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Subpart F<br />Presented by: <br />Seth Primosch<br />Edward Umling<br />April 19-20, 2010<br />
Discussed in this Module<br /><br />Policy Overview of “Subpart F” (§§ 951-964)<br />How Subpart F Accelerates U.S. tax o...
Policy Overview<br />General Rule – Deferral<br />A U.S. taxpayer is not subject to taxation on the earnings of a foreign ...
(but only to the extent of E&P)
Foreign Base Company Sales Income “FBCSI”
Foreign Base Company Sales Service Income “FBCSvI”
Foreign Personal Holding Company Income “FPHCI”
Certain Investments in US property §956</li></ul>3<br />Note: list is not all inclusive<br />
4<br />
5<br />
“Tainted” Income<br />U.S. tax arises only if a CFC earns “tainted” income but only to the extent of earnings & profit<br ...
“Tainted” Income<br />Such subpart F income is taxable as a dividend and a foreign tax credit is available.<br />Upon a su...
Foreign Base Company Sales Income<br />I.R.C §954(d)(1)<br />
9<br />Base Company Income has four categories<br />FBCI<br />FPHCI<br />FBCSvI<br />FBCSI<br />FBC oil related income<br />
Additional §951 inclusion under Subpart F not discussed in the Module<br />Foreign base company oil related income<br />In...
A simple explanation<br />FBCSI represents income from certain related party transactions where the products acquired or s...
Base Company Sales IncomeDefined in §954(d)(1)<br />The purchase from a related person and sale to any person, <br />The p...
In case of property sold on behalf of a related person, the property which is sold) is manufactured, produced, grown, or e...
Base Company Sales Income<br />The “foreign base company sales income” referred to means income from the purchase and sale...
Policy Overview <br />U.S.<br />Mfg.<br />Example- Separation of selling in manufacturing from to achieve a lower tax liab...
Example without Sales Subsidiary<br />U.S.<br />Foreign Buyers<br />16<br />Tax Incurred<br />
Now, interpose a “Sales Subsidiary”<br />U.S.<br />FBC  sales sub  in low Tax<br />Country Y<br />Foreign Buyers<br />Coun...
Results<br />18<br /><br />
How Subpart F Operates<br />U.S.<br />Sales Outside Luxembourg                                                   constitut...
How Subpart F Operates<br />U.S.<br />“Base Company Sales Income” <br />100%<br />Luxembourg<br />(Mfg.)<br />Sells Produc...
Exceptions to the FBCSI<br />If product is purchased and sold to unrelated party<br />Product is manufactured in the home ...
Product that is manufactured by the CFC  (Substantial Contribution Test)<br />The CFC satisfies the test if all the facts ...
Old Regulations  - Test 1“Substantial Transformation” <br />	If purchased personal property is substantially transformed p...
Old Regulations  - Test 2Provides  when a CFC is considered Manufacturing<br /> 	If the activities of the CFC are “substan...
Old Regulations Substantial Transformation Of Property Examples in Treasury Regulation 1.954-3(a)(4)(ii) <br />The transfo...
New RegulationsProduct that is manufactured by the CFC  (Substantial Contribution Test)<br />The CFC satisfies the test if...
Material selection, vendor selection and control of raw materials, work-in-process, and finished goods
Management of manufacturing costs (i.e. risk of loss, or cost reduction)
Control of logistics</li></li></ul><li>New RegulationsApplication of the (Substantial Contribution Test)<br />“The weight ...
Under the New RegulationsHow is the Substantial Contribution Test is Applied ?<br />28<br />US<br />P<br />Property is del...
How is the Substantial Contribution Test is Applied ?Continued…<br />29<br />CFC1 owns intellectual property  used in manu...
How is the Substantial Contribution Test is Applied ?<br />30<br />CFC 1<br />Country X<br />Finally CFC 1 sells the finis...
CFC 1 does not satisfy the substantial contribution test because it does not make a substantial contribution through the a...
Change the Facts - Example <br />	Assume the same facts except for the following: <br />	CFC 1 through its employees, enga...
Result<br />Under the facts and circumstances of the business, CFC 1 would satisfy the test because it makes a substantial...
Another ExampleContract Manufacture <br />34<br />CFC 1<br />Country X<br />CM<br />Country Y<br />CM provides its own mat...
Additional Information<br />Employees of CFC 1 select the materials that will be used to manufacture<br />CFC 1 does not o...
Question<br />36<br /><br />CFC 1<br />Country X<br />CM<br />Country Y<br />Buyers<br />Country  T<br />Is there a subpa...
Result<br />If the manufacturing activities undertaken with respect to product occur through the activities of its employe...
38<br />
Foreign Base Company Service Income(“FBCSvI”)<br />I.R.C. §954(e)(1)<br />
FBCSvI<br />Policy Overview<br />Performing services “For, or on behalf of”<br />Substantial Assistance Test<br />40<br />
Policy Overview<br />U.S.<br />Sells Items that Require Service Contracts<br />Low Tax<br />Country Y<br />Buyer<br />Coun...
Policy Purpose for BCSvI<br />Deny tax deferral where the service subsidiary is separated from the manufacturing activity ...
FBCSvI §954(e)(1)<br />Income (whether in the form of compensation, commissions, fees, or otherwise) derived in connection...
<br />“For, or on behalf of”<br />Services must be performed “for, or on behalf of,” a related person to constitute forei...
“For, or on behalf of”Treas. Reg. § § 1.954-4(b)(1)(i) thru (iv)<br />The receives a financial benefit from, a related per...
Substantial Assistance TestTreas. Reg. 1.954-4(b)(2)(ii) <br /><br />If substantial assistance furnished by a related per...
Measuring “if assistance is the “Principal Element”<br />The cost to the controlled foreign corporation of the assistance ...
