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 released new versions of draft Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding. Draft instructions did not accompany the draft form and are not expected to be released in the near future.
The form has been divided into a form to be provided by individuals (W-8BEN) and a form to be provided by entities (W-8BEN-E). Also, a tax identification number issued by the foreign country of residence will now be required on the forms. According to the IRS’s unofficial comment, the instructions will detail how a beneficial owner will complete the foreign tax identifying number line as a resident in a jurisdiction that does not routinely use tax identification numbers like Japan. The instructions are also expected to address a withholding agent's due diligence regarding this line.
In connection with the Foreign Account Tax Compliance Act (FATCA), for participating foreign financial institutions (FFIs) and deemed-compliant FFIs, the Form W-8BEN includes references to both an FFI-EIN (used for filing purposes) and a FATCA identification number (used for public verification purposes).
On June 21, the Treasury Department announced that the governments of Japan and Switzerland have expressed a "mutual intent to pursue a framework for intergovernmental cooperation" for implementation of the FATCA provisions. The statement with Japan offers a framework for cooperation to facilitate FATCA implementation by supplementing direct reporting under FATCA by Japanese financial institutions with exchange of information on request, under provisions of the United States-Japan income tax treaty. According to a Treasury release, the framework adopted by Japan and Switzerland represents FATCA Model II. Model II establishes a framework of direct reporting by foreign financial institutions to the IRS, supplemented by information exchanged between the governments whereas Model I, adopted by France, Germany, Italy, Spain, and the United Kingdom in February 2012, contemplates reporting by FFIs to their respective governments, followed by the automatic exchange of this information with the United States.
The US Tax Court issued an opinion finding that an advance made by the foreign parent company to U.S. reverse hybrid entity (i.e., an entity which is treated as a corporation for US tax purposes but is treated as a pass-through entity for foreign tax purposes) in connection with a corporate acquisition was a loan for federal tax purposes (NA General Partnership & Subsidiaries v. Commissioner, T.C. Memo 2012-172 (June 19, 2012)).
As a UK-based utility company’s US subsidiary acquired a US utility company, the US subsidiary issued $4 billion in fixed-rate loan notes and $896 million of floating-rate notes to the UK parent in connection with the acquisition. The parties treated these unsecured loan notes as debt on their books, and reported as such to the Securities and Exchange Commission. The US subsidiary deducted $932 million of interest expense. The IRS disallowed the interest expense asserting that the advance was a capital contribution.
The US subsidiary was a Nevada general partnership that elected to be treated as a corporation under the check-the-box regulations for federal income tax purposes. While not stated in the opinion, it is possible that the US subsidiary, which is a general partnership, was treated as a pass-through entity for UK tax purposes so that the UK parent also deducted interest expense incurred by the US subsidiary (or did not report interest income received from the US subsidiary) for UK tax purposes.
The Tax Court concluded that the advance was debt and, thus, that the related payments of interest were deductible by examining the 11 factors which the Ninth Circuit (to which an appeal would lie) would use to determine whether an advance is debt or equity:
The U.S. Court of Appeals for the Federal Circuit reversed the Court of Federal Claims’ grant of summary judgment for the government and instead concluded that the "associated property rule" contained in regulations, as applied to property temporarily withdrawn from services, is not a reasonable interpretation of the Code (Dominion Resources, Inc. v. United States, 2011-5087 (Fed. Cir.))
Under the interest capitalization rule, interest expense incurred while a property is produced or improved needs to be capitalized. The general formula to determine the amount of interest to be capitalized is the amount of "production expenditures" multiplied by the weighted-average interest rate on the debt during the time of the production of the property. In case of improvements, the regulations define "production expenditures" to include not only the amount spent on improvements of the property but also the adjusted basis of the entire unit being improved that is temporarily withdrawn from service (so-called "associated property"). The Federal Circuit majority held that the associated-property rule is not a reasonable interpretation of the statutory language of the Internal Revenue Code.
Although the Federal Circuit decision could be reversed by the U.S. Supreme Court, or withdrawn on the basis of a rehearing, taxpayers that have applied the associated-property rule to property improvements in prior tax years may wish to file a Form 3115 to change their method of accounting to be able to both discontinue the application of the rule for future projects and recapture deferred deductions.
