Quarterly tax developments, June 2017 - EY

In this issue: Tax developments .......................... 2 Other considerations ...................... 5 Things we have our eyes on ............ 8

Quarterly tax developments What you need to know about this quarter’s tax developments and related US GAAP accounting implications June 2017

Appendix: New IRS audit regime for partnerships has limited tax accounting considerations .. 11

Tax developments Welcome to our June 2017 Quarterly tax developments publication. We once again describe certain latest tax developments previously summarized in Tax Alerts or other EY publications or identified by EY tax professionals or EY foreign member firms. These developments may affect your tax provision or estimated annual effective tax rate. We compile this information because we recognize that, for many companies, the most challenging aspect of accounting for income taxes is identifying changes in tax law and other events when they occur so the accounting can be reflected in the appropriate period. However, this publication is not a comprehensive list of all changes in tax law and other events that may affect income tax accounting. This edition covers certain enacted and effective tax legislation, as well as regulatory developments, legislative proposals and other items through 15 June 2017, except as noted. We list EY publications that you can access through our Client Portal if you are registered. Anyone interested in registering should contact Joan Osborne at [email protected]. See our previous editions for additional tax developments.

Legislation enacted in the second quarter Federal, state and territories Alabama — On 20 April 2017, Alabama enacted legislation requiring multistate financial institutions to include loans and credit card receivables in their calculation of how income subject to the financial institution excise tax is assigned to Alabama. The change applies to tax years beginning on or after 1 January 2017. See the State and Local Tax Weekly for 28 April 2017. Indiana — On 13 April 2017, Indiana enacted legislation placing the burden of proof for switching from the state’s statutorily prescribed apportionment formula to an alternate formula on the party seeking to make the change. The change is effective 1 July 2017. See the State and Local Tax Weekly for 28 April 2017. On 28 April 2017, Indiana enacted legislation eliminating the enterprise zone (EZ) loan interest credit for interest received on qualified loans made after 31 December 2017. The legislation also eliminates the EZ investment cost credit for qualified investments made after 31 December 2017. Taxpayers may, however, carry forward unused EZ loan interest credits and EZ investment cost credits attributable to qualified loans/investments made before 1 January 2018 to tax years beginning before 1 January 2028. See the State and Local Tax Weekly for 19 May 2017. Montana — On 3 May 2017, Montana enacted legislation adopting amendments to the Multistate Tax Compact (MTC) recommended by the Multistate Tax Commission. The amendments replace the current “cost of performance” rules for sourcing sales of non-tangible property and services with “market-based” sourcing rules. The changes are effective for tax years beginning after 31 December 2017. See the State and Local Tax Weekly for 12 May 2017. New York — On 10 April 2017, New York enacted legislation affecting numerous incentives and credits positively or negatively, including: • Tax incentives available under the Excelsior Jobs Program Act and the employee training incentive program • The Empire State film production tax credit and post-production tax credit • The New York Youth Jobs Program tax credit (formerly the Urban Youth Jobs Program) • The Empire State apprenticeship tax credit • Investment tax credit claims for the production or distribution of electricity or steam or the delivery of natural gas after extraction from wells and the production of water through pipes • The Excelsior R&D credit The effective dates of the changes vary. See the State and Local Tax Weekly for 5 May 2017. Oklahoma — On 17 April 2017, Oklahoma enacted legislation limiting eligibility for the wind energy credit for zero-emission facilities by requiring the facilities to be operational by 1 July 2017 to claim the credit instead of 1 January 2021. The change is effective immediately. See the State and Local Tax Weekly for 28 April 2017. Tennessee — On 26 April 2017, Tennessee enacted legislation allowing certain multistate manufacturers to use a single sales factor method to apportion their income to the state for franchise tax purposes. The election is available for tax years starting on or after 1 January 2017 and is binding for five years. See Tax Alert 2017-721, dated 2 May 2017.

