MODULE 2.10 UNITED STATES OPTION

Transcription

1 THE ADVANCED DIPLOMA IN INTERNATIONAL TAXATION June 2018 MODULE 2.10 UNITED STATES OPTION ADVANCED INTERNATIONAL TAXATION (JURISDICTION) TIME ALLOWED 3¼ HOURS This exam paper has three parts: Part A, Part B and Part C. You need to answer five questions in total. You must answer: Both questions in Part A (25 marks each) The question in Part B (20 marks) Two questions from Part C (15 marks each) Further instructions All workings should be made to the nearest month and in US Dollars, unless otherwise stated. Start each answer on a new page and clearly indicate which question you are answering. If you are using the on-screen method to complete your exam, you must provide appropriate line breaks between each question and clearly indicate the start of each new question using the formatting tools available. Marks may be allocated for presentation. The time you spend answering questions should correspond broadly to the number of marks available for that question. You should therefore aim to spend approximately half of your time answering Part A, and the other half answering Parts B and C. The first 15 minutes of the exam consists of reading time. You will be allowed to annotate the question paper during this time; however, you will not be permitted to start writing or typing your answer. The Presiding Officer will inform you when you can start answering the questions. For your information this paper is accompanied by: United States Model Income Tax Convention 2016

2 General Note You are required to prepare analyses of United States federal tax issues as instructed in the directions for each question. Assume in each case that there are no other transactions in the taxable year that affect your answer. If you find that a question is ambiguous, or that you do not have sufficient data to answer it, respond to the question and explain the nature of the ambiguity or describe the missing information. Unless otherwise indicated, apply the law in effect prior to the adoption of the Tax Cuts and Jobs Act of Unless otherwise indicated, assume for purposes of arithmetic simplicity that the normal US Federal Income Tax rate is 40% for individuals and 35% for corporations (the approximate maximum rates under the current law) and that all net income is taxed at those rates. For individuals, however, assume that long-term capital gains, dividends from US corporations and dividends from foreign corporations from countries that have tax treaties with the US are taxed at the preferential rate of 20%. The US statutory withholding tax rate, where applicable, is 30%. Unless otherwise indicated, assume that there is no bilateral income tax treaty in force between the US and any other country referred to in the questions, even if you know that such a treaty in fact exists. When the problem indicates that a treaty is relevant to the analysis, apply the terms of the United States Model Income Tax Convention 2016 (US Model Tax Convention). Where possible, calculate the US tax consequences of your analysis using the simplified tax rate assumptions described in the previous paragraphs. Where taxpayers are individuals, ignore possible personal deductions and exemptions. Page 2 of 7

3 PART A You are required to answer BOTH questions from this Part. 1. In each of the following situations, you are required to describe the extent to which the entity and its owners would be subject to United States federal income taxation, assuming that no income tax convention applies: 1) The entity is a Delaware corporation, owned equally by two citizens and residents of Country X. (4) 2) The entity is a Delaware general partnership, owned equally by two citizens and residents of Country X. (4) 3) The entity is a private limited company, formed in the United Kingdom and wholly owned by a US corporation. (5) 4) The entity is an Irish general partnership, owned equally by two individual US citizens and resident, with and without all available elections. (5) 5) How would your answers to 3) and 4) change under the Tax Cuts and Jobs Act of 2017? (7) Total (25) 2. John is a citizen and resident of Brazil. He is the sole owner of WatchOut, a Brazilian sociedad limitada, treated as a corporation for United States tax purposes. WatchOut designs, manufactures and sells guidance systems for driverless cars. WatchOut is considering opening a showroom in California to demonstrate its products and a warehouse to hold inventory for sale to its US customers. John, who had never previously been to the US, decided to visit in order to investigate expanding WatchOut s operations. He arrived in the US on 15 November 2016 and returned to Brazil on 24 December He was not present in the US during On 30 November 2016, while in the US, John received a $10,000 dividend from USCo, a Delaware corporation in which he owned a 15% interest, and made his monthly interest payment of $2,000 on the mortgage for his home in Brazil to a Brazilian bank. The portion of John s 2016 salary which related to his time in the US was $10,000. John concluded that the US business opportunity for WatchOut is strong and intends to form a wholly owned Delaware corporation (WatchOutUS) to conduct its business in the US. Under these plans, WatchOutUS will maintain a California showroom to demonstrate WatchOut products and a California warehouse for delivery of WatchOut products to US customers. WatchOutUS will have no authority to contract on behalf of WatchOut, and all price negotiations and contract execution will remain the responsibility of WatchOut. WatchOutUS will not represent any other products. It will be fairly compensated by WatchOut, for the services provided. 1) What are John s US federal tax liabilities for 2016? (10) 2) How would your answer to 1) change if there was a treaty between the US and Brazil, substantially the same as the 2016 US Model Tax Convention? (5) 3) What are the advantages and disadvantages of forming WatchOutUS, with and without an applicable income tax treaty substantially the same as the 2016 US Model Tax Convention? (10) Total (25) Page 3 of 7

