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Santander Holdings USA Asks the Supreme Court to Address Economic Substance Doctrine

by | Apr 7, 2017 | , , ,

From 2003 to 2007, Sovereign Bancorp, Inc. (Sovereign) – now known as Santander Holdings USA, Inc. (Santander) – engaged in a so-called STARS transaction with Barclays Bank. According to Santander, “[b]y engaging in the STARS transaction, Sovereign transferred some of its income tax liability from the United States to the United Kingdom,” it “secured a loan of $1.15 billion,” and it received a payment “which effectively reduced its lending costs.” On its Federal corporate income tax returns for those years, Sovereign claimed foreign tax credits (FTCs) for UK taxes it paid in connection with the STARS transaction. It also claimed deductions for the interest paid on the $1.15 billion loan.

In 2009, the Internal Revenue Service (IRS) issued a Notice of Deficiency disallowing Sovereign’s FTCs and its deductions for interest paid on the $1.15 billion loan. The IRS did not challenge Sovereign’s compliance with the statutory and regulatory rules governing FTCs, instead arguing that Sovereign’s STARS transaction lacked “economic substance.” Sovereign paid the deficiency and sued for a refund in the US District Court for the District of Massachusetts. When the district court held for Sovereign on both issues, the IRS appealed to the US Court of Appeals for the First Circuit, but only with respect to the FTC issue. The crux of the issue was how to treat the UK taxes and the related FTCs for purposes of the “economic substance” analysis. Relying on Salem Financial, Inc. v. U.S., 786 F.3d 932 (Fed. Cir. 2015), and Bank of New York Mellon Corp. v. Comm’r, 801 F.3d 104 (2d Cir. 2015), the IRS argued that the UK taxes should be treated as an expense but that the related FTCs should be ignored in determining pre-tax profit. Citing IES Indus., Inc. v. U.S., 253 F.3d 350 (8th Cir. 2001), and Compaq Computer Corp. v. Comm’r, 277 F.3d 778 (5th Cir. 2001), Sovereign argued that either both should be included in the profit analysis or both should be ignored. The First Circuit held that Sovereign’s STARS transaction lacked “economic substance,” and upheld the disallowance of the FTCs at issue. In doing so, it treated the UK taxes as expenses that reduced pre-tax profit and ignored the related FTCs, following the Federal and Second Circuit’s approach. Santander Holdings USA, Inc. v. U.S., 844 F.3d 15 (1st Cir. 2016).

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Taxpayer Advocate Questions IRS CID’s Narrow Reading of the Taxpayer Bill of Rights

by | Apr 6, 2017 | , ,

On March 30, 2017, the US Treasury Inspector General for Tax Administration (TIGTA) published a report identifying numerous violations of taxpayer rights from 2012 to 2014 by the Internal Revenue Service Criminal Investigation Division (IRS CID) in structuring cases. TIGTA examined over 300 investigations for structuring in this time period and identified 21 cases in which taxpayer rights had been compromised.

The Bank Secrecy Act of 1970 (BSA) requires US financial institutions to file reports of currency transactions exceeding $10,000. A provision of the BSA, 31 U.S.C. § 5324(a), prohibits structuring, that is, setting up a transaction for the purpose of evading this reporting requirement. Violations of the law can result in fines, imprisonment and asset forfeiture. This law is administered by the US Department of the Treasury, and one of its major goals is to monitor traffic in illegal-source funds (i.e., funds used in drug transactions or to support terrorism). (more…)



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Tax Court Holds Section 883 Regulations Valid under Chevron Test

by | Apr 3, 2017 | , , , ,

On March 28, 2017, the US Tax Court issued its opinion in Good Fortune Shipping SA v. Commissioner, 148 T.C. No. 10, upholding the validity of regulations issued under Internal Revenue Code (Code) Section 883.

