Friday, June 28, 2013

Economic substance doctring

Economic Substance Doctrine

Economic substance analysis begins with Gregory v. Helvering, 293 U.S. 465 [14 AFTR 1191] (1935), “the Supreme Court's foundational exposition of economic substance principles under the Internal Revenue Code.” ACM P'ship v. Comm'r, 157 F.3d 231, 246 [82 AFTR 2d 98-6682] (3d Cir. 1998).

 In Gregory, the taxpayer engaged in a series of transactions which were technically consistent with the Internal Revenue Code but which lacked any real economic substance and defeated the purpose of the Code provisions. 293 U.S. at 467–70. The taxpayer attempted to avoid paying taxable dividends on stock transfers from her wholly-owned corporation by first creating a new corporation to which she transferred the stock, and then liquidating the new corporation and transferring the stock to herself. Id. at 467–68. She claimed that the transaction did not create taxable dividends because she had received the stock ““in pursuance of a plan of reorganization”” within the meaning of the Internal Revenue Code. Id. at 468–69 (citation omitted). Although the transactions technically fell within the definition of a corporate reorganization, which normally would have meant that the transfers were exempt from taxation, the Court held that the IRS could collect tax on the dividends. Id. at 469–70. The Court explained that “[t]he whole undertaking, though conducted according to the terms [of the statute], was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization” and as such it defeated the “plain intent” of the Internal Revenue Code. Id. at 470. Therefore, pursuant to the cours will look to determine whether a claimed deduction “exalt[s] artifice above reality,” or “look beyond the form of [a] transaction” to determine whether it has the “economic substance that its form represents,”CM P'ship , 157 F.3d at 247 (citation and alteration omitted); accord Freytag v. Comm'r, 904 F.2d 1011, 1015 [66 AFTR 2d 90-5322] (5th Cir. 1990) (“The fundamental premise underlying the Internal Revenue Code is that taxation is based upon a transaction's substance rather than its form. Thus sham transactions are not recognized for tax purposes, and losses allegedly generated by such transactions are not deductible.”), aff'd on other grounds, 501 U.S. 868 [68 AFTR 2d 91-5025] (1991).

The Supreme Court has explained that a “natural conclusion” of its holding in Gregory was that transactions that “do not vary control or change the flow of economic benefits[ ] are to be dismissed from consideration.” Higgins v. Smith, 308 U.S. 473, 476 [23 AFTR 800] (1940); accord Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1355 [98 AFTR 2d 2006-5249] (Fed. Cir. 2006). This Court, the Federal Circuit, and other Courts of Appeals have followed a similar approach. See Klamath, 568 F.3d at 543. 36

A lack of economic substance is sufficient to invalidate the transaction regardless of whether the taxpayer has motives other than tax noted by theSupreme Court's prescript in Frank Lyon Co. v. United States, 435 U.S. 561 [41 AFTR 2d 78-1142] (1978), which addressed the factors courts should consider when assessing whether a transaction lacks economic substance.

Frank Lyon generateda “multi-factor test for when a transaction must be honored as legitimate for tax purposes,” including whether the transaction: “(1) has economic substance compelled by business or regulatory realities, (2) is imbued with tax-independent considerations, and (3) is not shaped totally by tax-avoidance features.  The transaction must exhibit objective economic reality, a subjectively genuine business purpose, and some motivation other than tax avoidance.” Southgate Master Fund, LLC ex rel. Montgomery Capital Advisors, LLC v. United States, 659 F.3d 466, 480 [108 AFTR 2d 2011-6488] (5th Cir. 2011).

Importantly, these factors are phrased in the conjunctive, meaning that the absence of any one of them will render the transaction void for tax purposes. Thus, if a transaction lacks economic substance compelled by business or regulatory realities, the transaction must be disregarded even if the taxpayers profess a genuine business purpose without tax-avoidance motivations..

