Tax News and Developments North American Tax Practice Group

Newsletter October 2014 | Volume XIII-X

IRS Notice 2014-58 -- The Economic Substance Doctrine

On October 9, 2014, the IRS issued Notice 2014-58, which provides guidance

concerning the application of the economic substance doctrine (and related

penalties), which were added to the Code in 2010. The Notice provides an

expanded definition of the "transactions" to which the economic substance doctrine

is to be applied. More importantly, the Notice addresses situations in which the

no-fault penalty imposed on transactions lacking economic substance under

Section 6662(b)(6) can be applied on the grounds that the transaction is subject to

a "similar rule of law." We will provide detailed comments on the Notice in a

forthcoming newsletter.

By Richard M. Lipton (Chicago)

IRS Finalizes Revisions to Circular 230

Final Circular 230 regulations issued by the IRS on June 12, 2014 are now in

effect. These regulations, which establish minimum standards of conduct

concerning practice before the IRS, have eliminated the rules for so-called

"covered opinions" and have dismissed the need for ubiquitous legends on all

documents and emails. More specifically, the IRS has changed the rules so that

these disclaimers can now be deleted permanently.

For a more detailed discussion on Circular 230, see Richard M. Lipton's IRS

Finalizes Revisions to Circular 230, Journal of Taxation (September 2014).

OECD Delivers First Seven Components of its Action Plan on Base Erosion and Profit Shifting (BEPS)

In July 2013, the OECD and G20 countries adopted a 15-point Action Plan on

Base Erosion and Profit Shifting (“BEPS”). The first set of seven of the Action Plan

components (the “2014 Deliverables”) were released by the OECD Committee on

Fiscal Affairs (“CFA”) on September 16, 2014, and include:

Two final reports for Action 1 (Digital Economy) and 15 (Multilateral

Treaty);

One interim report for Action 5 (Harmful Tax Practices); and

Four reports containing draft recommendations for:

o Action 2: Hybrid Mismatches

In This Issue:

IRS Notice 2014-58 -- The Economic Substance Doctrine

IRS Finalizes Revisions to Circular 230

OECD Delivers First Seven Components of its Action Plan on Base Erosion and Profit Shifting (BEPS)

The OECD Moves Forward on Initiatives to Curb Treaty Abuse, while US Tax Treaties are Stalled in the US Senate

An Uncertain Path for Tax Extenders

Safeway Successfully Defends Inter-jurisdictional Tax Plan (Yet Again)

Recent French Decision Regarding the Business Tax Cap Mechanism

Publication by the French Tax Administration of Final Transfer Pricing Disclosure Form and Related Guidelines

Recent Development in the Netherlands - Time to Check Your Dutch Holding Company or Financial Services Company’s Substance?

US Supreme Court to Hear Three State Tax Cases

New Illinois “Click-Through” Nexus Law Addresses Some Issues While Leaving and Creating Others

Never a Dull Moment… Michigan Seeks to Re-Write History By Retroactive Repeal of the Multistate Tax Compact

Save the Dates: Baker & McKenzie Announces Upcoming Tax Conferences in San Francisco, Hong Kong, San Diego and Miami

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2 Tax News and Developments October 2014

o Action 6: Treaty Abuse

o Action 8: Transfer Pricing of Intangibles

o Action 13: Transfer Pricing Documentation (“TPD”) and Country-by-

Country Reporting (“CbCR”)

The CFA also issued an Explanatory Statement, which explains that the four

reports containing draft recommendations will be finalized along with the

completion of the remaining Action Plan components in 2015 (the “2015

Deliverables”, due to significant interaction with those deliverables. The first of the

2015 Deliverables are expected to be released in September 2015, and a final

deliverable is scheduled for release in December 2015. The 2015 Deliverables will

include the resolution of pending technical issues and the completion of the

implementation measures for the 2014 Deliverables. Once finalized, the measures

adopted by the OECD would only become effective through changes in domestic

laws, changes to bilateral tax treaties or through the multilateral instrument

envisioned in Action 15.

Below, we provide a brief summary of key points from each of the 2014

Deliverables.

Action 1 - Digital Economy

Action 1 of the BEPS Action Plan (the “Action 1 Report”) focuses on the digital

economy. As the digital economy has increasingly become intertwined with the

economy as a whole, the Action 1 Report does not try to ring fence the digital

economy, but instead focuses on areas in which the digital economy exacerbates

other BEPS risks. A key feature of the digital economy that exacerbates BEPS

risks is mobility with respect to intangibles, users and business functions.

Accordingly, multinational enterprises (“MNEs”) have been able to create business

models under which their infrastructure is centralized at a distance from a market

jurisdiction, while goods and services are sold into that market jurisdiction from a

remote location. Further, the digital economy has increased the ability for MNEs to

conduct activities in jurisdictions with minimal personnel on the ground. This has

provided opportunities for MNEs to achieve BEPS by fragmenting their physical

operations across jurisdictions to avoid creating a taxable presence.

The Task Force on the Digital Economy (“TFDE”), a subgroup within the OECD,

prepared the Action 1 Report. The final report presents seven options for dealing

with the tax challenges created by the digital economy. Five are listed under the

heading of direct tax options and two are listed under the heading of consumption

tax options.

The direct tax options are designed to deal with the problem of MNEs having a

significant presence in a jurisdiction without being considered to have a taxable

permanent establishment (“PE”) under tax treaty principles. The first direct tax

option is to modify the exemptions from PE status in current treaties because

certain activities that are currently considered preparatory or auxiliary have

become essential to certain businesses. A second, creative option presented

would be to create a new nexus standard based on a MNE’s digital presence in a

jurisdiction. The third option focuses on replacing the concept of PE with a

“significant presence” test, which would require some physical presence, combined

with criteria for determining the MNE’s digital presence in the jurisdiction. The next

option would be to impose a withholding tax on digital transactions and the final

direct tax option would be to introduce a bandwidth or bit tax.

Upcoming Tax Events:

Doing Business Globally

Santa Clara, California November 3, 2014 Chicago, Illinois November 4, 2014 New York, New York

November 5, 2014 Dallas, Texas November 6, 2014 30th Annual Asia Pacific Tax Conference

Hong Kong November 13-14, 2014 Second Annual Baker & McKenzie / TEI Tax Workshop

Austin, Texas November 18, 2014 2014 Tax Controversy Workshop

San Francisco, California November 21, 2014 2015 Annual North America Tax Workshop

San Diego, California January 9, 2015

Latin American Tax Conference

Miami, Florida March 17-19, 2015

Baker & McKenzie/Bloomberg BNA Global Transfer Pricing Conference

Paris, France March 30, 2015

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3 Tax News and Developments October 2014

The first consumption tax option provided by the TFDE would be to streamline

compliance mechanisms in order to justify lowering the threshold for exemption of

low value imports for value added tax (“VAT”) purposes. The thresholds in many

jurisdictions were established before the advent and growth of the digital economy.

The second consumption tax option is developing “clear and accessible”

registration mechanisms that would allow for extraterritorial VAT collection.

Action 2 - Hybrid Mismatches

The report related to Action 2 of the BEPS Action Plan (the “Action 2 Report”)

provides recommendations for coordinated domestic tax legislation and tax treaty

provisions to neutralize hybrid mismatch arrangements. The use of hybrid

mismatch arrangements is a sophisticated means to achieve the shifting of income

from an entity subject to tax in a high tax jurisdiction to an entity subject to a low

tax rate on income but incorporated in a high tax jurisdiction. Such results can be

achieved through the use of hybrid entities (i.e., an entity that is treated as a

taxable person in one country but transparent in another country) or through the

use of hybrid financial instruments (i.e., an instrument that is treated as debt under

the laws of the payer country but as equity in the recipient country).

The Action 2 Report is composed of two parts. Part I sets out recommendations for

domestic law changes. Part II sets out recommended changes to the OECD Model

Tax Convention to deal with transparent entities, including hybrid entities, and

addresses the interaction between the recommendations included in Part I and the

provisions of the OECD Model Tax Convention.

The proposed domestic rules target two types of payment. First, the rules are

aimed at so-called “deduction / no inclusion” or “D/NI” outcomes, which are

payments that are deductible under the rules of the payer jurisdiction and not

included in the ordinary income of the payee. In such cases, the Action 2 Report

recommends that the response should be to deny the deduction in the payer’s

jurisdiction. In the event the payer jurisdiction does not respond to the mismatch,

the Action 2 Report recommends the jurisdictions adopt a defensive rule that

would require the payment to be included as ordinary income in the payee’s

jurisdiction. Second, the rules are also aimed at payments that give rise to

duplicate deductions for the same payment. In the case of double deduction

situations, the Action 2 Report recommends that the primary response should be

to deny the duplicate deduction in the parent jurisdiction. A defensive rule that

would require the deduction to be denied in the payer jurisdiction would only apply

in the event the parent jurisdiction did not adopt the primary response.

