63 rd Tax Institute CROSS-BORDER TAX UPDATE Millennium Hotel, Buffalo, NY Monday, November 14, :30-4:00 Session A

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1 63 rd Tax Institute CROSS-BORDER TAX UPDATE Millennium Hotel, Buffalo, NY Monday, November 14, :30-4:00 Session A Marla Waiss, Esq. Hodgson Russ LLP Jeff Zawada, Tax Director FreedMaxick CPAs, P.C. The Guaranty Building 150 King Street West, Suite Pearl Street, Suite 100 Toronto, Ontario Buffalo, NY Canada M5H 1J9 (716) (416) mwaiss@hodgsonruss.com 424 Main Street 100 Meridian Centre Suite 800 Suite 310 Buffalo, New York Rochester, New York (716) (585) Jeff.zawada@freedmaxick.com

2 Worldwide Taxation for U.S. Citizens and U.S. Residents U.S. citizen (no matter where resident or domiciled) and U.S. resident taxed on a worldwide basis. U.S. income tax U.S. estate and gift tax Who is a U.S. citizen? Born in U.S.A. Person born outside the U.S. to U.S. parent (depends on year of child s birth and U.S. physical presence of U.S. parent) 2

3 Residency For U.S. Income Tax Purposes Green card holder; or Satisfy days test (Substantial Presence Test) 1/6 days 2 nd preceding year + 1/3 days 1 st preceding year + days current year > 182 and present at least 31 days in U.S. in current year Closer connection exception tax home in foreign country and ties are closer to other country (Form 8840) Tax treaty rules treaty tie-breaker rules (Form 8833) Filing differences between two residency exceptions 3

4 Example of Substantial Presence Test John is present in U.S. for 150 days in 2016, 123 days in 2015 and 84 days in /3(123) + 1/6(84) = 205 John is a U.S. resident for 2016 tax year, unless exception applies Rule of thumb for snowbirds do not go over 120 days each year! 4

5 Residency for U.S. Transfer (Gift and Estate) Tax Purposes Residency based on domicile (intent to remain permanently) Green Card holders Facts and Circumstances test 5

6 U.S. Estate Tax U.S. citizens & residents at death Non-citizen/residents assets U.S. real property U.S. tangible personal property U.S. stock worldwide assets only U.S. situs Assessed on fair market value of asset; maximum rate of 40% 6

7 U.S. Estate Tax Exemption U.S. citizens & residents $5.45M in 2016 Non-citizen/resident pro-rated exemption under US/Canada Treaty U.S.-situs assets x U.S. estate tax exemption Worldwide assets Requires filing of U.S. estate tax return to claim exemption Example: Canadian (NRA) dies in 2016 owning a U.S. vacation home worth $3M and has total assets of $15M; 1/5 of $5M exemption applies ($1M), so amount taxable is $2M instead of $3M. 7

8 Applies to U.S. Gift Tax U.S. citizens & residents transfers all gratuitous Non-citizen/residents only gratuitous transfers of certain U.S.-situs assets U.S. real property U.S. tangible personal property Assessed on fair market value of transferred asset; maximum rate of 40% 8

9 U.S. Gift Tax Exemptions U.S. citizens & residents $14,000 annual gift tax exclusion per donee (2016) $148,000 annual gift tax exclusion for gifts to non-u.s. citizen spouse (2016) $5.45M lifetime gift tax exemption (2016) Non-citizen/residents $14,000 annual gift tax exclusion per donee (2016) 9

10 FinCEN Report 114: Foreign Bank Account Report (FBAR) New Due Date for 2016 FBARs! April 15 for residents and June 15 for non-residents. Extension request can be made extending to Oct. 15. Who must file: U.S. Person that has a financial interest in or signature authority over foreign financial accounts and Aggregate value of account(s) is more than $10,000. Financial Account securities, brokerage, savings, checking, cash value insurance or annuity policies, mutual funds, Registered Retirement Savings Plans (RRSPs), Registered Education Savings Plans (RESPs), etc. 10

11 Other U.S. Reporting Forms U.S. Resident Abroad May Need to File* Form 3520/3520A Foreign Trust Form 5471 Foreign Corporation Form 8865 Foreign Partnership Form 8858 Foreign Disregarded Entity Form 8938 Specified Foreign Assets Form 8621 PFIC *NOT AN EXHAUSTIVE LIST!! 11

