Washington Tax Insight June 2019
Politics and Congressional Activity
Congress returned on June 3rd from a Memorial Day recess to face a number of pressing issues. Negotiations on budget and spending legislation are in the hands of House Speaker Pelosi (D-CA) and Senate Majority Leader McConnell (R-KY) with a goal of reaching agreement in time to prevent the need to pass a continuing resolution prior to the start of the fiscal year on October 1st. The goal is to reach agreement on a bipartisan deal that would cover 2019 and 2020. A meeting between White House officials and Congressional leaders on May 21st did not produce a deal, but House Minority Leader McCarthy (R-CA) said that negotiators had agreed to meet again but with no specific date determined.
One financial issue that must be dealt with by September is the need to increase the debt ceiling limit, which governs the federal government’s ability to borrow. Absent an increase, automatic mandatory cuts in both defense and domestic federal spending will occur with draconian effect — and, at this point, there does not appear to be a plan for managing this issue in a timely fashion. The government can use “extraordinary measures” to manage the debt limit, but projections reflect that these will be exhausted by early fall. Democrats are likely to use this issue as leverage on other issues that they would like to deal with by the end of 2019.
The escalating conflict between the US and China on trade policy has resulted in dueling tariff increases and significant drops in the US stock market with no clear resolution in sight. Many in the Republican Party disagree with Administration policy but do not appear ready to challenge them beyond some verbal complaining. President Trump also threatened to impose tariffs on Mexico to induce that country to reduce migration to the United States.
Democratic investigations and oversight of several matters related to the Trump Administration continue including the issue of President Trump’s tax returns being provided to the House Ways & Means Committee. After Treasury Secretary Mnuchin declined to provide the tax returns in response to the Ways & Means Committee request, Chair Neal (D-MA) subpoenaed this information for tax years 2013-2018, but that has also not been responded to, so the issue will head to the courts.
Ways & Means Committee: The Committee held a hearing on May 15th on climate change covering the economic and health impacts along with the use of the tax code to address the issue. Committee Democrats discussed carbon pricing as a way to reduce emissions, but no specific proposals for implementing carbon pricing were endorsed. The Baker-Schultz Carbon Dividends Proposal was discussed by the chairman of the Climate Leadership Council, which is supported by a number of large companies including from the energy industry. The proposal would implement an escalating fee on companies’ carbon emissions, beginning at $40 per ton, in exchange for a rollback of regulations on greenhouse gases. The fees collected would be returned to US households in the form of quarterly dividend payments. Committee Republicans argued against a carbon tax stating their preference for new tax incentives for clean energy development and federal investment in innovative technologies.
The Committee also held a hearing on the “tax gap” – the difference between federal taxes owed and paid on a timely basis – and how to reduce it. The IRS has estimated the tax gap to be around $450 billion for the 2008-2010 timeframe. Chair Neal cited decreases in the IRS enforcement budget and audit efforts as contributing to the problem, and he also noted that the tax gap could be underestimated due to the fact that it does not cover international noncompliance.
Senate Finance Committee: Ranking Democrat Wyden (D-OR) introduced the Clean Energy for America Act, which would combine 44 energy-related tax incentives into 3 new permanent green energy incentives, while repealing all tax incentives for fossil fuels. The legislation would provide up to a $1-per-gallon tax credit for fuels that are at least 25% cleaner than average, a 30% investment tax credit to clean electricity or a 2.4 cent-per-kilowatt hour credit for production, a tax credit for energy-efficient homes and a tax deduction for qualifying commercial buildings.
Chair Grassley (R-IA) and Ranking Democrat Wyden (D-OR) announced that the Committee has initiated an investigation into potential abuse of the Code section 170 tax deduction for conservation-oriented land donations, which are known as syndicated conservation easements. Under this code section, individuals may qualify for a tax deduction if they donate land that will be environmentally conserved, but the taxpayers under investigation may have tried to exploit the provision by an appraisal that overestimates the value of the property thereby inflating the deduction and then dividing the deduction between investors. The IRS released Notice 2017-10 in 2016 which dealt with conservation easement abuse followed several months later by Congressional testimony that the IRS had started enforcement activity for many of the entities that had claimed the deduction.