The recommended changes to the OECD Model Tax Convention include a change

to Article 4(3) of the Convention that would restrict dual resident entities from

unduly obtaining the benefits of treaties. To avoid the potential for tax avoidance in

some countries, cases of dual treaty residence would be solved on a case-by-case

basis rather than on the basis of the current rule, which is based on place of

effective management of entities. The recommendations in Part II also include an

update on the portion of the 1999 OECD report on “The Application of the OECD

Model Tax Convention to Partnership” (the “Partnership Report”) that dealt with the

application of treaty provisions to partnerships. The conclusions of the Partnership

Report were designed to ensure that the provisions of tax treaties produce

appropriate results when applied to partnerships, in particular in the case of a

partnership that constitutes a hybrid entity. Part II of the Action 2 Report

recommends that the income of transparent entities be treated for purposes of the

OECD Model Tax Treaty in accordance with the principles of the Partnership

Report.

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4 Tax News and Developments October 2014

Action 5 - Harmful Tax Practices

The OECD’s efforts to combat what it classifies as harmful tax practices began in

1998 when it issued a report entitled Harmful Tax Competition: An Emerging

Global Issue. Ring-fencing regimes, across the board corporate tax reductions on

particular types of income (e.g. Patent Box legislation) and taxpayer specific

rulings related to preferential regimes are the types of harmful tax practices that

the OECD has focused on. The concern is that these types of regimes create a

“race to the bottom” that would ultimately drive applicable tax rates on certain

mobile sources of income (e.g., royalty income) to zero for all countries. In order

for a regime to be considered preferential, it must offer some form of tax

preference in comparison with the general principles of taxation in the relevant

country.

Action 5 calls for the Forum on Harmful Tax Practices, a subgroup in the OECD, to

revamp the work on harmful tax practices that began in 1998 with a priority on (i)

improving transparency, including compulsory spontaneous exchange of

information on rulings related to preferential regimes and on (ii) requiring

substantial activity in a jurisdiction to be eligible for any preferential regime. The

Forum on Harmful Tax Practices is to deliver three outputs: first, finalization of the

review of member country preferential regimes; second, a strategy to expand

participation to non-OECD member countries; and, third, consideration of revisions

or additions to the existing framework.

The interim report on Action 5 (the “Action 5 Report”) outlines the progress thus

far. With regard to the substantial activity requirement, the Action 5 Report has

focused on what would qualify as substantial activity in the context of preferential

tax treatment related to income arising from qualifying intellectual property. The

Forum considered three approaches, settling on a nexus approach and rejecting a

value creation approach and a transfer pricing approach. The nexus approach

would allow preferential tax treatment to income generated from patents and IP

functionally equivalent to patents, so long as there is a direct nexus between the

income receiving benefits and the expenditures contributing to that income. The

nexus approach determines what income may receive tax benefits by applying the

following calculation:

Qualifying expenditures incurred

to develop IP asset

Overall expenditures incurred

to develop IP asset

x Overall

Income from

IP Asset

= Income

receiving tax

benefits

The Action 5 Report also provides a framework for the compulsory spontaneous

exchange of information on rulings related to preferential regimes. Spontaneous

information exchange is only required for taxpayer-specific rulings related to

preferential regimes. To be subject to such reporting, the ruling must (i) apply to

income from geographically mobile activities, such as the provision of intangibles,

financial and other service activities; (ii) be a preferential regime; (iii) provide a no

or low effective tax rate; and (iv) be taxpayer specific. The word “compulsory” is

understood to introduce an obligation to spontaneously exchange information

wherever the relevant conditions are met.

Action 6 - Treaty Abuse

The following is a brief review of Action 6, for a more indepth discussion see the

article below which discusses Action 6 in greater detail. Action 6 called for work to

be carried out to (i) develop model treaty provisions and recommendations

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5 Tax News and Developments October 2014

regarding the design of domestic rules to prevent the granting of treaty benefits in

inappropriate circumstances; (ii) clarify that tax treaties are not intended to be used

to generate double non-taxation; and (iii) identify the tax policy considerations that

countries generally should consider before deciding to enter into a tax treaty with

another country. The common goal of the proposed changes to the OECD Model

Tax Convention is to ensure that States incorporate in their treaties sufficient

safeguards to prevent treaty abuse. The Action 6 Report recommends a minimum

level of protection that should be implemented.

With regard to treaty shopping, the report recommends a three-pronged approach.

First, in the title and preamble, treaties should include a clear statement that the

Contracting States intend to avoid creating opportunities for non-taxation or

reduced taxation through tax evasion or avoidance. Second, limitation on benefits

provisions, similar to those found in US treaties, should be included in treaties.

Third, a general anti-abuse rule based on the principal purposes of transactions or

arrangements test should also be added to treaties.

Action 8 - Transfer Pricing of Intangibles

In response to Action 8, the OECD issued the Guidance on Transfer Pricing

Aspects of Intangibles (the “Action 8 Report”), which amends Chapters I, II and VI

of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax

Administrations (2010, the “Transfer Pricing Guidelines”). The Executive Summary

of the Action 8 Report notes that, because there are strong interactions between

the work on ownership of intangibles under Action 8 and the work under Actions 9

and 10 on risk, recharacterisation of transactions, and hard to value intangibles,

the Action 8 Report will not be finalized until the Action 9 and 10 work is completed

in 2015. Interim guidance is indicated by bracketed and shaded portions of the text

and relate specifically to:

Sections B.1 and B.2 of Chapter VI relating to ownership of intangibles,

Section D.3. of Chapter VI relating to intangibles whose valuation is

uncertain at the time of the transaction,

paragraph 2.9 of the Guidelines relating to the use of other methods,

guidance on the application of profit split methods contained in paragraphs

6.146 to 6.149, and

certain examples relating to the foregoing provisions.

The Executive Summary also indicates that the second phase of work to be

completed in 2015 will consider the following special measures, i.e., outside the

arm’s-length principle, under Action 9:

providing tax administrations with authority in appropriate instances to

apply rules based on actual results to price transfers of hard to value

intangibles and potentially other assets;

limiting the return to entities whose activities are limited to providing

funding for the development of intangibles, and potentially other activities,

for example by treating such entities as lenders rather than equity

investors under some circumstances;

requiring contingent payment terms and / or the application of profit split

methods for certain transfers of hard to value intangibles; and

requiring application of rules analogous to those applied under Article 7 of

the OECD Model Convention to certain situations involving excessive

capitalisation of low function entities.

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6 Tax News and Developments October 2014

The Executive Summary emphasizes that no decisions have yet been made

regarding which special measures will be adopted or whether such measures are

consistent with Article 9 of the OECD Model Tax Convention.

Revisions to Chapter I of the Transfer Pricing Guidelines address location savings,

other local market features, assembled workforce and MNE group synergies. For

example, the Action 8 Report indicates that local market features, (e.g., the

purchasing power and product preferences of households in a particular market,

the degree of competition in the market, etc.) do not constitute intangibles. On the

other hand, contractual rights, government licenses or know-how necessary to

exploit that market may be intangibles. The Action 8 Report also indicates that

incidental synergistic benefits arising purely as a result of membership in an MNE

group do not require separate compensation or allocation among the members of

the group. Where synergistic benefits arise from deliberate concerted group

actions, compensation or allocation of the benefit is required.

The remainder of the Action 8 Report addresses changes to Chapter VI of the

Transfer Pricing Guidelines, focusing on:

the definition of intangibles;

the distinction between intangible assets and market specific

characteristics;

factors affecting valuation of intangibles, e.g., funding, ownership/control,

and functions, risks and assets;

valuation approaches; and

transfer pricing treatment of hard to value intangibles.

In a briefing prior to the release of the 2014 Deliverables, Pascal Saint-Amans,

director of the OECD’s Center for Tax Policy and Administration, indicated that

Actions 8, 9 and 10 will mean the end of the “cash box,” saying that

“[M]ultinationals will have to realize that the tax benefits of excess returns going to

a cash box where nothing is happening is over.” (23 Transfer Pricing Report 643,

9/18/2014) While the Action 8 Report, particularly Section B of the Chapter VI

revisions, outline different avenues for neutralizing the “cash box”, i.e., taxing

profits located in low- or no-tax jurisdictions, the Action 8 Report does not address

where such profits should be taxed.

