Tax Update

Tax Update

In this section of Jnet, we provide brief updates on legislative, judicial, and administrative developments in tax that may impact Japanese companies operating in the United States.

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April 2015

White House Transmits Japan Protocol to Senate

On April 13, the White House announced that a new Protocol to amend the income tax treaty between the United States and Japan has been transmitted to the Senate.

The Protocol was signed in January 2013 and, once ratified and with its entry into force, would amend the existing United States-Japan income tax treaty (2003) so as to bring that agreement into closer conformity with the current tax treaty policies of both the United States and Japan. The Protocol with Japan now joins other tax treaties and Protocols that are pending action by the Senate—agreements with Switzerland, Luxembourg, Hungary, Chile, Poland, and Spain, and a Protocol amending the OECD convention on mutual administrative assistance in tax matters.

The Senate Foreign Relations Committee has approved and reported five tax treaties and Protocols (agreements with Switzerland, Luxembourg, Hungary, Chile, and the OECD) for action by the full Senate. Historically, unanimous consent motions are the customary procedure for Senate approval of tax treaties, so any senator may prevent approval by objecting. A two-thirds vote after unlimited debate is otherwise required by the Treaty Clause of the U.S. Constitution for ratification. In May 2014, Sen. Rand Paul (R-KY) objected to unanimous consent motions concerning Senate approval of the Protocol to amend the income tax treaty with Switzerland.

NYC Conformity Provisions Enacted

A package of legislation that conforms New York City corporate and banking tax laws to reforms enacted for State purposes last year and makes technical corrections to last year's New York State tax reforms was signed into law by New York State Governor Cuomo. The new legislation is effective retroactively to tax years beginning on or after January 1, 2015.

Like in case of New York State tax reform last year, New York City's general corporate taxis merged with its bank tax. The new City corporate tax, to a considerable extent, mirrors the revised New York State Corporate Franchise Tax and includes the following:

  • Taxpayers will pay the highest of (1) tax on business income allocated to New York City, (2) tax on business capital allocated to New York City, or (3) fixed-dollar minimum tax based on New York City source receipts. The subsidiary capital tax is repealed.
  • Entire net income tax base and net operating loss (NOL) provisions are substantially revised. 
  • New customer-based sourcing rules and an 8% election for receipts from qualified financial instruments for receipts factor apportionment purposes are introduced.
  • Unitary combined reporting provisions are introduced. The "substantial intercorporate transactions" requirement as a prerequisite to filing a combined return is repealed.

There are certain areas, however, where the City will not conform to New York State law. Most of the areas of non-conformity involve rates.

House Passes Permanent Sales Tax Deduction, Estate Tax Repeal

On April 16, the House of Representatives passed bills that would (1) make permanent a provision to allow individual taxpayers to elect to deduct state and local sales taxes (H.R. 622, State and Local Sales Tax Deduction Fairness Act of 2015) and (2) repeal the federal estate tax (H.R. 1105, Death Tax Repeal Act of 2015).

H.R. 622, which passed the House with a 272-152 vote, would make permanent the ability to elect to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes. A version of this provision was made part of the Code on a temporary basis in 2004 and has been the subject of a number of extensions since. Most recently, the provision was made applicable to taxable years beginning before January 1, 2015, as part of the Tax Increase Prevention Act of 2014.

The Death Tax Repeal Act of 2015 was passed by the House with a 240-176 vote. The bill would repeal the estate and generation-skipping transfer (GST) taxes for decedents dying after or transfers made after the enactment of the bill. The bill would not repeal the gift tax but would lower the top marginal gift tax rate to 35%. The lifetime exemption would remain at $5 million (as adjusted for inflation for years after 2011). The bill would not change the current rules for determining tax basis of property received from a decedent or by gift; thus, the basis of property acquired from a decedent's estate generally would continue to be stepped-up.

While the U.S. Senate's plans regarding these bills are unclear at this time, the Obama Administration released Statements of Administrative Policy stating that the administration "strongly opposes" both bills.

Regulations - Allocation of Research Credit Among Members of Controlled Group

On April 2, the Treasury Department and IRS released temporary regulations (T.D. 9717), and by cross-reference, proposed regulations (REG-133489-13) concerning allocation of the research credit to members of a controlled group.

All members of a controlled group are treated as a single taxpayer for purposes of computing the research credit. As the research credit is computed on a group-wide basis, the group credit must be allocated among its members.

For tax years beginning prior to January 1, 2012, regulations required an allocation of the group credit in a two-step procedure:

  • First, in proportion to each member's stand-alone entity credit, to the extent that the group credit does not exceed the sum of the stand-alone entity credits of all of the members; and 
  • Second, if the group credit exceeds this sum, by allocating the excess group credit in proportion to the "qualified research expenses" or QREs of the members of the controlled group. 

A provision of the American Taxpayer Relief Act of 2012 (enacted January 2, 2013) requires the allocation of the group credits to each controlled group member based on its share of the QREs for tax years ending after December 31, 2011. In March 2013, the IRS issued Notice 2013-20 providing that controlled groups must allocate the group credit to each member in proportion to each member's contribution of QREs for the tax year without regard to the stand-alone credit amounts of the members.

