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 firstname.lastname@example.org or 212 872 2190 with questions.
An IRS Large Business & International (LB&I) Directive posted August 5, 2011 (dated July 28, 2011) provides that, in an effort to balance resources and workload priorities, LB&I examiners are not to challenge a taxpayer's treatment of success-based fees paid or incurred in a Reg. section 1.263(a)-5(e)(3) transaction in tax years ended before April 8, 2011, when the taxpayer's original return position is to capitalize at least 30% of the total success-based fees incurred by the taxpayer with respect to the transaction. LB&I Control Number: LB&I-04-0511-012.
The IRS issued Rev. Proc. 2011-29 on April 8, 2011, to provide a safe harbor for allocating success-based fees paid or incurred in transactions described in Reg. section 1.263(a)-5(e)(3). Rev. Proc. 2011-29 permits electing taxpayers to treat 70% of the success-based fees as an amount that does not facilitate the transaction. The remaining 30% of the fee must be capitalized as an amount that facilitates the transaction.
The LB&I directive applies only to transaction costs paid or incurred in transactions described in the above regulations by either an acquiring corporation or a target corporation. The directive further provides that its rule applies only for the amounts deducted on originally timely filed returns, and not for refund claims (whether formal or informal).
The New Jersey Supreme Court addressed the constitutionality of the "throwout rule" which existed under the state's Corporate Business Tax law in the years in question and held that this apportionment rule operated permissibly with respect to receipts attributed to states where the taxpayer was protected under Public Law 86-272 which prohibits states from imposing corporate income taxes solely because of in-state sales solicitation activities, or simply did not have the requisite contacts to establish nexus. However, the high court held that the rule did not operate constitutionally with respect to receipts attributable to states that, for tax policy reasons, had declined to adopt a corporate income tax or other business presence or business activity tax. Whirlpool Properties, Inc. v. Director, Div. of Taxation.
New Jersey requires multistate corporate taxpayers to apportion income using a three-factor formula that consists of property, payroll, and double-weighted sales although recently enacted legislation gradually phases-in single sales factor apportionment for the privilege period beginning on or after January 1, 2012. New Jersey's throwout rule affects the computation of the New Jersey sales factor by excluding from the denominator - or "throwing out" - receipts attributable to a state or foreign country "in which the taxpayer is not subject to a tax on or measured by profits or income, or business presence or business activity." As a result, sales made into a state in which (1) the taxpayer does not have a substantial nexus, (2) the taxpayer is protected from taxation under Public Law 86-272, or (3) there is no tax based on profits or income, or business presence or business activity (e.g., Nevada) are eliminated from the sales factor denominator therefore increasing the taxpayer's New Jersey sales factor. For tax periods beginning after June 30, 2010, the throwout rule is repealed.
The high court held that the throwout rule was arguably constitutional when the untaxed receipts were thrown out because of lack of nexus or because of Public Law 86-272. In this situation, the throwout rule still operated to increase New Jersey's share, but New Jersey also may have contributed to the production of the receipt. On the other hand, in the court's view, throwing out receipts not taxed as a result of a chosen policy by a sister state was unconstitutional because the determination to throw out the receipts was in no way related to the taxpayer's activity in New Jersey. Rather, it was solely related to the other state's chosen tax policy.
The Superior Court of New Jersey affirmed a tax court decision which held that the corporate ownership of a limited partnership interest did not create nexus with New Jersey for Corporate Business Tax purposes. The taxpayer was a limited partner in a partnership that, following a restructuring, housed its former banking solutions division. It was undisputed that the taxpayer had no place of business, property, employees, agents or representatives in New Jersey. The taxpayer's sole asset was the interest in the partnership, which was engaged in business in New Jersey.
Before the Superior Court, the state argued that the taxpayer's reorganization was designed to avoid paying tax to New Jersey and that the taxpayer had nexus with New Jersey because it was engaged in a unitary business with the partnership and derived taxable business receipts (i.e., partnership distributions) from New Jersey. The court disagreed by noting that (1) there was no evidence to indicate that the reorganization took place for tax avoidance purposes, (2) no unitary relationship existed as the taxpayer was not engaged in the same line of business as the partnership and there was no sharing of technology, operational facilities, know-how, or offices even though a few officers were shared, and (3) New Jersey law did not specifically provide that a partnership distribution was considered "business receipts" for Corporate Business Tax purposes.
A petition was filed with the Texas Supreme Court challenging the constitutionality of the revised franchise tax which was enacted in 2006 during a special legislative session called in response to a mandate from the Texas Supreme Court that the legislature reform the state's property tax system for funding public schools. The bill amended the Texas Tax Code by essentially replacing the existing franchise tax with a new franchise tax based on taxable gross margin. Numerous types of entities that were not previously subject to tax, including limited partnerships, became subject to the revised franchise tax effective January 1, 2008.
