Newsletter September 2018 | Volume XVII, Issue 8 Tax News and Developments North America Tax Practice Group In Memoriam – David Tillinghast With much sadness, Baker McKenzie mourns the loss of David Tillinghast who passed away on August 15 at age 88. We were extremely fortunate to have had David as our partner for many years prior to his retirement in 2014. Without question, David was considered one of the most outstanding international tax lawyers of our time. In the words of our former Chair, Len Terr, David was "a pioneer in the ever-changing, dynamic practice of international tax law" and "a genuinely modest, unassuming, low-key person." He was a trusted colleague, a great mentor and a wonderful friend to us all. To read more about David's extraordinary career and accomplishments, please click here. Our deepest sympathies go out to David's family and many friends. He will be greatly missed. By: Melinda Phelan, Chair, North America Tax Practice Group, Dallas Treasury and IRS Release Proposed GILTI Guidance On September 13, 2018, Treasury and the IRS released proposed regulations under section 951A. As of the date of this newsletter, the proposed regulations had not been published in the Federal Register. The proposed regulations provide some important guidance with regard to various mechanical and computational aspects of the GILTI regime, as well as rules for reporting requirements. The proposed regulations also include revisions to Treas. Reg. sec. 1.951-1 to address certain “avoidance structures” under the pro rata shares rules, to coordinate certain aspects of the subpart F and GILTI regimes, and also to reflect statutory changes to the definition of US shareholder and the elimination of the so-called 30-day requirement. The proposed regulations do not contain any rules on the foreign tax credit (including rules on expense allocation to the section 904(d)(1)(A) GILTI basket) as it relates to GILTI. The preamble states that such rules will be included in separate notices of proposed rulemaking. The preamble does provide that “it is anticipated” that the section 78 gross-up related to the section 951A inclusion will be assigned to the GILTI basket. The proposed regulations provide detailed rules on many of the computational aspects of the GILTI regime including: the calculation of tested income and tested loss; the calculation of the amount of qualified business asset investment (or “QBAI”); rules on tested interest expense and tested interest income; the effect of the GILTI inclusion amount on earnings and profits and basis in the stock of the relevant foreign corporations; basis adjustments as a result of using a tested loss; and rules for determining the GILTI inclusion amount for domestic partnerships and their partners. The proposed regulations include anti-abuse rules to disregard basis in certain circumstances if the basis either (i) could affect the amount of QBAI or (ii) would result in a deduction or loss (e.g., amortization deductions with respect to intangibles) that, absent the application of the antiabuse rule, would be allocated and apportioned to gross tested income of the CFC. In This Issue: In Memoriam – David Tillinghast Treasury and IRS Release Proposed GILTI Guidance Treasury Finalizes Inversion Regulations Making Sense of the IRS’s Latest Transactional Rulings Another FATCA Deadline, Another Extension D.C. Circuit Reverses Tax Court in Good Fortune Shipping and Applies Chevron OECD Discussion Draft on Financial Transactions Under BEPS Actions 8-10 IRS Issues Guidance on Section 162(m) Amendments Vive La (Withholding Tax) Révolution and Special Issues for US Citizens and Residents in France Baker McKenzie Citing to section 7805(b)(1)(B), the preamble states that the proposed regulations will apply to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of US shareholders in which the taxable of such foreign corporations end. Baker McKenzie will soon issue a client alert summarizing the main aspects of the proposed regulations and noting our observations on particular points of interest. Among other things, the client alert will include additional analysis of the anti-abuse rules. Any written or electronic comments on the proposed regulations and requests for a public hearing must be received by Treasury within 60 days of publication of the proposed regulations in the Federal Register. By: Erik Christenson, San Francisco Treasury Finalizes Inversion Regulations On July 11, 2018, Treasury released final regulations under section 7874 and other Code sections addressing inversion transactions (the “Final Regulations”). The Final Regulations largely finalize, with few substantive changes, regulations that Treasury issued in temporary form in 2016 (the “2016 Temporary Regulations”). For a more detailed discussion of the 2016 Temporary Regulations, please see the Baker McKenzie Client Alert, “Treasury Issues Temporary Regulations on Inversions”, distributed on May 3, 2016 and also available under Insights at www.bakermckenzie.com. Inversion transactions have slowed in the wake of the expansive guidance that Treasury announced in Notice 2014-52, Notice 2015-79, and the 2016 Temporary Regulations. The 2017 Tax Cuts and Jobs Act (the “TCJA”) further limits the tax benefits of inverting. In particular, the TCJA provides that dividends a shareholder receives from a “surrogate foreign corporation,” i.e., a foreign corporation that acquires a domestic entity in a transaction subject to section 7874(a), are not eligible for reduced rates on qualified dividend income. Surrogate foreign corporations are also treated less favorably under the new base erosion and anti-abuse tax (“BEAT”) in section 59A. In computing modified taxable income for BEAT purposes, a