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IRS Guidance

Law School Professors File Amicus Briefs in Support of Commissioner’s Position in Altera

by Roger J. Jones | Aug 3, 2016 | Appellate Courts, IRS Guidance, Transfer Pricing Resource, Uncategorized

Two groups of law school professors have filed amicus briefs with the US Court of Appeals for the Ninth Circuit in support of the government’s position in Altera Corp. v. Commissioner, Dkt Nos. 16-70496, 16-70497. Read more on the appeal of Altera here and the US Supreme Court’s opinion addressing interplay between the Administrative Procedure Act (APA) procedural compliance and Chevron deference here. Each group argues that Treas. Reg. § 1.482-7 represents a valid exercise of the Commissioner’s authority to issue regulations under Internal Revenue Code (Code) Section 482 and that the US Tax Court (Tax Court) erred in finding the regulation to be invalid under section 706 of the APA.

One group of six professors (Harvey Group) first notes its agreement with the arguments advanced by the government in its opening brief. In particular, the Harvey Group concurs with the argument that “coordinating amendments promulgated with Treas. Reg. § 1.482-7(d)(2) vitiate the Tax Court’s analysis in Xilinx that the cost-sharing regulation conflicts with the arm’s-length standard.” It then goes on to note its agreement with the government’s argument that “the ‘commensurate with the income’ standard … contemplates a purely internal approach to allocating income from intangibles to related parties.”

Having thus supported the government’s commensurate-with income-based arguments, the Harvey Group argues that the regulation in question is, in any event, consistent with the general arm’s-length standard of Code Section 482. It does so based principally on the proposition that “[s]tock-based compensation costs are real costs, and no profit-maximizing economic actor would ignore them.” However, that said, “there are material differences between controlled and uncontrolled parties’ attitudes, motivations and behaviors regarding stock-based compensation.” Thus, according to the Harvey Group, the Tax Court erred when it concluded that “Treasury necessarily decided an empirical question when it concluded that the final rule was consistent with the arm’s-length standard,” because “[n]o empirical finding that uncontrolled parties do, or might, share stock-based compensation costs is required to support Treasury’s regulation.” Accordingly, the Tax Court’s reliance on State Farm and the cases following it was a “key misstep” by the Tax Court.

The Harvey Group also proposes that, should the Ninth Circuit find that the term “arm’s length standard” or the meaning of the “coordinating regulations” is ambiguous, the government’s interpretation embodied in Treas. Reg. § 1.482-7 should be afforded Auer deference. Read more on deference principles in tax cases and the unique challenges of Auer deference. Auer deference is a special level of deference that can apply when an agency interprets its own regulations, although there are several limitations on its use. Finally, if the Ninth Circuit decides that the regulations “have an infirmity,” the Harvey Group argues that “[t]he best remedy is to remand to Treasury for further consideration.”

A second group of nineteen professors (Alstott Group) similarly agrees with the government’s arguments to the Ninth Circuit. The Alstott Group argues that the 1986 addition of the “commensurate with income” standard [...]

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Investment Tax Credit Lessee Income Inclusion Guidance Issued

by Philip Tingle, Chelsea Hess, Gale E. Chan, Heather Cooper and Madeline Chiampou Tully | Jul 26, 2016 | IRS Guidance, Uncategorized

New Internal Revenue Service temporary regulations provide guidance on the income inclusion rules that apply when a lessor elects to treat a lessee as having acquired investment credit property under Treas. Reg. § 1.48-4. As expected, the new temporary regulations also provide that a partner of a lessee partnership cannot increase its basis in its partnership interest for this income inclusion.

Read the full article.

Protecting Confidential Taxpayer Information in Tax Court

by McDermott Will & Emery, Jeffrey M. Glassman and Kevin Spencer | Jul 21, 2016 | Court Procedure Matters, IRS Appeals, IRS Audits, IRS Guidance, Privilege and Non-Disclosure, Transfer Pricing Resource, Trial Courts, Uncategorized

Taxpayers value confidentiality, particularly if there is a dispute with the IRS that involves highly-sensitive trade secrets or other confidential information. Not surprisingly, complex tax litigation often raises the question of what confidential information has to be “made public”—through discovery responses or the introduction of exhibits or testimony in a deposition or at trial—so that a taxpayer can dispute IRS adjustments in court if administrative efforts to resolve the case are not successful. Fortunately, the Tax Court tends to protect highly-sensitive trade secrets or other confidential information from public disclosure even when the judge must review the information to decide the case.

