Tax Reform Legislation Update

 

Draft tax reform legislation was released by the House Ways of Means Committee on November 2, 2017.  The Senate Finance Committee is working on its own version of tax reform legislation which is expected to be released in the next few weeks.  Before legislation could be sent to the president, both the House and the Senate would need to pass identical versions of the legislation.  At this time, it is unclear how much of the reform legislation of the Senate will differ from the released House bill.

The House legislation mirrors many of the provisions listed in the Republicans’ tax reform framework and provides new details.  Below is a summary of some of the notable provisions contained in the House legislation:

 

Individuals

• Imposes four tax rates on individuals: 12%, 25%, 35%, and 39.6% effective tax year 2018.  The maximum rate of 39.6% applies to single taxpayers with $500,000 or more taxable income and $1,000,000 or more taxable income for married taxpayers filing jointly.

• The standard deduction increases from $6,350 to $12,200 for single taxpayers and from $12,700 to $24,400 for married taxpayers filing jointly effective 2018.

• Most of personal deductions would be repealed, including the medical expense, alimony deduction, the casualty loss deduction, and the deduction for state and local income or sales taxes. Deduction for state and local real property taxes would be limited to $10,000 effective 2018.

• Deduction for mortgage interest attributable to acquisition indebtedness (acquired after November 2, 2017) in excess of $500,000 would be disallowed. However, the mortgage interest deduction on existing mortgages would remain the same - $1.1 million acquisition and home equity indebtedness.

 

Alternative Minimum Tax (“AMT”)

• The AMT would be repealed effective 2018.

 

Estate & Gift Tax

• The estate tax exclusion amount would be increased to $11 million from $5.5 million. The estate tax would be repealed after 2023.

 

S-corps and Partnerships (“Passthrough Entity”)

• Passive activity income from a passthrough entity would be taxed at the 25% tax rate. Generally, non-passvie activity income from a passthrough entity would be taxed at ordinary income rate.

 

Business

• The bill introduces a flat 20% tax rate.
• The bill introduces 100% expensing of qualifying property (excluding no real property) acquired and placed in service after September 27, 2017 and before January 1, 2023.
• Net operating losses (“NOLs”) deduction will be limited to 90% of taxable income. NOLs will have indefinite carryforward period with no carryback provision.
• Repeal Section 163(j) limitation for interest paid to related party, but introduces a deduction limitation of 30% of adjusted taxable income for businesses with average gross receipts in excess of $25 million.
• Repeal Section 199 domestic activity deduction.
• Disallow deductions for entertainment, amusement, or recreation activities.
• The bill limits tax deferral provision under Section 1031 to real estate.
• Most business and energy credits would be repealed except for research and development (“R&D”) credits.
• The performance-based compensation exception for Section 162(m) 1 million officer compensation limitation would be repealed. And covered employees subject to Section 162(m) will increase.

 

International

• The bill would introduce a dividend exemption for foreign source dividend received by 10% U.S. corporate owners.
• Repeal Section 902 indirect foreign tax credit provision.
• Repeal Section 956 which subjects immediate taxation on a controlled foreign corporation’s undistributed earnings that are reinvested in U.S. property.
• Unremitted foreign earnings as of December 31, 2017 would be immediately taxed at rate of 12% (for earnings attributable to cash or cash equivalents) or 5% (for the remainder).

 

As mentioned above, the House tax reform legislation faces a number of significant legislative procedures and hurdles prior to being signed into law.  We will continually monitor and provide updates on any developments.

외국 계열사가 소유한 무형 자산에 대한 로열티 또는 라이센스 비용

최근 IRS는 해외 관계사가 소유한 지적 자산을 사용 하는 대가로 미국 내 기업이 해외로 지불하는 로열티에 대한 지침을 제공하는 “practice unit”을  발표 했다. Practice unit은 IRS 조사원이 기업들 간에 발생되는 이전 가격 거래와 그에 관련된 이슈들에 대한 세무 감사를 진행함에 있어 유용한 감사 전략과 주요 사항들을 제공한다. (하단의 IRS발행물 참조.)

IRS는 미국 내 기업들이 사업을 위해 해외 관련 기업들의IP를 사용하고 있음을 인식하고 있다. 이와 같은 거래 내역들은 미국 정부의 세수 (revenue collection)에 중대한 영향을 끼친다. 앞서 소개된Practice unit은 아래에 기재된 잠재적 이슈들에 대한 감사 지침을 제공한다:

이슈 1: 해외 모기업 (“FP”)의 어떠한 무형 자산이 미국 내 계열사 (“USS”)에 의해 사용 되었나?

이슈 2: 미국 내 계열사 (“USS”)가 해외 모기업(“FP”)에게 무형 자산의 라이센스 비용으로arm’s length consideration을 지불하였나?

이슈3: 지불된 비용이 무형 자산의 사용으로 창출된 소득에 상응하는가?

이슈 1을 판단하기 위하여 조사원은 거래 내역의 본질을 – 무형 자산의 사용 여부와 존재 여부– 검증한다. 조사원은 여러가지의 관련 서류를 검토하여 아래와 같은 사항들을 점검하여야 한다:

• 검증 할 업체들 간에 무형 자산(IP) 이 존재하는가?
• 어떤 종류의 무형 자산이 있는가?
• 무형 자산의 사용 권한이 있는가?

