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Stamford

Tax Technical ForumMarch 24, 2010

PwC

PricewaterhouseCoopers March 24, 2010

Circular 230 Disclaimer

This document was not intended or written to be used, and it cannot be used, for the purpose of

avoiding tax penalties that may be imposed on the taxpayer.

Stamford Tax Technical Forum


Introduction – Joining us today

Marc Silverman Stamford Tax Leader

Telephone: (203) 539-5604

E-mail: [email protected]

Stuart Finkel

Repairs and Maintenance/Fixed Assets

Partner

Telephone: (646) 471-0616


Fred Gordon

Washington Legislative

Director

Telephone: (202) 414-1357


Ken Hunter

State Cash Tax Savings Ideas

Partner

Telephone:(203) 539-4218


Jim Bartek

State Cash Tax Savings Ideas

Director

Telephone: (646) 471-7395


Stephanie Jones

Accounting Methods

Director

Telephone: (646) 471-4554


Usman Mazhar

International Tax Update

Director

Telephone: (703) 918-3540


Stamford tax technical forum


Introduction – Joining us today (continued)

Greg Byrne

State and Local Tax Update

Partner

Telephone: (973) 236-7191


Anna Hoti

State and Local Tax Update

Director

Telephone: (203) 539-4206


Tim Gogerty

R&E/M&E

Director

Telephone: (646) 471-6547




Agenda

8:00 a.m. – 8:30 a.m. Breakfast and Registration

8:30 a.m. – 9:00 a.m. Introduction

• Program Introductions

• Overview and Agenda

Marc Silverman

ROTATION 1

9:00 a.m. – 9:45 a.m.

• R&D/M&E

• State Cash Tax Savings Ideas

• International Tax Update

Tim Gogerty

Ken Hunter and Jim Bartek

Usman Mazhar

ROTATION 2

10:00 a.m. – 10:45 a.m.

• State Cash Tax Savings Ideas

• Accounting Methods

• International Tax Update

Ken Hunter and Jim Bartek

Stephanie Jones

Usman Mazhar

ROTATION 3

11:00 a.m. – 11:45a.m.

• R&D/M&E

• Repairs and Maintenance/Fixed Assets

• Accounting Methods

Tim Gogerty

Stuart Finkel

Stephanie Jones

LUNCH

12:00 p.m. – 1:30 p.m.

• Washington Legislative

• State and Local Update

Fred Gordon

Anna Hoti and Greg Byrne

CONSULTATIONS

1:30 p.m. – 5:30 p.m.


Cash tax update:Research and development

Meals and entertainment tax updateTimothy Gogerty



• Senate approved $138 billion version of extender bill on March 10 (which was approved

by House in December)

• Extends research credit – CFC look-through, active financing exception and 15-year

recovery period for leasehold, restaurant and retail improvements through the end of

2010

• Total cost: $33.7 billion over 10 years

• Revenue raisers – “black liquor” biofuel credit provision, pension funding relief and

codification of economic substance. (“Black liquor” and economic substance offsets

were included in health care package)

• Senate amendment – modify the sec. 45 renewable energy tax credit to include refined

coal products used for steel industry fuel

• Timing for final action to renew expired business tax provisions remains uncertain. Since

the credit has currently expired, benefits of the credit cannot be taken into account

for financial statement or federal tax payment purposes for amounts paid or

incurred after December 31, 2009 (APB 28).

2009 GAO Report

• “The Research Tax Credit‟s Design and Administration Can be Improved”

Legislative outlook – Extenders, APB 28 and GAO



Union Carbide Corp. v Commissioner, T.C. Memo 2009-50 (March 10, 2009)

• Tax Court rejected “Discovery Test”

• Applies “Cohan Rule” (accepted oral testimony and some estimates)

• Evidence that Manufacturing Process Improvements (MPI) may be credit eligible

• Extrapolations and estimation

For more information:

WNTS Insights, May 23, 2009 and May 21, 2009

Year in review / Recent cases



US v McFerrin, (5th Cir. 2009), 2009-1 USTC ¶50,430

• Erroneous refund suit to recover credit paid out to the McFerrin's

• Supported Union Carbide decision

• Even in the absence of contemporaneous documents, estimating through oral

testimony is acceptable


WNTS Insights, June 10, 2009




FedEx Corp. v US, (USDC WD TN, 2009), 2009-1 USTC ¶50,435

• Internal Use Software (IUS) case

• Court ruled that FedEx appropriately relied on 2000 Final Regulations even though IRS

issued new proposed IUS regulations in 2001

• Court declined to follow 2004 IRS Announcement (Option A use innovative test of

reduction in cost or improvement in speed and “Discovery Test” or Option (B) use

innovative test of unique or novel and intended to differ in significant and inventive ways

from prior software implementations or methods


WNTS Insights, June 11, 2009




Deere & Co. v Commissioner, 133 T.C. No. 11 (2009)

• Held the gross receipts of a US corporation's foreign branches (which were disregarded

entities) must be included in the corporation's section 41 research credit calculation

• Issue Not addressed: Should transactions between domestic and foreign controlled

group members be disregarded in capturing “gross receipts” for purposes of the regular

research credit? The taxpayer community says “YES!” “All members of the same

controlled group should be treated as a single taxpayer” (Sec.41(f)(1)(A)(ii)). See also

CCA 200233011 (May 1, 2002). The IRS says “NO!” See CCA 200620023 (February

14, 2006)

• See IRS Examination Trends slide #77


WNTS Insights, October 27, 2009




TG Missouri Corp. v Commissioner, 133 T.C. No. 13 (2009)

• Supply costs cannot be “property of a character subject to depreciation”

• Depreciable nature / characterization of property is measured in the hands of the

taxpayer not by some generic test

• Mold costs for molds that were sold to customers and retained by TG Missouri to

produce customer parts were properly defined as supplies and allowed


WNTS Insights, November 17, 2009




Trinity Industries, Inc. v US, (USDC ND TX 2010)

• US District Court determined design and development of prototype ships can be credit

eligible

• Integration challenges can be present when combining various components

• Affirmation of “Substantially All” 80% process of experimentation test (and the ability of

“shrink-back” – even though this taxpayer conceded they had no records that would

support shrink back)


WNTS Insights, February 15, 2010




IRS LMSB Division issued Directive #2 January 15, 2009

• Definition of a claim covered under Tier I designation

• The issuance of Mandatory Research Credit Claim Information Document Request

(“Mandatory IDR”)

• Notice 2008-39 re centralized filing in Ogden UT of amended corporate tax returns

involving R&D credits, Notice 2008-39 does not apply to corporate taxpayers subject to

electronic filing requirements

• Possible assertion of penalties under IRC Section 6676

Year in review / IRS developments



Research tax credits – IRS exam issues

• IRS Exam Issues

• Highly compensated employees

• Computational

- Base amount

• Acquisitions and/or dispositions (Section 41(f)(3)(A) and (B))

- Duty of consistency

• Allocation of credit

- Definition of gross receipts

• “Indirect” supervision

• “Routine” engineering

• Internal use software

• Statistical sampling

• Prototype costs



IRS examination trends – Intercompany royalties, dividends,

and sales

Issue: Should transactions between domestic and foreign group members be disregarded

in capturing “gross receipts” for purposes of the regular research credit?

• The taxpayer community says “YES!”

- “All members of the same controlled group should be treated as a single taxpayer.”

(Section 41(f)(1)(A)(ii))

- See also CCA 200233011 (May 1, 2002)

• The IRS says “NO!”

- See CCA 200620023 (February 14, 2006)

• Informal IRS Appeals Settlement Guidelines

- Anecdotal reports suggest include 50% of Gross Receipts in issue

16



IRS examination trends – Support activities

Regulatory Affairs; Patent Counsel• FSA 200131007

• Qualified Research includes direct support of R&D

• Without regulatory approval to sell a drug in the US, the US rights are worthless

• “Substantially all” process of experimentation rule of Treas. Reg. § 1.41-4(d)(2)

• Patent costs specifically recognized in Treas. Reg. § 1.174-2(a)(1)

• Patent costs are at issue in Proctor and Gamble case in US District Court in Southern

District of Ohio

17



IRS examination trends – Pre-acquisition research

expenditures

CCA 200234063

• Corporation A‟s year end: December 31

• Corporation T‟s year end: December 31

• Corporation T was a stand-alone corporation

• A acquired T on October 1, 2009

• Section 41(f)(3)(A): If A acquires T, then for purposes of calculating A‟s credit for any

taxable year ending after such acquisition, A‟s QREs incurred during periods before the

acquisition shall be increased by T‟s QREs;

- Similarly, A‟s gross receipts for such periods shall be increased by T‟s gross

receipts.

18



Legislative update – Proposed tax credit to encourage new

Therapies

• The provision would create a temporary credit to an overall cap of $1 billion to

encourage investments in new therapies to prevent, diagnose, and treat acute and

chronic diseases

• The provision would have the following features

- Limited to “small companies” defined as business having 250 or fewer employees

- Credit amount would equal 50% of investments in “qualified therapeutic discovery

projects”

- Qualifying investments would include those made during 2009 and 2010

19



FFA 20094301F Deductibility of statutory stock options under § 174 (10/23/09)

FACTS:• In a previous year, the corporation acquired another company that offered both a § 422

incentive stock option plan (ISO) and a § 423 employee stock purchase plan (ESSP).

• Although a number of the acquired company's employees exercised their options and

purchased stock, the company did not claim its deduction for those activities.

• The acquiring corporation then attempted to claim deductions in subsequent tax years.

20



FFA 20094301F Deductibility of statutory stock options under § 174 (10/23/09)

Position of IRS Office of Chief Council:• Research or experimental expenditures paid by an employee in the course of business

may be allowed as a deduction under Code Sec. 174(a)(1). • Although the definition of research or experimental expenditures is broad as defined by

Reg. §1.174-2(a)(1), the definition does not include any expenses, including payment of a "spread," incurred by an employee in the exercise of ISOs or ESSPs.

• Moreover, Code Sec. 421 specifically disallows a deduction under Code Sec. 162 for compensation attributable to a statutory stock option.

• Accordingly, the corporation may not deduct the "spread," paid by an employee that resulted from the exercise of a statutory stock option as a research or experimental expenditure under Code Sec. 174.

21



Top 5 R&D tax credit planning opportunities

1. Capture process R&D a. Treasury Regulations example 3 – shredded foodb. Union Carbide Case

2. Software development costsa. Product software – leased, licensed or sold to a 3rd partyb. Internal use software

a. FedEx caseb. Trinity case

3. Capturing all qualified expendituresa. Wages, supplies and contract researchb. Direct Supervision and direct supportc. 80% ruled. Stock optionse. Puerto Rico

22



Top 5 R&D tax credit planning opportunities

4. State and Global R&D tax credit a. 27 states offer some sort of R&D tax creditb. Globally many countries offer a credit, deduction or other type of relief

i. United Kingdomii. Franceiii. Irelandiv. Australiav. Many others

c. “Patent Box”/”Innovation Box”a. Reduced royalty rates for created IP

5. Prepare a solid audit strategya. Increased focus on filing requirements and elections and revocations (280C, AIRC,

ASC)b. Notice 2008-39 centralized filing of amended claims in Ogden UT. c. ATG re: R&D Claimsd. Establishing Nexus between claimed QRE and Business Componentse. Establishing fixed base percentage and factoring in of acquisitions and dispositionsf. Increased focus on terms of contracts and evaluation of rights and risksg. AM 2008-002 re “Protective” 280C electionsh. Super or “Mandatory” IDR updated February 2009

23



Deductibility of software development costs

Strategy• GAAP v. Tax• Identify, analyze and document large-scale software implementations to maximize the

tax benefits as follows:- Cost Segregation – NPV benefit and potential exposure substantiation from

acceleration of deductions- R&D Activity – Maximization of available R&D deductions and tax credits for certain

new or improved software/e-business initiatives in the core infrastructure, business process and software development areas (including ERP implementations).

Benefits• Improves cash flow• Limit risk from IRS challenges of deferral of tax deductions• Identify available R&D credits

24



Bringing it all together



Translating Trends to Your Business

Cash is King There is renewed market interest in non-aggressive, straight forward cash tax savings

Tax Risk Management Companies are more focused than ever on getting numbers correct on an originally filed tax

return. Contemporaneous documentation supporting FIN 48 assertions is a big plus

resulting from cash tax planning

LegislationRecent legislation provides guidance on application of the regulations and related rules

Knowledge TransferOften companies that completed previous studies do not implement procedures to ensure

annually recurring benefits

Permanent Effective Tax Rate BenefitsR&D Tax Credit, Section 199, Meals & Entertainment and Transaction Costs Analysis



Fixed asset taxDepreciation, repairs and

maintenance

Alternative energy incentivesStuart Finkel



Current market conditions:Issue, action, impact

Issue In the current economic climate, cash remains a priority for companies to sustain corporate activities

and fund working capital, dividend payments, capital improvements, recent/planned acquisitions,

research and development, etc.

Action Companies can generate additional cash flow by first scrutinizing their federal, state and non-U.S tax

profiles. Companies then have identified the right levers to consider cash tax planning to enhance

free cash flow by reducing current tax payments and accelerating quick refunds.

Impact Immediate benefit to company by increasing liquidity pools in the organization. Longer term benefit to

validate their cash tax management objectives and collaborate to devise a multiyear strategy around

recurring cash tax savings to meet such objectives.



