What Entity Do You Want To Be?

Transcription

1 What Entity Do You Want To Be?

2 Presenters: Carla M. Smaston, Plante Moran Chip Chambley, Dixon Hughes Goodman, LLP

3 Agenda I. Choice of Entity for Foreign Operations Overview of U.S. System Tax Classifications & Elections II. Anti-Deferral/Repatriation III. Selling Outside the United States IV. Foreign Production V. U.S. Tax Considerations for Foreign Investors in U.S. Operations VI. Foreign Acquisitions / Case Studies VII. Wrap-up

4 Overview U.S. Tax System U.S. Tax system subjects U.S. companies, citizens, and residents to U.S. income tax on worldwide income Foreign Tax Credit (FTC) may be available in order to mitigate double taxation Earnings generated by foreign corporations owned by U.S. persons Generally deferred from U.S. taxation until earnings repatriated as a dividend U.S. C-Corporations can claim credit for underlying taxes paid by foreign corporation U.S. Individual taxpayers (S-Corporation owners) not eligible to claim this credit upon dividend distributions Election is available for U.S. persons to be subject to current taxation of foreign earnings and claim FTC for underlying foreign taxes paid Eliminates ability to defer U.S. taxation of foreign earnings Treats foreign entity as Flow-Through entity for U.S. tax purposes 4

5 Default Classifications of Entities Each eligible entity type has a default classification Entities where all owners have limited liability Default = Corporation Entities where at least one owner has unlimited liability Default = Tax Transparent Partnership if more than one owner Disregarded if only one owner 5

6 Entity Classification Classification of a foreign entity depends on the following determinations: Does a separate business entity exist? What is the entity s default classification? Does the member possess limited liability? Entity Classification Election: Is the entity a per se corporation? What is its desired classification? Entity Classification Election on Form

7 Per Se Corporations Domestic Inc. Corp. Insurance companies Foreign entities Individually identified for each country Most commonly SA, AG, PLC, and other publicly traded entities These entities can only be corporations for U.S. tax purposes 7

8 Check the Box Basics The check-the-box regulations generally provide that a wide range of entities, including foreign entities such as a foreign limited liability company, are entitled to elect their classification for U.S. federal tax purposes Elections may be made to treat an eligible entity as a corporation, as a disregarded entity (if it has a single owner), or as a partnership (if it has more than one owner) for U.S. federal income tax purposes Under Treas. Reg , certain entities are considered per se corporations and a check-the-box election cannot be made to treat a per se corporation as a partnership or disregarded entity Non per se entities are referred to as eligible entities 8

9 Check the Box Basics when to file & election term Classification Election Made by filing Form 8832 for the entity anytime 12 months prior to the effective date of the election through 75 days after the effective date of the election (sometimes 3 year and 75 days retroactive) Relief is possible for taxpayers to file late elections where certain conditions are met Once a classification election is made for an entity, a subsequent election generally cannot be made again to change the election for 60 months There is one exception: if the classification election is made upon the entity s formation (an Initial Election) an election can be made again even if it is within the 60 month period 9

10 Operations through a Foreign Branch US Co. registers to conduct business in foreign jurisdiction. Pros: Simple manner to conduct foreign operations. Beneficial if foreign jurisdiction imposes significant income taxes. Cons: No U.S. tax deferral on active income. US Co. must file annual income tax returns in foreign jurisdiction. Exposes US Co. to legal claims of foreign creditors. US Co $100 Foreign $100 Income 10

11 Operations through a Foreign Partnership/Joint Venture US Co. organizes a distinct Joint Venture entity under the laws of the foreign jurisdiction: Pros: Beneficial if foreign jurisdiction imposes significant income taxes. U.S. Co. should not have obligation to file income tax returns in foreign jurisdiction. Depending on the type of foreign entity, may insulate US Co. to legal claims of foreign creditors. Cons: No U.S. tax deferral on active income. Foreign legal and regulatory upkeep. Annual Form 8865 filing requirement. US Co $100 JV Partner For JV $100 Income 11

