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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July 2015

"Highway Bill" Signed into Law

On July 31, President Obama signed H.R. 3236, Surface Transportation and Veterans Health Care Choice Improvement Act of 2015.

H.R. 3236 provides funding and authorizes spending with respect to the highway trust fund through October 29, 2015. In addition to measures concerning TSA fees and veterans' health issues, the bill includes a number of tax-related provisions to raise approximately $5 billion in revenue to offset the cost of the additional months of spending for surface transportation as follows:

  • The bill generally would modify the schedule for filing tax returns to: (1) March 15 (or two and a half months after the close of the tax year) for partnerships and S corporations; and (2) April 15 (or three and a half months after the close of the tax year) for C corporations. The bill would direct the Secretary of Treasury to modify the rules governing extensions for returns for C corporations, partnerships, trusts, employee benefit plans, tax exempt organizations, and others. 
  • The bill would require estates with positive estate tax liability to report to both the IRS and the appropriate heirs the value, on the owner's death, of bequeathed property. 
  • The bill would require mortgage lenders to expand Form 1098 reporting to include: (1) the origination date, (2) outstanding principal, and (3) the property address that relate to the reported mortgage interest expense.
  • The bill would provide that an overstatement of basis is an omission of gross income for purposes of determining whether a substantial income omission was made on the return triggering the extended six-year statute of limitation.
  • The bill would extend the ability of employers to transfer excess defined benefit plan assets to retiree medical accounts and retiree group-term life insurance through 2025. Originally enacted in 2012, the underlying provision currently expires on December 31, 2021.

In addition to these revenue offsets, the bill would decrease the excise tax on LNG and LPG to 14.1 cents per gallon (down from 24.3 cents) and 13.2 cents per gallon (down from 18.3 cents), respectively, for sales or use of fuel after December 31, 2015

Draft Proposal for Innovation Box

Two senior members of the Ways and Means Committee—Rep. Charles Boustany (R-TX) and Rep. Richard Neal (D-MA)—have released for public comment a discussion draft and technical explanation of an "innovation box" proposal.

The innovation box draft proposal would substantially lower the rate of tax for a corporation with respect to dispositions of intellectual property (IP) and products produced using IP. The proposal would establish a special deduction equal to 71% of the lesser of the taxpayer's innovation box profit or taxable income for the tax year. This would result in an effective tax rate of approximately 10% on innovation box profits. However, the deduction could not be taken into account in computing any net operating loss and therefore could not create, or increase, the amount of a net operating loss deduction.

The international tax reform working group of the Senate Finance Committee, in its final report (July 7, 2015), included among its recommendations the adoption of an innovation box regime. The working group's report noted that some 11 countries have adopted such regimes, and that an apparent consensus has been reached in connection with the OECD's base erosion and profits shifting (BEPS) project around a modified nexus approach that would permit innovation box regimes. An early change to U.S. tax policy is necessary, the authors of the working group's report wrote, to prevent these shifts in the international landscape from leading to "…a significant detrimental impact on the creation and maintenance of intellectual property in the United States, as well as on the associated domestic manufacturing sector, jobs, and revenue base."

Ways and Means Members Propose to Reform Partnership Audit Rules

The Ways and Means Committee members, Rep. Renacci (R-OH) and Rep. Kind (D-WI) introduced H.R. 2821, the Partnership Audit Simplification Act, a bill that would reform the partnership audit rules.

H.R. 2821 in general would replace the existing partnership audit procedures established by the Tax Equity and Fiscal Responsibility Act (TEFRA) and the "electing large partnership" audit rules with a single set of rules. If enacted, H.R. 2821 generally would be effective for partnership tax years ending after 2018, with partnerships permitted to elect to apply the new rules for any partnership year beginning after date of enactment.

H.R. 2821 is largely similar to proposed changes included in the tax reform bill introduced by former Ways and Means Chairman Dave Camp (R-MI) in the last Congress. Although the Obama Administration has not yet expressed an official position on H.R. 2821, the administration's budget proposals for FY 2016 also include a similar proposal. Because H.R. 2821 can be expected to be estimated as raising revenue, members of Congress might consider using it to offset costs of other legislation.