Five year NOL carry back provision

On November 6th, 2009, the Worker, Homeownership, and Business Assistance Act of

2009 was amended to provide an election that allows most business taxpayers to elect an

increased carryback period for net operating losses (NOLs) incurred in either 2008 or 2009.

• This provision which extends the carryback period from Two (2) to Five (5) years

• May provide significant benefits for taxpayers that do not qualify as eligible small

businesses (ESBs) under the extended NOL carryback provision enacted earlier this

year

• This provision excludes taxpayers that have received assistance through the Troubled

Asset Relief Program (TARP)

29



Fixed asset tax

Depreciation acceleration

opportunities



Cost segregation and fixed asset depreciation

Issue / Action Benefits

• Fixed asset classifications may not be optimal due to

misclassification of tangible personal property as real

property or case law changes, resulting in under-

depreciation for tax purposes

• Companies should strive for proper classification of

assets in the year placed in service on an originally filed

tax return

• Revenue Procedure 2008-52 provides guidance to

reclassify these assets and allow for “catch-up”

depreciation – considered a change in accounting

method

• An in-depth review allows a company to document and

support specific asset reclassifications from 39-year real

property to 5-year and 7-year personal property and 15-

year land improvements

• Catch-up deduction in Year 1 via a Section 481(a)

Adjustment, utilizing Form 3115, Application for Change

in Accounting Method – No amended returns required

• Established cost segregation methods are recognized

by the IRS, through its Cost Segregation Audit

Techniques Guide

• Accurate reporting of book-tax differences for complete

deferred tax basis reporting

• Maximize and capture often missed opportunities such

as bonus depreciation in 2001-2004 and 2008-2009,

and the 15-year recovery period for leasehold

improvements from 2005-2009



Why are fixed assets misclassified

Companies frequently misclassify tangible personal property (IRC Section 1245) as real

property (IRC Section 1250) resulting in less than optimal depreciation deductions. The

following are some of the reasons fixed assets could be misclassified:• Constructed assets are accounted for based on limited invoice detail (and tax

personnel unable to identify personal property from construction invoices)• Engineering/facilities personnel are not knowledgeable about regulatory definitions for

personal property• Purchased assets are pooled, leading to difficult asset tracking• Fixed assets are often characterized and recorded in the company's fixed asset ledger

with minimal input provided by the tax department• Enterprise Resource Planning systems struggle to provide accurate reporting

information resulting in the tax accounting for fixed assets being routinely handled off-line with inadequate system support.

32



Fixed assets legislative update

Fixed Asset Depreciation (Revenue Procedure 2008-52)• Allows for automatic accounting method change of depreciable lives for assets for

which depreciation claimed was less than the allowable amount.• “Catch-up” in year of change – the amount of “missed depreciation” from the date the

asset was placed in service is deducted in the current year.• Examples include an asset method change from non-residential real property (39-year)

to MACRS asset class 28.0, Manufacture of Chemicals and Allied Products (5-year).

Bonus Depreciation• The Economic Stimulus Act of 2008 and American Recovery and Reinvestment Act of

2009 temporarily re-enact the additional 50% first-year depreciation deduction for qualified property and leasehold improvements placed in service from January 1, 2008 to December 31, 2009.

Qualified Leasehold Improvement Property• The Emergency Economic Stabilization Act of 2008 and American Recovery and

Reinvestment Act of 2009 extend the 15-year recovery period for Qualified leasehold improvement property placed in service from October 22, 2004 to January 1, 2010.

33



Bonus depreciation

Section 168(k) allows a taxpayer to take advantage of 50% bonus depreciation for qualified

properties and leasehold improvements:

• Property must be acquired by the taxpayer after January 1, 2008 and before

December 31, 2009.

• Property must be placed in service before January 1, 2010 (excluding LPPP).

• Taxpayer must be the original, or first, user of the property

• Must be “Qualified Property” as follows:

- MACRS property with a GDS recovery period of 20 years or less

- Water Utility property

- Computer Software other than Sec. 197 property

- Qualified leasehold improvement property (“QLHI”)

• Written Binding Contract Considerations

34



Bonus depreciation planning considerations, continued

Other provisions that may potentially reduce, offset or eliminate the benefit of bonus

depreciation:

• § 460 – accelerated revenue recognition

• § 199 – reduces QPAI and taxable income

- Trading permanent for timing difference

• § 263A – additional depreciation capitalized into inventory/property

• Expiring NOLs or other expiring tax attributes

• Taxpayer's foreign tax credit position

35



Bonus depreciation planning considerations, continued

On the back-end of 2009:

• Enter into WBCs by 12/31/09 for LPPP and certain aircraft

• Ensure property is placed in service by 12/31/09 (by 12/31/10 for LPPP and certain

aircraft)

• For LPPP produced by a third party consider prepaying to the extent of construction to

maximize qualifying basis as of 12/31/09.

36



Qualified leasehold improvement property

The American Jobs Creation Act of 2004 and subsequent Acts provide that “qualified

leasehold improvement property” placed in service after October 22, 2004 and before

January ,1, 2010 is 15-year MACRS property (straight-line) with a 15-year recovery period

(Code Sec. 168(e)(3)(E)(iv)). For the leaseholds to qualify, the following must apply:

• Improvements are made under or pursuant to a lease either by the lessee (or sub

lessee) or the lessor, of that portion of the building to be occupied exclusively by the

lessee (or sub lessee);

• The improvements are placed into service more than 3 years after the date that the

building was first placed into service; and

• The improvements are section 1250 property, but are not attributable to the

enlargement of the building (expansion), to any elevator or escalator, to any structural

component benefitting a common area, or to the internal structural framework of the

building.

37



Repairs and maintenance




What taxpayers sometimes do Capitalize routine repairs and maintenance expenditures

Optimal tax method Currently deduct repairs costs paid or incurred during the taxable year

How to implement Automatic method change

How to identify Review current policies regarding how repair and maintenance costs are

treated for federal income tax purposes and identify current year repair

deductions

39




Companies may generally deduct the ordinary and necessary expenses paid or incurred during the taxable year including incidental repairs (Reg. Sec. 1.162-4).

Companies should deduct the costs of incidental repairs incurred in connection with the routine repair and maintenance of their assets to the extent such costs:• Do not materially add to the value of the property• Do not appreciably prolong the useful life of the property, but keep it in an ordinarily

efficient operating condition• Are not in the nature of replacements that arrest deterioration and appreciably prolong

the life of the property• Do not adapt the property to a new and different use

These costs “keep” an asset in operating capacity versus “put” an asset into such capacity.

Many companies follow their book method of capitalizing insignificant repair expenditures and depreciating such costs over the recovery period of the respective asset(s).

40



Tax repairs: Re-Proposed tangible regulations

Overview (Regulation §§ 1.263(a)-1 through 1.263(a)-3):

• The IRS issued re-proposed regulations March 7, 2008 for amounts paid to acquire,

produce or repair tangible property, addressing many issues including:

- Materials and Supplies

- De minimis rule

- Unit of Property (UOP)

- Material increase in value (betterment, etc.)

- Repair allowance

• When finalized, the re-proposed regulations are expected to be effective prospectively

41



Tax repairs: Re-Proposed tangible regulations, continued

• “Plan of Rehabilitation” eliminated• More liberal view of repairs via proposed regulation examples:

- Asbestos removal and replacement with similar insulation

- Retail store “re-branding” and periodic layout construction (§ 1250 property)

- Roof replacement (as long as not a “betterment”)

- Turbine blade replacements within a steam turbine

42



Repairs and maintenance expense examples

Routine repairs and maintenance expenses may include:

• HVAC

• Repainting

• Mending leaks

• Plastering

• Replacing windows, tiles

• Replacement parts

• Repairing and replacing roofing materials

• Rebranding

• Sidewalks, parking lots and pavement

• Storm drainage, sanitary sewage and water service

43



Repairs method changes – Rev proc 2009-39

• Updates and modifies RP 2008-52

• Permits repairs method changes to be filed automatically

• Separates repairs method changes into two separate automatics:

- Repairs

- Retirements

- Two Forms 3115

- Separate § 481(a) adjustments

44



Repairs vs. Capitalization : Tier I issue

• Designated as an Emerging Issue in May 2009

- (Public September 2009)

• Significant increase in CAMs since Dec 2008

• Substantial Sec. 481 (a) adjustments

• Unit of Property (UOP) key issue

• Finally something published

- Industry Director Directive #1 (1/22/10)

- Industry Director Directive #2 (1/22/10)

• What can we expect?

45



Repairs vs. Capitalization : Other considerations

• Unit of Property

• Retirements

• Leasehold Improvements

46



Repairs and maintenance – Next steps

To address accounting for repairs and maintenance costs for federal income tax purposes,

taxpayers should:

• Review current policies regarding how repair and maintenance costs are treated for

federal income tax purposes and identify current year repair deductions

• Consider filing an automatic application for a change in accounting method to change

from capitalizing and amortizing to currently deducting incidental costs.

47



Alternative and renewable

energy incentives



Green incentive opportunities for your business

Increasingly companies are going green to reduce costs, manage risks, and generate new

revenue opportunities. Tax credits/deductions incentivize renewable investments and

energy saving improvements:

• Renewable Energy Property Investment Tax Credits (“ITC”)

• Renewable Energy Production Tax Credits (“PTC”)

• Election to claim PTC in lieu of PTC

• Grants in lieu of energy credits

• Section 179D Energy Efficient Commercial Building Deduction

A variety of other incentives exist as well:

• Alternative fuel credits

• Alternative vehicle credits

• Specialized credits – carbon sequestration

• State and local incentives are very widespread

49



Renewable energy investment tax credits and energy

production tax credits

• Wind (placed in service before 2013)

• Biomass (open- and closed-loop) (before 2014)

• Geothermal (before 2014)

• Hydropower (before 2014)

• Marine (waves and tides) (before 2014)

• Municipal solid waste and landfill gas (before 2014)

• Refined coal including steel industry fuel (before 2010)

• Solar (through 2016)

• Geothermal (either 10% without placed in service date,

or 30% credit through 2013)

• Fuel cell (through 2016, capped at $1,500 per half-

kilowatt of capacity)

• Microturbine (defined as less than 2,000 kilowatts)

(through 2016, capped at $200 per kilowatt of capacity)

• Small wind (defined as 100 kilowatts or less) (30%

credit through 2016, with no credit cap for tax years

after 2008)

• Combined heat and power systems (10% credit

through 2016)



Section 179D – Energy-efficient commercial building deduction

Under Section 179D, the costs of energy efficient commercial building property placed in service before 2014 are allowed as a current deduction for otherwise capital costs:

• Tax deduction of up to $1.80 per square foot is available, for buildings that achieve a 50% energy savings target

• Energy efficient commercial building property includes Building Envelope, Interior Lighting, or Heating and Cooling systems

• The basis of any energy efficient commercial building property must be reduced by the amount of the deduction

• Notice 2008-40, provides where energy efficient commercial building property is owned by a federal, state or local government, the deduction may be allocated to the designer of the property, not the owner

The “Marginal Abatement Cost of Carbon”

• Calculations of the “marginal abatement cost of carbon” (MACC) show that many building energy efficiency and lighting projects are “double winners” because they

• Reduce carbon emissions and energy usage, while also…Saving costs • Since many of these projects also qualify for Section 179D, evaluating them on an

after-tax basis makes the return on investment attractive

51



Election to claim ITC in lieu of PTC

The American Recovery and Reinvestment Act (ARRA) provides an election allowing

qualified Section 45 production tax credit (PTC) facilities (other than solar, refined coal, or

Indian coal) to elect the 30 percent Section 48 investment tax credit (ITC) in lieu of the

Section 45 production credit.• The election applies to the eligible basis of depreciable (or amortizable) qualified

Section 45 property placed in service between January 1, 2009 and December 31, 2013 (December 31, 2012 for wind facilities)

• Qualifying property must be tangible personal property or other tangible property not including a building or its structural components if such property is integral to the facility

• Consideration: Day-one tax benefits vs. year-over-year section 45 credits16

52



Grants in lieu of energy credits

ARRA creates a new grant program option in lieu of the Section 45 energy production

credit or the Section 48 energy investment credit.

• The grant amount is 30 percent of the depreciable or amortizable basis of the energy property in the case of wind, biomass, Section 45 geothermal, solar, landfill, gas, trash, hydro, marine, qualified fuel cell, or small wind property

• The grant amount is 10 percent for microturbine, combined heat and power, small irrigation, section 48 geothermal, and geothermal heat pump

• The basis of the underlying property must be reduced by 50 percent of the amount of the grant

• The grant program will be administered by the Treasury Secretary• The grant program is uncapped – any qualified application will be honored

53



Grant in lieu of energy credits – General applicationrequirements

The grant in lieu of credit application is roughly 20 questions long including:

• Type of entity (corporation, partnership, etc.)

- Remember: Partnerships that include an exempt entity (government, 501(c)) are

not eligible for a grant

• Type of energy property

• Cost basis of energy property

- Remember: These costs require attestation

- Basis determined under federal tax rules

• Jobs data – full/part-time, construction and operational phases

54



Grant in lieu of energy credits – Attestation requirements

“For properties that have a cost basis in excess of $500,000 applicants must submit an

independent accountant‟s certification attesting to the accuracy of all costs claimed as part

of the basis of the property.”

Costs are for tangible

property (not including a

building) which is an

integral part of the facility

Only the portion of the

facility that is the

specified energy property

is taken into account in

computing the cost basis.