Retirement Savings Legislation: The House approved by a bipartisan vote of 417-3 the Setting Every Community Up for Retirement Enhancement (SECURE) Act, which would encourage individuals to participate in retirement plans, make it easier for smaller businesses to offer tax-qualified retirement savings plans to their employees, and promote savings for certain nonretirement expenses. The bill also addresses certain unintended consequences of a change to the so-called “kiddie tax” in the TCJA by repealing the change. SFC Chair Grassley and Ranking Democrat Wyden had introduced their own version of retirement legislation in April, but they are considering a process by which the Senate would approve the House-passed version of the bill. The resolution of these issues will be taken up after June 3rd when Congress returns from the Memorial Day recess.
IRS Reform Legislation: The House approved the IRS reform bill on a voice vote in early April and sent the legislation to the Senate, where originally it was expected to also pass easily, but its progress has been blocked by several Democrats who have raised objections to a provision in the legislation that would codify the IRS Free File program, which is a partnership between the IRS and private software providers that was established to make no-cost tax return preparation software available to certain lower-income taxpayers. The initial concern was that codifying the program, which currently exists as a memorandum of understanding, would prevent the IRS from developing its own return preparation software and offering it to the public directly. Then concerns arose about the current program due to press reports that some private software providers were hiding details about their Free File software on internet search engines and steering taxpayers instead to fee-based products, including recent reports of this affecting members of the military. The IRS Commissioner has now said that the agency is bringing in an independent consultant to review Free File. Members of both parties appear to be interested in resolving this issue with the expectation that the legislation will move forward at some point.
Infrastructure Legislation: A second meeting between the White House and Democratic Congressional leaders to discuss funding for infrastructure legislation produced no progress on the issue, which was caught up in political disagreements about other issues. Also, the President had sent a letter to the leaders prior to the meeting stating that he was not willing to work on infrastructure issues until Congress passes the US-Mexico-Canada Agreement, which is a replacement for the North American Free Trade Agreement. Although there continues to be bipartisan support for moving ahead on an infrastructure bill, the issue is not on a fast track for action in 2019.
Treasury and the IRS
Treasury and the IRS have released a significant amount of guidance on the TCJA to date. Treasury has until June 22, 2018 (18 months after the TCJA was enacted) to issue final rules that can operate retroactively back to the enactment date.
The Treasury Department’s Inspector General for Tax Administration issued a report on the status of TCJA guidance developed and published by the Office of Chief Counsel. As of the beginning of the 2019 Filing Season, Chief Counsel had issued 79 published TCJA guidance products with four additional guidance products issued prior to April 1st. The report stated that Chief Counsel planned to issue more than 90 published guidance products after March 29th. There are currently several guidance products under review by the Office of Management and Budget for publication in the Federal Register.
Global Intangible Low-Taxed Income (GILTI): Final GILTI regulations are expected to be issued in the near term. At a recent ABA tax meeting, a Treasury representative suggested that the final rules may include a high tax exception that would exclude income that is already subject to a foreign tax rate above 13.125%. Questions about US partners in partnerships that own controlled foreign corporations with a GILTI inclusion will likely be answered after June 22nd according to comments from an IRS official at the ABA meeting. He stated that the issues are more likely to be addressed in forthcoming regulations on previously taxed earnings and profits, which are on a longer timeline than the GILTI final regulations, that will focus on how corporations determine that type of income in general.
Code section 163(j)/Limitation on Deduction of Business Interest: A Treasury official stated at the recent ABA tax meeting that they are reviewing guidance related to the debt interest deduction limit, and that the second set of rules under Code section 163(j) should include tax treatment of debt-financed distributions and the definition of interest subject to the deduction limit with the possibility of narrowing that definition.
Section 956/Repatriation: The IRS issued final regulations that reduce the amount of income included under Code section 956 for certain domestic corporations. The final rules exclude corporations that are US shareholders (as defined in Code section 951(b)) from the application of Code section 956 to maintain symmetry between the taxation of actual repatriations and the taxation of effective repatriations. In general, under Code section 245A and the final regulations, respectively, neither an actual dividend to a corporate US shareholder, nor such a shareholder’s tentative Code section 956 amount, will result in additional US tax.
