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New Proposed Regulations Address Signature Requirement for Section 754 Election

Fri, 11/03/2017 - 12:00am
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  Summary On October 11, 2017, Treasury issued proposed regulations (REG-116256-17) (Proposed Regulations) that would remove the signature requirement associated with making a section 754 election to adjust the basis of partnership property. The Proposed Regulations would reduce regulatory burdens by eliminating partnership relief requests for unsigned section 754 elections.  
  Details Background
Section 754 provides that if a partnership files an election (Section 754 Election), in accordance with regulations prescribed by the Secretary, the basis of partnership property shall be adjusted, in the case of a distribution of property, in the manner provided in section 734 and, in the case of a transfer of a partnership interest, in the manner provided in section 743. Such an election shall apply with respect to all distributions of property by the partnership and to all transfers of interests in the partnership during the taxable year with respect to which such election was filed and all subsequent taxable years.

Under current regulations, a Section 754 Election is made in a written statement that is included in a timely filed partnership return for the taxable year in which the distribution or transfer occurs. It must (i) set forth the name and address of the partnership making the election, (ii) be signed by any one of the partners, and (iii) contain a declaration that the partnership elects under section 754 to apply the provisions of section 734(b) and section 743(b).

Taxpayers have two avenues of corrective relief in the event of a failure to make a timely Section 754 Election: (1) automatic relief under section 301.9100-2 if the error is discovered and corrected within 12 months from the due date of the partnership return (including extensions); or (2) through a private letter ruling request pursuant to section 301.9100-3 (collectively with 301.9100-2, “9100 Relief”). Historically, the IRS receives numerous requests for 9100 Relief with respect to inadvertently unsigned Section 754 Elections, especially where returns have been electronically filed. The proposed regulations are intended to alleviate the administrative burden associated with the filing of Section 754 Elections pursuant to existing regulations. 

New Rules
In order to ease the administrative burden on partnerships seeking to make a valid Section 754 Election and to eliminate the need to seek 9100 Relief, the Proposed Regulations remove the requirement that the Section 754 Election must be signed by a partner in the partnership. Accordingly, under the Proposed Regulations, partnerships are able to make a valid Section 754 Election by filing a statement with a timely filed partnership tax return for the taxable year in which the distribution or transfer occurs that contains a) the name and address of the partnership making the Section 754 Election and b) a declaration that the partnership elects under section 754 to apply the provisions of section 734(b) and 743(b). Under the Proposed Regulations, the signature requirement has been eliminated.
 
Effective Date
The updated rules are proposed to apply to taxable years ending on or after the date the regulations are published as final. However, partnerships may rely on the Proposed Regulations for periods preceding the proposed applicability date. Consequently, partnerships that timely filed a partnership return containing a Section 754 Election consistent with the requirements of the Proposed Regulations will be treated as having made a valid Section 754 Election, notwithstanding the lack of a partner’s signature. 
  BDO Insights Treasury and the IRS intend to simplify the process for making a Section 754 Election in order to decrease regulatory burdens. To this end, the Proposed Regulations would remove the signature requirement in making a valid Section 754 Election. As a result of the effective date provided for in the Proposed Regulations, taxpayers who have previously filed an unsigned Section 754 Election that is consistent with the requirements of the Proposed Regulations may not need to seek 9100 Relief. 
 
For more information, please contact one of the following practice leaders:
  Jeffrey N. Bilsky
National Tax Office Partner
    Julie Robins
National Tax Office Managing Director
    David Patch
National Tax Office Managing Director
    Will Hodges
National Tax Office Senior Manager
      Katie Pendzich
National Tax Office Senior Manager    

House Tax Bill Released

Thu, 11/02/2017 - 12:00am
Summary On November 2, 2017, the House of Representatives released a draft tax reform bill titled the “Tax Cuts and Jobs Act.”  The bill would reduce individual and business tax rates, would modify or eliminate a variety of itemized deductions as well as repeal the estate and alternative minimum taxes, and would change the taxation of foreign income.  The Ways & Means Committee intends to formally markup the bill the week of November 6 with full House floor consideration planned before Thanksgiving.  Most of the provisions would be effective starting in 2018. 
  Details Under the House bill, individuals would be subject to four tax brackets at 12, 25, 35, and 39.6 percent.  The 39.6 rate would apply at $1 million for married taxpayers filing jointly and $500,000 for other filers.  The standard deduction would be increased, from $6,350 to $12,000 for single filers and from $12,700 to $24,000 for married taxpayers filing jointly.  Personal exemptions would be repealed; however, the child tax credit would be expanded.

Itemized deductions would be changed significantly by the bill.  Deductions for state and local income and sales taxes would be eliminated for individuals, and the deduction for local property taxes paid would be capped at $10,000.  Mortgage interest expense deductions would be limited to acquisition indebtedness on the taxpayer’s principal residence of up to $500,000 for new mortgage indebtedness, reduced from the current limit of $1 million (existing mortgages would be grandfathered).  Home equity indebtedness would no longer be deductible. Cash contributions to public charities would be limited to 60 percent of the donor’s adjusted gross income, an increase from 50 percent adjusted gross income limitation under current law.  Deductions for tax preparation fees, medical expenses, moving expenses, and personal casualty losses would be repealed, but the deduction for personal casualty losses would remain for relief provided under special disaster relief legislation. The overall limitation on itemized deductions would also be removed.  The individual alternative minimum tax (AMT) would be repealed. Transition provisions would ensure taxpayers with AMT carryforwards would be able to use the remaining credits between 2018 and 2022.

Notably, most of the reform provisions are effective beginning after 2017; however, the changes to the mortgage interest expense deduction are effective for debt incurred on or after November 2, 2017.

The exclusion of gain from the sale of a principal residence would be phased out for married taxpayers with an adjusted gross income in excess of $500,000 ($250,000 for single filers) but the act changes the use requirements and calls for taxpayers to live in the residence for five of the previous eight years to qualify, up from the current requirement to use the residence for two of the previous five years. The bill further repeals the deduction for alimony payments effective for any divorce decree or separation agreement executed after 2017.

Estate, gift, and generation-skipping transfer (GST) tax exclusions for individuals would be increased to $10 million (as of 2011) and then adjusted for inflation, and the estate and GST taxes would be then be repealed after 2023 but would maintain the step-up in basis provisions. Beginning in 2024, the top gift tax rate would be lowered to 35 percent with a lifetime exemption of $10 million and an annual exclusion of $14,000 (as of 2017) indexed for inflation. 

Impacting businesses, the corporate tax rate would be reduced from 35 percent to 20 percent, and certain “business income” from pass-through entities would be taxed at 25 percent instead of an owner’s individual rate.  Bonus depreciation of 100 percent would be available for qualifying property placed in service before January 1, 2023, new property types would qualify for bonus depreciation and expense amounts would be expanded.  The bill proposes to eliminate the Domestic Production Activities Deduction and change other aspects of entertainment expenses, net operating losses, like-kind exchanges, business credits, and small-business accounting methods, among other provisions.  The bill would also repeal the corporate alternative minimum tax (AMT) and make existing AMT credit carryforwards refundable over a period of five years.

Taxation of a corporation’s foreign income would change from a worldwide system to an exemption system, with a 100-percent exemption from U.S. tax for the foreign source portion of dividends paid by a foreign subsidiary to U.S. corporate shareholders that own 10 percent or more of the foreign subsidiary.  To transition to the exemption system, the bill also includes a transition tax for untaxed foreign earnings accumulated under the current worldwide taxing system. The House bill also includes provisions to prevent base erosion. A separate tax alert discussing in more detail the House bill’s proposals relating to the taxation of foreign income and foreign persons is forthcoming.   
         
The bill would impact tax-exempt entities as well through the expanded application of unrelated business income tax (UBIT) rules and a flat 1.4 percent tax of the net investment income of entities including private foundations. 
  BDO Insights The release of the House bill represents the first significant and detailed legislative step toward tax reform under the Trump Administration.  As drafted, most of the provisions would be effective for the 2018 tax year.  The House Ways & Means Committee is expected to formally markup the legislation the week of November 6, with full House consideration planned before Thanksgiving.

There are additional provisions in the proposed legislation effecting education credits, retirement accounts, deferred compensation, and private foundations, among others.
 
For more information on matters discussed above, please contact one of the following practice leaders:
  Todd Simmens
Controversy and Procedure Technical Practice Leader   Ben Willis
Corporate Tax Technical Practice Leader   Joe Calianno
International Tax Technical Practice Leader      Jack Nuckolls
PCS Technical Practice Leader  
 

Property Tax Reassessments Could Have Expensive Consequences

Tue, 10/31/2017 - 12:00am
The real estate sector has rebounded significantly in the past few years, but as property value grows, so do commercial property tax liabilities. And, according to Dorothy Radicevich, jurisdictions that reassess values every couple of years rather than annually, could lead to big increases in a company’s tax bill.

In a recent interview with National Real Estate Investor, Dorothy shares her take on how local taxing authorities are handling commercial property taxes, and gives an example of how BDO is helping businesses cope with property value reassessments.
  Read the Full Article
  For more information on how property value reassessments in your local jurisdiction may impact your business, contact Dorothy Radicevich, national property tax leader and principal in the state and local tax practice.
 

BDO Transfer Pricing News - October 2017

Tue, 10/31/2017 - 12:00am
Transfer pricing is increasingly influencing significant changes in tax legislation around the world. This 25th issue of BDO’s Transfer Pricing Newsletter focuses on recent developments in the field of transfer pricing in Cyprus, Germany, India, Spain, Switzerland and the United Kingdom. As you will read, major changes in legislation will be made in the coming period, and interesting developments occur in various countries around the world.
  View the Newsletter

California Again Extends Water’s-Edge Election For Groups With New Foreign Affiliate Taxpayer-Members

Mon, 10/30/2017 - 12:00am
Summary In FTB Notice 2017-04 (Oct. 16, 2017), the California Franchise Tax Board (FTB) has extended the water’s-edge election relief issued in 2016 for groups that have a unitary foreign affiliate become a California taxpayer-member as  a result of California’s economic/factor-presence nexus statute.  Absent such relief, a water’s-edge election could be terminated.
  Details As we elaborated in our September 2016 BDO SALT Alert, all taxpayer-members must consent to a California water’s-edge election.  Failure to adhere to California’s consent procedures renders the election terminated.  For taxable years beginning in 2011, California enacted an economic/factor-presence nexus statute that included a sales threshold of $500,000 (indexed for inflation).  Cal. Rev. & Tax. Code § 23101(b).  For the 2016 taxable year, the sales threshold is now $547,711.  As a result, a unitary foreign affiliate with California sourced sales in excess of the threshold (for example, from sales of tangible personal property or services, licenses of software or intangibles, or interest income on intercompany debt) that was outside a California water’s-edge group could become a California taxpayer-member by virtue of meeting the sales threshold.  However, the unitary foreign affiliate had not consented to the California’s water’s-edge election, and under Cal. Rev. & Tax. Code § 25113 the election could be terminated.
 
