International Tax Monthly August 2017


IRS Launches CbC Reporting Pages and FAQs

The IRS recently introduced its new Country-by-Country reporting website pages and published frequently asked questions related to the reports.

The IRS CbC website includes a CbC reporting guidance page (http://bit.ly/2v3lxin) that contains links to the final CbC Treasury Regulations on filing for early reporting periods, model competent authority arrangements, OECD guidance, and forms and instructions.

CbC reporting is part of Action 13 of the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) Action Plan, which is intended to promote greater transparency by providing tax administrations with relevant and reliable information to conduct high-level transfer pricing risk assessments.

To accomplish this, a competent authority will automatically exchange CbC reports prepared by multinational enterprise (MNE) groups with a reporting entity in its jurisdiction with partner jurisdiction competent authorities in all jurisdictions in which the MNE group operates. This will occur only if:

• A legal instrument allowing for the automatic exchange of information (for example, double taxation convention (DTC) or tax information exchange agreement (TIEA)) is in force, and

• A competent authority arrangement (CAA) for the exchange of CbC reports is operative with such second-mentioned jurisdictions.

The ultimate parent entity of a U.S. MNE Group with $850 million or more of revenue in the relevant preceding annual reporting period will file Form 8975, “Country-by-Country Report,” and Schedules A, “Tax Jurisdiction and Constituent Entity Information,” with its annual income tax return.

Here’s an edited version of the most commonly asked questions on this issue. The full FAQs can be found here: http://bit.ly/2vCrQ9K.

Q. Does the IRS intend to follow the OECD schema as part of electronically filing Form 8975?

For U.S. reporting, Form 8975 and Schedules A will be filed using an IRS-approved eXtensible Markup Language (XML) schema that’s compatible with the Modernized e-File (MeF) system. However, when the IRS conducts international exchanges with partner jurisdictions under a double taxation treaty or tax information exchange agreement and a competent authority arrangement, the IRS will use the approved OECD XML schema. The MeF schemas and business rules are now available through the Registered User Portal and your e-Services mailbox.

Q. How will the IRS use CbC data?

The data will be used by the IRS in conjunction with other taxpayer data for high-level assessment of transfer pricing, and other BEPS tax risks, and for economic and statistical analysis. The assessments and analyses will be done in accordance with the OECD guidance on appropriate use of CbC reporting information (.pdf) and in accordance with our DTC and TIEA obligations and CAA commitments.

Q. Which tax jurisdictions does the IRS have CAAs with for the automatic exchange of CbC reports?

The U.S. competent authority is committed to entering into CAAs with those jurisdictions within the Inclusive Framework that have a legal instrument allowing for the automatic exchange of information with the United States. In addition, the United States will need to determine that the jurisdictions have appropriate safeguards to ensure that the information received remains confidential and is used solely for tax purposes, and that they have the infrastructure for an effective exchange relationship.

Q. When will the United States start exchanging CbC reports with other tax jurisdictions?

Consistent with the OECD guidance, the United States intends to begin exchanging CbC reports no later than June 2018.

Q. How do I report instances (or suspicions) of unauthorized disclosure or misuse of exchanged tax information?

Visit http://bit.ly/2vCKChn for guidance. When reporting such instances, you shouldn’t include information that could identify a taxpayer, such as a taxpayer identification number or Social Security number.

Q. When can I file Form 8975?

Beginning on September 1, 2017, Form 8975 and Schedules A may be filed for a reporting period with the income tax return for the taxable year of the ultimate parent entity of the U.S. MNE group with or within which the reporting period ends. Form 8975 and Schedule A are now available on IRS.gov.

Q. Is the United States allowing transitional filing options for MNE groups with an ultimate parent entity in a tax jurisdiction that requires Country-by-Country reports for periods that begin after January 1, 2016, or “parent surrogate filing”?

Yes. And an ultimate parent that files (or has filed) an income tax return for a taxable year without a Form 8975 attached and wishes to file a Form 8975 for an early reporting period must follow the procedures for filing an amended income tax return and attach Form 8975 and Schedules A to the amended return. Those doing so for an early reporting period must do so within twelve months of the close of the taxable year that includes the early reporting period. More information is available in IRS Revenue Procedure 2017-23.

Q. How are U.S limited liability companies (LLCs) reported on Form 8975?

Generally, U.S. LLCs that don’t elect to be treated as corporations for federal income tax purposes are treated as “stateless,” and their financial and employee information should be provided on a Schedule A (Form 8975) for stateless entities.

However, such an LLC that’s wholly and directly owned by a business entity, which is organized and has its tax jurisdiction of residence in the United States, will be considered to have its tax jurisdiction of residence in the United States. If such an LLC owns another LLC, that entity also will be considered to be a U.S. business entity with its tax jurisdiction of residence in the United States.

For additional information about CbC reporting, consult your tax advisor.

Anti-Injunction Act Blocks Efforts for More Lenient Tax Treatment

The U.S. Court of Appeals for the District of Columbia Circuit, affirming a district court, has concluded that the Anti-Injunction Act barred the suit of taxpayers who didn’t meet the requirements of a streamlined compliance program but who nonetheless sought to have the court allow them to participate in that program.

