Daily Tax Update - May 20, 2010

BAUCUS AND LEVIN RELEASE EXTENDERS, JOBS BILL WITH CARRIED INTEREST AND INTERNATIONAL AND CORPORATE OFFSETS—HOUSE POSTPONES VOTE UNTIL NEXT WEEK: Today, Senate Finance Chairman Max Baucus and House Ways and Means Chairman Sander Levin released the summary of the “American Jobs and Closing Tax Loopholes Act” (H.R. 4213). The legislation includes small business tax cuts and would extend through 2010 several tax provisions that expired at the end of 2009. The legislation also includes several international and corporate tax offsets and a provision to tax carried interests as ordinary income.

• Today, House Speaker Nancy Pelosi said that the House vote would be postponed until at least next week. Pelosi said, "It could be that in the interest of giving sufficient notice, we may put off going to the Rules Committee until Tuesday. We'll have an announcement about that shortly. Again, we want to have the best possible bill but we also want to be able to give adequate notice to members, to all of you, to those who follow the actions of Congress.” The Senate vote may slip until after the Memorial Day recess.
• The offsets include:
• Taxation of carried interest. To the extent that carried interest does not reflect a return on invested capital, investment fund managers will be required to treat 75% of the remaining carried interest as ordinary income. A transition rule would apply prior to January 1, 2013.
• Rules to prevent splitting foreign tax credits from income ($6.325 billion). The bill will adopt the Administration’s FY 2011 budget proposal to implement a matching rule that would suspend the recognition of foreign tax credits until the related foreign income is taken into account for US tax purposes. The provision would apply to all “split” foreign taxes claimed by taxpayers after the date of introduction.
• Source rules on guarantees ($2.025 billion). The legislation would provide a specific source rules for guarantees, effectively reversing the Tax Court’s recent decision in Container Corp. v. Commissioner, so that guarantees issued after the date of enactment would be soured like interest rather than services.
• Technical correction to statute of limitations provision in the HIRE Act. The bill would make a technical correction to the foreign compliance provisions of the Hiring Incentives to Restore Employment (HIRE) Act to clarify that the statute of limitations period under section 6501(c)(8) will not be tolled if the failure to provide information is shown to be due to reasonable cause and not willful neglect.
• Denial of foreign tax credit with respect to foreign income not subject to United States taxation by reason of covered asset acquisitions ($4.025 billion). The bill would prevent taxpayers from claiming foreign tax credits with respect to foreign income that is never subject to US taxation because of a covered asset acquisition (i.e., where a taxpayer acquires an entity treated as a corporation for foreign tax purposes but a non-corporate entity for US tax purposes, resulting in a basis step-up). The provision would generally apply to related party transactions occurring after the date of introduction and unrelated party transactions occurring after the date of enactment.
• Separate application of foreign tax credit limitation to items resourced under tax treaties ($253 million). The bill would segregate for foreign tax credit purposes certain income earned by foreign branches and disregarded entities of US corporations that is treated as foreign source under treaties. The provision would apply to taxable years beginning after the date of enactment.
• Limitation on the use of section 956 for foreign tax credit planning (i.e., the “hopscotch” rule) ($1.010 billion). The bill would limit the amount of foreign tax credits that may be claimed with respect to a deemed dividend under section 956 to the amount that would have been allowed with respect to an actual dividend. The provision would apply to the affirmative use of section 956 after the date of enactment.
• Special rule with respect to certain redemptions by foreign subsidiaries ($255 million). The bill would discourage “out-from-under” tax planning (i.e., where a foreign-based corporation sells stock in a US company to its foreign subsidiary and the transaction is treated as a dividend from the foreign subsidiary) by preventing the foreign subsidiary’s earnings from being reduced so that the earnings would remain subject to US tax (including withholding tax) when repatriated to the foreign parent corporation as a dividend. The provision would apply to acquisitions after the date of introduction.
• Modification of affiliation rules for purposes of rules allocating interest expense ($405 million). The bill would modify the interest expense allocation affiliation rules so that certain foreign source interest expense will be taken into account in the determination of the foreign tax credit limitation. The provision would apply to taxable years beginning after the date of enactment.
• Repeal of 80/20 rules ($153 million). The bill would repeal the 80/20 company rules and the 80/20 rules for interest paid by resident alien individuals. The bill would include relief for existing 80/20 companies that meet specific requirements and are not abusing the 80/20 company rules. Subject to the relief for these existing 80/20 companies, the provision would apply to taxable years beginning after December 31, 2010.
• Gain recognized in certain spin-off transactions (e.g., “Reverse Morris Trust” transactions) ($260 million). The bill would treat distributions of debt securities in a tax-free spin-off transaction in the same manner as distributions of cash or other property. Subject to a transition rule, the provision would apply to exchanges after the date of enactment.
• Taxation of dividends received in certain business reorganizations (e.g., the “boot-within-gain” limitation) ($460 million). The bill would repeal the boot-within-gain limitation in the case of any reorganization transaction (both domestic and cross-border transactions) if the exchange has the effect of the distribution of a dividend. Subject to a transition rule, the provision would apply to exchanges after the date of enactment.
• Ensuring collection of employment taxes earned by certain service professionals ($9.618 billion). The bill would require the payment of Social Security and Medicare taxes in the case of (1) an S corporation is engaged in a professional service business that is principally based on the reputation and skill of 3 or fewer individuals or (2) an S corporation that is a partner in a professional service business. The bill would also clarify that individuals that are engaged in professional service businesses are unable to avoid employment taxes by routing their earnings through a limited liability company or a limited partnership.
• The summary can be accessed here.
• For additional information, contact Mark J. Silverman - msilverman@steptoe.com or Philip R. West - pwest@steptoe.com

TREASURY AND IRS ISSUE LONG-AWAITED GUIDANCE ON US TAX IMPOSED BY SUBSTITUTE DIVIDEND PAYMENTS: Today, the IRS issued Notice 2010-46, which withdraws Notice 97-66 and provides for a new regulatory framework to be developed to address withholding issues in securities lending transactions.

