A flood of enacted and proposed legislation and regulations is making the international tax arena one of particular interest to CPAs and their clients.
The Obama administration's proposed $3.8 trillion budget for 2011 includes changes to the international tax reform regime, which, if enacted, would have significant implications for multinational companies.
The budget includes proposals to defer the deduction of interest expense related to deferred income; foreign tax credit reforms; elimination of the proposal to repeal the check-the-box rules; and a proposal to tax excessive returns associated with offshore transfers of intangibles. The foreign tax credit proposals would pool consolidated earnings and profits of all foreign subsidiaries, and would prevent splitting of foreign income and foreign taxes.
"When you look at [the proposals], the interest expense deferral is what concerns them the most," said Rodney Lawrence, principal-in-charge of KPMG's international corporate services practice. That proposal would defer the deduction of interest expense that is properly allocated and apportioned to a taxpayer's foreign-source income that is not currently subject to U.S. tax. "If you borrow and incur interest expense at the U.S. level, you get a deduction," he explained. "Likewise, if a U.S. corporation borrows to buy a foreign subsidiary, the interest expense is deductible in the U.S. even if it leaves the earnings of the foreign subsidiary offshore and never brings the profits back. The administration proposal would allow the deduction if and when you bring the foreign subsidiary earnings back into the U.S. tax base."
IN THE IRS'S CROSSHAIRS
Not only multinationals, but small, privately held companies are now a key target for the IRS, observed David Gannaway, director in the Litigation and Corporate Financial Advisory Services Group at New York-based Marks Paneth & Shron.
"Companies out there engaged in international transactions need to realize these issues are on the radar screen," he said. "They should take the extra time and review positions taken on the tax return to make sure they are sustainable. Authorities are looking for unusual international transactions, parking inventory overseas, moving or leaving funds offshore for periods of time, recording items as sold when not, transfer pricing that takes advantage of tax havens - in short, schemes that businesses create through layering foreign companies that reduce taxes will be scrutinized."
FACTA AND HIRE
FATCA, the Foreign Account Tax Compliance Act of 2009, recently passed as part of the HIRE jobs creation legislation, will result in the most comprehensive gathering of U.S. taxpayer foreign financial holdings ever, according to Kevin Packman, a partner in the Miami office of Holland & Knight.
The bill would require foreign financial institutions to provide the name and tax identification number and account balances of U.S. account holders to the IRS, noted Remy Farag, international tax analyst at the Tax & Accounting business of Thomson Reuters. "Institutions that do not comply are subject to 30 percent withholding."
"The bill would impose substantial burdens on every foreign financial institution that does any kind of banking-related activities in the U.S., especially midsized institutions," he said. "They would have to certify that clients that maintain accounts outside the U.S. are not U.S. citizens. The administrative costs will be tremendous."
"It's going to be very complicated for foreign banks to implement," noted Robert Culbertson, a partner in the Washington office of Paul Hastings. "For example, a German bank with 400 branches in Germany has to put steps in place to ensure that when a German dentist opens an account, he's not an American. That's unfortunate but unavoidable."
Washington-based tax attorney Martin B. Tittle said that the FATCA provisions will make it "more difficult for tax dodgers to conceal assets and income in foreign banks."
One reason he says "more difficult" instead of "impossible" is that, "with respect to the new withholding provisions [HIRE Sec. 5011], there will be a temptation for people intent on hiding money overseas to look for 'bank sandwiches' as a method of avoiding disclosure while, at the same time, receiving returns based on U.S. assets." The "bank sandwich" would involve transferring and investing funds through a series of overseas banks to mask the origin of the money.
MORE INTERNATIONAL EXAMINERS
The administration proposal to add as many as 1,500 international examiners will clearly beef up the IRS's ability to conduct international audits, according to Charles Edge, director of transfer pricing at Atlanta-based Bennett Thrasher: "Anybody with any international transaction is being asked to provide a copy of their internal transfer-pricing study. You're not required to, but if you don't have a study, then it's more likely that an adjustment will be proposed. Having the study protects you from that and reduces the likelihood of an adjustment being made, providing pricing falls within the guidelines in the regs."
Transfer pricing looks at transactions that occur between related parties in a controlled group, said Liz Sweigart and Rob Jennings, partners at Houston-based Calvetti, Ferguson & Wagner. "Fully 80 percent of global trade now happens between affiliated parties," noted Jennings.
"For example, if a company based in the U.S. markets sneakers that are manufactured by a related party in Singapore, the question is, what price should the U.S. company be paying to related Singapore entities for the sneakers?" explained Sweigart. "Transfer pricing is a way in which related parties can manipulate profit left behind in jurisdictions where subsidiaries are located, so the transfer-pricing provisions aim to make sure that related parties operate at arm's length, as if they were unrelated."
Foreign tax credit reform is among the budget proposals that concern tax departments. According to the administration, current law permits inappropriate separation of creditable foreign taxes from the associated foreign income in certain cases. In general, the proposal would adopt a matching rule to prevent the separation of creditable foreign taxes from the associated foreign income.
"Tax departments need to have a clear understanding of their foreign tax credit position, so if there are significant changes as a result of the proposals, they can respond proactively," said Jonathan Lysenko, director of international tax at the New York office of Amper, Politziner & Mattia. "If it will be more expensive to bring cash back from overseas as a result of changes in the future, they should be ready to bring it back before the changes go into effect."
A Tax Court case decided in March presents a planning opportunity for foreign companies with U.S. subsidiaries, according to Harold Pskowski, managing editor for international publications at BNA Tax and Accounting.
"In the Container Corp. case, a U.S. subsidiary borrowed money and paid its Mexican parent a fee for guaranteeing the loan," he said. "The IRS position has always been that the payment from the U.S. subsidiary to the foreign parent in exchange for the guarantee reduces U.S. income but is U.S.-source income to the foreign parent, which is subject to withholding. If the parent and the subsidiary are in the same tax bracket it's a wash. Here the Tax Court said the payment was foreign-source income, which was not subject to withholding. For foreign multinationals, this could be a good decision where the payments aren't otherwise covered by a treaty."