The voluntary program was for persons who hadn’t properly complied with foreign account reporting requirements.

The Anti-Injunction Act does not bar all legal claims pertaining to taxation, but it does bar suits seeking to restrain the assessment or collection of taxes. Taxpayers have, however, a number of other ways to challenge the assessment and collection of taxes, including, for example, paying and suing for a refund.

Foreign Account Voluntary Compliance Programs

Since 2009, the IRS has had programs in place to encourage compliance by persons who aren’t complying with reporting requirements linked to foreign assets, accounts and income. Two of those programs are the Offshore Voluntary Disclosure Program (OVDP) and Streamlined Filing Compliance Procedures.

In 2014, the IRS introduced the streamlined procedures. To participate, a taxpayer had to comply with the following requirements, among others:

  • File three years of tax returns and six years of Reports of Foreign Bank and Financial Accounts (FBARs).
  • Pay tax and interest for three years.
  • Pay a miscellaneous Title 26 offshore penalty equivalent to 5% of the value of the taxpayer’s foreign assets.

The streamlined procedures are aimed at U.S. taxpayers whose failure to disclose their offshore assets was nonwillful.

Under transition rules or treatment, taxpayers already in an OVDP before July 1, 2014, were able to receive the favorable penalty terms of the streamlined procedures provided they remain in the OVDP. Specifically, a taxpayer is liable for only the 5%, not the 27.5%, miscellaneous offshore penalty. The benefit of nonprosecution letters remains available under the transition treatment because the participants never exit the OVDP.

Facts of This Case

After a number of years of failing to report funds held in foreign bank accounts, the taxpayers in the case at hand each entered the OVDP. Beginning in 2014, they tried to withdraw from that program and apply for the streamlined procedures. The IRS told them that they could enter the streamlined procedures only through transition rules.

The taxpayers didn’t claim that they’d paid all of the taxes and penalties they owed with respect to all the years relevant to the voluntary programs considered in this case. They claimed that they’d paid taxes for the three years covered by the streamlined procedures.

In addition, they argued that the IRS’s actions harmed them, so they sued to have the court allow them to directly enter the streamlined program. They also sought to retain benefits that are available only under the OVDP — specifically, assurances from the IRS that it wouldn’t refer matters for criminal prosecution for past tax years.

The Court Decisions

The U.S. District Court ruled that it didn’t have jurisdiction to hear the taxpayers’ suit. Because the taxpayers sought to restrain the assessment or collection of taxes and they had alternative remedies, the court held that the Anti-Injunction Act stripped it of jurisdiction.

The appeals court determined that the Anti-Injunction Act barred the taxpayers’ suit. It reasoned that the taxpayers, as participants in the 2012 OVDP, were required to pay eight years’ worth of accuracy-based penalties. These penalties were treated as taxes under the Anti-Injunction Act and any lawsuit that sought to restrain their assessment or collection was therefore barred.

This lawsuit, in which the taxpayers sought to qualify to enroll in the streamlined procedures, did just that because those procedures don’t require a participant to pay any accuracy-based penalties for the three years covered by the program. Accordingly, the taxpayers’ lawsuit, if successful, would have the effect of stopping the IRS from collecting accuracy-based penalties for which they’re currently liable. The appeals court concluded that this fact alone demonstrated that the Anti-Injunction Act barred their suit.

Court Rejects Two Contentions

The court rejected two of the taxpayers’ contentions:

1. They argued that their claim didn’t fall under the act’s scope because they sought only to apply for the streamlined procedures and that their eligibility to enroll alone had no immediate tax consequences. However, the court noted that it recognized the need to engage in a careful inquiry into the remedy sought and any implication that the remedy may have on assessment and collection. Here, the taxpayers conceded that they would enroll in the streamlined procedures if they were deemed eligible, thereby stopping the IRS from collecting the OVDP accuracy-based penalties.

2. The taxpayers also argued that their eligibility for, or enrollment in, the streamlined procedures wouldn’t necessarily prevent the IRS from collecting the accuracy-based penalties, because they would be liable for all taxes and penalties if the IRS determined that they’d either acted willfully in failing to report their overseas assets or had failed to comply with the requirements of the streamlined program. But the court found that the taxpayers’ attempt to take advantage of the streamlined program’s more lenient tax treatment might be thwarted by the possibility of an adverse IRS determination. This didn’t make their lawsuit one that was not brought for the purpose of restraining the assessment or collection of any tax.

The appeals court acknowledged that the Anti-Injunction Act doesn’t apply where the taxpayer has no other remedy for its alleged injury. As the district court noted, the taxpayers can pay their taxes and file a refund suit. This adequate “alternative avenue” means that the Anti-Injunction Act applies to them. (Maze v. IRS (CA DC 7/14/2017), 120 AFTR 2d 2017-5054)

High Court Refuses to Review Bank’s Foreign Tax Credits

The Supreme Court declined to review an appeals court ruling that the “trust” component of a Structured Trust Advantaged Repackaged Securities (STARS) transaction lacked economic substance.

