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Tax News and Developments North American Tax Practice Group
Newsletter October 2014 | Volume XIII-X
IRS Notice 2014-58 -- The Economic Substance Doctrine
On October 9, 2014, the IRS issued Notice 2014-58, which provides guidance
concerning the application of the economic substance doctrine (and related
penalties), which were added to the Code in 2010. The Notice provides an
expanded definition of the "transactions" to which the economic substance doctrine
is to be applied. More importantly, the Notice addresses situations in which the
no-fault penalty imposed on transactions lacking economic substance under
Section 6662(b)(6) can be applied on the grounds that the transaction is subject to
a "similar rule of law." We will provide detailed comments on the Notice in a
forthcoming newsletter.
By Richard M. Lipton (Chicago)
IRS Finalizes Revisions to Circular 230
Final Circular 230 regulations issued by the IRS on June 12, 2014 are now in
effect. These regulations, which establish minimum standards of conduct
concerning practice before the IRS, have eliminated the rules for so-called
"covered opinions" and have dismissed the need for ubiquitous legends on all
documents and emails. More specifically, the IRS has changed the rules so that
these disclaimers can now be deleted permanently.
For a more detailed discussion on Circular 230, see Richard M. Lipton's IRS
Finalizes Revisions to Circular 230, Journal of Taxation (September 2014).
OECD Delivers First Seven Components of its Action Plan on Base Erosion and Profit Shifting (BEPS)
In July 2013, the OECD and G20 countries adopted a 15-point Action Plan on
Base Erosion and Profit Shifting (“BEPS”). The first set of seven of the Action Plan
components (the “2014 Deliverables”) were released by the OECD Committee on
Fiscal Affairs (“CFA”) on September 16, 2014, and include:
Two final reports for Action 1 (Digital Economy) and 15 (Multilateral
Treaty);
One interim report for Action 5 (Harmful Tax Practices); and
Four reports containing draft recommendations for:
o Action 2: Hybrid Mismatches
In This Issue:
IRS Notice 2014-58 -- The Economic Substance Doctrine
IRS Finalizes Revisions to Circular 230
OECD Delivers First Seven Components of its Action Plan on Base Erosion and Profit Shifting (BEPS)
The OECD Moves Forward on Initiatives to Curb Treaty Abuse, while US Tax Treaties are Stalled in the US Senate
An Uncertain Path for Tax Extenders
Safeway Successfully Defends Inter-jurisdictional Tax Plan (Yet Again)
Recent French Decision Regarding the Business Tax Cap Mechanism
Publication by the French Tax Administration of Final Transfer Pricing Disclosure Form and Related Guidelines
Recent Development in the Netherlands - Time to Check Your Dutch Holding Company or Financial Services Company’s Substance?
US Supreme Court to Hear Three State Tax Cases
New Illinois “Click-Through” Nexus Law Addresses Some Issues While Leaving and Creating Others
Never a Dull Moment… Michigan Seeks to Re-Write History By Retroactive Repeal of the Multistate Tax Compact
Save the Dates: Baker & McKenzie Announces Upcoming Tax Conferences in San Francisco, Hong Kong, San Diego and Miami
Baker & McKenzie
2 Tax News and Developments October 2014
o Action 6: Treaty Abuse
o Action 8: Transfer Pricing of Intangibles
o Action 13: Transfer Pricing Documentation (“TPD”) and Country-by-
Country Reporting (“CbCR”)
The CFA also issued an Explanatory Statement, which explains that the four
reports containing draft recommendations will be finalized along with the
completion of the remaining Action Plan components in 2015 (the “2015
Deliverables”, due to significant interaction with those deliverables. The first of the
2015 Deliverables are expected to be released in September 2015, and a final
deliverable is scheduled for release in December 2015. The 2015 Deliverables will
include the resolution of pending technical issues and the completion of the
implementation measures for the 2014 Deliverables. Once finalized, the measures
adopted by the OECD would only become effective through changes in domestic
laws, changes to bilateral tax treaties or through the multilateral instrument
envisioned in Action 15.
Below, we provide a brief summary of key points from each of the 2014
Deliverables.
Action 1 - Digital Economy
Action 1 of the BEPS Action Plan (the “Action 1 Report”) focuses on the digital
economy. As the digital economy has increasingly become intertwined with the
economy as a whole, the Action 1 Report does not try to ring fence the digital
economy, but instead focuses on areas in which the digital economy exacerbates
other BEPS risks. A key feature of the digital economy that exacerbates BEPS
risks is mobility with respect to intangibles, users and business functions.
Accordingly, multinational enterprises (“MNEs”) have been able to create business
models under which their infrastructure is centralized at a distance from a market
jurisdiction, while goods and services are sold into that market jurisdiction from a
remote location. Further, the digital economy has increased the ability for MNEs to
conduct activities in jurisdictions with minimal personnel on the ground. This has
provided opportunities for MNEs to achieve BEPS by fragmenting their physical
operations across jurisdictions to avoid creating a taxable presence.
The Task Force on the Digital Economy (“TFDE”), a subgroup within the OECD,
prepared the Action 1 Report. The final report presents seven options for dealing
with the tax challenges created by the digital economy. Five are listed under the
heading of direct tax options and two are listed under the heading of consumption
tax options.
The direct tax options are designed to deal with the problem of MNEs having a
significant presence in a jurisdiction without being considered to have a taxable
permanent establishment (“PE”) under tax treaty principles. The first direct tax
option is to modify the exemptions from PE status in current treaties because
certain activities that are currently considered preparatory or auxiliary have
become essential to certain businesses. A second, creative option presented
would be to create a new nexus standard based on a MNE’s digital presence in a
jurisdiction. The third option focuses on replacing the concept of PE with a
“significant presence” test, which would require some physical presence, combined
with criteria for determining the MNE’s digital presence in the jurisdiction. The next
option would be to impose a withholding tax on digital transactions and the final
direct tax option would be to introduce a bandwidth or bit tax.
Upcoming Tax Events:
Doing Business Globally
Santa Clara, California November 3, 2014 Chicago, Illinois November 4, 2014 New York, New York
November 5, 2014 Dallas, Texas November 6, 2014 30th Annual Asia Pacific Tax Conference
Hong Kong November 13-14, 2014 Second Annual Baker & McKenzie / TEI Tax Workshop
Austin, Texas November 18, 2014 2014 Tax Controversy Workshop
San Francisco, California November 21, 2014 2015 Annual North America Tax Workshop
San Diego, California January 9, 2015
Latin American Tax Conference
Miami, Florida March 17-19, 2015
Baker & McKenzie/Bloomberg BNA Global Transfer Pricing Conference
Paris, France March 30, 2015
Baker & McKenzie
3 Tax News and Developments October 2014
The first consumption tax option provided by the TFDE would be to streamline
compliance mechanisms in order to justify lowering the threshold for exemption of
low value imports for value added tax (“VAT”) purposes. The thresholds in many
jurisdictions were established before the advent and growth of the digital economy.
The second consumption tax option is developing “clear and accessible”
registration mechanisms that would allow for extraterritorial VAT collection.
Action 2 - Hybrid Mismatches
The report related to Action 2 of the BEPS Action Plan (the “Action 2 Report”)
provides recommendations for coordinated domestic tax legislation and tax treaty
provisions to neutralize hybrid mismatch arrangements. The use of hybrid
mismatch arrangements is a sophisticated means to achieve the shifting of income
from an entity subject to tax in a high tax jurisdiction to an entity subject to a low
tax rate on income but incorporated in a high tax jurisdiction. Such results can be
achieved through the use of hybrid entities (i.e., an entity that is treated as a
taxable person in one country but transparent in another country) or through the
use of hybrid financial instruments (i.e., an instrument that is treated as debt under
the laws of the payer country but as equity in the recipient country).
The Action 2 Report is composed of two parts. Part I sets out recommendations for
domestic law changes. Part II sets out recommended changes to the OECD Model
Tax Convention to deal with transparent entities, including hybrid entities, and
addresses the interaction between the recommendations included in Part I and the
provisions of the OECD Model Tax Convention.
The proposed domestic rules target two types of payment. First, the rules are
aimed at so-called “deduction / no inclusion” or “D/NI” outcomes, which are
payments that are deductible under the rules of the payer jurisdiction and not
included in the ordinary income of the payee. In such cases, the Action 2 Report
recommends that the response should be to deny the deduction in the payer’s
jurisdiction. In the event the payer jurisdiction does not respond to the mismatch,
the Action 2 Report recommends the jurisdictions adopt a defensive rule that
would require the payment to be included as ordinary income in the payee’s
jurisdiction. Second, the rules are also aimed at payments that give rise to
duplicate deductions for the same payment. In the case of double deduction
situations, the Action 2 Report recommends that the primary response should be
to deny the duplicate deduction in the parent jurisdiction. A defensive rule that
would require the deduction to be denied in the payer jurisdiction would only apply
in the event the parent jurisdiction did not adopt the primary response.
