United States: Tax Talk: Volume 9, Issue 4

EDITOR'S NOTE

Tax Talk doesn't remember much about 1985. But we do remember that, after Ronald Reagan was re-elected president in 1984, tax reform was a very hot topic (remember the Tax Reform Act of 1985?). Anyway, for all the talk, it took Congress until October, 1986 to come up with the landmark Tax Reform Act of 1986. We're not saying it will take that long for fundamental tax reform this time around but, for all the talk of Big Tax Reform, we are still only looking at two "plans" actually in writing: the one on the President's campaign website (three pages—and we're being generous) and the one the House Republicans released last June. As discussed in our article below, the rest is speculation, including about how a "destination based cash flow tax" ("DBCFT") would work.

Speaking of a DBCFT, one fascinating tidbit is that the outline of a cash flow tax was set forth in a U.S. Treasury paper in 1977, the first year of the Carter Administration. One of the report's authors, David Bradford, went on to expand the concept in papers written in 2001 and 2003 before his untimely death in 2005. Other authors (and other tax reform panels) have also weighed in so there is quite a bit of academic thought on the topic.1 Unfortunately, there is no practical experience.

In the meantime, Tax Talk observes that, in the vacuum surrounding Big Tax Reform, bar associations continue to meet and talk about the section 385 regulations, financial institutions are earnestly complying with the Section 871(m) Delta One guidance, seminars are being given on all sorts of topics which may be obsolete by 2018 and tax advisors keep advising based on current law. The only place tax reform is having any impact is in some public securities disclosures. "Kitchen sink" disclosures that anything and everything might change in a Trump tax reform are now creeping into Edgar filings. Also, tax advisors are struggling to develop contract clauses that attempt to protect their clients against the unknowable and unforeseeable tax reform (we've even seen provisions that can be activated based on a Twitter "tweet"). Apart from that, there is not much tax advisors can do except soldier on and watch their Twitter feeds very carefully.

So, is it 1985 or 1986? No one knows...

TAX REFORM UNDER GOP CONTROL?

In case you haven't heard, Donald Trump is now president of the United States. Republicans now control the House, Senate, and Presidency. With this trifecta, the GOP is in the best position in years to push sweeping tax reform. The question then, is what form that tax reform will take. In terms of official guidance, we only have a few documents to work with: (1) the House GOP plan entitled A Better Way – Our Vision for a Confident America (the "House Plan"),2 (2) president-elect Trump's tax plan released in September3 (based on an earlier plan of the Trump campaign entitled Tax Reform That Will Make American Great Again (together the "Trump Plan")).4 Separately, Republicans are moving forward legislation that could significantly alter the way IRS regulations are interpreted by courts.

Tax Reform Plans

Both plans would reduce the number of individual income tax brackets from seven brackets to three, with the top marginal rate of each plan being 33 percent. Both plans would repeal the 3.8 percent tax on net investment income and the alternative minimum tax. The Trump Plan would put a limit on the use of itemized deductions, while the House Plan would eliminate itemized deductions apart from the home mortgage interest deduction and deductions for charitable contributions.

Currently, under section 1014 of the Code,5 the basis of property acquired from a decedent is adjusted to be the fair market value of such property, without taxation on this step up. The Trump Plan would eliminate the estate tax, but capital gains held until death valued over $10 million would be subject to tax, with some exceptions. The House Plan would repeal the estate tax, but would no longer allow for a step-up in basis at death.

Both plans call for overhauls to the corporate and business income tax system, although each plan lacks technical detail. Both plans would eliminate the corporate alternative minimum tax, and while the Trump plan calls for a 15 percent corporate tax rate, the House Plan calls for a 20 percent corporate tax rate. The Trump campaign stated the Trump Plan was intended to give all pass-throughs a 15 percent rate, but only if such taxpayers elect to file their taxes as if they were incorporated. It is so far unclear how this would work in practice. The House Plan

would tax small businesses and pass-throughs at 25 percent, but such taxpayers will be treated as having paid reasonable compensation to their owners.

