International Taxation

2

My Background

• 1962 Graduated from Niigata High School• 1963 Went to the USA for college education• 1967 Graduated from Oklahoma State University with BS in Accounting• 1967 -1970 Worked in the audit department New York & Tokyo offices of Price Waterhouse & Co. (now PriceWaterhouse Cooper)• 1972 -1978 Joined New York International Tax Division of Peat Marwick Mitchell (now KPMG)• 1978 - 1988 Worked in Tokyo Office of Peat Marwick Mitchell

• 1988 -2001 Worked in New York Office of KPMG. Became the Japanese Tax Practice Leader of KPMG in the US• 2001 Retired from KPMG• 2001 -2004 Full-time professor at IUJ• 2004 – 2008 Outside Statutory Auditor of Takeda Pharmaceutical Company• 2004 – Now Visiting Professor at IUJ

3

What is International Taxation?

• There are no international tax laws• It is an inter-action of more than one country’s

tax laws and rules• Tax laws and rules of more than one country

which are applied to a cross-boarder transaction.

• Global business has no border but tax laws & rules will continue to have a clear border.

• Risk (double taxation) and Opportunity (reduction of total tax liability)

4

International Tax Topics• APA – Advance Pricing

Agreement• Arm’s length standard• Check-the-box-rules• Correlative adjustment• Corporate inversion• Double taxation• Double-dip lease• Dual resident• Effective tax rate vs.

statutory tax rate• Foreign tax credit• Hybrid entity• Hybrid instruments• LLC –Limited Liability Company

• LLC• Pass-through entity• Permanent establishment• Tax arbitrage• Tax haven• Tax shelter• Tax sparing credit• Tax treaty• Tax treaty shopping• Thin capitalization• Tie-breaker rule• Transfer price• Withholding tax• Withholding tax agent

5

Features of International Taxation

• What’s tax? Government expenditures = tax (or non-tax) revenue + government debts (e.g. Japanese government bonds, US Treasury Bills, etc.)

• Financial accounting vs. Tax accounting

• Tax systems are different in every country.– Tax rate– Tax basis = determination of taxable income– Different taxes– Allowable deductions (depreciation, entertainment expense, etc.)– Definition of terms– Culture & practice

• Tax practice (tax culture and tax enforcement practice) is different in every country

• In cross-border transactions, income to a party in a country is cost/expense to other of another country in almost all cases

History of International Taxation-I

In 1950’s, US companies’ expansion overseas began

1n 1960’s, US introduces various tax laws & rules governing cross-border transactions. For example:

Subpart F rules (tax haven taxation)Thin capitalization ruleTransfer pricing regulationsTaxation of inbound investment (i.e. foreign corporation)

6

History of International Taxation - II

In 1970’s, US tighten foreign tax credit rules1. Clarifying source rules2. New rule concerning allocation of expenses3. Clarification of what are qualifying foreign taxes

Developing countries have began to adopt similar tax laws & rules of USA

Japan’s example

Tax haven taxation – 1978 (1963) Transfer pricing law – 1986 (Regulations in 1968)Thin capitalization - 1992 (1950’s)Consolidated tax return- 2002 (1950’s)Limited Liability Company – 2008 (1970’s)Foreign dividend exclusion – 2010 (2008)

7

Growth of KPMG International Tax Practice -1

8

International Tax Transfer Pricing International ExecutivePractice Practice Tax Practice

1965 None None None

1970 Group of 3 partners, 5 managers & 10 staff None Nonein New York. Small group in Los Angles, San Francisco, Chicago, and Houston. Outside the USA, there were a small group in London, Paris, Frankfurt, Singapore and Sydney

1980 Number of professionals specialized in None IET (International Executive Tax) group started International Taxation doubled. US offices of in New York with 2 partners, 4 manager andMiami, Washington, D.C., Atlanta, Dallas, Boston 8 staff. Paris & London offices had US tax Denver, and Dallas and outside US offices of partners to service US expatriate clients of Amsterdam, Munich, Zurich, Milan, Madrid, US multinational companiesDublin, Hong Kong, Tokyo and Mexico City

Growth of KPMG International Tax Practice - 2

9

1990 Almost all offices in major cities in the US and Washington D.C. office started Economic IET Practice expanded to large offices like around the world have International Tax Group Consulting Group with 2 partners and 5 Chicago, Los Angles, Brussels, Tokyo,

managers to provide transfer pricing analysis Singapore & Hong Kongservices. 2 partners had PhD in Economics