In the Tax Court, the general rule is that all evidence received by the Tax Court, including transcripts of hearings, are public records and available for public inspection. See Internal Revenue Code (Code) Section 7461(a). Code Section 7458 also provides that “[h]earings before the Tax Court . . . shall be open to the public.” Code Section 7461(b), however, provides several important exceptions. First, the court is afforded the flexibility to take any action “which is necessary to prevent the disclosure of trade secrets or other confidential information, including [placing items] under seal to be opened only as directed by the court.” Second, after a decision of the court becomes final, the court may, upon a party’s motion, allow a party to withdraw the original records and other materials introduced into evidence. In our experience, the trend appears to be erring on the side of protecting information from disclosure.

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Tax Court Issues Five Discovery Orders Addressing Admissibility of Expert Reports

by Jeffrey M. Glassman and McDermott Will & Emery | Jul 20, 2016 | Court Procedure Matters, IRS Guidance, Transfer Pricing Resource, Trial Courts, Uncategorized

On July 13, 14, and 15, 2016, Judge Laro of the US Tax Court (Tax Court) ruled on five taxpayer-filed motions in limine to exclude expert reports in Guidant LLC f.k.a. Guidant Corporation, and Subsidiaries, et al. v. Commissioner. At issue in the case are a number of IRS transfer pricing adjustments to the taxpayer-corporation’s income under Section 482.

In support of its adjustments, the IRS offered numerous expert reports to the Tax Court, and the taxpayer sought to exclude these reports. The taxpayer raised the following major arguments:

Argument: The IRS expert reports failed to contain opinions.

The taxpayer argued that three of the reports should be excluded because they did not comply with Tax Court Rule 143(g)(1), which requires that expert witnesses generally prepare written reports, and requires that expert reports include “a complete statement of all opinions the witness expresses and the basis and reasons for them.” In federal district court practice (under somewhat different rules), this requirement generally means that an expert must separately state, and clearly delineate, his or her expert opinions in a written report—usually in a “conclusions” or “opinions” section. In Tax Court, the requirement for a clear and concise written expert report is even more significant than in federal district court practice because, under Rule 143(g)(1), expert reports are treated as direct testimony of the expert (although, in many cases, additional expert testimony and cross-examination may be helpful or necessary).

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IRS Issues Safe Harbors under Which the IRS Will Not Assert That a Corporation Lacks the Requisite ‘Control’ for Purposes of Section 355(a)

by Jay M. Singer | Jul 18, 2016 | IRS Guidance, Uncategorized

On July 15, 2016, the Internal Revenue Service (IRS) released Rev. Proc. 2016-40. This revenue procedure provides safe harbors in which the IRS will not assert that a distributing corporation, D, lacks control of another corporation, C, within the meaning of Code section 355(a)(1)(A) when D acquires putative control of C through C’s issuance of stock and C subsequently engages in a transaction that actually or effectively reserves the effect of the stock issuance. In general, D can only distribute the stock of C to D shareholders in a tax-free spin-off under Code section 355 if D has control of C within the meaning of Code section 368(c) immediately before the spin-off. To satisfy the control requirement of section 368(c), D must have 80 percent of the vote and 80 percent of each nonvoting class of C stock. Historically, in situations in which D owned less than 80 percent of the stock of C, D would satisfy this requirement by having C recapitalize its stock into “high vote” and “low vote” classes of stock immediately before the spin-off. D would then distribute the “high vote” stock with more than 80 percent of the vote of all C stock to D shareholders in a tax-free spin-off under section 355. However, publicly traded corporations often dislike having multiple classes of stock with different voting rights outstanding. As a result, when C becomes an independent publicly traded corporation following the spin-off, it often seeks to recapitalize its “high vote” and “low vote” classes of stock into a single class with identical voting rights. Prior to 2013, the IRS issued a number of private letter rulings permitting C to engage in such recapitalizations following its first regularly scheduled board meeting after a spin-off without retroactively causing the spin-off to fail to be tax-free under section 355. In 2013, the IRS announced it would no longer issue such rulings while it studied the issue.

