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Business Without Borders In A Flat World

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International tax considerations related to structuring your client's non-US operations. …

International tax considerations related to structuring your client's non-US operations.

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  • 1. Business without Borders in a “Flat” World:International Tax Considerations Related to Structuring Your Client’s Non-US Operations Presented by Stuart Anolik, Esq. Managing Director, CBIZ MHM, LLC. 1
  • 2. Circular 230 NoticeAny tax advice contained in this program is not intended tobe used and cannot be used for the purposes of avoiding anypenalties that may be imposed by the Internal RevenueCode. 2
  • 3. Worldwide vs. Territorial Taxation vs. Deferral• Worldwide – U.S. persons (individuals, partnerships, LLCs, and corporations) and residents are subject to U.S. tax on their worldwide income. See §§ 1 and 11 of the Internal Revenue Code of 1986, as amended (the “Code”). – §§ 871, 881 and 882 of the Code subject non-resident aliens and foreign corporations to U.S. tax on U.S. source income. See §§ 861 through 885 of the Code for rules to determine US and foreign source income.• Territorial Tax/Exemption System – Foreign income of residents is not taxed (some jurisdictions exempt some but not all foreign income of residents by taxing a resident’s foreign income once it is repatriated) – Examples of Countries with a territorial tax system• Deferral – The postponement of current taxation on the net income or gain economically accrued by a taxpayer » Ability to use pre-US tax dollars for international expansion » Increases cash flow » Increases earnings per share and thus shareholder value 3
  • 4. Territorial Tax/Exemption System• Territorial Tax Systems • Hong Kong • Singapore – How it works• Exemption Systems • Netherlands • Cyprus – How it works 4
  • 5. Deferral and Subpart F Income• Defined: A US shareholder of a controlled foreign corporation (“CFC”) is required to include in income certain types of income earned by the CFC, even though such income is not distributed to the US shareholder. Section 951(a)(1)(A)(I). – A “US shareholder” is defined as a US person who owns directly, indirectly, or constructively 10% or more of the combined voting power of all classes of stock entitled to vote. Section 951(b). – A “CFC” is defined as a foreign corporation in which more than 50% of its stock, by vote or value, is held by US shareholders at any time during the year. Section 957(a). 5
  • 6. Deferral - Subpart F Income• Overall “Foreign Base Company Income” (“FCBI”) – Special Rules – De Minimis Rule • If foreign base company income and insurance income is less than the lesser of 5% of gross income or $1 million  the income is not included – Full Inclusion Rules • If the sum of foreign base company income and insurance income is greater than 70% of gross income  full amount is included in income – High Tax Exception • If the foreign base company income is subject to an effective rate of income tax imposed by a foreign country that is greater than 90% of the maximum rate of tax in the US  the income is not included 6
  • 7. Foreign Base Company Sales Income (“FBCSI”)Example 1: • USCo develops software program • ForCo acquires software through a non- USCo exclusive 3-year license • Unrelated customer either downloads the software or the software is drop shipped - Is this Subpart F income? ForCo Bermuda Unrelated Customer Outside Bermuda 7
  • 8. FBCSI (con’t)Example 2: - Same facts as Example 1 except ForCo is USCo involved in software reproduction, packaging and printing manuals - Is this Subpart F income? ForCo Bermuda Unrelated Customer Outside Bermuda 8
  • 9. Exception for Sale of Manufactured Property FBCSI does not include Components income derived from the Raw Materials (Related) Manufacturer sale of personal property manufactured by the seller (even if raw materials were purchased Customer from a related person)  Definition of “manufacturing”: If the product sold in effect is not the same product that is purchased. Two Tests: 1. “Substantial transformation test”: Conversion costs are greater than 20% of cost of goods sold), such as transformation of wood pulp into paper. • Packaging, labeling, or minor assembly will not constitute mfg. 9
  • 10. FBCSI – Manufacturing Exception (con’t)2. “Substantial contribution test” – CFC treated as manufacturer if it makes “substantial contribution” through its own employees; contract manufacturing (Reg. §1.954-3T(e), as amended by TD 9438 (12/29/2008)) • Weigh economic significance of functions performed based on indicia of mfg: – Oversight and direction of the mfg activities or process – Activities considered in, but that are insufficient to satisfy, the substantial transformation test – Material selection, vendor selection, or control of the raw materials, work-in-process or finished goods – Management of mfg costs or capacities (e.g., managing the risk of loss, cost reduction or efficiency initiatives associated with the mfg process, demand planning, production scheduling or hedging raw material costs) – Control of mfg related logistics – Quality control (e.g. sample testing or establishment of standards) 10