Example – Substantial Assistance §1.954-4(b)(3)<br />48<br />US<br />B Manufactures and sells machines to C<br />B Pays A ...
Exceptions to FBCSvI<br />An exception to the definition of foreign base company services income is provided for income de...
50<br />
Branch Rules<br />I.R.C. §952(d)(2 )<br />
Congressional Concerns<br />Companies may circumvent anti-deferral by using a branch company<br />Separation of the sales ...
General Rule - §954(d)(2)<br />Branch rule is implicated where a CFC carries on purchasing or selling activities by or thr...
General Rule - §954(d)(2)<br />The December Regulations treat the branch rules as mutually exclusive:  If the manufacturin...
Two Scenarios – Two Tests<br />US<br />US<br />MFG<br />Sales<br />Sales<br />MFG<br />55<br />
Mfg. Test<br />Sales Test<br />MFG<br />Sales<br />Sales<br />MFG<br />56<br />
Sales Test<br />Branch rule applies to sales/purchase branch when the tax rate imposed by the country where the branch is ...
Sales Test<br />Compare the actual tax rate on income in country X to a hypothetical tax that would apply if those sales w...
Mfg.Test<br />The test is REVERSEDfor the Mfg branch<br />Branch Rule applies if the tax rate in the country in which the ...
Mfg. Test<br /><ul><li>Compare the actual tax rate on sales income to a hypothetical tax that would apply if the sales inc...
Hypothetical tax is determined under foreign law</li></ul>Sales<br />Country<br />Y<br />Test<br />looks down<br />MFG<br ...
Manufacturing branches are tested separately<br />Manufacturing branches are tested separately if the CFC manufactures “di...
Testing Separately<br />Country A sells to related and unrelated parties and does not make substantial contributions to th...
Results<br />63<br /><br />.<br />Sells Televisions<br />The Analysis starts with the Country B.  The tax rate is not 5 p...
Results - Continued<br />64<br /><br />.<br />Sells Televisions<br />Next,  analyze the Country C.  The Country A rate is...
Discussion<br /><br />The branch rules do not automatically mean that the income is FBCSI but that the parent company and...
<br />Two tests…but six procedural steps<br />Identify the sales and purchasing locations<br />Determine the ETR in the l...
Discussion - The Substantial Contribution Test <br />Under the December Regulations, if the substantial contribution test ...
Trying to locate the tested manufacturing branch when more than one location satisfies the manufacturing test<br />68<br /...
69<br />.<br />Sells Product<br />Country A<br />10%<br />Country B<br />12.5%<br />Country C<br />28%<br />Ships Product ...
70<br />.<br /><br />Result<br />The branch rule does NOT apply...<br />Substantial transformation test is met by country...
What happens if no single location satisfies the manufacturing test when substantial contribution is present?<br />71<br /...
Group various locations together (i.e. all locations that are not treated as “high-tax” are grouped together and all locat...
Determine which grouping that provides the “demonstrably greater” contribution to manufacturing and test that grouping fir...
This example assumes the low tax jurisdictions provides the “demonstrably greater” contribution to the manufacture than th...
Perform tax rate disparity test on low tax jurisdictions<br />75<br /><br />CFC 1<br />Sales<br />CM <br />Final Product<...
After you do the tax rate disparity test how much income is FBCSI?<br />What if you have included in some of the low tax g...
Debrief<br /><br />Step 1 – identify the tested sales and purchasing locations.<br />Step 2 –  group various locations to...
International Tax Planning Issues to Consider<br />Suppose a CFC purchases manufactured product from an unrelated party an...
79<br />
Foreign Personal Holding Company Income (“FPHCI”)<br />I.R.C. §954(c)<br />
FPHCI Includes…<br />FPHC income is that portion of income that includes:<br /> dividends, interest, royalties, rents, and...
Exceptions to FPHCI<br />Temporary provision granting look-through rules beginning after December 31, 2005 and before Janu...
How to Apply the Same Country Exception<br />Dividends and interest ─ ifCFC is incorporated where the business of the payo...
Payor ─ is organized under  laws of same country as CFC
Payor ─ uses substantial part of assets in trade or business in country of incorporation (50% test)</li></ul>83<br />
How to Apply the Same Country Exception<br />Rents and royalties ─ if CFC is incorporated where the property is used, payo...
How to Apply the Same Country Exception<br />Portfolio interest is not excluded<br />Interest allocable to payor’s foreign...
Example ─ same-country exception rule<br />GmbH 1 acquires GmbH 2 and GmbH 2 dividends up<br />GmbH 1<br />RESULT<br />Sam...
Alternate Scenario of Same-Country Exception<br />GmbH forms a Holding company to acquire GmbH  Sub<br />GmbH P<br />RESUL...
Process for Inclusion of “Subpart F income”<br />(§954) ─ Determine income included as Subpart F<br />(§954(b)(5)) ─ Alloc...
Full Inclusion Rule §954(b)(3)(B)<br />If the sum of the foreign base company income and the gross insurance income for th...
Exception For Certain Income Subject To High Foreign Taxes (“High Tax Exception”)<br />income that was subjected to an eff...
Non-Dividend Repatriation I.R.C. §956<br />91<br />
Introduction<br />Generally when a loan is made by a subsidiary CFC corporation to its parent or to another affiliate it i...
Example<br />93<br />US <br />Parent<br />§956 is implicated to the extent of Earnings and Profit (unless an exception app...
Non-Dividend Repatriation §956<br />Applies to U.S. shareholders of CFC<br />Attempts to tax dividend equivalents<br />Hyp...
Tax Court in Ludwig v. Comr. <br />In Ludwig, the court rejected the Service's argument that a U.S. shareholder's pledge o...
The Treasury provides two exceptions to §956<br />Notice 88-108 provides “30/60” day exception<br />These are obligations ...
