Source: https://www.icpas.org/connections/communities-topic/tax/international-tax-articles
Timestamp: 2017-08-21 10:10:41
Document Index: 440290666

Matched Legal Cases: ['§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§555']

The International Tax section is a compilation of alerts and articles written by members of the ICPAS Taxation International Committee as well as links to websites and other resources of interest to the International tax community. Follow the links below for more information on these topics.
International Tax Committee Articles
John M. Kelleher, Partner
On July 28, the Treasury Department and IRS issued Notice 2017-36, which provides for a 12-month delay for the documentation requirements of the Section 385 regulations. Previously, the final documentation requirements were set to be effective for debt instruments issued or deemed issued on or after Jan. 1, 2018.
The notice asks for comments from taxpayers on whether the proposed delay in effective date of the regulations provides adequate time for taxpayers to develop necessary systems or processes in order to comply with the various documentation requirements. Comments are due Sept. 1, 2017.
Section 385 Background
Final and temporary regulations under Section 385 of the Internal Revenue Code, which address the classification of related-party debt as debt or equity for tax purposes, originally were released on Oct. 21, 2016.
Subsequently, on July 7, 2017, the Treasury Department released Notice 2017-38 with its interim report on reducing the tax regulatory burden. The report, required by executive order, identifies eight federal tax regulations issued on or after Jan. 1, 2016 – including the final and temporary regulations issued under Section 385 – that could impose an undue burden on U.S. taxpayers, add undue complexity to the federal tax laws, or exceed the statutory authority of the IRS.
A final report that recommends “specific actions to mitigate the burden imposed by” the identified regulations is due to the president by Sept. 18, 2017.
Taxpayers should note that the 12-month regulation delay applies to only the documentation portion of the Section 385 regulations, as the rest of the Section 385 final and temporary regulations are subject to the original effective dates.
In addition, the Section 385 regulations in their entirety continue to be under review by Treasury under Notice 2017-38. As with the other regulations identified in the notice, it is possible that certain regulations ultimately could be withdrawn and not reproposed.
Potentially affected taxpayers should review Notice 2017-36 and provide comments regarding their ability to comply with the extended deadline for documentation requirements to the IRS by the Sept. 1 due date.
Streamlined Procedures for Disclosing Unreported Foreign Assets
Varsha Pancholi
vpancholi@pancholicpa.com
Options for U S taxpayers with Undisclosed Financial Assets
Taxpayers with undisclosed Foreign Financial Assets have following 2 options to get compliant with U S Income-Tax laws:
1) OVDP-Offshore Voluntary Disclosure Program
2) SFCP-Streamlined Filing Compiiance Procedure
Focus of this article is point #2 -Streamlined Filing Compliance procedure which is a friendlier and less costly approach to bring non-compliant taxpayers back into the tax filing system compared to Offshore Voluntary Disclosure Program. This procedure was announced in June 2014 via IRS Revenue Ruling IR-2014-73. The procedure is effective from July 1st 2015 and is open ended.
Under the Streamlined Program, there are 2 broad categories:
1) SFO-Streamlined Foreign Offshore - applicable to US Citizens or lawful permanent residents or their estates who are non residents as described in Publication 54.
2) SDO-Streamlined Domestic Offshore - applicable to US Citizens or lawful permanent residents or their estates and are residents as described in Publication 54.
Streamlined Filing Compliance Procedure (SFCP) Eligibility Requirements:
> U S Individuals and estates only
> Failed to report foreign financial assets and pay all taxes
> Able to certify failures are related to non-willful conduct
> Not currently under IRS examination/Audit
> Have a valid Taxpayer Identification Number
Procedural Steps for Streamlined Procedure:
If you are eligible to use the SFCP, then you must follow all procedural steps listed below. If you fail to properly comply with these steps, then your application will be rejected for the streamlined procedures. Instead, your tax return simply be processed in the usual manner and you will not be able to avail yourself of any of the benefits of the streamlined procedures.
1) File all delinquent returns: An applicant for the Streamlined Foreign Compliance procedures must first file all delinquent or amended tax returns for the most recent three years for which the due date has already passed. At the same time, the taxpayer must file any associated informational returns, including Forms 3520, 5471, and 8938. In addition, the applicant must file any delinquent FBAR forms for the past six years for which the FBAR filing requirement has passed,
2) Label Returns: In order to ensure that your application under the Streamlined Foreign Compliance Procedures is accepted, it must be properly labeled as "Streamlined Foreign Offshore" or :Streamlined Domestic Offshore".. This labeling requirement is absolutely critical to identify that your returns are being submitted under the streamlined procedures.
3) Certification: Taxpayers are required to sign a Certification certifying (a) that the applicant is eligible for the Streamlined Foreign Compliance Procedure (b) that all required FBARs have now been filed and (c) that the failure to file tax returns, report all income, pay all tax, and submit all required information returns, including FBARs, was not the result of willful conduct. Copies of this certification must be attached to each and every tax return and informational return being submitted under the streamlined procedures.
4) Payment of Taxes: the taxpayer must submit payment of all tax due as reflected on delinquent or amended tax returns filed under the process. This payment should include ail applicable statutory interest associated with the late payment amounts. When submitting this tax due, include the taxpayer identification number on the check to ensure proper processing.
5) Filing of FBAR: Finally, the taxpayer must electronically file any delinquent FBARs for each of the most recent 6 tax years for which the FBAR due date has passed. The taxpayer must indicate 'Filed under Streamlined Procedures" in the explanation box. it puts IRS on notice that final step in the Streamlined Foreign Offshore Procedures submission process has been met.
Advantages of Streamlined Filing Compliance Procedure:
> No upfront clearance required from IRS to participate in the procedure.
> Three year income tax filing period in lieu of 8 year OVDP period.
> Six year FBAR filing period in lieu of the 8 year OVDP period.
> Lot less expensive compared to OVDP. No late filing, late payment, information return, FBAR or accuracy-related penalties. The hefty penalty of 27.5% under OVDl is reduced to 5% for SDO. No penalty under SFO.
Disadvantages of Streamlined Filing Compliance Procedure:
> Must certify, under penalties of perjury, NON-WLLFUL conduct.