2 | Quarterly tax developments June 2017

IRC conformity The following chart lists the states that enacted legislation this quarter updating their conformity to the US Internal Revenue Code (IRC). The chart includes enactment and effective dates and the date of conformity. Additional information on a state’s IRC conformity can be found in the cited reference. State

Enactment date

Date of conformity

Effective date

Reference

Maine

26 April 2017

31 December 2016

Tax years beginning on State and Local or after 1 January 2016 Tax Weekly for 28 April 2017

Nebraska

10 May 2017

10 May 2017

10 May 2017

State and Local Tax Weekly for 12 May 2017

South Carolina

5 April 2017

31 December 2016

5 April 2017

State and Local Tax Weekly for 14 April 2017

International Australia — On 4 April 2017, Australia enacted legislation imposing a 40% tax on profits generated in Australia by large, multinational companies (i.e., those with over AU$1 billion in annual global revenues) and shifted out of the country without business reasons and/or economic substance. The legislation also implements expanded transfer pricing rules in line with Actions 8–10 of the Base Erosion and Profit Shifting (BEPS) initiative of the Organisation for Economic Co-operation and Development (OECD). The changes generally apply to tax years beginning on or after 1 July 2017. See Tax Alert 2017-571, dated 31 March 2017. Italy* — On 21 June 2017, Italy enacted legislation limiting the amount of notional interest companies may deduct by decreasing the rate used to calculate the deduction to 1.6% from 4.75%. The change is effective 24 June 2017. Other changes included: • Changing the definition of the “arm’s-length principle” for transfer pricing purposes so it aligns with OECD principles • Denying tax benefits under Italy’s patent box regime for income from trademarks, in accordance with the OECD’s BEPS recommendations • Treating “carried interest” income as capital gains, rather than employment income, if certain conditions are met These changes are effective from 24 April 2017. See Tax Alert 2017-716, dated 2 May 2017. Malaysia — On 10 April 2017, Malaysia enacted temporary reductions in its corporate income tax rate. For tax years 2017 and 2018, the 24% corporate rate on certain business income will decrease to a range of 20% to 23%. The applicable rate will depend on how much a company’s taxable income increased from the prior tax year (e.g., a 20% rate would apply to companies whose taxable income increased over 20%). See Tax Alert 2017-769, dated 10 May 2017.

Legislation effective in the second quarter International India — Effective 1 April 2017, related party interest deductions are limited for Indian companies and foreign companies with a permanent establishment (PE) if certain conditions apply. The limit is the lesser of 30% of earnings before interest, taxes, depreciation and amortization or the actual interest paid.

*

A Tax Alert has not been published on this development.


In certain circumstances, Indian tax authorities will treat an excess payment resulting from transfer pricing adjustments as an interest-bearing advance made by the Indian payer unless the excess payment is refunded. The changes were enacted 31 March 2017. See Tax Alert 2017-604, dated 7 April 2017. Japan — Effective 1 April 2017, various spin-off transactions are exempt from tax if certain requirements are met. Companies may also claim a larger research credit when their research costs increase, but they must satisfy additional requirements to deduct certain director compensation. The changes were enacted 27 March 2017. See Tax Alert 2017-560, dated 29 March 2017. United Kingdom — Effective 1 April 2017, the corporate income tax rate decreases to 19% from 20% for income earned from 1 April 2017 through 31 March 2020. On 1 April 2020, the rate will decrease to 17%. See Tax Alert 2015-2188, dated 19 November 2015.

Treaty changes The following chart lists the tax treaties that became effective in the second quarter of 2017. Each treaty’s general withholding tax rates or exemptions for dividends, interest, royalties and capital gains on sales of shares are listed, where applicable. Exceptions to these general withholding rates or exemptions may apply (for instance, reduced rates may apply to certain categories of investors, or capital gains from immovable property or property-rich companies may be taxable). If the second quarter effective date does not apply to both countries, the other effective date is noted. Countries involved

Summary of changes

Cyprus

India

Provides general withholding tax rates of 10% on dividends, interest and royalties; exempts capital gains from tax. Effective 1 January 2017 for Cyprus.

Hong Kong

Korea

Provides general withholding tax rates of 15% on dividends and 10% on interest and royalties.

Hong Kong

Russia

Provides general withholding tax rates of 10% on dividends, 0% on interest and 3% on royalties; exempts capital gains from tax.

India

Indonesia

Provides general withholding tax rates of 10% on dividends, interest and royalties.

India

Korea

Provides general withholding tax rates of 15% on dividends and 10% on interest and royalties; no capital gains exemption except for minority shareholders. Effective 1 January 2017 for Korea.

India

Mauritius

Provides general withholding tax rate of 7.5% on interest and 15% on royalties.

