volume 100, number 3 october 19, 2020

Volume 100, Number 3 � October 19, 2020

For more Tax Notes® International content, please visit www.taxnotes.com.

© 2020 Tax Analysts. All rights reserved. Tax Analysts does not claim

copyright in any public domain or third party content.

The Tax Notes team is proud to unveil Document Comparison, now available while

viewing a Treasury decision.

Create a redline showing final regs versus proposed regs with one click. View the

original document and the redline version side-by-side, download the redline in PDF or

HTML format, easily search within both the proposed and redline regs simultaneously,

and quickly find the information you need using our table of contents.

Look for the Compare icon at the top of a Treasury decision to try out Document

Comparison today!

taxnotes.com/compare

The Answers You Need. Now.For more Tax Notes® International content, please visit www.taxnotes.com.



TAX NOTES INTERNATIONAL, VOLUME 100, OCTOBER 19, 2020 329

Volume 100 Number 3tax notes international®

CONTENTS

331 FROM THE EDITOR

HIGHLIGHTS

333 Proposed Regs Modify Effective Foreign Tax Rate Calculationby Carrie Brandon Elliot

339 Proposed FTC Regs: More Politics, Less Principleby Mindy Herzfeld

COMMENTARY & ANALYSIS

349 U.S. Tax Reviewby James P. Fuller and Larissa Neumann

373 Stop BEATing Up Your Brother-Sister, Part 2by Corey M. Goodman and Lorenz F. Haselberger

393 Emerging From Crisis: The Changing EU VAT Landscapeby Aleksandra Bal

401 Uncertainty Regarding Transfer Pricing And Country-by-Country Reporting In Nigeriaby Gali Aka

LETTER FROM EUROPE

405 Democracy in Chaos: Where Will the Election Train Stop?by Frans Vanistendael

CURRENT & QUOTABLE

411 Taxation of SMEs to Support Economic Recovery Post-COVID-19by Elizabeth Allen and David Child

FOR THE LOVE OF TAX

419 Walking a Unique Path: A Conversation With Miller & Chevalier’s Loren Pondsby Nana Ama Sarfo

COUNTRY DIGEST

Australia

423 Australian Parliament Approves Budget Tax Measures in 3 Days

Canada

424 Some CRA Audits Might Be Abandoned In Pandemic’s Wake

425 Expat’s Ties to Canada Sufficient For Taxation, Court Finds

European Union

426 EU Hopes for Quick Agreement On DAC7, Prepares DAC8

427 EU Will Respect New OECD Deadline For Reaching Global Tax Deal

429 Progressive Turnover Taxes Valid Under State Aid Rules, AG Says

Ireland

430 Digital Tax Discussions Feature In Ireland’s 2021 Budget Speech

Multinational

432 U.N. Releases Proposed Treaty Article On Digital Services Taxes

433 G-20 Ministers Greenlight New Deadline For OECD Global Tax Accord

Netherlands

435 Dutch Exit Tax Proposal Moving Forward Despite Legal Concerns

ON THE COVER

344 OECD Now Aiming for Global Corporate Tax Reform Deal By Mid-2021by Stephanie Soong Johnston

Cover photo: [email protected]




CONTENTS

330 TAX NOTES INTERNATIONAL, VOLUME 100, OCTOBER 19, 2020

Spain

436 Spanish Cabinet Proposes Cryptocurrency Control, Tax Amnesty Ban

United Kingdom

437 Amazon’s Direct Sales Not Subject To U.K. Digital Services Tax

438 U.K. Furlough Scheme to Support Businesses Forced to Close

439 U.K. Tax Review Should Focus On Reliefs, OECD Says

United States

441 Public Partnerships and Private Equity Lament Withholding Rules

444 Review of BEAT Waiver Regs Halved Affected Taxpayer Estimate

445 BEAT Waiver Language on Applicable Taxpayer Is About Flexibility

447 New Disregarded Payment Rules ‘Less Wrong,’ Practitioner Says

448 EU Lacks Basis to Impose Tariffs In Boeing Dispute, USTR Says

451 TAX CALENDAR

THE LAST WORD

455 Splendid Isolation: Boris Johnson Pivots Toward a No-Deal Brexitby Robert Goulder





tax notes international®

FROM THE EDITOR

The Best-Laid Plans . . .

In 2020 we’ve all learned to deal with having our plans postponed, canceled, or stripped down to bare bones because of the coronavirus pandemic. The OECD is no different. For most of the year, officials insisted that an agreement on a global corporate tax reform plan would be reached this year. Reality finally hit home last week: The OECD announced that it is now targeting mid-2021 for agreement on its global fix for the digital age (p. 344).

The OECD published the blueprints for its two-pillar proposal on October 12, shortly after the 137-member inclusive framework approved them for release. The blueprints largely follow up on previous drafts with clarifications and enhanced details on the pillars’ main components. Adding a sense of urgency to the proceedings, OECD tax chief Pascal Saint-Amans warned that $100 billion in lost revenue could be at stake if countries fail to agree on a multilateral solution. Ever the optimist, Saint-Amans said he believes that the political will exists to rebuild the international tax system.

Political will and patience will be required to fix the dysfunctional EU VAT rules. The European Commission has embarked on a long-term plan to reform the entire VAT system. The plan includes 25 initiatives to address administrative complexity, rising compliance costs, high levels of fraud, and a host of other ills. Aleksandra Bal examines the proposed reforms — with the caveat that unanimity of member states is still required to pass tax legislation in the EU (p. 393).

And what will it take to “get Brexit done”? Well, first you need to understand the importance of fish in the U.K.’s failed negotiations for a free trade agreement with the EU. Robert Goulder explains that and more in his look at Brexit developments and the growing likelihood of a no-deal outcome (p. 455).

Mindy Herzfeld looks at the political messaging behind the proposed U.S. foreign tax credit regs (p. 339).

Atlas [email protected]






Website:

Copyright 2020, Tax AnalystsISSN 1048-3306 (Print)ISSN 2688-6480 (Online)

www.taxnotes.com

President and CEO:

Chief Content Officer:

Executive Editor, Commentary:

Executive Editor, News:

Cara Griffith

Jeremy Scott

Jasper Smith

Chuck O’Toole

Editor in Chief:

Deputy Editor:

Legal Editors:

Managing Editor:

Associate Editor:

Contributing Editor:

Chief Economist:

Contributing Editors:

Editor in Chief, Acquisitions & Engagement:

Acquisitions Staff:

Tax Notes Today International Editor in Chief:

News Editors:

Editorial Assistant:

Chief Correspondents:

Reporters:

Copy Chief:

Editorial Staff:

Production Director:

Production Manager:

Production Staff:

Graphic Designer/Photographer:

Cathleen Phillips

Randall Jackson

Laura Breech, Cheryl Burns

Doug Smith

Justyna Pekalak

Lee A. Sheppard

Martin A. Sullivan

Carrie Brandon Elliot, Robert Goulder, Nana Ama Sarfo

Faye McCray

Paige Jones, Jordan Parrish, Allison Turner, Nicole Wilder

David D. Stewart

Herman P. Ayayo, Cindy Heyd, Grant Hilderbrandt, Amy Kendall

Megan Urbach

Amanda Athanasiou, Stephanie Soong Johnston

Annagabriella Colón, Ryan M. Finley, William Hoke, Sarah Paez, Kiarra M. Strocko, Andrew Velarde

Betsy Sherman

Craig Dubyk, Richard Farrell, Emily Hollingsworth, Sarah Karney, Cera Lee, Katherine Pulliam, Kristen Rethy, Fran Slimmer, Tara Taghizadeh

Stephanie Wynn

Paul Doster

Gary Aquino, José Carrasquillo, Isabel Church, Nikki Ebert, Jack Frost, Alice Haar, Mary Ann Johnson, Donna Katac, Soledad Olivera, William Patterson, Tyler Prest,Nayareh Rooholamini, Faith Smalls, Michelle Smith, Dieter Stach, Steve Torregrossa, Brianna Woodfork

Derek Squires

Correspondence:

Frequency:

Form of Citation:

Regarding editorial matters and submissions, please contact the Editor in Chief at: Tax Notes International, 400 S. Maple Ave., Suite 400, Falls Church, VA 22046 USA, or email [email protected].

Tax Notes International is published 51 weeks of the year by Tax Analysts.

Articles appearing in Tax Notes International may be cited by reference to the date of the publication and page, thus: Tax Notes Int’l, Jan. 22, 2018, p. 281.

Customer Service: Toll-Free: (800) 955-2444 Canada: (800) 955-3444U.S.: (703) 533-4400* *Within the continental U.S.

www.taxnotes.com/support

© Tax Analysts 2020. All rights reserved. Users are permitted to reproduce small portions of this work for purposes of criticism, comment, news reporting, teaching, scholarship, and

research only. Any use of these materials shall contain this copyright notice. We provide our publications for informational purposes, and not as legal advice. Although we believe that our

information is accurate, each user must exercise professional judgment, or involve a professional to provide such judgment, when using these materials and assumes the responsibility and

risk of use. As an objective, nonpartisan publisher of tax information, analysis, and commentary, we use both our own and outside authors, and the views of such writers do not necessarily

reflect our opinion on various topics.






HIGHLIGHTS

NEWS ANALYSIS

Proposed Regs Modify Effective Foreign Tax Rate Calculationby Carrie Brandon Elliot

Final regs issued in July under section 951A contain guidance on how to make an election to apply the section 954(b)(4) high-tax exception to global intangible low-taxed income. Proposed regs issued the same day under section 954 generally conform the subpart F high-tax election to the GILTI high-tax election.

They also modify the GILTI final regs by adding income groupings and changing deduction allocation and apportionment rules when calculating the effective foreign tax rate (EFTR). The new proposed section 954 regs call for withdrawal of the new section 951A regs when the proposed regs are finalized.

The GILTI high-tax election rules and examples are in final reg. section 1.951A-2(c)(7) and (8), while the GILTI and subpart F integrated rules and examples are in prop. reg. 1.954-1(d)(1)-(9).

The GILTI final regs (T.D. 9902) are the subject of four previous articles that focused on the tested unit concept, disregarded payments, interest expense deductions, and timing and manner of electing the high-tax exclusion. (Prior coverage: Tax Notes Int’l, Sept. 14, 2020, p. 1421; Tax Notes Int’l, Sept. 21, 2020, p. 1541; Tax Notes Int’l, Sept. 28, 2020, p. 1673; and Tax Notes Int’l, Oct. 5, 2020, p. 7.)

The new proposed regs (REG-127732-19) contain guidance on the treatment of income subject to a high rate of foreign tax under the subpart F income and GILTI regimes. Historically, reg. section 1.954-1(d) has implemented the section 954(b)(4) subpart F high-tax exception; and the new proposed regs relating to the high-tax exception for both regimes are in new prop. reg. 1.954-1(d).

Section 954(b)(4) allows the exclusion of a controlled foreign corporation’s high-tax income items from foreign base company income (FBCI)

and insurance income, or subpart F income. The subpart F high-tax exception is generally governed by regs originally issued in 1988 and updated in 1995. As part of the Tax Cuts and Jobs Act, Congress enacted the section 951A GILTI regime, incorporating the section 954(b)(4) high-tax exception.

Subpart F high-tax regs and the new GILTI final regs each contain guidance for high-tax income that would otherwise be included in subpart F or tested income, but these rules do not conform to each other. The proposed regs integrate these two high-tax exclusions and provide a single election to exclude high-tax income under section 954(b)(4) for both GILTI and subpart F purposes.

The new proposed regs carry over GILTI high-tax provisions to subpart F income, but also modify some of the new GILTI provisions. The proposed regs:

• provide a single high-tax election for both subpart F and GILTI;

• include the GILTI regs’ CFC group rules in lieu of a separate election for each CFC;

• require that the GILTI regs’ determination of whether income is high tax be made on a tested unit basis;

• simplify the EFTR determination with new rules grouping together some income that would otherwise be subpart F and tested income;

• introduce a new method for allocating and apportioning deductions to gross income;

• include the GILTI regs’ per country tested unit combination rule and introduce a new de minimis tested unit combination rule;

• introduce a new antiabuse rule;• replace the GILTI regs’ reference to books

and records with a new reference to applicable financial statements and add substantiation requirements; and

• introduce new coordination rules and modify full inclusion rules.

This article is the first in a series addressing how the new proposed regs change the high-tax




HIGHLIGHTS


election rules for both GILTI and subpart F income. It will focus on the new income groupings and the new deduction allocation and apportionment rules that modify how the GILTI regs calculate the EFTR inputs.

Prop. reg. section 1.954-1(d)(1)(i) provides the general rule warranting the guidance in paragraphs (2)-(9). It is conceptually identical to the GILTI final regs, although it replaces “tentative tested gross income” in the GILTI regs with “item of gross income” and “tentative tested income” with “tentative net item.” A CFC’s inclusion year item of gross income qualifies for the high-tax exception described in section 954(b)(4) only if two requirements are met:

• a CFC election to apply the high-tax exception must be in effect in the CFC inclusion year; and

• the tentative net item related to the item of gross income must be subject to an effective rate of foreign tax that is greater than 90 percent of the section 11 maximum tax rate (18.9 percent, or 90 percent of 21 percent).

High-Tax Income Exception

Section 952(a)(2) defines subpart F income to include FBCI as defined in section 954. Section 954(b)(4) and 951A provide an exception to FBCI and tested income for some income subject to high foreign taxes, and these provisions are restated in reg. section 1.954-1(d) — that is, FBCI and tested income do not include a CFC’s income if the income was subject to an effective rate of foreign income tax greater than 90 percent of the maximum rate of tax specified in section 11.

The rules for determining whether the high-tax exception applies to CFC income consist of a seven-step calculation in reg. section 1.954-1(d):

• calculate items of gross income (instead of tentative gross tested income items);

• assign expenses other than foreign income tax to items of gross income;

• assign foreign income tax expenses to items of gross income;

• determine tentative net items (instead of tentative tested income);

• calculate foreign income tax paid or accrued on tentative net items;

• calculate the EFTR for each tentative net item; and

• compare the EFTR with the 18.9 percent threshold to determine whether each item of gross income qualifies for the high-tax exception.

The EFTR equals the U.S. dollar amount of foreign income tax related to the tentative net item divided by the sum of the tentative net item and the foreign tax.

Income Groupings

In defining an item of gross income, the new proposed regs introduce three new income groupings in section 1.954-1(d)(1)(ii). An item of gross income is defined as one of three possibilities in prop. reg. section 1.953-1(d)(1)(ii)(A)-(C):

• a general gross item;• an equity gross item; or• a passive gross item.

The first possibility, a general gross item, is the aggregate amount of all gross income without regard to items in section 952(c)(2) (income recharacterized as subpart F income) that is attributable to a single tested unit and has four characteristics:

• it is in a single separate section 904 foreign tax credit limitation category;

• it is not an equity gross item;• it is not passive foreign personal holding

company income; and• it is of a type that would be treated as gross

tested income, gross FBCI, or gross insurance income without regard to the high-tax exception.

The second possibility, an equity gross item, is the sum of general gross items (without regard to the above second characteristic) that has one of two characteristics:

• it is income or gain arising from stock; or• it is income or gain arising from interests in

passthrough entities.

Income or gain arising from stock consists of dividends, income from dispositions of stock, and similar items earned by a tested unit and subject to preferential tax treatment under the tax law of the tested unit’s residence country. Preferential tax treatment does not include FTCs. Equity gross income does not include gain from stock dispositions if the stock would be dealer property.




HIGHLIGHTS


Income or gain arising from interests in passthrough entities is gain from the disposition of, or a distribution related to, an interest in a passthrough entity (including a disregarded entity) attributable to a tested unit and subject to preferential tax treatment under the tax laws of the tested unit’s tax residence. Again, preferential tax treatment does not include FTCs.

The third possibility, a passive gross income item, is the sum of general gross items (without regard to the third characteristic) that constitutes a single item of passive foreign personal holding company income described in prop. reg. section 1.954-1(c)(1)(iii)(B).

Under prop. reg. section 1.954-1(d)(1)(iii)(A), a CFC’s gross income is attributable to a tested unit to the extent that it is reflected (as modified for disregarded payment adjustments) on the tested unit’s applicable financial statement (not separate books and records as in the GILTI regs). All CFC gross income is attributable to only one tested unit.

The principles of reg. section 1.904-4(f)(2)(vi) apply to adjust a tested unit’s gross income to reflect disregarded payments taking into account the rules in prop. reg. section 1.954-1(d)(1)(iii)(B)(1)-(5). These rules basically mirror the disregarded payment rules in the GILTI high-tax exception final regs.

Rationale

Under reg. section 1.954-1(d), the EFTR is determined on the basis of a CFC’s net FBCI. Single items of income to be tested for high-tax exception eligibility are aggregated. For example, the aggregate amount of a CFC’s income from dividends, interest, rents, royalties, and some annuities constitute a single item of income.

In contrast, the GILTI final regs determine EFTR by aggregating gross income that would be gross tested income within a separate category to the extent attributable to a CFC’s tested unit. The tentative tested income items and foreign taxes of multiple tested units that are tax residents of or located in the same foreign country generally are aggregated.

Applying these rules on a tested unit basis ensures that high-tax and low-tax income items are not inappropriately aggregated to determine the EFTR, while still allowing some level of

aggregation to minimize complexity. Also, measuring the EFTR on a tested unit basis reflects the likelihood that CFCs will earn more high-tax income given the TCJA’s reduction of corporate federal income tax rates.

The proposed regs calculate the EFTR for both the GILTI exclusion and the subpart F exception on a tested unit basis. The proposed regs also group general-category income items that would otherwise be tested income, FBCI, or insurance income. By grouping these income items, taxpayers avoid the complex analysis required to determine whether income would meet the definition of subpart F income. For example, taxpayers will not be required to determine whether income is foreign-based company sales income versus tested income if the high-tax exception applies.

The proposed regs generally group foreign personal holding company income in the same manner as the existing regs. Future regs may propose conforming changes to the income grouping rules in reg. section 1.904-4(c) and request comments.

Income and deductions attributable to equity transactions are also separately grouped if the income is subject to preferential tax treatment in the tested unit’s tax-resident country. The purpose of this grouping is to separately test for high-tax eligibility income that is subject to foreign tax at a different rate than other general-category income and that is susceptible to timing manipulation.

Under current subpart F regs, EFTRs are determined separately for several different income categories, requiring taxpayers to classify their income items into these categories when making a high-tax election. Moreover, the GILTI final regs require taxpayers to determine whether their income would otherwise qualify as tested income. Both processes require complex factual analysis. The proposed regs, however, modify the income categories to simplify the EFTR determination.

The proposed regs group together income that would otherwise qualify as subpart F or tested income to determine if it is high tax and eligible for the exception. This grouping of income types may eliminate the need for taxpayers to determine to which category an income item belongs. For example, under current regs, the




HIGHLIGHTS


taxpayer may need to determine whether income is foreign base company sales income or tested income. Under the proposed regs, taxpayers can avoid this analysis because the income would fall into the new broader category that includes both foreign base company sales income and tested income.

The proposed regs will also decrease incentives for taxpayers to organize their operations solely to ensure that income will fall into a specific category. For example, taxpayers may have an incentive to generate sales rather than services income to raise or lower the EFTR in those FBCI categories. By manipulating the EFTR of income categories, taxpayers could maximize their tax savings from the high-tax exception. Under the proposed regs, these incentives are diminished since income items are grouped into broader categories.

Deduction Allocation and Apportionment

Reg. section 1.954-1(d)(1)(iv)(A)-(D) contain rules for deduction allocation and apportionment. In general, a tentative net item is an item of gross income in one of the three above groupings determined by allocating and apportioning deductions to items of gross income under principles of reg. section 1.960-1(d)(3). Each item of gross income is treated as gross income in a separate income group, and all other income is treated as assigned to a residual income group.

Deductions (other than taxes) are attributable to a tested unit if they are reflected on its applicable financial statement. In applying the principles of reg. section 1.960-1(d)(3), deductions attributable to a tested unit are allocated and apportioned based on the income and activities related to the expense, but only reduce items of gross income attributable to the same tested unit (including income attributed to the tested unit because of disregarded payments and regardless of whether the tested unit has gross income in the relevant income group during the CFC inclusion year).

In applying reg. section 1.861-9 and -9T, interest deductions attributed to a tested unit are allocated and apportioned only on the basis of the income or assets of that tested unit. No interest deductions attributable to the tested unit are allocated or apportioned to the assets or gross

income of another tested unit, or of a corporation owned by the CFC indirectly through the tested unit.

If a tested unit has a loss or deduction (including for taxes) on a transaction involving stock or an interest in a passthrough entity, and income or gain would have been an equity gross item, the deduction or loss is allocated and apportioned solely to the item of gross income relating to the tested unit, regardless of whether there is any gross income included in that item during the CFC inclusion year.

The proposed regs contain guidance on the effect of a potential or actual change in taxes paid or accrued. The amount of current-year tax paid in relation to an item of gross income generally does not take into account any potential reduction in foreign income tax that may occur because of a future distribution to shareholders of all or part of the income. However, to the extent the CFC’s foreign taxes are reasonably certain to be returned to a shareholder by the foreign country on a subsequent distribution to the shareholder, the foreign taxes are not treated as paid or accrued under prop. reg. section 1.954-1(d)(1)(iv) or 1.954-1(d)(5).

Foreign income taxes that have not been paid or accrued because they are contingent on a future distribution of earnings are also not taken into account. If a redetermination of U.S. tax liability is required to account for the effects of a foreign tax redetermination, reg. section 1.954-1(d)(1)(iv) and (5) are then applied in the adjusted year taking into account the adjusted amount of the redetermined foreign tax.

Reg. section 1.954-1(d)(1)(v) addresses portfolio interest and treatment of some income under the FTC rules. Portfolio interest as defined in section 881(c) does not qualify for the high-tax exception under section 954(b)(4).

For FTC treatment of distributions of passive income that were excluded from FBCI, insurance income or tested income under section 954(b)(4), taxpayers are directed to section 904(d)(3)(E) and reg. section 1.904-4(c)(7)(iii). These rules address FTC treatment of dividends paid out of otherwise passive income that qualified for the high-tax exception, including distributions that cause decreases in foreign tax.




HIGHLIGHTS


Reg. section 1.954-1(d)(5) addresses foreign income taxes paid or accrued on a tentative net item. This is the amount of the CFC’s current-year taxes allocated and apportioned to the related item of gross income.

Rationale

The TCJA is silent on how to allocate and apportion deductions to gross income for high-tax exception purposes, even though this can affect a tested unit’s EFTR.

Under the final GILTI regs, deductions are allocated and apportioned among separate items of a CFC’s gross income even if the deductions are reflected on the books and records of only one tested unit and are likely only taken into account to compute foreign taxable income for foreign tax purposes in that tested unit’s foreign jurisdiction.

Again, the final GILTI regs use items on the books and records as the starting point for determining gross income attributable to a tested unit. Those regs do not, however, use books and records to allocate and apportion deductions to gross income. Instead, the final regs apply the general allocation and apportionment rules to convert tentative gross tested income items into tentative tested income items.

In other words, deductions are generally allocated and apportioned under the principles of reg. section 1.960-1(d)(3) by treating each tentative gross income item as income in a separate tested income group as defined in reg. section 1.960-1(d)(2)(ii)(C). Under those principles, some deductions (like interest expense) are allocated and apportioned among a CFC’s gross income items based on a specific factor like assets or gross income. The result is that deductions on a single tested unit’s books and records used to compute foreign taxable income may not be the same as those used to determine a tentative tested income item for GILTI high-tax exception purposes.

This result is illustrated by an example in the proposed regs’ preamble. It assumes that a CFC’s only activity is owning interests in TU1 and TU2, two foreign disregarded entities that are both tested units. An equal amount of gross income is attributed to TU1 and TU2. TU1’s and TU2’s income is subject to 30 percent and 15 percent foreign income tax rates, respectively.

TU1 accrues deductible interest expense paid to a third party that is allocated and apportioned to the CFC’s gross income using the modified gross income method in reg. section 1.861-9T(j)(1). This causes interest expense incurred by TU1 to be allocated and apportioned equally between TU1 and TU2 for GILTI high-tax exclusion purposes.

The foreign countries in which TU1 and TU2 are tax resident, however, only allow deductions of interest expense to resident entities that accrue the expense. Therefore, TU1’s residence country allows a deduction for all of the interest expense, while TU2’s residence country does not allow a deduction for any of it. Under the final GILTI regs, the allocation of interest expense for U.S. tax purposes may cause TU1’s gross income to not qualify for the GILTI high-tax exception while causing TU2’s gross income to qualify, even though the tax rate in TU1’s country is higher.

The policy goal of section 954(b)(4) is to identify income subject to a high EFTR. It is better served if the EFTR is determined by reference to income that approximates taxable income as computed for foreign tax purposes rather than U.S. tax purposes. The use of U.S. instead of foreign tax rules to determine the amount and timing of items included in the high-tax exception calculation remains appropriate to ensure that the calculation is not distorted by foreign tax rules that do not conform to U.S. tax principles.

Therefore, the proposed regs generally determine tentative net items by allocating and apportioning deductions to items of gross income under U.S. tax principles to the extent the deductions are reflected on the tested unit’s applicable financial statement. This is consistent with the manner in which gross income is attributed to the tested unit. A tentative net item better approximates the foreign tax base under this method than the allocation and apportionment rules in the section 861 regs.

The proposed regs allocate and apportion deductions to the extent reflected on the appliable financial statement only for section 954(b)(4) high-tax exception purposes and not any other purpose (like determining a CFC’s U.S. taxable income for subpart F or GILTI purposes, or determining its FTCs under section 960). The section 954(b)(4) rules are intended to approximate the foreign tax




HIGHLIGHTS


base, while the subpart F, GILTI, and FTC calculations continue to use the deduction allocation and apportionment rules in the section 861 regs.

Treasury and the IRS are considering whether it would be appropriate in limited cases to allocate and apportion a CFC’s deductions based on the contents of its applicable financial statement, and request comments in this regard. For example, a rule could allocate and apportion deductions (other than foreign tax expense) only up to the amount of a tested unit’s items of gross income and allocate and apportion deductions in excess of that to all of the CFC’s gross income.

Moreover, applying a method based on financial statements to calculate the high-tax exception could affect the allocation and apportionment of deductions to determine the amount of an inclusion related to a CFC’s gross income that is not eligible for the high-tax exception. One approach that addresses this is to provide that deductions allocated and apportioned to an item of gross income based on a financial statement to calculate a tentative net item under the high-tax exception cannot be allocated and apportioned to a different item of gross income that does not qualify for the exception for purposes of calculating a subpart F or GILTI inclusion.

These approaches would be limited changes to the traditional rules for allocating and apportioning deductions. They are intended to address concerns that deductions not allocated and apportioned using a consistent method when the high-tax exception has been elected could be viewed as being double counted. The deductions would reduce tentative net income for purposes of determining eligibility for the high-tax exception, and also reduce the amount of a U.S. shareholder’s subpart F or GILTI inclusions related to a different item of gross income. Comments are requested on this issue.

Examples

Prop. reg. section 1.954-1(d)(9) has six examples, while the GILTI final regs have five examples. The common facts for the examples are identical. The differences in the examples include use of applicable financial statements instead of books and records, item of gross income instead

of tentative gross tested income, and tentative net income instead of tentative tested income. Also, the conclusions in the examples speak to the status of the CFCs’ income as FBCI and tested income when comparing the EFTR to the high-tax threshold.

Examples 1 and 2 of the proposed regs address the effect of disregarded interest and the effect of disregarded payments for services, respectively. These illustrate the same concepts as examples 1 and 2 of the GILTI final regs.

Example 3 of the proposed regs addresses application of the tested unit rules and illustrates the same concepts as Example 4 in the GILTI final regs. Similarly, Example 5 in the proposed regs addresses the CFC group rules and mirrors Example 5 in the final GILTI regs.

Examples 4 and 6 of the proposed regs address application of a new de minimis combination rule and a new antiabuse rule, and there is therefore no equivalent in the final GILTI regs. These provisions will be addressed in a future article.

The proposed regs contain no equivalent of Example 3 in the final GILTI regs, which covers interest expense allocated and apportioned to income of a lower-tier CFC. This is because allocation and apportionment of interest expense under the section 861 regs for high-tax purposes was modified in the proposed regs, which offer a closer alignment of income and deductions with the contents of financial statements and therefore the foreign tax base.

Effective Dates

The effective dates of the GILTI final regs are in reg. section 1.951A-7(b). Section 1.951A-2(c)(7) and (8) apply to tax years of CFCs beginning on or after July 23, 2020, and to tax years of U.S. shareholders ending in or with the CFC tax year-end.

Taxpayers may choose to apply the GILTI rules to tax years that begin after December 31, 2017, and before July 23, 2020, provided they consistently apply the GILTI rules along with rules in the section 954 regs that were finalized with the GILTI regs in T.D. 9902. Those rules align specific GILTI reg provisions with FBCI provisions and have similar effective dates that are set forth in reg. section 1.954-1(h).




HIGHLIGHTS


The effective dates of the proposed regs are in prop. reg. 1.954-1(h). Prop. reg. section 1.954-1(d) applies to tax years of CFCs beginning on or after the date that final regs are filed for public inspection, and to tax years of U.S. shareholders ending in or with the CFC’s year-end.

The proposed regs recommend that reg. section 1.951A-2(c) be amended by removing paragraphs 1.951A-2(c)(7) and (8), which contain the GILTI high-tax exception rules. As stated in the proposed regs’ preamble, the section 954(b)(4) high-tax exception should apply consistently to all of a CFC’s items of gross income. These proposed regs provide for a single election for purposes of both subpart F income and tested income. As a result, when the proposed regs are adopted as final, the GILTI-specific high-tax exception rules will be withdrawn.

NEWS ANALYSIS

Proposed FTC Regs: More Politics, Less Principleby Mindy Herzfeld

Over 100 years ago, the United States enacted a foreign tax credit, in what Columbia University law professor Michael J. Graetz has described as an act of extraordinary generosity to other countries. Providing that kind of credit means defining what constitutes a foreign income tax, and the regulations that do so — last substantially revised in 1983 — have held on despite the fundamental retooling of the U.S. international tax system, the growth in the FTC’s importance for U.S. companies’ overall tax liability, and the increasing assertiveness of other countries in imposing more taxes on U.S. companies.

At the same time, the determination of foreign tax creditability has always had more to do with politics than principle. And that’s undoubtedly what’s behind the recent attempt by the U.S. Treasury Department to fundamentally redefine the foreign income tax for FTC purposes. Among lengthy proposed regulations (REG-101657-20) released September 21 — which mostly address Tax Cuts and Jobs Act changes but also include a hodgepodge of topics that were apparently bumping up against the reality of a possible change in administration — are revisions to reg. section 1.901-2 setting out new guidelines for when a foreign tax is considered a creditable income tax. The new rules are unmistakably a response to unilateral measures by other countries (such as digital services taxes) and multilateral developments at the OECD, which last week released highly anticipated blueprints with proposals for taxing the digitalized economy.

As drafted, the proposed rules — which essentially grant a credit only for foreign taxes imposed on a tax base practically identical to the U.S. income tax base — probably aren’t implementable. Thus, it’s unclear whether they were released simply for negotiating purposes, with the recognition that they’re unlikely to be finalized in current form. And if that’s the case, it’s also unclear who’s supposed to be influenced: other countries, U.S. multinationals, Congress, or perhaps a subsequent administration.




HIGHLIGHTS


Background

IRC section 901 allows U.S. persons to elect to claim as a credit the amount of any income taxes paid or accrued to a foreign country during a tax year (or paid in lieu of those taxes under section 903). Reg. section 1.901-2 defines a creditable tax as a foreign tax whose predominant character is that of an income tax in the U.S. sense. That test is met only if the tax is considered likely to reach net gain in the normal circumstances in which it applies, while the net gain requirement is satisfied if the tax meets realization, gross receipts, and net income requirements. A foreign tax either is or is not a foreign income tax, in its entirety, for all persons subject to it.

Among the key changes in the proposed regs is a new nexus requirement that “a foreign tax conform to traditional international norms of taxing jurisdiction as reflected in the Internal Revenue Code.” The preamble explains that the fundamental purpose of preventing double taxation is served most appropriately “if there is substantial conformity in the principles used to calculate” U.S. and foreign tax bases. The existing conformity tests address only the calculation of the base; the proposed rule introduces a qualitative test — namely, that there be sufficient nexus between the income subject to tax and the foreign jurisdiction imposing the tax.

The preamble acknowledges that those changes will tighten the rules governing — and will likely restrict — the creditability of foreign taxes. What the preamble doesn’t say is that those changes would also render uncreditable foreign taxes imposed under the OECD’s recent proposals.

Back to the Future

This is not the first time the U.S. government has considered introducing a jurisdictional test in defining an income tax. A 1980 temporary and proposed version of the regulations required that a foreign income tax follow “reasonable rules regarding source of income, residence, or other bases for taxing jurisdiction.” The prior rules — which imposed tighter restrictions than the current rules in myriad other ways — were the subject of major controversy, and the government was forced to withdraw and repropose them. (According to practitioners, the initial proposal

“produced an outpouring of criticism which was unprecedented in magnitude and tone,” with complaints about the administration’s “attempt to usurp the legislative authority of the Congress by substantially altering the criteria for” creditability. Prior analysis: Tax Notes, Oct. 17, 1983, p. 203.)

Back in the 1980s, when there was no such thing as a digital company, complaints against limitations on creditability came primarily from the oil and gas sector, the industry most heavily invested overseas at that time and therefore most affected by the regulations. (The origin of the 1983 regs had a lot to do with oil-rich nations’ redesign of their royalty regimes to allow U.S. multinationals to claim an FTC.) Although the rule regarding reasonableness for source and nexus was not the most controversial aspect, it was dropped when the regs were finalized in 1983. But the regs didn’t include suggestions from business organizations that the regulations affirmatively state that there’s no requirement that a foreign tax be based on “reasonable rules of taxing jurisdiction.”

A Digital Odyssey

The preamble to the recently proposed rules pulls no punches in explaining the need for the current revisions. It describes how several countries have adopted or are considering various “novel extraterritorial taxes that diverge in significant respects from traditional norms of international taxing jurisdiction as reflected in the Internal Revenue Code.” Treasury has received requests for guidance on whether the definition of a foreign income tax includes a jurisdictional limitation, as well as recommendations that it adopt a rule requiring a foreign tax to be on income that bears “an appropriate connection” to that country to be eligible for the FTC.

The novel extraterritorial taxes that the preamble refers to include the DSTs enacted or proposed by at least 10 countries. To date, the U.S. government has attempted to combat those taxes only via trade measures: The Office of the U.S. Trade Representative has found that France’s tax violates trade agreements and has launched investigations into several others. But trade sanctions won’t preclude U.S. taxpayers from attempting to claim a credit for DSTs, and if the




HIGHLIGHTS


taxes have no net cost to U.S. taxpayers, most have little incentive to protest them. Some companies have asked that the government hold back on taking an aggressive stance against DSTs for fear that that could provoke a wider trade war (see IBM’s July 9 letter). In broadly rewriting the FTC rules in a way that could prevent U.S. companies from claiming credits for a wider scope of foreign taxes — not limited to DSTs — Treasury might be trying to encourage a larger group of U.S. businesses to support the OECD’s digital project.

A ‘Goldilocks’ Nexus Rule

International activity, both on the DST front and in the broader shift to destination-based taxes, has prompted the U.S. government to suggest that to qualify as a creditable income tax, foreign law must require sufficient nexus with a taxpayer’s activities that give rise to the income that it wants to subject to tax. A tax on income that lacks sufficient nexus to the foreign country — for example, on a taxpayer that lacks operations, employees, or management there — would not be creditable. A foreign country’s exercise of tax jurisdiction would have to be consistent with U.S. income tax jurisdictional nexus principles.

Treasury said it considered basing the jurisdictional nexus requirement on the permanent establishment and business profits standards in the U.S. model treaty but found those standards too rigid and prescriptive. It also said a test based on the U.S. statutory effectively connected income standard was too broad and did not necessarily target the primary concerns about the new extraterritorial taxes, which are based on destination-based criteria. The “just right” test that Treasury settled on requires a foreign tax on a nonresident to be based on the nonresident’s activities in the foreign country without taking destination-based criteria into account.

U.S. Norms Are Traditional Norms

Under the new standard, a foreign tax will qualify as an income tax for U.S. FTC purposes only if it conforms with established international norms — which the preamble says are reflected in the IRC and related guidance — for allocating profit among related parties, allocating a nonresident’s profits to a taxable presence, and

taxing cross-border income based on source. That description reflects an underlying assumption that the U.S. rules and established international norms are one and the same. Only U.S. legal standards for asserting tax jurisdiction will be acceptable in determining whether a foreign tax meets the test to be a creditable income tax.

That approach assumes away the possibility that U.S. jurisdictional standards will change in a way that might not be consistent with established norms.

Traditional Jurisdiction

Under the new nexus rule, a foreign tax imposed on nonresidents is creditable only if the foreign law determines the amount of income subject to tax based on the nonresident’s activities in that country — including its functions, assets, and risks — without heavily weighting the location of customers, users, or other similar destination-based criteria. Generally, only rules consistent with section 864(c), which sets out the (very poorly defined) guidelines for taxing income effectively connected with a U.S. trade or business, or with articles 5 and 7 of the U.S. model treaty (the PE and business profits articles), would meet that requirement. DSTs, equalization levies, and destination-based taxes (such as the one proposed by House Republicans in 2016) would not.

Traditional Sourcing

It’s not just the nexus rule that must conform to U.S. tax principles: A foreign tax is creditable only if the jurisdiction’s sourcing rules are “reasonably similar” to U.S. sourcing rules. For taxes on services income, the foreign tax must be on income sourced based on the place of performance of the services, not the location of the services recipient. For taxes on gain from sales or other dispositions of property by a nonresident, the nexus requirement is satisfied only in connection with gains on the disposition of real property in the foreign country or movable property that’s part of a PE. The simplicity of the rule here belies the many complexities of U.S. sourcing rules and their evolution in response to the challenges of sourcing income from digital activities and products.




HIGHLIGHTS


The proposed regulations provide an example of the type of tax that wouldn’t be considered an income tax under the revised definition, modeled on other countries’ new digital taxes. The example describes a levy imposed by Country X on nonresident companies that furnish electronically supplied services to users in X, with the base computed by deeming a portion of the company’s overall net income related to those services to be attributable to a deemed PE, determined using a formula based on the percentage of the company’s total users in X. The tax fails the jurisdictional nexus test because its base isn’t computed based on the company’s activities in the country, instead taking user location into account.

Transfer Pricing

The new definition of creditable tax requires a special rule to address income allocated under transfer pricing rules, which might not be consistent with the nexus and sourcing principles outlined above. The jurisdictional nexus requirement generally is satisfied only if the foreign tax law’s transfer pricing rules are determined under arm’s-length principles. Transfer pricing rules consistent with the section 482 arm’s-length standard or the OECD’s guidelines satisfy that requirement, but foreign transfer pricing rules that allocate profits based on destination-based criteria don’t.

The preamble requests comments on whether special rules are needed to address foreign transfer pricing rules that allocate profits to a resident on a formulary basis, rather than based on arm’s-length prices, such as through the use of fixed margins. In the absence of a special rule, multinationals’ taxes paid under Brazil’s transfer pricing rules, for example, might not be creditable.

CFC Rules

Taxes collected from income earned in other countries under controlled-foreign-corporation-type systems don’t satisfy traditional nexus requirements. But the United States has the world’s most expansive CFC regime, and the proposed regs provide that a foreign income tax imposed as a CFC-type rule doesn’t fail the creditability requirement. While CFC rules are sanctioned, it’s unclear how antiavoidance rules

might fare under the new regime. Also likely not creditable under the revised definition are indirect taxes on capital gains such as those favored by India and outlined in a toolkit containing recommendations for developing countries released by the Platform for Collaboration on Tax.

Don’t Draw Inferences

While the regulations are a major departure from existing rules, the U.S. government doesn’t fold on positions taxpayers might be taking under current law, saying no inference should be drawn regarding the application of existing regulations to the treatment of novel extraterritorial foreign taxes such as DSTs, diverted profits taxes, or equalization levies.

One tax not mentioned is the Puerto Rican excise tax, whose creditability the government said almost a decade ago (Notice 2011-29, 2011-16 IRB 663) that it was analyzing, adding that it wouldn’t penalize taxpayers for claiming a credit for the tax until it issued further guidance. That creditability is so important in Puerto Rico that immediately following the release of the proposed regs, the country’s treasury secretary contacted Treasury Assistant Secretary for Tax Policy David Kautter to confirm that the proposed regulations aren’t meant to affect the excise tax regime but instead are “directed at certain taxes on digital services.” Assurances and intentions aside, the rules as drafted would render the tax noncreditable.

The U.S. Sense of Taxes

The proposed rules also revise the criteria for what it means to be an income tax in the U.S. sense — specifically, what it means for a tax to be on net gain. Under the existing regs, whether a foreign tax is considered to tax net gain is determined based on whether it does so in “normal circumstances.” To correct what Treasury calls the “uncertainty and undue burdens” that result from that standard, the proposed rules would determine whether a tax is a foreign income tax based on foreign tax law rather than on how the tax applies.

Also revised is the net income definition, which generally requires that a tax be imposed on a base that starts with gross receipts and allows




HIGHLIGHTS


for recovery of significant costs and expenses. Existing rules provide that a foreign tax on gross income might satisfy the net income requirement if it is almost certain to reach some net gain in the normal circumstances in which it applies.

The proposed regs would revise this standard to require that a tax base conform in “essential respects” to the determination of taxable income for U.S. purposes. The preamble states that any foreign tax imposed on a gross basis is not an income tax in the U.S. sense, regardless of its rate or the extent of associated costs.

The new rules would also require that deductions allowed under the foreign tax law approximate the cost recovery provisions of the code. A tax imposed on gross receipts or gross income without reduction for any costs or expenses attributable to earning that income can’t qualify as a net income tax, even if in practice there are no or few costs and expenses attributable to the types of gross receipts included in the tax base.

While the preamble says that a foreign tax law that denies deductions or limits deductibility won’t cause a tax to flunk the test so long as it’s consistent with U.S. tax law, practically speaking, that’s an impossible standard. The preamble provides as an example limitations on interest expense deductibility similar to section 163(j), saying those kinds of restrictions are consistent with the rule that principles of U.S. law apply to determine whether a tax is a creditable income tax. But there are so many differences in calculating the bases of the U.S. and foreign income taxes that determining whether a foreign law deduction or limitation on a deduction is consistent with a similar provision in U.S. law would be quite the task — for example, is an interest expense limitation permissible only if it conforms to section 163(j)? What if Congress revises it? And what about deductions on net equity? Aside from the complexity in making that determination at any one point in time, there’s no allowance for the constant evolution of U.S. tax law.

Creditable Foreign Taxes and the OECD’s Pillars

While revisions to the section 901 regs were long overdue, the preamble also acknowledges that the proposed regs may already be out of date.

If the OECD’s suggestions achieve consensus, most of the taxes being proposed under pillars 1 and 2 wouldn’t be creditable under the proposed regs. The preamble says that if an agreement is reached on those proposals that includes the United States, changes to the U.S. FTC system might be required. But without those kinds of changes, double taxation would result.

Between the U.S. regulatory comment process, changes that may result from the OECD’s work, and possible changes within Treasury, it seems likely that the proposed rules will never come into force in their current form. But if their real intent is a political negotiating tactic, that may be beside the point.

Mindy Herzfeld is professor of tax practice at University of Florida Levin College of Law, of counsel at Ivins, Phillips & Barker, and a contributor to Tax Notes International.

Follow Mindy Herzfeld (@InternationlTax) on Twitter.




HIGHLIGHTS


OECD Now Aiming for Global Corporate Tax Reform Deal by Mid-2021by Stephanie Soong Johnston

Countries could not agree on a renovation of the international tax system in 2020 as planned, but they now have the blueprints that the OECD hopes will provide the foundation for an accord in 2021.

The OECD on October 12 published its hotly anticipated plans setting out the technical details of a two-pillar multilateral proposal for rebuilding corporate tax rules for an increasingly digital and globalized economy. The blueprints, drafted and negotiated by 137 member jurisdictions of the OECD’s inclusive framework on base erosion and profit shifting, were approved for release after the group’s October 8-9 virtual meeting.

A public consultation document was also posted, eliciting input from stakeholders on the blueprints until December 14 before a virtual public consultation event set for January 2021.

Pillar 1 envisages amending profit allocation and nexus rules to grant more taxing rights to market jurisdictions over a portion of in-scope multinationals’ residual profits. Pillar 2 would introduce minimum corporate taxation through a global anti-base-erosion (GLOBE) mechanism.

Governments involved in the project hope that adoption of a common, coordinated approach to update global corporate tax rules will ensure more effective and more equitable taxation of new business models and, more broadly, multinational enterprises.

Countries also expect that a multilateral approach would discourage the spread of a patchwork of unilateral measures, such as digital services taxes, which could lead to instability in the global tax system. The urgency of those goals has become even more acute as revenue-starved countries grapple with the economic fallout of the public health crisis.

“The public pressure on governments to ensure that large, internationally operating, and profitable businesses pay their fair share and do so in the right place under new international tax rules has increased as a result of the current COVID-19 pandemic,” the inclusive framework said in a statement. “At the same time, a

consensus-based solution could provide businesses with much-needed tax certainty in order to aid economic recovery.”

Although countries had initially targeted the end of 2020 for political consensus on the two-pillar approach, that timeline became untenable after the project ran into political differences over issues such as scope and tax rates, as well as difficulties arising from the COVID-19 pandemic.

“We agree to swiftly address the remaining issues with a view to bringing the process to a successful conclusion by mid-2021 and to resolve technical issues, develop model draft legislation, guidelines, and international rules and processes as necessary to enable jurisdictions to implement a consensus-based solution,” the inclusive framework statement says.

The coronavirus crisis “did affect our capacity to deliver a deal on time,” OECD Secretary-General Angel Gurría conceded during an October 12 press conference. Because of travel restrictions and pandemic lockdowns, the inclusive framework held nearly 70 virtual meetings to continue working on the project. Despite the challenges, the group managed to put themselves in a good position to finally deliver on a consensus-based solution, he said.

“The international community at large . . . took a very important step toward their goal of rewriting international tax rules,” Gurría said. “This is no mean feat in the time of COVID.” Gurría presented the blueprints to G-20 finance ministers during their October 14 virtual meeting as part of his tax report to the group.

Pillar 1

The pillar 1 blueprint largely follows previously leaked drafts, displaying an evolution from the so-called unified approach, which the OECD secretariat had proposed in October 2019 to bridge different inclusive framework members’ divergent views on how to move the project forward.

Pillar 1 retains a three-part framework for taxing multinationals, with amount A, which gives a new taxing right to market jurisdictions over a portion of residual profits of in-scope MNE groups; amount B, which represents a fixed return for the baseline marketing and distribution activities occurring in market jurisdictions,




HIGHLIGHTS


aligned with the arm’s-length principle; and dispute prevention and resolution mechanisms to enhance tax certainty.

The blueprint notes that inclusive framework members must make political decisions on issues related to the scope of amount A. While amount A would apply to two broad categories of companies — those that provide “automated digital services” and those that may be considered “consumer-facing businesses” — it says that more work is necessary to reach political agreement “on the use of these categories,” alluding to the desire of some countries to apply pillar 1 rules to automated digital services companies first.