Action 13 - Transfer Pricing Documentation and Country-by-Country Reporting

Action 13 starts from the proposition that providing “adequate” information to tax

administrators results in the transparency required for transfer pricing assessments

and examinations, which together are a key element towards addressing BEPS. In

January of this year, the OECD issued draft guidance on TPD and CbCR. This

draft was met with concern by the taxpayer community, particularly with regard to

the onerous level of information required, the confidentiality of said information,

and the possibility that some of this information would be gathered for use in a

formulary approach, notwithstanding that the OECD has stated that such an

approach was not their objective. As part of the 2014 Deliverables issued on

September 16, 2014, Action 13 is addressed via a new proposed Chapter V to the

OECD Guidelines.

Per the proposed Chapter V, the information requirements of taxpayers would fall

within three documents: (i) CbCR; (ii) a transfer pricing “Master File;” and (iii) a

transfer pricing “Local File.”

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7 Tax News and Developments October 2014

The CbCR is a template that would capture the following information for each tax

jurisdiction in which the taxpayer does business:

Revenue (Unrelated Party, Related Party, and Total);

Profit before income tax;

Income tax paid and accrued;

Total employment (headcount by full time employee);

Capital;

Retained earnings;

Tangible Assets (excluding cash and equivalents); and

Business activity of each legal entity in the jurisdiction.

The Master File is intended to provide the information regarding the taxpayer’s

global business operations and transfer pricing policies. In addition, the Master File

should address intangible assets owned and developed by the MNE as well as its

overall intercompany financing activities. This document is intended to be available

to all relevant tax administrations.

In contrast, the Local File would capture transactional information that is country-

specific, including relevant related party transactions (and amounts of said

transactions) as well as the taxpayer’s analysis of these transactions.

The Executive Summary of the Action 13 Report indicates that the proposed

Chapter V reflects an effort to balance the information needs of the tax

administrations against taxpayer concerns over inappropriate use of information,

compliance costs, and the burdens imposed on their business. Notably, the

Executive Summary highlights that the tax administrations of some emerging

markets, including Argentina, Brazil, China, Colombia, India, Mexico, South Africa,

and Turkey, would have balanced these competing interests by requiring additional

taxpayer information in the CbCR, including data regarding related party interest

payments, royalty payments, and “especially” service fees. The current draft of

Chapter V requires such information to be captured in the Local File.

The response so far from the taxpayer community has been mixed. Taxpayers

have reacted positively to the narrower scope of the CbCR, which is more in line

with the comments they provided and is also broadly consistent with public

statements made by OECD officials (including those made at the Bloomberg BNA /

Baker & McKenzie Transfer Pricing Conference in Paris, on March 31, 2014).

Certain issues have yet to be addressed, such as whether the CbCR Template

would be filed in only the parent company’s jurisdiction and, if so, whether it would

be shared via treaty exchange of information provisions or through some other

mechanism. It is expected that the OECD will address these and other

implementation issues in a subsequent report to be issued in January 2015. The

Executive Summary mandates countries participating in BEPS to reassess no later

than the end of 2020 whether modifications to the content of these reports should

be made to require reporting of additional or different data.

Action 15 - Multilateral Treaty

The extensive current network of bilateral tax treaties were drafted with the

elimination of double taxation in mind. Current bilateral treaties have been valuable

in creating consistency in the tax rules applicable to cross-border trade and

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8 Tax News and Developments October 2014

investment. As globalization has changed the way international business is

conducted, certain aspects of the current treaty system have created opportunities

for BEPS. The OECD recognizes that modifying the current network of 3000+

treaties on a one by one basis would be a slow process that might lead to

inconsistent results. Accordingly, in the report on Action 15 (the “Action 15

Report”), the OECD concludes that it would be both desirable and feasible for a

multilateral instrument to be developed to modify tax treaties and address the

BEPS opportunities created by the current treaty system. The Action 15 Report

suggests that this instrument should be negotiated through an International

Conference open to G20 countries, OECD members and other interested

countries. Furthermore, the Action 15 Report suggests that the Conference should

be limited in scope to implementing the BEPS Action Plan and should take place

within the next 2 years.

The Action 15 Report discusses the numerous challenges that developing a

multilateral instrument would pose technically and provides guidance on certain

features the multilateral instrument could include to combat these challenges. First,

the Action 15 Report suggests that the multilateral instrument would only apply to

parties that have an existing bilateral treaty relationship to facilitate cooperation.

Furthermore, the multilateral instrument would need to consider how treaties

negotiated in the future would be subject to the multilateral instrument. The goal of

the OECD would be to modify provisions of treaties, not amend them. The Action

15 Report explains that the multilateral instrument would need to take into account

situations where a treaty and the multilateral instrument interact. For instance, the

US takes a particular stance when negotiating limitation of benefit provisions that

may differ from the accepted approach in the multilateral instrument limitation of

benefits provision. With these types of issues in mind, the Action 15 Report

repeatedly stresses the importance of flexibility in developing the multilateral

instrument. This again would be a significant challenge, because certain countries

may be willing to make concessions on an issue in a bilateral negotiation that

would not be practical in a multilateral negotiation. The Action 15 Report tries to

address this issue by proposing the possibility of allowing countries to opt-in or out

of certain provisions other than the core provisions of the multilateral instrument.

As the multilateral instrument would be subject to countries’ normal ratification

processes, it would be essential that there be strong political support and initiative

across jurisdictions for the multilateral instrument to succeed.

By Steven Hadjilogiou and Sean J. Tevel (Miami), Michelle A. Martinez (Chicago) and Eric Torrey, Washington, DC

The OECD Moves Forward on Initiatives to Curb Treaty Abuse, while US Tax Treaties are Stalled in the US Senate

OECD Releases Report on BEPS Action 6: Preventing Treaty Abuse

On September 16, 2014, the Organization for Economic Development (“OECD”)

issued reports on seven out of 15 points of an action plan (the “BEPS Action Plan”)

initially developed in 2013 to address perceived abuses from base erosion and

profit shifting (“BEPS”). One of those reports, entitled Preventing the Granting of

Treaty Benefits in Inappropriate Circumstances (the “Report”), addresses Action 6

– Preventing Treaty Abuse, which was billed by the OECD as “one of the most

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9 Tax News and Developments October 2014

important sources of BEPS concerns.” The majority of the Report focuses on treaty

shopping, which involves a taxpayer attempting to qualify for benefits of an income

tax treaty between two countries, one of which has no substantive connection with

the taxpayer. For example, a corporation that is tax resident in Country A may

want to invest funds in a subsidiary in Country B, but doing so could subject the

dividend payments to Country B withholding tax that is not reduced or eliminated

by an income tax treaty between Country A and B. Country C, on the other hand,

has a favorable treaty with Country B, a participation exemption in its domestic law

for incoming dividends from a Country B subsidiary, and no withholding under its

treaty with Country A on outbound dividend payments from a Country C subsidiary

to a Country A parent. Thus, by interposing a newly-formed subsidiary in Country

C, the dividends could be paid from Country B to Country C and from Country C to

Country A without the imposition of any withholding tax. The ability to “shop” for a

favorable jurisdiction to insert between Countries A and B is one of the principal

treaty abuses that concerns the OECD.

The OECD suggests a three pronged approach to address treaty shopping under

which income tax treaties should include: (1) a clear statement that the treaty is

entered into to prevent tax avoidance and is not intended to be used to generate

double non-taxation; (2) a “US style” limitation on benefits (“LOB”) article; and (3) a

general anti-abuse rule based on the principal purpose of the transactions or

arrangements (the “principal purpose test” or “PPT”) that addresses, among other

things, conduit arrangements. According to the March 2014 discussion draft of the

Report, treaties seemingly would need to include all three prongs to meet OECD

standards. But, in the recently-issued Report, the OECD states that countries

could choose between the second and third prongs. If a treaty did not include the

PPT rule described in prong three, it should include an LOB article coupled with

another mechanism (e.g., domestic laws) to address conduit arrangements. This

clarification appears to address concerns voiced by the United States about

including PPT provisions in its treaties, and concerns expressed by other countries

that the LOB provision did not, on its own, adequately combat conduit

arrangements.

The Report also includes proposed language for a model LOB article and related

commentary. Interestingly, the OECD’s model LOB contains some of the more

restrictive provisions from the various iterations of US LOB articles. At least two

provisions are noteworthy: (1) the publicly traded test in paragraph 2 includes

additional, alternative requirements that the public company either (i) is “primarily

traded” on an exchange located in its country of residence, or (ii) is “primarily

managed and controlled” in its country of residence; and (2) the derivative benefits

provision in paragraph 4 requires that, in the case of indirect ownership, each

intermediary is itself an equivalent beneficiary.

