In its Annual Report to Congress, the Taxpayer Advocate Service (TAS) recently reported summons enforcement actions under Internal Revenue Code (Code) Sections 7602, 7604, and 7609 as one of the “Most Litigated Issues” this year. Below, we summarize the general law related to summons enforcements actions and the findings set forth in the Annual Report.
On January 10, 2017, the National Taxpayer Advocate Nina E. Olson released her 2016 Annual Report to Congress.
According to the Taxpayer Advocate Service (TAS), the report was delivered to Congress with no prior review by the Internal Revenue Service (IRS) Commissioner, the Secretary of the Treasury or the Office of Management and Budget. The primary sections of the report include:
Practice Point: TAS, an independent organization within the IRS, is an excellent (and often underutilized) resource for individual and corporate taxpayers who may be at a standstill with the IRS – especially on a technical, administrative, or “red-tape” issue. Taxpayers of all shapes and sizes should consider, where appropriate, utilizing the TAS in appropriate circumstances where they are encountering delays in the administration of their tax disputes.
This post is the first in a four-part series addressing highlights of the Annual Report that may be of interest to our readers.
In October 2015, final recommendations on Base Erosion and Profits Shifting (BEPS) were released, setting in motion epochal changes that will impact the global effective tax rate (ETR) of multinational enterprises (MNE) in the coming years.
Country-by-Country Reporting (CbCR) is the first, almost globally adopted output of the BEPS process currently facing MNEs. It raises some potentially far-reaching questions with respect to traditional operating models and supply chain structures, and also affects the future of cross-border dispute resolution. Harnessing the potential upsides and downsides of these and the other evolutions will be a driver of the future ETR of MNEs.
View the five-minute video below, in which McDermott lawyers discuss the implications of Country-by-Country Reporting for MNEs.
Adoption of the base erosion and profit shifting (BEPS) action items in specific countries can be expected to alter traditional multi-national enterprises (MNE) tax strategy processes. In this regard, it is appropriate to note that tax authorities and the Organization for Economic Co-operation and Development (OECD) often seem to overlook, or conveniently ignore, that MNE strategies are often a function of the rules established by countries to develop their own tax base (at the expense of other countries). In other words, countries, in their respective self-interests, grant incentives of various sorts to encourage economic investment. MNEs take advantage of these incentives to minimize their tax liabilities, which the BEPS process views as, somehow, inappropriate behavior of MNEs denuding the tax base of other countries.
Like water going downhill, MNE planning strategies will utilize the most efficient path to achieve desired objectives. This is a fiduciary duty to shareholders. Effective tax rates are a major expense of all MNEs, which need to be managed as effectively as possible in a competitive world. For example, if Country A offers an incentive such that MNE #1 makes an investment in Country A, as opposed to Country B which offers no such incentive, the net result is that jobs and economic activity are created in Country A not B. Country B may perceive that its tax has been eroded. But who has done this? Country A via its incentive or MNE #1?
International tax disputes arise when Country B challenges the activity of MNE #1 asserting that it should have been paying tax in Country B. If there is a treaty between Countries A and B, there could be a mutual agreement procedure (MAP) proceeding. If that proceeding stalls for whatever reason, then all parties would benefit from processes that would lead to resolution.
The transparency demanded by the Country-by-Country (CbC) package and related matters evolving on a unilateral country basis (seeking, once again, to attract tax base away from other countries) will create new opportunities and paradigms for MNE effective tax rate strategies. It may be that these evolutions will drive planning and acquisition strategies toward treaty or non-treaty protected corporate structures designed to: (i) take advantage of new opportunities created by the new regimes; and (ii) minimize transfer pricing exposures, imposition of exit or other taxes on the movement of intangibles or other assets, and so on. As these strategies evolve, the net result may not be an outcome that was anticipated by organizers of the BEPS project. This was certainly the case with respect to design of our current international tax system just after World War I.
These evolutions in the international tax world reflect, not surprisingly, what is evolving in the global political world. The popular press regularly addresses what is often described as globalism vs. populism, which reflects an apparent trend of voters and governments to focus less on the global good and more on local needs. The same phenomenon appears to be evolving in the world of cross-border [...]
Continue Reading
On January 9, 2017, the US Supreme Court denied the petitions for certiorari filed in two federal tax cases.