Some inclusive framework members had called for phasing in amount A by focusing on automated digital services first and consumer-facing businesses afterward, in an effort to reach agreement, but the United States is adamant that pillar 1 does not ring-fence digital companies, many of which are American. Complicating matters further, the United States had pushed for pillar 1 to be implemented on a safe harbor basis so companies could opt into the regime in exchange for greater tax certainty, an idea that many countries oppose. “The scope of amount A remains to be settled upon,” the blueprint says.

Political decisions are also required on the “quantum” of amount A, the amount of residual profit to be allocated to a market jurisdiction to be taxed. The quantum would be calculated with a formula that would take into account a yet-to-be-determined threshold amount and percentage.

The blueprint notes general agreement among countries for an “innovative solution to deliver early certainty and effective dispute resolution for amount A,” but there are still differences in opinion about the scope of mandatory binding dispute resolution beyond amount A.

Countries must also make decisions about the scope and application of amount B, which some countries want to broaden. Amount B sets out a system of fixed returns for baseline marketing and distribution activities in market jurisdictions, under which fixed returns will be determined using the transactional net margin method and will potentially vary by industry and region, the blueprint says.

Despite outstanding open issues, the blueprint sets out some key design features of the

components of pillar 1. Amount A would have a revenue threshold based on annual consolidated group revenue, along with “a de minimis foreign in-scope revenue carveout.” It would establish new nexus rules to determine which market jurisdictions could receive amount A and a formulaic approach for reallocating residual profits.

The blueprint indicates that amount A should include a loss carryforward regime and contemplates a regime that would allow in-scope MNEs to bring in existing losses recorded before the introduction of the new taxing right.

Pillar 1 definitively eliminates the concept of amount C, which, under the original unified approach, had represented the return exceeding amount B that may be required for entities with activities that go beyond standardized distribution functions. As acknowledged by OECD officials, amounts A and C each represent a portion of residual profit, and therefore taxation of both amounts by the same jurisdiction could lead to disputes and double taxation.

The blueprint notes that different options are under consideration for removing the double-counting risk. One proposal adjustment — the “marketing and distribution profits safe harbor” — would apply a cap to the amount A calculation.

To enhance the tax certainty aspect of pillar 1, the blueprint retains a dispute resolution panel mechanism that would ensure agreement among tax administrations about how amount A would apply to a particular MNE group. It also considers the creation of a new multilateral convention to implement the new rules.

The blueprint makes it clear that inclusive framework members that agree on pillar 1 must withdraw any unilateral measures they may have implemented to tax digital activity, and refrain from introducing new ones in the future, although discussions continue about what constitutes a relevant unilateral measure.

Pillar 2

The pillar 2 blueprint follows up on previous drafts and sets out more details about its main components: the income inclusion rule (IIR), the undertaxed payment rule (UTPR) and the subject-to-tax rule (STTR). It also makes clear that the IIR and the UTPR comprise the GLOBE rules, a




HIGHLIGHTS


concept first proposed by the French and German governments in November 2018.

The UTPR would act as a backstop to the IIR, which would also be complemented by a switch-over rule “that removes treaty obstacles from its application to certain branch structures and applies where an income tax treaty otherwise obligates a contracting state to use the exemption method.”

The blueprint confirms that the GLOBE would apply to MNE groups with €750 million or more in annual gross revenues, in line with the threshold set out in action 13 (country-by-country reporting) of the BEPS project. The GLOBE would exclude some parent entities, including investment and pension funds and government entities.

The IIR and UTPR would rely on a common tax base, which would be calculated using financial accounts prepared with accounting standards — international financial reporting standards or another standard — that the MNE group parent uses for its consolidated financial statements. “The effective tax rate (ETR) is determined by applying the tax base and covered taxes on a jurisdictional basis,” the blueprint says. The GLOBE tax calculation process would include a mechanism that would curb ETR volatility, as well as a formulaic substance carveout, it adds.

“If an MNE’s jurisdictional ETR is below the agreed minimum rate, the MNE will be liable for an incremental amount of tax that is sufficient to bring the total amount of tax on the excess profits up to the minimum rate,” the blueprint says. The inclusive framework has not yet agreed on a minimum rate.

Neither the IIR nor the UTPR need bilateral treaty revisions because they can be implemented through domestic law, but the STTR and the switch-over rule do, the blueprint notes. Such changes could be done through treaty negotiations and amendments or through a multilateral convention. The multilateral instrument of the BEPS project could serve as a model for the latter, according to the blueprint. The STTR would also need to be a key component to reach consensus on pillar 2, as many developing countries view the rule as especially important.

The inclusive framework made several design choices to ensure easier administration and compliance. However, the blueprint notes that “the finalization of pillar 2 also requires political agreement on key design features of the subject-to-tax rule and the GLOBE rules including carveouts, blending, rule order and tax rates where, at present, diverging views continue to exist.”

There are still outstanding questions about the coexistence of the GLOBE with the U.S. global intangible low-taxed income regime introduced by the Tax Cuts and Jobs Act, but the inclusive framework recognizes that the coexistence must be part of any political agreement.

More technical work must be done on the coordination between the GLOBE rules and the GILTI regime. “That includes the coordination with the application of the GILTI to U.S. intermediate parent companies of foreign groups headquartered in countries that apply an IIR,” the blueprint says. It also confirms that the inclusive framework “strongly encourages” the U.S. government to curb its base erosion and antiabuse tax when it comes to payments to entities that fall under the IIR.

What’s at Stake

During the October 12 press conference, Pascal Saint-Amans, director of the OECD’s Centre for Tax Policy and Administration, highlighted some statistics from the OECD secretariat’s economic assessment on the two pillars, released the same day, noting that as much as $100 billion in additional revenue could be at stake if countries are unable to agree on a multilateral solution.

The report finds the two pillars could collectively boost global corporate income tax revenues by 1.9 percent to 3.2 percent, which translates to an estimated $50 billion to $80 billion annually.

Taking the GILTI regime into account, global corporate income tax revenues could increase by 4 percent, or $60 billion to $100 billion, per year, the assessment says. Final estimates would depend on several factors, including the agreed design of the two pillars, their implementation, reactions by affected MNEs and governments,




HIGHLIGHTS


and economic developments that may arise in the future, the report adds.

Countries hope multilateral global tax reform will discourage the spread of revenue-based DSTs, which have heightened trade tensions among countries, particularly between the United States and France, as well as other trading partners that have either implemented or are planning to introduce DSTs.

If countries are unable to agree on a solution, unilateral measures, such as DSTs, would proliferate, leading to economic inefficiencies, double taxation, and trade disputes, the assessment says. Broad DST implementation could lead global GDP to sink by as much as 1.2 percent, according to the assessment.

Questions are already swirling about whether countries will hold off on unilateral measures as OECD talks slip into 2021. The European Commission on October 13 said it would abide by the OECD’s new timeline, but if talks fail again, it would press ahead with its own plans to tax digital activity. The U.N. Committee of Experts on

International Cooperation in Tax Matters is also scheduled to consider a proposal for a new model tax convention article to tax digital services during its October 20-23 and October 26-29 virtual meetings.

Speaking later October 12 during the 17th edition of the OECD Tax Talks webcast series, Saint-Amans said that agreement is feasible and that technical conditions are in place to allow the politicians to decide whether to agree to the two-pillar solution. “Let’s make sure that this doesn’t go to waste, because in the time of COVID, the last thing we need . . . is a trade war,” he said.

There is the political will among countries to address the tax challenges of digitalization and globalization, and to rebuild a new international tax system, according to Saint-Amans.

“This will happen — the only question is when and how,” Saint-Amans said. “Will it take a few months of hard negotiations? Will it take a few years after some chaos? We hope this can be done through cooperation.”




HIGHLIGHTS








U.S. Tax Review

by James P. Fuller and Larissa Neumann

Final Section 245A Regulations

Section 245A provides a 100 percent deduction to domestic corporations for some dividends received from foreign corporations after December 31, 2017 (the “section 245A deduction”). Under the section 954(c)(6) exception, a dividend received by a controlled foreign corporation from a related CFC is generally not subject to current tax under sections 951(a) and 954(c).

Surprising temporary regulations (T.D. 9865) were issued last year that limited the section 245A deduction and the section 954(c)(6) exception in the case of certain distributions and transactions. These were distributions and transactions viewed by Treasury and the IRS as involving CFC earnings and profits that were not subject to the so-called Tax Cuts and Jobs Act integrated international tax regime. At the same time, Treasury and the IRS also issued proposed regulations.

The new final regulations (T.D. 9909) retain the general approach and structure of the 2019 proposed (and temporary) regulations, with some revisions, and remove the temporary regulations. Many taxpayers and tax advisers believe the temporary — and now the final — regulations exceed Treasury and the IRS’s authority as the regulations would seem to rewrite the statute. This will likely lead to litigation.

New proposed regulations (REG-103470-19) were also issued addressing the coordination of the new extraordinary disposition rules with the global intangible low-taxed income rules in section 951A. As discussed further below, these are among the most complicated regulations ever written by Treasury and the IRS and became necessary to avoid double or excess taxation in the context of Treasury and the IRS’s efforts to prevent what they perceive to be a tax planning opportunity.

Authority

As noted above, several commentators stated that Treasury and the IRS lack the authority to issue these section 245A regulations. These commentators state that the extraordinary disposition and extraordinary reduction rules in the 2019 temporary and proposed regulations are contrary to the statutory text of section 245A and are therefore not authorized by section 245A(g). We agree with these comments. Some commentators also stated that the extraordinary disposition rules are contrary to section 245A because they attempt to alter the effective dates of section 965, which imposed a transition tax on certain untaxed foreign earnings measured as of no later than December 31, 2017; and section 951A (GILTI), the new TCJA category of income that is subject to current U.S. taxation starting in the first tax year of a CFC beginning on or after January 1, 2018. We also agree with these comments.

James P. Fuller and Larissa Neumann are with Fenwick & West LLP in Mountain View, California.

In this article, the authors discuss final and proposed section 245A regulations.






Other commentators stated that the 2019 regulations are not reasonable because the application of the rules may result in excess U.S. taxation in certain situations.

Treasury and the IRS believe that sections 245A(g), 954(c)(6), and 7805(a) provide authority for these regulations. They stated that the phrase “necessary or appropriate” is broad, and its use in sections 245A(g) and 954(c)(6)(A) reflects Congress’s intent to confer extensive rulemaking authority upon Treasury and the IRS regarding those provisions.

They also believe that the section 245A deduction appropriately operates within the statutory framework to complement, not contradict, the application of section 965 and the GILTI and subpart F regimes. Treasury and the IRS stated that the regulations limit the section 245A deduction in connection with extraordinary dispositions because E&P generated in those transactions is not subject to tax under section 965 or the GILTI and subpart F regimes and, as a result, is not of the residual type for which the section 245A deduction is intended to potentially be available.

Treasury and the IRS stated that regulations limit the section 245A deduction in connection with extraordinary reductions because the section 245A deduction can result in complete avoidance of U.S. tax regarding subpart F income and tested income that, absent the extraordinary reduction, could be included in income by the selling U.S. shareholder under the subpart F or GILTI regimes, respectively.

They further stated that the regulations limit the section 954(c)(6) exception in cases in which its application would otherwise allow E&P that had accrued after December 31, 2017 (the last measurement date for determining the amount of E&P subject to section 965), and that was generated by income that had never been tested under the subpart F and GILTI regimes to inappropriately qualify for an exception to the subpart F regime. Treasury and the IRS believe that while section 954(c)(6) was added to the code to allow certain CFCs to reinvest E&P attributable to active foreign activities without incurring current U.S. tax, the section 954(c)(6) exception was not intended to apply in cases in which the effect would be to permanently eliminate income

from the U.S. tax base, which would constitute an abuse of section 954(c)(6).

In the view of Treasury and the IRS, the 2019 regulations and the new final regulations under section 954(c)(6) are intended to ensure that the section 954(c)(6) exception does not apply to permanently eliminate income from the U.S. tax base through certain transactions preventing the taxation of income that would otherwise be taxed under the subpart F regime in cases in which it is distributed to a CFC. Accordingly, they believe that these regulations are necessary and appropriate to prevent the abuse of the section 954(c)(6) exception.

Commentators stated that the regulations are an attempt by Treasury and the IRS to rewrite the statute and to apply section 965 or the GILTI regime during the period beginning on January 1, 2018, and ending on the last day of the last tax year of a CFC before the GILTI regime applies (the “disqualified period”).

Treasury and the IRS disagreed with this characterization. They stated that the regulations are not an attempt to change the effective dates of section 965 or the GILTI regime. Rather, they said the regulations limit the availability of the section 245A deduction and the section 954(c)(6) exception in certain limited circumstances in which the effect would be contrary to the appropriate application of those provisions in the context of the TCJA’s integrated approach to the taxation of income, or E&P generated by income, of a CFC.

They also stated that the extraordinary disposition rules apply to a limited category of transactions — that is, those that take place outside the ordinary course of business between related parties and exceed the lesser of $50 million or 5 percent of the CFC’s total income for the tax year. They believe that these exceptions demonstrate that the extraordinary disposition rules do not change the effective dates of section 965 or the GILTI regime but rather ensure the proper coordination of multiple statutory provisions in circumstances in which there is a heightened risk of base erosion.

Excess Taxation

Several commentators stated that the regulations are unreasonable because they could






result in excess U.S. taxation. For example, commentators cited the potential for the extraordinary disposition rules and the disqualified basis (DQB) rules in Treas. reg. section 1.951A-2(c)(5) to apply to the same transaction. Commentators also stated that as a result of the unavailability of foreign tax credits and other tax attributes (such as net deemed tangible income returns as defined in section 951A(b)(2)), the extraordinary disposition rules impose a different tax cost on extraordinary disposition E&P than would have been imposed had the income or gain to which the E&P is attributable been subject to tax under the GILTI regime when it was generated.

Another commentator said that the extraordinary reduction rules are contrary to sections 1248(j) and 964(e)(4) because those provisions govern extraordinary reductions and the 2019 regulations in effect override those provisions. Finally, one commentator stated that the extraordinary reduction rules result in excess U.S. taxation in the context of dividends that partially fail to qualify for the section 954(c)(6) exception because they are partly attributable to subpart F income.

Treasury and the IRS believe that the proposed coordination rules consider the application of the rules of Treas. reg. sections 1.245A-5(c) and (d) and 1.951A-2(c)(5) to the same transaction and, accordingly, address excess taxation concerns. They also state that the U.S. tax cost of an extraordinary disposition is not, and is not intended to be, equivalent to the cost of applying section 965 or the GILTI regime to the same transaction. Instead, Treasury and the IRS believe that the extraordinary disposition E&P is not of the type of E&P that Congress intended to qualify for the section 245A deduction and the section 954(c)(6) exception.

They stated that as an “act of administrative grace,” the 2019 regulations deny only 50 percent of the section 245A deduction and the section 954(c)(6) exception to approximate the tax rate that taxpayers may have expected to pay on similar E&P under section 965 or the GILTI regime. This is not intended to place taxpayers in an equivalent position as though they had been subject to those provisions. Instead, it is intended to prevent extraordinary disposition E&P from

inappropriately qualifying for the section 245A deduction or the section 954(c)(6) exception.

The 2019 regulations also do not override the application of section 1248(j) or 964(e)(4). Both provisions impose taxation on built-in stock gain (to the extent of certain E&P of the CFC) as if it were a dividend, but neither one expressly permits the section 245A deduction. Both provisions envision that there will be contexts in which the deemed dividend under section 1248(j) or 964(e)(4) could fail to qualify for the section 245A deduction. The fact that the statutory text of these provisions ties their eligibility for tax exemption to their ability to qualify for the section 245A deduction demonstrates that the same policies underlying the application of section 245A to actual dividends is also intended to apply to deemed dividends under section 1248(j) or 964(e)(4). Accordingly, Treasury and the IRS believe that the regulations further the policies underlying sections 1248(j) and 964(e)(4) by limiting the availability of the section 245A deduction for both actual and deemed dividends in the same manner.

Finally, one commentator asserted that the interaction of the extraordinary reduction rules with the rules under temp. Treas. reg. section 1.245A-5T(f) (and prop. Treas. reg. section 1.245A-5(f)) that limit the section 954(c)(6) exception could result in subpart F income being subject to U.S. tax more than once in certain cases in which a portion of the amount distributed would not otherwise qualify for the section 954(c)(6) exception. Treasury and the IRS believe that while not discussed in the comment, the same issue could arise in the context of tiered extraordinary disposition amounts. In response, they modified the rules in Treas. reg. section 1.245A-5(d)(1) and (f)(1) and related provisions of Treas. reg. section 1.245A-5 that limit application of the section 954(c)(6) exception.

Extraordinary Dispositions

Under the 2019 regulations, a specified 10-percent-owned foreign corporation (SFC) is generally considered to have undertaken an extraordinary disposition regarding an asset if the SFC:

• disposed of that asset outside of its ordinary course of activities to a related party during its disqualified period; and






• the sum of all extraordinary dispositions undertaken by the SFC exceeded the lesser of $50 million or 5 percent of the gross value of the SFC’s assets.

Determining whether the disposition of an asset was outside the ordinary course of the SFC’s business was a facts and circumstances determination. Prop. Treas. reg. section 1.245A-5(c)(3)(ii)(B). Also, dispositions occurring with a principal purpose of generating E&P during the disqualified period and dispositions of intangible property (as defined in section 367(d)(4)) were per se outside the ordinary course of an SFC’s activities. Prop. Treas. reg. section 1.245A-5(c)(3)(ii)(C).

Commentators recommended that transactions occurring under a plan of integration after the acquisition of an unrelated group be excluded from the definition of extraordinary disposition. One commentator suggested that any integration of an acquired group that was acquired within 12 months of January 1, 2018, be excluded. The commentators noted that post-acquisition integration, including through mergers and asset sales, may occur for a variety of nontax business reasons, including consolidating ownership of certain assets, aligning business segments, creating synergies, and combining legal entities.

Further, the commentators stated that certain acquisitions and the related post-integration transactions were planned before the TCJA was enacted and would likely have occurred regardless of whether the TCJA was in effect at the time of the acquisition and post-acquisition integration. One commentator acknowledged, however, that courts have typically found mergers to not be within the ordinary course of a business’s activities.

Treasury and the IRS believe that recently acquired assets are indistinguishable from non-recently acquired assets for the purposes of determining whether an extraordinary disposition has occurred. First, an extraordinary disposition that occurs during the disqualified period implicates the policy concerns of the extraordinary disposition rule regardless of whether the taxpayer intended to avoid tax. That is, regardless of the taxpayer’s subjective intent, such transactions, absent rules to address them,

could give rise to inappropriate results, such as E&P that are not of the type for which the section 245A deduction was intended to be available giving rise to a section 245A deduction. Second, the regulations apply only to post-acquisition integrations occurring during the disqualified period.

Treasury and the IRS state that they are aware that some taxpayers undertook extraordinary dispositions for the purpose of increasing the basis of an asset or generating E&P eligible for the section 245A deduction, without being subject to U.S. tax on the recognition of the built-in gain in the asset. There are a number of ways that an asset could be transferred within an organizational structure that, even in the absence of special rules, would not give rise to inappropriate tax results. The fact that an asset was recently acquired does not change this fact — the length of time that an asset was held does not impact the potential ways in which the asset can be transferred within a group of related entities. Therefore, the final regulations did not adopt this recommendation.

Intangible PropertyA commentator requested a general exception

for transfers of intangible property, stating that the rules as drafted would penalize the repatriation of intangible property to the United States, contrary to one of the TCJA’s goals, and that other transfers of intangible property (that is, those between related CFCs) are addressed under Treas. reg. section 1.951A-2(c)(5). The extraordinary disposition rules were issued in response to a concern regarding highly structured transactions that took place during the disqualified period to create stepped-up basis for the transferee and generate E&P for the transferor. A transfer of intangible property will often fall within these criteria and thus would raise the same concerns as other highly structured asset dispositions during the disqualified period. The final regulations thus did not adopt this comment and continue to treat transfers of intangible property as extraordinary dispositions subject to the per se rule.

Exception for Inventory Property

A commentator recommended that the final regulations adopt an exception to the per se rule for transfers of intangible property described in






section 1221(a)(1). The commentator stated that the DQB rules, which similarly address transfers of property occurring during the disqualified period, provide for an exception regarding property described in section 1221(a)(1). Treas. reg. section 1.951A-2(h)(2)(ii). The commentator further stated that the facts and circumstances test in temp. Treas. reg. section 1.245A-5T(c)(3)(ii)(B) (and prop. Treas. reg. section 1.245A-5(c)(3)(ii)(B)) would be sufficient to address any concerns of abuse.

Treasury and the IRS agreed that it is appropriate to except certain ordinary course transfers of intangible property ultimately sold to unrelated customers from the per se rule. However, they believe that the exception from the per se rule should not be based on whether the property is described in section 1221(a)(1).

Accordingly, the final regulations provide that a disposition of certain types of intangible property defined in section 367(d)(4) is not per se treated as an extraordinary disposition if the intangible property is transferred to a related party during the disqualified period with a reasonable expectation that the property will be sold to an unrelated customer within one year of the transfer. Treas. reg. section 1.245A-5(c)(3)(ii)(C)(2)(i). This rule is intended to apply primarily to routine transfers of limited intangible property rights in furtherance of transactions with unrelated customers.

Treasury and the IRS did not include transfers of intangible property described in section 367(d)(4)(C) or (F), such as trademarks and goodwill, in the exception. This is because these types of intangible property are not routinely transferred to unrelated customers. Also, transfers of copyright rights within the meaning of Treas. reg. section 1.861-18 or intangible property described in section 367(d)(4)(A) that qualify for the exception to the per se rule are still subject to a presumption that they occur outside the ordinary course of the transferor SFC’s activities. Treas. reg. section 1.245A-5(c)(3)(ii)(C)(2)(ii). This presumption can be rebutted only if the taxpayer shows that the facts and circumstances clearly establish that the disposition took place in the ordinary course of the SFC’s activities.

Platform Contribution Payments

A commentator recommended that transfers of intangible property from a CFC to a related CFC that occur as a result of a platform contribution transaction (PCT) under Treas. reg. section 1.482-7 be excluded from the per se rule. The commentator noted that in cases in which PCT payments represent payments from a U.S. shareholder to a CFC as consideration for a deemed transfer of intangible property, the result is that intangible property is effectively transferred into the United States from abroad.

The final regulations do not include this recommendation. The ultimate destination of the intangible property transferred in an extraordinary disposition and the motivations of the taxpayers involved in the transfer are generally irrelevant in determining whether a transfer should be treated as an extraordinary disposition. Whether or not the intangible property is transferred to the United States or for nontax business reasons, a transfer during the disqualified period generates E&P that have not been subject to U.S. tax and an associated increase in the basis of the transferred property to the benefit of a related person. Accordingly, the final regulations continue to treat transfers of intangible property as subject to the per se rule without regard to whether the transfers occur in connection with a PCT.

Extraordinary Disposition AccountsThe 2019 regulations generally limited the

section 245A deduction to the extent that the dividend is paid out of the extraordinary disposition account (EDA) of the section 245A shareholder. For this purpose, those regulations provided an ordering rule under which a dividend was considered paid out of non-extraordinary disposition E&P before it was considered paid out of the extraordinary disposition E&P account. Similar rules applied regarding the limitation on amounts eligible for the section 954(c)(6) exception. The 2019 regulations generally defined non-extraordinary disposition E&P based on the section 245A shareholder’s share of the E&P of the SFC described in section 959(c)(3) in excess of the balance in the section 245A shareholder’s EDA determined immediately before the distribution.






The 2019 regulations measured a section 245A shareholder’s share of the E&P of an SFC described in section 959(c)(3) based on the percentage of stock (by value) of the SFC owned, directly or indirectly, by the section 245A shareholder after the distribution and all related transactions. Thus, in cases in which the section 245A shareholder sold all of its stock of the SFC, the section 245A shareholder’s share of E&P described in section 959(c)(3) was considered to be zero regarding any dividend that was related to the sale under the measurement rule.

As a result, the measurement rule treated no portion of the dividend as being distributed from non-extraordinary disposition E&P even though, assuming that a dividend was first sourced from E&P other than E&P generated in an extraordinary disposition, none of the dividend was sourced from E&P generated in an extraordinary disposition.

The final regulations revised this rule to measure the section 245A shareholder’s share of E&P described in section 959(c)(3) based on the percentage of stock of the SFC that the section 245A shareholder owns immediately before the distribution. Treas. reg. section 1.245A-5(c)(2)(ii)(A)(2).

Losses After Extraordinary Dispositions

One commentator stated that a dividend will avoid being sourced from an EDA only to the extent that the non-extraordinary disposition E&P equals or exceeds the amount of the dividend. The commentator requested that regulations clarify the determination of non-extraordinary disposition E&P and the sourcing of dividends from an EDA to address cases involving losses generated after the extraordinary disposition and distributions giving rise to “nimble” dividends subject to section 316(a)(2).

Treasury and the IRS believe this comment implicates two issues, the first of which is whether losses incurred after the disqualified period should reduce an EDA to the extent that such losses reduce E&P generated in an extraordinary disposition. They believe that losses incurred after the disqualified period should not reduce the EDA because extraordinary disposition E&P that are offset by losses provide a tax benefit to a section 245A shareholder. Specifically, extraordinary disposition E&P prevent offsetting

losses from decreasing other E&P or creating a deficit that must be offset by future E&P that could give rise to future dividends. For every dollar of decreased E&P, an additional dollar distributed would be unable to qualify for the section 245A deduction and would instead reduce the distributee’s basis in stock in the distributing corporation under section 301(c)(2) or constitute taxable gain to the distributee under section 301(c)(3).

In this way, extraordinary disposition E&P prevents post-extraordinary-disposition losses from reducing the SFC’s ability to pay dividends eligible for the section 245A deduction. Thus, the extraordinary disposition E&P provide the same benefit in cases in which they are offset by a loss as they do absent a loss: Those E&P increase the SFC’s ability to pay dividends otherwise eligible for the section 245A deduction. Accordingly, like the 2019 regulations, the final regulations do not reduce an EDA by reason of losses incurred after the disqualified period. Treas. reg. section 1.245A-5(c)(3)(i)(A).

The comment also implicates a second issue, which is whether a so-called nimble dividend should be considered paid out of extraordinary disposition E&P in cases in which the distributing SFC has an overall deficit in E&P, even factoring in the E&P supporting the nimble dividend. Treasury and the IRS are studying the extent to which nimble dividends should qualify for the section 245A deduction generally and may address this issue in future guidance under section 245A.

Prior Extraordinary Disposition Amounts

A section 245A shareholder reduces the balance of its EDA regarding an SFC by the prior extraordinary disposition amount. In general, the prior extraordinary disposition amount is intended to measure the extent to which the section 245A shareholder’s EDA has disallowed the section 245A deduction or caused a subpart F inclusion as a result of prior dividends of an SFC. However, this amount also includes certain other prior dividends of an SFC to generally ensure that the EDA is reduced to the extent that a dividend out of extraordinary disposition E&P does not give rise to a section 245A deduction under other provisions (such as under section 245A(e) for hybrid dividends).






A commentator stated that the definition of a prior extraordinary disposition amount did not appropriately take into account section 956, and as a result, Treas. reg. section 1.956-1(a)(2) can in effect deny the section 245A deduction regarding the same extraordinary disposition E&P more than once. Treas. reg. section 1.956-1(a)(2) reduces a U.S. shareholder’s section 956 amount to the extent that the U.S. shareholder’s tentative amount determined under section 956(a) regarding a CFC for a tax year would be eligible for a section 245A deduction if the U.S. shareholder received that tentative amount as a distribution from the CFC. The commentator recommended reducing the EDA by 200 percent of the amount included in the income of a section 245A shareholder under section 951(a)(1)(B) by reason of the application of temp. Treas. reg. section 1.245A-5T(b) (and prop. Treas. reg. section 1.245A-5(b)) to the hypothetical distribution under Treas. reg. section 1.956-1(a)(2).

Treasury and the IRS agreed with this comment. As a result, the final regulations modify the definition of a prior extraordinary disposition amount to take into account certain income inclusions under section 956. Treas. reg. section 1.245A-5(c)(3)(i)(D)(1)(iv). Also, the final regulations add a new type of prior extraordinary disposition amount for prior dividends that would have been subject to Treas. reg. section 1.245A-5(c) but failed to qualify for the section 245A deduction because they did not satisfy the requirement that the recipient domestic corporation be a U.S. shareholder regarding the distributing SFC. Treas. reg. section 1.245A-5(c)(3)(i)(C). Finally, the final regulations clarify that an EDA is maintained in the same currency as the extraordinary disposition E&P.

Successor RulesGenerally, in cases in which specified

transactions occurred (for example, a transfer of stock of an SFC for which a section 245A shareholder has an EDA), the 2019 regulations provided that the balance of the EDA was preserved by either transferring the account balance to another section 245A shareholder or requiring the section 245A shareholder to maintain the account regarding a different SFC (“successor rules”).

The purpose of the successor rules was to ensure that a section 245A shareholder succeeds to (or is attributed) an EDA upon certain transactions to the extent that, after the transaction, the section 245A shareholder would likely be able to access the E&P to which the EDA relates. Absent these rules, an EDA could be separated from the E&P to which it relates, which could give rise to inappropriate results.

A commentator recommended that EDAs terminate after a specified period. Treasury and the IRS believe that it would be inappropriate to terminate the accounts in cases in which a dividend out of extraordinary disposition E&P can still give rise to a section 245A deduction (or the application of the section 954(c)(6) exception). Accordingly, this comment was not adopted.

Treasury and the IRS believe that the coordination rules in the proposed regulations alleviate the concerns raised by this comment by generally eliminating a section 245A shareholder’s EDA in certain cases as the property that gave rise to the account is amortized or depreciated and those deductions reduce E&P otherwise potentially eligible for the section 245A deduction. The final regulations also alleviate these concerns by generally eliminating the EDA if no person is a section 245A shareholder of the SFC after certain transfers of stock of the SFC.

Nonrecognition Transactions

The successor rules under the 2019 regulations addressed some nonrecognition transactions. Specifically, the 2019 regulations provided that upon certain distributions of stock under section 355 made under a reorganization described in section 368(a)(1)(D), a section 245A shareholder’s EDA regarding the distributing SFC was allocated between the distributing SFC and the controlled SFC.

Other than this rule, the 2019 regulations did not provide any special rules for transfers of EDAs in nonrecognition transactions in which a section 245A shareholder transfers stock of an SFC. Also, prop. Treas. reg. section 1.245A-5(c)(4)(i) provided that a transaction described in Treas. reg. section 1.1248-8(a)(1) in which a section 245A shareholder transferred a share of stock of an SFC did not result in any transfer of the section 245A shareholder’s EDA. This was because after the transfer, the section 245A shareholder could






access the E&P to which the EDA relates by reason of section 1248 and Treas. reg. section 1.1248-8.

A commentator recommended that the rule addressing EDA transfers in reorganizations under sections 368(a)(1)(D) and 355 be extended to stand-alone section 355 distributions in which E&P of the distributing SFC are allocated to the controlled SFC. Treasury and the IRS agreed with this comment. As the commentator noted, certain stand-alone section 355 distributions could otherwise separate EDAs from related extraordinary disposition E&P, which could give rise to inappropriate results. Thus, the final regulations provide that a section 245A shareholder’s EDA regarding a distributing SFC is allocated between the distributing SFC and the controlled SFC in any section 355 distribution in which E&P of the distributing SFC are decreased and E&P of the controlled SFC are increased by reason of Treas. reg. section 1.312-10.

To address similar issues, the final regulations also provide rules regarding the transfer of EDAs in nonrecognition transactions. The final regulations provide that in a transaction described in Treas. reg. section 1.1248-8(a)(1) in which stock of an SFC is transferred to a foreign acquiring corporation in exchange for stock of a foreign corporation, any EDA regarding the SFC remains with the pre-transaction section 245A shareholder.

An exception to this rule applies in the case of a transaction described in Treas. reg. section 1.1248(f)-1(b)(2) or (3). In this type of transaction, the EDA is transferred in the manner provided in Treas. reg. section 1.245A-5(c)(4)(i), with certain adjustments, in order to generally ensure that a section 245A shareholder succeeds to an EDA to the extent that, after the transaction, the section 245A shareholder would likely be able to access the E&P to which the EDA relates. Other transactions described in Treas. reg. section 1.1248-8(a)(1) cause the EDA to be transferred to the extent and in the manner provided under the general rule of Treas. reg. section 1.245A-5(c)(4)(i).

Similarly, the final regulations also provide a rule addressing transactions in which an SFC acquires the assets of another SFC in a triangular asset reorganization and the section 245A shareholder of the target SFC receives stock of a

domestic corporation that controls the acquiring SFC. In these triangular reorganizations, the domestic corporation whose stock was issued in the triangular reorganization succeeds to the EDA of the section 245A shareholder regarding the target SFC.

Related Domestic Corporations

The 2019 regulations did not provide explicit rules addressing issuances of stock of an SFC. For example, if a section 245A shareholder owns all the stock of an SFC and the SFC issues new stock to another section 245A shareholder, the second section 245A shareholder would not inherit any portion of the first section 245A shareholder’s EDA regarding the SFC under the successor rules of the 2019 regulations. Treasury and the IRS were concerned that these issuances could raise the same policy concerns as those addressed by the successor rules and, absent rules to address, could facilitate the avoidance of the extraordinary disposition rules by separating an EDA from the E&P to which it relates.

Consider, for example, a case in which FP, a foreign corporation, owns all the stock of US1 and US2, each of which is a domestic corporation, and US1 owns all the stock of CFC1, an SFC whose E&P is maintained in U.S. dollars and as to which US1 has an EDA of $100x. In such a case, if US2 contributes property to CFC1 in exchange for stock representing 99 percent of the stock of CFC1, and thereafter CFC1 pays $100x of dividends pro rata to US1 and US2, only the $1x dividend received by US1 would be an extraordinary disposition amount (US2’s $99x dividend would not, as US2 did not inherit any of US1’s EDA), even though, as a factual matter, the entire $100x of dividends may represent E&P generated by CFC1 in an extraordinary disposition. Moreover, for example, if US1 were to later transfer all of its stock of CFC1 to a U.S. individual, the remaining balance of US1’s EDA regarding CFC1 may never give rise to an extraordinary disposition amount.

Rather than address these transactions solely through the antiabuse rules in Treas. reg. section 1.245A-5, the final regulations provide a rule that treats related domestic corporations as a single domestic corporation for purposes of determining the extent to which a dividend is an extraordinary disposition amount or a tiered extraordinary






disposition amount. Thus, in the example above, the $100x of dividends paid by CFC1 are extraordinary disposition amounts regarding both US1 and US2 as a result of US1’s EDA. The final regulations also treat related domestic corporations as a single domestic corporation for purposes of reducing a section 245A shareholder’s EDA by prior extraordinary disposition amounts.

Effect of Section 338(g) Election

The 2019 regulations did not address whether a section 245A shareholder of the new target succeeded to an EDA regarding the old target in cases in which a section 338(g) election is made regarding an SFC target. The new target does not inherit any of the E&P of the old target. As a result, no distributions by the new target could represent a distribution of E&P of the old target generated in an extraordinary disposition.

Thus, the final regulations provide that, in connection with an election under section 338(g), a section 245A shareholder of the new target generally does not succeed to an EDA regarding the old target. Special rules provide for transactions in which a section 338(g) election is made and not all of the stock of the SFC target is subject to the qualified stock purchase.

Balance After Stock Transfers

Under the 2019 regulations, if a section 245A shareholder ceased to be a section 245A shareholder regarding a lower-tier CFC as a result of a direct or indirect transfer of stock of the lower-tier CFC by an upper-tier CFC, a special rule preserved the section 245A shareholder’s remaining balance of its EDA regarding the lower-tier CFC. Under this rule, the section 245A shareholder’s EDA was preserved by increasing the account regarding the upper-tier CFC by the remaining balance.

Treasury and the IRS believe that this rule should be revised to address the treatment of the remaining balance of a section 245A shareholder’s EDA regarding an SFC in cases in which the section 245A shareholder (the “transferor”) directly or indirectly transfers all of its stock of an SFC. In cases in which no related party regarding the transferor is a section 245A shareholder of the SFC following the transfer, the transferor’s

remaining EDA balance is eliminated, to the extent not allocated or attributed to another EDA.

In these cases, the remaining balance generally represents an individual’s or a foreign (non-CFC) person’s share of E&P of the SFC, such that after the transfer, distributions of the E&P are unlikely to give rise to a dividend eligible for the section 245A deduction. Therefore, there is generally not a policy need to continue tracking such E&P.

However, the elimination rule does not apply if a section 245A shareholder that is a related party of the transferor continues to own stock of the SFC after the transfer — instead, the related section 245A shareholder succeeds to the remaining account balance. Moreover, transactions with a principal purpose of avoiding this limitation on the application of the elimination rule are disregarded. For example, if a U.S. individual acquires all of the stock of an SFC from a section 245A shareholder and later, under a plan that included the acquisition, transfers all of the stock of the SFC to a domestic corporation that is a section 245A shareholder of the SFC, the transfer to the U.S. individual would be disregarded.

The final regulations added a rule that a transfer of stock of an SFC otherwise subject to Treas. reg. section 1.245A-5(c)(4)(iv)(A) is deemed to have been undertaken with a principal purpose of avoiding the purposes described in this antiabuse rule if stock of the SFC is transferred to a section 245A shareholder within one year after the transaction that would be subject to Treas. reg. section 1.245A-5(c)(4)(vii).

Tiered Extraordinary Disposition AmountsThe 2019 regulations limited the application of

the section 954(c)(6) exception regarding certain dividends attributable to extraordinary disposition E&P from a lower-tier CFC to an upper-tier CFC.

A commentator stated that this limitation on the section 954(c)(6) exception gives rise to an incentive to avoid making a distribution (or otherwise generating a dividend to shareholders) to avoid subpart F income. Furthermore, the commentator stated that in certain cases, a dividend subject to this limitation on the section 954(c)(6) exception may nonetheless qualify for an






exception under section 954(c)(3), permitting deferral regarding distributed E&P.

Accordingly, the commentator recommended that the final regulations instead adopt a tracking approach, under which dividends from a lower-tier CFC attributable to extraordinary disposition E&P would be eligible for the section 954(c)(6) exception, and the EDA of an upper-tier CFC receiving a dividend attributable to extraordinary disposition E&P would be increased by the amount of the dividend attributable to extraordinary disposition E&P (while making corresponding downward adjustments to the EDA of the lower-tier CFC).

In the alternative, the commentator recommended that this approach apply solely regarding lower-tier dividends paid before June 18, 2019 (the date on which the 2019 regulations were published), to provide relief regarding dividends from lower-tier CFCs that were expected to qualify for the section 954(c)(6) exception.

Treasury and the IRS believe that limiting the application of the section 954(c)(6) exception in this context is necessary to prevent the inappropriate deferral of tax, and that it minimizes the administrative and compliance burdens associated with a rule that would adjust upper-tier and lower-tier CFCs’ EDAs. The limitation on the section 954(c)(6) exception achieves the appropriate balance between preventing deferral of U.S. tax regarding extraordinary disposition E&P and avoiding incentives to defer distributions.

Similar to the rules limiting the application of the section 245A deduction to distributions attributable to extraordinary disposition E&P under Treas. reg. section 1.245A-5(b), the incentive to defer distributions is mitigated by the fact that the limitation on the section 954(c)(6) exception generally applies only after other E&P (including E&P accumulated after the disqualified period and previously taxed E&P) are distributed.

Furthermore, failing to limit the application of the section 954(c)(6) exception would allow taxpayers to use extraordinary disposition E&P to defer U.S. tax on subsequent taxable transactions. For example, assume that USP owns 100 percent of the stock of CFC1; CFC1 owns 100 percent of

the stock of CFC2; and CFC2’s E&P is maintained in the U.S. dollar. USP has a $100x EDA regarding CFC2, which has no E&P other than $100x of extraordinary disposition E&P. Finally, assume that CFC1 has $100x of built-in gain regarding its stock in CFC2.

In the absence of the extraordinary disposition E&P, a sale of the stock of CFC2 by CFC1 generally would result in $100x of capital gain that is subpart F income taken into account by USP in the year of sale under sections 954(c) and 951(a). With the extraordinary disposition E&P, however, CFC2 could (in the absence of any rule denying the section 954(c)(6) exception) distribute a $100x dividend to CFC1 before the sale, and the dividend could be eligible for the section 954(c)(6) exception while eliminating the built-in gain in the stock of CFC2.

If the rules only transferred the EDA from CFC2 to CFC1, the section 245A shareholder could effectively indefinitely defer recognizing the built-in gain in the stock of CFC2 until it causes CFC1 to pay a $100x dividend. While similar benefits may be obtained in the case of same-country dividends under section 954(c)(3), Treasury and the IRS believe that the transactions are relatively infrequent.

For these reasons, the final regulations did not adopt this recommendation and, accordingly, continue to limit the application of the section 954(c)(6) exception regarding certain dividends attributable to extraordinary disposition E&P from a lower-tier CFC to an upper-tier CFC. The final regulations also provide that transactions structured to use section 954(c)(3) to avoid the purposes of the final regulations are subject to adjustments under the antiabuse rule.

Extraordinary Reductions

Bilateral Election to Close Tax YearIf an extraordinary reduction occurs

regarding a CFC, and there is an extraordinary reduction amount or tiered extraordinary reduction amount greater than zero, the controlling section 245A shareholder (or shareholders) of a CFC can elect to close the CFC’s tax year for all purposes of the code and as a result be considered to not have undertaken an extraordinary reduction. As a condition for making the election, however, the controlling






section 245A shareholders must enter into a written, binding agreement concerning the election with certain U.S. tax-resident shareholders of the CFC.

Because the election can only be made if there is an extraordinary reduction amount or tiered extraordinary reduction amount greater than zero, the election cannot be made if the CFC only has a tested loss for the tax year.

A commentator stated that it was unclear who is required to enter into this agreement and that only the controlling section 245A shareholders at the time of the extraordinary reduction should be required to make such an election. The final regulations provide that each controlling section 245A shareholder participating in the extraordinary reduction with an extraordinary reduction amount greater than zero, and each U.S. tax resident that is a U.S. shareholder of the CFC at the end of the day of the extraordinary reduction (thus including a person that becomes a U.S. shareholder of the CFC by reason of the extraordinary reduction), must enter into a binding agreement to close the tax year of the CFC. This rule is reflected in the analysis of an example in prop. Treas. reg. section 1.245A-5(j)(4)(iii), which was retained in the final regulations.

This approach was not modified as requested by the commentator because closing the tax year of a CFC affects the tax consequences of both the transferors and transferees in an extraordinary reduction, and inconsistent treatment could give rise to inappropriate results (for example, both a transferor and transferee could claim to have income inclusions under sections 951(a) or 951A(a) and claim deemed-paid foreign credits under section 960(a) or (d), regarding the same income of the CFC).

The final regulations also allow a U.S. tax resident that owns its interest in the CFC through a partnership to delegate the authority to enter into the binding agreement on its behalf, provided that the delegation is under a written partnership agreement (within the meaning of Treas. reg. section 1.704-1(b)(2)(ii)(h)).

Finally, changes were made to the scope of the reference to Treas. reg. section 1.964-1(c) regarding the election to close the tax year for extraordinary reductions and to the consistency

requirement of Treas. reg. section 1.245A-5(e)(3)(i)(E).

Election to Close Tax YearCommentators stated that it might not be clear

in certain instances whether an election to close the tax year is beneficial. Accordingly, the commentators recommended that the final regulations provide additional flexibility as to when this election is required to be made.

The final regulations did not adopt this recommendation. The election is timely when filed with the controlling section 245A shareholder’s timely filed (including extensions) original tax return for the tax year in which the extraordinary reduction occurred. Thus, taxpayers have considerable time to decide whether to make the election. Furthermore, permitting later elections would potentially result in amended tax returns and considerable administrative complexity.

Allocation Between Tax PeriodsIf an election is made under Treas. reg. section

1.245A-5(e)(3)(i) to close a CFC’s tax year for all purposes of the code, then all U.S. shareholders that own (within the meaning of section 958(a)) stock of the CFC on that date compute and take into account their pro rata share of subpart F income or tested income earned by the CFC as of that date.

A commentator recommended modifying the “closing-of-the-books” approach because of administrative complexity for the CFC and because the closing-of-the-books method may provide inconsistent results. The commentator also suggested that this approach would provide tax planning opportunities and traps for the unwary because an extraordinary item of income (for example, gain from the disposition of a capital asset) might arise pre- or post-sale, but the item would only be allocated to the period in which it arises.

The commentator instead recommended adopting principles similar to those in Treas. reg. section 1.1248-3 to allocate subpart F income and tested income of a CFC between the pre- and post-sale portions of the year based on a daily proration. The commentator acknowledged, however, that this approach could delay restructuring or commercial decisions and






suggested allowing a taxpayer to elect to allocate extraordinary items to the period in which they arise, similar to an approach under Treas. reg. section 1.1502-76(b).

The final regulations did not adopt this comment for several reasons. First, the election under Treas. reg. section 1.245A-5(e)(3)(i) is provided to allow controlling section 245A shareholders and U.S. tax residents to agree to close the CFC’s tax year and take into account their pro rata share of subpart F or tested income earned by that date in lieu of being subject to the extraordinary reduction rules. Treasury and the IRS believe that closing the tax year provides a more precise method for determining the amount of subpart F income and tested income attributable to each owner. Second, the rule provides taxpayers with flexibility, given that controlling section 245A shareholders may choose not to make the election (or U.S. tax residents may choose not to agree to make the election) in cases in which it would not provide the preferred outcome. Finally, the commentator’s recommended approaches present administrative complexities and may delay commercial transactions.

ReportingFor purposes of determining a controlling

section 245A shareholder’s extraordinary reduction amount, the shareholder’s pre-reduction pro rata share of subpart F income or tested income is reduced by specified amounts taken into account by transferee shareholders. A commentator indicated that it may be difficult for a controlling section 245A shareholder to determine a transferee’s pro rata share of subpart F income or tested income and recommended that the final regulations provide that a controlling section 245A shareholder may make this determination by relying on information provided by a transferee in accordance with IRS forms and instructions.

While Treasury and the IRS may consider whether information reporting would be appropriate in this context in future guidance, the final regulations did not adopt this recommendation. Parties to an extraordinary reduction transaction can negotiate to share the needed information, however. Furthermore, in some instances, parties to an extraordinary

reduction transaction are related and therefore readily have access to such information.

Nonrecognition TransactionsLike the 2019 regulations, the final regulations

do not contain special rules for extraordinary reductions occurring as a result of nonrecognition transactions such as reorganizations or transfers subject to section 351(a) or 721(a). Treasury and the IRS continue to study these transactions and the potential to use them to avoid the purposes of the extraordinary reduction rules.

For example, Treasury and the IRS are concerned that taxpayers may avail themselves of partnerships to attempt to shift the tax liability, in whole or in part, regarding E&P of a CFC attributable to subpart F income or tested income to a related foreign partner that is not owned by a U.S. shareholder. Treasury and the IRS requested comments on this matter and other cases in which nonrecognition transactions could be used to avoid the purposes of the extraordinary reduction rules.

Antiabuse Rule

One commentator said that the antiabuse rule is vague and overly broad. The commentator stated that although the policies underlying the extraordinary disposition rules and the extraordinary reduction rules are related, the origins of the transactions giving rise to the concerns and the focus of the two rules differ. Accordingly, the commentator recommended that the final regulations clarify the purposes of Treas. reg. section 1.245A-5 and include examples regarding the applicability of the antiabuse rule and the scope of the adjustments that may be made under the rule.