  • 11. FBCSI – Branch Rule• Buying, selling, or manufacturing branch treated as separate subsidiary if: – Created or organized outside CFC’s country of incorporation, and – Tax effect of branch is same as if it were a subsidiary (i.e., tax rate on branch is less than 90% and 5% points less than rate on home office of CFC) • Case law does not impute activities of related or unrelated contract manufacturers for purposes of branch rules; but does impute it for purposes of contract manufacturing• Practical effect is to treat branches outside home country as generating subpart F income if tax benefit obtained by having branch• Applies also to 70% full inclusion rule 11
  • 12. Foreign Base Company Services Income (“FBCSVI”)Example 3: USCo - Post-sale services provided by Bermuda - Help desk located in Bermuda Software - Web site development in Bermuda - Is this Subpart F income? ForCo - Where are the services performed?Bermuda Services CUSTOMERS 12
  • 13. FBCSVI (con’t)Example 4: - Same as Example 3 except ForCo retains USCo employees. Services at USCo customer location in Ireland Software - Is this Subpart F income? ForCoBermuda Services CUSTOMERS 13
  • 14. Foreign Personal Holding Company IncomeExample 5: - ForCo develops copyright-protected content and licenses it USCo - ForCo continuously updates the materials - ForCo receives royalties for the use of the materials ForCo - Is this Subpart F income?Bermuda CUSTOMERS 14
  • 15. 956: Investment in US Property• US Shareholder must include in income its share of CFC’s basis in investment in US property in excess of: • Prior inclusions under Section 956 • Limited to current and accumulated E&P reduced by current distributions 15
  • 16. 956: US Property• Tangible property in US• Stock of US corporation• Obligations of US person• Rights to intangible use in US 16
  • 17. 956: Intangible Property• A right to use intangible property (patent, copyright, invention, design, secret process or other similar right) acquired or developed by the CFC for use in the US is considered property for section 956 purposes. Section 956(c)(1)D) – Unless otherwise demonstrated, a right actually used principally in the US will be considered acquired or developed for use in the US. Treas. Reg. section 1.956-2(a)(1) 17
  • 18. Entity Classification – Reg. §301.7701-2(a) Definition of “entity” for federal tax law is independent of local law. A business entity is any entity recognized for federal tax purposes that is not a “trust”. Note: A trust by definition is not a “business entity.” Any entity that is called a “trust” but which carries on business (as opposed to investment) activities is a business entity that must be classified as set forth below. A business entity with two or more members can be a corporation or a partnership. A business entity with only one owner is classified as a corporation or is disregarded. If an entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch or division of the owner. 18
  • 19. Corporations Include: A business entity organized as a corporation under a Federal or State statute. Associations electing to be classified as corporations under Reg. §301.7701-3. A business entity taxable as an insurance company under Subchapter L of the Code. A business entity conducting “banking activities and deposits insured under the Federal Deposit Insurance Act.” Certain foreign entities. 19
  • 20. Entity Classification – Making the Election Executing the Election The election must be signed by: • Each member of the entity (including foreign owners), or • Any member, owner or officer authorized under local law to make the election. • If the election is retroactive and membership changes, members that have withdrawn between effective date and date of filing must also sign the election.  Sixty Month Rule • Once an affirmative election is made, a new election for the same entity cannot be made for 60 months. • Does not apply for initial classification if the default classification is used, or for elections effective 1/1/97 • Exception for more than 50% ownership change. Requires prior permission from the IRS. 20
  • 21. Entity Classification – Making the Election (con’t) How to Make Election: File Form 8832 - Entity Classification Election Effective Date of Election: • On the date specified on the form, so long as that date is (i) not earlier than the 75th day prior to the date of filing, and (ii) not later than one year from the date of filing. • If no date is specified, the election is effective on the date of filing.  When Election Should be Filed: • When an eligible entity chooses not to adopt the default classification (discussed below). • When an eligible entity wishes to change its current classification. 21
