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State and Local Tax Alert - April 2016

Fri, 04/08/2016 - 12:00am
Rhode Island Adopts Combined Reporting Regulation
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Summary On March 10, 2016, Rhode Island adopted Regulation CT-16-17, which provides guidance regarding the state’s water’s edge unitary combined reporting requirement for Business Corporation Tax purposes starting with taxable periods beginning after December 31, 2014.  The regulation, which is divided into 23 rules, explains all aspects of Rhode Island combined reporting, including determination of the combined group, computation of taxable income and apportionment, tracing and utilization of net operating losses (“NOLs”) and credits, and various administrative requirements.  See Regulation CT-16-17.
  Details Background
On June 19, 2014, Rhode Island Governor Lincoln Chafee signed into law H.B. 7133 (now codified under Title 44, chapter 11 of the General Laws of Rhode Island), which implemented the water’s edge unitary combined reporting requirement.  The law also implemented single sales factor apportionment, market-based sourcing of receipts from sales of other than tangible personal property, a lower 7-percent tax rate, and the elimination of the requirement to addback related member intangible expenses and interest.  See BDO’s SALT Alert which discusses these law changes.
 
Composition of Combined Group
H.B. 7133 requires combined reporting with respect to two or more unitary corporations, wherever incorporated, that are more than 50 percent owned by a common owner, whether that owner is corporate or non-corporate, or whether or not that owner is a member of the combined group.  While a corporation, wherever incorporated, may be included in a combined return, Rhode Island excludes a non-U.S. corporation from the combined group if more than 80 percent of its sales factor is outside the United States.  Rhode Island also excludes the income (and attributed expenses and apportionment) of an included non-U.S. corporation, to the extent that such income is subject to the provisions of a comprehensive income tax treaty between the United States and a foreign jurisdiction.  This exclusion does not apply (with some exceptions) if the foreign jurisdiction is a “tax haven” jurisdiction.  The definition of “tax haven” in the regulation is the same as it is in H.B. 7133, and the regulation does not expand on or interpret it.

The regulation specifies that the following unitary entities that meet the 50-percent direct or indirect ownership requirement are included in a combined report:
  • U.S. C corporations;
  • Any C corporation, regardless of where it is incorporated or formed, if its sales factor for total receipts inside the United States. is 20 percent or more; and
  • A C corporation that is a resident of a country that does not have a comprehensive income tax treaty with the United States, and earns more than 20 percent of its income from intangible property or service-related activities that are deductible against the business income of the other members of the combined group to the extent of that income and related apportionment factor.
The following entities are excluded from a combined report:
  • A non-U.S. C corporation if its sales factor for total receipts outside the United States is more than 80 percent;
  • S corporations, and partnerships and LLCs treated as pass-through entities for federal tax purposes;
  • Any sole proprietorship or similar entity that is disregarded for federal income tax purposes;
  • State banks, mutual savings banks, federal savings banks, trust companies, national banking associations, building and loan associations, credit unions, and loan and investment companies;
  • Public service corporations;
  • Insurance companies; and
  • Captive insurance companies subject to the insurance premiums tax.
Common Ownership Requirement
H.B. 7133 defines “common ownership” to mean “more than fifty percent (50%) of the voting control of each member of the group is directly or indirectly owned by a common owner or owners, either corporate or non-corporate, whether or not owner or owners are members of the combined group.”

The regulation specifies that the 50-percent ownership test is satisfied in the following circumstances:
  • A parent corporation and one or more corporations or chains of corporations which are directly or indirectly connected through voting stock ownership with the parent, if:
    • The parent owns more than 50 percent of the outstanding voting stock of at least one corporation; and
    • More than 50 percent of the outstanding voting stock of each of the corporations, other than the parent, is owned directly or indirectly by one or more of the other corporations.
  • Two or more corporations, if more than 50 percent of the outstanding voting stock of each of the corporations is directly or indirectly owned by the same person; and
  • Two or more corporations, more than 50 percent of whose voting stock is cumulatively owned, or for the benefit of, members of the same family (i.e., an individual, his or her spouse, a party to a civil union, ancestors, brothers or sisters, lineal descendants, and their respective spouses).
For purposes of ascertaining ownership, the regulation requires the use of the following rules:
  • An individual indirectly owns voting stock that is owned by any of the following:
    • A spouse who is not legally separated from the individual,
    • A party to a civil union,
    • Children, grandchildren, and parents, and
    • An estate or trust of which the individual is an executor, trustee, or grantor, to the extent that the estate or trust is for the benefit of that individual’s spouse, party to a civil union, children, grandchildren or parents;
  • Voting stock owned by a corporation is indirectly owned by any shareholder (or group of shareholders if acting in concert) owning more than 50 percent of the voting stock of the corporation;
  • Voting stock owned by a general partnership is indirectly owned by a partner in proportion to the partner’s capital interest in the partnership;
  • Voting stock owned by a limited partnership is indirectly owned by the general partner who has authority to determine how the stock is voted; and
  • The Rhode Island Division of Taxation may rely on the constructive ownership rules under IRC § 318 to demonstrate that the direct or indirect ownership requirement is met.
Unitary Business Requirement
H.B. 7133 defines “unitary business” as follows:
 
[T]he activities of a group of two (2) or more corporations under common ownership that are sufficiently interdependent, integrated or interrelated through their activities so as to provide mutual benefit and produce a significant sharing or exchange of value among them or a significant flow of value between the separate parts. The term unitary business shall be construed to the broadest extent permitted under the United States Constitution.
 
The regulation provides a detailed description of the definition of “unitary business.” Specifically, the regulation notes that the following characteristics indicate sufficient interdependence to support a finding of a unitary relationship between two or more entities or businesses:
  • Same line of business;
  • Vertically structured business;
  • Strong centralized management;
  • Non-arm’s length prices;
  • Existence of benefits from joint, shared or common activity; and
  • Exercise of control.
In addition, the regulation notes that for purposes of assessing whether a unitary relationship exists between two entities or businesses, unity of operations and unity of use (i.e., common purchasing, common advertising, common accounting, common marketing, etc.) should be considered.  Guidance is provided with respect to holding companies, and newly formed and acquired entities.

Affiliated Group Election
H.B. 7133 allows an “affiliated group,” as defined in IRC § 1504, to make a five-year election to be treated as a combined group in lieu of a unitary business group, notwithstanding the absence of a unitary relationship.  The election may not be revoked unless approved by the Division.

The regulation notes that, to make the election, a taxpayer must check the box on Form RI-1120C and file a completed return.  Once made, the election is binding for five consecutive tax years beginning with the year of election.  This rule is also applicable to an entity that enters the affiliated group after the year of the election.  To revoke the election, a taxpayer must petition the Division in writing, citing reasonable cause (e.g., a significant restructuring).

An affiliated group may not make the election if those entities in which it has an ownership interest between 50 percent and 80 percent would materially impact the combined return were they to be included in the combined return.  To clearly reflect income, the Division may require an affiliated group to include certain entities that are not included in its federal consolidated return, or exclude certain entities that are so included. 

Combined Group Net Income and Apportionment
The regulations note the following with respect to the calculation of a combined group’s net income:
  • Determination of taxable income for the combined group is based on the product of the pre-apportioned taxable income of the combined group, and the apportionment factor of the combined group;
  • The taxable income of the combined group and the apportionment factor includes each member’s pro-rata share of income and receipts from a flow-through entity;
  • The principles relating to deferral, eliminations, and exclusions as set forth in the IRS’s consolidated return regulations are applied for purposes of determining the taxable income and apportionment of the combined group;
  • The numerator of the apportionment factor includes the Rhode Island receipts of each member of the combined group in the numerator, regardless of whether or not a member has nexus with Rhode Island – a Finnigan approach;
  • A combined group member’s apportionment factor includes its distributive share of the apportionment factor of a flow-through entity based on costs of performance sourcing rather than market sourcing, as generally required under the Corporation Business Tax;
  • The taxable year of the combined group is the taxable year of the federal consolidated group if two or more members are included in a federal consolidated return – otherwise, use the taxable year of the designated agent (see discussion below); and
  • Where one or more members of a combined group have different accounting periods, the designated agent must elect to determine the taxable income of all such members in one of the following ways:
    • A separate income statement prepared from the books and records for the months included in the group’s taxable year; or
    • Include all of the income for the year that ends during the group’s taxable year.
NOLs and Tax Credits
With respect to NOLs and tax credits, H.B. 7133 limits the use of an NOL carryforward or tax credit created before January 1, 2015, to the entity that created it.  H.B. 7133 allows the use of an NOL and tax credit created in a taxable year beginning after December 31, 2014, by the combined group.

In addition to the rules noted in H.B. 7133, the regulation specifies the following with respect to the use of NOLs (the same rules apply to tax credits), and provides a number of examples demonstrating the operation of these rules:
  • No deduction is allowable for an NOL sustained during any taxable year in which a taxpayer was not subject to Business Corporation Tax;
  • For the year in which an NOL is allowed, such NOL is limited by the amount of that corporation’s federal taxable income for that year;
  • NOLs are be carried forward from year-to-year separately by the individual entity that originally incurred the underlying loss, and remain the tax attribute of that entity;
  • Where a member ceases to be a member of the combined group, any NOL carryforward owned by the member is no longer available for use by the other members of the combined group;
  • If a member joins a new combined group, the member may not share the NOL carryforward with the members of its new combined group, unless one of the members of the new combined group was also a member of the combined group during the year the loss was incurred; and
  • Where a member has an NOL carryforward and subsequently merges out-of-existence, the surviving entity assumes the NOL carryforward.
Minimum Tax
The Rhode Island tax is the greater of a $500 minimum tax or the tax computed on apportioned net income.  The regulation notes that the minimum tax of a combined group is the product of the number of members in the combined group with Rhode Island nexus and the amount of the minimum tax.

Administrative Requirements
Designated Agent.  The regulation requires a combined group to appoint a designated agent as the filer of the combined return, and to act on behalf of the combined group with respect to all matters relating to the combined return (e.g., responding to notices and correspondences, participating in audits, executing documents, etc.).  The designated agent must be a member of the combined group that itself is subject to a Business Corporation Tax filing responsibility.  The corporation that files the first combined return is deemed to be the designated agent, and remains the designated agent until the Division is notified that another member of the combined group will act as the designated agent.

