Insights Vol. 1 No. 7: F.A.T.C.A. 24/7

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FOREIGN FINANCIAL INSTITUTIONS: WHO DEALS WITH THE I.R.S. ON F.A.T.C.A.?

On August 1, the Internal Revenue Service (“I.R.S.”) clarified in its F.A.T.C.A. Frequently Asked Questions (“F.A.Q.”) that the I.R.S.’s main contact with a foreign financial institution (“F.F.I.”) will be the “responsible officer” identified under Question 10 of the registration form (i.e., Form 8957, which should be completed on the I.R.S. F.A.T.C.A. portal and not in paper form). However, the I.R.S. reiterated that the responsible officer can authorize as many as five additional points of contact to receive F.A.T.C.A.-related information regarding the F.F.I. and to take other F.A.T.C.A.-related actions on behalf of the F.F.I.

Additionally, the responsible officer will receive an automatic e-mail notification to check the F.F.I.’s F.A.T.C.A. message board when certain messages are posted. For example, when the F.F.I.’s registration status changes, the responsible officer will receive an e-mail notification. Such e-mail notifications will include the last several characters of the F.F.I.’s F.A.T.C.A. identification number so that the officer can identify which F.A.T.C.A. account is being referred to. If no e-mail notifications are received, the responsible officer must verify that the e-mail address entered in Question 10 of the registration form is correct, as well as ensure that their spam blocker is not preventing e-mail notifications from getting through. Note that the responsible officer can only list one e-mail address on Question 10 of the registration form.

I.R.S. LIST OF REGISTERED F.F.I.’S

On August 1, the I.R.S. also updated its F.A.Q. on the list of registered F.F.I.’s. (“F.F.I. List”). The I.R.S. stated that it is possible that an F.F.I. that appears in the search tool on the I.R.S.’s website will not appear in a downloaded F.F.I. List in C.S.V. format.

Because some C.S.V.-compatible spreadsheet and database applications may only display a maximum number of records, an F.F.I. that is located on the list beyond that maximum limit may not be seen. To address this problem, the I.R.S. suggests that taxpayers try to use another spreadsheet and database application or text editor to open the downloaded C.S.V. file.

Corporate Matters: Convertible Note Financing

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We have seen an increased number of term sheets for convertible note financings lately and thought it might be helpful to discuss some of the terms and conditions of these notes. In an earlier issue of Insights, we discussed angel investing and the risks (and rewards) of that strategy. Convertible note financings are used for seed financing and are a very economical and efficient way for start-up companies to obtain seed capital without losing control of the early-stage company.

CONVERTIBLE NOTE

A convertible note financing is short-term debt that automatically converts into shares of preferred stock upon the closing of a Series A financing round. This method of financing is favored by company founders because it can be completed very quickly, is somewhat simple, and is relatively inexpensive in terms of legal costs. A convertible note purchase agreement and note can be a few pages long and prepared and closed in a few days.

While start-up companies can issue common stock to early investors, there are a variety of reasons why the founders may be reluctant to do so. These include the difficultly in putting a value on an early stage company and potential tax issues for founders issued stock at nominal values. Because convertible notes are debt not equity, their issuance puts off the valuation matter until the later round of financing – by which time the company may have developed to an extent where more and better information is available on which to base a valuation.

Tax 101: Tax Planning and Compliance for Foreign Businesses with U.S. Activity

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I. INTRODUCTION

The U.S. tax laws affecting foreign businesses with activity in the U.S. contain some of the more complex provisions of the Internal Revenue Code. Examples include:

• Effectively connected income,
• Allocation of expenses to that income,
• Income tax treaties,
• Arm’s length transfer pricing rules,
• Permanent establishments under income tax treaties,
• Limitation on benefits provisions in income tax treaties that are designed to prevent “treaty shopping,”
• State tax apportionment,
• F.I.R.P.T.A. withholding tax for transactions categorized as real property transfers,
• Fixed and determinable annual and periodical income, and
• Interest on items of portfolio debt.

One can imagine that it is no easy task to identify income that is subject to tax, to identify the tax regime applicable to the income, and to quantify gross income, net income, and income subject to withholding tax. Nonetheless, the I.R.S. has identified withholding tax obligations of U.S. payers as a Tier I audit issue.