• If the expected grant amount is less than $1 million, then an agreed-upon procedures (AUP) attest engagement is acceptable

• If the expected grant amount is $1 million or more, then a positive assurance attest engagement is required

• Both attestation engagements should be performed under the attestation standards issued by the American Institute of Certified Public Accountants

• Attestation is performed on management‟s assertion regarding the eligibility of the costs

• Various resources are available to assist engagement teams in this area.

55



Grant in lieu of energy credits – Timeline and key dates for energy property eligibility

“Begin construction” and “placed in service”

• To qualify, construction must begin on the eligible energy property installation in 2009 or 2010

• Construction requires physical work of a significant nature, much like bonus depreciation

• Safe harbor: 5% of total project costs incurred

As long as construction begins in 2009-2010, the energy property need not be placed inservice until the given property‟s specified statutory date

Applications must be received by October 2011

56



Transaction costs analysis



Transaction costs analysis:Issue, action and impact

Issue Companies involved in a transaction (acquisition, merger, sale, IPO, spin, etc.), may be capitalizing

otherwise deductible ordinary and necessary, preliminary due diligence and financing related costs

(i.e., Investment Bankers, Legal, Accounting, etc.).

Action Review Transaction Costs to analyze, categorize and properly document activities and expenses

incurred in connection with exploring and entering into transactions for the purpose of evaluating the

proper federal income tax treatment of such costs.

Impact Effective Tax Rate Driver and Immediate cash flow impact through federal and state tax savings

including current year reduction of income taxes.



Transaction cost analysis (TCA)Capitalization of intangibles regulations and TCA

• On December 29, 2003, the Treasury released final regulations relating to the capitalization of costs incurred in connection with the acquisition or creation of intangible assets.

• The regulations are comprehensive in coverage of different types of capital transactions and create an initial presumption that transaction costs are nondeductible for tax.

• “Bright-line” test for certain acquisition transaction - Except with respect to inherently facilitative amounts, an amount should be capitalized if the amount relates to activities performed after the earlier of –- The date on which a letter of intent or exclusivity agreement is executed by

representatives of the acquirer and the target; or- The date on which the material terms of the transaction are authorized or approved

by the taxpayer‟s board of directors.

59



Transaction cost analysis (TCA)Inherently facilitative amounts

• Inherently facilitative amounts - An amount paid in the process of investigating or otherwise pursuing a covered transaction facilitates that transaction if the amount is inherently facilitative, regardless of when the amount is paid or activity is performed.- Securing an appraisal or fairness opinion- Structuring the transaction- Preparing and reviewing documents that effectuate the Transaction- Obtaining regulatory approval- Obtaining shareholder approval- Conveying property

60



Transaction cost analysis (TCA)Documentation of Success-based fees

• An amount paid that is contingent on the successful closing of a transaction must be capitalized unless the taxpayer maintains detailed documentation establishing the portion of the fee allocable to activities that do not facilitate the acquisition.

• The documentation must be completed on or before the due date of the taxpayer‟s timely filed tax return (including extensions) for the taxable year during which the transaction closes.

• Comment: Investment banker success-based fees if paid by the Buyer and the Target are probably the single biggest cost in any major acquisition. It will no longer suffice just to obtain a letter from the investment bankers making a rough allocation of their time spent before and after board approval.

61



Transaction costs analysisFive costs categories

1. Ordinary and Necessary Activities (Section 162)

- Certain activities/costs not directly attributable to the transaction (i.e., activities

providing value to company regardless of any transaction)

- Business planning, tax advice, compensation/employment related, integration

activities

2. Abandoned Alternatives (Section 165)

- Alternative transactions explored but not pursued (i.e., IPO, sale, spin-off, strategic

acquisition, status quo, etc.)

- Alternative structures explored but not pursued

3. Preliminary Due Diligence (Section 162/195)

- Investigatory and due diligence activities prior to bright line date

- “Expansion” versus “New Business” considerations

62



Transaction costs analysisFive costs categories

4. Capitalized/Amortizable

- Organizational expenditures

- Debt-related costs

- Other tangible/intangible assets with a life or term requiring capitalization (i.e., D&O

insurance, leases, etc.)

5. Capitalized/Non-Currently Deductible (Section 263)

- Activities/costs directly attributable to completing the transaction (e.g., SEC filings,

Hart-Scott- Rodino filings, negotiations, etc.)

- Due diligence activities on or after bright line date

63



Transaction cost analysis (TCA)

LTR 200830009

• Company and Acquisition Co. may allocate costs based upon the entity to which the

services were rendered and/or on whose behalf services were provided

• Determination of whether documentation supporting allocations is sufficient for

purposes of -5(f) is to be determined on exam - PLR does note that the regulation does

not require time records

• Company and Acquisition Co. may allocate lump-sum provider services to the services

provided

• Transaction was a covered transaction (acquiror and target related under 267(b))

• Company may deduct investigatory costs under sec 162

• Acquisition Co. may deduct investigatory costs as start-up expenditures under sec 195

• Costs allocated to financing to be deducted in accordance with reg sec 1.446-5

• Costs related to an abandoned securitization financing plan which were represented by

the taxpayer as not mutually exclusive with regard to the final financing were allowed as

a loss by the Company under sec 165

64



Transaction costs analysis – FAS 141 (R)

Statement of Financial Accounting Standard (“SFAS”) No. 141(R), Business Combinations,

requires that acquisition related costs and restructuring costs, incurred after December 15,

2008, be accounted for as expenses as incurred. Therefore, companies must now

consider the tax accounting implications of expensing transaction costs including, but not

limited to, the following:

• Need to potentially account for tax consequences before the transaction has been

consummated (i.e., in a pre-combination period);

• Transaction structure (i.e., asset vs. stock) and the tax treatment to determine whether

a tax benefit is recognizable; and

• Impact to the effective tax rate to the extent costs are considered facilitative and capital

in a stock transaction (without a section 338(h)(10) election).

65



State cash tax savings ideasKen Hunter

Jim Bartek



A view point

• Demographic shift to the south and west, leading to (and driving from) growth in these states

(1.4 million to the south as per the Pew research center report on migration flows titled “Who

Moves? Who stays put? Where‟s home?” 2005 – 07)

- Many of these states are also the most impacted by the recent credit and housing

downturn

• State and Local governments are in significant need of new business revenue:

- The Center for Budget Policy and Priorities estimates 47 states to have a combined

budget shortfall of $350B by 2011

- Moody‟s has issued a negative outlook on most forms of state and local debt

- State tax revenue to date in 2009 shows the steepest decline on record

(WSJ, 07/10/09)

- Only two states (MT and ND) currently have a budget surplus (Source – McNichol,

Elizabeth, and Iris J. Lav. “State Budget Troubles Worsen.” Center on Budget and Policy

Priorities. 12 Aug. 2009. www.cbpp.org)

- The news is not all bad. As of February 28, 2010, California‟s tax receipts were $2.1

billion over estimates.

• Most states are facing record levels of unemployment:

- Federal government forecasts national unemployment to be between 9.8 and 10.1 %

(with several states reporting significantly higher unemployment rates)

- Every 1% increase in unemployment decreases state revenues 3 – 4% (Kaiser Family

Foundation research)

Slide 67



Many state & local jurisdictions are offering unprecedented

tax credits and incentives to stimulate business investments

Slide 68

Key drivers:

• State and local bodies are using statutory tax credits and negotiated economic incentives to induce

taxpayers to locate or expand operations in specific jurisdictions, thereby generating tax revenue

• Credits may be statutorily available based on project specifications

• Project cost reductions may be obtained through negotiation with state, local, and federal

governments, as well as utility providers

Available credits may include:

• Statutory credits/exemptions

• Employment based tax credits

• Investment tax credits

• Research and development tax credits

• Training tax credits

• Enterprise zone tax credits

• Sales and use tax exemptions

Available incentives may include:

• Cash

• Wage withholding refunds/grants

• Job creation grants

• Training grants

• Industrial development agency

• Sales/property exemptions

• Property tax abatements

• Industrial development bonds

• Public infrastructure grants

• Tax apportionment relief

• Utility incentives



Tax credits & incentives – economic incentives indices

Indices of potential economic incentive opportunities:

• Increased job creation (25+)

• Fixed asset investment ($10,000,000 annually)

- Including purchasing modernization/replacement equipment

• Employee training (100+ trainees)

• Economically disadvantaged areas

- Specially designated federal, state, and local enterprise zones

- Tax increment financing districts “TIFs”

- Less developed census tracts

• Research and development activities

• New construction/occupation of new facility

• Relocating to a new facility

• Reverse offshoring

• Consolidation of multiple locations

• Mergers & acquisitions

- Transferring employees from duplicative pre-merger operations

Slide 69



Tax credits & incentives – critical success factors

Critical success factors:

• Formal demonstration of project value to community is critical

• Prepare fiscal and economic impact analysis

- Economic analysis demonstrates the direct, indirect and induced employment,

earnings and/or construction period impacts upon the communities

- Fiscal impacts demonstrates the direct, indirect and induced tax revenue impact

upon the communities

• Prepare a tax burden analysis

• Estimate current and projected state and local tax liability

- Income/franchise/payroll/property/sales/utility taxes

• Compare state and local tax liability between multiple locations

- Prior to consideration of incentives

- After inclusion of incentives

Slide 70



Targeted industries

• Manufacturing and industrial processing

• Assembly, warehousing, distribution

• R&D, high-tech, communications

• Financial and professional services

• Data and information processing

• Customer-service and call centers

Slide 71



Some recent transactions

Slide 72

Sector Manufacturing Services Services Services

Type of operation Plant expansion Customer care

center

Data center Customer care center

Location selected IN OH GA PA

Alternate locations considered OH FL, PA FL VA, FL

# FTEs 45 (retain 350) 245 (retain 1,300) 40 360

Capital investment 10 M 1 M 120 M 5 M

Average loaded cost per FTE 35.5K 65K 60K 44.5K

Total incentives negotiated 1.1 M 3.7 M 21 M 1.4 M

Duration of incentives 1 – 10 years 1 – 7 years 1 – 10 years 1 – 3 years

Types of incentives • Job creation

• Investment

• Training grant

• Job creation

• Cash grant

• Training grant

• Job creation • Job creation

• Cash grant

• Training grant

Types of tax refunds • Property tax

abatement

• Local rebate

• Refundable credit

• Cash

reimbursement

• Sales tax exemption

• Property tax abatement

• Cash

reimbursement



1. California – Enterprise Zone Program – Hiring and Sales/Use Tax Credit – Unique

Interpretations

2. Colorado – Enterprise Zone Program – Hiring and Investment Tax Credits – Often

Miscalculated

3. Port Credits – Alabama, Georgia, North Carolina, South Carolina, Louisiana, Mississippi,

Massachusetts

4. Research & Development Credits – Opportunities available at the state level for various

differences from the federal credit calculation

5. New York – Empire Zone – Increased audit activity is resulting in many clients reaching out

to PwC to assist them with their calculation and audit activity

6. Georgia – Jobs Tax Credits – Retaining Tax Credits

7. Texas – Enterprise Zone Designations

8. New Jersey – BEIP, BRRAG, Urban Transit Program

9. New York City – REAP – LMREAP-ICAP

10.Connecticut – Fixed Capital Credit

Often overlooked cash tax savings opportunities?



Sales and use tax opportunitiesQuestions

• Does your company purchase a significant amount of capital assets or consumable

expense items?

• Does your company self-assess use tax on purchases?

• Are taxability determinations on sales or purchases made predominantly by accounts

payable or purchasing personnel?

• Does your company outsource sales and use tax compliance or consulting?

• Does your company have effective policies and procedures in place for sales and use

tax determinations?

• Is your company currently under audit or recently completed an audit for sales and use

tax purposes?



Sales and use tax opportunitiesIssue

• States reliance on sales and use tax

• Compliance is complex

• Exemptions vary per jurisdiction

• Impractical to stay informed of exemption opportunities and filing requirements in all 46

taxing jurisdictions

• This tax could be the most costly tax that your company is paying and your company

may not realize it!



Sales and use tax opportunitiesAction

• Review Sales and Use Tax process

• Review samples of fixed asset and consumable expense purchases

• Determine if refund opportunities exist

• Apply corrective measures



Sales and use tax opportunitiesImpact

• Identify sales and use tax refunds

• Eliminate/reduce exposure to assessments for tax, interest and penalties

• Increase cash flow

• Reduce tax burden

• Improve process effectiveness



Sales and use tax opportunitiesSummary of Connecticut opportunities

• Manufacturing exemption limited to a specified production process. However, partial

(50%) exemption is more expansive, and includes pre and post-production as well as

research and development.

• Certain services are taxable at 1%. However, in certain cases, vendors have treated

such services as taxable at 6%.

• While Connecticut has a broad based tax on services, there are many exceptions.

• Taxable services are sourced based upon where the benefit is derived, which can

provide an opportunity to source some or all of a service outside the state.

• Bad debts written-off for Federal income tax purposes may be eligible for a sales tax

credit.

• Numerous exemptions are available based on industry (e.g., biotechnology) or nature

of purchase (e.g., certain aircraft).



