International Income Tax - Chapter 4 Income Tax... · through Antilles and utilize the U.S. income tax treaty exemption on interest expense paid to the N.A. lender. This income tax

International Income TaxationChapter 4: FOREIGN PERSON’S NONBUSINESS US SOURCE INCOME

Professors Wells

Presentation:

January 31, 2019

2

Foreign Persons: Nonbusiness U.S. Source Income –Ch. 4

Code §871 (a) & §881(a) –concerning the 30% gross tax on fixed or determinable annual or periodic income (FDAP).

But, FDAP can be “effectively connected” with a U.S. trade or business and then be taxed on a netincome basis. §864(c)(2).

Possible modification of the applicable (gross withholding) tax rates by (1) a Code section or (2) a bilateral U.S. income tax treaty.

M(Foreign Corp)

US ToB/ECIUS P.E./Bus. Profits

Active: “Net Basis Tax”(with Branch Profits Tax)Chapter 3

Passive Investor: WithholdingChapter 4

“Fixed Determinable

Annual Periodical”

3

Why impose tax on a gross basis? P. 229

Flat tax on a gross income facilitates collection at source without a taxpayer filing an income tax return.

Limited potential to collect in foreign place.

Gross income and net income are approximately the same amount in many situations involving investment income (i.e., no significant expenses are incurred to generate the investment income).

Is 30% the appropriate tax rate? Cf., corporate tax rate of 35%.

M(Foreign Corp)

Passive Investor: Withholding



30% or

Treaty Rate

4

What is “FDAP Income”? p. 230

Interest, dividends, rents and royalties and other fixed or determinable annual or periodic “gains, profits and income”. Code §871(a)(1)(A) & §881(a)(1).

Consider other income sources: annuities, retirement plan distributions, alimony.

M(Foreign Corp)

Passive Investor: Withholding



30% or

Treaty Rate

Section 871(m) (p.234) was enacted to prevent foreign investors from avoiding U.S. withholding tax on dividends by recharacterizing them through the use of derivative or similar contracts.

Via Treas. Reg. §§ 1.871-7(b)(2), 1.881-2(b)(2), the IRS subjects substitutepayments under securities lending arrangements to withholding as interest.

Wodehouse Case p. 231One Payment Disposition

5"

Wodehouse Case p. 231 One Payment Disposition

Lump sum amount was received for an exclusive book right in the United States. Sale of the property interest in a copyright. Held: one lump sum amount (not contingent) represented the acceleration of all the royalties and, therefore, FDAP. Do not need multiple payments to have “annual or periodic” payments.

Lump sum amount was received for an exclusive book right in the United States.Sale of the property interest in a copyright.

Held: one lump sum amount (not contingent) represented the acceleration of all the royalties and, therefore, FDAP.

Do not need multiple payments to have “annual or periodic” payments.

6

FDAP Income Additional Examples p. 232

1) Rental income gross-up for expenses or real estate taxes paid by tenant –Rev. Rul. 73-522

2) Annuity payments from a U.S. insurer. Rev. Rul. 2004-75. Treated as having a U.S. source even though sold by a foreign

Lessor(Foreign Corp)

County Property Assessor

RentUS-Owned Parent

Extra Rent

branch in a foreign country. Cf., branch bank sourcing rules.3) §871(m) treats “dividend equivalent amounts” as FDAP subject to

withholding. A dividend equivalent amount includes payments under a securities lending or repo transaction, payments under an NPC, and other similar arrangements. New 2013 regulations provide complex rules on how much investment return correlation is needed for a contractual return to be considered a dividend equivalent amount.

Rev. Rul. 73-522 Illustration

7

Chihuahua Gas p. 234§881(a) as Basis for Decision

Rent not paid by a Mexican corporation (HIDRO) ETBUS to related Mexican corporation (Gas) for U.S. use of trucks.

Tax liability results from a Code §482 adjustment. No payments had been made from which the tax could be withheld. Tax obligation of the recipientof the imputed rent exists under §881.

Must an actual payment be made to trigger (1) §881(a) & (2) withholding at source?

Chihuahua GasCorporation

HidroCorporation

US Tractor Fleed

US Office

RentFree

8

U.S. Source Interest & Tax Exemptions p. 238

1) Bank (and S&L) account interest:Code §§871(i)(2)(A) & 881(d)

2) Portfolio debt investment interest:Code §§871(h) & 881(c)

“Bearer” form no longer permitted to qualify for portfolio interest exception. Bond must be in registered form.

Note the carve-out from the portfolio interest exception for bonds held by 10%+ owners or for contingent interest.

What is the impact of these exemption provisions on the U.S. capital markets?

3) However, no exception for 80/20 companies any longer (p.240)

9

Dividends from a U.S. Corporation p. 240

1) Dividends from a U.S. corporation.Code §861(a)(2)(A) – sourcing

• Limited Grandfather Rule for “Existing 80/20 Companies.” 80/20 Company is a US Corp. formed before January 1, 2011 and 80%+ foreign source income: No exception for new companies but a grandfathering for pre-2011 companies if business has not changed.Code §871(i)(2)(B) – untaxed proportion based on foreign percentage.Cf., interest rule: a sourcing rule

2) Foreign corp. with U.S. source dividends. The branch profits tax rule eliminates the tax liability on dividend.

10

Wagering Income p. 241

1) Las Vegas gambling – Code §871(j)

2) Horse & dog racing – Code §872(b)(5)

3) Lottery winnings?

