Washington Tax Insight November 2019
Politics and Congressional Activity
The House and Senate both passed a continuing resolution (CR) that extends government spending authority through November 21st, thereby averting a government shutdown at the end of September. The House has approved a number of the annual appropriations bills, but they were developed prior to the passage of the Bipartisan Budget Act of 2019 (BBA) (enacted on August 2nd), which lifted the statutory caps on discretionary spending and suspended the statutory debt limit until mid-2021. The Senate is scheduled to consider an appropriations package, but it will be challenging to reach agreement between the two chambers on the appropriations bills by the new deadline. The CR does not include any permanent tax changes, e.g. tax extenders.
Now that Congress is back in session, there are 6 weeks remaining on the legislative calendar in 2019 for work to be completed on the spending bills as well as issues such as gun safety and regulation, prescription drug pricing, trade, and the House impeachment inquiry and possible trial in the Senate. Speaker of the House Nancy Pelosi and Senate Majority Leader McConnell are considered to both be experienced dealmakers, but tensions between the two bodies have increased in the context of the House impeachment proceedings, with the government funding issue looming as a critical issue that the two leaders must resolve – either with approval of legislation for the new fiscal year or another short-term funding proposal that would take the issue into January.
The fate of tax issues including the tax extenders, technical corrections, and retirement legislation is unclear, but it is difficult to see how these issues advance by the end of the year, unless they are attached to must-pass legislation, such as the spending package. Both Ways & Means Committee Chair Neal (D-MA) and Senate Finance Committee Chair Grassley (R-IA) have said that they continue to believe that it will be possible to reach agreement on these tax issues in 2019, although neither has been specific about what legislative vehicle could be used for tax bills.
Congress & The White House
House/Ways & Means Committee: The Ways & Means Committee approved several bills on drug pricing, vaping, and health policy. The Committee approved the Lower Drug Costs Now Act, which would impose an excise tax on drug manufacturers that do not participate in a proposed mandatory federal program to negotiate maximum prices for certain prescription drugs. The timing for Floor action is unclear, with Senate Majority Leader McConnell stating that he will not take up the bill on the Senate Floor this year. The Committee also approved the Protecting American Lungs Act, which would impose an excise tax on vape devices that is equivalent to the $1.01 federal tax on cigarette packs. This bill would raise $9.9 billion over a 10-year period with the revenue used to offset the cost of several other health-related bills that the Committee approved related to various tax-preferred health care savings vehicles. House Floor action is not yet scheduled. There is support for similar legislation in the Senate from Ranking Democrat Wyden (D-OR) and possibly SFC Chair Grassley (R-IA), although the latter has not said he agrees with using the tax code.
The House approved the Corporate Transparency Act, which would require corporations to disclose the identities of their beneficial owners in an effort to disclose information on anonymous shell corporations and address illicit money laundering and tax evasion. The bill would require US companies to report the names, dates of birth, passport or driver’s license numbers and current addresses of those who receive gains from company profits to the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN).
A bipartisan group of Committee members met with civic leaders to discuss the impact of the new Opportunity Zone program on their communities and whether the anticipated economic development has, in fact, occurred.
Senate/Senate Finance Committee: The Senate is scheduled to vote on a package of appropriations bills to fund federal agencies including the Commerce Department, the Justice Department, NASA, the Department of Agriculture, FDA, the Department of Interior, the Environmental Protection Agency, the Department of Veterans Affairs, the Department of Transportation, and the Department of Housing and Urban Development.
On October 23rd by a vote of 43-52, the Senate failed to approve legislation that would have rescinded IRS regulations to implement the cap on state and local tax deductions (SALT) that was enacted as part of the TCJA. In the House, Ways & Means Democrats have been discussing legislation that would repeal the SALT deduction cap, but the Senate action would signal there is little chance this issue would advance this year.
The White House: Administration officials continue to comment publicly on issues that could be included in a Tax Reform 2.0 package, including the Director of the Economic Council, Lawrence Kudlow, who recently discussed changes to the number of tax brackets for individuals. Other ideas that are frequently cited as possible inclusions are the permanent extension of some temporary provisions in the TCJA, such as the individual provisions, and indexing of capital gains.
