Pre-Immigration Tax Planning, Part III: Remedying The Adverse Consequences of the Covered Expatriate Regime

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INTRODUCTION

Following our previous articles regarding pre-immigration planning and the expatriation rules applicable to covered expatriates (see here and here), this article considers some techniques for implementation before and after expatriation, with the objective to reduce the adverse treatment of the covered expatriate regime to the extent possible depending on the specific facts and circumstances of each individual.

For a Green Card holder, expatriating prior to becoming a long-term resident would eliminate the application of the covered expatriate regime. For a U.S. citizen (other than children under certain situations), the circumstances that will allow for a tax-free expatriation are more restrictive. An individual is considered a covered expatriate if he or she meets one of three tests. Pre-expatriation planning can eliminate the application of the covered expatriate regime for some individuals, while for others additional planning may be needed to reduce the unfavorable effect of the covered expatriate rules.

Pre-Immigration Income Tax Planning, Part II: Covered Expatriates→

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INTRODUCTION

Continuing on from our previous article concerning pre-immigration planning, this article will explain the tax rules by which an individual seeking to renounce his or her U.S. citizenship or green card status may be affected.

To relinquish U.S. citizenship or a green card, a formal act of relinquishment is required. Therefore, a green card holder who moves outside the U.S. will continue to be treated as a U.S. resident for tax purposes until he or she formally relinquishes green card status or it is rescinded by the government. A U.S. citizen residing outside the U.S. will have to formally relinquish his or her citizenship in order to be removed from the U.S. tax system. As a general rule, termination of U.S. residency becomes effective on the last day of the calendar year in which the status was relinquished. However, under certain circumstances, termination may be effective midyear.

Upon expatriation, should an individual be considered a “covered expatriate,” he or she may be subject to an exit tax, and following expatriation, any gifts and bequests made by such an individual may be subject to a succession tax in the case of U.S.-resident recipients.

For planning purposes, U.S. citizens wishing to relinquish their citizenship should determine if they are covered expatriates prior to undertaking any such action. Green card holders wishing to relinquish green card status must first determine if they are treated as long-term residents. If so treated, green card holders should determine if they are covered expatriates under the same tests applicable to U.S. citizens.

Shifting Income and Business Operations

volume 2 no 4   /   Read article

By Stanley C. Ruchelman and Kenneth Lobo

This month, our team delves into the Joint Committee Report addressing international tax reform in a series of articles.The report discovers that a better tax result is obtained when income is booked in low tax countries. Stanley C. Ruchelman and Kenneth Lobo explain.  See more →

See all articles in this series →

I.R.S. Defines Measure for Tax Rate Disparity Test

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In order to reduce its overall foreign tax rate, a company may attempt to separate its foreign manufacturing from its foreign sales operations. If a foreign manufacturing entity sells products at a low margin to a related foreign sales entity in a lowtax jurisdiction, less foreign taxes are paid than if the foreign manufacturing entity sold the products directly to customers. This type of transaction would generally trigger foreign base company sales income (“F.B.C.S.I.”) for the sales entity, while the manufacturing entity could rely on the exception whereby income produced by certain manufacturing activities is not included in F.B.C.S.I. (the “Manufacturing Exception”).

McDonald's Accused of Re-Routing Royalty Payments to Avoid Billions in European Taxes

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Labor unions are accusing McDonald’s of avoiding €1 billion in tax by re-routing revenue through Swiss and Luxembourg units.

McDonald’s apparently asked its various franchises to pay it royalty revenue for using the McDonald’s brand.

Insights Vol. 2 No. 2: Updates & Other Tidbits

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BUSINESSMAN PLEADS GUILTY TO CONCEALING $8.4 MILLION

A Connecticut business executive, George Landegger, pled guilty to willfully failing to report $8.4 million held in Swiss bank accounts to the I.R.S. During the early 2000’s until 2010, Landegger maintained undeclared accounts which reached a maximum value of over $8.4 million at an unidentified Swiss bank.

While Landegger’s defense attorney confirmed that Landegger has not been accepted to the Offshore Voluntary Disclosure Program (“O.V.D.P.”), Landegger, according to the prosecutors, repeatedly rejected the possibility of disclosing his undeclared accounts to the I.R.S. through the O.V.D.P. and instead proactively took steps to conceal his accounts. Landegger held his undeclared accounts in a sham entity formed by a Swiss lawyer under the laws of Liechtenstein. In August 2013, the Swiss lawyer pled guilty to tax fraud conspiracy charges and has been cooperating with prosecutors.

