Tuesday, December 2, 2008

IRS Provides Temporary Relief under Subpart F in Response to the Liquidity Crisis

Excerpt from Practical US/International Tax Strategies by Edward Tanenbaum and Diana Wessells (Alston & Bird LLP)

Treasury and the IRS issued Notice 2008-91, which provides temporary and limited relief to a particular aspect of Section 956, in connection with the current liquidity crisis. Under Sections 951 and 956, a U.S. shareholder of a controlled foreign corporation (CFC) is subject to tax on the amount equal to the lesser of (1) the U.S. shareholder’s pro rata share of the average of the amounts of U.S. property held (directly or indirectly) by the CFC as of the close of each quarter of the taxable year, less the amount of earnings and profits previously included in the U.S. shareholder’s gross income, or (2) the U.S. shareholder’s pro rata share of the applicable earnings of the CFC. The effect of these provisions is to treat the U.S. shareholders of the CFC as receiving the amount invested in U.S. property as a constructive dividend. Section 956 is consistent with the other provisions of subpart F insofar as it is intended to prevent the tax-free repatriation of earnings.

Read More on Relief Provided by Notice 2008-91 (free)

Tuesday, November 25, 2008

China’s New Thin Capitalization Rules: Specific Debt/Equity Ratios Established

Excerpt from Practical China Tax and Finance Strategies by Peter Guang Chen (Deloitte Tax LLP, New York City)

Article 46 of China’s new Enterprise Income Tax Law (EITL) provides that a Chinese enterprise’s ability to deduct interest payments on borrowings from related parties is subject to a “prescribed standard.” However, the EITL, which became effective January 1, 2008, did not address what this “prescribed standard” would be. Without a clear answer on an acceptable debt-to-equity ratio in China, many financing and tax planning plans had to be put on hold, particularly for those multinational corporate groups doing cross-border intercompany financing of their subsidiary operations in China.

This important issue was addressed recently in Circular 121 issued jointly by the Ministry of Finance and the State Administration of Taxation.

Read More on Key Issues of Circular 121 (free)

Wednesday, October 29, 2008

Financial Bailout Package Contains International Tax Provisions

Excerpt from Practical US/International Tax Strategies by Lilo Hester, Ken Wood, Karen Jacobs, Eric Oman, Staci A. Scott and Carlos Probus (Ernst & Young LLP)

Earlier this month, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (Division A), the Energy Improvement and Extension Act of 2008 (Division B), and the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 (Division C) (H.R.1424), herein collectively referred to as the Act. The Act was passed by the Senate on October 1, 2008, and by the House of Representatives on October 3, 2008. The Act has been widely publicized as the “bailout bill” because it provides the U.S. government with authority to purchase up to $700 billion in “troubled,” illiquid assets owned by various financial institutions.

International tax provisions of the Act include:

• Elimination of the distinction between foreign oil and gas extraction income (FOGEI) and foreign oil related income (FORI) and the combination of FOGEI and FORI into one foreign oil basket, applying the existing FOGEI limitation.

• Extension for an additional tax year (through December 31, 2009) of the controlled foreign corporation (CFC) look-through provision of Section 954(c)(6).

• Extension for an additional tax year (through December 31, 2009) of the exception to treatment as foreign personal holding company income for income derived in the active conduct of a banking, finance, or similar business.

• Extension for an additional tax year (through December 31, 2009) of the exception to treatment of certain insurance income as subpart F income.

Read more on international tax provisions with respect to individuals

Tuesday, October 21, 2008

IRS Enhances Opportunity for U.S. Multinationals to Access Cash from Controlled Foreign Corporations

Excerpt from Practical US/International Tax Strategies by Douglas S. Stransky, Lewis J. Greenwald, Ameek Ashok Ponda and Eric J. Fuselier (Sullivan & Worcester)

On October 3, 2008, the U.S. Internal Revenue Service (IRS) issued Notice 2008-91, which expands the ability of a controlled foreign corporation (CFC) to make short-term loans to its U.S. parent to fund operations without creating an income inclusion for U.S. federal income tax purposes. This Notice applies for a CFC’s first two taxable years ending after October 3, 2008. Thus, for a CFC with a calendar taxable year, the Notice applies for calendar years 2008 and 2009. On October 16, 2008, the IRS issued a correction to provide that Notice 2008-91 will not apply to the taxable year of a CFC beginning after December 31, 2009.

Current Law
Generally, under Internal Revenue Code (Code) section 956, a loan made from a CFC to its U.S. parent is considered to be an investment in U.S. property because the CFC holds an “obligation” of the U.S. parent. Under this Code section, the average amount of the CFC’s investment in U.S. property held at the end of each quarter of the taxable year is potentially treated as a “deemed dividend” to the U.S. parent and, thus, taxable on the U.S. parent’s federal income tax return.
In some circumstances, however, the U.S. parent can have a loan outstanding from its CFC without triggering any income inclusion. Under Notice 88-108, for example, even if a CFC makes a loan to its U.S. parent that extends over a quarter end, there should be no income inclusion provided that this loan is outstanding less than 30 days.

But if the CFC were to hold any number of obligations that would (without regard to the 30-day exception) constitute U.S. property for aggregate periods totaling 60 or more days during a taxable year, this 30-day exception would not apply.

Notice 2008-91
In Notice 2008-91, the IRS has supplemented Notice 88- 108 so that a loan from a CFC to its U.S. parent would only constitute an obligation that results in an income inclusion if the loan is held for more than 60 days from the time it is incurred. Notice 2008-91 further provides that if a CFC holds obligations that would (without regard to the 60-day exception) constitute U.S. property for aggregate periods totaling 180 or more days during a taxable year, then this 60-day exception would not apply. Thus, Notice 2008-91 effectively extends the periods within which a taxpayer can hold an obligation without triggering the application of Code section 956. A CFC can apply Notice 2008-91 or Notice 88-108, but not both.

