Recently I took a few minutes to speak with Taxlinked.net about some of the current issues being faced within the international tax context. Here is the full text of the interview:
TL: What is the US government doing to curtail tax or corporate inversions in the country? Are there are proposed rules seeking to regulate this practice and keep companies stateside?
Stephen Bush (SB): Internal Revenue Code § 367 has been periodically strengthened to impose in certain situations shareholder gain on transfers of appreciated US property to a foreign corporation, which would otherwise be non-taxable if it wasn’t a foreign transaction. In 2004, after inversions became more popular, a corporate level solution was enacted with § 7874 to impose gain on the corporation if certain criteria were met, such as ownership by US shareholders of the foreign acquiring corporation, and not enough “substantial business activities” within the foreign corporation’s home country. If the foreign corporation after the acquisition of the US entity has 80% of the same ownership as the domestic entity did before the transaction, then the foreign corporation is treated as a US entity for US tax purposes. If the common ownership is over 60% but less than 80%, the transaction is treated as an inversion transaction, but the foreign corporation is respected as foreign. It is under the latter transaction in which many strategies were put in place to avoid the purpose of § 7874 and to avoid US tax.
Most recently, in November of this year, the IRS and Department of the Treasury issued Notice 2015-79, stating the IRS and Treasury’s intention to issue regulations to § 7874, which will further address some of the strategies tax planners have used to avoid US taxation through inversion transactions. Specifically, the transactions covered under this notice are those in which the foreign acquiring corporation has substantial business activities in the foreign country, but is otherwise not subject to tax in that country, and when a US entity combines with a foreign acquiring entity, but the common parent of those entities is in a different country than the foreign entity, and that country may offer more opportunities to avoid US tax.
The first situation may occur when the management or control of the foreign corporation is in a different country than where the corporation is established, and thus the “substantial business activities” still occur in the foreign country enough to where inversion won’t be recognized by the United States. Similarly, based upon certain entity classifications, an entity can be classified as a corporation for US tax purposes, but be seen as transparent in the foreign country, thus satisfying the substantial activity test in the eyes of the IRS, but otherwise not subject to tax in the foreign country. In order to prevent this, the IRS and treasury intend to issue regulations that will require the foreign corporation to be taxed in the foreign jurisdiction in order for § 7874 not to impose inversion gain on the inversion transaction.
The second situation results when a new foreign parent owns the foreign acquiring corporation and the US entity, and that parent owns enough of the combined group (more than 20%) to where that group won’t be treated as a US entity for § 7874 purposes. Because it is doubtful that this is done to achieve a substantial business purpose other than tax avoidance, the IRS and the Treasury intend to issue regulations in which certain stock of the third country parent will be ignored when determining the 80/20% test to determine US ownership after the transaction. This will ensure that the US entity was not combined with a foreign entity that is owned by a parent in another country simply to avoid US tax.
TL: Some of the rules proposed by the Obama administration to curb tax inversion have backfired, making American companies more vulnerable to foreign takeovers. What are your thoughts on this?
TL: What are your thoughts on BEPS’ new interpretation of permanent establishment (PE)? How will this redefinition affect businesses in the long run? Who will benefit and who will lose from this move?
SB: The thought process behind a global agreement to prevent base erosion is well intentioned, and it certainly will give countries with strong business connections a clearer road map as to whether certain transactions will effectively deem a company established enough in a jurisdiction to be taxed there. On the other hand, however, the new guidelines for permanent establishment could have the effect of rendering a company to be taxed in a jurisdiction where traditionally certain transactions wouldn’t have such an effect, creating chilling effect on a company’s willingness to engage there.
I worked on a project where one company owned loans that were originated in the US, but purchased them later and in a marketplace which otherwise wouldn’t render the company vulnerable to being taxed in the US. The company hired another servicing agency to service the loans in the US and, based on the treaty, wasn’t considered to have a permanent establishment in the US because it was an independent agency relationship. Given the details of the relationship, the proposed changes to Article 5, paragraph 5 would otherwise render the servicing company to create a permanent establishment in the US because the servicing company is close enough to an agency relationship, not independent under the new wording of the proposed language. For situations like this where companies come to rely on such a safe harbor, it could mandate a huge change in order to avoid paying more taxes.
Ultimately, however, the treaties enacted between many of the major players prevent any extra tax being imposed when there are certain transactions that create revenue in both jurisdictions. The headache will come when companies are forced the analyze their methods of doing business to determine whether or not they’ll be subject to tax in certain countries, but, hey, that is what we’re here for.
