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As previously reported by Ropes & Gray, on July 24, 2018, the Ninth Circuit reversed the Tax Court’s prior decision in the Altera case and upheld the IRS regulation requiring the allocation of stock-based compensation in qualified cost-sharing agreements. The decision was particularly notable since it ended in a 2-1 vote, in which Judge Reinhardt, who passed away in March 2018, cast the deciding vote. Late last week, the Ninth Circuit appointed a new judge, Susan Graber, to replace Judge Reinhardt under a local procedural order mandating that the court clerk randomly draw a replacement judge upon the death of any panel member. However, in lieu of awaiting any motions for rehearing, today the Ninth Circuit withdrew its opinion “to allow time for the reconstituted panel to confer on this appeal.” Since a withdrawn decision has no legal effect and the decision of the court could change, affected taxpayers who have not already taken action in response to the decision should consider watching and waiting for a new opinion to be issued before taking any further action. To read today’s order, click here.

In an unexpected 2-1 decision, Judge Reinhardt, who passed away in March of this past year, cast the Ninth Circuit’s deciding vote to reverse the Tax Court’s prior ruling in Altera. In 2015, the Tax Court invalidated Treasury Regulation 1.482-7A(d)(2)’s requirement that related parties allocate stock-based compensation costs when entering into cost-sharing agreements to develop intangible assets. The Tax Court’s decision in Altera centered on the IRS’s failure to support the regulation with examples of unrelated parties sharing stock-based compensation costs (comparable uncontrolled transactions). This failure was fatal, according to Judge Marvel of the Tax Court, because to require related taxpayers to share stock-based compensation absent any evidence of similar behavior by unrelated parties would mean the regulation did not seek parity between these groups of taxpayers, contrary to the long-standing arm’s-length principle for transfer pricing. As a result, the Tax Court held that the regulation did not meet the reasoned decision-making standard in the State Farm Supreme Court case.

Click here to read the full alert.

Move over, South Dakota v. Wayfair Inc. During the long debate over the U.S. Supreme Court’s physical presence standard for state sales taxes, a quiet revolution in state corporate income taxes has been taking place — the shift to market-based sourcing for services income. By the early 2000s, only a smattering of states had adopted market-based sourcing; by 2018, that number has grown to include more than half of the states. Now that the Supreme Court has resolved the physical presence standard in its recent Wayfair decision, bringing with it new nexus standards for state taxes, will market-based sourcing be the next state tax debate?

Click here to read the full Law360 article that contains further insights from Gabby and Michael Benison, a summer associate at Ropes & Gray.

On June 21, 2018, the Supreme Court ruled 5-4 in South Dakota v. Wayfair et al. that the Constitution does not prevent the State of South Dakota from requiring large online retailers without actual physical presence in the state to collect and remit sales tax. The Supreme Court’s decision is based on a South Dakota statute that it viewed as not imposing significant burdens on interstate commerce, because, among other things, it was prospective in its application, imposed a single level of tax and applied only to non-resident sellers that deliver more than $100,000 in goods or services or engage in 200 or separate transactions for the delivery of goods and services into South Dakota. The Court otherwise left open the question of whether other statutory conditions would render a similar result.

Click here to read the full alert.

On May 21, 2018, the IRS Large Business & International Division (“LB&I”) announced its fourth set of compliance campaigns.  The six new campaigns include one campaign centered on Forms 3520 and 3520-A compliance.  A Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, must be filed to report certain transactions regarding foreign trusts under section 6048 of the Internal Revenue Code, including:

  • Creation of a foreign trust by a U.S. person
  • Any transfer of money or property to a foreign trust, including by reason of death
  • Ownership of foreign trusts, including death of the U.S. owner of a foreign trust
  • Loans and distributions from foreign trusts
  • Gifts or bequests from foreign individuals or estates
  • Gifts from foreign corporations or partnerships

A Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, must be filed annually by a foreign trust with a U.S. owner.

The other five new compliance campaigns focus on (1) withholding, depositing, and reporting requirements of withholding agents under Forms 1042 and 1042-S; (2) compliance with tax treaties providing for exemptions from U.S. income; (3) itemized deductions claimed on Form 1040-NR, the U.S. Nonresident Alien Income Tax Return; (4) tax credits claimed on Form 1040-NR; and (5) the capitalization of interest associated when the construction of real and certain personal property.  As in prior campaigns, in addition to conducting audits, education of taxpayers and practitioners will be an important aspect of most of these campaigns.

