International Tax Update

Transcription

1 Managing Effective Tax Rate Through International Tax Planning William James, Principal Matthew Campbell, Senior Managing Consultant June 11, 2009 acumen insight ideas attention reach expertise depth agility talent International Tax Update Subpart F: Look-through Rule & Country of Incorporation Exception Subpart F: Section 956 & Limited Relief Canada/U.S. Treaty New Protocol Commonly Missed International Form Subpart F: Look-through Rule & Country of Incorporation Exception 1

2 Subpart F Issues Subpart F Income Failure to identify & report foreign personal holding company income Failure to identify & report foreign base company sales income Failure to identify & report Section 956 investment in U.S. property Foreign Personal Holding Company Income Foreign Personal Holding Company Income is generally passive types of income earned by CFC Interest earned by CFC1 is FPHCI Interest paid from CFC2 to CFC1 normally FPHCI In 2004, exception for CFC to CFC payments eliminated this as FPHCI The provision was set to expire 12/31/08 Extended by 2008 Extenders Act to tax years of CFRCs beginning before Interest paid by CFC3 to CRC2 is not FPHCI Deemed not to be abusive because both entities are organized in France (same country exception) Foreign Base Company Sales Income Sale of finished goods produced by CFC2 Foreign Base Company Sales Income Sale of product to related party Where product was not produced By the seller or In the country of incorporation of CFC and For consumption outside the country of incorporation Sale by CFC3 to CFC2 is not a problem Same country exception (France to France) Sale by CFC2 to CFC1 is not a problem Product produced by CFC2 Sale by CFC1 to Third Party is a problem CFC1 did not produce property Property was produced outside of Switzerland Produce is for consumption in Canada 2

3 Investment in U.S. Property (Section 956) CFC3 has investment in U.S. property to extent U.S. Parent has borrowed Notice permits loan to extent it is settled within 60 days CFC1 s sale of product to U.S. Parent generally does not give rise to investment in U.S. property Make sure intercompany account is settled periodically. If liability is not settled, there could be deemed loan from CFC1 to U.S. Parent Section 956 Subpart F through Investment in US Property CFCs normally cannot invest in US property without creating current income inclusions via Subpart F Policy rational is if money is brought into U.S., taxation should result because while distribution has not been made, taxpayer has funds safely the U.S. & further deferral of taxation should not continue Section 956 Earning Invested in US Property U.S. shareholder s gross income includes pro rata share of any increase in CFC investment of CFC earnings in U.S. property Items frequently missed as investments in US property US parent pledges of more than 66.66% of stock in CFC Loans by CFC to domestic parent or U.S. affiliate Pledges or guarantees by CFC of loan taken by US parent 3

4 Section 956 Inclusion Amount included in income is lesser of Excess of shareholder s pro rata share the average of amounts of U.S. property held by CFC as of end of quarter of such taxable year over E&P Shareholder s pro rata share of applicable E&P Temporary Relaxation of Section 956 Due to Financial Crisis Notice provides relief in what is termed obligation for purposes of Section 956 Obligation paid within 60 days of issuance is not treated as investment in U.S. property; however exception is not applicable on successive 60 day loans if investment in aggregate is held more than 180 days in year Notice previously provided more limited exception if obligation is paid within 30 days of being incurred & overall was held for less than 60 days in the year Commonly Missed International Tax Issues 4

5 Policy Change with Form 5471 Penalties $10,000 failure to file penalty will be imposed whenever there is failure to file a Form 5471 when required Abatement requests may be filed but likely will be more difficult to obtain with this change in policy that appears focused on tax gap Commonly Missed International Tax Issues Failure & incorrect reporting of related party transactions on Form 5471, Schedule M Reporting accounts payable as loans on Form 5471, Schedule M Failure to report officers & directors on Form 5471, pg. 1 Incorrect currency conversions on Form 5471 Failure to file Form 5471, Schedule O when foreign corporation is organized or has reorganization Failure to add organizational chart Failure to attach legal entity organization chart for Forms 8858 Commonly Missed International Tax Issues Failure to report transfer to foreign corporation on Form 926 Failure to allocate & apportion expenses in calculating FTC on Form 1118 Understatement of foreign source income in calculating FTC under Section 863(b) sourcing rules Failure to file Form 5713 (international boycott form)(kuwait, Lebanon, Libya, Qatar, Saudi Arabia, Syria, UAE, Yemen) 5

