· 6/3/2015 · 2 PLR 201452002 ; 6 . 3 IRS revokes Rev. Rul. 78-130; issues triple drop and check guidance : 11 . 4 Section 901(m) & Notice 2014 -44 : 15 . 5 Treasury …

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International Tax Updates

June 4, 2015

June 4, 2015

1 GRA Regulations 3

2 PLR 201452002 6

3 IRS revokes Rev. Rul. 78-130; issues triple drop and check guidance

11

4 Section 901(m) & Notice 2014-44 15

5 Treasury proposes fundamental changes to US Model Treaty 25

6 IRS Guidance 27

7 Significant cases 32

7.1 BMC Software, Inc. v. Commissioner 33

7.2 Illinois Tool Works, Inc. v. Commissioner 38

7.3 Bank of N.Y. Mellon Corp. v. Commissioner 42

7.4 Evans v. Commissioner 44

7.5 C&J Energy Services v. City of Miami General Employees' and Sanitation Employees' Retirement Trust

47

7.6 Outer continental shelf cases 49

8 UK Diverted profits taxes 51

9 Base Erosion and Profit Shifting 56

9.1 BEPS action plan 61

10 BEPS – Going forward 83

11 Legislative updates 86

Agenda

2 International Tax Updates

Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty

Section 901(m) & Notice 2014-44 IRS revokes Rev. Rul. 78-130; issues triple drop and check guidance PLR 201452002 GRA Regulations Agenda

June 4, 2015

GRA Regulations


1 GRA Regulations Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Overview

• A U.S. person who transfers stock or securities to a foreign corporation pursuant to Treas. Reg. §1.367(a)-3(b) through (e) may be allowed to enter into a Gain Recognition Agreement (“GRA”) to avoid current taxation on such transfer.

• The terms of agreement required for GRAs are embodied in Treas. Reg. §1.367(a)-8(c):

- The taxpayer agrees to recognize the gain if a “triggering event” occurs during a set timeframe (not less than 60 months) following the close of the year in which the initial transfer occurs.

◦ In general, gain recognized in the year of the initial transfer, but taxpayer may opt (at time of entering into the GRA) to recognize gain in the year of a triggering event (interest must be paid on additional amount in either case).

- The taxpayer must extend the statute of limitations for the transfer through the close of the eighth full taxable year following the taxable year of the initial transfer.

- The taxpayer must file annual certifications stating whether a triggering event has occurred for each of the 5 full taxable years following the taxable year of the initial transfer.

- A gain recognition agreement does not protect against a dividend required to be recognized under section 367(b).

Gain Recognition Agreements — Basic Concepts




June 4, 2015

Overview

• Applicable to US persons who fail to file gain recognition agreements (GRAs) and related documents, or to satisfy other reporting obligations required for certain transfers of property to foreign corporations in nonrecognition exchanges.

• Generally incorporate the provisions of proposed regulations issued on January 31, 2013, with certain modifications.

• Address failures to file (and deficient filings of) certain documents required in the Sections 367(a) and 6038B regulations concerning outbound transfers, as well as Form 926, and the Section 367(e)(2) regulations for liquidations into foreign corporations.

• Require the US person to demonstrate that any failure was not 'willful’ when seeking relief from gain recognition, but continue to apply the 'reasonable cause and not willful neglect' standard to US persons seeking penalty relief for failure to report under Section 6038B.

• Revoke the IRS directive put into place in 2010 (the 'GRA Directive'), which applies to timely filed but deficient GRAs and related documents, effective November 19, 2014.

• Eliminate the requirement that the IRS respond to requests for relief for missed and deficient GRA filings within 120 days of receipt of the request.

• Extend the requirement to file a Form 926 to outbound stock transfers where the US transferor files a GRA.

Effective Date

• The regulations are effective for all requests for relief filed on or after November 19, 2014.

Final and temporary regulations [T.D. 9704] — Failure to file or deficiencies in gain recognition agreements and other documents




June 4, 2015

PLR 201452002


2 PLR 201452002 Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Overview

• PLR 201452002 analyzes certain intercompany transactions occurring pursuant to a global restructuring plan that could potentially trigger recapture of consolidated overall foreign loss (COFL) or consolidated separate loss limitation (CSLL) accounts.

- IRS respected timing of transactions and determined that no recapture was triggered because the intercompany transactions occurred within a consolidated group, even though the plan called for deconsolidation in a later step.

- Upon deconsolidation, the consolidated tax attributes were apportioned among each member.

• The PLR highlights the importance of timing the steps of a transaction sequence, and providing business purpose supporting such timing (as well as an overall transaction), so as to ensure that the transaction elements which could potentially trigger such recapture occur within consolidation.

PLR 201452002 – IRS rules that intercompany transactions in restructuring do not require FTC recapture


2 PLR 201452002 Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Background

• The Parent Group had general basket COFL and CSLL accounts, as well as a passive basket overall domestic loss (ODL) account.

• Because of significant overlap between the places of incorporation and business operations of the Parent Group Foreign Entities and the FDRE1 Foreign Entities, the Foreign Parent entered into a Global Structure Alignment Plan to reduce the overlap and simplify the global structure.

PLR 201452002


2 PLR 201452002

FPS

FP

FSub1

Parent

Sub1

Sub2

FSub3

Parent Group Foreign Entities

FSub2

FDRE1 Foreign Entities

FDRE1

FDRE2

Public Country B

Country B

Country A

Country A

Country A

Country A

Country A

(No CFCs)

US

US

US

US

Parent Group

DRE1



June 4, 2015

Transaction

1. On Date 1, Sub1 formed Holdco, a US LLC, which elected to be treated from inception as a corporation for US federal income tax purposes.

2. On Date 2, Sub1 contributed its ownership interests in DRE1 and certain intercompany agreements to Holdco in exchange for all ownership interests in Holdco (Contribution 1).

3. On Date 3, Holdco was converted from an LLC to a corporation.

4. On Date 4, FDRE1 contributed its ownership interests in FSub2 to FDRE3, a newly formed Country A entity disregarded from inception for US federal income tax purposes. Immediately following this transfer, FDRE1 contributed all of its interests in FDRE3 (and other assets), to Holdco solely in exchange for Holdco common stock (Contribution 2). As a result of Contribution 2, Sub1's ownership of Holdco no longer met the Section 1504(a)(2) consolidation requirements, and Holdco became the parent of a consolidated group that included Sub2. (See Diagram 2 below.)

PLR 201452002


2 PLR 201452002

FDRE3

HoldCo (U.S.)

FPS

FP

FSub1

Parent

Sub1

Sub2

FSub3


FSub2


FDRE1

FDRE2

Public Country B

Country B

Country A

Country A

Country A

Country A

Country A

(No CFCs)

US

US

US

US

DRE1

4

Contribution 2

1

Formation

2

Contribution 1 3

Conversion to Corp.



June 4, 2015

PLR 201452002


2 PLR 201452002

FP

FSub1

Parent

Sub1

Sub2

FSub3


FSub2


FPS

FDRE1

FDRE2

Public Country B

Country B

Country A

Country A

US

US

US

US

Parent Group

DRE1

HoldCo

US

Holdco Group

FDRE3

Analysis

• The ruling notes that recapture could potentially occur to the extent required by Treas. Reg. sec. 1.1502-9(b)(6)(i), which applies to FTC recapture rules.

• PLR 201452002 confirms that intercompany transactions within consolidated groups do not trigger recapture of COFL or CSLL accounts.

- It also highlights the importance of timing the steps of a transaction sequence, and providing business purpose supporting such timing (as well as an overall transaction).

• The tax attributes that previously belonged to the Parent Group were apportioned among its members prior to deconsolidation, with those belonging to HoldCo and Sub2 carrying into the HoldCo Group

• Note that the consolidated return regulations addressing OFLs include an anti-abuse rule which clients should keep in mind when considering various potential restructuring transactions.

