WELCOME TO OUR WEBINAR

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1 WELCOME TO OUR WEBINAR International Franchise Structures Tuesday, September 15, :00 p.m. EDT If you cannot hear us speaking, please make sure you have called into the teleconference number on your invite information. US participants: Outside the US: The audio portion is available via conference call. It is not broadcast through your computer. *This webinar is offered for informational purposes only, and the content should not be construed as legal advice on any matter.

2 Structuring to Enhance Franchise Value A Primer for Franchise Companies on International Structuring: Currently utilized international structures Alternatives and variations Practical implications Summary review of tax issues Where is international franchising going? Future trends and implications Page 2

3 Contents The Future of International Structures U.S. Legislative Agenda BEPS and the OECD Guidelines Structuring to Enhance Franchise Value Introduction International Structuring Basics Intangible Property Rights Global Franchise Operations Structures for US Public Corporations Deferral Structure Business Activity Discussion Structures for Non-Public Companies Blocker Structure Full Flow-Thru International Deferral Alternative Parent Structure Page 3

4 The Future of International Structures U.S. Legislative Agenda BEPS and the OECD Guidelines Page 4

5 The Future of International Structures U.S. Legislative Agenda Now that Congress has returned from its August recess the top priority for House Ways and Means Committee Chairman Paul Ryan (R-Wisconsin) will be the consideration of a major tax bill to reform the international tax system, based on a measure, expected to be released in September, that will dominate the agenda well into October. Objectives include: (1) to unlock $2 trillion of American companies parked overseas IF brought back into the US under favorable tax rules; (2) to stay ahead of the tax reform project underway at the OECD for base erosion and profit shifting ; (3) enacting a US innovation box for development of innovative products in the US through lower tax rates; and (4) stem the tide of corporate inversions and cross-border mergers;. Comprehensive tax reform has stalled, over the issue of individual tax rates, so the focus is now on the need to triage the tax system and address reform of international rules. While it is possible that the Committee could include some other domestic business tax provisions in the package it is very unlikely that it will include a reduction in the corporate tax rate. Both Congress and the Administration are concerned that failure to address these issues will result in a massive wave of inversions and self-help efforts by major US companies. The details of Ryan s international reform plan have not been released, but the likely contents will include: (a) a transition from the current US system of worldwide taxation to a territorial system in which foreign profits are generally not subject to taxation when earned and subject to a low level of taxation when brought into the US (through a dividend-exemption mechanism), (b) base erosion provisions to remove incentives for US companies to operate in extreme low-tax jurisdictions (or to encourage those jurisdictions to raise their rates), (c) a one-time tax on accumulated foreign profits not previously taxed by the US that would be dedicated to US infrastructure, and (d) innovation box to encourage US companies to undertake development, and commercialization in the US. Page 5

6 The Future of International Structures BEPS and the OECD Guidelines The Organization for Economic Cooperation and Development (OECD), is releasing guidelines for member countries (U.S., EU, China, etc.) for addressing base erosion and profit shifting (or BEPS) The main objective is to provide tools and anti-abuse rules in order to limit inappropriate shifting of taxable profits. The focus is to restrict the use of tax-haven countries (BVI, Cayman, etc.) and Require increased scrutiny of substance, in particular in relation to entities receiving interest, dividends and royalties. Adverse consequences may include: Disallowance of interest deductions Unavailability of treaty benefits to reduce local interest / dividend withholding taxes New / Anticipated Anti-Abuse Rules Increase Need for Substance Effective January 1, 2016, the EU adopted a general anti-abuse rule ("GAAR") for the disallowance of tax benefits (e.g., reduced treaty rates for withholding taxes) for transactions with a main purpose of avoiding tax (ie, transactions that lack a valid commercial reason). The EU has announced that a similar rule that will be implemented for interest and royalties. Local tax authorities have become increasingly aggressive in evaluating substance in related party transactions. Page 6

7 Structuring to Enhance Franchise Value Introduction International Structuring Basics Intangible Property Rights Global Franchise Operations Page 7

