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Practitioners Anticipate Tax Filing Season Wins and Woes 

David Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: tax season kickoff. February 12 marks the start of the 2021 U.S. tax filing season. But this year, much like last year, will be far from normal. First, the IRS announced that the tax season will begin three weeks later than in previous years. This is the second filing season since the start of the coronavirus pandemic and the third since the Tax Cuts and Jobs Act took effect. This has presented taxpayers and practitioners with some familiar but still unique challenges. Here to talk more about this is Tax Notes senior reporter William Hoffman. Bill, welcome back to the podcast.

William Hoffman: Hi, David. Thanks for having me back.

David Stewart: Now, I understand you talked to two practitioners about the 2021 filing season. Can you tell us about them?

William Hoffman: Well, first of all, Phyllis Jo Kubey is an enrolled agent based in New York City. She served most recently as chair of the Internal Revenue Service Advisory Council's Wage and Investment Subgroup, working with the tax agency's Wage and Investment Division on implementation of coronavirus emergency tax legislation, such as the CARES Act. Interestingly, Forbes also picked Phyllis's Twitter feed as one of the top 100 to follow in 2021. Ryan Losi is executive vice president at PIASCIK certified public accountants in Richmond, Virginia, leading the company's business development efforts. Ryan also heads the company's international and real estate practices. Before PIASCIK, Ryan worked in international tax at both KPMG and Pricewaterhouse Coopers. Ryan's business takes him all over the world, allowing him to indulge a passion for scuba diving, for which he's earned an advanced open water certification to 100 feet deep.

David Stewart: What sort of issues did you get into?

William Hoffman: Well, I've been writing tax return filing season coverage at Tax Notes Today for almost 10 years and this year I wanted to do something different. We recruited these two tax professionals specifically to hear of two very different perspectives on this most unusual 2021 filing season. I also wanted to go beyond the routine questions about how this filing season differs from the last and what we can expect this year from the IRS, so our tax professionals talk about the tax agencies' response and practitioners' preparations for February 12 when the IRS will receive almost one-third of the individual returns it expects to receive in just one day before April 15. We also conducted the first Tax Notes podcast top 10 lightning round of major practitioner and IRS filing season issues, and challenged our guests to give us their first impressions and thoughts without any advance notice or preparation for the question. It was exciting, at least as exciting as tax filings season podcasts get.

David Stewart: All right, sounds great. Let's go to that interview.

William Hoffman: Welcome, Phyllis and Ryan. Thank you for joining us on the Tax Notes podcast.

The IRS starts accepting individual tax returns for the 2021 filing season on February 12th, almost three weeks late this year, but practitioners have been completing electronic and paper returns and storing them for weeks in advance of submission. Are you worried given the IRS's disappointing history with technology and long lines about the agency's ability to receive approximately 40 million tax returns in one day? That's almost one third of the individual returns the IRS would normally receive and process by April 15, and that's not to mention all the intervening deadlines for corporations, partnerships, and so on. Also do you have any plans for client issues in case the IRS is unable to promptly process the roughly 37 million returns that it would usually have finished by now? Phyllis, please go first.

Phyllis Jo Kubey: Yeah. Thanks, Bill. That's a really good question. I do have faith that the IRS has done a lot of troubleshooting on this and they know what to expect so I would like to give them the thumbs up that we will not have any technological disasters. Of course, you know, one never knows; things do happen. In terms of what I'm doing in my practice, my clientele is not habitually an early filing bunch, so I've pretty much been collecting information as I usually do. Most of my clients' stuff is not yet complete. So I'm working away, and in terms of what I'll be filing on the 12th, I think if I submit anything that day, it will be some amended 2019 and prior year returns that I've had in the hopper but haven't been able to transmit.

William Hoffman: All right. Ryan?