In response to this comment, the final regulations include examples illustrating the application of the antiabuse rule. Treas. reg. section 1.245A-5(h) and (j)(8)-(10). Also, Treasury and the IRS determined that the antiabuse rule should be self-executing rather than applicable under the discretion of the commissioner. Accordingly, the antiabuse rule is modified to this effect.

Applicability Date

The proposed regulations incorporated the applicability date of the temporary regulations by






cross-reference. The temporary regulations apply to distributions made after December 31, 2017, consistent with the applicability date of section 245A. The temporary regulations were issued under section 7805(b)(2), which permits Treasury and the IRS to issue retroactive regulations within 18 months of the enactment of the statutory provision to which the regulations relate.

The final regulations apply to tax periods ending on or after June 14, 2019 — the date the proposed regulations were filed with the Federal Register.

In a case in which both the temporary regulations and the final regulations could apply, only the final regulations apply. Treas. reg. section 1.245A-5(k)(1). For example, if a CFC has a tax period ending on November 30, 2019, and it made a distribution during that period on December 1, 2018, a portion of which would be an ineligible amount, the final regulations apply to the distribution. Distributions made after December 31, 2017, and before the final regulations apply, continue to be subject to the rules set forth in the temporary regulations. However, a taxpayer may choose to apply the final regulations to distributions made during this period, provided that the taxpayer and all related parties consistently apply the final regulations in their entirety.

Proposed Section 245A Regulations

As discussed above, Treasury and the IRS issued final section 245A regulations intended either to eliminate a perceived abuse or rewrite the statute’s effective dates, depending upon one’s perspective. In doing so, the possibility for excess taxation can result. These proposed regulations are an attempt to ameliorate that result. They are quite complicated.

Specifically, the new proposed section 245A regulations address whether and how to coordinate the extraordinary disposition rule and the DQB rule. In certain cases, the extraordinary disposition rule and the DQB rule, when applied together, can give rise to excess taxation as to a section 245A shareholder (or as to the section 245A shareholder and a related party).

For example, consider a case in which a CFC that is wholly owned by a section 245A shareholder sells an item of specified property

during the disqualified period to another CFC that is wholly owned by the section 245A shareholder. There is a single amount of gain (the gain that the transferor CFC recognizes upon the sale) that gives rise to both extraordinary disposition E&P of the transferor CFC (the E&P generated upon the sale) and DQB in the item of specified property held by the transferee CFC (the basis step-up in the item of specified property resulting from the sale).

The gain will in effect be subject to U.S. tax as to the section 245A shareholder in cases in which the extraordinary disposition E&P is distributed as a dividend by the transferor CFC. Also, an amount (such as an amount of future gross tested income of the transferee CFC) equal to the gain might be indirectly taxed as to the section 245A shareholder as a result of not being offset or reduced by deductions or losses attributable to the DQB (because, but for the DQB rule, such deductions or losses would have offset or reduced the amount and sheltered it from U.S. tax).

The DQB rule may in certain cases also have the effect of reducing, in an amount equal to the gain, E&P of the transferee CFC that would otherwise have been eligible for the section 245A deduction in cases in which it is distributed as a dividend to the section 245A shareholder. This could occur because, in general, deductions or losses that are subject to the DQB rule nevertheless reduce E&P.

Treasury and the IRS believe that one approach would permit taxpayers to effectively unwind the tax effect of an extraordinary disposition. Under this approach, a section 245A shareholder’s EDA would be eliminated if, regarding each item of specified property taken into account in determining the initial balance of the account, an election were made under Treas. reg. section 1.951A-3(h)(2)(ii)(B)(3) to reduce the item’s adjusted basis (and thus eliminate the item’s DQB) and provided that certain other requirements were met (for example, the person to which the item of specified property was transferred in the extraordinary disposition was a CFC, which remains a CFC for at least five years after the extraordinary disposition).

However, the proposed regulations did not adopt this approach. Treasury and the IRS determined that it could give rise to inappropriate






results, such as the elimination of an EDA in cases in which it is unlikely that the extraordinary disposition rule and the DQB rule, when applied together, would result in excess taxation.

Also, the approach could be difficult to administer. For example, after the extraordinary disposition, the CFC to which the specified property was transferred might be transferred outside the U.S. taxing jurisdiction but remain a CFC because of the the TCJA’s repeal of section 958(b)(4), with the result that in effect there is little or no U.S. tax cost to the CFC having reduced the adjusted basis (and eliminated the DQB) of the item of specified property. Furthermore, because the EDA regarding the transferor CFC would have been eliminated, the E&P attributable to the extraordinary disposition could reduce gain that would otherwise be recognized on the disposition of stock of the transferor CFC as a result of the section 245A deduction.

Moreover, there would be additional administrative and compliance burdens if the regulations adopted an approach under which an EDA is tentatively eliminated in cases in which elections are made under Treas. reg. section 1.951A-3(h)(3) to reduce adjusted bases (and eliminate DQB), but then the EDA is retroactively restored if the transferee CFC ceases to be a CFC or becomes a CFC only by reason of the repeal of section 958(b)(4).

The second approach would adjust DQB of an item of specified property to the extent that gain to which the DQB is attributable is in effect subject to U.S. tax by reason of the extraordinary disposition rule. Similarly, an EDA of a section 245A shareholder would be adjusted to the extent that, regarding DQB attributable to gain to which the EDA is also attributable, the DQB gives rise to deductions or losses that are allocated and apportioned to residual CFC gross income of a CFC by reason of the DQB rule.

The proposed regulations use a coordination mechanism that is broadly consistent with this approach. The coordination mechanism involves two operative rules — one that reduces DQB in certain cases (the “DQB reduction rule”) and another that reduces an EDA in some cases (the “EDA reduction rule”).

Also, to reduce burdens and to facilitate compliance, the proposed regulations provide two

versions of both the DQB reduction rule and the EDA reduction rule, similar to the approach taken in Treas. reg. section 1.1248-2 and 1.1248-3 (providing rules for determining E&P attributable to a block of stock in simple and complex cases). These versions achieve the same results. The first version (prop. Treas. reg. section 1.245A-7) may be applied to so-called simple cases, and the second version (prop. Treas. reg. section 1.245A-8) applies to complex cases.

As discussed below, the simple case is complex, and the complex case is extraordinarily complex (similar to Treas. reg. section 1.1248-2 and -3). Treasury and the IRS’s interest in eliminating a perceived abuse has opened the proverbial door to a whole new universe.

The rules for simple cases may be applied in cases in which two conditions are satisfied. These conditions eliminate the need for certain additional rules that are necessary under the version for complex cases. The first condition provides requirements related to the seller SFC regarding which there is an EDA. The second condition provides requirements related to an item of specified property for which an extraordinary disposition occurred and to the buyer CFC holding the item.

As an example, the version for simple cases generally applies if:

• the seller SFC is wholly owned (directly or indirectly, within the meaning of section 958(a)) by the section 245A shareholder at the time of the extraordinary disposition and remains wholly owned by the section 245A shareholder;

• the seller SFC does not succeed to E&P of another SFC regarding which there is an EDA;

• the items of specified property for which an extraordinary disposition occurred are acquired by a buyer CFC wholly owned by the section 245A shareholder and certain related parties, and the buyer CFC remains wholly owned by the section 245A shareholder and certain related parties; and

• the buyer CFC retains the items of specified property it acquires in the extraordinary disposition and does not acquire items of specified property with DQB that were transferred in another extraordinary disposition.






The determination as to whether the version for simple cases is available is made regarding a tax year of a section 245A shareholder. If the conditions for applying the version for simple cases are not satisfied for a tax year, then the version for complex cases must be applied beginning with that tax year and all subsequent tax years. Also, if the conditions for applying the version for simple cases are satisfied for a tax year but the section 245A shareholder chooses not to apply the version for simple cases for that tax year, then the version for complex cases applies to that tax year. However, for a subsequent tax year, the section 245A shareholder may apply the version for simple cases, provided that the conditions for applying the version for simple cases are satisfied for that tax year and have been satisfied for all earlier tax years.

Further, for purposes of determining whether the conditions for applying the version for simple cases are satisfied, any requirement that references a section 245A shareholder, an SFC, or a CFC does not include a successor of the section 245A shareholder, the SFC, or the CFC, respectively.

As a result, the version of the rules for simple cases is not available if the section 245A shareholder’s EDA regarding an SFC has been adjusted in accordance with the successor rules of Treas. reg. section 1.245A-5(c)(4). Thus, for example, the version of the rules for simple cases is not available if the assets of the section 245A shareholder are acquired by another domestic corporation, or if the assets of the seller SFC are acquired by another SFC, in each case, in a transaction described in section 381 and subject to Treas. reg. section 1.245A-5(c)(4)(i) or (ii), respectively.

Rules for Simple Cases

The DQB Reduction RuleThe DQB reduction rule provides that in cases

in which an EDA of a section 245A shareholder gives rise to an extraordinary disposition amount or tiered extraordinary disposition amount, the disqualified bases of certain items of specified property are reduced by the same amount solely for purposes of Treas. reg. section 1.951A-2(c)(5). This rule is intended to ensure that as the extraordinary disposition rule applies to cause

gain — to which extraordinary disposition E&P are attributable — to in effect be subject to U.S. tax, the DQB rule generally does not apply to the basis of an item of specified property attributable to that gain (because that basis is no longer generated at no U.S. tax cost), and, accordingly, items of deduction or loss attributable to that basis become eligible to offset income subject to U.S. tax.

For a tax year of a section 245A shareholder, the disqualified bases of items of specified property that correspond to the section 245A shareholder’s EDA are generally reduced by the sum of the extraordinary disposition amounts or tiered extraordinary disposition amounts for the tax year. This correspondence requirement is intended to ensure that the rule only reduces DQB of an item of specified property that is attributable to gain that was taken into account in determining the initial balance of the account, and thus that the rule does not reduce DQB of an item of specified property that is attributable to other gain (for example, DQB of an item of specified property that corresponds to an EDA of another section 245A shareholder or that does not correspond to an EDA).

The amount of the reduction under the DQB reduction rule is allocated pro rata across the DQB of each item of specified property that corresponds to the section 245A shareholder’s EDA based on the item’s DQB, relative to the aggregate disqualified bases of the items. Treasury and the IRS believe that a pro rata approach is appropriate because the initial balance of the EDA reflects an aggregate of the gain of each item of specified property that corresponds to the account (reduced by losses regarding certain items of specified property). Also, alternative approaches would be unduly complex, such as a stacking approach in accordance with which a reduction is applied first regarding DQB of a particular item of specified property, then regarding another item of specified property, and so on.

Timing Rules

For purposes of applying the DQB reduction rule for a tax year of a section 245A shareholder, DQB of an item of specified property is determined as of the beginning of the tax year of the CFC holding the item that includes the date on






which the section 245A shareholder’s tax year ends (and, to avoid circularity issues, without regard to any reductions to DQB of the item of specified property under the DQB reduction rule for that tax year of the CFC). Then, DQB of the item of specified property is reduced as of the beginning of the tax year of the CFC. Thus, for example, DQB of an item of specified property is reduced before any depreciation, amortization, or other cost recovery deduction allowances attributable to the basis of the item are determined for the CFC’s tax year.

The EDA Reduction RuleThe EDA reduction rule provides that in cases

in which items of deduction or loss attributable to DQB of an item of specified property are allocated and apportioned to residual CFC gross income of a CFC and have the effect of reducing certain E&P of the CFC that could otherwise qualify for the section 245A deduction when distributed, the EDA to which the specified property corresponds is reduced by up to the same amount.

This rule is generally intended to ensure that because the application of the DQB rule results in income of the CFC being indirectly taxed to a section 245A shareholder (or a related party that is a domestic corporation, a “domestic affiliate”) and a reduction in the E&P of the CFC available to be distributed to the section 245A shareholder and any domestic affiliates as a dividend to which the section 245A deduction could be available if distributed, the extraordinary disposition rule no longer applies to E&P attributable to gain, to which the DQB is also attributable.

Requiring reduction in the capacity to pay dividends for which the section 245A deduction could be available if the E&P were distributed ensures that the EDA reduction rule applies only once the DQB rule has resulted in a tax detriment to the section 245A shareholder (or a domestic affiliate). To the extent that there has not been a reduction in the CFC’s capacity to pay dividends for which the section 245A deduction could be available if the E&P were distributed, the DQB rule might generally not give rise to a tax detriment to the section 245A shareholder (or a domestic affiliate).

This is because the section 245A shareholder’s (or domestic affiliate’s) basis in its stock of the CFC is generally increased under section 961 by

the amount of the income indirectly taxed to the section 245A shareholder (or domestic affiliate). Such basis increase is, for example, available to reduce gain that would otherwise be recognized on a disposition of stock of the CFC (including gain that would be taxed at the full corporate tax rate even though, for instance, the basis increase is attributable to an inclusion under section 951A that in effect is taxed at a preferential rate).

For a tax year of a CFC, a section 245A shareholder’s EDA is generally reduced by the lesser of two amounts. The first amount is intended to approximate in an administrable manner the extent to which the DQB rule (by reason of the allocation and apportionment of items of deduction or loss to residual CFC gross income of the CFC) reduced the E&P of the CFC available to be distributed to the section 245A shareholder and any domestic affiliates as a dividend to which the section 245A deduction could be available. In order to reduce administrative and compliance burdens, the proposed regulations disregard the holding period requirement of section 246(c) for purposes of determining if a section 245A deduction would be available if E&P were distributed.

To compute the first amount, the CFC’s E&P at the end of the tax year are determined, taking into account distributions during the tax year. Then, those E&P are adjusted, including by generally increasing the E&P by items of deduction or loss that are or have been allocated to residual CFC gross income of the CFC solely by reason of the DQB rule (“adjusted earnings”).

Lastly, the adjusted earnings are reduced by the sum of the previously taxed E&P accounts regarding the CFC under section 959 (taking into account any adjustments to the accounts for the tax year) in order to reflect that an amount equal to such sum would not have been eligible for the section 245A deduction were it distributed by the CFC to the section 245A shareholder and any domestic affiliates.

The second amount necessary to determine the reduction in a section 245A shareholder’s EDA is the balance of the section 245A shareholder’s residual gross income account (RGI account) regarding the CFC. The balance of the RGI account generally reflects items of deduction or loss allocated and apportioned to residual CFC






gross income of the CFC solely by reason of the DQB rule, to the extent that the allocation and apportionment is likely to increase income of the CFC that is subject to U.S. taxation at the level of the section 245A shareholder and any domestic affiliates under section 951 or 951A.

Tracking the items of deduction or loss through an account mechanism allows for a reduction under — and facilitates compliance with — the EDA reduction rule in certain cases — for example, a case in which a CFC does not have any adjusted earnings for its tax year in which items of deduction or loss are allocated and apportioned to residual CFC gross income (such that there cannot be a reduction under the EDA reduction rule to the section 245A shareholder’s EDA that year) but in a later tax year has sufficient adjusted earnings to allow for a reduction.

Timing Rules

A reduction to an EDA of a section 245A shareholder by reason of the application of the EDA reduction rule regarding a tax year of the CFC occurs as of the end of the tax year of the section 245A shareholder that includes the date on which the CFC’s tax year ends (and, for example, after the determination of any extraordinary disposition amounts or tiered extraordinary disposition amounts for the tax year). Thus, a reduction to a section 245A shareholder’s EDA under the EDA reduction rule occurs after the application of the DQB reduction rule for the tax year of the section 245A shareholder.

Absent such an approach, there could be circularity issues because the computation of a reduction under one rule might depend on an amount that is potentially affected by the other rule, and it would be unclear which rule applies first. Applying the EDA reduction rule at the end of a tax year also ensures that it applies after the full effect of the DQB rule has been taken into account for the year.

Rules for Complex Cases

The DQB Reduction RuleThe version of the DQB reduction rule for

complex cases uses the same architecture as the version of the rule for simple cases, but it provides additional rules to address scenarios in which the

conditions provided in prop. Treas. reg. section 1.245A-6(b)(1) and (2) are not satisfied. Prop. Treas. reg. section 1.245A-8. For example, the version for complex cases addresses scenarios in which, after the extraordinary disposition of an item of specified property, the item is transferred to another person (whether the transfer is taxable or nontaxable).

Ownership Requirement

To address the possibility that an item of specified property has been transferred after the extraordinary disposition (with the result that the section 245A shareholder or a related party may not directly or indirectly own an interest in the item), the version of the DQB reduction rule for complex cases provides that an ownership requirement must be satisfied for DQB of an item of specified property to be eligible for relief under the DQB reduction rule.

The ownership requirement is intended to ensure that the DQB reduction rule applies regarding an item of specified property only if it is likely that the section 245A shareholder (or the section 245A shareholder and a related party) would be meaningfully affected by the application of the DQB rule as to the item of specified property such that, absent the DQB reduction rule, the extraordinary disposition rule and the DQB rule would, in cases in which they are applied together, result in meaningful excess taxation as to the section 245A shareholder (or the section 245A shareholder and a related party).

Also, the ownership requirement is intended to ensure that the DQB reduction rule takes into account only disqualified bases of items of specified property for which the section 245A shareholder can reasonably be expected to have or obtain the necessary information to accurately apply the DQB reduction rule.

The ownership requirement is satisfied regarding an item of specified property if, on one or more days during the tax year of the section 245A shareholder, the item is held by the section 245A shareholder, a related party, or a specified entity in which the section 245A shareholder or a related party owns directly or indirectly at least a 10 percent interest. Prop. Treas. reg. section 1.245A-8(b)(3). As a result, the DQB reduction rule can apply to, for example, an item of specified property that is sold at a loss by a CFC of the






section 245A shareholder to a third party on any day that falls within the tax year of the section 245A shareholder, such that a reduced portion of the CFC’s loss will be attributable to DQB and thus subject to the DQB rule for the CFC’s tax year.

As an additional example, the DQB rule can apply to an item of specified property that is held by a CFC of the section 245A shareholder, all the stock of which is sold by the section 245A shareholder to a third party on any day that falls within the tax year of the section 245A shareholder, such that a reduced portion of the CFC’s amortization deductions regarding the specified property for its tax year that includes the sale and its subsequent tax years will be subject to the DQB rule.

Basis Benefit Amounts

In certain cases in which an item of specified property with DQB is transferred after the extraordinary disposition of the item, the extraordinary disposition rule and the DQB rule, when applied together, do not give rise to excess taxation as to a section 245A shareholder (or as to the section 245A shareholder and a related party). This may occur, for example, if the section 245A shareholder benefits from the DQB of the item of specified property under a transaction that is not subject to the DQB rule. This could occur through a sale of the item by a CFC of the section 245A shareholder to an unrelated person at a gain (with the result that, but for the use of the DQB, the CFC would have had a greater amount of gain that would have been taken into account in computing the CFC’s tested income). In such a case, the DQB reduction rule need not apply to an amount of the section 245A shareholder’s EDA equal to the amount of the DQB benefit. Prop. Treas. reg. section 1.245A-10(c)(2) (Example 2).

The proposed regulations provide that, for a tax year of a section 245A shareholder, the amount of the reduction to disqualified bases under the DQB reduction rule is equal to the sum of the extraordinary disposition amounts or tiered extraordinary disposition amounts for the tax year, less the balance of the section 245A shareholder’s basis benefit account regarding the EDA. A basis benefit account regarding an EDA generally reflects the extent to which the DQB of one or more items of specified property that correspond to the EDA has been used to offset or

reduce income subject to U.S. tax (the use of DQB to such an extent, a basis benefit amount).

For these purposes, the use of DQB by a U.S. tax resident to offset or reduce taxable income, or the use of DQB by a foreign person (including a CFC) to offset or reduce income effectively connected with a trade or business in the United States, is always considered to offset or reduce income subject to U.S. tax.

As an example, in the case of an item of specified property that is held by a U.S. tax resident and that has DQB by reason of the application of Treas. reg. section 1.951A-3(h)(2)(ii)(B)(1)(ii) to a previous transfer of the item of specified property by a related CFC to the U.S. tax resident, there is a basis benefit amount equal to the portion of the DQB that gives rise to an item of depreciation or amortization of the U.S. tax resident for a tax year of the U.S. tax resident.

However, the use of DQB by a CFC to offset or reduce income taken into account in computing subpart F income, tested income, or tested loss is considered to offset or reduce income subject to U.S. tax only if the CFC is described in Treas. reg. section 1.267A-5(a)(17), and thus a meaningful portion of the CFC’s income is indirectly subject to current U.S. tax.

DQB can be used to reduce or offset income subject to U.S. tax regardless of whether the DQB is reduced or eliminated under Treas. reg. section 1.951A-3(h)(2)(ii)(B)(1). For example, in a case in which a CFC sells an item of specified property with DQB to a related CFC, the rule of Treas. reg. section 1.951A-3(h)(2)(ii)(B)(1) generally does not prevent the DQB from reducing or offsetting income subject to U.S. tax (for instance, income from the sale that, but for the use of the DQB, would have been taken into account in computing the seller CFC’s tested income), even though the buyer CFC succeeds to the DQB under the rule. Thus, the proposed regulations provide that a basis benefit amount can be created from the use of DQB regardless of whether the DQB is reduced or eliminated as a result.

Further, the proposed regulations provide certain timing rules regarding when the use of DQB gives rise to a basis benefit amount. For example, if an item of deduction or loss arising from the use of DQB is deferred under section 267(a)(2), then the determination of whether a






basis benefit amount arises is made when, in a later tax year, the deduction or loss is no longer deferred.

Similarly, if an item of deduction or loss arising from the use of DQB of an item of specified property is disallowed under section 267(a)(1), then a basis benefit amount would arise when and to the extent that gain is reduced on the sale of that specified property (or other property with basis determined by reference to that specified property) under section 267(d) in the hands of specified persons whose income is directly or indirectly subject to U.S. tax.

Adjustments to a Basis Benefit Account

A basis benefit account is adjusted at the end of each tax year of a section 245A shareholder. Generally, the basis benefit account is increased by a basis benefit amount regarding an item of specified property that corresponds to the EDA, provided that the basis benefit amount is assigned to the tax year of the section 245A shareholder. However, in the case in which the extraordinary disposition ownership percentage regarding the EDA is less than 100 percent (such that the initial balance of the EDA reflects only a portion of the gain from the extraordinary disposition of the item of specified property), only the same ratable portion of the basis benefit amount may increase the basis benefit account.

A basis benefit amount regarding an item of specified property is assigned to a tax year of a section 245A shareholder if two conditions are satisfied. First, the ownership requirement must be satisfied regarding the item of specified property. As a result of this first condition, a basis benefit amount is assigned to a tax year of a section 245A shareholder (and thus only limits a potential reduction under the DQB reduction rule) only if the use of the DQB giving rise to the basis benefit amount provides a meaningful benefit to the section 245A shareholder or a related party. This condition is also intended to ensure that the section 245A shareholder can reasonably be expected to obtain information about the item of specified property necessary to accurately calculate and reflect the basis benefit amount.

Second, the use of the DQB must occur in the section 245A shareholder’s tax year (in a case in which the section 245A shareholder is the person

that uses the DQB) or a tax year of a person ending with or within — or, in certain cases, beginning with or within — the tax year of the section 245A shareholder (in a case in which the section 245A shareholder is not the person that uses the DQB).

As a result of these assignment rules, in a case in which a CFC of a section 245A shareholder holds an item of specified property and the CFC sells the item of specified property (or the section 245A shareholder sells all of the stock of the CFC) to a third party on a day that falls within the tax year of the section 245A shareholder, a use by the CFC of DQB of the specified property to generate a basis benefit amount on a day that falls within the same tax year of the section 245A shareholder is generally assigned to that tax year of the section 245A shareholder.

At the end of each tax year of a section 245A shareholder, the balance of a basis benefit account is decreased to the extent that the basis benefit account limits a reduction under the DQB reduction rule.

DQB Timing Rules

To address the possibility that an item of specified property is held by a person other than a CFC, the timing rules for purposes of the version of the DQB reduction rule for complex cases provide that DQB of an item of specified property is generally determined and reduced as of the beginning of the tax year of the specified property owner of the item. The specified property owner of an item of specified property is generally the person that held the item of specified property on at least one day during the tax year of the person that includes the date on which the section 245A shareholder’s tax year ends.

Also, to address cases in which, absent a special rule, two or more persons might be considered the specified property owner, a special rule provides that the specified property owner is the person that held the item of specified property on the earliest date that falls within the section 245A shareholder’s tax year.

Thus, for example, if CFC1 transfers an item of specified property to CFC2 on a date that falls within the tax year of a section 245A shareholder, and the tax year of each of CFC1 and CFC2 includes the day of the close of the tax year of the section 245A shareholder, then CFC1 (and not CFC2) would be the specified property owner for






purposes of applying the DQB reduction rule for the tax year of the section 245A shareholder.

The EDA Reduction RuleThe version of the EDA reduction rule for

complex cases uses the same architecture as the version of the rule for simple cases but provides additional rules to address scenarios in which the conditions provided in Treas. reg. section 1.245A-6(b) are not satisfied.

For example, the version for complex cases addresses scenarios in which the CFC that holds an item of specified property that corresponds to an EDA of a section 245A shareholder is not wholly owned by the section 245A shareholder and any domestic affiliates, or the CFC also holds an item of specified property that corresponds to another EDA.

Computing the Reduction

The EDA reduction rule depends in part on the extent to which the DQB rule has, as to a CFC that holds items of specified property that correspond to an EDA of a section 245A shareholder regarding an SFC, reduced E&P of the CFC available to be distributed to the section 245A shareholder and any domestic affiliates as a dividend to which the section 245A deduction could be available.

The EDA reduction rule for complex cases provides several additional rules for purposes of measuring this reduction to the CFC’s capacity to pay dividends eligible for the section 245A deduction, to address the possibility that the section 245A shareholder and any domestic affiliates do not own all of the stock of the CFC (including because the section 245A shareholder or a domestic affiliate disposed of stock of the CFC during the CFC’s tax year), as well as other issues.

First, the version for complex cases provides an ownership requirement under which, for the section 245A shareholder’s EDA to be reduced by reason of the application of the EDA reduction rule regarding a tax year of the CFC, the section 245A shareholder (or a domestic affiliate) must be a U.S. shareholder regarding the CFC on the last day of the CFC’s tax year. The ownership requirement is measured on the last day of a CFC’s tax year because the EDA reduction rule depends on a section 245A shareholder’s portion

of the CFC’s adjusted earnings, which are measured on an annual basis.

Second, the version for complex cases provides special rules for deficits of the CFC subject to Treas. reg. section 1.381(c)(2)-1(a)(5). These rules generally provide that the CFC’s adjusted earnings are determined by not taking into account these deficits in determining E&P because in general the deficits do not affect or limit the CFC’s ability to distribute its other E&P as a dividend.

Also, for purposes of determining a CFC’s adjusted earnings, the CFC’s E&P are reduced by the amount of items of deduction or loss that are attributable to DQB and that give or have given rise to a deficit subject to Treas. reg. section 1.381(c)(2)-1(a)(5). This is because the application of the DQB rule to these items has not affected or limited the CFC’s ability to distribute certain earnings as a dividend, and reducing the CFC’s E&P by the amount of the items generally ensures that the application of the DQB rule to these items does not give rise to relief under the EDA reduction rule. A CFC could have a deficit subject to Treas. reg. section 1.381(c)(2)-1(a)(5) and comprising items of deduction or loss attributable to DQB if, for example, the CFC acquired in a transaction subject to section 381 the assets of another CFC that held items of specified property with DQB.

Third, the version for complex cases provides a rule that allocates the CFC’s adjusted earnings to the section 245A shareholder based on the percentage of stock of the CFC that the section 245A shareholder and any domestic affiliates own. This allocation serves as a proxy for measuring the portion of the adjusted earnings of the CFC that the section 245A shareholder and any domestic affiliates would receive if the CFC were to distribute all of its adjusted earnings to its shareholders.

The adjusted earnings as so allocated to a section 245A shareholder are further adjusted to reflect certain previously taxed E&P accounts regarding the CFC, certain hybrid deduction accounts regarding shares of stock of the CFC, and the balance of any EDAs regarding the CFC (other than, in general, the portion of the balance of an EDA regarding the CFC that, by reason of a merger or similar transaction of the SFC into the






CFC or vice versa, is attributable to an EDA regarding the SFC).

The end result is intended to measure the extent to which the DQB rule has reduced E&P of the CFC available to be distributed to the section 245A shareholder and any domestic affiliates as a dividend to which the section 245A deduction could be available.

Computing the Increase to an RGI Account

The EDA reduction rule depends in part on the balance of a section 245A shareholder’s RGI account regarding a CFC. The EDA reduction rule for complex cases provides several additional rules for purposes of computing an increase to a section 245A shareholder’s RGI account regarding a CFC.

First, to address the possibility that the CFC may hold multiple items of specified property, some of which correspond to an EDA of the section 245A shareholder and others of which correspond to another EDA (or to no EDA), the rule for complex cases provides that the section 245A shareholder’s RGI account can be increased only by items of deduction or loss (to which the DQB rule applies) that are attributable to DQB of an item of specified property that corresponds to the section 245A shareholder’s EDA.

Also, in cases in which the section 245A shareholder owned less than all of the stock of the SFC when the SFC undertook an extraordinary disposition (such that the extraordinary disposition ownership percentage as to the section 245A shareholder’s EDA regarding the SFC is less than 100 percent), the section 245A shareholder’s RGI account can be increased by only the same ratable portion of the items of deduction or loss.

These rules ensure that a reduction under the EDA reduction rule to the section 245A shareholder’s EDA can occur only by reason of the application of the DQB rule to the portion of DQB of an item of specified property that is attributable to gain to which the EDA is also attributable.

Further, to address the possibility that the section 245A shareholder and any domestic affiliates do not own all of the stock of the CFC holding items of specified property that correspond to an EDA of the section 245A shareholder, a limit applies regarding the extent

to which an item of deduction or loss (or portion thereof) may increase the section 245A shareholder’s RGI account.

The limit is generally based on the portion of the CFC’s subpart F income or tested income taken into account by the section 245A shareholders and any domestic affiliates under section 951 or 951A. This limit ensures that a reduction under the EDA reduction rule to the section 245A shareholder’s EDA can occur only to the extent that the application of the DQB rule has likely increased income of the CFC that is subject to U.S. taxation at the level of the section 245A shareholder and any domestic affiliates.

Allocating Reductions

Because a reduction under the EDA reduction rule to an EDA may be a function of certain adjusted earnings of a CFC (that is, an amount that is not regarding the EDA), absent a special rule in certain complex cases, the adjusted earnings could give rise to a reduction to two or more EDAs that in aggregate exceeds the adjusted earnings.

This could occur, for example, in a case in which a section 245A shareholder has two EDAs (that is, an EDA regarding two SFCs) and owns all the stock of a CFC, which in turn owns the items of specified property that correspond to each of the EDAs. In that case the aggregate amount of reductions to the EDAs could exceed the extent to which the application of the DQB rule has, as measured by certain adjusted earnings of the CFC allocated to the section 245A shareholder, reduced the earnings of the CFC available to be distributed to the section 245A shareholder as a dividend to which the section 245A deduction could apply.

The proposed regulations provide a rule that limits the aggregate reductions to EDAs by reason of the application of the EDA reduction rule regarding a tax year of a CFC to certain adjusted earnings of the CFC. The proposed regulations also provide an example illustrating this rule.

Finally, the proposed regulations provide a rule that prevents an EDA from being reduced below the balance of the basis benefit account that relates to the EDA. This limitation may occur if extraordinary disposition E&P (and therefore the initial balance of the EDA) reflect losses recognized regarding one or more items of






specified property transferred in the extraordinary disposition.

Items of Specified Property

In certain complex cases, an item of property may have DQB even though the item itself was not transferred as part of an extraordinary disposition. For example, a share of stock may have DQB if the share was received in exchange for an item of specified property with DQB in a transaction to which section 351 applies. Absent special rules, the share of stock would not correspond to an EDA of a section 245A shareholder, and thus, for example, the DQB of the share of stock could not be reduced under the DQB reduction rule.

The proposed regulations provide special rules to address this and similar issues. For instance, the proposed regulations provide that certain items of property that have DQB by reason of Treas. reg. section 1.951A-3(h)(2)(ii)(B)(2)(i) (increase corresponding to adjustments in other property), (ii) (exchanged basis property), or (iii) (increase by reason of section 732(d)) are generally treated as items of specified property that correspond to an EDA of a section 245A shareholder.

As a result, the DQB of such items of property may be reduced under the DQB reduction rule, and items of deduction and loss attributable to such DQB and allocated and apportioned to residual CFC gross income of a CFC may give rise to a reduction to an EDA under the EDA reduction rule.

The proposed regulations also include an anti-duplication rule to ensure that DQB of an item of specified property, as well as DQB of another item of property attributable to that DQB (“duplicate DQB”), are not both taken into account for purposes of the DQB reduction rule, as taking into account both amounts of DQB could inappropriately limit the reductions under the DQB reduction rule. Also, to the extent that under the anti-duplication rule duplicate DQB is not taken into account for purposes of the DQB reduction, the duplicate DQB is generally reduced to the same extent that the DQB of the item of specified property to which the duplicate DQB is attributable is reduced.

As an example of the application of these special rules, consider a case in which a single

item of specified property (“Item A”) corresponds to an EDA of a section 245A shareholder, and Item A is transferred in a transaction to which section 351 applies in exchange for a share of stock (“Item B”). Also, assume that the EDA gives rise to a $10x extraordinary disposition amount and that, at that time, Item A has $10x of DQB and Item B also has $10x of DQB (all of which is attributable to the DQB of Item A).

Here, Item B is considered an item of specified property that corresponds to the EDA, but generally only the DQB of Item A is taken into account for purposes of the DQB reduction rule, with the result that the entire $10x reduction under the DQB reduction rule is allocated to Item A (such that Item A’s DQB is reduced by $10x). However, under the special rule of prop. Treas. reg. section 1.245A-8(b)(5)(i)(B), Item B’s DQB is then reduced by the same amount.

Extraordinary Disposition

In some complex cases, an EDA of a section 245A shareholder may be adjusted in accordance with the rules of Treas. reg. section 1.245A-5(c)(4), with the result, for example, that another section 245A shareholder succeeds to a portion of the EDA or a portion of the EDA is attributed to another EDA. The proposed regulations provide two sets of special rules to address these cases.

First, in cases in which a portion of an EDA (the “attributed account”) is attributed to another EDA (the “successor account”), the proposed regulations ensure that the disqualified bases of the items of specified property that correspond to the attributed account are eligible to be reduced under the DQB reduction rule by reason of an amount in the successor account that gives rise to an extraordinary deposition amount or tiered extraordinary disposition amount, to the extent attributable to the attributed account.

This rule also ensures that the successor account, to the extent attributable to the attributed account, may be reduced under the EDA reduction rule by reason of an allocation and apportionment of an item of deduction or loss attributable to DQB of an item of specified property that corresponds to the attributed account. This rule ensures these results by treating the attributed account and successor account as separate EDAs for purposes of the proposed regulations.






As an example of this rule, consider a case in which US1, a domestic corporation, owns all of the stock of CFC1, a CFC as to which US1 has an EDA with a $40x balance (the “CFC1 EDA”), and CFC2, a CFC as to which US1 has an EDA with a $60x balance (the “CFC2 EDA”). If CFC1 were to merge into CFC2, and thus under the rules of Treas. reg. section 1.245A-5(c)(4) the $40x balance of the CFC1 EDA were attributed to the CFC2 EDA such that the balance of the CFC2 EDA would become $100x, then $40x of the $100x balance of the CFC2 EDA would be treated for purposes of the proposed regulations as an EDA regarding CFC1 (the CFC2 EDA to such extent, the “deemed CFC1 EDA”), even though CFC1 would no longer be in existence.

As a result, after the merger, the deemed CFC1 EDA would, by reason of the application of the EDA reduction rule to a tax year of CFC2, generally be reduced by the lesser of (i) the adjusted earnings of CFC2, less the balance of (a) the previously taxed E&P accounts regarding CFC2; (b) the hybrid deduction accounts regarding shares of stock of CFC2; (c) the balance of the CFC2 EDA (but not including the portion of the balance of the CFC2 EDA that is treated as the deemed CFC1 EDA), to the extent taken into account as described in prop. Treas. reg. section 1.245A-8(c)(1)(i)(B)(3); and (d) the balance of the deemed CFC1 EDA, to the extent taken into account as described in prop. Treas. reg. section 1.245A-8(c)(1)(i)(B)(3); or (ii) the balance of the RGI account (if any) regarding CFC2 that relates to the deemed CFC1 EDA.

Second, special rules address the extraordinary disposition ownership percentage. The DQB reduction rule and the EDA reduction rule take into account the extraordinary disposition ownership percentage as to a section 245A shareholder’s EDA, which generally represents the portion of gain on the extraordinary disposition of an item of specified property that is reflected in the initial balance of the EDA. Special rules ensure that, after an EDA is adjusted under Treas. reg. section 1.245A-5(c)(4), the extraordinary disposition ownership percentage continues to accurately reflect the portion of gain that is reflected in the (adjusted) balance of the EDA.

As an example of the application of these special rules regarding the extraordinary

disposition ownership percentage, consider a case in which the extraordinary disposition ownership percentage as to a section 245A shareholder’s EDA regarding an SFC (“EDA 1”) is 80 percent, and by reason of Treas. reg. section 1.245A-5(c)(4)(i) another section 245A shareholder (that did not previously have an EDA regarding the SFC) succeeds to a portion of EDA 1 equal to 40 percent of the balance of EDA 1 (the portion of EDA 1 to which the other section 245A shareholder succeeds, “EDA 2”).

Here, the extraordinary disposition ownership percentage as to EDA 1 is thereafter 48 percent for purposes of the proposed regulations (80 percent, less the product of 80 percent and 40 percent), and the extraordinary disposition ownership percentage as to EDA 2 is 32 percent for purposes of the proposed regulations (the product of 80 percent and 40 percent). As an additional example, if in the preceding example the other section 245A shareholder instead had an EDA regarding the SFC, and the extraordinary disposition ownership percentage as to that EDA was 20 percent (“EDA 2”), then under prop. Treas. reg. section 1.245A-8(e)(1), the extraordinary disposition ownership percentage as to EDA 2 would become 52 percent for purposes of the proposed regulations (20 percent, plus the product of 80 percent and 40 percent).

Other Rules

Coordination With Disqualified Payment RuleThe coordination mechanism of the proposed

regulations also applies to cases in which a prepayment during the disqualified period gives rise to extraordinary disposition E&P of an SFC under the antiavoidance rule of Treas. reg. section 1.245A-5(h) and items of deduction or loss of a CFC are allocated and apportioned to residual CFC gross income under the disqualified payment rule. Prop. Treas. reg. section 1.245A-5(j)(8) (Example 7). The coordination mechanism generally applies in the same manner as if the disqualified payment had given rise to DQB of an item of specified property that corresponds to the EDA.

Currency Translation RulesAccounts created under the proposed

regulations are maintained in the functional






currency of the items to which they relate. Therefore, a basis benefit account is maintained in the same functional currency as the EDA to which it relates. Similarly, an RGI account is maintained in the functional currency of the CFC whose allocations to residual CFC gross income are being measured and tracked by that account.

The application of the DQB reduction rule and the EDA reduction rule may also require currency translation because these rules require amounts determined in the functional currency of one person to be applied to reduce attributes of another person that may have a different functional currency. In this regard, the proposed regulations provide that the DQB of — and the basis benefit amount regarding — an item of specified property that corresponds to an EDA are translated into the functional currency in which the EDA is maintained, using the spot rate on the date the extraordinary disposition occurred.

Moreover, prop. Treas. reg. section 1.245A-9(b)(4) provides that a reduction in DQB of an item of specified property under the DQB reduction rule is translated into the functional currency in which the DQB of the item of specified property is maintained, and reductions in an EDA are translated into the functional currency in which the EDA is maintained, in each case using the spot rate on the date the associated extraordinary disposition occurred.

Antiavoidance RuleProp. Treas. reg. section 1.245A-9(b)(5)

contains an antiavoidance rule providing that appropriate adjustments are made if a transaction or arrangement is engaged in with a principal purpose of avoiding the purposes of these proposed regulations. As an example, the antiavoidance rule applies if a section 245A shareholder causes its tax year to end on a particular date with a principal purpose of avoiding a basis benefit amount being assigned to that tax year.

Election to Eliminate DQBTaxpayers may have elected to reduce an item

of specified property’s adjusted basis (and thus eliminate the item’s DQB) in accordance with Treas. reg. section 1.951A-3(h)(2)(ii)(B)(3) (a “basis elimination election”) before the proposed regulations were issued. In certain cases, the proposed regulations, once finalized, may provide more favorable outcomes for taxpayers than a basis elimination election. Therefore, the proposed regulations permit taxpayers to revoke a basis elimination election during a transition period, which under the proposed regulations is 90 days after the proposed regulations are finalized. Prop. Treas. reg. section 1.245A-9(c)(1). This transition period is intended to provide a taxpayer with sufficient time to consider whether it would prefer a basis elimination election or to apply the rules of the proposed regulations. The proposed regulations set forth the procedures for revoking a basis elimination election. These procedures require a taxpayer to file a revocation statement, as well as amended returns reflecting the revocation of the election.

Applicability Dates

The proposed regulations are proposed to apply to tax years of foreign corporations beginning on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register (the “finalization date”) and to tax years of a U.S. person in which or with which such tax years of foreign corporations end. For tax years beginning before the finalization date, a taxpayer may apply the rules set forth in the final regulations, provided that the taxpayer and all related parties consistently apply the rules to those tax years.







Stop BEATing Up Your Brother-Sister, Part 2

by Corey M. Goodman and Lorenz F. Haselberger

This is the second installment in a two-part series addressing practical considerations in allocating liabilities under the base erosion and antiabuse tax among members of a U.S. consolidated tax group. As we observed in part 1, while much ink has been spilled parsing the implications of the BEAT since it was enacted as part of the Tax Cuts and Jobs Act, this practical element of the BEAT has received very little

attention.91 This two-part series is intended to address that issue, as well as other similar consolidated tax allocation issues arising out of other elements of the TCJA.

Recall that the BEAT — described at length in part 1 — is effectively a minimum tax that may apply to taxpayers that make specified tax-deductible payments to foreign affiliates. For an applicable taxpayer subject to the BEAT, the BEAT liability — also referred to as the base erosion minimum tax amount (BEMTA) — is equal to the excess of (1) the product of the taxpayer’s modified taxable income (MTI) for the relevant tax year, multiplied by the applicable BEAT minimum tax rate (now 10 percent), over (2) the taxpayer’s regular tax liability for that tax year, reduced for some credits.92 The taxpayer’s MTI is equal to its regular taxable income increased by some addbacks, including (1) the taxpayer’s base erosion tax benefits (BETBs) for the tax year93 and (2) the base erosion percentage (BEP)94 of any net operating loss deduction allowed to the taxpayer for the tax year.95

In part 1, we introduced the existing legal regimes relevant to the allocation of BEAT liability within a consolidated group. We described the flexibility that a consolidated group has in allocating tax liabilities, and the reasons why it may find it desirable to enter into a formal tax-sharing agreement to do so. We summarized the principal methods for allocating consolidated tax liability (CTL) for purposes of calculating

Corey M. Goodman is a partner and Lorenz F. Haselberger is an associate in the tax practice at Cleary Gottlieb Steen & Hamilton LLP in New York.

The authors thank Diana Wollman, Jason Factor, and Victoria Ju for their helpful comments and thank members of the Tax Club for their insights. All mistakes are their own.

In this article, the final installment of a two-part series, the authors provide a framework for taxpayers to identify and analyze questions that may arise in connection with the allocation of base erosion and antiabuse tax liability and other Tax Cuts and Jobs Act elements within a consolidated group.

Copyright 2020 Corey M. Goodman and Lorenz F. Haselberger. All rights reserved.

91Corey M. Goodman and Lorenz F. Haselberger, “Stop BEATing Up

Your Brother-Sister,” Tax Notes Int’l, Oct. 12, 2020, p. 197.92

Reg. section 1.59A-5(b)(2).93

Reg. section 1.59A-3(c)(1).94

Reg. section 1.59A-2(e)(3).95

Reg. section 1.59A-4(b). The BEP for an NOL equals the relevant taxpayer’s BEP for the tax year in which the NOL arises (i.e., its vintage year).






earnings and profits under section 1552. And we described the contours of the BEAT itself, with a focus on those aspects of the BEAT rules we found to be most relevant to the allocation of economic responsibility for the BEAT within a consolidated group. We also examined special rules applicable to applying the interest expense limitation of section 163(j) in the context of a consolidated group, with a focus on the interaction between those rules and the BEAT.

At the end of part 1, we posed the following three questions that a consolidated group must ask itself in determining the method or methods it wishes to use to allocate economic responsibility for the BEAT:

1. Should the group hold individual members responsible for the impact of the BEAT using a measure that differs from how the group divides up its regular (non-BEAT) consolidated tax items?

2. What metric should the group use to measure the impact of the BEAT on the group? Is it BEMTA, or some other measure?

3. Once a group has determined how to measure the cost of the BEAT, how should it determine how much of that cost is attributable to each member’s activities?

In this second segment, we offer a conceptual model for taxpayers to use to answer these questions. Building on the legal foundations we described in part 1, we break down these questions into more granular issues, to provide a framework for taxpayers to identify and analyze questions that may arise in connection with the allocation of BEAT liability within a consolidated group.

V. Framework for Allocating the BEAT

A. Section 1552 Allocation Rules

To better understand the distortions that can arise in allocating BEAT liability to consolidated group members, it is useful to begin with a simple numerical example that illustrates the application of the basic allocation methods under section 1552. Those methods were described in more detail in part 1, but for ease of reference they are repeated below:

• Under the section 1552(a)(1) method, each consolidated group member’s allocation of CTL is determined in proportion to its contribution to the group’s consolidated taxable income (CTI).96

• Under the section 1552(a)(2) method, CTL is allocated to each group member based on the ratio of (1) what the member’s tax liability would be if it filed a separate return, subject to some adjustments (the member’s separate return tax liability) over (2) the sum of the separate return tax liabilities of all members of the group.97

• Under the rarely used section 1552(a)(3) method, CTL is initially allocated to each member based on the section 1552(a)(1) method, but the result is then compared with the allocation that would result from applying the section 1552(a)(2) method, to determine the relative increase or decrease to each member’s taxes resulting from consolidation. Any such increases are then reallocated to members that benefited from a decrease.98

As we noted in part 1, a separate method, the “with and without” method, is set forth in proposed Treasury regulations for the purpose of allocating corporate alternative minimum tax liability under section 1552, as an incremental liability to be allocated among the group members. Under this method, the amount of consolidated AMT liability allocated to a member would be determined by multiplying the consolidated AMT by a fraction equal to (1) the separate adjusted AMT of the member (equal to the excess of (A) the consolidated AMT for the year over (B) the consolidated AMT for the year computed by excluding the member’s items of income, gain, deduction, loss, and credit) divided by (2) the sum of the separate adjusted AMT of all members for the year.99

96Section 1552(a)(1) and reg. section 1.1552-1(a)(1)(i).

97Section 1552(a)(2) and reg. section 1.1552-1(a)(2).

98Section 1552(a)(3) and reg. section 1.1552-1(a)(2)(i).

99See prop. reg. section 1.1552-1(g)(2) (proposed Dec. 30, 1992); and

prop. reg. section 1.1502-55(h)(6)(iv) (proposed Dec. 30, 1992). See also Section II.D in part 1.






