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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