H. Jacob Lager

Archive for February, 2012|Monthly archive page

EPIC: “Fails charges” guidance provided by IRS

In Fails charges, IRS regulations on February 27, 2012 at 8:00 am

Which sovereign jurisdiction can tax an item of income?

This eternal question arises whenever Wall Street creates a new financial product involving multinational parties.

For “fails charges,” the Service just issued a new batch of rules (found at Regulation Sec. 1.863-10) to determine whether these fees should be treated as US or foreign income.

So, uh, what’s a “fails charge?”

These payments developed in the world of high-stakes bond trading as a response to persistent failures to deliver Treasury securities in 2008.  Under certain arrangements, if one party fails to deliver Treasury securities to another by an agreed-upon date, the failing party pays an amount (the “fails charge”) to the other party. For US taxpayers, the treatment of these fees are relatively straightforward.

However, until this week, the general income-sourcing rules provided little guidance for foreign traders who become entitled to such fees.

Now, the final IRS regulations provide that the source of income from a qualified fails charge is generally determined by reference to the residence of the recipient.

With two exceptions.

First, qualified fails charge income earned by a qualified business unit of a taxpayer will be sourced to the country in which the qualified business unit is engaged in a trade or business.  Second, qualified fails charge income arising from a transaction effectively connected to a U.S. trade or business will be sourced to the United States.

Oddly, the final IRS regulations do not address the proper sourcing of a non-qualified fails charge, which begs the question of the “qualified” designation’s relevance.

Er, slight “regulation fail?”

Photo provided by Chris Griffith.

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EIGHTH CIRCUIT REMINDER: MINNESOTA NOT A FOREIGN COUNTRY

In Yes you must pay taxes on February 20, 2012 at 12:55 am

Despite a public education, I’m fairly certain that Minnesota is not its own sovereign nation.

And – whadayaknow?! – the Eighth Circuit agrees.

In an unpublished opinion released on January 31, the panel denied a taxpayer’s protest-based appeal, noting that the following arguments “have been repeatedly rejected by the courts as frivolous”:

“Taxpayers were not citizens of United States but rather were citizens of their home state (the ‘Republic of Minnesota’ who were not subject to income tax (United States v. Gerads, 999 F.2d 1255, 1256 (8th Cir. 1993)); and Income derived from sources within United States is non-taxable by the US government. (United States v. Clayton, 506 F.3d 405, 412 (5th Cir. 2007)).”

The panel further sanctioned the (reluctant) taxpayer $5,000 for bringing frivolous the appeal based on discredited, tax-protestor arguments.

I largely agree with the decision, but I do think some municipalities (*cough* Berkeley, California *cough*) might have a more persuasive argument on this point.

That’s a joke, Berkeleyites. Circular 230! “Do not rely!” Consult your own counsel (either tax or spiritual).

“PLAIN ENGLISH” TAKES UNLIKELY VICTORY AGAINST TAX CODE IN FOREIGN TAX CREDIT RULING

In Uncategorized on February 11, 2012 at 12:16 am

Some tax professionals are true artists. With poetic grace, they can demonstrate a client’s investment intent, business purpose, reasonable cause, or lack of willfulness.

One thing they can’t do is change the English language.

Which is what one taxpayer sadly realized last week, when the IRS published Chief Counsel Advice 201204008. There, the Service ruled that a taxpayer’s amended return/claim for refund was not timely where the taxpayer later elected to deduct instead of credit foreign taxes paid in an earlier year, thereby generating an increased net operating loss carryback from the earlier year.

In an inspired (?) bit of creativity, the taxpayer attempted to invoke Section 6511(d)(3)(A) to extend the normal three year statute of limitations for filing amended returns to ten years since that section is effective for refund claims related to foreign tax credits “allowable” to the taxpayer.

Unfortunately, the statute actually only applies to foreign tax credits that were “allowed” (i.e. taken by) the taxpayer. Citing the Dictionary (not even Black’s Legal Dictionary; just the regular old Dictionary), the Service noted the difference:

“The distinction between an ‘allowed’ credit and an ‘allowable’ credit is an important one. The term ‘allowable’ is defined as ‘that which may be allowed, legitimate, permissible.’ Random House Dictionary, Random House, Inc. 2011. The term ‘allowed,’ on the other hand, is defined as that which is permitted.”

Here, because the taxpayer filed an amended return in which it affirmatively elected to claim a foreign tax deduction, the option to use a credit was no longer “allowed.” No tax credit, no ten year statute of limitations, no net operating loss. Good day, Sir.

Care to test your reading comprehension? Like this post (include email address) and I’ll send you a copy of the ruling.