An American Solution to Offshore Tax Evasion

Volume 2 No 5    /    Read Article

By Robert J. Alter (guest author)

The United States Department of Justice Tax Division and the I.R.S. have been ramping up an intense crackdown on offshore tax evasion, and while new budget cuts have vastly reduced I.R.S. resources, the cutbacks are having no effect on I.R.S. enforcement initiatives in this area. Robert J. Alter of McElroy, Deutsch, Mulvaney & Carpenter discusses the U.S. crackdown on offshore tax evasion and the various programs available to rectify noncompliance, including the Offshore Voluntary Disclosure Program, Streamlined Procedures, Delinquent International Information Return Submission Procedures, and Delinquent F.B.A.R. Submission Procedures.   See more →

Transfer Pricing Implications of the B.E.P.S. Action Plan

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Determined to eliminate so-called “double non-taxation,” as well as no or low taxation, associated with practices that are perceived to segregate taxable income from the activities that generate them, the Group of Twenty (“G20”) and the Organisation for Economic Co-operation and Development (“O.E.C.D.”) released their Action Plan on Base Erosion and Profit Shifting (“B.E.P.S. Action Plan”) in 2013. Included in the B.E.P.S. Action Plan are several provisions related to transfer pricing:

• Action 4: Limit base erosion via interest deductions and other financial payments;
• Action 8: Assure that transfer pricing outcomes are in line with value creation – Intangibles;
• Action 9: Assure that transfer pricing outcomes are in line with value creation – Risks and capital;
• Action 10: Assure that transfer pricing outcomes are in line with value creation – Other high-risk transactions; and
• Action 13: Re-examine transfer pricing documentation.

The O.E.C.D. has since delivered a number of reports and recommendations related to these actions, including revisions to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (“Transfer Pricing Guidelines”), and it continues to perform additional work on deliverables scheduled for later this year.

The Italian Voluntary Disclosure

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INTRODUCTION

Italy has a long history of tax amnesty programs established under a broad variety of names and rules. Interestingly, every new program has been described as “the last chance” for tax evaders to comply with the Italian tax code. It is no wonder that, as in all prior cases, Italy’s most recent voluntary disclosure program (the “V.D.”) has been defined as the “last call.” Having said that, and sensitive to prior performance, we firmly believe that for a wide range of reasons the V.D. will truly be the last opportunity for Italian citizens and residents to get their tax matters in order.

One indicator is heightened criticism of the typical Italian de facto tolerance toward tax evasion, which is now being blamed for the country’s ongoing economic crisis. Accordingly, the war against tax havens, as initiated by the U.S. under F.A.T.C.A. and subsequent inter-governmental agreements, has changed the way the whole world approaches such matters. Today, there is a new sensitivity toward tax compliance and no discernable government or media tolerance towards tax avoidance.

In addition, a different approach is now being taken with respect to tax amnesty matters. In the past, there was a sort of “reward” for the penitent evaders. Such individuals were granted the opportunity to regularize their positions by paying a low flat-rate extraordinary tax. The V.D. is different. Under the new provisions of the Law n. 186, dated December 15, 2014, (the “V.D. Act”), a taxpayer who enters the V.D. procedure (“V.D. Applicant”) will be required to pay every single euro of unpaid tax; the only benefit lies in the reduction of penalties, which are less than those applicable in an ordinary tax audit procedure.

The Future of Ireland as a Place to Carry On Business in Light of Recent E.U. & O.E.C.D. Initiatives

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INTRODUCTION

Ireland has long been established as the onshore location of choice for the world’s leading multinational enterprises (“M.N.E.’s”). Although Ireland’s attractiveness as a location for foreign direct investment is based on a number of factors, the low corporate tax rate of 12.5% is crucial.

Ireland’s corporate tax regime has received persistent and pervasive scrutiny from international media in recent times, focusing on topics such as the “Double Irish,” the O.E.C.D. B.E.P.S. initiative, and the Apple investigation. What must not be forgotten in the midst of such coverage is that Ireland has nothing to hide and nothing to fear from any of the above issues. Ireland is a small jurisdiction, and as far back as the 1950’s, the cornerstone of the economy has been foreign direct investment (“F.D.I.”).

