It’s Time for Tax-Exempt Entities to Restate Their 403(b) Plans

Under a new IRS program, tax-exempt entities who sponsor 403(b) retirement plans can adopt pre-approved documents that include determination letters that confirm the tax-qualified status of their plans. Plan sponsors need to adopt pre-approved plans before March 31, 2020, in order to qualify for the program.

Under a 403(b) plan, eligible employees can elect to make pre-tax contributions towards the cost of their own retirement benefits. The accumulated savings is most often used to purchase an annuity when the participant retires. Until now, a plan sponsor could not receive a determination from the IRS that its 403(b) plan satisfied all applicable tax requirements.

However, on January 13, 2017, the IRS announced the opening of a “remedial amendment period” under which plan sponsors can adopt pre-approved plan documents retroactively to the later of January 1, 2010, or the date that the plan was first adopted. Various entities such as insurance companies, financial service providers and companies that sell standardized retirement plan documents have already received approval of their forms of 403(b) plan documents. Most plan documents can be customized to reflect the terms of an existing 403(b) plan. The IRS will not review or provide determination letters for individually designed 403(b) plan documents.

By adopting a pre-approved document that has a determination letter, a 403(b) plan sponsor can protect against an assertion (for example, in the course of an IRS audit) that its plan document is not tax-qualified and that the plan sponsor and participants are not eligible to receive the tax benefits afforded under the Code. Therefore, it is highly recommended that sponsors of 403(b) plans adopt an IRS-approved plan document before March 31, 2020. Although the deadline for adoption is almost three years away, plan sponsors should begin discussions with their legal counsel regarding the conversion of their current documents to a pre-approved plan.

*Katharine’s license application in the State of Wisconsin is pending.

This post was written by Katharine G. Shaw and Bruce B. Deadman of  Davis & Kuelthau, s.c.
For more legal analysis, go to The National Law Review

Hurricane Harvey Client Alert: Tax Filing and Payment Deadlines Extended for Victims

Victims of Hurricane Harvey in some designated areas now have until January 31, 2018 to file certain federal tax returns and make payments.

On August 28, 2017, the US Internal Revenue Service (IRS) announced in a news release that it would postpone various individual and business federal tax return filing and payment deadlines that were to occur on or after August 23, 2017 until January 31, 2018 for certain persons affected by Hurricane Harvey. Specifically, this extension applies to taxpayers located in areas designated by the Federal Emergency Management Agency (FEMA) as qualifying for individual assistance.[1] Any taxpayer with an IRS address of record located within these designated areas will automatically receive the extension. Taxpayers in areas that are later added as qualifying for individual assistance by FEMA will automatically receive the extension as well. Additionally, taxpayers who are outside of the designated area but have necessary records needed to meet deadlines located in a designated area may qualify for the extension, but must contact the IRS to determine eligibility for relief.

As noted above, the specific relief announced by the IRS extends federal tax return filing and payment deadlines for individuals and businesses with original deadlines that would have occurred starting on August 23, 2017 to January 31, 2018. In other words, individuals and businesses will have until January 31, 2018 to file federal tax returns and make federal tax payments that have either an original or extended due date during this period. For individuals, the extension covers 2016 income tax returns that received “automatic” filing extensions until October 16, 2017; however, tax payments associated with these returns are not eligible for the extension because the payments were originally due on April 18, 2017. Additionally, the extension applies to the September 15, 2017 and January 16, 2018 deadlines for making quarterly estimated tax payments. For businesses, the extension covers the October 31, 2017 deadline for quarterly payroll and excise tax returns. Notably, the IRS announcement also states that the IRS will waive late-deposit penalties for federal payroll and excise tax deposits that are normally due on or after August 23, 2017 and prior to September 7, 2017, as long as the deposits are made by September 7, 2017.


[1] When the IRS news release was originally issued on August 28, there were 18 counties in areas designated by FEMA as qualifying for individual assistance. By August 30 (and as of August 31), FEMA had designated another 11 counties, bringing the total counties eligible for this relief up to 29.

