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.
A Delaware Superior Court complaint was unsealed alleging that transactions between certain retailers and gift card servicing companies were sham transactions designed to avoid Delaware's unclaimed property laws. According to the complaint, over two dozen named Delaware-incorporated retailers have excluded gift cards from their unclaimed property compliance because those entities maintain agreements with third party gift card servicing companies in which the third party companies purport to be the holder of the unredeemed cards and to manage unclaimed property payments to various other states. The third party servicing companies are generally formed in states that do not require the escheat of gift cards to the state, such as Florida and Ohio.
The complaint, a qui tam action where a private individual assists the state in prosecution of another, was originally filed in June 2013 by an Ohio resident but was under seal from June 2013 and only made public recently. The complaint alleges that the contractual arrangements between the gift card servicing company and Delaware retailers lack substance because the retailers issuing the cards retain possession, custody, and control of the value of unredeemed gift cards. Therefore, the complaint argues, the agreements are sham transactions designed to defraud the state out of millions of dollars in unclaimed property revenue.
If the complaint is decided in favor of the state, it could expose the defendant companies to millions of dollars of unclaimed property liability as well as significant damages, interest, and other costs. It is anticipated that this litigation may well spur similar litigation against other gift card servicing companies as well as against arrangements where a card issuer has not used a card servicing company, but instead has formed its own, separately incorporated gift card subsidiary. Delaware is reportedly challenging the gift card subsidiary structure of some companies under audit.
On April 21, the U.S. Government Accountability Office (GAO) release a report concerning the effects of budget cuts on IRS staffing and performance. In its report—Internal Revenue Service: Absorbing Budget Cuts Has Resulted in Significant Staffing Declines and Uneven Performance, GAO-14-534R (April 21, 2014)—the GAO findings reflect that:
- Appropriations for the IRS have declined to below fiscal year (FY) 2009 levels, and "full-time equivalents" have been reduced by about 8,000 since FY 2009.
- Planned performance in enforcement and taxpayer service has decreased or fluctuated. For example, in the FY 2014 congressional justification, the audit coverage target for individual examinations was 1.0% for 2014, and the target was lowered to 0.8% in the FY 2015 congressional justification.
- The IRS has absorbed approximately $900 million in budget cuts since FY 2010 through savings and efficiencies and by reducing, delaying, or eliminating services. For example, IRS delayed two information technology projects (information reporting and document matching and return review program) and substantially reduced employee training.
On April 25, the IRS released Notice 2014-32 announcing modifications and clarifications to the regulations under section 367(b) relating to the treatment of property used to acquire parent stock or securities in certain triangular reorganizations involving foreign corporations. Revisions to be made to the regulations, known as the "Killer B regulations," would include:
- Elimination of the deemed contribution model under the existing regulations;
- Modification of the amount of income and gain taken into account for purposes of applying the priority rules of section 367(a) and (b); and
- Clarification of the application of the anti-abuse rule.
On April 1, California Senate Bill 1372 was amended to provide for revised tax rates on corporate entities. Under current law, the corporate income/franchise tax rate is 8.84 percent. As amended, Senate Bill 1372 would, if enacted, for tax years beginning on and after January 1, 2015, revise the rate for taxpayers that are publicly held corporations, as defined. Such corporations would be subject to tax at a rate from 7 percent to 13 percent.
The rate applied to a particular taxpayer would be based on the so-called compensation ratio of the corporation. The numerator of the "compensation ratio" would equal the greater of the compensation paid to the taxpayer's chief operating officer or the taxpayer's highest paid employee while the denominator would equal the median compensation of all the taxpayer's U.S. employees. The amount of the compensation is determined based on the calendar year preceding the tax year at issue.
Taxpayers required to be included in a combined report would be treated as a single taxpayer for purposes of determining the compensation ratio. Corporate taxpayers with a compensation ratio over 400 would be subject to tax at the highest 13 percent tax rate.
Senate Bill 1372 would also increase the applicable tax rate by 50 percent for those taxpayers that have a specified decrease in full-time employees employed in the United States as compared to an increase in foreign and contract employees.
On April 18, the U.S. Governmental Accountability Office (GAO) released a report providing data on the number and characteristics of large partnerships and IRS audits of large partnership returns. For these purposes, "large partnerships" were defined as those that reported having 100 or more direct partners and $100 million or more in assets.
In this report, the GAO found:
- The number of large partnerships increased from 720 in tax year 2002 to 2,226 in tax year 2011.
- Large partnerships increased in terms of the average number of direct partners and average asset size.
- The number of completed field audits of large partnership returns increased from 11 in FY 2007 to 31 in FY 2013.
- The audits closed through IRS "campus function audits" increased from 42 to 143 over the same period, FY 2007 to FY 2013.
