Washington Tax Insight May 2020
Politics and Congressional Activity
The COVID-19 crisis continues to be the focus for the agenda of Congress and the Administration with efforts to deal with both the public health crisis and the economic crisis. Congress has now enacted four pieces of legislation aimed at addressing the health and economic impacts of the pandemic, and additional legislation is expected this year.
The Senate returned to work in Washington on May 4th as scheduled. Senate Majority Leader McConnell (R-KY) has been clear in public statements that he does not favor allowing proxy voting believing that Members need to be present to work on legislation and judicial confirmations.
The House was scheduled to return to Washington for work on May 4th, but leadership decided not to do so based on the advice of the House Physician, because the number of virus cases in the District of Columbia continues to rise. They are scheduled to return on May 11th. House Majority Leader Hoyer (D-MD) said that he will continue to discuss with Republican leaders the issue of how House committees can meet if Members are not in Washington so as not to hold up the consideration of legislation.
Presidential Election Update: Former Vice President Joe Biden is expected to be the Democratic nominee for President after gaining enough convention delegates in several Presidential primaries to be presumed the eventual winner of the nomination. The other remaining candidates have withdrawn from the race and have endorsed Biden. At this time, both parties have indicated that they intend to hold their party conventions as planned, but it is possible those plans could change due to the COVID-19 crisis. One of the key issues under debate at this time is whether to allow voting by mail for all voters in the November elections, a decision that would be made by the individual states.
Government Response to COVID-19, the Coronavirus Pandemic
In response to the COVID-19 crisis, government officials in Washington DC have taken a number of actions related to the economic effects of the crisis including legislation, regulatory action, and government agency action.
As summarized in past True Alerts (Tax Issues Addressed by COVID-19 Emergency Legislation; Congressional Action on the COVID-19 Pandemic: The CARES Act; New Funding for the PPP, New IRS Guidance & Prospects for a 4th Phase of Federal Economic Relief), Congress has passed four major pieces of legislation to provide economic relief to the US economy and US taxpayers.
The most recent legislation provides additional funding for the Paycheck Protection Program (PPP) and the Economic Injury Disaster Loan Program (EIDL). No tax provisions are included in the legislation, and the legislation does not include any new funding for state and local governments, which is a key priority for Democrats.
House Speaker Pelosi (D-CA) has made it clear since the CARES Act passed that House Democrats want to work on additional legislation (CARES 2) to include various stimulus items that were not included in the already enacted legislation, while also emphasizing that Congress needs to ensure that the funds in the CARES Act are being appropriately directed to states, cities, and small businesses. House and Senate Republicans have voiced their interest in additional legislation, but they have indicated that they want to see the CARES Act fully implemented first. Senate Majority Leader McConnell (R-KY) has said that he believes the next bill should focus on healthcare needs and addressing any shortcomings of the CARES Act, and he also stated after Senate approval of the most recent legislation that he will not agree to approving the next bill by unanimous consent in the Senate.
One of the most contentious issues to be dealt with in the CARES 2 bill will be whether additional aid should be directed to state and local governments with some Republicans voicing concern about the level of federal spending on the crisis legislation and the federal deficit. Democrats will make this issue the centerpiece of any bill, and although McConnell has indicated public reluctance on this issue, it is expected that he will agree to additional relief in return for Republican priorities, such as workplace liability limitations. Reportedly, Democrats will also want to revisit the issues of direct payments to individuals and unemployment insurance.
White House officials have discussed some of their own ideas for new recovery proposals including a payroll tax cut, tax incentives for restaurants, entertainment, and sports, infrastructure, fiscal aid to state and local governments, and insurance liability protections.
The bills already enacted were bipartisan efforts driven by the need to address the COVID-19 crisis quickly with the Speaker describing them as emergency and mitigation legislation. The CARES 2 bill may be the subject of a more traditional partisan debate in both the House and the Senate and represent a “recovery” effort. The power players who will negotiate this next package of relief will be the President, Treasury Secretary Mnuchin, House Speaker Pelosi, and Senate Majority Leader McConnell.
It is expected that House Democrats will want to move quickly on the next piece of legislation, and that they could act as soon as the week of May 11th when they are scheduled to return to Washington. The general consensus is that there will be additional legislation at some point, but that the resistance from Republicans to moving quickly makes the timeline uncertain. Two factors affecting the timing and the substance of the package will be whether and when the economy starts to recover and the impending November elections with both parties trying to assess the best way forward from a political standpoint.