The recommended changes to the OECD Model Tax Convention include a change
to Article 4(3) of the Convention that would restrict dual resident entities from
unduly obtaining the benefits of treaties. To avoid the potential for tax avoidance in
some countries, cases of dual treaty residence would be solved on a case-by-case
basis rather than on the basis of the current rule, which is based on place of
effective management of entities. The recommendations in Part II also include an
update on the portion of the 1999 OECD report on “The Application of the OECD
Model Tax Convention to Partnership” (the “Partnership Report”) that dealt with the
application of treaty provisions to partnerships. The conclusions of the Partnership
Report were designed to ensure that the provisions of tax treaties produce
appropriate results when applied to partnerships, in particular in the case of a
partnership that constitutes a hybrid entity. Part II of the Action 2 Report
recommends that the income of transparent entities be treated for purposes of the
OECD Model Tax Treaty in accordance with the principles of the Partnership
Report.
Baker & McKenzie
4 Tax News and Developments October 2014
Action 5 - Harmful Tax Practices
The OECD’s efforts to combat what it classifies as harmful tax practices began in
1998 when it issued a report entitled Harmful Tax Competition: An Emerging
Global Issue. Ring-fencing regimes, across the board corporate tax reductions on
particular types of income (e.g. Patent Box legislation) and taxpayer specific
rulings related to preferential regimes are the types of harmful tax practices that
the OECD has focused on. The concern is that these types of regimes create a
“race to the bottom” that would ultimately drive applicable tax rates on certain
mobile sources of income (e.g., royalty income) to zero for all countries. In order
for a regime to be considered preferential, it must offer some form of tax
preference in comparison with the general principles of taxation in the relevant
country.
Action 5 calls for the Forum on Harmful Tax Practices, a subgroup in the OECD, to
revamp the work on harmful tax practices that began in 1998 with a priority on (i)
improving transparency, including compulsory spontaneous exchange of
information on rulings related to preferential regimes and on (ii) requiring
substantial activity in a jurisdiction to be eligible for any preferential regime. The
Forum on Harmful Tax Practices is to deliver three outputs: first, finalization of the
review of member country preferential regimes; second, a strategy to expand
participation to non-OECD member countries; and, third, consideration of revisions
or additions to the existing framework.
The interim report on Action 5 (the “Action 5 Report”) outlines the progress thus
far. With regard to the substantial activity requirement, the Action 5 Report has
focused on what would qualify as substantial activity in the context of preferential
tax treatment related to income arising from qualifying intellectual property. The
Forum considered three approaches, settling on a nexus approach and rejecting a
value creation approach and a transfer pricing approach. The nexus approach
would allow preferential tax treatment to income generated from patents and IP
functionally equivalent to patents, so long as there is a direct nexus between the
income receiving benefits and the expenditures contributing to that income. The
nexus approach determines what income may receive tax benefits by applying the
following calculation:
Qualifying expenditures incurred
to develop IP asset
Overall expenditures incurred
to develop IP asset
x Overall
Income from
IP Asset
= Income
receiving tax
benefits
The Action 5 Report also provides a framework for the compulsory spontaneous
exchange of information on rulings related to preferential regimes. Spontaneous
information exchange is only required for taxpayer-specific rulings related to
preferential regimes. To be subject to such reporting, the ruling must (i) apply to
income from geographically mobile activities, such as the provision of intangibles,
financial and other service activities; (ii) be a preferential regime; (iii) provide a no
or low effective tax rate; and (iv) be taxpayer specific. The word “compulsory” is
understood to introduce an obligation to spontaneously exchange information
wherever the relevant conditions are met.
Action 6 - Treaty Abuse
The following is a brief review of Action 6, for a more indepth discussion see the
article below which discusses Action 6 in greater detail. Action 6 called for work to
be carried out to (i) develop model treaty provisions and recommendations
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5 Tax News and Developments October 2014
regarding the design of domestic rules to prevent the granting of treaty benefits in
inappropriate circumstances; (ii) clarify that tax treaties are not intended to be used
to generate double non-taxation; and (iii) identify the tax policy considerations that
countries generally should consider before deciding to enter into a tax treaty with
another country. The common goal of the proposed changes to the OECD Model
Tax Convention is to ensure that States incorporate in their treaties sufficient
safeguards to prevent treaty abuse. The Action 6 Report recommends a minimum
level of protection that should be implemented.
With regard to treaty shopping, the report recommends a three-pronged approach.
First, in the title and preamble, treaties should include a clear statement that the
Contracting States intend to avoid creating opportunities for non-taxation or
reduced taxation through tax evasion or avoidance. Second, limitation on benefits
provisions, similar to those found in US treaties, should be included in treaties.
Third, a general anti-abuse rule based on the principal purposes of transactions or
arrangements test should also be added to treaties.
Action 8 - Transfer Pricing of Intangibles
In response to Action 8, the OECD issued the Guidance on Transfer Pricing
Aspects of Intangibles (the “Action 8 Report”), which amends Chapters I, II and VI
of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations (2010, the “Transfer Pricing Guidelines”). The Executive Summary
of the Action 8 Report notes that, because there are strong interactions between
the work on ownership of intangibles under Action 8 and the work under Actions 9
and 10 on risk, recharacterisation of transactions, and hard to value intangibles,
the Action 8 Report will not be finalized until the Action 9 and 10 work is completed
in 2015. Interim guidance is indicated by bracketed and shaded portions of the text
and relate specifically to:
Sections B.1 and B.2 of Chapter VI relating to ownership of intangibles,
Section D.3. of Chapter VI relating to intangibles whose valuation is
uncertain at the time of the transaction,
paragraph 2.9 of the Guidelines relating to the use of other methods,
guidance on the application of profit split methods contained in paragraphs
6.146 to 6.149, and
certain examples relating to the foregoing provisions.
The Executive Summary also indicates that the second phase of work to be
completed in 2015 will consider the following special measures, i.e., outside the
arm’s-length principle, under Action 9:
providing tax administrations with authority in appropriate instances to
apply rules based on actual results to price transfers of hard to value
intangibles and potentially other assets;
limiting the return to entities whose activities are limited to providing
funding for the development of intangibles, and potentially other activities,
for example by treating such entities as lenders rather than equity
investors under some circumstances;
requiring contingent payment terms and / or the application of profit split
methods for certain transfers of hard to value intangibles; and
requiring application of rules analogous to those applied under Article 7 of
the OECD Model Convention to certain situations involving excessive
capitalisation of low function entities.
Baker & McKenzie
6 Tax News and Developments October 2014
The Executive Summary emphasizes that no decisions have yet been made
regarding which special measures will be adopted or whether such measures are
consistent with Article 9 of the OECD Model Tax Convention.
Revisions to Chapter I of the Transfer Pricing Guidelines address location savings,
other local market features, assembled workforce and MNE group synergies. For
example, the Action 8 Report indicates that local market features, (e.g., the
purchasing power and product preferences of households in a particular market,
the degree of competition in the market, etc.) do not constitute intangibles. On the
other hand, contractual rights, government licenses or know-how necessary to
exploit that market may be intangibles. The Action 8 Report also indicates that
incidental synergistic benefits arising purely as a result of membership in an MNE
group do not require separate compensation or allocation among the members of
the group. Where synergistic benefits arise from deliberate concerted group
actions, compensation or allocation of the benefit is required.
The remainder of the Action 8 Report addresses changes to Chapter VI of the
Transfer Pricing Guidelines, focusing on:
the definition of intangibles;
the distinction between intangible assets and market specific
characteristics;
factors affecting valuation of intangibles, e.g., funding, ownership/control,
and functions, risks and assets;
valuation approaches; and
transfer pricing treatment of hard to value intangibles.
In a briefing prior to the release of the 2014 Deliverables, Pascal Saint-Amans,
director of the OECD’s Center for Tax Policy and Administration, indicated that
Actions 8, 9 and 10 will mean the end of the “cash box,” saying that
“[M]ultinationals will have to realize that the tax benefits of excess returns going to
a cash box where nothing is happening is over.” (23 Transfer Pricing Report 643,
9/18/2014) While the Action 8 Report, particularly Section B of the Chapter VI
revisions, outline different avenues for neutralizing the “cash box”, i.e., taxing
profits located in low- or no-tax jurisdictions, the Action 8 Report does not address
where such profits should be taxed.
