Timing of a US Federal Tax Controversy

Understanding the timing of a US Federal tax controversy is helpful in creating a sound and efficient strategy. This timeline shows the typical timing of a US Federal tax controversy, from the IRS’s examination of the return, through administrative appeals, litigation in Tax Court, Circuit Court appeal, and to ultimate assessment of tax.

IRS Issues IPU on Identifying Foreign Goodwill or Going Concern

On October 13, 2016, the Internal Revenue Service (IRS) released an LB&I International Practice Unit (IPU), available here, providing guidance to IRS agents relating to the identification of foreign goodwill or going concern value (FGWGC) for purposes of Internal Revenue Code (Code) Section 367. The IPU indicates that it was last updated on September 22, 2016.

The IPU focuses on the threshold question of whether, as a factual matter, FGWGC can exist in the first place in light of all the facts. As an example, the IPU states that because a business operation conducted outside the United States is a prerequisite for the existence of FGWGC, it is necessary to understand whether immediately before a transfer, the transferor of the property was engaged in a trade or business conducted outside the United States.

The IPU discusses the process of identifying foreign goodwill or going concern value, citing to authorities such as Newark Morning Ledger, TAM 200907024, the Bluebook and legislative history. It then discusses the steps that IRS agents should follow to identify FGWGC, with citations to various authorities as resources.

FGWGC is a hot topic right now. On September 14, 2015, the Department of the Treasury (Treasury) and the IRS issued proposed regulations that address the tax treatment under Code Sections 367(a) and (d) of certain transfers of property by United States persons to foreign corporations. As we have discussed here, the proposed regulations would change the law to tax all transfers to a foreign subsidiary of goodwill and going concern value for use in a trade or business outside the United States.  These proposed regulations raise serious questions regarding whether Treasury and the IRS exceeded their authority on this point.

Types of Tax Court Opinions and Their Precedential Effect

Most tax cases are decided by the US Tax Court (Tax Court). The Tax Court issues two categories of opinions: (1) formally published dispositions; and (2) unpublished dispositions. The first category consists of opinions that are published in the Tax Court Reports and technically are called “division opinions” but are more commonly referred to as “T.C. opinions.” The second category consists of three sets of unpublished dispositions: (1) memorandum opinions (commonly referred to as “memo opinions” or “T.C. memos”); (2) summary opinions; and (3) orders. A common question asked by taxpayers relates to the difference between these forms of dispositions in terms of precedential effect. Continue Reading

UTP Filings Continue to Rise

The IRS has released statistics for the 2010 to 2014 tax years relating to Schedule UTP (Uncertain Tax Position) filings, showing that there were 6,320 uncertain tax positions reported in 2014. The statistics show a steady increase in the reported positions, which totaled 4,740 in 2010, although this may also be attributed to the fact that the number of Schedule UTP filers has increased from 2,143 in 2010 to 2,747 in 2014. It is not surprising that the number of Schedule UTP filers have increased from 2010 to 2014 since reporting requirement has decreased from corporations with at least $100 million in assets (2010) to $10 million in assets (2014). However, the increase in filers has not affected the average number of uncertain tax positions per filer, which remains stable at 2.3. The most common types of UTPs reported continues to be IRC section 41 research credit and IRC section 482 transfer pricing, which collectively account for over half of all reported uncertain tax positions. The chart is available here for your consideration.

Tax Controversy Options

Knowing your options for a US Federal tax controversy is helpful in creating a sound and efficient strategy. The attached chart depicts the typical options involved in a US Federal tax controversy, from the IRS’s examination of the return, through administrative appeals, litigation in Tax Court, Circuit Court appeal, and to ultimate assessment of tax.

Deference Denied to IRS Notice Issued Post-Litigation

Sometimes a loss in a discovery battle is really a win. That is certainly the outcome in Sunoco, Inc. v. United States, 2016 WL 334578 (Fed. Cl., No. 1:15-cv-00587, 10/6/16). In Sunoco, Judge Wheeler of the Court of Federal Claims denied Sunoco’s motion to compel production of the background file documents for Notice 2015-56 (Aug. 15, 2015). The court, however, denied the motion on the grounds that the requested documents are unnecessary because the Notice is not entitled to Skidmore deference.

Under Skidmore v. Swift, courts may give deference to an agency’s interpretation of its governing laws even when the agency does not use its rulemaking powers. In deciding whether to give deference to the agency’s interpretation, courts consider the interpretation’s “thoroughness evident in its consideration, the validity of its reasoning, its consistency with earlier and later pronouncements, and all those factors which give it power to persuade, if lacking power to control.”  323 U.S. 134, 139-140 (1944).

In June 2015, Sunoco filed a complaint seeking refunds for federal income taxes relating to the tax treatment of the alcohol fuel mixture credit. Sixty-five days after the complaint was filed, the Internal Revenue Service (IRS) issued Notice 2015-56 taking a position contrary to Sunoco’s. The parties filed cross-motions for judgment on the pleadings and partial summary judgment. In its filings, the government claimed, among other things, that Notice 2015-56 was entitled to Skidmore deference. In response, Sunoco sought internal IRS documents relating to the issuance of Notice 2015-56 that it contended would assist the court in determining whether Skidmore deference was appropriate.

