Intro in taxation.pptx

1.1. INTRO IN US TAXATION SYSTEM
AND GLOBAL TAX STRATEGY
Integrate
Your GTS Into
Your business
Repatriation of Foreign
Taxes
Minimization
of Local
Country Taxes
Increase
FSI
Reduce
FSE
Local
Country
Permanent
Savings
Global
Alloc. of
Income to
Low-Tax
Countries
Multi-
Dip
Financing
Convert
USI to FSI
FSI with
Tax Allocations
FSI with
Local
Deduction
Interest
Use and
Creation of
Deficits
Credits Contract Hybrids
R&D Special
Allocations
of Foreign
Taxes
Step-ups
Commiss-
ionaires
Hybrid
Instruments
G&A
Prepaid
Taxes
Withholding Tax
Minimization
Local
Country
Consolidation
Loss Utilization
Cost
Sharing
Deferral Planning
Dual
Residents
Reverse
Hybrids
Tax Incentives
Interaction
with FSC
Transfer
Pricing
Optimization of
Offshore Cash
Utilization
Defer
E&P
Repatriate
Foreign
Taxes
“Tax-Free”
Repatriation
Structures
Small
Dividend
Accelerati
on of
Foreign
Taxes
Keep E&P
Offshore
Defer
all
E&P
Use of Cash
One Timers:
– Reorgs / Redemp
Interaction with
Financing
(Onshore vs
Offshore Cash)
Hybrid
Entity
Losses
OFLs
Reduce Your Global ETR,
While Optimizing Your Cash
Utilization
§338
Step-ups
Manu-
facturing
-
Accel. of
Foreign
Taxes
– Deficits
– PTI
– Debt Repayment
Annual:
– Stock Options
– Factoring
– §956 /
Basis
– Cost sharing
eBusiness
§936
GTS

 The extraterritorial approach of the United States tax system
creates the risk of double taxation
1.1. INTRO IN US TAXATION SYSTEM AND
GLOBAL TAX STRATEGY (CONTINUED)
EXEMPTION
CREDIT
DEDUCTION
Systems for Avoiding Double Taxation:
CREDIT VS. DEDUCTION IN REG ARDS TO FOREIGN TAX FOREIGN TAX?
Credit: elective, dollar-for-dollar
Deduction: business expenditure, reduces taxable income
Exception: FTC limitation significantly reduces the benefit of the credit
The taxpayer is in an NOL position that is expected to last beyond the 5 year FTC carry forward period

 Inbound transaction: non-U.S.
persons, non-U.S. entities with U.S.
income and/or U.S. activities.
Example: a foreign corporation has
income and/or activities in U.S. –
Toyota – selling ‘into’ the U.S., and
Toyota would generally be considered
in the inbound category.
 Form 1120F if a corporation – branch
profits tax may apply
 Form 1065 if a foreign partnership
 Form 1040NR if Foreign Trust with U.S.
ECI Form 5472 - Information return of a
25% Foreign Owned US Corporation or a
Foreign Corporation Engaged in a US
Trade or Business
1.1. INTRO IN U.S. TAXATION SYSTEM AND
 Outbound transaction: U.S.
persons, U.S. entities with
NON-U.S. income and/or NON-
U.S. activities.
Example: U.S. headquartered
corporation has income and/or
activities in other countries –
Walmart – sells many of its
products outside of U.S.
 FBAR – FinCEN Report 114 to
report foreign financial accounts
 Form 8938 to report certain
financial assets owned by a U.S.
person – Specified Individual

 Many companies seek to expand into the United States for a
variety of reasons.
 Key initial considerations
 Where to set-up (state and city considerations)
 Type of Entity (Branch, Partnership, C-Corp and others)
 Business and strategic reasons for setting up in the United States
 Management Logistics, book and record keeping
 Short term & long term strategy for the business (exit strategy?)
 Related Party payments- Transfer Pricing, Subpart F Income
 Human Capital Considerations and Employee Mobility
 Setting up business in the United States has important
federal and state tax implications.

State and Local tax considerations
 Overview
 Nexus
 Income Taxes
 Sales Taxes
 Payroll Taxes / Personal Income Taxes

 A. Non-Resident Alien – Not a “Resident Alien”
 B. Resident for Income Tax Purposes
1. Green Card
2. Substantial Presence Test
3. Voluntary Election, Net Investment Income Tax for dual residents
Exceptions:
4. The Closer Connection
5. Treaties: Tie Breaker
C. Foreign Corporations
1.2. DEFINING THE FOREIGN INVESTOR:
STATUS FOR TAX PURPOSES

 2. Substantial Presence Test
You must pass both the 31-day and 183-day tests.
-31 day test: Were you present in United States 31 days during current
year?
-183 day test.
A. Current year days in United States x 1 =_____days
B. First preceding year days in United States x 1/3 =_____days
C. Second preceding year days in United States x 1/6 =_____days
D. Total Days in United States =_____days (add lines A, B, and C)
If line D equals or exceeds 183 days, you have passed the183-day
test.
STATUS FOR TAX PURPOSES (CONTINUED)

 Foreign taxpayer (both Alien Individuals and Foreign Corporations)
pay U.S. tax on U.S. Income in two entirely different ways depending
upon
• whether the income the Foreign Taxpayer earns is from “passive”
sources or
• whether the income results from the Foreign Taxpayer’s conduct of an
“active trade or business” in the U.S.
Passive (Non Business Income) Active Trade or Business Income
1) 30% Flat Tax Rate – Gross Income 1) Graduated Corporate Tax Rates
2) Withholding Obligations and Contingency 2) Graduated Income Tax Rates
3) Effectively Connected Income

1) Graduated Corporate Tax Rates

2) Graduated Income Tax Rates
3) Effectively Connected Income – foreign source income that is attributable to
a Foreign taxpayer’s U.S. trade or business activity may be taxed by the U.S.

