View
79
Download
1
Category
Preview:
DESCRIPTION
FROM PRINCIPLES TO PLANNING. Cross-border Financing. Cross-border Financing Knox Teague, Dixon Hughes Goodman LLP Tim Bloos , MNP LLP Mark Pearlman, MNP LLP. Inbound Financing to the U.S.: Considerations Knox Teague, Dixon Hughes Goodman LLP. Earnings Stripping Debt / Equity - PowerPoint PPT Presentation
Citation preview
FROM PRINCIPLES TO PLANNING
Cross-border FinancingFROM PRINCIPLES TO PLANNING
Cross-border FinancingKnox Teague, Dixon Hughes Goodman LLP
Tim Bloos, MNP LLPMark Pearlman, MNP LLP
Inbound Financing to the U.S.: Considerations
Knox Teague, Dixon Hughes Goodman LLP
Earnings Stripping
Debt / Equity
Withholding Tax
U.S. Inbound Financing Considerations
Earning Stripping and Form 8926: Technical Rules IRC § 163 (j)Who is Subject to Earnings Stripping
• A U.S. company, or• A foreign company with a U.S. branch that pays or accrues interest expense:
Deducts interest expense paid or accrued to a related person if no U.S. income tax (or reduced U.S. income tax) is imposed with respect to such interest,
ORPaid or accrued to an unrelated person if (a) no gross basis U.S. tax is imposed with respect to such interest, and (b) there is any guarantee by a related person which is either foreign or a tax exempt organization
U.S. Inbound Financing Considerations
Earning Stripping and Form 8926: Technical Rules IRC § 163 (j)• Earnings Stripping General Rule: Statute
IF• Taxpayer pays disqualified interest • Net interest expense exceeds 50% of adjusted taxable income
plus any excess limitation carry forward and • The debt to equity ratio is > 1.5 to 1
THEN• Some portion of disqualified interest disallowed and treated as
paid next year
U.S. Inbound Financing Considerations
Earning Stripping and Form 8926: Technical Rules IRC § 163 (j)
• Disallowed Interest Expense• Can be indefinitely carried forward• Can be deducted to the extent of “excess limitation” in future
years
• Excess Limitation• 50% of ATI minus net interest expense• Can be carried forward (and added to current year limitation) for
three succeeding years
U.S. Inbound Financing Considerations
Earning Stripping and Form 8926: Technical Rules IRC § 163 (j)• Proposed regulations
• “Exempt related person interest expense” is • “Disallowed interest expense” to the extent that it does not
exceed • “Excess interest expense”
• Proposed regulations predate 1993 enactment of disallowance for unrelated person interest guaranteed by a related foreign or exempt person
U.S. Inbound Financing Considerations
Earning Stripping and Form 8926: Technical Rules IRC § 163 (j)
• Key Definitions• Exempt related person interest expense
• Related party• Tax-exempt interest
• Debt-equity ratio• Debt• Equity
• Excess Interest Expense (EIE)• Net Interest Expense (NIE)• Adjusted Taxable Income (ATI)
• Excess limitation• Guarantee
U.S. Inbound Financing Considerations
IRC § 163(j) – Key Technical Differences – Affiliated Group Rules
• FCo is not an includible corporation
under IRC §1504(b)(3). Thus, US1 and US2 are not members of an affiliated group under IRC §1504(a)
• US1 and US2 are treated as affiliated corporations under Prop. Reg. §1.163(j)-5(a)(3). Under IRC §318(a)(3)(C) US1 and US2 are treated as owning indirectly 100% of each other
FCo
US2US1
US3
U.S. Inbound Financing Considerations
Earning Stripping and Form 8926: Technical Rules IRC § 163 (j)
Section 385 Debt or EquityThe regulations prescribed under this section shall set forth factors which are to be taken into account in determining with respect to a particular factual situation whether a debtor-creditor relationship exists or a corporation-shareholder relationship exists. The factors so set forth in the regulations may include among other factors
(1) whether there is a written unconditional promise to pay on demand or on a specified date a sum certain in money in return for an adequate consideration in money or money's worth, and to pay a fixed rate of interest,
(2) whether there is subordination to or preference over any indebtedness of the corporation,
(3) the ratio of debt to equity of the corporation,
(4) whether there is convertibility into the stock of the corporation, and
(5) the relationship between holdings of stock in the corporation and holdings of the interest in question.
U.S. Inbound Financing Considerations
Section 385 Debt or EquityJudicial guidance
MIXON, JR., EST. OF v. U.S., 30 AFTR 2d 72-5094, 07/05/1972.“Mixon factors”
Laidlaw Transportation Inc., et al. v. Commissioner, TC Memo 1998-232.
Intent of parties, etc.
