A number of states have recently proposed or passed new laws related to state-level taxation, some of which are taxpayer-friendly and some of which are expected to impose additional tax burdens on taxpayers. They vary in subject from efforts by states to mitigate the new federal limitation on the deductibility of state and local taxes to proposed changes to state income taxation of “carried interest.” This update reflects some of those recent proposals and laws.
Finance Bill 2019 – Proposed relaxation of entrepreneurs’ relief rules
The proposed amendment to entrepreneurs’ relief (“ER”) in Finance Bill 2019 is designed to address one of the outstanding issues with the current law when dilution of a company results in the loss of ER. Under the current rules, a shareholder who has held, for at least 12 months prior to disposal, at least 5% of both the ordinary shares and 5% of the voting rights in a trading company (or holding company of a trading group) and is also an officer or employee of the relevant company can benefit from a lower rate of capital gains tax (10%) on the chargeable gain at time of disposal.
However, an issue of new shares, usually upon a new investment into the company, can reduce an individual’s percentage shareholding below the required 5% holding threshold. If this occurs, the individual would lose any ER completely, even in respect of the gain which accrued when the required threshold was satisfied. This consequence has been seen as a barrier to growth for companies.
The proposed amendment will allow individuals, where an issue of shares will lower their holding below the 5% threshold, to elect to crystallise a gain by deeming a disposal and reacquisition of their shares or securities at market value immediately before an issue of shares. Any gain that has accrued up until that point will still qualify for the lower, 10% rate of capital gains tax. The individual can also elect to carry forward the gain, retaining the 10% ER rate, to a time when the individual actually sells the shares to avoid a dry tax charge. Further gains which accrue after the issue of shares will be taxed at the standard 20% CGT rate.
The new proposals will only apply where the share issue which creates the dilution is made wholly in cash, for genuine commercial reasons and not to secure a tax advantage. The new rules will apply for share issues which occur on or after 6 April 2019.
UK Finance Bill 2019 published – UK commercial property tax regime for non-resident investors to change, but some relief for trading businesses
On 6 July 2018 the UK Finance Bill 2019 was published by the UK Government. The draft Finance Bill contains the details of the new regime on taxation of non-UK resident investors in UK real estate that had been proposed in a consultation by HMRC following the November 2017 Budget (see Proskauer Tax Talks blog entry of 22 November, here). The rules will come into force on 6 April 2019 and, for the first time, the charge to UK capital gains tax will be extended to include gains made by non-UK investors in UK commercial property and in certain “property-rich” vehicles.
In general, the structure of the new regime will be as proposed in the November consultation with a few amendments. One of the key changes from the consultation is the inclusion in the draft legislation of an exception from the scope of the new charge for trading entities (described in more detail below).
Alongside direct disposals of UK land, disposals of “property-rich” assets will be caught by the new legislation (such as shares in a company) that derive at least 75% of their value from UK land. Where a number of companies or other entities are disposed of in a single arrangement, the assets of all of the entities will be aggregated in order to establish whether this 75% test is satisfied. Indirect disposals will be within the charge to tax where the investor holds at the date of the disposal, or has held within two years prior to disposal, a 25% or more interest in a property-rich asset (either directly or through a series of entities). This test has been relaxed from the consultation, as the draft Finance Bill reduces the look-back period from five years to two, and includes an additional exception allowing an investor to disregard a holding of 25% or more during the two years prior to a disposal if the holding was only greater than 25% for an insignificant proportion of the total length of the holding period.
Under the revised proposals in the Finance Bill, an offshore investor will be exempt from UK tax on any gain on disposal of a property-rich company if the investor can reasonably conclude that the underlying UK land is, to all but an insignificant extent, used in the course of a trade carried on by the company or a person connected to the company. The trade must have been ongoing for 12 months prior to the disposal, and must be expected to continue. How this exemption will be applied in practice remains to be seen, but this could be an important development for investors in companies carrying on UK businesses such as hotels and some retail businesses.
