US International Tax Legislative Reform Update & OECD BEPS Report

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Presentation on developments in the US corporate tax reform, as well as the findings and implications of the OECD BEPS report.

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US International Tax Legislative Reform Update & OECD BEPS Report

  1. 1. US International TaxLegislative Reform Update & OECDBEPS Report Eric D. Ryan, International Tax Partner Paulus Merks, Tax Partner Netherlands Ágata Uceda, EMEA Transfer Pricing Director DLA Piper, March 7 2013
  2. 2. Agenda  Eric, Paulus and Agata  A (very) short history of international corporate tax  Policy options  Corporate tax rates comparison  Paulus and Agata  The OECD presented Base Erosion and Profit Shifting  Key pressure areas  Tax planning structures  Eric  Typical offshore IP structure entities  US concerns regarding profit shifting  The Amazon case  US international tax reform proposalsUS International Tax Legislative Reform Update March 7, 2013 2
  3. 3. A (Very) Short History ofInternational Corporate Tax 2009: UK and Japan go territorial 2013: US multinationals 1918: Foreign tax credit 1990 & 2003: EU have $1-2 trillion in 1923: Relief of double 1962: Subpart F Directives on dividend offshore untaxed taxation as goal exemption earnings Circa 1920 1960s 1990 2009US International Tax Legislative Reform Update March 7, 2013 3
  4. 4. Corporate Tax Rates ComparisonUS International Tax Legislative Reform Update March 7, 2013 4
  5. 5. Policy Options Hybrid Option Incremental (e.g. Policy worldwide Territoriality Change to Worldwide Formulary consolidation (dividend ExistingConsolidation Appointment contingent exemption) System on low (transfer foreign tax pricing) rate)US International Tax Legislative Reform Update March 7, 2013 5
  6. 6. Base Erosion and Profit Shifting  The OECD presented the Base Erosion and Profit Shifting ("BEPS") report on February 15, 2013 to G-20  Acknowledgement and support from G-20. UK leading the initiative.  What is BEPS?Base erosion and profit shifting 7 March, 2013 6
  7. 7. Key pressure areas of BEPS  International mismatches  Hybrid mismatch arrangements and arbitrage  Application of treaty concepts  To profits derived from delivery of digital goods and services  Conduit companies (beneficial ownership)  Derivatives (withholding taxes)  The effectiveness of anti-avoidance measures  GAARs, CFC regimes, thin-capitalisation rules, avoidance of tax treaty abuse  Harmful preferential tax regimes, special attention to transparency and substanceBase erosion and profit shifting 7 March, 2013 7
  8. 8. Key pressure areas of BEPS  Transfer pricing  Shifting of risks and intangibles  Artificial (legal) splitting of ownership of assets between entities  Intercompany financing, captive insurances and guarantees  Transactions that would rarely take place between third parties  Action plan to be presented June 2013Base erosion and profit shifting 7 March, 2013 8
  9. 9. Investments in holding countries  NETHERLANDS  Inward stock investment: USD 3.207 billion  Outward stock investment: USD 4.002 billion  LUXEMBOURG  Inward: USD 2.129 billion  Outward: USD 2.140 billion  HUNGARY  Inward: USD 233 billion  Outward: USD 176 billion  AUSTRIA  Inward: UDS 271 billion  Outward: USD 300 billionBase erosion and profit shifting 7 March, 2013 9
  10. 10. Dutch CV / BVInsert filename here Date of presentation 10
  11. 11. The Dutch Sandwich of Google andFacebookInsert filename here Date of presentation 11
  12. 12. Leverage acquisitionBase erosion and profit shifting 7 March, 2013 12
  13. 13. Group As Tax Planning StructureBase erosion and profit shifting 7 March, 2013 13
  14. 14. Group As tax planning structureBase erosion and profit shifting 7 March, 2013 14
