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.
The Tax Foundation released its 2014 State Business Tax Climate Index. The annual study seeks to measure each state's business tax climate to determine how states measure up to one another in terms of tax systems conducive to business investment and operation.
The study compares the states on the five aspects: corporate income or major business tax, individual income tax, sales and use tax, unemployment insurance, and property tax.
With respect to a state's corporate income tax regimes, the Tax Foundation primarily analyzes two factors when ranking the states - the corporate tax rate and the corporate tax base. Generally, states score well if they have a relatively low, single-rate system that applied to a broad base of business activity. Poor scores result from states that have a complex, multi-rate system with a high top marginal rate. For sales tax purposes, a state generally scores well if the combined state and local rate is low, and it allows exclusions for business inputs.
The top ten states in this year's index are Wyoming, South Dakota, Nevada, Alaska, Florida, Washington, Montana, New Hampshire, Utah, and Indiana. Interestingly, Indiana ousted Texas from the top ten this year. Utah and Indiana are the only states in the top ten that have both a sales tax and a corporate income tax.
The bottom ten states were Maryland, Connecticut, Wisconsin, North Carolina, Vermont, Rhode Island, Minnesota, California, New Jersey, and New York. The study notes that North Carolina, which recently enacted tax reform legislation, should move as high as 17th once those reforms are effective.
On October 18, the Illinois Supreme Court held that the state's click-through nexus statute was void and unenforceable. In the majority's view, the statute constituted a discriminatory tax on electronic commerce, and is thus prohibited under the Internet Tax Freedom Act (ITFA) (Performance Marketing Ass'n, Inc. v. Hamer, Doc. No. 114496 (Ill. October 18, 2013)).
In March 2011, Illinois' use tax and service use tax laws were amended to adopt click-through nexus provisions applicable to certain retailers. Specifically, under the 2011 law, a "retailer maintaining a place of business in Illinois" included retailers that entered into contracts with in-state persons who, in exchange for consideration or a commission, referred customers to the retailer by a link on the in-state person's Internet website, provided that total sales under all such agreements exceeded $10,000 per year. The Illinois law - unlike other states' click-through statutes - provided no means for a remote retailer to rebut the presumption that the associate or affiliate relationships, standing alone, created nexus.
In 2012, a state circuit court judge found that a relationship with in-state residents was insufficient to create substantial nexus with Illinois, and that the click-through nexus provisions ran afoul of the Internet Tax Freedom Act, which prohibits a state from imposing "discriminatory taxes on electronic commerce."
As the Illinois Supreme Court at this time affirmed the circuit court's finding that the click-through statute was preempted by the ITFA, Illinois' click-through nexus statute is void and unenforceable unless the state seeks and obtains review by the U.S. Supreme Court or the ITFA expires (as it is currently scheduled to do in November 2014).
On October 24, the U.S. Tax Court, in a case of first impression, addressed how section 199 applies to U.S. corporations that manufacture products through agreements with contract manufacturers (ADVO, Inc. v. Commissioner, 141 T.C. No. 9 (October 24, 2013)).
The taxpayer during 2005, 2006, and 2007 distributed direct mail advertising for its clients in the United States. The clients either supplied the advertising material (which the taxpayer would include in the mailing envelope) or the taxpayer supplied the materials for distribution. When supplied by the taxpayer, third-party commercial printers were contracted by the taxpayer to print the advertising material. The taxpayer asserted that its gross receipts attributed to its printed direct mail advertising and distribution products qualified as "domestic production gross receipts" under section 199. The IRS countered that because the taxpayer contracted its actual printing out to third-party printers, it did not manufacture any qualifying production property.
The Tax Court concluded that the taxpayer did not have the benefits and burdens of ownership of the direct advertising materials and was not entitled to the deduction under section 199. In reaching its decision, the Tax Court de-emphasized the importance of the taxpayer's control over the manufacturing process and design, and instead placed greater emphasis on the fact that the taxpayer did not take title or risk of loss with respect to the printed materials (paper and ink) until after the completion of the printing.
On October 29, the IRS Large Business and International (LB&I) division released an LB&I directive for IRS examiners to use in determining whether an unrelated party in a contract manufacturing arrangement may claim the section 199 deduction because it satisfies the benefits and burdens test (LB&I Control No: LB&I- 04-1013-008 (October 29, 2013)). The LB&I directive updates the old directive issued in July 2013 and requires the examiners to request that the taxpayer provide:
- A statement that explains the basis for the taxpayer's determination that it had the benefits and burdens of ownership in the year or years under examination
- A certification statement signed by the taxpayer
- A certification statement signed by the counterparty
The benefits and burdens statement and certification statements are to be provided to the examiner within 30 days of the date that an information document request (IDR) is issued.
If the taxpayer provides the benefits and burdens statement and certification statement, LB&I examiners are directed not to challenge that the taxpayer has the benefits and burdens of ownership for purposes of section 199 with respect to each qualifying property upon which a qualifying activity is performed under the contract manufacturing arrangement.