This post was written by Donald-Bruce Abrams, Casey S. AugustJennifer Breen and William P. Zimmerman of Morgan, Lewis & Bockius LLP. All Rights Reserved. Copyright © 2017
For more legal analysis go to The National Law Review 

Tax Changes Implemented As Part of Revenue Package Supporting Illinois Budget

Yesterday afternoon, after months of wrangling and a marathon 4th of July weekend session, the Illinois House of Representatives voted to override Governor Bruce Rauner’s veto of Senate Bill (SB) 9, the revenue bill supporting the State’s Fiscal Year (FY) 2017-2018 Budget. The vote ended Illinois’ two year budget impasse and may avoid a threatened downgrade of Illinois bonds to junk status. The key tax components of the bill as enacted Public Act 100-0022 (Act) are as follows:

Income Tax

Rate increase. Income tax rates are increased, effective July 1, 2017, to 4.95 percent for individuals, trusts and estates, and 7 percent for corporations.

Income allocation. The Act contains a number of provisions intended to resolve questions regarding how income should be allocated between the two rates in effect for 2017.

  • Illinois Income Tax Act (IITA) 5/202.5(a) provides a default rule, a proration based on the days in each period (181/184), for purposes of allocating income between pre-July 1 segments and periods after the end of June when rates increase. Alternatively, IITA 5/202.5(b) provides that a taxpayer may elect to determine net income on a specific accounting basis for the two portions of their taxable year, from the beginning of the taxable year through the last day of the apportionment period, and from the first day of the next apportionment period through the end of the taxable year.

Note: This provision will create planning opportunities for taxpayers. For example, a taxpayer who paid bonuses to employees early in the year may wish to elect specific accounting, whereas taxpayers who paid bonuses out after the effective date of the tax increase may wish to pro rate under the default rule.

  • A new sub-section (IITA 202.5(c)(3)) provides that a taxpayer who elects a specific allocation different from the default rule must divide any Section 204 exemptions between the respective periods in amounts which bear the same ratio to the total exemption allowable under Section 204 as the total number of days in each period bears to the total number of days in the taxable year. We note that no mention is made regarding the treatment of credits.
  • Finally, another new sub-section (IITA 202.5(c)(4)) provides that a taxpayer who elects a specific allocation different from the default rule may not claim negative net income for one portion of the year and not the other. If a taxpayer’s net income otherwise would be negative for a portion of the year, the taxpayer is required to attribute all of its net income to the portion of the taxable year with positive net income and report net income for the other portion of the taxable year as zero.

Elimination of non-combination rule. For taxable years beginning on or after December 31, 2017, the definition of “unitary business group” is amended to eliminate the non-combination rule for group members that use different apportionment methods. There is no exception for insurance companies.

Note: For calendar year corporations, this change will take effect this year.

Expanded definition of “United States.” For taxable years ending on or after December 31, 2017, the definition of “unitary business group” is amended to include an expanded definition of “United States” to include the fifty states, the District of Columbia and “any area over which the United States has asserted jurisdiction or claimed exclusive rights with respect to the exploration for or exploitation of natural resources,” but not any territory or possession of the United States.

Note: For calendar year corporations, this change will take effect this year.

Decoupling from Domestic Production Activities Deduction (DPAD). The Act decouples from the federal domestic production activities deduction.

Research and Development Credit Extended and Reliance Protected. The research and development credit is restored retroactively (it had expired on January 1, 2016) and extended through December 31, 2021. The Act provides that all actions taken by taxpayers “in reliance on the continuation of the credit” are “hereby validated.”

Income Cap on individual taxpayer eligibility for certain exemptions and credits. Taxpayers with adjusted gross income for a taxable year in excess of $500,000 (in the case of spouses filing a joint federal return) or $250,000 (for all other taxpayers) may not claim the standard exemptions set forth in IITA Section 204. (IITA 5/204(g)). In addition, they may not claim a tax credit for residential real property taxes (IITA 5/208) or the education expense credit (IITA 5/201(m)).

Increased education expense credit. The education expense credit is increased to $750 for tax years ending on or after December 31, 2007. (See note above about limitations on taxpayer eligibility for the credit.)

Instructional materials credit. A new credit (maximum $250.00) is created for taxpayers who are teachers, instructors, counselors, principals or aides in qualified schools (for at least 900 hours during a school year) for instructional materials and supplies.

