practical international the international business ... · reduction in the effective rate that the...

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February 29, 2012Volume 16, Number 4

Articles

International Tax PlanningPrivate Letter Ruling: CFC Qualifies for Same-Country Exception to FBCSI Though Some Manufacturing Activities Conducted Outside Same CountryBy Bob Giusti, Matt Berger and Javier Salinas (Ernst & Young)...........................................................................p. 2

U.S.--Government Releases Framework for Plan to Cut Corporate Tax Rate By Mel Schwarz and Dustin Stamper (Grant Thornton LLP)......p. 3

Treasury, IRS Issue Proposed FATCA Regulations By Philip R. West and Amanda P. Varma (Steptoe & Johnson LLP)............................................................p. 4

Canada--Latest Step in CRA’s New Audit Approach: “Risk Assessment” Interviews with Large Businesses By Patrick Lindsay and Sal Mirandola (Borden Ladner Gervais LLP)......................................................p. 9

Ireland--Irish Finance Bill 2012 Published—Contains Corporate Tax Changes; Benefits for Financial IndustryBy Paul Fleming, Norah Walsh, Tim Kiely, Joe Bollard and Kevin McLoughlin (Ernst & Young)............................................p. 13

Russia--Russia Drops Proposed Tax on Eurobonds—For NowBy Lidia Kelly (Reuters).............................................................p. 15

New Transfer Pricing Rules in RussiaBy Dmitri V. Nikiforov, Alyona N. Kucher and Anna S. Eremina (Debevoise & Plimpton LLP).....................................................p. 16

A Twice-MonThly RepoRT on inTeRnATionAl TAx plAnning

Advisory Board page 6

Same-Country Exception AppliesThe IRS has ruled that income to a CFC from the sale of products to related parties is not foreign base company sales income under the same country manufacturing exception of Section 954(d)(1)(A), even when some of the manufacturing of products occurred in more than one country. The ruling found that the exception of Reg. Section 1.954-3(a) is not limited to the final state of manufacturing. Page 2

U.S. Administration Proposals: Corporate Tax of 28 Percent and Minimum Tax on Foreign EarningsThe proposals call for elimination of most business tax incentives, and would limit the ability of companies to place income from intangibles in tax havens. The proposals call for an end to accelerated depreciation and deductions for corporate interest. Page 3

Is Reporting by Governments the FATCA Compliance Goal? Foreign banks and other financial institutions would avoid direct dealings with the IRS if they reported account information to their own government, which in turn would make information available to the IRS. A review of the newly released FATCA proposed regulations. Page 4

New Round of Tax Audits in Canada, AKA an "Engaged Approach to Compliance"Canada's tax authorities plan to conduct individual risk-assessment interviews with large businesses. Suggestions for companies wondering where to draw the line. Page 9

In ThIs Issue

WTEPRACTICAL INTERNATIONAL

TAX STRATEGIESWORLDTRADE EXECUTIVEThe International Business Information SourceTM

2 www.wtexec.com/tax.html

u.s.

(Section 954(d)(1), continued on page 7)

International Tax Planning

Executive Summary In Private Letter Ruling (PLR) 201206003, the IRS ruled that a controlled foreign corporation’s (CFC) income from the sale of products to related parties is not foreign base company sales income (FBCSI) under the same country manufacturing exception of Section 954(d)(1)(A); CFC satisfied the same country manufacturing exception since the products were purchased from an unrelated corporation organized and which (partly) manufactured the products in CFC’s country of incorporation.

Detailed DiscussionIn the letter ruling, Taxpayer is a domestic corporation

and the common parent of an affiliated group of corporations filing a U.S. consolidated federal income tax return. Taxpayer conducts activities directly and through domestic and foreign subsidiaries. Taxpayer owns CFC, which was created under the laws of Country 1.

Foreign corporation (FC) is not related to Taxpayer, or any of Taxpayer’s subsidiaries and other affiliated groups within the meaning of Section 954(d)(3). FC was created under the laws of Country 1.

Pursuant to an agreement between Taxpayer affiliates and FC affiliates, FC and its affiliates perform physical manufacturing activities for certain products, and sell finished products to Taxpayer affiliates (including CFC) for distribution in Taxpayer’s supply chains within the region. CFC resells the products to various Taxpayer distribution center affiliates, which are themselves considered related persons within the meaning of Section 954(d)(3). In a typical arrangement, Taxpayer distribution center affiliates will on-sell products to Taxpayer sales entities which then sell such products to third-party

customers that are usually located within the same jurisdiction as the relevant Taxpayer sales entity.

The manufacture of products by FC and its affiliates entails several stages of production in multiple jurisdictions involving component parts production and final assembly. Though FC purchases most of the components as raw materials, FC manufactures exclusively in Country 1 several critical component parts incorporated in the products at issue.

Some Manufacturing Activities Outside CountryFC and its affiliates also conduct finishing

manufacturing activities with respect to the products in countries other than Country 1 (Country 2) at certain finishing manufacturing plants. The activities conducted at such plants include the manufacture of component parts embedded in the products, the assembly of the products, packaging, and the labeling and shipping of the products. FC’s finishing manufacturing activities in Country 2 are conducted through wholly-owned subsidiaries of FC.