12 Operations through a Disregarded Entity US Co. organizes a distinct entity under the laws of the foreign jurisdiction. Said entity thereafter makes an Entity Classification Election for U.S. tax purposes. Pros: Beneficial if foreign jurisdiction imposes significant income taxes. U.S. Co. should not have obligation to file income tax returns in foreign jurisdiction. Depending on the type of foreign entity, may insulate US Co. to claims of foreign creditors. Cons: No U.S. tax deferral on active income. Losses may be limited by DCL regime (C corporation). Foreign legal and regulatory upkeep. Annual Form 8858 filing requirement. US Co $100 Foreign $100 Income 12

13 Operations through a Foreign Corporation US Co. organizes a subsidiary under the laws of the foreign jurisdiction. Said foreign entity is treated as a corporation for U.S. tax purposes. Pros: May provide tax deferral for income generated from active sources and income not involving related parties. U.S. Co. should not have obligation to file income tax returns in foreign jurisdiction. Depending on the type of foreign entity, may insulate US Co. to claims of foreign creditors. Cons: Application of U.S. Controlled Foreign Corporation regime. Section 902 credits available? Foreign legal and regulatory upkeep. Annual Form 5471 filing requirement. $100 Dividend US Co Foreign $100 Income 13

14 Repatriation / Anti-Deferral Repatriation Foreign Tax Credits Currency Considerations Anti-Deferral Subpart F Section

15 Selling Outside the United States Selling directly or through 3 rd Parties Opportunities Consider a Domestic International Sales Corporation Tax Risks To be discussed tomorrow in the presentation on effective tax rate strategies Creating a taxable presence in a foreign country VAT register, collect & remit? Business risks/issues with tax implications Increased credit risk Foreign currency risk Title passage revenue recognition, foreign source income 15

16 Selling Outside the United States Selling through wholly-owned foreign affiliates Opportunities DISC would still apply on sales to the foreign affiliate Tax Risks & Issues Potential double taxation Transfer Pricing how much profit in the foreign affiliate VAT Subpart F income on sales outside the foreign affiliate country (see next slide) Repatriation taxes withholding & US taxes Business risks/issues with tax implications Title passage on sales to the foreign affiliate 16

17 Selling Outside the United States CFC1 sells products mfd by USP to 3 rd party U.S. Parent Third Party (Germany) CFC1 (Switzerland) CFC2 (France) Third Party (France) Definition of Subpart F Foreign Base Company Sales Income Sale of product to a related party Where product was not produced By the seller or In the country of incorporation of the CFC and For consumption outside the country of incorporation Sale by CFC1 to German Third Party is a problem -- CFC1 did not produce the property Property was produced outside of Switzerland Product is for consumption in Germany Sale by CFC2 to French Third Party is not a problem CFC2 did not produce the property Property was produced outside of France but the sale is for use or consumption in the country of incorporation of the CFC (France) 17

18 Foreign Production Opportunities Ownership of IP Significantly larger opportunity to take advantage of deferral Issues & Risks Transfer pricing issues Subpart F income More complicated due to branch rules and foreign to foreign sales 18

19 U.S. Tax Considerations for Foreign Investors Foreign Investors in U.S. partnerships or domestic LLC s will become U.S. taxpayers Foreign Corporations file Form 1120-F Individuals file Form 1040NR Also requires U.S. entity to address withholding rules under IRC. Sec 1446 U.S. Entity selection could have impact on foreign filing requirements (may not be consistent or may be adverse e.g. Canada s views on U.S. LLC s) 19

20 U.S. Tax Considerations for Foreign Investors Foreign Investors in U.S. Corporations will need to address U.S. tax withholding on repatriations Consider application of Treaties Debt vs. Equity (IRC Sec 163(j) and 385) Foreign Entity selection unlikely to impact foreign owners beyond normal foreign tax rules (i.e., any CTB election for a foreign entity made by U.S. owners generally won t affect foreign owners in that entity) 20