India

Singapore

Provides general withholding tax rate of 15% on interest.


Other considerations Court decisions, regulations issued by tax authorities and other events may constitute new information that could trigger a change in judgment in recognition, derecognition or measurement of a tax position. These events also may affect your current or deferred tax accounting.

Federal, state and territories Federal — In a notice, the Government listed the 2017 rates for certain energy-related credits. See Tax Alert 2017-641, dated 14 April 2017. In Revenue Ruling 2017-09, the Government outlined the circumstances under which it will and will not treat related transfers of property into and out of a corporation (i.e., North-South transactions), which are part of a spin-off, as a taxable exchange for federal income tax purposes. See Tax Alert 2017-774, dated 10 May 2017. In Revenue Procedure 2017-33, the Government provided guidance on changes made by the Protecting Americans from Tax Hikes Act of 2015 to the IRC’s provisions on bonus depreciation and other accelerated deductions. See Tax Alert 2017-690, dated 26 April 2017. In Revenue Procedure 2017-30, the Government updated its list of automatic accounting method changes. See Tax Alert 2017-672, dated 24 April 2017. The Government said it will not follow, in other US districts, a decision by the US District Court for the Western District of Louisiana allowing a building materials and supplies retailer to claim 50% bonus depreciation for two buildings constructed before 1 January 2009 but not open for business until after that date. See Tax Alert 2017-860, dated 24 May 2017. Connecticut — The Government issued guidance on changes to the state's income apportionment provisions (i.e., the move to a single sales factor apportionment formula and the adoption of marketbased sourcing) that applies to corporations as of 2016. Among other things, the guidance addresses: • Taxpayers affected by the apportionment changes, such as manufacturers and financial services companies • General sourcing rules • Market-based sourcing rules, including sourcing receipts from the sale of services • Sourcing receipts from the rental, lease or license of intangible property • Examples of how various sourcing rules would apply See the State and Local Tax Weekly for 28 April 2017. Iowa — The state Court of Appeals held that Iowa tax authorities correctly excluded an out-of-state holding company from an Iowa consolidated corporate tax return because the holding company was not doing business in the state, even though it held intangible property used in Iowa by its Iowa-based subsidiaries. The Court also upheld the tax authorities’ denial of the subsidiaries’ deduction of certain expenses allocated to them but paid by the holding company. See Tax Alert 2017-800, dated 16 May 2017. Michigan — The US Supreme Court refused to review a decision by the Michigan Court of Appeals upholding the state legislature’s 2014 retroactive repeal of the MTC, which barred multistate taxpayers from basing refund claims on the MTC’s three-factor apportionment formula. See Tax Alert 2017-843, dated 22 May 2017. Oregon — The state Tax Court held that Oregon’s corporate excise tax applies to an out-of-state wholesale tire distributor with no property or employees in Oregon because an Oregon-based independent contractor completed warranty claims on the wholesaler’s behalf. See the State and Local Tax Weekly for 12 May 2017. Texas — The Fourth Court of Appeals held that a company could not deduct from its cost of goods sold a payment it made to a federal asbestos trust fund for personal injury claims related to asbestos litigation because the payment did not qualify as a cost of quality control under Texas law. See the State and Local Tax Weekly for 14 April 2017.


Tax amnesties This table shows the tax amnesties that were announced or went into effect in the second quarter of 2017. Jurisdiction

Amnesty period

Taxes covered

Reference

Oklahoma

1 September 2017 through Taxes, including corporate State and Local Tax Weekly 30 November 2017 income taxes, for tax for 19 May 2017 periods ending before 1 January 2016

Brazil

Applications must be Taxes, including corporate Tax Alert 2017-911, dated submitted by 31 August 2017 income taxes, overdue as 6 June 2017 of 30 April 2017

Zambia

24 April 2017 through 31 July 2017

Taxes, including corporate Tax Alert 2017-749, dated income taxes, for tax periods 5 May 2017 before 1 March 2017