Sales Tax

Sales tax base not expanded to include services. The Act does not change the sales tax rate or expand the base to tax services.

Gasohol, majority blended ethanol, biodiesel and certain biodiesel blends. The Retailers’ Occupation Tax Act, Use Tax Act and Services Tax Act are amended to provide that gasohol is taxed at 100 percent of sales proceeds, effective July 1, 2017. Exemptions for blended ethanol, biodiesel and biodiesel blends are extended through 2023.

Manufacturing, Machinery and Equipment Exemption expanded to include graphic arts. The manufacturing, machinery and equipment exemption is expanded to include graphic arts machinery and equipment, effective July 1, 2017.

State Tax Lien Registration Act

The Act creates a central state tax lien registration system, which eliminates the requirement for the Illinois Department of Revenue (DOR) to post liens for taxes due in counties throughout the state. Taxpayers are required to pay any administrative fee imposed by the DOR by rule when creating the State Tax Lien Registry.

Revised Uniform Unclaimed Property Law

The Act includes a complete rewrite of the Illinois Unclaimed Property Laws, which we describe in a separate post.

This post was written byMary Kay McCalla MartireFred M. Ackerson and  Lauren A. Ferrante of McDermott Will & Emery.

Key Tax Changes in the American Health Care Act

The American Health Care Act (“AHCA”), passed by the House of Representatives on May 4, 2017, repeals many of the taxes added by the Affordable Care Act (“ACA”) and makes changes to other tax rules.  Some of the notable changes proposed to be made to the Internal Revenue Code are:

            1. The individual mandate to maintain health insurance and the employer mandate to offer health insurance remain in the Code, but the taxes are “zeroed out” effective retroactively to 2016.

            2. The following taxes, fees, credits and limitations are repealed as of the year shown below:

·         The net investment income tax (NIIT) (2017)

·         The 0.9% additional Medicare tax (2023)

·         The small employer health insurance credit (2020)

·         The $2500 limitation on contributions to a health flexible spending account (FSA) (2017)

·         The annual fee on branded prescription drug sales (2017)

·         The medical device excise tax (2017)

·         The annual fee on health insurance providers (2017)

·         The elimination of a deduction for expenses allocable to the Medicare Part D subsidy (2017)

·         The 10% tanning salon tax (June 30, 2017)

            3.         The “Cadillac” tax on high cost health plans is delayed until 2026.

            4.         Individuals may be reimbursed for over-the-counter medications under a health savings account (HSA), health FSA or a health reimbursement arrangement (HRA) (2017).

            5.         The penalty tax on withdrawals from an HSA not used for a qualified medical expense is reduced from 20% to 10% (2017).

6.         The bill would replace the current ACA premium tax credit with a new refundable, advanceable tax credit effective January 1, 2020.  The credit could be applied toward the cost of any eligible health insurance coverage, whether purchased on or off the Exchange.  The credit is age-based as follows:

Age

Annual Credit

Under 30

$2,000

30 – 40

$2,500

40 – 50

$3,000

50 – 60

$3,500

60 and over

$4,000

The maximum credit for a family is $14,000. The credit is adjusted each year by CPI + 1%.

The credit is phased out depending on the individual’s modified adjusted gross income (MAGI) for the year.  It begins phasing out for an individual with income of $75,000 ($150,000 for joint filers) by $100 for every $1,000 in income above those thresholds.  The MAGI dollar limitations are also indexed for inflation beginning in 2021.              To be eligible to claim the credit, the individual must be covered by “eligible health insurance,” not be eligible for “other specified coverage” (including employer coverage or a government sponsored health program) and be a U.S. citizen or a qualified alien.

7.         The bill would make the following changes to health savings accounts, effective in 2018:

§  The maximum contribution to an HSA would be increased to the out-of-pocket maximum (in 2017, $6,550 for self-only and $13,100 for family coverage).  Under current law, HSA contributions are limited to $3,400 for self-only and $6,750 for family coverage.
§  Both spouses could make a “catch-up” contribution to the same HSA.  Under current law, each spouse must have his or her own HSA.
§  If an HSA is established within 60 days after coverage under a high deductible plan begins, the individual could be reimbursed for medical expenses incurred within that 60-day period.  Under current law, an individual cannot be reimbursed for any expense incurred before the HSA is established.

