Daily Tax Update - December 15, 2011: Treasury, IRS Finalize Regs Regarding Foreign Base Company Sales Income

TREASURY, IRS FINALIZE REGULATIONS REGARDING FOREIGN BASE COMPANY SALES INCOME:  Treasury and the IRS issued final regulations under section 954(d)(2) addressing foreign base company sales income (FBCSI) as a result of the activities of branches of controlled foreign corporations (CFCs).  Section 954(d)(1) provides, in general, that income of a CFC from purchases and sales of personal property constitutes FBCSI if the products were produced outside of the country of incorporation of the CFC and sold or purchased for use outside of such country.  Under section 954(d)(2), if a CFC carries on purchasing, selling, manufacturing, producing, constructing, growing, or extracting activities by or through a branch, and the carrying on of those activities has substantially the same tax effect as if the branch were a wholly owned subsidiary of the CFC, then the branch and the remainder of the CFC will be treated as separate corporations for purposes of determining the FBCSI of the CFC..  The final regulations provide guidance on the application of this branch rule, particularly in situations where a CFC has multiple branches.  The final regulations adopt the approach of proposed regulations (REG-150066-08) issued on December 29, 2008.

  • The determination of whether a branch’s activities have "substantially the same tax effect" is made under the tax rate disparity test of Treas. Reg. § 1.954-3(b)(1)(i)(b) and (ii)(b).  With respect to a sales or purchases branch, one compares the tax rate on income from the purchase or sale activities of the branch with the rate that would apply if the income were earned by the CFC.  With respect to a manufacturing branch, one compares the tax rate on the income from the purchasing and selling activities of the CFC with the tax rate on that income under the laws of the country in which the manufacturing branch is located.
  • The temporary regulations had provided that if none of the branches or the  remainder of the CFC independently satisfy the substantial contribution test for an item of personal property, then for purposes of applying the tax rate disparity test, the tested manufacturing location is the location of manufacture, production, or construction, "unless the 'tested sales location' provides a demonstrably greater contribution to the manufacture, production, or construction of the property."  A number of commenters inquired as to whether the word "demonstrably" indicated a higher standard of proof.  The word "demonstrably" was removed from the final regulations in order to eliminate this uncertainty.
  • The proposed regulations had generally provided for the grouping of branches that did not have a tax rate disparity with the purchasing or selling branch or remainder of the CFC treated as purchasing or selling on behalf of a manufacturing branch.  The grouping rule applies for the purposes of Treas. Reg. § 1.954-3T(b)(2)(ii), which sets forth the rules that apply after it has been determined that a branch and the remainder of a CFC will be treated as separate corporations. In response to comments, this section was revised to clarify that the grouping rule aggregates "the activities of" the relevant branches or remainder. 
  • Finally, the final regulations deleted paragraph (d) of Treas. Reg. § 1.954-3(b)(2)(ii), which had provided that income that was already classified as FBCSI under the purchasing or selling branch rules is not again classified as FBCSI under the manufacturing branch rules.  This paragraph is no longer necessary due to the addition of Treas. Reg. § 1.954-3(b)(1)(ii)(c)(1), which precludes this duplication.   
  • The final regulations apply to taxable years of CFCs beginning after June 30, 2009, and for taxable years of US shareholders in which or with which the taxable years of these CFCs end.  A taxpayer may also choose to apply these regulations retroactively with respect to its open taxable years that began prior to July 1, 2009. The taxpayer may so choose if and only if the taxpayer and all members of the taxpayer’s affiliated group (within the meaning of section 1504(a)) apply these regulations, in their entirety, to the earliest taxable year of each controlled foreign corporation that ends with or within an open taxable year of the taxpayer and to all subsequent taxable years.
  • The regulations can be accessed via: http://www.steptoe.com/publications/2011-32394_PI.pdf
  • For additional information, contact Philip R. West - pwest@steptoe.com, Gregory N. Kidder - gkidder@steptoe.com, or Amanda Varma -avarma@steptoe.com 

TREASURY, IRS ISSUE TEMPORARY REGULATIONS ON FOREIGN FINANCIAL ASSETS:  Treasury and the IRS have issued temporary regulations relating to the provisions of the Hiring Incentives to Restore Employment (HIRE) Act regarding the reporting of foreign financial assets (section 6038D of the Internal Revenue Code of 1986).  The regulations are to be published in the Federal Register on December 19, 2011 and are effective for taxable years ending after that date.  The text of the temporary regulations is also the text of corresponding proposed regulations.