The additional requirements in the publicly traded test first appeared in US LOB

articles in 2004 protocols to US income tax treaties with Barbados and the

Netherlands. US Treasury testimony before the US Senate on those protocols

indicated that one of the reasons for adding the “primarily traded” and “primarily

managed and controlled” requirements was to combat inversion transactions,

which at the time generally involved a US multinational changing its tax residence

from the United States to another jurisdiction via a “self-inversion” or a combination

with an unrelated foreign company. The inclusion of this expanded publicly traded

test in the OECD model language is of note because inversion transactions were

not identified in the OECD BEPS Action Plan.

The stricter derivative benefits provision in the OECD’s model LOB is reflective of

a progressive tightening within US income tax treaties. Modern US income tax

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treaties have generally only placed limits on indirect ownership for purposes of

qualifying a subsidiary of a publicly traded company and/or satisfying the

ownership/base erosion test. However, the LOB in the pending protocol to the

Spain-US Income Tax Treaty (the “Spain-US Protocol”) (discussed below) adds a

new limitation on indirect ownership in the derivative benefits test. The OECD’s

model LOB follows the approach taken in the Spain-US Protocol and limits

permissible indirect ownership for purposes of all three provisions. There is,

however, language in the OECD’s model derivative benefits provision that appears

to result, though perhaps unintentionally, in an effective prohibition on indirect

ownership. While the Spain-US Protocol only restricts residency of qualifying

intermediaries for purposes of the derivative benefits test (i.e., requiring that each

intermediate owner by a resident of an EU or NAFTA state), the OECD’s model

LOB requires that each intermediary be an “equivalent beneficiary.” For purposes

of the OECD’s model, a person is considered an equivalent beneficiary only if that

person is an individual, a governmental entity, a non-profit organization, a

pension/investment fund or a publicly traded company. This restriction effectively

prohibits indirect ownership in the derivative benefits test because it is impossible

for most of these persons to be an intermediate entity and improbable for the rest.

The effective prohibition on indirect ownership would even apply to intermediaries

resident in the same contracting state as the person claiming treaty benefits, which

is a significant departure from the corresponding provision in the Spain-US

Protocol and the other LOB provisions limiting indirect ownership.

The Report suggests the model LOB language, including the two provisions

discussed above, reflects the consensus position of the OECD members as of July

2014. However, the proposed measures have not been formally finalized and may

undergo further modification as other action items within the BEPS Action Plan are

addressed. Indeed, the OECD has indicated it plans to do further work to refine

the model LOB language.

Stalled US Income Tax Treaties: the List Awaiting Senate Ratification Continues to Grow

On July 16, 2014, the Senate Foreign Relations Committee approved (i) a new

bilateral income tax treaty with Poland (the “Poland-US Treaty”) and (ii) the Spain-

US Protocol. Both of these measures join a growing list of income tax treaties and

protocols awaiting ratification by the US Senate. This list already included a

protocol to the Luxembourg treaty (signed in 2009), a protocol to the Switzerland

treaty (signed in 2009), the first ever income tax treaty with Chile (signed in 2010),

and a new treaty with Hungary (signed in 2010). These treaties have languished in

the Senate due mostly to Senator Rand Paul’s (R-Kentucky) concern that the

information exchange provisions within these treaties violate Fourth Amendment

privacy rights. These treaties remain stalled due to the US Senate leadership’s

unwillingness to override Senator Paul’s procedural objection and put ratification of

these treaties to a formal vote, which would require substantive floor debate with

respect to each treaty.

The provisions within the Poland-US Treaty and the Spain-US Protocol would

bring those treaties more in line with other recently negotiated bilateral income tax

treaties. The updates include, but are not limited to, (i) a normalization of the

period after which a construction site, installation project, drilling rig, or exploration

site becomes a permanent establishment to 12 months, (ii) an adjustment of the

maximum withholding tax rates on dividends, interest and royalties, including zero

withholding rates on all three items of income for certain Spanish residents, and

(iii) the modernization of the LOB article in the Spain-US income tax treaty and the

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11 Tax News and Developments October 2014

debut of an LOB article in the Poland-US Treaty (which had been one of only two

US income tax treaties that did not include an LOB article but allowed for a

complete exemption from withholding on interest payments). The pending LOB

articles in both treaties depart from the US Model treaty by including a

headquarters company test, a derivative benefits test, and the anti-triangular rule.

Additionally, the derivative benefits provision in the Spain-US Protocol departs

from all previous versions of that particular provision by requiring, in the case of

indirect ownership, that each intermediate owner also be a resident of a country

within the EU or NAFTA.

A number of other income tax treaties and protocols are at various stages of the

ratification process. Notably, a protocol to the Japan-US Income Tax Treaty was

signed in 2013 but has yet to be sent to the US Senate by the President. In

addition, income tax treaties with Norway and Romania have been negotiated and

initialed, and are awaiting signature. While the US Treasury continues to expand

and modernize the US treaty network, those efforts have been hindered by

procedural issues in the US Senate.

By Matthew S. Mauney (Houston)

An Uncertain Path for Tax Extenders

We are once again approaching the end of a Congress where the members will need to retroactively extend more than 50 tax provisions. The path for extenders is more complicated this year and will likely depend on whether the US Senate flips as a result of the midterm election. This article provides a general overview of extenders and the possible paths for passage. Extenders is comprised of several provisions that affect businesses and individuals. The most popular business extenders are bonus depreciation, the research credit, Internal Revenue Code section 954(c)(6) (“CFC Look Through”), and the active financing exceptions to subpart F (generally for banks and similar financial institutions). The most controversial business extender is the production tax credit for renewable energy and cellulosic biofuels. For individuals, the most popular extenders include the deduction for state and local sales tax for individuals who reside in states without income taxes, and enhanced current expensing for small businesses. Unlike the extenders exercise at the end of the last Congress, this Congress is not faced with the expiration of the lower tax rates on individuals and estates (the Bush tax cuts enacted in 2001 and 2003). In January 2013, Congress passed the American Taxpayer Relief Act of 2012 which permanently extended most of the Bush tax cuts, including the Alternative Minimum Tax patch. The Senate tried to pass a two-year extension (through 2015) earlier this year. Rather than making hard choices, the Expiring Provisions Improvement Reform and Efficiency Act of 2014 would extend all of the expired provisions for a cost of $84.1 billion over 10 years. The bill was partially offset by various proposals that would address the tax gap and ultimately failed on the Senate floor due to a procedural vote. Republicans expressed frustration with the Senate bill because the majority prevented several amendments, including an amendment to repeal the medical device excise tax, which was enacted as part of the Affordable Care Act.

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The House is using extenders to pave the road for tax reform. The House believes that Congress should select those extenders which support good policies, and such provisions should be permanently extended outside of tax reform. This will provide Congress with more flexibility in lowering corporate and individual tax rates. To that end, the House Committee on Ways and Means held several hearings to highlight key extenders, including CFC look-through, the active financing exceptions to subpart F, and the research credit. Before leaving for fall recess, the House passed the Jobs for America Act (H.R. 4), which would permanently extend the research credit, bonus depreciation, enhanced current expensing for small businesses, and Subchapter S-Corporation relief. The bill also would repeal the medical device excise tax. Unlike the Senate bill, the Jobs for America Act does not contain any offsets and would cost $572 billion over ten years. The timing and content of extenders will depend on the outcome of the November election. If the election results in the status quo (the Senate is held by the Democrats with a razor thin margin), then a likely outcome is that the parties will come together in the lame duck and extend the expired provisions through 2015. Senate Democrats are unlikely to permanently extend selected provisions unless their priorities are also permanently extended (e.g., permanent extension of relief for the low income housing tax credit). Additionally, Senate Democrats may demand the inclusion of anti-inversion offsets, especially if more businesses announce inversion transactions in the near future. The timing and content of extenders is less clear if the Republicans take the Senate. While House leadership recognizes that extenders is a priority, the Republicans may have a stronger negotiating position in the lame duck and may be unwilling to accept extension of the production tax credit and temporary extensions of certain other extenders. However, both parties and both houses support the extension of most of the provisions that affect the business community. Additionally, there is agreement that extenders should not be fully offset. The lame duck will be a short, intense session, and hopefully Congress will pass extenders before the end of the year.

By Joshua D. Odintz (Washington, DC)

Safeway Successfully Defends Inter-jurisdictional Tax Plan (Yet Again)

Ontario’s Superior Court of Justice recently affirmed the validity of Safeway’s hotly-

disputed Canadian interprovincial financing structure, despite continued resistance

from Ontario’s Ministry of Finance. Back in 2001, the well-known grocery retailer’s

Canadian operating company put in place a tax plan designed to achieve

efficiencies arising from differences in how the corporate tax base was defined in

Ontario as compared to other Canadian jurisdictions. In simple terms, the

operating company replaced its retained earnings with money borrowed from a

related corporation, and the resulting debt was then transferred to Safeway Ontario

Finance Corporation (“SOFC”). Since SOFC was resident in Ontario but

incorporated outside Canada, and because the financing structure used a special

form of sealed debt instrument, the Canadian operating company was able to

deduct the interest paid on the debt without a corresponding income inclusion in

SOFC’s hands. The result was tax savings of roughly $6 to $7 million for each year

the financing structure was in place. In 2005, Ontario amended its legislation to

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13 Tax News and Developments October 2014

bring its corporate tax base in line with other Canadian jurisdictions, effectively

closing down the tax planning opportunity that had become known as the “Finco”

plan. As a result, Safeway’s Canadian subsidiaries, like other companies involved

in the Finco plan, promptly unwound their financing structure and repatriated the

underlying funds up the corporate chain.