On September 9, 2016, the FTB issued Notice 2016-02 that, if certain conditions were satisfied, the California water’s-edge election would not be terminated if California’s economic/factor-presence nexus statute resulted in a unitary foreign affiliate becoming a non-consenting California taxpayer-member of the water’s-edge group.  However, Notice 2016-02 only provided relief for taxable years ending on or before December 31, 2016.  Notice 2016-02 provided no relief for the 2017 taxable year.
 
With the issuance of Notice 2017-04, if the conditions originally set forth in Notice 2016-02 are satisfied, then water’s-edge election relief will be provided for unitary foreign affiliates that become California taxpayer-members solely as a result of California’s economic/factor presence statute for taxable years beginning on or before December 31, 2017.    
  BDO Insights
  • The issuance of Notice 2017-04 is an important continuing development for California water’s-edge groups that have had a unitary foreign affiliate become a California taxpayer in 2017 or prior years as a result of California’s economic/factor presence nexus statute, including the interplay with the FTB’s market-based sourcing regulations.
  • Taxpayers considering the effect of Notice 2017-04 should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740s.
 
For more information, please contact one of the following practice leaders: 
  West:     Southeast: Rocky Cummings
Tax Partner
      Scott Smith
Tax Managing Director
  Paul McGovern
Tax Managing Director
      Tony Manners
Tax Managing Director
      Northeast:     Southwest: Janet Bernier
Tax Principal
      Tom Smith
Tax Partner
  Matthew Dyment
Tax Principal
      Gene Heatly
Tax Managing Director
      Central:     Atlantic: Nick Boegel
Tax Managing Director
      Jonathan Liss
Tax Managing Director
  Joe Carr
Tax Partner
      Jeremy Migliara
Tax Managing Director
  Mariano Sori
Tax Partner
      Angela Acosta
Tax Managing Director
  Richard Spengler
Tax Managing Director

Tax Reform Framework Released

Mon, 10/30/2017 - 12:00am
Summary On September 27, 2017, the Trump Administration, the House Ways & Means Committee, and the Senate Finance Committee released a unified framework “to achieve pro-American, fiscally responsible tax reform.”  The White House notes that the September 27 “Framework” is intended to “deliver a 21st century tax code that is built for growth, supports middle-class families, defends our workers, protects our jobs, and puts America first. It will deliver fiscally responsible tax reform by broadening the tax base, closing loopholes, and growing the economy.”
 
While the Framework includes many of the tax reform principles put forward over the past several months, including the June 2016 Blueprint and the Trump Administration’s April 2017 proposal, it is the first plan set forth by the Administration and both Congressional tax writing committees.  Included in the Framework are domestic and international proposals, which would include changes to individual rates, increases to the standard deduction and child credit, changes to itemized deductions, repeal of the estate tax, generation-skipping transfer tax, and alternative minimum tax, reduction of the corporate rate and rate for income from small businesses, expensing of certain capital investments, and changes to the taxation of foreign profits.  As a first step of the legislative process, as of October 26, 2017, both the House and Senate have adopted a budget resolution providing for a tax package that would increase the deficit by $1.5 trillion.  While draft legislative text has not yet been made public, it is expected that the House Ways & Means Committee will release a bill week of October 30, which will continue the formal legislative process.
  Details The Framework’s domestic proposal would reduce from seven to three the number of individual tax rates, which would be 12, 25, and 35 percent.  To ensure that the highest income earners do not contribute less taxes than they do today, there would be the potential for an additional fourth top rate.  The Framework does not specify the income ranges that would fall into each of the brackets, or the rate or income threshold for the additional top rate.  The standard deduction would be doubled to $12,000 for single filers and $24,000 for married filers filing a joint return.  Personal exemptions would be repealed; however, the child tax credit would be expanded.

Under the details of the Framework, many itemized deductions would be repealed, except those for mortgage interest and charitable contributions.  Eliminated deductions would include those for medical expenses, state and local income taxes, real estate taxes, personal property taxes, investment interest expense, tax preparation fees, and other miscellaneous deductions.  The Framework does not address existing carryovers of these deductions.  The individual Alternative Minimum Tax (AMT) would also be repealed.  Benefits that encourage higher education and retirement savings, however, would be retained. 

The Framework would also repeal the estate and generation-skipping transfer taxes.  No details are provided for the effective date of the proposed repeal, and the Framework does not address the gift tax. The Framework was also silent as to whether the current so-called “step up” in basis rules for a decedent’s assets would continue to apply for income tax purposes after the repeal of the estate tax.
         
For businesses, the corporate tax rate would be lowered from 35 to 20 percent.  Income from small businesses conducted as sole proprietorships, partnerships, and S corporations would be taxed at a maximum rate of 25 percent, effectively taxing such income at the entity level.  The Framework would eliminate the Domestic Production Activities Deduction, indicating that the provision “will no longer be necessary” based on the proposed deduction in tax rates.  Research and development and low-income housing credits would remain, however, and current deductions would be permitted, for at least five years, for investment in certain depreciable assets made after September 27, 2017.
 
From an international tax perspective, the Framework incorporates certain proposals that were seen previously in the GOP House Blueprint and the President’s “one-page” tax reform proposal.  For instance, the Framework proposes a shift from our current worldwide tax system to a territorial system.  In particular, the Framework would “replace the existing, outdated worldwide tax system with a 100% exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake).”
 
In conjunction with moving to a territorial system, the Framework also includes a transition tax, which has been a common thread in moving to a territorial system.  Specifically, the Framework “treats foreign earnings that have accumulated overseas under the old system as repatriated. Accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents. Payment of the tax liability will be spread out over several years.” It is worth noting that the Framework did not provide specific rates for the two types of earnings (cash/cash equivalents and illiquid assets) or a specific number of years for payment of the tax liability the way the previously released GOP House Blueprint did. Specifically, the GOP House Blueprint provided that accumulated foreign earnings would be subject to tax at 8.75 percent to the extent held in cash or cash equivalents and otherwise would be subject to tax at 3.5 percent (with companies able to pay the resulting tax liability over an eight-year period).
 
One item notably not included in the Framework was the border adjustment tax that previously was included in the GOP House Blueprint. The fact that such proposal is not included in the Framework is not surprising, given that on July 27, 2017, the “Big Six” group of senior Republicans issued a joint statement specifically abandoning the proposed border adjustment tax that was included in the GOP House Blueprint.  However, there was a proposal included in the Framework that was not included in the GOP House Blueprint or the President’s one-page tax reform proposal.  This new proposal is designed to stop corporations from shipping jobs and capital overseas.  Specifically, the proposal states the following:
 
To prevent companies from shifting profits to tax havens, the framework includes rules to protect the U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations.[1]

The Framework, however, does not provide specific details relating to the new proposal or how such proposal will operate under the new system.  The details of such provision likely will be provided when an actual bill is proposed reflecting the new tax reform framework. 

Another item that was included in the Competitiveness and Growth for All Job Creators Section of the Framework that can impact cross border transactions and base erosion is the interest expense limitation proposal, whereby the deduction for net interest expense incurred by C corporations will be partially limited.[2] The Framework does not elaborate on what “partially limited” may mean.  Details likely will be provided when an actual bill is proposed reflecting the new tax reform framework.
  BDO Insights The Trump Administration’s tax reform Framework proposes the most significant and comprehensive changes to the tax code in years.  The impact would span business formation and location to individual taxes and estate planning.  While the Framework lacks details and has no effective date, it is expected that Congressional tax writing committees will begin consideration of tax reform over next several weeks – the first official step in the tax legislative process.

Given the emphasis placed by certain Congressional leaders and the White House on tax reform, U.S. multinational companies should be evaluating the potential tax impact of the proposals included in the Framework if such Framework moves forward.   BDO can assist U.S. multinational companies in reviewing how the proposals included in the Framework can impact them. Specifically, BDO can assist U.S. multinationals in planning for possible tax reform by helping them model the potential implications of certain proposals included in the Framework (such as the transition tax discussed above) by analyzing and reviewing certain tax attributes, such as earnings and profits, foreign tax pools, tax basis, and loss carryforwards.  
 
For more information, please contact one of the following practice leaders:
  Joe Calianno
International Tax Technical Practice Leader   John Nuckolls
PCS Technical Practice Leader   Todd Simmens
Controversy and Procedure Technical Practice Leader   Ben Willis
Corporate Tax Technical Practice Leader   [1] The Framework also states that the committees will incorporate rules to level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies. [2] The Framework also notes that the appropriate treatment of interest paid by non-corporate taxpayers will also be considered.
 

BDO World Wide Tax News – October 2017

Mon, 10/30/2017 - 12:00am
The October 2017 issue of the World Wide Tax Newsletter, published by BDO International, summarizes recent tax developments of international interest around the world including content from: Asia Pacific, Europe and the Mediterranean, Latin America, the Middle East, as well as North America and the Caribbean.
  View the Newsletter

“F” Reorganization Under Rev. Rul. 2008-18: Timing Of OSUB Election Is Key

Fri, 10/27/2017 - 12:00am

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Summary Pre-transaction restructuring for S Corporations using the “F” Reorganization has become a very commonly used technique, especially for Private Equity (PE) firms that wish to acquire a closely-held corporation (the transferee corporation or “Target”) in transactions that require tax-free rollover equity.

The “F” Reorganization structure involves the formation of a new S Corporation (the resultant corporation or “NewCo”), followed by a contribution of the stock of the Target into NewCo in exchange for NewCo stock.  Following the contribution, a Qualified Subchapter S Subsidiary (QSub) election is made to treat the Target as a disregarded entity for income tax purposes.  This strategy follows the model established by Revenue Ruling (Rev. Rul.) 2008-18,[1] and is often the strategy of choice where the parties wish to avoid potential tax or structural inefficiencies.

For example, if rollover equity is desired in a tax-free manner by the seller(s), and if the PE firm wishes to obtain a cost basis in the assets acquired, this strategy often precedes the conversion of the QSub to a single-member limited liability company (SMLLC), which is also a disregarded entity for tax purposes.  The conversion of one disregarded entity into another disregarded entity has no federal income tax consequences. 