Read Related Articles

Tuesday, October 14, 2008

Proposed Section 108 Regulations May Result in Disparate Treatment of S Corporation Shareholders

Excerpt from Practical US/Domestic Tax Strategies by Jeanne Sullivan (KPMG LLP)

Recently, Treasury published proposed regulations under section 108 on the reduction of tax attributes for S corporations (73 FR 45656-01). The proposed regulations provide guidance on the manner in which an S corporation applies the rules of section 108(b) in a year in which the S corporation has discharge of indebtedness income (COD income) that is excluded from gross income under section 108(a). In particular, the proposed regulations address situations in which S corporation losses and deductions that are treated as net operating losses (NOLs) for purposes of section 108 exceed the amount of the S corporation’s excluded COD income (Excess Deemed NOL). The proposed regulations provide rules whereby the Excess Deemed NOLs are apportioned among the S corporation’s shareholders after tax attribute reduction. As we shall see, the rules may result in potentially disparate treatment of the S corporation shareholders.

Subchapter S generally provides simplified pass-through treatment for corporations that meet its eligibility requirements. To avoid the complexities that can result from the variations in economic rights associated with partnerships, subchapter S requires that each shareholder be allocated a pro rata share of an S corporation’s items of income (including tax-exempt income), loss, deduction and credit as well as a pro rata share of nonseparately computed income and loss (section 1366(a)) and that the S corporation issue only a single class of stock (section 1361(b)(1)(D)). Nevertheless, the S corporation is a separate entity that also retains certain corporate characteristics and the rules of section 108 are applied at the corporate entity level.

Read More: Discharge of Indebtedness and Section 108

Tuesday, September 23, 2008

Mexico Tax Audits

Excerpt from August 2008 Issue of Practical Mexican Tax Strategies by Jaime González-Béndiksen (Baker & McKenzie)

The Mexican tax administration continues to increase its audit activity in practically all sectors of taxpayers, with special emphasis being paid lately to the pharmaceutical and oil sectors. This article excerpt will briefly discuss some of the transfer pricing issues being raised in recent audits.

Transfer Pricing
Secret comparables. It appears that the tax administration is testing the waters with respect to the use of the so-called secret comparables. These are comparables that the tax administration gathers from its own internal records, such as customs records. The administration gathers information on imports of what it considers to be products similar to those of the taxpayer and, on the basis of such information, rejects the prices paid by the Mexican taxpayer to its related parties abroad. The taxpayer is allowed to review the information gathered by the tax administration and to make notes. It does not, however, have any access to the entire customs files of the administration such that it could confirm whether or not the information gathered by the administration is correct or such that it could locate other information to disprove the administration’s findings. In our view, use of the secret comparables violates Constitutional principles and, as such, should be overturned by our courts when this matter comes to their attention.

Business Restructuring. The tax administration continues to audit business or supply-chain restructurings. It is not that the restructuring, as such, are prohibited. The tax administration’s arguments are basically that the restructuring and, consequently the transfer pricing study to support it, lacks substance. The administration tries to disprov the functions and risks that have arguably being transferred from the Mexican entity to one or more foreign companies within the same group. Regarding functions, the administration generally argues that in fact no functions were transferred abroad. Typically, where the taxpayer argues that purchasing and sales functions are now outside of Mexico, the tax administration looks into whether the foreign entity now charged with the functions has, in fact, employees to carry on these functions and whether or not the Mexican personnel formerly charged with these functions has left the Mexican company or continues to work there. Where managerial functions have reportedly been moved outside of Mexico, the tax administration also looks into whether the employees of the Mexican company formerly charged with the managerial functions in question, have or have not been relocated. On the risks side, the administration looks into whether the Mexican company’s history shows any such risks in fact occurring in the past, such as inventory risks, product liability, bad debts, etc. Its motto is that where there is nothing to lose no risk is being assumed.

These audits, however, typically forget to address the fact that whatever flaws the functions or risks may have, assets have in fact moved. Intangibles are now owned by a foreign member of the group. The production is also owned by a foreign principal who either sells it to a commissionaire in Mexico or sells it to the Mexican company for distribution. No doubt the mere fact that the Mexican taxpayer now owns virtually no assets, calls for a lower return. As mentioned earlier, this is often ignored by the auditors.

More on Business Restructuring

Tuesday, September 16, 2008

Tax Auditors Look to Substance in Centralized IP Structures

Excerpt from August 2008 Issue of Practical US/International Tax Strategies by John Henshall (Deloitte & Touche LLP)

In the early 1990s the first businesses transformed corporate efficiency, and profitability, by taking a holistic view of their business and optimizing their supply chain networks—the complex web suppliers, production and R&D facilities, distribution centers, sales subsidiaries, channel partners and customers. Typically the best commercial structure involved a centralization of regional activity into “Principal” company supported by “contract” or “toll” manufacturers and “commissionaire” sales or “simple” distributors, supported by “shared service centers” to take care of back-office functions. Today most multinationals don’t derive a significant proportion of their profits from the physical act of making products but rather from the ideas they generate that lead those products, wherever products are made. As this state of affairs evolved so did the centralized business model and IP planning is now a signifi cant element in any business restructuring.

Business restructurings are by their nature an enormous strain on the organization and they are not undertaken purely for tax reasons. Tax is, however, taken into account when deciding where the centralized entity should locate; in most reorganizations high-tax countries then see high-profit activities moving away. These governments are fearful of the fiscal consequences of the more profitable element of their tax base moving offshore and will audit the transition vigorously.

