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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 Michael Peggs and Scott R. Robson review the draft guidance and express disappointment.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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Joint Audits: A New Tool for Cross-Border Tax Evasion

Joint Audits: A New Tool for Cross-Border Tax Evasion

When a large corporate taxpayer receives an audit notification letter from the tax authority in its country of residence, the taxpayer typically knows what to expect: a lengthy process of documenting and defending its tax position. It also knows the process under domestic law for appealing adverse tax adjustments, and if cross-border issues are raised, it knows how to take advantage of Mutual Agreement Procedures between competent authorities under an income tax treaty. The full process can take years to resolve. Now, however, a pilot program between German and Italian tax authorities empowers a joint cross-border audit team to conduct a single joint audit of cross-border operations between the two countries. The joint audit is intended to be more effective for resolving issues of double taxation in cases involving complex facts related to (i) transfer pricing issues, (ii) residency or permanent establishment issues, and (iii) aggressive tax planning schemes. Marco Orlandi of Ludovici Piccone & Partners, Milan, examines the actual process followed in the pilot program and comments on whether the goals of the joint audit have been achieved.

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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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Income Shifting: Common Ownership or Control Under Code §482 in an Inbound Transaction

Income Shifting: Common Ownership or Control Under Code §482 in an Inbound Transaction

The Large Business and International Division of the I.R.S. (“LB&I”) periodically develops international practice units (“I.P.U.’s”) that serve as training material for international examiners.  In November 2017, an I.P.U. entitled “Common Ownership or Control Under IRC 482 – Inbound” was published.  On the same date, the I.R.S. issued a sister I.P.U. for outbound transactions, “Common Ownership or Control Under IRC 482 – Outbound.”  Together, they serve as a primer for determining whether sufficient control exists between two parties to bring the arm’s length transfer pricing rules of Code §482 into play.  Stanley C. Ruchelman explains how the I.R.S. trains its examiners when determining whether a transfer pricing adjustment is appropriate. 

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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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India: Legal and Practical Strategies for Managing Tax Disputes

India: Legal and Practical Strategies for Managing Tax Disputes

Most readers of this journal are front-end tax planners, proposing plans to be implemented by clients.  Regrettably, not all plans escape examination by the tax inspector, and in India, that number is on the rise.  Sanjay Sanghvi of Attorneys Khaitan & Co., Mumbai explains how to prepare for a tax examination in India and provides practical insights into the examination, appeals, and judicial review processes.

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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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Transfer Pricing Adjustment Does Not Reduce Dividend Received Deduction from C.F.C.

When the I.R.S. successfully maintains an adjustment to transfer pricing within an intercompany group, taxable income is increased to one participant but cash remains at the level that existed at year-end prior to the I.R.S. adjustment.  To avoid a second tax adjustment, the party with excessive cash – as determined after the I.R.S. adjustment – may be treated as if it incurred an account payable, which can be repaid free of additional tax.  In Analog Devices, the I.R.S. attempted to argue that the account payable of the C.F.C. should be treated as an actual borrowing.  The effect of an actual borrowing limited the favorable tax treatment under Code §965.  That provision temporarily allowed an 85% dividends received deduction for a U.S. corporation receiving a dividend from a controlled foreign corporation.  The Tax Court disagreed with the I.R.S. position. Kenneth Lobo and Beate Erwin explain.

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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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Treasury Attacks European Commission on State Aid – What Next?

On August 30, 2016, the European Commission ordered Ireland to claw back €13 billion ($14.5 billion) plus interest from Apple after favorable Irish tax rulings were deemed to be illegal State Aid.  The U.S. Treasury Department issued a white paper shortly before the decision staking out the reasons why the European Commission crusade is unjustified, especially in relation to its retroactive effect.   This trans-Atlantic conflict is placed in context in an article by Kenneth Lobo and Beate Erwin.

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

In the March 2016 edition of Insights, Kenneth Lobo, Sheryl Shah, and Beate Erwin look at the following recent developments: (i) an A.B.A. recommendation for higher Cuban compensation for seized U.S. businesses, (ii) U.S. inversions and European State Aid investigations targeting U.S. companies, (iii) an increase in the stakes faced by Coca Cola in its transfer pricing dispute with the I.R.S., and (iv) the U.K. reaction to the Google Settlement tax payment.

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3M Case to Test “Foreign Legal Restrictions” Regulations Under Code §482

Who knows best, the I.R.S. or the U.S. Supreme Court? Refusing to give up on its position that Code §482 trumps a foreign law that caps amounts used in related-party transactions, the I.R.S. is challenging 3M, a corporation that is acting in compliance with Brazilian law. Elizabeth V. Zanet and Galia Antebi delve into a legal issue that most adviser though was settled years ago by the U.S. Supreme Court.

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International Practice Unit: License of Intangible Property from U.S. Parent to a Foreign Subsidiary

Christine Long explains how I.R.S. examiners are encouraged to determine whether foreign subsidiaries are paying fair compensation for using I.P. owned by U.S. parent companies.

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Taxpayers Take Note: I.R.S. Publishes Audit Guides for International Examiners

U.S.-based companies facing an I.R.S. examination of international operations may secretly wish to obtain an advance look at how I.R.S. examiners plan to carry out the examination. After all, what better way to prepare for a test than to get the questions in advance? Surprise – the Large Business & International (LB&I) Division of the I.R.S. has published its training guides for examiners.

LB&I is responsible for examining tax returns reporting international transactions, and it is in the process of revising the method by which returns are chosen for examination and the the process by which those examinations are conducted. Several aspects of the guidance will be addressed through out this edition of Insights. Stanley C. Ruchelman explains.

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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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