Ireland makes no secret of its wish to compete with other jurisdictions for F.D.I., and its highly competitive corporate tax regime, including the 12.5% tax rate, forms part of a broader strategy that allows Ireland to “play to win.”

This article will discuss some of the main O.E.C.D. and E.U. initiatives impacting Ireland and the effects such initiatives are likely to have on Ireland and the M.N.E.’s which are based here.

Deoffshorization in Russia: C.F.C. Legislation Comes into Effect

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Federal law No. 376 of November 24, 2014, On Amendments to Part One and Part Two of the Tax Code of the Russian Federation (concerning the taxation of controlled foreign companies and foreign organizations), and commonly referred to as the “C.F.C. Law,” came into force on January 1, 2015. It marks the beginning of deoffshorization of the Russian economy and introduces entirely new tax rules for Russian businesses having affiliates based outside Russia.

The C.F.C. Law introduces the following three new legal concepts, previously nonexistent in Russian tax legislation:

• Controlled foreign company (“C.F.C.”),
• Russian tax residence for foreign companies, and
• Beneficial owner of income.

The C.F.C. Law establishes the obligation of taxpayers to notify the tax authorities of their participation in foreign entities. It also establishes rules for computing and taxing C.F.C. profit and share transactions of companies that own real estate in Russia. It provides for recognition of foreign non-corporate structures (such as trusts, private foundations, partnerships, etc.) as separate taxpayers.

Following the O.E.C.D. lead in the B.E.P.S. proposals, these amendments have two broad goals: (i) they ensure business transparency and (ii) they combat the use of low-tax jurisdictions to obtain unjustified tax benefits.

CONTROLLED FOREIGN COMPANIES

A controlled foreign company is a foreign entity (or non-corporate structure) that is:

1. Not a tax resident of the Russian Federation and
2. Controlled by Russian tax residents, either legal entities or individuals (“Controlling Persons”).

Corporate Matters: Is Your Deal Safe? How the F.C.P.A. Affects Mergers & Acquisitions

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Foreign-based companies that do not do business in the United States might understandably ask how the Foreign Corrupt Practices Act (“F.C.P.A.”) can impact them. The answer is unexpectedly and profoundly – if the foreign company becomes an acquisition target of a U.S. company.

As 2015 begins, it is no longer news to anyone that a U.S. company doing business abroad must have a robust anti-corruption and anti-fraud compliance program. An effective compliance program can prevent F.C.P.A. problems from arising or, if such problems do arise, reduce a company’s penalties. It is equally important to remember that the F.C.P.A. can have as significant an impact on a company’s merger and acquisition transactions as it can on its everyday operations. For that reason, a foreign company looking to partner with, or be acquired by, a U.S.-based entity, must make sure that its conduct does not adversely affect or jeopardize such efforts. Recent developments in 2014, as well as past history, illustrate this point.

The F.C.P.A. plays a significant role in mergers and acquisitions. An acquiring company is expected to conduct due diligence to ascertain the acquired entity’s F.C.P.A. compliance. If in the course of that due diligence, the acquiring company uncovers violations by the entity to be acquired, it is expected to disclose them and remedy them. Otherwise, it risks F.C.P.A. liability of its own. In guidance issued in 2012, the D.O.J. warned:

[A] company that does not perform adequate FCPA due diligence prior to a merger or acquisition may face both legal and business risks. Perhaps most commonly, inadequate due diligence can allow a course of bribery to continue—with all the attendant harms to a business’s profitability and reputation, as well as potential civil and criminal liability.

The Proposed United Kingdom "Diverted Profits Tax"

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INTRODUCTION

The United Kingdom proposes to introduce, on profits arising as of April 1, 2015, a “Diverted Profits Tax.” This is intended to override the normal international tax arrangements when H.M.R.C. (the U.K. tax authority) does not like the outcome. Domestic laws, O.E.C.D. practice, and a network of Double Tax Agreements provide a definition of “Permanent Establishment” defining what income is or is not taxable within the country of operation. Similarly, “Transfer Pricing” rules should enable the tax authorities to ensure that the price used for transactions between related entities is appropriate for calculating proper division of taxable revenue between the countries concerned. While many believe that these are not working as well as they should, the problems need a more subtle and sophisticated solution rather than a blunderbuss approach.