How prove net gambling winnings?

Any offset for invested funds/tax basis?

Any offset for gambling losses? Note§165(d) – losses allowed to extent of gains.

Withholding at source?

11

Impact of Income Tax Treaty Provisions p. 242

Tax treaty reduction – withholding rates:

Dividends: 15%; but, 5% for certain corps.

(Note: recent U.S. treaties – zero withholding tax for payments from subsidiaries)

Interest: -0-

Royalties: -0- (cross-licensing – next slide)

Pensions, annuities and alimony payments: -0-

Annuity defined – see Abeid case, p. 243

12

Royalty Withholding and Cross Licensing

Rev. Proc. 2007-23 – cross-licensing – two parties grant licenses to each other.

Withholding obligation on gross value? Net? Rev. Proc. 2007-23 states:

(1) No §1001 gain (or loss) when mutual gains of licenses.

(2) “Net consideration” to be taken into account for (withholding) tax purposes – assuming a “qualified patent cross licensing arrangement” (QPCLA).

(3) Financial statement conformity (i.e., “booking”) requirement.

13

“Treaty Shopping” – Funds Inbound into the U.S. p. 244

Historical background: (1) Netherlands Antilles finance sub created by (2) U.S. corp. Purpose: To facilitate borrowing arrangements through Antilles and utilize the U.S. income tax treaty exemption on interest expense paid to the N.A. lender.

This income tax treat functioned as a “treaty with the world”. Why?

14

Aiken Industries Conduit Arrangement

Transaction Steps:

1) MPI borrows from ECL.

2) ECL sells MPI note to Industrias (in exchange for Industrias notes).

3) MPI pays interest to Industrias.Note: Honduras – U.S. income tax treaty exempts interest from source taxation.

4) Industrias pays interest to ECL

Valid business purpose?

ECL

CCN Aiken Industries

MPIIndustrias

12

3

4

15

Rev. Rul. 84-152 (now obsolete)

Swiss parent with U.S. operatingsub and Netherlands Antilles financing sub (brother-sister subsidiaries).

1. P provides funds to S at 10% interest rate

2. Antilles sub loans funds to U.S. brother-sister at an 11% interest rate, funds sourced from Swiss parent.

Conduit analysis – U.S. to Antilles to Switzerland. Antilles entity was notrecognized. Tax under the Swiss treaty?

Is “derivative benefits” concept applicable?

PSwitzerland

SAntilles

RUnited States

1

2

16

Northern Indiana Public Service p. 253

Borrowing by N.A. subsidiary of U.S. parent corporation to exploit the N.A. – U.S. income tax treaty interest exemption.

Tax Court decision: Finance subsidiary is recognized as the borrower. Treated as adequately capitalized.

What debt-equity ratio is necessary to recognize finance subsidiary transaction?

Other suggestions?

17

Limitations on “Treaty Shopping” – Treaty & Code p.255

1) Treaty Shopping – Article 22.2) Anti-conduit regulations – Code §7701(1) – conduit entities are

disregarded. p. 255.The key factors that will trigger the exercise of power by the IRS to recharacterize conduit entities are:

—The participation of the intermediate entity or entities reduces the tax imposed by Section 881,—Such participation is ‘‘pursuant to a tax avoidance plan,’’ and either—The intermediate entity is related to the financing or financed entity or would not have participated in the financing arrangement but for the fact that the financing entity engaged in the transaction with the intermediate entity.

Reg. § 1.881–3(a)(4).The regulations also identify the factors that will determine whether there is a tax-avoidance purpose:

—Is there a ‘‘significant reduction’’ in the tax otherwise imposed under Section 881?—Did the conduit have the ability to make the advance without advances from the related financing entity?—What was the period of time between the respective transactions?—Did the financing transactions occur in the ordinary course of business of the related entities?

Reg. § 1.881–3(b)(2).The regulations also establish a rebuttable presumption in favor of the taxpayer if the conduit entity ‘‘performs significant financing activities with respect to the financing transactions forming part of the

financing arrangement.’’ See Reg. § 1.881–3(b)(3).

Is a tax “treaty override” occurring here? p. 256

18

Limitations on “Treaty Shopping” – Treaty & Code p.255Ingersoll-Rand v. Commissioner, T.C. Dkt. No. 025769-13

I-R Company(Delaware)

I-R Company Ltd.(Bermuda)

I-R (Barbados) Hldgs(Barbados)

Global Hldg.(Bermuda)

IRCO Note$3.6 billion / 11%)

IRCO Note1

2

Interest(5% treaty rate wht)

3

Loan3

Loan

Ontario 3(Hungary)

Hungary

Note

Interest

(0% treaty rate wht)

3Loan

I-R (Luxembourg) S.a.r.l. (Luxembourg)

Lux Note2

Loan

2

Interest

(0% treaty rate wht)

33

December 29, 2015: Court order issued that IRS and Ingersoll-Rand agreed to an $86 million withholding tax assessment

19

Hybrid Entities Cross Border Arbitrage p. 257Pre-§894(c) Idea for Homeless Income

NA General Partnership, et al. v. Commissioner, TC Memo 2012-172 (Scottish Power)*

$932 million

(Interest o

n Notes)

U.S. Tax Consolidation

Reverse Hybrid Entity

* Note: Tax years predated Section 894(c) proposed regulations targeting this structure

TargetUnited States

Parent(U.K.)