• Companies should also pay careful attention to the ‘hair trigger’ nature of the OFL recapture rules, which can and do override non-recognition provisions in many cases.



June 4, 2015

Rev Ruls 2015 -9 &10: IRS revokes Rev. Rul. 78-130; issues triple drop and check guidance


3 IRS revokes Rev. Rul. 78-130; issues triple drop and check guidance Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes

Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty Section 901(m) & Notice 2014-44 IRS revokes Rev. Rul. 78-130; issues triple drop and check guidance

PLR 201452002 GRA Regulations Agenda

June 4, 2015

Rev. Rul. 78-130

Step 1: FS2 forms NewCo

Step 2: USP transfers stock of FS1 to FS2 in exchange for additional shares of voting common stock of FS2.

Step 3: Pursuant to a plan of reorganization, X, Y, Z, and FS1 transfer substantially all of their assets (subject to liabilities) to NewCo, in exchange for additional shares of common stock of NewCo.

Rev Rul 2015-9: IRS Revokes Rev. Rul. 78-130 Common recasts of multi-step transactions



FS1

Z Y X NewCo FS1

USP

FS2 1

2

2

FS1 Stock

FS2 voting Common stock

FS2 forms NewCo

3

NewCo Common Stock

3

Substantially all assets



June 4, 2015

Rev. Rul. 78-130

U.S. Tax Consequences

1. The transfer of FS1 to FS2 was not an exchange qualifying under Section 351.

2. NewCo viewed as acquiring substantially all the assets of X, Y, and Z in D Reorganization.

3. NewCo viewed as acquiring substantially all the assets of FS1 in a C Reorganization.

Rev. Rul. 2015-9 (Same Facts as Rev. Rul. 78-130)

U.S. Tax Consequences

1. P’s transfer of FS1 stock treated as a Section 351 exchange, not a triangular C Reorganization.

2. FS1’s transfer of its assets to N followed by S1’s liquidation treated as a D Reorganization.

What this means

• The characterization of a cross-border stock transfer can have significant US tax implications.

- For example, under the outbound stock transfer and gain recognition (“GRA”) rules of Treas. Reg. 1.1367(a)-3 and -8, a Section 351 transfer followed by a D Reorganization is treated in a different manner than a triangular C Reorganization.

• Rev. Rul. 2015-9 illustrates the need to consider how the various cross-border provisions, including but not limited to Sections 367(a), (b), (d), (e), and 1248(f), affect a transaction, and to properly structure the form of a transaction to obtain favorable US tax results.

• This ruling makes clear that the IRS will not treat certain transactions as triangular C Reorganizations if the transaction is structured to fit the facts of Rev. Rul. 2015-9.

Rev Rul 2015-9: IRS Revokes Rev. Rul. 78-130 Common Recasts of Multi-Step Transactions


3 IRS revokes Rev. Rul. 78-130; issues triple drop and check guidance Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes



June 4, 2015

Rev Rul 2015-10 Triple drop and check



Rev. Rul. 2015-10

• The IRS treated the first two transfers, by P and FS1, as Section 351 exchanges.

• The IRS treated the transfer of the Domestic LLC to FS3 and Domestic LLC’s election to be treated as a disregarded entity together as a D Reorganization as opposed to a Section 351 exchange followed by a Section 332 liquidation.

- Consistent with PLR 201150021 & 201252002.

• Prior to the ruling, other potential characterizations included:

1. Three Section 351 transfers followed by a Section 332 liquidation, and

1. One Section 351 transfer followed by a triangular C Reorganization

• There has also been concern a Triple Drop and Check could be viewed as a direct D Reorganization of LLC into FS3 in an ‘all boot D Reorganization.

- FS1 stock would be deemed contributed through the chain to FS3, who then used such FS1 stock to acquire LLC in a D Reorganization.

- FS1 stock would be considered ‘grandparent’ stock, and would thus be treated as boot in the D Reorganization.

• Rev. Rul. 2015-10 clarifies that an all boot D Reorganization is not the appropriate characterization for a Triple Drop and Check.

FS3

USP

Domestic LLC

Domestic LLC

FS1

FS2

LLC Shares

1

USP contributes LLC to FS1

FS1 contributes LLC to FS2

FS2 contributes LLC to FS3

2

3

LLC checks-the-box to become disregarded

4



June 4, 2015

Section 901(m) & Notice 2014-44


4 Section 901(m) & Notice 2014-44 Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Pre-Section 901(m) Targeted transactions


4 Section 901(m) & Notice 2014-44

• US tax rules allowed step up in inside basis of assets of a foreign target.

- Section 338(g) election.

- Acquire disregarded entity for US tax purposes.

• USP acquires FT for $300.

• Acquisition price exceeds value of assets at FT by $200.

• USP makes section 338(g) election to step up basis of assets in FT to FMV, thereby creating $200 of amortizable goodwill.

• Amortizable goodwill allows FT to reduce E&P for US tax purpose without impacting taxable income at FT.

• Amortization may convert low taxed E&P to higher taxed E&P.

USP (US)

FT (Foreign) FT (Foreign)

§338(g) election

FMV: 300 Tax Basis: 100

FT Owners

Cash

FT Stock

FMV: 300 PP&E: 100 Goodwill: 200



June 4, 2015

Section 901(m) disallows a credit for the disqualified portion of any foreign income tax determined with respect to the income or gain attributable to the relevant foreign assets.

• “Disqualified portion” – the percentage obtained by dividing (i) the aggregate amount of basis differences allocated to a tax year by (ii) the income for such tax year as measured for foreign tax purposes

• “Basis difference” – the increase in the tax basis of an asset for U.S. tax purposes as a result of a CAA

• Basis difference generally is allocated to each tax year in the same manner as depreciation/amortization

Operative rules under section 901(m)




June 4, 2015

Section 901(m) Denial of FTCs in case of covered asset acquisitions



USP (US)

FSub (Foreign)

FT (Foreign)

FT (Foreign)

FT Owners Cash

FT Stock

• FSub purchases FT after December 31, 2010 and makes a section 338(g) election.

• Total stepped-up basis is $1,500,000 (all assets have a 15-year life).

• Basis immediately prior to acquisition was 0, so “basis difference” is $1,500,000.

• FT’s foreign income for year 1 is $1 million and foreign tax is $500,000.

x $500,000 [foreign taxes] = $50,000 disallowed tax

Disqualified portion of year 1 tax: $100,000 [$1,500,000 ÷ 15] $1,000,000 [foreign income]



June 4, 2015

“Disposition” of relevant foreign asset (“RFA”) triggers basis difference

• Section 901(m) provides upon the “disposition” of a RFA, any remaining basis difference is allocated to the tax year of disposition

• Prior to Notice 2014-44, the term “disposition” was not specifically defined by the statute

• Lack of definition resulted in uncertainty and opportunity for taxpayers to take positions minimizing basis differences from acquisitions

Operative rules under section 901(m)




June 4, 2015

Notice 2014-44 IRS concern with statutory disposition rule



USP (US)

Fsub (Foreign)

FT (Foreign) FT (Foreign)

1 Qualified stock purchase - §338(g) election

2

§338 CAA

FT Owners

Cash

FT Stock

• The acquisition of FT stock is a section 338 covered asset acquisition (“CAA”), and the assets of FT are RFAs.

• For U.S. tax purposes, FT is deemed to distribute all of its assets and liabilities to FSub in a tax-free liquidation pursuant to sections 332 and 337.

• Taxpayers take the position that the deemed liquidation constitutes a disposition of the RFAs for purposes of section 901(m).

- All of the basis difference is allocated to FT’s final taxable year.

- Thus, no basis difference is allocated to any later taxable year.