  15. 15. Typical Offshore IP Structure Entities • Performs R&D function US US Company • Management Customers • US Distributor Sale • Low-tax jurisdiction • Has non-US rights to exploit IP Non-US Foreign IP/Operating Co • Direct sales to non-US customers Customers (Swiss, Ireland, etc.) • Bears commercial risks (e.g. inventory, bad debt, f/x) Sale • Entitled to IP profits • Conducts/contracts manufacturing • Performs sales and marketing Sales and Mktg function in local jurisdictionsMarketing Information Subsidiaries • “Check-the-box” tax election to be viewed as branch • No valuable intangible assets • Limited risksUS International Tax Legislative Reform Update March 7, 2013 15
  16. 16. Tax Planning Results andUS Concerns regarding Profit Shifting As a result of these structures, profits accumulate in specifically chosen low-tax foreign subsidiaries “The data speak for themselves. Unequivocally, low-tax countries have a disproportionate share of profit.” U.S. Commerce Department’s Bureau of Economic Analysis, 2009 U.S. Senate hearings, September 2012, criticize HP and Microsoft of avoiding US taxes, while acknowledging the techniques are legal Congressional Research Service, “An Analysis of Where American Companies Report Profits; Indications of Profit Shifting,” January 18, 2013, concludes:  “. . . The analysis presented here appear to show that significant shares of profits are being reported in tax preferred countries and that these shares of profits are disproportionate to the location of the firm’s business activity as indicated by where they hire workers and make investments  “For example, American companies reported earnings 43% of overseas profits in Bermuda, Ireland, Luxembourg, the Netherlands, and Switzerland in 2008, while hiring 4% of their foreign workforce and making 7% of their foreign investments in those economies”US International Tax Legislative Reform Update March 7, 2013 16
  17. 17. IRS Reaction to Taxpayer IP ValuationMethods – The Amazon Case  Amazon.com is the world’s largest online retailer  In 2005, Amazon US entered into a “qualified cost sharing arrangement” with Amazon US AEHT, agreeing to share with AEHT the R&D costs of developing Amazon’s future IP Cost  AEHT also made a “buy-in” for the rights Buy-In to exploit Amazon US’ preexisting IP in Sharing Payments Europe. Amazon originally valued this buy- Payments in at $216.7 million using standard methods available at the time AEHT  During audit, however, the IRS’ (Luxembourg) economists valued Amazon’s IP to be worth $3.6 billion using a discounted cash flow method. Use of this method under the previous regulations was rejected by the Tax Court in the 2009 Veritas case  The IRS economists also used a perpetual life for the IP and aggregated the items IP to Amazon Amazon capture synergies: two concepts that wereAmazon UK Germany France also rejected by the Veritas court  Amazon is currently challenging the IRS’ valuation in Tax CourtUS International Tax Legislative Reform Update March 7, 2013 17
  18. 18. US International Tax Reform Proposals  Two recent proposals from President Obama:  Treasury’s 2013 Green Book  “The President’s Framework for Business Tax Reform”  Two Republican proposals to move the US to a territorial system:  Chairman Camp’s Discussion Draft  Senator Enzi’s Territorial Bill  Simpson-Bowles Plan  Senator Levin’s CUT Loopholes ActUS International Tax Legislative Reform Update March 7, 2013 18
  19. 19. 2013 Green Book – Prior Proposals Retained  On February 13, 2012, Treasury released its latest annual budget proposal, “General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals” (Green Book), retaining in large part the same proposals from the 2012 budget, but also adding a few more  Significant retained proposals include: 1. Excess returns tax on transfer of intangibles offshore  If a US parent transfers covered intangibles to a related CFC, then the “excess intangible income” would be Subpart F income if subject to a low foreign ETR (less than 15%)  Discussed in more detail later in the Camp proposal (slides 14-16) 1. Expand §936(h)(3)(B) definition of “intangible property”  Thus, for purposes of §367(d) and §482, IP would include goodwill, going concern value, and workforce in place 1. Determine FTCs on pooled basisProposed Changes to US International Tax Rules March 7, 2013 19