taxpayer may not subtract payments to a surrogate foreign corporation for cost of goods sold. Domestic entities that invert under section 7874 within 10 years after the date of the TCJA are subject to recapture provisions relating to the section 965 transition tax, which have the effect of taxing the section 965 inclusion amounts at a 35 percent rate. Finally, the TCJA increased the excise tax on stock-based compensation of insiders in expatriated corporations under section 4985, from 15 to 20 percent. In light of the continued focus on inversion transactions in the TCJA, Treasury’s decision to finalize the sweeping guidance in the 2016 Temporary Regulations is perhaps not surprising. The Final Regulations are largely the same as the 2016 Temporary Regulations, but a few aspects of the Final Regulations are worth highlighting. Although the Global and EU Disclosure New York, NY ► September 26, 2018 Doing Business Globally Seattle, Washington ► October 10, 2018 Dallas, Texas ► October 18, 2018 Global Tax Reform: Impact and Response London ► October 11, 2018 19th Annual International Tax and Trust Training Program New York, NY ► October 16, 2018 Miami, FL ► October 18, 2018 To review the complete Tax Events Calendar visit www.bakermckenzie.comCtaxCevent 2 Tax News and Developments September 2018 Baker McKenzie rules remain extremely broad, Treasury introduced several changes that will simplify taxpayers’ analysis under section 7874. Serial acquisition rule. Under the “serial acquisition” rule in the 2016 Temporary Regulations, stock of the foreign acquiring corporation was disregarded in applying the ownership test if that stock was attributable to certain prior domestic entity acquisitions. On September 29, 2017, in Chamber of Commerce of the United States of America, et al. v. Internal Revenue Service, Dkt. No. 1:16-CV-944-LY (W.D. Tex. Sept. 29, 2017), the US District Court for the Western District of Texas ruled that this temporary regulation violated the Administrative Procedures Act by failing to provide notice and an opportunity for comment. The District Court order in favor of the Chamber of Commerce stood out to many practitioners as a rare taxpayer win against the government’s assertion of the Anti-Injunction Act, 26 U.S.C. § 7421(a). Notwithstanding the Chamber of Commerce decision, Treasury finalized the serial acquisitions rule in Treas. Reg. § 1.7874-8, effective for domestic entity acquisitions completed on or after April 4, 2016 – i.e., the same effective date as in the 2016 Temporary Regulations. The preamble acknowledges the procedural defects that the court found in Chamber of Commerce, but goes on to note that the court ruled the serial acquisition rule was substantively valid and within Treasury’s authority under sections 7874(c)(6) and (g). The preamble then simply states that the Final Regulations adopt the rule, without any further comment on the effective date. Treasury apparently views the promulgation of the Final Regulations as a resolution to the controversy over the 2016 Temporary Regulations. Treasury had appealed the Chamber of Commerce decision to the Court of the Appeals for the Fifth Circuit, but abruptly requested that the appeal be dismissed as moot on July 26, 2018. While Treasury has signaled that it is moving on from the 2016 Temporary Regulations from a litigation perspective, the Final Regulations remain tied to the 2016 Temporary Regulations due to their effective date. Treasury did make a few clarifications to the serial acquisitions rule. The Final Regulations clarify that in determining the number of shares that are attributable to the prior domestic entity acquisition (and therefore disregarded), stock that the target shareholders were deemed to receive in that transaction under the nonordinary course distributions rule or under the anti-abuse rule in section 7874(c)(4) should not be taken into account. This clarification simplifies the analysis for taxpayers. The Final Regulations also add an exception for prior domestic entity acquisitions that qualify for the “internal group restructuring” exception. Substantial business activities test. Under the “substantial business activities” test in the 2016 Temporary Regulations, a foreign acquirer was not subject to section 7874 if at least 25 percent of the expanded affiliated group’s employees (by headcount and compensation), tangible and real assets, and income were located in the country of organization of the foreign acquirer, and the foreign acquirer was also a tax resident of that country. The Final Regulations clarify 3 Tax News and Developments September 2018 Baker McKenzie that the tax residency requirement does not apply if the relevant country does not impose a corporate income tax. Some commentators suggested that a group should be able to satisfy the 25 percent requirement based on the employees, assets, and income located in the foreign acquirer’s country of tax residence. Treasury rejected this approach, pointing to the statutory language which requires substantial business activities in the country of organization. See section 7874(a)(2)(B)(iii). Passive assets rule. Under the “passive assets” rule in the 2016 Temporary Regulations, in applying the section 7874 ownership test, a portion of the foreign parent’s stock is disregarded if more than 50 percent of the foreign group’s property consists of “foreign group nonqualified property.” Under the Final Regulations, the passive assets rule applies only for purposes of determining ownership by value, not by vote. This approach is consistent with other rules under the section 7874 ownership test, including the “serial acquisitions” rule and the “non-ordinary course distributions” rule discussed below. The Final Regulations