doing business in the u.s. taxes - pwc deutschland

Doing business in the United StatesA guide to the key tax issues

2014

www.pwc.com

Contents

Foreword i

I. Federal tax issues 1

A. Taxesoncorporateincome 1

B. Otherfederaltaxes 2

C. UStradeorbusiness 4

D. Effectivelyconnectedincome 5

E. Branchincome 5

F. Permanentestablishment(PE) 6

G. Grouptaxation 6

H.Transferpricing 7

I. Thincapitalization 7

J. Controlledforeigncompanies (CFCs) 8

K. Scorporations 8

L. Determiningincome 8

M.Corporatedeductions 12

N. Creditsandincentives 18

O.Administrativeissues 22

II. State and local tax issues 36

A. Activitiesthatcouldsubjectaforeignentitytostatetax 36

B. Dividinguptaxableincomeamongthestates:multistateapportionment 37

C. Taxfilingsincludemorethanjustthein-stateentity:combined,water’sedge,worldwidefilingmethodologies,andtaxhavens

38

D. Adjustmentstofederaltaxableincome 39

E. Treatmentofforeign-source income 39

F. Stateswithtransferpricingadjustmentpower 40

G. Indirecttaxconsiderations 40

H. Localtaxation 42

I. Creditsandincentives:stateandlocal 42

III. US tax treaties 44

IV. Transfer pricing 46

A. Elementsoftransferpricing 46

V. Individual tax issues 50

A. Personalincometaxrates 50

B. Alternativeminimumtax (AMT) 51

C. Stateandlocalincometaxes 52

D. Residence 52

E. Othertaxes 53

F. Incomedetermination 55

G. Foreigntaxreliefandtax treaties 60

H.Othertaxcreditsand incentives 61

I. Taxadministration 61

J. Otherissues 63

VI. Health care 66

VII. Financing US operations 67

A. Debtvs.equity 67

B. Cashpooling 70

VIII. Setting up a US tax department 71

How can PwC help? 72

Appendix A: Summary of US tax treaty benefits 73

Appendix B: List of countries with which the United States has entered into social security totalization agreements

78

Contents (continued)

AllwouldagreethattheUnitedStateshasacomplextaxsystemthatsignificantlyaffectsbusinessdecisionsandbusinessoperations.Ormoreprecisely,aftertakingintoaccountfederal,state,andlocallevelsoftaxation,theUnitedStateshasmanycomplextaxsystems.

ThiscomplexitycreatessignificantchallengesforcompaniesdoingbusinessintheUnitedStates:navigatingthelawandadministrativeprocesses,managingriskrelatedtotaxissues,andavoidingpitfallsthatcantripupeventhemostsophisticatedwithoutconstantandthoroughvigilance.Businessesneedtoallocatesignificantresourcestocomplianceandgovernancefocusedontaxmatters.And,ofcourse,theenvironmentinwhichbusinessoperatestodaymakesunderstandingandaddressingthesechallengesanevenmoreimportantendeavorforfinanceandnon-financeexecutivesalike.

Atthesametime,thereareopportunitiesforcompaniesseekingtoconductbusinessintheUnitedStates.AccordingtothePwC-OrganizationforInternationalInvestment’s2014InsourcingSurvey,thepercentageofinsourcingCFOswhosaytheUSoffersabetterbusinessenvironmentcomparedtootheradvancedcountriesincreased35pointssince2011(from23%to58%).Nearlytwo-thirdsofCFOsanticipateincreasedinvestmentintheUnitedStateswithinthenext12months,andmorethanhalfexpecttoincreaseemploymentoverthatsameperiod.Withanunderstandingoftheincentivesbuiltintotheapplicabletaxpoliciesandthepotentialtoachieveenhancedafter-taxresultsfrombusinessoperationsthroughunderstandingtheeffectofUStaxrules,businessescanenhancetheirdeliveryinthisimportantmetricofperformance.

TheindividualcircumstancesandobjectivesofforeignbusinesseseithercurrentlydoingorlookingtodobusinessintheUnitedStatescanvarygreatly.EachcompanywillhaveaparticularsetofperspectivesinregardtoitsoperationsintheUnitedStatesascomparedtoUS-basedcompanies.

Ifullyappreciatetheseuniquechallengesandopportunitieshavingspentmostofmycareerinseniortaxexecutiverolesinnon-UScompanieswithsubstantialUSoperations.Itisoftenfrustrating,butalwaysrewarding,tonavigatethroughtheconfusionandcomplexityandidentifythekeyinsightsthatwillenhancebusinessperformanceandeffectivelymanagerisk.

ThisguideisintendedtoleveragePwC’sextensiveexperienceinregardtoUSoperationsofforeignbusinessestoprovideabroadunderstandingofthebasictaximplicationsofbusinessoperationsintheUnitedStates,aswellastoofferhelpfulobservationsintothetaxconsequencesforforeigncompanies.

Ibelieveyouwillfinditausefulguidethroughthemanychallengesand opportunities.

However,asaguide,itcanonlybeastartingpoint.PwChasaglobalnetworkofmultidisciplinarytaxprofessionalswhohavedeep,practicalexperienceinassistingbusinessesinvestingintotheUnitedStates.Westandreadytohelpinanywaywecan.

Joel Walters USInboundTaxLeader [email protected] +1(202)754-0351

Foreword

A guide to the key tax issues | i

A guide to the key tax issues | 1

A. Taxes on corporate income

1. Corporate income tax

UStaxationofincomeearnedbynon-USpersonsdependsonwhethertheincomehasanexuswiththeUnitedStatesandthelevelandextentofthenon-USperson’spresenceintheUnitedStates.AforeigncorporationengagedinaUStradeorbusinessistaxedatregularUScorporatetaxrates,butonlyonincomefromUSsourcesthatiseffectivelyconnectedwiththatbusiness,andat30%onUS-sourceincomenoteffectivelyconnectedwiththatbusiness.Bycontrast,US-residentcorporationsaretaxedbasedontheirworldwideincome.

TheUScorporateincometax(CIT)rateisbasedonaprogressiverateschedule;however,analternativeminimumtaxprovidesforaflatratewithfewerdeductions.

2014 taxable income US corporate income tax

Over ($) But not over ($) Pay ($) +% on excess

of the amount over ($)

0 50,000 0 15 0

50,000 75,000 7,500 25 50,000

75,000 100,000 13,750 34 75,000

100,000 335,000 22,250 39 100,000

335,000 10,000,000 113,900 34 335,000

10,000,000 15,000,000 3,400,000 35 10,000,000

15,000,000 18,333,333 5,150,000 38 15,000,000

18,333,333 35 0

The39%taxrateappliestotaxableincomebetween$100,000and$335,000toeliminatethebenefitofthe15%and25%rates,andthe38%taxrateappliestotaxableincomebetween$15,000,000and$18,333,333toeliminatethebenefitofthe34%rate.Specialrulesapplytopersonalservicecorporationsandpersonalholdingcompanies.

2. Alternative minimum tax (AMT)

AnAMTisimposedoncorporationsotherthanScorporationsandsmallCcorporations(generallythosenothavingthree-yearaverageannualgrossreceiptsexceeding$7.5million).Thetaxis20%ofalternativeminimumtaxableincome(AMTI)inexcessofa$40,000exemptionamount(subjecttoaphase-out).AMTIiscomputedbyadjustingthecorporation’sregulartaxableincomebyspecifiedadjustmentsand‘taxpreference’items.Taxpreferenceoradjustmentitemscouldarise,forexample,ifacorporationhassubstantialaccelerateddepreciation,percentagedepletion,intangibledrillingcosts,ornon-taxableincome.

I. Federal tax issues

2 | Doing business in the United States

3. Gross transportation income taxes

Foreigncorporationsandnonresidentalienindividualsaresubjecttoayearly4%taxontheirUS-sourcegrosstransportationincomethatisnoteffectivelyconnectedwithaUStradeorbusiness.Transportationincomeisanyincomederivedfrom,orinconnectionwith,

1. theuse(orhiringorleasing)ofanyvesseloraircraft,or

2. theperformanceofservicesdirectlyrelatedtotheuseofanyvesseloraircraft.

B. Other federal taxes

1. Sales taxes

TheUSdoesnotimposeafederalsalestaxorvalue-addedtax(VAT).

Inbound insight: Not having a federal sales tax or VAT is unusual in terms of typical tax systems around the globe. This deviation from the global norm requires additional communication and business performance analysis for senior management of non-US parent companies, who are more familiar with doing business in territories with a more common mix of income and consumption taxes.

2. Customs duties and import tariffs

AllgoodsimportedintotheUnitedStatesaresubjecttocustomsentryandaredutiableorduty-freeinaccordancewiththeirclassificationundertheapplicableitemsintheHarmonizedTariffScheduleoftheUnitedStates.Theclassificationalsoidentifieseligibilityforspecialprogramsandfreetradeagreementpreferentialduty rates.

Whengoodsaredutiable,advalorem,specific,orcompounddutyratesmaybeassessed.Anadvaloremrate,thetypemostoftenapplied,isapercentageofthevalueofthemerchandise,suchas7%advalorem.Aspecificrateisaspecifiedamountperunitofmeasure(weightorquantity),suchas6.8centsperdozen.Acompoundrateisacombinationofbothanadvaloremrateandaspecificrate,suchas0.8centsperkiloplus8%advalorem.USCustomsandBorderProtection(CBP)requiresthatthevalueofthegoodsbeproperlydeclaredregardlessofthedutiablestatusofthemerchandise.

PaymentofdutybecomesdueatthetimeanentryisfiledwithCBP.Theobligationforpaymentisonthepersonorfirminwhosenametheentryisfiled,theimporterofrecord.Theimporterofrecordhasalegalobligationtoexercisereasonablecareinallaspectsofitsimportingactivity.

Inbound insight: This area can be overlooked by foreign businesses not familiar with the US rules. Opportunities can arise through careful consideration of the application of intercompany transfer prices and other aspects of the duty obligation.



3. Excise taxes

TheUSgovernmentimposesexcisetaxesonawiderangeofgoodsandactivities,includinggasolineanddieselfuelusedfortransportation,airtravel,manufacturingofspecifiedgoods,andindoortanningservices.AnewfeeonhealthplansundertheAffordableCareAct(ACA),calledthePatient-CenteredOutcomesResearchInstitute(PCORI)fee,isreportedandpaidasanexcisetaxaswell.

Theexcisetaxratesareasvariedasthegoodsandactivitiesonwhichtheyarelevied.Forexample,theexciseimposedonindoortanningservicesis10%oftheamountpaidfortheservices,whiletheexciseimposedonthesaleofcoalminedintheUnitedStatesisthelowerof$1.10pertonor4.4%ofthesaleprice.

4. Stamp taxes

Thereisnofederal-levelstamptax.However,stateandlocalgovernmentsfrequentlyimposestamptaxesatthetimeofofficiallyrecordingarealestateorothertransaction.Thestateorlocalsalestaxonrealestatemaybeastamptaxonthedocumentsrecordingthetransferoftherealestate.

5. Capital gain taxes

Thecorporatetaxrateonlong-termcapitalgainscurrentlyisthesameasthetaxratesapplicabletoacorporation’sordinaryincome.(Bycontrast,individualsmaybesubjecttoalowerrateonlong-termcapitalgainthanonshort-termcapitalgain.)Thus,themaximumcorporaterateis35%,excludingtheadditionalphase-outrates.However,differencesmayarisewhereAMTisimposed.

6. Accumulated earnings tax

Corporations(otherthanScorporations,domesticandforeignpersonalholdingcompanies,corporationsexemptfromtaxunderSubchapterFoftheInternalRevenueCode,andpassiveforeigninvestmentcompanies)accumulatingearningsandprofitsforthepurposeofavoidingshareholderpersonalincometaxaresubjecttoapenaltytaxinadditiontoanyothertaxthatmaybeapplicable.Theaccumulatedearningstaxequals15%of‘accumulatedtaxableincome.’Generally,accumulatedtaxableincomeistheexcessoftaxableincomewithcertainadjustments,includingadeductionforregularincometaxes,overthedividendspaiddeductionandtheaccumulatedearningscredit.Notethatacorporationcanjustifytheaccumulationofincome,andavoidtax,basedonitsreasonablebusinessneeds.

7. Personal holding company tax

UScorporationsandcertainforeigncorporationsthatreceivesubstantial‘passiveincome’andare‘closelyheld’maybesubjecttopersonalholdingcompanytax.Thepersonalholdingcompanytax,whichisleviedinadditiontotheregulartax,is20%ofundistributedpersonalholdingcompanyincome.



8. Payroll taxes affecting employers

AllpaymentsforemploymentwithintheUnitedStatesarewagessubjectto(1)federalincometaxwithholding,(2)FederalInsuranceContributionsAct(FICA)taxes(i.e.,socialsecurityandMedicare),and(3)theFederalUnemployment(FUTA)tax,unlessanexceptionapplies.ForemployeessenttotheUnitedStatesbytheirforeignemployer,thereisademinimisexceptionforamountslessthan$3,000andvisitsoflessthan90days;also,certaintreatyprovisionsmayeliminatetheneedtowithholdincometaxes(butgenerallynottheneedtoreport).

Similarly,foreignemployersusuallyrelyontreatyreliefforworkersemployedintheUnitedStateswithrespecttosocialsecurityandMedicaretaxes.Ifsuchreliefisnotavailable,theforeignemployermustpayandwithholdsocialsecuritytaxesequalto6.2%ofwagesfortheemployerand6.2%fortheemployee,upto$117,000in2014,andMedicaretaxesequalto1.45%fortheemployerand1.45%fortheemployee.Note:ThereisnocaponwagessubjecttoMedicaretaxes.Theemployeralsomustwithholdanadditional0.9-percentMedicaretaxonwagesabove$200,000.TheFUTAtaxisbetween0.6and6.0%(dependingoncreditsforstateunemploymenttaxes)onthefirst$7,000ofwagespaidtoanemployee.

Aforeignemployergenerallymustfilequarterlyandannualemploymenttaxreturnsandannualwagestatements(FormsW-2)initsnameandemployeridentificationnumberunlesssuchstatementsarefiledbyaproperlyauthorizedthirdparty.

Inbound insight: Corporate officers traveling to the United States for only a short period of time may generate employment tax liabilities because their earnings are wages for FICA and FUTA purposes and US-source income (including a portion of equity and deferred compensation granted in the foreign country) for wage withholding purposes.

9. Environmental tax

Importers,manufacturers,andsellersofpetroleumorotherozone-depletingchemicals(ODC)aresubjecttoanenvironmentaltaxcalculatedperweightoftheODCusedinthemanufactureoftheproduct.ThetaxisdeterminedunderanexactortablemethodprovidedintheinstructionstoForm6627.Iftheweightcannotbedetermined,thetaxis1%oftheentryvalueoftheproduct.

C. US trade or businessGenerally,aforeigncorporationengagedinaUStradeorbusinessistaxedatregularUScorporatetaxratesonincomefromUSsourcesthatiseffectivelyconnectedwiththatbusinessandat30%onUS-sourceincomenoteffectivelyconnectedwiththat business.

ThereisnodefinitioninthetaxstatuteofatradeorbusinesswithintheUnitedStates—instead,thatconcepthasbeendevelopedmainlybytheIRSandcourtdecisionsthroughafacts-and-circumstancesanalysis.Theforeigncorporationneeds



toconsiderthenatureandextentofitseconomicactivitiesintheUnitedStates,eitherdirectlyorthroughitsagents:

• Thebusinessmusthaveaprofitmotive.

• Activitiesgenerallymustbe‘considerable,continuous,andregular.’

• Ministerial,clerical,orcollection-relatedactivitiesgenerallyarenotsufficientlyprofit-orientedtoconstituteaUStradeorbusiness.

• Isolatedactivitiesgenerallydonotrisetothelevelofatradeorbusiness.

• Anagent’sactivitiesintheUnitedStatesmayresultinaUStradeorbusiness.

D. Effectively connected incomeIfanon-USpersonhasaUStradeorbusiness,thequestionariseswhatincomeis‘effectivelyconnected’tosuchUStradeorbusiness.AllUS-sourceactiveincomeearnedbyanon-USpersonistreatedaseffectivelyconnected.Passive-typeincomeandgainfromthesaleofcapitalassetsaretreatedaseffectivelyconnectedtoanon-USperson’sUStradeorbusinessonlyifaconnectionwiththeUStradeorbusinessexists.Suchaconnectionexistsifthepassive-typeincomeorcapitalgainisderivedfromassetsusedintheUStradeorbusiness(theassetusetest)ortheactivitiesconductedintheUStradeorbusinessareamaterialfactorintheproductionofthepassive-typeincomeorcapitalgain(thebusinessactivitiestest).

Certaintypesofforeign-sourceincomegeneratedthroughaUSofficecanbeeffectivelyconnectedincome.Theseinclude:

• RentsorroyaltiesforuseofpropertyoutsidetheUnitedStatesthatarederivedintheactiveconductofaUStradeorbusiness.

• Foreign-sourcedividendsorinterestderivedinactiveconductofbankingbusinessintheUnitedStates,orreceivedbyacorporationtheprincipalbusinessofwhichistradinginstocksorsecuritiesforitsownaccount.

• GainfromthesaleoutsidetheUnitedStatesofinventorypropertyandpropertyheldforsaletocustomers,unlessthepropertyissoldforuseoutsidetheUnitedStatesandanon-USofficemateriallyparticipatesinthesale.

E. Branch incomeTaxratesonbranchprofitsarethesameasoncorporateprofits.UStaxlawalsoimposesa30%branchprofitstaxinadditiontoUScorporate-levelincometaxesonaforeigncorporation’sUSbranchearningsandprofitsfortheyeartheyareeffectivelyconnectedwithaUSbusiness.Thetaxablebaseforthebranchprofitstaxisincreased(decreased)byanydecrease(increase)intheUSnetequityofthebranch.Thebranchprofitstaxonprofitsmaybereducedoreliminatedentirelyifarelevanttreatysoprovides.ThepurposeofthebranchprofitstaxistotreatUSoperationsofforeigncorporationsinmuchthesamemannerasUScorporationsownedbyforeign persons.



Withcertainexceptions,a30%(orlowertreatyrate)branchprofitstaxisimposedoninterestpaymentsbytheUSbranchtoforeignlenders.Inaddition,thetaxappliesiftheamountofinterestdeductedbythebranchonitsUStaxreturnexceedstheamountofinterestactuallypaidduringtheyear.

F. Permanent establishment (PE)Multinationalentities,suchascorporationsandpartnerships,faceavarietyoftaxsystemsinthecountrieswheretheyoperate.Toreduceoreliminatedoubletaxationbetweencountries,promotecross-bordertrading,andalleviatetheburdenofadministrationandenforcementoftaxlaws,countriestypicallyenterintoincometaxtreatiesoutlininghowpartiestothetreaty(contractingstates)willbetaxedonincomeearnedineachcontractingstate.

IncometaxtreatiescontainanarticledescribingwhetheranenterprisehascreatedaPEwithacontractingstate.TheexistenceofaPEisimportantbecauseanenterpriseestablishingsufficientcontactwithacontractingstatetorisetothelevelofaPEgivesthecontractingstatetherighttotaxtheenterprise’sincomeattributabletothePE.Thisincludesincomefromcarryingonabusinessinthecontractingstateandpassiveincome,suchasinterest,dividends,androyalties.

APEgenerallymeans:

1. thereisafixedplaceofbusinessthroughwhichthebusinessofanenterpriseiswhollyorpartlycarriedon,or

2. anagentactingonbehalfoftheenterprisehasandhabituallyexercisestheauthoritytoconcludecontractsbindingontheenterprise.

ForfurtherdiscussionofUStaxtreaties,seesectionIII,UStaxtreaties.

Inbound insight: In certain circumstances, foreign businesses can consider making protective filings with the IRS related to their exposure to taxation in the United States. This option should be analyzed carefully to determine the circumstances when it should be considered.

G. Group taxationAnaffiliatedgroupofUS‘includible’corporations,consistingofaparentandsubsidiariesdirectlyorindirectly80%owned,generallymayoffsettheprofitsofoneaffiliateagainstthelossesofanotheraffiliatewithinthegroupbyelectingtofileaconsolidatedfederalincometaxreturn.

AforeignincorporatedsubsidiarymaynotbeconsolidatedintotheUSgroup,exceptforcertainMexicanandCanadianincorporatedentities.Apartnershipmaynotbeincludedinaconsolidatedreturn,evenifitis100%ownedbymembersofanaffiliatedgroup,sinceapartnershipisnotacorporation.However,amember’searningsthatflowthroughfromapartnershipareincludedaspartoftheconsolidatedgroup’staxableincomeorloss.



Filingonaconsolidated(combined)basisisalsoallowed(ormayberequiredorprohibited)underthetaxlawsofcertainstates.

Sales,dividends,andothertransactionsbetweencorporationsthataremembersofthesamegroupgenerallyaredeferredoreliminateduntilsuchtimeasatransactionoccurswithanon-memberofthegroup.Lossesincurredonthesaleofmembersofthegrouparedisallowedundercertaincircumstances.

H. Transfer pricingTransferpricingregulationsgovernhowrelatedentitiessetinternalpricesforthetransfersofgoods,intangibleassets,services,andloansinbothdomesticandinternationalcontexts.Theregulationsaredesignedtopreventtaxavoidanceamongrelatedentitiesandplaceacontrolledpartyonparwithanuncontrolledtaxpayerbyrequiringanarm’s-lengthstandard.

Thearm’s-lengthstandardgenerallyismetiftheresultsofacontrolledtransactionareconsistentwithresultsthatwouldhavebeenrealizedifuncontrolledtaxpayershadengagedinasimilartransactionundersimilarcircumstances.Ifacompanyisnotincompliancewiththearm’s-lengthstandard,theIRSmayincreasetaxableincomeandtaxpayableintheUnitedStates.Afteratransferpricingadjustment,amultinationalcompanymayfacedoubletax,payingtaxonthesameincomeintwocountries.Multinationalcompaniesmayrequest‘competentauthority’relieffromdoubletaxationthroughataxtreaty.

Toavoidpotentialtransferpricingpenalties,oneavenueavailabletocompaniesmaybetoobtainanadvancepricingagreement(APA)withtheIRS,unilaterally,orwiththeIRSandanothertaxauthority,bilaterally,coveringinter-companypricing.

Inbound insight: The IRS currently is devoting more resources to auditing inbound companies with a specific focus on intangible and financing transactions. These developments place an increased emphasis on inbound companies to demonstrate results consistent with the arm’s-length standard. They also serve as a reminder for an inbound company to revisit its intercompany pricing policies and intercompany agreements to ensure that those policies and the terms of those agreements are consistent with how the company actually operates its business in the United States.

I. Thin capitalizationThincapitalizationrulesmayapplytodisallowinterestpaymentsrelatedto‘excess’debtandtorecharacterizesuchpaymentsasdividends.Thetaxpayer’sinterestexpensedeductioncanbelimitedandsuspendedifmorethan50%oftheadjustedtaxableincomeofathinlycapitalizedcorporation(withsimilarrulesforacorporatepartnerinapartnership)isshelteredbyinterestpaidtoarelatedparty(orpaidtoathirdpartybutguaranteedbytherelatedparty)thatisnotsubjecttoUStaxonthe income.



Inbound insight: Use of debt to finance US operations continues to be recognized as part of an acceptable capital structure. However, the amount of debt used and the cost of that debt to the US business in the case of intercompany debt can be subject to careful scrutiny, so a thorough analysis to support the decisions made should be performed.

J. Controlled foreign companies (CFCs)UndertheSubpartFregimeoftheInternalRevenueCode,aCFCisanyforeigncorporationwithrespecttowhichUSshareholdersownmorethan50%ofeitherthevotingpowerofallclassesofstockentitledtovoteorthetotalvalueofallclassesofthecorporation’sstockonanydayduringtheforeigncorporation’staxyear.

Inbound insight: The acquisition of a US business by a foreign acquirer can result in both foreign ownership above the US business and CFCs underneath the US business. Particular care should be taken in dealing with the complex issues that can arise in this circumstance.

K. S corporationsCorporationswith100orfewershareholders,noneofwhommaybecorporations,thatmeetcertainotherrequirementsmayelecttobetaxedunderSubchapterSoftheInternalRevenueCodeandthusareknownasScorporations.Scorporationsaretaxedinamannersimilar,butnotidentical,topartnerships.Thatis,alltaxitems,suchasincomeanddeductions,flowthroughtotheownersoftheentity.Thus,ScorporationsgenerallyarenotsubjecttoUSfederalincometaxatthecorporatelevel.