Unfortunately (for the affected corporate taxpayers), Ontario’s legislative

amendment was only one of a number of steps eventually taken by Canadian tax

authorities to combat the Finco plan. Several provinces proceeded to issue tax

reassessments to claw back the tax savings achieved under the now-defunct

financing plan, relying heavily on the General Anti-Avoidance Rule (or “GAAR”) in

their respective income tax statutes. Although many of the taxpayers involved

fought back, most were prevented from proceeding to formal litigation because the

tax authorities held their matters in abeyance pending the resolution of a select

number of court cases (two in Alberta, and two in Ontario). Safeway was the only

corporate group whose disputes were allowed to proceed to court in both

jurisdictions.

Represented by a litigation team led by Jacques Bernier and Mark Tonkovich from

Baker & McKenzie’s Toronto office, Safeway’s subsidiaries litigated the Alberta

side of the tax controversy first through Alberta’s trial court, then before the Alberta

Court of Appeal, and finally in a leave application before the Supreme Court of

Canada. Receiving clear and carefully-reasoned trial and appellate judgments, the

taxpayers were wholly successful at every stage of the Alberta litigation. Following

on the heels of the Alberta victories, the Ontario side of the dispute proceeded

before the Ontario Superior Court of Justice in April 2014. Once again, Safeway’s

position was well-received at trial: SOFC successfully defended against each

argument advanced by the Ontario tax authority in its attempt to substantiate the

disputed Finco tax reassessments, and SOFC received a concise judgment

allowing its case in full in mid-September.

Stepping back, both the Alberta and the Ontario litigation stand for the proposition

that there is nothing abusive about a Canadian taxpayer using bona fide

commercial transactions to take advantage of one province’s lower tax rates or

more-favorable tax rules. Taxpayers navigating any of Canada’s various tax

systems should take comfort from the sound first principles upon which these

several court judgments are based when engaging in tax planning to achieve

efficiencies in their Canadian operations.

By Mark Tonkovich (Toronto)

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14 Tax News and Developments October 2014

Recent French Decision Regarding the Business Tax Cap Mechanism

On September 19, 2014, the French Constitutional Court issued a decision

regarding the Business Tax cap mechanism. The decision is of particular interest

to taxpayers disposing of significant real estate assets and who implemented a

reorganization transaction. Indeed, the legal provision at hand which was declared

unconstitutional significantly increased in certain cases the Business Tax burden of

those taxpayers. Repayment opportunities may exist and should be seized rapidly.

For a more detailed discussion, see the October 2014 Baker & McKenzie Paris

Tax Legal Alert, France – Opportunity to Claim a Business Tax Refund Further to a

Successful Claim Brought by Baker & McKenzie Before the French Constitutional

Court, also available under publications at www.bakermckenzie.com. If you are

interested in receiving European Tax Client Alerts directly, contact

taxnews@bakermckenzie.com to be added to the European Tax distribution list.

By Eric Meier, Régis Torlet, and Edouard de Rancher (Paris)

Publication by the French Tax Administration of Final Transfer Pricing Disclosure Form and Related Guidelines

On September 16, 2014, the French tax administration released the final versions

of the Transfer Pricing disclosure form and guidelines which may require large

enterprises to communicate, on an annual basis, a transfer pricing disclosure form

requiring the following information:

1. The enterprise’s main activities, intangible assets and a general

description of their transfer pricing policy; and

2. A description of the activity with a summary of transactions and

presentation of transfer pricing methods

For a more detailed discussion and to view comments from Baker & McKenzie’s

tax practitioners, see the September 2014 Baker & McKenzie Paris Tax Legal

Alert, Publication by the French Tax Administration of Final Transfer Pricing

Disclosure Form and Related Guidelines, also available under publications at

www.bakermckenzie.com. If you are interested in receiving European Tax Client

Alerts directly, contact taxnews@bakermckenzie.com to be added to the European

Tax distribution list.

By Caroline Silberztein, Benoît Granel, and Laura Nguyen-Lapierre (Paris)

Recent Developments in the Netherlands - Time to Check Your Dutch Holding Company or Financial Services Company’s Substance?

The Netherlands is one of the jurisdictions known for its extensive treaty network

and numerous tax and non-tax related benefits, which have attracted substantial

investments by US multinationals. This has resulted in many Netherlands-based

active operations, regional headquarters, holding companies and financial services

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15 Tax News and Developments October 2014

companies (i.e. performing licensing and/or financing activities for the group).

While the group as a whole may very well have active operations in the

Netherlands, typically holding and financial services companies have limited

operational substance because of the nature of their activities. Although, as a

general rule, a company incorporated under Dutch law is always considered a

Dutch tax resident, in the international treaty context, the issue of beneficial

ownership is key in order to invoke treaty benefits. The beneficial ownership issue

is, in principle, a source country issue. However, as discussed below, the

spontaneous information exchange that will be triggered where the Dutch

substance requirements are not met, may have an impact on the source country’s

assessment of beneficial ownership.

For financial services companies, minimum substance requirements have been

around for at least ten years now, based on Dutch tax practice and various

decrees offering guidance specifically for entities that wish to enter into an

advance pricing agreement with the Dutch tax authorities. Recent changes have

now turned these substance requirements into law. This is inspired by international

developments around the mutual assistance in the field of taxation, but also in the

context of the OECD's Base Erosion and Profit Shifting initiative.

Legislation on Substance requirements for Financial Services Companies (FSCs)

On 1 January 2014 new legislation was implemented in Dutch law (article 3a

Uitvoeringsbeschikking Wet op de Internationale Bijstandverlening), which created

the legislative basis for substance requirements for financial services companies

(hereinafter referred to as “FSCs”).

a. When does a company qualify as an FSC?

The requirement on the basis of which companies should actively provide

information with regard to their level of substance (potentially resulting in

exchanges of information with other jurisdictions) specifically applies to Dutch

companies which qualify as an FSC. Dutch law defines an FSC as a company

whose activities in a fiscal year consist for 70% or more of directly or indirectly

receiving and paying interest, royalties, rent or lease installments, to or from

non-resident affiliated companies. In determining whether a company is an

FSC, the relevant factors taken into account are (i) the activities performed by

the company and time spent by its employees; (ii) the assets used; (iii) the

company’s turnover; and (iv) the profit generated by the company on each of

its activities. The decree is unclear with regard to how each of these factors

needs to be weighed. Holding activities should be excluded when applying the

70% test.

b. What are the substance requirements applicable to an FSC?

The new legislation confirms the substance requirements set forth below:

i. at least 50% of the FSCs statutory board members that are authorized to

represent the company are Dutch residents;

ii. the Dutch resident board members have sufficient professional expertise

to properly fulfil their duties. These duties at least include decisions on

entering into transactions and the follow-up on those transactions;

iii. the FSC has qualified personnel to execute and administer its

transactions;

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16 Tax News and Developments October 2014

iv. the board decisions are made in the Netherlands;

v. the FSC’s main bank accounts are held in the Netherlands;

vi. the FSC’s bookkeeping is prepared in the Netherlands;

vii. the FSC’s business address is in the Netherlands;

viii. the FSC is not, to its best knowledge, considered a tax resident in another

country;

ix. the FSC incurs real risks in relation to its financing, licensing, rental or

leasing activities; and

x. the FSC maintains sufficient equity considering the real risks it incurs.

c. What are the consequences of not meeting the substance requirements?

The legislation states that FSCs should actively inform the Dutch tax

authorities about whether they meet the full list of Dutch substance

requirements, throughout the fiscal year for which a tax return is filed. This is

done through checking a box in the Dutch corporate income tax return. FSCs

that do not meet (all of) the substance requirements will be required to provide

detailed information explaining reasons for not meeting the substance

requirements and data on the nature of income and whether treaty benefits

have been invoked. With this information, the Dutch tax authorities will verify

the substance level and if decided that the FSC does not meet the desired

substance level, the Dutch tax authorities can decide to exchange information

on the FSC with the relevant jurisdictions. The exchange of information will

only be done if treaty benefits or benefits on the basis of the EU Interest &

Royalty Directive have been (or could have been) invoked. Such information

may inspire the tax authorities in these countries to deny tax treaty benefits or

the application of the EU Interest and Royalty Directive.

