Friday , December 9, 2022 |   03:42:39 IST
INTL TAXATION INTL MISC TP FDI LIBRARY VISA BIPA NRI
About Us Contact Us Newsletters
 
NEWS FLASH
 
DTAA - payments received by assessee to be fee for technical services and not royalty both under I-T Act & India-Netherlands DTAA: ITAT (See 'Breaking News') TP - where transactions are not closely linked, their ALP is to be determined separately - international transaction of payment of Royalty needs to be separately benchmarked de hors other international transactions under Manufacturing segment: ITAT (See 'Breaking News') TP - Advance to AE - Non-levy of interest on such advances attracts Transfer pricing provisions and it is appropriate to charge interest @LIBOR+2%: ITAT (See 'Breaking News') Oh GST! You have indeed turned into a fantastic 'beast' in 5 yrs! (See 'taxindiaonline') TP - order passed u/s 154 is to rectify an error prevailent in a previous order & the rectified order takes effect on the date of the original order: ITAT TP - If there was an error in an assessment order & was subsequently rectified, re-assessment order passed in respect of the original order becomes redundant - YES: ITAT (See 'Breaking News') TP - outstanding demand arising out of issues already decided in favour of the assessee by the Tribunal in the earlier assessment years cannot be recovered - Stay granted: ITAT (See 'Breaking News') I-T - Payments received by foreign company from Indian Customers on account of Centralized Services do not constitute FTS: ITAT (See 'Breaking News') Cancel GST Registration (See 'taxindiaonline') I-T - Inland Haulage Charges received by shipping business shall form part of income from operation of ships in international traffic: ITAT (See 'Breaking News') I-T - Revenue should consider reply filed by assessee before passing orders u/s 148A(d): HC (See 'Breaking News') TP - it is fit case for remand where Transfer Pricing adjustment has to be re-computed after considering that the assessee provided similar services to unrelated parties & claims to have charged no interest w.r.t. outstanding receivables therefrom: ITAT (See 'Breaking News') TP - Order passed beyond statutory period of limitation u/s 153(5) deserves to be quashed: ITAT (See 'Breaking News') Should students pay GST on Hostel rent? (See 'taxindiaonline') OECD inflation rises to 10.7% in October month (See 'TII BREIF')
 
SIGN IN
 
Username
Password
Forgot Password
 
   
Home >> TII EDIT
 
    
TII EDIT
A peep into President Biden's Fiscal-verse!
By D P Sengupta
Sep 30, 2022

SOMETIMES it is difficult for someone from outside the USA to understand its tax laws and the process under which such laws are made. The American system of governance has a large number of checks and balances. The President of the USA is the most powerful person in the world but there are limitations to his power. The Budget is the domain of the Congress consisting of the House of Representatives and the Senate. It is not often that all the three organs of the State are controlled by one of the two parties - the Democrats and the Republicans. It seems that the American voters have decided not to give absolute majority to any of the parties and very often this results in the President being unable to carry through his agenda. Besides, the current Senate is divided exactly at 50-50 between the two parties and the Vice-President using her casting vote can get any legislation through only if all the Democratic caucus vote together. If anyone of the Democratic Senators disagrees with any aspect of a particular Bill, he/she can virtually block the entire initiative. This has happened in this Senate with Senator Joe Manchin blocking many of the initiatives of President Biden. The senators, in order to get re-elected will have to consider the sentiments of that particular electorate even if that is perceived to be opposed to the Party's policies.

The very broad essential difference between the two parties in the sphere of taxation is that the Republicans are generally opposed to any new taxes and tax hikes and believes in minimum government interference whereas the Democratic party strongly believes in redistributive justice and intends to spend on social welfare measures by finding resources through additional taxation and closing the loopholes.

President Biden's initial plan was to legislate the Build Back Better Act that was passed by the House of Representatives by a narrow 220-213 margin but was opposed by Senator Joe Manchin who balked at the quantum of spending and took the view that this would result in more inflation. It was then that Charles Ellis (Chuck) Schumer the current Senate majority leader engaged with Senator Manchin and some other Senators and finally the spending was scaled back by excluding social safety net proposals. To fund the ambitious spending programme, new source of revenue was to be found. The main source identified was the Alternate Minimum Tax on the lines of the global minimum tax of 15% that was already agreed upon by the USA in its parleys with the OECD, and from ending the so-called carried interest loophole.