2000 Over 2000 tax professionals in major and medium 15 US offices and several offices outside the Nearly 1000 professionals in major cities size offices around the world specialize in US have a group specializing in Transfer around the world specializes in IET practicein International Tax Pricing Group (e.g. London, Tokyo & Sydney),

2010 Nearly 2500 tax professionals in major and Transfer Pricing Group is formed in offices Remains at the same level of 1000 medium cities specialize in International Tax in the countries of the emerging market. For professionalsincluding cities in emerging market like China, example, KPMG has transfer pricing specialistsIndia and Brazil in Beijing, Shanghai, San Paulo, New Delhi

and Jakarta

10

Cross-border Transactions

Country A Country BCountry A Country B

① 　Capital

② Loan 　

③ Intangible (know-how)

④ 　Service

① 　 Dividend

② 　Interest③ 　Royalty④ 　 Fee

11

Tiger Woods Case

TotalCalifornia Florida Michigan New York Japan UK Dubai Germany

Golf tournament prize money 1,000,000 2,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 9,000,000Appearance money 1,000,000 1,000,000 1,000,000 3,000,000

Endorsement income Niki 10,000,000 10,000,000 American Express 10,000,000 10,000,000 GM - Buick 10,000,000 10,000,000 Others 18,000,000 1,000,000 1,000,000 20,000,000

Total income 62,000,000

Withholding tax rate on a 9% 0% 6% 15% 20% 15% 0% 25% nonresident

Tax 90,000 60,000 150,000 600,000 150,000 0 750,000 1,800,000

Marginal tax rate as a resident 9% 0% 6% 15% 50% 31% 0% 53%

California Florida Tax 25,496,000 21,927,500 3,568,500

In the USA Outside USA

12

Anneka Sorenstein Case

TotalCalifornia Arizona Florida Michigan New York Japan UK Dubai Germany Sweden

Golf tournament prize money 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 9,000,000Appearance money 1,000,000 1,000,000 1,000,000 3,000,000

Endorsement income Niki 10,000,000 10,000,000 American Express 10,000,000 10,000,000 GM - Buick 10,000,000 10,000,000 Others 18,000,000 1,000,000 1,000,000 20,000,000

Total income 62,000,000

Withholding tax rate on a 9% 5% 0% 6% 15% 20% 15% 0% 25% 25% nonresident

90,000 50,000 60,000 150,000 600,000 150,000 0 750,000 1,850,000

Marginal tax rate as a resident 9% 5% 0% 6% 15% 50% 31% 0% 53% 50%

Sweswn California Florida Resident of Monaco Tax 31,000,000 Tax in Monaco 0 Foreign tax credit -1,850,000 Taxes in other 1,850,000 Net tax sweden 29,150,000 21,048,000 17,345,000

Taxes in other jurisdictions 1,850,000

Tax saving 9,952,000 13,655,000 29,150,00031,000,000 31,000,000 31,000,000 31,000,000

In the USA Outside USA

Tiger

13

Risks in Tiger Woods and Anneka Sorenstam Cases

• Determination of resident*1. Bank account, 2. Ownership of real estate3. Driver’s license, 4. Physical residence (i.e. number of days)5. Voter registration.

• Source or origin of income*1. Place of services rendered2. Recipient’s residence3. Payer’s residence4. Place of contract signing5. Place of filming and appearance6. Place of benefit (advertising effect)

Tiger

14

Basic Principle of International Taxation - 1

• Capital Export Neutrality

A tax system meets the standard of capital-export neutrality if a taxpayer’s choice between investing capital at home or abroad is not affected by taxation. Domestic income and foreign income are taxed at the same rate.

• Capital Import Neutrality

– A tax system meets the standard of capital-import neutrality if all taxpayers doing business in a country are taxed at the same rate whether domestic taxpayer or foreign taxpayer earns it.

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Basic Principle of International Taxation - 2

• Nationality Rule

– Nationality rule is the taxation system based on the legal connection (i.e. place of incorporation) to a country. Under this rule, the worldwide income of a domestic corporation is taxed in that country.

– USA, UK, Germany, Japan, Indonesia

• Territoriality Rule

– Territoriality rule is the tax system based on the factual connection to a country. A taxpayer is expected to share the costs of running a country which makes possible the production of income, its maintenance and investment and its use through consumption.