8 Introduction International Structure Objectives Best practices legal operating structure Aligned with the global franchise strategy to compete in an effective and efficient manner Fund the growth of globalizing the brand / business (and the cost of needed presence outside the U.S.) Enhance franchise value Public Companies: Improving earnings per share ( EPS ) Private Companies: Increasing available cash for investment in business growth Increase future cash flow funds may be re-invested in international expansion, including acquisitions and joint ventures Structure should facilitate cash repatriation (to US) and potential exit strategies Page 8

9 Introduction International Structuring Model Company value can be enhanced through evaluating available options for an efficient international structure, which Increase cost efficiencies Limit exposures Address key business objectives An international structure involves choice of location and form for these key elements: Holding company Intangible Property Principal company Given fixed Sales and Service locations Parent Company Management Services, Financing and Domestic Distribution and Services Parent Profit International Franchisor/Principal (non-us for low tax rate) Centralize International IP, Risks and cash-flow Coordinate/Fund Distribution and Services Residual Profit Limited Risk Distributor (often high-taxed) Local Distribution of Product or Supplies Controlled Profit Limited Risk Service Provider (often high-taxed) Franchise Development and Support Activities Controlled Profit See Global Tax Rate Makers, JP Morgan (May 2012) Page 9

10 Introduction Impact of Structure on Income Tax Income Tax Rate Factors US based companies are taxed at 35%/40% rate, plus 20-24% on US shareholder distributions or capital gains for a total tax burden of 54% US shareholders of international flow-thru structures are taxed on worldwide income as earned at a total net rate of 40-42% (depending on state) Effective tax rates for US multinational companies with significant international operations and deferred foreign income can be 20-30%, (total tax burden on US shareholders still 54%, without repatriation planning) Tax rates for companies domiciled outside the US (or able to invert or on the foreign earnings) can be as low 15-20% (total burden of 36% with full repatriation) Page 10

11 International Structure Basics Blocker Structure An efficient international structure Take advantage of treaties to reduce withholding taxes Limit direct connection of U.S. company to foreign jurisdictions Choice of location and form is important: Netherlands, Luxembourg, Ireland and Switzerland for treaty protection Plus Dubai, Singapore, Hong Kong Asia and ME presence Disregard (CTB) for flow-thru to U.S. of foreign costs and taxes Regard (as corporation) to control timing and amount for inclusion to U.S. parent corporation U.S. Parent Company Management Services, Financing and Domestic Distribution and Services Parent Profit International Franchisor/Principal (non-us for low tax rate) Coordinate Franchise Payments Franchise Fees Income inclusion and credits Page 11

12 International Structure Basics Objectives Corporations are blockers between jurisdictions and layers of ownership Limited liability for shareholders, as well as corporate liability between countries Facilitate local payrolls and employment contracts for personnel providing franchisee support or managing franchisee relationships Facilitate accumulation and allow efficient repatriation of surplus cash to the parent company and/or shareholders Provides for proper allocation of revenues, expenses and income among jurisdictions and taxable parties Platform for Joint Ventures and M&A transactions Acquisitions including placement of debt, ease of post-close reorganization, integration of business units or assets Disposition of subsidiaries or assets (segregation of business units or assets, reinvestment of proceeds, reduce tax on gains) Permits use of internal debt for efficient transfers of cash, reduction of net asset values, interest deductions Allows utilization of participation exemption and foreign tax credits to reduce taxable income on distributions Page 12

13 Intangible Property Rights ( IPR ) Legal Concepts Global IPR Management Concepts: 1. Protection of intangible property and related rights (IPRs), e.g., intellectual property, technology, trademarks, through patents, copyrights, registrations, etc. For franchising, legal protection of trade marks, copyrights and confidential information is a main component of franchise agreements May require more extensive identification and documentation of IPRs, including legal registration, as well as clarity of economic or beneficial owner 2. Exploitation of IPRs through licensing, production and distribution of products, provision of services, or other contractual arrangements Revenues from franchisees often include 2 types of income streams: franchise rights (royalties), and services (training, oversight); and sometimes also re-sale of retail product, equipment and supplies Franchise royalties may be subject to withholding tax in some countries (consider gross-up provisions or use of treaty based intermediary company) Page 13

