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When Baskets Go Beyond Weaving – Understanding Foreign Tax Credit Baskets Under the Look-Through Rules

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When Baskets Go Beyond Weaving – Understanding Foreign Tax Credit Baskets Under the Look-Through Rules

While the word “basket” may trigger a mental image of a bicycle with a daisy basket that is a gift in early childhood, the term has a totally different connotation in the tax world. It denotes “foreign tax credit baskets” to an international tax geek in the U.S. The foreign tax credit provisions are among the most complicated areas of U.S. and become further complicated when a “U.S. Shareholder” of a Controlled Foreign Corporation includes income in one year but receives distributions in another. In their article, Neha Rastogi and Stanley C. Ruchelman explore the labyrinth of the foreign tax credit provisions that are designed to ensure that (i) income and (ii) related foreign taxes are reported in the same foreign tax credit basket. The takeaway is that, if the exercise is not computed properly, double taxation of income is sure to arise.

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The Aftermath of YA Global: Who is a Partner?

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The Aftermath of YA Global: Who is a Partner?

The YA Global case has drawn widespread attention due to the U.S. tax implications for foreign investment partnerships investing in U.S. securities or making use of a U.S. investment manager. The I.R.S. prevailed in the U.S. Tax Court, and the foreign investment partnership was found to have been engaged in the conduct of a U.S. trade or business in the facts presented. The Tax Court has now released a follow-up memorandum opinion that addresses the following question: what standard should be applied when determining whether a foreign recipient of an income payment from a partnership should be recognized as a partner for income tax purposes and subject to Section 1446 withholding tax? At stake is the U.S. withholding tax imposed on partnerships with foreign partners and U.S. effectively connected income. Wooyoung Lee and Stanley C. Ruchelman address the issue. Sometimes, financial engineers develop a plan that works well when stress tested in the office, but is far too complicated for the I.R.S. and Tax Court judges.

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French Life Insurance “101” – For U.S. Persons, Run Away

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French Life Insurance “101” – For U.S. Persons, Run Away

An individual takes out life insurance in order to provide for his heirs and to obtain peace of mind. Tax treatment for the individual during life and the heirs is straightforward when everyone resides in one country. But when a life insurance policy is written in France and the insured or the heirs are U.S. citizens or residents, what the policy holder, his estate, or the beneficiaries may encounter is anything but peace of mind. To their chagrin, each may find that he or she is in the crosshairs of contrary laws in two countries resulting in sub-optimal tax results. In their article, Sophie Borenstein, of attorneys Klein Wenner in Paris, Neha Rastogi, and Stanley C. Ruchelman discusses the French and U.S. tax rules applicable to a French life insurance policy. Grown men have cried over less complicated matters.

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Information Reporting on Foreign Trusts and Gifts – New Regulations

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Information Reporting on Foreign Trusts and Gifts – New Regulations

On May 8th, the Treasury Department and the I.R.S. proposed regulations regarding information reporting in the context of U.S. persons, foreign trusts, and gifts from non-U.S. persons. When adopted in final form, they will affect (i) U.S. persons who engage in transactions with, or are treated as the owners of, foreign trusts and (ii) U.S. persons who receive large gifts or bequests from foreign persons. The scope of the proposed regulations is broad, and many existing regulations are affected. Wooyoung Lee and Stanley C. Ruchelman take a deep dive addressing specific regulatory provisions that are affected. Many “open doors” that currently exist have been closed. The authors tell all, linking explanations in the preamble to the proposed regulations with specific regulations in the proposal.

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Will Service Automation Companies Qualify for the Q.S.B.S. Exemption?

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Will Service Automation Companies Qualify for the Q.S.B.S. Exemption?

Many U.S. investors and business owners are familiar with the tax exemption provided to U.S. individuals recognizing gains from the sale of certain U.S. stock, defined as qualified small business stock (“Q.S.B.S.”). The Q.S.B.S. exemption plays an important role in the growth of hi-tech industry, which is dependent on investments by U.S. persons. It typically benefits U.S. individuals who invest in start-up software companies. However, the Q.S.B.S. exemption is not available for investment gains related to corporations engaged in the provision of nonqualified services, such as health care, brokerage, law, engineering, architecture, and accounting. However, a business that develops software that is used in those may qualify in certain circumstances, but not qualify in others. The key is whether the software is a tool for a person performing the nonqualified business or the software supplants the individual in performing the business. In this article, Stanley C. Ruchelman addresses two I.R.S. rulings illustrating the facts that distinguish a computer program that is a tool for service providers from facts that cause a program to be treated as a robot service provider.

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Unravelling of the Matryoshka Doll – Impact of the C.T.A. on entities having nexus to the U.S.

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Unravelling of the Matryoshka Doll – Impact of the C.T.A. on entities having nexus to the U.S.

