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The Accidental Taxpayer

The Accidental Taxpayer

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The Accidental Taxpayer

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Presentation Transcript

    1. The Accidental Taxpayer Tax Tips for Crossing Borders in Business and in Life

    2. Focus Cross-border business investments (including private equity) Outbound from the U.S. to foreign countries Accidents and prevention Hazards in the Internal Revenue Code Conceptual; based on real life

    3. Not the Focus Individual income tax (Mesa Hodson) Expatriation or impatriation 911 exclusion Income, estate and gift tax planning (Jerry Guillott) Foreign inheritance and wealth taxes (UHY Global Network) Inbound investors (another speech) Taxation in foreign countries (numerous other speeches)

    4. Typical Accidents Individual pays more U.S. tax because of how a foreign investment is structured Anti-deferral provisions of IRC accelerate income recognition Restructuring triggers U.S. tax Double taxation due to asymmetries between foreign U.S. tax rules

    5. Top Six Categories Subpart F Income Passive Foreign Investment Company Foreign Tax Credits International Restructuring Transfer Pricing Punitive Provisions

    6. Basic Tenets Deferral Income of foreign corporations is not taxed until repatriated Unless an accelerator applies Income from other foreign investment arrangements is taxed currently Branch income to U.S. owner Partnership to U.S. partners Recognition Foreign tax credits 15% tax on qualified dividend income

    7. 1. Subpart F Income Foreign Personal Holding Company Income Dividends, interest, rents, royalties, capital gains Personal service contracts Foreign Base Company Sales Income Foreign Base Company Services Income Investment in U.S. Property Recognized by U.S. shareholder in year the income is earned by foreign corporation

    8. CFC Controlled foreign corporation (CFC) >50% of vote or value is owned by U.S. Shareholders U.S. Shareholder owns >10% of vote Attribution and constructive ownership

    9. Subpart F Inclusion Deemed dividend to U.S. Shareholder Pro rata share of CFCs Subpart F income Up to current E&P of CFC Skips over intervening foreign entities Actual dividend in same year treated as previously taxed income Not eligible for 15% rate on dividends

    10. Accidents Attribution from family members spouse, children, grandchildren and parents Attribution from corporations If > 50% in value Options are considered exercised if owned by U.S. persons, but not by foreign persons U.S. partnership is U.S. Shareholder Subpart F income flows through to U.S. partners even if they own indirectly <10% of CFC Arrangements to avoid >50% of voting power

    11. Prevention Examples of ownership avoiding CFC No U.S. person owns >10% of voting power > 10% shareholders collectively own < 50% Invest through foreign rather than U.S. partnership Elect to treat foreign entities below first tier as disregarded or as partnerships

    12. Passive Income Foreign Personal Holding Company Income Dividends, interest, rents, royalties Capital gains Personal service contracts Exceptions Look-thru rules (expire 12/31/09) Active business Same country High tax De minimis income

    13. Accidents Incorporating a bank account offshore to collect passive income Personal service contracts Taxable presence in U.S. Rental income that is not active PFIC exposure for U.S. persons who are <10% shareholders

    14. Prevention Avoid base companies with little business connection to foreign country Look-thru rule for dividends, interest, rents, royalties from related CFC CFC has right to designate who performs contract Documenting where services are performed Active marketing of rental property Intangible property holding company with cost-sharing

    15. Sales Foreign Base Company Sales Income Purchase or sale involves related party Items produced outside Salescos country Sold for use outside Salescos country Exceptions Substantial transformation De minimis Branch rule

    16. Accidents Establishing a sales company or agent in low-tax jurisdiction where products are not used Assuming there is a look-thru rule Using branches outside CFCs country of incorporation Agents

    17. Prevention New contract manufacturing regulations and the branch rule 50-50 ownership with foreign investor Split management and control from where CFC is organized

    18. Services Foreign Base Company Services Income Performed for or on behalf of related person and Performed outside Servcos country Substantial assistance Exceptions Related to sale of property De minimis

    19. Accidents Subcontracting to related party in low-tax country Getting substantial assistance from related U.S. party in excess of safe harbors attribution of CFCs personnel to U.S. Taxable presence in U.S.

    20. Prevention 50-50 company with NRA relative Assistance of related party is not substantial Set up in low-tax country without need to subcontract Arms length pricing Agreements limiting activities Split management and control from where CFC is organized

    21. Investment in U.S. Property Loans to U.S. related party Making foreign earnings available without distributing a dividend Increase in investment in U.S. property = deemed dividend Affirmative use of 956

    22. Accidents Using CFCs cash to fund U.S. operations through a loan CFC guarantees bank loan to U.S. related party Shares of CFC serve as collateral for loan to U.S. Cross-collateral arrangements on lines of credit Acquiring shares of U.S. company that is CFCs shareholder, or is owned >25% by U.S. shareholders in the aggregate

    23. Prevention Short-term loans Pledging up to 66 2/3 of stock of CFC Acquiring less than 25% of voting power of related U.S. company

