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 2016

Regulations: "Inversions" and earnings stripping; new business tax reform framework

On, April 4, 2016, the Treasury Department and IRS released for publication in the Federal Register temporary regulations (T.D. 9761) and by cross-reference proposed regulations (REG-135734-14) that address transactions that are "structured to avoid the purposes of sections 7874 and 367" and certain post-inversion tax avoidance transactions.

The 204-page temporary regulations concern certain domestic corporations and domestic partnerships with assets that are directly or indirectly acquired by a foreign corporation and certain persons related to the domestic corporations and domestic partnerships.

In a related release, Treasury explained that the temporary and proposed regulations are intended to reduce the benefits of and limit the number of corporate tax inversions—including by addressing earnings stripping. As Treasury explained, in undertaking an inversion transaction, companies move their tax residence overseas to avoid U.S. taxes without making significant changes in their business operations. After an inversion, many of these companies continue to take advantage of the benefits of being based in the United States.

Today's Treasury release explains that the regulations will:

  • Limit inversions by disregarding foreign parent stock attributable to recent inversions or acquisitions of U.S. companies—to prevent a foreign company (including a recent inverter) that acquires multiple U.S. companies in stock-based transactions from using the resulting increase in size to avoid the current inversion thresholds for a subsequent U.S. acquisition
  • Address earnings stripping by: (1) targeting transactions that generate large interest deductions by simply increasing related-party debt without financing new investment in the United States; (2) allowing the IRS on audit to divide debt instruments into part debt and part equity, rather than the current system that generally treats them as wholly one or the other; and (3) facilitating improved due diligence and compliance by requiring certain large corporations to do up-front due diligence and documentation with respect to the characterization of related-party financial instruments as debt. If these requirements are not met, instruments will be treated as equity for tax purposes
  • Formalize Treasury's two previous actions in September 2014 and November 2015

Treasury will continue to explore additional ways to address inversions.

Michigan: Court invalidates department's guidance on unitary group composition

Recently, the Michigan Court of Appeals addressed whether, in the context of a unitary group, indirect ownership was the same as "constructive ownership" under federal law. The case involved two corporate entities and a limited partnership. Under the Michigan Business Tax (MBT) test for a unitary group―which is also applied for purpose of the corporate income tax that became effective in 2012—one member of the group must directly or indirectly own or control more than 50 percent of the ownership interests of the other members. In Revenue Administrative Bulletin 2010-01, which addressed the unitary business group control test, the Department of Treasury adopted IRC §318 type-attribution rules to determine whether a group of persons met the requisite ownership and control tests. Applying the tests outlined in RAB 2010-01, the Department determined that the parties at issue constituted a unitary group. The taxpayer protested this determination.

Because the parties agreed that no entity directly owned more than 50 percent of any of the others, the issue before the court was whether there was sufficient indirect ownership or control. Although indirect ownership was not defined in the MBT Act, a term used in the Act and not defined differently was to be given the same meaning as when used in a comparable context in federal tax law. The trial court, while noting that there was no directly comparable federal provision, nevertheless held that the most contextually analogous rules were the international tax rules that required a U.S. shareholder to include in its return the income of a controlled foreign corporation. These federal provisions adopted the same attribution rules under IRC § 318 that the Department applied in its RAB, thus, the trial court held that the parties were a unitary group. The taxpayer appealed.

The appeals court rejected the Department's application of IRC §318 in determining whether the indirect ownership test was met. The court emphasized that although the MBT law mandated that federal tax laws must be applied to define a statutorily undefined term, the federal context must be comparable to the Michigan context. The appeals court determined that "constructive ownership"—a legal fiction—was not a "comparable context" to "indirect ownership." Moreover, the federal tax statutes and regulations were replete with examples illustrating that indirect ownership and constructive ownership were two different concepts. Because there was no comparable federal context in the IRC, the court applied the "ordinary and primarily understood meaning" of "indirect ownership" and ultimately defined indirect ownership to mean ownership through an intermediary, not ownership by operation of legal fiction. The court concluded that the parties were not unitary and granted the taxpayer's summary judgment motion.

 

March 2016

Proposed regulations: FBAR reporting change

The Financial Crimes Enforcement Network (FinCEN) of the U.S. Treasury Department issued a release announcing that a notice of proposed rulemaking would be issued to revise the regulations implementing the Bank Secrecy Act regarding "Reports of Foreign Bank and Financial Accounts" (FBAR).