Aimed at curbing money laundering, terrorism financing, and other nefarious activity, Congress enacted the Corporate Transparency Act (“C.T.A.”) on January 1, 2021. However, the C.T.A. became fully effective from January 1, 2024. It now requires certain domestic and foreign entities to disclose to the Financial Crimes Enforcement Network (“FinCEN”), a division of the U.S. Treasury Department, the identity of their beneficial owners and control persons. A failure to do so can attract heavy penalties. The targets of the C.T.A. are much like Matryoshka dolls, having many layers between what appears on the surface and what exists at the heart. Neha Rastogi and Stanley C. Ruchelman guide the reader through the in’s and out’s of what is likely the most invasive legislation enacted by Congress.

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Receipt of a Profits Interest in a Partnership by a Service Provider – Not Taxable

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Receipt of a Profits Interest in a Partnership by a Service Provider – Not Taxable

In E.S. N.P.A. Holding L.L.C. v. Commr., the U.S. Tax Court decided that the indirect receipt of a profits interest in a partnership in exchange for services was not a taxable event for the recipient. The decision was largely an application of Revenue Procedure 93-27, in which the I.R.S. provided guidance on the tax treatment of an individual who directly provides services to a partnership in exchange for the receipt of a profits interest. However, it is not a run-of-the-mill fact pattern that involves the grant of a profits interest to an individual in the financial services sector. Rather, it is about how an individual running a business through a taxable C-corporation was able to (i) arrange a sale of 70% of the C-corporation’s business to new investors bringing in fresh capital and (ii) by choosing a proper structure open a pathway to receive future profits without channeling income through the C-corporation. Wooyoung Lee, Nina Krauthamer, and Stanley C. Ruchelman explain the applicable I.R.S. regulations defining a “profits interest,” an important 8th Cir. Case reversing a decision of the U.S. Tax Court, the Revenue Procedure, and finally E.S. N.P.A. Holding v. Commr.

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Moore v. U.S. – A Case for the Ages to be Decided by Supreme Court

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Moore v. U.S. – A Case for the Ages to be Decided by Supreme Court

Moore v. U.S. is a case that asks the following question: does the U.S. Constitution impose any limitations on Congress to impose tax where no Subpart F income is realized during the year by a C.F.C. and no dividends have been paid to shareholders? It does so in the context of the change in U.S. tax law provisions designed to avoid double taxation of income in a cross border context. Prior to 2018, U.S. law eliminated double taxation on direct investment income of a U.S. corporation by allowing an indirect foreign tax credit for income taxes paid by a ≥10%-owned foreign corporation. In 2018, the U.S. scrapped that method and adopted a D.R.D. for dividends paid to a U.S. corporation by a ≥10%-owned foreign corporation. To ensure that accumulated profits in the foreign corporation at the time of transition would be taxed under the old system, the transition tax required a one-time increase in Subpart F income attributable to the deferred foreign earnings of certain U.S. shareholders. However, the tax was imposed in certain circumstances on individuals who never were entitled to claim an indirect foreign tax credit under the old law and were not eligible to claim the benefit of the D.R.D. Mr. and Mrs. Moore were two such individuals. They paid the transition tax, filed a claim for refund, and brought suit in the U.S. Federal District Court to recover the tax paid. They lost in the district court and again on appeal. A writ of certiorari was filed with the U.S. Supreme Court and the case was accepted for consideration. Most pundits believe the Moores have no chance of winning. Stanley C. Ruchelman and Wooyoung Lee evaluate their chances, pointing out that the last chapter of the saga has not yet been written. 

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Did You Just Manifest the Opposite of What You Wanted - (IN)Ability to Use G.I.L.T.I. Losses to Offset Gain

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Forward-looking tax planning for U.S. taxpayers and their foreign subsidiaries was never an easy task. Since the adoption of the G.I.L.T.I. regime, domestic tax plans must be adjusted when applied to a cross border scenario. In their article, Stanley C. Ruchelman and Neha Rastogi examine a straightforward merger of related corporations, each operating at a loss, followed by a significant gain from the sale of an operating asset. What is a statutory merger when two companies are based outside the U.S.? What information must be reported on a U.S. Shareholder’s U.S. income tax return? What forms are used to report the information? Do the G.I.L.T.I. rules make operating losses of a C.F.C. useless to a U.S. Shareholder when a C.F.C. sells operating assets at a sizable gain? These and other issues are explored by the authors.

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Is it Safe to Use a S.A.F.E.?

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Is it Safe to Use a S.A.F.E.?

