Tag: Tax

Currency Conversion Concerns: New York Issues Guidance on Virtual Currencies

Mcdermott Will Emery Law Firm

On December 5, 2014, the New York Department of Taxation and Finance (Department) released TSB-M-14(5)C, (7)I, (17)S.  This (relatively short) bulletin sets forth the treatment of convertible virtual currency for sales, corporation and personal income tax purposes.  The bulletin follows on a notice released by the Internal Revenue Service (IRS) in March of this year, Notice 2014-21.

The IRS Notice indicates that, for federal tax purposes, the IRS will treat virtual currency as property, and will not treat it as currency for purposes of foreign currency gains or losses.  Taxpayers must convert virtual currency into U.S. dollars when determining whether there has been a gain or loss on transactions involving the currency.  When receiving virtual currency as payment, either for goods and services or as compensation, the virtual currency is converted into U.S. dollars (based on the fair market value of the virtual currency at the time of receipt) to determine the value of the payment.

The IRS Notice only relates to “convertible virtual currency.”  Virtual currency is defined as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.”  Convertible virtual currency is virtual currency that “has an equivalent value in real currency, or that acts as a substitute for real currency.”

The Department’s bulletin also addresses only convertible virtual currency, and uses a definition identical to the IRS definition.  The Department indicates that it will follow the federal treatment of virtual currency for purposes of the corporation tax and personal income tax.

For sales and use tax purposes, the bulletin states that convertible virtual currency is intangible property and therefore not subject to tax.  Thus, the transfer of virtual currency itself is not subject to tax.  However, the exchange of virtual currency for products and services will be treated as a barter transaction, and the amount of tax due is calculated based on the fair market value of the virtual currency at the time of the exchange.

The Department should be applauded for issuing guidance on virtual currency.  It appears that these types of currencies will be used more and more in the future, and may present difficult tax issues.

However, the Department’s guidance is incomplete.  There are a couple of unanswered questions that taxpayers will still need to ponder.

First, the definition of convertible virtual currency is somewhat broad and unclear.  The Department and the IRS define “convertible” virtual currency as currency that has an “equivalent” value in real currency, but equivalent is not defined in either the IRS Notice or the bulletin.  Many digital products and services use virtual currency or points that cannot be legally exchanged for currency to reward users, and the IRS and the Department should be clearer about the tax treatment of those currencies.

Second, although the Department will follow the federal treatment for characterization and income recognition purposes, the bulletin does not discuss apportionment.  This is likely a very small issue at this point in time, but the Department will, some day, need to address how receipts from gains in the exchange of virtual convertible currencies are apportioned.

Virtual currencies will create issues not only in the tax world, but also in the unclaimed property world.  The Uniform Law Commission has begun its efforts to rewrite the Uniform Unclaimed Property Act, and the treatment of virtual currency will be an issue discussed during the rewrite.  Companies that use virtual currencies, convertible or not, should follow the rewriting process to make sure the drafters are informed of all of the issues these companies will face.

ARTICLE BY

Mark Yopp
OF
McDermott Will & Emery

Senate Approves Energy Tax Extenders

Mcdermott Will Emery Law Firm

On Tuesday, December 16, 2014, the U.S. Senate passed the tax extenders bill by a vote of 76-16, extending a number of energy tax incentives through the end of the year.  The Senate’s passage of H.R. 5771 followed the U.S. House of Representatives’ (House) approval earlier this month (see our post on December 8), and the bill is expected to be signed into law by President Obama as early as this week.

The $42 billion bill includes extensions through the end of the year of nearly $10 billion in energy tax incentives, including the New Market Tax Credit in Section 45D, the Production Tax Credit in Section 45 (the PTC), and the bonus depreciation rules in Section 168(k).

Many were disappointed that some of the tax incentives – including the PTC – were extended retroactively only through the end of the year, meaning that tax payers have just a few weeks left to take advantage of them. There would have been far more certainty for companies looking to invest in renewable energy projects if the tax incentives were extended for one or more years beyond the end of 2014.  Several lawmakers suggested that the two week extension was better than nothing, but the short extension period means that Congress has merely punted the need for greater tax reform in this area into 2015.  As it stands, the energy tax incentives extended by this bill will have expired by the time Congress returns to Washington, D.C., on January 6, 2015, following its winter break.  That means that Congress may be in the same place again next year under pressure to pass a year-end bill – instead of focusing on more comprehensive reform and a possible phase-out of the PTC.

