Flipping the Switch on Foreign Corporation s Form of Doing Business in the U.S.

Transcription

1 ABA Section of Taxation, U.S. Activities of Foreigners & Tax Treaties Committee 2014 Joint Fall CLE Meeting September 18-20, 2014 Denver, Colorado v2/1 Flipping the Switch on Foreign Corporation s Form of Doing Business in the U.S. Scott Harty Smith, Gambrell & Russell, LLP Atlanta, GA sharty@sgrlaw.com Moderator Sam K. Kaywood, Jr., Esq. Alston & Bird LLP Atlanta, GA sam.kaywood@alston.com Panelists Michael Snider Davis Graham & Stubbs, LLP Denver, CO michael.snider@dgslaw.com

2 BRANCH PROFITS TAX OVERVIEW v2/2 DGSLAW.COM

3 BPT OVERVIEW Purpose is to equalize treatment of branch remittances with subsidiary distributions BPT is imposed after corporate level tax on net taxable income Dividends of U.S. subsidiaries of foreign parent companies subject to 30% withholding tax (subject to reduction under an applicable income tax treaty) 30% branch level tax imposed when earnings that are attributable to the branch are not reinvested but rather remitted to the foreign corporation v2/3 DGSLAW.COM 3

4 BPT OVERVIEW BPT applies to the Dividend Equivalent Amount ( DEA ) of the branch (subject to reduction under an applicable income tax treaty). Branch may refer to any effectively connected earnings & profits ( ECE&P ) of a foreign corporation To compute the DEA of a branch: o Start with ECE&P (current and accumulated) o Increase DEA if U.S. Net Equity decreases (i.e., funds are remitted to foreign corporation) o Increase limited to beginning accumulated ECE&P o Decrease DEA if U.S. Net Equity increases (i.e., funds are reinvested in branch) v2/4 DGSLAW.COM 4

5 BPT OVERVIEW U.S. Net Equity is a measure of the assets used in the business generating ECI. Net equity decreases when funds are remitted and net equity increases when funds are reinvested Liabilities do not fairly reflect dividend paying ability so net equity means the adjusted bases of the U.S. assets reduced by the U.S. liabilities Liabilities taken into account are the U.S. Connected Liabilities as of the end of the year v2/5 DGSLAW.COM 5

6 BPT EXAMPLE Each year foreign corporation earns $100,000 through a U.S. branch for 3 years and pays tax at a 35% rate. All earnings are reinvested. Year 3 ECE&P = $195,000 Year 3 U.S. Net Equity = $195,000 Year 3 DEA = $0 In year 4, the foreign corporation earns another $100,000 and remits $150,000. Year 4 ECE&P = $260,000 Year 4 U.S. Net Equity = $110,000 Year 4 Decrease in U.S. Net Equity = $85,000 Year 4 DEA = $150,000 ($65,000+$85,000) Year 4 BPT = $45,000 ($150,000 x 30%) v2/6 DGSLAW.COM 6

7 COMPLETE TERMINATION OF U.S. BRANCH FCo U.S. Branch Branch $ Buyer Sale or termination of branch not subject to BPT if: o o Has no U.S. assets at end of tax year or FCo resolves to liquidate and dissolve and have no U.S. assets at end of next tax year; Neither FCo nor a related company uses any U.S. assets of the branch in an U.S. trade or business for the next three years Failure to comply with one of these four tests means that cash remitted to FCo is subject to BPT (subject to DEA calculations, etc.) o FCo does not have ECI for the next 3 years; and o FCo waives statute of limitations v2/7 DGSLAW.COM 7

8 COMPLETE TERMINATION OF U.S. BRANCH F Parent Cash used in U.S. Branch or derived from sale of U.S. Branch cannot be loaned to a related company with U.S. trade or business: FCo FCo 2 Cash cannot be used as security for a loan to FCo 2 s U.S. branch U.S. Branch IP License $ Loan U.S. Branch IP cannot be licensed to U.S. Branch of FCo 2. FCo does not have ECI for the next 3 years; and Special rules for deferred ECI under 864(c)(6) and 861(c)(7) v2/8 DGSLAW.COM 8

9 SPECIAL CONSIDERATIONS FOR FOREIGN CORPORATIONS v2/9 DGSLAW.COM

10 THRESHOLD CONSIDERATIONS How much U.S. activity will the foreign corporation have? Will it rise to the level of a U.S. trade or business? A foreign corporation in a treaty country must have a PE to be subject to the BPT. Is there an applicable income tax treaty that contains a branch profits article? At what point does the foreign corporation establish branch? No bright line test - consider facts and circumstances v2/10 DGSLAW.COM 10