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.

The McKesson Transfer Pricing Case

volume 1 no 7   |   Read article

By Sherif Assef

In this month’s lead article, Sherif Assef of Duff & Phelps weighs the consequences of a recent Tax Court of Canada case involving risk shifting and function shifting within a multinational group when neither risks nor functions are actually shifted. Nonetheless, profits were shifted and this annoyed the C.R.A.  See more →

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. 6: F.A.T.C.A. 24/7

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INSTRUCTIONS TO KEY F.A.T.C.A. TAX FORMS RELEASED

On June 19, Instructions for the Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding and Reporting, were released. The instructions provide useful guidance because they allow entities to attach alternative certifications based on an Inter-Governmental Agreement (“I.G.A.”) or the regulations instead of checking a box on the form.

On June 24, the Internal Revenue Service (“I.R.S.”) released final instructions on Form 8966, F.A.T.C.A. Report. The instructions provide that taxpayers must file Form 8966 for the 2014 calendar year on or before March 31, 2015. They will get an automatic 90-day extension for calendar year 2014 without the need to file any form or take any action.

Corporate Matters: Professional Limited Liability Companies and Professional Corporations

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In our March issue we discussed incorporation basics and entity selection. We focused on limited liability companies and corporations, as they are the most common entities used. We thought it might be helpful to follow up on that article with a brief discussion on professional limited liability companies and professional corporations.

PROFESSIONAL LIABILITY COMPANY

A professional limited liability company (“P.L.L.C.”) is organized for the sole purpose of providing professional services by licensed professionals. Generally, states don’t allow L.L.C.’s for businesses where a license is required. Licensed professionals who want the benefits of an L.L.C. must form a P.L.L.C. instead. A P.L.L.C. must be organized solely for the purpose of engaging in either a single licensed profession, or in two or more that can be lawfully practiced together. The name of the business must include the words “professional limited liability company,” or the abbreviation “P.L.L.C.” Generally, any person who is licensed to practice in a state under a designated profession may organize a P.L.L.C. A professional is a person licensed in a field such as health, law, engineering, architecture, accounting, actuarial science, or another similar field. However, licensing requirements may vary state by state. Therefore, one must thoroughly review the applicable statute for the state in which the P.L.L.C. will conduct business.

A professional or group of professionals considering incorporation would consider a P.L.L.C. for the favorable pass-through tax treatment and limited liability – a member of a P.L.L.C. is not liable for acts of another member or the entity’s debts. Note, however, that members remain personally liable for their own professional misconduct or malpractice. So, even if you practice a profession through a P.L.L.C., it is a good idea to carry malpractice insurance.

First Circuit Holds Corporation's Possessions Tax Credit Was Not Reduced

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Recently, the First Circuit held that Code §936 does not require a credit cap decrease for the U.S. seller of business lines in Puerto Rico if the buyer is a foreign entity that does not pay U.S. corporate income tax. In OMJ Pharmaceuticals, Inc. v. U.S., a U.S. corporation based in Puerto Rico transferred a significant portion of its assets to an Irish subsidiary; the corporation was not required to decrease its base period income for the purposes of computing the cap on its Section 936 possessions tax credit. As a result, the corporation’s credit was not capped at the lower amount that was asserted by the I.R.S., thus allowing the corporate taxpayer a refund of close to $53 million.

From 1976 to 1996, Code §936 provided to U.S. corporations a credit that fully offset the federal tax owed on income earned in the operation of any trade or business in Puerto Rico. Under the Small Business Job Protection Act of 1996 (P.L. 104-188), the credit was repealed and phased out over a ten-year period. During this transition period, the credit remained available only to those taxpayers who had claimed it in previous years. Furthermore, during the last eight years of the transition period the taxable income that an eligible taxpayer could take into account in computing its credit was capped at an amount roughly equal to the average of the amounts it had claimed in previous years. Although the cap was generally fixed, it could be adjusted up and down to account for the taxpayer’s purchases and sales of lines of business that had generated credit-eligible income.

