Washington Tax Insight March 2017
Politics and Congressional Activity
Congress faces a full legislative agenda for the spring including budget deadlines, health care reform and tax reform. President Trump addressed Congress on February 28th, presenting his budget and legislative priorities for this year, but provided no details. The White House has stated publicly that they will release an outline of the President’s FY 2018 budget proposal by mid-March with a detailed budget to follow later this spring.
Budget deadlines will have to be addressed, including the debt limit on federal borrowing, which is suspended until March 16th. Treasury has the ability to manage its accounts and obligations for a short period to avoid exceeding the limit, but it is likely that Congress will want to deal with this issue in a timely manner due to Republican control of the Congress and the White House. The official deadline for Congress to pass a budget resolution is April 15th. The first budget resolution was passed earlier this year and dealt with health care reform, but a second resolution is expected to advance covering tax reform.
Congressman Mick Mulvaney was confirmed as the new director of the Office of Management and Budget, and in that role, he will be the key player in developing the President’s annual budget plan. The President’s budget is expected to include a request for funding for construction of the wall between the US and Mexico, which could exceed $20 billion. House Republicans have not determined yet how to proceed on this issue, keeping in mind that passage in the Senate of this legislation will likely require the approval of eight Senate Democrats.
Congress must deal with expiration of the current Continuing Resolution (CR) on April 28th, and it is unclear whether Congressional leadership will choose to attach potentially controversial measures such as the Mexico wall funding issue to that legislation. House Democratic Caucus Chair Crowley (D-NY) has said Democrats won’t support an extension of the CR if the border wall provision is included. The budget is also expected to include a trillion-dollar infrastructure plan and increases in defense spending. There are currently budget spending caps in place, so the White House budget must include spending cuts to offset spending increases or the spending caps will have to be lifted, which will draw opposition from Republican fiscal conservatives.
House Republicans are expected to release legislation to revise the Affordable Care Act (ACA) in the near future. They have released the outline of a plan for repealing the ACA that provides a set of policy specifics, including an overhaul of Medicaid, repeal of the penalty for Americans without insurance, tax credits, repeal of the ACA taxes, and a modification of the individual insurance market. It was described as a “starting point for discussion” and it does not include tax offsets for the replacement plan. Congressional leadership hope to move this legislation by the Easter Congressional recess.
Other issues which Congress must address include completion of confirmation of the Administration’s cabinet appointees, consideration of the nomination of Neil Gorsuch to the Supreme Court with hearings to begin on March 20th and investigations by the intelligence committees into Russian involvement with Trump campaign officials.
The President signed an executive order that provides that, unless prohibited by law, whenever an executive department or agency publicly proposes a new regulation, it must identify at least two existing regulations to be repealed. The Office of Information and Regulatory Affairs (OIRA) issued a memorandum on February 2nd setting forth interim guidance for implementing it. The guidance states that effective immediately, for each significant regulatory action, agencies should (1) identify two existing regulatory actions the agency plans to eliminate or propose for elimination on or before September 30, 2017 and (2) fully offset the total incremental cost of such new significant regulatory action as of September 30, 2017. It is not clear how this executive order might impact tax regulations.
The Joint Committee on Taxation (JCT) issued its annual “Blue Book,” which provides a detailed explanation of every tax law change enacted in 2016, covering the six major tax bills signed into law last year. For each provision, the document includes a description of present law, reasons for change, explanation of the provision, and effective date. The JCT also issued its annual summary of revenue estimates for tax expenditures. This year’s report may be useful during the debate on tax reform which will incorporate the potential elimination of many corporate tax expenditures.
Treasury and the IRS
On January 31, Representative Rokita (R-IN) introduced H.J. Res. 54, which calls for using the Congressional Review Act (CRA) process to roll-back the Code section 385 debt-equity regulations finalized by Treasury during President Obama’s last year in office. House Democrats have come out strongly against the proposed legislation, and sixteen Democratic members of the Ways & Means Committee signed a letter to their Republican colleagues urging them not to repeal these regulations. To date, the Trump Administration has not moved forward with any specific attempts to undo the regulations.