Example 1: Consider a consolidated group with three members: Parent (P) and its two wholly owned subsidiaries (S1 and S2). In 2019 P had separate taxable income of $100x and paid $16x of foreign taxes; S1 had no separate taxable income (and no gross income at all) but made deductible payments of $200x to a foreign person treated as related for BEAT purposes; and S2 had separate taxable income of $200x. Assume that the P group qualified as an applicable taxpayer in 2019 (that is, it meets the threshold gross receipts and BEP tests that determine which taxpayers are subject to the BEAT)100 and that all foreign taxes are creditable by the P group in the current year. What is the result?

Absent the BEAT, the P group’s CTL for 2019 would be $5x, equal to its CTI of $100x multiplied by 21 percent (or $21x) less a consolidated foreign tax credit of $16x. Taking into account the BEAT, the P group’s CTL increases to $30x. More specifically, in addition to its regular tax liability of $5x, the P group has BEMTA of $25x, calculated as the excess of (1) the product of (A) the P group’s MTI (that is, the $100x of CTI plus S1’s $200x of BETB, or $300x) multiplied by (B) the applicable BEAT rate (now 10 percent) over (2) the P group’s regular tax liability as reduced by its FTCs ($5x). How is the $30x of CTL allocated between the members?

Under the section 1552(a)(1) method, the P group’s $30x of CTL is allocated in proportion to the contribution of each member to CTI, as shown in Table 1.

As reflected in Table 1, because the section 1552(a)(1) method looks only to each member’s contribution to CTI, it has the patently uneconomic result that S1 is allocated none of the P group’s $25x of consolidated BEMTA even

though it generated all the BETBs that caused the P group to be subject to the BEAT and contributed to the P group’s consolidated BEMTA. Also, note that the section 1552(a)(1) method takes no account of P’s FTCs in allocating the P group’s CTL, because FTCs have no effect on CTI (they only affect tax liability). As an economic matter, it is unclear whether P should be penalized or rewarded for its FTCs. On one hand, the FTCs have the effect of increasing the P group’s BEMTA by reducing its regular tax liability (but without altering the total tax compared with a scenario in which the credits did not exist — it is always $30x). On the other hand, if P were an unaffiliated corporation filing a stand-alone return, it would not have been subject to the BEAT and would have been able to use the FTCs at full value to reduce its regular tax liability in the current year.

Under the section 1552(a)(2) method, the P group’s $30x of CTL is allocated to each member based on the ratio of (1) the member’s separate return tax liability over (2) the sum of the separate return tax liabilities of all members of the group. Its application to Example 1 is shown in Table 2.

As with the section 1552(a)(1) method, as shown earlier, S1 is still not allocated any CTL, because its separate return tax liability is still $0, even taking BEMTA into account. But, in contrast to the section 1552(a)(1) method, the section 1552(a)(2) method takes into account P’s FTCs, which have the effect of reducing P’s regular separate return liability from $21x to $5x at the expense of generating $5x of separate return BEMTA. In this particular circumstance, the section 1552(a)(2) method is arguably less distortive than the section 1552(a)(1) method but still results in P bearing slightly more tax in the group than its regular tax liability would suggest it should bear. Also, consider whether it is appropriate to allocate CTL to P for its separate return BEMTA, given that the base erosion 100

See section 59A(e) and reg. section 1.59A-2(b). See also Section II.A in part 1.

Table 1. Allocation Under Section 1552(a)(1) Method in Example 1

Contribution to CTI Allocation FractionConsolidated

BEMTA Allocation CTL Allocation

P $100x 33.33% $8.33x $10x

S1 -$200x 0% $0 $0

S2 $200x 66.67% $16.67x $20x






payments that cause P to be subject to the BEAT are generated exclusively by S1.101

To this last point, note that Table 2 assumes that in calculating the separate return tax liabilities of each of P, S1, and S2 under section 1552(a)(2), the affiliation of the entities — although generally ignored for purposes of the consolidated return rules under section 1502 — is taken into account in determining whether the entities are part of an aggregate group that is subject to the BEAT. However, there is nothing in section 1552(a)(2) or reg. section 1.1552-1(a)(2) that specifically requires this result (which is hardly surprising given that the relevant rules antedate the BEAT by more than five decades).102 Had each member been viewed completely independently, P would not have had any BEMTA because it had no base erosion payments. And whether S1’s separate return tax liability included any BEMTA would depend on whether S1 met the gross receipts test when measured for its aggregate group, ignoring P and S2. These

adjustments would have resulted in significantly more BEMTA being allocated to S2, which itself had no base erosion payments.

Next, Table 3 illustrates how the with-and-without method that applied for purposes of allocating corporate AMT liability would apply in these circumstances. Under the principles of this method (which were described earlier), each member’s allocation of consolidated BEMTA should be determined by multiplying consolidated BEMTA by a fraction equal to (1) the separate adjusted BEMTA of the member (equal to the excess of (A) the consolidated BEMTA for the year over (B) the consolidated BEMTA for the year computed by excluding the member’s items of income, gain, deduction, loss, and credit) divided by (2) the sum of the separate adjusted BEMTAs of all members for the year.

The with-and-without method is specifically designed for a minimum tax (which is what the BEAT is), and accordingly, this example uses it only to allocate the P group’s $25x of consolidated BEMTA. The remaining $5x of regular CTL could be allocated under one of the basic methods described earlier or another method that satisfies section 1552. The results under this method are in a sense less distortive than the other methods because each member’s allocation of consolidated BEMTA is determined directly by reference to the proportion of consolidated BEMTA that its inclusion in the group “caused,” as determined on a with-and-without basis (that is, by measuring what consolidated BEMTA would have been if the relevant member’s items were excluded from the consolidated return, and comparing it with actual consolidated BEMTA). Thus, for example, S1 receives a significantly larger share of BEMTA than under either of the two basic methods applied earlier, consistent with the fact that it generates all the P group’s BETBs.

101This quirk in the rules, under which P could have a BEMTA

liability under the method of calculating BEMTA in section 59A, even though it had no base erosion payments, illustrates how important it is that the BEP test exists. Without it, a taxpayer could have been subject to the BEAT without undertaking any base-eroding activities. It also illustrates, more starkly than the example in Section II.C of part 1, how the BEAT results in a noneconomic loss of FTCs.

102In fact, one could interpret the section 1552 regulations to require

the opposite. Reg. section 1.1552-1(a)(2)(ii) specifically defines a member’s separate return tax liability for purposes of these rules as the member’s “tax liability computed as if it has filed a separate return for the year,” with some adjustments to preserve aspects of consolidation (e.g., adjustments are made for excess loss accounts and intercompany transactions). Reasoning by implication, the fact that the section 1552(a)(2) regulations provide for adjustments to preserve the consolidated effects of intercompany transactions suggests that analogous affiliate transactions in the BEAT context, like the existence of base erosion payments, should retain their status in calculating separate return tax liability. Notably, however, none of the adjustments are for “limitation” or “threshold” issues such as those described in Section I.A of part 1. The lack of such adjustments suggests that in calculating a member’s qualification as an applicable taxpayer, one might ignore the activities of other members of the consolidated group in applying this rule.


Taxable Income FTC

Regular Tax

Liability BETB MTI BEMTA

Separate Return

Tax Liability

Allocation Fraction

Consolidated BEMTA

AllocationCTL

Allocation

P $100x $16x $5x $0 $100x $5x $10x 19.23% $4.81x $5.77x

S1 -$200x $0 $0 $200x $0 $0 $0 0% $0 $0

S2 $200x $0 $42x $0 $200x $0 $42x 80.77% $20.19x $24.23x






Note, however, that the with-and-without method still produces some odd and arguably uneconomic results: S2 receives a third of the P group’s consolidated BEMTA even though it generates no BETBs and has no FTCs or other tax attributes that could increase BEMTA. This result obtains because absent the inclusion of S2’s $200x of separate return income on the P group’s consolidated return, the P group’s base erosion payments ($200x) exceed its gross income (P’s $100x of income), such that only $100x of the base erosion payments is treated as BETBs in the current year; in turn, when S2’s income is taken into account, it offsets the remaining $100x of S1’s base-eroding deductions, turning them into BETBs that increase consolidated BEMTA.

Table 4 summarizes and compares the BEMTA allocations that result under each of the three methods examined earlier.

Example 2: Now consider a second variation. What would the result be if the facts were the same as Example 1, except that instead of having $100x of taxable income, P had $0 of net income ($50x of gross income), $50x of base erosion payments, and $0 in credits; and S1 had $200x of gross income (rather than $0) offset by $200x of base erosion payments? In this case, the consolidated MTI would be $450x (P’s $50x of BETB + S1’s $200x of BETB + S2’s $200x of net taxable income). Regular tax would be $42x (S2’s $200x of net taxable income * 21 percent). BEMTA would be $3x, equal to 10 percent of $450x, minus $42x.

Table 3. Allocation Under Corporate AMT (With-and-Without) Method in Example 1

Regular CTL Without M

ItemsMTI Without

M Items

Consolidated BEMTA

Without M Items

Separate Adjusted BEMTA

Allocation Fraction

Consolidated BEMTA

Allocation

P $0 $200x $20x $5x 11.11% $2.78x

S1 $47x $300x $0 $25x 55.55% $13.89x

S2 $0 $100x $10x $15x 33.33% $8.33x

Table 4. Comparing Allocations Under Section 1552(a)(1), Section 1552(a)(2), and With-and-Without Methods in Example 1

Section 1552(a)(1) Allocation Section 1552(a)(2) Allocation

With-and-Without

Allocation

Consolidated BEMTA CTL

Consolidated BEMTA CTL

Consolidated BEMTA

P $8.33x $10x $4.81x $5.77x $2.78x

S1 $0 $0 $0 $0 $13.89x

S2 $16.67x $20x $20.19x $24.23x $8.33x


Contribution to CTI Allocation FractionConsolidated

BEMTA Allocation CTL Allocation

P $0 0% $0 $0

S1 $0 0% $0 $0

S2 $200x 100% $3x $45x






Under the section 1552(a)(1) method, S2 would bear 100 percent of the tax, because it had 100 percent of the taxable income.

Under the section 1552(a)(2) method, on their separate returns, P would have generated $5x of BEMTA independently ($50x of base erosion payments at a 10 percent rate); S1 would have $20x of BEMTA; and S2 would have $0 of BEMTA and $42x of regular tax liability. Therefore, the group’s taxes in consolidation would be divided up 5/67 * $45x for P ($3.36x); 20/67 * $45x for S1 ($13.43x); and the remainder ($28.21x) to S2, as reflected in Table 6.

As in the case of Example 1, the resulting allocations are arguably distortive. Under the section 1552(a)(1) method, S2 is allocated all of the $3x of consolidated BEMTA even though it is not responsible for any of the BETBs that contributed to the BEMTA or caused the group to qualify as an applicable taxpayer subject to the BEAT. In contrast, under the section 1552(a)(2) method, P and S1 are allocated 37.3 percent ($16.79x/$45x) of the group’s CTL, even though 93.3 percent ($42x/$45x) of that liability is arguably attributable to the regular non-BEAT tax imposed on S2’s $200x of net taxable income.

One could argue that the group’s regular tax isn’t entirely attributable to S2’s income in Example 2, because a marginal change to S2’s taxable income results in a disproportionately small change to the group’s tax (taking into account the BEAT), compared with the change in the group’s regular tax. For example, if S2’s income was reduced from $200x to $150x, the group’s total tax including BEAT would be $40x instead of $45x, and BEMTA would increase from $3x to $8.5x. Put differently, the $50x reduction to S2’s income results in only a $5x reduction to the group’s taxes, so the marginal tax rate on S2’s income at that level is 10 percent. Regular tax, on

the other hand, would decrease at a marginal rate equal to the normal 21 percent corporate tax rate, from $42x to $31.5x. By contrast, a marginal increase of $50x to S2’s taxable income would increase overall group tax by $7.5x to $52.5x — a tax rate of 15 percent on the additional income.

These results illustrate two effects. First, an increase to S2’s income brings the group past the inflection point described in part 1, such that the BEAT liability no longer exceeds regular tax liability, effectively increasing the marginal tax rate from the 10 percent BEAT rate to the 21 percent corporate rate. Second, at a high level, these results illustrate the very complexity this article is trying to address: No one member is singularly responsible for the group’s BEAT taxes or its regular taxes. The interaction between the members’ different tax items creates the group’s tax and cannot easily be distilled into assigning “responsibility” to a single member for the marginal effect of $1 of income or deduction on the group’s tax.

B. Causes of Distortion

As examples 1 and 2 illustrate, consolidated taxpayers ought to carefully consider modifying the method they use to allocate consolidated taxes to apply to the BEAT. In contemplating those modifications, it is first useful to understand why the various distortions might happen. Those distortions are illustrated in examples 1 and 2 and in the remainder of this section, but at a high level, the conditions that create them are described here.

1. Membership in a Consolidated Group Affects a Member’s BEAT Liability, but the Direction of That Effect Is Not Always the SameConsolidated group membership could

increase a member’s BEAT liability or decrease


Taxable Income FTC

Regular Tax

Liability BETB MTI BEMTA

Separate Return

Tax Liability

Allocation Fraction

Consolidated BEMTA

AllocationCTL

Allocation

P $0 $0 $0 $50x $50x $5x $5x 7.46% $0.22x $3.36x

S1 $0 $0 $0 $200x $200x $20x $20x 29.85% $0.9x $13.43x

S2 $200x $0 $42x $0 $200x $0 $42x 62.69% $1.88x $28.21x






that liability. It could subject to the BEAT a member that would otherwise not have been subject to it. It could subject to the BEAT a group that would otherwise not have been subject to it. It could taint a member’s separate return attributes (like NOLs and section 163(j) carryforwards103) for BEAT purposes in a manner that would not have occurred, or might have occurred differently, had the member not been part of the group. Occasionally, such as in the case of intercompany interest payments, inclusion in a consolidated group could alter the calculation of a member’s base erosion payments. Because consolidated group members use each other’s tax credits, deductions, and NOLs, the activities of one group member can affect the likelihood and amount of BEAT liability resulting from another member’s activities.

2. Membership in a Consolidated Group Is Not the Only Relationship That Matters for Purposes of the BEATOne of the quirks of the BEAT rules is that they

focus on different measures of relatedness. One sort of relationship (a 50 percent relationship) matters for being part of a taxpayer’s aggregate group for purposes of applying the BEP test and the gross receipts test.104 Another sort of relationship (a 25 percent test) matters for identifying foreign related parties to whom a base erosion payment is made.105 And if an entity is a member of a consolidated group (itself an 80 percent test), relatedness to foreign non-group members applies to every group member if any group member bears the requisite relationship to a foreign affiliate.106

These different relationship tests matter, principally in determining whether membership in a group achieves a tax savings (for the member or the group), or imposes a tax cost, when compared with what the member’s and group’s taxes would be if the entity were not a member of the group. It also means that a transaction between a consolidated group member and a foreign affiliate might be treated as a base erosion

payment because of consolidation if the foreign affiliate bears the requisite 25 percent relationship to any group member but not to the particular member making the payment.

3. Measurement of Group Items of Income and Deduction for Regular Tax Purposes Does Not Adequately Account for the Effect of a Member’s BEAT-Related Activities on the GroupSpecifically, because the amount of BEAT is

based on the amount of otherwise tax-deductible payments that constitute base erosion payments, a member whose activities contribute the most to the imposition of the BEAT may conversely have the lowest taxable income as calculated under reg. section 1.1502-12 when the BEAT is not taken into account. Therefore, absent special rules addressing the BEAT under a tax-sharing agreement or applicable law, a member most likely to trigger or increase a BEAT liability may in fact be allocated less than its fair share of the group’s tax liability that includes the BEAT, as illustrated in examples 1 and 2.

Applying these concepts to specific items of income, loss, deduction, and credit is instructive:

1. A member that makes base erosion payments generating BETBs increases the likelihood of the BEAT being imposed and increases the amount of the BEMTA. On a separate-return basis, assuming the taxpayer would not have been subject to the BEAT, those deductions have the opposite effect: They would reduce the taxpayer’s taxable income and tax cost. Should members with more BETBs be more responsible for BEMTA? Initially, the answer seems like it would almost certainly be yes. But consider the other effects described below, which cut in different directions.

2. A member that has a significant amount of non-base-eroding deductible payments has several distinct effects on the group:• The deductions reduce the likelihood of

the BEAT being imposed at all, by lowering the BEP, thereby reducing the likelihood that the group becomes an applicable taxpayer.

• If a group is an applicable taxpayer, these deductions affect the amount of

103See sections II.A and III in part 1.

104See section 59A(e)(3) and reg. section 1.59A-2(c).

105See section 59A(g)(1).

106See reg. section 1.1502-59A(b)(3).






BEAT imposed on the use of a group’s NOLs in the year in which the loss is incurred.107

• Further, if a group is an applicable taxpayer, the value of the group’s tax savings attributable to non-base-eroding deductions changes based on the relationship between the group’s overall CTI and its aggregate BETBs. (See the discussions of the inflection point and related chart in Section II.C of part 1, and at the end of Section V.A above.) Should the member contributing these “good” losses receive a hypothetical 21 percent benefit for each of them, and the burden of the BEAT be borne by another, more “culpable” member? Or should the loss-contributing member be paid only for the tax savings its losses actually generated?

• Note that this issue arises whether the member can absorb all of its own deductions using its own taxable income or other group members absorb the deductions. But the effect of this absorption under the various methods of allocating taxes will differ.

3. As described in more detail in Section II.A of part 1, NOLs that were generated while the BEAT was in effect can be tainted, and to the extent they are used as carryforwards in a particular year, the tainted amount would be added to the taxpayer’s income in calculating MTI, to which the BEAT minimum tax rate applies. If one member uses another’s NOL carryforwards that were generated during a period in which the BEAT was in effect, this use could therefore increase the likelihood and amount of BEAT imposed in the year of use, because the NOLs that were tainted create MTI addbacks to the extent of the BEP from the vintage year in which the deductions arose.

4. If one member contributes a significant amount toward the calculation of the

group’s regular tax liability under section 26(b), that has two opposing effects:• In a non-BEAT world, it increases the tax

costs of the group.• In a BEAT world, additional regular tax

liability reduces the likelihood that the BEAT is imposed, or could reduce the amount of BEMTA imposed, because BEMTA is measured by the excess of the BEAT rate multiplied by MTI, over the regular tax liability. As a result, a member with significant regular tax liability could shield another member with significant BETBs from exposing the group to the BEAT. This is another consequence of the inflection point described in Section II.C of part 1 — the cost of that additional taxable income changes, depending on the activities of the other group members.

• In contrast, if the group is otherwise in a loss position for a year in which it is subject to the BEAT, the inclusion of an additional income-generating member in the group accelerates the inclusion of those losses in MTI in the current year by increasing BETB, and it correspondingly increases BEMTA.

5. If one member has a significant amount of FTCs (or other credits that are disadvantaged by the BEMTA calculation), those credits effectively increase the likelihood and amount of BEMTA, because they reduce the measure of regular tax liability that is then compared with the BEMTA,108 potentially without any effect on the group’s total CTL.109 In such a case, the credits could disappear without providing any tax benefit. Ordinarily, a member might expect to be compensated for the use of credits it generated. If the credits are wasted because of the BEAT, what is the

107See reg. section 1.59A-4(b)(2)(ii).

108See section 59A(b)(1)(B) and, for tax years beginning after 2025,

section 59A(b)(2)(B); and reg. section 1.59A-5(b)(2) and (3).109

To put numbers on this point, if a taxpayer with $50 of regular tax liability and $10 of credits had MTI of $500, its total regular tax would be $40; MTI * 10 percent would be $50; and BEMTA would be $10. If it had no credits at all, its total regular tax would be $50; MTI * 10 percent would also be $50; and BEMTA would be $0. In either case, total tax, including BEMTA, is $50.






right way to handle that loss of value? Should the member be paid for the use of its credits even though it did not create a group benefit, on the theory that the member might have benefited from its credits had it not been a group member or had the group not been an applicable taxpayer? Should this be funded by a member that is more responsible for subjecting the group to the BEAT?• How do the answers to the questions

immediately above change, if at all, depending on the type of credit? For example, until tax year 2025, use by the group of tax credits under sections 41(a), 42(a), 45(a), and 48 generated by the member generally decrease the likelihood and amount of BEAT liability, because those credits are given more favorable treatment than other credits like FTCs.110

• The answers to these questions can be particularly consequential in a U.S.-parented group with an international holding company separate from the domestic operating companies. But it can also matter in a group in which different consolidated group members each have their own stack of CFC subsidiaries.

6. The cliff effect described in Section II.C of part 1 illustrates how crossing the BEAT thresholds (the gross receipts test and the BEP test) can have significant negative consequences for tax groups, while staying below the thresholds is business as usual. In determining how to share BEAT liability, how should a group measure the effect and assign responsibility for the cliff effect, if at all? For example, if a member with significant BETBs but low gross receipts would not have been subject to the BEAT on its own, should it suffer the consequences of the BEAT costs it imposes on the group because the group’s activities push it above the gross receipts threshold?

7. Another issue that groups must consider is that allocating BEAT liability to a member that has generated significant deductions or losses (but increases BEAT liability) would result in negative basis adjustments for the loss member under reg. section 1.1502-32. In some situations, these negative adjustments could create an excess loss account. The group should consider whether this is a desirable outcome, even if it otherwise makes sense to hold the loss member accountable for BEAT liability.

C. Potential Alternative Measures

Because of the highly fact-sensitive nature of the analysis, the best path forward for many consolidated groups may be to authorize the common parent of the group to determine how to allocate BEAT for each tax year, in its discretion. This was the approach taken by many consolidated groups for the corporate AMT. If that is not possible, consolidated groups should consider a flexible set of rules.

If the group needs to agree on an allocation method in advance, then, to properly measure a particular member’s contribution to the group’s BEAT liability, the group would need to track some or all of the above items separately for each member, and also make some judgments on the relative importance of each item to the allocation of BEAT liability. There is no single formula that necessarily balances all member contributions perfectly. The methods of doing so can be as complex as the BEAT itself, or alternatively, they might trade simplicity for potential unfairness among members.

In light of the distortions created by the section 1552 methods as illustrated by the examples in Section V.A, and the various causes described in Section V.B, several possible alternatives to allocating BEAT liability are suggested next, along with a description of how each alternative would apply in examples 1 and 2. As will become evident, the ability of each alternative method to fairly divide taxes depends significantly on the underlying facts.

Alternative 1: Allocate total taxes minus BEMTA using any existing method and by reducing each member’s liability for any credits 110

See reg. section 1.59A-5(b)(3).






and deductions of that member that would be used on the group’s return in calculating regular tax liability. Then calculate BEMTA on a consolidated basis and allocate the entire amount of BEMTA among the members based on the amount of each separate entity’s BETBs. If this results in overpayments of tax to the common parent, the excess should be paid to members that did not receive full credit for their FTCs or non-base-eroding NOLs.

Revisiting Example 1, if this alternative method is used in combination with the section 1552(a)(1) method, the group’s CTL (excluding BEMTA) of $5x would be allocated one-third to P ($1.67x) and two-thirds to S2 ($3.33x), based on their taxable income. The $25x of BEMTA would be allocated entirely to S1, which generated all the BETBs.

Applying the same combination of methods to Example 2, the CTL (excluding BEMTA) of $42x would be allocated 100 percent to S2, because S2’s $200x of net taxable income generates all of the group’s regular tax liability. The $3x of BEMTA would be split one-fifth to P ($0.6x) and four-fifths to S1 ($2.4x). Consider whether this allocation is actually fair to S2. Although it would have borne $42x of taxes had it filed separately, the fact is that under the alternative BEAT regime for calculating tax liability, S2’s $200x of income would have attracted only $20x of tax (that is, the income contributes $200x to the group’s $450x of MTI, which is taxed at the 10 percent BEAT rate). Is it fair for P and S2, each of which had taxable income if you ignore their deductions, to bear such a small proportion of the group’s total liability? Perhaps, but only if the group views the BEAT as a purely incremental tax, rather than an entirely separate alternative regime for calculating taxes.

Alternative 1A: Same as Alternative 1, except (1) allocate BEMTA based on each member’s separate return tax liability for BEMTA, or (2) allocate BEMTA based on the group’s with-and-without liability for BEMTA for each member. Either of these two latter approaches would require the group to decide how it wants to deal with the cliff effect if none (or less than all) of the individual group members would not meet the gross receipts or BEP tests on their own.

Alternative 2: Allocate taxes other than BEMTA using any existing method, calculating

the amount of those other taxes without giving members reductions for any of their credits used on the group’s return. Allocate any remaining tax liability (generally BEMTA less credits) based on the amount of each separate entity’s BETBs.

Returning again to Example 1, if we apply Alternative 2 alongside the section 1552(a)(1) method, $21x of the group’s $30x of CTL would be allocated between P ($7x) and S2 ($14x), based on their taxable income. The remaining $9x (BEMTA minus FTCs) would be allocated entirely to S1, which generated all the BETBs. Effectively, neither P nor S2 benefited from the FTCs that were eliminated as a result of the BEAT.

This approach might make sense if the group believed that P should not get the full benefit of the tax credits and that S1 should not be held fully responsible for their loss even though it effectively caused the BEMTA. The theory for this alternative would be that the members of the group share liability for the effect of the BEAT once the group becomes an applicable taxpayer.

The results under Example 2 are the same as under Alternative 1 because no group member has any credits in that example.

Alternative 3: If the group is an applicable taxpayer and there is an incremental BEAT liability, allocate all taxes based on the members’ stand-alone MTI.

This alternative effectively treats reversed tax deductions (that is, BETB addbacks to MTI) the same as taxable income, but as illustrated below, it has different outcomes depending on whether the member whose base erosion payments generate BETBs for the group has stand-alone taxable income.

Under Example 1, P has $100x of stand-alone MTI, S1 has $0 of stand-alone MTI, and S2 has $200x of stand-alone MTI. Therefore, P is allocated one-third of the group’s $30x of CTL ($10x), S1 is allocated $0, and S2 is allocated $20x. Even though S1 made deductible base erosion payments of $200x that resulted in $200x of BETB for the group, it had no stand-alone MTI because it had no stand-alone income, and accordingly is not allocated any of the group’s CTL.

Under Example 2, P has stand-alone MTI of $50x, and S1 and S2 each have stand-alone MTI of $200x, so P is allocated one-ninth of the $45x of CTL ($5x), and S1 and S2 are each allocated $20x.






In this particular circumstance, this method assigns as much weight to the reversed deductions generated by S1 as it does to S2’s taxable income. But as illustrated by the results under Example 1, this method does not always produce that result.

Alternative 4: Hold each group member responsible for exactly the taxes that it would have borne on a separate-return basis, similar to the treatment bank regulators might request.111

For obvious reasons, this solution does not perfectly replicate the group’s taxes, because the group’s total liability will almost never be the same as the sum of its parts. That said, it has some conceptual advantages over other measures because it does not hold any members accountable for adverse consequences of being consolidated group members or give them credit for any of the benefits. If a group were to adopt this approach for all its members, the common parent might ultimately have a liability to the IRS that was more or less than the aggregate payments it received from its members. For this reason, this alternative may not be appropriate for groups in which the common parent does not have adequate access to liquidity. What is likely to happen in this alternative is that some elements of the calculation result in members paying more than their share, and other elements result in those same members paying less than their share.

This approach also does not sidestep the limitation and threshold issues described earlier; the group would still need to decide, in applying a separate-return measure, whether it would apply groupwide limitations and thresholds to each individual member.

The results under Example 1 are that P would have a tax liability of $5x if the group did not treat P as an applicable taxpayer, and $10x if it did. One might question whether allocating $10x of liability to P makes sense here, given that P had no BETBs at all. Effectively, treating P as an applicable taxpayer results in a loss (to P) of a

portion of the benefit of its FTCs, even though it made no base erosion payments on its own. S1’s liability would be $0 in both cases, and S2’s liability would be $42x.

As applied to Example 2, if the group were to treat each member as an applicable taxpayer, P’s liability would be $5x, S1’s would be $20x, and S2’s would remain $42x. This is $22x more than the entities are liable for in consolidation. If, however, the group did not treat the members as applicable taxpayers, neither P nor S1 would have any tax liability, and S2 would have $42x of liability. The $3x difference between those separate amounts and the total tax is attributable to BEMTA, and the group would need to source the $3x from somewhere to satisfy its tax bill to the IRS.

VI. Fact Patterns and Questions

Some elements of the BEAT might require more bespoke solutions, even if one of the methods above is implemented. This section presents further examples of some more complicated allocation issues presented by the BEAT.

A. Group Entry and Exit

As with all consolidated groups, groups that are subject to the BEAT must consider how to treat BEAT-related liabilities generated by members when those members enter or exit the group. Some of these issues relate to the treatment of disallowed section 163(j) limitation carryforwards, which is addressed later, in Section VI.D. Other issues are not specific to the BEAT, such as the treatment of NOLs, similar to the discussion of Marvel described in Section I.B of part 1.

One unique issue raised by the BEAT is how to address departures of members that remain part of the aggregate group with other consolidated group members after the departure. For example, if only a portion of the equity in a group member is sold, such that the member remains 50 percent affiliated with the consolidated group, the entity’s post-departure activities would continue to be taken into account in applying the gross receipts test and the BEP test to the aggregate group of which it remains a part.

In this circumstance, special rules do not appear necessary in the group’s tax-sharing

111See Section I.B.1 in part 1. Although it sounds simple, this

particular allocation method requires significant compliance burdens to keep track of separate books and records for multiple years under hypothetical separate returns for the relevant members.






agreement.112 Rather, the departing member would become a separate taxpayer and its own applicable taxpayer for periods after it exits the consolidated group. A tax-sharing agreement should, however, ensure that the departing member remains liable for taxes attributable to its activities while it was a group member.

By contrast, when a member enters a consolidated group, the group should ensure that the member’s historic BEAT-related attributes are properly accounted for. Specifically, the new group should track the BEP that applies to the new member’s historic NOL carryforwards and track the portion of its section 163(j) carryforwards that are treated as having been paid to foreign related parties.

B. NOLs

When a taxpayer has NOL carryforwards generated in a year in which the BEAT was in effect (that is, 2018 or afterward), a portion of those NOL carryforwards equal to the applicable taxpayer’s BEP in the year the NOLs were generated (the vintage year) is treated as an addback in calculating MTI in the year in which the NOL is used.113 This rule effectively taints a taxpayer’s NOL carryforwards. The BEP that is applied to a taxpayer’s NOLs is equal to the BEP for that taxpayer’s aggregate group.

Groups whose tax-sharing agreements compensate members for the use of their NOLs, and that allocate tax liabilities based on some measure of separate return tax liability (that is, the section 1552(a)(2) method, Alternative 4 above, or any similar variation of a stand-alone calculation) need to consider how to measure each individual member’s BEP for purposes of this calculation. For example, if P and S1 were members of a

consolidated group in year 1, and S1 generated NOLs in that year, in considering what value is attributable under a tax-sharing agreement to S1’s NOLs when they are used in year 2, should the group assume that the vintage-year BEP applied to those NOLs is the P group’s percentage? Or should S1’s individual BEP apply, as if S1 were not a member of the P group in the year the NOL was generated? If the latter, should the group also assume that S1 is unrelated to P and other affiliates of P? Because BEP is measured by the aggregate group rather than the consolidated group, these determinations can have a considerable effect on the value attributable to S1’s NOLs.

C. Affiliation

Another issue groups will need to consider is how to allocate tax liability caused by base erosion payments that would not have been treated as such had the paying entity not been a member of a consolidated group. Although hopefully a rare occurrence, this fact pattern could arise if a group member makes payments to a foreign party that would not have been treated as related (under section 59A(g)) to the group member on a separate basis but is treated as related to another member of the consolidated group. In that circumstance, reg. section 1.1502-59A(b)(3) treats the foreign party as related to each group member.

This fact pattern raises an issue unlike the other issues created by applying the BEAT in a consolidated group, because it is not a calculation issue resulting from the aggregation of different member activities. Rather, it is a characterization issue, which actually increases the aggregate amount of base erosion payments compared with what they would have been had the members been viewed separately.

Thankfully, this issue seems fairly unlikely to occur. For this reason, it could be something that the group chooses to address as and when it arises, rather than hardwire a particular solution to the problem in advance. The group’s solution would likely depend on why the particular base erosion payment is made and whether in the group’s view it is fair to hold the heretofore unrelated payer accountable for the additional BEMTA caused by consolidation.

112Depending on the tax allocation method chosen, a group may

decide that a member’s exit is an appropriate time for a true-up payment if the member either over- or underpaid its tax liabilities while it was a member. But there is nothing specific to the BEAT rules that would require additional adjustments.

113Reg. section 1.59A-4(b)(2)(ii).






D. Interest Expense Deductions

1. Allocation Issues Exclusive to Section 163(j)In part 1, we summarized the rules governing

the application of section 163(j) to consolidated groups, as well as the interaction of those rules with the BEAT, as relevant to groups seeking to allocate the economic incidence of section 163(j) and the BEAT to their group members. Some of the allocation questions arising out of these rules relate exclusively to section 163(j).

A simple example is a two-member consolidated group in which one member has enough adjusted taxable income as measured for section 163(j) purposes to allow all its business interest expense to be deductible, and the second member would have been subject to a section 163(j) limitation on an independent basis. Assuming the first member has excess ATI capacity, the second member will have greater capacity for interest deductions.

One might argue that this second member should pay a higher share of the group’s tax burden because its inclusion in the group reduced its tax liability compared with what it would have been on a stand-alone basis. But should that second group member be required to pay to the other member the amount of tax liability it would have been responsible for on a stand-alone basis? The first member, with additional ATI capacity, did not give up a tax attribute that could have been valuable later, because excess capacity for business interest expense deductions cannot be carried forward under the law. In this case, consolidation helped reduce one member’s liability for taxes compared with its separate tax return liability, but it did not increase any other member’s, now or in the future.

If that two-member group adopted the section 1552(a)(1) method, it might decide that each member calculates its separate taxable income by taking into account only its portion of the group’s section 163(j) limitation. This would be consistent with how the section 1552(a)(1) method treats other limitations, like the charitable contribution deduction.114 It would cause any member that would not have individually been subject to a

section 163(j) limitation to bear a higher proportion of the group’s taxes.115

If instead the group adopted the section 1552(a)(2) method, it appears that a member that would not have been subject to the section 163(j) limitation on its own would get the benefit of a reduced measure of separate return tax liability, and therefore a lower portion of the group’s taxes.

If the group simply allocated to each member the taxes that member would have paid independently, the group would still need to decide whether to implement those methods by assuming the group’s aggregate section 163(j) limitation applied to all group members, or if each member would calculate its limitation separately.

If the group chose to adopt a method similar to the with-and-without method applied to the corporate AMT, the results would be more difficult to predict. A member’s share of the group’s tax burdens could be reduced to the extent the member generates income that produces extra section 163(j) capacity, but, of course, the member would also need to pay the group for the extra tax resulting from that extra income.

The commercial issue is more complicated if inclusion in a group makes a member worse off. Is it fair, for example, to penalize a group member whose interest expense would be fully deductible on a stand-alone basis, if, as a result of that member’s inclusion in a consolidated group, some of its interest expense is treated as nondeductible under section 163(j) because the group overall does not have capacity for all group members’ deductions? If the member’s contribution to consolidated tax is measured by reference to its actual income and actual deductions, the member would be penalized, because it would have higher taxable income (and therefore higher tax) than if its income were measured on a stand-alone basis, under which all deductions were allowed. Its proportion of the CTL would effectively be increased.

The answer to this question is up to the members, and what they think is fair given the circumstances. The group may want to consider

114See supra note 15 in part 1.

115Note that the section 1552 regulations do not actually treat the

section 163(j) limitation this way. However, it is consistent with the approach taken by those regulations in analogous contexts.






the specific factual reasons its interest expense was subject to a section 163(j) limitation in a particular year. For example, a consolidated group could be composed of (1) some members paying interest expense, each with sufficient taxable income independently to avoid a section 163(j) limitation, plus (2) other members whose ATI is negative. If the latter members’ losses reduce the group’s overall ATI sufficiently to result in a section 163(j) limitation being imposed on a groupwide basis, the group overall is worse off than had those members been excluded from the calculation. No member wins in this scenario: Members with interest expense may have had lower taxable income and lower income tax on a stand-alone basis than they do as members of the group, because of section 163(j); and members with no interest expense because of negative ATI would presumably have no taxable income in either situation. So which members should bear the burden of that section 163(j) limitation, and how does that choice compare with how the substantive rules described in this article actually allocate that burden?

2. Allocation Issues Arising From the Interaction of Section 163(j) and the BEATWhen the interactions of section 163(j) and the

BEAT are taken together, the complexities only increase.

As described earlier and in part 1, under reg. section 1.1502-59A(c), a group member that makes no actual base erosion payments whatsoever might still be deemed to have made those payments to the extent it makes deductible business interest expense payments to third parties, as long as some other group member makes deductible business interest expense payments to a foreign related party. Treasury apparently made a choice in the regulations that liabilities anywhere in the group should effectively be treated the same. But what if there are unrelated third parties invested in some members of the group and not in others?

If the group is an applicable taxpayer subject to the BEAT, is it fair to treat the first member (the one that made no base erosion payments) as having made base erosion payments for purposes of splitting up tax liability? That is, should the group respect the deemed base erosion payments the member makes under reg. section 1.1502-

59A(c)(4)? Presumably, there are some situations in which it would be better to allocate the incidence of the resulting BEMTA to the group member that actually made the payments. It depends on what reasons the group had to allocate its interest expense among the entities. If it was a matter of convenience, such that the group members all benefited from the borrowing, and the group was indifferent to which entity bore the specific financing obligations, a deemed allocation of BETBs may not be unfair. But if there were real commercial differences in deciding to locate the debt in one location versus another — including considerations concerning pricing, regulators, the preferences of the lenders, uses of proceeds, or the investments by unaffiliated equity holders — the deemed allocation may not properly reflect the legitimate commercial choices the group made on where to locate its debt.

If the group did want to allocate liability for BEMTA to the member that actually made the base erosion payments (rather than allocating those payments pro rata to all members paying interest), the group would need to adopt a special section 163(j)-BEAT policy for tax allocation purposes that overrides the deemed rules set forth in the regulations. This solution has the inherent appeal of bearing some relationship to reality — the member is responsible only for base erosion payments it actually made. But it would be complicated to administer.

One possibility is for the group to adopt a method similar to the section 1552(a)(2) method — that is, each member’s responsibility for the BEAT is based on what its taxes would have been on a stand-alone basis. But the group should consider whether adopting that method could have adverse or unexpected consequences for other aspects of the BEAT unrelated to section 163(j). Alternative methods, such as allocating to each member its tax liabilities as if it filed a separate return, would also achieve this result, but taxpayers ought to consider the complexity of maintaining a full set of hypothetical books and records in order to properly track the members’ individual base erosion payments, and how to apply the gross receipts and BEP tests on a stand-alone basis. Every solution has a potential drawback.

The group would also want to consider the effect of deemed base erosion payments on






section 163(j) carryforwards. For example, if a deemed allocation of attributes occurred during a year in which the group was subject to a section 163(j) limitation overall, the first group member (the one that did not pay related-party interest) might be allocated more tax attributes that it can carry forward into future years than it would have been allocated had it been a stand-alone taxpayer. These carryforwards, assuming they can be used, would ultimately provide some offset to the burden the member might bear if it is allocated group taxes based on the deemed allocation of BEAT liabilities.

The interaction of section 163(j) and the BEAT raises difficult questions. Should the group determine to accept or reject the deemed character rules for purposes of both the BEAT and section 163(j)? Or are there circumstances in which accepting the deemed characterization rules for one regime makes sense, but not for the other? For example, accepting the deemed rule for section 163(j) purposes might not produce as uneconomic a result as the BEAT rules, because the section 163(j) rules do not permanently disallow the deduction — they only defer it to a future year. To the extent a member is saddled with a deemed section 163(j) limitation, it would also get a deemed section 163(j) carryforward, for which it could be compensated (or use for itself) in later years.

The BEAT rules, by contrast, create a permanent loss of the relevant deduction, so if a member is deemed to make a BEAT payment that it did not make and is forced to pay the group accordingly, that member would not be expected to recover payments from other group members in later years, and it would not have a tax attribute carryforward that it could use in later years.

A potential middle ground could capture some (but not all) of these effects. For example, the member with deemed BETBs could be trued-up upon departure from the group. If it has previously underpaid for group tax liabilities by ignoring the deemed BETBs, it would be consistent for the group to realize value from any remaining section 163(j) carryforwards attributable to the subsidiary on exit. If the member has previously overpaid for group tax liabilities by making payments for its deemed BETBs, it would be consistent to give the departing subsidiary the value of whatever

carryforwards are left in the entity at the time of a group exit. The group would need to make a judgment call about whether this middle ground is an acceptable resolution. First of all, it would not work at all for a member that does not depart the group eventually. Second, the amount of the true-up on the departure would not relate in any way to the amount of extra tax-sharing payments the member made while it was part of the group for BETBs on current-year deductions.

E. Election to Waive Deductions

New BEAT regulations, finalized September 1, contain a special rule allowing taxpayers to elect to waive some deductions for BEAT planning purposes.116 Specifically, reg. section 1.59A-3(c)(6) provides that in calculating a taxpayer’s BETBs, the taxpayer may waive allowed deductions, including depreciation deductions. The cost of doing so is that this deduction would then be treated as waived for all purposes of the code and regulations, subject to specified carveouts. This waiver rule was originally proposed in December 2019 in response to taxpayer requests for clarification about whether deductions would constitute BETBs if the taxpayer declined to take them.117 Presumably, these comments were seeking to give taxpayers flexibility to manage their ability to avoid the cliff effect: If the taxpayer is close to the 3 percent BEP test limitation, it could waive some base-eroding deductions and build in some cushion so that it would not risk being treated as an applicable taxpayer.

In the context of a consolidated group, which member or members should pay the price of the lost deductions? What is particularly interesting about this question is that it is not about allocating BEAT liability. Instead, it arises in a situation in which the group’s overall tax liability is calculated without reference to the BEAT, because the entire point of the waiver is to avoid the BEAT. But because of the waiver, the group’s CTL is higher than it would have been had the members not been subject to the BEAT in the first instance, because the group would have calculated tax

116T.D. 9910.

117See REG-112607-19, at Part III.






under non-BEAT methods and taken the relevant deduction. Effectively, the waiver increases one or more members’ separate taxable income under reg. section 1.1502-12, and therefore the overall CTI under reg. section 1.1502-11.

Should the members simply resort to their normal, non-BEAT rules on how to allocate tax liability based on those measures, or would that be unfair to the group member whose deduction was waived, which effectively took a hit for the team by increasing its overall taxable income for the group’s benefit? The question is also not as simple as merely asking what the group’s, or the member’s, liability would have been if the member with the deductions had not been part of the group. Presumably, the member’s separate return tax liability would be lower absent consolidation because it likely would not have chosen to waive the deduction.

Some other questions the group may want to consider in deciding this question:

• Which group members would have been primarily responsible for the group’s BEAT liability had the deduction not been waived? Would it have been the member with the waived deduction, or some other member?

• Which of the different elements described in this article relevant to the calculation of BEAT liability does the member bring to the group? Does it have significant FTCs or other tax credits that are disadvantaged by the BEMTA calculations? If so, the waiving member may benefit the most from the waiver, because it would otherwise potentially lose those credits through the application of the BEAT, without any monetary benefit to the group.

• Does the member whose deduction was waived have significant other deductions that are not BETBs? What is the effect of the member, overall, on the group’s BEP test? What is the effect of the member on the group’s qualification as an applicable taxpayer generally?

• Who made the choice to cause the member to waive the deduction?

In this particular situation there are many possible outcomes, and the effect of the waiver or the fact patterns in which it would arise are nearly impossible to predict. Accordingly, the best

solution to this issue is probably to address it in the particular year in which an election is made, based on the facts at the time. Without knowing whether the member whose deductions are waived would be primarily responsible for BEMTA in the absence of the waiver, it is difficult to create a concise set of rules to address the hypothetical outcome in advance. If taxpayers seek to adopt a bespoke (that is, “when needed”) approach to addressing the effect of this election, they should make that rule clear in their tax-sharing agreements, lest some other default rule allocating tax liabilities become operative.

VII. Existing Tax-Sharing Agreements

After grappling with the difficult conceptual issues of the best way to allocate BEAT liabilities among consolidated group members, taxpayers should review their existing tax-sharing agreement to determine whether and how it addresses the BEAT and allocates BEAT liability. As noted in part 1, tax-sharing agreements often piggyback off the definitions and principles of section 1552 and the regulations under section 1502 in allocating tax among group members. Accordingly, tax-sharing agreements may include references to measures of CTL and CTI that are defined in the code. The methods under section 1552 each allocate among a consolidated group that group’s CTL. Groups with tax-sharing agreements in place should carefully read through the definitions they use, to ensure that the agreement includes BEMTA in the calculation of the measure of the group’s taxes that is being divided. Notably, in December 2019 Treasury issued a revised final version of reg. section 1.1502-2, which now specifically includes BEMTA as a component of a group’s CTL.118

Also, taxpayers with tax-sharing agreements that allocate liabilities among group members based on a measure of each member’s taxable income, like under the section 1552(a)(1) method, may want to revisit that decision in the context of the BEAT. Although this measure can work well (albeit not perfectly) in the context of regular income tax liability, it does not function as well in

118See reg. section 1.1502-2(a)(9) and (b); and T.D. 9885 (“tax on base

erosion payments of taxpayers with substantial gross receipts”).






situations like the BEAT that impose an alternative, parallel system of measuring income, using a different tax rate (as illustrated by the earlier examples). The concept of picking up BEAT liabilities using a measure of taxable income does not make sense on its face, because the purpose of the definition of taxable income is to calculate the group’s income that is subject to taxation under section 11, rather than section 59A.

For this reason, BEAT concepts are not included in the definition of a member’s separate taxable income, as determined under reg. section 1.1502-12. Accordingly, taxpayers that incorporate the concept of separate taxable income into their tax-sharing agreements must consider whether the agreement uses the term in a manner for which it might be inappropriate. For example, if the tax-sharing agreement divides the group’s total CTL based on each member’s separate taxable income, it would be comparing apples and oranges, because CTL includes BEAT liability, but the BEAT has no effect on the measurement of separate taxable income. Discrepancies like this can create distortions, as illustrated in examples 1 and 2.

VIII. Other Allocation Issues

This article has primarily focused on the BEAT because the BEAT appears to present the most significant opportunity for distorted tax allocations within a consolidated group. However, there are elements of other aspects of the TCJA that deserve consideration (in addition to section 163(j)). This section briefly addresses two of them: the calculation and allocation of consolidated global intangible low-taxed income inclusions, and the limitations on deductions for GILTI and foreign-derived intangible income.

A. Consolidated GILTI

Reg. section 1.1502-51 addresses the calculation of a consolidated group’s GILTI inclusion and allocates it to a particular member (that is, the amount of GILTI that is added to the member’s taxable income under section 951A). Reg. section 1.1502-50 addresses a consolidated group’s GILTI deduction and its allocation to a particular member (that is, the amount of a member’s GILTI income that is eligible for a 50 percent deduction under section 250, resulting in an effective 10.5 percent tax rate on GILTI).