12 IRS Streamlined Procedure 3 years of returns, 6 years of FBARs. Domestic and Foreign Procedure. 5% penalty applies to those qualifying under Domestic procedure. Foreign procedure applies to certain U.S. persons residing abroad No penalties if failure to file was non-willful. Non-Residency Requirement: must have been present in U.S. on less than 36 days in at least one of last 3 years. Problem for snowbirds! Delinquent Information Return or Delinquent FBAR Submission Procedures. 12

13 Expatriation Since June 17, 2008: Section 877A imposes an Exit Tax Regime on certain U.S. citizens who renounce U.S. citizenship or certain Long-Term Green Card Holders who terminate their immigration status. 13

14 Who are U.S. Tax Expatriates? U.S. Citizens Most commonly done by formally renouncing at U.S. Consulate outside the U.S. Long-term green card holders Held green card in 8 of the prior 15 tax years Does not expire must be revoked or determined to be abandoned File I

15 Exit Tax Applies to Covered Expatriates Net worth U.S. $2 Million; or Average tax liability for prior 5 years > $161,000 in 2016; or Failure to certify compliance with U.S. tax obligations for prior 5 years Form

16 Inversions In General Inversion transactions are a restructuring whereby a foreign subsidiary of a US parent becomes the parent of the former US parent. The shareholders of the former US parent become shareholders of the former subsidiary / new foreign parent. 16 Old Inversion Transaction. Do not pursue without consulting a tax advisor.

17 Inversions IRS Defense History In 1984, Congress adopted Section 1248(i). Shareholders of 10% corporate shareholder of a foreign corporation exchanges stock of the corporation for the foreign corporation, the shareholder recognizes gain as if the foreign corporation was distributed in redemption or liquidation. Notice (adopted as regulations in 1996) Attacked inversions at the shareholder level. The transfer of stock or securities of a domestic corporation by a U.S. person to a foreign corporation is taxable under Section 367(a)(1) if all U.S. transferors own in the aggregate 50 percent or more of either the total voting power or the total value of the stock of the transferee corporation immediately after the exchange 17

18 Inversions IRS Defense History Notice The affected transactions are those in which, as a result of an issuance or transfer of stock or stock rights, there would be a reduction in the amount a third party would pay for the stock of one or more corporations involved in an inversion transaction 1996 Regulations Adopted Notice Required that the acquiring foreign corporation have an active foreign business and be substantial in value relative to the target U.S. corporation. 18

19 Inversions IRS Defense History 2004 Section 7874 The taxable income of an "expatriated entity" shall in any defined year be at least the "inversion gain" of the entity for the taxable year. The term "expatriated entity" may include a domestic corporation with respect to which a foreign corporation is a "surrogate foreign corporation. A surrogate foreign corporation may include a foreign corporation that acquires, directly or indirectly, substantially all of the properties, directly or indirectly, of a domestic corporation if at least 60 percent of the foreign corporation's stock (by vote or value) after the acquisition is held by former shareholders of the domestic corporation by reason of holding its stock. Only if expanded affiliated group does not have substantial business activities in the foreign country where they were created or organization. 19

20 Inversions IRS Defense History 2004 Section 7874 (continued) The "inversion gain" generally includes the income or gain recognized by reason of the transfer of stock or other properties by the expatriated entity during a defined period as a part of the acquisition (generally 10 years) If the foreign corporation would be a "surrogate foreign corporation" if 60 percent was replaced with 80%, then Section 7874(b) treats the foreign corporation as a domestic corporation. Tax on inversion gain would not apply. Excise Tax under Section 4985(a) IRS ruled that acquiring two domestic corporation at the same time, even though the shareholders received less than 60% of the stock in each transaction, Section 7874 should still apply. 20

21 Inversions IRS Defense History IRS ruled that pursuant to a plan or a series of transactions, two or more foreign corporations complete, in the aggregate, an acquisition as described in Section 7874(a)(2)(B)(i), they could still be surrogate foreign corporations. Notice (replaced with 2016 temporary regulations) Avoidance of being a surrogate foreign corporation using cash and liquid assets to skew the percentage test. Regulations will exclude from the denominator stock of the foreign corporation attributable to non-qualified property. Concern that a domestic target corporation could avoid the ownershippercentage test by making distributions before the acquisition. Regulations will ignore non-ordinary course distributions. 21

22 Inversions IRS Defense History Notice (replaced with 2016 temporary regulations) Limit transactions that are structured to avoid the purposes of Section 7874 Limit certain post-inversion tax avoidance transactions; and Make corrections and clarifications to Notice Temporary Regulations (fearsomely complex) Implemented to overcome a series of different abuses 22

