Planning for Intangible Property Migration in an Uncertain Environment. ABA Section of Taxation Mid Year Meeting January 25, 2013

Transcription

1 Planning for Intangible Property Migration in an Uncertain Environment ABA Section of Taxation Mid Year Meeting January 25,

2 Presenters Moderator Kenneth Christman, Ernst &Young Panelists Chris Bello, Associate Chief Counsel (International Division), IRS Brian Jenn, International Tax Counsel, U.S. Treasury Elizabeth Lewis, McDermott Will & Emery John Peterson, Baker & McKenzie 2

3 Treas. Reg. Section

4 Cost Sharing Agreement (CSA) Regulations On Dec. 16, 2011, IRS released final CSA regulations Closely follow 2009 temporary regulations New provisions and examples relating to application of Income Method Additional guidance on use of contingent payments and determination of reasonably anticipated benefits (RAB) shares 4

5 Section 367(d) 5

6 Section 367(d) Overview A transfer of intellectual property by a U.S. person to a foreign corporation in 351 or 361 exchange is treated as though the transferor sold the IP to the foreign corporation in exchange for deemed annual payments that are contingent on the productivity, use or disposition of the IP over its useful life. Section 367(d) applies regardless of whether the property is to be used in the U.S., in connection with goods to be sold or consumed in the U.S., or in connection with a trade or business outside the U.S. Section 367(d) does not apply to a sale or license of IP to a foreign corporation. 6

7 Deemed Annual Payment The U.S. transferor is required to annually include, over the useful life of the intangible property, an amount that represents an arm s length charge for the use of the property. The appropriate arm s length charge is determined in accordance with Treas. Reg , which incorporates the commensurate with income standard. The useful life of intangible property for purposes of determining the period over which the 367(d) deemed payment must be made is capped at 20 years. Amounts in included in income under 367(d) are treated as ordinary, foreign source income in general basket. 7

8 Definition of IP Section 367(d)(1) defines intangible property by cross reference to 936(h)(3)(B). The regulations exempt the transfer of foreign goodwill and going concern value from 367(d). Treas. Reg (d)- 1T(b). Foreign goodwill and going concern value are defined as the residual value of a business operation conducted outside of the U.S. after all other tangible and intangible assets have been identified and valued. Current definitional issues Workforce in place compare IRS Industry Directives vs. VERITAS Network of independent agents TAM Domestic vs. foreign GW/GCV Is GW/GCV 936(h)(3)(B) intangible in first place? 8

9 Planning Challenges Presented By New CSA Regs Platform concept Indefinite useful life? Preference for income method/apm? Taxes business opportunity? Denies CSA participant full fruits of new R&D? Expansive view of compensable intangibles? Treatment of commensurate with income (CWI) Greater use of hindsight and effective cap on returns? IRS 1-way street position vs. 2-way street? 9

10 Alternative Approach All in Section 367(d) Contribution Contributed intangibles made available to CSA by CFC Limit compensable intangibles to 936(h)(3)(B) list Limit value to pre-existing intangibles? Business opportunity not compensable (see HCA case)? Would VERITAS case holdings apply? Decay factor based on useful life Valuation approaches other than income method Avoid Treas. Reg (i)(6) PCT trigger cap on returns Foreign GW/GCV transferred to CFC exempt from tax Can IRS recharacterize as direct PCT? 10

11 IP Joint Ventures 11

12 Alternative Approach Foreign IP Parent and CFC form a new foreign partnership Partnership Parent (US) E.g., Parent contributes its IP for a 5% common interest and a 100% preferred interest 5% common 100% preferred CFC (Foreign) 95% common CFC contributes cash and an obligation to fund all future R&D on the transferred IP Contribution of Intangibles Foreign Partnership Contribution of cash and obligation to fund R&D 12

