In this second quarter update, we cover some of the most important tax issues for companies in the technology, clean technology, life sciences, and communications and media industries and touch on what your organization can do to stay ahead of them.
New Tax Rules on Inversions
The US Treasury Department and the IRS released proposed regulations under Section 385 that enable a more expansive treatment of tax issues related to inversions, including new guidance for multistep acquisitions and earnings stripping. These changes would impact corporations that issue indebtedness for related entities by setting new thresholds and documentation requirements for treating this interest as indebtedness (rather than stock) for federal tax purposes. Although the proposed Section 385 is effective only when finalized, it would apply to debt instruments issued on or after April 4, 2016.
Second Chance at Tangible Property Regulation Benefits
The IRS updated its list of automatic changes with the issuance of Revenue Procedure 2016-29, which removes some changes, modifies several others, and identifies a handful of accounting method changes that now qualify for automatic consent.
A key modification is the extension on requesting an automatic method change for an item previously changed within the most recent five tax years (including the year of change). The new procedure extends this waiver for one additional year as it relates to most method changes connected with the tangible property regulations (TPR).
This extension allows taxpayers who have made a method change for eligible items during one of the prior four tax years to request a second change in accounting method for 2015 for the same item. The waiver applies to tax years beginning before January 1, 2016. This could give taxpayers who already requested a method change a second chance if the original change wasn’t made properly or a benefit wasn’t fully realized. Read our Alert for background on TPR.
Changes to Tax Accounting for Stock-Based Compensation
On March 30, 2016, the FASB issued Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation—Stock Compensation. ASU 2016-09 simplifies the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements as well as classification in the statement of cash flows.
Under the ASU, an entity recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. Currently, excess tax benefits are recorded in equity; tax deficiencies are recorded in equity to the extent of previous windfalls and then to the income statement. The ASU eliminates the requirement to defer recognition of an excess tax benefit until the benefit is realized through a reduction to taxes payable. Under the new guidance, the benefit will be recorded when it arises, subject to normal valuation allowance considerations. This simplification significantly reduces the administrative complexities and cost of accounting for excess tax benefits and tax deficiencies, but it will increase the volatility of income tax expense.
All tax-related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the current requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities.
For public business entities, ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For all other entities, the amendments are effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018.
State Tax Updates
In March, the California Franchise Tax Board (FTB) released Chief Counsel Ruling 2015-03, which addresses the treatment of services revenue by business taxpayers in computing their California income tax apportionment factor.
The ruling provides guidance as to when taxpayers should include receipts from services in the numerator of their California apportionment factor. FTB’s approach was first to classify services as either marketing- or nonmarketing-related services. The guidance indicates taxpayers receiving revenue from marketing services would consider the location of their “customers’ customers” in determining where the benefit of a service was received. Alternatively, taxpayers receiving services revenue considered nonmarketing look to the locations where their customers benefit from the service in their own business operations and don’t look through to the location of their customers’ customers.
In February, FTB published Notice 2016-01 recognizing that litigation involving the matter of Gillette v. Franchise Tax Board may continue in the US Supreme Court. (Gillette petitioned the court for a writ of certiorari—the term for the court’s acceptance of a case for review.) This case involved the ability of taxpayers to elect to use a three-factor, evenly weighted apportionment formula. FTB indicated it will defer taking action on claims for refund, audits, appeals, and protests involving the Multistate Tax Compact apportionment election “until the conclusion of litigation.
In April, the Texas Supreme Court ruled in Hallmark Marketing Company v. Combs that taxpayers shouldn’t reduce their Texas margins tax apportionment factor denominator by “net losses.” This ruling is expected to lead to refund claims by taxpayers that previously overstated their Texas apportionment factor by understating the receipts included in the denominator of their Texas apportionment factor.
IRS Proposes Regulations That May Impact IP Migrations
The Department of Treasury and the IRS issued proposed regulations under Internal Revenue Code (IRC) Section 367(d) in September 2015 that target transfers of foreign goodwill and going-concern value. These regulations are intended to curtail intangible property (IP) migrations and to be retroactive to September 14, 2015. They’re proposed to apply to transfers occurring on or after September 14, 2015, and to transfers occurring before September 14, 2015, due to check-the-box elections filed after September 14, 2015. Although only in proposed form at this point, these regulations are problematic for any company considering offshoring their intellectual property.
As background, the offshoring of a company’s IP is generally accompanied by a transfer of the related intangibles. This is typically accomplished in two steps:
- Any goodwill and going-concern value is transferred in a tax-free manner under current law.
- The remainder of the IP is sold in a taxable transaction.
The rules as they stand today allow for the outbound transfer of foreign goodwill and going-concern value in a favorable manner under the Section 367 regulations. Taxpayers could generally accomplish a tax-free transfer of these intangibles while being subject to tax only in the United States on the gain inherent in the transferred IP (along with other property specified in the IRC).
For many tech companies, this gain may be absorbed by net operating losses or other tax attributes. The proposed regulations would eliminate this favorable treatment of foreign goodwill and going-concern value, subjecting their transfer to US tax either on a current basis or via a deemed royalty over the life of the intangibles. This can be an indefinite life under the proposed regulations, while under current law it’s limited to 20 years.
The Treasury and the IRS view the outbound tax-free transfer of goodwill and going-concern value as an abusive transaction, as evidenced in the preamble to the proposed regulations. It’s thought that taxpayers assign a significant—often inflated—value to these assets (which reduces the value allocated to other intangible assets that aren’t eligible for the favorable treatment) and transfer them tax free. However, it’s clear from the current code and regulations, along with various Senate and committee reports dating back to the enactment of the current Section 367(d) in 1984, that the transfer of foreign goodwill and going-concern value shouldn’t be subject to US taxation.
The Treasury has held numerous hearings to date on the proposed regulations, during which taxpayers and practitioners are given the ability to raise their concerns. Here are some of the concerns of note with these proposed regulations:
- The reasonableness of the Treasury retroactively changing an established position that’s existed for at least 30 years
- The retroactive date of the regulations
- The regulations being inconsistent with Congressional intent
- The removal of the 20-year useful life of intangibles
In particular, the retroactive date of the regulations creates a dilemma for taxpayers when it comes to planning. Taxpayers aren’t required to follow the proposed regulations because they aren’t binding law; however, they clearly indicate the direction the Treasury is headed. So, how should we treat a current outbound transfer of intangibles? How should the transaction be reported? What happens if the proposed regulations are finalized in their current form on a retroactive basis? These are all considerations that should be given to current and future tax planning ideas. It’s clear the Treasury wants to finalize these proposed regulations under the current administration, which means implementing planning prior to the presidential election will be critical.
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Moss Adams LLP continuously reviews the regulatory and tax landscape for technology, clean technology, life sciences, and communications and media companies. For more information about any of the issues discussed above, or for insight on how they may impact your business, contact your Moss Adams professional.