14 Intangible Property Rights ( IPR ) Structure Concepts On-Shore (treaty-based) Structure Off-shore Structure License of international IPRs Parent Company (US) International (non-u.s.) Franchisor Non-US Revenue Tax rate: 10% - 20% Advantages Can help achieve lower income tax rate Relatively low cost of administration Disadvantages May delay timing of IPR transfer while deciding on substance License of international IPRs Variable Rate Royalty Parent Company (US) IP Co (non-us) International (non-us) Franchisor Advantages Lower average income tax rate Exit options available (if necessary) Workable during start-up period of international structure (expected losses in E&P due to IP buy-in) Disadvantages No treaty network for IP Co Not available for U.S. flow thru structures Tax rate: 0% Non-US Revenue Tax rate: 12% - 20% Page 14

15 Intangible Property Rights ( IPR ) Economic Concepts Economic transfer/ migration of IPRs 1. Consider the alternative transfer mechanisms Cross border license, sale, cost sharing, acquisition or development funding All are permitted under appropriate parameters, such as transfer pricing regulations and OECD guidelines, taking into account implications of the applicable jurisdiction May depend upon the type of IPR transferred and the timing/value For example, license of developed trade marks, sale of acquired rights (if high basis or NOLs), foreign affiliate funding of the creation/development of international rights 2. Determination of IPR values KEY ISSUE: Timing transfer may be more effective/beneficial/least costly when: No significant foreign markets or income streams yet exist Existing U.S. NOLs available to offset initial gains or license income Various methods are available to value transfers, which are required to support the intercompany license royalties 3. Prudent use of off-shore IP vehicles is advisable due to lack of income tax treaties, withholding tax and exposure to permanent establishment Page 15

16 Global Franchise Operations Function and Intercompany Arrangements Principal company functions 1. Serves as the HubCo for international activities Coordinating major activities with franchisees, as well as affiliates, and operating as the international franchisor Owns or licenses valuable IPRs 2. Typical Principal company location alternatives Global Principal in US -- default without international tax planning US and foreign affiliate (i.e., Ireland, Switzerland, Singapore, Hong Kong) Regional principals (US, Europe and Asia), if franchisee or operational needs 3. Limited risk service (LRS) companies Shared services, procurement, foreign vendor management, franchisee support, etc. Do not own or license valuable IPRs, and IPR development on a cost-plus basis only, under certain conditions 4. Limited risk distribution (LRD) Routine sales support activities May centralize the purchase of some product, supplies or equipment for franchisees Page 16

17 Global Franchise Operations Product and Other Sales U.S./NA Product Supplier License of international IPRs Parent Company Management Services, Financing and Domestic Distribution and Services Intercompany Sales Product Supplier International Franchisor/Principal (non-us for low tax rate) Centralize IP, Risks and cash-flow International Distribution and Services Trading Profit Sales or Resales Franchise Fees Limited Risk Distributor Limited Risk franchisee Distributor Product Location franchisee flexibility Product Location flexibility Trading Profit may be limited by Subpart F considerations Page 17

18 Global Franchise Operations Intermediary Services License of international IPRs Parent Company Management Services, Financing and Domestic Distribution and Services Parent Profit International Franchisor/Principal (non-us for low tax rate) Centralize IP, Risks and cash-flow Coordinate/Fund International Services Service Profit Intercompany Service Fees Franchise Fees Services or contracted services Service Profit may be limited by Subpart F considerations) Limited Risk Service Limited Provider Risk Service Limited Support Provider Risk Service Activities Location Support Provider Flexibility Activities Location Support Flexibility Activities Location Flexibility Page 18

19 Structures for US Public Corporations Deferral Structure Business Activity Discussion Redux: IPR Structures and Supply Chain Page 19