  20. 20. 2013 Green Book – New Proposals 1. Tax gain from sales of partnership interest on a look-through basis  Under RR 91-32, gain from the sale of a partnership interest not taxable to non- resident aliens and foreign corps to the extent not ECI  But RR 91-32 founded upon shaky legal reasoning / ignores lack of statutory authority  Under the proposal, gain/loss from sale/exchange of a partnership interest would be ECI to extent attributable to ECI property (i.e., a codification of RR 91-32)  In addition, transferee of partnership interest would be required to withhold 10% of amount realized on sale/exchange of partnership interest 1. Prevent use of leveraged distributions from related foreign corps  Under current law, one foreign corp can avoid dividend treatment on the repatriation of E&P by funding a second foreign corp with no E&P, where the shareholder has enough basis to characterize distribution as return of basis  Current remedy is to simply rely on anti-abuse rules (e.g., §1.956-1T(b)(4))  Under the proposal, to the extent foreign “funding corporation” funds (e.g., capital contributions, loans, or distributions) a related foreign “distributing corporation,” the US shareholder’s basis in stock of distributing corp is not taken into account for the purpose of determining distribution treatment under §301  I.e., the distribution receives capital gain treatment  Note that “a principal purpose” must be to avoid dividend treatment  Effectively shuts down a proven repatriation strategyUS International Tax Legislative Reform Update March 7, 2013 20
  21. 21. 2013 Green Book – New Proposals(Continued) 3.Extend §338(h)(16) to certain asset acquisitions  Under current law, where a proper §338 election is made, §338(h) (16) prevents the seller from increasing allowable FTCs  Under the proposal, §338(h)(16) would be extended to also deny an increase in FTCs for all “covered asset acquisitions” under §901(m) 3.Remove foreign taxes from §902 corp’s foreign tax pool when earnings are eliminated  Under current law, certain transactions (e.g., redemptions, spin- offs) can eliminate E&P other than by reason of a dividend  The result is that the taxpayer can claim indirect FTCs for foreign taxes paid on earnings that will no longer fund dividend distributions  Proposal would reduce the amount of foreign taxes paid in the event a transaction results in the elimination of E&P other than by reason of a dividendUS International Tax Legislative Reform Update March 7, 2013 21
  22. 22. Obama Proposed Business TaxReform – Key Provisions  On February 22, 2012, President Obama released a 23-page plan to reform the taxation of US companies, entitled “The President’s Framework for Business Tax Reform”  Intended to be revenue neutral  Reduce the corporate tax rate to 28%  Repeal most corporate tax expenditures (i.e., deductions, credits, incentives)  Accelerated depreciation repeal is the biggest change; 5x as valuable as proposed international tax changes  Retain the Research and Experimentation Tax Credit  Tighten the definition of Domestic Manufacturing for the §199 Tax Credit, but increase the credit rate  Tax “carried interest” as ordinary income  Tax large partnerships as corporationsUS International Tax Legislative Reform Update March 7, 2013 22
  23. 23. Obama Proposed Business TaxReform – Key Provisions (Continued)  Require CFCs to pay a “minimum tax” on overseas profits, offset by FTCs  No indication yet what the minimum rate would be. But the idea is to target tax havens, where no FTCs are available. Thus, this may not be a problem for income earned in higher tax jurisdictions (e.g., Ireland, Switzerland)  Defer interest deductions related to deferred income of CFCs until that income is taxable in the US  Interest deductions allocable to CFCs cannot exceed the pro rata share of income derived from the subsidiary which is subject to current US tax  Determine FTCs on a pooled basis  Total FTCs allowed = Total foreign taxes paid × (Relevant distribution ÷ Total foreign income earned)  Tax CFCs on excess income from covered intangibles if the foreign tax rate is below 15% (discussed in the context of the Camp proposal)  Broaden the definition of “intangible property” (for §367(d) and §482) to include goodwill, going concern value, and workforce in placeUS International Tax Legislative Reform Update March 7, 2013 23