The temporary regulations released at this time follow the allocation approach in Notice 2013-20. Group members are no longer required to calculate a stand-alone entity credit. The temporary regulations are effective for tax years beginning on or after April 3, 2015 and are scheduled to expire on April 2, 2018. A taxpayer may apply the temporary regulations for tax years beginning after December 31, 2011 but before April 3, 2015. If a taxpayer decides not to apply the temporary regulations for a tax year beginning after 2011 and before April 3, 2015, the provisions of Notice 2013-20 are to apply.

March 2015

2014 APA Statistics Released

On March 30, the IRS released the advance pricing agreement (APA) statistics for calendar year 2014.

Number of Cases:

  2014 Cumulative

(Since 1991) 
Unilateral Bilateral Multilateral Total
Applications Filed 31 74 3 108 1,964
Executed New 11 42   53 885
Renewal 9 39   48 516
Pending Requests   New 34 149 4 187 N/A
Renewal 28 119 2 149 N/A
Canceled or Revoked 0 0 0 0 11
Withdrawn 0 1 0 1 190

Average Number of Months to Complete:

  New Renewal Combined
Unilateral 26.7 36.9 31.3
Bilateral 44.2 35.7 35.7
Combined 40.5 35.9 35.9

From 2013 to 2014, the number of applications filed slightly decreased from 111 to 108 while the number of cases executed significantly decreased from 145 to 101, resulting in slight increase in the number of pending cases from 331 to 336.

Of the total number of bilateral APAs executed in 2014, 47% of the cases were agreed between the U.S. and Japan, with the other three treaty countries with significant activity being Canada (15%), the United Kingdom (10%), and Korea (8%).

Budget Resolutions Approved by House and Senate

Both the House and the Senate passed their respective versions of the budget on a mostly party-line basis, congressional leaders have set in progress a bicameral negotiation which will begin when an expected conference committee is convened after Congress returns to Washington in early April 2015. The Budget Act provides for final action on the resolution by May 15 although there are no consequences for failure to meet that deadline.

A congressional budget resolution, provided the House and Senate agree to a final version, would establish revenue targets for future appropriations and tax legislation. A budget resolution does not appropriate funds or change tax law, and it is not signed by the president.

The House passed its budget on March 26, after considering several alternative budgets offered by a number of members. The final budget adopted by the House was very similar to the budget approved by the House Budget Committee and include the following tax reform proposals:

  • Lower rates for individuals, corporations, and passthrough entities (with a goal of reducing the top individual and corporate tax rates to 25%)
  • Repeal of the alternative minimum tax
  • Transitioning away from a worldwide tax system to "a more competitive international tax system"
  • "Broadening the tax base by closing special interest loopholes that distort economic activity"
  • Repeal of "Obamacare" in its entirety, including all the tax increases, mandates, and subsidies included in that legislation

The House budget calls on the Ways and Means Committee to report legislation within its jurisdiction that would have the effect of reducing the deficit $1 billion over 10 years (using macroeconomic estimates), but without increasing revenue relative to current law.

The Senate passed its version of a budget on March 27. During the long floor deliberation, the Senate adopted several dozen amendments to the version of the bill passed by the Senate Budget Committee, including a few amendments that were focused on tax-related matters.

The original proposed budget resolution released by the Senate Budget Committee included the following:

  • A $5.1 trillion reduction in spending over the 10-year budget window
  • Revising spending and revenue targets of various Senate committees to take into account legislation relating to tax reform, extending certain (unspecified) expired tax provisions, and repealing the medical device excise tax
  • Repealing "Obamacare"
  • Requiring the Joint Committee on Taxation to provide a macroeconomic estimate of "major" tax legislation—in addition to the "conventional" revenue estimate
  • Changing certain Senate procedural rules relevant to tax legislation

Among the amendments to the budget resolution adopted by the Senate were those addressing the following tax-related issues:

  • Support for extending and expanding refundable tax provisions that benefit working families, childless workers, and the middle class
  • Opposition to federal taxes or fees imposed on carbon emissions from any product or entity that is a direct or indirect source of emissions
  • Support for permanently increasing the maximum amount of the section 179 small business expensing allowance to $1 million and the investment limitation to $2.5 million and indexing them both for inflation
  • Support for an undefined decrease in the corporate income tax as a method for preventing U.S. jobs from being moved overseas
  • Repeal of the federal estate tax

Democratic Report on Tax Avoidance Strategies

On March 3, coinciding with a Senate Finance Committee hearing focusing on "tax fairness," ranking member Senator Ron Wyden (D-OR) released a report that identifies the six strategies identified by his staff as "tax avoidance" as well as broad policy and regulatory recommendations by his tax staff to address some of these strategies. Among the items listed in Senator Wyden's report as tax avoidance strategies are the following:

  • Using collars to avoid paying capital gains taxes
  • Using wash sales to time the recognition of capital income
  • Using derivatives to convert ordinary income to capital gains or convert capital losses to ordinary losses
  • Using derivatives to avoid constructive ownership rules for partnership interests
  • Using basket options to convert short-term gains into long-term gains
  • Avoiding income taxes under nonqualified deferred compensation plans.