There is a General legal Advice Memorandum (“GLAM”) on Notice 2008-91<br />GLAM 2009-13 provides guidance with regard to m...
GLAM Notes<br />The GLAM points out that the CFC is deemed to have acquired property as of the date it acquires an adjuste...
What about a loan made on December 31st ?<br />GLAM indicates (unless an exception applies) that §956 would apply to the l...
What about a series of loans?<br />GLAM states that a series of loans must be executed independently or else periods of di...
<br />Debrief<br />General Rule for Subpart F is:  “Deferral”<br />A U.S. taxpayer is not subject to taxation on the earn...
(but only to the extent of E&P)
US shareholder can claim a FTC
Subsequent distributions qualify as PTI
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Umling Primosch Subpart F

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Umling Primosch Subpart F

  1. 1. Subpart F<br />Presented by: <br />Seth Primosch<br />Edward Umling<br />April 19-20, 2010<br />
  2. 2. Discussed in this Module<br /><br />Policy Overview of “Subpart F” (§§ 951-964)<br />How Subpart F Accelerates U.S. tax on a CFC’s earnings<br />Branch Rules<br />Foreign Personal Holding Company Income<br />Look-through Rules<br />Non-Dividend Repatriation<br />Planning for Distributions of PTI<br />2<br />
  3. 3. Policy Overview<br />General Rule – Deferral<br />A U.S. taxpayer is not subject to taxation on the earnings of a foreign subsidiary until the earnings are repatriated.<br /><ul><li>Exceptions ─ “tainted income”
  4. 4. (but only to the extent of E&P)
  5. 5. Foreign Base Company Sales Income “FBCSI”
  6. 6. Foreign Base Company Sales Service Income “FBCSvI”
  7. 7. Foreign Personal Holding Company Income “FPHCI”
  8. 8. Certain Investments in US property §956</li></ul>3<br />Note: list is not all inclusive<br />
  9. 9. 4<br />
  10. 10. 5<br />
  11. 11. “Tainted” Income<br />U.S. tax arises only if a CFC earns “tainted” income but only to the extent of earnings & profit<br />Personal holding company income (inherently passive items) dividends, interest, rents, royalties etc.<br />Exceptions: Look Through and same country exception through January 1, 2010 <br />Foreign Base Company Income<br />Section 956 income (earnings invested in U.S. property)<br />6<br />
  12. 12. “Tainted” Income<br />Such subpart F income is taxable as a dividend and a foreign tax credit is available.<br />Upon a subsequent distribution the dividend is not taxed but it is treated as previously taxed income.<br />7<br />
  13. 13. Foreign Base Company Sales Income<br />I.R.C §954(d)(1)<br />
  14. 14. 9<br />Base Company Income has four categories<br />FBCI<br />FPHCI<br />FBCSvI<br />FBCSI<br />FBC oil related income<br />
  15. 15. Additional §951 inclusion under Subpart F not discussed in the Module<br />Foreign base company oil related income<br />Insurance income<br />Bribe income<br />Boycott income<br />Income from blacklisted countries<br />Withdrawals from investments in less developed countries<br />Section 956 – (will be discussed later)<br />10<br />
  16. 16. A simple explanation<br />FBCSI represents income from certain related party transactions where the products acquired or sold do not have a economic and legal connection to the CFC’s country of incorporation because they were not manufactured or consumed in the CFC’s country of incorporation.<br />11<br /><br />
  17. 17. Base Company Sales IncomeDefined in §954(d)(1)<br />The purchase from a related person and sale to any person, <br />The purchase from any person and sale to, a related person, and <br />the purchase from any person or sale to any person on behalf of a related person.<br />12<br />
  18. 18. In case of property sold on behalf of a related person, the property which is sold) is manufactured, produced, grown, or extracted outside the country under the laws of which the controlled foreign corporation is created or organized and;<br />the property is sold for use, consumption, or disposition outside such foreign country, or, in the case of property purchased on behalf of a related person, is purchased for use, consumption, or disposition outside such foreign country.<br />13<br />
  19. 19. Base Company Sales Income<br />The “foreign base company sales income” referred to means income from the purchase and sale of property, without any appreciable value being added to the product by the selling corporation. <br />14<br />
  20. 20. Policy Overview <br />U.S.<br />Mfg.<br />Example- Separation of selling in manufacturing from to achieve a lower tax liability<br />100%<br />Lower Tax<br />No Mfg<br />Country Y<br />Buyer<br />Country X <br />15<br />
  21. 21. Example without Sales Subsidiary<br />U.S.<br />Foreign Buyers<br />16<br />Tax Incurred<br />
  22. 22. Now, interpose a “Sales Subsidiary”<br />U.S.<br />FBC sales sub in low Tax<br />Country Y<br />Foreign Buyers<br />Country X<br />17<br />
  23. 23. Results<br />18<br /><br />
  24. 24. How Subpart F Operates<br />U.S.<br />Sales Outside Luxembourg constitute FBS Income<br />100%<br />Luxembourg<br />(Mfg.)<br />Sells Product <br />UK<br />Buyer<br />Luxembourg<br />Sales Office<br />19<br />
  25. 25. How Subpart F Operates<br />U.S.<br />“Base Company Sales Income” <br />100%<br />Luxembourg<br />(Mfg.)<br />Sells Product <br />UK<br />Buyer<br />Luxembourg<br />Sales Office<br />20<br />
  26. 26. Exceptions to the FBCSI<br />If product is purchased and sold to unrelated party<br />Product is manufactured in the home country of incorporation of the CFC<br />Product that is manufactured by the CFC (954(d)(1) (Substantial Transformation Test)<br />Product sold for use and consumption in the CFC country of incorporation (same country exception)<br />21<br /><br />Product that is manufactured by the CFC (Proposed Reg. 1.954-3(a)(4)(iv)(b)) (Substantial Contribution Test)<br />Issued December 24, 2008<br />
  27. 27. Product that is manufactured by the CFC (Substantial Contribution Test)<br />The CFC satisfies the test if all the facts and circumstances clearly demonstrate that the CFC made a substantial contribution <br />through the activities of its employees to the manufacture of the Property. <br />See Proposed Reg. 1.954-3(a)(4)(iv)(a)<br />22<br />through the activities of its employees<br />