The House Plan would repeal the current depreciation system and allow the cost of capital (for both tangible and intangible assets) to be fully and immediately deductible. However, deductions for net interest expenses on debt would only be allowed as a deduction against interest income; unused deductions could be carried forward. The Trump proposals would allow firms engaged in U.S. manufacturing to fully expense capital investments, with no deduction for corporate interest expense.

In addition, the House Plan proposes the United States switch to a border adjusted cash flow tax for businesses. Under a cash flow tax, a business is taxed on its cash flow, i.e., its business receipts less its expenditures. With a cash flow tax, assets would be immediately expensed. A border adjusted tax conforms to a "destination-based" principle – generally, tax is levied where goods end up rather than where the goods were produced. This would exclude from the U.S. federal tax base the sale of goods and services to non-U.S. persons, but include sales to U.S. persons, including sales by non-U.S. persons into the U.S. A change to a border adjusted tax flow tax would be a drastic departure from the current U.S. system. Also, there is no clarification on a topic near and dear to Tax Talk: the treatment of financial instruments, financial institutions, and financial transactions in a cash flow tax world.

Ending Chevron Deference?

The Regulatory Accountability Act of 2017 (the "Act"), passed by the House on January 11, 2017, would eliminate the deference courts give to agency regulations, including Internal Revenue Service ("IRS") regulations. In Chevron, U.S.A. Inc. v. Natural Resources Defense Council Inc., 467 U.S. 837 (1984), the Supreme Court held that a court cannot overrule an agency regulation under an ambiguous statute unless it is "arbitrary or capricious in substance, or manifestly contrary to the statute." Moreover, under Chevron, a court is required to give deference to an agency's interpretation. This so-called "Chevron deference" allows agencies, including the IRS, to issue interpretive regulations with a high threshold for challenge. The Act would modify a number of the rules surrounding the Administrative Procedure Act, including replacing "Chevron deference" with a de novo review of regulations. If the Act were to become law, taxpayers would have greater opportunity to argue that IRS regulations should be overturned.

CURRENT STATUS OF SECTION 871(M) AND RELATED RULES

Overview

Section 871(m) is the Code provision that treats "dividend equivalents" paid under certain contracts as dividends from sources within the Unites States and therefore subject to U.S. withholding tax if paid to a non-U.S. person. The current guidance on section 871(m) exists in three places: (1) the final regulations from September 2015;6 (2) Notice 2016-76 (the "Notice") from December 2016,7 which announces changes to the final regulations; and (3) the final qualified intermediary agreement from December 2016, found in Rev. Proc. 2017-15, which implements and expands on Notice 2016-76 regarding the withholding tax liability of qualified derivatives dealers ("QDDs"). For practical purposes, the main takeaways for dividend equivalent withholding generally from the December guidance are threefold. First, the effective date for the application of section 871(m) is January 1, 2017, for delta-one instruments but will be delayed until January 1, 2018, for non-delta-one instruments. Second, QDDs are no longer exempt from withholding on dividends received on physical shares. Third, a QDD will not be liable for withholding tax on dividends paid to the QDD on physical shares or on dividend equivalents the QDD receives in its capacity as an equity derivatives dealer in 2017.8

The Notice indicates that the section 871(m) regulations will continue to apply beginning January 1, 2017, to any payment with respect to a potential 871(m) transaction that has a delta of one, including combined transactions; however, 2017 will be a phase-in year for such transactions. As for non-delta-one transactions, the Notice announces the IRS's intent to amend the section 871(m) regulations so that the regulations will not apply to payments made with respect to any non-delta-one transaction before January 1, 2018, and 2018 will also be a phase-in year for these non-delta-one transactions. When enforcing the section 871(m) regulations for the applicable phase-in years, the Notice states the IRS will afford relief to taxpayers or withholding agents who have made a good faith effort to comply with the regulations.