> If the Internal Revenue Service receives or discovers evidence of willfulness, fraud, or criminal conduct, it may open an examination or investigation that could lead to civil fraud penalties, FEAR penalties, information return penalties, or even referral to Criminal Investigation."
> Once taxpayers enters the Streamlined Filing Compliance Procedure, he/she cannot file under OVDP.
With increased enforcement of reporting provisions governing the disclosure of foreign assets, taxpayers wishing to use the revised streamlined provisions should act promptly, as eligibility for penalty relief depends upon the taxpayer's taking corrective action before being contacted by the IRS.
New Regulations Require Foreign-Owned Domestic Disregarded Entities to File Form 5472
Kris Ker and Joe Buoscio
Key Highlight: For tax years beginning on or after January 1, 2017, a foreign-owned U.S. disregarded entity is required to file Form 5472 and maintain records in a manner comparable to a 25% foreign-owned domestic corporation. Each failure to file the required form is subject to $10,000 penalty.
On December 13, 2016, the IRS issued final regulations under Code Sec. 6038A to treat foreign-owned U.S. disregarded entities as domestic corporations for reporting and record maintenance purposes. The new rule mandates that a foreign–owned U.S. disregarded entity be treated similarly to a foreign-owned U.S. regarded corporation and therefore is required to file Form 5472, “Information Return of a 25 percent Foreign –Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.”
In addition, the foreign-owned U.S. disregarded entity must maintain books and records sufficient to establish the accuracy of the informational return and the correct U.S. tax treatment of reported transactions. This includes the requirement to obtain an Employment Identification Number (EIN) in connection with filing Form SS-4 and supporting responsible party information (e.g., individual owners must obtain an identification number (ITIN) with the IRS they may not previously possess). The process in obtaining such information may take some time. Consequently, a taxpayer should initiate such process proactively in 2017 if subject to the new provisions.
As explained in the preamble to the regulations, information gathered from this change “will enhance the United States’ compliance with international standards of transparency and exchange of information for tax purposes and will strengthen the enforcement of U.S. tax laws.”
Before the new regulation, a U.S. disregarded entity owned by a foreign person did not have any separate income or informational return filing requirements. Its owner was treated as directly owning the assets and liabilities of the disregarded entity. Reporting requirements, if any, fell upon the foreign owner of the disregarded entity. However, no U.S. income or informational return was required if both the foreign owner and its U.S. disregarded entity had no U.S. source income or U.S. trade or business.
The IRS is concerned that these U.S. disregarded entities can be used to shield their foreign owners of non-U.S. assets or U.S. bank accounts. The new regulation is intended to allow the IRS to determine whether there is any tax liability, and to share information with foreign tax authorities in satisfaction of its obligations under United States tax treaties and information exchange (or other similar international) agreements.
Because of the IRS’s underlying goal to share information with foreign authorities to fulfill obligations under international agreements and treaties, reporting exceptions for Form 5472 provided in Reg. Sec. 1.6038A-2(e)(3) and (4) are not applicable to the foreign-owned U.S. disregarded entities. These aforementioned reporting exceptions are provided to lessen duplicative reporting because the required information would already be reported by another person in another form or context. However, in the context of exchanging information with foreign authorities, it would be easier and less laborious for the foreign authorities to extract the information from one form as opposed to multiple forms.
For the Form 5472 informational return, the disregarded entity treated as a U.S. Corporation (a deemed U.S. Corporation) has the same tax year as its foreign owner if that foreign owner has required U.S. return filing obligation. If the foreign owner does not have any U.S. return filing obligation, the tax year would be the calendar year.
The new regulations are effective December 13, 2016, and apply to tax years beginning after December 31, 2016 and ending after December 12, 2017. For a calendar year deemed U.S. Corporation, a Form 5472 is required for tax year 2017.
International Tax Alert - 9 13 16
IRS Publishes New Form W-8BEN-E Withholding Certificate with Expanded Treaty Benefits Claim
Documentation Requirements for Related-Party Debt Instruments Under Proposed Section 385 Regulations
Taxpayers Forces to Allow Production of Foreign Back Account Records
Taxpayers Forced to Allow Production of Foreign Bank Account Records | 1-25-16
IRS Explains Level of Lending & Underwriting Activities That Give Rose to U.S. Trade or Business
In Chief Counsel Advice 201501013, IRS has concluded that the lending and underwriting (stock distribution) activities of a foreign partnership (Fund) conducted on its behalf through its U.S. agent (Fund Manager) rose to the level of a U.S. trade or business. According to IRS, these activities do not qualify for the “trading in stocks and securities” exception under Code Sec. 864(b)(2)(A) (the Trading Safe Harbors). Therefore, the foreign corporation that is a partner of Fund (Foreign Feeder) is treated as being engaged in a U.S. trade or business. Background on the U.S. trade or business rules. A foreign corporation that is engaged in U.S. trade or business is subject to U.S. federal income tax on income that is effectively connected with the conduct of a U.S. trade or business. (Code Sec. 882(a)(1)) A foreign corporation is considered to be engaged in a U.S. trade or business if that foreign corporation is a member of a partnership that is engaged in a U.S. trade or business. (Code Sec. 875(1)).
The Code does not include a comprehensive definition of the term “trade or business within the United States.” Instead, the Code provides only that the term “trade or business within the United States” includes the performance of personal services within the U.S. at any time within the tax year, does not include certain de minimis personal service activity, and also does not include, under certain circumstances, “trading in stocks or securities” or trading in commodities. Code Sec. 864(b). There is no other statutory definition of the term. The courts and IRS have adopted a facts and circumstances test to evaluate whether the activities of a foreign person cause that person to be engaged in a U.S. trade or business. Treas. Reg. § 1.864-2(e). For a foreign corporation to be engaged in a U.S. trade or business, the foreign corporation's profit-oriented activities in the U.S. must be “considerable, continuous, and regular,” according to U.S. case law. In other words, the conduct of activities in the U.S. that are ministerial and ancillary to a business conducted outside the U.S. are not sufficient to give rise to a U.S. trade or business.
