President Trump released his budget proposal for the 2018 FY on May 23, 2017, expanding on the budget blueprint he released in March. The budget proposal and blueprint reiterate the President’s tax reform proposals to lower the business tax rate and to eliminate special interest tax breaks. They also provide for significant changes in energy policy including: restarting the Yucca Mountain nuclear waste repository, reinstating collection of the Nuclear Waste Fund fee and eliminating DOE research and development programs.
Taxpayers can choose whether to litigate tax disputes with the Internal Revenue Service (IRS) in the US Tax Court (Tax Court), federal district court or the Court of Federal Claims. Claims brought in federal district court and the Court of Federal Claims are tax refund litigation: the taxpayer must first pay the tax, file a claim for refund, and file a complaint against the United States if the claim is not allowed. Claims brought in the Tax Court are deficiency cases: the taxpayer can file a petition against the IRS Commissioner after receiving a notice of deficiency and does not need to pay the tax beforehand.
As demonstrated in the chart below, approximately 97 percent of tax claims are instituted in the Tax Court. It should be noted that, after a taxpayer files a petition in Tax Court, the taxpayer no longer has the option of bringing the claim in any other court for the year(s) at issue.
Tax Court Versus Tax Refund Litigation
On April 5, 2017, in an unanimous court reviewed opinion, the United States Tax Court determined that disclosure of a worker’s tax return information to absolve the employer from liabilities arising out of the employer’s withholding requirement is not subject to the general prohibition against disclosing taxpayer return information pursuant to Internal Revenue Code (IRC) Section 6103, and does not shift the burden of proof to the Internal Revenue Service (IRS).
In Mescalero Apache Tribe v. Commissioner, 148 T.C. 11 (2017), the IRS determined that a number of the Mescalero Apache Tribe’s workers were not independent contractors, but employees. If the IRS prevailed in its worker reclassification determination then, as the employer, the Mescalero Apache Tribe would be jointly and severally liable for Federal income tax that should have been withheld on the workers’ earnings. To prevent double taxation, IRC Section 3402(d) provides that the IRS cannot collect from the employer the withholding tax liability if the employees have already paid income tax on their earnings. To prove its position that the workers were independent contractors and alternatively to reduce any potential withholding tax liability if the workers were classified as employees, the Mescalero Apache Tribe asked each worker to complete Form 4669, Statement of Payments Received. However, the Mescalero Apache Tribe had trouble locating each of its workers because many had moved or lived in hard-to-reach areas without phone service or basic utilities. Continue Reading IRS is Required to Search Tax Return Information Records to Help Determine Worker Classification
“The IRS and Treasury recently issued final regulations under Code Sec. 367(a)and (d) that make a monumental change in how those provisions have applied since they were enacted over 30 years ago. For the first time, the regulations subject to taxation the otherwise tax free transfer of foreign goodwill and going concern value by a domestic corporation to a foreign subsidiary for use in a trade or business outside the United States.”
Originally published in CCH International Tax Journal (Note from the Editor in Chief)
The Treasury and IRS recently issued final regulations under §385 that reclassify certain indebtedness as equity. While the final regulations have limited application to U.S.-based multinationals, they do apply to obligations of domestic corporations to related controlled foreign corporations (‘‘CFCs’’). It is critical to avoid such debt being reclassified as stock under the regulations because of the significant adverse U.S. tax consequences.
Originally published in Bloomberg BNA Tax Management International Journal, February 10, 2017.
The US Court of Federal Claims awarded damages of more than $206 million to the plaintiffs in a case involving the cash grant program pursuant to Section 1603 of the American Recovery and Reinvestment Act of 2009 (the Section 1603 Grant). In its opinion, published on October 31, 2016, the court held that the US Treasury Department (Treasury) had underpaid the Section 1603 Grants arising from projects in the Alta Wind Energy Center because it had incorrectly reduced the plaintiffs’ eligible basis in the projects. The court rejected the Treasury’s argument that the applicants’ basis in the facilities was limited to only development and construction costs, and accepted the plaintiffs’ position that the arm’s length purchase price of the projects prior to their placed-in-service date was a reasonable starting point to determine the projects’ value. The court determined that the facilities, having not yet been placed in service and having only one customer pursuant to a master power purchase agreement (PPA), could not have any value assigned to goodwill or going concern value which would reduce the amount of eligible costs for purposes of the Section 1603 Grant. The court noted that the transactions surrounding the sales of the facilities were conducted at arm’s length by economically self-interested parties, and that the purchase prices and side agreements were not marked by “peculiar circumstances” that influenced the parties to agree to a price in excess of the assets’ value. Importantly, the court also held that PPAs were more like land leases, and should not be viewed as separate intangible assets from the underlying facilities, and are thus eligible property for purposes of the Section 1603 Grant. Finally, the court accepted the plaintiffs’ pro rata allocation of costs between eligible and ineligible property.