Action 13 - Transfer Pricing Documentation and Country-by-Country Reporting
Action 13 starts from the proposition that providing “adequate” information to tax
administrators results in the transparency required for transfer pricing assessments
and examinations, which together are a key element towards addressing BEPS. In
January of this year, the OECD issued draft guidance on TPD and CbCR. This
draft was met with concern by the taxpayer community, particularly with regard to
the onerous level of information required, the confidentiality of said information,
and the possibility that some of this information would be gathered for use in a
formulary approach, notwithstanding that the OECD has stated that such an
approach was not their objective. As part of the 2014 Deliverables issued on
September 16, 2014, Action 13 is addressed via a new proposed Chapter V to the
OECD Guidelines.
Per the proposed Chapter V, the information requirements of taxpayers would fall
within three documents: (i) CbCR; (ii) a transfer pricing “Master File;” and (iii) a
transfer pricing “Local File.”
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7 Tax News and Developments October 2014
The CbCR is a template that would capture the following information for each tax
jurisdiction in which the taxpayer does business:
Revenue (Unrelated Party, Related Party, and Total);
Profit before income tax;
Income tax paid and accrued;
Total employment (headcount by full time employee);
Capital;
Retained earnings;
Tangible Assets (excluding cash and equivalents); and
Business activity of each legal entity in the jurisdiction.
The Master File is intended to provide the information regarding the taxpayer’s
global business operations and transfer pricing policies. In addition, the Master File
should address intangible assets owned and developed by the MNE as well as its
overall intercompany financing activities. This document is intended to be available
to all relevant tax administrations.
In contrast, the Local File would capture transactional information that is country-
specific, including relevant related party transactions (and amounts of said
transactions) as well as the taxpayer’s analysis of these transactions.
The Executive Summary of the Action 13 Report indicates that the proposed
Chapter V reflects an effort to balance the information needs of the tax
administrations against taxpayer concerns over inappropriate use of information,
compliance costs, and the burdens imposed on their business. Notably, the
Executive Summary highlights that the tax administrations of some emerging
markets, including Argentina, Brazil, China, Colombia, India, Mexico, South Africa,
and Turkey, would have balanced these competing interests by requiring additional
taxpayer information in the CbCR, including data regarding related party interest
payments, royalty payments, and “especially” service fees. The current draft of
Chapter V requires such information to be captured in the Local File.
The response so far from the taxpayer community has been mixed. Taxpayers
have reacted positively to the narrower scope of the CbCR, which is more in line
with the comments they provided and is also broadly consistent with public
statements made by OECD officials (including those made at the Bloomberg BNA /
Baker & McKenzie Transfer Pricing Conference in Paris, on March 31, 2014).
Certain issues have yet to be addressed, such as whether the CbCR Template
would be filed in only the parent company’s jurisdiction and, if so, whether it would
be shared via treaty exchange of information provisions or through some other
mechanism. It is expected that the OECD will address these and other
implementation issues in a subsequent report to be issued in January 2015. The
Executive Summary mandates countries participating in BEPS to reassess no later
than the end of 2020 whether modifications to the content of these reports should
be made to require reporting of additional or different data.
Action 15 - Multilateral Treaty
The extensive current network of bilateral tax treaties were drafted with the
elimination of double taxation in mind. Current bilateral treaties have been valuable
in creating consistency in the tax rules applicable to cross-border trade and
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8 Tax News and Developments October 2014
investment. As globalization has changed the way international business is
conducted, certain aspects of the current treaty system have created opportunities
for BEPS. The OECD recognizes that modifying the current network of 3000+
treaties on a one by one basis would be a slow process that might lead to
inconsistent results. Accordingly, in the report on Action 15 (the “Action 15
Report”), the OECD concludes that it would be both desirable and feasible for a
multilateral instrument to be developed to modify tax treaties and address the
BEPS opportunities created by the current treaty system. The Action 15 Report
suggests that this instrument should be negotiated through an International
Conference open to G20 countries, OECD members and other interested
countries. Furthermore, the Action 15 Report suggests that the Conference should
be limited in scope to implementing the BEPS Action Plan and should take place
within the next 2 years.
The Action 15 Report discusses the numerous challenges that developing a
multilateral instrument would pose technically and provides guidance on certain
features the multilateral instrument could include to combat these challenges. First,
the Action 15 Report suggests that the multilateral instrument would only apply to
parties that have an existing bilateral treaty relationship to facilitate cooperation.
Furthermore, the multilateral instrument would need to consider how treaties
negotiated in the future would be subject to the multilateral instrument. The goal of
the OECD would be to modify provisions of treaties, not amend them. The Action
15 Report explains that the multilateral instrument would need to take into account
situations where a treaty and the multilateral instrument interact. For instance, the
US takes a particular stance when negotiating limitation of benefit provisions that
may differ from the accepted approach in the multilateral instrument limitation of
benefits provision. With these types of issues in mind, the Action 15 Report
repeatedly stresses the importance of flexibility in developing the multilateral
instrument. This again would be a significant challenge, because certain countries
may be willing to make concessions on an issue in a bilateral negotiation that
would not be practical in a multilateral negotiation. The Action 15 Report tries to
address this issue by proposing the possibility of allowing countries to opt-in or out
of certain provisions other than the core provisions of the multilateral instrument.
As the multilateral instrument would be subject to countries’ normal ratification
processes, it would be essential that there be strong political support and initiative
across jurisdictions for the multilateral instrument to succeed.
By Steven Hadjilogiou and Sean J. Tevel (Miami), Michelle A. Martinez (Chicago) and Eric Torrey, Washington, DC
The OECD Moves Forward on Initiatives to Curb Treaty Abuse, while US Tax Treaties are Stalled in the US Senate
OECD Releases Report on BEPS Action 6: Preventing Treaty Abuse
On September 16, 2014, the Organization for Economic Development (“OECD”)
issued reports on seven out of 15 points of an action plan (the “BEPS Action Plan”)
initially developed in 2013 to address perceived abuses from base erosion and
profit shifting (“BEPS”). One of those reports, entitled Preventing the Granting of
Treaty Benefits in Inappropriate Circumstances (the “Report”), addresses Action 6
– Preventing Treaty Abuse, which was billed by the OECD as “one of the most
Baker & McKenzie
9 Tax News and Developments October 2014
important sources of BEPS concerns.” The majority of the Report focuses on treaty
shopping, which involves a taxpayer attempting to qualify for benefits of an income
tax treaty between two countries, one of which has no substantive connection with
the taxpayer. For example, a corporation that is tax resident in Country A may
want to invest funds in a subsidiary in Country B, but doing so could subject the
dividend payments to Country B withholding tax that is not reduced or eliminated
by an income tax treaty between Country A and B. Country C, on the other hand,
has a favorable treaty with Country B, a participation exemption in its domestic law
for incoming dividends from a Country B subsidiary, and no withholding under its
treaty with Country A on outbound dividend payments from a Country C subsidiary
to a Country A parent. Thus, by interposing a newly-formed subsidiary in Country
C, the dividends could be paid from Country B to Country C and from Country C to
Country A without the imposition of any withholding tax. The ability to “shop” for a
favorable jurisdiction to insert between Countries A and B is one of the principal
treaty abuses that concerns the OECD.
The OECD suggests a three pronged approach to address treaty shopping under
which income tax treaties should include: (1) a clear statement that the treaty is
entered into to prevent tax avoidance and is not intended to be used to generate
double non-taxation; (2) a “US style” limitation on benefits (“LOB”) article; and (3) a
general anti-abuse rule based on the principal purpose of the transactions or
arrangements (the “principal purpose test” or “PPT”) that addresses, among other
things, conduit arrangements. According to the March 2014 discussion draft of the
Report, treaties seemingly would need to include all three prongs to meet OECD
standards. But, in the recently-issued Report, the OECD states that countries
could choose between the second and third prongs. If a treaty did not include the
PPT rule described in prong three, it should include an LOB article coupled with
another mechanism (e.g., domestic laws) to address conduit arrangements. This
clarification appears to address concerns voiced by the United States about
including PPT provisions in its treaties, and concerns expressed by other countries
that the LOB provision did not, on its own, adequately combat conduit
arrangements.
The Report also includes proposed language for a model LOB article and related
commentary. Interestingly, the OECD’s model LOB contains some of the more
restrictive provisions from the various iterations of US LOB articles. At least two
provisions are noteworthy: (1) the publicly traded test in paragraph 2 includes
additional, alternative requirements that the public company either (i) is “primarily
traded” on an exchange located in its country of residence, or (ii) is “primarily
managed and controlled” in its country of residence; and (2) the derivative benefits
provision in paragraph 4 requires that, in the case of indirect ownership, each
intermediary is itself an equivalent beneficiary.