  28. 28. Old Regulations - Test 1“Substantial Transformation” <br /> If purchased personal property is substantially transformed prior to sale, the property sold will be treated as having been manufactured, produced, or constructed by the selling corporation. <br />23<br />
  29. 29. Old Regulations - Test 2Provides when a CFC is considered Manufacturing<br /> If the activities of the CFC are “substantial in nature” and are considered to constitute manufacturing”<br /> “substantial in nature” – safe harbor test provided<br /> where conversion costs account for 20% of the cost of goods sold.<br />24<br />
  30. 30. Old Regulations Substantial Transformation Of Property Examples in Treasury Regulation 1.954-3(a)(4)(ii) <br />The transformation of wood pulp to paper <br />The transformation of steel rods to screws and bolts <br />The transformation of fish into canned fish <br />25<br />
  31. 31. New RegulationsProduct that is manufactured by the CFC (Substantial Contribution Test)<br />The CFC satisfies the test if… a substantial contribution through the activities of its employee<br /> Such as….<br />26<br /><ul><li>Oversight and direction of manufacturing
  32. 32. Material selection, vendor selection and control of raw materials, work-in-process, and finished goods
  33. 33. Management of manufacturing costs (i.e. risk of loss, or cost reduction)
  34. 34. Control of logistics</li></li></ul><li>New RegulationsApplication of the (Substantial Contribution Test)<br />“The weight accorded to the performance of any quantum of any activity (whether or not specified…) will vary with the facts and circumstances of the particular business...”<br />27<br />Stated another way…<br />The Substantial Contribution test is a fact and circumstance test where no single activity is more important than another.<br />
  35. 35. Under the New RegulationsHow is the Substantial Contribution Test is Applied ?<br />28<br />US<br />P<br />Property is delivered to a contract manufacturer under terms of agreement<br />CFC 2<br />Country X<br />CFC 1<br />Country X<br />Property is purchased from a related party<br />Unrelated <br />CM<br />Country Y<br />
  36. 36. How is the Substantial Contribution Test is Applied ?Continued…<br />29<br />CFC1 owns intellectual property used in manufacturing process<br />CFC 1 retains the right to control raw materials, work in process, finished goods and right to oversee and direct activities or processes but does not exercise through its employees, its powers to control the raw materials, WIP, FG and does not exercise powers of oversight and direction.<br />CFC 1does not through its employees direct the use or development of the intellectual property<br />CFC 1<br />Country X<br />Unrelated <br />CM<br />Country Y<br />CM performs substantial transformation, assembly and conversion outside of Country X<br />
  37. 37. How is the Substantial Contribution Test is Applied ?<br />30<br />CFC 1<br />Country X<br />Finally CFC 1 sells the finished product outside Country X<br />Buyers<br />Country T<br />RESULTS<br /><br />nosubstantial contribution to manufacturing<br />
  38. 38. CFC 1 does not satisfy the substantial contribution test because it does not make a substantial contribution through the activities of its employees to the manufacture of the product. <br />Mere contractual rights to control materials and to direct the manufacturing activities or process pursuant to which the property is manufactured, along with ownership of intellectual property are not sufficient to satisfy the test.<br />31<br /><br />Explanation of Results<br />
  39. 39. Change the Facts - Example <br /> Assume the same facts except for the following: <br /> CFC 1 through its employees, engages in designing the product, participating in quality control and maintain control over manufacturing and related logistics. <br /> Moreover, employees of CFC 1 exercise the right to oversee and direct the activities of CM in the manufacture of product.<br />32<br />
  40. 40. Result<br />Under the facts and circumstances of the business, CFC 1 would satisfy the test because it makes a substantial contribution through the activities of its employees to the manufacture of product. <br />33<br /><br />
  41. 41. Another ExampleContract Manufacture <br />34<br />CFC 1<br />Country X<br />CM<br />Country Y<br />CM provides its own materials and physically performs the substantial transformation, outside CFC 1 home country of incorporation<br />Buyers<br />Country T<br />
  42. 42. Additional Information<br />Employees of CFC 1 select the materials that will be used to manufacture<br />CFC 1 does not own the materials or work-in-process during the manufacturing process. However, CFC 1 through its employees, exercises oversight and direction of the manufacturing process and provides quality control. <br />CFC 1 manages the manufacturing costs and capacities with respect to the product by managing the risk of loss and engaging in planning and production scheduling.<br />35<br />
  43. 43. Question<br />36<br /><br />CFC 1<br />Country X<br />CM<br />Country Y<br />Buyers<br />Country T<br />Is there a subpart F pickup here?<br />
  44. 44. Result<br />If the manufacturing activities undertaken with respect to product occur through the activities of its employees prior to sale then CFC 1 would qualify for the manufacturing exception because it makes a substantial contribution through the activities of its employees to the manufacture of product. <br />37<br /><br />
  45. 45. 38<br />
  46. 46. Foreign Base Company Service Income(“FBCSvI”)<br />I.R.C. §954(e)(1)<br />
  47. 47. FBCSvI<br />Policy Overview<br />Performing services “For, or on behalf of”<br />Substantial Assistance Test<br />40<br />
  48. 48. Policy Overview<br />U.S.<br />Sells Items that Require Service Contracts<br />Low Tax<br />Country Y<br />Buyer<br />Country X<br />Services the Product as a condition of the sale<br />41<br />
