Tax Publications

Subscribe to Tax Publications feed
This is a feed of the latest BDO USA TaxPublications.
Updated: 13 hours 14 min ago

Partnership Taxation Alert - October 2016

Tue, 10/18/2016 - 12:00am
Structuring Like-Kind Exchange Transactions Outside of Revenue Procedure’s 2000-37 Safe-Harbor
Download PDF Version
Summary On August 10, 2016, in the case of Estate of George H. Bartell Jr. et al. v. Commissioner, 147 T.C. No. 5, the Tax Court approved a reverse section 1031 exchange where the safe harbor tests under Revenue Procedure 2000-37 (“Rev. Proc. 2000-37”) were not met. The case and the court’s reasoning may support alternatives for structuring reverse exchanges that, for whatever reason, cannot meet the safe harbor.
Details Background

The exchange of property for other “like-kind” property may be nontaxable under section 1031. In the majority of like-kind exchanges, the relinquishment of property is generally not simultaneous with the acquisition of replacement property. These non-simultaneous exchanges are referred to as “deferred exchanges.”  Where replacement property is acquired before relinquished property is transferred, it is referred to as a “reverse exchange.”  Rev. Proc. 2000-37 was issued on September 18, 2000, to provide guidance and a safe harbor for reverse exchanges. The applicability of section 1031 to reverse exchanges outside of the safe harbor is often unclear.

In its opinion in Bartell v. Commissioner, the court stated that “where a section 1031 exchange is contemplated from the outset and a third-party exchange facilitator, rather than the taxpayer, takes title to the replacement property before the exchange, the exchange facilitator need not assume the benefits and burdens of ownership of the replacement property in order to be treated as its owner for section 1031 purposes before the exchange.”
 
Further, the court noted that “caselaw provides no specific limit on the period in which a third-party facilitator may hold title to the replacement property before the titles to the relinquished and replacement properties are transferred in a reverse exchange.”
 
The Rev. Proc. 2000-37 Safe-Harbor

IRC Section 1031 allows non-recognition of gain only to the extent that replacement property is “like-kind” to relinquished property. If all or part of the replacement property is not of a like-kind, gain will be recognized to the extent of that portion of consideration which is not of like-kind. Therefore, in order to fully defer the gain realized on the disposition of relinquished property, the taxpayer must acquire like-kind replacement property of equal or greater value to complete the exchange.

Improvements constructed on real property already owned by a taxpayer are not like-kind to other property and do not qualify as like-kind to relinquished property transferred by the taxpayer. Therefore, if a taxpayer uses proceeds from the sale of relinquished property for the construction of improvements on land already owned by the taxpayer, the amount used would be considered to be boot creating recognized gain, even if a qualified intermediary is used.

In order to complete these so-called “build-to-suit” exchanges, it is necessary to ensure that the taxpayer isn’t the owner of the replacement property until construction is complete. Rev. Proc. 2000-37 provides a safe harbor that allows a taxpayer to treat an accommodation party as the owner of the property for federal income tax purposes, thereby enabling the taxpayer to accomplish a qualifying like-kind exchange where proceeds from the sale of relinquished property will be used to fund construction of replacement property.

If the requirements of Rev. Proc. 2000-37 are satisfied, a taxpayer may complete a reverse section 1031 exchange regardless of whether the taxpayer has the various benefits and burdens of ownership with respect to the replacement property during construction and would otherwise be treated as the owner for federal tax purposes. Under the Revenue Procedure, a party that holds bare legal title to the property (referred to as an “exchange accommodation titleholder” or “EAT”) will be treated as the owner of the property for federal income tax purposes.1

Given the nature of a build-to-suit exchange transaction, it is often difficult to meet the 180-day time limit established in Rev. Proc. 2000-37. The Revenue Procedure, however, specifically provides that “the Service recognizes that ‘parking’ transactions can be accomplished outside of the safe harbor provided in this revenue procedure.” Unfortunately, the IRS has provided no guidance describing when such a non-safe harbor transaction could still qualify as a section 1031 like-kind exchange. Based on the Tax Court’s opinion in Bartell, taxpayers may be able to successfully complete a built-to-suit like-kind exchange transaction where the EAT holds bare title for a period exceeding 180 days.2
 
Estate of George H. Bartell Jr. Et Al. V. Commissioner

In this case, Bartell Drug entered into an agreement to purchase property in Lynnwood, WA, in 1999 and made periodic earnest money payments under the agreement. The sale agreement contained a clause stating that both the buyer and seller agreed to reasonably cooperate with each other to accomplish an exchange under section 1031. Bartell Drug ordered a commitment for title insurance, did due diligence on the property, applied for a building permit for the site and ordered a traffic study from a traffic engineering firm.

Bartell Drug engaged a facilitator for section 1031 exchanges, agreeing that EPC Two, a single member LLC formed for the exclusive purpose of providing services to Bartell Drug, would take title to the Lynnwood property in order to effect the section 1031 exchange. EPC Two obtained the title to the land as well as a title insurance policy. A loan was obtained in order to fund the acquisition of the Lynnwood land as well as the construction of a new drug store on the property. The loan was made to EPC Two, but was nonrecourse to the entity and was guaranteed by Bartell Drug. The commitment letter from the bank stated the purpose of the loan as “to finance the acquisition of land and construction of a new store in Lynnwood, WA under the benefits of 1031 tax-free exchange.”

Bartell Drug and EPC Two entered into an agreement where EPC Two was to construct a drug store on the Lynnwood property. Bartell Drug indemnified EPC Two for liabilities with respect to the project. After the bank loan proceeds were exhausted, the Bartell Drug funded the construction of the project. The agreement allowed Bartell Drug to manage the construction of the project and to lease the property once the construction was complete.

In December 2001, Bartell Drug executed an exchange agreement for the exchange of relinquished property for the Lynnwood Drug Store using a qualified intermediary in a transaction intended to qualify for tax deferred treatment under section 1031. Because the length of time the property was held by EPC Two was greater than 180 days, the safe harbor rules under Rev. Proc. 2000-37 would not have applied even if Rev. Proc. 2000-37 had been effective prior to the initiation of the like-kind exchange.

The central issue between the taxpayer and the IRS in this case is whether Bartell Drug or EPC Two should be considered the owner of the Lynnwood property for Federal income tax purposes prior to EPC Two’s exchange of the Lynnwood Drug Store to the taxpayer. If it were to be ruled that Bartell Drug was the owner of the Lynnwood property prior to the exchange, then the taxpayer would have been engaged in a nonreciprocal exchange with himself.3

The IRS stated that under the benefits and burdens test, Bartell Drug already owned the Lynnwood property before December 2001, thereby precluding any exchange as of that date. The petitioners contended that EPC Two must be treated as the owner and that the agency analysis should be employed consistent with previously permitted like-kind exchanges. They point out that both the Tax Court and the Court of Appeals for the Ninth Circuit, to which an appeal in this case would ordinarily lie, have expressly rejected the proposition that a person who takes title to the replacement property for the purpose of effecting a section 1031 exchange must assume the benefits and burdens of ownership in that property to satisfy the exchange requirement. Previous caselaw has permitted taxpayers to exercise any number of indicia of ownership and control over the replacement property before it is transferred to them, without jeopardizing section 1031 exchange treatment.

The Tax Court acknowledged that courts have historically exhibited a lenient attitude toward taxpayers’ attempts to come within the terms of section 1031, citing several relevant cases. The Court went on to state that it would put considerable emphasis on a taxpayer’s use of a third-party exchange facilitator rather than the benefits and burdens test. Citing previous caselaw (Biggs v. Commissioner, 632 F.2d at 1173; Alderson v. Commissioner, 317 F.2d at 791), the Tax Court stated that it has been established that where a section 1031 exchange is contemplated from the outset and a third-party exchange facilitator, rather than the taxpayer takes title to the replacement property before the exchange, the exchange facilitator need not assume the benefits and burdens of ownership of the replacement property in order to be treated as its owner for section 1031 purposes before the exchange. The Tax Court concluded that the transaction qualified for section 1031 treatment under existing case law principles and that Bartell Drug’s disposition of the relinquished property and acquisition of the Lynnwood property in 2001 qualifies for non-recognition treatment pursuant to section 1031.
  BDO Insights
  • Reverse exchange transactions offer taxpayers advantageous tax deferrals when structured correctly, particularly where the taxpayer wants to build or modify the replacement property. The findings in the Bartell case may allow taxpayers to take advantage of these tax deferrals even when they do not fall within the safe harbor limits of Rev. Proc. 2000-37.
  • While meeting the requirements of the revenue procedure ensure that the transaction will avoid IRS challenge, the Tax Court’s decision opens up the possibility that if an exchange facilitator who takes bare legal title of the replacement property is properly utilized, the taxpayer can manage the construction of replacement property, guaranty acquisition and construction loans, lend funds to facilitate completion of the project and make other necessary arrangements and still  successfully complete a reverse like-kind exchange even without meeting the safe harbor requirements.
  • It is worth noting, however, that the Tax Court specifically stated that “we express no opinion with respect to the applicability of section 1031 to a reverse exchange transaction that extends beyond the period at issue in these cases. In view of the finite periods in which the exchange facilitator in these case could have held, and in fact did hold, title to the replacement property, we are satisfied that the transaction qualifies for section 1031 treatment under existing caselaw principles.” In light of this commentary, caution is warranted in structuring non-safe harbor exchange transactions that go beyond the facts of Bartell and the authorities described therein.
  • An attorney from the IRS Office of Associate Chief Counsel (Income Tax and Accounting) recently stated that the IRS considering appealing the Bartell decision to the Ninth Circuit. The IRS is considering the best strategy for supporting its legal analysis, which may or may not ultimately include an appeal. Regardless of its decision regarding an appeal, it appears the IRS is unlikely to give up on its position.