The PLR specifically notes Taxpayer’s representation that the manufacturing activities performed by FC in Country 1 with respect to the Country 1 manufactured component parts are substantial in nature and “constitute the manufacture, production, or construction of property” with respect to the finished products within the meaning of Treas. Reg. Section 1.954-3(a)(4)(iii), and are substantial with respect to the manufacture of the finished products as a whole. Taxpayer further represents that the manufacturing activities performed by FC and its affiliates with respect to products in Country 2 may “constitute the manufacture, production, or construction of property” with respect to finished products within the meaning of Treas. Reg. Section 1.954-3(a)(4)(iii).

As PLR 201206003 discusses, the definition of FBCSI under Section 954(d)(1) includes income derived in connection with the purchase of personal property from any person and its sale to a related person where the property which is purchased is manufactured, produced, grown, or extracted outside the country under the laws of

Private Letter Ruling: CFC Qualifies for Same-Country Exception to FBCSI Though Some Manufacturing Activities Conducted Outside Same CountryBy Bob Giusti, Matt Berger and Javier Salinas (Ernst & Young)

Bob Giusti ([email protected]) is a Partner in Ernst & Young’s San Jose, California office. Matt Berger ([email protected]) is a Manager in the New York office. Javier Salinas ([email protected]) is a Manager in the Washington office. The authors are with Ernst & Young’s International Tax Services.

February 29, 2012 Practical International Tax Strategies® 3

u.s.

(Corporate Tax Rate, continued on page 8)

The administration on February 23 released a framework for tax reform that would lower the corporate tax rate to 28 percent and more narrowly target tax incentives to specific areas of the economy, particularly alternative energy and manufacturing.

Specifically, the framework would expand and make permanent the research credit, but would limit or repeal most other business tax benefits. The framework also rejects the idea of shifting to a territorial tax system, calling instead for a minimum tax on the foreign earnings of U.S. corporations and several changes that would limit the ability to place income (particularly income from intangibles) in foreign countries with lower taxes. The plan is focused on corporate taxes and does not address individual tax reform.

The plan was outlined in a 25-page document from the Treasury Department that is light on details in some areas and leaves several key issues unresolved. In general, the administration lays out a vision for an essentially revenue-neutral overhaul of the corporate tax code, balancing a reduction in the corporate tax rate with revenue offsets the president has proposed before

The basic premise starts with the “presumption that we should eliminate all tax expenditures for specific industries” with exceptions aimed at preserving large incentives for U.S. investment like the research credit and Section 199 deduction. The plan does not list all the incentives to be repealed, but does target several specific provisions:

• repealing the last-in, first-out (LIFO) method of accounting;

• repealing oil- and gas-related tax incentives; • changing the tax treatment of many insurance

industry products; • taxing carried interest in a partnership as ordinary

income; and • eliminating five-year depreciation for noncommercial

aircraft. Tax incentives not repealed would be made permanent,

and the plan would increase the rate for the alternative simplified research credit to 17 percent. The Section 199

domestic production activities deduction would increase to 10.7 percent in order to preserve the three-point reduction in the effective rate that the current 9 percent deduction offers against the current 35 percent corporate rate. Treasury acknowledged that these changes would leave the plan short on revenue needed to fully fund a rate cut to 28 percent, and offered three additional options for reforming the corporate tax base:

• changing current depreciation schedules; • limiting deductions for interest; and • creating parity between the tax treatment of pass-

throughs and C corporations. The administration’s framework clashes with

many Republican ideas for tax reform. A number of congressional Republicans have said corporate reform cannot be done without also addressing individual taxes and have called for reducing both the top individual and corporate rate to 25 percent or lower. In addition, Sen. Mike Enzi, R-Wyo., and Ways and Means Committee Chair Dave Camp, R-Mich., have released proposals to move the tax code toward a more territorial system.

But the plan was not immediately rejected on Capitol Hill. Mr. Camp released a statement praising some of the administration’s general tax reform principles but disagreeing with the administration’s positions on several issues. Tax reform appears unlikely in 2012, but it could emerge as a major campaign issue in advance of 2013. The White House plan has little in common with the tax platforms of the current Republican candidates for president, who have all called for rates lower than 28 percent

The following discussion provides more information on specific elements of the White House plan.

President’s Goals for Tax Reform The administration provides only a basic framework

for tax reform, and several issues are unresolved. But the framework document provides a detailed premise for reform that offers important insights into the tax positions the administration has taken and will likely take.

There is broad bipartisan agreement that the statutory U.S. corporate rate of 35 percent is among the highest in the world and should be lowered. The administration agrees with this, but repeatedly asserts that the effective U.S. corporate tax rate, after taking into account tax various incentives and rules, is consistent with that of trading partners like France, Japan and the United Kingdom. The administration argues that reform is

Government Releases Framework for Plan to Cut Corporate Tax Rate By Mel Schwarz and Dustin Stamper (Grant Thornton LLP)

Mel Schwarz ([email protected]) is a Partner, and Dustin Stamper ([email protected]) is a Manager, with Grant Thornton’s National Tax office in Washington. The authors specialize in tax legislation and regulatory developments.


(FATCA, continued on page 5)

u.s.