On September 19, Senator Carl Levin (D-MI) introduced a bill that aims at closing "offshore corporate tax loopholes" and would repeal the "check-the-box" and the "CFC look-thru" rules.
As chairman of the Senate permanent subcommittee on investigations, Senator Levin has focused on the taxation of offshore income. In February 2013, he reintroduced a bill, the Cut Unjustified Tax Loopholes Act to address tax haven income.
Certain measures in the proposed legislation would:
- Prevent the use of intellectual property transfers as tax-avoidance tools by taxing excess income earned from transferring intellectual property to offshore subsidiaries
- Provide Treasury with greater authority to address foreign governments and financial institutions that aid tax avoidance, including the ability to prohibit U.S. banks from doing business with foreign banks in jurisdictions that impede U.S. tax enforcement
- Require SEC-registered corporations to disclose employment, revenues and tax payments on a country-by-country basis
- Eliminate the tax incentive for companies to move jobs and operations offshore by limiting their ability to claim immediate tax deductions for expenses related to those offshore operations while deferring the U.S. tax on the income those operations generate
- Repeal "check-the-box" and "CFC look-through" rules, thereby making offshore subsidiaries "disappear" for tax purposes and treating taxable passive income as tax-deferred active income
- Prevent multinationals from using short-term loans from their offshore subsidiaries essentially to repatriate income while avoiding taxes that would apply to repatriated money
On September 13, the Treasury Department and IRS released final regulations (T.D. 9636) that provide guidance on whether and when a taxpayer must capitalize costs incurred in acquiring, maintaining, or improving tangible property. Treasury and the IRS also released proposed regulations (REG-110732-13) that revise the rules for dispositions of tangible property.
The final regulations are generally effective for tax years beginning on or after January 1, 2014, and may be adopted in earlier years under certain circumstances. The proposed regulations are also expected (when finalized) to be effective for tax years starting on or after January 1, 2014, and may be adopted in earlier years under certain circumstances.
As most businesses will have to make one or more tax accounting method changes or elections to comply with these regulations, the IRS is expected to issue transition guidance that will allow taxpayers to change their methods of accounting under automatic consent procedures. In addition, the IRS Large Business and International (LB&I) "stand-down" for auditing repairs and related dispositions will end starting in 2014, which means that most taxpayers will no longer have the option to defer compliance with the new rules.
The final regulations adopt the same general framework as the 2011 temporary regulations and retain many of the same provisions. However, the IRS and Treasury made several significant changes in the final regulations including the following:
- De minimis safe harbor: A taxpayer with an applicable financial statement may follow its book minimum capitalization policy for acquired tangible property as long as the policy does not exceed $5,000 (the threshold is $500 for a taxpayer without an applicable financial statement).
- Election to follow book capital improvement costs: A taxpayer may elect to follow its book capitalization policy for improvement costs with respect to amounts that were capitalized on its books and records for the tax year.
- Routine maintenance safe harbor: Certain qualifying cyclical maintenance activities will be deemed not to result in a capital restoration.
- Partial relief from casualty loss rule: The amount of post-casualty replacement expenditures that exceed the adjusted basis of the property damaged in the casualty does not need to be treated as a capitalizable restoration cost.
- Revisions to the capitalization standards: Although the unit of property definitions under the temporary regulations were not changed, certain aspects of the capitalization standards were revised and clarified.
- Materials and supplies: Unlike the temporary regulations, a taxpayer may not elect to capitalize and depreciate materials and supplies that are not rotable, temporary, or standby emergency spare parts. The definition of materials and supplies is expanded to include property that has an acquisition or production cost of $200 or less ($100 or less under the 2011 temporary regulations).
As anticipated by Notice 2012-73, the proposed regulations significantly revamped the rules for dispositions of tangible property subject to the Modified Accelerate Cost Recovery System (MACRS). Under the proposed regulations, taxpayers will no longer have to elect general asset account treatment to achieve flexibility with respect to the treatment of component dispositions. The proposed regulations allow a taxpayer to make a partial disposition election to recognize gain or loss on a disposition-by-disposition basis with respect to any portion of an asset. In addition, the proposed regulations would make the recognition of a casualty loss mandatory and not subject to the partial disposition election.
Due to the significant nature of the changes, the revised rules for dispositions of property were issued in proposed rather than final form, and the disposition rules in the temporary regulations continue to be effective until they are removed or sunset.
On September 6, the Treasury Department and IRS released proposed regulations (REG-161948-05) that apply to importation of loss property in a tax-free transaction.
In case of importation of loss property, including contribution in-kind of property with built-in loss by a foreign corporation to its U.S. subsidiary, the transferee U.S. corporation's basis in the property is required to be adjusted downward to its fair market value. However, there have been questions concerning how to determine whether property is importation property, and questions regarding the application of the anti-loss importation provisions and their interaction with other rules of the Code. To address these issues, the proposed regulations provide a framework for identifying importation property and for determining whether the transfer of the property is a transaction subject to the anti-loss importation provisions.
