Washington Tax Insight September 2019
Politics and Congressional Activity
An assessment of the year thus far for Congressional achievements is a mixed bag with many important issues yet to be dealt with in 2019. Although the budget deal that Congress reached before the recess began is arguably an accomplishment, there is still opportunity for problems when Congress returns in September because Congress will need to approve appropriations legislation that specifies the funds allocated for the various departments and functions of the federal government before October 1st. The Senate’s legislative achievements have consisted solely of noncontroversial bipartisan measures, such as a land conservation package, and must-pass bills, including disaster relief and emergency aid for the border; an annual military policy measure, and the 2-year budget deal. The list of achievements for the House mostly consist of symbolic actions, since most of the approved legislation will not move in the Senate. The Congress has failed to deal with the issues of the high cost of prescription drugs, immigration reform, and infrastructure. As the race for the White House heats up, it is uncertain what Congress will be able to accomplish when it returns from its August recess on September 9th.
Senate/Senate Finance Committee: SFC Republican Senator Johnny Isakson (R-GA) announced that he will be retiring at the end of 2019 due to health concerns. Prior to leaving for their August recess, the Senate Environment and Public Works (EPW) Committee advanced a bipartisan five-year $287 billion surface transportation authorization bill with the action now shifting to the Senate Finance Committee to determine funding options before the full Senate votes on the bill. The current authorization does not expire until September 30, 2020. The Chairs of the EPW and Finance Committees have met to discuss funding options including raising fuel taxes, although that idea is not popular with either Republicans or Democrats. Staff were tasked with developing options during the recess.
Tax Treaties: The Senate approved protocols to four tax treaties that have been waiting for ratification for years including treaties with Japan, Luxembourg, Spain, and Switzerland. The President signed the protocols. Both Switzerland and Spain have received notification of exchange of instruments. The Swiss protocol will go into effect once the exchange of instruments is complete as will the Japan protocol. Spain’s protocol will go into effect 90 days after the country receives notification under the agreement.
The pending treaties with Chile, Poland, and Hungary are still pending in the Senate Foreign Relations Committee as the Treasury Department seeks to clarify how provisions in those agreements interact with the base erosion and anti-abuse (BEAT) provision enacted in the TCJA and whether the new treaties would override that provision. These are new treaties and not amended agreements, which means they could override provisions of the TCJA. If Treasury adds reservations to these treaties, the other countries will have to approve them again, which could further delay Senate approval. The treaties with Hungary and Chile were signed in 2010, and the treaty with Poland was signed in 2013.
Wayfair Decision legislation: A Multistate Tax Commission representative has suggested that federal legislation in response to the US Supreme Court Wayfair decision is currently unlikely to advance because states are generally not imposing onerous compliance burdens on businesses. He stated that states are giving remote sellers adequate time to comply with tax collection requirements and are not pursuing retroactive collection. Also, the current Chair of the Judiciary Committee, Jerrold Nadler (D-NY) has expressed reservations about infringing on the states’ sovereignty to tax remote sellers.
The White House
The Administration is reviewing legislation introduced by Senator Scott (R-FL) that would cut taxes by the amount raised from the tariffs imposed on China. The US has raised $43 billion in import duties from the tariffs that are already effective and additional tariffs are scheduled to go into effect on September 1st and December 15th. The details of the Scott proposal have not yet been released. Some commentators have suggested that the quickest way to reduce taxes would be to find a resolution to the trade war with China.
The White House has also been considering proposals that would index capital gains to inflation and cut payroll taxes, although more recent comments from the President indicate that he does not plan to pursue either at this time. In mid-August, White House National Economic Council Director Kudlow said that the White House is working with leaders at the Congressional tax-writing committees on a new plan to cut taxes, which he called “Tax Cuts 2.0”. The President has claimed that he has the authority to index capital gains to inflation without new legislation, but Democratic leaders and some tax commentators disagree with this position, while Treasury Secretary Mnuchin has reportedly been studying the issue.
The Senate Finance Committee issued reports from three of the six task forces that were set up to examine temporary tax provisions in various policy areas, specifically the areas of energy, cost recovery, and individual, excise and other expiring provisions. In his statement releasing the three reports, Chair Grassley (R-IA) said that the outstanding reports are expected to be finalized and announced in the near future. He said that once all reports have been released, the next step will be to prepare a legislative package based on the proposals that the task forces received, the areas of consensus among the task force members, and continued bipartisan discussions. He stated that addressing extenders must be a priority for Congress when it returns in September. The cost recovery task force is, however, the only report that included some consensus ideas, while the other two reports largely just summarized the issues and the comments that were filed from outside groups and industries.
