Washington Tax Insight March 2020
Politics and Congressional Activity
The Senate completed the impeachment trial of President Trump with an acquittal, and the Senate has now moved on to its regular agenda for the year, which includes approval of funding for the federal government for FY 2021. The Democratic caucuses and primaries are under way with Super Tuesday on March 3rd followed by other state primaries leading to the Democratic convention in July.
Although typically a Presidential election year with a divided government does not produce significant legislation, 2020 could prove otherwise with the Congress already having approved the US-Mexico-Canada Agreement (USMCA), which has been signed by the President. If Congress is unable to reach agreement on FY 2021 funding, they will likely pass a continuing resolution that would extend into a lame-duck session after the November elections. The Surface Transportation Act, which authorizes all highway and transit programs will expire on September 30th and needs to be reauthorized or extended but Congress will face an issue on how to deal with funding the Act. Other issues that may be addressed include consumer data privacy legislation, the Department of Defense Authorization legislation, prescription drug pricing, family leave legislation, and the Water Resources Development Act.
Tax Legislation in 2020
House/Ways & Means Committee: The House Ways & Means Committee held a hearing on corporate taxation and the TCJA, called “The Disappearing Corporate Income Tax.” Committee Chair Neal (D-MA) opened the hearing with a negative critique of the TCJA and criticized the Treasury Department for regulatory guidance that is arguably too generous to corporations with Democrats arguing that Treasury has mismanaged the regulatory implementation of the law. After the hearing, Chair Neal said that he intends to hold a series of hearings this year on the TCJA with a separate hearing on the international provisions.
The Committee also held a hearing entitled “Paving the Way for Funding and Financing Infrastructure Investments” on January 29, 2020. House Democrats have now released their framework for a five-year infrastructure proposal that calls for $760 billion in new spending, but it includes no specific options for offsetting the cost of the bill. The new spending recommended in the document covers highways, bridges, and mass transit, in addition to rail transportation, airport and aviation infrastructure, harbor maintenance and water resources, and broadband infrastructure.
Treasury Secretary Mnuchin testified before the Committee about the Administration’s FY 2021 budget proposal. The Committee held a hearing that focused on paid family and medical leave and a review of the 27-year old Family and Medical Leave Act, which is a law that guarantees most workers job-protected (but unpaid) leave and continued medical coverage for certain family and medical reasons. The House approved legislation, HR 4742, that would tax nicotine used in vaping, but the bill is unlikely to be considered by the Senate this year.
Senate/Senate Finance Committee: Treasury Secretary Mnuchin testified before the Committee on the Administration’s FY 2021 budget proposal. During the hearing, much of the discussion focused on the implementation of the TCJA through regulations from the Treasury Department and the IRS. Committee Democrats argued that the Treasury Department has taken an overly broad approach to drafting regulations implementing the corporate and international provisions which has resulted in $100 billion of corporate tax relief. Ranking Democrat Wyden (D-OR) has introduced legislation called the “Blocking New Corporate Tax Giveaways Act,” which would block an exemption in the proposed global intangible low-tax income (GILTI) regulations that provides an elective exemption from paying any GILTI taxes on certain income, if companies pay at least an 18.9 percent effective tax rate on that income. The legislation would clarify that high-taxed amounts are excluded from tested income for purposes of determining GILTI only if such amounts would be foreign base company income or insurance income.
Senate Democrats have pushed SFC Chair Grassley (R-IA) to hold a hearing on alternative energy issues, which are key to the issue of climate change. He has thus far not agreed to do so, citing the attempt to schedule a hearing in 2019, which was complicated by Democratic interest in expanding the electric vehicle credit.
White House: The White House released its $4.8 trillion fiscal 2021 budget package which projects declining budget deficits and a balanced budget by 2035. The package assumes an extension of the set of provisions from the TCJA that are set to expire in 2025 related to individuals, estates and passthrough businesses, which will cost $1.4 trillion. It calls for repealing several alternative energy incentives, enactment of a new program called Education Freedom Scholarships, and the expansion of certain health-care related proposals (HSAs and MSAs).
Economic advisers to the White House have proposed a new minimum tax on corporations as part of the election year “Tax Cut 2.0” package, which is designed to address criticism that the 2017 tax law has allowed some corporations to eliminate all federal taxes and to potentially raise revenue to pay for middle class tax cuts. The TCJA eliminated the corporate alternative minimum tax, while lowering the corporate tax rate from 35 percent to 21 percent. Other proposals being considered include a cap on state and local tax deductions for corporations, similar to that imposed on individuals in the TCJA, which has been controversial.