20 Structures for U.S. Corporation Deferral Structure An efficient international structure Take advantage of treaties to reduce withholding taxes Limit direct connection of U.S. company to foreign jurisdictions Regard (as corporation) to control timing and amount of profit inclusion to U.S. Choice of location and foreign activities: Netherlands, Luxembourg, Ireland and Switzerland for treaty protection Plus Dubai, Singapore, Hong Kong Asia and ME presence Requires significant foreign business operations to defer foreign income (see the case for foreign oversight) U.S. Parent Company Management Services, Financing and Domestic Distribution and Services Parent Profit International Franchisor/Principal (non-us for low tax rate) Coordinate Franchise Payments Perform business activities (954(c)) Franchise Fees Repatriation of foreign income and credits Page 20

21 Structures for U.S. Corporation Business Activities The case for foreign franchise oversight Consider the advantage of being in the same time zone or geographic proximity with foreign franchisees Facilitate more regular and continuous contact to improve chances of success of the foreign markets Training, start up assistance, and oversight can be done on a real time basis Consider regionalizing the franchisee oversight (Europe, Asia, ME, S.Am) Reduces lost travel time and cost to foreign locations Additional considerations: Contracting authority for international business arrangements could be concluded outside the US Location should have multi-language capability, including English, and choice of laws flexibility Employee availability should consider productivity (working hours), social costs and difficulty of termination/severance Income tax deferral (foreign profit not taxed as earned in U.S.) IF comply with active business requirements of US tax regulations (IRC 954c related to foreign personal holding company income or FPHCI) Should be alignment with foreign franchise oversight activities, with choice of location Page 21

22 Structures for U.S. Corporation IPR Structure Options (redux) On-Shore (treaty-based) Structure Off-shore Structure License of international IPRs Parent Company (US) International Franchisor (non-us) Non-Us Revenue Tax rate: 10% - 20% Advantages Can help achieve lower income tax rate Relatively low cost of administration Disadvantages May delay timing of IPR transfer while deciding on substance License of international IPRs Variable Rate Royalty Parent Company (US) IP Co (non-us) International Franchisor (non-us) Advantages Lower average income tax rate Exit options available (if necessary) Workable during start-up period of international structure (expected losses in E&P due to IP buy-in) Disadvantages No treaty network for IP Co Tax rate: 0% Non-US Revenue Tax rate: 12% - 20% Page 22

23 Structures for U.S. Corporation Supply Chain Product and Service (redux) License of international IPRs Parent Company Management Services, Financing and Domestic Distribution and Services Intercompany Service Fees Product Supplier International Franchisor/Principal (non-us for low tax rate) Centralize IP, Risks and cash-flow International Sales and Services Trading and Service Profit Sales or Resales Franchise Fees Services or contracted services Limited Risk Distributor Limited Risk franchisee Distributor Product Flexible Locations Supplies Flexible Locations Limited Risk Service Limited Provider Risk Support Service Limited Activities Provider Risk Flexible Support Service Locations Activities Provider Flexible Support Locations Activities Flexible Locations Page 23

24 Non-Public International Structure Basics International Blocker Full Flow-Thru Structure US Flow-Thru with International Deferral Redux: The Importance of Supply Chain Alternate Parent Structure Page 24

25 Non-Public International Structure Basics Blocker Structure (redux) An efficient international structure Take advantage of treaties to reduce withholding taxes Limit direct connection of U.S. company to foreign jurisdictions U.S. Parent Company Management Services, Financing and Domestic Distribution and Services Parent Profit Income inclusion and credits Choice of location and form for these key elements: Netherlands, Luxembourg, Ireland and Switzerland for treaty protection Disregard (CTB) for flow-thru to U.S. of foreign costs and taxes Regard (as corporation) to control timing for inclusion to U.S. parent corporation utilizing E&P deficit and deemed paid credits International Franchisor/Principal (non-us for low tax rate) Coordinate Franchise Payments Franchise Fees Page 25