  • A "specified individual" must generally file a statement of his "specified foreign financial assets."  The term "specified individual" includes US citizens, resident aliens, and nonresident aliens who have elected to be taxed as US residents.
  • Filing of Form 8938, "Statement of Specified Foreign Financial Assets" is required where the specified individual (i) is required to file an annual tax return with the IRS, (ii) holds an "interest" in specified foreign financial assets during the taxable year, and (iii) the aggregate value of the specified foreign financial assets exceeds a specific threshold.  (The Form is not yet available.)
    • A specified person has an interest in a specified foreign financial asset if any income, gains, losses, deductions, credits, gross proceeds, or distributions attributable to the holding or disposition of the specified foreign financial asset are, or would be required to be reported, included or otherwise reflected by the specified person on an annual return.
    • The minimum aggregate value threshold is $50,000 on the last day of the taxable year, or  $75,000 at any time during the taxable year.  Higher threshold amounts apply for individuals who are married filing jointly, and for individuals residing outside of the United States. 
  • A "specified foreign financial asset" is defined as:
    • Any financial account maintained by a foreign financial institution or a financial account maintained by a financial institution that is organized under the laws of a US possession.  (Such accounts do not include accounts maintained by a US payor);
    • Any stock or security held for investment that is issued by any person other than a United States person (an asset is held for investment by a specified person for purposes of the regulations if that asset is not used in, or held for use in, the conduct of a trade or business of the specified person);
    • Any financial instrument or contract held for investment (not for the individual’s trade or business) that has an issuer or counterparty that is not a United States person;
    • Any interest in a foreign entity that is held for investment;
    • Any such asset owned by an entity disregarded as an entity separate from its owner; and
    • Any such asset owned by a child, if the parent has elected to include certain unearned income of the child in his gross income.
  • Assets not subject to reporting include:
    • An asset for which the individual uses mark-to-market accounting under section 475;
    • A financial account maintained by a foreign financial institution for the individual that uses mark-to-market accounting for all of the holdings in the account;
    • An interest in a social security, social insurance, or other similar program of a foreign government; and
    • A beneficial interest in a foreign trust or a foreign estate, unless the individual knows or has reason to know based on readily accessible information of the interest.
  • Information to be reported includes:
    • In the case of a financial account maintained by a foreign financial institution, the name and address of the foreign financial institution and the account number of the account;
    • In the case of stock or a security, the name and address of the issuer, and information that identifies the class or issue of which the stock or security is a part;
    • In the case of a financial instrument or contract held for investment, information that identifies the financial instrument or contract, including the names and addresses of all issuers and counterparties;
    • In the case of an interest in a foreign entity, information that identifies the interest, including the name and address of the entity;
    • The maximum value of the specified foreign financial asset during the portion of the taxable year in which the specified person has an interest in the asset;
    • In the case of a financial account that is a depository or custodial account under section 1471(d)(2), whether such financial account was opened or closed during the taxable year;
    • The date, if any, on which the specified foreign financial asset, other than a financial account that is a depository or custodial account under section 1471(d)(2), was either acquired or disposed of (or both) during the taxable year;
    • The amount of any income, gain, loss, deduction, or credit recognized for the taxable year with respect to the reported specified foreign financial asset, and the schedule, form, or return filed with the Internal Revenue Service on which the income, gain, loss, deduction, or credit, if any, is reported or included by the specified person;
    • The foreign currency exchange rate and the source of the rate used to determine the specified foreign financial asset’s US dollar value; and
    • For a specified foreign financial asset excepted from reporting on Form 8938 under §1.6038D-7T(a), the specified person must report the number of each type of form on which the asset is reported directly
  • A specified person is not required to report a specified foreign financial asset on Form 8938, "Statement of Specified Foreign Financial Assets," if the specified person reports  the asset on at least one of certain specified forms timely filed with the Internal Revenue Service for the taxable year.
  • A joint interest in a specified foreign financial asset is subject to reporting by each joint owner of the asset.  For purposes of determining whether the owners have an interest exceeding the reporting thresholds, each joint owner (other than a married couple filing a joint return) must include the full value of the jointly owned asset.
  • Special rules apply to bona fide residents of US territories
  • Individuals required to file Form 8938 may also be required to file Form TD F 90-22.1, "Report of Foreign Bank and Financial Accounts" (FBAR reports).  FBAR reports and Form 8938 are not regarded as duplicative.
  • Individuals who fail to disclose the required information are subject to a penalty of a minimum $10,000 and maximum of $50,000, depending on the length of the lapse of disclosure. An accuracy-related penalty may also be imposed.
  • If an individual has an interest in one or more specified foreign financial assets and the IRS determines that the individual has not provided sufficient information to demonstrate the aggregate value of the assets upon request by the Secretary, then the aggregate value of the assets is presumed to be in excess of the applicable reporting threshold for the purpose of imposing penalties.
  • No penalty will be imposed for failure to report due to reasonable cause. A foreign law restriction on disclosure does not constitute reasonable cause.
  • A person may elect to apply the rules of the regulations for taxable years ending before December 19, 2011.
  • The rules also apply to "specified domestic entities."  The regulations relating to such entities are reserved.
  • The regulations can be accessed via: http://www.steptoe.com/publications/2011-32263_PI.pdf  and http://www.steptoe.com/publications/2011-32254_PI.pdf
  • For additional information, contact Philip R. West - pwest@steptoe.com or Stanley Smilack - ssmilack@steptoe.com 