Background: The U.S. Court of Appeals for the First Circuit had found that the trust transaction, which involved the participating bank transferring assets to a disregarded foreign trust and claiming credits for foreign taxes paid:

  • Had no legitimate business purpose, and
  • Absent the generation of foreign tax credits, provided no objective economic benefit.

Economic Substance

To determine whether a transaction has economic substance, courts usually make a two-pronged factual inquiry:

1. Was the taxpayer motivated by no business purpose (other than getting tax benefits) in entering into the transaction (subjective test)?

2. Did the transaction have objective economic substance — that is, was there a reasonable possibility of a profit (objective test)?

The economic substance doctrine allows the government to look beyond technical compliance with the Internal Revenue Code to ascertain the real nature of the transaction at issue.

Both the United States and foreign countries may tax the foreign-source income of U.S. taxpayers. To ease this double taxation burden, the tax code permits most U.S. taxpayers who pay income taxes to a foreign country to either deduct those taxes from gross income for U.S. purposes or credit them dollar for dollar against their U.S. income tax liability on foreign-source income.

Facts of the Recent Case

Sovereign Bancorp, Inc., later known as Santander Holdings USA, Inc., engaged in a STARS transaction promoted by the U.K.-chartered Barclays Bank PLC. As described by the court, the transaction featured Barclays receiving substantial benefits under U.K. tax laws and lending funds to U.S. banks at a lower cost than otherwise might be available to them.

As part of the STARS transaction, Sovereign created a trust to which it contributed $6.7 billion of income-generating assets. The trustee of the trust was made a U.K. resident so that the trust’s income was subject to U.K. income tax at a 22% rate. The trust income was also subject to U.S. income tax and was attributed to Sovereign. Sovereign paid the U.K. taxes and then claimed a foreign tax credit in calculating its U.S. income tax liability. This component of the transaction was referred to by the court as the “trust transaction.”

Over the course of a year, Barclays acquired a $1.15 billion interest in the trust, which it was required to sell back to Sovereign, for $1.15 billion, at the end of the transaction. Sovereign treated the $1.15 billion as a loan and claimed interest deductions on it. The trust engaged in certain actions that generated a U.K. tax benefit for Barclays in exchange for which Barclays made a monthly payment equal to half of the amount of U.K. taxes paid by Sovereign on the trust’s income that Sovereign netted against its interest obligation on the purported loan.

The IRS disallowed foreign tax credits claimed by Sovereign for 2003, 2004 and 2005. The tax agency claimed that the Barclays payment was effectively a rebate of the U.K. taxes paid, in that it relieved Sovereign of half the burden of its U.K. taxes. It further claimed that the STARS transaction as a whole was a sham without economic substance. Sovereign sued to recover $234 million in federal income taxes, penalties and interest.

Lower Court Decision

In 2013, the Massachusetts U.S. District Court granted Sovereign partial summary judgment that the Barclays payment should be accounted for as revenue to Sovereign in assessing whether Sovereign had a reasonable prospect of profit in the STARS transaction.

Sovereign then moved for summary judgment on its claims for refunds of taxes paid in 2003, 2004 and 2005, as well as deficiency interest assessed by the IRS. The district court again sided with Sovereign, upholding the legitimacy of both the trust and loan transactions and allowing Sovereign to claim interest deductions and foreign tax credits for the U.K. taxes paid. The court also found that, since the credits and interest deductions were properly claimed, Sovereign should not be assessed penalties.

Reversible Error

The First Circuit found that the district court had committed reversible error and that the government was entitled to summary judgment as to the economic substance of the trust transaction.

The court noted that it didn’t matter whether the Barclays payment was characterized as a rebate or income because, regardless, the trust transaction itself didn’t have a reasonable prospect of creating a profit without considering the foreign tax credits and thus was not a transaction for which Congress intended to give such a benefit.

The First Circuit found that the transaction was shaped solely by tax avoidance features, lacked a bona fide business purpose, and was “profitless,” in that the purported profit from the Barclays payment was more than negated by the costs of the transaction. The entire function of the trust transaction was exposure to U.K. taxation in order to generate foreign tax credits, which does not “advance the Tax Code’s interest in providing foreign tax credits in order to encourage business abroad or in avoiding double taxation.”

Contractual Remedies

The First Circuit also found it telling that the trust transaction lacked any real economic risk, as Barclays and Sovereign both had contractual remedies and took other steps to minimize such risk. It also noted that Sovereign’s U.K. tax liability was artificially generated through a series of “circular cash flows” through the trust, which, as noted above, existed just to generate the desired tax effect.

Accordingly, the First Circuit reversed the district court’s decision as to the economic substance of the trust transaction and the foreign tax credits claimed. The Supreme Court refused to review the First Circuit’s decision. (Santander Holdings USA, Inc. v. U.S. (CA 1 12/16/2016), 118 AFTR 2d 2016-6914, cert denied 6/26/2017)