An interesting side note to the trial was the court’s refusal to allow the government’s economics expert to testify. According to the court’s procedural rules, experts are required to list “all publications authored in the previous ten years.” During voir dire, the expert confirmed that he had provided a listing of all of his articles, not just the ones that he had published in the last 10 years. The plaintiffs’ counsel also introduced a report that the government’s expert had authored in another case, and the expert also confirmed that the second report had a listing of all of his articles. However, during trial, the plaintiffs’ counsel exposed that the government’s expert had “attempted to conceal articles he wrote for Marxist and East German publications.” While the hidden articles had nothing to do with the testimony he was prepared to give to the court, nonetheless, the court refused to admit him as an expert and to testify explaining “[t]he Court simply could not rely on the substantive expert testimony of a witness who was untruthful in describing his background and qualifications.” As a result, the government had no expert to rebut the plaintiffs’ case and to support its counterclaims against the plaintiffs.
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.
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.
On April 18, 2016, the Supreme Court denied certiorari in the foreign tax credit dispute involving Albemarle Corp. We have previously written about the case here, here, and here, which involved the timeliness of claims for refund pursuant to Internal Revenue Code (IRC) section 6511(d)(3)(A)’s 10-year limitations period.
Generally, a taxpayer must file a claim for refund within the later of three years from the time the original return was filed, or two years from the time the tax was paid. Congress extended this period for refund claims related to foreign tax credits (FTC). IRC section 6511(d)(3)(A) extends the refund limitation period to “10 years from the date prescribed by law for filing the return for the year in which such taxes were actually paid or accrued.” Before IRC section 6511(d)(3)(A) was amended in 1997, the statute required that refund claims be made within 10 years from the date prescribed by law for filing the return for the year with respect to which the claim was made.
In the Albemarle case, the taxpayer filed refund claims related to foreign taxes paid that were more than 10 years after the date the tax returns for the years were due, without extension. The taxpayer argued that the plain language of the statute permitted it to file a claim for refund within 10 years from the date the payment was in fact (actually) made, which was less than 10 years before the claims were filed. Both the US Court of Federal Claims and the Federal Circuit disagreed, with the latter holding that the term “actually … accrued” is ambiguous and that Congress intended that the relevant period commenced on the due date of the original returns.
Taxpayers with a similar fact pattern to Albemarle, and who desire to dispute the holding in that case, will want to file suit in local district court to avoid the negative precedent and hope that a court not bound by the Federal Circuit will reach a different decision. Taxpayers may also want to consider filing protective refund claims in situations where it does not appear that a tax payment to a foreign jurisdiction will actually be made (and there will be enough time to file a formal refund claim with the IRS) within 10 years from the date the US federal income tax return was filed to avoid the situation in Albemarle.
Effective May 1, 2016, the Internal Revenue Service (IRS) will begin applying previously announced changes to the Large Business & International (LB&I) Division’s examination process. Publication 5125 begins by setting forth expectations for the LB&I exam team and the taxpayer or its representatives. It then addresses IRS expectations regarding refund claims. Finally, the publication discusses the three stages of the LB&I examination process—planning, execution and resolution—and how the IRS and taxpayers should conduct themselves during each stage.
The IRS had previously released draft publication 5125 in November 2014, which concerned some taxpayers, particularly with respect to the statement that informal refund claims would only be accepted within 30 days of the opening conference. Final Publication 5125 retains the 30-day period for making informal refund claims, but provides that LB&I will not require a formal claim after the 30-day period if an issue has been identified for examination (unless IRS published guidance specifically requires a formal claim). Exceptions may also be granted by LB&I senior management.
Publication 5125 also made changes to the examination process based on the recent shift to an issue-based audit approach. The case manager will have overall responsibility for the case, which may be beneficial to taxpayers involved in recent audits where domestic and international personnel appeared to share responsibility for the conduct of the audit. Factual and issue development are also heavily stressed, with an emphasis on the information document request (IDR) process and a focused and useful examination plan. The publication also states that IRS team members are expected to seek the taxpayer’s acknowledgment of the facts and to resolve any disputes prior to the issuance of Form 5701, Notice of Proposed Adjustment.
Taxpayers should review Publication 5125 to familiarize themselves with the current audit process and to ensure that IRS team members are following the guidance. To the extent an IRS team member is not following the guidance, taxpayers should not hesitate to discuss the matter with the team manager.