21 Foreign Acquisitions Financing To be discussed during separate session Acquisition Planning Due Diligence To be discussed during separate session 338(g) Election Structuring Transfer Pricing Holding Companies Case Studies Case Study #1 -- Flow Through Acquisition Case Study #2 -- Flow Through / Deferral with Holding Company Example Case Study #3 -- C-Corporation Acquisition 21

22 Foreign Acquisitions Case Study #1 Simple Flow-through Client is an S Corp Manufacturing Company Looking to grow through acquisition No prior international activity Anticipate substantial growth internationally 22

23 Foreign Acquisitions Target Western European company Tax rate is comparable to US corporate tax rate Located in a Treaty Country However, the country views S corporations as pass-through entities and therefore will impose 15% withholding on dividends. Therefore we interposed a UK holding company Step-up in basis UK imposes no withholding taxes on dividends Client Parent (S Corp) Holding Company (UK) European Operating Co 23

24 Foreign Acquisitions Steps 1. Incorporated new Eastern European Holdco -- treated as corporation 2. New Holdco issued debt to acquire Contract Mfg Client Parent Note 2 -- New Intercompany Debt Results 1. Contract Mfg profit no longer taxable in the US 2. $10 million could be repatriated without tax using Note 2 principal 3. Additional amounts could be repatriated at the capital gain tax rate Target LLC Holdco Eastern Europe Contract Mfg SE Asia Note 1 -- Existing Intercompany debt 24

25 Foreign Acquisitions Subsequent Expansion Client identified another target, this time in western Europe Planning included: Establishing new holding company in western Europe Transferred old holding company to New Holding Check the box election on old holding to make it a disregarded entity New Holding borrowed funds to acquire New Target Results New debt refreshed the repatriation strategy More earnings continue to be deferred offshore All earnings qualify for capital gain tax rate upon repatriation to the US 25

26 Foreign Acquisitions Case Study #2 Flow-through/Deferral Structure Client is an S Corp Manufacturing Company Looking to grow through acquisition Goal to triple revenue in 5 years No prior international activity Anticipate substantial growth internationally 26

27 Foreign Acquisitions Target US manufacturer with a SE Asian contract manufacturer affiliate Tax holiday in SE Asia Target is selling membership in a single member LLC including the ownership interest in the SE Asian contract mfr SE Asia is a DRE SE Asia has a liability to US LLC for $10 million for the cost of the facility Client Parent (S Corp) Target LLC Contract Mfg SE Asia Note 1 -- Existing Intercompany debt 27

28 Foreign Acquisitions Steps 1. Incorporated new Eastern European Holdco -- treated as corporation 2. New Holdco issued debt to acquire Contract Mfg Results 1. Contract Mfg profit no longer taxable in the US 2. $10 million could be repatriated without tax using Note 2 principal 3. Additional amounts could be repatriated at the capital gain tax rate Target LLC Client Parent Holdco Eastern Europe Contract Mfg SE Asia Note 2 -- New Intercompany Debt Note 1 -- Existing Intercompany debt 28

29 Foreign Acquisitions Subsequent Expansion Client identified another target, this time in western Europe Planning included: Establishing new holding company in western Europe Transferred old holding company to New Holding Check the box election on old holding to make it a disregarded entity New Holding borrowed funds to acquire New Target Results New debt refreshed the repatriation strategy More earnings continue to be deferred offshore All earnings qualify for capital gain tax rate upon repatriation to the US 29

30 Foreign Acquisitions Final Structure Target LLC Client Parent New European Holdco Note 3 New debt to acquire Europe Note 2 -- Debt from incorporation New Europe Target Holdco Eastern Europe Contract Mfg SE Asia Note 1 --Original Intercompany debt 30