Combined Report.  A combined return is required to include the following:
  • Listing of companies included in the combined report, along with each company’s federal Employer Identification Number (“EIN”) and North American Industry Classification System (“NAICS”) code;
  • On a combined basis, federal taxable income, Rhode Island additions and deductions, receipts using the Finnigan method, and Rhode Island tax;
  • Copy of the first four pages of the completed U.S. Form 1120 as filed with the IRS;
  • Copy of the separate company income and loss consolidation spreadsheet as filed with the IRS; and
  • Information on credits and NOLs.
Affiliated Group.  An affiliated group must include copies of the following with its return:
  • Its federal consolidated return;
  • Any and all supporting documents, forms, schedules and statements filed with the federal consolidated return, including IRS Form 851, and all IRS Forms 1122; and
  • Supporting statements for each corporation included on the federal consolidated return, including, for each such corporation, columns showing items of gross income and deduction, as well as a computation of taxable income.
BDO Insights
  • Rhode Island is one of several states that has recently adopted combined reporting (e.g., Connecticut, District of Columbia, Wisconsin, and West Virginia) – a trend among states, like single sales factor apportionment and market-sourcing for receipts from sales of other than tangible personal property, which Rhode Island has also adopted. 
  • Rhode Island’s combined reporting regulation is comprehensive and provides many examples to assist taxpayers with the application of the combined reporting rules – especially as it pertains to the inclusion/exclusion of entities, computation of combined income, and utilization and tracing of NOLs.
  • The regulations related to the pro forma combined return requirement asked taxpayers to calculate a Financial Accounting Standard 109 (or FAS 109) deduction.  The deduction is not allowed for purposes of mandatory unitary combined reporting.
 

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

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

BDO Indirect Tax Alert - April 2016

Fri, 04/01/2016 - 12:00am
Brought to you by BDO International, the latest edition of Indirect Tax News covers current developments in indirect tax from across the world, including countries like Belgium, Vietnam and Spain. Some highlights include:
  • UNITED ARAB EMIRATES: The UAE will implement VAT on January 1, 2018. The rate will be 5%. Healthcare, education and some basic food items will be exempt.
  • ARGENTINA: The Supreme Court concluded that provinces should not treat goods manufactured and sold within their province differently than goods manufactured outside their province.
  • UNITED STATES: An overview of sales tax nexus in the U.S.

Download

China Tax Newsletter - April 2016

Fri, 04/01/2016 - 12:00am
The April 2016 edition of BDO China's China Tax Newsletter features recent tax-related news and developments in China, including the following topics:
 
  • VAT Expansion
  • Simplification of Dedication Taxes
  • Income tax Policy on Interest Income Derived from Railway Bonds

Download

International Tax Alert - March 2016

Wed, 03/30/2016 - 12:00am
Chinese Government Expands Implementation of VAT Reform Effective May 1, 2016
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  Summary On March 7, 2016, China’s Ministry of Finance (“MOF”) and State Administration of Taxation (“SAT”) jointly issued Notice Caishui [2016] No. 32 (“Notice”) as a result of the 4th Session of the 12th National People's Congress (“NPC”) held on March 5, 2016.    
Details On January 1, 2012, China launched its Value-Added Tax (“VAT”) Reform Pilot Program in the city of Shanghai and gradually expanded the program nationwide.  The VAT Reform Pilot Program was initially rolled out in specified industries, including transportation, research & development, information technology (“IT”), creative cultural business, leasing of moveable and tangible goods, attestation and consulting, and logistics and ancillary. 

According to the Notice released on March 7, 2016, effective May 1, 2016, the current VAT Reform will be expanded to the following four additional industries nationwide:
  1. Construction industry;
  2. Real estate industry;
  3. Financial services industry; and
  4. Lifestyle services industry (i.e., hospitality, food and beverage, healthcare, and entertainment).

The Notice mandated that all existing Business Tax (“BT”) payers will be converted into the VAT system and covered by the VAT Reform.
 
Before the VAT Reform Pilot Program launched in 2012, VAT was levied on the supply of goods; the provision of repair, processing and replacement services; and imports, while BT was levied on the provision of other services and the transfer of intangibles and real properties.  Co-existence of the VAT and BT has led to a number of issues such as double taxation because an input tax credit is available for VAT payers, while generally no such mechanism exists under the BT system.  The aim of the VAT Reform is to reduce double taxation in the prevailing system and to foster development of specified modern service industries by gradually transitioning these industries from the BT system to the VAT system.

In accordance with Notice Caishui [2016] No. 32, upon implementation, VAT will ultimately apply to sales and importation of all goods and provision of all services in or to China.  The BT will effectively cease, which represents $320 billion and 15 percent of Chinese 2015 tax revenue based on the Chinese Ministry of Commerce statistics.1
BDO Insights As the expanded VAT Reform becomes effective on May 1, 2016, the timeframe for successful implementation is extremely challenging for both the affected enterprises and tax authorities at all levels, particularly given the complexity of the VAT issues arising in these newly covered sectors.  Detailed implementation rules are expected to be released by authorities soon.

The expanded VAT Reform presents various opportunities and challenges for all affected businesses.  Uncertainties and questions are likely to follow.  While the underlying matter is tax compliance, the VAT reform will require changes in affected enterprises’ operations models, management processes and financial reporting.

Affected businesses and companies, which include multi-national enterprises operating in China, are advised to assess their preparedness and proactively design a plan to ensure compliance, smooth transition, and minimization of the transition costs.  Actions which we believe companies should consider performing in the near term include the following: 
  1. Obtain a complete and accurate understanding and interpretation of the new rules and implementation guidance from MOF and SAT.  Prepare an implementation plan for the changes upon the May 1, 2016 effective date.  New rules include but are not limited to the Chinese VAT Golden Tax System, VAT invoicing system, VAT verification process, monthly VAT filing and the increasing scrutiny under the VAT Reform.
  2. Analyze the impact on the overall business model, and assess means by which to optimize the business model and maximize tax savings in China.
  3. Perform a thorough tax and financial analysis of the transaction flows and analyze the detailed tax impact on each income stream in China.
  4. Revisit pricing policies including, but not limited to, related party transactions in China.
  5. Reassess relative business contract clauses with regard to taxes for existing and potential customers.
  6. Review and update financial accounting and IT systems in China, and evaluate the overall impact on the business model (e.g. pricing, invoicing, financial reporting, input and output VAT accounting entries, net basis method etc.).  Ensure the changes in accounting and IT systems comply with the VAT requirements.
  7. Update accounting policies and book-keeping operations for proper accounting for assets and liabilities associated with VAT, and transition from BT to VAT for accurate financial reporting and tax filing.
  8. Organize and provide internal and/or external trainings for employees and other stakeholders.
  9. Evaluate the overall impact on annual financial statements and the audits of both statutory stand-alone and consolidated financial statements.
  10. Discuss the detailed implementation plan with local tax advisors and leverage resources such as industry and tax experts to minimize transition and tax compliance costs.
1 Source: Chinese Ministry of Commerce http://gks.mof.gov.cn/zhengfuxinxi/tongjishuju/201601/t20160129_1661457.html

This alert has been prepared in consultation with BDO International member firms for general informational purposes only and should not be construed as tax advice. As such, you should consult your own tax advisor regarding your specific tax matters.
 
For more information, please contact one of the following practice leaders:
 

Robert Pedersen
Partner and International Tax Practice Leader

 

Monika Loving 
Partner

 

Joe Calianno
Partner and International Technical
Tax Practice Leader

 

Shupei (Larry) Miao
Senior Director/Head of China Desk

  Bob Brown
Partner  

Chip Morgan
Partner

  Ingrid Gardner
Managing Director UK/US Tax Desk  

Brad Rode
Partner

  Gordon Gao
Tax Partner (BDO China)   William F. Roth III
Partner   Scott Hendon
Partner   Jerry Seade
Principal   Veena Parrikar
Principal, Transfer Pricing   David Zhang
Partner, China Desk

State and Local Tax Alert - March 2016

Mon, 03/28/2016 - 12:00am
Chicago Personal Property Lease Transaction Tax VDA Program
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Summary The Chicago Department of Finance (“Department”) issued on June 9, 2015 Ruling #12 that provided that the Chicago Personal Property Lease Transaction Tax (“Lease Tax”) applies to non-possessory computer leases, including cloud-based products and services, on-line searchable databases, and other items.  The Department has taken the position that these transactions have always been subject to the Lease Tax, which has caught many companies off-guard and who may now be subject to substantial amounts of Lease Tax, interest, and penalties for previous transactions.  The Department is currently offering a Voluntary Disclosure Agreement (VDA) Program that can assist companies to significantly reduce the amount of Lease Tax, interest, and penalties associated with the Department’s expanded interpretations in Ruling #12.       
Details The Chicago Department of Finance (“Department”) issued on June 9, 2015 Lease Tax Ruling #12 that provides that taxable transactions include, but are not limited to, the following:
  1. Cloud-Based Products and Services: Word processing, calculations, data processing, tax preparation, spreadsheet preparation, presentations and other applications available through access to a provider’s computer and its software.  These examples are often referred to as cloud computing, cloud services, hosted environment, software as a service (SaaS), platform as a service (PaaS), or infrastructure as a service (IaaS)
  2. On-Line Searchable Databases: Real estate listing and prices, stock prices, economic statistics, weather statistics, job listings, resumes, marketing data, company profiles, consumer profiles, and similar information that has been compiled, entered and stored on the provider’s computer.
The Department has taken the position that these transactions have always been subject to Lease Tax.  The Department may assess Lease Tax on providers that have not charge Lease Tax on taxable transactions as well as companies where the provider did not charge Lease Tax on taxable transactions.

VDA Program Opportunity
The Department is offering a VDA program for taxpayers that have not addressed or underreported their Lease Tax obligations.  This VDA program should provide significant cost savings for companies that were unaware of their Lease Tax liabilities.  The potential benefits of the VDA program include:
  1. Limited look back period (depending on company’s set of facts, the look back period is to January 1, 2015, January 1, 2016, or 4 years from the VDA filing date)
  2. Abatement of penalties
  3. Abatement of interest
Note – BDO has successfully worked with the City of Chicago on Lease Tax VDAs for our clients that meet the required conditions.  It is imperative that you contact us if you meet the Lease Tax requirements for filing a VDA. 

What To Do
Given the above, companies that provide or use taxable products or services within the city of Chicago should:
  1. Determine if your organization has received prior correspondence from Chicago
  2. Determine what historical tax compliance, if any, has been with the city of Chicago.
  3. Evaluate the VDA Decision Tree , and
  4. Take action and contact BDO for further guidance and best practices.
Companies at Highest Risk
  1. Companies located in Chicago that have not addressed or underreported their Lease Tax obligations.
  2. Companies located in other states but with nexus and customers in Chicago who have not addressed or underreported their Lease Tax obligations.
  3. Companies that provide or use cloud based products or services within Chicago.

BDO Insights BDO’s State and Local Tax Practice BDO has significant experience with Chicago’s VDA Program and has successfully assisted many clients with this VDA program.  BDO’s success is largely attributable to our experience working with the Chicago Department of Finance.
 