On February 8, 2012, Treasury and the IRS issued proposed regulations under Internal Revenue Code Sections 1471 through 1474 (enacted as part of the Foreign Account Tax Compliance Act (FATCA) provisions of the Hiring Incentive to Restore Act of 2010 (the HIRE Act)), which require foreign financial institutions (FFIs) to identify and report U.S. account holders or face a 30 percent withholding tax on certain payments. The proposed regulations are voluminous (388 pages) and will need to be carefully analyzed by FFIs, U.S. withholding agents, and other persons potentially impacted by FATCA. A summary of certain significant developments and provisions in the proposed regulations is provided below.

Government-to-Government Alternative In connection with the release of the proposed

regulations, the United States, France, Germany, Italy, Spain, and the United Kingdom released a joint

In return, the United States would agree to: (1) eliminate the obligation of each FFI established in the FATCA partner to enter into a separate FFI agreement; (2) allow FFIs established in the FATCA partner to comply with their FATCA obligations by reporting information to the FATCA partner rather than the IRS; (3) eliminate U.S. withholding under FATCA on payments to FFIs established in the FATCA partner; (4) treat specific categories of FFIs established in the FATCA partner as deemed compliant or presenting a low risk of tax evasion; and (5) commit to reciprocity with respect to collecting and reporting on an automatic basis to the authorities of the FATCA partner information on the U.S. accounts of residents of the FATCA partner.

Under this approach, FFIs established in the FATCA partner would not be required to terminate the account of a recalcitrant account holder or impose “passthru” payment withholding on payments to recalcitrant account holders and payments to other FFIs organized in the FATCA partner or other jurisdiction with which the United States has a FATCA implementation agreement.

Transition RulesThe proposed regulations refine the transition rules

of Notice 2011-53: • Treasury and the IRS intend to publish a draft model

FFI agreement in “early 2012” and a final agreement in fall 2012.

• For reporting in 2014 and 2015 (with respect to calendar years 2013 and 2014), FFIs will be required to report only name, address, TIN, account number, and account balance with respect to U.S. accounts. Reporting on income will be phased in beginning in 2016 (with respect to the 2015 calendar year) and reporting on gross proceeds will begin in 2017 (with respect to the 2016 calendar year).

• Withholding on “passthru” payments will not be required before January 1, 2017, but participating FFIs will be required to report annually the aggregate amount of certain payments made to each nonparticipating FFI.

• A two-year transition (until January 1, 2016) rule (with certain due diligence requirements imposed) is provided for implementation of the Section 1471(e) requirement that an FFI’s obligations under an FFI agreement apply to the U.S. accounts of the participating FFI and U.S. accounts of each other FFI that is a member of the same expanded affiliated group.

Treasury and the IRs intend to publish a draft model FFI agreement in “early

2012” and a final agreement in fall 2012.

statement describing an intergovernmental approach to “improving international tax compliance and implementing FATCA.”

The joint statement outlines a possible framework for an intergovernmental approach, under which a partner country (a FATCA partner) would agree to: (1) pursue legislation to require FFIs in its jurisdiction to collect and report to FATCA partner tax authorities the information required by FATCA; (2) enable FFIs established in the FATCA partner (other than FFIs that are excepted pursuant to the agreement or in U.S. guidance) to apply the necessary diligence to identify U.S. accounts; and (3) transfer to the United States on an automatic basis the information reported by the FFIs.

Treasury, IRS Issue Proposed FATCA Regulations By Philip R. West and Amanda P. Varma (Steptoe & Johnson LLP)

Philip West ([email protected]) is a Partner, and Amanda Varma ([email protected]) is an Associate, in the Washington office of Steptoe & Johnson. Mr. West’s practice is focused on international tax issues for both domestic and foreign companies and individuals. He is Chair of the firm’s Tax Practice. Ms. Varma’s practice is concentrated in tax law, including international and corporate tax planning, tax legislative and regulatory developments, and tax controversies.


u.s.

(FATCA, continued on page 6)

FATCA (from page 4)

Due DiligenceThe proposed regulations provide detailed guidance

on the due diligence that participating FFIs will be required to undertake to identify U.S. accounts. The approach of prior preliminary FATCA guidance (Notices 2010-60 and 2011-34) is modified in certain respects.

U.S. Indicia

As in prior guidance, the proposed regulations apply different due diligence rules to preexisting and new individual and entity accounts. The proposed regulations also require FFIs to look for “U.S. indicia” for individual accounts, which are refined to include (1) identification of an account holder as a U.S. person; (2) a U.S. place of birth; (3) a U.S. address; (4) a U.S. telephone number; (5) standing instructions to transfer funds to an account maintained in the United States; (6) a power of attorney or signatory authority granted to a person with a U.S. address; or (7) a U.S. “in-care-of” or “hold mail” address that is the sole address on file.

Preexisting Individual AccountsWith respect to preexisting individual accounts, the

private banking rules of Notice 2011-34, which required enhanced diligence for certain accounts, are eliminated and replaced with requirements based on account value threshold. Preexisting accounts with a balance or value that does not exceed $50,000 and certain cash value insurance and annuity contracts held by individual account holders with a value or balance of $250,000 or less are exempt from review unless the FFI elects otherwise. Preexisting accounts with a balance or value below

The proposed regulations provide detailed guidance on the due diligence

that participating FFIs will be required to undertake to identify u.s. accounts.

$1,000,000 are subject only to a review of electronically searchable data for indicia of U.S. status.