Connecticut sales and use tax opportunitiesManufacturing exemption - Full exemption

• Manufacturing Machinery

- Directly used in a manufacturing production process

- Predominantly used on the production line (more than 50%)

- Research and Development

• Materials and Tools

- Directly used in industrial plant in the actual fabrication of finished products to be

sold

• Fuel

- Directly used in industrial plant in the actual fabrication of finished products to be

sold

- Directly used to furnish power to an industrial manufacturing plant

• Repair, Replacement, Component, and Enhancement Parts

- If used in the manufacturing process



Connecticut sales and use tax opportunitiesManufacturing exemption-Partial (50%) exemption

• Partial exemption is available for a broader range of purchasers than the full exemption

(e.g. Fabricators, Processors, Qualifying Independent Contractors)

• Partial exemption may include certain:

- Machinery and equipment used for pre and post production

- Research and development equipment

- Testing or measuring devices

- Repair and replacement parts

- Other materials, tools, molds, dies, fuel

- Sample and prototype development not available for sale



Connecticut sales and use tax opportunitiesServices taxed at 6%

Services that may be taxed at 6%:

• Repair Services (not calibration)

• Fabrication Services (unless for resale)

• Personnel Services

• Certain Business Consulting Services (can include management, business analysis,

training)

• Advertising Services

• Other enumerated services



Connecticut sales and use tax opportunitiesServices taxed at 1%

• Computer and Data Processing Services may include:

- Designing, implementing or converting systems

- Computer consulting services

- Provision of computer time, storage and filing of information

- Customizing canned software

- Developing or creating custom computer software

- Downloaded software

- Providing access to information



Connecticut sales and use tax opportunitiesExempt services

• Services provided by a professional in his or her professional capacity

- Medical and Legal

- Engineering

- Accounting (other than management advisory)

• Certain testing and inspection services

• Qualifying leased employees



Connecticut sales and use tax opportunitiesOther opportunities of note

• Bad debts written off as uncollectible for Federal income tax purposes may be eligible

for refund or credit

• Specific exemptions include:

- Biotech industry

- Publishing and broadcasting

- Certain computer disc producers

- Certain paving contracts

- Certain computer hardware and supplies

• Planning

- Software

- Sourcing of services

- Nexus

• Other States



Accounting methodsStephanie Jones



Accounting method

opportunities



Accounting method planning considerations

Use accounting methods to achieve tax objectives, including

• Deferring income and/or accelerating deductions if want to:

- Decrease current cash taxes

- Increase NOL carrybacks (consider recently enacted 5 year NOL CB and 10 year

CB)

Note: Transition from 6% to 9% §199 rate in 2010

• Accelerating income and/or deferring deductions if want to:

- Utilize expiring NOLs, Foreign Tax Credits

- Reduce §382 limited NOLs

• Determining E&P of CFCs if are:

- Repatriating earnings from the FC,

- Previously repatriated earnings from a FC without properly determining the E&P of

the FC, or

- Generating a material amount of Subpart F income



Method change procedural

rules



Method change procedural rules:Identifying an Accounting method

Framework for Analysis

• Three Components

- Has a method been adopted?

- What is the optimal method?

- How does the taxpayer implement the change?



Method change procedural rules:Identifying an Accounting method change

Has an accounting method been adopted?

• Method generally adopted for:

- Each “item”

- Within each trade or business (§446(d))

- Within each legal entity (§1.1502-17)

• Generally, US taxpayers adopt a method if used:

- On one return and method is proper, or

- On two consecutively filed returns and method is improper (Rev. Rul. 90-38)

• Foreign taxpayer does not adopt a method until the first taxable year E&P is

"significant” for US tax purposes. See §1.964-1(c)



Method change procedural rules:Identifying an Accounting method change (continued)

Why file a request for change in method?

• For favorable changes, could lose benefit of unauthorized change on exam

• For unfavorable changes, risk of IRS initiated change on exam with less favorable

terms and conditions (Rev. Proc. 2002-18)

- Change effected in the earliest open year

- No spread of section 481(a) adjustment

- Exam agent determines new method (likely least favorable method for taxpayer if

there are multiple permissible methods)

• Schedule B to Form 1120 requires disclosure of whether the taxpayer has made a

change in method of accounting for book and/or tax purposes (even if change was

made without a Form 3115)




How is a method change implemented?

• Guidance for changing a method of accounting voluntarily

- Rev. Proc. 97-27 – non-automatic method changes

- Rev. Proc. 2008-52 – automatic method changes

• Three primary determinations required for voluntary changes

- Automatic or Non-automatic

- Sec. 481(a) adjustment, positive vs. negative

- Examination status




Exam status

• General rule: Cannot file while under examination

• Exceptions

- Window period (90-day or 120-day), if issue not under consideration

- Director consent

- Change without audit protection, where permitted

- Issue pending

• If an exception applies, generally required to send copy of the Form 3115 to revenue

agent, appellate conferee, and/or district counsel (as appropriate)



Method change procedural rules: Summary

Non-automatic

(Rev. Proc. 97-27

Automatic

(Rev. Proc. 2008-52)

Due date Last day of taxable year With original, timely filed tax return

IRS filing fee $4,200 (plus $150 for each additional

legal entity)

None

Where to file File with IRS National Office# Original with tax return; duplicate with

IRS National Office#

481(a) spread for adjustment Favorable: 1 Year

Unfavorable: 4 Years

Taxpayer under exam Obtain director consent unless filing during a window period for an issue that is

not under consideration:

• First 90 days of taxable year if under continuous exam for at least 12 months

• 120 days after an examination ends

#Triplicate may be required for certain changes.



Method change procedural rules:New developments: Rev. Proc. 2009-39

• Rev. Proc. 2009-39 released August 27, 2009

- Amplifies, clarifies, and modifies Rev. Procs. 2008-52 and 97-27

- Changes certain procedural rules, as well as methods eligible for automatic

consent.

- Clarifies that in computing section 481(a) adjustment, must consider impact of

section 263A and other relevant accounts.

• Changes to the definition of “Under Examination”

- A taxpayer is considered “under exam” if:

• Foreign corporation and controlling domestic shareholder is under exam.

• Under review by the Joint Committee on Taxation (“JCT”), or

• Participates in the IRS CAP program

• Clarifies “Issue Under Consideration” (IUC) for Foreign Corporations

- IUC if the treatment of a distribution or deemed distribution, or the amount of

earnings and profits or foreign taxes deemed paid, is an issue under consideration

for the controlling domestic shareholder(s).



Method change procedural rules:New developments: Rev. Proc. 2009-39

New automatic method changes

• Repair and maintenance costs

• Dispositions of depreciable property

• Non-incidental materials and supplies

• Ratable accrual of real property taxes

• Tenant construction allowances

• Debt issuance costs

Modified automatic method changes

• Section 118

• UNICAP methods

• LIFO and IPIC

• Subnormal goods

• Advance payments

• Self-insured employee medical benefits

• Bonuses and vacation pay

• Timing of incurring liabilities under a

workers‟ compensation act, tort, breach

of contract, or violation of law

• Section 467 rental agreements



Method change procedural rules:New developments: Foreign corporations

• Recently finalized §964 regulations clarify that FC‟s are treated substantially the same

as domestic corporations when adopting or changing a method of accounting for

purposes of determining E&P (a US tax concept). Specifically,

- Accounting method adoption rules are applicable

• i.e., use of a proper E&P method on a single return or use of an improper E&P

method in two consecutively filed returns results in adoption

• Except E&P methods do not need to be adopted until the first time E&P is

significant for US tax purposes

- Accounting method change rules are applicable

• i.e., changing an adopted E&P method generally requires IRS consent via filing

Form 3115

• An E&P method of accounting used by an FC may not be changed by simply

adjusting E&P in earlier years

- Accounting method principles are applicable

• i.e., determination of permissible accounting methods generally based on US

tax principles



Top accounting method

changes



Unbilled service receivables

What taxpayers sometimes do Recognize income as services are performed

Optimal tax method Recognize unbilled receivables when performance of services is complete, not as the

taxpayer engages in the activity, unless the services are divisible

How to implement • Non-automatic method change

How to identify • Unbilled receivables on the balance sheet

• No deferred tax liability



Advance payments

What taxpayers sometimes do Include advance payments in income when received

Optimal tax method Defer advance payments under Rev. Proc. 2004-34 or Treas. Reg. §1.451-5

How to implement • Rev. Proc. 2004-34 – Automatic method change #

• Treas. Reg. §1.451-5 – Non-automatic method change

How to identify • Deferred revenue on the balance sheet

• Deferred tax asset

• Book-tax difference based on change in account balance

# Rev. Proc. 2009-39 provides an automatic change when a taxpayer changes the way advance payments

are recognized in the taxpayer‟s applicable financial statements (implying such changes require consent).



Disputed income

What taxpayers sometimes do Recognize income although the right to receive the income is in dispute

Optimal tax method Defer recognition of disputed income (and related COGS) under Rev. Rul. 2003-10

How to implement Non-automatic method change

How to identify • Contra-receivable on the balance sheet


• Book-tax difference based on change in contra receivable account (e.g. pricing

reserve or bad debt allowance)



Bad debts

What taxpayers sometimes do Deduct when uncollectible receivables are removed from the balance sheet

Optimal tax method Deduct when bad debt is wholly worthless, or partially worthless and specifically

reserved

How to implement Automatic method change to specific charge-off method

How to identify • Bad debt allowance on the balance sheet





Fixed section 263A percentage

What taxpayers sometimes do Determine additional costs to be capitalized under section 263A by applying a fixed

percentage to the value of ending inventory

Optimal tax method Capitalize only those costs required under section 263A and use favorable allocation

methodologies


How to identify • Inventory on the balance sheet

• Use of fixed percentage to compute additional section 263A costs

• Fixed percentage high relative to taxpayer‟s facts (compare capitalized amount to

gross ending inventory)

Note: Rev. Proc. 2009-39 provides a new automatic change for taxpayers that want to change from not capitalizing to

capitalizing costs if the taxpayer is otherwise using proper UNICAP methods.



Subnormal goods

What taxpayers sometimes do Value obsolete or damaged inventory at cost; Claim loss only when the goods are

disposed

Optimal tax method Write down subnormal FIFO goods below cost by valuing such goods at bona fide

selling prices or, if applicable, at scrap value


How to identify • Inventory reserves on the balance sheet



Note: Taxpayers using the LIFO method may not value subnormal goods below cost, but may write down such goods for

AMT purposes.



Lower of cost or market (“LCM”) inventory method

What taxpayers sometimes do • Value goods at net realizable value in accordance with book LCM method; or

• Value goods at cost

Optimal tax method Use tax LCM method and value FIFO goods at reproduction or replacement cost, or if

applicable, an actual offering price


How to identify • Decline in inventory costs, and/or offering price below cost

• If LCM reserve on balance sheet, either no book-tax difference (and thus following

book LCM) or book-tax difference based on change in account balance (and thus

valuing at cost)

• If no LCM reserve, no deferred tax liability



Software development costs

What taxpayers sometimes do Capitalize and amortize in accordance with book method

Optimal tax method Deduct internally developed software as incurred if qualify under Rev. Proc. 2000-50


How to identify • Software costs (e.g., in intangibles or CIP) on balance sheet


• No book-tax difference

Note: Similarly, research and experimental expenditures may qualify under a similar automatic

method change.



Prepaid payment liabilities

What taxpayers sometimes do Follow book method and capitalize and amortize prepaid “payment liabilities” over the

period to which such expenses relate

Optimal tax method Deduct prepaid payment liabilities that are incurred with useful life of 12-months or

less


How to identify • Prepaid payment liabilities on balance sheet (e.g., insurance, warranties, software

maintenance contracts, licenses, fees, permits, etc)


• No book-tax difference

Note: Prepaid goods or services also may be deducted when incurred if reasonably expect to receive goods or services

within 3 ½ months of payment (non-automatic method change).



Self-insured medical IBNR accruals

What taxpayers sometimes do Deduct self-insured medical incurred but not yet reported (“IBNR”) liability when paid

Optimal tax method Deduct self-insured medical liabilities of active employees, retired employees and the

medical portion of workers compensation in the year the services are provided#

How to implement • Automatic method change

• Unwind VEBA, if applicable

How to identify • Medical IBNR accrual on the balance sheet



# Rev. Proc. 2009-39 modified the automatic change for IBNR medical expenses to explicitly include medical services provided to retirees and employees filing claims under a workers‟ compensation act or out of any tort, breach of contract, or violation of law.



Rebates and returns

What taxpayers sometimes do Deduct items such as volume rebates, customer incentives, and sales returns when

paid

Optimal tax method Apply the recurring item exception to the extent the liability is fixed and determinable

at year-end and paid within 8 ½ months

How to implement • Automatic method change for rebates

• Non-automatic method change for returns

How to identify • Accrued customer rebates/incentives, or accrued sales returns on the balance

sheet





Accrued service liabilities

What taxpayers sometimes do Deduct when paid

Optimal tax method Deduct when services are provided


How to identify • Accrued customer rebates/incentives, or accrued sales returns on the balance

sheet



Examples: Co-op advertising, warranty service contracts, professional fees (especially legal fees rendered that are accrued in a legal reserve)



Accrued bonus


Optimal tax method Deduct in the year the bonus liability is incurred to the extent paid within 2 ½ months

after year-end. To be fixed at year end, accrued bonuses generally must be

• Either based on a fixed formula or a fixed pool approved by the Board by the end

of the tax year AND

• Paid regardless of whether the employee to which the bonus is originally allocated

is still employed at the time of payment.

NOTE: Unfavorable IRS CCA (200949040) was released in December 2009

How to implement Automatic method change if bonus is not fixed.

Also should consider change in bonus policy to create fixed liability.

How to identify • Accrued bonus on balance sheet





Accrued compensation


Optimal tax method Deduct in the year the compensation liability is incurred to the extent paid within 2 ½

months after year-end

How to implement Automatic method change.