For more information, please contact one of the following practice leaders: 
  Jeffrey N. Bilsky Julie Robins David Patch Rebecca Lodovico   1 Under Rev. Proc. 2000-37, the IRS will not challenge the qualification of property as either “replacement property” or “relinquished property” (as defined in section 1.1031(k)-1(a)) for purposes of section 1031 and the regulations thereunder, or the treatment of the exchange accommodation titleholder as the beneficial owner of such property for federal income tax purposes, if the property is held in a qualified exchange accommodation arrangement (“QEAA”). Property is held in a QEAA if all of the following requirements are met:
  1. Qualified indicia of ownership of the property is held by an exchange accommodation titleholder. Such qualified indicia of ownership must be held by the exchange accommodation titleholder at all times from the date of acquisition by the exchange accommodation titleholder until the property is transferred. Qualified indicia of ownership means legal title to the property, other indicia of ownership of the property that are treated as beneficial ownership of the property under applicable principles of commercial law (e.g., a contract for deed), or interests in an entity that is disregarded as an entity separate from its owner for federal income tax purposes (e.g., a single member limited liability company) and that holds either legal title to the property or such other indicia of ownership;
  2. At the time the qualified indicia of ownership of the property is transferred to the exchange accommodation titleholder, it is the taxpayer's bona fide intent that the property held by the exchange accommodation titleholder represent either replacement property or relinquished property in an exchange that is intended to qualify for non-recognition of gain (in whole or in part) or loss under section 1031;
  3. No later than five business days after the transfer of qualified indicia of ownership of the property to the exchange accommodation titleholder, the taxpayer and the exchange accommodation titleholder enter into a written agreement (the “qualified exchange accommodation agreement”) that provides that the exchange accommodation titleholder is holding the property for the benefit of the taxpayer in order to facilitate an exchange under section 1031 and this revenue procedure and that the taxpayer and the exchange accommodation titleholder agree to report the acquisition, holding, and disposition of the property as provided in this revenue procedure. The agreement must specify that the exchange accommodation titleholder will be treated as the beneficial owner of the property for all federal income tax purposes. Both parties must report the federal income tax attributes of the property on their federal income tax returns in a manner consistent with this agreement;
  4. No later than 45 days after the transfer of qualified indicia of ownership of the replacement property to the exchange accommodation titleholder, the relinquished property is properly identified. Identification must be made in a manner consistent with the principles described in section 1.1031(k)-1(c). For purposes of this section, the taxpayer may properly identify alternative and multiple properties, as described in section 1.1031(k)-1(c)(4);
  5. No later than 180 days after the transfer of qualified indicia of ownership of the property to the exchange accommodation titleholder, (a) the property is transferred (either directly or indirectly through a qualified intermediary (as defined in section 1.1031(k)-1(g)(4))) to the taxpayer as replacement property; or (b) the property is transferred to a person who is not the taxpayer or a disqualified person as relinquished property; and
  6. The combined time period that the relinquished property and the replacement property are held in a QEAA does not exceed 180 days.
Further, property will not fail to be treated as being held in a QEAA as a result of any one or more of the following legal or contractual arrangements, regardless of whether such arrangements contain terms that typically would result from arm's length bargaining between unrelated parties with respect to such arrangements:
  1. An exchange accommodation titleholder that satisfies the requirements of the qualified intermediary safe harbor set forth in section 1.1031(k)-1(g)(4) may enter into an exchange agreement with the taxpayer to serve as the qualified intermediary in a simultaneous or deferred exchange of the property under section 1031;
  2. The taxpayer or a disqualified person guarantees some or all of the obligations of the exchange accommodation titleholder, including secured or unsecured debt incurred to acquire the property, or indemnifies the exchange accommodation titleholder against costs and expenses;
  3. The taxpayer or a disqualified person loans or advances funds to the exchange accommodation titleholder or guarantees a loan or advance to the exchange accommodation titleholder;
  4. The property is leased by the exchange accommodation titleholder to the taxpayer or a disqualified person;
  5. The taxpayer or a disqualified person manages the property, supervises improvement of the property, acts as a contractor, or otherwise provides services to the exchange accommodation titleholder with respect to the property;
  6. The taxpayer and the exchange accommodation titleholder enter into agreements or arrangements relating to the purchase or sale of the property, including puts and calls at fixed or formula prices, effective for a period not in excess of 185 days from the date the property is acquired by the exchange accommodation titleholder; and
  7. The taxpayer and the exchange accommodation titleholder enter into agreements or arrangements providing that any variation in the value of a relinquished property from the estimated value on the date of the exchange accommodation titleholder's receipt of the property be taken into account upon the exchange accommodation titleholder's disposition of the relinquished property through the taxpayer's advance of funds to, or receipt of funds from, the exchange accommodation titleholder.
2 Note that Rev. Proc. 2000-37 was inapplicable to the Bartell case since the exchange was initiated prior to the issuance of the revenue procedure. It is unknown as to whether the applicability of the Rev. Proc. 2000-37 would have affected the court’s opinion. 3 “A taxpayer cannot engage in an exchange with himself; an exchange ordinarily requires a ‘reciprocal transfer of property, as distinguished from a transfer of property for money consideration.’” DeCleene v. Commissioner, 115 T.C. 457, 469.

Federal Tax Alert - October 2016

Tue, 10/18/2016 - 12:00am
IRS Releases Audit Technique Guide: Capitalization of Tangible Property, §1.263(a)

Download PDF Version

Summary The IRS issued its LB&I Capitalization of Tangible Property Audit Technique Guide (“ATG”) in September, 2016, as a tool for IRS examiners to use for identifying potential tax issues associated with §1.263(a) and related regulations (“Regulations”). The ATG provides the evolutionary history of the Regulations, overview of the purpose of the Regulations, IRS examination considerations as well as a general discussion of the numerous areas covered by the Regulations.  
 
While the ATG does not provide much new information, it is illustrative for understanding how the IRS will examine tax issues associated with the Regulations.  The ATG, 18 chapters spanning 202 pages, provides an overview of the major areas of the Regulations, potential audit issues, how agents are to address prior capitalization studies, audit risk areas and scope, interview questions, and tax treatment of related areas, e.g. §199 deductions, §263A inventory and self-constructed property, and Alternative Minimum Tax, among others. 
  Details The introductory discussion of the ATG highlights relevant case law and guidance influential to the drafting of the Regulations, including the history of the versions of the Regulations (e.g. proposed, temporary, etc.) leading up to finalization of the Regulations.  For quick reference, the ATG includes a useful glossary of terminology commonly used throughout the Regulations and ATG.  It also identifies a variety of compliance considerations, such as which version of the Regulations were relied upon for implementation of method changes, review of repair studies, the 2012 LB&I “stand-down,” use of statistical sampling, industry specific guidance, examination considerations, and interview questions.
 
The remaining chapters of the ATG are subdivided by topics as follows:
  • Unit Of Property
  • Amounts Paid To Acquire Or Produce Property
  • De Minimis Safe Harbor
  • Improvement Rules – Betterment, Restoration, New Or Different Use
  • Safe Harbors, Special Rules, And Other Provisions
  • Materials And Supplies
  • Leased Property
  • Dispositions
  • General Asset Accounts
  • Accounting Method Changes
Each chapter includes an explanation of the chapter’s context and the general rules, provided in plain language, sometimes with examples.  Several examples in the ATG supplement the many examples in the Regulations and give additional insight into making the subjective determination of whether an expenditure is a capital improvement or a deductible repair. The Audit Procedures section of each chapter identifies recommended documents IRS Agents should consider for review, specific areas of audit risk, and detailed examination considerations, such as costs that have been deducted or capitalized, whether the repair definition has changed, which elections were made, evaluation of repair/improvement work order systems, project tracking, and documentation.
 
Throughout the ATG there are explanations of the interrelated nature of the varying areas of the Regulations and accounting method changes.  For example, the application of the routine maintenance safe harbor, replacement of separate assets, disposition of components, and partial disposition elections can each have bearing on whether to capitalize an expenditure and whether a gain or loss on disposition may be recognized. The ATG provides guidance to IRS examiners on navigating the interplay of the various accounting methods, elections, and safe harbors provided in the Regulations.
 
A significant portion of the narrative in the ATG is also given to the timing of when the method changes were filed, under which version of the regulations, under which Revenue Procedure guidance, and whether method changes were filed and then refiled.  All of these factors are addressed in the ATG and provide instruction to Agents regarding the application of the Regulations, to accounting methods taxpayers may or may not have adopted through accounting method changes.  
 
Subjectivity Remains
The Regulations provide many examples to illustrate how the Regulations are to be applied. However, in a number of areas, the examples in the Regulations are not as complete as some may like to provide a high degree of certainty of whether an expenditure is to be capitalized or deducted. Yet, despite the length of the ATG, there are still areas of significant subjectivity left to IRS Agents and Taxpayers to address on a factual case-by-case basis.  For example, if a Taxpayer’s de minimis expensing amount is greater than the allowed thresholds ($2,500/$5,000), Agents are not instructed to negotiate whether the policy “clearly reflects income.” The ATG instructs that the taxpayer must provide the burden of proof. Likewise, IRS Agents are not given any additional guidance to determine whether an expenditure is a “material increase in productivity, efficiency, strength, quality, or output” for purposes of identifying a betterment.  The ATG simply provides that this is fact-dependent for each case and the Agent must consider the purpose of the work, physical nature of the work performed, and physical effect of the work on the UOP.
 
Taxpayers entering IRS Examinations should expect the IRS to audit their implementation of the Regulations.  It is also wise to be prepared to support any method changes filed to implement the Regulations or, in the alternative, support their current methods, justifying with support why method changes were not filed.
  BDO Insights The following recommendations are provided to enable you to begin preparing for an IRS examination related to the tangible property regulations.
  • Use the ATG as a roadmap for understanding how IRS agents will approach audit issues related to the tangible property regulations. 
  • For taxpayers that have already implemented the Regulations, verify that method changes were made to a proper method of accounting and that method changes were filed properly under the appropriate Revenue Procedure(s).
  • Prepare for IRS exams by assessing your documentation of the adoption of the Regulations, evaluating identified audit risk areas, and addressing potential questions IRS examiners may ask.
  • Taxpayers that find that their accounting methods, documentation, or past repair studies are lacking should bolster support in anticipation of IRS exams.
The Accounting Methods group within BDO USA’s National Tax Office has extensive experience assisting taxpayers of all industries and sizes with their accounting method issues, filing accounting method change requests, and navigating IRS examinations of accounting method changes. Please contact a BDO professional if you would like to discuss how BDO can assist you with an accounting method or IRS exam issue.
 
For more information, please contact one of the following practice leaders: 
  Nathan Clark
Managing Director
Dave Hammond
Partner
Marla Miller
Managing Director Yuan Chou
Managing Director Phil Hofmann
Managing Director Travis Butler 
Managing Director
Connie Cunningham
Managing Director  

State and Local Tax Alert - October 2016

Tue, 10/11/2016 - 12:00am
New Jersey Terminates Personal Income Tax Reciprocity Agreement with Pennsylvania


Download PDF Version


Summary

On September 2, 2016, New Jersey Governor Chris Christie (R) notified Pennsylvania that New Jersey terminated the reciprocity agreement between the two states.  The reciprocity agreement requires each state to limit personal income tax reporting, payment, and withholding to the state of residency with respect to a resident individual that works in the other state.  As a result of the termination, effective January 1, 2017, a Pennsylvania employer will be required to pay New Jersey withholding tax on the wages of a Pennsylvania resident employee attributed to work performed in New Jersey, and a New Jersey employer will be required to pay Pennsylvania withholding tax on the wages of a New Jersey resident employee attributed to work performed in Pennsylvania.
 

Details

Very generally, an individual is required to report and pay income tax to the state of residency on wages wherever earned and, if different, to the state of work to the extent his or her wages are attributed to work performed in that state.  The state of residency typically provides a credit to the extent of taxes paid to the state of work.  An employer is required to withhold and pay income tax to the state where work is performed.
 
The reciprocity agreement between New Jersey and Pennsylvania, which had been in effect since December 31, 1977, allowed an employee who resided in one of these states and worked in the other to limit income tax reporting and payment to his or her state of residence.  This removed the burden on such an employee to report and pay income tax to the state of work, too.  The agreement similarly limited an employer’s income tax withholding responsibility with respect to such an employee to the state of residency and, thus, eliminated the burden on such an employer to pay withholding tax to the employee’s state of work.
 
By its terms, the agreement terminates as of the beginning of a calendar year upon 120 days written notice by either state.  As a result of the September 2, 2016, notice given by New Jersey, the New Jersey-Pennsylvania reciprocity agreement terminates effective January 1, 2017.


BDO Insights
  • Beginning January 1, 2017, a New Jersey employer with a New Jersey resident employee working in Pennsylvania may be required to register with Pennsylvania (or update its Pennsylvania registration) and pay withholding tax on wages attributed to the employee’s work performed in Pennsylvania.  These wages would no longer be subject to New Jersey withholding as they presently are.  The New Jersey resident may have a personal income tax reporting and payment obligation in Pennsylvania where he or she did not have one before.  The reverse would apply to a Pennsylvania employer with a Pennsylvania resident employee working in New Jersey.
  • Highly compensated Pennsylvania residents working in New Jersey should be mindful of the potential to pay considerably more in personal income tax as a result of the termination of the reciprocity agreement.  Pennsylvania imposes a flat 3.07 percent tax, but New Jersey applies a graduated rate structure with a top 8.97 percent rate.


