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Federal Tax Alert - November 2016

Tue, 11/22/2016 - 12:00am
Special Report Tax Briefing: Post-Election Tax Policy Update
Donald Trump's election as the 45th President of the United States on November 8 is expected to bring changes to the tax laws for individuals and businesses. President-elect Trump had made tax reduction a centerpiece of his economic plans during his campaign, saying he would, among other things, propose lower and consolidated individual income tax rates, expand tax breaks for families, and repeal the Affordable Care Act. As the next few weeks and months unfold, taxpayers will learn more about Trump's tax plans.
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International Tax Newsletter - November 2016

Mon, 11/21/2016 - 12:00am
The Indian Tiffin XI - from BDO India
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 homecooked 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:
 
  • The drivers of economic and social development attracting global co-operation for a pro-business, pro-growth agenda in the India Economic Update from the desk of the Managing Partner
  • The deals ticker from across the border, in the M&A Tracker
  • Hear about why a post-Brexit Britain remains one of the best places in the world in which to grow a global business with pronounced focus on exploring international synergies, from the Head of BREXIT Taskforce in the UK, in our Featured Story
  • At a time when businesses look at entering international markets as one of their strategic growth priorities, we invite our Guest Column from an avid advisor and speaker on Managing Cultural Change 

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Compensation & Benefits Alert - November 2016

Fri, 11/18/2016 - 12:00am
IRS Releases Updated Cost of Living Adjustments for the 2017 Plan Year Download PDF Version
Summary On October 27, 2016, the Internal Revenue Service (“IRS”) announced cost-of-living adjustments affecting dollar limitations for pension plans and other retirement-related items for the 2017 tax year. The table below summarizes the updated IRS limits on benefits and compensation, the updated limits on certain welfare plans, and the updated taxable wage base for the FICA Social Security tax. The IRS issued technical guidance detailing these items in Notice 2016-62, Rev. Proc. 2016-55 and Rev. Proc. 2016-28.  
  Retirement Plan Updated Limits   2017 2016 2015 2014 2013 Maximum Elective Deferral 402(g)(1) for 401(k)/403b/457 Plans $18,000 $18,000 $18,000 $17,500 $17,500 Catch-up Contributions 414(v)(2)(B)(i) for 401(k)/403b/457 Plans $6,000 $6,000 $6,000 $5,500 $5,500 Defined Contribution Plan
Annual Additions Limit 415(c)(1)(A) $54,000 $53,000 $53,000 $52,000 $51,000 Defined Benefit Plan
Annual Benefit Limit 415(b)(1)(A) $215,000 $210,000 $210,000 $210,000 $205,000 Qualified Plan
Compensation Limit 401(a)(17)/404(l) $270,000 $265,000 $265,000 $260,000 $255,000 Highly Compensated Employees Compensation Test 414(q)(1)(B) $120,000 $120,000 $120,000 $115,000 $115,000 Top Heavy Key EE Definition
Officer Test 416(i)(1)(A)(i) $175,000 $170,000 $170,000 $170,000 $165,000 SIMPLE Plan
Maximum Contributions 408(p)(2)(E) $12,500 $12,500 $12,500 $12,000 $12,000 SIMPLE Plan Catch-up Contributions 414(v)(2)(B)(ii) $3,000 $3,000 $3,000 $2,500 $2,500 SEP Maximum Contribution 408(j) $54,000 $53,000 $53,000 $52,000 $51,000 SEP Minimum Compensation 408(k)(2)(C) $600 $600 $600 $550 $550 SEP Maximum Compensation 408(k)(3)(C) $270,000 $265,000 $265,000 $260,000 $255,000 IRA Contribution Limit 219(b)(5)(A) $5,500 $5,500 $5,500 $5,500 $5,500 IRA Catch-up Contributions 219(b)(5)(B) $1,000 $1,000 $1,000 $1,000 $1,000 ESOP Limits 409(o)(1)(C)(ii) Five Year Distribution Threshold $1,080,000 $1,070,000 $1,070,000 $1,050,000 $1,035,000 ESOP Limits 409(o)(1)(C)(ii) Additional Year Threshold $215,000 $210,000 $210,000 $210,000 $205,000 Control Employee (board member or officer) 1.61-21(f)(5)(i) $105,000 $105,000 $105,000 $105,000 $100,000 Control Employee (compensation-based) 1.61-21(f)(5)(iii) $215,000 $215,000 $215,000 $210,000 $205,000   Welfare Plan Updated Limits   2017 2016 2015 2014 2013 Flexible Spending Arrangement 125(i) $2,600 $2,550 $2,550 $2,500 $2,500 Health Savings Account 223(b)(2)(A) $3,400 $3,350 $3,350 $3,300 $3,250 Adoption Assistance Credit 137(a)(2) $13,570 $13,400 $13,400 $13,190 $12,970    FICA Social Security Tax Updated Limit   2017 2016 2015 2014 2013 Social Security Taxable Wage Base $127,200 $118,500 $118,500 $117,000 $113,700 Social Security Insurance Rates 6.20% 6.20% 6.20% 6.20% 6.20% Medicare Insurance Rates 1.45% 1.45% 1.45% 1.45% 1.45% Additional Medicare Insurance Tax Rates for wages, compensation or self-employment income in excess of $250,000/$125,000/$200,000 depending on filing status 0.90% 0.90% 0.90% 0.90% 0.90%  
For more information please contact one of the following practice leaders: 
  Joan Vines
Managing Director, National Tax Office
Compensation & Benefits 
  Penny Wagnon
STS GES Managing Director,
Compensation & Benefits    Carl Toppin
STS GES Senior Manager,
Compensation & Benefits    Ellyn Bess
STS GES Partner,
Compensation & Benefits   Kim Flett
Managing Director, Tax
Compensation & Benefits
   

State and Local Tax Alert - November 2016

Wed, 11/16/2016 - 12:00am
California Franchise Tax Board Issues Guidance on Processing of Cases Raising the Multistate Tax Commission Compact Election Issue
Summary On November 1, 2016, the California Franchise Tax Board (“FTB”) issued FTB Notice 2016-03, which provides the FTB’s intended courses of action on Multistate Tax Commission (“MTC”) Compact election cases following the U.S. Supreme Court’s denial of the taxpayers’ petition for a writ of certiorari in The Gillette Company v. California Franchise Tax Board, No. 15-1442.  The FTB will resume processing MTC Compact refund claims, protests and appeals, and audits in the normal course of business.  In addition, the FTB advises taxpayers that they should make tax deposits or pay proposed deficiency assessments in order to stop the accrual of interest, and penalties will be imposed on a case-by-case basis.
  Details Gillette Background
On December 31, 2015, the Supreme Court of California decided Gillette Co. et al. v. Franchise Tax Board, Docket No. S2016587 (Cal. Dec. 31, 2015) in which the court held that the state is not bound to allow the use of the MTC Compact election to use an evenly-weighted, three-factor apportionment formula, rather than the double-weighted sales factor formula mandated under Cal. Rev. & Tax. Code § 25128 for taxable years prior to 2013.  See the BDO SALT Alert that discusses this case.  The taxpayers in Gillette filed a petition for a writ of certiorari from the U.S. Supreme Court, but on October 11, 2016, the U.S. Supreme Court denied the taxpayers’ petition.
 
FTB Actions on MTC Compact Election Cases
The FTB will take the following actions in cases where taxpayers attempted to make an election based on the MTC Compact:
 
Claims for Refund – The FTB will process claims for refund based on the MTC Compact election issue in the normal course of business.  The Notice states that taxpayers may expect to receive formal notices of denial in response to their claims over the next several months.
 
Administrative Protests and Appeals – The FTB will place administrative protests that include the MTC Compact election issue into active status and resume working on such cases in the normal course of business.  The FTB will also work with the State Board of Equalization to return administrative appeals involving the MTC Compact election issue to active status.
 
Audits – The FTB will process audits involving the MTC Compact election issue in the normal course of business.  The Notice states that taxpayers should consult with the auditors assigned to such cases in order to determine the timeline in each case.
 
Interest and Penalties - The Notice states that taxpayers may make tax deposits pursuant to Cal. Rev. & Tax. Code § 19041.5, or may pay proposed deficiency assessments in order to stop the accrual of interest on deficiency assessments.  In addition, penalties will be imposed as appropriate on a case-by-case basis.
  BDO Insights
  • Although the decision in the Gillette case stands, it is only one of a number of MTC Compact cases that are currently pending, including two on petitions for writs of certiorari before the U.S. Supreme Court.  On October 20, 2016, Kimberly-Clark filed a petition for a writ of certiorari challenging the decision in favor of the state from the Minnesota Supreme Court.  Kimberly-Clark Corp. v. Minnesota Commissioner of Revenue, No. 16-565.  The taxpayers involved in Gillette Commercial Operations, Inc. v. Dept. of Treasury, No. 325258 (Mich. Ct. App. Sept. 29, 2015) have until November 21, 2016, to file a petition for a writ of certiorari with the U.S. Supreme Court regarding Michigan’s retroactive repeal of the MTC Compact.  Sonoco Products Co. v. Michigan Department of Treasury, No. 16A250.  In addition, cases from Oregon and Texas related to the MTC Compact are still moving through the courts in those states.  The MTC Compact election question is still unsettled in many states, and taxpayers should monitor these cases as they proceed.
  • Taxpayers affected by FTB Notice 2016-03 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.
   

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

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






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

China Tax Newsletter - November 2016

Tue, 11/15/2016 - 12:00am
The November 2016 edition of BDO China's China Tax Newsletter features recent tax-related news and developments in China, including the following topics: 
 
  • Notice on Tax Policies Relating to Administrative Settlement Amounts
  • Announcement on Issues Relating to Urban Land Use Tax
  • Announcement on Improving the Administration of Advance Pricing Arrangements
  Download

International Tax Alert - November 2016

Tue, 11/15/2016 - 12:00am
The Service and Treasury Finalize Regulations under Section 956 Involving Partnerships  Summary On November 3, 2016, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“Service”) published final regulations (TD 9792) that provide rules regarding the treatment as U.S. property of property held by a controlled foreign corporation (“CFC”) in connection with certain transactions involving partnerships. In addition, the final regulations provide rules for determining whether a CFC is considered to derive rents and royalties in the active conduct of a trade or business for purposes of determining Subpart F income, as well as rules for determining whether a CFC holds U.S. property as a result of certain related party factoring transactions.
Details Certain key items detailed in the preamble to the final regulations (the “preamble”) and certain changes made by the final regulations to the Section 956 proposed regulations published in 2015 and in 1988 are discussed below.
 
  1. Partnership Property Indirectly Held by a CFC Partner
Proposed §1.956-4(b)(1) provided that a CFC partner in a partnership is treated as holding its attributable share of property held by the partnership and for purposes of Section 956, a partner’s adjusted basis in the property of the partnership equals the partner’s attributable share of the partnership’s adjusted basis in the property.
 
  1. Revenue Ruling 90-112’s Outside Basis Limitation
Treasury and the Service published Revenue Ruling 90-112 on December 31, 1990, that held that a CFC that is a partner in a partnership is treated as indirectly holding property held by the partnership when the property would be U.S. property if the CFC held it directly. However, the revenue ruling included a limitation providing that the amount of U.S. property taken into account for purposes of Section 956 when a CFC partner indirectly owns property through a partnership is limited by the CFC’s adjusted basis in the partnership.
 
The preamble notes that Treasury and the Service have determined that an outside basis limitation should not be incorporated into the rule in proposed §1.956-4(b)(1). Revenue Ruling 90-112 is obsoleted.
 
  1. Consistent Use of Liquidation Value Percentage Method
In contrast to the rule provided in proposed §1.956-4(b) providing that a CFC partner’s attributable share of partnership property is determined in accordance with the CFC partner’s liquidation value percentage, proposed §1.956-4(c) provided that a partner’s share of a partnership obligation is determined in accordance with the partner’s interest in partnership profits. The final regulations retain the liquidation value percentage method set forth in proposed §1.956-4(b), and revise the general rule in proposed §1.956-4(c) to implement the liquidation value percentage method.
 
  1. Time for Determining the Liquidation Value Percentage
Proposed §1.956-4(b)(2)(i) provided that the liquidation value percentage of partners in a partnership should be determined upon the occurrence of events described in §1.704-1(b)(2)(iv)(f)(5) or §1.704-1(b)(2)(iv)(s)(1) (“revaluation events”). In light that partners’ relative economic interests in the partnership may change significantly as a result of allocations of income or other items under the partnership agreement even in the absence of a revaluation event, §1.956-4(b)(2)(i) of the final regulations provides that a partner’s liquidation value percentage must be re-determined in certain additional circumstances. Specifically, if the liquidation value percentage determined for any partner on the first day of the partnership’s taxable year would differ from the most recently determined liquidation value percentage of that partner by more than 10 percentage points, then the liquidation value percentage must be re-determined on that day even in the absence of a revaluation event.
 
  1. Obligations of Foreign Partnerships
The final regulations adopt the general aggregate approach that was contained in proposed §1.956-4(c)(1) (with certain modifications) as it relates to obligations of foreign partnerships.  More specifically, final §1.956-4(c)(1) generally provides that an obligation of a foreign partnership is treated as a separate obligation of each of the partners in the partnership to the extent of each partner’s share of the obligation. The final regulations provide that a partner’s share of the partnership’s obligation is determined in accordance with the partner’s liquidation value percentage as provided in §1.956-4(b)(2)(i) (without regard to the rules in §1.956-4(b)(2)(ii) relating to special allocations). The final regulations also include an exception for obligations of partnerships in which neither the lending CFC nor any person related to the lending CFC is a partner as well as a special obligor rule in the case of certain partnership distributions. See below for applicability dates.
 
  1. Exceptions from General Rule of Aggregate Treatment
Proposed §1.956-4(c)(2) provides an exception from the aggregate treatment of proposed §1.956-4(c)(1) that applies if neither the CFC that holds the obligation (or is treated as holding the obligation) nor any person related to the CFC (within the meaning of §954(d)(3)) is a partner in the partnership on the CFC’s quarterly measuring date on which the treatment of the obligation as U.S. property is being determined. Certain comments recommended adding additional exceptions to the general rule of aggregate treatment.
 
The preamble notes that Treasury and the Service have concluded that there is no reason to provide a more expansive exception from U.S. property treatment for obligations of a foreign partnership with certain U.S. persons as partners than would apply with respect to obligations incurred directly by those same U.S. persons. In addition, the Treasury and the Service have determined that the additional exceptions to aggregate treatment suggested in the comments are not warranted.
 
