Reprinted from Tax Notes International, July 3, 2023, p. 13
Medtronic
On May 23 the Tax Court ordered Medtronic and the IRS to file a stipulated decision stating that the resolution of Medtronic's transfer pricing case does not preclude Medtronic from seeking future foreign tax credits relating to the transfer pricing adjustments made by the court.1
Under the court's transfer pricing decision in Medtronic,2 Medtronic's Puerto Rican subsidiary is required to pay additional royalties to Medtronic U.S. for 2005 and 2006. These additional royalties will give rise to additional FTCs.
In February the IRS filed a Computation of Entry of Decision, to which Medtronic objected. Medtronic agreed with the IRS's computations but requested that the court's decision include language reserving its right to claim additional FTCs for tax years 2005 and 2006. The IRS argued that Medtronic's proposed language would make the decision an impermissible advisory opinion that exceeded the bounds of Rule 155, which governs the requirements for computation by the parties for entry of decision.
The court disagreed with the IRS, reasoning that because the proposed language does not determine that Medtronic is entitled to the FTCs, it does not render the court's decision an advisory opinion. The court further determined that Medtronic's request does not violate Rule 155(c), which confines argument to "consideration of the correct computation of the amount to be included in the decision." The court stated that Medtronic does not seek to argue new issues, but only to state that its 2005 and 2006 tax liability could be affected by future claims for FTCs related to the royalty payments.
IRS Summons Power Reinforced
A unanimous Supreme Court reinforced the summons power of the IRS by rejecting a test the Ninth Circuit had proposed for determining when the Service must provide notice of a demand for documents.
As a result of the Court's decision in Polselli,3 third parties cannot prevent the IRS from gaining access to their bank account information if the IRS seeks that information to collect a delinquency from another taxpayer.
In Polselli, the Service wanted to collect more than $2 million in taxes assessed against Remo Polselli and issued summonses for bank records of Polselli, Polselli's wife, and other third parties. The IRS issued the summonses to the banks but did not notify the account holders. When the banks told the account holders, a few of them moved to quash the summonses. The district court held that because no notice was required, the account holders could not bring a motion to quash.
On appeal to the Sixth Circuit, the account holders cited a Ninth Circuit rule that required notice unless the delinquent taxpayer had "some legal interest or title in the object of the summons."4 To determine whether such a legal interest existed, the Ninth Circuit examined "whether there was an employment, agency, or ownership relationship between the taxpayer and third party."5 A divided Sixth Circuit rejected the Ninth Circuit test and affirmed the district court ruling. The Supreme Court followed the Sixth Circuit.
"A straightforward reading of the statutory text supplies a ready answer [to whether the legal interest test applies]: The notice exception does not contain such a limitation," Chief Justice Roberts wrote for the Court.
At oral argument, the government proposed that as long as a summons is "reasonably calculated to assisting in collection," it can fairly be characterized as being issued "in aid of" that collection. The Court did not tackle that question.
Justice Ketanji Brown Jackson wrote a concurring opinion, in which Justice Neil Gorsuch joined, arguing that "courts must not interpret section 7609(c)(2)(D)(i) as if [the IRS] has been gifted with boundless authority" to issue summonses without notice.
Another Challenge to TCJA Regulation
Varian Medical Systems Inc. has joined the list of taxpayers challenging the validity of regulations purporting to alter the effective date of some Tax Cuts and Jobs Act provisions.
Varian filed a Tax Court petition on May 306 seeking to invalidate the reg. section 1.78-1(c) dividends rule, on the heels of similar challenges in Sysco Corp.,7 filed in the Tax Court, and Kyocera,8 filed in the U.S. District Court for the District of South Carolina.9
The taxpayers are challenging the validity of a regulation purporting to deny domestic corporations a deduction for section 78 dividends deemed received from their fiscal-year foreign subsidiaries between January 1, 2018, and the end of the subsidiaries' first tax year ending after December 31, 2017.10
Before enactment of the TCJA, section 78 treated the gross-up for deemed paid foreign taxes as a dividend; taxpayers receiving an FTC were deemed to have received the income that was paid over to the foreign government in taxes. The TCJA amended section 78 to deny dividend treatment of the gross-up for purposes of the dividends received deductions under sections 245 and 245A so as to deny taxpayers a deduction for credited taxes.
The amendment, however, was applicable "to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of United States shareholders in which or with which such taxable years of foreign corporations end."11 Thus, shareholders of fiscal-year foreign corporations appeared to be able to deduct deemed dividends of creditable tax. Reg. section 1.78-1 purported to change the effective date so that the denial of a deduction applied to "section 78 dividends that are received after December 31, 2017, by reason of taxes deemed paid under section 960(a) with respect to a taxable year of a foreign corporation beginning before January 1, 2018."
