Energy Boost
Treasury and IRS Issue Interim Guidance on IRA Domestic-Content Bonus Credit. The Treasury Department and the Internal Revenue Service (IRS) released IRS Notice 2023-38 (“Notice”) on May 12, providing interim guidance on domestic-content requirements under the Inflation Reduction Act (IRA). The Notice applies to the new bonus credit available for energy facilities, projects and energy-storage technologies otherwise qualifying for the current or tech-neutral production tax credits (PTCs under sections 45 or 45Y) or the current or tech-neutral investment tax credits (ITCs under section 48 or 48E). While not explicitly addressed, the Notice presumably also applies to the phase-out of the direct-pay election for qualifying tax-exempt entities intending to monetize the applicable credits.
The Notice includes definitions and rules for determining whether an energy facility or project meets: (1) the 100% domestic-sourcing mandate for steel and iron and (2) the manufactured-products requirement, both of which must be satisfied to qualify for the bonus credit. The Notice bases the domestic-content rules on the Buy America Requirements administered by the Federal Transit Administration, which have long applied to federally funded transportation and mass-transit projects. While welcome news to energy-project developers, the interim guidance will require significant analysis of the myriad components and manufactured products comprising energy projects to ensure they meet the domestic-sourcing rules set out in the Notice to qualify for the bonus credit.
The Treasury Department and the IRS noted that the interim guidance will be reflected in proposed regulations on the domestic-content requirements, which are intended to apply to taxable years ending after May 12, 2023. In the interim, the Notice permits taxpayers to rely on the guidance with respect to energy facilities, projects or energy-storage technology that commence construction before the date that is 90 days after the proposed regulations are published in the Federal Register.
Unlike the other interim guidance that the Treasury Department and the IRS have released on IRA provisions, the Notice does not invite public comment nor offer areas where specific feedback is requested. Nevertheless, the Treasury Department and the IRS continue to engage with industries seeking to access tax credits under the IRA, and taxpayers should consider providing feedback on the Notice to take advantage of the continuing opportunity to influence the proposed and final regulations.
Legislative Lowdown
Senate Democrats Scrutinize Tax Practices of Pharmaceutical Companies, While Republicans Take Aim at Pillar Two. On Thursday, May 11, the Senate Finance Committee held a hearing that was intended to discuss the perceived tax avoidance by multinational pharmaceutical companies in the wake of the 2017 Tax Cuts and Jobs Act (TCJA). However, none of the Republican lawmakers in attendance focused on pharmaceutical-industry-specific issues, instead, seizing the opportunity to highlight the merit of TCJA and criticize the ongoing implementation of the Organisation for Co-operation and Development (OECD) Pillar Two global minimum-tax regime. In his closing remarks, Senate Finance Committee Chairman Ron Wyden (D-OR) joked that “the Republican side of the committee seems to have attended a different hearing.”
Committee Democrats said that large pharmaceutical companies often hold their most valuable intellectual property (IP) abroad or manufacture products overseas so that they can attribute significant profits to foreign tax jurisdictions. Democrats also claimed that while there was profit shifting before TCJA, the law significantly decreased penalties on companies that relocate their operations and assets abroad. Testifying on the issue, Brad Setser, a fellow at the Council on Foreign Relations, said TCJA’s introduction of the Global Intangible Low-Taxed Income (GILTI) regime incentivized companies to move their production and IP offshore.
Several Republican lawmakers disagreed with Democrats on the merits of TCJA’s international tax provisions, arguing that the law ended inversions, increased domestic research and development (R&D) expenditures and boosted U.S. corporate tax receipts. Moreover, committee Ranking Member Mike Crapo (R-ID) said TCJA led to record-high corporate tax receipts and significantly increased U.S. competitiveness in global markets.
In their questions, Republicans highlighted several aspects of the OECD Pillar Two agreement that they believed were disproportionately harmful to U.S. companies. Ranking Member Crapo and Sen. Chuck Grassley (R-IA) noted that the global minimum-tax rules are more advantageous for countries that use subsidies than those that employ non-refundable tax credits. Specifically, Sen. Todd Young (R-IN) suggested that myriad U.S. corporate tax breaks, like the R&D incentive, would be treated much less favorably under the regime than the direct subsidies used by China to grow its domestic manufacturing sector. Ranking Member Crapo and Sen. Marsha Blackburn (R-TN) also criticized the Biden administration for failing to consult Congress throughout the development of the Pillar Two agreement.