New York: Guidance on Identifying Investment Capital

New York State Department of Taxation and Finance issued a technical memorandum outlining the identification requirements for Article 9-A taxpayers with investment capital.

Under New York's recent corporate tax reform (effective for tax years beginning on or after January 1, 2015), net investment income from qualifying investment capital is excluded from a taxpayer's business income. Similarly, investment capital is excluded from a taxpayer's business capital tax base.

To qualify, investments in non-unitary corporate stock must: 1) qualify as a "capital asset" under IRC section 1221; 2) be held for investment for more than one year; 3) generate long-term capital gain or loss under the IRC if disposed of; 4) for stock acquired on or after January 1, 2015, have never been held for sale to customers in the regular course of business; and 5) before the close of the day on which the stock was acquired, be clearly identified in the corporation's records as stock held for investment in the same manner as required under IRC section 1236(a)(1).

The technical memorandum sets forth the procedures required to satisfy the identification requirement for investment capital. Taxpayers generally are required to perform identification procedures with regard to stock and options currently held that may qualify as investment capital before October 1, 2015. Taxpayers also need to consider procedures that allow for proper identification of stock acquired on or after October 1, 2015, as investment capital before the close of the day on which such stock was acquired.

Washington State: Changes relating to B&O Tax, Nexus, Unclaimed Property

On July 8, the governor of the State of Washington signed into law legislation that makes changes to the state's business and occupation (B&O) tax and sales and use tax statutes, including:


  • Repeal of the preferential B&O tax rate for royalty income
  • B&O tax nexus changes
  • Introduction of click-through nexus rules
  • Changes in sales and use tax exemption rules on manufacturing and R&D machinery and equipment 
  • Increase in late payment penalties
  • Unclaimed property administrative changes

The nexus changes are effective September 1, 2015. All other provisions are effective August 1, 2015.

June 2015

BEPS - Tax Committee Chairmen Request Treasury Coordinate with Congress

On June 9, the chairmen of the congressional tax-writing committees wrote to Treasury Secretary Jack Lew, calling on Treasury to work with Congress concerning the international tax proposals being considered under the OECD's base erosion and profit shifting (BEPS) project and in advance of OECD International Tax Conference being convened in Washington, D.C.

Senate Finance Committee Chairman Orrin Hatch (R-UT) and House Ways & Means Committee Chairman Paul Ryan (R-WI) wrote that they were troubled by some positions the Treasury Department apparently was agreeing to as part of the BEPS project. In particular, they were concerned about that foreign governments would be able to collect the "master file" information directly from U.S. multinationals without any assurances of confidentiality or that the information collection is needed

As some recent press reports indicated that the Treasury Department believes it currently has the authority under the Internal Revenue Code to require country-by-country reporting and that the IRS guidance on this reporting will be released later this year, Mr. Hatch and Mr. Ryan believed the authority to request, collect, and share this information with foreign governments is questionable and requested that the Treasury Department and IRS provide the tax-writing committees with a legal memorandum detailing its authority for requesting and collecting the country-by-country information from certain U.S. multinationals and master file information from U.S. subsidiaries of foreign multinationals. They also requested a document (i) identifying how the country-by-country reporting and other transfer pricing documentation obtained by the IRS on foreign multinationals operating in the United States will be utilized and (ii) providing the justification for agreeing that sensitive master file information on U.S. multinationals can be collected directly by foreign governments. They warned that Congress will consider taking action to prevent the collection of the country-by-country and master file information if requested information is not provided.

Mr. Hatch and Mr. Ryan also expressed concerns about other proposals of the BEPS project including modification to the permanent establishment rules, use of highly subjective general anti-abuse rules (GAAR) in tax treaties, and introduction of interest-deductibility limitation.

This Hatch-Ryan letter is largely consistent with the position taken by Senator Hatch and then Ways & Means Chairman Dave Camp in the last Congress. In particular, the House and Senate tax writers have consistently viewed much of the OECD's BEPS work product to be within the jurisdictional domain of the legislative branch, not the executive. The Hatch-Ryan letter, however, moves beyond general criticism to directly question Treasury's authority to implement the country-by-country reporting standard.

