Washington Tax Insight October 2019
Politics and Congressional Activity
The number of legislative days for Congress remaining in 2019 are limited with both chambers in session for three weeks in October and limited days in November with a proposed adjournment date of December 13, 2019. The long list of outstanding legislative issues that has been pending in 2019 continues, and the House inquiry into impeachment of the President will now present another challenge to the Congress completing additional items on the list, such as gun control, the new trade deal with Mexico and Canada, and immigration reform.
The House passed a continuing resolution (CR) that extends government spending authority through November 21st, thereby averting a government shutdown at the end of September. The funding bill has also been approved by the Senate and the President is expected to sign the bill. The House has approved a number of the annual appropriations bills, but the Senate has not approved any thus far, so it will be challenging for agreement between the two chambers on the appropriations bills to be reached by the new deadline. The CR does not include any permanent tax changes, e.g. tax extenders.
House/Ways & Means Committee: Speaker Pelosi introduced legislation that lowers the cost of prescription drug prices by directing the Department of Health and Human Services to negotiate prices directly with major drug manufacturers with the threat of a high excise tax on sales that would start at 65 percent and increase every three months with a maximum of 95 percent. The tax would be imposed if a company “refuses to enter into negotiations after being selected by the Secretary or if the manufacturer leaves the negotiation before a maximum fair price is agreed to.” The Senate Finance Committee has also been working on a proposal.
Senate/Senate Finance Committee: SFC Ranking Democrat Wyden (D-OR) released a white paper on a mark-to-market system for high-income taxpayers that would result in the taxation of capital gains at ordinary rates. Under the plan, taxpayers subject to the new regime would be required to pay tax annually at ordinary rates, not long-term capital gains rates on any net gain associated with tradable assets held at the end of the year. Non-tradable assets, such as real estate or business interests held by the taxpayer, would not be assessed annually but instead, a “look-back charge” designed to minimize the benefit of deferral would be determined upon sale or transfer. His proposal is unlikely to be considered prior to the 2020 elections with the Senate under Republican control, but rather it is positioned as a potential revenue raising idea for post-2020.
Tax Treaties: Treasury has announced the entry into force of four tax treaties that were part of a package recently approved by the Senate including agreements with Japan, Spain, Switzerland, and Luxembourg. The Japanese protocol will reduce taxes on interest and certain dividends while also establishing a mandatory binding arbitration process. The Spanish protocol will reduce taxes on interest, royalties, certain direct dividends, and capital gains and provides for mandatory binding arbitration. The protocols with both Switzerland and Luxembourg both modernize the exchange of information, and the Swiss agreement provides for mandatory binding arbitration.
The White House – Tax Reform 2.0 in 2020
Treasury Secretary Mnuchin has told reporters that the Administration will be looking at Tax Cuts 2.0 in 2020, although he did not offer specific details about what this set of tax proposals would be. In the past, the Administration has used this term to refer to permanent extensions of the TCJA’s tax relief for individuals, passthrough entities, and estates, which is due to expire in 2025. He has commented that this tax reform package will target middle-class and small-business taxpayers. The House approved a permanent extension of some of these tax relief provisions in 2018 when Republicans still controlled the House, but the legislation was never considered by the Senate and has since then expired with the new Congress. The Joint Tax Committee estimates the cost of such legislation at $920 billion over 10 years.
The Senate Finance Committee has now issued reports from five of the six task forces that were set up to examine temporary tax provisions in various policy areas, including the areas of economic and community development, health policy, energy, cost recovery, and individual, excise and other expiring provisions. The one remaining report is expected to be finalized soon, and Chair Grassley has said that once all reports have been released, the next step will be to prepare a legislative package based on the task force proposals and the areas of consensus among the task force members. The Ways & Means Committee approved a package of extenders in June, but the full House has not yet voted on it. It remains to be seen, however, whether Congress can agree on an extenders package, since House Democrats continue to support the position that an extenders package must be paid for by including revenue offsets.
There continues to be a stalemate with respect to moving on technical corrections legislation between the Republicans who want to fix issues with the 2017 tax law and Democrats, who are opposed to “fixing” a bill they were not involved in drafting. Action in 2019 looks to be unlikely.
