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.
On November 21, President Obama signed into law H.R. 674, the 3% Withholding Repeal and Job Creation Act of 2011. The legislation repeals a requirement that government entities withhold 3% on certain payments made to vendors. The withholding requirement was originally enacted in 2005, but delayed by subsequent legislation, effectively never entered into force. The legislation also includes provisions enhancing the tax preference for hiring veterans.
The Joint Committee on Taxation (JCT) has provided House Ways and Means ranking Democrat Sander Levin (MI) with a preliminary revenue estimate of the lowest possible corporate rate that can be achieved by repealing or modifying corporate tax expenditures. The JCT estimates that the revenue saved by repealing or modifying most corporate tax expenditures would offset the cost of reducing the corporate rate to 28%. The "very preliminary" estimate did not quantify the revenue effect of a number of existing preferences, suggesting that a more detailed estimate could produce a score showing additional revenue gains.
The IRS posted a Memorandum of Legal Advice concluding that a taxpayer’s providing financial statements prepared using IFRS (International Financial Reporting Standards) to its lending bank violated the LIFO (last in, first out) conformity requirements (Legal Advice 20114702F).
Under the case considered, as the taxpayer (a US corporation) was required by its foreign parent to adopt IFRS to facilitate the processing of preparing worldwide consolidated financial statements, the taxpayer had used, and continued to use, the LIFO inventory method for a portion of its inventory for both tax and financial reporting purposes. The taxpayer provided the IFRS-only balance sheet and income statement to its lending bank, related to lending requirements imposed by the bank related to a letter of credit. It also provided tabulated financial statements (including LIFO adjustments) to the IFRS column to arrive at U.S. GAAP. However, the taxpayer did not make a distinction between primary or supplemental information with these financial statements and did not include explanatory footnotes regarding the change. The IRS concluded that the documents did not meet the exception for supplemental or explanatory information, and that the issuance of these financial statements to the lending bank violated the LIFO conformity requirements.
The IRS Large Business & International (LB&I) division released a memorandum for LB&I employees, providing additional Schedule UTP (Statement of Uncertain Tax Position) guidance and procedures for examinations. The guidance is to be followed by LB&I examiners for any examination that includes a return containing a Schedule UTP.
The guidance provided by the memorandum includes the following:
- If the Schedule UTP is deemed not to have met the requirements of the instructions, the IRS Centralized Review Team will contact the taxpayer. Examiners and/or specialists are not to take any further actions.
- The examination of a return with a Schedule UTP is not mandatory. The presence of the Schedule UTP is, in and of itself, not to be the sole factor used to determine whether or not to proceed with an examination.
- When examining a return with a Schedule UTP, territory managers must be notified and be involved in team discussions during the pre-exam analysis.
- The examination team may ask the taxpayer for information about the relevant facts affecting the tax treatment of the position and information about the identity of the tax issue but cannot ask the taxpayer to explain the rationale for determining that the issue was uncertain, or for information about the hazards of the position or an analysis of support for or against the tax position. Also, the team cannot ask for copies of workpapers used to prepare the Schedule UTP, any tax accrual workpapers, or any documents privileged under the modified policy of restraint.
- The fact that an issue disclosed on the Schedule UTP was present on a prior year audit is not sufficient to automatically roll over an issue from one year to the next. The fact that an issue disclosed on a 2010 Schedule UTP is selected for examination is not sufficient to automatically raise the issue in a prior year whether or not that prior year is already under examination.
- If the examination team thinks that an issue disclosed on the Schedule UTP must be addressed in a prior year that is under examination, the approval of the team manager is required before the issue is included in the audit plan or a discussion occurs with the taxpayer. If the team thinks that an issue disclosed on the Schedule UTP is to be addressed in a prior year not under examination, the approval of the team manager is required to order a prior-year return.
The memorandum also states that the LB&I division has prepared a training module for IRS examiners, which will be available by December 31, 2011, and that before starting the examination of any return including a Schedule UTP, IRS employees will be required to complete this training.