As previously described in part in Disputing Tax and in a recent Bloomberg article that included remarks from Kat Gregor, Facebook has been involved in a multi-front litigation with the IRS for almost two years.  It began when Facebook refused to extend the statute of limitations for a sixth time to allow the IRS to continue to its nearly five-year long audit of Facebook for the tax years 2008 to 2010.  The IRS responded by filing suit to enforce a summons and then by issuing a Notice of Deficiency alleging that Facebook owed additional tax as a result of its $7 billion undervaluation of certain intangibles transferred to Facebook Ireland.  Facebook appealed the Notice of Deficiency in Tax Court and also filed two separate lawsuits in the U.S. District Court for the Northern District of California. Continue Reading Northern District of California Strikes a Blow to the Taxpayer Bill of Rights in Facebook Decision

On May 14, 2018, the Supreme Court struck down the Professional and Amateur Sports Protection Act (PASPA) in Murphy v. NCAA. PASPA was passed in 1992 to prevent the expansion of sports gambling by the states. Prior to PASPA, only four states, Nevada, Delaware, Montana and Oregon, had legalized sports wagering. Until the Supreme Court’s decision, PASPA prevented any additional states from joining their ranks.

The Supreme Court was presented with a challenge to the state of New Jersey’s attempts to repeal prior states laws prohibiting sports wagering. The state argued that its actions could not be constitutionally prohibited under principles of state sovereignty. The Supreme Court agreed, reasoning that, under the Tenth Amendment, the federal government could either pass its own federal legislation regulating sports wagering and thereby pre-empt state legislation or leave the states to regulate sports wagering as they saw fit, but it could not compel state legislatures to enact state laws in service of federal interests.

Although the decision leaves open the possibility that the federal government could pass legislation prohibiting sports wagering affecting interstate commerce, unless it does so, the right to authorize sports wagering has been returned solely to the states. Several states in addition to New Jersey, including New York, Pennsylvania, Connecticut, Mississippi, and West Virginia, recently passed legislation authorizing sports wagering in anticipation of PASPA being struck down. Nearly 20 states have separately passed legislation to allow for fantasy sports gaming, including most of New England, New York, and the Mid-Atlantic, as well as a collection of states across the Southern and Midwestern United States.

As states rush to change their laws, industry experts estimate that the sports wagering industry could grow to tens or even hundreds of billions of dollars in gross revenue. Although some commentators have already issued warnings about the regressive nature of gambling taxes and the limited profitability of sports wagering, many states are betting on a sports wagering payday and tacking revenue raising measures onto these legalization efforts. A new Pennsylvania law, for instance, requires a license fee of up to $50,000 to conduct fantasy contests and a 15% tax on gross gaming revenues, the total revenue after deducting prizes paid out, and a $10,000,000 license fee and a 34% tax on gross gaming revenue. A new Mississippi law will charge a license fee of $5,000 to fantasy sports operators and impose a tax on 8% of revenues. Legislation introduced in Kentucky would charge a $250,000 initial license fee to sports wagering operators and impose a 20% tax on gross gaming revenue. Although New York has already passed authorizing legislation, it is considering a modified law that would enable mobile sports wagering and charge a tax of 8.5% on gross gaming revenue. As for Massachusetts, it has already legalized fantasy sports gaming through July 31, but is now proposing a permanent provision that would also add a $100,000 license fee and a 15% tax. At this rate, the main wager may be whether the new laws will be fully operational in time for football season.

Click here to read the full client alert.

In this Ropes & Gray podcast, Gabby Hirz, counsel in the tax controversy group, is joined by Loretta Richard, a partner in the tax and benefits group and co-founder of the tax controversy group, and Christi Lazo, counsel in the private client group, to discuss another notable Tax Court decision, Lender Management LLC v. Commissioner of Internal Revenue. Lender Management considered whether a family office was operating a trade or business and could therefore deduct investment expenses as business expenses.

In a recent Tax Notes International article, “Is Fishing in Tax Waters Getting Easier or Just More High Tech?,” Brian Studniberg, Gabby Hirz and Loretta Richard provide commentary on the continued role of international information exchange on request given the availability of automatic information exchange.

Click here to read the full article including further insight from the group.