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10 45am irs developments

  1. 1. 48th Annual Bank & Capital Markets Tax Institute IRS Developments Ellen Rotenberg, PwC Mike Gaffney, PwC Barry Shott, PwC November 14, 2013 10.45am to 12.15pm
  2. 2. IRS Developments - Topics 1. Introduction – General Observations 2. UTP – describe LB&I process around evaluating UTP schedule 3. Economic substance doctrine – status of LB&I field directive 4. Significant Controversy issues – GLAM on Stock Lending; Recent FTC generator cases, impact on LB&I processes 5. Pre-filing Agreements– section 199 and R&E 6. IDR Process – New guidance and timelines 7. Closing Comments and Q&A PwC November 2013 2
  3. 3. IRS Developments - LB&I process around evaluating UTP schedule UTP Filing Statistics – September 2013 IRS Release Taxpayer Information: TY 2011 TY 2010 Sch. UTP filers 2,138 2,143 Percent of Repeat filers 77% -Percent of UTP filers in CAP 2% 2% Publicly Traded UTP filers 56% 58% Total Uncertain Tax Positions 5,582 5,105 UTPs reported on Part II (PY) 1,178 -Average UTP per Taxpayer 2.6 2.4 UTP Filers reporting only 1 UTP 41% 48% Most common UTPs (% of total): 1) Research Credit -- IRC 41 2) Transfer Pricing -- IRC 482 3) Capitalization -- IRC 263* PwC 24% 22% 6% 21% 22% 7% November 2013 3
  4. 4. Global Developments – Economic Substance JITSIC Learning ? US – Codification of Economic Substance Section 7701(o); Debt vs. Equity Decisions UK – General Anti-Abuse Rule (GAAR) Australia – Part IV A change to “reasonable hypothesis” Canada – Legislation based on OECD Mexico – Fundamental Tax Reform Luxembourg – Anti-abuse provisions France – Anti-abuse provisions, treaty provisions and financing limitations Australia – Former government proposal on thin capitalization and removing interest deductions related to foreign dividend income. Netherlands – Decree on substance for Intra-group Financing and Licensing Germany – Anti-abuse provisions, treaty provisions and withholding tax tests Indirect Capital Gains Tax - Chile, Peru, Panama, Spain, Dominican Republic November 2013 PwC
  5. 5. Codification / Clarification of Economic Substance Overview • The economic substance doctrine is a judicially created doctrine that can deny the tax benefits associated with a transaction challenged by the IRS if a court determines that the claimed tax benefits were unintended by Congress and the transaction serves no economic purpose other than tax savings. • IRC §7701 (o) codified the economic substance doctrine. • Effective for transactions entered into after March 30, 2010. • IRC §6662(b)(6) imposes a 40% strict liability penalty for transactions that fail to meet the codified economic substance doctrine (20% if “adequately disclosed”). • No exceptions (including the reasonable cause and good faith exception - §6664(c)(1)) to the penalty are available. PwC 5
  6. 6. Recent Cases – Economic Substance and Substance Over Form Holding Adjustment Penalty Bank of New York (February 2013) Economic substance $225 million in credits Not addressed Barnes (April 2013) Business purpose / substance over form Yes - $2 million WFC (May 2013) Economic substance $423 million Not addressed Dow(June 2013) Economic substance $1 billion & sham transaction Yes – 20% (no exact number) John Hancock (August 2013) Substance over form $560 million Not addressed BB&T (September 2013) Economic substance $659 million in deductions and credits disallowed Yes - $113 million PwC $59 million
  7. 7. US – Economic Substance Provision – 7701(o) • When is it Relevant? • Transactions will be treated as having economic substance only if both an objective requirement and a subjective requirement are met. • The “objective requirement” is met only if the transaction changes the taxpayer’s economic position in a meaningful way. • The “subjective requirement” is met only if the taxpayer has a substantial purpose for entering into the transaction. • Neither “meaningful” nor “substantial” is defined. • If a taxpayer relies on a profit potential - the present value of the reasonably expected pretax profit must be substantial in relation to the present value of the expected net-tax benefits. • Fees and transaction expenses must be counted in determining net pre-tax profit. Regulations must be issued regarding when foreign taxes are to be treated as expenses in determining pretax profit. A taxpayer may rely on factors other than profit potential to demonstrate compliance with Code Section 7701(o). • IDD (2010 and 2011) and Notice 2010-62 • Penalty. November 2013 PwC
  8. 8. IRS Developments - Economic substance doctrine – status of LB&I field directive July 2011 Directive for examiners to use 4 steps in determining whether and when to seek high-level review in asserting the codified economic substance doctrine and its associated strict liability penalty. 1. IRS examiner should evaluate whether the circumstances in the case are those under which application of the economic substance doctrine to a transaction is likely not appropriate. 2. IRS examiner should evaluate whether the circumstances in the case are those under which application of the doctrine to the transaction may be appropriate. 3. IRS examiner determines that the application of the doctrine may be appropriate, the guidance provides a series of inquiries an examiner must make before seeking approval to apply the doctrine. PwC November 2013 8