Read More: Why Is Substance Important?

Tuesday, September 9, 2008

The Internal Revenue Service Provides Limited Relief from the AHYDO Rules for Pre-2009 Financing Commitments

Excerpt from Practical US/Domestic Tax Strategies by Yoram Keinan and Mark H. Leeds (Greenberg Traurig, LLP)

The Internal Revenue Service has responded again to the troubled credit markets by easing the potential tax burden on corporations that issue debt pursuant to previously established financing commitments (Commitments).

On August 8, 2008, the Service issued a Revenue Procedure that describes circumstances under which it will not treat a debt instrument issued pursuant to a Commitment as an applicable high yield discount obligation (AHYDO) for federal income tax purposes. The AHYDO rules can result in both deferral of interest and original issue discount (OID) deductions, as well as a disallowance of such deductions. As a result, corporate borrowers who were lucky enough to lock Commitments prior to the current credit crunch will not face possible deferral and/or disallowance of interest and OID deductions on their debt as a result of actions taken by their lenders.

Read More on the Background of the AHYDO Rules (free)

Thursday, August 14, 2008

IRS Disallows Foreign Tax Credits Claimed for Cross-Border Trust

Excerpt from Practical US/International Tax Strategies by Lawrence Hill and Alexander Roberts (Dewey & LeBoeuf LLP)

Recently, the IRS issued a Chief Counsel Advice memorandum (CCA) advising the disallowance of foreign tax credits claimed by a U.S. corporation (U.S. Corporation) in connection with income and assets transferred to a cross-border trust (Trust) on the grounds that the Trust arrangement lacked economic substance. The IRS determined that the cross-border trust “served no legitimate non-tax purpose and was not reasonably expected to generate an economic profit for the taxpayer.” In the alternative, the IRS concluded that the series of transactions involved in the arrangement lacked economic substance as an integrated transaction. In addition, the IRS determined that the foreign tax credits should be denied under Section 269(a)(1) and (2) because the taxpayer formed and transferred funds to a subsidiary with the principal purpose of avoiding U.S. federal income tax.

Read More on IRS Challenges of Cross Border Trusts (free)

Tuesday, August 5, 2008

Dutch Cooperatives Provide Tax Planning Opportunities

Excerpt from Practical European Tax Strategies by Joseph B. Darby III, Thomas van der Vliet(Greenberg Traurig LLP) andShane Kigen (Ernst & Young)

There is a famous Dutch proverb that states, “The art is not in making money, but in keeping it.” To help achieve this laudable goal, the Dutch have thoughtfully provided a Dutch cooperative holding structure that allows multinational enterprises and private equity funds to keep a significantly greater after-tax share of the money they make.

Cooperatives have been a business form used in the Netherlands for well over a century. However, only recently have tax lawyers fully begun to exploit this distinctive vehicle in international tax planning. What makes a cooperative exciting to tax planners is its unique treatment under the Dutch dividend withholding tax. Unlike its close relatives, the Dutch private or public company (BV/NV), a cooperative is not subject to the 15 percent withholding tax on dividend distributions. The absence of a levy of dividend withholding tax makes the cooperative a logical choice as a holding company. In conjunction with the Netherlands’ extensive treaty network, a cooperative holding structure generally permits foreign members of a cooperative to repatriate profits free from Dutch withholding tax.

More on Legal Attributes of Dutch Cooperative

Tuesday, July 29, 2008

The IRS Fixes Subpart F -- Sort Of

Excerpt from Practical US/International Tax Strategies by Joseph B. Darby III (Greenberg Traurig LLP) and Brainard Patton (Counselor at Law)

Ronald Reagan famously commented that the most scary phrase in the English language is, “We’re from the government and we’re here to help you.”

An even more celebrated saying is, “If it ain’t broke, don’t fix it.”

Now comes the Internal Revenue Service—unquestionably, these people are from the government—and they have decided to “help” us by delving into Subpart F of the Internal Revenue Code and “fixing” some esoteric but very important rules, including rules that address the consequences of contract manufacturing under the so-called “branch rule.” The branch rule is a significant limitation on the so-called “manufacturing exception,” which in turn is arguably the most important exception to the often tangled and always confusing “Subpart F rules” governing controlled foreign corporations (CFCs).

Let’s be frank about this: The branch rule is unquestionably broken, and has been broken for a long time. Now, let’s be even more frank: The branch rule is “broken” primarily because the Internal Revenue Service tried to fix it in the first place. Needless to say, some people—OK, a lot of people—have concerns about sending the IRS to fix a rule that the IRS has made far worse on several previous occasions.

Read More on the Proposed Regulations (free)

Tuesday, July 15, 2008

Documenting “Benefits” of Intercompany Services Becoming Increasingly Important in Europe as New U.S. Regulations are Implemented

Excerpt from Practical US/International Tax Strategies by Michelle M. Johnson (Ceteris. Inc.)

In late May (2008) the Tax Court of Lombardy reversed a previous judgment of the Provincial Tax Court of Milan regarding a taxpayer’s intercompany services charges. The Milan judgment had ruled in favor of the taxpayer by recognizing the deductibility of services charges related to the “provision of market information useful to manage the sales process and management control” by the parent company. These first degree judges had concluded that these services were “necessary” or at least “useful” in improving the management of the business of the Italian-controlled entity, thereby warranting the deduction.

The Tax Court of Lombardy overturned this decision in favor of the Italian tax authorities’ original position that no deduction should be allowed since there was an absence of a specific connection to the interests of the recipient. Even though the parent had calculated the services’ cost shares among its subsidiaries based on proportion of turnover, the appeal-level judges ruled that in the case of the Italian subsidiary this was not representative of the actual benefit received.