26 Non-Public International Structure Basics Full Flow-Thru Structure Advantages: Early losses may be deductible to shareholders; Seller may obtain capital gains rates if sells entire business (advantage to buyer of asset purchase for step up); and taxes flow-thru and creditable to shareholders (instead of being subject to deemed paid credit limitation) Applications: Expected sale of business prior to profitability; Limited potential foreign markets or non-u.s. business activity. Downside: Reduced operating cash flows due to need to pay current U.S. income taxes on foreign income. Combined federal (40%) plus state income taxes, results in total taxation of 40-45% (even after foreign tax credits) earnings taxed automatically (whether cash distributed or not), less credit for foreign taxes. Shareholders U.S. Parent Company Management Services, Financing and Domestic Distribution and Services Parent Profit International Franchisor/Principal (non-us for low tax rate) Coordinate Franchise Payments Franchise Fees Full income inclusion and credits to shareholders Page 26

27 Non-Public International Structure Basics U.S. Flow-Thru with International Deferral Structure Advantages: repatriates earnings may qualify for lower 20% rate upon repatriation ( qualified dividend income or QDI from a treaty country); income is not subject to U.S. income tax until distribution of foreign E&P (can be deferred further by foreign losses, debt and basis recovery strategies); Examples: If foreign income taxed (under Principal structure at 15%), saves 25% on current basis Upon repatriation the repatriated earnings are taxed at 25% (with state), for total tax cost of 36% U.S. income is still subject to 40%+ income tax rates, BUT some former U.S. income may be deferred. Neutral Applications: Seller may obtain capital gains rates on U.S. assets and foreign business (already in deferral structure).; taxes do not flow-thru and are not creditable to shareholders (deemed paid credit limitation), BUT foreign earnings could be taxed at net lower rates; Early losses are not deductible to shareholders, BUT reduce E&P pool and lower future repatriation tax Shareholders U.S. Parent Company Management Services, Financing and Domestic Distribution and Services Parent Profit International Franchisor/Principal (non-us for low tax rate) Franchise Payments Franchise Fees U.S. income inclusion to shareholders Repatriation of foreign income at QDI rates and deductible foreign taxes Page 27

28 Non-Public International Structure Basics Supply Chain Product and Service (redux) Product Supplier License of international IPRs Parent Company Management Services, Financing and Domestic Distribution and Services International Franchisor/Principal (non-us for low tax rate) Centralize IP, Risks and cash-flow International Sales and Services Trading and Service Profit Important Point: Principal strategy is necessary both for foreign income deferral AND to keep foreign income tax rates low. Examples: 1. If net foreign tax rate is 30%, total tax cost will be in excess of 48% upon repatriation; 2. If income is subject to Subpart F, the income inclusion to shareholders losses both QDI and FTC. Sales or Resales Franchise Fees Services or contracted services Limited Risk Distributor Limited Risk franchisee Distributor Product Flexible Locations Supplies Flexible Locations Limited Risk Service Limited Provider Risk Support Service Limited Activities Provider Risk Flexible Support Service Locations Activities Provider Flexible Support Locations Activities Flexible Locations Page 28

29 Non-Public International Structure Basics Alternative Structure Transparent Parent Company (for tax purposes). U.S. shareholders pay tax on distributed foreign earnings. The structure allows for consolidated accounting, and single U.S. based equity plans and financing. Applications: Substitute for traditional U.S. Corporate structure: Significant non-u.s. revenues; and/or non- U.S. business growth; Reduces U.S. corporate level complexity, while allowing for intercompany arrangements. Inversion is not possible (or expensive); and/or U.S. IP value is significant. Preserves ability to convert to U.S. corporate structure or flow-through, while avoiding high exit cost for foreign IP rights. U.S. Company Domestic Distribution and Services Shareholders Parent Company International Franchisor/ Principal (non-us) Franchise Fees Page 29

30 Questions Any Questions? Page 30

31 Thank You DLA Piper LLP (US) 33 Arch Street, 26th Floor Boston, MA Please be advised that any tax advice given herein (or attached) is limited to the available facts, and is not intended to be used for the purpose of avoiding penalties or recommending to others any matter addressed herein DLA Piper. DLA Piper is a global law firm operating through various separate and distinct legal entities. For further information about these entities and DLA Piper's structure, please refer to the Legal Notices page of this website. All rights reserved. Page 31