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Tax Provisions of the American Families Plan

On Wednesday, April 28th, the White House announced the American Families Plan, the “human capital” infrastructure proposal.  The American Families Plan would spend $1.8 trillion, including $800 billion in tax cuts over ten years, offset by $1.5 billion in new taxes over the same period.  This blog summarizes the tax provisions of the American Families Plan.

Tax Cuts

The American Families Plan proposes extending the expanded Affordable Care Act premium tax credits and the expanded Child Tax Credit enacted under the American Rescue Act, and making the Child Tax Credit, the Child and Dependent Care Tax Credit, and the Earned Income Tax Credit fully refundable on a permanent basis.

Increased Individual Ordinary and Capital Gains Top Rates

The American Families Plan would increase ordinary income rates from 37% to 39.6%, which when added to the 3.8% Medicare tax, would be 43.4% for the top ordinary income tax bracket.  The capital gains tax rate for households over $1 million would be increased from 20% to 39.6%, which, including the 3.8% Medicare tax, would also be 43.4%.  If this proposal is enacted, taxpayers will tend to hold their appreciated property rather than sell it and increasingly use financial products, such as prepaid forward contracts and costless collars, to reduce risk and monetize their appreciated publicly-traded positions.

Limiting Section 1014 Step-Up Basis at Death

Very generally, under section 1014, heirs acquire a decedent’s assets with a “stepped up” basis equal to fair market value so that the assets may be sold without income tax.  The American Families Plan proposes to end “stepped up basis” under section 1014 for gains in excess of $1 million (or $2 million per couple).[1]  Although the proposal is phrased as simply ending stepped up basis, it has been widely reported that the proposal would treat death as a realization event (i.e., upon death a decedent would be treated as if all of his or her assets were sold and the gain in excess of the $1 million/$2 million threshold would be subject to tax).[2]  The American Families Plan also proposes that, for family-owned businesses and farms that are given to heirs who continue to run the business, tax on the appreciation would be due only upon a sale or when they are no longer family-owned and operated.  It has been reported that a 15 year fixed-rate payment plan would be available for the taxes on certain illiquid assets.[3]  No tax would be due for a gift to charity.  Consequently, and as a result of the increased capital gains rates, gifts to charities would become much more attractive than under current law.

End Capital Gain Treatment for Carried Interests

Under current law, a partner who receives a share of future profits of (or a “carried interest in”) a partnership in exchange for services is not subject to income tax upon receipt and may be allocated capital gains from the partnership or realize capital gains upon a sale of the carried interest.  Generally, under section 1061, certain holders of carried interests are entitled to long-term capital gains treatment only if they satisfy a three-year holding period (rather than the normal one-year period).

As mentioned above, the American Families Plan proposes to increase the highest marginal long-term capital gains rate so that it is equal to the highest marginal ordinary income rate.  In addition, the American Families Plan proposes to “close the carried interest loophole so that hedge fund partners will pay ordinary income rates on their income just like every other worker.”  It is, however, unclear whether the proposal will apply to all carried interest or only the carried interests currently subject to section 1061, and it is unclear what the mechanism for the change will be.  If carried interests are taxable at ordinary income rates, we expect fund managers  increasingly to receive their compensation in the form of deferred compensation.  Finally, changes to the capital gains rate eliminate the benefits of issuing stock compensation, as capital gains would be taxable at the same rate as ordinary income.

End Section 1031 Like-Kind Exchanges

The American Families Plan proposes to end section 1031 tax-free like-kind exchanges for real estate gains in excess of $500,000.  If this proposal is enacted, we expect real estate investors will use up-REIT structures and leveraged distributions to diversify and achieve liquidity for their appreciated real estate holdings.

3.8% Medicare Tax Reform

Under current law, limited partners and S shareholders can avoid paying the 3.8% Medicare tax on business income.  The American Families Plan indicates that it would expand the 3.8% Medicare tax to apply to all those earning over $400,000.

