Berwyn Boston Detroit Harrisburg New York Orange County Philadelphia Pittsburgh Princeton Washington, D.C. Wilmington

Transcription

1 February 2010 Berwyn Boston Detroit Harrisburg New York Orange County Philadelphia Pittsburgh Princeton Washington, D.C. Wilmington Follow Us on Twitter Recent Guidance on Post-Spin Payments Between Distributing and Controlled Annette M. Ahlers Speakers Corner Ellen McElroy and Todd B. Reinstein will be teaching the Tax Executive Institute s Federal Tax Course - Level 1 meeting on Tax Accounting Issues: Methods, Periods, and Hot Topics in East Lansing, Michigan on April 27. Quotable Annette M. Ahlers was quoted in Practitioners Eager for NOL Carryback Guidance, published in the March 8, 2010 issue of Tax Analysts. See page 4 for details. Published Gregory J. Nowak and Bryan D. Keith had an article, IRS Issues Proposed Regulations on Basis Reporting by Mutual Funds and Brokers, published in the December 2009 issue of the WorldTrade Executive, Inc. s Practical U.S./Domestic Tax Strategies. The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship. Internal Revenue Service rules require that we advise you that the tax advice, if any, contained in this publication was not intended or written to be used by you, and cannot be used by you, for the purposes of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please send address corrections to phinfo@pepperlaw.com Pepper Hamilton LLP. All Rights Reserved. Companies that engage in Section 355 spinoff transactions enter into numerous transition agreements to address hold-over issues between the formerly affiliated companies. These agreements typically include a tax matters agreement, license agreements, transition services agreement, etc. The intent of these documents is to make sure that issues arising after the distribution, but occurring because of activities prior to the distribution, or because of continuing transactions between the parties after the spinoff, are addressed fairly and properly taken into account for federal income tax purposes. For example, if the controlled company is a customer of the distributing company, a transition services agreement may provide for continued provision of goods or services by the distributing company through some specified period of time until the controlled company can find other providers for those services after it becomes independent. In addition, administrative and overhead services are often provided by the distributing company to the controlled company for some limited period of time until the controlled company can obtain its own employees to provide those services for itself. In its private letter rulings, the IRS allows these types of continuing relationships for a limited period of time post-spin, as long as the goods and services are provided at fair market value and the companies agree to limit the time period, thus indicating a true separation. Field Attorney Advice F A recent Field Attorney Advice memorandum, 1 issued by the IRS Associate Area Counsel in Detroit, provided a taxpayer with assistance in resolving several income and timing issues related to This publication may contain attorney advertising. in this issue... 1 Recent Guidance on Post-Spin Payments Between Distributing and Controlled 3 D.C. Plans to Raise Revenue Still Include Combined Reporting This Time with Taxpayer Guidance 4 Annette Ahlers Quoted in Tax Analysts on 5-Year Carryback of 2008 or 2009 NOLs 5 Pepper Hamilton s Tax Practice Group