U.S. Inbound Financing Considerations
US Withholding TaxCertain income received by foreign persons is subject to US gross basis taxation. The income must be:
Fixed, determinable, annual or periodic (“FDAP”)US source
If these conditions are met, the income will generally be subject to withholding under IRC Sections 1441 or 1442 (generally at a 30% rate)
The withholding rate can be reduced or eliminated based on an applicable tax treaty or Code section (e.g., portfolio interest exception)
FDAP includes interestUS compliance requirements
U.S. Inbound Financing Considerations
Financing U.S. Operations/Acquisitions by Canadian MNCs
Tim Bloos, MNP LLP
“Double Dip” Financing Strategy• Canco has wholly-owned Opco in the US that carries on active business• Opco requires capital in order to finance operations/expansion/acquisition• Canco borrows to capitalize a newly formed Finco which makes a loan to Opco• Opco uses the funds from the loan in its active business and pays interest to
Finco which it deducts from its active business earnings• Earnings of Finco from the interest are exempt surplus earnings and may be
repatriated to Canco by way of dividend without any incremental taxation at the Canadian corporate level.
Ideally, there should be no withholding tax on the dividends paid to Canco.• Canco makes interest payments to a third party lender and takes an interest
deduction against its earnings.
Financing U.S. Operations of Canadian MNCs
Canadian Tax Issues• Interest Deductibility
Borrowing for purpose of earning income both at the Canco level and at the Opco level
• Section 17 interest imputation rulesAnti-avoidance rule ensures inclusion in income certain amounts or loans owing by non-residents to Canadian corps that are outstanding for one year or longer
• Exception: Debts owed by CFA in course of active business
Financing U.S. Operations of Canadian MNCs
Canadian Tax Issues (cont’d)• Character of financing arrangement
• Must qualify as a foreign affiliate (FA) and a controlled FA (CFA)• Interest income earned by Finco recharacterized as active business
income under recharacterization rules of Canadian foreign affiliate rules
• Direct Lending• Acquisition Financing
• Finco and Opco must both be resident in a designated treaty country• Opco should be able to deduct the interest paid on the Finco loan
against its active business earnings• Interest income earned by Finco is taxed at a low effective rate
• Anti-avoidance• Ss. 95(6)(b) should not apply as long as the financing involved is new
financing
Financing U.S. Operations of Canadian MNCs
1. Preferred Share (Repo) Financing Arrangement
• Application: For Canadian-based external financing• Structure: Transaction has different treatment between Canada - U.S.• Profile: Companies with $10m or more in financing requirements• Maintenance: Annual maintenance costs relatively low• Main Risk Areas:
Legal and tax treatment of transactionsLegislative change
• Level of Complexity: High• General Acceptance: Disclosed in a number of public prospectuses• Unwind: Relatively easy
Financing U.S. Operations of Canadian MNCs
DEDUCTION
DEDUCTION
Preferred Share (Repo) Financing Arrangement (cont’d)
Canco
OpcoFinco
Third party borrowing
Sale and repurchase
Preferred Shares
Financing U.S. Operations of Canadian MNCs
Preferred Share (Repo) Financing Arrangement (cont’d)Results
• (U.S.) Transaction based on substance as a borrowing secured by a pledge of the preferred shares
Interest deduction in the U.S.
No withholding tax under treaty on interest payments to Canco
• (Canada) Transaction based on form as a subscription for preferred shares by Canco funded from borrowed money
Interest deduction in Canada
Payments from U.S. received as dividends exempt from tax to Canco
Financing U.S. Operations of Canadian MNCs
Preferred Share (Repo) Financing Arrangement (cont’d)(U.S.) Characterization of transaction as collateralized debt
• Locked in termination date
• Provision for “stated interest”
(Canada) Must establish beneficial ownership of the preferred shares
Fully U.S.-Canadian income tax treaty compliant
• No disregarded entities
• No contingent interest in the structure
Financing U.S. Operations of Canadian MNCs
2. Tower Financing Structure• Application: For third party U.S. or Canadian lender• Structure: Use of multiple hybrid entities• Profile: Companies with US$40 million or more in financing requirements• Maintenance: Low to moderate• Main Risk Areas:
Legislative changes (hybrid entities)Treaty changes (hybrid entities)
• Level of Complexity: High• Acceptance: Fairly commonly used for large financings• Unwind: Complex
Financing U.S. Operations of Canadian MNCs
Third Party Debt
US Holdco
US Opco
Loan
Canco
Cansub
NSULC
USLLC
USLP
Tower Financing Structure (cont’d)
Financing U.S. Operations of Canadian MNCs
Interest Deduction
Interest Deduction
Tower Financing Structure (cont’d)Interest deduction in Canada and the U.S. in respect of the same borrowing.
No Canadian or U.S. withholding tax on the interest paid by USLP if the borrowing is from an unrelated US or Canadian lender under the U.S.-Canada income tax treaty.