Retirement Savings and Pension Legislation:
The bipartisan legislation that was approved overwhelmingly in the spring in the House continues to be stalled in the Senate despite bipartisan support in that chamber due to objections from some Senators on a handful of issues. It is unclear whether there will be a path for this bill to move this year unless there is unanimous agreement on proceeding, or it is attached to a must-pass bill.
Green Energy Package:
There have been reports about the possibility of the Ways & Means Committee considering a “green energy package” that would include energy-focused extenders for renewable and alternative energy sources as well as the credit for electric vehicles. Potential revenue offsets that have been discussed include tax increases for the oil and gas industry and an increase in the corporate tax rate. Since the Senate is unlikely to agree to these revenue offsets, any movement on this kind of package in the House is likely to be seen as an effort to send a message on Democratic priorities.
Treasury and the IRS
Tax Cuts & Jobs Act (TCJA) Guidance
Bonus Depreciation: The IRS issued final and proposal rules under Code section 168(k) for the 100-percent depreciation deduction (bonus depreciation). Under the TCJA, businesses are allowed to immediately write off most depreciable business assets when placed in service after September 27, 2017 but before 2023. The TCJA also expanded eligible property to include certain used depreciable property and certain film, television, or live theater productions. These rules address the operational and computation rules for the additional first year depreciation deduction and its elections including the final rules covering the four requirements for property to qualify. The proposed rules address five major issues including the treatment of a series of related transactions, self-constructed aseets, and a de minimis rule related to the disposal of property.
Tax Accounting Guidance under Code section 451: The IRS issued two sets of proposed regulations under Code section 451 that address accounting changes made by the TCJA. The proposed regulations provide a deferral method of accounting for taxpayers that do not have an applicable financial statement (AFS) and those that do. They also provide a definition of advance payment and advance payment acceleration provisions. Taxpayer comments are requested and are due by early November.
Rules for Employer-Provided Vehicles used for Personal Use: The IRS issued proposed regulations on the valuation rules for employers and employees to determine the amount includable in an employee’s gross income for the personal use of an employer-provided vehicle based on Notice 2019-08 from earlier in 2019. The new rules update the fleet-average and vehicle cents-per-mile valuation rules to align the limits on the maximum fair market values (FMVs) for use of special valuation rules with changes made by the TCJA to the depreciation limitations under Code section 280F. The guidance also includes transition rules for employers electing to change methods to take advantage of the higher limits. Comments are due by late October.
Base Erosion and Anti-Abuse Tax (BEAT) guidance: The Office of Management and Budget (OMB) is currently reviewing two sets of regulations on the BEAT under Code section 59A. The BEAT applies generally to corporations (other than regulated investment companies, real estate investment trusts, and S corporations) that have average annual gross receipts of at least $500 million for the last three tax years and whose base erosion percentage is three percent or higher. The gross receipts and the base erosion percentage are computed by applying aggregation rules in the statute with additional guidance in regulations proposed in December of 2018. OMB is reviewing the final version of these rules and another set of new proposed rules addressing other issues with the BEAT.
TIGTA Report on TCJA International Tax Guidance: The Treasury Department Inspector General for Tax Administration (TIGTA) issued a report assessing the implementation of the TCJA. The report included the following findings:
- The IRS encountered significant challenges in the development of timely guidance needed to implement international provisions. This affected the Large Business and International Division’s ability to develop compliance plans and provide training to its employees.
- The Act required the development of new tax forms and instructions as well as significant revisions to existing tax forms that increased the reporting burden for affected taxpayers.
- The Large Business and International Division also encountered significant challenges related to the processing of certain electronically filed tax Year 2018 tax returns because of the compressed delivery deadlines for processing changes, the timing of the issuance of guidance, and the Federal Government shutdown.
- Lastly, the large Business and International Division encountered hiring and training challenges in its implementation of the international provisions during Calendar Years 2018 and 2019. As a result, the large Business and International Division did not have sufficient subject matter expertise to respond to taxpayers’ inquiries and develop compliance strategies to ensure that taxpayers comply with the Act’s filing requirements for the international provisions.
Other Issues and Guidance
Built-in gains guidance: The IRS issued proposed regulations under Code section 382 to advise taxpayers on the amounts of income and deduction included in the calculation of built-in gains and losses. The rules consolidate several prior notices on point including Notice 1987-79, Notice 1990-27, Notice 2003-65, and Notice 2018-30. The proposed regulations are intended to simplify the application of Code section 382 and provide more certainty to taxpayers. Comments are due by early November.
