Plenary: global trends impacting international tax planning and a US tax update Tom Calianese, Ernst & Young LLP James Sauer, Ernst & Young LLP Gerrit Groen, Ernst & Young LLP
Disclaimer Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited located in the US. This presentation is 2013 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are not necessarily those of Ernst & Young LLP. Page 2 Global Tax Desk Day New York 20 March 2013
Your presenters Tom Calianese Ernst & Young LLP Iselin, NJ Gerrit Groen Ernst & Young LLP New York, NY James Sauer Ernst & Young LLP New York, NY
Agenda US developments Legislative update Technical developments International developments Developments in tax policy Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) report EU update
US developments
Elements of key US tax reform proposals President s Framework for Business Tax Reform (September 2012) and FY 2013 budget blueprint (February 2012) Sen. Enzi s United States Job Creation and International Tax Reform Act (February 2012) Chairman Camp s Discussion Draft (October 2011) Wyden-Coats Bipartisan Tax Fairness and Simplification Act (April 2011) Deficit Commission* Report (December 2010) Overview Deficit and debt impact Corporate taxes Revenue-neutral (business sector) Revenue-neutral Revenue-neutral Revenue-neutral Reduces debt held by the public to 60% of gross domestic product (GDP) by 2014 and 40% by 2037 Corporate tax rate Business tax expenditures 28%. 25% effective rate for manufacturing (lower rate for advanced) Eliminatesexpenditures for specific industries, with exceptions. Identifies tax bias for debt finance and taxing large flow-through business as issues 35% 25% 24% 28% Not addressed Eliminates unspecified tax expenditures Reduces many business tax expenditures. Limits Eliminates all business deductibility of interest to real tax expenditures (non-inflationary) interest only Research and development tax credit Makes permanent. Increases the alternative simplified credit to 17% Not addressed Not addressed Not extended Repealed Accelerated depreciation Moves toward economic depreciation Not addressed Not addressed Limits depreciation allowances to accelerated depreciation system (as proxy for economic depreciation) Eliminates or modifies, details not specified International taxation Transition relief Retains worldwide system. Imposes minimum tax on overseas profits Not addressed Territorial tax system with 95% Territorial system, with deduction for the post-2012 95% deduction for the foreign-source portion of dividends foreign-source portion of received from controlled foreign dividends received from corporations (CFCs) CFCs 10.5% elective tax on pre-effective date foreign earnings, which could be spread over up to eight years 5.25% mandatory tax on pre-effective date foreign earnings (spread over up to eight years) future distribution taxed at 1.25% Repeals tax deferral of active foreign earnings. Reinstitutes Territorial system, per-country foreign tax credit. current taxation of Includes repatriation holiday passive foreign income with reinvestment retained requirements Not addressed * President s National Commission on Fiscal Responsibility and Reform (co-chaired by Erskine Bowles and former Sen. Alan Simpson (R-WY)) Transition relief not discussed. Revenue estimate suggests little or no transition Page 7 Global Tax Desk Day New York 20 March 2013
Key considerations for companies Companies have a lot at stake under a base-broadening, rate-reducing tax reform Any revenue-neutral reform means winners and losers across industries and within industries Details of provisions may matter enormously Still early in the debate What can companies do? Follow details of debate Understand and model effects of potential reforms on company Take advantage of opportunities for planning/minimizing risks Work through trade associations and company coalitions/groups to influence the debate and frame issues Page 8 Global Tax Desk Day New York 20 March 2013
Planning for legislative change
Legislative change key aspects of planning Managing/harvesting attributes Accessing high-tax pools before deemed inclusion date Accessing deficits/hovering deficits Earnings and profits (E&P) and tax-pool planning Accounting method elections Triggering built-in losses Section 304 transactions Utilization of foreign tax credit (FTC) carryforwards Accelerating foreign taxes without E&P (e.g., withholding taxes (WHT)) Page 10 Global Tax Desk Day New York 20 March 2013