Before the hearing, Chairman Wyden released a Democratic staff memorandum reflecting the updated results of his ongoing investigation into the tax practices of multinational pharmaceutical companies. Among other findings, the report alleges that the average effective tax rate of the seven largest U.S. pharmaceutical corporations was 11.3% in 2021. In conjunction with the memorandum, Wyden published a letter from the Joint Committee on Taxation that estimates the foreign share of the taxable income of large pharmaceutical companies to be approximately 75%.
Discussions regarding international taxation come as several governments have already begun to enact policies to implement the Pillar Two regime. Notably, the European Union reached a preliminary agreement in December for each member country to adopt the changes to their domestic tax laws by the end of 2023. Other countries, such as South Korea, the United Kingdom, Australia and Japan, have also taken steps toward adoption of the global minimum tax.
Tax Worldview
Bicameral Tax Writers Assert Jurisdiction Over Development of Taiwan Tax Agreement. Last week, the chairmen and ranking members of the House Ways and Means and Senate Finance committees issued a joint statement in favor of modifying the tax code to alleviate double taxation between the United States and Taiwan. The renewed interest in legislative action comes as lawmakers from both parties seek to expand trade with Taiwan to counter China’s growing economic and military strength. While the tax writers support the development of “treaty-like benefits” for Taiwan, they note that the current U.S. policy of strategic ambiguity toward the country “precludes [Taiwan] from the typical process of remedying double taxation through a treaty.”
On May 4, Senate Foreign Relations Committee Chairman Bob Menendez (D-NJ) introduced bipartisan legislation that would accomplish the lawmakers’ objectives by allowing the Biden administration to negotiate a “tax agreement” between the American Institute in Taiwan and the Taipei Economic and Cultural Representative Office, which would be subject to congressional approval. In a statement after the bill’s introduction, Chairman Menendez said that “[a]s far as [he was] concerned, [the bill] is a treaty, and virtually all treaties end up in the Foreign Relations committee.”
However, Senate Finance Committee Ranking Member Mike Crapo (R-ID) criticized Chairman Menendez’ position, arguing that the agreement is a “Finance Committee issue” because it will be accomplished through the tax code, not through the traditional treaty ratification process. Tax committee members are now reportedly working on their own proposal. Notwithstanding jurisdictional disagreements, Treasury Secretary Janet Yellen took a neutral position, arguing that the lack of a formal economic agreement with Taiwan is a “very significant problem” and the United States really needs to explore ways to deal with it.
The proposed legislation follows the passage of the CHIPS Act of 2022, which included a broad range of incentives to support the domestic manufacture of semiconductors. However, eligible manufacturers currently face double taxation from business operations in the United States and Taiwan. A tax arrangement between the two countries would address that issue and, presumably, create a formal mechanism for resolving disputes. To date, several other U.S. trade partners have implemented formal tax agreements with Taiwan, including the United Kingdom, Germany and France.
OECD Says Pillar One Agreement Likely in July. At the Tax Council Policy Institute conference last week, Manal Corwin, director of the Centre for Tax Policy and Administration at the Organisation for Economic Co-operation and Development (OECD), said the text of the Pillar One multilateral convention (MLC) would likely be published by the end of July. Corwin noted that the release of the MLC hinges on agreement from the OECD/G20 Inclusive Framework, but “[g]iven the progress to date and the constructive engagement among delegates,” the process is “still on track.”
Pillar One would reallocate the profits of certain multinational corporations to tax jurisdictions where businesses have customers but not a physical presence. Currently, several countries levy unilateral digital service taxes (DSTs) to collect revenue from companies engaging in certain digital activities within their jurisdictions. However, in 2021, the OECD/G20 Inclusive Framework committed not to enact new DSTs until the earlier of Dec. 31, 2023, or the implementation of the MLC.