Tax Extenders: There continues to be no clear plan for consideration of the tax extenders with supporters hoping that the government spending bill with its November 21st deadline date could be a possible vehicle for these tax provisions. Bipartisan Senate legislation has not yet been considered in the Senate Finance Committee, while the Ways & Means Committee-approved legislation has not moved to the House Floor. Two bills dealing with specific extenders were placed on the “consensus calendar” ensuring action on the House Floor by the end of the year without prior approval from the Ways & Means Committee, specifically incentives for short-line railroads (Code section 45G credit) and legislation for craft beer, wine, and distilled spirits (excise tax reduction due to expire after 2019). Similar bills are pending in the Senate, but that body does not have a process similar to the “consensus calendar” so committee action will be necessary. Green energy tax incentives also continue to be discussed in the House, but a Committee markup is looking unlikely as Congress nears the end of this Session.
Treasury and the IRS
Tax Cuts & Jobs Act (TCJA) Guidance
Stock Attribution for Controlled Foreign Corporations (CFCs): The IRS issued proposed rules on stock attribution that address modifications to Code section 958(b) made by the TCJA including repeal of Code section 958(b)(4). Code section 958 provides rules for determining direct, indirect, and constructive stock ownership. Generally, the proposed changes aim to make the operation of certain rules consistent with their application before the TCJA was enacted. The rulemaking also provides relief concerning the effect of the repeal of Code section 958(b)(4) on the application of subpart F. The proposed rules address the interaction with Code sections 267, 332, 367(a), 672, 706, 863, 904, 958, 1297, and 6049. In conjunction with this rulemaking, the IRS issued Revenue Procedure 2019-40, which provides additional guidance on the repeal of Code section 958(b)(4), penalties under Code sections 6038 and 6662, modified filing requirements for Form 5471 (Information Return of US Persons with Respect to Certain Foreign Corporations), and examples to illustrate the rules described in the guidance.
Code Section 199A Deduction – Safe Harbor for Rental Real Estate Enterprises: The IRS issued Revenue Procedure 2019-38 creating a safe harbor for a rental real estate enterprise to be treated as a trade or business under Code section 199A, which thereby allows these taxpayers to use the 20 percent deduction for certain qualified business income. The guidance defines a “rental real estate enterprise” as an interest in real property held to generate rental or lease income that may include an interest in one property or interests in multiple properties. The taxpayer must hold each interest directly or through an entity disregarded as an entity separate from its owner. The guidance includes several requirements that must be met to qualify for the safe harbor.
Base Erosion and Anti-Abuse Tax (BEAT) Regulations: During a recent panel discussion, the IRS Associate Chief Counsel (International), Peter Blessing, commented that he does not expect to see major changes in the anti-abuse rules included in the proposed BEAT regulations, although he did suggest that an additional category might be added. The proposed rules address three specific categories of transactions involving “intermediaries acting as a conduit to avoid a base erosion payment,” transactions designed to increase the deductions accounted for in the base erosion percentage denominator, and related-party transactions designed to avoid the application of rules concerning banks and registered securities dealers.
Global Intangible Low-Taxed Income (GILTI) Rules: At a recent tax conference, Russell Jones, Special Counsel to the IRS Associate Chief Counsel, stated that taxpayers cannot rely on the basis adjustment rules that were included in the proposed regulations. Final regulations were issued in June, but the IRS didn’t adopt the proposed general basis adjustment rule for tested loss controlled foreign corporations under Code section 961 or the Code section 1502 consolidated group stock basis adjustment rules. The preamble to the final rules expressly stated that taxpayers could not rely on the adjustment for consolidated groups rule, but the failure to mention the other rules did not mean that they could be utilized.
Other Issues and Guidance
Expiring Debt Equity Rules and Corporate Inversions
Debt equity regulations were issued in 2016 to discourage corporate inversions, whereby a US corporation reincorporates offshore primarily for tax purposes. Possible changes to these rules are reportedly connected to TCJA changes, which were intended to reduce incentives for companies to invert. The IRS issued Notice 2019-58, informing taxpayers that its 2016 debt equity temporary regulations under Code section 385 would expire on October 13th. The temporary regulations relate to certain aspects of the related party debt-equity, including exceptions for qualified short-term debt obligations and consolidated groups. The guidance explains that taxpayers may rely on the notice of proposed rulemaking cross-referencing the temporary regulations “until further notice is given, provided that the taxpayer consistently applies the rules in the 2016 Proposed Regulations in their entirety.” A letter dated October 18th from thirteen Senate Democrats was sent to Treasury Secretary Mnuchin opposing any action by Treasury to weaken or eliminate the Treasury Department regulations that they believe have been effective in reducing the number of corporate inversions.