Abandonment of provision to modify Carried interest advantage

The concept of carried interest involves investments by Private Equity, which essentially refers to investment partnerships that buy and manage companies before selling them. It is an alternative investment class that invests or acquires companies that are not listed on the stock Exchanges. The idea is to extract value from the investment before exiting the investment. There are of course risks involved in such investments.

Typically, a PE firm would consist of General Partners (the fund managers) and Limited Partners. The limited partners can be pension funds, insurance companies, HNI, sovereign wealth funds and they bring in most of the investments in the Private Equity Fund that is managed by the General Partners. Generally, the limited partners own about 99% of the fund and the general partners own 1% of the same but have the full liability. Thus, the risk of the investment is borne by the general partners. It is possible for individual investors also to invest in the PE Fund through a Fund of funds, an exchange traded fund or through a special purpose acquisition company. Unlike venture capital, private equity funds do not invest in start-ups. These funds also do not invest in listed companies but may make investment to facilitate delisting from the exchanges.

The PE firm charges a management fee that is normally around 2% of the investment. This will be treated as ordinary income. But, the main attraction of the fund is on exit and in the sharing of the resultant gain. The general rule is the sharing of the gain in a ratio of 80:20. On exiting, first the capital is returned both to the GP and the LP. The remainder is then divided in the agreed ratio. It is the share of profit of the GP that is known as the carried interest. This is paid only after the fund earns profits beyond a rate of return known as the hurdle rate, generally between 7-9% per annum. The GPs thus gain 20% of the profits by investing 1% of the money.

According to Wikipedia, the concept of carried interest can be traced back to 16th century when European ships were crossing to Asia and the Americas. The captain of the ship would take a 20% share of the profit from the carried goods to pay for the transport and the risk of sailing over oceans.

Again, according to Wikipedia, in the 20th century, the concept of favourable treatment to this particular form of return, is traced to the oil and gas industry where the oil exploration companies funded by the financial partners explored and developed hydrocarbon resources and also took the risk of failure and the profits generated were split between the investors and the explorers.

There are arguments both for and against the favourable tax treatment. Those in favour point to the fact that sweat equity of the non-financial partners were also investment and hence should benefit from the favourable tax treatment of the long- term capital gains that under the US laws, apply for gains from disposition of assets after 1 year holding period. Those who criticise this favourable treatment argue that the nature of the reward is like a bonus and should be taxed as ordinary income. It seems most of the Americans favour the abolition of the special treatment.

In fact, Mr. Donald Trump in his campaign had promised to end the favourable treatment but finally his Tax Cut and Jobs Act, 2017 could only manage to increase the holding period from 1 year to 3 years in order to benefit from the lower rate of taxation as capital gains Section 1061 was added to the IRC by the 2017 Act to bring about the change. The section however, does not use the expression carried interest but, refers to an 'applicable partnership interest'. Under the US law, partnerships are transparent entities and income of the partnership passes through to the partners and since the PE funds are organized as LLPs, the benefits also get passed on to the partners, thereby benefiting the general partners.

President Biden's original proposal in regard to the carried interest in the Build Back Better Act, also was relatively modest in the sense that there was no provision for taxing this income as ordinary income but a proposal was made to change the minimum holding period from 3 years to 5 years. However, owing to the opposition of Senator Krysten Sinema of his own Democratic Party even this modest change was also abandoned.

Excise tax on share repurchase

The revenue required for fulfilling the various promises and programmes had then to be found from some other sources. Here is where an excise tax of 1% on share buy backs came into the final agreement.

There were many in the Democratic Party who earnestly believe in reducing the corporate power in all spheres and were against the concept of share buy backs. Companies normally reward their shareholders by either distributing dividends or buying back their own shares from the existing shareholders. In the first case, the shareholders pay tax at normal rate but in case of share buy backs, the total number of available shares gets reduced and consequently the share price increases thereby increasing the wealth of the remaining shareholders. It is thus a tax efficient way of rewarding the company promoters and important shareholders.

