DC Enacts Budget That Limits QHTC Program

Summary

On July 22, 2019, Mayor Muriel Bowser signed the District of Columbia Fiscal Year 2020 Budget Support Act of 2019 (B23-0209), which contains the Downloading Lost Revenues Amendment Act of 2019 (the Amendment).
As the name indicates, the new Amendment is aimed at reducing tax benefits to Qualified High Technology Companies (QHTCs) to increase and reallocate revenue to housing, environment, and other social programs in the District.  The changes impact sales and use taxes, income tax credits, and the corporate franchise tax.
 

Details

The District of Columbia provides several tax incentives for taxpayers that are certified as QHTCs. Qualifying taxpayers are those with two or more employees in the District, with an owned or leased office in the District, generating more than 51 percent of their District-sourced receipts from qualified activities. The benefits include income tax rate abatements, credits, sales and use tax exemptions, and property tax abatements. 
 
The Amendment repeals the sales and use tax incentives as of the effective date of the bill. The Amendment also reduces the hiring credit from $5,000 to $3,000 and the percentage of qualified wages that generate the credit. Furthermore, hiring credits generated by employees hired after October 1, 2019, may no longer be carried forward. Additionally, the reduced six-percent corporate franchise tax rate is limited to five years, and there is a cap of $250,000 of benefit per tax year from the reduced tax rate.  
 
Sales and Use Tax
Effective October 1, 2019, the Amendment repeals the sales and use tax exemptions for QHTCs found in D.C. Ann. Code Sections 47-2001(n)(2)(G) and 47-2005(31).  Currently, qualifying sales by QHTCs are exempt from the District’s sales tax.   The other exemptions that will be repealed include the qualifying purchases by QHTC of computer software or hardware, visualization and human interface technology equipment, including operating and applications software, computers, terminals, display devices, printers, cable, fiber, storage media, networking hardware, peripherals, and modems. 
 
Income Tax Credits
The Amendment changes the calculation of the credit for hiring qualified employees from 10 percent of wages paid in the 24 months after hiring to 5 percent.  The updated computation applies to employees hired after December 31, 2017, and will be reflected in tax returns related to tax years beginning after December 31, 2019.
 
The Amendment also reduces the maximum allowable credit to from $5,000 to $3,000 for each qualified employee for tax years beginning after December 31, 2019.  Finally, the Amendment eliminates the ability to carry forward unused credits for employees hired on or after October 1, 2019.  Unused credits generated on wages from qualified employees hired prior to October 1, 2019, are still carried forward for 10 years. 
 
Corporate Franchise Tax
Currently, QHTCs subject to the corporate franchise tax are permitted a five-year abatement of the corporate franchise tax once the corporation has income, up to $15 million. After that, the QHTC is subject to an income tax rate of 6 percent.
 
For tax years beginning after December 31, 2019, the Amendment limits the application of the reduced 6 percent corporate franchise tax rate to the earlier of five years or when the taxpayer is no longer a QHTC.  Furthermore, the Amendment also caps the total amount of franchise tax benefit that a QHTC may receive because of the reduced rate to $250,000 per taxable year.  Under current law, there is no limit on the amount of franchise tax benefit that can result from the reduced rate. 
 

BDO Insight

  • Since the QHTC program was first introduced in 2000, the program has undergone various modifications and refinement of definitions. As a result, taxpayers are encouraged to review the requirements annually. 
  • The Amendment did not change the five-year abatement of the corporate franchise tax for corporate QHTCs, subject to a $15 million total limitation or the exemption from the District’s unincorporated business tax for non-corporate entities.  
  • Other property tax abatements, relocation and retraining credits are still in effect.
  • Due to the District’s unique legislative process, the Budget Act is subject to a 30-day Congressional review.  The act was passed via Emergency Act, which enacts the provisions for 90 days while the Budget Act is under congressional review.  As of this alert, the projected date that the Budget Act will become law is estimated to be October 23, 2019.

 


CONTACT

Elil Arasu
State and Local Tax Managing Director
  Jeff Saltzberg
State and Local Tax Managing Director

 
Tim Schram
National Practice Tax Leader Credits & Incentives Managing Director
   

Chinese Import Duty Refund Opportunity

Trouble with China Tariffs? This Could Help.

Turbulence related to tariffs has become troublingly commonplace. In May of this year, the President announced that retaliatory tariffs on nearly $200 billion of Chinese exports under Section 301 of the Trade Act of 1974 would increase from 10 to 25 percent for tariff codes set forth on the so-called “List 3” products. For U.S.-based businesses that import these goods, which includes merchandise ranging from laptops to shoes to food items, this increase creates a host of problems — decreased sales, the need to rework supply chains and cash flow issues, to name just a few.

