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U.S. TAX DEVELOPMENTS
Inbound Investment into the U.S.
Technical Updates & Planning
Strategies
PRESENTED BY
James Barry
Bernard Moens
Mayer, Brown, Rowe & Maw (Chicago)
PricewaterhouseCoopers LLP (Washington, D.C.)
2007 OFII Tax Conference
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Agenda
• Introduction
• Technical Updates
– Treaties
– Final DCL Regulations
– IRS Enforcement and Audit Strategies
• Inbound Strategies
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Administrative Matters
• The views expressed in this presentation should not
be relied on as accounting, auditing, or tax advice. The
outcome of any independent situation depends on the
specific facts and circumstances in which the issue
arises and on the interpretation of FAS 109, FIN 48,
and other relevant literature in effect at the time.
• This document was not intended or written to be used,
and it cannot be used, for the purpose of avoiding tax
penalties that may be imposed on the taxpayer.
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Technical Updates
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Treaty Developments
• Treaty Activity
• Trends and Highlights
• Memorandums of Understanding & Competent
Authority Agreements
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Treaty Developments
Treaty Activity
•
•
•
•
Aug. 7, 2006 – U.S.-Bangladesh treaty entered into force
Aug. 31, 2006 – U.S.-Sweden protocol entered into force
Nov. 27, 2006 – New U.S.-Belgium treaty signed
Dec. 21, 2006 – The U.S.-French protocols to the income and
estate treaties between the U.S. and France entered into
force.
• March 20, 2007 - The U.S. and Brazil signed Tax Information
Exchange Agreement
• March 22, 2007 – The Netherlands Antilles-U.S. Tax
Information Exchange Agreement entered into force
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Treaty Developments
Treaty Activity
• Late in 2006, the Administration sent to the Senate for
ratification proposed protocols to treaties with Germany,
Denmark and Finland.
• The Administration is near completion of a U.S. income tax
protocol with Norway.
• Administration also signed a new income tax treaty and
protocol with Belgium and completed negotiations on a new
income tax treaty with Iceland. It is expected that these
treaties will be sent to the Senate for ratification in coming
months.
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Treaty Developments
Treaty Activity
Renegotiation of Older Treaties
• Iceland: US Treasury has reportedly initialed a new
agreement. Start and length of ratification process unclear
• Hungary – US Treasury has reported a new agreement with
Hungary is "substantially complete“
• Poland – US Treasury has said that renegotiation with
Poland is a high priority but first round of negotiations has
not yet occurred
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Treaty Developments
Treaty Activity
• Nov. 14, 2006 – New U.S. Model Income Tax Treaty and
Technical Explanation released
– Incorporates new U.S. tax treaty policy that has been
reflected in recent treaties, protocols, and competent
authority agreements
– Reflects opening position of the U.S. in treaty negotiations
regarding tax rate reductions, including:
• Dividends: 15%, reduced to 5% in certain cases
• Interest: 0%, except in certain cases
• Royalties: 0%
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Treaty Developments
Treaty Activity
• Inclusions in Model Treaty
– Closely follow content of recent agreements, such as U.S.
treaties with Germany, Sweden, Denmark, and Finland
• Absent from Model Treaty
– An arbitration article
– Derivative benefits or equivalent beneficiaries provision
– Elimination of withholding tax on dividends
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Treaty Developments
Treaty Activity
• New Guidance Provided by the Model Technical Explanation
– Treatment of Fiscally Transparent Entities
– Attribution of Profits to a Permanent Establishment
– Resolving Inconsistent Beneficial Ownership Concepts in
the Application of Reduced Rates of Tax for Dividends
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Treaty Developments
Trends & Highlights
• Trend toward zero withholding tax on certain types of
dividends (80%-owned subsidiaries)
– Feature in recent treaties with Australia, Mexico, Japan,
UK, the Netherlands, and Sweden
– Other countries pending include Germany, Finland,
Denmark, Norway, Belgium and France
– Not featured in newly-released U.S. Model Income Tax
Treaty
• Limitation on Benefits Clauses and Impact on Privately-Held
Companies / Active Trade of Business Qualification
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Treaty Developments
Memorandums of Understanding & Competent Authority Agreements
• Recent experiences with competent authority
proceedings
- Derivative benefits
- Dutch finance companies
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Treaty Developments
Memorandums of Understanding & Competent Authority
Agreements
• US & UK Agree to Change Dual Consolidated Loss Regimes
• The IRS published a competent authority agreement between the
United States and the United Kingdom with respect to dual
consolidated losses (DCLs) under Section 1503(d).