 U.S. residents are taxed on worldwide income
 U.S. nonresidents are taxed on
 U.S. source FDAP (Fixed, Determinable, Annual,
Periodic Income)
 ECI (Effectively Connected Income)
 Dispositions of U.S. real property

1.2. CHECK-THE BOX-ELECTION
 How can these rules be used to my advantage?
 Are there disadvantages associated with “checking-the-box”
in an international context?
Four-factor entity classification rules
 Continuity of life
 Centralization of management
 Limited liability
 Free transferability of interest

 Foreign Disregarded
Entity
1.2. CHECK-THE BOX-ELECTION (CONTINUED)
US Co
Sale for $90
AUS
Branch
Resale for
$100
Results:
- $90 is disregarded
- US Co includes branch’s $100 of
gross receipts
and expenses on its Federal income tax
return
 Foreign Corporation
US Co
Sale for $90
AUS Co
Resale for
$100
Results:
- US has $90 of sales income
- Absent Subpart F, AUS Co net
income is not taxable in the US
- AUS Co expenses are not
deductible by US Co

 80 foreign limited liability business entities, including:
 German, Austrian & Swiss Aktiengesellschaft
 French & Luxembourgian Societe Anonyme
 Most Latin American countries’ Sociedad Anonima
 Australian, Indian, Cypriot, Hong Kong & UK Public Limited Company
 Nova Scotia ULC not listed
PER SE FOREIGN CORPORATIONS

International Tax Planning
 Utilize foreign losses
 Trigger utilizable “excess” foreign taxes without dividend formalities and
difficulties
 Expand foreign sales corporation (FSC) benefit to profit earned by foreign
affiliates on U.S. manufactured product
 Eliminate most forms of tainted related party Subpart F income (i.e.,
intercompany dividends, interest, royalty, or sales)
 Strip cash out of certain foreign jurisdictions without withholding tax
 “Step up” foreign assets and achieve other foreign tax reductions
 Facilitate worthless stock write-offs without executing formal liquidation process
 Eliminate “prepaid” tax on intercompany profit in inventory
 Obtain U.S. tax free step ups for complete or partial acquisitions of foreign
companies
 Eliminate fourth and lower tier foreign tax credit problems
 Obtain U.S. tax deduction for foreign employee stock option spreads (Caution:
issue of voluntary foreign tax.)
 Eliminate passive foreign investment company status at lowest tier (“naked”)
subsidiary

 General Disadvantages of “Check-the-Box”
Branch/Partnership Election:
 Triggers Section 1248 with first tier subsidiary elections
 Earlier tolling of unutilized excess FTCs of first tier subsidiaries
 Inadvertent application of subpart F manufacturing or sales branch rule for
elections below first tier level
 Default rule may produce unintended results
 Triggers FTC dilution if high-taxed entities are “branched” with lower-taxed entities
 Dual consolidated loss compliance
 Five-year irrevocable election
 All shareholders or officers must elect
 Converts de minimus passive income to passive income for FTC purposes

1.3.1. Income Tax – Unites States source income, limited types
of foreign Source income (found in §861 - §865)
1.3.2.Estate Tax - Unites States Situs assets only (includes real
estate)
1.3.3. Gift Tax – real and tangible personal property with a
Unites States Situs
1.3.4.** Branch Tax – Corporations only (§ 884)
Sourcing rules:
1. U.S. Source Income
2. Foreign Source Income
3. Deductions
1.3. TYPE OF TAX AND SOURCING RULES

 Interest: Place of residence (incorporation of payor)
 Rents and royalties: Place of use
 Personal services: Place where services are performed
 Sale of real property: Place where property is located
 Dividends: Place of incorporation (generally residence) of payor
 Sale of personal property: Inventory vs. non-inventory
1.3.1.INCOME TAX (CONTINUED)
SOURCE OF INCOME

Exceptions:
SOURCE OF INCOME
 Interest income
 Foreign banking branches
 Dividends
 25% look-through rule
 Personal services income
 Commercial traveler
exception

 Rental income is sourced according to the location or place of use of the
leased property
 861(a)(4) – rental income from property located or used in the US is USI
 862(a)(4) – rental income from property located or used outside the US is
FSI
 Rental income is to be withheld at source under 1441(a) and 1442(a) at a
tax rate of 30%
 1445(a) – in the case of a disposition of a US real property interest by a
foreign person, the transferee is required to withhold 10 percent of the
transferor’s amount realized.
No withholding applies if rental income is effectively connected with the conduct of a
US trade or business, W -8ECI must be provided to withholding agent (exception, a
partnership must withhold on portion of ECI allocable to a foreign partner at a 35%
tax rate).
Election available to treat real property income as effectively connected with a US
trade or business – 871(d) and 882(d).
Taxed at regular rates on a net basis.
SOURCE OF INCOME - RENTS

15% and can be as high as 35% for both corporations and individuals
 Source of Income – Royalties
SOURCE OF INCOME - ROYALTIES
US Co
CFC
Manufacturer
License of Foreign IP
Royalties  Patents, copyright, secret processes or
formulas, trademarks and other intangible
property outside the US constitute foreign
source income.
Most countries subject royalty payments to withholding
tax, which may be reduced by a tax treaty

 Interest – the source of interest income is generally determined by
reference to the residence of the debtor; interest paid buy a
resident of the United States constitutes U.S. source income, while
interest paid by foreign residents is generally foreign-source
income.
 Dividends – the source of dividend income generally depends on the
nationality or place of incorporation of the corporate payer; that is,
distributions by U.S. corporations constitute domestic-source
income.
SOURCE OF INCOME – INTEREST, DIVIDENDS
There are, however, several impor tant exceptions to these rules.