Make Permanent the Section 461(l) Limitation on Excess Business Losses

Under section 461(l), business losses in excess of $250,000 (or $500,000 for a joint return, both indexed for inflation) that are not deductible become net operating losses.  Section 461(l) will expire in 2026.  The American Families Plan would make section 461(l) permanent.

No Repeal of the Cap on Social Security Taxes

Under current law, employers and employees are each subject to a 6.2% social security tax (for a total of 12.4%) and self-employed individuals are subject to a 12.4% social security tax on their first $142,800 (in 2021) of wages.  It had been reported that the Biden Administration would lift the cap so that the social security tax applied to all wages and self-employment income.  This proposal was not in the American Families Plan.

No Change to the Gift and Estate Taxes

The American Families Plan does not propose any change to the gift and estate taxes.

No Repeal of the SALT Limitation

Currently, only a maximum of $10,000 annually of state and local taxes (SALT) are deductible from federal income.  The American Families Plan does not propose to change the SALT limitation.

Dramatic Increase in Tax Enforcement for High-Income Taxpayers

The American Families Plan proposes to dramatically increase IRS funding (by $80 billion, according to news reports[4]) and audit rates for taxpayers earning more than $400,000.  The American Families Plan also proposes to give the IRS authority to regulate paid tax return preparers and require financial institutions to report financial account cash flow to the IRS.

 

[1]              In addition, individuals would be able to exclude $250,000 (and couples $500,000) of gain from a principal residence, as is the case under current law.

[2]             Biden’s Capital-Gains Tax Plan Would Upend Estate Planning by the Wealthy – WSJ

[3]             Biden’s Capital-Gains Tax Plan Would Upend Estate Planning by the Wealthy – WSJ

[4]             Biden Seeks $80 Billion to Beef Up I.R.S. Audits of High-Earners – NY Times.

Comparison of the Biden Administration and Senate Finance Committee International Tax Proposals

On March 31, 2021, the Biden administration released a factsheet for the “Made in America Tax Plan”.  On April 5, 2021, Senate Finance Chair Ron Wyden (D-Ore.) and Senators Sherrod Brown (D-Ohio) and Mark Warner (D-Va.) released “Overhauling International Taxation: A framework to invest in the American people by ensuring multinational corporations pay their fair share” (the “Senate Finance Plan”), a parallel set of proposals to the Made in America Tax Plan.  On April 7, 2021, the Treasury Department released a report on the Made in America Tax Plan that provides more detail on the Biden Administration’s tax proposals (the “Treasury Report”).  Finally, on April 5, 2021, the Treasury Secretary, Janet Yellen, gave a speech to the Chicago Council on Global Affairs and, on April 8, 2021, wrote an op-ed in the Wall Street Journal advocating a global minimum tax, which is a chief component of the Made in America Tax Plan.

Together, while these proposals retain the basic international architecture of the Tax Cuts and Jobs Act, they effectively would flip the U.S. international tax system from a largely “territorial system”, with an effective U.S. tax rate of 10.5% on the foreign-source income of U.S. multinationals (50% of the domestic rate), to one that is largely “worldwide”, with a rate between 16.8% to 28% (representing between 60% and 100% of the domestic rate).  This dramatic increase in the taxation of offshore income (both in absolute terms and as a percentage of the domestic corporate tax rate), which would increase the aggregate U.S. federal, state, and local tax rate to the highest of any OECD country, could affect U.S. competitiveness unless our trading partners enact corresponding increases to their own corporate tax rates.  The threat of global tax competition – arising in part from the Administration’s proposed increase – led Secretary of the Treasury Janet Yellen to call for a global minimum tax.

The proposals do not address other elements of global tax competition, such as the OECD’s proposal that expands the ability of countries to tax internet and remote services, or transfer pricing, or a uniform corporate income tax.  Although Treasury Secretary Janet Yellen has voiced support for some of these efforts, it is unclear exactly what measures the Biden administration would propose.