SENATE SUBCOMMITTEE MAJORITY STAFF RELEASES REPORT ARGUING CORPORATE OFFSHORE FUNDS NOT "TRAPPED":  A report released yesterday by Sen. Carl Levin (D-MI), chairman of the US Senate Permanent Subcommittee on Investigations, argues that large multinational US corporations with substantial offshore funds have placed nearly half of those funds in US bank accounts and US investments without paying any US tax on those foreign earnings. The survey results are presented in an addendum to an earlier report in October 2011.

  • According to the report, "Earlier this year, a survey was sent to 27 US multinational corporations and found they held more than half a trillion dollars in tax-deferred foreign earnings at the end of FY2010. The survey also found that 46% of those foreign earnings – almost $250 billion – was maintained in US bank accounts or invested in US assets such as US Treasuries, US stocks other than their own, US bonds, or US mutual funds. The survey also found that corporations varied widely in the extent to which they placed foreign earnings in US assets."
  • The executive summary states, "The Report Addendum recommends against enacting a second corporate repatriation tax break for an additional reason to those enumerated in the Report : because undistributed accumulated foreign earnings are not trapped offshore. US corporations are already investing nearly half of those foreign earnings in US assets without paying any US taxes on them, allowing those corporations to reap benefits from the US financial system without paying the tax dollars needed to support that system. Enacting still another corporate repatriation tax incentive would further exacerbate that tax unfairness."
  • Sen. Levin said, "Some multinational corporations say they want to bring foreign funds back to America, but can do it only if they get a special tax break. They claim their foreign funds are otherwise 'trapped' abroad, but new data show that is not true. Many US multinationals have already invested a large portion of their foreign funds right here in the United States, taking full advantage of the safety and security of the US financial system to protect their money while paying no US taxes on those funds to support the US system."  Levin added, "Right now, US multinationals are benefiting from the stability and security that US banks, US investments, and US dollars provide without paying their fair share to sustain our economy."
  • Ways and Means member Rep. Kevin Brady (R-TX) said, "The Senator’s report is flawed and factually deficient. The questionable assertion that allowing US companies to bring back stranded profits from overseas to invest now in American jobs, research, and expansion would somehow damage this struggling economy is simply not grounded in fact or in practice." Brady continued, "The previous tax holiday that occurred in 2005 created jobs, boosted the economy, and increased federal tax revenues which in turn led to the strongest growth year in the decade that wasn’t fueled by an artificial asset bubble."  Brady added, "By omitting numerous real life examples of companies creating jobs and unleashing new investment, as well as ignoring recent economic studies that demonstrate the economic boost from repatriation, this report appears to be little more than a factually deficient attack on bi-partisan legislation that could help get our economy back on the right track. At the end of the day, this report fails to explain how a dollar of American profit left overseas is better than a dollar of profits back home that could be invested in American jobs, research, expansion and financial stability. While the ultimate solution is comprehensive tax reform that permanently lowers the barriers to bringing US investment back home, the clock is ticking on this dismal economy.  We need a free-market solution that creates tax revenue rather than spends it."
  • For additional information, contact Philip R. West - pwest@steptoe.com or  Amanda Varma - avarma@steptoe.com

SENATE LEADERS OPTIMISTIC IMPASSE CAN BE RESOLVED: Senate Democratic and Republican leaders were hopeful today that an agreement was near on extending this year's payroll tax cut, renewing unemployment benefits and averting a shutdown of the federal government.   Senate Majority Leader Harry Reid said that he and Senate Minority Leader Mitch McConnell hope they can reach an agreement, "that would get us out of here in a reasonable time, in the next few days."  Reid said, "There are a few issues still outstanding, but they're really small in number." 

  • McConnell said, "We’ve been in useful discussions about how to wrap this session up. We hope to be able to pass a combination of appropriation bills and we are working hard to resolve the remaining differences on the payroll tax extension and the related issues that are important to both sides." McConnell added, "We’re confident and optimistic we’ll be able to resolve both on a bipartisan basis."
  • Democrats have backed away from their demand for surtax on millionaires to help finance payroll tax cuts.  House Speaker John Boehner said, "I appreciate the fact that they gave up on the millionaire's surtax."  But he said "they didn't give anything up" because "they never had the votes for their so-called millionaire's surtax."
  • The House is expected to vote on a $1 trillion spending bill tomorrow, thus averting a federal government shutdown.
  • In remarks today, President Obama said, "his Congress cannot or should not leave for vacation until they have made sure that that tax increase doesn't happen. Right now Congress needs to make sure than 160 million working Americans don't see their taxes go up on January first. None of the workers who join us here today can afford a thousand dollar tax increase next year...It wouldn't be good for the economy." Obama said there's "no reason" why the government shouldn't be able to extend the payroll tax cut and unemployment insurance before the holidays. He also added that there's "no reason the government should shut down over this."  Obama added, " would expect all of us to what's necessary."