  1. Special Obligor Rule in the Case of Certain Distributions
The 2015 proposed regulations included a special funded distribution rule that increases the amount of a foreign partnership obligation that is treated as U.S. property when the following requirements are satisfied: (i) a CFC lends funds (or is a pledgor or guarantor with respect to a loan) to a foreign partnership whose obligation is, in whole or in part, U.S. property with respect to the CFC pursuant to proposed §1.956-4(c)(1) and existing §1.956-2(a); (ii) the partnership distributes an amount of money or property to a partner that is related to the CFC (within the meaning of §954(d)(3)) and whose obligation would be U.S. property if held (or treated as held) by the CFC; (iii) the foreign partnership would not have made the distribution but for a funding of the partnership through an obligation held (or treated as held) by the CFC; and (iv) the distribution exceeds the partner’s share of the partnership obligation as determined in accordance with the partner’s interest in partnership profits. When these requirements are satisfied, proposed §1.956-4(c)(3) provided that the amount of the partnership obligation that is treated as an obligation of the distributee partner (and thus as U.S. property held by the CFC) is the lesser of the amount of the distribution that would not have been made but for the funding of the partnership and the amount of the partnership obligation.
 
The final regulations clarify the funded distribution rule by providing with respect to the “but for” requirement in proposed §1.956-4(c)(3) that a foreign partnership will be treated as if it would not have made a distribution of liquid assets but for a funding of the partnership through obligations held (or treated as held) by a CFC to the extent the foreign partnership did not have sufficient liquid assets to make the distribution immediately prior to the distribution, without taking into account the obligations.
 
  1. Other Key Items
Besides the items detailed above, the final regulations also include comments and details on the following items:
 
  1. Finalization of the “active rents and royalties” exception to Subpart F income.
  2. Changes to §1.956-1, reflecting statutory changes enacted in 1993, regarding the methodology for calculating the amount determined under Section 956.
  3. New examples that illustrate the distinction between funding transactions that are subject to the anti-avoidance rule in §1.956-1(b) and common business transactions to which the anti-avoidance rule does not apply.
  4. Finalization of rules related to property acquired by a CFC in certain related party factoring transactions.
  5. Revisions and clarifications to the definition of special allocation for purposes of determining a partner’s attributable share of partnership property.
  6. Introduction of a new proposed rule which provides that a partner’s attributable share of property of a controlled partnership is determined solely in accordance with the partner’s liquidation value percentage, without regard to any special allocations.
  Effective/Applicability Dates The rules in §1.954-2(c)(1)(i) and (d)(1)(i) (regarding the active development test) apply to rents or royalties, as applicable, received or accrued during taxable years of CFCs ending on or after September 1, 2015, and to taxable years of U.S. shareholders in which or with which such taxable years end, by only with respect to property manufactured, produced, developed or created, or, in the case of acquired property, property to which substantial value has been added, on or after September 1, 2015.
The rules in §1.954-2(c)(1)(iv), (c)(2)(ii), (d)(1)(ii) and (d)(2)(ii) (regarding the active marketing test), as well as the rules in §1.954-2(c)(2)(iii)(E), (c)(2)(viii), (d)(2)(iii)(E), and (d)(2)(v) (regarding cost-sharing arrangements), apply to rents or royalties, as applicable, received or accrued during taxable years of CFCs ending on or after September 1, 2015, and to taxable years of U.S. shareholders in which or with which such taxable years end, to the extent that such rents or royalties are received or accrued on or after September 1, 2015.
 
The Section 956 anti-avoidance rules in §1.956-1(b) apply to taxable years of CFCs ending on or after September 1, 2015, and to taxable years of U.S. shareholders in which or with which such taxable years end, with respect to property acquired, including property treated as acquired as the result of a deemed exchange of property pursuant to Section 1001, on or after September 1, 2015.
 
The rules regarding factoring transactions in §1.956-3 (other than §1.956-3(b)(2)(ii)) apply to trade or service receivables acquired (directly or indirectly) after March 1, 1984.
 
The remaining rules in the final regulations apply to taxable years of CFCs ending on or after November 3, 2016 (the date the final regulations were published in the Federal Register), and taxable years of U.S. shareholders in which or with which such taxable years end. In general, these remaining rules apply to property acquired, or pledges or guarantees entered into, on or after September 1, 2015, including property considered acquired, and pledges and guarantees considered entered into, on or after September 1, 2015, as a result of a deemed exchange pursuant to Section 1001. See §1.956-4(c) (dealing with obligations of foreign partnerships); §§ 1 1.956-2(c), 1.956-4(d), and 1.956-1(e)(2) (dealing with pledges and guarantees, including pledges and guarantees by a partnership and with respect to obligations of a foreign partnership); and §1.956-3(b)(2)(ii) (dealing with trade and service receivables acquired from related U.S. persons indirectly through nominees, pass-through entities, or related foreign corporations). Two rules, however, apply to all obligations held on or after November 3, 2016. See §§1.956-2(a)(3) and 1.956-4(e) (dealing with obligations of disregarded entities and domestic partnerships, respectively). Finally, §1.956-4(b) (dealing with partnership property indirectly held by a CFC) applies to property acquired on or after November 3, 2016.
 
Revenue Ruling 90-112 is obsolete as of November 3, 2016.

For additional details see §§1.956-1 through 1.956-4 and 1.954-2, TD 9792, REG-122387-16 and REG-114734-16.
  BDO Insights Taxpayers who are partners in foreign partnerships should consider the implications of the rules discussed above. BDO can help our clients understand the application and implication of these new final regulations.   
 
For more information, please contact one of the following practice leaders:
  Robert Pedersen
Partner and International Tax Practice Leader
           Chip Morgan          Partner 
    Joe Calianno
Partner and International Tax Technical Practice Leader    Brad Rode
Partner 
    William F. Roth III
Partner, National Tax Office   Jerry Seade
Principal    Scott Hendon
Partner    Monika Loving
Partner    Annie Lee
Partner   Sean Dokko
Senior Manager 

State and Local Tax Alert - November 2016

Wed, 11/09/2016 - 12:00am
Potential State Tax Consequences of the Final and Temporary IRC Section 385 Regulations Summary On October 13, 2016, the United States Department of Treasury and Internal Revenue Service issued final and temporary regulations under Internal Revenue Code (“IRC”) Section 385 (the “Section 385 regulations”).  The Section 385 regulations narrow the proposed regulations that were issued on April 4, 2016, yet retain the targeted transactions and funding rule, extend the period of time to comply with the regulations’ documentation and financial analysis requirements, exclude certain short-term cash pooling arrangements, and make other changes to the proposed regulations.  For a discussion of the potential state tax consequences of the proposed regulations issued in April, see the BDO SALT Alert.  Based on the various ways in which states conform to the IRC and Treasury Regulations for purposes of state income tax, including the federal consolidated return regulations, the Section 385 regulations could have material consequences for state corporate income tax (and possibly other state and local tax) purposes.
  Details Effective Dates
The Section 385 regulations are effective October 21, 2016, the publication date, and apply to taxable years ending on or after the date that is 90 days after the publication date or January 19, 2017.  However, the documentation requirements of the Section 385 regulations (see below) do not apply to debt instruments issued (or deemed issued) prior to January 1, 2018.  Nonetheless, a number of transition rules could result in earlier application for some taxpayers.
 
The Recast Rules in Treas. Reg. §§ 1.385-3 and 1.385-3T (see, “Targeted Transactions and Funding Rule,” below) grandfather debt instruments issued before April 5, 2016 (rather than before April 4, 2016, as was provided in the proposed regulations.)  In addition, Treas. Reg. § 1.385-3(b)(3))(viii) also grandfathers distributions and acquisitions occurring before April 5, 2016, for purposes of applying the Funding Rule (see below).
 
Debt instruments that are issued between April 5, 2016, and 90 days after the publication date (January 19, 2017) that would be re-characterized as stock under the Recast Rules are deemed to be exchanged for stock immediately after the date that is 90 days after the publication date (January 19, 2017). 

Overview of Section 385 Regulations
What follows addresses a few of the notable features of the Section 385 regulations that could have state corporate income tax consequences.  It is important to understand that the following only highlights certain features of the Section 385 regulations and does not address all of the myriad complex provisions, ordering rules, transition rules, and operating rules of these regulations.
 
  • “Covered Member” and “Expanded Group” 
In general, the Section 385 regulations will, in certain situations, reclassify intercompany financing arrangements as stock, not debt, and thereby re-characterize any corresponding interest payments as non-deductible distributions for federal income tax purposes.  The regulations will apply to debt instruments issued by a “covered member” (defined to include only a domestic U.S. corporation) to another member of the covered member’s “expanded group.”  An expanded group generally means a group of related U.S. and non-U.S. corporations that satisfy an 80 percent vote or value test, as long as the common parent is not a S corporation, real estate investment trust (“REIT”), or regulated investment company (“RIC”).  Unlike the earlier proposed regulations, the Section 385 regulations currently do not apply to foreign (non-U.S.) issuers of intercompany debt instruments, including controlled foreign corporations (“CFC”).  S corporations and non-controlled RICs and REITs are also excluded from being a member of an expanded group.
 
  • Documentation Requirements
Under Treas. Reg. § 1.385-2, a debt instrument issued by a covered member to another member of the expanded group will have to satisfy contemporaneous documentation requirements for the debt to be treated as such and not as stock.  However, these requirements only apply if (1) the stock of at least one member of the expanded group is traded on an established financial market, as defined in Treas. Reg. § 1.1092(d)-1(b); (2) the expanded group has total assets in separate or consolidated financial statements that exceeds $100 million; or (3) the expanded group has annual total revenue in separate or consolidated financial statements that exceeds $50 million.  Further, at least for federal tax purposes, the documentation requirements do not apply to an “intercompany obligation,” as defined in Treas. Reg. § 1.1502-13(g)(2)(ii), or to intercompany debt issued by one member of a federal consolidated group to another member, but only for the period during which both parties are members of the same consolidated group. 
 
If applicable, the written documentation must demonstrate that (a) the covered member issuer has an unconditional obligation to repay a sum certain, (b) the holder of the debt instrument has the rights of a creditor that are not subordinated to rights of shareholders (e.g., ability to enforce payment, ability to trigger an event of default or acceleration of payment, etc.), (c) there must be a reasonable expectation of repayment as of the date of issuance based on the issuer’s financial position, and (d) there are actions evidencing a debtor-creditor relationship (e.g., actual payments of principal and interest evidenced by wire transfer records, bank statements, as well as journal entries in a centralized cash management system or accounting system of the expanded group).  There are a number of special documentation rules applicable to revolvers, master and cash pooling arrangements, and other certain types of intercompany financing arrangements.  In addition, with respect to exercising its rights as a creditor, if principal or interest is not paid when due, there must be written documentation that the related party holder reasonably exercised the diligence and judgment of a creditor and, if rights to enforce payment were not exercised, there must be written documentation that supports the holder’s actions to not enforce payment that are consistent with the reasonable exercise of the diligence and judgment of a creditor.  If all documentation requirements are satisfied, and the covered member’s debt instrument issued to another member of the expanded group satisfies the federal common law requirements to be treated as debt for federal tax purposes, then the debt instrument will be respected as debt, and not stock, for federal income tax purposes.
 
The Section 385 regulations relax the timely preparation requirement of the required documentation.  Under the proposed regulations, the documentation of the (1) issuer’s unconditional obligation to repay a sum certain, (2) creditor’s rights, and (3) reasonable expectation of repayment had to be prepared within 30 days of the relevant date (e.g., the issuance of the intercompany debt instrument) and the documentation of the actions evidencing a debtor-creditor relationship had to be prepared within 120 days after the relevant date to which the action relates (e.g., the date of payment of interest, the date of default, etc.).  The Section 385 regulations require that documentation be prepared by the date the covered member issuer’s federal income tax return (including extensions) is filed for the tax year of the relevant date.
 
  • Targeted Transactions and Funding Rule   
Like the proposed regulations, Treas. Reg. §§ 1.385-3 and 1.385-3T set forth the Recast Rules aimed at three types of targeted intercompany financing arrangements that will be treated as stock, and not debt, regardless of satisfying the documentation requirements and the federal debt or equity case law:  (1) debt instrument issued by a distribution from the covered member to another member of the expanded group; (2) debt instrument issued by a covered member to another member of the expanded group to acquire another expanded group member’s stock; and (3) debt instrument issued by a covered member to another member of the expanded group to acquire another expanded group member’s assets.  Certain exceptions may apply. 
 
Further, under the “funding rule,” a debt instrument that is not a qualified short-term debt instrument (as defined in Treas. Reg. § 1.385-3(b)(3)(vii)) is treated as stock if it is issued by a covered member to another member of the expanded group in exchange for property, and it is used to fund certain distributions or acquisitions of stock or assets.  A “per se funding rule” applies if the issuance of the debt instrument occurs 36 months before or 36 months after the distribution or acquisition.  As with the targeted transactions, certain exceptions may apply.      
 
There is also an anti-abuse rule aimed at transactions with a “principal purpose of avoiding the purposes of” Treas. Reg. §§ 1.385-3 or 1.385-3T.  The addition of a co-obligor on an intercompany debt instrument may come within the anti-abuse rule.
 
Although the Section 385 regulations generally do not apply the targeted transactions rules and the anti-abuse rule to debt instruments issued in a taxable year ending before January 19, 2017, certain transition rules could apply these rules to that prior taxable year.  Likewise, although the funding rules generally do not apply to a debt instrument issued prior to April 5, 2016, certain transition rules need to be taken into account.
 
  • Exceptions 
Among other exceptions and special rules, the Section 385 regulations have three notable exceptions that could present questions for state corporate income tax purposes:
  • “[S]olely for purposes of applying §§ 1.385-3 and 1.385-3T,” members of a federal consolidated group, as defined in Treas. Reg. § 1.1502-1(h), are treated as one corporation and the rules discussed above related to the three targeted intercompany financing arrangements and funding rule do not apply under this “one corporation” exception.
  • Certain “qualified short-term debt instruments” issued as part of cash pooling and similar arrangements and that satisfy a number of specific requirements are also excluded from the target intercompany financing transactions, although the documentation requirements may still apply. 
  • The Section 385 regulations also apply an “expanded group earnings account” exception or reduction.  That is, the aggregate amount of debt instruments issued by a covered member that are treated as stock under any of the three targeted transactions or the “funding rule” are reduced (i.e., at least a portion of the debt instrument is treated as debt) to the extent of the “expanded group earnings” of the covered member.  While this exception was contained in the proposed regulations, only the current earnings of the covered member counted.  With the Section 385 regulations, accumulated earnings of the covered member are included, but only those earnings accumulated by the covered member in a taxable year ending after April 4, 2016, for the period during which the covered member is a member of the expanded group with the same expanded group parent.
 