This blog describes the Biden Administration’s international tax proposals and compares them with the Senate Finance Plan.[1]

GILTI

The “global intangible low-taxed income” (“GILTI”) regime generally imposes a 10.5% minimum tax on 10-percent U.S. corporate shareholders of “controlled foreign corporations” (“CFCs”) based on the CFC’s “active” income in excess of a threshold equal to 10% of the CFC’s tax basis in certain depreciable tangible property (such basis, “qualified business asset investment”, or “QBAI”).  GILTI is not determined on a country-by-country basis, and, therefore, under current law a U.S. multinational corporation may be able to avoid the GILTI tax with respect to its subsidiaries operating in low tax-rate countries by “blending” income earned in the low tax-rate countries with income from high tax-rate countries.

Effective Tax Rate on GILTI

Under the Made in America Tax Plan, the effective tax rate on GILTI for corporate taxpayers would increase from 10.5% to 21%, which represents an increase in the effective tax rate on GILTI to 75% of the corporate tax rate (21%/28%) from 50% of the corporate tax rate under current law (10.5%/21%).

While the Senate Finance Plan acknowledges that it is necessary to increase the effective tax rate on GILTI for U.S. corporate taxpayers, it does not propose a specific rate.  Instead, it suggests that the rate could be anywhere between 60% and 100% of the domestic corporate tax rate.

Country-by-country determination

Today, GILTI is applied on a global basis and U.S. multinationals can avoid the GILTI tax on investments in low-tax jurisdictions by “blending” the income earned in low-tax jurisdictions with income earned in high-tax jurisdictions.  The Made in America Tax Plan would require GILTI to be determined on a country-by-country basis that would prevent blending.  Accordingly, income earned in low tax-rate countries would be subject to the minimum tax under the GILTI regime.

The Senate Finance Plan similarly addresses the “blending” issue, but provides for two alternatives to address the issue.  The first option would be the same country-by-country determination proposed in the Made in America Tax Plan.  The second option would be to exclude high-taxed income from GILTI altogether, effectively taxing only GILTI in low-taxed jurisdictions.

The Treasury Report asserts that this transition to a country-by-country determination would raise more than $500 billion in revenue over a decade.

Elimination of 10% of QBAI exclusion

Both the Made in America Tax Plan and the Senate Finance Plan propose the elimination of the exclusion of 10% of QBAI from the GILTI calculation.  Accordingly, the first dollar of CFC “active” income would be subject to the GILTI tax.

Treating research and management expenses occurred in the U.S. as domestic expenses (provided only in the Senate Finance Plan)

Under current law, a portion of certain expenses are allocated to foreign source income for purposes of determining the effective foreign tax rate on that income, which may subject the foreign income to GILTI.  To encourage research and certain types of management activities within the U.S., the Senate Finance Plan proposes to treat research and management expenses incurred in the United States as entirely “domestic expenses”, which would not cause U.S. multinationals that incur them to be subject to additional GILTI.

FDII

The “foreign-derived intangible income” (“FDII”) regime provides a lower 13.5% effective tax rate for certain foreign sales and the provision of certain services to unrelated foreign parties in excess of 10% of the taxpayer’s domestic QBAI.

Under the Made in America Tax Plan, FDII would be repealed in its entirety.

The Senate Finance Plan would retain FDII, but make a number of significant changes to the current regime:

  • The exclusion of 10% of domestic QBAI would be removed.
  • The effective tax rate on FDII would be made equal to the effective tax rate on GILTI.
  • FDII would be redefined as “foreign deemed innovation income” (rather than “foreign deemed intangible income”), and would provide for a lower effective tax rate on “deemed innovation income”, which would be determined by reference to expenses for “innovation-spurring” activities that occur in the United States, such as research and development and worker training. No further details are given.  It is unclear how the revised FDII regime would interact with existing incentives, such as deductions for research and development provided under section 174.

BEAT

The “base erosion and anti-abuse tax” (“BEAT”) generally provides for an add-on minimum tax, currently at 10%, on certain deductible payments that are made by very large U.S. corporations to related foreign parties.