In a related action, the Treasury Department sent to the Office Management and Budget (OMB) for review a piece of guidance under Code section 385, described as a “pre-rule”, and that document has now been cleared by OMB but not released publicly. Although the details of this pre-rule have not been made public, some reports say that the IRS may seek to curtail its current Code section 385 regulations or replace them entirely with a revised rule. Speculation is that this “pre-rule” will preview proposed Code section 385 rules and request taxpayer input on concerns with the rules.
IRS Priority Guidance Plan: The IRS issued a new priority guidance plan that lists 203 projects of focus for 2019-2020. The Plan continues to prioritize TCJA projects with 50 related projects. In addition, the Plan includes projects related to the IRS reform bill and the implementation of the partnership audit reforms.
Virtual Currency Transactions: The IRS issued Revenue Ruling 2019-24 and a set of FAQs as a supplement to Notice 2014-21 on taxpayer reporting obligations for specific transactions involving virtual currency (“cryptocurrency”). The revenue ruling addresses two issues related to the determination of gross income under Code section 61 for “hard forks of a cryptocurrency.” The IRS said that some taxpayers with virtual currency transactions have failed to report income or transactions properly and failed to pay the correct tax on the transactions, so the IRS is policing non-compliance through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.
Allocating Partnership Liabilities: The IRS released final regulations under Code section 752 on allocating partnership liabilities among partners. The rulemaking addresses when certain obligations to restore a deficit balance in a partner’s capital account are disregarded under Code section 704, when partnership liabilities are treated as recourse liabilities under Code section 752, and how bottom dollar payment obligations are treated under Code section 752. The IRS also issued final regulations to instruct how partnership liabilities are allocated for disguised sale purposes. The regulations replace temporary regulations, and the IRS notes that it continues to study different approaches for determining the appropriate treatment of liabilities in the context of disguised sales.
Interbank Offered Rates: The IRS issued proposed regulations to transition to reference rates other than interbank offered rates (IBORs) in debt instruments and non-debt contracts. In general, the rules clarify that the modification of contracts to reflect changes described in the new rules will not trigger capital gains tax under Code section 1001 if certain conditions are met.
Adoption of a Global Minimum Tax & Digital Taxation
The OECD continues to work on a plan to tax digital commerce as part of the BEPS initiative along with a general discussion of global tax rules. The G20 leaders endorsed the plan developed by the Inclusive Framework on BEPS with the goal of a final report by the end of 2020.
Program of Work
Pillar 1: On October 9th, the OECD released a public consultation document on the Secretariat’s proposal for a “unified approach” under Pillar 1. Pillar 1 focuses on revising the allocation of taxing rights among countries, including new approaches to nexus (permanent establishment) issues and the arm’s length principle. Stakeholders are invited to submit comments by November 12th, and a public consultation will take place on November 21-22. The proposal was prepared by the Secretariat and does not reflect a consensus of members of the Inclusive Framework.
This proposal would revise nexus and profit allocation rules with the result that global companies “pay tax wherever they have significant consumer-facing activities and generate their profits” — departing from the physical-presence approach to nexus and proposing a formulary tax approach that departs from the arm’s-length standard.
In the past, the OECD has suggested 3 possible approaches to income allocation for income generated from cross-border activities: (1) a user-participation approach which would tax businesses in jurisdictions where their users are located, regardless of the company’s physical presence; (2) a marketing-intangibles approach which would tax businesses in the jurisdictions where they reach consumers or users; and (3) a significant economic-presence approach which would determine nexus based on the location of a business’s revenue sources. This “unified approach” is an attempt to combine these approaches into a tax regime that works for affected companies.
There would likely be a number of technical issues related to implementing this approach, and the OECD has asked for comments on several questions including: (1) whether there should be additional business carveouts; (2) how the unified approach should relieve companies from double taxation “on an individual-entity and individual-country basis;” (3) how to define amounts outlined in the calculations in the new tax regime; (4) the possible segmentation of business lines; (5) the treatment of losses; and (6) the sourcing of sales. Implementation would likely require a multilateral convention to ensure simultaneous adoption among countries according to Pascal Saint-Amans, who is the Director of the OECD’s Centre for Tax Policy and Administration.