The rebasing rules as proposed in the consultation have also been relaxed in the draft Finance Bill:
- Investors will now be able to rebase their holding in indirect assets to April 2019 market value – this is something that had been lobbied for by the industry and is a helpful change. Previously rebasing was only going to be possible for direct disposals of UK property.
- Non-UK resident companies which become UK resident after April 2019 will also now be able to elect to rebase to the April 2019 value.
Disappointingly, the application of the new law to collective investment vehicles, in particular real estate funds, will be the subject of further consultation by HMRC.
Digital Economy: Supreme Court Overturns Physical Presence Requirement for State Sales Tax
In a landmark decision changing course on decades of precedent, the United States Supreme Court decided on June 21, 2018 South Dakota v. Wayfair, Inc., et al. Justice Kennedy, writing for the Court’s 5-4 majority, expressly overruled the physical presence rule established over fifty years ago in Bellas Hess[1] and affirmed over twenty-five years ago in Quill,[2] which prohibited states from collecting sales tax from online vendors lacking an in-state physical presence. While the Court stopped short of formally declaring the South Dakota tax statute constitutional, instead remanding the case to the South Dakota Supreme Court to resolve any other potential arguments under the Court’s “dormant Commerce Clause”[3] jurisprudence and under other existing case law,[4] the case strongly supports the view that the physical presence rule in Quill inadequately addressed the realities of the digital economy and its effects on interstate competition and state tax revenues.
Even under Quill, many states had passed a variety of measures aimed at recouping tax revenue from the expanding digital economy. These measures intended to capture sales and use tax revenue that had been lost from declining sales at brick-and-mortar retailers—where the right of a state to impose sales tax (regardless of the residence of the purchaser) is in no doubt. Wayfair is widely expected to be taken as a go-ahead for other states to adopt laws based on South Dakota’s model statute (likely with an eye to the details noted in the Court’s opinion). As a result, many internet-trade companies, especially smaller retailers, may face significant burdens in complying with the differing tax regimes of thousands of state and local jurisdictions.
The Majority Opinion’s Reasoning
The Court’s majority opinion declared that Quill was “unsound and incorrect.”[5] The physical presence rule was 1) not a necessary interpretation of the Complete Auto substantial nexus requirement; 2) created rather than resolved market distortions; and 3) imposed an “arbitrary, formalistic distinction” of the type rejected by the Court’s modern dormant Commerce Clause precedents. In addition, the Court noted that the physical presence rule was “an extraordinary imposition by the Judiciary on States’ authority to collect taxes and perform critical public functions.”
Throughout its opinion, the Court explained how the expansion of e-commerce had changed economic realities. Quill was decided prior to the Internet revolution, which exacerbated its shortcomings. As a result, the Court said, Quill “increased the revenue shortfall faced by States seeking to collect their sales and use taxes” and “put both local businesses and many interstate businesses with physical presence at a competitive disadvantage.”
The Future of Taxation of Interstate E-Commerce
As noted, though the Wayfair decision overturned Quill’s physical presence standard, it left open the possibility of challenging state taxes on other grounds under existing general dormant Commerce Clause jurisprudence. As a result, the statute, upon remand (and any similar tax statutes passed by other states) generally will be subject to the four-pronged test from Complete Auto[6]. According to Complete Auto, state taxes are valid under the Court’s dormant Commerce Clause jurisprudence so long as they 1) apply to an activity with a substantial nexus with the taxing state; 2) are fairly apportioned; 3) do not discriminate against interstate commerce; and 4) are fairly related to the services the state provides.
Applying the first element to South Dakota’s statute, the Court stated that the nexus was “clearly sufficient” because the sellers’ significant quantity of business could not have occurred unless they had availed themselves of “the substantial privilege of carrying on business in South Dakota.”
