Tax News

CCH (cch.taxgroup.com) reports:

  A Texas Court of Appeals has upheld a district court's ruling that the state's $5-per-customer admission tax imposed on sexually oriented businesses violated the First Amendment to the U.S. Constitution and was therefore invalid. Applying a strict scrutiny analysis, the court held that the tax was a content-based tax that the Texas Comptroller failed to show was necessary to serve a compelling state interest.

  The Comptroller conceded that the tax could not survive a strict scrutiny analysis and argued instead that the tax was content-neutral and therefore subject to intermediate scrutiny. However, even under an intermediate-scrutiny standard, the tax would fail constitutional muster because it was not narrowly tailored to further a substantial governmental interest.

 

CCH (cch.taxgroup.com) reports:

  The Minnesota Tax Court has determined that the Commissioner of Revenue properly disregarded intercompany transactions between a taxpayer and two subsidiaries because they lacked economic substance or business purpose and were created solely to avoid Minnesota corporate franchise taxes.

  HMN Financial, Inc., Home Federal Savings Bank (HF Bank), Osterud Insurance Agency, Inc., and Home Federal REIT, Inc. (collectively, "HMN") were part of a unitary business that filed a Minnesota combined report for the tax years at issue. HF Bank created HF REIT and Home Federal Holding, Inc. ("HF Holding") in February 2002. HF Holding was treated as a foreign operating corporation ("FOC") under Minnesota law and was not included in HMN's combined reports for Minnesota tax purposes. In the case at hand, the taxpayer created a captive real estate investment trust (REIT) structure in which the REIT would get a 100% dividends paid deduction; the holding company would be excluded from the unitary group for tax purposes as a FOC; and the Bank would get an 80% dividends received deduction. This sophisticated tax avoidance plan allowed the taxpayer to evade nearly all Minnesota tax liability.

  HMN argued that because HF Holding met the literal definition of a FOC, the Commissioner could not disallow its transactions. However, Minnesota statutes pertaining to FOCs indicate the opposite. Under Minn. Stat. 290.34(1), the Commissioner may review transactions when a corporation deals in the commodities or services of a related corporation in a manner that creates a loss or improper net income or reduces the taxable net income attributable to the state. Despite HMN's argument that this statute is only operable as a fair pricing statute, the Tax Court held that it applies to more than buyers and sellers. Applying the statute, the Tax Court found that the necessary corporate ownership was present and that HF REIT and Holding dealt in the commodities or services of HF Bank. Additionally, Minn. Rule 8034.0100 permits the Commissioner to determine reasonable taxable net income and disregard devices commonly employed to distort income. As such, the Commissioner possessed the requisite authority to review the captive REIT transactions in their entirety to determine if they were a sham or lacking in economic substance.

  Minnesota courts apply the economic substance doctrine, which permits the disallowance of transactions that lack practical, economic effects beyond the creation of tax benefits, to test whether a taxpayer's challenged arrangements undermine Minnesota's tax policy. While HMN asserted that there were legitimate business purposes other than the avoidance of tax, including helping the bank meet or exceed performance goals, compete with other banks, and enhance employee retention, the Tax Court held that the only business reason asserted for establishing the captive REIT was the avoidance of tax. HMN never attempted to raise capital, did not increase its net income through captive REIT transactions, did not treat new entities or transactions in a normal business fashion, and dissolved both the REIT and the holding company when the Minnesota legislature changed the FOC requirements by increasing the payroll and property limits. In light of this evidence, the Tax Court determined the purported business purposes of the REIT to be a pretext and the only genuine reason for the transactions to be an avoidance of Minnesota taxes.

HMN Financial, Inc. and Affiliates v. Commissioner of Revenue , Minnesota Tax Court, No. 7911-R , May 27, 2009, ¶203-469

  Other References:

  Explanations at ¶10-360

CCH (cch.taxgroup.com) reports:

  A subsidiary's transfer of assets to a newly formed partnership in exchange for a majority partnership interest did not result in a constructive distribution that would require gain recognition by the corporate parent under Code Sec. 311(b). Since the majority partnership interest received by the subsidiary was worth less than the assets it contributed to the partnership, a gratuitous transfer of partnership interests to the minority partners was assumed to have been made. However, the assumed gratuitous transfer did not constitute a constructive distribution of appreciated property by the corporate parent to its shareholder trusts, despite the identity of interests between the trust beneficiaries and the minority partners. The primary purpose of the transfer was not to provide an economic benefit to the minority partners and, derivatively, to the shareholder trusts because the assumed gratuitous transfer was unintentional and was not beneficial to the shareholder trusts.