A partnership is then created by either distributing a nominal, e.g., 1% interest in the LLC to one of the shareholders of the S Corporation, or by compensating a key employee with a nominal interest in the LLC.  After a period of time has passed, an election under Internal Revenue Code Section (Sec.) 754 is made by the partnership, and the PE firm purchases an interest in the partnership.  The S Corporation will recognize gain equal to the percentage of the underlying LLC that is sold, and the PE firm receives a tax basis step-up for the underlying assets that it purchased.[2] 

Following these steps as outlined in Rev. Rul. 2008-18 will satisfy the objectives of the Target shareholders and the PE firm.  However, the timing of the QSub election can be a “trap for the unwary,” as highlighted in a recent Private Letter Ruling, PLR 201724013.[3]
  Details “F” Reorganization
The Internal Revenue Code provides that corporations and shareholders do not recognize gain with respect to certain qualifying reorganizations.[4]  To satisfy the requirements for this nonrecognition benefit, a transaction must meet one of the statutory definitions of a “reorganization” set forth in Sec. 368(a)(1).  Sec. 368(a)(1)(F) provides that a reorganization includes a mere change in identity, form, or place of organization of one corporation, however effected, i.e., an “F” Reorganization. 

Treasury Regulations elaborate that a mere change occurs if, as a result of a transaction or series of transactions: (1) All the stock of the resulting corporation, including stock issued before the transfer, is issued in respect of the transferring corporation’s stock; (2) There is no change in the corporation’s ownership in the transaction, except a change that has no effect other than that of a redemption of less than all of the corporation’s shares; (3) The resulting corporation does not hold any property or have any tax attributes immediately before the transfer; (4) The transferring corporation completely liquidates in the transaction; (5) The resulting corporation is the only acquiring corporation; and (6) The transferor corporation is the only acquired corporation.[5]  To meet the fourth requirement, the transferring corporation is not required to legally dissolve.[6]

An “F” Reorganization is, by its statutory definition, limited to a transaction involving a single entity which is treated as a corporation for federal tax purposes.[7]  Two corporations can be involved in a type “F” Reorganization if only one corporation has an active trade or business, and that active trade or business is treated as contained within the newly-formed corporation created to enter into the reorganization.  Moreover, a series of related transactions can together constitute an “F” Reorganization; the “F” Reorganization will generally continue to qualify as such even if it is preceded or followed by other related transactions.[8]  The acquiring company succeeds to the tax attributes of the transferor company and is treated as the transferor would have been treated had there been no reorganization.[9]

The interplay of the “F” Reorganization with S Corporations and QSubs provides valuable planning opportunities, but also introduces complexities.

QSubs
While an S Corporation generally cannot have a corporate shareholder,[10] the tax law permits an S Corporation to have a disregarded corporate subsidiary if it owns 100% of the subsidiary’s stock,[11] the subsidiary is not an ineligible corporation,[12] and the S Corporation parent elects to treat the subsidiary as a QSub by filing Form 8869, Qualified Subchapter S Subsidiary Election

An entity thus meets the QSub eligibility requirements - outlined in Sec. 1361(b)(3)(B) - if it is a corporation otherwise eligible to be an S Corporation, but its stock is owned entirely by a single electing S Corporation.[13] 

When a parent S Corporation makes a QSub election for its wholly owned subsidiary, the subsidiary is generally deemed to have engaged in a tax-free liquidation for tax purposes.  As a result, the QSub is treated as a division of the S Corporation parent for federal income tax purposes.[14]  The deemed liquidation of a QSub into its parent is subject to the rules generally applicable to liquidating distributions of a corporation, including the “step transaction doctrine,”[15] whereby the deemed liquidation could be treated as part of a larger transaction.[16]

The parent S Corporation can make the QSub election at any time during the tax year.[17]  However, the requested effective date of the QSub election generally cannot be more than:
  1. Twelve months after the date the election is filed, or
  2. Two months and 15 days before the date the election is filed.
The QSub eligibility requirements must be met at the time the election is made and for all periods during which the election is to apply.[18]

Using a QSub can be a valuable tax planning opportunity where there is a business reason to maintain certain S Corporation operations in a separate subsidiary.  Moreover, since a QSub is treated as a division of its parent S Corporation, the sale of an interest in a QSub is treated as a sale of an undivided interest in its assets for federal income tax purposes (corresponding to the amount of stock sold),[19] which provides the buyer with a “step-up” in the basis of the acquired assets for depreciation and amortization purposes.  The corporation that is formed as a result of a sale of a QSub interest would be a C Corporation.  Since the owners would prefer to hold a pass-through entity to afford a single level of tax on a subsequent asset sale at capital gains tax rates, the QSub is typically converted to a SMLLC immediately prior to the sale.  A sale of a partial interest in a SMLLC would still result in a partial asset sale for income tax purposes, but it would create a partnership for income tax purposes.[20]

Rev. Rul. 64-250: S Election Continuity
In Rev. Rul. 64-250,[21] the IRS held that when an S Corporation merges into a newly-formed corporation in a transaction that qualifies as an “F” Reorganization, and the newly-formed surviving corporation also qualifies as an S Corporation, the reorganization will not terminate the S election, and the S election remains in effect for the new corporation.  This principle of continuity of the election has been amplified by Rev. Rul. 2008-18, which addresses certain “F” Reorganizations involving QSubs.

Rev. Rul. 2008-18: “F” Reorganizations involving QSubs
In Rev. Rul. 2008-18, the IRS held that where the shareholders of an existing S Corporation (Target) cause it to become the wholly-owned subsidiary of a new S Corporation holding company (NewCo) owned by the same shareholders, and NewCo timely elects to treat Target as a QSub effective immediately following the transaction, these steps are treated as an “F” Reorganization under Sec. 368(a)(1)(F).[22]  

The requirements for an “F” Reorganization are met, with NewCo continuing the tax attributes of Target, because Target is treated as a QSub and disregarded for income tax purposes, and all of its activity is treated as occurring within the newly-formed entity. 

Rev. Rul. 2008-18 cited Rev. Rul. 64-250 in concluding that an election of S Corporation status on Form 2553, Election by a Small Business Corporation, should not be required for NewCo, as Target’s S election remains in effect for NewCo.  However, a new employer identification number (EIN) is generally required for NewCo, while Target (now a QSub) retains its existing EIN.

In the wake of Rev. Rul. 2008-18, the IRS redesigned Form 8869, Qualified Subchapter S Subsidiary Election, allowing taxpayers to check a box in Part II, Item 14, to indicate that the election is made in combination with an “F” Reorganization described in Rev. Rul. 2008-18.  Checking this box puts the IRS on notice that no new S Corporation election is required and that the S Corporation status has transferred from Target to NewCo.

An “F” Reorganization pursuant to Rev. Rul. 2008-18 typically entails the following sequence of steps:
Step 1: The shareholders of Target contribute all of their shares to NewCo, in exchange for all of the shares of NewCo, thus causing Target to become a wholly-owned subsidiary of NewCo.

Step 2: Effective on the same date as the contribution in Step 1, NewCo files Form 8869 to treat Target as a QSub.

As discussed above, in order to achieve the objectives of both the buyer and the seller(s), the reorganization is often followed by the conversion of Target (the QSub) to a limited liability company (LLC) via a state law merger or a state law formless conversion,[23] in preparation for a subsequent transaction.

PLR 201724013
In PLR 201724013, the IRS granted relief under Sec. 1362(f) for an inadvertently invalid QSub election where the defect related to the timing of the election.[24] The facts involved an “F” Reorganization intended to follow the basic sequence of steps outlined in Rev. Rul. 2008-18.

The PLR describes the following fact pattern:  Effective on Date 1, “X” was organized and elected to be an S Corporation effective that date.  “Sub” was organized on Date 2 and made an S election effective on Date 3.  On Date 4, as part of a transaction intended to qualify as an “F” Reorganization, Sub’s shareholders contributed all of their stock in Sub to X, thereby causing Sub to become a wholly-owned subsidiary of X.  Sub then converted to an LLC under state law on Date 5, and by default was treated as a disregarded entity for federal tax purposes.  Afterwards, X made an election to treat Sub as a QSub effective on Date 4.

X’s election to treat Sub as a QSub was considered ineffective, because Sub did not meet the QSub eligibility requirements of Sec. 1361(b)(3)(B) - specifically, classification as a corporation - at the time the election was filed, which was after it had converted from a corporation to a disregarded entity for federal income tax purposes.  However, the generally requested timelines for a QSub election appear to have been met, i.e., a requested effective date not more than two months and 15 days before the date the election is filed.

The IRS found that the ineffective QSub election was inadvertent and thus granted relief under Sec. 1362(f), concluding that Sub will be treated as a QSub effective on Date 4.

This PLR highlights that “F” Reorganizations described in Rev. Rul. 2008-18 can bring about a potential “compliance trap”:  a QSub election filed “timely, but too late,” with potentially adverse tax consequences where inadvertent termination relief is not pursued or not granted. 
  Timing Determines Tax Implications “F” Reorganization Outside Rev. Rul. 2008-18
PLR 201724013 does not disclose the time period that elapsed between the transfer of Sub’s (i.e., Target’s) stock to X (i.e., NewCo) and the conversion of Sub to an LLC. 

If no significant time period elapsed since the stock transfer, then the LLC conversion could be viewed as part of an overall plan of reorganization for the transfer of assets from Target to NewCo and the liquidation of Target for federal income tax purposes.  Under the step transaction doctrine, the completion of these steps within a short period of time should result in an “F” Reorganization outside of Rev. Rul. 2008-18, without the need for a valid QSub election for the period of time during which Target was organized as a corporation.

Therefore, the QSub election could be skipped altogether if the LLC conversion takes place immediately after the stock contribution and the plan of reorganization is clearly documented, so as to leave no doubt regarding “F” Reorganization treatment.  Pursuant to Rev. Rul. 64-250 (discussed above), no new S election would be required in this scenario.

If, however, the LLC conversion occurs long after the contribution of Target stock to NewCo, the transaction does not qualify as an “F” Reorganization and a valid QSub election is essential to avoid potential risks associated with momentary C Corporation status of Target.

Consequently, the time interval between the steps is the principal factor that determines the level of risk to be weighed when considering whether or not inadvertent invalid election relief under Sec. 1362(f) should be sought.

Potential Risks of Ineffective QSub Election
Momentary C Corporation status of Target could result in “built-in gains” (BIG) tax exposure upon the liquidation of Target into NewCo for tax purposes.   

When a C Corporation converts to S status, BIG tax is assessed at the highest corporate income tax rate (currently 35%) when the corporation disposes of assets with unrealized BIG in a taxable sale or exchange during a 5-year recognition period.[25]

In addition to BIG tax, tax is due at the shareholder level, i.e., 65% of gain remaining after payment of the BIG tax flows to the shareholder via the S Corporation and is subject to tax at the shareholder’s individual income tax rate.

Moreover, if the transaction does not qualify as an “F” Reorganization outside of Rev. Rul. 2008-18, a new S election would be required for NewCo.  Where the taxpayer unwittingly relies on Rev. Rul. 64-250 and does not make an S election, any subsequent gain on the sale of assets could be subject to two levels of tax under the C Corporation rules, and the subsequent liquidation could generally be subject to the 3.8% net investment income tax.[26]

Practical Merit of Following Rev. Rul. 2008-18
Even though “F” Reorganization treatment could be achieved outside of Rev. Rul. 2008-18 where a QSub election is considered ineffective, taxpayers should keep in mind that there is practical merit to adhering to the sequence of steps outlined in Rev. Rul. 2008-18, followed by a conversion of Target to an LLC via a state law formless conversion. 