    24. 2. PFIC Passive Foreign Investment Company Income or asset tests Nasty surprise on disposition Election to recognize income currently Interaction with Subpart F Once a PFIC, always a PFIC

    25. Accidents Companies without significant hard assets Too much cash Receiving an excess distribution (including disposing of shares) Amount allocated to each day in holding period of current year plus prior years As far back as 1/1/87 Tacking of holding periods Taxed at highest rate plus interest Disposition of indirectly owned PFIC U.S. Shareholder prior to 1/1/98

    26. Prevention Qualified electing fund Pro rata share of ordinary income and capital gain Not qualified dividend income for 15% rate Purging election Attribution of active business from subsidiaries Regular testing Active assets such as receivables instead of passive assets such as cash Exceptions Start-up year Change in business

    27. 3. Foreign Tax Credits Direct credit tax withheld from payments tax paid by individuals (including as partners in partnerships), foreign branches and permanent establishments Indirect (deemed paid) credit U.S. corporate shareholder receives dividend Tax paid by foreign corporation in which U.S. person owns >10%

    28. Foreign Tax Credits Reduce U.S. income tax with foreign tax Credit is limited to U.S. tax on foreign source income Separate limitation for passive income Excess tax carries back 1 year and forward 10

    30. Gross vs. Net

    31. Accidents Failing to supply foreign withholding agent with treaty information Refund of over-withheld tax Failing to document amount of foreign tax paid Assuming that low rate of withholding will yield fully creditable tax Overall foreign loss

    32. Prevention Limit activities to those not creating a taxable permanent establishment in foreign country Consider having permanent establishment instead of withholding tax on gross income Include gross-up provision in agreements Submit treaty documentation to withholding agent before payment is made Estimate interest allocation and other expenses reducing foreign tax credit limitation

    33. Asymmetries Foreign tax cannot offset U.S. tax on U.S. source income, e.g., Services performed in the U.S. Income from sale of personal property including shares of stock Exceptions for sales of Inventory, if title passes outside U.S. Certain depreciable property Shares of stock of foreign affiliates

    34. Services

    35. Accidents Foreign withholding tax on payments for services performed in U.S. Capital gains subject to foreign tax, especially from transferring shares of stock Passing title in the U.S. on sales of inventory to foreign buyers

    36. Prevention Build up amounts of low-tax foreign source income by passing title outside the U.S. Check treaty for re-sourcing of income to country imposing tax Include gross-up provision in agreements Sell shares of foreign company in country where it is engaged in active business if shares are owned >80% by U.S. resident

    37. Check-the-Box Election to treat foreign company as other than a corporation for U.S. tax purposes Disregarded entity (1 shareholder) Partnership (>1 shareholder) Not all foreign entities are eligible Foreign tax credits, losses, and other items flow through to owners; no deferral Especially for individuals to take credit for taxes paid by foreign entities No change for 5 years unless ownership change

    38. No Elections for X & Y

    39. Elections for X & Y

    40. Accidents Foreign entity is a per se corporation Assuming no election is necessary Default rules for foreign entities are opposite of U.S. Corporation in absence of election Filing Form 8832 late or incomplete Late election by return date without extension 9100 relief for retroactive election Foreign entity must have Taxpayer Identification Number Incremental U.S. tax because foreign rates are lower Investments involving non-U.S. investors Day before rule

    41. Prevention Selective use of check-the-box election 15% rate on dividends from treaty countries (expires 12/31/10) Verify in advance if foreign entity is eligible (Treas. Reg. 301.7701-2) Check the box on lower-tier entities in order to avoid Subpart F and PFIC Provide distributions for investors to pay incremental U.S. tax Timing of election

    42. Offshore Funds Foreign corporation as blocker Future liquidity event Preserving deferral for U.S. shareholders Avoiding PFIC

    43. Accidents Blocker is a CFC Subpart F income (especially Subcos paying dividends after 12/31/09) Not organized in a treaty country Gain on sale possibly dividend Limited use of foreign tax credits Blocker is a PFIC Lower-tier entities not eligible for check-the-box election

    44. Prevention Examples of ownership avoiding CFC No U.S. person owns >10% of voting power U.S. shareholders collectively own < 50% Invest through foreign rather than U.S. partnership Elect to treat foreign entities below first tier as disregarded or as partnerships

    45. 4. Restructuring Transfer of property to a foreign corporation or partnership in a nonrecognition transaction Sale or other transfer of shares of foreign corporations Liquidation of foreign corporation Preservation of the ability to tax previously untaxed earnings

    46. 367(a) - Outbound Nonrecognition transactions (e.g., 351, 354, 368) Transfer of appreciated property Transfer of intangible property as if a license Transfer of shares of a subsidiary Recognizing gain Exception for active business

    47. 367(b) Inbound, etc. Nonrecognition transactions (e.g., 332, 355, 368) Liquidation of Sub 1 with undistributed earnings Check-the-box election Recognizing untaxed earnings as deemed dividend Foreign-to-foreign transfers