Under U.S. case law, for purposes of determining whether a foreign person is engaged in a U.S. trade or business, the activities undertaken on behalf of the foreign person by an agent may be considered to be performed by the foreign person, regardless of the degree of control the foreign person exercises over the agent.
Background on the Trading Safe Harbors. The Trading Safe Harbors are two statutory exceptions that exempt certain trading activities conducted by or for a foreign person from being treated as a U.S. trade or business. (Reg. § 1.864-2(c)) The first exception requires that the foreign person not conduct those activities through an agent who has been granted discretionary authority or through a U.S. office of the foreign person. The second exception, however, permits trading through an agent with discretionary authority or through the foreign person's U.S. office, but requires that the foreign person not be a dealer. The Code Sec. 864 regulations define a “dealer in stocks or securities” as “a merchant of stocks or securities, with an established place of business, regularly engaged as a merchant in purchasing stocks or securities and selling them to customers with a view to the gains and profits that may be derived therefrom.” Treas. Reg. § 1.864-2(c)(2)(iv)(a). In this regard, a person that buys and sells, or holds, stocks or securities solely for investment or speculation is not a dealer.
With respect to lending, Treas. Reg. § 1.864-4(c)(5) stipulates that a foreign person is considered engaged in the active conduct of a banking, financing, or similar business within the U.S. when the person “[m]ak[es] personal, mortgage, industrial, or other loans to the public” in the U.S. According to IRS, although this regulation provides rules for determining whether income is effectively connected to a banking, financing, or similar business, these regulations demonstrate that the conduct of that type of business in the U.S. does not qualify as “trading in stocks or securities” for purposes of the Trading Safe Harbors.
Similarly, the Code Section 864 regulations establish that underwriting generally does not constitute trading for purposes of the Trading Safe Harbors. Those regulationss describe a narrow set of circumstances under which a foreign underwriter may qualify for the Trading Safe Harbors. Specifically, a foreign underwriter will not be treated as a dealer, and will not be engaged in a trade or business within the U.S., if the foreign person acts as an underwriter, or as a selling group member, for the purpose of making a distribution of stocks or securities of a domestic issuer only to foreign purchasers of such stocks or securities. Treas. Reg. § 1.864-2(c)(2)(iv)(b)(1) and Treas. Reg. § 1.864-2(c)(2)(iv)(c), Example (1). According to IRS, the limited nature of this exception demonstrates that distributing stocks or securities to U.S. customers exceeds the level of underwriting activity permitted to qualify as “trading in stocks or securities.”
In Year 1, Fund was organized as a U.S. limited partnership. It converted to a Country X limited partnership (foreign partnership) in Year 2. During Year 1 and Year 2, Foreign Feeder, a Country X corporation, was a limited partner in Fund. Country X does not have an income tax treaty with the U.S.
During Year 1 and Year 2, Fund had no employees, but was instead managed exclusively by Fund Manager. Under a management agreement, Fund appointed Fund Manager as Fund's agent and irrevocable attorney-in-fact with full power to buy, sell, and otherwise deal in securities and related contracts for Fund's account. Furthermore, Fund granted Fund Manager the full power and authority to perform every act necessary and proper to be done as fully as Fund might or could do personally. Under such authority, Fund Manager conducted an extensive lending and underwriting (stock distribution) business on behalf of Fund.
In Year 1 and Year 2, Fund (through Fund Manager) actively solicited unrelated borrowers in the U.S. and made multiple loans to those borrowers. Fund made “personal, mortgage, industrial, or other loans to the public” in the U.S. In addition, Fund Manager (on Fund's behalf) also committed extensive time and resources to conduct Fund's underwriting (stock distribution) activities. Through Distribution Agreements, Fund (through Fund Manager) purchased shares from U.S. issuers and sold those shares to purchasers in the U.S. and abroad.
Fund Manager conducted these business activities and otherwise managed Fund primarily through an office in the U.S. No employees of Fund Manager worked exclusively for Fund, and Fund Manager provided similar services for other investment entities.
Taxpayer loses. IRS concluded that the nature and extent of Fund's lending and underwriting activities in the U.S. during Year 1 and Year 2 rose to the level of a U.S. trade or business within the meaning of Code Section 864(b). According to IRS, these activities were: (i) actively conducted, (ii) profit oriented, and (iii) undertaken on a “considerable, continuous, and regular basis.” In this regard, IRS attributed the activities of Fund Manager (its U.S. agent) to Fund, as such activities were performed by Fund Manager on behalf of Fund, for purposes of Code Section 864(b) and Code Section 882.
Second, IRS ruled that Fund's lending and underwriting (stock distribution) activities do not qualify for the Trading Safe Harbors. During the years at issue, Fund had no employees of its own, but conducted its business entirely through the authority granted to Fund Manager. Hence, Fund granted discretionary authority to Fund Manager to conduct a lending and underwriting business in the U.S. on behalf of Fund. Therefore, Fund Manager was not a resident broker, commission agent, custodian, or other independent agent for purposes of the first Trading Safe Harbor during the years at issue. Fund was ineligible for the Second Trading Safe Harbor, because its underwriting activities made it a “dealer in stocks or securities.”
Finally, according to IRS, even if Fund's lending and underwriting activities had qualified for the Trading Safe Harbors, Fund would have been ineligible for the Trading Safe Harbors during Year 1 and Year 2 because Fund: (i) granted discretionary authority to Fund Manager; and (ii) acted as a dealer during Year 1 and Year 2.
Problems Remain with the IRS Offshore Voluntary Disclosure Program
National Taxpayer Advocate (NTA) Nina Olson has released her 2014 annual report to Congress, and it highlights flaws with the IRS offshore voluntary disclosure program (OVDP). According to the NTA, the flaws do not bode well for fairness and justice in IRS's implementation of future settlement programs and undermine voluntary taxpayer compliance. The NTA has recommended a number of changes, including allowing taxpayers to amend their IRS closing agreement in order to benefit from a number of recent OVDP changes.