Accounts with a balance exceeding $1,000,000 are subject to a review of electronic and non-electronic records (including the customer master file and the most recent documentary evidence and account opening documentation) for U.S. indicia. This enhanced review is only required, however, where certain information (i.e., nationality/residency status; current residence/mailing addresses, current phone number, standing instructions to transfer funds, an “in care of” or “hold mail” designation, and power of attorney or signature authority) is not available through an electronic search. If a relationship manager is assigned to an account with a balance exceeding $1,000,000, the FFI must establish whether the relationship manager has “actual knowledge” that the account holder is a U.S. person.

New Individual AccountsWith respect to new individual accounts, the FFI

will be required to review the information provided at the opening of the account and determine whether U.S. indicia are present. If U.S. indicia are identified, the FFI must obtain additional documentation or treat the account holder as recalcitrant. The preamble states that “FFIs will generally not need to make significant changes to the information collected during the account opening process in order to identify U.S, accounts, except to the extent that U.S. indicia are identified.”

The proposed regulations provide rules on records that must be kept with respect to both new and preexisting accounts.

Compliance VerificationThe proposed regulations require FFI officer

verification that the FFI has complied with the terms of the

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u.s.

FATCA (from page 5)

Richard E. AndersenArnold & Porter LLP (New York)

Joan C. ArnoldPepper Hamilton LLP (Boston)

Sunghak BaikErnst & Young (Singapore)

William C. BenjaminWilmer Cutler Pickering Hale and Dorr LLP

(Boston)

Steven D. BortnickPepper Hamilton (New York)

Joseph B. Darby IIIGreenberg Traurig LLP (Boston)

Rémi DhonneurKramer Levin Naftalis & Frankel LLP

(Paris)

Hans-Martin EcksteinPricewaterhouseCoopers

(Frankfurt am Main)

Jaime González-BéndiksenBéndiksenLaw

(Mexico)

Alan Winston GranwellDLA Piper (Washington)

Jamal Hejazi, Ph.D.Gowlings, Ottawa

Lawrence M. HillDewey & LeBoeuf LLP (New York)

Advisory BoardMarc Lewis

Sony USA (New York)

Keith MartinChadbourne & Parke LLP

(Washington)

William F. RothBDO USA, LLP

Kevin RoweReed Smith (New York)

John A. SalernoPricewaterhouseCoopers LLP

(New York)

Michael J. SemesBlank Rome LLP (Philadelphia)

Douglas S. StranskySullivan & Worcester LLP (Boston)

Michael F. SwanickPricewaterhouseCoopers LLP

(Philadelphia)

Edward TanenbaumAlston & Bird LLP (New York)

Guillermo O. TeijeiroNegri & Teijeiro Abogados

(Buenos Aires)

David R. TillinghastBaker & McKenzie LLP (New York)

Eric TomsettDeloitte & Touche LLP (London)

FFI Agreement. Verification of compliance through third party audits, however, is generally not required. Further, according to the preamble, “[i]f an FFI complies with the obligations set forth in an FFI agreement, it will not be held strictly liable for failure to identify a U.S. account.”

Grandfathered ObligationsThe proposed regulations expand the scope of a

grandfathering rule in the HIRE Act, which provided that a payment under any obligation outstanding on March 18, 2012 (or from the gross proceeds from any disposition of such an obligation) is not subject to FATCA withholding. The proposed regulations extend the March 18 date to January 1, 2013. An “obligation” is generally defined to include debt and certain legal agreements, but not equity. Comments are requested on the definition of “obligation.”

Deemed Compliant FFIsThe categories of FFIs treated as deemed compliant

under Section 1471(b)(2) are expanded to include

“registered deemed-complaint FFIs” (local FFIs, non-reporting members of participating FFI groups, qualified investment vehicles, restricted funds, and FFIs in compliance with an agreement between the United States and a foreign government that register with the IRS) and “certified deemed-complaint FFIs” (non-registering local banks, retirement plans, non-profit organizations, certain owner-documented FFIs, and FFIs with only low-value accounts).

“Passthru” Payments According to the preamble, Treasury and the IRS

continue to consider ways to implement the passthru payment requirement while easing the compliance burden. Comments are requested on this issue.

The preamble also states that Treasury and the IRS are studying options to prevent U.S. institutions from serving as “blockers” with respect to passthru payments (as U.S. institutions are required to withhold with respect to withholdable payments but not passthru payments).

©2012 Steptoe & Johnson q


u.s.

Section 954(d)(1) (from page 2)

which the CFC is created or organized, and the property is sold for use, consumption, or disposition outside such foreign country. See Treas. Reg. Section 1.954-3(a)(1).

Treas. Reg. Section 1.954-3(a)(2) provides that FBCSI does not include income derived in connection with the purchase and sale of personal property in a transaction described in Treas. Reg. Section 1.954-3(a)(1) if the property is manufactured, produced, constructed, grown or extracted in the country under the laws of which the CFC that purchases and sells the property is created or organized. Thus, CFC’s sale of products to various Taxpayer distribution center affiliates considered related persons would not generate FBCSI if another person physically manufactures such products in Country 1.

