Current through Register Vol. 24-06, March 15, 2024
This rule is organized into eight parts, as
follows:
* Purpose and general scope
* Transactions or arrangements specifically identified
as potential tax avoidance
* Relevant factors in transactions deemed unfair tax
avoidance
* Economic positions of participants
* Substantial nontax reasons for entering into an
arrangement
* Results of unfair tax avoidance
transactions
* Tax periods affected
* Penalty provisions
Other rules. There are three auxiliary rules that
address the following three types of arrangements.
* WAC
458-20-28001 Construction joint
ventures and similar arrangements described in
RCW
82.32.655(3)(a);
* WAC
458-20-28002 Disguised income
arrangements described in
RCW
82.32.655(3)(b);
and
* WAC
458-20-28003 Sales and use tax
avoidance arrangements described in
RCW
82.32.655(3)(c).
(1)
Purpose and general
scope.Chapter 23, Laws of 2010 1st sp. sess., enacted as
RCW
82.32.655 and
82.32.660, as well as amended
RCW
82.32.090, to address unfair tax avoidance.
Although taxpayers have the right to enter into arrangements or transactions
that have lower tax consequences, the legislature recognized that certain
arrangements and transactions are contrary to the intent of the taxation
statutes. The legislation and this rule address certain identified arrangements
and transactions that unfairly avoid taxes and prescribe specific remedial
actions to be taken by the department in such cases. The legislation and this
rule do not affect or apply to any other remedies available to the department
by statute or common law, as these remedies are expressly preserved by the
legislation.
(a)
Rule examples.
This rule includes a number of examples that identify a set of facts and then
state a conclusion. The examples should be used only as a general guide. The
department will evaluate each case on its particular facts and circumstances
and apply both this rule and other statutory and common law authority. An
example that concludes an arrangement or transaction is not unfair tax
avoidance under this rule does not mean that the taxpayer is entitled to any
particular tax treatment or that the arrangement or transaction is approved by
the department under other authority. It may still be disregarded or
disapproved by the department under other statutory or common law authority.
In addition, each fact pattern in each example is
self-contained (i.e., "stands on its own") unless otherwise indicated by
reference to another example. Examples concluding that sales tax applies to the
transaction assume that no exclusions or exemptions apply, and the sale is
sourced to Washington.
(b)
Definitions.(i) "Potential tax
avoidance" and "identified transaction" both refer to an arrangement or
transaction that has the potential to be unfair tax avoidance because it meets
the elements of an arrangement or transaction described in subsection (2) of
this rule.
(ii) "Unfair tax
avoidance" means an arrangement or transaction that meets the elements of an
arrangement or transaction described in subsection (2) of this rule, and that
is also determined under all the facts and circumstances to be unfair tax
avoidance based on the factors identified in subsection (3) of this
rule.
(iii) "Affiliated" means
under common control.
(iv) "Common
control" means two or more entities controlled by the same person or
entity.
(v) "Control" means the
possession, directly or indirectly, of more than fifty percent of the power to
direct or cause the direction of the management and policies of an entity,
whether through the ownership of voting shares, by contract, or otherwise. A
person's power to cause the direction of management and policies includes power
that is held by:
(A)Persons related to the
taxpayer; and
(B) Persons with whom
the taxpayer acts in concert to direct the management or policies of the
entity.
(vi) "Related"
includes:
(A) An entity's parent, owner,
subsidiary, or affiliate under common control;
(B)An individual person's spouse,
grandparent, parent, sibling, child, or grandchild; and
(C)In the case of a trust, the trust or a
related person as defined in (A) or (B) of this subsection that:
(I)Has a beneficial interest in the
trust;
(II)Has control over the
trust or trust property; or
(III)
Is the settlor and has retained significant control over the trust.
(vii)
"Moving" or "moves" is any act or series of acts to ensure that income is
received by a person who is not taxable in Washington on that income; and that
the taxpayer or a related person receives substantially all the benefit of the
income. Such acts may include without limitation: An assignment, transfer,
lease, or license of income-producing assets; the sale of property or services
at less than could be obtained in an arm's length transaction; and capital
contributions and distributions from a capital account.
(viii) "Specific written instructions" means
tax reporting instructions that specifically address an arrangement or
transaction and specifically identify the taxpayer to whom the instructions
apply. Specific written instructions may be provided as part of an audit, tax
assessment, determination, closing agreement, or in response to a binding
ruling request.
Specific written instructions will not be construed as revoked
by operation of this rule or its statutory authority, but the department may
revoke specific written instructions by written notice to the
taxpayer.
(ix) "Person" or
"company" has the same meaning as provided in
RCW
82.04.030.