Subsidiary/PartnershipUnited States

$932 million (Cash Dividend)

20

Foreign (forward) hybrid entity:

Corporation in the foreign country but partnership (conduit) status in the U.S.

Reverse hybrid entity:Corporation for U.S. tax purposes but flow-through entity status for foreign tax purposes.

PSwitzerland

RUnited States

1

Question: does the US-Netherlands, US-Switzerland or no treaty apply?

PSwitzerland

SNetherlands

RUnited States

2

RUnited States

PSwitzerland

3

SUnited States

Dividend

Interest

Dividend

Hybrid

ReverseHybrid

§894(c) limits treaty benefits and denies deductibility in the NA General Partnership fact pattern (i.e., deductible interest in that fact patterns becomes dividend [to extent of amount of dividend to reverse hybrid] for all tax purposes).

SNetherlands

Hybrid Entities Cross Border Arbitrage p. 257Response #1: §894(c)

Consistent with OECD Multilateral Agreement Article 3.

21

NA General Partnership, et al. v. Commissioner, TC Memo 2012-172 (Scottish Power)*

$932 million

(Interest o

n Notes)

U.S. Tax Consolidation

Reverse Hybrid Entity

* Note: Tax years predated Section 894(c) proposed regulations targeting this structure

TargetUnited States

Parent(U.K.)

Subsidiary/PartnershipUnited States

$932 million (Cash Dividend)

Hybrid Entities Cross Border Arbitrage p. 257Response #2: §267A

267A denies a deduction for disqualified related party amount attributable to a hybrid transaction by hybrid entity.Disqualified related party amount is defined as interest or royalty to the extent such amount is not included in the income (or a fictional deduction provided against this income inclusion) in the related party’s foreign jurisdiction.Hybrid Transaction: Inconsistent treatment of payment.Hybrid Entity: Entity is fiscally transparent

in one jurisdiction but not so in the other.

22

Treaty Shopping p. 259Problem 1

Investors own ILL (Swedish corp.)

ILL organized in a jurisdiction (Sweden) where all its shareholders reside.

Article 11 of the income tax treaty exempts the interest payments from tax withholding at source.

No “treaty shopping” here – all ILL owners are Swedish residents (and not U.S. persons).

AmFish(US Corporation)

ILL(Sweden)

JohnsonOlson

23

Problem 2: Substantial Presence Test? p. 260

2006 Treaty Art. 22 (2)(e) –50% rule.

(i) At least 50% is owned by aresident for at least ½ of thedays of the year; and

(ii) Less than 50% of the grossincome is paid directly orindirectly to nonresidents ofthe two treaty countries in adeductible form, i.e., the“base erosion test” is notapplicable.


ILL(Sweden)

JohnsonOlson

24

Problem 3 p. 2602006 Treaty Article 22(2)(e) and (3)

Sale of all stock (when?) to a corp. located in 3rd country (Brazil – no tax treaty).

Treaty benefits are probably jeopardized; but, what if 50 percent of stock of Superrichstock is traded on a U.S. stock exchange or in Sweden? No protection.

Or, an active trade or business in Sweden – Article 22(3).


ILL(Sweden)

Superrich Corp(Brazil)

25

Problem 4 ILL Shares Listed on an Exchange p.260

Treaty article 22(2)(c)(i) & 22(5)(a)).

Treaty benefits are preserved if all ILL shares are trading on the Swedish stock exchange (one of the tax treaty partner countries).

Why preserve tax treaty benefits here?


ILL(Sweden)

Public (Swedish Exchange)

26

Problem 5 p.260ILL Shares Traded & Sold

Shares listed and 75 percent of shares sold mostly to non-treaty country residents. Art. 22(2)(c)(i).

Treaty benefits preserved if 75 percent of shares trading on Sweden exchange? Not allshares (of class) must be listed.

Therefore, must Art. 22(2)(e) test be satisfied? Percent owned by Swedish?


ILL(Sweden)

Public (Swedish Exchange)

27

Problem 6 p.260Shares Are Sold Directly to 3rd Country

75 percent of the ILL shares are sold directly to non-treaty country residents and not publicly listed.

Article 22 will deny treaty benefits to ILL.

Why deny the tax treaty benefit when the shares are not publicly traded?


ILL(Sweden)

JohnsonBrazilian S/H

75% 25%

28

Problem 7 p. 260The “Base Erosion” Test

Loan from bank in Norway to Partsub in Sweden and then loan to parent in U.S.

Partsub being used as a financing subsidiary, although already an operational(?) sub.

Article 22(3) (which preserves a tax treaty benefits in certain trade or business situations) will probably notprotect Partsub since no relationship between the lending transaction & trade or business in Sweden.

AmCorp(US Corporation)

PartSup(Sweden)

Norwegian Bank Loan

Loan

Interest

29

Problem 8 p. 260Base Erosion Test

Loan from bank in Norway to sub in Sweden to parent in U.S. Amcar (Parent corp.) guarantees the loan to Partsub.

Even if OK under the treaty (Art. 22(3)), note that the guarantee of the loan by Amcar would trigger the application of the anti-conduit rules. See Reg. §1.881-3(c)(2).


PartSup(Sweden)

Norwegian Bank Loan

Loan

Interest

Guarantee

30

Problem 9 p. 260Base Erosion Test

Loan from (1) bank in Norway to sub in Sweden (2) to parent in U.S.

