Economic Distortions Arising from Deferral

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By Christine Long

This month, our team delves into the Joint Committee Report addressing international tax reform in a series of articles.The report explains what corporate tax executives know but most tax advisers and voters forget: The after-tax returns can be greater when one chooses to build a plant outside the U.S. Moreover, it never makes sense to repatriate the earnings and trigger the recognition of deferred tax expense. Is this the way to manage an economy? Christine Long comments.  See more →

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Competitiveness of the U.S. Tax System

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By Stanley C. Ruchelman, Andrew P. Mitchel, and Sheryl Shah

This month, our team delves into the Joint Committee Report addressing international tax reform in a series of articles. The report compares the U.S. tax system with the systems of other countries. Stanley C. Ruchelman, Andrew P. Mitchel, and Sheryl Shah explain what the J.C.T. staff believes. It is not pretty.  See more →

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Repatriation of Foreign Earnings v. Related Party Indebtedness

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On March 13, 2015, the United States Court of Appeals for the Fifth Circuit (the “Appeals Court”) reversed a decision of the United States Tax Court regarding the rules relating to the repatriation of earnings under Code §965.

Code §965 was a temporary statute permitting an 85% dividends received deduction in connection with the repatriation of earnings from a foreign subsidiary as long as the proper tests were satisfied. One test related to intercompany loans to foreign subsidiaries allowing them to pay the low-tax dividends. Even though the statute is not currently in effect, the reasoning of the Appeals Court suggests that substance will at times prevail, even if it works against the I.R.S.

BMC Software, Inc. (“BMC”) was a software developer that generated income from licensing operations. It had in effect a qualified joint cost-sharing agreement with a subsidiary. In 2002, the agreement was terminated and BMC began to pay royalties to the subsidiary in return for the transfer of rights back to BMC. In an I.R.S. examination, the arm’s length nature of the royalty amount was challenged and ultimately was resolved through two closing agreements entered into in 2007. The first determined that the amount of an arm’s length royalty was less than the amount paid. The second permitted BMC to treat the excess payment as a loan to the foreign subsidiary. This treatment, which has a long history in practice, was permitted under Rev. Proc. 99-32. As a result, the cash flow between BMC and its subsidiary was not changed but made to conform to the agreed amount of an arm’s length royalty, and the return of the cash would be tax-free but for some deemed interest.

J.C.T. Report on Competitiveness – A Step Toward Consideration of New Rules

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By Stanley C. Ruchelman

This month, our team delves into the Joint Committee Report addressing international tax reform in a series of articles. Stanley C. Ruchelman leads with comments on the J.C.T. analysis of Subchapter N of today’s Code – the foreign provisions.  See more →

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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.

Insights Vol. 2 No. 3: F.A.T.C.A. 24/7

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FOREIGN ACCOUNTS – UPDATE TO 2014 INSTRUCTIONS TO FORM 8938

Form 8938, Statement of Specified Foreign Financial Assets, requires the disclosure of certain foreign financial assets owned by U.S. citizens, resident alien individuals, and nonresidents who elect to be treated as resident alien individuals for U.S. tax purproses. (E.g., a nonresident alien having a U.S. citizen spouse may elect be treated as a U.S. resident for purpose of filing a joint income tax return.) Form 8938 is attached to the individual’s income tax return for the applicable year (starting with tax year 2011) and must be filed by the due date for said return, including extensions.

Updates to the 2014 instuctions for the Form 8938 reporting requirements were announced on March 10, 2015 and incorporate final Treasury Regulations under Internal Revenue Code (the “Code”) §6038D, adopted in December 2014. The final regulations are effective for taxable years beginning after December 19, 2011. The update contains additional information not included in the updated instructions for Form 8938. Taxpayers and their tax return preparers must review these recent changes to the form’s instructions to make sure it does not affect their filing obligations.

Dual Resident Taxpayers

A dual resident taxpayer, within the meaning of these regulations, is an individual who is considered a resident of the U.S. under the Code and applicable regulations because he or she meets the “Green Card Test” or the “Substantial Presence Test” and is also a resident of a treaty country (pursuant to the internal tax laws of that country). The updated instructions apply to dual resident taxpayers who determine their income tax liability for all or a portion of the taxable year as if they were nonresident aliens (pursuant to a provision of an income tax treaty that provides for resolution of conflicting claims of residence by the U.S. and its treaty partner).

Corporate Matters: Partnerships

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In previous issues, we discussed limited liability companies and the various benefits of using such entities, including pass-through taxation, asset protection, ease of formation and flexibility. There are partnerships that can be used to achieve the same results that may be of particular interest to individuals from jurisdictions where the limited liability company is not recognized to the same extent as it is in the United States. These are “Limited Partnerships,” “Limited Liability Partnerships” and “Limited Liability Limited Partnerships.” We thought it may be helpful to outline the differences between these three types of partnerships. Research should be conducted on a state-by-state basis depending on the jurisdiction one is interested in – the following discussion focusses on Delaware.