    48. 1248 Sale of Shares Capital gain treated as dividend to extent of E&P of Opco and Subco Eligible for 15% rate on dividend from treaty countries (thru 12/31/10) Indirect foreign tax credits Sale, dividend, spin-off If Opco sells Subco, similar treatment under 964(e) for Opco If individual sells CFC

    49. Accidents Failure to recognize income under 367 Active business transfer of hot assets Failure to treat gain as dividend under 1248 or 964(e) Failure to consider earnings of lower-tier entities for 1248 Sale within 5 years after foreign corporation ceases to be a CFC Failure to report transfer of assets on Form 926

    50. Prevention Check-the-box election on lower-tier foreign entities before transfer Spin-off versus liquidation All E&P for 367(b) vs. 1248 E&P Compare alternatives such as sale of assets

    51. 7874 Inversion Foreign corporation acquires assets of USCO by acquiring its shares After the acquisition, former shareholders own >80% (60%) Lack of substantial business activities in Forcos country Forco treated as domestic corporation (>80%)

    52. Accidents Transfer of shares of USCO in exchange for shares of Forco Former shareholders include non-U.S. persons when determining 60% or 80% Also applies to domestic partnerships

    53. Prevention Business activity of expanded affiliated group where Forco is organized Outbound F reorganization Sale of shares Legislative proposals?

    54. Recast Step transaction Form over substance Tax avoidance motive or accident Statutory and regulatory overrides

    55. 304 - Redemption Sale of Sub 2 to Opco Sales proceeds treated as dividend to Sub 1 to extent of E&P of Opco and Sub 2 Dividend not limited to amount of gain realized Variations Intentionally triggering 304

    56. D Reorganization Sale as in 304 but Sub 2 is liquidated Recharacterized as D reorganization with boot Gain is taxed to extent of E&P of Sub 2 and Opco Check-the-box election

    57. Accidents Failure to consider possible recharacterization Steps may comprise one transaction Foreign tax on transfer of shares No foreign tax credits

    58. Prevention Review IRS characterization of similar transactions Upstream sale Whether foreign tax credits will offset U.S. tax

    59. 5. Transfer Pricing Intercompany arrangements Arms length (third- party) standard Based on economic study of comparable situations

    60. Tax Audits IRS audit adjustments to maximize income Management and guarantee fees Royalties for intellectual property including marketing intangibles Margins on sales Rents for use of assets Interest on open account debt Foreign tax authorities adjustments to maximize income in foreign country OECD Guidelines

    61. Accidents Double taxation resulting from adjustments If no treaty, no competent authority relief Non-OECD methods Statute of limitations Lack of contemporaneous documentation

    62. Prevention Economic study as sword and shield Specialized entities in low-tax countries Intellectual property holding company Finance company Sales company Contract manufacturer Commissionaire to minimize income in high-tax countries

    63. 6. Punitive Provisions Foreign Corrupt Practices Act Illegal payments Including from foreign subsidiary Anti-Boycott Rules Agreeing to cooperate with boycott Form 5713 Treasury Report TDF90-22.1 on foreign financial accounts IRS Forms 5471, 8865, 8858

    64. FCPA U.S. taxpayer gets no deduction Foreign subsidiary gets no deduction in determining earnings & profits Even if not a violation of local law Deemed dividend to U.S. shareholder

    65. Anti-Boycott Boycott list: Kuwait, Lebanon, Libya, Qatar, Saudi Arabia, Syria, United Arab Emirates and Yemen Reporting requirement Even if no agreement to boycott Tax implications of participating in boycott Reduced foreign tax credit Deemed dividend of foreign corporations earnings Boycott factor or specific income

    66. FBAR Treasury Departments requirement U.S. persons must disclose foreign financial accounts financial interest or signature authority aggregate value >$10,000 Due June 30 of following year no extensions

    67. Tax Reporting 5471 8865 8858 926 1116/1118 8832 5713 8621 Foreign Corporation Foreign Partnership Foreign Disregarded Entity Transfer of property to foreign corporation Foreign Tax Credit Check-the-Box Election Boycott Report PFIC QEF

    68. Accidents Payments may be legal; possibly tax deductible in foreign country Foreign nationals not aware of U.S. rules Failure to report; or providing incomplete information Absence of contemporaneous documentation for transfer pricing

    69. Prevention Comprehensive FCPA program Annual compliance review FBAR due June 30 of each year (no extensions) File forms and complete all applicable schedules Update transfer pricing documentation annually

    70. Conclusions Accidents are preventable Remain eternally vigilant Plan ahead!

    71. UHY Advisors TX, LLC Meril Markley 713-407-3206 International Tax mmarkley@uhy-us.com Jerry Guillott 713-407-3830 Gift & Estate Tax jguillott@uhy-us.com Income Tax Mesa Hodson 713-407-6508 Expatriate Tax mhodson@uhy-us.com

    72. Q & A