The proposed rule would:

  • Expand and clarify the exemptions for certain U.S. individuals with signature or other authority over foreign financial accounts, by amending the FBAR regulation and eliminating the requirement for officers and employees of companies/entities to report on accounts for which they have signature or other authority, but no financial interest, due solely to their employment, provided that their employer has an FBAR filing obligation to report the foreign financial account
  • Remove the special rules permitting limited account information to be reported when a U.S. person has a financial interest in or signature authority over 25 or more foreign financial accounts, and instead require all U.S. persons required to file an FBAR to report detailed account information on all foreign financial accounts for which they are required to file an FBAR
  • Require institutions to maintain a list of all officers and employees with signature or other authority over foreign financial accounts, with this list to be made available to FinCEN and law enforcement upon request
  • Make other changes, including a change to the filing date for FBAR reports due in 2017 and a revision to reflect electronic filing of FBARs

Filing date

The FBAR is a calendar year report with the 2015 calendar year FBAR due June 30, 2016. However, beginning with the 2016 calendar year, as changed by recent legislation, the due date for FBAR reporting will be April 15 of the year following the December 31 report ending date. Extensions provided by various FinCEN notices during the last five years are not addressed in the proposed regulations.
As noted in a footnote in the proposed rule, FinCEN stated that it "understands that, as part of the final rule, it would need to determine the effect of the provisions of this proposed rule on earlier FBAR deferrals.…" The proposed regulations do not provide for a proposed effective date.

Louisiana: New corporate income tax, franchise tax, sales tax laws

Louisiana's special legislative session ended with lawmakers agreeing to tax increases and spending cuts, many of which are temporary, in an effort to address a budget deficit for the fiscal year beginning July 1, 2016.

Corporate income tax and franchise tax

Among the corporate income and franchise tax provisions are measures that:

  • Restore the dividend exclusion for dividends received from banks
  • Expand the corporate franchise tax to apply to all corporations doing business in Louisiana through an interest in a pass-through entity and that revise the definition of "corporation"
  • Impose a limit on a net operating loss (NOL) carryover deduction and clarify that it cannot exceed 72% of Louisiana's net income for any return filed on or after July 1, 2015
  • Adopt a related-party expense disallowance rule (i.e., addback provisions)
  • Re-order the application of NOLs from prior years
  • Provide rules for the order in which credits can be applied
  • Reduce enterprise zone credits and remove hotels from eligibility
  • Allow for the electorate to vote on a state constitutional amendment to eliminate the corporate deduction for federal income taxes paid

Sales and use taxes

The legislature also passed bills that expand the state's sales and use tax nexus rules; that impose limits on compensation allowed vendors for collecting and remitting sales and use tax on behalf of the state; and that impose limits on the exclusions and exemptions previously available for sales and use tax purposes. In general, the effective date for the sales and use tax changes is April 1, 2016.

There is also a new 1% (one percent) state-level sales and use tax that will be effective April 1, 2016, through June 30, 2018.

 

February 2016

IRS announces APMA will accept bilateral APAs with India

On February 1, the IRS announced that on February 16, 2016, the Advance Pricing and Mutual Agreement office (APMA) will begin accepting requests for bilateral advance pricing agreements (bilateral APAs) between the United States and India. This mid-February date is intended to allow taxpayers sufficient time to file their APA requests before the start of the new Indian fiscal year (April 1).

The IRS release (IR 2016-13) represents an important step in strengthening ties between the two governments in the taxation of multinationals. Bilateral APAs provide greater predictability in taxation, easing the uncertainty of doing business in each country.

Background

In January 2015, the U.S. and Indian competent authorities jointly announced that they had reached agreement on a framework for resolving longstanding competent authority cases involving Indian-resident affiliates performing information technology-enabled services or software development services. In light of this agreement, APMA began accepting requests in March 2015 for pre-filing conferences (PFCs) for bilateral APAs between the United States and India.

The U.S. and Indian competent authorities are reported to have resolved recently as many as 100 mutual agreement procedure cases and more are expected to be settled early this year. As a result of the competent authorities' progress in concluding cases since that time, the U.S. competent authority and the Indian competent authority are now ready to accept requests for bilateral APAs covering information technology-enabled services, software development services, or other issues for whose resolution transfer pricing principles are relevant.

FIRPTA withholding tax rate in section 1445(a) increases to 15% beginning February 17, 2016; IRS revises Form 8288 and instructions

Beginning Wednesday, February 17, 2016, the withholding tax rate in section 1445(a) will increase to 15% (from the previous rate of 10%) of the amount realized by a foreign person that disposes of a "U.S. real property interest" (USRPI). Section 1445 contains withholding tax rules relating to the Foreign Investment in Real Property Tax Act (FIRPTA).