The Michigan Department of Treasury previously announced in a Notice that the holding in the Kmart case applied for Michigan Business Tax (MBT) purposes. Thus, a "person" that is a federal disregarded entity is considered a separate entity for purposes of the MBT. Consequently, such disregarded entities cannot file as a division of their owner and must file a separate MBT return or file as a member of a unitary business group. The Notice provided that this new interpretation applies to all open MBT periods and that amended or original returns must be filed by June 30, 2011. The due date was subsequently extended to October 31, 2011, then again to December 31, 2011. Most recently, the Department revised the Notice again to provide that new and amended returns due under the Kmart decision will be due on July 1, 2012. There is a possibility that Michigan lawmakers will reach agreement on a legislative fix prior to the new due date.
The 2004 provision to temporarily reduce corporate tax on foreign earnings repatriation "produced no appreciable increase in U.S. jobs or research investments, and led to U.S. corporations directing more funds offshore," according to a report released by the Senate permanent subcommittee on investigations. While the provision in the American Jobs Creation Act of 2004 allowed corporations a one-year window to repatriate foreign earnings at an effective rate of 5.25%, currently pending House and Senate bills would provide a second partial tax holiday for repatriation of foreign earnings—H.R. 942, "the American Research and Competitiveness Act of 2011, and S. 1671, the Foreign Earnings Reinvestment Act".
Subcommittee Chairman Carl Levin (D-MI) has long been a critic of the provision. His staff surveyed 20 multinationals including the 15 corporations that repatriated the most earnings. It sought information about the amounts of offshore funds repatriated, domestic employment, executive compensation, stock buybacks, and other items over the period 2002-2008. The staff also reviewed academic studies of the 2004 repatriation.
The subcommittee staff found that the top 15 corporations repatriated more than $150 billion, but reduced their combined U.S. workforce by 20,931 and increased R&D expenditures from 2004 through 2007, but at slightly lower rates than before repatriations. The staff also found that those 15 companies accelerated stock repurchases and increased executive compensation.
The report recommends against enacting a second repatriation tax holiday.
The U.S. Government Accountability Office (GAO) issued a report concerning IRS tax information exchanges with tax agencies of other countries.
The GAO report (GAO-11-730) focused on (1) identifying all income tax treaties and similar agreements between the United States and other countries; (2) describing the volume of exchange activity, types of information exchanged between the United States and its treaty partners, and request processing times; and (3) identifying opportunities to improve the effectiveness of current U.S. information exchange procedures.
The GAO recommended (and the IRS concurred) that the IRS require the collection of consistent and accurate data on specific tax information exchange cases, and of feedback from program users on a routine basis as part of its operations.
California Franchise Tax Board issued a Notice addressing when the FTB Chief Counsel Office will issue rulings as to whether taxpayers are doing business in California. Effective for tax years beginning on or after January 1, 2011, new economic nexus standards apply in California. In general, the FTB will consider a corporation to have California corporate income/franchise tax nexus if it has more than $500,000 in California sales, $50,000 in California property, or $50,000 in California payroll. However, even if an entity does not meet one of these bright-line tests, it is still necessary to determine whether nexus exists because the taxpayer is "actively engaging in any transaction for the purpose of financial gain or pecuniary profit" under the general doing business definition. The Notice provides that the FTB will accept ruling requests as to whether taxpayers are considered "doing business" under the general definition, but will not provide guidance on whether taxpayers meet the bright-line factor presence tests because, in the FTB’s view, whether a taxpayer meets the factor presence tests is a factual determination. The Notice also provides that requesting advice on doing business will not prevent taxpayers from later taking advantage of the state’s voluntary disclosure program, even if the taxpayer’s identity is disclosed during the course of communicating with the FTB.
A Texas Administrative Law Judge (ALJ) considered whether a taxpayer was allowed to use the Multistate Tax Compact (MTC) three-factor (sales, property, and payroll) apportionment election in filing its Texas franchise tax returns (commonly known as the ‘margin tax’) for the 2008 and 2009 tax years. Under Texas’ revised franchise tax law adopted in 2006, multistate taxpayers apportion their tax base to Texas using a single-sales factor apportionment formula. However, the MTC, which was adopted in Texas in 1967, allows taxpayers to elect to use a three-factor evenly-weighted formula. The MTC compact remains part of Texas’ tax law. Before the Texas franchise tax was revised in 2006, a specific statute provided that the MTC’s apportionment provisions did not apply to the franchise tax. This provision was repealed when the franchise tax was revised in 2006. As such, the taxpayer argued that because there was no specific prohibition against the use of the MTC election, it should be allowed for purposes of the revised franchise tax.