"The applicability date in the second sentence of Treas. Reg. section 1.78-1(c) is invalid because it directly contradicts a law duly enacted by Congress and signed by the President," the Varian petition argues.
Procedural Change May Accelerate Tax Reg
The Biden administration has removed a Trump-era requirement that subjected some Treasury regulations to review by the Office of Information and Regulatory Affairs, which is part of the Office of Management and Budget. Under a memorandum of agreement adopted in 2018, OIRA review was required for Treasury regulations if they would be seriously inconsistent with or otherwise interfere with actions planned or taken by other federal agencies, raise novel legal or policy issues, or have an annual nonrevenue economic impact of at least $100 million, measured against a baseline of taking no action.
Removing OIRA review shortens the process for promulgating new regulations. The former procedure allowed OIRA up to 45 days to conduct a review, subject to extensions. Any disagreements between OIRA and Treasury were resolved through negotiation or elevation within the administration.
OIRA acts as a watchdog to ensure that regulations proposed and finalized by administrative agencies are consistent with administration policy and are worth the related costs under a cost-benefit analysis.
FIRPTA IRS Guidance
In AM 2023-003, dated May 12, Peter Blessing, IRS associate chief counsel (international), addressed the application of the exception under section 897(c)(3) under the 1980 Foreign Investment in Real Property Tax Act rules to stock held by partnerships.
In the advice, PRS is a partnership and NRA is a nonresident alien individual who owns a 25 percent interest in the capital and profits of PRS. The other partners of PRS are U.S. citizens, unrelated to NRA. CORP is a domestic corporation that is a real property holding corporation (USRPHC) under section 897(c)(2) that is publicly traded.
Two situations are presented in the advice. In the first, PRS holds 8 percent of CORP's outstanding stock and NRA owns no stock of CORP (except through PRS). PRS disposes of all its CORP stock and the gain is allocated proportionately to each of PRS's partners, including NRA. In the second situation, PRS holds 4 percent of CORP's stock and NRA directly holds 4.5 percent of CORP's stock in addition to stock it indirectly holds through PRS. NRA disposes of its directly held PRS stock at a gain.
Under section 897, gain or loss of a nonresident alien individual or a foreign corporation from disposition of a U.S. real property interest (USRPI) is taken into account as if the taxpayer were engaged in a trade or business within the United States during the tax year, and as if the gain or loss were effectively connected with that trade or business. USRPI includes any interest in a domestic corporation, unless it was at no time a USRPHC during the shorter of when the taxpayer held the interest or the five-year period ending on the date the interest was disposed.
Section 897(c)(3) provides that if any class of stock of a corporation is regularly traded on an established securities market, stock of that class shall be treated as a USRPI only in the case of a person that, at some time during the relevant holding period, held more than 5 percent of that class of stock (the "regularly traded exception"). Whether any person holds more than 5 percent is determined by applying the attribution rules in section 318(a), but by substituting "5 percent" for "50 percent" in section 318(a)(2)(C), which addresses attribution of stock owned by corporations to their shareholders (upward attribution), and section 318(a)(3)(C), which addresses attribution of stock owned by shareholders to corporations (downward attribution). Section 318(a)(2)(A) provides that stock owned, directly or indirectly, by or for a partnership is considered as owned proportionately by its partners.
Although section 897(c)(3) does not provide its own definition of the term "person," section 7701(a)(1) provides that the term "person" includes a partnership. Accordingly, section 897(c)(3) generally applies at the partnership level, unless it is more appropriate for the partnership to be treated as an aggregate of its partners for this purpose. Under an aggregate approach, the partners of a partnership, and not the partnership, are treated as owning the partnership's assets and conducting the partnership's operations.
Neither section 897 nor its legislative history addresses whether a partnership should be treated as an aggregate for this purpose. To determine whether aggregate treatment is appropriate, the advice considered that the foreign person that disposes of a USRPI is required to file a U.S. tax return, unless the regularly traded exception applies. It states that the question is whether a partner's share of a partnership's income is subject to U.S. tax based on nexus. For example, when a foreign person invests through a partnership that engages in a trade or business in the United States, the trade or business is imputed to the foreign person, and the foreign person is required to file U.S. tax returns. Also, a permanent establishment of the partnership is attributed to the partner for purposes of any applicable treaty.
The advice, therefore, determines that section 897(c)(3) applies at the partnership level when a partnership holds stock directly in a USRPHC. It reasons that the ability to determine whether a corporation is a USRPHC is no more difficult than in the case of an individual or entity investing directly in the corporation.
