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WEDNESDAY, JANUARY 15, 2020, 1:00-2:50 pm Eastern

FOR LIVE PROGRAM ONLY

Fundamentals of Corporate Outbound Taxation:

Boot Camp

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mailto:[email protected]

January 15, 2020

James Loizeaux, Managing Director, Global

Tax Services

CliftonLarsonAllen

[email protected]

John Samtoy, Tax Principal

Holthouse Carlin & Van Trigt

[email protected]

Fundamentals of Corporate Outbound Taxation: Boot Camp

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

FOCUS • CLARITY • COMMITMENT

FUNDAMENTALS OF U.S. CORPORATE OUTBOUND TAXATION

January 15 th, 2020John Samtoy, HCVT [email protected]

T A X | A U D I T | B U S I N E S S M A N A G E M E N T | M E R G E R S & A C Q U I S I T I O N S

TOPICS COVERED

I. Introduction and Overview

II. Anti-Deferral Regimes

III. Sourcing Rules

IV. Foreign Tax Credit

V. Information Reporting

VI. Q&A

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INTRODUCTION AND OVERVIEW – OUTBOUND TAXATION

• The U.S. taxes its citizens and residents, including domestic corporations, on their worldwide income.

• A credit against the U.S. tax liability is allowed for taxes imposed by foreign countries.

• Limit double taxation.

• The status of corporations as separate taxable entities is respected.

• Deferral of U.S. taxation on income

• Anti-deferral regimes• PFIC, GILTI, Subpart F, 956

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INTRODUCTION AND OVERVIEW – OUTBOUND TAXATION

• Territorial tax systems

• Participation exemption – and partial territorial system

• TCJA introduced §245A

• §245A - 100% dividend received deduction – “participation exemption”

• Domestic corporations that are U.S. shareholders of specified foreign corporations on the foreign sourced portion of the dividends received.

• Specified foreign corporation:

• A CFC or any other foreign corporation with a U.S. domestic corporate shareholder other than PFIC.

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§245A – PARTICIPATION EXEMPTION

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• Deduction only applies to foreign sourced portion of the dividends received.• Income excluding ECI and dividends from 80% owned

domestic corporations / total income.

• Deduction is denied on hybrid dividends • Dividend where FC receives a deduction or other foreign

tax benefit.

• Anti-deferral regimes – including GILTI – can cause income to be deemed distributed to U.S. Co. The income that is deemed distributed will not be treated as a dividend for §245A.

• Section 902 was repealed as part of TCJA (§245A essentially takes it place).

U.S. Co will receive a deduction for 100% of the dividend received from Foreign Co.

Dividend

Foreign Co.(not a PFIC)

U.S. Co

15%


ANTI-DEFERRAL REGIMES – DETERMINING CFC STATUS

• A controlled foreign corporation or CFC is a foreign corporation with U.S. Shareholders that own more than 50% of the vote or value of the corporation.

• A “U.S. Shareholder” is defined as a U.S. Person that owns 10% of a foreign corporation directly, indirectly, or constructively.

• CFC implications • Anti-deferral regimes: Subpart F, 956 (investments in U.S.

property), and GILTI.• Annual filing of Form 5471.

• Issue spotting: for any interest in a foreign corporation test whether it is a CFC. If it is not a CFC also test whether it is a PFIC.

1 0


DETERMINING CFC STATUS – IS FOREIGN CORPORATION A CFC?

Example 1

Foreign Corporation

6 different

U.S. Corps

5 U.S.

Indv

There are 11 U.S. owners, each own 9.09% interest, no

foreign owners. All owners are unrelated.

No YesForeign

Corporation

6 different

U.S. Corps

Example 2

U.S.

100%

5 U.S.

Indv

1 1


DETERMINING CFC STATUS – IS FOREIGN CORPORATION A CFC?

No Yes

U.S. 1

Example 3

Foreign Corporation

FC U.S. 2 U.S. 3

45% 9% 9% 37%

U.S. 1

Example 4

Foreign Corporation

FC U.S. 2 U.S. 3

45% 15% 9% 31%

1 2


ANTI-DEFERRAL REGIMES - PFIC

• Passive foreign investment company or PFIC

• Foreign corporation that is not a CFC where more than 75% of the gross income is passive or

• 50% or more of the assets held by the corporation produce passive income.

• PFIC implications • All income is ordinary income (distributions and capital gains).• Interest charge is imposed, in addition to income tax, on distributions that are

considered excess distributions (distributions greater than 125% of three year average).

• Form 8621 required to be filed annually.

• Passive Income

• Foreign personal holding company income with exceptions – income in §954(c)

• Generally dividends, interest, royalties, rent, annuities, gains from property that give rise to such income

1 3


ANTI-DEFERRAL REGIMES - PFIC

• Asset test – Any asset that would give rise to such income

• Cash is a passive asset and service companies often have little in the way of assets other than cash

• Look through 25% owned corporations (ex – holding company looks through to subsidiary income/assets).

• Issue spotting: look for foreign mutual funds, ETFs, similar traded instruments in brokerage accounts, real estate holding companies, service companies.

• Alternatives to PFIC treatment:

• Qualified Electing Fund (QEF)

• Mark to Market (MTM)

1 4


ANTI-DEFERRAL REGIMES - GILTI

• GILTI or Global Intangible Low Taxed Income is an anti-deferral regime introduced with TCJA.

• Referred to as a “global minimum tax”

• Requires U.S. shareholders (10% owners) of a CFC to compute their GILTI inclusions by taking into account their allocable share of tested income from CFCs.

• GILTI at a high level is 100% of a CFC’s foreign earnings less (1) subpart F income (if any) and (2) 10% net basis in depreciable tangible property.