Large Business & International Division (LB&I)/IRS/Appeals Timing: The LB&I division issued a memorandum establishing timeframes for the transfer of cases to the Office of Appeals and setting new guidelines for closing cases. Examination cases under the Coordinated Industry Case program or the Large Corporate Compliance program should be closed to Appeals within 240 days from the issuance of the 30-day letter. For all other cases, they should be closed to Appeals within 120 days.
Microcaptive Insurance Tax Abuse Cases: The IRS has sent letters to nearly 200 companies, which it says engaged in abusive microcaptive insurance transactions, offering to settle open investigations into the arrangements in exchange for taxpayers agreeing to forego tax benefits and pay penalties. The IRS has included microcaptive transactions on its annual “Dirty Dozen” list of tax scams since 2014 and also marked them as potentially abusive in 2016 with disclosure requirements. The IRS has won three cases on this issue in recent years with the dispute being over Code section 831(b). The IRS settlement offer is available to companies with at least one open year under audit and cases with unresolved years under the IRS Independent Office of Appeals’ jurisdiction. Those taxpayers who decline to participate in the current settlement program will maintain their right to appeal but will be ineligible for future settlement options.
Compliance Assurance Process (CAP) for 2020: The IRS announced that it is expanding its Compliance Assurance Process (CAP) and accepting new applications for 2020. The CAP program is designed to improve tax compliance by large corporate businesses by “employing real-time issue resolution tools and techniques,” with the IRS and the taxpayer working together to resolve issues prior to filing. “Successful conclusion of CAP allows the IRS to achieve an acceptable level of assurance regarding the accuracy of the taxpayer’s filed return and to substantially shorten the length of the post filing examination.” The IRS has also expanded the list of open-year exceptions and developed a process for new applicants who are currently under examination. Corporate taxpayers can apply between September 16 and the end of October, and a decision on acceptance into the program will be made by January 31, 2020.
Amazon Case on the Definition of Intangibles: The IRS lost their case with Amazon over cost-sharing rules related to the definition of intangible assets based on prior regulations that have been withdrawn and are out-of-date in light of a change in the law as part of the TCJA that applies the IRS position to future cases. The Ninth Circuit rejected the IRS argument that items such as Amazon’s goodwill, the value of its in-place workforce, and other intangible concepts that are not intellectual property can be read into regulations that were withdrawn in 2009 stating that the IRS interpretation was too broad. The impact of the decision is limited due to the fact that Code section 367(d)(4) now includes a definition of intangibles that reaches some of these items, but it will have an impact on some outstanding cases.
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. Pascal Saint-Amans, who is the Director of the OECD’s Centre for Tax Policy and Administration, stated recently that the goal continues to be to publish a proposal for a unified plan this fall with a public consultation prior to the end of the year.
Program of Work
Pillar 1: The first pillar is based on profit allocation and nexus rules with a goal of finding the right scope for a unified approach that may involve allocating a proportion of residual profits above a profit threshold to market jurisdictions. At a recent tax conference, Chip Harter, the Treasury Deputy Assistant Secretary for International Tax, commented, “We should be setting the threshold for extraordinary profits as part of a scoping exercise to define those scenarios where the current rules are not functioning well.” He went on to say, “When we talk about routine returns, we may not be talking about it in the same way an economist does, and we might usefully choose a conservatively higher threshold as the appropriate scope of a departure of arm’s-length standards and traditional nexus standards.”
Richard Collier, a Senior Tax Advisor at the OECD, said the OECD’s goals for developing a unified approach under Pillar 1 are identifying a direction to solve the digitalization issue, making the approach as simple as possible, and addressing dispute resolution. There is a recognition that there is reluctance to replace the current arm’s-length principle, and that there is a need to consider the overlap between the new approach and the arm’s-length principle, with the OECD planning to manage the overlap by ensuring that it falls on the weakest part, which the OECD said is the role of residual profits. Mr. Harter commented that while full residual profit-based allocation isn’t being considered, what is being discussed among the countries in the Inclusive Framework on BEPS is an incremental approach on some agreed-to fraction of profits to be allocated to the market jurisdiction. He commented that “The goal should be to isolate cases where current rules are breaking down and allowing enterprises to achieve tax results that have become to be perceived as politically unacceptable while preserving, for the vast majority, the outcomes we expect under the current system.”