For more information, please contact Mariano Sori or Katie Girmscheid

International Tax Alert – March 2016

Mon, 03/28/2016 - 12:00am
As part of the 2016 Budget announced on March 16, 2016, the United Kingdom Government revealed changes to the withholding tax regime with respect to royalties.  Measures being introduced include:  widening the scope of royalty payments to which withholding tax applies and introducing anti-avoidance legislation.
Download PDF Version
Summary Three new measures were introduced in the United Kingdom’s 2016 budget, which relate to withholding tax on royalties:
  1. UK withholding tax will apply to a wider definition of royalty payments, bringing more royalties within the scope of the rules;
  2. UK withholding tax will now apply to royalty payments attributable to UK permanent establishments (“PEs”); and
  3. A targeted domestic anti-treaty abuse rule was introduced with immediate effect.
The first two measures will apply to payments made on or after the date that the 2016 Finance Bill receives Royal Assent (expected July 2016) and the anti-treaty abuse measure is effective for payments made on or after March 17, 2016.
Background In today’s global economy, multinational groups often derive large sums from the exploitation of intellectual property that is often held in low tax, low substance locations.  The UK Government is concerned that groups are able to structure tax deductible royalty payments from the United Kingdom in such a way that the United Kingdom loses its right to tax those royalties, either because the legislation requiring withholding tax is not broad enough to capture such payments and/or the payments are structured in such a way as to take advantage of one of the UK’s double tax treaties.  
Details Current Rules
Under the United Kingdom’s existing withholding tax regime, a 20-percent income tax must be deducted from certain UK source royalty payments.  “UK source” is not currently defined.
 
Withholding tax is only required in fairly limited circumstances, for example with respect to payments for patent royalties, copyright owned abroad, certain design rights, and payments of other royalties that are “annual payments” ( i.e., payments that are regarded as pure income profit to the recipient).  Many royalty payments are, therefore, not currently subject to the UK’s withholding tax rules.
 
Where withholding tax is due, this can often be reduced under the provisions of one of the United Kingdom’s many double tax treaties.  Under current UK domestic law there is no treaty anti-abuse rule; although many UK treaties include a “main purpose” test, as does the EU Interest and Royalties Directive.
 
Broadening the definition of royalties subject to withholding tax
 The definition of royalties that are subject to UK withholding tax will be broadened.  Relevant intellectual property will be defined as:
  1. any patent, trademark, registered design, copyright, design right, performer’s right or plant breeder’s right;
  2. any similar rights under UK or non-UK law;
  3. any idea, information or technique not protected by rights in (a) or (b) above; and
  4. the public lending right in respect of a book. 
There will be no requirement for the payment to be regarded as an annual payment to fall within the definition of relevant intellectual property.   
 
Cinematographic film or video recordings and soundtracks of such continue to be excluded, as do copies of works which have been exported from the UK for distribution outside the UK.
 
The impact of this change will mean that many royalties payments, previously not subject to UK withholding tax, e.g., royalties in respect of trademarks or brands that were not “annual payments,”  will now be within the scope of the UK withholding tax rules.
 
The proposed changes will apply to payments made on or after the date that the 2016 Finance Bill receives Royal Assent (expected July 2016), and will include an anti-forestalling rule that will ignore the effect of payments being accelerated and will counteract the effect of any other arrangements put in place March 16, 2016, to avoid the application of the changes.
 
Definition of UK source - royalties attributable to UK PEs
Withholding tax on royalties applies when a payment is made for relevant intellectual property and the source of that income is the United Kingdom.  Source is not currently defined under UK tax legislation.  As a result, it was often unclear whether withholding tax should apply to royalty payments attributable to UK PEs of foreign companies.
 
A new rule provides that the payment of a royalty by a non-UK resident will always have a UK source when the payer is a non-UK resident carrying on business in the UK through a PE in the UK, and the obligation to make the payments arises in connection with the business carried on through that UK PE.  It is not necessary that the royalty payment be deductible in the UK PE under the UK’s profit attribution rules for a withholding tax obligation to arise.  Rather, the test is whether the obligation of the non-resident to make royalty payments arises or is connected with the activities that the non-resident has in the UK PE.
 
As well as applying to actual UK PEs, the rule will also apply to notional UK PEs under the Diverted Profit Tax rules.
 
In both cases, where the UK has a double tax treaty with the country of residence of the beneficial owner of the royalty, that treaty will govern the taxation of the payment, subject to the anti-avoidance rule discussed below.
 
The proposed changes will apply to payments made on or after the date that the 2016 Finance Bill receives Royal Assent, and will also include an anti-forestalling rule.
 
Disapplication of treaty benefits - purpose based anti-avoidance rule
A new rule comes into effect for royalty payments made on or after March 17, 2016, where there are arrangements in place of which the purpose, or one of the main purposes, is to obtain a tax advantage by virtue of a double tax treaty in a way that is not in line with the object and purpose of the treaty.   This will apply to royalties where there is an existing duty to withhold, and, of course, to royalties paid under the wider definition discussed above, once those rules are effective.  The payer and payee must be connected for the provision to apply.
 
The provision is modeled closely on the OECD’s anti-abuse rule (principal purpose test) that will become part of the OECD model tax convention.  The commentary to the OECD model tax convention, which will help explain how the rules will operate and be interpreted, will be followed by the UK tax authorities (“HMRC”) when applying the new UK domestic rule.
 
Where the relevant double tax treaty with the United Kingdom has a main purpose test with respect to royalties and that provision does not apply to disallow treaty benefits, HMRC have said that it is unlikely that the new domestic rule will apply.
 
Examples of when the rule would apply include conduit arrangements, and assignment of IP to a treaty country where the main purpose, or one of the main purposes of the assignment is to take advantage of the treaty between that country and the United Kingdom.  Each case will, of course, be fact specific. 
BDO Insights Groups should be reviewing their royalty arrangements urgently in light of the new UK rules to determine whether UK withholding tax obligations will arise on future royalty payments. 

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

Robert Pedersen
Partner and International Tax Practice Leader

 

William F. Roth III
Partner

 

Bob Brown
Partner

 

Jerry Seade
Principal

  Scott Hendon
Partner  

Joe Calianno
Partner and International Technical
Tax Practice Leader

  Monika Loving
Partner  

Ingrid Gardner
Managing Director UK/US Tax Desk

  Brad Rode
Partner   Chip Morgan
Partner     Veena Parrikar
Principal, Transfer Pricing    

International Tax Alert – March 2016

Mon, 03/28/2016 - 12:00am
The United Kingdom Government announced its 2016 Budget on March 16, 2016, in which it confirmed that the United Kingdom will be passing legislation to implement the agreed upon Organisation for Economic Co-operation and Development (“OECD”) recommendations for addressing both hybrid mismatches and interest deductibility.
Download PDF Version
Summary On March 16, 2016, Chancellor George Osborne announced the United Kingdom’s 2016 Budget.  At the heart of the Chancellor’s speech was a business tax road map designed to take the economy to 2020 and beyond.
 
Two key measures included in the business tax road map stem from the outputs of the OECD/G20 Base Erosion and Profit Shifting Project (“the BEPS Project”).  These are responses to the Final Report on Action Item 2: Neutralize the Effects of Hybrid Mismatch Arrangements, draft legislation for which has already been issued and the Final Report on Action Item 4: Limiting Base Erosion Involving Interest Deductions and Other Financial Payments, which was the subject of recent consultation.
 
The measures will be included in the United Kingdom’s Finance Bill 2016, and will apply with effect from January 1, 2017, for Action 2 and from April 1, 2017, for Action 4.
Background Action Item 2 of the BEPS Project is designed to ensure that multinational companies can no longer benefit from the use of hybrid instruments or hybrid entities. The use of such hybrids has enabled multinational companies to avoid tax on income that would otherwise be included in taxable profit.
 
Draft legislation implementing Action Item 2 was issued in December 2015.  This takes into account the responses received following consultation, further discussions with stakeholders, and the Final Report issued by the OECD in October 2015.   Mr. Osborne announced in the Budget that the draft legislation will be amended, prior to enactment, to widen the scope of the rules to eliminate the tax advantage arising from the use of permanent establishments.
 
Action Item 4 of the BEPS project seeks to eliminate base erosion by way of interest deduction and other financial payments.  Following consultation, Mr. Osborne announced in the Budget that the United Kingdom will be implementing a fixed ratio rule limiting corporation tax deductions interest.
Details BEPS Action Item 2
 
The UK draft legislation follows the OECD’s recommendations closely and applies to seven types of hybrid arrangements.
 
Deduction/non-inclusion mismatches
Four of the hybrid arrangements targeted fall within what is termed “deduction/non- inclusion” mismatches.  These are arrangements that include: hybrid financial instruments; hybrid transfers (e.g. repo/stock lending type arrangements); payments made by a hybrid entity payer; and payments made to a hybrid entity. 

In each case, where a payment or quasi-payment is made by a UK entity, the United Kingdom will deny a tax deduction to the extent that the income is not included in the taxable income of the recipient.  Where the payee is subject to UK tax and the payer jurisdiction has not implemented rules under BEPS Action Item 2, the United Kingdom will include the payment (that would otherwise not be taxed) in UK taxable profits. In that case, where the hybrid recipient is a UK Limited Liability Partnership (“UK LLP”), the United Kingdom will include the payment in UK taxable income as if the UK LLP were a UK resident company.

There are exclusions from the application of these rules, i.e., where there is a “permitted reason.”  Permitted reasons are where the recipient is: a person not liable to tax on any profits; a person being subject to tax that is not charged on foreign source income; a person not being liable to tax on the ground of sovereign immunity; or certain offshore funds and authorized investment funds.

It should also be noted that, generally, deemed deductions that arise only for tax purposes, e.g., notional interest deductions, should not be caught. 

Double deductions
Two of the hybrid arrangements targeted involve double deductions.  These are where there is a double deduction in a hybrid entity or in a dual resident company.  Broadly, the rules apply to deny UK deductions where there is a deduction elsewhere for the same expense, and that deduction is not offset against income that is included in the taxable profits of both relevant territories.

Imported mismatches
This rule applies where there is a series of arrangements whereby a UK payer makes a non-hybrid payment to another entity and that entity, in turn, makes a payment to a third entity. If the payment to the third entity falls within any of the six hybrid arrangements above, the new UK rules will deny the non-hybrid deduction in the UK payer.

In each case above, the new rules apply to either related parties (which has a 25- percent threshold for capital, voting or value) or control group companies (which has a 50-percent threshold for capital, voting or value, or applies where companies are consolidated for accounting purposes), and to structured arrangements.
 
