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 or Makoto Nomoto, Partner, Tax, at email@example.com or 212 872 2190 with questions.
The IRS Office of Chief Counsel has released an advice memorandum (CCA 201043028 dated August 13, 2010, and released October 29, 2010) concerning whether the difference between a taxpayer’s valuations for customs purposes and for income tax purposes that results from the taxpayer’s application of the “first sale” rule always violates Internal Revenue Code (IRC) section 1059A.
Under U.S. customs valuation rules, there is a standard known as the “first sale” which allow importers to use the price paid by an intermediary to a foreign manufacturer, rather than the price paid by the importer to the intermediary, as the basis for determining the transaction value of merchandise being imported into the United States. Importers often choose the “first sale” value because it minimizes customs duties. Use of the first sale rule generally results in a disparity between the customs valuation and the income tax valuation because the income tax valuation is based on the price paid by the importer to the intermediary.
IRC section 1059A generally provides that if a transfer price paid by an importer exceeds the value reported by the importer for customs purposes, the lower value reported to customs must be used for income tax purposes. However, Reg. section 1.1059A-1(c)(2) recognizes that, when differences between valuations for customs purposes and income tax purposes result from real value added, a taxpayer may report different amounts for customs and income tax purposes without an adjustment under IRC section 1059A.
The IRS Office of Chief Counsel concluded that the difference between valuations for customs purposes and for income tax purposes—resulting from a correct application of the “first sale” rule—does not violate IRC section 1059A.
Senate Bill 858, which contains certain corporate income tax law changes as a part of an overall budget agreement, was signed into law by Governor Schwarzenegger on October 19. Most importantly, the bill amends the rules concerning net operating losses (NOLs).
While NOLs are currently suspended for the tax years beginning on or after January 1, 2008 and before January 1, 2010, the bill extended the suspension of NOLs so that no NOL deduction would be allowed for any tax year beginning on or after January 1, 2008 and before January 1, 2012. For any NOL or NOL carryover for which a deduction is denied, the carryover period would be extended:
- By one year for losses incurred during the 2010 tax year
- By two years for losses incurred during the 2009 tax year
- By three years for losses incurred during the 2008 tax year
- By four years for NOLs incurred in tax years beginning before January 1, 2008
For the 2008 and 2009 tax years, the NOL suspension provisions would not apply to taxpayers with less than $500,000 of net business income subject to tax. For the 2010 and 2011 tax years, the NOL suspension provisions would not apply to taxpayers with less than $300,000 of pre-apportioned income subject to tax on a unitary group basis.
The NOL carryback provisions are amended to conform to the extended suspension period. The NOLs attributable to tax years beginning on or after January 1, 2013, can generally be carried back to the two tax years preceding the tax year of the loss. However, in no circumstances could any NOL be carried back to any tax year beginning before January 1, 2011. The maximum amount of the carryback allowed depends on the year to which the loss is attributable as follows:
- Year beginning on or after January 1, 2013, and before January 1, 2014: 50%
- Year beginning on or after January 1, 2014, but before January 1, 2015: 75%
- Year beginning on or after January 1, 2015: 100%
Senate Bill 858 also contains provisions concerning sourcing of receipts from sales of intangibles and substantial understatement penalty.
On October 1, 2010, the Michigan Department of Treasury issued a notice to taxpayers providing that federally disregarded entities must file separate MBT returns or, if applicable, file as a member of a Michigan unitary business group for Michigan Business Tax (MBT) purposes in light of the decision by the Michigan Court of Appeals ("Kmart Mich. Prop. Servs., LLC v. Dep’t of Treasury").
In the Kmart decision, the Michigan Court of Appeals held that a single-member limited liability company (SMLLC) disregarded for federal income tax purposes was required to file a return separate from its owner for purposes of Single Business Tax (SBT), which has been repealed and replaced by MBT. The court’s rationale was that the SMLLC was a “person” as defined in the SBT law, and, as such, was required to file a separate return under the SBT Act. Previously issued guidance provided that Michigan conformed to the federal check-the-box regulations regarding entity classification for SBT purposes.
As the MBT Act similarly defined the term “person,” the Department of Treasury’s position has been that Michigan followed the federal check-the-box provisions for MBT purposes. The October 1 notice revises the Department’s position and now requires that a federally disregarded entity file as a separate person (or a separate member of a unitary business group) for MBT purposes.