 Source of Income – Title Passage
SOURCE OF INCOME – TITLE PASSAGE RULE
AUS
Distributor
US Co
US Factory
 “50/50 Rule for manufactured property. See § 863(b), Treas. Reg. § 1.863-3
- Property factor
- Sales factor
 Title passage is important for both U.S. and foreign taxpayers.
 Source of Income – gain or loss on sale of property
- Real Property
- Personal Property

APPORTIONMENT RULES
 Interest expense --------------
 R&E expenditures
 State income taxes
 Net operating losses
 Stewardship expenses
 Losses from sale of property
 Legal and accounting
expenses
SPECIAL APPORTIONMENT RULES
1) Fungibility principle
 Allocate interest to all gross income,
even if borrowing relates to specific
asset
2) Apportionment base
 Must use assets per §864(e)(2)
3) Measuring the asset base
 Classification: Based on type of
income produced (U.S. versus foreign
source)
 Valuation: Tax book value, but may
elect market value
4) Af filiated groups
 Treated as single corporation for
purposes of apportioning interest
expense
5) CFC Netting Rules

SOURCE OF INCOME CHART
Form
W-8EXP
No Withholding
1042-S Reporting
Form
W-8ECI
No Withholding(1)
1042-S Reporting
Form
W-8IMY
QI FWP
Non-US Persons
Form
W-8BEN
NQI NWFP
No Withholding
No Withholding
1042-S Reporting
Form W-8BENs from
Beneficiaries
Statutory Exemption
Income
Withholding
Requirements
Non-Treaty Claim
No EIN/TIN
3-year Form W-8
BEN
Treaty Claim(1)
1042-S Reporting
No 1042-S Reporting
EIN/TIN
1042-S Reporting
EIN/TIN
Form W-8 BEN
Indefinite
US Persons
Form W-9
(1) If no EIN/TIN, 30% WHT unless statutory exempt.
US Source Income Paid to
No Withholding

 Bank deposit interest
 Portfolio interest
 OID* (until redemption)/ short term OID
 Capital gains (some exceptions exist)
 ECI
*original issue discount
Income tax treati e s with foreign countries may exempt or reduce the amount of tax due on items such as
interes t or dividen d s
STATUTORY EXEMPTIONS FROM WITHHOLDING
TAX

 Treasury Regulation 1.861-18:
 Transfer of one or more “EULA” (End User License Agreement), with no rights to
reverse engineer or copy and distribute to the public = sale of goods.
 Transfer of “OEM” (Original Equipment Manufacturer) - type rights=royalty–bearing
license
 EULA with a limited term = lease of tangible property.
SOURCE OF INCOME – SOFTWARE
REGULATIONS
*The regulations do not provide specific guidance on several software /
e-commerce transactions (e.g., cloud computing, software maintenance agreements).
FP
Sale of Goods
USD
Ships pre-
packed
copies
Royalties
Resells copies
to customers
USP
FD
Master
Program
Files with
Right to Copy
and Distribute
Purchase
Price of Goods
Makes
copies and
sells to
customers
License of Software IP

 Non resident alien individual dies owning U.S. real estate or shares of certain types
of entities that own U.S. real estate.
 Apply to transfers of both tangible and intangible property situated or deemed
situated in the U.S. upon a non-resident alien’s death (Qualified Domestic Trust
appropriate for a married couple when one of the spouses is a non -citizen)
Stock in foreign corporations and proceeds for a policy insuring the life of a non -resident alien –
are not considered to have a U.S. situs.
1.3.2.ESTATE TAX
U.S. situs assets:
 Any tangible and intangible property located in the U.S. at death
 Real Estate located in the U.S.
 Generally shares of stock owned in U.S.
 Generally partnership interest in U.S. assets
 Generally debt obligations of U.S. persons, states and government authorities
*debt exceptions:
- bank deposits – FBAR requirement
- life insurance proceeds
- portfolio debt

FBAR (Report of Foreign Bank and Financial Accounts )
A U.S. person (defined below) that has a financial interest in or signature authority
over foreign financial accounts must file an FBAR (Report of Foreign Bank and
Financial Accounts) if the aggregate value of the foreign financial accounts exceeds
$10,000 at any time during the calendar year.
Rule for penalties: The civil penalties for a non-willful violation can not exceed
$12,459 per violation. Civil penalties for a willful violation can not exceed the greater
of $124,588 or 50% of the amount in the account at the time of the violation.
Issue: The individual foreign investor that invest in U.S. real estate in equity amounts
of $1,000,000 or more is going to be forced to use a corporation formed outside of
the United States (Foreign Corporations) somewhere in their investment structure if
they are going to avoid the U.S. estate tax.
*Tax Treaty can help to solve the problem.
1.3.2.ESTATE TAX (CONTINUED)

 Non-resident aliens are subject to gift tax on gifts of property
situated in the U.S. and generally are not taxed on gifts they make
of intangible property even though it may be considered located in
the U.S.
Intangible U.S. property: U.S. bank accounts (the account is not connected
with a U.S. trade or business);
Cash in U.S. brokerage accounts;
Bonds issued in the U.S.;
Stock in domestic corporations;
Interest in partnership or LLCs (Might go into different category)
1.3.3. GIFT TAX

Enforced by withholding at source: withheld and remitted to the IRS by withholding
agent who has “control, receipt, custody, disposal, or payment” of income subject to
the tax.
 Tax imposed on the gross amount of the payment.
 Rate of withholding tax may be reduced or eliminated by an income tax treaty.
1.4. WITHHOLDING TAXES
Withholding Agent
AUS Co US Co
Royalties
License of sof tware
 U.S. Co. would be required to withhold tax on royalties paid to use of sof tware in the Unites
States.
 Australia treaty would generally provide for a reduced rate of withholding if Australia Co
provided a properly completed
 IRS Form W8-BEN.
- §871 and §881 impose US tax on foreign individuals and entities
- §1441(Non-resident aliens), §1442 (Foreign corporations), §1446 (Foreign partners) are the
administrative sections regarding the withholding tax
- §1462 – tax withheld at source under §1441 & §1442 is credited against payee’s liability under
§871 & §881

1.4. WITHHOLDING TAXES (CONTINUED)
FC B
FC A
QI
US Portfolio Co.s
US
Fund B
US Portfolio Co.s
US
Fund A
Foreign
Fund A
NWFP
W-8BEN
(2)
W-9(1)
W-9(1)
NRA
NRA
(1) No US Withholding tax
(2) US Withholding

1.4. WITHHOLDING TAXES (CONTINUED)
US Op.
Entity
US Fund
Foreign
Fund
US
Foreign Corp.
W-9
W-9
50%
50%
60%
40%
ECI 1,000
Form 1065 & Form 8804
Form 1065
Form 8804
Form 1120-F
Form 8813
500 * 60% * 35%
500 * 40% * 39.6%
Foreign
Individual
-The fact that the payor did not withhold does
not excuse the foreign recipient from paying
tax
-The IRS can proceed against either the payor
or the foreign recipient for withholding tax due.