Pillar 2: Pillar 2 focuses on minimum taxation, which is also known as the global anti-base-erosion proposal involving four rules: the income inclusion rule, the switch-over rule, the undertaxed payment rule, and the subject-to-tax rule. Achim Pross, the Head of the International Cooperation and Tax Administration division at the OECD Centre for Tax Policy and Administration, has said that the rules will not be applied at the same time, but the ordering has not yet been determined. He did suggest that the discussion at a recent OECD consultation recommended that the inclusion rule should rank first. In recent comments, he confirmed that the inclusion rule that will be used to enforce a minimum tax rate and will apply in cases in which income is not yet taxed at a minimum level will be used to achieve a minimum rate of tax, but the rate has not yet been determined.
US Government & Business Reaction
The US Trade Representative held a hearing on the French digital tax on August 19th during which all of the public witnesses, including Facebook, Amazon, and Google, expressed disapproval of the tax. Companies testified that the new French tax would present significant challenges including creating new measures to track individual user data, which would require companies to retool their data collection systems.
US Treasury officials continue to express opposition to the unilateral measures that many countries have put into place. Assistant Secretary Harter has commented that the stakes are high with this effort to reach a consensus-based solution and continues to note the breakdown in international consensus represented by the actions take by individual countries. He has said, “The international tax system is at a pivotal, even perilous point in its history.”
The UK & Brexit
New UK Prime Minister Boris Johnson has declared that the UK will leave the European Union by October 31st, with or without a new deal. PM Johnson received permission from the Queen to suspend Parliament’s session for up to 5 weeks starting in mid-September. In response, the PM suffered defections from his party that left him with a minority government unable to call for a general election. His opponents want to request a 3-month extension from the EU to avoid a no-deal exit at the end of October. Scotland’s highest court ruled that the move to suspend Parliament was illegal, while the High Court in London found that it was not a matter for the courts. The UK Supreme Court has now ruled unanimously that PM Johnson broke the law by suspending Parliament and declared the suspension “void” and never legally have taken effect so that Parliament has returned to its duties. The ruling also found that the PM had given the Queen improper advice when he asked for permission to suspend Parliament. There is speculation that PM Johnson will now call for a general election.
The European Council President has said that the UK has not submitted any workable proposal yet for leaving the EU, while commenting that a no-deal exit for the UK is not the preference of the EU. Taxpayers must continue to prepare for the possibility of a no-deal exit on October 31st including consideration of issues involving employees and new hires with respect to freedom of movement. If the current deal is ratified, there are transition rules that may apply with respect to residence and work permits with respect to some countries, e.g., the Netherlands.
The OECD released six “stage 2” peer review reports concluding that the US, UK, Belgium, Switzerland, Canada, and the Netherlands are all improving their cross-border tax dispute resolution process.
Canada and Switzerland have deposited their instruments of ratification for the Multilateral BEPS Convention.
An EU state aid case decision earlier this year found that the UK anti-avoidance rule exemptions violated the state aid rules, and that the UK must recover revenue lost through the exemption. HM Revenue & Customs is appealing the ruling and two UK-based multinationals who benefited from the exemption have filed appeals with respect to the case. According to the Commission, the UK provision could have been justified if profits from financing the loans resulted only from activities that occurred outside the UK, but if they were derived from UK activities, the exemption wouldn’t be justified and would constitute illegal state aid that must be recovered. Note that the EU continues to be in control of competition policy until the UK officially leaves the European bloc.
EU member countries are not in agreement about proposals for a common corporate tax base and new anti-tax abuse provisions and whether they should apply to all companies or only to large multinationals. A common corporate tax base would allow multinational companies to use one set of tax returns across the EU. The 2016 proposal only applies to EU-based companies with an annual turnover of 750 million euros ($824 million), but some member countries want it to apply to all companies with other members arguing for exemptions for certain sectors or for small/medium-sized companies. Key anti-tax abuse provisions that relate to the scope issue include proposed interest-deduction limits, controlled foreign company rules, exit taxation, hybrid mismatches, a general anti-tax abuse provision, and transfer pricing rules. Some of these rules already apply under the Anti-Tax Avoidance Directive (ATAD) which took effect earlier this year. An EU official said that the ATAD rules set minimum standards with member countries permitted to go beyond them, which means there is no uniformity for companies.