– France, Hong Kong, Switzerland

Jurisdiction To Tax

Residence Jurisdiction (Nationality Rule)

A country may impose a tax on income because a nexus between the country and the person earning the income

Source Jurisdiction (Territoriality Rule)

A country may impose a tax on income because of a nexus between that country and the activities that generated the income

17

Taxation of Inbound Investment Form of Operations

– Business trip– Representative office ********************************– Branch – a part of corporation– Pass-through entity, e.g. partnership, LLC (not taxable entity.

Income or loss belong to each investor/partner)– Subsidiary – legally separate entity– Joint venture – could be in corporate form or pass-through entity

form– M & A of existing company **********************************Transfer pricingThin capitalization

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Taxation of Inbound Investment Taxation of Branch

• Permanent establishment– Factual determination– Treaty Definition

• Effectively connected income• Income attributable to a permanent establishment• Application of arm’s length standard• Allocation of head office expenses• If a subsidiary is established in a given country, such

subsidiary is generally treated same as the corporation is such country for tax purposes.

• Some countries offer tax incentives to subsidiary companies of foreign investors to encourage investment in such countries e.g. Ireland & Brazil,

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Taxation of Inbound Investment Government Policy

• Government tax policy toward inbound foreign investment.

– Encourage = tax incentive: – Discourage = high withholding tax

• Foreign investment incentive

– Tax holiday – zero or low corporate income tax rate– Zero withholding tax on dividend, interest and royalty– Tax sparing credit

22

Taxation of Outbound Investment

• Foreign income exclusion vs. worldwide income taxation with foreign tax credit system

• Deferral of foreign subsidiary’s income• Tax haven taxation (Slide 26)• Foreign dividend exclusion

– Countries adapted the territoriality rule– Special measure – USA’s one time exclusion and

Japan introduced the foreign dividend exclusion provision in 2009

23

Use of Tax Haven Country

USA UK

USA UKBahamas

1,000

1,000700

Sales 1,000Cost -600Profit 400Tax@50% -200Profit after tax 200

1,000 -700 300 -0 300

Before

After

US company set up a subsidiary company in Bahamas which imposes no income tax and sells product to an unrelated UK distributes.

Sales 700Cost -600Profit 100Tax@50% 50Profit after tax 50

Bahamas

Foreign Tax Credit System - I • General Rules Foreign tax credit system generally exists in a country which taxes its

corporation or individual based on nationality. With respect a country which adapt territorial rule, a foreign tax credit is not allowed since foreign income is not taxed in that country

• Type of foreign tax credit

• Direct foreign tax credit - foreign tax on branch/partnership income, foreign withholding tax

• Indirect foreign tax credit - foreign tax on subsidiary income ( USA – 6th tier subsidiary, Japan – 2nd tier subsidiary (since 1992))

• Tax sparing credit – foreign tax credit for a foreign tax not actually paid

• Creditable foreign tax – generally foreign tax assessed on income

Foreign Tax Credit System- II• Foreign tax credit limitation –

– Per country limitation,– Overall limitation, – Type of income limitation (etc. dividend, interest, business income–

• Use of unused foreign tax credit and limitation – • Planning opportunity and managing foreign tax credit • Implication to use of a holding company structure

26

Anti-Avoidance Measures• Tax Avoidance vs. Tax Evasion

– Tax avoidance is the deferral, avoidance or reduction of tax by lawful means, sometimes taking the advantage of loopholes in tax laws or rules.

– Tax evasion is the reduction of tax by illegal means, usually involving fraud and willful neglect,

• Tax avoidance measures adapted by various countries– Taxation of tax haven subsidiary – Controlled foreign corporation (CFC) rules– Anti-treaty shopping rule– Thin capitalization rule– Taxation of unrealized gains on transfers of

property

Tax Treaty - I

• Facilitate and encourage economic, cultural, athletic exchange of two countries• Every county has a network of tax treaties

– Indonesia– 57– Japan – 47– Netherland – 84– Mongolia - 31

• OECD Model or UN Double Taxation Convention • Tax treaty provision override internal tax law • Definition of various terms

Tax Treaty -II

• “Tie-breaker” rule

• Permanent establishment

• Treaty shopping • Gift & estate tax treaty • Totalization/Social Security Agreement

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Recent Development in Tax Treaty

• Treaties have been and are being negotiated to adapt to the changing time. (New Japan-US Tax Treaty signed in 2003. Old treaty was signed in 1972)

• Reduction of withholding tax rates• Exchange of information• Competent authorities procedures – mitigation of

double taxation in transfer pricing cases• Limitation on Benefits article To prevent third country residents from receiving treaty benefits (i.e. treaty shopping)• Elimination of tax sparing credit article