Landegger agreed to pay a civil penalty of over $4.2 million and more than $71,000 in back taxes as part of his plea, entered on January 15, 2015. Landegger’s sentencing will be held May 12. He faces a maximum sentence of five years in prison. In his statement, I.R.S. Acting Special Agent-in-Charge Thomas E. Bishop stressed that uncovering hidden offshore accounts and income is the Service’s top priority and that it will continue working with the Department of Justice to do so. This case illustrustrates the importance of a timely O.V.D.P. submission.

OBAMA PROPOSES INCREASE IN CAPITAL GAINS TAX, ELIMINATION OF STEPPED-UP BASIS ON INHERITED ASSETS

President Obama has proposed a 28% tax rate on capital gains for couples with $500,000 in annual income and eliminating the stepped-up basis on inherited investments. Obama believes that these tax increases will help to pay for expanded benefits for middle- and low-income households. Congressional Republicans have indicated that they would not support Obama’s proposal.

Insights Vol. 2 No. 1: Updates & Other Tidbits

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TAX EVASION INDIAN STYLE: CRIMINAL OR CIVIL OFFENSE?

Judicial authorities in India are recommending that the country adopt a similar position as the United States with respect to offshore bank accounts. While investigating the “black money” held in undeclared Swiss bank accounts by 628 wealthy Indians, two of the judges recommended that tax evasion should constitute a criminal offense and not simply a civil one.

The scandal has been at the forefront of both political discussion and legal debate since there is a fine line that is being straddled between disclosing and punishing these tax evaders versus violating the confidentiality clause from the Indian-Swiss tax treaty. According to the treaty, these account names can only be revealed once charges identifying the specific individual have been filed.

In India, “black money” has always been an obstacle to tax collection. Black money constitutes undeclared income that has been “hidden,” profits from the undervaluation of exports, and earnings from fake invoices or unaccounted-for goods. Black money not only affects the national treasury, but has fueled corruption, too. According to the judges, classifying tax evasion as a criminal offense, and dealing with these lawbreakers more strictly should serve as a deterrent.

HAND IT OVER, MICROSOFT?

In conjunction with its audit of Microsoft’s cost-sharing transfer pricing methods for the 2004-2006 tax years, the I.R.S. has filed a petition for enforcement of an issued summons for 50 types of documents, including those relating to marketing, R&D, financial projections, revenue targets, employees, studies, and surveys.

Insights Vol. 1 No. 11: Updates & Other Tidbits

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B.E.P.S. PROJECT FACES CHALLENGE IN ADDRESSING C.F.C. RULES

The O.E.C.D.’s pending base erosion and profit shifting action plan is due to face a significant challenge as to how to address controlled foreign corporations. Action 3, which strengthens C.F.C. rules, is set to be released in 2015. Currently, European case law restricts the scope of E.U. members establishing C.F.C. regimes.

Stephen E. Shay of Harvard Law School says the U.S. is encouraging the expansion of the C.F.C. rules as a way to solve several of the issues the B.E.P.S. action plan is trying to address, however, these new rules run the risk of being contrary to E.U. jurisprudence. The E.U.’s ability to adopt stringent C.F.C. rules is limited by the Cadbury Schweppes (C-196/04), a 2006 ruling from the Court of Justice of the European Union. The Court held that E.U. freedom of establishment provisions preclude the U.K. C.F.C. regime unless the regime “relates only to wholly artificial arrangements intended to escape the national tax normally payable.”

Without resolving the issue among E.U. countries, Action 3 may not be effective in appropriately addressing earnings stripping. However, Shay also added that Action 2, which neutralizes the effects of hybrid mismatch arrangements, so far appears to include an approach that works without C.F.C. rules.

CHARGES LAID AGAINST U.S. CITIZEN FOR MAINTAINING ALLEGED SECRET SWISS BANK ACCOUNTS

Department of Justice announced that charges have been laid against Peter Canale, a U.S. citizen and resident of Kentucky, for conspiring to defraud the I.R.S., evade taxes, and file a false individual income tax return. It is alleged that Canale conspired with his brother and two Swiss citizens to establish and maintain secret, undeclared bank accounts in Switzerland.