The ALJ disagreed, noting that the revised franchise tax apportionment statute states that taxpayers shall apportion their taxable margin to Texas using a receipts only methodology. Nothing in the statute specifically allows for use of any other methodology. The ALJ noted that this statutory directive was incorporated into the Comptroller’s rules and FAQ and that none of the legislative history suggested that use of the MTC apportionment provisions would be allowed under the revised franchise tax.
The Treasury Department and IRS released final regulations (T.D. 9553) clarifying that a single-owner eligible entity that is disregarded as an entity separate from its owner for federal income tax or any other purpose (a disregarded entity) is treated as a corporation for tax administration purposes related to federal employment taxes and excise taxes. The release adopts rules that were proposed in September 2009, and removes corresponding temporary regulations.
On September 8, President Obama outlined his proposal for "American Jobs Act" with $447 billion economic stimulus to a joint session of Congress. The proposal would:
- Increase the temporary 2% payroll tax cut to 3.1% for 2012 and expand it to the employer share for the first $5 million in wages
- Extend for one year the 100% business expensing provision that is effective for 2011.
- Eliminate the 6.2% employer share of payroll taxes to the extent that firms increase their payroll by adding new workers or increasing the wages of their current worker, capped at $50 million in payroll increases
- Provide a $4,000 tax credit to employers for hiring long-term unemployed workers, a $5,600 tax credit for hiring unemployed veterans, and a $9,600 tax credit for hiring unemployed veterans with service-connected disabilities
On September 12, the White House released legislative text of the proposal with the following revenue offsets:
- Limit to 28% the value of itemized deductions for those who earn more than $200,000/$250,000 (single/joint filers)
- Eliminate preferential rate on carried interests
- Repeal various oil and gas incentives
- Modify corporate jet depreciation
- Modify taxation of dual capacity taxpayers
On September 23, the White House released legislative text of the president’s "plan for economic growth and deficit reduction." The 284-page document includes text and analysis of the revenue offsets the administration sent to Congress September 19.
Close business loopholes and broaden the business tax base:
- Repeal last-in, first-out (LIFO) method of accounting for inventories
- Repeal lower-of-cost-or-market inventory accounting method
- Eliminate coal preferences
Reform treatment of insurance companies and products:
- Modify rules that apply to sales of life insurance contracts
- Modify dividends-received deduction for separate accounts
- Expand pro rata interest expense disallowance for corporate-owned insurance
Reform the U.S. international tax system:
- Defer deduction of interest expense related to deferred income
- Determine foreign tax credit on a pooling basis
- Excess income from transfers of intangibles to low-taxed affiliates
- Valuation and definition of intangible property
- Limit earnings stripping by expatriated entities
- Reinstate superfund taxes
- Make unemployment insurance surtax permanent
- Increase certainty with respect to worker classification
On September 16, the "Leahy-Smith America Invents Act" (H.R. 1249), patent reform legislation that effectively bans future issuance of patents on tax planning strategies, was signed into law by President Obama.
A provision in the new law (section 14 of the Act) generally deems any invention that is a "strategy for reducing, avoiding, or deferring tax liability" as "prior art," and consequently unpatentable. The law provides an exception for systems used to prepare tax or information returns or for financial management, to the extent severable from any tax planning strategy. The prohibition applies to pending and future patent applications, but does not affect existing patents.
U.S. Supreme Court Grants Certiorari Concerning Whether Overstatement of Basis is Omission of Income Triggering a Six-Year Statute of Limitations
On September 27, the U.S. Supreme Court granted a petition for writ of certiorari concerning whether an overstatement of basis resulting in an understatement of gross income is an omission for purposes of extending the three-year statute of limitations to six years. "Home Concrete & Supply, LLC v. United States", 11-139, cert. granted September 27, 2011. There has been a split among the U.S. courts of appeals on the issue.
The District of Columbia FY 2012 Budget Support Act became law on September 14. The new law adopts mandatory unitary combined reporting for tax years beginning on or after December 31, 2010.
The District of Columbia Office of Tax and Revenue has announced that any estimated payments due before 45 days after September 14, 2011, are due the next subsequent installment due date. For example, if a combined group's tax year begins on January 1, 2011, the first, second and third "catch up" payments are due on December 15, 2011, together with the fourth quarter payment under combined reporting.
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