IRS Won't Challenge Credits against US Income Tax for Payments of Mexico's New Flat Tax

by Scott Studebaker (WorldTrade Executive, Inc.)


Mexico’s new flat tax, the IETU, will go into effect on January 1, 2008. The new tax has caused anxiety among U.S. investors over the tax implications. Investors and tax professionals have worried that the new tax might not qualify as an income tax under Article 24 of the U.S.-Mexico tax treaty. This, in turn, would mean that U.S. investors would not be able to receive a credit against their U.S. income taxes for the IETU paid in Mexico—a classic case of double taxation.

But the IRS has stepped in with a welcome, if provisional, clarification. On December 10, the IRS issued Notice 2008-3, in which it said that it, too, had not determined whether the IETU qualified as an income tax under Article 24(1) of the Treaty, and that the agency was going to study the new tax in order to make a determination.


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Setting Up an Entity in India

Excerpt from Practical Asian Tax Strategies
article by Jon Eichelberger, Brendan Kelly, Eugene Lim & Beng Ti Tan (Baker & McKenzie, Beijing)

While the U.S. is the oldest, India is the biggest democracy in the world. India has a large pool of educated human resources and a well-developed legal and banking system, and English is the business language, making the country a favored destination for foreign investment.

An offshore entity interested in establishing a presence in India should first determine short- and long-term objectives. This includes the mission of the entity in India, the type of operations to be conducted and the timelines for site selection, hiring personnel, etc. Based on the initial analysis, the next important step is to determine the type of entity that should be set up. The new entity can be a Liaison office (LO), Project office (PO), Branch office (BO), or an incorporated company, public or private (Company). If the objective is short-term, a foreign entity can also post a representative in India to carry out its activities.

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Managing Transfer Pricing Risk in Brazil

Brazil, the ninth largest economy in the world, has developed a unique set of transfer pricing rules that differ from the Organization for Economic Cooperation and Development (OECD) based approach adopted by most countries around the world. As result of this uniqueness, multinational corporations (MNCs) face a number of transfer pricing difficulties which may range from an increased burden on compliance activities to double taxation. Further, Brazilhas signed several Tax Information Exchange Agreements with foreign tax authorities (including one recently with the U.S.) that increase the exposure of MNCs to transfer pricing issues.

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Recent Developments to China’s Export VAT Refund Regime

The latest VAT adjustments have caused significant concern for many enterprises operating in China, as well as for companies overseas that source materials and products from China. One of the major concerns stems from the lack of notice given for the latest change which was published June 19, 2007 with an effective date of July 1, 2007. For some foreign investors, the changes have resulted in a significant increase in the cost of procuring and producing goods in China for export. In some cases, these cost increases potentially frustrate the business and economic objectives of moving global sourcing and production activities to China by not allowing ample time for adjustments to their operations to cope with these changes.

There are some planning techniques to mitigate the VAT impact on business sourcing and exporting.

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Canada-US Tax Protocol Will Impact Transfer Pricing Disputes

One of the most important and novel changes made by the new Protocol to amend the US-Canada tax treaty is the mandatory arbitration procedure. The provision is called “mandatory” in the sense that it is binding on the tax authorities of the United States and Canada. Taxpayers will have an opportunity to decide whether invoking the arbitration procedure is in their best interests.

Under the Protocol and diplomatic notes, intercompany transfer pricing issues are among those that can be submitted for arbitration. In addition, both competent authority cases already under consideration of competent authorities at the time of the Protocol entering into force and new cases, submitted after the Protocol enters into force, will qualify for submission to the arbitration (provided certain requirements are met).

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FIN 48: What Kind of Documentation Do You Need and How Do You Protect It

FIN 48, recently issued by the FASB, sets forth standards for recognizing any position taken on an income tax return that impacts the amount of income tax reported on a taxpayer's financials. As firms move to comply with this rule, they will need to know what documentation is necessary and whether the documents will be protected.

The disclosures and calculations necessitated by FIN 48 require the taxpayer to engage in extensive analysis of its tax risk from current and past transactions in preparing its annual and interim financials. This analysis may take memoranda. Although tax opinions are not required by FIN 48, “[FASB] believes that a tax opinion can be external evidence” supporting a taxpayer’s tax-risk analysis. Depending on the materiality and/or complexity of a given tax position, a taxpayer ’s preparation of supporting documentation or its engagement of outside counsel for the preparation of legal opinions or memoranda may assist in meeting the MLTN threshold for recognition or in increasing the measurement of the benefit to be recognized.