• GILTI = the excess of the “net CFC tested income” over the “net deemed tangible income return”

• Net CFC tested income = gross income less deductions allocable gross income excluding:• ECI• Subpart F gross income• High taxed subpart F income (18.9%+ effective foreign tax rate)• Dividends received from a related person• Foreign oil and gas extraction income

1 5


ANTI-DEFERRAL REGIMES - GILTI

• Net deemed tangible income return = QBAI – allocable interest expense.

• QBAI - 10% of net depreciable tangible property used in a trade or business (section 167)

• A U.S. domestic corporate shareholder will be able to take a deduction of up to 50% of their GILTI inclusion and they are entitled to an 80% indirect foreign tax credit

• The deduction is 50% of the GILTI amount, limited to taxable income, from 2018 to 2025, and 37.5% starting in 2026

• The foreign tax credit is limited to 80%.

• Separate FTC basket for GILTI and may not carryback or carryover excess FTC

• Effective U.S. Corporate Tax Rates on GILTI (before allowable FTC)

• 21% x 50% deduction = 10.5% (2018 – 2025)

• 21% x (100%-37.5%) deduction = 13.125% (2026 and beyond)

• Election to exclude high taxed income (18.9% or 90% of US corporate rate) from GILTI in the proposed regulations but the effective date is only after regulations are finalized.

• See Prop Reg §1.951A-2(c)(6)(i)(A).1 6

WEALTH ADVISORY | OUTSOURCING | AUDIT, TAX, AND CONSULTING

Investment advisory services are offered through CliftonLarsonAllen Wealth Advisors, LLC, an SEC-registered

investment advisor

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Jim Loizeaux

Subpart F/Section 956 Income

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Create Opportunities

Anti-Deferral Provisions

• Concept

– Deny deferral to “tainted” foreign earnings

– Simultaneously allow deferral for active foreign business profits

• Specific Regimes

– Foreign Personal Holding Company (enacted in 1937 and repealed for tax years after 2004)

– Subpart F (enacted in 1962)

– Passive Foreign Investment Company (enacted in 1986)

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Subpart F income

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• Subpart F income includes: • Insurance income• Foreign personal holding company income

• Interest • Rents• Royalties• Dividends• Certain capital gains – including from sales of stock and

interests in entities• Personal service contracts – watch out for loan out

companies.• Foreign base company sales income • Foreign base company services income• Foreign base company oil related income • Other types – boycott income, illegal bribes or kickbacks

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Subpart F income – De minimis Rule

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Foreign Base Company Income – Exceptions and Special Rules• De minimis rule

• No part of a CFC’s income will be FBCI if the FBCI is less than 5% of its gross income and less than $1,000,000

• Full inclusion rule• If more than 70% of a CFC’s gross income is FBCI then all of the

income will be FBCI• High Tax Exception

• Exclusion for income that is subject to an effective rate of tax that is greater than 90% of the maximum US corporate rate

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FPHC Income Defined - §954(c)

• Dividends, interest, royalties, rents, and annuities

• Net gains from certain property transactions

• Net gains from certain commodities transactions

• Certain foreign currency gains

• Income equivalent to interest

• Income from notional principal contracts

• Certain personal services contract income

• Payments in lieu of dividends made pursuant to an agreement to which §1058 applies

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FPHC Income - Exceptions

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General Rule & Definitions

Same

Country

Exception

Active Trade or

Business

Exception

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Active Trade or Business Exceptions §954(c)(2)(A)

• FPHCI does not include rents or royalties derived in active conduct of a trade or business and received from an unrelated person

• Rental Income (Reg. §1.954-2(c))

– Lease of personal property that CFC regularly manufactures or produces (or if acquired, has added substantial value to), or,

– Lease of real property, for which CFC regularly performs active and substantial management and operational functions during the lease period

• Royalty Income (Reg. §1.954-2(d))

– License of property that CFC developed, created, or produced

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Subpart F income – Same Country Exception

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Foreign Personal Holding Company Income Exceptions• Same country exception

• Dividends and interest are excluded when – received from a related corporation that is created or organized in the same country as the CFC and that uses a substantial part of its assets in a trade or business in that country

• Rents and royalties are excluded when – received from a related corporation and the relevant property is used in the same country as the CFC.

• Limitations on use – the same country exception will not apply:• To the extent that it reduces the payor’s subpart F income. • To the extent that dividends are attributable to E&P

accumulated during a period where the recipient did not hold the stock of the distributing corporation

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Subpart F income – Look-Through Rule

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Foreign Personal Holding Company Income Exceptions• Look Through Rule

• In general dividends, interest, rents, and royalties that are received from a related CFC are excludable to the extent they are attributable or allocable to income that is neither Subpart F or ECI.

• The exception will not apply to the extent that it reduces Subpart F income of the payor or another CFC.

• This exception applies to cross border payments.• Currently extended to tax years that begin through the

end of 2019. The look through rule has been extended several times in the past (originally set to expire in 2011).

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FBC Sales Income - Example

• Property is not manufactured in Belgium

• USCo and CFC are related parties

• Sales by CFC to German customers constitute FBC Sales income

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USCo

CFC

(Belgium)

Belgium customer

German customer

Product

sale

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FBC Services Income - §954(e)

• “FBC services income” means income (whether in the form of compensation, commissions, fees or otherwise) derived in connection with the performance of technical, managerial, engineering, architectural, scientific, skilled industrial, commercial or like services if certain conditions are met

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FBC Services Income - §954(e)

• Income earned by a CFC will be considered services income if three conditions are met:– CFC must earn gross income from the performance of

services;

– Services must be performed either for or on behalf of a related person; and

– Services must be performed outside the country of the CFC’s incorporation.