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.
Treasury and the IRS
Inversions: The 2017 tax law appears to have reduced the attractiveness of corporate inversions, with some inverted companies reverting to a structure with a US parent, and other companies questioning whether there are still tax advantages to having a non-US address. One consideration is the new global minimum tax on US companies’ foreign income.
Global Intangible Low-Taxed Income (GILTI): The IRS issued Notice 2019-46, which announces forthcoming regulations to allow a domestic partnership or S corporation that is a US shareholder of a controlled foreign corporation to apply proposed regulations issued in October of 2018 (providing for a hybrid method) for determining the amount of the GILTI inclusion. This guidance applies to domestic partnerships and S corporations for taxable years ending before June 22, 2019. The IRS has said that proposed regulations will be issued in the near future that provide rules consistent with two examples covered in this Notice. They have requested comments as to the results described in these examples and what general standards or principles should be applied with respect to the application of the Proposed Regulations. The guidance also provides penalty relief for a domestic partnership or S corporation that acted consistently with proposed §1.951A-5 on or before June 21, 2019, but files a tax return consistent with the final regulations under §1.951A-1(e). Certain notification and reporting outlined in the Notice must be met to prevent the penalties.
Opportunity Zones: December 31, 2019, will be a critical day with respect to investments in Opportunity Zones, since under the current guidance that is the last day to invest in a Qualified Opportunity Fund to get the potential 15% step-up basis over 7 years, and the first day when investors can put their 1231 gains from 2019 into QOFs. Under the law, investors must reinvest capital gains into QOFs by December 31, 2019, and hold them for seven years to qualify for 15% forgiveness on the taxable gains from the investment. If the funds are held for five years, then 10% of the capital gains are forgiven. Both the seven- and five-year windows end on December 31, 2026, which is the date when gains can no longer be invested in QOFs. Gains generally must be invested in a QOF during a 180-day window beginning on the date of the sale or exchange.
Under the second set of proposed regulations that were issued, capital gains from the sale or exchange of Section 1231 property used in a trade or business are eligible for the tax deferral if invested in a QOF. Capital gain income from Section 1231 property is determinable only as of the last day of the taxable year so the 180 day window starts on that day – but also ends on that day for the investment rule for 7 years in a QOF. Some commentators have suggested that the government should consider having the 180-day window start on the date of the sale or exchange of the 1231 property.
Penalty Waiver: The IRS has announced that it will automatically waive 2018 tax under withholding penalties and issue tax refunds for those who are eligible for such a waiver but haven’t yet claimed it on their tax returns. The waiver applies to those taxpayers who paid at least 80% of their estimated taxes for 2018 through withholding but did not claim relief by filing the required Form 2210.
Other Issues and Guidance
Cloud Transactions and Digital Content: The IRS issued proposed regulations on the classification of cloud transactions under US international tax provisions for sourcing purposes. The rules are also designed to classify “transactions involving computer programs, including by applying the rules to transfers of digital content.” Existing rules under §1.861-18, which date back to 1998, still provide useful guidance for transactions involving digital content, according to the IRS. The new rules would broaden the application to include digital content, “which is defined in proposed §1.861-18(a)(3) as any content in digital format that is either protected by copyright law or is no longer protected solely due to the passage of time (e.g., books, movies, and music in digital format, in addition to computer programs).” The proposed rules are intentionally broad with the IRS explaining that the definition of cloud transactions is intended also to apply to other transactions that share characteristics of on-demand network access to technological resources, including access to streaming digital content and access to information in certain databases.
The IRS also noted that cloud computing transactions, “which are typically characterized by on-demand network access to computing resources, would not generally be subject to classification under existing §1.861-18 since such transactions typically do not include the transfer of a computer program, nor would such transactions be subject to proposed §1.861-18 since such transactions typically do not include the transfer of a copyright right or copyrighted article, or provision of development services related to computer programming. Thus, the proposed rules provide for classifying a cloud transaction as either a provision of services or a lease of property or both. Comments are due 90 days after the August 14th publication of the proposed rules in the Federal Register.
