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Debt Characterization and Deductibility Under Domesticated International Rules

Debt Characterization and Deductibility Under Domesticated International Rules

The limitation of interest deductibility to 30% of adjusted E.B.I.T.D.A. has focused the attention of U.S. corporations and their lenders on new constraints. How does a borrower demonstrate the capacity to carry and service debt, and how do related parties demonstrate that the rate of interest and other terms attaching to a cross-border loan are arm’s length? Michael Peggs and Stanley C. Ruchelman address these issues, explaining the three methods used to identify the boundary between debt and equity: (i) the qualitative approach of case law (I know it when a I see it, although I can’t agree to a uniform standard of application), (ii) the data-driven approach of comparative analysis (I know it when I can measure the effect, much like gravity), and (iii) the procedural approach for borrowers as set out in the Code §385 regulations which were in effect for a short period of time (I know it when I follow the recipe in the regulatory cookbook).

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O.E.C.D. Discussion Draft on Financial Transactions – A Listing of Sins, Little Practical Guidance

O.E.C.D. Discussion Draft on Financial Transactions – A Listing of Sins, Little Practical Guidance

In July, the O.E.C.D. Centre for Tax Policy and Administration released Public Discussion Draft on B.E.P.S. Actions 8-10: Financial transactions (the “Discussion Draft”) addressing financial transactions (e.g., loans, guarantees, cash pools, captive insurance, and hedging). Michael Peggs and Scott R. Robson review the draft guidance and express disappointment. The Discussion Draft is not a thought leader, as tax authorities have successfully litigated the issues inherent in intercompany loans. Decided cases generally reflect a “not in my back yard” approach to deductions for interest expense. The Discussion Draft makes statements regarding allocation of risks in financial transactions that are inconsistent with arm’s length evidence. It also promotes decisions based on 20-20 hindsight. All these lead to several unanswered questions: What is the ultimate meaning of the term “arm’s length” when used in a cross-border financial transaction? Is it the terms and conditions that exist in actuality among lenders and borrowers, or is it the terms and conditions that should exist in the mindset of the tax authorities?

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Managing a Transfer Pricing Exam? Wash Your Hands with Soap and Water

Managing a Transfer Pricing Exam? Wash Your Hands with Soap and Water

For management of a U.S. subsidiary of a foreign parent, the process by which the I.R.S. conducts an examination of a tax return creates a heightened stress level.  It begins with the arrival of an information document request ("I.D.R.") for transfer pricing documentation, which often comes as a surprise to a company.  Typically, two or three years have passed since the close of the year under examination and little is recalled about transactions.  From there, the expressed positions of I.R.S. examiners and management often are at odds.  Drawing on many years of experience in defending intercompany transfer pricing policies, Michael Peggs takes a step back from the fray to examine how opposing, pre-conceived notions on both sides combine with the Semmelweis Reflex to exacerbate what should be a straightforward tax examination.

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Can the Arm’s Length Standard Beat the R.A.P.? Transfer Pricing After the T.C.J.A.

Can the Arm’s Length Standard Beat the R.A.P.? Transfer Pricing After the T.C.J.A.

Experienced tax litigators know that Congress often protects the I.R.S. when an important case is lost.  Yes, the taxpayer wins.  But Congress codifies the I.R.S. position by an amendment to the law.  The T.C.J.A. revised Code §482 legislatively, thereby reversing Tax Court decisions in the Amazon and Veritas cases that dismissed two arguments raised by the I.R.S. in transfer pricing litigation – mandatory use of aggregate basis of valuation (grouping of intangibles for valuation purposes) and the realistic alternative principle (challenging the business judgment for the transaction).  Michael Peggs and Sheryl Shah explain this attack on the arm’s length principle of taxation.

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O.E.C.D. Releases Mutual Agreement Procedure Peer Review Report for the U.S.

O.E.C.D. Releases Mutual Agreement Procedure Peer Review Report for the U.S.

The B.E.P.S. Action 14 Report, Making Dispute Resolution Mechanisms More Effective, acknowledged that the actions to counter B.E.P.S. must be complemented with effective dispute resolution mechanisms.  Participating countries agreed to have their compliance with the minimum standard reviewed by their peers.  The U.S. is among the first few countries that have been reviewed.  Neha Rastogi and Michael Peggs summarize the M.A.P. report card issued for the U.S. 

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Eaton A.P.A. Cancellations Were an Abuse of I.R.S. Discretion

Eaton A.P.A. Cancellations Were an Abuse of I.R.S. Discretion

A recent U.S. Tax Court decision involving Eaton Corporation affirmed that the I.R.S. cannot arbitrarily circumvent administrative rules that are set down in revenue procedures and relied upon by the I.R.S. and a taxpayer.  As a result, the I.R.S. must reasonably exercise its discretion when seeking to terminate an advance pricing agreement with a taxpayer.  Michael Peggs looks at the process of obtaining an advanced pricing agreement and comments on the court’s decision.

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Amazon Makes the C.U.T. – An Important Taxpayer Win, A Reminder to Consider Transactional Evidence

Amazon Makes the C.U.T. – An Important Taxpayer Win, A Reminder to Consider Transactional Evidence

Last month, Insights reported on the Tax Court decision in Amazon v. Commr., involving the “buy-in” payment made as compensation for the right to use pre-existing I.P. in a related-party cost-sharing arrangement (“C.S.A.”).  This month, Michael Peggs comments on the lessons learned from the taxpayer victory in that case regarding (i) the transfer pricing method used, (ii) the assumptions made and analyses used to value the buy-in payment, and (iii) the correct treatment of intangible development costs within the term of the C.S.A.

