Form 1120F and Schedules M-3, H, I & P

Institute of International BankersAnnual Tax Conference – New York

June 18, 2007

Steven Quint (CALYON Bank): ModeratorKarina Pogrebinsky – KPMGLawrence Weinblatt – PWC

Debra Taylor – Ernst & YoungStuart Zwerling – Deloitte Tax LLP

Paul Epstein – Office of Assoc. Chief Counsel (Int’l ) - IRS

Form 1120F, and Schedules M-3, H, I & P

• Required for Foreign Corporation Tax Years 2007– E-File will be optional for 2007 year tax returns

• Adopts new schedules– Schedule M-3 (Corporations with assets > $10 million)– Schedule H (Home Office and Trade or Business Expense

Allocation - §1.861-8)– Schedule I (Interest Expense Allocation - §1.882-5)– Schedule P (Reconciliation of Foreign Partner K-1 to effectively

connected income)

• Coordinates §1.882-5(d)(2) “set(s) of books and records” for 1120F Schedule L and for new schedules

Form 1120F: Schedule LSchedule L Books and Records:• §1.6012-2(g)(1)(iii) permits ECI generating assets and U.S. based asset reporting

• §1.882-5(d)(2) set(s) of books definition of “U.S. booked liabilities” is adopted consistent with the regulation (“Schedule L Books”)

• Interbranch Assets• Non-U.S. Assets (non-ECI assets)• U.S. Assets (those includible under §1.884-1(d))• Interbranch and 3rd Party Liability breakout

• Schedule L Books uniformly used for Form M-3 books, and Schedules H, I & P

• Schedule H – Part IV deductions on trade or business books allocated and apportioned to ECI/non-ECI• Schedule I - §1.882-5 reporting of U.S. booked liabilities and book expense• Schedule P – Liabilities on partnership trade or business books• Form 1120F, Page 5, Section II – Determination of branch interest for branch-level interest tax

• Worldwide reporting permitted

Schedule M-3:Net Income (Loss) Reconciliation (1120F)

Financial Statement Identification:• Audited Statements• Unaudited Statements• Trial Balances• Non-Banks (Worldwide Statement)• Foreign Banks (Books used for Sched. L)

Part I (Financial Statement Net Income):• Nonconsolidated Statement (with parent)

• May have subsidiaries consolidated• Include Disregarded Entities not on Statement• Exclude Subsidiaries/Entities in Consolidation• Eliminations for inter-company dividends• Line 11: Adjusted financial net income that constitutes the Foreign Corporation for tax purposes

Schedule M-3:Net Income (Loss) Reconciliation (1120F)

Part II: Reconciliation of Financial Gross Income in Part I, Line 11 to Taxable Income

• Columns (a) – (c) adjust financial income to U.S. tax principles before apportionment to ECI• Columns (d) & (e) apportion gross income to ECI and non-ECI-

• Non-Banks: Column (a) is Worldwide Gross Income – i.e. column (d) allocates only to non-ECI• Foreign Banks: Column (a) is Sched L books determined under §1.882-5(d)(2) principles Column (d) may allocate column (a) amount to non-ECI

• Line 23 special treatment allocates some offshore booked items to ECI

• New Lines• Substitute Interest and Dividends Rec’d (Proprietary Securities Lending)• Expanded Mark-to-Market categories• Global Dealing Income

Schedule M-3:Net Income (Loss) Reconciliation (1120F)

Part II: Reconciliation of Financial Gross Income in Part I, Line 11 to Taxable Income

• Line 23: Foreign Banks Only – Report ECI not on Schedule L books

• Income/gains - §864(c)(6) and (c)(7)• Certain securities attributable to U.S. office under the material participation test in §1.864-4(c)(5)(iii) • Line 28 col. (e) reconciles to 1120F, line 29

Part III: Reconciliation of Deductions to ECI• U.S. Source Substitute Interest and Dividends Paid

• Special Reporting in columns (c) and (d) for non-ECI amounts not in column (a) or (e)

• Interest equivalents (e.g. guarantee fees)• Home Office Allocation – From Sched. H

Schedule M-3:Net Income (Loss) Reconciliation (1120F)

Part III: Reconciliation of Deductions to ECI

• Interest Expense Reconciliation to Schedule I

• Amounts Reconcile to total deductions on Form 1120 F, Line 26

Schedule I: §1.882-5 Interest Expense Allocation

Identification of Step 3 Method

Step 1: US Assets• Schedule L Books• Aggregate adjustments (Column (a))• P’Ship Liabilities (Column (b))• Other non-Sched L US Assets – Column (c)

Step 2: US-Connected Liabilities• Identification of Ratio • USCL Amount• Liability Reduction Election

Step 3: U.S. Booked Liabilities/Int.• §1.882-5(d)(2) booked amount• Partnership booked liabilities

• Schedule P Carryovers

Schedule I: §1.882-5 Interest Expense Allocation

Step 3: AUSBL Method• Bank 30-Day LIBOR Election Box• Actual Excess Interest Rate (if applicable)• Scaling Ratio (if applicable)

• Hedging (not reported here)

Step 3: Separate Currency Pools Method• Handles Four Currencies on Form • 3% Currency Election Box• Liability Reduction Election Amount• WW Avg. Borrowing Rate Ratio• Deduction by Currency

Summary of Results:• Allocation under 3-Step Formula• Directly Allocable Interest• Adjustments for Deferrals/Tax-Exempt• Deduction to 1120F, pg. 3, line 18

Schedule H: Deductions Allocated to ECI under §1.861-8

Part I: Direct Allocations• Identification of Costs• Adjustments to U.S. Principles• Direct Allocations to non-ECI• Residual Deductions

Part II : Indirect Allocations• Translation to US Dollars• Total H/O Allocation - Line 21

Part III: Financial Records & Methods• Gross Income Ratio• Gross Asset Ratio• Personnel Headcount Ratio• Ratios are not safe harbors

Schedule H: Deductions Allocated to ECI under §1.861-8

Part III (cont’d): Financial Records• Cost Acct’g Reports, etc.

Part IV: Trade or Business Books• Schedule L Books• Identification of Costs• Adjust to U.S. Tax Principles• Allocable Deduction Pool

Part IV: Schedule L Deductions Allocable to ECI/non-ECI

• Direct allocations for NPC Exp.• Direct cost allocations• Indirect cost allocations• Reconciles to Form 1120F, pg. 3

Schedule P: Reconciliation of Foreign Partner Income

Part I: List of Foreign Partner Interests• Report only top tier P’ship Interests• Attach schedule if over 5 Interests

Part II: Reconciliation of Form K-1 to ECI, Deductions and Book Interest Expense:

• Trade or Business Line Gross-ups• Gross Income• Non-Interest Expense Deductions

• Other Gross Income• Other non-Interest Expense• Interest Expense Groupings

• Trade or Business Lines• Other Interest Lines• Directly Allocable Amounts• Amounts Flow to Schedule I

Schedule P: Reconciliation of Foreign Partner Income

Part III: Partner Outside Basis for InterestExpense Allocation under §1.882-5:

• Partner Basis under §705• Identification of direct allocations• Other Partner Liabilities

•Flows to Schedule I, Line 8, col. (b)• Adjusted Outside Foreign Partner Basis• Apportionment of Adj. Outside Basis

•Flows to Schedule I, Line 5, col. (b) • Identify “Income” or “Asset” Method