Inbound insight: Only US citizens or residents may be shareholders of an S corporation. As a result of this requirement and the requirement that S corporation shareholders cannot be corporations or partnerships, S corporations generally are not a form of business organization available to be selected by inbound companies.

L. Determining income

1. Inventory valuation

Inventoriesgenerallyarestatedatthelowerofcostormarketonafirst-in,first-out(FIFO)basis.Last-in,first-out(LIFO)maybeelectedfortaxpurposesonacostbasisonlyandgenerallyrequiresbookandtaxconformity.

Thetaxlawrequirescapitalizationfortaxpurposesofseveralcostsallocabletothemanufacturingprocessthatfrequentlyareexpensedascurrentoperatingcostsforfinancialreporting(e.g.,theexcessoftaxdepreciationoverfinancialstatement depreciation).



2. Capital gains

Gainsorlossesonthesaleorexchangeofcapitalassetsheldformorethan12monthsaretreatedaslong-termcapitalgainsorlosses.Gainsorlossesonthesaleorexchangeofcapitalassetsheldfor12monthsorlessaretreatedasshort-termcapitalgainsorlosses.Theexcessofnetlong-termcapitalgainovernetshort-termcapitallossisconsiderednetcapitalgain.

Capitallossesareallowedonlyasanoffsettocapitalgains.Anexcessofcapitallossesovercapitalgainsinataxyearmaybecarriedbackthreeyearsandcarriedforwardfiveyearstobeusedagainst(offset)capitalgains.

Fordispositionsofpersonalpropertyandcertainnonresidentialrealpropertyusedinatradeorbusiness,netgainsarefirsttaxableasordinaryincometotheextentofthepreviouslyallowedorallowabledepreciationoramortizationdeductions,withanyremaindergenerallytreatedascapitalgain.Forothertradeorbusinessrealproperty,netgainsgenerallyaretaxedasordinaryincometotheextentthatthedepreciationorcostrecoveryclaimedexceedsthestraight-lineamount,withanyremaindertreatedascapitalgain.

Anexceptiontocapitalgaintreatmentexiststotheextentthatlossesonbusinessassetswererecognizedinprioryears.Anetlossfromthesaleofbusinessassetsistreatedasanordinaryloss.Futuregains,however,willbetreatedasordinaryincometotheextentofsuchlossesrecognizedinthefiveimmediatelyprecedingyears.

3. Dividend income

AUScorporationgenerallymaydeduct70%ofdividendsreceivedfromotherUScorporationsindeterminingtaxableincome.Thedividends-receiveddeductionisincreasedfrom70%to80%iftherecipientofthedividenddistributionownsatleast20%butlessthan80%ofthedistributingcorporation.Generally,dividendpaymentsbetweenUScorporationsthataremembersofthesameaffiliatedgrouparedeferredoreliminateduntilatransactionwithathirdpartyoccurs.Withminorexceptions,aUScorporationmaynotdeductanyamountofdividendsitreceivesfromaforeign corporation.

4. Stock dividends

AUScorporationcandistributeatax-freedividendofcommonstockproportionatelytoallcommonstockshareholders.Iftherighttoelectcashisgiven,alldistributionstoallshareholdersaretaxableasdividendincomewhethercashorstockistaken.Thereareexceptionstotheserules,andextremecautionmustbeobservedbeforemakingsuchdistributions.

5. Interest income

Interestincomegenerallyisincludibleinthedeterminationoftaxableincome.

6. Rental income

Rentalincomegenerallyisincludibleinthedeterminationoftaxableincome.



7. Royalty income

Royaltyincomegenerallyisincludibleinthedeterminationoftaxableincome.

8. Partnership income

Theincome(loss)ofapartnershippassesthroughtoitspartners,sothatthepartnershipitselfisnotsubjecttotax.Thus,eachpartnergenerallyaccountsforitsdistributiveshareofthepartnership’staxableincome.

9. Foreign income (Subpart F income) of US taxpayers

a. In general

Generally,aUScorporationistaxedonitsworldwideincome,includingforeignbranchincomeearnedandforeigndividendswhenreceived.Doubletaxationisavoidedbymeansofforeigntaxcredits;alternatively,adeductionmaybeclaimedforactualforeigntaxesthatarepaid.

InthecaseofCFCs,certaintypesofundistributedincomearetaxedcurrentlytotheUSshareholders(SubpartFincome).Generally,SubpartFincomeincludesincomethatiseasilytransferredtoalow-taxjurisdiction.

b. PFIC rules

Incomefromcertainpassiveforeigninvestmentcompanies(PFICs)—definedasanyforeigncorporationif,forthetaxyear,75%ormoreofitsgrossincomeispassiveoratleast50%ofitsassetsproduce,orareheldfortheproductionof,passiveincome—alsoissubjecttospecialrulesdesignedtoeliminatethebenefitsofdeferral.

TherearethreeregimesunderthePFICrules:(i)theexcessdistributionregime,whichisthedefaultregime;(ii)thequalifiedelectingfund(QEF)regime;and(iii)themark-to-marketregime.ThelattertworegimesareelectiveandcausetheUSshareholderinthePFICtobeeithertaxedcurrentlyonitsproportionateshareofthePFIC’sordinaryearningsandcapitalgainseachyear(theQEFregime)ortaxedannuallyontheincreaseinvalue,ifany,ofthePFICstock(themark-to-market regime).

IftheUSshareholderdoesnotmakeeitheraQEFormark-to-marketelectionforthefirstyearofownership,theUSshareholderissubjecttotaxationunderthedefault,excessdistributionregime.Underthisregime,ifaPFICmakesanactualdistribution,thedistributiongenerallywillbetreatedasanexcessdistributiontotheextentitexceeds125%oftheaverageofthedistributionsmadewithrespecttothestockoverthethreeimmediatelyprecedingyears.Theexcessdistributionisspreadoverthetaxpayer’sholdingperiod,andtheamountallocatedtoeachyearintheholdingperiodissubjecttotaxatthehighestmarginaltaxrateineffectforthatyear.

Thistaxamountalsoissubjecttoaninterestcharge,whichisdesignedtoeliminatethebenefitofthetaxdeferralthatarisesoutofhavinganoverseasinvestmentforwhichnocurrentUSincometaxesarepaid.Furthermore,gainsondispositionof



PFICstockgenerallyaretreatedasexcessdistributionsaswell.Finally,PFICscanbeownedindirectlythroughotherentities,includingotherPFICs,underownershipattributionrules.

IftheUSshareholderdesirestoapplyeithertheQEFormark-to-marketregimeafterthefirstyearofitsholdingperiod,itmust‘purge’thePFICtaintofthepriorportionofitsholdingperiod(andpayanyapplicabletaxandinterest)orseekrelieftofiletherelevantelectionretroactivelyatthebeginningofitsholdingperiod.

Inbound insight: Given the different tax consequences under each regime, it is important that a US investor in a foreign corporation timely and accurately identify whether the foreign corporation is a PFIC to timely determine whether one of the elections should be made.

10. Dispositions of interests in US real property (FIRPTA)

Ingeneral,undertheForeignInvestmentinRealPropertyTaxActof1980(FIRPTA),gainorlossfromthedispositionbyaforeignpersonofaUSrealpropertyinterest(USRPI)istreatedasifthegainorlosswereeffectivelyconnectedtotheconductofaUStradeorbusinessand,accordingly,issubjecttoUSincometaxundernormalgraduatedtaxrates.

AUSRPIincludesanyinterest,otherthananinterestsolelyascreditor,inrealproperty(includinganinterestinamine,well,orothernaturaldeposit)locatedintheUnitedStatesortheUSVirginIslands.Theterm‘realproperty’includes:(1)landandunseverednaturalproductsoftheland;(2)improvements;and(3)personalpropertyassociatedwiththeuseofrealproperty.InadditiontoadirectinterestinUSrealproperty,aUSRPIincludesaninterestinadomesticcorporationif,atanytimeduringtheshorterof(1)theperiodafterJune18,1980,duringwhichthetaxpayerheldtheinterestor(2)thefive-yearperiodendingonthedateofthedispositionoftheinterestinthecorporation,thedomesticcorporationwasaUSrealpropertyholdingcompany(USRPHC).

Ingeneral,adomesticcorporationisaUSRPHCifthefairmarketvalueofitsUSRPIsequalsorexceeds50%ofthefairmarketvalueof(1)itsUSPRIs,(2)itsinterestsinrealpropertylocatedoutsidetheUnitedStates,plus(3)anyotherofitsassetsthatareusedorheldforuseinatradeorbusiness.

Inbound insight: It should be noted that the FIRPTA rules presume that an interest in a domestic corporation (other than an interest solely as a creditor) is a USRPI and therefore is subject to tax upon disposition unless, prior to the disposition of shares in the corporation, the shareholder requests a statement from the corporation that its shares are not USRPIs and the corporation provides the requested statement on a timely basis. If the presumption is not rebutted, the disposition is subject to the FIRPTA rules regarding reporting and withholding.



M. Corporate deductions

1. Depreciation and amortization

Depreciationdeductionsareallowancesthatmaybetakenforcapitaloutlaysfortangibleproperty.Forpropertyplacedinserviceafter1986,capitalcostsmustberecoveredbyusingthemodifiedacceleratedcostrecoverysystem(MACRS)method.Dependingonthetypeoftangibleproperty,thegeneralcostrecoveryperiodsare3,5,7,10,15,20,27.5,and39years(31.5yearsforpropertyplacedinservicebeforeMay13,1993).Thecostrecoverymethodsandperiodsarethesameforbothnewandusedproperty.Mosttangiblepersonalpropertyfallsinthethree-,five-, orseven-yearclass.

Propertyplacedinthethree-,five-,seven-,or10-yearclassisdepreciatedbyfirstapplyingthe200%declining-balancemethodandthenswitchingtothestraight-linemethodwhenuseofthestraight-linemethodmaximizesthedepreciationdeduction.Propertyinthe15-or20-yearclassisdepreciatedbyusingthe150%declining-balancemethodandlaterswitchingtothestraight-linemethod.Anelectionmaybemadetousethealternativedepreciationsystem(basically,thestraight-linemethodoverprescribedlives).

Residentialrentalpropertygenerallyisdepreciatedbythestraight-linemethodover27.5years.Nonresidentialrealpropertyisdepreciatedbythestraight-linemethodover39years(31.5yearsforpropertyplacedinservicebeforeMay13,1993).

Anelectiontousethestraight-linemethodovertheregularrecoveryperiodoralongerrecoveryperiodalsoisavailable.Alternatively,taxpayersmayelecttousethe150%declining-balancemethodovertheregularrecoveryperiodforallpropertyotherthanrealproperty.The150%declining-balancemethodisrequiredforAMT purposes.

FormosttangiblepersonalandrealpropertyplacedinserviceintheUnitedStatesafter1980butbeforeJanuary1,1987,capitalcostswererecoveredusingtheacceleratedcostrecoverysystem(ACRS),whichappliedacceleratedmethodsofcostrecoveryoverperiodsspecifiedbystatute.ThegeneralACRSrecoveryperiodswere3,5,10,15,18,and19years.

Specialrulesapplytoautomobilesandcertainother‘listed’property.Accelerateddepreciationdeductionscanbeclaimedonlyiftheautomobileisused50%ormoreforqualifiedbusinessuseasdefinedinrelatedregulations.Further,forautomobilesplacedinserviceafter1986,theallowableyearlydepreciationdeductioncannotexceedspecificdollarlimitations.

SeparatemethodsandperiodsofcostrecoveryarespecifiedbystatuteforcertaintangiblepersonalandrealpropertyusedoutsidetheUnitedStates.

Rapidamortizationmaybeallowableforcertainpollutioncontrolfacilities.



Taxdepreciationisnotrequiredtoconformtobookdepreciation.Taxdepreciationgenerallyissubjecttorecaptureonthesaleordispositionofcertainproperty,totheextentofgain,whichissubjecttotaxasordinaryincome.

Thecostofmostintangibleassetsgenerallyiscapitalizedandamortizableratablyover15years.

Inbound insight: Companies with a large amount of fixed assets can benefit from careful analysis of current depreciation methods, for regular tax, AMT, and E&P purposes. Proper classification of assets and the application of the correct recovery periods can have a substantial impact on current-year taxable income and E&P.

2. Section 179 deduction

Corporationscanelecttoexpense,uptoastatutoryamountperyear,thecostofcertaineligiblepropertyusedintheactiveconductofatradeorbusiness,subjecttoataxableincomelimitationandtoaphase-outofthededuction.ThisiscommonlyreferredtoastheSection179deduction.

Taxcutsenactedin2003temporarilyincreasedthemaximumdollaramountthatmaybedeductedunderSection179from$25,000to$100,000andalsoincreasedthephase-outamountfrom$200,000to$400,000.Theseamountshavebeenfurthermodifiedandextendedseveraltimesonatemporarybasis,increasingtoahighof$500,000and$2million,respectively,fortaxyearsbeginningin2010and2011,andthento$125,000and$500,000,respectively,fortaxyearsbeginningin2012,beforerevertingtothepermanentamountsof$25,000and$200,000,respectively,fortaxyearsbeginningin2013andthereafter.TheAmericanTaxpayerReliefActof2012(ATRA)signedintolawonJanuary2,2013,increasesthemaximumamountandphase-outthresholdin2012and2013tothelevelsineffectin2010and2011($500,000and$2million,respectively).Fortaxyearsbeginningin2014,theamountsrevertedto$25,000and$200,000,respectively.

3. Bonus depreciation

A50%specialfirst-yeardepreciationallowance(i.e.,bonusdepreciation)applies(unlessanelectionoutismade)fornewMACRSpropertywitharecoveryperiodof20yearsorless,certaincomputersoftware,waterutilityproperty,andcertainleaseholdimprovementsacquiredafterDecember31,2007.ThespecialallowanceappliesforregularincometaxandAMTpurposes.NoAMTadjustmentismadeifthespecialallowanceisused.Thespecialallowancedoesnotapplytopropertythatmustbedepreciatedusingthealternativedepreciationsystemorto‘listedproperty’notusedpredominantlyforbusiness.Thespecialallowancereducesbasisbeforeregulardepreciationisfigured.Claimingbonusdepreciationonautomobilesalsomayaffectthefirst-yeardepreciationlimitsonsuchautomobiles.

ATRAextendedbonusdepreciationthroughDecember31,2013(December31,2014,forlong-production-periodproperty(LPPP)andcertainaircraft).ThisprovisionhadbeensettoexpireonDecember31,2010(December31,2011,forLPPP



andcertainaircraft),asextendedbytheSmallBusinessJobsActof2010.

• ATRAdidnotextend100%bonusdepreciation,whichexpiredattheendof2011.

• ATRAextendedforoneyear,totaxyearsbeginningin2013,theprovisionallowingacorporationtoelecttoaccelerateAMTcreditsinlieuofbonus depreciation.

Inbound insight: Due to the numerous changes in the law related to depreciation deductions, a review of prior years and a forecast of future years should be completed regularly.

4. Depletion

Fornaturalresourcepropertiesotherthantimberandcertainoilandgasproperties,depletionmaybecomputedonacostorapercentagebasis.

Costdepletionisamethodofdepletionappliedtoexhaustiblenaturalresources,includingtimber,whichisbasedontheadjustedbasisoftheproperty.Eachyear,theadjustedbasisofthepropertyisreduced,butnotbelowzero,bytheamountofdepletioncalculatedforthatyear.Thecurrent-yearcostdepletiondeductionisbasedonanestimateofthenumberofunitsthatmakeupthedepositandthenumberofunitsextractedandsoldduringtheyear.

Percentagedepletionisamethodofdepletionappliedtomostmineralsandgeothermaldeposits,and,toamorelimitedextent,oilandgas.Percentagedepletionisdeductibleatratesvaryingfrom5%to25%ofgrossincome,dependingonthemineralandcertainotherconditions.Percentagedepletionmaybedeductedevenafterthetotaldepletiondeductionshaveexceededthecostbasis.However,percentagedepletionislimitedto50%(100%foroilandgasproperties)oftaxableincomefromtheproperty(computedwithoutallowancefordepletion).Generally,percentagedepletionisnotavailableforoilorgaswells.However,exceptionsexistfornaturalgasfromgeopressurizedbrineandforindependentproducersofoiland gas.

5. Goodwill

Thecostofgoodwillgenerallyiscapitalizedandamortizableratablyover15years.

6. Start-up expenses

Generally,start-upexpendituresmustbeamortizedovera15-yearperiod;however,certaintaxpayersmayelecttodeductsomeexpensesinthetaxyearinwhichthetradeorbusinessbegins.



7. US manufacturing deduction

Overthelastseveraldecades,varioustaxincentivesystemswereenactedintheUnitedStatestoencourageexportsbutlaterwererepealed,includingtheextraterritorialincome(ETI)regime,whichwasrepealedasaresultofaWorldTradeOrganization(WTO)rulingthattheETIregimefavoredUSgoodsandviolatedthenationaltreatmentprovisionsoftheGeneralAgreementonTariffsandTrade.Inresponse,theUnitedStatesenactedtheAmericanJobsCreationActof2004,whichintroducedaphase-outrepealofETIandintroducedthedomesticproductionactivitiesdeductionunderSection199,seekingtocompensateUSmanufacturersforthelossofETI benefits.

UnderSection199,taxpayersarealloweda9%deductionforqualifiedproductionactivities(QPA)income(subjecttoataxableincomelimitation).ThedeductionisavailabletoalltaxpayersactivelyengagedinQPA.Forcorporatetaxpayers,thedeductiongenerallywillmeanafederalincometaxrateof31.85%onQPAincome.Importantly,thedeductionalsoappliesincalculatingtheAMT.

Thereisalimitontheamountofthedeductionequalto50%ofW-2wagesallocabletoQPA(subjecttoaspecificeffectivedate).Thedeductionisnotallowedfortaxpayersthatincuralossfromtheirproductionactivitiesorhaveanoverallloss(includingacarryoverloss)fromallactivities.

Ataxpayer’sQPAincomeiscalculatedusingthefollowingformula:domesticproductiongrossreceiptslessthesumofcostofgoodssoldallocabletosuchreceiptsandotherexpenses,losses,ordeductionwhichareproperlyallocabletosuchreceipts.

Inbound insight: The Section 199 deduction applies to a variety of US domestic production activities, including the production of tangible personal property, qualified films, construction of real property, and the development of computer software. Because the Section 199 deduction is a permanent deduction, any overlooked deductions can be claimed on amended federal income tax return.

8. Bad debt

Baddebtresultingfromatradeorbusinessmaybedeductedintheyearthedebtbecomesworthless.Determiningthedatethedebtbecomesworthlessmaypresent difficulty.

9. Charitable contributions

Deductionsforallowablecharitablecontributionsmaynotexceed10%ofacorporation’staxableincomecomputedwithoutregardtocertaindeductions,includingcharitablecontributionsthemselves.Deductionsforcontributionssolimitedmaybecarriedovertothefivesucceedingyears,subjecttothe10%limitationannually.



10. Employee benefit plans (retirement plans and expenses)

TheInternalRevenueCodeprovidesincentivesforemployerstoprovideretirementbenefitstoworkers,includingemployeepension,profit-sharing,andstockbonusplans.Theemployerisallowedacurrentdeductionforcontributionsmadetofundtheretirementbenefitsandpayexpenses;theemployees’taxliabilityisdeferreduntilthebenefitsarepaid.

TheseprogramsaresubjecttotheEmployeeRetirementIncomeSecurityActof1974(ERISA),whichgovernseligibility,vesting,spousalrights,fiduciaryduties,reportinganddisclosure,andotherrelatedissues,aswellastotheextensiverequirementsfortaxqualificationundertheInternalRevenueCode.Qualifiedretirementplansmustnotdiscriminateinfavorofhighlycompensatedemployees,andaresubjecttoadditionalrulesregardingeligibility,vesting,benefitaccrual,funding,spousalrights,andfiduciaryduties.

For-profit,non-governmentemployersgenerallyhavetwotypesofavailableplans.Thefirstcategoryisthedefinedbenefitplan,oftensimplyknownasapensionplan,towhichanemployercontributesonanon-goingbasistocovertheamountofretirementincomeowedtoemployeesundertheplan(whichwillvarybasedonyearsofservice,averagesalary,and/orotherfactors),beginningattheirretirementandgenerallycontinuingforlife.Anyinvestmentgainsorlosseswillnotaffecttheamountofbenefitspaidtoparticipantsbutwillaffecttheamountanemployermustcontributetocoverits obligation.

Thesecondcategoryisthedefinedcontributionplan,includingthecommonlyoffered‘401(k)plan,’towhichanemployer’scontributions(ifany)areallocatedamongtheseparateaccountsofparticipatingemployees.Investmentgainsorlossesandthehistoryofcontributionswillaffectthevalueofaparticipant’saccountatretirementbutwillnotaffectanemployer’scontributionssincetheemployerisnotobligatedtoensureanyspecifiedlevelofbenefitintheplan.A401(k)planalsoprovidesemployeesapre-taxmeansofsavingfortheirownretirement,andpermitstheemployertomatchthesecontributions.

Non-profitemployers,includingcharitiesandgovernmententities,havesimilarretirementplans,althoughsomedifferentrequirementsapply.Smallemployersandself-employedindividualsalsohavesimilaroptionsavailablebutmaybesubjecttodifferentrequirements.

Inbound insight: The rules applicable to employee benefit plans, in terms of application to both a US business and its employees, can create particular complexity for businesses with non-US parent companies. This is often due to the interaction between the employee benefit plans at the parent company and the US business, as well as the movement of employees into and out of the US for varying periods of time.



11. Fines and penalties

Nodeductiongenerallyisallowedforfinesorpenaltiespaidtothegovernmentforviolationofanylaw.

12. Bribes, kickbacks, and illegal payments

Anamountpaid,directlyorindirectly,toanypersonthatisabribe,kickback,orotherillegalpaymentisnotdeductible.

13. Taxes

Stateandmunicipaltaxesaredeductibleexpensesforfederalincometaxpurposes.

14. Research or experimental expenditures

CorporationscanelectunderSection174toexpenseallresearchorexperimental(R&E)expendituresthatarepaidorincurredduringthetaxyearortodefertheexpensesfor60months.TaxpayersalsocanmakeaspecialelectionunderSection59(e)toamortizetheirresearchexpendituresover120months.AportionoftheresearchexpendituresmayqualifyforaresearchtaxcreditthatisdescribedinsectionI.N.5.

TheIRSinSeptember2013issuedproposedregulationsunderSection174thatareconsideredtaxpayerfavorable.Theproposedregulationswouldaddressseveralissuesrelatedtowhetherthesubsequentsaleoruseoftangiblepropertycreatedthroughresearchisdeductible,amendtheexistingregulationsclarifyingthedepreciablepropertyrule,clarifythatintegrationtestingcouldqualifyasanR&Eexpense,provideadefinitionof‘pilotmodel,’andintroducethe‘shrink-back’ruleconcepttotheSection174context.


Inbound insight: The proposed regulations would apply to any tax year ending on or after the publication date of a Treasury decision adopting these rules as final regulations. The IRS, however, states that it will not challenge return positions consistent with the proposed regulations. Thus, taxpayers may rely on the proposed regulations until the date the final regulations are published in the Federal Register.

15. Other significant items

• Nodeductiongenerallyisallowedforacontingentliabilityuntilsuchliabilityisfixedanddeterminable.

• Costsincurredforentertainmentmustmeetstrictteststobedeductible.Thedeductionforbusinessmealandentertainmentexpensesgenerallyis50%oftheexpensesincurred.Therearealsolimitationsonthedeductibilityofinternationalanddomesticbusinesstravelexpenses.

• Royaltypayments,circulationcosts,mineexploration,anddevelopmentcosts,andothermiscellaneouscostsofcarryingonabusinessaredeductible,subjecttocertainconditionsandlimits.


16. Net operating losses (NOLs)

AnNOLisgeneratedwhenbusinessdeductionsexceedgrossincomeinaparticulartaxyear.AnNOLmaybecarriedbacktooffsetpastincomeandpossiblyobtainarefundorcarriedforwardtooffsetfutureincome.Generally,alossmaybecarriedbacktwoyearsand,ifnotfullyused,carriedforward20years.

SpecialrulesregardingNOLsmayapply(1)tospecifiedliabilitylossesor(2)ifataxpayerislocatedinaqualifieddisasterarea.