The “Diverted Profits Tax,” at a rate of 25% (mildly penal, compared with the Corporation Tax rate of 21%), is to be imposed if H.M.R.C. does not like the answer produced by these well-established procedures and succeeds in claiming, under this new law, that profits have, nevertheless, been “diverted.” The draft legislation sets out very detailed rules. These are available on the H.M.R.C. website, but those who follow matters very closely would be well-advised to continue to examine the extensive comments that are being made. The draft legislation gets very close to giving H.M.R.C. the power to determine unilaterally the level of taxable income. “Tax by administrative discretion” is a policy normally associated with authoritarian or left-wing governments. The United Kingdom may well, post-election, have a leftwing government who will be delighted to be presented with what, to them, is a very attractive measure.

APPROPRIATE STRATEGIES FOR AFFECTED BUSINESSES

What do those affected by the draft legislation and their advisers need to do or know? The provisions will not apply to S.M.E.’s, i.e., groups with less than £10 million of annual sales within the U.K. Others will need to consider their position very carefully and make contingency plans on the assumption that the provisions will be enacted, although perhaps in a substantially amended form. H.M.R.C. forecasts that the measure will eventually bring in £350 million per annum, but goes on to say that it “is not expected to have a significant economic impact.” American readers in particular will be well aware that there is a huge gap between the initially-forecast yield of a tax avoidance measure and the outcome. Hastily proposed and badly designed tax legislation is often more successful at creating economic damage than producing revenue or desirable changes in activities.

Foreign Correspondence: Notes from Abroad

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HOLIDAY SHOPPING, CANADIAN RETAIL PRICES AND TRANSFER PRICING CONTROVERSY

By Michael Peggs

When people think of massive transfer pricing cases, the driver typically is the diversion of profits to a low-tax jurisdiction. But transfer pricing issues are now filtering down to the level of retail shoppers facing retail price disparity in adjacent jurisdictions. A typical case is the premium that Canadian purchasers generally pay over prices charged in the U.S. for comparable products.

Before the internet, it was customary for Canadians to receive flyers in the mail from U.S. grocery and department stores. The flyers offered bargains for the holidays. The internet now allows instant price comparisons and greater choice for Canadian consumers. Disregarding sub rosa impediments to competition that permeate many areas of the Canadian economy – think of cultural preferences – Canadians have complained loudly that retail prices are unfairly high when compared with exchange-adjusted U.S. prices. A typical example is print media where the premium for pricing the Canadian edition was not reduced over the period in which the Canadian dollar reached parity with its U.S. counterpart.

The Canadian government is now preparing to give the Competition Bureau new powers to persuade U.S. multinationals with Canadian retail operations to lower prices or to achieve retail price parity, as will be determined. One hopes that Industry Canada will intervene with the Canada Revenue Agency (“C.R.A.”) before drafting legislation, as an unintended consequence may be a new round of Canadian transfer pricing controversy.

Corporate Matters: Don't Be Late - Time is of the Essence

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When purchasing New York real estate, whether a commercial building or residential property, choosing the correct words with which to provide for the closing date in the contract of sale can make the difference between a smooth closing and a calamitous default. This article discusses the nuances of various terms of art so that a purchaser can protect its contract deposit and position as contract vendee.

New York is unusual in that a contract may recite a specific date for the closing of title but without the addition of certain talismanic words it is not the “Law Date” with regard to the property, meaning the date on which title must close. In order for a closing date specified in a contract of sale to become a Law Date, the specified date must be qualified by the phrase time is of the essence. “Time Is of the Essence” is a term of art that renders the specified closing date an ironclad date. Consequently, when Time Is of the Essence a purchaser’s failure to close on a specified date will result in default; by the purchaser and typically the loss of its contract deposit.

Thus, a closing scheduled for “on,” or “on or about,” or “on or before” or “in no event later than” a specified date does not lock-in the parties to close on that date. Such phrases assure that the parties will be afforded a reasonable time within which to perform the closing, beginning on the specified date. Generally, utilization of one of the foregoing phrases is regarded as permitting a 30-day adjournment of the closing date set forth in the contract.