The Made in America Tax Plan would replace the BEAT regime with the “Stopping Harmful Inversions and Ending Low-tax Developments” or “SHIELD” regime.  Similar to the BEAT, the SHIELD regime would also deny U.S. multinationals tax deductions for payments made to related parties, but only if the related parties receiving the payments are subject to a low effective rate of tax.  The tax rate at which the SHIELD regime is triggered would initially be equal to the 21% proposed GILTI rate, but would be replaced by an eventual global minimum tax rate established under a multilateral agreement.

The SHIELD regime would also expand the anti-inversion rules by treating any foreign corporation as a U.S. corporation for U.S. federal income tax purposes if (i) more than 50% (rather than 80% under current law) of the value or vote of the stock of the foreign corporation is owned by the former owners of the acquired U.S. company or (ii) any amount of the foreign corporation is owned by the former owners of the acquired U.S. company if the foreign corporation is “managed and controlled” in the United States.

The Senate Finance Plan would instead retain the BEAT regime, but would change the rules in a couple of ways:

  • Under current law, taxpayers can apply 80% of their low-income house credits, renewable electricity production credits and certain energy credits to reduce their BEAT liability. In a pro-taxpayer change, the Senate Finance Plan would allow taxpayers to use 100% of these credits to reduce their BEAT liability. The Senate Proposal also notes that rules regarding foreign tax credits, which also generally increase the BEAT amount, may need to be addressed.
  • The BEAT would be bifurcated into two minimum taxes. The first, at 10%, would operate as BEAT currently operates.  A new higher rate would apply to “base erosion payments” that erode the tax base.

This table summarizes the Senate Finance Plan’s and the Made in America Tax Plan’s proposed changes to the international tax rules:

The Made in America Tax Plan The Senate Finance Plan

GILTI

–       Effective tax rate: 75% of the corporate tax rate (21%/28%)

–       Eliminate exclusion for 10% of QBAI

–       Country-by-country determination

 

 

 

–       Effective tax rate: 60-100% of the corporate tax rate (e.g. 16.8% – 28%)

–       Eliminate exclusion for 10% of QBAI

–       Country-by-country determination OR mandatory high-tax exclusion

–       Treat expenses for research and management in the U.S. as domestic expenses for foreign tax credit purposes

FDII

–       Repeal

–       Eliminate exclusion for 10% of QBAI

–       Equalize tax rates on FDII and GILTI

–       Replace “deemed intangible income” with “deemed innovation income”

BEAT

–       Replace with the SHIELD regime

–       Seek international cooperation in implementing global minimum corporate tax

–       Restore full value of certain credits under the BEAT regime

–       Create second, higher bracket for “base erosion payments”

 

[1] Our prior blog post provided a summary of the changes in the Made in America Tax Plan.

The Made in America Tax Plan: The Biden Administration Outlines its Tax Reform Proposals

On March 31, 2021, the White House released a factsheet describing the “American Jobs Plan”, a $2.3 trillion proposal for infrastructure spending that also contains certain significant tax credits, and the “Made in America Tax Plan”, a tax proposal that would generate revenue to pay for the American Jobs Plan spending. The White House estimates that the Made in America Tax Plan will raise $2 trillion in tax revenue over the next 15 years.

The Made in America Tax Plan contains a number of proposals that apply principally to multinational corporate taxpayers, many of which are similar to those proposed by President Biden during his presidential campaign.  The proposals include a significant increase to the U.S. federal corporate income tax rate (but still well below the pre-2017 rate), a “minimum” tax on the book income of large corporations, and significant changes to some of the international tax rules that were enacted as part of the Tax Cuts and Jobs Act in 2017.

The factsheet is not proposed legislation, and each element of the Made in America Tax Plan must be introduced and passed by Congress before it can become law. It is very possible that some or all of the proposals in the Made in America Tax Plan will be substantially modified before being enacted into law. Additionally, Senate Finance Chair Ron Wyden (D-Ore.) and Senators Sherrod Brown (D-Ohio) and Mark Warner (D-Va.) introduced a separate international tax proposal on April 5, 2021.  The Senators’ plan is somewhat different than the Made in America Tax Plan.