When applying the economic substance doctrine, the proper focus is on the particular transaction that gives rise to the tax benefit, not collateral transactions that do not produce tax benefits.  Transactions lack objective economic reality if they “do not vary, control, or change the flow of economic benefits.””Southgate , 659 F.3d at 481 (citation and alteration omitted). “The objective economic substance inquiry asks whether the transaction affected the taxpayer's financial position in any way.” Id. at 481 n.41 (citation, quotation marks, and alterations omitted). “This is an objective inquiry into whether the transaction either caused real dollars to meaningfully change hands or created a realistic possibility that they would do so[,]” meaning ““a reasonable possibility of profit from the transaction existed apart from tax benefits.”” Id. at 481 & n.43 (citation and other footnote omitted). “That inquiry must be “conducted from the vantage point of the taxpayer at the time the transactions occurred, rather than with the benefit of hindsight.”” Id. at 481 (citation omitted). (212) 588-1113

Wednesday, June 19, 2013

6015 - IRS litigating position in innocent spouse cases

Department of the TreasuryInternal Revenue ServiceOffice of Chief Counsel NoticeCC-2013-011June 7, 2013

Subject: Litigating Cases that Involve Claims for Relief From Joint and Several Liability Under Section 6015

This Notice provides Chief Counsel attorneys with guidance regarding the standard and scope of review that the Tax Court applies when reviewing requests for section 6015(f) relief from joint and several liability.

 This Notice also provides litigation guidance for cases that involve claims for relief under section 6015. This Notice obsoletes Chief Counsel Notice CC-2009-021 (June 30, 2009) and Chief Counsel Notice CC-2004-26 (July 12, 2004).

Discussion In Wilson v. Commissioner, 705 F.3d 980 (9th Cir. 2013), aff'g T.C. Memo. 2010-134, the Ninth Circuit held that “determine,” as used in section 6015(e)(1)(A), provides a de novo standard and scope of review in section 6015(f) cases petitioned to the Tax Court.

The Service issued an action on decision acquiescing in the court's holding. AOD 2012-07, I.R.B. 2013-25 (June 17, 2013).

A.     Standard and Scope of Review in Section 6015(f) Cases

In all section 6015(f) cases, the scope of review is de novo as provided in Porter v. Commissioner, 130 T.C. 115 (2008), and the standard of review is de novo as provided in Porter v. Commissioner, 132 T.C. 203 (2009). Chief Counsel attorneys should no longer argue that the Tax Court should review the Service's section 6015(f) determinations for abuse of discretion or that the court should limit its review to evidence in the administrative record.

Although Chief Counsel attorneys are no longer required to preserve the standard and scope of review issues for appeal, they should continue to work with petitioners to stipulate to evidence in the administrative record that is relevant to the court's determination regarding section 6015 relief.

B.     Requests to CCISO for a Determination Regarding Relief

Although the Tax Court makes the final determination regarding a petitioner's entitlement to relief under section 6015(b), (c), or (f), it is still appropriate for the Service to have the first opportunity to make a determination regarding relief. If the Service has not made a determination regarding a petitioner's entitlement to section 6015 relief before the petitioner filed a petition, the trial attorney must request a determination from the Cincinnati Centralized Innocent Spouse Operations (CCISO) unit. 1 This can occur in two situations.

First, section 6015(e)(1) provides the Tax Court with jurisdiction when a taxpayer files a petition six months after filing a request for relief with the Service but before a determination is issued.

Second, section 6213(a) provides the Tax Court with jurisdiction over innocent spouse issues before the Service makes a determination when a taxpayer raises section 6015 relief for the first time in a petition from a Notice of Deficiency.Chief Counsel attorneys who send a request to CCISO using the United States Postal Service should address the request to: IRS-CCISO Stop 840F P.O. Box 120053 Attn: Department One Manager Covington, KY 41012If using a private delivery service, address the request to: IRS-CCISO 201 West Rivercenter Boulevard Stop 840F Attn: Department One Manager Covington, KY 41011Requests should be marked “EXPEDITE - TAX COURT CASE PENDING” and include the Form 8857 2 , the Tax Court petition, and any other relevant documents and information in the attorney's possession.

If the petitioner does not provide the Form 8857, the trial attorney should still request CCISO to consider the innocent spouse issue. The request should inform CCISO that it should provide the results of its review directly to Counsel and should not issue a determination letter to the petitioner. In newly-docketed cases brought under the six-month rule of section 6015(e), the trial attorney should wait to request the administrative file until after CCISO completes its determination. If documents from the file are needed to timely answer the petition, the trial attorney should request copies of those documents from CCISO.

The trial attorney should remain in close contact with CCISO while a request is pending. Chief Counsel attorneys can ask CCISO questions about submitting a request or about the status of a request by calling (866) 897-4270 (ext. 8147).C. Litigating Section 6015 Cases After receiving CCISO's determination, the trial attorney should share the determination with petitioner. If CCISO determines that a petitioner is not entitled to section 6015 relief, the petitioner may request that Appeals consider the denial of relief. The trial attorney should refer the case to Appeals under normal procedures if there is sufficient time before the trial calendar. If there is not sufficient time, but the parties agree that Appeals' review would facilitate settlement, the parties should jointly request a continuance.