Partsub organized shortly before the loan agreements were concluded.

Anti-conduit rules would almost certainly apply. Reg. §1.881-3(a)(4) factors appear to be present.

Objective of the intermediary is to reduce U.S. income tax.


PartSup(Sweden)

Norwegian Bank Loan

Loan

Interest

31

Capital Gains p. 260Source to the Residence

General Rule: Capital gains are that are not effectively connected with a trade or business are not subject to US taxation as they are not FDAP in nature and thus not subject to withholding.

Treaty provides the same general rule (with exceptions). See U.S. Model Tax Treaty, Article 13(6).

Code §865(a) – source of capital gains from sale or exchange of personal property is at the residence of the taxpayer. Therefore, foreign income for a foreign taxpayer.

Cf., intellectual property transactions. Sale; contingent payments effect – as royalty?

32

Withholding at Source Mechanisms p. 262

Code §§1441 & 1442 – Withholding at source at 30% rate on FDAP income.

No withholding requirements for ECI – ETBUS income. Code §§1441(c) & 1442(b).

Documentation provided to the payor: IRS Form W-8ECI (formerly IRS Form 4224).

33

What Amount is Subject to Withholding? p. 262

Consider Rev. Rul. 72-87

Concerning corporate E&P calculation. Must payor assume the existence of adequate E&P for dividend characterization. Obsolete by Reg. §1.1441-3(c)(2)(i).

Consider other situations where recovery of tax basis (i.e., basis is not gross income).

What if a nontaxable stock dividend? §305.

34

Cascading Royalties p. 263Foreign Withholding Agent

Rev. Rul. 80-362 – licensing arrangements re U.S. patent:

A foreign country – license to X(no income tax treaty with U.S.)

X Netherlands corporation(Dutch – U.S. treaty) – sublicense

Y U.S. Corporation

Royalties from X to A are not exempt.

ANon-Treaty

XNetherlands

YUnited States

LicenseUS IP

Sub- LicenseUS IP

RoyaltyRoyalty

35

SDI Netherlands p. 265Withholding Agent Issue

Facts:1. SDI Bermuda licenses to SDI Netherlands2. SDI Netherlands which licenses to SDI USA.

Why a Dutch intermediary?

Issue: Netherlands to Bermuda royalty payment as U.S. sourced and subject to U.S. gross withholding at source? Held: No.

No conduit argument by IRS.

The SDI Bermuda deal was separate.

SDIBermuda

SDINetherlands

SDIUnited States

LicenseGlobal IP

Sub- LicenseUS IP

RoyaltyRoyalty

36

Withholding Agent Responsibilities p. 270

Who is the withholding agent?

How does one know whether the payee is domestic or foreign? IRS Form W-9.

Possible exception in ECI & USTB, with representation from recipient.

Use an alternative approach: obtain certification from the home country re tax status as being a resident in other country?

Refund procedure, after status documented?

37

Withholding for Compensation Income p. 272

Normal wage withholding, rather than 30 percent flat rate, for employee.

Rev. Rul. 70-543, p. 248, involving self-employed individuals and horse racing operator. 30% gross withholding at source required for fighter and golfer, but not for horse racing operation (if prior IRS Form 4224 provided, now IRS From W-8ECI).

38

Partnerships & Withholding at Source p. 275

Code §1446. The partnership must withhold an amount equal to: (1) the allocable share of partnership income, times (2) the maximum marginal income tax rate.

Any actual distribution is not relevant for this purpose. Note similarity to the branch tax.

The withheld amount will not equal the amount of the net income tax liability.

Consequently, an income tax return is required of the partner.

39

Proposed (2010) Additional Withholding Tax Regime p.276

Proposed Chapter 4, Code §§1471-1474.

Proposed “Foreign Account Tax Compliance Act” (FATCA), in Tax Extenders Act of 2009, H.R. 4213.

To impose a 30% withholding tax at source unless foreign recipient (bank or other) certifies no substantial U.S. owners.

To be a “filter” for Chapter 3 withholding.

40

Taxation of U.S. Real Property Gains (FIRPTA) p. 277

Code §897 – gain on U.S. real property sale treated as ECI of USTB .

What is the definition of a “U.S. real property interest” for this purpose?

Real property interests, mines, wells, and “associated personal property”.

Leasehold interests; options to purchase.

What is the reason for this special tax regime pertinent to real property?

41

Further Definition of U.S. Real Property Interest p. 279

Consider:

(1) Loans, but an “equity kicker” loan?

(2) Sale of stock of a “United States real property holding corporation” (all gain subject to tax, not only the U.S. %).

Not including publicly traded stock (except for 5%+ shareholder).

42

Definition of U.S. Real Property Holding Corp.

Holds U.S. real property greater than 50% of both (1) real property and (2) trade or business assets of the corporation.

Note: comparative asset values (and currency fluctuations) could cause constant changing of above or below the 50% level.

Why exclude liquid assets from this calculation? An “anti-stuffing rule”?

US RP Holding Company

US RPHolding Company

ForeignShareholder

Buyer

43

Treatment of the Foreign Corporation – Special Rules p.281

1) Sale of Shares of foreign corporation; but liquidation & redemption distribution?

2) Distribution by foreign corporation of its appreciated U.S. real property triggers gain recognition. Code §897(d)(1).

3) Possible applicability of tax non-recognition provisions. E.g., Rev. Rul. 84-160 & Code §351 dropdown of assets into a U.S. holding corp. Code §897(e).