• Purpose is to deny tax deferral where a service subsidiary is separated from manufacturing or similar activities of the CFC and organized in another country primarily to obtain a lower tax rate

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FBC Services Income - §1.954-4(b)(1)

• Services performed for or on behalf of a related person:

– CFC receives substantial financial benefit

– Related person obligated to perform services

– Services as a condition/material term of sale or

– Substantial assistance furnished

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Foreign Currency Exchange Gain or loss

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• Foreign currency exchange gain or loss on distributions of previously taxed income is calculated as the difference between:• The value of the distribution translated at the spot

rate on the date of distribution, and• The U.S. dollar amount at which the earnings were

previously included in the U.S. shareholder’s U.S. Federal taxable income

• Exchange gain or loss is ordinary income reportable as other income on the U.S. shareholder’s U.S. Federal tax return

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Earnings Invested in U.S. Property (§956)

• Concept” Constructive dividend of active foreign business profits

• Current inclusion for earnings invested in U.S. property

31

US.

U.S. shareholders

Controlled Foreign

Corporation

$

LOAN______________________

______________________

______________________

______________________

______________________

______________________

______________________

______________________

______________________

______________________

______________________

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Investment in U.S. Property - §956

• Income inclusion is the lesser of the amount invested in U.S. property or the undistributed earnings of the CFC

• Includes:

– Tangible property located in the U.S.

– Domestic stock (25% rule)

– Loans to a U.S. person

– Rights to use certain intangibles in the U.S.

– Certain pledges and guarantees

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Investment in U.S. Property - §956

• Pledges and guarantees

– Includes pledges of CFC assets

– Includes pledges of CFC stock if ◊ Greater than 2/3 of stock is pledged and

◊ Accompanied by negative covenants

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Amount Taxable to U.S. Shareholder

– Investment of earnings in U.S. property is the lesser of:◊ The excess of:

• A shareholder’s pro rata share of the average of the amounts in U.S. property held by the CFC as of the close of each quarter of the taxable year, OVER

• The amount of E&P previously taxed as described in Sec. 959(c)(1)(A)

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Application of §956 to Corporate U.S. Shareholders

• Section 245A provides a 100% DRD to a foreign dividend received by a corporate U.S. shareholder from a CFC

• Reg. § 1.956-1(a)(2)(i)

– Excludes a corporate U.S. shareholder from the application of §956

– The amount determined under §956 is reduced by the amount the U.S. shareholder would be allowed as a deduction under §245A

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investment advisor

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Sourcing of Income

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Why Sourcing Matters

• Source of income rules are the foundation of the U.S. international tax system

• Foreign persons are only taxed on their U.S. sourced income

• U.S. persons are taxed on their worldwide income

• Sourcing of income impacts the foreign tax credit calculation

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General Rules

• The U.S. tax system assigns source to income on the basis of the economic activity giving rise to it

• Where income can readily be associated with economic activity or assets within a geographic territory that determines its source

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Statutory Authority for Income Sourcing

Section 861

Section 862

Section 863

Income from U.S. sources

Income from non-U.S. sources

Special rules

Definitions & special rules for

allocation of deductions

Source rules for personal

property sales

Section 864

Section 865

Treaties may modify the above sourcing rules.

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General Rule - Interest

• Sections 861(a)(1) and 862(a)(1)

• Generally sourced by reference to the debtor’s residence or place of incorporation

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General Rule - Dividends

• Sourced based on the residence of the payor or from the place of incorporation of the corporation

• Dividends paid from a U.S. corporation are U.S. source income

– Section 861(a)(2)

• Dividends paid from a foreign corporation are foreign source income

– Section 862(a)(2)

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General Rule – Rents & Royalties

• The source of rental or royalty income is governed by the place where the property is physically located or used

• Applies to both tangible and intangible property

– Sections 861(a)(4) and 862(a)(4)

– Intangibles include patents, copyrights, know-how, customer lists, goodwill, trademarks

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General Rule – Real Property

• Source of income from the sale of real property based on location of the property

– Sections 861(a)(5) and 862(a)(5)

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General Rule – Tangible Property

• The source of income is governed by the place of residence (tax home) of the seller

– Sale by a U.S. resident is U.S. source income

– Sale by a nonresident shall be foreign source income

– Section 865(a)

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General Rule – Intangible Property

• Fixed Price

– Sourced to the residence of the seller

– Sections 865(a) and 865(d)(1)(A)

• Contingent Payment

– Not treated as a property sale but rather as a royalty

– Source of income is based on the royalty sourcing rules

– Section 865(d)(1)(B)

• Goodwill

– Sourced to the location of the goodwill

– Section 865(d)(3)

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General Rule - Inventory

• Passage of title test

– When rights, title, and interest of the seller in the property is transferred to the buyer (title passage)

– Where bare legal title is retained by the seller, the sale is deemed to occur at the time and place of transfer of beneficial ownership and the risk of loss

– Sections 861(a)(6), 862(a)(6), and 865(b)

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Purchased Inventory

• Sourced to where it is sold

• Examples:

– A U.S. person purchases goods produced in China and sold in Germany (foreign sourced)

– A U.S. person purchased goods produced in China and sold in the U.S. (U.S. sourced)

– A U.S. person sells goods in China purchased in the U.S. (foreign sourced)

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Manufactured Inventory

• Inventory that is manufactured in the U.S. and sold outside the U.S. is sourced on the basis of production activities

– Section 863(b)

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Personal Services

• Sourced to the place where services are performed

– Sections 861(a)(3) and 862(a)(3)

• Income allocated on a working day basis

• Exception:

– Commercial traveler exception (foreign sourced):◊ Section 861(a)(3)

◊ In the U.S. for 90 days or less

◊ Services performed for a foreign person or office in a foreign jurisdiction

◊ Total compensation is $3,000 or less

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FOREIGN TAX CREDIT – OVERVIEW

• Foreign Tax Credit Overview

• U.S. persons are subject to tax on worldwide income.