The Office of the Texas Comptroller announced that it has reconsidered its policy on allowing franchise taxpayers to file amended reports changing their election to deduct either costs of goods sold (COGS) or compensation. As the Texas franchise tax is based on a taxable entity's taxable margin, taxable "margin" is the lesser of: 1) 70% of total revenue; 2) total revenue minus cost of goods sold (COGS); or 3) total revenue minus compensation and benefits. Currently, a Texas rule provides that the election to deduct either COGS or compensation must be made by the original or extended due date of the franchise tax report. Under the revised policy, taxpayers can amend returns changing their previously made elections. Amended reports can be filed for all periods open under the statute of limitations.
The Treasury Department and IRS released proposed regulations (REG-142561-07) to provide guidance concerning the identity and authority of the agent for the consolidated group. The consolidated return regulations generally require an agent to act on behalf of the consolidated group. Historically, this agent has been the common parent of the group but amendments to the regulations have permitted other entities to be designated to act as agent for the group. The proposed regulations address administrative details regarding the designation as follows:
- The entity which becomes the agent as a result of being the default successor of the previous agent is required to notify the IRS in writing that it is a default successor.
- If the agent's existence terminates without a default successor, the agent must notify the IRS in writing of the designation and provide an agreement executed by the designated entity to serve as the agent.
- If the designated entity was not itself a member of the group during the consolidated return year, the agent for the group must furnish a statement by the designated entity to become primarily liable for the tax.
- A designated substitute agent must give notice to each member of the group when the IRS has designated a substitute agent for the group.
- If an entity ceases to be a member of a group, that entity may file a written notice of that fact with the IRS and request a copy of a notice of deficiency with respect to the federal income tax for a consolidated return year during which the entity was a member.
The IRS Office of Chief Counsel released a Chief Counsel Advice memorandum addressing "worthlessness" with regard to the stock of a subsidiary that remains a member of the group and that holds a tax refund claim or other legal claim at the end of the year. The memo concludes that a tax refund or other legal claim is an asset in the hands of the subsidiary, and that to the extent that the value of the claim exceeds state law minimum capital requirements, the subsidiary's stock cannot satisfy the requirements of worthlessness under the regulations. AM 2012-003 (dated April 10, 2012, and release date, May 4, 2012).
Illinois: Department of Revenue Asks State Supreme Court to Address Click-Through Nexus
On May 7, 2012, a circuit court judge ruled in favor of the plaintiff Performance Marketing Association (PMA) in a case challenging the constitutionality of Illinois' click-through nexus provisions, which went into effect on July 1, 2011. The Illinois law, unlike other states' click-through laws, provided no means for a remote retailer to rebut the presumption that the associate or affiliate relationships with Illinois residents, standing alone, created nexus.
The judge's rather brief final order does not offer a detailed analysis of why he held for the PMA. Rather, the order simply provides that a relationship with in-state residents is insufficient to create substantial nexus with Illinois. In addition, the judge determined that the click-through nexus provisions ran afoul of the Internet Tax Freedom Act.
It has been reported that the Illinois Department of Revenue will appeal the case to the state's highest court.
Washington: State High Court Addresses B&O Tax Recoupment
The Washington State Supreme Court was asked by the Ninth Circuit to clarify the circumstances under which a seller can pass business & occupation (B&O) tax through to customers (Peck v. AT&T Mobility). B&O tax is a tax imposed on gross receipts sourced within the state of Washington. Two earlier Washington court decisions had addressed pass-through of B&O tax in the context of car sales and had, apparently, created some confusion. In the instant case, a telecommunications service provider had included a surcharge on the bill for gross receipts tax recovery; however, the provider argued that it was proper because the recovery charge was disclosed.
In addressing this question, the Washington Supreme Court first observed that the B&O tax is a tax imposed on businesses for the privilege of doing business in the state. The tax is not intended to be imposed on customers and is to be treated as an overhead cost, similar to rents, salaries, etc. In the court's view, recouping the B&O tax as a line-item gives consumers the impression that the tax is similar to a sales or other transactional tax. Although sellers are free to pass on overhead costs, including B&O tax, it must be done by including such costs in the overall sales price rather than as a separate surcharge. Accordingly, the court concluded that the telecommunications service provider could not pass-through B&O tax to customers as a surcharge on the customer's bill, despite the fact that the surcharge was disclosed.