Almost immediately after its enactment, there were reports that the new tax was unconstitutional as applied to partnerships because the Texas Constitution contains a provision that prohibits the state from taxing the income of natural persons, including a person's share of partnership and unincorporated association income, unless the tax is approved by a majority of the registered voters in a statewide referendum. The revised franchise tax based on taxable margin was never approved by voters.
In the recently-filed petition, the petitioners (individual owner of an interest in a limited partnership and the entity itself) allege that the revised franchise tax violates the Texas Constitution because it is a "net income tax" imposed on a natural person's share of partnership income and was never approved by voters.
The IRS issued Notice 2011-53 which provides a timeline for the implementation of information reporting and withholding provisions under the Foreign Account Tax Compliance Act ("FATCA") and discusses certain procedural matters that will be addressed in regulations to be issued in the future.
- Certain responsibilities of participating foreign financial institutions (FFIs) will commence in 2013.
- Section 1471(a) withholding obligations with respect to U.S. source fixed or determinable, annual or periodical (FDAP) payments will begin on January 1, 2014.
- FFIs that would otherwise be subject to the "chapter 4 withholding" will be identified as participating FFIs and therefore would not be subject to such withholding if they have registered as participating FFIs and entered into FFI Agreements by June 30, 2013.
- The section 1471(b)(1)(D) withholding obligations of participating FFIs with respect to pass-thru payments will be specified in future regulations, but will begin no earlier than January 1, 2015.
The IRS posted a revised list of "frequently asked questions" (FAQs) on Schedule UTP, Uncertain Tax Position Statement. The revised list of FAQs includes eight new FAQ items (Questions 5 through 12) addressing:
- What does a taxpayer with no 2010 tax position for which reserves have been recorded file with its 2010 tax return?
- What is the definition of "reserve" for purposes of Schedule UTP?
- What actions is a corporation to take when, on examination by the IRS, it reevaluates its tax position for an earlier year?
- What actions does a corporation take when, due to a change in circumstances, it determines that a tax position is now uncertain?
- What effect does a merger have on filing a Schedule UTP?
- How is a reserve relating to a carried forward NOL to be reported?
- Does a corporation report accruals of interest on an earlier tax position that it was not required to report on Schedule UTP?
- Is a corporation to report a tax position for which it has recorded a reserve (or did not record a reserve because it expected to litigate the position) that would result in a line-item adjustment to Form 1120?
The IRS released Announcement 2011-42 providing that the IRS will discontinue the "high-low method" for substantiating lodging, meal, and incidental expenses incurred during travel away from home, beginning with 2011. The IRS will publish a revenue procedure providing the general rules and procedures for substantiation omitting the high-low substantiation method.
The U.S. Court of Appeals for the First Circuit affirmed an April 2010 memorandum opinion of the Tax Court, concluding that the cost of a covenant not to compete may not be amortized over its one-year term, but that the covenant not to compete is an amortizable section 197 intangible and must be amortized over 15 years. Recovery Group, Inc. v. Commissioner, No. 10-1886 (1st Cir. July 26, 2011)
The New York Department of Taxation and Finance has issued a second advisory opinion on the taxability of e-books under its sales and use tax law. In an earlier opinion, the Department had determined that the sale of a book delivered electronically (an "e-book") was not the sale of a taxable information service. The recent advisory opinion expanded the inquiry to consider whether e-books are subject to sales tax under other provisions of New York tax law. New York imposes sales and use tax on tangible personal property, including prewritten computer software, and certain enumerated services. The Department observed that the e-books, which are sold over the Internet, do not contain any prewritten computer software. As such, they are not taxable as tangible personal property.
On July 19, 2011, Governor Rick Perry signed Senate Bill 1 which makes numerous changes to the tax laws in Texas, including the controversial provision to expand sales and use tax nexus standards. Senate Bill 1 amends the definition of "seller" or "retailer" to include a person that, pursuant to an agreement with another person, possesses tangible personal property owned by the other person and is authorized to sell, lease, or rent the property without action by the property owner. In addition, the definition of a retailer doing business in Texas is amended to include certain out-of-state retailers that hold a substantial ownership interest in or are owned in whole or in substantial part by, a person that has a business location in Texas, if:
- The retailer sells the same or substantially similar line of products as the in-state person and uses the same or a substantially similar business name, or
- The in-state person's business location or employees are used to promote or facilitate the retailer's sales to consumers, or otherwise enable the retailer to establish and maintain a market in Texas, including receiving exchanged merchandise.