The remainder of this post contains a short summary of the proposals under the Made in America Tax Plan and the tax credits in the American Jobs Plan:

Increase in corporate income tax rate

Under the Made in America Tax Plan, the U.S. federal corporate income tax rate would be increased from 21% to 28%. The Tax Foundation has estimated that, taking into account state and local taxes, the aggregate U.S. corporate tax rate would be 32.34%, which would be the highest in the OECD.  (The Tax Foundation estimates that the United States is currently the 12th highest in the OECD, with a combined U.S federal, state and local rate of 25.76%.)[1]

Revised GILTI regime

The “global intangible low taxed income” (“GILTI”) regime was enacted as part of the Tax Cuts and Jobs Act. Very generally, GILTI imposes a 10.5% minimum tax on 10-percent U.S. corporate shareholders of “controlled foreign corporations,” based upon the controlled foreign corporation’s “active” income in excess of a threshold equal to 10% multiplied by the foreign corporation’s tax basis in certain depreciable tangible property.[2]  (This basis is referred to as “qualified business asset investment”, or “QBAI”.)  GILTI is not determined on a country-by-country basis, and, therefore, under current law a U.S. multinational corporation may be able to avoid the GILTI tax with respect to its subsidiaries operating in low tax-rate countries by “blending” the low rate with income from subsidiaries operating in high tax-rate countries.

The Made in America Tax Plan would make three changes to the GILTI regime.

  • The effective tax rate on GILTI for corporate taxpayers would increase from 10.5% to 21%, which represents an increase in the effective tax rate on GILTI to 75% of the corporate tax rate (21%/28%, assuming the U.S. federal corporate tax rate is raised to 28%) from 50% of the corporate tax rate under current law (10.5%/21%).
  • GILTI would be required to be determined on a country-by-country basis. Accordingly, income earned in low tax-rate countries would become subject to GILTI, whereas under current law, it might be blended with higher-taxed income and either reduce or eliminate GILTI entirely.
  • The exclusion equal to 10% of QBAI would be removed.

Together, these proposals would change the GILTI regime in a manner that would generally tax foreign source income of U.S. multinational corporations at a significantly higher rate and make offshore investments by U.S. multinationals much less attractive than under current law.

Repeal of FDII regime; expansion of R&D investment incentives

The “foreign derived intangible income” (“FDII”) regime under current law is intended to provide a counterbalance to the GILTI regime by encouraging U.S. multinational groups to keep intellectual property in the United States by providing a lower 13.5% effective tax rate for certain foreign sales and the provision of certain services to unrelated foreign parties in excess of 10% multiplied by the taxpayer’s QBAI.[3]

The Made in America Tax Plan would repeal the FDII regime in its entirety.  The factsheet states, without detail, that the revenue from the repeal of the FDII regime will be used to expand more effective research and development (“R&D”) investment incentives.

Multi-lateral global minimum tax agreement and replacement of BEAT

The factsheet indicates that the Biden Administration will seek a global agreement on a strong minimum tax through multilateral negotiations and will repeal and replace the “base erosion and anti-abuse tax” (“BEAT”) with a regime that denies deductions to U.S. multinationals that make payments to countries in jurisdictions that have not adopted the minimum tax. (The BEAT is a 10% minimum tax that applies to very large multinational corporations and limits deductions on certain transactions with related foreign persons.)[4]

Strengthening “anti-inversion” rules; imposing U.S. tax on foreign corporations with U.S. management and operations

The factsheet indicates that President Biden will seek to prevent U.S. corporations from merging with foreign corporations and reducing their U.S. federal income tax while retaining management and operations in the United States.  It is unclear whether tax would be imposed on the merger, or whether such a resulting foreign corporation would be treated as a U.S. corporation.  It is also unclear what effect this proposal might have on foreign corporations that previously inverted.