As discussed in the last issue of the Washington Tax Insight, the White House sent a memorandum to the heads of executive departments and agencies directing a temporary regulatory freeze pending review, including no regulations to be sent to the Office of the Federal Register without review by the President, regulations not yet published to be withdrawn, and those which have been published but have not taken effect to be postponed for 60 days. Thus, it is possible that some of the regulations and new rules discussed in this section will be impacted by this executive action.
Treasury and the IRS released final and temporary regulations under Code sections 871(m) and 1441 addressing withholding tax on payments that are contingent upon or determined by reference to US source dividend payments, i.e. dividend equivalents. The regulations generally adopt the proposed regulations issued in 2015 with respect to the definition of “broker,” determining the delta with respect to simple contracts and options listed on a regulated exchange, the amount and timing of a taxpayer’s liability, and the treatment of qualified indices. The regulations also provide guidance on the qualified derivatives dealer regime and the party responsible for determining whether a transaction is a Code section 871(m) transaction.
In early January, the IRS issued proposed regulations that would impose a centralized audit regime for partnerships that determines income and collects tax at the partnership level rather than the partner level. These proposed regulations have now been withdrawn by the IRS. The audit structure established by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) was repealed by the Bipartisan Budget Act of 2015 with new rules covering procedures for electing out of the centralized partnership audit regime, filing administrative adjustment requests, and the determination of amounts owed by the partnership or its partners attributable to adjustments that arise out of an examination of a partnership.
Treasury and the IRS issued temporary regulations that address transfers of appreciated property by US persons to partnerships with foreign partners related to the transferor. The regulations override the rules providing for nonrecognition of gain on a contribution of property to a partnership in exchange for an interest in the partnership under Code section 721(a) pursuant to Code section 721(c) unless the partnership adopts the remedial method and certain other requirements are satisfied.
Treasury and the IRS issued final regulations regarding the application of the modified carryover basis rules of Code section 1022. The final rules modify provisions of existing regulations under various sections of the Code relating to the estate tax to take into account the application of the modified carryover basis rules of Code section 1022.
Treasury and the IRS issued final regulations under Code section 7704(d)(1)(E) relating to the qualifying income exception for publicly traded partnerships (PTPs). Code section 7704(a) provides that, as a general rule, PTPs will be treated as corporations for federal income tax purposes with Code section 7704(c) providing an exception if 90 percent or more of a PTP’s gross income is “qualifying income.” These rules define the activities that generate qualifying income from exploration, development, mining or production, processing, refining, transportation, and marketing of minerals or natural resources.
The IRS Large Business & International (LB&I) division announced thirteen issue-based campaigns in line with its move toward issue-based examinations and a compliance campaign process in which audit resources are grouped around specific issues of concern. Some of the issues covered are energy credits under Code section 48C; micro-captive insurance transactions described in Notice 2016-66; transactions between commonly controlled entities that provide taxpayers a means to transfer funds from the corporation to related pass through entities or shareholders; S corporation losses claimed in excess of basis; transfer pricing issues for US distributors of goods sourced from foreign-related parties; and repatriation structures being used for purposes of tax free repatriation of funds and proper reporting of repatriations.
The IRS LB&I also released an International Practice Unit (IPU) covering basket transactions described in Notices 2015-73 and 2015-74 and included in the 13 LB&I issue campaigns described in the prior paragraph.
Treasury and the IRS released Revenue Procedure 2017-23, which describes the process for filing Form 8975, Country-by-Country Report, and accompanying Schedules A, Tax Jurisdiction and Constituent Entity Information, by ultimate parent entities of US multinational enterprise groups for reporting periods that begin on or after January 1, 2016 but earlier than June 30, 2016, the applicability date of the final regulations implementing country-by-country reporting.
In a speech in early February, President Trump stated that he would like to see Congress approve legislation to repeal or modify the law that bans political activities by churches in Code section 501(c)(3), the so-called Johnson amendment passed in 1954. Chair Brady has stated publicly that he supports this position.