As noted above, the IRS redesigned Form 8869 in that a box may be checked to indicate that the QSub election is made in combination with an “F” Reorganization described in Rev. Rul. 2008-18.  Upon receiving Form 8869 with this box checked, the IRS would not expect a separate Form 2553 for NewCo.  In this manner, a taxpayer can establish a clear paper trail for filing Form 1120S for NewCo as a continuation of Target.
 
For more information on matters discussed above, please contact:
  Kevin Anderson
Partner, National Tax Office          Randy Schwartzman
Regional Managing Partner, Northeast Tax Practice   [1] 2008-1 CB 674 (March 7, 2008). [2] In situations where the tax basis step-up relates to Sec. 197 amortizable intangible assets, it is often necessary to consider the anti-churning rules under Sec. 197(f). Where the PE firm acquires a partnership interest and obtains a Sec. 743(b) basis adjustment, the anti-churning rules may be inapplicable. For example, see Regs. Sec. 1.197-2(h)(12)(v) and Regs. Sec. 1.197-2(k), Example 19. [3] March 8, 2017; released June 16, 2017. [4] Secs. 354-368. [5] Treasury Regulations Section (Regs. Sec.) 1.368-2(m)(1). [6] Regs. Sec. 1.368-2(m)(1)(iv). [7] H.R. Rep. No. 97-760, at 541 (1982); Rev. Rul. 96-29, 1996-1 CB 50; PLR 201014048 (Dec. 30, 2009); PLR 200825031 (Mar. 19, 2008); PLR 200803012 (Oct. 17, 2007); PLR 200803005 (Oct. 19, 2007). [8] Regs. Sec. 1.368-2(m)(3)(i), (ii). [9] Sec. 381; Regs. Sec. 1.381(b)-1(a)(2). [10] Sec. 1361(b)(1)(B); Regs. Sec. 1.1361-1(f). [11] Sec. 1361(b)(3)(B); Regs. Sec. 1.1361-2 and 1.1361-3. [12] A domestic corporation is eligible to elect S Corporation status if (i) it has no more than 100 shareholders, (ii) all of its shareholders are individuals (with certain exceptions for estates, trusts, and tax-exempt organizations), (iii) none of its shareholders are nonresident aliens, and (iv) it has only one class of stock. Ineligible entities are insurance companies taxed under subchapter L of the Code, bank or thrift institutions using the reserve method of accounting for bad debts under Sec. 585, possessions corporations under Sec. 936, and domestic international sales corporations (“DISCs”) or former DISCs. [13] Sec. 1361(b)(3)(B). [14] Regs. Sec. 1.1361-4(a). However, QSubs are treated as separate entities for purposes of employment taxes and certain excise taxes (Regs. Sec. 1.1361-4(a)(7) and (8)); QSubs are also treated as separate entities for legal purposes. [15] The step transaction doctrine is a judicially developed concept that forms a subset of the more general “substance over form” doctrine that originated in the Supreme Court’s decision Gregory v. Helvering, 293 U.S. 465 (1935). Under the step transaction doctrine, the IRS and courts generally treat a series of formally separate “steps” as a single transaction if the steps are “in substance integrated, interdependent, and focused toward a particular end result” (Penrod v. Comr., 88 T.C. 1415, 1428 (1987); Christian Est. v. Comr., T.C. Memo 1989-413. On the other hand, separate steps are not disregarded, even if the steps are taken pursuant to an overall plan, if each step is meaningful and has independent economic significance.  [16] See Regs. Sec. 1.1361-4(a)(2)(i). [17] Regs. Sec. 1.1361-3(a)(3). [18] Regs. Sec. 1.1361-3(a)(1). [19] Sec. 1361(b)(3)(C)(ii)(I). [20] Rev. Rul. 99-5, 1999-1 CB 434 (January 15, 1999). [21] 1964-2 CB 333. [22] Rev. Rul. 2008-18, Situation 1. [23] Statutes in the majority of states provide for “formless conversions,” which allow an entity to retain its existence yet change its legal status, merely requiring the filing of a form with the Secretary of State’s office declaring the status of the entity going forward. [24] Sec. 1362(f), Inadvertent invalid elections or terminations, provides in pertinent part that if a QSub election was not effective for a taxable year for which it was made by reason of a failure to meet the requirements of Sec. 1361(b), and the Secretary determines that the circumstances resulting in ineffectiveness were inadvertent, then such corporation shall be treated as a QSub during the period specified by the Secretary. To obtain such relief, a Private Letter Ruling is necessary. [25] Sec. 1374. [26] Sec. 1411.

Disaster Tax Relief and Airport and Airway Extension Act of 2017 Creates Employee Retention Credit for Certain Employers

Wed, 10/25/2017 - 12:00am
Summary President Trump signed into law the Disaster Tax Relief and Airport and Airway Extension Act of 2017 (Public Law 115-63).  As part of the Act, eligible employers located in a federally designated disaster zone on specified dates may be eligible for an employee retention credit equal to the lower of $6,000 or 40% of qualified wages paid to eligible employees for periods during which the employer’s business was inoperable, as follows:
 
  • Hurricane Harvey Disaster Area (August 23, 2017-December 31, 2017)
  • Hurricane Irma Disaster Area (September 4, 2017-December 31, 2017)
  • Hurricane Maria Disaster Area (September 16, 2017-December 31, 2017)
  Details On September 29, 2017, President Trump signed into law the Disaster Tax Relief and Airport and Airway Extension Act of 2017.  Section 5023 of the Act creates an employee retention credit for certain employers affected by Hurricane Harvey, Hurricane Irma, and/or Hurricane Maria.  To be eligible for the credit, the employer must have been actively conducting a trade or business within a federally designated disaster zone on a certain date (August 23, 2017, in the case of Harvey; September 4, 2017, in the case of Irma; and September 16, 2017, in the case of Maria) and become inoperable before January 1, 2018, as a result of hurricane damage. 
 
The credit is treated as a current year business credit under Internal Revenue Code (IRC) § 38(b), and is based on qualified wages paid by an eligible employer to an eligible employee.  For this purpose, an “eligible employee” is an employee whose principal place of employment on the applicable date shown above was in a designated disaster zone.  The term “qualified wages” means wages paid to an eligible employee on or after the applicable date shown above and before January 1, 2018, for the period during which the business first became inoperable through the date when the business resumed significant operations.  Qualified wages include wages paid without regard to whether the employee performs no services, performs services at a location other than his or her principal place of employment, performs services at his or her principal place of employment before significant operations have resumed. 
 
The credit amount is equal to forty percent (40%) of the qualified wages paid and is capped at $6,000 per eligible employee.  Also, an eligible employer cannot claim the credit for an otherwise eligible employee if the employer is allowed a Work Opportunity Tax Credit with respect to the employee under IRC § 51.
  BDO Insights
  • The “hurricane credit” could provide some needed relief for businesses affected by the recent hurricanes, as well as helping employee retention while working towards resuming full operations.
  • The “hurricane credit” will help businesses in 104 counties in states across the Gulf of Mexico and Atlantic coasts.
 
For more information, please contact one of the following practice leaders:
  Tanya Erbe
Tax Managing Director   Tim Schram
Tax Managing Director   Taryn Goldstein
Tax Managing Director    

RI, OH, and Other States Tax Amnesty Updates and Developments

Tue, 10/24/2017 - 12:00am
Summary Tax amnesty programs and voluntary compliance initiatives are again popular among the states, as our recent SALT Alerts have addressed.  MTC On-line Marketplace Seller initiative, New Jersey, Oklahoma, Rhode Island and Texas, and Virginia.  In keeping with the trend, the Rhode Island Division of Taxation has recently issued guidelines for the Rhode Island Tax Amnesty Program that will start December 1, 2017.  Ohio’s recently enacted budget bill includes provisions for a tax amnesty program to commence on January 1, 2018.  New California legislation expands certain features of the state’s voluntary disclosure program with respect to partnerships and S corporations.  Finally, the Multistate Tax Commission (“MTC”) announced that it is extending the Online Marketplace Seller Voluntary Disclosure Initiative’s application period.         
  Details Rhode Island Tax Amnesty Program
 
As discussed in our prior SALT Alert, H.B. 5175 (signed August 3, 2017) required the Division of Taxation to establish a tax amnesty program.  The Division issued Advisory 2017-29 on September 27, 2017.  According to the Advisory, the Division will begin accepting amnesty applications on December 1, 2017.  The tax amnesty program will end on February 15, 2018, and applies to any taxable period ending on or before December 31, 2016.  For eligible participants, all penalties and 25 percent of interest will be waived in exchange for payment of all taxes owed for the eligible tax periods.
 
The Division also announced in its Advisory that it will be mailing notices to 90,000 taxpayers, beginning in early November.  The notices will provide the taxpayer’s account balance and an amnesty application form.  Although the Division plans to send out notices, the amnesty program also applies to those taxpayers whose Rhode Island tax delinquencies are not known to the Division. 
 
The Rhode Island Tax Amnesty Program applies to all state administered taxes and runs through February 15, 2018.  All amnesty applications and payments must be made or postmarked on or before 11:59 p.m. on February 15, 2018. 
 
Ohio Tax Amnesty Program
 
Ohio’s 2018-2019 Budget Bill (H.R. 49, August 22, 2017) included a tax amnesty program to run from January 1, 2018, through February 15, 2018.  Although the Ohio Tax Commissioner is required to establish the guidelines of the amnesty program, most state taxes are “qualified delinquent taxes,” including sales and use taxes, commercial activity tax (“CAT”), personal and school district income taxes.  Taxes must be due and payable as of May 1, 2017, be unreported or underreported, and unpaid.  In exchange for payment of the taxes due, all penalties and one-half of the interest will be waived.
 
California Expands its Voluntary Disclosure Program
 
In S.B. 813 (signed September 25, 2017), new law expands California’s voluntary disclosure program (“VDP”), effective January 1, 2018.  Nonresident partners and out-of-state administered trusts with California beneficiaries will be eligible to participate in the California VDP.  Based on a legislative analysis, California’s, like a number of other states, creation of an economic factor presence nexus standard, coupled with market-based sourcing for receipts from services or licenses of intangibles, increases the likelihood that partnerships and trusts will have a California filing obligation. 
 
The new law also expands the partnership tax penalties that are eligible for waiver under the VDP to include penalties on the failure of a limited liability company classified as a partnership for tax purposes to timely file returns and penalties related to S corporation failures to file returns. 
 
MTC Online Marketplace Seller Voluntary Disclosure Initiative Developments
 
An October 12, 2017, update issued by the MTC indicates that Rhode Island is the 25th state to join the MTC’s Online Marketplace Seller Voluntary Disclosure Initiative.  See the BDO SALT Alert for the other 24 states and a description of the MTC’s tax amnesty program.   
 
