H. Jacob Lager

Posts Tagged ‘windfall tax’

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IRS slooooowwwlllly acknowledging electronic docs; Supreme Court takes on windfall tax circuit split

In IRS regulations, Windfall tax, You heard it here first on November 2, 2012 at 9:05 am

“Can you just scan that to me?”

If you’re like me, a “no” response to the above question generates nothing short incredulity, animosity, and exasperation.  At times, it can seem there is no logic as to which institutions will get you information easily and which will not.

For example:

  • My bank once required that I submit a faxed form to make an IRA contribution, even though I had made the previous 10 months’ contributions by phone without incident;
  • Just today, a potential buyer of a client’s real estate would only generate a hard copy offer letter to be transmitted by “snail mail”; and, of course
  • I’ve lost count of how many different ways the IRS and California’s FTB have changed their verification procedures for e-filing tax returns.  Some years, I have to actually submit a signature verification.  Some years I just point and click.  This year, for a corporate return, I actually had to print, scan, and upload a form for the first time.

Well, in a victory for people who hate paper, the IRS just recently issued published advice concluding that its Form W-8, “Certificate of Foreign Status,” may, under certain circumstances be successfully scanned into an electronic system and then transmitted directly to a withholding agent through that system.

What does all this mean?

When a foreign person is paid certain types of U.S. income (typically interest, dividends, rents, royalties, premiums, annuities, service income, and other periodic income items), the recipient is often subject to backup tax withholding of 30 percent on the payment.  The U.S. payor is generally charged with withholding and paying over this amount to the IRS.  The U.S. payor is only relieved of this obligation if the foreign payee issues to the responsible party documentation upon which the payor can rely to treat the payment as made to a U.S. person or to a foreign person entitled to a reduced rate of withholding.

The IRS “W-8” family of forms are often used to provide this very documentation.  These forms are generally certifications that either the recipient resides in a treaty-favored country (W-8BEN), a foreign pass-through entity (W-8IMY), receiving the payment as taxable US income otherwise effectively connected with a domestic trade or business, or a foreign government (W-8EXP).

The IRS issued guidance on August 8, 2012 liberalizing the manner in which these forms may be transmitted to payors.

According to the Service, Form W-8 that is signed with a handwritten signature, scanned into an electronic system, and then transmitted directly to a payor through that electronic system (for example, as a PDF or facsimile), may be relied upon to avoid withholding if the following requirements are met:

  • The system design and operation must make it reasonably certain that the person furnishing the form is the person named on the form (for example, verifying that the email address of the sender accompanying the electronically transmitted form indicates that the sender is the person named on the form);
  • The submitted Form W-8 must provide the payor with exactly the same information as the paper Form W-8 (the Service acknowledges that a complete and legible scanned copy of the form meets this requirement);
  • The submitted Form W-8 must contain an electronic signature by the person whose name is on the form (in a further display of profound trust, the IRS notes that signing, scanning, and transmitting a document “constitute a process associated with” the form that reflects that the form is uh . . . signed); and
  • The payor must be able to produce, upon IRS request, a hard copy of the electronic Form W-8.

But just before you crazy kids start faxing and scanning all willy-nilly, the Service gave itself an out:  “Whether a withholding agent may accept a Form W-8 that is transmitted to the withholding agent electronically will depend on the facts and circumstances.”

Whew!  That was close.

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From the “you heard it here first” department:

On October 29, 2012 (which just so happened to be my birthday), the Supreme Court granted certiorari to the PPL Corp. decision in an effort to determine the split between the Third and Fifth circuits, which respectively have endorsed and rejected a mechanical framework for determining whether a taxpayer’s foreign tax is creditable under Code Section 901.

(You might remember our brief summary of the split.)

According to the taxpayer, the issue is whether creditability of a foreign tax should be determined using a formalistic or substance-based approach.  The government described the matter much more narrowly, arguing that the 1997 U.K. windfall tax (a one-time assessment) was not a creditable income tax.

PPL Corp. is the only tax case granted certiorari this term, so you know we’ll be following it closely.

Photo provided by jepoirrier.

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Circuit Split Alert! – Fifth Circuit Diverges from Third in Holding UK Windfall Tax Creditable

In Court decisions, Foreign taxes on June 12, 2012 at 8:59 am

It’s a tax blogger’s dream.  In Entergy Corp. v. Commissioner, The Fifth Circuit just held on June 5 that a US company’s UK windfall tax payment qualifies as a creditable foreign tax and creates a circuit split after the Third Circuit recently held otherwise.

What’s a Windfall Tax?

In 1997 the United Kingdom enacted a windfall tax on the excess profits of certain recently privatized utility companies.  The tax was meant to address public backlash against what was perceived as bargain sales of the utilities.

The tax imposed on each of the utilities a 23 percent assessment on the difference between: (1) a company’s “profit-making value” (its average annual per day profit multiplied by nine) and (2) its “flotation value” (the price for which it was acquired).

Here, the US taxpayer who owned a UK subsidiary that operated a privatized utility paid the windfall tax and sought a US income tax credit based on that payment.  The IRS disallowed the credit.  As the Eighth Circuit noted, the parties “essentially disagreed on whether the Windfall Tax . . . constituted a tax on excess profits, creditable under I.R.C. § 901, or a tax on unrealized value” for which no credit would be allowed.

What this Means – Foreign Tax Credit Defined

In general, regulation 1.901-2(a) allows a credit only for foreign taxes the “predominant character” of which is an income tax in the US sense. To have that character, the tax must:  (1) reach only realized income, (2) be imposed on the basis of gross receipts, and (3) target only net income.

Third Circuit/IRS Position

In a previous case, the Third Circuit held that the windfall tax did not meet the second requirement – that it be imposed on gross receipts, or an amount not greater than gross receipts. According to this argument, the windfall tax statute focuses on “profit-making value,” an average profits calculation based on a particular time period, not “gross receipts,” even though gross receipts may impact the tax indirectly.

Fifth Circuit/Taxpayer Position

The Fifth Circuit court rejected the Third Circuit’s approach and, more pointedly, the notion that it must only examine the windfall statute’s text in reaching its conclusion.  Instead the panel examined the tax’s history and actual effect of the foreign tax on taxpayers.  Noting that “both the design and effect of the windfall tax was to tax an amount that, under US tax principles, may be considered excess profits realized by the vast majority of the windfall tax companies,” the panel ruled that the tax was designed to reach net gain under normal circumstances.  In practice, the taxpayer demonstrated that the windfall tax’s application would be based on “either actual income or an imputed value not intended to reach more than actual gross receipts.”  Consequently, the tax’s “predominant character” was that of the US income tax and that it was a creditable foreign tax under section 901.

At the moment, it’s unclear whether the split will reach the Supreme Court for final determination.  The essence of the clash lies in how an unconventional foreign tax might satisfy the three-prong test for US credit-worthiness.  While the issue may not be headline-grabbing like a civil rights or due process dispute, the US tax response to more exotic foreign taxes that are not easily categorized represents a real cost to US-based multinationals (this case involved a credit of $243 million).  I would guess we’ll see this up for certiorari sooner than later.