Introduction to the New World of Global Tax Planning

Domestic implementation of the recommendations set out in the BEPS final reports from 2015 have the potential to significantly impact effective tax rate planning. The immediate issue flows from the new country-by-country transfer pricing documentation regime (CbC). The critical consequence of the CbC regime, as well as many of the other BEPS initiatives, will be an inevitably heightened focus of tax authorities on testing locally reported transfer pricing results on a profit split basis.

Read the full article here.

 

IRS Begins Formal Assessment of CAP Program

On August 26, the Internal Revenue Service (IRS) announced that its Large Business & International (LB&I) division is in the process of assessing the Compliance Assurance Process (CAP) program. CAP is a real-time audit program that seeks to resolve the tax treatment of all or most return issues before the tax return is filed.  CAP began as a pilot program in 2005 with 17 taxpayers and has grown to currently include 181 taxpayers. In 2011, the CAP program was made permanent and expanded to include Pre-Cap and Compliance Maintenance. Pre-Cap provides interested taxpayers with a roadmap of the steps required for gaining entry into CAP, which as noted above is the standard real-time audit program whereby the IRS examines relevant transactions and proposed reporting positions before the tax return is filed. Cap Maintenance is intended for taxpayers who have been in CAP, have fewer complex issues, and have a track record of working cooperatively and transparently with the IRS. Under this phase, there is a reduced level of review with respect to the pre-filing review and the post-filing examination.

We previously wrote about the potential death of the CAP program. Based on the recent announcement, it appears that CAP is now on its deathbed. The recent announcement states that no new taxpayers will be accepted into the CAP program for the 2017 application season that begins in September 2016, which means that only taxpayers currently in the CAP and Compliance Maintenance phases may continue in the program. No new Pre-Cap application will be accepted and taxpayers currently in pre-Cap will not be accepted into the CAP phase. However, taxpayers currently in the CAP phase may be moved into the Compliance Maintenance phase, as appropriate. The announcement is not surprising in light of recent reorganization changes by the IRS and shifts to a “campaigns” approach, which we have written about here and here. The announcement explains that the CAP assessment is necessary given the IRS’s limited resources and constraints, combined with a business need to evaluate existing IRS programs to ensure that they are aligned with LB&I’s strategic vision. We will continue to monitor developments on this front, but for now any taxpayers that were planning on applying for the CAP program will no longer have that opportunity.

Scott Singer Informs on the Effect of Loans to Financially Troubled Subsidiary in a Debt-Equity Analysis

One often overlooked debt-equity issue is presented by continuing transfers to a subsidiary that is reasonably creditworthy at the inception but subsequently encounters difficulties, in spite of which (or maybe because of which) and continues to receive advances from the common parent or one of its finance subsidiaries. The issue is whether the subsequent difficulties should cause the advances made after some point in time to be equity rather than debt.

Scott Singer Installations, Inc. v. Commissioner, T.C. Memo. 2016-161, [read here] involves a corporation that began business in 1981 and operated with some success. In order to fund its growth, its sole shareholder began to borrow from other persons and relend the proceeds to the corporation in 2006. (No notes were executed; no interest was charged; and no maturity dates were imposed.) The corporation was initially profitable, but experienced a decline in business in 2008. The court held that the shareholder loans from 2006 through 2008 constituted  debt because the corporation’s success provided a basis for the shareholder’s having a reasonable expectation that those loans would be repaid, but that the funds transferred after 2008 were not debt because as a result of the decline in business, the shareholder “should have known that future advances would not result in consistent repayments.”

The court cited no case in which this approach was applied. Whether shareholder could have a reasonable expectation of repayment is a factual issue for which authority is not needed. However, this approach is somewhat unusual. A particularly difficult question in many cases is the point after which advances should be treated as equity. The general downturn in the economy may have simplified it here. It is important to note that the advances made before 2009 were not recharacterized as equity; it appears that if it were appropriate to treat them as debt when they were made, they remain debt.

The Tax Court in Scott Singer focused heavily on the lender’s reasonable expectation of repayment in characterizing the later advances as equity. However, it is important to note that the debt-equity determination is often extremely complex and fact-specific. The question of lending to a troubled company arises frequently in the third-party lending context. In these situations, a lender often seeks a higher interest rate and/or additional collateral to account for the problems that the company is experiencing. When a third-party lender extends credit to a troubled company, they often look to assets and their priority relative to other creditors in considering whether to loan additional funds.