Extension to permanent establishments
Mr. Osborne announced in the Budget that the draft legislation will be amended, prior to enactment, to widen the scope of the rules to eliminate the tax advantage arising from the use of permanent establishments. 
 
The example included in the business tax roadmap is of a UK company paying interest to a finance branch of a company in a third country.  The interest income is not taxed in the head office county because of a participation exemption for the branch, and the income is not taxed in the branch because there is no taxable PE in the branch territory due to limited activity there.  This might be, for example, a Luxembourg company with an Irish non-trading branch.
Details BEPS Action Item 4
 
The United Kingdom will be introducing a restriction on the tax deductibility of corporate interest consistent with the recommendations in BEPS Action Item 4.  Specifically, the United Kingdom will introduce a fixed ratio rule from April 1, 2017, that will limit corporation tax deductions for net interest expense to 30 percent of earnings before interest, tax, depreciation, and amortization (“EBITDA”).  This applies to third party and connected party net interest expense.
 
It is recognized that some groups have high borrowing levels for sound commercial reasons.  A group ratio rule based on the net interest to EBITDA ratio for the worldwide group will also, therefore, be implemented. 
 
To ensure that the new rules are targeted at larger businesses, there will be a de-minimis group threshold of GBP2m of net UK interest expense.
 
Draft legislation implementing the changes has not yet been issued, as consultation is ongoing in respect of the detailed design of the rules.  The current worldwide debt cap rules will be repealed, but rules with similar effect will be integrated into the new rules.  
BDO Insights The United Kingdom Government has fully embraced the agreed rules set out in the OECD’s BEPS Action Item 2 and these new rules will enter into effect for payments made on or after January 1, 2017. 

There will be no grandfathering of existing arrangements and there is no commercial purpose override as there is with the UK’s existing anti-arbitrage rules.  Although the new legislation will largely impact debt financing arrangements that make use of hybrid instruments or hybrid entities, other payments, e.g., royalties, rentals, or other expenses are within scope. The new rules will therefore present multinational companies with a significant challenge in maintaining a low effective tax rate if the use of hybrid techniques has been one of the principal means of lowering global taxes.

Groups with existing hybrid mismatch arrangements should consider now how they might restructure to be ready to enter into new arrangements before the commencement date of January 1, 2017.  
Groups should also consider the potential impact of the implementation of BEPS Action Item 4 on interest expense deductibility in the United Kingdom.

For further information or a discussion about the impact of the proposed new rules on your particular circumstances, please contact Ingrid Gardner or your BDO tax advisor.

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

Robert Pedersen
Partner and International Tax Practice Leader

 

William F. Roth III
Partner

 

Bob Brown
Partner

 

Jerry Seade
Principal

  Scott Hendon
Partner  

Joe Calianno
Partner and International Technical
Tax Practice Leader

  Monika Loving
Partner  

Ingrid Gardner
Managing Director UK/US Tax Desk

  Brad Rode
Partner   Chip Morgan
Partner     Veena Parrikar
Principal, Transfer Pricing    

International Tax Newsletter - March 2016

Wed, 03/23/2016 - 12:00am
The Indian Tiffin VII - from BDO India   With the announcement of the Union Budget for 2016, the government and India Inc. work to see how the economy absorbs policy directives to drive domestic business & win international confidence yielding higher trade & investments.
 
The latest Indian Tiffin issue (VII) covers:
  • Indian Economic Update - An overview of the budget; significant announcements and reforms likely to impact economic performance
  • M&A Tracker – deal pronounced across borders and sectors
  • Feature Story – instituting financial and risk controls as a barometer of operational efficacy for sound financial reporting and adherence to mandatory compliance
  • Guest Column – highlights current drivers and near-future strategy on fructifying this campaign to give a winning reason to international businesses on why to manufacture in India. Our guest columnist is the Executive Director of All India Association Industries (AIA); one of BDO India’s key associates.  

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Federal Tax Alert - March 2016

Wed, 03/23/2016 - 12:00am
Increased Tax Opportunity to Defer Sales of Gift Cards Redeemable For Goods and Services
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Summary For taxpayers in the retail, service, and hospitality industries, the sale of gift cards has become a lucrative business practice. Some gift cards are redeemable only for merchandise, while other gift cards can be redeemed for either merchandise or services. In a gift card purchase transaction, a taxpayer receives an advance payment from the customer in exchange for a future obligation to provide goods, or a mix of goods and services, when the gift card is redeemed. The sale of a gift card is generally deferred from revenue recognition until the redemption of the gift card for financial reporting purposes. However, for federal income tax purposes, the deferral of gift card sales is limited to either a one-year deferral or a two-year deferral. Taxpayers receiving sales of gift cards that are redeemable for either goods or services may be under a mistaken assumption that they do not qualify for the two-year deferral method. Recently, the IRS National Office clarified in a technical advice memorandum (TAM 201610017) the availability of the two-year deferral method for such gift cards. Accordingly, taxpayers that are currently recognizing gift card sales upon receipt or on the one-year deferral method should review their accounting methods to determine whether an additional year of deferral is available for tax purposes.
Details Background

For tax purposes, amounts received by an accrual-method taxpayer for goods or services to be provided in the future must generally be included in gross income in the taxable year of receipt. However, deferral for gift card sales is permitted under one of two exceptions: section 1.451-5 of the Income Tax Regulations or Revenue Procedure 2004-34.
Treas. Reg. § 1.451-5 generally allows accrual-method taxpayers a deferral for advance payments received for the sale of goods and provides that a taxpayer may defer recognition of the advance payment until the taxable year that the payments are recognized in revenues under the taxpayer’s method of accounting for financial reporting purposes. However, Treas. Reg. § 1.451-5(c) provides that a taxpayer generally may not defer advance payments with respect to an agreement for the sale of inventoriable goods beyond the end of the second taxable year following the year the taxpayer receives a substantial advance payment such as a gift card sale (hence, a two-year deferral). The regulations provide that the term “agreement” includes a gift certificate as well as any agreement obligating a taxpayer to sell goods in a future tax year and which also contains an obligation to perform services that are to be performed as an integral part of such sales (this is referred to as “integral services”). Therefore, a taxpayer may use the two-year deferral method for sales of gift cards that are redeemable for goods or integral services.
  Example 1 - Gift Card Redeemable for Goods and Integral Services: On December 2015, ABC, a calendar-year accrual-basis taxpayer that operates retail stores and an e-commerce website, sells a $100 gift card that is redeemable for products available at its retail stores or website. The gift card is also redeemable for any additional fee charged by the taxpayer to provide an assortment of integral services including delivery, installation, and repair of such products. The gift card, which has no expiration date and can be tracked electronically, is fully redeemed in June 2018, at which time the $100 revenue is recognized for financial reporting purposes. For federal income tax purposes, ABC may use the two-year deferral method of Treas. Reg. § 1.451-5(c) to defer the $100 gift card sale no later than the end of the second taxable year following the year the advance payment is received. Thus, ABC recognizes the $100 in gross income on the federal tax return for the taxable year ended
December 31, 2017.
There are special rules with respect to gift cards that are redeemable for goods, integral services, and for services that are unrelated to the taxpayer’s sale of goods. The regulations in Treas. Reg. § 1.451-5(a)(3) provides that if an agreement for the sale of goods in a future taxable year also obligates the taxpayer to perform services that are not to be performed as an integral part of the sale of goods (non-integral services), then the amount received will only be treated as an “advance payment” to the extent such amount is properly allocable to the obligation to sell goods. The portion of the amount not allocable to the sale of goods obligation will not be considered an advance payment to which Treas. Reg. § 1.451-5 applies. According to the IRS in TAM 201610017, the taxpayer aggregates all gift cards outstanding at the end of the tax year of the cards’ sale into a single pool and allocates the pool between the portion reasonably expected to be redeemed for goods and the portion reasonably expected to be redeemed for non-integral services. The amount reasonably allocable to future sales of goods would be eligible for the two-year deferral period.
  Example 2 - Gift Card Redeemable for Goods and Non-integral Services: On December 24, 2015, a calendar-year accrual-basis taxpayer that operates retail stores and an e-commerce website in direct competition with ABC, sells a $100 gift card that is redeemable for products available at its retail stores or website. The gift card can also be redeemed for any additional fee charged by the taxpayer to provide an assortment of related integral services including delivery, installation, and repair of such products. Additionally, the gift card can be redeemed for the sale of automotive repair services that XYZ provides at its retail location and that are unrelated to XYZ’s sale of goods. At the end of 2015, XYZ is able to aggregate all gift cards outstanding at year-end into a single pool and can allocate the pool between the portion reasonably expected to be redeemed for goods (90%) and the portion expected to be redeemed for non-integral services (10%).

The gift card, which has no expiration date and can be tracked electronically, is fully redeemed in December 2017, at which time the $100 revenue is recognized for financial reporting purposes. For federal income tax purposes, ABC may use the two-year deferral method of Treas. Reg. § 1.451-5(c) to defer $90 of the gift card sale no later than the end of the second taxable year following the year the advance payment is received. Thus, ABC recognizes the $90 in gross income on the federal tax return for the taxable year ended December 31, 2017. However, the remaining $10 is not allocable to the sale of goods obligation and is ineligible for the two-year deferral method.      
If an allocable amount received for gift card sales is not an advance payment for purposes of Treas. Reg. § 1.451-5, the TAM states that such amounts must either be included in gross income in the taxable year of receipt or deferrable under Rev. Proc. 2004-34.
 
The second exception to recognizing advance payments in the year of receipt, Rev. Proc. 2004-34, is broader but provides a shorter deferral period. Under this revenue procedure, an accrual-basis taxpayer may defer all or part of certain advance payments for, among other things, services or the sale of goods not recognized under Treas. Reg. § 1.451 until the taxable year following the year in which payment is received. Under this deferral method, a taxpayer must include the advance payment in gross income for the taxable year of receipt to the extent recognized in revenues in its applicable financial statements for that taxable year, and include the remaining amount of the advance payment in gross income in the subsequent taxable year (hence, a one-year deferral). Regardless of which exception the taxpayer selects, the taxpayer cannot defer the gift card receipts for tax purposes beyond the year in which it takes them into account for financial reporting purposes.
 
Opportunity for Extended Deferral

Gift cards are generally redeemable for merchandise and the vast majority have no expiration dates. Increasingly, taxpayers in the retail sector, such as department stores, superstores, and membership-only warehouse clubs, sell gift cards that are redeemable for both merchandise and services. As previously discussed, the taxpayer may perform integral services that are integrally related to the sale of goods, such as the repair, installation, or delivery of such sales. In other cases, the taxpayer may provide non-integral services such as automotive repair, photography studio, or travel-related services. In the restaurant and hospitality industry, gift cards are often redeemable for services (for example, spa treatments, meals at a restaurant) and for merchandise sold at the location or online (for example, souvenirs or
gift shops).