The good news?

The Office of the U.S. Trade Representative (USTR) opened a short period for importers to request exclusions from the additional 25 percent tariff imposed on Chinese imports as of September 24, 2018.
 

But, there’s no time to waste. The deadline to file a request with USTR is September 30, 2019.  

What’s the benefit?

While applying for the refund does not guarantee you’ll receive it, if the exclusion is approved, the cost savings can be significant. Any exclusions granted will result in a duty refund retroactive to September 24, 2018, and will remain in effect for one year from the date on which the exclusion is published on the Federal Register. This will allow companies the time needed to make some short-term supply chain shifts necessary to reduce their tariff exposure.  

Obtaining an exclusion is one of the most effective ways to mitigate the financial liability of increased tariffs on the import of Chinese origin goods, and the least disruptive to a company’s existing supply chain. 

How do you apply?

In the online request form, a company needs to demonstrate that it cannot source the goods from a U.S. or third country supplier, and that the company will suffer a significant financial impact from the additional tariffs. Importantly, the requester can claim “small business” status (as defined in the Small Business Administration regulations), which may increase the chances of success.  Many companies have already applied for this exclusion, and time is running out.
 

If you’re interested in learning more, contact Yun Gao or fill out the form and a member of our Customs & International Trade Services team will get back to you.  

 


CONTACT
 

Damon V. Pike
Principal

James Pai
Senior Manager 

Yun Gao
Manager 

Travis Fournier
Manager

Jay Cho
Manager 

Family Office Structuring in Light of Lender Ruling

Recent court rulings and tax reform legislation has an impact on family office expense deduction. The lack of definition and bright-line test determining “trade or business activities” means that we must carefully consider the distinct facts and circumstances of each family office.
 

Background

Tax reform legislation on December 22, 2017, suspended miscellaneous itemized deductions under IRC Section 212. IRC Section 212 allowed taxpayers to deduct expenses incurred for the production or collection of income to the extent such expenses exceeded 2 percent of the taxpayer’s adjusted gross income. IRC Section 162, on the other hand, has not been suspended and continues to permit taxpayers to deduct ordinary and necessary expenses paid during a given taxable year in carrying on a trade or business. Consequently, a family office that is found to be engaged in a trade or business can continue to deduct expenses related to the family office. Notably, on December 13, 2017, the U.S. Tax Court released its opinion in Lender Management, LLC v. CIR, and held that Lender Management carried on a trade or business within the meaning of IRC Section 162.
 

Is a Family Office a Trade or Business under IRC Section 162?

There is no definition of “trade or business” in the tax code. Instead, we are left to analyze a client’s facts on a case-by-case basis. The U.S. Supreme Court’s holding in Higgins v. CIR, 312 US 212 (1941) stands at one end of the spectrum. In that case, the court held that the management of one’s own investments generally does not give rise to a trade or business. The U.S. Tax Court’s holding in Lender stands at the other end of the spectrum. The tax court found that the activities of Lender Management, a family office that managed investments for several generations of the same family, gave rise to a trade or business.
 
What was the difference? While there continues to be no bright-line test for determining the existence of a trade or business, we’ve highlighted below some differentiating facts from each case.
 

Higgins v. CIR

The taxpayer held extensive investments in real estate, bonds, and stocks, and devoted a considerable amount of time managing investments and hired others to assist in that effort. The Internal Revenue Service conceded that the real estate activities were a trade or business and therefore permitted the claimed deductions allocable to that activity. In dispute was the deduction for those expenses incurred for managing taxpayer’s stocks and bond portfolio.
 
During the years in question, the taxpayer’s investment affairs were coordinated through an office maintained in New York. The taxpayer’s primary residence, however, was in Paris, France where a second office was maintained. “The offices kept records, received securities, interest and dividend checks, made deposits, forwarded weekly and annual reports and undertook generally the care of the investments as instructed by the owner. Purchases were made by a financial institution. [Taxpayer] did not participate directly or indirectly in the management of the corporations in which he held stocks or bonds.”
 
The taxpayer argued that the regular and continuous nature of the activities differentiated them from that of a small investor. The Service countered that “mere personal investment activities never constitute carrying on a trade or business, no matter how much of one’s time or of one’s employees’ time they may occupy.” Ultimately, the court was not persuaded by the taxpayer’s argument and found that the regularity of an activity does not, in and of itself, give rise to a trade or business.
 