A retailer that holds a substantial ownership interest in or is owned in whole or in substantial part by, a person that maintains a distribution center or warehouse in the state of Texas and delivers property sold by the retailer to consumers is likewise considered to be doing business in Texas.
The substantial ownership requirement generally means at least 50% direct or indirect ownership.
These provisions are effective January 1, 2012.
The Treasury Department and IRS released temporary regulations (T.D. 9529) and, by cross-reference, a notice of proposed rulemaking (REG-101352-11), removing the duplicate-filing requirement for Form 5472, "Information Return of 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business".
Under existing rules, a 25% foreign-owned domestic corporation and a foreign corporation engaged in trade or business in the United States must attach Form 5472 to its corporate income tax return to report certain transactions between the corporation and certain related parties. In addition, the duplicated Form 5472 must be separately submitted to the Internal Revenue Service.
According to the preamble to the temporary regulations, the IRS has determined that the duplicate filing is no longer necessary because of advances in electronic processing by the IRS. However, the preamble states that a reporting corporation that does not timely file an income tax return still must timely file a paper Form 5472 without the income tax return.
These rules apply for tax years ending on or after June 10, 2011.
The IRS updated a list of "frequently asked questions and answers" (Q&As) concerning the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI) providing certain participating taxpayers to request an extension of time to supply certain information beyond the August 31, 2011 deadline.
As the 2011 OVDI was launched by the IRS in February 2011, participating taxpayers are to file all original and amended tax returns and include payment for taxes, interest, and penalty by August 31, 2011. The updated Q&A 25.1 provides that if a taxpayer cannot make a complete submission by August 31, 2011, the IRS may extend the deadline up to 90 days if the taxpayer requests an extension and can demonstrate a good faith attempt to fully comply with the measures contained in Q&A 25 on or before August 31, 2011. For these purposes, a "good faith attempt to fully comply" must include submissions of property completed and signed agreements to extend the period of time to assess tax (including penalties) and to assess penalties with respect to the Report of Foreign Bank and Financial Accounts, Form TD-F 90-22.1. The requests for extension must include a statement of those items that are missing, the reasons why they are not included, and the steps taken to secure them.
The IRS released Notice 2011-54 which provides additional time for individuals who are required to file a Report of Foreign Bank and Financial Accounts, Form TD-F 90-22.1 (FBAR), in order to report their signature or other authority over, but no financial interest in, foreign financial accounts held during 2009 or earlier calendar years if such reporting was properly deferred under Notice 2009-62 or Notice 2010-23. The new filing deadline is November 1, 2011.
Also, the Treasury Department's Financial Crimes Enforcement Network (FinCEN) issued FinCEn Notice 2011-2 which extends the deadline to submit a FBAR until June 30, 2012 for an employee or officer of an investment advisor registered with the Securities and Exchange Commission who has signature or other authorities over, but not financial interest in, a foreign financial account of persons that are not registered investment companies. The extension applies for FBARs for calendar year 2010 and FBARs 2009 or earlier calendar years for which the filing deadline was properly deferred under IRS Notice 2009-62 or Notice 2010-23. Previously, FinCEN allowed an extension to file a FBAR for certain other individuals under FinCEN 2011-1.
The IRS released Notice 2011-55 which suspends the information reporting requirements with respect to foreign financial assets and certain interests in a passive foreign investment company (PFIC). The Notice suspends the requirement to attach Form 8938, "Statement of Specified Foreign Financial Assets", to income tax returns that are filed before the release of Form 8938, and also suspends a reporting requirement for tax years beginning on or after March 18, 2011, for PFIC shareholders that are not otherwise required to file Form 8621, "Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund".
The New Jersey Division of Taxation issued a Technical Advice Memorandum (TAM-17) on June 6, 2011 which addressed the Division's treatment of transfer pricing and advance pricing agreements (APAs). TAM-17 notes that the Division has broad authority to make adjustments to a tax return deemed necessary to make a "fair and reasonable" determination of the amount of tax payable under New Jersey Law. While the Division will generally respect the federal transfer pricing standards, the Division maintains that it is not bound by the federal determination. TAM-17 states that burden falls on each taxpayer to show by "clear and convincing evidence" that the tax return reports the "true earnings" of the taxpayer. The Division intends to issue regulations consistent with TAM-17.
The Treasury Department's Financial Crimes Enforcement Network (FinCEN) issued a notice (FinCEN Notice 2011-1) announcing that a "small subset of individuals" with only signature authority over certain foreign financial accounts who are required to file a Report of Foreign Bank and Financial Accounts, Form TD-F 90-22.1 (FBAR) with respect to those accounts will receive a one-year extension beyond the upcoming filing date of June 30, 2011 to June 30, 2012. The IRS also issued a related release (IR-2011-57).