Cox Enterprises, Inc. & Subsidiaries, TC Memo. 2009-134, Dec. 57,852(M)

Other References:

 
Code Sec. 311

  CCH Reference - 2009FED ¶15,554.25

  Tax Research Consultant

  CCH Reference - TRC CCORP: 6,152

CCH (cch.taxgroup.com) reports:

  The Tax Court had jurisdiction to hear a petition to redetermine IRS's determination of a tax deficiency and the imposition of an accuracy-related penalty under Code Sec. 6662 against a married couple who were disallowed a loss stemming from the husband's ownership interest in his single-member limited liability company (LLC) that, in turn, owned an interest in a partnership. The notice of deficiency stated that the taxpayers had no basis in the LLC and that the taxpayers were not at risk. The notice was not issued prematurely as contended, and the affected items set forth in the notice were affected items that required determinations at the partner level, including the imposition of an accuracy-related penalty. The IRS issued the notice of deficiency within the three-year limitation period and the notice was valid because the IRS opted not to commence a partnership-level proceeding and was, therefore, not required to issue a final partnership administrative adjustment to the partnership before issuing the notice of deficiency to the taxpayers.

A. Meruelo, 132 TC No. 18, Dec. 57,848

Other References:

 
Code Sec. 465

  CCH Reference - 2009FED ¶21,893.32

 
Code Sec. 704

  CCH Reference - 2009FED ¶25,124.465

 
Code Sec. 6662

  CCH Reference - 2009FED ¶39,654.45

 
Code Sec. 7442

  CCH Reference - 2009FED ¶42,058.12

  CCH Reference - 2009FED ¶42,058.1535

  Tax Research Consultant

  CCH Reference - TRC PART: 60,302
CCH Reference -
TRC PART: 60,558
 

CCH (cch.taxgroup.com) reports:

  The IRS has issued final, temporary and proposed regulations under Code Sec. 7874 addressing the treatment of foreign corporations as surrogate foreign corporations. The regulations affect mainly domestic corporations or partnerships (and certain parties related to them) and certain foreign corporations that acquire substantially all of the properties of such domestic corporations or partnerships. The regulations are effective on June 12, 2009.

Background

  A foreign corporation is generally treated as a surrogate foreign corporation under Code Sec. 7874(a)(2)( if pursuant to a plan or a series of related transactions (1) the foreign corporation completes the direct or indirect acquisition of substantially all of the properties held directly or indirectly by a domestic corporation; (2) after the acquisition, at least 60 percent of the stock (by vote or value) of the foreign corporation is held by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation; and (3) after the acquisition, the expanded affiliated group, as defined in Code Sec. 7874(c)(1), that includes the foreign corporation does not have substantial business activities in the foreign country in which, or under the law of which, the foreign corporation is created or organized, when compared to the total business activities of the expanded affiliated group. Similar provisions apply to transactions involving the acquisition by a foreign corporation of substantially all of the properties constituting a trade or business of a domestic partnership. The level of ownership in the surrogate foreign corporation by former shareholders of the domestic corporation or former partners in the domestic partnership determines the treatment of the transaction.

  In June 2006, the IRS issued temporary regulations (T.D. 9265) concerning the treatment of a foreign corporation as a surrogate foreign corporation, along with proposed regulations cross-referencing the temporary regulations (NPRM REG-112994-06 ). In July 2006, the IRS issued Notice 2006-70, 2006-2 CB 252, announcing that the effective date in Temporary Reg. §1.7874-2T(j) would be amended for certain acquisitions initiated prior to December 28, 2005. After considering the comments received on these regulations, the IRS has decided to withdraw the 2006 temporary regulations and the related proposed regulations and to replace them with the present temporary and proposed regulations.

Temporary Regulations

  Stock held by a partnership. The temporary regulations modify the rule of Reg. §1.7874-1(e) to apply only for purposes of determining whether the ownership condition of Code Sec. 7874(a)(2)((ii) is satisfied and provide other partnership look-through rules.

  Indirect acquisition of properties. The temporary regulations retain the 2006 temporary rules on indirect acquisitions of properties held by a domestic corporation and clarify that the identified transactions do not represent an exclusive list of transactions that constitute indirect acquisitions. The temporary regulations also clarify that the acquisition of an interest in a partnership is an indirect acquisition of a proportionate amount of the properties of the partnership for purposes of Code Sec. 7874(a)(2)((i).

  The temporary regulations also retain and modify the rule under which a foreign issuing corporation is treated as acquiring a proportionate amount of the stock or assets of a domestic corporation in the case where such stock or assets are acquired by another corporation in exchange for stock of the foreign issuing corporation, which directly or indirectly owns more than 50 percent of the stock (by vote or value) of the acquiring corporation after the acquisition. First, this rule is modified to apply if the acquiring corporation and the foreign issuing corporation are members of the same expanded affiliated group after the acquisition. Second, the rule is modified to apply to an acquisition of a partnership's properties. Finally, the rule is modified to apply if a partnership acquires properties of a domestic corporation or partnership in exchange for stock of a foreign issuing corporation, but only if the foreign issuing corporation and the partnership would be members of the same expanded affiliated group after the acquisition if the partnership were a corporation.

