It’s now up to Congress to fix a tax law error that has meant multinationals and private equity firms are reporting and paying taxes on some previously exempted overseas investments.
IRS proposed rules (REG-104223-18) would ease the reporting requirements on U.S. shareholders gathering information on their investments in potentially hundreds of overseas foreign corporations. But the relief falls short of fixing the glitch that is hitting multinationals like Coca-Cola Co.
Bills from Rep. John Lewis (D-Ga.) and Sen. Johnny Isakson (R-Ga.) (H.R. 4509, S.2589) would fix the problem by reinstating a rule that would shield U.S. shareholders from reporting taxes on foreign corporations in which they have less than a 10% stake. Staffers for Lewis didn’t return requests for comment.
Isakson, a Senate Finance Committee member, said in an Oct. 8 statement that he raised concerns during a committee markup of the tax law about the issue, which was flagged early on for having “unintended consequences for American companies in various industry sectors, including Coca-Cola, that have long-standing business investments in partner companies headquartered abroad.”
Any technical corrections will be subject to careful negotiations in the coming months. Making fixes is a Republican priority, and aside from a few high-profile errors, Democrats have been hesitant to help fix what they see as a Republican product.
Still, that’s likely the only hope for companies now that the IRS said in the regulations that its statutory authority only extends to fixing various unintended consequences, not the root of the problem. In each of the situations addressed by the IRS, the changes were made “in accordance with the regulatory authority,” it said.
“Fixing it legislatively is the best hope for resolution of this problem,” said Rafic H. Barrage, principal in Baker & McKenzie’s North America Tax Practice Group in Washington.
The issue arises from the repeal of a tax code Section 958(b)(4) rule that kept some foreign-held assets outside the U.S. tax net, resulting in U.S. shareholders with less than 50% ownership of a foreign corporation having to report and pay tax as if they owned a stake in a controlled foreign corporation. A controlled foreign corporation (CFC) is majority owned by U.S. shareholders who own 10% or more of the total stock.
“I feel like Treasury and IRS have done a lot to try and fix those issues. This is probably a good exhibit to take to Congress to say, ‘Look at this mess that was created by the 958 repeal, and maybe we should reconsider it,’” Barrage said.
It isn’t the first time the IRS has signaled that a technical correction must come from Congress.
In September final rules on tax code Section 168(k), the IRS said a “legislative change” is the only way to fix an error preventing restaurants and retailers from immediately writing off the cost of interior improvements.
The regulations and revenue procedure that the IRS released on Oct. 1 narrowly address some of the consequences of being deemed a CFC.
Practitioners said the repeated mention of “regulatory authority” in the rules confirms that the IRS and Treasury believe they can’t go further to address the issue.
“The implication of doing such limited changes certainly confirms that a broader fix would require a technical fix to the statute,” said John Harrington, a partner at Dentons US LLP in Washington and chair of the Bloomberg Tax International Advisory Board.
The IRS acknowledged in the guidance that the foreign entities aren’t CFCs in reality and it proposed letting those taxpayers use more easily attainable information to calculate their taxes.
“The IRS said we’ve got this special authority under this regulation for reporting issues, so we’re tapping into that authority to fix the problem,” said Chip K. Collins, managing director and group head of QI compliance and FATCA at UBS AG.
House Ways and Means Committee ranking member Kevin Brady (R-Texas) included an attempt to fix the error in a package (amendment to H.R. 88) in December 2018 that failed to pass.
“The Brady bill also would have reinstated 958(b)(4) into the code and more narrowly targeted the abuse Congress was going for,” Barrage said.
Coca-Cola is headquartered in Atlanta, Isakson’s hometown. The company didn’t respond to requests for comment.
On behalf of Coca-Cola, Gregory S. Nickerson, a principal at the Washington Tax & Public Policy Group, in a March letter asked Treasury and the IRS to issue guidance that is more consistent with Congress’s intent.
Nickerson didn’t return a request for comment.
Congress didn’t intend for the repeal of Section 958(b)(4) to “override the bedrock principle of the CFC Rules that a U.S. taxpayer should not be taxed on subpart F income from an entity it does not control either individually or collectively with other U.S. taxpayers,” the letter said.
“There is nothing wrong with the IRS closing off tax avoidance opportunities, but it’s just irksome that in general the 958(b)(4) repeal was horrendously bad for taxpayers in ways totally inadvertent,” said Ian Weinstock, a partner at Kostelanetz & Fink LLP in New York.
—With assistance from Kaustuv Basu.