Joint Tax Committee: The Joint Committee on Taxation (JCT) issued a report in connection with the Ways & Means Committee hearing on infrastructure that provides an overview of selected provisions and options relating to funding and financing infrastructure investments. The report addresses the use of private activity bonds, new markets tax credits, and the opportunity zones incentive to fund infrastructure projects. The JCT also released a report in connection with a Ways & Means Committee hearing on the corporate income tax and the TCJA with the report addressing domestic corporations’ federal tax receipts and tax liabilities. The report summarizes present law and accounting rules regarding corporate taxation, specifically addressing behavioral responses relating to recent tax changes, including the acceleration of deductions, deferral of income, and treatment of NOLs and NOL carryovers.
Congressional Budget Office: The nonpartisan Congressional Budget Office issued a report covering the outlook for the federal budget for the next ten years, called the Budget and Economic Outlook: 2020 to 2030. The report predicts that cumulative deficits will total $13.1 trillion, which is $720 billion higher than the ten-year period included in last year’s report. The two key legislative factors contributing to the deficit increase are the Bipartisan Budget Act of 2019, which lifted the statutory caps on discretionary spending for fiscal years 2020 and 2021, and the Further Consolidated Appropriations Act, 2020, which included $400 billion in tax cuts.
Treasury and the IRS
Tax Cuts & Jobs Act (TCJA) Guidance
Treasury and the IRS have issued a significant amount of guidance on provisions of the TCJA, but there are a number of projects that remain outstanding. Treasury has said that new regulations for the TCJA will be done by the end of the fiscal year, but Chip Harter, Deputy Treasury Secretary for International Affairs, has said that Treasury and the IRS will need to continue to follow up to ensure that the international regulations are compatible with other code provisions. He suggested that regulations on Foreign-Derived Intangible Income (FDII) may be released this spring, and regulations on the Global Intangible Low-Taxed Income (GILTI) are expected this summer.
Guidance on the Repatriation Tax under Code section 965: Despite a recent announcement from the IRS that they are considering relief for some companies with respect to the repatriation tax under Code section 965, they have now stated that they do not plan to issue additional guidance. A Treasury Department official stated that they will consider relief on a case-by-case basis with the public announcement intended to encourage taxpayers to contact the IRS for consideration of their case. The issue relates to fact patterns where a company’s earnings were taxed first as dividends under the previous system and then again by the TCJA’s deemed repatriation tax. IRS officials have said that companies would need to prove that they were double-taxed, after taking into account foreign tax credits, before relief would be provided. They will also need to show that the transactions were entered into for legitimate business reasons and not to obtain a tax benefit.
Form 1118, Foreign Tax Credit for Corporations: The IRS released draft Instructions to Form 1118, Foreign Tax Credit for Corporations, to reflect the recently published final regulations. The Instructions note a change in the manner in which foreign source exchange losses are reported on Schedule A. They also state that since most domestic partnerships and S corporations are no longer required to include amounts under Code section 951A, most domestic corporations will only need to complete one line on Schedule D.
Business Meals & Entertainment Deduction under Code section 274: The IRS issued proposed regulations on the deduction for meals and entertainment expenses under Code section 274 implementing changes to the treatment of business entertainment expenses in the TCJA. The TCJA eliminated the business deduction for activities considered to be entertainment, but food and beverage expenses that can be claimed separately from business entertainment expenses still qualify for the 50% deduction. Under the statute, it was unclear when the provision of food and beverages would constitute entertainment. The legislative history of the TCJA provided that a 50% deduction for business-related food expenses should continue to be allowed. In the new guidance, those meal expenses that are indistinguishable from entertainment expenses are disallowed. The IRS provides in the proposed rules that deductible meal expenses separate from an entertainment activity must reflect the actual prices separate from the entertainment or, if those are unavailable, reflect an estimate of the reasonable value of those purchases to avoid businesses inflating the cost of food and beverages. The new guidance also explains the requirements for meal expenses to qualify for the 50% business expense deduction, stating that they must “not be lavish or extravagant under the circumstances, and the taxpayer (or an employee of the taxpayer) must be present at the furnishing of the food or beverages.” The deductible meal expense must be for a purchase between the taxpayer and someone with whom they could presumably conduct business. Finally, the rules address how the deduction can be claimed for travel expenses, clarifying a limitation on the deduction for those food and beverage purchases that occur on business travel with others, and detail how the regulations apply to other meal expenses, which are subject to the 50% limitation. The IRS plans to hold a public hearing on the proposed rules on April 7, 2020.