The Potential State Tax Consequences
Almost every state having a corporate income tax begins the calculation of state taxable income with federal taxable income, either before or after federal net operating losses and special deductions.  The state will then apply various addition and subtraction modifications to such federal taxable income related to various items of federal income, gain, loss, and deductions.  The state will also conform to the Internal Revenue Code as of a specific date (“as in effect”), on a moving date basis (“as amended”), or will only conform to specifically adopted Internal Revenue Code sections.  A state may also include Treasury Regulations as part of its conformity with the IRC, may conform to Treasury Regulations as long as they are consistent with other provisions of state tax law, or may be silent with respect to conformity to Treasury Regulations.  The manner of a state’s conformity to the Internal Revenue Code will be an important consideration as a threshold matter when determining whether and how a state conforms to the Section 385 regulations.
 
More importantly, and especially for separate return states (but also for some unitary combined reporting and nexus consolidated return states), whether a state conforms to the federal consolidated return rules will be critical.  For example, a number of separate return states specifically provide that an affiliate of a federal consolidated group filing a separate state return must determine its federal taxable income starting point “as if” the affiliate had filed a separate federal return.  As discussed above, the “one corporation” exception is inapplicable if a federal consolidated return is not filed or if a covered member is not an affiliated member of a federal consolidated return group.  As a result, if a state adopts or conforms to the Section 385 regulations, but is an “as if” state, the “one corporation” exception is applicable for federal tax purposes, but may not be for state corporate income tax purposes.
 
Likewise, the documentation requirements of the Section 385 regulations do not apply to an “intercompany obligation,” as defined in Treas. Reg. § 1.1502-13(g)(2)(ii) (or, based on the “one corporation” exception, intercompany debt issued by one member of the federal consolidated return group to another member).  As a result, if a state does conform to the Section 385 regulations, but not the federal consolidated return regulations, taxpayers may be in a situation where the documentation requirements need not be followed for federal tax purposes, but they will apply for state tax purposes.    
 
Moreover, the “expanded group earnings account” exception or reduction in the amount of a covered member’s intercompany debt that is re-cast as stock may be limited in application in these separate return and other states.  For instance, the Section 385 regulations indicate that a federal consolidated group has one expanded group earnings account and that it is the current and accumulated (in a taxable year ending after April 4, 2016) earnings and profits of the common parent corporation.  For a separate return state (and certain unitary combined reporting states, such as California), the current and accumulated earnings may have to be calculated on a separate entity basis.
 
The exclusion of S corporations from the Section 385 regulations may not apply at the state level.  For example, a state such as Tennessee does not conform to the federal income tax treatment of S corporations (including qualified subchapter S subsidiaries) as pass-through entities (or disregarded entities) and treats them similar to federal C corporations for franchise and excise (income) tax purposes.  It is unclear whether Tennessee or a similar state, if it conforms to the Section 385 regulations, would exclude an S corporation from its application of the regulations.  Other states, such as New Jersey and New York, require a separate S election be made for state tax purposes.  In the event such separate election is not made, the federal S corporation is treated as a C corporation for state tax purposes.  Neither New Jersey nor New York conform to the federal consolidated return regulations, but if they do conform to the Section 385 regulations, the failure to make the separate state S election could have additional state tax consequences.  Similarly, states such as Georgia that require nonresident shareholders to consent to state tax jurisdiction for the entity to be treated as an S corporation, could compound failures to file consents to jurisdiction if they conform to the Section 385 regulations.
 
If a state recasts intercompany debt as stock by conforming to the Section 385 regulations, the recast could also have net worth franchise tax implications.  See, e.g., National Grid Holdings, Inc. v. Comm’r of Revenue, No. 14-P-1662 (Mass. Ct. App., June 8, 2016) (effect of recast of intercompany debt under federal and state common law on the non-income measure of the Massachusetts excise tax).  See the BDO SALT Alert.  Lastly, the recast of the payment of principal and interest as dividends could have consequences for both the payor and recipient of the recast dividend, including for the sales factor of a state’s apportionment formula.   
  BDO Insights
  • The Section 385 regulations are exceedingly complex and a determination of their applicability and effect for state corporate income tax purposes should proceed in conjunction with consultation with appropriate federal income tax advisors.
  • Even if the Section 385 regulations do not have federal income tax consequences, they may independently have state income tax consequences both from a documentation and intercompany debt recast standpoint depending on how a state conforms to the Internal Revenue Code and Treasury Regulations, including the federal consolidated return regulations.
  • There are a number of intercompany financing arrangements employed for state tax purposes that could be affected by the Section 385 regulations, including those specifically in response to state related party interest expense “addback” statutes, depending on a state’s conformity to the IRC and Treasury Regulations.
  • Taxpayers affected by state income tax consequences of the Section 385 regulations 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.
   

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

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






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 
 

Compensation & Benefits Alert - November 2016

Mon, 11/07/2016 - 12:00am
Changes in Longstanding Tax Return Due Dates Impact Retirement Plan Contribution Dates Download PDF Version
Summary Certain tax return and extension due dates will change for taxable years ending on or after December 31, 2016, based on provisions included in the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 that was signed into law on July 31st, 2015. The changes represent years of lobbying by The American Institute of CPAs to have a more logical flow of tax return due dates, especially to have pass-through entity returns and the resulting Form K-1s due before individual and corporate tax returns affected by the information.
Details New Due Dates
The main change is that partnership tax returns are due a month earlier, while most C Corporation tax returns are due a month later.

CAUTION: Special Circumstance Apply to Certain C Corporation Returns with a June 30th year end.

Even though these changes will prove to be useful, there are a few oddities that confuse when a Form 1120 for C Corporations are due. In order to balance the bill’s impact on tax revenue over a ten year period, C Corporations have a number of due dates to keep track of depending on the year end of the corporation.

The table below highlights the new and existing original and extension due dates by form type.
  Return Current Due Dates New Due Dates  Notes Individual,
Form 1040  April 15th  

 Extendable to  October 15th  April 15th    
 
 Extendable to
 October 15th No changes  Partnership,
Form 1065  April 15th

 Extendable to  September 15th  March 15th

 Extendable to  September 15th Fiscal year partnerships will have a due date the 15th day
of the 3rd month after year end with a six-month extension S Corporation, Form 1120S  March 15th

 Extendable to  September 15th  March 15th

 Extendable to  September 15th No changes for S Corporation entities C Corporation with a 12/31 Year End,
Form 1120   March 15th

 Extendable to  September 15th  April 15th
 Thru 2025:

 Extendable to  September 15th
 2026 and  thereafter:  Extendable to  October 15th The extension due date for calendar year-end C Corporations will
remain the same through 2025 and then change by a month in 2026 C Corporation with a 6/30 Year-End, Form 1120  September 15th

 Extendable to  March 15th  Pre-2026:  September 15th

 Post-2026:  October 15th
  C Corporations with 6/30 year ends will not have their original due date change until 2026 C Corporation with All Other Year-Ends,
Form 1120  15th day of 3rd  month  after  year-end

 Extendable to  the 15th day of 9th month after year-end  15th day of 4th  month  after year-  end

 Extendable to the  15th day of 10th   month  after year-  end For C Corporations with year-ends other than 12/31 or 6/30 Trusts & Estates,
Form 1041  April 15th

 Extendable to  September 15th April 15th

Extendable to September 30th Trusts and estate returns will have a 5 ½ month extension Exempt Organizations, Form 990  May 15th
 Extendable to

August 15th
Second extension to November 15th May 15th



Extendable to November 15th Instead of two three-month extensions, Exempt Organizations will have one six-month extension
BDO Insights No plan sponsor who relies on its extended tax return to determine the payment requirement will have an earlier deadline under these new rules. Partnerships that file the Form 1065 without extension will need to pay retirement plan contributions one month earlier than the current rules allow.
 
Background and Authority
Sponsors of qualified retirement plans rely heavily on a special rule that allows them to deduct contributions made next year on this year’s income tax return. The general deduction rule that requires accrual basis taxpayers to pay amounts within 2 1/5 months following the year end in order to deduct on the current year’s return, is trumped by IRC 404 that governs all deductions for contributions of an employer to an employees’ trust. Specifically, IRC section 404(a)(6) provides the following:

"Time when contributions deemed made. For purposes of paragraphs (1), (2) and (3), a taxpayer shall be deemed to have made a payment on the last day of the preceding taxable year if the payment is on account of such taxable year and is made not later than the time prescribed by law for filing the return for such taxable year (including extensions thereof)."

Therefore, the aforementioned changes to the tax return due dates affect the timing of the employer deductions.
 
For more information on your exposure the ERISA Title I penalties and the increased amounts, please contact: 
  Joan Vines
Senior Director, National Tax 
Compensation & Benefits Carl Toppin
Senior Manager, National Tax
Compensation & Benefits Kim Flett
Managing Director, National Tax
Compensation & Benefits Andy Gibson
Regional Managing Partner 
Tax Services Alex Lifson
STS GES Principal 
Compensation & Benefits Penny Wagnon 
Senior Director
Compensation and Benefits

Expatriate Tax Newsletter - November 2016

Fri, 11/04/2016 - 12:00am
BDO's Expatriate Newsletter covers timely tax-related updates and regulations from countries around the globe. The November 2016 issue highlights developments in Switzerland, Belgium, United States and more.

Topics include: 
  • Switzerland: Current Immigration Developments Regarding Foreign Workforce 
  • Belgium: Discussion on the calculation of the benefit in kind of housing facilities
  • United States: Individual taxpayer identification number (ITIN) may be expiring
  Download

State and Local Tax Alert - November 2016

Thu, 11/03/2016 - 12:00am
New Jersey Sales and Use Tax Rate Change Effective January 1, 2017 Download PDF Version
Summary On October 14, 2016, legislation was enacted that will reduce the New Jersey sales and use tax rate from 7 percent to 6.875 percent for the period January 1, 2017, through December 31, 2017. The rate will be further reduced to 6.625 percent for all periods beginning on January 1, 2018.  In addition, the legislation includes special transitional provisions for taxing sales transactions that stretch across the tax rate change dates.
  Details Transitional Provisions
Below are some examples explaining how the transitional provisions will be applied:

Example 1: Tangible personal property is sold on or after July 15, 2016, but prior to January 1, 2017. This property is not delivered until on or after January 1, 2017, but prior to January 1, 2018. In this case, the tax rate will be computed at 6.875 percent.

Example 2: Services are sold on or after July 15, 2016, but prior to January 1, 2017. The services are not delivered until on or after January 1, 2017, but prior to January 1, 2018. In this case, the taxpayer would first need to calculate the ratio of the number of days falling within each of the said periods (July 15, 2016—December 31, 2016, and January 1, 2017—December 31, 2017) to the total number of days covered. Next, the taxpayer would apply the tax applicable to each period, apportioned based on the ratio calculated above.

Example 3: If a service or maintenance agreement is put into effect on or before December 31, 2016, and covers billing periods ending in the period January 1, 2017—December 31, 2017, the seller should use the tax rate at 7 percent if the bill is provided before January 1, 2017. If the bill is provided on or after January 1, 2017, but prior to January 1, 2018, the seller would need to use the tax rate of 6.875 percent.

Note: Computing the tax for transactions occurring over the tax years 2017 and 2018 would be calculated in the same way as in the examples described above.
  BDO Insights
  • For companies planning a significant large purchase transaction or making capital expenditures in New Jersey, the timing of the rate change may provide a sales tax savings.
  • Companies responsible for collecting and remitting New Jersey sales tax should ensure that their sales orders and POS systems are reflecting the correct tax rates.
  • Companies paying New Jersey sales tax at the point of sale are urged to review all invoices from their vendors to verify the application of the new reduced sales tax rates beginning January 1, 2017.
  • Companies that are self-assessing New Jersey use tax should ensure that their calculations reflect the application of the new reduced use tax rates beginning January 1, 2017.
  • Companies with sales that straddle the transitional periods should verify the application of sales or use tax in accordance with the rules.
 
BDO’s State and Local Tax Team has significant experience with New Jersey Sales and Use Tax issues. For questions related to matters discussed above, please contact one of the following practice leaders: 
  Dennis Sweeney
State and Local Tax Managing Director       Harri Persaud
State and Local Tax Senior Manager   Allie Kant
State and Local Tax Manager   Jin Shi
State and Local Tax Senior Manager

JIN SHI State and Local Tax Senior Manager 212-885-8496 / jshi@bdo.com 

R&D Tax Alert - November 2016

Thu, 11/03/2016 - 12:00am
Final Regulations Expand Software-Development Activities Eligible for Research Tax Credits Download PDF Version
Summary On October 3, 2016, the Internal Revenue Service (“IRS”) issued final regulations (T.D. 9786) concerning the section 41 research tax credit (“research credit”) and its treatment of expenditures related to the development of software, both internal-use software (“IUS”) and non-IUS. The final regulations have been anticipated after the IRS published taxpayer-friendly proposed regulations (REG-153656-03) in January 2015.

Under the new regulations and historically, IUS development generally must meet a higher standard to qualify than non-IUS development. The final regulations, however, narrow the definition of “IUS” considerably and thereby broaden the range of software development expenditures eligible for the credit.

The final regulations retain a major portion of the proposed regulations with some modifications. This alert outlines the changes between the historical guidance and the proposed and final regulations and recommended action items. Please consult the final regulations for details potentially relevant to your particular circumstances.
Details

IUS vs. Non-IUS
The final regulations define “IUS” as the proposed regulations did, as software that is developed by (or for the benefit of) the taxpayer for use in general and administrative (“G&A”) back-office functions that facilitate or support the conduct of the taxpayer’s trade or business. G&A functions are limited to financial management functions, human resource management functions, and support services functions.   

The final regulations clarify that software is not IUS if the software (1) is not developed for use in G&A functions that facilitate or support the conduct of the taxpayer’s trade or business; (2) is developed to be commercially sold, leased, licensed, or otherwise marketed to third parties; and (3) is developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system.

Similar to the proposed regulations, the final regulations provide that the determination of whether software is IUS depends on the intent of the taxpayer and the facts and circumstances at the beginning of the software development; subsequent events and intentions do not matter.

Dual Function Software and Safe Harbor 
The final regulations provide that software developed for use in G&A and non-G&A functions—“dual function” software—is presumed to be for internal use. However, the presumption does not apply if a taxpayer can identify a subset of elements of dual function software that only enables a taxpayer to interact with third parties or allows third parties to initiate functions or review data on the taxpayer’s system. The qualified research expenditures (“QRE”) allocable to third party subsets of the dual function software may be eligible for the research credit.   