  • 22. Entity Classification – Default Rule• Effect of Failure to Make Affirmative Election • If the entity is domestic, it is classified as a partnership or a branch. • If the entity is foreign, it is classified as a corporation if all of its members have limited liability, or as a partnership or a branch if one or more members do not have limited liability. • Note that this is a strict legal liability test, not a substance over form test. This differs from the limited liability test under the old classification rules, where (for example) one looked to whether the member had assets which could be used to satisfy claims asserted against it in determining whether the member had limited liability. • On the other hand, the liability must arise by reason of being a member. For example, a mere guarantee of a subsidiaries debts would not be enough to establish a lack of limited liability. 22
  • 23. Permanent Establishment• OECD Model Treaty article• Application to electronic commerce of the PE definition.• Does a server at a given place may ever constitute a PE: – No PE is web site hosted on the server of a ISP who maintains control of the server. – A PE could exist where enterprise carries on business through a web site and also owns or leases and operates the server on which the website is stored and used.• Whether human intervention is required for a PE to exist. – To what extent is human intervention necessary for automatic equipment to be considered a PE? – Whether the intervention must necessarily take place in the country or can be done from abroad? – Different views on all above. 23
  • 24. Business vs. Passive Income• Generally, if you are engaged in a trade or business you will be subject to tax on your net income• If a nonresident receives interest, dividends or royalties that are U.S. sourced, there is a flat 30% withholding tax due on the gross proceeds paid – Withholding tax can be limited or eliminated pursuant to an income Tax Treaty 24
  • 25. Source Inventory Sales Income • Title Passage • Manufacture in U.S. and Sale Abroad = 50/50 Source Royalty Income – Place of Use Sale of Intangible • Contingent price = same as royalty • Lump sum = residence of seller Rental Income – Place of Use Services – Place of Performance 25
  • 26. Characterization Determines: • Application of Source Rules • Application of CFC Rules • U.S. Taxing Rights on Foreign Persons • Application of Foreign Tax Credit Rules • Application of Transfer Pricing Rules 26
  • 27. Characterization – Software Regulations 1.861-18  Four categories: • Transfer of copyright rights – Right to reproduce/display for public – License or sale of rights • Transfer of copyrighted article – Site license ok – Sale or rental of article • Provision of Services • Provision of know-how 27
  • 28. Characterization of Income• Characterization important – Double taxation if source and residence country characterize income differently. – If income characterized as a royalty, withholding tax (“WHT”) may apply.• OECD Model treaty article 12(2): payment of any kind received as a consideration for the use of, or right to use, any copyright of literary, artistic or or scientific work including cinematography films, any patent, trade mark, design or model, plan, secret formula or process, or for information concerning industrial or scientific experience.• OECD revised commentary deals with consideration for computer software: – Transfer of copyright article = sale – Partial transfer of copyright article = royalty• Characterization of income under US law 28
  • 29. Entity Characterization - Terminology A per se corporation includes: • A domestic corporation organized under any federal or state statute describing the entity as “incorporated”; • a foreign entity on the per se list (generally public limited companies).  An “eligible entity” is any entity other than a per se corporation. 29
  • 30. Example – U.S. Developed Software Software developed in U.S. and sold abroad • Sale of copyrighted article = 50/50 source • License of copyright right = 100% foreign source royalty Planning to maximize foreign tax credit – license foreign affiliate to copy and distribute 30
  • 31. Inbound Investments – Investments by Foreign Persons• Foreign individuals and entities that are not engaged in a U.S. trade or business are subject to withholding tax on certain payments from U.S. sources at a 30% rate. The tax applies to the gross amount of the payment. The types of payments (referred to as “fixed or determinable annual or periodic” or “FDAP” income) subject to withholding are: – Dividends (including dividend-equivalent payments pursuant to swaps or securities loans) – Interest (big exception for “portfolio interest” – see next slide) – Rents – Royalties – **Note: Capital gains are NOT treated as FDAP income (but see FIRPTA, on the next slide)• Must be from US sources – payments to foreign individuals or entities from foreign sources are not subject to withholding tax.• Withholding tax is collected by payors of FDAP income that are “withholding agents” (U.S. banks, financial instititions, corporations, etc.). Withholding agents report taxes withheld to the IRS on Form 1042-S. 31