13 Alternative Approach Foreign IP Partnership Contribution of intangibles tax-free under 721 Parent taxed annually on preferred yield plus 5% of remaining partnership profits Principal of preferred interest taxable only on redemption Principal limited to value of pre-existing intangibles Does 482 (or CWI) apply to tax free 721 exchange? See Treas. Reg (b)(1)(iii) and Treas. Reg (b)(2)(iv)(h) Compare Eli Lilly and section Treas. Reg (f)(1)(iii) Need to be wary of mixing bowl rules Applicability of VERITAS case holdings? Decay factor based on useful life? Valuation approaches other than income method? 13

14 OECD Transfer Pricing Guidelines Draft Chapter 6 14

15 Definition of Intangibles Discussion starts out with following sentence [T]he word intangible is intended to address something which is not a physical asset or a financial asset, and which is capable of being owned or controlled for use in commercial activities. Note there is no requirement of separate transferability. (OECD 7) Implicit three-fold division of intangibles Owned intangibles Controlled intangibles Properties of Business Should intangibles be limited to property in which there are legally cognizable rights? If legally cognizable rights define intangibles then whose law governs? What about trade secrets? 15

16 Definition of Intangibles Should intangibles be separately transferable? Are there properties of business that are transferable only as part of transfer of business as a whole? Can recognition of properties of business be reconciled with requirement that intangibles be identified with "reasonable specificity (OECD 11). Does recognition of properties of business as intangibles result in unlimited discretion in government to find new and valuable intangibles? Concern would be with application of the Income Method which requires only identification of premium return, not identification of specific intangibles. 16

17 Concept of Intangible Related Return Intangible Related Return (IRR) defined at OECD 28 to mean economic return from business operations involving the use of that intangible after deducting Costs related to the business operations, and Returns to business functions, assets other than intangible and risks. Does this include mere profit potential from any source in excess of routine returns? OECD 40 provides that party that has right to intangible related return would be expected to physically perform through its own employees, the important functions related to the development, enhancement, maintenance and protection of the intangibles. Note: a list of such important functions is given. It does not include financing. 17

18 Concept of Intangible Related Return How to interpret failure to mention financing as an important function. One possibility: financing activity is simply not permitted an intangible related return. However, such an interpretation would be inconsistent with general principle that taxpayers are allowed to structure transactions as they see fit as long as Transactions have economic substance All related parties receive an arm s length return Consequently, if financier takes on risk, can have right to upside as well as downside loss. Failure to allow financiers an equity-like stake in intangible can be seen as OECD trying to prevent entities in low-tax jurisdictions with capital but few employees or functions to get intangible related return. 18

19 Concept of Intangible Related Return Second possibility is to say that financiers can get upside potential in intangible asset (presuming such a return meets arm s length standard). However, such a return is not properly thought of as an intangible related return. Possibly it is a return to bearing risk. Is first possibility consistent with right of taxpayer to decide on business structure? Second possibility does not raise ultra vires issue. However, if second possibility is the correct interpretation, language in OECD 40 is certainly ambiguous and hard to interpret. Given that issue of appropriate return to financing function is important issue, ambiguous drafting raises issue of whether concept of Intangible Related Return is useful. 19

20 Valuation Approaches Challenging comparability issues for intangibles may be difficult to adjust When determining the consideration for transferring intangibles or rights in intangibles (as opposed to use/license arrangements) Are CUPs available Reliability of CUPs Profit split methods Use of financial valuation techniques Acquisition Price method Accepts approaches of Treas. Reg

21 Options Realistically Available OECD 80 :Determining arm s length compensation: OECD Discussion Draft states that parties must consider options realistically available. Perspective of both parties must be considered. Analysis must not be one sided and must not be unduly swayed by considerations such as: Specific circumstances of one of the parties - for example, lack of resources Price should not be set at a level that would eliminate possible future profit Bargaining range must be considered. Danger of revenue authorities speculation as to what constitutes realistic. Realistic alternative principle harder to apply outside of context of CSA which deals with binary choice: cost share vs. license 21

