On January 7, 2021, the Internal Revenue Service (the “IRS”) and the U.S. Department of the Treasury (the “Treasury”) issued final regulations[1] (the “Final Regulations”) providing guidance on Section 1061 of the Internal Revenue Code (the “Code”).[2] The Final Regulations modify the proposed regulations[3] (the “Proposed Regulations”) that were released in July of 2020. We previously discussed the Proposed Regulations with a series of “Key Takeaways” in our client alert published here. This post highlights certain changes made to the Proposed Regulations, and certain important provisions of the Proposed Regulations that remain unchanged in the Final Regulations. Continue Reading
Tax Proposals of President-Elect Biden and Other Prominent Democrats
This blog summarizes some of the tax proposals of President-elect Joe Biden and other prominent Democrats.
Narrowing of UK intermediaries’ DAC 6 reporting requirements
On 30 December, the UK government laid regulations that will significantly reduce the type of cross-border arrangement that will need to be reported by UK intermediaries under the so-called DAC 6 rules on 31 January 2021 and in the future.
In the last year or so, we have regularly written about DAC 6 in our Tax Talks blog and in our monthly UK Tax Round Up. As a reminder, DAC 6 is the wide ranging EU regime for reporting “cross-border tax arrangements” which requires certain “intermediaries” and taxpayers to report to HMRC a wide range of transactions entered into since 25 June 2018 that met a “hallmark” set out in the implementing EU Directive. In the UK the first reports in respect of reportable cross-border tax arrangements are due to be made by 31 January 2021.
As a result of finalising the UK-EU Trade and Cooperation Agreement (TCA) under which the UK and the EU have agreed how they will interact following the end of the Brexit transition period the UK’s obligation is solely to “not weaken or reduce the level of protection … below the level provided for by the standards and rules which have been agreed in the OECD … in relation to the exchange of information … concerning … potential cross-border tax planning arrangements [being the OECD’s Mandatory Disclosure Rules (MDR)]”. The UK has decided that compliance with the MDR reporting only requires reporting of cross-border arrangements meeting the conditions in the category D hallmarks under DAC 6, which relate to arrangements designed to circumvent reporting under the OECD’s Common Reporting Standards rules and/or to seek to hide the identity of the beneficial ownership of entities in the arrangements.
The new scope of DAC 6 reporting applies from 11 pm on 31 December 2020, so that the first reports (and future reports) under DAC 6 will only require reporting of these category D arrangements. This significantly narrows the range of transactions that might otherwise have had to have been reported on.
The government has also announced that it will consult on new reporting rules to implement the MDR as soon as practicable, and that these new rules will then replace DAC 6 in its entirety.
HMRC will update its guidance in due course to reflect these changes. Although the changes significantly narrow the scope of DAC 6 reporting requirements for the UK, the requirements set out in the applicable EU Directive continue to apply where an EU intermediary is involved in a transaction, so UK businesses (or their EU-based advisers) that are party to cross-border transactions involving the EU will still need to consider the full scope of DAC 6.
Coronavirus: President Trump Signs Consolidated Appropriations Act, 2021; Summary of the Tax Provisions
On December 27, 2020, President Trump signed into law the Consolidated Appropriations Act, 2021 (the “Act”). The Act enhances and expands certain provisions of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) (H.R. 748). This blog post summarizes the tax provisions of the Act.
Court of Appeal decides that Jersey companies were UK tax resident
In HMRC v Development Securities, the Court of Appeal (the “CA”) has overruled the Upper Tribunal and agreed with the First-tier Tribunal that the relevant Jersey incorporated subsidiaries of a UK parent were resident in the UK for tax purposes by reason of being centrally managed and controlled in the UK.
While of considerable interest, it should be remembered that the question of where a company is centrally managed and controlled is principally one of fact and so different facts might yield a different conclusion.
What the CA’s decision shows is that the line between non-UK and UK residence can be a fine one when it depends on whether the overseas company’s directors gave due consideration to the transaction as a whole or just to a small element of it, and that, accordingly, non-UK company boards should always make sure that they give proper consideration to the transaction as a whole, albeit informed by advice or recommendations that they might have received from the UK, to minimise the risk of being treated as UK resident.