Tax Issues: Both parties are considering additional tax proposals to give relief to small businesses covering issues such as expediting tax refunds, easing IRS deadlines, and providing incentives to cover basic needs like rent and mortgage payments. Many members have said they want to see how some of the already enacted incentives like the Employee Retention Tax Credit are working before they move ahead on other ideas. The next bill could possibly become a vehicle for dozens of individual and business tax provisions that expire in 2020 including credits for craft alcoholic beverages, electric vehicles, coal production and carbon sequestration, although these issues are unrelated to the COVID-19 issues. Democrats may want to reconsider one tax provision in the CARES Act that loosened rules for pass-throughs with respect to net operating losses (NOLs), because of the data that shows that the benefit of this provision largely goes to wealthy taxpayers.
The House voted to establish a new bipartisan select subcommittee charged with overseeing implementation of coronavirus relief legislation, but the House Democratic leadership postponed a planned vote on a proposal that would have changed House rules to allow for remote voting by proxy. A bipartisan task force has been convened to review remote voting by proxy and reopening the House with the goal of getting more buy-in from Members.
Treasury and the IRS
Tax Cuts & Jobs Act (TCJA) Guidance
Hybrid Transactions/Code § 245A(e) & § 267A: The IRS issued two sets of regulations (final and proposed) regarding hybrid transactions under § 245A(e) and § 267A. These anti-hybrid rules were included in the TCJA and generally operate to deny US tax deductions in certain cases involving entities and payments of interest, royalties, or dividends, if such entities or payments are treated differently under US and foreign tax laws and such different treatment results in double non-taxation. The IRS guidance states, “Hybrid arrangements can be ‘hybrid entities,’ in which a taxpayer is treated as a flow-through or disregarded entity in one country but as a corporation in another, or ‘hybrid instruments,’ which are financial transactions that are treated as debt in one country and as equity in another.”
The final regulations give guidance on determining and tracking hybrid dividends and the deductibility of interest or royalties paid as a result of hybrid or branch arrangements. The rules also cover dual consolidated losses and entity classifications to prevent the same deduction from being claimed under the tax law of both the US and a foreign jurisdiction. Finally, they mandate reporting for the administration of certain rules in the final regulations.
The proposed regulations adjust hybrid deduction accounts to take into account earnings and profits of a controlled foreign corporation that are included in income by a US shareholder. The rules address, for purposes of the conduit financing rules, arrangements involving equity interests that give rise to deductions (or similar benefits) under foreign law. The guidance also covers the treatment of certain payments under the global intangible low-taxed income (GILTI) provisions.
IRC § 965 Transition Tax: The Large Business & International (LB&I) Division of the IRS added a new compliance campaign on the § 965 Transition Tax, led by John Hinding, Director of Cross Border Activities. The IRS description states: Section 965 requires United States shareholders to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. Taxpayers may elect to pay the transition tax in installments over an eight-year period. For some taxpayers, some or all of the tax will be due on their 2017 income tax return. The tax is payable as of the due date of the return (without extensions).
The IRS issued a new set of FAQs on net operating losses (NOLs) filed by taxpayers with inclusions under § 965, which discuss the impact of changes made by the CARES Act to the NOL rules including allowing losses to be carried back for up to five years for tax years beginning after December 31, 2017 and before January 1, 2021 (covered period). The IRS explained that taxpayers may elect under § 172(b)(3) to waive the carryback period for NOLs arising during the covered period, or, in lieu of that election, taxpayers may make an election under § 172(b)(1)(D)(v)(I) to exclude tax years in which they have a § 965(a) inclusions (§ 965 years) from the carryback period. The IRS also issued Revenue Procedure 2020-24 and a set of FAQs for filing Forms 1139 and 1045 that explain the procedure for the elections.
COVID-19 Crisis Guidance & Related Issues
Employee Retention Credit FAQs: The IRS has updated and expanded its FAQs on the new Employee Retention Credit, which is a refundable tax credit to eligible employers for certain employment taxes equal to 50 percent of up to $10,000 in qualified wages paid to employees effective from March 12, 2020, through December 31, 2020. The updated FAQs now include nearly 100 questions on a number of major issue areas including which employers are eligible for the credit and the determination of qualified wages. The IRS states that its FAQs are “not included in the Internal Revenue Bulletin, and therefore may not be relied upon as legal authority. This means that the information cannot be used to support a legal argument in a court case.”
Refund Claims/IRS and the Joint Tax Committee: Doug O’Donnell, the Commissioner of the LB&I Division, has said that the IRS is working with the Joint Committee on Taxation (JCT) to develop a streamlined process for dealing with refund applications from taxpayers that will need review by Congress. The IRS must submit reports to the JCT when it issues refunds of more than $2 million for individual taxpayers or $5 million for corporations. Typically, this is a routine task, but with the economic impacts of COVID-19 and the changes to the NOL rules, the IRS expects an increase in refund requests.
