Monthly Tax Roundup (Volume 1, Issue 7)
With passage of the CHIPS and Science Act and the Inflation Reduction Act over the summer, the tax policy agenda has shifted to the regulatory front as this issue highlights a number of important developments at the Internal Revenue Service (IRS). With Congress now on recess until after the November mid-term elections, we expect this regulatory focus to continue as guidance under the advanced manufacturing investment credit and the new corporate book alternative minimum tax is developed.
Tax Fact: The Treasury Inspector General for Tax Administration (TIGTA) says the amount of tax liability reported by taxpayers under the section 956 tax on repatriated earnings is $251 billion. Of that, $94 billion has already been paid, with another $157 billion scheduled to paid in installments.
I'm proud to be paying taxes in the United States. The only thing is -- I could be just as proud for half the money. – Arthur Godfrey, American radio broadcaster
Proposed Regulations Would Circumscribe Access to Appeals
The U.S. Department of the Treasury (Treasury) and the IRS recently issued proposed regulations clarifying the role that the IRS Independent Office of Appeals (Appeals) has in resolving federal tax controversies without litigation. The proposed regulations define a "federal tax controversy" that is eligible for Appeals consideration and exclude 24 matters from this definition, thus making these matters ineligible for Appeals consideration. Treasury and the IRS also requested comments on whether items relating to requests for changes in accounting method and requests for Section 9100 relief should be added to the list of exclusions.
Appeals' historical mission statement has been to "resolve tax controversies, without litigation, on a basis which is fair and impartial to both the Government and the taxpayer in a manner that will enhance voluntary compliance and public confidence in the integrity and efficiency of the Service." The Taxpayer First Act of 2019 (TFA) formally established an "Independent" Office of Appeals under Section 7803(e) and codified Appeals' historical mission statement with the additional duty of resolving federal tax controversies on a basis that "promotes a consistent application and interpretation of" federal tax laws. Section 7803(e)(3)(B). The TFA also provided that the Appeals process is "generally available to all taxpayers" (emphasis added) and set forth special notification procedures that apply if the IRS denies a taxpayer's request for referral to Appeals. Section 7803(e)(4)-(5). These aspects are notable given recent litigation in which taxpayers have asserted an absolute right to Appeals.
The proposed regulations begin by defining a "federal tax controversy" that is eligible for Appeals consideration as a dispute over an administrative determination with respect to a particular taxpayer made by the IRS in administering or enforcing internal revenue laws that arises out of the examination, collection, or execution of other activities concerning the amount or legality of the taxpayer's income, employment, excise, or estate and gift tax liability; a penalty; or an addition to tax. See Prop. Reg. § 301.7803-2(b)(2). The proposed regulations then identify seven disputes over IRS administrative determinations that fall outside the definition of a federal tax controversy but will nevertheless be treated as a federal tax controversy, e.g., liabilities and penalties that are outside of Title 26 of the United States Code but nevertheless are administered by the IRS. See Prop. Reg. § 301.7803-2(b)(3).
Most importantly, the proposed regulations identify 24 federal tax controversies that are excepted from Appeals consideration. The two most notable exceptions are for taxpayer arguments that a Treasury regulation is invalid or that an IRS notice or revenue procedure is procedurally invalid. The proposed regulations provide that Appeals will not consider such arguments unless there is an unreviewable decision from a federal court invalidating the regulation, notice, or revenue procedure. Although the proposed regulations remain in proposed form and the comment period remains open through November 14, 2022, the IRS immediately implemented these two exceptions via a memorandum to Appeals employees containing a forthcoming update to the Internal Revenue Manual. This appears to be in response to what the memorandum refers to as an increase in cases where the taxpayer asserts that a Treasury regulation is invalid, or an IRS notice or revenue procedure is procedurally invalid. We have covered many examples of such cases in prior editions of this newsletter, including here.
Finally, the notice of proposed rulemaking requests comments on whether disputes relating to requests for changes in accounting method and requests for Section 9100 relief should be added to the list of exceptions from Appeals consideration. This could signal a potential IRS willingness to reverse its 2016 policy decision that precluded these matters from Appeals consideration. See IRM 220.127.116.11 & 11 (Oct. 6, 2016).
IRS Will Provide Relief for U.S. Companies that Amend Puerto Rico Tax Decrees
The IRS announced in Notice 2022-42 that it will amend the foreign tax credit noncompulsory payment rules to permit U.S. companies to amend existing tax agreements, known as tax decrees, with Puerto Rico. Under final regulations issued in December 2021, the Puerto Rican excise tax on goods and services and the related effectively connected income (ECI) tax will no longer be eligible for a U.S. foreign tax credit beginning in 2023. In June 2022, Puerto Rico enacted Act 52-2022 that provides an option for taxpayers to amend their existing tax decrees to adopt a new income tax and royalty withholding tax framework not subject to the ECI and excise taxes. The IRS explained that the Notice is intended to facilitate Puerto Rico's transition to Act 52-2022 given Puerto Rico's status as a U.S. territory.
