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I.R.S. Adds New Issues of Focus for Cross-Border Audits

I.R.S. Adds New Issues of Focus for Cross-Border Audits

In late 2018, LB&I announced five additional campaigns aimed at determining whether taxpayers are complying with tax rules in the following areas of the law: (i) foreign tax credits claimed by U.S. individuals, (ii) offshore service providers that assist taxpayers in creating foreign entities and tiered structures to conceal the U.S. beneficial ownership of foreign financial accounts, (iii) F.A.T.C.A. compliance by F.F.I.’s and N.F.F.E.’s, (iv) tax return compliance by foreign corporations that ignore the fact that they are engaged in a U.S. trade or business under the rules of U.S. tax law, and (v) late issuance of Work Opportunity Tax Credit (“W.O.T.C.”) certifications that result in the need to file amended tax returns and result in a misuse of I.R.S. resources when returns are filed without the W.O.T.C certifications. The move follows more than two years, of I.R.S. publications that alert the public to certain issue-based approaches being followed by examiners. Galia Antebi and Elizabeth V. Zanet summarize the new releases.

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Modifications to the Foreign Tax Credit System Under the Tax Cuts and Jobs Act

Modifications to the Foreign Tax Credit System Under the Tax Cuts and Jobs Act

The T.C.J.A. introduces new concepts in foreign tax credit planning and eliminates others.  Gone are the pool of post-1986 earnings & profits and deemed-paid foreign tax credits for intercompany dividends.  In their place is a dividends received deduction.  Allocations of interest expense between foreign-source income and domestic income now must be based on tax book value.  Entities that manufacture in one jurisdiction and sell in another will find that the source of income is controlled only by production activities.  Neha Rastogi and Stanley C. Ruchelman explain.

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Foreign Tax Credits: General Principles and Audit Risks

Foreign Tax Credits: General Principles and Audit Risks

In April, the Large Business & International Division (“LB&I”) of the I.R.S. published an International Practice Unit directed to the foreign tax credit claimed by individuals.  Tax advisers to Americans living abroad or having global investment portfolios may find that the Practice Unit indicates topics of interest for the I.R.S.  Fanny Karaman and Galia Antebi explain the concepts covered, including persons eligible to claim the credit, foreign taxes that qualify for credit, whether to deduct or credit a foreign income taxes, foreign tax credit limitations, and means of ameliorating the effect of unused credits in a particular year.

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Foreign Tax Credit May Not Be Available for Gains Derived Outside the U.S.

Foreign Tax Credit May Not Be Available for Gains Derived Outside the U.S.

Merely because a foreign country imposes an income tax and the tax is creditable does not mean that effective relief from double taxation is available.  The U.S. retains the first right to tax income and gains that are domestic in character, and the income or gain on which the foreign tax is imposed must be categorized as foreign for relief to be provided.  Kenneth Lobo and Galia Antebi focus on this issue and advise that advance planning will be required.

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§338(g) Election in the Cross-Border Context: I.R.S. Targets Foreign Tax Credit Enhancer

§338(g) Election in the Cross-Border Context: I.R.S. Targets Foreign Tax Credit Enhancer

Code §338(g) allows a taxpayer to elect to treat certain share purchases as if the transactions were asset purchases.  As a result, the premium paid for the shares can be pushed down to increase the basis in operating assets of the acquired company.  The step-up in depreciable basis results in steeper depreciation and amortization deductions for U.S. tax purposes.  Because a comparable tax benefit is not obtained in the jurisdiction where the target operates, the Code §338(g) treatment magnifies the effective tax rate in the foreign country when looked at from a U.S. tax viewpoint.  This creates mountains of excess foreign tax credits that can be used to reduce U.S. tax on other items of foreign-source income, provided those items are subject to little or no foreign tax and fall within the same foreign tax credit limitation basket.  A similar result can be achieved through a check-the-box election, which acts as a poor man’s Code §338(g) election.  Code §901(m) attempts to disallow the enhanced level of the foreign tax credit, and the I.R.S. recently issued temporary and proposed regulations.  Rusudan Shervashidze and Stanley C. Ruchelman explain the labyrinth of rules.

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Regulations Would Address Foreign Tax Credit Planning for E.U. State Aid Adjustments

Regulations Would Address Foreign Tax Credit Planning for E.U. State Aid Adjustments

Now that Apple, Starbucks, and other U.S. companies face significant tax adjustments in Europe, the I.R.S. is concerned with protection of the U.S. tax base.  In Notice 2016-52, the I.R.S. announced that the foreign tax credit splitter rules will be applied in future regulations to ensure that the increased taxes are not separated from the earnings and profits to which they relate.  Elizabeth V. Zanet and Stanley C. Ruchelman explain these preemptive steps to prevent the creation of imaginative financial products that monetize unused foreign tax credits of target companies.