- The percentage of IRS audits that resulted in no change to the taxpayer's return varied from FY 2007 to FY 2013 but was 52% for campus function audits and 45% for field audits in FY 2013.
On March 27, the IRS released the advance pricing agreement (APA) statistics for calendar year 2013.
Number of Cases:
|Canceled or Revoked
Average Number of Months to Complete:
|Bilateral / Multilateral
From 2012 to 2013, the number of applications filed slightly decreased from 126 to 111 while the number of cases executed slightly increased from 140 to 145, resulting in a reduction in the number of pending cases from 391 to 331.
Of the total number of bilateral APAs executed in 2013, 53% of the cases were agreed between the U.S. and Japan, with the other two treaty countries with significant activity being Canada (19%) and the United Kingdom (8%).
On March 12, the House Judiciary Committee held a hearing on "Exploring Alternative Solutions on the Internet Sales Tax Issue." The purpose of the hearing was to examine several proposed alternatives to requiring vendors to collect tax on sales made over the Internet under the Marketplace Fairness Act of 2013 (MFA) which was passed by the Senate last year. In September 2013, the Chairman of the committee, Bob Goodlatte, published seven guiding principles on the issue including 1) tax relief; 2) tech neutrality; 3) no regulation without representation; 4) simplicity; 5) tax competition; 6) states' rights; and 7) privacy rights.
In his opening statement at the hearing, Chairman Goodlatte observed that, in his view, the MFA suffers from several fundamental defects including 1) the public perception that the MFA imposes a new tax on Internet sales; 2) significant costs of compliance; and 3) the potential to expose remote sellers to multiple audits in jurisdictions where the sellers have no presence.
The witnesses including various state and local tax professionals from industry, private law practice and policy groups presented the following alternatives:
- Implementation of a multistate compact similar to the Streamlined Sales and Use Tax Agreement (SSUTA) that would apply exclusively to remote sales.
- "Home base" approach whereby remote sellers would collect tax on their sales based on the rate and base in its home state, remit that tax to the seller's home state, and then the taxing authority would distribute the collected tax proportionally to each state where the sales were destined.
- Implementation of provisions to require remote sellers to file information reports on sales made without collection of tax with a federal clearinghouse that would aggregate all reports for each purchaser and provide the purchasers and the state of residence with the consolidated information on the volume of purchases.
- Prohibition on doing business in the state by remote sellers that do not collect sales taxes.
- Imposition of origin based sourcing sales where tax is imposed based on the location of the seller, rather than the buyer, with revenues retained by the origin state.
On March 25, the U.S. Supreme Court held (8 to 0) that severance payments made to employees who are terminated against their will are taxable wages and are subject to certain withholding taxes, including FICA taxes. United States v. Quality Stores, Inc., 12-1408 (S. Ct. March 25, 2014).
The Supreme Court found that the Sixth Circuit's decision upholding the refund claim by the taxpayer was wrong because the Sixth Circuit relied on the definition of wages under a provision governing income tax withholding (section 3402(o)) rather than FICA's definition of wages. The Court noted that the IRS (in Rev. Rul. 90-72) still provides that severance payments tied to the receipt of state unemployment benefits are exempt from, not only income tax withholding, but also from FICA taxation.
On March 31, New York Governor Andrew Cuomo signed the bills which enact the tax changes included in the Executive Budget and provide an estimated $2 billion tax relief. On the corporate tax side, the bills repeal the Article 32 Banking Franchise Tax and substantially revise the Article 9-A general corporate franchise tax. Under the new regime, banks are subject to the revised Article 9-A tax. The corporate tax changes are generally effective for tax years beginning on or after January 1, 2015. The changes do not apply for New York City corporate and banking tax purposes unless and until New York City enacts its own conforming legislation.
Highlights of the corporate tax reform are as follows:
- A corporation will be considered "deriving receipts from activity" and thus having nexus in New York if it has $1 million or more in receipts within New York.
- Tax on subsidiary capital will be eliminated.
- While C corporations currently pay tax on one of four bases including entire net income, minimum taxable income, capital, and fixed dollar minimum, which produces the highest tax, minimum taxable income while the minimum taxable income base will be eliminated.
- "Entire net income" base is replaced by "business income" base which is defined as entire net income minus net investment income and net "other exempt income."
- Tax rate on business income would be 6.5% for taxable years beginning on or after January 1, 2016.
- Capital tax rate will be gradually reduced and eliminated for tax years beginning on or after January 1, 2021.
- Fixed dollar minimum tax cap will be increased from $5,000 to $200,000.
- For non-US companies, entire net income will be limited to effectively connected income (i.e., worldwide income taxation is eliminated).
- New York NOLs are computed on a post-apportionment basis, can be carried back to the three taxable years preceding the loss year, and can be carried forward for twenty years.