• Certain taxpayers may elect to use, or relieve, losses in either
the United States or the United Kingdom to the extent permitted
by the rules of the contracting state, as modified by the
agreement.
• Included are the rules and conditions that must be satisfied for a
taxpayer to use dual consolidated losses in the U.S. or UK, with
respect to which relief is available under the terms of the
agreement.
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Dual Consolidated Loss Rules –
Key Issues with Recent
Regulatory Changes
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Background
• Section 1503(d) provides that a “dual consolidated loss”
(“DCL”) for any taxable year of a corporation shall not be used
to reduce the taxable income of any other member of the
affiliated group for the taxable year or another taxable year.
• A DCL generally is defined as a net operating loss (“NOL”) of
a U.S. corporation that is subject to income tax of a foreign
country on worldwide or residence basis. IRC Sec.
1503(d)(2)(A).
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Separate Unit Combination Rule
• Historically, separate branches of a single domestic
corporation would be combined when applying the DCL rules.
• The new regulations extend the rules to situations in which
entities are owned by more than one member of a
consolidated group. Thus, if two members of a consolidated
group own an interest in a foreign entity, the DCL rules can
apply to losses of that entity.
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Separate Unit Combination Rule Example.
Treas. Reg. § 1.1503(d)-7, Ex. 1.
Unrelated
Party
Combine
(U.S.)
P
50%
50%
100%
(U.S.)
DRC
(For X)
DE3
(For Y)
PRS
100%
(For X)
DE1
(For X)
FB
100%
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(For X)
FB
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Domestic Reverse Hybrid Entities
Preamble specifically
notes that the DCL rules
do not apply to these
structures.
Bank
Loan
U.S. Corporation
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Foreign
Corporation
US Domestic
Reverse
Hybrid
U.S. Corporation
U.S. Corporation
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Transparent Entities
• Regulations provide that foreign entities that are transparent
under local law such as partnerships and grantor trusts
generally will not be treated as separate units of a domestic
corporation.
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Foreign Use Rules
• The DCL rules only apply if there are losses are “used” in a
foreign country.
• The new regulations provide that a foreign use is deemed to
occur only if two conditions are satisfied.
– The first condition is satisfied if any portion of a deduction
or loss taken into account in computing the DCL is made
available under the income tax laws of a foreign country to
offset or reduce, directly or indirectly, any item that is
recognized as income or gain under such laws (including
items of income or gain generated by the dual resident
corporation or separate unit itself), regardless of whether
income or gain is actually offset, and regardless of whether
these items are recognized under U.S. tax principles.
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Foreign Use Rules
– The second condition is satisfied if items that are (or could
be) offset pursuant to the first condition are considered,
under U.S. tax principles, to be items of: (1) a foreign
corporation; or (2) a direct or indirect (for example, through
a partnership) owner of an interest in a hybrid entity,
provided such interest is not a separate unit.
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Indirect Foreign Use Rules
• Regulations provide that the DCL rules will
apply to certain transactions which move
losses from a separate unit to another
entity that would not be literally subject to
the DCL rules because that second entity
is not a separate unit subject to the DCL
rules.
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Indirect Foreign Use Rules –
Treas. Reg. § 1.1503(d)-7, Ex. 6.