ComplexrulesmaylimittheuseofNOLsafterreorganizationorotherchangeincorporateownership.Generally,iftheownershipofmorethan50%invalueofthestockofalosscorporationchanges,alimitisplacedontheamountoffutureincomethatmaybeoffsetbylossescarriedforward.

17. Payments to foreign affiliates

AUScorporationgenerallymayclaimadeductionforroyalties,managementservicefees,andinterestchargespaidtoforeignaffiliates,totheextenttheamountsareactuallypaidandarenotinexcessofwhatitwouldpayanunrelatedentity(i.e.,areatarm’slength).USwithholdingonthesepaymentsmayberequired.

18. Premium payments to captive insurance companies

AUScorporationgenerallymayclaimadeductionforinsurancepremiumspaid,eventhoughtheinsuranceispurchasedfromanaffiliatedinsurancecompany(captiveinsurancecompany).Tobetreatedasinsurancefortaxpurposes,theinsurancearrangementhastoinvolvethetransferofinsurancerisk,resultinadequateriskdistribution,andmeetcommonlyacceptednotionsofinsuranceunderUStaxprinciples.IfthecaptiveinsurancecompanyisdomiciledoutsidetheUS,thepremiumpaymentswouldbesubjecttoanexcisetaxof4%ondirectpremiums(otherthanforlifeinsurance)and1%onlifeinsuranceandreinsurancepremiums.However,theexcisetaxmaybeexemptunderataxtreaty.Insurancepremiumsarenotsubjecttowithholdingtaxes(otherthanunderFATCA;seediscussionbelow).

N. Credits and incentives

1. Temporary credits and incentives extended

Numeroustemporarytaxprovisionsthatexpiredattheendof2011wererenewedretroactivelytoJanuary1,2012,andextendedthroughDecember31,2013,aspartofATRA.Asofthisprinting,theseprovisionshavenotbeenrenewedfor2014.Congressmaypasslegislationrenewingandextending(retroactivelytoJanuary1,2014)atleastsomeoftheseprovisionslaterin2014.



ThegeneralbusinessincentivesthatwererenewedandextendedbyATRAincludethefollowing:

• increasedSection179expensinglimitof$500,000witha$2millionphase-outthresholdandanexpandeddefinitionofSection179property

• researchcredit

• subpartFexceptionforactivefinancingincome

• look-throughtreatmentofpaymentsbetweenrelatedCFCsundertheforeignpersonalholdingcompanyrules.

• 15-yearstraight-linecostrecoveryforqualifiedleaseholdimprovements,restaurantbuildingsandimprovements,andretailimprovements

• seven-yearrecoveryperiodformotorsportsentertainmentcomplexes

• workopportunitytaxcredit

• wagecreditforemployersof

active-dutymilitarymembers

• railroadtrackmaintenancecredit

• specialexpensingrulesforqualifiedfilmandtelevision productions

• newmarketstaxcredit

• minerescueteamtrainingcredit

• expensingofadvancedminesafety equipment

• enhancedcharitabledeductionforcontributionsoffoodproperty

• treatmentofsomedividendsofregulatedinvestmentcompanies(RICs)

• RICsconsideredqualifiedinvestmententitiesunderFIRPTA

• specialrulesforqualifiedsmallbusinessstock

• reductioninScorporationrecognitionperiodforbuilt-ingainstax

2. Foreign tax credit (FTC)

Generally,inanyyear,ataxpayercanchoosewhethertotakeasacredit(subjecttolimitation)orasadeductionforeignincome,warprofits,andexcessprofittaxespaidoraccruedduringthetaxyeartoanyforeigncountryorUSpossession.AnFTCreducesUSincometaxliabilitydollarfordollar,whileadeductionreducesUSincometaxliabilityatthemarginalrateofthetaxpayer.

FortaxpayerswithanNOLfortheyear,theFTCisofnovalueinsuchyear.However,abenefitmightbereceivedeitherinanearlieryear(througharefundofpreviouslypaidtaxes)oralateryear(throughareductionoffuturetaxes).Notealsothatataxpayerhastheabilitytoswitchfromcredittodeduction(orfromdeductiontocredit)atanytimeina10-yearperiodcommencingwhentheforeigntaxeswerepaidoraccrued.Generally,anFTCmaybecarriedbackoneyearand,ifnotfullyused,carriedforward10years.

TheFTCgoesbeyonddirecttaxestoincludeforeigntaxespaid‘inlieuof’ataxonincome,warprofits,orexcessprofitsthatotherwisegenerallywouldbeimposed.Italsoincludesdeemed-paid(indirect)taxespaidforcertainUScorporateshareholdersofnon-portfolioforeigncorporationswhenactualordeemeddividendsarereceived.TheFTCsystemhasnumerouslimitationstomitigatepotentialabusesofthecreditbytaxpayers.



3. General business credit

Variousbusinesscreditsareavailabletoprovidespecialincentivesfortheachievementofcertaineconomicobjectives.Ingeneral,thesecreditsarecombinedintoone‘generalbusinesscredit’forpurposesofdeterminingeachcredit’sallowancelimitationforthetaxyear.Thegeneralbusinesscreditthatmaybeusedforataxyearislimitedtoatax-basedamount.Ingeneral,thecurrentyear’screditthatcannotbeusedinagivenyearbecauseofthecredit’sallowancelimitationmaybecarriedbacktothetaxyearprecedingthecurrentyearandcarriedforwardtoeachofthe20yearsfollowingthecurrentyear.

Ingeneral,thecurrent-yearbusinesscreditisacombinationofthefollowingcredits(asofthiswriting,someofthesecreditshaveexpired,butmayberenewedretroactivelybyCongress):

• investmentcredit

• workopportunitycredit

• alcoholfuelscredit

• researchcredit

• low-incomehousingcredit

• enhancedoilrecoverycredit

• disabledaccesscreditforcertaineligiblesmallbusinesses

• renewableelectricityproduction credit

• empowermentzoneemployment credit

• Indianemploymentcredit

• employersocialsecuritycredit

• orphandrugcredit

• newmarketstaxcredit

• smallemployerpensionplanstartupcostcreditforeligible employers.

• employer-providedchildcare credit

• railroadtrackmaintenancecredit

• biodieselfuelscredit

• lowsulfurdieselfuelproduction credit

• marginaloilandgaswellproductioncredit

• distilledspiritscredit

• advancednuclearpowerfacilityproductioncredit

• non-conventionalsourceproductioncredit

• newenergyefficienthomecredit

• energyefficientappliancecredit

• aportionofthealternativemotorvehiclecredit

• aportionofthealternativefuelvehiclerefuelingpropertycredit

• HurricaneKatrinahousingcredit

• HurricaneKatrinaemployeeretentioncredit

• HurricaneRitaemployeeretention credit

• HurricaneWilmaemployeeretentioncredit

• minerescueteamtrainingcredit

• agriculturalchemicalssecuritycreditforeligiblebusinesses

• differentialwagepaymentcredit

• carbondioxidesequestration credit

• aportionofthenewqualifiedplug-inelectricdrivemotorvehiclecreditforvehiclesthatwillvarybasedonthedateofpurchase



4. Employment credits

A‘workopportunitytaxcredit’isavailableforemploymentofcertaintargetedgroupsofindividualswhoareviewedasdifficulttoemploy.‘Creditable’wagesgenerallyarethefirst$6,000ofwagespaidtoeachqualifiedemployeefortheyear.Thecreditis40%ofcreditablewages,foramaximumcreditof$2,400.ATRAextendedthiscreditthrough2013.

5. Research credit

TheresearchtaxcreditunderSection41isavailableforcompaniesthatmakequalifiedresearchexpenditurestodevelopneworimprovedproducts,manufacturingprocesses,orsoftwareintheUnitedStates.Thecreditwasenactedin1981onatemporarybasistohelpincreaseR&EspendingintheUnitedStates.Sincethentheresearchcredithasbeenextendedabout15times,mostrecentlyaspartofATRA,retroactivetoJanuary1,2012,andisavailablewithrespecttoqualifiedresearchexpenses(QREs)incurredbeforeJanuary1,2014.

Theresearchcreditgenerallyiscomputedbycalculatingcurrent-yearQREoverabase.Thebaseiscalculatedusingeithertheregularresearchcredit(RRC)methodorthealternativesimplifiedcredit(ASC)method.UndertheRRCmethod,thecreditequals20%ofQREsforthetaxyearoverabaseamountestablishedbythetaxpayerin1984–1988orbyanothermethodforcompaniesthatbeganoperationsafterthat period.

TheASCequals14%—forthe2009taxyearandthereafter—ofQREsover50%oftheaverageannualQREsinthethreeimmediatelyprecedingtaxyears.IfthetaxpayerhasnoQREsinanyofthethreeprecedingtaxyears,theASCmaybe6%ofthetaxyear’sQREs.ThetaxpayermustmakeatimelyASCelectiononForm6765attachedtoanoriginallyfiledreturnfiledbytheduedateforthatreturn(including extensions).

TaxpayersusingtheRRCalsomaytakea20%creditforincrementalpaymentsmadetoqualifiedorganizationsforbasicresearch.FortaxyearsendingafterAugust8,2005,taxpayersalsomaytaketheEnergyResearchConsortiumCredit,whichprovidesa20%creditforexpendituresonqualifiedenergyresearchundertakenbyanenergyresearchconsortium.

ThedeductionforR&Eexpenditures(seesectionI.M.14above)mustbereducedbytheentireamountofthecreditunlessanelectionismadetoreducetheamountofthecredit.



Inbound insight: The application of the research credit rules when a US business is compensated for its R&E costs by a foreign parent or other foreign related party often is misunderstood.

The rules provide that in determining a taxpayer’s research tax credit, all members of the same controlled group of corporations should be treated as a single taxpayer. Companies often net the reimbursement against their current QREs, resulting in lost opportunities to utilize available credits. This area should be reviewed closely if US entities are being reimbursed by related foreign entities for any potentially qualified activities.

In light of the proposed regulations under Section 174, taxpayers should evaluate their QREs to determine the possible impact of the new rules regarding pilot models, integration testing, and ‘shrinkback.’

Congress may extend the credit, retroactively to January 1, 2014, by the end of 2014.

6. Inbound investment incentives

Theregenerallyarenospecificincentivesrelatedtoinboundinvestmentatthefederallevel,otherthancertainportfoliodebtandbankdepositexceptions.Theportfoliodebtexceptionenablesnonresidentsandforeigncorporationstoinvestincertainobligations(whichmustmeetcertainstatutoryrequirementstoqualifyas‘portfoliodebt’)intheUSwithoutbeingsubjecttoUSincome(orwithholding)taxontheinterestincome.

7. Qualified private activity bonds

Interestincomereceivedoncertainqualifiedprivateactivitybondsgenerallyisexemptfromfederalincometax.Thisenablesabusinessenterprisetoissuethebondsatalowerinterestrate.

O. Administrative issues

1. Withholding

a. Withholding on payments to non-US persons

UnderUSdomestictaxlaws,aforeignpersongenerallyissubjectto30%UStaxonitsUS-sourceincome.PersonsmakingUS-sourcepayments(‘withholdingagents’),suchasUS-sourceinterest,dividends,androyalties,toforeignpersonsgenerallymustwithhold30%ofthepaymentamountastaxwithheldatsource.Inothersituations,withholdingagentsmayapplyalowerrateofwithholdingifthepayeeiseligibleforareducedrateunderataxtreatyorbyoperationoftheUStaxlaws.SeethelatesteditionofIRSPublication515.

TheUnitedStateshasenteredintovariousincometaxtreatieswithcountriesinordertoavoiddoubletaxationofthesameincomeandtopreventtaxevasion.SeeAppendixAbeloworthelatesteditionofIRSPublication901forasummaryof



thebenefitsresultingfromthesetreaties.Seealsothediscussionoftaxtreatiesinsection IIIbelow.

Theabilitytoapplyareducedratedependsonwhetherthewithholdingagentreceivesvaliddocumentationevidencingtheforeignpayee’seligibilityforalowerrateofwithholding.ValiddocumentationincludesFormW-8.SincetherearevariousFormsW-8,thepayeemustdeterminewhichoneisthecorrectformtobecompleted.

FormW-8BEN,Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding,isthemostcommonlyusedFormW-8.ThatversionisusedtoestablishthatthepayeeisnotaUSpersonandisthebeneficialowneroftheincomeforwhichFormW-8BENisbeingprovided.FormW-8BENalsocanbeusedtoclaimareducedrateofwithholdingbasedonanapplicableincometaxtreaty.Note:FormW-8BENisusedonlybyindividuals.EntitiesuseFormW-8BEN-E.

InadditiontoFormW-8BEN,otherformsthatcanbeprovidedbyaforeignpayeetoreduceoreliminatewithholdingare:

• FormW-8ECI,Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the United States,isprovidedbyanon-USentitythatisengagedinaUStradeorbusiness.

• FormW-8EXP,Certificate of Foreign Government or Other Foreign Organization for United States Tax Withholding,isprovidedbynon-USgovernmentsornon-UStax-exemptorganizations.

• FormW-8IMY,Certificate of Foreign Intermediary, Foreign Flow Through Entity, or Certain US Branches for United States Tax Withholding,isprovidedbyanon-USflow-throughentity(e.g.,partnership)thatisnotengagedinaUStradeorbusiness.FormW-8IMYmustbeaccompaniedbyFormW-8orFormW-9fortheunderlyingownersandwithholdingstatement.

TreatyclaimsmadebynonresidentalienindividualsthatprovideindependentpersonalservicesintheUSaremadeonForm8233,Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual,insteadofonFormW-8BEN.

FormsW-8BEN,W-8ECI,andW-8EXPgenerallyarevalidforthreeyearsplustheyearofreceipt.Newformsarerequiredpriortotheexpirationofthreeyearsifthereisachangeintheinformationdisclosedbythepayeeontheforms.FormW-8IMYisvalidindefinitelyunlessthereisachangeintheinformationdisclosedbythepayeeontheforms.Form8233isvalidforonlyoneyear.

b. Withholding on payments to US persons

AllUSandnon-USentitiesareresponsibleforinformationreportingandbackupwithholdingforpaymentsmadetoUSnon-exemptrecipients,includingUSindividuals,partnerships,LLCs,andnon-corporatebanks.Backupwithholdingatthecurrentrateof28%isrequirediftheUSnon-exemptrecipientfailstoprovideapropertaxpayeridentificationnumber(TIN)priortopaymentorifthepayorisinstructedtobackupwithholdbytheIRS.



PaymentsmadetoUSexemptrecipientsarenotsubjecttoreportingorbackupwithholdingandsuchrecipientsarenotrequiredtoprovideaTIN.Exemptrecipientsincludegovernments(federal,state,andlocal),tax-exemptorganizationsunderIRCSection501(a),individualretirementplans,internationalorganizations,foreigncentralbanksofissue,andmostcorporations.

PaymentsmadetoUSnon-exemptrecipientsfordividends,grossproceeds,interest,compensationforservices,rents,royalties,prizes,awards,andlitigationawards,amongothers,mustbereported.AproperTINshouldbeobtainedfromallUSpayeestoavoidbackupwithholding.ATINisbestobtainedbyreceivingaFormW-9,Request for Taxpayer Identification Number and Certificate,fromUSpayees,includingexemptrecipients.TheIRS’sTINMatchingProgramalsocanbeutilizedtoverifynamesorTINswithIRSrecordstoensureaccuracy.

Inbound insight: The US reporting and withholding rules apply whether payments are made to related or unrelated parties. This means that the appropriate Form W-8 or W-9 must be provided to a company making a payment to a related party.

Non-US companies that are controlled by US persons or that earn more than a certain amount of US-source income are classified as US payors. As a result, these companies must report all reportable payments made to a US non-exempt recipient. Also, if the US non-exempt recipient fails to provide its TIN in the proper manner, backup withholding must be imposed and remitted to the IRS.

2. Information reporting

a. Reporting payments to non-US persons

AnytaxeswithheldonpaymentsmadetoforeignpayeesmustbereportedtotheIRSonForm1042,Annual Withholding Tax Return for US Source Income of Foreign Persons.Form1042mustbefiledwiththeIRSonorbeforeMarch15followingthecalendaryearinwhichtheincomesubjecttoreportingwaspaid,unlessanextensionoftimetofileisobtained.Form1042mustbefiledifaForm1042-Sisfiled(seebelow),evenifthereisnowithholdingonthepayment.

AwithholdingagentmustfilewiththeIRSandfurnishtoeachforeignpayeeForm1042-S,Foreign Person’s US Source Income Subject to Withholding.Form1042-SistheinformationreturnusedbywithholdingagentstoreportUS-sourcepaymentspaidtoforeignpayees.Form1042-SmustbefiledwiththeIRSandfurnishedtotheforeignpayeeonorbeforeMarch15followingthecalendaryearinwhichtheincomesubjecttoreportingwaspaid,unlessanextensionisobtained.Form1042-Sisrequiredwhetherornotwithholdingonthepaymentshasoccurred.

b. Reporting payments to US persons

AUSentityengagedinatradeorbusinessthatduringthecalendaryearmakespaymentstoaUSnon-exemptpayeetotaling$600ormoremustreporttheamountofthepaymentsonForm1099-MISC,Miscellaneous Income.Paymentssubjectto



Form1099-MISCreportingincludecompensationforservices(otherthanwagespaidtoemployees),rents,royalties,commissions,gains,andcertaintypesofinterest.USpayersareresponsibleforreportingthepaymentwhethermadebycash,check,orwiretransfer.Amountspaidbypaymentcard(includingdebt,credit,andprocurement)arenotsubjecttoForm1099-MISCreportingbythepayor.

Form1099-MISCmustbefurnishedtopayeesnolaterthanJanuary31oftheyearsubsequenttotheyearofpaymentandmustbefiledwiththeIRSbyFebruary28oftheyearfollowingthepayment.Requeststoextendthesedatesmaybemade,butextensionsarenotautomatic.

Ifthepayorisrequiredtofile250ormoreForms1099-MISC,itmustfiletheformselectronicallywiththeIRSbyuseoftheFilingInformationReturnsElectronically(FIRE)system.IfForms1099-MISCarefiledelectronically,theduedateforfilingwiththeIRSisextendedfromFebruary28toMarch31.

ThepayoralsomustfileForm945,Annual Return of Withheld Federal Income Tax,toreportanybackupwithholding.Form945mustbefiledwiththeIRSbyJanuary31oftheyearsucceedingtheyearofpayments.

c. FATCA

FATCA,theForeignAccountTaxComplianceAct,wasenactedin2010topreventanddetectoffshoretaxevasion.WhilethenamemayimplythatFATCAisdirectedatfinancialinstitutions,manyglobalcompaniesoutsidethefinancialservicesindustrymaybeaffectediftheyhaveentitiesintheirworldwidenetworkfallingunderthepurviewofFATCA,orhaveoperationalareasthatmakeorreceivepaymentssubjectto FATCA.

SincebeforeFATCAapplied,multinationalenterprisesthatarewithholdingagentshavebeenobligatedtoreport,withholdonpayments,anddocumentpayees,butFATCAwillrequirechangestotheseactivitiesandimposeadditionalrequirementsfortransactionswithnon-USentities.FATCAmandatesthatmultinationalbusinessesevaluateentitypayeesdifferently,engageinwithholdingoncertaingrossproceedstransactions(achangefromhistoricprocesses),andreportdifferentinformationtothe IRS.

ThewithholdingprovisionsofFATCAarescheduledtobegininJuly2014.CompliancewithFATCAmayrequirechangestoexistingsystemsandprocessesacrossbusinessunitsandregions,therenewalofpoliciesandday-to-daypractices,andnewtaskssuchasregisteringwiththeIRS.

Inbound insight: Many non-US companies with business operations in the United States have non-US companies engaged in activities such as holding shares, financing, and treasury or insurance operations. These activities require a careful review of the companies throughout the corporate group to determine the appropriate application of the FATCA rules.



i. FATCA compliance obligations

FATCAimposesnewregistration,duediligencereviews,informationreporting,andtaxwithholdingobligationsonentitiesthatqualifyasforeignfinancialinstitutions(FFIs).ByasearlyasApril2014,legalentitieswithFFIcharacteristicsmustdeterminewhethertheyare,infact,FFIsandshouldregisterwiththeIRS.

Multinationalcorporationsshouldexaminetheirtreasurycenters,retirementfunds,andholdingcompanies,tonameafewexamples,toensurethattheydonotmeetthedefinitionofanFFI.ProperlyidentifyingtheFATCAstatusofeachentityinalargeorganizationisexpectedtotakesignificanttimeandeffort,becausethefinalFATCAregulationsimposeseveraldifferentincomeandassettestsatboththeentitylevelandtheglobalorganizationlevel.

RegardlessofFATCAstatus,obligationsareimposedonpayorsofUS-sourcefixedordeterminable,annual,orperiodical(FDAP)income,whichincludemanymultinationalcorporations.Thesecompaniesmusthaveprocessesandproceduresinplacetoidentifyandcategorizenon-USpayeesforFATCApurposes,report,andpotentiallyapply30%withholdingtaxtoavoidbeingliableforthewithholdingtaxandpotentialpenalties.EvenifaforeignentityisnotanFFI,FATCAstillrequirestherecipientofaUS-sourcepaymenttoestablishitsFATCAstatuswithappropriatedocumentation.

FATCAalsoextendsexistingreportingandwithholdingrequirementsandimposewithholdingonUSFDAPpaymentstoFFIentitiesthatdonotreportcertaininformationregardingtheirUSaccountstotheIRS.Thiswithholdingtaxalsoappliestothesametypesofpaymentstocertainnonfinancialforeignentities(NFFEs)thatdonotprovideinformationontheirsubstantial(i.e.,greater-than-10%)USownerstoawithholdingagent.

ii. FATCA exemptions

ThereareseveralimportantexemptionsfromFATCAtothewithholdingoftaxonUS-sourcepayments.Forexample,FATCAwithholdingshouldnotapplywhenthepayeeprovidestothewithholdingagentappropriatedocumentationdemonstratingthatthepayeeisnotsubjecttowithholding.EventhoughwithholdingunderFATCAdoesnotapply,inthatcasereportingstillisrequired.Thewithholdingagentalsomustevaluatewhetherreportingandwithholdingapplyundercurrentinformationreportingrules.

NFFEsthateitherhavenosubstantialUSownersorthatproperlyidentifytheseownerstowithholdingagentsshouldnotbesubjecttowithholding,norshouldNFFEsthataredeemedbytheIRStorepresentalowriskofUStaxevasion,suchaspubliclytradedcompaniesandtheiraffiliates,andthoseengagedinactivetradesorbusinesses.AwithholdablepaymenttoadocumentedUSentityisnotsubjecttothe30%tax,butreportingapplies.

iii. Actions to comply with FATCA

MultinationalcorporationsneedaFATCAcomplianceprogramtoensurethatallnecessaryFATCAclassifications,documentation,monitoring,andreporting



areundertaken.Thisprocessshouldbedocumentedinaseriesofpoliciesandproceduresensuringthattheprocesshascontrolsthatcanbereplicatedandtested.Further,theprogram,whichshouldhighlightchangesinbusinesspracticesthatmaybenecessaryforFATCAcompliance,wouldbeintendedtoinformseniormanagementthatallareasoftheorganizationhavebeenreviewedaccordingtorequirements.

iv. How FATCA works

FATCAcompelscompliancebyimposingwithholdingobligationsthatofferasignificantfinancialincentivetostakeholderstodotheirparttocomply.Specifically,FATCAgenerallyrequiresmultinationalbusinessesandFFIstowithhold30%onpaymentsthatmeetthedefinitionofa‘withholdablepayment’whenmadetonon-compliantpayees.Theterm‘withholdablepayment’generallyreferstothegrossamountofmosttypesofUS-sourceincome,suchasinterestordividendsonUSsecurities,aswellasgrossproceedsfromthesaleorredemptionofUSsecurities.

However,theUSTreasuryandIRShavenarrowedthescopeofFATCAwithholdingtoapplytospecifictypesofentitiesidentifiedinthelegislationandtothosepersonsthataredeemedtoposeasignificantriskoftaxevasion.Asanexample,withholdingdoesnotapplytocertainpaymentsmadeintheordinarycourseofatradeorbusiness,suchasmostpaymentsforservices.ToutilizeanyFATCAexception,documentationofthecharacterandsourceofpaymentisrequired;therefore,properreportingstillwillberequireddespitethewithholdingexceptions.

v. The impact of IGAs

TomitigatecertainforeignlegalimpedimentstoFATCAcompliance,intergovernmentalagreements(IGAs)havebeennegotiatedbetweentheUSTreasuryandothergovernments.UndercertainIGAs,includingmostoftheIGAssignedasofthiswriting(withmoretobefinalized),informationwillbeexchangeddirectlybetweentheIRSandtheforeigntaxingauthority.ThisobligatesentitiesinIGAjurisdictionstoreportinformationtotheirgovernmentthatmaynothavebeenrequiredorpermittedinthepast.