Electronic Requests for PLRs and Other Advice: The IRS issued Revenue Procedure 2020-29, which permits and instructs taxpayers on the electronic submission of requests for private letter rulings (PLRs) and other advice from the Associate Chief Counsel Offices and the LB&I Division. The guidance temporarily allows for the electronic submission of requests for letter rulings, closing agreements, determination letters, and information letters. It includes certain security requirements for electronic signatures and a declaration that must be signed and submitted acknowledging the risks inherent in sending confidential information via email. The IRS stated that it will continue to accept advice requests sent by regular mail and private delivery but advised that staffing restraints are likely to cause processing delays for paper submissions.
Suspension of FTC Carryback Rulings/NOL Changes in CARES Act: On April 17th, the IRS issued Revenue Ruling 2020-08, which suspends Revenue Ruling 71-533, while it determines whether the 10-year limit under IRC § 6511(d)(3)(A) “applies to claims for refund or credit of an overpayment resulting from a foreign tax credit (FTC) carryback arising as a result of a net operating loss (NOL) carryback from a subsequent year.” The IRS is also reconsidering Revenue Ruling 68-150. The suspensions will not be applied adversely against taxpayers filing claims in accordance with the rulings during this time. Revenue Ruling 71-533 involved the application of § 6511(d)(3)(A) to certain refund and credit claims for overpayments related to foreign tax credit (FTC) carrybacks and carryforwards that arise due to an NOL carryback from a subsequent year. § 6511(D)(3)(A) grants a 10-year limitation period for refund or credit claims related to overpayments attributable to taxes that qualify for § 901 FTCs.
FATCA: The IRS issued guidance extending the due date for certifications under the Foreign Account Tax Compliance Act (FATCA) due to impacts from the COVID-19 crisis by adding Question 21 on the FATCA Certification FAQ page. The guidance states that an automatic extension of time will be granted for an entity with an original certification due date of July 1, 2020, which is now due December 15, 2020.
Other Issues and Guidance
FAQs on Transfer Pricing Documentation: The IRS issued a set of FAQs on transfer pricing documentation best practices. The guidance follows a 2018 Directive issued by the LB&I Division to its employees on the appropriate application of penalties in certain transfer pricing examinations. The FAQs also respond to a 2018 IRS Advisory Council recommendation that the IRS do more to encourage higher quality transfer pricing documentation. The FAQs provide guidance on questions including the benefit of robust transfer pricing documentation, the guiding principles of an arm’s-length analysis, and areas in which the IRS believes taxpayers could do a better job of documenting their methods and analyses. The IRS guidance suggests that if taxpayers improve the quality of their documentation, the IRS will be able to dismiss transfer pricing issues earlier in an examination cycle.
LB&I Compliance Campaigns: The LB&I Division of the IRS has added several new compliance campaigns, including one on the § 965 Transition Tax (see discussion above). The compliance campaigns are part of the IRS initiative to move toward issue-based examinations with “a process in which the organization decides which compliance issues that present risk require a response in the form of one or multiple treatment streams to achieve compliance objectives.” The other compliance campaigns are:
- Nonresident Alien Tax Treaty Exemptions
- Swiss Bank Program Campaign
- Syndicated Conservation Easement Transactions
- US Territories – Erroneous Refundable Credits
Unrelated Business Income Tax: The IRS issued proposed regulations under IRC § 511 that instruct exempt organizations subject to tax on their unrelated business taxable income (UBTI) on how to determine if they have more than one unrelated trade or business and on calculating their UBTI. This guidance also clarifies that inclusions of subpart F income and GILTI are treated in the same manner as dividends for purposes of § 512(b)(1).
Tax-Deferred Spinoff Private Letter Ruling: The IRS issued its first private letter ruling, PLR 202009002, approving a tax-deferred spinoff of a non-income collecting trade or business, which appears to recognize that an active trade or business can exist without producing income. The IRS had indicated the intent to move in this direction with Revenue Ruling 2019-9, which revoked two prior revenue rulings that required income collection for a spinoff. The IRS also made a statement in September of 2018 that it was studying whether significant research and development activities could remove the need for income collection prior to spinoffs.
APA Program Report: The IRS has published its 21st annual report on advance pricing agreements (APAs) and the Advance Pricing and Mutual Agreement Program (APMA). The report shows a significant decline in the number of APA applications in 2019 as compared to 2018, although in 2018, the number of applications hit a near-record high. The IRS finalized 120 APAs out of 208 requests in 2019 with the IRS noting that the most transactions covered involved the sales of tangible goods or services, while as of December 31, 2019, a backlog of 454 applications was reported.