Ryan Losi: Well, you know, similar to Phyllis, I think the majority of taxpayers will probably experience little to any delay other than the actual three-week announcement of acceptance of returns that the commissioner made, but like her practice, probably a good 85 to 90 percent of our clients do not actually file timely returns. We asked for extensions and whether they're extensions that are available to domestic taxpayers or the special extensions available to international taxpayers. We use those quite a bit, so really the second half of the year is when we filed the majority of our returns.

And I will tell you, those are ones I'm more concerned about that the IRS processes correctly. If the 10 months, over the last 10 months or 11 months, is any indication that the service's ability to process timely, chronologically, in order, amended returns that were filed pre-COVID also during COVID as well as applying payments correctly on whether those were payments made on the extended due date, that the commissioner and treasury extended us last year to July 15, or whether it's just amended returns where you're choosing to apply the refund claim to a subsequent year, my hopes are not very high that the service is going to get that right.

And that's based on countless experiences at our firm and myself have had over these past 10 months. I think that the vast majority of taxpayers that have simple tax picture, maybe W-2 and they're under the standard deduction is an excess of what the itemized deduction would be for them. They're probably going to have maybe a fairly routine exercise. But I think for clients that have complications with multiple years carrying into 2020, I'm not holding my breath.

William Hoffman: Phyllis, you and I have talked about the extension issues before in previous filing seasons. I'm wondering if you share his concerns or you feel that enrolled agents more generally are concerned or not about the processing of extensions and maybe the expected increase in volume given our current situation.

Phyllis Jo Kubey: Yes, I do. I do agree with Ryan. And you know, when you ask about how the transmission of returns will go, that's one issue. You e-file a return if it gets through the system without any immediate rejections. That's step one. But then after that, there is a lot of stuff that goes on behind the scenes that [like] the IRS returns get flagged for identity verification. They get flagged for errors. There are various other processing things that go on in the background that can delay.

And in terms of what Ryan said about the ordering of things, that can definitely create a big mess. And in terms of extensions, you get another layer of filing. And if you have clients that are apt to have balances due, you want to set up the payments with the extensions so that's another layer of work. So I do think, you know, I, and my enrolled agent colleagues and all tax professionals do have some tremendous concern about these issues.

William Hoffman: Interesting. Phyllis, you and many other tax pros have noted to me how important IRS and state tax conformity is harmonizing deadlines, tax forms, regulations, United States tax law, and how important that is to tax practitioners practices during filing season. Can you tell me how much time and what kind of work the current state and federal systems impose on your particular practice and whether and how the IRS or the tax profession might minimize the troubles of tax conformity?

Phyllis Jo Kubey: Well, I think the major burden is keeping on top of where the state tax agencies are with tax conformity both for individuals and businesses. I know New York state, which as a general rule did not conform to a lot of recent tax legislation, just within the last couple of weeks came out with some guidance that was a big sigh of relief for people who filed New York returns because they are conforming on some of the retirement provisions in the CARES Act and the SECURE Act.

And we have a lot of issues that we thought were really going to be messes. For instance, if somebody decided to ,take advantage of the federal three-year spreading out of a retirement distribution and if that weren't the case with the state, you'd have issues not only filing the tax return and reconciling, adding things back on the state return, but also you'd have huge issues with basis going down the line.

So keeping on track of these things, it takes a lot of time and something that I looked at yesterday might change today. So I know having a practice where a lot of people do a lot of different state returns, I'm going to have to make sure to go and check out those websites before I file anything, and then it's not only a matter of the state taxing authorities. It's how are the software vendors able to keep up and incorporate last-minute changes into our tax software? So we've had issues before where it's like, "Well, I know that this was finalized weeks ago, but, 'Hey, Thomson Reuters (that's my talk software vendor) why haven't we incorporated this? '" I totally get it that it's a nightmare for tax software vendors who have to test all of these things with the IRS, with the state tax agencies. And it's a big issue.

William Hoffman: Interesting. Ryan, how does your real estate and cross-border international tax experience compare with Phyllis's? Especially considering, at least as far as I understand it, that the U.S. tax professionals are more or less at the mercy of foreign authorities over which he or she has no control.

