In this section of Jnet, we provide brief updates on regulatory developments in tax that may impact Japanese companies operating in the United States. Please contact your local KPMG representative with questions.
President Obama on February 1, 2010, released the administration’s fiscal year (FY) 2011 (beginning October 1, 2010) budget, which contains a number of tax proposals. The Treasury Department also on February 1, 2010, released the “Green Book”— "General Explanations of the Administration’s Fiscal Year 2011 Revenue Proposals."
The proposal goes to Congress, which will consider it over the coming months, produce its own budget blueprint, and assign to the House and Senate tax committees guidelines for producing tax legislation.
Many of the tax proposals are identical to those made in the administration’s budget for FY 2010 (released in May 2009). The Congress did not have a chance to consider most of the tax proposals contained in the FY 2010 budget as the Congress had to devote a significant amount of time for the health care reform issues.
Some of the major tax proposals included in the FY 2011 budget are as follows:
- The temporary higher rates of 33% and 35% would be eliminated, and the previous higher tax rates of 36% and 39.6% would be restored beginning in 2011 for taxpayers with income over $250,000 (Joint) and $200,000 (Single).
- Capital gains and dividends that otherwise would be taxed at the 36% or 39.6% tax rates would be subject to a maximum rate of 20% instead of 15% beginning in 2011.
- The reductions in itemized deductions and personal exemptions for higher income taxpayers would be restored beginning in 2011.
- “Making Work Pay Credit” would be extended through the end of 2011.
- Carried interests, (i.e., capital gains allocated by a partnership to a person providing services to the partnership such as a fund manager) would be taxed as ordinary income after December 31, 2010.
- Estate, gift, and generation-skipping taxes would be kept permanently at the 2009 level.
- Bonus depreciation would be extended through 2010.
- The higher limit of $250,000 and phase-out threshold of $800,000 on fixed asset expensing would be extended to tax year beginning in 2010.
- Research and experimentation credit would be made permanent as of January 1, 2010.
- Last-In, First-Out method of accounting for inventories would be repealed for tax years beginning after December 31, 2011.
- Lower-of-Cost-or-Market method of accounting for inventories would be repealed for tax years beginning after 12 months from the date of enactment.
- Deduction for punitive damages would be denied after December 31, 2011.
- Gain on qualified small business stock issued after February 17, 2009 and held for more than five years would be completely excluded from income.
- Various changes would be made with regard to provisions related to energy, financial institutions and products, and insurance.
"International (effective for tax years beginning after December 31, 2010)"
- Unlike the 2010 budget proposal, the “check-the-box” rules would "NOT" be changed.
- Interest expense deductions would be deferred to the extent allocated and apportioned to foreign source income that is not currently subject to U.S. tax.
- Deemed paid foreign tax credit would be computed on a pooling basis.
- To prevent splitting of foreign income and foreign taxes, foreign tax credit would be allowed only when and to the extent the associated foreign income is subject to U.S. tax in the hands of the taxpayer claiming the credit.
- Earnings stripping rule would be tightened with respect to expatriated entities by (1) eliminating the debt-to-equity safe harbor; (2) lowering the adjusted taxable income threshold for the limitation from 50% to 25%; (3) limiting the carryforward period for disallowed interest to 10 years; and (4) eliminating the carryforward of excess limitation.
- The rule under section 356(a)(1) would be repealed to prevent repatriation of earnings in certain cross-border reorganizations.
- 80/20 company rule under section 861(c) would be repealed.
- Certain substitute dividend payments made to foreign investors with respect to equity swaps referencing U.S. securities would be treated as U.S. source income subject to U.S. withholding tax.
- Codification of economic substance doctrine - A 30% penalty would apply to tax understatements attributable to transactions lacking economic substance (20% with adequate disclosure).
- Information reporting and withholding rules would be strengthened with respect to offshore accounts and entities.
- Information reporting rules would be expanded for the payments made after December 31, 2010 by requiring: (1) reporting of payments made to corporations; (2) service providers to furnish their taxpayer identification numbers on Form W-9; (3) requiring information reporting on all non-wage payments by federal, state, and local governments to procure property or services; and (4) information reporting on expenses incurred in a real estate rental activity whether it constitutes a trade or business.
- Information return penalties for non-willful failures will be increased from $50 per failure with $250,000 annual maximum to $100 per failure with $1.5 million annual maximum for the returns required to be filed after December 31, 2011.