Business people at a company need to be cautioned that pumping money into a subsidiary that is sustaining losses (and probably needs the money to prevent sinking) may lead to adverse tax consequences unless the entity’s stock becomes worthless. One approach may be to have the subsidiary issue a combination of notes and preferred stock.

Discussion Draft of Modernization of Derivatives Tax Act

On May 18, 2016, Senate Finance Committee Ranking Member, Senator Ron Wyden, released a financial product tax reform discussion draft that, if adopted, would significantly alter the current tax rules with respect to financial products (derivatives), as well as the tax treatment of certain non-derivative positions that are offset by derivatives. The discussion draft is referred to as the Modernization of Derivatives Tax Act, or MODA.

Read the full article here.

 

Taxpayer Argues First Circuit Should Not Follow Tax Court Decision by Judge Indicted for Tax Fraud

On August 15, 2016, the taxpayer in Santander Holdings USA filed its brief to the US Court of Appeals for the First Circuit in its case involving what the Internal Revenue Service (IRS) has labeled a “foreign tax credit generator” transaction. The taxpayer prevailed at the district court level and the IRS appealed that decision, arguing that the lower court’s opinion was contrary to existing precedent in the Tax Court and other appellate courts. Much has been written about these cases and the issue presented, but this post focuses on an interesting argument raised by the taxpayer regarding the weight to be afforded to a prior Tax Court opinion.

The taxpayer’s brief argues that the Tax Court opinion in Bank of New York Mellon should not be followed because “the judge in that case—Judge Diane Kroupa—faced a disabling conflict when she rendered” the opinion due to the fact that she was indicted for tax fraud in April 2016 and was under audit by the IRS and allegedly committing further tax fraud at the time she was considering the Bank of New York Mellon case. Citing an opinion by the US Court of Appeals for the Ninth Circuit, the taxpayer argued that the alleged misconduct directly implicated the character and integrity of Judge Kroupa and that the other appellate opinions on this issue heavily relied on her factual findings in deciding their cases. It further argued that the government’s reliance on “Judge Kroupa’s defective factual findings, [which were] made in a tainted proceeding … should be given no weight here.” Finally, the taxpayer, referencing the Eaton case, stated that, “[r]ecognizing Judge Kroupa’s inherent conflict of interest in any case, the Tax Court has already permitted one taxpayer to move for reconsideration more than three years out of time.” We have previously discussed the indictment of Judge Kroupa here and here.

It remains to be seen how the Tax Court will act in Eaton, as the parties continue to brief the matter raised in the motion for reconsideration, and what reaction the government and the First Circuit will have to the taxpayer’s argument in Santander Holdings USA. We will continue to follow these matters and provide updates in the future.

Sixth Circuit Defines ‘Corporation’ for Purposes of Overpayment Interest

The US Court of Appeals for the Sixth Circuit recently held in U.S. v. Detroit Medical Center that a nonprofit entity incorporated under state law falls within the definition of a ‘corporation’ for purposes of determining the interest rate applicable to tax refunds. The case is worth reading for its plain meaning analysis as well as its reliance on prior case law dating back hundreds of years.

In Detroit Medical, a not-for-profit corporation overpaid its taxes, entitling it to a refund plus interest. Under the Internal Revenue Code (Code), ‘corporations’ receive lower interest rates on refund than other taxpayers. The taxpayer claimed that, as a not-for-profit corporation, it should not be treated as a ‘corporation’ and thus was eligible for the higher interest rate resulting in an extra $9.1 million in refunds. The Sixth Circuit found nothing in the relevant statute that excludes a not-for-profit corporation from the definition of “corporation.” In reaching its holding, the court relied on various statutory construction principles, including: (1) in the absence of any statutory definition to the contrary, courts presume that Congress adopts the customary meaning of the terms it uses; (2) the word “includes” is a term of inclusion, not exclusion; (3) dictionary definitions (both old and new) are appropriate tools to determine the meaning of a word used in the Code; and (4) when Congress uses particular language in one section of a statute but omits it in another part of the same Act, the general rule is that Congress acted intentionally and purposely in the disparate inclusion or exclusion.

As further support for its plain meaning analysis, the Sixth Circuit relied primarily on an 1819 opinion by Chief Justice Marshal in Dartmouth College that permitted charitable organizations to be treated as corporations.  The court further noted that in 1612, Sir Edward Coke wrote in The Case of Sutton’s Hospital that a charitable hospital and school founded at the London Charterhouse was as valid a corporation as any other because it possessed all the characteristics that are of the essence of a corporation. Finally, the court cited to commentaries by William Blackstone from 1753 that charitable corporations are one of three basic kinds of corporations.