6 Commonly Missed International Tax Issues Failure to make Section 338 election for foreign subsidiary when beneficial Failure to make dual consolidated loss election Failure to identify transfer pricing exposure or planning opportunities Commonly Missed International Tax Issues Failure to file Form 1042, Form 1042-S & 1042-T (annual withholding tax return) Failure to provide for Section 1446 (Forms 8804, 8805 & 8813) withholding for foreign partners whether or not distributions made. Form 8813 is required on or before 15 th day of 4 th, 6 th, 9 th & 12 th month of partnership s tax year New Protocol to U.S./Canada Income Tax Treaty Ratified by US Senate & In Force January 1,

7 New Fifth Protocol to U.S./Canada Income Tax Treaty Prior to ratification of U.S./Canada protocol, a LLC was not resident for treaty purposes because it was not liable to tax (unless it elected to be taxed as corporation for US federal income tax purposes). As a result, U.S. taxpayer that invested in Canada through U.S. LLC was not eligible for treaty benefits, even if owned 100% by US resident taxpayers This caused interest, dividend or royalty payments made to a U.S. LLC from Canada to be subject to 25% Canadian withholding tax, rather than reduced treaty rates In addition, LLCs which carried on business in Canada were subject to Canadian income tax even if LLC did not have permanent establishment (PE) in Canada New Fifth Protocol to U.S./Canada Income Tax Treaty Under 5 th Protocol ratified by U.S. Senate on September 23,2008, new paragraph 6 was added that, while not defining LLC as taxpaying entity, indicates payments of interest, dividends or royalties from Canada to U.S. LLC that is wholly owned by U.S. taxpayers would be eligible for reduced withholding rates under treaty Once Protocol is effective January 1, 2010, dividends are eligible for 5% or 15% withholding tax as opposed to 25% withholding generally Interest may be exempt from withholding entirely Royalties are subject to10% withholding tax New Fifth Protocol to U.S./Canada Income Tax Treaty However, under new Protocol no new reduced rate of withholding is allowed an otherwise qualifying US resident shareholder of Unlimited Liability Company (ULC) Accordingly, 25% withholding is required as of January 1, 2010 Contact BKD International Tax Services with regard to migration strategy for affected taxpayers 7

8 Transfer Pricing What is Transfer Pricing? Analyzes prices for transactions between related parties in different tax jurisdictions International boundaries Certain domestic boundaries Transfer prices should be on arm s length basis As if related parties were unrelated What is Transfer Pricing? Examples of intercompany transactions subject to transfer pricing rules include Transfer of tangible goods e.g., finished goods, raw materials, work in progress, machinery & equipment Transfer of intangible property e.g., patents, technology, know-how, formulas, trademarks, trade names, customer lists, etc. Provision of services e.g., technical, management, research & development, engineering, etc. Financing e.g., loans, guarantee fees, leasing, etc. 8

9 Importance of Transfer Pricing Companies have expanded internationally due to global nature of economy Global expansion is no longer limited to large companies This means more companies are now subject to transfer pricing rules around globe (approximately 50 countries have specific transfer pricing laws/legislation) as their expansion is generally through creation of related party legal entities Importance of Transfer Pricing Transfer pricing brings obligations & potential opportunities Companies are obligated to comply with transfer pricing rules by preparing adequate transfer pricing documentation subject to penalties for lack of compliance Opportunities are available in certain cases to utilize transfer pricing rules to companies advantage by shifting profits from high to low tax jurisdiction Transfer Pricing in Recession Unless you don t read news publications, watch TV or have internet access i.e., live in a cave we are in deep global recession What does that mean with regard to multinational company s transfer pricing arrangements resulting tax positions? 9