More corporations and partnerships would be required to e-file for tax years ending after December 31, 2010.
On January 26, speaking at a New York State Bar Association Taxation Section meeting, IRS Commissioner Douglas Shulman announced that the IRS is considering implementing a reporting requirement relating to uncertain tax positions pursuant to FIN 48. The IRS on the same day issued an advance copy of Announcement 2010-9 with more details about the proposed requirement and requested public comments.
According to the Announcement, the IRS is developing a schedule that would be required to be filed by a business taxpayer with total assets in excess of $10 million if the taxpayer determines its federal income tax reserves under FIN 48 or other accounting standards (including IFRS and country-specific generally accepted accounting standards) relating to uncertain tax positions involving U.S. federal income tax. The proposed schedule would be filed with the Form 1120, "U.S. Corporation Income Tax Return", or other business tax return, and would require a concise description of each uncertain tax position for which a reserve is recorded with “sufficient detail” including:
- The Code sections potentially implicated by the position
- A description of the tax year(s) to which the position relates
- A statement that the position involves an item of income, gain, loss, deduction, or credit against tax
- A statement that the position involves a permanent inclusion or exclusion of any item, the timing of that item, or both
- A statement whether the position involves a determination of the value of any property or right
- A statement whether the position involves a computation of basis
The schedule would also require a taxpayer to specify for each uncertain tax position the maximum amount of federal income tax that would be due if the position were disallowed in its entirety on audit (i.e., determined without regard to the taxpayer’s risk analysis regarding its likelihood of prevailing on the merits under FIN48).
The Announcement also states that the IRS is considering seeking legislation imposing a penalty for failure to file the schedule or to make adequate disclosure.
Comments are requested concerning the proposed schedule, and must be filed with the IRS by March 29, 2010.
Congress adjourned for 2009 without enacting an extension of the research credit. Unless and until Congress acts, a research credit is not available for amounts paid or incurred after December 31, 2009 as the termination of the credit applies without regard to the taxpayer’s tax year. This marks the fifth time in the last decade Congress has allowed the research credit to expire. The previous four times Congress eventually reinstated the research credit retroactively, and seamlessly, with no gap in coverage. Most recently, in October 2008, Congress reinstated the research credit for the period January 1, 2008, through the current December 31, 2009 termination date.
On December 9, 2009, the House passed legislation—H.R. 4213, The Tax Extenders Act of 2009—that would provide a one-year extension of the credit (and numerous other expiring provisions) through December 31, 2010. The Senate failed to take up this legislation before it adjourned for the year. On December 22, 2009, however, the leaders of the Senate Finance Committee informed the Senate leadership that, “early in the next year, we intend to address the extension of various tax provisions expiring on or before December 31, 2009 . . . without a gap in coverage, just as the House did.”
Although H.R. 4213 would not make any substantive changes to the research credit, there have been several proposals during the 111th Congress that would make the research credit permanent and make significant changes to the credit in future years. The most notable have been H.R. 422 and S. 1203 which would make the research credit permanent, replace the traditional credit (for tax years beginning after 2010) with the alternative simplified credit (ASC) which is currently an elective method of computing the credit, and raise the ASC rate from 14% to 20%.
A bill to allow taxpayers to count charitable contributions for Haiti relief made through February 28, 2010 in tax year 2009 has been passed by the House and the Senate and signed into law by President Obama on January 22, 2010. As the IRS clarified in IR 2010-12 on January 25, 2010, only cash contributions (including contributions made by text message, check, credit card, or debit card) made to qualifying charities by a taxpayer who itemize deductions on their 2009 returns qualify for this special provision. Taxpayers have the option of deducting these contributions on either their 2009 or 2010 returns, but not both.
The IRS Large and Mid Size Business (LMSB) division issued two LMSB Industry Director’s Directives, elevating the “repairs vs. capitalization” change in accounting method examination issue to a Tier I issue. The Directives provide direction to IRS field agents concerning the examination of a taxpayer who changes its method of accounting to re-characterize previously capitalized costs as deductible repairs and maintenance expenses. The Directives also state that IRS examiners are not to cite or rely on March 2008 proposed regulations for tangible assets until the regulations are issued in final format and that the granting of consent to change accounting method by the IRS National Office does not preclude IRS examiners from auditing the issue.