AssessingFATCA’simpactwillrequireidentifyingwhetheranIGAmayapplytotheentityorpaymentstreamatissue.ProvisionsinthefinalregulationsoranyIGAthatprovidemorefavorableresultsmaybeutilized.Thislikelywillincreasethecomplexityoftheprocess,dueinparttothemultiplepathstocompliance(e.g.,regulationsoranIGA).TheregulatorshavefocusedonhavingconsistentrequirementsineachIGA,buttherearenoticeabledifferencesintheagreementssignedtodate.ForanMNC,thiswillrequireananalysisoftheapplicableFATCArulesacrossalljurisdictionsinwhichitoperates.

vi. Companies with FFIs in their groups

FATCAimposesthemostsignificantobligationsonFFIs.CompaniesengagedinnonfinancialbusinessesmaythinkthatfewornoneoftheirforeignentitiesconstituteanFFI.However,thedefinitionofanFFIisbroadandincludesmoretypesofentitiesthanonemightexpect.



Althoughtherulesprovidevariousexceptions,thefollowingaretypesofentitiesthatmaybeFFIs:

• Non-US retirement funds and foundations—Non-USretirementfundswhosegrossincomeisprimarilyattributabletoinvesting,reinvesting,ortradinginfinancialassetsandareprofessionallymanagedbyanotherentityareclassifiedasinvestmententities.However,certainretirementfundsentitledtoreceivebenefitsunderataxtreatyareexamplesofretirementfundsthatarenotFFIsunderFATCA.

• Treasury centers, holding companies, and captive finance companies—ThesetypesofentitiesarespecificallyidentifiedinthedefinitionofanFFI.Amongtheactivitiesrelevantinassessingwhetheralegalentityistreatedasan FFIare:

- cashpooling

- securitizationandfactoringactivities

- hedgingactivities(includingwhetherhedgesareenteredintowithaffiliatesorwith‘customers’)

- customerfinancingoperations

- offshorecashdeploymentandinvestmentstrategies

- in-housebankandexternalcreditor‘banking’-typeoperations.

• Special-purpose entities and banking-type subsidiaries—Althoughfrequentlyutilizedtoaccesslower-costsourcesoffundingforoperationsoracquisitions,themixofactivitiesinwhichtheseentitiesareengagedandhowincomeisderivedmaycausethemtofallwithintheFFIdefinition.

• Captive insurance companies—Generally,captiveinsurancecompaniesmaynotbedeemedFFIsforFATCApurposesbecausetheydonothaveanycashvalueorannuitycontracts.However,suchcaptivesstillshouldevaluatetheirbusinessoperationstodetermineiftheyfallwithinasanothercategoryofFFI.Theseothercategoriesmayincludedepositoryinstitutions,custodialinstitutions,investmententities,andcertainholdingcompaniesandtreasury centers.

WhenanMNCdeterminesthatithasentitieswithinitsglobalstructurethatmeettheabovedefinition,theMNCshoulddetermineifitmayqualifyforanexception.Oneoftheprimaryexceptionscoversholdingcompaniesandtreasurycentersthatarepartofagroupthatisdeterminedtobe‘nonfinancial.Thestatusof‘nonfinancial’isbasedontheratiosofactivevs.passiveincomeandassets,aswellastheincomegeneratedbytheholdingcompaniesandtreasurycenters.

IfanMNCcannotqualifyforanyexceptions,itmustproperlyregisterallofitsentitiesthatareFFIs.Toavoidthe30%withholdingtaxonUS-sourcepaymentsitreceives,eachFFImustusetheIRS’sonlineFATCAportaltoexecuteanFFIagreement,confirmitsduediligence,andreceiveanewidentificationnumber,theGlobalIntermediaryIdentificationNumberorGIIN.TheFFIswillusetheirGIINsonalldocumentationtheyprovide.



vii. Companies that make US-source cross-border payments

FATCAgenerallyapplieswhenamultinationalbusinessmakesawithholdablepayment.Fromapracticalperspective,alargerangeofpayorscanbeimpacted—justaboutanymultinationalbusinessthatmakespaymentsfallingwithinthisdefinitionwillexperiencetheimpactofFATCA.Asaresult,globalorganizationsshouldfocustheireffortsonpaymentdetailssuchas:

• whichlegalentityordepartmentisauthorizingthepayment

• whichlegalentityordepartmentismakingthepayment

• therecipientofthepayment

• documentationoftherecipient

• source(andUSfederalincometaxsourcing)ofthepayment

• thecharacterofthepayment.

Inbound insight: Accuracy of payment details is imperative when dealing with FATCA. Multinationals with outbound payments from the United States should ensure internal governance of the cross-border payments is sound and that payments are reflective of any transfer pricing arrangements in place.

viii. Expansive definition of a withholdable payment

Theterm‘withholdablepayment’generallyreferstothegrossamountofUS-sourceFDAPincome,andcanincludeothertypesofUS-sourceincomenototherwisesubjecttowithholdingunderChapter3oftheIRC.Forexample,grossproceedsfromthesaleofcertainpropertyareincludedinthedefinition.

Treasuryfunctions,accountspayabledepartments,andotherareasofaglobalorganizationmaymakemanywithholdablepayments.Thefollowingareafewcommonexamplesofthird-partyorintercompanypaymentsthatmaybeincludedinthedefinition:

• interestanddividends

• bankandcustodialfees

• advisoryandbrokerfeesassociatedwithmergerandacquisitionactivity

• insuranceorreinsurancepremiumspaidforinsuringUSrisk

• grossproceedsfromderivatives,swaps,andotherhedgingarrangements,typicallyperformedbythetreasuryfunction

CertainpaymentsmadeintheordinarycourseofbusinessarenottreatedaswithholdablepaymentsunderFATCA.However,someofthesepayments(suchaspaymentsforservices,rents,androyalties)remainsubjecttoexistinginformationreportingandwithholdingrequirements.CertainobligationsinexistenceonJuly1,2014,areconsidered‘grandfathered’andarenotsubjecttoFATCAwithholding.



ix. Obligation to identify payees and remit tax

AsacoreconceptofFATCA,payorsofawithholdablepaymentmustask,‘whoisthepayee?’and‘isitFATCAcompliant?’Governmentforms,suchastheW-8BENandW-8IMY,currentlyreliedupontodocumentpayees,arebeingmodifiedtoaccommodateFATCA.Inaddition,therecentlyreleasedregulationsthatharmonizetheFATCArequirementswiththeexistingIRCChapter3withholdingrequirementshavealteredthewayinwhichdocumentationcanbeusedandhavealsomodifiedthewayinwhichothertypesofinformationcanbeusedtofacilitateproperwithholdingandreporting.

Importantly,theFATCAregimealsorequireswithholdingagentstocommence30%FATCAwithholdingonwithholdablepaymentsbeginningonJuly1,2014(withwithholdingongrossproceedsbeginningin2017).

PayorswillneedtousethenewdocumentstoensurethattheircounterpartiesareFATCAcompliantorexemptfromwithholding.Forexample,ifthewithholdingagentreceivessufficientdocumentation,suchasaglobalintermediaryidentificationnumber(GIIN)fromanFFIoravalidFormW-8,withholdingisnotrequired(althoughreportingstillmustbecompleted).

x. Companies that are receiving US-source payments

Thoseentitieswithinagroupreceivingwithholdablepaymentsmaybesubjectto30%FATCAwithholdingiftheycannotprovideproperdocumentation.ThesemayincludeanonfinancialentitylocatedoutsidetheUnitedStates,whichmaybetreatedasanNFFEandsubjecttoFATCAwithholdingifitfailstotimelyandproperlyidentifyitselftoitswithholdingagent.

xi. The cost of noncompliance

BusinessesthatdonotadheretothenewobligationsunderFATCAmayfaceavarietyofconsequences,withpossiblelossof30%ofthevalueofspecificpaymentsbeingofforemostconcern.ConsistentwithotherUSinformationreportingregimes,apayorthatfailstodeductandremitFATCAwithholdingwhenrequiredwillbeliablefor100%oftheamountnotwithheldaswellasrelatedinterestandpenalties.

3. Filing requirements

a. Tax periodUScorporatetaxpayersaretaxedonanannualbasis.Corporatetaxpayersmaychooseataxyearthatisdifferentfromthecalendaryear.Newcorporationsmayuseashorttaxyearfortheirfirsttaxperiod,andcorporationschangingtaxyearsalsomayuseashorttaxyear.

b. Tax returnsTheUStaxsystemisbasedontheprincipleofself-assessment.Acorporatetaxpayermustfileanannualtaxreturn(generallyForm1120)bythe15thdayofthethirdmonthfollowingthecloseofitstaxyear.Ataxpayercanobtainasix-monthextensiontofileitstaxreturn,providedittimelyandproperlyfilesForm7004anddepositsthefullamountofanytaxdue.Failuretotimelyfilemayresultinpenalties.



4. Important tax return due dates for businesses

Form No. Title Purpose Due date

W-2 Wage and Tax Statement

Employers must provide employees with statements regarding total compensation and amounts withheld during year.

Must be sent to employees on or before January 31, with copies to the Social Security Administration.

1099 series Various Information returns to be provided to recipients of dividends and distributions, interest income, non-employee compensation, miscellaneous income, etc.

Must be sent on or before January 31.

1120 series, including 1120S (for S corporations)

US Corporation Income Tax Return

Income tax returns for domestic corporations or foreign corporations with US offices.

March 15 (Form 7004 may be filed to obtain an automatic six-month filing extension)

Schedule K-1 Partner’s Share of Income, Deductions, Credits, etc.

Information returns to be provided to partners by partnerships.

March 15

1065 US Return of Partnership Income

Information returns to be filed by partnerships.

April 15 (Form 7004 may be filed to obtain an automatic five-month filing extension)

State income tax returns

Various Income tax returns for states where corporation carries on trade/business.

Varies, often April 15

5. Payment of tax

Ataxpayer’staxliabilitygenerallymustbeprepaidthroughouttheyearinfourequalestimatedpaymentsandfullypaidbythedatethetaxreturnisinitiallydueforthatyear.Forcalendar-yearcorporations,thefourestimatedpaymentsareduebythe15thdaysofApril,June,September,andDecember.Forfiscal-yearcorporations,thefourestimatedpaymentsareduebythe15thdaysofthefourth,sixth,ninth,and12thmonthofthetaxyear.Generally,noextensionstopayareallowed.Failuretopaythetaxbytheduedatescanresultinestimatedtaxandlatepaymentpenaltiesandinterestcharges.

Theinstallmentpaymentsmustincludeestimatesofregularcorporateincometax,AMT,environmentaltax,and,forforeigncorporations,thetaxongrosstransportationincome.Toavoidapenalty,corporationsmustcalculatetheinstallmentpaymentsbasedonatleast25%ofthelesserof(i)thetaxshownonthe



currenttaxreturnor(ii)theprioryear’staxliability,providedthatthetaxliabilitywasapositiveamountintheprioryearandthatsuchyearconsistedof12months.However,corporationswithtaxableincomeofatleast$1million(beforeuseofNOLsorcapitallosscarryforwards)inanyofthethreeprecedingyearsmaynotcalculatetheinstallmentbasedpaymentontheprioryear’staxliability,exceptindeterminingthefirstinstallmentpayment.Instead,suchcorporationsmustcalculatetheinstallmentpaymentsbasedonthetaxshownonthecurrenttaxreturn.

Corporationswithmorethan$1billioninassetsmustmakeestimatedtaxpaymentsthatare100.25%oftheamountotherwisedueinJuly,August,orSeptemberof2014.SuchoverpaymentswillbebalancedoutinOctober,November,orDecemberof2014whenpaymentsof99.75%oftheamountotherwiseduewillbepaidbycorporationswithmorethan$1billioninassets.

6. Audit cycle

Manylargeandmid-sizebusinessesareundercontinuousauditbytheIRSandstatetaxauthorities.Theauditsmayincludetheentirelistoftaxesforwhichthebusinessisliable.Smallerbusinessandpersonswithlowerincomesgenerallyaresubjecttoauditonarandombasisofiftheirreturnsareselectedforauditbasedoncertaincriteria.

7. Audit programs (CAP)

TheIRSComplianceAssuranceProgram,orCAP,isacollaborativepre-filingprograminwhichthetaxpayerandtheIRSexaminationteamworktogethertoresolvepotentialtaxissuesbeforethetaxpayerfilesitsnexttaxreturn.Taxpayerswithassetsgreaterthan$10millionareeligibletoapplyforadmissiontoCAP.

EnteringCAPcanbearisk-mitigationstrategyfortaxpayers.ThroughparticipationinCAP,taxpayerscanminimizeoreliminatetheirtaxriskbygainingcertaintyregardingtaxpositionspriortofilingataxreturn.

Inbound insight: Inbound companies were excluded from CAP in its initial form as a pilot program. When CAP was made permanent in March 2011, the IRS opened it to applications from inbound companies, thereby expressing a willingness to work with inbounds to determine the effectiveness of CAP for such taxpayers.

The main IRS concerns regarding inbound participation in CAP included:

• The availability and accessibility of required documentation on a real-time basis: and

• Issues based on the laws of the foreign jurisdiction where the inbound company is based, such as differences between the financial accounting systems of that country and the United States (e.g., GAAP vs. IFRS) and the possible lack of US-style certified financial statements.

The IRS attempts to address these issues by requiring adjustments to the CAP Memorandum of Understanding (MOU) for inbound companies seeking to participate in CAP.



8. Statute of limitations

TheIRSgenerallyhasthreeyearsafteranoriginalreturnisfiledtoassessincometaxes.Areturnwillbedeemedtohavebeenfiledonitsduedate,evenifthereturnisactuallyfiledonanearlierdate.

9. Topics of focus for tax authorities

Currently,theIRSisfocusedon‘abusivepayments’relatedtocontributiontocapitalofacorporation,domesticmanufacturingdeduction,foreignearningsrepatriation,foreigntaxcredit‘generators,’repairsvs.capitalizationchangeinaccountingmethod,researchcreditclaims,transferofintangibles/offshorecostsharing,withholdingtaxes,andworkerclassificationasemployeeorindependentcontractor.

Inbound insight: Increased cross-border information sharing along with the OECD BEPS initiative (discussed in section IV.B below) are likely to affect audits of inbound companies in the near future, perhaps tempered by short-term IRS budget and resource issues.

10. Tax shelters

Treasuryregulationsrequiretaxpayerstodisclosetransactionsdeterminedtobeabusiveorpossiblyabusive.Currentinformationonthesetransactions,knownaslistedandreportabletransactions,isavailablefromtheIRSwebsite.

11. Accounting for income taxes

ForUSfederaltaxpurposes,thetwomostimportantcharacteristicsofataxmethodofaccountingaretimingandconsistency.Ifthemethoddoesnotaffectthetimingforincludingitemsofincomeorclaimingdeductions,itisnotanaccountingmethodandgenerallyIRSapprovalisnotneededtochangeit.Toaffecttiming,theaccountingmethodmustdeterminetheyearinwhichanincomeorexpenseitemistobereported.

Ingeneral,toestablishanaccountingmethod,themethodmustbeconsistentlyapplied.Onceanaccountingmethodhasbeenadoptedforfederaltaxpurposes,anychangemustberequestedbythetaxpayerandapprovedbytheIRS.Changesinaccountingmethodscannotbemadethroughamendingreturns.Thetwomostcommonmethodsofaccountingaretheaccrualbasisandcashbasismethods.

12. Penalties

CivilandcriminalpenaltiesmaybeimposedforfailingtofollowtheInternalRevenueCodewhenpayingUStaxes.Thecivilpenaltyprovisionsmaybedividedintofourcategories:delinquencypenalties,accuracy-relatedpenalties,informationreportingpenalties,andpreparer,promoter,andprotesterpenalties.Many,butnotall,oftheseprovisionsincludeexceptionsforreasonablecauseinnotcomplying.Inaddition,manyincluderulesastohowthepenaltiesinteractwiththeotherpenalties.




Thesefourmaincivilpenaltycategoriesmayfurtherbedivided.First,thedelinquencypenaltiesmaybedividedintofailuretofile,failuretopay,andfailuretomaketimelydepositsoftax.Failuretomaketimelydepositsoftaxappliestotaxpayersrequiredtomakeinstallmentpaymentsandwithholdingtaxpayments.

Second,thepenaltiesrelatingtotheaccuracyoftaxreturnsaredividedintothenegligencepenalty,thesubstantialunderstatementpenalty,substantialoverstatementofpensionliabilities,substantialestateorgifttaxvaluationunderestimates,andthevaluationpenalties.Thesepenaltiesalsoarecoordinatedwiththefraudpenaltytoeliminateanystackingofthepenalties.Again,likeotherprovisions,thefraudpenaltyisnotintendedtobeimposedasastackedpenalty.

Thethirdcategoryofpenaltiesistheinformationreportingpenalties.Thesepenaltiesmaybeimposedonthosewhohaveadutyonlytoreportinformationtothe IRS.

Thefourthcategoryofcivilpenaltiesconsistsofthepreparer,promoter,andprotesterpenalties.Thereturnpreparerpenaltyapplieswithrespecttoapositiononareturnforwhichthepreparerdidnothavesubstantialauthority.Alsoincludedinthiscategoryisapenaltyforwillfulorrecklessattempttounderstatethetaxliabilityofanotherperson.Inaddition,returnpreparerpenaltiesmaybeimposedforfailuretofurnishacopyofareturnorclaimforrefundtothetaxpayer,signthereturnorclaimforrefund,furnishhisorheridentifyingnumber,orfileacorrectinformation return.

Otherpromoterandprotestorpenaltiesincludeapenaltyforpromotingabusivetaxshelters,aidingandabettingtheunderstatementoftaxliability,andfilingfrivolousincometaxreturns.Acourtmayawardsanctionsandcostsifapersoninstitutesormaintainsaproceedingprimarilyfordelay,takesapositionthatisfrivolous,orunreasonablyfailstopursueavailableadministrativeremedies.

Inadditiontothesemajorcivilpenalties,thereareinternationaltax-relatedpenaltiesforfailuresotherthantimelyandaccuratefiling—e.g.,willfulfailuretoreportinternationalboycottactivity,failureofanagenttofurnishanoticeofafalseaffidavitrelatingtothewithholdingtaxondispositionsofUSrealpropertyinterests,failureofaUSpersontofurnishinformationrelatingtoCFCsandcontrolledforeignpartnerships,andfailureofaUSpersontoreportforeignbankaccounts.Pensionandemployeebenefit-relatedtaxpenaltiesareintendedtoprotectthepolicyreasonsforthetaxincentivesincluding,mostnotably,earlywithdrawalofpensionfunds.Anothergroupofspecializedpenaltiesappliestotax-exemptorganizations.

Criminalpenaltiesexistforsituationswhenthefailurestostaywithinthetaxsystemaremoreegregious.Althoughapplicabletocorporatetaxpayers,theyareappliedmorefrequentlytoindividuals.

Inadditiontothepenaltyprovisions,interestatstatutoryratesgenerallyappliestounderpaymentsoftax.



13. Elective entity classification (‘check-the-box’)

ForUSfederalincometaxpurposes,theInternalRevenueCodeandtheTreasuryregulationsprescribetheclassificationsofbusinessentitiesandorganizations.WhetheranorganizationisanentityseparatefromitsownersforUSfederalincometaxpurposesisamatteroffederaltaxlawanddoesnotdependonwhethertheorganizationisrecognizedasanentityunderlocallaw.

AbusinessentitywithtwoormoremembersisclassifiedforUSfederalincometaxpurposesaseitheracorporationorapartnership.Abusinessentitywithonlyoneownerisclassifiedasacorporationorisdisregarded.Iftheentityisdisregarded,itsactivitiesaretreatedinthesamemannerasabranch,division,orsole proprietorship.

Theinitialclassificationofabusinessentitydependsontheprescribeddefaultclassification.Thedefaultclassificationisbasedonseveralfactors,includingwhethertheentityisdomestic(organizedorincorporatedintheUnitedStates)orforeign(notorganizedorincorporatedintheUnitedStates).

Withrespecttoforeignentities,theregulationsdeemcertainentitiesas‘perse’corporations.‘Perse’corporationsmustretainthedefaultclassificationofcorporationandmaynotelectclassificationasapartnershipordisregardedentity.Anyotherforeignentitygenerallyhasthedefaultclassificationofcorporationifallownershavelimitedliability,orthedefaultclassificationofpartnership(ordisregardedentity)ifoneormoreownershasunlimitedliability.

Aneligibleforeignentitythatisnotclassifiedasa‘perse’corporationmayelectaclassificationthatdepartsfromthedefaultclassification.TheelectionissubjecttospecificproceduralrulesandismadebyfilingForm8832,Entity Classification Election,withtheIRS.

Inbound insight: The limited liability company (LLC) is a popular form of business entity organization in the US because of the limited liability for owners, as determined under state law, as well as flexibility under the ‘check-the-box regulations.’ That is, a US LLC has the default classification of either a disregarded entity or partnership (depending on the number of owners), but is eligible to make an entity classification election to change from the default classification to the classification of corporation for US income tax purposes.


ForeigncompanieswithactivityintheUnitedStatesoftenaresurprisedthatsuchactivitymaytriggerbothfederalandstate-leveltaxes.Evenmoresurprisingisthattherearenouniformrulesamongthestatesastowhetherstatetaxliabilityattaches;insomecases,significantstatetaxliabilitiesmaybeimposedeveniflittleornoUSfederaltaxobligationsexist.

Foreigncompaniesmaynothaveexperiencedealingwithtaxingauthoritieswithinacountrythathavesuchbroadtaxingpowers.

Inbound insight: Several aspects of state taxation are critical for owners of non-US companies to understand, including a state’s power to tax, income apportionment among multiple states, filing methodologies, tax base issues, treatment of foreign-source income, transfer pricing adjustment considerations, registration requirements, and indirect taxes.

A. Activities that could subject a foreign entity to state tax Astate’spowertoimposeataxisderivedfromtheUSConstitutionandmaybelimitedbytheCommerceClauseoftheConstitution,theDueProcessClauseoftheConstitution,federalstatutes,suchasPublicLaw(P.L.)86-272,andstatelaw,suchas‘doingbusiness’statutes.

UStreatiesgenerallydonotapplytostatetaxation,unlessspecificallymentionedinthetreatyorifastatevoluntarilyfollowstreatyprovisions.Aforeignentityshouldunderstandthevariousbasesforstatetaxationthatmaysubjectitsactivitiestostate taxation.

Astategenerallymayimposeitstaxonanentitytotheextentasufficient‘nexus,’ortaxableconnection,existsbetweentheentityandthestate.WhileUSfederaltaxationgenerallyrequiresathresholdlevelofactivityofbeing‘engagedinatradeorbusiness’orhavinga‘permanentestablishment,’merephysicalpresenceinastate,suchashavingemployeesorpropertyinthestate,generallymaybesufficientfornexustoexistforstatetaxationpurposes,.Thus,aforeigncompanymaynothaveapermanentestablishmentinaparticularstate,butitmayhavesufficientnexustothatstatetobecomesubjecttothatstate’staxes.

Statesalsomayassertthataforeigncorporationhasnexusthroughthein-stateactivitiesofanagentoraffiliate.Somestatesalsohaveapplied‘economic’nexusor‘factorpresence’principles.

Economicnexuscouldbedeemedtoexistbetweenastateandacompanybasedonthepresenceofintangiblepropertyinastate.Forexample,thelicenseoftrademarkstoacompanylocatedinastatecouldcreatenexusfortheout-of-statelicensoronthebasisthattheintangiblesare‘present’inthestate.A‘factorpresence’standardestablishesnexusbasedonacertainlevelofsalesactivityintoastateevenintheabsenceofphysicalpresenceinthestate.StatessuchasCalifornia,Ohio,andWashingtonhaveenactedfactorpresencestandardsforcertaintaxes.California’sfactorpresencestatute,forexample,providesthatanentityisdoingbusinesswiththestateiftheentity’sCaliforniasalesexceed$500,000.