On or after February 17, 2016, any person (a "withholding agent") that acquires a USRPI from a foreign person generally will be required to withhold an amount equal to this new rate of 15% of the amount realized by a foreign person, and to use Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, to deposit that amount with the IRS no later than the 20th day after the acquisition. A withholding agent that fails to timely deposit the required amount generally will be jointly and severally liable for the amount it fails to timely deposit, plus penalties and interest.

Form 8288 is revised

To reflect the increase to 15% of the FIRPTA withholding tax rate specified in section 1445(a), and other changes to the FIRPTA rules made by the Protecting Americans from Tax Hikes Act of 2015, P.L. 114-113 ("PATH Act"), the IRS has issued a new version of Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests (Rev. February 2016), and the Instructions for Form 8288 (Rev. February 2016).
The Instructions for Form 8288 (Rev. February 2016) discuss the increase in the section 1445(a) withholding tax rate, and also discuss other amendments made by the PATH Act to the rules relating to the FIRPTA rules in the Code that may affect filers of Form 8288. For example, these instructions also address the new exemption from FIRPTA tax and withholding for qualified foreign pension funds that was added by Section 323 of the PATH Act, and confirm that a qualified foreign pension fund or any entity wholly owned by such fund is not a foreign person for purposes of FIRPTA withholding reported on Form 8288.

Background

The increase to 15% in the IRC section 1445(a) withholding tax rate was made by Section 324 of the Path Act as signed into law by President Obama on December 18, 2015 (the date of enactment). This increase was made effective for dispositions after the date which is 60 days after the date of the enactment of the PATH Act.

U.S. model income tax treaty (2016)

The U.S. Treasury Department today announced the release of a newly revised "U.S. Model Income Tax Convention" that will serve as the baseline text that Treasury will use as it negotiates tax treaties. Today's release is the first update to the U.S. model income tax treaty since 2006.

Overview

According to a Treasury Department release, the 2016 model income tax treaty includes:

  • A number of provisions intended to eliminate double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance; however, it does not reduce withholding taxes on payments of "highly mobile income"—income that taxpayers can easily shift around the globe through deductible payments such as royalties and interest—that are made to related persons that enjoy low or no taxation with respect to that income under a preferential tax regime
  • Updates reflecting technical improvements developed in the context of bilateral tax treaty negotiations and do not represent substantive changes to the prior model
  • A new article that obligates treaty partners to consult with a view to amending the treaty as necessary when changes in the domestic law of a treaty partner draw into question the treaty's original balance of negotiated benefits and the need for the treaty to reduce double taxation
  • Measures to reduce the tax benefits of corporate inversions—it denies reduced withholding taxes on U.S. source payments made by companies that engage in inversions to related foreign persons
  • Rules requiring that disputes between tax authorities regarding the application of tax treaties be resolved through mandatory binding arbitration—the "last best offer" approach to arbitration in the new model income tax treaty is substantively the same as the arbitration provision in four U.S. tax treaties in force and three U.S. tax treaties that are awaiting the advice and consent of the Senate
    Treasury reports that the 2016 model income tax treaty reflects changes made in response to comments received to the proposed model treaty provisions released in May 2015.

Technical explanation expected

The Treasury release states that Treasury is preparing a detailed technical explanation of the 2016 model income tax treaty to be released this spring. The preamble to the model income tax treaty invites comments regarding certain situations that need to be addressed in the technical explanation for the so-called "active trade or business" test of Article 22 (Limitation on Benefits). The deadline for public comments on this subject is April 18, 2016.

Internet access tax ban is enacted, part of trade legislation

President Obama on February 24, 2016, signed into law H.R. 644, the "Trade Facilitation and Trade Enforcement Act of 2015," which generally concerns trade and customs items. The legislation also includes a provision that makes permanent the ban on states and localities taxing internet access or placing multiple and discriminatory taxes on electronic commerce. The new law allows "grandfathered" states and localities to continue their existing taxes on internet access through June 2020.

The measures in the legislation are paid for by expanded customs user fees and increased penalties for a failure to file a tax return.

Background

First enacted in 1998 on a temporary basis, the general ban on states and localities taxing internet access or placing multiple and discriminatory taxes on electronic commerce has been extended numerous times. States and localities that had imposed and enforced taxes on internet access prior to October 1, 1998, generally can continue to do so under "grandfather provisions through June 2020."

