In a recent decision, the German Federal Tax Court (Bundesfinanzhof or "B.F.H.") held that repayment of capital by a U.S. subsidiary to its German parent company is not taxable in Germany. While this decision is in line with prior caselaw, it is significant because the B.F.H. held that domestic rules apply when determining the extent to which a distribution by a non-E.U. subsidiary to its German parent comes from profits and the extent to which it comes from capital. Because the participation exemption rules under German law exempts only 95% of the dividend through a disallowance of deemed expenses, tax is due on the 5% of the distribution that is attributable to earnings. Under the decision, two factors control the treatment of a distribution from a non-E.U. country: (i) the domestic accounting or corporate law treatment of the residence country and (ii) the ordering rules under German tax law. Beate Erwin and Nina Krauthamer explain the decision and how it interfaces with the ordering rules of U.S. domestic law under which distributions care treated as dividends, return of capital, and capital gains.

The issues raised by virtual currency and the underlying blockchain technology affect tax law, transfer pricing, regulatory rules, civil law accounting rules, and valuation. The issues in all these areas share one common goal: protection of users and investors through the prevention of fraud and abuse. Beate Erwin explains recent guidance by the Financial Action Task Force in this area and the likely effect of the guidance on national laws around the world.

The foreign derived intangible income (“F.D.I.I.”) regime allows for a reduced rate of corporate tax rate on hypothetical intangible income used in a U.S. business to exploit foreign markets.  Many implementation issues that were left open when the provision was enacted have been addressed in proposed I.R.S. proposed regulations issued early March.  In their article, Fanny Karaman and Beate Erwin explain (i) which taxpayers benefit from the regime, (ii) the way deductions are taken into account, (iii) whether the deduction is always available when a U.S. corporation sells on a foreign market, (iv) the way in which foreign use of sales or services is established, and (v) the way in which related-party transactions can qualify as F.D.D.E.I. sales or services.

Hybrid arrangements come in various forms but share a common goal: Each is designed to enhance beneficial tax results by exploiting differences in tax treatment under the laws of two or more countries.  Anti-hybrid rules were adopted as part of the T.C.J.A., which was enacted in the waning days of 2017.  In December 2018, the I.R.S. released proposed regulations that provide guidance on anti-hybrid rules adopted by Congress.  New terms must be understood, including (i) the deduction/no inclusion (“D./N.I.”) rules, (ii) tiered hybrid dividends, (iii) the hybrid deduction account (“H.D.A.”) that addresses timing, and (iv) a principal purposes test denying the benefit of the dividends received deduction.  If final regulations are adopted by June 22, 2019, they will be effective retroactively to the date of enactment of the statute.  In their article, Beate Erwin and Fanny Karaman explain the workings the proposed regulations.

Nothing is certain in this world, except death and taxes – and even taxes are subject to change.  The ever-expanding definition of a permanent establishment (“P.E.”) and ever diminishing exceptions to a P.E. under the O.E.C.D.’s B.E.P.S. Project has made one thing clear – the restrictions local jurisdictions put on activities by foreign taxpayers to trigger taxation are tightening.  The dwindling preparatory and auxiliary activities exception is a prime example.  Neha Rastogi and Beate Erwin explain.

When foreign corporations have certain limited activities in the U.S., a question that arises is whether a taxable presence exists in the U.S. for Federal income tax purposes.  A foreign corporate taxpayer with direct activities or operations in the U.S. is subject to U.S. corporate income tax and branch profits tax if it conducts a U.S. trade or business generating effectively connected income. Recently, the I.R.S. Large Business and International division published an international practice unit (“I.P.U.”) addressing the creation of a P.E. through the activities of a “dependent agent.” Fanny Karaman and Beate Erwin lead the reader through the I.P.U. and explain the four-step process that is used by the I.R.S. to evaluate whether a permanent establishment exists.

The U.S. Department of State administers the Exchange Visitor Program, which designates sponsors to provide foreign nationals with opportunities to participate in educational and cultural programs in the U.S. and return home to share their experiences. These students receive taxable stipends, file tax returns, and reduce taxable income by costs associated with participation. Unfortunately, a recent Tax Court case, Liljeberg v. Commr., has determined that the travel and lodging costs of these individuals could not be deducted. Neha Rastogi and Beate Erwin explain that while home is where the heart is, a “tax home” is where a person is expected to live taking into consideration the person’s principal place of employment.