For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Principal
  Ashley Morris
Tax Managing Director
    Mariano Sori
Tax Partner
  Scott Smith
Tax Managing Director
    Richard Spengler
Tax Managing Director
  Tony Manners
Tax Managing Director






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

China Tax Newsletter - October 2016

Thu, 10/06/2016 - 12:00am
The October 2016 edition of BDO China's China Tax Newsletter features recent tax-related news and developments in China, including the following topics:  
 
  • Changes in Tax Treatments on Commercial Prepaid Cards
  • Notice on Improvement of Income Tax Policies Relating to Equity Incentive and Capital Contributions in the Form of Technology
  • Notice on Issues Relating to Deductions of Highway Toll Fees for VAT Purpose
  Download

Federal Tax Alert - October 2016

Wed, 10/05/2016 - 12:00am
Opportunity For Fiscal Year Taxpayers to Claim Missed Bonus Depreciation on 2015 Assets Download PDF Version
Summary A highlight of the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act”) is the five-year extension of additional first-year depreciation, or “bonus depreciation,” from 2015 through 2019.  Enacted on December 18, 2015, the “PATH Act” retroactively extended 50-percent bonus depreciation to apply to qualified property placed in service in 2015.  The enactment came too late for some fiscal year taxpayers that had already filed federal tax returns for tax years beginning in 2014 and ending in 2015, and for taxpayers with a taxable year of less than 12 months beginning and ending in 2015.  Consequently, these taxpayers may have failed to claim bonus depreciation on their tax returns for qualifying property placed in service in 2015.  Recently, the Internal Revenue Service issued relief guidance in Rev. Proc. 2016-48 to provide affected taxpayers with procedures for claiming, or not claiming, the 50-percent bonus depreciation on such property.
Background In recent years, section 168(k) of the Internal Revenue Code provides an additional first-year depreciation deduction equal to 50 percent of the unadjusted depreciable basis of certain qualified property.  For both regular and alternative minimum tax (“AMT”) purposes, bonus depreciation is mandatory for qualified property unless the taxpayer chooses to elect out for any class of property by filing a statement.  The regulations to section 168(k) provide that the election not to deduct additional first year depreciation must be made by the due date, including extensions, of the federal tax return for the taxable year in which the taxpayer places the property in service.  Once made, generally the election may be revoked only with the written consent of the Commissioner of Internal Revenue.
  
On December 18, 2015, Congress enacted the PATH Act (P.L. 114-113), which, among other things, amended section 168(k) of the Internal Revenue Code by extending the placed-in-service date for property to qualify for the 50-percent bonus depreciation.
 
Prior to amendment by the PATH Act, section 168(k) allowed a 50-percent additional first year depreciation deduction for qualified property acquired by a taxpayer after 2007 and placed in service by the taxpayer before 2015 (or before 2016, in the case of longer production period property and aircraft described in section 168(k)(2)(B) and (C)). 
 
The PATH Act amends section 168(k) by extending the placed-in-service date to before January 1, 2020 (before January 1, 2021, in the case of property described in section 168(k)(2)(B) and (C)).  In addition, the Act extends bonus depreciation under a phase-down schedule through 2019:
  • At 50 percent for 2015-2017;
  • At 40 percent in 2018; and
  • At 30 percent in 2019.
Many fiscal year taxpayers with a taxable year beginning in 2014 and ending in 2015 filed their 2014 federal tax returns prior to the enactment of the PATH Act and without the knowledge that bonus depreciation would be available in 2015.  Similarly, taxpayers with a taxable year of less than 12 months beginning and ending in 2015 also filed the tax returns for the short year before the PATH Act was enacted.  Consequently, these taxpayers did not claim bonus depreciation for qualified property placed in service in 2015 or affirmatively elect out of bonus depreciation for such property.  The Service is aware that such taxpayers may be uncertain about whether 50-percent bonus depreciation would be available for 2015.  As a result, the Service issued Rev. Proc. 2016-48 to provide the procedures for claiming, or not claiming, the 50-percent bonus depreciation for such property.  
Options to Claim Missed Bonus Depreciation No Election Out of Bonus Depreciation Made by Taxpayer
Rev. Proc. 2016-48 applies, in part, to a taxpayer that did not claim the 50-percent additional first year depreciation for some or all qualified property placed in service by the taxpayer after December 31, 2014, on its federal tax return for its taxable year beginning in 2014 and ending in 2015 (2014 taxable year) or its taxable year of less than 12 months beginning and ending in 2015 (2015 short taxable year).
 
A taxpayer that did not affirmatively elect out of bonus depreciation on its timely filed 2014 taxable year return or its 2015 short taxable year return and did not claim the bonus depreciation may claim the 50-percent bonus depreciation by filing either:
 
  1. An amended federal tax return for the 2014 taxable year return or the 2015 short taxable year return, as applicable, before the taxpayer files the tax return for the immediately succeeding taxable year; or
  2. A Form 3115, Application for Change in Accounting Method, under section 6.01 of Rev. Proc. 2016-29 (automatic change #7), with the taxpayer’s timely filed (including extensions) federal tax return for the first or second tax year following the 2014 taxable year or the 2015 short taxable year, as applicable.  The taxpayer must own the property subject to the method change request as of the first day of the year of change.  An automatic Form 3115 must be attached to the timely filed (including extensions) federal tax return for the year of change and a copy of the Form 3115 must be mailed to the IRS office in Covington, Kentucky on or before the filing date of that return.  

In order to claim any missed bonus depreciation on 2015 qualified property, affected taxpayers should carefully consider the options outlined in Rev. Proc. 2016-48 and take the appropriate corrective action.

Election Out of Bonus Depreciation Made by Taxpayer
A taxpayer that made an affirmative election out of bonus depreciation on its timely filed return for the 2014 taxable year or the 2015 short taxable year, as applicable, for a class of property that is qualified property, may revoke that election under the relief provision of Rev. Proc. 2016-48.  To revoke the election, the taxpayer must file an amended federal tax return for the 2014 taxable year or the 2015 short taxable year, as applicable, in a manner that is consistent with the revocation of the election and by the later of:
 
  1. November 11, 2016; or
  2. Before the taxpayer files its federal tax return for the first taxable year succeeding the 2014 taxable year or the 2015 short taxable year.

Lastly, to the extent that the taxpayer made the affirmative election on its timely filed return for the 2014 taxable year or the 2015 short taxable year as applicable for property, and does not revoke that election within the time and manner described above, that election will be respected by the Service.
  Other Depreciation-Related Items  In addition to the bonus depreciation guidance addressed above, Rev. Proc. 2016-48 provides guidance for issues related to two other depreciation-related sections affected by the PATH Act.  The PATH Act amended section 179(f) by extending the application of that section from any taxable year beginning after 2009 and before 2015 to any taxable year beginning after 2009 and before 2016.  Furthermore, the PATH Act amended section 168(k)(4) by allowing corporations to elect not to claim the 50-percent bonus depreciation for certain property placed in service generally after December 31, 2014, and before January 1, 2016, and instead to increase their AMT credit limitation under section 53(c).  Rev. Proc. 2016-48 sets forth procedures for affected taxpayers who wish to take advantage of these extensions.
 
Rev. Proc. 2016-48 is effective as of August 26, 2016.   
BDO Insights In order to claim any missed bonus depreciation, affected taxpayers should carefully consider the options outlined in Rev. Proc. 2016-48 and take the appropriate corrective action.  To the extent that no affirmative election out of bonus depreciation was made on the timely filed 2014 taxable year return or the 2015 short taxable year return, a taxpayer can choose to either amend that return or file a Form 3115, but must be mindful of the limited time period to take advantage of these options.

The Accounting Methods group within BDO USA’s National Tax Office has extensive experience assisting taxpayers of all industries and sizes with their accounting method issues and filing accounting method change requests with the Service.
 
For more information, please contact one of the following practice leaders: 
  Marla Miller Yuan Chou Nathan Clark Connie Cunningham Dave Hammond Travis Butler     

State and Local Tax Alert - September 2016

Fri, 09/30/2016 - 12:00am
California Franchise Tax Board Issues Amended Market-Based Sourcing Regulations for the Sourcing Of Dividends, Interest, and Receipts from Sales of Goodwill and Marketable Securities for Purposes of the California Sales Factor
Download PDF Version
Summary  On September 15, 2016, the California Office of Administrative Law approved the California Franchise Tax Board’s (“FTB”) amendments to the FTB’s current market-based sourcing regulations, 18 Cal. Code Regs. § 25136-2 (the “amended regulations”) and filed the amended regulations with the California Secretary of State.  The amended regulations provide sourcing rules for dividends and interest, gross receipts from sales of goodwill, and definitions for marketable securities and sourcing rules for sales of marketable securities.  The amended regulations are effective retroactively to taxable years beginning on or after January 1, 2015, and affected taxpayers will have to apply the amended regulations for their 2015 California return on or before October 17, 2016.  In addition, and in tandem with California’s economic/factor presence nexus statute, the amended regulations could result in income tax nexus for corporations that are currently non-filers with California and other potential California income tax consequences. 

 

Details Background

For taxable years beginning on or after January 1, 2011, if the former single sales factor apportionment election was made, and for taxable years beginning on or after January 1, 2013, California has required market-based sourcing for gross receipts from sales of services and intangibles.1 As a general rule under 18 Cal. Code Regs. § 25136-2, such gross receipts are sourced based on where the “benefit of a service is received” or to the extent an intangible is used in the state. 
 
The FTB’s existing regulations were issued on March 27, 2012, and did not provide sourcing guidance with respect to dividends, interest, and receipts from sales of goodwill or marketable securities.  The amended regulations attempt to provide this guidance. 
 
Sourcing of Dividends, Interest, and Receipts from Sales of Goodwill
 
The amended regulations’ sourcing rule for dividends and receipts from sales of goodwill is the same as the existing rule applicable to sales of stock and pass-through entity interests in 18 Cal. Code Regs. § 25136-2(d)(1)(A). 
 
  • Dividends and receipts from sales of goodwill are sourced, as follows: 
    • If 50 percent or more of the amount of the assets of a corporation or pass-through entity sold are not intangibles (using the original cost basis of the assets), then dividends and goodwill are sourced based on the average of the corporation or pass-through entity’s property and payroll factors for the most recent 12 month taxable year, or the current taxable year if the sale occurs more than six months into the taxable year; or
    • If more than 50 percent or more of the amount of the assets of the corporation or pass-through entity sold are intangibles (using original cost basis), then the dividends and goodwill are sourced based on the sales factor of the corporation or pass-through entity’s most recent 12 month taxable year, or the current taxable year if the sale occurs more than six months into the taxable year. 

Although the property and payroll factors or sales factor of the corporation whose assets, including goodwill, are sold may be determinable from the taxpayer’s books and records, there will be situations when a taxpayer’s books and records do not contain such information with respect to a corporation that has distributed a dividend to the taxpayer.  For example, dividends received from a 50 percent or less owned corporation that is engaged in a unitary business with the taxpayer corporation are dividends that likely are business income and receipts includible in the sales factor; however, it may be problematic to obtain such a payor’s California apportionment and asset information.  Under these circumstances, the sourcing of dividends may have to be determined based on a method of reasonable approximation.2  
 
  • The amended regulations’ sourcing rule for interest income is, as follows:
    • Interest from investments, other than from loans (as defined in California’s bank and financial corporation income apportionment regulation, 18 Cal. Code Regs. § 25136-4.2(b)(7)), is sourced to where the investment is managed.
    • Interest from loans secured by real property is sourced to the location of the real property.
    • Interest from loans not secured by real property is sourced to the borrower’s location. 