also better coordinate the various rules that exclude certain stock from the denominator of the ownership fraction. Lastly, the Final Regulations clarify that the anti-abuse rule in section 7874(c)(4) can apply to disregard a transfer designed to circumvent the passive assets rule. Third country rule. The Final Regulations adopt the “third country” rule in the 2016 Temporary Regulations. Under this rule, in some circumstances, a portion of the foreign acquirer’s stock is disregarded for purposes of the ownership test if the stock relates to a related acquisition of a foreign entity that is a tax resident of a different jurisdiction than the foreign acquirer. In addition to some technical clarifications, the Final Regulations introduce limited exceptions for transactions where the expanded affiliated group has substantial business activities in the foreign acquirer’s jurisdiction, or and where both the foreign acquiring corporation and the foreign target are organized in a foreign country without an income tax and are not tax residents of any other country. Non-ordinary course distributions rule. The Final Regulations adopt the “nonordinary course distribution” (“NOCD”) rule in the 2016 Temporary Regulations, with a few clarifications and changes. Under this rule, where a domestic entity has made NOCDs during a 36-month look-back period, the former owners of the domestic entity are treated as receiving stock of the foreign acquirer with a fair market value equal to the amount of the distributions, for purposes of applying the ownership test by value. The Final Regulations refine the definition of “distribution,” and modify certain special rules for distributions under section 355. The Final Regulations also clarify how the NOCD rule interacts with the “expanded affiliated group” rules of section 7874(c)(2)(A) and Treas. Reg. § 1.7874-1. The Final Regulations include technical guidance on how to allocate the stock deemed to exist under the NOCD rules among different shareholders, how to address transactions involving multiple foreign acquirers, and how to apply the NOCD rule to multiple domestic entities that are aggregated and treated as a single entity under Treas. Reg. § 1.7874-2(e). 4 Tax News and Developments September 2018 Baker McKenzie De minimis exceptions. Consistent with the 2016 Temporary Regulations, the Final Regulations include de minimis exceptions to the “nonqualified property” rule in Treas. Reg. § 1.7874-4, the passive assets rule in Treas. Reg. § 1.7874-7, and the NOCD rule in Treas. Reg. § 1.7874-10. The Final Regulations broaden these exceptions to make it easier for taxpayers to qualify. Under the de minimis exception as set forth in the 2016 Temporary Regulations, the ownership percentage of the former owners of the domestic entity (determined without regard to the above rules) must be less than 5 percent by vote and value. In addition, each former owner of the domestic entity must own, directly or by attribution, less than 5 percent of the interests in each member of the expanded affiliated group. Recognizing that it could be very difficult to evaluate the second requirement in the public company context, Treasury modified the second requirement so that only former owners of at least 5 percent of the interests in the domestic entity (directly or by attribution) must be taken into account. Expatriated foreign subsidiaries. The Final Regulations largely adopt the definitions in the 2016 Temporary Regulations. Treasury introduced some changes in light of the TCJA’s repeal of section 958(b)(4). After TCJA, stock in a foreign corporation may be attributed “downward” from a foreign parent to a US subsidiary, with the result that a foreign corporation may now be a “controlled foreign corporation” (“CFC”) solely because a domestic sister corporation is deemed to own its stock. The Final Regulations clarify that in determining whether a foreign entities is an “expatriated foreign subsidiary” (“EFS”), stock will not be attributed from a foreign owner “downward” to a domestic entity. Without this change, the definition of EFS could potentially be broad enough to encompass not only CFCs of the domestic target, but also historic subsidiaries of the foreign acquirer. Along similar lines, the Final Regulations replace the term “non-CFC foreign related person” with the new term “non-EFS foreign related person.” The Final Regulations make similar changes with respect to the regulations under sections 304(b)(5)(B), 367(b), 956, and 7701(l). Additional guidance under sections 304, 367, 956, and 7701. The 2016 Temporary Regulations included guidance under sections 304(b)(5)(B), 367, 956(e), and 7701(l) intended to reduce the tax benefits of certain post-closing transactions. The Final Regulations largely finalize these rules, with the changes noted above relating to “downward” attribution. The Final Regulations introduced an additional change to the general definition of “obligation” under section 956. While the prior regulations included both the so-called “30/60 day exception” of Notice 88-180 and the “60/180 day exception” of Notice 2008-91, the Final Regulations remove the 60/180 day exception. Note that neither of these exceptions applies to an obligation of a non-EFS foreign related person, which can be treated as US property under the Final Regulations. By: Paula Levy and Robert Hammill, Palo Alto 5 Tax News and Developments September 2018 Baker McKenzie Making Sense of the IRS’s Latest Transactional Rulings Between August 2013 and September 2017, the IRS had limited spin-off rulings to selected “significant issues” (Rev. Proc. 2013-32, 2013-28 IRB 55). In September 2017, the IRS temporarily reversed this policy and expanded the program to include some