The trial attorney should prepare to defend CCISO's denial of relief at trial, but may settle or concede the case as appropriate.In cases in which the nonrequesting spouse has not intervened or is not a joint petitioner, the trial attorney should, except in rare circumstances, follow the determination made by CCISO that the petitioner is entitled to relief and settle the case in accordance with CCISO's determination. In the rare circumstance that the trial attorney and the trial attorney's manager believe that evidence in the administrative file, discoverable evidence, or evidence that may be adduced at trial warrant not following CCISO's determination, the matter must be coordinated with Branches 1 or 2 of the Procedure and Administration Division.

If Appeals makes the determination that the petitioner is entitled to relief, the trial attorney should follow the determination and settle the case in accordance with that determination.If the nonrequesting spouse is a joint petitioner or an intervenor in the case, the Service cannot provide section 6015 relief or settle with the requesting spouse unless the nonrequesting spouse agrees and is a party to the settlement. Corson v. Commissioner , 114 T.C. 354 (2000).

 If, however, the nonrequesting spouse is not a joint petitioner or an intervener, the Service may settle the case with the requesting spouse. Thus, in cases in which the nonrequesting spouse is a party, the trial attorney should only treat the determination by CCISO or Appeals to grant relief as a recommendation by that function (unless the nonrequesting spouse agrees that the petitioner is entitled to relief).If the nonrequesting spouse does not agree that the petitioner is entitled to relief, the trial attorney should decide whether granting relief is appropriate. Making that decision requires the trial attorney to consider CCISO's or Appeals' determination, the evidence in the administrative file, discoverable evidence, statements and documents submitted by the nonrequesting spouse, and evidence that may be adduced at trial.

Therefore, the case may require further development before a decision is made regarding whether granting relief is appropriate. If the trial attorney agrees that the petitioner is entitled to relief, the trial attorney should enter into a stipulation of settled issues with the petitioner with the understanding that the case will still need to proceed to trial on the innocent spouse issue. If the trial attorney agrees with the nonrequesting spouse that the petitioner is not entitled to relief, the trial attorney should prepare to defend CCISO's denial of relief at trial.Questions concerning this Notice should be directed to Branch 1 or 2 of Procedure and Administration at (202) 622-4910 or (202) 622-4940, respectively._________/s/__________Drita TonuziAssociate Chief CounselProcedure & Administration 1  The trial attorney should not move the Tax Court to remand these cases for a determination by the Service regarding section 6015 relief. In Friday v. Commissioner, 124 T.C. 220 (2005), the Tax Court held that section 6015 does not provide for remand.2  I n cases brought under section 6213(a), if the petitioner has not submitted a Form 8857, “Request for Innocent Spouse Relief,” the trial attorney should request that the petitioner complete the form and submit it to the attorney. (212) 588-1113

Friday, June 14, 2013

constructive dividends section 301(c)

Funds that a corporation distributes to a shareholder with respect to its stock are taxed to the shareholder as dividends to the extent of the corporation's earnings and profits. Secs. 301(c), 316. Any excess is considered to be a nontaxable return of capital to the extent of the shareholder's basis in the [*10] corporation, and any remaining amount is taxable to the shareholder as a gain from the sale or exchange of property. See sec. 301(c)(2) and (3); Truesdell v. Commissioner, 89 T.C. 1280, 1295-1298 (1987). Characterization of a distribution as a dividend does not depend upon a formal dividend declaration. See Boulware v. United States, 552 U.S. 421, 429 [101 AFTR 2d 2008-1065] (2008); Truesdell v. Commissioner, 89 T.C. at 1295; see also Noble v. Commissioner, 368 F.2d 439, 442 [18 AFTR 2d 5982] (9th Cir. 1966), aff'g T.C. Memo. 1965-84. Corporate funds that a controlling shareholder diverts to personal use are generally characterized as constructive distributions to the shareholder for tax purposes. See Erickson v. Commissioner, 598 F.2d 525, 531 [44 AFTR 2d 79-5241] (9th Cir. 1979), aff'g in part, rev'g in part T.C. Memo. 1976-147; Strong v. Commissioner, T.C. Memo. 2005-125. Such a diversion may occur where a controlling shareholder causes a corporation to pay his or her personal expenses and the payment is made without expectation of repayment or without a bona fide intent that it be in repay[pg. 942] ment of a shareholder loan. See Hood v. Commissioner, 115 T.C. 172, 179-180 (2000); see also Noble v. Commissioner, 368 F.2d at 443; Clark v. Commissioner, 266 F.2d 698, 710-711 (9th Cir. 1959), aff'g in part, rev'g in part and remanding T.C. Memo. 1957-129. (212) 588-1113

