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INTERNATIONAL TAX REFORMAND “BREXIT”

ACC Arizona Chapter Meeting, October 13, 2016

Anil Kalia, International Tax Partner, DLA Piper

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Latest Development in International Tax Reform:BEPS

BREXIT: Impact on International Structures

Topics

Latest Developments inInternational Tax Reform:BEPS

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Illustrative Deferral Tax Structure

1 SaasCo transfers rights to non-US market to aCayman subsidiary.

2 CaymanCo has rights to non-US market andsublicenses that right to an Irish subsidiary.

4 FranceCo provides sales and marketingactivities and employs local Frenchemployees.

3 IrelandCo sells the SaaS application to Frenchcustomers.

The Structure

The Net Tax Result

France. Modest amount of income and tax inFrance (notwithstanding that is the location of thecustomer). It gets a “cost plus” payment for itsactivities.

Ireland. Modest amount of tax in Ireland(notwithstanding that it is the entity that collectedthe revenue). Most of the Ireland profit is strippedout by the royalty it pays to CaymanCo.

Cayman. Most of the profits land in CaymanCo(subject to zero tax), although there is little to nopeople or IP development in the Cayman Islands.

US. The United States will impose tax if CaymanCoever pays a dividend, but until then there is no UStax and the tax can be deferred.

SaasCo(US)

US IP

1 CaymanCo

Frenchcustomer

3

Non-US IP

IP Transfer

IrelandCo

FranceCoPerformsSales andMarketingActivities

Sublicense

Sales

$

4

2

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Base erosion and profit shifting (BEPS) refers to tax planning strategies thatexploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity (and little or nooverall corporate tax being paid)

Annual losses from 4-10% of global corporate income tax revenues (USD100-240B) due to BEPS

The Organisation for Economic Cooperation and Development (OECD) led aproject to develop recommendations for governments to address BEPSconcerns:

– Ensure that profits are taxed where economic activities take place andvalue is created

– Put an end to double non-taxation (while preventing double taxation)

What is “BEPS”?

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BEPS Project

OECD/G20 Base Erosion and Profit Shifting Project involved inputfrom more than 80 countries, including:

– 34 members of the OECD

– All G20 members

– More than 40 developing countries (including China and India)

– UN, IMF and World Bank Group

23 discussion drafts published, 12,000 pages of comments, 11 publicconsultations, regular webcasts, range of conferences around world

2015: final package of BEPS measures (13 final reports that address15 actions)

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The recommendations of the BEPS Project are “soft law” legalinstruments.

They are not legally binding but there is an expectation that they will beimplemented by participating countries through local, bindinglegislation.

All OECD and G20 countries have committed to consistentimplementation in the areas of preventing treaty shopping, Country-by-Country Reporting, fighting harmful tax practices and improvingdispute resolution.

BEPS Project

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BEPS Project: 15 Actions / Focus AreasAction Description

1 Tax Challenges of Digital Economy

2 Hybrid Instruments and Entities

3 Controlled Foreign Company

4 Interest Expense

5 Harmful Tax Practices

6 Treaty Abuse

7 PE Avoidance

8 Intangibles

9 Risk and Capital

10 Other High Risk Transactions

11 Data Collection / Analysis

12 Disclosure Rules

13 Transfer Pricing Documents

14 Improve Dispute Resolution

15 Multilateral Instrument

Final reports available at: http://www.oecd.org/tax/beps-2015-final-reports.htm

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BEPS Transfer Pricing Rules

New rules regarding IP rights and IP profits

Legal IP holder no longer entitled to substantially all of the profitsfrom use of intangible

Instead, profits are attributable to the party that (i) performs andcontrols IP-related functions, (ii) contributes assets and (iii)assumes risk associated with development, enhancement,maintenance, protection and exploitation of intangible

Without control, the legal IP holder can only get profitsattributable to cost of capital

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BEPS Transfer Pricing Rules: Illustrative Structure

SaasCo(US)

US IP

1 CaymanCo

Frenchcustomer

3

Non-US IP

IP Transfer

IrelandCo

FranceCoPerformsSales andMarketingActivities

Sublicense

Sales

$

4

2

What does this mean for our taxstructure?

CaymanCo: Pre-BEPS. The Irishentity sells the SaaS application to thecustomer and collects the revenue.The Irish company pays a royalty toCaymanCo, so most of the profits fromthe sale land in the Cayman Islands(subject to no tax).

CaymanCo: Post-BEPS. There willbe pressure to show that CaymanCoperforms IP-related development andcontrol functions. Otherwise, taxingauthorities could allocate more of theprofits (and taxable income) to otherjurisdictions.

How to address this new risk?

Consider moving IP holding companylocation to a jurisdiction in which it ismore operationally feasible to do IP-related development.

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BEPS “Permanent Establishment” Rules

Most jurisdictions will impose tax on a foreign company if the foreigncompany creates a “permanent establishment” (i.e., a taxable nexus) or“PE” in the jurisdiction

A PE may result if sales people negotiate and conclude contracts in thejurisdiction.

– Ex. SaaSCo sales person travels from the US to UK and negotiatesand signs contracts with UK customers. SaaSCo may now have aPE in the UK and may be subject to UK tax.

Multinationals have addressed this risk by putting in procedures toensure that sales contracts are not signed in the local jurisdiction.

Under the BEPS proposals, a contract may be considered to beconcluded in a state (resulting in a PE) even if it is signed outside thestate. A PE can also result if the sales person habitually plays theprincipal role leading to the conclusion of contracts.