11 BRANCH CONSIDERATIONS Benefits of a Branch o Administratively simpler o Fewer expenses and less complexity o Foreign banks and insurance companies may need the capital of the parent to meet minimal capitalization requirements Possible Drawbacks of a Branch o No limitation of liability foreign corporation is responsible for liabilities o Must confirm state tax treatment and foreign law treatment of branches operated through LLCs o Foreign corporation must obtain a federal EIN and file a U.S. corporate income tax return o May lose deductions if tax return not timely filed (Swallows Holdings) v2/11 DGSLAW.COM 11

12 PARTNERSHIP CONSIDERATIONS Foreign corporation may wish to partner with a U.S. or foreign entity to operate a U.S. business. Cost/benefit analysis is similar to a branch Partners are treated as (and taxed) as if they are engaged in a U.S. trade or business If a foreign corporation sells its partnership interest, Rev. Rul may treat the gain as U.S. source ECI Ruling has been controversial for lack of authority. President s Green Book continues to propose codification of Rev. Rul (concern that foreign taxpayers may claim gain is not subject to U.S. tax due to lack of statutory authority) v2/12 DGSLAW.COM 12

13 PARTNERSHIP CONSIDERATIONS Partnerships may also permit the use of a hybrid entity, which may be helpful for foreign tax purposes If a foreign corporate entity invests in a U.S. limited partnership that elects to be taxed as a corporation it may provide foreign tax benefits 99% German GmbH Dividend withholding applicable and subsidiary considerations remain 1% Beware domestic reverse hybrid rules v2/13 DGSLAW.COM 13

14 DOMESTIC REVERSE HYBRID STRUCTURE Consolidated Return FCo 99% DRH U.S. Opco Loan Interest Dividends Bank DRH is a U.S. general partnership that elects to be a U.S. corporation for U.S. tax purposes FCo treats DRH as transparent for U.S. tax purposes- deducts interest on foreign tax return DRH deducts interest paid to Bank on U.S. consolidated return See Reg (d)(2)(iii), Example v2/14 DGSLAW.COM 14

15 DEDUCTING INTEREST ON FOREIGN DEBT Interest allocation rules of apply F Parent Loan Interest Bank % of worldwide debt allocated to U.S. Branch Interest paid to foreign bank allocated to U.S. Branch in proportion to U.S. debt U.S. Branch Branch level withholding tax may apply, subject to treaty reduction ( 884(f)) Hybrid scenarios v2/15 DGSLAW.COM 15

16 SUBSIDIARY CONSIDERATIONS Benefits of a Subsidiary o Liability protection for foreign parent o No need to obtain a federal EIN or file a U.S. income tax return o Intangible benefit of being recognized as a U.S. corporation o State and foreign tax treatment should be clear Costs of a Subsidiary o More complex and costly structure o May increase taxes for foreign corporation depending on treaty analysis v2/16 DGSLAW.COM 16

17 TREATY ISSUES FOR FOREIGN CORPORATIONS v2/17 DGSLAW.COM

18 TREATY ISSUES Section 884(e): Treaty coordination provision reduces the BPT to the treaty dividend rate imposed on domestic corporations paying dividends to wholly owned foreign parent companies Many treaties have eliminated withholding for 80% owned subsidiaries: U.K., Japan, Germany, Australia, France, Netherlands Some treaties entirely eliminate the branch profits tax v2/18 DGSLAW.COM 18

19 TREATIES THAT ELIMINATE BPT China Cyprus Egypt Hungary (newly executed treaty, not yet ratified, will permit branch profits tax) Jamaica Korea Morocco Norway Pakistan Philippines v2/19 DGSLAW.COM 19

20 TREATY ISSUES In order to claim the benefits of an income tax treaty, the foreign corporation must be a qualified resident of the foreign country For treaties entering into force after December 31, 1986, the foreign corporation only needs to satisfy the LOB article For treaties entering into force before December 31, 1986, the foreign corporation must satisfy BOTH the LOB article and one of the qualified resident tests under In order to be a qualified resident a foreign corporation must meet: The ownership/base erosion test Public ownership test, or Active business test v2/20 DGSLAW.COM 20