  Acquisitions by multiple foreign corporations and acquisitions of multiple domestic corporations. To address acquisitions by multiple foreign corporations intended to avoid Code Sec. 7874, the temporary regulations provide that if pursuant to a plan or a series of related transactions, two or more foreign corporations complete, in the aggregate, an acquisition described in Code Sec. 7874(a)(2)((i), then each foreign corporation will be treated as completing the acquisition for purposes of determining whether such a foreign corporation will be treated as a surrogate foreign corporation. With respect to acquisitions of multiple domestic corporations or partnerships, the temporary regulations clarify that if a foreign corporation completes more than one such acquisition pursuant to a plan or a series of related transactions, then, for purposes of Code Sec. 7874(a)(2)((ii), the acquisitions will be treated as a single acquisition and the domestic corporations and/or domestic partnerships will be treated as a single entity.

  "By reason of" standard. The temporary regulations clarify that the "by reason of" condition of Code Sec. 7874(a)(2)((ii) is satisfied if stock of a foreign corporation is received in exchange for, or with respect to, stock in a domestic corporation or an interest in a domestic partnership. This includes a taxable or nontaxable distribution. The "by reason of" condition may be satisfied other than through exchanges or distributions. In addition, the "by reason of" standard applies based on the amount of stock of the foreign corporation received in exchange for, or with respect to, the stock of the domestic corporation or interest in the domestic partnership. This determination is based on the relative values of the stock of the domestic corporation or interest in a domestic partnership and any other property exchanged for the stock of the foreign corporation.

  Substantial business activities condition. The temporary regulations do not retain the safe harbor for determining if the substantial business activities condition of Code Sec. 7874(a)(2)((iii) is satisfied or the examples illustrating the general rule provided by the 2006 temporary regulations. Thus, taxpayers can no longer rely on such safe harbor or the examples; instead, they must apply the general rule to determine whether the substantial business activities condition is satisfied. The temporary regulations also add to the items not taken into account in determining whether the substantial business activities condition is satisfied any assets, business activities or employees located in the foreign country in which the foreign acquiring corporation is created or organized if such assets, business activities or employees are transferred to another country pursuant to a plan in existence at the time of the acquisition. In addition, for purposes of the substantial business activities condition, a member of the expanded affiliated group that holds at least a 10-percent capital and profits interest in a partnership will take into account its proportionate share of the items of the partnership, including business activities, employees, assets, income, and sales.

  Publicly traded foreign partnerships. The temporary regulations also clarify that, for purposes of Code Sec. 7874, a foreign partnership is treat as a foreign corporation if the partnership would, but for
Code Sec. 7704(c), be treated as a corporation under Code Sec. 7704(a) at the time of the Code Sec. 7874(a)(2)((i) acquisition, or at any time after the acquisition pursuant to a plan that existed at the time of the acquisition. A publicly traded foreign partnership treated as foreign corporation under this rule is treated as a foreign corporation for all purposes of Code Sec. 7874.

  Options and similar interests. Under the temporary rules, for purposes of Code Sec. 7874, an option or similar interest in a domestic corporation or a domestic or foreign partnership will be treated as stock of the domestic corporation or an interest in the partnership with a value equal to the holder's claim on the equity of the domestic corporation or partnership immediately before the Code Sec. 7874(a)(2)((i) acquisition. An option or similar interest in a foreign corporation will generally be treated as stock of the foreign corporation with a value equal to the holder's claim on the equity of the foreign corporation immediately after the acquisition. These rules will not generally apply to the extent that treating an option or similar interest as stock of a corporation or an interest in a partnership would duplicate, in whole or in part, a shareholder's or partner's claim on the equity of the corporation or partnership.

  Economically equivalent interests. To address certain transactions intended to avoid Code Sec. 7874 that involve interests substantially equivalent to equity interests in foreign corporations, the temporary regulations provide that, for purposes of Code Sec. 7874, any interest, including stock or a partnership interest, that is not otherwise treated as stock of a foreign corporation will be treated as stock of the foreign corporation if the following two conditions are satisfied: (1) the interest entitles the holder to distribution rights that are substantially similar in all material respects to the distribution rights entitled to a shareholder of the foreign corporation by reason of holding stock in the foreign corporation; and (2) treating the interest as stock of the foreign corporation has the effect of treating the foreign corporation as a surrogate foreign corporation.

  Insolvent entities. The temporary regulations clarify that, for purposes of Code Sec. 7874, if immediately prior to the first date, properties are acquired as part of a Code Sec. 7874(a)(2)((i) acquisition, a domestic corporation is in a title 11 or similar case or the liabilities of the domestic corporation exceed the value of its assets, then any claim by a creditor against the domestic corporation will be treated as stock of the domestic corporation. A similar rule applies with respect to a domestic or foreign partnership. A creditor that is treated as a shareholder of a domestic corporation or as a partner in a partnership is treated as a shareholder or partner for all Code Sec. 7874 purposes.