How to identify • Accrued bonus on balance sheet




Examples: vacation pay, commissions, severance (including severance accrued in a restructuring reserve)


Payroll tax liabilities

What taxpayers

sometimes do

Do not accrue payroll taxes on year-end accrued

incentive compensation (e.g. bonuses, vacation

pay, severance)

Optimal tax

method

Treat payroll tax liabilities as fixed and

determinable in the same taxable year in

which

the related compensation is fixed and

determinable, even though uncertainty may exist

at the end of such year as to the amount of the

final liability

How to identify How to implement Automatic method change.



Real and personal property tax

What taxpayers sometimes do Follow book method of accounting (ratable accrual)

Optimal tax method Use “lien date” method with the recurring item exception, under which property taxes

are accrued to the extent the liability is fixed by year end (the lien date has occurred),

the amount is reasonably determinable, and is paid within 8 ½ months after year end,

where preferable

How to implement Automatic method change.

How to identify • Significant real and personal property tax liabilities in the following states: CA, AL,

CT, ME, MD, NH, NJ, NV, VT, and WV or fiscal year taxpayer

• No book-tax difference/no deferred tax liability


Note: Rev. Proc. 2009-39 provides a new automatic change for taxpayers that want to change their method of accounting for real property taxes to the ratable accrual election.


International tax updateUsman Mazhar



Agenda

I. Administration international budget proposals

II. Tax treaty update

A. US-Hungary tax treaty

B. US-Chile tax treaty

I. Guaranty Fees: Recent developments

116


Section I

Administration international

budget proposals



Overview Key Proposals

On February 1, 2010, the Obama Administration released Treasury‟s FY 2011 “Green

Book,” which contains a high-level outline of proposals for fiscal year 2011 affecting

international tax issues. Most still have a 2011 effective date.

Fundamental changes to US international tax law:

1. Foreign disregarded entity scaleback has been dropped, and CFC look-through

extended through 2011.

2. New Subpart F category added for “excessive returns” attributable to outbound IP

transfers ($15.5B).

3. Deferral of deductions allocable to unremitted foreign earnings – now on interest

expense only ($25.6B, down from $52.9B).

4. Blending section 902 foreign tax credit pools – unchanged from FY 2010 except for new

regulatory authority delegation($32B, up from $24.5B).

Section I: Administration international budget Proposals

118


OverviewNew or Changed from FY 2010

Rules on matching income and foreign tax credits tightened.

Limit income-shifting through intangible property transfers (sections 367(d) and 482).

Prevent repatriation of earnings in “Cash D” reorganizations.

• Change from FY 2010: Now also includes domestic/inbound reorganizations.

Deny deductions to US insurance companies for certain reinsurance premiums paid to

affiliated foreign reinsurance companies (new in FY 2011).

Limit earnings-stripping by expatriated entities.

• Definition of “expatriated” is critical; generally operates as if section 7874 were

applicable for taxable years beginning after 7/10/1989.

• Change from FY 2010: “Guaranteed debt” now also subject to 25% threshold.

Section I: Administration International Budget Proposals

119


OverviewNew or Changed from FY 2010 (continued)

Expand US withholding tax on securities lending and derivative transactions.

• Change from FY 2010: Removes safe harbor and provides more discretion to Treasury

to make exceptions.

Tighten reporting requirements for foreign financial accounts.

• Change from FY 2010: Now similar to FATCA provisions passed by House.


120


OverviewCarryovers from FY 2010

Codify economic substance doctrine.

• Slight reduction in revenue estimate from $4.7B to $4.2B.

Repeal 80/20 company provisions.

• Unclear why the proposal does not take a more targeted approach.

Modify tax rules for dual-capacity taxpayers.

• Most relevant for oil and gas industry.


121


Foreign disregarded entity scaleback dropped and CFC

Look-through extended

Scaleback of “check-the-box” use of foreign disregarded entities proposed in FY 2010 has

been dropped in the FY 2011 Budget.

• Current business planning and structuring ideas using foreign disregarded entities

should continue to be viable, subject to other limitations.

• Treasury has stated its intention for current law to remain in effect for "check-the-box"

use of foreign disregarded entities.

There is a proposal to extend CFC look-through (section 954(c)(6)) through tax year 2011.

• Most other tax extenders (including the active financing exception to Subpart F under

section 954(h)) are also proposed to operate through 2011.

• This date is one year beyond the FY 2010 Budget proposal.

Section I: Administration international budget proposals

122


• “Foreign-related deductions” of US interest would be allowed only to the extent

allocable or apportionable to currently-taxed foreign income.

• As the Joint Committee commented, an interest deduction deferral without worldwide

interest apportionment (WWIA) would be an “overcorrection.”

- WWIA has been pushed back to 2018 in enacted legislation; its impact is evident in

the revenue estimate.

• Unlike the FY 2010 proposal, this deferral would not apply to other expenses properly

allocable or apportionable to unremitted foreign income.

- Excludes directly allocable expenses such as stewardship costs.

• Concerns had been expressed about the impact of the FY 2010 proposal on US

headquarters jobs.

• Also excludes expenses allocable to directly-earned, currently-taxed foreign-source

income (e.g., through foreign branches or sections 862 and 863(b)).

Deferral of interest deductions allocable to unremitted

foreign earnings scope



• No carryforwards.

- Unlike the FY 2010 proposal (and more similar to Chairman Rangel‟s 2007 bill), the

FY 2011 proposal would not create carryforwards of interest expense, instead,

previously deferred interest expense would be picked up proportionately on

remittances of deferred foreign earnings.

• Allocation and apportionment under current rules.

- Unlike the FY 2010 proposal, the FY 2011 proposal would expressly use current

rules for allocating and apportioning interest expense.

- The proposal grants authority to write anti-abuse regulations, apparently signaling

plans to address aggressive planning techniques under current interest

apportionment rules.

• Pre-effective date E&P.

- While transition rules are not addressed, it may be appropriate to provide a

transition rule to exclude pre-effective date E&P from the deferral calculations, like

Chairman Rangel's bill in 2007.

Deferral of Interest deductions allocable to unremitted

foreign earnings mechanics


124


US MNC and Competitor in Territorial Tax Jurisdiction with 35% Corporate Rate

Present

law

FY 2011

Budget

Present

law

FY 2011

Budget

Foreign Subsidiary

Earnings before tax 100.0 100.0 100.0 100.0 100.0 100.0

Foreign income taxes 25% 25.0 25.0 25.0 25.0 25.0 25.0

Earnings after tax 75.0 75.0 75.0 75.0 75.0 75.0

Dividends - - - 75.0 75.0 75.0

Parent

Domestic Income 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0 1,000.0

Domestic Expenses 900.0 900.0 900.0 900.0 900.0 900.0

Interest 50.0 50.0 50.0 50.0 50.0 50.0

Allocable to foreign income 50% 25.0 25.0 25.0 25.0 25.0 25.0

Deferred - 25.0 - - - -

Taxable domestic income 100.0 125.0 100.0 100.0 100.0 100.0

Taxable foreign income - - - 100.0 100.0 -

Worldwide income 100.0 125.0 100.0 200.0 200.0 100.0

Tax before foreign tax credit 35% 35.0 43.8 35.0 70.0 70.0 35.0

Foreign tax credit - - - 25.0 25.0 -

Parent income tax 35.0 43.8 35.0 45.0 45.0 35.0

Worldwide income tax 60.0 68.8 60.0 70.0 70.0 60.0

Foreign 25.0 25.0 25.0 25.0 25.0 25.0

Parent 35.0 43.8 35.0 45.0 45.0 35.0

Reinvest foreign income

RateItemUS MNC US MNC

Repatriate all foreign incomeForeign

com-

petitor

Foreign

com-

petitor

Deferral of interest deductions allocable to unremitted foreign

earnings Example 1


125


• USP owns CFC and has foreign branch, FB. The value of the investment in CFC and

the value of FB‟s assets are proportionate to their foreign source income.

• In Year 1, CFC earns $100 of foreign-source income and FB earns $25 of foreign-

source income. USP has US interest expense, of which $20 is apportioned to its

investment in CFC and $5 is apportioned to FB's assets. CFC remits its $100 of

earnings to USP as a taxable dividend. USP can deduct all $25 of US interest expense

apportioned to foreign-source income.

• In Year 2, the income and interest expense numbers are the same as in Year 1, but

CFC only remits $50 of its earnings to USP as a dividend. USP can deduct $15 of US

interest apportioned to foreign-source income (50% of the interest expense apportioned

to USP's investment in CFC and 100% of the interest expense apportioned to FB's

assets).


foreign earnings Example 2


126


CFC Foreign

Source Income

(FSI)

Foreign

Branch

FSI

Remittance to

US Parent

Interest

Expense Pool

Interest Expense

Apportioned to Foreign

Branch

Allowable

Deduction

Year 1 100 25 100 20 5 25

Year 2 100 25 50 20 5 15

Year 3 100 25 120 30 5 29

• In Year 3, the income and interest expense numbers are the same as in Years 1 and 2,

but CFC remits $120 to USP as a dividend (which constitutes 80% of CFC's current and

accumulated E&P). USP can deduct $29 of US interest expense apportioned to

foreign-source income (80% of the pool of interest expense apportioned to USP's

investment in CFC and 100% of the interest apportioned to FB's assets).


foreign earnings Example 2 (continued)


127


The Administration‟s FY2011 Budget Proposals include two new provisions to prevent

“inappropriate shifting of income” associated with intangible assets to low-tax jurisdictions:

• Tax currently “excess” returns associated with transfers of intangibles offshore.

- New proposal would add a category of Subpart F income to cap the amount of US tax

deferral on profits earned by CFCs from their use of transferred US intangible assets.

- This provision is estimated to raise $15.5 billion over 10 years.

• Limit shifting of income through intangible property transfers.

- Modified version of the FY 2010 proposal, operating under sections 367(d) and 482.

- This provision is estimated to raise $1.2 billion over 10 years.

Increased tax burden on outbound transfers of intangiblesSection I: Administration international budget proposals

128


• Under this proposal, if a US person transfers an intangible from the United States to a

related CFC that is subject to a low foreign effective tax rate (ETR) in circumstances

that evidence “excessive income shifting”, then an amount equal to the “excessive

return” would be treated as subpart F income in a separate foreign tax credit basket.

• Terms such as “low foreign ETR,” “excessive income shifting,” and “excessive return”

have not been defined.

- Treasury officials have indicated that the revenue impact of the proposal was estimated

assuming the provision applied to ETRs of 10 percent or less and returns of 30 percent

or more.

- It is unclear how the ETR would be measured and whether the referenced 30 percent

return is a rate of return on assets or equity or a profit margin on sales or on some other

base.

Subpart F Inclusion for “Excess Returns” from IP transferred

offshore


129


• Clarifies that the definition of intangible property for purposes of sections 367(d) and

482 would include workforce-in-place, goodwill, and going concern value.

- The JCT‟s analysis suggest that foreign goodwill would still be included in the exception.

• Codification of the “realistic alternative” principle included in the Temporary Cost Sharing

Regulations.

- This method allows for the valuation of transferred intangible assets with reference to

alternative uses of the intangible assets that may be available to the transferor at arm‟s

length.

• This proposal also would allow the IRS to value intangible properties on an aggregate

basis “where that achieves a more reliable result”.

• Valuation of intangible property:

- FY2010 – Intangibles must be valued at their “highest and best use”.

- FY2011 – Intangibles may be valued taking into consideration the prices or profits that

the controlled taxpayer could have realized by choosing a realistic alternative to the

controlled transaction undertaken.

Tightening of existing rules for taxing IP transferred offshoreSection I: Administration international budget proposals

130


• If enacted into law, these proposals may have significant impact on outbound transfers

of intangible property and the current transfer pricing policies of US multinationals.

• Additional details on the proposals should be forthcoming as part of Congressional

hearings on the Budget.

Increased tax burden on outbound transfers of intangibles

potential impact


131


Blending pools of Deemed-Paid foreign tax credits Scope

FY 2011 proposal is generally unchanged from FY 2010.

The Administration did not adopt the Joint Committee recommendation to use the approach

of Chairman Rangel‟s 2007 bill, blending section 901 as well as section 902 foreign tax

credits.

• The Administration‟s choice to limit the FY 2011 proposal to section 902 credits is

appropriate to its emphasis on addressing deferred foreign-source income.

• Section 901 credits relate only to currently-taxed foreign-source income.

The new proposal does not contradict Joint Committee interpretations that the blending

proposal includes:

• All E&P back to the beginning of the income tax regime.

• Credits attributable to 10/50 companies.


132


The FY 2011 proposal still effectively treats all of a taxpayer‟s CFCs as a single CFC for

section 902 purposes.

Section 902 credits would be determined based on the percentage of section 902-eligible

E&P included in income.

Taxes deemed paid for = Pool of section x Included E&P

purposes of section 902 902 credits Total E&P Pool

foreign tax credit

The new grant of regulatory authority may reflect comments on the complexity of

implementation.

• CFC-by-CFC accounts.

• Shareholder-by-shareholder accounts.

• Other issues of administrability.

Blending pools of Deemed-Paid foreign tax credits

Mechanics


133


Assume taxpayer wholly owns two CFCs. CFC1 has $200 of E&P after paying $50 in tax,

and CFC2 has $300 of E&P after paying $50 in tax. If either CFC1 or CFC2 remits $100,

taxpayer has taxes deemed paid for purposes of the section 902 credit of $20 (i.e., ($50 +

$50) x $100/$500).