E&P planning Section 304 CFC3 (hightaxed) CFC HoldCo (low-taxed) CFC2 (lowtaxed) USP CFC2 stock US$1,000x cash B = US$1,000x V = US$1,000x CFC1 CFC2 Facts CFC HoldCo acquires all of the shares of CFC2 from CFC1 for US$1,000x cash. Results CFC HoldCo s acquisition of the CFC2 stock from CFC1 is a Section 304 transaction that results in dividend income to CFC1 to the extent of the earnings and profits of CFC HoldCo first and then of CFC2. Dividend received by CFC1 should not give rise to Subpart F income if an exception applies (e.g., Sec. 954(d)(6)). Low-taxed E&P of CFC Holdco (and CFC2 thereafter) has been migrated to CFC1. Considerations What happens to CFC1 s basis in CFC2 stock? Consider Notice 2001-45 to determine whether it is a listed transaction or substantially similar under individual facts; if so, then requires disclosure under Treas. Reg. 1.6011-4 on Form 8886. Page 11 Global Tax Desk Day New York 20 March 2013
Section 312 built-in loss USP CFC HoldCo CFC 1 CFC 2 CFC 2 CFC 1 distribution of CFC 2 stock results in reduction in E&P equal to adjusted basis of CFC 2 stock 312(a) CFC HoldCo receives taxable dividend equal to fair market value (FMV) of CFC 2 stock distributed Questions: In what year is E&P reduction taken? What is 902 formula? Would reduction in E&P of CFC result in a corresponding reduction in the CFC s 902 tax pool under the FY 2013 budget plan? Page 12 Global Tax Desk Day New York 20 March 2013
Consolidation regime All in US$ Dividend $15 USP Tax consolidation regime where regarded deductions are segregated from an operating company Possibility that dividends from the OpCo to HoldCo are Subpart F income unless Section 954(c)(6) or same country exception applies Dividend $165 CFC HoldCo (X) CFC OpCo (X) Interest $150 FinCo CFC OpCo Income $400 Tax (70) ($400 - $150) X 28% E&P $330 Pays $165 dividend CFC HoldCo Interest ($150) Dividend 165 E&P $15 Pays $15 dividend US Dividend $15 78 35 Income $50 Benefit $17.50 Page 13 Global Tax Desk Day New York 20 March 2013
US tax planning with subsidiaries in Italy Acquisition of Italian target Top US Co EU Co Existing Co (ITA) NewCo (ITA) 4. Step-up 5. Tax consolidation/merger 1. Loan 3. Sale Seller (ITA) Target (ITA) NewCo (ITA) 2. Contribution Overview 1. Italian HoldCo is leveraged by its EU parent company 2. Target contributes its business in NewCo 3. HoldCo purchases NewCo stock (assumed by FY 2013) 4. NewCo elects for step-up on its own assets 5. HoldCo and NewCo elect for tax consolidation/merger Anticipated Italian tax analysis Leverage must have business purpose Interest deductible within 30% earnings before interest, taxes, depreciation and amortization (EBITDA) of HoldCo 30% EBITDA of Target may be used under tax consolidation Interest paid should be exempt from WHT E.g., one-year holding period, EU Co as interestbeneficial owner Contribution of business is non-taxable Registration tax issue to be managed Target is subject to 1.375% effective corporate income tax (CIT) upon sale of NewCo NewCo elects for step-up by paying 16% substitute tax NewCo will benefit from 31.4% amortization (Italian corporate income tax ((IRES) 27.5% + Italian regional production tax (IRAP) 3.9%) Anticipated US tax analysis US creditability of Italian 16% tax may be achieved under certain circumstances Page 14 Global Tax Desk Day New York 20 March 2013
US tax planning with subsidiaries in Italy Migration of Italian IP Principal/IPCo (e.g., CH or Lux) 3. Sale of IP USA Inc SubCo (EU) Holdings (Italy) OpCo (Italy) New IPCo Srl (Italy) 2. Step-up election 1. Contribution Overview OpCo contributes, in exchange for shares, a research and development (R&D) division including the intangible property (IP) to a New IPCo Srl (FY1) New IPCo Srl makes a step-up election on IP (FY2) Sale of any residual IP or final amortization (FY5) Further developments of IP will be owned by foreign Principal/IPCo which remunerates New IPCo at cost plus for R&D Anticipated Italian tax analysis Contribution is tax-free Step-up election requires 16% tax payment in three annual instalments (30% - 40% - 30%) and allows amortization at 31.4% (IRES 27.5% + IRAP 3.9%) Tax amortization of IP should offset royalty income Sale of any residual IP with no capital gain Anticipated US tax analysis US creditability of Italian 16% tax may be achieved under certain circumstances Page 15 Global Tax Desk Day New York 20 March 2013