Opportunity Zones, Form 8996: The IRS revised Form 8996, Qualified Opportunity Fund (QOF), to reflect final regulations on the subject. Form 8996 allows corporations and partnerships to certify that they are organized to invest in qualified opportunity zone (QOZ) property and to report that the QOF meets the 90% investment standard that section 1400Z-2 imposes. The IRS also revised the Instructions to Form 8996.
Income Tax Withholding Rules under Code sections 3401 and 3402: The IRS issued proposed regulations that update and instruct employers on the amount of federal income tax to withhold from employee wages, reflecting changes made by the TCJA and the revised 2020 Form W-4. The new guidance aligns with the withholding system in effect for 2019 and 2020 and can be used by employers for withholding until the regulations are finalized.
Rules on Value of Personal Use of Employer Vehicles: The IRS issued final regulations for determining the maximum value of a vehicle for use with the fleet-average and vehicle cents-per-mile valuation rules reflecting changes made by the TCJA and aligning with changes made by the TCJA to the depreciation limitations in Code section 280F. The IRS states that “consistent with the substantial increase in the dollar limitations on depreciation deductions under Code section 280F(a), these final regulations increase, effective for the 2018 calendar year, the maximum base fair market value of a vehicle for use of the 13 fleet-average or vehicle cents-per-mile valuation rule to $50,000.” Under Code section 280F(d)(7), the fair market value of a vehicle for purposes of the fleet-average and vehicle cents-per-mile valuation rules will continue to be adjusted annually for inflation.
Gift & Estate Taxes: The IRS published final regulations correcting Treasury Decision 9884, which addressed the effect of recent legislative changes to the basic exclusion amount allowable in computing federal gift and estate taxes. These regulations affect donors of gifts made after 2017 and the estates of decedents dying after 2017.
Other Issues and Guidance
Carbon Sequestration Credit under Code section 45Q: The IRS issued Notice 2020-12 and Revenue Procedure 2020-12 related to the carbon sequestration credit under Code section 45Q. Notice 2020-12 clarifies the definition of “beginning of construction” for purposes of the sequestration credit under Code section 45Q. It provides broad guidance to help businesses determine when construction has started on a qualified facility or on carbon capture equipment. The IRS also issued Revenue Procedure 2020-12, which provides a safe harbor for partnerships to allocate the carbon oxide sequestration, which simplified the rules for partnerships that can claim the credit. The IRS states that, “The safe harbor is similar to those developed for partnerships receiving the wind energy production tax credit and the rehabilitation credit.” The IRS also stated that it plans to issue additional guidance “on issues ranging from secure geological storage to utilization to recapture of the credit.” Treasury Secretary Mnuchin testified in the recent Senate Finance hearing that he has directed the forthcoming guidance to be issued in March rather than April.
OECD – Adoption of a Global Minimum Tax & Digital Taxation
The OECD continues its work on establishing new rules to identify where taxes on multinationals should be paid (nexus rules) and on what portion of profits these entities should be taxed (profit allocation rules) under Pillar One. The goal is to ensure that multinational enterprises (MNEs) conducting ongoing and significant business in places where they may not have a physical presence can be taxed in those jurisdictions.
Following a 2-day meeting of the Inclusive Framework on BEPS, the OECD announced that the group had agreed to move forward on the “Unified Approach” to Pillar One, which deals with the reallocation of tax rights with some revisions made at the meeting and some key decisions made on outstanding issues. In a statement from the group, the OECD has acknowledged there are disagreements between the participants in the project including the US about key issues in the project, but the parties have publicly recommitted to finding a solution by the target date of the end of 2020.
The OECD “Statement on the Two-Pillar Approach to Address the Tax Challenges Arising From the Digitalisation of the Economy” seeks to reaffirm the commitment of OECD members “to reach a consensus-based long-term solution to the tax challenges arising from the digitalization of the economy, and will continue working toward an agreement by the end of 2020.” The Statement also takes note of a December proposal put forward by the US to implement Pillar One on a “safe harbor basis” while acknowledging concerns with this approach. “The Statement also highlights other critical policy issues that must be agreed under Pillar One before a decision can be taken,” the OECD stated. “The ‘safe harbour’ issue is included in the list of remaining work, but a final decision on this issue will be deferred until the architecture of Pillar One has been agreed upon.”