The I.R.S. has published proposed regulations on Code §965, which requires a U.S. Shareholder to pay income tax on a pro rata share of previously untaxed foreign earnings held in a C.F.C. and certain other foreign corporations. The tax is commonly referred to as the transition tax. It is designed to tax deferred foreign income prior to the transition to a participation exemption system for intercompany dividends from certain foreign corporations. A multi-step computation is required to (i) measure post-1986 E&P, (ii) allocate E&P deficits among affiliated foreign corporations, (iii) calculate the aggregate foreign cash position, (iv) compute allowed deductions, and (v) determine foreign tax credits. Elizabeth V. Zanet, Rusudan Shervashidze, and Beate Erwin detail the required steps as well as special rules applicable to individuals.

When U.S. tax planners attend foreign conferences, it is not uncommon to hear pointed barbs that the U.S. is an outlier when it comes to rules enforcing “best practices” on global business transactions. However, when it comes to reverse hybrids and hybrid mismatches, the rules are not all that different on both sides of the Atlantic. Fanny Karaman and Beate Erwin compare approaches taken by ATAD 2 with U.S. tax law after the Tax Cuts and Jobs Act.

M&A transactions have accelerated as the U.S. economy reacts to the adoption of favorable rules under the Tax Cuts & Jobs Act. But, as mentioned in “Coming to the U.S. After Tax Reform,” an article by Jeanne Goulet in this edition of Insights, many adverse sleeper provisions have also been introduced. For those tax advisers assigned due diligence tasks in advance of an M&A transaction, several additional pages have been added to the D.D. Checklist. Elizabeth V. Zanet and Beate Erwin address the new exposure areas that must be identified by the D.D. team.

Foreign students leaving their home country and arriving in the U.S. for higher education may come across many things that seem alien to them – like the accent, culture, and inexplicably large food portions. But one area where they are treated as the aliens is under U.S. Federal income tax law, where foreign students holding F-1 visas are treated as nonresident aliens who are subject to special tax provisions.  Neha Rastogi and Beate Erwin discuss tax residence status, Federal income tax consequences, and U.S. reporting requirements for holders of F-1 visas.

Prior to recent tax reform legislation, Code §163(j) was an earnings stripping provision that placed a cap on interest expense deductions on debt instruments held or guaranteed by foreign related persons that were not subject to full 30% withholding tax on U.S.-source interest income or guarantee fees.  Under the T.C.J.A., Code §163(j) is now simply a cap on all business interest expense.  Notice 2018-28 addresses open matters arising from the change.  This includes the carryover of disallowed interest from prior years to 2018, the Super-Affiliation Rules under the new law, and the loss of excess limitation carryforwards.  Elizabeth V. Zanet and Beate Erwin explain these and other items in the Notice.

In Europe, an individual’s right to the protection of personal data is a fundamental right.   The E.U. General Data Protection Regulation (“G.D.P.R.”) takes effect on May 25, 2018, to protect that right.  The G.D.P.R. is notable because it applies to all companies processing personal data of persons residing in the European Economic Area regardless of the company's location and irrespective of whether the company has a physical presence in these countries.  Severe penalties are provided for violators. Fanny Karaman and Beate Erwin provide a layman’s guide to the G.D.P.R.

The final months of the Obama administration saw the hurried adoption of temporary regulations in an attempt to extend its tax policy into the current administration.  However, reliance on temporary regulations that are adopted without a public comment period may have been misguided.  In October, a U.S. District Court struck down a provision under temporary anti-inversion regulations for violating the required notice and comment period under the Administrative Procedure Act.  Beate Erwin and Sheryl Shah explain the web of issues involved in the decision.

The sharing economy uses digital platforms to connect suppliers willing to provide services or use of assets with consumers.  Think of Uber and Airbnb.  These multinationals are structured to channel profits to low-tax jurisdictions.  As with Google and Microsoft, tax authorities have begun to challenge these business models.  In part two of this series, Fanny Karaman and Beate Erwin explain how these business models are being challenged.

In August, the O.E.C.D. released public comments on proposed changes to the Model Tax Convention.  Beate Erwin and Stanley C. Ruchelman examines the suggestions received by the O.E.C.D. and provides observations on the interplay between the O.E.C.D. proposed changes and existing U.S. approaches to these issues.  Areas covered include whether competent authority agreements can define undefined terms thereby removing the interpretation from local courts, whether a limitation on benefits (“L.O.B.”) clause or a principle purpose test (“P.P.T.”) is the better approach to limit treaty shopping, and whether a home that is leased to others can be a permanent home for purposes of applying the residence tiebreaker provision in a treaty. 