The Court suggested, without deciding, that several limitations in South Dakota’s statute would satisfy the second and third elements of the Complete Auto test. First, the law protected small retailers by setting a threshold requiring tax collection only from online vendors who conducted more than 200 separate in-state transactions or had annual in-state sales exceeding $100,000. Second, the obligation to collect tax did not apply retroactively. Third, South Dakota is one of more than 20 states that has adopted the Streamlined Sales and Use Tax Agreement, which reduces the administrative costs of compliance for retailers.
While states are widely expected to model legislation on the South Dakota statute, it remains to be seen just what modifications they will make, especially given the wide disparities between existing state tax regimes. States may attempt to lower the economic thresholds, even though they already provide scant protection in large states, such as California. Nor did the Court provide a clear answer on whether a retroactive statute would be unconstitutional. Finally, as acknowledged in the majority opinion, Congress may choose to resolve these remaining issues by taking action.
Please contact any of the authors listed here or any other Proskauer tax attorney with whom you normally consult to discuss the implications of Wayfair in your particular circumstances.
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The substantial assistance of summer law clerk Scott Tan in preparing this post is gratefully acknowledged by the authors.
[1] National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967).
[2] Quill Corp. v. North Dakota, 504 U.S. 298 (1992).
[3] U.S. Const. Article 1, Section 8, Clause 3.
[4] Specifically, the opinion remanded for consideration of the other prongs of the four-pronged test of Complete Auto Transit, Inc. v Brady, 430 U.S. 274 (1977). The first prong, requiring a substantial nexus, was the prong at issue in Quill and Wayfair.
[5] As noted, the Opinion of the Court was written by Justice Kennedy and joined by Justices Thomas, Ginsburg, Alito and Gorsuch. Importantly, Chief Justice Roberts’s dissent (joined by Justices Breyer, Kagan and Sotomayor) takes little to no issue with the majority view that Bellas Hass and Quill were likely wrongly decided, but disagrees with the decision of the majority to overrule those decisions and would instead have put the issue squarely on Congress, where a number of bills to reach this result have been proposed over the years with no success.
[6] Complete Auto Transit, Inc. v Brady 430 U.S. 274 (1977).
Division of Corporate Finance Releases Updated C&DIs
On May 11, 2018, the Securities and Exchange Commission’s Division of Corporate Finance (the “Division”) released new Compliance and Disclosure Interpretations (“C&DIs”) comprising the Division’s new interpretations of the proxy rules and Schedules 14A and 14C. The new C&DIs replace interpretations previously published in the Division’s Proxy Rules and Schedule 14A Manual of Publicly Available Telephone Interpretations and the Division’s March 1999 Supplement to the Manual of Publicly Available Telephone Interpretations (“Telephone Interpretations”).
Of interest for equity compensation matters is C&DI 161.03, which clarifies disclosure obligations in the New Plan Benefits Table that is required in a proxy statement pursuant to Item 10(a)(2) of Schedule 14A when shareholders are being asked to approve the adoption or material amendment of an equity plan. Previously, telephone interpretation guidance provided that when the New Plan Benefits Table is required in a proxy statement, even if an amount of “0” will be entered in the table, all of the individuals and groups for which award or benefit information is required should be listed in the table. New C&DI 161.03 updates this guidance in providing an alternative method of satisfying the Item 10(a)(2) requirement for individuals and groups for which award and benefit information to be reported is “0” through a narrative disclosure accompanying the New Plan Benefits Table, rather than in the New Plan Benefits Table itself. While such individuals and groups must still be reported, this C&DI provides some flexibility in the manner of reporting.
The Division noted that some of the new C&DIs reflect “substantive” changes to the previously available Telephone Interpretations, some reflect “technical revisions,” and the remaining reflect only non-substantive changes. The following table includes each of the new C&DIs identified by the Division as containing substantive or technical changes, together with the previously available Telephone Interpretation guidance that has now been superseded.