Many accrual-basis taxpayers that sell gift cards recognize such advance payments under the one-year deferral method prescribed by Rev. Proc. 2004-34. While this affords a limited deferral benefit for tax purposes, some taxpayers may incorrectly assume that sale of gift cards redeemable for both goods and services (whether integral or non-integral) are ineligible for the two-year deferral method. In our experience, taxpayers are under the mistaken assumption that Treas. Reg. § 1.451-5 applies only to advance payments for goods and therefore gift cards that are redeemable for goods and services may not be deferred beyond the one-year deferral method. For such taxpayers, it is advisable to review the current accounting practices and gift card usage. To the extent that the company’s gift card usage experience indicates a substantial portion of gift cards being redeemed beyond the end of the tax year following the year of receipt, taxpayers may be entitled to, and benefit from, an additional year of deferral under Treas. Reg. § 1.451-5. In the case of gift cards redeemable for goods and non-integral services, taxpayers evaluating the two-year deferral method need to follow the Service’s guidance in TAM 201610017 to estimate a reasonable allocation between the sale of goods and the sale of non-integral services.

At the present time, any change in method of accounting to the two-year deferral method must be made by filing a Form 3115, Application for Change in Accounting Method, with the IRS under the advance consent (non-automatic) procedures of Rev. Proc. 2015-13. A non-automatic Form 3115 must be filed with the IRS National Office on or before the last day of the year of change and an IRS user fee will apply. Upon receiving consent, the taxpayer takes the favorable section 481(a) adjustment benefit entirely in the year of change.
 
For more information, please contact one of the following practice leaders:
 

Travis Butler
Senior Director

 

Yuan Chou
Senior Director

 

Nathan Clark
Senior Director

 

Dave Hammond
Partner

 

Marla Miller
Senior Director

   

International Tax Alert - March 2016

Tue, 03/22/2016 - 12:00am
The United Kingdom Government Announces 2016 Budget 
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Summary On March 16, 2016, Chancellor George Osborne announced the United Kingdom’s 2016 Budget.  At the heart of the Chancellor’s speech was a business tax road map designed to take the economy to 2020 and beyond.  
 
The main principal underpinning the road map is that taxes should be low, but must be paid.  Further, there should be a level playing field, both between large and small businesses and between different corporate structures.  The tax system should encourage entrepreneurship and not reward aggressive tax planning.
 
Key business measures included in the road map that are likely to impact United States businesses investing in the United Kingdom are summarized below.
Details Further reduction in the rate of corporation tax
 
Since 2010, the main rate of corporation tax in the UK has reduced from 28 percent to 20 percent, which is now the rate for all companies regardless of size.  This rate is further set to reduce to 19 percent from April 1, 2017, and was to reduce to 18 percent from April 1, 2020.  The Government announced in the Budget that the rate of corporation tax will now reduce to 17 percent from April 1, 2020.
 
Corporation tax payment dates
 
Very large groups, i.e., those with UK profits in excess of GBP20m (divided by number of group companies) are to have their corporation tax payment dates accelerated by 3 ½ months, so that payments are now due in the third, sixth, ninth, and twelfth months of the accounting period.  This change was due to commence for accounting periods starting on or after April 1, 2017, but has been pushed back two years to April 1, 2019.
 
Corporation tax loss relief
 
Currently trading losses carried forward may be offset fully against profits arising from the same trade in the same company during future accounting periods.  There are similar restrictions on other types of losses.  For losses incurred on or after April 1, 2017, two changes are to be made:
 
  • Companies will be able to use carried forward losses to offset profits arising from other income streams it has or from other companies within the group (by way of “group relief”) in future periods; but
  • Losses carried forward can only be used against 50 percent of profits in excess of GBP5m.  Where there are a number of companies in a group, the GBP5m allowance will apply per group not per UK entity. 

Tax deductions for interest expense
 
Action Item 4 of the Organisation for Economic Cooperation and Development (“OECD”) Base Erosion and Profit Shifting (“BEPS”) project seeks to prevent erosion of the tax base through the use of excessive interest deductions.  Following consultation on how the OECD’s recommendation in Action Item 4 should be implemented in the UK, a restriction on the amount of interest that companies can deduct will be introduced from April 1, 2017.
 
The restriction to be introduced is a fixed ratio rule limiting net interest expense (third party and group) to 30 percent of the group’s UK earnings before interest, tax, depreciation and amortization (“EBTIDA”).   In recognition that many groups have genuine commercial needs for borrowing; a group ratio (net interest to EBITDA) may be applied instead. 
 
The proposed rule has a de minimis threshold of GBP2m net UK interest expense.
 
As a result of the new rule, the existing “world-wide debt cap” rules will be repealed.
 
Hybrid mismatch arrangements
 
The UK has already issued comprehensive draft legislation that implements the OECD’s BEPS Action Item 2 in respect of neutralizing tax advantages arising from hybrid mismatch arrangements.   These new rules are effective from January 1, 2017. 
 
This draft legislation is to be extended to eliminate the tax advantage arising from the use of mismatches involving permanent establishments.  The example given in the Budget documents is that of a company with a non-taxable branch (e.g. Luxembourg with a non-trading Irish branch) lending to the UK.
 
Withholding tax on royalty payments
 
Three new measures will be introduced to extend the circumstances in which UK withholding tax (at 20 percent) will apply to royalty payments:
 
  1. UK withholding tax will apply to a wider definition of royalty payments, bringing more royalties within the scope of the rules;
  2. UK withholding tax will now apply to royalty payments attributable to UK permanent establishments; and
  3. A targeted domestic anti-treaty abuse rule was introduced. 

The first two measures will apply to payments made on or after the date that the 2016 Finance Bill receives Royal Assent (expected to be in July 2016), and the anti-treaty abuse measure is effective for payments made on or after March 17, 2016.
 
Transfer pricing documentation
 
Legislation will be introduced to amend the definition of “transfer pricing guidelines” within the current UK legislation to incorporate the revisions to the OECD Transfer Pricing Guidelines as part of the BEPS initiative.  Interpreting the UK transfer pricing rules will therefore be done by reference to the revised OECD Guidelines.   This will apply from April 1, 2016. 
 
Patent box
 
The UK will introduce legislation to reform the Patent Box so that it is aligned with the nexus approach agreed as part of the BEPS project.  Under this approach companies will only benefit from the beneficial (ten percent) regime where they undertake R&D investment.  The new approach will apply from July 1, 2016, although existing IP currently included in the patent box regime will be grandfathered until June 30, 2021. 
 
Given the further reduction in the corporation tax rate, the UK Government has said that it will keep the case for reducing the ten-percent patent box rate under review.
 
Taxation of profits from dealing in and developing land
 
The UK tax system is to be changed so that trading profits arising from dealing in or developing UK land will always be chargeable to UK tax irrespective of the residence status of the landowner and regardless of whether this activity is conducted through a permanent establishment or not.
 
Protocols amending double tax agreements with a number of jurisdictions have already been agreed and take effect from March 16, 2016.  The charge to tax will apply universally from the date that the Finance Act passes the report stage in its passage through the House of Commons.
 
Substantial Shareholding Exemption
 
The Substantial Shareholding Exemption (“SSE”) was introduced in 2002 and applies in certain circumstances to exempt capital gains incurred by UK companies disposing of qualifying shareholdings.  The UK Government will consult on the extent to which the SSE is delivering on its policy objective of ensuring that tax does not act as a disincentive to commercial transactions or group restructurings and whether changes could be made to increase its simplicity, coherence and international competitiveness.
  BDO Insights The UK Government continues to move forward with its stated ambition of making the UK’s corporation tax regime the most competitive in the G20.  The UK’s low corporate tax rate together with incentives for innovation are designed to encourage inbound investment, yet are balanced by rules designed to ensure that businesses in the UK pay the tax that is due in the UK.  
 
For more information, please contact one of the following practice leaders:
 

Robert Pedersen
Partner and International Tax Practice Leader

 

William F. Roth III
Partner

 

Bob Brown
Partner

 

Jerry Seade
Principal

  Scott Hendon
Partner  

Joe Calianno
Partner and International Technical
Tax Practice Leader

  Monika Loving
Partner  

Ingrid Gardner
Managing Director UK/US Tax Desk

  Brad Rode
Partner   Chip Morgan
Partner     Veena Parrikar
Principal, Transfer Pricing    

State and Local Tax Alert - March 2016

Tue, 03/22/2016 - 12:00am
Louisiana Adopts Related Party Expense Addback, a Non-Graduated Corportation Income Tax Rate, an Additional Limit on NOLS, and Imposes the Franchise Tax on Entities Classified as Corporations and Corporations that Indirectly Own Property Located in the State 


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Summary Louisiana Governor John Bell Edwards (D) signed several bills in March 2016 related to the Corporation Income Tax and Franchise Tax.  Together, the bills limit the use of a net operating loss (or NOL) carryover to 72 percent of Louisiana net income; require an addback to income for certain related party expenses; allow a 100 percent dividend received deduction (or DRD) for dividends received from certain banks; and adopt a non-graduated, 6.5-percent rate of tax.  In addition, Governor Edwards signed a bill that extends the franchise tax to entities taxed as corporations for federal income tax purposes, imposes the franchise tax on corporations that indirectly own Louisiana property through a flow-through entity, and provides for another holding company deduction.  See the following discussion for the effective dates of these law changes.  
Details NOL Carryover Limitation, H.B. 20 and H.B. 116, 2016 1st Extra. Sess. (La. 2016)
In legislation enacted in June 2015, Louisiana extended the net operating loss carryforward to 20 years, eliminated the 3-year carryback, and limited the amount of deductible net operating loss carryover to 72 percent of the net operating loss carryovers available for use in the taxable year. 

These changes applied to original returns filed after June 30, 2015.  A taxpayer that filed a return after July 1, 2015, based on an extension filed prior to that date, was allowed a deduction equal to one-third of the amount disallowed as a result of the 72-percent limit for each of its taxable years beginning in 2017, 2018, and 2019. See the BDO SALT Alert that discusses these and other changes in the law.

In H.B. 20, Louisiana further limits the amount of deductible net operating loss carryover to 72 percent of Louisiana net income, but allows the one-third deduction enacted under the June 2015 legislation in addition to the general net operating loss deduction.  This change in the law was signed by Governor Edwards on March 9, 2016, and was made retroactively effective as of January 1, 2016.

In addition, in H.B. 116, Louisiana changes the ordering of the application of net operating loss carryovers to the most recent taxable year where a loss from more than one year must be taken into account.  This change in the law was signed by Governor Edwards on March 10, 2016, and becomes effective January 1, 2017.
 
