Inbound Issues and Planning

International Tax Issues

PLI, New York, January 30, 2014

Peter Glicklich

Davies Ward Phillips

& Vineberg LLP

Oren Penn

PricewaterhouseCoopers

LLP

Kimberly Blanchard

Weil, Gotshal & Manges LLP

Agenda

• Recent Developments Under FATCA

• Revisiting Selected Topics Under FIRPTA

• Sales of Partnership Interests

• Selected Current Issues Under Tax Treaties

• BEPS Developments

• Sun Capital and “Engaged in a US Trade or Business”

• Rethinking the Character of Income

• Section 871(m) Developments

2NYC #136412.2

Recent Developments Under FATCA -

Background• The Foreign Account Tax Compliance Act (“FATCA”) imposes a 30%

withholding tax on payments to certain foreign entities of certain non-effectively connected US source income.

• A Foreign Financial Institution (“FFI”) otherwise subject to this tax is not subject to withholding if any of the following three conditions are met -(i) it complies with § 1471(b) for its US accounts, which requires registering with the IRS, (ii) it is deemed to comply with the requirements, or (iii) it is an exempt beneficial owner.

• Section 1471(b) generally requires an FFI to identify US accounts and to report such accounts to the IRS.

• The U.S. Treasury Department has entered into Intergovernmental Agreements (IGAs) with approximately 30 foreign countries, including Switzerland, the Cayman Islands and Bermuda. A “Model 1” IGA enables FFIs resident in the foreign partner country to comply under prong (ii) above without having to register with the IRS under prong (i) above. A “Model 2” IGA retains the basic structure of FATCA, but permits aggregate reporting of accounts.

3NYC #136412.2

Recent Developments Under FATCA -

Background

• A foreign entity that is not an FFI (a NFFE) is subject to FATCA withholding unless

– it is exempt under the regulations or

– it provides the withholding agent with either (i) a certificate that it does not have any ”substantial US owner” or (ii) the name, address, and taxpayer identification number of each such substantial US owner.

• The withholding agent must report to the IRS the information concerning any substantial US owner.

• FATCA “withholdable payments” include most types of FDAP as well as to capital gains on the disposition of property producing US source interest or dividends.

– Beginning no earlier than 2017, FATCA withholding also applies to gross proceeds from such US debt or equity instruments.

– Beginning no earlier than 2017, FATCA may also require an FFI to withhold tax on payments it makes that are “attributable to” withholdablepayments (“foreign pass-thru payments”).

4NYC #136412.2

Recent Developments Under FATCA – Final

Regulations• Final regulations were issued on January 17, 2013 and revised/updated

on September 10, 2013.

– Obligations outstanding on June 30, 2014 will generally be exempt from FATCA withholding.

– Grandfathering is further extended for obligations that would not otherwise be subject to FATCA but for any “foreign pass-through payments” or Section 871(m) dividend equivalent payments – no earlier than six months after final guidance issued.

• The final regulations attempt to coordinate the FATCA rules with the provisions of IGAs.

– IGAs typically test FFI status of branches separately, whereas the regulations apply disregarded entity concepts.

• The final regulations attempt to coordinate FATCA with Chapter 3 withholding.

– Note special rules for QIs

• The final regulations contain expanded exemptions for low-risk accounts, e.g. in retirement funds.

5NYC #136412.2

Recent Developments Under FATCA –

What’s Next for Inbound Investors?

• Inbound investors will need to provide new Forms W-8 to avoid FATCA withholding.

– As of this writing, final Forms and instructions are not available, but a draft Form W-8BEN shows how detailed these new forms are likely to be.

• Inbound investors will need to determine whether they are

– Exempt FFIs (e.g., sovereign investors and many pension plans)

– Exempt NFFEs (e.g., active operating businesses)

– Non-exempt FFIs required to register or fall within an IGA

– Non-exempt NFFEs required to provide US significant owner information

• Foreign persons must also evaluate their withholding responsibilities under FATCA.

• These rules will apply to a broad array of payments!

6NYC #136412.2

Revisiting Selected Topics Under FIRPTA –

USRPHC Determination

A corporation is a USRPHC if:

• The fair market value of its interests in USRPIs equals or exceeds 50% of

• The fair market value of

– Its USPRIs

– Its interests in real estate outside of the United States

– Its assets used or held for use in a trade or business (including goodwill).

Exceptions:

• Investment company rule

• Business expansion rule; Reg. §1.897-1(f)(4), Example (2)

• Owner of 5% or less of shares where a class is publicly traded

• Domestically controlled REITs

7NYC #136412.2

USRPHC Determination - continued

Investment company rule:

• Liquid assets are presumed to be held for use in the entity's trade or business if the principal business is trading or investing for its own account.