Collateral consequences of the foreign group technical taxpayer rules
Collateral consequences of foreign consolidated group tax payments Issue Tax liability of a foreign consolidated group is allocated among its members pursuant to Reg.1.901-2(f)(3) in proportion to each member s allocable share of the group s income. Each member is treated as having legal liability under foreign law for its portion of the group taxes. US tax principles apply to determine tax consequences if one person remits a tax that is the legal liability of another person. Reg. 1.901-2(f)(3)(iv). Raises possibility of deemed distributions and/or contributions to the extent (i) parent is not reimbursed or (ii) is reimbursed without appropriate arrangements in place that treat parent as acting on behalf of subsidiaries and subsidiaries as reimbursing parent for tax payments made on their behalf. Page 17 Global Tax Desk Day New York 20 March 2013
Collateral consequences of foreign consolidated group tax payments examples All in US$ Country X Country X Tax =$100 $30 Contribution Parent (Country X) Tax = $100 $50 Distribution US Parent $50 Contribution Subsidiary (Country X) 901 Liability = $30 Head Company (Country X) Member 2 (Country X) 901 Liability = $50 Member 1 (Country X) Foreign group Page 18 Global Tax Desk Day New York 20 March 2013
Collateral consequences of foreign consolidated group tax payments Reimbursements to parent by members Reimbursements to agent or other person for payment by agent of liability of principal should not be treated as giving rise to a contribution or distribution. Principle has been applied to payment to parent for member s portion of consolidated tax liability. See Rev. Rul. 73-605; GCM 39367; and Beneficial Corp. v. Commissioner (18 T.C. 396 (1952)). Must a formal agency or lending arrangement be in place? Preamble to final regulations (TD 9576) suggests so:... a shareholder s payment of a corporation s tax on a corporation s reimbursement of a shareholder for paying its tax liability will not result in a deemed capital contribution and deemed dividend treatment if arrangements are in place that treat the shareholder s payment of the tax as pursuant to a lending or agency arrangement. Otherwise, risk of deemed contributions/distributions upon payment of tax by parent company and further distribution/contribution upon reimbursement. Page 19 Global Tax Desk Day New York 20 March 2013
Collateral consequences of foreign consolidated group tax payments (cont.) Treatment of tax losses Treas. Reg. 1.901-2(f)(3)(iii)(C) requires allocation of net loss of a member to other members proportionally to income of other members unless mandatory provisions under foreign law require other allocation. No provision allows for reimbursement by parent or other members to member with net loss. Under Beneficial Corp. and Dynamics Corp. v. United States (392 F.2d 241), if one member reimburses another for net loss contributed to group, it is not treated as reimbursement for value and gives rise to distribution/contribution. See also GCM 39367. But, in case of potential triangular distribution/contribution via common shareholder, consider authorities on whether shareholder benefits. See Sammons v. Commissioner (472 F.2d 449 (5 th Cir. 1972)) and Gulf Oil Corp. v. Commissioner (89 TC 1010). Page 20 Global Tax Desk Day New York 20 March 2013
Collateral consequences of foreign consolidated group tax payments (cont.) Steps to take to reduce risk of distribution/contribution: Consider having group members enter into a tax-funding agreement or other reimbursement agreement Local approaches to allocating liability may differ from the approach in the technical taxpayer regulations Allocation of losses of group members Intercompany deductible payments Agreement will need to be carefully drafted to ensure it follows technical taxpayer tax liability allocation method, while coordinating with specifics of local rules Consider treatment under local law of different categories of income with different statutory rates and categories of deductions that are specially allocable to certain income (e.g., capital gains and losses) Page 21 Global Tax Desk Day New York 20 March 2013
International developments