Background on OVDP. In 2009, IRS announced an OVDP for those who voluntarily and timely disclosed unreported offshore income for 2003 through 2008. A second OVDP in 2011 allowed taxpayers with undisclosed income from hidden offshore accounts for 2003 through 2010 the chance to get current with their taxes. In 2012, IRS announced a new OVDP that was similar to the 2011 OVDP, but had no set deadline for using the program. IRS also provided streamlined filing compliance procedures for certain "low risk" nonresident U.S. taxpayers who were subject to different degrees of review based on the amount of the tax due and the taxpayer's response to a "risk" questionnaire. In June of 2014, IRS made key expansions in the streamlined procedures to accommodate a wider group of U.S. taxpayers who have unreported foreign financial accounts.
Background on NTA report. The NTA's annual report to Congress creates a dialogue within IRS and the highest levels of government to address taxpayers' problems, protect taxpayers' rights, and ease taxpayers' burden. The NTA delivers its report directly to the tax-writing committees in Congress (the House Committee on Ways and Means and the Senate Committee on Finance), with no prior review by the IRS Commissioner, the Secretary of the Treasury, or the Office of Management and Budget.
2014 NTA report. The NTA's 2014 annual report cites the IRS OVDP as one of the agency's most serious problems for taxpayer rights, despite recent changes to the program.
According to the NTA annual report, between 2009 and 2014, IRS generally required persons who inadvertently failed to report offshore income and file one or more related information returns (e.g., a "Report of Foreign Bank and Financial Accounts" (FBAR)) to enter into a punitive OVDP and either pay a penalty designed for "bad actors" or "opt out" and be examined.
In general, persons with inadvertent violations had to "opt out" and be audited in order to seek a lesser penalty. Unfortunately, under the "opt out" process, there was uncertainty about the penalty that would result from the audit, process delays, and the cost of representation.
According to the NTA's annual report, "[i]nside the 2011 OVD programs, taxpayers with small accounts paid over eight times the unreported tax—over ten times the 75 percent penalty for civil tax fraud—and those who were unrepresented generally paid even more."
NTA's analysis of the problems. According to NTA, the penalty for failure to file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR), was aimed at criminals and other "bad actors." In fact, Congress dramatically increased the maximum penalty for willful violations, as a result of reports of people intentionally "attempting to conceal income from the IRS."
The IRS's efforts to apply willful penalties to "bad actors" has eroded the distinction between willful and non-willful violations. Because Schedule B of Form 1040 (U.S. Individual Income Tax Return) asks if the taxpayer has a foreign account and references the FBAR filing requirement, the government has been somewhat successful in arguing— in court cases involving "bad actors" — that, in some cases, the filing of a Schedule B can turn a subsequent failure to file an FBAR into a willful violation (called "willful blindness"). The IRS acknowledges that the existence of the checkbox on Schedule B does not turn every FBAR violation into a willful one. However, it suggests that it may do so when the taxpayer has also tried to conceal the account and/or has a large account. The IRS does not identify other relevant factors or provide assurance that it will only pursue a willful penalty against those also engaged in tax shelters, tax evasion, or criminal conduct. As a result, most taxpayers do not know how the IRS will apply this guidance to them.
Until recently, IRS generally required "benign actors," who inadvertently fail to comply, to enter its OVDP settlement and pay the same offshore penalty as "bad actors" or risk "opting out," according to the NTA. However, NTA stated that it is inconsistent with the statutory scheme for "benign actors" to pay the same penalty as "bad actors." Nonetheless, IRS data indicate that "benign actors" paid a proportionately greater offshore penalty than "bad actors." The NTA attributed the problems to IRS delays, which may have prompted some "benign actors" to accept disproportionate offshore penalties. Furthermore, the NTA stated that IRS's one-sided interpretations of OVDP FAQs likely prompted other "benign actors" to accept disproportionate offshore penalties.
Even though recent OVDP changes treat certain benign actors more reasonably, the OVDP guidance-making and disclosure process remains flawed, according to the NTA. For example, IRS will not allow those who already agreed to pay disproportionate offshore penalties to benefit from the most recent changes.
According to the NTA, IRS still does not formally ask for internal or external comments before issuing OVDP guidance or publicly explain its rationale for adopting certain comments and not others. Finally, IRS does not disclose its interpretations of FAQs or other internal guidance to the public.
NTA's recommendations. The NTA stated that IRS' correction of the flaws would further the taxpayer right to be informed. In this regard, the NTA has recommended that IRS undertake the following actions:
Improve the transparency of OVDP guidance and streamline programs;
Allow taxpayers to elevate or appeal a revenue agent's OVDP determination and streamlined program determination; and
Allow taxpayers to amend their IRS closing agreements to benefit from recent changes to OVDP.
U.S. Companies Doing Business in Canada
Erika Stefanski
Erika.Stefanski@mcgladrey.com
Are you doing business in Canada or have plans to expand to Canada? Frequently, taxpayers are not aware that by selling into Canada, or providing services such as installation or marketing, they may be required to file returns and/or pay income taxes in Canada. Such taxpayers may also need to file a special disclosure if they claim benefits under the US Canada income tax treaty (the "Treaty").
U.S. companies that carry on business in Canada are subject to Canadian income tax unless a Treaty exemption applies. The Canadian Income Tax Act broadly defines carrying on business. Typically, selling goods or services into Canada from the U.S. without conducting any other activities in Canada would not cause a U.S. company to be considered as carrying on business. However soliciting sales through an agent or employee in Canada, storing inventory in a public warehouse, or providing services in Canada generally qualifies as a trade or business and will trigger a filing requirement.
While U.S. companies may be considered to be carrying on business in Canada, they may not be subject to Canadian income taxation if their activities are protected under the Treaty. Under Article VII of the Treaty, business profits of a U.S. company are exempt from tax in Canada unless the business is carried on through a “permanent establishment,” which is defined in Article V of the Treaty.
Common activities that constitute a permanent establishment (“PE”) include having a fixed place of business, providing services not protected under the Treaty, or having a dependent agent with the authority to contract that regularly exercises such authority. Examples of having a fixed place of business include having an office, even if it is dedicated space at a customer’s premises, a place of management, or a construction or installation project lasting more than 12 months. Services not protected under the Treaty include services provided by an individual present in Canada for 183 days in any 12 month period if more than 50% of total business revenue is derived from the services; in addition services that are provided for 183 days or more in a 12 month period with respect to the same connected project also constitute a PE.
