In this first quarter update, we cover some of the most important tax issues for companies in the technology, clean technology, life sciences, and communications and media industries and touch on what your organization can do to stay ahead of them.
R&D Payroll Tax
The R&D credit was permanently extended as part of the Protecting Americans from Tax Hikes (PATH) Act of 2015. It includes some enhancements starting in 2016, including offsets to alternative minimum tax and payroll tax for eligible businesses. The credit is still based on credit-eligible R&D expenses, but offsets apply to only those costs incurred beginning in 2016. The new payroll tax offset allows companies to receive a benefit for their research activities regardless of whether they’re profitable. The maximum benefit an eligible company is allowed to claim against payroll taxes each year under the new law is $250,000. Read our Insight for an in-depth look, or view our infographic for a quick synopsis.
New Approach for IRS Exam Process
Starting May 1, 2016, the Large Business and International (LB&I) division of the Internal Revenue Service (IRS) will change its examination approach from an entity-focused to issue-focused campaign. As detailed in Publication 5125, the new examination process will be conducted in three stages: planning, execution, and resolution.
Publication 5125 emphasizes issue and factual development, specifying that the LB&I exam team will:
- Explain why it’s considering each issue
- Develop facts using the information document request process
- Provide written factual narratives documenting all relevant facts and seek the taxpayer’s acknowledgement of such facts as well as documentation of those facts in dispute prior to the issuance of Form 5701, Notice of Proposed Adjustment
Under this new approach, it’s possible that a single taxpayer may be faced with an examination that consists of multiple issues and campaigns, each with a different exam team and different exam timelines. It’s important that taxpayers understand the new process to ensure it’s being followed; however, there are significant unknowns regarding the speed and uniformity of implementation.
The Office of Appeals will return an exam case to LB&I’s jurisdiction if during the course of the appeal a taxpayer introduces new evidence or a new issue that wasn’t considered during the LB&I exam. Furthermore, if a taxpayer presents a new, relevant legal argument during appeals, the Office of Appeals will provide the LB&I exam team an opportunity to review and comment; however, the Office of Appeals will retain the jurisdiction of the case. Publication 5125 confirms that cases presented to the Office of Appeals must have 365 days remaining on the statute of limitations.
State Tax Developments
California Competes Tax Credit
To continue California’s mission of attracting businesses to grow their operations in the state, the Governor’s Office of Business and Economic Development (GO-Biz) continues to grant California Competes Tax Credits (CCTC). Through this final fiscal year 2015 and 2016 period, GO-Biz will have awarded California businesses with over $380 million in income tax credits. In exchange, each of these awardees contractually agreed to come, stay, or grow their business in California over the next three to five years.
Like its name, the CCTC is a program that has businesses competing against one another through a selection process. Although there are a number of different factors, GO-Biz generally selects awardees based on the quality and quantity of full-time jobs and capital investments that the business is proposing to expend in California.
Over the next two years, California will be awarding an additional $400 million in tax credits. The next application period for fiscal year 2016 and 2017 will be opening later this year. Whether you operate a small business or a multinational enterprise, this program may provide a significant tax benefit if you’re looking to grow your operations in the Golden State. Read our summary of the process for more details.
Oregon Enterprise Zone Tax Credits
To claim Oregon’s enterprise zone property tax incentives and related e-commerce income tax credits, companies must apply for the Oregon enterprise zone program prior to commencing any expansion project—before beginning construction, purchasing equipment, hiring additional staff, or taking any other expansion steps. This makes awareness of the incentive a critical first step. After that, claiming one or both incentives take a bit of planning and analysis, but the tax savings can be significant. Read our Insight for more details on which businesses and properties qualify.
State Law Changes
- Alabama. Alabama’s factor presence economic nexus is effective for tax years beginning on or after January 1, 2015. A physical presence is no longer required. Nexus results when a taxpayer has either $50,000 of property or payroll in Alabama or $500,000 of sales sourced to Alabama—or 25 percent of property, payroll, or sales if lesser.
- Tennessee. The same factor presence economic nexus as Alabama applies to Tennessee.
- Connecticut. There are two updates for Connecticut:
- Mandatory unitary Connecticut combined reporting. Effective for tax years beginning on or after January 1, 2016, commonly owned corporations engaged in a unitary business where at least one corporation is subject to the Connecticut corporation business tax are required to file their corporation business tax returns on a unitary basis.