The additional requirements in the publicly traded test first appeared in US LOB
articles in 2004 protocols to US income tax treaties with Barbados and the
Netherlands. US Treasury testimony before the US Senate on those protocols
indicated that one of the reasons for adding the “primarily traded” and “primarily
managed and controlled” requirements was to combat inversion transactions,
which at the time generally involved a US multinational changing its tax residence
from the United States to another jurisdiction via a “self-inversion” or a combination
with an unrelated foreign company. The inclusion of this expanded publicly traded
test in the OECD model language is of note because inversion transactions were
not identified in the OECD BEPS Action Plan.
The stricter derivative benefits provision in the OECD’s model LOB is reflective of
a progressive tightening within US income tax treaties. Modern US income tax
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10 Tax News and Developments October 2014
treaties have generally only placed limits on indirect ownership for purposes of
qualifying a subsidiary of a publicly traded company and/or satisfying the
ownership/base erosion test. However, the LOB in the pending protocol to the
Spain-US Income Tax Treaty (the “Spain-US Protocol”) (discussed below) adds a
new limitation on indirect ownership in the derivative benefits test. The OECD’s
model LOB follows the approach taken in the Spain-US Protocol and limits
permissible indirect ownership for purposes of all three provisions. There is,
however, language in the OECD’s model derivative benefits provision that appears
to result, though perhaps unintentionally, in an effective prohibition on indirect
ownership. While the Spain-US Protocol only restricts residency of qualifying
intermediaries for purposes of the derivative benefits test (i.e., requiring that each
intermediate owner by a resident of an EU or NAFTA state), the OECD’s model
LOB requires that each intermediary be an “equivalent beneficiary.” For purposes
of the OECD’s model, a person is considered an equivalent beneficiary only if that
person is an individual, a governmental entity, a non-profit organization, a
pension/investment fund or a publicly traded company. This restriction effectively
prohibits indirect ownership in the derivative benefits test because it is impossible
for most of these persons to be an intermediate entity and improbable for the rest.
The effective prohibition on indirect ownership would even apply to intermediaries
resident in the same contracting state as the person claiming treaty benefits, which
is a significant departure from the corresponding provision in the Spain-US
Protocol and the other LOB provisions limiting indirect ownership.
The Report suggests the model LOB language, including the two provisions
discussed above, reflects the consensus position of the OECD members as of July
2014. However, the proposed measures have not been formally finalized and may
undergo further modification as other action items within the BEPS Action Plan are
addressed. Indeed, the OECD has indicated it plans to do further work to refine
the model LOB language.
Stalled US Income Tax Treaties: the List Awaiting Senate Ratification Continues to Grow
On July 16, 2014, the Senate Foreign Relations Committee approved (i) a new
bilateral income tax treaty with Poland (the “Poland-US Treaty”) and (ii) the Spain-
US Protocol. Both of these measures join a growing list of income tax treaties and
protocols awaiting ratification by the US Senate. This list already included a
protocol to the Luxembourg treaty (signed in 2009), a protocol to the Switzerland
treaty (signed in 2009), the first ever income tax treaty with Chile (signed in 2010),
and a new treaty with Hungary (signed in 2010). These treaties have languished in
the Senate due mostly to Senator Rand Paul’s (R-Kentucky) concern that the
information exchange provisions within these treaties violate Fourth Amendment
privacy rights. These treaties remain stalled due to the US Senate leadership’s
unwillingness to override Senator Paul’s procedural objection and put ratification of
these treaties to a formal vote, which would require substantive floor debate with
respect to each treaty.
The provisions within the Poland-US Treaty and the Spain-US Protocol would
bring those treaties more in line with other recently negotiated bilateral income tax
treaties. The updates include, but are not limited to, (i) a normalization of the
period after which a construction site, installation project, drilling rig, or exploration
site becomes a permanent establishment to 12 months, (ii) an adjustment of the
maximum withholding tax rates on dividends, interest and royalties, including zero
withholding rates on all three items of income for certain Spanish residents, and
(iii) the modernization of the LOB article in the Spain-US income tax treaty and the
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11 Tax News and Developments October 2014
debut of an LOB article in the Poland-US Treaty (which had been one of only two
US income tax treaties that did not include an LOB article but allowed for a
complete exemption from withholding on interest payments). The pending LOB
articles in both treaties depart from the US Model treaty by including a
headquarters company test, a derivative benefits test, and the anti-triangular rule.
Additionally, the derivative benefits provision in the Spain-US Protocol departs
from all previous versions of that particular provision by requiring, in the case of
indirect ownership, that each intermediate owner also be a resident of a country
within the EU or NAFTA.
A number of other income tax treaties and protocols are at various stages of the
ratification process. Notably, a protocol to the Japan-US Income Tax Treaty was
signed in 2013 but has yet to be sent to the US Senate by the President. In
addition, income tax treaties with Norway and Romania have been negotiated and
initialed, and are awaiting signature. While the US Treasury continues to expand
and modernize the US treaty network, those efforts have been hindered by
procedural issues in the US Senate.
By Matthew S. Mauney (Houston)
An Uncertain Path for Tax Extenders
We are once again approaching the end of a Congress where the members will need to retroactively extend more than 50 tax provisions. The path for extenders is more complicated this year and will likely depend on whether the US Senate flips as a result of the midterm election. This article provides a general overview of extenders and the possible paths for passage. Extenders is comprised of several provisions that affect businesses and individuals. The most popular business extenders are bonus depreciation, the research credit, Internal Revenue Code section 954(c)(6) (“CFC Look Through”), and the active financing exceptions to subpart F (generally for banks and similar financial institutions). The most controversial business extender is the production tax credit for renewable energy and cellulosic biofuels. For individuals, the most popular extenders include the deduction for state and local sales tax for individuals who reside in states without income taxes, and enhanced current expensing for small businesses. Unlike the extenders exercise at the end of the last Congress, this Congress is not faced with the expiration of the lower tax rates on individuals and estates (the Bush tax cuts enacted in 2001 and 2003). In January 2013, Congress passed the American Taxpayer Relief Act of 2012 which permanently extended most of the Bush tax cuts, including the Alternative Minimum Tax patch. The Senate tried to pass a two-year extension (through 2015) earlier this year. Rather than making hard choices, the Expiring Provisions Improvement Reform and Efficiency Act of 2014 would extend all of the expired provisions for a cost of $84.1 billion over 10 years. The bill was partially offset by various proposals that would address the tax gap and ultimately failed on the Senate floor due to a procedural vote. Republicans expressed frustration with the Senate bill because the majority prevented several amendments, including an amendment to repeal the medical device excise tax, which was enacted as part of the Affordable Care Act.
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The House is using extenders to pave the road for tax reform. The House believes that Congress should select those extenders which support good policies, and such provisions should be permanently extended outside of tax reform. This will provide Congress with more flexibility in lowering corporate and individual tax rates. To that end, the House Committee on Ways and Means held several hearings to highlight key extenders, including CFC look-through, the active financing exceptions to subpart F, and the research credit. Before leaving for fall recess, the House passed the Jobs for America Act (H.R. 4), which would permanently extend the research credit, bonus depreciation, enhanced current expensing for small businesses, and Subchapter S-Corporation relief. The bill also would repeal the medical device excise tax. Unlike the Senate bill, the Jobs for America Act does not contain any offsets and would cost $572 billion over ten years. The timing and content of extenders will depend on the outcome of the November election. If the election results in the status quo (the Senate is held by the Democrats with a razor thin margin), then a likely outcome is that the parties will come together in the lame duck and extend the expired provisions through 2015. Senate Democrats are unlikely to permanently extend selected provisions unless their priorities are also permanently extended (e.g., permanent extension of relief for the low income housing tax credit). Additionally, Senate Democrats may demand the inclusion of anti-inversion offsets, especially if more businesses announce inversion transactions in the near future. The timing and content of extenders is less clear if the Republicans take the Senate. While House leadership recognizes that extenders is a priority, the Republicans may have a stronger negotiating position in the lame duck and may be unwilling to accept extension of the production tax credit and temporary extensions of certain other extenders. However, both parties and both houses support the extension of most of the provisions that affect the business community. Additionally, there is agreement that extenders should not be fully offset. The lame duck will be a short, intense session, and hopefully Congress will pass extenders before the end of the year.