Like the proposed regulations, the final regulations provide a safe harbor that allows taxpayers to include 25 percent of the QREs of the dual function subset in computing the amount of the taxpayer’s credit, as long as the third-party functions are reasonably anticipated to constitute at least 10 percent of the dual function subset’s use.

High Threshold of Innovation Test 
Certain IUS development may qualify for the research credit if it meets an additional three-part “high threshold of innovation” (HTI) test.

Outlined in the 1986 legislative history and modified in the final regulations, the HTI test requires, first, that the software be innovative, as where the software results in a reduction in cost, improvement in speed, or other measurable improvement that is substantial and economically significant. Notably, the final regulations abandon the higher standard of earlier regulations requiring that the software be unique and novel and differ in a significant way from prior software implementations.

Second, the software development must involve significant economic risk, as where the taxpayer commits substantial resources to the development and there is substantial uncertainty, because of technical risk, that such resources would be recovered within a reasonable period. The proposed regulations required this uncertainty relate to either capability or methodology, but the final regulations do not. Instead, they provide that the focus should be on the level of uncertainty, and not the type of uncertainty, which means that uncertainty regarding the software’s appropriate design can qualify. The regulations do suggest, though, that appropriate design uncertainty alone would rarely qualify as being substantial.

Third and finally, the software must not be commercially available for use by the taxpayer, as where the software cannot be purchased, leased, or licensed and used for the intended purpose without modifications that would satisfy the first two requirements.

The final regulations further clarify that, for purposes of the HTI test:
  • Revolutionary discovery is not required; and
  • The HTI test does not apply to the attempt to develop or improve software for use in (1) an activity that constitutes qualified research, (2) a production process to which the requirements of section 41 are met, or (3) a new or improved software and hardware product developed together by the taxpayer. 

Effective Date

The final regulations are prospective and apply to taxable years beginning on or after October 4, 2016, the date of their publication in the Federal Register. The proposed regulations state the IRS will not challenge return positions consistent with the proposed regulations for taxable years ending on or after January 20, 2015, the date they were published in the Federal Register.   


BDO Insights Taxpayers who pay for the development of software should:
  • Review their development efforts to address specific issues and opportunities the final regulations create, e.g., whether software treated as IUS under the old rules would be treated as IUS under the new rules, whether the significant economic risk tests’ clarified “substantial uncertainty” test may now be met, whether any software is “dual function” software; and
  • Consider whether and how the final regulations, notwithstanding their effective date, might be leveraged to support any software development expenses under examination by tax authorities.
 
For more information, please contact one of the following practice leaders:
 

Chris Bard 
National Leader 

 

Jonathan Forman
Principal

 

Jim Feeser
Managing Director

 

Hoon Lee
Partner

  Chad Paul
Managing Director   

Patrick Wallace
Managing Director 

  David Wong Partner  

 

State and Local Tax Alert - October 2016

Wed, 10/26/2016 - 12:00am
U.S. Supreme Court Grants Leave to File Complaints by a Group of States Against Delaware and Consolidates Appeals in Unclaimed Property Disputes Download PDF Version
Summary On October 3, 2016, the U.S. Supreme Court, in the exercise of its original jurisdiction to hear disputes between states, granted leave to file complaints by 24 states in unclaimed property disputes between 23 states and Delaware over abandoned MoneyGram Payment Systems, Inc. (“MoneyGram”) “official checks.”[1]  The Court also consolidated Delaware’s complaint against Pennsylvania and Wisconsin with the multiple-state complaint filed against Delaware earlier in 2016, and requires all parties to file answers to the complaints and counterclaims within 30 days.[2]  The conflict between the 23 states and Delaware involves unclaimed “official checks” remitted to Delaware under the second priority rule for reporting unclaimed property that was established by the U.S. Supreme Court in Texas v. New Jersey in 1965.[3] 

The complainants argue against Delaware that such checks should be remitted to the state where the checks were purchased in accordance with the Disposition of Abandoned Money Orders and Traveler’s Checks Act (“Federal Disposition Act”).[4]
Details Background
All states and the District of Columbia have enacted unclaimed property laws, under which a company holding such property (the “holder”) must report and remit the property to the appropriate state after the time prescribed by that state has passed.  The U.S. Supreme Court established priority rules to determine the states’ jurisdiction to take custody of unclaimed property in Texas v. New Jersey.  Under the priority rules generally, the state of the rightful owner’s last known address receives first priority.  If the holder’s records do not reflect a last known address, the property is reported to the holder’s state of legal domicile or incorporation.

Following the second priority rule, MoneyGram remitted “official checks” with an unknown owner address to Delaware, the company’s state of incorporation.  Official checks are similar to money orders in that the customer pays the value of the official check plus a transaction fee for an instrument that is pre-printed with the value of the customer’s remitted payment.  In addition, MoneyGram is directly liable for the pre-printed value of its official checks. The only substantive differences between money orders and official checks are where they are sold, and the value that can be reflected
on them.[5]

The complaints of the 24 state group have been accumulating for several months. See the BDO SALT Alert that discusses the Pennsylvania complaint filed on February 26, 2016.
 
States Filing Complaints
The states filing complaints against Delaware claim that the official checks should be remitted to the state of purchase under the Federal Disposition Act.  The Federal Disposition Act grants unclaimed property jurisdiction to the state of purchase for an abandoned “money order, traveler’s check, and other similar written instrument (other than a third party bank check) on which a banking or financial organization or a business association is directly liable,” to the extent of that state’s laws.  The complainant states assert that although “other similar written instrument (other than a third party bank check)” is not explicitly defined, MoneyGram official checks are substantially similar to money orders and should fall under the Federal Disposition Act.
 
Delaware’s Arguments
Delaware claims that MoneyGram remitted the official checks appropriately in accordance with the second priority rule and the decision in Pennsylvania v. New York, 407 U.S. 206 (1972), in which the U.S. Supreme Court held that the state of incorporation had the right to escheat sums owed on an uncashed money order where the owner’s address is unknown.

Delaware acknowledges that the Federal Disposition Act effectively overturned the U.S. Supreme Court’s holding in Pennsylvania v. New York for money orders.  However, Delaware argues that the official checks in this case qualify as “third party bank checks” and, thus, are explicitly excluded from the Federal Disposition Act.  In addition, Delaware argues that official checks were known and recognized monetary instruments at the time the Federal Disposition Act was enacted, and yet they were not specifically included.  Finally, Delaware asserts that official checks differ from money orders and traveler’s checks in many ways and, therefore, do not fall under the “other similar written instrument (other than a third party bank check)” provision in the Federal Disposition Act.  
BDO Insights
  • Unclaimed property holders should monitor these consolidated cases as they proceed, because the outcome will impact the unclaimed property laws of many states and holders. 
  • The eventual outcome of this case could assist in interpreting and applying the various state unclaimed property laws, which can be difficult to navigate.  The outcome is still uncertain and original jurisdiction cases can take a significant amount of time to resolve, but states and holders are eager for the Court’s guidance.
 

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

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






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
    [1] Arkansas, et al. v. Delaware, U.S. No. 220146 and Delaware v. Pennsylvania and Wisconsin,
U.S. No. 220145. [2] Pa. Treas. Dep’t v. Gregor, No. 1:16-cv-00351 (M.D. Pa. filed Feb. 26, 2016); Wis. Dep’t of Revenue v. Gregor, No. 16-cv-281 (W.D. Wis. filed April 27, 2016); Arkansas v. Delaware, Motion for Leave to File Bill of Complaint (U.S., No. 22O146 filed June 9, 2016). [3] 379 U.S. 674 (1965). [4] 12 U.S.C. §§ 2501-2503 (1974). [5] MoneyGram money orders are generally subject to low face-value limits, whereas official checks are not.  In addition, money orders are generally sold at traditional retail locations, while official checks are sold at financial institutions.

State and Local Tax Alert - October 2016

Wed, 10/26/2016 - 12:00am
Ohio Department of Taxation Issues Guidance Related to Nonresident Taxpayers' Gain From the Sale of a Closely-Held Business Download PDF Version
Summary On October 7, 2016, the Ohio Department of Taxation issued a personal income tax information release that provides guidance relating to an equity investor’s apportionment of gain from the sale of a closely-held business.  This guidance was issued as a result of the Supreme Court of Ohio’s holding in Corrigan v. Testa, Slip Opinion No. 2016-Ohio-2805 (May 4, 2016).
Details In the Corrigan case, the Supreme Court of Ohio held that Ohio Rev. Code § 5747.212, as applied to the taxpayer, was unconstitutional under the Due Process Clause of the Fourteenth Amendment of the U.S. Constitution.  See the BDO SALT Alert that discusses this case.  Ohio Rev. Code § 5747.212 provides special rules for apportioning the gain from the sale of a taxpayer’s ownership in a closely-held business.

As a result of the decision in Corrigan, the Department issued Information Release IT 2016-01 on October 7, 2016, to provide the following:
  • The Court’s analysis and holding are confined solely to Ohio Rev. Code
    § 5747.212 and are not expanded to any other Ohio statute;
  • The Court found that Ohio Rev. Code § 5747.212 was unconstitutional as applied to the taxpayer, but the Court did not find the statute unconstitutional on its face, thus, it was found to be unconstitutional only in this specific situation; and
  • The Court found that an ownership interest in a business is an intangible asset.  The Court followed the general rule of law that a capital gain derived from the sale of an intangible asset is allocable as nonbusiness income to a nonresident taxpayer’s state of domicile because neither the taxpayer nor the sale of the asset has a taxable link (or unitary relationship) to Ohio.
The Department also provided guidance for a nonresident taxpayer who was assessed or paid tax on an amount calculated under Ohio Rev. Code § 5747.212. 
  • If the taxpayer already filed a refund application or petitioned for review of an assessment relating to the applicability of Ohio Rev. Code § 5747.212, no further action is needed at this time and these cases will be reviewed.  However, if the taxpayer has additional information that further supports the taxpayer’s position as a result of the Corrigan decision, the additional information can be sent to taxpayer’s point of contact at the Department.
  • If a nonresident taxpayer believes that he or she is entitled to a refund of amounts previously paid based on the decision in Corrigan, the taxpayer may file amended tax returns that include:
    • A “Reasons and Explanation of Corrections” page for each amended return that cites Corrigan v. Testa, Slip Opinion No. 2016-Ohio-2805 as the basis for the amended return; and
    • For each return, a detailed statement specifying the factual and legal reasons why the Corrigan decision is applicable to the taxpayer.
  BDO Insights
  • A nonresident taxpayer that realized a gain from the sale of an interest in a pass-through entity should consider whether a refund opportunity may be available based upon the decision in Corrigan as applied to the taxpayer’s specific situation.  The amended return or refund claim must follow the requirements of Information Release IT 2016-01 and must be for payments of income tax made within four years of the date the refund is requested.  In addition, the payments and tax years for which the taxpayer is requesting a refund must not have been the subject of a Settlement Agreement with the Department. 
  • If the taxpayer recognizes a capital gain and treats it as nonbusiness income because Ohio Rev. Code § 5747.212 is not applicable, the gain is not eligible for Ohio’s Small Business Deduction for tax years 2013 and 2014 or Ohio’s Business Income Deduction for tax years 2015 and forward.  A nonresident taxpayer should consider whether this impacts the potential refund opportunity available.
 


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

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






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 
 

Federal Tax Alert - October 2016

Tue, 10/25/2016 - 12:00am
New Final Regulations Clarify the Definition of Real Property for Purposes of the Real Estate Investment Trust Provisions Download PDF Version
Summary On August 30, 2016, Treasury issued final regulations (T.D. 9784) that clarify the definition of real property for purposes of the real estate investment trust (“REIT”) provisions of the Internal Revenue Code (“Code”).  The final regulations adopt the proposed regulations that were issued on May 14, 2014 (REG-150760-13), with some modifications, and replace the definition of real property in prior Reg. Section 1.856-3(d).

The rules in the new Treas. Reg. Section 1.856-10 are generally intended to be a clarification of current law rather than create new standards.  Real property is defined as land and improvements to land.  Improvements to land include inherently permanent structures and structural components of inherently permanent structures that have a passive function.  In certain circumstances, intangible assets may also be defined as real property.

The final regulations list a number of safe harbor assets that will be treated as real property for purposes of Section 856.  If a particular asset is not listed, the regulations provide factors that must be used to determine whether a distinct asset qualifies as real property based on all the facts and circumstances surrounding the asset.  Examples are provided to illustrate how to apply the regulations.

The definition of real property contained in the new regulations is limited to Code Sections 856 through 859, and is not controlling for any other section of the Code unless there is a specific reference in another section of the Code or Regulations that directs application of the new regulations. 

The regulations are effective for taxable years beginning after August 31, 2016.  However, taxpayers are permitted to rely on the final regulations for periods beginning on or before the applicability date. 
Definition of Real Property Background
In order for a taxpayer to qualify as a REIT, at least 75 percent of the value of its total assets has to represented by real estate assets, cash, and cash items (including receivables), and government securities at the close of each quarter of the taxable year.  Real estate assets are defined by the Code to include real property, including interests in real property and interests in mortgages on real property.  Interests in real property is defined to include fee interests and co-ownership of “land or improvements thereon.” 

Prior to the issuance of these final regulations, Treas. Reg. Section 1.856-3(d) promulgated in 1962 defined real property for purposes of the REIT provisions as “land or improvements thereon, such as buildings or other inherently permanent structures thereon (including items which are structural components of such buildings or structures).”  The prior regulation also stated that the local law definition of the term “real property” was not controlling for the REIT provisions. 
 
The IRS issued a series of revenue rulings between 1969 and 1975 addressing whether certain assets qualify as real property for purposes of Section 856.  The IRS has also issued various private letter rulings (“PLRs”) to REITs that have invested in types of assets that are not directly addressed by the regulations or the published rulings.  However, PLRs may not be relied on by taxpayers other than the taxpayer that received the ruling and are limited to their particular facts. 

The limited published authority has created uncertainty around the definition of real property for purposes of the REIT tests.  Therefore, Treasury and the IRS realized there was a need to provide updated guidance which ultimately resulted in the issuance of these final regulations.  

The final regulations modify Reg. Section 1.856-3(d) by referencing new Reg. Section 1.856-10 for the definition of real property. 

Real Property
New Treas. Reg. Section 1.856-10 (b) states that the term real property means land and improvements to land.  As under the former definition, the local law definitions of real property are not controlling in determining the meaning of the term real property for the REIT provisions of the Code. 