Elimination of deductions for expenses relating to “offshoring jobs” and new tax credits for “onshoring jobs”

The Made in America Tax Plan would eliminate deductions for expenses arising from offshoring jobs (i.e., moving a factory from the United States to a foreign jurisdictions) and provide tax credits for onshoring jobs.  There is no detail on these proposals.

Minimum corporate tax on “book income”

The Made in America Tax Plan would impose a 15% minimum tax on “large, profitable corporations” based on “book income”, which appears to refer to GAAP income. This proposal is in line with President Biden’s presidential proposal of a minimum tax of 15% on book income for corporations with book income exceeding $100M.  The proposal does not indicate how the minimum tax would be computed for companies that use IFRS or other non-GAAP methods of accounting.

Fossil fuels and environmental cleanup

The Made in America Tax Plan proposes to eliminate all subsidies, loopholes, and special foreign tax credits available to the fossil fuel industry. The factsheet also indicates that the Plan would restore payments from polluters into the Superfund Trust Fund to cover costs of environmental cleanups.

Strengthening enforcement against corporations

The Made in America Tax Plan also proposes strengthening enforcement against corporations by increasing funding and resources to the IRS, with a stated goal of raising audit rates.

Tax credits in the American Jobs Plan

Aside from the proposed tax law changes in the Made in American Tax Plan, the American Jobs Plan also proposes a series of tax credits. These tax credits include:

  • Point of sale rebates and tax incentives to buy American-made electric vehicles;
  • A business tax credit for low- and middle-income families and small businesses to invest in disaster resilience;
  • A targeted investment tax credit for construction of high-voltage capacity power lines;
  • An investment tax credit and production tax credit for clean energy generation and clean energy storage;
  • Reform and expansion of the section 45Q tax credit, which provides a tax credit on a per-ton basis for CO2 that is sequestered by new equipment placed into service. The American Jobs Plan proposed to make the credit direct pay and easier to use for certain industrial applications, air recapture, and retrofits of existing power plants;
  • Targeted tax credits to expand affordable housing rental opportunities in underserved communities;
  • The Neighborhood Homes Investment Act tax credit (which is proposed to be $20 billion over five years) to build or rehabilitate 500,000 homes;
  • Expanding the home and commercial efficiency tax credits under the Weatherization Assistance Program;
  • A tax credit (50% of the first $1 million in construction costs per facility) to encourage the building of child care facilities at places of work; and
  • An expansion of the section 48C tax credit program, which aims to build a robust U.S. manufacturing capacity to supply clean energy projects with American-made parts and equipment.

[1] See Biden Infrastructure Plan: American Jobs Plan | Tax Foundation.

[2] Under section 250, the 10.5% rate is provided through a 50% deduction, which is generally not available for non-corporate taxpayers unless an election under section 962 is made.  All section references are to the Internal Revenue Code.

[3] The lower effective rate is achieved through a deduction.  See section 250.

[4] Section 59A.  Corporations subject to the BEAT are generally those with annual gross receipts exceeding $500M whose base erosion percentage is 3 percent or higher.  A base erosion percentage generally is the base erosion tax benefits divided by the corporation’s total deductions.

UK Budget 2021

The UK has now been in lockdown, on and off, for the best part of a year. With the COVID-19 vaccination programme now in full swing in the UK, and hopefully with light at the end of tunnel, attention has inevitably turned to the question of “how are we going to pay for it all?”.  Sweeping and significant tax rises have been feared and, following last year’s Office of Tax Simplification (OTS) review into capital gains tax (CGT), it was thought that an increase in CGT rates could well be on the cards.

But in Rishi Sunak’s budget announcement yesterday, aside from the deferred increases in the rate of corporation tax (discussed below), there were no such immediate tax rises.  At least for now, the government’s predominant short term focus appears to be on policies intended to stimulate growth and investment – highlighted by the new super deduction for capital investment costs.