transactional rulings (Rev. Proc. 2017-52, 2017-41 IRB 283), introducing an 18-month “pilot program” under which the IRS would issue rulings beyond just selected “significant issues”. The pilot program covers distributions that taxpayers intend to qualify as tax-free under sections 355(a) and 355(c) as well as D/355 spin-offs. Rev. Proc. 2017-52 set forth procedures under which taxpayers may request transactional rulings on spin-off transactions, as well as clarifying existing procedures for taxpayers that are requesting rulings limited to certain “significant issues” relating to spin-off transactions. Overall, the apparent purpose of the pilot program is to allow taxpayers to obtain more comfort on spin-offs, including areas that were restricted under the prior IRS ruling policy. PLR 201827006 A recent letter ruling (PLR 201827006), released July 6, 2018, was issued under the IRS’s pilot program to address the tax consequences of a spin-off transaction, specifically a business spin under sections 368(a)(1)(D) and 355 – a D/355 spinoff. A spinoff transaction generally refers to a transaction where a parent corporation distributes its stock in a corporation that it controls, after which the shareholders hold stock in both the parent/distributing corporation and the controlled corporation. Under section 355, a corporation may generally distribute the stock of a controlled corporation to its shareholders without recognizing gain or loss if specific requirements are met. In a D/355 spin-off, the distributing corporation contributes assets to the controlled corporation before the spin-off of the business. In PLR 201827006, the parent, a publicly traded corporation, is the parent company of a worldwide group of foreign and domestic affiliates (the “Parent Group”). Parent and its domestic affiliates file a consolidated US federal income tax return. The parent had proposed multiple transactions to effect the separation of the “SpinCo Business”, involving internal contributions and distributions and an external contribution followed by an external distribution. The IRS ruled on the tax consequences of each of the “covered transactions” and a liquidationreincorporation involved in the spin-off. The IRS said the covered transactions qualify for tax-free treatment and it set forth the basis determinations and holding periods for assets and shares transferred. Concerning the liquidation6 Tax News and Developments September 2018 Baker McKenzie reincorporation (a “significant issue”), the IRS said the transfer of assets to a newly formed company would not preclude the subsidiary’s conversion to an LLC from qualifying as a section 322 complete liquidation. Although letter rulings are binding only on the taxpayer that obtained the ruling, they can provide insight into the IRS’s position on issues. Under the pilot program, the taxpayer must identify where they deviate from the standard representations in the appendix of Rev. Proc. 2017-52. This puts the onus on the taxpayer, and simplifies the process for the IRS. In PLR 201827006, the IRS allowed differences from some of the standard representations, identified which alternative representations the taxpayer had made, listed those not made, and described any modified representations. In short, taxpayers can look quickly at the representations and know the features of the spin transactions. Of particular note is that the business purpose was not discussed in the letter ruling. Rev. Proc. 2017-52 requires the taxpayer to represent that a distribution is motivated, in whole or substantial part, by one or more business purposes. Although a transactional ruling may address a significant legal issue pertaining to the business purpose, the IRS will generally not rule on whether the distribution satisfies a business purpose requirement. PLR 201812001 & PLR 201812002 Generally, a taxpayer cannot spin primarily to obtain a permitted non-abusive tax reduction, but can spin to avoid a more tax-expensive but similarly tax-free alternative to achieve some permitted business purpose. Treas. Reg. 1.355-2(b)(3) provides that if a corporate business purpose can be achieved through a non-taxable transaction that does not involve the distribution of stock of a controlled corporation and which is neither impractical nor unduly expensive, then the separation is not carried out for that corporate business purpose. Two recent identical letter rulings, released March 23, 2018, ruled that for purposes of Treas. Reg. 1.355-2(b)(3), avoiding federal income tax through a spin “can be considered” favorably as a reason why similarly non-taxable alternatives to the spin would be “impractical or unduly expensive”. The PLRs expressed no opinion on whether the distributions at issue were in fact carried out for a valid corporate business purpose for purposes of Treas. Reg. 1.355- 2(b)(1). The facts presented in PLR 201812001 & PLR 201812002 are summarized here: Foreign Parent (FP) wholly owns US Sub 1 (USP1). FP also owns at least 80% of Foreign Sub 1 (FS1), which owns at least 80% of US Sub 2 (USP2). FS1 also owns Foreign Sub 2 (FS2), which owns Foreign Sub 3 (FS3), which owns Foreign Sub 4 (FS4). FS4 owns the remaining percentage of USP2. USP1 owns 7 Tax News and Developments September 2018 Baker McKenzie various US subsidiaries while USP2 owns various US subsidiaries and foreign subsidiaries. Both USP1 and USP2 are common parents of consolidated groups. The spin-off involved the following steps. First, USP1 distributed a cash dividend to FP. Within some number of months after this distribution, FP proposed to undertake the following steps. USP2 would contribute certain assets and liabilities, including its stock in the subsidiaries of the US Consolidated Group (and excluding