ARTICLE BY

Heather Cooper
OF
McDermott Will & Emery

Tax Deficiencies and Automatic Penalties: Challenging by Reasonable Cause?

HMB Chartered B

Increasingly, taxpayers are seeing the imposition of penalties on deficiency assessments. In fact in a number of situations the imposition of the penalty is automatic upon the issuance of the assessment. The penalties, which may range from 20% to 25% of the liability, are imposed for late payment or underpayment of taxes. Such penalties are generally imposed without taking into consideration the fact there is a lack of guidance or legal authority with respect to the substantive issue which gave rise to the tax underpayment. Absent legal authority or guidance, the taxpayer is left to his own devices to interpret statutory changes or guess at policies when preparing and filing returns. Should the interpretation be inconsistent with that of the taxing authority, the taxpayer is rewarded with a penalty. The imposition of a non-deductible penalty leaves the taxpayer with basically two choices: pay the penalty and move on, or challenge the penalty citing reasonable cause.

A logical person would conclude that if there is no legal authority or guidance addressing the underlying issue, the taxpayer acted reasonably when preparing and filing its return. This is precisely what the New Jersey Supreme Court concluded in United Parcel Services General Services Co. v. Director Division of Taxation. The court noted the absence of legal authority or guidance gives rise to a genuine question of law and fact. A taxpayer who interprets a statute based on his knowledge in light of the lack of legal authority has demonstrated reasonable cause.  The New Jersey Supreme Court’s approach is logical and more importantly fair. Although not precedent outside of New Jersey, one could hope that other Departments review the court’s rationale and re-evaluate their penalty policies particularly in those instances where legal authority or regulatory guidance is nonexistent.

ARTICLE BY

Marilyn A. Wethekam
OF
Horwood Marcus & Berk Chartered

2014 Year-End Illinois Estate Planning: It’s Time for a Careful Review

Much Shelist law firm logo

As 2014 comes to a close, now is the perfect time for careful planning to address the income, estate, gift and generation-skipping taxes that can directly affect you.  In addition to making sure your estate plan is up to date, making a few important decisions now can reduce your tax liability later.

Transfer Tax Exemption and GST Exemption

The exemption amount that individuals may transfer by gift and/or at death without being subject to federal transfer taxes increased in 2014 to $5,340,000; it will further increase to $5,430,000 in 2015.  The maximum federal estate tax rate remains 40%.  In contrast, Illinois imposes a state estate tax once a decedent’s estate exceeds $4,000,000 (which is not adjusted for inflation). The rates of Illinois estate tax range from 8% to 16% (with the Illinois estate tax paid allowable as a deduction for federal estate tax purposes). Both the federal and Illinois estate tax laws allow for a marital deduction for assets passing outright to a spouse or to qualifying trusts for the benefit of a surviving spouse.  Illinois allows this deduction to be claimed even if a marital deduction is not elected for federal purposes.

In order to impose a death tax at each successive generational level, a generation-skipping transfer (“GST”) tax – equal to the highest estate tax rate – is assessed on transfers to grandchildren or more remote descendants.  However, every taxpayer is also given a separate federal GST exemption equal to the federal transfer tax exemption (i.e., $5,340,000 in 2014 and $5,430,000 in 2015).

Estate planning documents should be reviewed to make certain that beneficial use of the federal and state transfer tax exemptions, federal and/or state marital deductions and federal GST exemption are being utilized.

Annual Exclusion Gifts

Making use of annual exclusion gifts remains one of the most powerful – and simplest – estate planning techniques. For 2014 (and 2015), individuals can make an unlimited number of gifts of up to $14,000 per recipient, per calendar year.  Over a period of time, these gifts can result in substantial transfer tax savings, by removing both the gift itself and any income and growth from the donor’s estate, without paying any gift tax or using any transfer tax exemption.  An individual cannot carry-over unused annual exclusions from one year to the next.  If such exclusions are not utilized by the end of the year, the balance of any annual exclusion gifts that could have been made for that year are lost.  These transfers may also save overall income taxes for a family, when income-producing property is transferred to family members in lower income tax brackets (who are not subject to the “kiddie tax”.)