Substantive Changes
| Prior Telephone Interpretation | New C&DI |
| Cumulative voting rights disclosure
Rule 14a-4 The authority to cumulate votes among directors, in the discretion of the proxy, need not be printed in bold-face type on the proxy card itself pursuant to Rule 14a-4(b)(1). There should, however, be appropriate disclosure of cumulative voting in the proxy statement.
|
Cumulative voting rights disclosure
Question 124.01 Question: Rule 14a-4(b)(1) states that a proxy may confer discretionary authority with respect to matters as to which a choice has not been specified by the security holder, so long as the form of proxy states in bold-faced type how the proxy holder will vote where no choice is specified. If action is to be taken with respect to the election of directors and the persons solicited have cumulative voting rights, can a soliciting party cumulate votes among director nominees by simply indicating this in bold-faced type on the proxy card? Answer: Yes, as long as state law grants the proxy holder the authority to exercise discretion to cumulate votes and does not require separate security holder approval with respect to cumulative voting. [May 11, 2018] |
| Preliminary proxy materials for shareholder submissions
7S. Rule 14a-4(c)(1), (c)(2) (a) If a company receives timely and complete notice of a matter submitted by a shareholder in accordance with Rule 14a-4(c)(2)(i), the company does not have discretionary voting authority on the matter. Thus, if the company wants to vote its proxies on the matter at the annual meeting, it must include the matter on its proxy card and provide in its proxy statement the necessary disclosure, including, inter alia, information on how and why the company intends to vote on the matter. In this circumstance, the company may not rely on the discussion in Section IV(D) of Release No. 34-40018 (May 21, 1998) on filing proxy statements in preliminary form. The benefits of that interpretive position are available only when a company properly may exercise discretionary voting authority on a non Rule 14a-8 matter… Here, because the company has received timely and complete notice, thereby precluding it from exercising discretionary authority, the company cannot file a plain-vanilla proxy statement under Rule 14a-6. (b) If the notice is timely but deficient (i.e., does not comply with the requirements listed in 14a-4(c)(2)(i) by, for example, failing to indicate that the proponent intends to deliver a proxy statement and form of proxy to holders of at least that percentage of the company’s voting shares necessary to approve the matter), the company would not be required to put the matter on its proxy card. However, the company’s ability to exercise discretionary authority is conditioned on including in its proxy statement advice on the nature of the matter and how the company intends to exercise its discretion to vote on that matter. The company’s ability to file a plain-vanilla proxy statement pursuant to Rule 14a-6 will depend upon, among other factors, the extent of its comments on, or discussion in, its proxy material of any solicitation in opposition in connection with the meeting. [Superseded] |
Preliminary proxy materials for shareholder submissions
Question 124.07 Question: The Division has permitted registrants to avoid filing proxy materials in preliminary form despite receipt of adequate advance notification of a non-Rule 14a-8 matter as long as the registrant disclosed in its proxy statement the nature of the matter and how the registrant intends to exercise discretionary authority if the matter was actually represented for a vote at the meeting. See Section IV.D of Release No. 34-40018 (May 21, 1998). Can a registrant rely on this position if it cannot properly exercise discretionary authority on the matter in accordance with Rule 14a-4(c)(2)? Answer: No. [May 11, 2018] |
| Preliminary proxy statements for corporate name changes
Rule 14a-6(a) The caller raised the question whether a preliminary proxy statement need be filed in connection with a proposed corporate name change to be submitted for shareholder approval at the issuer’s annual meeting, along with a shareholder proposal and the election of directors. While the latter two items fall within one of five Rule 14a-6(a) exclusions from the preliminary proxy filing requirement, a change in the issuer’s name to delete the surname of a long-dead founder that bore no relation to a change in the present membership of the board of directors would not appear to qualify for exclusion under the literal reading of the rule. As set forth in Exchange Act Rel. No. 25217 (Dec. 21, 1987), the underlying purpose of these exclusions is “to relieve registrants and the Commission of unnecessary administrative burdens and processing costs associated with the filing the processing of proxy material that is currently subject to selective review in preliminary form.” Consistent with this purpose and the reason for the name change proposal, the Division staff advised the requestor that a preliminary proxy filing relating to the planned name change was not required. |