Treas. Reg. Section 1.954-3(a)(4)(ii) provides that purchased property, which is substantially transformed prior to sale, is treated as having been manufactured by the selling corporation. Treas. Reg. Section 1.954-3(a)(4)(iii) provides that if purchased property is used as a component of property that is sold, and the operations conducted by the selling corporation in connection with the property purchased and sold are substantial in nature and generally considered to constitute the manufacture of property, then the sale of the property will be treated as the sale of a manufactured good. Here, CFC purchases products from FC and its affiliates. FC and its affiliates manufacture products in a multi-step process, which involves component part production and final assembly in multiple jurisdictions. The ruling indicates that the manufacturing activities with respect to Country 1 manufactured component parts are conducted by FC exclusively in Country 1, and manufacturing activities with respect to some component parts and final assembly are conducted by FC and its affiliates in Country 2.

Based on the facts presented and Taxpayer ’s representation that the activities conducted by FC in Country 1 constitute manufacturing within the meaning of Treas. Reg. Section 1.954-3(a)(4)(iii) and are substantial with respect to the products as a whole, the IRS ruled that income earned by CFC with respect to the sale of products purchased from FC, or its affiliates, to a related person within the meaning of Section 954(d)(3), is not FBCSI within the meaning of Section 954(d) because the income qualifies for the same country manufacturing exception under Section 954(d)(1)(A).

ImplicationsThough private letter rulings may not be used or

cited as precedent by persons other than the taxpayer requesting the ruling, this ruling indicates how the IRS may determine whether a CFC earns FBCSI from its purchase and resale of manufactured property. Interestingly, the IRS determined that although Taxpayer represented that it believed the manufacturing activities performed by

FC and its affiliates with respect to the products outside Country 1 may “constitute the manufacture, production, or construction of property” of finished products within the meaning of Treas. Reg. Section 1.954-3(a)(4)(iii), CFC was still able to qualify for the exception under Treas. Reg. Section 1.954-3(a)(2) notwithstanding that the products were partly manufactured in Country 2. Consistent with

The ruling acknowledges the possibility of two or more manufacturing locations

for the same product and finds that the manufacturing exception of 1.954-3(a) is not limited to the final stage of

manufacturing.

the recent multiple manufacturing branch rules of Treas. Reg. Section 1.954-3(b)(1)(ii)(c)(3) and the implications of the safe harbor test in Treas. Reg. Section 1.954-3(a)(4)(iii), the ruling acknowledges the possibility of two or more manufacturing locations for the same product and finds that the manufacturing exception of 1.954-3(a) is not limited to the final stage of manufacturing. q

Swiss Take Steps to Clean Up Tax-Haven Image

Switzerland announced plans on February 22 to force banks to do more to make sure foreign clients’ money is taxed in an attempt to shake off its past as a haven for untaxed funds as it seeks to put an end to a damaging U.S. tax probe. “The focus is on enhanced due diligence requirements for banks when accepting assets as well as a requirement for foreign clients to make a declaration on the fulfillment of their tax obligations,” the cabinet said in a statement. The announcement comes on top of a raft of measures already announced in recent years, including a planned withholding tax on foreign assets held in Switzerland and better co-operation with foreign authorities pursuing alleged tax dodgers. A global crackdown from cash-strapped governments in recent years has chipped away Switzerland’s cherished tradition of banking secrecy, which helped it build up a $2 trillion offshore wealth management industry. — Caroline Copley (Reuters) q


u.s.

(Corporate Tax Rate, continued on page 9)

Corporate Tax Rate (from page 3)

needed not to lower how much corporations pay overall, but rather to end economic distortions and complexity that slow economic growth.

The framework document then makes the case that our current corporate tax code encourages debt financing over equity, pass-through organizations over C corporations, and shifting of profits overseas. These are all characterized as unfavorable economic distortions, and many of the proposals in the plan are intended to reverse them.

Trading Tax Expenditures for Corporate Rate Cut The plan seeks to trade a rate cut to 28 percent for

the repeal of targeted tax incentives. It says that reform should start with the “presumption that we should

tax purposes overstate true economic depreciation and are often shorter than under accounting rules. According to Treasury, accelerated depreciation is a less-effective way to encourage investment than simply lowering rates. The position appears to represent a shift in policy, because the administration has pushed hard over the last several years for expensing provisions such as 100 percent bonus depreciation.

• Limiting the deduction for corporate interest—The plan states that reducing the deductibility of interest for corporations should be considered to further limit the current bias toward debt financing. No details are offered as to how this would be accomplished

• Establishing parity between pass-throughs and C corporations—The administration asserts that C corporations and “large non corporate entities” such as partnerships and S corporations should be treated more alike. The plan does not provide any details on how this could be achieved, but the argument is similar to statements from Senate Finance Committee Chair Max Baucus, D-Mont., indicating an interest in taxing some large pass-throughs as C corporations. The administration points to proposals from President Bush’s 2005 Advisory Panel on Tax Reform and President Obama’s 2010 Economic Recovery Advisory Board. Obama’s board offered suggestions such as taxing publicly traded partnerships as C corporations, taxing pass-throughs over a certain size threshold as C corporations or eliminating the double taxation of corporate income. Bush’s panel suggested taxing all large businesses at the entity level but excluding dividends and distributions from individual income.

Manufacturing Incentives The president’s plan seeks to preserve tax incentives

for U.S. investment. This is primarily done by retaining and modifying the research credit and Section 199 deduction, which the administration has proposed several times before. As it has done in previous budgets, the administration proposes to increase the alternative simplified research credit rate from 14 to 17 percent.