4 PART B You are required to answer THIS question. 3. IceBerg is a Delaware corporation. It is the worldwide leader in the ice machine business, and its products are in high demand around the world. IceBerg has operated entirely within the United States since its inception ten years ago, with all non-us sales taking place through an unrelated US wholesale distributor. Because international demand for its products has grown significantly, IceBerg is considering establishing an international presence. It intends to establish three foreign corporations: IceCream, IceCycle and IceSkate. Both IceCream and IceCycle will be wholly owned by IceBerg; IceSkate will be wholly owned by IceCream. Each entity will be a corporation for US and foreign tax purposes, and none of the entities will be located in a country which has any income tax treaties in force. IceBerg will license all of its intellectual property to IceSkate, allowing for the production and sale of ice machines in Europe. IceSkate will pay an arm s length royalty, which meets the commensurate with income standard, to IceBerg. IceBerg will also sell component parts necessary to produce ice machines to IceSkate. IceCycle will be the international distributor of ice machines produced by both IceBerg and IceSkate. IceCycle will purchase machines from both IceSkate and IceBerg for resale to international customers. IceCycle will also perform repair and warranty services for all ice machines it sells. IceCream will purchase rum from RumCo, a Country Y corporation, owned 20% by IceBerg and 80% by RumRunner, an unrelated foreign corporation, and resell the rum throughout the international marketplace. It will also sell rum to IceBerg for resale in the US. RumCo will purchase its rum from RumRunner. The proposed international structure is as follows: IceBerg US 35% Tax RumRunner Country A 100% 100% 20% IceCream Country X 40% Tax IceCycle Country Y 30% Tax RumCo Country Y 30% Tax 80% 100% IceSkate Country Z 20% Tax Continued Page 4 of 7

5 3. Continuation You are required to answer the following questions: 1) Will the income earned by IceSkate from the production of ice machines and sale of product to IceCyle give rise to any Subpart F income inclusion to IceBerg? (10) 2) Will the income earned by IceCycle from the resale of product purchased from IceBerg and/or IceSkate give rise to any Subpart F income inclusion to IceBerg? (6) 3) Will the income earned by RumCo from the purchase of rum from RumRunner and its resale to IceCream give rise to any Subpart F income inclusion to IceBerg? (4) Total (20) Page 5 of 7