In denying Skidmore deference to Notice 2015-56, the court identified three factors – the timing of the Notice, the lack of authority and the inconsistency with prior IRS advice. The court found the Notice to be self-serving because it was issued when “it was actually litigating.” Additionally, the Notice provided no authority for its position, which the court would have expected considering its finding that the position conflicted with the Internal Revenue Service’s position in a Chief Counsel Advice issued two years earlier. Thus, the court denied Sunoco’s motion to compel on the ground that it was moot because Notice 2015-56 is not entitled to deference.

In situations where the government is claiming deference to agency pronouncements, taxpayers should consider requesting the background files. These files might shed light on the matters considered by the government and provide a defense to the deference argument.

IRS Appeals – Changes Afoot?

IRS Appeals cases within the Large Business and International (LB&I) division that involve a significant number of issues, a significant amount of money, or highly complex issues are typically assigned to a “team” of IRS Appeals officers. The Appeals Team Case Leader (ATCL), however, has “complete control” of the case, is “independent” from the IRS Examination Team and, except for certain coordinated issues, has settlement authority for all work assigned to the Appeals team. See I.R.M. (09-25-2013). Currently there are 35 ATCLs.

Rumors are rampant, however, that the IRS may soon eliminate the ATCL’s settlement authority and require review and approval of settlements by an Appeals Team Manager (ATM), of which there are only a handful. On September 22, 2016, at an annual conference sponsored by the Internal Revenue Service and the New York Chapter of the Tax Executives Institute, Reinhard Schmuck, an ATCL for Area 9 in New York, confirmed that the IRS is considering changes to ATCL’s settlement authority. He indicated that the review was initiated in response to a report filed by the Treasury Inspector General for Tax Administration that determined that in a sample of penalty Appeals cases, the case files did not always support Appeals’ decisions to abate penalties as required by Appeals criteria. See TIGTA Report Number:  2015-10-059 to the Internal Revenue Service Chief of Appeals (July 30, 2015). He cautioned, however, that the IRS had not made any final decisions.

Attendees at the conference, including former Appeals Officers and practitioners, expressed dismay at the proposed change because the LB&I Appeals process, which has worked well and instilled confidence in taxpayers, is not broken. This change may be a devastating blow to resolution at Appeals, and may cause a chilling effect on seeking redress at Appeals before heading to court. What is the use of spending a significant amount of time and effort to negotiate at Appeals if the decision maker is not even part of the negotiations?

What can we expect if the rumors ring true:

(1) Additional delays at Appeals;

(2) Unhappy ATCLs and ATMs;

(3) Unfair and unreasoned settlements;

(4)  Increased assertion of penalties; and

(5) Taxpayers avoiding Appeals and an increase in tax litigation.

The new procedures were rumored to be effective October 1. We do not have confirmation of a change in policy, but once the rumors are confirmed, we will report back.

Tax Court Anticipates Releasing Revisions to its Rules in the Near Future

At the ABA Section of Taxation meeting in Boston last week, Chief Judge Marvel of the US Tax Court announced that the court anticipates issuing revisions to its rules in the near future. These rule revisions will address two areas: (1) e-filing matters, including the ability to electronically file a petition; and (2) revisions necessitated by changes made by Congress at the end of 2015 (for our earlier report on this subject, see here). Chief Judge Marvel also noted that the court is continuing to review its rules and prior comments received from the public, and may issue further revisions in the future.

IRS Updates Rules Regarding Appeals Conferences

The Internal Revenue Service (IRS) has revised the Internal Revenue Manual (IRM) regarding Appeals Conferences.  Below is a summary of material changes to IRM 8.6.1, effective October 1, 2016:

  • The IRM was revised to reflect that most conferences in Appeals will be conducted by telephone.  The revision also provides guidance for when in-person conferences are appropriate (e.g., when there are substantial books and records to review that cannot be easily referenced with page numbers or indices, or when there are numerous conference participants that create a risk of an unauthorized disclosure or breach of confidentiality).
  • IRM, In-Person Conferences: Circuit Riding was added.  If the assigned Appeals employee is in a post of duty that conducts circuit riding, circuit riding will be permitted when the address of the taxpayer, representative or business (for business entities) is more than 100 miles from a customer-facing virtual conference site or 150 miles from the nearest Appeals Office.  Area Directors have the discretion to deviate from these mileage limitations.  Circuit riding will also be allowed if the nearest Appeals Office cannot take the case due to high inventories or lack of technical expertise, or if there is no convenient alternative.
  • Language was added in IRM to state that Appeals has the discretion to invite Counsel and/or Compliance to the conference.  The IRM notes that the prohibition against ex parte communications must not be violated and references Rev. Proc. 2012-18.
  • The definition of a new issue was updated in IRM  The IRM retains prior language stating that a new issue is a matter not raised during Compliance’s consideration and adds that any issue not raised by Compliance in the report (e.g., 30-Day Letter) or rebuttal and disputed by the taxpayer is a new issue.

The revised IRM 8.6.1 is available here.

UK Government Confirms Introduction of New Cap on Interest Deductibility

The UK Government has recently confirmed that it will be introducing a new cap on interest deductibility. Under the new rule, the ability of groups to obtain tax relief for interest will be limited by reference to a ratio of their net interest expense to EBITDA. The new rule will apply from 1 April 2017, leaving affected groups with very little time in which to consider its impact and to refinance their existing arrangements.

In the latest issue of McDermott’s newsletter International News, covering international tax topics of interest, we have published an article discussing the proposed rule. Read the full article here.