A member’s GILTI amount is determined under reg. section 1.1502-51(b), and is determined using the member’s share of the consolidated measure of qualified business asset investment,119 the consolidated measure of specified interest expense (a reduction to tested income),120 the member’s individual calculation of tested income,121 and the member’s share of consolidated tested loss.122 (For readers less familiar with the GILTI rules, GILTI is calculated as a member’s net tested income for its CFCs, minus 10 percent of its QBAI for CFCs with tested income, and minus specified interest expense.) The member’s allocated share of each of these measures is based on the ratio of the member’s tested income for tested income CFCs to the consolidated group’s total tested income for tested income CFCs (without reduction for tested losses).123

As should be clear, applying this rule involves a mix of groupwide and member-specific calculations and raises similar issues to the BEAT in determining how a group ought to determine a member’s share for purposes of allocating its liability under a tax-sharing agreement.

For example, the member’s share of consolidated QBAI is based on the QBAI across the group for all tested income CFCs of any group member. A member’s share of specified interest expense is based on the interest expense and interest income of each CFC of the group. And a member’s share of tested loss is based on the tested losses of all tested loss CFCs of the group. Each of these items is a reduction to the member’s GILTI inclusion.

These rules may not have a significant impact for a consolidated group in which a single member owns all the group’s CFCs or owns a significant portion of the group’s CFCs through an international holding company.

However, if individual members of a group hold different CFCs (perhaps for valid commercial reasons related to the operations of the particular member), this aggregation of losses,

119Reg. section 1.1502-51(e)(9).

120Reg. section 1.1502-51(e)(13).

121Reg. section 1.1502-51(e)(12)(i).

122Reg. section 1.1502-51(e)(12)(ii).

123Reg. section 1.1502-51(e)(10).






interest expense, and QBAI could result in some members with tested income CFCs benefiting from the tested losses, net interest expense, and QBAI of other members’ CFCs. If a member’s contribution to the group’s overall tax costs is allocated based on its individual GILTI inclusion as measured under these rules (for example, as part of the member’s separate taxable income under reg. section 1.1502-11, under the section 1552(a)(1) method), the member’s tax liabilities as allocated may be lower than they would have been had the member not been included in the group, because it has benefited from another member’s tax attributes. The issues here seem similar (although, of course, more complex, because of the complexity of the GILTI rules themselves) to the sharing of NOL carryforwards within a group more generally. That is, if a group has decided that member B should be compensated for the use of B’s NOL carryforwards by other group members in calculating CTI, the group may consider adopting a similar rule in the context of CFC tested losses, QBAI, and interest expense.

The imbalances created by this sharing of losses (in particular, across CFCs of different consolidated group members) could have been magnified in part with basis adjustments made to the CFC’s stock (and also to the stock of the consolidated members themselves), reflecting the portion of a CFC’s tested losses that are used to offset other CFCs’ tested income. Under prior proposed regulations, on a subsequent sale of those tested loss CFCs, the selling member would recognize additional gain in the amount equal to the portion of the CFC’s tested losses that were used to offset other CFCs’ tested income in the GILTI calculation. Those regulations were rescinded when final GILTI regulations were issued in June 2019, but Treasury is continuing to study stock basis issues related to CFC tested losses.124

B. Limitation on Deductions

In addition to the allocation issues related to the calculation of the GILTI inclusion, there are

similar issues related to the calculation of the GILTI deduction. Section 250 establishes a 50 percent deduction for GILTI for domestic corporations.125 It also provides rules defining a new category of favorably treated export income — FDII — and establishes a 37.5 percent deduction for FDII income of domestic corporations.126

Both the GILTI and FDII deductions are subject to an aggregate limitation, such that they do not apply to the extent that FDII plus GILTI together exceed the taxpayer’s taxable income.127 For consolidated groups, regulations under section 250 provide that the calculation of FDII and the determination of the amount of the deduction are set forth in special regulations under section 1502.128 In calculating the deduction, reg. section 1.1502-50(b) specifically allocates section 250 deductions for GILTI and FDII to specific members based on the amount of a member’s FDII deduction allocation ratio and GILTI deduction allocation ratio, respectively.

For the GILTI deduction, each group member is allocated its proportion of the group’s consolidated GILTI,129 after adjusting that amount for the taxable income limitation described earlier. Each member’s proportion is based on its own GILTI amount, multiplied by the GILTI deduction rate.

Specifically, once a member’s own GILTI inclusion is calculated (influenced by group measurements as described earlier), each member then adds up its GILTI inclusion to get the total consolidated measure. This consolidated (aggregate) GILTI inclusion is then reduced so that the total GILTI deduction for the entire group is subject to the taxable income limitation. Afterward, the net amount is divided up among the members.130 In this way, each member of the

124See prior prop. reg. section 1.951A-6(e); and T.D. 9866, at Section

VIII.C.

125Section 250(a)(1). These deductions are 21.875 percent for FDII and

37.5 percent for GILTI for tax years beginning after 2025. Section 250(a)(3).

126There are numerous other issues presented by the calculation of

FDII in a consolidated group (as compared with the calculation of the deduction for FDII), which we do not address here.

127Section 250(a)(2).

128See reg. section 1.250(a)-1(e) (deductions) and reg. section 1.250(b)-

1(f) (FDII calculation).129

Consolidated GILTI itself is merely equal to the sum of the GILTI of all the group’s members.

130Reg. section 1.1502-50(b)(1)(ii) and (2)(ii).






group with a GILTI inclusion effectively shares, pro rata, in the group’s overall limitation on GILTI deductions. But should they share that limitation economically?

As it relates to the allocation of liability for these taxes among group members, the limitation on deductions to taxable income presents issues similar to other sorts of deductions subject to limitations in consolidated groups, like the deduction for charitable contributions and for the dividends received deduction. Members with significant GILTI inclusions but without significant NOLs or deductions might, on a stand-alone basis, have a lower tax rate on GILTI income than in a consolidated group, if other members of the group have NOLs and deductions that reduce the group’s overall taxable income. The consolidated group would need to consider this issue as well, and determine whether it is appropriate to charge a member for what the tax cost of its GILTI inclusion would have been on a stand-alone basis, or instead whether it should charge the member what the tax cost of its GILTI inclusion actually was in the consolidated group.

The limitation on the FDII and GILTI deductions does not prevent the inclusion of FDII and GILTI in taxable income. Therefore, another result of the limitation is to force a taxpayer to chew through its other deductions and NOL carryforwards against FDII and GILTI income first, before providing the further deduction for FDII and GILTI. As a result, deductions and NOL carryforwards that might have generated 21 cents of tax benefits per $1 of deduction might generate only 10.5 cents or $0.07875 (37.5 percent of 21 percent) of benefits for GILTI and FDII,

respectively. Because the FDII and GILTI deductions cannot be carried forward to future years, this limitation is effectively a permanent loss of the relevant tax attribute. Consolidated groups whose FDII and GILTI deductions may be subject to this limitation should consider how they want to allocate that reduced value between group members that generated the income and those that generated the relevant deductions.

IX. Conclusion

As illustrated by the selection of issues discussed in this article, for a consolidated group whose members or stakeholders have a commercial interest in how the group shares its tax liabilities, the TCJA has introduced considerable additional complexity to an already complicated area. As with most elements of the TCJA, in resolving these issues, there is simply no choice but to develop a deep understanding of the relevant legal regimes, how they interact with one another, and how they apply to the relevant taxpayer’s specific facts. Absent a crystal ball, adopting a flexible approach to these issues may enable a group to avoid significant and unpredictable distortions, although commercial considerations and negotiations may demand a more formulaic measure. Even still, taxpayers may wish to give themselves the ability to address unexpected circumstances as they arise.







Emerging From Crisis: The Changing EU VAT Landscape

by Aleksandra Bal

In 2020 the world plunged into the worst crisis of the century. The COVID-19 pandemic has affected all aspects of our lives and changed the way we work, study, travel, and do business. It has also forced numerous businesses into bankruptcy and left millions unemployed.

Although it may seem to be a strange and unrealistic concept at first, a crisis is always accompanied by an opportunity. A famous quote by Rahm Emanuel, former mayor of Chicago, says: “Never let a serious crisis go to waste. And what I mean by that it’s an opportunity to do things you think you could not do before.” As we slowly embark on the path to recovery and as the details of the new normal gradually emerge, it is useful to consider whether Emanuel’s quote will hold true for the EU VAT system. Will the EU VAT system adapt to — and, perhaps, take advantage of — the new reality?

Experts across the political spectrum agree that changes to the EU VAT legislation are very much needed. The system is plagued by multiple problems and inefficiencies, including its growing complexity, rising compliance costs, and a high

level of fraud. The COVID-19 crisis is further evidence that the VAT gap must be closed, and this must happen soon, because the cash-strapped member states need extra revenue to finance massive stimulus programs. Compliance must also be made simpler. Businesses that are cutting costs to survive the aftermath of the pandemic can hardly afford the growing expense of frequently changing and country-specific VAT reporting requirements.

I. The VAT Gap Problem

The VAT gap is the difference between expected VAT revenue and the amount of VAT actually collected. It provides an estimate of revenue loss resulting from tax fraud and tax avoidance, but also from bankruptcies, financial insolvencies, and genuine miscalculations. According a recent report from the European Commission, EU member states lost an estimated €140 billion in VAT revenues in 2018.1 Romania recorded the highest national VAT gap (33.8 percent), followed by Greece (30.1 percent) and Lithuania (25.9 percent). In absolute terms, Italy (€35.4 billion), the United Kingdom (€23.5 billion), and Germany (€22 billion) lost most VAT revenue.

Although the overall VAT gap for 2018 was almost €1 billion less than the 2017 estimates, the forecast for 2020 anticipates a reversal of this trend. The European Commission predicts that the VAT gap will increase to around €164 billion in 2020 because of the effects of the COVID-19 crisis on the economy. This means that EU countries will lose 17 percent more VAT revenue than they did in 2018. While some crisis-related VAT revenue losses are inevitable, the EU should take decisive action to prevent revenue loss resulting from illegal activities.

Aleksandra Bal is an indirect tax technology specialist. Email: [email protected]

The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organizations with which she is affiliated.

In this article, the author examines the European Commission’s plans to reform the VAT system by January 2025.

1European Commission, “Study and Reports on the VAT Gap in the

EU-28 Member States — 2020 Final Report” (Sept. 2020).






II. A Package for Fair and Simple Taxation

The European Commission presented its vision of the future VAT system in its Tax Package for Fair and Simple Taxation, which was announced July 15. The package includes three instruments: an Action Plan for Fair and Simple Taxation Supporting the Recovery Strategy (COM(2020) 312 final), a proposal to amend Directive 2011/16/EU on administrative cooperation (COM(2020) 314 final), and a communication titled “On Tax Good Governance in the EU and Beyond” (COM(2020) 313 final). The main objectives of the package include:

• reducing tax obstacles and unnecessary administrative burdens for businesses in the single market;

• helping member states enforce existing tax rules and improve tax compliance; and

• helping tax authorities combat tax fraud and evasion more effectively by making better use of existing data and sharing new data more efficiently.

The action plan is a set of 25 initiatives that the European Commission will implement by 2024 to make taxation fairer and simpler and to fully exploit modern technologies. Fifteen of the measures are directly related to VAT or other indirect taxes, and the most important of these measures are discussed in this subsection.

A. Single EU VAT Registration

Under the existing rules, a taxpayer must register for VAT purposes if its taxable turnover exceeds or is expected to exceed a certain threshold. The registration threshold varies by member state — it can be as low as around €6,700 (DKK 50,000) in Denmark or as high as €65,000 in Italy. Foreign businesses (that is, those that are neither established in nor have a fixed establishment in a member state) do not benefit from any registration threshold — they must register as soon as they supply goods and services in any member state.

There are exceptions to the general rule. For example, the one-stop shop (OSS) permits a taxpayer to register in a single member state and then remit all EU VAT through the member state of registration. However, the OSS applies only to supplies of electronic, broadcasting, or telecommunication services to nontaxable customers.

Taxpayers that have cross-border operations may face VAT registration, compliance, and payment obligations in multiple member states. Because the VAT directive (2006/112) allows the member states to determine their own registration procedures and VAT reporting obligations, both tend to vary significantly from member state to member state. This goes against the fundamental principle of the single market — that is, it should be as easy to do business in another member state as it is in one’s home state. For this reason, the European Commission intends to propose a single EU VAT registration system that will allow businesses registered in one member state to supply goods and services anywhere in the EU. The commission expects to prepare this proposal in 2022 or 2023.

B. Modernizing VAT Reporting Obligations

Businesses that have cross-border obligations face a heavy burden from the EU VAT reporting system because the type and format of the information they need to provide varies with the member state. Each state has its own views regarding what transaction data businesses must collect and how they should transmit this data to the tax administration.

Filing VAT returns in multiple countries is not easy. The content of the returns changes frequently, and filing instructions (if any even exist) are available only in the national language. In addition to filing VAT returns, the majority of the member states have also introduced other VAT compliance obligations — examples include real-time reporting of transaction data; periodic reporting of transaction data, often using the Standard Audit File for Tax format (commonly known as SAF-T); mandatory e-invoicing; split payments, which typically involve having the customer make separate payments for VAT and the net cost of the supply or having the bank separate a single fee; and mandatory digital reporting — all of which add another layer of complexity for companies doing business in several member states.

2

2For more information on VAT compliance obligations in Europe, see

Aleksandra Bal, “VAT Trends in Europe: Digitalization and Real-Time Filing,” Tax Notes Int’l, Feb. 18, 2019, p. 717.






The European Commission recognizes the challenges posed by divergent country-specific VAT reporting rules and intends to present a legislative proposal for modernizing VAT reporting obligations in 2022 or 2023. The new rules should provide tax administrations with more detailed information and do so in real time. The commission will also examine the need to expand e-invoicing.

This is not the commission’s first attempt to standardize and simplify VAT reporting. In 2013 the commission proposed introducing a standard VAT return, which would have included at least five obligatory boxes to reflect output and input VAT, the associated net figures, and the net amount to be paid or refunded.3 The idea behind the standard VAT declaration was to allow all businesses to provide the same type of information in a common, and preferably electronic, format to each member state so that a business submitting a VAT return in one member state could easily complete and submit a VAT return in another member state. Ultimately, however, the standard return proposal gained little support from the member states, and it was dropped.

C. Extending the One-Stop Shop

The OSS is an optional scheme that allows businesses supplying telecommunication, broadcasting, or electronic services to nontaxable persons in other member states to account for VAT — including payments that would normally be due in multiple EU countries — in just one EU country.

The OSS includes two schemes: the union scheme (for businesses that are established in the EU or have a fixed establishment in an EU country) and the nonunion scheme (for businesses that are not established in the EU and do not have any branches in the EU). Beginning July 1, 2021, the OSS will be extended to intra-Community distance sales of goods, and a similar special scheme will be introduced for distance

sales of goods imported from third territories or third countries.4

In 2022 or 2023, the European Commission intends to propose an amendment to the VAT directive to further extend the scope of the OSS to include all business-to-consumer (B2C) transactions. A taxpayer should be able to report all B2C transactions in the EU using a single VAT return that is submitted in its member state of establishment. During this time, the commission will also examine the possibility of making the use of the import OSS mandatory and revising the threshold for its use.

D. Eurofisc 2.0 and VAT Committee

The European Commission has announced several organizational changes aimed at improving the functioning of the VAT system.

In 2022 or 2023, the commission plans to present a proposal to strengthen Eurofisc’s role in the fight against VAT fraud in cross-border transactions. Eurofisc is a network of anti-fraud experts from various national tax administrations that was set up in 2010 to improve member states’ ability to combat organized VAT fraud, especially carousel fraud. Eurofisc allows member states to exchange early warnings regarding businesses suspected of being involved in carousel fraud. Since mid-May 2019, Eurofisc officials have been able to use transaction network analysis, an automated data mining tool that tries to detect VAT fraud at an early stage by collecting information from multiple sources and providing better visualization of carousel fraud chains and trends.

The commission plans to take steps to ensure that Eurofisc has more data and tools at its disposal and that it is closely connected to other relevant EU bodies and national authorities. Eurofisc will become an EU hub for tax information that extends beyond VAT, and it will also assist financial market authorities, customs, the European Anti-Fraud Office, and Europol. Within the newly expanded Eurofisc, the

3European Commission, Proposal for a Council Directive amending

Directive 2006/112/EC on the common system of value added tax as regards a standard VAT return, COM(2013) 721 final (Oct. 23, 2013).

4This is one of several legislative changes included in the VAT e-

commerce package, which includes two directives and four regulations. For more information, see Bal, “What Non-EU Businesses Should Know About the EU’s New VAT E-Commerce Rules,” Tax Notes Int’l, Apr. 20, 2020, p. 297. See also note 15 infra and related text.






expertise needed to respond to new fraud patterns that arise from changing business models will be developed jointly. In this way, a common investment at the EU level will directly benefit all member states regardless of their resources and capabilities.

In its present form, the VAT committee is an advisory group made up of representatives from the member states and the commission. It does not have any legislative powers and thus plays no role in adopting implementing measures. However, the action plan calls for the European Commission to propose a change to the VAT directive that would turn the VAT committee into a comitology committee,5 which would act by qualified majority and oversee the adoption of relevant implementing acts by the commission. This should improve the efficiency of the decision-making process regarding VAT and contribute to a more uniform application of the EU VAT legislation, which should benefit taxable persons having economic activities in several member states.

E. Verification of Cross-Border Transactions

Under the existing VAT system for intra-EU trade, the supply of goods that are transported to another member state gives rise to two taxable transactions: a zero-rated intra-Community supply in the country of departure and an intra-Community acquisition by the customer in the country of arrival. If the customer is entitled to an input VAT deduction, it can offset the VAT that it paid on the acquisition as deductible VAT on the same return on which it reports the VAT collected on the later sale, and it does not need to pay anything to the tax authorities.

This system for intra-EU trade is complex and susceptible to fraud because it permits a customer to purchase goods VAT-free in other member states. Missing trader fraud occurs when a

company that has purchased goods VAT-free from another member state sells them on domestically and fails to remit VAT it received on this sale to the tax authorities. According to the European Commission’s latest VAT gap report,6 cross-border VAT fraud accounts for around €50 billion in lost revenue per year in the EU — that is more than a third of 2018’s estimated €140 billion VAT gap.

Member states’ options are limited when it comes to detecting fraudulent cross-border transactions. A taxpayer that makes intra-Community supplies must submit recapitulative statements (commonly known as EC sales lists) to the tax authorities in its state of residence periodically. The tax authorities in that state enter the information into the VAT Information Exchange System (VIES) database. VIES makes the data available to the tax authorities in the member state of destination. The disadvantage of the VIES is that it does not allow for timely data verification — fraudsters typically disappear before the authorities detect the fraudulent operations.

The European Commission intends to strengthen and modernize the system for the exchange of information about cross-border transactions. It plans to explore the possibilities of automated data sharing and the use of new technologies to identify noncompliant taxpayers. Because the commission believes that 2 percent of organized crime groups may be responsible for 80 percent of missing trader fraud,7 tax authorities should apply targeted measures and a risk-based approach to focus their controls on noncompliant taxpayers while allowing honest businesses to operate without unneeded interruptions.

F. VAT Dispute Resolution

According to the action plan, the European Commission will advance a legislative proposal on a prevention and dispute resolution

5Comitology refers to a set of procedures through which EU

countries control how the European Commission implements EU law. Before it can implement an EU legal act, the commission must consult a committee that includes representation from every EU country. The committee provides an opinion on the commission’s proposed measures. These opinions can be more or less binding on the commission, depending on the procedures specified in the legal act being implemented.

6European Commission, supra note 1.

7European Commission, Amended proposal for a Council

Regulation Amending Regulation (EU) No 904/2010 as regards measures to strengthen administrative cooperation in the field of value added tax, COM(2017) 706 final (Nov. 30, 2017).






mechanism in 2022 or 2023. At this time the EU does not have a specific legal instrument for resolving disputes concerning the implementation of the VAT directive or VAT double taxation.8 The only European instruments that businesses can turn to when they are unsure about the VAT consequences of a cross-border transaction or receive unfavorable treatment from a public authority in another member state are cross-border VAT rulings and a service known as SOLVIT.

The VAT Cross-Border Rulings system is a pilot project that allows taxable persons to obtain advance rulings on the VAT treatment of complex cross-border transactions. At this time, Belgium, Cyprus, Denmark, Estonia, Finland, France, Hungary, Ireland, Italy, Latvia, Lithuania, Malta, the Netherlands, Portugal, Slovenia, Spain, and Sweden are participating in the program. A taxable person that plans to engage in cross-border transactions in one or more of the participating member states to request an advance ruling on the VAT treatment of the envisaged transaction in the member state where it is registered for VAT purposes. In response to a request, the member states concerned will consult each other. The main disadvantage of the cross-border ruling process is that there is no guarantee that they will agree on the VAT treatment of the envisaged transactions.

SOLVIT is an informal problem-solving network that can help EU businesses that believe their rights have been breached by public authorities in another EU member state. It is a faster alternative than a court case or a formal complaint to the commission. A business that encounters a problem exercising its rights can seek help from a SOLVIT center in its home country, which will send the case to the SOLVIT center in the country where the problem occurred. In turn, that center will deal with the authority in question. In 2019 SOLVIT handled 2,380 cases. Most of the VAT disputes involved refunds.9

G. Financial Services

Most financial and insurance services are exempt from VAT under article 135 of the VAT directive. The exemption means taxable persons that supply these services cannot deduct input VAT, which becomes a cost. To prevent the creation of nondeductible input tax, member states may allow parties to opt to be taxed on financial services. Eight members states have elected this option: Austria, Belgium, Bulgaria, Croatia, Estonia, France, Germany, and Lithuania. The scope of this option varies by member state.

The VAT exemption for financial services dates back to 1977 — the same year that the EU VAT legislation was put into place. It was introduced because of the difficulty involved in determining the taxable base for individual financial transactions. However, because of the increase in the outsourcing of input services by financial operators and the digitalization of the economy, the exemption creates two significant problems. First, outsourcing increases the costs for the financial sector because the VAT on goods and services purchased to supply the financial and insurance services may not be deducted. The increased cost of doing business puts EU financial institutions at a competitive disadvantage and is an obstacle to innovation, especially for small companies. Second, it is often not clear what the scope of the exemption is and how to treat new forms of financial and insurance transactions such as crowdfunding or cryptocurrency transactions. This is further aggravated by the fact that the member states interpret and apply the VAT rules on financial services inconsistently, which results in legal uncertainty, high compliance costs, and increased litigation before the Court of Justice of the European Union.

Financial institutions have tried to offset the impact of their input VAT burden by using VAT groups or cost-sharing arrangements. VAT groups allow several closely bound persons to form a single taxable person for VAT purposes, which means supplies between group entities are untaxed. Cost-sharing arrangements allow persons with exempt or nontaxable supplies to reduce the VAT incurred on expenses by creating a common structure (that is, a cost-sharing group) from which they receive exempt input supplies and share costs. However, the CJEU recently

8For direct tax issues, countries can rely on double tax treaties and

Council Directive (EU) 2017/1852 to resolve double taxation disputes.9See European Commission, “SOLVIT — Problems Solved, Taxation”

(last updated Sept. 14, 2016).






found that cost-sharing arrangements are not applicable to the financial and insurance sectors.10 Regardless, neither instrument can remove the cause of the problem — the VAT exemption itself. Instead, they merely alleviate one of the symptoms — that is, the cost of nondeductible input tax.

In the action plan, the European Commission promised to present a legislative proposal to modernize the VAT rules for financial services in 2022 or 2023. The modernization should take account of the rise of the digital economy and financial technology in addition to the increased outsourcing of input services by financial and insurance institutions. The proposal must ensure a level playing field within the European Union and should also consider the competitiveness of EU companies on an international level.

H. Travel Agents

The VAT directive provides special rules for travel agents who deal with customers in their own names and use supplies from other businesses to facilitate travel. Under the special scheme, all transactions that the travel agent performs for a particular journey are treated as a single supply to the customer at the place where the agent is established. The agent accounts for VAT on the profit margin and is not entitled to an input VAT deduction. The special scheme seeks to ensure that VAT accrues to the country where the travel services are actually provided, and it prevents businesses that provide travel services from facing multiple registration obligations.

Because of differences in the interpretation and application of the VAT legislation among the member states, the treatment of travel agents’ services has become one of the most complex areas of VAT, one that demands specialized knowledge and experience. The rules can also distort competition between travel agencies established within and outside the EU that organize travel in the EU. Moreover, the travel industry has changed significantly since the special scheme was introduced more than 40

years ago. Increases in digitalization and the rise of the sharing economy have created more opportunities for smaller tourism businesses and led to the formation of new travel distribution chains, including travel agents sourcing products from online intermediaries rather than purchasing them directly from principal suppliers.

The European Commission intends to revise the margin scheme for travel agents to simplify it and to ensure a level playing field within the EU. In 2017 the commission commissioned a study analyzing the functioning of the rules for travel agents and reviewing all relevant CJEU judgments on the topic.11 The study identified the following options for change:

• abolishing the margin scheme;• modernizing the scheme and allowing

entities to opt out; and• expanding the scope of the OSS regime to

B2C travel services.

In May the commission opened a public consultation on the special scheme.12 Interested parties were invited to provide their views on the problems caused by the margin scheme and suggest solutions by September 14.

I. Platforms

The VAT e-commerce package will introduce significant changes for platform operators.13 Beginning July 1, 2021, online platforms will be deemed to be the suppliers of goods that companies sell to private individuals in the EU in the following two situations:

• the sale of goods to final consumers in the EU by non-EU sellers where the goods were already released into free circulation and are located in the EU (irrespective of the value of the goods);

• the importation of goods with a value of up to €150 that are destined for an EU final consumer (irrespective of whether the seller is established in the EU or outside the EU).

10See Commission v. Luxembourg, C-274/15 (CJEU 2017); ‘DNB Banka’

AS v. Latvia, C-326/15 (CJEU 2017); Poland v. Aviva Towarzystwo Ubezpieczen na Zycie S.A. w Warszawie, C-605/15 (CJEU 2017); and Commission v. Germany, C-616/15 (CJEU 2017).

11European Commission, “Study on the Review of the VAT Special

Scheme for Travel Agents and Options for Reform — Final Report,” TAXUD/2016/AO-05 (Dec. 2017).

12European Commission, “VAT Scheme for Travel Agents

(Evaluation)” (last visited Oct. 2020).13

See note 15 infra and related text






Online platforms will have to collect and pay the VAT on these sales.

The European Commission expects to propose another set of measures to address the platform economy in 2022 or 2023. These measures should provide clarity and legal certainty regarding the VAT treatment of transactions between platform users, the VAT status of users, and the place of supply of services provided through online platforms. The commission will also examine the role of platforms in VAT collection.

Another element of the tax package that may affect platforms is the proposal to amend Directive 2011/16/EU on administrative cooperation. If approved, it will introduce an obligation for platform operators to report income that sellers earn from supplying goods and services through the platform. Specifically, the obligation will apply to the following types of platform-facilitated operations: immovable property rentals, personal services (that is, time- or task-based work), sales of goods, rentals of any mode of transport, and investing and lending in the context of crowdfunding.

J. Transport Sector

In December 2019 the European Commission released the European Green Deal (COM(2019) 640 final) a set of policy initiatives with the overarching goal of making the EU sustainable and climate neutral by 2050. One of the Green Deal’s focal areas is the reduction of pollution caused by transportation. To achieve the EU’s 2050 goal of climate neutrality, transport-related emissions must be reduced by 90 percent compared with 1990 levels.

Against this background, the European Commission wants to examine the possibilities for “greener taxation” of the passenger transport sector. This includes reviewing the exemptions related to passenger transport in the VAT directive to ensure their coherence with the goals of the European Green Deal. The commission also plans to simplify the VAT rules regarding the place of supply for passenger transport services.

III. The Ongoing 2016 VAT Action Plan

While the Tax Package for Fair and Simple Taxation is an ambitious plan, the European

Commission is also still implementing measures based on its previous VAT roadmap. To create a single, fraud-proof EU VAT area, the 2016 VAT action plan (COM(2016) 148 final) proposed modernizing the VAT e-commerce rules, simplifying compliance obligations for small and medium-sized enterprises, implementing a definitive VAT system for intra-EU trade, and modernizing the VAT rate policy.14

A. Approved Measures

Only two of the 2016 plan’s four initiatives have actually been enacted and scheduled for implementation. The commission approved the e-commerce VAT package on December 5, 2017,15 and it was supposed to enter into force January 1, 2021. However, because of the COVID-19 pandemic, implementation has been postponed until July 1. Because some member states are requesting another six-month postponement, it is likely that we will not see the new rules in operation until 2022.16

On February 18, the Economic and Financial Affairs Council approved the new VAT regime for SMEs.17 Under the new rules, member states can continue exempting SMEs based on an annual turnover threshold that cannot be higher than €85,000. Further, the new rules will open the exemption to small enterprises that are established in member states other than the one in which the VAT is due. This exemption will apply if:

• the turnover in the relevant member state (that is, the state in which the SME owes

14For an evaluation of the 2016 VAT action plan, see Bal, “A Progress

Report on the EU’s Efforts to Revamp its VAT System,” Tax Notes Int’l, Jan. 28, 2019, p. 393.

15Council Directive (EU) 2017/2455 of December 5, 2017, amending

Directive 2006/112/EC and Directive 2009/132/EC as regards certain value added tax obligations for supplies of services and distance sales of goods; Council Implementing Regulation (EU) 2017/2459 of December 5, 2017, amending Implementing Regulation (EU) No 282/2011 laying down implementing measures for Directive 2006/112/EC on the common system of value added tax; and Council Regulation (EU) 2017/2454 of December 5, 2017, amending Regulation (EU) No 904/2010 on administrative cooperation and combating fraud in the field of value added tax.

16For more information on this topic, see Bal, supra note 4.

17Council Directive (EU) 2020/285 amending Directive 2006/112/EC

on the common system of value added tax as regards the special scheme for small enterprises and Regulation (EU) No 904/2010 as regards the administrative cooperation and exchange of information for the purpose of monitoring the correct application of the special scheme for small enterprises.






VAT but is not established) is below that member state’s SME threshold; and

• the entity’s total annual EU turnover is below €100,000.

The new VAT scheme for SMEs will apply as of January 1, 2025.

B. Outstanding Measures

The member states have not been able to reach consensus on the two outstanding measures of the 2016 VAT action plan: the definitive VAT system and the rate policy.

According to commission proposals, the definitive VAT system should take effect in 2022. However, given the slow progress and lack of consensus, it is unlikely that this deadline will be met. The aim of the definitive VAT system is to replace the existing rules that apply to trade between member states with definitive arrangements based on the principle of taxation in the member state of destination. Under the definitive VAT system, the concepts of intra-Community supply and acquisition will be abolished and replaced with a single intra-Union supply. A supplier of goods will be required to charge the VAT of the country of arrival and remit this VAT to his local tax administration via an OSS system. If the customer in an intra-Union supply is a reliable trader — that is, a certified taxable person — then the supplier will not have to charge VAT, and the customer will account for VAT by means of a reverse charge mechanism.

While the member states agree that it is better to have one cross-border transaction instead of two, some are concerned about the certified taxable person concept and the potential negative effects of the supplier’s VAT liability. There is a general consensus that the proposal needs to undergo a thorough technical analysis before final policy choices are made. ECOFIN has recommended expanding the scope of this discussion to include other measures — for example, new reporting obligations — and consider the possibility of broader application of new technologies.18

The other commission proposal stemming from the 2016 VAT action plan that has not been approved yet is the reform of the VAT rate system. At present, member states can apply a standard rate of at least 15 percent and two reduced rates that are not lower than 5 percent. The latter can only apply to supplies of goods and services specified in Annex III of the VAT directive. The commission’s proposal seeks to give member states more flexibility in applying reduced rates by replacing Annex III with a new negative list of goods and services to which reduced rates may not be applied. Some member states consider the proposed rates reform to be part of the definitive VAT system, while others think that it should be discussed and adopted independently.

IV. Conclusion

The European Commission has a very ambitious tax agenda for the next few years. The Tax Package for Fair and Simple Taxation presents several initiatives that the EU plans to undertake by 2024, and some parts of the 2016 VAT action plan are still being implemented.

The reforms that will actually be enacted will depend on the political will of all member states, because unanimity is still required to enact EU tax legislation. Some significant and politically sensitive measures — for example, the creation of the definitive VAT system and standardized VAT reporting obligations — that failed to gain support in the past may face insurmountable obstacles again. However, the ongoing health crisis and the need for recovery funds may encourage member states to be more willing to compromise and reach consensus. As Milton Friedman once said:

Only a crisis — actual or perceived — produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes the politically inevitable.

Given the number of initiatives under consideration, one thing is certain — the road to a robust, fraud-proof single market with fair and simple taxation is a long one.

18Council of the European Union, “ECOFIN Report to the European

Council on Tax Issues,” ST 8891 2020 INIT (June 17, 2020).







Uncertainty Regarding Transfer Pricing And Country-by-Country Reporting in Nigeria

by Gali Aka

In 2018 Nigeria’s Federal Inland Revenue Service (FIRS) issued revised Income Tax (Transfer Pricing) Regulations and Income Tax (Country-by-Country Reporting) Regulations. Together, the two regulations provide a new set of compliance requirements for Nigeria and make substantial changes to the existing rules. The regulations are in line with the OECD base erosion and profit-shifting project’s final report on action 13, and their release makes Nigeria one of only a few African countries that have fully adopted the report’s recommendations.

While we applaud the FIRS for reaching this major milestone, there are potential problems lurking in some of the regulations. This article focuses on these issues, examines the legality of some of the related provisions, and looks at the impact of these questions on taxpayers.

Transfer Pricing Regulations

Contradictory and Potentially Void Provisions

Regulation 18 of the 2018 transfer pricing regulations provides that the regulations should be applied in a manner consistent with the arm’s-length principle in article 9 of the U.N. and OECD model tax conventions and also in accordance with the OECD transfer pricing guidelines, as long as those documents do not contradict the relevant domestic tax laws.

However, in contradiction with that commitment, the FIRS suppressed the application of the arm’s-length principle in regulation 7(5), which provides that notwithstanding any other provision of the regulations, the deduction allowed for royalties paid for the transfer of right in an intangible “shall not exceed 5 [percent] of the earnings before interest, tax, depreciation, amortisation and that consideration, derived from the commercial activity conducted by the person in which the rights transferred are exploited.” This provision contradicts the procedure for establishing an arm’s-length price, a standard that is firmly entrenched in the OECD and U.N. transfer pricing guidelines.

Furthermore, regulation 7(5) is inconsistent with section 24 of the Companies Income Tax Act (CITA), which provides that:

for the purpose of ascertaining the profits or loss of any company of any period from any source chargeable with tax under this Act, there shall be deducted all expenses for that period by that company wholly, exclusively, necessarily and reasonably incurred in the production of those profits. [Emphasis added.]

Based on this provision, once royalties paid for the use of right in an intangible asset meet the

Gali Aka is a manager in the transfer pricing unit of the Tax, Regulatory, and People Services of KPMG Advisory Services in Lagos, Nigeria.

In this article, the author discusses Nigeria’s transfer pricing and country-by-country reporting regulations, focusing on the questionable

legality of some of the provisions and discussing other concerns that may result in taxpayer uncertainty.






“wholly, exclusively, necessarily and reasonably incurred” test, then the FIRS should not allow restrictions on deductions on any other basis than the arm’s-length principle.1

This would ordinarily render regulation 7(5) null and void because the FIRS does not have the jurisdiction to amend the tax laws. However, the Finance Act 2019, which seeks to address tax revenue gaps, bases the tax deductibility of related-party expenses on their consistency with Nigeria’s transfer pricing regulations, thereby strengthening the provisions in regulation 7(5).

Regulation 7(5) could distort economic activities by treating companies engaged in intangible transactions with their foreign counterparts unfavorably because the same restriction on royalty payments would not apply to similar transactions between independent parties. One question that comes to mind is whether taxpayers can challenge the validity of regulation 7(5) based on the following logic:

• The government should maintain cohesion in the tax system.

• The regulation contradicts the objective and procedure of establishing the arm’s-length principle in Nigeria.

• Regulation 7(5) may lead to a treaty override. The arm’s-length principle is an international standard set forth in article 9 of Nigeria’s existing double tax agreements. Generally, once an agreement comes into existence at the international level and binds two states, one needs to determine the status of the agreement under domestic law and its relationship with that law. Section 45 CITA clearly gives precedence to the DTA in case of conflict.

• The FIRS has gone beyond the powers that section 61 of the FIRS Establishment Act (FIRSEA) 2007 confer upon it to make rules and regulations that it believes are necessary or expedient to give effect to the provisions of the act or ensure the proper administration of its provisions.

The FIRS made the transfer pricing regulations to clarify and create certainty regarding the application of section 22 CITA, which empowers the FIRS to adjust the pricing of transactions between related entities when, in its opinion, those transactions have not been made on terms consistent with the arm’s-length principle. Without the transfer pricing regulations, section 22 CITA and similar provisions in other acts could increase the risk that assessments to additional tax liabilities for taxpayers might be made on frivolous bases.

Looking at the clear objective of section 61 FIRSEA, the FIRS may be deemed to have exceeded its boundaries because the rule contained in regulation 7(5) is a matter that should be left to the legislature.

The FIRS and Administrative Penalties

Regulation 13 of the revoked 2012 transfer pricing regulations provided that “a taxable person who contravenes any of the provisions of these Regulations shall be liable to a penalty as prescribed in the relevant provision of the applicable tax law.” This penalty provision was intended to encourage compliance with the transfer pricing regulations. Unfortunately, the CITA does not contain a specific penalty for failure to file transfer pricing returns, and so it was difficult for the FIRS to enforce compliance.

Could the FIRS apply, by extension, the penalties that section 55(3) CITA establishes for late filing of companies’ income tax returns (NGN 25,000 for the first month and NGN 5,000 for each additional month, respectively about $65 and $13) or apply section 60(3) CITA, which empowers the FIRS to impose a fine equivalent to the amount of the tax liability (determined based on transfer pricing adjustments), on taxpayers who fail to file returns requested under section 60 CITA?

Section 61 FIRSEA does not empower the FIRS to stipulate penalties for noncompliance with its regulations. Therefore, whether the FIRS has jurisdiction to impose the stipulated penalties may be challenged in a court of law.

Retroactive Application of the Regulations

Based on regulation 27, the commencement date of the 2018 transfer pricing regulations is the basis period beginning after the regulations’

1Approval from the National Office for Technology Acquisition and

Promotion is not required to remit or deduct royalty payments in tax computations. See Stanbic IBTC Holding PLC v. Financial Reporting Council of Nigeria, LPELR-46507 (CA) (2018).






effective date of March 12, 2018. Thus, the new transfer pricing regulations should apply to financial years beginning after March 12, 2018. However, the FIRS has sought to apply the new regulations to periods before the effective date of the regulations by attempting to impose administrative penalties for failure to file transfer pricing returns — more specifically, it sought to apply the penalties found in the 2018 amendments to returns covered by the prior version of the regulations.

This act by the FIRS contradicts section 6(1) of the Interpretation Act 2004, which provides that the repeal of an enactment shall not “revive anything not in force or existing at the time when the repeal takes effect” and “affect the previous operation of the enactment or anything duly done or suffered under the enactment.” Thus, the FIRS acted ultra vires when it substituted the penalties for failure to file transfer pricing returns under the now-repealed 2012 regulations with those contained in the 2018 transfer pricing regulations — that is, assuming for the sake of this argument only that the FIRS can actually prescribe those penalties.

CbC Reporting Regulations

Local Filing Obligations in Nigeria

Regulation 4 of the CbC reporting regulations establishes the local filing obligations, including specific limitations on the obligations.

However, the conditions in regulation 4(2)(b) may not trigger a local filing obligation if the jurisdiction of a multinational enterprise’s ultimate parent entity has a CbC reporting and filing requirement even if that jurisdiction does not have an exchange of information agreement with Nigeria.

Notably, Nigeria is a signatory to the Multilateral Convention on Mutual Administrative Assistance in Tax Matters, which came into force for Nigeria on September 1, 2015, and was amended to accommodate countries that were not part of the original agreement. The United States has not approved the protocol and amended convention, citing a desire to restrict information sharing to countries with which it has one-to-one tax information exchange agreements.

The provisions of regulation 4 may not apply to constituent entities of MNE groups

headquartered in the United States — or other jurisdictions in similar situations — if the ultimate parent entities would be filing CbC reports. The FIRS would need to amend the rules on local filing if it wanted to impose local filing requirements on those MNE group entities. In the absence of amended rules, the best that the FIRS can hope for is that MNEs comply voluntarily.

Entities Owned by Unrelated MNE Groups

The FIRS guidelines for CbC reporting in Nigeria require entities that are included in the consolidated financial statements of an MNE group under the equity accounting method to comply with the Nigerian CbC reporting regulations. This is a deviation from the equivalent provision in the OECD guidance on the implementation of CbC reporting, which provides that:

If an entity is not required to be consolidated under applicable accounting rules, the entity would not be considered a Constituent Entity and, accordingly, the financial data of such an entity would not be reported in the CbC Report. Therefore, an entity included in the MNE Group’s consolidated financial statements under equity accounting rules would not be a constituent entity. [Emphasis added.]

The CbC reporting requirement is one of the BEPS minimum standards that members of the BEPS inclusive framework have committed to implement consistently. As a member, Nigeria should not deviate from the OECD’s standard.

Exchange of CbC Reports

The first automatic exchanges of CbC reports occurred in June 2018. According to the OECD, as of July 2020 more than 2,400 bilateral exchange relationships have been activated by jurisdictions that have committed to exchange CbC reports. These include exchange relationships between the 87 signatories to the CbC Multilateral Competent Authority Agreement, between EU member states under EU Council Directive 2016/881/EU, and between signatories to bilateral competent authority agreements for exchanges under DTAs or TIEAs (including 41 bilateral agreements with the United States).






Today, Nigeria can share CbC reports with 58 jurisdictions, but it cannot receive any. This is because Nigeria made the notification provided for in paragraph 1(b) of section 8 of the Multilateral Competent Authority Agreement that it should be treated as a non-reciprocal jurisdiction — in other words, Nigeria has committed to send CbC reports to its exchange partners, but it will not receive CbC reports from its exchange partners.

Given that the CbC reporting regulations have been in effect for more than two years, one may wonder why Nigeria remains a non-reciprocal jurisdiction. One would expect that within this time frame the FIRS could have put the necessary policies and processes in place to ensure information is safeguarded and data access is restricted, policies that would allow Nigeria to receive CbC reports.

Penalties for Noncompliance

The model legislation for CbC reporting regulations does not include provisions regarding penalties to be imposed in the event of noncompliance by MNEs. It is, however, assumed that jurisdictions would extend their existing transfer pricing penalty regime to include failure to comply with the requirements to file the CbC report. Because Nigeria made its CbC reporting regulations under section 61 FIRSEA, the propriety of any noncompliance penalties is debatable because the FIRS may not impose penalties through regulations.

Multiple CbC Notification Requirements

The Nigerian CbC reporting regulations require that each constituent entity of an MNE group make a notification on or before the last day of the reporting accounting year of the group. The CbC reporting notification form released by the FIRS requires an entity to provide information on the entity making the notification, including the identity and tax jurisdiction of the ultimate/surrogate parent entity and a list of all Nigerian constituent entities.

A single CbC notification form provides a full picture of all Nigerian constituent entities and

complies with the CbC reporting regulations, but the FIRS still requires each constituent entity to replicate this information irrespective of its numbers.

Conclusion

Nigeria’s implementation of the transfer pricing documentation and CbC reporting requirements set out in the OECD BEPS final report on action 13 is a step in the right direction.

Recognizing the significant benefits that the new rule offers the FIRS, benefits that help the FIRS undertake high-level risk assessment of transfer pricing and other BEPS-related tax risks, Nigeria should continue to take steps to have qualifying competent authority agreements in effect with jurisdictions in the BEPS inclusive framework and other jurisdictions that have significant investments in Nigeria.

The FIRS should also ensure consistent implementation of the transfer pricing documentation and CbC reporting rules, and it should align these rules with global practice. Consistent implementation not only ensures a level playing field for resident taxpayers but also provides certainty for potential investors. The FIRS should, therefore, revisit those provisions that contradict the principal act and those that deviate from global practice.

To enforce compliance, the FIRS may choose to approach the legislature and request that it convert the transfer pricing and CbC reporting regulations into an act of the National Assembly or impose penalties already contained in the relevant principal acts, where applicable. Another alternative would be to approach a competent court to impose administrative fines for noncompliance.

The shortcut approach to enforcing compliance will only create more controversies and uncertainties. The legislators should wake up and preserve the integrity of the Nigerian tax system by working closely with the executive arm of government to revise the tax laws to support the economic policies of the government.






LETTER FROM EUROPE

Democracy in Chaos: Where Will the Election Train Stop?

by Frans Vanistendael

The U.S. election train is moving very fast, but nobody knows where its end station will be. The uncertainty is not because of a thin polling difference between the candidates. It is because nothing in this campaign, including President Trump, is certain or predictable. From this side of the Atlantic it is impossible to predict the condition of the United States in less than 100 days’ time. But that condition is crucial because a weakened and unpredictable United States will weaken its friends and allies across the world.

The Challenges of This Election

There are many challenges that will be affected by the outcome of the election. There are international problems:

• China’s clear challenge to U.S. economic and political leadership;

• climate change as a symptom of the wider issue of limited global resources and unlimited world growth;

• growing doubt about multilateralism and treaty-based solutions to issues of political (nuclear control) and economic conflict; and

• the intractable problem of continuing civil war in Islamic countries and the lingering threat of terrorism.

On the domestic front, there are the following:

• the widening Black Lives Matter movement in response to incidents of police violence, and the deepening perception of racism that cuts across U.S. society;

• the issue of massive immigration from Latin America;

• the growing inequality in the distribution of the benefits of globalization and the tendency toward protection of the U.S. national market;

• the growing concentration of economic power in mega-companies and the total breakdown of traditional U.S. antitrust policy; and

• an unprecedented surge of rowdiness in the public discourse, facilitated by new techniques of communication, to the point that it becomes impossible to conduct a rational debate on fundamental societal issues.

This is an impressive list of problems. It would be enough to feed several presidential election debates. However, the complexity of these issues is often reduced to sound bites during debates, exchanged in a few seconds. This excludes any rational debate. Instead, political opponents resort to quick, knee-jerk reactions based on instinct and emotion.

Last, but not least, there is the unknown factor of the COVID-19 pandemic. In the United States the pandemic has thrown millions of people out of balance: 8.2 million people infected and more than 220,000 people dead, and several million unemployed or bankrupt. This looks pretty gloomy for an incumbent president. But then the unthinkable happened: Trump himself was infected. There were a few days of schadenfreude for his opponents.

But then the unexpected happened, and Trump returned like Superman, descending from

Frans Vanistendael is professor emeritus at KU Leuven in Belgium.

In this article, the author discusses the upcoming U.S. presidential election and its potential impact on democracy in the United States and abroad.




LETTER FROM EUROPE


a military helicopter to the White House and playing the invincible hero to “make America great again.” His supporters loved the show and were jubilant. How the COVID-19 factor will affect the U.S. election is absolutely unpredictable. Trump is not behaving as if he is competing in a democratic election on political issues, but rather as if he is fighting a special boxing competition in which anything goes.

A Personal and Not a Political Goal

In 2015 Donald Trump was the most unlikely candidate for president. He was not taken seriously by either Republicans or Democrats. Unlike past U.S. presidents, he had no military or government experience. He was first and foremost a business tycoon with interests in a special niche of real estate, entertainment, and television. He had never shown any interest in political or societal problems and had never shown any interest in a political career, other than one day becoming president of the United States.