The amended regulations do not define where a borrower is deemed located with respect to interest on a loan not secured by real property.  California’s bank and financial corporation income apportionment regulation also sources interest from loans not secured by real property according to the borrower’s location.  18 Cal. Code Regs. § 25137-4.2(c)(3)(D).  Under the bank and financial corporation income apportionment regulation, a borrower’s location is the borrower’s commercial domicile in the case of a business borrower or the borrower’s billing address in the case of a borrower that is not engaged in business.3 As with the sourcing of dividends, the amended regulations lack clarity for determining the borrower’s location.  If the borrower’s location cannot be determined, then the interest is sourced using a method of reasonable approximation, and if the source of the interest still cannot be reasonably approximated, then the borrower’s billing address is used to source.4 
 
Sales of Marketable Securities
 
The amended regulations provide two definitions for marketable securities.  One for securities and commodities dealers, and another for everyone else.  For non-dealers, a marketable security is generally any security traded on an established securities market that is quoted by brokers and dealers.  However, a marketable security for this purpose does not include “those types of securities that are traded in transactions specifically excluded from gross receipts under Revenue and Taxation Code Section 25120.”5 As a result, investments and securities held as part of the management of a corporation’s treasury function whose gross receipts are excluded from the California sales factor by Cal. Rev. & Tax. Code § 25120(f)(2)(K) are excluded from the definition of marketable security for non-dealers.    
 
For a securities dealer or a commodities dealer, a marketable security includes stock, pass-through entity interests, notes, bonds, debentures, notional principal contracts, derivatives, commodities, and any other “security” as defined in Sections 475(c)(2), (e)(2)(B), (C), and (D), and 1256(a) of the Internal Revenue Code of 1986, as amended.  Notably, the definition of marketable security for dealers does not include that the security must be traded on an established securities market.  The gross receipts from marketable securities for such dealers includes dividends and interest.[6]  However, receipts from hedging transactions are excluded as gross receipts from marketable securities.[7]
 
Gross receipts from sales of marketable securities so defined are sourced by 18 Cal. Code Regs. § 25136-2(e), as follows:
 
  • Gross receipts from the sale of a marketable security to an individual customer are sourced to the customer’s billing address.
  • Gross receipts from the sale of a marketable security to a business customer is sourced to the state of that customer’s commercial domicile based on the taxpayer’s books and records.  Based on the preponderance of the evidence, the taxpayer may use other credible information to determine the business customer’s commercial domicile and source the receipts to that state. 
  • If the individual customer’s billing address or the business customer’s state of commercial domicile cannot be determined, then the location of the customer may be reasonably approximated.  

As addressed above, for a securities or commodities dealer, gross receipts from marketable securities include the dividends and interest thereon.  The amended regulations do not define the location of the customer for dividends or interest paid with respect to a marketable security.  As a result, dividends or interest received on a marketable security may be sourced to California if the payor’s commercial domicile is in California.
 
Complications of Economic/Factor Presence Nexus for Current Non-filers
 
For taxable years beginning on or after January 1, 2011, Cal. Rev. & Tax. Code § 23101(b) was added.  Section 23101(b) established an economic/factor presence nexus standard for an out-of-state corporation.  To be considered doing business in California, among other factor-presence criteria, an out-of-state corporation with more than $536,446 of gross receipts for its 2015 taxable year (or 25 percent of its total sales) sourced to California under California’s sales factor sourcing rules is deemed doing business in California and subject to income/franchise tax.8
 
As a result of the amended regulations, a corporation, which was not a California taxpayer because it had no receipts from California other than dividends or interest from stock, securities or investments, and loans in or to one or more corporations with commercial domiciles in California could now have nexus with California.  Since dividends and interest are treated as gross receipts from marketable securities for a dealer, the sourcing rule for marketable securities receipts of dealers has a bias in favor of the payor’s commercial domicile.  Further, for non-dealers dividends received from payors having California apportionment factors or interest on loans or investments from California borrowers also could have such receipts sourced to California which could result in a California income tax return filing obligation.  Therefore, there could be situations where a dividend paid by a U.S. subsidiary of a foreign parent corporation or a U.S. subsidiary paid interest on an intercompany loan from a foreign affiliate could result in California nexus for the foreign corporation.  It is FTB’s position that receipts from intercompany transactions are included in determining whether the sales factor threshold of the California economic/factor presence statute is satisfied.    
 
In addition to these California nexus consequences for current California non-filing corporations, there could be California water’s-edge election implications as well resulting from the FTB’s recent Notice 2016-02.  See the BDO SALT Alert.
 
Effective Dates
 
The amended regulations are effective for taxable years beginning on and after January 1, 2015.  A taxpayer may elect to apply the amended regulations to open tax years beginning on or after January 1, 2012. 
  BDO Insights
  • For calendar year taxpayers currently on extension for their 2015 taxable year, the amended regulations will apply to 2015 California Form 100 or Form 100-W tax returns having an extended due date of October 17, 2016. 
  • Likewise, since the amended regulations apply to taxable years beginning on or after January 1, 2015, California taxpayers should assess what, if any, impact the amended regulations may have on their existing deferred tax balances, and adjust accordingly as of the effective date. 
  • The amended regulations in conjunction with California’s economic/factor presence nexus statute could have the consequence of rendering a non-California corporate income/franchise tax filer a filer, particularly dealers in marketable securities and other corporations receiving dividends or interest from California corporations or borrowers. 
  • Given the FTB’s position that intercompany receipts count toward the economic/factor presence nexus sales factor threshold, an intercompany loan by a foreign affiliate excluded from the water’s-edge group to a California subsidiary or affiliate that results in interest sourced under the amended regulations to California, could result in California nexus for the foreign affiliate if the interest sourced to California exceeds the sales factor threshold.  The amended regulations sourcing rules for dividends, receipts from sales of goodwill, and receipts from marketable securities could have similar California nexus consequences for current non-filers.    
  • A partnership, including LLCs classified as a partnership for federal and California income tax purposes, must file a California Form 565 (partnership information return) if it is doing business in or has any income from California sources.  Cal. Rev. & Tax. Code §§ 18633(a) and 18633.5(a).  As with a corporation that has not previously had a California income/franchise tax return filing obligation, a partnership or LLC similarly may now have a California information return filing requirement.  California imposes a “per partner/per month” failure to file a partnership information return of $18 for a 12 month maximum or $216 maximum penalty per partner.9
  • Especially with respect to receipts from sales of marketable securities, taxpayers must apply the statutory exclusions from the definition of gross receipts contained in Cal. Rev. & Tax. Code § 25120(f)(2) before applying the new sourcing rules provided by the amended regulations.  For example, for taxpayers that are not securities or commodities dealers, gross receipts in connection with the management of investments by their treasury function are excluded from the California sales factor under Cal. Rev. & Tax. Code § 25120(f)(2)(K).  In addition, dividends, interest, and especially receipts from sales of goodwill will also be subject to exclusion from the sales factor if they constitute substantial gross receipts from an occasional sale or transaction under 18 Cal. Code Regs. § 25137(c)(1)(A) and Appeal of Imperial, Inc., Nos. 472648 and 477927 (Cal. State Bd. Equal., July 13, 2010).
 


For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Principal
  Ashley Morris
Tax Managing Director
    Mariano Sori
Tax Partner
  Scott Smith
Tax Managing Director
    Richard Spengler
Tax Managing Director
  Tony Manners
Tax Managing Director






   
Southwest:

Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 
1 Cal. Rev. & Tax. Code § 25136.
218 Cal. Code Regs. § 25136-2(d)(1)(B).  If the taxpayer’s books and records do not contain the property and payroll factors or sales factor information of the dividend distributing corporation, then 18 Cal. Code Regs. § 25136(d)(1)(B) requires a method of reasonable approximation be used to source the dividends.  If the sourcing of the dividends is not capable of reasonable approximation, then the regulations direct the taxpayer to use “the billing address of the purchaser” (18 Cal. Code Regs. § 25136-2(d)(1)(C)), which also may be problematic to apply when the intangible receipt being sourced is a dividend from a corporation. 
3 18 Cal. Code Regs. § 25137-4.2(b)(2).
4 18 Cal. Code Regs. § 25136-2(d)(1)(B), (C). 
5 18 Cal. Code Regs. § 25136-2(b)(5).
6 Thus, dividends and interest of a securities dealer or commodities dealer are sourced according to 18 Cal. Code Regs. § 25136-2(e) and not according to 18 Cal. Code Regs. § 25136-2((d)(1)(A).
7 18 Cal. Code Regs. § 25136-2(b)(6).  See also Cal. Rev. & Tax. Code § 25120(f)(2)(L).  The “treasury function” exclusion from gross receipts includible in the California sales factor under Cal. Rev. & Tax. Code § 25120(f)(2)(K) does not apply to securities or commodities dealers, because they would be “principally engaged in the trade or business of purchasing and selling intangible assets of the type typically held in a taxpayer’s treasury function.”  
8 California’s economic/factor presence nexus statute is indexed for inflation.  Cal. Rev. & Tax. Code § 23101(b)(2), (c).  California’s sales factor presence threshold was $500,000, $509,500, $518,162, $529,562, and $536,446 for 2011, 2012, 2013, 2014, and 2015, respectively. 
9 Cal. Rev. & Tax. Code § 19172.
 

State and Local Tax Alert - September 2016

Fri, 09/23/2016 - 12:00am
Missouri Issues Sales Tax Notice to Taxpayers Regarding Potential Changes to the Taxability of Delivery Changes Download PDF Version
Summary The Missouri Department of Revenue recently issued a notice to taxpayers regarding the Missouri Supreme Court’s decision in Alberici Constructors, Inc. v. Director of Revenue, 452 S.W.3d 632 (Mo. 2015) concerning the taxability of delivery charges for sales tax purposes.  A 2015 law change requires the Department to send such a notice if a decision of the Department, the Administrative Hearing Commission, or a court modifies the taxability of an item, and a reasonable person would not have expected the decision based on prior law or regulation.  However, the notice is unclear as to the modification to the law, and its format raises a concern that future notices could be similarly confusing.
  Details The Notification Requirement
The notification requirement was enacted in 2015 in response to a perceived abuse by the Department, whereby it assessed small business taxpayers for sales tax on items the Department had previously treated as exempt.  The notification requirement law requires the Department to notify taxpayers via United States mail, email, or other electronic means of direct communication when a decision of the Director of Revenue, the Administrative Hearing Commission, or a court modifies the taxability of an item, and a reasonable person would not have expected the decision solely on prior law or regulation.  Further, the law waives liability for taxes for taxpayers actively selling the type of items affected by the decision on the date the decision was issued until receipt of notice of the law change, unless the taxpayer had previously remitted tax on the items subject to the decision or had prior notice of its sales tax collection and remittance responsibility.  See the BDO SALT Alert that discusses the notice requirement and other law changes.
 