By way of background, in this case the UK tax resident parent company of a group, Development Securities plc (“DS”), wished to implement a tax planning scheme whereby the group would use latent losses incurred on the acquisition of some of its subsidiaries and properties (the “Relevant Subsidiaries and Properties”) to offset other gains in the group.
In order to implement the scheme, three new companies were incorporated in Jersey as subsidiaries of DS and granted call options that entitled them to buy the Relevant Subsidiaries and Properties if certain conditions were satisfied. The options were exercised at a price in excess of the market value of the assets, and so not in the best interests of the Jersey subsidiaries considered in isolation. The Jersey-based directors of the Jersey subsidiaries approved the transactions on advice from DS and were then replaced by UK-resident directors so that the companies became UK tax resident. The Relevant Subsidiaries and Properties were transferred to other group companies and losses were crystallised on the transfer. Those losses were treated as accruing to DS as a result of an election made under section 179A of the Taxation of Chargeable Gains Act 1992.
HMRC challenged the tax residency of the Jersey subsidiaries arguing that the significant director level decisions as to whether to enter into the transaction were taken in the UK and not by the companies’ boards of directors in Jersey and that all that the Jersey companies’ directors considered was whether the transaction was legal under Jersey law.
The First-tier Tribunal decision
As was reported in the UK Tax Round Up in August 2017, the FTT accepted that all board meetings of the Jersey subsidiaries had a Jersey resident majority (three directors were Jersey resident and one director was UK resident), the board meetings were held in Jersey and the decisions were actually taken at those board meetings.
However, the FTT also found that given the uncommercial nature of the scheme transactions, the Jersey corporate law required the transactions entered by the Jersey subsidiaries to be approved by DS, the UK company.
Accordingly, the FTT had held that the central management and control of the Jersey companies was exercised in the UK by DS because the directors of the Jersey subsidiaries were approving the decisions that had already been taken by DS. Thus the Jersey companies were UK tax resident.
The Upper Tribunal decision
As reported in the Tax Talks on 19 June 2019, the UT overturned the FTT’s decision, ruling that the Jersey subsidiaries were resident in Jersey because the central management and control was exercised in Jersey and not in the UK.
Contrary to the FTT’s conclusion, the UT did not find that the transactions that the Jersey companies entered into were uncommercial because the subsidiaries were not disadvantaged due to the acquisition being funded by DS. Having analysed the Jersey corporate law, the UT concluded that the directors of the Jersey companies had only to satisfy themselves that the interests of the group’s parent were taken into account.
The UT agreed with the FTT’s finding that the single UK resident director acted by “rubber stamping” the decisions. However, the UT also found that the Jersey directors properly exercised their directors’ duties by considering the transactions in detail and concluding that they were in the interests of DS and therefore the Jersey companies.
The Court of Appeal
The CA has now overturned the UT’s criticism of the FTT’s findings and reinstated the FTT’s decision that the Jersey companies were UK tax resident. In particular, the CA noted that there was a misunderstanding by the UT as to the importance of the uncommercial nature of the transactions when considering that this issue was not a determining factor in the case.
Noting that the key test for where the central management and control of a company is exercised is set out in De Beers Consolidated Mines Ltd v Howe the CA agreed with the FTT in that the question of where the Jersey companies were tax resident required answers to (1) who was making the strategic and management decisions regarding the company’s business and (2) where were those decisions made. Both are a question of fact.
The CA noted that an important finding by the FTT was that the Jersey directors were, as a matter of fact, acting under instructions or orders from DS in confirming the lawfulness of their decision but without considering the merits of the decision. This led to a conclusion that the decision to enter into the relevant transactions was, in fact, taken by DS and not by the directors in Jersey.
All the Jersey directors were trying to ensure was that they were acting lawfully in implementing the instructions from DS, but this question was separate from the FTT’s key findings as to who made the decision to enter into the transactions and where that decision was made.
Analysis
This is an important decision in the line of cases considering the tax residence of overseas incorporated companies.
In Wood v Holden in 2006 it was held that mere influencing of the decision of the directors by a third party (e.g: a parent or third party adviser) does not necessarily lead to a conclusion that the central management and control is removed from the non-UK company’s directors.