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Many Unresolved Issues Remain Despite New Canada-US Tax Protocol

On September 21 representatives from the U.S. and Canada signed the 5th Protocol to the Canada-U.S. Income Tax Convention. These amendments to the Canada-US. Tax Treaty will have a major impact on the use of hybrid entities. On the one hand the changes will allow greater use of US LLCs by permitting US residents to receive treaty benefits on Canadian source income. However, the rules will adversely affect many hybrid unlimited liability companies used by US firms to invest or carry on business in Canada.

The new changes will also permit Canada to take a more aggressive approach to combat treaty shopping. Determining whether a particular US person is entitled to treaty benefits will be significantly more complex than in the past.

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Mexico Issues Decree to Diminish Negative Effects of Flat Tax on Certain Industries, Including Maquiladoras

Mexico's Congress recently approved a tax reform package for fiscal year 2008 that includes the creation of a new single rate business tax, the IETU, which reflects the Mexican government's policy objective of collecting more revenue. In addition, on November 5, 2007 Mexican President Felipe Calderon issued a Tax Subsidy Decree (Tax Subsidy Decree) in order to diminish the negative effects of the IETU on certain industries, including the maquiladora export industry.



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What to Expect During Upcoming IRS Examinations

by Ellen McElroy and Christian Wood (Pepper Hamilton LLP)

In upcoming examinations the IRS is giving priority to non-shareholder contributions, Section 936 exit strategies, Section 41 credit claims, Section 199 domestic production deductions, as well as claims of foreign tax credits and use of hybrid instruments.

As a brief review, for examination purposes, the IRS has designated certain tax issues into one of three tiers, based on a combination of factors, including the likelihood of taxpayer non-compliance, the presence of established legal authority, and the implication of substantial revenue. Examiners must raise Tier I issues, and once a Tier I issue has been raised, any resolution of the issue must be approved by LMSB (Large and Mid-Size Business division) executives. Unlike traditional IRS examinations that have been fully resolved by the exam team, LMSB specialists must approve Tier I issue settlements. IRS examining agents are directed to examine all Tier II issues, but are not required to do so. The examinations of Tier III issues follow traditional examination procedures.

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Japan Transfer Pricing Issues and Intangible Assets

The Japanese tax authorities increasingly have been concerned with transfer pricing issues related to intangible assets as a result of the advanced globalization of business activities. Newspapers have reported cases where significant tax assessments have been made when the underlying disagreement with the tax authorities related to the value and location of intangible assets.

The Revised Transfer Pricing Administration Guideline and a collection of Case Studies have been published as additional guidance. The revised Guidelines give specific examples of intangible assets, which should be investigated in transfer pricing audits.



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Mexican Flat Tax Creditability Continued

If the conclusion is that the United States, for the purposes of its federal income tax, determines that the IETU is not an income tax creditable to the United States parent company, then IETU tax paid in Mexico will not be creditable in the United States, thus causing double taxation at the international level. Mexico's Secretary of Finance, Agustin Carstens, stated at the beginning of October that the Mexican government had reached an agreement with various other countries with respect to whether or not the IETU will be creditable, including: the United Kingdom, Italy, India, South Africa and the Bahamas.

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Is the New Mexican Flat Rate Tax Creditable in the US and Canada?

On Monday, October 1st, 2007, an array of amendments to the several Mexican tax laws, the abrogation of the Asset Tax Law and the enactment of a new tax (Impuesto Empresarial de Tasa Única - IETU) were published in the Mexican Official Gazette.

One of the most significant aspects of the new legislation was the introduction of a new tax that will work as a truly minimum corporate tax. This tax will be compared with the annual income tax liability and will be paid only if the income tax liability is lower.

Upon the entrance into effect of this new tax, the Asset Tax will be eliminated. This new tax is truly a minimum corporate tax because it will admit very limited credits against the income tax. The single rate minimum tax will admit loss carry forward alternatives. This minimum tax will affect 40% of the companies that as of this year did not pay income tax. The taxable basis of this new tax is broader than the one of the income tax because of the existence of less deductible items.

