An Introduction to the U.S. Aspects of International Taxation with an International Planning Example

Size: px

Start display at page:

Download "An Introduction to the U.S. Aspects of International Taxation with an International Planning Example"

Maude Montgomery
5 years ago
Views:

1 An Introduction to the U.S. Aspects of International Taxation with an International Planning Example Steven D. Bortnick, Esquire Presented to: Rowan University October 31, v2

2 Agenda Taxation of Citizens/U.S. Corporations Taxation of Inbound Transactions FATCA Taxation of Outbound Transactions Impact of the Tax Treaties Planning Example Q+A Careers in Tax 2

3 Citizens/U.S. Corporations Taxed on worldwide income regardless of residence Exclusion for earned income of individuals - Amount - $100,800 in 2016 (Indexed) - Bona fide resident Potential for double taxation - Foreign tax credits - Impact of tax treaties Eliminate/reduce source country tax Treat income as foreign source to enhance foreign tax credit Savings Clause Somewhat unique Creates incentive to invert 3

Inversion Understanding the Issue Before Shareholders Consolidated return 35% tax on all income U.S. Corporation Dividends (or deemed dividends) 35% U.

4 Inversion Understanding the Issue Before Shareholders Consolidated return 35% tax on all income U.S. Corporation Dividends (or deemed dividends) 35% U.S. tax U.S. Subsidiaries Foreign Subsidiaries Tax to foreign governments 4

5 Inversion Understanding the Solution After Shareholders of U.S. Corporation Shareholders of Foreign Acquirer Foreign Acquiring Co. Management Fees Interest on Intercompany Loans U.S. Corporation New Foreign Subsidiaries U.S. Subsidiaries Historic Foreign Subsidiaries 5

6 Stabs at Thwarting Inversions Taxation on outbound transfers of stock. Anti-inversion legislation - Foreign acquiring corporation may be taxed as corporation if 80% or more of stock is owned by shareholder of the inverted U.S. corporation. - Loss of certain US tax benefits if more than 60% or more of stock of foreign corporation is owned by shareholders of the inverted U.S. corporation. - Exceptions to cover bona fide non-tax motivated transactions. IRS regulations under above statutes. Multiple bills to further restrict inversions. Final regulations treated debt of related parties as equity (October) In this video, Steven D. Bortnick discusses the state of U.S. regulation regarding corporate tax inversions. Mr. Bortnick was interviewed at InterGrowth 2016 which took place in New Orleans, LA on May 2-4, 2016: 6

7 U.S. Tax Residents (a/k/a Resident Aliens) Taxed on worldwide income regardless of citizenship Relevant only to individuals - U.S. corporations taxed on worldwide income even if not resident in the U.S. - Foreign corporations taxed based on rules described below - Distinguish from European management and control test Tests for U.S. residence: - Green card test - Substantial presence test - First year election Potential for double taxation - Source country taxation of income - Other countries that tax citizens on worldwide income 7

8 U.S. Tax Residents (a/k/a Resident Aliens) Impact of tax treaties - Hierarchy of connections to establish single residence (individuals) - Reduce/eliminate source country taxation - Change source of income to maximize foreign tax credit Foreign tax credit to minimize double taxation 8

9 Non-Resident Alien Individuals and Foreign Corporations Only tax on income from U.S. sources or which is effectively connected to a U.S. trade or business ( ECI ) Taxation of U.S. source Fixed or Determinable Annual or Periodic Income - 30 percent (or lower treaty rate) - Withheld at source - Gross tax (no deductions) 9

10 What is U.S. Source Income? Dividends from U.S. persons/entities Interest from U.S. persons/entities Rents from property located in the U.S. Royalties for intangibles exploited in the U.S. Income from services performed in the U.S. Certain gains 10

11 ECI Must conduct a trade or business - More than mere investing e.g., Triple net lease NOT a trade or business, but active management of real estate IS - Special exception for trading in securities and commodities Must be in the US - Mexican radio station case Broadcasting/advertising from Mexico into US NOT US business Detailed rules on whether income is effectively connected to the trade or business 11

12 Special Rule for U.S. Real Estate Foreign Investment in Real Property Tax Act ( FIRPTA ) Gain on the sale of U.S. real property is ECI - Overrides the general rule that U.S. does not tax capital gains of foreign persons - Overrides treaty provisions that preclude source country taxation of capital gain of resident of other treaty jurisdiction 12