In addition, the MTC announced that the deadline for submitting an application to participate in the Voluntary Disclosure Initiative has been extended from October 17, 2017, to November 1, 2017.     
  BDO Insights
  • While these types of state tax amnesty programs present a great opportunity for a taxpayer to come into compliance with one or more states and taxes, without having to pay penalties and with reduced interest, most states also administratively provide voluntary disclosure agreement programs with limited look-back periods that should also be considered.  
  • In addition to establishing tax compliance and a waiver of penalties, state tax amnesty programs and voluntary disclosure agreements may allow a taxpayer to reduce accounting reserves.       
  • A number of states publish “top delinquent taxpayer lists” on their department of revenue websites.  For example, related Rhode Island legislation (S.B. 719, enacted and effective July 1, 2019) requires the Division of Taxation to publish a list of corporations and limited liability companies that have failed to pay corporate income taxes and filing fees.  Thus, tax amnesties and VDAs allow a taxpayer with a large tax delinquency to come into compliance and avoid having their reputation tarnished by appearing or continuing to appear on the list.
  • Taxpayers considering participating in state tax amnesty and VDA programs should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740, including the impact on current and deferred taxes, uncertain tax benefits, and disclosures, as well as with respect to sales/use and indirect taxes under ASC 450, including impact on reserves and accruals.
 
For more information, please contact one of the following practice leaders: 
  West:     Southeast: Rocky Cummings
Tax Partner
      Scott Smith
Tax Managing Director
  Paul McGovern
Tax Managing Director
      Tony Manners
Tax Managing Director
      Northeast:     Southwest: Janet Bernier
Tax Principal
      Tom Smith
Tax Partner
  Matthew Dyment
Tax Principal
      Gene Heatly
Tax Managing Director
      Central:     Atlantic: Nick Boegel
Tax Managing Director
      Jonathan Liss
Tax Managing Director
  Joe Carr
Tax Partner
      Jeremy Migliara
Tax Managing Director
  Mariano Sori
Tax Partner
      Angela Acosta
Tax Managing Director
  Richard Spengler
Tax Managing Director

The BDO 600

Tue, 10/24/2017 - 12:00am


How are director compensation practices of publicly traded companies different depending on company size and industry? This unique survey focuses specifically on mid-market companies and enables a year-over-year comparison of board of director pay.

Now in its eleventh year, the BDO 600 survey examines board compensation practices of 600 mid-market public companies and tracks trends in director compensation within eight different industry segments including: energy, financial services - banking, financial services - nonbanking, healthcare, manufacturing, real estate, retail, and technology.

Benchmark yourself against top industry peers and see what goes into a board director's average compensation mix, including: 
  • A breakdown of compensation by industry and company size
  • The proportions of compensation in equity versus cash
  • Trends to watch for FY 17

Overall results: 


Fill out the short form on this page to download the survey results.  
For questions, comments or suggestions, please contact: 
  Andy Gibson
404-979-7106
agibson@bdo.com Tom Ziemba
312-233-1888
tziemba@bdo.com

The Indian Tiffin XVI – 2017 from BDO India

Fri, 10/20/2017 - 12:00am
A bi-monthly publication from BDO India, "The Indian Tiffin" brings together business information, facilitating decision-making from a multi-dimensional perspective. The unique name of this thought leadership piece is inspired most literally by Indian tiffins, referring to home cooked lunches delivered to the working population by 'dabbawalas' – people who deliver the packed lunches (tiffins). In that same sense, the purpose of “The Indian Tiffin” newsletter is to deliver a variety of news to satiate your palate, from domestic and cross-border updates to India business perspectives.
 
This issue covers:
  • India Economic Update by Milind S.Kothari, Managing Partner, BDO India LLP: Fate of economic policies and reforms agenda is driven by political compulsion, especially, when elections are around the corner.
  • The M&A Tracker from Rajesh Thakkar, Partner/Transaction Tax, Tax & Regulatory Services.  Learn about 132 M&A deals that were completed between July 2017, and September 2017, with an aggregated value of approximately $794.56 million USD. Domestic deals dominated with 80 deals, followed by 52 cross border deals.
  • Featured Story by Shrikant Kamat, Partner/Indirect Tax: Mid-Term Review of the Foreign Trade Policy - It’s time for course correction.
  • Guest Column feature with Akshay Chudasama/Managing Partner Mumbai, and Veena Sivaramakrishnan/Partner, Shardul Amarchand Mangaldas: Dynamic Indian legal landscape
 
View The Indian Tiffin, Edition XVI here.

International Tax Alert - October 2017

Fri, 10/13/2017 - 12:00am
International Tax Proposals Included in the Tax Reform Framework Summary On September 27, 2017, the White House and congressional Republicans released their tax reform framework, the Unified Framework for Fixing our Broken Tax Code (the “Framework”). The nine-page document outlines their objectives for tax reform, which they hope will stimulate the economy and promote job growth. An overview of the international tax proposals included in the Framework are discussed below. 
  Details From a corporate income tax perspective, the Framework includes a number of proposals, including reducing the corporate tax rate to 20% and eliminating corporate AMT. From an international tax perspective, the Framework incorporates certain proposals that were seen previously in the GOP House Blueprint and the President’s “one-page” tax reform proposal.  For instance, the Framework proposes a shift from our current worldwide tax system to a territorial system.  In particular, the Framework proposes to “replace the existing, outdated worldwide tax system with a 100% exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake).”
 
In conjunction with moving to a territorial system, the Framework also includes a transition tax, which has been a common thread in moving to a territorial system.  Specifically, the Framework “treats foreign earnings that have accumulated overseas under the old system as repatriated. Accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents. Payment of the tax liability will be spread out over several years.” It is worth noting that the Framework did not provide specific rates for the two types of earnings (cash/cash equivalents and illiquid assets) or a specific number of years for payment of the tax liability the way the previously released GOP House Blueprint did. Specifically, the GOP House Blueprint provided that accumulated foreign earnings would be subject to tax at 8.75 percent to the extent held in cash or cash equivalents, and otherwise would be subject to tax at 3.5 percent (with companies able to pay the resulting tax liability over an eight-year period).
 
One item notably not included in the Framework was the border adjustment tax that previously was included in the GOP House Blueprint.  For a discussion of the prior proposal relating to border adjustment see our February Tax Alert. The fact that such proposal is not included in the Framework is not surprising, given that on July 27, 2017, the “Big Six” group of senior Republicans issued a joint statement specifically abandoning the proposed border adjustment tax that was included in the GOP House Blueprint. 
 
However, there was a global minimum tax type proposal included in the Framework that was not included in the GOP House Blueprint or the President’s one-page tax reform proposal.  This new proposal is designed to stop corporations from shipping jobs and capital overseas.  Specifically, the proposal states the following:
 
To prevent companies from shifting profits to tax havens, the framework includes rules to protect the U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations.[1]
Unfortunately, the Framework does not provide specific details relating to the new proposals or how such proposals will operate under the new system.  The details of such provisions will likely be provided when an actual bill is proposed reflecting the new tax reform framework.
Another item that was included in the Competitiveness and Growth for All Job Creators Section of the Framework that can impact cross border transactions and base erosion is the interest expense limitation proposal, whereby the deduction for net interest expense incurred by C corporations will be partially limited.[2] The Framework does not elaborate on what “partially limited” may mean.  Details likely will be provided when an actual bill is proposed reflecting the new tax reform framework.
  BDO Insights Given the emphasis placed by certain Congressional leaders and the White House on tax reform, U.S. multinational companies should be evaluating the potential tax impact of the proposals included in the Framework if such Framework moves forward.   BDO can assist U.S. multinational companies in reviewing how the proposals included in the Framework can impact them. Specifically, BDO can assist U.S. multinationals in planning for possible tax reform by helping them model the potential implications of certain proposals included in the Framework (such as the transition tax discussed above) by analyzing and reviewing certain tax attributes, such as earnings and profits, foreign tax pools, tax basis, and loss carryforwards.  
 
For more information, please contact one of the following practice leaders:
  Monika Loving
International Tax Services
Partner and National Practice Leader      Chip Morgan
Partner
International Tax Services   Joe Calianno
Partner and International Tax Technical Practice Leader
National Tax Office   Robert Pedersen
Partner
International Tax Services   Sean Dokko
Senior Manager
National Tax Office   William F. Roth III
Partner
National Tax Office   Annie Lee
Partner
International Tax Services   Jerry Seade
Principal
International Tax Services   Natallia Shapel
Partner
International Tax Services   [1] The Framework also stated that the committees will incorporate rules to level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies.
  [2] The Framework also notes that the appropriate treatment of interest paid by non-corporate taxpayers will also be considered.
 

International Tax Alert - October 2017

Fri, 10/13/2017 - 12:00am
Applicability Date for Section 987 Regulations Extended by One Year Summary In Notice 2017-57 (the “Notice”), the Department of the Treasury and the Internal Revenue Service (collectively, “Treasury), announced the intention to amend the regulations under IRC §987 to defer the applicability date of the final regulations under IRC §987, as well as certain provisions of the temporary regulations under IRC §987, by one year.    
  Details On January 9, 2017, Treasury published Treasury Decision 9794, which contains final regulations relating to the determination of the taxable income or loss of a taxpayer with respect to a qualified business unit (“QBU”) subject to IRC §987 (a “§987 QBU”); the timing, amount, character, and source of any §987 gain or loss; and other regulations (the “Final Regulations”). On the same date, Treasury also published Treasury Decision 9795, which contains temporary regulations under §987 (the “Temporary Regulations”). For a discussion of the Final and Temporary Regulations, see our December 2016 Tax Alert
 
The Final Regulations under §987 were identified in Notice 2017-38, as significant tax regulations requiring additional review pursuant to Executive Order 13789, a directive designed to reduce tax regulatory burdens. For a discussion of Notice 2017-38 see our July 2017 Tax Alert. As part of that review, the Notice states that Treasury is considering changes to the Final Regulations that would allow taxpayers to elect to apply alternative rules for transitioning to the Final Regulations and alternative rules for determining §987 gain or loss.
 