As a result, in Situation 1, NRA is subject to the FIRPTA rules by treating PRS as an aggregate of its partners. PRS holds 8 percent of CORP's stock, and the regularly traded exception does not apply. Therefore, the stock is considered a USRPI with respect to any foreign partner of PRS and, when PRS disposes of its stock of CORP, NRA is allocated its allocable share of the gain recognized on the disposition.
In Situation 2, NRA holds 4.5 percent of the stock of CORP directly. Because of the section 318(a)(2)(A) attribution rules, NRA is also treated as holding its proportionate share of stock held by PRS. Therefore, NRA is treated as indirectly owning an additional 1 percent of the stock of CORP (that is, 25 percent of PRS's 4 percent of the CORP stock). Because NRA is treated as holding a total of 5.5 percent of the stock of CORP under section 897(c)(3), when NRA disposes of its stock of CORP, the stock is considered a USRPI, and NRA's gain recognized on the disposition is effectively connected income under section 897(a).
Chile Tax Treaty
The U.S. Senate approved the proposed Chile-U.S. double taxation agreement on a 95-2 vote. The treaty will enter into force once each country has notified the other of the completion of its ratification procedures. The president must sign the ratification instruments to complete the approval and ratification process in the United States.
The treaty would help reduce double taxation and withholding rates on interest on U.S. investments in Chile. The treaty is consistent with the U.S. model tax treaty and is the first treaty between the two countries. It was signed on February 4, 2010.
The withholding tax rate for interest can be 4 percent if the interest is beneficially owned by certain banking-type entities. In all other cases, the maximum withholding rate on interest may not exceed 15 percent for a period of five years from the date on which the interest withholding provisions take effect. After the five-year period, the interest rate may not exceed 10 percent.
Royalties for the use of, or the right to use, industrial, commercial, or scientific equipment, but not including ships, aircraft, or containers are taxable at a rate not to exceed 2 percent. In all other cases, royalties are taxable at a rate not to exceed 10 percent.
Dividends are taxable at a rate not to exceed 5 percent if the beneficial owner is a company that directly owns at least 10 percent of the voting stock of the company paying the dividends. In all other cases, dividends are taxable at a rate not to exceed 15 percent.
Both countries use the credit method for the elimination of double taxation.
The treaty contains a limitation on benefits provision and an exchange of information provision.
The withholding tax provisions will apply from the first day of the second month following its entry into force. Its other provisions will apply beginning January 1 of the year following its entry into force.
Corporate AMT Notice
The IRS released Notice 2023-42, 2023-26 IRB 1, in early June, which waives estimated tax penalties on failure to pay 2023 estimated tax payments of a corporation's alternative minimum tax liability. As corporations subject to corporate AMT do not have full guidance on its application, this is helpful relief, although still quite limited, as it only relates to 2023.
The notice provides that to avoid receiving a penalty notice, taxpayers must still file Form 2220, "Underpayment of Estimated Tax by Corporations," with their federal income tax return, even if they owe no estimated tax penalty. The Form 2220 must be completed without including the corporate AMT liability from Schedule J of Form 1120, "U.S. Corporation Income Tax Return." Affected taxpayers must also include an amount of estimated tax penalty on line 34 of their Form 1120, even if that amount is zero.
House Republicans Advance Tax Plan
Tax bills approved by the House Ways and Means Committee on June 13 would retroactively restore the expensing of research and development costs, bonus depreciation, and net interest deductibility. The proposed legislation would also repeal the 16.4-cent-per-barrel excise tax on oil and cut more than $200 billion worth of energy tax credits approved last year in the Inflation Reduction Act (P.L. 117-169).
The Build It in America Act (H.R. 3938), the Small Business Jobs Act (H.R. 3937), and the Tax Cuts for Working Families Act (H.R. 3936) are likely to be starting points for tax negotiations between the House of Representatives, controlled by Republicans, and the Democratic president and Senate. The Republican bills received no Democratic support in the Ways and Means Committee.
One notable provision would expand the creditability for U.S. tax purposes of taxes imposed by U.S. possessions and foreign countries located in North, Central, or South America (but excluding Cuba and Venezuela). The bill would exempt any "Western Hemisphere tax" from application of the new, more restrictive Treasury regulations published last year that define whether a foreign tax is a creditable "income, war profits, or excess profits tax."12 The Western Hemisphere tax provision would apply to tax years beginning before January 1, 2027.
The three bills contain more than $237 billion in tax cuts, to be paid for in part by cutting credits enacted last year when Democrats controlled all three branches of the federal government. Many of the provisions in the bills would expire after 2025; sunsetting the provisions reduces the projected budgetary cost. Note that the projected budgetary impact of the TCJA was reduced via its provision that, beginning in 2022, R&D costs would no longer be expensed, a provision the current proposal would repeal with retroactive effect. The TCJA requires domestic R&D costs in tax years beginning after December 31, 2021, to be amortized over a five-year period and foreign R&D costs in those years to be amortized over a 15-year period; under the House bill, amortization would apply to costs incurred in tax years beginning after December 31, 2025. In other words, the House bill would extend expensing of R&D costs, but only for 2022-2025.