Other Issues and Guidance
IRS Personnel: The IRS announced the appointment of Peter Blessing to the position of Associate Chief Counsel, International, Office of Chief Counsel. The Associate Chief Counsel, International, is responsible for coordinating and directing all activities of the international component of the Office of Chief Counsel, which provides legal advisory services on all international and foreign tax matters, related to the activities of non-US taxpayers within the US and the activities of US or US-related taxpayers outside the US. Mr. Blessing has been a managing director at KPMG and a partner with Sherman & Sterling.
Ownership Attribution for CFCs: The IRS issued proposed rules that provide ownership attribution guidance for controlled foreign corporations. The IRS explains that the guidance provides rules “regarding the attribution of ownership of stock or other interests for purposes of determining whether a person is a related person with respect to a controlled foreign corporation (CFC) under section 954(d)(3).” The proposed rules also provide guidance on determining whether “a CFC is considered to derive rents in the active conduct of a trade or business for purposes of computing foreign personal holding company income (FPHCI).”
S Corporations: The IRS issued proposed rules under Code sections 641 and 1361 on the expansion of the class of permissible potential current beneficiaries (PCBs) of an electing small business trust (ESBT) to include nonresident aliens (NRAs). The IRS explained that the proposed regulations would “ensure that the income of an S corporation will continue to be subject to US Federal income tax when an NRA is a deemed owner of a grantor trust that elects to be an ESBT.” The IRS issued Revenue Procedure 2019-13, which provides guidance on cash distributions made in redemption of C corporation stock formerly classified as S corporations and during the post-termination transition period as defined under Code section 1377(b).
IRS Compliance Campaigns: The IRS launched three new compliance campaigns by the Large Business and International (LB&I) Division focused on captive services providers, offshore banking, and the filing of information Form 5471 by officers, directors, or shareholders in certain foreign corporations. The goal of the captive services provider campaign is to ensure that US multinational companies are paying their captive service providers no more than arm’s length prices. The offshore private banking campaign addresses tax noncompliance and the information reporting associated with these offshore accounts. The goal of the Form 5471 campaign is to improve compliance with the requirement to attach a Form 5471 to an income tax, partnership or exempt organization return.
Transfer Pricing Audits: A February 2019 directive on the conduct of transfer pricing audits is requiring tax examiners to include extra analysis in some of their international cases. If an audit could generate an adjustment to a multinational company that then could result in a dispute with a foreign tax authority, the examiner is required to consult with advance pricing and mutual agreement (APMA) personnel in order to get their suggestions on how to handle the case, which could help the IRS in competent authority negotiations between the governments.
Foreign Currency Regulations: Treasury and the IRS took action in the area of foreign currency under Code section 987 to address comments that temporary regulations issued in December 2016 were overly burdensome. The Section 987 rules were identified in 2017 as part of an effort by the Trump Administration to deal with regulations published in 2016 that were deemed to impose an undue financial burden on taxpayers or to add undue complexity.
The rules withdraw temporary regulations from December 2016 on partnership allocations of assets and liabilities from transactions that involve business units operating in a foreign currency, which were deemed to have the potential to distort gain or loss calculations under Code section 987, which governs the calculation of taxable income or loss when a taxpayer owns one or more qualified business units (QBUs) with a functional currency other than the US dollar, and the functional currency is different from the taxpayer’s. The IRS provides that until new regulations are proposed, taxpayers may use any reasonable method for determining a partner’s share of assets and liabilities reflected on the books and records of an eligible QBU held indirectly through the partnership.
Despite the fact that some commentators had called for the termination of all of the temporary rules, the IRS chose to issued final regulations on the recognition and deferral of gains or losses under Code section 987. The final rules cover combinations and separations of QBUs subject to Code section 987 and the recognition and deferral of foreign currency gain or loss with respect to certain QBU terminations. The IRS did not want to permit the selective recognition of losses and deferral of gains.