• Notice: This raises significant policy concerns because:

- The basis difference continues to exist after the deemed liquidation; and

- No foreign income tax is disqualified because no gain was recognized for foreign income tax purposes.

CTB election



June 4, 2015

• Section 901(m) definition of disposition:

- The Notice definition of disposition includes only transactions that are taxable for U.S. income tax purposes, foreign income taxes purposes, or both.

- Transactions that are disregarded for U.S. and foreign income tax purposes are not dispositions for purposes of section 901(m) under the rules announced in the Notice.

• The Unallocated Basis Difference:

- Under the Notice, section 901(m) continues to apply to an RFA until the Unallocated Basis Difference is eliminated. A positive Unallocated Basis Difference may be reduced in one of two ways:

o U.S. depreciation/amortization deductions under the applicable cost recovery method, and

o In the case of a disposition, the lesser of (a) the foreign taxable gain (Foreign Disposition Gain or U.S. loss (U.S. Disposition Loss), or (b) the remaining Unallocated Basis Difference (the rules operate in reverse if the unallocated basis difference is negative w/r/t a RFA, e.g., U.S. gain reduces a negative Unallocated Basis Difference).

- In the case of a disposition that is taxable for both U.S. and foreign purposes, the entire Unallocated Basis Difference is taken into account in the year of the disposition.

• Special rules for Section 743(b) CAAs

- In the case of a Sec. 743(b) CAA, the disposition amount takes into account the foreign disposition gain or loss or U.S. disposition gain or loss that is allocable to the partnership interest transferred in the Sec. 743(b) CAA taking into account the basis adjustment under Sec. 743(b) allocated to the RFA under Sec. 755.

New rules in notice 2014-44




June 4, 2015

Notice 2014-44 Section 4.04 Example 1 – CTB Liquidation Not a Disposition



USP (US)

CFC (Country A)

FT (Country A) FT (Country A)


2

§338 CAA

CTB election

FT Owners

$ 300

FT Stock

• CFC’s acquisition of FT stock is a section 338 CAA, and Asset is an RFA.

• For U.S. tax purposes, as a result of the CTB election, FT is deemed to distribute Asset to CFC in a tax-free liquidation.

• Under the Notice, the CTB election is not a disposition of Asset for purposes of section 901(m) because no gain or loss was recognized for purposes of U.S. or Country A income tax.

- No Unallocated Basis Difference will be taken into account by FT as a result of the deemed liquidation.

- Section 901(m) will continue to apply until the entire $200 Unallocated Basis Difference has been taken into account under section 901(m)(3)(B).

Asset (land)

Asset (land)

U.S. Basis: $100 For. Basis: $100




June 4, 2015

Notice 2014-44 Section 4.04 Example 2 – Partial Disposition



FT (Country A)

USP (US)

CFC (Country A)

FT (Country A)


2

§338 CAA

Transfer

FT Owners

$300

FT Stock

Asset Asset



FC (Country A)

FC Stock & Cash

Asset

Asset


• CFC’s acquisition of FT stock is a section 338 CAA, and Asset is an RFA.

• FT’s transfer results in $50 gain for foreign tax purposes, but no gain for U.S. tax purposes.

• There is a disposition of Asset for purposes of section 901(m) because the transfer results in gain being recognized by FT for foreign tax purposes.

- FT takes into account the portion of the Unallocated Basis Difference equal to the Disposition Amount of $50 (i.e., the lesser of the foreign disposition gain of $50 or the unallocated basis difference of $200).

- Section 901(m) will continue to apply to Asset, as held by FC, until the remaining $150 Unallocated Basis Difference has been taken into account under section 901(m)(3)(B).



June 4, 2015

• Notice 2014-44 describes regulations addressing Section 901(m)’s application to asset dispositions that occur on or after July 21, 2014

• Notice 2014-45 precludes taxpayers from using the statutory disposition rule through the check-the-box election filed on or after July 29, 2014.

• Notice 2014-44 guidance will determine the Section 901(m) tax consequences of a check-the-box entity classification election that is filed on or after July 29, 2014, and is effective on or before July 21, 2014.

• Taxpayers may consistently apply the guidance to all Section 743(b) CAAs occurring on or after January 1, 2011.

Notice 2014-45 sets Notice 2014-44 effective date for 901(m) regulations for retroactive check-the-box elections




June 4, 2015

Treasury proposes fundamental changes to US Model Treaty


5 Treasury proposes fundamental changes to US Model Treaty Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes



June 4, 2015

Overview • The proposal was released by Treasury on May 20, 2015, with comments requested within 90 days. • Proposed changes represent some of the most significant changes in US tax treaty policy in decades • Proposed revisions include:

- Disallowance of treaty benefits for income attributable to exempt permanent establishments ◦ Similar to triangular branch rule included in many US tax treaties, but more expansive.

- Denial of treaty benefits for income subject to a special tax regime ◦ Disallows treaty benefits for interest, royalties, and other income derived from a related person if the recipient is subject

to a special tax regime. - Denial of treaty benefits for payments made by US companies that are expatriated entities

◦ Provide s that any dividend, interest, royalty, or other income payments made by an expatriated entity within ten years of that entity’s expatriation event will be taxed in accordance with US domestic law notwithstanding the other provisions of the treaty.

- Further restrictions on treaty eligibility under the limitation on benefits article ◦ Includes derivative benefits test ◦ Adds base erosion requirement to the subsidiary of a public company test ◦ Modifies LOB discretionary relief to require a demonstration of substantial nontax nexus to the taxpayer’s residence state

- Ability of Treasury to partially terminate a treaty based on subsequent changes in law ◦ New Article 28 permits Treasury to partially terminate provisions relating to dividends, interest, royalties, and other

income if at any time after the signing of the treaty the general rate of company tax applicable in either contracting state falls below 15% with respect to substantially all of the income of resident companies, or either contracting state provides an exemption from taxation to resident companies for substantially all foreign source income,

Treasury proposes fundamental changes to US Model Treaty


5 Treasury proposes fundamental changes to US Model Treaty Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes



June 4, 2015

IRS Guidance


6 IRS Guidance Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Overview • Announces the intention to issue future regulations, and takes a two-

pronged approach. • First, it addresses the treatment of cross-border business combination

transactions themselves under Sections 7874 and 367. That guidance involves the following: - Disregarding certain stock of a foreign acquiring corporation that holds a

significant amount of passive assets for purposes of the ownership continuity test ratio.

- Disregarding certain non-ordinary course distributions by the US company for purposes of the ownership continuity test ratio.

- Changing the treatment of certain transfers of the stock of the foreign acquiring corporation – such as in a spin-off.

• Second, it addresses post-transaction steps that taxpayers may undertake with respect to US-owned foreign subsidiaries, under Sections 304(b)(5)(B), 956(e), and 7701(l). - The Section 304 guidance would tighten the limitation under Section

304(b)(5)(B) and thereby further limit the ability to bypass the former US parent company (with the CFC’s E&P) where the new foreign parent sells shares of the former US parent company to a lower-tier CFC.

- The Section 956(e) guidance would treat as ‘US property’ post-inversion acquisitions by CFCs of debt or equity interests in the new foreign parent corporation or certain foreign affiliates, regardless of whether the funds involved were made available to a US shareholder.

Notice 2014-52 — Restrictions on ‘inversion’ transactions


6 IRS Guidance

New Foreign Parent

Foreign Target US Target

CFC Target



June 4, 2015

Overview

• The Section 7701(l) guidance would maintain CFC status for existing foreign subsidiaries of the US company even when the new foreign parent or another foreign affiliate makes an equity investment that gives it a majority interest. Specifically, the foreign acquirer would be treated as though it had made the investment in the US parent company and not the CFC.

Effective date

• Generally applies only to business combination transactions completed on or after September 22, 2014, except for the Section 304 provision, which applies to all stock acquisitions completed on or after September 22, 2014 that meet Section 304 criteria. The Notice indicates that future guidance in this area will apply prospectively from the date of issuance, and only to groups that completed their business combination transactions on or after September 22, 2014.

