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)

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)

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

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)