March 11, 2010
AGENDA
I.Welcome and Introductions
II.Pending Legislation
a.Administration’s FY 2011 Tax and Budget Proposals
The FY 2011 Budget contains several provisions of particular interest to the business community that we would like to discuss:
i.Research and Development Credit – We applaud the Administration for proposing to make permanent the research and development credit as of January 1, 2010. Uncertainty about the future availability of the credit diminishes its incentive effect. For example, it is difficult for taxpayers to factor the credit into long-term decisions to invest in research projects that will not be initiated and completed prior to the credit’s expiration.
ii.Check-the-Box – We applaud the Administration for withdrawing its proposal to repeal the “check-the-box” rules.
iii.Taxation of Cell Phone Usage – We applaud the Administration’s decision to recommend changes to section 280F(d)(4) (removing cell phones and other email devices from the definition of listed property) consistent with TEI’s comments and affirm our support for the moratorium on audits of cell phone usage.
iv.Codification of the Economic Substance Doctrine – TEI continues its opposition to the codification of the economic substance doctrine for the reasons set forth in our letter dated December 4, 2009,1 to the chairs and ranking members of the House and Senate tax-writing committees. We invite a discussion about the prospects for introducing a “reasonable cause” exception to the imposition of the related strict liability penalty.
v.Outbound Transfers of Intangible Property – The Administration’s proposal on outbound transfers of intangible property would subject to taxation under Subpart F so-called excessive returns on income from intangibles shifted out of the United States to related controlled foreign corporations subject to a low effective tax rate. We invite a discussion about the method chosen to provide a backstop to section 482 to prevent abuse and its effect on competitiveness.
b.Tax Reform – Given the Administration’s current priorities, what is the status of the Administration’s proposals to reform the international provisions of the Code and, indeed, its plans for broad-based, fundamental tax reform?
III.Regulatory Actions and Other Initiatives
a.Announcement 2010-9
Announcement 2010-9 (2010-7 IRB 408) represents the latest step in the IRS’s continuing effort to identify transactions and areas of risk that should be the focus of its examination resources. In line with Forms 8275 and 8886, and Schedule M-3, it is designed to assist the IRS in more efficiently analyzing – rather than searching for – transactions. TEI is preparing written comments on Announcement 2010-9. We welcome the opportunity to discuss the Office of Tax Policy’s role in developing the Announcement and the proposed schedule and related instructions.
b.Section 457A
Enacted as part of the Emergency Economic Stabilization Act of 2008 (Pub. L. No. 110-343, 122 Stat. 3765), section 457A applies to any compensation that is deferred under a nonqualified deferred compensation plan of a “nonqualified entity,” and requires that such compensation be included in gross income when there is no longer a substantial risk of forfeiture.
Section 457A was originally targeted at preventing U.S. managers of offshore hedge funds from deferring their compensation, but the final statute applies much more broadly, for example, potentially applying to any U.S. taxpayer receiving deferred compensation from a foreign employer or to a nonresident alien with an existing deferred compensation arrangement who becomes a U.S. resident for U.S. federal income tax purposes.
Under section 457A(b), a “nonqualified entity” is (1) any foreign corporation, unless substantially all of its income is (A) effectively connected with a U.S. trade or business, or (B) “subject to a comprehensive foreign income tax,” and (2) any partnership, unless substantially all of its income is allocated to persons other than (A) foreign persons with respect to whom such income is not subject to a comprehensive foreign income tax, and (B) U.S. tax-exempt organizations. Section 457A(d)(2) defines “comprehensive foreign income tax” as ―
with respect to any foreign person, the income tax of a foreign country if —
(A) such person is eligible for the benefits of a comprehensive income tax treaty between such foreign country and the United States, or
(B) such person demonstrates to the satisfaction of the Secretary that such foreign country has a comprehensive income tax.
Interim guidance on the statute was provided in Notice 2009-8, 2009-4 I.R.B. 347 (Jan. 8, 2009). In Question 8 of that notice, the IRS addresses how a taxpayer may determine whether substantially all of a foreign corporation’s income is subject to a comprehensive foreign income tax:
(a) In general. For purposes of § 457A, substantially all of the income of a foreign corporation is subject to a comprehensive foreign income tax if, for the taxable year of the foreign corporation ending with or within the service provider's relevant taxable year . . . ―
(i) either (A) the foreign corporation is eligible for the benefits of a comprehensive income tax treaty between its country of residence and the United States . . ., or (B) the foreign corporation demonstrates to the satisfaction of the Secretary that it is resident for tax purposes in a foreign country that has a comprehensive income tax; and
(ii) the foreign corporation is not taxed by the foreign corporation's country of residence under any regime or arrangement that is materially more favorable than the corporate income tax otherwise generally imposed by such country. (Emphasis added.)
An exception to this rule is provided in the next paragraph:
(b) Exception where nonresidence source income is excluded. Notwithstanding paragraph A-8(a), substantially all of the income of a foreign corporation will not be treated as subject to a comprehensive foreign income tax if —
(i) the foreign corporation's taxable income determined under the laws of its country of residence excludes, in whole or in part, nonresidence source income realized by the foreign corporation; and
(ii) the aggregate amount of nonresidence source income of the foreign corporation that is excluded for the relevant taxable year (the excluded amount) exceeds 20 percent of the gross income of the foreign corporation.