The Final and Temporary Regulations were effective on December 7, 2016. Treas. Reg. §1.987-11(a) provides that, except as otherwise provided in §1.987-11, §1.987-1 through 1.987-10 apply to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016 (i.e., 2018 for calendar year taxpayers). Corresponding provisions under §§ 861, 985, 988 and 989 also apply to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016.[1]
 
Similarly, Temp. Reg. §1.987-1T (other than Temp. Reg. §§ 1.987-1T(g)(2)(i)(B) and (g)(3)(i)(H)) through 1.987-4T, 1.987-6T, 1.987-7T, and 1.988-1T (the “Related Temporary Regulations”) apply to taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016.[2]  All other provisions in the Temporary Regulations, including the provisions relating to the deferral of section 987 gain or loss and the temporary section 988 regulations, are subject to different applicability dates.[3] 
 
A taxpayer may apply the Final Regulations and the Related Temporary Regulations to taxable years beginning after December 7, 2016 (i.e., 2017 for calendar year taxpayers), provided the taxpayer consistently applies those regulations to such taxable years with respect to all §987 QBUs directly or indirectly owned by the taxpayer on the transition date, as well as all §987 QBUs directly or indirectly owned on the transition date by members that file a consolidated return with the taxpayer or by any controlled foreign corporation, as defined in IRC §957, in which a member owns more than 50 percent of the voting power or stock value, as determined under IRC §958(a).[4] The transition date is the first day of the first taxable year to which the §§ 1.987-1 through 1.987-10 are applicable with respect to a taxpayer under § 1.987-11.[5]
 
In the Notice, Treasury stated their intention to amend §§ 1.861-9T, 1.985-5, 1.987-11, 1.987-1T through 1.987-4T, 1.987-6T, 1.987-7T, 1.988-1, 1.988-1T, 1.988-4, and 1.989(a)-1 to provide that the Final Regulations and the Related Temporary Regulations will apply to taxable years beginning on or after two years after the first date of the first taxable year following December 7, 2016. Thus, for a taxpayer whose first taxable year after December 7, 2016, begins on January 1, 2017, the Final Regulations and the Related Temporary Regulations will apply for the taxable year beginning on January 1, 2019.
 
A taxpayer may, however, elect under § 1.987-11(b) to apply the Final Regulations and the Related Temporary Regulations to taxable years beginning after December 7, 2016 (subject to the conditions in § 1.987-11(b)), including taxable years beginning on or after one year after the first day of the first taxable year following December 7, 2016 (the original applicability date in § 1.987-11(a)).
 
The intended amendments would not affect the applicability date of the Temporary Regulations other than the Related Temporary Regulations.
  BDO Insights The delay in the applicability date for the Final and Related Temporary Regulations provides taxpayers additional time to gather the required information to transition to such rules, if required. In addition, the delay provides Treasury additional time to consider changes to the Final and Related Temporary Regulations in response to comments received on the §987 regulations, including comments related to the transition rule in the Final Regulations and the method prescribed by the Final Regulations for calculating foreign currency gain or loss.  
 
For more information, please contact one of the following practice leaders:
  Monika Loving
International Tax Services
Partner and National Practice Leader      Chip Morgan
Partner
International Tax Services   Joe Calianno
Partner and International Tax Technical Practice Leader
National Tax Office   Robert Pedersen
Partner
International Tax Services   Sean Dokko
Senior Manager
National Tax Office   William F. Roth III
Partner
National Tax Office   Annie Lee
Partner
International Tax Services   Jerry Seade
Principal
International Tax Services   Natallia Shapel
Partner
International Tax Services   [1] See §§1.861-9T(g)(2)(vi); 1.985-5(g); 1.988-1(i);1.988-4(b)(2)(ii); 1.989(a)-1(b)(4); 1.989(a)-1(d)(4). [2] See §§ 1.987-1T(h); 1.987-2T(e); 1.987-3T(f); 1.987-4T(h); 1.987-6T(d); 1.987-7T(d); 1.988-1T(j). [3] See §§ 1.987-1T(h) (concerning §§ 1.987-1T(g)(2)(i)(B) and (g)(3)(i)(H)); 1.987-8T(g); 1.987-12T(j); 1.988-2T(j). [4] Sections 1.987-11(b); 1.987-1T(h); 1.987-2T(e); 1.987-3T(f); 1.987-4T(h); 1.987-6T(d); 1.987-7T(d). [5] Section 1.987-11(c).

Pending U.S. Tax Reform

Thu, 10/12/2017 - 12:00am
Download PDF Version 

Moving from a worldwide system of taxation to a territorial system of taxation requires the ability to understand and build a framework for the future state. Given the emphasis placed by certain Congressional leaders and the White House on tax reform, U.S. multinational companies should be evaluating the potential tax impact of the proposals which could include a one-time taxable event for accumulated overseas earnings in moving to a territorial system of taxation.  
  How Can BDO Help?  BDO can assist U.S. multinationals in planning for possible tax reform by helping them model the potential implications of certain proposals by analyzing and reviewing key tax attributes, such as earnings and profits, foreign tax pools, tax basis, and loss carryforwards.

In an attempt to break down the complexity of what U.S. international tax reform proposals mean to multinational organizations, BDO looks at five questions every Tax, Treasury, and Logistics executive should ask in light of the changing international tax landscape.   CURRENT STATE
Worldwide System of Taxation Data Management and Tax Attribute Modeling Strategic Planning Compliance and Reporting   POTENTIAL FUTURE STATE
Territorial System of Taxation
 
For more information, please contact one of the following practice leaders:
  Joe Calianno
Partner and International Tax Technical Practice Leader
National Tax Office       Monika Loving
Partner and International Tax Practice Leader
   

International Tax Alert - October 2017

Thu, 10/12/2017 - 12:00am
Department of the Treasury Releases Report Recommending Changes to Eight Tax Regulations Summary On October 2, 2017, the Secretary of the Department of Treasury (“Treasury”) issued a second report to President Trump on identifying and reducing tax regulatory burdens as directed by President Trump’s Executive Order 13789, a directive that instructed the Secretary of Treasury, to review “all significant regulations” issued on or after January 1, 2016, that (i) impose an undue financial burden on U.S. taxpayers, (ii) add undue complexity to Federal tax laws, or (iii) exceed the statutory authority of the Internal Revenue Service (“IRS”). Notice 2017-38 was published in July 2017 identifying eight regulations for review in response to Executive Order 13789. The Report states that Treasury continues to analyze all recently issued significant regulations and is considering possible reforms of several recent regulations not identified in Notice 2017-38 including regulations under Section 871(m), relating to payments treated as U.S. source dividends, and the Foreign Account Tax Compliance Act.
 
In addition, the Report states that Treasury and the IRS have initiated a comprehensive review, coordinated by the Treasury Regulatory Reform Task Force, of all tax regulations, regardless of when they were issued. This review will identify tax regulations that are unnecessary, create undue complexity, impose excessive burdens, or fail to provide clarity and useful guidance, and Treasury and the IRS will pursue reform or revocation of those regulations. As part of the process coordinated by the Treasury Regulatory Reform Task Force, the IRS Office of Chief Counsel has already identified over 200 regulations for potential revocation, most of which have been outstanding for many years. The Report states that Treasury and the IRS expect to begin the rulemaking process for revoking these regulations in the fourth quarter of 2017 and also seek to streamline rules where possible. Later reports and guidance will provide details on the regulations identified for possible action, the reasons that they may be revoked, and the manner in which revocation would occur.
 
Most importantly, the Report sets forth the Treasury Secretary’s recommendations on the eight regulations identified in Notice 2017-38. Treasury expects to issue additional reports on reducing tax regulatory burdens, including, as directed in the executive order, the status of Treasury’s actions recommended in the Report. An overview of the Report’s recommendations on three regulations that particularly impact international tax and cross border transactions are discussed below.
  Details
  1. Final and Temporary Regulations under Section 385 on the Treatment of Certain Interests in Corporations as Stock or Indebtedness[1]
These final and temporary regulations address the classification of related-party debt as debt or equity for U.S. Federal income tax purposes. The regulations are primarily comprised of (i) rules establishing minimum documentation requirements that ordinarily must be satisfied for purported debt obligations among related parties to be treated as debt for Federal tax purposes (the “Documentation Regulations”); and (ii) rules that treat as stock certain debt that is issued by a corporation to a controlling shareholder in a distribution or in another related-party transaction that achieves an economically similar result (the “Distribution Regulations”).[2] For a discussion of the final and temporary regulations under Section 385 see our October 2016 Tax Alert.
 
The Report states that Treasury and the IRS are considering a proposal to revoke the Documentation Regulations as issued and are actively considering the development of revised documentation rules that would be substantially simplified and streamlined in a manner that will lessen their burden on U.S. corporations, while requiring sufficient legal documentation and other information for tax administration purposes. In place of any revoked regulations, the Report states that Treasury and the IRS would develop and propose streamlined documentation rules, with a prospective effective date that would allow time for comments and compliance. Consideration is being given, in particular, to modifying significantly the requirement, contained in the Documentation Regulations, of a reasonable expectation of ability to pay indebtedness. The treatment of ordinary trade payables under the documentation regulations is also being reexamined. It is also expected that any proposed streamlined documentation rules would include certain technical, conforming changes to the definitional provisions of the Section 385 regulations.
 
The Distribution Regulations address inversions and takeovers of U.S. corporations by limiting the ability of corporations to generate additional interest deductions without new investment in the United States. Regarding the Distribution Regulations, the Report states that Treasury has consistently affirmed that legislative changes can most effectively address the distortions and base erosion caused by excessive earnings stripping, as well as the general tax incentives for U.S. companies to engage in inversions. In the view of Treasury, tax reform is expected to obviate the need for the Distribution Regulations and make it possible for these regulations to be revoked. Treasury believes that proposing to revoke the existing Distribution Regulations before the enactment of fundamental tax reform, could make existing problems worse. If legislation does not entirely eliminate the need for the Distribution Regulations, Treasury will reassess the Distribution Regulations and Treasury and the IRS may then propose more streamlined and targeted regulations.
 
  1. Final Regulations under Section 367 on the Treatment of Certain Transfers of Property to Foreign Corporations[3]
Section 367 of the Internal Revenue Code generally imposes immediate or future U.S. tax on transfers of property (tangible and intangible) to foreign corporations, subject to certain exceptions, including an exception for certain property transferred for use in the active conduct of a trade or business outside of the United States.  Final regulations under Section 367 eliminate the ability of taxpayers to transfer foreign goodwill and going concern value to a foreign corporation without immediate or future U.S. income tax. For a discussion of the final regulations under Section 367, see our December 2016 Tax Alert
 
The Report states that Treasury and the IRS have concluded that an exception to the current regulations may be justified by both the structure of the statute and its legislative history. Thus, to address taxpayers’ concerns about the breadth of the regulations, the Office of Tax Policy and IRS are actively working to develop a proposal that would expand the scope of the active trade or business exception described above to include relief for outbound transfers of foreign goodwill and going-concern value attributable to a foreign branch under circumstances with limited potential for abuse and administrative difficulties, including those involving valuation. The Report further states that Treasury and the IRS currently expect to propose regulations providing such an exception in the near term.
 