The bill now moves to the Senate where significant changes are expected.

This post was written by Cynthia A. Moore of  Dickinson Wright PLLC.

Trump Tax Reform Proposal

Trump tax reformOn April 26, 2017, Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn introduced the Trump Administration’s tax reform proposal (the “Trump Proposal”) in a briefing. The proposal appears to borrow heavily from the tax reform plan put out by Mr. Trump during his presidential campaign with the significant exception that this reform proposal advocates adoption of a territorial tax system.

The proposal, set forth in a bulleted one-page document, was notably short on detail, and Secretary Mnuchin stated that many details will be finalized in subsequent discussions with Congress. Below, we highlight the major components in the Trump Proposal that we anticipate will be of the greatest interest to our clients.

Major Proposals 

Reduce the number of individual tax rate brackets. Under the Trump Proposal, the top rate for individual income tax would go down to 35 percent from its current rate of 39.6 percent (which is above the top rate of 33 percent proposed by Mr. Trump during his presidential campaign). The number of tax brackets would also be reduced from seven to three (10 percent, 25 percent, and 35 percent). Effectively, these changes would reduce income tax rates for most individual taxpayers, though no determination has been made on the income levels where these brackets would be set.

Expanded standard deduction. The standard deduction for individuals would be doubled under the Trump Proposal, which would effectively create a zero rate for many lower income taxpayers. Additionally, a higher standard deduction would reduce the number of taxpayers who would use itemized deductions, thus simplifying the return filing process for many taxpayers.

Eliminate most individual deductions. Secretary Mnuchin noted that most individual deductions will be eliminated, with the exception of the mortgage interest deduction and the charitable contribution deduction. This change may prove controversial because it repeals the deduction for state and local income taxes.

Other individual provisions. Consistent with the Trump campaign’s position, the proposal also would repeal the alternative minimum tax, the estate tax, and the Affordable Care Act’s 3.8 percent tax on net investment income.

Adoption of a territorial system. The Administration would also shift the United States to a territorial tax system, a proposal that was also advocated in the House Republican Tax Reform Blueprint (the “House Blueprint”)1 released last year, as a way to “level the playing field” for U.S. companies. A territorial tax system generally would exempt from taxation the foreign earning of U.S. headquartered companies. This is a significant change from an early Trump campaign position that advocated a worldwide tax system without deferral.

One-time repatriation tax. The Trump Proposal includes a one-time repatriation tax on the foreign earnings of U.S. companies, which is consistent with the Trump campaign position. However, in his remarks, Secretary Mnuchin did not give a specific repatriation rate even though the Trump Administration in prior comments has advocated for a 10 percent repatriation rate. This may suggest that the Administration is moving to the House Blueprint’s suggested bifurcated rates of 3.5 percent for foreign earnings and profits invested in “hard” assets and 8.75 percent for earnings and profits held as cash equivalents.

15 Percent business income rate and treatment of pass-through entities. The Trump Proposal would impose a 15 percent rate on all business income, including corporations and individuals receiving business income from S corporations, partnerships and other pass-throughs. It is uncertain whether this 15 percent rate will apply to all pass-through income. Secretary Mnuchin has previously stated that the 15 percent business rate would apply to small business income but would not be “a loophole for people that should be paying a higher rate.”

No mention of a cash-basis tax system or the border adjustability tax. The Trump Proposal did not contain any discussion of a cash-basis tax system or the border adjustability approach under the House Blueprint. Under the tax reform proposals of the Trump campaign, U.S. manufacturers would have been allowed to elect full and immediate expensing (subject to loss of the interest deduction) or retain current law depreciation and interest deductions. The Trump Proposal did not contain this earlier campaign proposal. On the issue of the border adjustable tax, Secretary Mnuchin noted that the Administration was continuing discussions with the House. Because the Trump Proposal briefing only provided a general overview of the Administration’s proposals, it is possible that President Trump could endorse either of these ideas at a later date.