- Modifications will be made to the sales sourcing rules in computing the single-receipts apportionment factor.
- Combined reporting is generally required for corporations that are engaged in a unitary business and meeting the direct or indirect more-than-fifty-percent ownership threshold. Combined reporting may be elected where no unitary business is conducted.
- Metropolitan Transportation Business Tax Surcharge will be made permanent.
On February 26, House Ways and Means Committee Chairman Dave Camp (R-MI) released a proposal for comprehensive tax reform. The 979 pages of the proposal would rewrite the Internal Revenue Code in much the same way Congress did in 1986 and modify hundreds of provisions of the Code.
Business Provisions in the proposal include the following:
- The proposal would reduce the statutory maximum corporate tax rate to 25% over five years, eliminating the current 15% tax bracket.
- It would also eliminate the corporate alternative minimum tax (unused AMT credits would be refundable over several years).
- The cost of the reduction in the rate would be offset by a great number of base-broadening measures, including elimination or modification of accelerated cost recovery system, requirement to amortize research and advertizing expenses, modification of net operating loss (NOL) rules to limit the amount of NOL deductions permissible in any year, repeal of the last-in, first-out and lower-of-cost-or-market methods of accounting for inventory, and phase out of the special deductions for domestic production activities.
- Research & development tax credit regime would be made permanent and simplified by allowing only the alternative simplified credit method and by eliminating some categories of eligible expenses (such as for computer software development).
- Assets of "systemically important" financial institutions above $500 billion would be subject to an annual excise tax of 14 basis points.
International Provisions of the proposal include the following:
- The proposal would adopt a "territorial" system, under which active foreign earnings of U.S. companies would be allowed a dividend-received deduction of 95%.
- Income from intangibles, deemed to be income in excess of 10% of the basis of assets, would be subject to tax, but at a reduced rate effected, after phase-in, by a 40% deduction.
- The proposal also includes other measures to avoid erosion of the U.S. tax base through, for example, the excessive placement of debt in the U.S. relative to worldwide group debt.
- Accumulated, untaxed foreign earnings would be taxed at 8.75% if invested in cash or cash equivalents or would be taxed at 3.5% if invested in other assets. The resulting tax could be paid in installments over eight years.
Individual Provisions of the proposal include the following:
- The seven current tax brackets would be reduced to three—10%, 25%, and 35%—the top rate, reduced from 39.6%, applicable to single filers with income of $400,000, married joint filers with income of $450,000.
- Capital gains and dividends would be taxed at these same ordinary rates, but only after a 40% deduction, correspondingly reducing the effective rate.
- The individual alternative minimum tax would be repealed.
- The standard deduction would be increased.
- The revenue cost of these changes would be offset by modification or elimination of tax preferences, elimination of personal exemptions, reduction in the principal limitation of the home mortgage interest deduction from $1 million to $500,000, elimination of the deduction for state and local taxes, limitation of the benefit of itemized deductions (other than the deduction for charitable contributions) and the standard deduction at the 25% rate, limitation of tax preferences involving exclusions from income (such as certain employer-provided benefits, foreign earned income, tax-exempt interest, and untaxed Social Security benefits) in essence imposing a 10% surtax on these items.
Other technical changes for current provisions of the Code are extensive and are designed to eliminate inconsistencies and overlaps, as well as to more narrowly target them. For example, while there are 15 tax benefits for higher education currently, the proposal would consolidate them into five including American Opportunity Tax Credit, deduction for work-related education expenses, exclusion for scholarships and grants, gift tax exclusion for tuition payments, and tax-free section 529 plans.
It would also make extensive changes to the provisions in the areas of insurance, real estate, tax-exempt financing, executive compensation, and partnerships and other pass through entities.
The Joint Committee on Taxation (JCT) prepared a series of documents that examine the various provisions in the tax reform proposal.
On February 16, the IRS Large Business & International (LB&I) division released a transfer pricing audit "roadmap."
The roadmap is developed by Transfer Pricing Operations (TPO) to provide the transfer pricing practitioners with audit techniques and tools to assist with the planning and execution of transfer pricing examinations. The roadmap is organized around a basic 24-month audit time-line and provides advice and links to useful reference material.
On February 28, the IRS released Rev. Proc. 2014-17 that describes the accounting method changes under the proposed disposition regulations. Specifically, the 91-page revenue procedure:
- Continues to allow late general asset account elections through 2013 for assets currently owned
- Removes the ability to file late general asset account elections for assets not currently owned
- Allows a late partial disposition election under the proposed regulations to be treated as a change in method of accounting for a limited period of time
- Will continue to allow a method change for a "ghost" unit of property (basis is being depreciated but physical asset is gone)—this change does not apply if the disposition involves only part of the unit of property
- Provides the ability to revoke a general asset account election
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