In this section of Jnet, we provide brief updates on legislative, judicial, and administrative 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 July 1, the U.S. Government Accountability Office (GAO) publicly released a report titled "Corporate Income Tax: Effective Tax Rates Can Differ Significantly from the Statutory Rate (GAO-13-520)" which was prepared for Congress pursuant to a request to examine the effective tax rates paid by U.S. corporate income taxpayers and to compare those rates to the statutory rate.
Effective tax rates differ from statutory tax rates in that they attempt to measure taxes paid as a proportion of economic income, while statutory rates indicate the amount of tax liability (before any credits) relative to taxable income, which is defined by tax law and reflects tax benefits and subsidies built into the law. GAO compare book tax expenses to tax liabilities actually reported on corporate income tax returns.
For tax year 2010 (the most recent information available), profitable U.S. corporations that filed a Schedule M-3 paid U.S. federal income taxes amounting to about 13% of the pretax worldwide income that they reported in their financial statements (for those entities included in their tax returns). When foreign and state and local income taxes are included, the effective tax rate for profitable filers increased to around 17%.
The inclusion of unprofitable firms, which pay little if any tax, also raised the effective tax rates because the losses of unprofitable corporations greatly reduce the denominator of the measures. Even with the inclusion of unprofitable filers, which increased the average worldwide effective tax rate to 22.7%, all of the effective tax rates were well below the top statutory tax rate of 35%.
The GAO could only estimate average effective tax rates with the data available and could not determine the variation in rates across corporations. The limited available data from Schedules M-3, along with prior GAO work relating to corporate taxpayers, suggested that effective tax rates are likely to vary considerably across corporations
The Appellate Division of the New York Supreme Court held that the enactment of the Metropolitan Commuter Transportation Mobility Tax (Payroll Tax) comported with the requirements of the New York Constitution. In doing so, the court reversed a trial court decision holding that the tax was unconstitutional because it was a "special law" relating to the property, affairs, or government of any local government that had been enacted without a "home rule message" (an affirmation of the legislation by either two-thirds of the local legislatures in the affected areas or the local chief executive officer with the consent of a majority of the local legislature) required under the New York Constitution.
In 2009, the Payroll Tax was enacted by the New York State Legislature in response to a budget shortfall in the Metropolitan Transit Authority (MTA). The Payroll Tax is imposed on employers engaged in business in the Metropolitan Commuter Transportation District (MCTD) and on net earnings of self-employed persons attributed to the MCTD. Some of the affected counties and municipalities in the MCTD later brought suit challenging the constitutionality of the Payroll Tax under several provisions of the New York constitution.
The trial court determined that the bill adopting the Payroll Tax was a "special law" because it applied only to certain counties, rather than every county in New York State. A special law must be passed with a "home rule" message unless a special law serves a substantial state concern. However, the court determined that there was no substantial state concern because the MTA budget shortfall affected only counties in the MCTD and the Payroll Tax was imposed only in the MCTD. As such, the trial court judge held that the statute was unconstitutionally enacted by the New York Legislature.
On appeal, the appellate court, relying on a number of decisions of New York's highest court addressing when a substantial state concern existed, reversed the trial court's finding. In the appellate court's view, New York's mass transit system, which is funded by the Payroll Tax, (1) provides direct benefits to the regional and state economy, (2) boosts economic activity across the state, and (3) could create jobs not only in New York City but in communities as far away as Buffalo, Albany, and Plattsburgh. The court ruled that the Payroll Tax clearly serves a substantial state concern. As such, the exception to the general rule that special laws be passed with a home rule message applied.
On July 9, the U.S. Court of Appeals for the District of Columbia reversed and remanded a decision to the Tax Court, after concluding that non-resident aliens may calculate their winnings (and losses) from gambling activities in the United States on a per-session basis (Park v. Commissioner, No. 12-1058 (D.C. Cir. July 9, 2013)).
The IRS determined that the winnings of non-resident alien gamblers—such as the taxpayer in this case, a South Korean businessman—are to be taxed differently from those of U.S. citizen gamblers. U.S. citizens are able to subtract losses from their wins within a "gambling session" to arrive at per-session wins or losses. However, for non-resident aliens, the IRS applied a per-bet rule—rather than a per-session rule, effectively precluding non-resident aliens from offsetting losses against wins.
The taxpayer in this case (after being assessed for over $134,000 on slot machine winnings) claimed that he ought to be allowed to calculate his winnings on a per-session basis. The Tax Court, however, agreed with the IRS that a non-resident alien generally cannot deduct or offset gambling losses against gambling winnings.
On appeal, the D.C. Circuit noted that section 871, which imposes taxes on non-resident aliens for all "gains," was interpreted by the IRS as covering every winning pull of the slot machine—a per-bet approach. The D.C. Circuit also noted that the term "gains" also appears in section 165(d) which provides that "losses from wagering transactions shall be allowed only to the extent of the gains from such transactions" allowing U.S. citizens to measure gains/losses on a per-session basis. The D.C. Circuit found that since the same term—gains—is used in both sections 871 and 165(d), it "makes little sense" whether a gambler is a U.S. citizen or a non-resident alien to measure gambling winnings on casino games such as slots on a per-bet rather than per-session basis.