Trade Bill Includes Tax Provisions

H.R. 1295, the Trade Preferences Extension Act of 2015, passed by Congress and signed into law by the president on June 29 addresses a number of expiring trade items and also includes a number of tax-related provisions as revenue offsets:

  • Significant increases (in many cases, doubling or tripling) in penalties for failure to file correct information returns
  • Significant increases (in many cases, doubling or tripling) in penalties for failure to furnish correct payee statements
  • Modifications to the due dates of some corporate estimated tax payments due in 2020
  • A requirement that taxpayers claiming the American Opportunity, Hope Scholarship, and Lifetime Learning education credits or deductions for Qualified Tuition and related expenses to receive a statement provided by the educational institution regarding qualified expenses in order to claim the tax benefits
  • A new provision excluding taxpayers taking advantage of the section 911 exclusions from claiming a refundable child tax credit

Texas: Reduction in Franchise Tax Rates

On June 15, House Bill 32, the Franchise Tax Reduction Act of 2015, has been signed into law by Governor Abbott. The bill, which applies to original reports filed on or after January 1, 2016, permanently reduces Texas franchise tax rates.

Specifically, the general one percent rate will be reduced to 0.75 percent. The 0.5 percent rate that applies to taxpayers primarily engaged in wholesaling and retailing will be reduced to 0.375 percent.

Another provision of the bill provides relief to small businesses. Currently, a taxable entity may elect the EZ computation (and reduced rate) if its total revenues are not more than $10 million. Under the revised law, a taxable entity may elect the EZ method if its total revenue does not exceed $20 million. House Bill 32 also reduces the franchise tax rate for taxpayers electing the EZ computation from 0.575 percent to 0.331 percent.

California: Regulatory Project on Space Transportation Activities

The FTB recently announced that it will hold an interested parties meeting on July 9, 2015 to explore a regulatory project on space transportation activities. More specifically, the FTB wants to assess the advisability of undertaking a regulatory project on how the state should source receipts derived from sending people and cargo to and from space. At this initial meeting, FTB staff plan to solicit input from industry and practitioners on tax issues that should be addressed in any proposed regulation.

Possible topics for discussion include (1) how space transportation activities should be defined; (2) at what point should aircraft or space vehicles be considered as traveling into space; and (3) what factors and weight should apply to receipts derived from space transportation activities. Apparently recognizing that space travel is not without kinks, the regulation may also need to address the treatment of receipts from unsuccessful or aborted missions. Finally, the pesky problem of receipts assigned to a jurisdiction where a taxpayer is not taxable takes on a whole new meaning when dealing with receipts that could be assigned to locations beyond the earth's atmosphere.

California: Law Mandating Combined Reporting Only for Interstate Taxpayers Held Unconstitutional

The California Court of Appeal, Fourth District ruled that the trial court erred when it sustained the FTB's objection to a taxpayer's claim that allowing to elect between combined reporting and separate accounting only to intrastate taxpayers violated the Commerce Clause.

Under California law, multistate taxpayers engaged in a unitary business are required to file a combined report while unitary groups that are completely intrastate in nature can elect to file combined or use separate accounting. The taxpayer, a motorcycle company and its several subsidiaries, argued that the differential treatment afforded to intrastate and interstate unitary businesses violated the Commerce Clause.

After quickly concluding that the differential treatment prong was satisfied, the court reviewed a number of discrimination cases and determined that the taxpayers had sufficiently alleged that the differential treatment of intrastate and interstate unitary groups was discriminatory under Commerce Clause precedent. The court next remanded the case to the trial court to address the Board's contention that even if the differential treatment discriminated against interstate commerce, it nonetheless passed a strict scrutiny analysis because the state had a legitimate reason for the discriminatory treatment.

May 2015

Treasury's Proposed Revisions to U.S. Model Tax Convention

On May 20, the Treasury Department released drafts of the following five proposed revisions to the U.S. Model Tax Convention for public comment:

  • Proposed treaty rule addressing so-called "exempt permanent establishments"
  • Proposed treaty rules addressing payment by "expatriated entities"
  • Proposed treaty rules addressing "special tax regimes"
  • Proposed limitation on benefits treaty article
  • Proposed treaty article addressing subsequent changes in law

As noted in a Treasury release, the aims of these revisions are: (1) to determine that the United States is able to maintain the balance of benefits negotiated under its treaty network as the tax laws of treaty partners change over time; and (2) to deny treaty benefits to companies that change their tax residence in an inversion transaction.