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Treaty Shopping

US SecuritiesGermany

Middle Ease (Saudi Arabia)

Fund Fund

DividendW/H Tax 0%

DividendW/H Tax 0%

W/H Tax 30%

31

Individual Taxation

• USA is one of rare countries taxes its citizens and permanent residents wherever they actually reside

• Almost all countries tax individuals based on their residency.• Taxation of fringe benefits (e.g. housing, home leave,

education, stock option, etc.) varies• Definition of “resident” varies

– Generally 183 days rule but some countries use one year rule

– USA has a unique “substantial presence” rule – Some countries have “permanent resident” and “non-

permanent resident “ classification.• “Permanent Traveler”

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US Substantial Presence RuleNonresident in 2009Days in

Year Year Total2007 120 x 1/6 202008 120 x 1/3 402009 120 x 1/1 120

180

Resident in 20092007 126 x 1/6 212008 129 x 1/3 432009 120 x 1/1 120

184

Takefuji Case

3333

Takefuji Corp.

-Japan-

YST Investment

-Netherland-

Yasuo Takei(Father)-Japan-

Toshiki Takei(Son)-Hong Kong?-

Gift – 720 shares of YST Investment

15.7 millions shares

②

①

④

⑥

③

⑤

800 shares 720 shares

Takefuji

35

Takefuji Case - 1

1. Takefuji Corp. was established by Yasuo Takei and engaged in consumer financing business

2. In December 1997, YST Investment was established by Yasuo Takei in Netherland with 800 shares

3. In 1997, Yasuo Takei’s son, Toshiki Takei, “moved” to Hong Kong to establish his residency there and spent about 65% of the year in Hong Kong.

4. In March 1998, Yasuo Takei made a tax-free transfer of 15.7 millions shares of Takefuji Corp to YST Investment, which represented about 10% of the outstanding shares of Takefuji .

5. In December 1998 Takefuji Corp went public on the Tokyo Stock Exchange.

35Takefuji

36

Takefuji Case - 26. In December 1999, Yasuo Takei gifted to Toshiki Takei 720

shares of YST Investment, which assets were mostly the shares of Takefuji Corp. Takefuji’s stock was traded at 11,850 Yen at that time. 720 shares were valued at 160 billion Yen.

7. Prior to 2000, a gift of non-Japanese assets to a non-resident individual was not subject to Japanese gift tax. Thus, Toshiki Takei did not pay any gift tax. Hong Kong has no gift tax.

8. Japanese tax authorities determined that Toshiki Takei effectively lived in Japan and his “move” to Hong Kong was only to create a situation to avoid paying Japanese gift tax. He was assessed 130 billion Yen including penalties and interest

9. Toshiki Takei is contesting the assessment claiming that he was a nonresident of Japan at the time of gift.

10. In December 2011, the Japanese Supreme Court handed down a decision in favor of Toshiki Takei resulting in a refund of 130 billion yen plus interest of 40 billion yen.

36Takefuji

37

Takefuji Case - 3Japanese tax laws amended in two areas:

• Tax free incorporation

• Gift tax – Japanese inheritance and gift tax rules never contemplated this type of situation (Japanese citizen residing and owning assets outside Japan). There were loopholes. In 2000, the tax laws were amended and if the donor or donee was a resident of Japan within 5 years before the time of gift or death, the donee is subject to Japanese gift tax on all gifts from the donor.

Takefuji

38

Thin Capitalization – Leveraging US OperationsCapitalization Case A Case B

Capital 1,000,000 9,000,000Debt (inter-company loan @10% interest rate) 9,000,000 1,000,000 Total 10,000,000 10,000,000

Taxable InocmeNet Income before interest expense 1,000,000 1,000,000Interest expense 900,000 100,000

100,000 900,000Tax Burden

US subsidiary of Indonesian companyTax @40% 40,000 360,000Withholding tax @10% 90,000 10,000 Total tax cost 130,000 370,000

US subsidiary of French companyTax @40% 40,000 360,000Withholding tax @0% 0 0 Total tax cost 40,000 360,000

US subsidiary of Hong Kong companyTax @40% 40,000 360,000Withholding tax @30% 270,000 30,000 Total tax cost 310,000 390,000

Thin Cap

Thin CapitalizationThin Capitalization

Tax Implication in Home Country - 1lication in Home Country - 1

39

Case A Case B Case A CaseB

Senario I - High home country tax rate Senario I - High home country tax rateNo external funding in home country External funding in home country