Tuition and Medical Gifts

Individuals can make unlimited gifts on behalf of others by paying their tuition costs directly to the school or their medical expenses directly to the health care provider (including the payment of health insurance premiums).

Lifetime Utilization of New Transfer Tax Exemption

The ability to transfer $5,430,000 ($10,860,000 per married couple) – after annual exclusion and medical and tuition gifts, and without having to pay gift taxes – paves the way for many planning opportunities.  When combined with valuation discounts and leveraging strategies (e.g., family partnerships, sales to grantor trusts, grantor retained annuity trusts,  etc.), tremendous amounts of wealth may pass for the benefit of many generations free of federal and Illinois transfer taxes. Lifetime gifts utilizing the exemption amounts will almost always result in overall transfer tax savings (unless the assets which have been transferred decline in value). The main reason is the removal of the income and growth on the gifted assets from the taxable estate.

For individuals who fully used their transfer tax exemptions in prior years, consideration should be given to making gifts of the additional inflation adjusted amount (i.e., the $90,000 increase in the transfer tax exemption from 2013 to 2014, and an additional $90,000 increase in the exemption from 2014 to 2015).

Benefits of Acting Early. The main benefit of making gifts that utilize the transfer tax exemption is to remove from the taxable estate the income and appreciation on those assets from the date of the gift to the date of death. The sooner the gifts are made, the more likely that additional income and growth on such assets will escape taxation.

Gifts in Trust. Despite the tax savings, many individuals are uneasy about making outright gifts to their descendants. Such concerns are usually addressed by structuring the gifts in trust, which allows the donor to determine how the assets will be used and when the descendants will receive the funds. The use of gift trusts can also provide the beneficiaries with a level of creditor protection (including protection from a divorcing spouse) and additional transfer tax leverage. This is particularly effective when coupled with applying GST exemption to the trust (discussed above) and making the trust a “grantor trust” for income tax purposes (discussed below).

Many individuals may not be comfortable giving away significant amounts of wealth. However, the gift trust technique is not limited to trusts for descendants, but may also include a spouse as a beneficiary (or as the sole primary beneficiary).  Making the spouse a beneficiary of a gift trust (generally referred to as a spousal lifetime access trust, or “SLAT”) provides indirect access to the trust assets, while allowing the income and growth to accumulate in the trust (if not otherwise needed), and pass free of estate and gift taxes.

One of the most powerful estate planning strategies is the utilization of a “grantor trust.”  Significant additional transfer tax benefits can be obtained by structuring a gift trust as a “grantor trust” for income tax purposes. The creator (or “grantor”) of a “grantor trust” is required to report and pay the tax on the income earned by the trust. This allows the grantor to pass additional funds to the trust beneficiaries free of gift and estate taxes and income taxes, as the grantor’s payment of the trust’s income taxes each year would be considered his or her legal obligation and would not be considered additional gifts.

Taxable Gifts

Although individuals generally dislike paying taxes, making taxable gifts and paying a gift tax may prove to be beneficial.  While the federal government imposes a 40% estate tax on taxable estates and a corresponding 40% gift tax on taxable gifts, Illinois does not impose a gift tax. Thus, taxable gifts result in an overall savings of state estate and gift tax.  Moreover, the differing manner in which the gift and estate taxes are computed and paid results in overall transfer tax savings.