In approximately the year 2000, a relative of Canale died and left a substantial portion of assets which were held in an undeclared Swiss bank account to Canale and his brother, Michael. The brothers met with two Swiss citizens, who agreed to continue to maintain the assets in the undeclared account for the benefit of the Canales.

New I.R.S. Procedures for Canadian Retirement Plans

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On October 7, 2014, the I.R.S. released Revenue Procedure 2014-55, which provides guidance for U.S. citizens or residents who own a Canadian Registered Retirement Savings Plan (“R.R.S.P.”). In short, U.S. citizens/Canadian residents, Canadian citizens/U.S. residents, and dual citizens will no longer need to file Form 8891 to defer the accrued R.R.S.P./R.R.I.F income for U.S. tax purposes. The deferral will now occur automatically, assuming the individual is “eligible.” These new procedures will apply even if the contributions to the R.R.S.P./R.R.I.F. were made as a resident of Canada.

However, practitioners should note that this does not alleviate the need to file Form 8938 or FinCen Form 114 upon receiving a distribution from an R.R.R.P.

Original Treatment

An individual who is both a U.S. citizen/resident and a beneficiary of a R.R.S.P will be subject to current U.S. income taxation on income accrued in the plan even though the income is not currently distributed to the beneficiary. In Canada, the individual is not subject to Canadian income taxation until the accrued income is actually distributed from the plan. This leads to a mismatch in the timing of the U.S. tax and the Canadian tax, resulting in possible double taxation.

Article XVIII, Paragraph 7 of the U.S.-Canada Income Tax Convention (the “Treaty”) provides that an individual may defer U.S. taxation on income accumulated in an R.R.S.P., but only if the individual makes an annual election to defer the taxation of income.

Recapitalization of L.L.C. Interests and Issuance of Profit Interests Held to be Gifts in Estate Freeze

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Code §2701 is a provision which renders the transfer of a partnership or membership interest to a family member a gift. The tax typically applies in an “estate freeze” scenario, where one generation attempts to transfer assets which appreciate in value to another generation, thereby removing it from their estate for estate tax purposes. In its latest Chief Counsel Advice (“C.C.A.”), the I.R.S. held that a recapitalization of a limited liability company (“L.L.C.”) triggers a gift under Code §2701 in a case where a mother retained a right of distribution but transferred the gain or loss attributable to the L.L.C.’s assets to her sons. The I.R.S. held that the interest retained by the transferor (a distribution right on the existing capital account balance) was a senior interest, whereas the transferred interest held by the sons (the right to future gain of the L.L.C.’s assets) was found to be a subordinate interest. What is notable and most troubling here is that the interests transferred to the sons are so-called “profits interests,” issued for future services to be rendered to the L.L.C.

IN GENERAL

Code §2701 imposes special gift tax valuation rules when partnership or membership interests are transferred to family members. Family members covered under Code §2701 include the spouse of the transferor, any lineal descendant of the transferor or the transferor's spouse, and the spouse of any such descendant. In general, Code §2701 devalues interests of senior family members in order to increase the value of interests transferred to junior family members. Code §2701 generally applies to situations where the transferor retains a senior interest and transfers a subordinate interest to the transferee – such as when a parent keeps preferred shares and transfers common shares to family members.

Action Item 15: Developing a Multilateral Instrument to Modify Bilateral Tax Treaties

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AN EXERCISE IN “POINT/COUNTERPOINT”

Implementation of many of the B.E.P.S. Action Items would require amending or otherwise modifying international tax treaties. According to the O.E.C.D., the sheer number of bilateral tax treaties makes updating the current treaty network highly burdensome. Therefore, B.E.P.S. Action Item 15 recommends the development of a multilateral instrument (“M.L.I.”) to enable countries to easily implement measures developed through the B.E.P.S. initiative and to amend existing treaties. Without a mechanism for swift implementation of the Action Items, changes to model tax conventions merely widen the gap between the content of the models and the content of actual tax treaties.

Discussion of Action Item 15 has centered on the following issues:

• Whether an M.L.I. is necessary,
• Whether an M.L.I. is feasible, and
• Whether an M.L.I. is legal.

In the spirit of these ongoing discussions concerning Action Item 15, we offer our commentary in a “point/counterpoint” format.

Corporate Matters: Delaware or New York L.L.C.?