Developments in tax policy 1 Increased tax competitiveness Reduction in headline corporate tax rates Incentives for IP development/r&d activities Conclusion of tax treaties for key markets Extended availability of ruling processes 2 Tax residency and beneficial ownership Permanent establishment Anti-haven rules/blacklists Expanded jurisdictions Common themes Response to global scrutiny Major governments shaping debate OECD and EU input Differing responses between hub and destination territories 3 Convergence/ alignment of tax systems 4 Consistency in transfer-pricing methodologies Increased diligence/scrutiny in ruling processes EU Common Consolidated Corporate Tax Base (CCCTB) Wider adoption of International Financial Reporting Standards (IFRSs) General Anti-Avoidance Rules (GAARs) Page 23 Global Tax Desk Day New York 20 March 2013
Global attention on corporate tax
OECD report on BEPS The OECD report Addressing Base Erosion and Profit Shifting was released on 12 February 2013 Project being driven by the governments of several key OECD member countries, including the US, UK, Germany, France and Australia Origins in discussions in the G20 and also are closely linked with the G8 Due to high-level government interest in this project, the work is being conducted on an accelerated timetable, and the recommendations that come out of it will have the strong endorsement of OECD member countries Focuses on the same international tax issues that are the subject of hearings and headlines in the US, UK and elsewhere Page 25 Global Tax Desk Day New York 20 March 2013
Key pressure areas The OECD BEPS report is mainly a background document that sets the stage for future work of the OECD. The report identifies the following key pressure areas : International mismatches in entity and instrument characterization Application of treaty concepts to profits derived from the delivery of digital goods and services Tax treatment of related-party debt financing, captive insurance and other intra-group financial transactions Transfer pricing, particularly in relation to the shifting of risks and intangibles, artificial splitting of ownership of assets among legal entities within a group, and transactions among related-party entities that would rarely take place among independent entities The effectiveness of anti-avoidance measures, in particular GAARs, CFC regimes, thin capitalization rules and rules to prevent tax-treaty abuse The availability of harmful preferential regimes Page 26 Global Tax Desk Day New York 20 March 2013
Next steps The action plan to be issued by the OECD in the summer: Identify actions needed to address BEPS Set deadlines Identify resources needed While this project will not trigger immediate changes in law and treaties, the deep and broad political support means it is time to think about the longer-term implications of the report, including the potential impact it could have on tax reform developments in the US and elsewhere. Page 27 Global Tax Desk Day New York 20 March 2013
European Commission (EC) Action Plan On 6 December 2012, the EC published An Action Plan to Strengthen the Fight Against Tax Fraud and Tax Evasion. This included two recommendations: An EU-common approach to identification of tax havens Encouragement to apply certain measures in relation to third countries that adopt tax practices incompatible with minimum standards of good governance. Coordinated common actions by Member States to resolve double deductions and double non-taxation cases Member States should ensure through their Double Taxation Agreements (DTAs) that double non-taxation does not occur, e.g., by inclusion of subject to tax provisions. Member States should adopt GAARs. Page 28 Global Tax Desk Day New York 20 March 2013
Summary Potential US tax reform could lead to changes in the approach to international tax planning. OECD and EC reports provide a framework for developments in international approach to tackling tax avoidance. What does this mean on a country-by-country level? Mature markets Emerging markets Page 29 Global Tax Desk Day New York 20 March 2013
Questions?
Contacts Tom Calianese Ernst & Young LLP Iselin, NJ +1 732 516 4490 thomas.calianese@ey.com Gerrit Groen Ernst & Young LLP New York, NY +1 212 773 8627 gerrit.groen@ey.com James Sauer Ernst & Young LLP New York, NY +1 212 773 1161 james.sauer@ey.com
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