February 2015

Tax Proposals in FY 2016 Budget

On February 2, President Obama transmitted to Congress his fiscal year (FY) 2016 budget, containing the administration's recommendations to Congress for spending and taxation for the fiscal year that begins on October 1, 2015.

Overview:

The president proposes expenditures for discretionary programs $74 billion above the spending caps set in the Budget Control Act of 2011, divided roughly equally between defense ($561 billion) and nondefense ($530 billion) discretionary programs.

The president also proposes a six-year $478 billion program for transportation infrastructure, the cost of which would be offset in part by a one-time tax on the unrepatriated foreign earnings of U.S. multinational corporations. The tax on unrepatriated earnings would be part of a transition to a proposed fundamental change in the taxation of the future foreign earnings of U.S. corporations, which would be taxed on a current basis at a reduced rate.

The president proposes reducing the corporate income tax rate to 28%, but the budget does not provide revenue to offset the cost of such a reduction. Instead, the budget refers only to eliminating tax expenditures, such as accelerated depreciation and "reducing the tax preference for debt financed investment."

For individuals, the president proposes to increase the rate of tax on capital gains for certain high earning individuals. In addition, bequests and gifts would be treated as realization events for purposes of taxing capital gains—a fundamental change in the taxation of estates.

Business tax provisions:

Many business tax proposals in the FY 2016 budget are familiar, having been included in previous budgets, such as:

  • Reforms to the international tax system
  • Limiting the ability of domestic entities to expatriate
  • Repeal of natural resources production preferences
  • Repeal of LIFO and LCM accounting
  • Taxation of carried interests in partnerships as ordinary income
  • Insurance industry reforms
  • Marking financial derivatives to market
  • Modification of the like-kind exchange rules
  • Modification of the depreciation rules for corporate aircraft
  • Denying a deduction for punitive damages
  • Make permanent and reform the credit for research and experimentation
  • Make permanent the Subpart F exception for active financing income
  • Make permanent look-through treatment of payments between related CFCs

Some previous proposals have been modified significantly.

The rate of tax on the liabilities of financial institutions with assets in excess of $50 billion would be reduced from 17 basis points to 7 basis points, but the application of the tax would be broadened to include insurance companies, savings and loan holding companies, exchanges, asset managers, broker-dealers, specialty finance corporations, and financial captives. These changes have roughly doubled the revenue relative to the proposal in the FY 2015 budget.

The FY 2016 budget also includes a number of new and significant proposals. Chief among these is a fundamental reform of the system of taxation of the foreign earnings of U.S. companies, which would raise $474 billion over 10 years. In place of the current system of deferral, the budget proposal would impose a minimum tax on foreign earnings above a risk-free return on equity invested in active assets. The minimum tax, imposed on a country-by-country basis, would be set at 19% less 85% of the per-country foreign effective tax rate. The new minimum tax would be imposed on a current basis, and foreign earnings could then be repatriated without further U.S. tax liability.

As part of the transition to the new system of taxation of foreign earnings, the budget would also impose a one-time 14% tax on earnings accumulated in CFCs that have not previously been subject to U.S. tax. A foreign tax credit would be allowed for foreign taxes associated with those earnings, reduced in proportion to the one-time tax rate relative to the maximum corporate rate. The transition tax would be payable ratably over five years.

Individual tax revisions

As in the case of businesses, many of the individual (personal) tax proposals in the budget are familiar, including:

  • Limit the tax value of certain deductions and exclusions to 28%
  • Impose a new minimum tax (the "Fair Share Tax") of 30% of AGI
  • Limit the total accrual of tax-advantaged retirement benefits
  • Conform SECA taxes for professional service businesses
  • Restore the estate, gift, and GST parameters to those in effect in 2009

One of the key sets of revisions proposed by the president involves reforms to the taxation of capital gains for upper-income taxpayers, which would offset the cost of extension and expansion of tax preferences for middle and lower-income taxpayers. The highest tax on capital gains would be increased from 23.8% (including the 3.8% net investment income tax) to 28%. In addition, a transfer of appreciated property would generally be treated as a sale of the property. Thus, the donor or deceased owner of an appreciated asset would be subject to capital gains tax on the excess of the asset's fair market value on the date of the transfer over the transferor's basis. The proposal provides a $100,000 per-person exclusion for gains realized by reason of death, and it would continue the current law exclusion for principal residences. Relief would also be provided for small businesses. These changes would raise about $208 billion over 10 years.

Revenue from imposition of new taxes on upper-income taxpayers would be used in part to offset tax preferences to middle and lower-income taxpayers, such as:

  • Increasing the maximum child and dependent care credit
  • Permanently extending increased refundability of the child tax credit
  • Expanding and making permanent the earned income tax credit
  • Creating a new $500 "second earner" tax credit
  • Permanently extending the American Opportunity Tax Credit

Treasury's explanation:

The Treasury Department on February 2 released an accompanying explanation of the tax proposals of the budget—Treasury's Green Book—which describes those proposals in greater detail.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the authors only, and do not necessarily represent the views or professional advice of KPMG.

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