International Argentina — The tax authorities instructed their legal department to stop contesting pending court cases involving liability for the Minimum Presumed Income Tax, if the taxpayer proved that it had accounting and tax losses in a specific tax year. See Tax Alert 2017-939, dated 9 June 2017. Australia — The Full Federal Court upheld transfer pricing adjustments to a related party loan because the loan’s 9% interest rate was excessive. See Tax Alert 2017-715, dated 2 May 2017. Belgium — The Court of Justice of the European Union held that Belgium’s 5.15% fairness tax violates European Union (EU) law because it discriminates against foreign companies with Belgian PEs and could subject certain dividends to double taxation. See Tax Alert 2017-833, dated 22 May 2017. Canada — The Federal Court of Appeal upheld a decision by the Tax Court of Canada allowing limited partners in an upper-tier partnership to claim losses from a lower-tier partnership that exceeded the amount of capital the partners actually had at risk in the lower-tier partnership. See Tax Alert 2017-907, dated 6 June 2017. China — The Government issued transfer pricing guidance that further aligns China’s practices with the OECD’s Transfer Pricing Guidelines. The guidance also: • Outlines how Chinese tax authorities should review intercompany royalties when determining the appropriate allocation of profits from the use of intangible property • Authorizes Chinese tax authorities to deny deductions for service fees paid to a related party if the transaction lacks economic substance See Tax Alert 2017-611, dated 10 April 2017. Denmark — The National Tax Board ruled that a foreign construction company did not create a PE by sending personnel to Denmark for 18 months to supervise a Danish subcontractor’s construction of certain engineering structures for the company’s use in another country. See Tax Alert 2017-797, dated 16 May 2017. France — The EU Court of Justice held that France violated EU law by applying its 3% dividends tax to dividends distributed by subsidiaries that are residents of other EU member states. See Tax Alert 2017-898, dated 2 June 2017. Germany — The Federal Constitutional Court held that German rules limiting a loss-making corporation’s ability to claim net operating losses (NOLs) following a partial change in company ownership violated the German Constitution. In reaching this conclusion, the Court noted that a partial transfer of company ownership did not justify treating the loss-making corporation differently from other corporate taxpayers. See Tax Alert 2017-795, dated 16 May 2017.


Ghana — The Government issued guidance interpreting various provisions in the Income Tax Act, such as withholding tax, changes in ownership, repairs and improvements of depreciable assets, loss carryovers and capital allowances. See Tax Alert 2017-867, dated 25 May 2017. India — The Government added shared services as another category of transactions covered by India’s safe harbor transfer pricing rules and extended the rules’ expiration date two years to 31 March 2019. See Tax Alert 2017-956, dated 14 June 2017. Israel — In accordance with the OECD’s BEPS recommendations, the parliament’s Finance Committee approved regulations that condition income tax benefits under Israel’s preferential tax regime for income from intellectual property (IP tax regime) on the amount of research and development a company conducts in Israel and abroad. With the regulations’ approval, the statutory changes to Israel’s IP tax regime, which were enacted 29 December 2016, became effective as of 1 January 2017. See Tax Alerts 2017-827, dated 19 May 2017, and 2017-744, dated 5 May 2017. The Israeli Central District Court recharacterized an intellectual property (IP) transfer made by an acquired Israeli company to its US parent company as a sale of the company’s entire business, including its workforce. The Court also held that the company incorrectly valued the IP under Israeli transfer pricing rules. See Tax Alert 2017-955, dated 14 June 2017. Poland — The Ministry of Finance identified an investment structure that may violate general antiavoidance rules because it allows closed-end investment funds to avoid paying corporate income tax on partnership income and appears to lack economic substance. Additionally, the Ministry warned that it may scrutinize these structures, and could deny related tax benefits. See Tax Alert 2017-763, dated 9 May 2017. Uruguay — In a decree, the Government modified the tax treatment of derivative financial instruments so that the corporate income tax only applies to 5% of a company’s gains on the instruments, provided up to 10% of a company’s total income is subject to the tax. The Government also outlined special rules for PEs of financial intermediary institutions. See Tax Alert 2017-872, dated 30 May 2017.


Things we have our eyes on National, state and local governments continue to seek to increase their revenues. Companies should continue to monitor developments in this area. Some of these potential tax law changes are summarized here.