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When a client is considering commencing business operations in New York, we are often asked whether it is preferable to form a limited liability company (“L.L.C.”) in New York or in Delaware. As we have mentioned in a previous issues, Delaware is generally the preferred jurisdiction for incorporation and the jurisdiction we typically recommend.

We thought it might be helpful to set out a short summary of issues that one will encounter in choosing between a New York or a Delaware L.L.C. and the relevant advantages and disadvantages of using either state.

Filing Fees

The fee for filing the articles of organization for a New York L.L.C. is $200, while the fee for filing a certificate of formation in Delaware is only $90.00. However, if the Delaware L.L.C. intends to conduct business in New York, it must file an application of authority for a foreign limited liability company, accompanied with a certificate of good standing from Delaware.

The determination of whether the Delaware L.L.C. is conducting business in New York is largely fact specific. The filing fee for the application for authority is $250, and the Delaware fee for a certificate of good standing can range from $50 (for a short form certificate) to $175 (for a long form certificate).

Insights Vol. 1 No. 7: Updates & Other Tidbits

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KENNETH WOOD NAMED ACTING DIRECTOR OF I.R.S. TRANSFER PRICING OPERATIONS

On July 24, the I.R.S. selected Kenneth Wood, senior manager in the Advance Pricing and Mutual Agreement Program, to replace Samuel Maruca as acting director of Transfer Pricing Operations. The appointment took effect on August 3, 2014. We previously discussed I.R.S. departures, including those in the Transfer Pricing Operations, here.

To re-iterate, it is unclear what the previous departures signify—whether the Large Business & International Division is being re-organized, or whether there are more fundamental disagreements on how the Base Erosion and Profit Shifting (“B.E.P.S.”) initiative affects basic tenets of international tax law as defined by the I.R.S. and Treasury. Although there is still uncertainty about the latter issue, Ken Wood’s appointment seems to signify that the Transfer Pricing Operations’ function will remain intact in some way.

CORPORATE INVERSIONS CONTINUE TO TRIGGER CONTROVERSY: PART I

President Obama echoed many of the comments coming from the U.S. Congress when he recently denounced corporate inversion transactions in remarks made during an address at a Los Angeles technical college. As we know, inversions are attractive for U.S. multinationals because as a result of inverting, non-U.S. profits are not subject to U.S. Subpart F taxation. Rather, they are subject only to the foreign jurisdiction’s tax, which, these days, is usually lower than the U.S. tax. In addition, inversions position the multinational group to loan into the U.S. from the (now) foreign parent. Subject to some U.S. tax law restrictions, interest paid by the (now) U.S. subsidiary group is deductible for U.S. tax purposes with the (now) foreign parent booking interest at its home country’s lower tax rate.

“Inverted companies” have been severely criticized by the media and politicians as tax cheats that use cross-border mergers to escape U.S. taxes while still benefiting economically from their U.S. business presence. This has been seen as nothing more than an unfair increase of the tax burden of middle-income families.

U.S.-Based Pushback on B.E.P.S.

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INTRODUCTION

In addition to the aggressive actions by some foreign countries to levy more taxes on U.S. taxpayers before a consensus has been reached, the process established by the O.E.C.D. raises serious questions about the ability of the United States to fully participate in the negotiations.

Ultimately, we believe that the best way for the United States to address the potential problem of B.E.P.S. is to enact comprehensive tax reforms that lower the corporate rate to a more internationally competitive level and modernize the badly outdated and uncompetitive U.S. international tax structure.

So say Representative Dave Camp (R) and Senator Orrin Hatch (R), two leading Republican voices in Congress, on the O.E.C.D.’s B.E.P.S. project.

Does this somewhat direct expression of skepticism represent nothing more than U.S. political party politicking or a unified U.S. government position that in fact might be one supported by U.S. multinational corporations? The thought of the two political parties, the Administration and U.S. industry agreeing on a major political/economic issue presents an interesting, if unlikely, scenario. This article will explore that scenario.

OVERVIEW OF B.E.P.S./WHY B.E.P.S.?/WHY NOW?

Base erosion and profit shifting (“B.E.P.S.”) refers to tax planning strategies that exploit gaps and mismatches in tax rules in order to make profits “disappear” for tax purposes or to shift profits to locations where there is little or no real activity and the taxes are low. This results in little or no overall corporate tax being paid.