Several additional details were offered regarding the proposal to narrow and increase the Section 199 deduction. The new version of the proposal would bring the general deduction from 9 to 10.7 percent, which Treasury said is designed to achieve a top corporate rate of 25 percent on domestic manufacturing activities. The plan also proposes an even higher rate for “advanced manufacturing,” without specifying what constitutes advanced manufacturing or what the rate would be. Earlier versions of this proposal offered a deduction of 18 percent. The new version includes no new information on which activities would be excluded from the deduction,

eliminate all tax expenditures for specific industries, with a few exceptions that are critical to broader growth and fairness.” The tax expenditures that would be retained would be made permanent.

The plan does not clarify whether tax expenditures would be repealed for both corporations and pass-through entities, and it does not offer an exhaustive list of which provisions should be repealed and which should be kept. Instead, Treasury lists five examples, all of which have already been identified in previous presidential budgets:

• repealing the last-in, first-out (LIFO) method of accounting;

• repealing oil- and gas-related tax incentives; • changing the tax treatment of many insurance

industry products; • taxing carried interest in a partnership as ordinary

income; and • eliminating five-year depreciation for noncommercial

aircraft. The administration does not provide any concrete

revenue estimates, but does acknowledge that further “base broadening” would be needed to produce enough revenue to make the package revenue neutral. The plan provides the following three options and says “several would be needed” to bring the rate to 28 percent:

• Repealing accelerated depreciation—The administration argues that the depreciation schedules allowed for

The administration argues that reform is needed not to lower how much

corporations pay overall, but rather to end economic distortions and

complexity that slow economic growth.


u.s.

Corporate Tax Rate (from page 8)

(CRA Audit Approach, continued on page 10)

and in the past the administration has specifically targeted only oil- and gas-related production.

The framework document also proposes making the Section 45 alternative energy production credit permanent and refundable. The other incentives specifically identified in the plan have been previously offered in the president’s budget, including proposals to:

• increase the Section 179 expensing limit to $1 million;

• allow businesses with up to $10 million gross receipts to use cash accounting;

• double the start-up expensing limit from $5,000 to $10,000; and

• expand the health insurance tax credit for small businesses.

International Incentives The administration’s plan explicitly rejects the move

to a territorial system, which generally seeks to tax only income earned in the United States. The framework document states that such a move “could aggravate, rather than ameliorate, many of the problems in the current code.”

Instead, the president reproposes international provisions from his budget, which would:

• limit interest deductions attributable to foreign source income until the income is repatriated;

• tax “excess profits” associated with the shifting of intangibles to “low tax jurisdictions;”

• deny deductions for the costs of moving operations overseas and provide a 20 percent credit for the costs of moving operations to the United States; and

• impose a minimum tax on overseas profits. No new information is offered on the proposed

minimum tax on overseas profits. It is unclear what the rate would be and how the minimum tax would be calculated.

Advancing the Plan The administration does not appear to be close

to offering legislative language or resolving the open issues. There is no concrete revenue estimate for the whole package, though the administration pledges that corporate tax reform “should not add a dime to the deficit.” This pledge appears to be based on a current policy baseline that assumes all temporary tax incentives expire, because the administration says it would pay for the cost of extending the current temporary incentives that it supports, which it estimates at $250 billion. q

© 2012 Grant Thornton LLP

Canada

What’s Happening?The Canada Revenue Agency (CRA) plans to conduct

individual risk-assessment interviews with a select group of 50 large businesses in the near future. These taxpayers face the prospect of being labeled “high-risk,” a designation that will likely come with significant costs related to increased audit scrutiny.

It is important for potential interviewees to understand what to expect from this process, and what their rights are, in order to prepare for the interview and determine the most effective way to participate.

CRA’s New Audit ApproachThe interviews are part of the CRA’s new approach

to large business audits. Instead of assigning audits based on a taxpayer’s gross income,1 the CRA intends to select audits based on “risk.” At the interviews, the CRA is expected to: explain its new audit approach; provide information regarding its initial risk assessment of the taxpayer and identify issues of concern for the next audit cycle; and ask for information regarding the taxpayer’s own assessment of its tax risks.

The interviews are part of the first phase of the new risk-based audit approach, which is being introduced

Latest Step in CRA’s New Audit Approach: “Risk Assessment” Interviews with Large Businesses

By Patrick Lindsay and Sal Mirandola (Borden Ladner Gervais LLP)

Patrick Lindsay ([email protected]) is a Partner in the Calgary office, and Sal Mirandola ([email protected]) is a Partner in the Toronto office, of Borden Ladner Gervais. Mr. Lindsay’s practice is concentrated in tax litigation at all levels, as well as tax settlement negotiations. He has worked extensively with companies in the banking, oil and gas, and mining sectors. Mr. Mirandola’s practice is focused on tax dispute resolution from audit to appeal, including disputes before various courts and administrative agencies related to federal and provincial tax matters.


CRA Audit Approach (from page 9)

Canada


gradually over five years. Within five years, the CRA plans to meet with all large file taxpayers to discuss their risk categorization.