- Net operating loss deductions. Effective for income years beginning on or after January 1, 2015, a taxpayer’s net operating loss (NOL) deduction may not exceed 50 percent of its net income. Taxpayers with more than $6 billion of unused NOLs from income years beginning before January 1, 2013, may elect to forfeit 50 percent of the balance of their unused NOLs and utilize the reduced balance to exceed the 50 percent limitation in income year 2017 until the reduced balance is fully utilized. This election must be made on a timely filed 2015 corporation business tax return. Information on how to make this election is provided in the form’s 2015 instructions.
- New York. Significant changes to New York’s corporate tax law are effective for tax years beginning on or after January 1, 2015, including changes impacting apportionment for so-called digital products, changes to combined return requirements, and changes to the NOL deduction rules.
International Tax Planning
Patent Box Regimes
As part of the larger base erosion and profit shifting (BEPS) initiative, the Organisation for Economic Co-operation and Development (OECD) finalized its recommendations in September 2015. Measures calling for a nexus approach for the taxation of intellectual property (IP) were subsequently adopted by the European Commission on January 28, 2016. Specifically, the OECD and the commission have targeted patent box regimes, which is a tax incentive that reduces the statutory corporate income tax rate on certain income arising from the exploitation of IP. At a high level, the G20 and all OECD member countries have agreed to the following with respect to patent box regimes:
- By December 31, 2015, countries must begin the process of changing laws for existing IP regimes.
- By June 30, 2016, new regimes including the modified nexus approach must take effect and existing regimes must close to new entrants.
- By June 30, 2021, grandfathering ends for tax benefits on noncompliant regimes—those not under the new nexus standard, for example.
As required by the European Commission, all European Union member states must conform their patent box regimes to the new standards and are in the process of updating tax legislation and implementing guidance. There’s a limited window to take advantage of the older, more generous regimes.
Familiarize yourself with the coming changes if you have operations in any OECD countries or are looking to expand there.
Heavier IRS Scrutiny on Foreign Subsidiaries
The IRS released three documents it’s using to train its examiners. These documents focus on controlled foreign corporations (CFC), Subpart F, and Form 5471. This training is part of an IRS focus on developing the skills of IRS agents to better identify issues at the exam level. While this information isn’t legal precedent, it provides helpful information related to how the IRS might audit a company with foreign subsidiaries.
It will benefit companies with foreign subsidiaries to be familiar with these developments, because their tax returns are likely to be subject to more scrutiny.
The IRS has instructed its examiners to:
- Look into whether there are any CFCs that aren’t being reported
- Request foreign corporation stock certificates, articles of organization, the foreign corporation's organization chart, corporate minutes, and shareholder agreements
- Perform Internet research to see where a company indicates it has a presence
- Conduct taxpayer interviews in determining whether there’s substantive voting control over any foreign entities
- Determine direct and indirect ownership of the foreign corporation, taking into account any stock attribution rules
Subpart F Income
The IRS also issued guidance on whether a US taxpayer is deemed to have Subpart F income as a result of services performed by its CFC. The IRS instructed its examiners to look into organizational structure, internal employee directories, travel records, cost center reports, and transaction agreements to establish whether a related-party transaction actually took place.
Failure to File Complete Form 5471
The IRS also issued guidance on when to assess penalties for the failure to file a complete Form 5471. Internal Revenue Code Section 6038 may apply when a Form 5471 isn’t filed, is filed late, or is substantially incomplete. Section 6038 provides for an initial penalty of $10,000 per Form 5471 per year. The statute of limitations for assessing and collecting penalties is three years after a substantially complete Form 5471 has been filed. The term substantially complete isn’t defined in the code or regulations. A Form 5471 may be deemed not substantially complete if it includes, for example, an understatement of related-party purchases, incomplete earnings and profit information, a balance sheet and income statement inconsistent with US generally accepted accounting principles, or income statement and income tax amounts that aren’t in both functional and US currencies.
We're Here to Help
Moss Adams continuously reviews the regulatory and tax landscape for technology, clean technology, life sciences, and communications and media companies. For more information about any of the issues discussed above, or for insight on how they may impact your business, contact your Moss Adams professional.