In 2013 a new investment scheme was introduced to the world. A Simple Agreement for Future Equity (“S.A.F.E.”) allows a company to receive funds in exchange for an obligation to issue shares in the future at favorable conversion rates for an investor at the happening of a fundraising round, a liquidity event, or an I.P.O. The S.A.F.E. is popular among start-up tech companies because of its simplicity. However, it does not properly fit into any of the usual categories of investment vehicles, such as debt or equity, and there is much ambiguity as to the proper characterization of a S.A.F.E. for U.S. tax purposes. Stanley C. Ruchelman and Daniela Shani take a deep dive into the tax issues that surround the character of a S.A.F.E. Should it be treated as debt, equity, a warrant, a prepaid variable forward contract? None of the above? While the I.R.S. was asked by the A.I.C.P.A. to provide guidance on the character of a S.A.F.E. arrangement, the I.R.S. declined to include the matter in its 2023-2024 list of regulatory priorities.

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Too Bad To Be True – Code §§267A and 894(c) Signal the End for Cross Border Hybrids

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Too Bad To Be True – Code §§267A and 894(c) Signal the End for Cross Border Hybrids

If you are a tax professional, you know your client is in a pickle if a provision under U.S. tax law disallows a deduction for the payor of an expense and another provision subjects the corresponding income of a foreign counterparty to U.S. tax, notwithstanding its residence in a treaty partner jurisdiction. That is the predicament that is faced when Code §§267A and 894(c) apply to outbound payments of deductible items to hybrid entities. In their article, Stanley C. Ruchelman and Neha Rastogi explain the death knell of what had been a common planning technique for U.S. tax advisers. They point out that, in certain circumstances involving payments to a reverse hybrid entity, relief might be provided by resort to competent authority proceedings.

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Farhy v. Commr. – The Penalty for Failing to Timely File Form 5471 May Not Be Assessed Administratively

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Farhy v. Commr. – The Penalty for Failing to Timely File Form 5471 May Not Be Assessed Administratively

Sometimes, good things happen to the undeserving. In the play “Pygmalion,” Alfred Doolittle – the undeserving father of Eliza Doolittle – receives a bequest from a faraway benefactor. In Farhy v. Commr., a scofflaw who refused to file Form 5471 for several Belize companies and received penalty notices regarding the seizure of his property convinced the Tax Court that the penalty was not self-enforcing. Rather, the Department of Justice would be required to initiate enforcement proceedings in District Court to collect the assessed penalties. Stanley C. Ruchelman and Wooyoung Lee explain the reasoning of the decision and then ask which other penalties have similar requirements. In answer, they survey client alerts published on the internet by various firms. Surprisingly, the answers are not consistent.

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New Tax Relief on Repatriation of Intangible Property

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New Tax Relief on Repatriation of Intangible Property

Code §367(d) provides rules for intercompany transfers of intangible property to related parties abroad. Not only are they taxable when first made, but they may continue to give rise to taxable income for the transferor for extended periods of time, notwithstanding a fixed price that is arm’s length at the time of the original transfer. Recently, U.S. companies have considered repatriating intangible property previously transferred abroad, in light of favorable provisions under the F.D.D.I. regime, the inability to defer tax under the C.F.C. rules, both Subpart F and G.I.L.T.I., and the prospect of Pillar 2’s adoption. However, the rules that applied to repatriation of intangible property left issues unanswered. In early May, the I.R.S. published proposed regulations affecting transactions in which U.S. corporations bring intangible property back to the U.S. In their article, Stanley C. Ruchelman and Daniela Shani review the legislative background of the proposed regulations and address the key principles involved before the toll charges of Code §367(d) are turned off. If the repatriation transaction can be effected tax free under U.S. domestic law to the prior transferor or a qualified successor, no gain is recognized.

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Economic Substance: Views From the U.S., Europe, and the B.V.I., Cayman, and Nevis

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Economic Substance: Views From the U.S., Europe, and the B.V.I., Cayman, and Nevis

Like concepts of beauty, the presence or absence of economic substance in the tax context often is in the eye of the beholder. More importantly, economic substance means different things to tax authorities in different jurisdictions and the approaches in taxpayer obligations varies widely. This article looks at the concept of economic substance in three separate localities. Stanley C. Ruchelman and Wooyoung Lee look at the U.S., addressing case law establishing the requirement and the 2010 codification of the concept into the tax code. Werner Heyvaert, a partner in the Brussels Office of AKD Benelux Lawyers, and Vicky Sheik Mohammad, an associate in the Brussels Office of AKD Benelux Lawyers, look at the Danish Cases that establish an abuse of rights view for aggressive tax planning – the taxpayer abused rights granted to it by E.U. law – and the Unshell Directive designed to remove certain tax benefits from shell companies. David Payne, Global Head of Governance for Bolder Group, looks at the self-certification rules that have been adopted in the B.V.I., Cayman, and Nevis.