In its ruling, the court further held that there was no trade or business where a taxpayer “merely kept records and collected interest and dividends from his securities, through managerial attention for his investments.”
 

Lender Management, LLC v. CIR

Lender Management, LLC was owned by Keith Lender with a 99-percent interest, and Marvin Lender’s trust with a 1-percent interest.  Lender Management, LLC directed the investment and management of assets owned by three investment LLCs, which were owned individually by members of the Lender family or by trusts for the benefit of children, grandchildren, and great-grandchildren of the Lender family. Most of the family members who invested in the investment LLCs were not owners of Lender Management, LLC.  Keith Lender indirectly owned small interests in the investment LLCs (no more than 17.1-percent during any tax year). 
 
Lender Management, LLC was structured using a profit-based model.  The operating agreement of the investment LLCs permitted Lender Management, LLC to hold the exclusive right to direct the business affairs of the investment LLCs.  The members of the investment LLCs could withdraw their investments at any time, subject to liquidity constraints.  Lender Management, LLC received a profits interest in each of the investment LLCs in exchange for the services it provided the investment LLCs and their members.
 
Lender Management, LLC provided investors of the investment LLCs with one-on-one investment advisory and financial planning services. Lender Management, LLC held annual business meetings for all clients in the investment LLCs.  While Lender Management, LLC engaged outside experts, Lender Management, LLC exercised ultimate authority over the investment LLCs and did not always follow the advice of the outside experts.
 
The tax court found that Lender Management, LLC was engaged in a trade or business, and as such, was entitled to deduct its expenses under IRC Section 162.
 

Hellmann v. CIR

Also in the family office trade or business foray, is Hellman v. CIR, a case brought before the tax court but ultimately settled out of court. GFM LLC, the family office at the center of Hellmann, differs from Lender in that GFM LLC is managed by four family members who are the sole owners of GFM LLC and of all the underlying investment partnerships through various trusts.
 
While we don’t know how the tax court might have ruled, prior to the settlement, the court issued an order calling for additional factual development. In its ruling, the tax court found that several factors are indicative of a family office trade or business including: 

  1. The manner in which the family office is compensated for its services.
  2. The nature and extent of the services provided by the family office employees.
  3. The relative amounts of expertise possessed and time devoted by family office employees versus outside investment managers and consultants.
  4. The individualization of investment strategies for different family members with differing investment preferences and needs.
  5. The proportionality (or lack thereof) between the share of profits inuring to each family member in his or her capacity as an owner of the family office and the share of profits inuring to that same individual in his or her capacity as an investor in the managed funds.

Each of these factors weighed heavily in the tax court’s decision in Lender. Of note, the court in Hellmann highlighted some facts differentiating the case before them from Lender.  Specifically, GFM LLC managed assets for only four family members, fewer than the Lender family office managed assets for, and each of those family members were close to each other geographically and personally. The investors in Lender were geographically dispersed and not all on speaking terms with each other. Further, all the owners in GFM LLC were also investors in the underlying investment partnerships. In fact, each of the four owners in GFM LLC owned a 25 percent profits interests, the same proportionate ownership they held in the underlying investment partnerships.
 

BDO Insight

Upon review of the court rulings, we examine several considerations. Most notably, in Lender, Keith Lender wasn’t primarily engaged in personal investment activities like the taxpayer in Higgins. Keith merely had a small indirect interest in the investments managed by Lender Management, LLC. Instead, Lender Management, LLC managed investments for multiple generations of the Lender family with its primary objective to earn the highest return on those assets it was managing.
 
Moreover, unlike the taxpayer in Higgins, Keith was operating Lender Management, LLC to earn a profit. Lender Management, LLC received carried interests as compensation and engaged in activities comparable to that of a hedge fund manager. This is contrary to a typical family office structure that operates on a reimbursement model.
 
Further, Lender Management, LLC had a bona fide service relationship with its investors, which included several generations of the Lender family. Investors were able to withdraw funds at any time, investment choices were driven by the needs of the investors, and Keith Lender met regularly with investors to discuss their cash flow needs and risk tolerance.

 


CONTACTS
 

John Nuckolls
Managing Director, National Senior Technical Director, Private Client Services
                     Jason Cain
Family Office Services Managing Partner

 
Traci Pumo
Managing Director, National Technical Director, Private Client Services
  Amy Pienta
Family Office Services Senior Director

 
Jeremy Mertens
Tax Managing Director, Private Client Services
  Craig Witcher
Managing Director

Duty Refund Opportunity on Chinese Imports

Trouble with China Tariffs? This Could Help.