Tax 101: Outbound Acquisitions - Holding Company Structures

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When a U.S. company acquires foreign targets, the use of a holding company structure abroad may provide certain global tax benefits. The emphasis is on “global” because standard U.S. benefits such as deferral of income while funds remain offshore may not be available without further planning once a holding company derives dividends and capital gains. This article will discuss issues that should be considered when setting up a company overseas, particularly a foreign holding company, in order to maximize foreign tax credits despite the limitations under the U.S. tax rules, and to reduce the overall U.S. taxes paid. These issues include challenges to the substance of a holding company, recent trends in inversion transactions, the net investment income tax on investment income of U.S. individuals, and the significance of the O.E.C.D. Base Erosion and Profit Shifting report on tax planning structures.

U.S. TAXATION OF INTERCOMPANY DIVIDENDS AMONG FOREIGN SUBS

If we assume the income of each foreign target consists of manufacturing and sales activities that take place in a single foreign country, no U.S. tax will be imposed until the profits of the target are distributed in the form of a dividend or the shares of the target are sold. This is known as “deferral” of tax. Once dividends are distributed, U.S. tax may be due whether the profits are distributed directly to the U.S. parent company or to a holding company located in another foreign jurisdiction. Without advance planning to take advantage of the entity characterization rules known as “check-the-box,” the dividends paid by the manufacturing company will be taxable in the U.S. whether paid directly to the parent or paid to a holding company located in a third country. In the latter case, and assuming the holding company is a controlled foreign corporation (“C.F.C.”) for U.S. income tax purposes, the dividend income in the hands of the holding company will be viewed to be an item of Foreign Personal Holding Company Income, which generally will be taxed to the U.S. parent company, or any other person that is treated as a “U.S. Shareholder” under Subpart F of the Internal Revenue Code.

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.

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.

Insights Vol. 1 No. 5: F.A.T.C.A. 24/7

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I.R.S. PUBLISHES 1ST F.F.I. LIST

On June 2, implementation of the Foreign Account Tax Compliance Act (“F.A.T.C.A.”) reached another milestone. On that date, the I.R.S. published its first list of foreign financial institutions (“F.F.I.’s”) that have registered with the I.R.S. to show intent to comply with F.A.T.C.A. and have received a Global Intermediary Information Number (“G.I.I.N.”) to document that compliance. The I.R.S. list is important since U.S. withholding agents who are being asked by F.F.I.’s not to remit the 30% withholding tax imposed under F.A.T.C.A. must first obtain a G.I.I.N. from the F.F.I. and then confirm on the I.R.S. published list that the G.I.I.N. is accurate and in full force.

More than 77,000 F.F.I.’s appear on this first list and include foreign affiliates of some of the U.S.'s largest financial institutions. Among those financial institutions are Bank of America, JPMorgan Chase, Merrill Lynch, and Franklin Templeton.

Corporate Matters: Breaking Up Shouldn't Be So Hard to Do

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We have found that clients typically have to be persuaded to think about what will happen if a commercial relationship does not work out. In this issue we will discuss break up provisions and what you should look for when entering a business relationship or other form of contractual obligation.

The problem of what happens if a relationship does not work out as planned can arise in many different legal contexts: (i) Landlord/Tenant – in some instances matters concerning lease renewal are not determined when the lease is signed, but rather, they are negotiated at the expiration of the term; (ii) Joint Venture/Partnerships – many joint ventures or partnership are set up in ways that make deadlock a distinct possibility; (iii) General Contracts – either party to a contract can breach the terms and conditions; (iv) Marriage Contracts – apparently 50% of these are breached by one of the parties (the cleanest resolution of these breaches one governed by a pre-nuptial agreement). When everyone is in a good mood the assets are divided, even when the last thing on anyone’s mind is the division of assets.

Tax 101: Taxation of Foreign Trusts

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INTRODUCTION: WHAT IS A FOREIGN TRUST?

In General

A trust is a relationship (generally a written agreement) created at the direction of an individual (the settlor), in which one or more persons (the trustees) hold the individual's property, subject to certain duties, to use and protect it for the benefit of others (the beneficiaries). In general, the term “trust” as used in the Internal Revenue Code (the “Code”) refers to an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts.