The gift and estate tax, although “unified,” work quite differently. The estate tax is “tax inclusive:” the tax is determined based upon the assets owned at death, and paid from those assets (similar to the income tax, which “after tax” dollars must be used to pay the tax). However, the gift tax is “tax exclusive:” the gift tax is determined based on the assets gifted, and paid from other assets owned by the donor. As an example, if you previously used your transfer tax exemption and then make a $1,000,000 gift you would incur a $400,000 gift tax, $1,400,000 will be removed from your estate, and the donees will receive $1,000,000.  However, if you die without making the $1,000,000 gift, you would have the full $1,400,000 included in your estate, resulting in approximately $676,000 of federal and Illinois estate taxes, leaving only $724,000 rather than $1,000,000 for your descendants. In order to leave $1,000,000 for your descendants at death you would need approximately $1,934,000. The estate tax on such amount would be approximately $934,667, leaving $1,000,000 for your descendants. Stated another way, by gifting assets the IRS gets 40¢ for each $1.00 your beneficiaries receive, but by dying with the assets the IRS gets 93¢ for each $1.00 your beneficiaries receive. However, there are also potential downsides: paying a tax earlier than otherwise may be needed, the possibility that the estate tax may be repealed or the rates reduced, the loss of income/growth on assets used to pay the gift tax, the possibility that the transfer tax exemption may be increased which would have allowed the gifts to pass tax free, etc.

Making Use of Historically Low Interest Rates

Interest rates remain very low (with increases likely on the horizon). The current (and historically low) interest rates continue to create an environment ripe for estate planning and transferring wealth to descendants on a tax-advantaged basis.  Techniques such as grantor retained annuity trusts (“GRATs”), charitable lead trusts (“CLTs”), intra-family loans (bearing the minimal interest in order to avoid a gift of 0.39% for loans of 3 years or less, 1.90% for loans of 3 to 9 years, and 2.91% for loans of 9 years or more as of November 2014), and sales to “grantor trusts” are sensitive to interest rate changes – and are very beneficial in a low interest rate environment.

Illinois QTIP

Given the disparity between the $5,340,000 federal estate tax exemption and the $4,000,000 Illinois estate tax exemption, married couples domiciled in Illinois should make certain that their estate plans are structured to take advantage of the Illinois QTIP marital deduction.  Otherwise, an estate plan that is designed to fully utilize the federal $5,340,000 exemption can inadvertently cause a $382,857 Illinois estate tax upon the death of the first spouse.

Net Investment Income (Medicare) Tax

Higher-income-earners should also plan for the 3.8% surtax on certain unearned income and the additional 0.9% Medicare tax that applies to individuals earning in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately.) While the 0.9% additional tax on wages is only imposed on individuals, the 3.8% tax on net investment income is imposed on individuals, estates and trusts. Individuals are only subject to this new 3.8% Medicare tax if their “modified adjusted gross income” exceeds $250,000 for joint filers ($125,000 for a married individual filing a separate return) and $200,000 for single individuals.  In 2014, trusts and estates are subject to this tax at a $12,150 threshold ($12,300 in 2015). The approach to minimizing or eliminating the 3.8% surtax depends on each taxpayer’s individual situation. Some taxpayers should consider ways to minimize (e.g., through deferral) additional net investment income for the balance of the year, while others should review whether they can reduce modified adjusted gross income other than unearned income. In contrast, others may want to accelerate net investment income and/or modified adjusted gross income that would be received next year so that it is included this year (e.g., to take advantage of deductions this year). Year-end planning (such as timing the receipt of net investment income, the receipt of modified adjusted gross income and the payment of deductible expenses) can save significant taxes.

Retirement Plans and Beneficiary Designations

Contribution limitations for pension plan and other retirement accounts for 2015 were recently released by the IRS.  The following adjustments were triggered by an increase in the cost-of-living index:

  • Elective deferral contribution limits for employees who participate in a 401(k), 403(b) and 457(b) plans increased from $17,500 in 2014 to $18,000 in 2015.
  • The catch-up contribution limit for employees (aged 50 or older) who participate in a 401(k), 403(b) and governmental 457(b) plans increased from $5,500 in 2014 to $6,000 in 2015.

The end of the year is a good time to review the beneficiary designations on your pension plan and other retirement accounts (as well as life insurance policies).  Failing to name beneficiaries or keep designations current to reflect changing circumstances can create substantial difficulties and expense (both emotionally and financially) – and may lead to unintended estate, gift and income tax consequences.  You should make certain to designate beneficiaries when participating in a new retirement plan and update beneficiary designations when circumstances dictate (e.g., death of a spouse).  Finally, it is prudent to maintain a current list of accounts with beneficiary designations – which specifies the type of asset, account numbers, account custodians/administrators and beneficiaries designated for each account (primary and contingent).

ARTICLE BY

Gregg M. Simon
OF
Much Shelist, P.C.