Code Section 887(a) imposes a four percent tax on a foreign corporation’s US-source gross transportation income for each year. Code Section 883(c)(1) exempts from US tax a foreign corporation’s gross income from the international operation of ships if the foreign country in which the corporation is organized grants an equivalent exemption to corporations organized in the United States. Code Section 883(c)(1) provides that this exemption does not apply if 50 percent or more of the value of a foreign corporation’s stock is owned, directly or indirectly, by individuals who are not residents of a foreign country that grants an equivalent exemption to US corporations. Regulations issued under Section 883 provide that ownership through shares of a foreign corporation issued in bearer form is disregarded in determining whether the corporation passes the 50 percent or more test (Ownership Regulations).

The taxpayer in Good Fortune Shipping challenged the validity of the Ownership Regulations. It based its challenge on its claim that the Ownership Regulations do not satisfy the two prongs of the test under Chevron USA, Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). This argument, in turn, was based primarily—if not exclusively—on the taxpayer’s assertion that US Congress had left no “gap” in Code Section 883 for US Department of the Treasury and the Internal Revenue Service (IRS) to fill; this is because the operative term “own” that appears in the statute has a common, ordinary meaning such that further interpretation by the IRS is not necessary. Thus, the taxpayer argued, the Ownership Regulations fail step one of the Chevron analysis. (more…)



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Acting IRS Chief Counsel appoints new Deputy Chief Counsel (Operations)

by | Mar 30, 2017 | , , , ,

The Acting Chief Counsel announced that effective April 1, 2017, Drita Tonuzi will serve as the Deputy Chief Counsel (Operations), in Washington DC.  In this position, Ms. Tonuzi will provide legal guidance and litigation support to the Internal Revenue Service (IRS) and the Departments of Treasury and Justice in all matters pertaining to the administration and enforcement of the Internal Revenue laws.  This includes responsibility for all litigation in the United States Tax Court as well as the management of personnel in fifty field offices nationwide and in headquarters operations in Washington, DC. She will directly supervises nine Divisions including Large Business and International (LB&I), Small Business/Self Employed (SB/SE), Tax Exempt and Governmental Entities (TEGEDC), Wage and Investment (W&I), General Legal Services (GLS), Criminal Tax (CT), Procedure and Administration (P&A), Finance and Management (F&M) and Counsel to the National Taxpayer Advocate (CNTA).

Ms. Tonuzi began her career with the Office of Chief Counsel in 1987 in the Manhattan Office, where she litigated cases before the United States Tax Court. She served as the Securities & Financial Services Firms Industry Counsel and managed a group of attorneys, Deputy Division Counsel for the Large Business & International Division (formerly LMSB), where she was responsible for the operation and litigation of the organization and most recently she served as Associate Chief Counsel Practice and Administration.

With Ms. Tonuzi’s promotion, Kathryn Zuba has been appointed as the Acting Associate Chief Counsel, Procedure and Administration. Ms. Zuba will head an office of more than 150 professionals, who provide legal services to the IRS, other components of the Chief Counsel’s Office, other government agencies, and the public in the areas of federal tax procedure and administration. The responsibilities of this office include matters relating to the reporting and payment of taxes; assessment and collection of taxes; the abatement, credit or refund of over-assessments or overpayments of taxes; the filing of information returns; bankruptcy; disclosure; FOIA; privacy law; litigation sanctions; judicial doctrines; ethics; and liaison with the courts.



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Taxpayer Rights Around the World (Part 2)

by | Mar 24, 2017 | , , ,

We previously posted on Day One of the 2nd International Conference on Taxpayer Rights in Vienna, Austria. Below, we summarize the panels and issues discussed on Day Two.

Four panels were held on March 14: (1) Penalties and General Anti-Avoidance Rules; (2) The Role of Intergovernmental Actors in Furthering and Protecting Taxpayer Rights: A Conversation; (3) Building Trust I: Transforming Cultures of Tax Agencies; and (4) Building Trust II: Safeguards on Tax Agency Power.