10 Transfer Pricing in Recession During recession, the following goals will become especially critical for taxpayers with cross-border activities Avoid trapped profits in foreign countries (unable to use foreign tax credits) Conserve cash Avoid excessive tax payments in some countries while there may be losses in others Mitigate risk of tax adjustment which would result in double taxation Managing all of these goals involves reviewing existing transfer pricing arrangements Transfer Pricing in Recession During recession, tax authorities will likely increase scrutiny of companies with cross-border activities to raise revenues as coffers dwindle Will likely target corporations as they do not vote Will more likely target inbound companies Will scrutinize loss-making companies President Obama & IRS have publicly stated transfer pricing enforcement will become critical Other countries have also indicated & demonstrated that they will step-up enforcement IRS has hired & will hire large number of economists & issue specialists to enforce transfer pricing compliance Tax authorities likely to challenge changes to transfer pricing policies Transfer Pricing in Recession Depending upon taxpayer s profile, economic downturn may represent opportunity or threat from a tax perspective Will largely be threat Threats Tax structure which contemplates residual profit to entrepreneur (or principal) can face adverse consequences in recession as other entities are often guaranteed profit Risk of audits increases as treasury coffers dwindle & tax authorities fight for revenues Opportunities Can review TP arrangements & comparables to compensate for or to mitigate certain threats given unrelated parties may renegotiate pricing arrangements in severe recession 10

11 TP in Recession Threat Example 1 - Recession may trap profits in certain entities Taxpayer s historical TP strategy has been largely neutral as it was largely able to utilize any foreign tax credits U.S. parent now in loss & may not be able to take foreign tax credits & even be in net operating loss carryforwards (NOLs) situation for present & future tax years Overseas related party distributors are at statutory tax rate roughly similar to U.S. Distributors are to earn operating margin (OM) of 3% - 6% based upon comparables determined during period of economic growth & stability Taxpayer s revenues have rapidly declined & its costs have increased in all of its legal entities including its distributors Existing TP arrangement leaves too high of return in distributors given current economic climate TP in Uncertain Economy Threat Distribution Example Distributor Profit & Loss Statement Pre-Transfer Pricing Adjustment Pre-Recession Year Recession Year Sales $100 $75 Decline COGS (Transfer Price) $71 $42 Gross Profit SG&A Increase Targeted Operating Profit 4 3 Targeted Operating Margin per CPM 4.0% 4.0% Transfer Price $71 $42 Decrease to U.S. Revenue TP in Uncertain Economy Threat Need to mitigate adverse consequences of company s existing TP policy Existing policy now creates lower TP from the U.S. parent company given It has to essentially guarantee profit at distribution entity Distribution entity s revenues have decreased & its costs have increased leading to lower price from U.S. to ensure profit Was not much of issue before as U.S. was largely able to take foreign tax credits - with losses may not be able to take foreign tax credits 11

12 TP in Uncertain Economy Possible Solutions Look at revised comparables and make adjustments to transfer prices accordingly Use financial data from comparables that includes recession years would reduce OM Commonly employed methodologies take into account historical data, which is used to set future transfer prices Use loss-making comparables TP in Uncertain Economy - Opportunity Sales Distribution Example Distributor Profit & Loss Statement Pre - and Post - Transfer Pricing Comparison Recession Year - Unadjusted $75 Recession Year - Adjusted $75 COGS (Transfer Price) $42 $44 Increase Gross Profit SG&A Targeted Operating Profit 3 1 Targeted Operating Margin per CPM 4.0% 1.3% Decline Transfer Price $42 $44 Relative increase to U.S. Revenues TP in Uncertain Economy - Opportunity Result - Increased transfer price leads to: Increased revenues for U.S. company Increased profits in U.S. which may be shielded by NOL Somewhat aids the foreign tax credit position of the U.S. company Decreased tax in overseas distribution entities Even though decreased sales and increased costs, the adjusted TP serves to mitigate the adverse impact on the company s tax position 12