Preliminary proxy statements for corporate name changes
Question 126.02 Question: Is a registrant required to file a preliminary proxy statement in connection with a proposed corporate name change to be submitted for security holder approval at the annual meeting? Answer: No. As set forth in Release No. 34-25217 (Dec. 21, 1987), the underlying purpose of the exclusions from the preliminary proxy filing requirement is “to relieve registrants and the Commission of unnecessary administrative burdens and preparation and processing costs associated with the filing and processing of proxy material that is currently subject to selective review procedures, but ordinarily is not selected for review in preliminary form.” Consistent with this purpose, a change in the registrant’s name, by itself, does not require the filing of a preliminary proxy statement. [May 11, 2018] |
| Information required pursuant to Note A of Schedule 14A
9S. Schedule 14A, Note A Note A to Schedule 14A requires that information called for by Items 11, 13 and 14 be provided when security holders are asked to authorize the issuance of additional securities to be used to acquire another specified company when there will be no separate opportunity to vote on the acquisition. This would be the case even when the securities will be sold in a public offering for cash to finance the transaction. [Superseded] |
Information required pursuant to Note A of Schedule 14A
Question 151.01 Question: A registrant solicits its security holders to approve the authorization of additional common stock for issuance in a public offering. While the registrant could use the cash proceeds from the public offering as consideration for a recently announced acquisition of another company, it has alternative means for fully financing the acquisition (such as available credit under an executed credit agreement in the full amount of the acquisition consideration) and may choose to use those alternative financing means instead. Would the proposal to authorize additional common stock “involve” the acquisition for purposes of Note A of Schedule 14A? Answer: No. Raising proceeds through a sale of common stock is not an integral part of the acquisition transaction because at the time the acquisition consideration is payable, the registrant has other means of fully financing the acquisition. The proposal would therefore not involve the acquisition and Note A would not apply. By contrast, if the cash proceeds from the public offering are expected to be used to pay any material portion of the consideration for the acquisition, then Note A would apply. [May 11, 2018] |
| New Plan Benefits Table
Schedule 14A, Item 10(a)(2) If the New Plan Benefits Table is required, all of the individuals and groups for which award or benefit information is required should be listed (including those for which the amount to be reported is “0”). |
New Plan Benefits Table
Question 161.03 Question: If a registrant is required to disclose the New Plan Benefits Table called for under Item 10(a)(2) of Schedule 14A, should it list in the table all of the individuals and groups for which award and benefit information is required, even if the amount to be reported is “0”? Answer: Yes. Alternatively, the registrant can choose to identify any individual or group for which the award and benefit information to be reported is “0” through narrative disclosure that accompanies the New Plan Benefits Table. [May 11, 2018] |
| Elimination of preemptive rights
** Schedule 14A ** A proxy statement requesting shareholder approval of the elimination of preemptive rights involves the modification of a security for purposes of Item 12 of Schedule 14A (and may be tantamount to creation of a new security, depending on the facts and circumstances, thereby raising an issue regarding Securities Act registration absent an exemption). Thus, the financial statement requirements of Item 13 would apply. |
Elimination of preemptive rights
Question 163.01 Question: Does a proxy statement seeking security holder approval for the elimination of preemptive rights from a security involve a modification of that security for purposes of Item 12 of Schedule 14A? Answer: Yes. Accordingly, financial and other information would be required in the proxy statement to the extent required by Item13 of Schedule 14A. [May 11, 2018] |
Technical Revisions
| Prior Telephone Interpretation | New C&DI |
| Proxy card circulation in connection with Form S-4