Taxability of Delivery Charges
In Alberici Constructors, Inc. v. Director of Revenue, the Supreme Court upheld the denial of a use tax refund sought by the taxpayer on a separately stated charge for the delivery of a rented crane, where the delivery charge was negotiated as part of the transaction, but the agreement indicated that the purchaser had the option of using a third-party carrier.  The taxpayer had challenged the refund denial based on the Department’s regulation, which provides that if the purchaser is required to pay for a delivery charge as “part of the sales price,” the entire sales price is subject to tax, but if the purchaser is not required to pay for the delivery charge as “part of the sales price,” the service is not subject to tax if separately stated.  See Mo. Code Regs. tit. 12, § 10-103.600(3)(A) (emphasis added).  The taxpayer had interpreted this provision to mean that a delivery charge is not taxable when the charge is not required to be paid as part of the sales price, which is consistent with the Department’s earlier rulings.  For example, in Letter Ruling No. LR 7268 (May 23, 2013), the Department ruled that a separately stated pizza delivery charge is not taxable because the purchaser has the option to avoid the charge by picking-up the order at the seller’s location.
 
The Missouri Supreme Court in Alberici Constructors upheld the Administrative Hearing Commissions’ decision that the separately stated charge for delivery of a rented crane was taxable because the parties agreed to the delivery charge as part of the sale.  The court reasoned that the taxpayer’s interpretation of the regulation was at odds with the intent of the legislature to impose tax on a delivery charge that is part of the sale as per the definition of “sales price” in the statute.  See Mo. Rev. Stat. § 144.605(8) (Sales price means “the consideration including the charges for services … that are a part of the sale”) (emphasis added).  The court had held in an earlier decision, May Dep’t Stores v. Director of Revenue, 791 S.W.2d 388 (Mo. 1990), that separately stated delivery charges were excluded from tax, unless the service is part of the sale and the intention of the parties is the determining factor when assessing whether the service is part of a sale.  In Alberici Constructors, the court found the taxpayer’s receipt of the crane and payment of the delivery charge within 16 days after the date of the agreement to be evidence in support of the parties’ intention to include the delivery charge as part of the sale.
 
In light of the decision in Alberici Constructors, the Missouri Department of Revenue recently ruled that a separately stated pizza delivery charge was taxable because “[t]he customer requests such service when placing the order, and both parties intend it to be a feature of the transaction.”  See Letter Ruling No. LR 7722 (Jul. 29, 2016).  The Department so ruled even though the purchaser had the option of avoiding the charge by picking-up the pizza at the seller’s location, which contradicts its earlier ruling regarding the taxability of a similar separately stated pizza delivery charge.
 
The Department’s Notice
The Department’s notice does not specifically state that the decision in Alberici Constructors court modifies the taxability of an item.  Rather, the notice merely directs the taxpayer to Alberici Constructors and warns that the decision may require collecting and remitting taxes on delivery charges.  The notice then provides the following factors to consider when determining whether a delivery charge is part of the sale: (i) when title passes from the seller to the purchaser; (ii) whether the delivery charges for separately stated; (iii) who controls the cost and means of delivery; (iv); who assumes the risk of loss during delivery; and (v) whether the seller derives financial benefit from the delivery.  These factors are consistent with Department’s rulings and Southern Red-E-Mix v. Director of Revenue, 452 S.W.2d 632 (Mo. 1995).
  BDO Insights
  • The Department sent the notice, the first of its kind to be issued under the notification law, to nearly 100,000 registered taxpayers.  However, there arguably has been no change in the sales tax treatment of delivery charges since before and after Alberici Constructors, the intent of the parties controls the taxability of a delivery charge, regardless of whether the charge is separately stated.  Further, the Director issued the notice without specifically stating how the court’s decision modified the existing sales tax law, and yet, as evidenced by its recently issued letter ruling regarding pizza delivery charges, has decided that any delivery charge resulting from a request by the customer for delivery is subject to tax.  Accordingly, this first notice from the Department does not bode well for taxpayers’ desire for alerts that inform them of changes to the sales tax law, and the notice’s format and lack of specificity, if followed in future notices, might result in confusion rather than clarity.
  • Whether the Department was required to send a notice is questionable given that Alberici Constructors did not result in a change in the taxability of an item.  However, the decision in Alberici Constructors (and earlier decisions) seemingly invalidates the portion of the Department’s regulation relating to the taxability of delivery charges.  See Mo. Code Regs. tit. 12, § 10-103.600(3)(A).  Accordingly, the Department may have issued the notice as a precursor to assessing sales tax on all untaxed delivery charges without the risk that a taxpayer may challenge the assessment on the grounds that the Department failed to provide the required notice in light of its earlier rulings.
   

For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Principal
  Ashley Morris
Tax Managing Director
    Mariano Sori
Tax Partner
  Scott Smith
Tax Managing Director
    Richard Spengler
Tax Managing Director
  Tony Manners
Tax Managing Director






   
Southwest:

Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

State and Local Tax Alert - September 2016

Fri, 09/23/2016 - 12:00am
California Franchise Tax Board Issues Notice on the Treatment of Existing Water's-edge Elections when a Foreign Affiliate Becomes Subject to Tax in California
Download PDF Version
Summary

Beginning in 2011, California enacted its factor presence statute under which an out-of-state corporation, including a non-U.S. corporation, with more than $500,000 of gross receipts (indexed for inflation) sourced to California is subject to the state’s corporation income/franchise tax and becomes a California taxpayer. However, since such “new” taxpayer never consented to the water’s-edge election, the election could be terminated for that electing group.  In FTB Notice 2016-02 (Sept. 9, 2016), the California Franchise Tax Board (“FTB”) addresses the treatments the FTB will apply in situations where a unitary foreign affiliate of a water’s-edge combined reporting group becomes subject to income/franchise tax after the enactment of the “factor presence nexus” statute beginning January 1, 2011.


Details


Background
A multinational unitary group of affiliated corporations, one or more of whose members are subject to California corporation income/franchise tax, may make a water’s-edge election to allocate and apportion income of the unitary group’s business.  Under Cal. Rev. & Tax. Code § 25111(a), a water’s-edge election is effective for an initial term of 84 months (seven years), unless terminated earlier under Cal. Rev. & Tax. Code § 25113.  The water’s-edge election automatically continues after the seven year anniversary date, unless a worldwide combined reporting election is made.

In general, when a water’s-edge election is made, the income (or loss) and apportionment factors of a unitary foreign affiliate of the group are excluded from the California water’s-edge combined report under Cal. Rev. & Tax. Code § 25110, as long as the unitary foreign affiliate does not have effectively connected income with a U.S. trade or business, or at least 20% of its apportionment factors assigned to U.S. locations (collectively, “United States Income”).       

Pursuant to Cal. Rev. & Tax. Code § 25113, a water’s-edge election is effective only if every member of the water’s-edge group with nexus in California (a “taxpayer member”) makes or consents to the election.  If a unitary foreign affiliate did not have a physical presence with California for taxable years prior to January 1, 2011, it could not have made or consented to the water’s-edge election.  During those years, the unitary foreign affiliate was not a taxpayer.  

For taxable years beginning on or after January 1, 2011, Cal. Rev. & Tax. Code § 23101(b) was added.  Section 23101(b) established a “factor presence economic presence” standard for an out-of-state corporation, including a unitary foreign affiliate, to be considered “doing business” in California.  Among other factor-presence criteria, an out-of-state corporation with more than $500,000 of gross receipts sourced to California under California’s sales factor sourcing rules was now deemed “doing business” in California and subject to income/franchise tax.1 When applied to a unitary foreign affiliate with no physical presence but more than $500,000 of California sales after January 1, 2011, the affiliate becomes a California taxpayer.  Since the unitary foreign affiliate never made nor consented to the making of the water’s-edge election, the election could be terminated for the entire group under Section 25113, an issue that the FTB has raised in audit examinations.

Under Cal. Rev. & Tax. Code § 25113(b)(4), if a member of the water’s-edge group subsequently becomes subject to California corporation income/franchise tax and becomes a taxpayer member of the water’s-edge group, the deemed election provisions apply and the new taxpayer member is deemed to have made or consented to the water’s-edge election.  As a result, if an out-of-state unitary affiliate, including a non-U.S. unitary affiliate with United States Income, later becomes a taxpayer member of the water’s-edge group because of the “factor presence economic nexus” statute, the water’s-edge election does not terminate.  Prior to 2011, both types of entities were already “members” of the California water’s-edge group.

Nonetheless, the deemed election provisions of Section 25113(b)(4) are silent as to the treatment when a non-member unitary foreign affiliate becomes a California taxpayer.     

FTB Notice 2016-02
In FTB Notice 2016-02, issued on September 9, 2016, the FTB acknowledges that neither Cal. Rev. & Tax. Code § 25113 nor the regulations thereunder address the effect on an existing water’s-edge election due entirely to a change in law (i.e., enactment of Cal. Rev. & Tax. Code § 23101(b)) that changes the status of a non-electing unitary foreign affiliate from a non-taxpayer and non-member to a California taxpayer.  The Notice addresses three situations and provides the following “treatments”:  

First, as noted above, if a unitary foreign affiliate has United States Income both before and after the taxable year in which California’s “factor presence economic nexus” statute makes the affiliate a taxpayer member, the deemed election provisions of Cal. Rev. & Tax. Code § 25113(b)(4) apply and the group’s water’s-edge election remains intact.

If a unitary foreign affiliate does not have United States Income and becomes a California taxpayer after January 1, 2011, by virtue of the “factor presence economic nexus” statute, the FTB will treat the affiliate as deemed to have made the water’s-edge election.  As a result, the water’s-edge election remains intact.

Finally, if a unitary foreign affiliate did not have United States Income before, but has United States Income after the taxable year in which it becomes a California taxpayer, the FTB will treat the affiliate as deemed to have made the water’s-edge election.  Likewise, the water’s-edge election remains intact.

Under the second and third situations, the commencement date of the unitary foreign affiliate’s deemed election is the same as the commencement date of the taxpayer members who actually made the existing California water’s-edge election.  

The “Conditions”
FTB Notice 2016-02 may provide relief for some California water’s-edge groups having to contend with California’s “factor presence economic nexus” statute.  Unfortunately, any relief that the “treatments” provided by FTB Notice 2016-02 are limited, including for taxable years ending on or before December 31, 2016.  

For the preceding treatments to apply, FTB Notice 2016-02 imposes the following conditions, all of which must be satisfied:

  1. There must have been a valid water’s-edge election made prior to September 9, 2016; 
  2. At the time the water’s-edge election was made, the unitary foreign affiliate could not make the election because the affiliate was not subject to California income/franchise tax; 
  3. The unitary relationship between the water’s-edge group and the foreign affiliate remained continuously in effect between the time the water’s-edge election was made and the time the foreign affiliate became a California taxpayer; and
  4. The unitary foreign affiliate became a California taxpayer under the “factor presence economic nexus” statute on or before December 31, 2016.

If all four of these conditions are satisfied, the FTB will not seek to terminate the water’s-edge election.

The “First Seven-Year” Issue
A water’s-edge election is effective for an initial term of seven years and continues each taxable year thereafter unless a worldwide combined reporting election is made.  It could be argued that the issues or situations raised in FTB Notice 2016-02 only arise if or when the “factor presence economic nexus” statute results in a unitary foreign affiliate becoming a California taxpayer after the first seven years of the water’s-edge election.  The FTB could also take a position that the water’s-edge filing continues until the end of the first seven-year period and then terminates.  The FTB did not address this issue and whether the economic/factor presence in California of the unitary foreign affiliate could terminate the group’s waters-edge election in the first seven years of the election.  