2 payments and provision of services between the distributing and controlled company post-spin. In the FAA, X, a global manufacturing company spun off Z, a components producer. The spinoff was pursued for the business purpose of alleviating competitive barriers to each business to buy and/or sell to others and to allow each business to attract and retain employees with stock that was more closely tied to each company s performance. The FAA states that the spinoff was tax-free under Section 355. Certain of the X employees who worked in facilities that were now held by Z were subject to a collective bargaining agreement and thus, X agreed to keep these employees on its payroll and to lease them to Z. In this arrangement, X agreed to pay the leased employees salaries, provide them with employee benefits, pay all their taxes related to payroll and benefits, and to pay the related workman s compensation payments. Z supervised the leased employees and directed their schedules and activities. Z reimbursed X monthly for the costs incurred by X with respect to the leased employees. X and Z also agreed, in a tax sharing agreement, that X would take the reimbursement amounts into income, and treat the payments with respect to the leased employees as a compensation expense, and Z would treat its payments to X consistently with X s treatment. However, X did not treat the payments and reimbursements consistently for every year in which the parties had the arrangement between them. Thus, in some years X did not include the reimbursements into income, but sought a deduction for the amounts paid to the leased employees. The arrangement between X and Z was ultimately terminated after several years. Income Characterization X argued that the reimbursements it received from Z should not be income because the payments were part of the spinoff transaction under an open transaction theory, citing Arrowsmith v. Commissioner. 2 The IRS stated that Arrowsmith did not apply because there was no open transaction, as all the terms of the leased employee payments and reimbursements were contained in an agreement entered into by the parties. Thus, that arrangement between X and Z did not involve an unknown fact or other event that occurred post-transaction, as was the case in Arrowsmith. The IRS stated that the leased employee arrangement was dictated by the collective bargaining agreement with respect to these employees and not by the spinoff itself. The IRS also made the point that while they were not bound by the terms of the X and Z tax sharing agreement with respect to the tax characterization of the payments if the agreement misstated or improperly applied the law, X in fact did not follow the agreement when it decided not to take Z s reimbursement payments into income. Thus, X was seeking to change the deal without any regard to Z s tax consequences, and without regard to the potential whipsaw of the government if Z in fact did deduct the reimbursement fees paid to X, but X succeeded in treating such payments as part of the spinoff transaction and not income. Citing to Commissioner v. Danielson, 3 the IRS stated that courts have a preference for treating the tax consequences of contracting parties consistently and thus, avoiding a whipsaw to the government in the tax treatment of transactions. Pepper Perspective The lessons to be learned from the IRS review of this case are plentiful, even though the facts in the FAA seem to be compellingly in favor of the government because of the potential whipsaw positions and the terms of the tax sharing agreement. Taxpayers need to be aware that entering into post-spinoff agreements as part of a Section 355 transaction will generally be given tax effect as if they stand on their own. This will usually result in tax consequences separate and apart from the spinoff. Nevertheless, it also could be argued that this position should be apparent by the requirements that the IRS typically imposes on taxpayers in their rulings practice namely that all fees and payments and terms of transition agreements are negotiated at arm s length and priced at fair market value. In addition, because numerous transition and other operating agreements are typically entered into as part of a spinoff transaction, careful attention should be paid to the relevant clauses addressing the tax consequences in such agreements, and not left open to later interpretation by each party in a separate manner. En d n o t e s 1 FAA F (May 15, 2009), available at U.S. 6 (1952) F.2d 771 (3d Cir. 1967) (en banc). 2

3 D.C. Plans to Raise Revenue Still Include Combined Reporting This Time with Taxpayer Guidance La n c e S. Ja c o b s j a c o b s l e p p e r l a w.c o m Marc D. Nickel nickelm@pepperlaw.com This past August, the Council of the District of Columbia passed emergency legislation intending to address the District s projected budget gaps of hundreds of millions of dollars for the foreseeable future. 1 The key revenue raiser in that bill was a mandate that after December 31, 2010, all corporations taxable in the District would be required to use combined reporting to determine their income apportionable or allocable to the District. 2 It should be noted, however, that this emergency legislation expired after 90 days. As a result, the combined reporting provisions (as well as the other measures in the bill) sunset well before they had any impact on the District's businesses. However, in late December 2009, the council passed permanent legislation, deemed the Fiscal Year 2010 Budget Support Act of The act became effective on March 3, 2010 and restores the combined reporting provision, and several other provisions intended to raise revenue. Miscellaneous Re v e n u e Ra i s e r s f r o m Em e r g e n c y Legislation Retained Just as in the emergency legislation, the act decouples the District from the discharge of indebtedness income provisions of the American Recovery and Reinvestment Act of 2009, and increases the District's sales tax rate to 6 percent. Additionally, the act continues to authorize the District s chief financial officer to implement a tax amnesty for periods before December 31, The act also retains the emergency legislation s replacement of the statute disallowing related party expense deductions. The history of this provision is replete with confusing placement in the statutes, followed by imprecise language, all of which served to make taxpayers question its applicability to corporate and other business entities, and whether it applied to deductions for anything other than royalties. The act clears up the confusion by repealing the current statute, the District s Code Section (a)(19), and replacing it with a more clearly worded statute in Section (d). The new statute specifically disallows deductions for interest and intangible expenses paid to Taxpayers should expect that the council will seek to enact a combined reporting scheme, regardless of how unpopular it may be. related entities, as well as royalties. Importantly, the legislation makes this provision retroactively applicable to tax years beginning after December 31, All of these measures are intended to increase revenue; however, the Act s most significant provision is its revised plan to implement combined reporting in A Different Mandate for Combined Reporting The act retains the emergency legislation s combined reporting provisions, the most sweeping change contained in the legislation. Using identical language, the act requires that after December 31, 2010, all corporations taxable in the District of Columbia shall determine the income apportionable or allocable to the District of Columbia by reference to the income and apportionment factors of all commonly controlled corporations organized within the United States with which they are engaged in a unitary business. 4 Just like the emergency legislation, the act lacks any guidance or explanation as to what the District considers a unitary business, how the report is to be computed mechanically, or how tax attributes will be affected by the combined report. However, unlike the emergency legislation, the act itself does not make a legislative mandate that corporations use combined reporting in 2011, but rather it mandates that [t]he Council shall pass legislation to require such reporting. Accordingly, the council will have to 3