Turbulence related to tariffs has become troublingly commonplace. In May of this year, the President announced that retaliatory tariffs on nearly $200 billion of Chinese exports under Section 301 of the Trade Act of 1974 would increase from 10 to 25 percent for tariff codes set forth on the so-called “List 3” products. For U.S.-based businesses that import these goods, which includes merchandise ranging from laptops to shoes to food items, this increase creates a host of problems — decreased sales, the need to rework supply chains and cash flow issues, to name just a few.

The good news?

The Office of the U.S. Trade Representative (USTR) opened a short period for importers to request exclusions from the additional 25 percent tariff imposed on Chinese imports as of September 24, 2018.
 

But, there’s no time to waste. The deadline to file a request with USTR is September 30, 2019.  

What’s the benefit?

While applying for the refund does not guarantee you’ll receive it, if the exclusion is approved, the cost savings can be significant. Any exclusions granted will result in a duty refund retroactive to September 24, 2018, and will remain in effect for one year from the date on which the exclusion is published on the Federal Register. This will allow companies the time needed to make some short-term supply chain shifts necessary to reduce their tariff exposure.  

Obtaining an exclusion is one of the most effective ways to mitigate the financial liability of increased tariffs on the import of Chinese origin goods, and the least disruptive to a company’s existing supply chain. 

How do you apply?

In the online request form, a company needs to demonstrate that it cannot source the goods from a U.S. or third country supplier, and that the company will suffer a significant financial impact from the additional tariffs. Importantly, the requester can claim “small business” status (as defined in the Small Business Administration regulations), which may increase the chances of success.  Many companies have already applied for this exclusion, and time is running out.
 

If you’re interested in learning more, contact Yun Gao or fill out the form and a member of our Customs & International Trade Services team will get back to you.  

 


CONTACT
 

Damon V. Pike
Principal

James Pai
Senior Manager 

Yun Gao
Manager 

Travis Fournier
Manager

Jay Cho
Manager 

The Importance of Total Tax Liability And Global Outlook to Business Planning

By Monika Loving and Damon V. Pike
This article originally appeared in Tax Notes International on May 20, 2019.

Globalization and digital technology have provided unprecedented growth opportunities for U.S.-based businesses. Tax executives at these companies have never been better positioned to help lead their corporation’s business strategies at home and abroad. However, our new survey shows that sweeping changes to the U.S. domestic tax code and volatile international trade relations are competing for the bulk of in-house tax professionals’ time and attention. Tax executives who focus on their business’s total tax liability and put systems in place to monitor and adapt quickly to external changes can maximize their roles as strategic business advisers.

The BDO USA LLP 2019 tax outlook survey1 polled 150 tax executives at U.S. public companies with $1 billion or more in annual revenues to find out how they’re handling both immediate challenges and forward-looking concerns. Although the future is murky, one thing is clear: Tomorrow’s tax professionals will need to strike a balance between responding to external shifts and playing a proactive role in the overall business strategy.

A key to unlocking a proactive stance is monitoring a company’s total tax liability and communicating it to the board and C-suite members. Analyzing the sum of all taxes (income- and non-income-based taxes) owed at the international, federal, state, and local levels allows tax professionals and their peers to make better business decisions — from mergers and acquisitions to hiring and establishing operations abroad. The need to analyze total tax liability is even more imperative considering that according to a recent National Association for Business Economics survey, more than 75 percent of economists predict the United States will enter a recession by the end of 2021.2 Findings from our survey support this sentiment — more than 1 in 4 tax executives think the economy will only grow for one to two more years. Strategic tax planning today will improve cash flow and better prepare a business for a future downturn.

The tax outlook survey shows that only slightly more than half (58 percent) of tax executives believe they have a “high” understanding of their organization’s total tax liability. Even those who feel like they do have a grasp on this critical metric may not be communicating it effectively to company stakeholders. According to BDO’s recent board survey,3 fewer than half of board members (44 percent) say they have a “strong understanding” of their companies’ total tax liability and its impact on corporate tax strategy, while 51 percent say they have a “moderate understanding.” These discrepancies present an opportunity for tax executives to concentrate on total tax liability and educate themselves and their board members about its implications for business decisions.
 

U.S. Tax Code Changes

One of the challenges keeping corporate tax executives from being more strategic and forward thinking is the ongoing interpretation of, and compliance with, U.S. tax code changes. With tax rules changing more in the last two years than in the last few decades, 46 percent of surveyed executives said adjusting to federal tax changes is their top issue in 2019. As senior tax professionals work through their first tax return filing season with most provisions of the Tax Cuts and Jobs Act (P.L. 115-97) in effect, they are challenged to keep up with the deluge of TCJA-related guidance on issues such as Opportunity Zones, section 199A, and global intangible low-taxed income. Half of tax executives surveyed claim that the time they spend helping their company adapt to U.S. tax reform has increased substantially since the enactment of the TCJA. Democrats’ regaining control of the House of Representatives this year means that additional changes to the tax code could be on the horizon.
 