21 TREATY EXAMPLE - CHINA Chinese corporation plans to invest in the U.S. and would prefer to use a company organized outside of China (due to foreign exchange controls) as an intermediary entity Direct investment would result in dividends subject to a 10% withholding tax pursuant to the treaty China U.S. Dividend v2/21 DGSLAW.COM 21

22 TREATY EXAMPLE - CHINA No branch profits tax for Chinese companies under U.S. China income tax treaty Indirect investment through disregarded Hong Kong entity into U.S. LLC would result in no BPT on remittances by U.S. LLC to foreign parent corporation China Hong Kong Effective tax rate on remittances reduced by 10% No BPT 894 anti-hybrid rules apply? U.S. LLC v2/22 DGSLAW.COM 22

23 TREATY EXAMPLE GERMANY STRUCTURING INTO BRANCH PROFITS German investor asks if it is preferable to invest in the U.S. through a corporation or an LLC German Investor Investing directly through a U.S. corporation results in a 15% withholding tax on dividends Dividend No estate tax exposure under the U.S. German estate tax treaty U.S v2/23 DGSLAW.COM 23

24 TREATY EXAMPLE GERMANY STRUCTURING INTO BRANCH PROFITS Investing through a German GmbH into a LLC (treated as a disregarded entity for U.S. and German purposes) may result in no U.S. BPT No BPT under Article 10 if derivative benefits test is met German Investor At least 95% owned by 7 or fewer individuals entitled to treaty benefits Less than 50% of the gross income is paid to individuals not entitled to treaty benefits Section 861(a)(2)(B) withholding? German GmbH U.S. LLC Distribution v2/24 DGSLAW.COM 24

25 Switching from a U.S. Branch to a U.S. Subsidiary Switching from a U.S. Branch to a U.S. Subsidiary v2/25 DGSLAW.COM

26 In General FCo U.S. Sub Contribute U.S. Branch Treated as an incorporation of an existing business Forms of transaction o o Check the box on a branch operating through an eligible entity Contributing business to a newly formed corporation Generally governed by Section 351 Section 884 and potentially Section 897 also apply v2/26 DGSLAW.COM 26

27 Branch Profits Tax Requirements to avoid BPT o Section 351 requirements satisfied o Transferor itself must satisfy Section 351 control requirements (i.e., own 80% after the transaction) o Transferor agrees to remain liable for BPT upon subsequent disposition of transferee stock o Transferee must elect to receive an allocation of transferor s previously untaxed ECE&P (Treas. Reg T(d)(4)) v2/27 DGSLAW.COM 27

28 Effect of Election on Transferor Branch Profits Tax o Subject to BPT on subsequent disposition of transferee stock o May not benefit from branch termination exemption from BPT in same year Effect of Election on Transferee o Allocated a portion of transferee s ECE&P as if 381(a) applied o Distributions out of such ECE&P qualify for treaty relief only to extent that transferor would have qualified for reduction of BPT under a treaty v2/28 DGSLAW.COM 28

29 Treatment of Retained Assets Retained IP/$$ FCo Contribute U.S. Business FCo retains cash and IP which is loaned to U.S. Sub Increase DEA, causing BPT unless a treaty applies If treaty protection is available, is T(d)(4) election needed? License/ Loan U.S. Sub v2/29 DGSLAW.COM 29

30 FIRPTA Requirements for nonrecognition on contribution of a USRPI o FIRPTA Rules apply independently of 884 o Satisfy Section 351 requirements o Receive a USRPI in exchange (i.e., U.S. subsidiary is a USRPHC) o Satisfy filing requirements of Treas. Reg T(d)(1)(iii) or Notice 89-57, as applicable v2/30 DGSLAW.COM 30

31 Switching from a U.S. Subsidiary to a U.S. Branch Switching from a U.S. Branch to a U.S. Subsidiary v2/31 DGSLAW.COM

32 In General Treated as a liquidation of U.S. subsidiary for tax purposes Forms of transaction o Checking the box on an eligible entity o Converting from corporation to an eligible entity o Liquidating corporation for state law purposes Liquidations generally governed by Section 331 or 332 o Can generally plan into, or out of, a taxable or nontaxable liquidation (See Granite Trust) o Outbound Section 332 liquidations subject to Sections 367 and 332(d) Section 884 and potentially Section 897 also apply v2/32 DGSLAW.COM 32