The Treaty provides guidance for activities that will not cause the U.S Company to rise to the level of a PE in Canada. A fixed place of business used solely for the storage, display, or delivery of merchandise, such as renting space in a public warehouse, will not constitute a PE. A fixed place of business used solely for advertising or for the supply of information that is preparatory in character does not cause a PE. Carrying on business through a broker, commission agent, or other agent of independent status, provided that they are acting in the ordinary course of their business, also does not cause a PE.
A U.S Company carrying on business in Canada is required to file a treaty-based Canadian corporate income tax return, even if the activities are protected under the Treaty. This informational return discloses the activities protected under the Treaty. This return is due six months after year-end and Revenue Canada may impose late filing penalties of $2,500 plus interest.
In recent months, we have seen an increase in notices sent by Revenue Canada to U.S. clients requesting tax returns, even in cases where clients have engaged in minimal activities in Canada. Accordingly, it appears that Revenue Canada is paying closer attention to U.S. companies doing business in Canada.
A district court has largely dismissed a taxpayer's challenges to his penalty for failing to file FBARs (Report of Foreign Bank and Financial Account) with respect to his foreign account, finding that he failed to make the required filings, he had no reasonable cause for that violation, and his constitutional objections were without merit. Moore v. U.S., (DC WA 04/01/2015) 115 AFTR 2d 2015-591. However, the court reserved ruling on the taxpayer's Administrative Procedures Act (APA) claims and ordered the parties to supplement the record. In arriving at its conclusions, the court had to tackle a number of FBAR-related issues, such as the appropriate standard of judicial review, for which there is little to no case law.
The Bank Secrecy Act (BSA) gave the Treasury Department authority to collect information from U.S. persons who have financial interests in or signature authority over financial accounts maintained with financial institutions located outside of the U.S. A provision of the BSA requires that a Form 114, Report of Foreign Bank and Financial Accounts (FBAR) be filed if the aggregate maximum values of the foreign financial accounts exceed $10,000 at any time during the calendar year. Enforcement authority regarding the FBAR has been delegated to IRS.
For non-willful BSA violations, the civil penalty that IRS can impose on a person who fails to file FBARs cannot exceed $10,000. (31 CFR 5321(5)(b)(i)). However, "[n]o penalty shall be imposed" if several requirements are met, including that "such violation was due to reasonable cause."
For nearly two decades, James Moore maintained a foreign account subject to FBAR requirements. The account was opened in the Bahamas, was ultimately migrated to Switzerland, and at all relevant times contained a balance between $300,000 and $550,000.
Mr. Moore filed no FBARs until at least 2009. Around that time, he became aware of IRS's voluntary offshore disclosure program to encourage people who had not been reporting foreign accounts to come forward. He ultimately amended six years of tax returns (from 2003 through 2008) to report income for each of those years from his foreign account. In addition, Mr. Moore in 2010 filed late FBARs for 2003 through 2008, as well as his first timely-filed FBAR for 2009.
In October of 2011, an IRS agent interviewed Mr. Moore and then prepared an FBAR Penalty Summary Memo (memo) recommending that IRS impose a $10,000 penalty for each year from 2005 to 2008. The memo, which provided the agent's reasoning in detail for recommending the penalty, wasn't disclosed to Mr. Moore until he filed this lawsuit.
In December of 2011, IRS sent Mr. Moore a letter proposing a $40,000 penalty that provided virtually no information about the basis for the penalty, demanded that he accept the penalty or request a conference with Appeals by Jan. 28, 2012, and explained that if nothing was done by that date, the penalty would be assessed and collection procedures would be instigated. However, on Jan. 23, 2012, IRS assessed a $10,000 penalty against Mr. Moore for 2005 only. Mr. Moore requested an appeal, and his counsel provided detailed arguments in a letter as to why Mr. Moore acted with reasonable cause In December of 2012, IRS responded in a brief letter upholding the penalties and assessed the $10,000 penalties for each of the remaining three years on Jan. 24, 2013.
Mr. Moore filed suit late in 2013. He argued that IRS violated the Fifth Amendment's Due Process Clause, the Eighth Amendment's Excessive Fines Clause, and the Administrative Procedures Act (APA) (other arguments were deemed abandoned). He sought a refund of $10,500 he paid toward the 2005 penalty and asked the court to set aside the remaining penalties. IRS sought summary judgment on his claims, as well as on its counterclaims to reduce to judgment the penalties for 2006 to 2008.
In setting out the undisputed facts of the case, it was established that, as a matter of law, Mr. Moore committed non-willful violations of the BSA and was thus subject to civil penalties. The remaining issue was whether Mr. Moore could escape liability based on having acted with reasonable cause. The court noted as an initial matter that there was no binding case law providing standards for judicial review of FBAR civil penalty assessments, then determined that it would apply de novo review in reviewing Mr. Moore's liability for the FBAR penalty.
• "Reasonable cause" defined for BSA purposes. The court found that, although the term "reasonable cause" wasn't defined in the BSA or applicable regulations, it made the most sense to attribute to it the meaning of the phrase in other statutes involving IRS's tax assessment role (e.g., Code Sec. 6664(c)(1) and Code Sec. 6677(d)) and found that a person would have "reasonable cause" for an FBAR violation when he committed that violation despite an exercise of ordinary business care and prudence.
• Reasonable cause lacking in this case. The court then examined Mr. Moore's explanation in support of reasonable cause and found that he had no objective basis for his purported belief that he didn't have to report his account. The court determined that he knew of the requirement to report the account vis-a-vis Schedule B, Foreign Accounts and Trusts, which he didn't self-prepare during the years at issue but had done so in the past. Also, in two tax questionnaires used by his return preparer that were part of the record, he indicated to his preparer that he had no interest in a foreign account, and there was no evidence that he otherwise disclosed the account to the preparer.