According to the IRS and FinCEN news releases, the FBAR deadline is extended to June 30, 2012, for the following individuals:
- An employee or officer of a regulated entity such as a bank, a financial institution, or a U.S. listed company who has signature or other authority over and no financial interest in a foreign financial account of another entity more than 50% owned, directly or indirectly, by the regulated entity (a "controlled person").
- An employee or officer of a controlled person of a regulated entity who has signature or other authority over and no financial interest in a foreign financial account of the regulated entity or another controlled person of the regulated entity.
All other U.S. persons required to file an FBAR this year must meet the June 30, 2011 filing date (which requires that the FBAR be received by the IRS in Detroit by that date - the so-called "mailbox rule" does not apply to FBAR filings).
The IRS released Rev. Proc. 2011-35 providing procedures that a corporation (Acquiring) may use to establish its basis in stock of another corporation (Target) when it acquires the Target stock in a transferred basis transaction.
The IRS has a long-held view that the optimal method for establishing basis in stock acquired in stock-for-stock exchange transactions (B reorganizations) is a survey of the surrendering Target shareholders. The IRS also has long recognized that it will not be practical to survey all surrendering Target shareholders in all such cases, particularly when Target stock is publicly traded. To mitigate this concern, Rev. Proc. 81-70 issued in 1981 provided survey procedures, as well as procedures for the use of statistical sampling and estimation of basis.
However, since the publication of Rev. Proc. 81-70, the operation of the securities market has changed significantly, including a pervasive shift to the holding of stock in "street name" by nominees. Because these nominee holders are subject to strict confidentiality and other restrictions, the IRS noted it is often difficult, if not impossible, for corporations acquiring stock in a B reorganization to obtain the information necessary to establish basis in acquired stock using the procedures prescribed by Rev. Proc. 81-70.
Rev. Proc. 2011-35 adopts the surveying and statistical sampling guidelines in Rev. Proc. 81-70, but updates and revises them to take current market practices into account. Rev. Proc. 2011-35 also adopts certain safe harbor methodologies and expands the applicability of these provisions by permitting their use in any transferred basis transaction.
On May 25, Michigan Governor Rick Snyder signed into law an eight-bill package that includes H.R. 4361, legislation that replaces the Michigan Business Tax with a corporate income tax. Effective January 1, 2012, the new law would impose a corporate income tax at a rate of 6.0% on every taxpayer with business activity within Michigan or ownership interest or beneficial interest in a flow-through entity that has business activity in Michigan. Highlights of the new corporate income tax regime are as follows:
- Nexus: The new law retains the MBT's current nexus standard, one that is based on more than one day of physical presence, or "active solicitation" and $350,000 of Michigan sourced gross receipts. Also, ownership of a passthrough entity doing business in Michigan will create corporate income tax nexus for the corporate owner.
- Taxable Entities: While all types of "persons" including pass-through entities are subject to MBT, only corporations are subject to the new corporate income tax.
- Withholding: Passthrough entities would be required to withhold tax on distributions to nonresident individuals. Likewise, passthrough entities with over $200,000 in business income (after allocation and apportionment) would be required to withhold on the distributive share of business income attributed to each member that is a corporation or a passthrough entity.
- Tax Base: The computation of the tax base would start with federal taxable income. The related-party expense disallowance provisions apply to certain interest and intangible-related expenses. While losses generated under the MBT cannot be applied to offset corporate income tax liability, losses incurred after December 31, 2011 can be carried forward on a post-apportionment basis for 10 years.
- Combined Reporting: Taxpayers engaged in a unitary business are required to file combined returns.
- Apportionment: The new law generally retains the MBT's single-sales factor apportionment and market-based sourcing provisions. For taxpayers that own an interest in a passthrough entity, the amount of business income attributed to the passthrough entity's business activity in Michigan would be apportioned to Michigan at the passthrough entity level.
- Credits: Generally, the new corporate income tax does not adopt the MBT's generous credit regime. Other than a small business credit, there are essentially no credits for businesses, and taxpayers cannot use credits earned under the MBT to offset corporate income tax liability. However, taxpayers that earned certain credits under the MBT can elect to continue to calculate and pay tax under the MBT until such credits are used up.
- Insurance Companies and Financial Institutions: Generally, the taxation of insurance companies and financial institutions has not changed. Insurance companies will continue to be taxed on gross premiums at a rate of 1.25%. Financial institutions will continue to be subject to a tax on net capital; however, the current franchise tax MBT rate of 0.235% is increased to 0.29%.
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