The current international tax system was established on principles dating back to the first half of the 19th century, when a nation’s retail economy consisted mostly of brick-and-mortar stores.  As the purchase of services and goods was gradually dematerialized and internet giants such as Google or Microsoft appeared, governments struggled adapt tax rules to keep up with new business models.  Now, governments around the world have shifted their focus to a relatively new part of the digital economy called the “sharing economy.”  Fanny Karaman and Beate Erwin look at recent tax developments in the world of Airbnb and Uber.

Earlier this year, the O.E.C.D. proposed amendments to Article 5 (Permanent Establishment) of the Model Tax Convention and Commentary.  The revisions eliminate loopholes that exist for commissionaire arrangements, artificial characterization of core activities as “preparatory,” avoidance of permanent establishment status through artificial fragmentation of contracts, and the use of not-so-independent agents.  Neha Rastogi, Beate Erwin, and Stanley C. Ruchelman explain the replacement provisions.

The New England Patriots recently made headlines with the purchase of two private team jets.  Was this plan implemented only to provide more space for beefy footballers, or did ownership identify the nifty situation that could lead to a jackpot of tax savings for high-ticket assets purchased in 2017?  Beate Erwin and Stanley C. Ruchelman explain that with increased depreciation deductions this year at high tax rates and possible recapture in a future year at low tax rates, the odds are good.

The I.R.S. has a long history in misapplying U.S. tax rules applicable to a sale of a partnership interest.  For U.S. tax purposes, a partnership interest is treated as an asset separate and apart from an indirect interest in partnership assets.  In Rev. Rul. 91-32, the I.R.S. misinterpreted case law and Code provisions to conclude that gains derived by foreign investors in U.S. partnerships are subject to tax.  No one thought the I.R.S. position was correct, but then, in a field advice to an agent setting up an adjustment, the I.R.S. publicly stated that the ruling was a proper application of U.S. law when issued and remains so today. The adjustment was challenged in the Tax Court, and the tax bar is eagerly awaiting a decision.  Stanley C. Ruchelman and Beate Erwin examine the I.R.S. position, the string of losses encountered by the I.R.S. when challenged by taxpayers, and the Grecian Magnesite case awaiting decision.

Ever heard of qualified small business stock (“Q.S.B.S.”) as a means of investing in start-up companies?  Although it is not typically thought of as a tax planning tool for foreign investors, when the foreign person is an applicant for an EB-5 visa, the tax results can be surprisingly good.  Fanny Karaman and Beate Erwin explain.

B.E.P.S. Action 4 focuses on the need to address base erosion and profit shifting using deductible payments, such as interest, that can give rise to double nontaxation in inbound and outbound investment scenarios. The U.S. addressed this problem many years ago with Code §163(j).  In light of recent I.R.S. guidance providing a step-by-step plan to assist auditors when analyzing interest payments, non-U.S. practitioners should be aware of the thin capitalization debt rules when planning for multinational structures.  Kenneth Lobo and Beate Erwin explain how the provision works in general and in several illustrative fact patterns. 

Concepts of usufruct and bare legal ownership are widely used estate planning tools by parents resident in civil law jurisdictions in Europe.  However, when the next generation is resident in a common law jurisdiction such as the U.S., the results are not always pretty.  Fanny Karaman and Beate Erwin examine the tax consequences for the U.S. children and the steps available to the European parents that may limit adverse tax consequences in the U.S.

Even absent a distribution, shareholders of U.S. corporations may, under certain circumstances, be subject to a second layer of tax: the accumulated earnings tax (“A.E.T.”).  The tax is imposed on the accumulation of earnings beyond the reasonable needs of the business.  Although rarely imposed on well-advised taxpayers, the A.E.T. could become increasingly important if the tax rate disparity between the corporate and individual income taxes increases under proposals put forth by the current administration.  Fanny Karaman and Beate Erwin look at a recent Chief Counsel Advice Memorandum where the absence of liquidity within the corporation was found to be an irrelevant factor in determining that earnings were unreasonably accumulated by the corporate taxpayer.

Elizabeth V. Zanet and Beate Erwin compare the proposals that comprise the Trump tax plan and the House Republican Tax Reform Blueprint, which will be submitted to Congress as part of a massive overhaul of U.S. tax law.  Tax rates for individuals and corporations would likely be lowered, the standard deduction would be increased, and capital gains tax rates would remain at the same level.  The net investment income tax would be repealed.  The estate tax and generation skipping tax would be repealed.  The gift tax would remain.  Other provisions are discussed, also.

This month, we reminisce on the best of 2016, with articles on the brewing transatlantic trade war disguised as European Commission attacks on illegal State Aid given to U.S.-based groups.