TAX CONTROVERSY 360
TAX CONTROVERSY 360
McDermott Will & Schulte’s real-time tax disputes insights
TAX CONTROVERSY 360
McDermott Will & Schulte’s real-time tax disputes insights
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Proposed Regulations Address Applicable Adjustments to Stock and Stock Rights under Code Section 305(c)

by | Dec 8, 2016 | ,

In an apparent response to coordination questions raised by comments to proposed regulations under Code Section 871(m) (relating to certain cross-border dividend equivalent payments), the US Department of the Treasury issued proposed regulations on April 12, 2016, (the Proposed Regulations) addressing deemed distributions of stock and stock rights under Code Section 305(c). Among other stated goals, the Proposed Regulations attempt to “resolve ambiguities concerning the amount and timing of deemed distributions that are or result from adjustments to rights to acquire stock.” The Proposed Regulations also provide guidance to withholding agents regarding the current withholding and information reporting obligations under chapters three and four with respect to such deemed distributions.

In the latest issue of the Journal of Taxation of Financial Products, we have published an article outlining the Proposed Regulations, describing the types of transactions, including adjustment events, giving rise to deemed distributions with respect to stock rights, as well as describing the amount and timing thereof. A companion article in this issue of the Journal addresses the related withholding and information reporting considerations.

As discussed in the article, the Proposed Regulations, while not answering all pertinent questions, attempt to provide clarity on the question of whether certain adjustments with respect to stock rights result in deemed distributions for purposes of Code Sections 305(b) and 301. It will be interesting to see whether the regulations are finalized in their current form or will be subject to extensive comments and potentially re-proposed. It is worth noting that a number of comments to the Proposed Regulations have already been submitted, largely seeking clarifications on certain aspects of the Proposed Regulations. However, some of the comments submitted to date suggest that the regulations are inappropriate and should not be adopted, based largely on the notion that the adjustments at issue do not result in an accretion to wealth in many instances, and thus should not result in taxable income. A critical question regarding the timing and content of final regulations may ultimately depend on the views of withholding agents as to the withholding and reporting provisions.



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Tax Court Inconsistent on IRS’s Use of ‘Secret Subpoenas’

by | Dec 7, 2016 | , ,

We have previously written about Judge Mark V. Holmes’ dislike of the Internal Revenue Service’s (IRS) practice of issuing subpoenas to non-parties without informing the taxpayer. To recap, Tax Court Rule 147 allows a party to issue a subpoena to a non-party but does not specifically require that prior notice be given to the other side of the issuance of the subpoena. Rather, the subpoena is enforceable as of the beginning of the court’s trial session. In contrast, Fed. R. Civ. Proc. 45 requires notice to other parties before service of non-party subpoenas for the production of documents, information or tangible things.  In two prior orders, Judge Holmes ordered that the IRS must serve on taxpayers all non-party subpoenas together with all responses and documents that the non-parties produced have been in the form of unpublished orders. In his orders, Judge Holmes adopted the notification requirement of Fed. R. Civ. Proc. 45, and explained his rationale for his orders.

Unfortunately for taxpayers, Tax Court orders are not to be treated as precedent under Tax Court Rule 50(f), and therefore are not binding on any other Judge of the Tax Court. This point is illustrated by Judge Carolyn P. Chiechi’s December 2, 2016, orders in six related cases (see, e.g., Tangel v. Commissioner), where she stated that “[a] party that issues a subpoena under Rule 147(a) and/or (b) is not required to give prior notice to the other party.” Judge Chiechi further noted that under the facts and circumstances presented the IRS did not issue the subpoenas to harass, annoy, embarrass, oppress or cause an undue burden on the taxpayers. (more…)



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BEPS Multilateral Agreement

by | Dec 6, 2016 | ,

The most recent element of the ongoing global dispute resolution process is the late November 2016 release of the so-called multilateral instrument (MLI), a cornerstone of the base erosion and profit shifting (BEPS) project. It is an ambitious effort of the Organization for Economic Cooperation and Development (OECD) to impose its will on as many countries as possible. The explanation comprises 85 single-spaced pages and 359 paragraphs. The MLI draft itself is 48 similar pages. The purpose of the MLI is to facilitate implementation of the BEPS Action items without having to go through the tedious process of amending approximately two thousand treaties.