On August 29, the Treasury Department issued a release stating that same-sex couples, legally married in jurisdictions that recognize their marriages, will be treated as married for federal tax purposes in order to implement the federal tax aspects of the U.S. Supreme Court's decision in United States v. Windsor, invalidating a key provision of the 1996 Defense of Marriage Act.
According to the Treasury release, this treatment applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage. Treasury reported that same-sex couples will be treated as married for all federal tax purposes, including income and gift and estate taxes, and that the guidance will apply to all federal tax provisions when marriage is a factor, including filing status, claiming personal and dependency exemptions, standard deduction, employee benefits, IRA contributions, and earned income tax credit or child tax credit.
Legally married same-sex couples generally must file their 2013 federal income tax return using either the "married filing jointly" or "married filing separately" filing status. Individuals who were in same-sex marriages may, but are not required to, file original or amended returns choosing to be treated as married for federal tax purposes for one or more prior tax years still open under the statute of limitations.
On the same day, the IRS issued Rev. Rul. 2013-17 and lists of "frequently asked questions" as technical guidance for the federal tax treatment of individuals in same-sex marriages.
On August 30, the Treasury Department and IRS released final regulations (T.D. 9633) under section 362(e)(2) concerning the determination of the basis of assets and stock in certain nonrecognition transactions. The final regulations generally adopt substantive rules of regulations proposed in 2006 with certain changes intended to simplify the application of the rule and are applicable to transactions occurring after September 3, 2013.
As a result of enactment of the American Jobs Creation Act of 2004, section 362(e) provides that, in certain nonrecognition transactions including tax-free contributions in-kind of built-in loss property, the basis of the property in the hands of the transferee would be the fair market value of the transferred property rather than the basis carried over from the transferor.
After regulations were proposed in October 2006, the IRS received questions and became aware of "certain ambiguities." The preamble notes that the changes and additions made with the final regulations include:
- Defining and redefining such terms as "U.S. return," "controlling U.S. shareholder," and "value."
- Clarifying the time for filing and the person that must file a statement that the transferor and acquiring entities are making an election to reduce the basis in stock instead of basis in transferred property.
- Expanding an example to illustrate the application of the rules to transactions involving the assumption of fixed and contingent liabilities
- Confirming and clarifying application of the rules to transactions involving partnerships and S corporations
On August 26, the U.S. Government Accountability Office (GAO) publicly released Global Manufacturing: Foreign Government Programs Differ in Some Key Respects From Those in the United States (GAO-13-365, released August 26, 2013 and dated July 25, 2013). The GAO was asked to identify innovative foreign programs that support manufacturing that may help develop U.S. policy including taxation.
The GAO examined four countries - Canada, Germany, Japan, and South Korea and found that the four countries offer a wider variety of government programs to support the manufacturing sector in the areas of innovation, trade, and training. Concerning innovation and R&D, the report points out that the foreign government programs place greater emphasis on commercialization to help manufacturers bridge the gap between innovative ideas and sales.
The Texas Comptroller issued guidance on a revised rule (Rule 3.588), which addresses the Texas franchise tax cost of goods sold (COGS) deduction. Texas franchise tax is imposed on Texas-source "gross margin" which may be computed by subtracting COGS (or payroll or 70% of sales upon taxpayer's election) from sales. Intended to further align the Texas COGS deduction with the federal inventory capitalization rules, the revised rule:
- Allows a deduction for the entire amount of certain indirect labor costs, such as supervisory labor without regard to the four percent cap.
- Provides a new definition of "service costs" and allows these costs to be fully included in COGS without regard to the four percent cap to the extent they are allocable to the acquisition or production of goods. Other service costs not allocable to the acquisition or production of goods are excluded from the COGS deduction but are used to calculate the four percent cap.
- Provides that job-related expenses, including but not limited to, education, business use of a company car, out-of-town travel/meal reimbursements, and per diem payments deductible for federal purposes may now be included in a taxpayer's labor cost deductible as COGS in light of the recent Winstead decision, in which a Texas district court invalidated a Texas regulation insofar as it attempted to exclude from the definition of "compensation" certain working condition benefits that were deductible under federal law.
- Confirms a previously-announced policy that allows taxpayers to file amended returns switching from a COGS election to a compensation election and vice-versa.
- Provides that property taxes paid on buildings and equipment are now deductible as direct costs of production.
On August 1, President Obama announced that he will nominate John Koskinen to serve as the next IRS Commissioner. If confirmed, Koskinen would replace Daniel Werfel, who is scheduled to step down in September 2013.
Koskinen previously served as non-executive chairman of Freddie Mac from 2008 to 2011, and as acting chief executive officer in 2009. From 2004 to 2008, he was the president of the U.S. Soccer Foundation, and before that was deputy mayor and city administrator of Washington, D.C., from 2000 to 2003. Koskinen also practiced law and clerked for the chief judge of the U.S. Court of Appeals for the District of Columbia Circuit.
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