This week is a big week for the retail industry: its results can predict the overall success of an important shopping period. If stores perform well, this week can contribute significantly toward a successful quarterly earnings report. Given the potential of these few shopping days, retailers are understandably focused on what happens from the time the doors swing open in the dark early morning and tired shoppers race to claim their Black Friday bargains to the end of the night when the registers shut down. However, some industry-watchers are already planning for what happens beyond the 2015 holiday season and anticipating what improvements they can make for a strong showing in 2016.
The IRS recently introduced Revenue Procedure 2015-56, the much anticipated Industry Issue Resolution that provides a capitalization safe harbor percentage for retail and restaurant store remodels. The safe harbor provides qualifying taxpayers the opportunity to deduct 75% and capitalize 25% of qualifying remodel costs. Detailed here, the Revenue Procedure may be a boost to an industry that is often at the mercy of a fickle consumer base and under pressure to provide a continuously improving customer experience. The revenue procedure is effective for taxable years beginning on or after January 1, 2014.
As we’ve mentioned in previous posts on our sister blog, the Retail Law Advisor, consumers demand a lot from their retail experience. They want an omnichannel approach, technology on demand, and a personalized experience. In response, retailers continue to blend shopping and entertainment, including food and hospitality services, into the shopping experience.
This approach isn’t cheap: retailleader.com outlines the cost of several different types of capital improvements and which ones provide the most ROI. According to analysts, most remodels are fueled by competition and what will create most excitement in a community. A fresh look can increase foot traffic but even small changes, such as the installation of sustainability solutions to product displays, can make existing customers take notice.
Retailers need to approach the process with goals, timelines and a thorough plan. Embarking on a capital improvement project, no matter how large or small, has potential to affect daily operations and thus the overall customer experience. In addition, if a retail or restaurant establishment wants to use the new safe harbor, it will be treated as a change in method of accounting, implicating Form 3115, Application for Change in Accounting Method. And, as with any major adjustment, enhancement or expansion to a business, owners and operators should consult their team of advisors to ensure they are not just compliant with regulations but positioned to maximize their investment.
Following on its prior Notice 2014-52 anti-inversion guidance, the IRS has issued new Notice 2015-79 to further limit (i) inversion transactions that are contrary to the purposes of the Section 7874 anti-inversion rules and (ii) the benefits of post-inversion tax avoidance transactions. The Notice also describes corrections and clarifications to the prior Notice 2014-52. According to the Treasury Fact Sheet, the guidance both strengthens the scope of the existing anti-inversion rules and prevents inverted companies from transferring foreign operations “out from under” the U.S. tax net without paying current U.S. tax.
The Notice addresses transactions structured to avoid the Section 7874 anti-inversion rules by (i) requiring the foreign acquiring corporation to be subject to tax as a resident of the relevant foreign country in order to have substantial business activities in the relevant foreign country; (ii) disregarding certain stock of the foreign acquiring corporation in “third-country” transactions; and (iii) clarifying the definition of nonqualified property for purposes of disregarding certain stock of the foreign acquiring corporation.
The Notice also describes future regulations that will address certain post-inversion tax avoidance transactions by (i) defining inversion gain for purposes of Section 7874 to include certain income or gain recognized by an expatriated entity from an indirect transfer or license of property and providing for aggregate treatment of certain transfers or licenses of property by foreign partnerships for purposes of determining inversion gain; and (ii) requiring an exchanging shareholder to recognize all of the gain realized upon an exchange of stock of a controlled foreign corporation (as defined in section 957) (CFC), without regard to the amount of the CFC’s undistributed earnings and profits, if the transaction terminates the status of the foreign subsidiary as a CFC or substantially dilutes the interest of a United States shareholder (as defined in section 951(b)) (U.S. shareholder) in the CFC.