In prepared remarks delivered at The George Washington University International Tax Conference, IRS Commissioner Douglas Shulman said he would establish a new Transfer Pricing Practice within the Large and Mid-Size Business (“LMSB”) Division. Commissioner Shulman noted that “[f]rom a taxpayer's perspective, it seemed that all too often we were taking too long to resolve transfer pricing issues …that it was difficult for the taxpayer or representative to know who at the Service was responsible for resolving the issue… and that we were not always consistent in our resolution of these issues.” He also noted from an IRS perspective “we need more people with industry specific and transfer pricing expertise to match up with corporate taxpayers and to fully develop the issues, discuss them with taxpayers and their representatives, and ultimately resolve the issues…” In order to address these issues, and to ensure organizational consistency and focus, the Commissioner said that his agency is establishing a Transfer Pricing Practice within the LMSB Division which will “help examination personnel throughout the organization by providing technical expertise as needed, assist in the development of new risk assessment techniques to better identify the taxpayers and issues with the greatest risk, and develop examination best practices to ensure optimal resource allocation.” The IRS Commissioner said that his “goal with the establishment of the Transfer Pricing Practice is to significantly improve how we address transfer pricing issues in the future.”
Other areas addressed by the Commissioner include the following:
- On the use of foreign tax credits, the IRS continues to litigate cases that arose before temporary regulations that sought to shut down “credit generators” lacking economic risk.
- On hybrid entities, “…all countries with real economies and real tax systems have a shared interest in reducing the kind of arbitrage that makes income disappear … where the economic activity is taking place.”
- The IRS is reviewing withholding tax compliance by commercial banks, hedge funds, and other taxpayers.
- The administration remains in the “early stages” of its efforts to “crack down on undeclared bank accounts and ramp up our investigations and prosecution of foreign offshore issues.”
- The government’s agreement with UBS “proved to the world – especially to account holders, promoters and banks – that we’re serious about our international efforts.”
- The IRS intends to expand its treaty staff and tax attaché program.
- The government will “take a unified look at the entire web of business entities controlled by high wealth individual[s], which will enable us to better assess the risk such arrangements pose to tax compliance.”
The New Jersey Supreme Court issued a decision reversing the Appellate Division, and holding that a taxpayer was liable for corporation business tax (“CBT”) in tax years before the “doing business” regulation was amended (Praxair Technology, Inc. v. Director, Division of Taxation, A-91/92-08 (N.J. December 15, 2009)).
As the CBT was generally imposed on taxpayers “doing business” in the state, the regulation interpreting the statutory term “doing business” was amended in 1996 to include an example of a taxpayer deriving income from licensing intangibles to New Jersey customers. The taxpayer argued that it must not be held liable for tax, interest, and penalties for tax years prior to the 1996 amendment to the regulation because it was not clear whether an intangible holding company with no physical presence in New Jersey was subject to tax.
The New Jersey Tax Court disagreed with the taxpayer, observing that the amendment to the regulation did not expand the statute because a regulation is merely an interpretation of existing law. The taxpayer appealed, and the New Jersey Appellate Division reversed the Tax Court’s decision with regard to the tax years prior to the 1996 amendment noting that the decision relied upon by the Tax Court addressed tax years after the amendment.
The New Jersey Supreme Court reversed the appeals court, and held that the taxpayer was liable for CBT for the pre-1996 tax years because 1) the expansive “doing business” statute was sufficient to put the taxpayer on notice that it was subject to New Jersey CBT; 2) the regulation itself, prior to the amendment, defined “doing business” to include “all activities which occupy the time or labor of men for profit” and; 3) it was erroneous to assume that a regulatory change could operate to create liability for an out-of-state taxpayer, as this would be an inappropriate delegation of legislative authority.
The U.S. Tax Court released an opinion generally upholding the taxpayer’s use of the comparable uncontrolled transaction (CUT) method to determine the amount of the buy-in payment made with respect to the transfer of preexisting intangible property under a cost sharing arrangement. Veritas Software, Inc. v. Commissioner, 133 T.C. No. 14 (December 10, 2009). The taxpayer entered into a cost sharing arrangement (consisting of a research and development agreement and a technology license agreement) with its Irish subsidiary, to develop and manufacture storage management software products. Under the cost sharing arrangement, the taxpayer granted the subsidiary the right to use certain preexisting intangibles in Europe, the Middle East, Africa, and Asia. In consideration for the transfer of preexisting intangibles, the subsidiary made a $166 million buy-in payment to the taxpayer. The taxpayer used the comparable uncontrolled transaction (CUT) method to calculate the payment. The IRS, however, issued a notice of deficiency after using an income method; the IRS determined a requisite buy-in payment of $2.5 billion and made an income allocation to the taxpayer of that amount. In general, the Tax Court agreed with the taxpayer finding that the IRS’s determinations were “arbitrary, capricious, and unreasonable.”