In essence, the MLI implements the BEPS Action items in treaty language. While consistency is obviously an intended result, the MLI recognizes the reality that many countries will not agree to all of the provisions. Accordingly, countries are allowed to sign the agreement, but then opt out of specific provisions or make appropriate reservations with respect to specific treaties. This process is to be undertaken via notification of the “depository” (the OECD). Accordingly, countries will be able to make individual decisions on whether to update a particular treaty using the MLI.

(more…)



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Transfer Pricing Compensating Adjustments: Another IRS Loss

by | Dec 5, 2016 | , ,

Following the resolution of a transfer pricing adjustment, there are inevitable compensating adjustment issues to be addressed. Revenue Procedure 99-32 provides the guidelines. A frequent issue concerns whether the “account” that can be elected constitutes “related-party indebtedness” for other purposes of the Internal Revenue Code. One issue has related to the long-since expired provisions of Section 965 relating to repatriations (which may arise from the dead in the Trump administration). In Notice 2005-64, the IRS indicated that it does without any analysis.

In BMC Software, Inc. v. Commissioner, 115 AFTR 2d 2015-1092 (5th Cir. 2015), the Fifth Circuit reversed a US Tax Court decision in favor of the IRS, finding, in essence, that the transfer pricing closing agreement entered long-after the taxable years in question was not indebtedness for Section 965 purposes. Its plain language interpretation was that under Section 965, “the determination of the amount of indebtedness was to be made as of the close of the taxable year for which the election under Section 965 was in effect.” Accordingly, the accounts receivable could not have existed at the end of the testing period. The court also noted that the taxpayer had not agreed to “backdate” the accounts receivable.

The Tax Court has just agreed to follow the Fifth Circuit opinion in BMC Software. In Analog Devices, Inc. v. Commissioner, 147 T.C. No. 15 (Nov. 22 2016), the Tax Court essentially followed the logic of the Fifth Circuit in a similar situation involving a IRS assertion of the same Section 965 consequence of a subsequent year closing agreement in a transfer pricing case.

Practice Point:  The relationship of closing agreement in transfer pricing cases and compensating adjustments is inevitably complex, especially in situations where there are other debt-related issues in the years in question. If the anticipated tax reform bill again introduces a repatriation incentive, these issues will arise once again. The key will be to address them in closing agreements as best as possible.



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IRS Changes Course on Characterization of Termination Fees

by and | Dec 5, 2016 | ,

Termination fee clauses are commonly incorporated in merger agreements to compensate a party for time and expenses incurred in the event that the deal is not consummated. Where the merger is terminated by one party, the clause generally requires either the target to pay the acquirer a termination fee (if the target terminates), or the acquirer to pay the target a reverse termination fee (if the acquirer terminates). Typically, termination fees range from 1–3 percent of the transaction value, which may result in a cash payment in the billions of dollars depending on the size of the transaction. The tax treatment of termination fees, both in terms of deductibility or income inclusion and the character of the fee as either ordinary or capital, has been the subject of past litigation, Internal Revenue Service (IRS) regulatory action, and informal IRS advice.

Internal Revenue Code (Code) Section 165 allows a deduction for any loss sustained during the taxable year and not compensated for by insurance or otherwise. Section 162 provides deductions for ordinary and necessary business expenses paid or incurred during the taxable year. In contrast, Code Section 263 provides generally that a deduction is not allowed for new buildings or for permanent improvements or betterments made to increase the value of any property of estate. Prior to the promulgation of the INDOPCO regulations, litigation ensued over whether the payor of a termination fee could deduct such payment under Code Sections 162 or 165 or had to capitalize the payment under Code Section 263. In 2003, the IRS promulgated the INDOPCO regulations and specifically addressed the situations under which termination fees could be deducted immediately. For more background on this subject, see here.