One set of draft provisions addresses issues arising from "special tax regimes" that provide very low rates of taxation in certain countries—in particular to mobile income, such as royalties and interest. Consistent with the BEPS project, the proposals are intended to avoid instances of "stateless income" or double non-taxation, whereby a taxpayer uses provisions in the tax treaty, combined with special tax regimes, to pay no or very low tax in the treaty partner countries.

The second set of draft provisions is intended to reduce the tax benefits from a corporate inversion by imposing full withholding taxes on key payments such as dividends and base stripping payments, including interest and royalties, made by U.S. companies that are "expatriated entities" as defined under the Internal Revenue Code.

Also part of the effort to eliminate BEPS, proposed revisions are intended to prevent taxpayers from inappropriately obtaining the benefits of a tax treaty on income that escapes tax in their country of residence. These include more robust rules on (1) the availability of treaty benefits for income that is not subject to tax by a treaty partner because it is attributable to a permanent establishment located outside the country of residence; and (2) the ability of a company to make excessive base eroding payments.

The revised limitation on benefits (LOB) article includes a reworked version of the existing "derivative benefits" rule, to provide the opportunity of qualifying for treaty benefits based on a broader concept of ownership that includes certain third-country ownership.

Treasury has invited comments on these proposed treaty rules. The U.S. Model Tax Convention was last updated in 2006.

Senate Finance Tax Reform Working Group Recommendations Delayed

On May 21, Senate Finance Committee Chairman Orrin Hatch (R-UT) and ranking member Senator Ron Wyden (D-OR) announced that they would give their tax reform working groups additional time to develop specific recommendations.

Each working group is assigned to one of five topics (individual income tax, business income tax, savings and investment, international tax, community development and infrastructure) and had been tasked with making recommendations back to the Senate Finance Committee during the week of May 25, 2015. Since March 2015, the working groups have spent months holding meetings and roundtables with congressional and administration staff, taxpayers, and other stakeholders. In addition, comments from interested parties were solicited, and stakeholders responded by submitting over 1,400 suggestions.

The delay is notable in two ways. First, it narrows the window in which the Senate Finance Committee could act on the working group recommendations this year because many believe that complex and potentially controversial legislation like tax reform could become impossible once the 2016 presidential race begins in earnest later this summer. Second, while some speculated that the bipartisan groups' work product might be something short of actual tax reform recommendations, it appears that Hatch and Wyden still expect the working groups to develop recommendations and are willing to wait a bit longer to get them.

IRS Request for Comments on New Financial Accounting Revenue Recognition Standards

On May 29, the IRS released Notice 2015-40 to request comments regarding the effect on taxpayers' methods of accounting of new financial accounting revenue recognition standards announced by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB).

The new standards for the timing of income for financial accounting purposes may affect the timing of income for tax accounting purposes for many taxpayers, such as taxpayers:

  • Currently using the percentage of completion method
  • Deriving income from the provision of services
  • Engaging in bill and hold transactions for the sale of goods
  • Accounting for sales and returns of goods
  • Earning income from warranties

The new standards may affect some industries more than others. For example, it has been noted that the new standards may affect the software, entertainment, manufacturing, and construction industries because the new standards may change the timing of income recognition for financial accounting purposes significantly for these industries.

As the IRS noted, accounting method changes for federal income tax purposes require the permission of the IRS. Notice 2015-40 states that the new standards raise a number of substantive and procedural issues for the IRS, including whether the new standards are permissible methods of accounting for federal income tax purposes, the types of accounting method change requests that will result from adopting the new standards, and whether the current procedures for obtaining IRS consent to change a method of accounting are adequate to accommodate those requests.

Because adoption of the new standards may create or increase differences between financial accounting and tax accounting rules, the IRS and Treasury Department are considering whether to issue guidance on the new standards and request public comments on the scope, substance, and form of guidance needed. Comments are due on or before September 16, 2015.

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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