 FIRPTA is a law dating back to the 1980s, a time when foreign
purchases of iconic American real estate fed widespread anxiety
that foreign investors could dominate the U.S. real estate market.
FIRPTA addressed those fears by erecting barriers to foreign
ownership of U.S. real estate, most notably by requiring foreign
investors to pay a 30% withholding tax on real estate investments in
the U.S. However, this requirement didn't apply to foreign investors who owned shares in
real estate investment trusts (REITs), provided they owned less than 5% of the REIT's stock.
1.5. FIRPTA (FOREIGN INVESTMENTS IN U.S.
REAL PROPERTY) RULES

Fixed or determinable annual or periodical income.
U.S. source fixed or determinable annual or periodical income that is not
effectively connected with the conduct of a U.S. trade or business is subject
to a 30% tax.
1.6. FDAP CONCEPT

 Generally, in the case of passive capital gains caused by a Non Resident Alien
or Foreign Corporation, there is no taxation. Therefore, there was no need to
devise a taxing structure*.
*This is not the case for Foreign Investors that invest in U.S. real estate or Foreign Investors that
are not governed by “gains income” tax treaty and have “effectively connected capital gains
income”.
Source of Gain from the Disposition of Real Property Interests
 § 861(a)(5) – gains, profits and income from the disposition of a US real property
interest is USI
 § 862(a)(5) treats gain from the disposition of real property located outside the US
as FSI
US Property Interest
 § 897(a)(1) treats a foreign person’s gain or loss from the disposition of a US real
property interest as if the foreign person were engaged in a US trade or business
and as if the gain or loss were effectively connected with such trade or business.
1.7. INVESTING IN U.S. REAL ESTATE

TAX DEFERRAL VIA § 1031
§ 1031 of the Internal Revenue Code provides tax deferral for certain exchanges of
property held for investment or used in a trade or business. To qualify for deferral, the
property relinquished in the exchange must be exchanged for a “like -kind”
replacement property.
(CONTINUED)
DISPOSITION AND TAX DEFERRAL
Many equity, real estate, and hedge funds organized as partnerships.
GP
P
LP1
LP3
LP2
GP:
- determine investment strategy
- solicit capital contributions
- acquire, manage, and sell assets
- arrange loans
- administrative support
LP:
- contribute capital to the partnership but
do not participate in the fund's management
*can invest their own capital in the par tnership as well,
but such investments usually represent a small share
(between 1 percent and 5 percent) of the total capital invested.

When investors is not interested in direct ownership of property:
(CONTINUED) DISPOSITION AND TAX
DEFERRAL
- Cycle 10-18 years
- Subject to SEC regulations and
requirements
- Publicly available option for all
investors if it’s publicly traded.
- Funds are fairly liquid if publicly
traded and can be bought and sold on
the market as frequently as desired
- In general, REITs typically pay out at
least 90% of income to shareholders in
order to secure exemption from
taxation. From there, dividend payments
made to shareholders are taxed as
ordinary income, unless certain
extenuating circumstances apply.
- Returns with a time horizon of 6 -10
years.
- Not publicly traded and therefore not
subject to SEC regulations and
requirements
- Only available to accredited investors
- Funds are less liquid and generally
require that capital be invested in
properties over a term of at least six
years
- Performance is based on the
performance of the real estate market
funds are invested in and not the stock
market
- Fund operates tax-free; when funds are
distributed to investors, gains and
losses are taxed at the individual level
at either long-term capital gains rates
or short-term capital gains rates.
REIT
(Real Estate Investment Trust)
Private Equity Funds:
(Equity + Debt investment in real
estate):

 Real Estate Tax Planning Tools
 Liquidation of corporation after sale
 The portfolio loan (Foreign person(s) capitalize domestic corporation par t debt under
por tfolio interest rules and equity)
 Like king Exchange
 Sale of Stock in foreign corporation
(CONTINUED) DISPOSITION AND TAX
DEFERRAL
Advantages Corporate Liquidation Portfolio Loans
1 one single tax paid deduction of interest on loans made to acquire the real estate
2 proceeds of sale transferred free of tax foreign seller will be receiving tax free interest from the note
3 (deal-by-deal basis) the property can be used to secure the note until its full payment
4
Distribution upon liquidation return basis first any
excess is capital gain, not subject to US tax, not ECI Foreign Investor (if owns< 10% of the real estate) will receive
the interest that is deductible by the Foreign Co free of any U.S. tax
Advantages Like-Kind Exchange (sec. 1031) Sale of Stock in a Foreign Co (with a use of sec. 1031)
1 tax deferred more cash to seller versus sale of asset
2 leverage and increased CF for reinvestment
3 wealth and asset accumulation

1.9. CONCEPT OF PFIC
 Passive Foreign Investment Company (PFIC) (§§1291-1298)
• Taxation of U.S. shareholders
 QEF election: Current taxation
or
 Excess distribution:
Pay deferred tax + interest charge
or
 Mark-to-Market Election
PFIC
Stock
Bond

2.1. INTERNATIONAL TAX AGREEMENTS:
TREATY
Tax resident in
other country
Taxable on the
income in other
country
•Treaty rules
•IRC Section 894
US citizens
subject to US
tax no matter
what

General Purpose: Tax treaties provide benefits to both governments by setting out
clear rules that will govern tax matters relating to trade and investment between the
two countries.
2.1. INTERNATIONAL TAX AGREEMENTS:
TREATY (CONTINUED)
 General Function:
 to provide certainty on “threshold” question – weather the taxpayers cross -boarded activities
will subject it to taxation by two or more countries
 protection from double taxation.
 Reduction of “excessive” taxation by reducing withholding taxes that are imposed at source.
 To regulate provisions coordinating the pension rules of the tax systems of the two countries ,
child support and employee stock options
“Saving clause” : treaty does not af fect the taxation by either treaty countr y of its residents or
its citizens.
“Treaty -shopping” prevention – “limitation of benefits"
USP
NZ Hold Co
Australian Co
Royalties
Royalties
License Sub
Licenses

2.2. PERMANENT ESTABLISHMENT:
DEFINITION AND IMPORTANCE
Fixed place of business:
- Place of management
- Branch or an office
- Factory
- Workshop
- A mine, oil, or gas well, quarry, other place where natural resources are extracted
Using target country sales agent
An enterprise of one country shall not be deemed to have a permanent
establishment in the other country merely because it carries on business
in that other contracting state through a broker, general commission agent, or an
other agent of an independent status, provided that such persons are acting in the
ordinary course of their business.
US multi-national corporations doing business in foreign countries (and foreign based multi-national
corporations doing business inside the US or foreign countries other than their own) are typically subject
to the domestic tax laws of the countries where they engaged in business activities.