  49. 49. Policy Purpose for BCSvI<br />Deny tax deferral where the service subsidiary is separated from the manufacturing activity or related corporation and organized in a country to obtain a lower tax rate from service income<br />Exception<br />Same Country Exception<br />Unrelated Person<br />42<br />
  50. 50. FBCSvI §954(e)(1)<br />Income (whether in the form of compensation, commissions, fees, or otherwise) derived in connection with the performance of technical, managerial, engineering, architectural, scientific, skilled, industrial, commercial or like services which<br />CFC performs for or on behalf of a related person (954(e)(1)(A) )<br />Outside the country of incorporation (954(e)(1)(B) )<br />43<br />
  51. 51. <br />“For, or on behalf of”<br />Services must be performed “for, or on behalf of,” a related person to constitute foreign base company services income. <br />The regulations identify four situations where a CFC is to perform services for, or on behalf of, a related person when the services are not directly provided to a related person, but the related person is involved with the services transaction<br />44<br />
  52. 52. “For, or on behalf of”Treas. Reg. § § 1.954-4(b)(1)(i) thru (iv)<br />The receives a financial benefit from, a related person for performing services<br />CFC performs services which a related person was obligated to perform<br />CFC performs services for the property sold by a related person and that performance constitutes a condition of the sale<br />The CFC receives substantial assistance from a related person by performing the CFC's services<br />45<br />
  53. 53. Substantial Assistance TestTreas. Reg. 1.954-4(b)(2)(ii) <br /><br />If substantial assistance furnished by a related person then, the CFC is deemed to have provided services (i.e. supervision, know-how, financial assistance and equipment, material, or supplies).<br />Test of substantial - If assistance is a principal element in producing the income <br />46<br />
  54. 54. Measuring “if assistance is the “Principal Element”<br />The cost to the controlled foreign corporation of the assistance furnished equals or exceeds 50% or more of the total cost to of the services performed by such corporation. <br />47<br />
  55. 55. Example – Substantial Assistance §1.954-4(b)(3)<br />48<br />US<br />B Manufactures and sells machines to C<br />B Pays A to do installation and maintenance<br />CFC<br />A<br />CFC <br />B<br />CFC <br />C<br />
  56. 56. Exceptions to FBCSvI<br />An exception to the definition of foreign base company services income is provided for income derived by a CFC in connection with certain services related to sales of property which is produced, manufactured, grown or extracted by the CFC. <br />See I.R.C. §954(e)(2); Treas. Reg. §1.954-4(d).<br />49<br />
  57. 57. 50<br />
  58. 58. Branch Rules<br />I.R.C. §952(d)(2 )<br />
  59. 59. Congressional Concerns<br />Companies may circumvent anti-deferral by using a branch company<br />Separation of the sales and manufacturing functions inappropriately<br />Causes profits to end up in a lower tax jurisdiction<br />52<br />
  60. 60. General Rule - §954(d)(2)<br />Branch rule is implicated where a CFC carries on purchasing or selling activities by or through a branch outside the CFC’s country of incorporation and using that branch has substantially the same tax effect as if the branch were a wholly owned subsidiary.<br />Branch is then treated as a separate corporation in determining FBCSI.<br />53<br />
  61. 61. General Rule - §954(d)(2)<br />The December Regulations treat the branch rules as mutually exclusive: If the manufacturing branch rules apply the sales branch rules does not apply (i.e. no overlap)<br /><br />Note- There are different rules for <br />sales and manufacturing branches<br />54<br />
  62. 62. Two Scenarios – Two Tests<br />US<br />US<br />MFG<br />Sales<br />Sales<br />MFG<br />55<br />
  63. 63. Mfg. Test<br />Sales Test<br />MFG<br />Sales<br />Sales<br />MFG<br />56<br />
  64. 64. Sales Test<br />Branch rule applies to sales/purchase branch when the tax rate imposed by the country where the branch is located is less than 90% of and at least 5 percentage points below the ETR if it had the income otherwise been earned in the country where the CFC is located<br />MFG<br />Country Y<br />Sales<br />Country X<br />57<br />
  65. 65. Sales Test<br />Compare the actual tax rate on income in country X to a hypothetical tax that would apply if those sales were earned in country Y<br />Apply the rate disparity test<br />MFG<br />Country Y<br />Tax determinations shall be made by taking into account only the income, war profits, excess profits, or similar tax laws (or the absence of such laws) of the countries involved. Treas. Reg. §1.954-3(b)(2)(i)(e) <br />Sales<br />Country X<br />Test<br />looks up<br />58<br />
  66. 66. Mfg.Test<br />The test is REVERSEDfor the Mfg branch<br />Branch Rule applies if the tax rate in the country in which the CFC is organized is less than 90% of and at least five percentage points below, what it would be if the income was earned where the manufacturing branch is located. <br />Sales<br />Country<br />Y<br />MFG<br />Country X<br />59<br />Test<br />looks down<br />
  67. 67. Mfg. Test<br /><ul><li>Compare the actual tax rate on sales income to a hypothetical tax that would apply if the sales income were earned in the Manufacturing branch home country
  68. 68. Hypothetical tax is determined under foreign law</li></ul>Sales<br />Country<br />Y<br />Test<br />looks down<br />MFG<br />Country X<br />60<br />
  69. 69. Manufacturing branches are tested separately<br />Manufacturing branches are tested separately if the CFC manufactures “different” products in separate branches or hybrid entities.<br /> “Different”=“Distinct”<br />61<br /><br />.<br /><br />Branch <br />B<br />Branch <br />A<br />Example<br /><br />Branches A&B are tested separately if they are making distinct products. <br />NOTE:One branch cannot taint another<br />Results<br />
