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Saving Clementine: Improving the Code §163(j) Deduction

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Saving Clementine: Improving the Code §163(j) Deduction

While the proposed regulations amending Code §163(j) are helpful in many instances, they do not help certain taxpayers. Those that borrow funds to make investments in real estate through partnerships will find themselves on the wrong side of the tax reform provision that limits a taxpayer’s deduction for business interest to 30% of adjusted taxable income arising from the business. Exempt from the cap are (i) taxpayers having gross receipts that do not exceed $25 million and (ii) taxpayers engaged in, inter alia, a qualifying real property trade or business, or “R.P.T.O.B.” The election for exemption is irrevocable for as long as a taxpayer conducts the R.P.T.O.B. In their article, Andreas A. Apostolides, Nina Krauthamer, and Stanley C. Ruchelman identify the fact patterns that are problematic, explain why they are not covered, and suggest that the I.R.S. may wish to revisit this matter.

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S.A.L.T. Cap Repeal Case Dismissed

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S.A.L.T. Cap Repeal Case Dismissed

·       Several high-tax states – whose taxpayers are negatively affected by the T.C.J.A.’s $10,000 cap on the Federal deduction for state and local taxes ­– have instituted a legal challenge that is working its way through the courts.  On the last day of September, the U.S. District Court for the Southern District of New York ruled against the states under long standing authority that the Congress has broad power to eliminate tax benefits previously granted.  However, this may not be the end of dispute.  Nina Krauthamer and Lisa Singh, an extern at Ruchelman P.L.L.C. and a student at New York Law School, recap the ongoing saga and the latest results.

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New Developments on the E.U. V.A.T. Regime of Holding Companies

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New Developments on the E.U. V.A.T. Regime of Holding Companies

Like state and local tax in the U.S., where tax exposure can be underestimated by many corporate tax planners, the V.A.T. rules in the E.U. contain many pitfalls. This is especially true when it comes to recovery of V.A.T. input taxes by holding companies. A corporate tax adviser may presume that all V.A.T. input taxes paid by a holding company are recoverable. Yet, despite abundant jurisprudence, debate continues regarding the V.A.T. recovery rights of holding companies. The starting point in the analysis is easy to state: Holding companies that actively manage subsidiaries can recover V.A.T., while holding companies that passively hold shares cannot. The problem is in the application of the theory, where the line between active and passive behavior is blurred by seemingly inconsistent decisions. Bruno Gasparotto and Claire Schmitt of Arendt & Medernach, Luxembourg, explain the rules and how they have been applied by the C.J.E.U.

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I.R.S. Notice 2018-28 Announces Code §163(j) Regulations on Interest Payment Deductions

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I.R.S. Notice 2018-28 Announces Code §163(j) Regulations on Interest Payment Deductions

Prior to recent tax reform legislation, Code §163(j) was an earnings stripping provision that placed a cap on interest expense deductions on debt instruments held or guaranteed by foreign related persons that were not subject to full 30% withholding tax on U.S.-source interest income or guarantee fees.  Under the T.C.J.A., Code §163(j) is now simply a cap on all business interest expense.  Notice 2018-28 addresses open matters arising from the change.  This includes the carryover of disallowed interest from prior years to 2018, the Super-Affiliation Rules under the new law, and the loss of excess limitation carryforwards.  Elizabeth V. Zanet and Beate Erwin explain these and other items in the Notice.

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Qualified Business Income - Are You Eligible for a 20% Deduction?

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Qualified Business Income - Are You Eligible for a 20% Deduction?

Have you ever been asked to define the undefinable?  At first glance, the new 20% Q.B.I. deduction – a reduced tax rate for the self-employed and partnerships introduced by the Tax Cuts and Jobs Act (“T.C.J.A.”) – seems to be just that: a maze in which the general rule is modified in hidden ways through subdivisions of subsections and in definitions that have substantive effect.  In their article, Stanley C. Ruchelman and Fanny Karaman logically guide the reader in detail and with illustrations.

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Tax Roulette: Buying a Business Jet in 2017 – Why Following the Patriot’s Example May Lead to a Jackpot

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Tax Roulette: Buying a Business Jet in 2017 – Why Following the Patriot’s Example May Lead to a Jackpot

The New England Patriots recently made headlines with the purchase of two private team jets.  Was this plan implemented only to provide more space for beefy footballers, or did ownership identify the nifty situation that could lead to a jackpot of tax savings for high-ticket assets purchased in 2017?  Beate Erwin and Stanley C. Ruchelman explain that with increased depreciation deductions this year at high tax rates and possible recapture in a future year at low tax rates, the odds are good.

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Trump and the Republican-Led Congress Seek Overhaul of International Tax Rules

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Trump and the Republican-Led Congress Seek Overhaul of International Tax Rules

Elizabeth V. Zanet and Beate Erwin compare the proposals that comprise the Trump tax plan and the House Republican Tax Reform Blueprint, which will be submitted to Congress as part of a massive overhaul of U.S. tax law.  Tax rates for individuals and corporations would likely be lowered, the standard deduction would be increased, and capital gains tax rates would remain at the same level.  The net investment income tax would be repealed.  The estate tax and generation skipping tax would be repealed.  The gift tax would remain.  Other provisions are discussed, also.