The Sixth Circuit’s approach of applying a strict plain meaning analysis is consistent with its approach in prior tax cases, including its interpretation of Code section 956 in The Limited and Code section 1256 in Wright  Additionally, the opinion highlights the importance in tax litigation of not limiting one’s argument to just the most recent cases and searching for useful authority outside the tax context. In a recent opinion involving the interpretation of Code section 6662, the Tax Court in Rand employed a similar approach by applying the rule of lenity and relying on an 1820 Supreme Court opinion dealing with homicide at sea.

Brexit: The Consequences for International Tax Planning

Just over a month has now passed since the referendum in which the United Kingdom voted narrowly to leave the European Union: an event which some have characterized as the greatest potential shock to the UK economy since the Second World War. For most multinational groups considering the potential consequences of Brexit on their tax position, however, the best advice is probably the same as that provided by the famous wartime poster: “Keep Calm and Carry On.”

While much remains to be resolved about the United Kingdom’s exit from the European Union, what has become clear is that it will not happen quickly. The Government has stated that it will not serve formal notice of its intention to leave the European Union before the New Year, which will start a period of negotiation that, under the European Union Treaty, is anticipated to take two years. The United Kingdom is thus likely to remain an EU member state until at least 2019.

Brexit will almost certainly result in some changes to the United Kingdom’s tax landscape, and these may well cause complications for some multinationals.

Read the full article here.

Inversions and Debt/Equity Regulations Top Treasury’s 2016–2017 Priority Guidance Plan

Yesterday, the US Department of the Treasury (Treasury) released the 2016–2017 Priority Guidance Plan (Plan) containing 281 projects that are priorities for Treasury and the Internal Revenue Service (IRS) during the period July 2016 through June 2017. The Plan contains several categories of topics, starting with consolidated returns and ending with tax-exempt bonds. The Plan also contains an appendix that lists more routine guidance that is generally published each year. Treasury and the IRS will update and republish the plan during the next 12 months to reflect additional items that have become priorities and guidance that has been published during the year. The public is invited to continue to provide comments and suggestions as guidance is written throughout the year. Continue Reading

IRS UPDATES FATCA FAQs

On August 8, 2016, the IRS updated the “frequently asked questions” (FAQs) on the FATCA IDES Technical FAQs section at IRS.gov.

IDES stands for the “International Data Exchange Services” system that allows the IRS to exchange taxpayer information with foreign tax authorities. While the FAQs are focused primarily on technical issues, such as data preparation, testing and security, several of the revisions provide guidance on substantive FATCA reporting issues.

New Q:A18 clarifies that reports made by “Direct Reporting Non-Financial Foreign Entities” (NFFE) located in Model One IGA jurisdictions are to be made directly to the IRS rather than through their Host Country Tax Authority (HCTA). Generally when using IDES, files uploaded by a foreign financial institution (FFI) in a “M1O2” jurisdiction will be routed to the HCTA. The FAQ provides that “when a Direct Reporting NFFE applies for its Global Intermediary Identification Number(GIIN) through the FATCA Online Registration portal it must specify its jurisdiction as ‘Other’ if it is located in a M1O2 jurisdiction.” The GIIN assigned as a result of this registration option then instructs IDES to route transmissions directly to the IRS.

M1O2 stands for “Model 1, Option 2” which enables FFIs located in jurisdictions with Model 1 IGAs to report directly through IDES rather than to their HCTA, if such procedure is permitted by their HCTA.

The IRS also updated Q:C20, which deals with “nil” FATCA reports (i.e., FATCA reports in which no US accounts are reported). The revised FAQ confirms that generally, only Direct Reporting Non-Financial Foreign Entities and Sponsoring Entities’ reporting on behalf of a Sponsored Direct Reporting NFFEs are required to submit a nil report. Nil reports are optional for all other filers. The FAQ clarifies that while nil reporting may not be required by the IRS, it may be required by the local jurisdiction under that jurisdiction’s FATCA legislation, and reminds taxpayers to consult with local tax administration before filing FATCA reports.

The IRS continues to periodically update both the technical and substantive FATCA FAQs on its website to provide guidance to affected entities as compliance issues arise.

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