By Joshua D. Odintz (Washington, DC)
Safeway Successfully Defends Inter-jurisdictional Tax Plan (Yet Again)
Ontario’s Superior Court of Justice recently affirmed the validity of Safeway’s hotly-
disputed Canadian interprovincial financing structure, despite continued resistance
from Ontario’s Ministry of Finance. Back in 2001, the well-known grocery retailer’s
Canadian operating company put in place a tax plan designed to achieve
efficiencies arising from differences in how the corporate tax base was defined in
Ontario as compared to other Canadian jurisdictions. In simple terms, the
operating company replaced its retained earnings with money borrowed from a
related corporation, and the resulting debt was then transferred to Safeway Ontario
Finance Corporation (“SOFC”). Since SOFC was resident in Ontario but
incorporated outside Canada, and because the financing structure used a special
form of sealed debt instrument, the Canadian operating company was able to
deduct the interest paid on the debt without a corresponding income inclusion in
SOFC’s hands. The result was tax savings of roughly $6 to $7 million for each year
the financing structure was in place. In 2005, Ontario amended its legislation to
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13 Tax News and Developments October 2014
bring its corporate tax base in line with other Canadian jurisdictions, effectively
closing down the tax planning opportunity that had become known as the “Finco”
plan. As a result, Safeway’s Canadian subsidiaries, like other companies involved
in the Finco plan, promptly unwound their financing structure and repatriated the
underlying funds up the corporate chain.
Unfortunately (for the affected corporate taxpayers), Ontario’s legislative
amendment was only one of a number of steps eventually taken by Canadian tax
authorities to combat the Finco plan. Several provinces proceeded to issue tax
reassessments to claw back the tax savings achieved under the now-defunct
financing plan, relying heavily on the General Anti-Avoidance Rule (or “GAAR”) in
their respective income tax statutes. Although many of the taxpayers involved
fought back, most were prevented from proceeding to formal litigation because the
tax authorities held their matters in abeyance pending the resolution of a select
number of court cases (two in Alberta, and two in Ontario). Safeway was the only
corporate group whose disputes were allowed to proceed to court in both
jurisdictions.
Represented by a litigation team led by Jacques Bernier and Mark Tonkovich from
Baker & McKenzie’s Toronto office, Safeway’s subsidiaries litigated the Alberta
side of the tax controversy first through Alberta’s trial court, then before the Alberta
Court of Appeal, and finally in a leave application before the Supreme Court of
Canada. Receiving clear and carefully-reasoned trial and appellate judgments, the
taxpayers were wholly successful at every stage of the Alberta litigation. Following
on the heels of the Alberta victories, the Ontario side of the dispute proceeded
before the Ontario Superior Court of Justice in April 2014. Once again, Safeway’s
position was well-received at trial: SOFC successfully defended against each
argument advanced by the Ontario tax authority in its attempt to substantiate the
disputed Finco tax reassessments, and SOFC received a concise judgment
allowing its case in full in mid-September.
Stepping back, both the Alberta and the Ontario litigation stand for the proposition
that there is nothing abusive about a Canadian taxpayer using bona fide
commercial transactions to take advantage of one province’s lower tax rates or
more-favorable tax rules. Taxpayers navigating any of Canada’s various tax
systems should take comfort from the sound first principles upon which these
several court judgments are based when engaging in tax planning to achieve
efficiencies in their Canadian operations.
By Mark Tonkovich (Toronto)
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14 Tax News and Developments October 2014
Recent French Decision Regarding the Business Tax Cap Mechanism
On September 19, 2014, the French Constitutional Court issued a decision
regarding the Business Tax cap mechanism. The decision is of particular interest
to taxpayers disposing of significant real estate assets and who implemented a
reorganization transaction. Indeed, the legal provision at hand which was declared
unconstitutional significantly increased in certain cases the Business Tax burden of
those taxpayers. Repayment opportunities may exist and should be seized rapidly.
For a more detailed discussion, see the October 2014 Baker & McKenzie Paris
Tax Legal Alert, France – Opportunity to Claim a Business Tax Refund Further to a
Successful Claim Brought by Baker & McKenzie Before the French Constitutional
Court, also available under publications at www.bakermckenzie.com. If you are
interested in receiving European Tax Client Alerts directly, contact
[email protected] to be added to the European Tax distribution list.
By Eric Meier, Régis Torlet, and Edouard de Rancher (Paris)
Publication by the French Tax Administration of Final Transfer Pricing Disclosure Form and Related Guidelines
On September 16, 2014, the French tax administration released the final versions
of the Transfer Pricing disclosure form and guidelines which may require large
enterprises to communicate, on an annual basis, a transfer pricing disclosure form
requiring the following information:
1. The enterprise’s main activities, intangible assets and a general
description of their transfer pricing policy; and
2. A description of the activity with a summary of transactions and
presentation of transfer pricing methods
For a more detailed discussion and to view comments from Baker & McKenzie’s
tax practitioners, see the September 2014 Baker & McKenzie Paris Tax Legal
Alert, Publication by the French Tax Administration of Final Transfer Pricing
Disclosure Form and Related Guidelines, also available under publications at
www.bakermckenzie.com. If you are interested in receiving European Tax Client
Alerts directly, contact [email protected] to be added to the European
Tax distribution list.
By Caroline Silberztein, Benoît Granel, and Laura Nguyen-Lapierre (Paris)
Recent Developments in the Netherlands - Time to Check Your Dutch Holding Company or Financial Services Company’s Substance?
The Netherlands is one of the jurisdictions known for its extensive treaty network
and numerous tax and non-tax related benefits, which have attracted substantial
investments by US multinationals. This has resulted in many Netherlands-based
active operations, regional headquarters, holding companies and financial services
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15 Tax News and Developments October 2014
companies (i.e. performing licensing and/or financing activities for the group).
While the group as a whole may very well have active operations in the
Netherlands, typically holding and financial services companies have limited
operational substance because of the nature of their activities. Although, as a
general rule, a company incorporated under Dutch law is always considered a
Dutch tax resident, in the international treaty context, the issue of beneficial
ownership is key in order to invoke treaty benefits. The beneficial ownership issue
is, in principle, a source country issue. However, as discussed below, the
spontaneous information exchange that will be triggered where the Dutch
substance requirements are not met, may have an impact on the source country’s
assessment of beneficial ownership.
For financial services companies, minimum substance requirements have been
around for at least ten years now, based on Dutch tax practice and various
decrees offering guidance specifically for entities that wish to enter into an
advance pricing agreement with the Dutch tax authorities. Recent changes have
now turned these substance requirements into law. This is inspired by international
developments around the mutual assistance in the field of taxation, but also in the
context of the OECD's Base Erosion and Profit Shifting initiative.
Legislation on Substance requirements for Financial Services Companies (FSCs)
On 1 January 2014 new legislation was implemented in Dutch law (article 3a
Uitvoeringsbeschikking Wet op de Internationale Bijstandverlening), which created
the legislative basis for substance requirements for financial services companies
(hereinafter referred to as “FSCs”).
a. When does a company qualify as an FSC?
The requirement on the basis of which companies should actively provide
information with regard to their level of substance (potentially resulting in
exchanges of information with other jurisdictions) specifically applies to Dutch
companies which qualify as an FSC. Dutch law defines an FSC as a company
whose activities in a fiscal year consist for 70% or more of directly or indirectly
receiving and paying interest, royalties, rent or lease installments, to or from
non-resident affiliated companies. In determining whether a company is an
FSC, the relevant factors taken into account are (i) the activities performed by
the company and time spent by its employees; (ii) the assets used; (iii) the
company’s turnover; and (iv) the profit generated by the company on each of
its activities. The decree is unclear with regard to how each of these factors
needs to be weighed. Holding activities should be excluded when applying the
70% test.
b. What are the substance requirements applicable to an FSC?
The new legislation confirms the substance requirements set forth below:
i. at least 50% of the FSCs statutory board members that are authorized to
represent the company are Dutch residents;
ii. the Dutch resident board members have sufficient professional expertise
to properly fulfil their duties. These duties at least include decisions on
entering into transactions and the follow-up on those transactions;
iii. the FSC has qualified personnel to execute and administer its
transactions;
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16 Tax News and Developments October 2014
iv. the board decisions are made in the Netherlands;
v. the FSC’s main bank accounts are held in the Netherlands;
vi. the FSC’s bookkeeping is prepared in the Netherlands;
vii. the FSC’s business address is in the Netherlands;
viii. the FSC is not, to its best knowledge, considered a tax resident in another
country;
ix. the FSC incurs real risks in relation to its financing, licensing, rental or
leasing activities; and
x. the FSC maintains sufficient equity considering the real risks it incurs.
c. What are the consequences of not meeting the substance requirements?