• In 1997, Treasury and the IRS issued regulations governing the source and character of substitute dividend payments made pursuant to securities lending transactions. After those regulations were issued, taxpayers expressed concern that the regulations could lead to over withholding in cases where the same shares of stock were lent to multiple non-US parties in concurrent transactions. To address these concerns, the Treasury and IRS issued Notice 97-66, which used a formulary method to calculate the amount of US tax to be imposed.
• In 2008, the Senate Permanent Subcommittee on Investigations released a report, “Report on Dividend Tax Abuse: How Offshore Entities Dodge Taxes on US Stock Dividends,” which examined securities lending transactions. The committee reported that “soon after [Notice 97-66] was issued, some US financial institutions and offshore entities began to take advantage of the wording of the Notice to structure stock loan transactions that they claimed eliminated all withholding tax on substitute payments.”
• In March of this year, Congress passed the Hiring Incentives to Restore Employment Act (the “HIRE Act”). The HIRE Act added new section 871(l), which provides that certain dividend equivalent payments are treated as US-source dividends.
• Notice 2010-46 withdraws Notice 97-66 effective for payments made on or after September 14, 2010 (the effective date of new section 871(l)). According to Notice 2010-46, Treasury and the IRS will issue new regulations to replace the formulary approach under Notice 97-66 with a documentation-based regime under which withholding agents may reduce withholding to the extent that withholding is shown to have been made on another substitute payment or dividend with respect to identical securities.
• The regulations will also exempt certain financial institutions (“Qualified Securities Lenders”) from withholding at source on substitute dividend payments if they assume responsibility and liability for properly withholding, reporting, depositing, and paying US tax with respect to substitute dividend payments.
• The regulations will include an anti-abuse rule stating that a withholding agent or Qualified Securities Lender may not rely on the regulations to reduce withholding where the withholding agent or Qualified Securities Lender knows or has reason to know that the securities lending transaction or series of transactions has a principal purpose of reducing or eliminating the amount of gross basis tax that would have been due in the absence of such transaction or transactions.
• The regulations are anticipated to be effective for transactions entered into on or after January 1, 2012.
• Prior to September 14, 2010, taxpayers may continue to rely on Notice 97-66 with certain modifications—a withholding agent or foreign lender cannot rely on Notice 97-66 when the withholding agent or foreign lender knows or has reason to know that a securities lending transaction or series of such transactions has a principal purpose of reducing or eliminating the amount of gross-basis tax that would have been due in the absence of such transaction or transactions.
• Notice 2010-46 provides transition rules that will apply after September 14, 2010 and until formal regulations are issued.
• The Treasury and IRS have requested comments on: (1) the definition of a Qualified Securities Lender; (2) the treatment of substitute dividends paid to a Qualified Securities Lender where that entity holds the relevant position in a proprietary account; (3) whether additional rules are required to address abusive securities lending transactions in addition to the new anti-abuse regulation; (4) the treatment of substitute dividends with respect to securities transferred from a commingled account containing securities held by a Qualified Securities Lender in its proprietary capacity and other securities held for customers; (5) whether a QI that is a Qualified Securities Lender should be required to provide certain information to another QI that has borrowed securities in a securities lending transaction; and (6) the definition of a series of securities lending transactions.
• For additional information, contact Philip R. West - pwest@steptoe.com or Amanda Varma - avarma@steptoe.com

DOGGETT INTRODUCES INTERNATIONAL TAX LEGISLATION: On May 18, Ways and Means Committee member Lloyd Doggett introduced H.R. 5328, the “International Tax Competitiveness Act of 2010.”

• The bill would treat foreign corporations that are managed and controlled in the United States as domestic corporations if such corporations have more than $50 billion in assets or the stock of the corporation is regularly traded on an established securities market. This provision is identical to the managed and controlled provision in the 2009 “Stop Tax Haven Abuse Act.”
• The bill would also repeal the section 954(c)(6) look-through rule for royalties, repeal the “80/20” rule for interest and dividends, and amend the “boot within gain rule” of section 356(a) so that money and property received by the taxpayer shall be treated as a dividend to the extent such money and property would have been treated as a dividend if distributed to the taxpayer immediately after the exchange in redemption of stock having a fair market value equal to the amount of the money and property received.
• For additional information, contact Philip R. West - pwest@steptoe.com or Amanda Varma - avarma@steptoe.com

MISCELLANEOUS GUIDANCE RELEASED TODAY:
Revenue Ruling 2010-14 which provides the rates for interest on tax overpayments and underpayments for the calendar quarter beginning July 1, 2010. The interest rates will be 4 percent for overpayments (3 percent in the case of a corporation), 4 percent for underpayments, 1 and one-half percent for the portion of a corporate overpayment exceeding 10,000, and 6 percent for large corporate underpayments. This quarterly determination is required by section 6621 of the Internal Revenue Code.

TAX BILLS INTRODUCED MAY 19TH:

H.R.5340 : To allow a State to opt out of K-12 education grant programs and the requirements of those programs, to amend the Internal Revenue Code of 1986 to provide a credit to taxpayers in such a State, and for other purposes.

Sponsor: Rep Garrett, Scott [NJ-5] (introduced 5/19/2010)      Cosponsors (None)

H.R.5343 : To amend the Internal Revenue Code of 1986 to provide an investment tax credit for advanced biofuel production property.

Sponsor: Rep Herseth Sandlin, Stephanie [SD] (introduced 5/19/2010)      Cosponsors (1)

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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