TL: Delaware, Nevada and Wyoming are considered to be “incorporation-friendly” states within the US. What would drive companies to set up there versus internationally?
SB: Once a company decides it wants to do business in the United States, and decides that incorporating is the best route, that company has to incorporate under the laws of one of the states. There is no Federal method of incorporating, and so one of the states has to be chosen to do business in the US. Nevada, Wyoming and Delaware are the best states in which a multinational can incorporate because of the flexibility of the corporate laws, no requirement for actual presence by an officer within the state, and typically pretty low corporate tax rates on the state level. Despite this, any company incorporated in the US is subject to Federal tax as well as the state tax, and so the flexibility of the states doesn’t necessarily offer any further benefit regarding Federal corporate tax laws.
In regards to other aspects of state tax laws, such as sales and use, it could be a disadvantage to conduct business in certain states, depending upon what type of business that company is involved in. For instance, based upon a 1992 United States Supreme Court case, most states do not collect sales tax on digital goods sold online. However, some states are beginning to impose such a tax, claiming that the company selling the goods has enough of an economic “nexus” with the state that sales tax can be legally imposed.
TL: There’s talk in the US of creating a “patent box” to keep American companies from moving their intellectual property abroad. What’s the latest on this push and do you think this is the right move?
SB: Creating a US patent box is not the best way to go, in my opinion. Given the already existing complexity of the US tax code, introducing new provisions specifically designed to address intangibles will only make it more costly and less efficient to comply with the tax laws, and won’t raise revenues to the point of benefitting the country, or incite development of new technologies. If a country like the US wants to keep patents and development within its borders, the easiest and most efficient route to go would be to lower the corporate tax rates in general, keeping jobs, productivity, and ultimately revenue from being outsourced.
Installing a lower tax for ownership and use of patents in the US would help corporations who own the patents to new technologies and new ideas, however, there is no added incentive to actually create and develop new ideas that would lead to patentable technologies. In order to promote the US as a hub for creating, the US government should find a way to subsidize those who spend the time to develop technology and who may need more of a financial cushion to make the mistakes and create the experiments that would lead to something new. Many of the current patent boxes don’t even require the R&D to be done within that country. This would allow companies to keep their main operations outside the US borders but through creative structuring incur a lower tax rate on just the patents that company owns. A country would not benefit from that.
This is also true for the creation of jobs. If a company has a structure in place that keeps the patent ownership in a certain jurisdiction but the main operations, development of patents, and actual use of patents is elsewhere, the country with the low tax for patents suffers. Furthermore, it is quite difficult to relate actual use of the patent to the patent itself, which becomes more troublesome than it’s worth when a patent box requires that the activities stemming from new ideas and technology be used in that country. Much like compliance with specifying whether certain patents would fall under the benefit of a patent box, this would add to the cost of lowering a company’s taxes, which would render it much less useful.
TL: Anything else you’d like to share with the Taxlinked.net community?
SB: I think one aspect of international transactions that a lot of small businesses I advise are beginning to take advantage of is the use of Bitcoin as payment for services and products. The use of Bitcoin as a form of payment has many countries somewhat at a loss as to how to deal with the taxation of this type of currency, and talk of how to regulate it will only increase in the next few years, whether it is Bitcoin or another cryptocurrency.
While income in the form of Bitcoin is still taxed as income (or a gain, depending on how a person uses it), there are many advantages for small businesses, especially those that engage in international transactions when it comes to receiving and making payments. Fees are almost nil when it comes to making an actual transaction, and for those businesses that engage in transactions that require an exchange of currencies, doing this in the form of digital currencies reduces many of the expenses that otherwise are commonplace when using traditional payments. Additionally, there is no application process as a merchant to accept Bitcoin, no extra time waiting for pending transactions to be approved by a bank, and there is only one exchange rate for it, allowing merchants to only worry about translating it into his or her country of origin.
While the chance exists that Bitcoin won’t fully catch on, a small business really has nothing to lose by at least accepting Bitcoin. I always welcome the opportunity to work with businesses overseas interested in establishing themselves in the US and discussing their options as far as corporate engagement, and whether certain strategies like accepting cryptocurrencies will bolster profitability.
My firm VinceLegal specializes in growing small international businesses that otherwise wouldn’t have access to solid legal assistance in the United States when choosing to incorporate or otherwise take advantage of tax efficient ways of doing business overseas, and we are always interested in growing our network.