The legislation states that FSCs should actively inform the Dutch tax
authorities about whether they meet the full list of Dutch substance
requirements, throughout the fiscal year for which a tax return is filed. This is
done through checking a box in the Dutch corporate income tax return. FSCs
that do not meet (all of) the substance requirements will be required to provide
detailed information explaining reasons for not meeting the substance
requirements and data on the nature of income and whether treaty benefits
have been invoked. With this information, the Dutch tax authorities will verify
the substance level and if decided that the FSC does not meet the desired
substance level, the Dutch tax authorities can decide to exchange information
on the FSC with the relevant jurisdictions. The exchange of information will
only be done if treaty benefits or benefits on the basis of the EU Interest &
Royalty Directive have been (or could have been) invoked. Such information
may inspire the tax authorities in these countries to deny tax treaty benefits or
the application of the EU Interest and Royalty Directive.
Impact on Advance Pricing Agreement (“APA”) and Advance TaxRulings (“ATR”) environment
In addition to the legislative changes effective January 1, 2014, a number of
related decrees were updated on June 12th, 2014. These decrees essentially
provide guidance around the ruling procedures relevant to Dutch companies that
wish to enter into an APA (for FSCs) and/or an ATR with the Dutch tax authorities.
With the update, no change in the existing APA/ATR practice is envisaged. The
relevant aspects that did change are addressed below.
a. What is the impact on FSCs that wish to obtain an APA after June 12th, 2014?
An FSC that wishes to obtain an APA for its activities must meet the minimum
substance requirements as explained above, with a particular focus on the real
risk requirement (see 2.b ix above). Detailed guidance is provided with respect
to when an FSC is considered to run a real economic risk. The decree further
includes updated examples, as well as information on potential spontaneous
exchange of information (i.e. the APA) on the basis of mutual assistance
legislation. Most importantly, for APA’s issued after June 12th, 2014, if an FSC
only meets the minimum substance requirements and the Dutch group to
which it belongs does not have any other activities in the Netherlands (nor any
plans to expand in the Netherlands), the content of the APA may be
spontaneously exchanged with the relevant foreign tax authorities.
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17 Tax News and Developments October 2014
b. What is the impact on (holding) companies that wish to obtain an ATR?
While FSCs typically apply for an APA on the transfer pricing aspects, an ATR
applies more broadly and provides advance certainty with respect to general
corporate income tax matters such as the application of the Netherlands
participation exemption regime, the permanent establishment findings and the
dividend withholding tax exemptions. While the substance conditions pursuant
to which a holding company could obtain an ATR had never been formally
confirmed, the updated ATR decree dated June 12, 2014 now specifically
confirms that Dutch holding companies are eligible for an ATR if conditions
2.b.i - viii of the above-described substance requirements are met.
Furthermore, the decree now also states that when a (holding) company does
not yet meet the aforementioned substance requirements on a stand-alone
basis, it can still apply for an ATR if the group to which the entity belongs has
operational activities in the Netherlands or has concrete plans to engage in
operational activities in the future.
Considering this new development and in particular the impact that this has on
information exchange, multinationals are well advised to review their existing
substance level in the Netherlands.
By Margreet G. Nijhof, Mounia Benabdallah and Steven Vijverberg, (Amsterdam)
US Supreme Court to Hear Three State Tax Cases
Historically frustrated by the US Supreme Court’s lack of interest in state tax
cases, state tax professionals have plenty to follow this term as the Court has
granted certiorari in three cases involving state tax issues. Following is a summary
of the cases, CSX Transportation, Direct Marketing Association, and Wynne, and
state tax issues the Court will address.
CSX Transportation v. Alabama Dep’t of Revenue
On July 1, 2014 the US Supreme Court granted certiorari for the second time in
CSX Transportation v. Alabama Dep’t of Revenue, No. 12-14611 (11th Cir. 2013).
At issue is Alabama’s sales tax regime and whether it discriminates against
interstate rail carriers in violation of the federal Railroad Revitalization and
Regulatory Reform Act of 1976 (“4-R Act”). The 4-R Act precludes states from
imposing “another tax that discriminates against a rail carrier.” 49 U.S.C. §
11501(b)(4). The Supreme Court initially granted certiorari in this case to
determine whether a railroad was permitted to challenge a state tax exemption
under the 4-R Act as being “another tax that discriminates against a rail carrier.”
The Court answered that question in the affirmative, but left open for remand the
question of whether Alabama’s fuel and sales tax regime is actually discriminatory.
Alabama taxes the purchase of diesel fuel differently among transportation
businesses. For example, rail carriers pay a 4% sales tax on purchases of diesel
fuel, motor carriers pay an excise tax of 19¢ per gallon, and water carriers are
completely exempt from tax on diesel fuel purchases. CSX Transportation, Inc.
(“CSX”), an interstate rail carrier, is subject to Alabama’s 4% sales tax and
challenged Alabama’s taxing scheme on the grounds that exempting its
competitors from sales tax discriminates against rail carriers and in violation of the
4-R Act.
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On remand, the district court upheld the Alabama exemption finding that motor
carriers pay excise tax on diesel fuel in an amount equal to the sales tax paid by
rail carriers. The 11th Circuit reversed on appeal, stating that CSX established a
prima facie case of discrimination upon demonstrating that a comparison class of
competitors (i.e., motor and water carriers) did not pay sales tax on diesel fuel
purchases. Alabama was unable to offer a reasonable justification for treating rail,
motor, and water carriers differently. In its order granting certiorari the Supreme
Court directed both parties to brief the issue of whether, in resolving a claim of
unlawful tax discrimination under the 4-R Act, a court should consider other
aspects of the State’s tax scheme (i.e., excise tax) rather than focus solely on the
challenged tax provision (i.e., sales tax).
Direct Marketing Ass’n v. Brohl
On July 1, 2014 the US Supreme Court granted certiorari in Direct Marketing Ass’n
v. Brohl, No. 12-1175 (10th Cir. 2013). The Supreme Court will consider whether a
state regulation imposing a sales tax notice and reporting obligation is procedurally
barred from review in federal court pursuant to the federal Tax Injunction Act
(“TIA”). The TIA provides that “district courts shall not enjoin, suspend or restrain
the assessment, levy or collection of any tax under State law where a plain,
speedy and efficient remedy may be had in the Courts of such State.” 28 U.S.C. §
1341.
Direct Marketing Association (“DMA”) is challenging a Colorado regulation that
requires non-collecting, out-of-state retailers that have more than $100,000 in
gross Colorado sales to (1) notify their Colorado customers that they must self-
report use tax on their purchases, (2) provide their Colorado customers with an
annual purchase summary, and (3) provide a report to the Colorado Department of
Revenue that details each of their Colorado customers and their purchases. See
Colo. Code Regs. 39-21-112.3.5. DMA brought its challenge in the US District
Court for the District of Colorado, arguing that the Colorado regulation’s notice and
reporting requirements violate the Commerce Clause by discriminating against out-
of-state retailers. The district court agreed with DMA and permanently enjoined the
enforcement of Colorado’s regulation.
On appeal, the 10th Circuit held that the TIA deprived the district court of
jurisdiction to enjoin the Department from enforcing its regulation. The appellate
court reasoned that the TIA applied because the law at issue concerned the levy or
collection of a state tax and DMA could have sought a “plain, speedy, and efficient
remedy” at the state level. DMA argued that the TIA does not preclude federal
jurisdiction where (1) a taxpayer is not seeking to avoid a tax and (2) it is not
challenging a tax assessment, but a notice and reporting requirement. The
Supreme Court will now ultimately decide whether the TIA deprives federal courts
jurisdiction in cases involving some aspect of state tax administration, or whether
the TIA’s bar only applies to taxpayers seeking to avoid the “levy or collection” of a
state tax.
Comptroller v. Wynne
Comptroller of the Treasury of Maryland v. Brian Wynne, Docket No. 13-485
involves a constitutional challenge to Maryland’s county-level personal income tax
credit for taxes paid to out-of-state jurisdictions. Maryland residents are generally
subject to the state’s personal income tax, which is comprised of both a state-level
tax and a county-level tax. Currently, Maryland provides its residents with a state
tax credit for income taxes paid to other states, but does not extend the credit to
Maryland’s county income taxes, which can be as high as 3.20% of net income.