Although welcome, that is unlikely to be the end of the story.  On 23rd March 2021 the government will publish a range of tax-related consultation papers which may well set the tone for the future UK tax landscape.  It is quite possible that this will include a roadmap for CGT changes.  And while the chancellor yesterday confirmed the government’s intention not to raise rates of income tax, national insurance or VAT, that doesn’t completely rule out, for example, the possibility of aligning the national insurance treatment of the self-employed with the employed in the coming years.

So what was announced yesterday?

The April 2023 increase in corporation tax from 19% to 25% for companies with annual profits in excess of £250,000 (with a tapered rate between profits of £50,000 and £250,000) is obviously a key point.  On a positive note, there was the corporation tax 130% “super deduction”, i.e. a first year capital allowance of 130% for plant and machinery expenditure, for the next two years.  And also in the next two years UK companies will be able to carry back trading losses to not just the prior year but the three prior years, subject to a group-level cap at £2m of losses for each of the earliest two years.

As was widely trailed, furlough payments are extended to the end of September, with employees receiving 80% of salary for hours not worked due to COVID-19 during this time. Employers will be required to contribute 10% in July and 20% in August and September.

Outside these more mainstream announcements a few points jumped out.  Amendments will be made to the hybrid mismatch rules to correct certain technical issues in the current legislation which is welcome (and expected).  The detail of these changes will be included in the Finance Bill published on 11th March.  On the enterprise management incentive (EMI) front, a new consultation was published aimed at enhancing the effectiveness of EMI tax advantaged share options, and it was confirmed that until April 2022 HMRC will continue to disregard reduced working hours (e.g. in connection with furlough) in determining EMI option tax benefit eligibility. On research & development (R&D) tax reliefs, a consultation on extending and simplifying the existing regime has been announced.  Although no new announcement was made yesterday, we are also waiting for the response to the consultation on the proposed UK asset holding company regime and this is likely to be published on 23rd March.

Leaving the tax announcements to one side, other noteworthy points included the investment project announcements, including a new £22bn UK infrastructure bank which will invest in private and public infrastructure projects to help meet government objectives on climate change and regional economic growth, a £375m ‘breakthrough’ fund which the British Business Bank will invest in R&D-intensive businesses, and new designated “freeport” locations around England (with discussions ongoing about delivering these in Scotland, Wales and Northern Ireland) the businesses in which will benefit from enhanced tax reliefs including enhanced capital allowance deductions and SDLT relief.

Despite the early noise regarding the threat of CGT rises, in many ways yesterday’s budget announcement was entirely unsurprising given that we are still in lockdown.  However the papers which are unveiled on 23rd March are expected to give a clearer indication on the government’s longer term direction on increasing tax revenue and modernising the tax system to encourage growth. So expect more to come.

COVID-19: OECD updates its guidance on residence and permanent establishments

Background

From the beginning of the UK’s first lockdown in March of last year we have reported on the impact of the pandemic on individual and corporate tax residence and permanent establishment risk.

In April 2020 the OECD published guidance on the impact of COVID-19 on double tax treaties (DTTs), including in relation to tax residence, tie breakers and permanent establishments (reported by us in Tax Talks). When reporting on the previous guidance we noted that further consideration would be needed should the pandemic continue for a significant time. Accordingly, the OECD has recently updated its guidance to reflect the pandemic’s persistence and the risk that some measures taken in response to the pandemic may no longer be described as temporary. Key aspects of the latest guidance as regards residence and permanent establishments are set out below.

Corporate residence

The guidance states that the pandemic is unlikely to change an entity’s tax residence under a DTT, reaffirming that a temporary change in location of board members is an extraordinary and temporary situation in response to COVID-19.

In cases of dual residence, the guidance confirms that an entity’s place of residence under the tie-breaker DTT provision is unlikely to be affected where individuals are participating in the management and decision-making of an entity and cannot travel because of a COVID-19-related measure imposed (or recommended) by at least one of the relevant jurisdictions.

