The 2009 year has been one of many changes and proposed changes, including in the stock market, in the economy, in healthcare and in the U.S. federal tax regime.
On The SILO – LILO Front
Although the Internal Revenue Service previously decided that a settlement initiative was the most effective way to address its opposition to SILO and LILO transactions, it did not extend settlement offers to all parties involved in those transactions. In addition, some parties who extended offers decided against accepting them. Thus, SILO and LILO transactions remain in the news and are subject to proposed changes.
The credit downgrade of some parties to SILO and LILO transactions, as a result of the financial crisis, has triggered a technical default in some transactions. The penalty for the default is a termination payment in the amount certain financial institutions were expecting from the transactions, which is to be paid by the public agency lessees in the transactions, notwithstanding that no lease payments have been missed. More than one member of Congress considers these termination payments to be unjustified windfalls for the financial institutions at the expense of the public agencies. As a result, legislation is pending (e.g., Close the SILO/LILO Loophole Act introduced by Senator Menendez) which would amend the Internal Revenue Code to impose a 100% excise tax on the windfall proceeds received by certain parties to LILO and SILO transactions.
Any institution which participated in LILO or SILO transactions should pay attention to developments in respect of the proposed Close the SILO/LILO Loophole Act and other similar proposed legislation since, if enacted, the consequences for certain parties to those transactions may be draconian. And, given decreased tax revenues as a result of the sluggish economy, the ever-increasing government need for revenue, and the attribution by certain commentators of recent accidents to these transactions, it would not be surprising to see some iteration of a penalty on termination payments in SILO and LILO transactions enacted.
Tax Havens and Tax Evasion Under Siege
The joint investigation by the Internal Revenue Service and Justice Department of UBS’ offshore accounts also remains in the news. And, the investigation seems to have grown into a global crackdown on tax havens and tax evasion, with Germany, France and other countries aggressively pursuing similar and other transactions.
Beyond the offshore accounts involved in the UBS investigation, persons who do other types of business with or through so-called offshore secrecy jurisdictions (such as Bermuda, the Cayman Islands and Switzerland) should expect heightened interest in their transactions and possible changes in the U.S. tax law.
For example, if enacted, the Stop Tax Haven Abuse Act introduced by Senator Levin would subject many U.S. and foreign banks and other financial institutions with customers in tax havens to increased scrutiny and increased financial reporting. Under some proposals, those entities might even be prohibited from engaging in certain transactions. In addition, if the Act were enacted, certain offshore hedge funds, and foreign corporations which are publicly traded or have assets of $50 million or more, and who have substantially all of their officers and senior management located primarily in the United States, would be treated as domestic entities for U.S. tax purposes.
The Levin proposal would also codify the so-called “economic substance” doctrine, extend the 30 percent U.S. gross withholding tax to dividend-equivalent amounts, close certain foreign trust loopholes, extend the three-year statute of limitations to six years, and remove penalty relief for legal opinions related to tax haven transactions. Alone or in combination, these changes may have a substantial impact on businesses engaged in international transactions.
The Presidential View of International Tax Reform
President Barack Obama has also weighed in with his own suggestions on the topic of international tax reform. His fiscal year 2010 tax and revenue proposals, if enacted, may have an even greater impact than the Stop Tax Haven Abuse Act. Although they also would codify the “economic substance” doctrine and extend the three-year statute of limitations to six years in international transactions, they include other proposals in respect of commonly used financing vehicles and structures.
For example, a common structure whereby U.S. corporations organize foreign corporations which, under current law, are allowed to defer U.S. federal taxation on foreign income until repatriated would be substantially curtailed under President Obama’s proposal since the foreign corporation would be required to defer deductions until the income is repatriated.
The foreign tax credit regime would also be revamped so that taxpayers would not be able to claim foreign tax credits for taxes paid on foreign income which is not subject to current U.S. taxation (as some taxpayers believe they can) under existing law, and foreign tax credits would be computed on a pooled basis taking into account all foreign income and combining affiliates.
Although hedge funds and private equity are concerned about President Obama’s proposal to bi-furcate carried interest income into services income (subject to ordinary rates) and invested capital income (subject to capital gains rates), his proposal to tax certain overseas “tax nothings” (under the check-the-box rules) as corporations may have a greater impact, and many consider it likely to be enacted.
The President’s other proposals will also impact virtually all institutions which engage in international transactions, since they would enhance the current qualified intermediary program and impose withholding obligations on non-qualified intermediaries. In addition, because President Obama has asked Congress to provide more revenue to the Internal Revenue Service for enforcement, there will be an increased likelihood of being audited for all persons. International transactions may take front and center stage in that regard since the commissioner of the Internal Revenue Service has also indicated that the Service has begun to speak with other countries about engaging in joint cross-border examinations.
Beyond Health Care Reform
Although the healthcare debate has generated controversy in respect of coverage and cost issues, lost in some of the debate are some equally controversial tax provisions included in some of the healthcare proposals, one of which would deny the benefit of reduced withholding rates under a treaty for payments to certain controlled foreign corporations, even where the treaty’s limitation on benefits provision is satisfied. Although this proposal has generated consternation in the tax bar, its placement in proposed healthcare legislation is a reminder for business groups that healthcare reform needs to be paid for with taxes and that the current aversion to a general rate increase may come at the expense of business and financial institutions.
Withholding Tax Return and Other Tax Return Reforms
Partly in response to the UBS investigation, the Internal Revenue Service has moved withholding up to a high priority issue in an effort to ensure that both individuals and corporations are satisfying their withholding tax obligations and not attempting to circumvent withholding taxes or claim improper exemptions from withholding taxes in cross-border transactions. A broad range of transactions is being scrutinized ranging from non-filers, to checking whether withholding forms which have been filed are correctly prepared, to off-shore accounts, to U.S. taxpayers using shell foreign corporations to claim exemptions, to sophisticated leasing and swap transactions and to foreign tax credit generators. Withholding agents and persons delivering withholding tax forms or failing to deliver forms should expect audits of their cross-border transactions which focus on withholding issues and forms.
In addition, because of a recent win by the Internal Revenue Service in the Swallows Holding case, the requirement of filing income tax returns is also in the news. At issue in the case was a provision in the Internal Revenue Code which provides that a foreign corporation’s deductions are only allowed if they are connected with income which is “effectively connected” with the conduct of a business in the United States and if the corporation files a tax return, and a Treasury Regulation which provides that the Internal Revenue Service can disallow a foreign corporation’s deductions if the corporation fails to file a return within 18 months of its due date. An earlier, lower-court decision determined that the 18-month filing requirement was not a reasonable exercise of the treasury’s power to issue regulations. A more recent appellate decision, to the contrary, held that the 18-month filing requirement was a reasonable exercise of the treasury’s power. Accordingly, foreign corporations who are and even those who may be engaged in a U.S. business should take this recent appellate decision into account.
For both mundane tax return items and complex international transactions, change is in the air for the ensuing months, and there is much to pay attention to at year-end.