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The Comptroller of Maryland increased Wynne’s tax liability by denying credits
claimed for the county portion of the Maryland income tax. Wynne challenged the
assessment under the “dormant Commerce Clause” of the US Constitution, which
the US Supreme Court has held to implicitly limit the power of state and local
governments to enact laws affecting interstate commerce. Maryland’s highest court
held that Maryland’s law unconstitutionally interfered with interstate commerce
because Maryland residents were taxed at a higher rate when income was
received from within and without the state as opposed to taxpayers receiving
income exclusively within Maryland. The higher tax rate was a result of double
taxation because of the lack of a complete credit. The Comptroller of Maryland
asserts that the Maryland taxing scheme does not discriminate against interstate
commerce and multiple taxation is often an unavoidable consequence of the
combined effect’ of two different states’ statutes. Although the Supreme Court’s
ruling will focus on Maryland’s tax credit-mechanism, its ruling may have broader
implications if it addresses the applicability/scope of the dormant Commerce
Clause.
By Drew Hemmings (Chicago), Michael C. Tedesco and David Pope (New York)
New Illinois “Click-Through” Nexus Law Addresses Some Issues While Leaving and Creating Others
In response to the Illinois Supreme Court’s invalidation of Illinois’ “click-through”
nexus law in Performance Marketing Ass’n v. Hamer, 998 N.E.2d 54 (Ill. 2013),
Illinois enacted a new “click-through” nexus law on August 26, 2014, making two
important changes to the law previously voided. First, the new law imposes use tax
collection obligations on retailers utilizing print or broadcast marketing affiliates in
addition to online marketing affiliates. This change attempts to remedy the
preemption of the prior “click-through” nexus law by the Internet Tax Freedom Act
(“ITFA”) by eliminating the discrimination against electronic commerce. Second,
the new law creates a rebuttable presumption of nexus, rather than a conclusive
determination, for any out-of-state retailers meeting the “click-through” nexus sales
thresholds.
However, questions remain regarding the constitutionality of the new law. First, the
presumption of nexus applies to out-of-state retailers based upon total sales
through affiliate referrals regardless of whether any of those sales are to Illinois
customers. Second, the new law improperly imposes use tax collection obligations
on retailers engaging in constitutionally protected advertising activities.
Prior Illinois’ “Click-Through” Nexus Law
In 2008, New York enacted the nation’s first “click-through” nexus law, also known
as the “Amazon Law.” Illinois’ “click-through” nexus law became effective in 2011
and, similar to the “click-through” nexus laws enacted by states across the country,
contained many of the same requirements as New York’s law. New York’s highest
court upheld New York’s law in Amazon.com & Overstock.com v. New York State
Dep’t of Tax’n & Finance, 987 NE2d 621 (NY 03/28/13), cert. denied, 571 U.S.
(12/2/2013). However, the Illinois “click-through” nexus law included two notable
differences. First, the Illinois law did not provide a rebuttable presumption of nexus.
Rather, Internet retailers who satisfied the law’s requirements, including certain
sales thresholds and contract requirements with in-state affiliates, had nexus
conclusively. Second, to satisfy the law’s $10,000 sales threshold, sales were not
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20 Tax News and Developments October 2014
required to be sales to Illinois residents. Instead, $10,000 in gross receipts from
any source, including entirely out-of-state sources, satisfied the sales threshold. In
short, through these two unique provisions, substantial nexus under Illinois’ law
could have been little more than an out-of-state online retailer’s marketing affiliate
sitting in Illinois.
In striking down the prior statute and affirming the decision of the Illinois Circuit
Court in Performance Marketing Ass’n v. Hamer, No. 2011 CH 26333 (Ill. Cir. Ct.
Cook Cty. 5/7/12), the Illinois Supreme Court held that, under the US Constitution’s
Supremacy Clause (“Supremacy Clause”), the ITFA preempted Illinois’ “click-
through” nexus law by prohibiting discriminatory taxes on electronic commerce.
The court determined that Illinois’ law imposed use tax collection obligations on
out-of-state retailers who used online marketing without imposing similar
obligations on retailers utilizing print or broadcast marketing. The Illinois Supreme
Court declined to address whether the Illinois Circuit Court correctly held that the
statute also violated the US Constitution’s Commerce Clause (“Commerce
Clause”). For prior coverage, see prior Tax News and Developments article Illinois
Supreme Court Invalidates State’s Click-Through Nexus Law (Vol. 13, Issue 6,
December 2013) located under publications at www.bakermckenzie.com.
Illinois’ New “Click-Through” Nexus Law Addresses Some Constitutional Issues But Faces Others
Illinois’ new “click-through” nexus law appears to have remedied the glaring
constitutional violations present under the prior law. First, by imposing use tax
collection obligations on retailers utilizing instate print or broadcast marketing
affiliates in addition to Internet marketing affiliates, the new law seemingly
eliminates the discriminatory tax on electronic commerce prohibited by ITFA.
Second, by creating a rebuttable presumption of nexus, as opposed to a
conclusive determination of nexus, for out-of-state retailers who exceed the
$10,000 sales threshold from referrals, the law may no longer facially violate the
Commerce Clause as determined by the Illinois Circuit Court, but not addressed by
the Illinois Supreme Court.
Illinois Law Creates Presumption of Nexus Even if the Affiliates’ Referrals Result in No Sales to Illinois Customers
Illinois’ new “click-through” nexus law may remain susceptible to other
constitutional challenges. First, under the law, a retailer’s presumption of nexus
with Illinois is in no way predicated upon the retailer actually making sales to
Illinois customers through affiliates’ referrals. Instead, the law creates a
presumption of nexus if Illinois affiliates simply refer $10,000 in sales to the
retailer, even if all of the sales are to non-Illinois customers. This is a key
difference between Illinois’ law and the law upheld in New York.
It is unclear whether Illinois’ insertion of a rebuttable presumption of nexus into the
new law is enough to cure the constitutional defect identified by the Illinois Circuit
Court. The court in Amazon stated that “it is not unreasonable to presume that
affiliated website owners residing in New York State will reach out to their New
York friends, relatives and other local individuals [to solicit customers and increase
their referrals to the retailer].” To the extent that Illinois courts believe that it is
reasonable to presume that marketing affiliates residing in Illinois would reach out
to their Illinois friends, relatives and other local individuals to solicit customers for
the retailer, perhaps the Illinois law could survive a facial challenge. However, the
presumption of nexus created by New York’s “click-through” nexus law may have
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21 Tax News and Developments October 2014
been on firmer constitutional footing because the statute specifically connected the
presumption of nexus to actual referrals from New York affiliates which resulted in
sales to New York customers. In contrast, the new Illinois’ law may
unconstitutionally seek to regulate commerce outside of the State of Illinois.
Of course, to the extent that a taxpayer can demonstrate that its particular facts do
not support the presumption of nexus, the taxpayer could successfully challenge
the constitutionality of the statute on an as-applied basis. For example, this could
occur if the Illinois affiliates’ referrals do not result in the retailer making any, or
relatively few, sales to Illinois customers, despite the retailer making substantial
sales to Illinois customers through other means such as the retailer’s own direct
mail and online solicitations. In addition, the statute may not be constitutional as-
applied if affiliates merely post website links to the retailer’s webpage without
actually engaging in any in-state solicitation on behalf of the retailer. Such activities
may more closely resemble online advertising.
Illinois Law Targets Various Forms of Advertising as Nexus-Creating Activities
Illinois’ inclusion of in-state print and broadcast advertising as additional nexus
creating activities for a retailer simply because a tracking mechanism is provided
by the affiliate may run afoul of the Commerce Clause. By amending the law to
include referrals by print and broadcast marketing affiliates to eliminate the IFTA
discrimination on electronic commerce, Illinois may have expanded the scope of
the law too far as to violate the Commerce Clause’s protection of advertising
activities. Courts generally hold that advertising activities, alone, are insufficient to
create substantial nexus for an out-of-state retailer. Illinois’ new law provides that a
presumption of nexus will exist for a retailer having a contract with a person
located in this State under which the person, for a commission or other
consideration refers potential customers to the retailer by providing a promotional
code or other mechanism that allows the retailer to track purchases referred by
such persons. Examples of mechanisms include a link on the person’s Internet
website, promotional codes distributed through the person’s hand-delivered or
mailed material, and promotional codes distributed by the person through radio or
other broadcast media.
Many retailers include promotional or tracking mechanisms in online, print or radio
advertisements merely to track the effectiveness of various advertising efforts.
Under a plain reading of the new law, retailers who engage in these otherwise
innocuous advertising activities are presumed to be maintaining a place of
business in Illinois and required to register to collect use tax. On this point, Illinois’
new law is clearly open to constitutional challenges on an as-applied basis, but the
question remains whether the law’s rebuttable presumption of nexus is enough to
prevent the law from being facially unconstitutional as well. Corporations
maintaining relationships with Illinois affiliates should carefully review Illinois’ new
“click-through” nexus law and consider its applicability and enforceability.