$ 3 5 U.S. Co rporate
T a x
-$ 10 Fo reign T a x
Credi t
$ 2 5 Net U.S. T a x D ue
2.3. FOREIGN TAX CREDIT AND ITS LIMITATIONS
US Co
$100 Foreign
Source Income
($10 Foreign tax)
US Co :
- Co rporation
- Pa rtnershi p
- D i sregarded
Enti ty
Advantage Disadvantage
LLC Graduated Individual Income Estate tax applies
Partnership Tax only on U.S. source income
Gift Tax applies to Transfer of
Interest
Capital Gains Tax Rate at 15%
Pass Through to the members - single tax
Limited Personal Liability
No Disclosure of Ownership
No branch tax
LLC formed as
1) Disregarded
Separation between business assets and personal
finances
(Single Member LLC) Ignored for federal income tax purposes
Separate legal entities under state law
Advantage of swapping appreciated real estate for a
replacement property
C Corporation Graduated Corporate Tax Rates
Capital Gains Taxed as
Ordinary Income
No Branch tax and No Gift tax on Transfer of Shares
Dividend and/or Interest
Tax(Double Tax)
Limited Personal Liability and no disclosure of ownership
Fo reign Co :
- no t w/T a x
T rea ty Co unty
- w/ T a x T reaty
Co unty

Foreign Source Gross Income US Tax
- - Foreign Source Expenses X Liability = FTC Limit
Worldwide Taxable Income
2.3. FOREIGN TAX CREDIT AND ITS
LIMITATIONS (CONTINUED)
 § 904 provides a foreign tax credit limitation
 § 902: when a foreign corporation pays a dividend, shareholder is entitled to
claim a “deemed paid” foreign tax credit for a proportionate amount of the
foreign corporation’s foreign income taxes.
 Indirect credit (available to 10% corporate shareholders)
 Direct credit
 § 901: a credit for taxes imposed on and paid by the U.S. taxpayer (e.g.
withholding tax)
 § 78 gross-up income (equals amount of deemed paid credit)
Deemed
paid credit
=
Foreign corporation’s
foreign income taxes
x
Dividend received by shareholder
Foreign corporation’s
undistributed E&P

 Lesser of:
 U.S. tax on net foreign-source income or foreign taxes paid or
accrued
 Applied separately to FTC “baskets”
 Excess FTC:
 Carryback 2 years
 Carryforward 5 years
How to increase limitation?
 Gross income: Recharacterize as foreign source for U.S. tax purposes
 Deductions: Recharacterize as U.S. source for U.S. tax purposes

U.S. parent
corporation
1st tier
foreign sub
2nd tier
foreign sub
 Qualification requirements
- Minimum 10% direct ownership at each level
- Minimum 5% indirect ownership through chain
- Dividend distributions up to U.S. parent
 Number of qualifying tiers
- Historically, limited to 1st, 2nd and 3rd tiers
- TRA 1997: Extended to 4th, 5th and 6th tiers (but only if CFCs)
 Tracing foreign taxes to dividends
$ $

48
Facts:
 Domestic corporation has a foreign branch (Note: Branches include
legal entities that are “disregarded” under check-the-box regulations)
 Total income of $100 is attributable entirely to foreign branch
 U.S. tax rate = 35%
Foreign tax return
Taxable income . . . $100
Tax rate . . . . . . . . . .20
Foreign tax. . . . . . . $ 20
CASE 1: 20% foreign tax rate “Excess limitation”
U.S. tax return
Tax rate . . . . . . . . . .35
Pre-credit tax . . . . . 35
Credit (foreign tax) . (20)
U.S. tax. . . . . . . . . . $ 15

Foreign tax return
Tax rate . . . . . . . . . .50
Foreign tax . . . . . . $ 50
CASE 2: 50% foreign tax rate “Excess credits”
U.S. tax return
Tax rate . . . . . . . . . .35
Pre-credit tax . . . . . 35
Credit (limitation) . . (35)
U.S. tax. . . . . . . . . . $ 0
$15 Excess credit

CROSS CREDITING—EXAMPLE
Case 1:
 Domestic corporation has a branch in country X
 Total income of $100 is attributable entirely to branch in X
 Tax rates: U.S. = 35%, X = 50%
Foreign income taxes (50% x $100) . . . . . . . . . . . . . . . . $50
Average foreign tax rate . . . . . . . . . . . . . . . . . . . . . . . . . 50%
Limitation:
(A) Total taxable income $100
(B) Precredit U.S. tax ($100 x 35%) $ 35
(C) Foreign source taxable income $100
Limitation (line B x C ÷ A) . . . . . . . . . . . . . . . . . . . . . . . . . $35
Excess credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15
Question: Amount of excess credits?

CROSS CREDITING —EXAMPLE (CONT’D)
Case 2:
 Domestic corporation also has branch in country Y
 Branch in Y generates $100 profit
 Y tax rate = 25%
Foreign income taxes (50% x $100) + (25% x $100) . . . $75
Average foreign tax rate ($75 ÷ $200) . . . . . . . . . . . . . . 37.5%
Limitation:
(A) Total taxable income ($100 + $100) $200
(B) Precredit U.S. tax ($200 x 35%) $ 70
(C) Foreign source taxable income $200
Limitation (line B x C ÷ A) . . . . . . . . . . . . . . . . . . . . . . . . . $70
Excess credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 5
Question: Amount of excess credits?