Impact on Advance Pricing Agreement (“APA”) and Advance TaxRulings (“ATR”) environment

In addition to the legislative changes effective January 1, 2014, a number of

related decrees were updated on June 12th, 2014. These decrees essentially

provide guidance around the ruling procedures relevant to Dutch companies that

wish to enter into an APA (for FSCs) and/or an ATR with the Dutch tax authorities.

With the update, no change in the existing APA/ATR practice is envisaged. The

relevant aspects that did change are addressed below.

a. What is the impact on FSCs that wish to obtain an APA after June 12th, 2014?

An FSC that wishes to obtain an APA for its activities must meet the minimum

substance requirements as explained above, with a particular focus on the real

risk requirement (see 2.b ix above). Detailed guidance is provided with respect

to when an FSC is considered to run a real economic risk. The decree further

includes updated examples, as well as information on potential spontaneous

exchange of information (i.e. the APA) on the basis of mutual assistance

legislation. Most importantly, for APA’s issued after June 12th, 2014, if an FSC

only meets the minimum substance requirements and the Dutch group to

which it belongs does not have any other activities in the Netherlands (nor any

plans to expand in the Netherlands), the content of the APA may be

spontaneously exchanged with the relevant foreign tax authorities.

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17 Tax News and Developments October 2014

b. What is the impact on (holding) companies that wish to obtain an ATR?

While FSCs typically apply for an APA on the transfer pricing aspects, an ATR

applies more broadly and provides advance certainty with respect to general

corporate income tax matters such as the application of the Netherlands

participation exemption regime, the permanent establishment findings and the

dividend withholding tax exemptions. While the substance conditions pursuant

to which a holding company could obtain an ATR had never been formally

confirmed, the updated ATR decree dated June 12, 2014 now specifically

confirms that Dutch holding companies are eligible for an ATR if conditions

2.b.i - viii of the above-described substance requirements are met.

Furthermore, the decree now also states that when a (holding) company does

not yet meet the aforementioned substance requirements on a stand-alone

basis, it can still apply for an ATR if the group to which the entity belongs has

operational activities in the Netherlands or has concrete plans to engage in

operational activities in the future.

Considering this new development and in particular the impact that this has on

information exchange, multinationals are well advised to review their existing

substance level in the Netherlands.

By Margreet G. Nijhof, Mounia Benabdallah and Steven Vijverberg, (Amsterdam)

US Supreme Court to Hear Three State Tax Cases

Historically frustrated by the US Supreme Court’s lack of interest in state tax

cases, state tax professionals have plenty to follow this term as the Court has

granted certiorari in three cases involving state tax issues. Following is a summary

of the cases, CSX Transportation, Direct Marketing Association, and Wynne, and

state tax issues the Court will address.

CSX Transportation v. Alabama Dep’t of Revenue

On July 1, 2014 the US Supreme Court granted certiorari for the second time in

CSX Transportation v. Alabama Dep’t of Revenue, No. 12-14611 (11th Cir. 2013).

At issue is Alabama’s sales tax regime and whether it discriminates against

interstate rail carriers in violation of the federal Railroad Revitalization and

Regulatory Reform Act of 1976 (“4-R Act”). The 4-R Act precludes states from

imposing “another tax that discriminates against a rail carrier.” 49 U.S.C. §

11501(b)(4). The Supreme Court initially granted certiorari in this case to

determine whether a railroad was permitted to challenge a state tax exemption

under the 4-R Act as being “another tax that discriminates against a rail carrier.”

The Court answered that question in the affirmative, but left open for remand the

question of whether Alabama’s fuel and sales tax regime is actually discriminatory.

Alabama taxes the purchase of diesel fuel differently among transportation

businesses. For example, rail carriers pay a 4% sales tax on purchases of diesel

fuel, motor carriers pay an excise tax of 19¢ per gallon, and water carriers are

completely exempt from tax on diesel fuel purchases. CSX Transportation, Inc.

(“CSX”), an interstate rail carrier, is subject to Alabama’s 4% sales tax and

challenged Alabama’s taxing scheme on the grounds that exempting its

competitors from sales tax discriminates against rail carriers and in violation of the

4-R Act.

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18 Tax News and Developments October 2014

On remand, the district court upheld the Alabama exemption finding that motor

carriers pay excise tax on diesel fuel in an amount equal to the sales tax paid by

rail carriers. The 11th Circuit reversed on appeal, stating that CSX established a

prima facie case of discrimination upon demonstrating that a comparison class of

competitors (i.e., motor and water carriers) did not pay sales tax on diesel fuel

purchases. Alabama was unable to offer a reasonable justification for treating rail,

motor, and water carriers differently. In its order granting certiorari the Supreme

Court directed both parties to brief the issue of whether, in resolving a claim of

unlawful tax discrimination under the 4-R Act, a court should consider other

aspects of the State’s tax scheme (i.e., excise tax) rather than focus solely on the

challenged tax provision (i.e., sales tax).

Direct Marketing Ass’n v. Brohl

On July 1, 2014 the US Supreme Court granted certiorari in Direct Marketing Ass’n

v. Brohl, No. 12-1175 (10th Cir. 2013). The Supreme Court will consider whether a

state regulation imposing a sales tax notice and reporting obligation is procedurally

barred from review in federal court pursuant to the federal Tax Injunction Act

(“TIA”). The TIA provides that “district courts shall not enjoin, suspend or restrain

the assessment, levy or collection of any tax under State law where a plain,

speedy and efficient remedy may be had in the Courts of such State.” 28 U.S.C. §

1341.

Direct Marketing Association (“DMA”) is challenging a Colorado regulation that

requires non-collecting, out-of-state retailers that have more than $100,000 in

gross Colorado sales to (1) notify their Colorado customers that they must self-

report use tax on their purchases, (2) provide their Colorado customers with an

annual purchase summary, and (3) provide a report to the Colorado Department of

Revenue that details each of their Colorado customers and their purchases. See

Colo. Code Regs. 39-21-112.3.5. DMA brought its challenge in the US District

Court for the District of Colorado, arguing that the Colorado regulation’s notice and

reporting requirements violate the Commerce Clause by discriminating against out-

of-state retailers. The district court agreed with DMA and permanently enjoined the

enforcement of Colorado’s regulation.

On appeal, the 10th Circuit held that the TIA deprived the district court of

jurisdiction to enjoin the Department from enforcing its regulation. The appellate

court reasoned that the TIA applied because the law at issue concerned the levy or

collection of a state tax and DMA could have sought a “plain, speedy, and efficient

remedy” at the state level. DMA argued that the TIA does not preclude federal

jurisdiction where (1) a taxpayer is not seeking to avoid a tax and (2) it is not

challenging a tax assessment, but a notice and reporting requirement. The

Supreme Court will now ultimately decide whether the TIA deprives federal courts

jurisdiction in cases involving some aspect of state tax administration, or whether

the TIA’s bar only applies to taxpayers seeking to avoid the “levy or collection” of a

state tax.

Comptroller v. Wynne

Comptroller of the Treasury of Maryland v. Brian Wynne, Docket No. 13-485

involves a constitutional challenge to Maryland’s county-level personal income tax

credit for taxes paid to out-of-state jurisdictions. Maryland residents are generally

subject to the state’s personal income tax, which is comprised of both a state-level

tax and a county-level tax. Currently, Maryland provides its residents with a state

tax credit for income taxes paid to other states, but does not extend the credit to

Maryland’s county income taxes, which can be as high as 3.20% of net income.

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19 Tax News and Developments October 2014

The Comptroller of Maryland increased Wynne’s tax liability by denying credits

claimed for the county portion of the Maryland income tax. Wynne challenged the

assessment under the “dormant Commerce Clause” of the US Constitution, which

the US Supreme Court has held to implicitly limit the power of state and local

governments to enact laws affecting interstate commerce. Maryland’s highest court

held that Maryland’s law unconstitutionally interfered with interstate commerce

because Maryland residents were taxed at a higher rate when income was

received from within and without the state as opposed to taxpayers receiving

income exclusively within Maryland. The higher tax rate was a result of double

taxation because of the lack of a complete credit. The Comptroller of Maryland

asserts that the Maryland taxing scheme does not discriminate against interstate

commerce and multiple taxation is often an unavoidable consequence of the

combined effect’ of two different states’ statutes. Although the Supreme Court’s

ruling will focus on Maryland’s tax credit-mechanism, its ruling may have broader

implications if it addresses the applicability/scope of the dormant Commerce

Clause.