44

Code §1445 FIRPTA p.284Withholding at Source

Transferee must withhold 10 15 percent of the gross amount realized from the disposition transaction. The real “final tax”?

Applies to the proceeds (including debt) and not to the gain realized from the real estate sales transaction.

U.S. income tax return is required from the seller (to determine netgain/loss).

Cf., possible information reporting.


US RPHolding Company

ForeignShareholder

Buyer

Purchase Price

Less 10% WHT

45

Code §1445 Exceptions to FIRPTA p.285 Withholding at Source

Exceptions to the withholding requirements – Code §1445(b):

1) Not a foreign seller, e.g., U.S. individual.

2) Corporation not a USRPHCo. How prove this status?

3) IRS “qualifying statement” received.

4) Future use for certain residence purposes.

5) Regularly traded shares (+/- 5%).

46

Code §1445 & Entity Distributions p. 286

Foreign corporate distributions –withhold 35% of the gain (or 20 percent if provided per regulations). Tax applies to the corporation which knows its tax basis for distributed asset. §1445(e)(2).

U.S. corp.? 10% on liquidation distributions.

Partnership & trust distributions –

Withhold 35% of the gain realized to extent allocable to a foreign partner/foreign trust beneficiary. §1445(e)(1).


ForeignShareholder

Stock Cash

47

FIRPTA & Tax Treaties p. 287

Is any FIRPTA tax immunity provided under an applicable U.S. bilateral income tax treaty? No.

See U.S. Model Treaty, Article 13, re jurisdiction to tax real estate income – including disposition gain – in the country of situs (including the stock of a USRPHCo.).

48

FIRPTA and REITS

Major Exception to FIRPTA:

1. Publicly Traded Corporation that is less than 5% owned. See §897(c)(3)

2. Ownership of up to 10% of a REIT. See §897(k)(1).

49

US DomesticSubsidiary

Foreign-Owned Parent

Third CountryOperations

US-OwnedParent

US Domestic Subsidiary

Third CountyOperations

Foreign Holding Company

Foreign-Owned US-Owned

Current Reality: Residence Choice is Often a Territorial Jurisdiction

Base Erosion

Base Erosion

•Supply Chain Transactio

n

•Lease Strip

ping Transaction

•Interest S

tripping Transactio

n

•Royalty Strip

ping Transaction

•Service Strip

ping Transaction


n

•Lease Strip

ping Transaction

•Interest S

tripping Transactio

n

•Royalty Strip

ping Transaction

•Service Strip

ping Transaction

Residual

Profits

ResidualProfits

ResidualProfits

Res

idua

lP

rofi

ts

1920sMercantile Structure

ImperialCo(England)

Colony Co(India)

• Supply Chain Transaction• Lease Stripping Transaction• Interest Stripping Transaction• Royalty Stripping Transaction• Service Stripping Transaction

TP: Cost + x%

RESIDUAL

International Policy Challenge: Base Erosion and Profit Shifting

TP: Cost + x%

TP: Cost + x%

Tax Base Erosion and Homeless Income: Collection at Source is the Linchpin,” 65 TAX L. REV. 535 (2012)

50

Base Erosion and Profit Shifting:Financing the US Enterprise p. 287

Foreign party capitalizes the U.S. subsidiary with both (1) debt and (2) equity.

Dividends subject to possible withholding at source; not deductible by the payor corp.

Interest is deductible (subject to §163(j)) and not subject to outbound withholding (under most bilateral treaties).

What is “debt” as contrasted with “equity”?

See Code §385.

ForeignParent

US Subsidiary

Interest vs.

Dividends

Base Erosion: Interest Stripping

51

High Profile Re-Leveraging Transactions

GlaxoSmithKline Tyco

GSK Investment

(Switzerland)

GSK Americas(US)

Tyco Int’l(Switzerland)

Tyco Electronics Corp(US)

$13.5 Billion Intercompany DebtTax Deficient of $864 million (2001-2003)Additional Exposure of $1.06 billion (2004-2008)

Interest: $2.8 billion (tax of $883 million)(add’l $6.6 billion of interest in later years)

Foreign Owned MNE Structure Inverted MNE Structure

IRS Conceded Case Before Trial Outcome: Tyco settled for~$220 million with another $250 million in later years.

Base Erosion and Profit Shifting:First Battlefield: Is Interest “Excessive” p. 288

52

Base Erosion and Profit Shifting:First Responder: Section 163(j) p. 288

Foreign Parent

US Subsidiary

Interest Deduction Reduces US Tax Base

Interest Income is Low-Taxed in foreign Country

Old §163(j) New §163(j)

General Applicability Corporations Only “All” TaxpayersDebt-to-Equity Threshold 1.5-to-1 Threshold NoneRelated / Unrelated Interest Related party interest All interestGeneral Debt Limitation 50% of taxable income 30% ATI + Bus. Int.Carryforward of Disallowed Interest Yes YesCarryforward of Excess Limitation 3 years None

53

Base Erosion and Profit Shifting:First Responder: Section 163(j) p. 288

General RuleBusiness Interest Expense is not deductible to the extent it exceeds the sum of:

(a) the business interest income of such taxpayer for the taxable year and(b) 30% of the taxpayer’s adjusted taxable income for the taxable year and(c) floor plan financing interest (relevant to auto dealers who sell on credit).