The notice requires filing of amended returns by both the “owner” entity and the previously disregarded entity having Michigan nexus. A previously disregarded entity that filed an MBT return as a branch or division of its owner entity will be considered a non-filer under Michigan law. Interest will be due for any deficiency in tax owed, and will be added to the tax from the time the MBT return was originally due. However, failure to file penalties will be waived for all MBT returns filed and paid by January 31, 2011.
Following the issuance of the proposed regulations (REG-119046-10) on September 7, 2010 authorizing the IRS to require corporations to file a schedule disclosing uncertain tax positions (Schedule UTP), IRS Commissioner Douglas H. Shulman made a speech at the American Bar Association conference in Toronto on September 24, 2010 announcing that the IRS was releasing the following documents on that day:
- Announcement 2010-75 containing the final Schedule UTP and related instructions
- Announcement 2010-76 clarifying and modifying the IRS policy of restraint
- New field direction from the Deputy IRS Commissioner providing initial guidance regarding the examination of Schedule UTP and related matters
According to Announcement 2010-75, in response to comment letters received, the finalized Schedule UTP and related instructions reflect the following changes to the proposed schedule released on April 19, 2010:
- The filing requirement of Schedule UTP is phased in based on the taxpayer’s total assets:
|$100 million or more
|$50 million or more
|$10 million or more
- The requirement to report the “maximum tax adjustment” is eliminated. Instead, the final Schedule UTP requires the taxpayer to rank its reportable tax positions from highest to lowest based on the size of the position’s reserve amount computed for audited financial statement purposes. Also, the Schedule UTP requires the taxpayer to identify “major tax positions” which account for 10% or more of the total reportable tax positions.
- The requirement to disclose positions for which a reserve was not established due to an administrative practice of the IRS is eliminated.
Announcement 2010-75 also contains various clarification provisions.
Announcement 2010-76 communicates various modifications to the IRS policy of restraint including the following:
- Clarification that disclosure of issues on Schedule UTP does not otherwise affect the protections afforded under the policy of restraint
- Clarification that a taxpayer may redact the following information from any copies of tax reconciliation workpapers relating to the preparation of Schedule UTP that it is asked to produce during an examination: 1) Working drafts, revisions, or comments concerning the concise description of tax positions reported on Schedule UTP; 2) The amount of any reserve related to a tax position reported on Schedule UTP; and 3) Computations determining the ranking of tax positions to be reported on Schedule UTP or the designation of a tax position as a major tax position.
- Adoption of a policy that the IRS will generally not seek documents that would otherwise be privileged even though the taxpayer has disclosed the document to a financial statement auditor.
The directive from the Large Business and International (LB&I) Division Deputy Commissioner for Services and Enforcement states that a centralized process will be established within the division to determine whether the disclosures are in compliance with the schedule instructions and to select issues and returns for audit.
Finally, Commissioner Shulman mentioned in his speech that the IRS will not automatically share information reported on Schedule UTP with foreign governments pursuant to treaties or information exchange agreements. Since US treaties and/or information exchange agreements do not require disclosure in cases in which there is no reciprocity, Shulman stated that it would be a very rare occasion that the IRS would exchange information disclosed on Schedule UTP unless the requesting government has similar information it can make available to the IRS.
The Treasury Department and IRS released final regulations (T.D. 9502) under section 883 concerning the exclusion of international transportation income derived by foreign corporations. The final regulations generally adopt regulations that were issued in temporary and proposed form in 2007. According to the preamble, the following issues were considered based on the comments received on the 2007 temporary regulations:
- While commentators recommended that the final regulations adopt a standard for determining whether services are “incidental activities” (income from which is excludable) based on the OECD Model Convention principles, the Treasury and the IRS rejected the use of the OECD definition and adopted the facts and circumstances approach because of the concern that the standard could be interpreted in an inappropriately expansive manner.
- The final regulations permit a foreign corporation to take into account ownership of bearer shares for purposes of satisfying a stock ownership test, when the bearer shares are maintained in a dematerialized or immobilized book-entry system.
The final regulations are generally applicable to tax years beginning after June 25, 2007 and to open tax years beginning on or after December 31, 2004. A new provision regarding bearer shares is only applicable to tax years beginning on or after September 17, 2010.
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