• A credit against the U.S. tax liability is allowed for taxes imposed by foreign countries.

• Credit is limited to the U.S. tax that applies to foreign sourced income.

• Limitation is calculated separately for each category or “basket” of income.

• Pre-2018 years – general and passive income baskets

• Income re-sourced by tax treaties

• Before 2007 nine baskets

• Post-2017 years – changes to FTCs under TCJA highlighted by two new baskets:

• Foreign Branch Income (FBI) Basket and GILTI Baskets

5 1


FOREIGN TAXES ELIGIBLE FOR CREDIT

• Foreign taxes eligible for credit • Income tax (a tax imposed on income) or a tax in lieu of an income tax and• Imposed by a foreign country or U.S. possession

• Tax – “compulsory payment pursuant to the authority of a foreign country to levy taxes”

• Compulsory payment – amount taxpayer is liable for after applying foreign tax law (including application of tax treaties).

• Income Tax - must satisfy three tests: realization, gross receipts, net income

• Taxes in lieu of an income tax• Country must have a generally imposed income tax

• Taxpayer would have been subject to income tax but a specific provision imposes the in lieu of tax instead as a substitute tax.

5 2



• Income tax treaties and country specific rulings• “Typically” clarify treatment of specific taxes but do not expand the

definition of foreign taxes allowable for credit.

• See ‘taxes covered’ article with language to include ‘substantially similar’ taxes.

• Still need to be aware of rules that are applicable on a country by country basis.

• Example: Netherlands tax on imputed investment income (net worth of savings and investments) is allowable as a foreign tax credit – Revenue Ruling 2002-16

5 3


EXAMPLE: IN LIEU OF TAX

5 4

• Country X has a tax on realized net income that is generally imposed. Nonresidents are subject to a separate gross income tax on income from country X that is not attributable to a trade or business carried on in country X.• Tax qualifies as an ‘in lieu’ of tax whether it is paid by

the nonresident directly or through withholding.

• Country X imposes both an excise tax and an income tax. The excise tax, which is payable independently of the income tax, is allowed as a credit against the income tax. The excise tax paid is imposed in addition to, and not in substitution for, the generally imposed income tax.• Even though a credit is allowed the taxpayer is subject

to an income tax and a separate excise tax on the same income. No credit is allowed under 903.

Examples from Reg 1.903-1

Taxpayer

Country X



• Taxpayers are generally limited to claiming a foreign tax credit on ‘direct’ foreign taxes.

• Direct - taxpayer is liable for foreign tax or is the owner of the income on which the foreign taxes are imposed under U.S. tax purposes.

• Includes taxes paid by flow through (‘transparent’) entities

• Withholding taxes are considered direct taxes of the payee of the income even though they are imposed on the payor.

• Indirect taxes – income taxes imposed on a foreign corporate entity.

• U.S. Corporations may claim indirect credits on deemed income only after tax reform – 902 is repealed.

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FOREIGN TAX CREDIT LIMITATION

•The foreign income tax credit is limited to the U.S. tax that applies on each separate category or ‘basket’ of income.

• General – foreign source income not included in another basket

• Passive – foreign person holding company income under 954(c) including interest, dividends, rent, royalties• Passive category income also includes dividends from a DISC or former DISC.• Passive category income does not include high taxed income (90% of U.S.

Corporate rate or 18.9%)

• Foreign Branch Income (new)

• GILTI (new)

• Income re-sourced by Treaty

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FOREIGN BRANCH INCOME - DEFINITIONS

• FBI: business profits of a U.S. person attributable to a QBU that is a transparent entity in one or more foreign countries.

• Excludes passive category income.

• Income from: • QBUs held directly or indirectly through DREs. • Distributive share of partnership income that is attributable to partnership foreign branches, direct or indirect

DRE activity, or through another passthrough entity held by the partnership with similar income. • Any other similar income from a pass-through entity

• Foreign branch: a QBU that conducts a trade or business outside the U.S..

• QBU: Any separate and clearly identified unit which maintains separate books and records whose activities constitute a trade or business.

• Presumption that QBU exists where activities give rise to a PE under a relevant U.S. income tax treaty.

• Activities of a partnership, estate, or trust that represent a separate trade or business are deemed to be a QBU even if no separate set of books are maintained.

• Required to determine amounts that would be reflected on those books if separate records were maintained.

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EXAMPLE: IDENTIFYING A FOREIGN BRANCH

5 8

P, a domestic corporation, is a partner in PRS, a domestic partnership. All other partners in PRS are unrelated to P. PRS conducts activities solely in Country A (the Country A Business), and those activities constitute a trade or business outside the United States. PRS reflects items of income, gain, loss, and expense of the Country A Business on the books and records of PRS's home office. PRS's functional currency is the U.S. dollar. PRS is in the business of manufacturing bicycles

Abbreviated analysis:

• Country A Business's activities comprise a trade or business conducted outside the United States.

• PRS does not maintain a separate set of books and records with respect to the Country A Business. However the Country A Business's activities are deemed to satisfy the requirement that a QBU maintain a separate set of books and records with respect to the relevant activities.

• The activities of the Country A Business therefore constitute a foreign branch for purposes of computing the foreign tax credit limitation.

• PRS is a U.S. partnership

• PRS conducts business in a FC

• PRS’s functional currency is the USD

• PRS does not maintain a separate set of books for FC activity.