Pillar 2: In an OECD document titled “General Tax Report to G20 Finance Ministers and Central Bank Governors,” the OECD reported on its work on Pillar 2. Under Pillar 2, the OECD aims to find an approach “that leaves jurisdictions free to determine their own tax system, including whether they have a corporate income tax and where they set their tax rates, but considers the right of other jurisdictions to apply the rules explored further below where income is taxed at an effective rate below a minimum rate.” The OECD Report said, “Some agreement has already been reached on the design of Pillar Two like the fact that it will operate as a top-up to an agreed fixed rate of tax that will be set once other key design elements of the proposal are finalized.”
Unilateral Action by Countries—and a Statement from the European Union
Italy has announced that its digital services tax will take effect on January 1, 2020, but Italy continues to be an active participant in international negotiations on a global consensus proposal. Austria’s Federal Council passed a package of tax reform proposals that includes a digital advertising tax, which would take effect on January 1, 2020. Margrethe Vestager, who is the incoming vice-president of the European Commission, will be in charge of digital policy, and she recently stated, “If no effective agreement can be reached by the end of 2020, the EU should be willing to act alone on a digital tax.”
The French government published draft guidance for its digital services tax, which is retroactively effective from January 1, 2019, with the first payment having been due on October 25th. The draft guidance covers reporting and payment procedures including information about how companies should calculate their French user base, but it did not cover the scope of the tax, so that some companies are unclear about whether they will have to pay it.
US Government & Business Reaction
A Treasury spokesperson said that the US is studying the Pillar 1 proposal and “is actively engaged in the process aimed at forging a consensus on international tax issues,” while also noting that the “US remains firmly opposed to unilateral digital services taxes.”
Key concerns for business with a final OECD consensus proposal will be whether profits are only taxed once and whether there is a procedure by which there is an effective and timely resolution of disputes between countries. A real challenge will be whether the new system can be administered and adopted on a global basis, considering that many of the countries in the Inclusive Framework are developing countries.
The UK & Brexit
After the UK Parliament once again failed to approve a new Brexit deal reached by the European Union and the UK, the EU agreed by unanimous vote to delay Brexit until January 31, 2020, thereby granting a 3-month extension to Britain’s EU membership, beyond the original due date of October 31st. The agreement allows the UK to leave earlier if a withdrawal agreement is ratified by both the UK and the EU. Prime Minister Boris Johnson has called for an election on December 12th, which passed Parliament on October 28th with the required two-thirds support. Two anti-Brexit parties, the Liberal Democrats and the Scottish National Party, have suggested they would support holding an election, with their belief that a new Parliament might support holding a second Brexit referendum.
The Platform for Collaboration on Tax, which is a joint initiative of the IMF, OECD, UN and World Bank Group, is asking for feedback from the public by November 8th on a draft toolkit designed to help developing countries in the implementation of effective transfer pricing documentation requirements. The Development Working Group of the G20 requested the toolkit, which is part of a series the Platform is preparing to help developing countries implement international tax best practices.
Netherlands Tax Reform: The Dutch Ministry of Finance published the government’s tax plans for 2020, which will be discussed by Parliament, but are expected to take effect on January 1, 2020. The proposals include: (1) an amended reduction of the corporate income tax rate to 21.7% starting in 2021; (2) the introduction of a minimum equity rule for banks and insurers; (3) changes to anti-abuse rules relating to specific dividend withholding tax and corporate income tax provisions; (4) the introduction of an interest and royalty withholding tax for payments to listed jurisdictions starting in 2021; and (5) the establishment of a permanent establishment (PE) definition aligned with the 2017 OECD Model Tax Convention.
France 2020 Finance Bill: France’s 2020 Finance Bill includes tax measures that would (1) reduce the corporate income tax rate; (2) implement the EU ATAD 2 directive into domestic law; (3) tax executive directors of large French companies; and (4) impose VAT liability on online platform operators facilitating online sales.
Mexico’s 2020 Tax Reform Proposals: Mexico’s President has presented to its Congress a series of proposed tax measures as part of the 2020 Budget, including changes to the Income Tax Law, the Value Added Tax (VAT) Law, and the Federal Tax Code (FTC). There are no proposed changes to the existing rates, but there are several measures designed to address tax avoidance and/or evasion, based on the OECD BEPS action plan, including restrictions on the deduction of interest, hybrid arrangements, and the definition of a permanent establishment. Also, the government is proposing changes to the taxation of foreign providers of digital services. Congress will consider the legislation and make changes with a final bill expected to be signed by the end of the year.