In contrast, under current law, taxpayer would have taxes deemed paid for purposes of the

section 902 credit of $25 if CFC1 made the remittance and $17 if CFC2 made the

remittance.

Blending pools of Deemed-Paid foreign tax credits Example


134


“Technical Taxpayer” Provision

The proposal would create “a matching rule to prevent the separation of creditable foreign

taxes from the associated foreign income.”

• The FY 2011 proposal expressly would grant Treasury the authority to issue new

regulations.

• Proposed legislation may also provide specific anti-abuse rules.

For the FY 2010 proposal, Treasury officials indicated informally that the new legislative

proposal will be similar to the “technical taxpayer” regulations under section 901 proposed

in August 2006, but go beyond them.

• Those regulations dealt with foreign consolidated groups and reverse hybrids, among

other provisions.

The FY 2011 revenue estimate is $27B, almost 50% higher than for FY 2010.

• The higher estimate raises questions about the scope of the FY 2011 proposal.


135


Looking forward Legislative path for 2010

Budget and tax reform hearings are expected in House Ways & Means Committee and

Senate Finance.

• Chairman Rangel may introduce a revised version of his comprehensive 2007 tax

reform bill.

• Tax reform hearings would be expected to address jobs, economic growth,

competitiveness issues.

• Possible multi-year legislative process if started in 2010.

New statutory pay-go law and mounting deficit concerns.

• Pay-go violations would lead to mandatory sequestration of certain spending programs.

• Increasing pressure to look for revenue offsets to use as “pay-fors”.


136


Looking forward Business Community Reaction and Coordination

Proposals represent fundamental changes to US rules

• Significant challenge to global competitiveness of US-headquartered companies.

• Would move United States further from tax rules of our trading partners.

• Territorial systems in place for foreign source dividends in 25 of 30 OECD countries.

PACE Coalition (Promote America‟s Competitive Edge)

• Trade associations and interested companies.

• Maintain active lobbying and educational campaign.

• pace4jobs.org


137


Section II

Tax treaty update



Section II: Tax treaty update

US-Hungary tax treaty

On February 4, 2010, Hungary and the US signed a new tax treaty to replace the current

1979 treaty. Although the effective date is uncertain, if instruments of ratification are

exchange by the end of December 2010 the new treaty would be effective for taxable years

beginning on January 1, 2011.

The most significant difference between the existing and the new treaty is the addition of a

modern Limitation of Benefits (“LOB”) article. The new article includes the following

features:

• Publicly traded test (in line with the 2004 Dutch Protocol).

• Ownership/base erosion test (in line with the 2004 Dutch Protocol).

• Active trade or business test (similar to the 2006 US Model Treaty which generally

requires a fact and circumstances analysis).

• Derivative benefits test (for companies that are directly or indirectly owned by a

qualified resident of EU, NAFTA and European Free Trade Association which includes

Switzerland. Corporate owners must meet the publicly traded test of the LOB of the

treaty between their country and the US)

139


• Headquarters company test (similar to the 2004 Dutch Protocol which provides that a

group of financing activities alone will not be sufficient to qualify as acceptable

supervisory activities).

• The so-called triangular branch rule. This rule applies where the branch is located in a

third country and the combined taxation by the treaty country and the country of the

branch is less than 60% of what the applicable home office country tax would have

been. Dividends, interest and royalties earned by those branches from sources in the

other treaty country will be subject to a 15% rate.

The new treaty generally provides for an exemption from tax on royalties and interest (other

than contingent interest which is subject to a 15% tax rate).

Unlike newer treaties with EU countries, the new treaty with Hungary does not contain an

exemption for certain parent/subsidiary dividends. The general tax rate of 15% will be

reduced to 5% if the beneficial owner of the dividend holds directly at least 10% of voting in

the company paying the dividends.

US-Hungary tax treaty Section II: Tax treaty update

140



US-Chile tax treaty

Also on February 4, 2010, Chile and the US signed a new tax treaty . This treaty is the

second US treaty with a Latin American country (after Venezuela). The effective date is

uncertain.

The treaty is broadly based on the 2006 US Model Income tax Treaty. Some of the features

of this treaty are the following :

• Inclusion of certain natural resource-related activities as permanent establishment (e.g.,

installation project and supervisory activities in connection with on-land exploration ,or a

drilling rig or ship used for the exploration of natural resources if it lasts for more than 6

months) as well as enterprises that performs services for periods exceeding in

aggregate 183 days in any twelve month period.

• Dividend payments are generally subject to a 15% tax rate with a reduction to 5%

where the beneficial owner is a company which holds directly at least 10% of the voting

power of the company paying the dividends. The treaty does not contain an exemption

from tax for certain parent/subsidiary dividends.

141


• Interest payments are generally subject to a 10% rate (15% for the first 5 years after

the interest provision enter into force) except that a 4% rate will apply to interest paid by

certain entities (e.g., banks or entities engaged in financial activities). In addition,

contingent interest is subject to a 15% rate.

• Royalties may be taxed at a 2% rate on payments for the use of industrial, commercial

or scientific equipment. A 10% rate applies to payments for the use of copyrights.

• A capital gains taxation on disposition of equity interest at a rate of 16% except that

certain substantial holdings (50% for shares and 20% for other equity interests) are not

subject to this 16% limit.

• The LOB article is consistent with other modern treaties (e.g., publicly traded test, base

erosion test, active trade or business test, head quarters test, so-called triangular

branch rule, etc.)


US-Chile tax treaty

142


Section III

Guarantee Fees – Recent

developments



Case involved a dispute regarding whether a US subsidiary, Container Corp., was required

to withhold US tax from guarantee fees it paid to its Mexican parent corporation, Vitro, for

guaranteeing debt it had issued to unrelated third parties.

Court concluded that, because they were more analogous to payments for services

(performed by the Mexican parent in Mexico) than payments of interest (on a note issued

by the US company), the guarantee fees were foreign source income and, thus, not subject

to US tax under §881 or withholding under §1441.

Container Corp. v. Comm'r,134 T.C. No. 5 (2010) Case Summary

Section III – Container corp case

144


The case

• In 1990, Container Corp. issued $155

million of senior notes to refinance its

outstanding debt.

• Vitro guaranteed the notes pursuant to a

guarantee agreement.

• The guaranty agreement required

Container Corp. to pay Vitro an annual

fee equal to 1.5% of the outstanding

principal balance of the notes.

Vitro

(Mexico)

Container Corp.

(US)

third

parties

$155 Million

Senior

Notes

guarantee

fee

guarantee

agreement


145


US Tax treatment of guarantee fees

Under §881(a), certain fixed or determinable annual or periodical ("FDAP") income received

by foreign corporations from sources within the United States is subject to US tax at a rate

of 30 percent, which is withheld at source.

Thus, in order for guarantee fees to be subject to tax under §881(a), they must be both

FDAP income and US source.

Under Regs. §1.1441-2(b), FDAP income is defined broadly to include virtually all types of

income other than capital gains from the sale of property. Guarantee fees are generally

considered to fall within this definition of FDAP income.


146


Source of income rules

§§861 through 865 govern the source of income for US tax purposes. The source rules

address the source of specific categories of income, but do not provide a specific method for

determining the source of guarantee fees.

Under case law, where no sourcing rule exists for a specific item of FDAP income, its source

is determined by reference to the statutory rule governing the type of income to which it is

most analogous.

Guarantee fees are frequently analogized to interest and fees for services.

• Source of interest income is generally determined by reference to the residence of the

obligor;

• Source of income derived from the performance of personal services is determined by

reference to the location where such services are performed.


147


IRS View in Container Corp. case

• The IRS asserted that the guarantee fees at issue were paid by the US subsidiary to its

Mexican parent corporation in exchange for its use of the parent corporation's

creditworthiness.

• The IRS argued that such guarantee fees are analogous to interest and, thus, should

be US-source income.

• The court disagreed.


148


US Tax court view in Container Corp. case

• The court reasoned that the guarantee fees compensated the Mexican parent for

incurring a contingent future obligation to pay its subsidiary's debt, and that incurring

such obligation was analogous to providing a service.

• Further, the Mexican parent was able to incur the obligation because it had sufficient

assets and creditworthiness. As such assets were located in Mexico and such

creditworthiness derived from the decision making of its corporate board, also located in

Mexico, the court reasoned that the service of incurring the obligation was performed in

Mexico.

• As a result, the court concluded that the guarantee fees were Mexican source income

not subject to US tax under section 881(a).


149


Observations

• Statutory sourcing rules source services income to where the services are performed,

rather than to the location of the personnel or assets that made the services possible.

The court‟s reference to the location of the Mexican parent's assets and board of

directors is inconsistent with this treatment.

• The court did not consider whether the guarantee fees at issue were more analogous to

a type of income other than interest or services income.

- For example, the Container Corp. court described the Mexican parent‟s obligation as

a “secondary” credit risk, similar to certain payments made under a credit default

swap (“CDS”). Payments made under a CDS are commonly analogized to notional

principal contracts (“NPCs”) or option contracts, payments in connection with which

are typically sourced to the residence of the recipient under Regs. §1.863-7(a)(1)

(NPCs) or §865(a) (option premiums).


150


Relevance

• Many foreign multinationals receiving a guarantee fee from a US subsidiary may not

need to rely on the sourcing rule to exempt guarantee fees from US taxation. The “other

income” article that is contained in many (but not all) US tax treaties would preclude US

taxation of the guarantee fee unless the guarantor has a permanent establishment in

the United States to which the fee is attributed.

• Application of the principles of the Container Corp. to U.S multi-nationals could convert

what might otherwise be foreign source income into US source income, possibly limiting

the US company's ability to credit foreign income taxes.


151


Section IV

Miscellaneous



New Section 304 regulations

• The IRS has issued final, temporary, and proposed regulations under Section 304 (T.D.

9477) that apply to certain transactions that are subject to section 304 but that are

entered into with a principal purpose of avoiding the application of section 304 to a

corporation that is controlled by the issuing corporation in the transaction, or with a

principal purpose of avoiding the application of section 304 to a corporation that

controls the acquiring corporation in the transaction.

• It has, therefore, amended the regulations to provide that for purposes of determining

the amount of a property distribution that is a dividend (and the source thereof) under

section 304(b)(2), the acquiring corporation will be treated as acquiring for property the

stock of a corporation (deemed issuing corporation) that is controlled by the issuing

corporation, if, in connection with the acquisition for property of stock of the issuing

corporation by the acquiring corporation, the issuing corporation acquired stock of the

deemed issuing corporation with a principal purpose of avoiding the application of

section 304 to the deemed issuing corporation.

• The regulations apply to acquisitions of stock occurring on or after December 29, 2009.

Section IV – Miscellaneous

153


• On December 28, 2009, the IRS issued Notice 2010-12, further extending the exception

provided under Notice 2008-91 to also apply to a CFC‟s tax year which immediately

follows the last tax year of that CFC to which the expanded exception would otherwise

have applied.

• Notice 2008-91 provided a US tax payer the option for the first two years of a CFC

ending after October 3, 2008 and beginning before January 1, 2010 to have a (i) 60

days grace period within which the US obligation must be repaid and (ii) aggregate

holding period for US debt obligations of 180 days.

- Notice 2010-12 emphasizes that the liberalized treatment of CFC loans under

section 956 will not apply to any tax year of a CFC beginning on or after January 1,

2011.

- It also notes that the IRS does not anticipate extending the application of the

expanded exception to any additional periods.

• Notice 2010-12 also extends through calendar year 2010 the application of Rev. Proc.

2008-26, which liberalized the definition of “readily marketable securities” for purposes

of section 956.

Notice 2010-12: Extension of guidance under Section 956(c)

Slide 154


154


Total return swaps

• The IRS Large and Mid-Size Business (LMSB) Division has published an industry

director directive to provide guidance and information document requests for

uncovering and developing cases related to total return swap (TRS) transactions that

may have been executed to avoid tax with respect to US source dividend income paid

to foreign corporations.

• Taxpayers have been arguing that the payments made pursuant to certain transactions

are foreign source under Treas. Reg. 1.863-7 and are not subject to US withholding tax

and Form 1042-S reporting.

• The intent of the directive is to provide guidance on developing facts for determining

when a transaction that is in form a TRS will be respected in substance as a notional

principal contract, and when such a swap will be recharacterized in accordance with its

substance as an agency agreement, repurchase agreement, lending transaction, or

some other form of economic benefit.


155


Washington legislative updateFred Gordon



Agenda

The Current State of Play in Washington

• The Final Four: The Road to Easter Recess

- Health care

- Expiring tax provisions

- Job creation proposals

- Small business

• Administration FY 2011 Budget/ International Tax Proposals

• Other Key Proposals on the Horizon

• Outlook for Tax Reform

This document was not intended or written to be used, and it cannot be used, for the purpose of avoiding tax

penalties that may be imposed on the taxpayer.



2010 Congressional schedule

President‟s State of the Union address January 27

President‟s FY 2011 budget submission February 1

President‟s Day recess February 15 – 19

Spring recess March 29 – April 9

Congressional budget deadline April 15

Memorial Day recess May 31 – June 4

Independence Day recess July 5 – July 9

August recess August 9 – September 10

Target adjournment TBD (early October)

Midterm congressional elections November 2

“Lame duck” session ?