section 6663 fraud penalty

In deciding whether a failure to file is fraudulent under section 6651(f), the same elements that are considered in imposing the addition to tax for fraud under section 6663 and former section 6653(b). Clayton v. Commissioner, 102 T.C. 632, 653 (1994). Those elements are: (1) the existence of an underpayment and (2) fraudulent intent with respect to some portion of the underpayment. See Petzoldt v. Commissioner, 92 T.C. 661, 698-699 (1989).  

Section 6663 Fraud Penalty Fraud is an intentional wrongdoing on the part of a taxpayer with the specific purpose to evade a tax believed to be owed. Sadler v. Commissioner, 113 [*18] T.C. 99, 102 (1999). 

The penalty in the case of fraud is a civil sanction provided primarily as a safeguard for protection of revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer's fraud. Helvering v. Mitchell, 303 U.S. 391, 401 [20 AFTR 796] (1938); Sadler v. Commissioner, 113 T.C. at 102.

 The Commissioner has the burden of proving by clear and convincing evidence an underpayment for each year in issue and that it is due to fraud. Sec. 7454(a); Rule 142(b). 

The Commissioner must show that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of taxes. Katz v. Commissioner, 90 T.C. 1130, 1143 (1988). If the Commissioner establishes that any portion of the underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud and subject to a 75% penalty, unless the taxpayer establishes that some part of the underpayment is not attributable to fraud. Sec. 6663(a) and (b). In the case of a joint Federal income tax return, the section 6663 penalty “shall not apply with respect to the spouse unless some part of the underpayment is due to the fraud of such spouse.” Sec. 6663(c). 

 Fraudulent intent may be inferred from various kinds of circumstantial evidence, or “badges of fraud”, including the consistent understatement of income, inadequate records, implausible or inconsistent explanations of behavior, concealing assets, and failure to cooperate with tax authorities. Bradford v. Commissioner, 796 F.2d 303, 307 [58 AFTR 2d 86-5532] (9th Cir. 1986), aff'g T.C. Memo. 1984-601 [¶84,601 PH Memo TC].

In the context of the seventy-five percent penalty of § 6663,  “fraud is intentional wrongdoing on the part of the taxpayer with the specific intent to avoid a tax known to be ow ing.” Bradford v. Comm'r, 796 F.2d 303, 307 [58 AFTR 2d 86-5532] (9th Cir. 1986) (quoting Akland v. Comm'r, 767 F.2d 618, 621 [56 AFTR 2d 85-5649] (9th Cir. 1985)). To estab lish liability for the civil fraud penalty, “the Government must establish: (1) a knowing falsehood; (2) an intent to evade taxes; and (3) an underpayment of tax.” Considine v. United States, 683 F.2d 1285, 1286 [50 AFTR 2d 82-5678] (9th Cir. 1982). [pg. 2013-473]

. Fraudulent intent is a question of fact that must be considered on the basis of an examination of the record and the taxpayer's course of conduct, drawing reasonable inferences therefrom. Spies v. United States, 317 U.S. 492, 499 [30 AFTR 378] (1943); Petzoldt v. Commissioner, 92 T.C. at 699. Because fraudulent intent can seldom be established by direct proof, it may be proved by circumstantial evidence. See Clayton v. Commissioner, 102 T.C. at 647; Petzoldt v. Commissioner, 92 T.C. at 700. Thus, intent to defraud may be inferred from any conduct the likely effect of which would be to conceal, mislead, or otherwise prevent the collection of taxes believed to be owing. Spies, 317 U.S. at 499. Courts look to a nonexclusive list of factors, or “badges of fraud”, to determine whether fraudulent intent exists. Niedringhaus v. Commissioner 99 , T.C. 202, 211 (1992); King's Court Mobile Home Park, Inc. v. Commissioner, 98 T.C. 511, 516 (1992). 