Final regulations were released on January 19, 2017, and published in the Federal Register on January 24, 2017. However, on January 20, 2017, President Trump's Chief of Staff, Reince Priebus, sent a memorandum to all heads of

executive departments and agencies instructing, among other things, that all regulations released but not yet published must be immediately withdrawn for review and approval. The IRS on the other hand announced on January 24, 2017 that the new section 871(m) regulations were "approved by the Office of Management and Budget," and had "an effective date of January 19, 2017."9 Despite this announcement and the publication of the regulations in the Federal Register, practitioners are unclear on whether these regulations were published in contravention of the order from the Executive Branch, and if so, what that means.

FINAL QI AGREEMENT AND AMENDMENTS TO FFI AGREEMENT

On December 30, 2016, the IRS issued Rev. Proc. 2017-15 and 2017-16. Rev. Proc. 2017-15 contains the final qualified intermediary ("QI") agreement in Rev. Proc. 2017-15, originally proposed in July 2016 in the form of Notice 2016-42.10 Rev. Proc. 2017-16 contains amendments to the foreign financial institution ("FFI") agreement.

New from the proposed QI agreement, the final agreement (1) implements and expands on Notice 2016-76 regarding the withholding tax liability of qualified derivatives dealers ("QDDs"), and (2) generally makes other modifications to compliance rules.

Notice 2016-76 announced the IRS's intention to revise the final regulations to provide that a QDD will remain subject to withholding under chapter 3 and 4 on dividends it receives from physical shares held. The Notice announced that a QDD's "section 871(m) amount" will be determined by looking to a QDD's "net delta exposure," which involves aggregating a QDD's delta for all physical positions and potential section 871(m) transactions with respect to an underlying security. Further, the Notice stated that a QDD's tax liability with respect to an underlying security would be reduced, but not below zero, by the amount of withholding tax suffered by the QDD on the receipt of the same dividend payment on that underlying security. This left some ambiguity with respect to whether a cascading withholding tax might apply, because the rule in Notice 2016-76 could have been read to mean that a QDD's liability was determined based on its net delta exposure (which if perfectly hedged by physicals would be zero), and that liability could be reduced, but not below zero, by withholding on dividends from a hedge of physical shares. It was not clear from the proposed QI agreement or Notice 2016-76 whether a QDD's withholding tax on physical shares could be credited against any amounts a QDD would be required to withhold.

The final QI agreement provides relief to QDDs. Under the final QI agreement, a QDD will not be liable for withholding tax on dividends paid to the QDD on physical shares or on dividend equivalents the QDD receives in its capacity as an equity derivatives dealer in 2017 (but a QDD will remain liable for tax on dividends and dividend equivalents received in any other capacity). The final QI agreement implements the "net delta exposure" concept from Notice 2016-76.

Further, the final QI agreement calculates a QDD's tax liability as the sum of (1) for each dividend on each underlying security, the amount by which its tax liability under section 881 for its section 871(m) amount exceeds the amount of tax paid by the QDD in its capacity as an equity derivatives dealer under section 881(a)(1) on that dividend; (2) its tax liability under section 881 for dividend equivalent payments received as a QDD in its non-equity derivatives dealer capacity; and (3) its tax liability under section 881 for any payments such as dividends or interest, received as a QDD with respect to potential section 871(m) transactions that are not dividend or dividend equivalent payments to the extent the full liability was not satisfied by withholding.

The final FFI agreement contains updates for foreign financial institutions to comply with the Foreign Account Tax Compliance Act ("FATCA"), generally reflecting updates to the FATCA regulations (discussed below) and the expiration of transitional periods.

FINAL AND PROPOSED FATCA REGULATIONS

On December 30, 2016, the IRS published modifications to regulations under FATCA. The regulations generally make technical changes to existing FATCA regulations and incorporate FATCA guidance that was previously issued by the IRS. For example, the regulations provide that no withholding on "foreign passthru payments" will be required until the later of January 1, 2019, or the date on which final regulations are published that define the term "foreign passthru payments." Similarly, withholdable payments under FATCA do not include gross proceeds from a sale of property occurring before January 1, 2019. Both of these provisions were contained in Notice 2015-66, and are now incorporated into the regulations.