Related Party Expense Addback, H.B. 55, 2016 1st Extra. Sess. (La. 2016)
In H.B. 55, Louisiana adopts an addback for otherwise deductible interest expenses and costs, intangible expenses and costs, and management fees paid, accrued, or incurred in connection with a transaction with a related member. The definition of related member and intangible expenses does not appear to be defined in H.B. 55 or elsewhere in Louisiana law.

Addback is not required:
  • To the extent the related member’s corresponding item of income was in the same taxable year subject to a state net income tax;
  • To the extent the related member’s corresponding item of income was subject to a net income tax of a foreign nation of which the related member is a resident and that has an enforceable income tax treaty with the United States;
  • For the portion of the expense the taxpayer establishes that the related member paid to a person that is not a related member; or
  • If the taxpayer establishes that the transactions giving rise to the related member expense did not have as a principal purpose the avoidance of Louisiana tax. 
For purposes of the “subject to tax” exceptions, income is subject to a state or foreign nation net income tax if the income is reported and included in income of the related member, not eliminated in consolidation or combination, and attributed to the taxing jurisdiction based on the taxing jurisdiction’s allocation and apportionment methodology. 

This change in the law applies to taxable years beginning after December 31, 2015, and is effective as of the date Governor Edwards signed the bill, which was March 10, 2016.
 
DRD for Dividends Received from Certain Banks, H.B. 7, 2016 1st Extra. Sess. (La. 2016)
The legislation enacted in June 2015 also limited the amount of the deduction for a dividend received from the following entity-types to 72 percent of the amount received: Louisiana banking corporations, national banks doing business in Louisiana, and capital stock associations whose stock is subject to ad valorem taxation.  This change generally applied to an original return filed after June 30, 2015, and before July 1, 2018.

In H.B. 7, Louisiana removed the 72-percent cap as applied to dividends received from Louisiana banking corporations, national banks doing business in Louisiana, and capital stock associations whose stock is subject to ad valorem taxation.  Thus, Louisiana allows for a 100-percent deduction for the receipt of such dividends.  This change in the law is effective as of the date signed by Governor Edwards, which was March 4, 2016.

Non-Graduated Corporation Income Tax Rate, H.B. 29, 2016 1st Extra. Sess. (La. 2016)
Louisiana has historically taxed the income of a corporation using a progressive rate structure with rates that range from 4 percent to 8 percent, depending on the amount of taxable income.  In H.B. 29, which was signed by Governor Edwards on March 9, 2016, Louisiana adopted a non-graduated, 6.5-percent rate of tax, effective for taxable years beginning after December 31, 2016.
 
Franchise Tax, H.B. 19, 2016 1st Extra. Sess. (La. 2016)
In H.B. 19, Louisiana adopts the following changes to the Franchise Tax:
  • Imposes the tax on an entity taxed as a corporation for federal income tax purposes (unless it is an LLC taxed as an S corporation, or any other entity that was acquired by an S corporation in 2012 or 2013);
  • Imposes the tax on a corporation that owns property located in the state through a partnership, LLC taxed as a partnership for federal income tax purposes, joint venture, or any other business organization of which the
  • corporation is a member of a controlled group of corporations as defined in I.R.C. § 1563;
  • Provides for an additional holding company deduction for investments and advances to an 80-percent or more
  • owned subsidiary corporation that is subject to the franchise tax; and
  • Increases the initial tax imposed on a newly taxable corporation from $10 to $110. 
These changes in the law apply to taxable years beginning on or after January 1, 2016, and are effective as of the date Governor Edwards signed the bill, which was March 10, 2016.
 

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

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

Compensation & Benefits Alert - March 2016

Wed, 03/16/2016 - 12:00am
IRS Provides Guidance to Individuals on What to Do with Forms 1095
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Summary Most individuals are receiving for the first time in 2016 Forms 1095 from employers and insurance companies. These forms support the Form 1040 questions regarding whether each individual in the household had coverage for each month in 2015 and whether or not penalties are due from the individual under the Affordable Care Act’s (ACA) individual mandate. The Forms will also be used by the IRS to verify that individuals who were given federal subsidies for health insurance purchased on the exchange were indeed eligible for the subsidy and if not, to pursue  recovery of the overpaid subsidies from the individuals.   
Details For more information about these forms contact your BDO client service profession or one of the ACA specialists listed herein.

The IRS e-mail communication is copied below in its entirety.
 
Here’s What You Need to Do with Forms 1095-A, 1095-B and 1095-C

You, your employees or your clients may receive one or more forms that provide information about 2015 health coverage. These forms are 1095-A, 1095-B and 1095-C. The following health care tax tips provide some answers to common questions about these forms: For more information on these forms, see our Questions and Answers about health care information forms for individuals.
 
For more information, please contact one of the following practice leaders:
 

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

 

Penny Wagnon
Sr. Director, Compensation & Benefits

 

Linda Baker
Sr. Manager, Compensation & Benefits

 

Kim Flett
Sr. Director, Compensation & Benefits

  Don Hughes
Manager, Compensation & Benefits  

 

Federal Tax Alert - March 2016

Wed, 03/16/2016 - 12:00am
Congress Extends the Work Opportunity Credit through December 31, 2019, and the IRS Extends the Related Employee Application Due Date
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Summary Congress recently extended the application of the work opportunity tax credit (the “WOTC”) to an employee who began working after December 31, 2014, and before January 1, 2020. Because the extension was not enacted until December 15, 2015, and the application for pre-screening an employee must be filed within 28 days after an employee begins work, the Service granted transitional relief extending the application due date for an employee hired on or after January 1, 2015 and on or before May 31, 2016, to June 29, 2016.
Details Background
The WOTC is a credit available to a taxpayer that employs an individual from a targeted group, such as, very generally, a qualified IV-A recipient, a qualified veteran, a qualified ex-felon, a designated community resident, a vocational rehabilitation referral, a qualified summer youth employee, a qualified food stamp recipient, a qualified SSI recipient, a long-term family assistance recipient, or a long-term unemployment recipient hired on or after January 1, 2016.1  The amount of the WOTC is 40% (25% in the case of an employee who does not meet certain minimum employment requirements) of the first-year wages paid or incurred by an employer during the taxable year to employees who are members of a targeted group.2 

While the number of employees who may qualify for the WOTC is not limited, the amount of qualified first-year wages that may be taken into account with respect to any individual during a taxable year is generally limited to $6,000 (a $2,400 maximum credit). However, the wage limitation is $12,000 (a $4,800 maximum credit) in the case of a qualified veteran with a service-connected disability who has a hiring date not more than one year after having been discharged from active duty in the armed forces,3  $14,000 (a $5,600 maximum credit) in the case of a qualified veteran without a service-connected disability having aggregate periods of unemployment during the one-year period ending on the hire date which equal or exceed six months4 and $24,000 (a $9,600 maximum credit) in the case of a qualified veteran with a service-connected disability having aggregate periods of unemployment during the one-year period ending on the hire date which equal or exceed six months.5 

Pre-Screening Process
An employee may not be treated as a member of a targeted group unless the employee goes through a pre-screening process. That is, the employer must either: (1) on or before the day the individual begins work, obtain certification from a designated local agency (“DLA”) that the individual is a member of a targeted group; or (2) complete Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, on or before the day the individual is offered employment and submit the form to the appropriate DLA within 28 days after the individual began work.6 

Traditional Relief
In light of the fact that the extension of the WOTC to wages paid or incurred by an employer with respect to an employee who began work after December 31, 2014, and before January 1, 2020, was not enacted until December 15, 2015, the Service granted transitional relief with respect to the pre-screening process. Specifically, the Service has given taxpayers until June 29, 2016, to submit a completed Form 8850 to the appropriate DLA for employees hired 2015 on or after January 1, 2015 and on or before May 31, 2016, to June 29, 2016.7   
BDO Insights
  • The Service’s transitional relief makes good sense. Without it, a qualifying employee who began work as late as mid-November 2014 could be excluded from the WOTC before the credit extension was even granted and, thus, render Congress’s extension of the WOTC for another year virtually worthless.
  • The WOTC can be a valuable credit that ranges between $2,400 and $9,600 per qualifying employee who began work during the taxable year. However, as noted above, each employee is subject to a pre-screening application process and the application deadline for 2014 hires is fast approaching. BDO can assist with determining which employees are from a targeted group as well as the pre-screening application process.
 
For questions related to matters discussed above, please contact Janet Bernier, Tanya Erbe, or Tom Alberte.


1 Section 51(a), (b)(1), and (d)(1).  Each of the specified categories within this targeted group is further defined in section 51(d); ‘Protecting Americans from Tax Hikes Act of 2015, Sec. 142(b).
2 Section 51(a), (b)(1), and (i)(3).
3 Section 51(b)(3) and (d)(3)(A)(ii)(I).
4 Section 51(b)(3) and (d)(3)(A)(iv).
5 Section 51(b)(3) and (d)(3)(A)(ii)(II).
6 Tax Increase Prevention Act of 2014, Pub. L. No. 113-295, § 119.
7 Notice 2016-22.

International Tax Alert - March 2016

Wed, 03/16/2016 - 12:00am
Argentina Update: Argentina Updates White List of Cooperative Jurisdictions 
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Date/Timing Effective January 1, 2016.
Affecting Taxpayers with Argentinean subsidiaries that engage in transactions with countries included in or excluded from Argentina’s tax white list. 
Background In May 2013, the Argentina’s tax authority (“AFIP”) published Decree 589/2013 which established the process for determining when countries are considered to be low tax or no tax jurisdictions for purposes of a broader application of local transfer pricing rules.

Subsequently, in January 2014, the AFIP issued Resolution 3576 which made public a list of “cooperative” jurisdictions, also known as the “white list.” These jurisdictions are countries and territories that generally have signed tax information exchange agreements with Argentina. Examples of cooperative jurisdictions include: Brazil, Canada, and the United States.

For tax purposes, a country not listed on the white list is generally considered “not cooperative.” Accordingly, this would automatically trigger the tax treatment for low or no tax jurisdictions under domestic law which will generally include being subject to higher withholding taxes on outbound payments, tougher transfer pricing regulations, application of controlled foreign corporation rules and imposition of additional taxes on inbound payments.
Updates Countries added to the white list:
  • Barbados, Belarus, Bulgaria, Cameroon, Cyprus, Gabon, Gibraltar, Hong Kong, Niue, Senegal, Seychelles, and Uganda.
Countries excluded from the white list:
  • Angola, Haiti, Kenya, Kuwait, Montenegro, Nicaragua, Qatar, the United Arab Emirates, and Vietnam.  