Notice 2014-52 — Restrictions on ‘inversion’ transactions




June 4, 2015

Overview

• Clarifies the definition of ‘transaction’ in the context of Section 7701(o).

- Provides the Service’s view on when a particular transaction should be analyzed on the basis of all the steps taken together (an aggregation approach) versus on the basis of the individual steps (a disaggregation approach), stating that both are appropriate depending on the facts and circumstances.

- With respect to the disaggregation approach, provides that the Service may apply the economic substance doctrine to individual steps in the transaction where those steps are tax-motivated and unnecessary to accomplish the non-tax objective.

• Clarifies the meaning of ‘similar rule of law’ under the accuracy related penalty described in Section 6662(b)(6).

- States the IRS’ position that the term ‘similar rule of law’ could include the ‘sham transaction doctrine’ if the factors and analysis are the same as those used under Section 7701(o). However, the Service confirmed that the term ‘similar rule of law’ does not include other judicial doctrines such as the substance over form or step transaction doctrines.

Effective Date

• Effective for transactions entered into after March 30, 2010.

Notice 2014-58 — Guidance on codified economic substance doctrine and related penalties




June 4, 2015

Facts

• The taxpayer had several advances during the tax year from controlled foreign corporations (CFCs), two of which were collected within 30 days and were not outstanding for more than 60 days cumulatively throughout the year. Another advance was outstanding more than 60 days during the year in question.

Issue

• Whether the advances under a line of credit from taxpayer’s CFCs constituted an investment in US property for purposes of Section 956.

Conclusion/Implications

• Unless a CFC holds for fewer than 60 calendar days during a taxable year all obligations which, without regard to the 30-day rule described in Notice 88-108, would constitute United States property within the meaning of Section 956, the exclusion from the definition of the term ‘obligation’ in Notice 88-108 does not apply with respect to any obligation held by the CFC.

CCA 201516064 — IRS issues CCA limiting taxpayers’ ability to use ‘short-term obligation’ exception to Section 956




June 4, 2015

Significant cases


7 Significant cases Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

BMC Software, Inc. v. Commissioner


7.1 BMC Software, Inc. v. Commissioner Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Facts:

• BMC Software, Inc. (BMC) is a US corporation that develops and licenses computer software. It collaboratively developed software with a wholly owned foreign subsidiary under cost sharing agreements. BMC acquired the software rights when the cost sharing agreements terminated, paying royalties to the subsidiary in exchange.

• The IRS challenged the royalties as not arm's-length. In 2007, BMC and the IRS entered into a closing agreement increasing BMC's income for tax years 2003 through 2006 (the primary adjustments). In a second closing agreement executed in 2007, BMC elected to apply Rev. Proc. 99-32 to effect a cash repatriation of these transfer pricing adjustments.

• Rev. Proc. 99-32 is a tax relief mechanism that allows taxpayers to establish an account receivable in the amount of a transfer pricing adjustment, and to receive payment of that receivable without further tax consequences (although interest must be accrued on the receivable).

• This mechanism permits a taxpayer to receive cash payments that conform to the taxable income amount resulting from the transfer pricing adjustment. The mechanism also allows the taxpayer to avoid the collateral tax consequences of ‘secondary adjustments’ (such as deemed distributions or deemed contributions) that otherwise might arise from a primary adjustment.

BMC Software, Inc. v. Commissioner Three categories of hybrid mismatch arrangements




June 4, 2015

Facts:

• Pursuant to Rev. Proc. 99-32, the second closing agreement provided for BMC to establish interest-bearing accounts receivable for the foreign subsidiary's repayment of the transfer-pricing adjustment to BMC.

• BMC's tax years 2005 and 2006, which were covered by the 2007 transfer-pricing adjustment, coincided with the company's eligibility period for the Section 965 repatriation incentive. Section 965 permitted a US company to receive certain CFC dividends in one tax year with a dividends-received deduction (DRD) that reduced the US federal income tax rate on those dividends by 85 percent.

• Section 965(b)(3) required companies to deduct from the eligible dividend amount the amount of any increase in aggregate related party indebtedness (RPI) (basically, debt owed by CFCs to related persons, including US shareholders) from October 3, 2004, to the end of the Section 965 tax year elected.

• BMC elected to receive its Section 965 dividends in its tax year ending March 31, 2006.

• Of the $721 million repatriated from the foreign subsidiary, BMC claimed that $709 million qualified for the Section 965 DRD.

• The IRS concluded on audit that $43 million of the $709 million did not qualify for the DRD, taking the position that the Rev. Proc. 99-32 accounts receivable deemed established for 2005 and 2006 constituted an RPI increase during the relevant period.

• The IRS relied on Notice 2005-64, which declared that Rev. Proc. 99-32 receivables would be treated as RPI for Section 965(b)(3) purposes.





June 4, 2015

Issue:

• Whether an account receivable established under Rev. Proc. 99–32 may constitute increased RPI for purposes of the related party debt rule of section 965(b)(3).

Tax Court – BMC Software, Inc. v. Comm’r, 141 T.C. 224 (2013)

• The accounts receivable constitute indebtedness for the purposes of section 965(b)(3).

• The accounts receivable closing agreement does not preclude reducing the dividends received deduction under section 965(b)(3) as it refers to the repayment of A/R, not the establishment of A/R.

• Section 965 doesn’t contain an intent requirement; there is no need for round-tripping.

Court of Appeals – BMC Software, Inc. v. Comm’r, 780 F.3d 669 (5th Cir. 2015)

• Because the accounts receivable did not exist during the relevant section 965(b)(3) testing period, the statute did not require it to be taken into account in determining the RPI for purposes of calculating the section 965 DRD.

- The court did not directly address the broader question of whether the accounts receivable fell within the definition of RPI.

• The court also determined that BMC Software did not agree to backdate the existence of the accounts receivable for section 965(b)(3) purposes in its Rev. Proc. 99-32 Closing Agreement.





June 4, 2015



7.1 BMC Software, Inc. v. Commissioner

Parent (U.S.)

CFC

A/P

A/R

-

Primary Adjustments:

• Parent's taxable income is increased.

• CFC's taxable income is decreased.

Secondary Adjustments:

• A/R is established from Parent (U.S.) to CFC (foreign).

• A/P is established from CFC (foreign) to Parent (U.S.).

Court Findings:

• A/R created by Rev. Proc. 99-32 does not increase RPI for purposes of section 965.

Other Considerations - Section 956:

• Consider whether the "debt" from foreign to U.S. has section 956 consequences.

+



June 4, 2015

Illinois Tool Works, Inc. v. Commissioner


7.2 Illinois Tool Works, Inc. v. Commissioner Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Illinois Tool Works Inc. v. Commissioner T.C. No. 10418-14, petition filed 5/8/2014


7.2 Illinois Tool Works, Inc. v. Commissioner

ITW (US)

Paradym (U.S. & Bermuda)

CSE (Foreign)

CSA (Bermuda)

Miller Insurance Ltd.

Foreign Subs

Cash Dist. $356.8M

CSA Loan $356.8M

Adjusted tax basis in CSE stock: $1.1B, disputed by IRS

1

2

$0 E&P, disputed by IRS 12/15/2006:

12/15/2006:

U.S. Tax Year-End: 12/31 Foreign Tax Year-End: 11/30



June 4, 2015

Facts from Taxpayer’s Petition

• IRS asserted that the nontaxable return of capital distributed by CSE to Paradym constituted a taxable ordinary dividend under section 301(c)(1) or taxable capital gain under section 301(c)(3).

- Also asserted a correlative increase in FTC due to the increase in FSI.

• Taxpayer states that CSE contemporaneously memorialized the CSA Loan in a promissory note.