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Albermarle: Refund Claims Relating to Foreign Tax Credits

We analyze a recent U.S. Court of Appeals case, Albemarle Corp. v. United States, that affirmed certain refund claims were barred by the statute of limitations. The case involved withholding taxes on payments of interest to Albemarle Corp. from its Belgian subsidiary during the years 1997 to 2001. The court held that the taxpayer’s claims for refunds, attributable to foreign tax credits, were time-barred in certain years.

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The Hewlett-Packard Debt v. Equity Case – Reply Brief Filed

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INTRODUCTION

The focus of a debt-versus-equity inquiry generally narrows to whether there was intent to create a debt with a reasonable expectation of repayment and, if so, whether that intent comports with the economic reality of creating a debtor-creditor relationship. This determination has led various courts of appeals to identify and consider a multi-factor test for resolving such inquires.

In the typical debt-versus-equity case, the I.R.S. will argue for equity characterization whereas the taxpayer will endeavor to secure debt characterization to obtain an interest deduction. In some cases, the roles are reversed, but this does not require that courts apply different legal principles. Some courts consider 10 factors, while others consider as many as 16 factors. No matter how many factors are considered, the multi-factor test is the established, standard analysis used in such disputes.

Moving Deductions into the U.S. as a Tax Planning Strategy

volume 2 no 4   /   Read article

By Stanley C. Ruchelman and Philip R. Hirschfeld

This month, our team delves into the Joint Committee Report addressing international tax reform in a series of articles. Taking a lead from the preceding article, the report discovers that a better tax result is obtained when deductible expenses are booked in high tax countries. Stanley C. Ruchelman and Philip R. Hirschfeld explain.  See more →

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Insights Vol. 1 No. 10: Updates & Other Tidbits

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ISRAEL ANNOUNCES ADOPTION OF O.E.C.D.’S COMMON REPORTING STANDARD

Israel has announced that it will adopt the Standard for Automatic Exchange of Financial Account Information: Common Reporting Standard (“C.R.S.”) issued by the O.E.C.D. in February 2013.

The C.R.S. establishes a standardized form that banks and other financial institutions would be required to use in gathering account and transaction information for submission to domestic tax authorities. The information would be provided to domestic authorities on an annual basis for automatic exchange with other participating jurisdictions. The C.R.S. will focus on accounts and transactions of residents of a specific country, regardless of nationality. The C.R.S. also contains the due diligence and reporting procedures to be followed by financial institutions based on a Model 1 F.A.T.C.A. intergovernmental agreement (“I.G.A.”).

At the conclusion of the October 28-29 O.E.C.D. Forum on Transparency and Exchange of Information for Tax Purposes, about 50 jurisdictions had signed the document. The U.S. was notably absent as a signatory to the agreement. In addition to the C.R.S., the signed agreement contains a model competent authority agreement for jurisdictions that would like to participate at a later stage.

Insights Vol. 1 No. 8: Updates & Other Tidbits

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U.K. WINDFALL WINDING DOWN

After an arduous path through the courts regarding the creditability of the U.K. windfall tax, the Third Circuit followed the holding of the U.S. Supreme Court and found the tax to be creditable in a case involve PPL Corp.

The U.S. and foreign countries can tax foreign-sourced income of U.S. taxpayers. To lessen the economic cost of double taxation, U.S. taxpayers are allowed to deduct or credit foreign taxes in computing income or net tax due. The amount of the U.S. income tax that can be offset by a credit cannot exceed the proportion attributable to net foreign source income. Code §901(b) specifies that a foreign credit is allowed only if the nature of the foreign tax is similar to the U.S. income tax and is imposed on net gain.

The U.S. entity PPL is a global energy company producing, selling, and delivering electricity through its subsidiaries. South Western Electricity PLC (“SWEB”), a U.K. private limited company, was an indirect subsidiary that was liable for windfall tax in the U.K. Windfall tax is a 23% tax on the gain from a company’s public offering value when the company was previously owned by the U.K. government. When SWEB paid its windfall liability, PPL claimed a Code §901 foreign tax credit. This was denied by the I.R.S. and the long and winding litigation commenced.

Initially, the Tax Court found the windfall tax to be of the same character as the U.S. income tax. The decision was reversed by the Third Circuit Court of Appeals, which held that the tax was neither an income tax, nor a war profits tax, nor an excess profits tax. It took into consideration in determining the tax base an amount greater than gross receipts. Then, the Supreme Court reversed, finding that the predominant character of the windfall tax is an excess profits tax based on net income. Therefore, it was creditable. In August, the Third Circuit followed the Supreme Court’s decision and ordered that the original decision in the Tax Court should be affirmed.