• PRS’s FC activity is still a branch for purposes of the FTC

Example from Prop Reg 1.904-4

P

PRS



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Jim Loizeaux

Section 861 Expense Allocation & Apportionment

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Why are the Allocation and Apportionment of deductions important?

• Calculating the foreign tax credit limitation

• Determining a CFC’s Subpart F income

• For a taxpayer with excess FTCs, deduction allocation to foreign sources is equivalent to the denial of the deduction

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Determination of Net Foreign Source Income Taxable Income

Foreign Source Gross Income…

• Less: Directly Allocable Expenses and Indirectly Appointed Expenses

• Equals: Net Foreign Sources Taxable Income

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Allocation & Appointment o Expenses: Basic Concepts

• Terminology

– Income Class

– Statutory Grouping (e.g., Foreign Source)

– Residual Grouping (e.g., US Source)

• Allocation of deduction to income classes is required

• Apportionment of deduction between statutory and residual groupings is required

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Allocate Versus Apportion Example

Mfg. Income

Dividends Interest Royalties Rents

US source

Foreign source

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Step One- Allocate to classes of gross income

(Ap

po

rtion

)Fo

reign so

urce vs U

S sou

rce

Apportion between foreign and US source income within the income class

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Step 1 Deduction Allocation

• Deductions are allocated to the class of gross income produced by the activities or property to which the deductions relate

• Example: Reg. 1.861-8(e)(4)

– Stewardship expenses—Deductions resulting from stewardship or overseeing functions are considered definitely related and allocable to dividends received or to be received from the related corporation

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Step 2Deduction Allocation (Con’t)

• After allocating deductible expenses to classes of gross income, taxpayers apportion such expenses between statutory and residual groupings

• Statutory and Residual groupings

– The term “statutory grouping” means the gross income from a specific source or activity which must first be determined in order to arrive at “taxable income”

– The residual grouping is gross income from other sources or activities

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• Units Sold

• Gross Receipts

• Gross Income

• Cost of Goods Sold

• Profits Contribution

• Expenses Incurred

• Compensation

• Space Utilized

• Time

• Assets

• Any Other Reasonable Method

Allocation & Apportionment: General Methods Allowed (Reg. 1.861-8)

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Allocation and Apportionment: Specific Deductions

• Special rules for the allocation and apportionment of the following types of expenses:

– Interest

– R&D

– State Taxes

– Charitable Contributions Legal and Accounting Fees

– Stewardship Functions (e.g., overhead, G&S, supervisory expenses, etc.)

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Allocation and Apportionment:

• What is interest expense?

– Generally = GROSS interest expense under Sec. 163 (including original issue discount) and modified by capitalization provisions such as Sec. 263A

– Also includes interest equivalents (e.g., loan amortization fees)

• General Concept

- Monday is fungible – interest expense is attributable to all actives and property and must be apportioned based upon assets (foreign and US)

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Allocation and Apportionment (con’t):

• Exceptions: specific allocation of interest expense

– Qualified non-recourse debt

– Integrated financial transactions

– CFC netting rule

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Allocation & Apportionment:Interest Expense

• Apportioned on affiliated group basis based on assets

• Use average tax book value

• Categorize assets based on income that is generated

• Foreign ratio =

Total assets of affiliated group

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Jim Loizeaux

PERMANENT ESTABLISHMENT

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Business Profits and Permanent Establishment

• Under a permanent establishment article, the business profits of a resident of one treaty country are exempt from taxation by the host treaty country unless those profits are attributable to a permanent establishment within the host country.

• Presence of a PE triggers local tax nexus, local tax filings, tax payments and potential transfer pricing exposureso A PE is considered locally to be a separate taxpayer

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Types of PE

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Fixed Place PE

• A permanent establishment is a “fixed place of business” through which the business of an enterprise is carried on in whole or in part

• There must be the conduct of a business and that conduct must occur at a fixed place

• Examples include...an office, branch, factory, place of management, place of extraction of natural resources, etc.

• Must read the actual language of the treaty

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Fixed Place PE (Cont’d)

• Business of the enterprise (wholly or partly) must be carried through the fixed place of business

• Generally no minimum threshold

– An isolated activity cannot lead to establishment of a fixed base PE as the ingredients of regularity, continuity and repetitiveness will be missing.

• Activity need not be of productive character (OECD Commentary)

• “Activity test” would be satisfied by having personnel (employee or dependent agent) at the fixed place of business.

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Illustrative List

• The term PE typically includes:

– A place of management

– A branch

– An office

– A factory

– A workshop; and

– A mine, an oil or gas well or any other place of extraction of natural resources

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Exclusions: Preparatory or Auxiliary Activities

• The following are excluded from the definition of PE:

– Use of facilities solely for storage or display of merchandise

– Maintenance of stock of goods solely for the purpose of processing by another enterprise

– Maintenance of a fixed place of business solely for

◊ Advertising

◊ Supply of information

◊ Scientific research

◊ Other similar activities which have a preparatory or auxiliary character

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Agency PE

• Replaces requirement of fixed place of business

• Dependent agents of the enterprise can be can be treated as employees if they habitually exercise authority to conclude contracts etc.

• Dependent agents are those who-

– Acts on behalf of enterprise

– Has authority to conclude contracts, or

– Has no authority but habitually maintains stock of goods and regularly delivers goods for the enterprise

• PE in the State would be only in respect of activities which the agent undertakes for the enterprise

• Contracts must relate to the profit making activity of the enterprise - “the business profits” of the enterprise

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Agency PE (Cont’d)

• OECD Commentary: An agent will not constitute a PE of its principal if he is “agent of an independent status”:

o Legally and economically, the agent is independent of the enterprise on whose behalf he acts, and

o When acting on behalf of the enterprise, the agent acts in the ordinary course of his business

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BEPS Action 7 Overview

• Organization for economic cooperation and development (OECD) concern about potential for companies to engage in Base erosion and profit shifting (BEPS) activity by entering into “arrangements that artificially avoid the occurrence of Permanent Establishments (PE’s).”