The Government Accounting Office (GAO) released a report titled, “Information on the Potential Impact on IRS and US Multinationals of Revised International Guidance on Transfer Pricing,” requested by SFC Chair Hatch (R-UT) addressing the impact of transfer pricing and country-by-country (CbC) reporting guidance produced by the OECD as part of its BEPS project. Stakeholders interviewed by the GAO said that CbC reporting requirements will increase compliance costs because CbC information is not information US multinational enterprises routinely collect or report, and thus will require new data systems and processes. Stakeholders believe that the new reporting requirements will increase audit activities and disputes, and potentially increase competitive and reputational risks.
The OECD released key documents, approved by the Inclusive Framework on BEPS, which will form the basis of the peer review of Action 13 Country-by-Country Reporting and for the peer review of the Action 5 transparency framework, the compulsory spontaneous exchange of information on tax rulings. The Action 13 standard and the Action 5 standard are two of the four BEPS minimum standards, which are subject to peer review in order to ensure timely and accurate implementation and thus safeguard the level playing field. All members of the Inclusive Framework on BEPS commit to implementing the minimum standards and participating in the peer reviews.
The OECD has invited taxpayer input on peer reviews of BEPS Action 14 on Dispute Resolution. The Mutual Agreement Procedure (MAP) peer review and monitoring process under Action 14 was launched in December 2016. The OECD is now gathering input for the Stage 1 peer reviews of Austria, France, Germany, Italy, Liechtenstein, Luxembourg and Sweden, and invites taxpayers to submit input on specific issues relating to access to MAP, clarity and availability of MAP guidance, and the timely implementation of MAP agreements for each of these jurisdictions using the taxpayer input questionnaire.
Responding to a request by the Development Working Group of the G20, the Platform for Collaboration on Tax, which is a joint initiative of the IMF, OECD, UN and World Bank Group, has developed a draft toolkit designed to assist developing countries in an important area of international tax policy, transfer pricing. The Platform is now seeking public feedback on that toolkit, which specifically addresses the ways developing countries can overcome a lack of data on “comparables,” or the market prices for goods and services transferred between members of multinational corporations.
Tax Reform Update – The Border Adjustment Tax (BAT)
Steven Mnuchin was confirmed to serve as Secretary of the Treasury, and he is expected to play a key role in developing the Administration’s tax policy reform plan. He served as finance chair of the Trump campaign and played a role in developing the Trump tax reform platform. Secretary Mnuchin commented publicly in one of his first interviews that the goal of the White House is to achieve tax reform by the August Congressional recess. Another key player in the Administration is Gary Cohn, a former president of Goldman Sachs Group Inc, who was named the head of the National Economic Council.
The White House has announced that they will release an outline of a comprehensive tax reform plan in the next few weeks. During the President’s address to Congress on February 28th, he called for “historic tax reform,” but he did not provide details and he did not state a position on the Border Adjustment Tax (BAT).k
With respect to timing, Congressional leadership have indicated that they want to move ACA reform before they move tax reform – whether they can combine the two in one budget reconciliation bill is an open question at this point with some Members willing to consider this but no consensus on that approach. House Speaker Ryan has stated he expects the House to complete tax reform by the August Congressional recess, but the Senate is unlikely to get tax reform legislation to the Floor until the fall so the final legislation would be worked out in a conference committee by the end of the year.
Border Adjustment Tax Proposal
House Republican leaders continue to defend a key provision of their tax reform blueprint, the Border Adjustment Tax (BAT), which exempts exports from tax and taxes all imports regardless of origin. House Speaker Ryan recently stated that the “drama” over the BAT and tax policy was expected, saying “We know this, and we will get tax reform done.” They are also facing concerns from some House conservatives who are not on board with a big new tax. One Republican member of the W&M committee, Congressman Renacci (R-OH) has asked for a committee hearing on the proposal saying that he has concerns that the provision will pick winners and losers and could fail to comply with US trade agreement commitments as well as who will pay for it.
Chair Brady has said that there will be hearings on “key aspects” of tax reform but he has not scheduled anything yet. Chair Barr (R-KY) of the House Financial Services Committee’s Monetary Policy and Trade Subcommittee has also indicated that he will assert his subcommittee’s jurisdiction over the BAT because of its potential impact on the value of the dollar.