Challenge to assessment & amount. The court then determined that, in evaluating IRS's assessment of the FBAR penalties, including the amount thereof, the appropriate standard of review was whether IRS's actions were "arbitrary, capricious, an abuse of discretion, or otherwise not accordance with the law" under the APA. The court observed that, unlike tax deficiencies, there are "no codified procedures" for IRS to use in assessing FBAR penalties. Thus, IRS can essentially fashion its own procedures for doing so, subject to constitutional limitations and the APA.
• Assessment fails to meet APA. The APA provision at issue in this case is §555. That section provides minimal procedural guarantees for "information adjudication," including that the agency give "[p]rompt notice" when denying any request made in connection with any agency proceeding, and that the notice include a "brief statement of the grounds for denial."
The court then examined the letter sent to Mr. Moore and found that it could not, on the record before it, determine whether IRS acted arbitrarily, capriciously, or abused its discretion in assessing the penalties. Specifically, the letter didn't actually indicate whether IRS considered relevant factors or whether it made a clear error of judgment. And the fact that the summary memo provided some explanation as to why the agent recommended imposing the maximum amount didn't make a difference in this case because that memo wasn't an explanation of the ultimate decision to impose a penalty.
The court noted, however, that the foregoing failure wasn't adequate grounds to overturn IRS's decision. Instead, the court decided that it would allow IRS to introduce additional material in support of its determination to show that its decision wasn't arbitrary. Specific instructions were provided to this effect. The court also stated that IRS "may also choose" to provide a better explanation for why it assessed the 2005 penalty in advance of the time indicated to Mr. Moore and that, absent an adequate explanation, the court would rule that assessing the 2005 penalty in January 2012 was arbitrary and capricious.
• Assessment procedures satisfied due process clause. The court then determined that IRS's penalty assessment procedures "served all of the purposes of due process." Namely, with respect to the 2006, 2007, and 2008 penalties, Mr. Moore was interviewed, received a notice proposing to assess the penalties, afforded an appeal process, and was issued notice of assessment. For 2005, although there was no meaningful pre-assessment review, IRS nonetheless allowed him to contest it, and Mr. Moore had the opportunity to seek judicial review of all of IRS's decisions.
• Penalty amount doesn't violate 8th Amendment. Finally, the court found that IRS's imposition of the maximum penalty of $40,000 didn't violate the excessive fines clause. It found that Mr. Moore didn't establish that the penalties were disproportionate to his offense, noting both the size of the account and that Congress authorized penalties of up to $10,000 without regard to the size of the unreported account.
Short-term Obligation Exception Didn't Apply to CFC's Loans to U.S. Parent
In Chief Counsel Advice (CCA) 201516064, the IRS has concluded that the short-term obligation exception to the controlled foreign corporation (CFC) U.S. property rules, which is provided by Notice 88-108, does not apply to any obligation owned by a CFC unless all obligations held during the tax year by the CFC that would be U.S. property were it not for the 30-day rule in Notice 88-108, meet Notice 88-108's 60-day test.
Every person who is a U.S. shareholder (as defined in Code Sec. 951(b)) of a CFC and who owns stock in such corporation on the last day of its tax year must include in gross income the amount determined under Code Sec. 956 with respect to that shareholder for that tax year (but only to the extent not excluded from income under Code Sec. 959(a)(2) (i.e., previously taxed subpart F income)). Code Sec. 956(a) defines that amount for any tax year as the lesser of:
The excess of (A) such shareholder's pro rata share of the average of the amounts of U.S. property held (directly or indirectly) by the CFC as of the close of each quarter of such tax year, over (B) that portion of the CFC's earnings and profits attributable to amounts included previously in that shareholder's gross income on account of investment in U.S. property (or which would have been so included except that it had already been included under another provision of the CFC rules); or
Such shareholder's pro rata share of the applicable earnings of such CFC.
The term "U.S. property" generally includes an obligation of a domestic corporation that is a U.S. shareholder of the CFC. (Code Sec. 956(c)(1)(C), Code Sec. 956(c)(2)(F), Code Sec. 956(c)(2)(L) ) Accordingly, a U.S. shareholder will generally have to include an amount in income if its CFC holds an obligation of the shareholder as of the close of a quarter of the CFC's tax year. The amount of the inclusion is determined with respect to the CFC's basis in the obligation averaged over the quarters in its year when it holds the obligation. However, as noted above, the inclusion amount will be limited in cases where the CFC has earnings and profits as described above or where the shareholder's pro rata share of the CFC's applicable earnings is less than the amount that it would otherwise include.
Exceptions for certain short-term loans. On Sept. 16, '88, IRS published Notice 88-108, 1988-2 CB 446, which announced that final regs issued under Code Sec. 956 (which still haven't been issued) would exclude from the definition of the term "obligation" an obligation that would constitute an investment in U.S. property if held at the end of the CFC's tax year, so long as the obligation was collected within 30 days from the time it was incurred (30-day rule). This exclusion wouldn't apply, however, if the CFC held, for 60 or more calendar days during the tax year, obligations which, without regard to the above 30-day rule, would constitute an investment in U.S. property if held at the end of the CFC's tax year (60-day rule).
In 1993, the Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66) amended Code Sec. 956 to provide that a CFC's investment in U.S. property is determined using the average of the amounts of U.S. property held by the CFC as of the close of each quarter of its tax year. However, the legislative history indicates that the amendment wasn't intended to invalidate the short-term obligation exception in Notice 88-108.
Facts. US Parent, a domestic corporation, wholly owned Alpha Corporation, a CFC which was organized in Country. US Parent and Alpha Corporation both had tax years ending Day 1. During Year 1 (which was after 1988), Alpha Corporation made several loans to US Parent pursuant to a line of credit. Amount 1 was outstanding on the last day of Alpha Corporation's quarter including Date 1.
On Date 2 (which was fewer than 30 calendar days after Date 1), US Parent repaid Amount 2, which was Amount 3 less than Amount 1, to Alpha Corporation Amount 3 remained outstanding after Date 2.
On Date 3, Alpha Corporation loaned Amount 4 to US Parent. Amounts 4 and 3 were outstanding on the last day of Alpha Corporation's quarter including Date 3.
On Date 4 (which was fewer than 30 calendar days after Date 3), US Parent repaid Amount 4 to Alpha Corporation.