Ryan Losi: Yeah. So, I mean, if you have a multi-state practice or even international practice, you really start to understand how jurisdictions and the ability for different jurisdictions to make their own laws, especially tax laws, whether it's conformity or de-conformity with the U.S. code really can keep you on your toes is the best way I can say it.

So for instance, certainly what Phyllis has comment about New York state changing, Virginia has been the same way the last probably five to seven years. I will say that Virginia conformed for the most part. And it was basically, you can guarantee that it was the first bill that was signed in the General Assembly every year. And someone who's championed in a number of bills and got patrons and gone through the committee testimony and got things pushed through, that worked except when you had a changing General Assembly. And if you've watched the political side of Virginia, it's changed and what happens is although something that to us professionals is supposed to be kind of routine and you would think it would be an easy passage, all of a sudden becomes a bargaining chip and we're waiting five to six months after the year end to even know what the prior tax laws are going to be, which is what we've been waiting on the past five years. Even so right now we're still waiting. We don't know what Virginia law is.

So I think that, you know, as a practitioner doing the federal side there's not retroactive treatment at the federal level unless it's beneficial. They're usually not going to do something that's negative on a retroactive basis, but you know, if you've got a multistate practice, you have 50 states and that's where you realize like every state can really write its own rules when it comes to income taxation for the most part. And that is a struggle. You have to have a team that's dedicated to following it. What you try to do is get a sense of the clusters of your clients so that you can monitor those clusters on a daily basis or definitely weekly basis.

Now, on the international front, it's a little different from a standpoint of there are entirely sovereign countries that have really no obligation to U.S. law. And so when you get clients that have assets abroad and whether those are business assets or certain types of investment vehicles, a lot of times you're at the mercy of a number of different people. It could be foreign trustees, it could be foreign brokerage or investment advisors. It could be foreign chartered accountants or foreign tax attorneys, or just having to really push your client to advocate and persuade them to meet the U.S. deadlines because they have their own separate deadlines and they have their own business cycles.

And so that's where it gets a little tough because in the international piece, not only we have to take into account other countries' finalization of tax returns and financials and provide that information timely so we can do the conversions to U.S. tax principles. But unlike on the domestic side, when you miss the international filings, there's a lot of statutory, huge civil fines under 6038 and 6039 of our code. And so therefore it's not just a matter of, "We just missed a deadline and it's going to be a slap on the wrist." Many times there's an automatic penalty in the realm of $10,000 or more and then you've got to fight to get it removed. And then the question is how do you bill that? And how do you collect it? How do you communicate? So that's kind of the struggle when you've got cross-border reporting for clients.

William Hoffman: Has the conformity problem gotten worse with COVID and economic contraction of the last couple of years?

Ryan Losi: I don't necessarily think COVID — I mean, I will say the decade of the 2000s it seemed like Congress passed every single year a major bill. And then finally after 2010, there was a little breathing room. It was only every two or three years. I think what happened is COVID intensified the ability to demonstrate if you couldn't work and be productive in a remote setting, then your customer and clients really saw it. It stood out and in particular the service and all of its different departments and even state tax authorities, just having people available to man phones or departments to process POA. It just jumped out dramatically. And so the amount of time that we're spending just trying to get the service or tax authority to address our issue — not fix it, just address it — so that we can communicate to the client that it's actually going to be resolved has dramatically gone up. But it was going up anyway at the federal level anyway because of the reduction in workforce at the IRS over the past decade.

William Hoffman: Phyllis, what do you think?

Phyllis Jo Kubey: Yeah, I would say definitely, Ryan, what you were saying about the pivoting of the IRS and the state tax agencies to a teleworking environment, that was a huge, heavy lift. I think, particularly for the IRS, where so many of the phone operations come out of Wage and Investment, which was one of the least telework-able business operating divisions prior to COVID. And I must say how they got that up and running was just astonishing. And I do think it's kind of fun when I call the practitioner priority service now and get to ask where people are. They sound just snug as a bug in a rug in their basement working from home.

