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Monthly Archives: October 2011

FATCA Guidance Expected By Year's End

IRS Deputy Associate Chief Counsel (International) Ronald Dabrowski said FATCA guidance is a key priority. The law requires foreign banks to disclose U.S. owned accounts to U.S. tax authorities or face, in some cases, a 30 percent withholding tax.

Speaking at the fall meeting of the American Bar Association Section of Taxation, Dabrowski said IRS is working on guidance on other tax provisions under the Hiring Incentives to Restore Employment (HIRE) Act (Pub. L. No. 111-147), which created FATCA.

The government is committed to getting proposed rules on the Foreign Account Tax Compliance Act (FATCA) out by the end of the year.

Regulations under new tax code Section 6038D, which imposes penalties if taxpayers do not report specified foreign financial assets on a form attached to their tax returns, should be out soon, Dabrowski said, noting that the recent draft version of the Form 8938 and instructions are “a good indication of where things are going.”

Read more at: Tax Times blog

The New Gift Tax Audits – IRS Identifies Non-Filers Using State Property Records

A new IRS gift tax compliance initiative responds to suspicions of widespread failure to file gift tax returns. According to Josephine Bonaffini, the Federal/State Coordinator for the IRS Estate and Gift Tax Program, between sixty percent and ninety percent of taxpayers fail to file a gift tax return despite having engaged in a transaction requiring a return.

Although gift tax audits are historically rare, the IRS has examined hundreds of taxpayers in the last two years whom the IRS suspects made large gifts, yet failed to file the appropriate returns. Borrowing from techniques long employed to identify noncompliant taxpayers in the income tax context, the IRS is using records obtained from third parties—namely, land records maintained in state and county offices—to root out intra-family land transfers for little or no consideration.

Land records maintained at local state offices are publicly available. However, the suspect transfers make up a small percentage of these voluminous and decentralized records. Thus, the IRS has asked state and county agencies that compile the relevant records to provide the IRS with those records. For instance, the California constitution contains cap on property tax increases following certain intra-family transfers, which inadvertently results in the California Board of Equalization (“BOE”) segregating the records of interest to the IRS—those on intra-family transfers—from the mass of irrelevant property records.

State or county agencies in fifteen states, including New York and Texas, have voluntarily agreed to provide records similar to those maintained by the California BOE. There is no reason to believe that the IRS has not made similar requests to agencies within many more, if not all, states, and more voluntary compliance from individual states may be forthcoming.

The recent flurry of gift tax compliance activity took many in the tax community by surprise. The compliance initiative received no appreciable public attention until the recent dispute in California federal court (discussed in more detail below), and the IRS has declined to comment on the initiative beyond the information provided in documents filed in that case. This mysterious quality gives the IRS’s recent activity the aura of a “stealth” program.

As with any federal tax law violation, the government may impose severe consequences for violating the gift tax provisions. But one curious aspect of the new gift tax compliance initiative is that the majority of examinations likely result in zero assessed tax or penalties.

According to Bonaffini, in the past two years, 323 taxpayers have been audited for failure to file gift tax returns relating to gifts of real property, 217 cases were still under examination, and another 250 cases were being researched to determine whether to conduct gift tax audits. At the time, the IRS had determined that ninety-seven taxpayers had violated gift tax reporting requirements by failing to file, and just twelve cases resulted in assessment of tax and penalties.

Although several states apparently complied voluntarily with the IRS’s requests for records, California did not. Rather, when the IRS requested the California BOE produce the neatly segregated records of intra-family transfers discussed above, the BOE refused, citing a state statute which forbids disclosure of personal information absent a court order.

On May 23, 2011, the court issued an order whereby it disagreed with the government and refused to issue the summons.

The IRS may heed the court’s suggestion and simply attempt to seek the relevant records directly from the counties. Alternatively, the government may resubmit its petition in federal court, in which case the tax community will await another court order. In any event, the court’s denial of the government’s petition may embolden additional states to refuse the IRS’s request for records.

For more information go to: http://www.forbes.com/sites/irswatch/2011/10/19/the-new-gift-tax-audits-irs-identifies-non-filers-

Read more at: Tax Times blog

Achieving Tax Efficiency with cross-border services and royalties in Latin America

In the global economy the growth of royalties and services associated to intellectual property and information technology has become critical for international taxation. On one-side governments of importing countries regularly source payments as territorial, based on the jurisdiction or location of payor. On the other, exporting countries push to resolve the issue through tax treaties. Unfortunately for US companies, one of their natural expansion markets is a “no-tax-treaty battleground”: Latin America (only Mexico and Venezuela have treaties with the US. A treaty with Chile is expected to be ratified by both countries soon).

Achieving Tax Efficiency with cross-border services and royalties in Latin America presents an important tax planning challenge in outbound taxation for US companies; as the corresponding inbound activity in Latin American countries is subject to high rates of income tax withholdings, and eventually, reverse VAT issues. In countries like Brazil, on top the income withholding tax issues, the scenario becomes even more complicated when the CIDE tax becomes applicable. The CIDE tax is a 10% surcharge withheld on certain services or royalties considered to be importation of technology. As such, the CIDE tax will not be creditable against US income taxes under the Internal Revenue Code, as it is not an income tax nor in lieu of income taxes.