As a result of these advances and repayments, Amount 3 was outstanding for more than 60calendar days during Year 1, although Amount 2 and Amount 4 were each outstanding for fewer than 30 calendar days during Year 1 and were cumulatively outstanding for fewer than 60 calendar days during Year 1.
CCA's conclusion. In the CCA, IRS concluded that if a CFC held an obligation, which (without regard to the 30-day rule in Notice 88-108) would be U.S. property, for 60 or more calendar days during a tax year, the CFC could not rely on Notice 88-108's exclusion from the definition of obligation for obligations that met the 30-day and 60-day tests.
IRS reasoned that the loans made to US Parent by Alpha Corporation in Year 1 were obligations that constituted U.S. property unless an exception applied. Alpha Corporation made a loan in Amount 1 to US Parent, which comprised (a) an obligation in the amount of Amount 2 that was repaid on Date 2 (the "Amount 2 Obligation") and (b) an obligation in the amount of Amount 3 that was still outstanding after Date 4 (the "Amount 3 Obligation"). It also made a loan in the amount of Amount 4 (the "Amount 4 Obligation").
The Amount 2 Obligation and the Amount 4 Obligation were each outstanding for fewer than 30 calendar days. Furthermore, the cumulative time that the Amount 2 Obligation and Amount 4 Obligation were outstanding during Year 1 was fewer than 60 calendar days. On that basis, US Parent argued that the Amount 2 Obligation and Amount 4 Obligation each qualified for the exclusion in Notice 88-108 for short-term obligations. US Parent argued that only the Amount 3 Obligation was U.S. property that had to be taken into account in determining the average amount of U.S. property held by Alpha Corporation in Year 1.
However, contrary to US Parent's position, IRS concluded that Notice 88-108 does not provide a blanket exception for specific obligations that meet the 30-day and 60-day tests. Instead, it provides an exception for obligations that meet the 30-day test if, and only if, all obligations held by a CFC meet the 60-day test. The Amount 3 Obligation was outstanding for a period in excess of 60 calendar days during Year 1. Because Alpha Corporation held an obligation of US Parent for 60 or more calendar days during the tax year, Notice 88-108 did not exclude any obligations of US Parent from the definition of "obligation" for Code Sec. 956 purposes.
Chief Counsel Advice 201516064 notes that Notice 88-108 was intended to apply in fact patterns in which CFC earnings are available for use in the U.S. for a small portion of the year. It reflects an understanding that short-term obligations outstanding for a small portion of the year may not be a repatriation of the type that Code section 956 was intended to address. However, Code section 956 generally requires that, if CFC earnings are available for use by a related U.S. person for a significant portion of the year, the amounts must be taxed similarly to the way that earnings distributed to a U.S. shareholder of the CFC would be taxed. Accordingly, Notice 88-108 provides that its short-term obligation exception does not apply if a CFC holds for 60 days or more during the tax year any obligations that would (without regard to the short-term obligation exception) be U.S. property.
Surface Transportation Act of 2015: Tax Provisions | Plante Moran
Proposed Regulations Eliminate 367 Goodwill Exception
Proposed Regulations Eliminate 367 Goodwill Exception | Plante Moran
IRS Tweaks Corporate Tax Inversion Rules
In the wake of Pfizer agreeing to merger with Allergen for 160 billion dollars, the Obamaadministration has again tighten the U.S. tax rules governing corporate tax inversions. Thereis wide spread speculation that a significant, if not primary purpose, of the Pfizer-Allergandeal was driven by the current structure of the U.S. corporate income tax system. Pfizer, aU.S. corporate entity who is potential subject to a top U.S. corporate tax rate of 35%, ismerging into a smaller Allergan, an Irish domiciled entity who is generally subject to a top12.5% income tax rate. The merger will allow Pfizer to benefit from the lower Irish top income tax rate on its accumulate and prospective non-U.S. income.
The Internal Revenue Service recently issued Notice 2015-79. Notice 2015-79 changescertain preferential U.S. tax rules under Internal Revenue Section 7874 (the Code sectionwhich governs inversion deals). Among the changes are new rules which:
1.) Require a new corporate parent tobe tax resident in the country where it is created;
2.) Limit the ability a new corporate parent to be tax resident in a country which is not thedomicile of either the acquirer or target;
3.) Strengthen certain anti-stuffing rules;
4.) Take intoaccount certain post-merger “tax avoidance” transactions; and,
5.) Clarify certain tax rules within Notice 2014-52, which was issued just last year, that were intended to limit U.S. corporations from engaging in inversion transactions.
Notice 2015-79 will make inversions slightlymore difficult. However, closing most of theissues presented by a corporate inversions that the administration is concerned about canonly be dealt with by changes to the Internal Revenue Code. In order to do that the Obamaadministration will need the cooperation of Congress, something that seems unlikely at themoment.
Click to view a copy of the Notice 2015-79.
IRS Can Now Revoke Your Passport If You Owe Them Money
David M. Henderson, CPA, CFP, JD, LLM
dhenderson@dugganbertsch.com
On December 4th, 2015 President Obama signed into law the Fixing America’s Surface Transportation Act) the “FAST Act”). The FAST Act amended the Internal Revenue Code (the “Code”) by adding Code 7345. Code section 7345 adds a new significant tool in the IRS efforts to collect taxes, including from those who live or travel internationally on business.
Code section 7345 allows the IRS to certify to the U.S. State Department that a person has a “seriously delinquent tax debt.” If such a certification is received then the State Department may deny, revoke, or otherwise limit a person’s passport. The IRS is required a contemporaneous notice of its certification to the State Department to the taxpayer. Taxpayer have a right to challenge the IRS certification in court.
A tax liability exceeding $50,000 (which will adjusted for future inflation) which the IRS has either filed a notice of a federal tax lien or levied property is considered a “seriously delinquent tax debt.” There are limited exceptions for certain IRS approved payment programs from the definition of “seriously delinquent tax debt.” There are also notice provisions; however, these may be truly effective in providing a right to timely contest a passport revocation given certain Code and IRS procedural rules and presumptions, including the last known address rule.