At this point, it remains unclear how the Trump Proposal will affect the current tax policy debate or the ongoing tax reform process.


1 The House Republican tax reform proposal is formally titled “A Better Way: A Pro-Growth Tax Code for All Americans.”

Prepared for the Border Adjustment Tax? A U.S. and Global Perspective

border adjustment taxWe have been monitoring the potential impact of the Border Adjustment Tax (BAT) across a number of jurisdictions.

In our 14 February 2017 update, we commented that issues regarding the legality of BAT and the serious and significant international implications of its application meant that the introduction of BAT was uncertain.

In this further update we consider further the issues being raised in the United States about the BAT, look at potential challenges to the BAT by the World Trade Organization (WTO) and consider what the BAT may mean for jurisdictions outside the U.S. trading with U.S. business.

U.S. concerns

The BAT is part of a comprehensive tax reform plan that would shift the U.S. system from an income tax to a cash-flow destination based consumption tax. It would operate by exempting gross receipts from exports from U.S. federal income tax, and denying any deductions for the cost of imports. The BAT would apply to sales and imports of products, services and intangibles, and affect all forms of businesses, including corporations, “pass-throughs” and sole proprietorships.

The blueprint is vague as to whether the BAT applies to financial transactions and advice. The expectation is that financial transactions will be exempted from the BAT base in some form, but that investment management services would be included in the base.

The policy of the BAT is to incentivize business activity in the U.S. by effectively penalizing imports and subsidizing exports. It is intended to discourage corporate inversions and erosion of the U.S. tax base by making transfer pricing issues moot. It also is estimated to pay for one-third of the cost of the overall tax reform bill.

The U.S. business community is pushing for tax reform in order to make U.S. companies more competitive in a global marketplace. However, because the BAT rewards exporters and punishes importers, the proposal has ironically divided the very business community that is driving reform. While importers could potentially have a larger tax liability than book income, exporters could potentially experience a negative tax situation, since their costs would remain fully deductible (assuming they were not imported). The controversy extends beyond the business community. Consumer groups fear the BAT will result in higher prices. Importers fear U.S. consumers would work around the tax by buying directly from offshore vendors. The BAT could spur increased mergers and acquisitions, as net exporters seek companies with income sufficient to offset negative taxable incomes.

House Republicans, who proposed the BAT, say the value of the U.S. dollar will increase concomitantly with the tax increase, effectively increasing the buying power of importers and thus mitigating the impact of the BAT. Economists and other analysts are mixed in their reaction as to how the dollar will react. Since many international contracts are denominated in the U.S. dollar and because many currencies are not free floating, it is unclear to what extent any fluctuation in the dollar will offset the impact of the BAT.

Further, it is unclear whether the Trump Administration will endorse the BAT. There have been mixed messages from the White House, but President Trump has made it clear he would like to impose some sort of levy on imports to level the playing field for U.S. businesses and to bring jobs back to the U.S.

WTO Implications

While the focus has been on the impact on U.S. businesses and consumers, there are significant and serious international implications of the BAT. It is unclear whether the BAT would violate WTO protocols and a challenge from the WTO seems almost certain.

The WTO’s Agreement on Subsidies and Countervailing Measures (SCM Agreement) only allows border adjustability for taxes imposed on products, the most common of these being value added taxes, sales tax and stamp duties. Whilst there seems to be some argument that a BAT is similar to a value added tax as it is focused on destination based consumption, the majority of commentators disagree with this analysis saying that the proposed BAT is a true corporate tax which in effect imposes a discriminatory subsidy in favour of net exporters. Further, the SCM Agreement prohibits the subsidizing of exports and of the use of domestic over imported goods.

Article II of the General Agreement on Tariffs and Trade (GATT) prohibits charging tariffs in excess of those in each country’s tariff schedule. The denial of deductions for the cost of imports could be considered equivalent to a tax on the imports themselves. In WTO terms, this could be viewed as the imposition of tariffs in excess of those provided for in the U.S. schedule or might violate the Article II requirement not to impose “other” duties or charges on imports. Article III of the GATT, which sets forth what are known as “national treatment” principles, generally requires that imports be treated no less favorably than domestically-produced goods. To the extent the BAT permits certain deductions (such as the cost of domestic wages), and thus generates lower tax rates for domestically-produced goods, while denying the same deductions for the same imported products, it would seem to violate the basic national treatment rules of the WTO.