In 2000 he briefly campaigned but bowed out before the primaries got rolling. Five years ago, Republicans had a wide field of 17 presidential candidates. Most held political office such as governor or held seats in Congress or state legislatures. Most shared comparable CVs. But Trump stood out, not because of his CV but because of his singular personality.

While the other candidates followed the rules of a democratic political debate, Trump flouted the rules and conventions because he did not consider his candidacy a political candidacy. To him, it was just an exercise in self-promotion as head of the Trump Organization, his business empire. His personality was characterized at the same time by a total lack of adherence to convention and good manners. It created an apparent emotional bond with those people in U.S. society who felt abandoned by the economic and cultural elite of the country: workers in traditional industries losing income and jobs because of competition from China and other emerging countries; people economically left behind in the financial crisis; people frightened since 9/11 by terrorist attacks and rising Islamic militancy; people afraid of a wave of uncontrolled immigration; and generally those who considered themselves the backbone of the country based on

the values of self-reliance, hard work, and traditional moral and family values.

By playing on the frustrations of these groups, Trump cobbled together a political program without any coherence or inner logic:

• disengagement from multilateral treaties and institutions;

• a wall against Latin American immigration;• immigration and visa restrictions against

Islamic countries;• tariff barriers against imports from China

and the EU;• denial of climate change and development

of U.S. oil and coal energy sources; and• defense of the constitutional right of U.S.

citizens to bear arms.

He brought this message, loud and clear, with no subtlety and with an outspoken disdain for conventional behavior or even good manners. In doing so he succeeded in shocking his opponents and pleasing his supporters, who felt they had been the underdogs in the media for a very long time. They finally had their media moment. Trump was draining the intellectual swamp. It brought him in direct conflict with dominant media groups, which he accused of publishing fake news. Although this alienated many people, it was a big success with his fans. It assured him the permanent media attention essential to his final goal: winning the presidency. To his supporters he is not their political leader, but rather a cult figure who on top happens to be president of the United States.

Drive, Ego, and Political Objectives

Because his opponents have been fighting him as a political opponent within a framework of preestablished political rules and conventions, Trump has escaped most fights unscathed. He does not follow preestablished rules and conventions. His goal is not a political objective. After realizing his dream of winning the presidency, his next goal is winning a second term so that his statue could be hewn in stone on Mount Rushmore, next to Washington, Jefferson, Roosevelt, and Lincoln. He once expressed that wish. If that pipe dream ever happens, the United States will no longer be a democracy.

Most people involved in politics have healthy egos that drive them to compete for positions of




LETTER FROM EUROPE


power. But in competing for power, their ego is mostly kept in check by the awareness that they are competing within the bounds of a structure of political logic. Within that structure the political logic may be extreme, but it always corresponds to a form of political reasoning.

In a democracy, the political ground rule is that when you are not backed by the majority, you lose your position. But Trump’s ego is so huge that there is no check possible within the bounds of the political structure. He is only interested in personal power, regardless of whether it is as head of the Trump Organization or president of the United States. He has no political program other than personal aggrandizement.

That’s why there is no new political program for the GOP in the 2020 elections. The program this year is the same as it was four years ago: Elect Donald Trump because you like him as he is. You don’t vote for him because of his political program; you vote for him because you like the kind of person he is, you like his style of being a U.S. president, and you like his tweets. That’s why there was no real political debate in the television confrontation with Democratic candidate Joe Biden. It was a kind of bar brawl. The tone changed immediately in the debate between the vice presidential candidates because both of their personalities were operating within the bounds of the political structure. The political positions defended by Vice President Pence, like nationalism, protectionism, low taxes, and law and order, are positions that are also defended by hard-line or even moderate conservatives, but they have been hijacked by President Trump, for the exclusive objective of his personal election.

That’s also why Trump’s COVID-19 infection was politically more an advantage than a setback. He characterized his infection as a “blessing from God.” He does not follow the rules and the routines of ordinary COVID-19 patients. His infection gave him an opportunity to show how exceptional he is. Yes, it was bad, but look how quickly he recovered, made a tour for his fans, and landed back at his desk at the White House. The only election setback that he would have to fear would be a serious relapse that would knock him out of the race for another two weeks. That would ruin his image and sow some doubt among his followers.

In spite of his political gaffes in the eyes of the “rational” world, and the opposition of a large majority of the media to his candidacy, Trump’s voter base has remained remarkably stable. In 2016 he carried 46.01 percent of the popular vote, while the polls had reported support of 42.2 percent in the second week of October. The gap between the two contenders is now larger than the gap in the election results in 2016. But with the margin of error inherent in the polls, there is no absolute guarantee yet for an Electoral College majority for Biden.

Trump Is a Threat to U.S. Democracy

That’s also why, four years ago, Trump refused to confirm that he would abide by the election results if Hillary Clinton won. During his current campaign he has reiterated this position many times. He implied that inevitably there would be fraud if he lost the election, justifying the fact that he would still be in office on January 20 next year when the exact distribution of votes in the Electoral College would still be in doubt. In the meantime, he has been making it difficult for the U.S. Postal Service to deliver mail-in votes in a timely fashion, while casting doubt on these votes’ legitimacy. He knows he will lose the mail-in voting segment of the electorate by a large margin. Watching these events from afar, the conclusion is clear: Donald Trump is a real threat to U.S. democracy. He is not playing by the rules — neither political, nor moral, nor any rules at all. The only rule he observes is to behave in such a way that he ends up on top.

This election is therefore the last chance for U.S. voters to restore democracy in a peaceful way and avoid political violence. In reading this sentence, some will say: This is fear-mongering by an outside European who knows nothing about U.S. society and U.S. politics — U.S. democratic institutions are robust enough. But even if U.S. democracy did get one more chance after four more years of Trump, why bet on the very last chance in 2024 if the issue can be settled in November?

How to Grasp Democracy in This Election

The question is how to grasp democracy in this election. It is important to be aware that Trump does not pursue a political program, but




LETTER FROM EUROPE


only his personal aggrandizement program. He constantly needs to feed the personal cult of a star celebrated by his followers. How do you fight a cult and a star? So far, political opponents have formulated political arguments against President Trump. But you don’t beat a popular star and his cult by political arguments.

According to Democratic opponents, there is almost nothing that President Trump has done right. That of course is not true. You may criticize some parts of the reform of corporate income tax, but rebalancing the U.S. corporate tax rate with the rest of the world was overdue. Two examples of clumsy opposition are the Mueller investigation on Russian influence in the 2016 election and the impeachment procedure for soliciting foreign interference from Ukraine in the 2020 election. There may have been legal grounds for impeachment, but it was clear that the final outcome was uncertain. Ordinary people were not interested in the nuances of the legal arguments. There was more interest in Monica Lewinsky’s affair with President Clinton because that was much more exciting to the personal imagination of many voters. In addition, the Democrats knew that they did not have the votes in the Senate to impeach.

Lessons From the 2016 Democratic Defeat

The Democrats have been very slow to learn from the 2016 defeat. What incensed Trump fans at the time was the air of intellectual and moral superiority of Hillary Clinton’s followers. This is still going on today: By supporting the wall against Latin American immigrants, supporting the police force even in problematic racial incidents, and defending historic monuments memorializing the Confederacy, Trump fans are depicted as being on the wrong side of history, morally and politically. They will not be convinced by the arguments of righteousness of human rights, good administration, and good institutions, because they see these arguments as infringements on their lifestyle and experience no benefits from an administration and institutions that support these ideas.

Trump fans also have their grievances. Democratic opponents must listen and take the complaints seriously if they want to convince these voters to change their minds on November

3. One grievance involves the general condemnation of Trump followers because they do not observe the COVID-19 rules and don’t wear masks to limit infection by the virus. When Trump came back from the hospital, he triumphantly took off his mask on the balcony of the White House, in defiance of the pandemic. Trump supporters should behave and wear masks, opponents say. However, during protests against police violence, streets were filled with young people jostling shoulder to shoulder. Few people were wearing masks, and there were no fines or condemnation.

A similar complaint applies to the violence, burning, and plundering during the demonstrations. Granted, many Black Lives Matter demonstrations have been peaceful and respectful. But if you claim moral superiority, you must practice the morals you have been preaching. Condemning violence committed on your side, even in the heat of the fight, strengthens the force of your message because it shows that you are convinced you can win without violence or intimidation.

A Victory for Democracy?

Despite all the uncertainty and chaos, cool analysis reveals that the prospect for a victory of U.S. democracy November 3 seems to be good. In the popular vote, Biden has a double-digit lead, and has been leading Trump in the polls every day of 2020. The probability that this lead will be reversed on Election Day is nil. In any functioning democracy in Europe, Biden would be the winner.

However, in the United States it is not the voters who decide, but the Electoral College. Here Biden also has a lead that, at the time I am writing, is calculated at 226 to 125. However, in that lead 57 votes are uncertain for Biden and 33 for Trump. In 11 states the Electoral College is still uncertain, because the margin between the two candidates varies from a minimum of 0.3 percent in Georgia to a maximum of 6.6 percent in Pennsylvania. Trump leads only in Texas with a few percentage points and Biden in all other undecided states, but with rather small margins. If we count the undecided states in which Biden leads with more than 5 percent as “Biden” states, Biden already has a majority of 282 votes in the Electoral College. The lead margin of more than 5 percent is




LETTER FROM EUROPE


beyond the widest margin of error that is used in poll statistics.

The prospects are therefore good for a comfortable Biden victory on Election Day, not only in the popular vote but also in the Electoral College. It also means that trust in the voters’ wisdom as the essence of democracy is justified in the United States, as I wrote in the conclusion of my last Letter From Europe.1

The Final Guardians of Democracy

I am quite sure that U.S. democracy will clear the popular vote hurdle. The question is whether it will clear the Electoral College hurdle. That hurdle is not only a question of voting, but also of counting the votes and making the results known to the general public. Whether that hurdle will be cleared does not depend on the millions of voters, but on the small group of U.S. citizens who are in charge of organizing, counting, and dispatching the results; on their executing their duty as members of the Electoral College; and on those in charge of deciding any legal challenges to this process and keeping law and order. They are in a sense the final guardians before the gates of democracy.

Because of the volume of mail-in votes, it is entirely possible that on the morning of November 4, Trump will lead in the number of votes counted and will claim to be the winner, not only of the popular vote, but also in the Electoral College. At that moment, it is of paramount importance that citizens in the counting offices keep their democratic nerve and continue to count the mail-in vote accurately and meticulously to minimize any legal challenge.

Counting the votes is the final and decisive moment in a democracy. It is also of the utmost importance that the citizens who are in charge of handling and deciding the legal challenges to the mail-in vote, which will be inevitable in some quarters, keep their cool and handle these challenges impartially, “sine ira et studio” (without anger and passion) as the non-democratic Romans used to say. Finally, it is also of the utmost importance that in those fateful days “law and order” is kept in and around the counting offices, to eliminate any disturbance of the counting process. During a few hours or days, the fate of democracy will be in the hands of ordinary citizens, and of state police and judicial officers in charge of delivering the result of democracy.

If at the end of this process Biden wins the presidency, the first thing he should do is to keep his election promise that he would reconcile and unite all Americans, including Trump fans. That would really make America great again. How Trump will do that, if he wins, is still a question mark.

1Frans Vanistendael, “An Unconventional Election,” Tax Notes Int’l,

Sept. 14, 2020, p. 1485.




LETTER FROM EUROPE







CURRENT & QUOTABLE

Taxation of SMEs to Support Economic Recovery Post-COVID-19

by Elizabeth Allen and David Child

Context

Whilst the impact of COVID-19 lockdowns has differed in each country, businesses large and small have suffered as a result. Many businesses have had to close and have had virtually no business income while having continuing and unavoidable expenses; e.g., property rents and maintenance costs. Others have been able to continue operations but with lower levels of income.

The key to the recovery of small and medium-size enterprises must be cash flow. Governments are doing many things to assist in their liquidity and preserve employment. These range from direct support (paying wages, facilitating loans, and providing cash injections to the self-

employed) to indirect support (such as delaying tax payments).1 However, less affluent governments that are struggling to fund essential (particularly health) services, are unlikely to be able to offer businesses direct support.

Fiscal policy must now complement any direct government support and reflect the changed world we find ourselves in. Governments also need revenue inflows to maintain public services, especially as the cost of some public services such as healthcare will have increased. So, there will be a delicate balance to be struck between the two conflicting aims.

Objectives

As a result of the global COVID-19 pandemic, lockdowns across the world have resulted in severe cash-flow difficulties for many SMEs and huge increases in unemployment. SMEs, while directly paying often less than 20 percent of the direct and indirect tax revenues, support larger businesses as both customers and suppliers. Small business start-ups fuel economic growth, as they can become the successful large businesses of the future. Hence, SMEs are a vital cog in business in all countries and provide employment for millions of employees and business owners. One of the goals of tax policy for economic recovery must be to enable this sector to recover from the financial impact of the business interruption caused by the COVID-19 lockdowns.

To help SMEs maintain cash-flow is the core goal of this fiscal policy and administration guidance. Even more fundamentally, this guidance aims to cover the immediate help that

This article is part of the series, “Post-COVID-19: How Governments Should Respond to Fiscal Challenges to Spur Economic Recovery,” coordinated by the International Tax and Investment Center (ITIC) to offer tax policy guidance to developing countries during the post-pandemic recovery phase.

Elizabeth Allen is a former head of a VAT Division (HM Customs & Excise) and of an Excise Division (HM Revenue & Customs), and David Child is a former head of Management and Consultancy Services (HM Customs & Excise).

In this installment, the authors look at the effect COVID-19 has on small and medium-size enterprises and on tax revenues, outlining the short-term help tax systems can provide SMEs to stay in business and how tax policies and administration can be regeared to help the SME sector grow.

Copyright 2020 Elizabeth Allen, David Child, and ITIC. All rights reserved.

1Examples of these actions for the United Kingdom can be found at

U.K. Government, “Part of Coronavirus (COVID-19): Business Support.”




CURRENT & QUOTABLE


SMEs will need from tax systems to stay in business. It also looks beyond the immediate period toward how tax policies and tax administration can be re-geared so as to help the SME sector grow in the future (and, thereby, provide governments with increased revenue inflows).

Scope

This paper looks at the impact of COVID-19 on both SMEs and tax revenues. Although there is a general understanding of the businesses that constitute SMEs, there is no standard global definition of these, as the economic situation differs in each country. However, most tax administrations segregate large businesses — hence SMEs, de facto, constitute all the other businesses that are required to register for tax.

The revenue from all taxes will have suffered as a result of the COVID-19 lockdowns and the subsequent reductions of economic activity — the affected taxes — are likely to include:

• income tax on profits: company, partnership, and self-employment;

• payroll taxes (including employee social security contributions);

• VAT/sales tax;• excise taxes;• environmental taxes;• withholding taxes;• capital gains tax;• taxes on wealth, inheritance, and estates;• property taxes (including local business

taxes and rates);• customs duties (and other import charges);• taxes on insurance premiums, property,

financial transactions, etc.;• business trading licenses and occupational

taxes;• license and annual fee charges (e.g., on

motor vehicles); and• user fees imposed by national or local

governments (including road tolls, etc.)

The impact of COVID-19 on SMEs goes wider than taxation, as those businesses have to contend with both regulations from other public sector bodies including local and regional authorities and other constraints that contribute to the costs of doing business, including:

Tax Policy and Administration to Support Taxpayers

With many SMEs either being unable to trade or trading at greatly reduced levels of turnover, and in order to facilitate their survival, the sector is seeking ways of deferring or reducing their tax liabilities so they can preserve their struggling cash flows.

The following categories highlight possibilities that tax policymakers and administrations might consider either for all SMEs or for the hardest hit sectors.

For All Taxes Due from SMEs

• Payment grace periods for all or for the hardest hit trade sectors;

• waive penalties and interest and suspend the “harsher” debt collection activities — e.g., distraint, third party liens, court recovery, bankruptcy, or insolvency action;

• allow time to pay agreements for tax owing over a realistic and long period (but conditional on all future returns being made and all taxes being paid in full and on time);

• introduce flexible payment plans so that tax is paid over a long period (at least a year) as and when possible, provided that the quarterly or annual totals are met;

• defer payment dates for a period — so if, e.g., VAT is due 21 days after the tax period ends, that could be extended to, e.g., 51 days;

In most markets:

• Restrictions on opening hours and other licensing rules

• Regulations covering product approvals, content, and labelling

• Hygiene and other health and safety requirements

• Environmental restrictions

• Product labelling and display restrictions.

In some markets:

• Unreliable electricity supplies

• Lack of safe drinking water

• Inadequate sanitation• Inadequate social and

medical benefits• Corruption of public

sector officials at all levels and across all parts of the public sector

• Flourishing illicit markets

• Lack of security and ineffective crime prevention.




CURRENT & QUOTABLE


• make automatic or rapid payments of tax refunds or rebates to SMEs within set credibility parameters;

• give a discount for timely payments made in full;

• provide a tax subsidy or credit for the hardest hit trade sectors which would then have a flat amount that they can deduct from any tax due;

• allow for credit card payments of tax;• make temporary changes in audit policy

and ways to assure tax certainty;• enhance taxpayer services to provide full

information on websites and through electronic communications and call centers; and

• develop communication initiatives to advise all taxpayers of the COVID-19 tax relief available to them and how to claim if a claim is required.

Customs Duties

• Reductions or duty suspensions for some sectors (where possible under regional external tariffs); and

• deferment periods extended for payment of import duty on goods for resale.

Excise and Environmental Taxes and Duties

• Rate reductions if specific duty rates apply, but bear in mind the potential health and environmental impact. (Ad valorem duties will automatically reduce proportionately as the commodity price reduces — e.g., on road fuel.)

VAT

• Align import VAT payment date to the VAT payment date for the tax period;

• set a lower VAT rate for the sectors hardest hit;

• set or increase a higher tax rate on nonessential and luxury goods — e.g., jewellery, perfume, high-end electrical equipment, luxury cars;

• raise the VAT registration threshold to allow smaller firms to de-register;

• make automated and expedited VAT refunds within set parameters instead of any credits carried over;

• extend the VAT tax accounting periods for SMEs — e.g., instead of monthly tax periods extend to 2 or 3 months);

• introduce (or extend the availability of) annual accounting with phased payments for the smaller businesses; and

• allow cash accounting for all SMEs up to a set (or higher) threshold turnover.

Income Tax on Business Profits• Tax rate reductions and rate band and

threshold increases, including seeking to remove many small businesses from the tax net.

• Where losses are made, no income tax liability accrues and, in order to keep a small business afloat, losses should be allowed to be carried over to the following year and credited against that year’s profits. Alternatively, SMEs might be allowed to render tax returns to cover a two-year period (2020 and 2021; or 2020-2021 and 2021-2022).

• Where the 2019-2020 tax year spans the COVID-19 lockdown period, the lack of income over the period may result in no tax due and any stage payments made may have been too high. In this case, a refund should be expedited, and any remaining stage payments canceled.

• For the current tax year, in the most hard-hit sectors (travel, hotels, restaurants, gyms, sports and entertainment businesses etc.), a nil overall profit could be assumed and any advance payments abandoned, deferring all liability to the next tax year.

• Allow 100 percent depreciation for capital goods allowances for businesses in the hardest hit sectors. This would advance the depreciation allowances that otherwise would have affected over a number of years and thus assist cash flow for businesses.

• Where there is a tax regime with a minimum threshold or a presumptive tax regime based on turnover or trade sector, the rates will need to be revised for the current tax year (to ensure that loss making businesses do not end up having to pay any income tax).

• Introduce a new higher rate of income tax for businesses that have made significant profits through the crisis (with this extra tax being available to help businesses who have suffered the most).




CURRENT & QUOTABLE


Withholding Tax on Wages of Employees of SMEs

• Increase personal allowances, thresholds, and/or broaden the rate bands;

• reduce the tax rates;• provide tax credits; and• allow employers to delay paying the tax

deducted for a longer period than is usually permitted.

Other Withholding Taxes Affecting SMEs

• Withholding tax on professional fees and when charged on imports could also be reduced or suspended; and

• withholding tax on property rents could be reduced or suspended.

Encouraging Economic Growth to Aid Recovery

Looking beyond the survival of businesses affected by the COVID-19 crisis, all countries will need to encourage economic growth in future years. This will be to encourage new businesses to be established and to enable existing, perhaps very small businesses, to grow. To create the investment climate that will achieve this will require countries to consider many actions that will assist this development. The following categories provide options.

Simplifying or Reducing Compliance Costs

• Simplify tax registration requirements for businesses and self-employed;

• develop presumptive taxes for the smaller SMEs (see Annex 1 for more detail);

• simplify forms and documents required — e.g., for import and export or temporary customs relief;

• develop single window and other electronic customs schemes sanctioned by the World Customs Organization that reduce form filling and simplify access so importers and exporters can make their own declarations;

• extend the availability of bonded warehouses so businesses can defer the payment of customs duties until the goods are needed for manufacturing or resale;

• work with other countries in regional customs unions or with countries having unilateral or multilateral trade agreements

to simplify documentation required across international trade;

• introduce or extend simplified import procedures for low-value goods;

• through consultation, seek to reduce costs on imports and exports — e.g., port and airport fees — and thus stimulate international trade;

• develop simple payment schemes that do not require a visit in person to a tax office — e.g., mobile phone “Pay As You Go” tax payments;

• revise penalties so as to support voluntary compliance — e.g., written warning for first penalty and suspended penalty for second penalty, with third penalty triggering double penalty;

• develop user-friendly electronic facilities for all tax processes;

• exempt all investors from all fees related to companies’ registration until the end of 2021; and

• identify regulations from other public sector bodies that contribute to compliance costs for businesses — e.g., licensing, restrictions on trading hours, restrictions on lorry driver hours — and seek to quantify compliance costs — e.g., through an annual survey, focus groups, trade associations — then deregulate as far as possible.

Options for Tackling the Informal Economy

• Develop presumptive taxation schemes where none exist (see Annex 1 for more details).

• Amnesty for back tax and failure to register penalties for previous failures to register or charge and remit the correct amount of tax together with stiffer penalties for those who fail to register during the amnesty.

• Task force to develop mechanisms to improve tax declarations and payments by professionals.2

2For case study information about the Kenyan experience of tackling

hard-to-tax self-employed professionals, see Daisy Ogembo, “Taxation of Self-Employed Professionals in Africa: Three Lessons from a Kenyan Case Study,” International Center for Tax and Development African Tax Administration Paper 17 (Mar. 2020).




CURRENT & QUOTABLE


• Provide taxpayer education programs in conjunction with advisers from other public sector organizations who provide business education to those without bookkeeping knowledge or experience and knowledge of other legislation appertaining to the type of business — e.g., consumer protection, health and safety, environmental.

• Develop compliance records for all taxpayers if none exist.

• Develop a risk-based audit program if none exists.

• Put in place an anti-corruption strategy, commitment, and actions to make as much as possible of the revenue processes corruption proof. Examples are:• separating decisions on which businesses

to audit from the local officials who have to carry out the audit;

• encouraging electronic declarations and payments as far as possible and developing easy payment processes for those without bank accounts — e.g., “Pay As You Go” tax cards for use with mobile phones;

• auditing all processes to identify which processes are at the highest risk of facilitating corruption; and

• requiring staff to declare relationships with any business taxpayers and ensuring that such staff never audit those taxpayers.

Tax Regimes That Might Be Introduced

• Because all countries will have revenue shortfalls and will need funds to enable them to support recovery, consideration might be given to new taxes, such as:• luxury tax on designer clothing,

accessories, jewellery, precious metals, as well as the use of robots, and luxury cars, yachts, planes, whether or not used for business purposes;

• additional taxes on telecommunications and e-commerce; and

• environmental taxes to encourage behavioral change as well as to raise revenue — e.g., plastic bags tax, pesticides tax, single use plastics tax, litter tax (on all fast food take away or drive-through businesses).

Additionally, there are suggestions for longer-term revenue enhancement particularly geared toward developing countries.3

Constraints on Tax Policy and Administration

There will be many challenges to be overcome to make both tax policy and tax administration changes, including:

• Funding for changes.• Legislation may need to be amended after

consultation with trade associations, chambers of commerce, etc. This may take time and require top level political commitment.

• IT systems may take some time to amend and will entail significant costs.

• More resources (and staff training) may be needed in the short term to develop special schemes, identify compliance costs that can be reduced through deregulation, administer and assure COVID-19 relief, communications, etc.

• Mobilizing donor assistance can be time-consuming.

Recommendations

• Time is of the essence. What governments do to help SME cash flows needs to be done quickly. Actions need to be simple and clear so that taxpayers know what applies to them and what they need to do to benefit from tax or other regulatory change.

• A first step should be to consult with trade associations and taxpayer representatives to identify their priorities for relief and relaxation of tax and other regulatory requirements affecting SMEs and then draw up a prioritized list for immediate action.

• The constraints on public sector authorities are real, and in an ideal world, it would be good to have plenty of time to develop proposals, consult, and design changes both in legislation and IT. SME cash flow cannot wait for the ideal timescale for implementing tax or other regulatory

3See Mick Moore, “How Can African Tax Collectors Help Cope With

the Economic Impacts of COVID-19?” International Center for Tax and Development blog, Apr. 8, 2020.




CURRENT & QUOTABLE


changes, so simple one-off developments may have to be deployed.

• Each country has a different mix of businesses and a different set of tax and regulatory requirements, so there is no “one size fits all.” Governments will need to choose the options that best fit their mix of businesses, priorities, and funding capacity.

Conclusion

This paper has aimed to set out a wide range of options both for relief and simplification of taxes and for reducing and simplifying other regulatory requirements. It should always be borne in mind that supporting businesses in their hour of need should result in an early economic recovery that, in turn, will result in future revenues. Where governments are seen to be assisting SMEs with their cash flow difficulties, they are also building trust and goodwill that should lead to improved tax compliance in the future.

Annex 1: Presumptive Taxes

1. What Are Presumptive Taxes?

Presumptive taxes are ways of assessing tax liability using indirect methods such as income reconstruction or by applying baseline taxation across the entire tax base. They are alternatives to formal tax regimes designed to capture the “hard to tax” who fail to register voluntarily, keep records of business costs and earnings, and render tax returns or payments, and are usually small operators with modest incomes derived from cash or barter transactions.

2. Why Use Presumptive Taxation?

In developing countries, presumptive taxation may be the most appropriate method of tax administration for specific groups of taxpayers. Most tax laws are designed by policymakers and drafted by lawyers who assume tax is assessed on well-defined measures of income and well documented in transparent accounting records. The reality is that most taxpayers do not possess the administrative resources to maintain accurate books or navigate complex tax codes. A highly informal economy impedes growth because of inefficiencies of

operation. Tackling the issue needs political will to introduce stricter enforcement and better information both for officials and for taxpayers.

3. Advantages and Disadvantages of Presumptive Taxation

In order to achieve a satisfactory take-up of presumptive tax regimes, there needs to be both an enticing reward and an off-putting penalty. They may need to be offered an enticement that is of value to them — e.g., free healthcare for children and the elderly, installation of safe water and sanitation, reliable electricity supplies, etc. Pitfalls are:

• a lack of communication with representatives of the informal sector and a high risk of misunderstanding and distrust;

• surveys used to develop indicators have not been updated regularly, so assessments tend to be arbitrarily applied to vulnerable small entities;

• most presumptive schemes provide little or no analytical data to enable risk assessed audits and enforcement to take place; and

• audit and assurance procedures have tended to be office-based because of the link to “tax clearance” schemes that require taxpayers to physically visit local tax offices, taking them away from their businesses.

Many presumptive regimes are seen as corrupt, unfair, and inefficient with processes that offer little or no incentive for businesses and individuals to graduate to the formal tax regime.

4. The Main Types of Presumptive Taxation

The table below shows the most common types of presumptive regimes.




CURRENT & QUOTABLE


Common Types of Presumptive Tax Regimes

Regime Advantages and Disadvantages

Simple lump-sum payments — a license regime: Licenses are easy for taxpayers to understand and comply with. Annual payments can be unaffordable, and more frequent license periods may be required (but at an increased administrative cost).

The main advantages are that licenses:

• are relatively easy to administer and reduce the opportunities for corruption;

• help authorities know who and where the small businesses are (for guidance, administration of public health, consumer protection laws, etc.); and

• provide an incentive to small businesses to stay on the right side of the law.

However, revenue inflows can be poor, not reflecting individual situations, and licenses can be regressive.

Tax indicator regime: This involves segmenting the small taxpayers according to trade sector, size and region. This usually requires an average tax payment to be calculated using groups of indicators as proxies for business income.

The reduction in compliance burden can be attractive to small businesses.

This regime can:

• distort investment; and• present difficulties in obtaining accurate data and

selecting appropriate and simple indicators.

For taxpayers, there are winners and losers; the scheme does not provide for a tax reduction in respect of losses.

Turnover regime: A regime based on turnover provides more equity to the taxpayer and an easier transition to the formal tax regimes. They can be designed to give an average proxy for tax on profit; or with variable rates — e.g., for different sectors.

A turnover-based regime:

• has the potential for higher revenue;• has a high risk of under declaration;• can favor businesses with a high profit margin; and• does not accommodate situations where a loss is made

(and hence runs counter to the principle of income tax being charged on business profits).

Agreed regime: This regime involves using indicators to obtain an estimate of tax due which is then subject to agreement between the taxpayer and the tax administration.

The regime:

• is equitable;• carries a very high risk of corruption; and• requires extensive and regularly updated research, data

collection, and analysis.




CURRENT & QUOTABLE







FOR THE LOVE OF TAX

Walking a Unique Path: A Conversation With Miller & Chevalier’s Loren Ponds

by Nana Ama Sarfo

Shortly after Loren Ponds finished her LLM in tax at Georgetown University, she packed up her apartment in Washington and moved to Germany to research international tax under a prestigious, German-funded global fellowship.

It would seem like a routine move for an international tax lawyer, especially one like Ponds, who was thinking about becoming a law professor and wanted to find a position that would pay her to write and shoptalk papers.

But at the time some of her classmates thought she could be damaging her career by accepting the German Chancellor Fellowship — which is awarded to 50 people annually — instead of going straight to a law or accounting firm. Several people warned her that she might not be able to get back on track. “I thought, well, the firms aren’t going anywhere, so let me try to do what I want to do and see how that works out,” Ponds told Tax Notes.

After moving to Germany in 2007, Ponds researched transfer pricing issues, which segued into a stint at the OECD in Paris. From there she landed at EY, where she spent several years in the firm’s national transfer pricing group. She then

took a historic tax job — majority tax counsel for the House Ways and Means Committee, where she helped write the Tax Cuts and Jobs Act.

It turns out that taking the unconventional path paid dividends for Ponds, who is now a member at Miller & Chevalier Chtd. and laughs that people now love her journey.

“You have to be a little resistant to outside pressure to follow a certain path if it works for you. Some people don’t have a very big appetite for risk,” Ponds said. “If something doesn’t make me a little bit excited and nervous, I don’t want to do it. That’s always been my approach.”

A Woman-Forward OECD

In Germany Ponds quickly realized that academia would make a great career, just not for her. She found the work a bit isolating and lonely. But while she was in Europe, she spent several months as a trainee at the OECD’s Tax Treaty, Transfer Pricing, and Financial Transactions Division (now folded into the Centre for Tax Policy and Administration). Not many U.S. tax attorneys get a chance to work at the OECD, and Ponds really valued that experience for the technical work and the mentorship. One thing she remembers about the OECD is just how woman-forward her team was.

“It was refreshing,” said Ponds, who worked under Mary Bennett and Caroline Silberztein — both now with Baker McKenzie LLP.

“It was an environment where we were encouraged to learn, grow, discuss, and exchange ideas; everyone’s input was valued. It was a really supportive environment,” Ponds said. “For a young lawyer, it was a really great environment to be in as I started to build my practice.”

For the Love of Tax is a regular series appearing in Tax Notes Federal, Tax Notes State, and Tax Notes International that invites practitioners and other tax professionals to share what attracted them to the tax field and the things they find most fulfilling about the work they do.

In this installment, Tax Notes International contributing editor Nana Ama Sarfo interviews tax attorney Loren Ponds about her path from Georgetown to the OECD, via Germany, to the House Ways and Means Committee staff where she helped write the Tax Cuts and Jobs Act.




FOR THE LOVE OF TAX


You Never Know Who Is Watching

When Ponds returned to the United States in 2009 she joined EY, where she spent nearly eight years working her way up within the firm’s national transfer pricing group. She started as a senior manager and later served as the global transfer pricing operations manager, a role in which she helped handle transfer pricing operations for the entire firm.

That role came early in her career, just two years after joining EY. For that position, Ponds moved to Germany and took on more international work. She said it was pivotal for her career both substantively and from a business standpoint.

“Up to that point my practice had been very U.S.-centric, but I learned a lot about transfer pricing administration, local country issues for parts of the world that I really hadn’t spent any time in, and differing concerns with respect to transfer pricing enforcement across different regions. The things taxpayers are concerned about when they are dealing with tax authorities in

other countries can be very different from the things they think about when they’re dealing with the IRS. And up to that point, the only way to really see that was through mutual agreement procedure cases, but you don’t really interact with the other side, so it was interesting,” Ponds said.

“It was also really instructive because I learned so much about the business of running the company and the economics and the metrics that matter,” Ponds added. “Understanding the economics of any business is key and I was able to do that at a very young age.”

While Ponds was at EY, U.S. tax reform became a real possibility under President Donald Trump, who had a Republican majority in both houses of Congress. When congressional Republicans decided to go ahead with tax reform, they tapped Barbara Angus, one of EY’s top international tax attorneys, to serve as chief tax counsel for the House Ways and Means Committee. As Angus was building her team, someone in Ponds’s professional network reached out to her unprompted and suggested that Ponds apply for a position with the committee, which ultimately hired her to handle the international provisions of the tax reform package.

“I was minding my own business, I was not thinking about leaving,” Ponds laughed. “The opportunity came, and of course, there was a lot of buzz and you can’t help but get excited about the prospect of getting to participate in serious tax reform, which hadn’t happened in 30 years.”

Interestingly, the individual who recommended that Ponds apply wasn’t exactly a career sponsor or formal mentor, but was rather a person who had taken an interest in Ponds’s career from afar and the direction in which it was going.

“I’ve had wonderful mentors along the way and often people think mentors have to be with you every step of the way. That’s not true. I do have longer-term mentors, but I’ve had mentors who were with me for a very short time, but played important roles that helped me take the next step,” Ponds said. This was an example.

“It was a nudge. But it was a nudge in the right direction, and a very pivotal moment in my career,” Ponds said. “A lot of little pushes along the way have really been instrumental for me, and I try to do this for others. A little push, or just

Loren Ponds




FOR THE LOVE OF TAX


helping someone make a connection, or offering a suggestion, can really make a difference. I don’t know that you always need a formal mentor; you just need someone in your corner — and it doesn’t have to be for long.”

Creating the Tax Cuts and Jobs Act

Ponds joined the Ways and Means Committee in April 2017. That same month, the Trump administration released its outline for business and individual tax reform. By December of that year the TCJA was signed into law. Between April and December Ponds and the rest of the congressional team worked grueling days . . . but what Ponds remembers the most is that the process was incredibly collaborative.

“My colleagues and I really had a great professional relationship forged out of fire. We were working together under extremely intense circumstances with a lot on the line, so a lot of credit has to be given to them,” Ponds said.

She and her colleagues “were taking meetings all the time, every day” in the lead-up to the release of the TCJA draft, Ponds said. “We never said no to a taxpayer meeting where people gave feedback, ideas, communicated concerns.”

Once the bill was released for markup, things became extremely frenzied. Ponds remembers that it was released on a Friday and she and her colleagues were on the phone early the next morning and over the entire weekend, getting feedback from taxpayers on how the rules would work with their specific facts.

The TCJA made several substantial changes to the U.S. corporate tax regime. It dropped the corporate tax rate from 35 percent to 21 percent, introduced the global intangible low-taxed income regime and the base erosion and antiabuse tax — two measures meant to protect the country’s tax base. It also moved the country closer to a territorial tax system.

“For the most part taxpayers were understanding of what we were trying to do, and I think most taxpayers on the whole were appreciative — if not of every single individual provision, certainly of the effort involved. The end results and the large ideological changes — the

lower corporate tax rate, the move to a more territorial system — were welcome,” Ponds said.

After the TCJA became law, Ponds stayed on for almost another year working on phase 2 of the package, identifying technical corrections and collaborating with Treasury. In October 2018 she decamped for Miller & Chevalier, where she now helps clients navigate the TCJA as it continues to evolve.

“Tax reform is an iterative process and the system continues to evolve. We see that now, with new proposals offered by a potentially new administration. We see that now with the OECD’s work regarding the digitalization of the economy. That’s the best part of what we do. Nothing stays the same,” Ponds said.

Conclusion

In the wake of the coronavirus pandemic, the job market is more uncertain for young lawyers as law firms defer start dates and furlough and lay off attorneys. Ponds recalls the profession faced similar struggles when she graduated from law school, months after the September 11 terrorist attacks.

In this environment, Ponds says it is especially important for young attorneys to remember that where they start is not necessarily where they will end up.

“I hope that people take away from this article that there are many, many paths to success,” Ponds said. “I’m not doing anything I don’t want to be doing. Maybe that’s a luxury, but it also takes some courage. I think you have to be honest about what you’re doing and why. And you have to be clear about your goals. It takes self-reflection and honesty. Not everyone wants to be a law firm partner and that’s OK.”

As Ponds continues in this latest phase of her career, she, too, believes there’s more for her to attain.

“I don’t feel I’ve reached the pinnacle. I’m still learning, I’m still growing, there’s much more left in store for me professionally,” Ponds said. “I don’t ever feel like I’ve made it. Absolutely not. I feel like I’m moving forward, like I’m making progress, but I’m not finished.”




FOR THE LOVE OF TAX







COUNTRY DIGEST

AUSTRALIA

Australian Parliament Approves Budget Tax Measures in 3 Daysby William Hoke

Within three days of being presented with the government’s 2021-2022 budget package, the Australian Parliament approved the measures, which include immediate expensing for asset purchases, corporate loss carrybacks, and accelerated tax cuts for individual taxpayers.

The budget announced October 6 includes legislation allowing businesses with annual revenues of up to AUD 5 billion (around $3.6 billion) to immediately write off the full cost of eligible depreciable assets installed or first used by June 30, 2022. Another provision allows companies with annual turnover of up to AUD 5 billion to carry back losses incurred in fiscal 2022 to profits made in fiscal 2019-2021. A third measure directed at businesses adds AUD 2 billion to previously proposed research and development tax incentives, effective July 1, 2021.

The House of Representatives approved the budget October 8, and the Senate followed suit a day later.

The budget also moves forward the effective dates for previously legislated personal tax cuts, making them retroactive from July 1. In July 2019 Parliament approved a multistage process for cutting individual taxes. The first stage provided for immediate refunds of up to AUD 1,080 for low- to middle-income earners. The second stage increased the maximum income amount qualifying for the 32.5 percent tax bracket in fiscal 2022-2023 from AUD 90,000 to AUD 120,000. Incomes between AUD 90,000 and AUD 180,000 are currently taxed at 37 percent, while incomes over AUD 180,000 are taxed at a 45 percent rate.

The budget also includes technical amendments to the corporate residency test to clarify that a company incorporated offshore will be treated as an Australian tax resident if it has a significant economic connection to Australia.

“This was all in the budget speech on Tuesday . . . and it’s law on Friday,” Prime Minister Scott Morrison said in a news conference October 9. “This is real change. This is a real budget that is going to have a real impact on Australians as we come out of this COVID-19 recession. This is the budget that Australians needed.”




COUNTRY DIGEST


CANADA

Some CRA Audits Might Be Abandoned In Pandemic’s Wakeby Amanda Athanasiou

Taxpayer audits have resumed in Canada, but they look different than they used to, and some could be discontinued in light of the COVID-19 pandemic’s effects on business, according to Canada Revenue Agency officials.

“We’re going to have to grapple with those difficult questions about continuing audits or shutting audits down,” considering factors like solvency, tax debt collectability, and a taxpayer’s level of noncompliance, Harry Gill, director general of the CRA’s Small and Medium Enterprises Directorate, said during the TaxCOOP 2020 World Tax Summit October 14. While the CRA is mindful that some businesses that were under audit in January or February are now in precarious financial positions, there won’t be any blanket free passes for industries that have been hit particularly hard by the pandemic, Gill added.

When audits were halted in March and essentially all CRA employees were ordered to stay home, thousands of auditors became available to work on Canada’s emergency relief programs, Gill said. “Our branch put forward something like 3,000 auditors to help out with phone lines for the Canada emergency response benefit and the Canada emergency wage subsidy,” he said, adding that a significant portion of the SME audit staff is still working on COVID-19-related relief measures.

Audits had resumed by June, with an initial focus on those that would result in a refund or credit, Gill said. “We didn’t want to hold up money that was owed to Canadians for businesses,” he said. High-risk audits resumed as well, and as of October, all medium-size business income tax audits had resumed, Gill said, adding that audits of small businesses will resume in November.

Gill said provincial governments have become an important source of third-party information for SME data analytics and risk assessment programs. He cited information received from the Ministry of Finance in British Columbia as an example. “A number of recent measures that have

been passed in that province, such as the speculation and vacancy tax around real estate and the Land Owner Transparency Act, have led to enhanced information-sharing opportunities,” he said.

Large business audits resumed early on, but audit teams that traditionally had been at a taxpayer’s facility essentially full time were working from home, said Alexandra MacLean, director general of the CRA’s International and Large Business Directorate. Fortunately, large businesses were generally well placed to interact with the agency electronically, she said, adding that audits this summer and fall are focused on the 2018 tax year. The economy was quite strong in 2018, and the agency will be “looking at different tax structures that were in place in that era with a view to counteracting base erosion and profit shifting,” she said.

MacLean noted that the government assistance distributed to businesses this year raises important tax considerations. “One is making sure that Canadian government assistance stays in Canada and isn’t shifted out of Canada using transfer pricing or other methods,” she said. Another is making sure taxpayers’ income and losses are being measured accurately, taking into account amounts received from the government, she added.

“We’re now in the middle of running what we’re calling phase one of our auditing of [the Canada emergency wage subsidy],” MacLean said. “It’s innovative that we’re doing it now; we’re not waiting for the end of the year,” which means that complications like employee turnover and failing memories aren’t in play yet. The agency wants to get the audit work for the wage subsidy done in as close to real time as possible and bring lessons from that experience back to the income tax auditing program, she said.




COUNTRY DIGEST


Expat’s Ties to Canada Sufficient For Taxation, Court Findsby Amanda Athanasiou

A Canadian citizen who claims to have moved to Ethiopia in 2006 was a Canadian tax resident in 2013, despite spending less than a third of his time there that year, a Canadian court ruled.

In its October 13 judgment in Biya v. The Queen, the Tax Court of Canada found that Nejib Abba Biya was a resident of Canada, and possibly of Ethiopia as well, in 2013 — a year for which the Canadian government attempted to tax C $230,828 of his income. Biya spent 255 days outside Canada in 2013, including four months in Ethiopia, but the evidence indicates that his life in Canada “remained deep-rooted,” albeit less settled than in prior years, according to the judgment.

Biya, a native Ethiopian, immigrated to Canada in 1981 and became a citizen there in 1985. He and his wife had three children in Canada but separated in 2006, at which point he claims to have moved to Ethiopia and worked there through 2017. Biya retained business, personal, and family connections in Canada and visited often, according to the case record.

The government pointed out that in 2013 Biya had an Ontario driver’s license and a car he could use in Toronto; paid rent for a Toronto apartment; and helped his son make a down payment on a Toronto condo, where Biya frequently stayed. He used a Canadian passport while traveling and didn’t pay income taxes anywhere else, the government argued.

Biya received over C $200,000 in employment income from a Canadian company in which he had a stake, and deposited the money in a Canadian account. A rental property he owned in Toronto yielded another C $63,000 in 2013 revenue. Biya had savings and business accounts with Scotiabank and a “very active” credit card with the Bank of Montreal, the judgment says.

Biya argued that his connections to Canada were all related to the fact that he had family there and didn’t negate his intent to live elsewhere. He rented a home in Ethiopia for years leading up to 2013, when he purchased the property, and claimed that as of that year, he had no access to a home in Canada. Biya said his Canadian passport

and credit card facilitated his travels, and that he couldn’t procure a credit card in Ethiopia.

Biya maintained that he had an Ethiopian bank account in 2013 and lived with his girlfriend in his Ethiopian home, where he had a gardener, house cleaner, driver, and pet dog. He sold his Canadian business in 2004 and had not been living in Canada for years before 2013, he said.

Biya is in the most difficult residency case category, since he was once an ordinary resident and claims that he has since severed his relationship with the country, Judge Ronald MacPhee wrote.

The court noted that Biya’s connections to Ethiopia support the possibility that he was a resident there as well as in Canada in 2013, but noted that a person can be a resident of more than one country simultaneously. If the test was one of mutual exclusivity, the evidence more strongly supported Biya’s Canadian residence, it said.

Biya spent a similar amount of time in Ethiopia and Canada — 122 days versus 110, the court said. While in Ethiopia, he “worked for a Canadian company . . . of which he owned shares, and directed that his pay be deposited in his bank account in Canada,” it said.

The factor that dominated the court’s analysis was Biya’s remaining ties to Canada, which included his family, bank accounts, Canadian employer, Toronto investment property, registered retirement savings plans, and Ontario Health Insurance Plan membership, the court said. ”Both financially and from a family perspective, the most important components of the appellant’s life were in Canada,” it concluded.

Biya was represented in Nejib Abba Biya v. The Queen, 2020 TCC 113, by Jeremie Beitel of Tax Chambers LLP. The government was represented by Dominik Longchamp.




COUNTRY DIGEST


EUROPEAN UNION

EU Hopes for Quick Agreement on DAC7, Prepares DAC8by Elodie Lamer

The EU Council still has issues to resolve regarding the proposal for a directive on administrative cooperation (DAC7) that would require automatic exchange of information on revenues generated by sellers on digital platforms.

According to sources, the German presidency of the EU Council hopes to put the issue on the agenda for the November Economic and Financial Affairs Council meeting.

“Member States have strongly pleaded for an alignment with the OECD Model Reporting Rules in order to allow platform operators and tax administrations to apply both frameworks as smoothly as possible in parallel,” a compromise proposal put forward by the German presidency October 8 and seen by Tax Notes says.

The scope of the directive has been a controversial aspect of the member state negotiations since it was proposed in July, but the German presidency notes that “the vast majority of Member States expressly welcomed specific deviations from the [model reporting rules], in particular concerning the scope of the Relevant Activities and Reportable Sellers.” The OECD rules cover activities such as the rental of immovable property and personal services. Personal services include “transportation and delivery services, manual labor, tutoring, copywriting, [and] data manipulation as well as clerical, legal, or accounting tasks.” The European Commission went further than those rules by also including the sales of goods and investing and lending in the context of crowdfunding.

“The broad scope remains an issue for some member states. We don’t have a compromise on the sale of goods at the moment. Germany has proposed some exceptions for certain platforms to try to solve this issue, but this hasn’t been accepted yet,” a source close to the talks told Tax Notes. Those exceptions include publicly traded entities.