The debate on tax reform may come down to differences between the House and the Senate on issues including the BAT, which has not gained much support yet in the Senate. Some Senators have expressed their opposition to it, and only 3 GOP Senators are needed to block the House tax plan because the Senate leadership does not expect Democratic support for the GOP tax reform package. Senator Graham (R-SC) commented recently that “it wouldn’t get 10 votes in his chamber.” Both SFC Chair Hatch and Majority Whip Cornyn (R-TX) have expressed skepticism about the proposal with Senator Cornyn asking Senator Hatch to hold a committee hearing on the proposal, which he is willing to schedule once the House produces legislative language for the BAT. SFC members Grassley (R-IA) and Roberts (R-KS) have raised concerns about the impact on the agriculture industries in their states. Without the revenue that the BAT raises, however, the House GOP plan cannot pay for the tax cuts included, and supporters state that they would lose the provision that would help prevent corporations from moving their operations out of the US.
There is no alternative plan to date that has been developed in the Senate. Chair Hatch in a recent speech stated that he is aligned with the President and Chair Brady on “virtually every fundamental tax reform question,” but that his panel would advance tax reform legislation on a parallel legislative track rather than starting with the House bill. Chair Hatch said Republicans agree on lower and fewer tax brackets for individuals, reducing the number of tax preferences, repealing the estate tax, lowering the corporate tax rate and moving to a territorial system.
Chair Hatch recently commented that “A major concern on tax reform is producing a bill that can get through the Senate, and that is likely going to require a separate Senate tax reform process, which will almost surely end up looking different from what passes in the House.” In a recent speech, he stated that several committee members have reservations about the BAT and they are working to understand how it would operate citing questions about who would ultimately bear the tax, whether it would be consistent with US trade obligations, and whether adjustments would be necessary to avoid undue burden on particular industries. He said, “We don’t have definitive answers to any of those questions at this point and without them, I don’t think I can give a definitive position on the proposal.”
After a closed-door Senate GOP lunch during which Speaker Ryan made the case for the BAT, Senator Cornyn called it a “high-risk gamble” and said he is “still a question mark.” Both Senators Blunt (R-MO) and Portman (R-OH) said that they are not yet supporters, and Senator Thune (R-ND) said he is keeping an open mind. Senator Cotton (R-AK), who has Walmart in his state, has publicly opposed the BAT.
The President has expressed concern about the BAT, calling it “too complicated,” but he has also praised it as a job creator. Treasury Secretary Mnuchin commented publicly that the White House is studying the BAT but has some concerns about it. Supporters of the BAT proposal are concerned that if the Trump tax plan does not include the BAT, it could be harder to rally support for it in the Senate.
Dueling coalitions have formed and are lobbying Congress and the White House with the American Made Coalition comprised of more than 25 members including GE and Boeing who support the BAT, and the Americans for Affordable Products, which has more than 100 companies and trade associations as members and who oppose the BAT.
Chair Brady has stated that he is listening to the concerns of stakeholders in the business community and that the committee would try to ease the transition from current law to the new system. He has said that he does not expect there to be carveouts or exemptions from the BAT, but some industries, such as financial services, believe their transactions should be treated differently.
As we have discussed in prior issues, Congressional leaders are considering the use of the budget reconciliation process to advance tax reform, but the Byrd rule requires that the legislation cannot increase the deficit in any year outside of the 10-year budget window. Reconciliation measures that do increase the budget in the out years must sunset at the end of the 10 year budget period. If the BAT is part of the tax reform package, it could present problems as it raises more than $1 trillion in the first decade, but long term, it starts to lose money when the US starts to run a trade surplus. It would be necessary to find other provisions that would address the revenue issue in the out years that are part of the budget reconciliation package. Speaker Ryan and Chair Brady have consistently said that their goal is to craft a proposal that doesn’t increase the deficit assuming economic growth and excluding the costs of repealing the ACA taxes. Secretary Mnuchin has not indicated whether the White House also has a goal of revenue neutrality with respect to tax reform.
There has also been considerable discussion about whether the BAT would be considered an impermissible export subsidy under the World Trade Organization (WTO) rules. Chair Brady continues to state that the BAT framework will be written in a way that is WTO-compliant, and that the US will prevail if a challenge is brought, which is likely. A WTO challenge to an American border adjustment system would take a period of time to run its course, but countervailing duties can be imposed outside the WTO in retaliation.