David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: the response to coronavirus. Whether or not it officially reaches full pandemic status, the coronavirus is having a significant economic impact, from canceled flights and quarantined cruise ships to idled factories. How is China, the country that is hardest hit, using tax policy to cope with the outbreak? Joining me now by phone is Daisy Dai, an assistant law professor at the Shanghai University of Finance and Economics. Daisy is also a senior academic visitor with the University of Oxford Faculty of Law. She recently wrote about this topic for Tax Notes. Daisy, welcome to the podcast.
Daisy Dai: Thank you so much, Dave. It is great to be here.
David Stewart: Well, why don't we start with an update on where things are with the virus as of the day we're recording this. It's currently February 26. Things are moving kind of fast. But where are things now?
Daisy Dai: So right now there are five new cases confirmed outside of Hubei province and 400 new cases confirmed in Hubei and the aggregate number of confirmed cases in China is around 78,000 and more than 25,000 has been cured and discharged from the hospital. So it is kind of clear that most of the new cases in China happened in the Hubei province. And since January 23, Hubei has been locked down to quarantine the coronavirus outbreak. And there has been some real decline in China due to the quarantine requirements. And Wuhan has a population of over 11 million and it is referred to as the Chicago of China because it is the capital and the largest city of Hubei and it has a key role in domestic transport in central China. So this is kind of where we are now because the whole of Hubei province has been locked down and Wuhan cannot get to anywhere else in China, so we hope the quarantine will continue to be effective and you have seen that to be very effective during the past month.
David Stewart: So is it just the one region that's being quarantined or are there other measures being taken elsewhere in China?
Daisy Dai: Actually most places in China have been under quarantine during the past month. And I do think I'm living in a very interesting time. Lunar New Year is considered the biggest time of the year for families to get together and celebrate. But this year, due to the outbreak, most places are locked down in China. And I was actually traveling with my family in Europe during the Lunar New Year and our return flight was canceled in Europe. So we had to reroute and we went through Moscow and then flew to Shanghai. And when we arrived in Shanghai, we had to stay home for 14 days, which is the quarantine requirement. And I think everyone in this country is making sacrifices to stop the spread of coronavirus. It has become a very concerned way of living for sure. And the message we got from the government is like the fastest thing we could do at this moment for GDP is to stay home.
So even today, a number of public places, like grocery stores or coffee shops, they check visitors' temperature at the entrance. And as I personally experienced during the past two weeks, each household only got one ticket to go out for grocery shopping. So this is kind of how the quarantine has taken place in most places in China and the university where I teach is still shut down. Students started online classes last week, but it is unsure when the school will start. Maybe in late March, but we don't know yet. That's kind of the situation that is going on.
David Stewart: Is it sort of eerie? There's just no one outside these days?
Daisy Dai: Well I'd say during the first week of February, the whole country was kind of empty because people were staying home. But it's getting much better now because the government sees the urgency to resume work, so most major transport traffic has been resumed during the past week.
David Stewart: What sort of tax measures is the government using as it's trying to combat the outbreak?
Daisy Dai: Right. And the government has taken several tax measures to help combat the outbreak. For example, the first one might be all of the medical workers who are fighting on the front line in Hubei, they will receive their salaries for tax-free and their subsidies for tax-free. And after the coronavirus outbreak, they will get paid vacation. And the second one I would mention is the import of medicines -- medical, and other protective supplies, vehicles used in the combat -- it's all tax-free. And the customs who are processing all these imports as a priority. And the third one might be donation tax deductions. Because before these particular recommended response, individuals, taxpayers or corporate taxpayers, they cannot deduct a full amount for donation. But this time, they can claim a full tax deduction for cash and goods donated made in to defeat the coronavirus.
And it doesn't have to be donations made for the Red Cross specifically. They can take full tax deductions for any donations made directly to the designated hospitals and other equivalent NGOs. And the companies who produce the key supplies for the prevention can take immediate deductions of all qualifying equipment costs. But without this particular regulatory response, they could only depreciate these key supplies over the new supplies. And with all these manufacturers who are producing the key supplies and who are investing in R&D, they could take a super deduction, which is simplified deductions of qualified R&D expenses. And on top of that, those high-tech enterprises can still get 15 percent preferential corporate income tax rates. And I know that the U.S. doesn't have to VAT, but China imposes VAT. And in Wuhan, taxpayers will be exempt from VAT and other taxes if the medical supplies they produced or purchased and donated towards keeping the coronavirus out. And a lot of enterprises producing masks, they will get qualifying financial subsidies from the government and those financial subsidies are not subject to corporate income tax. And we would expect more coming up, but these are the current tax measures that the government has adopted to combat the outbreak.
David Stewart: We'll get back to the interview in a moment, but first, here's Tax Analysts' president and CEO Cara Griffith with a word on an upcoming event. Cara.