(U.S.)
P
Bank
Loan
(U.S.)
S
(For)
DE1
99%
Interest on loan treated as
DCL because is available
to DE1 in both foreign
country and U.S.
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1%
(For)
FRH
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Indirect Foreign Use Rules –
Treas. Reg. § 1.1503(d)-7, Ex. 6.
(U.S.)
P
Bank
Interest on loan from DE3 to
DE1 will be disregarded
When applying DCL rules.
100%
Loan
100%
(For)
DE3
Loan
100%
(U.S.)
S
(For)
DE1
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99%
1%
(For)
FRH
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Indirect Foreign Use Rules –
Treas. Reg. § 1.1503(d)-7, Ex. 7.
(U.S.)
P
Bank
(For)
DE1
Hybrid Instrument
U.S – Equity
Foreign - Debt
(X)
FS
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Legislative and Regulatory Update
•
•
•
•
•
•
•
New Temporary Regulations Addressing Corporate Inversions (June 2006)
Revisions to Regulations Regarding Taxation of Restructurings Involving the
Transfer of U.S. Real Property Interests (June 2006)
Changes to Regulations Relating to Forms 5471 and 5472 Filing
Requirements (June 2006)
Temporary and Proposed Transfer Pricing Services and Intangibles
Regulations (Aug. 2006) and Additional Guidance (Dec. 2006)
Guidance Regarding Withholding Tax Treatment on Net Consideration for
Certain Cross-Licensing Agreements (March 2007)
Proposed Legislation on Treatment of Dividends, Corporate Residency
(April 2007)
Final Regulations Relating to Interest on Portfolio Indebtedness Obligations
(April 2007)
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IRS Enforcement & Audit Strategies
•
•
•
•
•
•
Current climate
Inter-Governmental Sharing of Information
Tax Arbitrage and Hybrid Entities
Recently-Identified Areas of IRS Compliance Interest
Delinquent International Returns & Potential Penalties
Forms in Development
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IRS Enforcement & Audit Strategies
Current Climate
•
Associate Chief Counsel (International), Steven Musher, said "International
tax compliance is now really a major emphasis for the Service. We're
putting a great deal more emphasis in this area.”
•
Frank Ng, IRS LMSB Deputy Commissioner (International) in November
2006: "International tax matters are a growing significant area within
the IRS and it is important that we work with taxpayers and the
practitioner community to improve voluntary compliance with the
international tax laws.“
•
In general, cross-border arbitrage using hybrids will be closely scrutinized
by the IRS as consistent with the priorities of IRS Commissioner Mark
Everson. "We see these as smoke, and sometimes there's fire, and
sometimes there isn‘t." Bettie Ricca, IRS deputy associate chief counsel
(international).
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IRS Enforcement & Audit Strategies
Inter-Governmental Sharing of Information
•
•
•
•
•
OECD's Forum on Tax Administration (FTA)
Joint International Tax Shelter Information Center (JITSIC)
– JITSIC is a permanent international secretariat whose members include
Australia, Canada, U.S. and the United Kingdom.
“Leeds Castle Group”
– Includes tax commissioners from the Australia, Canada, China, France,
Germany, India, Japan, South Korea, United Kingdom and United
States
– China and India are important participants because of significant foreign
direct investment in these countries
IRS and UK are sharing information to combat abusive tax arbitrage
IRS Sharing Information With Other Treaty Partners
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IRS Enforcement & Audit Strategies
Tax Arbitrage and Hybrid Entities
• New multilateral efforts are focused on cross-border
enforcement, particularly as it applies to underreported
income, as well as on "tax arbitrage" transactions.
• Audit experience with hybrid transactions.
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IRS Enforcement & Audit Strategies
Recently-Identified Areas of IRS Compliance Interest
• Protective Form 1120-F filings are being scrutinized to identify other
entities that should be paying federal income tax.