This ruling is just one example of issues that U.S.-headquartered taxpayers might encounter as they seek to comply with the new U.S. transfer pricing regulations for intercompany services. These new regulations are prompting U.S. taxpayers to examine their headquarters operations with greater scrutiny as they seek a more comprehensive approach to evaluating fully-loaded cost pools that may relate to activities that benefit non-U.S. subsidiaries. For many companies, implementing these new regulations has resulted in an increased amount of services charges made to foreign affiliates.

Read More: Best Practices to Reduce Your Risk of Disallowed Deductions (free)

Tuesday, July 8, 2008

Tax Issues Facing Supply Arrangements in Latin America

Excerpt from Practical Latin American Tax Strategies by Victor Cabrera, Jose Leiman, And Marc Skaletsky(KPMG LLP)

Over the past decade, many large multinational corporations (MNCs) have been moving their European and Asian operations from a decentralized group of stand alone full-fledged manufacturing and distribution (M&D) subsidiaries towards a “hub-and-spoke” system. Under these arrangements, the hub (the “Principal”) assumes functions and risks from the M&D subsidiaries. This centralization of functions and risks in the Principal hopefully brings a commensurate share of consolidated profits.1 The conversion of full-fledged M&D subsidiaries to a hub-and-spoke arrangement raises a series of non-tax and tax considerations and associated issues that must be resolved in order to implement the structure successfully.

Given the potential benefits of the hub-and-spoke structure, many MNCs have sought to implement the structure for their Latin American operations. However, when MNCs cast their sights on Latin America, they are quite often faced with a diverse and sprawling network of jurisdictions, each with its own rules and views on the operation of structures within their borders. Many MNCs doing business in Latin America learn that applying the European or Asian hub-and-spoke template to Latin America does not always result in a natural fit. MNCs that seek to implement a hub-and-spoke arrangement in Latin America must understand and plan for the specific regional issues they will face.

Read More about Specific Latin American Hub-and-Spoke Issues to Consider (free)

Japan GST/VAT Update:

Invoice Based System Recommended and A Rate Hike is Widely Expected

Excerpt from Practical Asian Tax Strategies by Edwin T. Whatley, Kazuo Taguchi and Gabriele Slattery (Baker & McKenzie, Japan)

GST/VAT Legislative Changes
There have been no significant changes to Japanese GST/VAT (referred to as “consumption tax” in Japan) legislation in the 12 months to May 2008. One legislative change, not specific to consumption tax that may have an effect on Japanese consumption taxpayers is the modification of some administrative aspects of the Japanese tax ruling system.

GST/VAT Rulings: Changes to Advance Ruling System
While formal rulings have, since the introduction of the tax ruling system in 2001, been binding on the National Tax Agency (“NTA”), Japan’s formal advance ruling system has thus far not been very useful in producing guidance for taxpayers. The authorities generally have taken a very narrow view of what types of questions fall within the scope of Japanese tax law issues upon which a ruling could be issued. In particular, the issuance of binding tax rulings has been limited to past transactions and future transactions which are certain to be conducted, the applicant’s name has been publicly disclosed and details of the ruling have been made public within 60 days in most cases. The tax authority has been under a “loose” obligation to issue a ruling within three months in principle.

Effective April 1, 2008, the tax ruling system has been modified in an effort to make the advance ruling system more useful for taxpayers.

Read More about Specific Improvements

Tuesday, July 1, 2008

Latin American Reorganization: Be Aware of Tax Issues

Excerpt from Practical Latin American Tax Strategies by John A. Salerno and Julian R. Vasquez (PricewaterhouseCoopers LLP)

Multinationals considering the reorganization of their group legal entity or operational structures in Latin America need to be cognizant of the potential income tax implications related to the sale or transfer of shares or other equity interests in their affiliates.

While most companies are keenly aware of the tax implications relating to the sale of a direct or indirect subsidiary to a third party, many do not realize that an intra-group transfer of shares in connection with, for example, the formation of a regional holding company structure or post-deal integration planning, may also trigger tax in certain Latin American countries. Absent tax treaty protection the tax cost of the transfer of shares can be quite high.

In some cases the relevant taxable “transfer” is not so evident, and may occur, for example, as a result of the liquidation of a nonresident shareholder of a Latin American company. Domestic law or tax treaty-based strategies often exist to minimize or eliminate the local country income tax burden on capital gains. Thus, particularly in the case of transactions with related parties, slight modifications of a transactional structure may, in certain cases, yield a more favorable tax results.

Read More on Brazil Tax Issues (free)

Tuesday, June 24, 2008

IRS Proposes New Regulations on Contract Manufacturing and Subpart F Income

Excerpt from Practical US/International Tax Strategies by Peter J. Connors, Stephen Lessard and Matthew A. Clausen (Orrick, Herrington & Sutcliffe LLP)

In response to the growing importance of contract manufacturing and other manufacturing arrangements, on February 28, 2008, the Treasury Department and the Internal Revenue Service (IRS) have proposed to modernize the foreign base company sales income (FBCSI) regulations. Under section 951(a)(1)(A)(i), a U.S. shareholder of a controlled foreign company (CFC) includes in gross income its pro rata share of the CFC’s subpart F income for the CFC’s taxable year that ends with or within the taxable year of the shareholder. Section 952(a)(2) defines subpart F income to include “foreign base company income.” Section 954(a)(2) defines foreign base company income to include FBCSI for the taxable year. While the proposed regulations are prospective in application, taxpayers may choose to apply these regulations “in their entirety to all open tax years” as if they were final regulations. This flexibility will be an important consideration in resolving disputes with the IRS.