II. State and local tax issues



OnestatutethatmayprotectinboundcompaniesisP.L.86-272,underwhichastateisprohibitedfromimposinganincometaxiftheonlybusinessactivityinthestateisthesolicitationofsalesoftangiblepersonalproperty,providedthattheordersareapprovedandshippedordeliveredfromoutsidethestate.Asthelanguageoftheprovisionindicates,theprotectionappliesonlytoincometaxandthesaleoftangiblepersonalproperty.Serviceactivitiesandothernon-tangiblepropertysalesarenot protected.

Withbroadnexusconcepts,statetaxjurisdictionsmayappeartohaveagreaterreachthanUSfederaltaxprovisionswithrespecttotaxingnon-USentities.However,thereisoneUSfederaltaxrequirementthatdoesnotapplytostatetaxation.Anon-USentitythatisneitherengagedinatradeorbusinesswithintheUnitedStatesnorhasapermanentestablishmentintheUnitedStatesstillmaybesubjecttowithholdingtaxonUS-sourceincomethatis‘fixedordeterminableannualorperiodicalincome,’suchasinterest,dividends,orroyalties.Fromastatetaxperspective,thereceiptofinterestordividendsbyitselfgenerallywillnotcreatenexus.Thereceiptofroyaltiesalsogenerallywillnotcreatenexusforstatetaxation,unlesssuchroyaltiesarederivedfromin-stateintangiblepropertythatisdeemedtocreate‘presence’inastatethathasadoptedaneconomicnexusrule.

Inbound insight: It is critical to understand that states generally do not follow US tax treaties, but rather adopt different rules on whether a state has tax jurisdiction over a company (i.e., does the company have nexus to the state). The concept of nexus to tax in a state has been evolving over a number of years and is both complex and subject to unexpected results. This is a topic that can create confusion within senior management of a non-US parent company, especially when disputes arise with states that are not anticipated due to the perceived limited activities in that state.

B. Dividing up taxable income among the states: multistate apportionmentNon-USentitiesmaybefamiliarwiththeUSfederaltaxconceptofeffectivelyconnectedincome—thatis,beingtaxedonincomethatisderivedfromaUSbusiness.However,forstatetaxpurposes,apercentageoftheentirenetincomeofanentity(orgroupofentities,asdiscussedbelow)maybesubjecttotaxbyastate.Thatpercentagegenerallyrelatestotheproportionatelevelofactivitytheentityhaswithinthestateascomparedwithitsactivityoutsidethestate.

Activitymaybemeasuredbytherelativein-statesales,property,payroll,oranycombinationofthethree.Somestatesweightsalesactivitygreaterthanpropertyandpayroll.Acurrenttrendamongstatesisamovetoasingle-salesweightedapportionmentfactor.Usingasingle-salesfactorresultsinthestateincreasingitstaxablereachamongout-of-statetaxpayersbecausetheabsenceofin-statepropertyandpayrolldoesnotservetodilutetheapportionmentpercentageassignedtothestate,aswouldbethecaseforastatethatincorporatesapropertyorpayrollfactor.



Complexitiesariseasstatesdonotuniformlyapportionincome.Forexample,theassignmentofserviceincometoaparticularstatemaybetreatedinvariousways.Somestatessourceserviceincometothelocationwheretheproviderincursthegreatercostinperformingtheservice.Otherstatesemployamarketplaceapproach,sourcingtowherethecustomerreceivesthebenefitoftheservice.

Salesoftangiblepersonalpropertygenerallyaresourcedtothestateofdestination.Oneexceptionappliestotheextentastatehasa‘throwback’rule.Underthrowback,salesaresourcedtothestateoforiginifthetaxpayerdoesnothavenexuswiththedestinationstateorcountry.

Inbound insight: The potential combination of (1) a state asserting nexus based merely on a company having a certain threshold level of sales in a state with (2) a single-sales factor apportionment regime and (3) US treaties not binding the state could result in substantial state income tax liability for an inbound company.

C. Tax filings include more than just the in-state entity: combined, water’s edge, worldwide filing methodologies, and tax havensStatesvaryintheirtreatmentofreportingincomeamongaffiliates.‘Separatecompany’statesrequireataxpayertoreportonlytheincomeofthetaxableentity.‘Unitarycombined’statesmayrequireaunitarygroupofcorporations—whichmaybedifferentfromaUSconsolidatedgroup,andwhichmayincludedifferentmembersfromstatetostate—tofileasacombinedgroupregardlessofwhetheraparticularentityhasnexuswiththestate.ThisunitarygroupcouldconsistonlyofUScorporations(a‘water’s-edge’filing)orcouldincludeallglobalentities(a‘worldwide’filing).

Generally,statesthatgivetaxpayersanoptionbetweenwater’s-edgeandworldwideprovideworldwidefilingasthedefault,likeCalifornia,andtaxpayersmustelecttofilewater’s-edgereturns.InCalifornia,awater’s-edgeelection,whichmustbemadeonatimelyfiledoriginalreturn,isan84-monthcommitment.ACaliforniawater’s-edgecombinedreportgenerallywillincludeaforeigncorporationtotheextentofitseffectivelyconnectedincome(incomederivedfromorattributabletosourceswithintheUnitedStates).NotethatCaliforniadoesnotrecognizeprovisionsofUStreaties.Thus,totheextenttreatieslimittheapplicationofeffectivelyconnectedincomeprovisionsoftheInternalRevenueCode,Californiadoesnotfollowthelimitations.Anycontrolledforeigncorporation(totheextentofitsSubpartFincomeoveritsearningsandprofits)isincludedintheCaliforniawater’s-edgecombinedreportaswell.Wisconsinhasasimilarruleregardingeffectivelyconnectedincome.

Accordingly,theriskexiststhatasingleentity’spresenceinaUSstatecouldbringtheincomeofaglobalgroupofaffiliatedentitieswithinthetaxingpowerofthat state.

Asnotedabove,compositionofthegroupmayvaryamongstates.Somestatesmayexclude‘80/20’companiesandmaydefinesuchcompaniesinvariousways


(generally,companieswith80%ormoreactivityoutsidetheUnitedStates).Otherstatesmayrequirecertaintaxpayerstobeexcludedfromareportinggroupbasedontheirbusiness.Forexample,afinancialinstitutionmaybeexcludedfromareportinggroupbecauseiteitherapportionsitsstatetaxableincomeinafashiondifferentfromitsotherrelatedaffiliatesoritissubjecttotaxonadifferenttaxbasesuchasgrossreceipts.

Adevelopmentthathasgainedimportanceinrecentyearsinvolvesstatesincluding‘taxhaven’entitieswithinareportinggroup.Statesthatwouldotherwiseimpose(orallowasataxpayerelection)awater’s-edgereturnlimitedtoUScompanieshavebeenexpandingtheirreachtoincludenon-USentitiesincorporatedordoingbusinessincertainforeignjurisdictions.

Alaska,theDistrictofColumbia,Montana,Oregon,andWestVirginiaincludesuchentitiestovaryingdegrees.TheMultistateTaxCommissionhasapprovedamodeltaxhavenstatutethatotherstatescouldadopt.Inboundcompaniesdoingbusinessinthesestatesshouldbeawarethatnon-USentitiescouldbeincludedinunitarystatereturnsbyvirtueoftheirincorporationoractivityinidentified‘taxhaven’ jurisdictions.

D. Adjustments to federal taxable incomeThestartingpointfordeterminingUSstatetaxableincomegenerallyisanentity’sfederaltaxableincome.Ifanentityhasnofederaltaxableincome,thisdoesnotmeanthatithasnostatetaxableincome.Somestatesmayrequireanaddbackofaforeigncorporation’sincomethatisexemptfromfederaltaxbytreaty.Otherstatesmayrequirefederaltaxableincometobecalculatedonaproformabasisasifatreatydidnotapply.

AnotherdiscrepancybetweenUSfederalandUSstatetaxableincomearisesduetorelated-partyexpenses.Certainexpenses,suchasroyaltiesandinterest,maybedeductibleforUSfederaltaxpurposes,butifsuchexpensesarepaidtoaforeignordomesticrelatedparty,thoseexpensesmayhavetobeaddedbacktotaxableincomeforUSstatepurposes.Whilemoststateshaveaforeigntreatyexceptiontotheaddback,theparticulartreatymustbeanalyzedbecausestatesmayconsideraUStreatythatcallsonlyforalowertaxratetobedifferentfromaUStreatythatexemptsalltheincomefromtax.

E. Treatment of foreign-source incomeWhilethetreatmentofforeign-sourceincometechnicallyisanissueforUSdomesticentities,thecomplexitiesofhowsuchincomeistreatedmaybeimportanttonon-USentitieswithfederalandstatetaxreportingobligations.

ForUSfederaltaxpurposes,domesticcorporationsreceivingdividendsfromforeignaffiliatesarenotallowedadividends-receiveddeduction(DRD)astheywouldfordividendsfromadomesticsubsidiary.Rather,theforeigndividendsareincludedintaxableincomeandthetaxpayermayreceiveacreditforforeigntaxespaid.Somestatesmayallowadeductionforalloraportionofdividendsreceivedfromaforeign entity.



USshareholdersofforeigncontrolledcorporations(CFCs)mayberequiredtoincludeaportionoftheforeignentity’sundistributedearningsintheirfederaltaxableincome.ThisdeemedincomeiscommonlyreferredtoasSubpartFincome.Forstatetaxpurposes,ifthestatestartswithfederaltaxableincome,the‘deemed’dividendwillbeincludedinthestatetaxbase.StatesdifferwithregardtotheextenttowhichtheSubpartFdeemeddividendandtheSection78dividendgross-uparesubjecttoaDRD.

Californiaemploysuniqueruleswithregardtoforeign-sourceincome.Californiarequiresthatawater’s-edgefilerincludeaportionofcertainCFCincomeandapportionmentfactors.TheportiontobeincludediscomputedusingaratiooftheCFC’sSubpartFincometoitstotalearningsandprofits(its‘inclusionratio’).Dividendspaidbetweenunitarygroupmembersareeliminatedtotheextentthedividendsarepaidfrompreviouslytaxedincome.Therealsoisa75%deductionforcertaindividendsnoteliminated(i.e.,paidfromexcludedincome).

F. States with transfer pricing adjustment powerManystateshaveIRCSection482-typepowerstoadjusttheincomeorapportionmentfactorsoftaxpayers(knowngenerallyasUDITPAsection18powers).Statesmayforcecombinedreportingoncertaintaxpayersregardlessofwhetherintercompanytransactionsareatarm’slength.Further,statesmaydisallowinterestexpensetoaforeignaffiliateundertheirSection482-typepowers,eveniftheIRShasnotadjustedthatsamepayment.Theseareconcernsfordomesticandforeigncompaniesalike,butitmaycomeasasurprisetonon-UScompaniesthatUSstateshavebroadincomeadjustmentpowersthatmirrorfederalpowers.

Inbound insight: A state may disallow deductions for certain interest or royalties paid to a related foreign entity, even though allowed by the IRS.

G. Indirect tax considerationsStateindirecttaxationgenerallyisanystatetaxthatisnotbasedonincome.Themostcommonindirecttaxisastate’ssalesandusetax,butotherindirecttaxesincludefranchisetaxes,realestatetransfertaxes,telecommunicationstaxes,commercialrenttaxes,andhoteloccupancytaxes.Theindirecttaxesthatapplydependonthenatureofthecompany’sbusinessactivities.Anon-UScompanymightbesurprisedatthenumberofindirecttaxesthatithastoconsider.

Thenexus-creatingactivitiesoutlinedinthediscussionaboveapplygenerallytostateincomeandfranchisetaxation.Anon-UScompany’sexposuretosalesandusetaxesdiffersslightlyfromthatforincomeandfranchisepurposesinthatastateisprecludedfromimposingitssalesandusetaxobligationsonanentityunlessthatentityhasaphysicalpresenceinthestate.

Conceptsofeconomicnexusoranintangiblepresencearenotrelevantforsalesandusetaxpurposes;however,statescontinuetopushtheboundsofwhata‘physical’presenceencompasses.Conceptsofcombinedandconsolidatedreporting



alsoarenotrelevantforsalestaxpurpose,aseachentityisaseparatetaxpayerforsalesandusetaxpurposes.Asaresult,stateshavebeenaggressiveinimposingagencyoraffiliatenexusasameansofbringingout-of-statecompaniesintotheirtaxing jurisdiction.

Incertainstates,arecenttrendistheestablishmentofnexusduetotheuseofaffiliatemarketersforout-of-statesellers.Affiliatemarketingisaninternet-basedmarketingpracticeunderwhichanin-statethirdpartypromotestheproductsorservicesofanout-of-statesellerbyprovidingalinkonitswebsitetothoseproductsorservicesandtheout-of-statesellercompensatesthein-statethirdpartyforsuchpromotion.Recently,somestateshaveenactedlegislationthatcreatesarebuttablepresumptionthatanout-of-statesellerengaginginaffiliatemarketingwithanin-statethirdpartyhasnexusandthereforeisrequiredtocollectsalestax.

Asdiscussedabove,oneofthenexusprotectionsforstateincomeandfranchisetaxesisP.L.86-272,butthatstatutedoesnotapplytonon-incometaxes.Accordingly,anentitywithemployeesengagedonlyinthesolicitationoftangiblepersonalpropertywithinastate,whichotherwiseisprotectedfromincometaxnexusunderP.L.86-272,stillmaybesubjecttoastate’ssalesandusetaxandothernon-income-basedtaxes(e.g.,franchisetaxesbasedonnetworth).

Onceacompanyhasnexustoastatewithrespecttosalesandusetaxes,thatcompanymustregisterwiththestate’staxdepartment,filesalestaxreturns,andpayitssalestaxliabilities.Dependingonthevolumeofsales,thecompanymayberequiredtofilereturnsonanannual,quarterly,ormonthlybasis.Generally,salestaxisimposedonretailsales,leases,rentals,barters,orexchangesoftangiblepersonalpropertyandcertainenumeratedservicesunlessspecificallyexemptedorexcludedfromtax.

Salestaxgenerallyisimposedinthejurisdictioninwhichthe‘sale’occurs.Thedefinitionof‘sale’differsfromjurisdictiontojurisdiction;however,thedefinitiongenerallyincludesboth(1)considerationand(2)transferoftitle,righttouse,orcontrol(possession)inthecaseoftangiblepropertyandcompletionoftheserviceactinthecaseofaservice.

Allretailsalesoftangiblepersonalpropertyarepresumedtobetaxablesalesunlessthecontraryisestablished.Whentangiblepersonalpropertyissold,andthepurchaserintendstoreselltheproperty,thesaleisnotaretailsale;rather,itisasaleforresale.Aresaleexemptionisallowedbecausetheintermediatesaledoesnotrepresenttheultimatesaleorfinalconsumptionsaleofthetangiblepersonalproperty.Theburdenofprovingthatasaleisnotasaleatretailisonthesellerunlessanexemptionapplies.Forexample,thecollectionofaresalecertificationfrompurchasersgenerallysupportsthepositionthatthesaleisanexemptsaleforresale.

Inbound insight: While appearing similar at first, a VAT is much different than a state sales or use tax, both with respect to incidence of taxation and items subject to tax. Further, not only states, but thousands of separate jurisdictions within states, levy sales and use taxes.



H. Local taxationCitiesthatimposetheirownincometaxmodeledaftertheirrespectivestate’scombinedunitaryreportingmethodologyincludeNewYorkCity;Portland,Oregon;andDetroit,Michigan.Anon-USentitydoingbusinessinKentuckyorOhiocouldfinditselfsubjecttodozensofindividualcityreturns,asmanycitiesinthosestatesimposeseparateincometaxfilingobligations.CompliancecomplexitiesmultiplybecauseUStaxationgeographiesarefurtherdividedwithinstatesandsomeUScitieshavesignificanttaxingpowers.

Inaddition,theseandothercitiesimposelocallevelsalesandusetaxes.Administratively,thesalestaxesusuallyarecollectedbyandremittedtothestate,andthenallocatedtothelocalities.Generally,therulesforthelocalitiesaremodeledaftertherulesforthestates,butthisisnotalwaysthecase.Therulescanvaryfromjurisdictiontojurisdiction.Overall,therearethousandsofindirecttaxingjurisdictionsintheUnitedStates.Anynon-UScompanydoingbusinessintheUnitedStatesshouldbeawareofallthevariousindirecttaxesthatmaybeimposed.

I. Credits and incentives: state and localFromaUSstateandlocaltaxperspective,therearetwomainmethodsforincentivizingbusiness:statutorycreditsanddiscretionaryincentives.

Statutorycreditstypicallyareofferedtoallqualifyingcompanieswithinajurisdictionandcan,incertaincircumstances,beclaimedretroactively.Discretionaryincentives,ontheotherhand,typicallymustbenegotiatedbetweenthetaxpayerandthestateandlocalgoverningbodiesoreconomicdevelopmentgroupspriortocommencementoftheproject.

1. Statutory credits

Stateandlocalgovernmentshavebecomemorecompetitiveinofferingtaxcreditstoattractandretaingrowingcompaniesforthepurposeofpromotingeconomicdevelopment.Todaytherearehundredsofstatutorytaxcreditsavailableasaresultofthiscompetition.

Anumberofthesecreditsmimicthefederalcreditsdiscussedabove,butusuallyapplytoactivitiesperformedonlyinagivenstateorlocaljurisdiction.Suchcreditsmayinclude:

• hiringandjobstaxcredits

• investmenttaxcredits

• alternativeandrenewableenergytaxcredits

• researchanddevelopmentcredits

• contributioncredits

• porttaxcredits.



2. Discretionary incentives

Stateandlocalgovernmentscontinuetoaddtotheincreasingcomplexarrayofeconomicincentivestoencourageprivate-sectorinvestment.

Thetypesofincentivesofferedvarysignificantlydependingonjurisdictionandindustry.Themajorityofincentivesarebased,atleastpartially,onincreasesinworkforceandcapitalinvestmentinproperty.Anumberofotherfactorssuchasthelocationoftheproject,wagesofemployees,amountandtypesofbenefitsofferedtoemployees,andtypeofinvestments,alsomaybeconsidered.

Incentivescantakemanyforms,suchas:

• propertytaxabatements

• infrastructuregrants

• traininggrants

• cashgrants

• withholdingtaxrebates

• reducedfinancing

• utilitytaxexemptions

• constructionfeewaivers.



TheUnitedStateshasinplacebilateralincometaxtreatieswithmorethan60countries.TheUSgovernmententersintosuchtreatiesforseveralreasons,including:

• tostimulateinternationaltradeandinvestment

• topromotecooperationamongcountriesinenforcingandadministeringtax laws

• topromoteinformationexchange

• toreduceoreliminatedoubletaxationandexcessivetaxation.

USincometaxtreatiestypicallycovervariouscategoriesofincome,including:

• businessprofits

• passiveincome,suchasdividends,interest,androyalties

• incomeearnedbyteachers,trainees,artists,athletes,etc.

• gainsfromthesaleofpersonalproperty

• realpropertyincome

• employmentincome

• shippingandairtransportincome

• incomenototherwiseexpresslymentioned.

Thecategoriesofincomecoveredvaryfromtreatytotreaty,andnotwotreatiesarethesame.AppendixAsummarizesthebenefits(reducedwithholdingrates)resultingfromUStaxtreaties.

Togaintreatybenefits,itisnecessarytosatisfytheconditionsoftheresidencyarticleaswellascertainotherrequirements.Ingeneral,anindividualistreatedasaresidentofthecountryinwhichtheindividualissubjecttotaxbyreasonofdomicile,residence,orcitizenship.Acorporationgenerallyistreatedasresidentinthecountryinwhichitissubjecttotaxbyreasonofitsplaceofmanagement,placeofincorporation,orsimilarcriteria.USdomesticrulescontainprovisionsthataddressthetreatmentoftheavailabilityoftreatybenefitstoincomereceivedbyfiscallytransparententities;someUStreatiesalsoaddressfiscallytransparententities.

ThevastmajorityofUStaxtreatiescontainlimitationonbenefits(LOB)articles.LOBarticlesareanti-‘treaty-shopping’provisionsthataredesignedtodenytreatybenefitswhenthepartyseekingthebenefitsdoesnothavesufficientconnectiontothejurisdictioninwhichitisresidenttosupporttheapplicationofthetreaty.Inrecentyears,USTreasuryhasmadeitaprioritytorenegotiatethemorecommonlyusedtreatiesthatdidnothaveLOBarticles.Twoofthosetreaties—theUStreatieswithHungaryandPoland—havebeenrenegotiatedbuthavenotyetbeenratified.

III. US tax treaties


LOBarticlesprovideobjectivetests(e.g.,ownership-baseerosiontest,publiclytradedcompanytest,oractivetradeorbusinesstest)todeterminewhetheranentityisappropriatelyclaimingtreatybenefitsorwascreatedmerelytoobtaintreatybenefits.Evenifobjectivetestsarenotmet,acountry’scompetentauthoritymaygranttreatybenefitsuponrequestbythetaxpayer.

TheUStaxtreatynetworkincludestreatieswithmostEuropeancountriesandothermajortradingpartners,includingMexico,Canada,Japan,China,Australia,andtheformerSovietUnioncountries.Therearemany‘gaps’intheUStaxtreatynetwork,particularlyinAfrica,Asia,theMiddleEast,andSouthAmerica.AnewtreatywithChilewassignedin2010buthasyettoberatified.

TherearecontinuedeffortstoexpandthenetworkofcountriesthathaveadequatetaxinformationexchangeagreementswiththeUnitedStates.Inadditiontoitsbilateralincometaxtreaties,theUnitedStatescurrentlyisapartytomorethan23taxinformationexchangeagreements,whichprovidethelegalbasisforexchangesofinformationbetweentaxadministrations.

Inaddition,theUSTreasuryhassignedmorethan25bilateralintergovernmentalagreements(IGAs)relatedtotheimplementationoftheFATCAinformationreportingandwithholdingtaxprovisions(discussedabove).Treasuryalsohasannouncedthat22otherjurisdictionshavereachedagreementsinsubstanceandwillbetreatedashavingIGAsineffectwiththeUS.

Inbound insight: As noted in the state and local tax discussion above, states are not restricted in their taxing powers by federal limitations such as ‘engaging in a trade or business,’ having a ‘permanent establishment,’ or treaty restrictions.

III. US tax treaties


IV. Transfer pricing

Transferpricingisatermusedtodescribeintercompanypricingarrangementsrelatingtotransactionsbetweenrelatedentities.Thesecanincludetransfersofintellectualproperty,tangiblegoods,orservices,aswellasloansorotherfinancingtransactions,whichcanoccuracrosslocal,state,orinternationalborders.Duetogrowinggovernmentdeficits,manyjurisdictionsareputtingadditionalpressureontransferpricinginordertosecureaportionofentities’profitsforthemselves.Thiscanresultintheriskofdoubletaxation,penaltiesforfailuretoproperlyallocateincomeamongtwoormorejurisdictions,ortheriskofinefficientallocationsoffunctions,assets,orrisksbetweenrelatedparties.Therefore,virtuallyalllargemultinationalsrequireconsiderationofinternationaltransferpricingstrategiesandpotentialrisks.

A. Elements of transfer pricingTransferpricingappliestoawiderangeofintercompanytransactions,includingtransactionsinvolving:

• tangiblegoods(e.g.,manufacturing,distribution)

• services(e.g.,managementservices,salessupport,ITservices)

• financing(e.g.,intercompanyloans,accountsreceivable,guarantees)

• intangibles(e.g.,royalties,costsharing,buy-inpayments,salesof intangibles).

Theinternationalstandardfordeterminingtheappropriatetransferpriceisthearm’s-lengthprinciple.Underthisprinciple,transactionsbetweentworelatedpartiesshouldnotdifferfromthosethatwouldbemadebetweenindependentcompaniesundersimilarcircumstances.ThisprincipleiscitedintheUStransferpricingrules(IRCSection482andtheTreasuryregulationsthereunder),theOECDTransferPricingGuidelines,andtheUNManualfordevelopingcountries.

Ifatransactionbetweenrelatedpartiesispriceddifferentlythanifitwerebetweenunrelatedparties,theIRSmaytreatthetransactionasthoughithadnotbeenconductedatarm’slengthandreallocateincomeandexpensesaccordingly,oralternativelyre-characterizethetransactionconsistentwiththeactualconductoftheparties.