Territorial scope is another issue. The commission has decided to include foreign

platforms. “It’s hard to ensure rules are respected by platforms which are outside of the EU; sanctions should be applied by member states, but they are not harmonized,” the source said. But member states reportedly expect big players to abide by the rules because they are already complying with VAT-related rules.

The last big hurdle relates to joint audits (that is, two or more tax administrations auditing together). According to the compromise text, joint audits would be optional for the member states, which some delegations believe would weaken the text. But there are many practical issues around those audits, such as language issues and different national procedures and competencies.

Joint audits may be rejected on any justified grounds, the compromise proposal says. It deletes the exception rule in article 12a(5) of the commission’s proposal, which provides that “the provision of information to the competent authority of a Member State in the context of a joint audit . . . may not be refused on the grounds that it would lead to the disclosure of a commercial, industrial, or professional secret or of a commercial process, or of information whose disclosure would be contrary to public policy.”

“Furthermore, the possibility to request a joint audit by taxpayers (Article 12a(4)) is discarded,” the compromise proposal says. The disposition on joint audits in the compromise proposal also states that “officials present in other Member States shall comply with both their domestic procedural and administrative law as well as the procedural and administrative law of the host Member State.”

The commission’s proposal states that the directive should be applied from January 1, 2022, but the German compromise proposal moves the adoption and application dates back one year “to give adequate time for all relevant stakeholders to implement the provisions of DAC7.”

DAC8 in the Making

In parallel, the commission is expected to publish “imminently” a roadmap on DAC8, which would focus on alternative means of payment and investment such as crypto-assets, Accountancy Europe’s tax expert Johan Barros tweeted October 8. Stakeholder feedback would then be expected on this inception impact




COUNTRY DIGEST


assessment. Sources in the commission said the timing for this publication is not fixed at the moment because of a number of factors, including internal approvals. But other sources said it is expected soon.

In its July “action plan for fair and simple taxation supporting the recovery strategy,” the commission said that “the emergence of alternative means of payment and investment — such as crypto-assets and emoney — threaten to undermine the progress made on tax transparency in recent years and pose substantial risks for tax evasion.” It promised that “in 2021, it will update the directive on administrative cooperation to expand its scope to an evolving economy and strengthen the administrative cooperation framework.” The commission’s website says the public consultation is planned for the first quarter of 2021, and the proposal for the third quarter.

“Crypto-assets pose two types of challenges for tax authorities. First, there is uncertainty about the legal status of crypto-assets, and therefore the tax treatment of transactions using crypto-assets. The second challenge for tax administrations is that crypto-assets can make it easier to avoid paying tax,” the commission said in September in an impact assessment on a separate proposal to regulate crypto-assets.

In the European Parliament, sources recalled that the Greens/European Free Alliance raised this issue in 2018 in a report, “Analysing Loopholes in the EU’s Automatic Exchange of Information and How to Close Them.” The report proposed establishing, through amendments to the directive on administrative cooperation, “explicit requirements that entities issuing, trading, or exchanging crypto-currencies should be considered as reporting financial institutions, who should be required to identify holders of crypto-currencies and report their holdings to their corresponding country of residence.”

EU Will Respect New OECD Deadline For Reaching Global Tax Dealby Stephanie Soong Johnston

The EU will hold off on unilateral plans to tax digital activity even though the OECD missed its 2020 deadline to reach agreement on a multilateral approach to modernize global tax rules.

The European Commission welcomes the OECD’s blueprints for a two-pillar proposal for rebuilding corporate tax rules for an increasingly digital and globalized economy, according to commission spokesperson Daniel Ferrie, who spoke to reporters during an October 13 press briefing. The OECD published the blueprints October 12.

“They are tangible deliverables for reaching our common goal and a solid basis for further negotiations,” Ferrie said. The original deadline for getting 137 jurisdictions working within the OECD framework to reach consensus on the proposal was the end of 2020, “but it’s clear that this will now not be possible,” he added.

The timeline became untenable after the project ran into political differences over issues such as scope and tax rates, as well as difficulties arising from the COVID-19 pandemic. As a result, the inclusive framework said it would continue working on the project “with a view to bringing the process to a successful conclusion by mid-2021,” according to an October 12 statement.

The process can’t be postponed again, and the new 2021 deadline “must be the final one, and the earlier, the better,” Ferrie said. “The credibility of the process must be preserved, and we can only do this by working together to reach political agreement as soon as possible. The commission calls on all global partners to remain engaged in the discussions and to continue work on the technical aspects without delay.”

The commission repeatedly threatened to take unilateral action if multilateral talks fail, and a proposal for an EU digital tax was expected in the first half of 2021. Although the commission will now respect the new OECD deadline, it still plans to take action if the OECD process collapses, according to Ferrie. This wouldn’t be the first time the EU would try moving unilaterally to tax




COUNTRY DIGEST


digital activity — it had tried to introduce an EU-wide digital tax but gave up in March 2019.

The OECD blueprints represent the culmination of work that started shortly after the OECD concluded the G-20-mandated base erosion and profit-shifting project in October 2015, following up specifically on action 1, which focused on the tax challenges of the digital economy. Governments involved in the project hope that adoption of a common, coordinated approach to update global corporate tax rules will ensure more effective and more equitable taxation of new business models and, more broadly, multinational enterprises.

Countries also expect that a multilateral approach would discourage the spread of unilateral measures, such as digital services taxes, which could lead to instability in the global tax system.

Pillar 1 envisages amending profit allocation and nexus rules to grant more taxing rights to market jurisdictions over a portion of in-scope multinationals’ residual profits. Pillar 2 would introduce minimum corporate taxation through a global anti-base-erosion mechanism.

However, negotiations have been challenging, especially on pillar 1, because many countries, including several in the EU, are keen to tax the so-called GAFA companies — Google, Apple, Facebook, and Amazon — and other tech giants. The United States is adamant that any multilateral tax reform should not ring-fence digital companies and is pushing for pillar 1 to apply not only to companies providing automated digital services, but also to consumer-facing businesses.

Complicating matters further, the United States called for pillar 1 to be implemented on a “safe harbor basis” so companies could opt into the regime in exchange for greater tax certainty — a proposal that many countries have opposed. The pillar 1 blueprint punted on a decision on that point, saying it was one of many outstanding political and technical issues that must be resolved among the inclusive framework members.

The project’s delay could lead some impatient governments to introduce their own digital tax plans or resume digital taxes they have already adopted. France implemented a 3 percent revenue-based DST that took retroactive effect

January 1, 2019, riling the United States, which views DSTs as discriminatory against U.S. companies. France held off on collecting the DST until the end of 2020 to give room for OECD negotiations, but the Office of the U.S. Trade Representative said it would impose 25 percent tariffs on $1.3 billion worth of French goods in January 2021 after finding that the tax unfairly hit U.S. companies. It is not yet clear whether those plans will change as well.

The French Ministry of Economy, Finance, and Recovery noted on October 12 the progress made at the OECD, saying that the technical work constitutes a solid basis for reaching a political decision. All countries must continue working toward making a decision quickly, it said in a statement sent to Tax Notes.

Other countries within the EU have also decided to introduce DSTs, including Austria and, most recently, Spain. These taxes and others are now the subject of another investigation by the Office of the U.S. Trade Representative and could lead to further trade wars.

According to a new OECD economic impact assessment, also published October 12, broad implementation of DSTs could cause world GDP to contract by more than 1 percent in a worst-case scenario.

The pillar 1 blueprint notes that “any consensus-based agreement must include a commitment by members of the inclusive framework to implement this agreement and at the same time to withdraw relevant unilateral actions, and not adopt such unilateral actions in the future.”

Elodie Lamer contributed to this article.




COUNTRY DIGEST


Progressive Turnover Taxes Valid Under State Aid Rules, AG Saysby Kiarra M. Strocko

An advocate general has challenged the European Commission’s state aid findings, saying that Hungarian and Polish tax regimes with progressive rate structures based on turnover rather than profit should be valid under EU law.

In her October 15 opinion in European Commission v. Hungary, C-596/19 P, and European Commission v. Poland, C-562/19 P, Advocate General Juliane Kokott urged the Court of Justice of the European Union to dismiss the commission’s appeals and uphold the General Court of the European Union’s judgments in favor of the Hungarian advertisement tax and the Polish tax on retail turnover.

The advocate general interpreted article 107(1) of the Treaty on the Functioning of the European Union and found that “state aid rules do not preclude taxation of turnover of undertakings at a progressive rate,” according to the CJEU’s October 15 release. The advocate general found that the commission wrongly concluded that the progressive rate scale of Poland’s tax on retail turnover and Hungary’s ad tax selectively favored taxpayers.

The commission took issue with Hungary’s 2014 Law on Advertisement Tax, which introduced a progressive tax on advertising turnover with rates ranging from 0 to 40 percent — increased to 50 percent in January 2015. Hungary adopted an amended version of the tax after the commission launched its investigation in 2015, with a smaller scale comprising a zero rate and a 5.3 percent rate applicable to revenue of HUF 100 million (about $323,000) or more. Hungary amended its law again in 2017 to address EU state aid concerns.

Poland enacted a similar progressive tax on the retail sector in July 2016. Its tax on retail turnover provides that, after exempting the first PLN 17 million (about $4.43 million), a 0.8 percent rate applies to gross retail revenue up to PLN 170 million, and a 1.4 percent rate applies to revenue exceeding PLN 170 million.

In Hungary v. European Commission, T-20/17, decided June 27, 2019, the General Court annulled the commission’s November 2016 determination

that Hungary’s progressive rate scheme improperly granted a selective advantage to some companies. In its May 16, 2019, decision in Poland v. Commission, joined cases T-836/16 and T-624/17, the General Court annulled the commission’s 2016 decision ordering Poland to suspend implementation of its retail revenue tax and a 2017 ruling that the tax violates EU state aid law.

Following similar rationale as in its judgment concerning Poland’s retail revenue tax, the General Court found that the commission should not have inferred that there were selective tax advantages solely from the progressive nature of the Hungarian ad tax. The General Court said provisions permitting companies that did not report a taxable profit in 2013 to deduct from their 2014 tax base 50 percent of losses carried forward did not infringe on state aid rules. The commission challenged both the General Court’s judgments in its July 2019 appeal and its August 2019 appeal.

In her nonbinding opinion, Kokott referenced prior case law, saying that based on the fundamental freedoms, “a progressive tax may be based on turnover since, first, the amount of turnover constitutes a criterion of differentiation that is neutral and, second, turnover constitutes a relevant indicator of a taxable person’s ability to pay.” According to the CJEU release, “the same must apply to the rules on State aid.”

Kokott said “a democratically mandated legislature” must weigh and account for the advantages and disadvantages of income taxation based on turnover or profit when deciding which tax is appropriate, instead of by an authority or a court. “In any case, the rules on State aid do not require the tax which is, in the Commission’s view, most appropriate to be introduced,” Kokott noted.

The advocate general also highlighted the similarities between the Hungarian and Polish taxes and the commission’s proposed digital services tax, saying that “around the world, turnover-based income taxes are on the rise.” Kokott noted that the commission’s proposed DST also “uses annual turnover as the basis for the taxation of undertakings. The Polish tax on the retail sector or the Hungarian advertisement tax and the planned EU digital services tax are no different in this respect.”




COUNTRY DIGEST


Further, Kokott agreed with the General Court’s finding that the Hungarian and Polish tax were not “manifestly inconsistent” to constitute state aid. She said a progressive rate does not necessarily constitute an inconsistency. Kokott noted that progressive rate structures are common and provide the means necessary to achieve taxation related to financial capacity. “High turnover does not necessarily lead to high profit, but high turnover is a prerequisite for high profit. The differentiation is therefore not inconsistent,” the release says.

Regarding the commission’s second ground of appeal for the Hungarian ad tax, the advocate general said the possibility for taxpayers to use losses within the first year of the advertisement tax for income tax purposes does not constitute state aid. According to the release, “since the fact that losses existed in the previous year is an objective criterion and undertakings with losses and undertakings with profits in the previous year are different in terms of the ability to bear additional non-profit-related taxation, the implementation of this transitional provision is similarly not inconsistent.”

IRELAND

Digital Tax Discussions Feature In Ireland’s 2021 Budget Speechby Amanda Athanasiou

Ireland’s COVID-19-era budget plan includes an immediate carbon tax increase, VAT reductions, and additional support for businesses as part of an almost €18 billion package that includes €270 million in tax measures.

Despite a projected deficit of €21.5 billion and under €7.5 billion in corporate tax receipts this year, there is no plan to adjust Ireland’s 12.5 percent corporation tax rate in the 2021 budget published October 13. Irish Finance Minister Paschal Donohoe warned during an October 13 budget speech that international developments on digital tax could raise challenges for Ireland regardless of whether agreement is reached at the OECD.

The global pandemic has complicated an economic environment already challenged by the lack of a bilateral trade deal between the EU and the United Kingdom in light of Brexit, Donohoe said. Ireland has spent €24.5 billion in pandemic support, “nearly eight times last year’s budget plan” and far beyond the €1.3 billion surplus Ireland started with in 2020, he said. “We have never experienced a challenge like this in modern times,” Donohoe added.

The path forward includes a green economic recovery, said Public Expenditure and Reform Minister Michael McGrath, who called the 2021 budget the largest and most ambitious in Ireland’s history. The budget includes a €7.50 carbon tax increase to €33.50 per metric ton of CO2, applicable to auto fuels beginning the night of the budget presentation. Other fuels will become subject to the increase May 1, 2021. The increase is expected to add €108 million to proceeds from an increase in the carbon tax included in the 2020 budget to produce an estimated total of €238 million in 2021.

McGrath noted that the carbon tax was never meant to be a revenue generator for the government, and that €100 million of those revenues will be available for residential energy efficiency investments — an 82 percent increase in available funds over 2020. To offset the effects of




COUNTRY DIGEST


the carbon tax increases on low-income individuals, the fuel allowance will be increased to €28 per week, up from €24.50, he said. One billion euros will be allocated to public transportation investments in 2021, he added.

The budget also includes a temporary VAT reduction from 13.5 percent to 9 percent for the hospitality and tourism sector. The change will apply from November 1, 2020, through December 2021 and is expected to cost €401 million over that period. Donohoe announced a standard VAT rate reduction from 23 percent to 21 percent to be applied between September 2020 and February 2021 as part of a July stimulus plan. The government has also tried to encourage consumer spending at local hotels and restaurants through a “Stay and Spend” scheme.

Donohoe said this year’s €7.5 billion in corporate tax receipts has helped to fund pandemic relief, and he promised an update to Ireland’s Corporation Tax Roadmap that will consider recent OECD reports on the tax challenges of the digital economy. “Agreement at the OECD would present challenges for Ireland, as changes to the international tax framework would see a reduction in the level of profits taxable here,” Donohoe said, adding that a lack of international agreement would also be bad for Ireland.

Donohoe said Ireland’s intellectual property tax regime will be amended so that “all intangible assets acquired after today will be fully within the scope of balancing charge rules,” Donohoe said. That change won’t produce substantial revenue, but will align Ireland’s IP tax regime with international best practice, he said.

Donohoe also said the tax warehousing scheme will be extended “to include repayments of temporary wage subsidy scheme funds owed by employers and preliminary tax obligations for the adversely affected self-employed.” The Department of Finance has initiated the application process to obtain EU funding for Ireland’s temporary wage subsidy scheme, he added.

A lot still depends on the path of the virus, Donohoe said, adding that this is a time for hope, rather than unfettered optimism. The Department of Finance projects a loss of 320,000 jobs for 2020 and a recovery of less than half of that number

next year. The expected deficit of €21.5 billion — huge by Irish standards — is not unlike what peer countries are experiencing, Donohoe said. He said an updated medium-term budget strategy will be coming next year and that the National Economic Plan will be published next month.




COUNTRY DIGEST


MULTINATIONAL

U.N. Releases Proposed Treaty Article On Digital Services Taxesby Ryan Finley

Members of the United Nations’ subcommittee on taxing the digital economy have proposed a new treaty article allowing source-country taxation of digital services revenue, parting ways with the proposal currently under consideration at the OECD.

According to a note released October 13, a drafting group formed from members of the U.N.’s digital taxation subcommittee have submitted a draft version of a new article 12B of the U.N. model tax convention for discussion during the U.N. Tax Committee’s upcoming meetings. The proposed article, which is a revised version of a proposal released in August, would generally recognize contracting states’ right to tax gross digital services income earned by a beneficial owner that is resident in the other contracting state and has no local permanent establishment.

The proposed article would apply to the beneficial owner’s “income from automated digital services,” which the draft broadly defines as “any payment in consideration for any service provided on the internet or an electronic network requiring minimal human involvement from the service provider” other than amounts that qualify as royalties under article 12 or fees for technical services under article 12A. According to the draft commentary, services are considered automated when “the user is able to make use of [the] service because of equipment and systems being in place, which allow the user to obtain the service automatically, as opposed to requiring a bespoke interaction with the supplier to provide the service.”

The draft commentary specifies that article 12B contains no quantitative or qualitative nexus thresholds, noting generally that the ability to derive income from automated digital services in a jurisdiction justifies taxation in that jurisdiction. The proposal does not specify the rate of tax, which would be set by bilateral negotiations, but suggests in the draft commentary that a “modest rate” of 3 to 4 percent would largely address double taxation concerns.

The proposal differs starkly from the pillar 1 blueprint just approved by the OECD’s inclusive framework, particularly in its lack of any nexus requirement and use of gross revenue rather than net profit — or some portion thereof — as the tax base. The draft commentary cites the constraints faced by developing countries’ tax administrations as justification for allowing tax on a gross basis.

“Many developing countries have limited administrative capacity and need a simple, reliable, and efficient method to enforce tax imposed on income from services derived by nonresidents. A withholding tax imposed on the gross amount of payments made by residents of a country, or nonresidents with a permanent establishment or fixed base in the country, is well established as an effective method of collecting tax imposed on nonresidents,” the draft commentary says.

To address concerns about the imposition of a gross revenue tax on unprofitable companies, the proposal would allow taxpayers subject to the new article to opt for taxation on net profit at the rate applicable under domestic law. Taxpayers that exercise this option would be taxed on their “qualifying profits,” which the draft article defines as 30 percent of the beneficial owner’s consolidated automated digital business segment revenue, multiplied by its gross automated digital services revenue in the jurisdiction. According to the draft commentary, this formulaic definition of the tax base is intended to approximate an equal weighting of assets, employees, and revenues and to prevent manipulation through intragroup transactions.

The note also includes annexes containing exchanges between the drafting group and commentators, including the U.S. Council for International Business. Regarding a comment that the proposed article would allocate taxing rights in a manner inconsistent with the OECD transfer pricing guidelines, the note says the drafting group rejects the assumption that market countries do not contribute to value creation. It also refers to the distinction between routine returns and non-routine profit — transfer pricing concepts that have strongly influenced the OECD’s pillar 1 proposal — as artificial.




COUNTRY DIGEST


According to the note, the problems associated with gross-basis taxation of income from taxing digital services are no more severe than they are for categories of income that may currently be taxed on a gross basis, including interest, royalties, and fees for technical services. The note also sharply rejects calls for a more cautious approach while negotiations among members of the inclusive framework on base erosion and profit shifting continue at the OECD, arguing that the proposal should be judged on its own merits.

“We feel that the multilateral approach is complex and difficult to implement for and does not result in fair or reasonable share for developing countries,” the note says. The U.S. Council for International Business “should rather request [the] other forum to give up its approach, which is being criticized all around for its complexity,” it adds.

G-20 Ministers Greenlight New Deadline For OECD Global Tax Accordby Stephanie Soong Johnston

Countries may have fallen short in reaching a global tax reform agreement in 2020, but the G-20 still supports those efforts, even if it means getting a deal over the finish line by mid-2021.

G-20 finance ministers acknowledged in a communiqué published after their October 14 virtual meeting that the COVID-19 pandemic had affected OECD-led efforts to get countries to agree on a proposal for modernizing international corporate tax rules.

The group also welcomed the OECD’s October 12 release of blueprints setting out the technical design of the two main components of that proposal. The blueprints were included in OECD Secretary-General Angel Gurría’s tax report to the G-20 finance ministers.

Pillar 1 calls for amending profit allocation and nexus rules to grant more taxing rights to market jurisdictions over a portion of in-scope multinationals’ residual profits. Pillar 2 would introduce minimum corporate taxation.

The 137 member countries of the OECD’s inclusive framework on base erosion and profit shifting drafted the two blueprints in response to a mandate from the G-20 to reach consensus by the end of 2020 on a multilateral solution addressing the tax challenges of the digital economy.

“Building on this solid basis, we remain committed to further progress on both pillars and urge the G-20/OECD inclusive framework on BEPS to address the remaining issues with a view to reaching a global and consensus-based solution by mid-2021,” the communiqué said.

Governments hope a common, coordinated approach will ensure more effective and equitable taxation of new business models and, more broadly, multinational enterprises. Countries expect that a multilateral approach would discourage the spread of a patchwork of unilateral measures such as digital services taxes, which could lead to instability in the global tax system.

The G-20 finance ministers also welcomed other aspects of Gurría’s tax report, including a new report on the taxation of cryptocurrencies




COUNTRY DIGEST


and an update on implementation of global tax transparency standards.

Pascal Saint-Amans, director of the OECD’s Centre for Tax Policy and Administration, noted that the G-20 finance ministers’ communiqué draws extensively from the inclusive framework’s cover statement, also published October 12. “I find it good and clear,” Saint-Amans told Tax Notes. “All ministers spoke, and all said they really want a solution by mid-[2021].”

France Revs Its Engines

Negotiations have been challenging, especially on pillar 1, because many countries, including several in the EU, are keen to tax the so-called GAFA companies — Google, Apple, Facebook, and Amazon — and other tech giants. The United States is opposed to ring-fencing digital companies and is pushing for pillar 1 to apply not only to companies providing automated digital services, but also to consumer-facing businesses.

Complicating matters further, the United States called for pillar 1 to be implemented on a “safe harbor basis” so companies could opt into the regime in exchange for greater tax certainty — a proposal that many countries have opposed. The pillar 1 blueprint punted on a decision on that point, saying it was one of many outstanding political and technical issues that must be resolved among the inclusive framework members.

During an October 14 press briefing, French Finance Minister Bruno Le Maire thanked the OECD for its technical work on the two pillars and said the organization had fulfilled its role perfectly. He expressed regret that politics had gotten in the way of agreement on the two-pillar solution and said France was ready to approve the two pillars.

Le Maire placed the blame squarely on the United States, which he said blocked agreement on pillar 1. While the United States said it would support pillar 2, it’s important that the two pillars must not be separated, he said.

France and the United States have been at the center of the political tensions for some time, after France implemented a 3 percent revenue-based DST that took retroactive effect January 1, 2019. The move riled the United States, which views

DSTs as discriminatory against U.S. companies. France held off on collecting the DST until the end of 2020 to give room for OECD negotiations, but the Office of the U.S. Trade Representative said it would impose 25 percent tariffs on $1.3 billion worth of French goods in January 2021 after finding that the tax unfairly affected U.S. companies.

Now that there’s no global tax deal, “I can confirm to you that, as it was understood with the United States and with all OECD members, we will raise our national digital taxation by the end of this year — I think it should be mid-December,” Le Maire told reporters.

Le Maire also called on the European Commission to introduce its own proposal for taxing digital activity at the beginning of 2021, saying that the EU must have an alternative solution. However, the commission said October 13 that it would respect the new deadline.

France’s announcement “is probably just a foretaste of what’s to come,” Will Morris, deputy global tax policy leader at PwC and tax committee chair for business at OECD, told Tax Notes, adding that more DSTs are likely.

“Large MNEs inside the narrow scope of the first wave of DSTs are probably relatively well set up to deal with those,” Morris said. “If the next wave of DSTs is broader — and uncoordinated — that could be considerably more chaotic. And that’s before you consider possible trade [and] tariff responses.”

While it’s good that the two blueprints give the business sector more details so they can understand the proposals, there is a lot of complexity and several unanswered questions, Morris said. As for the prospects of agreement by mid-2021, “I hope we get there, but it’s definitely not a straight, smooth path from here,” he added.

Neither the U.S. Treasury Department nor the Office of the U.S. Trade Representative responded to Tax Notes’ request for comment by press time.




COUNTRY DIGEST


NETHERLANDS

Dutch Exit Tax Proposal Moving Forward Despite Legal Concernsby Sarah Paez

Despite legal concerns from the state advisory body, Dutch lawmakers are moving forward with a proposal for a “dividend exit tax” that would affect corporations like Unilever that are moving their Dutch operations to low-tax jurisdictions.

Member of parliament Bart Snels of GroenLinks (the Greens party) submitted an amended proposal for the tax after the advisory division of the Council of State said it did not consider the tax justified because it is “legally untenable.”

Snels’s initial bill, introduced in July, proposed an exit tax on companies with annual revenue of €750 million or greater looking to relocate to low-tax jurisdictions or those without a dividend withholding tax. The exit tax would apply at a rate of 15 percent on the difference between a departing company’s market value and the amount of its paid-up capital for tax purposes.

The amended proposal extends the tax to all company head offices that leave for a state without a dividend tax, regardless of the size of the group to which the company belongs. It also limits the retroactive effect of the bill to September 18 instead of the originally proposed date of July 10.

According to an October 9 summary from the council, Snels’s initial proposed exit tax does not comply with principles like due care and legal certainty and conflicts with some international treaties and EU law. Specifically, the council said there are insufficient arguments about whether there is a valid tax claim on undistributed profits because of some tax treaties.

In the explanatory memorandum to the amended proposal, Snels said the Netherlands has a tax right under treaties — typically of 15 percent — on dividends paid by a company established in the Netherlands to investors residing in the other country. The treaties are not an obstacle to levying tax on the distribution of profit upon a company’s departure because the tax is levied “immediately prior to ‘departure’ in

the form of a protective additional assessment for which payment is deferred,” Snels wrote.

The council also said that because the exit tax was initially proposed to apply retroactively from July 10, it would affect cross-border reorganizations already in process. The council said it “does not consider it justified that such reorganizations of a business nature, which therefore do not involve the avoidance of dividend tax, are also affected by the retroactive effect of this scheme.”

The Greens have 14 members of 150 in the parliament, and would need to gather support from other parties to pass the bill after it is resubmitted.

Unilever N.V. shareholders voted September 21 with 99 percent majority to consolidate the company’s 90-year-old Anglo-Dutch structure under a U.K. parent, despite the threat of an €11 billion Dutch exit tax. The company’s U.K. shareholders were expected to vote on the plan October 12, and the company is aiming for a November completion date for its plan.

In an October 9 statement published by the Regulatory News Service, Unilever said it will carefully review the amended bill to assess any potential impact on the company’s plans. The board will move forward with the proposal for unification under a U.K. parent on the condition it is still the best option for the company, its shareholders, and other stakeholders, the statement says.

Neither Snels nor Unilever responded to requests for comment by press time.




COUNTRY DIGEST


SPAIN

Spanish Cabinet Proposes Cryptocurrency Control, Tax Amnesty Banby William Hoke

Spain’s Council of Ministers has proposed anti-fraud legislation that would require the reporting of cryptocurrency transactions and ban tax amnesties, large cash transactions, and dual-use software that allows companies to manipulate their accounting results.

On October 13 the government said it would ask the parliament to require the reporting of cryptocurrency balances and transactions, both in Spain and abroad, “if it affects Spanish taxpayers.”

The measures also include legislation intended to combat accounting fraud. “The objective is not to allow either the production or the possession of computer programs and systems that allow the manipulation of accounting and management data,” the government said in a series of tweets October 13.

The government also said it wants to lower the value of business transactions that can be carried out in cash from €2,500 to €1,000. In 2012 the parliament passed a law prohibiting the use of cash in transactions involving payments of €2,500 or more if at least one of the parties to the transaction is a business owner or a professional. (Payments to or deposits with credit institutions are exempted.) A related measure would reduce from €15,000 to €10,000 the amount of cash that can be paid to an individual with a tax domicile outside of Spain.

The plan to ban tax amnesties follows through on a pledge made by Prime Minister Pedro Sánchez in 2018. “There will never be a tax amnesty in our country again,” Sánchez said at the time.

Another proposed measure would reduce the amount of outstanding debt, from €1 million to €600,000, that would land a taxpayer on the list of tax delinquents published annually by the national tax agency.

Minister of Finance María Jesús Montero said October 13 that the government has a zero-tolerance policy regarding fraudulent practices. “There is no social justice, there is no tax justice, if

some seek to evade the commitments and obligations that the rest have,” she said.

The Ministry of Finance said the measures focus on the most complex and advanced forms of fraud, including schemes associated with new technologies. “In addition, [the anti-fraud package] allows prosecution of the inappropriate behavior of multinationals and fights against abusive tax planning,” the MOF said.

If approved by the parliament, the measures are expected to generate approximately €800 million of additional revenues a year, the MOF said.




COUNTRY DIGEST


UNITED KINGDOM

Amazon’s Direct Sales Not Subject To U.K. Digital Services Taxby William Hoke

The Tax Justice Network said reports that Amazon isn’t liable for the U.K. digital services tax on goods it sells directly isn’t surprising, and that the larger issue is Amazon’s ability to shift profits abroad.

The DST, which was introduced in July as part of Finance Act 2020 and applies retroactively from April 1, is payable by groups with consolidated worldwide digital services revenue exceeding £500 million per year and U.K. digital services revenue exceeding £25 million per year. The 2 percent tax is payable on revenue from social media services, search engines, and online marketplaces.

In August Amazon said it would increase by 2 percent all referral fees, Fulfillment by Amazon fees, multichannel fulfillment fees, and monthly Fulfillment by Amazon storage fees payable by vendors marketing products on the company’s Amazon Seller Central website. The company said the fee increase would go into effect September 1.

The Times reported October 14 that HM Revenue & Customs confirmed that the U.S.-based e-commerce company does not have to pay DST on its direct sales to customers.

The issue of whether offshore technology companies are paying a fair amount of tax to countries in which many of their users are resident has been a contentious one. “This measure will ensure [that] the large multinational businesses in scope make a fair contribution to supporting vital public services,” HMRC said in a DST policy paper published March 11.

“The absence of most of Amazon’s business from the U.K. is by design,” Alex Cobham, chief executive of the Tax Justice Network, said in an email to Tax Notes. The DST “is not intended to fall on revenues that arise from direct online sales of goods, such as Amazon’s,” he said. “The underlying issue with Amazon, and why it can outcompete most domestic businesses (and especially those with major physical presence) and so drive the growing erosion of high streets

across the U.K., is not the specific digital component, but the broader structure that allows it to shift most of its taxable profits out of the U.K. Even a broader DST would be a drop in the bucket compared to that, and the problem is not limited to digital companies, even if they are among the most aggressive.”

In a regulatory filing, Amazon reported that it paid £14.5 million of U.K. corporation tax in 2019 on revenues of £13.7 billion. The company said September 8 that it paid £293 million in direct taxes — including corporate tax, employer’s national insurance, stamp duties, and trade rates — last year.

Cobham said that while the OECD’s efforts to adapt harmonized rules for taxing the digital economy are failing, its “central logic is correct.” On October 12 the OECD pushed back its target date for reaching agreement on modernizing international corporate tax rules from the end of 2020 until mid-2021. Pillar 1 of the plans would amend profit allocation and nexus rules to grant more taxing rights to market jurisdictions over a portion of in-scope multinationals’ residual profits. Pillar 2 would introduce minimum corporate taxation.

“We need to tax multinationals according to where their real activity is,” Cobham said. “That would mean the U.K. taxing a share of Amazon’s global profits in proportion to the share of Amazon’s activity that takes place in the U.K. — the share of employment and sales, that is. And that approach needs to be applied to all sectors.”




COUNTRY DIGEST


U.K. Furlough Scheme to Support Businesses Forced to Closeby Andrew Goodall

Businesses legally required to close their premises during the winter because of coronavirus restrictions will receive grants to cover two-thirds of furloughed employees’ salaries, U.K. Chancellor of the Exchequer Rishi Sunak announced.

HM Treasury presented the policy as an extension of the job support scheme (JSS) that Sunak announced on September 24, which is the successor to the coronavirus job retention scheme scheduled to end on October 31. Sunak had declared that it would be wrong to hold people in jobs that “only exist inside the furlough.” The announcement coincided with official figures showing that economic growth slowed in August.

Treasury set out details of the expanded JSS, intended to run for six months starting November 1, in an October 9 release and fact sheet. The government will pay two-thirds of each furloughed employees’ salary up to a maximum of £2,100 a month. The scheme will cover “businesses that, as a result of restrictions set by one or more of the four governments in the U.K., are legally required to close their premises,” it said. Businesses required to provide only delivery and collection services from their premises will also be eligible.

“The expansion of the job support scheme will provide a safety net for businesses across the U.K. who are required to temporarily close their doors, giving them the right support at the right time,” Sunak said.

Employers will not be required to contribute toward wages but will need to pay National Insurance contributions (NICs) and pension contributions. Around half of potential claims are “likely not to incur employer NICs or auto-enrollment pension contributions and so face no employer contribution,” Treasury said.

HM Revenue & Customs intends to publish the names of employers who have used the expanded JSS. “Employees will be able to find out if their employer has claimed for them under the scheme,” Treasury added.

The government is also increasing cash grants to businesses in England that are closed in local

lockdowns. The grants, to provide support with fixed costs, will be linked to ratable values. Up to £3,000 per month will be payable, with payments made every two weeks.

The Labour Party criticized the new policy, which Sunak announced ahead of the anticipated closure of hospitality premises in the north of England amid concern over rising numbers of infections and hospital admissions.

“The fact the chancellor is having to tear up his winter [economy] plan before the autumn is out demonstrates the chaos and incompetence at the heart of government. His delay in delivering support has caused unnecessary anxiety and job losses,” Labour’s Shadow Chancellor Anneliese Dodds said in a statement. “Even at this late stage, he still has no plan to support sectors that are currently unable to operate at full capacity.”

‘A Welcome Step’

“Paying two-thirds of wages for employees in lockdown is a welcome step and it is encouraging to see that the chancellor has introduced flexibility and a sector-specific approach into the JSS and recognizes that this is an evolving situation,” said Kate Nicholls, chief executive of the trade group UK Hospitality. “However, worryingly, it does nothing to address the issues faced by sector businesses operating well below capacity due to restrictions and consumers avoiding travel and struggling to keep their workforce employed.”

“It is right that the chancellor has responded to our long-standing calls for more local support, as so many areas across the U.K. now face restrictions and closures. More generous cash grants will be of some help, but for most this will not be enough to offset a sustained cash crunch,” said Adam Marshall, director general at the British Chambers of Commerce.

“As welcome as this new support will be for companies shut down by government decree, additional local restrictions and lockdowns will have a material impact on many other firms, especially in supply chains and in town and city centers. Their cash flow concerns, and worries about future demand, must be heeded,” Marshall said.

“The steep rise in infections in some areas means new restrictions to curb numbers feel




COUNTRY DIGEST


unavoidable,” said Carolyn Fairbairn, director general at the Confederation of British Industry. “The chancellor’s more generous job support for those under strict restrictions should cushion the blow for the most affected and keep more people in work. But many firms, including pubs and restaurants, will still be hugely disappointed if they have to close their doors again after doing so much to keep customers and staff safe.”

“What has been announced by the chancellor today is a start but, on first look, it would not appear to have gone far enough to prevent genuine hardship, job losses, and business failure this winter,” Andy Burnham, mayor of Greater Manchester, said in a joint statement with three other northern mayors.

‘Sharp Slowdown in Growth’

The Office for National Statistics announced earlier on October 9 that GDP grew by 2.1 percent in August as lockdown measures “continued to ease.” This was the fourth consecutive monthly increase, but output remained 9.2 percent below its February level. Reuters reported that August figure was less than half the median forecast in its recent poll of economists, and the slowest increase since the economy began to recover in May from a record slump.

“While the latest data confirms a rebound in economic activity continued into August, the sharp slowdown in growth indicates that the recovery may be running out of steam, with output still well below pre-crisis levels,” said Suren Thiru, head of economics at the British Chambers of Commerce. The increase in activity in August largely reflected a temporary boost from the economy reopening and government stimulus, including the “eat out to help out” scheme, he noted.

Responding to the figures, Sunak acknowledged that “many people are worried” about the coming winter months. “Throughout this crisis, my single focus has been jobs — protecting as many jobs as possible, and providing support for people to find other opportunities where this isn’t possible. This goal remains unchanged,” he said.

U.K. Tax Review Should Focus on Reliefs, OECD Saysby Andrew Goodall

The combination of COVID-19 and Brexit makes the United Kingdom’s outlook “exceptionally uncertain,” and decisions made now will have an impact on the country’s economic trajectory for years to come, the OECD said.

Once a recovery is firmly established, the United Kingdom should carry out comprehensive tax and spending reviews — with a particular focus on reliefs and exemptions — and broaden the tax base to fund social objectives, according to the OECD’s economic survey published on October 14.

The coronavirus crisis “erupted against a background of subdued growth, stagnant productivity, and flat investment” in the United Kingdom and triggered one of the most severe falls in output of OECD countries, the OECD noted in a release, adding that this reflected “the [U.K.] economy’s deep integration in the world economy and the fact that the hard-hit service sector makes up around 80 percent of U.K. output and employment.”

A “rapid and massive emergency response” has helped to steady the economy, but the United Kingdom still faces “a prolonged period of disruption to economic activity, which risks exacerbating pre-existing inequalities and regional disparities,” the OECD suggested. “Most households have reported a drop in income since the crisis. Economic activity will only recover gradually, with several years of high unemployment likely due to business closures and delayed investment,” it said.

Assuming a smooth transition to a free trade agreement with the EU, the survey projected “an unprecedented fall in GDP in 2020 of 10.1 percent” with activity remaining below its pre-crisis level by the end of 2021. However, a disorderly exit from the EU single market without a trade agreement would have “a major negative impact on trade and jobs,” it noted.

Broadening the Tax Base

Productivity and investment growth have been weak in recent years, and an ambitious




COUNTRY DIGEST


agenda of reforms will be the “key to a sustainable recovery,” according to the survey. “Once the recovery is firmly established, addressing the remaining structural deficit and putting the public debt-to-GDP ratio on a downward path should come to the fore . . . [and] broadening the tax base would support social objectives, such as health, while raising equity,” the OECD said.

Leaving the EU single market is expected to lower growth prospects and tax revenues, the survey noted. It added that the United Kingdom also faces “strong pressures on health spending, which is predominantly financed from general taxation.” At 33.5 percent, the tax-to-GDP ratio “remains relatively low compared with many European countries,” the OECD said.

Reducing tax expenditures would improve resource allocation, and it will be important to “review the existing tax and spending mix with a particular view to end reliefs and exemptions that do not serve an economic or social purpose,” the OECD said. “In particular, ending relief or exclusion from the climate change levy and the carbon price floor and removing zero-rating on VAT for passenger transport would help even carbon pricing across sectors and fuels.”

The council tax could be increased to raise tax on high housing wealth, while bringing accumulated pension wealth into the inheritance tax base would raise fairness and continuing to “fight against tax evasion and avoidance” can bring revenue gains, the OECD said.

Business Property Relief

Inheritance tax relief of up to 100 percent of the value of business assets “could be contributing to the prevalence of family-owned businesses with an indirect negative impact on overall managerial quality,” the OECD said, citing research published in 2017 by the LSE Growth Commission. Poor management practices in smaller, family-run firms are “encouraged by U.K. tax laws on the inheritance of business assets,” the survey suggested.

The OECD said the U.K.’s Office of Tax Simplification (OTS) is reviewing the inheritance tax system to simplify tax filing and payments and examine whether the current framework distorts business transfer decisions. “If that is the case and given that ownership is often associated

with management in family-owned businesses, it will be useful to eliminate or reduce these reliefs to lower incentives to maintain businesses within families,” the OECD said.

The OTS has invited comments by November 9 to inform its review of capital gains tax. Its July 20 call for evidence requested views on the interaction between capital gains tax and other taxes, including inheritance tax. But it recognized that the government had expressed a “commitment to protecting the important role that business property relief plays in supporting family-owned businesses.”

The OTS had concluded in July 2019 that the interaction between inheritance tax and capital gains tax “may have a distortive effect on the process of deciding whether to transfer a business or farm during life or on death.”

National Insurance Contributions

The OECD recommended an increase in the rates of National Insurance contributions paid by self-employed workers, even though it recognized that they are “among those who suffered the greatest losses of income from the COVID-19 crisis.” Even before the crisis, it noted that the self-employed without employees were “at higher risk of very low income,” but they “enjoy considerable tax benefits compared with employees, in particular lower rates of social security contributions.”

Lower social security contribution rates for the self-employed “do not translate into significantly lower contributory benefits received, which makes self-employment attractive from a tax perspective,” the OECD argued, adding that it will be important to ensure that the low-income self-employed are able to “negotiate and access decent earnings net of social contributions.”

“The OECD is right to point out that the U.K.’s system of tax reliefs is unfair and distorts behavior,” Robert Palmer, executive director of Tax Justice UK, told Tax Notes. “Many of the existing tax breaks benefit the well-off and big business. As we build back from coronavirus, we need to fix the tax system so that it better supports high-quality public services, tackles inequality, and helps with a transition to a greener economy.”




COUNTRY DIGEST


HM Treasury’s Response

The OECD’s findings recognize “the size, scope, and speed of the government’s interventions to support jobs, businesses, and the economy,” HM Treasury said, adding that recent measures, including the plan for jobs and the winter economy plan, “strike the right balance between protecting jobs and providing people with new training and opportunities.”

UNITED STATES

Public Partnerships and Private Equity Lament Withholding Rulesby Eric Yauch

The final partnership withholding rules will continue to create headaches for publicly traded partnerships, and some practitioners hope they’ll get even more time to make the necessary adjustments to comply.

But it’s not just PTPs that are frustrated — private equity funds also will have to apply the final rules (T.D. 9926) released October 7 on section 1446(f) that are an odd fit with the way that industry operates, according to practitioners.

The final rules explain how to apply the 10 percent withholding rules on foreign partners when the gain on the disposition results in effectively connected income under another change made in the Tax Cuts and Jobs Act. The TCJA added section 864(c)(8) to the code and treats the gain on the sale of a foreign partner’s interest as effectively connected to a U.S. trade or business to the same extent as the gain or loss on the sale of the partnership’s assets at fair market value.

The TCJA provisions generally overturned the result of the Tax Court’s 2017 decision in Grecian Magnesite Mining, Industrial & Shipping Co. SA v. Commissioner, 149 T.C. No. 3 (2017), in which the court sided with the taxpayer and treated a foreign partner’s redemption of a partnership interest as a single asset and determined that it was foreign-source gain.

Just days after the TCJA was enacted and the end of 2017 was rapidly approaching, the PTP industry realized that section 1446(f) was going to be a big problem. The withholding rules were scheduled to go into effect on January 1, 2018, and without any guidance on how those large partnerships would implement withholding, there was a scramble to put the brakes on that law.

Former IRS Office of Chief Counsel attorney Glenn Dance had just left the government when the law was scheduled to take effect, and he reached out to government regulatory lawyers just a few days before Christmas to sound the alarm that markets would be in a state of panic if PTPs were immediately required to withhold.




COUNTRY DIGEST


“What’s the best way for me to get a meeting to discuss the development of regs under the new tax bill?” Dance asked in a December 21, 2017, email to Holly Porter, IRS associate chief counsel (passthroughs and special industries), the agency’s top lawyer for partnerships.

After discussions with PTP industry experts, the government quickly responded by temporarily suspending withholding for PTPs in Notice 2018-8, 2018-4 IRB 352, until more guidance was available. That was a welcome reprieve for the industry, but it only kicked the can down the road for PTPs.

Tara Ferris of EY said that when section 1446(f) was enacted, some in the PTP industry didn’t think the withholding regime was intended to apply to them.

After the law took effect, groups were encouraged to lobby for legislative changes to exclude PTPs from the regime, but as that possibility became increasingly unlikely, the focus shifted to whether Treasury could be flexible on the application of section 1446(f).

Treasury apparently didn’t think it could provide such relief, and that’s evident in the final rules, Ferris said.

“There definitely was a focus in these final regs on ensuring that withholding was collected on these PTP sales, and even on distributions, which is going to create a massive headache for the industry,” Ferris said.

Practitioners asked the government to put the withholding responsibility for the transfer of PTP interests on the custodial broker or the clearing organization, but neither recommendation was adopted in the final rules.

“So, we go back to where we were in the proposed rules, where the clearing broker has to do the withholding, and that’s a huge industry lift and creates several difficulties in the withholding space,” Ferris said. “It’s unfortunate that the government didn’t appreciate the difficulty that this is presenting.”

Under proposed reg. section 1.1446(f)-4(b)(3) and (4), a broker wasn’t required to withhold on the transfer of a PTP interest if it claimed on a qualified notice that less than 10 percent of the gain from the deemed sale would be treated as ECI, or the entire amount of the distribution is a qualified current income distribution (which is a

distribution that doesn’t exceed the net income of the PTP since the date of the last distribution).

Withholding under that rule was required of the PTP only if the partnership posted a qualified notice that falsely stated that one of those exceptions to withholding under section 1446(f)(1) applied to a transfer.

Qualified Notices

Several practitioners asked Treasury to scrap the withholding requirement under section 1446(f)(4) altogether. The final regs said PTPs shouldn’t be required to withhold under section 1446(f)(4) because it would affect distributions made to a transferee who doesn’t bear the responsibility for the underwithholding based on an incorrect qualified notice.

“Rather, as it is the partnership that determines the contents of its qualified notice, the partnership should bear the consequences resulting from its representations on the notice rather than any specific transferee,” the regs said.

Ferris said PTPs will likely be wary of putting out those qualified notices, especially if they face scrutiny and turn out to be inaccurate, which could put the partnership on the hook.

Dance said former regulations under section 1446 only required a PTP to post a qualified notice statement when a distribution included ECI. However, the final section 1446(f) regulations include a change that requires a qualified notice statement to break out the amount of a distribution that reflects ECI, as well as other types of income, such as fixed or determinable annual or periodic income.

“I’ve seen a lot of partnerships just treat all of their distributions as ECI for purposes of providing qualified notice. This could prove to be a bit more challenging,” Dance said. He added that the existing regs only allow the PTP to transfer withholding agent status to the brokerage community if it provides a qualified notice.

“If the PTP retained withholding agent status with respect to distributions to foreign partners, the identity of whom it does not even know at the time it makes distributions, it would be what I like to call a bad day,” Dance said.




COUNTRY DIGEST


Private Equity Problems

Meyer H. Fedida of Cleary Gottlieb Steen & Hamilton LLP said the government made a few changes in the final rules that were taxpayer-favorable and practical.

For example, the government clarified in the final rules that a buyer or other withholding agent would have no liability under section 1446(f) if they could show tax wouldn’t be due under section 864(c)(8), which alleviates concerns that withholding would be required even if there wasn’t a substantive tax bill.

But the private equity industry — which often uses partnerships in its structuring — will continue to struggle with withholding under the final rules, Fedida said.

One example of issues that are raised for funds is subsequent closings: Private equity funds don’t raise all their capital at once. Those funds generally take about a year to raise the necessary money from investors who subscribe to the fund and are referred to as subsequent closers.

When an investor in a subsequent closing invests in a fund, it becomes an investor (and partner) in the partnership and essentially gives to the partnership its pro rata share of the investments that already exist in the partnership, and normally there’s a time value of money charge. Part of that money in turn may be used to repay the earlier investors.

Fedida said there was a concern in the industry that such a transaction would trigger the disguised sale rules and the new investor would be treated as buying part of its interest from the older investors, which would trigger section 1446(f) withholding.