In this case, it has now been held that the UK parent could be taken to effectively take the decision for the non-UK company by giving instructions to proceed with the specific transactions notwithstanding that the non-UK’s directors considered (or satisfied themselves of) the legality of the relevant transactions but did not give any decision to the merits of the transactions. This led to a conclusion that the central management and control was conducted by the parent and therefore in the UK and not in Jersey.
This case serves a reminder that the important line between (i) a decision taken by a non-UK resident board that is being influenced by a third party on the one hand and (ii) a decision that is being dictated by a third party on the other hand can be a fine one and will depend on a detailed analysis of the facts in each case.
Particular attention should be paid to foreign subsidiaries that are under the control of UK parent companies. Each case in which it is important to ensure that the central management and control is exercised outside the UK needs to be considered on its facts.
Careful consideration would need to be given to the overall pattern of decision-making by directors of a foreign subsidiary, analyzing any instructions, directions or guidance given by the parent entities in order to determine whether the level of control exercised over the subsidiary is such that it would inadvertently remove the control from the hands of its directors. It is also important to ensure that the board of a non-UK resident company does actively engage in the decision making process and in fact makes the relevant decision rather than follows a decision that was already taken by a third party.
It is possible that this case can be confined to its facts as it is likely that it was influenced by a number of unusual elements such as (i) uncommercial nature of the transactions, (ii) short period of incorporation of the Jersey subsidiaries, (iii) change of Jersey-based directors to UK resident directors and (iv) the single decision that had to be taken by the board in relation to specific transactions.
It remains to be seen whether the decision will be appealed to the Supreme Court.
Extension of FBAR Filing Deadline for Certain Filers
On December 9, 2020, the Financial Crimes Enforcement Network (“FinCEN”) issued Notice 2020-1, extending the filing deadline for the Report of Foreign Bank and Financial Accounts, FinCEN Form 114 (FBAR), for certain individuals with signature or other authority over (but no financial interest in) employer-owned foreign financial accounts to April 15, 2022. FinCEN has provided similar extensions over the previous nine years.[1] This new extension applies to reporters with signatory authority during the 2020 calendar year and to those individuals whose reporting deadline was extended under prior notices.[2] All other filers must still file by April 15, 2021, although FinCEN will grant an automatic extension until October 15, 2021.
As reported in our prior client alerts,[3] the FBAR must be filed by a U.S. person that holds a financial interest in, or signature or other authority over, a foreign financial account if the aggregate value of all such U.S. person’s foreign financial accounts exceeds $10,000 at any time during the year. FBAR proposed regulations released in March 2016 and referenced by Notice 2020-1 would expand and simplify the category of persons exempted from filing an FBAR who have signature or other authority over, but no financial interest in, a foreign financial account where another U.S. filer is filing an FBAR with respect to the same account. These FBAR proposed regulations will not take effect until and unless they are adopted in final form. Until such time, the existing procedures for FBAR filings remain in effect, subject to the extension provided in Notice 2020-1.
Potential filers should note that the scope of individuals covered by Notice 2020-1 is broader than that of the FBAR proposed regulations. As described above, the FBAR proposed regulations exempt certain persons with signature or other authority over, but no financial interest in, certain foreign financial accounts from filing an FBAR only if another U.S. filer is filing an FBAR with respect to the same account. Under Notice 2020-1, however, these individuals are not obligated to file an FBAR, regardless of whether another U.S. filer is filing an FBAR with respect to the same account. It is unclear whether the final regulations, when issued, will only excuse an individual with signature or other authority over, but no financial interest in, a foreign financial account where another U.S. filer is filing an FBAR with respect to the same account or will eliminate this requirement to qualify for the exception. As a result, since the Notice grants an extension only until 2022, employees of registered investment advisors with signature or other authority over, but no financial interest in, a non-U.S. account could have to file an FBAR if the FBAR proposed regulations are finalized in their current form.
[1] The previous notices granted extensions to (1) officers and employees of covered entities with signature or other authority over, but no financial interest in, a foreign financial account of a controlled person (a controlled person is a United States or foreign entity more than 50 percent owned, directly or indirectly, by a covered entity), (2) officers and employees of a controlled person of a covered entity with signature or other authority over, but no financial interest in, a foreign financial account of the entity, the controlled person, or another controlled person of the entity, and (3) officers and employees of investment advisors registered with the Securities and Exchange Commission with signature or other authority over, but no financial interest in, the foreign financial accounts of persons that are not registered investment companies.