• Principal business is presumed to be trading or investing for its own account if the fair market value of the liquid assets ≥ 90% of the value of USRPIs, other real estate interests, and other assets used or held for use in a trade or business.

Other Investment Company Issues:

• Consider whether a holding company is always an Investment Company.

• Non-U.S. real estate interests and assets used in a trade or business are not attributed through an Investment Company.

8NYC #136412.2

Revisiting Selected Topics Under FIRPTA –

Infrastructure Contracts

• In Announcement 2008-115, the IRS said it is considering regulations defining USRPI with respect to certain rights granted by a government related to "the lease, ownership, or use of toll roads, toll bridges, and certain other physical infrastructure.”

• Typical transaction at Issue:

• Domestic partnership (DP) leases or purchases infrastructure assets and underlying land in U.S., e.g., toll road or toll bridge.

• Value of the leasehold interest derives from the right to charge and collect tolls (typically contracts to buy/sell production not USRPI).

• Taxpayer position: permit from government to collect tolls is not a USRPI but is an asset used or held for use in a trade or business.

• Government position: some of the permits may be USRPIs. Future proposed regulations would address how FMV of permits is taken into account to determine whether a corporation (holding an interest in DP) would be a USRPHC.

• Tension from “REIT rulings” (rents from real property)

9NYC #136412.2

Revisiting Selected Topics Under FIRPTA –

Publicly-Traded Partnerships

• A publicly traded partnership (PTP) is generally treated as a corporation under § 7704. That section defines “publicly traded” broadly and includes:

– Traded on an established securities market

– Readily tradable on a secondary market

• A PTP owning USRPIs that constitute greater than 50% of its assets by value can be a USRPHC, even if organized outside the U.S.

• The 5% regularly-traded exception applies only if any class of stock of a corporation is "regularly traded on an established securities market“; a PTP can be publicly traded within the meaning of §7704 yet not fall within this exception.

– Distinction between "traded" and "regularly traded"

– Traded on secondary market

• Determination made for 5-year period ending on transaction

• PTP could fall in and out of exception

• Exception does not apply to 5% or greater partner

10NYC #136412.2

Revisiting Selected Topics Under FIRPTA –

Anti-Abuse Rules

• The gross value of any foreign real estate and any assets used or held for use in a trade or business is reduced by outstanding debt that was entered into for the purpose of avoiding FIRPTA rules

• Liquidation of USRPHC (coordination with § 367(e)(2)); application of § 332(d) (§ 301 characterization of liquidating distribution)

• § 355 distribution of former USRPHC

• Domestications (gain limitation?)

• Measuring "10 years" under Notice 2006-46

• Reach of § 897(c)(1)(B) (note legislative proposal to repeal for REITs)

• § 897(h) and Notice 2007-55

• Mischief from Treas. Reg. § 1.892-5T(b)(1) (deemed commercial activity); 1.892-3T(a)(3) (partnership interest, other than a PTP, is not a “security”)

11NYC #136412.2

Sales of Partnership Interests – Background

• Treasury/IRS position in Rev. Rul. 91-32 is that gain or loss of a foreign person from the disposition of an interest in a partnership that conducts a trade or business through a fixed place of business or has a permanent establishment in the US is gain effectively connected with such trade or business or gain attributable to a permanent establishment to the extent of the partner’s proportionate share of partnership assets that generate such income.

• Several commentators believe that the Treasury/IRS analysis in Rev. Rul. 91-32 is technically flawed and is generally not supported by the statute or regulations.

– Current law treats a partnership interest as a capital asset. Whether gain on a disposition is ECI to a foreign partner generally requires that the asset meet the asset use or business activities tests of § 864(c)(4).

– In some cases, an analysis under current law results in a conclusion that gain on a disposition is not ECI.

– In other cases, an analysis under current law may reach the same result as Rev. Rul. 91-32.

• Gain on a disposition of a partnership interest is taxable under § 897(g) to the extent of the partnership’s USRPIs.

12NYC #136412.2

Sales of Partnership Interests – Background

• Recent developments related to Rev. Rul. 91-32

– CCM 20123903F confirmed the IRS position under Rev. Rul. 91-32,

concluding that gain from the sale of the taxpayer’s partnership interest

was treated as gain from the sale of the partner’s proportionate share

of the underlying assets and was ECI to the extent of gain attributable

to ECI generating assets of the partnership.

– Apparent intent to issue regulations implementing Rev. Rul. 91-32

– Grecian Magnesite v. Commissioner, docketed in Tax Court (Docket no.

019215-12), was originally scheduled to go to trial on October 21, 2013;

however a joint motion for continuance was filed. This could mean

either that the parties anticipate resolving the case without trial (e.g.,

settlement, summary judgment motion) or that they need more time to

prepare for trial.

13NYC #136412.2

Sales of Partnership Interests – Proposals

• Recent Administration proposals and the Baucus international tax reform discussion draft propose to codify the IRS’s position in Rev. Rul. 91-32.

• The proposals would provide that if a foreign person sells or exchanges a partnership interest, the gain to the transferor will be considered ECI to the extent they are considered to be engaged in a US trade or business by virtue of their membership in the partnership.

• Solely for the purposes of measuring the effectively connected gain or loss, the provisions deem all the assets of the partnership sold and the foreign partner is required to recognize ECI on the actual sale of their interest in the same proportion as they would have under the fictional sale of all the assets.

• These provisions also impose a 10 percent withholding tax on the transferee.– Requires the tax to be withheld by the purchaser of the ECI-generating

partnership interest and, where the purchaser fails to withhold the required tax, by the partnership itself on distributions that would otherwise be made to the purchaser.

14NYC #136412.2

Selected Current Issues Under Tax Treaties

– Treaty Overview

Note: All treaties are currently delayed by a hold on consideration

request by Senator Rand Paul (R-KY)

• Treaties and protocols previously approved in 2011 by the Senate Foreign Relations Committee but returned to committee in 2013 due to Sen. Paul’s procedural objections

– Hungary

– Luxembourg

– Switzerland

• Treaty sent to Senate Foreign Relations Committee

– Chile

15NYC #136412.2

• Treaties signed

– Spain (Jan. 14, 2013)

– Japan (Jan. 24, 2013)

– Poland (Feb. 13, 2013)

– Norway (initialed, awaiting signatures)

• Treaties in negotiation

– United Kingdom

– Vietnam

– Romania

– Brazil

– Colombia

Selected Current Issues Under Tax Treaties

– Spanish Protocol

• Modifications to Spanish Protocol – New standards for the US

Model?

• Standard for Discretionary Grant of Treaty Benefits

– Changed from the traditional format of the taxpayer being able to

establish that the acquisition, organization, and operation of the

resident company did not have a principal purpose of obtaining treaty

benefits to an evaluation of the extent to which the taxpayer met the

objective tests.

• Additional Restriction in the Equivalent Beneficiary/Derivative

Benefits Test

– Derivative benefits test has been modified to require that, where the

qualified owner of the tested company holds the company indirectly, all

intermediate owners must be residents of the EU or a NAFTA country.

16NYC #136412.2

BEPS Developments – Background

• OECD’s BEPS Action Plan released on July 19, 2013; provided a

roadmap for 15 work streams

• G-20 leaders endorsed the Action Plan at a G-20 Leaders meeting

in St. Petersburg on September 6, 2013

• Implementation of the Action Plan generally will be done through the

OECD working parties and a new task force on digital economy

taxation

– All G-20 members will participate on an equal footing (including non-

OECD)

– Ambitious deadlines of 12-27 months (although subsequent domestic

legislation or treaty renegotiation will be required in many cases)

– Working parties will need to seek new ways to find consensus to meet

deadlines, including, e.g., use of small focus groups and remote

working

17NYC #136412.2

BEPS Developments – Published Calendar

• On December 3, 2013, the OECD released a calendar for planned

stakeholder input into the BEPS project

– The calendar provides tentative time frames for the release of discussion

drafts, deadlines for comments, and public consultations

– Webcasts have also been announced, starting in January 2014

18NYC #136412.2

Discussion Draft Topic

(BEPS Action Item)

Expected Date

of Publication

Public

Comment

Period

Expected Date of

Public Consultation

Transfer Pricing Documentation and

Template for Country-by-Country ReportingFebruary 2014 21 Days March 2014

The Tax Challenges of the Digital Economy March 2014 30 Days April 2014

Hybrid Mismatch Arrangements March 2014 30 Days April 2014

Tax Treaty Abuse March 2014 30 Days April 2014

BEPS Developments – France and Mexico

• France: On December 30, 2013, France enacted a new measure that allows interest deductions only if the French borrower demonstrates that the lender is subject to a corporate tax on the interest income that equals 25% or more of the corporate tax that would be due under French tax rules.

• Mexico: On October 31, 2013, Mexico enacted a new income tax law that disallows deductions for interest and royalty payments when paid to a foreign entity that controls or is controlled by the Mexican entity, and– The recipient is a transparent entity whose owner is not subject to tax in its

jurisdiction,

– The recipient’s country of tax residence considers the payment to be disregarded, or

– The recipient does not include the payment as part of its taxable income under its jurisdiction’s rules.

• Mexico also disallows deductions for expenses that are deducted by another related entity, unless the corresponding income is included in the related entity’s taxable income in the same or subsequent tax year .

19NYC #136412.2

BEPS Developments – Chairman Baucus

International Tax Reform Discussion Draft

Denial of Deduction for Payments in a “Base Erosion Arrangement”:

• Broad and sweeping proposal aimed primarily at inbound investors

• Disallows deductions for any related party payment arising in

connection with a “base erosion arrangement” that reduces the

amount of foreign income tax paid or accrued

– A “base erosion arrangement” is one which involves (1) a hybrid

transaction or instrument; (2) a hybrid entity; (3) an exemption

arrangement; or (4) a conduit financing arrangement

– Primarily of interest to foreign parented groups

– For example, repo borrowings by US companies from foreign

companies may be affected

• Potentially far reaching and significant implications for various

related party arrangements and unintended consequences for US

subsidiaries claiming US deductions.

20NYC #136412.2

Sun Capital and “Engaged in a US Trade or

Business”

• What is the fuss about? Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 12-02312 (1st Cir. 2013) was not a tax case, much less an inbound tax case. But the court’s choice of language, its logic and reasoning, created a stir in the inbound community.

• What we thought was clear: Three categories of persons owning stocks and securities:

– Investors, who hold for long-term appreciation

– Traders, who seek to profit from short-term swings and engage in frequent trades

– Dealers, who generally have “customers”

• A foreign person who is an investor is not “engaged in a (US) trade or business” (ETB), whereas a dealer is; a foreign person who is a trader is generally not ETB by virtue of §864’s “trading safe harbors.”

– Same goes for a partner in a partnership

21NYC #136412.2

Sun Capital and “Engaged in a US Trade or

Business”

• In Sun Capital, the court held that a private equity partnership that

owned stock of a portfolio company conducted a “trade or

business” that could be viewed as under common control with the

portfolio company.

– The court applied a two-part “trade or business” test adopted by the

PBGC to impose withdrawal liability under pension rules.

– The PBGC test has been referred to as an “investment plus” test that

looks in part to whether the partnership’s agent (the affiliated

management company) provided services for a fee (it did, as is

typical) and to whether the partnership exercised control over the

portfolio company (it did, as is typical).

– The court was also influenced by the fact that the limited partners

“shared” indirectly in the manager’s fee income, which is typically

done by offsetting outside income against the management fee

otherwise payable by them.

22NYC #136412.2

Sun Capital and “Engaged in a US Trade or

Business”

• So if all this was enough to constitute a “trade or business” for PBGC purposes, is it enough to constitute a trade or business for income tax purposes?

– The Whipple/Higgins line of cases is to the contrary.

– The Sun Capital court cited and distinguished that line of cases, not so much on the basis that they were tax cases, but on their facts.

– A private equity partnership, much like a mutual fund, is a vehicle for investors to pool their money to make investments, and had not been thought to change the character of those investments. Is the typical private equity partnership more vulnerable to “trade or business” characterization because it takes majority stakes in private companies and exerts control over them, benefitting from fees? Or is this just a PBGC conceit irrelevant to tax?

• Sun Capital may, in the end, simply be a warning to fund sponsors about overleveraging portfolio companies that subsequently file for bankruptcy.

23NYC #136412.2

Rethinking the Character of Income: BEPS,

“The Cloud,” and Tidewater

• Why should we care?

– A foreign person is subject to US tax only on US source FDAP or ECI (or, where a treaty applies, income attributable to a US permanent establishment).

– Income is sourced differently based on what character it has; for example, rents are sourced to the US if the property is used in the US, whereas income from services is sourced to the US if the services are provided in the US.

– So a foreign person’s US tax liability can turn on properly characterizing items of income.

• Why is this a “recent development”?

– The growth of intangible/intellectual property worldwide has put pressure on properly characterizing income flows.

– In certain cases, the law has been uncertain for many years, and a 2009 case, Tidewater, created uncertainty out of certainty.

24NYC #136412.2

Rethinking the Character of Income:

Rents vs. Services

• How do we distinguish the provision of property rights under a

lease or license (that produces rents or royalties) from the

provisions of services that produces services income?

– This issue is addressed in the computer software case by regulations

at §1.861-18

• For example, it was traditionally believed that a “bareboat charter”

of a boat or a “dry lease” of an airplane was a lease, whereas a

“time charter” of a boat or a “wet lease” of an airplane was a

service.