13 TP in Uncertain Economy Threat Example 2- Taxpayer with services fees U.S. Parent company (USP) is trying to bring cash back to service debt & overseas entities are profitable USP has charged management fee for head office services to affiliates at cost based upon 1968 services regulations (i.e., no mark-up) Perceives they should use Services Cost Method (SCM) (cost safe harbor) under relatively new temporary services regulations but has yet to undertake analysis TP in an Uncertain Economy Opportunity Opportunity - Consider analyzing certain services under SCM & others with markup High value services can be marked-up using net cost plus (NCP) profit level indicator Low value services at cost Or even consider marking-up all services TP in an Uncertain Economy - Opportunity Results from Example 2 leads to More cash in U.S. Lower profits in subsidiaries due to higher deductions associated with marked-up service fees Issues to be overcome Challenge benefit of services by recipient country Challenge implementation of mark-up (previously none) by recipient country Determination of appropriate allocation keys Ensuring that stewardship costs are not included 13

14 TP in Uncertain Economy Effects of Certain TP Methods? Comparable Uncontrolled Price (CUP) - transfer prices should automatically adjust since they are based on taxpayer s market prices May mean constant refinement Comparable Profits Method (CPM) encourages averaging of years to derive arm s length transfer price Latest year of comparable data would likely include recession year & would result in lower targeted TP margin May take longer for effect recession to come into play due to lag of available data on databases & only one year of recession data that is averaged with two good years of stable profits TP in Uncertain Economy Lessons? Plan now tax planning could be in serious jeopardy Taxpayers should routinely reexamine their transfer pricing arrangements On annual basis for certain jurisdictions This includes examining comparables In economic downturn, comparable companies & tested party should be affected in same manner Comparables are used to determine transfer prices & should be reflective of market conditions Need to evaluate if comparables are faring in similar manner as tested party not always in same industry segment TP in Uncertain Economy Lessons? Consider adjustments & changes to comparables Reexamine existing comparable set by using subset of comparables in same industry or eliminate those that did not experience same relative sales decline Conduct new comparable search with companies experiencing the same downward sales trends broader search Consider loss-making comparables, if appropriate Employ different averaging periods use only years when recession was in effect for comparables or longer averaging period e.g., 10 years Regression analysis to adjust comparables (correlation between sales growth profitability) Use of other statistical methods to refine range Consider using specific point in interquartile range e.g., low end 14

15 TP in Uncertain Economy Lessons? Should reexamine industry analysis May allow taxpayer to justify certain results through industry analysis In third party situation, parties may reassess a contract during recession More willing to renegotiate to achieve fair result to ensure both parties are profitable maybe even share in loss Tax authorities often argue a licensee might seek to reduce or even eliminate royalty during period of unprofitability TP in Uncertain Economy Lessons? Review removal or imposition of mark-ups on services Consider conversions to avoid risk Example 1 - Convert loss-making, full-fledged distributor into limited risk distributor Example 2 - Convert manufacturers into contract manufacturers If you were considering migrating intangible property (IP) to low tax jurisdiction, now would be opportune time given values for IP should be low TP in Uncertain Economy Lessons? Royalty rates may be able to be reduced due to low profit potential under Commensurate with Income principle Having robust documentation will be key More likely to face challenges to TP arrangements in economic downturn Especially if there was need to refine or alter existing TP arrangements 15

16 Summary Annus Horribilis Increased number of countries with TP rules & economic recession will continue trend of increased audit activity What should multinational company do? Assess its current TP position Be proactive with regard to tax planning & TP Be diligent now more than ever in preparing TP documentation Countries with Effective Documentation Rules *Country has specific legislation or regulations requiring transfer pricing documentation or other guidelines strongly suggest transfer pricing documentation should be in place Argentina Australia Belgium Brazil Canada China Colombia Denmark Ecuador Estonia Finland France Germany Hungary India Indonesia Israel Japan Kazakhstan Lithuania Malaysia Mexico Netherlands New Zealand Norway Peru Poland Portugal Romania Russia Singapore Slovakia South Africa South Korea Spain Sweden Taiwan Thailand Turkey United Kingdom United States Uruguay Venezuela Vietnam Key Takeaways If U.S. Taxpayer has Canadian ULC, large unexpected taxes are on the horizon beginning if distributions are made unless a planning option is utilized Be aware of complexities in determining whether Subpart F income exists Be wary of CFC pledges or guarantees of U.S. parent debt as they or U.S. parent pledges of more than 2/3 of CFC stock all create Subpart F income 16

17 Questions? Enter them using GoToWebinar toolbar Contact Information: Will James, Principal Matt Campbell, Senior Managing Consultant