California: In-State Presence of Telecommuting Employee Creates Nexus
The California State Board of Equalization ruled that an out-of-state company had substantial nexus with California because of the presence of an in-state telecommuting employee (Matter of Warwick McKinley, Inc.). The Massachusetts-based taxpayer provided marketing and recruiting consulting services to clients in the clean/green energy sector. The company's sole contact with California was that it had an employee that worked out of her home in California. After learning that the taxpayer had paid payroll taxes for the California worker and after requesting certain information from the taxpayer, the Franchise Tax Board (FTB) assessed the taxpayer unpaid corporate franchise taxes, as well as various penalties. The company protested, arguing that the presence of a single-employee was not sufficient to create nexus. The Board ruled that the presence of the in-state employee was sufficient to create nexus.
The IRS has released the annual report on its Advance Pricing Agreement (APA) Program for the calendar year 2011 (Announcement 2012-13).
Number of Cases:
|Revised or Amended
|Canceled or Revoked
Average Number of Months to Complete:
|Bilateral / Multilateral
From 2010 to 2011, the number of applications filed decreased from 144 to 96 while the number of cases executed also decreased 69 to 42. The number of pending cases significantly increased (350 in 2010 and 445 in 2011). The average number of months to complete has increased by 2.9 months for unilateral APAs and also increased by 1.5 months for bilateral APAs.
As to the nature of the relationship between the controlled taxpayers, foreign parent/US subsidiary remains to represent the largest population.
|Foreign Parent / U.S. Subsidiary
|U.S. Parent / Foreign Subsidiary
|Foreign Company and U.S. Branch
The Treasury Department and IRS released final regulations (T.D. 9584) concerning the reporting requirements for interest on deposits maintained at U.S. offices of financial institutions and paid to nonresident alien individuals. The final regulations adopt regulations that were proposed in January 2011 with certain changes.
In response to concerns that these regulations might affect the investment and savings decisions of nonresidents, the final regulations revise the 2011 proposed regulations to require reporting only in instances of interest paid to a nonresident alien individual resident in a country with which the United States has in effect an information exchange agreement. A requirement contained in the 2011 proposed regulations that financial institutions were to include the information statement provided to nonresident alien individuals about providing this information to the government of the country where the recipient resides is removed.
In connection with the final regulations, the IRS issued Rev. Proc. 2012-24 providing a list of countries with which the United States has an income tax treaty or tax information exchange agreement that has an effective information exchange provision. Japan is included in the list.
The U.S. Supreme Court, divided 5-4, affirmed a decision of the Fourth Circuit that the extended six-year statute of limitations does not apply when the taxpayer has overstated the basis of property that was sold so that the resulting deficiency exceeded 25% of the amount of gross income reported on the return. United States v. Home Concrete & Supply, LLC, No. 11-139 (S. Ct. April 25, 2012).
The majority determined that this issue had been resolved already by Colony, Inc. v. Commissioner, 357 U. S. 28 (1958) which determined that the extended limitations period does not apply to an overstatement of basis and that there was no ambiguity in this Court holding which Treasury and the IRS could otherwise interpret through regulations. The dissenting opinion, however, pointed out that a change to the law (after Colony) left room for the interpretation by regulation.
Subsequently, the U.S. Supreme Court issued orders vacating judgments of various U.S. circuit courts of appeals.
On April 19, House Bill 386 to make changes to the sales and use tax statutes was signed into law by Governor Deal. The legislation:
- Adopts a single statutory manufacturing exemption and incorporates many of the definitions and examples currently found in the Georgia manufacturing exemption regulations;
- Expands the manufacturing exemption to include all "energy" (including natural or artificial gas, oil, gasoline, electricity, solid fuel, wood, waste, ice, steam, and water) necessary and integral to the manufacturing process (phased-in over 4 years);
- Adopts discretionary exemptions for certain regionally significant projects including immediate application of (i.e., waiver of the 4-year phase-in of) the energy exemption;
- Expands nexus definition through in-state affiliates or that have third-parties in the state performing certain activities;
- Adopts click-through nexus provisions; and
- Provides a bright-line test for sellers participating in convention and trade shows in Georgia.
On March 27, the IRS announced organizational and administrative changes and transitional procedures in connection with the creation of the Advance Pricing and Mutual Agreement (APMA) program (IR-2012-38).