President Obama health care tax proposals

Select Revenue Provisions Effective 10-year Revenue

Additional 0.9% HI tax on wages >$200,000/$250,000

Plus 2.9% HI tax on non-wage income

2013 $ 183.6 billion

Annual fee on health insurance providers 2014 $ 59.5 billion

Annual fee on drug manufacturers 2011 $ 33.4 billion

40% excise tax on coverage >$10,200/$27,500 2018 $ 32.7 billion

Eliminate biofuel producer credit for “Black Liquor” DOE $ 23.9 billion

Excise tax on medical device manufacturers 2013 $ 20.0 billion

Corporate information reporting 2012 $ 17.1 billion

Limit health FSAs in cafeteria plans to $2,500 2014 $ 11.4 billion

Codify economic substance doctrine, with related penalties DOE $ 4.9 billion

10% excise tax on indoor tanning services 2010 $ 2.7 billion

Eliminate expense deduction for Medicare Part D subsidy 2012 $ 2.6 billion

Approximate Total

(including other revenue provisions)

$412.2 billion


Source: Joint Committee on Taxation “very preliminary” revenue estimates


Administration health care proposal: Key changes to Senate-approved bill

• Delay tax on high-value health plans until 2018

- Increase thresholds in Senate-approved bill to $27,500 for a family, $10,200 for

individuals

• Adopt Senate 0.9 increase in Medicare HI tax on wages of upper-income individuals

($200,000), MFJ ($250,000)

- Add new 2.9 Medicare HI tax on investment income for upper-income individuals

• Increase from $23 billion to $33 billion over 10 years Senate-approved assessment on

pharmaceutical companies



Paying for health care reform(Senate-Passed Bill, H.R. 3950)


40% excise tax on coverage >$8,500/$23,000 2013 $ 148.9 billion

Additional 0.9% HI tax on wages >$200,000/$250,000 2013 $ 86.8 billion

Annual fee on health insurance providers 2011 $ 59.6 billion

Annual fee on drug manufacturers 2010 $ 22.2 billion

Annual fee on medical device manufacturers 2011 $ 19.2 billion




10% excise tax on indoor tanning services 2010 $ 2.7 billion

Approximate Total


$375.2 billion



Paying for health care reform(House-Passed Bill, H.R. 3962)


5.4% surtax on modified AGI >$500k/$1 million 2011 $ 460.5 billion

Eliminate biofuel producer credit for “Black Liquor” DOE $ 23.9 billion

Non-retail medical devices 2013 $ 20.0 billion



Tax treaty withholding limitation DOE $ 7.5 billion

Repeal of worldwide interest allocation DOE $ 6.0 billion

Codification of economic substance DOE $ 5.7 billion


Approximate Total


$556.2 billion



Expired business and individual provisions

Expired business tax provisions include:• Research credit

• Active financing exception

• CFC look-through treatment

• 15-year depreciation on leasehold, restaurant, and retail improvements

House-approved bill (H.R. 4213) fully offset• Tax “carried interest” as ordinary income

• Foreign Account Tax Compliance

Senate-approved version of H.R. 4213 also includes extended

unemployment and COBRA benefits (partially offset)• Codification of economic substance doctrine

• “Black liquor” cellulosic biofuel producer credit

• Pension funding relief



Job creation proposals

Administration proposals to promote job growth (12/8/2009)

• Extend bonus depreciation through 2010

• Extend COBRA subsidy

Senate-approved $15 billion version of H.R. 2847

• Temporary payroll tax holiday for hiring unemployed workers

• Highway funding, Build America Bonds, and Section 179 provisions

Revenue offsets


• Delay worldwide interest allocation rules until 2020

House-approved version of H.R. 2847


• Delay worldwide interest allocation rules until 2021



President Obama FY11 budgetSelected business tax proposals

Provisions (10 yr, $ billions)

Make the research tax credit permanent $(70.5)

Temporary recovery measures, including bonus depreciation $(92.7)

“Reform US international tax system” $ 127.0

“Financial Crisis Responsibility Fee” $ 90.0

Repeal LIFO $ 75.3

Eliminate certain tax provisions for oil, gas and coal companies $ 40.7

Expand reporting and compliance $ 19.9

Tax carried interest as ordinary income $ 28.6

Reinstate Superfund excise taxes $ 19.2

Codify the economic substance doctrine $ 7.2


Source: Joint Committee on Taxation revenue estimates


President Obama FY11 budgetInternational tax proposals

Provisions (10 yr, $ billions)

Determine foreign tax credit on a pooling basis $ 49.2

Defer deduction of interest expenses related to deferred income $ 35.5

Tax “excess returns” from transfers of intangibles $ 10.2

Prevent splitting of foreign income and foreign taxes $ 9.5

Modify tax rules for dual capacity taxpayers $ 8.2

Address offshore tax noncompliance $ 7.4

Disallow deduction for certain reinsurance premiums $ 2.3

Limit earnings stripping by expatriated entities $ 1.7

Prevent the avoidance of dividend withholding taxes $ 1.4

Repeal 80/20 company rules $ 1.0

Limit shifting of income through intangible property transfers $ 0.5

Total $ 127.0


Source: Joint Committee on Taxation revenue estimates


Key changes in administration‟s FY 2011 international

proposals

Check-the-box proposal dropped from FY 2011 budget.

Deferral of deductions allocable to unremitted foreign earnings – now on

interest expense only

• Estimated to raise $35.5 billion, down from $52.9 billion

New proposals to tax currently excess returns associated with transfers

of intangibles offshore

• Estimated to raise $10.2 billion



Additional FY 2011 international proposals: New or changed from FY 2010

Rules on matching income and foreign tax credits tightened. Limit income-shifting through

intangible property transfers (sections 367(d) and 482).

Prevent repatriation of earnings in “Cash D” reorganizations.

• Change from FY 2010: Now also includes domestic/inbound reorganizations.

Deny deductions to US insurance companies for certain reinsurance premiums paid to

affiliated foreign reinsurance companies (new in FY 2011).

Limit earnings-stripping by expatriated entities.

• Definition of “expatriated” is critical; generally operates as if section 7874 were

applicable for taxable years beginning after 7/10/1989.

• Change from FY 2010: “Guaranteed debt” now also subject to 25% threshold.

Expand US withholding tax on securities lending and derivative transactions.

• Change from FY 2010: Removes safe harbor and provides more discretion to Treasury

to make exceptions.

Tighten reporting requirements for foreign financial accounts.

• Change from FY 2010: Now similar to FATCA provisions passed by House.



Subpart F inclusion for “Excess Returns” from IP transferred

offshore

Under this proposal, if a US person transfers an intangible from the United States to a

related CFC that is subject to a low foreign effective tax rate (ETR) in circumstances that

evidence “excessive income shifting”, then an amount equal to the “excessive return” would

be treated as subpart F income in a separate foreign tax credit basket.

Terms such as “low foreign ETR,” “excessive income shifting,” and

“excessive return” have not been defined.

• Treasury officials have indicated that the revenue impact of the proposal was estimated

assuming the provision applied to ETRs of 10 percent or less and returns of 30 percent

or more.

• It is unclear how the ETR would be measured and whether the referenced 30 percent

return is a rate of return on assets or equity or a profit margin on sales or on some

other base.



Research credit

Current credit expired on December 31, 2009

Joint Committee on Taxation staff estimates permanent extension to cost $70.5 billion over

ten years

Extension expected to require revenue offset

Proposals would increase Alternative Simplified Credit (ASC) to 20 percent

• Baucus/Hatch bill (S. 1203) proposes elimination of base-period method after 2010

when ASC reaches 20 percent

• Similar bill (H.R. 422) introduced by House Ways and Means Committee member

Kendrick Meek (D-FL)



“Financial Crisis Responsibility Fee”

Proposed tax would apply to covered firms with more than $50 billion in

assets

• Exception for Fannie Mae, Freddie Mac, and automakers

Tax set at 15 basis points on a firm‟s qualifying liabilities, excluding deposits or reserves

assessed by a federal regulator (e.g. FDIC)

• Ways and Means staff exploring option of basing tax on income and not assets

Expected to raise $90 billion over first 10 years to cover projected TARP

losses

• Congressional Budget Office report cites incidence of tax burden being passed through

to consumers



Worker classification

Repeals Section 530 of the Revenue Act of 1978 one year after date of enactment

Permits IRS to require prospective reclassification of workers who are currently

misclassified under current law

Permits Treasury and IRS to issue generally applicable guidance on the proper

classification of workers under common law standards

Requires companies to give notice to independent contractors that explains how they will

be classified and the consequences thereof

Estimated to raise $7.3 billion over 10 years



Codification of “Economic Substance” doctrine

Must change in meaningful way pre-tax economic position and must be undertaken for

nontax business purpose

40-percent penalty for underpayments attributable to undisclosed transactions lacking

economic substance

20-percent penalty for disclosed transactions

Effective for transactions entered into after date of enactment

Estimated to raise $5.5 billion over 10 years



Additional Recent Anti-Deferral Proposals

Ways and Means Chairman Rangel Deferral Proposal

• Suspend US deductions related to unrepatriated foreign earnings and limit use of

foreign tax credits

Dorgan “Runaway Plant” Proposal

• Deny deferral benefits for income from property exported to the US from a CFC

jurisdiction

Dorgan “Tax Haven” Proposal

• Deny deferral benefits for US CFCs located in 40 “tax haven” jurisdictions, including

Bermuda

Other select proposals

• Repeal worldwide interest allocation rules

• Repeal sales source rule

• Treat all CFC income as Subpart F except for active home country income



Focus on offshore “Tax Havens”

President Obama has promised “aggressive action” on offshore “tax havens”

OECD issues updated 9-28-2009 report on countries implementing standards for exchange

of tax information

• OECD cites countries including Bahamas, Belize and Gibraltar for not having

“substantially implemented” international standards

• Switzerland, Cayman Islands and Bermuda promoted to “white” list



Focus on offshore “Tax Havens” (continued)

Rangel/Baucus Bill (H.R. 3933, S. 1934)

• Increased offshore compliance and information reporting

• Double statute of limitation for certain foreign financial assets and failure to comply with

new information reporting requirements

• Clarify treatment of US dividends received by foreign persons (e.g., total return swaps)

Levin/Doggett Bills (S. 506, H.R. 1265)

• Corporate residency “management and control” provision

• List of 34 “Offshore Secrecy Jurisdictions”

• Change presumption for transactions in tax-secrecy jurisdictions

• Increased IRS exam authority



Additional potential tax issues

Tax Reform

Estate Tax

Climate Change/Energy Incentives

Pension Funding Relief

Tax Technical Corrections

Highway and Aviation Trust Fund Taxes



Wyden-Gregg “Tax Fairness and Simplification Act of 2010”

(S. 3018)

Proposes a single 24-percent corporate rate

Proposes individual rates at 15, 25, and 35 percent

Repeals corporate and individual AMT

Revenue offsets include:

• Repeal of deferral

• Reduce interest deduction for corporate debt by inflation factor

• Foreign tax credit per-country limitation

• Limit depreciation to straight-line method

• Repeal of inventory property sales source rule exception

$230 billion net revenue loss projected after offsets

• Additional cost to be covered by reduction in federal spending on “corporate welfare”



State and local tax updateAnna Hoti

Greg Byrne



Connecticut – Proposed legislation

State Tax Initiatives

• RB 478

- Would remove the unreasonable exception from the intangible expense add back

under CGS 12-218c .

• RB 485

- Would require unitary-combined reporting.

• Applicable to income years commencing on or after January 1, 2010.

• Public hearing scheduled for 3/22/2010


Connecticut – Other proposed legislation


“Shell” bills introduced in the CT legislature. Note: All bills have been referred to Joint

Committees.

• House Bill 5179 (introduced 2/11/10) would require corporations to pay the corporate

income tax on the greater of a unitary-combined basis or on a separate company basis.

• House Bill 5190 (introduced 2/16/10) would limit the corporate deduction for noncash

compensation to $1 million.

• House Bill 5191 (introduced 2/16/10) would replace the flat 7.5 percent corporate

income tax rate with a 5 percent rate for net income of less than $200,000, 7.5 percent

rate on net income from $200,000 to $1 million, and a 10 percent rate on net income

over $1 million.

• House Bill 5242 (introduced 2/18/10) would replace the flat 7.5 percent corporate

income tax rate with a 5 percent rate for net income of less than $500,000, 7.5 percent

rate on net income from $500,000 to $10 million, and a 10 percent rate on net income

over $10 million.


Connecticut – Other proposed legislation (continued)


• SB 5481

- Proposed Connecticut legislation would create a presumption that a person is a

retailer if that person makes sales of tangible personal property or services "through

an independent contractor or other representative if the retailer enters into an

agreement with a resident" of Connecticut, who for a commission or other

consideration, directly or indirectly refers potential customers to the retailer via a link

on an Internet Web site or otherwise, if the cumulative gross receipts from such

sales are more than $2,000 during the preceding four calendar quarters.

- Under the proposed legislation, the presumption can be overcome by proof that the

resident with whom the retailer has an agreement did not engage in any solicitation

in the state on behalf of the retailer that would satisfy the nexus requirement of the

US Constitution.

- The legislation would be effective for sales that occurred on or after July 1, 2010.


Connecticut – Enacted legislation


Public Act 09-3

• Establishes an economic nexus standard.

• Imposes corporate business tax on "any company that derives income from sources

within the state, or that has a substantial economic presence within this state,

evidenced by a purposeful direction of business toward this state, examined in light of

the frequency, quantity and systematic nature of a company's economic contacts with

this state, without regard to physical presence, and to the extent permitted by the

Constitution of the United States."

• Economic nexus standard also applies to partnerships and S corporations for purposes

of filing information returns with the state.

• Applies to income years beginning on or after January 1, 2010.