There are some water’s-edge groups that, due to unforeseen circumstances, would prefer to terminate the water’s-edge election prior to the expiration of the seven-year period.  In general, the only way a water’s-edge group can terminate the election prior to the expiration of the first seven years is to request permission from the FTB.  However, if a non-member unitary foreign affiliate (i.e., an affiliate without United States Income) establishes economic/factor nexus by simply selling inventory to its California affiliate in excess of the California sales threshold, then the water’s-edge election could be terminated without having to seek permission.  At this point, it is not certain if this issue will apply to the first seven years of a water’s-edge election since it was not addressed by the FTB Notice.
    

BDO Insights

 

  • FTB Notice 2016-02 addresses an issue that simply was not anticipated when California enacted and amended its water’s-edge election statutes and the FTB’s water’s-edge regulations were issued in the years prior to January 1, 2011, when “factor presence economic nexus” came to California.
  • The “treatments” that will be followed by the FTB will be limited to water’s-edge electing groups for taxable years ending on or before December 31, 2016.
  • Further, uncertainties with the application of California’s market-based sourcing rules under the facts and circumstances may make it difficult for the California water’s-edge group to determine with certainty whether a unitary foreign affiliate has California sourced income.  If the foreign affiliate has service revenue, enters into a licensing agreement, or sells intangible property, it may be difficult to determine if the income will be sourced to California and will establish economic nexus as a result.  
  • It is unclear if the issues addressed in FTB Notice 2016-02 apply to the first seven years of the water’s-edge election, since the Notice did not make such a distinction.  It is possible that a water’s-edge group could terminate a water’s-edge election in the first seven years of the election without receiving FTB approval if a unitary foreign affiliate that does not have United States Income establishes economic/factor nexus in California and is therefore considered a California taxpayer.  

 


For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Principal
  Ashley Morris
Tax Managing Director
    Mariano Sori
Tax Partner
  Scott Smith
Tax Managing Director
    Richard Spengler
Tax Managing Director
  Tony Manners
Tax Managing Director






   
Southwest:

Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

[1] California’s “factor presence economic nexus” statute is indexed for inflation.  Cal. Rev. & Tax. Code § 23101(b)(2), (c).  California’s sales factor presence threshold was $500,000, $509,500, $518,162, $529,562, and $536,446 for 2011, 2012, 2013, 2014, and 2015, respectively.

International Tax Alert - September 2016

Fri, 09/23/2016 - 12:00am
IRS Identifies New Foreign Tax Credit Splitter Arrangements Relating to Certain Foreign Initiated Adjustments Download PDF Version
Summary On September 15, 2016, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “Service”) issued Notice 2016-52 (the “Notice”) which provides that Treasury and the Service intend to issue regulations under Internal Revenue Code (“IRC”) Section 909 to address the separation of related income from foreign income taxes paid by a “Section 902 corporation” pursuant to certain foreign-initiated adjustments.1 The regulations detailed in the Notice are intended to apply to foreign income taxes paid on or after September 15, 2016.

Discussion
IRC Section 909 is intended to prevent the separation of creditable foreign taxes from related income generally by deferring the right to claim credits until the related income is included in U.S. taxable income. The current Treasury Regulations under IRC Section 909 provide an exclusive list of foreign tax credit splitter arrangements and provide that split taxes are not taken into account for U.S. federal income tax purposes before the taxable year in which the related income is taken into account by the payor or, in the case of split taxes paid or accrued by a Section 902 corporation, a Section 902 shareholder of the Section 902 corporation.

The Notice provides that Treasury and the Service are aware that, in anticipation of a large foreign-initiated adjustment that relates to a prior taxable year, a taxpayer may take steps to separate the additional payment of foreign income tax from the income to which it relates. Such foreign-initiated adjustments may arise under European Union (“EU”) State aid law, to the extent EU State aid payments result in creditable foreign taxes.2

The Notice states that before a payment is made pursuant to a foreign-initiated adjustment, a taxpayer may attempt to change its ownership structure or cause the Section 902 corporation to make an extraordinary distribution so that the subsequent tax payment creates a high-tax pool of post-1986 undistributed earnings that can be used to generate substantial amounts of foreign taxes deemed paid, without repatriating and including in U.S. income the earnings and profits to which the taxes relate. The Treasury and the Service have determined that guidance to address these transactions is appropriate under IRC Section 909. Accordingly, the Notice provides that Treasury and the Service intend to issue regulations under IRC Section 909 that will identify two new splitter arrangements relating to Section 902 corporations that pay foreign income taxes pursuant to certain foreign-initiated adjustments. The regulations will apply similar rules to taxpayers that take the position that taxes paid by a U.S. person pursuant to certain foreign-initiated adjustments to the tax liability of a Section 902 corporation are eligible for a direct foreign tax credit under IRC Section 901. The Notice includes detailed rules (and certain exceptions) for when changes in ownership structures or certain distributions that, in connection with a foreign-initiated adjustment, will result in a foreign tax credit splitting arrangement.
BDO Insights BDO can assist our clients with understanding the complexities of foreign tax credit splitter arrangements and also advise on how the rules described in the Notice may impact the ability to claim foreign tax credits in certain situations when there is a foreign-initiated adjustment.
 
For more information, please contact one of the following practice leaders:
  Robert Pedersen
Partner and International Tax/Transfer Pricing Practice Leader          Chip Morgan             Partner 
    Joe Calianno
Partner and International Technical Tax Leader, National Tax Office   Brad Rode
Partner 
    William F. Roth III
Partner, National Tax Office   Jerry Seade
Principal    Scott Hendon
Partner    Monika Loving
Partner            [1] A “Section 902 corporation” is a foreign corporation with direct or indirect shareholders that includes at least one domestic corporation owning at least 10 percent of the foreign corporation’s stock (a “Section 902 shareholder”).  [2] It should be noted, however, that the Notice specifically provides that no inference is intended to be made as to whether (1) payments made pursuant to any particular foreign-initiated adjustment, including those arising under EU State aid law, qualify as payments of creditable foreign income taxes, or (2) taxes paid by a U.S. person pursuant to a foreign-initiated adjustment to the tax liability of a Section 902 corporation are eligible for a direct foreign tax credit under IRC Section 901.

China Tax Newsletter - September 2016

Tue, 09/20/2016 - 12:00am
The September 2016 edition of BDO China's China Tax Newsletter features recent tax-related news and developments in China, including the following topics:  
 
  • Notice on the Revision and Promulgation of High-tech Enterprises Accreditation and Administration Guidelines    
  • Administration of Individual Income Tax Collection    
  • Issuance of the Certificate of Chinese Fiscal Resident    
  View the newsletter

International Tax Alert - September 2016

Fri, 09/16/2016 - 12:00am
The Indian Tiffin X - from BDO India The latest Indian Tiffin issue (X) covers: 
  • Indian Economic Update – A look at the present government's commitment actualization of the economic reforms in India, from the desk of the Managing Partner.
  • M&A Tracker – The deals-runner from across the border.
  • Feature Story – Insights into the GST Law and what lessons from the international implementation can be adapted to enable India Inc. transition to a unified law by next year.
  • Guest Column – An International Strategist covers Indian start-ups in the online space and how the entrepreneurial revolution cannot ignore global growth as their differentiating and winning proposition.
  VIEW THE NEWSLETTER

International Tax Alert - September 2016

Mon, 09/12/2016 - 12:00am
Your Individual Taxpayer Identification Number May Be Expiring Download PDF Version

The newly released IRS Notice 2016-48 contains important compliance changes for foreign individuals applying for an Individual Taxpayer Identification Number (“ITIN”). Foreign individuals may have previously applied for an ITIN to satisfy U.S. tax requirements. However, based on the new law, ITINs that have not been utilized on a federal return at least once in the past three years will no longer be valid, unless renewed. Furthermore, ITINs issued prior to 2013 must also be renewed. Without proper renewal compliance, tax returns may not be processed or refunds could be delayed.
  Renewing an ITIN Unused ITINs – If an individual’s ITIN has not been reflected on either a 2013, 2014, or 2015 income tax return, the ITIN will no longer be valid as of January 1, 2017. The period to renew will begin on October 1, 2016, and taxpayers must utilize Form W-7 (marked with a “Rev. 9-2016” revision date). The revised Form W-7 should be available in September 2016.
 
Expiring ITINs – ITINs issued before 2013 will begin to expire, and taxpayers will need to start renewing their ID numbers. ITINs are a nine digit number (similar to a SSN), with the following numbering sequence: XXX-XX-XXXX. The middle two numbers, XXX-78-XXX or XXX-79-XXXX, that contain a 78 or 79, will start to expire first and require prompt renewal.
 
In August 2016, taxpayers will receive notices from the IRS regarding the expiration of their respective ITINs. The notice will also explain the ITIN renewal process. Only ITIN holders that require tax compliance with the U.S. authorities will need to renew; if there are no filing requirements necessary for 2016 or future years, no action is required at this time.  
  How to renew To renew, taxpayers must complete form W-7, Application for Individual Taxpayer Identification Number, utilizing version Rev. 9-2016, which should be available in September 2016. Taxpayers can submit their Form W-7 beginning on October 1, 2016. The IRS does not require a tax return to be included with Form W-7 with the remitted renewal application.  Once completed, a taxpayer can either mail the form along with certain required certified documents to the IRS, make an appointment with the IRS Taxpayer Assistance Center, or utilize an Acceptance Agent to complete the filing. As with all         Form W-7s, without the proper required documentation affixed to the form, the application can either be denied or delayed. The ITIN process and approval can be lengthy, so we recommend that the form and its attachments are properly submitted.
  BDO Knows BDO USA, LLP is a Certifying Acceptance Agent (“CAA”) and can assist with obtaining an ITIN and submitting any required forms. Please contact any member of BDO Acceptance Agent team for assistance in renewing your identification number.
  Office BDO's Certified Accepting Agents  Atlanta D. Scott Potts
Senior Manager, Expatriate Tax Services Charlotte Donna Chamberlain
Managing Principal, Expatriate Tax Services Charlotte Anita Schilling
Manager, STS - Expatriate Tax Services Detroit Lucia Spevacek
Senior Manager,  Expatriate Tax Services Houston Jim Miller
Managing Director, Expatriate Tax Services Houston John Pao
Senior Manager, Expatriate Tax Services Houston Mesa Hodson
Principal, Expatriate Tax Services New York Sima Devi
Associate, Expatriate Tax

Compensation & Benefits Alert - September 2016

Wed, 09/07/2016 - 12:00am
IRS Simplifies the Process for Correcting Late Rollovers between Retirement Accounts

Download PDF Version


Summary

Issued August 24, 2016, Rev. Proc. 2016-47 simplifies the process for correcting late rollovers from one tax-qualified retirement account to another. The guidance provides plan administrators and IRA trustees with an additional basis for accepting rollover contributions after the 60-day deadline.


Details

When a distribution is made from a tax-qualified retirement account, such amount will be taxable unless it is rolled over into another qualified account within 60 days of the distribution. Previously under Rev. Proc. 2003-16, taxpayers who missed the 60-day period needed to apply to the IRS for a private letter ruling and pay a user fee for a waiver of the requirement. Now, pursuant to Rev. Proc. 2016-47, relief is available without IRS intervention.

To obtain relief for the missed deadline, the individual must certify to the plan administrator or IRA trustee accepting the late contribution that (i) the IRS has not previously denied a request for a waiver of the 60-day rollover requirement, (ii) the failure resulted from any of the 11 common situations listed below, and (iii) the rollover contribution is being made as soon as practicable, not to exceed 30 days, after the impediment to making such contribution no longer applies.