"The Worker, Homeownership, and Business Assistance Act of 2009" was passed by the Senate and the House and signed into law by President Obama on November 6. The legislation includes the following tax provisions:
Special 5-Year Carryback of Net Operating Losses (NOLs):
- While corporate taxpayers are normally allowed to carry NOLs back by 2 years and forward by 20 years, the "American Recovery and Reinvestment Act of 2009 ("ARRA")" enacted in February allowed eligible small businesses to carry back NOLs incurred in one tax year either ending or beginning in 2008 up to 5 years.
- The new legislation allows all businesses (except for the “TARP recipients”) to elect to carry back up to 5 years NOLs incurred in one tax period ending after December 31, 2007, and beginning before January 1, 2010.
- Taxpayers are allowed to offset 50% of the available income from the fifth year and 100% of income from the remaining 4 carryback years.
- While the election under the new law would apply to both regular and alternative minimum tax (AMT) NOLs, the new law suspends the 90% limitation on the use of any AMT NOL deduction attributable to carrybacks of the NOL for an election is made (including their use in the first or second preceding tax years).
- A taxpayer must make the election for the extended carryback period under the new law by the extended due date for filing the return for the taxpayer’s last tax year beginning in 2009 in accordance with Revenue Procedure 2009-52. The election, once made, is irrevocable.
- A taxpayer that has already claimed a refund resulting from a 2-year carryback of its 2008 NOL can make an election under the new law to extend the carryback period. A taxpayer that has previously made an election to forego any carryback of an NOL from a tax year ended before November 6, 2009 is permitted to revoke that election by the extended due date of its last tax year beginning in 2009.
- An eligible small business making an election under "ARRA" can also make an election under the new five-year NOL carryback for one other tax year. For example, a calendar year eligible small business taxpayer can elect for 2008 under "ARRA" and also elect for 2009 under the new law.
- Special rules apply for insurance companies.
"Extension and Modification of First-Time Homebuyer Credit:"
- While a refundable tax credit for 10 % of the home purchase price up to $8,000 for the first-time homebuyer provided by ARRA was scheduled to expire November 30, 2009, the new law extends the credit to apply to a home purchased before May 1, 2010.
- Under the new law, individuals who have maintained the same principal residence for any five-consecutive year period during the eight-year period ending on the date of the purchase of a subsequent principal residence may be treated as a first-time homebuyer and allowed a credit up to $6,500.
- Under the new law, the income limitations are increased so that the credit phases out for taxpayers with modified adjusted gross income between $125,000 and $145,000 ($225,000 and $245,000 for joint filers) for the year of purchase.
- No credit is allowed for the purchase of any residence if the purchase price exceeds $800,000, and no credit is allowed unless the taxpayer is 18 years of age as of the date of purchase.
- The new law delays the effective date of worldwide interest allocation rules for seven years, until tax years beginning after December 31, 2017.
- The law increases the required payment of corporate estimated tax otherwise due in July, August, or September 2014, by 33 percentage points.
- The law increases the base amount on which the penalty for failure to file either a partnership or S corporation return is increased to $195 (from $89) times the number of partners or shareholders for each month (or fraction of a month) that the failure continues, for a maximum of 12 months.
The California State Board of Equalization (SBE) has held that gain from the sale of minority stock interest was apportionable business income. The taxpayer, a multinational group filing California tax return on a worldwide basis, acquired a subsidiary in a telecommunications business which subsequently entered into a strategic partnership with a Norwegian company and acquired a 47 percent interest in it. As the subsidiary and the stock of the Norwegian company were sold several years later, the taxpayer took the position that the gain was nonbusiness income allocable solely to its commercial domicile, Washington State. However, SBE has noted that the subsidiary generated business income as a result of its stock ownership and the resulting strategic business relationship with the Norwegian company. Accordingly, SBE has held that the gain was business income subject to apportionment.
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