Read More on New FBCSI Regulations (free)

Thursday, June 19, 2008

Sunset on the Horizon: Changes in Tax Planning for Foreign Investments

Excerpt from Practical US/International Tax Strategies by Isaac Grossman (Morrison Cohen LLP)

It doesn’t take long for investment professionals to adjust to changes in the tax rules governing investments. Application of the 15 percent long-term capital gains rates to individuals receiving qualified dividend income from domestic and certain foreign corporations is no longer news. As a result, investment decisions are based on the expectation that these rates will remain in effect. However, these changes among others will sunset after 2010, if no further legislation is adopted. Currently, it is not clear that further legislation will be on the national agenda when President Bush, the force behind many of these tax rate cuts, leaves the White House. Moreover, some would suggest that tax rates may be increased even sooner depending on the identity of the next president. If the rates sunset as currently drafted, the individual income tax rates will return to close to 40 percent and no special rate will be applied to dividends.

As many investments have a shelf life of several years, it is essential to think ahead of the curve and consider the impact of these upcoming changes.

In light of the expected increase in the tax rates for dividends from 15 percent to close to 40 percent, several basic assumptions for tax structuring investments must be reconsidered. First, the most basic decision in structuring a new operating or holding corporation both domestically and offshore is the proper capitalization of the corporation, i.e., the proper mix of debt and equity. Under current law, there is a tension between favoring debt or equity. Debt generally permits the issuing corporation to deduct current payments of interest to investors and interest payments often qualify for lower withholding tax rates than dividends. In addition, it is easier to return the principal amount of a debt instrument to the holder than to return the principal amount of an equity instrument to the holder due to the tax provisions relating to redemptions. Equity permits individual investors to pay capital gains rates on dividend payments and permits corporate recipients a dividends received deduction (for domestic investments) or indirect foreign tax credits (for foreign investments). When the tax rates sunset and individuals become taxable at ordinary rates on dividends, equity may become less tax effi cient for individual investors. Thus, the decision on capitalization will further favor debt.

Read More on Leveraged Recapitalization

Tuesday, June 17, 2008

OECD Transfer Pricing Guidelines

Excerpt from Practical European Tax Strategies by Peter Hann (KPMG in the UK)

The OECD has been moving rapidly with its projects to revise the transfer pricing guidelines and to issue a new version of the Model Tax Convention. Revised transfer pricing guidelines will be issued within the next few years, while the new version of the Model Tax Convention is expected to be finalized as soon as June 2008. The main issues relating to transfer pricing are summarized below.

Transfer Pricing Guidelines

Profit-based Methods

Following consideration of the responses to a consultation held in 2006 on transactional profit methods, in January 2008 the OECD published “issues notes” on various aspects of profi t based methods as part of a further consultation exercise.

The OECD working party has been examining the status of the transactional profit methods (transactional net margin method and profit split), which are at present regarded as methods of last resort in the OECD guidelines. The working party has tentatively concluded that the correct guidance on the approach to the selection of a transfer pricing method is to emphasize that the method used should take into account the appropriateness of that method in view of the functional analysis and comparability analysis, and also taking into account the strengths and weaknesses of the OECD recognized methods. This should also involve consideration of the availability of reliable information, especially of uncontrolled comparables, and the degree of comparability including the reliability of comparability adjustments that would need to be made.

The OECD Working Party takes the view that the traditional transactional methods (comparable uncontrolled price (CUP), resale price method and cost plus) have intrinsic strengths. Their latest proposal in these issues notes would, however, remove the exceptional status of the profit methods and put more emphasis on the functional analysis to determine the appropriate transfer pricing method and on the consideration of the relative strengths of the different methods in a particular case.

Owing to the intrinsic strengths of the traditional transactional methods, the OECD still considers that when a traditional transactional method and a transactional profit method can be applied in an equally reliable manner, the traditional transactional method is to be preferred.

Read More on the issues addressed in the “issues notes” published as part of the consultation:

Tuesday, June 10, 2008

FAS 123R and Cross-Border Tax Issues

Excerpt from Practical US/International Tax Strategies by Albert W. Liguori, Michael Murphy and J.D. Ivy (Alvarez & Marsal Taxand, LLC)

Most public companies provide some form of stock compensation to their executives and employees and as a result must grapple with the tax and financial statement treatment of such equity compensation awards. Crossborder employment situations further complicate the tax and financial statement treatment of these awards.

The impact of recent developments in the transfer pricing arena as they relate to how equity compensation is treated under Statement of Financial Accounting Standards No. 123R (FAS 123R) and FAS 109 have now become natural opportunities for companies to determine not only whether they are in compliance with the financial statement and transfer pricing rules but also to undertake some tax-efficient planning.

Under FAS 123R, stock based compensation, which includes stock options and restricted stock units, must be valued at grant date and recognized as an expense for book purposes over the equity compensations’ vesting period. The vesting period is also known as the “service period” for which an employee earns the right to benefit from such equity compensation. Naturally, the amount expensed must be tax-effected. However, most foreign jurisdictions as well as the U.S. do not allow a tax deduction for equity compensation until the vesting is complete or the equity compensation is exercised. This difference in time (i.e., expense now, deduct later) results in deferred tax accounts. When accounting for these deferred taxes, it is important to know if and where a deduction will ultimately become available for the stock compensation, a task easier said than done.