Business Interest Income is income allocable to a business* (excludes ”investment income”) and all interest includible in a C corporation’s income.Adjusted Taxable Income is taxable income without regard to:

(a) any item of income/gain/loss/deduction not “allocable to” a business*(b) any business interest expense or business interest income(c) section 172 net operating loss deduction(d) section 199A deduction, and(e) depreciation, amortization, and depletion (for tax years before 1/1/2022).Note: ATI apparently includes any GILTI, Subpart F Income, §956 Inclusions & FDII deductions.

*Business means a trade or business under case law but excludes (i) trade or business of an employee, (ii) electing real property business, (iii) electing farming business, (iv) certain utility business (electrical, water, sewage, gas & steam), and (v) small

businesses that have gross receipts of $25 million or less.

54

Base Erosion and Profit Shifting:Scope of Provision p. 289

Scope of Rule§163(j) applies to all taxpayers except excluded “businesses”. See previous slide. Special rules for partnerships/S Corps//Consolidated Groups. See Notice 2018-28 and proposed regulations (REG-106089-18) (Dec. 28)

Corporations: Business Interest Expense Limitation applies at a consolidated group level. How will these rules apply to partnerships owned within consolidated groups? Stay tuned.

Partnerships:1. Business Interest Expense Limitation determined at partnership level. 2. Deductible business interest expense is accounted for in computing the

partner’s share of separately stated income/loss. Disallowed business interest (disallowed at partnership level) is carried forward at the partner level to succeeding taxable years and deductible by the partner only if the partner is allocated excess taxable income from that partnership in a future year.

3. Partnership ATI is excluded from the partner’s separate ATI calculation for purposes of applying §163(j) on items outside partnership.

55

1. Inbound: Base Erosion and Profit Shifting:New §163(j)’s Disallowed Interest Definition

Base §163(j) ExampleTaxable Income $50

Interest Expense (Back Out) $110

Interest Income (Back Out) ($30)

Depreciation (Back Out) $70

Adjusted Taxable Income $200

30% of Adjusted Taxable Income $60

Business Interest Income $30

Business Interest Limitation $90

Business Interest Expense $110

Disallowed Interest Deduction $20

Allowed Interest Deduction $90

Disallowed Interest Carryforward $20



BANK

Foreign-Owned

$15 Business Interest

$95 Business

Interest

$50 Taxable Income b/4 163(j) (Depr. $70)(Business Int. Inc. $30)

56

1. Inbound: Base Erosion and Profit Shifting:New §163(j)’s Disallowed Interest Definition

§163(j) Partnership Example

Taxable Income b/4 §163(j) $100

Interest Expense (Back Out) $50

Adjusted Taxable Income $150

30% of Adjusted Taxable Income $45

Business Interest Limitation $45

Business Interest Expense $50

Disallowed Interest Deduction $5

Allowed Interest Deduction $45

After-§163(j) Taxable Income $105

Individual Share of Disallowed Interest $2

Individual Distributive Share $42

Corporation Share of Disallowed Interest $3

Corporation’s Distributive Share $63

USPartnership

CorporationIndividual

40% 60%

$50 business interest

$100 Taxable Income

57




Foreign-Owned

Base Erosion


n

•Lease Strip

ping Transaction

•Interest S

tripping Transactio

n

•Royalty Strip

ping Transaction

•Service Strip

ping Transaction

Residual

Profits

ResidualProfits

Base Erosion and Profit Shifting:Second Response: Base Erosion Alternative Tax

TP: Cost + x%

§59A enacts the “BEAT.”

Tax on excess of modified taxable income over regular taxable income. (5% in 2018, 10% in 2019-2025, 12.5% after 2025).

Modified taxable income is computed without benefit of “base erosion payments.”

Base erosion payments are deductible payments to a related foreign person that

results in a US tax deduction. But, a base erosion payment does not include a deduction for cost of goods sold except where foreign person is a surrogate foreign corporation (or related foreign person of a surrogate foreign corporation).Scope Limitation: Only applies to corporations with $500 million of gross receipts. Does not apply if full US withholding or net basis taxation applied to foreign recipient. Cost only services excluded.

58




Foreign-Owned

Base Erosion


n

•Lease Strip

ping Transaction

•Interest S

tripping Transactio

n

•Royalty Strip

ping Transaction

•Service Strip

ping Transaction

Residual

Profits

ResidualProfits

Base Erosion and Profit Shifting:Second Response: Base Erosion Alternative Tax

TP: Cost + x%

Modified Taxable Income is reduced only by credits allowed under §38* not to exceed 80% of the lesser of such credits or the base erosion minimum tax amount (determined without taking into account §38 credits).

Applicable Taxpayers are corporations other than a RIC, REIT, or S Corporation with average annual gross receipts (over 3 year

period of > $500 million and with a base erosion percentage of at least 3% (2% for certain financial institutions).

* §38 Credits: low-income housing credit, renewable electricity production credit, and energy credits

Final Thoughts: No carryforward mechanism. NO exception for payments to US branches. Also keeps track of base erosion payments that create NOLs.

59




Foreign-Owned

Base Erosion


n

•Lease Strip

ping Transaction

•Interest S

tripping Transactio

n

•Royalty Strip

ping Transaction

•Service Strip

ping Transaction

Residual

Profits

ResidualProfits

TP: Cost + x%

Proposed Regulations (REG-104259-18) (Dec. 13):1. BEAT applied on an aggregate group basis.2. Base erosion payments is determined on a

gross (not netted) basis except for mark-to-market gains and where statute provides for netting.

