to evade personal income taxes.
Senate Finance Committee
The SFC held a hearing on May 25th to examine the Administration’s FY 2018 budget and current tax reform proposals. Treasury Secretary Mnuchin testified, and he expressed a preference for retaining some current law tax policies, including the business deduction for net interest expense, while deferring comment on others, stating that ongoing negotiations with Congress would determine the outcome on many issues. He did state that he is reluctant to modify the depreciation rules, and that Treasury is looking at various different alternatives. On the BAT, he once again said that the Administration has reservations about the proposal, and that Treasury has been working closely with the House to consider changes to it.
Senate Republicans to date have not drafted their own tax reform proposal or released a detailed outline of a plan but appear to have started working with the House and the White House on these issues. Comments from many Senators, however, indicate that they have positions and priorities that may be at odds with those of the other parties.
Senator Majority Leader McConnell (R-KY) stated recently that tax reform must be revenue neutral, which is in line with the House GOP blueprint but is not aligned with recent comments by the White House. In contrast, SFC Chair Hatch (R-UT) has stated that he is not sure it is critical that tax reform be revenue neutral. If the Congressional Republican leadership continues with their plan to move tax reform as part of the budget reconciliation process, the Byrd rule will require that the bill not increase the deficit in years beyond the 10-year budget window unless those costs are offset by other savings in the bill, so the issue of revenue neutrality long-term must be considered.
Senator McConnell also stated recently that he does not believe the BAT proposal in the House GOP blueprint would pass the Senate, adding to the Administration’s misgivings about this proposal. There also may be disagreement between the House and Senate on the issue of depreciation, expensing and the deduction for net interest expense. The House GOP blueprint includes 100% expensing coupled with no current deduction for net interest expense, while Senator Thune (R-SD) has introduced legislation which he wants included in the Senate version of tax reform that would liberalize the current depreciation rules but doesn’t allow 100% expensing. His bill does not address the issue of business interest deductions, but there may be reluctance from both Senator Thune and Chair Hatch to repealing the deduction.
With respect to a timeline in the Senate, Senator McConnell has stated that his intention is to complete tax reform during the current Congress, which expires at the end of 2018. House Speaker Ryan and W&M Chair Brady continue to express hope that tax reform can be completed in 2017, while they acknowledge the challenges to achieving that.
Robert M. Gordon