In Chemtech Royalty Assoc. LP v. United States, Sup. Ct. Dkt. No. 16-810 (2016), 823 F.3d 282 (5th Cir. 2016),
Dow Chemical Co. challenged the decisions by the US Court of Appeals for the Fifth Circuit finding that the partnerships were a “sham” that should be disregarded for tax purposes and imposing the 40 percent substantial understatement penalty. In its petition, Dow complained of the “especially stringent” scrutiny applied by the Fifth Circuit to review a taxpayer’s decision to use the partnership form. “Applying that improper presumption against partnerships, the court became the first court in the nearly seventy years since Culbertson [337 US 733 (1949)] to hold that an investor that contributes its own capital in exchange for an equity interest in the partnership can be disregarded for tax purposes if its equity stake, like preferred stock, is relatively protected against fluctuations in profits and losses.”
The US Supreme Court also denied the petition filed by Dynamo Holdings Ltd. Partnership, Dynamo Holdings Limited Partnership v. United States, Sup. Ct. Dkt. No. 16-358 (2016) 816 F.3d 1310 (11th Cir. 2016),seeking review of an Eleventh Circuit decision that upheld the enforcement of IRS summonses. Dynamo asked the Supreme Court to consider whether it was unfairly denied a request to amend the case submission to support an evidentiary hearing under then new standard established by this Court in an earlier appearance of this case. Dynamo complained that “this Court held for the first time, United States v. Clarke, 573 US ___, 134 S. Ct. 2361 (2014), that an individual or entity that receives an IRS summons is entitled to a limited evidentiary hearing to obtain discovery to support the claim that the summons should be quashed where that party points to specific facts or circumstances plausibly raising an inference of bad faith.” In contrast, “[W]hen this case began in 2011, the standard in the Eleventh Circuit was that an individual or entity was entitled to an evidentiary hearing based upon the mere allegation of improper purpose . . . [and Dynamo was found by] the Eleventh Circuit to have satisfied that standard. On remand from Clarke, the district court denied Petitioners request to make amended submissions to meet the new standard, and the district court and Eleventh Circuit ruled that Petitioners’ former submissions did not meet the new standard.”
Practice Tip:
In deciding whether to file a petition for certiorari, the party should consider the likelihood of the petition being granted and whether the Court’s denial of the petition will result in an adverse negative inference for a continuing issue that is being litigated in other jurisdictions. These cases illustrate how difficult it is to have the Supreme Court grant review. The Supreme Court accepts few petitions each year and in the absence of a split in the circuits, a petition is unlikely to succeed [...]
Continue Reading
William J. Wilkins has tendered his resignation as Chief Counsel effective as of noon on January 20, 2017. Mr. Wilkins was nominated by President Obama to replace Donald L. Korb, who resigned from the position in late 2008. Mr. Wilkins was confirmed by the Senate to serve as Chief Counsel in July 2009. Prior to becoming Chief Counsel, Mr. Wilkins was a partner with WilmerHale and previously worked for the United States Senate Committee on Finance and as an associate at King & Spalding. He previously served as Chair of the Section of Taxation of the American Bar Association. William M. Paul has been named as Acting Chief Counsel.
The Chief Counsel is appointed by the President of the United States with the advice and consent of the United States Senate. The Chief Counsel is the chief legal advisor to the Commissioner of Internal Revenue on all matters pertaining to the interpretation, administration and enforcement of the Internal Revenue Laws and provides legal guidance and interpretive advice to the Internal Revenue Service, Treasury and taxpayers.
On January 4, 2017, the Internal Revenue Service (IRS) released a new “International Practice Unit” (IPU) on the value of intangibles in IRC Section 367(d) transactions in conjunction with cost sharing arrangements (CSA). See IPU here. The IPU notes that transferring highly valuable intangibles offshore has become a routine tax strategy for reducing a company’s effective tax rate for financial statement and tax purposes.
Typically, questions concerning the value of intangibles arise where a US taxpayer enters into a CSA with a controlled foreign corporation (CFC) in a low or no tax jurisdiction, and contributes resources, rights and capabilities (which may include IRC Section 936(h)(3)(B) intangibles) to the CSA. An arm’s length payment to the US taxpayer is then required for the contribution. Simultaneously with, or shortly before entering into a CSA, the US taxpayer transfers certain intangible property to the CFC in an IRC Section 351 or 361 transaction, which is taxable under IRC Section 367(d). Again, there is an arm’s length charge for the use of that intangible property.