(2)Transactions or arrangements
specifically identified as potential tax avoidance: Under
RCW
82.32.655(3), the following
arrangements or transactions are specifically identified as potential tax
avoidance.
(a)
Certain construction
ventures. Arrangements that are, in form, a joint venture or similar
arrangement between a construction contractor and the owner or developer of a
construction project but that are, in substance, substantially guaranteed
payments for the purchase of construction services and that are characterized
by a failure of the parties' agreement to provide for the contractor to share
substantial profits and bear significant risk of loss in the venture. See WAC
458-20-28001 for more
information.
(b)Redirecting
income. Arrangements through which a taxpayer attempts to avoid business
and occupation tax by disguising income received, or otherwise avoiding tax on
income from a person that is not affiliated with the taxpayer from business
activities that would be taxable in Washington by moving that income to another
entity that would not be taxable in Washington. See WAC
458-20-28002 for more
information.
(c)Property
ownership by controlled entity. Arrangements through which a taxpayer
attempts to avoid retail sales or use tax by engaging in a transaction to
disguise its purchase or use of tangible personal property by vesting legal
title or other ownership interest in another entity over which the taxpayer
exercises control in such a manner as to effectively retain control of the
tangible personal property. See WAC
458-20-28003 for more
information.
(3)
Factors in a specifically identified arrangement or transaction deemed
unfair tax avoidance: An arrangement or transaction identified in
subsection (2) of this rule, is not "unfair tax avoidance" unless the
arrangement or transaction is determined to be unfair tax avoidance under
consideration of one or more of the factors in this subsection. These factors
do not constitute a list of discrete elements that must be met for an
arrangement or transaction to be unfair tax avoidance.
(a)Whether there has been a meaningful change
in the economic positions of the participants in an arrangement or transaction,
apart from its tax effects, when the arrangement is considered in its
entirety;
(b)Whether substantial
nontax reasons exist for entering into an arrangement or transaction;
(c) Whether an arrangement or transaction is
a reasonable means of accomplishing a substantial nontax purpose;
(d) An entity's relative contributions to the
work that generates income;
(e)The
location where work is performed1; and
1 For apportionable activities, see
WAC 458-20-19401 through
458-20-19404.
(f)Other relevant factors.
(g)Application of factors:
(i) To the extent relevant, the department
may consider any or all factors listed in this subsection as part of an
analysis of whether an arrangement or transaction has sufficient substance to
be respected for tax purposes. The department may consider evidence of a
taxpayer's actual subjective intent, but the department is not required to
prove that tax avoidance was the subjective intent of any particular
arrangement or transaction.
(ii)
Right of rebuttal. If the department determines that the arrangement or
transaction meets the elements identified in WAC
458-20-28001,
458-20-28002, or
458-20-28003 and that one or more
of the factors identified in this subsection indicate unfair tax avoidance, the
department presumes the arrangement or transaction is unfair tax avoidance. The
taxpayer may rebut the presumption by proving that:
(A)The arrangement or transaction changes in
a meaningful way, apart from its tax effects, the economic positions of the
participants in the arrangement when considered as a whole; and
(B)One or more substantial nontax reasons
were the taxpayer's primary reason for entering into the arrangement or
transaction.
(4)When does an arrangement or
transaction change in a meaningful way, apart from its tax effects, the
economic positions of the participants in the arrangement when considered as a
whole?
(a)Whole
transaction. In evaluating any change to the economic positions of the
participants, the department considers all facts and circumstances relevant to
the individual economic position of each participant in the arrangement or
transaction as a whole.
(b)Meaningful change defined.
Meaningful change in economic position means, apart from its tax benefits, a
bona fide and substantial increase in profit or profit potential or a bona fide
and substantial reduction in costs or expenses between the form of the
arrangement or transaction chosen by the taxpayer and the actual substance of
the arrangement or transaction. The reasonably expected profit from the
arrangement or transaction must be substantial when compared to the reasonably
expected tax benefits that would be allowed if the arrangement or transaction
is to be respected.
(c)
Shifting profits insufficient. An arrangement or transaction that
merely shifts income or value between related persons does not result in a
meaningful change in economic position.
(5)When do substantial nontax reasons
or purposes exist for entering into an arrangement or transaction?
(a)
Subjective purpose. In
evaluating whether a taxpayer had a substantial nontax reason or purpose for an
arrangement or transaction, the department will consider all facts and
circumstances that are relevant to determining the taxpayer's subjective
intent. However, the department is not required to prove that tax avoidance was
the subjective intent of any particular arrangement or transaction, but may
presume such intent from the presence of other relevant factors.
