Introduction

In this month's roundup, we alert you to recent procedural guidance for spin-off transactions, explain the expanded safe harbor for the "domestic content bonus" for certain credits under the Inflation Reduction Act (IRA), and summarize newly proposed rules for international reporting penalties. On the judicial front, we review a recent taxpayer victory in the Ninth Circuit under the clear reflection of income doctrine and we dissect the DC Circuit's reversal of the Tax Court in a closely watched case addressing foreign reporting penalties.

Tax Fact: According to a recent Cato Institute report, corporate tax revenue as a share of the economy increased from 2.2 percent in 1981 to 3.5 percent in 2021 across 19 Organisation for Economic Cooperation and Development (OECD) countries. Corporate tax revenue as a share of all revenue also increased since 1981, rising from 8.6 percent of total revenue to 9.4 in 2021. 

"[O]n the day the Inflation Reduction Act was passed, we had one auditor for every 150 of the top tier most wealthy taxpayers in the country. I'm not talking about just like 10 million or more in income assets. I'm talking about 250 million, the top-most tier." –IRS Commissioner Danny Werfel

IRS Releases Section 355 Guidance for Corporate Private Letter Ruling Program

Layla Asali, David Zimmerman, and Caroline Reaves

The IRS released two items of guidance this month that relate to spin-off transactions: 

Rev. Proc. 2024-24 revises procedures for taxpayers requesting private letter rulings (PLRs) on tax-free spin-off transactions and solicits feedback on related section 355 issues. Rev. Proc. 2024-24 modifies Rev. Proc. 2017-52, 2017-41 I.R.B. 283, and supersedes Rev. Proc. 2018-53, 2018-43 I.R.B. 667. Among other items, Rev. Proc. 2024-24 sets forth new procedures for requesting rulings related to delayed distributions of the controlled company stock, retention of the stock or debt of the controlled company, and the solvency and viability of the distributing and controlled companies. Rev. Proc. 2024-24 provides new representations that taxpayers will be required to make in ruling requests. These new representations will be relevant primarily for transactions where the distributing corporation retains stock or securities of the controlled corporation and transactions where debt of the distributing corporation is expected to be exchanged for stock or securities of the spun-off corporation. Of particular note is the elimination of the so-called "direct issuance" mechanism for debt exchanges previously allowed under Rev. Proc. 2018-53. Rev. Proc. 2024-24 applies to ruling requests made after May 31, 2024.

Notice 2024-38 presents the IRS's current views on nine concerns that may arise in connection with certain spin-off transactions and requests feedback "for purposes of developing potential published guidance." In particular, the IRS casts doubt on whether the financial intermediary in direct issuance debt exchanges should be regarded as a creditor under general principles. This change in views will mandate more costly intermediated exchanges.  

The Notice sets forth the IRS's current views regarding nine identified areas of concern addressed by Rev. Proc. 2024-24:

• Distinction between delayed distributions of stock and securities of the controlled corporation and retentions of such stock
• Degree of connection between the distributing and controlled corporation that prevents genuine separations
• Solvency and continued viability of the distributing and controlled corporations
• Plan of reorganization requirement for divisive reorganizations
• Application of substance over form, agency, and other relevant theories to intermediated exchanges and direct issuance transactions
• Federal income tax treatment and consequences of post-distribution payments
• Effect of transactions related to the divisive reorganization on securities of the controlled corporation
• Replacement of historic debt of the distributing corporation
• Separate and distinct relevance and application of section 357 to assumptions of liabilities and section 361 to payments to creditors in satisfaction of debt

The Notice states that the IRS will take into account public feedback to develop published guidance, with the objective that the guidance be consistent with the Code, provide certainty to the taxpayers and the IRS, and "be responsive to the manner in which section 355 Transactions are engaged in by taxpayers and reflect current market practices and preferences." Comments on the Revenue Procedure and the Notice are requested by July 30, 2024.

Earlier this year, the IRS announced that it would issue rulings on "device" and on whether a distribution is pursuant to a "plan" under section 355(e). Although Rev. Proc. 2024-24 and Notice 2024-38 do not address device or section 355(e), the IRS has indicated in public comments that they are still working on representations and guidance related to those areas.

Treasury and the IRS Issue Proposed Regulations on International Reporting Penalties

George Hani and Sam Lapin

On May 8, 2024, the Department of the Treasury (Treasury) and the IRS issued proposed regulations, "Transactions With Foreign Trusts and Information Reporting on Transactions With Foreign Trusts and Large Foreign Gifts" (REG-124850-08) (the Proposed Regulations). The Proposed Regulations preview long-awaited formal guidance on anti-abuse provisions and reporting requirements addressing transactions with foreign trusts and receipt of large foreign gifts as well as loans from, and use of property of, foreign trusts. The Proposed Regulations are largely consistent with existing guidance, in particular Notice 97-43, but include certain additions and modifications to account for legislative changes since 1997. The reporting requirements with respect to foreign trusts and gifts from foreign persons have taken on prominence in recent years as the IRS has increased emphasis on enforcement and, as a result, imposed penalties for non-compliance. 