William Hoffman: I'm really glad that we've got two longtime tax professionals here on the podcast to compare and contrast their experiences and I want to call a lightning round. I'm going to call on each of you by name in turn and I'm going to mention 10 issues of what we believe are of current interest or concern to tax preparers and practitioners during the 2021 filing season.

I want your first impressions, thoughts, anecdotes, ideas, or insights about those things either for yourself, your clients, the IRS and tax administration, the tax profession, or the whole universe in general. I reserve the right as a Tax Notes Today reporter to follow up if you say something particularly intriguing. But in the meanwhile anything goes. Are you ready?

Ryan Losi: Yes.

Phyllis Jo Kubey: Ready.

William Hoffman: Phyllis, IRS Practitioner Services.

Phyllis Jo Kubey: IRS Practitioner Services is one of our most beloved and hated resources. Beloved because we really need that level of service that's particular and more specialized for practitioners and hated because of the IRS resource limitations that often equates to long hold times.

William Hoffman: Ryan, IRS Practitioner Services?

Ryan Losi: Efficient at addressing simple complex matters. Very inefficient at addressing complex tax matters.

William Hoffman: Number two to you, Ryan. IRS processing backlogs.

Ryan Losi: The commissioner needs to know what the frontline are experiencing because the message externally is not the same that I hear internally when I speak to the agents.

William Hoffman: Well, now that's worth following up. What are you hearing?

Ryan Losi: Even though all the mail must have been opened, which was publicly stated by the commissioner on 21st of January, the two weeks leading after that, I had a number of IRS calls. I try to pick Monday as my IRS call day and line them up assuming the POAs are processed. And in fact many of the returns that were filed — and let me qualify that amended tax returns that were filed — during that period leading up to July and even thereafter, although the mail may have been opened, it's not processed. And we need processed tax returns to have the final result that we're doing for our clients, which is finalizing their tax year and that account, and any carry forward attributes that go into effect a subsequent tax year.

William Hoffman: All right, round two. Phyllis, please. IRS processing backlog.

Phyllis Jo Kubey: I would echo what Ryan said. It's great, congratulations, and kudos to the IRS for getting all the mail out of the trucks in the parking lot and into the service centers. But that does not mean that those returns payments correspondence has all been processed.

William Hoffman: Phyllis. Fraud.

Phyllis Jo Kubey: Yikes. The balance between ease and efficiency of various programs and stopping fraudulent actors is really tricky. I mean, it's all over the place. It's been for years with the refundable credits. Now we have economic impact payments, which probably is not as open to fraud.

But a big one is fraudulent unemployment claims. When people have stolen legitimate taxpayers' identity and filed unemployment claims often in states where the taxpayer has never lived. So if they're lucky, the state unemployment agency did a little bit more probing and said, "Hey, is this really you?" and were able to cut it off at the pass.

But in many cases I have a lot of clients now who are receiving Forms 1099-G from the Ohio Revenue Agency, Ohio Tax Department. They've never lived in Ohio. They never worked in Ohio. And at least Ohio is sending the 1099G forms via the mail. Many states don't. You could be a victim of this kind of fraud and never know about it until a year or so down the line when you get an underreporter notice from the IRS. It's a mess.

William Hoffman: Ryan, same one word: fraud.

Ryan Losi: Vigilant. As a practitioner, and actually I think there was a shift in focus for many years, the fraud was focused on the taxpayer and trying to obtain taxpayer information, which is a 1 to 1 ratio. You have to go to each taxpayer. And there's been a shift the last couple of years of focusing on tax preparer firms. I call CPA firms, but I understand it doesn't necessarily involve just CPA firms. But where there's a one to many relationship they can go to one firm and obtain a lot of information about many clients.