22 United Nations Transfer Pricing Manual 22

23 United Nations Transfer Pricing Manual Adopted on October 15 th, 2012 Chapter on Intangibles to be added later. Chapter 10 on Country Practices describes observed TP practices of particular jurisdictions (Brazil, India, China and South Africa) and does address intangibles to some extent. May be harbinger of things to come deals with Chinese position that outbound royalties for manufacturing IP may decline over time deals with Indian position that valuable marketing intangibles in India are attributable to Indian marketing functions and valuable technology intangibles to Indian R&D functions and deals with Chinese and Indian position on Location Savings (incremental profits attributable to location in low cost jurisdictions) that may implicate return to intangibles. 23

24 Base Erosion and Profit Shifting ( BEPS ) 24

25 Overview of Issue There is increasing global perception that governments lose substantial corporate tax revenue as a result of (1) erosion of the taxable base and/or (2) shifting profits to locations where they are subject to more favorable tax treatment. Several recent high profile cases illustrate the manner in which such planning allows multinational enterprises (MNEs) to achieve effective tax rates much below the applicable statutory rates. In many cases, MNEs employ strategies that rely on (1) the interactions of tax laws in multiple jurisdictions and (2) deliberately enacted government policies aimed at enticing local country investment. Base erosion and profit shifting ( BEPS ) is receiving attention both in the U.S. and worldwide. 25

26 U.S. Attention Various proposals have been proffered to supplement 367(d) and 482 and further prevent erosion of the U.S. corporate tax base. Examples include: Expand / clarify scope of intangibles subject to 367(d) and 482 Impose current U.S. tax on certain excess profits generated by IP transferred by a U.S. person to a related CFC Impose current U.S. tax on low-taxed foreign income Combination of patent box and current U.S. tax on low-taxed foreign income President Obama addressed BEPS in his Framework for Business Tax Reform stating that the empirical evidence suggests that income-shifting behavior by multinational corporations is a significant concern that should addressed through tax reform. 26

27 International Attention OECD has undertaken a project to address BEPS, looking at whether, and if so why, the current rules allow for the allocation of taxable profits to locations different from those where the actual business activity takes place. The G20 is closely following the issue: Final declaration from the G20 Leaders Meeting in June 2012 references to the need to prevent base erosion and profit shifting. Final communication from the G20 Finance Ministers Meeting in November 2012 states [w]e also welcome the work the OECD is undertaking into the problem of base erosion and profit shifting. In November 2012, UK and German governments issued a joint statement (which was later joined by the French government) calling for coordinated action to strengthen international tax standards and urging other nations to back the OECD s efforts to address BEPS. 27

28 OECD BEPS Initiative: Key Pressure Areas The OECD has identified the following key pressure areas: Increased transparency on effective tax rates of MNEs. International mismatches in entity and instrument characterization (i.e., hybrid arrangements and arbitrage). Application of treaty concepts to digital goods and services. Tax treatment of related party debt-financing, captive insurance and other inter-group financial transactions. Transfer pricing, i.e., shifting of risks and intangibles, artificial splitting of ownership of assets, and transactions between related parties that independent parties would rarely undertake. Effectiveness of anti-avoidance measures (e.g., GAARs, CFC regimes and thin capitalization rules). The availability of preferential regimes for certain activities. A number of these issues are closely related to issues being addressed by the OECD through other avenues, including the OECD Transfer Pricing Guidelines. 28

29 OECD BEPS Initiative: Next Steps Collect hard data on the impact of government policies and taxpayer planning on effective tax rates. Consider whether rules developed in the past remain sufficient in the current business environment. Can anything short of formulary apportionment based on people functions provide the result some governments seek? Will significant change require abandoning the arm s length standard as we know it and/or renegotiating the international network of tax treaties? Deliver progress report to the G20 in early 2013 outlining actions necessary to address BEPS, including strategies to detect and respond to aggressive tax planning and ensure better tax compliance. 29