foreign subsidiaries), to US Spinco (a newly formed domestic corporation) in exchange for 100% of US Spinco’s stock. FS4 would sell its minority interest in USP2 to FP. USP2 would distribute 100% of US Spinco pro rata to FS1 and FP. FS1 would distribute its greater-than-80% interest of US Spinco stock to FP. FP would contribute 100% of US Spinco to USP1. And lastly, US Spinco would merge into USP1 with USP1 surviving. In the end, the foreign parent would directly own one consolidated common group parent with no CFCs under it, either with less cash or more debt than it previously had but with NOLs that can offset the income of the former USP2 consolidated group. The foreign parent would also indirectly own USP2, which now owns only CFCs. The taxpayer posited two alternative transactions to the spin-spin-drop merger involved, which it proved to be “impractical or unduly expensive” under Treas. Reg. 1.355-2(b)(3). In the first alternative, FP would contribute 100% of USP1 to FS1. FS1 would then contribute 100% of USP1 to USP2. In the second alternative, FS1 would transfer 100% of USP2 to FP. FP would then contribute 100% of USP2 to USP1. The alternatives are basically the same, except the second alternative doesn’t separate the foreign subsidiaries. Both alternatives would end with all corporations owned directly or indirectly by USP1 and USP2 being in one affiliated group with the foreign corporations. The taxpayer successfully argued that the two alternatives were inferior because (1) FP would incur an undefined increase in foreign taxes if it undertook either of the alternatives, and (2) the NOLs of US Consolidated Group 1 would be limited by Treas. Reg. 1.1502-21 if FP undertook either of the alternatives, but no such limitation would occur as a result of the proposed transaction. The rulings accepted the taxpayer’s representations. Per the rulings, “[t]he increased foreign tax costs and additional limitation on the use of NOLs anticipated to result under Alternative Transaction 1 and Alternative Transaction 2 can be considered for purposes of determining whether Alternative Transaction 1 and Alternative Transaction 2 are impractical and unduly expensive under § 1.355-2(b)(3).” Examples 6 and 7 of Treas. Reg. 1.355-2(b)(5) show that you cannot spin to make an S election because that is a relevant potential tax avoidance. Concern about the limitation on the use of NOLs appears for all intents and purposes to be a federal tax reduction reason, but per the rulings, it can be considered as a valid reason to avoid alternative transactions to a spin-off transaction. In short, the 8 Tax News and Developments September 2018 Baker McKenzie potential for the avoidance of federal taxes can be a good reason to undertake a spin rather than alternative transactions. By: Michael Farrell, Dallas Another FATCA Deadline, Another Extension As what seems to have become the normal course of action for the IRS, the IRS has once again delayed a deadline for reporting. Not that anyone is complaining about the extra time to procrastinate...err research their obligations and perform the necessary tasks. This time the delay is related to a participating foreign financial institution's (“FFI”) obligation to complete its Certification of Pre-Existing Accounts (“COPA”) and Periodic Certification (“Periodic”). The deadline to complete these certifications has been extended to December 15, 2018. This article is like the meals people wish they had when they were a kid, dessert first. The first part discusses which participating FFIs are required to complete the certifications. In the event a FFI finds out this affects them, the next part provides the details of the COPA and Periodic certifications. Does this Impact the FFI? Under the terms of the FFI agreement, participating FFIs agree to adopt a compliance program under the authority of the responsible officer. The compliance program must include policies, procedures, and processes sufficient to satisfy the due diligence, reporting, and withholding requirements of the FFI agreement. In addition, the participating FFI also agrees to perform, or have performed on its behalf, a review of its compliance for the certification period (about every three years). The results of such review are to be considered by the responsible officer in making the COPA and Periodic certifications. Upon initial review of the FFI's homepage on the FATCA Registration System, the FFI will likely find messages that notify the FFI that its COPA and Periodic certifications are due and that action is required. However, this does not necessarily mean that the FFI is required to complete the certifications. The notifications are tied to the classification entered when the FFI first registered. The FFI's representative may recall when initially registering, unless they only recently registered, that the classification options available from the pull-down menu provided by the IRS did not include a separate category for a Reporting Model 1 FFI. Instead, the classification the FFI was required to select was a Registered Deemed-Compliant Financial Institution (including a Reporting Financial Institution under a Model 1 IGA). It was precisely this classification that triggered the notifications, many of which were unnecessary. Precise details regarding which FFIs are required to submit COPA and Periodic certifications can be found in Revenue Procedure 2017-16, the Treasury 9 Tax News and Developments September 2018 Baker McKenzie Regulations, and applicable intergovernmental agreements. However, the IRS has provided a chart that gives a general overview of the types of entities that are required to be certified and which certification(s) they must submit.