Connecticut – Enacted legislation (continued)


Public Act 09-2 decouples CT Corporation Business Tax from I.R.C. Sec. 108 by requiring

taxpayers for taxable years ending after December 31, 2008, and before January 1, 2011,

to:

• Add back any income from the discharge of indebtedness in connection with the

reacquisition of an applicable debt instrument where the inclusion of that income in

federal gross income for the taxable year is deferred; and

• Subtract any income from the discharge of indebtedness in connection with the

reacquisition of an applicable debt instrument to the extent that the income was added

to federal adjusted gross income in computing Connecticut adjusted gross income for

the preceding tax year.

In addition, the legislation:

• Imposes a 10% corporate business tax surcharge on taxpayers whose gross income is

at least $100 million for income years beginning in 2009, 2010, and 2011.

• Disallows deductions for domestic production activities income under I.R.C. Sec. 199,

applicable to income years beginning on or after January 1, 2009;


Connecticut – Enacted legislation (continued)


• Amends the credit for production expenses for income years beginning on or after

January 1, 2010, so that the credit ranges from 10 percent to 30 percent of qualified

expenses, based on a taxpayer's production expenses and costs;

• Increases the maximum amount of the supplemental tax imposed on combined filers to

$500,000 from $250,000;

• Increases taxes on cigarettes and tobacco products

• Exempts estates up to $3.5 million from the estate tax and amends the rates on taxable

estates, applicable to estates of decedents who die on or after January 1, 2010;

• Exempts gifts up to $3.5 million from the gift tax and amends the rates on taxable gifts,

applicable to gifts made by a donor on or after January 1, 2010; and

• Delays for three years the scheduled increases in adjusted gross income exemption

thresholds and income thresholds for phasing out personal exemptions and credits.


Connecticut – Other developments


• As a result of state tax revenues failing to meet original projections, Connecticut's sales

and use tax rate will not decrease to 5.5 percent as of January 1, 2010, and will remain

at 6 percent.

• New de minimis withholding rule for employers with respect to nonresident employees.

- Employers not required to withhold CT income tax from any wages or compensation

earned in CT for nonresident employees assigned to primary work locations outside

CT if employees worked 14 or fewer days during calendar year.

- Nonresident employees that earn wages or compensation in CT continue to be

required to report such amounts as CT source income and pay the related CT

income tax, regardless of the 14-day rule for employer withholding. [Conn. Dept. of

Rev. Svcs., AN 2009(9), 12/2/09]


New Jersey – Proposed legislation


• Phase-in of single sales factor (A 1676).

- 70% sales factor, for privilege periods ending on or after July 1, 2010;

- 90% sales factor, for privilege periods ending on or after July 1, 2011;

- Single sales factor, for privilege periods ending on or after July 1, 2012.

- Bill also modifies sales factor with respect to airlines, by replacing the ratio based

on departures by a ratio of an airline's revenue miles in the state divided by total

revenue miles, effective July 1, 2010.

• Repeal of alternative minimum assessment (“AMA”) (S 79).

- AMA effectively repealed for periods commencing after June 30, 2006, but in place

for taxpayers that are protected under P.L. 86-272 and that do not consent to the

state's jurisdiction to impose the corporation business tax.

- Effective for privilege periods beginning on or after January 1, 2009.


New Jersey – Proposed Legislation (continued)


• Reduction of corporation business tax by 1% (S 758).

- Reduction of rate from 9% to 8%.

- Reduction of rate from 7.5% to 6.5%, for taxpayers with entire net income of

$100,000 or less, and from

- Reduction from 6.5% to 5.5%, for taxpayers with entire net income of $50,000 or

less.

- Applicable to privilege periods ending after December 31, 2008.

- Bill would further reduce the rate by one percent for three years for taxpayers that

relocate their headquarters into New Jersey.


California


California legislature introduced a number of tax proposals prior to its February 19, 2010

deadline:

• Abolish the FTB and transfer power and duties to the State Board of Equalization

effective January 1, 2010 (SB 1133).

• An amnesty spot bill, with current reference to the 2005 CA amnesty (SB 1251).

• Spot bill for phase-out of specified tax credits (SB 1316).

• Mandate on use of single sales factor apportionment beginning on or after January 1,

2011 (AB 1935) – last year, only ELECTIVE single sales factor apportionment was

enacted.

• Disallowance on use of NOL carrybacks, beginning on or after January 1, 2011 (AB

1936, AB 2100).

• Partial exemption for sales & use tax purposes on business equipment used in

manufacturing process (AB 2280, SB 1053).


Colorado


CO Governor signs into law tax increase of $231.3 million…

• Temporary suspension of exemption from sales & use tax for energy used in industrial

manufacturing activities (HB 1190, effective 3/1/2010).

• Standardized software subject to sales & use tax – definition of standardized software

deviates from uniform definition of prewritten software used by most other states (HB

1192, effective 3/1/2010).

• Affiliate nexus provisions (HB 1193, effective 3/1/2010).

• Cap on the use of NOLs to $250,000 annually for next 3 years, adds one additional

year in carryforward for every year a company‟s NOL is impacted, bill amended to

provide that taxpayer‟s may increase amount of remaining NOL by adding interest at

3.25% (HB 1199)

• Emergency regulations issued!


Florida


Florida legislature convened on March 2nd to review numerous corporate tax proposals

including:

• Mandatory combined reporting on a water‟s edge basis with so-called tax havens

included in the group (HB 675, SB 1406).

• Addback of intangible expenses, interest expenses and management fees paid to or

accrued directly or indirectly to related entities (HB 1333, SB 2502).

• Singles sales factor apportionment in certain cases (e.g., qualified capital expenditures

exceeding $250 million) (SB 1090).

• Bill placeholders for revisions to corporate income tax (unlikely that reform will take

shape in 2010) (SB 1890, SB 1912 and SB 1936).


Massachusetts


H.B. 4129 (Ch. 27), enacted, 6/26/09

• Decouples the state from various federal stimulus provisions.

• Increases the sales and use tax rate by 1.25%.

• Imposes an excise tax on direct broadcast satellite services.

• Requires taxpayer reporting on certain tax credits received.

H.B. 4359, enacted 11/23/09

• Tax amnesty established for two-month period beginning on April 1, 2010 and ending

on June 1, 2010.


Massachusetts – Governor‟s 2011 budget


• Repeal of sales tax exemptions.

• Calls for audits at partnership level.

• Penalty for failure to report a federal tax change or other state change from the lesser

of $100 or 10% of the tax due to 10% of the tax due, in addition to other measures

intended to assist DOR in its collection efforts.

• Proposes public disclosure of results of refundable or transferable tax credits.

• Information published on government website.


New York State – Tax reform


• New York State is considering tax reform, but it will not be part of the Governor‟s

Budget.

• The tax reform would be effective for tax years beginning on or after 1/1/11.

• The Gramm-Leach-Bliley transitional provisions would be repealed as of 1/1/11.

• Article 32 would be merged into Article 9-A.

• Water‟s Edge Unitary with binding 7 year election would include all members of its

affiliated group.

• Single factor apportionment.

• Customer based sourcing including services.

• Economic nexus.

• Would eliminate exemption for income from subsidiary capital.


New York State – Tax reform (continued)


• Investment income would be exempt from tax.

• Expenses attributable to investment income would be added back.

• Current partnership regulations would be retained.

• Single rate for all taxpayers as yet to be determined.

• Revenue neutral.

• Net Operating Loss (“NOLs”)

- New York net operating loss deduction (“NOLD”) would not be limited by the federal

NOLD source year or amount.

• Taxpayer‟s NOLD would be used to reduce the current year‟s allocated business

income.

- Taxpayer would only have to use the NOLD to reduce its allocated business income

down to an amount that equals tax on allocated capital.


New York State FY „11 budget proposal


• Extend bank tax and transitional provisions related to the Gramm-Leach-Bliley Act.

• Narrow affiliate nexus rules.

• Allow for statistical sampling for sales-use tax audits.

• Subject nonresidents to income tax on termination agreements and

non-compete covenants.

• Address the tax treatment of deemed asset sales by S corporation shareholders.

• Amend credits.


Texas margin tax


Legislation

• No legislative session in 2010.

Department Rulings/Regulations

• Comptroller of Public Accounts reluctant to make any policy decisions (letter rulings,

etc.)

• Little regulation activity.

Audits

• Heavy audit activity

- Focus on qualifications for retailer/wholesaler classification.

- Focus on qualification for COGS deduction (producers/manufacturers of TPP in the

ordinary course of business).


Texas margin tax – Comptroller policy newsletters


Conversions

• The Comptroller continues to follow the policy established under the prior Texas

franchise tax which considers an entity that is legally converting into another type of

entity to be a continuation of the original entity. A legal conversion from one taxable

entity to another taxable entity will have no effect on the entity's franchise tax filing

requirement. (Nov. 2009)

Contract Manufacturing and Cost of Goods Sold

• A taxable entity that contracts with an unrelated third party to manufacture goods to the

taxable entity's specifications is not considered a producer of those goods for purposes

of Texas Tax Code Section 171.002(c)(2).

• An entity that is not considered a producer is limited to acquisition, storage, handling

and other costs specified in Texas Tax Code Section 171.1012(d) as related to the

entity's goods in determining its deduction for the cost of goods sold. Costs directly

related to the production of goods that are typically allowed a producer, such as

research, experimental, engineering and design activity costs, are not allowed as cost

of goods sold for an entity that uses an unrelated third party to produce its goods. (Oct.

2009)


Texas margin tax – Comptroller policy newsletters

(continued)


Initial Reports

• Filing initial reports continues to be confusing for many Texas franchise taxpayers. To

simplify the filing process, the Comptroller has changed the initial report due date for

entities that become subject to the Texas franchise tax on or after Oct. 4, 2009. (Oct.

2009)


Washington


Washington House and Senate Budgets agree on the following:

• Repeal of direct seller‟s representative exemption.

• Imposition of an economic nexus standard for the B&O tax based on following

thresholds:

- excess of $50,00 in property

- excess of $50,000 of payroll or

- excess of $500,000 in receipts; or

- if at least 25% of taxpayer‟s total property, total payroll or total receipts are in the

State.

- nexus continues for 4 succeeding tax years even if thresholds not met in those

years.

• DOR given authority to impose penalties on abusive tax avoidance transactions.

• On March 11, 2010, Gov. Gregoire (D) signed proclamation for special session of

legislature beginning Monday, March 15th to focus on reaching a compromise on

budget and revenue packages.


Internet affiliate nexus

Proposed Legislative Developments

• Illinois – Presumption of nexus for remote sellers with in-state referrals in excess of

$10,000 (SB 3353).

• Iowa – Presumption of nexus for remote sellers with in-state referrals in excess of

$10,000 (HF 2510).

• Virginia – Proposal tabled in the House; expected to be included in the Senate‟s

budget.

• Proposals pending in California, Maryland and Vermont for similar provisions.

• Colorado – new affiliate sales tax law (HB 1193) prompts Amazon and Amazon.com to

sever ties with CO in-state affiliates.


Mandatory unitary combined reporting (MUCR)

• District of Columbia - unclear if future DC Council will introduce legislation later this

year to implement MUCR.

• Florida – bill would mandate combined reporting on water‟s edge basis, including

businesses in so-called tax haven countries (HB 675).

• Indiana – amendment would require MUCR; water‟s edge group would include

businesses in so-called tax haven countries.

• Iowa – bill would require MUCR effective January 1, 2010 (SSB 3122); bill is currently

in Senate Ways and Means with no further action.

• Maryland – MUCR proposal (SB 354) sent to Committee hearings, February 2010, no

further action at this time.

• Pennsylvania – legislation introduced in 2009 and carried over to 2010 session

mandates combined reporting on a water‟s edge basis (if passed, effective January 1,

2011, HB 1775).

• Virginia – bill mandates combined reporting on a water‟s edge basis, including so-called

tax haven countries. (if passed, effective for taxable years beg. on or after January 1,

2011, SB 705).

• NOTE: Bill was defeated in committee on February 16, 2010.



Net operating losses

• Hawaii – bill would suspend NOL carry back generated in taxable year 2009 to be

claimed in taxable years 2007 and 2008; NOL generated in taxable year 2010 may be

claimed in taxable years 2008 and 2009 (HB 1907).

• Idaho – bill would allow NOLs to survive post-merger; passed House on January 25,

2010 (HB 381). Note that language is currently limited to “mergers” and would not

include IRC section 332 liquidations or mergers under IRC section 368(a)(1)(C). NOLs

may be lost absent careful state planning.

• New Hampshire – bill increases cap on NOL carry forward from $1 million to $10 million

(SB 383).

• Kentucky - recently passed House budget would suspend NOL carry forward deduction

for 3 years (for taxable years beginning after December 31, 2009 and before January 1,

2013); Senate expected to remove NOL provision; budget negotiations continue to be

monitored.



Corporate disclosure legislation

• California – bill requires FTB to disclose names of taxpayers receiving more than

$1,000 in tax subsidy as well as amount taken; information to be publicly available and

posted online (SB 1086).

• Hawaii – bill requires disclosure and publication of corporations receiving a tax

expenditure in excess of $5,000; property tax abatement or reduction also required to

be reported (HB 2750, SB 2868).

• Massachusetts – bill requires disclosure of recipients of specific tax credits (HB 2).

• New York – bill requires comprehensive disclosure of certain items with taxpayer‟s

corporate franchise tax return (S 1350).


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This document is for general information purposes only and should not be used as a

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intended or written to be used, and it cannot be used, for purposes of avoiding US

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