Eleven Situations Qualifying for Self-Correction of Late Rollover Contributions

  1. The financial institution receiving the contribution or making the distribution to which the contribution relates made an error;

  2. The distribution check was misplaced and never cashed;

  3. The distribution was deposited into an account that the taxpayer mistakenly thought was an eligible retirement plan;

  4. The taxpayer’s principal residence was severely damaged;

  5. A member of the taxpayer’s family died;

  6. The taxpayer or a member of the taxpayer’s family was seriously ill;

  7. The taxpayer was incarcerated;

  8. Restrictions were imposed by a foreign country;

  9. The post office made an error;

  10. The distribution was made on account of a levy under Sec. 6331, the proceeds of which have been returned to the taxpayer; or

  11. The party making the distribution delayed providing information that the receiving plan or IRA required to complete the rollover, despite the taxpayer’s reasonable efforts to obtain it.

 
Actions by Plan Administrators
A plan administrator or IRA trustee may rely on the individual’s certification and accept the late rollover contribution, provided the plan administrator or IRA trustee does not have actual knowledge that is contrary to such certification. Notably, the contribution must be made to the plan or IRA within 30 days after any reason listed in the certification letter no longer prevents the individual from making the contribution.
 
Plan administrators now have three bases for accepting late rollover contributions:

  1. The automatic waivers permitted under Rev. Proc. 2003-16 involving untimely rollovers that resulted from financial institution errors;

  2. The written self-certifications under Rev. Proc. 2016-47 explaining the late rollover resulting from any of the 11 common situations described above; and 

An IRS private letter ruling waiving the 60-day rollover requirement, which was obtained by the individual for other circumstances in which an automatic waiver or self-certification letter is unavailable. 
 


For more information on your exposure the ERISA Title I penalties and the increased amounts, 
please contact:

  Joan Vines
Senior Director, National Tax 
Compensation & Benefits Carl Toppin
Senior Manager, National Tax
Compensation & Benefits  Kim Flett
Managing Director, National Tax
Compensation & Benefits

Federal Tax Alert - September 2016

Wed, 09/07/2016 - 12:00am
Repair v. Capitalization and Depreciation Changes Will Affect 2016 Business Returns The following briefing covers recent developments relating to repair, capitalization, and depreciation as embodied in the final "tangible property regulations," also known as the "repair regulations." In addition, significant changes to depreciation provisions, such as bonus depreciation and the Section 179 allowance, were made by the Protecting American from Tax Hikes Act of 2015 (PATH Act) (P.L. 114-113).

  Download

State and Local Tax Alert - August 2016

Wed, 08/31/2016 - 12:00am
North Carolina Issues Corporation Income Tax Proposed Market-Based Sourcing Rules and Makes Changes to the Sales/Use Tax that Impact Repair, Maintenance, and Installation Services Download PDF Version
Summary Recently, North Carolina Governor Pat McCrory (R) signed S.B. 726, 2015-2016 Sess. (N.C. 2016), S.B. 729, 2015-2016 Sess. (N.C. 2016), and H.B. 1030, 2015-2016 Sess. (N.C. 2016) into law. Together, these rules (i) propose market-based sourcing rules for Corporation Income Tax purposes and require the Department of Revenue to issue related proposed regulations; (ii) create sales and use tax exemptions related to certain repair, maintenance, and installation (“RMI”) services; (iii) make various changes to the Individual Income Tax; and (iv) update the state’s Internal Revenue Code (“IRC”) conformity date.
Details Corporation Income and Franchise Tax
Market-Based Sourcing – H.B. 1030 requires the Department to prepare proposed regulations related to the proposed market-based sourcing rules for services, intangibles, and banks found in H.B. 1030. Under the proposed non-bank market-based sourcing rules, sales from services are sourced to the state of delivery, sales from intangibles are sourced to the state of use, and reasonable approximation is allowed where the market for a receipt cannot otherwise be determined under the rules. Under the proposed bank market-based sourcing rules, each receipt type (e.g., sales, interest, fees, penalties, etc.) is sourced according to specific rules.

The Department must submit the proposed regulations to the Rules Review Commission on or before January 20, 2017, and accept comments on them for at least 90 days after publication. The Commission must then deliver the regulations approved by the Department to the Codifier of Rules, who must then enter them into the Administrative Code when the General Assembly enacts the proposed statutory rules and directs the Codifier to do so. At that time, the regulations will become effective.

Exclusions from Sales Factor – Under S.B. 729, effective for taxable years beginning on or after January 1, 2016, North Carolina excludes the following items from the calculation of the sales factor for apportionment purposes:
  • Gross receipts attributable to the notional principal amount of a swap contract or similar financial derivative that generates the cash flow traded in the swap agreement;
  • Dividends treated as foreign source under IRC § 862 (net of related expenses);
  • Subpart F inclusions under IRC § 951;
  • Foreign indirect tax credit gross-up amounts under IRC § 78; and
  • Dividends excluded for federal income tax purposes.
Qualified Air Freight Forwarder Apportionment – Also effective for taxable years beginning on or after January 1, 2016, S.B. 729 requires a corporation engaged in a freight forwarding business that is primarily carried on with an affiliated air carrier to apportion its income using the revenue ton mile fraction of its affiliated air carrier.

New Franchise Tax Base Effective Date – S.B. 729 clarifies that the new Franchise Tax base enacted in 2015 is effective for taxable years beginning on or after January 1, 2017, and applies to Franchise Tax reported and paid with 2016 and later Corporation Income Tax returns. See the BDO SALT alert that discusses the new Franchise Tax base.
 
Sales and Use Tax
RMI Services – Effective January 1, 2017, H.B. 1030 amends the definition of RMI services to clarify that those taxable services include certain refinishing, cleaning, inspection, and monitoring services. However, H.B. 1030 specifically exempts the following RMI services from sales and use tax:
  • Legally required inspection services;
  • Services provided by a related member;
  • Certain services performed to resolve an issue that was part of a real property contract;
  • Real property cleaning services;
  • Services on roads, driveways, parking lots, and sidewalks;
  • Snow and waste removal services, excluding portable toilet waste removal services;
  • Home inspection services to prepare real property for sale;
  • Landscaping services;
  • Clothing alteration and repair services, excluding the alteration and repair of belts and shoes;
  • Pest control services;
  • Moving services; and
  • Self-service car washes.
Real Property Contracts – Also effective January 1, 2017, H.B. 1030 repeals the rule that deemed someone engaged in retail trade could not be a real property contractor and, thus, provides nontaxable status to services performed by a real property contractor. In addition, H.B. 1030 amends the definition of a real property contract to limit the term to contracts involving capital improvements to real property.

Under H.B. 1030, North Carolina provides rules for a mixed real property and RMI services contract. Specifically, effective January 1, 2017, if the price of the taxable RMI services under such a contract does not exceed 10 percent of the contract price, then North Carolina treats the entire contract as a non-taxable real property contract. Otherwise, North Carolina treats the RMI services as performed under a separate contract.

Other Notable Sales and Use Tax Changes – H.B. 1030 and S.B. 729 also make the following notable changes to the sales and use tax law:
  • Exempt Service Contracts – Effective January 1, 2017, H.B. 1030 exempts service contracts sold by a motor vehicle dealer, or by or on behalf of a motor vehicle service agreement company, for a motor vehicle or related components, accessories, and systems.
  • Direct Pay Permits – Effective July 1, 2016, H.B. 1030 authorizes the Department to issue a direct pay permit for separately stated installation charges related to the purchase of tangible personal property and digital property, and the gross receipts from the provision of RMI services, for a boat, qualified jet engine, or aircraft. The permit entitles the holder to a use tax exemption to the extent the amount of installation charges and receipts from RMI services exceed $25,000.
  • Use Tax Expansion – Effective January 1, 2017, S.B. 729 expands the definition of storage to include holding property in the state for any period of time, but excepts property held as inventory. 
Individual Income Tax
H.B. 1030 and S.B. 729 together make the following changes to the Individual Income Tax:
  • Standard Deductions – H.B. 1030 phases-in modest increases to the standard deduction for each of the filing statuses over a two year period, beginning with the 2016 taxable year.
  • Claim of Right Deduction – S.B. 729 allows an itemized deduction for the repayment of an amount included in income in an earlier year under a claim of right, retroactively effective to taxable years beginning on or after January 1, 2014.
  • C.O.D. Income – Retroactive to tax years beginning on or after January 1, 2014, S.B. 729 allows a deduction for the amount of cancellation of indebtedness income included in federal taxable income under IRC § 108(i)(1), which relates to the deferral and ratable inclusion of income arising from business indebtedness discharged by the reacquisition of a debt instrument.
  • Expenses Related to Federal Credits – Beginning with the 2016 taxable year, S.B. 729 allows a deduction for the amount that a federal expense deduction is reduced if the taxpayer claimed a federal credit instead of the deduction, provided the state does not allow a similar credit.
  • Federal NOLs – Beginning January 1, 2016, S.B. 729 requires an addition to the federal adjusted gross income starting point for any federal net operating loss carried over to the current year that the taxpayer does not use and carries over to future taxable years.
  • Parental Savings Trust Fund Withdrawals – Beginning January 1, 2016, S.B. 729 requires an addition to the federal adjusted gross income starting point for an amount deducted in a prior year to the extent the amount was withdrawn from the Parental Savings Trust Fund of the State Education Assistance Authority and not used to pay for qualified higher education expenses of the beneficiary, unless the non-qualified use was made without penalty under IRC § 529 due to the beneficiary’s death or disability. 
Other Notable Changes
H.B. 1030, S.B. 726 and S.B. 729 together make the following changes to North Carolina tax law:
  • IRC Conformity – Effective June 1, 2016, S.B. 726 updates North Carolina’s IRC conformity date from January 1, 2015, to January 1, 2016, for income and other tax purposes.
  • Mill Machinery Tax – Retroactive to July 1, 2013, H.B. 1030 expands the one-percent Mill Machinery Tax (and the related sales tax exemption) to include purchases of certain specialized equipment used to unload and process bulk cargo at a ports facility. In addition, effective July 1, 2016, H.B. 1030 subjects certain specialized equipment used by certain metal recyclers, metal fabricators, and precious metal extractors to the tax.Intangible Holding Companies – S.B. 729 makes law changes that impact intangible holding company structures for Corporation Income Tax purposes. See the BDO SALT alert that discusses these law changes.
BDO Insights
  • The proposed market-based sourcing rules, along with this year’s market-based sourcing information report requirement and North Carolina’s phase-in of single sales factor apportionment formula, creates an expectation that the state will eventually adopt market-based sourcing for sales from services and intangibles. While the market-based sourcing rules are only proposed at this point in time, taxpayers should consider the impact that the proposed market-based sourcing rules may have on them for tax planning purposes.
  • As noted, North Carolina cannot adopt the proposed statutory market sourcing rules as the standard sourcing methodology until enacted (and the proposed regulations required to be prepared by the Department will not be effective until then). It is expected that the enactment of the proposed statutory market sourcing rules will be deferred until the next legislative session, which will convene on January 11, 2017.
  • Taxpayers affected by the clarification that the sales and use tax on RMI services includes refinishing, cleaning, inspection, and monitoring services may find relief due to the exemptions provided in the legislation that are effective January 1, 2017. However, as of the same date, taxpayers may need to update their sales and use tax systems to report and pay tax in accordance with the changes under H.B. 1030.
   