As explained in the IRS release, before February 26, 2012, the Advance Pricing Agreement (APA) program was part of the IRS Office of the Associate Chief Counsel (International) and the functions of the U.S. Competent Authority were generally exercised by the office of the Director, Competent Authority & International Coordination within the LB&I Division of the IRS. Effective February 26, 2012, the APA program and Competent Authority functions (including mutual agreement procedures) related to transfer pricing and other allocation issues, as well as determinations of permanent establishment status, are realigned and consolidated into APMA which is a single program within LB&I division.
The Director of APMA reports to the Director, Transfer Pricing Operations. Other Competent Authority functions are the responsibility of a new LB&I Treaty Assistance and Interpretation team in the office of the Assistant Deputy Commissioner (International), LB&I.
The IRS announced that it intends to revise the existing published guidance with respect to requests for APAs and Competent Authority assistance. Before issuing the updated guidance, the IRS will seek public comment. Pending issuance of future IRS guidance, taxpayers are directed to continue to follow and rely on Rev. Proc. 2006-9, as modified by Rev. Proc. 2008-31, with respect to requests for APAs and Rev. Proc. 2006-54, with respect to requests for Competent Authority assistance with certain exceptions.
On March 29, the House passed on a largely party-line vote, 228-191, a fiscal year 2013 budget resolution. The budget resolution is a blueprint containing instructions for various committees as they write spending bills.
The tax element of the resolution, proposed by Budget Committee Chairman Paul Ryan (R-WI), would set revenues at "historical norms" of 18% to 19% of GDP, according to the committee, while repealing the alternative minimum tax, making permanent the Bush tax cuts of 2001 and 2003, and cutting the maximum corporate and individual tax rates to 25%. The budget resolution also contemplates a shift in the worldwide system of taxation to a territorial system. The revenue cost of the reductions would be offset by unspecified base broadening provisions. It would also reduce spending to less than 20% of gross domestic product by 2016, from the 2012 level of 23.4%.
Senate Majority Leader Harry Reid (D-NV) had no immediate comment, but he has previously said that the Senate will not consider any budget resolution this year, relying instead on the spending parameters set last year in the Budget Control Act.
On the same day, the Senate blocked a motion to proceed to S. 2204, the Repeal Big Oil Tax Subsidies Act. The 51-47 procedural vote, which required 60 votes, effectively ends consideration of the bill, offered by Democrats to highlight their differences with Republicans on energy. The bill would have repealed many tax preferences and incentives for oil and gas production.
On March 7, the IRS issued two revenue procedures that resolve several key transitional issues with respect to the temporary repair regulations issued in December 2011. The revenue procedures are effective for tax years beginning on or after January 1, 2012.
Rev. Proc. 2012-19 provides the procedures by which a taxpayer may obtain automatic consent to change to the methods of accounting for materials and supplies as well as those for repairs vs. capital expenditures under the new temporary regulations.
Rev. Proc. 2012-20 provides the procedures by which a taxpayer may obtain automatic consent to change to the methods of accounting for depreciating or amortizing leasehold improvements, general asset accounts, MACRS property, and dispositions of MACRS property.
On March 15, the IRS posted an LB&I directive that provides guidance to IRS auditors with respect to taxpayer examinations concerning the repair vs. capitalization issue (LB&I-4-0312-004). The LB&I directive instructs IRS examiners to discontinue current examinations and not to begin any new examinations concerning the repair vs. capitalization issue.
However, if the taxpayer has filed a Form 3115, Application for Change in Accounting Method, on or after December 23, 2011 (the date when the temporary repair regulations were released) for a tax year not covered by the temporary regulations, the LB&I directive instructs IRS examiners to "risk assess" the Form 3115 and determine whether to examine it.
The Texas Comptroller announced a tax amnesty program that will be held later this year. Under Project Fresh Start, the Comptroller will waive penalties and interest for businesses that file delinquent tax reports or amend reports where taxes were underreported and pay all taxes due. The amnesty covers taxes and fees that were originally due before April 1, 2012. The program will run from June 12 through August 17, 2012. Taxpayers that have not filed a tax report, underreported tax on a previously filed report, or do not have a permit to report and remit Texas taxes are eligible for the program. Taxpayers that are under audit or have been identified for audit are not eligible to participate.
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