Daily Tax Update - February 18, 2010

THE DAILY TAX UPDATE WILL BE PUBLISHED ON A PERIODIC BASIS UNTIL CONGRESS RETURNS ON FEBRUARY 22ND

PRESIDENT SIGNS EXECUTIVE ORDER CREATING BUDGET COMMISSION: Today, President Obama signed an executive order creating a National Commission on Fiscal Responsibility and Reform to help reduce the government's budget deficit. Former Clinton White House Chief of Staff Erskine Bowles and former Republican Sen. Alan Simpson were selected as co-chairmen. The 18-member panel is to include eight Republicans, six named by GOP leaders in Congress and two by the White House. Obama said they were "taking on the impossible. They're going to try to restore reason to the fiscal debate and come up with answers.” According to the Executive Order, “The Commission is charged with identifying policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run. Specifically, the Commission shall propose recommendations designed to balance the budget, excluding interest payments on the debt, by 2015.” The Commission is tasked with submitting a list of recommendations to the President by December 1.

TAX COURT HOLDS GUARANTEE FEES SHOULD BE SOURCED BY ANALOGY TO SERVICES: On February 17, the Tax Court released its decision in Container Corp. v. Commissioner, 134 T.C. 5 (2010), holding that guarantee fees are analogous to payments for services and should be sourced to the place of performance. The decision appears favorable for foreign parents that guarantee obligations of their US subsidiaries because the fees for such guarantees will not be subject to withholding. The decision, however, appears problematic for US parents that guarantee debts of their foreign subsidiaries, because the fees for those guarantees would constitute US source income for purposes of calculating the section 904 foreign tax credit limitation. This problem would be heightened if US courts were to adopt the approach of the Tax Court of Canada in General Electric Capital Canada Inc. v. the Queen, 2009 TCC 563, which held that the parent guarantee in that case could not be viewed as de minimis. In our view, it is likely that the government will appeal the Tax Court’s decision, with a central focus being whether the guarantee payments are analogous to the letter of credit commissions in Bank of America. (See the discussion below describing how the Tax Court distinguished Bank of America.).

  • The case involved fees paid by Vitro International Corp. (“International”), a US corporation, to its Mexican parent, Vitro, S.A. (“Vitro”) in exchange for Vitro’s guaranteeing of notes issued by International. International paid Vitro a guarantee fee of 1.5% of the outstanding principal balance of the notes per year, from 1992 through 1994.
  • The Internal Revenue Service (“IRS”) argued that International should have withheld 30% of the guarantee fees paid to Vitro because the fees were US source fixed or determinable annual or periodical (“FDAP”) income. Container Corporation (“Container Corp.”), the successor to International, agreed that the payments were FDAP but argued that the payments were foreign source and thus not subject to withholding.
  • The sourcing rules of the Internal Revenue Code and the regulations thereunder do not specify the source of a guarantee fee. As a result, the Tax Court considered whether a guarantee fee is analogous to a payment that is subject to a specific sourcing rule.
  • The IRS argued that the guarantee payments were analogous to interest payments, which are sourced to the residence of the obligor, and thus should be US source. Container Corp. argued that the guarantee payments were analogous to services, which are sourced to the place of performance, and thus should be foreign source.
  • The Tax Court determined that guarantee payments are “payments for a possible future action” and thus analogous to services and sourced to the location of the guarantor. As a result, the court held that the guarantee fees paid by International to Vitro were foreign source and thus not subject to withholding.
  • The court considered the Court of Claims’ decision in Bank of America v. Commissioner, 680 F.2d 142 (Cl. Ct. 1982), in which the Court of Claims considered the source of fees received by Bank of America in transactions involving letters of credits. Bank of America received three types of commissions: (1) acceptance commissions, received when the bank stamped the letter of credit accepted and obligated itself to pay when the letter came due; (2) confirmation commissions, received when the bank confirmed letters of credit and committed to pay after certain conditions were met; and (3) negotiation commissions, received when the bank reviewed documents to ensure that the documents conformed to the terms of the letters of credit. The Court of Claims held that (1) acceptance and confirmation commissions were paid for the substitution of Bank of America’s credit for that of another bank and thus were analogous to interest and (2) negotiation commissions received by Bank of America were paid for Bank of America’s reviewing of documents and thus were analogous to payments for services.
  • In Container Corp., the Tax Court determined that a payment in exchange for a guarantee was not analogous to the acceptance and confirmation commissions at issue in Bank of America. The Tax Court stated that Vitro was “augmenting International’s credit, not substituting its own,” and that this distinction was significant because unlike Bank of America, which put its money directly at risk when it accepted or confirmed the letter of credit, Vitro was not required to pay any money unless and until International defaulted.
  • The court concluded that “[w]e realize that we are deciding a close question, but an analogy to interest has too many shortcomings: Guaranty fees do not approximate the interest on a loan; Vitro, not International, produced the guarantee fees; and Vitro’s guaranty was not an obligation to pay immediately, but a promise to possibly perform a future act.”
  • For additional information, contact Philip R. West – pwest@steptoe.com, Michael C. Durstmdurst@steptoe.com or Amanda Varmaavarma@steptoe.com

WYDEN, GREG PLAN TO INTRODUCE BIPARTISAN TAX REFORM BILL NEXT WEEK: Senators Ron Wyden (D-OR) and Judd Gregg (R-RH) issued a joint statement yesterday that they plan to introduce comprehensive tax reform legislation when the Senate returns next week. Their statement said, “For more than two years, we have been working together on tax reform legislation. While the prevailing wisdom is that there is no such thing as genuine bipartisanship–especially on issues as politically charged as taxes and health reform–we are proud to demonstrate that not only is bipartisanship possible, but that it also can bear significant, fiscally responsible legislative results. When Congress returns next week, we will be introducing the product of our collaboration: a comprehensive tax reform bill that will make the federal tax code simpler and fairer for all Americans and businesses of every size. We have written legislation that will offer tax relief to working families, promote job growth and encourage American businesses to invest and expand. We believe that our legislation will demonstrate that not only can Congress avoid a partisan debate over how best to address the expiring 2001 and 2003 tax cuts but that Democrats and Republicans also can achieve much more by working together than they can apart."

IRS OVERSIGHT BOARD RELEASES ANNUAL TAXPAYER SURVEY: The 2009 taxpayer attitude survey has been released by the IRS Oversight Board. The document can be accessed via: http://www.steptoe.com/publications/IRSOBSurvey2009.pdf

MISCELLANEOUS GUIDANCE RELEASED THIS WEEK:
Revenue Procedure 2010-18 provides the depreciation deduction limitations for owners of passenger automobiles first placed in service, and amounts to be included in income by lessees of passenger automobiles first leased, during calendar year 2010. This revenue procedure includes tables detailing these depreciation limitations and lessee inclusion amounts that reflect the automobile price inflation adjustments required by § 280F(d)(7) of the Internal Revenue Code.

Revenue Ruling 2010-07 sets forth the prevailing state assumed interest rates that are used by insurance companies to determine their reserves under section 807 for contracts that are issued in 2009 and 2010. The ruling supplements, in part, Rev. Rul. 92-19.

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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