LIMITED PARTNERSHIP

A Limited Partnership is a partnership where one or more of the owners are general partners and one or more of the owners are limited partners. The general partners have unlimited liability and are liable for all of the partnership’s debts and obligations. The limited partners have limited liability – limited to the amount of capital they have invested in the partnership. General partners control the partnership and are responsible for its operation. Limited partners have no say in the operation of the partnership and are subject to losing liability protection if they are found to be participating in the management of the partnership. The Delaware Revised Uniform Limited Partnership Act (“DRLPA”) provides that “a limited partner is not liable for the obligations of a limited partnership unless he or she is also a general partner or, in addition to the exercise of the rights and power of a limited partner, he or she participates in the control of the business.”

LIMITED LIABILITY PARTNERSHIP

A Limited Liability Partnership is a general partnership for which an election has been made to obtain limited liability for all of the general partners. Unlike a Limited Partnership, in a Limited Liability Partnership there are no limited partners and all partners can participate in the management of the partnership. As a general rule, the partners of a Delaware general partnership are liable for all of the obligations of the partnership.

Major U.S. Drug Company Avoids Billions in Taxes on $1,000 Pill

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Gilead Sciences Inc. (“Gilead”) has developed one of the most expensive drugs available and is avoiding billions of dollars in U.S. taxes by holding its profits outside of the U.S.

The U.S. company has produced a hepatitis C treatment that costs $1,000 per pill. The treatment, which consists of a 12-week regime of its hit drug, Sovaldi, and another pill called Harvoni, costs $94,500 and has alleviated the hepatitis infection and successfully cured most patients of hepatitis C. Since receiving approval for Sovaldi from the Food and Drug Administration in 2013, the profits poured in for Gilead.

Pre-Immigration Income Tax Planning, Part I: U.S. Tax Residence

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INTRODUCTION

Income tax planning for an individual preparing to immigrate to the U.S. involves both understanding the jurisdictional concepts of U.S. tax law and making intelligent life decisions to take advantage of the rules. In comparison to a business investment in the U.S., which involves the use of funds to accomplish a specific goal, individuals wishing to come to the U.S. make a series of personal changes that will affect all aspects of their lives. U.S. tax planning considerations are merely one part of the puzzle that must be solved. The key to the planning often requires a timely decision to accelerate or defer income, gain, or loss, so as to avoid unnecessary exposure to tax while in the U.S. In addition, it entails knowledge of the tax cost involved in the event an individual wishes to continue to live in an accustomed life style.

This article is the first in a series that will discuss the rules affecting individuals moving across borders. The series will address important considerations before, during, and after undergoing a period of U.S. tax residence, income tax planning opportunities for persons wishing to immigrate to the U.S., and ethical considerations that may apply when providing advice to the foreign individual. Departure taxes in other countries are beyond the scope of this article.

This installment discusses the tests by which a foreign individual is deemed to be a U.S. tax resident under domestic law and provisions for determining residence under income tax treaties. Domestic law applies the “Substantial Presence Test” and the “Green Card Test.” If an individual meets the conditions of either test, he or she will be considered to be a resident for income tax purposes.

GREEN CARD TEST

A foreign individual becomes a resident with respect to a calendar year if he or she is a lawful permanent resident of the U.S. at any time during that calendar year. A lawful permanent resident is an individual who has been lawfully granted the privilege of residing permanently in the United States as an immigrant in accordance with the immigration laws.

I.R.S. Defines Measure for Tax Rate Disparity Test

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In order to reduce its overall foreign tax rate, a company may attempt to separate its foreign manufacturing from its foreign sales operations. If a foreign manufacturing entity sells products at a low margin to a related foreign sales entity in a lowtax jurisdiction, less foreign taxes are paid than if the foreign manufacturing entity sold the products directly to customers. This type of transaction would generally trigger foreign base company sales income (“F.B.C.S.I.”) for the sales entity, while the manufacturing entity could rely on the exception whereby income produced by certain manufacturing activities is not included in F.B.C.S.I. (the “Manufacturing Exception”).