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I.R.S. Adds New Theory Why Merger Termination Fees are Capital Rather than Deductible Costs

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I.R.S. Adds New Theory Why Merger Termination Fees are Capital Rather than Deductible Costs

The I.R.S. and taxpayers have long argued whether fees paid by one party to another in a failed merger are capital costs or deductible costs.  The consequences of capitalization may be severe, as sufficiently large capitalized costs may never be fully offset by future income.  Recently, the I.R.S. enunciated a new theory in support of its capitalization position.  Kenneth Lobo and Nina Krauthamer look at two recent internal memoranda indicating the I.R.S. will continue to characterize most merger termination costs as capital rather than deductible costs.

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German-Trained Lawyer Could Not Deduct U.S. Educational Expenses

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Taxpayers generally may deduct all the ordinary and necessary expenses paid or incurred, during the tax year, in carrying on a trade or business.  Interesting questions arise when an individual moves to a new country of residence.  This was recently illustrated by a Court of Appeals decision involving a U.S. citizen who was German lawyer.  He returned to the U.S. and, in order to sit for the bar, was required to take additional law school classes. Elizabeth V. Zanet explores whether U.S. law school tuition was deductible.

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Artificial Loan Restructurings

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The I.R.S. has discovered that related taxpayers have been renegotiating existing intercompany loans to allow operating companies within the group to pay a higher rate of interest to a related party benefitting from favorable tax attributes without violating Code §482 principles. Andrew P. Mitchel and Sheryl Shah explain how the I.R.S. is taking aim at this new approach to self-help.

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Moving Deductions into the U.S. as a Tax Planning Strategy

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volume 2 no 4   /   Read article

By Stanley C. Ruchelman and Philip R. Hirschfeld

This month, our team delves into the Joint Committee Report addressing international tax reform in a series of articles. Taking a lead from the preceding article, the report discovers that a better tax result is obtained when deductible expenses are booked in high tax countries. Stanley C. Ruchelman and Philip R. Hirschfeld explain.  See more →

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Shifting Income and Business Operations

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volume 2 no 4   /   Read article

By Stanley C. Ruchelman and Kenneth Lobo

This month, our team delves into the Joint Committee Report addressing international tax reform in a series of articles.The report discovers that a better tax result is obtained when income is booked in low tax countries. Stanley C. Ruchelman and Kenneth Lobo explain.  See more →

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Action Item 2: Neutralizing the Effects of Hybrid Mismatch Arrangements

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On the heels of the discussion drafts issued in March, the Organization for Economic Cooperation and Development (“O.E.C.D.”) released the initial components of its plan to fight base erosion and profit shifting (the “B.E.P.S. Action Plan”). Action Item 2 addresses the effects of hybrid mismatch arrangements and proposes plans to neutralize the tax deficits caused.

These responses aim to tackle the following issues created by the hybrid mismatch arrangements:

  • Reduction in overall tax revenue,
  • Unfair advantage given to multinational taxpayers with access to sophisticated tax-planning expertise, and
  • Increased expense often incurred in setting up hybrid arrangements compared to domestic structures.

This article introduces the different hybrid arrangements, looks at the proposed changes in both domestic law and international tax treaties, and discusses the ripple effect this could have if implemented.

INTRODUCTION

A hybrid mismatch arrangement is one that exploits a difference in the way an entity or instrument is taxed under different jurisdictions to yield a mismatch in total tax liability incurred by the parties. The two possible mismatches that could result are either a “double deduction” (“DD”) or a deduction that is not offset in any jurisdiction by ordinary income (“D/NI”). These mismatches are brought about by the different interpretations afforded to the entities and transactions in relevantjurisdictions. The root cause of the hybrid mismatch is that an entity may be a “hybrid entity” and an instrument may be a “hybrid instrument.” Understanding the different hybrid arrangements is instrumental to understanding the plan proposed by the O.E.C.D.

O.E.C.D. Discussion Drafts Issued Regarding B.E.P.S. Action 2 - Neutralizing the Effects of Hybrid Mismatch Arrangements

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INTRODUCTION

On March 19, 2014, the O.E.C.D. issued two discussion drafts proposing steps to neutralize abusive tax planning through hybrid mismatch arrangements. One report proposed changes in domestic law; the second proposed changes to the O.E.C.D. Model Tax Convention.

The discussion drafts reflect the O.E.C.D.’s attempt to bring “zero-sum game” concepts to global tax planning. In a zero-sum game, transactions between two or more parties must always equal zero (i.e., if one party to a transaction recognizes positive income of “X” and pays tax on that amount, the other party or parties generally must recognize negative income of the same amount, thereby reducing tax to the extent permitted under law). Seen from the viewpoint of the government, tax revenue is neither increased nor decreased on a macro basis if timing differences are disregarded.

If all transactions are conducted within one jurisdiction, the government is the ultimate decision maker as to the exceptions to the zero-sum analysis. For policy reasons, a government may decide to make an exception to a zero-sum game result by allowing the party reporting positive income to be taxed at preferential rates or not at all, while allowing the party reporting negative income to fully deduct its payment. But, when transactions cross borders and involve related parties, taxpayers have a say in what is taxed and what is not taxed.