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Lost in Translation: Treatment of Foreign-Law Demergers Under U.S. Federal Tax Law

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Lost in Translation: Treatment of Foreign-Law Demergers Under U.S. Federal Tax Law

At a certain point in the life of a corporation that operates more than one business, management may wish to separate the different businesses into two or more separate corporate entities. In most cases, demergers are structured based on the requirements of the corporate law in the place of domicile of the corporation. Typically, a demerger of a foreign corporation that follows the corporate law provisions of applicable foreign law would also be exempt from tax in the relevant country. However, when one of the shareholders is a U.S. individual or corporation, U.S. Federal tax considerations should be taken into account to prevent unexpected U.S. tax for a U.S. investor. Demergers are given tax-free treatment under U.S. tax law only if the requirements of Code §355 are met. If not met, both the corporation that undergoes the demerger and its shareholders recognize gain in connection with an actual or deemed distribution of appreciated property. While the foreign corporation may have no U.S. tax to pay, the U.S. investor may find that tax would be due in the U.S. if the foreign corporation undergoing the demerger is a C.F.C. Stanley C. Ruchelman and Daniela Shani explain the various categories of tax free demergers under U.S. tax concepts and the consequences of failing to meet the requirements in the context of a corporation formed outside the U.S.

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Tax Considerations for a U.S. Holder Of Bare Legal Title in a Usufruct Arrangement

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Tax Considerations for a U.S. Holder Of Bare Legal Title in a Usufruct Arrangement

When European parents engage in inheritance planning by transferring bare legal title in shares of a privately held company to children resident in the U.S., the gift may bring with it a pandora’s box of tax issues. If the value of the bare legal title exceeds 50% of the value of the property when computed in accordance with U.S. tax rules for valuing split interests in property, the foreign company may become a C.F.C. That can trigger certain reporting requirements in the U.S. related to Form 5471 (Information Return of U.S. Persons With Respect To Certain Foreign Corporations) even though the children have no right to income from the company. Separate and apart from C.F.C. status, the basis which the children have in the shares is a carryover basis that will not be stepped up then the usufruct interest and the bare legal title are merged. Separate and apart from the foregoing issues is a potential F.B.A.R. filing requirement on FinCEN Form 114 (Report of Foreign Bank and Financial Accounts) with immediate effect. In their article, Nina Krauthamer, Wooyoung Lee, and Stanley C. Ruchelman explain these issues, why they pop up, and potential ways to mitigate some if not all of the problems.

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Code §245A – Sometimes Things Are More Than They Appear

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Code §245A – Sometimes Things Are More Than They Appear

Code §245A of effectively exempts U.S. corporation from U.S. Federal income tax on dividends received from certain foreign subsidiaries. It allows a deduction equal to the amount of the dividend received. Code §245A applies only with respect to dividends received “by a domestic corporation which is a United States shareholder.” Nevertheless, Code §245A can also apply to dividends received by a controlled foreign corporation from a qualifying participation in a lower-tier foreign corporation. The question presented in that fact pattern relates to how Code §245A will be applied. Is the controlled foreign corporation entitled to claim the deduction as dividends are received? Or is a U.S. corporation that is a U.S. Shareholder with regard to the foreign corporation entitled to claim the deduction at the time Subpart F income is reported in its U.S. tax return? Significantly different results may apply depending on the answer. Interestingly, the differences affect U.S. taxpayers other than the corporation that is a U.S. Shareholder. Stanley C. Ruchelman and Daniela Shani explain the different results that may apply.

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Late Filed Form 3520 – What Penalties to Expect and How to Respond

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Late Filed Form 3520 – What Penalties to Expect and How to Respond

When a U.S. person is faced with an asserted penalty for late filing of Form 3520 reporting the receipt of a foreign gift or bequest, the process to have the penalty abated is long and winding. Neha Rastogi and Stanley C. Ruchelman explain all the steps and suggest a strategy for supporting the taxpayer’s contention that reasonable cause exists for the compliance shortfall. In many areas of the tax law, less is more. The authors point out that as much favorable information as possible must be given to the Appeals Officer in order to demonstrate that the shortfall in compliance was not the result of negligence or disregard of the rules by the taxpayer.

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Tax 101: U.S. Tax Compliance For Dual Citizen Young Adults

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Tax 101: U.S. Tax Compliance For Dual Citizen Young Adults

It is not uncommon for a young adult who was born in the U.S. to noncitizen parents living temporarily in the U.S. to live abroad. Although he or she may never have returned to the U.S., the young individual is a U.S. citizen, and that status brings with it U.S. tax obligations. In their article, Nina Krauthamer, Wooyoung Lee, and Stanley C. Ruchelman address the tax obligations in the context of Ms. A, a typical young adult, born in the U.S., but living abroad. She may have a bank account in a foreign county, but ordinarily will not have her own source of income. At some point, Ms. A may receive gifts and bequests from her foreign parents or grandparents. At this point in her life, Ms. A’s U.S. tax compliance obligations become complex. Just how complex is explained by the authors.

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