Expansion of Non-Willful Standard for Relief From Non-Filing of Gain Recognition Agreement Reduces Compliance Burdens

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BACKGROUND

Outbound transfers (as defined) of stock or assets, as well as reorganization transactions that involve a foreign party to the reorganization, are subject to Code §367 and the regulations thereunder. Code §367(a) deals with outbound transfers of stock or assets and attempts to prevent the removal of appreciated property from U.S. taxing jurisdiction before its sale or other disposition. Code §367(b) applies to certain inbound and foreign-to-foreign reorganization transactions and is aimed at preserving the ability of the United States to tax, either currently or at a future date, the accumulated earnings and profits of a foreign corporation attributable to the stock of that corporation held by U.S. shareholders.

In the case of an outbound transfer of assets consisting of tangible property for use by the transferee, a foreign corporation in the active conduct of a trade or business outside of the United States, no gain under §367(a)(1) is triggered. Otherwise, gain under Code §367(a) equal to the fair market value in excess of tax basis is triggered. Code §367(a)(2) and Treas. Reg. §1.367(a)-3, in pertinent part, provide for exceptions to the general Code §367(a) gain recognition for outbound transfers of stock or securities. These sections provide for non-recognition of gain where appropriate, upon entering into a gain recognition agreement (a “G.R.A.”).

Under a G.R.A., gain recognition under §367(a) generally can be avoided on the condition that a G.R.A. is entered into by any U.S. transferor who owns at least 5% of the transferee foreign corporation immediately after transfer. The 5% threshold for requiring a G.R.A. is determined based on the greater of vote or value, taking into consideration attribution rules. A U.S. shareholder who does not own 5% or more of the stock does not have to sign a G.R.A. in order to claim non-recognition treatment for their exchange of stock for stock. The foreign parent corporation that issues stock or securities to these U.S. transferors is treated as the transferee foreign corporation for purposes of applying the G.R.A. provisions.

Insights Vol. 1 No. 10: Updates & Other Tidbits

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ISRAEL ANNOUNCES ADOPTION OF O.E.C.D.’S COMMON REPORTING STANDARD

Israel has announced that it will adopt the Standard for Automatic Exchange of Financial Account Information: Common Reporting Standard (“C.R.S.”) issued by the O.E.C.D. in February 2013.

The C.R.S. establishes a standardized form that banks and other financial institutions would be required to use in gathering account and transaction information for submission to domestic tax authorities. The information would be provided to domestic authorities on an annual basis for automatic exchange with other participating jurisdictions. The C.R.S. will focus on accounts and transactions of residents of a specific country, regardless of nationality. The C.R.S. also contains the due diligence and reporting procedures to be followed by financial institutions based on a Model 1 F.A.T.C.A. intergovernmental agreement (“I.G.A.”).

At the conclusion of the October 28-29 O.E.C.D. Forum on Transparency and Exchange of Information for Tax Purposes, about 50 jurisdictions had signed the document. The U.S. was notably absent as a signatory to the agreement. In addition to the C.R.S., the signed agreement contains a model competent authority agreement for jurisdictions that would like to participate at a later stage.

Action Item 8: Changes to the Transfer Pricing Rules in Relation to Intangibles - Phase I

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INTRODUCTION

Unlike some of the other B.E.P.S Action Items, Action Item 8 has a basis in existing O.E.C.D. rules. In this regard, the O.E.C.D. Transfer Pricing Guidelines41 have established the operating rules for transfer pricing. It is understandable that Action Item 8 merely presents a series of amendments to Chapters I, II, and VI of the O.E.C.D. Guidelines.

Action Item 8 states that it seeks to:

• Clarify the definition of I.P.,
• Provide guidance on identifying transactions involving I.P., and
• Provide supplemental guidance for determining arm’s length conditions for transactions involving I.P.

Action Item 8 also considers the treatment of local market features and corporate synergies.

Insights Vol. 1 No. 8: Updates & Other Tidbits

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U.K. WINDFALL WINDING DOWN

After an arduous path through the courts regarding the creditability of the U.K. windfall tax, the Third Circuit followed the holding of the U.S. Supreme Court and found the tax to be creditable in a case involve PPL Corp.

The U.S. and foreign countries can tax foreign-sourced income of U.S. taxpayers. To lessen the economic cost of double taxation, U.S. taxpayers are allowed to deduct or credit foreign taxes in computing income or net tax due. The amount of the U.S. income tax that can be offset by a credit cannot exceed the proportion attributable to net foreign source income. Code §901(b) specifies that a foreign credit is allowed only if the nature of the foreign tax is similar to the U.S. income tax and is imposed on net gain.