FATCA Introduction to the Problem Cayman

W-8 indicating foreign status Acquisition

Islands Corporation Bank sold tax evasion

13 FATCA Introduction to the Problem Cayman Islands Corporation US Debt Securities US W-8 indicating foreign status Acquisition of US debt securities on behalf of Cayman Islands Corporation Bank sold tax evasion scheme Cayman Islands Corp. = CFC US person should have paid tax currently Over-emphasis on forms Billions in lost revenue 13

14 FATCA - The Paradigm SHs FC2 FC1 GP income allocation LP FC FP account holders interest dividends Foreign Bank interest US Corp royalties FC3 FATCA wants to make sure that no US people are hiding behind a red entity 14

15 What If an FFI is not FATCA Compliant? U.S. source interest, dividends, royalties and other fixed determinable and periodic income is subject to 30% U.S. withholding tax Starting no earlier than January 1, % withholding on sale of U.S. loans and stock - 30% withholding on loan principal - 30% withholding on pass through payments 15

16 FATCA IGA Jurisdictions Algeria Cayman Islands Greenland Jersey Norway St. Kitts and Nevis Angola Chile Grenada Kazakhstan Panama St. Lucia Anguilla China Guernsey Kosovo Paraguay Antigua Colombia Guyana Kuwait Peru Sweden St. Vincent and the Grenadines Armenia Costa Rica Haiti Latvia Philippines Switzerland Australia Croatia Holy See Liechtenstein Poland Taiwan Austria Curaçao Honduras Lithuania Portugal Thailand Azerbaijan Cyprus Hong Kong Luxembourg Qatar Trinidad and Tobago Bahamas Czech Republic Hungary Macao Romania Tunisia Bahrain Denmark Iceland Malaysia San Marino Turkey Barbados Dominica India Malta Saudi Arabia Turkmenistan Belarus Dominican Republic Indonesia Mauritius Serbia Belgium Estonia Iraq Mexico Seychelles Ukraine Bermuda Finland Ireland Moldova Singapore Turks and Caicos Islands United Arab Emirates Brazil France Isle of Man Montenegro Slovak Republic United Kingdom British Virgin Islands Georgia Israel Montserrat Slovenia Uzbekistan Cabo Verde Germany Italy Netherlands South Africa Cambodia Gibraltar Jamaica New Zealand South Korea Canada Greece Japan Nicaragua Spain 16

17 FATCA - Further information For more information about FATCA, please see our presentation entitled FATCA After the Final Regulations and IGA Proliferation available at the following link: 17

18 US Investment Abroad (Outbound Transactions) US Person *100 dividend Country X imposes withholding tax on dividend. US imposes tax on dividend Foreign Corporation (Country X) Potential for double taxation Is treaty available to reduce withholding? Foreign tax credit in US for Country X tax. 18

Indirect Foreign Tax Credit US Corporation 8 dividend $ 1 country X withholding tax Potential for multiple taxation - Country X corporate tax - Country X withholding tax - US corporate tax on

19 Indirect Foreign Tax Credit US Corporation 8 dividend $ 1 country X withholding tax Potential for multiple taxation - Country X corporate tax - Country X withholding tax - US corporate tax on dividend to US corporation - US tax on dividends paid by Foreign Corp 10% Indirect FTC Foreign Corporation (Country X) Earns $100 Pays $20 Foreign tax Credit = Dividend Post 1986 Earnings of FC 8 Credit = X 20 = = 20% of dividend. It works - FC was subject to 20% corporate tax Dividend grossed up in US (i.e., taxed on 9.6) X Post 1986 Foreign income taxes of FC 19

withholding tax on income earned on US investments by corporation Could sell stock to generate all capital gains (taxed at

20 Potential for Income Deferral on Foreign Investments Investments All Over World US Person 100% Cayman Islands Corporation Absent special Rules: - No US tax on US person until cash distributed or sell Cayman Islands corporation Corporation will be US withholding tax on income earned on US investments by corporation Could sell stock to generate all capital gains (taxed at favorable rates If die holding stock, tax basis in stock of Cayman Islands corporation steps up to fair market value at time of death 20

