Internal Revenue Service Amends Notice Providing Guidance on Statutes of Limitation on Assessment (SOL) for U.S. Virgin Islands Residents; Determines that Three-Year Statute Applies for 2006 and Subsequent Years for All Taxpayers
Marjorie Roberts, Esq.
Marjorie Rawls Roberts, P.C.
The Internal Revenue Service (IRS) released Notice 2007-31 (Notice) on March 30, 2007 which provides that for taxable years ending on or after December 31, 2006, the U.S. federal statute of limitations for all U.S. citizens and residents claiming to be bona fide residents of the United States Virgin Islands (USVI) generally will commence upon the filing of an income tax return with the USVI. The Notice amended and supplemented Notice 2007-19, which the Treasury Department and the IRS had issued on February 21, 2007.
The earlier notice, Notice 2007-19, had provided interim rules concerning the statute of limitations on assessment of the U.S. income tax liability of a U.S. citizen or resident alien taking the position that he or she was a bona fide resident of the USVI. It required certain taxpayers to file a statement with the IRS setting out their income and tax liability and setting out the statutory basis for their determination that they qualified as bona fide USVI residents under the Internal Revenue Code of 1986, as amended and as applicable to the USVI (the Code). That notice had also announced that the Treasury Department and the IRS were studying the feasibility of an automatic exchange of information program with the USVI.
BIR-IRS Working Arrangement
Since the issuance of Notice 2007-19, the USVI Bureau of Internal Revenue (BIR) and the IRS have entered into a new working arrangement (the Working Arrangement) concerning the routine (automatic) exchange of information under the Tax Implementation Agreement between the United States of American and the Virgin Islands dated February 24, 1987. This Tax Implementation Agreement was signed in Washington, D.C. by J. Roger Mentz, then-Assistant Secretary (Tax Policy), Department of Treasury, for the United States, and Alexander A. Farrelly, then USVI Governor, and Anthony P. Olive, then BIR Director, for the USVI, and provided for mutual assistance in tax matters, including exchanges of information, for purposes of administering the tax laws of the respective Governments and especially to prevent avoidance or evasion of the Governments respective fiscal laws.
Notice 2007-31 provides that, in light of the new Working Arrangement, an individual income tax return filed with the USVI BIR by a U.S. citizen or resident alien who takes the position that he or she is a bona fide resident of the USVI for the entire taxable year will be deemed to be a U.S. income tax return of that individual for purposes of Code section 6501(a). In short, this means that USVI taxpayers will not be required to make a second filing with the IRS as was required (for taxpayers with gross income of at least $75,000) in Notice 2007-19 if a taxpayer wanted to start the statute of limitations for U.S. as well as USVI tax purposes.
Specifically, on March 21, 2007, the IRS and BIR officials serving as the competent authorities of the United States and the USVI, respectively, entered into the Working Arrangement, which provides guidelines and procedures for the routine exchange of information. Notice 2007-31 provides that the Working Arrangement will be terminated if the Tax Implementation Agreement is terminated, or it may be terminated upon written notice by either the IRS or the BIR. The text of the Working Arrangement is attached to the Notice.
The Working Arrangement provides in part that its authority to expand the information to be routinely provided by the USVI to the IRS is the Tax Implementation Agreement, specifically Article 4(2)(c) of the Tax Implementation Agreement. Article 4(2)(b) of the Tax Implementation Agreement already set out information that the USVI would routinely supply to the United States, including information about the ownership interests of all corporations subject to Virgin Islands tax with non-Virgin Islands source income that receive a rebate, subsidy or reduction of Virgin Islands taxes and information about any taxpayer subject to Virgin Islands tax with non-Virgin Islands source income who files an income tax return with the Virgin Islands claiming for the first time to be a Virgin Islands resident. In turn, Article 4(2)(c) provides that the USVI and United States competent authorities may agree to expand or limit the information that they routinely exchange.