On June 27, Senate Finance Committee leaders announced to their colleagues that they intend to start tax reform with a "blank slate" by stripping out "all of the special provisions in the form of exclusions, deductions and credits and other preferences that some refer to as ‘tax expenditures.'"
In a letter released by the committee, Chairman Max Baucus (D-MT) and ranking Republican Orrin Hatch (UT) asked their colleagues for submissions by July 26 outlining "what tax expenditures . . . should be included in a reformed tax code, as well as other provisions that should be added, repealed or reformed as part of tax reform."
Concerning the tax expenditures intended to be included in a reformed tax code, the letter states:
We both believe that some existing tax expenditures should be preserved in some form…but the tax code is also littered with preferences for special interests… [W]e plan to operate from an assumption that all special provisions are out unless there is clear evidence that they: (1) help grow the economy, (2) make the tax code fairer, or (3) effectively promote other important policy objectives.
According to the letter, the senators contend that their "blank slate approach" would maintain progressivity but skip over the argument, for now, of whether to lower rates or apply the revenue to deficit reduction. A JCT table in the letter indicates that "every $2 trillion of individual tax expenditures that are added back to the blank slate would, on average, raise each of the seven individual income tax brackets by between 1.3 and 2.2 percentage points from what they would be under the blank slate." Likewise, the table shows that every $200 billion of corporate tax expenditures that are added back to the blank slate would, on average, raise the top corporate income tax rate by 1.5 percentage points from what they would be under the blank slate.
On June 26, the U.S. Tax Court issued an opinion addressing its jurisdiction to review the cancellation of an advance pricing agreement (APA) by the IRS (Eaton Corp. v. Commissioner, 140 T.C. No. 18 (June 26, 2013)).
The taxpayer and the IRS entered into two advance pricing agreements (APAs) establishing a transfer pricing methodology for "covered transactions" between the taxpayer and its subsidiaries. Subsequently, the IRS determined the taxpayer had failed to comply with the applicable terms of the APAs and canceled them. The IRS then issued a deficiency notice and in applying an alternative transfer pricing methodology increased the taxpayer's income under section 482 by over $102 million for 2005 and over $266 million for 2006.
The taxpayer filed a petition with the Tax Court. The taxpayer alleged that it did comply with the terms and conditions of the APAs, and demonstrated that compliance to the IRS by disclosing errors in its data in 2010 and rectifying those errors. The taxpayer and IRS filed cross-motions for partial summary judgment, with the taxpayer claiming that the APAs were enforceable contracts, and that the IRS must show that the cancellations were appropriate under contract law. The IRS countered that it canceled the APAs under revenue procedures that reserve certain discretion to the Commissioner and that the cancellations were administrative determinations that the Tax Court has jurisdiction to review for abuse of discretion in order to resolve the merits of a deficiency determination.
The Tax Court agreed with the IRS that it has jurisdiction to review the cancellations of the APAs because they are administrative determinations necessary to determine the merits of the deficiency determinations. The court ordered that the taxpayer must show that the APA cancellations by the IRS were arbitrary, capricious or without sound basis in fact.
The Massachusetts Appellate Tax Board addressed whether a taxpayer, the Canadian-based Parent of a group of U.S. Subsidiaries, had nexus with Massachusetts following the transfer of certain employees and functions.
Specifically, the parent moved employees of certain Massachusetts subsidiaries to its payroll, and leased office space at an affiliate's Massachusetts location to house these new employees. After the transfers, the taxpayer was included in the Massachusetts combined group for the tax years at issue.
In this so-called "reverse-nexus" determination, the Commissioner asserted that nexus was established purely to utilize the taxpayer's significant losses. In contrast, the taxpayer argued that its transfer of employees and business functions had a valid business purpose and economic effect beyond the avoidance of tax.
After reviewing all of the evidence, including testimony of the taxpayer's employees, the Board determined that the transactions undertaken to establish nexus had no purpose other than tax avoidance and should be disregarded under the sham transaction doctrine. Crucial to this determination were internal communications and memoranda stating that the reorganization was intended to reduce Massachusetts tax liability and ensuring that there would be no impact to overall management. Furthermore, the Board noted that the centralization of the taxpayer's tax, insurance, and internal audit functions had largely already occurred prior to the tax years at issue and generally, nothing changed meaningfully for the employees that had purportedly been transferred.
On June 25, the IRS released Rev. Proc. 2013-32 which revises the IRS letter ruling policy concerning spin-offs, reorganizations, and other corporate nonrecognition transactions.