This morning the Senate passed H.R. 1314 (The Bipartisan Budget Act of 2015), which will completely change the way partnerships (and LLCs taxed as partnerships) are audited. The House passed the legislation on Wednesday and it is reported that President Obama will sign the legislation as soon as it reaches his desk. As discussed in Tuesday’s blog, this legislation will make it much easier for the IRS to audit partnerships and will also allow the IRS to assess and collect the proposed additional tax against the partnership itself as opposed to being required to assess the individual partners. Although the legislation implies it is only applicable to partnerships with over 100 partners, it can apply to even a two-partner partnership if one of those partners is itself a partnership. Although the legislation has a two-year delayed effective date, it is important to plan for this immediately in terms of drafting partnership agreements. For example, because the IRS will no longer notify the individual partners of an audit, the partners may insist in the partnership agreement that the partnership notify them of an audit and obtain partner consents relating to certain audit elections or IRS settlements. The legislation’s section-by-section summary provides a general overview of the new rules.
Note that the legislation also removes Section 704(e)(1) to eliminate the presumption that one is a partner for tax purposes merely because they have a capital interest in the partnership. This change was likely in response to the taxpayer arguments found in the 2012 Castle Harbour decision discussed in our 2012 blog where a debt-like partnership interest was argued to qualify as partnership equity based on this Section 704(e)(1) language. Now the Section 704(e) rules are more clearly limited to the context of gifted partnership interest.
As part of the current Bipartisan Budget Act of 2015, sweeping changes to the partnership audit rules could be imminent. The new rules would greatly simplify the IRS procedures for auditing partnerships and likely increase the audit rate of partnerships. The new rules would replace the current “TEFRA” and “Electing Large Partnership” rules with a new entity-level audit process that would allow the IRS to assess and collect the taxes against the partnership absent certain election out procedures. The new legislation is patterned after the recent H.R. 2821, but thankfully removes the onerous joint and several liability provision in the earlier bill and allows the IRS to reduce the potential tax rate assessed against the partnership to take into account factors such as tax-exempt partners and potential favorable capital gains tax rates. The new rules will simplify the current complex procedures on determining who is authorized to settle on behalf of the partnership and also avoid the IRS’s need to send various notices to all of the partners. Although partnerships with 100 or less partners can elect out of the new rules, such election is not available if there is another partnership as a partner. If passed, new rules are to apply to partnership taxable years beginning after December 31, 2017. Partnership agreements can be expected to need to take into account these changes.
In DJB Holding Corp. the 9th Circuit concluded that a purported related-party partnership was not a bona fide partnership for tax purposes and taxable income was redirected to the taxable C corporation performing the underlying profitable services. The ultimate taxable services were performed by the C corporation but a partnership agreement between that C corporation and an upper-tier pass-through entity directed 70% of the income to the upper-tier pass-through entity for the stated consideration that the pass-through entity (and its owners) provided a needed financial guarantee as shown in this simplified diagram. The 9th Circuit affirmed the Tax Court conclusion that this was not a bona fide partnership under the historical Culbertson and Luna authorities.
The underlying Tax Court decision essentially disregarded the upper-tier guarantor’s nominal ownership in the partnership, noting that the totality of the circumstances did not support partner status. First, as an factual matter, the partners did not respect their own documentation and the actual income sharing between the partners was substantially different than the documented sharing and the accountant did not file partnership tax returns. Second, the court did not find the guarantee to be of significant value and noted that the other related parties that joined in the guarantee did not also receive partnership interest. Third, the court noted that the unilateral control exercised by the taxable C corporation supported the lack of partnership status. The primary issue on appeal was whether the guarantee had any significant value. The 9th circuit court found that the record supported that there were no value to such guarantee, asserting that the 100% owned taxable C corporation would have been entitled to the guarantees of the ultimate individual owners through their existing obligations to the C corporation.
In new Notice 2015-66 the IRS said it plans to amend FATCA regulations to reduce certain collateral restrictions on grandfathered obligations and extend the following transition rules:
(1) the date for when withholding on gross proceeds and foreign passthrough payments will begin;
(2) the use of limited branches and limited foreign financial institutions (limited FFIs); and
(3) the deadline for a sponsoring entity to register its sponsored entities and redocument such entities with withholding agents.
According to the IRS, the Notice provides additional time for withholding agents and FFIs to address the phase-out of the transitional rules. The Notice also provides information on the exchange of information by Model 1 IGA jurisdictions with respect to 2014.