• IRS is examining a pool of Form 1120-F filings to determine if
taxpayers are engaged in U.S. trade or business or have a U.S.
permanent establishment under the applicable U.S. tax treaty.
• IRS is researching taxpayers on internet to determine extent of
taxable U.S. presence. Information will be shared with agents in
LMSB and SB/SE groups throughout U.S. who will conduct
examinations.
• Foreign controlled corporations with significant intercompany
transactions reported on Form 5472, and limited operating profit, are
being targeted.
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IRS Enforcement & Audit Strategies
Recently-Identified Areas of IRS Compliance Interest
• IRS is looking at inbound entities that have U.S. tax losses, as well
as transfer pricing, and withholding tax compliance.
• Extensive compliance initiative project to address noncompliance by
taxpayers responsible for withholding income tax under Sections
1441-1443. The IRS goal is to examine compliance of 300 taxpayers
in each of the five Large and Mid-Size Business (LMSB) divisions.
• IRS computer audit specialists and international examiners have
been analyzing information reported on Form 5471 and Form 5472
to determine whether reportable amounts reflected on those
information returns have been reported properly on Form 1042.
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IRS Enforcement & Audit Strategies
Delinquent International Returns & Potential Penalties
• The IRS is enforcing the Form 5471 filing requirement and
assessing $10,000 penalty per Form 5471 for incomplete
information or for failure to file the form.
• Chief Counsel Notice (CC-2004-036): penalties assist IRS by
increasing economic cost of non-compliance. IRS staff should
support imposition of penalties when issue is properly developed.
• Hazards of litigating a penalty are to be considered separately from
hazards of litigating a tax liability.
• IRS Chief of Appeals issued memo to staff establishing new policy
under which "penalty issues" will no longer be "traded" as part of
settlement process. Settlement of a penalty must be on the merits.
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IRS Enforcement & Audit Strategies
Forms in Development
• IRS has announced that it intends to revise Form 1120F for
the 2007 tax year.
• A new Schedule M-3, similar to the one required for domestic
corporations, is being developed and will require foreign
corporations with more than $10 million of U.S. assets include
the Schedule M-3 as part of their Form 1120 F.
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Relevant Inbound Strategies
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Defining Characteristic(s)
• Notional Deductions
– Belgian NID regime
– Notional Interest Deduction
• Indirect group relief
• Hybrid Treatment
– Repo transaction
– Delaware General Partnership
• Other
– Tax reduction
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Notional Deductions
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Swiss Financing Using
Notional Deductions
POTENTIAL BENEFITS
EU Co
(EU - Not
Switzerland)
 Deduction in the U.S.
 Low effective tax rate in Switzerland.
Non-Redeemable
Equity
CONSIDERATIONS
Interest
 Swiss Finance Co must obtain ruling.
 US-Swiss income tax treaty requirements.
 Section 163(j) earnings stripping.
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U.S. Co
(U.S.)
Swiss Finance Co
(Switzerland)
Loan
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Belgian NID Structure
Parent Co
TRANSACTION STEPS
1. ParentCo forms and contributes equity to NidCo.
2. NidCo loans cash to US Opco.
TAX BENEFITS/CONSIDERATIONS
• U.S. withholding tax (current treaty vs. proposed
protocol)
• Notional Interest Deduction in Belgium results in a
lowering of the effective Belgian corporation tax rate.
• Interest expense deduction in US Op Co.
• ParentCo’s tax implications should be considered.
STEP 1
Formation
and
capitaliza
tion of
NidCo
US Op Co
(U.S.)
NidCo
(Belgium)
STEP 3
Loan
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Indirect Group Relief
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Indirect Group Relief
SUMMARY
– UK 1 makes a loan to UK2, which is disregarded for US tax
purposes.
– UK 2 makes a loan to UK 3, which is also disregarded for
US tax purposes.