How BDO Can Help Our Clients As a best practice, taxpayers with Argentinean subsidiaries should review their transactions with countries included in or excluded from the AFIP’s white list. BDO can help taxpayers understand and comply with domestic rules as a consequence of transactions with or without white list jurisdictions.  BDO can also assist taxpayers to plan or restructure their Argentinean cross-border operations in a tax efficient manner taking into consideration the AFIP’s white list and all other relevant domestic and international tax rules. 
For more information, please contact one of the following practice leaders:
 

Robert Pedersen
Partner and International Tax Practice Leader

 

William F. Roth III
Partner

 

Bob Brown
Partner

 

Jerry Seade
Principal

  Scott Hendon
Partner  

Joe Calianno
Partner and International Technical
Tax Practice Leader

  Monika Loving
Partner  

Chip Morgan
Partner

  Brad Rode
Partner    

State and Local Tax Alert - March 2016

Mon, 03/14/2016 - 12:00am
New York City Commercial Rent Tax and Potential Voluntary Disclosure Program Opportunity
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Summary New York City (“NYC”) imposes a commercial rent tax (“CRT”) on every business tenant, lessee, or sub-lessee whose annual base rent paid for a tax year is greater than or equal to $200,000 with respect to any "taxable premises," subject to certain exceptions.  A “taxable premise” is one located in the Borough of Manhattan south of the center line of 96th street and that is used for or intended to be used for a trade, business, vocation, profession, or commercial activity. Certain tenants may be exempt from this tax including religious, educational or charitable organizations, as well as tenants in the World Trade Center Area (also known as the Liberty Zone).
 
Recently, there has been a significant increase in the number of CRT notices and inquiries, as well as audits. Imposition of penalties for failure to report the CRT can be equal to 25% of the tax liability. In addition, NYC business income tax audits (both General Corporation Taxes (“GCT”) and Unincorporated Business Taxes (“UBT”) are now expanded to include the CRT. During a recent GCT audit, the City identified the Company’s failure to file the CRT. Although the GCT audit encompassed only the most recent 3 tax years, the City assessed CRT taxes for a 12 year period, plus interest and penalties. (See this NYC UBT Audit Notice and CRT Audit Notice/Questionnaire).
 
However, help is available with respect to outstanding CRT liabilities. There is the option to participate in a Voluntary Disclosure Agreement (“VDA”), which typically would limit the look-back period to 3 years and includes abatement of all penalties.
  Details What to Do:

Given the above, companies should review the following:
  1. Determine if your organization has any taxable premises, as defined above, that have annual rent of $200,000 or greater;
  2. Determine the historical CRT compliance, if any, with New York City (from the date that the taxable premises was rented- current) 
  3. Determine what records are available related to the taxable premises (i.e. leases, rent payments, etc.);
  4. Determine eligibility to participate in a Voluntary Disclosure Program (“VDA”) (see the VDA decision tree); and
  5. Take action immediately where appropriate. 

When preparing NYC income tax returns, it is important to keep in mind while preparing NYC income tax returns that NYC has added direct questions to both the GCT and UBT returns, where the taxpayer must answer whether it is subject to the CRT and if so, if the taxpayer is in compliance with the CRT.
 
For those that have received audit letters and even those that haven't yet, please contact BDO at your earliest convenience for best practices and steps you can take to mitigate the CRT liability, interest, and penalties if timely addressed.
  BDO Experience BDO has significant experience with the NYC Department of Finance Voluntary Disclosure and Compliance Program. BDO has successfully assisted numerous of clients in the NYC CRT VDA program. Our success is largely attributable to BDO pre-approved review process and our relationships, and experience working with NYC. Additionally, please feel free to reach out to us with any questions, request for additional information, etc. We would be happy to address these for you while sharing best practices.
 
For questions related to matters discussed above, please contact Janet Bernier.
 

State and Local Tax Alert - March 2016

Mon, 03/14/2016 - 12:00am
California Sources the Sale of a Service Purchased by a Service Provider to the Customer's Customers' Locations
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Summary The California Franchise Tax Board recently issued Chief Counsel Ruling 2015-03 (Dec. 31, 2015), which provides guidance on where to assign the gross receipts from the sale of a service provided to a business customer who, in turn, uses that service to provide a service to their business customers for purposes of the Corporation Income Tax sales factor.  In the ruling, the Chief Counsel held that a taxpayer who provides integrated financial information and analytical applications services to its customers, who in turn provide financial services to their business customers, should assign such receipts to its business customer’s location rather than its customer’s customer location (sometimes referred to as the “look-thru” rule). 
  Details Background
Under Cal Rev. & Tax Code § 25136(a)(1), for purposes of the Corporation Income Tax sales factor, California requires sourcing receipts from the sale
of a service to the state to the extent the purchaser received the benefit of the service in California, effective for taxable years beginning after December 31, 2012.  In Cal. Code Regs. tit. 18, § 25136-2(b)(1), the Franchise Tax Board defines “benefit of a service received” to mean “the location where the taxpayer’s customer has either directly or indirectly received value from delivery of that service.”

At least until Ruling 2015-02, guidance on the application of the definition of “benefit of a service received” to business customers was limited to a few examples in the regulations pertaining to relatively straight-forward situations.  These examples include illustrations of taxpayers that sell non-marketing services to customers that do not use the services to provide services to their customers (e.g., payroll services, audit services, legal services, and services to real estate).  In these situations, the receipts are assigned to the state where the customer receives the service.  These examples also include an illustration of a taxpayer that sells marketing services (e.g., internet advertising services).  In this situation, the receipts are assigned to the state where the customer’s products are sold (i.e., the “look-thru” rule).  However, none of these examples provide guidance on where to assign receipts from the sale of a service used by a business customer to in turn provide services to their business customers.  See Cal. Code Regs. tit. 18, § 25136-2(b)(1) and (c)(2).  In this situation, it may be unclear whether the customer directly or indirectly received value from the delivery of the service at its location (or locations) or at its customers’ locations.

Under Cal. Code Regs. tit. 18, § 25136-2(d), the regulations provide guidance on where to assign receipts from the licensing of non-marketing (or manufacturing) and marketing intangibles.  With respect to the former, the receipts are assigned to California to the extent the non-marketing intangible is used by the customer in the state (e.g., used in manufacturing carried on in the state).  With respect to the latter, the receipts are assigned to California to the extent the marketing intangible is used by the customer’s customer in the state (e.g., based on the customer’s customers’ California sales or by use of the “look-thru” rule).  See Cal. Code Regs. tit. 18, § 25136-2(d)(2)(A)(1), (B), and (D).
 
Ruling 2015-02
The taxpayer in Ruling 2015-02 provides integrated financial information and analytical applications to global business customers that, in turn, provide financial and other similar services and product offerings to their own business customers.  The applications offer customers computer access to real-time news and quotes, company and portfolio analyses, multi-company comparisons, industry analysis, and other information and tools, which is based on content from hundreds of databases consolidated by the taxpayer.  The customers purchasing these applications are typically portfolio managers, market research and performance analysts, risk managers, and other similar professionals that can each have numerous users of the service and at different usage levels.

The taxpayer assigns a user ID to each user of an application (multiple user IDs are assigned if the customer has multiple users).  The taxpayer can track the amount of processing power that is used by each user ID, and match that usage to its associated geographic location.  While the taxpayer can track processing power usage, the taxpayer does not have the resources to determine the location and measure of the benefit of the service received by each customer.

The taxpayer requested a ruling that: (i) the service be considered a “non-marketing service” and the receipts from the sale thereof are assigned to California based on the location of its customers; and (ii) its data related to processing power usage should be used as a proxy for determining the location and measure of the benefit received by its customers.  With respect to the first issue, the Chief Counsel analogized the service provided by the taxpayer to a non-marketing intangible, characterized it as a “non-marketing service,” and ruled that receipts from sales of the taxpayer’s service should be assigned to California to the extent its customers receive the benefit of the service in the state (i.e., rather than look-thru to the customer’s customers to ascertain where they received the benefit).  With respect to the second issue, the Chief Counsel ruled that the taxpayer may assign receipts from the sales to California based on its processing power usage data.
BDO Insights
  • Because each ruling represents the conclusion of the Chief Counsel regarding the application of the law at that time to the facts specified, taxpayers are cautioned against reaching the same conclusion in other cases unless the facts, circumstances, and law are the same.  However, taxpayers now have some guidance as to how the Board may apply the Corporation Income Tax sales sourcing provisions where a non-marketing service provided by a taxpayer to its customer is in turn used to provide services to the customer’s customers, even if the facts and circumstances are not exactly the same.
  • A ruling is intended to be retroactive in effect, unless otherwise stated in the ruling.  Ruling 2015-02 does not limit the retroactive application of this ruling. Thus, California taxpayers that provide services to businesses that, in turn, use the service to provide their business customers with a service, should evaluate whether they may use a different sourcing methodology on a previously filed return.


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

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

Federal Tax Alert - March 2016

Mon, 03/14/2016 - 12:00am
Chief Counsel Advice Raises Questions Regarding Impact of “Bad-Boy” Conditions on Partnership Liability Allocations
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Summary A recently issued Chief Counsel Advice (CCA 201606027) determined that a partner’s limited guarantee was sufficient to create economic risk of loss with respect to a partnership liability. Of particular interest is the Internal Revenue Service’s (“Service”) belief that inclusion of so-called “bad-boy” conditions may alone be sufficient to cause an otherwise nonrecourse liability to be classified as recourse for purposes of Treasury Regulation Section (“Treas. Reg. §”) 752. If correct, the Service’s conclusion could call into question the manner in which many partnerships have historically allocated liabilities.

Given the importance of liability allocations for the purpose of determining basis and at-risk limitations, a reallocation of partnership liabilities could have significant tax consequences to the partners. Reconsideration of limited guarantees may be warranted.
Details Allocation of Partnership Liabilities
A partnership is required to allocate liabilities to those partners who bear economic risk of loss from the liability. Where no partner bears economic risk of loss, i.e., in the case of nonrecourse liabilities, Treas. Reg. §1.752-3 provides specific rules that typically result in a different allocation of partnership liabilities. Therefore, determining whether a partner bears economic risk of loss is critical to establish how liabilities should be allocated among the partners.

A partner bears the economic risk of loss for a partnership liability to the extent that, if the partnership constructively liquidated for no consideration, the partner or related person would be obligated to make a payment to any person (or a contribution to the partnership) because that liability becomes due and payable and the partner or related person would not be entitled to reimbursement from another partner or person that is a related person to another partner.