2.3. STRATEGIES AND TACTICS RELATED TO
FOREIGN TAX CREDIT
1) BIFURCATING EARNINGS AND TAXES
 Consolidation systems
 Biddle opportunities
German OHG structure
German stock dividend
Reverse Hybrid
 Vulcan
 Using US partnership rules
Generating High & Low Tax Pools

FOREIGN TAX CREDIT (CON’T)
Pre-tax Income CFC1 CFC2 Consolidated
Year 1 100 (50) 50
Year 2 100 100 200
Total 200 50 250
Foreign Tax (40%)
Year 1 20 0 20
Year 2 40 40 80
Total 60 40 100
Effective Tax Rate 30.0% 80.0% 40.0%
1. CONSOLIDATION SYSTEMS

FOREIGN TAX CREDIT (CONTINUED)
1. CONSOLIDATION SYSTEMS (CONTINUED)
AUSTRALIAN CONSOLIDATION REGIME
 U.S. Parent owns an Australian group
 All members are corporations for purposes of U.S. and Australian tax
 Group is either (A) Single Entry Group (Head Company (“HC”) is the
Australian HoldCo);
USP
Head Company
Subsidiary
Member
(A)
 HC becomes the “taxpayer” for all Australian
income tax purposes.
 All other wholly owned entities in the group are
treated as divisions of HC.
 Intercompany transactions within the group are
ignored for Australian income tax purposes.
 HC is fixed with all liability for Australian tax.
 Legal liability to pay Australian income tax
rests solely with the Head Company unless and
until the Head Company defaults.

1. CONSOLIDATION SYSTEMS (CONTINUED)
 HC becomes the “taxpayer” for all Australian income tax purposes.
 All other wholly owned entities in the group are treated as divisions of HC.
 Intercompany transactions within the group are ignored for Australian income tax
purposes.
 HC is fixed with all liability for Australian tax.

2. BIDDLE OPPORTUNITIES
GERMAN OHG (GENERAL PARTNERSHIP)
STRUCTURE
 OHG’s partners pay federal tax
 OHG pays trade tax
 U.S. borrows to make investment in OHG
U.S.
German
Subs
Organschaft
(German
Corporation)
Capital
Loan
OHG

2. BIDDLE OPPORTUNITIES (CONTINUED)
GERMAN STOCK DIVIDEND
 Regular dividend for German
purposes
 Reduces German rate to 30%
 Refund of German tax at hold-
co level
 Avoids US DCL (Dual
consolidated losses) rules GmbH
Stock Dividend
US
German Subs
Debt
Organschaft

2. BIDDLE OPPORTUNITIES (CONTINUED)
REVERSE HYBRID
 Taxes paid at F1
 E&P remains at F2
US
F1
F2
 Nature of liability
 Primary and sole at partner level?
 Can local tax authorities go against assets of the
partnership for payment of tax, or only against
partner’s interest in the partnership?
 Does funding mechanism for payment of
taxes make a difference?

3. VULCAN
SA Individual
50%
50%
 SA government only taxes
US corp’s 50%
 Vulcan case
 §902 regulations
US
SA Corp
Pre-tax 100
Tax 25
After tax 75

4. USING US PARTNERSHIP RULES
US
<80%
Step 1: CTB Partnership election for Foreign JV
Step 2: Section 754 election
Result: US investor obtained stepped-up basis for share of
partnership assets for US tax purposes
Foreign JV
Foreign
Shareholders

FMV 100
BASIS 0
FMV 100
BASIS 100
CFC2
US
CFC1
P/S
§704(C) ALLOCATIONS

E&P AND TAX POOLS
Foreign US Foreign US
Income 13 13 13 13
Depreciation (5) 0 (5) (10)
Taxable Income 8 13 8 3
Foreign Tax 3 3 3 3
E&P 10 0
Effective Rate 23% 100%
CFC 1 CFC 2

2.4. DEFINITION OF CFC AND SUBPART F
INCOME CONCEPT
U.S.
shareholders
Controlled
foreign
corporation
SUBPART F (§§951-964)
 CFC defined*
 U.S. shareholders own >
50% of stock, by vote or
value
 U.S. shareholder: U.S.
person that owns 10% or
more of stock
 Subpart F inclusion (deemed
dividend)
 Subpart F income
 Investments in U.S.
property
*Rule of thumb = 5 or fewer shareholders owning > 50%
Stock
Bond
Factory

INCOME CONCEPT (CONTINUED)
Deemed dividend
U.S.
shareholders
Controlled
foreign
corporation
 Year in which CFC has Subpart F income
 U.S. shareholder is taxed on deemed dividend (§951)
 U.S. shareholder can claim §902 credit (§960)
 FTCL basketing rule: Same character as underlying Subpart F
income
 Actual dividend distributions in subsequent years (§959)
 Traced first to CFC’s “previously taxed income” (PTI)
 Receipt of PTI is a tax-free return of capital

 Insurance income
 Income from insuring risks outside the CFC’s country of
incorporation
 Foreign base company sales income
 Income from the sale of goods
 Goods are purchased from or sold to a related person
 Goods are neither manufactured nor sold for use in CFC’s country of
incorporation
 Foreign base company services income
 Fees for services performed outside CFC’s country of incorporation
for a related person
 Foreign personal holding company income
 Passive investment income such as dividends, interest, rents,
royalties and capital gains
 Foreign base company shipping income
 Foreign base company oil-related income

 U.S. Taxation of U.S. persons on worldwide income
 Absent subpart F income, s foreign subsidiary earnings are not subject to U.S. tax
until distributed to the U.S. shareholder.
 Subpart F was enacted by Congress to limit the deferral of U.S. taxation of certain
income outside the U.S. by foreign corporations controlled by U.S. persons (CFC -
controlled foreign corporations).
US Co US Co
AUS
Branch
AUS Co
Income earned by
Australian Branch flows
into US return
Interest, dividends, rents
and royalties. Certain
sales income. Certain
service income.