  24. 24. House Ways and Means TerritorialIncome Proposal (Camp Proposal)  Proposed move to territorial system by Representative Camp (R-MI), Chairman of the House Ways and Means Committee  Revenue neutral  Reduce the corporate tax rate to 25%  95% deduction for dividends received by a domestic parent from foreign subsidiaries (i.e., a 1.25% tax rate)  Only applicable to portion of dividends attributable to foreign-source income derived from the active conduct of business  One year holding period requirement (similar to §246(c)(1))  FTCs cannot offset US tax due on these dividends  All foreign branches treated as CFCs  Thin capitalization rules – where (i) taxpayer has more foreign debt than US debt and (ii) overall debt is high  Maintain Subpart F, with changesUS International Tax Legislative Reform Update March 7, 2013 24
  25. 25. Camp Proposal (Continued)  Mandatory inclusion of pre-enactment undistributed foreign earnings in domestic parent’s income in the year of enactment, 85% is deductible (i.e., a 5.25% tax rate)  Taxpayers can pay cash tax over 8 years with interest (book tax treatment?)  If the inclusion is tied to E&P, then there will be disparate treatment based on §338 elections of targets (and other factors)  If the inclusion is tied to APB 23, many companies in fact indefinitely reinvest earnings in factories / targets, so often free cash is a fraction of APB 23 amount -> very high effective tax rate  If the inclusion is tied to cash, disparate treatment for cash-intensive companies  Interest deduction capped for US shareholders of affiliated groups with “excess domestic indebtedness”  Judged under either a) “relative leverage” test (total debt of group allocated to each member according to the debt-to-equity ratio of the entire group), or b) “percentage of adjusted taxable income” test (interest deductions allowed up to a designated percentage of adjusted taxable income)US International Tax Legislative Reform Update March 7, 2013 25
  26. 26. Camp Proposal:Three Alternative Base Erosion Options1) Obama’s excess returns proposal (no need for separate FTC baskets)2) Subpart F treatment of CFC income taxed at an ETR of less than 10% (determined country-by-country); same-country exception for active business income3) “Carrot and stick” option US International Tax Legislative Reform Update March 7, 2013 26
  27. 27. Enzi Territorial Bill  On February 9, 2012, Senate Finance Committee member Michael Enzi (R-WY) introduced his own territorial taxation bill, called the United States Job Creation and International Tax Reform Act of 2012 (S. 2091)  Similarities with Camp proposal  New §245A would provide 95% deduction for dividends received by 10% US shareholders of CFCs (or entities that elect to be treated as CFCs)  One year holding period  Differences from Camp proposal  Corporate tax rate remains unchanged at 35%  §1248 gain is also eligible for a 95% deduction  Elective inclusion of pre-enactment undistributed foreign earnings, 70% is deductible (i.e., 10.5% tax rate)  FTCs cannot offset US tax on this income US International Tax Legislative Reform Update March 7, 2013 27
  28. 28. Enzi Territorial Bill (Continued)  Differences from Camp Proposal (Continued)  Foreign branches are not treated as CFCs  Treasury to issue guidance to prevent inappropriate losses/FTC planning  Foreign income derived from intangibles created, developed, or produced in the US would receive a 50% deduction (i.e., 12.5% tax rate)  Does not override amended Subpart F rules (i.e., income that would be subject to current inclusion under Subpart F would still be so treated)  All income derived by a CFC in a country with an ETR of half (or less) the maximum US corporate tax rate considered Subpart F income  Exemption for income arising from substantial local activity  Several tests to define “substantial activity”  Ex: If a company operating in a low-tax jurisdiction (e.g., Ireland) has no income related to intangibles and passes the substantial activity test, exemption; if the same company derives 50% of its income from intangibles, no exemption US International Tax Legislative Reform Update March 7, 2013 28