The regulations require that each distinct asset be analyzed separately to determine if the asset is real property.  Therefore, it is necessary to first determine whether a property consists of one or more distinct assets prior to applying the rules in the regulation.

The determination of whether a particular separately identifiable item of property is a distinct asset is based on a facts and circumstances test.  The following four factors must be taken into account in order to determine whether an asset is a distinct asset:
  1. Whether the item is customarily sold or acquired as a single unit rather than as a component part of a larger asset;
  2. Whether the item can be separated from a larger asset, and if so, the cost of separating the item from the larger asset;
  3. Whether the item is commonly viewed as serving a useful function independent of a larger asset of which it is a part; and
  4. Whether separating the item from a larger asset of which it is a part impairs the functionality of the larger asset.
Once each distinct asset is identified, the other provisions of the final regulations are applied to determine whether the property qualifies as real property.

Land and Improvements to Land
Land is defined by the new regulations to include not only the land itself, but also the water and air space superjacent to land and natural products and deposits that are unsevered from the land.  Once natural products and deposits (such as crops, water, ores, and minerals) are severed, extracted, or removed from the land, they cease to be real property.  The mere storage of severed or extracted natural products or deposits in or on real property does not cause the stored property to be recharacterized as real property.

The regulations divide improvements to land into inherently permanent structures (“IPS”) and their structural components. 

Inherently Permanent Structures
An IPS is any permanently affixed building or other permanently affixed structure.  The affixation is considered permanent if the affixation is reasonably expected to last indefinitely (based on all the facts and circumstances).  Affixation may be to land or to another IPS, and may result by weight alone.  The preamble to the regulations clarifies that the Treasury Department and the IRS do not intend the term “indefinitely” to mean forever. 

The IPS must have a passive function.  A distinct asset that serves an active function, such as an item of machinery or equipment, is not a building or other IPS for purposes of the regulations, even if it is permanently affixed.

Buildings
A building is defined as a structure that encloses a space within its walls and is covered by a roof.  The regulations provide the following safe harbor list of assets that (if permanently affixed) will qualify as buildings: houses. apartments, hotels, motels, enclosed stadiums and arenas, enclosed shopping malls, factory and office buildings, warehouses, barns, enclosed garages, enclosed transportation stations and terminals, and stores. 

If a structure fails to qualify as a building, then it may still meet the definition of an other inherently permanent structure (“OIPS”).  For example, a structure that is not completely enclosed or that does not have a roof, such as an outdoor sports stadium or an unenclosed parking garage, do not qualify as buildings, but they may still qualify as an OIPS and, therefore, would still be real property under the final regulations.

Other Inherently Permanent Structures
An OIPS is a permanently affixed structure that does not meet the definition of a building, and serves a passive function.  Examples of passive functions are to contain, support, shelter, cover, protect, or provide a conduit or a route.  An OIPS cannot serve an active function, such as to manufacture, create, produce, convert, or transport. 

The regulations provide the following safe harbor list of distinct assets which (if permanently affixed) are considered OIPSs:  microwave transmission, cell, broadcast, and electrical transmission towers; telephone poles; parking facilities; bridges; tunnels; roadbeds; railroad tracks; transmission lines; pipelines; fences; in-ground swimming pools; offshore drilling platforms; storage structures such as silos and oil and gas storage tanks; and stationary wharves and docks.  OIPSs also include outdoor advertising displays for which an election has been properly made under section 1033(g)(3).

If a distinct asset does not serve an active function and is not listed in the regulations (or in guidance published in the Internal Revenue Bulletin) as one of the safe harbor buildings or OIPSs, then the determination of whether that asset is an IPS is based on a facts and circumstances test.  In making that determination, the following factors must be taken into account:
  1. The manner in which the distinct asset is affixed to real property;
  2. Whether the distinct asset is designed to be removed or to remain in place indefinitely;
  3. The damage that removal of the distinct asset would cause to the item itself or to the real property to which it is affixed;
  4. Any circumstances that suggest the expected period of affixation is not indefinite (for example, a lease that requires or permits removal of the distinct asset upon the expiration of the lease); and
  5. The time and expense required to move the distinct asset.
Structural Components
The term structural component is defined by the regulations as any distinct asset that is a constituent part of and integrated into an IPS and serves the IPS in its passive function.  Additionally, a structural component cannot produce or contribute to the production of income other than consideration for the use or occupancy of space, even if capable of producing such income.  If interconnected assets work together as a system to serve an IPS (for example, electricity, heat, or water systems), the assets are analyzed together as one distinct asset to determine if it is a structural component.  

A structural component will only qualify as real property if the REIT holds its interest in the structural component together with the real property served by the structural component.  For example, under the final regulations, the heating, ventilation, and air conditioning (“HVAC”) system of a building will only qualify as real property if the REIT also owns a real property interest in the IPS served by the HVAC system.  Likewise, a mortgage secured by a structural component is a real estate asset only if the mortgage is also secured by a real property interest in the IPS served by the structural component.  Additionally, if a distinct asset is customized in connection with the rental of space in an IPS, the customization does not affect whether the distinct asset is a structural component.

The regulations provide a safe harbor list of structural components, which includes the following distinct assets and systems (if integrated into the IPS and held together with the real property): wiring; plumbing systems; central heating and air-conditioning systems; elevators or escalators; walls; floors; ceilings; permanent coverings of walls, floors, and ceilings; windows; doors; insulation; chimneys; fire suppression systems, such as sprinkler systems and fire alarms; fire escapes; central refrigeration systems; security systems; and humidity control systems.

If an interest in a distinct asset is not listed as a safe harbor structural component in the regulations (or in guidance published in the Internal Revenue Bulletin), the determination of whether that asset is a structural component is based on a facts and circumstances test.  The following factors must be taken into account in that determination:
  1. The manner, time, and expense of installing and removing the distinct asset;
  2. Whether the distinct asset is designed to be moved;
  3. The damage that removal of the distinct asset would cause to the item itself or to the IPS to which it is affixed;
  4. Whether the distinct asset serves a utility-like function with respect to the IPS;
  5. Whether the distinct asset serves the IPS in its passive function;
  6. Whether the distinct asset produces income from consideration for the use or occupancy of space in or upon the IPS;
  7. Whether the distinct asset is installed during construction of the IPS; and
  8. Whether the distinct asset will remain if the tenant vacates the premises.
Intangible Assets
The final regulations provide that an intangible asset is real property or an interest in real property to the extent the intangible asset (1) derives its value from real property or an interest in real property, (2) is inseparable from that real property or interest in real property, and (3) does not produce or contribute to the production of income other than consideration for the use or occupancy of space.

A license, permit, or other similar right that is solely for the use, enjoyment, or occupation of land or an IPS and that is in the nature of a leasehold or easement generally is an interest in real property.  However, a license or permit to engage in or operate a business is not real property or an interest in real property if the license or permit produces or contributes to the production of income other than consideration for the use or occupancy of space.

Effective Date 
The final regulations apply for taxable years beginning after August 31, 2016  Taxpayers may rely on the final regulations for quarters that end before the applicability date.
  BDO Insights
  • The final regulations will likely not affect REITs that own traditional types of rental properties which generally include office, retail, industrial, multifamily and hotel properties. 
  • REITs that own more non-traditional assets, such as infrastructure assets, should analyze the property they own to confirm property it owns will continue to qualify as real property under the final regulations. Examples provided in the regulations illustrate a number of assets that may be treated as real property in certain situations. Such property includes:
    • Fruit-bearing plants
    • Boat slips and end ties
    • Indoor sculptures
    • Cold storage warehouse assets
    • Certain data center assets
    • Certain solar energy assets
    • Certain pipeline transmission assets
    • Land use permit
  • If a REIT has received a PLR on whether particular items qualify as real property, the REIT needs to review the final regulations to determine whether the PLR is consistent with the final regulations.  To the extent that the PLR is inconsistent with the final regulations, the PLR is revoked prospectively from the effective date of the final regulations.
  • To the extent that any REIT asset does not qualify as real property, the REIT will need to determine whether it is necessary to dispose of the property prior to the effective date of the regulations in order to comply with the REIT’s quarterly asset tests.
 
For more information, please contact one of the following practice leaders: 
  Jeffrey N. Bilsky
Partner, National Tax Office
Technical Practice Leader, Partnerships Julie Robins
Managing Director, National Tax Office
  David Patch
Managing Director, National Tax Office  Rebecca Lodovico
Senior Manager, National Tax Office 

BDO Indirect Tax News - October 2016

Mon, 10/24/2016 - 12:00am
Brought to you by BDO International, the latest edition of Indirect Tax News covers current developments in indirect tax from across the world, including Egypt, Malta, and Argentina. Some highlights of this issue include: 
 
  • EGYPT: VAT introduced
  • UNITED KINGDOM: Indirect tax implications of Brexit
  • LUXEMBOURG: VAT on directors' fees
  View the Newsletter

International Tax Alert - October 2016

Fri, 10/21/2016 - 12:00am
Earnings Stripping Regulations Under Section 385 Finalized Download PDF Version
Summary On October 13, 2016, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“Service”) issued final and temporary regulations under Section 385 of the Internal Revenue Code (the “Final and Temporary Regulations”).
Background Internal Revenue Code Section 385 authorizes the Secretary of the Treasury to prescribe rules to determine whether an interest in a corporation is treated for purposes of the Internal Revenue Code as stock or indebtedness (or as in part stock and in part indebtedness) by setting forth factors to be taken into account with respect to particular factual situations.

On April 4, 2016, the Treasury and the Service issued proposed regulations under Internal Revenue Code Section 385 (the “Proposed Regulations”) addressing the characterization of certain related party debt instruments as debt or equity for United States tax purposes.

The Proposed Regulations addressed three primary areas relating to debt/equity classification. The Proposed Regulations:
  1. Permitted the Service to re-characterize an instrument as part debt and part equity (the “Bifurcation Rule”);
  2. Required timely documentation to support debt classification of related party indebtedness (the “Documentation Rules”);[1] and
  3. Provided specific rules to characterize debt instruments as stock with respect to certain distributions, reorganization transactions and certain other types of transactions (the “Recast Rules”).
Additionally, the Proposed Regulations provided specific rules relating to the treatment of consolidated groups.
The general Recast Rule in the Proposed Regulations provided that a debt instrument can be treated as stock to the extent it is issued by a corporation to a member of the corporation’s expanded group (1) in a distribution, (2) in exchange for expanded group stock (subject to a limited exception), or (3) in exchange for property in certain asset reorganizations.

The “Funding Rule” in the Proposed Regulations targeted debt instruments issued with a principal purpose of funding a transaction described in the general Recast Rule. The Funding Rule contained a non-rebuttable presumption of a principal purpose within a 72-month period surrounding the distribution or acquisition. The Funding Rule in the Proposed Regulations applied if the instrument was issued by a member during the period 36 months before the distribution or acquisition and ending 36 months after the distribution or acquisition. The Proposed Regulations included an exception to the non-rebuttable presumption rule for certain ordinary course debt instruments (as defined in the Proposed Regulations).

The Proposed Regulations included several operating rules (rules for defining when members of the group are related for purposes of applying the rules, certain threshold exceptions, and specific exceptions relating to the application of the rules, anti-abuse rules, anti-avoidance rules, etc.).
 
The Proposed Regulations are discussed in more detail in our Tax Alert, Internal Revenue Service and Treasury Release Proposed Regulations Addressing Debtg/Equity Classifications for US Tax Purposes,” dated April 2016.

Final and Temporary Regulations
After the Proposed Regulations were issued, the Treasury and the Service received numerous written comments in response to the Proposed Regulations. Many of these comments criticized the broad application of the rules. In addition, many of the comments expressed concern that the Proposed Regulations would impose compliance burdens and result in collateral consequences that were not justified by the stated policy objectives of the Proposed Regulations. In response to the comments received, the Final and Temporary Regulations substantially revise the Proposed Regulations. The Final and Temporary Regulations significantly reduce the scope and breadth of the rules by including several important exclusions and exceptions relating to the application of the rules.  

The changes significantly reduce the number of taxpayers and transactions affected by the Final and Temporary Regulations. As narrowed, many issuers are entirely exempt from the application of §§1.385-2 (the Documentation Rules) and 1.385-3 (the Recast Rules). Moreover, with respect to the large domestic issuers that are subject to §1.385-3, that section has been substantially revised to better focus on extraordinary transactions that have the effect of introducing related-party debt without financing new investment in the operations of the issuer.
 