SHULMAN DISCUSSES INTERNATIONAL TAX ISSUES: Today, in remarks before the IRS/George Washington University 24th Annual Institute on Current Issues in International Taxation, IRS Commissioner Douglas Shulman said that the government plans to issue guidance under the Foreign Account Tax Compliance Act shortly after the new year.

  • Shulman said, "Congress wrote and passed FATCA to give us tools to combat offshore tax evasion. Since the law was passed, we have put out three pieces of guidance laying out a practical framework and timeline for implementation, such as phasing in the statute’s requirements. I have also directly engaged executives from banks and financial institutions around the globe, as have my colleagues at the Treasury Department and IRS. We have listened to their major concerns that generally fall into two categories. First, is the conflict between FATCA and other countries’ laws. Second, is the difficulty in implementing and administering the withholding requirements for passthru payments and the potential burden they place on foreign financial institutions." Shulman added, "We have taken these conversations very seriously and you can expect new proposed regulations from us soon after the new year that take into account the implementation concerns we have heard. One goal of these regulations is to address these concerns and provide a way forward to allow responsible corporate citizens to work through these tricky issues in a practical fashion."
  • Shulman continued, "[W]e are shifting our approach to be more strategic, and to view taxpayers through the prism of their business objectives and tax planning strategies. This is a real change. We traditionally viewed and pursued international issues through the lens of individual code sections. But this occluded our view of the larger, more meaningful picture. We were only getting a slice of it… and that needs to change. For example, when a US corporation shifts income to a low-tax jurisdiction, we need to look at the entire structure that was created to accomplish this. We need to understand the overall planning paradigm… What’s motivating the company...What are the benefits...What are the most aggressive positions…How are they managing tax exposure…In other words, we have to understand what they are trying to accomplish."  Shulman added, "o, we are shifting our approach to be more strategic and to view taxpayers through their business objectives and tax planning strategies. The end game is to try to develop a way of organizing our international compliance programs to:
    • Indentify the highest compliance risks among our taxpayer base;
    • Work cases as effectively and efficiently as possible;
    • Not waste our and taxpayers’ time on issues that do not pose compliance risk; and
    • Find appropriate ways to resolve cases as soon as possible."
  • Shulman discussed the major areas of focus for outbound and inbound companies. Shulman said, "For outbound situations – those US-based companies with foreign operations – corporate planning tends to revolve around four key goals:
    • First is income shifting, typically accomplished through transfer pricing around transactions such as intellectual property transfers.
    • Second is deferral planning. We have to make sure that deferral of US tax on foreign earnings is justified under our subpart F regime.
    • Third is foreign tax credit management of the foreign tax expenses of a US corporation’s foreign subsidiaries.
    • And fourth is repatriation, which centers around strategies for low- or tax-free return to the US of profits accumulated offshore."
  • Shulman continued, "For inbound activities of foreign-based multinational enterprises, the major issues include:
    • First, dealing with the threshold question of jurisdiction to tax. Under our domestic law and treaties, what level of activity exposes the foreign enterprise to US tax?
    • Second, income shifting. This is the mirror image of outbound income shifting, and here, too, the objective typically is to allocate income away from US taxing jurisdiction.
    • Third is inbound financing, which is often used by a foreign group to strip income through interest deductions or parental guarantee arrangements.
    • And, fourth, repatriation and withholding, which can include strategies on reducing withholding on the repatriation of the cash back to the foreign home office."
  • Shulman’s remarks can be accessed here.

TAX BILLS INTRODUCED DECEMBER 14TH:

1. [112nd] H.R.3661 : To amend the Internal Revenue Code of 1986 to make permanent and expand the temporary minimum credit rate for the low-income housing tax credit program.
Sponsor: Rep Tiberi, Patrick J. [OH-12] (introduced 12/14/2011)      Cosponsors (8)
Committees: House Ways and Means
Latest Major Action: 12/14/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

2. [112nd] S.1989 : A bill to amend the Internal Revenue Code of 1986 to make permanent the minimum low-income housing tax credit rate for unsubsidized buildings and to provide a minimum 4 percent credit rate for existing buildings.
Sponsor: Sen Cantwell, Maria [WA] (introduced 12/14/2011)      Cosponsors (10)
Committees: Senate Finance
Latest Major Action: 12/14/2011 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

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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