DTC SECTION 871(M) REPORTING

DTC Eligibility Procedures

The implementation of the section 871(m) regulations has far reaching impacts that extend beyond the realm of tax law. Recently, the Depository Trust Company ("DTC") has responded to the regulations by adjusting its eligibility procedures.11 Under the new procedures for a security to qualify as DTC eligible, an officer of the issuer will be required to certify if the security is treated as a "Section 871(m) transaction"; if it is such a transaction, the officer must then certify whether it is a "simple contract" or a "complex contract."12 If the security is treated as a "simple contract," then the applicable "delta" will also be required to be provided. In connection with the initial qualification, the officer must also agree that the issuer will provide DTC with information on dividend equivalent payments as they occur. DTC has created an "871(m) Dividend Equivalent Payment" template that sets forth the data that is required for the processing of these payments. As the DEPs occur, issuers will need to send this information to a designated DTC e-mail address.

DTC has warned market participants that the failure to timely comply with this new attestation requirement may result in a delay in DTC approval. Of course, a delayed approval could result in delayed settlements, and issuers and underwriters will be updating their procedures.

Compliance in January 2017

Historically, the DTC eligibility process was completed by the relevant distributors, without significant participation from the applicable issuers. The new required procedures, especially for frequent issuers, will require ongoing involvement from the relevant officer or officers from the issuers who make the required certifications, and accordingly, issuers will want to establish a means to reliably verify their accuracy. Together with their tax advisors and underwriters, these issuers will need to establish procedures to ensure that the certifications can be accurately completed on a timely basis, and that any required periodic notifications can be made to DTC.13

To view the full article please click here.

Footnotes

1. See Simple, Fair, and Pro-Growth: Proposals to Fix America's Tax System, President's Advisory Panel on Federal Tax Reform (Nov. 2005), available at https://www.treasury.gov/resource-center/tax-policy/Documents/Report-Fix-Tax-System-2005.pdf; and Alan J. Auerbach & Douglas Holtz-Eakin, The Role of Border Adjustments in International Taxation, American Action Forum 10 (Nov. 30, 2016), available at https://www.americanactionforum.org/wp-content/uploads/2016/11/The-Role-of-Border-Adjustments-in-International-Taxation.pdf.

2. Available at https://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf. For a more detailed discussion of the House plan, please see our last issue of Tax Talk, available at https://media2.mofo.com/documents/161012-tax-talk.pdf.

3. Available at https://www.donaldjtrump.com/policies/tax-plan.

4. Available at https://assets.donaldjtrump.com/trump-tax-reform.pdf.

5. All section references are to the Internal Revenue Code of 1986, as amended, and the regulations promulgated thereunder, unless otherwise indicated.

6. For a more detailed discussion of the Final Regulations, see our Client Alert, available at https://media2.mofo.com/documents/150921dividendequivalent.pdf.

7. For a more detailed discussion of Notice 2016-76, see our Client Alert, available at https://media2.mofo.com/documents/161206-irs-guidance-871m.pdf.

8. The QDD changes are discussed in more detail in the following article.

9. Marie Sapirie, Clarification Needed on PTP and Dividend Equivalent Regs, 2017 TNT 17-2 (January 27, 2017).

10. For a discussion of the Proposed QI Agreement, please see Vol. 9 Issue 2 of Tax Talk, available at https://media2.mofo.com/documents/160805taxtalk.pdf.

11. The DTC announcement is available at www.dtcc.com/~/media/Files/pdf/2016/10/31/4463-16.pdf.

12. A complex contract is any NPC or ELI that is not a simple contract; a simple contract is an NPC or ELI that has a fixed term and references a fixed number of underlying shares.

13. For more information, please see our December 27, 2016 special issue of Structured Thoughts, available at https://media2.mofo.com/documents/161227-structured-thoughts.pdf.

Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Morrison & Foerster LLP. All rights reserved

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Anna Pinedo
Allison Y. Peck
Similar Articles
Relevancy Powered by MondaqAI
Morrison & Foerster LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Morrison & Foerster LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions