The O.E.C.D.'s Approach to B.E.P.S. Concerns Raised by the Digital Economy

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On March 24, 2014, ten days after the O.E.C.D. released its public discussion draft on prevention of treaty abuse, a second public discussion draft was released, addressing the tax challenges of the digital economy (the “Discussion Draft”).

The Discussion Draft emphasizes the concept that the digital economy should not be ring-fenced and separated from the rest of the economy, given its relationship to the latter. It provides a detailed introduction to the digital economy, including its history, components, operations, and different actors. Surprisingly, it does not propose any groundbreaking approaches to addressing the base erosion and profit shifting (“B.E.P.S.”) challenges encountered in the digital economy. It simply reflects an approach that is consistent with the fight against B.E.P.S. – seeking to determine where economic activity takes place in the digital economy in order to best achieve taxation in a non-abusive fashion.

The Discussion Draft singles out six factors that characterize the digital economy in light of B.E.P.S. concerns:

1. Mobility of all facets of the digital economy, including the intangibles used, the users themselves, and the business functions carried on by various players in the business model;
2. Reliance on data;
3. Network effects;
4. Use of multi-sided business models;
5. Tendency towards monopoly or oligopoly; and
6. Volatility

O.E.C.D. Discussion Drafts Issued Regarding B.E.P.S. Action 2 - Neutralizing the Effects of Hybrid Mismatch Arrangements

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INTRODUCTION

On March 19, 2014, the O.E.C.D. issued two discussion drafts proposing steps to neutralize abusive tax planning through hybrid mismatch arrangements. One report proposed changes in domestic law; the second proposed changes to the O.E.C.D. Model Tax Convention.

The discussion drafts reflect the O.E.C.D.’s attempt to bring “zero-sum game” concepts to global tax planning. In a zero-sum game, transactions between two or more parties must always equal zero (i.e., if one party to a transaction recognizes positive income of “X” and pays tax on that amount, the other party or parties generally must recognize negative income of the same amount, thereby reducing tax to the extent permitted under law). Seen from the viewpoint of the government, tax revenue is neither increased nor decreased on a macro basis if timing differences are disregarded.

If all transactions are conducted within one jurisdiction, the government is the ultimate decision maker as to the exceptions to the zero-sum analysis. For policy reasons, a government may decide to make an exception to a zero-sum game result by allowing the party reporting positive income to be taxed at preferential rates or not at all, while allowing the party reporting negative income to fully deduct its payment. But, when transactions cross borders and involve related parties, taxpayers have a say in what is taxed and what is not taxed.

Tax 101: Form 5471 - How to Complete the Form in Light of Recent Changes

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INTRODUCTION

As part of the obligation to file income tax returns, U.S. persons owning 10% or more of the stock of a foreign corporation – measured by voting power or value of the stock that is owned – are obligated to provide information on the foreign corporation. Ownership is determined by reference to stock directly held, indirectly held through foreign entities, and deemed held through attribution from others. The scope and detail of the information to be reported is dependent on the percentage of ownership maintained by the U.S. taxpayer. As the degree of ownership increases, the amount of information increases. The reporting vehicle is Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations). For returns that report on tax year 2013, this form also reports on the net investment income tax (“N.I.I.T.”) arising through a controlled foreign corporation (“C.F.C.”).

Great emphasis is put on international tax compliance, and from 2009, the I.R.S. systematically assesses penalties for late filing of Form 5471. In addition, the 2010 Foreign Account Tax Compliance Act (“F.A.T.C.A.”) extended the statute of limitations for the I.R.S. to examine a tax return if certain information returns, including Forms 5471, were not timely or properly filed. The statute of limitations will remain open on the entire tax return and not only on Form 5471 if Form 5471 is not timely filed. Once the form is filed the statute of limitation will begin to run. To assist the I.R.S. to spot inconsistencies, beginning in tax year 2012, the I.R.S. assigned a unique reference identification number to each foreign entity, which allows the I.R.S. to compare forms filed with respect to a certain company over several years.

Insights Vol. 1 No. 2: Updates & Other Tidbits

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UPDATE TO STREAMLINED PROCEDURES: DIFFERENT STROKES FOR THE SAME FOLKS

In our prior issue, Insights Vol. 1, No. 1, we noted that, for a U.S. taxpayer entering into the Streamlined Procedures (i.e., fast-track program) in 2013, an I.R.S. agent informally advised filing tax returns for the years 2009, 2010, and 2011. Upon further discussions with the I.R.S., the agent revisited the issue, advising that a taxpayer entering into the program today would need to file the last three years of tax returns (i.e., 2010, 2011, and 2012). In the event the taxpayer does not file a timely 2013 return prior to the submission, the applicable look-back period is 2011, 2012, and 2013.

This advice is consistent with the 2012 O.V.D.P. F.A.Q. # 9, which answers the question “What years are included in the OVDP disclosure period?” as follows:

For calendar year taxpayers the voluntary disclosure period is the most recent eight tax years for which the due date has already passed. The eight-year period does not include current years for which there has not yet been non-compliance. Thus, for taxpayers who submit a voluntary disclosure prior to April 15, 2012 (or other 2011 due date under extension), the disclosure must include each of the years 2003 through 2010 in which they have undisclosed foreign accounts and/or undisclosed foreign entities. Fiscal year taxpayers must include fiscal years ending in calendar years 2003 through 2010. For taxpayers who disclose after the due date (or extended due date) for 2011, the disclosure must include 2004 through 2011. For disclosures made in successive years, any additional years for which the due date has passed must be included, but a corresponding number of years at the beginning of the period will be excluded, so that each disclosure includes an eight year period.