U.S. tax paid on net income of USLPU.S. withholding tax on dividends paid by USLP. (No Treaty – “Hybrid Issue”)
Financing U.S. Operations of Canadian MNCs
Tower Financing Structure (cont’d)Level of equity funding for USLP (thin cap)
Potential application of Section 894 DRHE rules if Plantation Patterns treats Canco as the “true obligor” of third party debt
Potential for check-the-box reform and whether the use of a NSULC that is a DRE is an abusive structure
Financing U.S. Operations of Canadian MNCs
3. Treaty-based Finance Structure - Luxembourg
• Application: For third party Canadian or internal borrowings• Structure: Use of foreign financing intermediary (Luxembourg,
Netherlands, etc.)• Profile: Companies with US$20 million or more in financing
requirements• Maintenance: Annual costs can be relatively high• Main Risk Areas:
• Treaty changes (US-Luxembourg treaty)• Level of Complexity: High• Acceptance: Commonly accepted and well understood. • Unwind: Relatively easy
Financing U.S. Operations of Canadian MNCs
Luxembourg Finance Intermediary
Financing U.S. Operations of Canadian MNCs
Canco
CanHoldco
Capital
Interest Deduction
Financing Arrangement
Lux FinanceCo
US Holdco
US
Opco
Interest Deduction
Loan (Bank)
Loan
Luxembourg Finance Intermediary (cont’d)Canco borrows to capitalize the Financing Arrangement
Financing Arrangement
CAN Holdco uses capital from Canco to either:
i. Make an interest free loan to LuxFinanceCo; or
ii. Capitalize Lux Finance Co. with equity using special preferred shares.
Notional Interest deduction in Lux reduces tax base in Lux so that effective tax rate is between 1-2% on interest income from US Opco
Financing U.S. Operations of Canadian MNCs
Luxembourg Finance Intermediary – Risks and IssuesCanada
‒ Interest deductibility‒ Application of CFC rules‒ Characterization of Financing Arrangement
‒ US‒ Anti –conduct financing rules‒ Substance over from rulings on debt characterization‒ Application of derivative benefits clause in US-Lux treaty‒ Interest stripping rules‒ Economic substance tests‒ Characterization of Financing Arrangement
‒ Luxembourg‒ Application of Notional interest deduction (ruling)‒ Transfer pricing on interest rate differential
Financing U.S. Operations of Canadian MNCs
Outbound Financing from the U.S.
Financing Canadian Operations/Acquisitions of U.S. MNCs
Mark Pearlman, MNP LLP Tim Bloos, MNP LLP
Canadian Tax Issues
• Application of treaty
• Withholding tax on interest
‒ Nil, if treaty protected, otherwise 25%
• Thin capitalization
• Deemed dividends
• Foreign Affiliate Dumping Provisions
• Unpaid amounts
• Deemed year ends
• Paid up capital
Financing Canadian Operations of U.S. MNCs
Thin Capitalization
• Ratio changed from 1.5:1 for fiscal periods beginning after 2012
• Expanded to include partnerships for fiscal periods beginning after March 29, 2012
• Disallowed interest will be treated as dividend triggering withholding tax for years after March 28, 2012
Financing Canadian Operations of U.S. MNCs
Thin Capitalization (cont’d)
1.5:1 Debt to Equity
Debt
• Debt to related non-resident parties (at least 25% votes or value or right to obtain share or redeem share to get to that level)
• Debt needs to be interest-bearing
• Average of highest balance in each month
Financing Canadian Operations of U.S. MNCs
Thin Capitalization (cont’d)
1.5:1 Debt to Equity
Equity
• Retained earnings (do not deduct deficits); plus
• Average of opening monthly contributed surplus contributed by non-resident; plus
• Average of opening paid-up capital of shares owned by non-resident
Financing Canadian Operations of U.S. MNCs
Thin Capitalization (cont’d)
• Partnership
• Debt obligation owed by a partnership with a Canadian Resident Corp member to a specified non-resident now captured
• Allocation done pro rata to their partnership interest
• Now applies to Branches too
Financing Canadian Operations of U.S. MNCs
Deemed DividendsLoans from Canadian sub to U.S. parent cannot be on 2 balance sheets
If not repaid treated as a deemed dividend
Withholding due
Can make an election to have loan remain outstanding
Interest rate needs to be at least 4% higher than treasury bill rate, currently 1%
Election can not be changed
• Loan by Loan Basis
Financing Canadian Operations of U.S. MNCs
Unpaid Amounts
Applies to deductible amounts accrued to non arms length parties and not paid
If on three balance sheets must be added back
Can make an election to treat it as paid
May trigger withholding tax
Financing Canadian Operations of U.S. MNCs
Deemed Year Ends
On acquisition of control
On amalgamations
On signing of letter of intent if target is Canadian- controlled Private Corp (CCPC) and will lose status
Financing Canadian Operations of U.S. MNCs
Paid up Capital
Similar to share capital
Relates to amount paid to company for the issuance of shares
Determined on a class by class basis
PUC of a share = PUC of the class__ # Shares of the class
Treated effectively in Canada as a non interest bearing loan
Can be repatriated at any time with no withholding tax implications
PUC part of equity for Thin Cap Calc.
