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Tax Law Guidance Continues to Come as 2018 Nears End

Dec. 18, 2018, 8:50 PM

The final weeks of 2018 are proving critical for companies, as the Internal Revenue Service continues to release key guidance on the 2017 tax law.

In Dec. 13 proposed rules (REG-104259-18) the agency told companies that the law’s unpopular base erosion and anti-abuse tax would apply to a narrower set of payments than some initially feared. And the agency previewed (Notice 2019-01) on Dec. 14 forthcoming rules that will tell companies how to order previously taxed income on tax returns—direction that is vital after the overhaul.

More guidance on the tax law is likely this month and early next year as the agency aims for mid-2019 completion of regulations. The IRS and Treasury Department hope to have final rules on major components of tax law by June, Lafayette G. “Chip” Harter, deputy assistant Treasury secretary for international tax affairs, has previously said.

The agencies have sent a number of regulations to the White House budget office in recent days for review by the Office of Information and Regulatory Affairs. Once OIRA studies rules and returns them to the department, the IRS usually releases them in short order.

Government guidance gives companies the tax certainty they need to make decisions on the best way to run their businesses, including where to invest money, how to qualify for new tax breaks, and how to treat often-complicated operations across industries.

“You have companies right now that are considering whether to undertake transactions, evaluating the impact of tax reform, looking at the organizational structures they have in place. From a tax perspective, this is a critical time for companies,” Joe Calianno, an international tax partner with BDO USA LLP in Washington, told Bloomberg Tax.

Here’s a rundown of major guidance to watch for in the coming days and weeks.

Foreign-Derived Intangible Income Deduction

Status: waiting on proposed rules

What it does: the deduction is a tax break for exporters

Proposed rules on the tax law’s deduction for what is called foreign-derived intangible income could explain how the IRS views elements of corporate deals.

The provision, under tax code Section 250, is meant to encourage corporations to make things in the U.S. and sell overseas. It reduces the effective tax rate on qualifying income to 13.1 percent until the end of 2025.

OIRA began reviewing the rules on Dec. 17. It has 45 days before sending them back to Treasury.

The detail in the proposed rules will be important for manufacturers, said Gregory Kidder, an international tax partner at Steptoe & Johnson LLP in Washington. For example, the IRS could explain whether it considers income to be foreign-derived when one member of a U.S. group makes parts and a second member assembles the parts and sells the items to a foreign company.

It isn’t clear whether the IRS would consider income from such an arrangement to be foreign-derived, he said.

Repatriation Tax

Status: waiting on final rules
What it does: imposes one-time tax on U.S. companies’ accumulated offshore earnings

Companies hope final regulations on the tax law’s repatriation, or transition, tax will be more generous than the proposed version.

The tax—15.5 percent on cash and 8 percent on illiquid assets—applies to earnings accumulated offshore since 1986. Proposed rules on the Section 965 provision came out in August (REG-104226-18).

Taxpayers can choose to pay in eight installments, but so far the IRS has said if a company overpays one installment, that money can only go to the next payment and can’t be refunded—a position that’s been widely criticized.

That question would be resolved by House Ways and Means Chairman Kevin Brady’s (R-Texas) Dec. 10 tax package (amendment to H.R. 88) that was a revised version of a late-November bill. Installment payments won’t prevent credits or refunds for overpayments, according to the bill. Congress may or may not act on the bill by year-end.

Anti-Hybrid Rules

Status: waiting on proposed rules
What it does: disallows deductions in cross-border transactions involving companies that take advantage of tax discrepancies between jurisdictions to secure a better tax outcome

Proposed rules aiming to prevent the abuse of cross-border tax mismatches could bring companies answers on what types of interest and royalty payments will result in the loss of a deduction.

OIRA finished on Dec. 17 reviewing the proposed rules, which deal with “hybrid mismatch” arrangements under tax code Section 267A. The new code section denies deductions for interest and royalties paid or accrued as part of a hybrid transaction or by a hybrid entity.

Hybrid mismatch arrangements are a form of tax arbitrage used to secure a more favorable tax outcome. A company could, for example, use the arrangement to claim a deduction for a payment in one jurisdiction without an increase in income in the other, or claim a deduction on both ends of a deal. Hybrid mismatch arrangements have been common in international tax planning, and were part of the OECD’s project to curb base-erosion and profit shifting.

Debt Interest Expense Cap

Status: waiting on final rules
What it does: limits write-offs of debt interest payments to 30 percent of adjusted taxable income

The IRS in late November released 439 pages of proposed rules (REG-106089-18) for the tax law’s new cap on debt interest payment write-offs. It now has to finalize definitions of exempted business activities, such as real property trades or businesses, which can opt out, and regulated utilities, which are automatically free from the limit, even if 10 percent of their activities don’t fit the category, thanks to a proposed de minimis threshold rule.