The Proposed Regulations first provide guidance on two anti-abuse provisions, sections 643(i) and 679, that address consequences of transactions with and ownership of foreign trusts by U.S. persons. 

• Section 643(i) treats loans from a foreign trust to a grantor or beneficiary as distributions. The Proposed Regulations provide definitions for and exceptions to the general rule under section 643(i). Of particular note, the Proposed Regulations formalize and elaborate on an exception under which a loan from a foreign trust to a U.S. person is not considered a distribution if made in exchange for a "qualified obligation." 
• Under section 679, a foreign trust is treated as grantor trust if it (1) has one or more U.S. beneficiary and (2) is established by U.S. persons. The Proposed Regulations provide details on key definitions, such as "U.S. person," particularly in the context of dual citizens, and provide guidance on when a direct or indirect loan from a foreign trust to a U.S. person will cause section 679 to apply.

The Proposed Regulations also provide guidance on information reporting requirements under section 6039F, which applies to U.S. persons that receive large foreign gifts, and section 6048, which has several distinct reporting requirements related to U.S. persons' transactions with and ownership of foreign trusts. 

• The Proposed Regulations define "foreign gift" for purposes of section 6039F, providing thresholds and aggregation rules that apply depending on whether a gift is received from a foreign individual or corporation. 
• Section 6048(a) requires that certain U.S. persons report "reportable events," which include (1) the creation of a foreign trust by a U.S. person, (2) any transfer of property to a foreign trust by a U.S. person, and (3) the death of any U.S. person that was treated as the owner of any portion of a foreign trust. The Proposed Regulations elaborate on the definition of each of those terms and, notably, include constructive transfers within the definition of "reportable event." 
• Section 6048(b) requires that a foreign trust owned to some extent by a U.S. person must report to the IRS and to each beneficiary information on its activities and operations, including distributions to U.S. persons. The Proposed Regulations also provide, in part, that a U.S. beneficiary that receives a statement from a foreign trust must treat distributions received in a manner that is consistent with the treatment the trust's treatment on the statement. 
• Section 6048(c) requires U.S. persons that receive one or more distribution from a foreign trust to report such distribution. The Proposed Regulations provide guidance on the definition of a reportable distribution, reporting requirements imposed on the foreign trust, and on the tax treatment to U.S. beneficiaries of distributions received.

Finally, the Proposed Regulations provide guidance on the penalties imposed to enforce those requirements. They provide guidance on the penalty for failure to report a foreign gift under section 6039F, which can amount to a maximum of 25 percent of the value of the gift, clarifying that the reasonable cause exception to the section 6039F(c) penalty adopts the principles set forth in the regulations under sections 6664 and 6651. They also provide guidance on section 6677 penalty for failure to comply with the reporting requirements imposed in section 6048, which can range from an amount equal to five percent up to 35 percent of the amount transferred or assets of the trust, as the case may be. 

Taxpayers may comment and request a public hearing on the proposed regulations through July 8, 2024.

Ninth Circuit Affirms Taxpayer Win Under the Clear Reflection of Income Doctrine

George Hani and Jim Gadwood

The U.S. Court of Appeals for the Ninth Circuit has affirmed the Tax Court's decision in Continuing Life Communities Thousand Oaks LLC v. Commissioner, T.C. Memo. 2022-31, which rejected an IRS-imposed accounting method change and upheld the taxpayer's accounting method (previously discussed here). The taxpayer provides housing and care to senior citizens under "life-care contracts" and these contracts require a resident to make an upfront payment to a trust. Upon the earlier of the resident's death or voluntary departure, the trustee pays a predetermined portion of this upfront payment (the Deferred Fee) to the taxpayer and returns the remainder to the resident or the resident's estate. The Deferred Fee increases over time to a maximum of 25 percent of the upfront payment after four years from the date of the life-care contract. For book and tax purposes, the taxpayer included the Deferred Fee in income over the resident's actuarially determined expected life (adjusted annually). The IRS stipulated that the taxpayer's method followed applicable Generally Accepted Accounting Principles (GAAP) but nevertheless sought to accelerate the Deferred Fee for tax purposes to the first four years of each life-care contract.