TheSection482regulationsareextensiveandattempttoaddressafullrangeoftransactionsinlightofthearm’s-lengthstandard.Inpractice,however,itisnoteasytodeterminetheappropriatearm’s-lengthresultbasedonagivensetoffactsandcircumstances.Transactionsingoodsandservicesmayembodyunique,companyorindustry-specificelementsthataredifficulttocomparewithothercompanies.TheSection482regulationsconcedetherarityofidenticaltransactions,andinsteadattempttodeterminethearm’s-lengthresultsbasedonthe‘bestmethod’rule.



1. Best method rule

TheSection482regulationsprovideseveralmethodstotestwhetherapricemeetsthearm’s-lengthstandard.Althoughthereisnostrictpriorityofmethods,andnomethodinvariablywillbeconsideredtobemorereliablethananother,everytransactionreviewedunderSection482mustbejudgedunderthemethodthat,underthefactsandcircumstances,providesthemostreliablemeasureofanarm’s-lengthresult(the‘bestmethod’).

Theselectionofamethodalsovariesdependingonthetypeofproperty.Forexample,theregulationsprovidefivemethodsfortransactionsinvolvingtangibleproperty,whileonlythreeareavailablefortransactionsinvolvingintangibleproperty.Notethatwhileeachmethodisimportanttounderstand,anexaminationofeachisbeyondthescopeofthisdiscussion.

2. Comparability factors

Todeterminethebestmethodavailable,therelativereliabilityofamethodisbasedonthedegreeofcomparabilitybetweenthecontrolledtransactionortaxpayersandtheuncontrolledcomparables,takingintoaccountcertainfactors.Whileaspecificcomparabilityfactormaybeofparticularimportanceinapplyingamethod,eachmethodrequiresananalysisofallthefactorsthataffectcomparabilityunderthat method.

3. Quality of data and assumptions

Whetheramethodprovidesthemostreliablemeasureofanarm’s-lengthresultalsodependsuponthereliabilityoftheassumptionsandthesensitivityoftheresultstopossibledeficienciesinthedataandassumptions.

Thecompletenessandaccuracyofthedataaffecttheabilitytoidentifyandquantifythosefactorsthatwouldaffecttheresultunderanyparticularmethod.Likewise,thereliabilityoftheresultsderivedfromamethoddependsonthesoundnessofsuchassumptions.Finally,thesensitivityofresultstodeficienciesindataandassumptionsmayhaveagreatereffectonsomemethodsthanothers.Inparticular,thereliabilityofsomemethodsdependsheavilyonthesimilarityofpropertyorservicesinvolvedinthecontrolledanduncontrolledtransaction.

4. Arm’s-length range

Duetothedifficultyindeterminingapricingmethodthatproducesthemostreliablemeasureofanarm’s-lengthresult,theSection482regulationsalsoprovidethatataxpayerwillnotbesubjecttoadjustmentifamethod’sresultsfallwithinanarm’s-lengthrange.Thearm’s-lengthrangeordinarilyisdeterminedbyapplyingasinglepricingmethodselectedunderthebestmethodruletotwoormoreuncontrolledtransactionsofsimilarcomparabilityandreliability.Thecomparablesusedfortheuncontrolledtransactionsmustbesufficientlysimilartothecontrolledtransaction.Ifmaterialdifferencesexistbetweenthetwotransactions,adjustmentsmustbemadefortheuncontrolledtransactiontohaveasimilarlevelofcomparabilityand reliability.



5. Penalties and documentation

TheUStransferpricingregulationsencouragetaxpayerstomakeaseriousefforttocomplywiththearm’s-lengthstandardinsettingpricesforcontrolledtransactions;reportanarm’s-lengthresultontheirincometaxreturn;documenttheirtransferpricinganalysis;andprovidedocumentationtotheIRSuponrequest.

FailuretocomplywiththeseregulationscanresultinlargeadjustmentsandsignificantpenaltiesunderSection6662(e).Thepenaltygenerallyisequalto20%oftheunderpaymentoftaxattributabletothemisstatement,butincreasesto40%oftheunderpaymentforagrossvaluationmisstatementwhenthedeviationintheactualandcorrectpriceis400%ormore(or25%orless).Havingcontemporaneoustransferpricingdocumentationinplaceatthetimethetaxreturnisfiledcanhelpprovideprotectionagainstthesepenalties.

Anotheravenueforavoidingpotentialtransferpricingpenaltiescanbeanadvancepricingagreement(APA)—anagreementbetweenagovernmentandataxpayerthatprovidesprospective‘certainty’foradefinedtermregardingcoveredintercompanytransactions.APAscanbeunilateral(betweenthetaxpayerandtheIRS),bilateral(withtheIRSandanothertaxauthority),ormultilateral(withtheIRSandmorethanoneothertaxauthority).

Inthefuture,otherapproachesforavoidingpenaltiesforcertaincontrolledtransactionswithouttheneedfordocumentationorAPAsmaybecomeavailable.Forexample,theUnitedStatesisconsideringprovidingsafeharborsforcertaintypesofroutinetransactions,suchasdistributionfunctionsofinboundcompanies.TheUSviewonthisapproachissimilartothatoutlinedbytheOECD.However,theUnitedStatesintendstoimplementanysuchpolicyinabilateralfashionthatwouldrequirereachingaseparateagreementwitheachtreatypartner.Asaresult,itlikelywilltakesometimebeforesafeharborsbecomeacomponentofUStaxpolicy.

B. The OECD’s BEPS project

TheOECDinJuly2013publishedanActionPlanthataddressestheperceivedflawsininternationaltaxrulesthatwerediscussedintheOECD’sFebruary2013BaseErosionandProfitShifting(BEPS)report.The40-pageActionPlancontains15separateactionpointsorworkstreams,someofwhicharefurthersplitintospecificactionsoroutputs.ThePlanisfocusedonaddressingtheseissuesinacoordinated,comprehensivemanner,andwasendorsedbyG20leadersandfinanceministersattheirsummitinSt.PetersburginSeptember2013.

Inbound insight: According to the Plan, most of the actions will take one to two (or more) years to complete. However, it may take considerably longer to fully implement these changes. Meanwhile, there are indications that the BEPS project and related developments already are leading to a material shift in the behavior of tax authorities.

Governments,revenueauthorities,andbusinessesallwillhavematerialrolestoplayiftheproposedchangesaretobeimplemented.


TheActionPlancallsforfundamentalchangestothecurrentmechanismsandtheadoptionofnewconsensus-basedapproaches,includinganti-abuseprovisions,designedtopreventandcounterbaseerosionandprofitshifting.Thesegenerallyfallunderthefollowingthreeareas:

• Newinternationalstandardsmustbedesignedtoensurethecoherenceofcorporateincometaxationattheinternationallevel.

• Arealignmentoftaxationandrelevantsubstanceisneededtorestoretheintendedeffectsandbenefitsofinternationalstandards,whichmaynothavekeptpacewithchangingbusinessmodelsandtechnologicaldevelopments.

• TheactionsimplementedtocounterBEPScannotsucceedwithoutfurthertransparency,orwithoutcertaintyandpredictabilityforbusiness.

The15workstreamsinthePlanare:

• thedigitaleconomy

• hybridmismatcharrangements

• CFCregimes

• financialpayments

• harmfultaxpractices

• treatyabuse

• PEstatus

• transferpricingandintangibles

• transferpricingandrisks/capital

• transferpricingandotherhigh-risktransactions

• dataandmethodologies

• disclosureofaggressivetaxplanning

• transferpricingdocumentation

• disputeresolutionmechanisms

• amultilateralinstrument.

Inbound insight: Companies should monitor the progress of the OECD workstreams, especially with regard to the OECD’s specific focus areas. Companies proactively should perform internal risk assessments of their existing and planned structures, considering the increased focus on ‘substance’ and the potential for more transparency and public disclosure of their tax return information and allocation of profits around the world. Since many of the Plan’s changes are directed at US businesses, companies with US operations should pay particular attention to changes in the behavior of US tax authorities even before any parts of the Plan are implemented in the United States.



V. Individual tax issues

TheUnitedStatesleviestaxonitscitizensandresidentsontheirworldwideincome.NonresidentaliensaretaxedontheirUS-sourceincome.FordiscussionofhowtheUnitedStatesdeterminestheresidencestatusofanalien,seesectionV.D.Residence, below.

A. Personal income tax ratesTheAmericanTaxpayerReliefActof2012(ATRA)permanentlyextendedthe2001and2003individualtaxratesthatweresettoexpireonDecember31,2012,formosttaxpayers.ATRAaddedanewtopindividualincometaxrateof39.6%andanewtoprateof20%forcapitalgainsandqualifieddividends.

Single taxpayers—2014 (1)

Taxable income in $

Over Not over Tax on column 1 in $ Tax on excess (%)

0 9,075 0 10

9,075 36,900 907.50 15

36,900 89,350 5,081.25 25

89,350 186,350 18,193.75 28

186,350 405,100 45,353.75 33

405,100 408,750 117,541.25 35

408,750 118,188.75 39.6

Married couples filing jointly and surviving spouses—2014 (1, 2)

Taxable income in $


0 18,150 0 10

18,150 73,800 1,815.00 15

73,800 148,850 10,162.50 25

148,850 226,850 28,925.00 28

226,850 405,100 50,765.00 33

405,100 457,600 109,587.50 35

457,600 127,962.50 39.6



Married individuals filing separately—2014 (1)

Taxable income in $


0 9,075 0 10

9,075 36,900 907.50 15

36,900 74,425 5,081.25 25

74,425 113,425 14,462.50 28

113,425 202,550 25,382.50 33

202,550 228,800 54,793.75 35

228,800 63,981.25 39.6

Head of household—2014 (1, 2)

Taxable income in $


0 12,950 0 10

12,950 49.400 1,295.00 15

49,400 127,550 6,762.50 25

127,550 206,600 26,300.00 28

206,600 405,100 48,434.00 33

405,100 432,200 113,939.00 35

432,200 123,424.00

Notes

1. Themaximumfederalincometaxrateoncapitalgainsis20%forassetsheldformorethan12months(23.8%ifthenetinvestmentincometaxdiscussedbelowapplies).Thegraduatedratesoftaxapplytocapitalgainsfromassetsheldfor12monthsorless.

2. Nonresidentaliensmaynottakeadvantageofhead-of-householdstatusorjointreturnrates.However,aUScitizenorresidentwithanonresidentalienspousemaydoso.

B. Alternative minimum tax (AMT)Inlieuofthetaxcomputedusingtheaboverates,theindividualAMTmaybeimposedunderatwo-tierratestructureof26%and28%.The26%rateisappliedtothefirst$179,500($89,750formarriedindividualsfilingseparatereturns)ofataxpayer’salternativeminimumtaxableincome(AMTI)inexcessofanexemptionamount;thereafter,the28%rateisapplied.

Theexemptionamountfor2014is$82,100formarriedcouplesfilingjointlyorsurvivingspouses,$41,050formarriedindividualsfilingseparatereturns,and$52,800forsingleindividuals.IfAMTIexceeds$156,500formarriedcouplesfilingjointly($78,250formarriedindividualsfilingseparatereturnsand$117,300



forothertaxpayers),theexemptionisreducedby25%oftheexcessamount.Theexemptionandphase-outamountsareindexedannually.

TheAMTispayableonlytotheextentitexceedstheregularnettaxliability.TheforeigntaxcreditisavailablefordeterminingAMTliabilitytotheextentoftheforeigntaxontheforeign-sourceAMTI,subjecttocertainlimitations.

AMTIgenerallyiscomputedbystartingwithregulartaxableincome,addingtaxpreferencedeductions(claimedinthecomputationofregulartaxableincome),andmakingspecialadjustmentstosomeofthetaxitemsthatwereusedtocalculatetaxableincome.Forexample,thetaxpayermustaddbackallstateandlocalincometaxesdeductedincomputingregulartaxableincome.

FornonresidentalienswithanetgainfromthesaleofUSrealpropertyinterests,theAMTiscalculatedonthelesserofAMTI(beforetheexemption)orthenetgainfromthesaleoftheUSrealpropertyinterest.

C. State and local income taxesMoststates,andanumberofmunicipalauthorities,imposeincometaxesonindividualsworkingorresidingwithintheirjurisdictions.(Formoreinformation,seesectionII,Stateandlocaltaxissues,above.)

D. Residence Thedeterminationofanalienindividual’sresidencestatusismadeusingasetofrelativelyobjectivetests.Theserulesgenerallytreatthefollowingindividualsas residents:

• All lawful permanent residents for immigration purposes (i.e., ‘green card’ holders). Residentalienstatusgenerallycontinuesuntilthegreencardisformallyrelinquished.Thus,individualswhoholdgreencardsbutleavetheUnitedStatestoliveabroadindefinitelyorpermanentlygenerallywillcontinuetobeclassifiedandtaxedasresidentaliensuntilthegreencardisrelinquished.Complexrulesalsoapplytoindividualswhorelinquishedtheirgreencardsiftheyheldthegreencardinatleasteightofthe15yearspriortorelinquishment.Inlightoftheserules,professionaltaxadviceshouldbesoughtpriortoobtainingorrelinquishingagreencard.

• Individuals who meet a ‘substantial presence test.’ AnindividualmeetsthistestifpresentintheUnitedStatesforatleast31daysinthecurrentyearandatotalof183equivalentdaysduringthecurrentyearandpriortwoyears.Forthepurposesofthe183-equivalent-dayrequirement,eachdaytheindividualispresentintheUnitedStatesduringthecurrentcalendaryearcountsasafullday;eachdayintheprecedingyearcountsasone-thirdofaday;andeachdayinthesecondprecedingyearcountsasone-sixthofaday.Notethatanindividualwhocanestablisha‘closerconnection’tohisorherhomecountrystillmayqualifyasanonresident,evenifthe183-equivalent-dayrequirement


ismet.Otherexemptionsarealsoavailableforcertainstudents,teachers,ortrainees;employeesofforeigngovernmentsandinternationalorganizations;certainindividualswithmedicalproblemsthatarisewhileintheUnitedStates;andcertainMexicanandCanadianresidentswhocommutetoworkintheUnitedStates.

Specialrulesapplywhendeterminingtheportionoftheyearanindividualwillbetreatedasaresidentornonresidentinthefirstandlastyearsofresidency.

Inbound insight: Resident alien status often results in lower US tax than nonresident alien status, due to increased allowable deductions and lower tax rates for certain married taxpayers. Consequently, certain nonresident aliens may choose to elect resident alien status, if specific requirements are met. Note that with resident alien status comes enhanced reporting requirements under FATCA (discussed in detail above). Resident aliens must file Form 8938, Statement of Specified Foreign Financial Assets.

TheUnitedStateshasincometaxtreatieswithanumberofforeigncountriesforthepurposeofeliminatingdoubletaxation.IfthereisataxtreatyineffectbetweentheUnitedStatesandanindividual’shomecountry,theprovisionsofthetreatymayoverridetheUSresidentalienrules.

Undermanyofthesetreaties,anindividualclassifiedasanincometaxresidentundertheinternallawsofboththeUnitedStatesandhisorherhomecountrywhocanshowthata‘permanenthome’isavailableonlyinthehomecountrygenerallywillbeclassifiedasanonresidentalienforpurposesofUSincometaxlawunderaseriesofothertests,ifnecessary.Aformmustbefiledtoclaimnonresidentalienstatusastheresultofataxtreaty.(Formoreinformation,seesectionIII,UStaxtreaties,above,andAppendixAforasummaryoftaxtreatybenefits.)

E. Other taxes

1. Social security contributions

For2014,socialsecuritytax(old-age,survivors,anddisability)iswithheldat6.2%onthefirst$117,000ofwagespaidtoresidentandnonresidentswhoworkasemployeesintheUnitedStates.Medicarehospitalinsurancetaxesarewithheldon1.45%ofallemployeewageswithnodollarcap.

Socialsecuritytaxforresidentself-employedindividualsequals12.4%ofthefirst$117,000;Medicarehospitalinsurancetaxesequals2.9%ofallnetself-employmentincomeofresidents.NonresidentaliensarenotsubjecttosocialsecurityandMedicarehospitalinsurancetaxesonself-employmentincome.

ForwagesreceivedintaxyearsbeginningafterDecember31,2012,theemployeeportionofMedicarehospitalinsurancetaxisincreasedbyanadditional0.9%onwagesreceivedinexcessof$250,000foramarriedcouplefilingajointreturn,



$125,000foramarriedindividualfilingaseparatereturn,and$200,000forallotherindividuals(thesethresholdsarenotindexedforinflation).Similarly,fortaxyearsbeginningafter2012,theMedicareportionoftheself-employmenttaxratesisincreasedbyanadditional0.9%(i.e.,to3.8%)forself-employmentincomeinexcessofthosethresholdamounts.

SocialsecurityandMedicarehospitalinsurancetaxesarenotdeductiblewhendetermininganemployee’staxableincomeforincometaxpurposes.However,adeductionisallowedforanamountequaltoone-halfofthecombinedself-employmentsocialsecurityandMedicarehospitalinsurancetaxesthatareimposed.

NotethattheUnitedStateshasenteredintototalizationagreementswithseveralnationsforthepurposeofavoidingdoubletaxationofincomewithrespecttosocialsecuritytaxes.TheseagreementsmustbetakenintoaccountwhendeterminingwhetheranyalienissubjecttoUSsocialsecurityandMedicarehospitalinsurancetaxesorwhetheranyUScitizenorresidentalienissubjecttothesocialsecuritytaxesofaforeigncountry.(ForalistofcountrieswithwhichtheUnitedStateshastotalizationagreements,seeAppendixB.)

Beginningin2013,anew3.8%‘unearnedincomeMedicarecontribution’taxappliestothelesserof(1)thetaxpayer’snetinvestmentincomeforthetaxyearor(2)thetaxpayer’sexcessmodifiedadjustedgrossincomeoverathresholdamount(generally,$200,000;$250,000foramarriedcouplefilingajointreturn).Thetax,whichisinadditiontoregularincometaxliability,appliestoallindividualssubjecttoUStaxationotherthannonresidentaliens.Netinvestmentincomegenerallyincludesnonbusinessincomefrominterest,dividends,annuities,royalties,andrents;incomefromatradeorbusinessoftradingfinancialinstrumentsorcommodities;incomefromapassive-activitytradeorbusiness;andnetgainfromthedispositionofnonbusinessproperty.

2. Capital gains taxes

Themaximumfederalregularincometaxrateoncapitalgainsis20%forassetsheldformorethan12months(23.8%ifthenetinvestmentincometax,discussedabove,applies).Thegraduatedincometaxratesapplytocapitalgainsfromassetsheldfor12monthsorless.

3. Consumption taxes

TheUnitedStatesdoesnothaveafederal-levelconsumptiontax.

4. Net wealth/worth taxes

TheUnitedStatesdoesnothaveafederallevelnetwealth/worthtax.



5. Inheritance, estate, and gift taxes

TheUnitedStatesimposesafederalestatetaxonthefairmarketvalueofassetsthatanindividualtransfersorisdeemedtotransferatdeath.IndividualswhoareUScitizensorresidentsaresubjecttofederalestatetaxontheirworldwideassets(usuallyincludinglifeinsuranceproceeds).IndividualswhoarenonresidentaliensaresubjecttoUSfederalestatetaxononlyUS-situsassetsandotherspecialrulesmayapply.Itcanbedifficulttodeterminewhetheraparticularindividualisresidentforestatetaxpurposes.

For2014,thereisa$5.34millionper-personestate,gift,andgeneration-skippingtransfertaxexemptionamount.Thetoptaxrateis40%.

Thepurposeofthegifttaxistopreventthelifetimetransferofassetswithoutestatetaxliability.Similarly,ageneration-skippingtaxexiststopreventavoidanceoftaxbyskippinggenerationswhenmakinglargetransfersofassets.

Notethatassetsbequeathedorgiventoanindividual’sspouseareexemptfromestateandgifttaxotherwiseimposedatdeathorthetimeofthegift,providedthespouseisaUScitizen.

6. Property taxes

TheUnitedStatesdoesnothaveafederal-levelpropertytax.

7. Luxury and excise taxes

TheUnitedStatesdoesnothavefederal-levelluxurytaxes.However,thefederalandstategovernmentsimposeexcisetaxesonavarietyofgoods.Forexample,federalandstateexcisetaxesareimposedongasolineanddieselfuelusedfortransportation.Theexcisetaxesarelevieditembyitemandlackanyuniformityinrates.

F. Income determination

1. Employment income

Citizens,residentaliens,andnonresidentaliensaretaxedoncompensationearnedforworkperformedintheUnitedStates,regardlessofwhenorwherepaymentsaremade,absentatreatyorInternalRevenueCodeprovisiontothecontrary.(Citizensandresidentaliensaretaxedoncompensationearnedforworkperformedanywhereintheworld,regardlessofwhereorwhenpaymentsaremade).

Employeesgenerallyarenottaxedonreimbursementsforeitherpersonallivingexpenses(i.e.,foodandlodging)orfortravelexpenseswhilein‘travelstatus,’subjecttovariouslimitationsandsubstantiationrequirements.However,reimbursementsforsimilarexpensesofaspouseordependentaretaxable.Notethatbeingin‘travelstatus’requiresatemporaryabsencefromanindividual’s



taxhome.Assignmentsformorethanoneyearinasingleworklocationarenotconsideredtobetemporary,regardlessofallotherfactsandcircumstances.

After-taxdollarscontributedbythetaxpayertoapensionarepartiallytaxable.Thecomponentofthepensionpaymentthatrepresentsareturnoftheafter-taxcontributionamountpaidisnotsubjecttotax.

2. Equity compensation

MultipletypesofequitycompensationareusedbyUScompanies,includingstockoptionsandvariouspaymentrightsbasedonstock.Thetaxationofthesedifferentinstrumentsvaries.

Ifataxpayerreceivesanoptiontobuyorsellstockorotherpropertyaspaymentforservices,thetaxpayermayhaveincomewhentheoptionisreceived(thegrant),whentheoptionisexercised(tobuyorsellthestockorotherproperty),orwhenthentheoptionorpropertyacquiredthroughtheexerciseoftheoptionissoldorotherwisedisposedof.Thetiming,type,andamountofincomeinclusiondependonwhetherthetaxpayerreceivesanon-statutorystockoptionorastatutorystockoption.Generally,taxpayersmayhaveincomewhenanon-statutorystockoptionisreceivedandwhenitisexercised.Upongrantandexerciseofastatutorystockoption,however,taxpayersgenerallydonotincludeanyamountinincomeuntilthestockpurchasedbyexercisingtheoptionissold.

ForeignnationalswhoaregrantedstockoptionspriortothestartdateoftheirresidencyintheUnitedStatesmaybesubjecttoUSincometaxatexerciseonallorpartoftherealizedincomeatsuchtime.Inmostcases,whenaforeignnationalwhoisaresidentalienexercisesanoptiontobuyforeignstock,thespreadbetweentheoptionpriceandthefairmarketvalueofthestockatthetimeofexerciseissubjecttoUSincometax.Aportionofthespreadwillbetreatedasforeign-source(totheextentallocabletoservicesrenderedintheforeigncountry).Asaresult,eventhoughthefullspreadwillbesubjecttotaxintheUnitedStates,aforeigntaxcreditgenerallymaybeclaimedtoreduceoreliminatetheUSincometax(assumingforeigntaxispaidonthisincome).

Inasituationthatisoftenoverlooked,ifaforeignnationalreturnstohisorherhomecountryandexercisesanoptionthatwasgrantedbeforethetaxpayerstartedresidencyintheUnitedStatesbutvestedwhilethetaxpayerwasintheUnitedStates,aportionoftheincomecouldbesubjecttoUStaxationbecauseitisattributedtotheperiodduringwhichheorsheperformedservicesintheUS.

Inbound insight: Stock options or restricted stock units that are granted or become vested while an individual is working in the United States may be subject to Section 409A. Section 409A imposes various requirements on equity compensation; a violation of these requirements may result in an additional 20% tax plus an interest penalty on the value of the compensation. Foreign nationals should review these grants to see if Section 409A applies and whether any changes must be made before working in the United States.



3. Business income

Whenanindividualworksforhimselforherself,thatindividualgenerallyisdeemedtohaveself-employmentincome.Self-employmentincomeistaxedunderUSlawinamannersimilartoemploymentcompensation.However,aself-employedindividualoftenmayhavemoreabilitytodeductbusinessexpensesthananemployee.Citizensandresidentalienindividualsmay(subjecttocertainexceptions)besubjecttoincreasedsocialsecuritycontributionsintheUnitedStatesonself-employmentincomeearnedwhileresidentintheUnitedSates(seesectionV.E.1.,Socialsecuritycontributions,above).