Questions to ExpectLetters issued to the selected taxpayers request a

meeting to discuss items including “the potential benefits of adopting an engaged approach to compliance.” The letter attaches a proposed list of questions for taxpayers, which include:

• How are your tax risks identified, managed, reported and monitored? What are the names of the individuals involved in this process?

• Will you disclose your own analysis of your tax risks?

• Preparing questions for the CRA regarding the new risk assessment audit process including the benefits, costs, and specific changes the taxpayer can expect. The most likely area of disagreement between the

taxpayer and the CRA involves how much information the taxpayer should provide regarding its own assessment of its tax risks. As such, we discuss below: perspectives of the CRA and taxpayers on this issue; the scope of the CRA’s authority to compel taxpayers to produce records; and the impact of the CRA’s request for taxpayer’s own tax risk assessments.

CRA: Taxpayers Must Self-AuditThe CRA’s position is that taxpayers are obligated to

disclose “concerns with regard to tax at risk” to assist the CRA to “identify audit issues.”2

In other words, taxpayers must self-audit and disclose results to the CRA. The extent to which the CRA can compel disclosure of a taxpayer’s own assessment of tax risks has not been tested in Canada. In the United States, the Internal Revenue Service has taken court action against taxpayers that declined to disclose such information, with mixed results.3

From the CRA’s perspective, the audit process would be more effective and cost-efficient if taxpayers simply disclosed their own assessment of their tax risks; “The CRA’s goal is to develop a useful and cost-effective program to better target its compliance efforts.”4

Taxpayers: Must I Tell my Adversary Where I am Vulnerable?

Tax litigation is inseparable from the audit process because information gathered during an audit can be used against taxpayers in litigation. The CRA litigates tax issues regularly using the largest law firm in the country, the Department of Justice. As such, any requests for information from the CRA need to be considered knowing that the CRA has a dual role as both auditor and adversary.

The CRA’s Authority To Access RecordsUnder the CRA’s primary audit power, it has broad

authority to “inspect, audit or examine the books and records of a taxpayer.”5 This authority is necessary for the CRA to carry out the purpose for which it exists – assessing taxpayer’s accuracy and honesty within a self-assessment system. This authority imposes obligations on taxpayers to: maintain and disclose proper books and records; provide “all reasonable assistance”; and answer “all proper questions.”6

Taxpayers should be aware that the CRA frequently asks for information that it cannot compel taxpayers to provide. For example, the CRA often requests access to legal opinions that are protected from disclosure by solicitor-client privilege.7 The CRA also requests

Taxpayers may challenge the reasonableness of the number, scope

and availability of the documents requested.

• Do you have a tax risk management committee? Who is on the committee? Will you provide meeting minutes?

• Describe a situation where you were not compliant and explain what you did.

• Do you use external tax planners? Are any paid on a contingency basis? The questions invite taxpayers to disclose their own

analysis of their tax risks. While most taxpayers may not object to providing the CRA with the necessary records to test the honesty and accuracy of their tax returns, it can be expected that many will take issue with disclosing their own mental impressions regarding their tax risks.

How to PrepareTaxpayers that participate in the interviews should

prepare by: • Reviewing the CRA interview request letter and

considering the questions attached to the letter; • Discussing the scope of the CRA’s authority to compel

answers to the questions and decide in advance how much information to provide at the meeting;

• Reviewing the internal processes for assessing tax risk and consider what information the CRA could compel the taxpayer to produce;

• Considering which individuals should attend, what materials to bring to the meeting, if any, and who will take meeting minutes; and


Canada



information for the purpose of auditing unnamed persons (for example, a client list), even though the CRA has no authority to demand such information without judicial authorization.8 Taxpayers should consider the limits of the CRA’s authority when considering an information request.

Since “risk-assessment” interviews are a new process and the scope of the compliance obligation is unclear, we expect considerable discussion between the CRA and taxpayers regarding the appropriate level of disclosure.

Limits on the CRA’s Authority to Access RecordsLimitations on the CRA’s authority to compel

taxpayers to produce records include: solicitor-client privilege; purpose; reasonability; and relevance. Each limitation is discussed briefly below.

Privilege The most important limitation on the CRA’s ability

to compel the production of information is the solicitor-client privilege. Accountants and other professionals do not have this protection, and the CRA has made it clear that it can and will demand to see accountants’ working papers and similar tax-related documentation where it chooses to do so.9

The current interviews are part of gradual changes in CRA audit practices that have evolved over the past several years. In response to these changes, many taxpayers have organized their tax risk assessment process so that many records are subject to solicitor-client privilege. In such cases, the taxpayers cannot be compelled to produce records that are properly subject to privilege. In some cases, privilege other than traditional solicitor-client privilege may apply, such as where legal advice is sought in anticipation of litigation. Where taxpayers assert privilege, the CRA may request sufficient information in order to assess whether they wish to challenge the privilege claim. The focus in such privilege disputes is often: (i) whether the records at issue were produced as part of a solicitor-client relationship; and (ii) where privileged records were provided to a third party, whether privilege was waived.

Most large businesses consider how to manage their information flow so as to create and preserve solicitor-client privilege where possible. The CRA interview questions directed at accessing the taxpayers’ own tax risks assessment are likely to result in large businesses analyzing their process for identifying tax-risks and considering whether that process should be modified so that solicitor-client privilege applies to more records.