(Please see www.irs.gov). As can be seen on the chart, certain Registered DeemedCompliant FFIs have certification obligations and others do not. This is the reason for many of the unnecessary notifications. If an FFI happens to be one of the FFIs that were errantly notified of a certification obligation, the IRS advises the FFI to login and update its FATCA classification (they now have a selection for a Reporting Financial Institution under a Model 1 IGA). FFIs can update their FATCA classification by updating their response to question 4 in the registration or by answering the question during the certification process. By updating, this should avoid inapplicable certification-related notices in the future. If the FFI choses to update the classification through the certification process and choose a classification that does not require a certification, the website advises the FFI accordingly. Certification of Pre-Existing Accounts The COPA is meant to satisfy the requirements of Treas. Reg. §1.1471-4(c)(7). As part of the COPA, the responsible officer must certify: • The FFI has completed the review of all high-value accounts and has treated any account holder of an account for which the FFI has not retained a record of any required documentation as a recalcitrant account holder. • The FFI has completed the account identification procedures and documentation requirements for all other preexisting accounts or, if it has not retained a record of the documentation required with respect to an account, treats such account accordingly. • To the best of his or her knowledge after conducting a reasonable inquiry, the FFI did not have any formal or informal practices or procedures in place from August 6, 2011, through the date that is two years after the effective date of its FFI agreement to assist account holders in the avoidance of FATCA. If the responsible officer is unable to make any of the certifications described above, he or she must make a qualified certification to the IRS stating that such certification cannot be made and that corrective actions will be required. The IRS has provided draft COPA certifications. There are five variations of the certification depending on the FFI's classification. (Please see www.irs.gov). Periodic Certification The COPA is meant to satisfy the requirements of Treas. Reg. §1.1471-4(f)(3). As part of the Periodic, the responsible officer must certify either effective internal controls or give a qualified certification. 10 Tax News and Developments September 2018 Baker McKenzie • Effective internal controls o The responsible officer (or designee) has established a compliance program that is in effect as of the date of the certification and that has been subjected to review. o With respect to material failures, that there are no material failures for the certification period or if there are any material failures, appropriate actions were taken to remediate such failures and to prevent such failures from reoccurring. o With respect to any failure to withhold, deposit, or report to the extent required under the FFI agreement, the FFI has corrected such failure by paying any taxes due (including interest and penalties) and filing the appropriate return (or amended return). • Qualified certification (given when an event of default or a material failure has been identified and the FFI has not corrected it as of the date of the certification) o With respect to the event of default or material failure, the responsible officer (or designee) has identified an event of default or the responsible officer has determined that as of the date of the certification, there are one or more material failures with respect to the FFI’s compliance with the FFI agreement and that appropriate actions will be taken to prevent such failures from reoccurring. o With respect to any failure to withhold, deposit, or report to the extent required under the FFI agreement, the FFI will correct such failure by paying any taxes due (including interest and penalties) and filing the appropriate return (or amended return). o The responsible officer (or designee) will respond to any notice of default (if applicable) or will provide to the IRS, to the extent requested, a description of each material failure and a written plan to correct each such failure. The IRS has provided draft COPA certifications. There are 12 variations of the certification depending on the FFI's classification. (Please see www.irs.gov). Summary Once the FFI has reviewed the required certifications and confirmed that it can make them, the certification process as presented on the FATCA Registration System is relatively straight forward. Given the extended due date, the FFI should have time to fix anything that would cause it to submit a qualified certification because such certification cannot be edited once it is submitted. The FFI will be required to complete the entire certification process again and all prior certifications remain in the registration system. By: Rodney Read, Houston 11 Tax News and Developments September 2018 Baker McKenzie D.C. Circuit Reverses Tax Court in Good Fortune Shipping and Applies Chevron Two-Step Test to Invalidate Section 883 Regulations On July 27, 2018, the D.C. Circuit released its opinion in Good Fortune Shipping SA v. Commissioner, Dkt. No. 17-1160. The D.C. Circuit reversed the Tax Court’s opinion, 148 T.C. No. 10, issued on March 28, 2017. The taxpayer had challenged the validity of Treas. Reg. § 1.883-4, which provides that “bearer shares,” shares that are owned by the person who holds the stock certificates, cannot be counted for purposes of applying the greater than 50% test under section 883(c)(1). The Tax Court had found the regulation to be valid under the Chevron test, but the D.C. Circuit