Transfer pricing adjustments involving consolidated group member

On February 29, the U.S. Tax Court issued an opinion concluding that the IRS Commissioner—in exercising authority under Code section 482 and adjusting the reported prices for items transferred among taxpayers and their foreign affiliates—is not required to determine the "true separate taxable income" of each controlled taxpayer in a consolidated group contemporaneously with making the transfer pricing adjustments. The Tax Court also concluded that the IRS Commissioner may aggregate one or more related transactions—instead of making specific adjustments for each type of transaction. In reaching these conclusions, the Tax Court denied a taxpayer motion for partial summary judgment. The case is: Guidant LLC v. Commissioner, 146 T.C. No. 5

Summary

The taxpayers are U.S. corporations that file consolidated federal income tax returns. For the years at issue, the taxpayers engaged in transactions with their foreign affiliates. The transactions included the licensing of intangibles, the purchase and sale of manufactured property, and the provision of services.
The IRS evaluated whether the income from the transactions with the related parties was allocated at arm's length, and considered the taxpayers' transfer pricing studies, financial data and other information provided by the taxpayers, as well as publicly available information.

The IRS concluded that the income was not allocated at arm's length, and adjusted the prices for the related-party transfers as reported by the taxpayers. The IRS then determined the consolidated group's "true consolidated taxable income" by posting all of the adjustments to the separate taxable income of the group's parent company (which increased the group's consolidated taxable income). The IRS did not make any specific adjustment to any subsidiary's separate taxable income. The IRS also did not determine any portion of the adjustments that related solely to tangibles, to intangibles, or to services.

The taxpayers moved for partial summary judgment, contending that the adjustments were arbitrary, capricious, and unreasonable as a matter of law because the IRS: (1) did not determine the "true separate taxable income" of each controlled taxpayer; and (2) did not make specific adjustments for each transaction involving an intangible, a purchase and sale of property, or a provision of services.

Today, the Tax Court denied the taxpayer motion for summary judgment, finding that section 482 and the related regulations do not require the IRS Commissioner—when exercising authority under section 482—to determine the true and separate taxable income of each controlled taxpayer in a consolidated group contemporaneously with the transfer pricing adjustment.

Tax provisions in the administration's FY 2017 budget

President Obama on February 9, 2016, transmitted to Congress his fiscal year (FY) 2017 budget, containing the administration's recommendations to Congress for spending and taxation for the fiscal year that begins on October 1, 2016. Although it is not expected that Congress will enact—or even vote on—the president's budget as a whole, the budget represents the administration's view of the optimum direction of spending and revenue policy.

Overview

The president proposes expenditures of $4.147 trillion. Expenditures would adhere to the sequestration caps of the Budget Control Act of 2011, as modified last fall by the Bipartisan Budget Act of 2015, although the budget anticipates lifting the caps in future years.

The budget would, according to the White House, reduce the deficit by $2.9 trillion over 10 years. More than $900 billion of that reduction would be attributable to changes in the taxation of capital gains and the reduction of tax benefits for upper income individuals. It would also be achieved through changes in the taxation of international business income (which would raise almost $800 billion in new revenue over 10 years), and from other business tax changes (which would raise approximately $337 billion).

The president also proposes to impose a new fee on oil that would raise almost $320 billion over 10 years. That new revenue would be committed to investment in transportation information infrastructure as part of a multi-agency initiative to build a "clean" transportation system less reliant on carbon-producing fuels.

The budget also reiterates the president's goal of cutting the corporate tax rate and making structural changes and closing loopholes. In The President's Framework for Business Tax Reform (February 2012), he proposed cutting the corporate rate to 28%. The budget does not, however, provide sufficient revenue to offset the cost of such a rate reduction.

Business tax proposals

Many other tax proposals in the FY 2017 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 and treating gain as ordinary income
  • Modification of the depreciation rules for corporate aircraft
  • Denying a deduction for punitive damages

Some previous proposals have been modified significantly, such as expanding the types of property subject to a proposed change to the like-kind exchange rules.

The budget also includes a proposal from last year's budget to impose a tax on the liabilities of financial institutions with assets in excess of $50 billion of 7 basis points.

In place of the current system of deferral of foreign earnings, the president is again proposing 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.

Individual (personal) 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 so-called "Buffett Rule") of 30% of AGI
  • Limit the total accrual of tax-advantaged retirement benefits
  • 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, the Green Book* indicates that 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 budget also includes a proposal to expand the definition of net investment income to include gross income and gain from any trades or businesses of an individual that is not otherwise subject to employment taxes. The change would potentially affect limited partners and members of LLCs, as well as S corporation owners.