The purpose of the Working Arrangement is to establish a new routine exchange of information program between the IRS and the BIR concerning income tax information of certain taxpayers who file an income tax return with the USVI under Code section 932(c)(2). This is the section that requires bona fide residents of the USVI to file their income tax return with and pay their income taxes to the BIR. The IRS will use the information to identify and examine such taxpayers and to encourage those taxpayers to comply with U.S. federal income tax laws and regulations. The Working Arrangement indicates that any requests for information or information exchanged pursuant to it and the Implementation Agreement constitute tax convention information under Code section 6105. Code section 6105 prohibits the disclosure of tax convention information, therefore, information regarding how the Working Arrangement was negotiated and the scope of information exchanged thereunder is confidential and persons cannot get such information pursuant to a request under the Freedom of Information Act.
The Working Arrangement sets out certain procedures and requirements.
First, the parties agree that the IRS will specify the information to be provided by the BIR in a written request for information to the BIR.
Second, the BIR agrees to provide electronic files of the requested information, including all income tax returns with schedules, statements, and attachments. The electronic files will be saved, indexed, and transmitted by the BIR to the IRS in accordance with instructions provided in the request for information.
Third, all income tax returns must be date stamped by the BIR in a clearly legible manner that doesnt obstruct any taxpayer information on the return.
Finally, the BIR must provide all requested information within 90 days after the original due date for income tax returns that are timely filed with the BIR, or to the extent the taxpayer timely files pursuant to a valid extension, within 90 days after the extended due date. If returns are delinquent or amended, then the information must be provided within 90 days after the end of the calendar-year quarter during which the requested information was received by the BIR. (The Working Arrangement does not indicate the consequences if the BIR does not provide the requested information within the indicated time frames.)
The Working Arrangement states that it is not intended to alter, amend, or rescind any provisions of U.S. federal law. Any provision of this Working Arrangement that conflicts with U.S. federal law will be null and void.
Notice 2007-31, however, does not change the IRS position that USVI residents previously had no statute of limitations for purposes of the IRS, which was first articulated by the IRS in 2006. Notice 2007-19 provided that for years prior to 2006, non-covered persons (that is, persons with gross income of $75,000 or more) could choose to file U.S Form 1040 with the IRS as provided in this Notice, noting on the first page of U.S. Form 1040 the applicable taxable year and that U.S. Form 1040 is being filed in accordance with Notice 2007-19. However, Notice 2007-19 stated, and Notice 2007-31 reaffirms, that the position of the IRS is that
the statute of limitations will only start to run from the date the additional return is filed with the IRS for such years.
Notice 2007-19 also continues to apply to covered persons (that is, persons with gross income under $75,000) for years prior to 2006. Covered persons may apply Notice 2007-19 to years prior to 2006 by providing documentation upon examination that establishes to the satisfaction of the IRS Commissioner that the taxpayer is a covered person. Once that is done, the statute of limitations will be deemed to have begun on the date of the filing with the BIR. In effect, this means that if the IRS determines during an examination that a person had less than $75,000 in gross income for a given year, then the person will be determined to have a three-year statute of limitations for that year.
Issues Raised by Notice 2007-31
Since it was signed early in 1987, the Tax Implementation Agreement has set out a number of items of information that the IRS is required to provide to the BIR, including copies of audit changes that disclose information relevant to the USVI and copies of Form 1099s and all other information returns where the income recipient is a USVI resident or lists a USVI address or has income from USVI sources. In contrast, the Working Arrangement is effectively a one way street, only requiring that the BIR provide information to the IRS. It does not provide for expanded transfer of information from the IRS to the BIR. Accordingly, the Working Arrangement does not enhance the BIRs ability to determine whether persons who should be filing in the USVI as bona fide residents are instead filing in the United States, for example, to expedite refunds or for other purposes.
Further, the position of the IRS is that the provisions of the Tax Implementation Agreement were not sufficient to start the statute of limitations for bona fide USVI residents filing their income tax returns with the BIR in accordance with Code section 932(c). In contrast, the IRS takes the position that the procedures and requirements of the Working Arrangement are sufficient to start the statute of limitations of such residents.