Rev. Proc. 2013-32 states that the IRS will no longer rule on whether such corporate transactions generally qualify for tax-free treatment. However, the IRS will issue a letter ruling on "significant issues" presented with respect to the transaction.
For example, a section 351 exchange that does not present any significant issues under section 351 may present a significant issue regarding the application of section 358 to the transferor in the exchange. Here, the IRS will rule only on the significant issue under section 358.
On May 6, the Joint Committee on Taxation (JCT) released a report to the House Ways and Means Committee's Tax Reform Working Groups containing a review of current law and suggestions made for tax reform proposals.
On February 13, 2013, Ways and Means Committee Chairman Dave Camp and Ranking Member Sander Levin announced the formation of 11 Ways and Means Committee Tax Reform Working Groups. The mission of each working group was to review current law in its designated area, research relevant issues, and compile related feedback from stakeholders, academics and think tanks, practitioners, the general public, and colleagues in the House of Representatives.
The JCT report provides an overview of the Internal Revenue Code as in effect for 2013 and provides a more detailed description of the Code provisions relevant to the topic area of each working group. The document also summarizes the suggestions for reform and other commentary submitted by the public to the various working groups through the website of the Ways and Means Committee Working Groups. In addition, at the request of Chairman Camp and Ranking Member Levin, the document briefly summarizes a selection of proposals to reform the Federal tax system that members of Congress, commissions, and others have presented to policy makers over the past several years.
IRS Large Business & International (LB&I) division posted a directive (LB&I-04-0413-002) that instructs IRS examiners not to challenge a taxpayer's treatment of its eligible milestone payments for investment banker fees in connection with a business acquisition provided that the taxpayer satisfies certain conditions.
As the IRS issued Rev. Proc. 2011-29 on April 8, 2011 providing a safe harbor for allocating success-based fees paid or incurred in a covered transaction, the LB&I directive sets forth different conditions depending on whether the tax years, in which the payments were made, ended before or after April 8, 2011, the date of Rev. Proc. 2011-29. However, in all cases, in order to satisfy the conditions under the LB&I directive, it is necessary that the taxpayer at least:
- Did not deduct more than 70% of any eligible milestone payment incurred in connection with the respective success-based fee on its original tax return for the year in which the taxpayer's liability for the eligible milestone payment accrued; and
- Is not contesting its liability for the eligible milestone payment.
On May 15, the IRS announced details concerning the sequestration-related furlough closures (IR-2013-51). Currently, closures are planned for May 24, June 14, July 5, July 22, and August 30, 2013. At a later date, the IRS may possibly announce one or two additional furlough days, if necessary.
According to the IRS release all IRS operations will be closed on the furlough days, and no tax returns will be processed and no compliance-related activities will take place on those days. The IRS release states:
- Taxpayers are to continue to file their returns and pay any taxes due as usual.
- Taxpayers intending to contact the IRS about their returns or payments need to take these furlough dates into account.
- Because none of the furlough days is considered to be a federal holiday, the IRS shutdown will have no effect on any tax-filing deadlines.
- The IRS will be unable to accept or acknowledge receipt of electronically filed returns on any day when the IRS is closed.
- Tax-payment deadlines are also unaffected.
- Some web-based online tools and phone-based automated services will continue to function on furlough days, while others will not.
The IRS stated that the taxpayer will have until the next business day when the last day for responding to an IRS request falls on a furlough day with respect to:
- Administrative summonses
- Requests for records in connection with a return examination, review or compliance check
- Document requests related to a collection matter
There will not be any additional time allowed to respond to other agencies or the courts.
On May 16, President Obama announced the appointment of Daniel Werfel, Controller of the Office of Management and Budget, as acting Commissioner of Internal Revenue as the former IRS acting director Steven Miller resigned in connection with the IRS's targeting of conservative groups. Werfel will serve as acting IRS Commissioner through the end of the fiscal year.
On May 16, the IRS updated a list of "frequently asked questions" (FAQs) on its website concerning the medical device excise tax, by adding a new question and answer concerning pre-filing agreements. According to the new FAQ, taxpayers may request a PFA on certain medical device excise tax issues including methodology to make certain determinations. Pre-filing agreements may be entered into between the IRS and taxpayers prior to filing of the tax returns concerning issues that require either a determination of facts or the application of well-established legal principles to known facts.
On May 22, the IRS posted a draft version of Form W-8BEN-E, which entities would use to certify as to their status as beneficial owners or payees of a payment for withholding tax purposes and also as to their status under the FATCA provisions as either payees or account holders of a foreign financial institution. The IRS has requested comments concerning the draft forms be submitted.
On May 10, the IRS announced a notice of change in Schedule M-3 filing requirements for corporations and partnerships with $10 million to $50 million in total assets. These corporations and partnerships that file Forms 1120, 1120-C, 1120-F, 1120S, 1065 and 1065-B will be permitted to file Schedule M-1, in place of Schedule M-3, Parts II and III, for tax years ending December 31, 2014, and later.
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