Attend the 2nd Annual Bank and Capital Markets Tax Institute West – December 2-3 in San Francisco

The National Law Review is please to give you information on the 2nd Annual Bank and Capital Markets Tax Institute WestBank and Captial Markets Tax Institute Dec 2-3 San Francisco, CA - Register Now!

Register today!

WHEN

December 2-3, 2-14

WHERE

San Francisco, CA

Due to the success of last year’s first ever west coast Bank and Capital Markets Tax Institute (BTI), we are proud to announce that BTI West will be coming back for a second year! For 48 years the annual BTI East in Orlando has provided bank and tax professionals from financial institutions and accounting firms in-depth analysis and practical solutions to the most pressing issues facing the industry, and from now on professionals on the west coast can expect the same benefits on a regular basis

The tax landscape is continually changing; you need to know how these changes affect your organization and identify the most efficient and effective plan of action. At BTI West you will have access to the same exceptional content, networking opportunities and educational value that have made the annual BTI East the benchmark event for this industry.

In an industry that thrives on both coasts, we will continue to offer exceptional educational and networking opportunities to ALL of the hard-working banking and tax professionals across the country. Join us at the 2nd Annual Bank and Capital Markets Tax Institute WEST, where essential updates will be provided on key industry topics such as General Banking, Community Banking, GAAP, Tax and Regulatory Reporting, and much more.

2015 COLAs (Cost of Living Adjustments) for Employee Benefit Plans

Varnum LLP

The Internal Revenue Service has announced the 2015 cost of living adjustments to various limits on employee benefit plans. The adjusted amounts generally apply for plan years beginning in 2015. Some of the adjusted amounts, however, apply to calendar year 2015:

1. he limit on an employee’s contributions made during the 2015 calendar year to a 401(k) or a 403(b) tax-sheltered annuity increases to $18,000. Participants who are age 50 or older by the end of 2015 may make an additional $6,000 catch-up contribution, which also increases from the 2014 limit.

2. The limit on an employee’s contributions made during the 2015 calendar year to a 457 plan sponsored by a governmental unit or a tax-exempt organization also increases to $18,000. Participants who are age 50 or older by the end of the 2015 plan year may make an additional $6,000 catch-up contribution, which also increases from the 2014 limit.

3. The limit on an employee’s compensation that may be considered for retirement plan purposes increases to $265,000 for plan years beginning in 2015.

4. The limit on annual benefits payable under defined benefit plans remains the same at $210,000 for plan years beginning in 2015.

5. The limit on allocations to individual accounts in defined contribution plans increases to the smaller of $53,000 or 100% of compensation for plan years beginning in 2015.

6. The taxable wage base for Social Security increases to $118,500. This figure may affect the “integration level” for plans that are integrated with Social Security.

7. Employees will be classified as highly compensated employees for the plan year beginning in 2015 if their compensation in the 2014 plan year exceeded $115,000.

8. Health savings accounts (HSAs) are a means of paying health care expenses under a high deductible health care plan. To be a high deductible health care plan, the deductible must be at least a minimum amount for the year and out-of pocket expenses cannot exceed a maximum amount for the year. Contributions to an HSA may be made by the employer or the employee, but the total annual contribution amount from both sources cannot exceed the smaller of the plan’s deductible for the year or the maximum contribution amount for the year. For 2015, the adjusted amounts for HSAs are:

  • Maximum contribution: Family: $6,650 Self: $3,350
  • Minimum deductible: Family: $2,600 Self: $1,300
  • Maximum out of pocket: Family: $12,900 Self: $6,450

9. Participants who attain age 55 by the end of the 2015 plan year may make an additional $1,000 “catch-up” contribution to their HSAs.