23 Section 385 Regulations Inversion regulations did not address earnings stripping. Section 385 Regulations, final and temporary, published October 14, Many changes from proposed regulations Eliminated bi-furcation rule Excluded foreign issuers Excluded S-Corporations and non-controlled RICs and REITs as common parents of Expanded Group Pertaining to documentation, extended period to document Delayed implementation More guidance on cash pooling Qualified short-term debt instruments 23

24 Section 385 Regulations Expanded Group 1 or more chains of includible corporations (excludes S-Corps) connected through stock ownership with a common parent (excludes S-Corps, RIC and REITs) corporation which is an includible corporation, but only if the common parent owns directly or indirectly 80% of the vote or value in at least 1 other includible corporation, and each includible corporation is owned directly by 1 or more other includible corporation directly 80% of the vote or value. Unlike an Affiliated Group under 1504, an Expanded Group can include: Corporations exempt under Section 501 Insurance companies under Section 801 Foreign Corporations Certain Possession corporations under Section 936 RIC and REITs (but not as common parent) DISCs 24

25 Section 385 Regulations Documentation and Maintenance Rules Applicable for intercompany debt (qualified issuer and holder part of same Expanded Group), and any member is publically traded, total assets exceed $100 million or total revenue exceeds $50 million. If document and maintenance requirements are not met, then it will be treated as stock, unless: Sufficient common law factors present to treat the Expanded Group Interest (EGI) as indebtedness. High percentage of EGI Compliant. Reasonable Cause and then compliant within reasonable time frame after. Regulated Terms (banking and insurance regulations) If document and maintenance requirements are met, instrument will be tested under general federal tax principals. 25

26 Section 385 Regulations Documentation and Maintenance Rules Must include complete and executed copies of all instruments, which must include: Unconditional obligation to pay a sum certain Creditor's rights Reasonable expectation of ability to repay EGI Actions evidencing debtor-creditor relationship 26

27 Section 385 Regulations Documentation and Maintenance Rules Cash Pools and similar agreements Can satisfy unconditional obligation and creditor s rights requirements through BOD resolutions, credit agreements, security agreements, etc. For reasonable expectation to repay, need written documentation with a new analysis date at least annually. Timing Must be documented no later than the time for filing the issuer s tax return, including extensions. Maintenance Requirements must keep all documentation for all tax years the debt is outstanding until expiration of statute of limitations Generally will not apply to Applicable Interests issued before January 1,

28 Section 385 Regulations Re-characterization Rules - Distributions of Debt Instruments and Similar Transactions General Rule Covered debt instrument (issued after April 4, 2016) is treated as stock to the extent the covered debt instrument is issued by a covered member to a member of the covered member s expanded group in one or more of the following: In a distribution, In exchange for expanded group stock, or In exchange for property in an asset reorganization, but only if a member of the expanded group immediately before the reorganization receives the covered debt instrument. 28

29 Section 385 Regulations General Rule Distribute Note Foreign Parent US Sub 1 US Sub 2 Or Foreign Sub 29

30 Section 385 Regulations Re-characterization Rules - Distributions of Debt Instruments and Similar Transactions Funding Rule Treated as stock to the extent it is both issued by a covered member to a member of their expanded group in exchange for property, and pursuant to the Per Se Funding Rule and Principal Purpose Rule, are treated as funding a distribution or acquisition as defined below: A distribution by the funded member to a member of their expanded group Certain acquisitions of expanded group stock; or Certain asset reorganizations. 30

31 Section 385 Regulations Funding Rule Distribute Cash Foreign Parent US Sub 1 US Sub 2 Cash Debt 31

32 Section 385 Regulations Re-characterization Rules - Distributions of Debt Instruments and Similar Transactions Funding Rule Per Se Rule a covered debt instrument is treated as issued with a principal purposes of funding a distribution of acquisition if it is issued by the funded member during the period beginning 36 months before the distribution or acquisition and ending 36 months after it. Principal Purpose Debt Instrument debt instrument issues by a corporation to a member of their expanded group, in exchange for property with a principal purpose of funding certain distributions or acquisitions. 32