Often, however, the seller will attempt to set an initial closing date or agree to adjourn a closing date only if Time Is of the Essence with regard to the new date. The purchaser must beware because the new date will be set on an iron-clad basis.

So what happens when a purchaser is confronted with a seller who demands a Time Is of the Essence closing date? There are various strategies which can be implemented by the purchaser to avoid a default if it is not ready to close on the specified date.

Canadian Immigration Trust Exemption Withdrawn

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INTRODUCTION

For over 40 years, Canada offered a unique tax benefit to individuals not previously Canadian resident or who had been resident in Canada for less than 60 months. Such persons were allowed to establish a nonresident trust, which would not be taxable by Canada and from which a Canadian resident beneficiary could receive tax-free capital distributions. In addition, and in comparison to U.S. tax rules, income accumulated in the trust at the end of the calendar year automatically became capital, following typical provisions in discretionary trusts. Once converted into capital, the rules for tax-free distributions of capital became applicable.

This made Canada an attractive jurisdiction for global elite. Wealthy immigrants to Canada could shelter foreign investment income and capital gains from Canadian tax for a period of up to 60 months after becoming resident. Needless to say, these structures became quite popular.

In a surprise move announced in February 2014, the tax benefit was withdrawn from 2015 onwards. However, if the trust received a contribution after February 22, 2014, it would become taxable from 2014 onwards. Importantly, no grandfathering was provided for existing trust arrangements, which is both unfortunate and unfair. The change impacts a large number of individuals, as many people have structured their tax planning on the basis of having this exemption for 60 months.

CANADIAN TAX SYSTEM

Canada has a common law definition of residence, which is basically a facts and circumstances test. When an individual establishes sufficient ties to Canada, that person will become resident. While Canada also has a substantial presence rule (183 days in the calendar year), this rule is only applicable to persons who spend time in Canada without becoming resident under common law principles. Citizenship and immigration status are not a basis for levying tax.

Anti-Deferral Regimes: U.S. Taxation of Foreign Corporations

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When a U.S. business expands abroad, it is frequently believed that the income of foreign subsidiary corporations will not be taxed in the U.S. until dividends are distributed to the U.S. shareholder. This is known as tax deferral, which is the general expectation of clients. However, in the U.S., tax deferral may be overridden by provisions accelerating the imposition of U.S. tax on U.S. shareholders of foreign corporations. As a result, income may be taxed before a dividend is distributed. This article describes the anti-deferral provisions of U.S. tax law that may be applicable in certain situations.

ANTI-DEFERRAL REGIMES

The Internal Revenue Code contains two principal anti-deferral regimes that may impose tax on a U.S. taxpayer on a current basis when its foreign subsidiaries generate income. These provisions reflect a policy under which Congress believes the deferral rules are being abused to inappropriately defer U.S. tax, especially if foreign tax is not imposed for one reason or another. The two regimes are the:

• Controlled Foreign Corporation (“C.F.C.”) regime under Code §§951-964, also known as the “Subpart F” provisions; and
• Passive Foreign Investment Company (“P.F.I.C.”) regime under Code §§1291-1298.

Controlled Foreign Corporations

Under Code §957(a), a foreign corporation is a C.F.C. if stock representing more than 50% of either the total combined voting power or the total value of shares is owned, directly, indirectly, or by attribution, by “U.S. Shareholders” on any day during the foreign corporation’s taxable year. With respect to a foreign corporation, a U.S. Shareholder is defined as a “U.S. person” that owns, under the foregoing expanded ownership rules, stock representing 10% or more of the total voting power of all classes of the foreign corporation’s stock that is entitled to vote. A “U.S. person” includes a U.S. citizen or resident, a U.S. corporation, a U.S. partnership, a domestic trust, and a domestic estate. Stock ownership includes indirect and constructive ownership under the rules of Code §958. Consequently, ownership can be attributed, inter alia, from foreign corporations to shareholders, from one family member to another, and from trusts and estates to beneficiaries, legatees, and heirs.