Oftentimes in these transactions, the US taxpayer values the intangibles transferred in the IRC Section 367(d) transfer separately from the platform contributions, even though, the IRS says, the intangibles conveyed in both transactions will be exploited on a combined basis. Based on the aggregation principles in the IRC Section 482 regulations, the IPU warns that a non-aggregate approach may not provide an arm’s length result. Moreover, despite taxpayer arguments to the contrary, the IPU maintains that the scope of intangible property for purposes of IRC Section 367(d) is just as broad as the scope of platform contributions.
Practice Point: The IPU is a good source of information of what the IRS’s examination division will consider when auditing an outbound transfer of intangible rights for use in a CSA. If you have or intend to engage in such a transaction, you should study the IPU to ensure that you have adequately documented the arm’s length payments for the transfer.
On January 6, 2017, the US Court of Appeals for the Fourth Circuit, by published opinion, affirmed the US Tax Court’s (Tax Court) earlier ruling in QinetiQ US Holdings, Inc. v. Commissioner. We previously wrote about the case here, here, and here. To refresh, the taxpayer had argued in Tax Court that the Notice of Deficiency issued by the Internal Revenue Service (IRS), which contained a one-sentence reason for the deficiency determination, violated the Administrative Procedure Act (APA) because it was “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” The APA provides a general rule that a reviewing court that is subject to the APA must hold unlawful and set aside an agency action unwarranted by the facts to the extent the facts are subject to trial de novo by the reviewing court. The Tax Court disagreed, emphasizing that it was well settled that the court is not subject to the APA and holding that the Notice of Deficiency adequately notified the taxpayer that a deficiency had been determined under relevant case law. The taxpayer appealed to the Fourth Circuit.
In an opinion written by Circuit Judge Barbara Keenan, the court concluded that the IRS complied with all applicable procedural requirements. The court reasoned that the Internal Revenue Code (Code) provided a unique system for judicial review that should govern the content requirements for a Notice of Deficiency. Per the court, it “is that specific body of law, rather than the more general provisions for judicial review authorized by the APA, that governs the content requirements of a Notice of Deficiency.” The court cited a Fourth Circuit opinion from 1959, in which it held that the Code’s provisions for de novo review are incompatible with limited judicial review of final agency actions allowed under the APA.
The court held that the APA’s requirement of a reasoned explanation in support of a “final” agency action does not apply to a Notice of Deficiency issued by the IRS. A Notice of Deficiency, the Court reasoned, cannot be a “final” agency action within the meaning of the APA, because the agency action is not one “by which rights or obligations have been determined, or from which legal consequences will flow.” After issuing a Notice of Deficiency, the IRS may later assert in Tax Court new theories and allege additional deficiencies. Moreover, a taxpayer may also raise new matters in Tax Court. In addition, the court cited to the Supreme Court’s 1988 opinion in Bowen v. Massachusetts, emphasizing that Congress did not intend for the APA “to duplicate the previously established special statutory procedures relating to specific agencies.”
The court also held that the Notice of Deficiency issued to QinetiQ satisfied the requirement of Code section 7522(a), which requires that the IRS “describe [in the Notice] the basis for, and identify the amounts (if any) of, the tax due, interest, additional amounts, additions [...]
Continue Reading
This year has been marked with substantial changes in the manner in which the Internal Revenue Service (IRS) operates. Shrinking resources and retiring IRS professionals have marred the IRS and its efficiency. The pervasive theme for 2016 was trying to do the job with fewer resources. For example, IRS audits continue to devolve with standardized information document requests (IDRs), international practice unit guides and issue-focused examinations (mostly focused on international tax issues). We say “goodbye” to old friends [au revoir Compliance Assurance Process (CAP) Program] and hello to new rules (e.g., partnership entity audit rules and adjustments). And we have born witness to the slow evisceration of the independence of IRS Office of Appeals.
As we turn the corner to a new year, we expect the IRS’s war on taxpayers to manifest itself in “campaign” after “campaign,” reminiscent of the tiered issue system of days gone by. We expect coordination on a national level to reside with IRS “issue specialists” controlling and dictating audits and appeals, which will increasingly challenge the efficiency of pre-litigation resolution techniques. The end result of these contractions may very likely be an increase in tax litigation as frustration with the administrative process boils over. But the wild card, of course, is what changes will be ushered in by the new administration. Will it be business as usual, or will we see a complete overhaul of the system? Only time will tell, as we wait with bated breath for the ball to drop. (more…)
Several notable court opinions were issued 2016 dealing with a variety of substantive and procedural matters. In our previous post – Tax Controversy 360 Year in Review: Court Procedure and Privilege – we discussed some of these matters. This post addresses some additional cases decided by the court during the year and highlights some other cases still in the pipeline.
Subscribe