  Modification to the internal restructuring exception. The IRS will issue regulations addressing the application of the internal group restructuring exception in Reg. §1.7874-1(c)(2) to certain divisive transactions. The regulations may apply to acquisitions completed on or after June 9, 2009.

  Effective and applicability dates. The temporary regulations generally apply to acquisitions completed on or after June 9, 2009. However, taxpayers may apply the temporary regulations to acquisitions completed prior to June 9, 2009, if the temporary regulations are applied consistently to all acquisitions completed prior to that date. The temporary regulations include the modifications announced by Notice 2006-70, 2006-2 CB 252, to the effective date of the 2006 temporary regulations for certain acquisitions initiated prior to December 28, 2005. These regulations will expire on or before June 8, 2012.

  Effect on other documents.
Notice 2006-70, 2006-2 CB 252, is obsolete as of June 9, 2009.

Proposed Regulations

  The text of the temporary regulations also serves as the text of the proposed regulations published simultaneously with the temporary regulations (NPRM REG-112994-06). Written or electronic comments and requests for a public hearing on the proposed regulations must be received by September 7, 2009.

T.D. 9453, 2009FED ¶47,021

Proposed Regulations, NPRM REG-112994-06, 2009FED ¶49,422

Other References:

 
Code Sec. 7874

  CCH Reference - 2009FED ¶43,970

  CCH Reference - 2009FED ¶43,970B

  CCH Reference - 2009FED ¶43,970C

  Tax Research Consultant

  CCH Reference - TRC INTL: 30,082.05

CCH (cch.taxgroup.com) reports:

  President Obama and House Ways and Means Committee Democrats agreed to pass major health care reform legislation by October, the administration announced on June 9. Obama said the upcoming bill, which will lower health care costs, expand primary care and provide wellness coverage, could be paid for in part by a cap on itemized deductions for wealthier taxpayers.

  Ways and Means Chairman Charles B. Rangel, D-N.Y., said Congress will respond to the president's commitment to health care reform. The White House meeting came shortly after Rangel joined with Energy and Commerce Committee Chairman Henry Waxman, D-Calif., and House Education and Labor Committee Chairman George Miller, D-Calif., to release a joint outline of the framework for health care reform.

  According to the framework, the legislation will reduce costs, while preserving the current choice of doctors, hospitals and health plans that many insured Americans currently enjoy. The legislation will also provide affordable health coverage for all Americans, according to the framework. While details of the revenue offsets were not given, the framework mentions a new small business tax credit that will protect firms providing health coverage. In recent weeks, lawmakers and the Obama administration have mulled proposals to cap the income tax exclusion for employer-provided health care.

  Lawmakers are considering several other options to offset the cost of financing major health care reform, according to a June 2 letter written by Joint Committee on Taxation Chief Thomas A. Barthold. Barthold's letter to Senate Finance Committee Chairman Max Baucus, D-Mont., and ranking member Charles E. Grassley, R-Iowa, includes a list of possible revenue offsets that would generate between $51.6 billion and $1.17 trillion over 10 years. Many of the proposals would cause taxpayers to lose their health care coverage unless those losses were mitigated through other health care reform measures, the letter states.

  Barthold's letter estimates that capping and indexing the income tax exclusion for employer-provided health insurance at the amount of the actuarial value of the 2010 standard option of the federal employees health benefit plans would raise $418.5 billion over 10 years. Applying the same cap only to taxpayers earning $100,000 and $200,000 (single and married, respectively) would raise $161.9 billion. Limiting the income exclusion for employer-provided health care to 50 percent of the total premium amount would raise $1.17 trillion; repealing the Code Sec. 213 deduction for medical expenditures over 7.5 percent of adjusted gross income (AGI) would raise $180.7 billion; and eliminating the exclusion for health expenditures made through flexible savings accounts and health reimbursement accounts would generate $68.6 billion. In addition, a proposal to impose a federal excise tax of 3 cents per 12 ounces of certain sugar-sweetened beverages would raise $51.6 billion, while increasing the federal excise tax on alcohol to $16-per-proof gallon for all alcoholic beverages, including beer, wine and spirits, would raise $61.5 billion.

  By Stephen K. Cooper, CCH News Staff

JCT Letter Regarding Health Care Revenue Raisers

House Committees Press Release: House Committees Brief Members on Draft Health Reform Outline

Health Reform Outline: Key Features of the Tri-Committee Health Reform Draft Proposal in the House

Ways and Means Release: Ways and Means Members Discuss Health Reform with President Obama
 

Tax Analysts report: