D 3-International

NOVEMBER 7-9, 2012 DISNEY CONTEMPORARY HOTEL | ORLANDO

47th

annualBANK & CAPITAL MARKETSTAX INSTITUTE

47th

annualBANK & CAPITAL MARKETS TAX INSTITUTE

WWW.BANKTAXINSTITUTE.COM

D-3: INTERNATIONALFantasia K-N November 9th, 1:45pm – 3:15pm

47th ANNUAL BANK & CAPITAL MARKETS TAX INSTITUTE DISNEY CONTEMPORARY HOTEL

Speakers:

ADRIAN FENTON

MIKE GAFFNEY

RON HARVEY

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47th Annual Bank & Capital Markets Tax Institute

International Panel

Mike Gaffney PwCRon Harvey PwCAdrian Fenton BNY Mellon

November 9, 20121.45pm to 3.15pm

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International Tax Panel - Topics

1. Subpart F - Special Rules for the Active Conduct of a Banking, Financing, Securities Dealing, or Similar Business

2. Beneficial Ownership Challenges – survey of Certain Jurisdictions

3. Euro Zone Crisis – Tax Issues

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Tax Planning for Controlled Foreign Corporations Under Subpart F

Section 954 (h) and 954 (c)(2)(C)

Special Rules for the Active Conduct of a Banking, Financing, Securities Dealing, or Similar Business

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Section 954(h)Active Financing: Defining Subpart F Income

Section 952 defines subpart F income as the sum of:

1. Certain income derived from the insurance of risks (determined under Section 953);

2. Boycott income (determined under sections 952(a)(3) and 999);

3. Certain illegal bribes and kickbacks;

4. Income from unrecognized foreign countries; and

5. Foreign base company income - determined under section 954.

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Section 954(h)Active Financing: Defining Foreign Base Company Income

1. foreign personal holding company income;

2. foreign base company sales income;

3. foreign base company services income;

4. foreign base company shipping income;

5. foreign base company oil related income.

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Section 954(h)Active Financing: Foreign Personal Holding Company Income (“FPHCI”)

Section 954(c) defines FPHCI to include the following eight categories, almost all of which have exceptions:

1. Dividends, interest, royalties, rents and annuities. Section 954(c)(1)(A).

2. Net gains from the sale of property which either generates passive types of income listed in 1 above (other than rents and royalties derived in an active business from an unrelated person) is an interest in a trust, partnership or REMIC, or generates no income. Section 954(c)(1)(B).

Certain gains by dealers on inventory or dealer property are excepted.

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Section 954(h) Active Financing: Foreign Personal Holding Company Income (“FPHCI”) – continued…

3. Net gains from commodity transactions unless (i) such gains arise out of bona fide hedging transactions necessary to the conduct of a business involving the commodity, or (ii) such gains are active business gains from the sale of commodities by a CFC when substantially all of the CFC's business is as an active producer, processor, merchant, or handler of commodities. Section 954(c)(1)(C).

4. Net foreign currency gains, other than transactions directly related to the business needs of the CFC. Section 954( c)(1)(D).

5. Income equivalent to interest, such as loan commitment fees. Section 954(c)(1)(E).

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Section 954(h) Active Financing: Foreign Personal Holding Company Income (“FPHCI”) – continued…

6. Income from notional principal contracts. -- Net income from notional principal contracts. Notional principal contracts entered into for purposes of hedging any item described in any preceding subparagraph shall not be taken into account for purposes of this subparagraph but shall be taken into account under such other subparagraph. Section 954(c)1)(F) was added to the Code by the TRA’97.

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Section 954(h) Active Financing: Foreign Personal Holding Company Income (“FPHCI”) – continued…7. Payments in lieu of dividends. -- Payments in lieu of dividends

pursuant to an equity securities lending arrangements which section 1058 applies. Section 954( c)(1)(G) was added to the Code by the TRA’97.

8. Personal Service Contract income – section 954(c)(1)(H) was added by the AJCA of 2004.

Generally speaking, there are / were (through 2011) exceptions for eligible financial service companies in categories 1, 2, 3, 4, 5, 6 and 7. There are “same country” exceptions for category 1, and there are business need, ordinary course, or dealer exceptions to categories 2, 3, 4, 5 and 6

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Section 954(h) Active Financing: Brief History

1. On August 5, 1997, President Clinton signed the Taxpayer Relief Act of 1997 (“TRA’97”) which contained the first active financing exception rules.

2. On August 11, 1997, the provision to exempt active financing income from Subpart F was “line-item vetoed” by Pres. Clinton, apparently due to faulty drafting.

3. On June 25, 1998, the U.S. Supreme Court ruled in a 6-3 decision that the President's use of the Line Item Veto was unconstitutional. This means that the one-year provision to exempt "Active Financing Income" from subpart F, which was contained in the 1997 Tax Act, will take effect as if never vetoed.

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4. On October 21, 1998 President Clinton signed the "Tax and Trade Relief Extension Act of 1998". One of the provisions of the Act is a MODIFIED one-year extension of the exception for certain active financing income earned by CFCs and certain income earned by dealers. The modified extension "raises the bar" that a CFC will have to meet in order to take advantage of the exception. The CFC must meet both the "substantial activity" requirement and the "predominantly engaged" requirement in order to benefit from the subpart F deferral for qualified financing income.

5. In December 1999, the Tax Relief Extension Act of 1999 extended the active financing provisions for an additional 2 years, which generally cover calendar years 2000 and 2001 for most calendar year corporations.

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6. In March 2002, President Bush signed the Job Creation and Worker Assistance Act of 2002, which extended the active financing provisions for an additional 5 years, from 2002 through the 2006. It has been extended through CFC years ending before January 1, 2012.

7. On August 2, 2012, the Senate Finance Committee approved by a vote of 19 to 5 the "Family and Business Tax Cut Certainty Act of 2012." As part of this bill, the existing AFE exceptions to FPHCI are extended an additional two years, until the end of calendar year 2013, or for certain CFCs through November 30, 2014

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Section 954(h) Active Financing: Requirements

Pursuant to section 954 (h), income derived by a CFC in theactive conduct of a financing business is excluded from thedefinition of FPHCI.

Therefore, any item of income that falls within the general definition ofFPHCI will not be FPHCI to the extent this financing exception applies. Income qualifying for the FPHCI exception also is excluded from thedefinition of foreign base company services income, pursuant to the lastsentence of section 954(e).

Section 954(h) provides two fundamental requirements that must besatisfied for the financing exception to apply:

1. The income must be derived by an eligible CFC, and 2. The income must be qualified financing income.

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Section 954(h) Active Financing: Eligible CFC

A CFC will be considered as an eligible CFC if it meets thefollowing two requirements:

• the CFC is predominately engaged in the active conduct of a financing business (e.g., loans, leases, factoring), and

• the CFC conducts substantial activity with respect to such business.

The determination of the eligibility of a CFC apparently is required tobe made annually.

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Section 954(h) Active Financing: Eligible CFC – Predominantly Engaged Test – Objective 70% Test

The predominately-engaged test is satisfied if the CFC derivesmore than 70 percent of its gross income from its financingbusiness with unrelated foreign customers.

Finance income derived from U.S. customers and related customers,and nonfinance income, works against satisfying this test. A separateCFC may be used to engage in the qualifying activities to avoid failingthe 70-percent test.

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Section 954(h) Active Financing: Eligible CFC-Substantial Activity Test –Facts & Circumstances

The substantial activity requirement is a facts-and-circumstances test.

The CFC must conduct material activities related to its finance businessand must conduct substantially all of the activities that give rise to itsfinance income.

For purposes of determining a CFC's eligible status, the income and activities of the entire CFC are taken into account. This includes theincome and activities of its qualified business units (QBUs) andactivities performed without the CFC's or QBU's home country. Activities of employees of related persons generally are not considered,unless certain conditions are satisfied - they are performed in the CFC'sor QBU's home country.

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Section 954(h) Active Financing: Eligible CFC must have Qualified Financing Income

An eligible CFC's active financing income is qualified financing income excluded from FPHCI if all of the following three requirements are met:

a. the income is derived from transactions with customers outside the United States,

b. substantially all of the activities in connection with the transactions are conducted by the CFC or QBU in its home country through their respective employees, and

c. the income is treated as earned by such CFC or QBU in its home country for purposes of such country's tax laws.

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Section 954(h) Active Financing: Eligible CFC must have Qualified Financing Income – continued…

Note that finance income received from transactions with related non-US customers qualifies if the above conditions apply. Qualified financing income is determined separately for the CFC and each of its QBUs. As a result, financing income derived by one QBU of an eligible CFC may qualify for the exception, whereas financing income of another QBU of the same eligible CFC may not qualify; e.g., where the QBU's finance income is not subject to tax in its home country.

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Section 954(h) Active Financing: Active Financing: Qualified Financing Income Types

Income derived by an eligible CFC or QBU of such CFC from the following types of activities be considered to be income derived in the active conduct of a banking, financing, or similar business (provided that the other requirements for these exceptions are satisfied):

1. regularly making personal, mortgage, industrial, or other loans in the ordinary course of the corporation's trade or business;

2. factoring evidences of indebtedness for customers;

3. purchasing, selling, discounting, or negotiating for customers notes, drafts, checks, bills of exchange, acceptances, or other evidences of indebtedness;

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4. issuing letters of credit and negotiating drafts drawn thereunder for customers;

5. performing trust services, including as a fiduciary, agent, or custodian, for customers, provided such trust activities are not performed in connection with services provided by a dealer in stock, securities or similar financial instruments;

6. arranging foreign exchange transactions (including any section 988 transaction within the meaning of section 988(c)(1)) for, or engaging in foreign exchange transactions with, customers;

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Section 954(h) Active Financing: Qualified Financing Income Types

7. arranging interest rate or currency futures, forwards, options or notional principal contracts for, or entering into such transactions with, customers;

8. underwriting issues of stock, debt instruments or other securities under best efforts or firm commitment agreements for customers;

9. engaging in leasing (including entering into leases and purchasing, servicing and disposing of leases and leased assets);

10. providing charge and credit card services for customers or factoring receivables obtained in the course of providing such services;

11. providing traveler's check and money order services for customers;

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12. providing correspondent bank services for customers;

13. providing paying agency and collection agency services for customers;

14. maintaining restricted reserves (including money or securities) in a segregated account in order to satisfy a capital or reserve requirement imposed by a local banking or securities regulatory authority;

15. engaging in hedging activities directly related to another activity described herein;

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16. repackaging mortgages and other financial assets into securities and servicing activities with respect to such assets (including the accrual of interest incidental to such activity);

17. engaging in financing activities typically provided in the ordinary course by an investment bank, such as project financing provided in connection with construction projects, structured finance (including the extension of a loan and the sale of participations or interests in the loan to other financial institutions or investors), and leasing activities to the extent incidental to such financing activities;

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18. providing financial or investment advisory services, investment management services, fiduciary services, or custodial services;

19. purchasing or selling stock, debt instruments, interest rate or currency futures or other securities or derivative financial products (including notional principal contracts) from or to customers and holding stock, debt instruments and other securities as inventory for sale to customers, unless the relevant securities or derivative financial products are not held in a dealer capacity;

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20. effecting transactions in securities for customers as a securities broker; and

21. any other activity that the Treasury determines to be a financing activity conducted by active corporations in the ordinary course of their business.

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Section 954(h) Active Financing: Qualified Financing Income Types -continued

The list above is similar, but not identical, to the list of 25 types of active financing income in the financial services basket if the foreign tax credit limitation regulations of reg. 1.904-4(e)(2(A) through (Y).

It is also important to keep in mind that qualified financing income of an eligible CFC or QBU of such CFC is determined separately for the CFC and each QBU, taking into account, in the case of an eligible CFC, only items of income, gain, deduction, loss or other items, as well as activities, of such CFC that are not properly allocable to any QBUs. Similarly, in the case of a QBU, qualified financing income is determined by taking into account such applicable items (e.g., income and activities) that are properly allocable to such QBU.

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Section 954(h)Active Financing: Eligible CFC’s Qualified Financing Income–Cross Border Transactions–Two Requirements for Finance Co’s

Two additional requirements are imposed when an eligible finance company CFC (not a Bank or Security Dealer) or QBU derives financing income from cross border transactions.

First, income from transactions with customers located in a country other than the home country of the CFC or QBU will qualify for the active financing income exception only if the CFC or QBU conducts substantial activity in its respective home country (a facts-and-circumstances determination). Failure to satisfy this requirement, however, does not disqualify the CFC's or QBU's income from home country customers.

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Section 954(h)Active Financing: Eligible CFC’s Qualified Financing Income–Cross Border Transactions–Two Requirements for Finance Co’s - continued

Second, an eligible CFC (or QBU) must derive more than 30 percent of its active financing gross income:

a. from transactions with customers who are not related persons; and

b. from transactions with customers that are located within the CFC‘s (or QBU's) home country.

If this requirement is not satisfied, the exception contained in section 954(h) does not apply to any of the financing income of such CFC or QBU (including income derived from home country customers), respectively.

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Section 954(h)Active Financing: Qualified Financing Income – Local Customer Example, CFC with QBU

The exceptions apply to income that is derived from transactions with customers located in the CFC's home country. In addition, the exceptions apply to income that is derived by a QBU of an eligible CFC from transactions with customers located in the QBU's home country.

Example: Assume that a CFC is incorporated in the UK and has a French QBU. Also assume that the activities of the UK CFC's head office together with the activities of the French QBU satisfy the substantial activity requirement. Income derived by the U.K. CFC from transactions with customers in the UK is eligible for the exceptions if substantially all of the activities in connection with the transaction are performed in the UK by employees of the UK CFC, and the income is treated as earned by the UK CFC in the UK for UK income tax purposes. In addition, income derived by the French QBU from transactions with customers in France is eligible for the exceptions if substantially all of the activities in connection with the transactions are performed in France by employees of the French QBU, and the income is treated as earned by the French QBU in France for French income tax purposes.

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Section 954(h)Active Financing: Qualified Financing Income–Cross Border Example, CFC w/QBU

Income derived by a CFC from transactions with customers not located in the CFC's home country or the U.S. is eligible for the exceptions if the CFC conducts substantial activity in its home country. In addition, income derived by a QBU of an eligible CFC from transactions with customers not located in the QBU's home country or the U.S. is eligible for the exceptions, but only if the QBU conducts substantial activity with respect to such a business in its home country. For this purpose, the substantial activity requirement is applied by looking only at the activities of the applicable CFC or QBU on a stand-alone basis. Thus, income derived by a QBU from transactions with customers not located in its home country (or in the U.S.) is eligible for the exceptions if the activities of the QBU itself constitute substantial activities (provided that the other requirements are satisfied).

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Section 954(h)Active Financing: Qualified Financing Income–Cross Border Example, CFC w/QBU – continued…

EXAMPLE: Consider again the UK CFC and the French QBU. If the head office of the UK CFC derives income from a transaction with a customer in Germany, the income is eligible for the exceptions if the activities of the CFC itself (without regard to those of the French QBU) satisfy the substantial activity requirement. Alternatively, if the French QBU derives income from a transaction with a German customer, the income is eligible for the exceptions if the activities of the French QBU itself satisfy the substantial activity requirement.

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Section 954(h)Active Financing: Eligible CFC – Predominantly Engaged-Differing Standards for Banks, Securities Dealer v. Lending, Finance Co’s

Under the 1998 Tax Act modification, a CFC is considered to be predominantly engaged in the active conduct of a banking, financing, or similar business if it is:

1. Engaged in the active conduct of a banking or securities business AND

2. License Requirement: The CFC is an institution licensed to do business as a bank in the United States (or is any other corporation not so licensed which is specified in regulations), or if the CFC is registered as a securities broker or dealer under applicable U.S. securities laws (or is any other corporation not so registered which is specified in regulations).

The Congress intended that these requirements for the active conduct of a banking or securities business look to the proposed PFIC regulations under prior law section 1296(b) (as in effect prior to TRA’97), which are the PFIC exceptions for foreign banks and securities dealers. See Prop. Reg. sec. 1.1296-4 and 1.1296-6.

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Section 954(h)Active Financing: Eligible CFC – Predominantly Engaged-Differing Standards for Banks, Securities Dealer v. Lending, Finance Co’s

Predominantly Engaged Requirement - Lending or finance business

Under the 1998 Tax Act modification, a CFC is considered to be predominantly engaged in the active conduct of such business if more than 70 percent of its gross income is derived directly from the active and regular conduct of a lending or finance business from transactions with customers which are unrelated persons. These requirements may create practical difficulties in requiring the CFCs to track their customer base by the geographic location of their customers, and to understand clearly the definition of gross income for GAAP purposes, which will generally be the starting point for any tax analysis. It is very important to note that Congress intends that transactions with customers located in the United States not be taken into account in determining whether the 70-percent test is satisfied, meaning that the gross income from dealing with U.S. customers should drop out of both the numerator and denominator of the 70% test.

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Section 954(h)Active Financing: Eligible CFC – Predominantly Engaged-Lending, Finance Co’s Activities

A CFC is considered to be engaged in a lending or finance business if it is engaged in the business of --

1. making loans;

2. purchasing or discounting accounts receivable, notes (including loans), or installment obligations;

3. engaging in leasing (including entering into leases and purchasing, - servicing and disposing of leases and leased assets);

4. issuing letters of credit and providing guarantees;

5. providing charge and credit card services; or

6. rendering services or making facilities available in connection with the foregoing activities carried on by the corporation rendering such services or facilities, or by another corporation which is a member of the same affiliated group. For this purpose, whether two corporations are affiliated is determined by reference to section 1504 with one modification: the exclusion for foreign corporations is disregarded.

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Section 954(h)Active Financing: Eligible CFC – Predominantly Engaged-Lending, Finance Co’s Activities – continued…

Whether any portion of a CFC's gross income is derived directly from the active and regular conduct of a lending or finance business is determined under all the facts and circumstances. The Treasury has been granted the authority to prescribe regulations to carry out the purposes of these exceptions.

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Section 954(h)Active Financing: Eligible CFC – Substantial Activity –Facts & Circumstances – Intent of Congress

In order to avoid taxpayers from dumping financing activities into Tax Haven shell companies with no employees, the 1998 Tax Act modified the active financing exception by, among other things, incorporating a substantial activity requirement.

All relevant factors can be taken into account, including the overall size of the CFC, the amount of its revenues and expenses, the number of its employees, the ratio of its revenues per employee, the amount of property it owns, and the nature, size, and relative significance of the applicable activities conducted by the CFC.

Treasury is granted the authority to prescribe regulations to carry out the purposes of these exceptions.

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Section 954(h)Active Financing: Eligible CFC – Requirement to Conduct Substantially All Activities Needed to Generate Income

A CFC is required to conduct substantially all of the activities necessary for the generation of income with respect to the business, which generally include the following:

• Initial solicitation of customers (including vendors);

• Advising customers on financial needs, including funding and financial products;

• Providing financial and technical advice to customers;

• Designing or tailoring financial products to customers' needs;

• Negotiating terms with customers;

• Performing credit analysis on customers and evaluating noncredit risks;

• Providing related services to customers;

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Section 954(h)Active Financing: Eligible CFC – Requirement to Conduct Substantially All Activities Needed to Generate Income –continued…

• Making loans, entering into leases, extending credit or entering into other transactions with customers that generate income that would be considered derived in the active conduct of a banking, financing, or similar business;

• Collecting from customers;

• Performing remarketing activities (including sales) following termination of transactions with customers;

• Responding to customers' failure to satisfy their obligations under transactions, including enforcement or renegotiation of terms, liquidation of collateral, foreclosure, and/or institution of litigation; and

• Holding collateral for transactions with customers.

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Section 954(h)Active Financing: Eligible CFC – Requirement to Conduct Substantially All Activities Needed to Generate Income –continued…

It is also important to note that the performance of back- office functions (including accounting for income or loss, recordkeeping, and routine communicating with customers) not be taken into account in determining whether the substantial activity requirement is satisfied.

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Section 954(h)Active Financing: Eligible CFC – Requirement to Conduct Substantially All Activities Needed to Generate Income

The substantial activity requirement is applied based on the activities of the CFC as a whole, including the activities of any QBUs of the CFC. In determining whether the substantial activity requirement is satisfied, activities performed in the country in which the CFC is incorporated (or in the country in which the QBU has its principal office) by employees of a related person of the CFC are taken into account, but only to the extent that the related person is compensated on an arm's-length basis for the services of such employees and such compensation is includible in the related person's income in such country for purposes of such country's income tax laws. For this purpose, a related person has the meaning provided in section 954(d)(3), substituting "at least 80 percent" for "more than 50 percent." Also, according to the 1998 blue book, the Congress intended that the activities of such a related person are not again taken into account in determining whether another CFC or QBU (e.g., the related person) satisfies the substantial activity requirement.

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Section 954(h)Active Financing: Sale of Assets used in an Active Financing Business

In general, FPHCI income includes net gains from the sale or exchange of property that gives rise to dividends, interest, royalties, rents, or annuities. Under the 1998 Tax Act, FPHCI does not include net gains from the sale or exchange of property that gives rise to dividends, interest, royalties, rents, or annuities if such property gives rise to income not treated as FPHCI for the taxable year by reason of the exceptions under section 954(h) or (i) for income derived in the active conduct of a banking, financing, or similar business or in the conduct of an insurance business.

The Congress intended that this exception applies only to the extent that, prior to its disposition, the property was held to generate or generated income which qualifies for the exceptions under section 954(h) or (i) (and such property was not so held for a principal purpose of taking advantage of such exception).

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Section 954(h)(6)Active Financing and Coordination with Section 954(c)(2)(C) Dealer Exception

The 1998 Tax Act provides that the exceptions under section 954(h) for income derived in the active conduct of a banking, financing, or similar business do not apply to income described in the dealer exception under section 954(c)(2)(C)(ii) for a dealer in securities which is an eligible CFC that satisfies the predominantly engaged requirement for a securities business.

At the same time that section 954(h) was enacted, and periodically extended, section 954(c)(2)(C) was being enacted and extended. Section 954(c)(2)(C) provides that dividends, interest, and their equivalents earned by a Regular Dealer in the ordinary course of the dealer’s trade or business are not considered FPHCI.

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Section 954(c)(2)(C) Securities Dealer Exception

The securities dealer exception to FPHCI applies to interest, dividends, income equivalent to interest, and in lieu of dividends amounts described in sec. 954(c)(1)(E) or (G) from any transaction (including hedges) or a transaction consisting of a deposit of collateral or margin described in sec. 956(c)(2)(J)) entered into in the ordinary course of the dealer's trade or business as such a securities dealer, but only if the income is attributable to activities of the dealer in the country in which the dealer is created or organized (or, in the case of a QBU of the dealer, is attributable to activities of the QBU in the country in which the QBU both maintains its principal office and conducts substantial business activity).

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Section 954(c)(2)(C) Securities Dealer Exception – continued…

To avoid this exception being used by booking sites without employees (ex. Cayman CFC), income is considered to be attributable to activities of the dealer in its country of incorporation (or to a QBU in the country in which the QBU both maintains its principal office and conducts substantial business activity), if such income is attributable to activities performed in such country by employees of the dealer (or QBU), and such income is treated as earned in such country by the dealer (or QBU) for purposes of such country's tax laws. For this purpose, income is considered to be earned in the country in which the dealer is created or organized (or, in the case of a QBU, in the country in which the QBU both maintains its principal office and conducts substantial business activity), if such income is sourced and allocable to such dealer (or QBU) in such country for purposes of such country's tax laws.

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Section 954(c)(2)(C) Securities Dealer Exception – continued…

Congress intended that the dealer exception not apply to income from transactions with persons located in the United States with respect to U.S. securities. This reflects the understanding of the Congress that the exception from current inclusion under subpart F for income earned by dealers in securities does not apply to activities that would otherwise be conducted in the United States. In addition, the Congress intended that the dealer exception will apply to interest paid by customers to the dealer on margin loans in connection with sales of securities (provided that the other requirements of the provision are satisfied).

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Special ASC 740 considerations – AFE & Look Through

CFC look-through

• Look-through treatment of payments between related CFCs

- CFC look-through rule expires on December 31, 2011

- Payments of dividends, interest, rents and royalties after December 31, 2011 between affiliated foreign subsidiaries will likely give rise to subpart F income in the US, unless other exceptions apply

- Tax accounting considerations

◦ Foreign parent may not be able to assert indefinite reinvestment (and avoid recording a tax liability) with respect to its investment in the lower-tier foreign subsidiary beyond the scheduled expiration date

› Without CFC look-through rule, dividends paid from lower-tier foreign subsidiary to its foreign parent may result in deemed dividend (e.g., subpart F income) to the US parent

◦ Impact on current taxes payable and deferred income taxes

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Special ASC 740 considerations – AFE

Active financing income

• Subpart F income - exceptions for active financing income

- Scheduled to expire on December 31, 2011

- Active financing income when earned by a CFC will likely be taxable in the US under subpart F, unless other exceptions apply

- Tax accounting considerations

◦ Impact on indefinite reinvestment assertions

◦ Impact on deferred income taxes

› Existing inside basis temporary differences of a foreign subsidiary may need to reflect both foreign and US deferred taxes if their reversal will result in future subpart F impacts

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Active Financing – Traps with Expiration

• Increased Complexity in analyzing 8 FPHCI categories

• Revisit section 954(b)(5) “deductions to be taken into account”

• Deductions, not losses on property transactions that are economic hedges to assets that generate dividend and interest

• Section 954(b)(5) doesn’t allow direct offset for CFC interest expense to a CFC’s FPHCI if the CFC has non-passive FPHCI due to reference to section 904(d)(2) financial services basket.

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Beneficial Ownership – Changing Landscape

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• The concept of beneficial ownership

• OECD position• Landmark decisions

• Recent trends

• India – The Vodafone case and emerging GAAR principles• Canada – Velcro Canada – Royalty after Restructuring• United States – Tier 1 TRS issue and Section 871(m)• Switzerland – March 2012 Swiss Administrative Court on TRS• China – Circular 601 and indirect transfers

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OECD – Initial Position from 1971

• 1966 Protocol to US-UK double tax treaty of 1945

• UK-Netherlands double tax treaty of 1967

• 1977 – new model Convention and Commentaries

• The initial position consistent with 1968-1970 discussions – to prevent

entitlement of agent/nominee

• The Conduit Companies Report of 1986 – proposed extension to hit

conduit companies “vary narrow powers which render it a mere

fiduciary or an administrator acting on account of the interested

parties …”

• 2003 – amendment of the Commentary – revised paragraphs 12 to 12.2

• US-UK protocol of 1966 to double tax treaty of 1945

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Part I – what is the term supposed to mean?

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The 2011 OECD Discussion Draft Proposals

• Domestic vs treaty based interpretation of the test

• Meaning of “beneficial owner” – “full right to use and enjoy the dividend … unconstrained by any contractual or legal obligation to pass the payment on…”

• Interaction of the test with other anti-avoidance measures relevant to treaty shopping

• Distinction of treaty test from other tests involving the “beneficial owner” test

• Future developments

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OECD – Current Position

• OECD guidance somewhat limited

• Mere nominees and agents debarred by beneficial owner test

• Other conduits with very narrow powers also debarred

• Interpretation in treaty context

• Current work of the OECD and likely outturn

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PwC

Cases on beneficial ownership

• Netherlands – Royal Dutch Case, 1994

- UK-Dutch dividend

• UK – Indofood International Limited v JPMC, 2006

- Interest Indonesian Issuer – Mauritius SPV, Dutch NewCo

• France –Bank of Scotland decision, 2006

- Dividend Usufruct sale

• Canada – Prevost Car Inc v Her Majesty the Queen, 2008

- Dividend from Canada via Dutch BV to UK-Swedish JV

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PwC

Canada -Prevost Car Inc – Dividend case, 2008

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UK Co (Henlys)

Sweden Co (Volvo)

Prevost (Canada)

Canadian tax inspectorate

5% w/h based on

Dutch treaty

divs

Prevost B.V. (Netherlands)

divs

divs

Assessments based on UK Co and Sweden Co as beneficial owners

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PwC

Canada – Velcro - Royalty after RestructuringFebruary 2012

Velcro (Canada)

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Velcro Holdings (Netherland)

Velcro Industries (Netherland Antilles) • Canada challenged 1995

Restructuring – was Velcro Holdings the beneficial owner of royalties or non-treaty Velcro Industries ?

• Tax Court of Canada rejected Minister’s two positions, Velcro Holdings was beneficial owner, and Velcro Holdings was not an agent, nominee or conduit

PwC

United States – IRS Industry Directive – TRS to avoid dividend withholding, 2010IRS issued an industry director directive (IDD) providing guidance to the field on selected TRS used to avoid dividend withholding tax. The intent of this IDD is to provide guidance on developing facts for determining when a transaction that is in form a TRS will be respected in substance as a notional principal contract, and when such a swap will be recharacterized in accordance with its substance as an agency or nominee agreement, repurchase agreement, lending transaction, or some other form of economic benefit by the foreign person.

Section 871(m) changed the law for sourcing dividend equivalents

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Amounts Equivalent to Dividends on X Stock

LIBOR +/- Spread

Appreciation

Depreciation

Dealer HF

PwC

Swiss Administrative Court – Denmark and Swiss Equity with TRS, March 2012

• Danish Bank with 61 employees hedged TRS with US, UK , French and German counterparties by buying Swiss equities

• Minimum swap was 3 months, average swap was 6 months

• Danish Bank not required to hedge, Court clarified that holding period of shares has no impact on beneficial ownership

• Swiss Government is expected to appeal the decision

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Amounts Equivalent to Dividends on X Stock

LIBOR +/- Spread

Appreciation

Depreciation

Danish Bank –full refund Client - Treaty without

full refund

10/26/2012

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PwC

Conclusion on Status of Beneficial Ownership

Situation is evolving – at OECD and country by country

No universal position – creeping Economic Protectionism

Specific treaty shopping and other anti-avoidance articles with clear effect may overtake beneficial ownership issue

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PwC

Euro Zone risks – legal and tax consequencesThe Background

What will be the consequences for the Departing State?

• National legislation to establish:

o monetary sovereignty

o new currency

o mechanism to redenominate debts owed by or to its nationals from Euros into the new currency

o Tax consequences?

• Departure is approved - EU supporting legislation

• Departure from the EU and Eurozone - exchange controls?

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PwC

Euro Zone risksWhat will a departure affect?

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Hedging and derivative contracts

Contracts with customers and

suppliers

Supply chain

planning

Bank loans/deposits Investments

in shares

Joint venture

agreements

Intra group loans

Any contract involving a payment in Euros to or

from a person in a Departing State

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PwC

Euro Zone risksWhat gives rise to tax risk?

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Early refinancing of external

debt

Repatriation of cash from

overseas

Impact on currency

tax hedging

Redenomination of contracts

Write off of investments

and loans

Impact on E&P pools

Eurozone tax convergence?

External to corporate group: tax is a part of the issue

Internal to group: tax is the whole issue

Foreign currency

exposures

Sub-F exposure

PwC

Euro Zone risksExcess cash

Overview

• CFC has excess EUR cash and deposits such cash with a local bank

• Group are concerned about the banks liquidity and the ability to extract cash out of Europe

• CFC has EUR functional currency

Options

• Distribute cash back to US / out of Euro co’s. Considerations:

• Look thru?

• FTC profile

• WHT costs

• Distributable reserves

• Have CFC switch Euro deposits to safer currencies, eg Dollars62

PwC

Euro Zone risksExcess cash switch Euros to Dollars – base case 1

63

o CFC may (i) deposit its excess cash in USD with U.S. banks or (ii) invest its excess cash in U.S. T-bills, because more comfortable with credit quality of USD issuers.

o CFC’s USD deposit or investment would give rise to FX (Section 988) gain/loss. Generally, net Section 988 gain gives rise to subpart F income while net Section 988 loss can only be used to reduce a CFC’s E&P. Assume that taxpayer wants to avoid creating FX exposure in CFC, and that any concerns about economic exposure to EUR are separately addressed through net investment hedges at USP level.

o Interest income from USD deposits or investments would give rise to Subpart F income.