The big technology companies generally do not even distribute dividends but reward the promoters and shareholders through occasional buy backs thereby accentuating the divide between labour income and capital income in the matter of taxation. In fact, the assumption behind President Trump's tax cut in 2017 was that the companies will make new investments through the saved tax money and thereby create new employment and job and opportunities in the USA. What actually transpired was that there was a record 806 billion buy back of shares in 2018 and the phenomenon reached a record high in the pandemic year when according to a Washington Post article, (The new Wall Street tax key to Democrats' Inflation Reduction Act- Jacob Bogage) in the past 12 months, the top 100 US firms bought 816 billion dollars of their own shares (Apple 85 billion, Google 55.4 billion, Meta 45.3 billion, Microsoft 28 billion etc.)

In fact, a Bill introduced by Democratic Senators Ron Wyden and Sherrod Brown proposing a 2% tax on share buy backs was already pending consideration. In terms of the proposal, called the Stock Buyback Accountability Act, a 2% excise tax would have been levied on the amount the corporations spend to buy back their own stock.

This proposal with slight modification has now been incorporated in the Inflation Reduction Act (IRA) through the incorporation of section 4501 in the Internal Revenue Code and applies to repurchases or buy backs after December 31, 2022. As part of the IRA, Treasury has been granted authority to promulgate regulations to carry out the purpose of the new excise tax and to prevent its avoidance.

The tax is 1% of the fair market value (FMV) of the stock repurchased and applies to certain covered corporations on repurchases effected directly or through specified affiliate. There is also an offset provision whereby the FMV of any stock issued by the covered company during the same taxable year can be offset against the FMV of the stock repurchased. The tax is not deductible for Federal Income tax purposes. Obviously, there are exceptions and the provision does not apply under several circumstances and most notably if the total value of the buy back in the taxable year does not exceed USD 1 million. The new tax in expected to generate 74bn USD over the next decade.

We may note that in India we have a buy-back tax right from 2013. This was initially restricted to share buy backs by private companies and was imposed to prevent avoidance of the then prevailing dividend distribution tax (DDT) since it was noticed that the such companies could get around the DDT by returning the shareholders money in the form of buy back. Subsequently, the ambit of the section 115QA was extended and now encompasses both listed and unlisted companies.

In the USA, the detailed guidelines will be issued by the treasury/IRS and the actual implications of the changes will be clearer. One apparent difference between the two systems is that in the USA, it is only an excise tax of 1% of FMV, whereas in India, the idea is to bring parity between the tax treatment of capital gains and the tax payable under buy back. Naturally, in India, the distributed income on which the tax is imposed gives the set off for the cost of shares issued by the company whereas in the USA the set off is given for the cost of shares issued within the same fiscal year. The other important distinction is that while in India the tax is an income tax and applies to both private and public companies in the USA, it is not an income tax and the covered corporation for the purpose of this excise tax is any American company that is publicly traded on any established securities market.

Minimum tax

The other and perhaps the main plank to raise revenue under the IRA is the alternate minimum tax for the corporates (AMT). An alternate minimum tax existed in the US tax code but President Trump removed the AMT for the corporates. This has now been reversed. However, the most important difference between the current regime and the earlier regime is that, the AMT will be calculated on the basis of the accounting profits and not on the basis of the taxable profits. In fact, the Biden-Harris tax plan proposed 'a 15% minimum tax on book income so that no corporation gets away with paying no taxes'. This is also line with the OECD Pillar 2 minimum tax proposal.

Sub-title A of the Act is actually Deficit Reduction and the minimum tax seems to be the fulcrum of the corporate tax reform through which the said objective is proposed to be achieved. The formulation in the Act in this regard is rather unusual:

"PART 1-

CORPORATE TAX REFORM SEC. 10101. (…)

Paragraph (2) of section 55(b) is amended to read as follows:

"(2) CORPORATIONS. -

"(A) APPLICABLE CORPORATIONS. -

In the case of an applicable corporation, the tentative minimum tax for the taxable year shall be the excess of-

"(i) 15 percent of the adjusted financial statement income for the taxable year (as determined under section 56A), over

"(ii) the corporate AMT foreign tax credit for the taxable year."

