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November 8, 2019
2019-6395

Report on recent US international tax developments 8 November 2019

The Internal Revenue Service (IRS) Large Business and International (LB&I) division this week announced a new compliance campaign on the Internal Revenue Code1 Section 965 transition tax. According to the IRS, the campaign will begin with 2017 returns and generally will require review of both 2017 and 2018 tax returns. Returns that are selected as part of the 965 campaign will also be reviewed for other material issues, if appropriate, especially with respect to Tax Cuts and Jobs Act (TCJA) planning.

An IRS official later elaborated on the scope of the 965 campaign. He was quoted as saying the IRS has identified several areas of noncompliance under Section 965, including incorrect accumulation of earnings and profits (E&P), issues associated with defining cash and cash equivalents, and problems with estimated tax payments. The official added that some multinationals are also facing issues in regard to calculating E&P and foreign tax credits for 10-50 companies, which are not controlled foreign corporations but specified foreign corporations included in the Section 965 computation. The 965 campaign reportedly will focus on large Section 965 inclusion taxpayers, as well as other high-risk Section 965 filers; for example, Form 5471 filers with positive E&P. Selected returns will go out to the field starting in January 2019, the official said.

An IRS official this week warned taxpayers that the Government is aware that transfer pricing could be used to reduce Base Erosion and Anti-abuse Tax (BEAT) and other TCJA tax liability. While taxpayers are currently reviewing their transfer pricing policies in light of the TCJA and are entitled to pick a price within a range of acceptable arm’s-length prices, the official was quoted as saying the IRS will target inappropriate prices that are chosen to avoid BEAT. “A taxpayer who attempts to avoid BEAT by using non-arm’s-length transfer pricing may be subject to a transfer pricing adjustment that will flow through and result in a BEAT adjustment,” the official said.

Another senior IRS official said that in enforcing BEAT, one area the IRS plans to focus on is taxpayers’ classification of costs as either deductible expenses or cost of goods sold (COGS). Since COGS is subtracted from gross receipts rather than deducted, some taxpayers may have an incentive to classify as COGS rather than as deductions to reduce their BEAT liability.

The Organisation for Economic Co-operation and Development (OECD) Secretariat on 8 November released the highly-anticipated public consultation document, “Global Anti-Base Erosion Proposal (‘GloBE’) – Pillar Two,” that is part of the ongoing project “Addressing the Tax Challenges Arising from the Digitalisation of the Economy” (BEPS 2.0). Pillar Two calls for the “development of a coordinated set of rules to address ongoing risks from structures that allow MNEs to shift profit to jurisdictions where they are subject to no or very low taxation.“ The proposals do not represent the consensus views of the Inclusive Framework.

The Pillar 2 consultation document lays out four component parts:

  • An income inclusion rule that would tax a foreign branch’s or controlled entity’s income if the income was subject to an effective tax rate below a minimum rate
  • An undertaxed payments rule that would deny a deduction or impose source-based taxation for a related party payment that was not subject to a minimum rate of tax
  • A switch-over rule to be introduced into tax treaties allowing residence jurisdictions to switch from an exemption to a credit method if the profits attributable to a permanent establishment or derived from immovable property are not subject to a minimum tax rate
  • A subject to tax rule to complement the undertaxed payment rule that would subject to withholding or other tax and adjust the treaty benefit, a payment on certain income that is not subject to a minimum tax rate

A public consultation meeting on Pillar Two will be held on 9 December 2019. The OECD invites comments on the document, which are due 2 December 2019.

There were also several other recent OECD developments worth noting.

The OECD on 5 November released additional guidance on Base Erosion and Profit Shifting (BEPS) Action 13 Country-by-Country Reporting (CbCR), along with a summary of common errors made by multinational enterprise (MNE) groups in preparing these reports. The existing guidance on the implementation of CbCR (the Guidance) has been updated to include questions and answers on, among other topics, the treatment of dividends, the deemed listing provision, accounting periods other than 12 months, the requirements for and operation of local filing, the use of rounded amounts and the information that must be provided with respect to the sources of data used.

The OECD this week announced it has developed a new Analytical Database on Individual Multinationals and Affiliates (ADIMA), which provides information on MNEs and their global presence. The ADIMA database contains public information on the physical and digital locations of the MNE, detailed financial and quantitative data (including revenue, profit, income tax and number of employees), as well as events such as large company restructurings. The database currently contains 100 of the largest publicly traded and not state-owned MNEs (by sales) in the world, with both more companies and data points expected to be added in future releases.

The OECD also recently issued additional guidance on the spontaneous exchange of information by no or only nominal tax jurisdictions. The guidance addresses the practical modalities regarding the exchange of information requirements of the “substantial activities requirement” for “no or only nominal tax” jurisdictions (the Standard) that was agreed to in 2018 by the Inclusive Framework on BEPS.

Endnote

1. All “Section” references are to the Internal Revenue Code of 1986, and the regulations promulgated thereunder.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax and Transaction Services, Washington, DC

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