Bonus Depreciation: The IRS issued Revenue Procedure 2019-33, which permits taxpayers to make a late election, or to revoke an election, under Code sections 168(k)(5), 168(k)(7), or 168(k)(10). The guidance covers certain property acquired by the taxpayer after September 27, 2017 and placed in service or planted or grafted, as applicable, by the taxpayer during its taxable year that includes September 28, 2017. Under Code section 168(k)(5), a taxpayer can elect to deduct additional first year depreciation for certain property. The IRS explains that “Section 168(k)(7) allows a taxpayer to elect not to deduct additional first year depreciation for any class of qualified property placed in service by the taxpayer during the taxable year to which the election applies.” Code section 168(k)(10) allows a taxpayer to elect to deduct 50%, instead of 100%, additional first year depreciation for certain qualified property.
Crypto Currency Letters from the IRS: The IRS announced a compliance effort directed at owners of virtual currencies who may owe back taxes on transactions or who failed to report certain transactions. More than 10,000 letters have been sent to taxpayers with an IRS request that they review their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties. There are 3 versions of the “educational” letters, which are all designed to help taxpayers understand their tax and filing obligations and how to correct past errors. In 2018, the IRS launched a new compliance campaign directed at virtual currencies. IRS Notice 2014-21 provide guidance on how broad tax principles apply to transactions using virtual currency and includes answers to 16 FAQs. The IRS stated that it plans to issue additional guidance in the near future.
Tax Court Decision in Altera — IRS withdraws Examiner Directive
As reported in earlier issues of this report, the US Court of Appeals for the Ninth Circuit has reversed the Tax Court’s decision in Altera (now a subsidiary of Intel) and upheld tax regulations on certain cross-border cost-sharing agreements within corporations, giving a victory to the IRS. The case involved what is known as share-based compensation and the issue of whether it should be deducted as a business expense. Following that decision, the IRS withdrew on July 31st a January 2018 directive, which had stopped new examinations related to stock-based compensation included in companies’ arrangements to share the costs of developing intangible property with foreign affiliates.
Since the Ninth Circuit ruling, large technology companies have increased their tax reserves. According to the withdrawal notice, examiners should continue applying the cost-sharing regulations that Altera had challenged, including opening new examinations of transfer pricing issues related to cost-sharing arrangements and stock-based compensation when appropriate. The IRS noted that it will continue to monitor developments related to the Ninth Circuit’s decision.
On July 22nd, Altera asked the Ninth Circuit to rehear the case, contending that the majority’s decision upsets settled principles of tax law and validates bad rulemaking. Several groups have filed amicus curiae briefs in support of Altera’s position, including the US Chamber of Commerce, PwC, Deloitte Tax LLP, and KPMG LLP. Three additional briefs were filed including one from tax officials from France, Germany, Japan, Mexico, the UK and other countries; another from Cisco Systems and 32 other companies; and a third from the National Association of Manufacturers, the National Foreign Trade Council, and several technology trade associations.
Adoption of a Global Minimum Tax & Digital Taxation
The OECD continues working 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 following their June 28-29 meeting with the goal of a final report by the end of 2020.
Commentators have suggested that a global economic slowdown in 2020 could complicate the OECD negotiations as a weakening economy would cause countries to review more closely what they would win or lose from global tax reform. Others suggest that the importance of reaching a global deal will override challenges since in the absence of a global deal, the unilateral country laws will stand. The OECD is scheduled to report on the economic impact of proposals in October of 2019, and there will be another public consultation on this project this fall.
Program of Work
Currently, one of the areas of dispute between the US and France is whether big tech companies should be singled out or whether the global proposals should address businesses in all industries. The US Treasury and the US business community favor the OECD-led, multilateral approach, which they believe will lead to a global proposal that is fair and applies to all industry sectors. Another key issue with respect to a potential global minimum tax will be the tax rate with interesting comments from the OECD Director of the Centre for Tax Policy and Administration suggesting that the tax rate could be close to the 12.5 % Irish corporate rate.
The US vs. France (and the UK)
In a joint press conference with President Trump at the close of the G7 summit, French President Macron publicly confirmed that the US and France have reached a compromise agreement which requires France to refund or credit all digital services tax (DST) paid by multinationals once a new international system for taxing multinationals in the digital industry is in place. Reactions from the business community including in the EU were not enthusiastic to this plan, however, with many stating that this approach would lead to greater tax uncertainty and heavy administrative burdens on the business sector.
Prior to this agreement, President Macron signed into law a new 3% digital services tax on revenue from some digital activities, such as targeted advertising and running a digital marketplace, by large companies in France. The current version of the tax, which is modeled on a tax proposal that several EU countries had supported at the EU level, would apply from January 1, 2019. An interesting suggestion has been made that the new French law could be deemed to be illegal state aid by giving preference to French companies over other European companies.
