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.

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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.

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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.

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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.

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