The subject has become increasingly important, particularly in absence of tax treaties. In the US, under the Internal Revenue Code, the tax credit system might be insufficient to resolve the issue from a cash flow perspective; and, secondly, it might present some tax optimization issues as well. Thirdly, another problem could arise when the royalty or service activity is parallel to certain support services, programming or commercialization activities in the importing country. Generally the use of independent contractors could be problematic and eventually not escape potential tax liability issues, including those emerging from the notion of “engagement in a local trade or business”, in absence of a protective permanent establishment provision per a tax treaty.

Three options to consider, from a tax planning perspective are:

1. Playing as a local with a Tax Hybrid. Reducing withholding taxation on the overseas service payments by creating a Sociedad de Responsabilidad Limitada (hereinafter referred as “SRL”), which is the equivalent of an LLC (or other eligible entity under the check-the-box regulations). This option is optimal when treaty networking becomes complex, expensive or unviable, as well when the growth is focused or concentrates in a particular country.

The SRL (or eligible entity) will become a tax hybrid, thus a disregarded entity in the US but a legal independent entity in the Latin American country. Accordingly the entity is a blocker and a conduit at the same time. As such, the parent company is protected from tax exposure or any other liability issues locally (particularly relevant when there is related marketing or support activity in the importing country), but from a tax perspective all taxes paid flow-through as direct tax credits, and all expenses as deductions, including as the latter all indirect taxes paid.

The key in this planning technique is that income tax withholdings on local payments for services or royalties are very low (or none), compared to the high rates applicable to cross border payments for the same. Additionally, the withholding tax is applicable over the gross amount paid, whereas the entity is taxed on a net basis. Most jurisdictions in Latin America do not tax dividends when declared after previously taxed profits or earnings, but this is an important issue to look country by country as a pre-condition, because it is necessary to ensure that surpluses flow back without tax implications. Thus, with proper planning, the efficiency and savings are significant.

In countries like Brazil, where strategizing becomes highly relevant not only from an income tax perspective but from a CIDE tax and indirect taxation perspective as well, there are additional options to bring efficiency. Brazilian tax law allows that any legal entity provided that its income is below the BzR$ 2.4 million threshold, to elect taxation under the simplified “presumed profits method”. One alternative to consider is to create one SRL for each contract or revenue stream from royalties or services, to meet the income threshold necessary to meet the presumed profits method election. Accordingly, in a service scenario, the presumed profits are considered to be 32% of gross revenue. With nominal tax rates in the 35%, the effective rate of taxation upon this election becomes 11,2 (compared to a 25% flat withholding rate applicable, including the 10% CIDE tax, when the payments are made directly to a foreign provider or licensor). Finally, any net profits accumulated at the local entity in Brazil can be repatriated as dividends at 0% income tax withholdings. Another advantage of the presumed profits method is that it will significantly simplify local compliance and reporting packages.

2. Treaty Networking. Avoiding withholding taxation on Service Payments adopting a Tax Treaty Country. Another approach if significant expansion is expected in several Latin American countries is to create an IP holding incorporated or filed on a jurisdiction with a good tax treaty network.

The critical factor is to overcome the limitation of benefit provisions provided under the treaties, as well as giving substance to the IP toolbox or holding. Jurisdictions of choice for Latin America are Spain and the Netherlands.

3. Transactional Structuring. Another alternative to avoid withholding taxation on royalties and technical assistance is by creating and selling a legal entity. This approach is relevant in a transactional planning scenario. An entity is formed in an offshore low tax and non-blacklisted jurisdiction (preferably with a tax treaty) and capitalized with a contribution in pre-paid royalties and services. Thereafter, the local client, affiliate or partner purchases the stock in the capitalized offshore entity.

A jurisdiction to consider in this planning technique is Barbados, as it is not blacklisted by the OECD and has tax treaties with a number of countries, including the United States.

Read more at: Tax Times blog

Foreign Investors in U.S. Partnerships Miss Schedule P

Foreign investors often miss Schedule P.

It applies to the ownership of any U.S. partnership including a limited liability company. Many foreign investors use a foreign corporation with the hope of avoiding US estate taxes. 

Now, the 2011 Schedule P (Form 1120-F) is required by a foreign corporation’s ownership of a U.S. partnership. Schedule P also reports the distributive shares of partnership effectively connected income and the foreign corporation’s effectively connected outside tax basis in interest. 
Part I is used to identify all partnership interests the foreign corporation directly owns that give rise to distributive share of income or loss that effectively connected with a trade or within the United States of the corporation. 

Part II is used to the foreign corporation’s distributive share of ECI and allocable expenses with the total income and expenses reported to it on Schedule K-1 1065), Partner’s Share of Income, Deductions, Credits, etc. 

Part III is used follows: The corporation’s outside its directly-held partnership that include ECI in the corporation’s distributive share is apportioned between ECI and non-ECI Regulations section 1.884-1(d)(3) determine the average value treated as asset for interest expense allocation purposes under Regulations.

Read more at: Tax Times blog