  • 32. Inbound Investments – Additional Rules• FIRPTA: Gain by foreign individuals or corporations on the sale of U.S. real estate is treated as income that is effectively connected with a U.S. trade or business subject to net basis tax, and requires the foreign seller to file certain disclosures with the IRS and to file a U.S. income tax return. This rule applies to the sale of stock of a U.S. corporation that holds U.S. real property assets the value of which constitute more than 50% of all the corporation’s assets (there are exceptions, such as for publicly traded companies and domestically controlled REITs). In addition, an interest in a partnership or trust can be treated as U.S. real property to the extent the interest is attributable to U.S. real property held by the partnership or trust. Interest in U.S. real property solely as a creditor (e.g., loan that is secured by a mortgage on U.S. real property) will not be subject to the FIRPTA rules.• Substantial Presence: An individual who is present in the U.S. for at least 183 days during the tax year will be treated as a U.S. person who is subject to tax on all income from all sources. A foreign person that spends time in the U.S. over the course of 3 years will have to count years spent in the prior years along with time in the current tax year toward the 183 day threshold.• Portfolio Interest: Interest from U.S. sources is usually exempt from withholding when paid to a lender, so long as the lender owns less than 10% of the debtor; and so long as the interest is not being paid to a CFC by a related person (e.g., its U.S. shareholders).• Branch Profits Tax: If a foreign corporation operates an unincorporated branch in the U.S. through which it engages in a U.S. trade or business, the U.S. applies rules that treat the branch as if it were a U.S. corporation that distributes dividends to its foreign parent when it earns profits that are not reinvested in its U.S. business. 32
  • 33. Inbound Investments – Form W-8• How does a withholding agent determine if the recipient of FDAP income is subject to withholding or is a U.S. resident subject to net income tax (no withholding required)? The recipient must submit the appropriate Form W-8 to the withholding agent to establish its foreign status and eligibility for benefits under a tax treaty.• Foreign individuals and corporations typically submit a W-8BEN; entities exempt from U.S. tax (such as a foreign central bank) file a W-8EXP; partnerships with foreign partners must file a W-8IMY and include the appropriate form for each partner (W-8 for foreign partners, W-9 for US partners) as well as additional documentation that helps the withholding agent determine the correct withholding. 33
  • 34. Tax Treaties:Countries that Have an Income Tax Treaty In Effect with US * applies to Armenia, Azerbaijan, Belarus, Georgia, Krygystan, Moldova, Tajikistan, Turkmenistan, and Uzbekistan 34
  • 35. Tax Treaties – Limitation on Benefits Clause• Tax treaties provide relief from double taxation to residents of countries that are tax treaty partners, usually via a reduced withholding rate or exemption from withholding.• A taxpayer demonstrates it is not a U.S. person and that it qualifies for treaty benefits by providing a Form W-8 to the payor of the FDAP income.• This relief is available generally to persons or entities that are legitimate “residents” of the treaty country. Treaties attempt to protect against treaty shopping by employing a “Limitation on Benefits” or “LOB” provision. Most U.S. tax treaties have an LOB provision.• Notably, the U.S.-Hungary and U.S.-Poland treaties do not have LOB provisions, although there is a new treaty with Hungary awaiting approval by the Senate and the Treasury Department has discussed revising the U.S.- Poland treaty to add an LOB provision. 35
  • 36. Limitation on Benefits (con’t)• A typical modern Limitations on Benefits article (generally, in treaties or treaty protocols signed after 1988) limits benefits to the following persons: – 1. Individuals who are resident in a Contracting State; – 2. Contracting States or their political subdivisions or local authorities; – 3. Resident tax-exempt organizations (e.g., pension funds) if more than one half of the organizations beneficiaries are qualified residents of a Contracting State; – 4. Persons resident in a Contracting State if (a) more than 50 percent of the beneficial ownership interests in the persons are owned by qualified residents described in items 1 through 3 above or item 5 below or by U.S. citizens and (b) less than 50 percent of the persons gross income is paid out to nonresidents in the form of interest, royalties, or other deductible payments; – 5. Resident companies the shares of which are substantially and regularly traded on one or more recognized exchanges in either Contracting State; – 6. Resident entities that are engaged in an active trade or business in the residence State if the income derived from the other State is derived in connection with or incidental to that business; and – 7. Persons obtaining a favorable determination from the competent authority. 36