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Tax Reform in Japan 2007

An interview with Al Zencak (Zeirishi-Hojin PricewaterhouseCoopers, Tokyo)


As reported in the previous issues of Practical Asian Tax Strategies, 2007 has brought significant tax reform for Japan. To get a better understanding of what this means for your multinational operations, we went to the experts at PricewaterhouseCoopers to discuss the major changes that were made and what opportunities and challenges these changes mean, along with some actions that your company should be taking to position itself to benefit from these recent changes.


View Excerpt from this Interview

Financing U.S. Subsidiaries of European Multinationals

European multinationals often attempt to minimize the U.S. corporate income tax burden on profitable U.S. subsidiaries by introducing related-party debt into their capital structure. While the tax planning objective is clear, the optimal financing structure often is not because of a labyrinth of complex U.S. tax issues. For example, a related party loan made by a group finance subsidiary located in a low-tax jurisdiction raises complicated factual and legal issues under the U.S. “anti-conduit” provisions. In very broad terms, these provisions empower the Internal Revenue Service (IRS) to disregard an intermediate entity in a back-to-back financing arrangement that is part of a plan to reduce U.S. withholding taxes.


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New Transfer Pricing Developments in China

Despite the continuing delays in the release of the China Transfer Pricing Contemporaneous Documentation Ruling, there have been further key developments in China’s transfer pricing environment. Some of these developments were included in the tax reform measures passed by the National Peoples Congress in March. However, more immediate issues have arisen from new circulars issued by the State Administration of Taxation (“SAT”) and actions being taken by some major tax jurisdictions in China. These developments indicate that transfer pricing continues to be a key focus area for the SAT.

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International Operations to Receive Close Scrutiny in IRS Examinations

The IRS is placing high priority on some types of cross-border transactions in future examinations. Targeted transactions include transfers of intangibles offshore to related foreign affiliates, use of international hybrid instruments, and claims of foreign tax credits. While the new priority system will probably result in more exams, it offers companies an opportunity to anticipate and plan for an IRS examination.



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Korean Transfer Pricing Regulations and Income Tax Changes for Non-Residents

Codification of the “Substance over Form” Rule


Recently, the Ministry of Government Legislation announced significant amendments to the regulations of the Law for the Coordination of International Tax Affairs (LCITA) which regulate international transactions. The primary reasons for revising the LCITA are to prevent tax evasion through the codification of the “substance over form” rule, improve consistency with globally accepted taxation guidelines and promote the overseas investments of Korea based companies.



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Determining Uncertain Tax Positions under FIN 48 for Operations in Mexico and China

Companies are evaluating the impact of FIN 48, a US Financial Accounting Standards Board Interpretation, for their reporting of operations in emerging international markets such as Mexico and China.


FIN 48 prescribes a comprehensive model for the manner in which a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return.



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When Tax Planning Rocks: How the Rolling Stones Went Dutch to Cut Taxes

Even before Mick Jagger figured out how to make money as an internationally-acclaimed rock star, he figured out how to keep it.

It is well-known that the pre-famous Jagger attended the London School of Economics—but this is usually regarded as little more than an ornamental bit of evidence about Jagger’s natural intelligence. What few people realize is that Jagger spent his time at the LSE majoring in accounting—and that this early training has returned spectacular dividends to Jagger and two of the other founding members of the Rolling Stones. (Ron Wood manages his wealth separately.)

Jagger was instrumental (no pun intended) in structuring one of the earliest and most sophisticated international song-licensing arrangements in the history of the music industry. Credible reports indicate that the Rolling Stones have earned $450 million in song licensing royalties over the past twenty years—and that the effective tax rate paid by band members on these earnings is a startlingly miniscule 1.5 percent.

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Accounting for Industry-Specific Risks in a Transfer Pricing Setting

Strategically placing a firm's functions, assets and risks within specific tax jurisdictions can result in the multinational organization maximizing its overall after-tax profits by being taxed in lower tax jurisdictions. Such a strategy often requires that a transfer pricing analyst adequately determine the appropriate intercompany price between related parties based on a set of comparable companies. When searching for comparables, however, transfer pricing analysts often fail to place enough emphasis on finding companies that operate within the same or similar industry as the tested party.
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Transfer Pricing in Singapore: What Can be Learned from the Recent China/US APA?

China’s revenue authority, the State Administration of Taxation (SAT) and the US Internal Revenue Service (IRS) have signed their first bilateral APA1. The APA involves US multinational retail giant Wal-Mart. The signing of this APA reflects a number of economic, as well as regulatory trends.
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