Israeli Law Confronts International Tax Treaties and Principles Via New Treatment of Mixed-Beneficiary Trusts

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HISTORY AND OVERVIEW OF ISRAELI TAXING MODELS IN RESPECT OF NON-ISRAELI TRUSTS

Pre-2006 Situation – the Corporate Model

Israel has come a long way in its efforts to tax foreign-established trusts, which historically were assumed to have been used to shelter Israeli-source funds of high net worth Israeli residents and their families. Prior to the adoption of any relevant comprehensive Israeli tax legislation in 2006, the practice consisted mostly of viewing trusts and beneficiaries similarly to corporations and shareholders.

Thus, under customary Israeli international tax rules, if the “management and control” of the non-Israeli trust was effected outside of Israel, the trust was considered to be nonresident because the trust’s assets were situated outside of Israel and the trustees had full discretion over their control. No formal powers were exercised directly or indirectly by Israeli beneficiaries. Hence, the trust was simply not subject to Israeli taxation. Moreover, discretionary distributions were viewed as tax-free gifts. In this way, wealthy Israelis could cause foreign trusts to be funded by Israeli-source wealth and invested outside Israel without subjecting the resulting income to Israeli tax.

Israel has neither an estate/inheritance tax nor a gift tax, which means that bona fide gifts and inheritances are free of tax for both the donor or the decedent and the recipient. Thus, a foreign trust ostensibly became the perfect Israeli tax planning tool. Assets could be donated by an Israeli settlor to a foreign irrevocable discretionary trust for the benefit of family members. Legally, the assets were no longer owned by the Israeli donor but rather by a foreign body managed and controlled by a foreign trustee. Therefore, the trust’s non-Israeli assets and income were outside the scope of Israeli taxation. Distributions by these trusts to Israeli resident beneficiaries that were bona fide discretionary gifts were exempt in the hands of an Israeli recipient.

The U.S.-Sweden I.G.A.: A Practitioner's Perspective

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Sweden recently entered into an intergovernmental agreement (“I.G.A.”) with the U.S. to address the application of F.A.T.C.A. to Swedish financial institutions. The subsequent modifications to Swedish law to accommodate the I.G.A. were made public on August 11, 2014 in a proposal by the Ministry of Finance. The proposal added numerous modifications to the requirements for compliance and published the reporting forms that will be due starting next year. The complexity of F.A.T.C.A. compliance will trigger a number of changes in many areas of Swedish legislation, which are likely to be approved by the Swedish Parliament in the fall of 2014. It is clear that F.A.T.C.A. will make life more complex for the regulated groups.

F.A.T.C.A. will have a broad, sweeping effect on Swedish financial institutions (“F.I.’s”), including large Swedish banks, insurance companies, and private equity companies. These F.I.’s have been planning for F.A.T.C.A. and have implemented technology, procedures, and training that have caused them to incur in significant costs. However, based on personal experience, it appears that there is a large group of “institutions” that do not understand that they are in fact F.I.’s and must act accordingly. Recently, when discussing due diligence procedures mandated by F.A.T.C.A. with management of a Swedish permanent establishment, the response was simply “thanks for the heads up,” which indicated that the compliance requirements were not yet on the company’s radar.

Some of these institutions may revert to the simplest solution – barring Americans from being accepted as investors or account holders. This solution, however, is suboptimal for an F.I. as it eliminates a large group of Swedish/U.S. dual citizens from the client base. Of greater importance is the fact that barring Americans does not mean an institution can ignore F.A.T.C.A. F.A.T.C.A. requires disclosure of U.S.-controlled foreign entities that may be account holders at these institutions, a task that will require creating new on-boarding procedures and a review of all preexisting accounts.

Inbound Investment in German Real Estate

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INTRODUCTION

Investments in German real estate are attractive to international investors. Low interest rates and positive economic conditions exist in Germany. The demand for commercial and residential rental properties has increased in urban centers such as Berlin, Düsseldorf, Frankfurt, Hamburg, Cologne, Munich, and Stuttgart. In these circumstances, it is expected that Germany will remain an attractive market for real estate investments.

Germany provides reliable political conditions, which are advantageous for a successful investment. However, there is an increasing complexity to the general legal conditions, and the success of a real estate investment strongly depends on proper structuring of the investment in a tax-efficient way.