  • 37. Tax Treaties – Conduit Rules• Some taxpayers attempt to route payments through entities in treaty countries that would qualify for treaty benefits, and pass that income on to a non-treaty jurisdiction.• The seminal conduit case is Aiken Industries, Inc., 56 TC 925 (1971): A Bahamas company wholly owned a U.S. subsidiary and a Honduras subsidiary. The Bahamas parent loaned money to the U.S. subsidiary. Interest payments from the U.S. to the Bahamas would be subject to 30% withholding. Instead, the Bahamas parent transferred the U.S. subsidiary’s note to the Honduras subsidiary, in exchange for similar notes issued by that subsidiary. As a result, the interest paid by the U.S. subsidiary to the Honduras subsidiary was exempt from withholding under the U.S.-Honduras tax treaty, and those interest payments were effectively transferred to the Bahamas parent under the notes issued to the Honduras subsidiary. 37
  • 38. Tax Treaties – Conduit Rules (con’t) • The Tax Court ruled that the U.S. Original loanfrom parent to subsidiary’s interest payment had not US subsidiary Bahamas Interest – been received by the Honduran identical to Parent payment from US sub corporation because: (1) receipt for purposes of a treaty required more than the mere “obtaining of physical possession on a temporary basis;” (2) receipt required “complete dominion and control over the funds;” (3) all the corporations were members of the same U.S. Interest – exempt Honduras group; from US Subsidiary withholding Subsidiary (4) the transaction had no economic or business purpose and was solely to obtain the treaty benefit; and (5) the Honduran corporation, in effect, was a mere collection agent and conduit. 38
  • 39. Foreign Tax Credit“Foreign Tax Credit” refers to the credit for foreign taxes paid by a U.S. taxpayer.(1) Who can claim the FTC:  The FTC can be claimed by US citizens (including a husband and wife filing a joint return), domestic corporations, affiliated corporations filing a consolidated return, resident aliens.  Partners in partnerships and shareholders in S corporations are able to claim an FTC for their proportionate share of partnership’s or S corporation’s foreign tax liability.  Estates and trusts may claim an FTC for foreign taxes attributable to beneficiaries.  A tax-exempt entity may be entitled to an FTC where taxes are imposed on unrelated business income.(2) Which foreign taxes will qualify: Tax must be “creditable” The payment must be a “tax” (compulsory payment pursuant to the authority of a foreign country to levy taxes); the tax must be paid or accrued to a foreign country or a U.S. possession; and the tax must be an income, war profits, or excess profits tax (or must be paid in lieu of such a tax, which means its predominant character is that of an income tax in the U.S. sense). 39
  • 40. What is Transfer Pricing?  Transfer pricing relates to transactions between separate but related companies, located in different countries.  Transactions involve exchange of either tangible or intangible Parent assets between the related companies. Company in home  Assets can be either goods (tangible or intangible) or services. country  Transfer price is established to reflect the arm’s length values of the goods or services exchanged in the transaction. Transfer price established to Transact  “A controlled transaction meets the arm’s-length standard if reflect arm’s length Goods & the results of the transaction are consistent with the results values of Services that would have been realized if uncontrolled taxpayers had transaction engaged in the same transactions under the same circumstance” [Treas. Reg. §1.482-1(b)(1)] Subsidiary  Form 5471-Schedule M in a foreign country 40
  • 41. So What? Transfer price is mutually agreed upon by the related companies. It is not determined by market forces The transaction is a significant opportunity for the parent company to shift taxable income to countries with lower tax rates The international relationship is generally operation driven, not tax driven. Some times, tax strategies are the primary reason for establishing the relationship The motivations of the parent company are at odds with the motivation of the taxing authorities Ernst & Young Global Transfer Pricing Report (2007-2008): • More than 75% of respondents to an Ernst & Young Survey believe that transfer pricing will be critically important to their companies over the next two years • More than 66.7% of respondents see an increased need for transfer pricing services • More than 85% consider transfer pricing a risk in regard to managing their financial statement risk • More than 50% of respondents have undergone transfer pricing audits 41