33 Section 385 Regulations Re-characterization Rules - Distributions of Debt Instruments and Similar Transactions Exceptions Covered Debt Instrument must be issued after April 4, Funding Rule does not apply to acquisition or dispositions occurring before April 5, Funding Rule excludes Qualified Short-Term Debt Instruments Certain acquisitions of subsidiary stock Compensatory stock options Distributions or acquisitions occurring as a result of transfer pricing adjustments Acquisition of expanded group stock by dealers in securities Reductions Expanded group earnings Qualified Contributions Thresholds Aggregate adjusted issue price of debt instruments held by members of the expanded group that would be treated as stock does not exceed $50 million Effective Date Applies to tax years ending after January 14,

34 Section 385 Regulations Steps 1. Identify Expanded Group 2. Identify Covered Member (included issuers, generally a domestic C-Corporation) 3. Identify transactions where Covered Member lends to another member of Expanded Group Documentation and Maintenance Rules Applies if a debt instrument is issued after January 1, 2018 by a Covered Member to a member of the Expanded Group, AND Stock of any member of Expanded Group is traded on public market, When instrument becomes an Expanded Group Instrument, total assets of Expanded Group exceed $100 million, OR When instrument becomes an EGI, total annual revenue of EG exceed $50 million. Re-characterization Rules 1. Does General or Funding Rules apply? 2. Look to Exceptions, Reductions and Thresholds 34

35 Important Rules for U.S. Taxpayers Residing Abroad Corporate Anti-Deferral Rules: Does U.S. taxpayer have an interest in a non-u.s. corporation or other entity? Foreign Trust Accumulation Distribution Rules: Is the U.S. taxpayer a beneficiary of a non-u.s. trust? 35

36 Corporate Anti-Deferral Rules Controlled Foreign Corporation (CFC) More than 50% by vote or value owned by U.S. Shareholders (e.g., U.S. persons with at least 10% voting power) Attribution rules not from nonresident alien family member; not from siblings Subpart F income (generally passive income) taxed currently to U.S. owner as a dividend (taxed at 39.6%) whether distributed or not Form 5471 filing 36

37 Corporate Anti-Deferral Rules Passive Foreign Investment Company (PFIC) 75% or more passive income or 50% or more passive assets No minimum U.S. shareholder ownership required Taxed when distributed or stock disposed at highest U.S. rate (39.6%) plus interest charge Form 8621 Inadvertent PFIC status QEF Election/Mark-to-Market Election 37

38 The Main Event 38

39 Candidate Tax Plans Hillary Clinton /2016/01/12/investing-in-america-by-restoringbasic-fairness-to-our-tax-code/ Donald Trump Individuals Personal Income Tax Rates Buffet Rule, which ensures 30% tax on those making over $1 million; 4% Fair Share Surcharge on income over $5 million Raising capital gain rates for short term trading 12%, 25%, 33% Capital Gains Tax Carried Interest Taxed as ordinary income Taxed as ordinary income Alternative Minimum Tax Repeal 3.8% Obamacare Tax Repeal Standard Deduction Increased to $30,000 MFJ and $15,000 single Itemized Deductions Capped at $200,000 MFJ and $100,000 single Head-of-Household status Personal Exemptions Loopholes Close Bermuda Reinsurance Loophole, Romney loophole, tax gaming loopholes. Eliminated Eliminated 39

40 Candidate Tax Plans Hillary Clinton Donald Trump Business Taxes Corporate Tax Rate Reduce from 35% to 15% Corporate Alternative Repeal Minimum Tax Repatriation One-time 10% tax rate US Manufactures Can elect to expense capital improvements and lose deductibility of corporate interest expense. On-site Childcare Credit Increase from $150,000 to $500,000 per year. Like-Kind Exchange Limit benefits Financial Institutions Impose a new "risk fee;" a graduated risk fee every year on the liabilities of banks with more than $50 billion in assets and other financial institutions that are designated by regulators for enhanced oversight. 40

41 Candidate Tax Plans Hillary Clinton Donald Trump Childcare expenses Above-the-line Deduction Children under 13 (capped at state average); dependent elder care; - Eligibility Income under $500,000 MFJ or $250,000 Single; families who use stay at home parents or grandparents and paid care givers; limit 4 children. Rebates / subsidies Expand investment in federal child care subsidies, universal pre-school, family leave changes Credits Doubling Child Care credit from $2,000 to $4,000. Dependent Care Savings Accounts (DCSAs) Offered to low-income taxpayers through earned income tax credit. Equal to 7.65% of remaining eligible childcare expenses. Family leave changes. Annual contributions to DCSA limited to $2,000 per year from all sources; partial government match. 41