Customs and Trade Developments

Many tax executives are watching Capitol Hill to see if it will approve the president’s plans to replace the 1994 North American Free Trade Agreement by ratifying the new United States-Mexico-Canada Agreement (USMCA). Disagreement over steel and aluminum tariffs imposed on Canada and Mexico, environmental and labor protections, and general political discord may prevent the deal from making it through a divided Congress. Also, the U.S. International Trade Commission4 recently released a report that found the USMCA would only increase U.S. GDP by an estimated $68.2 billion, or 0.35 percent. The modest estimated effect may sway on-the-fence lawmakers against the deal and could arm opponents with a quantitative argument for why a better deal needs to be negotiated.

Meanwhile, trade tensions with China are worsening. Because of China’s forced transfer of U.S. technology and intellectual property, the United States imposed tariffs on $250 billion worth of Chinese goods under section 301 of the Trade Act of 1974, spurring retaliatory measures from China. To date, nearly half of all Chinese goods brought into the United States have been subject to additional tariffs, many at a rate of 25 percent and the remaining at a rate of 10 percent. As negotiations continue and the future remains uncertain, many companies that had plants in China are moving manufacturing to Mexico5 and other countries to avoid the additional tariffs.

Even though nearly three-quarters of the businesses represented in the tax outlook survey must adhere to complex global tax regulations, only 12 percent of their tax executives name global taxes as their top challenge this year. This confirms that attention and resources are allocated to issues at home and highlights opportunities available to those tax executives who stay abreast of global concerns. However, trade tensions and tariffs will continue to play an important role. Corporate tax executives say they are pursuing several strategies in response to these issues, including:

  • reevaluating international supply chains and logistics (63 percent);
  • analyzing global import and export models (55 percent); and
  • altering strategic sourcing processes (43 percent).

BEPS Action Plan

Another global topic that is on the minds of senior tax professionals is the implementation of the OECD’s base erosion and profit-shifting action plan to address taxes in foreign jurisdictions. In 2013 the OECD published a plan to address corporate globalization, prevent the minimization of taxes in OECD jurisdictions, and ensure some standardization between international tax regimes. Compliance with the action plan and its corresponding domestic legal changes explains why 77 percent of tax executives surveyed say they have increased their focus on tax transparency, and 62 percent have increased their tax audit activity on transfer pricing.

While the jury is still out on whether the OECD plan is significantly curbing the shifting of profits from higher-tax to lower-tax territories, government regulators are increasingly scrutinizing digital taxation. As businesses become less brick-and-mortar and more cloudbased, governments worldwide are grappling with how to tax the companies that profit from selling services to their people and use their resources. Within Europe, France has taken the lead on digital services tax legislation, and other countries are certain to follow suit. However, 70 percent of executives responding to the survey say they are “only slightly” (31 percent) or “not at all” (39 percent) concerned with the United Kingdom’s DST legislation. The OECD is also on track to release additional details on its work on digital taxation by the end of 2019.

All these external forces, both domestic and international, could disrupt business growth. A potential downturn in the marketplace and continuing fallout from tax reform may stretch tax departments and hinder their ability to focus on global tax trends. Internal pressures to do more with less may mean less technology or fewer staff members to keep tax executives out of the daily minutiae and at the table making strategic decisions. If tax executives can demonstrate value through understanding and explaining their company’s total tax liability, they will be better equipped to play the role of business counselor and minimize their organization’s overall tax obligations, now and in the future.
 


CONTACT
 

Monika Loving
International Tax Services Partner & National Practice Leader
  Damon V. Pike
International Tax Principal, Customs & International Trade Services

 


[1] BDO, “BDO Tax Outlook Survey” (Feb. 2019).
[2] National Association for Business Economics, “Economic Policy Survey,” at 6 (Feb. 2019).
[3] BDO, “2018 BDO Board Survey” (Sept. 2018).
[4] U.S. International Trade Commission, “U.S.-Mexico-Canada Trade Agreement: Likely Impact on the U.S. Economy and on Specific Industry Sectors,” at 4889 (Apr. 2019).
[5] Matt Townsend and Eric Martin, “In Light of US Tariffs, Chinese Manufacturers Move to Mexico,” Mexico News Daily, Mar. 27, 2019.