  • 42. Purposes of a Transfer Pricing Analysis Parent Document a AssessCompany in Address Evaluate a new or transfer pricing exposure in the home international and existing inter- policy in event of an audit country state tax planning company transfer accordance with (by either the IRS or matters pricing policy the applicable a foreign taxing (proactive use of regulations authority) adjustments) Transact Goods & Services Sub in a foreign country Clients have turned to CBIZ for independent transfer pricing analyses. 42
  • 43. Possible Structure for E-Commerce Sales and Services Cost Share Advertisers USCo Fees rt ising 3rd Party AdveSoftware Advertising ShareSales ForCo Subscription Share Online Provider Bermuda 3rd Party Subscription Fees Subscribers/Customers Foreign of Online Provider Subs Consulting Services Legend: Software Branch for Sales US tax purposes 43
  • 44. CASE STUDIES 44
  • 45. FACTS US Co. •How should the payments from the 2nd tierUS co. wants to set up Offshore Co., a subsidiaries be structured (dividends,holding company that will allow it to interest, royalties)?conduct activities in foreign countries and to •How should payments be structureddefer US tax on the income from those between US Co. and Offshore Co.?activities. The second tier subsidiary •Where should Offshore Co. becompanies make payments to Offshore Co. incorporated?Offshore Co. may repatriate cash to US Co., OFFSHORE Co.hold onto the income, or distribute cashamong the second tier subsidiaries. Payments from subsidiaries Mexico UK South Africa Jordan Israel = “Check-the-box entity” – disregarded for US tax purposes 45
  • 46. Mauritius Cyprus UK Ireland (GBC1) 26% or 24%; losses of UK sub 12.5% for income from “active”Corporate tax on resident 3% 10% may be used by UK parent business; 25% for passive holding company (“group relief” provisions) income FTC available Yes Yes Yes Yes No, but there is a general Transfer pricing rules arm’s length requirement under Yes, but they are limited Yes Yes (new in 2011) local law Yes from nontreaty countries No; exemption from defenseTax on inbound dividends No (for most dividends) Yes – 12.5% or 25% (e.g., Mexico) – 3% tax No, but defense tax on dividends from foreign subs No but there is a tax on closely CFC rules No Yes that have lightly taxed passive held Irish corporations income Israel, Mexico, South Africa, Israel, Mexico, South Africa, Tax treaties South Africa, UK South Africa, UK, US US (plus many others) UK, US No withholding on dividends, No withholding on dividends, No withholding on dividends, No withholding on dividends, Withholding interest, or royalties paid to interest, or royalties paid to interest, or royalties under tax interest, or royalties under tax nonresidents nonresidents treaties treaties 46
  • 47. US Co. FACTS US Co. wants to buy equipment and lease it to its foreign operating company, located inOffshore Co. India. US Co. would like to defer paying any US tax on income generated in India, but would like the option of repatriating money back to the US.India Operating Company 47
  • 48. CBCC (US) Back to Back Lease Dividends/lease Withholding on rental payments payment from India 10.506% CYPRUS Mauritius tax on rental 3% Master income lease ofequipment Dividends/lease payments Withholding on dividend to Cyprus 0% MAURITIUS Cyprus tax on dividend income 0%Sublease of Lease Cyprus withholding tax onequipment payments dividend to US 0% Indian Operating Company US tax on dividend from Cyprus 15% 48
  • 49. EXAMPLE – BACK TO BACK LEASE US Co. Payment Taxation Master lease $10 lease 10.506% Indian withholding tax of equipment Dividend payment from payments ($1.05) = $8.95 net payment India $10 gross rental payment - $9 CYPRUS $8.95 income rental payment to US Co. = $1. $1 x .03 = $.03 Mauritius tax received by $1.05 FTC: $.03 - $1.05 = $0 Mauritius Mauritius tax  No US tax (disregarded) Lease payments Dividend $8.95 dividend No Mauritius withholding tax payments from Mauritius to No Cyprus tax on dividend Cyprus MAURITIUS $8.95 dividend from Cyprus to US No Cyprus withholding tax US tax on dividend: $8.95 x .15 = Co. $1.34 Net proceeds to $8.95 - $1.34 = $7.66Sublease of Lease US Co.equipment payments Effective tax rate $1.05 + $1.34 = $2.39 total tax Indian Operating on $10 rental 2.39/10 = 23.9% rate payment Company 49
  • 50. CBCC (US) Using a Disregarded US LLC Dividends/lease Withholding on rental payments payment from India 10.506% (India  US) Cyprus tax on rental CYPRUS income Master (US LLC receives income 0% lease ofequipment for Cyprus tax purposes) Lease payments US tax on rental income (Cyprus entity receives income for US tax 0% purposes) US LLC Cyprus withholding tax on dividend to US 0%Sublease ofequipment US tax on dividend from Cyprus 15% INDIA 50