- Not subordinated

- 5 year term

- Fixed interest rate of 6%

◦ Taxpayer argued this was an arm’s length interest rate

◦ Actually made the annual interest payments

- Recorded as debt for book and tax purposes

- Reasonable expectation of being repaid

- Loan was refinanced twice to extend maturity by one-year periods





June 4, 2015

Obama Administration FY 2013 Budget Proposal

• “[T]o the extent a foreign corporation (the ‘funding corporation’) funds a second, related foreign corporation (the ‘foreign distributing corporation’) with a principal purpose of avoiding dividend treatment on distributions to a U.S. shareholder, the U.S. shareholder’s basis in the stock of the distributing corporation will not be taken into account for the purpose of determining the treatment of the distribution under section 301.

• For this purpose, the funding corporation and the foreign distributing corporation are related if they are members of a control group within the meaning of section 1563(a), but replacing the reference to “at least 80 percent” with “more than 50 percent.”

• Funding transactions to which the proposal would apply include capital contributions, loans, or distributions to the foreign distributing corporation, whether the funding transaction occurs before or after the distribution.”





June 4, 2015

Bank of N.Y. Mellon Corp. v. Commissioner


7.3 Bank of N.Y. Mellon Corp. v. Commissioner Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Bank of N.Y. Mellon Corp. v. Commissioner


7.3 Bank of N.Y. Mellon Corp. v. Commissioner

Issues

• Can a taxpayer deduct interest incurred for borrowing made in connection with a transaction deemed to lack economic substance?

- This question, in the context of a structured trust advantaged repackaged securities (STARS) transaction, awaits resolution in the U.S. Court of Appeals for the Second Circuit.

Facts

• The Bank of New York Mellon Corp. is raising an arm’s-length defense in it challenge to a U.S. Tax Court decision that a complex lending deal with a foreign bank lacked economic substance. Mellon is successor in interest to the Bank of New York Co. (BNY), which entered into a deal with Barclay's Bank Plc. to obtain a $1.5 billion loan at a below-market interest rate through a complex deal that involved establishing a U.K. trust as a BNY subsidiary. The tax court disallowed Mellon Bank's claimed foreign tax credits of approximately $200 million related to the loan, finding that the lending deal was motivated by tax avoidance.

• Pending in the U.S. Court of Appeals for the Second Circuit. The IRS filed a reply brief Sept. 25 arguing that the Tax Court erred in ruling, on partial reconsideration, that the taxpayer was entitled to interest deductions on the loan. The court granted taxpayer's motion for the case to be heard on the same day and by the same panel as a case involving American International Group, Inc. (AIG), Docket No. 14-765. The case calendaring has been proposed for the week of May 5.



June 4, 2015

Evans v. Commissioner


7.4 Evans v. Commissioner Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Evans v. Commissioner: Home Sweet Home


7.4 Evans v. Commissioner

Issues

• What are the conditions a U.S. citizen must satisfy in order to claim the benefits of Section 911 to exclude foreign earned income from U.S. taxation?

Facts

• Joel B. Evans (“Evans”), a U.S. citizen, grew up in West Monroe, Louisiana. In 1997, he began working for Parker Drilling Co. In 2006, Evans was promoted to a management position at Parker’s facilities on Sakhalin Island, Russia. During the period 2007-2009, the tax years at issue in the case, Evans was on and off duty for Parker during alternating 30-day periods. While on duty he lived in housing that Parker provided. In addition, approximately three times a year, Evans spent one to three weeks on an offshore drilling platform.

• During the tax years at issue, Evans owned a house in his hometown of West Monroe. With the assistance of his mother, he maintained the house. During the years at issue Evans maintained other connections to Louisiana. He held a Louisiana driver’s license, had bank and credit card accounts in Louisiana and registered and maintain vehicles in Louisiana. His federal income tax returns listed his mother’s address as his mailing address.



June 4, 2015

Section 911

• Section 911 defines “tax home” by reference to Section 162(a)(2). Under this section, an individual’s home is the location of his regular or principal place of business.

• Section 911(d)(3) provides an exception to this general rule. If an individual’s “abode” is in the United States, he is considered to have a tax home in the United States.

• Under case law, a person’s abode is the place where he has the strongest economic, personal and family ties.

Holding

• The Tax Court held that an individual who worked alternating 30-day periods in Russia could not exclude his earnings from gross income under Section 911 because he maintained sufficient ties in Louisiana so that his abode was in the United States. The taxpayer was deemed to have stronger economic, family, and personal ties in the U.S. than he did in Russia where the drilling rig he supervised was located.

• In Evans, the Tax Court indicated that Section 911 was meant to provide some relief for taxpayers who bore the cost of maintaining a domestic and a foreign household. Which Evans’ did not have.

Evans v. Commissioner: Home Sweet Home


7.4 Evans v. Commissioner Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

C&J Energy Services v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust


7.5 C&J Energy Services v. City of Miami General Employees' and Sanitation Employees' Retirement Trust Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes



June 4, 2015

C&J Energy: Did I Buy or Did I Sell?


7.5 C&J Energy Services v. City of Miami General Employees' and Sanitation Employees' Retirement Trust

Facts

• C&J Energy Services, Inc. was allowed to proceed with a $2.86 billion merger with a unit of Nabors Industries Ltd. to lower its tax liability.

• Last June, C&J Energy Services, Inc. signed the merger agreement with a subsidiary of Nabors Industries Ltd., in which C&J was to pay $937 million in cash and 62.5 million shares for Nabors’ fracturing business.

- Nabors is headquartered in Bermuda (tax free), and C&J would from similar tax benefits. As a result, C&J was not paying a premium.

• The Delaware Supreme Court reversed the lower court’s decision to enjoin the merger.

- The lower court had determined that C&J’s board had violated its duties to seek the highest immediate value reasonably available, because the board did not engage in an active pre- or post-signing market check.

- The lower court enjoined the stockholder vote for 30 days and required C&J to shop itself around.

• The Delaware Supreme Court indicated that there is no “blueprint” that a board must follow when conducting the marketing process.

- When a board exercises its judgment in good faith, tests the transaction through a viable passive market check, and gives its stockholders a full informed, uncoerced opportunity to vote to accept the deal, the board should not be found to have violated its duties to the shareholders.



June 4, 2015

Outer continental shelf cases


7.6 Outer continental shelf cases Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

The IRS challenges activities on the outer continental shelf


7.6 Outer continental shelf cases

Adams Offshore Ltd. v. Commissioner, Docket No. 5541-14, filed 3/14/14

• A Bahrain-based operator of service vessels to the oil and gas industry is challenging income adjustments of $45.5m arising from activities the IRS claims are “effectively connected” to a U.S. trade or business.

• Adams Offshore provides various diving and vessel management services, including installation, inspection, survey, repair and maintenance of subsea pipeline and facilities.

- Adams Offshore has operations all over the world, including in the Gulf of Mexico, and its clients include oil and gas companies operating in the Gulf of Mexico.

Adams Challenge (UK) Ltd. v. Commissioner, T.C., Docket No. 4816-15, filed 2/20/15

• Adams Challenge is disputing income adjustments based on a determination that the company had income “effectively connected” with a U.S. trade or business.

• Adams Challenge owns a multi-purpose supply vessel of the same name, which is flagged and registered in the U.K. Adams Challenge chartered the vessel to Epic Diving and Marine Services LLC.

- Epic provides commercial diving and marine services in the Gulf of Mexico and around the world, including platform and pipeline services, well repair, plug and abandonment, underwater inspection, underwater construction and marine salvage.

• Adams Challenge claims that it performs no services within the United States, and thus has no obligation to file a U.S. tax return, but the IRS determined Adams Challenge understated its income and had earned $12.6m in U.S. waters.

