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The Proskauer Tax Blog

EU Council Agrees on Final Anti Tax Avoidance Directive

We wrote in February (European Commission Publishes Anti Tax Avoidance Package) about the draft EU Anti Tax Avoidance Directive (“ATAD”).

On 21st June 2016, the EU Council agreed on the final text of the ATAD and it will be adopted in the next Council meeting, which is scheduled for 12th July.

The Council had reached agreement on 17th June but certain Member States had requested additional time to consider its position.

The final ATAD includes measures in respect of the following topics:

  • Interest deduction limitation;
  • Exit taxation;
  • General abuse of law;
  • Controlled foreign companies (CFC); and
  • Hybrid mismatches.

Interestingly, the original proposal concerning a “switch-over” clause, which would have limited Member States’ ability to apply tax exemptions for income from low-taxed foreign subsidiaries and permanent establishments, was not adopted in the final version.

There have been some changes to the original draft text. The CFC provisions were debated significantly, for example. In effect, the final rules will treat as a CFC an entity or permanent establishment that that is taxed at less than 50% of tax rate applicable in the controlling company’s home Member State.

It is expected that the Member States will have until 31st December 2018 to implement the ATAD into their national law, except for the exit taxation rules, where the time limit will be 31st December 2019. The implementation of the interest deduction limitation provision may be postponed until 1st January 2024 in some circumstances, pending the OECD reaching agreement on a minimum standard (in situations where Member States have targeted rules that are equally effective to the interest limitation rules).

How these proposals will be integrated into the various Member States’ existing (often complex and sophisticated) anti-avoidance legislation remains to be seen, particularly in the light of the outcome of the OECD BEPS Action Points, which cover several of the same areas but in overlapping and sometimes conflicting ways.

The final proposal can be found at this link: Council June ATAD

The Tax Consequences of John Oliver’s $15 Million Medical Debt Forgiveness

It was widely reported that on the June 5 episode of the HBO program, Last Week Tonight, John Oliver forgave nearly $15 million of medical debt. That’s not quite right. This blog explains what really happened and why the forgiveness did not cause the debtors to recognize “cancellation of debt income” (“COD”) for federal income tax purposes. Proskauer helped structure the debt forgiveness and, on a pro bono basis, represented RIP Medical Debt, the charity that actually forgave the debt.

The Tax Consequences of Debt Forgiveness

Under section 61(a)(12) and section 1.61-12 of the Treasury regulations, generally when debt is forgiven, the taxpayer is taxable. So if an individual borrows $100, and then the creditor forgives the debt, the debtor generally has taxable income, and has to pay tax on the $100 of forgiven debt.

Section 108 provides certain exceptions to this general rule, but the exceptions are limited. For example, COD is not recognized when the debtor is insolvent or the debtor in a bankruptcy proceeding under title 11 of the United States Code. Some of the debtors whose debt was forgiven on Last Week Tonight might have qualified for one of the exceptions, but many would not have.

Therefore, if John Oliver (or, more precisely, his corporation, Central Asset Recovery Professionals, also known as “CARP”) had simply forgiven the debt, the debtors might have been taxable on the amount forgiven. Fortunately, that’s not what John Oliver actually did. Instead, he donated the debt to Medical Debt Resolution, Inc., which goes by the name, “RIP Medical Debt” (“RIP”). RIP is a Section 501(c)(3) charity whose purpose is to provide charitable aid by purchasing and forgiving the medical debt of poor people. RIP forgave the debt as a gift to the debtor out of “detached and disinterested generosity.” And that is why the debtors were not taxable.

Section 102(a) provides that gross income does not include the value of property acquired by gift. In other words, gifts are tax-free. Unfortunately, there is no definition of gift in the Internal Revenue Code. The Supreme Court in Commissioner v. Duberstein held that a gift “proceeds from a detached and disinterested generosity” and is made “out of affection, respect, admiration, charity or like impulses,” but doesn’t include a transfer that is made “from the constraining force of any moral or legal duty, or from the incentive of anticipated benefit of an economic nature.” In short, the donor has to have a pure heart for a “gift” to be a gift for tax purposes.

What would have happened if John Oliver’s corporation had forgiven the debt itself?

No one really knows. John Oliver is a decent sort of guy. But would his corporation have been proceeding out of detached and disinterested generosity, or in part to boost John’s ratings?

That’s where RIP comes in. RIP does have a pure heart. Its sole purpose is to forgive debt to help poor people. The Internal Revenue Service has held that “In general, a payment made by a charity to an individual that responds to the individual’s needs, and does not proceed from any moral or legal duty, is motivated by detached and disinterested generosity.” Rev. Rul. 2003-12, 2003-3 I.R.B. 283; Rev. Rul. 99-44, 1999-2 C.B. 549. And the IRS has ruled a number of times that when a charity acts out of detached disinterested generosity in making payments to victims or other members of a charitable class, the payments are nontaxable gifts. I.R.S. INFO 2013-0007 (Mar. 29, 2013); I.R.S. INFO 2013-0008 (Mar. 29, 2013); I.R.S. INFO 2010-0243 (Dec. 30, 2010).

Patients and poor people are each charitable classes. Medical debt is typically incurred by uninsured patients. RIP’s gifts of the forgiven debt to these members of charitable classes were made with a pure heart and therefore should constitute tax-free gifts.