The IRS argued that while the regulatory rule that consistent compliance with GAAP "will ordinarily be regarded as clearly reflecting income" (Treas. Reg. § 1.446-1(a)(2)), the taxpayer's accounting method for the Deferred Fee failed to satisfy the all-events test for accrual method taxpayers. In an unpublished opinion, the Ninth Circuit agreed with the Tax Court that the taxpayer did in fact satisfy the all-events test since the taxpayer's "right to receive any deferred entrance fee from a resident becomes fixed only once [the taxpayer] fulfills its statutory and contractual obligation to provide lifetime care to that resident." Slip Op. at 3 (emphasis in original). The Ninth Circuit concluded that the "provision of lifetime care is thus properly understood as a condition precedent, not a condition subsequent, to [the taxpayer's] right to receive any deferred entrance fee." Id.

Somewhat disappointingly, the Ninth Circuit did not engage on the more provocative aspects of the Tax Court's opinion regarding the clear reflection doctrine. The Tax Court had observed a contradiction between section 446 and Treas. Reg. § 1.446-1(a)(2). The former is conditional: "If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, then computation of taxable income shall be made under such method as, in the opinion of the secretary, does clearly reflect income" (emphasis added). The latter is unconditional: "However, no method of accounting is acceptable unless, in the opinion of the Commissioner, it clearly reflects income." The Tax Court referred to this contradiction as "plain" but observed that neither party had questioned the regulation's validity under Chevron step one. 

The Tax Court also concluded that century-old case law vested the Tax Court's predecessor — the Board of Tax Appeals — rather than the IRS Commissioner with discretion to determine whether an accounting method clearly reflects income. Subsequent case law giving this discretion to the IRS has led to "the peculiarity of discretion in the Commissioner to change accounting methods that courts can review for abuse of discretion in a de novo deficiency proceeding unbound and unjustified by any record that the Commissioner prepares." While questioning this state of affairs, the Tax Court concluded that "[t]his evolution is beyond our power as a trial court to change."

The Ninth Circuit did not accept this seeming invitation from the Tax Court to evaluate and potentially change the longstanding landscape regarding IRS discretion under the clear-reflection doctrine. Instead, the Ninth Circuit constrained itself to the straightforward holding that where a taxpayer's accounting method clearly reflects income and is consistent with regulatory requirements, the IRS lacks authority to impose an alternative accounting method that more clearly reflects income.

DC Circuit Reverses Tax Court, Holds IRS Can Assess Foreign Reporting Penalty

Jim Gadwood, Sam Lapin, and Omar Hussein

The Court of Appeals for the DC Circuit has reversed the U.S. Tax Court and held that the IRS has authority to assess section 6038(b) penalties for failing to file an IRS Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations. See Farhy v. Comm'r, No. 23-1179 (slip op.) (D.C. Cir. May 3, 2024). While a significant win for the IRS, this is unlikely to be the last word on the matter. Taxpayers residing in jurisdictions other than the DC Circuit with current or potential disputes over section 6038(b) penalties — or other similar penalties outside of Title 26, Subtitle F, Chapter 68 of the United States Code — should continue to consider their potential legal rights and remedies.

In Farhy, the IRS assessed section 6038(b) penalties against an individual who willfully failed to file Forms 5471 with respect to two wholly owned foreign corporations. After receiving an adverse Notice of Determination in a collection due process hearing, the taxpayer petitioned the Tax Court and argued that the IRS lacks authority to assess section 6038(b) penalties. The Tax Court held for the taxpayer, concluding that while Congress explicitly authorized the IRS to assess some penalties, Congress granted no such authority for the IRS to assess section 6038(b) penalties. The implication was that the IRS could seek to collect such penalties only through a referral to the Department of Justice (DOJ) to initiate a civil action against the penalized taxpayer. 

On appeal, the DC Circuit reversed the Tax Court and held that the IRS has authority to assess section 6038(b) penalties. The DC Circuit began its analysis by concluding that Congress enacted section 6038(b) to streamline enforcement of the requirement to file Form 5471 and that requiring the DOJ to bring a civil action to collect the penalty would be inconsistent with this purpose. In addition, the court held that the statutory provision directing the IRS — rather than a district court or the DOJ — to make reasonable cause determinations with respect to the section 6038(b) penalty would be anomalous if Congress did not intend for the penalty to be assessable by the IRS. The court also found that coordination of the section 6038(b) and section 6038(c) penalties, which apply to the same conduct, would be unworkable if the section 6038(c) penalty was assessable (a point the taxpayer conceded) but the section 6038(b) penalty was not. This could result in parallel court proceedings, preclusion issues, and forum shopping. Finally, the court found it persuasive that Congress has amended section 6038 seven times since enacting the section 6038(b) penalty without ever questioning the IRS's practice of assessing such penalties.