6 PART C You are required to answer TWO questions from this Part. 4. Widget Wizard Inc. is a New York corporation which manufactures widgets and gadgets and sells them to its wholly owned foreign corporations. In its audit of Widget Wizard Inc. s 2015 and 2016 federal income tax returns, the Internal Revenue Service (IRS) determined that the sale price from Widget Wizard Inc. to its wholly owned foreign subsidiaries was too low and made transfer pricing adjustments as follows: In 2015, Widget Wizard Inc. sold 25,000 widgets to Widgets UK for $10 each. Widget Wizard Inc. s cost of goods sold for each widget was $6. In its audit, the IRS determined that the arm s length price for each widget was $21. Widget Wizard Inc. has recorded gross receipts for 2015 of $10 million after the adjustment. In 2016 Widget Wizard Inc. sold 1,500,000 gadgets to Widget Wizard Canada Ltd at $10 each. Widget Wizard Inc. s cost of goods sold for each gadget was $6. The IRS determined that the arm s length price for each gadget was $19. Widget Wizard Inc. has recorded gross receipts for 2016 of $30 million after the adjustment. You are required to prepare a memorandum in which you address Widget Wizard Inc. s transfer pricing penalty exposure from the above transactions. 1) Is Widget Wizard Inc. subject to a transfer pricing penalty in 2015 and, if so, of what amount? (5) 2) Is Widget Wizard Inc. subject to a transfer pricing penalty in 2016 and, if so, of what amount? (5) 3) What steps could Widget Wizard Inc. have taken to reduce or eliminate any penalty to which it might be subject in 2015 and/or 2016? (5) Total (15) 5. Brakes Unlimited, a California corporation, manufactures and sells brake pads for automobiles. Brakes Unlimited is the sole owner of Nihon Brakes, a Japanese yūgen kaisha. Brakes Unlimited also sells brake pads in Canada via a Canadian branch. The brake pads sold in the United States and Canada are manufactured in the US; the brake pads sold in Japan are manufactured in Japan. In 2017, Brakes Unlimited earned $600,000 from US sales and $150,000 from sales in Canada through the Canadian branch. It paid tax at 35% in the US and 40% in Canada. In 2017, Nihon Brakes earned $250,000 from Japanese brake pad sales and paid 10% tax in Japan. 1) How much income and foreign tax credit will Brakes Unlimited report on its 2017 US tax return, assuming that Nihon Brakes is treated as a corporation for US federal income tax purposes? (10) 2) How would your answer to 1) change if Nihon Brakes makes a check the box election and is treated as a disregarded entity for US federal income tax purposes? (5) Total (15) Page 6 of 7

7 6. Edward is a citizen and resident of Country Y. He is contemplating a purchase of real estate in the United States. After consulting various websites, Edward is unsure whether it is better from a US tax perspective to purchase the property directly in his name, through a foreign corporation or through a domestic corporation. You are required to prepare a memorandum in which you address the advantages and disadvantages of each of the following alternative methods of purchasing real estate in the US: 1) Direct purchase of the real estate by Edward. (5) 2) Purchase of the real estate by Edward through a domestic (US) corporation. (5) 3) Purchase of the real estate by Edward through a foreign (non-us) corporation. (5) Total (15) 7. Adirondack Inc., a New York corporation, owns 100% of the stock of Adirondack Holdings Incorporated (AHI), an entity domiciled in Country X which is taxed as a corporation for both United States and Country X purposes. AHI in turn owns 100% of the stock of Adirondack Ltd (AL), a Country Y entity taxed as a corporation for US, Country X and Country Y purposes. As of the end of 2016, AL s post-1986 foreign income taxes are $200,000 and its post undistributed earnings are $600,000. As of the end of 2016 and before accounting for the distribution received from AL described below, AHI's post-1986 foreign income taxes are $200,000 and its post-1986 undistributed earnings are $700,000. All earnings and taxes of AHI and AL are foreign source general basket. During 2016, AL distributed $300,000 to AHI, and AHI distributed $500,000 to Adirondack Inc. Country X imposed a 20% withholding tax on the $500,000 distribution by AHI. There were no other withholding taxes imposed. Additionally, Adirondack Inc. has $650,000 of US source general basket income. You are required to determine Adirondack Inc. s US tax liability for 2016, assuming that it is subject to US tax at a rate of 35% and elects to credit its foreign taxes. (15) Page 7 of 7