Denomination is # of shares of the class
Financing Canadian Operations of U.S. MNCs
ULCCanadian
Co.
U.S. Co.
100 %100 %
Loan
3rd Party debt
Subscription agreement
Forward
• Support Agreement between U.S. Co & ULC for U.S. Company to purchase shares for cash so ULC can fund the forward subscription agreement
Support agreement
Double Dip-Hybrid Instrument• U.S. Company uses 3rd party debt to make a loan to Canco
Financing Canadian Operations of U.S. MNCs
Summary 1. Loan from U.S. Co. to Canco2. Forward subscription agreement between LLC and Canco3. Support agreement between U.S. Co. and LLC4. Guarantee from U.S. Co. to Canco
Financing & Inbound Investment: Debt
ULC
Canco
U.S. Co.
100 %4. Guarantee 1. Loan
2. Forward Subscription Agreement
3. Support Agreement
Double Dip-Hybrid Instrument (cont’d)
Steps1. U.S. Co takes out 3rd party loan
2. U.S. Co to make a loan to Canco
3. ULC enters into Forward Subscription Agreement with Canco to purchase Canco shares for cash for an amount equal to the principal amount of the loan at maturity
4. Simultaneously, U.S. Co enters into a support agreement with the ULC to purchase the share for cash so the ULC can fund the Forward Subscription Agreement
5. Simultaneously, U.S. Co provides Canco with a guarantee of the ULC’s performance under the Forward Subscription Agreement
Financing & Inbound Investment: Debt
Double Dip-Hybrid Instrument (cont’d)
ULCCanadian
Co.
U.S. Co.
100 %100 %
Loan
3rd Party debt
Subscription Agreement
Forward
ForwardSupport Agreement
• US Tax Consequences• Loan treated as equity• Payments on loan (interest and principal) treated as distributions
Double Dip-Hybrid Instrument
Financing Canadian Operations of U.S. MNCs
ULCCanadian
Co.
U.S. Co..
100 %100 %
Loan
3rd Party debt
Subscription agreement
Forward
• Canadian Tax Consequences• Deductible interest in CanCo• No withholding tax under the treaty• Consider Thin Corp
ForwardSupport agreement
Double Dip-Hybrid Instrument• U.S. Company uses 3rd party debt to make a loan to Canco
Financing Canadian Operations of U.S. MNCs
Foreign Affiliate Dumping Provisions
• Introduced in Aug 2012, amended in October 2012 for transactions after March 2012
• Applies to Canadian resident corp. (CRIC) controlled by a non-res corp. (Parent) that invests in foreign affiliate (subject corp.)
Traditional debt dumping
Foreign-owned Canco acquires shares of FA, creating additional debt in Canada with potential tax fee dividends (active business)
Effect of Rule
Deem dividend to be paid by CRIC to Parent to extent of non-share consideration and PUC reduction (withholding tax)
Financing Canadian Operations of US MNCs
Foreign Affiliate Dumping (cont’d)
Financing U.S. Operations of Canadian MNCs
‒ Rules apply beyond traditional debt dumping:
US (Parent)
US Co
Pref Shares FA (SC)
Canco (CRIC)
FA (SC)
Loan
1. Transactions constituting an “Investment”...‒ acquire shares‒ contribute capital‒ indebtedness*‒ options‒ extension of maturity,
redemptions, acquisition or cancellations date on debt/shares
‒ acquisition of CDN target where >75% of FMV is in FA shares of target
2. By a CRIC...3. In a subject corporation...
Foreign Affiliate Dumping (cont’d)‒ Where rules do not apply (exceptions):
1. Loans qualifying as PLOI (pertinent loan/indebtedness)‒ CRIC and Parent jointly elect on loan owing to CRIC‒ Imported interest applies instead of deemed dividend
2. Closely connected test‒ Business activities of FA are closely connected to CRIC
3. Certain corporate reorganizations4. Indirect funding test
‒ 3 conditions to meet5. PUC Redirection
‒ Deemed dividend reduced by PUC of CRIC or through a Dividend Substitution Rule.
Note: PUC can also be reinstated for purposes of the rule under certain circumstances
Financing U.S. Operations of Canadian MNCs
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.
IRS Circular 230 Disclosure
Questions?
Contact Information
Knox Teagueknox.teague@dhgllp.com
Tim Bloos, MNP LLPtim.bloos@mnp.ca
Mark Pearlman, MNP LLPmark.pearlman@mnp.ca
Recommended