Fraud may be proved by circumstantial evidence and inferences drawn from the facts because direct proof of a taxpayer's [*19] intent is rarely available. Niederinghaus v. Commissioner, 99 T.C. 202, 210 (1992). The taxpayer's entire course of conduct may establish the requisite fraudulent intent. DiLeo v. Commissioner, 96 T.C. at 874; Stone v. Commissioner, 56 T.C. 213, 223-224 (1971).   Fraudulent intent can be inferred from strong circumstantial evidence.” Bradford, 796 F.2d at 307; see 26 U.S.C. § 7454(a) (“In any proceeding involving whether the petitioner has been guilty of fraud with intent to evade tax, the burden of proof in respect to such issue shall be upon the Secretary.”). 

They include: (1) failure to file income tax returns; (2) failure to maintain adequate records; (3) failure to cooperate with tax authorities; (4) assertion of frivolous arguments and objections to the tax laws; (5) lack of credibility in testimony; (6) failure to make estimated tax payments; (7) understatement of income; and (8) concealment of income. See Laurins v. Commissioner, 889 F.2d 910, 913 [65 AFTR 2d 90-364] (9th Cir. 1989), aff'g Norman v. Commissioner, [*14] T.C. Memo. 1987-265 [¶87,265 PH Memo TC]; Bradford v. Commissioner, 796 F.2d 303, 307-308 [58 AFTR 2d 86-5532] (9th Cir. 1986), aff'g T.C. Memo. 1984-601 [¶84,601 PH Memo TC]; Recklitis v. Commissioner, 91 T.C. 874, 910 (1988). No single factor is determinative of fraud; however, the existence of several indicia may constitute persuasive circumstantial evidence of fraud. Niedringhaus v. Commissioner, 99 T.C. at 211; Petzoldt v. Commissioner, 92 T.C. at 700. The taxpayer's background and the context of the events in question may also be considered circumstantial evidence of fraud. Spies, 317 U.S. at 497; Plunkett v. Commissioner, 465 F.2d 299, 303 [30 AFTR 2d 72-5122] (7th Cir. 1972), aff'g T.C. Memo. 1970-274 [¶70,274 PH Memo TC]. We address the badges of fraud individually. 1. Failure To File Income Tax Returns[pg. 146] (212) 588-1113

Ordinary and necessary section 162 business expenses

Ordinary and Necessary Tax deductions are a matter of legislative grace, and taxpayers must satisfy the specific statutory requirements for the item claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 [69 AFTR 2d 92-694] (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 [13 AFTR 1180] (1934). 

Generally, a taxpayer may deduct ordinary and necessary business expenses paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a). 

Whether an expense satisfies section 162 is generally a question of fact. Commissioner v. Heininger, 320 U.S. 467, 475 [31 AFTR 783] (1943). An expense is ordinary if it is customary or usual within a particular trade, business or industry or relates to a common or frequent transaction in the type of business involved. Deputy v. du Pont, 308 U.S. 488, 495 [23 AFTR 808] (1940).

 A necessary expense is appropriate and helpful to the operation of the taxpayer's trade or business. See Commissioner v. Tellier, 383 U.S. 687, 689 [17 AFTR 2d 633] (1966); Carbine v. Commissioner, 83 T.C. 356, 363 (1984), aff'd, 777 F.2d 662 [57 AFTR 2d 86-406] (11th Cir. 1985). (212) 588-1113

Trust fund recovery penalty - "significant control" to be a "responsible person"

.  Code Sec. 6672 imposes the trust fund recovery penalty on any person who: (1) is responsible for collecting, accounting for, and paying over payroll taxes; and (2) willfully fails to perform this responsibility. The amount of the penalty is equal to the amount of the tax that was not collected and paid. 

The penalty is imposed on a “responsible person,” i.e., anyone in a business entity who has the duty to collect, account for, or pay over the tax. In determining whether there is willfulness, the courts have focused on whether a taxpayer had knowledge about the non-payment of the payroll taxes, or showed reckless disregard with respect to whether the payments were being made. Although the Code doesn't define who is “responsible” for purposes of the penalty, the Second Circuit has said that the determinative question is whether the individual has significant control over the enterprise's finances. 