  70. 70. Testing Separately<br />Country A sells to related and unrelated parties and does not make substantial contributions to the manufacturing through its employees. Country A does not tax Country B and C branches<br />62<br /><br />.<br />Sells Televisions<br />Country A<br />10%<br />Country B<br />12.5%<br />UK<br />28%<br />Manufactures flat screens (LCD’s) for TV’s <br />Manufactures Television Chassis<br />
  71. 71. Results<br />63<br /><br />.<br />Sells Televisions<br />The Analysis starts with the Country B. The tax rate is not 5 percentage points below the tax rate in Country B that would apply if the LCD’s were sold in the Country B<br />Test<br />looks down<br />Country<br /> A <br />10%<br />Country B<br />12.5%<br />Country C<br />28%<br />Manufactures flat screens (LCD’s) for TV’s <br />Manufactures Television Chassis<br />
  72. 72. Results - Continued<br />64<br /><br />.<br />Sells Televisions<br />Next, analyze the Country C. The Country A rate is low taxed when compared with Country C if the Chassis were sold through the Country C branch. Therefore, the branch rules apply to the chassis but not to the LCD’s.<br />Test<br />looks down<br />Country A<br />10%<br />Country B<br />12.5%<br />Country C<br />28%<br />Manufactures Flat screens for TV’s <br />Manufactures Television Chassis<br />
  73. 73. Discussion<br /><br />The branch rules do not automatically mean that the income is FBCSI but that the parent company and the branches are treated as separate CFC’s.<br />The income from Country B is not tainted and therefore excluded however, the income from Country C is included and currently taxable assuming no exception applies.<br />65<br />
  74. 74. <br />Two tests…but six procedural steps<br />Identify the sales and purchasing locations<br />Determine the ETR in the locations<br />Identify what locations the sales or purchasing should be compared with to determine whether low-tax jurisdiction exists<br />Determine how the sales and purchasing would have been taxed in the manufacturing or the country of incorporation (if relevant)<br />Apply the tax rate disparity test (mechanical test)<br />Determine the otherwise FBCSI<br />66<br />
  75. 75. Discussion - The Substantial Contribution Test <br />Under the December Regulations, if the substantial contribution test is met then, it is the same as physical manufacturing. So if only one location satisfies the substantial contribution test then that location represents the manufacturing location for purposes of applying the branch rules.<br />67<br />.<br />Did not meet the substantial contribution test so tax rate disparity test is applied against B<br />Test 2<br />looks down<br />A<br />Sales<br />B<br />Mfg<br />C<br />Mfg<br />Test 1<br />looks<br />
  76. 76. Trying to locate the tested manufacturing branch when more than one location satisfies the manufacturing test<br />68<br /><br />.<br />Sells Televisions<br />If more than one location independently satisfies the manufacturing test on the same item of property then, the location with the lowest ETR is the manufacturing location<br />Country<br />10%<br />Country<br />18%<br />Country<br />21%<br />Manufactures Television Chassis<br />Manufactures Television Chassis<br />
  77. 77. 69<br />.<br />Sells Product<br />Country A<br />10%<br />Country B<br />12.5%<br />Country C<br />28%<br />Ships Product to unrelated CM <br />Substantial Contribution made through its employees to Product of CM<br />Contract Manufacturer<br />Country D<br />
  78. 78. 70<br />.<br /><br />Result<br />The branch rule does NOT apply...<br />Substantial transformation test is met by country C branch AND, the new substantial contribution test is met by Country B branch. Therefore, the branch rule uses only the 12.5% rate for the tax rate disparity test.<br />Country A<br />10%<br />Country B<br />12.5%<br />Country C<br />28%<br />Contract Manufacturer<br />Country D<br />
  79. 79. What happens if no single location satisfies the manufacturing test when substantial contribution is present?<br />71<br /><br />Assume substantial contribution made to mfg through its employees by CFC 1<br />identify the sales location that should be tested<br />CFC 1<br />Sales<br />CM <br />Final Product<br />CM<br />Components<br />Identify purchasing locations.<br />
  80. 80. Group various locations together (i.e. all locations that are not treated as “high-tax” are grouped together and all locations that are treated as “low-tax” are grouped together)<br />72<br /><br />CFC 1<br />Sales<br />CM <br />Final Product<br />CM<br />Components<br />
  81. 81. Determine which grouping that provides the “demonstrably greater” contribution to manufacturing and test that grouping first.<br />73<br /><br />CFC 1<br />Sales<br />CM <br />Final Product<br />CM<br />Components<br />
  82. 82. This example assumes the low tax jurisdictions provides the “demonstrably greater” contribution to the manufacture than the “high-tax” jurisdictions.<br />74<br /><br />CFC 1<br />Sales<br />CM <br />Final Product<br />CM<br />Components<br />
  83. 83. Perform tax rate disparity test on low tax jurisdictions<br />75<br /><br />CFC 1<br />Sales<br />CM <br />Final Product<br />CM<br />Components<br />
  84. 84. After you do the tax rate disparity test how much income is FBCSI?<br />What if you have included in some of the low tax groupings locations that do not purchase or sell. Is this included as FBCSI?<br />The branch rule is intended to tax sales and purchasing income that has been separated from the manufacturing process. However, the December Regulations are not quite clear on this issue.<br />76<br />Question?<br /><br />
  85. 85. Debrief<br /><br />Step 1 – identify the tested sales and purchasing locations.<br />Step 2 – group various locations together (i.e. all locations that are not treated as “high-tax” are grouped together and all locations that are treated as “low-tax” are grouped together)<br />Step 3 – determine which grouping provides the demonstrated greater contribution to manufacturing<br />Step 4 – perform tax rate disparity test on that grouping first<br />Step 5 – Include FBCSI as subpart F<br />77<br />