이슈 2를 판단하기 위하여 조사원은 알맞는 세무 감사 프로그램을 통해 미국 내 계열사 (“USS”)가 해외 모사(“FP”) 에게 arm’s length consideration을 지불 하였는지 검증해야 한다. Arm’s length consideration의 여부는 Treas. Reg. 1.482-4(a) 를 통해 발표된 네가지의 방법 중 하나에 따라 판단한다:

• Comparable Uncontrolled transaction (“CUT”)
• Comparable Profits Methods (“CPM”)
• Profit Split or
• Unspecified Method

이슈 3을 판단하기 위하여 조사원은 경제 전문가와의 협업을 통하여 미국 계열사와 해외 모사 사이에서 발생된 무형 자산의 이전 또는 사용 대가가 무형 자산의 사용으로 창출된 소득과 상응하는지 신중히 검토해야 한다.

Take Away: 미국 계열사가 무형 자산의 사용을 위해 해외 기업에게 지불하는 로열티나 라이센스 비용에 대한 IRS의 검열이 엄격해지고 있다. 따라서 이와 관련된 거래 내역이 있는 기업들은 세금 보고를 위해 적절한 증빙 서류 (contemporaneous documentation)를 준비해 놓을 것을 권한다.

[Reference: IRS Practice Unit - License of Foreign Owned Intangible Property to U.S. Entity.pdf]

Royalty or License Payment for Intangible Property Owned by Foreign Affiliate

The IRS recently released a “practice unit” that provides guidance concerning outbound payment of royalties for the use of Intellectual properties owned by foreign affiliates.  The practice unit provides guidance for IRS examiners audit tactics and focus areas for specific leading international and transfer pricing issues and transactions.  [The IRS publication is attached for your reference.]

The IRS recognizes that many foreign businesses own valuable intangible property (“IP”) which is transferred to or used by their related U.S. entities for exploitation in the U.S. market.  Such transaction(s) have substantial impact to U.S. government’s revenue collection and this practice unit provides guidance in examining the following identified potential issues:

Issue 1:  What IP has been licensed from foreign parent (“FP”) by U.S. subsidiary (“USS”)?

Issue 2:  Did USS pay an arm’s length consideration for the license of IP to FP?

Issue 3:  Was the consideration commensurate with income attributable to the IP?

To address the Issue 1, the examiner is instructed to verify the substance of the transaction - whether IP has been licensed or transferred based on the facts and circumstances.   The examiner needs to review various documents to address the following fact elements:

• Is there a license of IP between controlled parties?
• What type of IP is being licensed?
• Determine what rights to the IP were licensed?

To address the Issue 2, the examiner is instructed to design audit program to confirm if the consideration paid by USS is within the arm’s length range.  Arm’s length consideration must be determined under one of four methods listed in Treas. Reg. 1.482-4(a):

• Comparable Uncontrolled Transaction (“CUT”),
• Comparable Profits Method (“CPM”),
• Profit Split or
• Unspecified Method

To address the Issue 3, the examiner must work with an economist to determine if the consideration for the transfer of IP from FP to USS is commensurate with the income attributable to the IP.

Take Away:  We are seeing an increasing scrutiny by the IRS concerning outbound royalty or license payment by U.S. entity for IP owned by foreign affiliates.  It is recommended that an adequate documentation is prepared contemporaneously to support tax filing position related to such transaction.

[Reference: IRS Practice Unit - License of Foreign Owned Intangible Property to U.S. Entity.pdf]

Proposed Regulations to Change Audit Process of Partnerships

 The IRS reissued proposed regulations to substantially change the audit process of Partnerships. Once finalized, these proposed regulations are effective to partnership tax years beginning after December 31, 2017.  There are two main provisions of the regulations that taxpayers should be aware of.

Audit Adjustment at Partnership Level -  Under the current partnership regime, unless partnerships are required to furnish more than 100 Schedule K-1s, partnership income adjustments resulting from IRS examinations are assessed at the partner level, reflecting each partners’ tax situations (e.g. tax rates, carryforwards, offsets, credits, exemptions and deductions).  If any underpayment/ adjustment is assessed from the examination, the individual partner is responsible for payment.

However, under the new rules, any adjustments made by the IRS must be paid by the partnership – the imputed underpayment.  The imputed underpayment is calculated by multiplying the total partnership adjustments by the highest rate of federal income tax in effect without regard to each partners’ marginal tax rates or tax attributes.  The new regime streamlines the audit process yet assesses tax at highest tax rates.  However, a partnership can elect to instead have the partners in the partnership to take into account the audit exam adjustments.  Such election should be considered on an annual basis.

Tax Matters Partner – A partnership may designate any person with a substantial presence in the United States as a representative.  The representative does not have to be a partner.  If such designation is not made by the partnership, the IRS may select any person as a partnership representative who will be responsible to respond to the IRS during the examination.  The representative has the sole authority to act on behalf of the partnership and all of its partners’ matters related to the examination, including agreeing to settlements, agreeing to examination adjustments, and statute of limitation extensions.