Read More on FAS 123R

Tuesday, June 3, 2008

China Issues Guidance on 15% Tax Rate for High/New Tech Enterprises

Excerpt from Practical Asian Tax Strategies by Todd Landau and Edward Shum (PricewaterhouseCoopers, China)

A new joint circular recently issued by the Chinese authorities provides important guidance on the availability of Chinese tax incentives under the new Corporate Income Tax (“CIT”) law, including the preferential 15% tax rate, for investments in High/New Tech Enterprises (“HNTE”). These rules have retrospective effect from January 1, 2008.

According to the new Chinese CIT law, effective from January 1, 2008, HNTEs can enjoy tax incentives, including a preferential CIT rate of 15%. In order to further clarify the criteria for qualifying as HNTEs, the Ministry of Science and Technology (“MST”), Ministry of Finance (“MoF”) and StateAdministration of Taxation (“SAT”) have issued the “Administrative Measures for Assessment of High-New Tech Enterprises” (“Measures”) andthe “Catalogue of High/New Tech Domains Specifically Supported by the State” (“Catalogue”) by way of a joint circular GuoKeFaHuo (2008) No.127,with retrospective effect to January 1, 2008.

Read More on 15% Tax Rate (free)

Tuesday, May 27, 2008

EU to Modernize VAT Rules on Financial and Insurance Services

Excerpt from Practical European Tax Strategies by Tracey Paveley (Baker & McKenzie)

The European Union (EU) has recognized that the EU VAT legislation in relation to financial and insurance services is becoming increasingly out of date as providers introduce more sophisticated and diverse financial products into the marketplace. Businesses are finding it difficult to define these products for VAT purposes within the confines of the current legislation.

This uncertainty surrounding the VAT treatment of financial and insurance products has led to an increased amount of tax litigation, particularly as businesses are often required to negotiate the application of the VAT exemption in multiple Member States. This process can be very costly for businesses.

In addition, there is growing concern that EU financial institutions are less efficient than their U.S. counterparts. The embedded irrecoverable VAT cost suffered by EU providers of financial or insurance services is considered one of the factors contributing to this perceived inefficiency.

Read More>

Tuesday, May 20, 2008

Brazilian Exporters Surprised by Change of Position on Inflation Correction

Excerpt from Practical Latin American Tax Strategies
published by WorldTrade Executive

Brazilian exporting firms have been surprised by the sudden reversal of a longstanding policy correcting tax credits for inflation.

For years, exporters have been able to use credits from their “presumed” excise tax (IPI) to compensate for payments of Brazil’s PIS-Cofins corporate social security taxes. This compensation was created as a fiscal incentive for exporters. Rather than exempt exporters from PIS/Cofins, which would have required legislation, the government adopted an administrative approach, granting a credit for what companies would have paid in excise taxes, the reason why it is referred to as the “presumed IPI.”

In practice, exporters have commonly allowed these credits to accumulate over several years before claiming them. Since these credits often date back six or seven years, the tax department has permitted companies to adjust their credits for inflation, using the country’s base interest rate.

But starting last December, the tax department has rejected this practice. In a series of decisions in February and March of this year, the department’s Superior Chamber of Fiscal Appeals, the last administrative recourse for companies, has supported this new policy, turning down the appeals of exporting firms.

More: How does this affect compensation for exporters?>

Wednesday, May 14, 2008

Mexico's Dictamen Fiscal Is Similar to New Fin 48 in the US

Excerpt from Practical Mexican Tax Strategies by Steve Axler & Dinorah Gonzalez (Halliburton)

One of the concerns resulting from the introduction of FIN 48 for many in-house tax practitioners, especially for US based multinational companies, is that the US Internal Revenue Service would now essentially have a road map to various tax positions taken by the taxpayer. However, the disclosure of tax positions to the tax authorities is not a new or unusual event in Mexico. In fact, for large taxpayers in Mexico this is an annual occurrence known in Spanish as the Dictamen Fiscal.

Often simply referred to just as “the Dictamen”, this is a tax audit of a Mexican legal entity or person that carries out business activities or any foreign residents with a permanent establishment in Mexico. The Dictamen Fiscal can only be performed by a registered and certified Mexican public accountant. Upon completion of the Dictamen, the accountant will issue a report which will be filed with the Mexican tax authorities (Servicio Administración Tributaria or “SAT”) stating whether, according to the applicable tax regulations and audit standards, the taxpayer has complied with its obligations. The public accountant is required to sign the Dictamen under penalty of perjury.

It cannot be emphasized enough the influence that a Mexican statutory auditor has regarding the tax positions taken by a taxpayer in Mexico.

More on Dictamen Fiscal

Tuesday, May 6, 2008

The Pot Calling the Pot Black: Congress Points a Finger at the Internal Revenue Code (and Itself)

Excerpt from Practical US/Domestic Tax Strategies by Joseph B. Darby III (Greenberg Traurig LLP)

On April 10, 2008, the Small Business Committee of the U.S. House of Representatives released a Report stating that small businesses, which could otherwise help the U.S. economy get “back on track,” are burdened by a variety of barriers under the “remarkably outdated tax code.”

In the legendarily famous words of Homer Simpson himself, “Duh!”

What makes this Report newsworthy is not the content but rather the author. We are familiar in politics with the “pot calling the kettle black,” since, after all, finger-pointing and blame-shifting is pretty much what Congress does. However, since the primary party to blame for the tax code being “remarkably outdated” is Congress itself, Congress has, in effect, decided to point a finger at itself: This is the pot calling the pot black. Now that is news, indeed.

The funny thing is that the Report is absolutely dead-on accurate in its criticisms of the Code—so much so that it gives the reader a small hope that some of the changes might actually be enacted. Experience shows that when members of Congress are bickering and blaming each other, very little gets done. However, when Congress decides to look in a mirror and blame itself—well, almost anything seems possible.

