Daily Tax Update - June 23, 2011: Treasury and IRS Issue Regulations on Determination of Basis in United States Property

Treasury and IRS Issue Regulations on Determination of Basis in United States Property: Today, Treasury and the IRS issued final regulations regarding the determination of basis in certain United States property acquired by a controlled foreign corporation ("CFC") in certain nonrecognition transactions.  According to the preamble to the regulations, "[t]he purpose of these regulations is to prevent a United States shareholder of a [CFC] from avoiding an income inclusion under section 951(a)(1)(B) where the [CFC] acquires United States property in an exchange to which these regulations apply and claims a basis in the United States property that is less than the amount of earnings and profits repatriated."

  • The regulations provide rules for determining (solely for purposes of applying section 956) the adjusted basis of certain United States property (specifically, stock or an obligation of a domestic corporation described in section 956(c)(1)(B) or (C)) acquired by a CFC in an exchange in which the CFC’s basis in the property is determined under section 362(a).  Under Treas. Reg. § 1.956-1(e)(6)(iii), the basis of such property shall be no less than the fair market value (at the time of the exchange) of any property transferred by the CFC in exchange for such specified United States property.  The assumption of a liability by the CFC in connection with the exchange will be considered the transfer of property, and the fair market value of such property will be the amount of the liability assumed.
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  • The regulations also include an anti-abuse rule to prevent taxpayers from avoiding the general rule by later transferring the United States property to a related person in another nonrecognition transaction.
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  • The regulations apply to property acquired in exchanges occurring on or after June 24, 2011.

WAYS AND MEANS HEARING ON EFFECT OF TAX REFORM ON FOREIGN INVESTMENT:  Today, the House Ways and Means Subcommittee on Select Revenue Measures held a hearing on the importance of foreign direct investment (FDI) to the U.S. economy and how tax reform might affect foreign-headquartered businesses that invest and create jobs in the United States.

Witnesses on the first panel were:

  1. Nancy L. McLernon, President and Chief Financial Officer, Organization for International Investment
  2. Alexander Spitzer, Senior Vice President – Tax, Nestle Holdings, Inc.
  3. Claude Draillard, Chief Financial Officer, Dassault Falcon Jet Corporation.
  4. Jeffrey DeBoer, President and Chief Executive Officer, The Real Estate Roundtable

The second panel consisted of:

  1. Gary Hufbauer, Peterson Institute for International Economics
  2. Robert Stricof, Tax Partner, Deloitte Tax LLP
  3. Bret Wells, Assistant Professor of Law, University of Houston Law Center
  • In his opening statement, Subcommittee Chairman Tiberi said, "Today’s hearing highlights an important contributor to our economy—foreign companies who directly invest in the United States.  Their investment is critical to growing the economy and creating jobs. Over the last ten years, affiliates of foreign companies have employed between five and six million workers in the United States. This month the Administration released two reports affirming the importance of foreign direct investment.  I agree and I look forward to working with the Administration to eliminate the regulatory barriers standing in the way of greater foreign investment.  Today’s hearing will also examine tax rules specific to foreign investment including earnings stripping and transfer pricing.  The effectiveness of these rules in preventing foreign companies from using the tax code to create a competitive advantage over domestic companies is the subject of great debate."
  • The witnesses on the first panel focused on how the United States tax code could be amended to promote further investment by foreign-headquartered companies.  In particular, several witnesses stated that the "earnings stripping" rules of section 163(j) are an impediment to foreign companies' further expansion in the United States.  Mr. Spitzer argued that companies borrow in the United States to fund U.S. expansion and should not be penalized for doing so.  Mr. Spitzer also noted that the IRS also may seek to recharacterize debt as equity as another method of disallowing interest expense. 
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  • The witnesses also identified transfer pricing as another area for improvement.  Ms. McLernon said, "Current transfer pricing rules have resulted in substantial complexity and uncertainty in their application to our members. OFII commends the efforts that have been made to date to reduce uncertainty in this area, including reducing administrative burdens in certain cases associated with complying with the transfer pricing rules, as well as increasing the ability to determine in advance appropriate transfer pricing methodologies under the IRS' Advanced Pricing Agreement program (both unilaterally and bilaterally with our treaty partners) and fully supports adding additional resources to these programs."  Mr. Spitzer also pointed out that, even when companies ultimately prevail in disputes with the IRS over issues such as transfer pricing or debt/equity, they must incur large expenses in litigating their position. 
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  • The witnesses on the first panel all agreed that the United States' high corporate tax rate is a significant disincentive for foreign companies to make further investments in the United States. 
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  • On the second panel, the witnesses also discussed the corporate tax rate, including its relation to income-shifting.  Mr. Hufbauer stated that corporate tax rates should be lowered 10 to 15 percent to discourage income shifting, rather than building a "moat" around the U.S. tax system.  Mr. Hufbauer also testified, "After reviewing various studies, I conclude that cutting the statutory tax rate by 10 percentage points would increase the US capital stock by at least 5 percent, and put at least 600,000 people back at work in US firms – in addition to new American employees in foreign firms. Existing employees would enjoy wage gains of almost 2 percent because the additional capital stock would boost productivity."
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  • The witnesses on the second panel also discussed the issue of earnings stripping.  Mr. Hufbauer said, "Of course the IRS seeks to deter excessive interest payments resulting from unduly high debt leverage (characterized as 'earnings stripping') and excessive royalty payments for intellectual property rights. But in my view, this is not the time to 'crack down' with new legislation designed to give the IRS even stronger tools. By and large, inward foreign investment is great for the US economy, and we should want more of it. To lessen tax abuse, the first step the Congress should take is to sharply lower the US corporate tax rate so that foreign firms doing business here have less incentive to remit income to their parent firms abroad in the form of interest and royalty payments."  Mr. Stricof noted that a 2007 study by the Treasury Department did not find conclusive evidence of earnings stripping and argued that an IRS form (Form 8926) intended to gather further information about earnings stripping "will not advance the study of the area and it may lead to false conclusions." 
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  • Testimony can be accessed here
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  • For additional information, contact Philip R. West - pwest@steptoe.com or  Amanda Varma -avarma@steptoe.com