At the conference, Corwin noted that negotiators continue to debate Amount B under Pillar One, which is intended to encompass the marketing and distribution activities of multinational businesses. The rules are aimed at streamlining the transfer pricing of in-country baseline marketing and distribution activities for taxing jurisdictions, as well as limiting transfer-pricing disputes.
In 2021, nearly 150 tax jurisdictions agreed to the basic principles of the Pillar One agreement. However, Corwin said that after the release of the MLC text, a “critical mass” of countries would need to ratify the agreement through their individual legislative and administrative processes for it to come into effect. To meet this threshold, the MLC must be implemented by the residence jurisdictions of the “substantial majority of the in-scope companies whose profits will be subject” to the agreement, in effect meaning that the United States must ratify the MLC for the “substantial majority” threshold to be satisfied. However, U.S. approval of the MLC would require the Senate to ratify a treaty by a two-thirds affirmative vote, which is unlikely to occur given Republicans’ strong opposition to the agreement. Addressing the possible implementation hurdles, Corwin said the OECD may offer “some form of transition measures … or other ways in which to continue the momentum, again, assuming that the milestones are being met."
1111 Constitution Avenue
Gillibrand Questions Werfel on the IRS’ Ongoing ERTC Delay. Earlier this month, Sen. Kirsten Gillibrand (D-NY) sent a letter to Internal Revenue Service (IRS) Commissioner Danny Werfel requesting an update regarding the current backlog of Employee Retention Tax Credit (ERTC) claims. In her letter, Sen. Gillibrand noted that she continues “to hear from New York businesses that have yet to receive their tax refunds for claims filed during the 2021 and 2022 tax seasons.” Sen. Gillibrand says that the ERTC was intended to be delivered quickly to ensure businesses could survive difficult economic conditions spurred by the COVID-19 pandemic and should be prioritized to protect local businesses. While the letter highlights administrative delays that may have occurred at the IRS due to historic underfunding, it suggests that recent funding provided to the agency from the Inflation Reduction Act should now expedite the issuance of refunds.
Noting that the ERTC backlog has only increased since last year, Sen. Gillibrand posed several questions to Commissioner Werfel, requesting answers by May 18. These questions include inquiries regarding the current state-by-state allocation of unresolved ERTC claims, as well as a request for a follow-up on Commissioner Werfel’s promises regarding the ERTC made during a Senate Finance Committee hearing last April. Last year, the Treasury Inspector General for Tax Administration issued a report detailing the explanations for ERTC delays, which included a lack of adequate scanning technology to digitalize returns, as well as a significant percentage of “questionable characteristics” of claimants that are identified using identity theft fraud filters.
IRS Releases Long-Awaited Report on Direct E-File Proposal. The Internal Revenue Service (IRS) released a Report to Congress on Tuesday, May 16, concerning the feasibility of an IRS-run direct e-file tax return system. The report was mandated by the Inflation Reduction Act, which provided the IRS $15 million to furnish an analysis on:
(a) the cost of developing and running an IRS-operated direct e-file tax system, including the costs to build and administer the system;
(b) taxpayer opinions and expectations based on surveys of such a system; and
(c) the opinion of an independent third party on the overall feasibility, approach, cost and capacity of the IRS to deliver such a system.
Among other conclusions, the report estimates the annual cost of a Direct File option to be between $64 million and $249 million, depending on the number of users. The report also identifies several potential implementation challenges that the agency indicates it will need further information to address. However, the report notes that the Treasury Department has directed the IRS to implement a “scaled Direct File pilot” in the 2024 filing season to further assess customer support and technology needs and the ability to overcome the potential operational challenges identified in the report. GOP lawmakers are likely to strongly oppose the creation of the pilot program because it was not explicitly approved by Congress.
Republican lawmakers have already criticized the merits of the “independent opinions” section of the report prepared by the organization New America as predetermined since the think tank has previously opined in favor of such an IRS-operated filing system. Republicans have also questioned the IRS’s statutory authority to build such a system, as well as its necessity and the potential conflict of interest in having the IRS serve as the tax preparer and tax auditor.