The maximum amounts that Social Security recipients may earn during 2015 without loss of Social Security benefits are as follows:

  • Recipients ages 62 through full retirement age: $1,310/mo. ($15,720/yr.)
  • Year recipient reaches full retirement age: $3,490/mo. up to the month the recipient reaches full retirement age. ($41,880/yr.)
  • There is a special rule that applies to earnings for one year, usually the first year of retirement, in which you can get a full social security check for any whole month you are retired, regardless of your yearly earnings.
  • “Full retirement age” for Social Security is:

Year of Birth

Full Retirement Age

Prior to 1938

Age 65

1938

Age 65 & 2 months

1939

Age 65 & 4 months

1940

Age 65 & 6 months

1941

Age 65 & 8 months

1942

Age 65 & 10 months

1943 – 1954

Age 66

1955

Age 66 & 2 months

1956

Age 66 & 4 months

1957

Age 66 & 6 months

1958

Age 66 & 8 months

1959

Age 66 & 10 months

1960 and later

Age 67
© 2014 Varnum LLP

‘Jersey Shore’ Star Pleads Not Guilty to Tax Fraud

McBrayer NEW logo 1-10-13

C’mon, admit it: you’ve watched at least a few minutes of MTV’s “Jersey Shore.” Okay, fine, not all of us have let our curiosity get the best of us, but for those who have, one of the main characters of the series is currently making headlines for a tax fraud case.Mike Sorrentino, whose nickname on the show was “The Situation,” is currently facing charges that he and his brother failed to pay $8.9 million of taxes between 2010 and 2012.

According to the IRS, the brothers filed false income tax returns, failing to report personal and business income and claiming false business deductions. Those earnings were largely from public appearances for which potentially thousands of dollars were paid. Authorities also accused Sorrentino of altering accounting records or having them altered after a grand jury issued a subpoena.

Sorrentino denies the allegations and has pleaded not guilty to the charges. His attorney made a public statement last month that Sorrentino “denies that he criminally violated the tax laws.” In effect this means that he is claiming the violations were due to negligence rather than fraud.

The difference between tax negligence and tax fraud is pretty significant, not only in terms of the mental state of the taxpayer at the time the filing was made but also in terms of the penalties attached. Penalties for fraud, of course, are much more significant.

While the IRS usually has a pretty good idea of when an individual has committed fraud or negligence, this is not always the case. Those who have been wrongfully accused of tax fraud need to work with an experienced attorney to ensure their rights are protected.

ARTICLE BY

McBrayer, McGinnis, Leslie & Kirkland, PLLC

Real Estate “Change in Ownership” Can Trigger Documentary Transfer Tax

Sheppard Mullin Law Firm

926 North Ardmore Avenue, LLC v. County of Los Angeles, (9/22/14, B248536)

The California Court of Appeals has recently held that, as a general rule, the Documentary Transfer Tax (“DTT”) applies whenever there is a “change in ownership” of real property under the California Revenue & Taxation Code. In the case, 926 North Ardmore Avenue, LLC v. County of Los Angeles, the court held that the phrase “realty sold” under the DTT Act includes a “change in ownership” (subject to the limited exceptions expressly included in the DTT Act).  San Francisco and Santa Clara Counties have already enacted amendments to their DTT ordinances to provide for this result, and there are several other counties (most notably Los Angeles and San Diego) that have taken this position without any change to their ordinances.

ARTICLE BY

D. Matthew Richardson
OF
Sheppard, Mullin, Richter & Hampton LLP

The Real Tax Benefits of Inverting to Canada

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On August 26, Burger King announced that it entered into an agreement to acquire Tim Hortons, Inc., the Canadian coffee-and-doughnut chain, in a transaction that will be structured as an “inversion” (i.e., Burger King will become a subsidiary of a Canadian parent corporation).  The deal is expected to close in 2014 or 2015. The agreement values Tim Hortons at approximately $11 billion, which represents a 30 percent premium over Tim Hortons’ August 22 closing stock price.

Canadian Flag

Under the terms of the deal, Tim Hortons shareholders will receive a combination of cash and common shares in the new company. Each common share of Burger King will be converted into 0.99 of a share of the new parent company and 0.01 of a unit of a newly formed, Ontario-based limited partnership controlled by the new parent company. Holders of shares of Burger King common stock, however, will be given the right to elect to receive only partnership units in lieu of common shares of the new parent company, subject to a limit on the maximum number of partnership units issued.  Burger King shareholders who make this election will be able to defer paying tax on the built-in gain in their Burger King shares until the partnership units are sold. 3G Capital, Burger King’s principal shareholder, has elected to receive only partnership units. 3G will own approximately 51 percent of the new Burger King-Tim Hortons company, with current public shareholders of Burger King and Tim Hortons receiving 27 percent and 22 percent, respectively.