A particular issue faced by non-UK resident companies because of the travel restrictions was the risk that UK directors of non-UK companies who participate in board meetings and take decisions in the UK could cause those companies to become UK tax resident by virtue of “central management and control” in the UK. HMRC’s guidance in the immediate aftermath of the March 2020 guidance was limited to the short-term and there has been no updated guidance since then. Therefore, businesses should not ignore the potential effect of the long-term of impact of COVID-19 and related travel restrictions on the tax status of their activities outside the UK. For investment managers, a potential medium- to long-term approach may be to consider re-engaging with the UK as a holding company jurisdiction as discussed by us in our Financier Worldwide article. For further details of HMRC’s approach to company residence in light of COVID-19 see our Tax Talks.

To be a “fixed place” permanent establishment under a DTT, the relevant location must have a certain degree of permanency as well as being at the disposal of an enterprise. Therefore, an employee’s “home office” when working from home will usually not create a permanent establishment where such home working is an extraordinary event in response COVID-19 rather being a requirement of the employer. However, a certain degree of permanence may exist if the individual continues to work from home after the pandemic response measures are lifted. As regards being at the employer’s disposal, the guidance points to the OECD’s Commentary on the issue and distinguishes between circumstances in which it is clear that the employer has required an individual to work from home (for example, by not providing an office for the employee in circumstances where the nature of the employment requires one) and those in which the employee performs most of their work from their home situated in one jurisdiction rather than from the office made available to them in the other jurisdiction. The OECD concludes that the home office in the latter scenario should not be taken to be at the employer’s disposal whereas in the former it could be.

Individual residence

The revised OECD guidance also sets out two situations which might result in an individual’s tax residence changing during the pandemic.

Firstly, an individual may be temporarily away from their home jurisdiction (for example, on holiday or undertaking a temporary work assignment) and become stranded, and tax resident, in the other jurisdiction under its domestic law. The guidance notes that the individual is unlikely to be resident in the other jurisdiction under the tie-breaker provision in the relevant DTT.

The second situation envisaged is where an individual works in a jurisdiction and attains residence there but then temporarily returns to a previous home jurisdiction, meaning that they either lose their residence in their current home jurisdiction or regain their residence in the previous home jurisdiction. The guidance notes that it is unlikely that a person would regain residence status as a result of “being temporarily and exceptionally in the previous home jurisdiction”. Even if residence was regained under that jurisdiction’s domestic law, it is unlikely under a DTT that an individual would be resident because of such temporary dislocation if their connection to the current home jurisdiction was stronger than the connection to the previous home jurisdiction.

HMRC’s guidance on the UK’s statutory residence test (the test that applies to determine whether an individual is resident in the UK or not) states that days spent in the UK due to COVID-19 will be treated as “exceptional” for the purposes of the statutory residence test and under that test 60 days spent in the UK in exceptional circumstances are not counted under the test (reported by us in a previous Tax Talks).

Conclusion

The guidance reaffirms the OECD’s position of April 2020 and, in our view, should offer some comfort to businesses and individuals concerned about changes in residence and permanent establish risk arising from COVID-19. However, the guidance states that in many circumstances factual determinations by tax administrations will still be required and the guidance does not replace such determinations and, most significantly, each jurisdiction may adopt different interpretations. In particular, in our view, taxpayers should be cautious if setting up non-UK entities or businesses and assuming that they can be managed from the UK during the remainder of the COVID-19-related travel restrictions, since in those cases there will be no track record of overseas management to fall back on.

We will report on any HMRC updates.

Please contact us if you have any queries about how any of the above or how COVID-19 will affect your business.

Regulations on Executive Compensation Excise Tax (Section 4960) for Tax-Exempt Employer and Their Affiliates Finalized

Employers that are tax-exempt or have tax-exempt affiliates (for example, a foundation) should pay close attention to a 21% excise tax under Section 4960 of the Internal Revenue Code on certain executive compensation.  Final Regulations under Section 4960 are described here.  The discussion includes traps for the unwary.  Please reach out to your Proskauer contact to discuss how these rules affect your organization.

Section 1061 Final Regulations on the Taxation of Carried Interest

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

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.

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