In response to concern that employees in employer-sponsored health plans might unfairly become subject to the Affordable Care Act's excise tax on high-cost plans because they reside in states where health care costs are higher than the national average, the president proposes modifying the threshold for application of the tax. The proposal would increase the threshold to the greater of the current law threshold or a "gold plan average premium" calculated for each state. (The tax currently is scheduled to be effective beginning in 2020.)

Treasury's explanation

The Treasury Department on February 9 released an accompanying explanation of the tax proposals of the budget—Treasury's Green Book*—which describes those proposals in greater detail.

*General Explanation of the Administration's Fiscal Year 2017 Revenue Proposals


North Carolina: Market-based sourcing guidelines

Corporate taxpayers with apportionable income greater than $10 million and an apportionment percentage less than 100% must recompute and report their 2014 apportionment for both corporate income and capital stock tax purposes using market-based sourcing rules. The Department of Revenue issued market-based sourcing guidelines and a form on which to file the market-based sourcing information reports that are due by April 15, 2016.

North Carolina: Department issues guidance on repair, maintenance, and installation services subject to sales and use tax effective March 1, 2016

Under legislation signed last year, effective March 1, 2016, certain repair, maintenance, and installation services are subject to North Carolina sales and use tax. The North Carolina Department of Revenue recently released two directives addressing the newly taxable services. One directive, SD-16-2, provides guidance on when sales and use tax applies to repair, maintenance, and installation services. The second directive, SD-16-1, addresses definitional changes that must be considered when determining if repair, maintenance, and installation services are taxable.

SD-16-2 notes that the definition of repair, maintenance, and installation services includes calibrating and restoring tangible personal property, troubleshooting or identifying problems with tangible personal property, and installing tangible personal property (unless the property is installed by a real property contractor). The definition of a "retailer" was amended to include a person engaged in delivering, erecting, installing, or applying tangible personal property. Excluded from this new definition of retailer are persons that solely operate as real property contractors or that strictly provide repair, maintenance, and installation services, and whose activities do not otherwise meet the definition of a "retail trade." In other words, repair, maintenance, and installation services performed by a person engaged in a retail trade are subject to retail sales tax unless otherwise exempt, making it necessary to understand what it means to be engaged in a "retail trade." SD-16-1 provides guidance on the definition of a "retail trade," which includes "[a] trade in which the majority of revenue is from retailing tangible personal property, digital property, or services to consumers.…" Examples of the types of businesses the changes affect are also provided in the directive. Notably, North Carolina will assume a business is engaged in retail trade in North Carolina if it is classified in the Retail Trade Sector (sector 44-45) of the NAICS code (e.g. hardware stores, electronics and appliance stores, floor covering stores, etc.). A business not in the Retail Trade Sector may meet the definition of "retail trade" provided the majority of revenue is from retailing tangible personal property, digital property, or services to consumers in the state. Per the DOR's website, the agency will contact all currently registered sales taxpayers by email or regular mail regarding these and other recent changes to the sales tax law.

 

January 2016

Finance members urge Treasury intensify efforts, EU state aid investigations

Leaders and members of the Senate Finance Committee today wrote to Treasury Secretary Jack Lew concerning EU state aid investigations of U.S. multinational companies.

Background

In recent years, the European Commission initiated formal investigations as to how various EU Member States treat certain multinational companies. In June 2014, the EC issued opening decisions with respect to Ireland, the Netherlands, and Luxembourg. In October 2014, the EC issued an opening decision with respect to Luxembourg, and then in December 2015, the EC announced its opening decision with respect to yet another Luxembourg case.

In October 2015, the EC announced final decisions in the Netherlands case and the Luxembourg case. In those decisions, the EC ordered these countries to recover amounts that the EC believed should have been collected in tax revenue from the companies, going back up to 10 years.

The Senate Finance Committee in December 2015 examined the potential impact these investigation could have on U.S. firms.

Finance Committee's letter

Today's letter (available on the Finance Committee website) requests that Secretary Lew increase efforts to caution the European Commission to avoid imposing retroactive results that are inconsistent with international tax standards. The letter concludes:

Our concerns are driven not only by these initial cases, but also by the precedent they will set that could pave the way for the EU to tax the historical earnings of many more U.S. companies – in some cases, the earnings in question could have been generated up to a decade ago. We urge Treasury to intensify its efforts to caution the EU Commission not to reach retroactive results that are inconsistent with internationally accepted standards and that the United States views such results as a direct threat to its interests. We also ask that you consider, under section 891, whether U.S. corporations are being subjected to discriminatory taxation.

 

For more information, please contact:

Mie Igarashi | +1 404 222 3212 | mieigarashi@kpmg.com

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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