The U.S. entity PPL is a global energy company producing, selling, and delivering electricity through its subsidiaries. South Western Electricity PLC (“SWEB”), a U.K. private limited company, was an indirect subsidiary that was liable for windfall tax in the U.K. Windfall tax is a 23% tax on the gain from a company’s public offering value when the company was previously owned by the U.K. government. When SWEB paid its windfall liability, PPL claimed a Code §901 foreign tax credit. This was denied by the I.R.S. and the long and winding litigation commenced.

Initially, the Tax Court found the windfall tax to be of the same character as the U.S. income tax. The decision was reversed by the Third Circuit Court of Appeals, which held that the tax was neither an income tax, nor a war profits tax, nor an excess profits tax. It took into consideration in determining the tax base an amount greater than gross receipts. Then, the Supreme Court reversed, finding that the predominant character of the windfall tax is an excess profits tax based on net income. Therefore, it was creditable. In August, the Third Circuit followed the Supreme Court’s decision and ordered that the original decision in the Tax Court should be affirmed.

Current Tax Court Litigation Illustrates Intangible Property Transfer Pricing and Valuation Issues

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MOVING INTANGIBLE PPROPERTY ASSETS OVERSEAS PRESENTS BOTH BUSINESS AND TAX ISSUES

The movement of intangible property (“I.P.”) offshore by U.S. multinational corporations has always been subject to high levels of I.R.S. scrutiny. This remains true in the current tax environment. It is a given that U.S. multinational companies are subject to a high level of U.S. corporate income tax at federal and state levels and their non-U.S. business operations are typically subject to lower tax rates abroad. As a result, U.S. multinationals can lower their global tax expense by transferring I.P. to an offshore subsidiary company (“I.P. Company”), when it is appropriate and consistent with the conduct of their international business operations.

In a typical arrangement within a group, the I.P. Company licenses the use of the I.P. to other members. Royalties paid by the other group members (including the U.S. parent, if total ownership of the I.P. is assumed by the I.P. Company) is claimed as a deduction in the tax jurisdictions of each member that is a licensee. If an I.P. Box Company arrangement is in place or a special ruling obtained, the royalties received by the I.P. Company will be subject to a low tax rate. Assuming that arrangements are in place to remove the royalty income from the category of Foreign Personal Holding Company Income for purposes of Subpart F, the net result is reduced tax for book and tax purposes. This yields greater profits for the multinational group and increased value for its shareholders.

Two cases that are currently in litigation illustrate the I.R.S. scrutiny given to transfers of I.P. to an I.P. Company and the resulting U.S. tax issues that are encountered. The cases involve Zimmer Holdings and Medtronic.

Corporate Inversions Transactions: Tax Planning as Treason or a Case for Reform?

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INTRODUCTION

Anyone may soarrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury. There is not even a patriotic duty to increase one’s taxes.

– Judge Learned Hand
Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934).

To invert or not to invert: That seems to be the question many U.S. corporations are deliberating today, particularly in the context of acquisitions of non-U.S. businesses. Although the level of the political and public outcry on the “evils” of inversion transactions is a recent phenomenon, inversion transactions are not new to the U.S. business community. This article provides a perspective on the issue of U.S. companies incorporating in other jurisdictions by means of inversion transactions. It will discuss the historical context, the legislative and regulatory responses, and current events including proposed legislative developments as of the date of publication. Finally, we will offer our suggestions for a reasonable approach to the inversion issue designed to balance the governmental and the private sector concerns.

INVERSIONS: DEFINITION AND HISTORY

What is an Inversion?

An inversion transaction is a tax-motivated corporate restructuring of a U.S.-based multinational corporation or partnership in which the U.S. parent corporation or U.S. partnership is replaced by a foreign corporation, partnership, or other entity, thereby converting the U.S. entity into a foreign-based entity. In a “self-inversion,” the U.S. entity effects an internal reorganization by re-domiciling in another jurisdiction. In an “acquisition-inversion,” a U.S. entity migrates to a foreign jurisdiction in connection with the purchase of a foreign-incorporated M&A target corporation. In this latter type of inversion, the target and the U.S. entity often can be combined under a new holding company in a lower-tax foreign jurisdiction.

Insights Vol. 1 No. 7: Updates & Other Tidbits

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KENNETH WOOD NAMED ACTING DIRECTOR OF I.R.S. TRANSFER PRICING OPERATIONS

On July 24, the I.R.S. selected Kenneth Wood, senior manager in the Advance Pricing and Mutual Agreement Program, to replace Samuel Maruca as acting director of Transfer Pricing Operations. The appointment took effect on August 3, 2014. We previously discussed I.R.S. departures, including those in the Transfer Pricing Operations, here.