Penalties and General Anti-Avoidance Rules

This panel looked at current research on the use of penalties and general anti-avoidance rules in tax administration from the perspectives of legal and economic theory and taxpayer behavior. Studies were discussed that found that delayed feedback on tax audit often results in increased tax compliance but reduces the perception of procedural fairness and diminishes trust in the taxing authorities. Participants in the studies viewed receiving delayed feedback and increasing the probability of audits and the potential for more fines. One conclusion presented was that the delay resulted in longer periods of uncertainty and may yield higher levels of honesty in the short term, but might undermine tax compliance in the long term. (more…)



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Taxpayer Rights Around the World (Part 1)

by | Mar 22, 2017 | , , ,

On March 13 and 14, the 2nd International Conference on Taxpayer Rights was held in Vienna, Austria. More than 150 individuals from more than 40 countries attended the conference, which connects government official, scholars and practitioners from around the world to explore how taxpayer rights globally serve as the foundation for effective tax administration. This is the first of two posts recapping the issues discussed at the conference.

Four panels were held on March 13: (1) The Framework and Justification for Taxpayer Rights; (2) Privacy and Transparency; (3) Protection of Taxpayer Rights in Multi-Jurisdictional Disputes; and (4) Access to Rights: the Right to Quality Service in an Era of Reduced Agency Budgets.

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Fast Track Settlement Now For SB/SE Taxpayers

by and | Mar 20, 2017 | , , , , ,

Today, the Internal Revenue Service (IRS) released Revenue Procedure 2017-25 extending the Fast Track Settlement (FTS) program to Small Business / Self Employed (SB/SE) taxpayers.  The IRS’s SB/SE group serves individuals filing Form 1040 (US Individual Income Tax Return), Schedules C, E, F or Form 2106 (Employee Business Expenses), and businesses with assets under $10 million.

FTS offers a customer-driven approach to resolving tax disputes at the earliest possible stage in the examination process. The program provides an independent IRS Appeals review of the dispute.  Under this approach, the IRS Appeals Officer acts as the mediator and has settlement authority.

The purpose of the program is to reduce the time to resolve cases and to provide the IRS Exam Team with the authority to settle cases based on hazards of litigation (which is generally reserved for IRS Appeals Officers).  FTS has been considered a great success by the IRS and many taxpayers.  The expansion of this successful alternative dispute resolution makes sense in light of the ever-shrinking resources of the IRS.



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IRS Opposes Granting of Certiorari in Cases Addressing Definition of Return

by and | Mar 16, 2017 | , , ,

Two petitions for certiorari pending before the Supreme Court of the United States ask the Court to resolve the question of whether a tax return filed after an assessment by the Internal Revenue Service (IRS) is a “return” for purposes of the Bankruptcy Code (BC). The answer to this question will determine whether a bankrupt taxpayer’s tax debts can be discharged or are permanently barred from discharge. According to these petitions, the courts of appeal are divided as to the answer.

BC § 523(a) generally allows a debtor to discharge unsecured debt, except for, inter alia, tax debts of debtors who: (1) failed to file tax returns; (2) filed fraudulent tax returns; or (3) filed late tax returns, where a bankruptcy petition is filed within two years of the date the late return was filed. See BC § 523(a)(1)(B)(i), (B)(ii), (C).

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Fourth Circuit Clarifies the Role of the Collection Due Process Hearing

by | Mar 10, 2017 | , , ,

In Iames v. Commissioner, No. 16-1154, the US Court of Appeals for the Fourth Circuit upheld the US Tax Court’s ruling that once a taxpayer has unsuccessfully challenged his tax liability in a preassessment hearing before the Internal Revenue Service (IRS) Office of Appeals, he is precluded from challenging his tax liability in a collection due process (CDP) hearing under Internal Revenue Code (IRC) Section 6330.