The above-referenced litigation and the INDOPCO regulations focused on the deductible versus capital issue and did not address the character a termination fee (either paid or received). However, informal IRS guidance treated termination fees as liquidated damages, and thus ordinary income, arguably because the taxpayer had not sold, exchanged or transferred any capital asset. See, e.g., Private Letter Ruling 200823012 (June 6, 2008), available here and Tech. Adv. Memo. 200438038 (Sept. 17, 2004), available here. In the Private Letter Ruling, the IRS held that Code Section 1234A, which provides that gain or loss attributable to the cancellation, lapse, expiration or other termination of a right or obligation with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer is treated as gain or loss from the sale of a capital asset, did not apply. However, in, recent guidance released in September and October of this year available here and here the IRS reversed course and provided that Code Section 1234A applies to termination fees pursuant to merger agreements. The IRS’s new position is that a target’s stock to which the termination fee relates would have been a capital asset in the hands of an acquirer, had the deal been completed, and that the acquisition agreement provides [...]

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Todd Welty Named ‘MVP of the Year’ for Tax Law

by | Dec 2, 2016 |

McDermott is proud to announce that Todd Welty has been chosen by Law360 as a 2016 “MVP of the Year” in the category of tax law. Mr. Welty’s selection is part of a Law360 series profiling lawyers who have made the most significant contributions in their areas of practice.

This is Mr. Welty’s second time winning this prestigious award, as he was previously selected as an MVP in 2014. Mr. Welty was one of only five lawyers selected in the tax category, and one of only 177 lawyers selected throughout all practice areas nationwide. His outstanding achievements in this area of law were featured in an individual profile published on December 1, 2016.

Mr. Welty was praised by Law360 for his exceptional tax controversy and litigation work.  In his role as co-chair of McDermott’s Tax Controversy practice, he has the ability to tap an extensive pool of talent, enabling him to assemble second-to-none teams of tax controversy and technical tax professionals. Mr. Welty is well known for his track record of winning difficult cases and his strategic resolution of high-stakes tax matters.

Read the full coverage of Todd Welty in Law360.



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December 2016 Changes to the Federal Rules of Civil and Appellate Procedure: Electronic Service and Word Counts

by | Dec 1, 2016 | , , ,

December 1 is an important day for federal litigators and for tax practitioners with cases pending in federal district and appellate courts. It brings with it changes to the rules governing their day-to-day practices. This year, those changes are few and simple but important.

First, electronic service no longer entitles litigants to three extra days to respond to something. Items not served personally have historically triggered what many practitioners referred to as a “mailbox rule” of three extra days to respond to the item, and the concept appears in Federal Rule of Civil Procedure 6(d) and Federal Rule of Appellate Procedure 26(c). For many years, items served electronically were inexplicably treated (contrary to fact) as if they were not delivered immediately. That is no longer the case. The rules have caught up to technology, and in district court and the courts of appeals serving an item by email or using the electronic case filing (ECF) system’s notice function will not give one’s adversary additional time to respond unless a local rule preserves the status quo, as Eastern District of Texas Rule of Civil Procedure 6 does.

Second, the courts of appeals have moved almost entirely to word-count limits for papers. For many years now, litigants did not have to comply with page limits for briefs if their papers complied with certain word-count limits. Other papers, however, such as motions and petitions had only page-count limits. Several applicable appellate rules (21 [mandamus petitions], 27 [motions], 29 [amicus briefs], 35 [rehearing en banc petitions], and 41 [rehearing petitions]) have been amended to include word-count limits. In addition, the word counts for briefs have been reduced from 14,000 to 13,000 for opening, response, and cross-appeal response-and-reply briefs; 16,500 to 15,300 for cross-appeal opening-and-response briefs; 7,000 to 6,500 for reply briefs.  Please see McDermott’s modified table showing the applicable word limits for the most common pleadings. These reductions were controversial when proposed and many circuits have opted out of them, as indicated in their local rules. E.g., 7th Cir. R. App. P. 32(c).