  86. 86. International Tax Planning Issues to Consider<br />Suppose a CFC purchases manufactured product from an unrelated party and sells to an unrelated party? Assume also that the CFC makes a substantial contribution through its employees to the manufacture of the final product.<br />Is there FBCSI? Do the branch rules apply?<br />78<br />
  87. 87. 79<br />
  88. 88. Foreign Personal Holding Company Income (“FPHCI”)<br />I.R.C. §954(c)<br />
  89. 89. FPHCI Includes…<br />FPHC income is that portion of income that includes:<br /> dividends, interest, royalties, rents, and annuities<br />the excess of gains over losses from the sale or exchange of property on certain property where a deemed dividend occurs<br />other items: f(x) currency gains, interest equivalents, commodity transactions (list is not all inclusive)<br />81<br />
  90. 90. Exceptions to FPHCI<br />Temporary provision granting look-through rules beginning after December 31, 2005 and before January 1, 2010.<br />Applies to dividends, interest, rents and royalties to the extent not allocable to subpart F income<br />Exception provided for rents and royalties from a related corporation received for the privilege of using property within the country where the CFC is organized (same country exception)<br />Active Trade or Business Exception for rents and royalties (Treas. Reg. §1.954-2(b), (c) and (d))<br />Export Financing (banks only)<br />82<br />
  91. 91. How to Apply the Same Country Exception<br />Dividends and interest ─ ifCFC is incorporated where the business of the payor is located<br />Rents and royalties ─ if CFC is incorporated where the property is used<br /><ul><li>Payor ─ is related to CFC
  92. 92. Payor ─ is organized under laws of same country as CFC
  93. 93. Payor ─ uses substantial part of assets in trade or business in country of incorporation (50% test)</li></ul>83<br />
  94. 94. How to Apply the Same Country Exception<br />Rents and royalties ─ if CFC is incorporated where the property is used, payor is related and the royalty is for the privilege of using the property within the country of the laws of the CFC<br />Exception – rents allocated to insurance income or FBCI<br />84<br />
  95. 95. How to Apply the Same Country Exception<br />Portfolio interest is not excluded<br />Interest allocable to payor’s foreign base company income is not excludable<br />Dividends must be paid out of E&P earned when the amounts were owed to the owner of the stock<br />85<br />
  96. 96. Example ─ same-country exception rule<br />GmbH 1 acquires GmbH 2 and GmbH 2 dividends up<br />GmbH 1<br />RESULT<br />Same country exception will not apply to pre-acquisition earnings & profit<br />GmbH 2<br />86<br />
  97. 97. Alternate Scenario of Same-Country Exception<br />GmbH forms a Holding company to acquire GmbH Sub<br />GmbH P<br />RESULT<br />GmbH Holding <br />Same country exception should apply to pre-acquisition earnings & profit because GmbH held stock when GmbH Holding earned its E&P<br />GmbH S <br />87<br />
  98. 98. Process for Inclusion of “Subpart F income”<br />(§954) ─ Determine income included as Subpart F<br />(§954(b)(5)) ─ Allocate and Apportion Expenses<br />(§954(b)(3);(4)) ─ Either full inclusion; de minimis exception or high tax exception<br />(§952)(c)) ─ Is there an E&P limitation?<br />88<br />
  99. 99. Full Inclusion Rule §954(b)(3)(B)<br />If the sum of the foreign base company income and the gross insurance income for the taxable year exceeds 70% gross income, the entire gross income for the taxable year shall be treated as foreign base company income or insurance income (whichever is appropriate).<br />89<br />
  100. 100. Exception For Certain Income Subject To High Foreign Taxes (“High Tax Exception”)<br />income that was subjected to an effective rate of by a foreign country greater than 90 percent of the maximum U.S. rate of tax will not be considered FBC income. This exception does not apply to Oil related income.<br />Shareholders must elect to exclude income under the high-tax exception (Treas. Reg. §1.954-1(d)(1)(i)).<br />90<br />
  101. 101. Non-Dividend Repatriation I.R.C. §956<br />91<br />
  102. 102. Introduction<br />Generally when a loan is made by a subsidiary CFC corporation to its parent or to another affiliate it is not considered a taxable event. However, Code Section 956, provides an exception, by treating an amount loaned by a controlled foreign corporation (CFC) to a related U.S. person as a deemed dividend to the CFC's U.S. shareholders. <br />92<br />
  103. 103. Example<br />93<br />US <br />Parent<br />§956 is implicated to the extent of Earnings and Profit (unless an exception applies) <br />S.A.<br />GmbH<br />
  104. 104. Non-Dividend Repatriation §956<br />Applies to U.S. shareholders of CFC<br />Attempts to tax dividend equivalents<br />Hypothetical deemed distribution<br /><br />Even if U.S. taxpayer had no “tainted” income, if the CFC makes a loan to the U.S. parent or invests in certain types of U.S. property, the U.S. taxpayer is taxed on the amount of that investment<br />94<br />
  105. 105. Tax Court in Ludwig v. Comr. <br />In Ludwig, the court rejected the Service's argument that a U.S. shareholder's pledge of CFC stock as collateral for a loan caused the CFC to be a “guarantor” of the loan and therefore subject to §956. <br />The government argued that “[t]he purpose of section 956 of the Code is to terminate the tax deferment privilege with respect to the earnings of controlled foreign corporations when such earnings are directly or indirectly repatriated.” <br />95<br />
  106. 106. The Treasury provides two exceptions to §956<br />Notice 88-108 provides “30/60” day exception<br />These are obligations the CFC collects within 30 days as long as the CFC does not have loans outstanding during the year for 60 or more days<br />Notice 2008-91 provides “60/180” day exception<br />expanded the exception to obligations collected within 60 days as along as the CFC does not have loans outstanding to a related person during the year for 180 days or more <br />96<br />