took a different direction, holding that the regulation “unreasonably interpreted” section 883(c)(1). Its reversal was primarily based on its determination that the IRS had failed to explain its basis for excluding bearer shares as a valid form of ownership. The D.C. Circuit did not address the first step of the Chevron test—whether the statute “unambiguously forecloses the agency’s interpretation.” Nat’l Cable & Telecomms. Ass’n v. FCC, 567 F.3d 659, 663 (D.C. Cir. 2009). Instead, it decided to “give the IRS the benefit of the doubt and assume that § 883 does not unambiguously foreclose its interpretation.” In jumping straight to step two— whether the IRS’s interpretation is “arbitrary or capricious in substance, or manifestly contrary to the statute”—the D.C. Circuit focused on “whether the [IRS] has reasonably explained how the permissible interpretation it chose is ‘rationally related to the goals of’ the statute.” Village of Barrington v. Surface Transp. Bd., 636 F.3d 650, 665 (D.C. Cir. 2011). This framing of Chevron step two aligns with the inquiry into the validity of a regulation under the Administrative Procedure Act—the arbitrary-or-capricious test. See Motor Vehicles Manufacturers Ass’n v. State Farm Mutual Automobile Insurance Co., 463 US 29 (1983) (“the agency must examine the relevant data and articulate a satisfactory explanation for its action including a rational connection between the facts found and the choice made. In reviewing that explanation, we must consider whether the decision was based on a consideration of the relevant factors and whether there has been a clear error of judgment.”). In that respect, the D.C. Circuit echoes what many other courts, including the Tax Court, have observed—namely, that State Farm overlaps with Chevron step two. Thus, Good Fortune Shipping shows that a court will inquire into the “reasonableness” of regulatory action by reference to the well-worn APA framework. Though sometimes given short shrift, Chevron step two has deeper and more meaningful significance when viewed through an APA lens. In addition, these doctrines—Chevron and the APA—are readily reconciled. It is no accident that the APA’s test in 5 U.S.C. § 706(2)(A) regarding the validity of a regulation— i.e., whether the regulation is contrary to statute, arbitrary or capricious, procedurally defective, or otherwise contrary to law—dovetails so closely with Chevron step two’s inquiry into whether a regulation is “arbitrary, capricious, or 12 Tax News and Developments September 2018 Baker McKenzie manifestly contrary to statute.” In short, the D.C. Circuit applied Chevron step two in the same way that it applies the State Farm analysis. The D.C. Circuit faulted the IRS for ignoring the word “own” in the statute by blurring the line between types of ownership and proof of ownership in the regulations. After noting the IRS’s change in position with respect to bearer shares--from providing a rebuttable presumption in 1991 that they are invalid to an irrebutable presumption in 2003 to a factual inquiry in 2010--the Court stated that the IRS “must nevertheless engage in ‘reasoned analysis’ sufficient to command our deference.’” The Court noted that the IRS had not explained why it had determined in 2003 that documentation could no longer be provided to substantiate the true ownership of bearer shares, just 12 years after it had determined that documentation could be provided. See State Farm Mutual Automobile Insurance Co., 463 US at 57 (“An agency’s view of what is in the public interest may change, either with or without a change in circumstances. But an agency changing its course must supply a reasoned analysis.”). Indeed, the sole explanation provided in the 2003 regulations for excluding bearer shares was the “difficulty of reliably demonstrating the true ownership.” The Court cited FCC v. Fox Television Stations Inc., in which the Supreme Court made clear that a mere change in agency policy, while not requiring “a more searching review” requires the agency to provide a reasoned explanation showing it is aware a change is occurring. 556 US 502 (2009). The D.C. Circuit also rejected the IRS’s disparate treatment of bearer share holders in other contexts. Specifically, it noted that for purposes of the branch profits tax under section 884, a corporation with bearer shares can meet a burden of proof provided it has no knowledge or reason to know the stock is closely held. Similarly, the Court rejected the IRS’s attempt to offer a post-hoc rationalization for the 2003 regulations where such explanation was not originally presented at the time the regulations were promulgated. The IRS in its brief also attempted to distinguish bearer share holders from nominees and trustees under the regulations, but the D.C. Circuit rejected this argument on the same basis. The D.C. Circuit ultimately rejected the IRS’s attempt to “paint with such a broad brush that it failed adequately to justify its categorical rule excluding the use of bearer shares in qualifying for the tax exemption in § 883.” See Goldstein v. SEC, 451 F.3d 873, 883 (D.C. Cir. 2006). This analysis mirrors an APA-type analysis, even though the Court chose to frame it as a Chevron-type analysis. Functionally, the two analyses are virtually indistinguishable in this case because the D.C. Circuit focused heavily on the IRS’s lack of explanation when issuing the regulation in question. The D.C. Circuit’s decision makes clear that a conclusory statement, unsupported by an adequate explanation, fails to satisfy the reasoned decision making standard. The case is also significant in that, despite the fact that neither party mentioned the APA in its briefs, the Court’s analysis is heavily based on that ground, albeit