The Need for De Minimis Rules. The legislation and notice create a complicated technical regime for determining which employees are subject to income tax at vesting, rather than distribution. In the case of a typical U.S. multinational company, TEI believes the administrative burden involved is out of proportion to the benefit in terms of tax policy. The deferred compensation programs of a typical U.S. multinational are designed for the U.S. workforce and only a very small proportion of the employees in those programs will be working abroad for a nonqualified entity. To lessen the administrative burden, de minimis rules should be adopted. For example, situations in which less than a specified percentage of an employer’s workforce participating in the deferral plans could potentially be affected, or where less than a specified percentage or amount of the compensation earned by a potentially affected expatriate participant is deferred compensation, rather than current compensation should be exempted from section 457A.
Comprehensive Foreign Income Tax Requirement. Where an employer has employees subject to section 457A, technical issues remain. Neither the statute nor Notice 2009-8 provides guidance on how an employer might demonstrate residence in a country with a “comprehensive foreign income tax.” One possibility would be to use similar tests already established elsewhere in the Code, e.g., section 901, which examines a foreign tax system to determine whether it implements an income tax in the U.S. sense, supplemented by minimum corporate tax rate requirements.
In addition, TEI is concerned that the requirement in subparagraph (a)(ii) of A-8 of Notice 2009-8 that the foreign corporation not be taxed by the foreign corporation's country of residence “under any regime or arrangement that is materially more favorable than the corporate income tax otherwise generally imposed by such country” may exceed the scope of the statute. Section 457A(d) requires that the taxpayer demonstrate only that it is entitled to the benefits of a comprehensive income tax treaty between the United States and the jurisdiction or that it is operating in a jurisdiction that has a comprehensive income tax. Accordingly, we recommend that subparagraph (a)(ii) be substantially modified.
For example, the term “materially more favorable” is not defined in the notice. In many countries ― such as China, India, Switzerland, or the United Kingdom ― it is common for companies to obtain rulings, tax holidays, or other economic development incentives that may ameliorate the corporate tax burden and permit them to remain competitive. Notice 2009-8 is silent whether these practices place a country within or outside the reach of subparagraph (a)(ii). For example, should a 75-percent tax holiday be viewed in the same manner as a 100-percent holiday? Would a ruling that reduces a taxpayer’s local tax burden by 30 percent have the same effect as one that results in an 80-percent reduction? These questions illustrate only some of the nuances that taxpayers may encounter in implementing these rules.
Exception Where Nonresidence Source Income Is Excluded. TEI is also concerned about paragraph (b) of A-8, which deems a foreign corporation an unqualified entity where the foreign jurisdiction’s laws exclude nonresidence source income and the excluded amount exceeds 20 percent of the corporation’s gross income. Notice 2009-8 indicates that the exclusion is very broad, potentially including credits, exemptions, and even deductions. Despite its breadth, it is unclear how paragraph (b)’s exclusion would apply, for example, if foreign source income were offset by the employer’s net operating losses.
Moreover, the application of Notice 2009-8 in respect of corporations in countries with territorial regimes that do not tax (in whole or in part) foreign-source income, such as dividends – the situation in respect of the majority of countries with which the United States has tax treaties – will be quite burdensome. This is because the Notice allows an employer to except from the excluded amounts dividends from corporations that themselves qualify as “subject to a comprehensive foreign income tax,” but requires the foreign employer to annually test its eligibility for such relief using an extremely complicated formula. TEI respectfully submits that this burden is unnecessary to accomplish the objectives of section 457A, and suggests that paragraph (b) should be significantly revised. Substantially the same results could be achieved by implementing an effective tax rate standard, e.g., by creating a safe harbor that permits employers to demonstrate that foreign source income is subject to a minimum tax rate.
TEI would be pleased to work with the Treasury Department in addressing these issues.
c.Debt/Equity classification
Rev. Proc. 2010-3, 2010-1 I.R.B. 110, updates the IRS’s annual “no ruling” revenue procedure. Section 4.02(1) states that there “may be instances where IRS will rule on whether an instrument issued by a domestic corporation is classified as stock or indebtedness.” Specifically, the IRS may “issue a letter ruling with respect to an instrument issued by a domestic corporation if (1) the taxpayer believes that the facts strongly support the classification of an instrument as stock and (2) the taxpayer can demonstrate compelling reasons to justify the issuance of a letter ruling.” (Emphasis added.)
TEI applauds Chief Counsel’s decision to issue rulings on the character of corporate instruments. We recommend that the policy be expanded to include the characterization of instruments as debt. Providing rulings to increase the certainty of characterization of instruments will minimize the frequency and scope of disputes and also permit the IRS to redirect scarce audit resources.2 We also recommend that the guidance be expanded to foreign corporate instruments and equity instruments issued by a partnership.
Finally, we note that a number of countries have adopted safe harbor guidelines prescribing the amount of permissible debt and equity in order to minimize disputes about thin capitalization. If the change in ruling policy affords the government sufficient experience to develop guidance on the indicia of equity and debt instruments, would the IRS or Treasury consider prescribing a safe harbor, debt-equity ratio, e.g., three to one, for non-financial institutions? In addition to definitional issues arising under section 385, (1) are there specific issues of concern to the IRS that TEI should consider before advancing a proposal for establishing a debt-equity safe harbor, and (2) would the IRS and Treasury be receptive to issuing safe harbor guidance?
IV.Proposed U.S.-Singapore Income Tax Treaty
TEI supports commencing bilateral treaty discussions with Singapore, and invites a discussion on the same.
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1
http://www.tei.org:80/dman/Document.phx/TEI+comments+on+Health+Care+Act+H+R++3962?folderId=%2F&cmd=download
2 This would be especially so when addressing deferred payment obligations with original issue discount, such as those at issue in the recently dismissed case of GlaxoSmithKline Holdings (Americas) v. Commissioner, United States Tax Court Docket No. 18940-08 (dismissed November 16, 2009).