  107. 107. There is a General legal Advice Memorandum (“GLAM”) on Notice 2008-91<br />GLAM 2009-13 provides guidance with regard to multiple obligations of one or more CFC’s<br />Provides insight in the governments' views on the application of §956<br />If taxpayer relies on “60/180” there is no requirement for a formal election<br />Done on a CFC by CFC basis<br />Applies for 2009, 2009 and 2010<br />97<br />
  108. 108. GLAM Notes<br />The GLAM points out that the CFC is deemed to have acquired property as of the date it acquires an adjusted basis in US property. This would include obligations on the date the loan was made or guaranteed.<br />Counting days for obligations – date of issuance is excluded and the date of repayment is included.<br />Counting days for purposes of §951-964 the holding period of the asset is determined by excluding the day the asset was acquired and including the day the asset was disposed.<br />98<br />
  109. 109. What about a loan made on December 31st ?<br />GLAM indicates (unless an exception applies) that §956 would apply to the loan for 2008 even though the date of issuance is not counted as a day in the holding period.<br />99<br />
  110. 110. What about a series of loans?<br />GLAM states that a series of loans must be executed independently or else periods of disinvestments will be ignored. GLAM holds that if it is determined a series of obligations constitutes successive rollovers of a single obligation then the disinvestment period will be ignored for the 60 and 180 day requirements.<br />100<br />
  111. 111. <br />Debrief<br />General Rule for Subpart F is: “Deferral”<br />A U.S. taxpayer is not subject to taxation on the earnings of a foreign subsidiary until the earnings are repatriated.<br /><ul><li>Exceptions ─ “tainted income”
  112. 112. (but only to the extent of E&P)
  113. 113. US shareholder can claim a FTC
  114. 114. Subsequent distributions qualify as PTI
  115. 115. Lesser of $1M or 5% of CFC gross income (de minimis)
  116. 116. 70% of CFC income is “Subpart F” then 100% rule
  117. 117. High tax kick-out (90% of U.S. tax)
  118. 118. Same country exception</li></ul>101<br />
  119. 119. Debrief<br /><br /> Generally, in order for income to be considered foreign base company sales income, the property purchased must be manufactured or produced outside the country in which the CFC is organized and must also be sold for use outside that country. <br />Sec. 954(d)(1)(A) and (B).<br />102<br />
  120. 120. Planning for Distributions of Previously Taxed Income<br />
  121. 121. PTI distributions excluded from income<br />I.R.C.§ 959 excludes from income distributions of E&P which were previously included into income (includes actual and deemed distributions)<br />Section 959(d) generally provides that a distribution from PTI is NOT a dividend.<br />Result upon distribution is that the CFC’s E&P and tax pools are immediately reduced to preclude the USSH from inappropriately gaining a 902 credit<br />104<br />
  122. 122. Exception to non-dividend treatment<br />A distribution of PTI through a chain of ownership.<br />Section 960(a)(3) provides that, for purposes of calculating a U.S. corporate Shareholder's §902 credit for taxes paid on PTI as it is distributed through a chain of ownership to a U.S. Shareholder a distribution of PTI is counted as a dividend when ultimately received by the corporate U.S. Shareholder (where no credit was previously given under 960)<br />105<br />
  123. 123. Planning for Distributionsunder the “Ordering Rules”<br />A distributions is first deemed to made from earnings that were previously taxed and included into income as investments in U.S. property (I.R.C. §956)<br />A distribution is next deemed to be made out of earnings that were currently or previously required to be included into income under §951(a)(1)(A).<br />106<br />
  124. 124. Planning for Distributionsunder the “Ordering Rules”<br />Finally, distributions that occur in excess of the CFC’s PTI are attributable to the remaining untaxed and undistributed E&P…first out of current then, accumulated E&P …<br />107<br />
  125. 125. Planning for Distributions using a chain of corporations<br />GmbH 2 invested 150 in U.S. property. The U.S. P must include 150 into income (I.R.C. §951(a)(1)(B))<br />U.S. P<br />GmbH 1 <br />US property<br />GmbH 2 <br />108<br />
  126. 126. Planning for Distributions using a chain of corporationsAdditional Facts<br />During the tax year GmbH dividends 150 to GmbH 1. The U.S. P does not have to include this into income under §951(a) due to the §959(b) exclusionary rule<br />U.S. P<br />GmbH 1 <br />US property<br />GmbH 2 <br />109<br />
  127. 127. Planning for Distributions using a chain of corporationsAdditional Facts<br /> Suppose GmbH subsequently invests in US property in the next year without the occurrence of a distribution, U.S. P would have to include into income because US p received the exclusion in the prior year<br />U.S. P<br />GmbH 1 <br />US property<br />GmbH 2 <br />The exclusionary rule contemplates an actual distribution that must occur <br />110<br />
  128. 128. <br />Debrief<br />Distributions of PTI are not considered a dividend (§959(d))<br />Distributions of PTI reduce E&P<br />Exception is provided (§960 (a)(3))<br />111<br />
  129. 129. 112<br />
  130. 130. Disclaimers<br />113<br /> The informal comments and the information presented in these slides should not be construed as constituting tax advice applicable to any specific taxpayer because each taxpayer’s facts are different.<br /> To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice mentioned in the presentation or contained in these slides is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transactions or matters addressed herein. <br />
  131. 131. Contact Information<br />114<br />Seth Primosch<br />Senior Accountant<br />ParenteBeard, LLC<br />1650 Market Street, Suite 4500 Philadelphia PA 19103 <br />seth.primosch@parentebeard.com<br />Edward Umling CPA, LLM<br />Senior Manager<br />Urish Popeck LLC<br />3 Gateway Center, Suite 2400<br />Pittsburgh, PA 15222<br />Tel: 1 412 391-1994<br />eumling@urishpopeck.com<br />

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