By Drew Hemmings (Chicago), Michael C. Tedesco and David Pope (New York)

New Illinois “Click-Through” Nexus Law Addresses Some Issues While Leaving and Creating Others

In response to the Illinois Supreme Court’s invalidation of Illinois’ “click-through”

nexus law in Performance Marketing Ass’n v. Hamer, 998 N.E.2d 54 (Ill. 2013),

Illinois enacted a new “click-through” nexus law on August 26, 2014, making two

important changes to the law previously voided. First, the new law imposes use tax

collection obligations on retailers utilizing print or broadcast marketing affiliates in

addition to online marketing affiliates. This change attempts to remedy the

preemption of the prior “click-through” nexus law by the Internet Tax Freedom Act

(“ITFA”) by eliminating the discrimination against electronic commerce. Second,

the new law creates a rebuttable presumption of nexus, rather than a conclusive

determination, for any out-of-state retailers meeting the “click-through” nexus sales

thresholds.

However, questions remain regarding the constitutionality of the new law. First, the

presumption of nexus applies to out-of-state retailers based upon total sales

through affiliate referrals regardless of whether any of those sales are to Illinois

customers. Second, the new law improperly imposes use tax collection obligations

on retailers engaging in constitutionally protected advertising activities.

Prior Illinois’ “Click-Through” Nexus Law

In 2008, New York enacted the nation’s first “click-through” nexus law, also known

as the “Amazon Law.” Illinois’ “click-through” nexus law became effective in 2011

and, similar to the “click-through” nexus laws enacted by states across the country,

contained many of the same requirements as New York’s law. New York’s highest

court upheld New York’s law in Amazon.com & Overstock.com v. New York State

Dep’t of Tax’n & Finance, 987 NE2d 621 (NY 03/28/13), cert. denied, 571 U.S.

(12/2/2013). However, the Illinois “click-through” nexus law included two notable

differences. First, the Illinois law did not provide a rebuttable presumption of nexus.

Rather, Internet retailers who satisfied the law’s requirements, including certain

sales thresholds and contract requirements with in-state affiliates, had nexus

conclusively. Second, to satisfy the law’s $10,000 sales threshold, sales were not

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20 Tax News and Developments October 2014

required to be sales to Illinois residents. Instead, $10,000 in gross receipts from

any source, including entirely out-of-state sources, satisfied the sales threshold. In

short, through these two unique provisions, substantial nexus under Illinois’ law

could have been little more than an out-of-state online retailer’s marketing affiliate

sitting in Illinois.

In striking down the prior statute and affirming the decision of the Illinois Circuit

Court in Performance Marketing Ass’n v. Hamer, No. 2011 CH 26333 (Ill. Cir. Ct.

Cook Cty. 5/7/12), the Illinois Supreme Court held that, under the US Constitution’s

Supremacy Clause (“Supremacy Clause”), the ITFA preempted Illinois’ “click-

through” nexus law by prohibiting discriminatory taxes on electronic commerce.

The court determined that Illinois’ law imposed use tax collection obligations on

out-of-state retailers who used online marketing without imposing similar

obligations on retailers utilizing print or broadcast marketing. The Illinois Supreme

Court declined to address whether the Illinois Circuit Court correctly held that the

statute also violated the US Constitution’s Commerce Clause (“Commerce

Clause”). For prior coverage, see prior Tax News and Developments article Illinois

Supreme Court Invalidates State’s Click-Through Nexus Law (Vol. 13, Issue 6,

December 2013) located under publications at www.bakermckenzie.com.

Illinois’ New “Click-Through” Nexus Law Addresses Some Constitutional Issues But Faces Others

Illinois’ new “click-through” nexus law appears to have remedied the glaring

constitutional violations present under the prior law. First, by imposing use tax

collection obligations on retailers utilizing instate print or broadcast marketing

affiliates in addition to Internet marketing affiliates, the new law seemingly

eliminates the discriminatory tax on electronic commerce prohibited by ITFA.

Second, by creating a rebuttable presumption of nexus, as opposed to a

conclusive determination of nexus, for out-of-state retailers who exceed the

$10,000 sales threshold from referrals, the law may no longer facially violate the

Commerce Clause as determined by the Illinois Circuit Court, but not addressed by

the Illinois Supreme Court.

Illinois Law Creates Presumption of Nexus Even if the Affiliates’ Referrals Result in No Sales to Illinois Customers

Illinois’ new “click-through” nexus law may remain susceptible to other

constitutional challenges. First, under the law, a retailer’s presumption of nexus

with Illinois is in no way predicated upon the retailer actually making sales to

Illinois customers through affiliates’ referrals. Instead, the law creates a

presumption of nexus if Illinois affiliates simply refer $10,000 in sales to the

retailer, even if all of the sales are to non-Illinois customers. This is a key

difference between Illinois’ law and the law upheld in New York.

It is unclear whether Illinois’ insertion of a rebuttable presumption of nexus into the

new law is enough to cure the constitutional defect identified by the Illinois Circuit

Court. The court in Amazon stated that “it is not unreasonable to presume that

affiliated website owners residing in New York State will reach out to their New

York friends, relatives and other local individuals [to solicit customers and increase

their referrals to the retailer].” To the extent that Illinois courts believe that it is

reasonable to presume that marketing affiliates residing in Illinois would reach out

to their Illinois friends, relatives and other local individuals to solicit customers for

the retailer, perhaps the Illinois law could survive a facial challenge. However, the

presumption of nexus created by New York’s “click-through” nexus law may have

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21 Tax News and Developments October 2014

been on firmer constitutional footing because the statute specifically connected the

presumption of nexus to actual referrals from New York affiliates which resulted in

sales to New York customers. In contrast, the new Illinois’ law may

unconstitutionally seek to regulate commerce outside of the State of Illinois.

Of course, to the extent that a taxpayer can demonstrate that its particular facts do

not support the presumption of nexus, the taxpayer could successfully challenge

the constitutionality of the statute on an as-applied basis. For example, this could

occur if the Illinois affiliates’ referrals do not result in the retailer making any, or

relatively few, sales to Illinois customers, despite the retailer making substantial

sales to Illinois customers through other means such as the retailer’s own direct

mail and online solicitations. In addition, the statute may not be constitutional as-

applied if affiliates merely post website links to the retailer’s webpage without

actually engaging in any in-state solicitation on behalf of the retailer. Such activities

may more closely resemble online advertising.

Illinois Law Targets Various Forms of Advertising as Nexus-Creating Activities

Illinois’ inclusion of in-state print and broadcast advertising as additional nexus

creating activities for a retailer simply because a tracking mechanism is provided

by the affiliate may run afoul of the Commerce Clause. By amending the law to

include referrals by print and broadcast marketing affiliates to eliminate the IFTA

discrimination on electronic commerce, Illinois may have expanded the scope of

the law too far as to violate the Commerce Clause’s protection of advertising

activities. Courts generally hold that advertising activities, alone, are insufficient to

create substantial nexus for an out-of-state retailer. Illinois’ new law provides that a

presumption of nexus will exist for a retailer having a contract with a person

located in this State under which the person, for a commission or other

consideration refers potential customers to the retailer by providing a promotional

code or other mechanism that allows the retailer to track purchases referred by

such persons. Examples of mechanisms include a link on the person’s Internet

website, promotional codes distributed through the person’s hand-delivered or

mailed material, and promotional codes distributed by the person through radio or

other broadcast media.

Many retailers include promotional or tracking mechanisms in online, print or radio

advertisements merely to track the effectiveness of various advertising efforts.

Under a plain reading of the new law, retailers who engage in these otherwise

innocuous advertising activities are presumed to be maintaining a place of

business in Illinois and required to register to collect use tax. On this point, Illinois’

new law is clearly open to constitutional challenges on an as-applied basis, but the

question remains whether the law’s rebuttable presumption of nexus is enough to

prevent the law from being facially unconstitutional as well. Corporations

maintaining relationships with Illinois affiliates should carefully review Illinois’ new

“click-through” nexus law and consider its applicability and enforceability.

By Matthew S. Mock and Roman Patzner, Chicago

Baker & McKenzie

22 Tax News and Developments October 2014

Never a Dull Moment… Michigan Seeks to Re-Write History By Retroactive Repeal of the Multistate Tax Compact

On September 12, 2014, Michigan Governor Rick Snyder signed a bill repealing

the Multistate Tax Compact (“MTC”) retroactive to January 1, 2008 (Public Act 282

of 2014). Michigan’s retroactive repeal of the MTC is in response to the recent

decision from the Michigan Supreme Court approving IBM’s use of the MTC’s

three-factor apportionment formula in lieu of Michigan’s single sales factor formula.