Interest Income 900,000 100,000 Interest Income 900,000 100,000Interest expense -900,000 -900,000

Tax @ 50% 450,000 50,000 Ne income 0 -800,000

Tax in USA 130,000 370,000 Tax @ 50% 0 -400,000

Total tax 580,000 420,000 Tax in USA 130,000 370,000

Total tax 130,000 -30,000Interest expense 900,000 900,000Cash out 1,030,000 870,000

Thin Cap

Thin CapitalizationTax Implication in Home Country - 2

40

Senario 2 - Low home country tax rate Senario 2 - Low home country tax rateNo external funding in home country External funding in home country

Case A Case B Case A Case B Interest Income 900,000 100,000 Interest Income 900,000 100,000

Interest expense -900,000 -900,000Tax @ 20% 180,000 20,000 Net income 0 -800,000

Tax in USA 130,000 370,000 Tax @ 20% 0 -160,000

Total tax 310,000 390,000 Tax in USA 130,000 370,000

Total tax 130,000 210,000Interest expense 900,000 900,000Cash out 1,030,000 1,110,000

Thin Cap

41

Transfer Pricing - Update• 80% of global trade is between controlled

group of companies• Tax transfer price vs. custom duty price• APA – many countries are adapting APA

procedure but the success of APA still uncertain.

• Competent authorities to settle transfer pricing cases to avoid double taxation

• Attacking home country corporations Takeda Case• The largest transfer pricing assessment

ever.* GlaxcoSmithKline Case – Team Project

42

Takeda’s Transfer Pricing Case

Takeda Pharmaceutical

Company

(Japan)

Abbott Laboratories

(USA)

TAP (USA)

50%

Sales of Prevacide 50%

Takeda

43

Takeda Case

• TAP is a 50/50 joint-venture established 30 years ago between Takeda Pharmaceutical Company of Japan and Abbott Laboratories of USA. Both are publically held companies and totally unrelated.

• TAP mainly imported and sold Takeda’s products in the USA

• In 2006, Osaka Tax Bureau adjusted the sales price of Prevacid for Yen 122 billion (about $1.2 billion) involving 6 years and assessed an additional tax of Yen 57 billion (about $570 million) claiming Takeda’s transfer price was too low.

• This is the largest transfer pricing assessment in Japan so far.

• Interesting fact was that Abbott sued Takeda claiming Takeda overcharged the price of Prevacid.

Takeda

44

Takeda Case - continued• The case has been referred to the competent

authorities of Japan and USA and it is uncertain how and when the case will resolved.

• The case is unusual since Takeda had no motivation or received any benefit by reducing the transfer pricing to TAP since 50% of the profit belongs to Abbott.

• Technically speaking the Japanese transfer pricing rules apply to an overseas company owned 50% by a Japanese company.

• Tokyo Tax Bureau also made a transfer pricing assessment of Yen 11.7 billion (about $117 million) to Honda with respect to its transactions with Honda’s 50/50 joint venture in China.

Takeda

45

Management of Effective Tax Rate - I

• Statutory Tax Rate vs. Effective Tax Rate**• Impact on financial statement analysis ratios:

ROA (return on assets) , ROE (return on equity), EPS (earnings per share)

• Cash flow management• Permanent differences vs. timing differences -

importance of discounted cash flow• Future tax payment (i.e. tax assessments upon

audit) is considered as a “loan” from government

• Different tax culture – GE & Panasonic comparison*

Management of Effective Tax Rate - II

• 1999 Tax Efficiency Scoreboard (see copy of CFO article)

• 3-year average ETR %• 3-year average Cash Rate (% of PBT)• 3-year average of non-US revenue %

• How to manage effective tax rate

• Advance planning is essential and tax consequences must be reviewed before a transaction is put in place

• Strengthening of internal tax department (Citicorp – 300 vs Mizuho – 5)• Constant monitoring is necessary• Use of outside tax professionals is essential – knowledge of country’s tax laws & rules, tax authorities’ administration & enforcement practice, and tax culture & development• No one major tax saving techniques but accumulation of many tax minimization

techniques.

47

International Tax Arbitrage - 1

For international tax purpose, avoiding double taxation should be the minimum objective of a company. Interaction of different countries’ tax systems can lead to double taxation and also at the same time can provide opportunities to minimize and sometime eliminate tax liability. When two countries classify the same transaction differently, the opportunity for Tax Arbitrage arises

1) Characterization of Income

A, worked, in Country X, for many years, and retired. He receives distribution from Country X. It’s treated as pension in Country X while the US considers such distribution as a payment similar to US social security. If neither country could claims it right to tax this distribution pursuant to tax treaty provision, A will not be taxed in either country.