3. Base Erosion Payment can exist even if the transaction is a nonrecognition transaction or a loss is recognized and even if payment is made in stock.

4. Exceptions to Base Erosion Payment: ECI, §988 exchange losses, disallowed business interest, cost of goods sold,

and proportional to extent withholding applied (e.g., 15% withholding = 50% subject to BEAT).5. Bank exception for securities issued for total loss absorbing capacity (TLAC).6. Large exception for qualified derivative payments that is not limited to just banks.7. Contains an anti-abuse rule regarding use of unrelated parties as conduits for a

principle purpose of avoiding base erosion payment characterization.8. Application of BEAT is applied at the partner level and the

partner is treated as making the partnership’s payments in relation to distributive share.

1. Inbound: Base Erosion and Profit Shifting:New Base Erosion Alternative Tax (“BEAT”)

60

BEATTaxable Income b/4 disallowances $50

Disallowed 3rd Party Interest $15

Disallowed Related Party Interest $5

Taxable Income (after §163(j)) (a) $70

Allowed Related Party Interest (90 of 95) $90*

Allowed Related Party Royalty $300

Total Base Erosion Payments (b) $390

Modified Taxable Income (c= a+b) $460

Applicable Rate- 5%, 10%, 12.5% 10%

BEAT Amount $46

BEAT Tax Liability $31.3

Inbound: Base Erosion and Profit Shifting:New Base Erosion Alternative Tax (“BEAT”)



BANK

$15 Business Interest

$95 Business

Interest

$300Royalty

Regular TaxTaxable Income b/4 163(j) $50

Disallowed Interest (§163(j)) $20

Regular Taxable Income $70

Corporate Tax Rate 21%

Regular Corporate Tax $14.7

*Note: Disallowed Interest allocated to unrelated party first

$50 Taxable Income b/4 163(j) (Depr. $70)(Business Int. Inc. $30)

61

Problem 1 p. 292Securities Income & Trading

NRA has U.S. securities transactions.

Dividends of $30,000 from shares and $200,000 gains and $100,000 losses; total net income of $130,000.

Not ETBUS - §864(b)(2)(A)(i).

Capital gains not taxable in the U.S.

Dividends subject to U.S. tax in U.S., so $9,000 tax on $30,000 of dividends (30% tax rate, unless 15% rate under a treaty).

62

Problem 2 p. 292Excess Capital Loss

NRA has $200,000 gains and $230,000 losses; net capital loss of $30,000.

Dividend income of $30,000.

Loss of $30,000 is not available to offset the tax on the $30,000 of dividend income (unless ECI & ETBUS). Withholding tax imposed at source on the dividends.

63

Problem 3 p. 292Discretionary Authority

Discretionary authority to buy and sell to be granted to broker.

NRA will not be treated as ETBUS.

Code §864(b)(2) safe harbor provision will continue to apply to the NRA.

64

Problem 4 p. 292§864(b)(2)(B) Safe Harbor

Foreign commodities dealer takes title to wheat in U.S. and the wheat is then sold to the Government of India FOB NYC.

Income from this sale is not FDAP and, arguably, dealer is not ETBUS (since only sporadic U.S. transactions) and, therefore, no U.S. tax liability even though U.S. source income under the title passage test.

No P.E. if an income tax treaty is applicable.

Events are solely in the U.S., but no U.S. tax.

65

Problem 5 p. 292Cf., Balanovski Scenario

Foreign sales reps send orders to purchasing agents in the U.S. and goods are purchased in the name of foreign corporation.

Orders are accepted in the foreign country.

Title transferred at port of destination.

Customers pay transit insurance.

Not a USTB or P.E.? If so, what income source (U.S. for foreign)?

Bolanovski Horenstein

CADIC(Argentina)

66

Problem 6 p. 293Related U.S. & Foreign Parties

Foreign corp. sells machinery parts throughout Europe.

Bought parts from a related company in the U.S. and took title to the parts in U.S. and delivered the parts to Europe.

Foreign corp. receives foreign source income from the sale of inventory. U.S. tax? No.

And, no imputed U.S. statusbecause the transaction is between related companies.

Colonial(US Corporation)

Empire(German)

Holdco(Swiss)

Sale

Sale

EuropeanCustomers

67

Problem 7 p. 293Foreign Corp - Services

Parts are delivered to customers at the U.S. factory and customers pay all shipping costs. Foreign sub receives a 20 percent commission from the U.S.

Empire receives services incomeand services income is sourced where those services are rendered. Presumably, those services are performed outside the United States.

Colonial(US Corporation)

Empire(German)

Holdco(Swiss)

Commission

EuropeanCustomers

Direct Sales

68

Problem 8 p. 293Royalties or Compensation?

Soprano from France made record in L.A.; similar to the Boulez case?

Receives 10 percent of gross revenue from worldwide sales, described as ‘royalties” under the contract between her and the U.S. recording company.

1) Copyright (royalty) or compensation?

2) Cf., tax treaty treatment: compensation (taxable) or royalty (exempt)? See Art. 17.

69

Problem 9 p. 293Community Income

U.S. citizen moved from U.S. to Peru as employee of sub of U.S. shipping co.

Married Peru citizen/resident.

Peru – community property jurisdiction.

Code §879 says community earnings belong to the working spouse.

Result: All his income (§911 exclusion?)