Finally, appellate practitioners need to determine how courts are implementing the changes. Some courts are applying the old rules to appeals docketed before December 1, 2016, and the new rules to ones docketed on or after December 1, 2016. Others are using the setting of the briefing schedule as the line of demarcation, and some appear willing to modify the rules in the middle of a briefing schedule.

Practice Note:  In light of these changes, now is a good time to review the local rules of the federal courts where your cases are pending or where you typically practice to ensure you are not dropping any deadlines or failing to meet your word counts.



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Court Holds Compensation Paid to Four Sons Was Not Reasonable

by and | Nov 30, 2016 | , ,

Reasonable compensation is a fact based analysis, and once again has been decided against the taxpayer. In Transupport, Inc. v Commissioner, T.C. Memo. 2016-216, the issue presented for decision was whether amounts deducted by the taxpayer, a distributor and supplier of aircraft engines and parts, during 2006‒2008 as compensation that was paid to the four sons of taxpayer’s president and majority shareholder were reasonable and deductible pursuant to Internal Revenue Code (IRC) Section 162 and whether accuracy related penalties applied. In 2005, the president and 98-percent owner of Transupport, gifted and sold shares in equal percentages to his four sons. The president and his four sons were the sole employees and officers for the tax years at issue. The president determined the compensation payable to his sons without consultation with his accountant or anyone else, and the only factors considered were reduction of reported taxable income, equal treatment of each son and share ownership. (more…)



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IRS Announces New Chief of IRS Appeals

by and | Nov 29, 2016 | ,

In further changes to the Internal Revenue Service (IRS) Appeals Division, it was recently announced that Donna C. Hansberry will replace Kirsten B. Wielobob as chief of IRS Appeals. Ms. Hansberry is currently the deputy commissioner of the Tax Exempt and Government Entities Division. She started as a trial attorney for the IRS Office of Chief Counsel in 1987 and was previously assistant to the commissioner (attorney-advisor for tax). Ms. Weilobob will move to the position of deputy commissioner for services and enforcement.

There have been very significant changes to IRS Appeals during the last several months that challenge whether the division will continue to be a successful tool for taxpayers and the IRS to resolve difficult cases that are stuck at the Exam Division. The “changing of the guard” may be a sign of more changes to come. Indeed, Ms. Hansberry was formerly a trial attorney and was in charge of the Joint International Tax Shelter Information Centre, director of global high wealth and abusive transactions. For prior coverage on changes at IRS Appeals, see our previous articles:

“More Changes to IRS Appeals Procedures”

“IRS Appeals – Changes Afoot?”

“IRS Updates Rules Regarding Appeals Conferences”



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Attorney Cannot File Petition to Recover Administrative Costs under Section 7430

by | Nov 22, 2016 | ,

In Greenberg v. Commissioner, 147 T.C. No. 13 (2016), an attorney sought the award of administrative costs (i.e., his attorney’s fees) for an earlier administrative proceeding in which he represented a taxpayer before the Internal Revenue Service. The attorney was owed fees for his representation of the taxpayer that remained outstanding, and the taxpayer agreed that the attorney would receive any administrative fees awarded under Internal Revenue Code Section 7430. The US Tax Court, however, held that because the attorney was not a party to the underlying administrative proceeding, the attorney could not be a “prevailing party,” which was required for an award of administrative costs under Section 7430. As such, the attorney was not the proper party to file a petition for fees under Section 7430, and thus, the court dismissed the case for lack of subject matter jurisdiction.



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