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Tax Court Order Indicates That E-Discovery and Predictive Coding Are Here to Stay

by Chelsea Hess, Kevin Spencer, McDermott Will & Emery and McDermott Will & Emery | Jul 18, 2016 | Court Procedure Matters, IRS Audits, IRS Guidance, Privilege and Non-Disclosure, Trial Courts, Uncategorized

On July 13, 2016, Judge Buch of the US Tax Court denied an Internal Revenue Service (IRS) motion to compel the production of electronically stored information (ESI) by Dynamo Holdings Limited Partnership and Beekman Vista, Inc., which was not delivered as part of a discovery response based on the mutually agreed-upon use of “predictive coding.” Predictive coding is an electronic discovery method that permits an efficient and effective approach when reviewing for relevance a large amount of data and documents. It is a relatively new discovery method that is gaining acceptance by courts around the country as an alternative to the costly and laborious physical review of data and documents. Judge Buch previously authorized the use of predictive coding in Dynamo Holdings, Ltd. vs. Commissioner, 143 T.C. No. 9 (2014).

The IRS and the taxpayers had agreed that the taxpayers would run a search for terms determined by the IRS on the potentially relevant documents. The taxpayers provided the IRS with samples of randomly selected documents from the universe of potentially relevant documents, from which the IRS identified the relevant documents. These selections were used to create a predictive coding model, which a computer can use to identify conceptually similar documents. The IRS also selected a “recall rate” of 95 percent. A search method’s recall rate is the percentage of all relevant documents in the search universe that are retrieved by that search method. The higher the recall rate, the fewer relevant but retrieved documents there will be. The taxpayers then delivered to the IRS all of the documents retrieved using the predictive coding model that were not privileged. More documents were identified in the initial search for terms than were identified using the predictive coding model. The IRS filed a motion to compel production of the documents identified in the initial terms search that were not produced.

The Tax Court denied the IRS’s motion, explaining that document review results are never perfect. The court stated that the IRS was seeking a perfect response, but that the Tax Court Rules and the Federal Rules of Civil Procedure require only that the responding party make a “reasonable inquiry” when making a discovery response. The court explained that “when the responding party is signing the response to a discovery demand, he is not certifying that he turned over everything, he is certifying that he made a reasonable inquiry and to the best of his knowledge, his response is complete.” The use of predictive coding does not change this standard, and the court held that the taxpayers satisfied the reasonable inquiry standard when they responded using predictive coding.

Practice Note: Due to the amount of data and documents generated by taxpayers in the normal course of business, discovery of ESI can be extremely burdensome and expensive for taxpayers. Nonetheless, it has become commonplace to see discovery requests for ESI. Although there is a substantial amount of guidance on this subject in other courts, the Tax Court has issued [...]

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IRS Finalizes Controversial Regulations Allowing Contractor Participation in Examinations

by Kevin Spencer and McDermott Will & Emery | Jul 14, 2016 | IRS Audits, IRS Guidance, Transfer Pricing Resource, Uncategorized

On July 12, 2016, the Internal Revenue Service (IRS) finalized regulations allowing third-party contractors (i.e., outside economists, engineers, consultants and attorneys) to participate in audits of taxpayers. The regulations are not limited to allowing outside parties to review taxpayers’ books and records, but extend to the full participation in summons interviews. The final regulations replace proposed and temporary regulations issued in 2014.

The IRS’s position is highly controversial and several organizations submitted comments arguing against finalization of the regulations. Additionally, the IRS’s position was the subject of a dispute between Microsoft and the IRS relating to the IRS’s use of the law firm of Quinn Emmanuel in an audit of Microsoft’s transfer pricing. It appears highly likely that taxpayers will challenge the validity of the final regulations in court, and at some point a court will be required to decide the issue. In the wake of the final regulations, taxpayers that are currently under audit should consider requesting that the IRS provide a list of all third-parties, including outside contractors that are being consulted with during an examination. It is a good practice to request in writing a list of the third-parties that the IRS contacts during the course of an examination.