For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Principal
  Ashley Morris
Tax Managing Director
    Mariano Sori
Tax Partner
  Scott Smith
Tax Managing Director
    Richard Spengler
Tax Managing Director
  Tony Manners
Tax Managing Director






   
Southwest:

Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

Expatriate Tax Newsletter - August 2016

Wed, 08/31/2016 - 12:00am
BDO's Expatriate Newsletter covers timely tax-related updates and regulations from countries around the globe. The August 2016 issue highlights developments in China, Italy, Sweden and more.
  Download

State and Local Tax Alert - August 2016

Mon, 08/29/2016 - 12:00am
Tennessee Department of Revenue Expected to Further Advance Sales and Use Tax Economic Nexus Rule Download PDF Version
Summary On August 8, 2016, the Tennessee Department of Revenue held a public hearing on Proposed Rule 1320-05-01-.129 that would establish a sales and use tax economic nexus standard in the state beginning 90 days after the Department files a final rule with the Tennessee Secretary of State.
Details Sales and Use Tax Economic Nexus
Under Proposed Rule 1320-05-01-.129, an out-of-state dealer who engages in the regular or systematic solicitation of consumers in the state through any means, and whose Tennessee taxable sales exceed $500,000 during any calendar year, has substantial nexus in the state. An out-of-state dealer subject to the economic nexus standard must register with the Department for sales and use tax purposes by January 1, 2017, and report and pay tax on sales of tangible personal property and other taxable items delivered to Tennessee consumers by July 1, 2017.

The economic nexus rule is not yet final. However, now that a public hearing has been held, the Department is expected to issue a final rule after various internal reviews are completed. Once the final rule is filed with the Secretary of State, it will become final 90 days after the date of such filing.
  BDO Insights
  • The Department is expected to file a final rule with the Secretary of State. An out-of-state dealer who solicits sales in Tennessee through any means and expects to exceed the $500,000 taxable sales threshold should consider the impact that this rule may have on them for tax planning and reporting purposes.
  • Tennessee followed Alabama by using a regulation to implement a sales and use tax economic nexus standard. See the BDO SALT alert that discusses the Alabama economic nexus standard. South Dakota and Vermont recently adopted economic nexus standards via legislation. See the BDO SALT alert that discusses the South Dakota economic nexus standard, and the BDO SALT alert that discusses the Vermont economic nexus standard. In addition, economic nexus legislation has been introduced in several other states.
  • Even though there appears to be an economic nexus trend, there is hope for taxpayers. Litigation is underway challenging the Alabama and South Dakota economic nexus standards, which at least has the effect of staying enforcement of the South Dakota law. In addition, on July 14, 2016, U.S. Representative Jim Sensenbrenner (R-WI) introduced H.R. 5893, 114th Congress, 2d. Sess. (2016), which, if enacted, would essentially codify the sales and use tax physical presence standard enunciated by the U.S. Supreme Court in Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and settle any disputes as to the appropriate sales and use tax nexus standard.
 


For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Principal
  Ashley Morris
Tax Managing Director
    Mariano Sori
Tax Partner
  Scott Smith
Tax Managing Director
    Richard Spengler
Tax Managing Director
  Tony Manners
Tax Managing Director






   
Southwest:

Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

International Tax Alert - August 2016

Thu, 08/18/2016 - 12:00am
Brazilian Disclosure System

Download PDF Version

Summary On May 9, 2016, the Brazilian Federal Tax Authorities (RFB) issued Normative Instruction 1,634/2016 (NI 1,634), which updates the requirements of the Corporate Taxpayer Identification (“CNPJ”). The CNPJ is the mandatory taxpayer ID for every legal entity that has operations or has assets in Brazil.
Discussion NI 1,634/2016 requires businesses to disclose the chain of ownership up to the ultimate beneficial owners. The new disclosure requirements are in line with international guidelines to improve transparency and facilitate a more effective battle against corruption and money laundering. Corporate entities that are beneficiaries are subject to these requirements.  The ultimate beneficiary includes individuals with significant influence or control, directly or indirectly, over the entity.

Significant influence refers to an individual that owns more than 25 percent (directly or indirectly), or holds or exercises the preponderance in corporate resolutions and the power to elect a majority of the entity's management, even without controlling it.

In the event taxpayers do not comply with the new requirements, the CNPJ will be suspended and transactions with financial institutions could be restricted. Furthermore, without a valid CNPJ, the company will not be able to issue an invoice or make a purchase.

Businesses are obligated to comply with the CNPJ from January 1, 2017, for the taxpayer that requests its registration from the same date on. Taxpayers that register before January 1, 2017, should inform the beneficial owners electronically in case of a change in the register no later than December 31, 2018. 
 
For more information, please contact one of the following practice leaders:
  Robert Pedersen
Partner and International Tax/Transfer Pricing Practice Leader          Chip Morgan              Partner 
    Joe Calianno
Partner and International Technical Tax Leader, National Tax Office   Brad Rode
Partner 
    William F. Roth III
Partner, National Tax Office   Fabrizia Hadlow
Managing Director   Scott Hendon
Partner    Jerry Seade
Principal    Monika Loving
Partner     

Compensation & Benefits Alert - August 2016

Tue, 08/16/2016 - 12:00am
Action Plan to Avoid Penalties for Missing or Erroneous Taxpayer Identification Numbers on Form 1095 Reporting
Download PDF Version
Summary Employers and insurance providers who issue Form 1095  with missing or erroneous taxpayer identification numbers (TIN) will not be penalized  under the information reporting rules,  provided  “reasonable efforts” are made to obtain missing or correct TINs.  Proposed regulations under Internal Revenue Code Section 6055 issued on July 29, 2016, specify the steps to be taken that satisfy the “reasonable efforts” requirement. 
Immediate Action Plan Employers should adopt procedures that satisfy the initial solicitation by incorporating a request for TINs for all individuals enrolling in health care coverage after July 29, 2016, and ensure the request is a part of any future open enrollment process in order to satisfy the initial solicitation requirements.   A second solicitation should be made 75 days after the application, and a third solicitation by December 31 of the next year, if necessary. 

A search of all current enrollees without a TIN should be conducted.  If an individual was enrolled as of July 29, 2016, a solicitation should be sent prior to October 12, 2016.  For anyone who enrolled after July 29, 2016, for which an initial solicitation has not been made, a request for the TINs should be made as soon as possible with a second solicitation 75 days after the enrollment date.  

For any IRS error messages indicating that a TIN and name provided on the 2015 return do not match IRS records, employers should verify the filing is consistent with their data and request the employee send the correct information within the 90-day window provided by the IRS to re-file the 2015 return.
To help motivate employees into action, inform employees of potential contact by the IRS if unable to confirm coverage for the dependents and a $50 failure to comply penalty assessable to them under Section 6723.
  Details The information reported under Section 6055 allows individuals to establish, and the IRS to confirm, that said individuals maintained the requisite healthcare coverage during the year and are not subject to penalties under the Affordable Care Act.

All employers offering health care benefits through a self-insured plan must furnish to employees and file with the IRS information on Forms 1095 (1095-B for small employers or 1095-C, Part III for large employers), which lists the name, taxpayer identification number (“TIN”), and the months of coverage for each employee and their dependents covered under the plan.

The final regulations under Section 6055 direct employers to report TINs for all covered individuals (employees and their dependents) and to provide a date of birth only if a TIN is not available after the employer makes reasonable efforts to obtain it, pursuant to previously existing TIN solicitation rules.  The proposed regulations establish TIN solicitation rules tailored for health care coverage.  Accordingly, the following procedures constitute reasonable efforts to obtain missing or correct TINs for purposes of Section 6055 reporting.
    Missing TIN Incorrect TIN Description Employer does not obtain a TIN for a covered individual. Employer obtains an incorrect TIN for a covered individual.  IRS notifies employer of an incorrect TIN through a Form 972-CG or penalty notice under Section 6721.*  Initial solicitation The date the employer receives a substantially complete application for new coverage (or to add an individual to existing coverage). 
    Second solicitation Within 75 days of the initial solicitation.
 
For all individuals enrolled in coverage prior to July 29, 2016, for which a TIN has not been obtained as of such date, the 75-day period ends October 12, 2016. By December 31 of the year in which the employer is notified of the incorrect TIN (or by January 31 of the following year if notified in the preceding December). Third solicitation December 31 of the year following the year of the initial solicitation. The employer must undertake another solicitation if notified in any year following the year of the notification described above.
* A Form 1095 filing error message received from the IRS indicating that a TIN and name provided on the return do not match IRS records does not constitute notification that would require the filer to solicit a TIN.
  Forms of Solicitation TIN requests may be made in a number of different formats:  (i) the provision of a renewal application that requests TINs for all covered individuals if sent by the applicable deadlines; (ii) subsequent solicitations may be delivered to the covered individuals with a return envelope; and (iii) by electronic means in accordance with IRS rules.
Penalties Failure to report the TIN of each covered individual on the Form 1095-B (or 1095-C, Part III) filed with the IRS and furnished to the employee may constitute an incorrect information return subject to penalties.   The combined penalties for failure to file a correct information return with the IRS (Section 6721) and failure to furnish a correct information return to an employee (Section 6722) are up to $500 per incorrect statement ($6 million annual cap).  See our prior alert.

However, employers will not be subject to penalties for failure to report a correct TIN if they demonstrate reasonable efforts to obtain the TIN by complying with the solicitation rules.  The initial and second solicitations relate to failures on returns required to be filed for the year that includes the effective date of coverage for a newly covered individuals.  The third solicitation relates to failures on returns filed for the year immediately following the year to which the second solicitation relates, and succeeding calendar year.   
 
Example:  Employer ABC, a small employer, maintains a self-insured healthcare plan.  Employee Z was hired on November 1, 2016.  Employee Z and his dependents entered ABC’s healthcare plan on November 1, 2016, although ABC had not received TINs for Z’s dependents.  Provided ABC (i) requests the TINs on the application for coverage (the initial solicitation), (ii) submits another request for TINs no later than January 15, 2017 (the second solicitation), and (iii) reports the dates of birth of the dependents on the 2016 Form 1095-B upon failing to receive the TINs after both solicitations, then ABC is able to demonstrate reasonable efforts to obtain the TINS and avoid penalties with respect to Z’s 2016 Form 1095-B.  ABC may similarly avoid penalties with respect to Z’s 2017 Form 1095-B (reporting date of births for Z’s dependents in lieu of their TINs), provided ABC submits another request for the TINs not later than December 31, 2017.
 
The penalties are imposed on the employers sponsoring the self-insured plans.  In the case of fully-insured health plans, the penalty is imposed on the health insurance issuer (the filer of the Form 1094-B) and actions taken by the sponsoring employer may satisfy the TIN solicitation requirements.  However, the health insurance issuer remains responsible for the penalties. 
Penalty Relief for 2015 The IRS will not impose penalties for returns and statements filed and furnished in 2016 to report coverage in 2015 reporting incorrect or incomplete information on the return or statement, including TINs.  However, no relief is provided to employers that do not make a good faith effort to comply with the reporting requirements.  Although the IRS fails to specify what constitutes a “good faith effort”  employers can show that they have made good faith efforts to comply with the information reporting requirements.  This relief applies to incorrect or incomplete information, including the omission of TINs to be reported on a 1095.
 
For more information, please contact one of the following practice leaders:
 

Joan Vines
Sr. Director, National Tax - Compensation & Benefits

 

Carl Toppin
Sr. Manager, Compensation & Benefits

 

Linda Baker
Sr. Manager, Compensation & Benefits

 

Kim Flett
Sr. Director, Compensation & Benefits

  Peter Klinger
Principal, Compensation & Benefits  

 

Pages