• Aim of Action 7

“Develop changes to the PE definition to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and specific activity exemptions. Work on these issues will also address related profit attribution issues.”

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BEPS - Action 7: PE Definition

• Replaces “conclusion of contracts” with:

• Habitually concludes contracts, or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise

• Supplements “in the name of” with:

• For the transfer of the ownership or right to use the enterprise’s property, or for the provision of services by that enterprise

Dependent Agent

Standard

• Option to eliminate safe harbor approach to the specific activity exemptions and adopt facts and circumstances approach to test whether an activity is preparatory and auxiliary

Preparatory and

Auxiliary Activities

• Addresses dividing up contracts to meet 12 months safe harbor

• Aggregates complementary functions conducted by connected enterprises and that are part of a cohesive business operation for purposes of testing whether an activity is preparatory or auxiliary

Anti-Fragmentation

rule

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Revised Permanent Establishment Proposals Potential Impact – Dependent Agent

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Before

If authority to conclude

contracts is not habitually

exercised: no PE risk

AfterThe mere convincing of potential buyers to accept standard terms of a contract without any active negotiation of the contract terms could be considered to come within the phrase “concluding contracts,” thus creating a potential PE risk.

Also, a contract may be considered to be concluded in a state even if it is signed outside that state

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Revised permanent establishment proposalsSpecific activity exemptions – Preparatory or Auxiliary

• Modification to make all activities subject to preparatory or auxiliary condition.

• What is preparatory or auxiliary?– Depends on the relative importance of the activity when compared with the business of the

enterprise as a whole.

– Expanded anti-fragmentation rule to apply to activities of preparatory or auxiliary character in reference to connected enterprises.

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Activities listed to be exempted

only if they are of a preparatory or

auxiliary character

Preparatory: carried on in contemplation of “essential and significant part of the activity as a whole”

Auxiliary: carried on to support the essential and significant part of the activity as a whole, without itself being part of that essential and significant activity

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Revised permanent establishment proposalsSpecific activity exemptions – Anti - Fragmentation

• Merely storing a stock of goods belonging to R Co at S Co’s facilities for processing by S Co would not result in a PE for R Co.

• If, however, S Co’s facilities are at the disposal of R Co, a PE could be considered to exist under Art. 5(1).

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Practice Points

• Identify clients with employees in foreign countries

• Discuss with the client what activities are to be performed, where and by whom

• Re-assess PE status and the new criteria

• Plan ahead for expansion

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Jim Loizeaux

Transfer Pricing

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Topics

• Importance of transfer pricing

• Basics of transfer pricing

• Transfer pricing penalties

• Transfer pricing audit triggers

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Importance

• Number one global tax issue (BEPS)

• Expect increased enforcement by all countries

• Expect more information sharing between tax

authorities (e.g., Country-by-Country Reporting)

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Importance

Planning

• Transfer pricing can be used in conjunction with International, and state tax planning to minimize a company's effective tax rate.

– Shift functions and risks to increase income in jurisdictions with NOLs.

– Create foreign source income to make use of existing foreign tax credits before they expire.

– Create deductible distributions (i.e., royalties, interest, management fees) versus a non-deductible dividend.

• Transfer pricing can be used to meet cash/treasury management objectives.

– Initiate inter-company loans to overcome cash shortages, resolve liquidity issues, or generate cash for investments or debt reduction.

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Regulations

• U.S. transfer pricing regulations

– Section 482

– IRC Section 6662

◊ Penalties (20% and/or 40%)

◊ Annual documentation is required to avoid penalties

• Other countries have similar regulations

– 90+ countries with OECD Guideline based transfer

pricing legislation and regulations

• Contemporaneous documentation

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What is a transfer pricing study?

A transfer pricing study is a report that describes and analyzes a company's cross border transactions with related parties. The study can be divided into two broad sections:

• Descriptive

– The descriptive section outlines the transaction, identifies the parties involved and describes the operations of each of the participants.

• Analytical

– The analytical section, also often referred to as the Economic Analysis, describes the procedures and methods used to test transfer prices on related party transactions and concludes whether the prices pass the arm's-length test.

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Basics of Transfer Pricing

In any case of two or more organizations, trades, or businesses

(whether or not incorporated, whether or not organized in the United

States, and whether or not affiliated) owned or controlled directly or

indirectly by the same interests, the Secretary may distribute,

apportion, or allocate gross income, deductions, credits, or allowances

between or among such organizations, trades, or businesses, if he

determines that such distribution, apportionment, or allocation is

necessary in order to prevent evasion of taxes or clearly to reflect

the income of any of such organizations, trades, or businesses. In the

case of any transfer (or license) of intangible property (within the

meaning of Code Sec. 936(h)(3)(B)), the income with respect to such

transfer or license shall be commensurate with the income attributable

to the intangible.

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The arm’s-length standard is achieved if the results of the

transaction are consistent with the results that would have

been realized if uncontrolled taxpayers had engaged in the

same transaction under the same circumstances (arm's

length result).

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• Types of transactions

– Tangible property

– Intangible property

– Controlled services

– Financing arrangements (rents, loans, guarantees,

etc.)

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• Functional and Risk analysis is the basis for

transfer pricing.

– What each party to the transaction does.

– What value each party brings/adds to the transaction.

– Who is at risk for each transaction.

• Underlying premise by tax authorities is that the

party performing the most functions and/or

exposed to the greatest risk, should profit most

from the transaction.