And so you have to be vigilant whether it's on a personal level, monitoring your credit or having locks on your credit or understanding transactions in various accounts, debit, credit accounts. But also for your clients, but also your firms having cybersecurity audits periodically by outside independent firms that can tell you honestly what your threats are and weaknesses and reporting on that. You're not going to ever eliminate it entirely and so what you can do is be vigilant about minimizing it.

William Hoffman: OK. Ryan, round four to you to begin with: your tax practice on COVID-19 in 2021.

Ryan Losi: Will likely be just as strong as 2020.

William Hoffman: Same question to you, Phyllis: your tax practice on COVID-19 in 2021.

Phyllis Jo Kubey: Yeah. I'd say it's kind of the tax professional full employment act. I don't think we're going to suffer for lack of business. There's going to be in my practice where I have a fairly one-to-one relationship with my clients because I am the chief cook and bottle washer. I don't have staff. Many of my clients I've known for years and I do have a little bit more of an individual relationship and a lot of them need a lot of hand holding. I anticipate that that hand holding is going to be on steroids this year.

And there will be a big issue even for the individual filers of do you file now? Do you wait? Really weighing the checks and balances on that because many taxpayers have other reasons that they need their 2020 returns yesterday, whether it's financial aid, whether they're applying for PPP loan or shuttered venue operations grants and need their 2020 numbers. So many things.

But then we have some significant proposed legislation. And one thing in particular that caught my eye was a bill that was proposed to exempt the first $10,200 of unemployment from federal taxation on the 2020 returns. So that could be a big game changer for many of my clients. I have a lot of people in the performing arts. Almost all of them have collected both regular and pandemic unemployment benefits. And that could really make a difference for them.

William Hoffman: Lightning round five. Phyllis: Paycheck Protection Program.

Phyllis Jo Kubey: OK. Paycheck Protection Program. Boy, you know, first we had the first Paycheck Protection Program, which had its own set of rules and we had guidance that if you applied for loan forgiveness through the PPP, you couldn't deduct the expenses on your tax return and that created a big brouhaha. And then we had the Consolidated Appropriations Act of 2021 that clarified that, yes, you could deduct the expenses that you used for the PPP loan. And oh, by the way, before you couldn't apply for PPP and the employee retention credit, but now you can, but you can't use the same expenses and there are all sorts of other things.

So I'm looking at smaller businesses, whether or not they use a tax practitioner and thinking: what resources are they having to pull away from other business operations to learn about, implement, and comply with these provisions that have changed pretty dramatically over the past several months?

William Hoffman: Ryan: Paycheck Protection Program?

Ryan Losi: Complex. Complex for all the reasons Phyllis said earlier. These are the computations we're having to go through right now to see — it was simple in 2020 you either claim the credit or applied for PPP. It was one or the other. It's not both. And it made it pretty simple and the majority of our clients went with PPP loan applications. Now you have something that's retroactive. It applies for the first two quarters of 2021, but now you have something that's retroactive regardless of whether you took PPP. And now you're having to bifurcate qualifying wages during the time period, but not only on a decrease in revenue, but even if there was a partial or full shutdown, which definitionally that's challenging and in certain lines of businesses.

And then also we're still waiting on guidance that our main trade association, the AICPA has asked specifically the commissioner and Treasury to address is: Can you claim ERTC on not the same dollar that you use for PPP forgiveness, but the excess because there was a limit on what you could claim for PPP expense forgiveness. It wasn't unlimited. It was based on presumed $100,000 annualized salary. And so if someone was paid more than that, could that excess? And what did they use for their testing period? Was it the eight week or 24 weeks? So that question has not been answered. So what does that mean? It means clients or taxpayers have to delay and pause and wait until we get that answer.

William Hoffman: Ryan to you. Sixth round: employee retention tax credit.

Ryan Losi: Who pays for it?

William Hoffman: Understood. Phyllis, employee retention tax credit.

Phyllis Jo Kubey: Complex. Ryan, well put.