** Rule 14a-6; Form S-4 ** A registrant can use its S-4 proxy statement/prospectus as a red herring. Since 1992, registrants have been able to solicit immediately upon filing of a preliminary proxy statement (absent invocation of confidential treatment under Rule 14a-6(e)(2)) rather than waiting 10 days pursuant to Rule 14a-6(a), so long as the proxy card (whether in preliminary or definitive form) is not circulated. Because a vote on the transaction described would amount to an investment decision with respect to the securities being registered, no proxy card could be sent until after the registration statement became effective and the final prospectus was furnished. |
Proxy card circulation in connection with Form S-4
Question 126.04 Question: Can a registrant that filed a Form S-4 send proxy cards to its security holders upon the filing of a preliminary proxy statement/prospectus? Answer: No, as Exchange Act Rule 14a-4(f) prohibits the delivery of proxy cards unless the security holders concurrently or previously received a definitive proxy statement filed with the Commission. Further, because a vote on the transaction described also would amount to a sale of the securities being registered, no proxy card can be sent until after the Form S-4 is declared effective and the final prospectus has been furnished to security holders. [May 11, 2018] |
| Filing of additional communications
** Rule 14a-6; Form S-4 ** An issuer filed a registration statement on Form S-4 that contained its proxy material. After the effective date of the registration statement, the issuer decided to mail an additional letter to shareholders in connection with the transaction. This letter is filed as additional soliciting material pursuant to Rule 14a-6 upon first use. |
Filing of additional communications
Question 126.05 Question: A registrant files a registration statement on Form S-4 that contains its proxy statement disclosure pursuant to Instruction E.1 of Form S-4. After the effective date of the registration statement, the registrant sends an additional communication to security holders relating to the transaction. Does this communication need to be filed as other soliciting material pursuant to Rule 14a-6(b) no later than the date it is first sent or given to security holders? Answer: Yes. Given the communication was sent after the furnishing of the definitive proxy statement, it should not be filed under Rule 14a-12. [May 11, 2018] |
| Disclosure requirements in connection with director elections
Schedule 14A An issuer recently solicited proxies for the election of 15 directors. In about three months, the issuer hopes to acquire another company, and will hold a special meeting to elect one of the officers of the newly acquired company as a sixteenth director. The issuer asked whether the proxy material for the special meeting would have to include the information required by Items 6 and 7 of Schedule 14A for the 15 recently elected directors. The issuer was informed that Schedule 14A would require that information to be included in the proxy statement. |
Disclosure requirements in connection with director elections
Question 158.01 Question: A registrant will hold a special meeting to elect one new person to its board of directors. The incumbent directors were elected at the annual security holder meeting three months ago and will not be up for re-election. Do the proxy materials for the special meeting have to include the information required by Items 7 and 8 of Schedule 14A for the incumbent directors? Answer: Yes. [May 11, 2018] |
| Director disclosure in connection with merger
Schedule 14A, Note A B is to be merged into A in a Rule 145 transaction. B’s shareholders will be voting to approve the transaction and will become shareholders of A. A’s shareholders are not voting on the proposed transaction. Three of B’s directors will become directors of A. Pursuant to Note A to Schedule 14A the Form S-4 should contain the information required by Items 6 and 7 of Schedule 14A as to the A directors. |
Director disclosure in connection with merger
Question 158.03 Question: B is to be merged into A in a Rule 145 transaction. B’s security holders will be voting to approve the proposed transaction and will become security holders of A. A’s security holders are not voting on the proposed transaction. Three of B’s directors will become directors of A. Is it necessary to include the information required by Items 7 and 8 of Schedule 14A as to the directors of A in A’s Form S-4, which includes B’s proxy statement? Answer: Yes. Pursuant to Note A to Schedule 14A, the Form S-4 should contain the information required by Items 7 and 8 of Schedule 14A as to the A directors. [May 11, 2018] |
UK Tax Round Up: May 2018
Welcome to the May edition of the Proskauer UK Tax Round Up. This month we saw Advocate Generals’ opinions in two European Court VAT cases with UK implications and welcome European Commission State Aid approval for EMI option schemes which had expired.
UK Tax Round Up: April 2018
Welcome to the April edition of the Proskauer UK Tax Round Up. This month saw changes to the taxation of termination payments and the UK’s adoption of the OECD Multilateral Instrument into its double tax treaties coming a step closer.