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Functional

Analysis

Transactions

Entities

Products

Markets/competition

Business processes

Forecasts/business plan

Organization/staff

Financial results

Agreements/terms

Assets

Functions

Risks


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Transfer Pricing Audit Triggers

• Operating loss - especially multi-year losses

• Large year-to-year shifts in operating profits or losses

• Large dollar transactions with affiliates

• Presence of intercompany intangible transactions

– Loan Guarantees

– Royalty and Licensing Fees

• Presence of intercompany services transactions

– Accounting Support

– HR Support

– Technical Support

– IT Support and/or Software

• Transactions with companies located in tax havens, or low-tax

countries

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CLASSIFICATION OF FOREIGN ENTITIES AND CTB RULES

• A foreign entity with limited liability for all members will be treated as a foreign corporation.

• An entity with unlimited liability for at least one member will be treated as a pass-through.

• A member of a foreign eligible entity has limited liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member

• We are permitted to elect whether or not a foreign entity is treated as a corporation or pass-through by filing Form 8832 “check-the-box” election.

• If we are dealing with a per se corporation, it is a corporation for U.S. tax purposes.

• The foreign legal form of the entity can be useful in classifying it e.g., SA or SrL

1 0 1


CLASSIFICATION OF FOREIGN ENTITIES AND CTB RULES

1 0 2

GermanyGMBH

German corporate entity

GermanyGMBH

Dividend

German entity treated as transparent for U.S. tax purposes per a check-the-box election – credit

allowed

• $100 income 30% German tax

• $100 of U.S. income at 21% rate = $21 tax liability

• $21 FTC and $9 FTC carryforward or available to offset other foreign income.

• Down years where there is an NOL – loss will flow through to U.S. parent

• $100 income 30% German tax = $70 E&P

• $70 dividend income – No U.S. tax because of 245A DRD

• Consider impact of GILTI.

• GILTI is determined on an annual basis – no carryforward of NOLs.

U.S. Co

100% 100%

U.S. Co


INFORMATION RETURN REPORTING REQUIREMENTS

• Information returns – report information on cross border ownership and transactions. Penalties for missed forms generally start at $10,000 and keep the statute open on returns indefinitely.

• Forms may include:

• Form 5471 – Interest in a foreign corporation

• Form 8865 – Interest in or transfer to a foreign partnership

• Form 8858 – Interest in a foreign disregarded entity or branch

• Form 8621 – Interest in a PFIC

• Form 926 – Transfers to a foreign corporation

• Form 8938 – Report of foreign financial assets

• Form 114 (FBAR) – Foreign bank account report1 0 3


FORM 5471 - OVERVIEW

• Required for:

• Category 1 – U.S. Shareholder of a specified foreign corporation (can include 10% corporate owner of non-CFC).

• Category 2: U.S. person who is an officer/director of a foreign corporation in which a U.S. person acquired stock of at least 10%

• Category 3: Acquisition of 10% ownership or disposition below 10% ownership threshold

• Category 4: U.S. person with control of CFC during the year

• Category 5: U.S. Shareholder of a CFC

• “U.S. shareholder” is a U.S. person who owns 10% or more of the CFC

• Issue Spotting: financial statements, balance sheet (investment in subsidiaries), obtain organizational chart, K-1 footnotes.

1 0 4


FORM 8865 - OVERVIEW

• Filing Required for:

• Category 1: U.S. person who controls the foreign partnership (owns more than 50% interest)

• Category 2: U.S. person owns at least 10% interest; and all U.S. persons own a combined more than 50%

• Category 3: Contribution of property (e.g. Section 721 transfer)• Owned directly or constructively at least a 10% interest after the contribution, or• The value of the property contributed exceeds $100,000

• Category 4: Reportable event• Acquisition of 10% interest or more, Disposition of 10% interest or more, 10%

change in proportional interest

• Issue Spotting: financial statements, balance sheet (investment in subsidiaries), obtain organizational chart, K-1s from foreign partnerships, K-1s indicating transfers to foreign partnerships

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U.S. Person

• A citizen or resident alien of the United States

• A domestic partnership

• A domestic corporation

• Any estate (other than a foreign estate, within the meaning of §7701(a)(31)(A))

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Foreign Disregarded Entity (FDE)

• An FDE is an entity that is not created or organized in the United States and that is disregarded as an entity separate from its owner for U.S. income tax purposes under §301.7701-2 and -3

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Form 8858 for Branches – 2018 Changes

• Post 2017, Form 8858 required for foreign QBUs (i.e., branches) of:

– A U.S. person,

– A controlled foreign corporation (CFC), or

– A controlled foreign partnership (CFP).

• A separate Form 8858 is filed for each foreign branch (FB) or foreign disregarded entity (FDE).

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Form 8858 for QBUs

• A foreign branch is a qualified business unit (“QBU”) per Reg. 1.989(a)-1(b)

• A QBU exists when activities of a corporation or partnership:

– Constitute a trade or business; and

– Separate books and records are maintained

• Trade or business

– Independent economic enterprise carried on for profit

– Expenses are deductible under Sections 162 or 212

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Tax Owner of FDE

• The tax owner of the FDE is the person that is treated as owning the assets and liabilities of the FDE for purposes of U.S. income tax law

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Who must file?