Federal, state and territories Tax reform — The Trump administration outlined a high-level tax reform proposal with a 15% tax rate for corporate and pass-through entity income and a one-time tax on the repatriation of foreign earnings of US companies at an unspecified rate. The plan also proposed switching to a territorial international tax system for US companies’ foreign earnings. It did not, however, address a proposal in the House Republican Blueprint on tax reform that would encourage exports by exempting them from tax while taxing imports. See Tax Alert 2017-692, dated 27 April 2017. Senate Finance Committee member John Thune (R-SD) introduced a bill that would make permanent 50% bonus depreciation and increase small business expensing limits to $2 million annually. Other proposals include allowing small businesses to deduct inventory costs immediately. The bill differs from the Blueprint, which would allow 100% expensing of all capital expenditures for tangible and intangible assets (including buildings but not land) and eliminate the deductibility of net interest expense. See Tax Alert 2017-813, dated 17 May 2017. Health care reform — The House of Representatives approved a health care bill that would allow employers to continue receiving a tax-free subsidy for offering a Medicare Part D prescription drug plan to their retirees and still deduct the full cost of their retiree prescription drug benefits. The bill would also repeal the current $500,000 cap on deductions for compensation paid to executives of certain health insurance providers. See Tax Alerts 2017-740, dated 4 May 2017, and 2017-768, dated 9 May 2017. Regulatory review — President Trump signed an executive order calling for the Treasury Department to identify all "significant tax regulations" issued on or after 1 January 2016 that impose undue financial burden or add undue complexity and to recommend specific actions to mitigate those burdens. Regulations potentially affected by the executive order include: • Final, temporary and proposed regulations under Section 385 on treatment of certain interests in corporations as stock or indebtedness • Final regulations on income and currency gain or loss with respect to a Section 987 qualified business unit and temporary and proposed regulations on recognition and deferral of Section 987 gain or loss See Tax Alert 2017-671, dated 21 April 2017. Partnership audit regime* — The Government re-released ranking member proposed regulations on implementing the new partnership audit regime enacted by the Bipartisan Budget Act of 2015. The regulations were initially released on 18 January 2017, but were withdrawn before publication by the then-incoming Trump administration as part of its review of all pending regulations. The reissued regulations are substantially the same as the previously released regulations. The reissuance signals the IRS's intent to finalize these regulations. For additional discussion of these regulations, see the Appendix in this publication. Derivatives taxation — Senate Finance Committee Ron Wyden (D-Ore.) introduced a bill that would require gains from derivatives to be recognized annually and treated as ordinary income, rather than capital gains. See Tax Alert 2017-720, dated 2 May 2017. New York — In draft regulations, the Government explained how to calculate NOLs generated before 1 January 2015 that will be carried forward to offset future business income. See Tax Alert 2017-809, dated 17 May 2017.

*

A Tax Alert has not been published on this development.


Pennsylvania — The state Supreme Court heard oral arguments on whether Pennsylvania’s statutory cap on net loss carryovers violates the uniformity clause in the state’s Constitution by classifying taxpayers based on their taxable income. See Tax Alert 2017-632, dated 12 April 2017. International Australia — In draft guidance, the Government outlined the criteria it will use to assess the extent to which cross-border related party financing arrangements comply with Australia’s transfer pricing rules. See Tax Alert 2017-815, dated 18 May 2017. Estonia — The Government proposed reducing the income tax rate on dividend payments to 14% from 20%, while subjecting certain related party loans to corporate tax. See Tax Alert 2017-673, dated 24 April 2017. European Union — The Council of the European Union amended its anti-tax avoidance directive to eliminate tax advantages created by certain hybrid instruments and hybrid entities (i.e., eliminate certain “hybrid mismatches” between EU and non-EU member states). The amendments apply to a broader range of hybrid mismatches, such as hybrid PE mismatches, hybrid transfers, imported mismatches, reverse hybrid mismatches and certain dual-resident mismatches. Members of the EU have until 1 January 2020 to incorporate the directive into their national laws. See Tax Alert 2017-881, dated 30 May 2017. Germany — The Parliament and State Council adopted legislation disallowing deductions for royalties and similar payments made to related companies in jurisdictions with “preferential tax regimes” for intellectual property (i.e., an IP box) that tax the payments at a rate below 25% and do not comply with OECD guidelines. The rules would not apply when a German company pays royalties to a foreign company that is subject to the German-controlled foreign corporation rules. The adopted legislation would also exempt cancelled debt from income tax for certain companies facing insolvency, provided those companies offset the income first with NOLs. The legislation will be enacted when signed by the president and published in the Federal Gazette. See Tax Alert 2017-723, dated 3 May 2017. In draft guidance, the Government outlined the circumstances under which German withholding tax would or would not apply to cross-border payments for the use of software and databases. See Tax Alert 2017-822, dated 18 May 2017. Hong Kong — The Government broadened its proposed income tax incentives for offshore aircraft financing and leasing businesses to include domestic aircraft financing and leasing companies. See Tax Alert 2017-868, dated 25 May 2017. Hungary — The Government proposed easing the requirements that companies must meet to exempt capital gains on share disposals from corporate income tax. See Tax Alert 2017-786, dated 12 May 2017. Italy — The Government proposed a process for determining whether a company has a PE in Italy and procedures for voluntarily disclosing an existing PE that was previously unreported. See Tax Alert 2017-947, dated 13 June 2017. Netherlands — The Government proposed broadening the scope of the current domestic dividend withholding tax exemption to include dividends distributed within an entrepreneurial group (i.e. a group actively engaged in a business) to a tax treaty jurisdiction shareholder. It also proposed eliminating the separate general dividend withholding tax exemption for Dutch cooperatives that act like a holding company. See Tax Alert 2017-816, dated 18 May 2017. Norway — The Government proposed extending the limit on interest deductions for intercompany loans to external loans for companies that are part, or can be part, of a consolidated group for financial accounting purposes. The proposal would also increase the deduction limit to NOK 10 million from NOK 5 million and includes safeguards to prevent the limitation from applying to loans that are not linked to profit-shifting arrangements. See Tax Alert 2017-746, dated 5 May 2017.