The flurry of Opco-Propco REIT conversions has hit a stumbling block this week when the IRS issued a Revenue Procedure announcing a “no rule” policy for a key corporate tax issue for many REIT spin offs. Basically to do a tax-free REIT spin off, the existing single corporation must be able to qualify the REIT entity as having a 5-year history as an “active trade or business”. Traditionally companies ask the IRS’s blessing that the new REIT’s assets met this very factual inquiry. However, the IRS now says it will “not ordinarily” issue those Section 355 rulings if the transaction is part of a plan to separate a REIT (or RIC) from a taxable C corporation. The “no rule” also applies to cases where the “active” business of either the historical or the spun off corporation is small (less than 5%) when compared to the value of the assets of that corporation. The latter issue is often described as whether a “mere peppercorn” of a business is sufficient for a spin off. The revenue procedure applies to all ruling requests that are postmarked or, if not mailed, received on or after September 14, 2015, and relate to distributions that occur after such date.
Today the IRS issued proposed regulations that eliminate the “foreign goodwill exception” under the Section 367(d) regulations and also limit the scope of property that is eligible for the so-called “active trade or business” exception generally to certain tangible property and financial assets. Thus, upon an outbound transfer of foreign goodwill or going concern value, a U.S. transferor will be subject to either current gain recognition under section 367(a)(1) or the tax treatment provided under section 367(d). The regulation preamble explains that this taxpayer-adverse change is in response to certain taxpayers attempting to avoid recognizing gain or income attributable to high-value intangible property by asserting that an inappropriately large share of the value of the property transferred is currently subject to the favorable treatment for foreign goodwill or going concern value. The proposed regulations also eliminate the rule that limits the useful life of intangible property to 20 years and provide that the useful life of intangible property is the entire period during which the exploitation of the intangible property is reasonably anticipated to occur, as of the time of transfer.
The text of the proposed regulations are incorporated into new TD 9738 (clarifying of the coordination of the transfer pricing rules with other Code provisions). The proposed regulations are proposed to apply to transfers occurring on or after September 16, 2015, and to transfers occurring before September 16, 2015, resulting from entity classification elections made under regulation section 301.7701-3 that are filed on or after September 16, 2015.
In CCA 201537022, the IRS allowed a real estate developer to capitalize its required “advance” to the city for common infrastructure improvement costs, subject to later year adjustment to the extent the city repaid the funds. In form, the developer initially financed the capital improvements with an advance, but the city’s obligation to repay the funds was contingent on bond financing based on revenues derived from ad valorem property taxes. Thus, the ruling concluded that the entire risk of development rested with the developer with only a contingent repayment and therefore the taxpayer’s disregard of the form of the transaction and treatment in accord with its substance “appears to have been proper”. However, the IRS denied the taxpayer’s inconsistent treatment where it followed the form in part and treated some of the repayment of the advance as tax-free municipal bond interest under Code § 103. Instead, the IRS required that later repayments to the developer reduce the tax basis for real estate lots not yet sold by that time and be reported as ordinary income if the lots have already been sold.
Yesterday the IRS published two sets of regulations addressing when a US owner of a Controlled Foreign Corporation (CFC) has a deemed repatriation through the use of a CFC-owned foreign partnership. The regulations are based on Section 956, which in essence deems a repatriation to the extent a CFC invests in “U.S. property” – which includes loans by the CFC to its owners and certain pledges by the U.S. owners of the CFC stock or assets. The new temporary and final regulations attack situations where a CFC, instead of doing a prohibited direct loan to its U.S. owner, forms a controlled partnership that instead makes the loan to the U.S. owner. In addition, the regulations provide that the Section 956 anti-abuse rule is not limited to entities that are funded with capital contributions or debt, and clarify that any tax attributes associated with an inclusion under Section 956 will be taken into account in applying the anti-abuse rule. The new proposed regulations go farther with respect to foreign partnerships owned by CFCs, and generally treat an obligation of a foreign partnership as an obligation of its partners to the extent of each partner’s share of the obligation, as determined in accordance with the partner’s interest in partnership profits. The proposed regulations also address a number of aggregate-entity partnership questions under Section 956, including extending certain current pledge and guarantee rules to pledges and guarantees made by partnerships. The regulations are generally effective on September 1, 2015 and apply to property acquired, or pledges or guarantees entered into, on or after September 1, 2015