- The IRS calculated the company’s total gross income based on the days of the ship’s “active presence” in the outer continental shelf, multiplied by a daily rate and an additional “meal rate.”



June 4, 2015

UK Diverted profits taxes


8 UK Diverted profits taxes Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

A new 25% (or 55% in the case of UK ring-fence O&G operations) tax on a company’s taxable diverted

profits in two scenarios:

Summary of legislation


8 UK Diverted profits taxes

Entities or transactions lacking economic substance: Where groups create a tax benefit by using transactions or entities that lack economic substance (including UK-UK transactions).

• A comparison of the value of the tax reduction and the financial benefit of the transactions; and

• Focus on situations where absent the tax benefit the UK expenditure would not have been incurred or the income would have been in the charge to UK tax.

Avoidance of a UK taxable presence: Where foreign companies have exploited the permanent establishment rules.

2

1 Scenario

Scenario



June 4, 2015

Applies when:

• Provision has been made between the UK company (or a UK PE of a non-resident) and another person (UK or non-UK) by means of a transaction or series of transactions;

• The parties are connected;

• The provision results in a tax mismatch outcome; and

• The insufficient economic substance condition is met.

Scenario 1 – Entities or transactions lacking economic substance



Payment/income diversion

Connected/Related Parties

UK Company Non-UK Company



June 4, 2015

The focus is on non-UK companies making direct sales to customers through UK activities. Scenario 1 applies where:

• There is a foreign company and:

- A person (‘the avoided PE’) is carrying on activities in the UK in connection with the supply of goods or services or property made by a foreign company to customers.

- It is reasonable to assume that the activity of the avoided PE or the foreign company (or both) is designed to ensure the company is not carrying on a trade through a UK PE; and

- Either or both the conditions below are met:

Scenario 2 – Avoidance of UK taxable presence



The mismatch condition

There are arrangements between the foreign company and another connected person that results in an effective tax mismatch outcome and the insufficient economic substance condition is met. (Same tests as Scenario 1.)

The tax avoidance condition

There are arrangements in place where the main purpose or one of the main purposes to avoid a charge to UK Corporation Tax.



June 4, 2015

Effective Date

• Profits arising on or after April 1, 2015.

Financial Reporting Implications

• UK DPT is expected to be considered a tax based on income for accounting purposes. As such, it would generally be subject to Accounting Standards Codification (ASC) 740 and International Accounting Standard (IAS) 12. If DPT is subject to ASC 740 / IAS 12 the following should be considered:

1. What accounting periods are affected;

2. Whether DPT affects or gives rise to deferred tax balances;

3. What disclosures are required or appropriate;

4. Impacts to effective tax rate calculations; and

5. Whether uncertain tax positions may exist.

Interaction with U.S. Foreign Tax Credits

• Treasury is still evaluating whether the UK government’s proposed diverted profits tax would be creditable under Section 901 and whether the Section 909 FTC splitter rules apply.

UK Diverted Profits Tax – Key Takeaways


8 UK Diverted profits taxes Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

Base Erosion and Profit Shifting


9 Base Erosion and Profit Shifting Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

“Base erosion and profit shifting (BEPS) is a global problem which requires global solutions. BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to artificially shift profits to low or no-tax locations where there is little or no economic activity, resulting in little or no overall corporate tax being paid. BEPS is of major significance for developing countries due to their heavy reliance on corporate income tax, particularly from multinational enterprises (MNEs).”

9 Base Erosion and Profit Shifting

What is Base Erosion and Profit Shifting (‘BEPS’)?




June 4, 2015

Nature

Comprehensive action plan published on 19 July 2013:

• Identifies 15 actions that are required to address BEPS;

• Sets deadlines for actions (the majority within 24 months); and

• Identifies resources and methodology required to implement solutions.

Timeline

OECD BEPS action plan – Overview



June 2012 Project announced/started

July 2013 Release of Action Plan with 15 separate actions/work streams

December 2015 Completion of remainder of Action Plan

February 2013 Release of document, ‘Addressing Base Erosion and Profit Shifting’

September 2014 Projected completion of approximately ⅓ of Action Plan

2016 and forward Monitoring, additional/on-going actions



June 4, 2015

Concerns

• Growing perception that governments lose substantial corporate tax revenue because of BEPS tax planning strategies.

• Public concern about whether particular companies and groups are paying their “fair share” of tax.

Data on Corporate Tax

• Corporate income tax rate gives rise to 3% of GDP across OECD countries.

• Revenue loss from BEPS is not extremely large in relation to tax revenues, but relevant because of perceived integrity of tax system.

• Unweighted average of corporate income tax as a percentage of total tax in OECD countries was 8.8% in 1965, 7.6% in 1975, 10.6 % in 2007,10% in 2008, 8.4% in 2009, and 8.6% in 2010.

• Increased segregation between the location where actual business activities and investments take place and the location where taxable profits are reported.

• ETR could be useful in determining whether BEPS is taking place.

OECD says MNEs may be engaging in BEPS





June 4, 2015

Areas of Focus

1. Countering base erosion and arbitrage between territories

2. Jurisdiction to tax, with particular focus on the digital economy

3. Transfer pricing, analyzing issues related to the arm’s length principle

15 Actions Organized Around Three Pillars

1. Improving interaction of corporate tax in different territories

2. Realignment of taxation and substance,

3. Transparency

The focus of BEPS





June 4, 2015

BEPS action plan


9.1 BEPS action plan Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

BEPS action points timeline

9.1 BEPS action plan


No Action Area of focus OECD deadline(s)

1 Address the tax challenges of the digital economy Digital economy Deliverable – Sept 2014

2 Neutralise the effects of hybrid mismatch arrangements Coherence (Hybrids) Deliverable – Sept 2014

3 Strengthen CFC rules Coherence (CFCs) September 2015

4 Limit base erosion via interest deductions and other financial payments

Coherence (Debt) September/December 2015 Deliverable – Dec 2014

5 Counter harmful tax practices more effectively, taking into account transparency and substance

Coherence (‘Deals’) September/December 2015 Deliverable – Sept 2014

6 Prevent treaty abuse Substance (Treaty) Deliverables – Sept 2014

7 Prevent the artificial avoidance of PE status Substance (PE) September 2015 Deliverable – Dec 2014

8 Assure that transfer pricing outcomes are in line with value creation: intangibles

Substance (TP) September 2015 Deliverable – Sept 2014

9 Assure that transfer pricing outcomes are in line with value creation: risks and capital

Substance (TP) September 2015 Deliverable – Dec 2014

10 Assure that transfer pricing outcomes are in line with value creation: other high-risk transactions

Substance (TP) September 2015 Deliverable – Dec 2014

11 Establish methodologies to collect and analyse data on BEPS and the actions to address it

Transparency (Data Collection) September 2015

12 Require taxpayers to disclose their aggressive tax planning arrangements Transparency (Schemes) September 2015

13 Re-examine transfer pricing documentation Transparency (Documentation) Deliverable – Sept 2014

14 Make dispute resolution mechanisms more effective Transparency (Disputes) September 2015 Deliverable – Dec 2014

15 Develop a multilateral Instrument Multilateral instrument December 2015 Deliverable – Sept 2014



June 4, 2015

Unilateral measures since 2014



Interest Deductibility • Austria • Finland • Italy • Norway • Poland • Russia (proposed) • Korea • Australia • South Africa • Uganda

• EU directives • Germany

(proposed) • Poland • Spain • Mexico

• Australia (proposed) • Japan (proposed) • Singapore (guidance) • South Africa • UK (proposed)

Hybrid Mismatches

• Poland • Russia • Spain • Brazil

• Chile • China • India (proposed) • Korea (proposed)

Strengthen CFC Rules

Artificial avoidance of PE & Recharacterisation • U.K.