First Circuit Holds Corporation's Possessions Tax Credit Was Not Reduced

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Recently, the First Circuit held that Code §936 does not require a credit cap decrease for the U.S. seller of business lines in Puerto Rico if the buyer is a foreign entity that does not pay U.S. corporate income tax. In OMJ Pharmaceuticals, Inc. v. U.S., a U.S. corporation based in Puerto Rico transferred a significant portion of its assets to an Irish subsidiary; the corporation was not required to decrease its base period income for the purposes of computing the cap on its Section 936 possessions tax credit. As a result, the corporation’s credit was not capped at the lower amount that was asserted by the I.R.S., thus allowing the corporate taxpayer a refund of close to $53 million.

From 1976 to 1996, Code §936 provided to U.S. corporations a credit that fully offset the federal tax owed on income earned in the operation of any trade or business in Puerto Rico. Under the Small Business Job Protection Act of 1996 (P.L. 104-188), the credit was repealed and phased out over a ten-year period. During this transition period, the credit remained available only to those taxpayers who had claimed it in previous years. Furthermore, during the last eight years of the transition period the taxable income that an eligible taxpayer could take into account in computing its credit was capped at an amount roughly equal to the average of the amounts it had claimed in previous years. Although the cap was generally fixed, it could be adjusted up and down to account for the taxpayer’s purchases and sales of lines of business that had generated credit-eligible income.

Tax 101: Outbound Acquisitions - Holding Company Structures

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When a U.S. company acquires foreign targets, the use of a holding company structure abroad may provide certain global tax benefits. The emphasis is on “global” because standard U.S. benefits such as deferral of income while funds remain offshore may not be available without further planning once a holding company derives dividends and capital gains. This article will discuss issues that should be considered when setting up a company overseas, particularly a foreign holding company, in order to maximize foreign tax credits despite the limitations under the U.S. tax rules, and to reduce the overall U.S. taxes paid. These issues include challenges to the substance of a holding company, recent trends in inversion transactions, the net investment income tax on investment income of U.S. individuals, and the significance of the O.E.C.D. Base Erosion and Profit Shifting report on tax planning structures.

U.S. TAXATION OF INTERCOMPANY DIVIDENDS AMONG FOREIGN SUBS

If we assume the income of each foreign target consists of manufacturing and sales activities that take place in a single foreign country, no U.S. tax will be imposed until the profits of the target are distributed in the form of a dividend or the shares of the target are sold. This is known as “deferral” of tax. Once dividends are distributed, U.S. tax may be due whether the profits are distributed directly to the U.S. parent company or to a holding company located in another foreign jurisdiction. Without advance planning to take advantage of the entity characterization rules known as “check-the-box,” the dividends paid by the manufacturing company will be taxable in the U.S. whether paid directly to the parent or paid to a holding company located in a third country. In the latter case, and assuming the holding company is a controlled foreign corporation (“C.F.C.”) for U.S. income tax purposes, the dividend income in the hands of the holding company will be viewed to be an item of Foreign Personal Holding Company Income, which generally will be taxed to the U.S. parent company, or any other person that is treated as a “U.S. Shareholder” under Subpart F of the Internal Revenue Code.

Insights Vol. 1 No. 5: Updates & Other Tidbits

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SUPPORT FOR PROPOSED BILLS LIMITING CORPORATE INVERSIONS WEAK GIVEN DESIRE FOR FULL INTERNATIONAL TAX OVERHAUL

The Stop Corporate Inversions Act was introduced in the Senate on May 20 by Senator Carl Levin. The bill represents an attempt to tighten U.S. tax rules preventing so-called “inversion” transactions, defined generally as those involving mergers with an offshore counterpart. Under current law, a U.S. company can move its headquarters abroad (even though management and operations remain in the U.S.) and take advantage of lower taxes, as long as at least 20% of its shares are held by the foreign company's shareholders after the merger. Under the bill, the foreign stock ownership for a non-taxable entity would increase to 50% foreignowned stock. Furthermore, the new corporation would continue to be considered a domestic company for U.S. tax purposes if the management and control remains in the U.S. and at least 25% of its employees, sales, or assets are located in the U.S. The Senate bill would apply to inversions for a two year period commencing on May 8, 2014. A companion bill (H.R. 4679) was introduced in the House which would make the changes permanent. However, the bills face opposition on the Hill with lawmakers indicating that the issue could be better solved as part of a broader tax overhaul. House Republicans favored pushing corporate tax rates lower as opposed to tightening inversion requirements, believing that the lower rates would give corporations an incentive to stay in the U.S. and invest, rather than go overseas for a better corporate tax rate. Senate Finance Committee Chairman Ron Wyden (D-Ore.) stated that he would consider the issue at a later time during a hearing on overhauling the international tax laws but would not introduce anti-inversion legislation nor would he sign onto the Levin bill. We agree that any changes to the inversion rules should not be made in isolation but as part of an overall rationalization of the U.S. international tax system.