Inversions have gotten plenty of negative publicity during the past few years.  Most of the reported deals involve U.S. companies that have acquired smaller foreign companies in low tax jurisdictions such as Ireland, Switzerland, and the U.K.  As with any inversion transaction, the U.S. company will continue to be subject to U.S. federal income tax on its worldwide income.  The U.S. company will benefit, however, from the ability to: (i) reorganize its controlled foreign subsidiaries under a new foreign parent corporation (thereby removing those subsidiaries from the U.S. “controlled foreign corporation” regime and also allowing for the future repatriation of non-U.S. source profits to the foreign parent corporation and avoid U.S. corporate income tax); and (ii) “base erode” the U.S. company with intercompany debt and/or license arrangements with the new foreign parent or its non-U.S. subsidiaries.

It has been reported that Burger King’s effective tax rate was 27.5 percent in 2013 and Tim Hortons was 26.8 percent (15 percent federal rate plus 11.8 percent provincial rate), so “base eroding” Burger King with deductible interest and/or royalty payments to Canada will not provide a significant tax benefit to Burger King.  Where the use of a Canadian parent corporation, however, will benefit Burger King (and other U.S. companies that have inverted into Canada) from a tax perspective is the ability to take advantage of Canada’s (i) “exempt surplus” regime, which allows for the repatriation of dividends from foreign subsidiaries into Canada on a tax-free basis; and (ii) income tax treaties that contain tax sparing provisions, granting foreign tax credits at rates higher than the actual foreign taxes paid.  The United States does not provide either of these tax benefits under its corporate income tax system or treaty network. 

Canadian Exempt Surplus Regime

In general, under Canadian law, dividends received by a Canadian corporation out of the “exempt surplus” of a foreign subsidiary are not subject to corporate income tax in Canada.  Exempt surplus includes earnings of a foreign subsidiary that is resident in, and carrying on an active business in, a country with which Canada has concluded an income tax treaty or, more recently, a tax information exchange agreement (TIEA).  A TIEA is an agreement between two jurisdictions pursuant to which the jurisdictions may request and share certain information that is relevant to the determination, assessment and collection of taxes, the recovery and enforcement of tax claims, and the investigation or prosecution of tax matters.  The extension of the exempt surplus regime to jurisdictions that have signed TIEAs (but not income tax treaties) with Canada is significant because Canada has signed such agreements with low-tax jurisdictions, such as the Cayman Islands, Bermuda, and the Bahamas. Historically, the use of a Barbados IBC, which has a maximum corporate income tax rate of 2.5 percent, was the preferred jurisdiction for a Canadian parent company operating in a low-tax jurisdiction because of the long standing Canada-Barbados income tax treaty.

On the other hand, dividends received by a Canadian corporation out of the “taxable surplus” of a foreign subsidiary will be taxable in Canada (subject to a grossed-up deduction for foreign taxes) at regular corporate income tax rates. Taxable surplus includes most types of passive income, such as royalties, interest, etc., and active business income of a foreign subsidiary that is resident in, or carrying on business in, a country with which Canada has neither an income tax treaty nor a TIEA.  Special rules may deem certain passive income (such as interest or royalties) to be included in exempt surplus if received by a foreign subsidiary resident in a tax treaty or TIEA jurisdiction, if those amounts are deductible in computing the exempt earnings of another foreign subsidiary.  For example, interest and royalties paid from an active business of a U.K. subsidiary of a Canadian parent corporation to a Cayman Islands subsidiary of such Canadian parent will be eligible to be repatriated to Canada from the Cayman Islands under the exempt surplus regime on a tax-free basis.

It is interesting to note, however, that Burger King will not be able to repatriate most of its foreign-source income to Canada on a tax-free basis under the exempt surplus rules.  The majority of Burger King’s foreign-source income consists of royalties and franchise fees, which will be considered passive income for Canadian income tax purposes.  (Burger King, which operates in about 14,000 locations in nearly 100 countries, has become a franchiser that collects royalty fees from its franchisees, not an operator of restaurants).