Harmful Tax practices & General Anti Abuse Rules • Poland • Chile • China • India



June 4, 2015

Key BEPS action items for drilling companies



Action 2: Hybrid mismatch arrangements

Action 4: Limiting base erosion via interest deductions and other payments

Action 7: Preventing the artificial avoidance of PE status

Action 8-10: Transfer pricing and value creation



June 4, 2015

1. Deduction/No Inclusion (D/NI): Where a deductible payment made under a financial instrument is not taxed as ordinary income by the payee’s jurisdiction.

2. Double Deduction (“DD”): Where a payment or item of expenditure incurred by an entity is deductible in more than one jurisdiction.

3. Indirect Deduction/No Inclusion (“Indirect D/NI”): Where the effect of a hybrid mismatch is shifted into another jurisdiction through another financial instrument.

Action 2 – Hybrid mismatch arrangement Three categories of hybrid mismatch arrangements




June 4, 2015

Action 2 – Hybrid mismatch arrangement Structures Affected: U.S.-Foreign Hybrid Instruments



US

CAN

Hybrid Loan

US

Lux

CPEC

US

France

ORA

Recommendation: Hybrid Financial Instrument

Response (Primary Rule): No deduction in payer country unless the US subjects to tax the accrued (or paid) amount as ordinary income. However, if US will subject amount to tax in a future year as ordinary income, local country deduction should be granted currently.

Defensive Rule (Secondary Rule): US should tax accrued (or paid) amount.

Imported Mismatch: Hybrid instruments can also create imported mismatches to the extent proceeds are lent to an entity in a third country (e.g., Can/Lux/France on-lends to a company in a third country).

*Also affected by proposed French anti-hybrid rule



June 4, 2015

Assume any

Profit Sharing payments within the German Organschaft are not taxed in the US because of a re-contribution strategy and no taxable dividends are paid by Germany 2.

Recommendation: Disregarded Hybrid Payments

Response (Primary Rule): No deduction in Germany except to the extent the US includes earnings of Germany 2 (e.g., as dividends) in ordinary income. However, if US will subject the earnings of Germany 2 to tax in a future year as ordinary income, a German deduction should be granted to extent of such inclusion in the future year.

Defensive Rule (Secondary Rule): US should tax accrued (or paid) amount on disregarded loan as ordinary income.

Action 2 – Hybrid mismatch arrangement Structures affected – First-tier disregarded loans



US

Ger1

Loan

Ger2



June 4, 2015

Recommendation: Reverse Hybrid Rule

Response (Primary Rule): Holland should deny the deduction for payments to CV.

Defensive Rule(s) (Secondary Rule): US should tax the payment under its CFC rules or Holland should treat the CV as a Dutch resident and tax the payment as ordinary income.

Action 2 – Hybrid mismatch arrangement Structures affected – Reverse hybrid entities



Imported Mismatch Rule: If none of the above actions are taken, Country A can deny the deduction if any of the Primary or Secondary Rules are not adopted.

USP

CV

BV1

BV2

HoldCo Country A

OpCo Country A

Loan

Loan



June 4, 2015

• All Reverse Hybrid same country loan structures caught irrespective of where in the structure

Recommendation: Reverse Hybrid Rule

Response (Primary Rule): Germany should deny the deduction for payments to KG.

Defensive Rule(s) (Secondary Rule): US should tax the payment under its CFC rules or Germany should treat the KG as a German resident and tax the payment as ordinary income.

Action 2 – Hybrid mismatch arrangement Structures affected – Same country loan structures



US

KG

Swiss

GER Loan



June 4, 2015

This structure is not described in the Hybrid Mismatch Report

Action 2 – Hybrid mismatch arrangement Structures affected – Finance branch alternative



US

OpCo

Lux 1

Lux 2

Interest

Treaty Abuse: May or may not be a WHT issue depending on applicable laws and treaties.

Reference the Treaty Abuse section later in this deck for additional information.

Finance Branch



June 4, 2015

Action 2 – Hybrid mismatch arrangement Structures not affected – Low-tax Finco loans



US

IRE*

Loan

FR

Assume Finco country treats interest as ordinary income.

This structure is not described in the Hybrid Mismatch Paper.

• Assumes Ireland has trading status

12.5% Tax • Also Gibraltar 10%

• Malta & Cyprus 10%



June 4, 2015

• The OECD seeks best practice rules on base erosion and profit shifting via interest expense and similar payments, particularly among related parties.

• The discussion draft makes it clear that a conclusion has not been reached in relation to the best practice recommendations.

- The discussion draft sets out various options for addressing this issue, concluding current rules do not address the underlying BEPS concerns.

- Other considerations include interactions with EU law and other BEPS workstreams, as well as how the rules would apply to certain industries/sectors.

• The OECD has rejected the arm's length standard and withholding tax regimes as efficient tools to prevent BEPS.

• There is a similar proposal in the Obama Administration’s annual budget.

- The proposal also resembles existing UK rules, although the current UK limit is the entire worldwide interest expense, not an allocation.

- Similar rules operate in Australia, Finland, France, Germany, and New Zealand as a carve-out from a ‘fixed ratio’ test (see next slide).

Action 4 – Interest deductions




June 4, 2015

Potential Best Practice Rules

1. Group-wide rules

- Limit net interest deductions to a proportion of the group’s actual net third party interest expense, based on a measure of economic activity such as earnings

- Limit interest deductions based on applying a group-wide ratio (such as net interest as a proportion of earnings)

2. Fixed financial ratio rules

- Restrict interest expense to a specified proportion of earnings, assets or equity of a company

- Benchmark ratio must be low enough to address BEPS concerns without giving rise to significant double taxation risk

3. Combination group-wide and fixed ratio rules

- Fixed ratio would be set “deliberately low” so that it would only permit full interest deductions for entities which pose little risk of BEPS

- Group-wide rules would be used as an alternative where the initial (fixed ratio) test led to non-deductible interest

Action 4 – Interest deductions




June 4, 2015

Example

Action 4 – Interest deductions Group-wide rule example



Interest cap Net expense Disallowed interest

FP 5 x 100 = 2.5 200

0 0

US 5 x 60 = 1.5 200

3.5 2

FS 5 x 40 = 1 200

1.5 0.5

Annual earnings FP $ 100 US $ 60 FS $ 40 Total $ 200

FP

FS US

Bank $100

$5 interest

$3.5 interest

$70 loan

$1.5 interest

$30 loan



June 4, 2015

Germany generally limits interest expense deductions to 30% of EBITDA.

Action 4 – Interest deductions Fixed ratio example



US

FinCo

Loan

GER

• Assume Germany’s EBITDA is EUR 10M

• Generally interest expense would be limited to EUR 3M even though Germany may have paid more interest than EUR 3M to FinCo

• A much lower fixed ratio to combat BEPS could be introduced by some countries



June 4, 2015

1. Businesses have significant involvement in another jurisdiction's economic life without creating a PE (e.g., commissionaire).

- Four options for amending of dependent agent rule and simple proposal to amend the independent agent rule–aimed at commissionaire arrangements, but likely to impact a broad range of taxpayer structure/arrangements.

- No requirement for contract/terms to be "in the name of" or for agent to be restricted to "concluding contracts"–activity leading to contracts is sufficient.

2. Separated/unwarranted use of specific activity exemptions to avoid PE.

- Preference to subject all specific activity exemptions to an overriding preparatory or auxiliary test; or

- Removal of specific exemptions for warehousing, purchasing, and data collection.

3. Fragmentation of activities/splitting of contracts within groups to avoid PE status.

- Looks at all activities or "associated enterprises" where there are "complementary functions" which are part of a "cohesive business operation.“

- Prevent avoidance of passing 12 month threshold by splitting contracts.

- Does not address profit attribution.