Code section 7345’s addition requires 1.) Immediately addressing any outstanding tax liabilities over $50,000 and 2.) Reviewing prior international tax positions and filings to ensure their correctness. Delinquent or incorrect international filings may result assessments against a taxpayer as penalties can easily exceed the $50,000 with respect to delinquent or incorrect international filings. FATCA, which is now operational, requires foreign financial institutions to directly report information on their account holders to the IRS. Due to procedural rules and FATCA the taxpayer may not have notice of these assessments until after their passport has been revoked, possibly resulting in undue hardships and business disruptions due to the inability of the taxpayer to travel abroad.
DUGGAN BERTSCH has successfully assisted individuals and companies in their international compliance, including correcting violations of these draconian laws and rules, and in their collection matters. There are many options to correct these issues and which option to choose will require a customize analysis of your particular facts and circumstance. Please feel free to contact our office if you would like assistance in any of your international compliance or IRS collection needs.
Disclaimer: This article is designed to provide information in regard to the subject matter and has been prepared with the understanding that neither the Illinois CPA Society nor the author of this article is providing accounting, tax or legal advice or is performing any legal, accounting or other professional service. If accounting, tax or legal advice or other expert
IRS Issues Rules on New Federal Inheritance Tax
Internal Revenue Code (the “Code”) section 2801 was added to the Code in 2008. Code section 2801 represented a dramatic departure from the conventional and established U.S. wealth transfer tax system. The wealth transfer tax system in the U.S. is generally comprised of three somewhat integrated tax regimes. The gift tax system taxes gifts by a transferor during his or her lifetime. The estate tax system taxes transferors that occur by death of the transferor. The generation skipping tax system can apply to tax transfers by a transferor to persons two generations below the transferor (e.g. a grandparent making a transfer to a grandchild) during life or at death. In the past all three systems usually placed filing and tax responsibilities on the transferor of property subject to the wealth transfer tax system.
Code section 2801 marks a significant departure from this system of putting the tax and filing burdens on a transferor. Transfers subject to Code section 2801 place both the tax liability and filing requirements with transferors coming within its scope upon the transferee of the property. Hence, this new Code section instituted a new federal inheritance tax. This new federal inheritance tax is in addition to the preexisting federal wealth transfer tax system that existed prior to its enactment.
This new federal inheritance wealth transfer tax taxes gifts and bequests from “covered expatriates” at the highest gift and estate tax rate in effect at the time of the gift or bequest. The recipient of this gift or bequest is directly liable for any tax due. By contrast, the receipt of a gift or bequest normally is not subjected to wealth transfer or income taxation at either the federal level or the state level. Hence, Code section 2801 is a radical departure from prior law.
Code section 2801 is currently limited to target only gifts and bequests from a “covered expatriate.” Who are these people that Congress has singled out for special treatment? A “expatriate” is either a U.S. who has renounced their citizenship or a long-term permeant resident (i.e. a green card holder resident in the U.S. during any part of at least 8 of the prior 15 years) who has terminated that status. To be “covered” the expatriate must either have:
Averaged $160,000 of U.S. income tax liability over the prior 5 years;
Have a net worth of at least $2 million dollars on renunciation/termination; or,
Failed to certify they were in compliance with their U.S. income tax obligation over the 5 prior years.
Code section 2801 as enacted is short and a relatively vague Code section. Congress delegated authority to the U.S. Treasury to issues rules that would flesh out the contours of Code section 2801. The IRS did exactly that on September 9, 2015 by issuing a series of proposed regulations.
The new proposed regulations require that the recipient of a gift or bequest to file a new form, Form 708, which has yet to have been issued even in draft form. The proposed regulation require that any recipients of a covered gift or bequest received on or after June 17, 2008 to file a Form 708 once the proposed regulations are finalized (i.e. imposing a retroactive filing requirement). Accordingly, a recipient will need to 1.) retain gifting records from 2008 until the present and 2.) file a Form 708 for each year that a gift or bequest was received form a covered expatiate during this period of time. The IRS has stated that it would provide a reasonable amount of time to both file and pay any associated tax after final regulations are issued. Typically this is a few months after proposed regulations are issued.
The more problematic aspect of the proposed regulations under Code section 2801 deals with burdens it puts on the receipt of a gift or bequest. The proposed regulations require the recipient to determine is the gift or bequest is received form a covered expatriate. Since status as a covered expatriate will depend upon facts unknown by the recipient of a gift or bequest, it is difficult to see how ANY recipient will able to have knowledge of an expatriate’s status as a covered expatriate absent the expatriate informing the recipient of his or her status as a “covered” expatriate. The “covered” expatriate may be reluctant to do so as acknowledgement of this status can imply that the expatriate maintained a certain level of income or net worth over at the least the prior 5 years. This acknowledgement may subject the expatriate to certain nontax risks aboard, including personal and political risks to the expatriate and his or her family.
The IRS takes this issue a bit further by announcing that there is a rebuttable presumption that a gift or bequest from an expatriate is from a “covered” expatriate absent the expatriate agreeing to the release of his or her tax personal tax information for the prior 5 years to the recipient of the gift or bequest. The IRS has provided a process by which the release of this information may occur if the “covered: expatriate agrees to it. The proposed regulations to do not otherwise elaborate on how this presumption may be rebutted by the recipient of the gift or bequest absent the recipient of the gift or bequest receiving tax information directly from the IRS.
Accordingly, the recipient is left in the inevitable position of having to either:
Assume the gift of bequest is a covered gift or bequest and pay the Code section 2801 tax at the highest rate when in fact the gift or bequest may not be subject I whole or in part to the Code section 2801 tax; or,
Risk personal lability for the Code section 2801 with the knowledge that should the transaction be questioned by the Internal Revenue Service that the deck will be stacked against him or her due to the rebuttable presumption.
DUGGAN BERTSCH has successfully assisted individuals expatriate. Our services include customized tax planning to minimize the U.S. tax costs associated with expatriation, structural planning to mitigate the Code section 2801 tax and risks associated with its presumptions, and assisting with the U.S. tax compliance issues for expatriates. Please feel free to contact our office if you would like assistance in any of your tax and penalty controversy needs.