The IRS’s choice in the proposed rules, under Section 163(j), of what fits into the definition of “business interest” subject to the limit, such as guaranteed payments, will surely generate some comments, practitioners said.

The proposed rules’ application of the limit to controlled foreign corporations—foreign corporations at least 50 percent owned by U.S. shareholders—took some by surprise.

Companies with debt-financed CFCs will also be trying to calculate the income of those CFCs based on interest deductibility limits in both the U.S. and the foreign jurisdiction.

But the income timing differences based on U.S. and foreign laws can cause a mismatch of taxable income between the U.S. and the foreign juridisdiction, which can complicate the calculation of a company’s global intangible low-taxed income (GILTI), said Cory Perry, international tax senior manager at Grant Thornton LLP’s Washington National Tax Office.

U.S. shareholders owning 10 percent or more of the stock in a controlled foreign corporation, either by vote or value, must pay tax on GILTI, according to a requirement added in tax reform.

Opportunity Zones

Status: waiting on final rules and more proposed rules
What it does: the tax incentive aims to drive investment dollars into low-income areas

Investors hoping to reduce their capital gains tax bills may get rules in January on a new incentive program designed to move those gains into economically distressed areas.

David Kautter, assistant Treasury secretary for tax policy, has previously hinted at the timing for additional opportunity zone guidance.

Investors are still uncertain about a number of decisions they will have to make, after the IRS released proposed guidance on Oct. 19 under Section 1400Z about how to qualify and set up opportunity funds. The second set of proposed rules—probably coming before the end of 2018—is likely to address how to exit investments.

Capital gains must first be moved into qualified opportunity funds before they are eligible for the tax break.

But investors still want clarity on how new businesses will maintain the tax break and are looking for rules flexible enough to allow good business decisions to drive how projects are funded, rather than decisions that are driven by tax planning.

If the IRS doesn’t clarify the proposed rules in their final form, it could “prevent a taxpayer from making a decision to invest in a qualified opportunity fund because of uncertainty associated with the ultimate benefits of that investment,” said Linda Schakel, a tax partner at Ballard Spahr LLP in Washington.

A region must meet income and job criteria in order to qualify for the tax break, according to the proposed rules.

Full Expensing Provision

Status: waiting on final rules
What it does: tax law allowed for five years of full and immediate expensing

A broad swath of industries—including retail, restaurant, and construction—will have their eyes on whether and how the final rules address a key error in the tax law’s full expensing provision.

Lawmakers amended tax code Section 168(k) to let most businesses fully and immediately write off the cost of capital purchases, but mistakenly assigned three types of property—which they had combined into one, called “qualified improvement property”—a 39-year cost-recovery period, rather than the intended 15-year period.

Only property types with recovery periods of 20 years or less qualify for the law’s 100 percent bonus depreciation provision. That left buyers of qualified improvement property unable to take advantage of the full expensing.

“The law, as it’s currently written, not only places me and my coalition colleagues at an extreme economic disadvantage, but provides the exact opposite result to that which was intended,” Matthew Herridge, co-owner of West Virginia-based Charton Management Inc., which manages several Burger King and Qdoba restaurants, said at a Nov. 28 IRS hearing.

Speaking on behalf of a group of businesses called the “QIP Coalition,” he asked the IRS to essentially hold off enforcing the error for at least one year as lawmakers work on getting a correction to the president’s desk.

Treasury and IRS officials have rejected the idea that they have the authority to override the law as written.

Unrelated Business Income Tax Change

Status: waiting on proposed rules
What it does: requires nonprofits to calculate unrelated business income tax based on each of their separate trades or businesses

The most controversial piece of IRS guidance for nonprofits will address how the organizations should report new tax liabilities on investment income, a question that stems from new code Section 512(a)(6), Lloyd Hitoshi Mayer, a professor of law at the University of Notre Dame, said.

The rules “will be very difficult to implement for most of them given the complex issues” they raise, Mayer said.

Unrelated business income tax is the tax paid by a tax-exempt organization on income from activity unrelated to its core mission.

The IRS issued interim guidance in Notice 2018-67 in August that allowed nonprofits to use the North American Industry Classification System (NAICS) to help sort out their unrelated business taxable income.

To contact the reporters on this story: Alison Bennett in Washington at abennett@bloombergtax.com; Siri Bulusu in Washington at sbulusu@bloombergtax.com; Lydia O'Neal in Washington at loneal@bloombergtax.com; Robert Lee in Washington at rlee@bloombergtax.com

To contact the editors responsible for this story: Meg Shreve at mshreve@bloombergtax.com; Colleen Murphy at cmurphy@bloombergtax.com

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