• U.S. persons that are “tax owners” of a foreign disregarded entity (FDE) or foreign branch either:

– Directly

– Indirectly; or

– Constructively (via a U.S. person that owns a 10% or greater interest in FDE indirectly through a controlled foreign corporation (“CFC”) or controlled foreign partnership (“CFP”)

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Tax Ownership

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FDE

USP

FPCFC

USP

FDE

USP

FDE

FP

100%

99.99%65%

100%

100% .01%

• PLR (201021002) The .01% represents a nominee interest that represents no economic or beneficial ownership and was established to satisfy local law requirements necessitating multiple owners

• Treat as a FDE and file form 8858

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Schedules Required

U.S. Person – Tax Owner of FDE

• Entire Form 8858

U.S. Person – Indirect or Constructive Ownership

• CFC – Category 4 filer and CFP – Category 1 filer

– Entire Form 8858

• CFC – Category 5 filer and CFP – Category 2 filer

– Form 8858 – Page 1 identifying information (above Schedule C)

– Form 8858 – Page 2 – Schedules G, H and J

– No Schedule M for CFC Category 5 filer

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Dormant FDEs

• Announcement 2004-4, 2004 I.R.B. 357, provides for a summary filing procedure for filing Form 8858 for a dormant FDE. A dormant FDE is an FDE that would be a dormant controlled foreign corporation (CFC) if it were treated as a foreign corporation for U.S. tax purposes

• If you elect the summary procedure, complete only the identifying information above Schedule C on page 1 of Form 8858 for each dormant FDE as follows:

– The top margin of the summary return must be labeled “Filed Pursuant to Announcement 2004-4 for Dormant FDE”

– Include the name, address, identifying number and tax year of the U.S. person filing 8858

– Include the annual accounting period of the dormant FDE and complete items 1a through 1e and 1g

– Complete items 3a through 3d, if applicable

– Complete items 4a through 4c

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General Filing Requirement

• US person

• Financial interest or signature or other authority over:

– Foreign finical accounts

– Aggregate value of > US $10,000 at any time during the year

• Due on April 15 of the following year. Extension to October 15. Form 1040/1120 extension does not extend FBAR filing date. However, must disclose existence of foreign accounts on Schedule B Form 1040.

• Not a part of a tax return! Must be filing separately.

• To avoid penalties, can provide reasonable cause arguments with online filing.

• Six year statute of limitations of FBARs- even if not filed.

• Retain FBAR records for five years.

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I. U.S. Person

1. Citizens and residents of U.S. IRC 7701(b) – No treaty tiebreakers

2. Green card holders

3. 183 day residence test- substantial presence

4. Domestic entities- partnership, corporation, estate, limited liability company, trust

5. Can be multiple filing – US corporation owns >50% of US corporation

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US

US Individual 100%

Bank AccountFC

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II. Financial Account

1. Bank, securities derivatives or other financial instrument accounts

2. Shares in a mutual fund (fund is available to the general public with a regular net asset value determination and regular redemption- not private equity or hedge funds)

3. Savings, demand checking, deposit, time deposit, insurance policy with cash surrender value or other account with financial institution.

4. Includes debit and prepaid credit cards

5. Includes accounts that generate neither interest or dividends - e.g., financial institution holds gold in your account

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III. Foreign Financial Account

1. Geographical location of account, not nationality of financial entity- so bank account in foreign branch of US bank is foreign account.

2. Account in U.S. branch of foreign bank is not foreign account.

3. Account on U.S. military facilities not foreign accounts.

4. Includes accounts outside of U.S. states, District of Columbia, Northern Mariana Islands, American Samoa, Guam, Puerto Rico, U.S. Virgin Islands, and Indian Lands

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IV. Financial Interest

A U.S. person has a financial interest in the following situations:

1. U.S. person is owner of record or ha legal title regardless of weather account is maintained in his/her name or for another.

2. The owner of record or holder legal title is: (a) a person acting as an agent, nominee, attorney or in some other capacity on behalf of the U.S. person; (b) a corporation in which the U.S. person owns directly or indirectly more than 50 percent of the total value of shares of stock or more than 50 percent of the voting power for all shares of stock; ( c )a partnership in which the U.S. person owns an interest in more than 50 percent of the profits or of the capital of the partnership; (d) A trust in which the U.S. Person either has a present beneficial interest either directly or indirectly, in more then 50 percent of the assets or from which such a person receives more than 50 percent of the current income

Example: John, U.S. citizen residing in Country X grants his brother Paul, a U.S. citizen, a Power of Attorney to access his Country X bank accounts. Paul is the owner of record. Both John and Paul have a financial interest in the account and must file FBARs.

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V. Signature Authority

• Authority of an individual to control the disposition of assets held in a foreign financial account by direct communication to the bank or other financial institution- even if no signature card.

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VI. Late Filings

• Financial Interest

– Penalties generally apply even if there is no unreported income related to the unreported accounts.

– Voluntary disclosure options allow for lower or no penalties

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VI. Late Filing (Con’t)

• Penalties

• Civil Penalties

– Reasonable cause- no penalty- reasonable reliance on preparer along with good faith. Reg. 1.6664-4.

– Non-willful negligence- up to $10,000 per year per account

– Willful failure to file- greater of 50% of highest balance per year or $100,000. Penalty is not limited to amount in account. So a $1 million account not filed for si years could result in a $3 million penalty.

◊ Willful- Voluntary, intentional violation of a known legal duty; includes “willful blindness;” burden of proof on IRS (I.R.M. 4.26.16.4.5 6 (07-01-2008)). See U.S. v. McBride, 908 F. Supp. 2d 1186 (U.S. Dist. Ct. Utah 2012); U.S. v. Williams, 110 AFTR 2d 2012-5298 (4th Cir 2012).

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1 2 9T A X | A U D I T | B U S I N E S S M A N A G E M E N T | M E R G E R S & A C Q U I S I T I O N S

JOHN SAMTOY – INTERNATIONAL TAX PARTNERHCVT LLP

[email protected]

mailto:[email protected]

James D. Loizeaux, J.D., CPA

Managing Director

National Tax Office – International Tax

[email protected]

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