2011 Joint Fall CLE Meeting Hyatt Regency Denver October 20-22, 2011

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1 ABA Section of Taxation 2011 Joint Fall CLE Meeting Hyatt Regency Denver October 20-22, 2011 Principal Structures Are Not Just for Manufacturers Planning for Service Providers Under Subpart F Moderator: Lowell D. Yoder, McDermott Will & Emery, LLP Panelists: Ginny Chung, Attorney Advisor Office of Tax Policy Department of Treasury Jeffery G. Mitchell, Chief Branch 2, Office of Associate Chief Counsel International, IRS Gretchen Sierra, Principal Deloitte Tax LLP

2 Overview General Definition of Foreign Base Company Services Income Foreign Base Company Sales/Services Overlap Issues Principal Structures for Service Providers Cloud Computing 1

3 Foreign Base Company Services Income Related Person: A CFC performs services for, or on behalf of, a related person (>50% ownership); and Outside Country: The services are performed outside of the CFC s country of organization 954(e); Regs

4 FBCServI Illustration U.S. Parent Services German OpCo Services Swiss Centralized Services Performed in Switzerland (Not FBCServI) Performed Outside Switzerland (FBCServI) 3

5 Place Where Services Performed Facts and circumstances test Generally, country where employees are physically located when performing the services Apportion services income based on employee time spent within and without the CFC s country (take into account relative value of the types of services) 4

6 Issues: Location of Services Apportion services income only with respect to employees or take into account subcontractors as well? Are sales and marketing activities taken into account? What if services are provided via a machine (e.g., server) located outside the CFC s country? 5

7 Definition of Services Services derived in connection with the performance of technical, managerial, engineering, architectural, skilled, industrial, commercial, or like services. Definition may be applied to include most services (e.g., telecommunication, financial, manufacturing) Substance & predominant character 6

8 Foreign Base Company Sales/Service Overlap Issues FBCSI includes income that is generally characterized as services (i.e., commissions for purchase or sale activities) What services are within scope of FBSCI rules? Includes certain purchase or sales agent commissions What else? Manufacturing, QA, logistics, other supply chain services? Raises issues regarding coordination of the FBSCI/FBServI rules 7

9 FBCServI/FBSCI Overlap Issues U.S. Parent Services Buy-Sell Centralized Supply Chain Services (X) -Place orders -Negotiate prices -Travel to mfg for QA -Logistics -Finding new mfrs Various Countries Manufacturers Toll Mfg (Y) Activities Performed In CtyX Activities Performed In CtyY FBSCI or FBCServI rules apply or both? 8

10 Related FBSCI Branch Rule Issues Related Party Buy-Sell CFC (Y) -independently qualifies under SC rules DRE1 DRE2 (Z) (X) -Doesn t independently qualify for SC, but does: -Logistics -Qualifying new manufacturers -Scorecard mfers -Place orders -Negotiate prices Is DRE1 and DRE2 purchase branch? 9

11 Principal Structures Centralize functions, intangibles, and risks in a low tax country (e.g., a center of excellence) FBCServIdefinition does not apply to the Services Principal if Services performed in Principal s country, or Principal performs services for unrelated persons 10

12 Regarded Principal Structure USP Luxembourg HoldCo India Subcontractor Service (cost +) Singapore Principal Centralized Functions, IP & Risks Service (revenues less cost +) Service Japan OpCo Services Relationship Unrelated Japanese Customer 11

13 Subpart F Analysis: Regarded Principal Structure Service fees derived by Principal are not FBCServI to the extent services are performed in Singapore What about services income derived by the Principal from oversight, IP and risks attributed to services performed in India and Japan by affiliates? 12

14 Disregarded Principal Structure USP Luxembourg HoldCo India Subcontractor Service (cost +) Singapore Principal Centralized Functions, IP & Risks Service (revenue less cost +) Service Japan OpCo Services Relationship Unrelated Japanese Customer 13

15 Subpart F Analysis: Disregarded Principal Structure Service fees derived by Principal are not FBCServI because services are provided to unrelated persons Caveat: The Principal s income is FBCServI if ( on behalf of ) USP substantially assists with the provision of the services, or Any related person guarantees Principal s services & provides any assistance 14

16 Substantial Assistance (Notice ) Costs to CFC of USP s services equals or exceeds 80% of total costs to CFC of providing the services May includes all costs, such as support services, financing, and royalties (should not include cost sharing payments) Note: Any payments to CFCs and third parties help with the 80% test 15

17 Principal/Customer Relationship Foreign HoldCo India Subcontractor Service (Cost +) Singapore Principal Service (Cost +) Japan OpCo Services Unrelated Japanese Customer 16

18 Subpart F Analysis: Principal/Customer Relationship Service fees derived by Principal are not FBCServI because services are provided to unrelated persons Caveat: The Principal s income is FBCServI if There is an on behalf of arrangement, and Services are considered as performed outside Singapore 17

19 Principal/Commissionaire Foreign HoldCo India Subcontractor Service Singapore Principal Remit Service (less cost +) Japan Commissionaire Services Relationship Service Unrelated Japanese 18

20 Subpart F Analysis: Principal/Commissionaire Japan contracts with the customer on behalf of the Principal and collects and remits fees to Principal Japanese affiliate has the relationship with the customer, but Principal is considered as performing services directly for the unrelated customer Same Subpart F analysis as Principal/Customer Structure (slide 17) 19

21 Factoring Service Receivables (PLR ) Principal sells a services receivable that has a basis less than face amount (deferred income under RP ) Gain recognized from factoring the receivable is not Subpart F income, Not FPHCI gain from the sale of an asset, and Characterized based on non-sub F services income 20

22 Cloud Computing What is it?: Method of providing goods and services over the Internet with the customer utilizing the software and/or hardware of the goods or service provider Three general categories of offerings: Software as a Service (SaaS): SaaS covers the range of application that are licensed for use as services provided to customers on demand typically across the Web. Platform as a Service (PaaS): The PaaS model makes all of the facilities required to support the complete life cycle of building and delivering Web applications and services entirely available from the Internet. Infrastructure as a Service (IaaS): IaaS is the delivery of computer infrastructure as a service. Rather than purchasing servers, software, data center space, or network equipment, clients instead buy those resources as a fully outsourced service. 21

23 Various Tax Issues Cloud Computing Character, Source, USTB/PE, ECI/Attributable Income, Transfer Pricing, and Subpart F Considerations 22

24 Cloud Computing USP US Servers Cost Sharing Arrangement CFC1 Hosting Fee Sales/Marketing/ Customer Support OpCo1 OpCo2 Sales/Marketing/ Customer Support (X) (Y) Software Arrangement Customers Software Arrangement

Silicon Valley Chapter

Silicon Valley Chapter Subpart F: Sales Income Review and Planning Strategies March 23, 2017 Biltmore Hotel & Suites, Santa Clara Lowell D. Yoder lyoder@mwe.com Subpart F Sales Income CFC purchases property