The OECD also released an analysis of its two-pillar approach finding that it would raise an additional $100 billion in tax revenue for participating OECD countries. Their analysis covered data from 200 countries and 27,000 MNEs and found that the new proposed Pillar Two rules could raise a significant amount of additional tax revenue. The report stated that by reducing the tax rate differentials between jurisdictions, the reform is expected to lead to a significant reduction in profit shifting by MNEs, suggesting that this would be important for developing economies as they tend to be more adversely affected by profit shifting than high-income economies.
The UK & Brexit
The UK and the EU are hoping to reach agreement on their relationship going forward by the end of the year with the UK still subject to EU laws until then, but with no ability to participate in EU decisions. The European Commission issued a memorandum to the Council of the European Union to launch the effort to reach a deal between the UK and the EU on trade and tax issues as a result of the UK leaving the EU on January 31, 2020. The document states that the EU wants the UK to continue to apply the bloc’s standards on the exchange of information on income, financial accounts, tax rulings, and other areas as part of a future relationship, thereby maintaining international standards on preventing tax avoidance and evasion. The document provided that a deal should ensure that the UK “applies the common standards applicable within the union and the United Kingdom at the end of the transition period in relation to the fight against tax avoidance practices and public country-by-country reporting by credit institutions and investment firms.” It should also reaffirm a shared commitment “to curb harmful tax measures” and consider a plan of action agreed on by the Group of 20 nations and the OECD, of which the UK is still a member. Finally, the document provided that “the envisaged agreement should uphold the common high standards in the areas of state aid, competition, state-owned enterprises, social and employment standards, environmental standards, climate change, and relevant tax matters.”
The OECD issued new guidance that covers transfer pricing for financial transactions for the first time. The rules are part of the OECD BEPS global tax compliance initiative. The guidance is intended to support consistency in the application of the arm’s length principle and minimize transfer pricing disputes and double tax. The report is intended to offer guidance to extend the arm’s length principle to intragroup loans, hedging, captive insurance and other financial dealings, requiring that a multinational and its subsidiaries should price their internal transactions the same way unrelated companies would. It includes examples to illustrate the transfer pricing issues discussed and is subdivided into five major sections: (1) Treasury function; (2) Financial guarantees; (3) Captive insurance; (4) Risk-free and risk-adjusted rates of return; and (5) Interaction with the guidance in Section D.1 of Chapter I. Draft rules in this area had been issued in 2017 under several Actions of the BEPS project, and the OECD collected public comments, which the OECD has taken into account.
An OECD official has publicly commented that the OECD is looking for alternatives to binding dispute resolution in order to allay the concerns of some countries about a potential loss of sovereignty with processes such as mandatory binding arbitration. A process for resolving disputes is a key part of the OECD’s BEPS project to update the international tax system.
The OECD invited public input on a draft policy document on the use of country-by-country (CbC) reports by tax administrations for assessing transfer pricing and related high-level risks and for economic and statistical analysis. Input is due by March 6th. The consultation meeting will take place on March 17, 2020. Action 13 of the BEPS project established a three-tiered standardized approach to transfer pricing documentation, including a CbC report that provides details of an MNE group’s profit before tax, tax accrued and other information relevant to a high level risk assessment, for each tax jurisdiction in which the MNE group has a constituent entity. Country-by-Country reporting is one of four BEPS minimum standards which all members of the Inclusive Framework on BEPS are committed to implementing.
The European Union updated its blacklist of uncooperative tax jurisdictions to include the Cayman Islands, Palau, Seychelles, and Panama. The total number of jurisdictions on the list is 12 with the others being American Samoa, Fiji, Guam, Samoa, Oman, Trinidad and Tobago, Vanuatu, and the US Virgin Islands. Being included on the EU’s blacklist causes reputational damage to a jurisdiction, makes access to EU funding harder for countries, and can put at risk tax benefits that EU companies have when doing business in listed countries. Under the current system, EU countries consider the blacklist to be part of their external relations strategy, focusing only on non-EU countries. The Code of Conduct group, which is a separate EU committee, assesses the tax policy of EU countries.