Summary of Key Changes
The Final and Temporary Regulations included the following important changes to the Proposed Regulations.
Changes to the overall scope of the regulations include the following:
  • The Final Regulations make some modifications to the definition of an Expanded Group for purposes of applying the rules.
  • The Final Regulations reserve on all aspects of their application to foreign issuers; as a result, the Final Regulations do not apply to foreign issuers significantly reducing the number of taxpayers affected by these rules. The Final and Temporary Regulations achieve this result by creating a new term, “covered member,” which is defined as a member of an expanded group that is a domestic corporation, and reserves on the inclusion of foreign corporations, including with respect to U.S. branches of foreign issuers.
  • S corporations and non-controlled regulated investment companies (“RIC”) and real estate investment trusts (“REIT”) are exempt from all aspects of the Final Regulations. However, the Final Regulations continue to treat a RIC or REIT that is controlled by members of the expanded group as a member of the expanded group.
  • The Final Regulations do not include a general bifurcation rule.
Changes to the documentation requirements in §1.385-2 include the following:
  • The Final Regulations eliminate the Proposed Regulations’ 30-day and 120-day timely preparation requirement, and instead treat documentation and financial analysis as timely prepared if it is prepared by the time that the issuer’s federal income tax return is filed (taking into account all applicable extensions).
  • The Final Regulations provide that, if an expanded group is otherwise generally compliant with the Documentation Rules, then a rebuttable presumption, rather than per se re-characterization as stock, applies in the event of a documentation failure with respect to a purported debt instrument. For this rebuttable presumption to apply, the taxpayer must demonstrate a high degree of compliance with the Documentation Rules.
  • The Documentation Rules apply only to debt instruments issued or deemed issued on or after January 1, 2018.
  • The Final Regulations clarify the ability of expanded group members to satisfy the documentation rules for EGIs issued under revolving credit agreements, cash pooling arrangements, and similar arrangements by establishing overall legal arrangements (mater agreements).
Changes to the rules regarding distributions of debt instruments and similar transactions under §1.385-3 include the following:
  • The Final and Temporary Regulations do not apply to debt instruments issued by certain specified financial entities, financial groups, and insurance companies that are subject to a specified degree of regulatory oversight regarding their capital structure.
  • The Final and Temporary Regulations generally exclude from the scope of §1.385-3 deposits pursuant to a cash management arrangement as well as certain advances that finance short-term liquidity needs when certain requirements are satisfied.
  • The Final and Temporary Regulations narrow the application of the Funding Rule by preventing, in certain circumstances, the so-called “cascading” consequence of re-characterizing a debt instrument as stock. To prevent inappropriate duplication under the Funding Rule, §1.385-3(b)(6) of the Final Regulations clarifies that once a covered debt instrument is re-characterized as stock under the Funding Rule, the distribution or acquisition that caused that re-characterization cannot cause a re-characterization of another covered debt instrument after the first instrument is repaid.
  • The Final and Temporary Regulations expand the earnings and profits exception detailed in the Proposed Regulations to include all the earnings and profits of a corporation that were accumulated while it was a member of the same expanded group and after the day that the Proposed Regulations were issued. Special rules apply when there is a change in control.
  • The Final and Temporary Regulations remove the “cliff effect” of the threshold exception under the Proposed Regulations, so that all taxpayers can exclude the first $50 million of indebtedness that otherwise would be re-characterized.[2]
  • The Final and Temporary Regulations provide an exception pursuant to which certain contributions of property are “netted” against distributions and transactions with similar economic effect.
  • The Final and Temporary Regulations provide an exception for the acquisition of stock delivered to employees, directors and independent contractors as consideration for the provision of services, if certain requirements are satisfied. 
  • The Final and Temporary Regulations provide that an expanded group partner’s share of a controlled partnership’s assets is determined in accordance with the partner’s liquidation value percentage.
  • The 90-day delay provided in the Proposed Regulations for debt instruments issued on or after April 4, 2016, but prior to the publication of final regulations, is expanded so that any debt instrument that is subject to re-characterization but that is issued on or before the date 90 days after the date of publication in the Federal Register, will not be re-characterized until immediately after the date 90 days after the date of publication in the Federal Register.
Effective/Applicability Dates
The Final and Temporary Regulations apply to taxable years ending on or after the date 90 days after the date on which the regulations are published in the Federal Register.[3]

The Documentation Rules in the Final Regulations under §1.385-2 do not apply to interests issued or deemed issued before January 1, 2018.

The Recast Rules in Final and Temporary Regulations under §§ 1.385-3 and 1.385-3T grandfather debt instruments issued before April 5, 2016 (rather than before April 4, 2016, as was provided in the Proposed Regulations). The Final and Temporary Regulations in §1.385-3(b)(3)(viii) also grandfather distributions and acquisitions occurring before April 5, 2016, for purposes of applying the Funding Rule.

Debt instruments that are issued between April 5, 2016, and 90 days after the publication of the Final Regulations in the Federal Register that would be re-characterized as stock under the Recast Rules are deemed to be exchanged for stock immediately after the date 90 days after the publication of the Final Regulations in the Federal Register.

See above regarding the expansion of the 90-day delay for re-characterization.
For more details regarding the dates of applicability, see §§ 1.385-1(f), 1.385-2(i), 1.385-3(j), 1.385-3T(k), 1.385-4T(g) and 1.752-2T(l)(4).

For more details on these rules and changes see the Final and Temporary Regulations
 
For more information, please contact one of the following practice leaders:
  Robert Pedersen
Partner and International Tax Practice Leader
           Chip Morgan            Partner 
    Joe Calianno
Partner and International Tax Technical Practice Leader    Brad Rode
Partner 
    William F. Roth III
Partner, National Tax Office   Jerry Seade
Principal    Scott Hendon
Partner    Monika Loving
Partner    Annie Lee
Partner   Sean Dokko
Senior Manager    [1] The Proposed Regulations provided that an instrument is not subject to the Documentation Rules unless one of the following conditions is met: (1) the stock of any member of the expanded group is publicly traded, (2) all or any of the portion of the expanded group’s financial results are reported on financial statements with total assets exceeding U.S. $100 million, or (3) the expanded group’s financial results are reported on financial statements that reflect annual total revenue that exceeds U.S. $50 million. The Final Regulations include this threshold. [2] The Proposed Regulations provided that the threshold exception would not apply to any debt instruments once the $50 million threshold was exceeded. [3] The Final and Temporary Regulations are scheduled to be published on October 21, 2016.

State and Local Tax Alert - October 2016

Fri, 10/21/2016 - 12:00am
Tennessee Department of Revenue Adopts Sales and Use Tax Economic Nexus Rule Download PDF Version
  Summary On October 3, 2016, the Tennessee Department of Revenue adopted Rule 1320-05-01-.129, which establishes a sales and use tax economic nexus standard in the state effective January 1, 2017.
  Details Sales and Use Tax Economic Nexus
Under Rule 1320-05-01-.129, an out-of-state dealer who engages in the regular or systematic solicitation of consumers in the state through any means, and whose Tennessee taxable sales exceed $500,000 during the previous twelve-month period, has substantial nexus in the state.  An out-of-state dealer subject to the economic nexus standard must register with the Department for sales and use tax purposes by March 1, 2017, and report and pay tax on sales of tangible personal property and other taxable items delivered to Tennessee consumers beginning July 1, 2017.
 
Rule 1320-05-01-.129 also provides guidance for out-of-state dealers who become subject to the economic nexus standard after March 1, 2017.  Such dealers must register with the Department and begin to report and pay Tennessee sales and use tax by the first day of the third calendar month following the month in which the dealer met the economic nexus threshold.  However, the rule specifies that such dealers are not required to collect and remit sales and use tax for periods before July 1, 2017.
  BDO Insights
  • The final rule makes some minor changes to the proposed rule with respect to which the Department recently held a public hearing.  See the BDO SALT Alert that discusses the proposed rule.  An out-of-state dealer who solicits sales in Tennessee through any means and expects to exceed the $500,000 taxable sales threshold should consider the impact that this rule may have on them for tax planning and reporting purposes.
   

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

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






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

Partnership Taxation Alert - October 2016

Thu, 10/20/2016 - 12:00am
Significant Changes to Disguised Sale Rules Under Sections 707 and 752 Download PDF Version
Summary On October 5, 2016, the IRS published final and temporary regulations (TD 9787 and TD 9788) under sections 707 and 752 of the Internal Revenue Code (“Code”). The new regulations provide guidance relating to disguised sales of property to or by a partnership under section 707, and special rules for allocating liabilities under section 752 for purposes of the section 707 disguised sale rules.
Details General Rule under Section 707

Section 707(a)(2)(B) provides that, under regulations prescribed by the Secretary, related transfers to and by a partnership that, when viewed together, are properly characterized as a sale or exchange of property, will be treated either as a transaction between the partnership and one who is not a partner, or between two or more partners acting other than in their capacity as partners. Under section 1.707-3, a transfer of property by a partner to a partnership and a transfer of money or other consideration from the partnership to the partner will generally be treated as a sale of property by the partner to the partnership, if based on all the facts and circumstances, the transfer of money or other consideration would not have been made but for the transfer of property and, for non-simultaneous transfers, the subsequent transfer is not dependent on the entrepreneurial risks of the partnership.

The existing disguised sale regulations provide several exceptions, including one related to reimbursements of capital expenditures (the “Preformation Expenditure Exception”) and another for distributions of certain debt-financed proceeds (the “Debt-Financed Distribution Exception”). Additionally, existing regulations exclude certain liabilities from disguised sale treatment (the “Qualified Liability Exclusion”). TD 9787 and TD 9788 contain final and temporary regulations, respectively, impacting these exceptions and exclusion.

Preformation Expenditure Exception

General Rule: In general, transfers of money or other consideration from a partnership to reimburse a partner for certain capital expenditures and costs incurred by the partner are not treated as part of a disguised sale of property. Capital expenditures include partnership organization and syndication costs, and costs capitalized to the basis of contributed property. The exception for preformation capital expenditures generally applies only to the extent that the reimbursed capital expenditures do not exceed 20 percent of the fair market value (“FMV”) of the property transferred by the partner to the partnership (the 20-percent limitation). The 20-percent limitation, however, does not apply if the FMV of the transferred property does not exceed 120 percent of the partner’s adjusted basis in the property at the time of the transfer (the 120-percent test).

New Rule – Aggregation of Assets: The final regulations clarify that the preformation expenditure exception applies on a property-by-property basis.[i] However, aggregation is permitted to the extent that:
  1. The total FMV of the aggregated property (of which no single property’s FMV exceeds one percent of the total FMV of the aggregated property) is not greater than the lesser of 10 percent of the total FMV of all property transferred by the partner to the partnership (excluding money) or one million dollars;
  2. The partner uses a reasonable aggregation method that is consistently applied; and
  3. The aggregation of property is not part of a plan in which the principal purpose is to avoid sections 1.707-3 through 1.707-5.[ii]
New Rule – Step-in-the-Shoes Transaction: Under the final regulations, a partner “steps in the shoes” of a person (to the extent the person was not previously reimbursed) with respect to capital expenditures incurred by the person with respect to the property transferred to the partnership. This rule applies to the extent the partner acquired the property in a non-recognition transaction under sections 351, 381(a), 721, or 731.[iii]

New Rule – Tiered Partnerships: In certain situations, an upper-tier partnership is eligible to apply the preformation expenditure exception to capital expenditures incurred by another person.[iv] This rule applies where:
  1. A person incurred eligible capital expenditures with respect to property;
  2. Such property is contributed by the person who incurred the capital expenditures to a partnership (lower-tier partnership); and
  3. Within two years from the date the capital expenditures were originally incurred, the person transfers an interest in the lower-tier partnership to another partnership (upper-tier partnership).
Under this rule, the upper-tier partnership may be reimbursed by the lower-tier partnership to the extent the person could have been reimbursed for the capital expenditures by the lower-tier partnership.[v] In addition, the person is deemed to have transferred the capital expenditures property to the upper-tier partnership and may be reimbursed by the upper-tier partnership of this section to the extent the person could have been reimbursed for the capital expenditures by the lower-tier partnership and has not otherwise been previously reimbursed.[vi] The aggregate reimbursements for capital expenditures may not exceed the amount that the person could have been reimbursed for such capital expenditures.

New Rule – Coordination with Qualified Liability Rules: Special rules apply if capital expenditures were funded by the proceeds of a qualified liability that is assumed by a partnership in connection with a transfer of property to the partnership.[vii] Under these rules, to the extent any qualified liability is used by a partner to fund capital expenditures, and economic responsibility for that borrowing shifts to another partner, the exception for preformation capital expenditures does not apply.[viii]

Further, capital expenditures are treated as funded by the proceeds of a qualified liability to the extent the proceeds are either traceable to the capital expenditures under section 1.163-8T or were actually used to fund the capital expenditures, irrespective of the tracing requirements under section 1.163-8T.[ix] However, if capital expenditures are incurred under a plan in which the principal purpose is to avoid the requirements of these rules, the capital expenditures are deemed funded by the qualified liability.[x]

New Rule – Definition of Capital Expenditures: For purposes of the preformation expenditure exception and qualified liability exclusion, the term capital expenditures has the same meaning as the term capital expenditures has under the Code and applicable regulations, except that it includes capital expenditures taxpayers elect to deduct, and does not include deductible expenses taxpayers elect to treat as capital expenditures.[xi]

Additional Notes: The IRS continues to study the appropriateness of the exception for preformation capital expenditures. Specifically, the IRS is considering whether the exception for preformation capital expenditures is appropriate and requests comments on whether the regulations should continue to include the exception, including any policy justifications for keeping the exception, and on the effects that removing the exception may have.

Debt-Financed Distribution Exception

General Rule: In certain situations, distributions funded with partnership liabilities that are made to a partner who transfers property to a partnership may be excluded from the disguised sale rules. A debt-financed distribution exception applies where the partnership incurs a liability and all or a portion of the proceeds of that liability are traceable to a transfer of money or other consideration to the contributing partner. However, this exception only applies to the extent that the amount of money or FMV of other consideration is does not exceed the partner’s allocable share of the partnership liability. Thus, to the extent the partner receives a distribution of debt-financed proceeds and is not allocated a portion of the liability, application of this exception is limited. Determination of a partner’s allocable share of the partnership liability is therefore critical in applying the debt-financed distribution exception.

New Rule – Determination of Share of Liabilities under Section 707: Under the temporary regulations, a partner’s share of any partnership liability for disguised sale purposes is the same percentage used to determine the partner’s share of the partnership’s excess nonrecourse liabilities.[xii] This rule applies regardless of whether the liability is recourse or nonrecourse. For purposes of the disguised sale rules, a partner’s share of partnership excess nonrecourse liabilities will be based on the partner’s share of partnership profits.[xiii] The temporary regulations also provide that, for disguised sale purposes, if another partner bears economic risk of loss (“EROL”) with respect to a liability, then no portion of that liability can be allocated to the contributing partner.[xiv]

New Rule – Qualified Liability Ordering Rule: The final regulations clarify that an amount excludable as a debt-financed distribution is determined prior to applying the preformation expenditure exception under section 1.707-4.[xv]

Effective Date: Section 707-5T(a)(2) is effective for any transaction with to which all transfers occur on or after January 3, 2017.[xvi] The temporary regulations are scheduled to expire on October 4, 2019.[xvii]

Qualified Liability Exclusion

General Rule: Provided that a transaction is not otherwise treated as a disguised sale, and the partnership’s assumption of a qualified liability, or a partnership’s taking property subject to a qualified liability, is not treated as part of a sale. Where the transaction is otherwise treated as a sale, however, the qualified liability gives rise to additional disguised sale consideration in an amount equal to the lesser of:
  1. The consideration the partnership would have been treated as transferring to the partner if the liability had been a nonqualified liability; or
  2. An amount equal to the amount of the liability multiplied by the partner’s net equity percentage with respect to the property.[xviii]
New Rule - Anticipated Reduction in Partner’s Share of Liability: The existing rules provide that an anticipated reduction in a partner’s share of liability must be taken into consideration in determining the partner’s share of a liability.[xix] The final regulations expand this rule to include the requirement that the anticipated reduction is not subject to the entrepreneurial risks of partnership operations.[xx]

New Rule – Exception Related to Certain Liability Shifts: As described above, a partner’s share of a partnership liability for disguised sale purposes is based on the partner’s share of partnership profits. Consequently, a partner cannot be allocated 100 percent of the liabilities for purposes of section 707. As a result, some amount of the liabilities will shift among partners. The shifting of a nonqualified liability that triggers a disguised sale can cause a portion of the qualified liability to be treated as consideration under the disguised sale rules as well. In order to mitigate the impact of the general rules, the final regulations include an exception in certain circumstances. Specifically, the partnership’s assumption of or taking property subject to a qualified liability is not treated as a transfer of consideration made pursuant to the sale, if the total amount of all liabilities other than qualified liabilities that the partnership assumes or takes subject to is the lesser of 10 percent of the total amount of all qualified liabilities the partnership assumes or takes subject to, or $1,000,000.[xxi]