By Matthew S. Mock and Roman Patzner, Chicago
Baker & McKenzie
22 Tax News and Developments October 2014
Never a Dull Moment… Michigan Seeks to Re-Write History By Retroactive Repeal of the Multistate Tax Compact
On September 12, 2014, Michigan Governor Rick Snyder signed a bill repealing
the Multistate Tax Compact (“MTC”) retroactive to January 1, 2008 (Public Act 282
of 2014). Michigan’s retroactive repeal of the MTC is in response to the recent
decision from the Michigan Supreme Court approving IBM’s use of the MTC’s
three-factor apportionment formula in lieu of Michigan’s single sales factor formula.
For background information on IBM, please refer to prior Tax News and
Developments article Michigan Supreme Court Holds that IBM Could Elect to Use
the MTC’s Evenly Weighted Three-Factor Apportionment Formula (Vol. 14, Issue
4, August 2014) available under publications at www.bakermckenzie.com.
The impetus for the retroactive law was the prospect of the Department of
Treasury (“Treasury”) issuing substantial refunds under the IBM decision for the
period January 1, 2008 - December 31, 2010. Treasury estimated that it owed
approximately $1.09 billion in tax refunds plus interest in 134 separate lawsuits
pending in the lower courts or at the administrative level.
Michigan’s repeal of the MTC occurred while the Michigan Supreme Court is
considering a motion for reconsideration of IBM filed by the Michigan Office of
Attorney General. Upon enactment of the new law, the Michigan Attorney General
filed a brief of supplemental authority requesting that the Michigan Supreme Court
apply the retroactive repeal of the MTC to IBM itself because, in his view, IBM is a
“pending case.”
In the meantime, consistent with IBM, the Michigan Court of Appeals issued an
unpublished decision approving use of the MTC’s three-factor apportionment
formula by another taxpayer, Lorillard Tobacco. The Court of Appeals did not
mention the motion for reconsideration of IBM or the repeal of the MTC in its
decision.
Effects of Michigan’s Repeal of the MTC on Taxpayers
Even though the six year retroactive application of a law raises many constitutional
concerns, Michigan courts have upheld “clarifying” amendments to tax laws
containing periods of retroactivity of five years in General Motors Corp. (2010) and
seven years in GMAC LLC (2009). The Court of Appeals in General Motors Corp.
upheld a retroactive amendment to the Use Tax Act upon finding that the
legislation was rationally related to a legitimate legislative purpose - preventing a
substantial loss of state tax revenue. General Motors Corp. involved a taxpayer’s
refund of tax as opposed to an assessment of tax. One of the Court’s reasons for
upholding the retroactive application of the new law was that the taxpayer did not
detrimentally rely on the prior law when filing its original returns. With respect to
Michigan’s repeal of the MTC, taxpayers who received assessments because they
elected to use the MTC’s three-factor apportionment formula on an original return
should consider asserting Due Process Clause violations.
Further, the MTC is not a typical state tax law; it is a valid, enforceable interstate
compact binding on all signatory states such as Michigan. While states may
withdraw from the MTC, nothing suggests that they may do so retroactively. As a
member state, Michigan received the benefits of MTC membership, while other
states and taxpayers relied on Michigan’s membership in the MTC during the
Baker & McKenzie
23 Tax News and Developments October 2014
relevant tax years. The Contracts Clause of the US Constitution prohibits states
from passing laws that impair the obligations of contracts. The validity of
Michigan’s retroactive repeal of the MTC will certainly be tested and litigation will
continue. Taxpayers with Michigan tax liabilities must closely monitor this rapidly
developing issue.
By Roman Patzner, Chicago
Save the Dates: Baker & McKenzie Announces Upcoming Tax Conferences in San Francisco, Hong Kong, San Diego and Miami
Autumn will be in full swing when our tax controversy practitioners from across the United States and Canada convene in San Francisco November 20-22, 2014 at the Westin Market Street Hotel for their annual North American Tax Controversy Training Workshop. In conjunction with that program, the group will be conducting a full-day program for clients on Friday, November 21st that will open with a traditional general session discussing ways to manage US and foreign tax audits, followed by interactive breakout sessions on topics such as Protecting Confidential Company Information, Best Practices and Pitfalls re IDR Directives, Intergovernmental Information Exchange and Foreign Tax Raids. Lunch will feature a presentation on how the recent change of leadership at the IRS Transfer Pricing Operation and LB&I International could ultimately affect the current audits and appeals process, and the afternoon has been designed to afford our client guests with the unique opportunity to train side-by-side with the Firm's own tax controversy practitioners as they hone their advocacy skills, as instructors from the National Institute of Trial Advocacy (NITA) and our more experienced Baker & McKenzie tax litigators will guide attendees through various exercises geared towards gathering information from witnesses, case analysis, offense/defense strategies, and preparing company personnel for actual IRS interviews. Participants can then practice these techniques and will be given real-time feedback and tips for improvement. We hope you will join us for what promises to be an informative and practical educational experience. CLE and CPE credit will be offered. For the complete agenda and registration information, please click here.
A world away and just a week earlier, our colleagues in the Asia Pacific region will convene in Hong Kong on November 13-15, 2014 for our 30th Annual Asia Pacific Tax Conference. This two-day event for clients will concentrate on global changes and the increasing political focus in the Asia Pacific region on tax collections, tax transparency and tax reform. If you or your colleagues are interested in attending or obtaining additional information on the Hong Kong tax conference, please click here to access the invitation, the agenda and complete registration details.
Baker & McKenzie tax attorneys and economists from around the globe will ring in the New Year in the San Diego area, as we return to the west coast for our 37th Annual North America Tax Conference and present a full-day workshop for clients on Friday, January 9th at the historic Hotel del Coronado. Workshop sessions will center around a number of hot topics in transfer pricing, tax controversy and international tax planning. Full conference details, agenda and registration information can be accessed here.
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24 Tax News and Developments October 2014
If the evolving Latin America tax landscape is what's on your mind, then the place you'll want to be is at the 16th Annual Latin America Tax Conference which will take place from March 17-19 in Miami, Florida. The program will provoke thoughtful exchange on the most current and challenging tax issues that business and industries face in their daily operations throughout Latin American. is program will include discussions led by representatives from several Latin American countries and will focus on the most current tax issues and challenges affecting business and industries in that region. Presenters from Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela, the US and several key European jurisdictions will provide truly global insights.
Each of these events will offer attendees the opportunity to network with some of the most informed professionals in industry and practice. If you're in the area, we would love to see you at these or future events as we continue our efforts to offer timely events across the country on the topics that most interest our clients. Please watch your in-box or refer to the Upcoming Events listing in this newsletter for announcements of future events, or contact us directly at [email protected] if you are interested in a specific event, or have a topic to suggest.
©2014 Baker & McKenzie. All rights reserved. Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm.
This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome.
Tax News and Developments is a periodic publication of Baker & McKenzie’s North American
Tax Practice Group. The articles and comments contained herein do not constitute legal advice or formal opinion, and should not be regarded as a substitute for detailed advice in individual cases. Past performance is not an indication of future results.
Tax News and Developments is edited by Senior Editors, James H. Barrett (Miami) and
David G. Glickman (Dallas) , and an editorial committee consisting of Theodore R. Bots (Chicago), Glenn G. Fox (New York), Kirsten R. Malm (San Francisco), Robert H. Moore (Miami), Patricia Anne Rexford (Chicago), Caryn L. Smith (Houston) and Angela J. Walitt (Washington, DC).
For further information regarding the North American Tax Practice Group or any of the items or Upcoming Events appearing in this Newsletter, please contact Carol Alexander at 312-861-8323 or [email protected].
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Tax Publications and Newsletters
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Tax Publications & Newsletters
Transfer Pricing
□ Transfer Pricing, Managing Intercompany Pricing in the 21st Century (2012)
□ European Transfer Pricing Handbook (2014)
□ Latin American Transfer Pricing Handbook (2014)
Tax Dispute Resolution
□ Handling Federal Tax Controversies in the United States (2014)
□ Handling Tax Controversies in Asia Pacific (2013) □ Handling Tax Disputes in Europe (2013)
□ Handling Tax Controversies in Latin America (2014)
Other Tax Publications
□ European Tax Transactions Guide (2014)
□ Latin America Tax Transactions Guide (2014) □ Latin America Concise Tax Guide (2014)
Electronic Tax Newsletters
□ Asia Pacific Tax Alerts - Periodic
□ China Tax Newsletter- Monthly □ North America Tax News and Developments - Bimonthly
□ European Tax Newsletter- Bimonthly
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