70

Problem 10 p. 293Outbound Alimony & Interest

Employee returns to U.S. without NRA wife and she is an ex-wife.

He transmits alimony (U.S. source) and child support (not income) to Peru.

Also, he pays (U.S. source) interest to Peru bank on his personal loan.

Interest payment subject to 30% U.S. tax withholding at source (tax treaty?).

71

Problem 11 p. 294Partnership Services §1446

NRA partner in U.S. partnership with USTB. Equal share in profits and losses.

NRA works in Ireland.

To what extent are services provided in the U.S.? U.S. source income if U.S. based services but not if foreign provided services.

Transform the NRA into an employee?

Include a “special allocation” provision in the partnership agreement?

72

Problem 12 p. 294U.S. Land Ownership USTB?

ETBUS? If not ETBUS, 30% withholding at source on the $100,000(?) annual rental income, plus any real estate taxes paid by the tenant. No deductions for expenses.

Therefore, elect Code §871(d) treatment. Then taxable on Code §1 progressive rates on the net income of each. U.S. Model Treaty –Article 6(5).

73

Problem 13 p. 294Sale of U.S. Land & FIRPTA

NRA sale of U.S. land (i.e., real property).

U.S. income tax treatment of the profit?

Yes, §897 imposes tax – FIRPTA rules.

§1445 imposes a withholding obligation at source on the payor.

U.S. Model Income Tax Treaty, Article 13(1), confirms that U.S. jurisdiction exists to tax these real property gains.

Leonardo&

Verdi

US Real Estate

US Buyer

Purchase Price Less15% Withholding

74

Problem 14 p. 294USRPHCo Status? 50%+ Test

NRA invested in wholly owned U.S. corporation:

1) NYC apartment for $2 million

2) Stock (publicly traded): $2 million

3) Art Gallery: $2 million (rented space; annual lease & no renewal right)

Consider (for FIRPTA purposes) the various alternatives concerning the relative fair market values of the several properties.

Romano

Knickerbocker(US Corporation)

Stock

Issue: Did USRPI > 50%of value in last 5 years?

75

Problem 15 p. 295Foreign Corp. Stock Sale

NRA invested in wholly owned foreigncorporation.

The interest in a foreign corporation is not a U.S. real property interest.

Sale of this stock would not be taxed under FIRPTA, but the stock value to be paid should be reduced by the purchaser by the embedded potential internal federal income tax liability.

Romano

Knickerbocker(Cayman Corp.)

Stock

Issue: Did USRPI > 50%of value in last 5 years?

76

Problem 16 p. 295Indirect U.S. Ownership

Status of Bluewater as a USRPHCo.?

Yes, became a USRPHCo. when acquiring shares of foreign corp. (Paradise) with U.S. real property (even though U.S. assets had a low tax basis). 40 U.S. and 30 foreign.

See Code §897(c)(5).

The sale of Bluewater shares by Casino (NRA) for 1 million profit results in FIRPTA gain and U.S. tax to Casino.

The “less than 5% rule” is not applicable.

Casino

Blue Water (US Corporation)

Issue: Look-through Paradise and Determine relative value of real property.

Caribbean Hotels

Paradise(Bahamas Corp.)

Florida Hotels

Public

sale

77

Problem 17 p. 295Disqualified Interest & §163(j)

New §163(j) now allows only 30% of ATI. ATI is $500,000 (regular taxable income $200 + interest expense of $280,000 and $20,000 depreciation). So, the interest expense is limited to $150,000 with regular taxable income of $330,00 ($500-$20-$150).

Section 59A does not apply as modified taxable income of $480,000 (regular taxable income of $330,000 plus base erosion payment of $150,000) x 10% is less than $330,000 x 21%.

78

Problem 18 p. 295

Does failure to tax internet profits create an unacceptable advantage for electronic commerce taxpayers over “bricks and mortar” taxpayers?

Note: 2009 commentary on this subject by some CEOs of “bricks and mortar” companies.

79

Problem 1 p. 296Tax Planning

Panco to acquire U.S. real property & stocks and bonds of U.S. real estate companies.

1) Current income – 30 percent tax, unless net election available.

2) Branch profits tax is ETBUS.

80

Problem 1, Continued

3) Listed securities investments – interest and dividends, subject to 30 percent withholding.

4) Sale of real estate – FIRPTA

5) Sale of securities – no tax, unless connected with real estate trade of business.

81

Problem 1, Continued

6) Dividends from Panco producing U.S. taxable income, unless branch profits tax.

7) Use debt leveraging?? But Section 163(j) may be applicable.

8) Cayco –

Where rendering services?

Not subject to FIRPTA.

82

Problem 2 p. 297

How much investment?

Profit projections?

Cash flow expectations?

How deal with U.S. profits?

Income tax status of the individual?

Anticipated structure and management?

83

Problem 3 p. 297

Nontax considerations, e.g., limitation of liability.

What alternative structures for tax planning?

Debt financing?

Resident alien status of individual?

Branch profits tax & FIRPTA applicable?

84

Summary p. 298

Investment environment in U.S. – Are tax burdens on foreign investment more favorable than for domestic based investment?

Cf., force of attraction rule vs. P.E. test (with only P.E. income being taxed).

Consider focus of U.S. income tax treaties.

Documents

International Income Tax - Chapter 4 Income Tax... · through Antilles and utilize the U.S. income tax treaty exemption on interest expense paid to the N.A. lender. This income tax