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Insights Vol. 3 No. 9: Updates & Other Tidbits

This month, the authors look briefly at several timely issues, including (i) the filing of appeals briefs in two major cases lost by the I.R.S., Altera and Xilinx, (ii) recent competent authority activity between the U.S. and India, (iii) the future of U.K. automobile assembly plants operated by U.K. subsidiaries of Japanese automakers, and (iv) final State Department rules concerning the revocation of U.S. passports issued to individuals who have a seriously delinquent tax debt.  Kenneth Lobo, Michael Peggs, Nina Krauthamer, and Sultan Arab contribute.

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B.E.P.S. Action 7 – O.E.C.D. Calls for Improved International Coordination on the Allocation of Branch Profit

One of three releases on July 4, the O.E.C.D.’s Additional Guidance on the Attribution of Profits to Permanent Establishments addresses the imponderable question – how much profit should be attributed to a P.E.?  The answer will make tax advisers quite happy: It depends on the facts, and the O.E.C.D. suggests that a coordinated global approach is required to avoid double taxation.  Stakeholders are invited to comment.  Michael Peggs examines five examples in the additional guidance.

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A New Way to Do the Splits: B.E.P.S. Guidance Falls Short of Enabling Global Formulary Apportionment

From the moment the B.E.P.S. Project began in 2013, multinational enterprises have been concerned that tax authorities would be emboldened to apportion income resulting from the joint commercialization of intangible assets.  Surprise.  A July 4 publication of the O.E.C.D. Revised Guidance on Profit Splits discussion draft does not place an over-broad profit apportionment tool in the hands of tax authorities.  Michael Peggs explains why the transactional profit split method may not be appropriate in many instances. 

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Transfer Pricing Positions of Consolidated Groups: After Guidant

Michael Peggs and Kenneth Lobo comment on the I.R.S. victory in the Guidant case where the I.R.S. applied the “one size fits all” approach to group-wide transactions. Their conclusion is that today’s I.R.S. victory may be tomorrow’s lost revenue where a taxpayer seeks competent authority relief for transfer pricing adjustments initiated abroad.

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Country-by-Country Reporting – Where Are We Going?

B.E.P.S. Action 13 addresses country-by-country reporting among tax authorities as a means of ferreting out mismatches between functions and profits. Now, CbC reporting is morphing in Europe to a public disclosure tool to bring N.G.O.’s into the process. Your tax savings through planning becomes a global problem for the N.G.O.’s to redress through public outcry. Michael Peggs and Kenneth Lobo tell all.

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A Proposed Treatment For H.T.V.I.

H.T.V.I. has been singled out as being one of the leading causes of base erosion and profit shifting (“B.E.P.S.”). Michael Peggs, co-head of the transfer pricing practice of Ruchelman P.L.L.C., makes a valiant attempt at explaining a method to value intangible property that is “hard to value” while being compliant with the B.E.P.S. Action Plan. He suggests a combination of common sense and reliable data.

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Tax Court Strikes Down I.R.S. Position on Stock-Based Compensation in Altera Case

Is the Altera case important because it struck down the I.R.S.’s stock-based compensation regulations related to cost sharing agreements? Or is it important because of the procedural analysis, which enabled the Tax Court to be in position to strike down a regulation? Beate Erwin, Stanley C. Ruchelman, and Michael Peggs explain why the case is important for both reasons. 

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Transfer Pricing Litigation from A to Z

A number of transfer pricing cases, many with potentially significant precedent value and tax provision consequences, are either at trial or proceeding to trial. Michael Peggs and Cheryl Magat comment on two of the major cases on the Tax Court Docket, Altera and Zimmer. Those who think arm’s length means “do what others do” will be surprised.

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Foreign Correspondence: Notes from Abroad

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HOLIDAY SHOPPING, CANADIAN RETAIL PRICES AND TRANSFER PRICING CONTROVERSY

By Michael Peggs

When people think of massive transfer pricing cases, the driver typically is the diversion of profits to a low-tax jurisdiction. But transfer pricing issues are now filtering down to the level of retail shoppers facing retail price disparity in adjacent jurisdictions. A typical case is the premium that Canadian purchasers generally pay over prices charged in the U.S. for comparable products.

Before the internet, it was customary for Canadians to receive flyers in the mail from U.S. grocery and department stores. The flyers offered bargains for the holidays. The internet now allows instant price comparisons and greater choice for Canadian consumers. Disregarding sub rosa impediments to competition that permeate many areas of the Canadian economy – think of cultural preferences – Canadians have complained loudly that retail prices are unfairly high when compared with exchange-adjusted U.S. prices. A typical example is print media where the premium for pricing the Canadian edition was not reduced over the period in which the Canadian dollar reached parity with its U.S. counterpart.

The Canadian government is now preparing to give the Competition Bureau new powers to persuade U.S. multinationals with Canadian retail operations to lower prices or to achieve retail price parity, as will be determined. One hopes that Industry Canada will intervene with the Canada Revenue Agency (“C.R.A.”) before drafting legislation, as an unintended consequence may be a new round of Canadian transfer pricing controversy.

I.R.S. vs. O.E.C.D. – How Are Tax Authorities Planning to Conduct Your Next Transfer Pricing Audit

This article addresses major developments in transfer pricing practice that will affect the way advice is given to clients and their ability to implement such advice. Over the past 15 months, the I.R.S. and the O.E.C.D. separately published transfer pricing audit and administrative initiatives that will significantly impact the way controlled transactions among related parties are reported. These initiatives are consistent with overall concerns raised in the Base Erosion and Profit Shifting (“B.E.P.S.”) Report of the O.E.C.D. Each stands independently of B.E.P.S. and will likely be unaffected by the ultimate actions plans implementing B.E.P.S. goals.

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