New Rule – Addition to Qualified Liability Definition: The final regulations expand the definition of qualified liability to include certain liabilities not incurred in anticipation of the property transfer. Under the final regulations, qualified liabilities will also include liabilities incurred in connection with a trade or business in which property transferred to the partnership was used or held, providing all the assets related to that trade or business are transferred to the partnership.[xxii] Assets that are not material to a continuation of the trade or business do not need to be included in the contribution. In meeting the definition of a qualified liability, the final regulations also provide that if the liability is a recourse liability, the amount of the liability may not exceed the FMV of the transferred property at the time of the transfer.[xxiii]

New Rule – Step-in-the-Shoe Transaction: The final regulations provide a rule similar to the rule described above in connection with the preformation expenditure exception. Specifically, a partner “steps in the shoes” of a person for purposes of the qualified liability rules with respect to a liability the person incurred or assumed to the extent the partner assumed or took property subject to the liability from the person in a non-recognition transaction described in sections 351, 381(a), 721, or 731.[xxiv]

New Rule – Tiered Partnerships: The pre-existing regulations provided only a limited tiered-partnership rule for cases in which a partnership succeeds to a liability of another partnership. Under the final regulations, a contributing partner’s share of a liability from a lower-tier partnership is treated as a qualified liability to the extent the liability would be a qualified liability had it been assumed or taken subject to by the upper-tier partnership in connection with a transfer of all of the lower-tier partnership’s property to the upper-tier partnership by the lower-tier partnership.[xxv] Further, the final regulations provide that in determining whether a liability would be a qualified liability, the determination of whether the liability was incurred in anticipation of the transfer of property to the upper-tier partnership is based on whether the partner in the lower-tier partnership anticipated transferring the partner’s interest in the lower-tier partnership to the upper-tier partnership at the time the liability was incurred by the lower-tier partnership.[xxvi]
  BDO Insights
  • While the regulations clarify that the preformation expenditure exception must be applied on an asset-by-asset basis, the ability to aggregate assets in certain situations should alleviate the administrative burden associated with contributions of numerous assets. Careful attention to the aggregation exception should be paid in order to ensure the ability to maximize potential benefits.
  • The rule coordinating the preformation expenditure exception and liability allocations effectively eliminates so-called “double-dip” transactions, where the partnership both reimburses the contributing partner’s preformation expenditures and assumes the liability used by the contributing partner to finance the capitalized expenditures.
  • Leveraged partnership transactions in which newly-obtained liabilities are used to fund distributions to property-contributing partners are severely impacted by these rules. For purposes of calculating the amount of debt-financed distribution exception, a contributing partner’s share of liabilities is based solely on such partner’s interest in partnership profits (excluding liabilities for which another partner bears the EROL).
  • While it is critical to consider the final and temporary regulations addressing disguised sales, it is important to bear in mind that the determination of a disguised sale transaction is inherently driven by facts and circumstances.[xxvii] Consequently, careful consideration should be given to the overall facts and circumstances to determine whether the transaction should be considered a disguised sale.[xxviii]
 
For more information, please contact one of the following practice leaders: 
  Jeffrey N. Bilsky Julie Robins David Patch Rebecca Lodovico     [i] Section 1.707-4(d)(1)(ii)(B). [ii] Section 1.707-4(d)(1)(ii)(B)(1), (2), & (3). [iii] Section 1.707-4(d)(2). [iv] Section 1.707-4(d)(3). [v] Id. [vi] Id. [vii] A qualified liability of the partner exists only to the extent the liability is:
  1. A liability that was incurred by the partner more than two years prior to the earlier of the date the partner agrees in writing to transfer the property or the date the partner transfers the property to the partnership and that has encumbered the transferred property throughout that two-year period;
  2. A liability that was not incurred in anticipation of the transfer of the property to a partnership, but that was incurred by the partner within the two-year period prior to the earlier of the date the partner agrees in writing to transfer the property or the date the partner transfers the property to the partnership and that has encumbered the transferred property since it was incurred;
  3. A liability that is allocable under the rules of §1.163-8T to capital expenditures with respect to the property;
  4. A liability that was incurred in the ordinary course of the trade or business in which property transferred to the partnership was used or held but only if all the assets related to that trade or business are transferred other than assets that are not material to a continuation of the trade or business; or
  5. A liability that was not incurred in anticipation of the transfer of the property to a partnership, but that was incurred in connection with a trade or business in which property transferred to the partnership was used or held but only if all the assets related to that trade or business are transferred other than assets that are not material to a continuation of the trade or business; and
If the liability is a recourse liability, the amount of the liability does not exceed the FMV of the transferred property (less the amount of any other liabilities that are senior in priority and that either encumber such property or are liabilities described in paragraph (a)(6)(i)(C) or (D) of this section) at the time of the transfer. [viii] Section 1.707-4(d)(4)(i) [ix] Id. [x] Section 1.707-4(d)(4)(ii) [xi] Section 1.707-4(d)(5) [xii] Section 1.707-5T(a)(2)(i) [xiii] Section 1.752-3(a)(3) provides that the partner's share of the excess nonrecourse liabilities of the partnership as determined in accordance with the partner's share of partnership profits. The partner's interest in partnership profits is determined by taking into account all facts and circumstances relating to the economic arrangement of the partners. In addition to allocations based on profits, partnerships may allocate excess nonrecourse liabilities under one of the following methods:
  1. Significant Item Method: The partnership agreement may specify the partners’ interests in partnership profits for purposes of allocating excess nonrecourse liabilities, provided the interests so specified are reasonably consistent with allocations (that have substantial economic effect under the section 704(b) regulations) of some other significant item of partnership income or gain.
  2. Alternative Method: Excess nonrecourse liabilities may be allocated among the partners in accordance with the manner in which it is reasonably expected that the deductions attributable to those nonrecourse liabilities will be allocated.
  3. Additional Method: The partnership may first allocate an excess nonrecourse liability to a partner up to the amount of built-in gain that is allocable to the partner on section 704(c) property (as defined under section 1.704-3(a)(3)(ii)) or property for which reverse section 704(c) allocations are applicable (as described in section 1.704-3(a)(6)(i)) where such property is subject to the nonrecourse liability to the extent that such built-in gain exceeds the gain described in paragraph (a)(2) of this section with respect to such property.
The significant item method, alternative method, and additional method do not apply for purposes of the debt-financed distribution rules under section 1.707-5. [xiv] Section 1.707-5T(a)(2)(i) [xv] Section 1.707-5(b)(3). [xvi] Section 1.707-9T(a)(5) [xvii] Section 1.707-5T(g) [xviii] Section 1.707-5(a)(5)(i) [xix] Under the pre-existing regulations, a partner's share of a liability, immediately after a partnership assumes or takes property subject to the liability, is determined by taking into account a subsequent reduction in the partner's share if (i) at the time that the partnership assumes or takes property subject to the liability, it is anticipated that the transferring partner's share of the liability will be subsequently reduced, and (ii) the anticipated reduction is not subject to the entrepreneurial risks of partnership operations. [xx] Section 1.707-5(a)(3)(iii) [xxi] Section 1.707-5(a)(5)(iii). [xxii] Section 1.707-5(a)(6)(i)(E) [xxiii] Section 1.707-5(a)(6)(ii) [xxiv] Section 1.707-5(a)(8) [xxv] Section 1.707-5(e)(2). [xxvi] Id. [xxvii] Section 1.707-3(b)(1) provides transfer of property (excluding money or an obligation to contribute money) by a partner to a partnership and a transfer of money or other consideration (including the assumption of or the taking subject to a liability) by the partnership to the partner constitute a sale of property, in whole or in part, by the partner to the partnership only if based on all the facts and circumstances:
(i)The transfer of money or other consideration would not have been made but for the transfer of property; and
(ii)In cases in which the transfers are not made simultaneously, the subsequent transfer is not dependent on the entrepreneurial risks of partnership operations. [xxviii] Section 1.707-3(b)(2) provides that the determination of whether a transfer of property by a partner to the partnership and a transfer of money or other consideration by the partnership to the partner constitute a sale, in whole or in part, is made based on all the facts and circumstances in each case. The weight to be given each of the facts and circumstances will depend on the particular case. Generally, the facts and circumstances existing on the date of the earliest of such transfers are the ones considered in determining whether a sale exists. Among the facts and circumstances that may tend to prove the existence of a sale are the following:
  1. That the timing and amount of a subsequent transfer are determinable with reasonable certainty at the time of an earlier transfer;
  2. That the transferor has a legally enforceable right to the subsequent transfer;
  3. That the partner's right to receive the transfer of money or other consideration is secured in any manner, taking into account the period during which it is secured;
  4. That any person has made or is legally obligated to make contributions to the partnership in order to permit the partnership to make the transfer of money or other consideration;
  5. That any person has loaned or has agreed to loan the partnership the money or other consideration required to enable the partnership to make the transfer, taking into account whether any such lending obligation is subject to contingencies related to the results of partnership operations;
  6. That the partnership has incurred or is obligated to incur debt to acquire the money or other consideration necessary to permit it to make the transfer, taking into account the likelihood that the partnership will be able to incur that debt (considering such factors as whether any person has agreed to guarantee or otherwise assume personal liability for that debt);
  7. That the partnership holds money or other liquid assets, beyond the reasonable needs of the business, that are expected to be available to make the transfer (taking into account the income that will be earned from those assets);
  8. That partnership distributions, allocations, or control of partnership operations is designed to effect an exchange of the burdens and benefits of ownership of property;
  9. That the transfer of money or other consideration by the partnership to the partner is disproportionately large in relationship to the partner's general and continuing interest in partnership profits; and
  10. That the partner has no obligation to return or repay the money or other consideration to the partnership, or has such an obligation but it is likely to become due at such a distant point in the future that the present value of that obligation is small in relation to the amount of money or other consideration transferred by the partnership to the partner.

Partnership Taxation Alert - October 2016

Thu, 10/20/2016 - 12:00am
New Proposed Regulations Address Liability Allocations and Deficit Restoration Obligations Download PDF Version
Summary On October 4, 2016, Treasury issued proposed regulations (REG-122855-15) (“Proposed Regulations”) that withdraw and revise prior proposed regulations issued on January 30, 2014 (REG-119305-11).  The new Proposed Regulations would strengthen anti-abuse rules in determining whether a partner bears the economic risk of loss (“EROL”) for partnership liabilities, and would create similar anti-abuse rules relating to a partner’s deficit restoration obligation.  Changes to loan guarantees and deficit restoration obligations may be necessary to avoid unfavorable tax consequences in the event the regulations are finalized.

Final and temporary regulations relating to disguised sales and liability allocations were released at the same time as the Proposed Regulations.  See TD 9787 and TD 9788.   The effects of those regulations are addressed in separate Alerts.

Anti-abuse Rules Relating to Liability Allocations
Treas. Reg. section 1.752-1(a) treats a partnership liability as recourse to the extent a partner or related person bears the EROL. Treas. Reg. section 1.752-2(b) treats a partner as bearing the EROL for a liability to the extent that the partner or a related person would be obligated to make a payment if the liability became due and the partnership had no assets with which to satisfy the liability.  For this purpose, an obligation to make a payment is not recognized if the facts and circumstances evidence a plan to circumvent or avoid the obligation. Proposed Regulation Section 1.752-2(j)(3)(ii) would provide the following non-exclusive list of factors that may indicate the existence of such a plan:

(A) The lack of commercially reasonable contractual restrictions that protect the likelihood of payment,

(B) The lack of a requirement (either at the time the payment obligation is made or periodically) to provide commercially reasonable documentation regarding the partner's or related person's financial condition to the benefited party.

(C) The fact that the term of the payment obligation ends prior to the term of the partnership liability, or the partner or related person has a right to terminate its payment obligation, if the purpose of limiting the duration of the payment obligation is to terminate such payment obligation prior to the occurrence of an event or events that increase the risk of economic loss to the guarantor or benefited party.

(D) The existence of a plan or arrangement in which the primary obligor or any other obligor (or a person related to the obligor) with respect to the partnership liability directly or indirectly holds money or other liquid assets in an amount that exceeds the reasonable foreseeable needs of such obligor.

(E) The fact that the payment obligation does not permit the creditor to promptly pursue payment following a payment default on the partnership liability, or other arrangements with respect to the partnership liability or payment obligation otherwise indicate a plan to delay collection.

(F) In the case of a guarantee or similar arrangement, the fact that terms of the partnership liability would be substantially the same had the partner or related person not agreed to provide the guarantee.

(G) The fact that the creditor or other party benefiting from the obligation did not receive executed documents with respect to the payment obligation from the partner or related person before, or within a commercially reasonable period of time after, the creation of the obligation.

Additionally, the Proposed Regulations would deem a plan to circumvent or avoid an obligation to exist if the facts and circumstances indicate that there is not a reasonable expectation that the payment obligor will have the ability to make the required payments if the payment obligation becomes due and payable.  In connection with this rule change, the Proposed Regulations would eliminate existing Treas. Reg. section 1.752-2(k), which limits the deemed EROL of a partner that owns its interest through a disregarded entity to the value of assets held by the disregarded entity.

Recognition of Deficit Restoration Obligations
In general, under Treas. Reg. section 1.704-1(b)(2)(ii), allocations specified by a partnership agreement that cause a partner to have a deficit capital account are respected only if the partner is unconditionally obligated to restore the amount of such deficit balance to the partnership within 90 days of the liquidation of his interest (a deficit restoration obligation, or “DRO”).  The Proposed Regulations would provide that a partner is not considered to be subject to a DRO to the extent such partner's obligation is a bottom dollar payment obligation that is not recognized under Treas. Reg. section 1.752-2(b)(3) or is not legally enforceable, or if the facts and circumstances otherwise indicate a plan to circumvent or avoid such obligation.  Proposed Regulation Section 1.704-1(c)(4)(B) provides a non-exclusive list of factors that may indicate the existence of a plan to circumvent or avoid a DRO obligation:

(i) The fact that the partner is not subject to commercially reasonable provisions for enforcement and collection of the obligation.

(ii) The fact that the partner is not required to provide (at the time the obligation is made or periodically) commercially reasonable documentation regarding the partner's financial condition to the partnership.