It remains to be seen whether the taxpayer will petition the Supreme Court to review the DC Circuit's opinion. Either way, we expect more judicial activity on this issue as similar cases make their way through the courts. For example, less than a month before the DC Circuit's opinion, the Tax Court followed its holding in Farhy in another case under the principle of stare decisis. See Mukhi v. Comm'r, 162 T.C. No. 8, No. 4329-22L (slip op.) (Apr. 8, 2024). Mukhi is appealable to the U.S. Court of Appeals for the Eighth Circuit and thus has the potential to create a circuit split, which could improve the odds for eventual Supreme Court review. 

IRS Issues Notice 2024-41 Providing a Safe Harbor for Domestic Content Bonus Determinations

Andy Howlett and Jorge Castro 

On May 16, 2024, the IRS issued Notice 2024-41, which expanded the safe harbors for the "domestic content bonus" that applies to certain credits that the IRA, Pub. L. 117-169, enacted or expanded. The IRS later released a corrected version on May 24, which restored some text that it inadvertently omitted. 

The credits at issue are:

• The section 45 credit for clean electricity production
• The section 48 investment tax credit for clean electricity facilities
• The section 45Y credit for clean electricity production for facilities placed in service after December 31, 2024 (replacing the section 45 credit)
• The section 48E investment tax credit for clean electricity facilities placed in service after December 31, 2024 (replacing the section 48 credit)

Each of these credits has a "domestic content bonus" provision, which increases the amount of the credit if the taxpayer certifies to the IRS that any steel, iron, or manufactured product which is a component of the facility was produced in the United States, as determined under certain provisions of Title 49 of the Code of Federal Regulations (the Department of Transportation (DOT) Buy America Requirements).

In the case of manufactured products, the relevant statutes for a "deemed production in the United States rule" provide that the manufactured products which are components of a qualified facility are deemed to have been produced in the United States. if not less than the "adjusted percentage" of the total costs of all such manufactured products of such facility are attributable to manufactured products (including components) which are mined, produced, or manufactured in the United States. The adjusted percentage is currently 40 percent for most facilities, but will increase beginning with facilities placed in service after December 31, 2024. This is the "adjusted percentage rule."

Last year, the IRS released Notice 2023-38, which provided guidance on the calculations required for the domestic content bonus, including with respect to the adjusted percentage rule. Notice 2024-41 modifies Notice 2023-38 and taxpayers may rely on the two notices for the domestic content bonus credit requirements for projects, the construction of which begins before the date that is 90 days after the publication of forthcoming proposed regulations on the issue. Separately and significantly, the IRS reserved the right to modify the "safe harbor" on the adjusted percentage rule (discussed below), and if it does so, taxpayers will have 90 days after such modification to begin construction and still rely on the unmodified safe harbor. 

Notice 2024-41 includes an elective "safe harbor" by which certain manufactured product components (MPCs) of a clean energy facility are deemed to have a fixed percentage cost compared to all MPCs. If, and only if, those MPCs are produced in the United States, then the fixed percentage cost can be used to determine the adjusted percentage for purposes of satisfying the adjusted percentage rule. The safe harbor essentially allows for an assumed cost, which will mean that taxpayers and manufacturers of clean energy facilities will not need to go through a complicated calculation in determining each component's overall cost to the facility. If a taxpayer elects to use the safe harbor, it must affirmatively notify the IRS in the manner described in Notice 2024-41 and it must use the safe harbor exclusively for the relevant calculations. 

The IRS demurred on most additional guidance relating the domestic content bonus, declining to respond to many issues that stakeholders raised in comments to Notice 2023-38. It stated that it and Treasury "intend to consider comments received on other sections of the notice in the context of forthcoming proposed regulations or any further guidance regarding the domestic content bonus requirements." 

Appellate Briefing Commences in Liberty Global

Jeffrey Tebbs

Briefing is underway in Liberty Global's appeal to the Tenth Circuit of an adverse ruling on the scope of the codified economic substance doctrine. On April 30, 2024 Liberty Global filed its opening brief. On May 6, Miller & Chevalier submitted an amicus brief on behalf of the National Foreign Trade Council (NFTC), cautioning that "[t]he district court's decision has the potential to destabilize the application of the federal tax law, inserting uncertainty into routine transactions never intended by Congress to be within the sweep of the economic substance doctrine." The brief for the DOJ is due on June 28, 2024. 

In a companion case that remains at the district court, the court recently discussed certifying a related procedural issue for interlocutory appeal. 

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

This, and related communications, are protected by copyright laws and treaties. You may make a single copy for personal use. You may make copies for others, but not for commercial purposes. If you give a copy to anyone else, it must be in its original, unmodified form, and must include all attributions of authorship, copyright notices, and republication notices. Except as described above, it is unlawful to copy, republish, redistribute, and/or alter this presentation without prior written consent of the copyright holder.