4. Capital gains

CapitalgainsofacitizenorresidentalienareincludedinworldwideincomeandaresubjecttoUStaxation(seesectionV.E.2.,Capitalgainstaxes,above).

Nonresidentaliensaretaxedat30%,collectedbywithholdingatthesourceofthepayment,onUS-sourcenetcapitalgainsiftheyareintheUnitedStatesfor183daysormoreduringthetaxyearinwhichthegainoccurs.Theoperationofthisprovisionislimitedtosituationsinwhichanalienisnototherwisetaxedasaresidentunderthesubstantialpresencetest(seesectionV.D.,Residence,above).CapitalgainsfromUSrealpropertyinterestsaretaxableregardlessofUS presence.

5. Dividend income

DividendincomereceivedbyacitizenorresidentalienissubjecttoUStax,whetheritisfromUSorforeignsources.

Nonresidentaliens’US-sourcedividendsgenerallyaresubjecttoaflat30%taxrate(orlowertreatyrate),usuallywithheldatsource.

6. Interest income

InterestincomereceivedbyacitizenorresidentalienissubjecttoUStax,whetheritisfromUSorforeignsources.

Nonresidentaliens’US-sourceinterestisgenerallysubjecttoaflat30%taxrate(orlowertreatyrate),usuallywithheldatsource.Notethatcertain‘portfoliointerest’earnedbyanonresidentaliengenerallyisexemptfromtax.

7. Rental income

RentalincomereceivedbyacitizenorresidentalienissubjecttoUStax,whetheritisfromUSorforeignsources.

Nonresidentaliens’US-sourcerentsaregenerallysubjecttoaflat30%taxrate



(orlowertreatyrate),usuallywithheldatsource.However,anonresidentaliencanelecttoreportrealpropertyrentalincomenetofexpenses,subjecttotaxatgraduatedrates.

8. Exempt income

Certainitemsaregenerallyexemptfrompersonalincometax.Threecommontypesoftax-exemptincomeincludeinterestfrommunicipalbonds,thevalueofinheritedproperty,andpropertyreceivedasagift.

Conversely,sometypesofincomethatenjoypreferentialtaxtreatmentinanindividual’shomecountrymaynotenjoythesametaxtreatmentintheUnitedStates.Forexample,certainretirement-typeaccountsinforeignjurisdictionsaretreatedas‘look-through’entitiesforUStaxpurposes.

9. Deductions

a. Employment expenses

Employeesmaybeabletoclaimanitemizeddeductionforcertain‘ordinaryandnecessary’unreimbursedwork-relatedexpenses.Commondeductionsincludetravelexpensesandtransportationcosts(otherthancommutingtoandfromwork),businessentertainmentandgifts,computersandcellphonesifrequiredforthetaxpayer’sjobandfortheconvenienceoftheemployer,uniforms,andhomeofficeexpenses.

Thedeductionforemploymentexpensesofanemployeeissubjecttotheflooron‘miscellaneous’itemizeddeductionsequalto2%ofadjustedgrossincome.Variousotherlimitationsandstrictsubstantiationrequirementsapply.Nonresidentaliensin‘travelstatus’maydeductcommutingexpenses;however,citizensandresidentaliensgenerallymaynot,becausetheytypicallyarenotin‘travelstatus.’

b. Personal deductions

Citizensandresidentalienscandeduct,asitemizeddeductions,thefollowingcommonpersonalexpenditures:

• qualifiedresidencemortgageinterest

• moststateandlocalincometaxesandpropertytaxes

• expensesincurredinproducingincomesubjecttothemiscellaneousitemizeddeductionsfloorequalto2%ofadjustedgrossincome

• medicalexpenses,casualty,disaster,andtheftlosses,andcharitablecontributions,subjecttolimitations

• childanddependentcareexpenses.

Certainpersonalexpensesareallowedasdeductionsagainstgrossincome(so-called‘above-the-line’deductions),includingalimonyandcertainstudentloaninterest.



Nonresidentaliensmaydeduct,subjecttolimitations,casualtyandtheftlossesincurredintheUnitedStates,contributionstoUScharitableorganizations,andstateandlocalincometaxes.

Individualswhoseadjustedgrossincomeexceedsathresholdamountaresubjecttoaphase-outrulethatreducestheiritemizeddeductions.For2014,thethresholdamountsare$305,050forjointfilersandsurvivingspouses;$279,650forhead-of-householdfilers;$254,200forsinglefilers;and$152,525formarriedtaxpayersfilingseparately.

c. Interest expenses (other than qualified residence interest)

Nodeductionisallowedforpersonalinterest,suchasonacarloan.However,interestpaidoninvestmentdebtisdeductible,butonlytotheextentthatthereisnetinvestmentincome(i.e.,investmentincomenetofinvestmentexpensesotherthaninterest).Disallowedexcessinvestmentinterestexpensemaybeclaimedasadeductioninsubsequentyears,totheextentofnetinvestmentincome.

d. Standard deductions

Insteadofitemizingdeductions,citizensandresidentaliensmayclaimastandarddeduction.Thebasicstandarddeductionfor2014is$12,400formarriedcouplesfilingajointreturnorsurvivingspouses;$6,200forsingleindividualsandmarriedindividualsfilingseparatereturns;and$9,100forheadsofhouseholds.Theseamountsareadjustedannuallyforinflation.Nonresidentaliensmaynotclaimastandarddeduction.

Individuals—includingresidentaliens—whoareblindorage65oroverareentitledtoahigherstandarddeduction.For2014,suchanindividualwhoismarriedorasurvivingspousemayincreasethestandarddeductionby$1,200;ofsuchanindividualissingleoraheadofhousehold,theadditionalstandarddeductionis$1,550.Ifanindividualisbothblindandage65orover,thestandarddeductionmaybeincreasedtwice.

e. Personal allowances

Citizensandresidentaliensareallowedapersonalexemptionforthemselves,fortheirspouse(subjecttoexceptions),andforeachoftheirdependents(whomustbecitizensorresidentsoftheUnitedStates,Canada,orMexico).

Nonresidentaliensareentitledtoonlyonepersonalexemption,exceptthatthosefromCanadaorMexicoalsocanclaimapersonalexemptionfortheirspouseifthespousehadnogrossincomeforUStaxpurposesandwasnotthedependentofanothertaxpayer.Inaddition,taxpayerscanclaimexemptionsfordependentswhomeetcertaintests.ResidentsofMexico,Canada,ornationalsoftheUSmustusethesamerulesasUScitizenstodeterminewhoisadependentandforwhichdependencyexemptionscanbeclaimed.



Pursuanttotaxtreaties,certainresidentsofSouthKoreaandcertainstudentsandbusinessapprenticesfromIndiamaybeabletoclaimexemptionsfortheirspouseanddependents.

For2014,thepersonalexemptionamountis$3,950,subjecttoreductionforindividualswhoseadjustedgrossincomeexceedsathresholdamount(thesameamountasfortheitemizeddeductionphase-out,above).Thepersonalexemptionisadjustedannuallyforinflation.

f. Losses

Anindividual’scapitallossdeductionisgenerallylimitedtotheindividual’scapitalgainsplusanadditionalamountof$3,000.Individualsmaycarryoveranyunusednetcapitallosstolatertaxyears,subjecttotheannual$3,000limitonusingnetcapitallossagainstordinaryincome.

Lossesincurredbyindividualsthatareattributabletoanactivitynotengagedinforprofit(i.e.,hobbylosses)aregenerallydeductibleonlytotheextentofincomeproducedbytheactivity.

Taxpayerswithnetoperatinglosses(NOLs)maycarrytheirlossesforwardandbacktocertaintaxyears.ThegeneralNOLcarrybackperiodisthetwoyearsprecedingtheyearthelosswasincurred.IftheNOLisnotfullyusedonthecarryback,thelossmaybecarriedforwardfor20taxyearsfollowingtheyearthelosswasincurred.

G. Foreign tax relief and tax treaties

1. Foreign tax relief

Taxpayers(generallyUSpersonsandforeignpersonswitheffectivelyconnectedUStradeorbusinessincome)mayclaimacreditagainstUSfederalincometaxliabilityforcertaintaxespaidtoforeigncountriesandUSpossessions.Foreignincome,warprofits,andexcessprofitstaxesaretheonlytaxesthatareeligibleforthecredit.Taxpayersmaychoosetodeductthesetaxeswithnolimitationor,alternatively,claimacreditsubjecttolimitations.

2. Tax treaties

TheUnitedStateshastaxtreatieswithanumberofforeigncountries.Underthesetreaties,residents(notnecessarilycitizens)offoreigncountriesaretaxedatareducedrate,orareexemptfromUStaxes,oncertainitemsofincometheyreceivefromsourceswithintheUnitedStates.Thesereducedratesand



exemptionsvaryamongcountriesandspecificitemsofincome.Underthesesametreaties,residentsorcitizensoftheUSaretaxedatareducedrate,orareexemptfromforeigntaxes,oncertainitemsofincometheyreceivefromsourceswithinforeigncountries.Mostincometaxtreatiescontainwhatisknownasa‘savingclause’thatpreventsacitizenorresidentoftheUnitedStatesfromusingtheprovisionsofataxtreatytoavoidtaxationofUS-sourceincome.(Formoreinformation,seesectionIII,UStaxtreaties,above,andAppendixA.)

TheUnitedStatesalsohasenteredintototalizationagreementsforthepurposeofavoidingdoubletaxationofincomewithrespecttosocialsecuritytaxeswithvariouscountries,whicharelistedinAppendixB.(SeealsodiscussionofsocialsecuritytaxesinsectionV.E.1,above.)

H. Other tax credits and incentives

1. Child Tax Credit

Citizens,residentaliens,andnonresidentaliensmayclaimachildtaxcreditifthequalifyingdependentchildisacitizen,national,orresidentoftheUnitedStates.Ifthechildisundertheageof17attheendof2014,ataxcreditisallowedforupto$1,000perchild.Theamountofthecreditisreducedoncethetaxpayer’sincomereachescertainthresholds.Ifthetaxpayerhasoneormorequalifyingchildrenandmorethan$3,000ofearnedincome,thetaxpayermaybeentitledtoarefundofupto15%ofearnedincomethatexceeds$3,000.

2. New Markets Tax Credit

TheNewMarketsTaxCredit(NMTC),enactedbyCongressaspartoftheCommunityRenewalTaxReliefActof2000,permittedindividualandcorporatetaxpayerstoreceiveacreditagainstfederalincometaxesformaking‘qualifiedequityinvestments’inqualifiedcommunitydevelopmententities.Thecreditexpiredattheendof2013butmaybereinstatedbyCongressonaretroactivebasisbeforetheendof2014.

3. Other tax credits

Numerousothertaxcreditsexistatthefederal,state,andlocallevelstoprovideincentivesforspecifiedinvestmentsoractivities.

I. Tax administration

1. Tax period

TheUStaxyearforindividualsgenerallyisthesameasthecalendaryear,i.e.,January1throughDecember31.



2. Tax returns

Individualincometaxreturns(Form1040)aredueonthe15thdayofthefourthmonthaftertheendofthetaxyear(i.e.,April15)unlessthatdayisaSaturday,Sunday,orfederalholiday,inwhichcasethereturnisconsideredtimelyfiledonthenextbusinessday.Ataxpayerwhocannotfilebythatdeadlinemayreceiveanautomaticsix-monthextensionoftimetofileForm1040.Todoso,thetaxpayermustfileForm4868,Application for Automatic Extension of Time to File US Individual Income Tax Return,bytheduedateforfilingthereturn.Notethatfilingforanextensiondoesnotextendthetimetopaytaxes.Iftheamountdueisnotpaidbytheregularduedate,interestwillaccrueandpenaltiesmayapply.

Marriedindividualsgenerallymayfileajointreturnonlyifeachiseitheracitizenoraresident.However,ifonlyonespouseisafull-yearorpart-yearcitizenorresident,ajointreturnmaybefiledifbothspousesagreetobetaxedasfull-yearresidentsontheircombinedworldwideincome.

Generally,jointfilingwillresultinalowertaxliabilitythanseparatereturns.Thisdeterminationcanbemadewithcertaintyonlyafterathoroughreviewofthetaxpayers’factsandcircumstances.Marriednonresidentaliens(i.e.,bothspousesarenonresidentaliens)maynotfilejointreturnsandmustusethetaxtableformarriedpersonsfilingseparatereturns.Nonresidentaliensmaynotfileasheadsofhousehold.

3. Payment of tax

Iffederalincometaxisowed,paymentisdueonApril15toavoidinterestandpenaltiesfornon-payment.Theduedatesforstateincometaxesmayvary.Estimatedtaxpaymentsmayberequiredduringtheyear(seebelow).

MosttypesofUS-sourceincomepaidtoaforeignpersonaresubjecttoawithholdingtaxof30%,althoughareducedrateorexemptionmayapplyifstipulatedintheapplicabletaxtreaty.Ingeneral,apersonwhopaysUS-sourceincometoaforeignpersonmustwithholdtheproperamountoftax,reportthepaymentonForm1042-S,andfileaForm1042by15Marchoftheyearfollowingthepayment.

Incometaxgenerallymustbewithheldfromemployeecompensation.Citizens,residentaliens,andnonresidenttaxpayerswithincomenotsubjecttowithholding(e.g.,self-employmentincome,interest,dividends,orcapitalgains)generallymustmakequarterlypaymentsofestimatedtaxdueApril15,June15,September15,andJanuary15.(Statesalsomayrequireestimatedincometaxpayments.)Nonresidentalienswhodonothaveanyincomesubjecttopayrollwithholdingtaxmustmakethreeestimatedtaxpayments(ratherthanfour)dueJune15,September15,andJanuary15,with50%duewiththefirstpayment.



4. Audit cycle

AnauditisanIRSreviewofanindividual’saccountsandfinancialinformationtoensureinformationisbeingreportedcorrectlyandtoverifytheamountoftaxreportedontheindividual’staxreturnisaccurate.Anindividual’staxreturnmaybeexaminedforavarietyofreasons,andtheexaminationmaytakeplaceinseveralways.Returnsarechosenbycomputerizedscreening,byrandomsample,orbyanincomedocumentmatchingprogram.Aftertheexamination,ifanychangestotheindividual’staxareproposed,thetaxpayereithercanagreewiththechangesandpayanyadditionaltaxowed,ordisagreewiththechangesandappealthedecision.

Intheeventofadisagreement,theIRShasanappealssystem.IfataxpayerdoesnotreachanagreementwiththeIRSOfficeofAppeals,orifthetaxpayerdoesnotwanttoappealthecasetothatoffice,inmostinstancesthetaxpayermaychallengetheIRSassessmentintheUSTaxCourtwithoutpayingthecontestedadditionaltaxbeforelitigation.

Iftaxpayersoverpaytheirtax,thereisalimitedamountoftimeinwhichtofileaclaimforacreditorrefund.TaxpayerscanclaimacreditorrefundbyfilingForm1040XandmailingittotheIRSServiceCenterwheretheoriginalreturnwasfiled.Aseparateformmustbefiledforeachyearorperiodinvolved,alongwithanexplanationofeachitemofincome,deduction,orcreditonwhichtheclaimisbased.Iftheclaimisdenied,thetaxpayergenerallycanchallengethedenialinfederalcourt.

5. Statute of limitations

Generally,theIRShasthreeyearsafterareturnisdueorfiled,whicheverislater,tomaketaxassessments.Thatparticulardatealsoisreferredtoasthestatuteexpirationdate.Thestatuteoflimitationsalsowilllimitthetimetaxpayershavetofileaclaimforcreditorrefund.

J. Other issues

1. Treatment of flow-through business entities

Certainlegalentitiesare‘flow-throughentities’(e.g.,partnershipsandScorporations).Incomeaccruedbysuchentitiesisnottaxedattheentitylevel.Instead,theincome‘flowsthrough’totheownersorshareholders,whoarethentaxedontherevenues.

Note: Certaintypesofforeignentities—includingsomepensionfundsandotherinvestmentvehicles—aretreatedasforeigntrustsforUStaxpurposesandmayhavefilingrequirementsinadditiontotheUSincometaxreportingoftheunderlying income.



2. Foreign exchange issues

AlthoughtheUnitesStatesdoesnothaveforeignexchangecontrols,any‘UnitedStatesperson’whohasaforeignfinancialaccount(orasignatureauthorityoversuchaccount)duringtheyearmayberequiredtofileareportwiththeUSTreasuryDepartmentbyJune30ofthefollowingyear.Theterm‘UnitedStatesperson’includesacitizenorresidentoftheUnitedStatesorapersoninanddoingbusinessintheUnitedStates.Theformneednotbefiledifthevalueofallforeignfinancialaccountsdoesnotexceed$10,000atanytimeduringtheyear.

ScheduleB(InterestandOrdinaryDividends)ofForm1040requirestaxpayerstostatewhethertheyhadafinancialinterestin(orsignatureauthorityover)afinancialaccountlocatedinaforeigncountry,orreceivedadistributionfromorwerethegrantorofortransferortoaforeigntrust.

NotealsothenewrequirementunderFATCAforresidentalienstofileForm8938,Statement of Specified Foreign Financial Assets.(Thisformisnotlimitedtobankaccounts.)

Inaddition,ifcashequaltoorinexcessof$10,000isbroughtintoorsentoutoftheUnitedStatesatanytimeintheyear,itmustbereportedtotheUSCustoms Service.

3. Work permits

IndividualswhoplantomovetotheUnitedStatesfortemporaryassignmentsmustapplyforandobtain,fromtheUSCitizenshipandImmigrationServices(USCIS),visasthatpermitthemtoworkintheUnitedStates.Typically,thevisawillbeanon-immigrantvisa,suchasanE,H,orLvisa.Thosewhoplantoremainonanon-USpayrollandworkforarelativelyshorttimeperiodintheUnitedStates(e.g.,severalweeks)maybeabletoobtainaB-1visa(businessvisitorvisa).ThetypeofvisawilldependonthenatureoftheproposedfunctionintheUnitedStatesandtheproposeddurationofthestay.

Notethatothertypesofvisas,suchasF,M,J,andQvisas,whichgenerallyallowtheindividualtoworkintheUnitedStatesasateacherortrainee,havetheirownspecializedrulesandlimitations.



AvisathatpermitsanindividualtoworkintheUnitedStatesforseveralyearsmaytakeseveralmonthstoobtain.AstheUSCISrulesareextremelycomplex,professionaladvicefromanimmigrationattorneyshouldbesoughtwellinadvanceofanyintendedmovetotheUS.

Anon-immigrantvisaisusuallylimitedtoafixednumberofyears.Animmigrantvisaforpermanentresidence(agreencard)allowsindividualstoremainindefinitelyintheUnitedStates,eveniftheychangeemploymentorceasetowork.

Note: Adviceshouldbesoughtpriortoapplyingforpermanentresidencetomakesurethatallbenefitsandobligationsthatareinvolvedarecorrectlyunderstood.

Inbound insight: Obtaining a green card is more complex than obtaining a non-immigrant visa; the process usually takes much longer, and the tax implications of having a green card are complex.



Anemployer’scoststoprovidehealthcareforitsemployeesgenerallyaredeductibletotheemployer,andthecostoftheplanandthebenefitsprovidedgenerallyaretax-freetotheemployee.

TheAffordableCareAct(ACA)changedthehealthcarelandscapeintheUnitedStates,affectingindividuals,insurers,employers,andthefederalandstategovernments.QualifiedhealthcareplansintheUnitedStatesmustcomplywithACArequirements,suchascoveragetoage26forchildren,first-dollarcoverageforpreventivecare,andeliminationofpreexistingconditionsexclusionsandannualandlifetimemaximums.Theserequirementsareinadditiontothepre-ACArequirementsapplicabletogrouphealthplans,includingHIPAA(privacyofhealthinformation,notices,etc.),COBRA(continuationcoveragefollowingcertainqualifyingevents),andmentalhealthparity.Anexcisetaxpenaltyisimposedforfailuretosatisfytheserequirements.Otherfeesandpenaltiesalsomayapplytohealthplansunderthe ACA.

IndividualslivingintheUnitedStatesmustmaintainminimumessentialcoverageorfaceataxpenalty.Qualifyingcoverageprovidedbyanemployerwillsatisfytheminimumessentialcoveragerequirementforindividuals,aswillcoverageunderanygovernmentalprogram,suchasMedicareorMedicaid.Individualandfamilycoveragemaybepurchasedonthenewstate-basedorfederallyassistedexchanges(alsocalledthe‘marketplace’).

TheexchangesfirstbecameavailableJanuary1,2014.IndividualsmayenrollforexchangecoverageduringanannualenrollmentperiodbeginninginOctoberbeforethebeginningofthecalendaryearandcontinuingthroughMarch.Enrollmentfor2014endedonMarch31,2014.Familieswithincomebelowcertainthresholdswhodonothaveaccesstominimumaffordablecoveragefromanemployeroragovernmentalplanmayqualifyforsubsidizedcoverageontheexchanges.

TherequirementtomaintaincoverageappliestoUScitizens,permanentresidents,andforeignnationalswhoqualifyasresidentaliens.Itdoesnotapplytononresidentaliens.UScitizenslivingabroadforacalendaryear(whoseincomequalifiesforexclusionunderCodeSection911)aretreatedashavingminimumessentialcoveragefortheyear.

Employerswithatleast50full-timeequivalentemployees—determinedacrossthecontrolledgroup,andbasedon30hoursofserviceaweek,butexcludinganyhoursofserviceforwhichanemployeedoesnotreceiveUS-sourceincome—mustofferhealthcoveragetoatleast95%oftheirfull-timeemployeesorpayalargepenaltyifoneoftheirfull-timeemployeesobtainssubsidizedcoverageonanexchange.Ifthecoverageofferedbytheemployerdoesnotsatisfythe‘minimumaffordablecoverage’requirement,theemployermustpayapenaltywithrespecttoeachemployeewhoobtainssubsidizedcoverageonanexchange.Inadditiontothesepenalties,newreportinganddisclosurerequirements,taxes,andindustryfeesareimposedunderthe ACA.

VI. Health care


VII. Financing US operations

A. Debt vs. equity

1. IRS Information Document Request (IDR)

Companiesoftenfinancetheoperationsoftheirglobalbusinessthroughintercompanyloans.Indeterminingwhetherintercompanyloansaretrulydebtinnatureorwhethertheyare,infact,equitytransactions,theIRShasdevelopeda13-partInformationDocumentRequest(IDR),whichincludesarequestforfinancialdataforyearsoutsideoftheparticularauditcycle.

IftheIRSfindsthetransactiontoappearmorelikeequitythandebtinnature,theinterestdeductiontakenonacompany’staxreturnassociatedwiththe‘debt’willbedenied.Forcompaniesthathaverecentlyincreasedtheirdebtlevel,itislikelythattheIRSwillfocusevenmoreonthisissue,potentiallyauditingfutureyearswhentheintercompanydebtexponentiallyincreases.

ThefactorstheIRSwillconsider—whicharebasedonrelevantcaselaw—include whether:

• anarm’s-lengthrateofinterestwaschargedandinterestpaymentsweremade

• thedebtisevidencedbywrittendocumentssuchasnotes

• thedebthasafixedmaturitydateandscheduledpayments

• thereisanexpectationthatthedebtwillberepaidwithfreeworkingcapital

• securityisgivenfortheadvances

• theborrowerisadequatelycapitalized

• theborrowerisabletoobtainadequateoutsidefinancingfromthird-party sources.

Whilenooneparticularfactororsetoffactorsiscontrolling,caselawhasestablishedthattheobjectivefactsofataxpayer’ssituationmustindicatetheintentiontocreateanunconditionalobligationtorepaytheadvances.Althoughcourtsconsiderboththeformandtheeconomicsubstanceoftheadvance,theeconomicsubstanceisdeemedmoreimportant.Themorearelated-partyfinancingarrangementresemblesaloanthatanexternallenderwouldmaketotheborrower,themorelikelytheadvancewillbeconsidereddebt.

2. Key Tax Court decision

AUSTaxCourtopinionfrom2012inwhichthecourtupheldthetaxpayer’sdebtcharacterizationofUSintercompanydebt—whilea‘memorandumdecision’thatdoesnotserveasbindingprecedent—isimportantbecauseitindicatestheTaxCourt’scurrentapproachtodebtvs.equitydeterminations.NotethattheTaxCourtisthefederaltrial-levelcourtthathearsmostfederaltaxcases.