48

International Tax Arbitrage - 2

2) Dual Non-Resident Corporation

F Corp is incorporated in country X but effectively managed in Country Y. F has business income in Country X but no P/E in country X. Country X uses “place of management” test to determine residence while Country Y uses “place of incorporation” test. F Corp could be treated as a non-resident corporation in both countries and could escape taxation from both countries.

3) Hybrid Entity

An entity can be classified as a corporation in Country X but a pass-through entity (e.g. a partnership) in Country Y.

4) Hybrid Instrument

An instrument can be regarded as equity in Country X whereas it is treated as debt in Country Y. An interest expense on “debt” is deductible in Country Y.

49

International Tax Arbitrage - 35) Double Dip Lease

Guidelines (definition for economic ownership) of treating a lease transaction as an operating (true) lease vs. capital (finance) lease could be different in County X and Country Y. Therefore, a certain lease arrangement can be treated as an operating lease in Country X whereas it is treated as a capital lease in Country Y. This could result in double depreciation (dip) of one leased property.

6) Dual Consolidation Loss Opposite of ２） above. By regarded as a resident

corporation in two countries, a loss of the company will be claimed in two countries at the same time.

Note: Certain countries either by their internal tax law or by tax treaty provisions have restricted the use of some of the above tax arbitrage techniques. However, there are still many countries which have not yet “caught up” with restricting the use of these techniques. Therefore, it may be legal and valid to utilize these types of tax arbitrage techniques.

Residence of Legal Entity (Corporation)

Place of Incorporation Test The place (e.g. country or other jurisdiction) of legal

incorporation determine the residency of a legal entity

Place of Management Test A place of management activities (e.g. location of

headquarters, the place of the board of driectors meeting) determine the residency of a legal entity.

51

Double Dip – R&D CreditsU.S.

• Policy – To encourage R&D activities in the U.S. so that the U.S. R&D environment will be fostered and enriched.

• Do not care who ultimately bear the R&D costs

Japan

• Policy – To encourage Japanese companies pay for the R&D activities and acquire intangibles so that they will be competitive technologically.

• Do not care where the R&D activities are performed.

51

52

Double Dip – R&D Credits

52

Japanese Parent

US Hold Co

US R&D Sub

Japan

US

US R&D Vendor (CRO)

$100 Fees

$100 Reimbursement

Consolidated

Max $100 R&D CreditJapanese Government

Max $100 R&D Credit US Government

53

Hybrid Entity – Check-the-Box Rule

U.S. Check-the-Box Rule allows taxpayers to freely choose whether a business entity should be treated as a corporation or a non-taxable pass-through entity for U.S. tax purposes except for certain specified corporate entities (e.g., US C-Corporations, Japanese KKs).

53

LLC LLC

Corp

Partnership or Corporation

Branch or Corporation

Corp Corp

Hybrid Entity

Corporate Characteristics

1. Continuity of Life2. Central Management3. Limited Liability4. Free Transferability of Ownership

Existence of 3 or more will generally teat an entity to be taxed as a corporation

Check-the Box RulesTreated as a corporation for US tax purposes:

Canada – Corporation and CompanyChina – Gufen Youxian GungsiGreece – Anonymos EtairiaIndonesia – Perseoan TerbukaJapan – Kabushiki KaishaThailand – Borisat Chamkad (Mahachon)

Double Dip Lease• Each country has different rules for classifying long-term leases,

sometime a country (e.g. USA, Japan, etc.) has different rules for accounting and tax purposes.

• In some countries, tax treatment simply follow the legal form.• Under US GAAP, if a lease meets one of the 4 conditions, the lease

must be treated as a capital lease.

1) Ownership of the leased property transfers to the lessee at the end of the lease term2) “Bargain puchase” option exists and transfer of ownership is likely3) The lease term extends at lease 75% of the assets life4) The present value of the minimum contractual lease payments equal or exceeds 90 % of the fair

market value of the assets at the time of the lessee signs the lease.

• Major international accounting firms have lease experts in all major cities around the world.

• Triple dip lease ?