The extent to which a partner or related person has an obligation to make a payment is based on the facts and circumstances at the time of the determination. All statutory and contractual obligations relating to the partnership liability are taken into account for these purposes, including:
  • Contractual obligations outside the partnership agreement such as guarantees, indemnifications, reimbursement agreements, and other obligations running directly to creditors or other partners, or to the partnership;
  • Obligations to the partnership that are imposed by the partnership agreement, including the obligation to make a capital contribution and to restore a deficit capital account upon liquidation of the partnership, and
  • Payment obligations (whether in the form of direct remittances to another partner or a contribution to the partnership) imposed by state law, including the governing state partnership statute.

Treas. Reg. § 1.752-2(b)(4)  provides that a payment obligation (such as a guarantee) is disregarded if, taking into account all the facts and circumstances, the obligation is subject to contingencies that make it unlikely that the obligations will ever be discharged. Further, if a payment obligation (including one arising under a guarantee) should arise after the occurrence of an event that is not determinable with reasonable certainty, the obligation is ignored until the event occurs.
 
Impact of Bad-Boy Conditions Under CCA 201606027
According to the facts included within CCA 201606027, one of the members of the LLC (the “Guarantor”) agreed that it would be unconditionally obligated on the outstanding loan balance upon any of the following events (the “bad-boy” conditions):
  1. The LLC fails to obtain the lender's consent before obtaining subordinate financing or transfer of the secured property;
  2. The LLC files a voluntary bankruptcy petition;
  3. Any person in control of the LLC files an involuntary bankruptcy petition against the LLC;
  4. Any person in control of the LLC solicits other creditors to file an involuntary bankruptcy petition against the LLC;
  5. The LLC consents to, or otherwise acquiesces or joins in an involuntary bankruptcy or insolvency proceeding;
  6. Any person in control of the LLC consents to the appointment of a receiver or custodian of assets; or
  7. The LLC makes an assignment for the benefit of creditors, or admits in writing or in any legal proceeding that it is insolvent or unable to pay its debts as they come due.

The Service found that the guarantee was sufficient to cause the Guarantor to bear the economic risk of loss with respect to the liability. This conclusion was predicated on the Service’s determination that a default on the loan would itself be sufficient to create a payment obligation by the Guarantor even in the absence of the above events.

However, the Service went on to say that even if the obligation of the Guarantor was conditioned on the occurrence of one of the listed events, such an occurrence was not so remote a possibility that it would cause the obligation created by these provisions to be considered “likely to never be discharged” within the meaning of Treas. Reg. § 1.752-2(b)(4). In other words, the IRS concluded that the “bad-boy” provisions in themselves cause the liability to be recourse.
BDO Insights
  • It is common practice for lenders to require limited guarantees from partners in order to protect the lender from certain acts that might be committed by the borrowing partnership or its affiliates. For example, a guarantee may provide that the partner is obligated to pay the debt only in the event that the partnership commits fraud or misappropriates assets.
  • Violation and enforcement of these so-called “bad-boy” provisions is generally considered to be so remote as to be disregarded for purposes of allocating liabilities under Treas. Reg. § 752. However, over the past several years lenders have required inclusion of additional carve-out provisions that may be pushing the bounds of traditional “bad-boy” guarantees. As illustrated by the CCA, if the IRS were to conclude that the possibility of such conditions occurring is not sufficiently remote, it may consider the guarantor to bear the economic risk of loss, altering the character and allocation of the guaranteed liabilities.
  • Because of the broad use of various “bad-boy” guarantees, the allocation of liabilities by many partnerships could be affected. Consequently, partnerships and their partners should review their limited guarantee arrangements to ensure the treatment of partnership liabilities is consistent with the regulations. As part of this analysis, careful attention should be given to: (i) whether the terms of a limited guarantee are subject to contingencies so remote that make it unlikely the guarantee will ever be discharged, or (ii) if the future events giving rise to the payment obligation can be determined with reasonable certainty. 

For questions related to matters discussed above, please contact Jeffrey Bilsky, David Patch or Julie Robins.

BDO Transfer Pricing News - March 2016

Mon, 03/14/2016 - 12:00am
This issue of BDO’s Transfer Pricing Newsletter focuses on recent developments in the field of transfer
pricing in Belgium, Brazil, Israel, Peru, Sri Lanka, Switzerland and Zimbabwe. As you will read, the ongoing work on OECD’s BEPS project, as well as the increasing importance of transfer pricing, is resulting in many changes around the world.
Download

Compensation & Benefits Alert - March 2016

Fri, 03/11/2016 - 12:00am
ACA Reporting (Forms 1095) Running Down to the Wire; Assistance Still Available to Meet March 31, 2016 Deadline  Download PDF Version
Summary Beginning this year, the Affordable Care Act (ACA) requires certain employers to report health coverage information to their employees and the IRS.  If you have already completed and mailed the 2015 Forms 1095 to employees, no further action is needed at this time.  If your Forms 1095 are still in process, most systems and vendors have an internal deadline that is earlier than the IRS’s March 31 deadline for providing copies to employees. In short, not much time remains to complete your reporting obligation to employees.1  
Details Triple Check If You Don’t Think the ACA Reporting Requirements Apply To Your Business

Employers with 50 or more full-time and full-time-equivalent employees in the 2014 calendar year are required to provide Form 1095-C to each employee who is considered full-time for any one month during 2015.    This determination is NOT made based solely on your entity’s employee count.  If your entity is connected to another entity through ownership you might be required to combine all employees when determining your requirement to prepare Forms 1095-C.  Subsidiaries with less than 50 employees that know little about other entities owned by the parent (especially foreign parents) are at particular risk for a filing requirement caused by the headcount of its brother-sister businesses.  

Even employers with fewer than 50 full-time and full-time equivalent employees that offer self-insured health benefits have a requirement to provide employees a Form 1095-B.   
Still Working...You're Not Alone While many employers are nearing completion of the forms,  some  are still in the early stages, i.e., identifying full time employees, extracting data from various systems, clarifying which codes apply  for Form 1095-C and locating a vendor that can produce the Forms.   
  Keep Going to Reduce Penalties Don’t give up on the process. There are penalties that apply for a failure to provide the Form 1095 as required. The IRS has indicated that it will be lenient on first year penalties, provided the employer made a good faith effort at compliance.   Missing the March deadline without making every effort to file as soon as possible could be considered an act of bad faith.  If the IRS does not think an employer acted in good faith, then it could apply a penalty of $250 for each IRS and payee copy not filed or furnished to the recipient, respectively.  The maximum penalty is $3 million for the IRS copies and $3 million for the recipient copies per calendar year.

Even if March 31 deadline is missed, continued diligence to prepare the Forms can avoid a failure to file the IRS copy before the applicable May or June due date and can significantly reduce the penalty of the late employee copy.  For failures that are corrected within 30 days after the filing due date, the $250 penalty is reduced to $50 per return and the maximum penalty of $3 million is reduced to $500,000 per calendar year. For failures corrected after 30 days but before August 1, the $250 penalty is reduced to $100 per return and the maximum penalty of $3 million is reduced to $1.5 million per calendar year.

Filers with gross receipts under $5 million are subject to the same per return penalty as outlined above but continue to get a break on the maximum annual penalty of $1 million per calendar year with reductions to $175,000  if  corrected within 30 days, and $500,000 if corrected after 30 days but before August 1.

On the other hand, taking no action could result in the penalty for intentionally failing to file of $1,000 per violation ($500 for each IRS and payee copy not filed or furnished to the recipient).
What To Do Re-evaluate your plan for compliance and be realistic. 
  • If the data gathering and code assignment is more than your in-house capabilities, request help from an outside source.
  • If your vendor has proven to be not capable, change vendors.
  • Deliver the Forms 1095 that you have completed to contain the penalty exposure to fewer undelivered Forms.  For instance, if the information on COBRA coverage is proving difficult to obtain or to combine with the information needed to file Forms 1095 for active employees, don’t delay the forms for the actives who are unaffected by COBRA benefits.   Deliver the forms that are ready and complete the COBRA information as soon as possible prior to the IRS filing deadline. 
1 The IRS copy of the Form 1095s must be transmitted with a Form 1094 no later than May 31, 2016 or June 30, 2016 if filed electronically.
 
For more information, please contact one of the following practice leaders:
 

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

 

Penny Wagnon
Sr. Director, Compensation & Benefits

 

Linda Baker
Sr. Manager, Compensation & Benefits

 

Kim Flett
Sr. Director, Compensation & Benefits

  Don Hughes
Manager, Compensation & Benefits  

 

International Tax Alert - March 2016

Fri, 03/11/2016 - 12:00am
Brazil Update: Dutch Holding Companies No Longer Excluded From Gray List  Download PDF Version
Date/Timing Effective December 21, 2015, when Declaratory Act 3/2015 was published in Brazil’s official gazette.
Affecting Taxpayers that own Brazilian entities that have transactions with Dutch holding companies.
Details On June 4, 2010, the Brazilian tax authorities issued Normative Instruction 1,037/2010, which designated a number of regimes as Privileged Tax Regimes (also known as gray list jurisdictions).  On June 24, 2010, Normative Instruction 1,045/2010 amended the original list.

The gray list originally included Dutch holding companies that lacked substantial economic activities.  This inclusion was suspended by Declaratory Act 10/2010 issued on June 24, 2010.

Gray list entities are subject to stricter thin capitalization and transfer pricing rules, even when the parties to the transaction are unrelated.  For example, interest paid or credited by Brazilian entities to related or unrelated parties that reside in a gray list jurisdiction is subject to a 0.3:1 debt-to-equity ratio versus the standard ratio of 2:1.  If the debt to equity ratio is not met, interest paid is not deductible for income and social contribution tax purposes.  There are additional requirements to identify the effective beneficiary of a payment and proof of economic substance.

Transfer pricing rules also apply to all transactions between Brazilian entities and gray list entities, treating the entities as if they were related.

Payments to gray list entities are generally not subject to higher withholding tax rates, which apply to payments to black list tax havens or low tax jurisdictions.
Updates The Brazilian tax authorities have reversed the exclusion of Dutch holding companies that lack substantial economic activities from the gray list by issuing Declaratory Act 3/2015 which revokes Declaratory Act 10/2010.
BDO Insights BDO can help you get a more in depth understanding as to how this change affects your business, evaluate alternatives with a practical perspective, and assist with cross-border restructuring as needed. 
 
For more information, please contact one of the following practice leaders:
 

Robert Pedersen
Partner and International Tax Practice Leader

 

William F. Roth III
Partner

 

Bob Brown
Partner

 

Jerry Seade
Principal

  Scott Hendon
Partner  

Joe Calianno
Partner and International Technical
Tax Practice Leader

  Monika Loving
Partner  

Fabrizia Hadlow
Senior Manager

  Brad Rode
Partner   Chip Morgan
Partner

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