OECD — Sixty-eight countries signed a multilateral agreement to modify their tax treaties to prevent BEPS. More than 1,100 income tax treaties are expected to be affected. See Tax Alerts 2017-873, dated 30 May 2017, 2017-920, dated 8 June 2017, 2017-953, dated 14 June 2017, 2017-954, dated 14 June 2017, and 2017-959, dated 14 June 2017. Switzerland — The Finance Minister introduced a revised corporate tax reform proposal with the objective of aligning the Swiss corporate tax system with international standards by replacing certain preferential tax practices with new internationally accepted measures. The proposal would, among others, give preferential tax treatment to certain IP-related income while complying with the OECD’s BEPS recommendations. Additionally, the proposal would allow companies to deduct up to 150% of qualified research and development expenses incurred in Switzerland. The tax relief provided by these proposals, however, would be limited to 70% of a company’s cantonal (i.e. state and local) income tax liability. See Tax Alert 2017-902, dated 5 June 2017. Uganda — The Government proposed allowing companies to deduct 50% of the cost basis of certain plants and machinery when they are placed in service and 20% of the cost basis of a new industrial building if certain conditions are met. The Government also proposed limiting the deductions and tax losses that petroleum operators may use to offset certain income earned under a petroleum agreement. Other proposals include applying the arm’s-length principle to employment relationships, including company directorships. See Tax Alert 2017-666, dated 21 April 2017.


Appendix

New IRS audit regime for partnerships has limited tax accounting considerations The 2015 enactment of a centralized Internal Revenue Service (IRS) audit regime for partnerships has raised questions about the income tax accounting considerations for a partnership that directly pays the income taxes resulting from adjustments made under the regime (an imputed underpayment). In this article, we review applicable portions of the new rules and discuss our conclusions regarding the applicability of Accounting Standards Update (ASC) 740, Income taxes, to the income tax payment made by the partnership.

Background General On 2 November 2015, the Bipartisan Budget Act (BBA) was enacted, which implemented a new Internal Revenue Service (IRS) centralized audit regime for entities treated as partnerships for federal income tax purposes. The BBA significantly alters the audit and income tax liability rules governing partners and partnerships for tax years beginning after 31 December 2017, and for partnerships that early elect into the regime for tax years after 2 November 2015, and before 1 January 2018. The BBA rules provide for a centralized partnership audit regime in which a partnership representative has sole authority to act on behalf of the partnership and its partners. Under the centralized partnership audit regime, all adjustments and items relating to a partnership are determined at the partnership level, and the IRS is no longer required to determine each partner's share of the adjustments to assess the correct tax due as a result of the partnership examination. Taxes resulting from adjustments to items under the regime are assessed and collected at the partnership level and referred to as an "imputed underpayment." Any penalties or additional amounts relating to such adjustments are also determined at the partnership level. The IRS initially released proposed regulations on the BBA rules on 18 January 2017, but withdrew them as part of the then-incoming Trump administration’s review of all pending regulations. The regulations were subsequently reissued and published in the Federal Register on 14 June 2017 and were not changed substantially.