Although the Report is concerned primarily with “small business” issues, the recommendations (if adopted) would benefit all tax-paying businesses, by simplifying the law and eliminating burdensome recordkeeping. Best of all, the Report might actually initiate a movement in Congress to consider the extraordinary burdens it places on U.S. taxpayers as part of the “voluntary” U.S. income tax system. In short, the Report is a surprisingly candid document that should be read by taxpayers of all sizes and stripes.


Thursday, April 24, 2008

Accounting—In Practice—for Back Office and Headquarters Services After Changes to Intercompany Service Transactions

Excerpt from Practical US/International Tax Strategies' interview with Transfer Pricing Specialist Eric Ryan, DLA Piper

In 2006 the Treasury Department and the IRS issued temporary regulations under Code Section 482 that phased out the simplified cost based method for reporting intercompany service transactions, and replaced it with the Services Cost Method (SCM). In order to find out how companies are adapting to the changes, Tax Strategies talked with Eric Ryan, a Partner with DLA Piper, resident in the Palo Alto office. Mr. Ryan has been working closely with many companies, primarily in high tech sectors, to implement the new rules.

Strategies: What kinds of companies are most affected by the changes to the new transfer pricing methods provided under the temporary service regulations?

Ryan: The key companies that are affected by this are U.S. multinationals that, on a regular basis, are charging out to their foreign affiliates some portion of what they consider U.S. headquarters costs. These companies in particular have basically had to do a complete relook at what they were doing previously.

Strategies: What has been the general taxpayer reaction to the SCM or Services Cost Method and the temporary regulations that allow expenses to be charged to affiliates without a markup?

Ryan: With the exception of one or two items, I think it has actually been favorable. Of course the SCM—the no-markup approach—is an exception to the arm’s length standard because the tax authorities would otherwise assume that there’s a profit motivation in arm’s length dealings. So what the IRS tried to do here was to keep the categories of expenses that could be allocated out without a markup to non high value-added activities. There was an earlier version of these proposed regulations issued in 2003 that had a formula which was just not workable, and it took a lot of effort to figure out if you could qualify for the new markup. Now the IRS has issued this list of 101 things that companies can allocate without a markup and that list, which is in Rev. Proc. 2007-13, we are coming to find out, is fairly extensive for General and Administrative activities.

More from this Interview (free)>

Tuesday, April 1, 2008

2008 Tax Reform in Japan

Excerpt from Practical Asian Tax Strategies by Yumiko Arai and Al Zencak
(PricewaterhouseCoopers, Tokyo)

The 83 trillion yen Japanese state budget and tax reform bill for fiscal 2008 passed the House of Representatives with a majority vote by the ruling parties. The budget and the tax reform bill cleared the lower house with an approval of the ruling Liberal Democratic Party and its coalition partner New Komeito party, making sure that the budget will pass through the parliament in time for the beginning of the new business year (April 1). The following excerpt reviews some of the major corporate taxation changes currently contained in the 2008 tax reform legislation.

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Tuesday, March 18, 2008

Thank God I'm a Country Boy

Why Country Songwriters Now Get Capital Gain Treatment for Their Music

Published in Practical US/Domestic Tax Strategies by Joseph B. Darby, III (Greenberg Traurig LLP)

As a tax lawyer, my professional life has the elements that my grandfather believed were essential to a really good job: indoor work, no heavy lifting.

In fact, there are only three things that I do as a tax lawyer. I help taxpayers (1) avoid income, (2) defer income, and (3) convert ordinary income into long-term capital gains. That’s really all there is to it, other than reading and understanding the Internal Revenue Code. All in all, as I said, a pretty cushy existence.

However, late at night, after everyone else has gone to bed, I sometimes wish I had time for one other important thing: I wish I had time to write country-western songs. You know the type of songs I’m referring to: mournful ballads sung with a twangy drawl, about how my old dog done died, and my new dog won’t hunt, and the finance company repossessed my truck, and my dern wife done run off with the guy from the finance company in my old truck, and my 12-gauge shotgun was in the back of the truck they took so I kain’t shoot no one, and my latest batch of homemade whisky just kilt four of my few remaining friends and blinded the rest, so there ain’t no one left who can see that I’m all tore up inside.

That’s what I call music.

Unfortunately, country songwriting is a tough racket, and so I have stuck until now with the practice of law, with the occasional tax or sports article on the side. The problem was that, until recently, all income from writing activities was taxed at ordinary federal income tax rates. There was no percentage in that kind of work, I figured.

You can imagine my amazement, therefore, when country songwriters managed to convince Congress in 2005 and 2006 that their creative endeavors deserved a special tax dispensation and that the sale of a copyright in a song is no longer ordinary income, but rather can be taxed at favorable capital gains tax rates.

This is a story worth telling. In fact, I may even write a song about it.


Monday, February 25, 2008

Intellectual Property Holding Companies: Tax Panacea or IP Mistake?

Excerpt from Practical US/Domestic Tax Strategies by Paul Dau, Paul Devinsky and Justin Hill (McDermott Will & Emery LLP)

Typical reasons for establishing intellectual property (IP) holding companies include (i) tax planning, (ii) protection in the event of insolvency, and (iii) administrative synergies, such as consolidation of legal costs. In reality the process of establishing and operating an IP holding company is far from trivial. By its very nature it brings together three complex legal fields, namely intellectual property, tax and insolvency. Moreover, the considerations that apply are usually multi-jurisdictional and therefore inherently complex. Oftentimes, IP holding strategies turn out to be optimized with one or more of the above legal fields more in mind than the others. Failure to assess properly competing economic and legal considerations in these complex international scenarios can lead to failure to meet objectives and runaway costs.