What one can gather from the literature is that if the tentative minimum tax of an applicable corporation exceeds its regular tax liability, then it must pay the difference as the alternate minimum tax and that the provision will come into effect from January1, 2023.

'Applicable corporation' is then defined to mean any corporation (other than an S corporation, a regulated investment company, or a real estate investment trust which meets the average annual adjusted financial statement income test of subparagraph (B) for one or more taxable years which- "(i) are prior to such taxable year, and" (ii) end after December 31, 2021. And the average adjusted financial statement income should be more than USD 1 billion for 3 taxable year period ending with the relevant tax year.

The AMT credit is of course, available for utilisation against the taxpayer's future regular tax liability.

The tax also applies to some foreign owned corporations when in addition to the general condition of average income of the MNC group exceeding USD 1 bullion, the average book income of the company for three taxable years ending with the relevant tax year must exceed USD 100 million.

The minimum tax does not apply in case of reorganisation and also in situations as may be determined by the Treasury Secretary. As the name suggests, a whole host of adjustments will have to be made from the financial statement income before applying the provision as provided in the IRC.

Enhanced Enforcement

'Tax administration is tax reform'. This adage is now put in practice through this tax plan by providing additional funding to the IRS that is in charge of the enforcement of the tax laws. Over the years, the Republicans have systemically haemorrhaged the tax administration by not filling the posts. According to reports, the IRS's enforcement ranks have shrunk by 30% since 2010. And with the departure of experienced examiners, the IRS has concentrated its examination basically to wage income earners and the agency has audited just 2.2% of the tax returns of the millionaires who have more opportunities to avoid taxes in view of the nature of their income and with the generous help from their lawyers and accountants. (Source: https://www.npr.org/2022/08/14/1117317757/irs-tax-evaders-dodgers-inflation-reduction-act-enforcement)

That apart, it is amusing to learn that the US IRS still depends a lot on paper returns and in case of discrepancies, taxpayers may have to use fax machines and that the processing system is run on COBOL developed in the 60's; its latest operating system is Windows XP computer systems that are no longer in existence! Apparently, as at July 2022, the IRS had a backlog of 10.2 million of unprocessed individual returns. Recently, a Washington Post journalist had a chaperoned tour of the IRS processing centre at Austin and has filed a hilarious report about the state of affairs there. ( Why does the IRS need $80 billion? Just look at its cafeteria. (https://twitter.com/crampell/status/1557031782930731009). Well, at least in this regard, we are miles ahead of the US IRS though we too still have issues with our processing centre.

It is to remedy this situation that the IRA proposes to invest USD 80 billion for revamping the IRS. Ironically, this is the provision that has come for severe criticism from the Republican Party and they are promising to undo the same should they retake the Congress in the mid-term due in November this year. Specifically attacked was the news of the proposed hiring of 87000 new hands with the insinuation that the new hires would come after ordinary people engaged in the informal sector. Considering the uproar, the Treasury Secretary Janet Yellen has written a formal letter to IRS Commissioner Charles P. Rettig outlying the priorities for spending the additional funding. According to a Press release, Secretary Yellen reaffirmed the Administration's commitment to not increasing audit rates relative to recent years on Americans making under $400,000 a year, noting that they will actually see a lower likelihood of audit due to improved technology and customer service. (https://home.treasury.gov/news/press-releases/jy0918)

"Specifically, I direct that any additional resources-including any new personnel or auditors that are hired-shall not be used to increase the share of small business or households below the $400,000 threshold that are audited relative to historical levels. This means that, contrary to the misinformation from opponents of this legislation, small business or households earning $400,000 per year or less will not see an increase in the chances that they are audited."

Mr. Rettig, an appointee of Mr Trump, has also himself reiterated the same in his letter to the members of the Senate adding: "The resources in the reconciliation package will get us back to historical norms in areas of challenge for the agency - large corporate and global high-net-worth taxpayers - as well as new areas like pass-through entities and multinational taxpayers with international tax issues, where we need sophisticated, specialized teams in place that are able to unpack complex structures and identify noncompliance."(https://www.irs.gov/pub/irs-utl/commissioners-letter-to-the-senate.pdf)

Loss limitation extension

This is a provision in the Revenue Code that limits the amount of trade or business loss that are allowed to be set off against non-business income of non-corporate taxpayers. This was originally brought in by Trump Administration's Tax Cut and Job Act in 2017 by incorporating Section 461(1) in the tax code. The limit was USD 250000 for single filers and 500000 for joint returns. The limitation indexed for inflation was set to expire in 2026. This has now been extended to the tax year 2028.