Relevant elements of the statute Electing out of the centralized audit Partnerships are eligible to opt out of the regime if: (1) They have 100 or fewer partners1 during the year (2) All partners are "eligible partners"2 at all times during the tax year. Imputed underpayment Under the new centralized audit regime, partnerships are generally responsible for paying any imputed underpayment that results from an IRS examination. The IRS will examine the partnership's items of income, gain, loss, deduction, and credit and partners' distributive shares for a particular year of the partnership (the reviewed year). Any adjustments will be taken into account by the partnership in the year that the audit or any judicial review is completed (the adjustment year). Alternatively, adjustments will be taken into account by the partners if a so-called push-out election is made, as discussed below.


"Push-out" election As an alternative to the partnership paying an imputed underpayment at its level, an eligible partnership may file a push-out election and furnish to each partner, for the reviewed year, a statement showing the partner's share of any adjustment. Upon making this election, the partnership is no longer required to pay the imputed underpayment and the partners would then take the adjustment into account on their respective returns in the year they receive such statement. As enacted, the push-out election is only available to the partnership under audit, and is not currently available to upper-tier partnerships that are partners in the entity. In December 2016, both the House and the Senate introduced bipartisan technical corrections that would address a number of issues discussed in the proposed regulations, including the ability for upper-tier partners that are partnerships themselves to make additional push out elections. At present, however, the technical corrections are not attached to any current legislative packages. At this time, the timing of any such legislation is unknown, as well as when such legislation could be enacted and how such legislation would affect the issuance of final regulations. Administrative adjustment request A partnership may also initiate a correction and file an "administrative adjustment request" relating to any partnership tax year to adjust the reporting of a previously reported item. Under the administrative adjustment request procedures, the adjustment is determined and taken into account for the tax year in which the administrative adjustment request is made. Prior-year tax returns are not amended. Adjustments resulting in imputed underpayments may be taken into account by either the partnership or the partners in the year the administrative adjustment request is made. Resulting overpayments Under the centralized audit process in the BBA, adjustments that do not result in an imputed underpayment (i.e., over-reporting of income) are taken into account by the partnership in the adjustment year. The statute provides that such adjustments are generally taken into account as a reduction in non-separately stated income or an increase in non-separately stated loss, or, in the case of an item of credit, as a separately stated item. There will likely need to be regulations to provide further guidance regarding these types of adjustments and any reallocation adjustments. When a partnership makes an administrative adjustment request, if the adjustment being made would result in the correction of an over-reporting of income, the partnership may not take the adjustment into account at the partnership level. Such adjustments must be taken into account by the partners. Further guidance needs to be issued by the Treasury Department regarding the procedures for filing administrative adjustment requests. The withdrawn proposed regulations provided that the reviewed-year partners would take such adjustments into account in the year they received the statement showing their share of such adjustments.

Other relevant sections Partnerships that cease to exist To the extent a cessation of the partnership occurs before the audit adjustment takes effect, the former partners of the partnership are required to include in their tax returns the partnership adjustments that resulted in the imputed underpayment or other amount due that was not paid by the partnership. Thus, the decision to settle any imputed underpayments and the collection of taxes by the partnership would appear to be generally an administrative ease on the part of the Government and to the partners in the partnership rather than an implication that the liability has truly shifted to the partnership under the new provisions.

Tax accounting implications Tax accounting considerations for the partnership under audit The accounting discussion that follows addresses the accounting in the standalone financial statements of the partnership under audit — that is, it does not address the accounting by the partner that, under US GAAP, may in some cases account for its interest on a consolidated, equity-method or cost-method basis, as discussed further below.


The new centralized partnership audit regime has raised the question of whether the settlement of an imputed underpayment and the related liability by the partnership is subject to the provisions under ASC 740 when the partnership does not elect to push out the imputed underpayment to the partners. On 2 September 2009, the Financial Accounting Standards Board (FASB) issued additional implementation guidance, through examples, on the accounting for uncertainty in income taxes. This additional guidance clarifies that entities should attribute income taxes to either the entity or its owners based on how the tax laws and regulations of each jurisdiction attribute income taxes, rather than based on who pays the income taxes. The following examples from ASC 740-10-55-226 through 740-10-55-228 illustrate the accounting for attribution of income taxes to the entity or its owners.