Nice Work If You Can Get It: A New Yorker's Guide to Change of Domicile

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New York State has been known to question individuals who leave the state, easily identifiable as prior New York residents who file Form IT-203, Nonresident and PartYear Resident Income Tax Returns. Often, the New York State Division of Taxation (the “Division of Tax”) will argue that the taxpayer has not established sufficient evidence to relinquish New York domicile. New York places a high standard on redomiciliation: “The taxpayer must prove his subjective intent based upon the objective manifestation of that intent displayed through his conduct,” and it is always challenging for the taxpayer to show subjective intent. Therefore, it was welcome news when Judge Herbert M. Friedman Jr., an Administrative Law Judge, in Albany, New York recently ruled in favor of the taxpayer Irenee D. May.

THE MATTER OF IRENEE D. MAY

Mr. May moved to New York State and acquired a home in Harrison, New York (the “Harrison House”), where he resided with his wife and two children. He worked for JP Morgan in New York City for almost 20 years. Mr. May was terminated from his job effective January 2005. Shortly after, Mr. May obtained a position in London, working for the Royal Bank of Scotland. Mr. and Mrs. May made plans for the family to move to London with their children. They rented an apartment in London for the whole family, including their nanny. The lease was for one year; the eventual goal of the family was to sell Harrison House and purchase a home in London.

Subsequently, the children were not accepted to the desired London schools; therefore, Mrs. May returned with the children to Harrison allowing them to continue attending their previous school in Greenwich, C.T. Mr. May’s daughter briefly attended school in London but later returned to Harrison to live with her mother and brother.

New Centralized Approach to International Audits

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Federal budget cuts have resulted in a new risk-based approach to international audits by the Large Business & International (“L.B.&I.”) division of the I.R.S.

On February 27, Sharon Porter, acting director of International Business Compliance within the L.B.&I., announced that the I.R.S. will “re-engineer” its approach to international audits and begin implementing a pilot program utilizing an experimental centralized method of risk assessment.

Using a §897(i) Non-Discrimination Election to Avoid F.I.R.P.T.A.

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Mistakes happen. Often nonresident alien individuals buy U.S. real property, often personal use property, in their individual names. This can be a costly mistake. With certain exceptions, if such an individual were to die while owning the property, a U.S. estate tax of approximately 40% of the value of the property could be imposed.

There is one method to restructure this investment in the case of a foreign individual, or an entity owned by a foreign individual, if such a person is eligible to claim the benefit of an income tax treaty with the United States and the treaty contains a so-called “Nondiscrimination Clause.” These clauses provide that a resident of a treaty state will not be treated any less favorably than a U.S. resident carrying on the same activities. This article will look at how a Nondiscrimination Clause can be used to avoid onerous F.I.R.P.T.A. provisions when a foreign person invests in U.S. real property.

The technique described in this article essentially permits a nonresident alien individual to transfer U.S. real property on a tax-free basis to a foreign entity, which will be treated as a domestic entity for income tax purposes and as a foreign (non-taxable) entity for U.S. estate tax purposes.

McDonald's Accused of Re-Routing Royalty Payments to Avoid Billions in European Taxes

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Labor unions are accusing McDonald’s of avoiding €1 billion in tax by re-routing revenue through Swiss and Luxembourg units.

McDonald’s apparently asked its various franchises to pay it royalty revenue for using the McDonald’s brand.

Falciani: "The Man Who Makes the Rich Tremble"

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There is no denying that HSBC Holdings plc (“HSBC”) has significantly benefited from the Swiss bank secrecy laws. A February 8, 2015 report by the International Consortium of Investigative Journalists (the “I.C.I.J.”) revealed the private banking information for a Swiss subsidiary of HSBC as of 2007. The list of clients with secret accounts includes royal families, ambassadors, terror suspects, drug cartels, arms dealers, tax evaders, and fugitive diamond merchants.

The I.C.I.J. announced that it received information on 100,000 accounts through its collaboration with the French newspaper Le Monde, which obtained it from a source in the French government. The information was initially provided by a former HSBC employee, a computer technician named Hervé Falciani. French newspapers have dubbed him “the Man Who Makes the Rich Tremble.”

Debt vs. Equity: Comparing HP Appeal Arguments to the PepsiCo Case

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INTRODUCTION

Historically, the I.R.S. and taxpayers often disagreed over whether a loan between related entities should be treated as equity rather than true debt. As a result, substantial case law has built up over the years, especially involving closely-held entities. One such case is Mixon, which was discussed in our prior publication from April 2014 as the leading case law providing for the 13 factors to be considered in debt-equity cases. In recent years, the I.R.S. has begun to focus on the debt-equity issue in the cross border arena, and new decisions are being issued. Two 2012 cases, in the United States Tax Court (the “Tax Court” or “Court”), went in different directions. In PepsiCo, the taxpayer prevailed and equity treatment was upheld. In contrast, the I.R.S. prevailed in Hewlett-Packard, where the Tax Court was convinced that the transaction should be categorized as a loan rather than equity. In this case, the court looked beyond the instrument at issue and also examined agreements between the shareholders in the transaction.