In the final rules, the government didn’t take a formal position on that point, but essentially said that if that transaction is treated as a disguised sale, there is a withholding obligation, Fedida said.

“What that could mean for the private equity industry is going to need to be explored,” Fedida said.

In the disguised sale context, the new investor might be treated as buying part of the interest from an existing partner. But from a mechanical perspective, the money goes into the partnership’s bank account and the partnership is the one that

has the facts, not the subsequent closers, Fedida said.

Fedida said he would’ve thought that the general partners would therefore be the withholding agents because they have control over the funds, but the preamble makes it clear that the new investor is the withholding agent.

“I think the industry is going to need to think more about how to make sure that everyone gets comfortable that there’s no [section] 1446(f) liability,” Fedida said.




COUNTRY DIGEST


Review of BEAT Waiver Regs Halved Affected Taxpayer Estimateby Andrew Velarde

The economic analysis of the base erosion and antiabuse tax regs led to an eleventh-hour change in the estimate of the number of affected taxpayers, reducing the prediction by more than 50 percent.

Tax Notes obtained a draft version of the final BEAT waiver regs that was sent to the Office of Management and Budget’s Office of Information and Regulatory Affairs for review before publication. It compared that with the version of the regs that was released publicly to discover what changes had been made. The regs reached OIRA review on August 3 and cleared review on August 21.

Most of the changes were concentrated in the economic analysis section of the preamble. Notably, while the draft version estimated that between 3,500 and 4,500 taxpayers would be affected by the regs, the publicly released version dropped that estimate to approximately 2,200. The draft version explains that its estimate is based off the number of filers that filed forms 1120, 5471, or 5472 and reported more than $500 million in gross receipts. It states that its estimates are based on the 2017 tax year, which did not include the BEAT. It also notes that its projections do not account for members in a taxpayer’s aggregate group.

The publicly released version states that its estimates come from a preliminary examination of the IRS’s Statistics of Income corporate sample from July 28 of returns that had Form 8991, “Tax on Base Erosion Payments of Taxpayers With Substantial Gross Receipts,” attached and also exceeded the $500 million threshold. While nearly 6,000 returns contained Form 8991, only 393 returns paid the BEAT, according to the publicly released version.

Under section 59A, the BEAT operates as a minimum tax — 5 percent for 2018, 10 percent for 2019-2025, and 12.5 percent thereafter — on related-party payments. The BEAT is calculated on the excess of modified taxable income over a taxpayer’s regular tax liability, reduced by some types of credits. It applies to corporations with annual gross receipts exceeding $500 million

whose base erosion percentage is 3 percent or higher. Base erosion percentage is calculated as the base erosion tax benefits divided by most deductions.

Alternative Approach

The most closely scrutinized portion of the regs, the waiver provision, provides the mechanism allowing taxpayers to elect to waive deductions to avoid the BEAT. Before the waiver was introduced, practitioners feared the cliff effect of the BEAT could theoretically lead to one dollar of base erosion tax benefit creating millions of dollars in BEAT liability for taxpayers. By providing the mechanism for the waiver, the regs address uncertainty about whether taxpayers could simply not claim a deduction on a tax return to avoid the BEAT. While practitioners had sought additional flexibility in the final regs (T.D. 9910) that were released on September 1, the guidance rejected taxpayer requests to allow taxpayers to decrease the amount of deductions waived by filing an amended income tax return.

According to the regs, an alternative approach on the waiver was considered, which would have provided that all deductions that could be claimed would be taken into account for purposes of the BEAT, even if they were not claimed on the return.

“Under both these regulations and the alternative regulatory approach, an applicable taxpayer would have to calculate its BEAT liability,” the publicly released version of the preamble states in added language explaining why Treasury did not estimate the change in compliance costs between the two approaches. “The only additional step a taxpayer that otherwise would be an applicable taxpayer may choose to take under these regulations is to calculate its tax liability with the waiver of certain deductions (all of which the taxpayer would already have documented) in order to avoid being an applicable taxpayer. The taxpayer would make this additional calculation to consider whether waiver of those deductions would result in a lower tax liability.”

The draft version of the regs’ preamble also lacked some detailed language found in the publicly released version that states the regs will have an economic effect of greater than $100




COUNTRY DIGEST


million compared with a no-action baseline. The released version of the preamble explains that that is because of the large size of businesses affected by the regs and the “general responsiveness of business activity to effective tax rates, one component of which is the deductibility of base erosion payments.”

“Based on these two magnitudes, even modest changes in the deductibility of base erosion tax benefits (and in the certainty of that deductibility) provided by the final regulations, relative to the no-action baseline, can be expected to have annual effects greater than $100 million,” the publicly released preamble states.

Neither version of the regs estimated the economic consequences of the guidance compared with the alternative approach, noting the difficulties in creating such an estimate.

The draft version of the regs also did not contain a section on the Congressional Review Act that was included in the publicly released version. The regs were determined to be a major rule that, under the act, delays the effective date of the regs until 60 days after they are published.

BEAT Waiver Language on Applicable Taxpayer Is About Flexibilityby Andrew Velarde

Less-than-definitive language in the base erosion and antiabuse tax regs on who is eligible to make a waiver election was drafted that way for the sake of flexibility.

The waiver provision under the final regs (T.D. 9910), released on September 1, provides the mechanism allowing taxpayers to elect to waive deductions, including depreciation, to avoid the BEAT. Before the waiver was introduced, practitioners feared the cliff effect of the BEAT could theoretically lead to one dollar of base erosion tax benefit creating millions of dollars in BEAT liability for taxpayers because the BEAT only applies for taxpayers with a base erosion percentage of at least 3 percent. While practitioners have praised the waiver provision generally, they had hoped for more leeway in permitting taxpayers to decrease waived amounts, a request that Treasury rejected.

Under the final regs, to make or increase the BEAT waiver election, “the taxpayer must determine that the taxpayer could be an applicable taxpayer for BEAT purposes but for the BEAT waiver election.”

Speaking on an October 15 webinar sponsored by the Practising Law Institute, Corey M. Goodman of Cleary, Gottlieb, Steen & Hamilton LLP said that a strict reading of the eligibility language could lead to the conclusion that a taxpayer could only waive as many deductions as is necessary to “fall a penny below the 3 percent threshold.” Such an interpretation would be absurd, Goodman argued.

According to Azeka Abramoff, special counsel to the IRS associate chief counsel (international), in drafting the rule, the IRS was worried that taxpayers might look to use the BEAT waiver deduction to waive deductions “in circumstances that have nothing at all to do with BEAT.” She posited a hypothetical in which a controlled foreign corporation might seek to waive a deduction to move from a tested loss position to a tested income position even if the CFC did not have effectively connected income.

“We added this language . . . trying to be broad enough to include some amount of




COUNTRY DIGEST


flexibility,” Abramoff said. “We recognize in the real world that taxpayers might not want to or might not be able to calculate, down to the penny, the exact amount of deduction that they need to waive. . . . They might want to waive a little bit more deductions just to reduce their risk and increase their certainty in being outside BEAT.”

Abramoff said that if a taxpayer thinks it needs to waive $100 of deductions to escape the BEAT and it decides to waive $110, the provision is flexible enough to allow that. But it isn’t flexible enough to allow that taxpayer to waive $200 or $300, she added.

“It will produce a lot of strategic gamesmanship on tax returns to figure out exactly how much a taxpayer can waive,” Goodman said.

Preventing Whipsaw

Base erosion payments include amounts paid or accrued to a foreign related party connected to the acquisition of depreciable or amortizable property. There is an exception for nonrecognition exchanges. However, to protect against abuse, if a transaction has a principal purpose of increasing a property’s basis that is acquired in a specified nonrecognition transaction, that exception is inapplicable. There is also an irrebuttable presumption that a transaction between related parties that increases the basis of property within six months of a taxpayer’s acquisition in a nonrecognition transaction has a principal purpose.

Addressing commentators, the final regs clarify that the antiabuse rule turns off the exception only to the extent of the basis step-up amount. The rules also clarify that the transaction must have a connection to the acquisition of the property by the taxpayer in a specified nonrecognition transaction.

Goodman wondered how the antiabuse rules would apply in practice and postulated an example in which a U.S. multinational with two tiers of CFCs distributed a depreciable asset out of the bottom-tier CFC to the first-tier CFC and the first-tier CFC then liquidated. If there was a business reason for the transaction, would it still be subject to the irrebuttable presumption?

Abramoff said that the six-month rule was added in recognition that principal purpose rules “can be incredibly difficult to apply.”

“An irrebuttable presumption is really one of the key ways in preventing whipsaw to the fisc because it would be very difficult to monitor these transactions otherwise,” Abramoff said, acknowledging that it could create the possibility of taxpayer foot faults. “If this is becoming a problem for a taxpayer in a sense that it is increasing the amount of base erosion benefits and pushing a taxpayer into BEAT and therefore putting them in a worse position . . . then the U.S. shareholder could waive those depreciation deductions and be put back in the same place they would have been had the property really originated at the top-tier CFC.”




COUNTRY DIGEST


New Disregarded Payment Rules ‘Less Wrong,’ Practitioner Saysby Annagabriella Colón

Recently proposed U.S. foreign tax credit regulations include new rules on how foreign gross income arising from disregarded payments should be assigned, but a practitioner said the regs probably need more work.

During the second day of an EY webinar on FTCs October 15, Doug Bailey of EY reminded attendees that although some may not entirely agree with some aspects of the new rules, they provide a “less wrong answer” than the prior regulations regarding the treatment of southbound disregarded payments.

On September 29 the IRS and Treasury released two sets of FTC regs: final regs (T.D. 9922) that follow up on proposed regs (REG-105495-19) released in December 2019, and a new set of proposed regs (REG-101657-20).

Under section 1.861-20(d)(3)(ii) of the 2019 proposed regs, if a foreign gross income item arose from a disregarded payment made by a foreign branch to its owner (a northbound disregarded payment), the payment would be assigned to a particular category based on the tax book value of the various assets of the disregarded entity. However, if the item of foreign gross income came from a disregarded payment to a foreign branch from its owner (a southbound disregarded payment), the payment would be assigned to a residual category.

The 2020 proposed regs take into consideration disregarded payments from the sale of property, remittances and contributions, and reattribution payments. Bailey said that results in more attention being given to parts of the disregarded payment, rather than just looking at it as a collective unit and treating it as such.

“This rule tries to be more surgical in trying to identify what pieces of the income might really be associated with — not a contribution, in the sense that [the] income is really being reattributed. I think this is a less wrong answer than we had in the prior version of the rule,” Bailey said. However, there may be some disagreement over how the rules operate, Bailey said, adding that he expects comments regarding the accuracy of the rules to be submitted.

Jose Murillo with EY agreed that the new rules are an improvement. “You have to give them credit for modifying and minimizing the loss of credits,” he said. “They still maintained some of the limitation in the prior proposal, but . . . reduced the instances in which southbound payments are going to result in lost credits.”

During the first day of the webinar, October 13, Raymond Stahl of EY said some taxpayers may have a problem apportioning research and experimentation expenditures from uncontrolled party transfers as set forth in the final FTC regulations.

Under reg. section 1.861-17(d), R&E expenditures that are not apportioned under the exclusive apportionment rule in reg. section 1.861-17(c) can be apportioned between the statutory and residual groupings based on gross receipts. Gross receipts from uncontrolled and controlled parties will be taken into account if there is a reasonable expectation that the taxpayer will license, sell, or transfer intangible property resulting from the R&E expenditures, but there are exceptions. For example, gross receipts from cost-shared intangibles are not taken into account for controlled corporations, and only gross receipts from specific products or services incorporating licensed or transferred intangible property from uncontrolled parties are allowed.

Stahl explained that the gross receipts of the taxpayer that incurs the R&E expenditure, as well as the controlled or uncontrolled parties that benefit from the intellectual property, are included under the rule. Specifically, taxpayers should not assign the gross receipts of a third party based on its income, but rather, should assign R&E expenditures that relate to those gross receipts to the groupings to which the taxpayer’s gross intangible income from the transfer of the IP was assigned, he said.

Stahl said the rules will pose some challenges, “particularly in connection with uncontrolled party transfers, because you’re taking into account not just the value of gross receipts from sales to controlled parties, but also you have to take into account gross receipts from sales [to] uncontrolled parties.” Locating those receipts may be difficult in some cases, he added.




COUNTRY DIGEST


EU Lacks Basis to Impose Tariffs In Boeing Dispute, USTR Saysby Annagabriella Colón

Washington’s decision to discontinue Boeing tax concessions precludes the EU from imposing retaliatory tariffs on U.S. imports, the Office of the U.S. Trade Representative (USTR) said after a WTO arbitrator issued a mixed decision.

“While we disagree with certain aspects of its valuation, the more important point is that the arbitrator did not authorize any retaliation for subsidies other than the Washington State tax break,” USTR Robert E. Lighthizer said in an October 13 response, referring to the preferential 0.2904 percent aerospace business and occupation tax rate Boeing had been receiving since 2013.

In its October 13 decision, the WTO arbitrator found that the EU has grounds to impose countermeasures of $3.99 billion to compensate for the impact of the Boeing subsidies on European aerospace company Airbus.

The arbitrator rejected the EU’s request to impose additional countermeasures regarding U.S. research and development subsidies for NASA and the Department of Defense, the release says. The WTO limited its review of the Boeing subsidy to its financial impact from 2012-2015, setting an annualized 2015 value of nearly $4 billion, the release states. The EU had set the value at about $8.6 billion.

Lighthizer was not pleased with the arbitrator’s valuation, however. Noting that Washington State repealed the Boeing tax break earlier this year, he said, “Any imposition of tariffs based on a measure that has been eliminated is plainly contrary to WTO principles and will force a U.S. response.”

On March 25 Washington Gov. Jay Inslee (D) signed Senate Bill 6690 repealing the preferential tax rate in an attempt avoid European tariffs on U.S. imports. The bill eliminated the preferential rate as of April 1, reinstating the general business and occupation tax rate of 0.484 percent.

Lighthizer said the United States is working to resolve the nearly 15-year-old dispute over airline subsidies, and “will intensify our ongoing negotiations with the EU to restore fair competition and a level playing field to this sector.”

In a separate October 13 release, EU Trade Commissioner Valdis Dombrovskis said the bloc is reluctant to impose additional tariffs on U.S. imports because of the economic damage wrought by the COVID-19 pandemic. Additional duties are not in either side’s best interest, he said. However, without a mutual agreement, the EU is prepared to move ahead with the tariffs, he added.

“I have been engaging with my American counterpart, Ambassador Lighthizer, and it is my hope that the U.S. will now drop the tariffs imposed on EU exports last year. This would generate positive momentum both economically and politically, and help us to find common ground in other key areas. The EU will continue to vigorously pursue this outcome,” Dombrovskis said in the release.

Since obtaining the green light from the WTO in October 2019, the U.S. government has imposed tariffs on almost $7.5 billion of EU imports in response to its Airbus subsidies. On June 23 the Office of the USTR published a review of action seeking public input regarding over $3 billion of potential additional tariffs on imports from France, Germany, Spain, and the United Kingdom in response to the subsidies.

The EU said the United States has kept its tariffs in place even though France, Germany, and Spain have been in compliance with the WTO’s May 2018 Airbus ruling since July.

Referring to the USTR’s statement in an October 13 email to Tax Notes, Boeing said the EU has no valid basis to impose retaliatory tariffs on U.S. goods. “We are disappointed that Airbus and the EU continue to seek to impose tariffs on U.S. companies and their workers based on a tax provision that has been fully and verifiably repealed,” it said. Boeing said it supported the repeal of the tax break even though it occurred during a difficult time for the company and the airline industry in general.

“Rather than escalating this matter with threats to U.S. businesses and their European customers, Airbus and the EU should be focusing their energies on good-faith efforts to resolve this long-running dispute,” the company said.

“Airbus did not start this WTO dispute, and we do not wish to continue the harm to the customers and suppliers of the aviation industry




COUNTRY DIGEST


and to all other sectors impacted,” Airbus CEO Guillaume Faury said in an October 13 release. “As we have already demonstrated, we remain prepared and ready to support a negotiation process that leads to a fair settlement.”

The world of tax– now available daily.

Tax Notes goes Global.Get the best of both worlds with Tax Notes

Today Global, combining our stellar U.S.

domes c and interna onal tax news

and analysis with a laser-sharp focus on

cross-border taxa on.

info.taxnotes.com/global




COUNTRY DIGEST


Tax Notes State Tax Notes Today State Audit Insight






TAX CALENDAR

October 20

Dividend Taxation in India — Webcast. Deloitte Tax LLP will host a webcast discussing India’s move away from assessing distribution tax on domestic companies to taxing dividends in the hands of shareholders, the impact of the change on the shareholders, the concept of beneficial ownership under its tax treaties, and the impact of the general antiavoidance rules, principal purpose tax, and the multilateral instrument.

Africa’s Transfer Pricing Forum — Webcast. Informa Connect Ltd. will host a webcast discussing the international tax landscape, implementation of the base erosion and profit-shifting project’s initiatives in various jurisdictions, and the politics of transfer pricing and how to gather data for transfer pricing analyses.

Email: [email protected]

October 21

Global Tax Dispute Resolution and Controversy — Webcast. As part of its global tax dispute resolution and controversy series, KPMG will host a webcast featuring members of its global tax dispute resolution and controversy network from France, Germany, the Netherlands, and the United Kingdom, discussing an update on the current initiatives and trends related to disputes and controversy in their jurisdictions.

Tax Platforms of the Presidential Candidates — Webcast. The USA branch of the International Fiscal Association will host a webcast discussing how the OECD’s continuing work on pillar 1 and pillar 2 could affect the U.S. election, business and international tax policy proposals from the Trump and Biden campaigns, and the potential landscape for U.S. business and international tax policy changes after the election.

Email: [email protected] Legislative Updates — Webcast.

KPMG will host a webcast discussing recent developments in the European legislative landscape, the EU’s recent introduction of new rules for mandatory disclosure of tax arrangements, and the significant amendment of the rules for posting workers in the EU.

OECD Pillar 1 and Pillar 2 — Webcast. The USA branch of IFA will host a webcast discussing ongoing developments with the OECD’s draft blueprints for pillar 1 and pillar 2 and their review by the inclusive framework.

Email: [email protected] for International Businesses — Webcast.

Informa Connect Ltd. will host a webcast discussing input recovery law, case law updates, digitizing VAT, and tax compliance in 2020.


October 22

R&D Tax Relief Claims — Webcast. BDO UK will host a webcast discussing how legislative changes, including the Coronavirus Business Interruption Loan Scheme and the upcoming introduction of IR35 and off-payroll working, will affect businesses making research and development claims. Contact: Amann Nirwal.

Email: [email protected] Seminar Series — Webcast. As part of its

Asia Seminar Series, Taxand will host a webcast discussing case studies on cross-border transactions, including intragroup transactions.

Email: [email protected] Tax on Trade — Webcast.

Russell Bedford will host a webcast discussing developments in international trade and the BEPS project, including the evolution of the international tax system, BEPS 2.0, customs duties changes, VAT and international trade, corporate tax reform, and permanent establishment changes.

Tel: +44 20 7410 0339

October 23

Foreign Tax Credit Regs — Webcast. The USA branch of IFA will host a webcast discussing final and proposed foreign tax credit regulations, including the changes between final and proposed regs as well as issues that were resolved by the final regs and issues that still remain. Mindy Herzfeld will moderate the event.





TAX CALENDAR


October 26

2020 Virtual Annual Conference — Webcast. The Tax Executives Institute will host a three-day virtual annual conference discussing U.S. federal and state COVID-19 response measures and developments involving international jurisdictions, including Canada and Europe.

Tel: (202) 638-5601

October 27

Residency in the Age of COVID-19 — Webcast. The USA branch of IFA will host a webcast discussing the general rule for tax residency, residency issues caused by the COVID-19 crisis, and responses by the United States and the OECD.

Email: [email protected] Income Tax and Post-BEPS

Intangible Migration — Webcast. Deloitte will host a webcast discussing BEPS action 8 and comparing revenue authorities’ approaches to intangible migration reviews post-BEPS, with a focus on Australia and the Asia Pacific region.

October 28

U.S. Tax Policy Developments — Webcast. Deloitte will host a webcast discussing the latest developments in coronavirus bill negotiations and other tax policy issues pending in Congress; how the federal government’s long-term budget outlook has been affected by previous tax and spending decisions and current economic conditions; what could happen to tax policy in 2021 depending on the outcome of the November elections; and what to anticipate for Asia Pacific investors.

Global Tax Dispute Resolution and Controversy — Webcast. As part of its global tax dispute resolution and controversy series, KPMG will host a webcast featuring members of its global tax dispute resolution and controversy network from Brazil, Canada, Mexico, and the United States, discussing an update on the current initiatives and trends related to disputes and controversy in their jurisdictions.

Transfer Pricing — Webcast. The USA branch of IFA will host a webcast discussing the impact of the economic downturn on transfer pricing and valuation issues.


Taxation of the Digitalized Economy — Webcast. EY will host a webcast discussing global developments regarding digital services taxes and an overview of the BEPS 2.0 pillar 1 and pillar 2 blueprints, which are expected to be released in October.

October 29

Transfer Pricing and Financing — Webcast. The Institute of Austrian and International Tax Law of Vienna University will host a webcast discussing the arm’s-length value of money. Contact: Julia Leitner.


November 3

India’s Equalization Levy — Webcast. Deloitte will host a webcast discussing an update on the OECD’s position on pillar 1 and pillar 2, India’s equalization levy, an overview of the U.N.’s proposal on income from automated digital services, and an Asia Pacific update on digital services taxes and other responses.

November 4

VAT — Webcast. Taxand will host a webcast discussing fixed establishments and VAT deduction of acquisition costs.

International Tax Dispute Resolution — Webcast. Informa Connect Ltd. will host a webcast discussing controversy implications of global tax policy developments, in-house perspectives on transfer pricing disputes in 2020, tax transparency, and sales and use tax one year after Wayfair.

Email: [email protected] Transparency and Corruption —

Webcast. The Institute for Austrian and International Tax Law will host part two of its webcast series on tax transparency and corruption, discussing interagency cooperation to combat illicit financial flows and misuses of attorney-client privilege. Contact: Eva Mader.


November 5

U.S. Taxes — Webcast. BDO UK will host a webcast discussing tax matters for professional services firms and their partners operating in the United States, an update on current and future tax




TAX CALENDAR


developments, how firms headquartered in the United Kingdom are running their operations in the United States, and the associated impact of these business structures on partners’ taxes. Contact: Emma Gilson.


November 6

Global Tax Dispute Resolution and Controversy — Webcast. As part of its global tax dispute resolution and controversy series, KPMG will host a webcast featuring members of its global tax dispute resolution and controversy network from Australia, China, and India, discussing an update on the current initiatives and trends related to disputes and controversy in their jurisdictions.

Scotland Virtual Conference — Webcast. The Chartered Institute of Taxation will host a webcast discussing a devolved taxes update, corporate residence and PE, and a tax adviser’s guide to estate planning with pensions.


November 10

Virtual 31st Annual Philadelphia Tax Conference — Webcast. The American Bar Association will host a three-day webcast covering the newest federal, state, and international legal developments and planning trends; employment and corporate tax updates; and developments in tax accounting methods, international taxation, and tax policy trends.


November 11

Operational Taxes for Banks — Webcast. Informa Connect Ltd. will host a webcast discussing regulatory and operational tax challenges for banks, DAC6 implementation in the United Kingdom, and tax developments in the United Kingdom and the EU.


November 12

Operational Taxes for Investment Managers — Webcast. Informa Connect Ltd. will host a webcast discussing how to stay ahead of key regulatory developments, updates to both global and European withholding taxes, and

implications of DAC6, as well as its implementation in EU member states.


November 17

Tax Strategies for COVID-19 Recovery — Webcast. CIOT will host a webcast discussing debt restructuring during the COVID-19 recovery phase, advice for estate planning in the aftermath of COVID-19, and tax considerations for businesses during the pandemic.

Email: [email protected] in the Post-COVID-19 Era — Webcast.

As part of its VAT webinar series, the IMF will host a webcast discussing VAT’s role in economic recovery; a high-level look at policy, registration, and administration issues; and lessons learned during the COVID-19 crisis and how they might affect the design of VAT in the future.


November 19

Direct Taxation at the CJEU — Webcast. The Institute for Austrian and International Tax Law will host a three-day event discussing pending and recently decided direct taxation cases at the Court of Justice of the European Union, focusing on interpretations of fundamental freedoms and how they might affect future CJEU decisions. Contact: Layomi Gunatilleke-Jester.


November 23

U.S. Tax Update — Webcast. The American Institute of CPAs and the Chartered Institute of Management Accountants will host a webcast discussing the implications of digital tax proposals for the United States, how multinationals are preparing for tax updates and looming regulatory changes, implications of international tax reform for check-the-box and hybrid-planning structures, and methods of approaching audits and tax controversies in the information age.


November 24

Indirect Tax Forum — Webcast. International Tax Review will host a webcast discussing VAT regime changes and the growing need for the digitalization and automation of tax departments.




TAX CALENDAR


Transfer Pricing — Webcast. Informa Connect Ltd. will host a three-day webcast discussing the transfer pricing landscape, preparation for future tax reform after COVID-19, the digital economy, the OECD’s pillar 1 and unified approach proposals, and the ways tax departments are using technology to improve efficiency.


November 25

Transparency, Transformation, Technology — Webcast. Informa Connect Ltd. will host a two-day webcast discussing tax technology, including automation, the future of the tax function, the effect of new technologies on the tax industry, and global transparency efforts.


December 1

Transfer Pricing — Webcast. Informa Connect Ltd. will host a three-day webcast discussing duties, Customs, and trade; the future of BEPS 2.0 and financial transactions; recommendations for businesses regarding incentives and transfer pricing; changes to transfer pricing forecasting and the assessment of transfer pricing adjustments; renewing transfer pricing policy for 2021; and how the future of U.S. tax reform could be changed by COVID-19.

Email: [email protected] Transfer Pricing Forum — Webcast.

International Tax Review will host a two-day webcast discussing the transfer pricing implications of the OECD’s unified approach, potential controversy, and methods to prevent and resolve disputes. Contact: Alicia Sprott.


December 3

VAT Update — Webcast. BDO UK will host a webcast discussing VAT for professional services firms, an update on U.K. and international VAT, and the potential impact of Brexit. Contact: Emma Gilson.


December 8

Transfer Pricing — Webcast. Informa Connect Ltd. will host a two-day webcast discussing the future for BEPS 2.0 and financial transactions, renewing transfer pricing policy for 2021, how the future of U.S. tax reform could be changed by COVID-19, tax forecasting changes and transfer pricing adjustments, transfer pricing recommendations for businesses, and how North American tax jurisdictions are adapting to COVID-19.


December 14

Digitalization of the Tax Function — Webcast. The Institute for Austrian and International Tax Law will host a webcast discussing the role of technology in helping businesses and tax administrations achieve better and more efficient tax compliance and how digital technologies can aid in the effective delivery of the tax administration’s services. Contact: Milena Gegios.


December 15

Sixth OECD Forum on Tax and Crime — Ottawa. The Canada Revenue Agency will host a three-day forum focusing on topics including the global fight against illicit financial flows, practical measures to ensure cross-agency implementation of the 10 global principles for combating tax and other financial crimes, and best practices for preventing illicit activity.


January 12, 2021

Equity, Efficiency, and Administration of VAT — Webcast. As part of its VAT webinar series, the IMF will host a webcast discussing VAT policy issues, administrative complexity arising from reduced VAT rates and exemptions, cross-border trade and digitalization, and options for VAT design improvement and its constraints, including political economy issues.







THE LAST WORD

Splendid Isolation: Boris Johnson Pivots Toward a No-Deal Brexitby Robert Goulder

The United Kingdom left the EU at 11 pm (GMT) on January 31 — a moment that was celebrated in much of the British Isles and bemoaned across most of continental Europe. Whatever your personal views on Brexit, or on multilateralism generally, we can agree that those events now seem like ages ago. What a long year 2020

has been, and it’s not over yet.

Formalities aside, Brexit remains unfinished business. The withdrawal agreement that the two sides approved in January did the minimum that was necessary to secure a technical departure. It left critical details over their future relationship to be determined during the transition period that runs through the end of 2020. During that time the country is still subject to EU law, making it feel as though little has changed.

As things stand, a “no-deal” Brexit looks more likely than not. By default, WTO rules may soon govern the terms of EU-U.K. trade, regardless of the WTO’s inability to maintain a functioning appellate body. That’s thanks to the United States.1

As judged by his actions, Prime Minister Boris Johnson has come to view a no-deal outcome as a desirable thing, despite whatever economic disruptions it brings. He’s also taken the unconventional step of trying to unilaterally scrap key portions of the withdrawal agreement — the same document he hailed as a historical achievement less than a year ago. Tax professionals would liken that move to a treaty

override. It’s what countries do when they experience buyer’s remorse. The EU calls it wantonly reckless and has initiated legal proceedings to prevent it from happening.

This article examines these recent developments and what lies ahead for affected taxpayers. I will also discuss fish. Trust me, it will make sense later — as much as anything makes sense in 2020.

Protocols and Borders

The withdrawal agreement has a limited purpose. It was never intended to govern the full scope of the EU-U.K. relationship once Brexit occurred. It contains none of the critical provisions addressing trade or taxation that are necessary to do that. It kicks the can down the road, but not far enough. The transition period could have been extended for an additional year or two, but the deadline to do so (June 30) has already come and gone. It’s late in the day for the two sides to be negotiating a free trade agreement (FTA) that would take effect January 2021. If, by some miracle, EU and U.K. negotiators were to agree on terms, there’s hardly time for businesses to adapt to it. Johnson’s self-imposed deadline for concluding an FTA (September 30) has also come and gone. We are hurtling toward a hard Brexit.

As previously discussed in this column, the withdrawal agreement addresses how segments of the EU-U.K. frontier are to be administered after separation, namely the land borders of Northern Ireland and Gibraltar. That’s where things get messy. There is a fundamental dissonance between the ambitions of Brexit and the 1997 Good Friday peace accord. The conflict was largely overlooked at the time of the Brexit referendum in 2016, and it still hasn’t been resolved. The portion of the withdrawal agreement known as the Northern Ireland protocol managed to address the problem, but only by indulging in some convenient pretense.2

1Frans Vanistendael, “A ‘Stonking Mandate’ for Boris’s Brexit,” Tax

Notes Int’l, Dec. 23, 2019, p. 1115. See also Robert Goulder, “How (and Why) the United States Paralyzed the WTO,” Tax Notes Int’l, Dec. 9, 2019, p. 947.

2See Robert Goulder, “Brexit, Boris, and Taxes: A Momentary Lapse of

Boundaries,” Tax Notes Int’l, Oct. 28, 2019, p. 381.




THE LAST WORD


That’s fine as a short-term patch, but it falls short of a viable long-term solution.

As a starting point, Brexit presumes the entire United Kingdom (including Northern Ireland) would be removed from the EU single market, placing it outside the EU customs union and harmonized VAT area. That necessitates a system of border checks; otherwise there’s a risk of leakage we commonly refer to as smuggling (a form of tax evasion). Without border checks, imported goods entering Northern Ireland from non-EU sources would eventually find their way into the EU market without being subject to appropriate customs duties and VAT charges. The EU is correct to exercise vigilance over goods crossing its borders; nobody should fault them for that. The challenge here is that reintroduction of border infrastructure is incompatible with the peace accord.

The pretense functions as the linchpin of the withdrawal agreement. It effectively calls for Northern Ireland to remain part of the EU single market, post-Brexit, as if the situs of the EU-U.K. boundary was moved into the middle of the Irish Sea. As a result, any goods being shipped from Manchester to Belfast would be afforded the same customs and VAT treatment as goods shipped from Manchester to Dublin. Both would be regarded as exports bound for a foreign country, although in the Belfast scenario the goods would technically never leave U.K. territory. The design of the protocol is understandably distressing to anyone inclined to assert the Britishness of Northern Ireland; that’s because it necessarily implies an Irishness. If the relocated border hangs around long enough, will people grow accustomed to it? You can see where that leads.

The concept was first suggested by EU negotiators a few years ago, but it was soundly rejected by then-Prime Minister Theresa May. Her assumption was that the U.K. public would never stand for any diplomatic solution to Brexit that resulted in some bits of the country continuing to be subject to EU rules — even if for the narrow application of customs and VAT. With the benefit of hindsight, she was wrong about that. The experience of the last few months suggests that many in the United Kingdom are fine with the protocol.

May’s successor, Johnson, revived the concept after realizing it was the only way to “get Brexit done.” The different approaches of May and Johnson are largely explained by the composition of their parliamentary support. During May’s time in office, the Tories lacked a majority and were forced to rely on the Democratic Unionist Party to form a ruling coalition. After the snap election of December 2019, the Tories enjoyed a majority and had the freedom to do whatever was necessary to finalize the withdrawal agreement — even if that meant tossing the Democratic Unionist Party under the bus. Johnson did so with remarkable ease and seems to have paid little price for the maneuver.

Will the Northern Ireland protocol stand the test of time? It’s hard to see how it can. What country would permit its own internal market to be segmented in such a manner? Its sole justification is that the alternative represents the kind of social destabilization nobody wants to see. We sometimes hear about a technological solution in which the necessary customs and VAT controls would occur virtually, without the need for physical border checks. These ideas may hold long-term potential, but they are unproven. Implementation might be a decade away. When you hear politicians speak of high-tech workarounds to the Irish border problem, chances are they’re being dismissive of the immediate risks.

Sovereignty and Mackerel

What went wrong during the transition period? The short answer is fish.

Everybody wanted an FTA, but the negotiations went poorly from day one. Johnson was seeking zero tariffs on U.K. exports and frictionless market access for U.K. service providers. That resembles the terms the country enjoyed before leaving the EU bloc, which they were never going to get. From Brussels’s perspective, it looked like the United Kingdom was seeking the best of both worlds — keeping the benefits of EU membership without suffering the associated burdens. From the U.K. perspective, the EU was being stingy by refusing to match the same terms as its FTA with Canada, known as the Comprehensive Economic and Trade Agreement (CETA).




THE LAST WORD


But CETA didn’t happen overnight. It took half a decade to negotiate, from 2009 to 2014. It still hasn’t been fully ratified, although portions of the agreement have been provisionally applied since 2017. It was optimistic to think the two sides could replicate CETA in a transition period of less than a year.

Michel Barnier, the EU’s lead Brexit negotiator, identified 18 separate policy areas on which the parties are miles apart, including fishing rights. EU officials felt so strongly about the business of fish that they insisted the issue could not be severable from a larger trade pact. In short, there would be no FTA unless it covered fish, which the EU regards as a common resource.

The United Kingdom fundamentally disagrees with the linkage. Johnson prefers a series of stand-alone trade deals, each addressing different subject matter. He sees no reason to combine fish with the treatment of things like aviation or financial services. That approach would allow the United Kingdom to scrap a deal on fish without jeopardizing the other elements of the parties’ trade relationship. But neither side has been willing to budge on fish.

Fishing and fish processing account for a relatively minor share of the U.K. economy. We’re talking about £1.4 billion per year and 24,000 jobs, or roughly 0.1 percent the country’s GDP. Why draw a line in the sand over fish? The answer is partly symbolic. Looking back at the Brexit referendum results, 52 percent of the overall public voted “Leave.” Among fishermen, 92 percent voted “Leave.” That tells you something about how they regarded the EU Common Fisheries Policy (CFP).

The CFP was established in the 1970s to divvy up fishing rights among EU member states. The EU itself has no claim to territorial waters — those rights are retained by individual member states. The CFP monitors the categories and numbers of fish caught each year from these territorial waters, which are delineated as exclusive economic zones (EEZs). The CFP then apportions fishing rights in these zones among member states. If you’ve ever studied the apportionment of corporate profits among rival tax jurisdictions, you will have some sense of the difficulty involved in apportioning fishing rights. The rule of thumb is that you can’t please everyone. The existence of the CFP is one of

the main reasons why Norway, one of Europe’s most prosperous nations on a per capita basis, declined to join the EU in the 1990s.

The objective of CFP is referred to as the “relative stability” principle. It extrapolates from a baseline, based on the number of fish caught in the 1970s, to establish quotas for how much of a particular type of fish each country can haul out of the EEZs. The quotas apply regardless of how many fish are to be found in a country’s own territorial waters. As a result, the United Kingdom can’t prevent fleets from other member states from entering their waters and filling their fish quota. Additionally, U.K. fleets are restricted in how many fish they can take from their own waters. U.K. waters account for around 50 percent of all EEZs, but the CFP quota system restricts the haul of U.K. fleets to only 25 percent of the available catch. U.K. fishermen resent the disproportionality.

An irony here is that the United Kingdom doesn’t consume most of its own catch. U.K. waters host large stocks of cod and mackerel, which U.K. consumers generally don’t seem to care for. Most of the fish that ends up in their bellies originates from other countries, while 80 percent of the U.K. haul is shipped off to purchasers in continental Europe. The ability of U.K. fishermen to serve that export market is facilitated by the EU single market, which the country is poised to leave in a matter of weeks. Without the EU membership or an FTA to take its place, there’s little to prevent U.K. fish exports from being smacked with high tariffs when sold abroad, causing foreign consumers to seek cheaper alternatives.

It’s a familiar conundrum. A no-deal Brexit may liberate U.K. fishermen from the dictates of the CFP, but with one important caveat. They would be free to catch all the mackerel they wish, but they might no longer have ready buyers at home or abroad.

Fish is a microcosm of Brexit. The single market giveth, and the single market taketh away.

Don’t Make Me Do It

We have a good sense of what the United Kingdom wants from Brexit. What does the EU want? Two things come to mind.




THE LAST WORD


First, the EU doesn’t want secessionist impulses spreading to other member states. That could happen if the winding down of the transition period goes smoothly and results in no major setbacks to the U.K. economy. It would be awkward for Brussels if the United Kingdom emerges from a no-deal Brexit entirely unscathed. That sounds cynical, but the matter is not trivial. Polls reflect significant pockets of anti-EU sentiment in Italy, Hungary, Poland, and even France. These views are often rooted in immigration policy and factors best described as cultural identity.

To lose a member as prominent as Italy or France would be devastating to the EU as a whole. Losing the United Kingdom was significant, of course, though it can be explained away by observing how the United Kingdom was always a reluctant participant. For instance, the country refused to adopt the euro. Bottom line: Brexit must be a one-off; there must be no repeat performances.

The other thing Brussels wants is to avoid the return of border checks for Northern Ireland. In theory the United Kingdom shares in this view, but everything is fair game in trade negotiations. To obtain the trade concessions he desires (and upon which his legacy will be judged), Johnson may need to sacrifice a few things — or at least appear willing to do so. To that end, Johnson did the unthinkable with the introduction of his Internal Market Bill a few weeks ago. The House of Commons approved the bill on September 21.3 It remains to be seen if the House of Lords will intervene to reject the bill, preventing royal assent. That almost never happens.

If Johnson intended to touch a nerve, he succeeded. The stated purpose of the bill is to remove internal trade obstacles among the United Kingdom’s four internal nations: England, Scotland, Wales, and Northern Ireland. That sounds fine, except that it’s squarely aimed at overriding the Northern Ireland protocol. Should it become law, the bill opens the door to significant border leakage that would force the EU to require border checks to prevent untaxed

goods from entering its territory — another of the things it is desperate to avoid.

Why would Johnson do this? One answer is that the smuggling of goods from north to south is not his problem. Seen as a form of tax evasion, that activity is no threat to the U.K. fisc. He’s assuming away the possibility of south-to-north smuggling, figuring that U.K. taxes would always be lower than EU taxes. The worry is that installation of border checks would rekindle historic animosities and stir up the “Troubles” of years gone by. To decision-makers in London, that seems like overblown fear-mongering, but to locals it seems like a legitimate concern.

Figuratively speaking, the Brexit talks now resemble a hostage negotiation in which Johnson has a bomb that he’s willing to detonate, despite the collateral damage. That’s called leverage.

The U.K. government does not deny that the Internal Market Bill contradicts international law, as embodied in the withdrawal agreement. Section 7A of the implementing legislation — the European Union (Withdrawal Agreement) Act 2020 — gives the terms of the withdrawal agreement priority over other domestic law. Section 10 of the Internal Market Bill would unilaterally override that by granting U.K. ministers the ability to “disapply or modify” export declarations or other export procedures. Additionally, section 43 of the Internal Market Bill would authorize the U.K. minister for Northern Ireland to interpret and disapply the relevant provisions of the withdrawal agreement as he sees fit. That includes the ability to interpret the withdrawal agreement in a different manner than European courts. By its terms, the Internal Market Bill is to apply notwithstanding the contrary provisions of other domestic or international law.

How does the Internal Market Bill square with the Good Friday peace accord? It seems to trample on the spirit of the peace accord in that it would surely result in border checks. Yet Johnson argues that his legislation upholds the accord by protecting against “extreme interpretations” of the Northern Ireland protocol. How that’s so isn’t clear. Johnson seems to be talking about the possibility of custom duties and import VAT being applied in a manner that doesn’t reflect a good’s true risk of border leakage. He seems to be saying the EU regards every item shipped into

3Andrew Goodall, “MPs Back Contentious Measures for Northern

Ireland Protocol,” Tax Notes Today Int’l, Sept. 23, 2020.




THE LAST WORD


Northern Ireland as a potential opportunity for smuggling and tax evasion. It’s difficult to follow Johnson’s reasoning here, but it’s the sort of statement he is obliged to make. No U.K. prime minister can be seen as publicly undermining the peace accord, at least not directly.

I don’t think anyone is fooled, not even in faraway places. Nancy Pelosi, D-Calif., speaker of the U.S. House of Representatives, made a point of condemning the Internal Market Bill at the first opportunity. She warned that enactment would be a deal killer for any future U.K.-U.S. bilateral trade deal. Joe Biden is running for president and is somewhat preoccupied these days, but he also cautioned Johnson against pursing the Internal Market Bill. He said the peace accord must not become a “casualty” of Brexit.

These U.S. reactions indicate that Ireland has some friends in high places. It may be an obscure point to Europeans, but the U.S. government perceives itself as the primary guarantor of the peace accord. A former U.S. senator, George Mitchell, was instrumental in facilitating the peace accord when he was a diplomatic envoy for the Clinton administration.

There’s another problem with the Internal Market Bill as it relates to the Sewel Convention. This concerns the powers of devolved legislative assemblies in Northern Ireland, Scotland, and Wales. The Internal Market Bill seeks frictionless trade within the United Kingdom via the mutual recognition principle. This means compliance with regulatory law anywhere in the country is deemed sufficient for regulatory compliance everywhere else in the country. That arguably violates the Sewel Convention, which provides that the Parliament in Westminster will not legislate over the local affairs of the devolved parliaments without their consent.

If the mutual recognition principle were to be applied broadly under the Internal Market Bill, the devolved parliaments (and their constituents)

could claim to be disenfranchised. A product that’s street legal in England would automatically be considered passable for sale in the other three territories. The bill isn’t winning Johnson any support in Scotland or Wales. If anything, it fuels the case for a second referendum on Scottish independence.

Getting On With It

The obstacles to an FTA seem insurmountable, and a continuation of the transition period is off the table. The United Kingdom doesn’t desire additional transition time. It’s a no-deal Brexit, then.

That doesn’t mean an FTA will never happen. Perhaps the two sides will rethink their positions after a few years of doing business under WTO rules. It’s possible the passage of time will cause some trade concerns to diminish in relative importance, while others rise to the foreground. There have been many forecasts about the adverse effects of a no-deal Brexit on jobs and economic growth. Again, the passage of time will lend perspective on how accurate those predictions are. The United Kingdom will learn the degree to which its firms require EU market access, and vice versa. That’s not the worst thing. Both sides should be able to gauge whether an FTA is worth the price of admission.

That being said, it would be a shame if the price for a few years of splendid isolation included social destabilization in Northern Ireland. Around 3,500 people died during the Troubles. One fears that the animosity that gave rise to that level of violence has not gone away entirely. It may endure just under the surface of ordinary life. If so, otherwise reasonable measures to enforce a country’s trade and tax rules could trigger all sorts of harm. These kinds of risks aren’t worth taking. The final word on Brexit might not be written for years to come. Here’s hoping it has a happy ending.




THE LAST WORD







CONTRIBUTORS

Nana Ama SarfoContributing Editor

Carrie Brandon ElliotContributing Editor

Robert GoulderContributing EditorThe Last Word

Lee SheppardContributing Editor

Aleksandra BalIndirect Tax Technology SpecialistLeiden, Netherlands

Richard T. AinsworthTax Tech Boston University Schoolof Law and New York University School of Law

James FullerU.S. Tax ReviewFenwick & West LLPMountain View, California

Mindy HerzfeldIvins, Phillips & Barker; University of Florida LevinCollege of Law

Ta ana FalcãoEmerging EconomiesInternational Tax Law Consultant and Policy AdviserMünster, Germany

Allison Chris ansThe Big PictureMcGill University,Montreal

Andrew Hughes Economist and TransferPricing SpecialistBrussels

Rick MinorInternational Tax LawyerChapel Hill, North Carolina





Global Coverage

Africa/Middle EastHenriette FuchsPearl Cohen Zedek Latzer BaratzTel Aviv

AsiaShrikant S. KamathMumbai

Jinji WeiBeijing

Australia/South PacificDavid GardeThe Tax ObjectiveSydney

Richard KreverUniversity of Western AustraliaCrawley, Australia

Adrian SawyerUniversity of CanterburyChristchurch

EuropeMichael BirkBirk InvestmentsAttenweiler, Germany

Sophie BorensteinKGA AvocatsParis

Francisco de Sousa da CâmaraMorais Leitao, Galvao Teles,Soares da Silva & AssociadosLisbon

Jean ComteBrussels

Pia DorfmuellerDentons Europe LLPFrankfurt

Janusz FiszerGESSEL Law OfficeWarsaw

Valters GencsGencs Valters Law FirmRiga

Andrew GoodallStoke-on-Trent, U.K.

Santhie GoundarLondon

Jörg-Dietrich KramerSeigburg, Germany

Maria KukawskaStone & Feather Tax Advisory Sp. z o.o.Warsaw

Martti NieminenUniversity of Tampere, Finland

Seppo PenttiläUniversity of Tampere, Finland

Marc QuaghebeurDe Broek van Laere & PartnersBrussels

Remco SmorenburgNorton Rose Fulbright LLPAmsterdam

Anelia TatarovaTatarova Law FirmSofia

Piergiorgio ValenteValente Associati GEB PartnersMilan

Jens WittendorffEYSoeborg, Denmark

North America/CaribbeanJack BernsteinAird & Berlis LLPToronto

Eduardo BrandtCreel, García-Cuéllar, Aiza y Enríquez SCMexico City

Iurie LunguALDDMontreal

Steve SuarezBorden Ladner Gervais LLPToronto

Koen van ’t HekEYMexico City

Bruce ZagarisBerliner Corcoran & Rowe L.L.P.Washington, D.C.

South AmericaCristian E. Rosso AlbaRosso Alba, Francia & AsociadosBuenos Aires

Lucas de Lima CarvalhoSão Paulo

David Roberto R. Soares da SilvaBattella, Lasmar & Silva AdvogadosSão Paulo

Frans VanistendaelLe er From EuropeKU LeuvenBrussels

Larissa NeumannU.S. Tax ReviewFenwick & West LLPMountain View, California

Philip WolfA Young Practitioner’s JourneyAntolin Agarwal LLPWalnut Creek, California




volume 100, number 3 october 19, 2020

Documents