Publication 946 – How to Depreciate Property: The IRS updated Publication 946, “How to Depreciate Property,” for use in preparing 2019 tax returns. The updated publication notes the dollar amount in effect for IRC § 179 expensing and the retroactive extension for 2019 and the expiration of certain depreciation at the end of 2020.
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.
G20 Finance Ministers and central bank governors, in a communique issued following their mid-April virtual meeting, said that they will continue their work on reaching a global agreement on the tax aspects of the digital economy despite the impacts of the COVID-19 crisis. The Chair’s summary released after the meeting stated that the ministers would resume their work once the COVID-19 crisis diminishes.
The next full Inclusive Framework meeting is scheduled for July, when the goal is for countries to sign off on a complete political agreement covering Pillars One and Two, with the OECD then to deliver their report to the G20 leaders at their November meeting. Thereafter, an implementation package would be prepared but likely not ready until 2021 at the earliest, with the package covering the process for countries to enact implementing legislation and the revision of multilateral instruments.
While speaking at a recent virtual conference, Pascal Saint-Amans, the OECD Director of the Centre for Tax Policy and Administration, stated that the OECD is still on course to complete its work by the end of the year despite the pandemic as the goal of reaching agreement remains a priority for world leaders, but he did say that the OECD would not begin any new projects during the pandemic. The OECD report, which was presented to the G20 Finance Ministers’ meeting, stated that efforts to ensure that digital companies are taxed fairly and to establish a minimum tax rate will now be more important after the pandemic, because countries will be looking to rebalance their tax burdens in the wake of the economic impact of the COVID-19 pandemic. In light of the economic impacts of the pandemic and the fact that many companies may be less profitable, however, the issue of economic losses becomes more important and must be accounted for in the new system – a complication that some believe has not been properly addressed to date.
Others, however, believe that negotiations may need to be extended due to the complications arising from the pandemic and the fact that the major players continue to be somewhat at odds over how a global tax deal should be structured. The timeline envisions that the parameters of a deal will be established by July in order to work out the details by the end of 2020. Without a deal, there is the threat of trade issues between the US and France over the French unilateral digital tax that is currently on hold. A number of other countries have approved unilateral digital taxes that have either come into force or will be effective in the near future.
European Union: Paolo Gentiloni, the EU’s Taxation Commissioner, has said that the EU will pursue an agreement among the EU countries on digital taxation if the OECD effort fails to produce a global agreement. Although the EU countries failed to reach an agreement in the past, he said he would urge the countries to put aside their differences and work together on a common economic plan that should include digital taxation and minimum taxation. Gentiloni sent a letter in response to a written question from a member of the Parliament stating that the European Commission (EC) strongly believes that a global deal on digital taxes is preferable to countries’ acting on their own and that the EC is actively engaged in the work being done at the OECD. He added that the EC would have to ensure that any global agreement reached could be enacted in line with EU law. Gentiloni is also the EU’s Economics Commissioner in charge of managing the EU discussion about possible approaches for a common EU response to rebuilding Europe’s economy after the pandemic.
The UK: The UK Treasury has said that it has no plans to suspend its digital services tax in light of the COVID-19 crisis despite requests to do so from trade groups representing digital companies. The tax came into effect on April 1st, and draft guidance was released as part of the Finance Bill.
The OECD has provided a significant amount of information related to tax issues and the COVID-19 crisis that is available on its website. The OECD Forum on Tax Administration, in collaboration with CIAT (Inter-American Center for Tax Administrations) and IOTA (Intra-European Organization of Tax Administrations), has published critical business continuity considerations for tax administrations in the context of the COVID-19 pandemic. They have also issued a unique dataset of country tax policy measures taken worldwide by governments in response to the pandemic, covering over 100 countries, with regular updates provided. The OECD is working on recommendations for businesses, taxpayers, and tax administrations on the taxation of cross-border workers due to the COVID-19 crisis.
US-Mexico-Canada Agreement & Tax Treaties
The Canadian Parliament has approved the United State-Mexico-Canada Agreement (USMCA), which will replace the North American Free Trade Agreement (NAFTA). The USMCA is expected to enter into force in the coming months, but the implementation date remains unclear. Once the agreement enters into force, certain subsidiaries of some US, Canadian, and Mexican-parented companies may no longer be eligible for tax treaty benefits. The USMCA may have implications for companies claiming US tax treaty benefits under the derivative benefits test of a treaty’s Limitation on Benefits (LOB) article. The language in these articles typically uses the term “qualifying person” which is generally defined with reference to the person being a resident of a country that is a party to NAFTA or a member state of the European Union. Reportedly, the IRS and Treasury are considering addressing the issue by unilateral action, including clarifying that references to NAFTA in existing US income tax treaties are to be interpreted as including the USMCA.