Earlier this year, Hewlett-Packard (“HP”) appealed its loss in the Tax Court to the U.S. Court of Appeals for the Ninth Circuit, arguing that the lower court’s finding – that the investment displayed more “qualitative and quantitative indicia of debt than equity” – was “clearly erroneous.”

HP CASE – FACTS AND TAX COURT DECISION

HP purchased an interest in a Dutch corporation, Foppingadreef (“FOP”), from AIG in 1996. The investment was originally structured by AIG as an equity investment in preferred shares. The other shareholder was a Dutch bank, ABN AMRO (“ABN”). FOP’s Articles of Incorporation provide that it was organized for the purpose of investing its assets in contingent interest notes (“C.I.N.’s”) and other approved debt instruments. FOP invested in C.I.N.’s issued by ABN which provided for interest consisting of a fixed element and a contingent element. The terms of the preferred shares, as structured by AIG, gave HP voting rights and preferred entitlement to dividend distributions. HP’s vote was slightly more than 20%.

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

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BUSINESSMAN PLEADS GUILTY TO CONCEALING $8.4 MILLION

A Connecticut business executive, George Landegger, pled guilty to willfully failing to report $8.4 million held in Swiss bank accounts to the I.R.S. During the early 2000’s until 2010, Landegger maintained undeclared accounts which reached a maximum value of over $8.4 million at an unidentified Swiss bank.

While Landegger’s defense attorney confirmed that Landegger has not been accepted to the Offshore Voluntary Disclosure Program (“O.V.D.P.”), Landegger, according to the prosecutors, repeatedly rejected the possibility of disclosing his undeclared accounts to the I.R.S. through the O.V.D.P. and instead proactively took steps to conceal his accounts. Landegger held his undeclared accounts in a sham entity formed by a Swiss lawyer under the laws of Liechtenstein. In August 2013, the Swiss lawyer pled guilty to tax fraud conspiracy charges and has been cooperating with prosecutors.

Landegger agreed to pay a civil penalty of over $4.2 million and more than $71,000 in back taxes as part of his plea, entered on January 15, 2015. Landegger’s sentencing will be held May 12. He faces a maximum sentence of five years in prison. In his statement, I.R.S. Acting Special Agent-in-Charge Thomas E. Bishop stressed that uncovering hidden offshore accounts and income is the Service’s top priority and that it will continue working with the Department of Justice to do so. This case illustrustrates the importance of a timely O.V.D.P. submission.

OBAMA PROPOSES INCREASE IN CAPITAL GAINS TAX, ELIMINATION OF STEPPED-UP BASIS ON INHERITED ASSETS

President Obama has proposed a 28% tax rate on capital gains for couples with $500,000 in annual income and eliminating the stepped-up basis on inherited investments. Obama believes that these tax increases will help to pay for expanded benefits for middle- and low-income households. Congressional Republicans have indicated that they would not support Obama’s proposal.

Insights Vol. 2 No. 2: F.A.T.C.A. 24/7

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GLOBAL TAX TRANSPARENCY IS RISING

The Foreign Account Tax Compliance Act (“F.A.T.C.A.”) enacted in 2010 has been the driving force and the primary impetus for global tax transparency across borders. It has led to a ginormous administrative challenge for banks and other financial institutions as well as withholding agents in 2015. The O.E.C.D.’s recent release of the common reporting standard has led Treasury Department officials to view it as “the multilateralization of F.A.T.C.A.”

The U.S. has negotiated more than 100 Intergovernmental Agreements (“I.G.A.’s”) with nations across the globe to implement F.A.T.C.A and allow tax information to be shared between governments, which has set the stage for discussion for the onset of global exchange of tax information. More than 50 I.G.A.’s had already been signed and the remainder are treated as in effect and should be signed soon.

I.G.A. Challenge

The I.G.A.’s represent a growing trend in global tax transparency, though implementation has posed a challenge to some nations. Implementing an I.G.A. may require changes to local legislation, such as approving actions that are required to be taken under the I.G.A. and thus essentially making F.A.T.C.A. a part of the law of that country. The Internal Revenue service (“I.R.S.”) said in December 2014 that jurisdictions with I.G.A.’s treated as agreed-in-substance will have more time to get the pacts signed if they can demonstrate “firm resolve” to finalize them, which is subject to a monthly review. Given the uncertainty of whether all agreed-in-substance I.G.A.’s will eventually be signed, and what the language of the signed I.G.A. will provide, 2015 will pose a growing concern for foreign financial institutions (“F.F.I.’s”), who are required to navigate multinational F.A.T.C.A. compliance, and for banks, who must put new procedures in place.