Withholding & Reporting of Dispositions of Partnership Interests: The IRS issued proposed regulations on withholding, reporting, and paying tax under Code section 1446(f) upon the sale, exchange, or other disposition of an interest in a partnership described in Code section 864(c)(8) and proposed section 1.864(c)(8)-1 of the income tax regulations. Based on guidance provided in Notice 2018-29, the regulations include rules that clarify the reporting rules applicable to transfers of partnership interests subject to Code section 6050K and implement withholding by brokers on transfers of certain interests in publicly traded partnerships subject to Code section 1446(f)(1).
Brexit: Following the EU Council approval of an extension to Article 50 to delay the Brexit date to October 31, 2019, with an option for the UK to leave earlier should there be Parliamentary approval of an exit plan, the UK Government continues to struggle to find a successful path to consensus. After failing again to gain Parliamentary approval of her compromise Brexit plan, PM May resigned as her party’s leader on June 7th but will stay on as Prime Minister until the Conservative Party chooses a new leader. The UK was required to hold elections to the European Parliament since they were still a member of the EU on May 23rd, and the “Brexit Party,” which ran on a no-deal platform gained more votes than any other party. This result has pushed leading contenders for the Conservative Party leadership to include the possibility of a no-deal exit as an option, but that option is unlikely to be approved by Parliament and could result in a vote of no-confidence in the new Government. Under the agreement with the EU, the UK may reconsider their entire Brexit strategy, but the extension agreement precludes reopening the withdrawal agreement. The UK may also revoke Article 50 and cancel Brexit altogether, or hold a new referendum on Brexit.
Digital Services Taxes: The OECD is working toward a plan to tax digital commerce as part of the BEPS initiative, but the debate has now broadened to a general discussion of global tax rules including addressing which countries are allowed to tax certain profits of multinationals and ensuring that multinationals pay their fair share of taxes. A detailed program of work will be presented to the G20 Finance Ministers meeting in June with a goal of a consensus-based long-term solution in 2020.
France: The French Finance Minister has recently made public comments that appear to expand the scope of the digital tax they are advancing to cover not only the value of a data collection network, but also the value created by the data. France has pledged to terminate its country tax once the OECD adopts a global proposal but has made it clear they will insist on “fair and efficient taxation on profits made on data.”
Unilateral Country Activity: An increasing number of EU countries are moving to adopt unilateral digital taxation proposals with most citing the failure of the EU to adopt an EU-wide tax during its March meeting. Poland’s Deputy Finance Minister has announced that Poland will move on a proposal modeled on the European Commission’s digital tax proposal with effect from 2020 that sets 3 separate thresholds designed to ensure that only companies with a significant digital presence are taxed. The Czech government has announced that it plans to impose a digital tax applicable to advertising and sale of user data on internet platforms for companies that have global revenue over 750 million euros to be effective mid-2020. Israel’s Ministry of Finance is considering options for the taxation of large digital MNEs designed to fill budget gaps with one option being a 3 to 5% tax on revenue modeled on the digital services tax being implemented in France. Other countries moving ahead with proposals include Mexico, Malaysia, Austria, India, Italy, New Zealand, and Spain.
US Activity: During a recent discussion at an ABA tax meeting, Deputy Assistant Secretary of International Tax Affairs Chip Harter commented that there is interest on the part of several countries within the OECD in the adoption of a global minimum tax similar to that included in the 2017 US tax law, but that the technical challenge of drafting the rules will be great. Recent comments from the Treasury’s Deputy International Tax Counsel suggested that any deal reached at the OECD level on a global minimum tax is likely to represent a “looser consensus” leaving the details of implementation to individual countries. He did comment, however, that many details of a plan would have to be agreed upon including whether the tax would apply based on a company’s global aggregated income and taxation, or if it would be broken down by jurisdiction.
At the ABA meeting, Mr. Harter stated that “vigorous diplomacy” is ongoing by the US in an attempt to stop countries from adopting unilateral tax measures that target digital companies, including from France and the UK. The US is arguing that the unilateral measures are political and should be deferred while the OECD is working toward a global consensus approach.