William Hoffman: Ryan: $3,000 child tax credit.

Ryan Losi: It seems excessive unless you reduce the income threshold for qualification. And again there's an acute section of the country that really has been devastated by this. I think it's more in the travel, leisure, retail, more of the retail merchants, not necessarily the big box retail, but the small retail, mom and pop shops. And then obviously in dining restaurants for the most part, and obviously the employees that are employed by those establishments.

But there's also a lot of businesses that have actually performed well and a lot of probably individuals as well because they're not paying commuting costs. They're not entertaining and doing leisure activities. All of that is cashflow. I think I saw on either a Nerd Wallet or some kind of financial report that cash savings is at an all-time high in the U.S. And so part of me thinks that people are not having the ordinary spend that they would normally have in a post-pandemic or even pre-pandemic. And so at what point do you really need to continue to basically exhaust the Treasury or the U.S. balance sheet? That's my concern.

William Hoffman: Understood. Phyllis: $3,000 child tax.

Phyllis Jo Kubey: Yes, I do have a client base where more of my clients would be underneath the phase-out limits and able to take advantage of this. It's a big change. And it will require being paid for as Ryan said.

William Hoffman: Ryan, eighth round. A third round of economic impact payments, $1,400 each.

Ryan Losi: Yeah. My thoughts are if you're going to do a fourth round, make it very acute and really narrow who can qualify, whether it's a business or an individual. My thoughts is if you're coming out of pandemic, just the natural process of coming out of like a recession, things are going get better and you should be experiencing that. And so typically that's when the government eases off the accelerator.

William Hoffman: OK. Phyllis, third round of economic impact payments.

Phyllis Jo Kubey: Right. I agree with a lot of what Ryan said. It's very difficult to determine someone's need simply from numbers on a tax return. I mean, I think that's always been the case. There are people who have very low adjusted gross incomes and taxable incomes who actually are doing quite fine and are probably putting these payments into savings.

There are other people who look on paper like they would not qualify and who are so-called higher income that are actually suffering greatly. It's really tough. I know that there's not a way to exercise more judgment than that from the IRS or the Treasury's perspective because they simply don't have a lot of the information.

William Hoffman: Fourth round of economic impact payments. I repeat, Phyllis, a fourth round of EIPs.

Phyllis Jo Kubey: I would probably repeat my answer. I think maybe we really do have to look at lowering the thresholds, but again, you know, you're never going to be able to have a simple answer that's going to apply to everyone fairly.

William Hoffman: Final round. Round 10 to you, Ryan, first. April 15.

Ryan Losi: Will it get extended? Again again, just like last year's extended deadline. It was moved to July 15.

William Hoffman: You believe it will be that way again?

Ryan Losi: No, I don't. I'm leaning towards it's probably not. There probably would have been guidance by now, or at least some kind of indication in addressing the public that they were at least contemplating it. And I haven't seen that, so I don't know whether it's going to be done. But if I were hedging, I would lean towards it's probably not.

William Hoffman: OK. Phyllis, April 15.

Phyllis Jo Kubey: April 15: a date etched in my forehead. I would not be surprised if we had another extension of the April 15 deadline. I can't remember exactly — oh, I think it was mid-March that they announced the extension of April 15 last year. I think it was right before the March 15 business filing deadline and everybody was kind of laying odds on whether that business deadline would be extended or not.

So I would not be surprised if we had an extension, whether it's until July 15 or whether it's a month or June 15. I wouldn't venture a guess on that. Especially if we have new tax legislation and other things that impact the IRS in terms of programs that they have to implement and administer. The filing season, which has always quite short, seems to have gotten shorter with the February 12 starting date. And I think extending that deadline past April 15 will give a lot of practitioners and taxpayers breathing space and allow them the "automatic extension" without having to do additional filing to achieve it.

William Hoffman: OK. Ryan Losi, Phyllis Jo Kubey, thank you very much for joining us. I hope you had a good time. I did.