The Second Circuit has instructed courts to consider the following relevant factors in determining whether an individual had significant control: whether the individual (1) is an officer or member of the board of directors; (2) owns shares or possesses an entrepreneurial stake in the company; (3) is active in the management of day-to-day affairs of the company; (4) has the ability to hire and fire employees; (5) makes decisions regarding which, when, and in what order outstanding debts or taxes will be paid; (6) exercises control over daily bank accounts and disbursement records; and (7) has check-signing authority. (U.S. v. Rem, (CA 2 1994) 74 AFTR 2d 94-6649) (212) 588-1113

Commuting expenses

Costs of commuting between a taxpayer's residence and place of business are generally nondeductible personal expenses. However, the Internal Revenue Service recognizes three exceptions: (1) transportation between the taxpayer's residence and a temporary work location outside the metropolitan area where the taxpayer lives and normally works is deductible (“temporary distant workplace exception”); 

(2) if the taxpayer has one or more “regular work locations away from the taxpayer's residence,” transportation between the taxpayer's residence and a temporary work location is deductible (“regular work location exception”); and

 (3) transportation between the taxpayer's residence (if the residence serves as the taxpayer's principal place of business) and a regular or temporary work location is deductible (“home office exception”). Rev. Rul. 99-7, 1999-1 C.B. 361 (212) 588-1113

FATCA Tax Compliance

FATCA compliance primer for U.S. multinationals 

The Foreign Account Tax Compliance Act (FATCA) rules, which impose significant reporting, documentation and withholding obligations, are not limited to financial institutions. These rules can also impose significant and burdensome requirements on U.S. multinationals. 

Below is a summary of the steps U.S. multinationals should take in order to ensure their compliance with FATCA. Background.  Generally effective for payments made after Dec. 31, 2012 (but delayed in IRS guidance; see below), the Hiring Incentives to Restore Employment Act of 2010 (HIRE Act, P.L. 111-147) established rules for withholdable payments to foreign financial institutions (FFIs; generally including non U.S. banks, broker-dealers and other custodians, investment vehicles, and certain insurance companies) and for withholdable payments to other foreign entities by adding a new Chapter 4 to the Code (Code Sec. 1471 through Code Sec. 1474). 

The new rules provide for withholding taxes to enforce new reporting requirements on specified foreign accounts owned by specified U.S. persons or by U.S.-owned foreign entities (“U.S. accounts”). Under Code Sec. 1471(d), a financial account is defined as any depository or custodial account maintained by the financial institution, or any equity or debt interest in the financial institution (other than interests regularly traded on an established securities market).

 Under Code Sec. 1471(a), a withholding agent must withhold 30% of certain payments to an FFI unless the FFI has entered into a “FFI agreement” with IRS to, among other things, report certain information with respect to U.S. accounts. Chapter 4 also imposes on withholding agents withholding, documentation, and reporting requirements with respect to certain payments made to certain other foreign entities. 

The registration, due diligence, information reporting and withholding obligations for U.S. source FDAP income under FATCA are generally effective as of Jan. 1, 2014. Entities will have to determine by October of 2013 whether they qualify as FFIs and, to the extent they do, register with IRS. The final FATCA regs were explained in a detailed six-part article published earlier this year 

. Application to U.S. multinationals.  U.S. multinationals may have group companies that could qualify as FFIs, such as treasury centers, captive financing or insurance companies, and retirement funds. Although most of the discussion related to FATCA's implications on U.S. payors of U.S. source withholdable payments has been focused on financial institutions, U.S. multinationals and, in certain scenarios, U.S. citizens and tax residents, may have withholding obligations. U.S. multinationals making withholdable payments to entities outside of the U.S. have to withhold 30% under the FATCA rules unless the entities make certain disclosures to IRS and to the U.S. withholding agent payor. For purposes of complying with the FATCA rules, U.S. multinational enterprises are expected to implement certain procedures that may require changes to previously used account payable systems and compliance processes. Roadmap to compliance.  U.S. multinationals should consider taking the following steps to ensure their compliance with FATCA:

 (1) The multinational has to make a determination as to which of the payments it makes qualify as a “withholdable payment” for purposes of FATCA. Withholdable payments generally include U.S. source fixed or determinable, annual or periodical (FDAP) income, such as interest, dividends, and most types of royalties and rents as well as gross proceeds from the sale of securities that could generate U.S. source income. Income effectively connected to a U.S. trade or business (e.g. fees for certain services), however, will not be subject to withholding under FATCA. 