The Effects of the BAT will extend far beyond the U.S. border

The European Union (EU) has already clarified it will not stand by without taking responsive action. Officials from jurisdictions like Canada, Mexico and Germany, have indicated their disapproval and concerns about the BAT. The impact on tax treaties, intended to prevent double taxation, is unclear. Many think a U.S. exemption from taxation of exports will result in a shift of the location of taxation, with non-U.S. jurisdictions taking custody of the income and taxing it. Countries around the world are concerned about how the denial of a deduction for the cost of imports and the strengthening of the U.S. dollar will affect the demand for their products, and their ability to afford products from the U.S.

Being a destination based cash flow tax, the BAT is not consistent with a corporate tax system, it goes against current principles of international taxation underlying the double tax treaties, and is not in alignment with the more recent global Base Erosion and Profit Shifting Rules (BEPS) initiatives launched by the Organisation for Economic
Co-operation and Development (OECD), Australia and the European Union.

Initial observations as to the BAT:

  • Granting a corporate income tax exemption on income derived from exports leads to a reduction of the income tax base and qualifies economically as a subsidy.

  • Disallowing a deduction for expenses relating to imports from the U.S. corporate tax base is effectively an increase of the tax base.

  • Due to its nature as a destination-based (cash-flow) tax, it is often compared to the European style value added tax (VAT) or the Australian goods and services tax (GST). However, the proposed BAT substantially differs from VAT and GST, e.g., in that:

    • VAT and GST is typically economically neutral for most businesses; and

    • end-consumers bear the same VAT burden irrespective of whether the services and supplies originate from the domestic market or from abroad.

  • Materially, the BAT appears to be a customs duty collection tool dressed in an income tax garment.

Economically, it has been said that BAT will eventually be trade neutral, due to the expected increase of the value of the U.S. dollar, however the value of a currency is also influenced by many other factors. In addition, it may be questioned whether (potential) effects on the exchange rate can be taken into consideration when analyzing and discussing the application of existing domestic and international tax law.

It is too early to finally assess the potential reaction of other countries on a potential enactment of the BAT by the U.S. In case of an enactment, many details will have to be better understood such as whether and how cross-border income payments from outside the U.S. (e.g., interest, royalties, dividends) will be subject to tax but exempted or rather be excluded from tax. In case of substantial frictions with the current tax systems, the reaction in Europe for example, may be a combination of both, a reaction at EU level as well as consequences drawn by individual member states.

Some states may question the income tax nature of the BAT or deny certain benefits such as treaty benefits based on applicable “subject-to-tax” clauses or alike. Whether or not certain states will go beyond that by requesting changes to the existing Double Taxation Treaties or their interpretation remains to be seen. Why for example should a country apply reduced withholding tax rates on royalties or alike if the respective income is not taxed in the U.S. for reasons of impeding the free trade between the U.S. and that particular country?

BAT may well also impact the current approach to globally harmonize the common understanding of fair international taxation, including the battle against the so-called BEPS which was triggered by biased rules governing international taxation.

Australia

Australia has been an early adopter for many of the OECD BEPS measures. It has recently passed legislation to implement a diverted profits tax, similar to that in the United Kingdom, a “Netflix” tax being a GST on intangible supplies via a digital platform operator by non-resident suppliers to Australian consumers. It has also introduced the Multinational Anti Avoidance Law to combat tax avoidance by multinational companies operating in Australia.

These measures show an increasing focus on cross border flows of business, and a move toward a destination model of taxing rather than an origination model. That is consistent with the BAT principles. However, given that the U.S. is Australia’s biggest trading partner and a destination of choice for many Australian companies seeking to expand globally, the impact of the BAT for Australian business cannot be underestimated.

While much of the focus in the U.S. has been on the impact of BAT on the import and expect of manufactured goods and products, cross border utilisation of intellectual property, intangibles, and management and head office charges are likely to be an area of ongoing focus as the BAT works its way through the legislative agenda.