31 Foreign Acquisitions Case Study #3 C-Corporation Acquisition Client is an C Corp Manufacturing Company Looking to grow through acquisition No prior international activity Anticipate some growth internationally Foreign Manufacturing Target Identified 31

32 Foreign Acquisitions Target Canadian manufacturer with distribution subsidiaries in various countries. Target shareholders are selling 100% of the stock of Target. All of Target s subsidiaries are a part of the deal. Client Parent (C Corp) Target Foreign Corp Sub 1 Europe Sub 2 Europe Sub 3 US 32

33 Foreign Acquisitions Steps: 1. Client Parent Corp. ( Client ) borrows directly from Bank. Assuming new debt is needed to finance the acquisition, Client can borrow the funds directly from bank and introduce acquisition debt into the transaction. 2. Client forms Canadian subsidiary, AcqCo. This entity will be the amalgamation company used to facilitate the Canadian Manufacturer acquisition. Client contributes cash to AcqCo totaling $25M in exchange for shares and a promissory note. The $25M is comprised of paid-up capital ( PUC ) totaling $12M and a $13M promissory note. Since the debt to equity ratio is less than 1.5:1, the interest payments made by AcqCo will be deductible for Canadian tax purposes. Cash Client Parent Corp. (U.S.) AcqCo (Canada) Shares & Note Receivable The formation has no adverse U.S. consequences and meets the non-recognition requirements of I.R.C

34 Foreign Acquisitions 3. AcqCo uses the cash received from Client to purchase 100% of Target Corp. stock from its shareholders. If there is a desire to move Target s subsidiaries out-from-under Target in a postacquisition reorganization, Canadian foreign affiliate dumping rules apply in situations where the total value of the foreign affiliates (i.e., Sub 1, 2, & 3) are valued at greater than 25% of the total purchase price. Client Parent Corp. (U.S.) AcqCo (Canada) There should be no U.S. federal income tax consequences resulting from the acquisition. Cash Target Corp. (Canada) Stock 338(g) election to be made. Sub 1 Europe Sub 2 Europe Sub 3 U.S. 34

35 Foreign Acquisitions 4. AcqCo and Target Corp. amalgamate to form NEW Target Corp., a Canadian company. NEW Target steps into the shoes of Target Corp. There should be no adverse U.S. tax consequences associated with the amalgamation. The amalgamation may be treated as a type A reorganization or 332 liquidation for U.S. tax purposes. Client Parent Corp. (U.S.) NEW Target Corp. (Canada) Results: Canadian manufacturing profits earned by NEW Target, Sub 1, and Sub 2 not taxable in the U.S. All subsequent repayments of the $12M PUC by NEW Target are not subject to withholding in the U.S. Principle repayments of the $13M loan are not subject to U.S. taxation. Interest payments made between NEW Target and Client are not subject to withholding. Sub 1 Europe Sub 2 Europe Sub 3 U.S. 35

36 Summary of U.S. Taxation of Alternate Structures US C-Corporation owning Foreign Corporation US C-Corporation owning Foreign Flow-Through Entity US S-Corporation or LLC owning Foreign Corporation US S-Corporation or LLC owning Foreign Flow-Through Entity Income Taxed Currently or Deferred Until Repatriation Foreign Tax Credit Available for Underlying Corporate Income Taxes Paid Foreign Tax Credit Available for Dividend Withholding Tax EX 1 Deferred Yes Yes EX 2 Current Taxation Yes Yes EX 3 Deferred No Yes Ex 4 Current Taxation Yes Yes NOTE: Deferral subject to Subpart F rules 36

37 Global Effective Tax Rates 4 examples 37

38 Carla M. Smaston, Plante Moran Chip Chambley, Dixon Hughes Goodman LLP 38

39 DISCLAIMER Scope and Limitations Disclosure This communication is limited in scope and content, and is strictly limited to the issue(s) addressed and based solely upon representations of facts presented herein. This communication is intended to provide general information for discussion purposes only and cannot be relied upon to avoid tax exposure, penalties, or any other purpose. 39

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