  1. Final Regulations under Section 987 on Income and Currency Gain or Loss with Respect to a Section 987 Qualified Business Unit[4]
These final regulations provide rules for: (i) translating income from branch operations conducted in a currency different from the branch owner’s functional currency into the owner’s functional currency; (ii) calculating foreign currency gain or loss with respect to the branch’s financial assets and liabilities; and (iii) recognizing such foreign currency gain or loss when the branch makes certain transfers of any property to its owner. Commenters argued that the transition rule in the final regulations imposes an undue financial burden because it disregards losses calculated for years prior to the transition but not previously recognized. Many taxpayers have also commented that the method prescribed by the final regulations for calculating foreign currency gain or loss is unduly complex and financially burdensome to apply, particularly where the final regulations differ from financial accounting rules. For a discussion of the final and temporary regulations under Section 987, see our December 2016 Tax Alert.
 
To address these difficulties, Treasury and the IRS published Notice 2017-57 that announced the intention to amend the regulations under Section 987 to defer the applicability date of the final regulations under Section 987, as well as certain provisions of the temporary regulations under Section 987 to taxable years beginning on or after two years after the first date of the first taxable year following December 7, 2016 (i.e., 2019 for calendar year taxpayers).
 
The Report states that Treasury and the IRS also intend to propose modifications to the final regulations to permit taxpayers to elect to adopt a simplified method of calculating Section 987 gain and loss and translating Section 987 income and loss, subject to certain limitations on the timing of recognition of Section 987 loss. Under one variation of a simplified methodology currently being considered, taxpayers would treat all assets and liabilities of a Section 987 qualified business unit (“QBU”) as marked items and translate all items of income and expense at the average exchange rate for the year. This methodology generally would result in determinations of amounts of Section 987 gain or loss that are consistent with amounts of translation gain or loss that would be determined under applicable financial accounting rules, as well as under the 1991 proposed Section 987 regulations.
 
The Report also provides that the IRS and the Office of Tax Policy are considering alternative loss recognition timing limitations that would apply to electing taxpayers. Under the base limitation under consideration, the electing taxpayer would be permitted to recognize net Section 987 losses only to the extent of net Section 987 gains recognized in prior or subsequent years. As a possible additional approach to limiting losses, the IRS and the Office of Tax Policy are also considering the administrability of a limitation under which the electing taxpayer would defer recognition of all Section 987 losses and gains until the earlier of (i) the year that the trade or business conducted by the Section 987 QBU ceases to be performed by any member of its controlled group or (ii) the year substantially all of the assets and activities of the QBU are transferred outside of the controlled group.
 
Finally, the Report states that the IRS and the Office of Tax Policy are considering alternatives to the transition rules in the final regulations. One alternative would be to allow taxpayers that elect to apply the loss limitations applicable to the simplified methodology discussed above to carry forward unrealized Section 987 gains and losses, measured as of the transition date with appropriate adjustments, and subject to such loss limitations. A second alternative under consideration would be to allow taxpayers adopting the final regulations to elect to translate all items on the QBU’s opening balance sheet on the transition date at the spot exchange rate, but not carry forward any unrealized Section 987 gains or losses.
  BDO Insights The Report’s recommendations on the three sets of regulations discussed above when effectuated should provide relief for taxpayers and alleviate certain compliance burdens that would otherwise apply. In particular, the Report’s recommendation on the Section 987 regulations could reduce complexity and simplify how the Section 987 regulations are applied. BDO can assist in reviewing how the Report’s recommendations can impact our clients.
 
For more information, please contact one of the following practice leaders:
  Monika Loving
International Tax Services
Partner and National Practice Leader      Chip Morgan
Partner
International Tax Services   Joe Calianno
Partner and International Tax Technical Practice Leader
National Tax Office   Robert Pedersen
Partner
International Tax Services   Sean Dokko
Senior Manager
National Tax Office   William F. Roth III
Partner
National Tax Office   Annie Lee
Partner
International Tax Services   Jerry Seade
Principal
International Tax Services   Natallia Shapel
Partner
International Tax Services      [1] T.D. 9790; 81 F.R. 72858. [2] In Notice 2017-36, Treasury and the IRS announced a delay in the application of the documentation requirements in the Section 385 regulations by 12 months to interests issued or deemed issued on or after January 1, 2019. [3] T.D. 9803; 81 F.R. 91012. [4] T.D. 9794; 81 F.R. 88806.

International Tax Alert - October 2017

Fri, 10/06/2017 - 12:00am
U.S. District Court holds that an Anti-Inversion Regulation was Unlawfully Issued Summary On September 29, 2017, the District Court for the Western District of Texas Austin Division granted the Plaintiff’s motion for summary judgment in Chamber of Commerce of the United States of America and Texas Association of Business v. Internal Revenue Service, United States Department of the Treasury, John A. Koskinen and Jacob J. Lew, to set aside the “Multiple Domestic Entity Acquisition Rule” in Temp. Reg. §1.7874-8T.
  Details In April 2016, the Department of the Treasury and Internal Revenue Service (collectively, “Treasury”), issued the “Multiple Domestic Entity Acquisition Rule,” identifying stock of foreign acquiring corporations that is to be disregarded in determining an ownership fraction relevant to the categorization of a corporation as domestic or foreign for federal tax purposes because the stock is attributable to prior domestic entity acquisitions (the “Rule”). The Rule was simultaneously issued as a temporary regulation effective immediately and as a proposed regulation subject to notice and comment.[1] Shortly after, and as a result of, the issuance of the Rule, Allergan plc and Pfizer Inc. walked away from their proposed $160 billion merger.
 
In August 2016, the Chamber of Commerce of the United States of America and the Texas Association of Business (the “Plaintiffs”) filed a lawsuit asserting that Treasury violated the Administrative Procedures Act (“APA”) by promulgating the Rule. While Pfizer Inc. and Allergan plc are not parties to the lawsuit, Pfizer Inc. is a member of the Chamber of Commerce of the United States of America and the Texas Association of Business and Allergan plc is a member of the Chamber of Commerce of the United States of America and the Greater Waco Chamber of Commerce which is a member of the Texas Association of Business. In the complaint, the Plaintiffs alleged that the issuance of the Rule (1) exceeded Treasury’s statutory jurisdiction, (2) was arbitrary and capricious rulemaking and (3) was in violation of the APA by failing to provide notice and an opportunity for comment. Accordingly, the Plaintiffs requested that the Court set aside the Rule.
 
The defendants in the case filed a motion to dismiss claiming that the Plaintiffs did not have standing and that the Anti-Injunction Act barred the Plaintiff’s suit. The Anti-Injunction Act provides that with 14 specified exceptions, “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court by any person, whether or not such person is the person against whom such tax was assessed.”[2]
 
Ultimately, the District Court held that the Plaintiffs had standing to sue as certain members (i.e., Allergen plc and Pfizer Inc.) would have standing to sue in their own right, and the Plaintiffs alleged an actual, concrete injury, that is fairly traceable to implementation of the Rule, and that would be redressed by a decision setting aside that Rule. The District Court also held that the Plaintiffs were not barred by the Anti-Injunction Act, stating that although the Rule may improve the government’s ability to assess and collect taxes, enforcement of the Rule does not involve the assessment or collection of a tax.
 
In addition, the District Court held that the Rule did not exceed the statutory jurisdiction of Treasury based on the broad authority granted by Congress in the statute and that Treasury did not engage in arbitrary and capricious rulemaking in issuing the Rule. The Court, however, held that the Rule was unlawfully issued stating that the Rule is a substantive or legislative regulation, not an interpretive regulation, and Treasury was therefore not excused from the notice-and-comment procedure required by the APA.  Accordingly, the District Court granted summary judgment in favor of the Plaintiffs to set aside the Rule.
  BDO Insights It is unclear at this stage whether Treasury will appeal the District Court’s ruling or what additional action will be taken by Treasury relating to the Rule. The holding, if upheld, could have implications to other substantive or legislative Treasury Regulations that are viewed instead by Treasury as interpretive Treasury Regulations.
 
For more information, please contact one of the following practice leaders:
  Joe Calianno
Partner and International Tax Technical Practice Leader
National Tax Office       Monika Loving
International Tax Practice Leader   Natallia Shapel
Partner    Annie Lee
Partner   Chip Morgan
Partner   Robert Pedersen
Partner   William F. Roth III
Partner
National Tax Office   Jerry Seade
Principal   Sean Dokko
Senior Manager
National Tax Office   [1] Temp. Reg. §1.7874-8T(j) and Prop. Reg. §1.7874-8. [2] IRC §7421(a).

Changing International Tax Landscape

Wed, 10/04/2017 - 12:00am


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Finance executives of U.S. multinational organizations (“MNEs”) should review how the interplay of the following initiatives can impact them: (i) Pending U.S. tax reform’s international proposals; (ii) the OECD’s BEPS initiative; and (iii) Brexit.
  1. How does the interplay of these three initiatives impact: 
  • Tax profile
  • Treasury options
  • Supply chain
  • Corporate structure
  2. What areas should be vetted? 
  • Identify tax efficient repatriation options.
  • Maximize foreign tax credits and after tax cash balances.
  • Navigate the potential “one-time tax” on foreign earnings under certain U.S. tax reform proposals.
  • Rework EU structures to mitigate IP, finance and supply chain challenges, as well as potential local exit and withholding taxes.
  • Evaluate overall impact on tax and financial disclosures.
  3. What tax attributes should be reviewed? 
  • Locate sources and calculate earnings and profits (“E&P”).
  • Calculate foreign tax pools.
  • Analyze foreign subsidiary share basis and fair market value.
  4. What are the key areas of planning considerations?
  • Holding company structures
  • Intellectual property situs
  • Tax attribute utilization
  • Supply chain modification
  5. Next steps? 
  • ​Review common denominators to evaluate alternatives (i.e., assess inventory of cash, including “trapped” cash; firm up E&P and associated foreign tax pools; analyze share and asset tax basis).
  • Reduce or harvest tax attributes as appropriate.
  • Model practical options for repatriation of foreign earnings.
  • Identify practical changes to the supply chain that balance the U.S. tax reform proposal’s potential territorial system implementation against the BEPS/EU/Brexit framework.
  • Consider approaches to income tax filings and transfer pricing.
 
For more information, please contact one of the following practice leaders:
  Joe Calianno
Partner and International Tax Technical Practice Leader
National Tax Office       Monika Loving
Partner and International Tax Practice Leader
   

R&D Tax Alert - October 2017

Mon, 10/02/2017 - 12:00am
IRS Issues Guidance for Section 41 Research Credit Expenses for LB&I Taxpayers Summary The IRS released a Directive dated September 11, 2017 (LB&I-04-0917-005), that provides guidance to Large Business & International (LB&I) Division examiners concerning Internal Revenue Code Section 41 credit for increasing research activities (Research Credit) examinations. The Research Credit is based, in part, on qualified research expenses (QREs) paid or incurred by a taxpayer, and the Directive allows LB&I taxpayers to apply a “safe harbor” where an adjusted amount of their GAAP ASC 730 research and development (R&D) expenses can determine a certain portion of QREs that will not be challenged if the requirements of the Directive are followed.
  Details The stated purpose of the Directive is to provide an efficient approach for determining the amount of QREs for taxpayers while also reducing the burden of doing so on examiners.