42 Candidate Tax Plans Hillary Clinton Donald Trump Estate Tax Estate Tax Closing the "step-up in basis" loophole; restore to 2009 parameters; increased rates for estates in $10s to $100s of millions in value; close complex loopholes pertaining to valuation. Treats bequests as realization event. Repeal Exceptions Exceptions Will contain careful protections and flexibility for small and closely-held businesses, farms and homes, and personal property and family heirlooms. Capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent s relatives will be disallowed. 42

43 History Base Erosion and Profit Shifting (BEPS) Globalization Globalization has boosted trade and increased foreign direct investments in many countries. Result- Shift from country specific operating models to global models (integrated supply chains, centralized service functions, etc.) Opportunity Globalization has opened up the opportunity for multi-national enterprises (MNE) to minimize their tax burden. Enterprise Concerns Double taxation G20 called on OECD to develop an action plan to address BEPS in a coordinated and comprehensive manner. 43

44 Base Erosion and Profit Shifting (BEPS) Action 1 Address the tax challenges of the digital economy Action 2 Neutralising the effects of hybrid mismatch arrangements Action 3 Strengthen CFC rules Action 4 Limit base erosion via interest deductions and other financial payments Action 5 Counter harmful tax practices more effectively, taking into account transparency and substance Action 6 Prevent treaty abuse Action 7 Prevent the artificial avoidance of PE status Action 8 Assure that transfer pricing outcomes are in line with value creation: intangibles Action 9 Assure that transfer pricing outcomes are in line with value creation: risks and capital 44

45 Base Erosion and Profit Shifting (BEPS) Action 10 Assure that transfer pricing outcomes are in line with value creation: other high risk transactions Action 11 Establish methodologies to collect and analyze data on BEPS and the actions to address it Action 12 Require taxpayers to disclose their aggressive tax planning arrangements Action 13 Re-examine transfer pricing documentation Action 14 Make dispute resolution mechanisms more effective Action 15 Develop a multilateral instrument 45

46 Base Erosion and Profit Shifting (BEPS) A central theme of the OECD s BEPS recommendations is increased transparency and reporting regarding business models, legal entity structures and transfer pricing practices used by multinationals. On May 23, 2016, the OECD Council approved the amendments to the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ("Transfer Pricing Guidelines"), as set out in the 2015 BEPS Report on Actions 8-10 "Aligning Transfer Pricing Outcomes with Value Creation" and the 2015 BEPS Report on Action 13 "Transfer Pricing Documentation and Country-by Count Reporting". 46

47 Base Erosion and Profit Shifting (BEPS) Action 13 Re-examine transfer pricing documentation 1. Requires MNEs to provide tax administrations with highlevel information regarding their global business operations and transfer pricing policies in a master file that is to be available to all relevant tax administrations. 2. Requires that detailed transactional transfer pricing documentation be provided in a local file specific to each country. 3. Large MNEs are required to file a Country-by-Country Report that will provide annually and for each tax jurisdiction in which they do business the amount of revenue, profit before income tax and income tax paid and accrued. 47

48 BEPS Action 13 Implementation (10/2016) Implemened Draft Bills Intention to Implement Australia - CBC / MF / LF Canada - CBC Bermuda - CBC Austria - CBC / MF / LF Finland - CBC / MF / LF Chile - CBC/ MF / LF Belgium - CBC / MF / LF Germany - CBC / MF Germany - LF China - CBC / MF / LF India - MF / LF Indonesia - CBC / MF / LF Denmark - CBC / MF / LF Israel - CBC / LF Israel - MF France - CBC Italy - CBC Jersey - CBC India - CBC Luxembourg - CBC New Zealand - CBC / MF / LF Ireland - CBC Norway - CBC Nigeria - CBC Japan - CBC / MF / LF Russia - CBC / MF / LF Norway - MF / LF Malaysia - CBC / MF / LF Singapore - CBC Peru - CBC / MF / LF Mexico - CBC / MF / LF South Africa - CBC Portugal - MF / LF Netherlands - CBC / MF / LF South Korea - CBC Romania - CBC Poland - CBC / MF / LF Sweden - CBC / MF / LF South Africa - MF / LF Portugal- CBC Switzerland - CBC Switzerland - MF / LF Romania - MF / LF Uruguay - CBC / MF Taiwan - CBC / MF / LF South Korea - MF / LF United Kingdom - MF / LF Spain - CBC / MF / LF United Kingdom - CBC United States - CBC Source: KPMG International member firms CBC = Country-by-Country Reporting MF = Master File LF= Local File 48