– Under a bareboat charter/dry lease, the customer gets the vessel and

does with it whatever it does with it.

– Under a time charter /wet lease, the owner of the vessel provides a

crew, etc.

25NYC #136412.2

Rethinking the Character of Income:

Tidewater

• Tidewater Inc. v. US, 565 F. 3d 299 (5th Cir. 2009) changed all that

• In Tidewater, a FSC case, the court held, on motion for summary

judgment, that a time charter was a lease, not a service.

– The court looked to control, not risk

– The court purported to apply §7701(e)

• What is §7701(e) about?

– Added in 1984 to address cases in which taxpayers were structuring

contracts as service contracts to avoid the tax-exempt entity leasing

rules

– Creates a presumption that a contract may be a lease

– Applies for all purposes of Chapter 1

• If the distinction between a lease and a service contract is really

about “control,” and not about risk, we’re not in Kansas anymore!

26NYC #136412.2

Rethinking the Character of Income:

What’s Next?

• If a foreign person makes a vessel available, it seems that it is

always a lease, such that the source of income depends on where

the vessel is used, rather on where the foreign person provides its

services.

• If a foreign person provides cloud computing services, and those

services are characterized as a lease based on the customer’s

control, the source of the income is where the services are used,

not where they are performed.

• But query whether Tidewater is limited to vessels?

27NYC #136412.2

Section 871(m) Developments

Section 871(m) is a source rule for certain dividend equivalent payments to backstop U.S. withholding tax (and FATCA) on dividend payments.

• As enacted, applied after 2010 to substitute dividend payments on securities lending or repos and payments under a “specified” notional principal contract contingent upon, or determined by reference, to a U.S. source dividend, and other “substantially similar” payments (as determined by future guidance).

• Beginning on March 19, 2012, specified NPCs to include all NPCs unless the Treasury Dept. determined the contract was of a type that did not have the potential for tax avoidance (“Extended NPCs”).

Notice 2010-46 provided rules to avoid cascading (i.e., multiple levels) of withholding as anticipated by § 871(m)(6).

28NYC #136412.2

Section 871(m) Developments

Temporary regulations published 1/23/12 (as corrected) at 1.871-16T(b), generally followed the statute and are not controversial.

• Extended NPC treatment was delayed until 1/1/14

• 2012 Proposed Regulations would have adopted a 7-factor approach to identifying extended NPCs with tax avoidance potential that would be subject to 871(m).

• Substantially similar payments included certain “equity-linked instruments” (“ELIs”) and gross-ups under those Proposed Regulations.

• Payments under certain broad-based indices would have not triggered 871(m) but narrow-based indices would have.

• Those Proposed Regulations would have applied to all outstanding NPCs, and to ELIs acquired after March 4, 2014.

Final regulations published 12/4/13 extended existing rules until the 2013 Proposed Regulations take effect (expected in 2016).

• The 2013 Proposed Regulations replaced the 7-factor approach with a one-factor test based upon having a “delta” of at least 70% on the date when the long party establishes the position.

– This change was in response to comments suggesting the 7-factor approach would be difficult to administer

29NYC #136412.2

Section 871(m) Developments

• 2013 Proposed Regulations would apply the “Delta rule” to both NPCs and ELIs.

• Delta is the ratio of the change in the fmv of the contract to the change in the fmv of the referenced property.

– Delta is to be computed “in a commercially reasonable manner”

– “Specified” ELIs would include convertible debt (with a sufficiently high delta)

– Certain transactions would be subject to deemed “delta one” treatment, and other transactions would be combined if entered into “in connection with each other” even if not on the same date or by the same party --these rules will not be easy to administer!

– Excludes dealers and a “qualified index” (based on 25 or more underlying securities, which does not provide a "high yield," and which is referenced by listed futures or options contracts)

– The 2013 Proposed Regulations compute gross amounts of dividend equivalency (without exception for estimates, and whether or not the long party receives any payment); some relief is proposed for withholding agents but broker dealers will have additional responsibilities.

30NYC #136412.2

Section 871(m) Developments

• Critics complain of having to retest the instrument upon each

trade.

• The 2013 Proposed Regulations provide for U.S. sourcing of

amounts based on a delta that is recomputed on the payment date

(not using the acquisition-date delta) (the instrument is not retested

to determine whether it should fall out of § 871(m) due to delta of

less than 70%).

• This approach to taxation (based on equivalent economic returns)

is troublesome-- but the Preamble to the 2013 Proposed

Regulations states that the approach should not be construed as

providing guidance with respect to any other section of the Code.

31NYC #136412.2