 Under the tax rate test, the selling of products by the Cayman
branch has substantially the same effect as if the Cayman Branch
were a subsidiary corporation.
INCOME CONCEPT: “BRANCH RULE”
 Under § 954(d)(2), the Cayman branch is treated as a separate CFC
and has Foreign Base Company Sales Income.
US
shareholder
CFC
Australia
Cayman
Manufactures
products
Sales
NZ
Customers
Sells for use in New Zealand
12.5%
0%

2.5. CFC INVESTING IN U.S. PROPERTY AND
SECTION 956 INVESTMENT
 Concept: Constructive dividend of active foreign business profits
 Treatment: Current inclusion under Subpart F
 Transactions triggering §956 inclusions
 CFC makes loan to U.S. shareholders (includes guarantees)
 CFC purchases stock issued by U.S. shareholders
 CFC purchases tangible property located in U.S.
 CFC purchases right to use intangible property in U.S.
 Certain pledges and guarantees
Controlled
foreign
corporation
U.S.
shareholders
Loan
$

SECTION 956 INVESTMENT (CONTINUED)
U.S.
CFC
$100,000 loan Foreign Bank
Pledge assets as
security on loan
CFC E&P = $200,000
Is this a Section 956 investment in U.S. property?
If so, what is the amount of the inclusion?
What other scenario is possible?
Pledge of CFC Assets

Agreement to buy note at maturity for
$100,000 if U.S. fails to pay loan. Separate
arrangements made for payment of interest.
Is this a Section 956 investment in U.S. property?
If so, what is the amount of the inclusion?
U.S.
CFC
$100,000 loan Foreign Bank

 § 956 treats investments by a CFC in certain “United States property” as giving rise
to a deemed dividend:
- Obligations of related U.S. persons
- Stock in related U.S. persons
- Most tangible property physically located in U.S.
- U.S. property
- Intangible property acquired or developed for use in the U.S .
2.5. CFC INVESTING IN US PROPERTY AND
 § 956 is intended to prevent a CFC from indirectly repatriating earnings to its U.S.
shareholders without incurring residual U.S. tax.
Public
USP
CFC
Buys back
USP stock
Deemed
dividends
$900 E&P
$100 Foreign
Taxes
 CFC’s acquisition of U.S. Parent
stock would cause it to hold a U.S.
property investment that is taxable
under § 956.
 USP would include earnings and be
liable for residual U.S. tax (i.e., 25%
of the deemed dividend).

2.6. FOREIGN PERSONAL HOLDING COMPANY
(FPHC)
 Concept: Incorporated pocketbook of wealthy U.S. citizens
 Definition of FPHC
 5 or fewer U.S. citizens or residents own 50% or more of stock
 60% or more of gross income is FPHC income
 Deemed dividend = Undistributed FPHC income
FPHC
Stock
Bond
U.S. citizens or
residents

 § 954(c) - FPHC income includes many types of passive income:
 Dividends, interest, royalties, rents and annuities
 Certain property transactions (generally, gains from the sale of property which ( i)
gives rise to passive income, (ii) is a partnership interest, or (iii) which does not
give rise to income)
 Generally excludes property that is used in a trade or business.
 Commodities transactions, foreign currency, gains, etc.
(FPHC) (CONTINUED)
US
shareholder
CFC
(Bermuda) Passive Income
Third Party OEMs
Software Royalties
Exception:
- Interest, dividends, rents and royalties
from related CFCs generally are not
subpart F income under § 954(c)(6) (the
CFC “look-through rule).
- Same-Country exception

EXAMPLE: SAME COUNTRY
(FPHC) (CONTINUED)
AUS 1
U.S.
AUS 2
Dividends
Interest
AUS 2 must have a substantial part of
its trade or business assets in
Australia and deductible payments
cannot reduce subpart F income of
the payor.

2.6.FOREIGN BASE COMPANY SALES INCOME
(FBCSI)
 Theory: Sales income that should be earned by U.S. parent
 Conditions (all three required for income to be subpart F):
 Purchase from or sale to related party
 Not manufactured in country of incorporation
 Sold for use outside country of incorporation
EXAMPLE: TAINTED ACTIVITIES
U.S.
Australia
Packaging
Operations
Packaged
Product
Sales to related
or unrelated
customers
outside Australia
Unpackaged
Product

 CFC ahs FBCSI since the income is derives from the purchase of personal property
from a related person, the property is sold for use outside of Australia and the
property is manufactured outside of Australia.
2.6.FOREIGN BASE COMPANY SALES INCOME
(FBCSI) (CONTINUED)
US Parent
CFC Australia
U.S.
sells to
CFC Resells for use in NZ
NZ
Customers
Manufactures microprocessors
Manufacturing exception: Income that would otherwise be FBCSI is excluded from subpart F
income if the CFC.
Deriving the income satisfies the manufacturing exception, through on of three tests:
1) Substantial transformation of the proper ty by the CFC;
2) The CFC per forms manufacturing activities that are (1) substantial in nature and
(2) generally considered to constitute manufacturing;
3) The CFC’s own employees make a “substantial contribution” to the manufacture
of proper ty by another person.
 The intent is that subpart F should
not apply where the CFC’s own
activities. Add substantial value to
the property being sold.

 CFC-1 would qualify under the “ substantial transformation”: test and not have
subpart F income.
 CFC-2 might qualify for the exception for activities that are substantial in nature
and generally considered to constitute manufacturing .
2.6.FBCSI (CONTINUED) : EXAMPLE OF
MANUFACTURING EXCEPTION
US
shareholder
CFC-1 CFC-2
Semiconductor
Equipment
Customers
Assembly &
Testing
Raw
materials
Microprocessors Finished Product

 CFC-1 would not have subpart F income if CFC-1’s employees make
a “substantial contribution” to the manufacturing of property by the
contract manufacturer.
2.6.FBCSI (CONTINUED) : EXAMPLE OF
CONTRACT MANUFACTURING
US
shareholder
CFC-1
CFC-2
(Distributor)
Contract
Manufactur
er
Consigns raw
materials
Finished Product Sells Finished Product
Quality control,
Product design,
Logistics, etc.