The regulations announced by Notice 2022-42 will provide that amending an existing tax decree does not cause any amount remitted to Puerto Rico that exceeds the amount of tax that would have been owed but for the amendment to be treated as a noncompulsory (and therefore non-creditable) amount under Treas. Reg. § 1.901-2(e)(5). As a result, increased income tax and royalty withholding taxes paid under the amended tax decrees are considered compulsory payments that may be creditable, assuming they otherwise meet the requirements for creditability. The relief provided in Notice 2022-42 applies in the case of tax decrees amended pursuant to Act 52-2022 on or before December 31, 2022. Furthermore, a taxpayer's Puerto Rico income tax liability under the amended tax decree must be less than the amount of income tax the taxpayer would have owed to Puerto Rico under its generally applicable income tax laws in the absence of any tax decree.
Treasury and the IRS invited comments on the forthcoming proposed regulations by January 9, 2023. Until the date of issuance of such regulations, taxpayers may rely on the Notice.
LB&I Updates Statute of Limitation Controls for Transition Tax Examinations
On September 21, 2022, the IRS Large Business & International Division (LB&I) updated an internal memorandum to employees assigned to examinations of the section 965 transition tax. This memorandum clarifies procedures for conducting transition tax examinations within the applicable statute of limitations.
LB&I's original memorandum, issued in November 2020, addressed when an examiner was permitted to allow the normal three-year assessment statute of limitations to expire without a statutory notice of deficiency, based on the expectation that a different Code provision would extend the limitation period. Specifically, an examiner could only rely on a different Code provision to extend the limitation period by securing approval from the team manager, obtaining concurrence from the territory manager, and preparing documentation "fully set[ting] forth the rationale and risk calculus to support the conclusion to allow the assessment statute to expire."
In addition to the standard three-year assessment limitation period in section 6501(a), the transition tax allows a six-year period to assess section 965 "net tax liability." The September 2022 memorandum clarifies that the same procedural steps must be followed before allowing the extended assessment period in section 965 to lapse. These restrictions prevent a cavalier assumption by the examiner that other Code provisions will extend the statute of limitations. For taxpayers under audit for the transition tax, the rules may result in additional pressure to consent to extensions of time.
The LB&I memorandum comes on the heels of the recent report from TIGTA, observing that the section 965 liability reported by taxpayers is $88 billion less than the revenue originally projected by the Joint Committee on Taxation. In that report, TIGTA expressed "concern" that the IRS had not conducted adequate "follow-up action" with "nonresponsive taxpayers" that had been issued "soft letters" encouraging the filing of amended tax returns.
IRS Memorandum Concludes Advance Payment of Section 367(d) Amounts is Not Respected
On September 23, the IRS released Chief Counsel Advice Memorandum 2022-003, in which it concluded that section 367(d) does not permit taxpayers to choose to make advance payments of annual inclusions for the use of intangible property that was previously transferred. According to the Advice Memorandum, an amount designated as an advance payment or prepayment is not respected as such and is instead treated as a distribution or otherwise "analyzed under general tax principles."
Section 367(d) provides that if a U.S. person transfers intangible property to a foreign corporation in an outbound transaction under section 351 or 361, the U.S. person is treated as having sold the intangible for payments contingent on use of the intangible and as receiving amounts annually that reflect the amounts that would have been received annually over the useful life of the property. Temporary Treasury Regulations issued in 1986 provide for a mechanism by which taxpayers can establish an account receivable to account for actual payments of section 367(d) amounts.
The Advice Memorandum acknowledges that a section 367(d) transfer is similar to a contingent sale or to a license of intangible property, either of which may permit an advance payment or prepayment, but it concludes that "neither section 367(d) nor the section 367(d) regulations give effect to advance payments" and "there is no basis for accelerating the annual section 367(d) inclusions" by reason of payment. The memorandum distinguishes prior situations in which the IRS itself deemed an amount paid in connection with an outbound transfer to be an advance payment of an annual section 367(d) inclusion, in the context of what it perceived at the time as inappropriate repatriation planning. See Notice 2012-39 and CCA 200610019.
The Advice Memorandum reflects an apparent trend by the IRS Office of Associate Chief Counsel (International) to announce coordinated strategy with LB&I on identified audit issues. For another example, see our Tax Alert on a May 2022 Advice Memorandum addressing expense allocation for purposes of the foreign-derived intangible income (FDII) deduction.
Congress Goes Out for Recess – Focus Shifts to the Regulatory Process and Lame Duck
With the passage of a continuing resolution funding the federal government through December 16, 2022, Congress is now in recess so members can campaign in advance of the November midterm elections. While things will be relatively quiet on the tax legislative front, we anticipate significant regulatory activity as the Treasury Department and the IRS develop guidance under the CHIPS and Science Act and the Inflation Reduction Act. Once Congress returns after the elections, there will be significant consideration of the potential components of a year-end lame duck tax package – with Democrats and Republicans needing to find that crucial balance between differing priorities.
The House and Senate both plan to reconvene the week after Thanksgiving. The goal is to wrap up all legislative work before adjourning for the year on or before December 16, 2022.
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