[2] See Notices 2019-1, 2018-1, 2017-1, 2016-1 2015-1, 2014-1, 2013-1, 2012-1, 2012-2, 2011-1, and 2011-2.
[3] June 16, 2011: “Delayed FBAR Filing For Signatory Authority” (http://www.proskauer.com/publications/client-alert/delayed-fbar-filing-for-signatory-authority) and March 14, 2011: “FinCEN Issues Final Rules on FBAR.” (http://www.proskauer.com/publications/client-alert/fincen-issues-final-rules-on-fbar).
IRS issues new FAQs on the interaction between the employee retention tax credit and PPP loans in M&A transactions
On November 17, 2020, the U.S. Internal Revenue Service (“IRS”) posted new FAQs providing that an acquisition of the stock or assets of a company that has received a loan under the Paycheck Protection Program (the “PPP”) generally will not cause the acquirer and members of its aggregated employer group (as defined below) to jeopardize their employee retention tax credits (“ERTCs”). While the FAQs expressly provide that they cannot be relied upon by taxpayers, and could be withdrawn at any time, the posting of these FAQs is a very welcome development after months of requests for guidance. Although not specifically addressed by the FAQs, the approach taken in the FAQs would presumably be applied to transactions regardless of whether they occurred before or after the posting of the new FAQs.
First, the FAQs provide that if a target company has repaid a PPP loan or submitted a PPP loan forgiveness application and established an interest-bearing escrow account prior to the date the stock of the target is acquired by an unrelated acquirer, the acquirer will not be treated as having received a PPP loan, and, therefore, the acquirer (and any member of its aggregated employer group, including the target) may claim ERTCs for wages paid after the closing date, and the acquiring employer’s ERTCs for wages paid before the closing date will not be subject to recapture.[1]
Moreover, a target that has not repaid a PPP loan or established an escrow account prior to the date of the acquisition will not jeopardize ERTCs of the acquirer or its aggregated employer group, whether taken before or after the acquisition date. However, the target will be ineligible for ERTCs before and after the acquisition date.
The FAQs also confirm that an acquirer that acquires the assets of a target that has received a PPP loan will not be treated as having received a PPP loan for purposes of the ERTC by reason of the asset acquisition if the acquiring employer does not assume the target’s obligations under the PPP loan. In this case, the acquiring employer (including any member of its aggregated employer group) may claim ERTCs for wages paid after the closing date, and the acquiring employer’s ERTCs for wages paid before the closing date will not be subject to recapture.
Finally, the FAQs provide that an acquirer that acquires the assets of a target that has received a PPP loan and assumes the target’s obligations under the PPP loan will not be treated as having received a PPP loan for purposes of the ERTC. However, wages paid to employees that were employed by the target (and, presumably, members of the target’s aggregated employer group, as described below) on the closing date will not qualify for the ERTC. Otherwise, the acquirer and any member of its aggregated employer group may claim ERTCs for wages paid after the closing date, and the acquiring employer’s ERTCs for wages paid before the closing date will not be subject to recapture.
The FAQs do not address whether a target that is acquired by an acquirer that has received a PPP loan may claim the ERTC. However, it would be entirely consistent with the FAQs to conclude that such a target may claim the ERTC.
Background
The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) (H.R. 748) provides certain employers with an ERTC equal to 50% of certain qualified wages paid to employees from March 13, 2020 through December 31, 2020.[2] The ERTC can be used to offset federal payroll taxes such as federal wage withholding tax and the employer’s and employee’s share of social security tax and Medicare, but not the federal unemployment tax. While the ERTC is capped at $5,000 per employee, it can be significant in the aggregate: for a company with 1,000 employees, the ERTC may be as much as $5 million.
The CARES Act also provides for PPP loans and provides that PPP loans may be forgiven if certain conditions are satisfied. However, to prevent double tax benefits, the CARES Act provides that an “employer” (including members of its aggregated employer group, as described below) cannot claim the ERTC if it has received a PPP loan (unless it repaid the loan by May 18 as part of the “safe harbor” for withdrawal from the PPP program). This is so regardless of when the loan was granted.