To re-iterate, it is unclear what the previous departures signify—whether the Large Business & International Division is being re-organized, or whether there are more fundamental disagreements on how the Base Erosion and Profit Shifting (“B.E.P.S.”) initiative affects basic tenets of international tax law as defined by the I.R.S. and Treasury. Although there is still uncertainty about the latter issue, Ken Wood’s appointment seems to signify that the Transfer Pricing Operations’ function will remain intact in some way.

CORPORATE INVERSIONS CONTINUE TO TRIGGER CONTROVERSY: PART I

President Obama echoed many of the comments coming from the U.S. Congress when he recently denounced corporate inversion transactions in remarks made during an address at a Los Angeles technical college. As we know, inversions are attractive for U.S. multinationals because as a result of inverting, non-U.S. profits are not subject to U.S. Subpart F taxation. Rather, they are subject only to the foreign jurisdiction’s tax, which, these days, is usually lower than the U.S. tax. In addition, inversions position the multinational group to loan into the U.S. from the (now) foreign parent. Subject to some U.S. tax law restrictions, interest paid by the (now) U.S. subsidiary group is deductible for U.S. tax purposes with the (now) foreign parent booking interest at its home country’s lower tax rate.

“Inverted companies” have been severely criticized by the media and politicians as tax cheats that use cross-border mergers to escape U.S. taxes while still benefiting economically from their U.S. business presence. This has been seen as nothing more than an unfair increase of the tax burden of middle-income families.

U.S.-Based Pushback on B.E.P.S.

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INTRODUCTION

In addition to the aggressive actions by some foreign countries to levy more taxes on U.S. taxpayers before a consensus has been reached, the process established by the O.E.C.D. raises serious questions about the ability of the United States to fully participate in the negotiations.

Ultimately, we believe that the best way for the United States to address the potential problem of B.E.P.S. is to enact comprehensive tax reforms that lower the corporate rate to a more internationally competitive level and modernize the badly outdated and uncompetitive U.S. international tax structure.

So say Representative Dave Camp (R) and Senator Orrin Hatch (R), two leading Republican voices in Congress, on the O.E.C.D.’s B.E.P.S. project.

Does this somewhat direct expression of skepticism represent nothing more than U.S. political party politicking or a unified U.S. government position that in fact might be one supported by U.S. multinational corporations? The thought of the two political parties, the Administration and U.S. industry agreeing on a major political/economic issue presents an interesting, if unlikely, scenario. This article will explore that scenario.

OVERVIEW OF B.E.P.S./WHY B.E.P.S.?/WHY NOW?

Base erosion and profit shifting (“B.E.P.S.”) refers to tax planning strategies that exploit gaps and mismatches in tax rules in order to make profits “disappear” for tax purposes or to shift profits to locations where there is little or no real activity and the taxes are low. This results in little or no overall corporate tax being paid.

Insights Vol. 1 No. 6: Updates & Other Tidbits

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THINK TWICE BEFORE EVADING TAXES (PART II) FOLLOW UP TO CREDIT SUISSE GUILTY PLEA

As we noted last month, Credit Suisse AG pleaded guilty to conspiracy to aid and assist U.S. taxpayers with filing false income tax returns and other documents with the I.R.S. Following Credit Suisse’s guilty plea to helping American clients evade taxes, New York State’s financial regulator is said to have picked Mr. Neil Barofsky as the corporate monitor for Credit Suisse Group AG. Monitors are chosen to act as the government’s post-settlement proxy, shining a light on the inner workings of corporations and suggesting steps to bolster compliance procedures.

Credit Suisse agreed to two years of oversight by New York’s financial regulator as part of its $2.6 billion resolution with the U.S. Credit Suisse’s settlement is the first guilty plea by a global bank in more than a decade, and the penalty agreed to is the largest penalty in an offshore tax case.

Insights Vol. 1 No. 5: Updates & Other Tidbits

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SUPPORT FOR PROPOSED BILLS LIMITING CORPORATE INVERSIONS WEAK GIVEN DESIRE FOR FULL INTERNATIONAL TAX OVERHAUL