Excerpt from Accounting Standards Codification 740-10-55-226 Entity A, a partnership with two partners — Partner 1 and Partner 2 — has nexus in Jurisdiction J. Jurisdiction J assesses an income tax on Entity A and allows Partners 1 and 2 to file a tax return and use their pro rata share of Entity A's income tax payment as a credit (that is, payment against the tax liability of the owners). Because the owners may file a tax return and utilize Entity A's payment as a payment against their personal income tax, the income tax would be attributed to the owners by Jurisdiction J's laws whether or not the owners file an income tax return. Because the income tax has been attributed to the owners, payments to Jurisdiction J for income taxes should be treated as a transaction with the owners. The result would not change even if there were an agreement between Entity A and its two partners requiring Entity A to reimburse Partners 1 and 2 for any taxes the partners may owe to Jurisdiction J. This is because attribution is based on the laws and regulations of the taxing authority rather than on obligations imposed by agreements between an entity and its owners. 740-10-55-227 If the fact pattern in paragraph 740-10-55-226 changed such that Jurisdiction J has no provision for the owners to file tax returns and the laws and regulations of Jurisdiction J do not indicate that the payments are made on behalf of Partners 1 and 2, income taxes are attributed to Entity A on the basis of Jurisdiction J's laws and are accounted for based on the guidance in this Subtopic. In the situation of a partnership paying an imputed underpayment, the liability assessed by the IRS and the payment of tax from the partnership is merely an administrative ease on the part of the Government to recoup the resulting additional tax due. This may be the case when there are a substantial amount of partners in a partnership and the partnership makes a determination to make the payment on the imputed underpayment as a means of administrative convenience to the partners. As the partners are responsible for the tax consequences of the transactions occurring within the partnership, the payment of the income tax related to the imputed underpayment is attributed to the partners and the payment made by the partnership should be treated as a distribution from the partnership to its owners (partners) in the standalone financial statements of the partnership. Accordingly, we do not believe ASC 740 applies to the liability related to the imputed underpayment even though the liability may be settled and the payment of tax can be made by the partnership. The payment of the imputed underpayment would be for the benefit of the partners and does not represent a tax on the income of the partnership. Until the partnership elects not to push out or is no longer permitted to push out the imputed underpayment of tax under the BBA rules, the partnership does not have an obligation to make the tax payment. Once the partnership elects not to push out or is no longer permitted under the BBA rules to push out the payment to the partners, the partnership then is committed and obligated to making the payment to settle the imputed underpayment of tax on behalf of the partners. Generally, the partnership would not recognize the obligation for the imputed underpayment until it is obligated to make the tax payment and can estimate the amount of the settlement or, if earlier, the IRS has made notice of the adjustment. To the extent the partnership has a contractual or legal obligation (including the BBA rules) to settle the underpayment, the timing of when the partnership recognizes a liability could be different. Any payment from the partnership to the IRS would be treated as a distribution to the partners in a similar manner to a withholding payment.


The partnership will also need to consider the requirements under US GAAP to assess whether the partnership's commitment to make tax payments on behalf of its partners is required to be disclosed in the footnotes to its financial statements.

Tax accounting considerations for the partner Under ASC 740, a partner's future tax consequences of recovering the financial reporting basis of its investment in the partnership are recognized as deferred tax assets or liabilities. Deferred tax assets and liabilities are recognized for the difference between the financial reporting basis and tax basis of the investment in the partnership at the investor level. The partners’ accounting for the settlement of the imputed underpayment of income taxes, whether pushed out to the partners or paid by the partnership, continues to be subject to the income tax accounting under ASC 740. The partners' accounting and presentation of income tax expense and related liability will depend on whether the partner is an upper-tier partnership or the partner consolidates the partnership (including amounts allocated to any noncontrolling interest holders) or accounts for its investment under the equity or cost methods. Based on the complexity of the partnership structure and the potential impact to the partner's tax basis related to the settlement of the imputed underpayment, corporate partners of effected audited partnerships should consider the potential impact on the carrying amount of their deferreds and/or any resulting uncertain tax positions.

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Quarterly tax developments, June 2017 - EY

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