This article provides an overview of the tax consequences of inbound investments in German real estate.

Different investment structures are compared:

• Holding the property directly,
• Holding shares in a property company, and
• Holding interests in a property partnership.

In addition to income tax, German real estate transfer tax aspects are discussed, and planning opportunities to reduce or eliminate German trade tax are explored.

I.R.S. Announces Major Changes to Amnesty Programs

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The I.R.S. announced major changes to its amnesty programs last month. These changes can be broken into two parts: changes to the 2012 Offshore Voluntary Disclosure Program (“O.V.D.P.”), which can be to referred to as the 2012 Modified O.V.D.P. or the 2014 O.V.D.P., and changes to the streamlined procedures (“Streamlined Procedures”). As the requirements for the latter are relaxed, the requirements for the former are tightened.

The changes in the amnesty programs reflect the new I.R.S. approach for addressing taxpayers with offshore tax issues. The new approach provides one path for willful taxpayers, with steeper penalties but certainty, and another path for taxpayers who believe their conduct was non-willful, with reduced penalties but uncertainty to the extent their conduct is subsequently proven willful.

CHANGES TO O.V.D.P.

The major changes to the 2012 O.V.D.P. include the following:

1. Changes to Preclearance Process

Under the 2012 O.V.D.P., all that was required was to submit a preclearance request was a fax to the I.R.S. O.V.D.P. department that contained the taxpayer’s name, social security number, date of birth, address, and if the taxpayer was represented by an authorized party, an executed power of attorney (P.O.A.).

Using the U.K. as a Holding Company Jurisdiction: Opportunities and Challenges

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INTRODUCTION: AN IDEAL HOLDING JURISDICTION?

At a time when a quintet of septuagenarian comics attempt to revive former glories with a final run of a live show of Monty Python in London, it is worth reflecting on the Holy Grail of the international tax practitioner: to find the perfect international holding company jurisdiction.

In this, the holding company jurisdiction needs certain characteristics:

• The possibility of returning profits to shareholders with minimal tax leakage;
• The ability to receive profits from underlying subsidiaries without taxation at home;
• The ability to dispose of investments in the underlying subsidiaries without triggering a tax charge on any profit or gain;
• A good treaty network to ensure that profits can be repatriated to the holding company from underlying subsidiaries, whilst minimizing local withholding taxes; and
• Low risk from anti-avoidance measures that profits of subsidiaries will otherwise be taxed in the holding company jurisdiction.

The U.K. has emerged over the last decade as an increasingly viable holding company jurisdiction, particularly for investments in countries within the European Union.

Swiss Trustees and Board Members of Foundations Have to Prepare for F.A.T.C.A.

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BACKGROUND

Trusts are unknown under Swiss law and family foundations are not commonly used because their purpose is very limited by law. Consequently, many Swiss trust companies, family offices or lawyers act as trustees of non-Swiss trusts or as members of family foundations. It is not uncommon for trustees, trusts or foundations, and underlying companies to be established under the laws of different jurisdictions, and typically Liechtenstein is used.

Foreign trusts and foundations, foreign trustees and underlying holding companies that invest in the U.S. must determine their classification under the Foreign Account Tax Compliance Act (“F.A.T.C.A.”) and possibly a relevant intergovernmental agreement (“I.G.A.”). In the case of Switzerland, a Model 2 I.G.A. exists.

The determination must be made prior to the end of June 2014, even if no U.S. owners or beneficiaries are involved. The reason is that, by 1 July 2014, a foreign entity that is a Foreign Financial Institution (“F.F.I.”) must register on the I.R.S. F.A.T.C.A. portal and receive a G.I.I.N. The I.R.S. has announced that the last date to register and receive a G.I.I.N. prior to 1 July 2014 is 5 May. Registration is required unless the F.F.I. is a certified deemed-compliant F.F.I. or a Non-Financial Foreign Entity (“N.F.F.E.”). An exempt F.F.I. could be a sponsored investment entity, a sponsored closely held investment vehicle, or an owner-documented F.F.I. In each of those fact patterns, another entity is engaged to carry out the F.A.T.C.A. reporting. An N.F.F.E. is an entity that is formed outside the U.S. that is not an F.F.I.