4 write specific legislation or otherwise specify how the combined reporting regime is to be implemented for this provision to have any affect on corporations conducting business in the District. Pepper Perspective In order for this bill to become law, it must be signed by the mayor, pass a 30-day Congressional review, and be published in the DC Register. All of those requirements were met, and the act became District law on March 3, Just as with the emergency legislation, it is important to note that the provision on combined reporting is not effective until It should be noted that one of the biggest challenges the lack of guidance on how to report has been partially addressed by putting the burden on the council to enact the combined reporting law, rather than simply requiring the District s corporate taxpayers to file blindly starting in Given the amount of negative feedback the Council received from business taxpayers on the emergency legislation, the establishment of combined reporting in the District is far from inevitable. The fact remains, though, that the District s fiscal affairs are still out of order, and will likely remain so for the foreseeable future. Accordingly, taxpayers should expect that the council will seek to enact a combined reporting scheme, regardless of how unpopular it may be. En d n o t e s 1 District Bill # , Act # (enacted Aug. 26, 2009), available at images/00001/ pdf. 2 See D.C. Enacts Combined Reporting, Sort Of: Other Provisions Included as Attempts to Raise Revenue (Oct. 8, 2009), available at 3 District Bill # , Act # , Title VII, Subtitle F, Sec Annette Ahlers Quoted in Tax Analysts on 5-Year Carryback of 2008 or 2009 NOLs Annette M. Ahlers was quoted in Practitioners Eager for NOL Carryback Guidance, published in the March 8, 2010 issue of Tax Analysts. Ahlers said that because of the inherently factual nature of claiming an NOL, business taxpayers have to proceed carefully. In the article, she recommended that a company contemplating the longer NOL carryback period take into account all projected issues and lay out the anticipated benefits of sticking to its current tax program versus reducing the NOL pool by carrying back losses to prior years, she said. She also noted that many companies are going through bankruptcy, which also complicates NOL decisions. Some clients are looking at every angle and implication in deciding whether or not to pursue the carryback claim, she said, noting that it isn t always a given that a longer carryback is beneficial. Because this is the first filing season for which taxpayers may claim the extended carryback periods, Ahlers said many businesses will be thinking about making an election. But even after calculations are made, a refund cannot be requested until a return is filed, which for many taxpayers won t be until the extended September 15 deadline, she said. It would be helpful for the IRS to address some of the unanswered questions that remain, Ahlers said. 4 District Bill # , Act # , Title VII, Subtitle U. 4

5 Pepper Hamilton s Tax Practice Group Federal and International Tax Issues Annette M. Ahlers ahlersa@pepperlaw.com Joan C. Arnold arnoldj@pepperlaw.com James W. Barson barsonj@pepperlaw.com Steven D. Bortnick bortnicks@pepperlaw.com Gordon R. Downing downingg@pepperlaw.com W. Roderick Gagné gagner@pepperlaw.com Howard S. Goldberg goldbergh@pepperlaw.com Benjamin M. Hussa hussab@pepperlaw.com Bryan D. Keith keithb@pepperlaw.com Timothy J. Leska leskat@pepperlaw.com Ellen McElroy mcelroye@pepperlaw.com Marc D. Nickel nickelm@pepperlaw.com Michelle Parten partenm@pepperlaw.com Lisa B. Petkun petkunl@pepperlaw.com Todd B. Reinstein reinsteint@pepperlaw.com Joan M. Roll rollj@pepperlaw.com Leonard Schneidman schneidmanl@pepperlaw.com Laura D. Warren warrenl@pepperlaw.com State and Local Tax Issues Philip E. Cook, Jr cookp@pepperlaw.com Lance S. Jacobs jacobsls@pepperlaw.com Employee Benefits Issues Jonathan A. Clark clarkja@pepperlaw.com David M. Kaplan kapland@pepperlaw.com Andrew J. Rudolph rudolpha@pepperlaw.com 5