  29. 29. Enzi Territorial Bill (Continued)  Differences from Camp Proposal (Continued)  Active financing exception to Subpart F  Eliminate FBC sales and services income from definition of Subpart F income  Create FTC basket for foreign intangible income  Accelerate effective date of worldwide interest allocation election to December 31, 2012  Affiliated group can elected to have all entities treated as a single corporation for the purposes of allocating interest expenses between US and foreign source income  Status: Bill referred to the Senate Committee on FinanceUS International Tax Legislative Reform Update March 7, 2013 29
  30. 30. Simpson-Bowles Plan  On December 1, 2010, the National Committee on Fiscal Responsibility and Reform published its final report entitled “The Moment of Truth”  Recommendations  Reduce the corporate tax rate to 28%  Repeal AMT  Eliminate the Domestic Production Deduction, along with 30 other tax credits and 75 other deductions  Eliminate LIFO method of accounting (for tax purposes)  Exempt active foreign-source income from US taxation  Maintain Subpart F for passive foreign-source income  Status: On December 3, 2010, the plan received a majority but not supermajority vote, and thus did not make it to CongressUS International Tax Legislative Reform Update March 7, 2013 30
  31. 31. CUT Loopholes Act  One February 11, 2013, Senator Levin introduced the Cut Unjustified Tax (CUT) Loopholes Act (S. 2075). Title I of the Act, entitled “Ending Offshore Tax Abuses,” proposes major changes to the US’ international tax provisions:  Foreign corporations “managed and controlled” in the US would be barred from claiming foreign status  Swap payments would become subject to US withholding tax  Limit “foreign-related deductions” to only “currently-taxed income”  Require FTCs to be calculated on pooled basis  Tax currently excess income to foreign affiliates receiving US IP  Broaden definition of “intangible asset” in §936(h)(3)(B) to include goodwill, going concern value, and workforce in place  Amend §163(j) so that “expatriated entities” cannot deduct “excess interest expense” for 10 years regardless of debt/equity ratio  Limit some foreign entities’ ability to make a check-the-box election  Terminate the recently extended §954(c)(6) look-thru rule  Currently tax loans from CFCs to US shareholdersUS International Tax Legislative Reform Update March 7, 2013 31
  32. 32. Side-by-Side Comparison 2013 Business CUT Camp Simpson- Green Tax Enzi Bill Loopholes Proposal Bowles Book Reform Act System of World- World- Territ- Territ- Territorial Worldwide Taxation wide wide orial orial Corporate 35% 28% 25% 35% 29% 35% Tax Rate Excess Returns Yes Yes Yes No No Yes Tax Minimum Tax Rate No Yes Possibly Yes No No F.S.I.US International Tax Legislative Reform Update March 7, 2013 32
  33. 33. Side-by-Side Comparison (Continued) 2013 Business CUT Camp Simpson- Green Tax Enzi Bill Loopholes Proposal Bowles Book Reform Act Inclusion of Pre- Mandatory Elective Enactment No No (85% (75% N/A No Undistributed deduction) deduction) Income FTCs Pooled Yes Yes No No No Yes Limit Interest No Yes Yes Yes Yes Yes Deduction Ability to Foreign Branches make CTB No No Yes No No Treated as CFCs elections limitedUS International Tax Legislative Reform Update March 7, 2013 33
  34. 34. Contact Eric D. Ryan International Tax Partner T: +1 650 833 211 E: eric.ryan@dlapiper.com Paulus Merks Tax Partner the Netherlands T: +31 20 5419 813 E: paulus.merks@dlapiper.com Ágata Uceda EMEA Transfer Pricing Director T: +31 20 5419 268 E: agata.uceda@dlapiper.comUS International Tax Legislative Reform Update March 7, 2013 34

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