The recently released regulations under Internal Revenue Code Section 385, addressing the circumstances under which related company debt will be classified as equity for federal income tax purposes, will have a significant impact on not only federal taxes but also on state and local taxes. For a more detailed discussion of these implications by our own Peter Faber, please see here.
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.
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.
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.
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 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. 8.7.11.2 (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.
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 revised IRM 8.6.1 is available here.
In today’s tax environment and with the potential monetary awards to whistleblowers under Internal Revenue Code (Code) Section 7623, taxpayers are facing the increased possibility that their confidential and privileged materials may be provided to the Internal Revenue Service (IRS) without the taxpayer’s consent. This raises serious privilege and ethical issues related to the attorney-client, work product and Code Section 7525 tax practitioner privileges.
In a welcome development, Drita Tonuzi, Associate Chief Counsel (Procedure & Administration), stated at a DC Bar Association event on September 8, 2016, that if someone who is not authorized to release a taxpayer’s documents turns them over to the government, they will first be reviewed to determine if the information is protected by federal laws or the Code. The Whistleblower Office will then redact confidential information before releasing it to examination agents. However, this leaves some unanswered questions.
Case law reflects that the unauthorized production of privileged materials by an ex-employee or by an employee without the authority to waive the privilege for the taxpayer should not be viewed as a waiver of the privilege. The problem is that taxpayers may not know that privileged materials have been provided to the IRS without the IRS’s consent and therefore would not be able to take steps to assert the privilege and request the return of such documents from the IRS. Taxpayers may want to make a request to the IRS at the beginning of an audit to provide it with a list of all materials received by third-parties so that the taxpayer can assess whether any privileged documents have been provided to the IRS without the taxpayer’s consent. If the IRS does not provide the list or refuses to acknowledge the taxpayer’s request, the taxpayer may have at least preserved its right to later assert privilege if it turns out privileged materials were provided to the IRS without the taxpayer’s consent.
If an IRS attorney receives privileged documents and does not return them to the taxpayer, this raises potential ethical issues. Attorneys who receive privileged documents where it is clear that such documents are privileged and were not intended to be disclosed by the taxpayer or the privilege was intended to be waived, may have a duty to not examine those materials and instead return them to the taxpayer. The IRS’s recent comment about reviewing and redacting what it believes is privileged before sending to the examining agent appears at odds with this duty.
In fact, since at least 2009, the IRS has demonstrated a growing awareness of the privilege concerns raised by whistleblowers that stand in a privileged relationship to a taxpayer, even while the IRS’s current policies have not fully addressed the problem. In August 2015, the Internal Revenue Manual was amended to provide that the IRS generally must assume that any “current employee whistleblower has access to information that may be subject to a privilege that has not been affirmatively waived by the taxpayer.” I.R.M. 25.2.2.4.4. That same section of the Manual and [...]
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The United States Government Accountability Office (GAO) recently released a report regarding how the Internal Revenue Service (IRS) communicates tax guidance to the public.This report was prepared following bipartisan requests from members of both houses of Congress.
The GAO report: (1) analyzed documents that defined IRS guidance types; (2) reviewed the IRS’s policies and procedures for issuing guidance; (3) reviewed literature on the IRS’s issuance of guidance; (4) interviewed individuals at relevant government and tax practitioner organizations; and (5) reviewed IRS guidance issued during 2013 through 2015. Below is a chart included in the GAO report that illustrates various forms of guidance, and the weight that the IRS says attaches to each.
The GAO found that the IRS uses many different forms of guidance to communicate its interpretation of tax laws to the public, but considers only the Internal Revenue Bulletin (IRB) guidance to be authoritative. The IRS’s statement that only IRB guidance is authoritative could be considered an oversimplification. We previously wrote (here, here, and here) about how deference principles may apply to various forms of guidance.
The GAO found further that while the IRS has detailed procedures for identifying, prioritizing, and issuing new guidance, the IRS lacks procedures for documenting the decision about what form of guidance to issue.
As discussed in an earlier post, 3M Co. v. Commissioner, T.C. Dkt. No. 5816-13, involves 3M Company’s (3M) challenge to the Internal Revenue Service’s (IRS) determination that Brazilian legal restrictions on the payment of royalties from a subsidiary in that country to its US parent should not be taken into account in determining the arm’s-length royalty between 3M and its subsidiary under Treas. Reg. § 1.482-1(h)(2). The case has been submitted fully stipulated under Tax Court Rule 122. We discussed the parties’ opening briefs, filed on March 21, 2016, here. Reply briefs were filed on June 29, with the IRS filing an amended reply brief on August 18.
3M returns to its argument that Treas. Reg. § 1.482-1(h)(2) is “procedurally invalid” because Treasury and the IRS failed to satisfy the requirements of section 553 of the Administrative Procedure Act (the APA) when they promulgated the regulations. 3M notes that the IRS completely ignored this argument in its opening brief. Citing the Supreme Court’s recent opinion in Encino Motorcars, discussed in more detail here, 3M points out that Treasury and the IRS made significant changes to the regulation, but offered no explanation for the changes. This, 3M argues, renders the regulation invalid. 3M observes that compliance with the two-step Chevron test would not save a regulation that is procedurally invalid, noting that such compliance is “a necessary but not a sufficient condition for a regulation to be upheld.”
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