without any express reference. Finally, the Court’s willingness Baker McKenzie North America Tax Chicago +1 312 861 8000 Dallas +1 214 978 3000 Houston +1 713 427 5000 Los Angeles +1 310 201 4728 Miami +1 305 789 8900 New York +1 212 626 4100 Palo Alto +1 650 856 2400 San Francisco +1 415 576 3000 Toronto +1 416 863 1221 Washington, DC +1 202 452 7000 13 Tax News and Developments September 2018 Baker McKenzie to use an arbitrary-and-capricious style analysis demonstrates that State Farm is not limited to determinations that are inherently factual or empirical. By: Brandon King, Washington, DC OECD Discussion Draft on Financial Transactions Under BEPS Actions 8-10 On July 3, 2018, the OECD issued a long-awaited discussion draft on transfer pricing for financial transactions. The draft is intended to cover a wide range of financial transactions and deals with a host of items that impact both the characterization and pricing of such transactions. A few of these items, which are likely to be of most interest to taxpayers and source of future tax disputes, include an accurate delineation of the transactions, alternatives available to both parties, role of implicit support, and appropriate remuneration for Treasury functions. For a summary of the draft guidance, please see Baker McKenzie’s Transfer Pricing publication, “Baker’s Insight: OECD discussion draft on financial transactions under BEPS Actions 8-10. What does it mean for transfer pricing policies?” distributed August 6, 2018. By: Moiz Shirazi, Chicago IRS Issues Guidance on Section 162(m) Amendments The Tax Cuts and Jobs Act (“TCJA”) amended Section 162(m) to eliminate the ability to deduct performance-based compensation of certain executives of a publicly-traded company. The amended section 162(m) provisions are generally applicable for taxable years beginning after December 31, 2017. However, the expanded provisions do not apply to remuneration provided pursuant to a written binding contract in effect on November 2, 2017 which is not modified in any material respect after that date. The IRS recently issued Notice 2018-68 containing initial guidance on these Section 162(m) amendments, including the transitional relief for written binding contracts. (Please see www.irs.gov). On balance, the guidance is not particularly favorable to taxpayers, as it takes a narrow view of the grandfathering relief for arrangements in effect under prior law, particularly for arrangements with negative discretion, and a broad view of the new group of section 162(m) covered employees. The IRS anticipates the guidance in the Notice will be incorporated into regulations, which will apply to any tax year ending on or after September 10, 2018. For a more thorough discussion, please see the Baker McKenzie 14 Tax News and Developments September 2018 Baker McKenzie Employee Benefits Client Alert, “IRS Issues Guidance on Section 162(m) Amendments,” distributed on August 27, 2018. Vive La (Withholding Tax) Révolution and Special Issues for US Citizens and Residents in France France has long been one of the few countries without a withholding tax system for salaries and other similar income payments. Instead, French taxpayers paid any income taxes owed in the year following the year in which the income was earned. Starting with the 2019 tax year, France will switch to a more modern system of income tax collection with the implementation of withholding system for salaries and retirement income. To eliminate double taxation in 2019, French taxpayers will receive a tax credit equal to the amount of tax calculated on 2018 income (other than “exceptional” income). This transition creates a significant tax issue for US taxpayers in France who often elected to take foreign tax credits for French income tax on an accrual basis. For these US taxpayers, the switch may create a foreign tax credit gap if no 2018 French income taxes are accrued. The sooner those US taxpayers can assess their potential US liability, the sooner they can consider potential actions to limit penalties and interest and set aside necessary funds for potentially larger US tax liabilities. For a more detailed discussion of the French changes and the potential impact on US taxpayers, please see the client alert “Vive La (Withholding Tax) Révolution and Special Issues for US citizens and residents in France” distributed on September 20, 2018. Tax News and Developments is a periodic publication of Baker McKenzie’s North America Tax Practice Group. The articles and comments contained herein do not constitute legal advice or formal opinion, and should not be regarded as a substitute for detailed advice in individual cases. Past performance is not an indication of future results. Tax News and Developments is edited by Senior Editors, James H. Barrett (Miami) and David G. Glickman (Dallas), and an editorial committee consisting of Glenn G. Fox (New York), Gwen Hulsey (Houston), Joseph A. Myszka (Palo Alto), John Paek (Palo Alto ), Alex Pankratz (Toronto), Julia Skubis Weber (Chicago), Angela J. Walitt (Washington, DC), and Robert S. Walton (Chicago). For further information regarding the North American Tax Practice Group, any of the items or Upcoming Events appearing in this Newsletter, or to receive Tax News and Developments directly, please contact Marie Caylor at 312-861-8029 or email@example.com. Your Trusted Tax Counsel ® www.bakermckenzie.com/tax www.bakermckenzie.com Baker & McKenzie 300 East Randolph Drive Chicago, Illinois 60601, USA Tel: +1 312 861 8000 Fax: +1 312 861 2899 15 Tax News and Developments September 2018
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North America Tax News and Developments - September 2018
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