Trusts can be characterized as grantor trusts or ordinary trusts. Ordinary trusts can be characterized as simple trusts or complex trusts; U.S. tax laws have special definitions for these concepts. A simple trust is a trust that is required to distribute all of its annual income to the beneficiaries. Beneficiaries cannot be charitable. A complex trust is an ordinary trust which is not a simple trust, i.e., a trust that may accumulate income, distribute corpus, or have charitable beneficiaries. Ordinary trusts are “hybrid” entities, serving as a conduit for distributions of distributable net income (“D.N.I.”), a concept defined in the Code,52 to beneficiaries and receiving a deduction for D.N.I. distributions, while being taxed on other income (e.g., accumulated income, income allocated to corpus).

A trust can be domestic or foreign. This article will focus on the U.S. tax consequences with respect to “foreign grantor trusts” (“F.G.T.”) and “foreign nongrantor trusts” (“F.N.G.T.”).

O.V.D.P. Update

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I.R.S. ANNOUNCES MAJOR CHANGES TO O.V.D.P. AND STREAMLINED PROCEDURES

After more than two weeks of speculation, 49 on June 18, 2014, the I.R.S. announced major changes to its current offshore voluntary disclosure programs earlier today. The programs affected are the 2012 Streamlined Filing Compliance Procedures for Non-Resident, Non-Filer U.S. Taxpayers (the “Streamlined Procedures”) and the 2012 O.V.D.P.

In general, as will be discussed in more detail below, the changes to the programs relax the rules for non-willful filers and at the same time potentially increase penalties for willful non-compliance.

The changes to the O.V.D.P., as announced today, include the following:

• Additional information will be required from taxpayers applying to the program;
• The existing reduced penalty percentage for non-willful taxpayers will be eliminated;
• All account statements, as well as payment of the offshore penalty, must be submitted at the time of the O.V.D.P. application;
• Taxpayers will be able to submit important amounts of records electronically; and
• The offshore penalty will be increased from 27.5% to 50% if, prior to the taxpayer’s pre-clearance submission, it becomes public that a financial institution where the taxpayer holds an account or another party facilitating the taxpayer’s offshore arrangement is under investigation by the I.R.S. or the Department of Justice.

F.B.A.R. Update: What You Need to Know

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NOTWITHSTANDING OFFICIAL COMMENTS, BITCOIN EXCHANGE ACCOUNTS SHOULD BE REPORTED ON F.B.A.R.’S

As noted in our previous issue, the I.R.S. clarified the tax treatment of Bitcoin, ruling that Bitcoin will not be treated as foreign currency but will be treated as property for U.S. Federal income tax purposes. As a result, the I.R.S. ruling may allow for capital gains treatment on the sale of Bitcoin. However, the ruling did not address whether Bitcoin is subject to Form 114 reporting.

This month, pursuant to a recent I.R.S. webinar, an I.R.S. official stated that Bitcoins are not required to be reported on this year’s Form 114. However, the official noted that the issue is under scrutiny, and caveated that the view could be changed in the future.

Notwithstanding the official’s comments, whether Bitcoin is a reportable asset will depend on the nature and manner it is held.

F.B.A.R. Assessment and Collections Processes: A Primer

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With the June 30^th deadline fast approaching and the recent cases addressing F.B.A.R. penalties, we thought it would be useful to provide a primer on F.B.A.R. assessment and collections processes.

BACKGROUND

In general, a U.S. person having a financial interest in, or signature authority over, foreign financial accounts must file an F.B.A.R. if the value of the foreign financial accounts, taken in the aggregate and at any time during the calendar year, exceeds $10,000.

The F.B.A.R. must be filed electronically by June 30 of the calendar year following the year to be reported. No extension of time to file is available for F.B.A.R. purposes.

Failure to file this form, or filing a delinquent form, may result in significant civil and/or criminal penalties:

• A non-willful violation of the F.B.A.R. filing obligation can lead to a maximum penalty of $10,000. If reasonable cause can be shown and the balance in the account is properly reported, the penalty can be waived.
• In the case of a willful violation of the filing obligation, the maximum penalty imposed is the greater of $100,000 or 50% of the balance in the account in the year of the violation.