The O.E.C.D. Announces Global Standard for Automatic Exchange of Information

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As we noted in our prior issue, the Leaders of the G-20 Summit endorsed automatic exchange of information reporting to combat tax evasion in September 2013. In particular, they stated:

We commend the progress recently achieved in the area of tax transparency and we fully endorse the OECD proposal for a truly global model for multilateral and bilateral automatic exchange of information. Calling on all other jurisdictions to join us by the earliest possible date, we are committed to automatic exchange of information as the new global standard, which must ensure confidentiality and the proper use of information exchanged, and we fully support the OECD work with G20 countries aimed at presenting such a new single global standard for automatic exchange of information by February 2014 and to finalizing technical modalities of effective automatic exchange by mid-2014. In parallel, we expect to begin to exchange information automatically on tax matters among G20 members by the end of 2015.

On February 13, 2014, the Organisation for Economic Co-Operation and Development (“O.E.C.D.”) announced a global standard for automatic exchange of financial account information. Over 40 countries made a joint statement an committed to an early adoption of this standard. On February 23, 2014, the G-20 finance ministers and central bank governors endorsed the proposal.

Tax 101: Undisclosed Offshore Accounts, Are You Eligible for Streamlined Procedures?

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By Stanley C. Ruchelman and Armin Gray

For persons having undisclosed offshore accounts and contemplating participation in the I.R.S. voluntary disclosure program, one frequently asked question is eligibility for the streamlined procedures (“Streamlined Procedures”) announced by the I.R.S. O.V.D.I. The Streamlined Procedures are effective as of September 1, 2012 and should be considered if there are offshore tax-noncompliance issues. If an individual qualifies, the benefits are substantial: he or she will be eligible for fast-track resolution of the case, the look-back period is limited to three years of delinquent tax returns and six years of F.B.A.R.'s, and he or she will avoid penalties. However, most taxpayers will not qualify as eligibility is limited to a narrow class of taxpayers where intentional tax non-compliance is unlikely to exist.   See more →

I.R.S. Issues Regulations Regarding P.F.I.C. Reporting Requirements

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On December 30, 2013, the I.R.S. released temporary and final regulations regarding P.F.I.C. reporting requirements. In T.D. 9650, the I.R.S. reaffirmed that it would not require any U.S. persons that owned any interest in a P.F.I.C. during 2010, 2011 or 2012 to file an information return on Form 8621 under the new rules unless they sold the stock, received a distribution or needed to make a P.F.I.C. election. However, Form 8621 will be required to be filed by any U.S. person that owned at any time during 2013 an interest in a P.F.I.C. Thus the form will filed with the 2013 income tax return that must be filed later this year.

The regulations adopted rules addressing constructive or indirect ownership. The constructive ownership or attribution rules can cause a person to become an owner of an interest in a P.F.I.C. even though no stock is directly owned in the P.F.I.C. As a result, ownership of P.F.I.C stock by a corporation, partnership, trust or estate can be attributed to the entity’s shareholders, partners or beneficiaries, who then can become subject to the P.F.I.C. rules.

BACKGROUND

U.S. investors must determine if any foreign corporation owned may be classified as a P.F.I.C. A foreign corporation will be classified as a P.F.I.C. if either (i) 75% or more of the corporation's gross income is passive income (such as from interest, dividends or capital gains) or (ii) 50% or more of the corporation's assets are held for the production of passive income (such as stocks, bonds or cash). A typical P.F.I.C. is an offshore investment company or mutual fund although P.F.I.C. status can be a potential issue for any foreign corporation, especially if the corporation has large cash reserves or is in the services business outside the U.S.

Year-End Review: I.R.S. O.V.D.P.

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The I.R.S. and the Department of Justice (“D.O.J.”) continued their tenacious efforts against offshore tax evasion. Three major events took place in 2013: (i) a shift in the methodology to detect quiet disclosures; (ii) the bank voluntary disclosure program (“B.V.D.P.”) announced by the United States and Switzerland on August 29, 2013, and (iii) certain notable convictions, plea deals, and civil penalties.

We expect the I.R.S. and D.O.J.’s unwavering focus on offshore tax evasion to continue in 2014 as F.A.T.C.A begins to be implemented. Some practitioners fear that when F.A.T.C.A. information reporting begins, the O.V.D.P. may end, as the I.R.S. will have received information automatically on foreign accounts. If a U.S. taxpayer remains uncertain about declaring foreign financial accounts, now is the time to take remedial action. There is no Plan B, if time runs out.

QUIET DISCLOSURES

While the I.R.S. officially has discouraged quiet disclosures, a Government Accountability Office (“G.A.O”) report, released on April 26, 2013, identified shortcomings in the I.R.S.’s ability to detect quiet disclosures. According to the G.A.O. report:

[The] G.A.O. analyzed amended returns filed for tax year 2003 through tax year 2008, matched them to other information available to IRS about taxpayers' possible offshore activities, and found many more potential quiet disclosures than IRS detected. Moreover, IRS has not researched whether sharp increases in taxpayers reporting offshore accounts for the first time is due to efforts to circumvent monies owed, thereby missing opportunities to help ensure compliance . . . Taxpayer attempts to circumvent taxes, interest, and penalties by not participating in an offshore program, but instead simply amending past returns or reporting on current returns previously unreported offshore accounts, result in lost revenues and undermine the programs' effectiveness.

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.