  • 51. QuestionsWhat if US Co. developed and manufactured the equipment, and the Indianoperating company paid royalties?If the Mauritius entity had to set up and maintain the equipment in India, whateffect would it have? Would it cause Mauritius entity to be taxable in India?Would the Mauritius entity have a permanent establishment under the India-Mauritius tax treaty?What if, instead of using a US LLC, we used a Cayman Islands entity that isdisregarded for US tax purposes?What if the Indian operating company was engaged in the sale of equipment, andrather than leasing and owning the equipment it purchased the equipment andsold it? What if the Indian operating company purchased raw materials andmanufactured the equipment and then sold it to third parties? 51
  • 52. USCO currently procures inventory from unrelated manufacturers In China USCO contracts with local Representatives that handle logistics USCO and quality control RecommendationFunds 1. Have USCO form a Hong Kong entity (HK Co) to handle the Chinese procurement 100% activities (liaison, quality control, negotiation in PRC and logistics). 9. HK Co operates as a representative office in PRC. a. Legal representative of branch required to pay individual income tax. b. Pay only expenses of branch (i.e., rent, electricity, local staff salary, taxes, HK CO etc) from branch bank account in PRC. HK c. Goods sold to HK CO and directly shipped to US by PRC suppliers. d. Funds remitted to HK bank account and purchases paid from HK bank account. Goods Issues HK Co Branch 17. So long as no business activities performed in HK as well as no physical office (e.g., negotiation occurs in PRC and USA), no HK income tax.Funds 18. HK Co representative office in PRC subject to tax based on cost plus basis (see PRC spreadsheet). Suppliers 52
  • 53. Tax Issues inChina and India 53
  • 54. Tax Issues in India – The Vodafone Case•In January 2011 the India Supreme Court found in favor of Vodafone, and held that Indianrevenue authorities did not have jurisdiction to impose withholding tax on the sale of stock of anIndian company, where no party to the sale transaction was an Indian resident.•Facts: As background, Vodafone’s Dutch subsidiary acquired the stock of a Cayman Islandscompany from a Cayman Islands subsidiary of Hutchinson Telecommunications Intl Ltd. TheCayman company acquired by Vodafone owned an indirect interest in an Indian company; therewere several other entities interposed between the Cayman company and the Indian company.The Indian tax authority attempted to impose a $2.5 billion withholding tax liability onVodafone’s $11.1 billion purchase of the Cayman company, alleging that the asset beingpurchased was the indirect interest in the Indian company. Indian tax law permits India toimpose withholding tax on gain from the sale of a capital asset where the asset is located in India.•What The Decision Means: The case provides certainty to non-Indian companies that India willnot tax capital gains in this scenario. It also reflects the view of many practitioners thatwithholding tax was inappropriately charged on these facts. In addition, the decision providesassurance that the Indian courts are not necessarily going to decide cases solely on the basis ofwhat is in the best interests of the Indian government and its revenue needs, demonstrating thatthe courts appear to be independent. 54
  • 55. M&A in India After Vodafone• Application of India’s tax rules is less ambiguous than prior to the Vodafone decision, and there is the possibility of going to court to obtain relief if a nonresident company feels it is being taxed unfairly.• Based on language in the opinion, India will look more closely at substance of transactions – this issue was discussed in the Vodafone decision and the Indian legislature is expected to pass anti-avoidance laws that are the equivalent of the substance-over-form doctrine in the US.• NOTE: The Indian legislature is considering a bill that would permit the taxation of capital gains on the indirect transfer of shares of an Indian company, where at least 50% of the assets of the transferor (directly or indirectly) consist of assets in India. Importantly, the bill would be retroactive to 1962, and accordingly would apply to transactions that occurred prior to the bill’s passage. 55
  • 56. M&A in China – Similar Issues?•China has issued guidance that provides jurisdiction to tax transactions similar to theVodafone transaction – Circular 698 provides that China may impose a 10% withholding taxon capital gains derived by non-Chinese companies form the sale or exchange of shares inChinese companies. Note that China may not offer the same judicial relief to nonresidentcompanies as India does. It is not even clear whether China is attempting to enforce thisrule.•At the same time China is actively encouraging Chinese companies to make investmentsoutside China. In the 12th Five Year Plan, China announced its intention to support thesecross border deals by relaxing regulations for these transactions, siging investmentprotection agreements (including with the EU), and seeking to enter into and update taxtreaties. 56
  • 57. Questions? 57
  • 58. CBIZ MHM, LLC Contacts Stuart Anolik Managing Director  301.951.3636  sanolik@cbiz.com 58
  • 59. Thank You 59

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