21 Check the Box and Hybrid Entities Pre factors Post regulations: - US corporations always corporations; - US partnerships/limited liability companies default to partnership but may elect corporation; - Foreign entity defaults to corporation if no member liable for debts of entity but may elect partnership; - Foreign entity defaults to partnership if member(s) has unlimited liability for debts of entity (e.g. general partner) but may elect corporation Created disregarded entities 21

22 Check and Sell The Problem US Corporation 100% Foreign Corporation Absent planning - Gain = subpart of income - US corporation subject to current tax even if no distribution of proceeds. 100% Foreign Corporation sale Buyer Business and Assets 22

Check and Sell Solution US Corporation Step 1 Elect to treat Foreign Corporation 2 as disregarded entity Foreign Corporation sale Buyer Step 2 Sell

23 Check and Sell Solution US Corporation Step 1 Elect to treat Foreign Corporation 2 as disregarded entity Foreign Corporation sale Buyer Step 2 Sell Foreign Corporation 2 - Deemed sale of assets - Sale of assets generally does not give rise to Subpart of income Foreign Corporation Business and Assets 23

partnership Income flows through to Foreign Corporation 1 all non-passive Foreign

24 Check the Box PFIC Planning Foreign Partnership 100% US Absent planning Foreign Corporation 1 would be PFIC Election to treat Foreign Corporation 2 as a partnership Income flows through to Foreign Corporation 1 all non-passive Foreign Corporation 1 Co-Investor - Foreign corporation 1 not PFIC >25% <75% Foreign Corporation 2 24

25 Cross Border Mergers and Acquisitions US Corporation Transfer of assets for >80% stock General rules transfer tax free contribution to controlled corporation Statute concern about loss of US taxing jurisdiction over assets/income Assets Foreign Corporation Outbound transfer generally results in current taxation - Various exceptions (use in a foreign trade or business) 25

26 Structuring a Cross Border Acquisition 26

27 General Tax Considerations in Cross-Border Investing Minimize taxes in foreign jurisdiction Avoid taxation before cash receipts ( phantom income ) Maintain capital gain on exit/partial exit and qualified dividend income on distributions Avoid/minimize tax on leveraged recap Avoid/minimize foreign withholding taxes Avoid UBTI for tax-exempt investors 27

28 General Tax Considerations in Cross-Border Investing (cont.) Maintain VCOC status of the fund Will a buyer like the structure or be able to restructure on a tax efficient basis? What does it take/cost to implement and maintain structure? 28

29 German Acquisition Structure US European & Non-treaty Investors PE Fund Alphabet Shares/ PECs/CPECs Luxco shares/loan German Holdco 1 shares German Holdco 2 Organschaft shares German Holdco 3 Mezzanine debt Senior debt shares German Target 29

30 Minimizing Foreign Taxes US European & Non-treaty Investors Luxco avoids German tax on sale of German Holdco 1 PE Fund Alphabet Shares/ PECs/CPECs Luxco avoids German tax on dividends from German Holdco 1 LUXCO shares/loan PECs & CPECs historically avoided 1% Luxembourg capital duty (no longer in existence) Organschaft German Holdco 1 German Holdco 2 shares shares PECs minimize tax on interest on loan to German Holdco 1 Alphabet shares permit distributions of proceeds from partial exit/leveraged recap without Luxembourg withholding tax German Holdco 3 German Target shares Mezzanine debt Senior debt Luxembourg participation exception avoids Luxembourg tax on dividends from German Holdco 1 or gain on sales of German Holdco 1 30

31 Avoiding Phantom Income Hybrid Instruments US European & Non-treaty Investors PE Fund LUXCO German Holdco 1 German Holdco 2 Alphabet Shares/ PECs/CPECs shares/loan shares PECs treated as debt in Luxembourg PECs treated as equity for U.S. tax purposes - Accruing yield would give rise to phantom income (OID) if PECs treated as debt in US Organschaft German Holdco 3 shares Mezzanine debt Senior debt German Target shares 31

32 Avoiding Phantom Income Hybrid Instruments (cont.) Terms that permit equity characterization in US even though Debt in Luxembourg - Very high debt: equity ratio if respected as debt - Long maturity (e.g., 49 years), preferably extendable by issuer - Subordinated to present and future debt, including trade payables - Payable only out of surplus or earnings - Payments deferred if would result in insolvency - Lack of creditors rights (e.g., acceleration of payments or financial covenants) - Name of instrument (e.g., preferred equity certificates) - Shareholders owning hybrid instruments in proportion to equity ownership - New pressures as a result of BEPS 32