(b)
Substantial nontax reason
defined. A substantial nontax reason is a bona fide nontax reason that
is a substantial motivating factor to the taxpayer's decision to enter into the
arrangement or transaction in this state. A bona fide nontax reason may include
the purpose of obtaining tax benefits from another government, provided the
benefits are not the same type, kind, or nature of any substantial Washington
state tax benefit obtained under the arrangement or transaction.
(c)
Partial safe harbor. For
purposes of applying this rule, the department will treat a stated nontax
purpose as a bona fide reason where all participants in an arrangement or
transaction are substantive operating businesses, adequately capitalized, and
carrying on substantial business activities using their own property or
employees. For purposes of applying common law or statutory remedies other than
under RCW
82.32.655, the department may treat stated
nontax reasons as other than bona fide, if appropriate under all facts and
circumstances.
(6)Results of an unfair tax avoidance
transaction:
(a)
Determination of
proper amount of tax. For tax benefits received on or after January 1,
2006, the department must disregard the form of an unfair tax avoidance
arrangement or transaction and determine the amount of tax based on the actual
substance of the arrangement or transaction, except as provided in subsection
(7) of this rule.
(b)Amount
of tax benefit defined. The tax benefit of an unfair tax avoidance
arrangement or transaction is the difference between the amount of tax due
based on the actual substance of the arrangement or transaction and the amount
of tax actually paid by the taxpayer based on the form of the arrangement or
transaction. In determining the amount of the tax benefit, the department will
credit the tax previously paid by the taxpayer against total tax assessed on
the revised transaction in accordance with customary department
practice.
(c)
Actual
substance. The actual substance of an unfair tax avoidance arrangement
or transaction is:
(i) For transactions or
arrangements described in subsection (2)(a) of this rule and WAC
458-20-28001, a sale of
construction services from the construction contractor to the developer or
owner.
(ii) For transactions or
arrangements described in subsection (2)(b) of this rule and WAC
458-20-28002, a sale of property
or services by a person subject to Washington taxes on the arrangement or
transaction.
(iii) For transactions
or arrangements described in subsection (2)(c) of this rule and WAC
458-20-28003, direct ownership of
the tangible personal property by the user.
(7)
Tax periods affected: The
legislation addressed in this rule applies to tax benefits received on or after
January 1, 2006. The legislation also contains exceptions to an application
based on when an arrangement or transaction is initiated. The relationship
between when the tax benefit is received and when the arrangement or
transaction is initiated is explained as follows:
(a)When is an arrangement or
transaction initiated? An arrangement or transaction is initiated when
the first tax benefits are received.
(b)
When are tax benefits
received? For purposes of this rule, the timing of receipt of tax
benefits is not dependent on the date on which the tax return is required to be
filed, but instead:
(i) Business and
occupation tax benefits are received on the date that, in the absence of tax
avoidance, the taxpayer would have been subject to B&O tax under
RCW
82.04.220.
(ii) Retail sales tax benefits are received
on the date of the retail sale; and
(iii) Use tax benefits are received on the
date of first use in Washington.
(c)
Tax benefits received January 1,
2006, through April 30, 2010. The department will not deny tax benefits
received by a taxpayer during this period if any of the following are true:
(i) The taxpayer reported its tax liability
in conformance with unrevoked specific written instructions issued to that
taxpayer or a person affiliated with the taxpayer as defined under subsection
(1)(b)(iii), and the taxpayer's arrangement or transaction does not differ
materially from that addressed in the specific written instructions.
(ii) The taxpayer reported its tax liability
in conformance with a determination or other document made available by the
department to the general public that specifically identifies and clearly
approves the arrangement or transaction, and the taxpayer's arrangement or
transaction does not differ materially from that addressed in the determination
or document.
(iii) The department
has completed a field audit of the taxpayer and the arrangement or transaction
is covered by the audit. An arrangement or transaction is covered by an audit
if the audit covered the same tax type (e.g., sales, use, business and
occupation) as the tax benefit obtained by the taxpayer from the arrangement or
transaction. An audit is complete when closed by the department.
(d)
Arrangement or
transaction initiated before May 1, 2010, and tax benefits
received after April 30, 2010. The department will not deny tax benefits
received by the taxpayer on or after May 1, 2010, if either of the following is
true:
(i) The taxpayer has reported its tax
liability in conformance with unrevoked specific written instructions issued to
that taxpayer or a person affiliated with the taxpayer as defined under
subsection (1)(b)(iii) of this rule, and the taxpayer's arrangement or
transaction does not differ materially from that addressed in the specific
written instructions.