Notwithstanding Republicans’ disapproval, Sens. Elizabeth Warren (D-MA) and Tom Carper (D-DE) led a letter to IRS Commissioner Danny Werfel last month requesting that the agency simplify the tax-filing process and expedite the consideration of an IRS-operated e-filing program. The letter highlights the e-file study, urging the IRS “to roll [the system] out as quickly as possible” if the report concludes that “such a system is feasible.” The letter was signed by 29 other Democratic senators, including Senate Finance Committee Chairman Ron Wyden (D-OR).
If the Treasury Department and IRS move forward with a direct e-file system, this would represent the first time the agency has directly engaged in tax preparation. Each year, commercial tax preparers provide an estimated 3–4 million free returns through the IRS Free File Program. In 2021, commercial preparers also provided more than 27 million free returns outside of the Free File Program.
At a Glance
Lawmakers Reintroduce Bipartisan LIHTC Expansion Legislation. On April 11, a bipartisan, bicameral group of lawmakers introduced the Affordable Housing Credit Improvement Act of 2023, which would significantly expand the Low-Income Housing Tax Credit (LIHTC) program. The legislation would restore the 12.5% LIHTC cap increase that expired in 2021 and further increase allocations by 50% over two years, in addition to several other credit expansions. The bill would also provide authority to states to grant an additional discretionary boost to improve the economic feasibility of certain projects. The bill has amassed 65 co-sponsors in the House and three in the Senate. Earlier this year, Senate Finance Committee Chairman Ron Wyden (D-OR) said he strongly “believe[s] the next opportunity for a big, bipartisan initiative is affordable housing."
Brownstein Bookshelf
Debt-Ceiling Talks Continue as “X Date” Approaches. President Joe Biden told reporters last week that he is meeting with House Speaker Kevin McCarthy (R-CA) on Tuesday to continue debt-ceiling negotiations in the lead-up to a possible default as early as June 1.
Hearings and Events
House Ways and Means Committee
The committee has no upcoming tax hearing scheduled for this week.
Senate Finance Committee
On Tuesday, the full committee held a hearing entitled “House Republican IRS Funding Cuts Impacting Federal Law Enforcement.” The following witnesses testified:
- Natasha Sarin, Associate Professor of Law, Yale Law School
- John Fort, Director of Investigations, Kostelanetz LLP
- Pete Sepp, President, National Taxpayers Union
- Chris Edwards, Kilts Family Chair in Fiscal Studies, Cato Institute
On Tuesday, the Subcommittee on International Trade, Customs and Global Competitiveness held a hearing entitled “Economic Cooperation for a Stronger and More Resilient Western Hemisphere.” The following witnesses testified:
- Jonathan Fantini Porter, CEO, Partnership for Central America
- Eric Farnsworth, Vice President, Council of the Americas
- Margaret Myers, Director, Asia and Latin America Program, Inter-American Dialogue, Woodrow Wilson Center
- Cathy Feingold, Director of the International Department, AFL-CIO
- Neil Herrington, Senior Vice President, Americas Program, United States Chamber of Commerce
On Thursday, the full committee will hold a hearing entitled “Tax Incentives in the Inflation Reduction Act: Jobs and Investment in Energy Communities.” The following witnesses will testify:
- Katie Harris, Legislative Director, BlueGreen Alliance
- Daniel Simmons, Principal, Simmons Energy and Environmental Strategies
- Philip Rossetti, Resident Senior Fellow, Energy, R Street Institute
- Patty Horvatich, Senior Vice President, Business Investment, Pittsburgh Regional Alliance
Senate Budget Committee
On Wednesday, the Senate Budget Committee will hold a hearing entitled “The Rich Get Richer, Deficits Get Bigger: How Tax Cuts for the Wealthy and Corporations Drive the National Debt.” The following witnesses will testify:
- Bobby Kogan, Senior Director Federal Budget Policy, Center for American Progress
- Bruce Bartlet, Former Deputy Assistant Secretary for Economic Policy, United States Department of Treasury
- Samantha Jacoby, Senior Tax Legal Analyst, Center on Budget and Policy Priorities
- Adam Michel, Director of Tax Policy Studies, Cato Institute
- Scott Hodge, President Emeritus and Senior Policy Advisor, Tax Foundation