Phyllis Jo Kubey: It's been a pleasure. Thank you. Really a lot of fun.

Ryan Losi: Bill, thank you again very much. I enjoyed this session.

David Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now from his home is Executive Editor for Commentary Jasper Smith. Jasper, what will you have for us?

Jasper Smith: Thanks, Dave. In Tax Notes Federal, Frank Agostino and Eugene Kirman explain the tax benefits available to service members and veterans. James Wittenbach analyzes the tax credit for new all-electric vehicles. In Tax Notes State, three practitioners with Pillsbury Winthrop Shaw Pittman explore the recent Delaware court decision of Verisign and what it means for taxpayers. Four professors argue that if New York’s proposed State Billionaire Mark-to-Market Tax Act is enacted, it should be upheld against any constitutional challenge based on retroactivity. And on the Opinions page, Robert Goulder examines the new restrictions on anonymous shell companies under the Corporate Transparency Act. Marie Sapirie examines New Jersey lawmakers' arguments for repealing the limitation on SALT deductions as a means of pandemic relief.

And now we'll take a closer look at what's new and noteworthy in our magazines. I'm here with Paul Crispino, an international tax attorney with two decades of multinational experience, including serving as associate tax legislative counsel in the Treasury Office of Tax Policy. Welcome, Paul.

Paul Crispino: Happy to be here.

Jasper Smith: Excellent. So today we'll be talking about Paul's upcoming article, which considers the potential future of market-based taxation through the lens of a 2014 Indian tax case involving Volkswagen Finance and the offshore advertising activity of actor Nicholas Cage. Paul, could you tell us a little bit more about your article?

Paul Crispino: The case actually involves Audi India, which is a distributor of Audi vehicles in India and Volkswagen Finance, which finances the purchases of those vehicles. Those two companies were waiting for the new launch of a vehicle targeting the Indian marketplace, and they were hoping to do a nice promotional spread for it, but the car was not yet available in India. So they decided to hold the event in Dubai in the UAE. And that's where the car was. So what they did was they flew in 150 guests, people who were journalists and prospective buyers into Dubai. And the centerpiece of that event was a three-hour appearance by the American actor Nicholas Cage. He was driven up to the event in the vehicle. He was interviewed by an Audi India representative and then he mingled with the guests. And for that three-hour appearance, he was paid $440,000 plus cost.

And the two companies, Audi India and Volkswagen Finance, they deducted the cost of the promotional event on their Indian tax return, which makes sense. Right? Because they're Indian companies and this is part of their business. But they never withheld any payment on the $440,000 they paid to Mr. Cage. And on audit, the auditor found that that payment was actually a royalty and subject to withholding tax. That decision was appealed to the appeals office in India, and that was upheld by the appeals office. Ultimately Volkswagen Finance, which is the main party and interest, they appealed that decision to the Tax Tribunal in Mumbai. And the Tax Tribunal ultimately upheld the government. And it did it not on the basis of a royalty as you would have thought because that's what the auditor found. Instead, they believe that their payment was an Indian source payments, and to get an Indian source payment, you need to have nexus.

So the real question became, well, where is the nexus between Mr. Cage's activities in Dubai and the Indian business that he was supposed to have a connection to? Well, the tribunal spends a lot of time in the decision focusing on the business activities of both Audi India and also Volkswagen Finance. And they find that they have a very close connection and their business connection is such that under the Indian law, which has a rule that says you could deem activities to have arisen and accrued in India, to the extent there's a business connection, the tribunal finds that rule applicable because of the business relationship that the event had to the two sponsors' business. Now the problem with that conclusion is how does that make Mr. Cage having that business connection? Because that was what the law requires. It requires that Mr. Cage has that connection, not the two sponsors.