(ii) The
taxpayer has reported its tax liability in conformance with a determination or
other document made available by the department to the general public that
specifically identifies and clearly approves the arrangement or transaction,
and the taxpayer's arrangement or transaction does not differ materially from
that addressed in the determination or document.
(e)
Arrangement or transaction
initiated on or after May 1, 2010. For arrangements and
transactions initiated on or after May 1, 2010, the department will not deny
tax benefits received by the taxpayer if the taxpayer reports its tax liability
in conformance with unrevoked specific written instructions issued to that
taxpayer, and the taxpayer's arrangement or transaction does not materially
differ from that addressed in the specific written instructions. Specific
written instructions for this purpose do not include instructions provided to
any other person. Further, taxpayers may not rely on any determination or other
document made available by the department to the general public prior to May 1,
2010, to the extent inconsistent with this rule.
(f)
When do transactions or arrangements
materially differ from those addressed in written guidance? An
arrangement or transaction materially differs from that addressed in written
guidance when there is a material change in the form or substance of the
arrangement or transaction, including without limitation, when there is a
change of any participant identified in specific written instructions.
Example 1. A taxpayer identifying itself obtains a
letter ruling from the department that specifically identifies an arrangement
that constitutes unfair tax avoidance under this rule. In its letter ruling,
the department approves the arrangement as presented and does not rule that the
arrangement must be disregarded or the tax benefits denied. The taxpayer's
arrangement does not materially differ at any point in time from the
arrangement addressed in the letter ruling, and the taxpayer reports its tax
liability in accordance with the letter ruling. The department will not
disregard the arrangement or deny the resulting tax benefits for that taxpayer
for any tax period, unless and until the letter ruling is expressly
revoked.
Example 2. Assume the same facts as Example 1, but
the letter ruling was sought by and issued to a person affiliated with the
taxpayer as defined under subsection (1)(b)(iii) of this rule. If the
arrangement was initiated and started to generate tax benefits prior to May 1,
2010, the department will not disregard the arrangement or deny the resulting
tax benefits for that taxpayer for any tax period, unless and until the letter
ruling is expressly revoked.
Example 3. Assume the same facts as Example 1, but
the letter ruling was not sought by or issued to either the taxpayer or an
affiliate. Assume that the arrangement or transaction is not addressed in any
published guidance made available to the public by the department. The
department must disregard the arrangement and deny the tax benefits received on
or after January 1, 2006.
Example 4. The department conducts a field audit
of a taxpayer for the period January 1, 2004, through December 31, 2008. The
taxpayer has engaged in an arrangement that constitutes unfair tax avoidance
under this rule. The arrangement was initiated January 1, 2004. The audit is
completed prior to May 1, 2010. In specific written instructions, the audit
expressly approves the arrangement. The taxpayer's arrangement does not
materially differ at any point in time from the arrangement addressed in the
audit instructions, and the taxpayer reports its tax liability in accordance
with the those instructions. The department will not disregard the form of the
arrangement or deny the tax benefits received for any tax period, unless and
until the audit instructions are expressly revoked.
Example 5. Assume the same facts as Example 4, but
the audit does not expressly approve the arrangement. Although the audit covers
the same tax type as the benefits received under the arrangement, the
arrangement is not specifically addressed in the audit's written reporting
instructions. The taxpayer's arrangement does not differ at any point in time
from the arrangement engaged in during the audit. Also assume that the
arrangement or transaction is not addressed in any other published guidance
made available by the department to the public.
* The department will not disregard the form of the arrangement
or deny the tax benefits received through December 31, 2008, because the period
is included in a completed field audit and is wholly included in the period
prior to May 1, 2010.
* The department must disregard the form of the arrangement and
deny tax benefits received after December 31, 2008, and prior to May 1, 2010,
because the period is not included in a completed field audit.
(8)
Unfair tax avoidance
penalty.
(a)
Penalty
imposed. Except as otherwise stated in this rule, the department must
assess a penalty of thirty-five percent on the amount of the tax benefit denied
because of the disregard of an unfair tax avoidance arrangement or transaction.
(i)
When the unfair tax avoidance
penalty applies. The thirty-five percent assessment penalty applies to
the tax benefits from engaging in unfair tax avoidance and received on or after
May 1, 2010, and denied under this rule.
(ii)
Penalty safe harbor. The
department will not apply the tax avoidance penalty if the taxpayer discloses
its participation in the tax avoidance arrangement or transaction to the
department before the department provides notice of an investigation or audit
of any kind or otherwise discovers the taxpayer's participation.
(iii)
Disclosure requirements.