No treaty between the U.S. and a foreign country will exempt any
foreign corporation from the branch profits tax UNLESS:
- Income treaty in effect;
- Foreign corporation is a qualified resident of the foreign country
(resident of this country in the year which it has a dividend
equivalent amount)
2.7. APPLICATION OF TREATY PROVISIONS TO
BRANCH PROFIT TAX

3.1. TRANSFER PRICING: POLICY
BACKGROUND AND DEFINITION
 U.S. rules are designed to prevent the improper shifting of
income, deductions, credits, and allowances among related
persons
 Concern that multinationals have a strong incentive to shift
income to low-tax jurisdictions or shift deductions to high-tax
jurisdictions through transactions with related parties
SECTION 482
 Goal: Clearly reflect income of affiliated corporations engaged in
intercompany transactions
 Standard: Arm’s-length price (or market value) standard for
evaluating transfer prices
 Practical difficulty: Market
values are often highly
judgmental and fact dependent
 Result: Transfer pricing is most contentious area of audit and
litigation controversy in international taxation

BACKGROUND AND DEFINITION (CONTINUED)
• Group profit = $25 ($100 - $60 -$15)
• Impact of alternative transfer prices:
– Transfer price of $60 would allocate entire $25 profit to foreign subsidiary
– Transfer price of $85 would allocate entire $25 profit to U.S. parent
– Transfer price between $60 and $85 splits profit between USP and FSUB
Export sale
of widget
Resale
of widget
Transfer
price = ?
Foreign
customer
Resale price
=$100
Manufacturing
cost = $60
Marketing
expense
= $15
U.S. parent
corporation
Foreign
marketing
subsidiary
Good, Services
$

REG. § 1.482-4
•Problem No comparables due to uniqueness of
intangibles
•Congressional response Commensurate with income requirement
•Pricing methods Comparable uncontrolled transaction method
Comparable profits method
Profit split method
U.S. parent
corporation
Foreign
manufacturing
subsidiary
PATENT
$
Royalty?
BACKGROUND AND DEFINITION (CON’T)
Intangibles

 Establishing prices for transactions between related companies in different tax
jurisdictions
 Section 482 grants broad powers to the IRS to reallocate income and deductions
to prevent tax evasion or to reflect income clearly
 Applicable standard is that of an uncontrolled taxpayer dealing at arm’s length
with another uncontrolled taxpayer
 Foreign countries often have their own transfer pricing provisions
 OECD guidelines (Organization for Economic Co-operation and Development)
BACKGROUND AND DEFINITION (CONTINUED)
WHAT IS TRANSFER PRICING?

 Arm-length principle: what would happen of transaction will occur
with unrelated party
 Pricing Methods
(Treas. Reg. § 1.482-3)
3.2.1. Comparable uncontrolled price
3.2.2. Resale price
3.2.3. Cost plus
3.2.4. Comparable profits
3.2.5. Profit split
3.2. ARM-LENGTH PRINCIPLE AND ITS
METHODS
(Treas. Reg. § 1.482-1): Taxpayer must identify and apply method that provides
most reliable result. Reliability is determined by (i) quality of comparables and (ii)
quality of data regarding comparables
- Functions performed by the parties involved
- Contractual terms governing transaction
- Risks assumed by each party
- Economic or market conditions in which parties conduct business
- Nature of property or services transferred in transaction

3.2.1. COMPARABLE UNCONTROLLED PRICE
METHOD
1. Determine which affiliate will be the tested party
2. Obtain data regarding comparable
uncontrolled parties
3. Choose profit level indicator, such
as operating profit/sales or
operating profit/operating assets
4. Construct arm’s-length range of
comparable profits for tested party
5. Make adjustment if reported profit lies outside arm’s-length range
A taxpayer had to present evidence of the transactions of unrelated,
uncontrolled companies in order to make the required comparison with an
arm's– length transaction.

1. Determine arm's length price
- Applicable resale price
- Appropriate gross profit
- Arm's length range
2. Consider degree of comparability and reliability
3. Consider data and assumptions
The resale price method measures the value of functions performed, and is
ordinarily used in cases involving the purchase and resale of tangible
property in which the reseller has not added substantial value to the tangible
goods by physically altering the goods before resale.
3.2.2. RESALE PRICE METHOD

1. Determine arm's length price: appropriate gross profit and arm’s
length range
Used in cases involving the manufacture, assembly, or other production of
goods that are sold to related parties.
3.2.3. COST PLUS METHOD

3. Determine Arm's length range
4. Analyze indirect evidence of comparable uncontrolled transactions.
The comparable profits method (CPM) evaluates if the amount charged in a
controlled transaction is arm's length based on objective measures of
profitability derived from uncontrolled taxpayers that engage in similar
business activities under similar circumstances.
3.2.4. COMPARABLE PROFITS
METHOD

1. Determine Appropriate share of profits and losses
The profit split method evaluates whether the allocation of the combined
operating profit or loss attributable to one or more controlled transactions is
arm's length by reference to the relative value of each controlled taxpayer's
contribution to that combined operating profit or loss.
3.2.5. PROFIT SPLIT
METHOD

3.4. ADVANCED PRICING AGREEMENT AND ITS
IMPLICATIONS
 Entered into by the IRS and a taxpayer
 Used to avoid expensive and time-consuming controversies
related to §482 issues
 Intended to lessen the uncertainties and enhance the
predictability of the tax consequences of intercompany
transactions

 Benefits of Transfer pricing:
 Lowering duty costs by shipping goods into high-tariff countries at
minimal transfer prices so that duty base and duty are low.
 Reducing income taxes in high-tax countries by overpricing goods
transferred to units in such countries; profits are eliminated and
shifted to low-tax countries.
 Facilitating dividend repatriation when dividend repatriation is
curtailed by government policy by inflating prices of goods
transferred.
3.6. BENEFITS AND CHALLENGES

 Challenges of Transfer pricing:
 Performance Measurement
the clouding effect of manipulating intra corporate prices on a
subsidiary’s apparent and actual profit performance difficulty in
maintaining relationships with subsidiaries that are negatively
impacted by transfer pricing.
 Taxation
- Tax and regulatory jurisdictions contribute to and compound transfer
pricing problems. Pricing that is justified and reasonable in the home
country may not be perceived as such in the host country.
3.6. BENEFITS AND CHALLENGES (CONTINUED)

REVIEW – U.S. TAXATION OF
FOREIGN SUBSIDIARIES
Tax Jurisdiction
- Taxed only on U.S. source income
- Excluded from U.S. consolidated return
Profit Repatriations
- U.S. parent can not claim dividend received deduction
- U.S. parent can claim a §902 credit
- FTCL basketing rules: 10/50 company or CFC look-through rule
Transfer Pricing
- Must use arm’s-length prices

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