Double Dip Lease

Operating (True) Lease – Country ALegal & economic owner Renter &user of lease propertyTake depreciation Take lease expense

LegalForm

Capital (Finance) Lease – Country BSeller /Financer Purschaser & economic ownerRecognize gain on sales & interest income Take depreciation & interest

expense

LesseeLessor

Hybrid Entity

58

Japanese Parent

US General Partnership

US Operating Sub

Japan

US

Bank$100 Interest

Consolidated

$100 Interest Deduction• Japanese Parent’s Branch for Japanese Tax Purposes

• Corporation for US Tax Purposes

Head office / Branch

$100 Interest Deduction

Nominal Partner

59

Hybrid Instrument – US Repo

Step 1

US Sub Issues preferred stock to US HoldCo.

Step 2

US HoldCo sells preferred stock to the Japanese Parent with forward purchase agreement

Step 3

US Subsidiary pays dividends to the Japanese Parent

Japan

US

Japanese Parent

US HoldCo

US Sub

Japanese Parent

US HoldCo

US Sub

US Sub Preferred Stock

US Sub Preferred Stock

Cash

Japanese Parent

US HoldCo

US Sub

Preferred Dividends

Step 4

US HoldCo buys back preferred stock from the Japanese Parent

Japanese Parent

US HoldCo

US Sub

US Sub Preferred Stock

Cash

59

60

Hybrid Instrument – US Repo

　

Capital Contribution

Japan

Dividends Income 600Exclusion@95% (570)Taxable Income 30Corp. Tax @40% 12

Total Japan Tax 12

USBusiness Income 1,000Income Tax @40%　 400After Tax Income 　 600

Total US Tax 400

Total Tax 412

- 300

　

RepoUSBusiness Income 1,000Interest Expense （ 1,000 ）Taxable Income 　　　　　　　 0Withholding Tax 　 100

Total US Tax 100

Japan

Dividends Income 1,000Exclusion @95% (950)Taxable Income 50Corp. Tax @40% 20

Total Japan Tax 20

+8

Total Tax 120- 292

Inter-Company LoanUS

Business Income 1,000Interest Expense (1,000)Taxable Income 　　　　 0Withholding Tax 　 100

Total US Tax 100Japan

Interest Income 1,000Exclusion 　　 Ｎ /ATaxable Income 1,000Corp. Tax @40% 400 Foreign Tax Credit (100)

Total Japan Tax 300Total Tax 400

+/- 0

- 280

- 280

60

61

Tax Sparing Scheme

Scenario 1Loan $200 Million

FOREIGNFINANCIER

Interest $15 million

COUNTRY XCOMPANY

Sparing

62

Tax Sparing Scheme

Scenario 2Loan from Foreign Financier to Country X Company, but loan is channeled through a New Zealand company

Loan$200 Million

Loan$200 Million

FOREIGNFINANCIER

Interest$15 million

COUNTRY XCOMPANY

NEW ZEALANDCOMPANY

Interest$15 million

Sparing

63

Tax Sparing Scheme

Loan$200 Million

Scenario 3Similar to scenario two, except two New Zealand companies are used – one to soak up the tax sparing credits and the other to accumulate tax losses

Interest$4.545 million

FOREIGNFINANCIER

Interest$10.455 million

Interest$15 million

COUNTRY XCOMPANY

NEW ZEALANDCOMPANY No.1

NEW ZEALANDCOMPANY No.2

Loan$139.4 million Equity capital

$60.6 Million

Loan$60.6 Million

Sparing

6464

Tax Sparing SchemeCountry X Company pays $15 million interest to NZ Co 2. NZ Co 2 is taxed in New Zealand as follows:

Interest incomeInterest expensesNew profit

Tax on net profit(33%)Tax sparing credits(10% x $15 million)

Tax to pay

15,000,000(10,454,545) 4,545,455

1,500,000 (1,500,000)

Nil_____

Sparing

Double Irish with a Dutch Sandwich

• Many US hi-tech companies (Apple, Starbucks, Google, Microsoft, HP, and others) are known to have used this techniques to shift profits to a low or no tax jurisdictions.