Cara Griffith: Thanks, Dave. I'm excited to announce a major anniversary for Tax Analysts. It's our golden year as the organization turns 50. Tax Analysts has gone from humble beginnings to becoming a leading provider of tax information and a forum for evenhanded debate. As part of our 50th anniversary, we will be hosting a gala dinner at the national portrait gallery on April 29 in Washington D.C. We will honor former IRS commissioner and longtime leader in the tax world, Larry Gibbs and discuss the future of tax policy with U.S. Treasury Assistant Secretary Dave Kautter. We hope you'll join us in celebrating our first half-century. To become a sponsor or purchase tickets, visit events.taxanalysts.org/50thanniversary.
David Stewart: You mentioned that the government had said something about staying home was the best thing you could do for GDP. What sort of economic effects is China experiencing from this outbreak and the quarantines?
Daisy Dai: A significant number of factories had shut down during the coronavirus outbreaks in the past month. And for these factories in particular, they had suffered some fair economic losses, especially those small and the medium-size enterprises. They couldn't afford employee wages and the rent at the same time that they had to remain shut down. For example, the most popular karaoke business in Beijing announced to terminate all employment contracts February 9 in response to the shutdown. And also the shutdown has impacted global supply chains. I read a famous survey that is done by the American Chamber of Commerce in Shanghai. And in the survey, they found 48 percent of companies report their global operations are already impacted by the shutdown. And these are American companies with manufacturing operations in the Shanghai region. So the shutdown has, I would say, substantial impact on both, not only global supply chains, but also in China's domestic SMEs.
Right now there are several obstacles to resume business. The first one might be the shortage of workers because companies in major cities like Shanghai and Beijing, they rely on migrant workers to resume business. But these migrant workers, they are currently stopped in villages or other distant cities. So to respond, since February 16, which was 10 days ago, they're trying to regroup. They had chartered hundreds of trains transporting the migrant workers to major cities, including Shanghai, and Guangdong in the south, and on the east coast. And the second one, according to the survey, and according to the Chinese business news, it is the shortage of masks. And I think it is almost a global shortage right now for the supply of masks, which comes from my personal experience in Europe.
And this morning I was just chatting with my host family in Charlottesville. They told me the hospital in Charlottesville is in short supply of surgical masks. And according to the survey that is done by the American Chamber of Commerce, 38 percent of companies said they did not have sufficient masks or other safety supplies to protect workers. But local regulations in Shanghai require all of these companies to provide masks to protect workers. And a third issue might be the logistic issue. Because the main traffic was shut down during the first and the second week of February, so people could not travel. And they had to reopen the main traffic and they reopened the main traffic in mid-February to transport both the supplies and the workers. So during the next week, the logistics will become less of a concern, but right now it is still a big concern for many factions. The last one might be the increase in compliance work for the companies to resume business. In Shanghai and the Guangdong province, for all these companies, if they want resume work, they must have filed several forms to obtain the local government's approval to reopen. And these appropriate requirements include whether the companies had checked its workers' recent travel records to see whether the workers have traveled to Hubei. And before last week, a lot of places still impose a 14-day quarantine requirements. But now about eight provinces have lowered that quarantine requirement, so workers do not have to stay home for 14 days strictly.
David Stewart: What sort of tax measures is the government taking to mitigate the economic effects of this outbreak?
Daisy Dai: So to mitigate the economic impact as we have seen, there is potential economic losses at this moment. And a lot of taxpayers, especially the companies, they couldn't take off work so they couldn't basically follow the tax filing, which was supposed to be due in the first week of February. So the monthly tax filing deadline is extended to the very end, Feb. 28. And for tax bills due across the whole country, taxpayers are encouraged to use the e-filing systems and digital invoices. The purpose is to minimize any human-to-human contact, which I think will be very helpful for the country to facilitate the use of all the online applications for tax filing purposes. And the second one might be the VAT exemption and the exemption from all the other taxes. Because the businesses in public transportation, and transportation for emergency supplies, and other essential medical services, they are right now exempt from VAT. This exemption is supposed to last until May and in the Hubei province, they will probably extend the extension to July. But we don't know that definite space yet. And the businesses that are severely affected, they can carry forward all the losses occurred in 2020 for an additional three years. It used to be five years and with this additional three years, it is eight years in total for them to carry forward the loss. And of course, the central government provides a lot of Social Security deferral payment and subsidies. Before these deferrals and subsidies, the SMEs had incurred a lot of huge economic loss because they have to pay the workers a substantial amount of Social Security payments on top of their salary. And the central government responded by deferring payments and they also subsidized the SMEs' rates, the Social Security payments.
David Stewart: Do you expect any additional measures from the government in the relatively near future?
Daisy Dai: Yes, very likely. The central government probably will announce more tax measures in March when business is for fully resumed. But at this point, only 70 percent have resumed work. And we also could expect more of the tax relief at the local government level because in China the local government has a lot of discretion to give tax relief for business, especially for business that is encouraged by the local government. For example, in Shanghai, the Shanghai government is already subsidizing certain businesses and the workers' training program in using online ads. And Shanghai also followed up with several preferential tax and financing treatments for the small and medium-sized enterprises, like they would guarantee the credit and reduce the financing cost. The purpose is to stabilize the SMEs' operations. Otherwise we might see more and more of the bankruptcy filings in this year.