Notice 2007-31 and the Working Arrangement do not, however, give any basis for why the information exchange provisions of the Tax Implementation Agreement were not sufficient when they were negotiated at length and formally agreed to in Washington, D.C. by senior persons at the U.S. Treasury Department and the USVIs Governor and BIR Director, while provisions in a Working Arrangement signed by the respective competent authorities are sufficient. The Tax Implementation Agreement clearly put the IRS on notice of who had moved to the USVI and was filing with the BIR as a bona fide resident of the USVI by specifically requiring the BIR to routinely provide the IRS with information about any taxpayer subject to USVI tax with non-USVI source income filing an income tax return with the USVI and claiming USVI residency for the first time. The Tax Implementation Agreement also required the BIR to routinely provide copies of audit changes that disclosed information relevant to the United States and, as referenced above, to provide information about the ownership interests of all corporations subject to USVI tax with non-USVI source income that receive a rebate, subsidy or reduction of USVI taxes. Moreover, the Tax Implementation Agreement gave the competent authorities broad powers to expand the information to be exchanged at any time and to determine the items of information to be exchanged and the procedures to be used to exchange such information. It was not, however, conditioned on the exercise of such powers and the development of such procedures.
In short, Notice 2007-31, while providing clear guidance going forward, does not provide any policy or other basis for maintaining the position that USVI taxpayers did not have applicable statutes of limitation from 1986 until 2005 when their returns were subject to the extensive information exchange provisions of the Tax Implementation Agreement and they filed their returns in accordance with the provisions of the Code.
Finally, Notice 2007-31, by keeping Notice 2007-19 intact for years before 2006, does not explain how the IRS can determine that no applicable statute of limitations exist under applicable law, and then develop by Notice a statute of limitations for certain bona fide USVI residents. Further, it does not address how Notice 2007-19 and Chief Counsel Advice 200624002 can take the position that no statute of limitations exists, in direct conflict with the position of the Third Circuit in Danbury, Inc. v. Anthony Olive, 820 F.2d 618 (3d Cir.), cert. denied, 484 U.S. 964 (1987), and the position taken by the IRS in Field Service Advice 199906031.
Congressional Request to Treasury for Retroactive Application of Statute of Limitations
On March 28, 2007, Congressman Charles B. Rangel (D-NY), Chairman of the House of Representatives Committee on Ways and Means, as well as three senators who service on the Senate Committee on Finance, John D. Rockefeller IV (D-WV), Orrin G. Hatch (R-UT), and Mike Crapo (R-ID), sent a letter to Henry M. Paulson, Jr. Secretary of the Department of the Treasury, strongly taking issue with the Treasury Departments position on the existence of a statute of limitations for tax years prior to 2006 as articulated most recently in November 2007-31. This letter stated at the outset that [w]e are writing you to express our extreme disappointment at the action recently taken by the Treasury Department concerning the statute of limitations applicable to U.S. citizens who are residents of the Virgin Islands. It goes on to state that under Notice 2007-19, taxpayers with incomes of $75,000 or more will have limited protection from a statute of limitation for prior taxable years. Even if they immediately file protective returns for prior taxable years, those individuals could face potential assessments for all prior taxable years beginning after 1986 regardless of the reason for the asserted underpayment, as long as the assessment process beings within the next three years. The letter goes on the state that we believe that the Notice has dubious legal basis. We know of no instance where a taxpayer has been denied due process of law for the protection of the statute of limitations based on their income level nor do we know of any provision of law that gives the Treasury Department the authority to decide that individuals are not entitled to the statute of limitations because of the size of their income. The letter ends with the statement that [i]n the absence of revision of the Notice, we would have to pursue legislative changes.
Notice 2007-31 concludes by announcing that the Treasury Department and the IRS intend to issue regulations under sections 932(c) and 7654(e) that incorporate the new interim rules.
The Working Agreement provides that in any situation where a conflict arises between the provision of this Working Arrangement and the Tax Implementation Agreement, the provisions of the latter will govern. In turn, the Tax Implementation Agreement provides that it shall not apply to the extent that an action or proceeding concerning taxes covered by this Agreement is barred by the applicable Governments statute of limitations. Thus, if the U.S. Congress obtains legislative changes clarifying that the applicable statute of limitations (generally three years) applies to USVI taxpayers when filing with the BIR retroactive to 1986, then the Working Arrangement will only apply to years that are open for USVI tax purposes and will not permit the IRS to request information retroactive for twenty years.
The information provided in this article is not legal advice. Readers should consult with their professional advisors to determine how this information may apply to their specific circumstances.
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