• It involve sending profits first via first Irish company, then to a Dutch company and finally to a second Irish company headquartered in a tax haven

• Search “Double Irish with a Dutch Sandwich” via Google and other search sites. Many articles and videos

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E-commerce Taxation OECD Definition

E-commerce is a commercial transaction, involving both organizations and individuals, that are based upon the processing and transmission of digitized data, including text, sound and visuals images and that are carried out over open networks (like, the Internet) or closed networks (like, AOL or Yahoo) that have gateway onto an open network

OECD Guideline:

1. Neutrality- Same as conventional trading

2. Efficiency- Minimum and reasonable cost

3. Certainty and Simplicity- Clear and understandable rules

4. Effectiveness and Fairness- Right amount of tax

5. Flexibility- Technological, commercial development of e-commerce

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Recent Trend & Development - I• Reduction of corporate tax rate & increase of VAT

tax rate• Introduction of transfer pricing rules and

documentation requirements*• Scrutiny of tax haven countries*

– OECD Report on Harmful Tax Competition: An Emerging Global Issue in 1999

– Tax Information Exchange Agreement (TIEA) –a transparency &

exchange of information for tax matters– “Gray List” of tax havens – 12 TIEA to be off the list.

• Increase of international tax examiners in most countries

• Joint audit – US & UK, US & Canada

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Recent Trend & Development - 2

• Joint International Tax Shelter Information Center (JITSIC) in Washington D.C. and London formed by Australia, Canada, USA, UK, and Japan

• Tax shelter regulations in the USA• Impact of FIN 48- uncertain tax

positions• E-commerce taxation

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Tax Shelter Legislation in the USA - 1• In post-Enron, US introduced in 2004

regulations to strengthen penalties for corporate tax shelter activity.

• General definition –any method that recovers more than $1 in tax for every $1 spent within 4 years

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Tax Shelter Legislation in the USA - 2

• The following transactions are required to be disclosed on a taxpayer’s tax return– Listed transactions by IRS– Confidential transactions– Transactions with contractual protections– Transactions generating tax losses exceeding

certain stated amounts ($10 million in a single year and $20 million in multi years).

– Transactions resulting in a “significant” ($10 million) book-tax difference

– Transaction generating a tax credit in excess of $250,000 if the underlying assets is held less than 45 days.

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Tax Shelter Legislation in the USA - 3

• Every “organizer and seller” (e.g. accounting firm, law firm, investment banker*, etc.) of potentially abusive tax shelter is required to maintain a list of any transactions that are reportable transactions.

• Reliance on common law doctrines to recharacterize transactions that may escape statutory or regulatory provisions– Sham transaction– Economic substance– Business purpose– Step transaction– Form over substance

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FIN 48 Uncertain Tax Positions - 1

• In 2006, Financial Accounting Standards Board (FASB) introduced Financial Interpretation Number 48 (FIN 48), a new interpretation of FASB Statement 109 – Accounting for Taxes

• FIN 48 requires a review of a company’s tax positions taken on all its tax returns. If a position is uncertain, a related liability must be recorded for the potential tax plus interest and penalty.– Public companies – 2007– Private companies – 2008

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FIN 48 Uncertain Tax Positions - 3• FIN 48 must be applied to all entities that

are included in consolidated financial statements of a company, domestic and foreign.

• For the tax positions that do not meet the MLTN threshold, companies must record the tax liabilities

• IRS Commissioner announced a proposal to require large businesses taxpayers to disclose their uncertain tax positions and related amounts on their tax returns – Road Map for IRS audit

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FIN 48 Uncertain Tax Positions - 2• FIN 48 requires companies to

evaluate their tax positions under two-step process:– First, it is necessary to determine

whether the tax position is “more likely than not” (MLTN) to be sustained by a taxing authority or court based on technical merits

– If the MLTN threshold (generally referred as 50% test) is met, the second step requires to measure the benefit

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Future Considerations

• For some of the tax authorities’ (e.g. Japan) prospective, the key issue is how to prevent the erosion of taxation basis

• Laws and rules that meet the objective of fairness and efficiency are sought by multinational companies.

• Expansion of tax treaty provisions to meet the changing time – global business and internet

• Clarification and uniformity of source rules• International cooperation? Governments have been reluctant

in this regard as they do not want to lose sovereignty over their tax policy. If there is no merit to a country, how can we expect to be cooperative.

• Tax authorities must know the behavior and motivation of taxpayers so that they can collect tax revenue in cost effective ways.

US Common Law Doctrines

– Sham transaction– Economic substance– Business purpose– Step transaction– Form over substance Show economic factors, aside from tax factors, that

made the transaction worthwhile.Potential to make money from the transaction

What You Should Have Learned From This Course

• You just touched the surface of International Taxation• Understand risks and opportunities in International

Taxation• Every country is different in tax laws, tax enforcement,

tax administration and tax culture• Tax laws change constantly• Learn to use outside tax professionals effectively• Plan ahead as it is too late to do anything a transaction

is consummated