France

The BAT could jeopardise the application of the tax treaty entered into by the U.S. and France. According to the most recent case law of the French high administrative court (Conseil d’Etat), treaty benefits must only be granted where there is an effective double taxation. If a French company pays a royalty to a U.S. company, such royalty will be exempt in the U.S. and the French revenue may take the view that the treaty does not apply. French domestic withholding tax of 30% may apply accordingly.

The BAT would clearly contradict some of the provisions of this treaty. By way of example, Article 7 provides that in determining the profits of a permanent establishment, there shall be allowed as deductions expenses which are reasonably connected with such profits, whether incurred in the State in which the permanent establishment is situated or elsewhere.

Germany

Germany has also been an early adopter of the BEPS rules – to the extent such rules were not already enacted before as German rules fighting cross-border base erosion and profit shifting were already rather sophisticated.

A mere reduction of the U.S. corporate income tax rate itself should generally not be of a concern from a German tax perspective. However, for purposes of the application of the Controlled Foreign Corporation (CFC) and Passive Foreign Investment Company (PFIC) rules pursuant to the German Foreign Tax Act, there will be an issue where the effective corporate income tax burden in the U.S. drops below 25%, measured by German tax standards.

However, Germany would certainly not welcome substantial single-sided impediments on the free trade imposed by BAT or other means.

United Kingdom

For United Kingdom businesses that export to the U.S., the introduction of a BAT could have far reaching consequences for sales, FX strategy and business organisation.

One area of particular difficulty relates to cross-border financial services (UK outbound and inbound): it is not yet clear how a BAT would deal with these (VAT systems are themselves complex in this area). Useful practical strategies may be drawn by U.S. businesses in conjunction with advisers both in the U.S. and jurisdictions with VAT systems, like the United Kingdom, as and when any BAT reform is rolled out in detail.

On a more general level, tax issues have gained a higher profile in the UK over the last few years. Like many other jurisdictions the UK is actively adopting the recommendations of the OECD’s BEPS initiative and actively encouraging EU policy to endorse the same. The UK’s implementation of these OECD recommendations has resulted in the UK seeking to tax profits created in UK, and trying to ensure that where value has been created in the UK that value is not artificially diverted for tax purposes to offshore jurisdictions.

The current UK Government’s enthusiasm for these OECD initiatives (and the automatic exchange of tax information including private tax rulings) is a continuation from the previous administration, faces little or no political opposition and is not in any way contaminated by BREXIT.

It can be noted that the OECD BEPS initiative’s overarching economic goal to ensure that value is taxed where it is created (not located) in fact, with increased attribution to human resource (rather than capital or IP), is not necessarily incompatible with the political objective of the Blueprint to increase value creation in the U.S. (and taxing it there).

Global high brand value service and product suppliers, and other businesses which are head-quartered outside of the UK, argue that the value of their sales derives from their domestic jurisdictions where their global high value brand products or IP was developed and where their technicians, designers, board etc. are based. As a result, value is not derived from a UK based sales centre, the services of which, if outsourced, would only cost a small amount in fees or commissions. It will be interesting to see how the lobby groups for U.S. based multinationals and a post-BREXIT UK each respond to the EU Commission’s state aid challenges, which were aimed at preventing low EU tax on EU sales. It may prove harder to resist greater taxation in the EU if there is no domestic tax in the U.S. in relation to the EU operations.

In addition to the policy arguments there are also technical issues with how the UK’s value based approach will sit with the proposed destination based approach in the US. For example, the U.S.-UK double tax treaty currently deals with direct taxes (such as federal profits, income and gains taxes) and is predicated on traditional tax bases such as residence and source and does not address indirect taxes (like VAT) at all. How this will be applied in the context of the U.S.-UK double tax treaty is not clear.

Conclusion

Given both the uncertainty regarding the intricacies and workings of the BAT as well as how it will interact with existing Double Tax Treaties, the introduction and operation of the BAT remains unclear

The impact of the proposed tax on net importers vs net exporters divides the business community and creates further uncertainty in an already uncertain economy. The same applies to the consequences on the application and interpretation of domestic tax and international tax law outside the U.S. It is hoped that detailed legislation as well as commentary addressing the concerns of the U.S. domestic and international community will go some way in resolving these issues in a time efficient manner.