(2) Next, the multinational should determine whether the non-U.S. recipient of the withholdable payment is an FFI or a non-financial foreign entity (“NFFE”). Generally, NFFEs that are publicly traded (including their subsidiaries) are not subject to FATCA. Non-publicly traded NFFEs and FFIs, however, must either comply with the disclosure rules or be subject to the 30% withholding tax. (3) To the extent the income recipient identified in Step 2 is an FFI, an inquiry must be made to determine whether the FFI is a participating FFI or a non-participating FFI. Non-participating FFIs will be subject to the 30% withholding. (4) For NFFE recipients, information should be requested and reported regarding any substantial U.S. owners. If such information is not provided, the payment should be subject to the 30% withholding tax. In order to meet the above requirements, MNEs would have to build out compliance processes to ensure that all necessary determinations, monitoring, documentation and reporting is in place for purposes of complying with the FATCA rules. References: For withholdable payments to FFIs and other foreign entities, (212) 588-1113

Tuesday, June 11, 2013 (212) 588-1113

Monday, June 10, 2013

Ways & Means Hearing June 13, 2013

Written Statement of
Alvin S. Brown, Esq.,
The Committee on Ways and Means
U.S. House of Representatives
Hearing on Tax Reform: Tax Havens, Base Erosion and Profit-Shifting
June 13 2013

Chairman Camp, Ranking Member Levin, and distinguished members of the Committee on Ways and Means.  I am a tax attorney specializing in IRS controversies. I previously had a full career in the Office of the IRS Chief Counsel as an interpretative attorney and manager with signature authority for the IRS on many complex tax matters. 
To resolve many of the tax minimization issues and tax abuses that are the subject of this hearing, the IRS could easily apply section § 7701(o) and its prevailing judicial precedent.  Section 7701(o) is the codification of the “economic substance doctrine”[1]  which provides that, in the case of any transaction to which the “economic substance doctrine” is relevant, the transaction shall be treated as having economic substance only if
(i)                         the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and
(ii)                        the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into the transaction. Section 7701(o)(5)(A) states that the term “economic substance doctrine” means the common law doctrine under which tax benefits are not allowable if the transaction does not have economic substance or lacks a business purpose.
The IRS is remiss in its failure to apply the explicit language of § 7701(o) to individuals and corporations creating foreign subsidiaries for the primary purpose and intent of minimizing, evading or avoiding their tax liabilities.  For example, the IRS could easily apply the explicit two-prong standards of § 7701(o) to the Irish subsidiaries of Apple as well as other manipulative corporate formations in offshore locations.   Those shell entities or other organizations, formed primarily to reduce U.S. taxation, can be treated as “sham” entities or disregarded by the IRS under the plain language of § 7701(o).   U.S. parents of these tax abusive organizations will find it difficult to establish that the offshore organization did not change their “economic position” in any “meaningful way” or that a “substantial purpose” was not tax motivated under § 7701(o) as well as judicial precedent establishing that the “substance” of a tax transaction prevails over its “form.”
The IRS is also remiss in not applying § 7701(o) to organizations formed solely to manufacture “carried interest” capital gain income.  Partnerships or corporations formed for the sole reason of converting ordinary income into capital gain could be disregarded under the plain language of § 7701(o), in addition to the application of judicial precedent for the “economic substance” doctrine.   “Carried interest” is manufactured by the general partners of private equity, venture capital, real estate, hedge funds and other investment vehicles organized as limited partnerships.  It is beyond understanding why the IRS does not attack these partnerships or corporations under the two-prong test of § 7701(o).   In substance, there are two parts of a carried interest transaction:  1) commission income or other income is received and 2) the income is utilized to generate capital gain income.    Any “carried interest” transaction can be bifurcated into the above two-part analysis either under § 7701(o) or the judicial precedent dealing with “substance over form”  articulated in classic cases such Commissioner v. Court Holding Co., 324 U.S. 331 (1945); Gregory v. Helvering, 293 U.S. 465 (1935).   The “carried interest” transactions are also technically tainted because income earned cannot be assigned after it is earned[2]
Unfortunately, the IRS has largely ignored its Congressional mandate to administer § 7701(o) to prevent the abuses identified by this Committee.


[1] Enacted s part of the Health Care and Education Reconciliation Act of 2010 (Act), Pub. L. No. 111-152. t. for transactions entered into on or after March 31, 2010.

[2] Lucas v. Earl, 281 U.S. 111 (1930) (212) 588-1113