The Directive only applies to LB&I taxpayers – those with assets equal to or greater than $10 million – that follow U.S. GAAP to prepare certified audited financial statements and report ASC 730 R&D costs on their financial statements, either as a line item or in a separately stated note. The guidance outlines a safe harbor approach taxpayers can follow to determine certain QREs in the credit year that will not be challenged by the IRS.

The QREs not to be challenged are the adjusted ASC 730 R&D costs reported on the taxpayer’s certified audited financial statements as described in detail in the Directive and include adjustments related to:
  • Foreign entities;
  • Schedule M-3 amounts;
  • GL Accounts or items specifically excluded from Section 174 (i.e. management studies and advertising);
  • GL Accounts such as travel, overhead, and other expenses not eligible as QREs under Section 41;
  • Costs incurred under contracts/agreements to perform research;
  • Contract research expenses;
  • Cost for R&D performed outside the U.S.;
  • Prototype overhead expenses, patent costs, and severance pay;
  • Certain stock-based compensation; and
  • Certain wage amounts for Qualified Individual Contributors, 1st Level Supervisor Managers, and Upper Level Managers.
Any additional amounts of QREs over the adjusted ASC 730 R&D costs claimed by the taxpayer are subject to risk assessment to determine the scope, if any, of an examination.

Eligible expenses included in the safe harbor
The Directive identifies the ASC 730 R&D expenses that may be eligible under the safe harbor, and claimed as QREs for the Research Credit, including:
  • Certain employees whose wage costs are charged to ASC 730 Financial Statement Cost Centers, including (a) 95% of Qualified Individual Contributors – employees who do not manage any other employees and (b) 1st Level Supervisor Managers – managers that directly manage only Qualified Individual Contributors;
  • The lesser of 10% of the sum of (a) and (b) above or 100% of the taxable wages for Upper Level Managers – managers that directly supervise any employee other than Qualified Individual Contributors, which are charged to ASC 730 Financial Statement Cost Centers. If a taxpayer wants to claim more than this limit, then 100% of these costs is considered $0, and any amount claimed for Upper Level Managers would be subject to risk analysis and examination;
  • Amounts paid or incurred for supplies used in the conduct of qualified research; and
  • Amounts paid to another party for the right to use computers during the conduct of qualified research.
Contract research expenses paid to another party other than an employee of the taxpayer for the performance of qualified research on behalf of the taxpayer are not eligible for inclusion as QREs under the safe harbor.

The taxpayer must sign the certification statement, under penalties of perjury, included in the Directive and agree to retain and make available documentation (the underlying books and records) that support the amounts claimed. If the certification statement and appendices provided in the Directive are not attached to the taxpayer’s tax return, the audit team will request these at the beginning of an examination if they determine the taxpayer followed this Directive.
  Effective Date The terms of the Directive can be followed on timely filed original returns, including extensions, on or after the date of the Directive.
  BDO Insights LB&I taxpayers should:
  • Assess whether this approach would be beneficial compared to their current approach of determining QREs;
  • Consider whether they can efficiently comply to the Directive with their current operations, processes, and resources and if not, whether they should invest the resources to do so; and
  • Review their documentation to ensure its availability upon request.
 
For more information, please contact one of the following regional practice leaders: 
  Chris Bard
National Leader
Los Angeles
    Jonathan Forman
Principal
New York
    Jim Feeser
Managing Director
Woodbridge
    Chad Paul
Managing Director
Milwaukee
    Patrick Wallace
Managing Director
Atlanta
    David Wong
Partner
Los Angeles
    Laura Morris
Managing Director
San Francisco
    Brad Poris
Managing Director
Long Island
    Joe Furey
Managing Director
Chicago
    Sanjiv Gaitonde
Senior Manager
Houston
      Gabe Rubio
Managing Director
Los Angeles    

International Tax Alert - September 2017

Wed, 09/27/2017 - 12:00am
Proposed Regulations Provide Guidance on the Definitions of Registration-Required Obligation and Registered Form
Summary On September 19, 2017, the Department of the Treasury and the Internal Revenue Service (collectively, “Treasury”), published in the Federal Register proposed regulations (the “Proposed Regulations”) that provide guidance on the definitions of registration-required obligation and registered form, including guidance on the issuance of pass-through certificates and participation interests in registered form. The Proposed Regulations also withdraw a portion of previously proposed regulations regarding the definition of a registration-required obligation. The preamble to the Proposed Regulations (the “Preamble”) states that the Proposed Regulations are necessary to address changes in market practices as well as issues raised by the statutory repeal of the foreign-targeted bearer obligation exception to the registered form requirement. 
  Details The classification of an obligation as in bearer or registered form has significant tax implications because a number of Code provisions impose sanctions on issuers and holders of registration-required obligations that are not issued in registered form. For example, issuers of a registration-required obligation that is not in registered form may be denied an interest deduction under IRC §163(f) or may be subject to an excise tax under IRC §4701. Also, IRC §149(a) provides that interest on a registration-required bond is not exempt from tax under IRC §103(a) unless the bond is in registered form. In addition, IRC §§ 871(h) and 881(c) exempt from federal income tax U.S.-source portfolio interest received by a foreign person (the “portfolio interest exception”) only if the obligation with respect to which the interest was paid is in registered form. Similar restrictions are found in IRC §§ 165(j) (generally denying the holder a deduction for a loss sustained on a registration-required obligation not in registered form), 312(m) (generally providing that the issuer’s earnings and profits cannot be decreased by interest paid on a registration-required obligation not in registered form), and 1287 (generally treating the holder’s gain on sale of a registration-required obligation not in registered form as ordinary income).
 
Historically, the Code provisions referenced above generally did not apply to obligations that complied with the foreign-targeting rules of prior IRC §163(f)(2)(B) and §1.163-5(c) (“foreign-targeted bearer obligations”). Under these rules, an issuer could issue foreign-targeted bearer obligations without penalty, provided the obligations were issued under arrangements reasonably designed to ensure that the obligations were sold only to non-U.S. persons. The portfolio interest exception also applies to interest paid on foreign-targeted bearer obligations issued under such reasonable designed arrangements.
 
The Hiring Incentives to Restore Employment Act (the “HIRE Act”), P.L. 111-147, 124 Stat. 71, §502, repealed IRC §163(f)(2)(B) and generally eliminated the special treatment of foreign-targeted bearer obligations. Foreign-targeted bearer obligations issued after March 18, 2012, are subject to the sanctions on bearer form obligations under IRC §§ 149(a), 163(f), 165(j), 312(m), and 1287. The Hire Act also revoked the portfolio interest exception for foreign-targeted bearer obligations, thus requiring that obligations issued after March 18, 2012, be in registered form to qualify for that exception. The HIRE Act did not, however, repeal the foreign-targeted bearer obligation exception to the excise tax under IRC §4701.[1]
 
On March 26, 2012, Treasury issued Notice 2012-20 (the “Notice”) to provide additional guidance on the definition of registered form. Under the Notice, an obligation is considered to be in registered form if it is issued either through a dematerialized book entry system in which beneficial interests are transferable only through a book entry system maintained by a clearing organization (or by an agent of the clearing organization) or through a clearing system in which the obligation is effectively immobilized. In addition, the Notice states that, for purposes of determining when an obligation is a registration-required obligation under IRC §4701, rules identical to the foreign-targeting rules under IRC §163(f)(2)(B), prior to its amendment by the HIRE Act, and §1.163-5(c) will apply to obligations issued after March 18, 2012.
 
Consistent with the Notice, the Proposed Regulations amend the definition of registered form to take into account current market practices and changes made by the Hire Act, including the repeal of the foreign-targeting rules in IRC §163(f)(2)(B). First, the Proposed Regulations provide that an obligation is considered to be in registered form if it is transferable through a book entry system, including a dematerialized book entry system, maintained by the issuer of the obligation, an agent of the issuer, or a clearing organization. Second, the Proposed Regulations provide that an obligation represented by a physical certificate in bearer form will be considered to be in registered form if the physical certificate is effectively immobilized. Third, the proposed regulations permit holders of obligations (or interests in obligations) to have a right to obtain physical certificates evidencing the obligation (or interests in the obligation) in bearer form without causing the obligation to be treated as not in registered form in two circumstances: (1) a termination of the clearing organization's business without a successor; or (2) the issuance of physical securities at the issuer's request upon a change in tax law that would be adverse to the issuer but for the issuance of physical securities in bearer form.
 
In addition, the Proposed Regulations amend the definition of a registration-required obligation in two ways. First, the Proposed Regulations specify the types of obligations that are treated as “of a type offered to the public” and withdraw the 1993 proposed regulations. Second, the Proposed Regulations take into account comments requesting clarification on the types of arrangements that qualify as pass-through certificates (e.g., a certificate issued by an investment entity that holds a pool of obligations, such as mortgage loans where each pass-through certificate represents an interest in the investment entity).
 
To the extent possible, the Proposed Regulations simplify the definitions of registered from and registration-required obligation by centralizing the rules in §1.163-5.
 
For a complete discussion of these rules along with other rules in the Proposed Regulations, see the Preamble and the Proposed Regulations.

The Notice stated that regulations incorporating the guidance described in the Notice will be effective for obligations issued after March 18, 2012. Accordingly, the Proposed Regulations will generally apply to obligations issued after March 18, 2012. However, taxpayers may apply the rules in section 3 of the Notice, including the default exception, for obligations issued prior to publication of a Treasury decision adopting these rules as final regulations in the Federal Register. The rules related to pass-through certificates, participation interests and regular interests in REMICs and the rules related to obligations not of a type offered to the public are not described in the Notice and, therefore, will apply only to obligations issued after the publication of a Treasury decision adopting these rules as final regulations in the Federal Register, except as otherwise provided in the next sentence. The existing regulations under §5f.103-1 will continue to apply to tax exempt bonds issued prior to the date 90 days after publication of a Treasury decision adopting these rules as final regulations in the Federal Register.
  BDO Insights As mentioned above, various Code sections may impose negative tax implications to issuers of a registration-required obligation that is not in registered form. BDO can assist issuers and holders of obligations in registered form as well as issuers and holders of registration-required obligations to navigate and understand these complex rules related to registered form and registration-required obligations.
 
For more information, please contact one of the following practice leaders:
  Joe Calianno
Partner and International Tax Technical Practice Leader
National Tax Office       Monika Loving
International Tax Practice Leader   Natallia Shapel
Partner    Annie Lee
Partner   Chip Morgan
Partner   Robert Pedersen
Partner   William F. Roth III
Partner
National Tax Office   Jerry Seade
Principal   Sean Dokko
Senior Manager
National Tax Office
    Scott Hendon
Partner
[1] See IRC §4701(b)(1)(B)(i). 

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