For background information on IBM, please refer to prior Tax News and

Developments article Michigan Supreme Court Holds that IBM Could Elect to Use

the MTC’s Evenly Weighted Three-Factor Apportionment Formula (Vol. 14, Issue

4, August 2014) available under publications at www.bakermckenzie.com.

The impetus for the retroactive law was the prospect of the Department of

Treasury (“Treasury”) issuing substantial refunds under the IBM decision for the

period January 1, 2008 - December 31, 2010. Treasury estimated that it owed

approximately $1.09 billion in tax refunds plus interest in 134 separate lawsuits

pending in the lower courts or at the administrative level.

Michigan’s repeal of the MTC occurred while the Michigan Supreme Court is

considering a motion for reconsideration of IBM filed by the Michigan Office of

Attorney General. Upon enactment of the new law, the Michigan Attorney General

filed a brief of supplemental authority requesting that the Michigan Supreme Court

apply the retroactive repeal of the MTC to IBM itself because, in his view, IBM is a

“pending case.”

In the meantime, consistent with IBM, the Michigan Court of Appeals issued an

unpublished decision approving use of the MTC’s three-factor apportionment

formula by another taxpayer, Lorillard Tobacco. The Court of Appeals did not

mention the motion for reconsideration of IBM or the repeal of the MTC in its

decision.

Effects of Michigan’s Repeal of the MTC on Taxpayers

Even though the six year retroactive application of a law raises many constitutional

concerns, Michigan courts have upheld “clarifying” amendments to tax laws

containing periods of retroactivity of five years in General Motors Corp. (2010) and

seven years in GMAC LLC (2009). The Court of Appeals in General Motors Corp.

upheld a retroactive amendment to the Use Tax Act upon finding that the

legislation was rationally related to a legitimate legislative purpose - preventing a

substantial loss of state tax revenue. General Motors Corp. involved a taxpayer’s

refund of tax as opposed to an assessment of tax. One of the Court’s reasons for

upholding the retroactive application of the new law was that the taxpayer did not

detrimentally rely on the prior law when filing its original returns. With respect to

Michigan’s repeal of the MTC, taxpayers who received assessments because they

elected to use the MTC’s three-factor apportionment formula on an original return

should consider asserting Due Process Clause violations.

Further, the MTC is not a typical state tax law; it is a valid, enforceable interstate

compact binding on all signatory states such as Michigan. While states may

withdraw from the MTC, nothing suggests that they may do so retroactively. As a

member state, Michigan received the benefits of MTC membership, while other

states and taxpayers relied on Michigan’s membership in the MTC during the

Baker & McKenzie

23 Tax News and Developments October 2014

relevant tax years. The Contracts Clause of the US Constitution prohibits states

from passing laws that impair the obligations of contracts. The validity of

Michigan’s retroactive repeal of the MTC will certainly be tested and litigation will

continue. Taxpayers with Michigan tax liabilities must closely monitor this rapidly

developing issue.

By Roman Patzner, Chicago

Save the Dates: Baker & McKenzie Announces Upcoming Tax Conferences in San Francisco, Hong Kong, San Diego and Miami

Autumn will be in full swing when our tax controversy practitioners from across the United States and Canada convene in San Francisco November 20-22, 2014 at the Westin Market Street Hotel for their annual North American Tax Controversy Training Workshop. In conjunction with that program, the group will be conducting a full-day program for clients on Friday, November 21st that will open with a traditional general session discussing ways to manage US and foreign tax audits, followed by interactive breakout sessions on topics such as Protecting Confidential Company Information, Best Practices and Pitfalls re IDR Directives, Intergovernmental Information Exchange and Foreign Tax Raids. Lunch will feature a presentation on how the recent change of leadership at the IRS Transfer Pricing Operation and LB&I International could ultimately affect the current audits and appeals process, and the afternoon has been designed to afford our client guests with the unique opportunity to train side-by-side with the Firm's own tax controversy practitioners as they hone their advocacy skills, as instructors from the National Institute of Trial Advocacy (NITA) and our more experienced Baker & McKenzie tax litigators will guide attendees through various exercises geared towards gathering information from witnesses, case analysis, offense/defense strategies, and preparing company personnel for actual IRS interviews. Participants can then practice these techniques and will be given real-time feedback and tips for improvement. We hope you will join us for what promises to be an informative and practical educational experience. CLE and CPE credit will be offered. For the complete agenda and registration information, please click here.

A world away and just a week earlier, our colleagues in the Asia Pacific region will convene in Hong Kong on November 13-15, 2014 for our 30th Annual Asia Pacific Tax Conference. This two-day event for clients will concentrate on global changes and the increasing political focus in the Asia Pacific region on tax collections, tax transparency and tax reform. If you or your colleagues are interested in attending or obtaining additional information on the Hong Kong tax conference, please click here to access the invitation, the agenda and complete registration details.

Baker & McKenzie tax attorneys and economists from around the globe will ring in the New Year in the San Diego area, as we return to the west coast for our 37th Annual North America Tax Conference and present a full-day workshop for clients on Friday, January 9th at the historic Hotel del Coronado. Workshop sessions will center around a number of hot topics in transfer pricing, tax controversy and international tax planning. Full conference details, agenda and registration information can be accessed here.

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Baker & McKenzie

24 Tax News and Developments October 2014

If the evolving Latin America tax landscape is what's on your mind, then the place you'll want to be is at the 16th Annual Latin America Tax Conference which will take place from March 17-19 in Miami, Florida. The program will provoke thoughtful exchange on the most current and challenging tax issues that business and industries face in their daily operations throughout Latin American. is program will include discussions led by representatives from several Latin American countries and will focus on the most current tax issues and challenges affecting business and industries in that region. Presenters from Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela, the US and several key European jurisdictions will provide truly global insights.

Each of these events will offer attendees the opportunity to network with some of the most informed professionals in industry and practice. If you're in the area, we would love to see you at these or future events as we continue our efforts to offer timely events across the country on the topics that most interest our clients. Please watch your in-box or refer to the Upcoming Events listing in this newsletter for announcements of future events, or contact us directly at TaxNews@bakermckenzie.com if you are interested in a specific event, or have a topic to suggest.

©2014 Baker & McKenzie. All rights reserved. Baker & McKenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm.

This may qualify as “Attorney Advertising” requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome.

Tax News and Developments is a periodic publication of Baker & McKenzie’s North American

Tax Practice Group. The articles and comments contained herein do not constitute legal advice or formal opinion, and should not be regarded as a substitute for detailed advice in individual cases. Past performance is not an indication of future results.

Tax News and Developments is edited by Senior Editors, James H. Barrett (Miami) and

David G. Glickman (Dallas) , and an editorial committee consisting of Theodore R. Bots (Chicago), Glenn G. Fox (New York), Kirsten R. Malm (San Francisco), Robert H. Moore (Miami), Patricia Anne Rexford (Chicago), Caryn L. Smith (Houston) and Angela J. Walitt (Washington, DC).

For further information regarding the North American Tax Practice Group or any of the items or Upcoming Events appearing in this Newsletter, please contact Carol Alexander at 312-861-8323 or carol.alexander@bakermckenzie.com.

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Baker & McKenzie Global Services LLC 300 East Randolph Drive Chicago, Illinois 60601, USA Tel: +1 312 861 8000 Fax: +1 312 861 2899

Tax Publications and Newsletters

Baker & McKenzie would like to deliver information that is relevant and useful in helping you achieve your company’s business objectives. Please take a moment to indicate which publications are of interest to you.

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Tax Publications & Newsletters

Transfer Pricing

□ Transfer Pricing, Managing Intercompany Pricing in the 21st Century (2012)

□ European Transfer Pricing Handbook (2014)

□ Latin American Transfer Pricing Handbook (2014)

Tax Dispute Resolution

□ Handling Federal Tax Controversies in the United States (2014)

□ Handling Tax Controversies in Asia Pacific (2013) □ Handling Tax Disputes in Europe (2013)

□ Handling Tax Controversies in Latin America (2014)

Other Tax Publications

□ European Tax Transactions Guide (2014)

□ Latin America Tax Transactions Guide (2014) □ Latin America Concise Tax Guide (2014)

Electronic Tax Newsletters

□ Asia Pacific Tax Alerts - Periodic

□ China Tax Newsletter- Monthly □ North America Tax News and Developments - Bimonthly

□ European Tax Newsletter- Bimonthly

□ Global VAT Newsletter - Bimonthly

Please fax or email the completed form to Debbie Shelist at +1 312 698 2500 or deborah.shelist@bakermckenzie.com www.bakermckenzie.com

Baker & McKenzie LLP 300 East Randolph Drive Chicago, Illinois 60601, USA Tel: +1 312 861 8000 Fax: +1 312 861 2899 © 2014 Baker & McKenzie All rights reserved