33 Avoiding Phantom Income Hybrid Instruments (cont.) Yield on PECs phantom income if - Issuer is a partnership and the yield is a guaranteed payment - Issuer is a corporation, PECs treated as preferred stock and constructive stock dividend rules apply 33

34 Avoiding Phantom Income Guaranteed Payments Payments not dependent on partnership income Constitutes ordinary income includable in the year in which the partnership deducts the amount for US tax purposes PEC yield presumably not guaranteed payments - Often payable only out of surplus or as declared - Generally no payments in event of insolvency - CPEC payments generally based on value of stock 34

35 Avoiding Phantom Income Preferred Dividends Redemption premium on preferred stock is amortized under rules similar to OID rules and treated as taxable distribution Change in conversion ratio or redemption price of preferred stock treated as taxable distribution - Preferred stock preferred and limited as to dividends and on liquidation So avoid this issue if preferred is participating - Distributions treated 1st as dividends to extent of earnings and profits 2nd as tax-free return of capital 3rd as capital gain - Risk that IRS may treat dividends as redemption premium if no intention to distribute currently 35

36 Preserving Capital Gains and Qualified Dividends - CTB Organschaft US European & Non-treaty Investors PE Fund LUXCO German Holdco 1 German Holdco 2 German Holdco 3 German Target Alphabet Shares/ PECs/CPECs shares/loan shares shares shares Mezzanine debt Senior debt Exit likely to be sale/ipo of German Holdco 1 - Luxco elected to be treated as partnership in U.S. so capital gain flows through to fund - Conversion of German Holdco 1 to corporation before IPO taxfree but watch out if sell too much in secondary - Subpart F/PFIC issue if Luxco corporation (no look-thru if less than 25% ownership) Dividends from German Holdco 2 (whether or not passed up through German Holdco 1) likely qualified dividends - German business activities rule in treaty LOB clause 36

37 Minimizing Foreign Taxes and Avoiding Phantom Income Loan to Disregarded Entity US European & Non-treaty Investors PE Fund Luxco GERMAN HOLDCO 1 German Holdco 2 Alphabet Shares/ PECs/CPECs shares/loan shares Interest accruing on loan to German Holdco 1 results in deduction in Germany - Organschaft (like U.S. consolidation) allows offset of interest deduction against operating profits Loan is disregarded in U.S. German Holdco 1 is a disregarded entity Organschaft German Holdco 3 shares Mezzanine debt Senior debt German Target shares 37

38 Minimize Tax on Leveraged Recap E&P Blocker Organschaft US European & Non-treaty Investors PE Fund Luxco German Holdco 1 GERMAN HOLDCO 2 German Holdco 3 Alphabet Shares/ PECs/CPECs shares/loan shares shares Mezzanine debt Senior debt German Newco 2 borrows and distributes proceeds to German Newco 1, etc. German Newco 2 has no earnings and profits - No tax if distribution doesn t exceed basis - Without German Newco 2 distributions from German Newco 3 likely to be dividends if it received dividends from German Target to pay debt principal German Target shares 38

Steven D. Bortnick Partner, Tax Practice Group 609.951.4117 212.808.2715 bortnicks@pepperlaw.

broad range of transactions, including asset, stock, cross-border and domestic acquisitions,

devoted to, the structuring of domestic and international private equity transactions.

39 Steven D. Bortnick Partner, Tax Practice Group Focuses his practice on domestic and international tax and private equity matters Handles a broad range of transactions, including asset, stock, cross-border and domestic acquisitions, recapitalizations and reorganizations Experienced in, and a significant portion of his practice is devoted to, the structuring of domestic and international private equity transactions. He advises business organizations on a variety of tax issues, and he is involved in the formation of private equity and hedge funds.

FATCA After the Final Regulations and IGA Proliferation

FATCA After the Final Regulations and IGA Proliferation Presented to the Princeton FATCA and CRS Forum on February 4, 2016 Steven D. Bortnick and Morgan L. Klinzing #37612904v.1 Steven D. Bortnick Partner,