Inparticular,atatimewhentheIRShasbeenaggressivelychallengingtaxpayers’intercompanyfinancingarrangements,inthiscasetheTaxCourtappliedaprincipledapproachbasedontraditionaldebtvs.equityfactorsasestablishedbycaselaw.Notethatthedebtvs.equitydeterminationisbasedonataxpayer’sparticularfactsand circumstances.



TheissueinNA General Partnership & Subsidiaries v. Commissioner,T.C.Memo.2012-172,waswhetheranadvancemadebythetaxpayer’snon-USparenttoitsUSgroupconstituteddebtorequityand,therefore,whetherthetaxpayerwasentitledtointerestexpensedeductions.Thecourt,rulinginfavorofthetaxpayer,upheldthetaxpayer’streatmentoftheadvanceasdebt.

TheTaxCourtappliedatraditionaldebtvs.equityanalysis,examiningaseriesoffactorsdevelopedbycourts.BecauseappealofthecasewouldlieintheUSCourtofAppealsfortheNinthCircuit,theTaxCourtfocusedoncaselawdevelopedbythatcircuit,whichconsidersthefollowingfactorsrelevanttodeterminewhetheranadvanceisdebtorequity:

• thenamegiventothedocumentsevidencingtheindebtedness

• thepresenceofafixedmaturitydate

• thesourceofthepayments

• therighttoenforcepaymentsofprincipalandinterest

• participationinmanagement

• astatusequalorinferiortothatofregularcorporatecreditors

• theintentoftheparties

• ‘thin’oradequatecapitalization

• identityofinterestbetweencreditorandstockholder

• paymentofinterestonlyoutof‘dividend’money

• thecorporation’sabilitytoobtainloansfromoutsidelendinginstitutions.

Inbound insight: The Tax Court’s analysis reflects that courts generally look to whether the borrower has the ability to generate sufficient cash flows to service and repay the debt. Interestingly, the test is often applied by looking at operating cash flow, i.e., whether the borrower would have the ability to generate sufficient operating cash flows to service the debt without being forced to sell its assets.



3. General approach of courts

a. Source of payments

Courtsoftenconsiderthesourceofpaymentsinanalyzingwhetheraninstrumentisdebtorequity.Inparticular,ifrepaymentdependsonearningsoristocomefromarestrictedsource,equitycharacterizationmaybeindicated.

Anotherfactorcourtsfrequentlyconsideriswhethertherelevantinstrumentsaresubordinatedtocreditors.

b. Intent of the parties

Courtsfrequentlyconsiderobjectiveindicationsoftheparties’intenttodeterminewhethertheyintendedtoenterintoadebtor-creditorrelationship.IntheTaxCourtcasediscussedabove,theIRSalsoarguedthattheparties’post-transactionconductdidnotdemonstrateintenttoformagenuinedebtor-creditorrelationship.TheIRSfocusedonthedelayedinterestpayments,andtheshort-termloanfromtheforeignparenttotheborrowertofundinterestpaymentsontheloan.

Inbound insight: The IRS has challenged intercompany debt arrangements by using hindsight evidence to assert that the behavior of the parties subsequent to the arrangement’s inception reveals that the parties never truly intended to create a debtor-creditor relationship. In general, existing case law suggests that it is not appropriate to re-characterize debt as equity by using hindsight evidence based on circumstances that the parties reasonably did not anticipate at the onset.

c. Inadequate capitalization

Ingeneral,ifacorporationisthinlycapitalized,advancesmadetothecorporationaremorelikelytobecharacterizedasequity.Courtsgenerallyfocustheiranalysisofacorporation’scapitalizationonitsdebt-to-equityratio.

d. Ability to obtain outside financing

Courtshaveheldthatevidencethatapurporteddebtorcouldhaveobtainedloansfromoutsidesourcesoncomparabletermspointstowardadebtcharacterization,whereasevidencethatadebtorcouldnothaveobtainedsuchloanspointstowardanequitycharacterization.


B. Cash poolingManycorporategroupstakeadvantageofso-calledcashpoolingarrangements(eitherphysicalornotional),inwhichcreditanddebitpositionsofmultiplemembersofagroupgenerallyareconcentratedinasingleaccount(eitherphysicallyornotionally).UStaxconsequencesshouldbeconsideredwithrespecttothesecashpoolingarrangements.Specifically,ifaUSgroupmemberisaskedtojoinacashpool,variousUStaxissuesmustbeconsidered.

IftheUSmemberonlydepositsfundswith(i.e.,lendsto)thecashpool,thetaxissuesinclude:

• intercompanyinterestratesmustbeadequateandatarm’s-length(considerthesafeharborrateunderSection482)

• requirementsforannualwithholdingtaxreturnsforUS-sourceincomeofforeignpersons

• ForeignBankandFinancialAccount(FBAR)andFATCAreportingrequirements.

IftheUSmemberdrawson(i.e.,borrowsfrom)thecashpool,additionalUStaxissuesthatmustbeconsideredinclude:

• interestdeductions

• withholdingtax/conduitissues

• subpartFissuestotheextentthereareCFCdepositors.

Inbound insight: If US subsidiaries of a US group member are required to join the cash pool, these considerations apply to each US participant in the pool. Consider using a subpool to manage multiplicity of issues.



Theorganizationandoperationofthetaxfunctionvariesgreatlybetweenindustriesandhomecountriesandevenbetweenindividualbusinesses.Atitscore,thedriversofthechoicesinthisareaarebasedonthedemandsandobjectivesofthebusinessinfivekeyareas,underpinnedbyeightcriticaltaxenablers:

Key areas

• Taxaccounting

• Compliance

• Planning

• Controversy

• Advocacy

Critical tax enablers

• Organizationalstructure

• Connectivity

• Process

• Documentmanagement

• Technology/automation

• Datacollection/manipulation

• Decisionmanagement

• Stakeholdermanagementand communication

TaxdepartmentsintheUnitedStatesallocateamaterialamountofresourcestowardcomplianceandtaxaccountinginlightofthecomplexnatureofthetaxsystemsandthesignificantemphasisplacedoncomplianceandreportingrequirementsbymanagement.Thisemphasiscanbeasignificantdemandonthefocusofthetaxdepartmentandfinancefunctionasawhole,requiringamaterialbudgetallocationascomparedtothatforotherordinaryfinanceactivities.Thetaxpayermustlooktoorganizational-ortechnology-basedsolutionstoaddressthemagnitudeoftheresponsibilitiesinthisarea.

Further,duetothemanylevelsoftaxationatthefederal,state,andlocallevels,businessesintheUnitedStatesoftenneedtomanagesimultaneouslynumerousdisputesondifferingtaxissuesateachlevel,placingburdensonthecompany’sbudgetsandresources.Theremaybetaxaccountingimplicationsduetothenumberandsizeoftaxdisputesthatcanbeopenatanygiventime.

Finally,asisthecaseinanumberofcountries,thetaxaffairsofbusinessesoperatingintheUnitedStatesareunderincreasingscrutinybypublicandpoliticalinstitutionsandthemedia.Thisfocusrequiresincreasedattentiontostakeholdermanagementinthedecision-makingandrisk-managementprocessesandadditionalthoughtintotheimplicationsofthetaxpositionsofthebusinessbeyondthefinancialstatementandbalancesheetdrivers.

Inbound insight: Senior management of non-US companies often is surprised to learn the level of investment in tax compliance required in the United States. Understanding the resources and budget that will be necessary for these activities—in addition to the desired investment in planning and risk management—is critical.

VIII. Setting up a US tax department


How can PwC help?

Ascanbeseenfromthediscussionabove,thecomplexityofUStaxlawhasaprofoundeffectonforeign-ownedUSoperationsand,importantly,thereturnoninvestment.Thesecomplexities,coupledwiththecomparativelyhighUScorporateincometaxrate,provideincentivetomanageefficientlyUSbusinesseswhileensuringthateffectivetaxrateremainscompetitive.InourexperiencewithUSinboundactivities,weareseeingincreasedactivityfromthetaxauthoritiesintheareasofjurisdictiontotax,incomeshifting,inboundfinancing,repatriation,and withholding.

PwC’sUSInboundTaxpracticecomprisesanationalnetworkofcross-disciplinaryprofessionalsdedicatedtounderstandingtheuniquenuancesfacedbyforeign-basedMNCs.Weprovidetechnicalsupportandend-to-endviewofissuestoassistMNCsinformulatingtheirUSinboundpolicies.Wehaveidentified,developed,implemented,anddocumentedawidevarietyofstrategiestohelpforeignMNCsmeettheirbusinessneedswhilemaintainingacompetitiveeffectivetaxrate.

Inthecurrentchallengingeconomicenvironment,wecanworktogetheron:

• Acquisitions and dispositions:EvaluatetheUStaximplicationsofUSinboundacquisitionsanddispositionsdesignedtoimplementkeyinitiatives

• Business and tax alignment:Aligncross-borderbusinessandtaxobjectives

• Compliance:AddresscompliancerequirementswithrespecttoUSfederalandstatetaxlaws,particularlytargetedareassuchastransferpricingand FACTA

• US income tax treaties and competent authority:DeterminetheapplicabilityanddesirabilityofobtainingthebenefitsofUStaxtreatiesinthecontextofcross-borderfinancingandinvestment,aswellasinternationalmergers,acquisitions,anddispositions

• US tax benefits:Considerfederalandstatetaxbenefits,includingcreditsandincentivesavailabletoUSinboundcompanies

• Legislative and regulatory services: Monitorreal-timedevelopmentsonfast-movingUSfederalandstatelegislativeandregulatorydevelopmentsandtheirimpactonbusinessplanning

• Audit support: RespondtoIRSandstaterevenueagencychallenges,includingpropercharacterizationofUSinboundfinancingsasdebtversus equity.

Ourapproachisdesignedtoidentifytaxopportunitiesandhelpmanageefficientlyadversetaxoutcomes,sothattheUSbusinessofaforeignMNCplaysitspartinimplementingagloballyeffectiveandintegratedapproachtotaxplanningforthegroupandsothatdesiredtaxoutcomesareintegratedseamlesslyintobusinessobjectivesandoperations.


Appendix A Summary of US tax treaty benefits

UnderUSdomestictaxlaws,aforeignpersongenerallyissubjectto30%UStaxonitsUS-sourceincome.USpersonsmakingpayments(‘withholdingagents’)toforeignpersonsgenerallymustwithhold30%ofpayments,suchasdividendsandroyalties,madetoforeignpersons.Inothersituations,withholdingagentsmayapplyreducedratesorbeexemptedfromwithholdingtaxatsourcewhenthereisataxtreatybetweentheforeignperson’scountryofresidenceandtheUnitedStates.

TheUnitedStateshasenteredintovariousincometaxtreatieswithcountriesinordertoavoiddoubletaxationofthesameincomeandtopreventtaxevasion.Thetablebelow,fromIRSPublication901(April2013),summarizesthebenefitsresultingfromthesetreaties.

Recipient Dividends paid by US

corporations in general

(%) (1)

Dividends qualifying for direct

dividend rate (%) (1, 2)

Interest paid by US obligors in general (%)

Royalties* (%)

Non-treaty 30 30 30 30/30/30

Treaty rates:

Australia (3) 15 (23) 5 (23, 24) 10 (5, 21) 5/5/5

Austria (3) 15 (9) 5 (9) 0 (19) 0/10/0

Bangladesh (3) 15 (22) 15 (22) 10 (11, 19) 10/10/10

Barbados (3) 15 (9) 5 (9) 5 5/5/5

Belgium (3) 15 (27, 28) 5 (24, 27, 28) 0 (19) 0/0/0

Bulgaria (3) 10 (27, 28) 5 (27, 28) 5 (19, 21, 27) 5/5/5

Canada (3) 15 (22) 5 (22) 0 (19) 0/10/0

China, People's Republic of (3)

10 10 10 10/10/10

Commonwealth of Independent States (CIS) (8)

30 30 0 (7) 0/0/0

Cyprus (3) 15 5 10 0/0/0

Czech Republic (3) 15 (9) 5 (9) 0 10/0/0

Denmark (3) 15 (27, 28) 5 (24, 27, 28) 0 (20) 0/0/0

Egypt 15 (4) 5 (4) 15 (4) 30/0/15 (3)

Estonia (3) 15 (9) 5 (9) 10 (20) 10/10/10

Finland (3) 15 (27, 28) 5 (24, 27, 28) 0 (20) 0/0/0

France (3) 15 (22) 5 (22, 24) 0 0/0/0

Germany (3) 15 (27, 28) 5 (24, 27, 28) 0 (19) 0/0/0

Greece (4) 30 30 0 0/30/0




(%) (1)




Royalties* (%)

(Continued)

Hungary (3) 15 5 0 0/0/0

Iceland (3) 15 (15, 22) 5 (15, 22) 0 (20) 5/5/0

India (3) 25 (9) 15 (9) 15 (12) 15/15/15

Indonesia (3) 15 10 10 10/10/10

Ireland (3) 15 (22) 5 (22) 0 0/0/0

Israel (3) 25 (9) 12.5 (9) 17.5 (12, 17) 15/10/10

Italy (3) 15 (22) 5 (22) 10 (23) 8/8/0

Jamaica (3) 15 10 12.5 10/10/10

Japan (3, 25) 10 (27, 28) 5 (27, 28) 10 (26, 27) 0/0/0

Kazakhstan (3) 15 (16) 5 (16) 10 10/10/10

Korea, South (3) 15 10 12 15/10/10

Latvia (3) 15 (9) 5 (9) 10 (20) 10/10/10

Lithuania (3) 15 (9) 5 (9) 10 (20) 10/10/10

Luxembourg (3) 15 (29) 5 (9) 0 (4) 0/0/0

Malta (3) 15 (27, 28) 5 (27, 28) 10 (19) 10/10/10

Mexico (3) 10 (22) 5 (22, 24) 15 (18) 10/10/10

Morocco 15 (3) 10 (3) 15 (3) 10/10/10

Netherlands (3) 15 (24) 5 0 0/0/0

New Zealand (3) 15 5 (22, 24) 10 5/5/5

Norway (3) 15 15 10 0/0/0

Pakistan (4) 30 15 30 0/30/0

Philippines (3) 25 20 15 15/15/15

Poland (3) 15 5 0 10/10/10

Portugal (3) 15 (9) 5 (9) 10 10/10/10

Romania (3) 10 10 10 15/10/10

Russia (3) 10 (16) 5 (16) 0 0/0/0

Slovak Republic (3) 15 (9) 5 (9) 0 10/0/0

Slovenia (3) 15 (22) 5 (22) 5 5/5/5

South Africa (3) 15 (9) 5 (9) 0 (19) 0/0/0

Spain (3) 15 (9) 10 (9) 10 10/8/5 (10)

Appendix A: Summary of US tax treaty benefits





(%) (1)




Royalties* (%)

(Continued)

Sri Lanka (3) 15 (30) 15 (30) 10 (19) 10/10/10

Sweden (3) 15 (27, 28) 5 (24, 27, 28) 0 0/0/0

Switzerland (3) 15 (9) 5 (9) 0 (19) 0/30/0

Thailand (3) 15 (9) 10 (9) 15 (12) 15/5/5

Trinidad & Tobago (3)

30 30 30 15/30/0 (14)

Tunisia (3) 20 (9) 14 (9) 15 15/15/15

Turkey (3) 20 (9) 15 (9) 15 (6, 12) 10/10/10

Ukraine (3) 15 (16) 5 (16) 0 10/10/10

United Kingdom (3, 25)

15 (22) 5 (22, 24) 0 (20) 0/0/0

Venezuela (3) 15 (22) 5 (22) 10 (20, 21) 10/10/10

Notes

*Pleasenotethetaxratesandassociatedfootnotesappearinginthe‘Royalties’columninthetableaddressthreetypesofroyalties,asdenotedinthemostrecentIRSpublication:industrialroyalties,motionpictureandtelevisioncopyrightroyalties,and‘other’copyrightroyalties.Theslashes‘/’betweeneachfigureandassociatedfootnote(s)aremeanttodemarcatethesethreetypesofroyalties,respectively.

1. NoUStaxisimposedonadividendpaidbyaUScorporationthatreceivedatleast80%ofitsgrossincomefromanactiveforeignbusinessforthethree-yearperiodbeforethedividendis declared.

2. Thereducedrateappliestodividendspaidbyasubsidiarytoaforeignparentcorporationthathastherequiredpercentageofstockownership.Insomecases,theincomeofthesubsidiarymustmeetcertainrequirements(e.g.,acertainpercentageofitstotalincomemustconsistofincomeotherthandividendsandinterest).ForItaly,thereducedrateis10%iftheforeigncorporationowns10%to50%ofthevotingstock(fora12-monthperiod)ofthecompanypayingthedividends.ForJapan,dividendsreceivedfromamorethan50%ownedcorporatesubsidiaryareexemptifcertainconditionsaremet.

3. TheexemptionorreductioninratedoesnotapplyiftherecipienthasaPEintheUnitedStatesandthepropertygivingrisetotheincomeiseffectivelyconnectedwiththisPE.Undercertaintreaties,theexemptionorreductioninratealsodoesnotapplyifthepropertyproducingtheincomeiseffectivelyconnectedwithafixedbaseintheUnitedStatesfromwhichtherecipientperformsindependentpersonalservices.Evenwiththetreaty,iftheincomeisnoteffectivelyconnectedwithatradeorbusinessintheUnitedStatesbytherecipient,therecipientwillbeconsideredasnothavingaPEintheUnitedStatesunderIRCSection894(b).


4. TheexemptionorreductioninratedoesnotapplyiftherecipientisengagedinatradeorbusinessintheUnitedStatesthroughaPEthatisintheUnitedStates.However,iftheincomeisnoteffectivelyconnectedwithatradeorbusinessintheUnitedStatesbytherecipient,therecipientwillbeconsideredasnothavingaPEintheUnitedStatestoapplythereducedtreatyratetothatitemofincome.

5. Interestdeterminedwithreferencetotheprofitsoftheissueroroneofitsassociatedenterprisesistaxedat15%.

6. Contingentinterestthatdoesnotqualifyasportfoliointerestistreatedasadividendandissubjecttotheratesunderthosecolumns,asappropriate.

7. Theexemptionappliesonlytointerestoncredits,loans,andotherindebtednessconnectedwiththefinancingoftradebetweentheUSandtheCISmember.Itdoesnotincludeinterestfromtheconductofageneralbankingbusiness.

8. ThetaxratesintheUStreatywiththeformerUSSRstillapplytothefollowingcountries:Armenia,Azerbaijan,Belarus,Georgia,Kyrgyzstan,Moldova,Tajikistan,Turkmenistan,and Uzbekistan.

9. Therateincolumn2appliestodividendspaidbyaRICorarealestateinvestmenttrust(REIT).However,thatrateappliestodividendspaidbyaREITonlyifthebeneficialownerofthedividendsisanindividualholdinglessthana10%interest(25%inthecaseofPortugal,Spain,andTunisia)intheREIT.

10. Therateis8%forcopyrightsofscientificwork.

11. Therateis5%forinterest(i)beneficiallyownedbyabankorotherfinancialinstitution(includinganinsurancecompany)or(ii)paidduetoasaleoncreditofanyindustrial,commercial,orscientificequipment,orofanymerchandisetoanenterprise.

12. Therateis10%iftheinterestispaidonaloangrantedbyabankorsimilarfinancialinstitution.ForThailand,the10%ratealsoappliestointerestfromanarm’s-lengthsaleoncreditofequipment,merchandise,orservices.

13. Thisistherateforroyaltiesfortheuseof,ortherighttouse,industrial,commercial,andscientificequipment.Therateforroyaltiesforinformationconcerningindustrial,commercial,andscientificknow-howissubjecttotherateincolumn5(‘otherroyalties’).

14. Therateis15%forcopyrightsofscientificwork.

15. Amountspaidtoapensionfundoremployeebenefitorganizationthatarenotderivedfromthecarryingonofabusiness,directlyorindirectly,bythefundororganizationareexempt.

16. Therateincolumn2appliestodividendspaidbyaRIC.DividendspaidbyaREITaresubjecttoa30%rate.

17. Anelectioncanbemadetotreatthisinterestincomeasifitwereindustrialandcommercialprofitstaxableunderarticle8ofthistreaty.

18. Therateis4.9%forinterestderivedfrom(i)loansgrantedbybanksandinsurancecompaniesand(ii)bondsorsecuritiesthatareregularlyandsubstantiallytradedonarecognizedsecuritiesmarket.Therateis10%forinterestnotdescribedintheprecedingsentenceandpaid(i)bybanksor(ii)bythebuyerofmachineryandequipmenttothesellerduetoasaleon credit.




19. Therateis15%(10%forBulgaria;30%forGermanyandSwitzerland)forcontingentinterestthatdoesnotqualifyasportfoliointerest.

20. Therateis15%forinterestdeterminedwithreferenceto(i)receipts,sales,income,profits,orothercashflowofthedebtororarelatedperson,(ii)anychangeinthevalueofanypropertyofthedebtororarelatedperson,or(iii)anydividend,partnershipdistribution,orsimilarpaymentmadebythedebtortoarelatedperson.

21. Interestreceivedbyafinancialinstitutionistaxexempt.ForVenezuela,therateis4.95%iftheinterestisbeneficiallyownedbyafinancialinstitution(includinganinsurancecompany).

22. Therateincolumn2appliestodividendspaidbyaRICorREIT.However,thatrateappliestodividendspaidbyaREITonlyifthebeneficialownerofthedividendsis(i)anindividual(orpensionfund,inthecaseofFranceorNewZealand)holdingnotmorethana10%interestintheREIT,(ii)apersonholdingnotmorethan5%ofanyclassoftheREIT’sstockandthedividendsarepaidonstockthatispubliclytraded,or(iii)apersonholdingnotmorethana10%interestintheREITandtheREITisdiversified.

23. Interestpaidoraccruedonthesaleofgoods,merchandise,orservicesbetweenenterprisesisexempt.Interestpaidoraccruedonthesaleoncreditofindustrial,commercial,orscientificequipmentisexempt.

24. Dividendsreceivedfroman80%-ownedcorporatesubsidiaryareexemptifcertainconditionsaremet.

25. Exemptiondoesnotapplytoamountpaidunder,oraspartof,aconduitarrangement.

26. Interestisexemptif(i)paidtocertainfinancialinstitutions,or(ii)paidonindebtednessfromthesaleoncreditofequipmentormerchandise.

27. Amountspaidtoapensionfundthatarenotderivedfromthecarryingonofabusiness,directlyorindirectly,bythefundareexempt.ThisincludesamountspaidbyaREITonlyiftheconditionsinfootnote31aremet.ForSweden,tobeentitledtotheexemption,thepensionfundmustnotsellormakeacontracttoselltheholdingfromwhichthedividendisderivedwithintwomonthsofthedatethepensionfundacquiredtheholding.

28. Therateincolumn2appliestodividendspaidbyaRICorREIT.However,thatrateappliestodividendspaidbyaREITonlyifthebeneficialownerofthedividendsis(i)anindividualorapensionfundholdingnotmorethana10%interestintheREIT,(ii)apersonholdingnotmorethan5%ofanyclassoftheREIT’sstockandthedividendsarepaidonstockthatispubliclytraded,or(iii)apersonholdingnotmorethana10%interestintheREITandtheREITisdiversified.DividendspaidtoapensionfundfromaRIC,oraREITthatmeetstheaboveconditions,areexempt.ForSweden,thepensionfundmustalsosatisfytherequirementsinfootnote30.

29. TheexemptiondoesnotapplyiftherecipientofthegainisanindividualwhoispresentintheUnitedStatesformorethan119daysduringtheyear.

30. TherateappliestodividendspaidbyaREITonlyifthebeneficialownerofthedividendsis(i)anindividualholdinglessthana10%interestintheREIT,(ii)apersonholdingnotmorethan5%ofanyclassoftheREIT’sstockandthedividendsarepaidonstockthatispubliclytraded,or(iii)apersonholdingnotmorethana10%interestintheREITandtheREITisdiversified.or(iii)apersonholdingnotmorethana10%interestintheREITandtheREITisdiversified.


Appendix B List of countries with which the United States has entered into social security totalization agreementsAustralia France Norway

Austria Germany Poland

Belgium Greece Portugal

Canada Ireland SouthKorea

Chile Italy Spain

CzechRepublic Japan Sweden

Denmark Luxembourg Switzerland

Finland Netherlands UnitedKingdom

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