Corporations related through greater than 50% ownership (by vote or value) are treated as members of an aggregated employer group. Also, chains of organizations (whether or not incorporated) conducting trades or businesses may be treated as an aggregated employer group if they are under common control. The test for common control depends on the types of organizations in the chain of ownership, but generally requires that corporations be connected through ownership of greater than 50% of the vote or value of each corporation and partnerships be connected through ownership of more than 50% of profits or capital.[3] Importantly, constructive (or deemed) ownership rules apply, so there may be affiliation even where not readily apparent from the face of a cap table.[4]
Without further guidance, the statutory rules described above suggest that an acquisition by an employer could result in the denial and forfeiture (i.e., recapture) of the ERTC for the acquiring employer (including any member of its aggregated employer group). For example, if a target has taken out a PPP loan, the statute appears to prohibit an acquiring employer (including any member of its pre-transaction aggregated employer group) from claiming the ERTC if it acquires a greater than 50% ownership stake in a target with a PPP loan, and to recapture any ERTCs it has already claimed. The converse also appears to apply – for example, if the acquirer has taken out a PPP loan, the target employer may be required to forfeit its ERTCs if the transaction causes the target employer to become a member of the acquirer’s aggregated employer group.
Thus, while the FAQs provide taxpayers with helpful guidance, they may not be relied upon by taxpayers, and the statute itself is unhelpful for acquirers acquiring stock of a target that has taken out a PPP loan and not repaid it by May 18. Similarly, employers that acquire the assets of a target that has received a PPP loan and assume the target’s obligations under the PPP loan cannot be certain under the statute that the assumption of the PPP loan will not cause them to be prohibited from claiming ERTCs and/or subject to recapture on any ERTCs that they have already claimed.
Although there have been multiple legislative proposals to permit an employer that receives a PPP loan to receive the ERTC by electing either to exclude qualified wages from “payroll costs” for purposes of determining its loan forgiveness under the PPP or to exclude qualified wages for purposes of calculating the ERTC, none of these proposals have directly addressed the interaction of PPP loans and the ERTC in the context of mergers and acquisitions.[5]
Conclusion
The approach taken in the IRS FAQs is taxpayer-friendly and provides some relief to ease taxpayer concerns that an acquisition of a target with a PPP loan would cause an employer to jeopardize its ERTC. However, the FAQs may not be relied on by taxpayers, and, therefore, are of limited use. Also, the FAQs do not address the treatment of a target with ERTCs that is acquired by an acquirer with an outstanding PPP loan.
[1] The IRS notes that the target must fully satisfy (i.e., repay) the PPP loan in accordance with paragraph 1 of the Small Business Administration Notice, effective October 2, 2020 (the “SBA October 2 Notice”), or submit a forgiveness application to the PPP lender and establish an interest-bearing escrow account in accordance with paragraph 2.a of the SBA October 2 Notice.
[2] Please see our blog post for more information on the ERTC.
[3] There are three ways common control is established: (i) a parent-subsidiary controlled group, where one or more chains of organizations are connected with a common parent through more than 50% ownership, (ii) a brother-sister controlled group, where two or more organizations are owned by 5 or fewer persons who are individuals, estates or trusts that own 50% or more of each organization, and more than 50% of the ownership of each organization is identical with respect to each organization, and (iii) a group of three or more organization, each of which is a member of a group of organizations described in (i) or (ii) above, in each case, the ownership percentage is based on vote or value of each corporation or profits or capital of each partnership. For this purpose, “common control” is determined based on this technical 50% ownership test, rather than the broader notion of “control” or “affiliate” from a corporate perspective or as used in the CARES Act for PPP loan purposes.
[4] In addition, even if there is minimal or no ownership overlap between entities, they could be treated as an aggregated employer group under the “affiliated service group” rules. An affiliated service group can arise if there is a service organization that regularly performs services for another organization. For example, organizations may be treated as part of an affiliated service group if the principal business of one organization is to regularly and continuously perform management services to another organization (or certain of its related organizations). Accordingly, a fund manager may be treated as part of an aggregated employer group with the portfolio companies it manages.
[5] For a summary of these proposals, please see our blog post.