INTENDED RESULT (UK)
– Interest income in UK 1 can be group relieved using interest
expense in UK 3
– Interest income in UK 2 is offset by interest expense on loan
from UK 1
– Unless can argue Condition C does not apply (may be
possible in certain circumstances) the AA rules may deny
deduction in UK
INTENDED RESULT (U.S.)
– Loan from UK 1 to UK2 is regarded and interest expense is
available for use in the US
– Loan from UK2 to UK 3 is disregarded.
– Consider impact of final DCL regulations (indirect foreign
use?).
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UK1
US
UK 2
UK 3
US
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Hybrid Treatment
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Delaware General Partnership
Foreign Parent
(Country X)
POTENTIAL BENEFITS
 Deduction in U.S. and Country X.
 Dividend from Co. Y may be exempt in Country X.
99%
Foreign SubCo
(Country X)
Unrelated
Lender
 Dividend from Co. Y not taxed in the U.S.
1%
 May be no or reduced withholding tax on interest.
CONSIDERATIONS
Interest
DGP elects to be
treated as a
corporation
DGP
(U.S.)
Loan
 Dual consolidated loss rules.
 Business purpose.
 Domestic reverse hybrid rules.
Company Y
U.S. Group
(U.S.)
U.S. CONSOLIDATED GROUP
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Repo Structure
OBJECTIVE
• Tax effective financing of US subsidiary aimed at e.g.
refinancing of existing debt or funding of investment
(e.g. acquisition).
Parent
TRANSACTION STEPS
1. To be determined based on facts of client
2. Note that it is necessary for the planning to contain a
mechanism for the repurchaser/ U.S. borrower to have
funds available to repay the principal.
Sub
INTENDED TAX CONSEQUENCES
US
• Treatment of integrated steps as a loan; deductibility of
the dividend payments on the Preference Shares as
interest expense (subject to applicable limitations).
• Reduced interest withholding rate under applicable
treaty.
FOREIGN JURISDICTION
• Exemption of part or all of the dividend from local
country taxation.
REPO
US
HoldCo
COMMON
SHARES
US OpCo
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PREFERENCE
SHARES
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Other
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The Netherlands
Proposed Tax Reform 2007 – Interest Box
• Effective rate is 5%
• Conditions:
– Taxpayer has to opt for application of the regime together with all
affiliated companies subject to CIT in the Netherlands
– In principle, regime applies for a minimum period of 3 years
– Group interest income that can benefit from this favorable regime
is restricted to the Official Interest rate (currently 4.25%) over the
company’s tax equity
– FX results are not included in the interest box but subject to
regular taxation
– Group interest box will have retro-active effect from January 1,
2007 after approval of EU in 2007
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The Netherlands
Group Interest Box Structure
OBJECTIVE
• Loan note should result in a full tax deduction for
financing costs in U.S. (subject to earnings stripping
regulations) with a corresponding taxable receipt at an
effective tax rate of 5% in the Netherlands when providing
funds directly from the Netherlands to the U.S.
TRANSACTION STEPS
1. Holdings Overseas B.V. incorporates U.S. Co.
2. Holding Overseas B.V, contributes the shares in U.S.
Group to U.S. Co.
3. U.S. Co distributes loan note to Holding Overseas B.V.
CONSIDERATIONS
• The distribution of the loan note would be subject to U.S.
withholding tax to the extent of the earnings and profits of
U.S. Group.
• Provided that the minimum requirements for the
participation exemption are met, dividend receipts from
U.S. Co should be tax exempt in the Netherlands
• Interest withholding tax on interest payments from U.S. Co
under the US-NL tax treaty
• Group interest box should approved by EU
• Threshold of group interest box should be met
• Structure can also be considered for qualifying EU group
to do US inbound financing
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Dutch or EU Co
Holding B.V.
(Netherlands)
Holding
Overseas B.V.
(Netherlands)
Loan
note
U.S. CO
(U.S.)
U.S. Group
(U.S.)
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