Copyright 2017 K & L Gates

IRS Dirty Dozen for 2017, Tax Shelters, and Captive Insurance: Attacking Past Problems Using a Voluntary Disclosure Strategy

House, Money, The IRS summarized its annual “Dirty Dozen” List of Tax Scams for 2017 in February. Practitioners and taxpayers should pay particular attention. The IRS is broadcasting their playbook. This list includes two principal types of tax matters: (1) scams that are intended to victimize taxpayers directly, and (2) scams in which taxpayers voluntarily – or unwittingly – agree to participate. The first set of scams includes identity theft, phone scams, and things like solicitations from fake charities. These items often result from direct attacks on taxpayers. The second set of scams typically involves a taxpayer’s voluntary participation, but there often are misunderstandings and reliance questions that can be very important to the resolution of the issue. Whatever the source, each problem creates a set of issues that taxpayers, their CPA advisors, and experienced tax counsel should evaluate very carefully.

Abusive Tax Shelters – Including Captive Insurance – Make the Dirty Dozen List…Again

Key among the scams that make the “Dirty Dozen” list is the abusive tax shelter. Abusive tax shelters have been a perennial target of the IRS for decades, and the IRS annually reaffirms its commitment to uncovering and stopping complex tax avoidance/evasion schemes.

One abusive tax shelter that repeatedly makes itself a topic for the IRS is the captive insurance structure. Captive insurance is a perfect example of a structure that can be fully defensible, fully abusive, or somewhere between the two. In many cases, captive insurance can be a legitimate business activity; however, often an ill-advised taxpayer will implement a plan that is attacked by the IRS as “abusive” because it was not properly designed.

Captive insurance generally is a legitimate, legislatively-approved tax structure. However, the IRS often determines that an abuse has occurred with respect to certain small or “micro” captive insurance companies. Federal tax law allows businesses to create “captive” insurance companies to protect against certain risks. The insured business claims tax deductions for premiums paid for the insurance policies, and the premiums are paid to a captive insurance company that normally is owned by the same owners of the insured business. The captive insurance company, in turn, can elect to be taxed only on the investment income from the pool of premiums, excluding taxable income of up to $1.2 million per year in net premiums.

In the type of structure that is likely to be classified as abusive, promoters persuade closely-held entities to create captive insurance companies. The promoters assist with creating and “selling” “insurance” binders and policies from the captive to the business to cover either ordinary business risks, or implausible risks, and charging high premiums while maintaining market rate commercial coverage with traditional insurers.

The promoted structure often results in premiums equal to the $1.2 million annually to take full advantage of the tax code provision. Underwriting and actuarial substantiation for the insurance premiums often do not exist, and the promoters manage the captive insurance companies in exchange for significant fees.

There are myriad variations of legitimate captive structures, and taxpayers should carefully evaluate any existing or proposed captive insurance program. Like other structures that are designated to be “abusive,” a captive insurance structure can result in a protracted and costly audit – and potentially a criminal investigation – if it is discovered by the IRS.

A clear warning sign to practitioners is when their client is advised to exclude you from analysis or review of the strategy or product.

Taking a Proactive Approach to Tax Issues: Considering a Voluntary Disclosure Strategy

It is the specter of exposure, including both investigations and costly audits, that reminds us of the alternative to simply sitting back and waiting for the government to audit: a voluntary disclosure. A voluntary disclosure may be used to address past reporting, non-reporting, or mis-reporting, and may be a viable strategy for many types of missteps – both the types specifically referenced by the IRS in its “Dirty Dozen,” and other items that create similar audit risks. The voluntary disclosure alternative is not an unconditional surrender, and it is not without risk, but a well thought-out, designed, and implemented voluntary disclosure can minimize costs, penalties, and the time involved in addressing problems. A thoughtfully designed voluntary disclosure strategy can offer material benefits, but it should never be implemented until after there has been comprehensive analysis conducted in an attorney-client privileged environment.

© 2017 Varnum LLP