The UK released details of a proposed 2% tax on digital revenue with an effective date of April 1, 2020, as part of its 2019-2020 Finance Bill. The tax would apply to businesses with at least 500 million pounds of worldwide digital revenue and 25 million pounds of UK digital sales. As with the French tax, this tax would terminate if global consensus is reached on the taxation of digital services. Reaction from the leaders of the Congressional tax-writing committees included comments that a UK digital services tax could jeopardize a post-Brexit US-UK trade deal.
The new president of the European Commission has stated that she also wants to address taxation of digital companies in order to make them pay their fair share of taxes, but with the transition of the leadership, it may be months before tax policy initiatives could advance, and tax proposals require unanimity, which was the problem with approving the prior EU proposal. Proposals from the other countries that are moving on a unilateral basis have not yet been enacted into law, including Spain, Italy, Austria, and the Czech Republic.
US Government & Business Reaction
Previously, the US had launched an investigation under Section 301 of the 1974 Trade Act into the French tax, and it is possible that the same action will be taken with the proposed UK DST. The Act gives the President broad powers to investigate and respond to a foreign country’s unfair trade practices and take appropriate action, including retaliation. A hearing was held on August 19th. Possible outcomes of the USTR action, which could take up to year, could be new tariffs or other trade restrictions on French goods.
Both SFC Chairman Grassley (R-IA) and Ranking Democrat Wyden (D-OR) publicly stated their opposition to the French tax and their support for the USTR investigation. After the announcement of the news about the US-France deal, SFC Ranking Democrat Wyden urged caution saying “The Trump administration should reject any deal that allows France and other countries to move ahead with discriminatory taxes on US technology companies, in exchange for vague promises down the line.” He went on to say that “If Donald Trump gives France a pass now, then it will be open season for foreign governments to go after major American employers.”
Despite their criticism of the French tax, the Chamber of Commerce has urged the US not to impose retaliatory tariffs, urging the US to continue working at the OECD level for a global solution. Similarly, comments filed with the USTR in advance of the hearing from US companies have also urged the US not to use tariffs but to urge France to abstain from the unilateral measure until the global negotiations are complete. Amazon has announced that it will treat the new 3% French tax on its marketplace as a consumption tax, which it will pass on to sellers on its website.
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 leaves 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.
PM Johnson has appointed Sajid Javid, a former Deutsche Bank executive, to be the new Chancellor of the Exchequer. Javid supported low taxes during the race for the leadership of the UK as did the Prime Minister, but they will face the reality of the conflict between increased public spending, reduced rates, and faster debt reduction in a post-Brexit world.
Draft legislation with explanatory notes to the UK Finance Bill 2019-20 were published on July 11th with several international provisions of interest. Draft legislation and supporting documents on a digital services tax were included, which is designed to be an interim measure until a global agreement is reached. Effective April 1, 2020, large groups that generate global revenues of more than £500 million per annum from the provision of certain digital services (£25 million or more attributable to UK users), such as social media platforms and online marketplaces, will be subject to a 2% digital services tax on revenues they earn which are linked to UK users. The UK Finance Bill release also includes draft legislation on corporate capital loss restrictions for gains after April 2020; deferral of corporation tax payments in certain circumstances for EU group asset transfers; broader share loss relief; technical amendments to the general anti-abuse rule; and broadening of the scope of capital gains tax relief on loans to traders.
The OECD relaunched its Tax Database website with a new design and new material including a summary of recent changes and comparative information on a range of tax rates and statistics in the OECD member countries.
The EU Council Directive on tax dispute resolution mechanisms in the EU became effective on July 1, 2019, with the aim of resolving the number of pending tax disputes between Member States by placing a legal duty on Member States to take binding decisions. The Directive applies to complaints submitted by companies or individuals starting on July 1, 2019 on disputes about income or capital related to a taxable period commencing on or after January 1, 2018. A detailed procedure for resolving disputes is included in the Directive.
The Netherlands government has published a legislative proposal implementing the EU mandatory disclosure directive. Under these rules, intermediaries and, in some cases, taxpayers, must report cross-border arrangements that meet certain hallmarks to the tax authorities, which are described in the legislation. The legislation fully enters into force on July 1, 2020 but applies to all reportable cross-border arrangements implemented between June 25, 2018, and June 30, 2020 with the deadline for reporting being August 31, 2020.
A public meeting was held to note the completion of a joint OECD and Brazil project designed to reduce the gaps between Brazil’s transfer pricing regime and OECD transfer pricing guidelines, which was required prior to Brazil joining the OECD.