In many cases, the holding company is a subsidiary within an international corporate group. Sometimes, although less often, the holding company is the parent company of the overall corporate group. Adoption of a suitable structure depends to a large extent on the headquarter jurisdiction, the mechanism by which the various synergies are anticipated to operate, and on the circumstances of the particular scenario.


Monday, February 11, 2008

Transfer Pricing and Customs Valuation

Excerpt from Practical US/International Tax Strategies by Peter E. Kirby (Fasken Martineau DuMoulin LLP)

While the income tax authorities in Canada and the U.S. have spent the last twenty years developing, refining, and explaining their policies for testing transfer pricing decisions, the customs authorities in these countries have been slower to come to grips with the issue. That has now changed and the customs authorities in Canada and the U.S. have begun to look more carefully at transfer pricing. As a result of that scrutiny, two things have become clear. First, a transfer price that may be acceptable to the income tax authorities may not be acceptable to the customs authorities. Second, a transfer price study that confirms the acceptability of transfer prices for income tax purposes is, in most cases, irrelevant for the purposes of customs valuation.


Tuesday, February 5, 2008

Spain’s Draft Regulations on Transfer Pricing Rules

excerpt from Practical European Tax Strategies written by Pedro Aguarón (Baker & McKenzie Barcelona, S.L.)

As a result of the new Law for Avoidance of Tax Fraud (LATF) enforceable in 2007, the Spanish transfer pricing legal framework has changed significantly.

One notable change is that the LATF introduced specific transfer pricing requirements. The taxpayer is required to properly document that the price used in related transactions is arm’s length and make this documentation available at the tax authorities’ request.

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Wednesday, January 30, 2008

Transfer Pricing in Latin America

In a recent discussion, PricewaterhouseCoopers' John Salerno joined the editors of Practical Latin American Tax Strategies to talk with ADM's Robert Frable and Sony's Marc Lewis about their tax operations in Latin America, their new procedures for dealing with FIN 48 and transfer pricing procedures. Following is and excerpt from the interview with Marc Lewis, the second in a series of excerpts from that exclusive interview:

Strategies: You had mentioned earlier some of the benefits of taking a regional approach to managing the Latin American tax burden. Is there anything specifically that you have been doing within your company to regionalize the approach to tax planning?

Lewis: Transfer pricing is probably a good way to illustrate a regional approach. It is important for a company to be consistent about its transfer pricing both regionally and globally, and I think it is important for many reasons. A regional approach is a good approach for transfer pricing because it forces you to look at things on a 50,000 foot level in the Americas, for instance. There are requirements now in pretty much every country, and you ask yourself, if I’ve got limited resources in my department, how am I going to tackle this kind of project.


Tuesday, January 22, 2008

Implementation Regulations for the New Enterprise Income Tax Law of China

Excerpt from Practical China Tax and Finance Strategies by Fuli Cao (Jones Day)

In December, the long-awaited new Enterprise Income Tax (EIT) Regulations were finally released. They define resident enterprise, reduce the tax rate and eliminate taxes on certain kinds of dividends. Many uncertainties still remain.

The EIT Law and the New EIT Regulations made major changes and clarifications, including the following:

  • Defined “resident enterprise” as an enterprise either established under the law of China or effectively managed in China.

  • Confirmed transfer pricing rules.

  • Introduced controlled foreign corporation rules.

  • Introduced thin capitalization rules.

  • Reduced the regular income tax rate from 33 percent to 25 percent.

  • Introduced a 20 percent tax rate for small-scale enterprises earning small profit.

More changes and clarifications:

Monday, January 14, 2008

Retrospective Adjustments of Intercompany Prices for Goods Sold into Russia

Excerpt from Russia Eurasia Executive Guide by Kurban Nepesov and Natalia Volkovskaya (KPMG)

In general, transfer pricing in Russia is not particularly complex, although for those importing goods from a related party, the balancing act between Russian customs and their local tax inspectorate can be challenging -- the two authorities are driven by opposing fiscal interests. For example, an increase of intercompany prices at which the Russian subsidiary purchases goods from its foreign affiliate should in principle lead to an increase of customs duty and import VAT and, therefore, to a decrease of its Russian profits tax liabilities (as the increased expense erodes the margin) for the importer. Thus, adjustments to established intercompany prices can lead to disputes with either the Russian customs or tax authorities -- or both!


Wednesday, January 2, 2008

Managing Tax Risk in Latin America

In a recent discussion, PricewaterhouseCoopers' John Salerno joined the editors of Tax Strategies to talk with ADM's Robert Frable and Sony's Marc Lewis about their tax operations in Latin America, their new procedures for dealing with FIN 48, and transfer pricing procedures. This excerpt from that interview takes a look at their strategies surrounding FIN 48:

Strategies: What has your overall experience been in managing the implementation of FIN 48 in the region?

Lewis: It is hard to say that the Latin American region presents something that is unique within FIN 48 implementation versus some of the other regions but I think one thing to consider is how much reliance a taxpayer can place on the availability of Competent Authority or APA relief. To a certain extent, it is dependent upon how active the Competent Authority is between different countries and how active the APA programs are between different countries. Latin America, Mexico and probably some others have pretty robust activities. However, in other countries, it is just building up, so I do not think you are at the same level as you see in some of the countries in Europe, Japan and other places where you can rely upon a Competent Authority or APAs in the assessment of uncertain tax positions.

Frable: FIN 48 was an interesting experience with this being the implementation year. I think everybody was surprised at how much time they ended up spending on the implementation. It took away from your day-today responsibilities. I think it is going to get better; tax departments, controllers and even outside auditors had to work through a learning curve.

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