  9. 9. IRS Developments - Economic substance doctrine – status of LB&I field directive 4. If an IRS examiner and his or her manager and territory manager determine that application of the economic substance doctrine is merited, guidance is provided on how to request approval of the appropriate Director of Field Operations (DFO). - Discuss the roll out of this directive after two years - what about “SAAR” in 246, 265, 901, 269 ? - Discuss the applicability of the directive to pre – 7701 (o) examination years - Directive n/a to DOJ PwC November 2013 9
  10. 10. IRS Developments - Significant Controversy issues – GLAM on Stock Lending PwC November 2013 10
  11. 11. GLAM - economic substance & stock lending • IRS: Economic substance doctrine applies to securities lending transactions used to avoid U.S. withholding tax • The IRS believes there are some financial institutions offering transactions structured as securities loans so that foreign clients are not subject to U.S. withholding taxes • The IRS uses the following facts to determine whether a foreign taxpayer did not have a nontax business purpose: - Stock loan had off-market terms; - U.S. financial institution marketed the stock loan as being able to avoid U.S. withholding taxes; - Foreign client could not give a bona fide reason for lending the shares; and - Stock loan did not have profit potential. PwC November 2013 11
  12. 12. GLAM - economic substance & stock lending • Conclusion of GLAM 2012-009: - Commissioner may tax the transaction in accordance with its substance. - Because Foreign Customer retained the economic benefits and burdens of the Reference Shares, the Commissioner may tax Foreign Customer as though Foreign Customer retained ownership of the securities and received a payment (via Foreign Affiliate) that, in substance, was the payment of a U.S. source dividend with respect to the Reference Shares. - Therefore, the payment from Foreign Affiliate to Foreign Customer would be subject to a 30 percent U.S. gross basis withholding tax. - Foreign Affiliate was a withholding agent with respect to the payment and accordingly is liable for the 30 percent tax. PwC November 2013 12
  13. 13. IRS Developments - Significant Controversy issues – GLAM on Stock Lending Economic Substance - While years under exam are pre 7701(o), the JCT Technical explanation (page 152) is instructive when it states "the doctrine is not intended to alter the basic tax treatment of certain business transactions that, under longstanding judicial and administrative practice (i.e., Notice 97-66 in this context ) are respected merely because the choice between meaningful economic alternatives is largely or entirely based on comparative tax advantages....." Dissenting view: a decision by the foreign holder might be “tax motivated”—if that term encompasses avoiding economic distortion because the form of transaction chosen by the issuer did not reflect the substantive economics of the transaction. However, it should be respected so long as the foreign holder actually changed its position for tax law purposes from ownership of shares to a derivative. PwC November 2013 13
  14. 14. Significant Controversy issues – Recent FTC generator cases Bank of New York Mellon Corp. v. Commissioner, 140 T.C. 2 (2013) , held that a STARS transaction lacked economic substance BB&T - Salem Financial Inc. v. United States, No. 1:10-cv-00192 (Fed. Cl. 2013) , STARS transaction lacked economic substance and that $112.7 million accuracy-related penalties were applicable Sovereign Bancorp Inc. v. United States, 1:09-cv-11043-GAO (D. Mass. 2009) held for Taxpayer, Government’s economic substance arguments did not convince Judge O’Toole Impact on … future cases (Wells Fargo) ? Appeals courts ? IRS settlement initiatives ? Application of ESD Directive? PwC November 2013 14
  15. 15. Significant Controversy issues – Recent FTC generator cases and economic substance • Will economic substance routinely be asserted in litigation as a back up argument even when technical arguments and other common law doctrines provide more targeted attacks? • Treatment of Foreign Taxas an Expense for Economic Substance Doctrine – In BNY, the Tax Court chose to follow its precedent with respect to the treatment of foreign taxes as an expense for economic substance doctrine. This, despite contrary rulings in the Fifth and Eighth Circuits (Compaq and IES). • Therefore, if the court’s decision is upheld on appeal (an appeal which lies in the Second Circuit), there will be a circuit split. • It is important to note that when Congress enacted section 7701(o) (i.e., codification of the economic substance doctrine) it provided Treasury and the IRS with the authority to override the Fifth and Eighth Circuits by way of promulgating relevant regulations, but they have not done so to date. PwC November 2013 15