The IRA proposes to make significant investments in the area of renewables and for fighting climate change promising to reduce carbon emission by 40% by 2030. It promises to lower energy bills by USD 500-1000 per year; it expands Medicare benefits and lowers health costs. In all, it proposes to invest around 437 billion USD consisting of 369 billion USD in energy security and climate change, USD 64 billion in Affordable care Act extension and 4 billion USD in drought resistance measures.

So, why is it called Inflation Reduction Act? It is hoped that the taxing measures will generate about USD 222 billion through the Minimum tax, 74 billion from the buyback tax, 124 billion USD from the better enforcement by empowering IRS, 265 billion from prescription drug pricing reform, and 52 billion from loss limitation extension. Overall, the Act is expected to generate 737 billion USD and since the total investments will be 437 billion, this will reduce deficit by USD 300 billion which in turn will reduce the inflation rate that is causing problems for the current administration.

Writing for Project Syndicate ( Why the Inflation Reduction Act is a Big Deal?), Joseph Stiglitz concludes: "No bill is perfect. In America's money-driven politics, there will always be compromises with special interests. The IRA is not as good as the original Build Back Better bill, which would have done more both to promote equitable growth and to fight inflation. But we can't let the perfect be the enemy of the good. Ultimately, the IRA is a very important step in the right direction."

 
 
INTL TAXATION INTL MISC TP FDI LIBRARY VISA BIPA NRI TII
  • DTAA
  • Circulars (I-T Act, 1922)
  • Limited Treaties
  • Other Treaties
  • TIEAs
  • Notifications
  • Circulars
  • Relevant Sections of I-T Rules,1962
  • Instructions
  • Administrative Orders
  • DRP Panel
  • I-T Act, 1961
  • MLI
  • Relevant Portion of I-T Act,1922
  • GAAR
  • MAP
  • OECD Conventions
  • Draft Guidelines
  • DTC Bill
  • Committee Reports
  • FATCA
  • Intl-Taxation
  • Finance Acts
  • Manual on EoI
  • UN Model Taxation
  • Miscellaneous
  • Cost Inflation Index
  • Union Budget
  • Information Security Guidelines
  • APA Annual Report
  • APA Rules
  • Miscellaneous
  • Relevant Sections of Act
  • Instructions
  • Circulars
  • Notifications
  • Draft Notifications
  • Forms
  • TP Rules
  • APA FAQ
  • UN Manual on TP
  • Safe Harbour Rules
  • US Transfer Pricing
  • FEMA Act
  • Exchange Manual
  • Fema Notifications
  • Master Circulars
  • Press Notes
  • Rules
  • FDI Circulars
  • RBI Circulars
  • Reports
  • FDI Approved
  • RBI Other Notifications
  • FIPB Review
  • FEO Act
  • INTELLECTUAL PROPERTY
  • CBR Act
  • NBFC Report
  • Black Money Act
  • PMLA Instruction
  • PMLA Bill
  • FM Budget Speeches
  • Multimodal Transportation
  • Vienna Convention
  • EXIM Bank LoC
  • Manufacturing Policy
  • FTDR Act, 1992
  • White Paper on Black Money
  • Posting Policy
  • PMLA Cases
  • Transfer of Property
  • MCA Circular
  • Limitation Act
  • Type of Visa
  • SSAs
  • EPFO
  • Acts
  • FAQs
  • Rules
  • Guidelines
  • Tourist Visa
  • Notifications
  • Arbitration
  • Model Text
  • Agreements
  • Relevant Portion of I-T Act
  • I-T Rules, 1962
  • Circulars
  • MISC
  • Notification
  • About Us
  • Contact Us
  •  
     
    A Taxindiaonline Website. Copyright © 2010-2023 | Privacy Policy | Taxindiainternational.com Pvt. Ltd. OPC All rights reserved.