33 Section 367(e)(2) Section 367(e)(2): U.S. subsidiary recognizes gain or loss Exceptions o United States real property interests (USRPIs) o U.S. business assets o Stock of a U.S. subsidiary General theme of exceptions is that gain effectively remains in U.S. tax jurisdiction Applies an aggregate approach to flow-through entities v2/33 DGSLAW.COM 33

34 Section 367(e)(2) USRPI Exception Same definition for USRPI as Section 897 (FIRPTA) USRPI Exception takes priority over U.S. business asset exception Not applicable to stock in a former U.S. real property holding corporation (USRPHC) Foreign parent does not recognize gain under FIRPTA if U.S. subsidiary is a USRPHC Must comply with FIRPTA filing requirements v2/34 DGSLAW.COM 34

35 Section 367(e)(2) U.S. Business Asset Exception 936(h) intangibles not eligible for exception o Customer lists subject to gain but not goodwill Must be used by U.S. subsidiary in a U.S. business prior to liquidation (no time requirement) Must be used by foreign parent in a U.S. business for 10 years following the liquidation Foreign parent must waive treaty protection for ECI Extensive filing requirements including equivalent of a GRA o IRS can choose to waive filing requirements v2/35 DGSLAW.COM 35

36 Section 367(e)(2) U.S. Subsidiary Exception 80% direct ownership by foreign parent If liquidating corporation is a USRPHC subsidiary must be a USRPHC Anti-abuse rule Must enter into a GRA which is triggered if the anti-abuse rule applies v2/36 DGSLAW.COM 36

37 Stock Exception Anti-Abuse Rule U.S. Sub 1 FCo U.S. Parent U.S. Sub 2 Liquidation U.S. Parent liquidates distributing stock of U.S. Sub 1 and U.S. Sub 2 Stock exception would normally apply (absent FIRPTA) But: o If FCo sells the stock of U.S. Sub or U.S. Sub 2 to a third party, within 2 years, the antiabuse rule applies o Is it better to spin off stock of the U.S. Sub that might be sold? v2/37 DGSLAW.COM 37

38 Section 367(e)(2) Section 367(e)(2) provides for recognition of gains and losses Limitations on losses o Loss assets must not qualify for an exception to Section 367(e)(2) o Losses limited to gains o Limitation on acquired losses o Section 336 anti-stuffing rules also apply Anti-abuse rule can apply to require recognition of gain or loss if a principal purpose of the liquidation is tax avoidance o Specifically includes the distribution of E&P with a principal purpose of avoiding tax v2/38 DGSLAW.COM 38

39 PLR USCo group had lower of levels of debt relative to its assets and earnings compared to that of Parent s Country A entities Parent (Country A) For valid accounting and financial purposes, Parent wished to liquidate USCo and operate in the U.S. through a branch Opco CFC 1 USCo Opco CFC 2 Intended to allow U.S. branch s deductions for interest of the Parent to be determined under Treas. Reg Opco CFC 1 Sub Opco 2 Sub v2/39 DGSLAW.COM 39

40 PLR Ruled that liquidation was nontaxable under Section 332 except with respect to gain attributable to intangibles Discussed, but did not apply, the anti-abuse rule GPCo CFC Parent (Country A) LP Opco CFC 1 Sub Opco CFC 2 Sub v2/40 DGSLAW.COM 40

41 Section 332(d) Treats an outbound liquidation of an applicable holding company as a Section 301 distribution Applicable holding company o Common parent of an affiliated group o Stock directly owned by distributee foreign corporation o Substantially all of the assets of which consist of stock in members of affiliated group o Has not been existence for 5 years Designed to prevent transaction intended to distribute E&P free of withholding tax v2/41 DGSLAW.COM 41

42 Section 332(d) Parent (Country A) Parent (Country A) USCo USCo $100 Opco Opco Opco earns $100 in E&P Opco distributes $100 in cash to USCo and USCo immediately liquidates $100 of earnings is distributed with no withholding tax U.S. activities remain in corporate solution v2/42 DGSLAW.COM 42

43 Branch Profits Tax Subsidiary s E&P becomes non-previously taxed ECE&P of foreign parent Foreign parent s U.S. net equity increased by the greater of: 1. increase in U.S. net equity as a result of liquidation or 2. total amount of U.S. net equity transferred by foreign parent to U.S. subsidiary in prior nonrecognition transactions v2/43 DGSLAW.COM 43