Some Questions Posed by Declining Audit Rates and Audit Campaigns

by McDermott Will & Emery | Jul 8, 2016 | IRS Appeals, IRS Guidance, Uncategorized

The IRS is spending increasingly less time auditing large companies. This is a good thing, right? But wait, the IRS is starting to launch audit campaigns. And some large taxpayers are still being audited even if they are not caught up in a campaign. What could be some of the consequences of these dynamics?

A recent report confirmed that IRS audits of large companies have fallen steeply in recent years. The report conducted by TRAC (Syracuse University’s Transactional Records Access Clearinghouse) (available here) analyzed IRS audit history of large companies from 2010 through 2015. The study found the IRS spent 34 percent less time on average auditing companies with $250 million or more in assets (Big Corps) in 2015 than it did in 2010. Audits of the largest companies are declining even more sharply: the IRS spent 47 percent less time auditing companies with assets of $20 billion or more (Giant Corps). Further, the total number of large businesses audited by the IRS’s LB&I (Large Business & International) Division in 2016 is 22 percent lower than it was last year during this time period.

Large taxpayers may take a deep breath once their continuous audit cycle becomes less continuous or stops altogether. This is understandable. But if you are a taxpayer that is audited, a number of important questions immediately come to mind:

Will we have good rapport with a new IRS audit team? We spent years building our relationship with the previous IRS team—has all that very important work gone out the window? Will I have the time to build rapport with the new IRS team, or will they be under such time pressure to audit discrete issues that we will have little opportunity to interact with the team and shape the audit plan?
Will the IRS team arrive with a preconceived idea of the “proper outcome”? Will information document requests (IDRs) be standardized? Will we be able to effectively negotiate the scope of IDRs? Or will the IRS team simply be fact-gatherers for a more centralized committee that makes decisions?
Will we be able to meet with actual decision makers? Or will the decision makers be a committee in the background that we never truly get to engage in a meaningful discussion? Will centralized decision makers take into account the specifics of our situation, or will we be “lumped in” with other taxpayers?
Will the IRS issue “fighting regulations” in an attempt to chill legitimate transactions? Will IRS audit teams attempt to apply these fighting regulations to transactions that predate the effective date of the new regulations? After all, doesn’t the IRS often contend that the new regulations are not really a change and simply reflect existing law?
Will fewer audits mean bigger adjustments? What institutional pressure is IRS Exam under to propose very large adjustments? What about penalties?
Will IRS Appeals exercise true independence and concede improper adjustments? Or will IRS Appeals simply “split the baby” based on inflated numbers? Will this combination of factors [...]

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IRS Updates List of Items Requiring National Office Review

by McDermott Will & Emery and Jeffrey M. Glassman | Jul 7, 2016 | Court Procedure Matters, IRS Appeals, IRS Audits, IRS Guidance, Transfer Pricing Resource, Uncategorized

On June 30, 2016, the Internal Revenue Service (IRS) issued Chief Counsel Notice 2016-009, which can be found here. In the notice, the IRS updated the list of issues that require IRS National Office review (the List). The List indicates those issues or matters raised by IRS field examiners that must be coordinated with the appropriate IRS Associate office.

There are several new items on the List. Notably, corporate formations with repatriation transactions, certain spin-off transactions and transactions that may implicate Treasury Regulation § 1.701-2 partnership anti-abuse rules are now also included. Debt-equity issues pursuant to Section 385 continue to be on the List.

In addition, now included are issues designated for litigation and issues that for technical tax reasons will not be referred to the IRS Office of Appeals under Revenue Procedure 2016-22, Section 3.03 (also relating to issues designated for litigation). We discussed Revenue Procedure 2016-22 in a recent posting. (more…)

IRS Issues IPU on Corporate Inversions

by McDermott Will & Emery | Jul 7, 2016 | IRS Audits, IRS Guidance, Transfer Pricing Resource, Uncategorized

On June 7, 2016 , the Internal Revenue Service (IRS) released an LB&I International Practice Unit (IPU), providing high-level guidance to IRS field examiners on the application of the anti-inversion rules of Internal Revenue Code section 7874 and certain of the regulations and notices issued thereunder (see here). The IPU notes that it is meant to provide only high-level conceptual guidance, and that many aspects of the highly complex notices and regulations recently issued in this area are beyond the scope of the IPU. Some of these issues will be addressed in future IPUs.

This high-level guidance to field examiners signals the IRS’s continued focus on international tax issues.