And that was something that was brought up by the Volkswagen Finance during the trial. They said, "Well, how could it be that Mr. Cage who performed services is pulled into the Indian tax net based on a sourcing rule?" And they pointed to the existing authorities, which basically cite the international norm that services are based and sourced based on where their activities occur. And what happened was the Tax Tribunal decided, well, those old case law that dealt with bricks and mortar companies? They don't apply in the international rules now given the digital economy. So they were looking at the new way of doing business and they said those laws don't apply as a case of first impression. When you step back from that decision, there's two real issues with it.

First, there's a real risk of someone like Mr. Cage being subject to double or even triple tax. Remember Mr. Cage is a U.S. citizen and a taxable resident, so he had to pay tax in the U.S. on that income. The real question was could he get a foreign tax credit for any withholding tax paid to India? And the reality is if you go back and look at the September 2020 regulations that were issued by the U.S. Treasury Department on foreign tax credits, they now say that you would need — and these are proposed regs of course — that you would need a jurisdictional nexus based on international norms. And those norms that I mentioned are based on having services sourced at the location of where they're performed, not where the recipient is. So in theory, he would not be able to get a foreign tax credit from the U.S. government, and he'd be paying tax in the U.S. and also in India. So I think that's one of the significant issues with this case.

And the second big problem, I think I have with the case as I mentioned in the article is that this is a court decision. This is not a legislature making this decision. And even though they may have looked to existing Indian law, they stretched that law beyond reason. Right? They stretched it to include things that were outside of international norms. And what we need really to do is have an international consensus on this type of activity. And it's interesting that something I mentioned about international consensus, because if you go look at pillar 1, the blueprint that was issued in October, there's a paragraph there, 525, and you'll see that it states certain inclusive framework members are looking for a result exactly the same as what the Tax Tribunal found. They're looking for a result that says, "If you have targeted marketing activities that are performed outside of the market jurisdiction, they believe that the market jurisdiction should have the right to tax those activities."

And you say, well, that's obviously a big change to international law. The rationale they give for that is that if you don't do that, multinationals will have an incentive to perform these remote activities and advertisements in low-tax jurisdictions. So some members of the inclusive framework, which I suspect probably includes India, are looking at this through the lens of an antiabuse rule. But that of course is part of pillar 1 and unlike a court decision, it's something that will be subject to international consensus.

How does this relate to pillar 1? I mentioned that paragraph 525 is one way. The other way is I think you could analogize Mr. Cage's activities to those of a consumer-facing business. Remember what those businesses do — usually they produce goods or services and then they use independent distributors to distribute those goods to different marketplaces.

Well, if you look at Mr. Cage, what did he do? He produced advertising with his image and then a distributor in this case, Audi India and Volkswagen Finance, they took his image and marketed it in India. And even though he, I think it's pretty well settled that he knew that was going to be used in India, you could have a consumer-facing business that doesn't know what the distributor will do with its goods. And then that consumer-facing business under pillar 1 would be pulled into these different jurisdictions by fact of these independent contractor and distributing the materials in a jurisdiction that you didn't even know they were doing. So I think that's another aspect of this case that will definitely come up in the future.

Jasper Smith: Thanks, Paul. We certainly appreciate that summary and it really was a summary because you examine those points in very thorough manner and came to some very powerful conclusions if you will so I'm intrigued to see what our audience thinks of it. And certainly the type of feedback that you get in line with that. If someone wanted to reach out to you, where might they find you online?

Paul Crispino: Well, you could find me on my LinkedIn profile.

Jasper Smith: Okay. So just Paul Crispino on LinkedIn.

Paul Crispino: Yes. You'll find me there. Excellent. Excellent. And of course you can find Paul's upcoming article online at taxnotes.com and be sure to subscribe to our YouTube channel, Tax Analysts, for more in-depth discussions on what's new and noteworthy in Tax Notes. And again, that's Tax Analysts with an S. Back to you, Dave.

David Stewart: You can read all that and a lot more in the pages of Tax Notes, Federal, State, and International. That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. And be sure to follow @TaxNotes for all things tax. 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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