US

CFC(EUR)

Deposit excess EUR cash with European banks

Deposit excess cash in USD with U.S. banks or invest excess cash in U.S. T-bills

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PwC

Euro Zone risksExcess cash switch Euros to Dollars – alternative 1

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US

CFC(EUR)

CFCSPV

(USD)

Contribute excess cash


o CFC contributes its excess cash to an SPV that has the UDS as its functional currency. The SPV’s only activity is to hold the USD deposits or the U.S. T-bills.

o CFC would not incur Section 988 gain/loss.

o Because the SPV has the USD as its functional currency there is no Section 988 gain/loss.

o SPV would be a full inclusion CFC and interest income in the SPV should give rise to Subpart F income.

o SPV could make annual dividend distributions to the U.S. shareholder out of PTI.

o Upon exit, because CFC’s basis in SPV stock is kept in EUR, if USD appreciated against the EUR, there may be a gain on distributions under Section 301(c)(3) or on sale.

o Recognition of gain avoidable if SPV checks the box to be disregarded. Section 332 provides non-recognition treatment for deemed liquidation.

PwC

Euro Zone risksExcess cash switch Euros to Dollars – alternative 2

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US

CFC(EUR)

Hedges with market


o Hedge its FX exposure with respect to the USD deposits or the U.S. T-bills with FX forward contracts that are Section 1256 contracts.

o Such hedging transactions may not constitute a “hedge” for tax purposes under Treas. Reg. § 1.1221-2 because it hedges a capital investment; therefore concerns about timing mismatches.

o CFC could solve timing concerns by establishing a mixed straddle account under Treas. Reg. § 1.1092(b)-4T with respect to its Section 1256 contracts and its USD Treasury bill and bank deposit positions.

o If a mixed straddle account is established, CFC should mark to market its U.S. T-bills, USD bank deposits and the hedge contracts.

o Note that this election should only be considered if the U.S. T-bills are of a short-term nature. This is because the marks of changes in the value of fixed rate dollar debts receivable attributable to interest rate fluctuations produce gains or losses from dispositions of securities under section 954(c)(1)(B), which don’t net against foreign currency losses or gains under section 954(c)(1)(D). The operation of the mixed straddle account rules minimizes, but does not completely eliminate this mismatch.

PwC

Euro Zone risksExcess cash switch Euros to Dollars – Base case 2

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US

CFCTreasury

Center(EUR)

EUR Notes to affiliated CFCs

EUR Notes from affiliated CFCs


Deposit excess EUR cash with European banks

o As in Base case 1 if a EUR functional currency CFC Treasury Center deposits its excess cash in USD such deposits or investments would give rise to Section 988 gain/loss.

o To the extent Treasury Center hedges its USD exposure with the market and it is a Section 475 dealer, the timing for realizing FX gain/loss arising from the USD deposits, T-Bills and the hedges should match under its marked to market method of accounting.

o To the extent that Treasury Center makes a 1.954-2(g)(4) election, it should be able to net the FX gain/loss arising from the hedges and the USD deposits. Potential subpart F mismatch from investing in fixed rate term debt instruments, because gains and losses from marking for interest rate fluctuations may not net against losses and gains for currency marks.

o If Treasury Center has USD functional currency, it can borrow excess EUR from affiliates, hedge those borrowings, convert the EUR to USD, and invest the USD.

o Because interest income from U.S. T-bills would give rise to subpart F income, Treasury Center’s interest payments to affiliated CFC lenders could give rise to subpart F income to the CFC lenders under the CFC look-through rules.

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PwC

Euro Zone risksExcess cash switch Euros to Dollars – Base case 2

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US

CFCTreasury

Center(EUR)

CFCSPV

(USD)

Contribute excess cash

Distribution

Distribution

EUR Notes from affiliated CFCs


EUR Notes to affiliated CFCs

o One alternative is for a Treasury Center is to contribute its excess cash to an SPV that has the USD as its functional currency. The SPV’s only activity is to hold the USD deposits or the U.S. T-bills.

o Treasury Center would not incur Section 988 gain/loss on the investments.

o Because the SPV has the USD as its functional currency, the USD deposits or U.S. T-bills would not give rise to Section 988 gain/loss to the SPV.

o Interest income in the SPV would give rise to Subpart F income that would be directly included annually by the U.S. shareholder.

o SPV could make annual distributions back to Treasury Center out of PTI.

o Because the passive income on U.S. T-bills is earned in SPV, interest payments made by Treasury Center to affiliated CFC lenders would not be tainted under the look-through rule.

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D 3-International

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Transcript of D 3-International