Under current law, for tax years beginning on or after January 1, 2022, the computation of adjusted taxable income for purposes of the limitation on the deduction for business interest under section 163(j) is determined without regard to any deduction allowable for depreciation, amortization, or depletion (that is, EBITDA). The House bill generally would delay the effective date of that provision to tax years beginning on or after January 1, 2026. Taxpayers would be able to elect whether to apply the net interest rule retroactively to years beginning after December 31, 2021, and before January 1, 2023.
The bill extends 100 percent bonus depreciation for qualified property placed in service after December 31, 2022, and before January 1, 2026 (January 1, 2027, for longer production period property and some aircraft), and for specified plants planted or grafted after December 31, 2022, and before January 1, 2026. The provision retains 20 percent bonus depreciation for property placed in service after December 31, 2025, and before January 1, 2027 (after December 31, 2026, and before January 1, 2028, for longer production period property and some aircraft), as well as for specified plants planted or grafted after December 31, 2025, and before January 1, 2027.
Republicans and Democrats tried and failed last year to negotiate compromise legislation that would extend R&D expensing, bonus depreciation, net interest expensing, and the child tax credit.
ABA International Guidance Requests
The ABA urged Treasury and the IRS to prioritize:
- finalizing the proposed FTC regulations (REG-112096-22) issued on November 22, 2022, and providing related guidance;
- providing guidance under the corporate AMT provisions of sections 55, 56A, and 59 related to dividends paid by controlled foreign corporations and the corporate AMT FTC;
- providing guidance under section 959 and related provisions (such as section 961) regarding foreign corporations with previously taxed earnings and profits resulting from, in part, subpart F income and global intangible low-taxed income inclusions, and other earnings subject to tax under various provisions of the TCJA; and
- providing guidance on the treatment of top-up taxes under pillar 2 model rules of the OECD for purposes of the FTC.
Those four requests were the highest-priority items on the ABA's Committee on Foreign Activities of United States Taxpayers. Other areas of requested guidance included:
- finalizing the proposed regulations (REG-130700-14) under section 861 on cloud transactions and digital transactions issued on August 14, 2019;
- guidance on the dividends-received deduction under sections 245A, 964(e)(4), and 1248(j) and the foreign branch loss recapture rule of section 91, including guidance on the coordination of such provisions with sections 304 and 1059;
- guidance under section 1291 regarding passive foreign investment companies; proposed regulations were issued on April 1, 1992 (T.D. 8404), and January 25, 2022 (REG-118250-20);
- regulations under section 367, including revisiting the section 367(b) regulations in light of the changes brought about by the TCJA; and
- guidance under section 987.
Footnotes
1. For prior coverage, see Larissa Neumann and Julia Ushakova-Stein, "U.S. Tax Review: IRA, Medtronic and Exxon, and Pillar 2," Tax Notes Int'l, Sept. 5, 2022, p. 1111.
2. Medtronic Inc. v. Commissioner, T.C. Memo. 2022-84.
3. Hanna Karcho Polselli v. IRS, No. 21-1599 (2023).
4. Ip v. United States, 205 F.3d 1168, 1175 (9th Cir. 2000).
5. Viewtech Inc. v. United States, 653 F.3d 1102, 1106 (2011).
6. Varian Medical Systems Inc. v. Commissioner, No. 8435-23.
7. Sysco Corp. v. Commissioner, No. 5728-23.
8. Kyocera AVC Components Corp. v. United States, No. 22-cv-02440.
9. For prior coverage of this issue, see Neumann, Ushakova-Stein, and Mike Knobler, "U.S. Tax Review: APA Update; Perrigo; Rawat, Kyocera, Mann; Cryptocurrency; Net Investment Income Tax," Tax Notes Int'l, June 5, 2023, p. 1321.
10. For prior coverage of this issue, see James P. Fuller and Neumann, "U.S. Tax Review," Tax Notes Int'l, Jan. 7, 2019, p. 35; Fuller and Neumann, "U.S. Tax Review," Tax Notes Int'l, Aug. 19, 2019, p. 681.
11. TCJA (P.L. 115-97), section 14223(d).
12. For previous coverage of those regulations, see Fuller, Neumann, and Ushakova-Stein, "U.S. Tax Review: Final Foreign Tax Credit Regulations," Tax Notes Int'l, Jan. 31, 2022, p. 517.
Originally published by Tax Notes.
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