David Stewart: Daisy, thank you very much for joining me today.
Daisy Dai: Thank you Dave. It's my honor to be here today.
David Stewart: I hope things go back to normal for you pretty soon.
Daisy Dai: Thank you, David. I hope so too and I'm so sorry to see that there are more cases in South Korea, Japan, and Italy. And I hope the whole world will combat this coronavirus pretty soon.
David Stewart: Now for another edition of Willis Weighs In, where Tax Notes contributing editor Ben Willis discusses tax planning issues.
Ben Willis: Thanks, Dave. Today we'll be discussing Rev. Rule 2019-24, and the IRS's failure to properly address tax-free forks. The proposition that I want you to leave with today is that hard forks can in fact be tax-free and the IRS in this revenue ruling left out critical facts that would be essential to making that determination. Those facts are largely based on value and whether or not there was a realization event.
So let's go ahead and start off with value. In situation two of the revenue ruling, we have B that owns 50 units of crypto R. Now because B owns 50 units of crypto R, they receive an additional 25 units of crypto S worth $50, which the IRS calls taxable accession to wealth. I don't believe there's enough information to actually reach that conclusion. Now let's say the 50 units of crypto were worth $500 in total, $10 a piece. And at the time of the hard fork, they decrease in value by a dollar to $9 such that crypto R in the hands of B is worth $450. And when they receive the additional $50 of the crypto S units, in total, they have the same value as before the hard fork. Because we're not given that information, we don't actually know if there was an increase in the value that they actually received or if this was more like a return of capital transaction or a simple division of property.
So what is the principle that focuses on that? Well, that principle comes from Eisner v. Macomber, which a lot of people cite for the proposition of non-realization when property is separated. There, there was a stock split and the U.S. Supreme Court specifically said the corporation is no poorer and the stockholder is no richer than they were before. So they own twice as many shares in the stock split, but each share was worth half what it previously was. So they had the same amount of value before and after, and the court concluded that there was no accession to wealth in that instance. Now it's important to realize that Congress, within a year after that case, enacted the Revenue Act of 1921, and created some very important provisions with respect to cryptocurrency. They created the like-kind exchange rules currently found in 1031, which were used to allow for tax-free exchanges of cryptocurrency up until 2018 where the TCJA changed that. They also enacted current section 305 for stock splits, 351 and 368 on tax-free reorganizations. So there's a lot that really stems from this case about when you recognize income and you take that into account or you've just modified something that you own.
Now, the next point that I want to mention on top of value is realization. The Supreme Court gave some great clarification to the principles under section 1001 when in Cottage Savings they allowed a taxpayer to claim a loss when they exchanged mortgages. And the reason they allowed that loss was because the property had legally distinct entitlements that were different than previously held property. Now we don't know if this cryptocurrency provides new legal entitlements. And so unless we know the value of crypto R, which we don't, and we know the legal entitlements provided by these cryptocurrencies, it's really impossible to say whether or not we have an accession of wealth that's taxable. One analogy to this, in addition to having a stock split, is just the separation of attractive land. You can subdivide land, but it's well recognized that you're not going to realize and recognize gain on that land until you sell those parcels.
So with all that said, I want to reiterate my point that it is my view that cryptocurrencies can indeed be tax-free upon a hard fork, and unfortunately the IRS failed to convey that in Rev. Rule 2019-24. Thank you for reaching out with your questions and your comments. Always appreciated. Please keep them coming. You can reach me at @WillisWeighsIn on Twitter or through my email at ben.willis@taxanalysts.org. Thanks.
David Stewart: And now coming attractions. Each week we preview commentary that'll be appearing in the Tax Notes magazines. I'm joined by Executive Editor for Commentary Jasper Smith. Jasper, what will you have for us?
Jasper Smith: Thanks, Dave. In Tax Notes Federal, Charles Rossotti argues that the IRS could shrink the tax gap by adding third-party reporting of unreported income. Tristan Evans-Wilent explains why stock acquisitions can involve transaction tax deductions. In Tax Notes State, three practitioners from RSM US discuss states’ plans to enact an interstate compact on credits and incentives. Richard Cram discusses the 1944 sales tax decision of McLeod v. Dilworth. And in Tax Notes International, Jakob Bundgaard and Louise Fjord Kjærsgaard discuss how the digitalization of the economy is affecting nexus rules. And Marco Rossi discusses a ruling by the Italian Tax Agency regarding the tax treatment of Brazilian interest on net equity payments. In the Opinions page, Joe Thorndike writes that there are arguments for keeping some elements of the tax legislative process from constant democratic oversight and Nana Ama Sarfo looks at BRITACOM – China’s Belt and Road Initiative Tax Administration Cooperation Mechanism.
David Stewart: You can read all that and a lot more in the March 2 editions of Tax Notes Federal, State, and International. That's it for this week. You can follow me online at @TaxStew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.
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