The disclosure must be in writing, it must identify the taxpayer, and it must
either request a ruling on the specific arrangement or transaction, or it must
provide sufficient information to allow the department to reasonably determine
whether the arrangement or transaction is unfair tax avoidance. Disclosure
under this subsection applies only to the specific arrangement or transaction
addressed in the disclosure. The disclosure no longer qualifies for the safe
harbor upon any material change to the arrangement or transaction, including a
change in participants.
(b)
Discovery. The department
discovers a taxpayer's participation in an unfair tax avoidance arrangement
when the department obtains any evidence of the participation from any
source.
(c)Notice. The
department provides notice of an investigation or audit when it provides either
oral or written notice to the taxpayer of the investigation or audit,
regardless of whether the audit covers the same tax type (e.g., retail sales,
use, business and occupation) as the tax benefit obtained from the unfair tax
avoidance arrangement or transaction.
(d)
Audits. Taxpayers subject to
an investigation or audit that was open as of May 1, 2010, shall be deemed to
have provided disclosure to the department that satisfies the requirements of
(a)(ii) of this subsection with respect to any arrangement or transaction
initiated prior to May 1, 2010, that results in a tax benefit of the same type
(e.g., retail sales, use, business and occupation) as covered in the open
investigation or audit. If the department fails to discover the taxpayer's
participation in a tax avoidance arrangement or transaction during an
investigation or audit closed after May 1, 2010, the taxpayer may still apply
for the safe harbor for future periods by disclosure in accordance with the
requirements of (a)(ii) of this subsection.
Example 6. On or after May 1, 2010, a taxpayer
identifying itself requests a letter ruling on its participation in an
arrangement that constitutes unfair tax avoidance under this rule. The taxpayer
specifically requests that the department determine whether the arrangement is
an identified transaction or unfair tax avoidance and provides all information
requested by the department. As of the date the letter ruling request is
received by the department, the department had not discovered the taxpayer's
participation in the arrangement and had not notified the taxpayer of its
intention to investigate or audit. If the department subsequently disregards
the arrangement and denies the tax benefits, the department will not apply the
thirty-five percent avoidance penalty to any denied tax benefit.
Example 7. Assume the same facts as in Example 6,
but the taxpayer does not specifically request that the department determine
whether the arrangement is an identified transaction or unfair tax avoidance.
However, in the ruling request, the taxpayer provides sufficient information
for the department to reasonably determine whether the arrangement is an
identified transaction or unfair tax avoidance. If the department subsequently
disregards the arrangement and denies the tax benefits, the department will not
apply the thirty-five percent avoidance penalty to any denied tax
benefit.
Example 8. Assume the same facts as Example 7, but
the taxpayer only requests a ruling on specific elements related to the tax
avoidance arrangement, not the arrangement as a whole. The ruling request
therefore does not contain information sufficient for the department to
reasonably determine whether the arrangement is an identified transaction or
unfair tax avoidance. If the department subsequently disregards the arrangement
and denies the tax benefits, the department must apply the thirty-five percent
avoidance penalty to any denied tax benefit.
Example 9. A taxpayer engages in an arrangement or
transaction from January 1, 2005, through December 31, 2010. Assume the
arrangement constitutes an unfair tax avoidance arrangement under this rule.
The taxpayer does not disclose the arrangement to the department in conformance
with (a)(ii) of this subsection. If the department subsequently disregards the
arrangement and denies the tax benefits, it must do so back to January 1, 2006,
subject to the statute of limitations. The department must also apply the
thirty-five percent avoidance penalty, but only to the portion of the
assessment that results from tax benefits received on or after May 1, 2010, and
denied under this rule.
Example 10. A construction contractor forms a
joint venture with a developer. The venture was initiated, wound up its
business, and was dissolved on April 1, 2010. Assume the joint venture
constituted an unfair tax avoidance arrangement under this rule. Also assume
that the venture has never been audited and did not report its tax liability in
conformance with specific written instructions, or any other written authority
that specifically identifies and clearly approves the arrangement. If the
department subsequently disregards the arrangement and denies the tax benefits,
it must do so back to January 1, 2006. The department will not assess the
thirty-five percent avoidance penalty, however, because no tax benefits were
received on or after May 1, 2010.
Example 11. Assume the same facts as Example 5,
for tax benefits received on or after May 1, 2010, the department must
disregard the form of the arrangement and deny the tax benefits received. In
addition, the department must assess the thirty-five percent tax avoidance
penalty unless the taxpayer discloses its participation in the arrangement in
accordance with this rule.
For further information refer to WAC
458-20-28001,
458-20-28002, and
458-20-28003.