  16. 16. When does the Economic Substance Doctrine apply? TP wins – ESD not asserted by IRS or addressed by court Inbound debt planning NAGP (TCM 2012)  Outbound debt planning PepsiCo (TCM 2012)  Acceleration of built-in loss Granite Trust (1st Cir.. 1956)  Moving assets offshore UPS (11th Cir. 2001)  Use of downstream merger Est. of Gilmore (3d Cir. 1942)  Avoiding Subpart F with CTB - Dover (TC 2004)  Trigger gain to use losses Cottage Savings (S. Ct. 1991)  PwC TP loses – ESD asserted but court applies substanceover-form or step transaction  Repatriation - Schering/Merck (3d Cir. 2011), Barnes (TCM 2013)  FTC generator – Hewlett-Packard (TCM 2012)  Creditor structured as partner – Historic Boardwalk (3d Cir. 2012), Castle Harbour (2d Cir. 2006)  LILO/SILO – John Hancock (TC 2013) TP wins – ESD asserted but rejected by court Treaty planning with backto-back debt , Northern Indiana (7th Cir. 1997)  Intercompany debt to generate losses in domestic group, Kraft (2d Cir. 1956)  Acceleration of built-in loss Shell (SD Tex 2008)  Structuring partnership redemption to avoid gain and trigger loss, Countryside (TCM 2008)  TP loses – ESD asserted and applied Create and trigger noneconomic loss Heinz (Fed. Cl. 2007) Coltec (Fed. Cir. 2007)  FTC generator Pritired (SD Iowa 2011) Bank New York ( TC 2013) BB&T (Fed. Cl. 2013) AIG (SDNY 2013)  Partnership basis shift Chemtech (MD LA 2013)  16
  17. 17. When is economic substance relevant? • Is the COES doctrine a doctrine arising in the context of promoted transactions involving non-economic losses and attribute trafficking, and therefore appropriately limited to those contexts? • Is there a fundamental distinction between such abusive planning and traditional corporate attribute planning where a taxpayer group maximizes the utilization of credits, loss carry forwards and economic losses that arise from the operation of its business? • Does a taxpayer need business purpose to affirmatively apply an antiabuse rule, like section 304 or section 956, when it works to the taxpayer’s advantage? • How do you evaluate Congressional intent? PwC Page 17
  18. 18. UK – GAAR - 2013 • …“has effect for the purpose of counteracting tax advantages arising from tax arrangements that are abusive”. • Arrangements are defined as “tax arrangements” if “it would be reasonable to conclude that the obtaining of a tax advantage was the main purpose, or one of the main purposes, of the arrangements”. • This test will apply to avoidance schemes which are in “the centre ground of tax planning” as well as to those which are artificial or abusive. • …“reasonable to conclude” that tax avoidance was one of the main purposes of the arrangement. • Tax arrangements are defined as “abusive” if, having regard to all the circumstances, “they are arrangements the entering into or carrying out of which cannot reasonably be regarded as a reasonable course of action”. • Tax benefit denied if rule applied. November 2013 PwC 18
  19. 19. IRS Developments - Pre-filing Agreements– section 199 and R&E • PFA described in IRM 4.30.1 and Revenue Ruling 2009-14 as a “component of the LB&I division’s issue management strategy • IRS and Treasury are required to make publicly available an annual report for the PFA program • Total time to complete PFAs for CY 2010, 2011 and 2012 was 385, 265, and 392 days • Issues for 2012 closed included • • Section 199 (1 received, not closed EOY) • PwC R&E credit (2 received, 2 closed) Deductibility of Settlement/ Fines (3 received, 2 closed) November 2013 19
  20. 20. IRS Developments - IDR Process – New guidance and timelines • November 4 – LB&I announce mandatory, stringent new practices for enforcing IDRs, issuing summonses, allowing almost no discretion even at manager level. • LB&I Directive – 04-1113-009 takes effect January 2. • Why ? • Taxpayers should……. PwC November 2013 20
  21. 21. WARNING: The following disclaimer and copyright notices must be customised for your local territory - if you need assistance with appropriate wording, contact your local Risk Management or Office of General Counsel. © 2010 PwC. All rights reserved. Not for further distribution without the permission of PwC. "PwC" refers to the network of member firms of PricewaterhouseCoopers International Limited (PwCIL), or, as the context requires, individual member firms of the PwC network. Each member firm is a separate legal entity and does not act as agent of PwCIL or any other member firm. PwCIL does not provide any services to clients. PwCIL is not responsible or liable for the acts or omissions of any of its member firms nor can it control the exercise of their professional judgment or bind them in any way. No member firm is responsible or liable for the acts or omissions of any other member firm nor can it control the exercise of another member firm's professional judgment or bind another member firm or PwCIL in any way.