Action 7 – Permanent establishment Three main areas of concern




June 4, 2015

Action 7: Develop changes to the definition of PE to prevent the artificial avoidance of PE status in relation to BEPS, including through the use of commissionaire arrangements and the specific activity exemptions. Work on these issues will also address related profit attribution issues.

Action 7 – Permanent establishment




June 4, 2015

• Arrangement whereby a person (the commissionaire) sells products in a given state in its own name but on behalf of a foreign enterprise that is the owner of the products.

• The commissionaire is compensated with a commission, reducing the amount of taxable profit in the country of the sale.

• Foreign enterprise takes position it does not have PE in country of sale because commissionaire is not a dependent agent that has the authority to conclude contracts “in the name of the enterprise.”

4 alternative approaches:

• Replace wording “conclude contracts” with “engages with specific persons in a way that results in the conclusion of contracts.”

• Replace “conclude contracts” with “concludes contracts, or negotiates the material elements of contracts.”

• Replace “contracts in the name or the enterprise” with “contracts which, by virtue of the legal relationship between that person and the enterprise, are on the account and risk of the enterprise.”

• Combine approaches 2 and 3 above.

Action 7 – Permanent establishment Commissionaire arrangements




June 4, 2015

• Currently, several types of activities are specifically excluded from constituting a PE, including maintaining facilities in a state for purposes such as storage, display or delivery of goods of merchandise; for the purpose of purchasing goods or collecting information for the enterprise; and others.

• The concern is that these exemptions are not restricted to preparatory or auxiliary activities.

• In the changing digital economy, some of the activities that are excluded from constituting a PE may be more likely to form the integral part of an enterprise’s business.

• Alternative approaches:

• Make all the activities currently listed subject to the requirement of being preparatory or auxiliary.

• Remove the exemption for the use of facilities for the delivery of goods or merchandise belonging to the enterprise.

• Delete the provision exempting the maintenance of a fixed place of business solely for purchasing goods or merchandise or collecting information for the enterprise (alternatively, retain the exemption for information collection).

Action 7 – Permanent establishment Specific activity exemptions




June 4, 2015

• Proposes an entirely new Chapter VII Special Considerations for Intra-Group Services to the OECD Transfer Pricing Guidelines; mirrors 1.482-9(b) in many ways

• Includes a cost plus safe harbor of 2% to 5% on low value-adding services: services performed by one or more members of an MNE group which are (a) supportive in nature, (b) not part of the core MNE business, (c) do not require the use of, nor create, unique and valuable intangibles, and (d) do not involve assumption, control, or creation of substantial or significant risk.

• The OECD provides additional guidance on:

1. A standard definition of low value-adding intra-group services;

2. The meaning of shareholder activities and duplicative costs;

3. Appropriate cost allocation methodologies;

4. Satisfying the benefits test;

5. Documentation that taxpayers should prepare and submit in order to qualify for the simplified approach in determining an arm’s length charge.

Action 8-10 – TP guidelines for low value-adding intra-group Services




June 4, 2015

• In the discussion draft on profit splits, the OECD’s position is that transactional profit splits may be appropriate where a multinational’s business is ‘highly integrated.’

- In such situations, strategic risks may be jointly managed and controlled by more than one related entity.

- The discussion draft treats transactional profit splits as a means of aligning profit with value creation, but it acknowledges the subjectivity of profit splits.

• The draft discusses different issues and questions that cover controversial areas of profit splits in the context of global value chains:

1. Integration and sharing of risks

2. Fragmentation

3. Lack of comparables

4. Hard-to value intangibles

5. Dealing with ex ante/ex post results

6. Dealing with losses

• The views and options included in the draft do not represent a consensus of all parties involved, but they do provide a useful overview of the current thinking and areas that will ultimately be addressed following further consultations.

Action 10 – Profit splits in the context of global value chains




June 4, 2015

• The draft on risk and situations calling for recharacterization or ‘special measures’ is divided into two parts:

- Part I would revise the OECD Transfer Pricing Guidelines to emphasize the parties’ substantive commercial and financial relationships;

- Part II has options for special measures on intangible assets, risk, and over-capitalization, some going beyond the arm’s length principle.

• Contractual allocations of risk are only a starting point, as they are still subject to a substantive analysis of the parties’ economic behavior in the context of the multinational’s entire value chain.

• The OECD would permit tax authorities to override a written contract among related entities, recasting terms to reflect risk allocation measures tax authorities believe unrelated parties would take in a similar commercial or financial relationship.

• The draft introduces the concept of ‘moral hazard’ between unrelated parties, the lack of incentive to guard against risk where one is protected from its consequences.

• The OECD poses provocative questions such as:

- Under the arm’s length principle, should transactions between associated enterprises be recognized where the sole effect is to shift risk?

- Under the arm’s length principle, what role, if any, should imputed moral hazard and contractual incentives play with respect to determining the allocation of risks and other conditions between associated enterprises?

Action 8-10 – Risk, recharacterization and special measures




June 4, 2015

BEPS – Going forward


10 BEPS – Going forward Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

• It is widely believed that many of the BEPS proposals will lead to a marked increase in tax assessments on U.S.-based multinational companies and that it will be more difficult for competent authorities to agree on principles to eliminate double taxation.

• The draft BEPS reports so far appear to provide tax authorities:

- More tools to challenge reported transfer pricing positions;

- More tools to assert broader taxing rights;

- More tools to challenge treaty benefits.

• In evaluating transactions, tax authorities may well have a basis, post-BEPS, to:

- Disregard legal entities;

- Disregard/recharacterize contractual arrangements;

- Ignore the allocation of risks/legal ownership of assets.

Prevailing “BEPS” impact prediction




June 4, 2015

• Overall, the IRS is more worried about the challenges BEPS will bring than they are hopeful that it will enhance enforcement of U.S. international tax laws.

• It is believed that both the IRS and Treasury see the United States as a potential net loser in a new BEPS world, perhaps substantially so.

• The IRS will face significant challenges in implementing the exchange of country-by-country reports and is concerned about the demands of post-exchange follow-up requests for information. Challenges include:

- Severe budget and personnel limitations;

- Many important and competing priorities.

• That being said, we have already seen IRS agents point to BEPS in pursuing issues on audit.

• We are also already seeing APMA adopt a more “conservative” approach.

IRS posture on BEPS




June 4, 2015

Legislative updates


11 Legislative updates Legislative updates BEPS – Going forward Base Erosion and Profit Shifting UK Diverted profits taxes Significant cases IRS Guidance Treasury proposes fundamental changes to US Model Treaty


June 4, 2015

General political landscape Issues influencing U.S. tax policy


11 Legislative updates

Global tax scrutiny

Divided government

Economic concerns

Federal budget deficits

International competitiveness



June 4, 2015

2016 Obama Budget

• Proposes to extend the look-through provisions.

• Proposes to impose a 19% minimum tax on foreign income.

• Proposes to impose a 14% one-time tax on previously untaxed foreign income.

• Proposes to limit shifting of income through intangible property transfers.

• Proposes to restrict the use of hybrid arrangements that create stateless income.

• Proposes to close loopholes under Subpart F.

• Proposes to extend the exceptions under Subpart F rules for active financing income.

Legislative update




June 4, 2015

• A number of BEPS-like proposals have been published in the U.S. international tax reform context

- Expanding Subpart F regime

◦ Baucus Option Z to end deferral and give 40% participation exemption

◦ Baucus Option Y to make “low tax” income Subpart F income

◦ Baucus Proposal to repeal “check-the-box” Subpart F planning and eliminate Section 954(c)(6) except for “non-hybrid” dividends

◦ Camp “Intangible Income” Subpart F proposal

Recent proposals




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Documents

· 6/3/2015 · 2 PLR 201452002 ; 6 . 3 IRS revokes Rev. Rul. 78-130; issues triple drop and check guidance : 11 . 4 Section 901(m) & Notice 2014 -44 : 15 . 5 Treasury …