CANTOR, KYL PULL OUT OF BIDEN DEFICIT TALKS OVER IMPASSE ON TAXES:  Today, House Majority Leader Eric Cantor and Sen. Jon Kyl left the Biden deficit reduction talks because there was disagreement in the group over whether to include tax increases. Cantor said, "Given this impasse, I will not be participating in today’s meeting and I believe it is time for the president to speak clearly and resolve the tax issue," Cantor said. "Once resolved, we have a blueprint to move forward to trillions of spending cuts and binding mechanisms to change the way things are done around here."  The Biden Group meeting was cancelled for the rest of today.

  • Senate Minority Leader Mitch McConnell said, "We’ve known from the beginning that tax hikes would be a poison pill to any debt reduction proposal. Those who are proposing them now either know this or they need to realize it quickly."

MISCELLANEOUS GUIDANCE RELEASED TODAY:

Announcement 2011-40 advises the public that the Internal Revenue Service is revising the optional standard mileage rates for computing the deductible costs of operating an automobile for business, medical, or moving expense purposes and for determining the reimbursed amount of these expenses that is deemed substantiated.  This modification results from recent increases in the price of fuel.  The revised standard mileage rates are 55.5 cents per mile for business use of an automobile and 23.5 cents for use of an automobile as a medical or moving expense.  The mileage rate for use of an automobile as a charitable contribution is fixed by statute and remains 14 cents.  The revised standard mileage rates apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes on or after July 1, 2011, and to mileage allowances that are paid both (1) to an employee on or after July 1, 2011, and (2) for transportation expenses an employee pays or incurs on or after July 1, 2011.  

TAX BILLS INTRODUCED JUNE 22ND:

1.[112nd] H.R.2279:  To amend the Internal Revenue Code of 1986 to extend the funding and expenditure authority of the Airport and Airway Trust Fund, to amend title 49, United States Code, to extend the airport improvement program, and for other purposes.
Sponsor: Rep Mica, John L. [FL-7] (introduced 6/22/2011)   Cosponsors (2)
Committees: House Transportation and Infrastructure; House Ways and Means
Latest Major Action: 6/22/2011 Referred to House committee. Status: Referred to the Committee on Transportation and Infrastructure, and in addition to the Committee on Ways and Means, for a period to be subsequently determined by the Speaker, in each case for consideration of such provisions as fall within the jurisdiction of the committee concerned.

2. [112nd] H.R.2280:  To amend the Internal Revenue Code of 1986 to provide for the taxation of income of controlled foreign corporations attributable to imported property.
Sponsor: Rep Cicilline, David N. [RI-1] (introduced 6/22/2011)   Cosponsors (None)
Committees: House Ways and Means
Latest Major Action: 6/22/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

3. [112nd] H.R.2286: To amend the Internal Revenue Code of 1986 to provide tax credit parity for electricity produced from renewable resources.
Sponsor: Rep Herger, Wally [CA-2] (introduced 6/22/2011)   Cosponsors (1)
Committees: House Ways and Means
Latest Major Action: 6/22/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

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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