The Stop Corporate Inversions Act was introduced in the Senate on May 20 by Senator Carl Levin. The bill represents an attempt to tighten U.S. tax rules preventing so-called “inversion” transactions, defined generally as those involving mergers with an offshore counterpart. Under current law, a U.S. company can move its headquarters abroad (even though management and operations remain in the U.S.) and take advantage of lower taxes, as long as at least 20% of its shares are held by the foreign company's shareholders after the merger. Under the bill, the foreign stock ownership for a non-taxable entity would increase to 50% foreignowned stock. Furthermore, the new corporation would continue to be considered a domestic company for U.S. tax purposes if the management and control remains in the U.S. and at least 25% of its employees, sales, or assets are located in the U.S. The Senate bill would apply to inversions for a two year period commencing on May 8, 2014. A companion bill (H.R. 4679) was introduced in the House which would make the changes permanent. However, the bills face opposition on the Hill with lawmakers indicating that the issue could be better solved as part of a broader tax overhaul. House Republicans favored pushing corporate tax rates lower as opposed to tightening inversion requirements, believing that the lower rates would give corporations an incentive to stay in the U.S. and invest, rather than go overseas for a better corporate tax rate. Senate Finance Committee Chairman Ron Wyden (D-Ore.) stated that he would consider the issue at a later time during a hearing on overhauling the international tax laws but would not introduce anti-inversion legislation nor would he sign onto the Levin bill. We agree that any changes to the inversion rules should not be made in isolation but as part of an overall rationalization of the U.S. international tax system.

Proposed Partnership Regulations Will Affect Partnership Deal Economics

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INTRODUCTION

In 2014-8 I.R.B., the I.R.S. proposed amendments to regulations issued under Code §707 relating to disguised sales of property to or by a partnership and under Code §752 regarding the treatment of partnership liabilities. The proposed regulations address certain deficiencies and technical ambiguities in the existing regulations and certain issues in determining partners’ shares of liabilities under Code §752. The proposals are designed to limit taxpayers’ ability to structure a sale of a partnership interest as a contribution of property by one partner and the receipt of a distribution by a second partner in a way that is not taxable in the year of the transaction. For a foreign investor, the proposed regulation regarding the interplay of partnership liabilities and investor basis in the partnership add another unwelcome level of complexity that must be accounted for in tax planning for an investment. The reason is that a partner’s ability to deduct losses of a partnership or L.L.C. is capped at the basis maintained in the partnership interest held. Partners have basis for liabilities of the partnership. The issue is the allocation of losses among the partners or members. The proposed regulations limit ways to increase basis through planning mechanisms that have been accepted for a long period of time.

PARTNERSHIP BASICS AND RELATED ISSUES

Background

A partnership is said to be created when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession, or business and when there is community of interest in the profits and losses.

Transfer Pricing - Bankruptcy Court Prevents I.R.S. from Pursuing Unsupported Transfer Pricing Claims; In Re: DeCoro USA, Limited, Debtor (2014 U.S.T.C. PAR 50,227)

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INTRODUCTION

A recent decision by the U.S. Bankruptcy Court, Middle District North Carolina (the “Court”) provides interesting guidance on the practical application of U.S. transfer pricing rules. While one would not normally expect significant transfer pricing insight from a bankruptcy court, an I.R.S. claim for tax due caused the Court to apply U.S. tax transfer pricing rules in a surprisingly clear, concise and practical manner in order to determine the validity of the claim. In holding the claim invalid, the Court provided valuable guidance to taxpayers and the I.R.S. alike, finding that assertions of underpayment of tax in connection with the pricing of a controlled transaction must be based on the facts presented, rather than those imagined by the I.R.S.

BACKGROUND FACTS

The DeCoro Group was founded in 1997 by an Italian businessman whose goal was to produce high quality Italian leather furniture at affordable prices on a worldwide basis. In order to accomplish this, a Chinese manufacturing plant was purchased then expanded. Business management of the DeCoro Group was carried out by DeCoro Limited (“DCL”), a Hong Kong company. Strategic customer relationships with furniture retailers around the world were developed and maintained by DCL. Through a Chinese manufacturing facility, DCL was engaged in the manufacture and sale of high end leather furniture.

Year-End Review: Net Investment Income Tax

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The Net Investment Income Tax (“N.I.I.T.”) was added to the Code on March 30, 2010. It is imposed at a rate of 3.8% of certain net investment income (“Net Investment Income”) of individuals, estates and trusts having income above specified triggering amounts. For individuals who are calendar year taxpayers, the tax first became effective in 2013. Thus, the current tax return filing season will be the first time taxpayers feel the effect of the tax. In late 2013, the I.R.S. released final and proposed regulations for the N.I.I.T. These regulations clarify proposals that were issued on December 5, 2012. This article provides a summary of the N.I.I.T. and explains how the new regulations will affect taxpayers.

IN GENERAL

Applicable Thresholds

Individuals will owe the tax if they have Net Investment Income and also have modified adjusted gross income over the following thresholds:

Filing Status	Threshold Amount
Married Taxpayers (Joint Filing)	$250,000
Married Taxpayers (Separate Filing)	$125,000
Single	$200,000
Head of household (with qualifying person)	$200,000
Qualifying widow(er) with dependent child	$250,000

These amounts are not indexed for inflation.