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)

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)

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

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)

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)

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