(iii) The fact that the obligation ends or could, by its terms, be terminated before the liquidation of the partner's interest in the partnership or when the partner's capital account is negative.

(iv) The failure to provide the terms of the DRO obligation to all the partners in the partnership in a timely manner.

Treasury asked for public comments as to whether and to what extent it is appropriate to continue to recognize DROs as payment obligations, and whether payment obligations created by partner notes should be treated as DROs.

Exculpatory Liabilities 
In the preamble to the Proposed Regulations, Treasury also requested comments regarding the proper treatment of exculpatory liabilities.  An exculpatory liability is a liability that is recourse to an entity under state law and section 1001, but for which no partner bears the EROL. Comments are requested regarding the proper treatment of an exculpatory liability under regulations under section 704(b), and the effect of such a liability’s classification under section 1001. Further, Treasury requested comments addressing the allocation of an exculpatory liability among multiple assets and possible methods for calculating minimum gain with respect to such liability.

Effective Date
The provisions relating to DROs are proposed to apply on or after the date the regulations are published as final.  The provisions relating to liability allocations are proposed to apply to liabilities incurred or assumed by a partnership, and to payment obligations imposed or undertaken with respect to a partnership liability on or after the date the regulations are published as final. Partnerships and their partners may rely on the Proposed Regulations immediately, except that Treas. Reg. section 1.752-2(k), which the regulations would eliminate, will continue to apply until the regulations are final.
BDO Insights If the Proposed Regulations are finalized, the allocation of liabilities by many partnerships may be altered to the extent that they run afoul of new anti-abuse provisions.  Partners whose share of partnership liabilities are reduced may recognize gain on deemed distributions as a result. Taxpayers relying on allocations of recourse partnership liabilities to claim losses and support negative tax basis capital balances should consider whether changes to guarantees and similar arrangements are necessary to avoid gain recognition.

In addition, partners relying on deficit restoration obligations to support negative capital accounts may be allocated income to reduce or eliminate the negative balances if their restoration obligations are no longer respected. In particular, partners who have implemented limited or terminable DRO’s should consider whether changes to their DRO obligations are necessary to avoid chargebacks of income in the event the regulations are finalized.
 
For more information, please contact one of the following practice leaders: 
  Jeffrey N. Bilsky Julie Robins David Patch Rebecca Lodovico

Partnership Taxation Alert - October 2016

Thu, 10/20/2016 - 12:00am
Liabilities Recognized As Recourse Partnership Liabilities Under Section 752

Download PDF Version


Summary On October 5, 2016, the IRS published final and temporary regulations (TD 9787 and TD 9788) under 752 of the Internal Revenue Code (“Code”).  The temporary regulations provide rules relating to when certain obligations are recognized for purposes of determining whether a liability is a recourse liability under section 752.  In particular, the rules address whether a bottom dollar payment obligation is recognized for purposes of determining if a partner or related party bears the economic risk of loss (“EROL”) for a liability under section 1.752-2.   
Details Overview
Section 1.752-1(a)(1) provides that a partnership liability is a recourse liability to the extent that a partner or related person bears the EROL for that liability under section 1.752-2.  Section 1.752-2(a) provides that a partner’s share of a recourse partnership liability equals the portion of the liability, if any, for which the partner or related person bears the EROL.  Section 1.752-1(a)(2) provides that a partnership liability is a nonrecourse liability to the extent that no partner or related person bears the EROL for that liability under section 1.752-2.  

A partner generally bears the EROL for a partnership liability if the partner or related person has a payment obligation under section 1.752-2(b).  A partner generally has a payment obligation to the extent that the partner or related person would have to make a payment if, upon a constructive liquidation of the partnership, the partnership’s assets were worthless and the liability became due and payable (constructive liquidation test). Section 1.752-2(b)(6) presumes partners and related persons will satisfy their payment obligations irrespective of their net worth, unless the facts and circumstances indicate a plan to circumvent or avoid the obligation.

Payment Obligations under the Temporary Regulations
The new section 1.752-2T provides that the determination of the extent a partner has a payment obligation under section 1.752-2(b)(1) is based on the facts and circumstances.[i] To the extent that a payment obligation is not recognized, section 1.752-2(b) is applied as if the obligation did not exist.[ii] All statutory and contractual obligations relating to the partnership liability are taken into account for purposes of applying these rules, including:
  • Contractual obligations outside the partnership agreement, such as guarantees, indemnifications, reimbursement agreements, and other obligations running directly to creditors, to other partners, or to the partnership;
  • Obligations to the partnership that are imposed by the partnership agreement, including the obligation to make a capital contribution and to restore a deficit capital account upon liquidation of the partnership as described in section 1.704-1(b)(2)(ii)(b)(3) (taking into account section 1.704-1(b)(2)(ii)(c)); and
  • Payment obligations (whether in the form of direct remittances to another partner or a contribution to the partnership) imposed by state or local law, including the governing state or local law partnership statute.
Under the temporary regulations, a bottom dollar payment obligation is not recognized for purposes of determining whether a partner or related person has EROL with respect to a liability.[iii] However, if a partner or related person has a payment obligation that would be recognized (initial payment obligation) but for the effect of an indemnity, reimbursement agreement, or similar arrangement, such bottom dollar payment obligation is recognized if, taking into account the indemnity, reimbursement agreement, or similar arrangement, the partner or related person is liable for at least 90 percent of the partner’s or related person’s initial payment obligation.[iv]

Definition of Bottom Dollar Payment Obligations[v]
A bottom dollar payment obligation is defined to include any payment obligation that is the same as or similar to any of the arrangements listed below:  
  1. With respect to a guarantee or similar arrangement, any payment obligation other than one in which the partner or related person is or would be liable up to the full amount of such partner's or related person's payment obligation if, and to the extent that, any amount of the partnership liability is not otherwise satisfied.[vi]
  2. With respect to an indemnity or similar arrangement, any payment obligation other than one in which the partner or related person is or would be liable up to the full amount of such partner's or related person's payment obligation, if, and to the extent that, any amount of the indemnitee's or benefited party's payment obligation that is recognized is satisfied.[vii]
  3. An arrangement with respect to a partnership liability that uses tiered partnerships, intermediaries, senior and subordinate liabilities, or similar arrangements to convert what would otherwise be a single liability into multiple liabilities if, based on the facts and circumstances, the liabilities were incurred pursuant to a common plan as part of a single transaction or arrangement, or a series of related transactions or arrangements, and with a principal purpose of avoiding having at least one of such liabilities or payment obligations with respect to such liabilities being treated as a bottom dollar payment obligation.[viii]
Notwithstanding the foregoing, a payment obligation is not a bottom dollar payment obligation merely because (1) a maximum amount is placed on the partner's or related person's payment obligation; (2) a partner's or related person's payment obligation is stated as a fixed percentage of every dollar of the partnership liability to which such obligation relates (vertical slice guarantee);[ix] or (3) there is a right of proportionate contribution running between partners or related persons who are co-obligors with respect to a payment obligation for which each of them is jointly and severally liable.[x]
 
Bottom Dollar Payment Obligations – Required Disclosure
A partnership must disclose a bottom dollar payment obligation with respect to a partnership liability on a completed Form 8275, Disclosure Statement.[xi] The Form 8275 must be attached to the partnership return for the taxable year in which the bottom dollar payment obligation is undertaken or modified.  The disclosure must include the following information:
  1. A caption identifying the statement as a disclosure of a bottom dollar payment obligation under section 752;
  2. An identification of the payment obligation with respect to which disclosure is made;
  3. The amount of the payment obligation;
  4. The parties to the payment obligation;
  5. A statement of whether the payment obligation is treated as recognized for purposes of section 1.752-2T(b)(3); and
  6. If applicable, the facts and circumstances that clearly establish that a partner or related person is liable for up to 90 percent of the partner’s or related person’s initial payment obligation and, but for an indemnity, reimbursement agreement, or similar arrangement, the partner’s or related person’s initial payment obligation would have been recognized.
A special rule for indemnities and reimbursement agreements is provided where an indemnity, reimbursement agreement, or similar arrangement will be recognized only if, before taking into account the indemnity, reimbursement agreement, or similar arrangement, the indemnitee’s or other benefited party’s payment obligation is recognized or would be recognized if such person were a partner or related person.[xii] 

Anti-abuse Rule
In order to avoid manipulation intended to achieve a federal income tax result that is not consistent with the economics of the arrangements, the new temporary regulations add an additional anti-abuse rule to prevent the partners from agreeing among themselves to create a bottom dollar payment obligation so that the liability will treated as nonrecourse.[xiii]  Under this rule, irrespective of the form of a contractual obligation, the Commissioner may treat a partner as bearing the EROL with respect to a partnership liability, or portion thereof, to the extent that with respect to a contractual obligation, another partner, or a person related to another partner, enters into a payment obligation and a principal purpose of the arrangement is to cause the payment obligation to be disregarded under the general rules.

Effective Dates
The new temporary regulations apply to liabilities incurred or assumed by a partnership and payment obligations imposed or undertaken with respect to a partnership liability on or after October 5, 2016, (other than liabilities incurred or assumed by a partnership and payment obligations imposed or undertaken pursuant to a written binding contract in effect prior to that date).[xiv]  A partnership may elect to apply the rules in the temporary regulations to all of its liabilities as of the beginning of the first taxable year of the partnership ending on or after October 5, 2016.[xv]

Transition relief is provided for any partner whose allocable share of recourse partnership liabilities immediately prior to October 5, 2016, exceeds the amount of the partner’s adjusted basis in its partnership interest at such time (the “Grandfathered Amount”).  Under the transition relief rules, a partnership can continue to apply the old rules to a transition partner to the extent of the partner’s adjusted Grandfathered Amount for a seven year period.[xvi]   

A transition partner will cease to be a transition partner if it is a partnership, S corporation, or a business entity disregarded as an entity separate from its owner, and if the direct or indirect ownership of that transition partner changes by 50 percent or more.[xvii] The termination of a transition partnership under section 708(b)(1)(B) does not affect the Grandfathered Amount of a transition partner that remains a partner in the new partnership, if the new partnership is treated as a continuation of the transition partnership.  In addition, a partner’s Grandfathered Amount is reduced for certain reductions in the amount of liabilities allocated to that partner under the transition rules and, upon the sale of any partnership property, for any tax gain (including Section 704(c) gain) allocated to the partner less that partner’s share of amount realized.
BDO Insights
  • With limited exception, the temporary regulations effectively eliminate the ability to use new bottom dollar payment obligations to create EROL for purposes of Section 752. These rules may have a significant impact on partners, including the immediate recognition of taxable income.  For example:
    • Without EROL, a partner will be allocated fewer partnership liabilities.  Therefore, the partner’s basis will be reduced, which may limit the ability of the partner to deduct allocable losses.
    • Partners with negative tax capital accounts due to prior loss allocations or prior cash distributions may be required to recognize taxable income to the extent they no longer have EROL with respect to a partnership liability. 
  • Any payment obligation, including an obligation to make a capital contribution and to restore a deficit capital account upon liquidation of the partnership may be a bottom dollar payment obligation if it meets the requirements described in the regulations.
  • An anti-abuse rule prevents partners from agreeing to create a bottom dollar guarantee in order to treat a liability as a nonrecourse liability in situations where a partner actually bears the EROL for a partnership liability.
  • Partners who have existing bottom dollar obligations will be able to use the former rules for a seven-year period to the extent that their allocable share of recourse partnership liabilities immediately prior to October 5, 2016, exceeds the amount of the partner’s adjusted basis at such time.  However, partners will need to monitor the Grandfathered Amount as it will be reduced for decreases in partner’s share of liabilities and on the sale of partnership property. 
 
For more information, please contact one of the following practice leaders: 
  Jeffrey N. Bilsky Julie Robins David Patch Rebecca Lodovico     [i] Section 1.752-2T(b)(3)(i). [ii] Id. [iii] Section 1.752-2T(b)(3)(ii)(A). [iv] Section 1.752-2T(b)(3)(ii)(B). [v] The temporary regulations provide an example illustrating the difference between guarantees of first and last dollars, i.e., top and bottom guarantees.  Specifically, Example 10 provides the following illustration:
A, B, and C are equal members of a limited liability company, ABC, that is treated as a partnership for federal tax purposes. ABC borrows $1,000 from Bank. A guarantees payment of up to $300 of the ABC liability is owed if any amount of the full $1,000 liability is not recovered by Bank.  B guarantees payment of up to $200, but only if the Bank otherwise recovers less than $200.  Both A and B waive their rights of contribution against each other.
Because A is obligated to pay up to $300 if, and to the extent that, any amount of the $1,000 partnership liability is not recovered by Bank, A's guarantee is not a bottom dollar payment obligation.  Therefore, A's payment obligation is recognized and the amount of A's EROL under section 1.752- 2(b)(1) is $300.
Because B is obligated to pay up to $200 only if and to the extent that the Bank otherwise recovers less than $200 of the $1,000 partnership liability, B's guarantee is a bottom dollar payment obligation and, therefore, is not recognized.  Accordingly, B bears no EROL under section 1.752-2(b)(1) for ABC's liability.
In sum, $300 of ABC's liability is allocated to A under section 1.752-2(a), and the remaining $700 liability is allocated to A, B, and C under section 1.752-3. [vi] Section 1.752-2T(b)(3)(ii)(C)(1)(i). [vii] Section 1.752-2T(b)(3)(ii)(C)(1)(ii). [viii] Section 1.752-2T(b)(3)(ii)(C)(1)(iii). [ix] A, B, and C are equal members of limited liability company, ABC, that is treated as a partnership for federal tax purposes. ABC borrows $1,000 from Bank. A guarantees payment of 25 percent of each dollar of the $1,000 liability that is not recovered by Bank is owed. A's guarantee satisfies the requirements described in section 1.752-2T.
If $250 of the $1,000 partnership liability is not recovered by Bank, A is only obligated to pay $62.50 ($250 x 0.25) pursuant to the terms of the guarantee.  Because A is obligated to pay a fixed percentage of every dollar of the partnership obligation to which such obligation exists, the arrangement will not be treated as a bottom dollar payment obligation to the extent of $62.50. The remaining portion of the liability, however, will be treated as a nonrecourse liability subject to section 1.752-3. [x] Section 1.752-2T(b)(3)(ii)(C)(2). [xi] Section 1.752-2T(b)(3)(ii)(D). [xii] Section 1.752-2T(b)(3)(iii). [xiii] Section 1.752-2T(j)(2). [xiv] Section 1.752-2T(l)(2). [xv] Section 1.752-2T(l)(3). [xvi] Id. [xvii] Id.

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