Canada’s Tax Sparing Provisions

Another tax benefit offered by a Canadian parent corporation is the ability to utilize the “tax sparing” provisions contained in many Canadian income tax treaties. Canada currently has income tax treaties that contain tax sparing provisions with more than 30 countries, including Argentina, Brazil, China, Israel, Singapore, and Spain. In general, the purpose of a tax spari
ng provision is to preserve certain tax incentives granted by a developing jurisdiction by requiring the other jurisdiction to give a foreign tax credit for the taxes that would have been paid to the developing country had the tax incentive not been granted.  For example, under Article 22 of the Canada-Brazil income tax treaty, dividends paid by a Brazilian company to a Canadian parent corporation are deemed to have been subject to a 25 percent withholding tax in Brazil and therefore, eligible for a 25 percent foreign tax credit in Canada, even though the treaty limits the withholding tax to 15 percent (and in actuality, Brazil does not even impose withholding taxes on dividends under its local law).  A similar benefit is available for interest and royalties paid from Brazil to Canada (e.g., a deemed withholding tax, and therefore foreign tax credit, of 20 percent, even though the treaty caps the withholding tax at 15 percent).  As noted above, the United States does not currently have any income tax treaties that contain tax sparing provisions.

Conclusion

With Burger King’s effective corporate tax rate of 27.5 percent in the United States in 2013 and Tim Hortons 26.8 percent in Canada, the tax benefits of Burger King inverting to Canada are not readily apparent.  Notwithstanding the lack of a significant disparity in these tax rates, Canada does offer the ability to exclude from its corporate income tax dividends received from the earnings of a foreign subsidiary that is resident in, and carrying on an active business in, a jurisdiction that has concluded an income tax treaty or TIEA with Canada.  This key benefit, along with the Canadian income tax treaties that contain tax sparing provisions, provides one more example of why U.S. multinationals are operating at a competitive disadvantage when compared to other OECD countries around the world. 

ARTICLE BY

Jeffrey L. Rubinger
 
OF 
Bilzin Sumberg Baena Price & Axelrod LLP

IRS Ruling Creates Opportunities for Tax Savings by Companies With Substantial Real Estate Assets

Katten Muchin Law Firm

On July 29, Windstream announced that it plans to spin off certain telecommunications network assets into an independent, publicly tradedreal estate investment trust (REIT). Windstream made the announcement after it obtained a favorable private letter ruling from the Internal Revenue Service (IRS) regarding the tax-free nature of the spin-off and the qualification of the spun-off entity’s assets as real property for REIT purposes.

Under the transaction, Windstream will spin off its existing fiber and copper network, real estate, and other fixed assets into a publicly traded, independent REIT. The REIT’s primary activity will be to lease the use of the assets back to Windstream through a long-term “triple net” exclusive lease. Windstream shareholders will retain their existing shares and receive shares in the REIT commensurate with their Windstream ownership. The transaction is intended to effectively enable Windstream to deduct, for federal income tax purposes, the amount of rent paid to the REIT without a corresponding corporate level income tax inclusion in income by the REIT—estimated to generate up to a $650 million annual overall reduction in taxable income between Windstream and the REIT.

Particularly notable about this transaction is that the private letter ruling obtained by Windstream is seemingly an indication by the IRS that it will respect the tax-free transaction of a spin-off even when coupled with an election for REIT status. The fact that the ruling recognized transmission infrastructure (e.g., wires and cable), in addition to the related real estate, as qualifying assets for REIT purposes is also a key development. The IRS issued proposed regulations in May that provided more specific guidance on what types of assets would be considered “real property” for purposes of meeting the requirements for making a REIT election, and Windstream’s private letter ruling is among the first to address the issue in light of the new regulations.

These developments mean that a REIT spin-off transaction might be available to many kinds of businesses. Companies (other than master limited partnerships) with similar assets, such as telecommunications, cables, fiber optics, and data centers, may be wise to explore opportunities to realize substantial tax savings through a similar transaction. However, there are several challenges that must be overcome to execute a successful REIT spin-off transaction.

ARTICLE BY

Jill E. Darrow
Reid A. Mandel
Glenn S. Miller
Saul E. Rudo
 
OF
Katten Muchin Rosenman LLP