Proskauer’s Commitment to Pro Bono

Proskauer is proud of its distinctive pro bono program, of which our assistance in connection with this comedic yet moving project is only one of many examples. Proskauer’s pro bono program offers significant opportunities to our lawyers at every level of experience in each of our offices and practice areas. The clients we help pro bono include community groups, refugees, veterans, domestic violence and human trafficking victims, visual artists and musicians, and Holocaust survivors, as well as lesbian, gay, bisexual and transgender individuals and interest groups. Our lawyers have also played a crucial role in shaping important issues such as gender rights, voting rights, prisoner rights (including a current Tax Department project connected to a recent statutory change benefiting wrongfully incarcerated individuals) and religious freedoms. We also work with our commercial clients to help find opportunities for their in-house lawyers and others in their organizations to participate in pro bono projects.

We believe that introducing associates to pro bono work early in their careers will help infuse them with a continuing commitment that will last through their entire career in the law. We view pro bono as an opportunity to impact others positively while developing professionally and personally, and we are pleased to be able share this example with our readers.

New IRS Regulations Subject Certain Partners to Self-Employment Taxes

On May 3, 2016, the U.S. Department of the Treasury issued new temporary and proposed regulations (Temp. Treas. Reg § 301.7701-2T) addressing the tax treatment of partners of a partnership that is the sole owner of an entity that is not a corporation (a “disregarded entity”) that employs the partners.  The regulations provide that for employment tax purposes, these partners are not employees of the disregarded entity and instead are treated as self-employed individuals for federal employment tax and benefit plan purposes.

While a disregarded entity is ignored for federal income tax purposes, it is still treated as a corporation for federal employment tax purposes.  However, a disregarded entity is not treated as a corporation for self-employment tax purposes. Accordingly, an individual owner is responsible for self-employment taxes on the net earnings of a disregarded entity owned by the individual.  See Treas. Reg § 301.7701-2(c)(2).

The recently issued temporary regulations provide that the rule that a wholly owned disregarded entity is disregarded for self-employment tax purposes also applies to partners in a partnership owning a disregarded entity. Characterizing such partners as self-employed individuals with respect to the disregarded entity subjects them to self-employment taxes. Additionally, self-employed partners are unable to participate in certain tax-favored benefit plans offered by the disregarded entity, such as “cafeteria” or Section 125 flexible spending and dependent care programs and are ineligible to exclude employer-provided accident and health plans from gross income.

The effective date of the temporary regulations is the later of August 1, 2016, or the first day of the latest starting plan year following May 4, 2016, of an affected health or retirement plan sponsored by a disregarded entity.

IRS Proposed Regulations Under Section 305(c)

In April, the IRS issued proposed regulations interpreting deemed distributions under Section 305(c). Specifically, the proposed regulations would clarify the amount and timing of deemed distributions that result from an adjustment to the right to acquire stock. These regulations will generally apply to deemed distributions occurring after they are finalized, but may be relied upon for deemed distributions occurring on or after January 1, 2018.

Section 305 governs situations where a corporation distributes its own stock or rights to acquire such stock. Although stock dividends are generally not taxable to the shareholders of such a corporation, Section 305(b) includes five exceptions to this general rule. Under Section 305(c), Congress specifically provided the Treasury Department the ability to promulgate regulations to expand the exceptions to the general rule to certain changes to warrants, options, instruments convertible into stock and other rights to acquire stock. Although the Treasury Department believes the current regulations are clear as to what constitutes a change that will be considered a taxable deemed distribution, it felt that they are unclear as to the amount and timing of the deemed distribution. The proposed regulations address these two areas. In addition, the proposed regulations provide guidance as to when and how a withholding agent must withhold on the deemed distribution.

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New Public Country-by-Country Reporting of Financial Information Proposed by European Commission

Country-by-country reporting (“CBCR”) is one of the OECD BEPS deliverables (under Action 13). It is expected to be a significant tool used by tax authorities’ auditors in evaluating a multinational group’s transfer pricing policies. CBCR will present significant challenges to multinationals groups’ internal tax departments, as the tax departments must reconcile public financial reports to their legal entities’ books and accounts and to local tax returns and country-by-country template reports. CBCR is also expected to be used by journalists and politicians to challenge the tax positions of multinational groups, where information can be accessed publicly.

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California “Waiting Time Penalties” Are Not Wages For Federal Income Tax Purposes

Our colleagues over at Proskauer’s ERISA Practice Center Blog have noted that a recent IRS information letter confirms that “waiting time penalties” paid under California law are not wages for federal income tax withholding purposes. Please click here for the full post and please see Chief Counsel Advice Memorandum 201522004 and IRS Information Letter 2016-0026 for additional information and guidance on this matter.

Proskauer Enhances Transactional Tax Capabilities with Addition of Partner David S. Miller

The Proskauer Tax Department is pleased to announce that David Miller has joined as a partner in our New York office.

Miller-David-2385-Web-195x230David advises clients on a broad range of domestic and international corporate tax issues. His practice covers the taxation of financial instruments and derivatives, cross-border lending transactions and other financings, international and domestic mergers and acquisitions, multinational corporate groups and partnerships, private equity and hedge funds, bankruptcy and workouts, high-net worth individuals and families, and public charities and private foundations. He advises companies in virtually all major industries, including banking, finance, private equity, health care, life sciences, real estate, technology, consumer products, entertainment and energy.

David has been consistently recognized by leading industry publications, such as Chambers Global, Chambers USA, Best Lawyers and The Legal 500, and in 2008 was the chairman of the Tax Section of the New York State Bar Association. David is strongly committed to pro bono service, and has been recognized by a number of leading legal public interest organizations.

David’s complete biographical and contact information may be accessed by clicking here.

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