Netherlands Tax Ruling Practice: The Dutch government published a draft decree and guidance proposing higher standards for obtaining advance tax rulings and advance pricing agreements on international tax matters from the Dutch tax authorities as well as establishing new transparency rules and procedures for Dutch tax rulings. The Dutch House of Representatives is scheduled to discuss the proposals on June 4th, which are expected to take effect on July 1st. Currently, it is not clear whether ruling requests that have been filed before July 1st will be subject to the new rules, but this question is expected to be addressed during the House debate.
Changes will be made in 3 areas: (1) the ruling process; (2) the content of tax rulings; and (3) transparency of the ruling practice. The new ruling process will be controlled by a new body that will function as the principal point of contact for all tax rulings considered to be “international.” Companies considering investing in the Netherlands may contact the liaison for potential foreign investors, which is part of the new body, the College Internationale Fiscale Zekerheld. There will now be a requirement of economic nexus and no ruling will be granted if avoiding Dutch or foreign tax is the sole or main purpose for the transaction or if the requested ruling covers direct transactions with entities established in jurisdictions that are on the Dutch list of low-tax jurisdictions. The new rules list a number of topics that can be the subject of a tax ruling. All tax rulings will be published in summary form but without identifying taxpayers.
Is the UK HMRC focusing on US Companies?: The UK HMRC recently published data showing that US multinational companies are 17% of the total £28 billion classified as “tax under consideration” for the tax year 2017-18. In 2015, the UK introduced its “diverted profits tax,” which taxes income deemed to have been shifted out of the UK for tax avoidance purposes at 25% instead of the current 19% for corporations — the same year that the OECD began its BEPS project. UK analysts have commented that multinational technology groups are a particular focus for the UK because the digital business models enable companies to generate revenues in places where it has little physical presence resulting in limited tax liability. The UK has proposed a new digital services tax (DST) effective in April of 2020. The DST is a 2% tax on the revenues of businesses that are considered to derive significant value from the participation of their users, potentially targeting search engines, social media platforms, and online marketplaces.
European Union: The European Commission prepared a document for consideration at a meeting on May 9th outlining 6 areas of taxation that need work, which will be used to prepare a strategic agenda for 2019-2024. The areas include: (1) enactment of a common consolidated corporate tax base (CCCTB); (2) EU list of non-cooperative tax jurisdictions; (3) transparency for multinationals with respect to aggressive tax planning (4) taxation of digital activities; (5) creation of a single VAT area; and (6) EU qualified majority voting on tax issues.
OECD Model Tax Treaty Released: The OECD released the full version of the 2017 edition of the OECD Model Tax Convention on Income and on Capital, which is used by many countries as a starting point for tax treaty negotiations. The condensed version of the treaty was published in December 2017. This full version includes not only the full text of the treaty, but also commentaries, non-member economies’ positions, the recommendation of the OECD Council, historical notes, and background reports.
The Tax-Writing Committees: Tax Extenders
Extenders: SFC Chair Grassley announced the formation of several bipartisan task forces to examine the expired and expiring tax provisions designed to make decisions on the issue of permanency or permanent expiration. In connection with the announcement, the Joint Committee on Taxation issued a report on tax provisions that expired in 2017 and 2018, and those set to expire in 2019. Five of the task forces deal with the issue areas of: (1) workforce and community development; (2) health taxes; (3) energy; (4) business cost recovery; and (5) combined group of individual excise taxes and other temporary policies. These task forces will consider “whether a continued short-term extension is sufficient to achieve the policy goals, whether a long-term extension is desirable to force a future Congress to reevaluate the provision down the road, or if permanency is warranted. A sixth task force will focus on related issues of temporary disaster tax relief and consider whether a permanent disaster relief tax provision should be enacted. All task forces are due to issue reports and recommendations by the end of June.
Ways & Means Democrats have held several meetings to discuss tax extenders but have not been able to reach consensus on whether and how to offset the cost of an extender package and a concern that the benefit of most extenders goes to businesses who are already seen to have benefited disproportionately from the 2017 tax law. Chair Neal has suggested the possibility of a Committee “walk-through” of the issues in the near future and said that he has spoken to Chair Grassley about acting soon on extenders. Reports are that Ways & Means Democrats are considering attaching an extension of the Earned Income Tax Credit to the bill and possibly using the estate tax as a pay-for by terminating the TCJA estate tax changes in 2023 rather than 2025.