IRC Section 6330, enacted by Congress to protect taxpayers from abusive or arbitrary collection practices, provides a set of procedural safeguards for taxpayers facing a potential levy action by the IRS: notice, an administrative hearing and judicial review. More specifically, before collecting a delinquent tax through a levy on a taxpayer’s property, the IRS must notify the taxpayer at least thirty days in advance of his right to an administrative hearing before the IRS Office of Appeals. IRC Section 6330(a) and (b). After the Office of Appeals makes its determination, the taxpayer may then petition the Tax Court for judicial review. IRC Section 6330(d)(1).

In general, the taxpayer may raise “any relevant issue relating to the unpaid tax or the proposed levy” at the CDP hearing. IRC Section 6330(c)(2)(A). There are, however, certain restrictions as to the circumstances under which a taxpayer may bring a CDP challenge. Under IRC Section 6330(c)(2)(B), a taxpayer can dispute the existence or amount of the underlying tax liability but only so long as he “did not otherwise have an opportunity to dispute such tax liability.”

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IRS Campaign Focuses on Definition of “Qualified Film” Under Section 199

by and | Mar 9, 2017 | , ,

On January 31, the Internal Revenue Service (IRS) announced 13 Large Business & International (LB&I) “campaigns.”  One campaign targets deductions claimed by multi-channel video programming distributors (MVPDs) and TV broadcasters under section 199 of the Internal Revenue Code (IRC).  According to the IRS’s campaign announcement, these taxpayers make several erroneous claims, including that (1) groups of channels or programs constitute “qualified films” eligible for the section 199 domestic production activities deduction, and (2) MVPDs and TV broadcasters are producers of a qualified film when they distribute channels and subscription packages that include third-party content.

IRC section 199(a) provides for a deduction equal to 9 percent of the lesser of a taxpayer’s “qualified production activities income” (QPAI) for a taxable year and its taxable income for that year.  A taxpayer’s QPAI is the excess of its “domestic production gross receipts” (DPGR) over the sum of the cost of goods sold and other expenses, losses or deductions allocable to such receipts.  IRC section 199(c)(1).  DPGR includes gross receipts of the taxpayer which are derived from any lease, rental, license, sale, exchange, or other disposition of “any qualified film produced by the taxpayer.”  IRC section 199(c)(4)(A)(i)(II).  A “qualified film” is “any property described in section 168(f)(3) if not less than 50 percent of the total compensation relating to the production of such property is compensation for services performed in the United States by actors, production personnel, directors and producers.”  IRC section 199(c)(6).  However, “qualified film” does not include property with respect to which records are required to be maintained under 18 U.S.C. § 2257 (i.e., sexually explicit materials).  Id.  Under regulations issued in 2006, “qualified film” also includes “live or delayed television programming.”  Treas. Reg. § 1.199-3(k)(1); see also Notice 2005-14, 2005-1 C.B. 498, §§ 3.04(9)(a), 4.04(9)(a). “Qualified film” includes “any copyrights, trademarks, or other intangibles with respect to such film.”  IRC section 199(c)(6).  The “methods and means of distributing a qualified film” have no effect on the availability of the section 199 deduction.  Id.  IRC section 168(f)(3), entitled “Films and Video Tape,” provides an exclusion from accelerated depreciation for “[a]ny motion picture film or video tape.”

Though the January 31 announcement did not explain the IRS’s position on these issues in detail, the IRS rejected both claims in two Technical Advice Memoranda (TAMs) issued in late 2016.  The IRS determined in TAM 201646004 (Nov.10, 2016) and TAM 201647007 (Nov.18, 2016) (the 2016 TAMs) that a subscription package of multiple channels of video programming transmitted by an MVPD to its customers via signal is not a “qualified film” as defined in IRC section 199(c)(6) and Treas. Reg. § 1.199-3(k)(1).  It also determined that an MVPD’s gross receipts from its subscription package are not from the disposition of a qualified film produced by the MVPD and are therefore not DPRG included in calculating a section 199 deduction.  The MVPD would only have DPRG from the subscription package to the extent its gross receipts are derived from an individual film or episode within the subscription [...]

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