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BEPS PE Rules: Illustrative Structure

SaasCo(US)

US IP

1 CaymanCo

Frenchcustomer

3

Non-US IP

IP Transfer

IrelandCo

FranceCoPerformsSales andMarketingActivities

Sublicense

Sales

$

4

2

What does this mean for our taxstructure?

IrelandCo and FranceCo: Pre-BEPS. The Irish entity sells theSaaS application to the customerand collects the revenue, but it is notsubject to French tax because itsigns contracts outside of Franceand does not have a “PE” in France.

IrelandCo and FranceCo: Post-BEPS. IrelandCo could have a PEin France (and become subject toFrench tax) if the French employeesnegotiate contracts on behalf ofIrelandCo.

How to address this new risk?

Confirm that local entities areperforming merely promotionalactivities and educate sales peopleon this risk.

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BEPS Country-By-Country Reporting

New “country-by-country” (CBC) reporting rules are intended toenhance transparency for tax administrations by providing themwith greater information about the full tax structure ofmultinational enterprises (MNEs)

Large MNEs (annual revenue of EUR 750M or more) will berequired to file reports in their HQ location that show their globalallocation of income, profit, taxes paid and certain economicindicators (capital, employees, retained earnings, tangibleassets), by entity and jurisdiction

Will be shared with other jurisdictions through automaticexchange of information procedures

Arguably this provides a “treasure map” for local jurisdictions tosee where the profits of the MNE are landing, as compared towhether the MNE has business substance

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BEPS CBC Rules: Illustrative Structure

SaasCo(US)

US IP

1 CaymanCo

Frenchcustomer

3

Non-US IP

IP Transfer

IrelandCo

FranceCoPerformsSales andMarketingActivities

Sublicense

Sales

$

4

2

What does this mean for our taxstructure?

FranceCo: Pre-BEPS. Historically,the French tax authorities have onlyseen the local tax return filed by theFrench company.

FranceCo: Post-BEPS. Goingforward, the French tax authoritieswill have access to the CBC reportfiled by SaasCo. They will see thatIrelandCo has significant sales inFrance, on which it only reports amodest amount of income, and willalso see that CaymanCo capturessignificant profits (subject to no tax)and has few employees (if any).

How to address this new risk?

It is not clear what local taxauthorities will do with this newinformation, but large MNEs shouldbe prepared to defend their taxstructures in all jurisdictions in whichthey have material business.

BREXIT: Impact onInternational Structures

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BREXIT Timeline

On June 23, 2016, 51.9% of British voters in nationwidereferendum voted for the UK to leave the European Union.

The new UK Prime Minister, Theresa May, has announced thatthe UK government will comply with the outcome of the vote.

May has pledged to trigger the exit process by invoking Article 50of the Treaty of the EU (likely in early 2017), upon which a two-year exit negotiation will begin before Brexit is implemented.

The plan is that existing EU law will be converted into UK law.

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BREXIT Impact: Regulatory Review

US multinationals with UK activities may need to assess whether thereare EU regulations that apply to their UK business that may no longerapply once Brexit is implemented.

It will be challenging to make this assessment. The UK regulatoryframework has become increasingly entwined with the EU over severaldecades and the outcome of the unwinding process is going to bedifficult to predict.

For the time being, it is business as usual. Currently, the UK remains amember of the EU and must continue to comply with EU laws andregulations.

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BREXIT Impact: Contractual Issues

Parties who want to escape their contractual obligations may invokeBrexit-related legal arguments founded in "force majeure" (whichentitles a party to contract relief or termination because of significantunforeseen events).

These are difficult arguments to win, but force majeure, termination andmaterial adverse change clauses should be considered carefully.

Other points to consider include: choice of law provisions,consideration of how exchange rate fluctuations might affect pricing,the allocation of compliance costs between parties, and disputeresolution procedures.

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BREXIT Impact: Supply Chain Management andHeadcount

Another point of consideration is the extent to which a businessinvolves the supply of goods or services between the UK and (a) otherEU Member States and (b) other countries with which the EU hasconcluded or is currently negotiating trade agreements.

Some businesses may consider relocation in order to maintain freeaccess to the EU market.

In addition, free movement of headcount is one of the core elements ofEU membership. If this is curtailed, some businesses may be affectedsignificantly. New visa requirements could make it difficult to recruitUK-based employees from the remaining EU Member States (and viceversa).

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BREXIT Impact: International Tax Issues

Withholding Taxes. UK companies can no longer rely on EU Parent-Subsidiary directive to exempt withholding taxes on related parties.They must rely on the tax treaty network, which may not be asbeneficial.

VAT. UK will likely continue to impose VAT but will no longer haveaccess to EU mechanisms that make VAT registration and compliancesimpler.

Customs Duties. Possible imposition of customs duties between theEU and the UK. This may depend on negotiations and whether the UKis permitted to remain in the EEA (European Economic Area).

Could this free the UK up to compete for multinationals lookingfor low-tax jurisdictions?

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Anil Kalia concentrates on international tax planning and operationalstructuring, cross-border transactions and joint ventures, financingtransactions, post-transaction integration, legal implementation andtax controversy.

Anil has represented a wide variety of clients, from multinationalcorporations to start-ups, across a range of industries such astechnology, finance, resource development and private equity. He hasdeep knowledge of issues related to US and foreign tax minimizationand transactional planning.

Anil John Kalia

Anil John KaliaPartnerT: +1 650 833 2026anil.kalia@dlapiper.com

Silicon Valley Office2000 University AvenueEast Palo Alto, CA 94303

EducationJ.D., University of California at LosAngeles School of Law Order of theCoif

B.A., History of Economics, YaleUniversity

AdmissionsCalifornia