Posted tagged ‘Legislation’

The Economic Substance Doctrine: Coming To A State Near You?

February 2, 2012

By Jonathan Prokup

Pennsylvania may soon join the other states that have challenged the use of the so-called Delaware Loophole, according to our colleagues at the State and Local Tax Blawg.  The legislation, contained in Pa. House Bill 2150, would disallow deductions that a parent operating corporation claims for royalty payments made to a “Delaware Holding Company.”

The new limitation would not apply where the transaction is related to “a valid business purpose.”  In this regard, the legislation defines a valid business purpose as, “[a] purpose, other than the avoidance or reduction of taxation, which alone or in combination with other purposes constitute the primary motivation for a business activity or transaction which changes in a meaningful way, apart from a reduction of taxation, the economic position of the taxpayer.” (more…)

Tax Talk Around The Web

December 6, 2010

By Jonathan Prokup

International Tax Changes Take Flight

August 11, 2010

The House of Representatives passed, and the President signed into law, H.R. 1586, the “FAA Air Transportation Modernization and Safety Improvement Act,” which curiously became the chosen vehicle for Congress and the Administration to provide assistance to states with budget shortfalls while paying for that assistance with changes in a number of international tax provisions.  Text of the final bill is available here; pdf is here.  See here for our prior summary of the relevant international tax provisions.

Although the changes are largely similar to what was proposed in earlier legislation, it appears that Congress eliminated a number of earlier proposals from the final bill, including the limitation on distributions in leveraged spin-offs and the repeal of the “boot dividend” rule.  Of particular note, Congress eliminated the new sourcing rule that would have treated guarantee fees as U.S.-source income. Earlier this year, the Tax Court held that guarantee fees paid by a U.S. company to its Mexican parent were properly treated as non-U.S. source income and therefore not subject to U.S. withholding taxes.  Container Corp. v. Comm’r, 134 T.C. No. 5 (2010).  Our prior discussion of the Tax Court opinion is here, with additional commentary here.  It remains to be seen whether the removal of this provision reflects a permanent abandonment of the proposal or whether it will reappear in one of the several other legislative vehicles floating through Congress.

Certain Uncertainty: Congress Juggles Tax Proposals

August 4, 2010

By Jonathan Prokup

Although death and taxes might, according to Benjamin Franklin, be the only certainties in this world, Congress is surely striving to add another – that is, the certainty of uncertainty.  Congress, it seems, is committed to keeping taxpayers in as much doubt as possible for as long as possible about the status of a variety of important provisions that will affect both substantive tax liabilities and compliance obligations.


The Extenders Bill Is Dead. Long Live The Extenders?

June 29, 2010

By Jonathan Prokup

Now that the tax extenders legislation has died, what’s next?  At least some of the provisions (e.g., the new tax regime for “carried interests”) are likely to find their way into future legislation.  But what about the tax extenders themselves, such as the look-through rule of section 954(c)(6) and the section 41 research credit?  Although many of the extensions involve tax expenditures (i.e., provisions that cost the Treasury money), they would almost certainly be offset by the bill’s revenue raisers, which were themselves styled as anti-abuse and loophole-closing provisions.  As a result, we probably have not seen the last of these measures.


Say That Again: A Summary of AJACTLA

June 1, 2010

By David Shakow

If you haven’t memorized the 433 pages of the latest version of the American Jobs and Closing Tax Loopholes Act of 2010 (undoubtedly named to allow for the euphonious acronym, AJACTLA), you are denying yourself a unique treat.  (To get the true flavor, don’t forget the fifteen pages of amendments included with the House passage of the bill on May 28.)  We will allow others to give you a full rundown of the 206 sections of the bill and content ourselves with a summary of the highlights.


More on Wyden-Gregg’s Interest Disallowance Rule

April 28, 2010

By Jonathan Prokup and David Shakow

You might recall our prior post on the Wyden-Gregg tax reform proposal in which we discussed the proposed limitation on corporate interest deductions.  To summarize, the legislation would limit the deductibility of payments on corporate debt to the amount of the interest in excess of the annual rate of inflation, thereby discouraging the use debt to finance corporate operations.

We previously asked: “Why use inflation as the index for disallowing interest deductions, rather than simply disallowing, say, a fixed portion of the interest deduction?”  Thanks to the efforts of Greg Hillson, an enterprising 3L at UVA, we are now able to answer that question.  Mr. Hillson contacted an economist from the Senate Budget Committee who directed him to the 1984 Treasury proposal on which the interest-disallowance provision was based.  (You can find that proposal, and Treasury’s explanation, here.)  Fortunately, Treasury’s explanation of its original proposal gives a sensible explanation of why the portion of interest payments that is attributable to inflation should not be deductible.

As our readers know, neither the making of a loan nor the repayment of principal is generally considered to be a taxable event.  Generally, only the payment or receipt of interest on the loan is deductible or taxable, as the case may be (putting aside the satisfaction of a debt for less than the principal amount).

Yet, from an economic perspective, the payment of interest can actually represent, in part, the repayment of principal.  Consider that the nominal interest rate on a loan reflects a variety of components–e.g., a credit-risk component that compensates the lender for the risk that the loan might not be repaid, so that a less credit-worthy borrower pays a credit-risk premium relative to a more credit-worthy borrower.  Of primary importance here is the inflation component, which (to quote the 1984 Treasury explanation) “compensates the lender for the anticipated reduction in the real value of an obligation of a fixed dollar amount [due to inflation].”  Thus, “the inflation component of nominal interest payments is, in effect, a repayment of principal.”

Stated differently, there are two ways to account for the impact of inflation on the principal amount of a loan—(i) include an inflation component in the interest rate, or (ii) index the principal balance to inflation.  In theory, either mechanism should produce similar economic results of protecting the real value of the lender’s interest in the principal loaned to the borrower.  (Of course, in practice, the outcomes are much messier; but that is beyond the scope of this post.)  Thus, as noted above, the payment of the inflation component of interest is economically equivalent to the repayment of an inflated principal amount.

In sum, there is a principled basis for suggesting that the portion of interest payments that is attributable to inflation should be disallowed as a deduction.  Nevertheless, two further questions are raised:

(1)    By the same theory, recipients of interest (i.e., lenders) should be permitted to exclude from their gross income the same inflation component for which no deduction would be allowed to the payers of such interest (i.e., borrowers).  that was part of the 1984 Treasury proposal.  Query why it has been omitted from the Wyden-Gregg bill.

(2)    How should periods of deflation be handled?  If, during periods of inflation, interest deductions should be limited because the payment of interest reflects, in part, the repayment of principal; during periods of deflation, interest deductions should be extended above the amount of interest paid under the same reasoning.

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