Purpose The CRA exists to verify taxpayers’ accuracy and

honesty within a self-assessing system, which is a distinctly

“regulatory” function. The powers granted to CRA are limited to the carrying out of this regulatory function, as opposed to a policing or legislative function.

The CRA has, on occasion, tried to use its regulatory powers to carry out a policing function. In these cases, where the CRA demands records for the primary purpose of advancing a criminal investigation (i.e., tax evasion), the CRA has no authority to compel a response. Courts have confirmed that CRA’s regulatory powers are not available where the CRA is carrying out a different function.10 Similarly, CRA document demands that are primarily directed at impeding a particular business activity have been overturned on the basis that they do not

The CRa frequently asks for information that it cannot compel taxpayers to

provide.

come within the “purpose” test of the CRA’s regulatory powers.11

Reasonability Any CRA request must provide a reasonable time to

comply.12 In addition to challenging the reasonableness of the time given to comply, taxpayers may challenge the reasonableness of the number, scope and availability of the documents requested. Often CRA requests are necessarily over-broad because the CRA does not have the benefit of knowing what records the taxpayer maintains. Where the scope is perceived as unreasonably broad, discussions with the CRA are needed to try to reach a suitable compromise. Where the CRA compels the production of records, such demand is a “seizure” within the meaning of the Canadian Charter of Rights and Freedoms.13

Since the Charter prohibits seizures that are “unreasonable,” any requests must be reasonable in order to be enforceable. The vast majority of the CRA’s requests for information are clearly reasonable. For example, a request for documents or information necessary to complete an audit is clearly reasonable. A demand to disclose a summary of potential uncertainties in one’s tax filings may be considered unreasonable.

Relevance The CRA is granted authority to “administer and

enforce the Act.”14 As such, the CRA can only compel the production of records or information relevant to this purpose. In the vast majority of cases, relevance is clear and the CRA is entitled to the information requested.


Canada


However, where relevance is unclear, it is important to consider whether this relatively low threshold is met. Where disputed, the Minister need only show that the requested records “may be relevant.”15

Taxpayers may question the extent to which their own mental impressions are “relevant.” The CRA’s job is to gather the necessary factual information and to form its own view as to whether the law has been complied with. Where the CRA has been provided with all of the information necessary to form that view as to the accuracy of the taxpayer’s returns as filed, it is not obvious that

the quality of representation. [Access to the records by the IRS] will have ramifications that will affect the form and detail of documents” prepared when assessing tax risks.16 The same considerations apply in Canada and the extent to which the CRA can access taxpayer records will impact the manner in which such records are prepared and maintained. __________

1 Currently, taxpayers with gross income exceeding $250 million are assigned a large case file manager and a team of auditors who together complete an annual audit. Taxpayers with gross income from $20 million to $250 million are selected for audit based on a complexity rating and are assigned to a single auditor.2 Canada Revenue Agency Technical Statement “Acquiring Information from Taxpayers, Registrants and Third Parties,” June 2, 2010, http://www.cra-arc.gc.ca/tx/tchncl/cqrngnfrmn/menu-eng.html, at para 5. 3 See, for example: U.S. v. Deloitte LLP, 2010 WL 2572965 (D.C. Cir. June 29, 2010) and v. Textron Inc., 577 F.3d 21 (1st Cir. 2009), cert. denied, 2010 WL 2025148 (May 24, 2010). Many corporations in the United States with assets in excess of $100 million must file a schedule identifying uncertain tax positions, see: http://www.irs.gov/pub/irs-utl/df1120.pdf. 4 Canada Revenue Agency, Income Tax Technical News No. 34, (April 27, 2006), available at http://www.cra-arc.gc.ca/E/pub/tp/itnews-34/README.html. 5 Section 231.1 of the Income Tax Act (Canada) (the “Act”). 6 Sections 230, 231.1 and 231.2 of the Act. 7 Boilerplate language used in requirements issued by the CRA often includes a request for legal opinions (without notice to taxpayers that privilege may apply) and contains a caution that criminal prosecution may occur if the requested information is not disclosed. 8 Subsection 231.2(2). The CRA can generally compel such information to be produced after obtaining judicial authorization: Artistic Ideas v. Canada, [2005] 2 CTC 25 (FCA).9 See, for example, Suarez, “Canada Updates Policy on Accessing Working Papers,” Tax Notes International, Vol. 55, no. 3, July 20, 2009 at p. 172.10 See for example: R. v. Jarvis, [2003] 1 CTC 135 (SCC) and R. v. Ling, [2002] SCR 214. 11 See for example: M.N.R. v. RBC Life Insurance Company et al., 2011 FC 1249 at para. 62 where J. Tremblay-Lamar writes: “It was not open to the Minister to seek ex parte authorization under the pretence of verifying compliance with the Act when her true purpose was to achieve through audits what the Department of Finance refused to do through legislative amendment.” 12 Subsection 231.2(1) of the Act. See also R. v. MacDonald, [2005] 5 CTC 77 (BC PC). 13 Canadian Charter of Rights and Freedoms, Part I of the Constitution Act, 1982 being Schedule B to the Canada Act 1982 (U.K.), 1982, c. 11, s. 8. 14 Sections 231.1 and 231.2 of the Act. 15 See for example: 1144020 Ontario Ltd. v. M.N.R., [2005] 3 CTC 310 (FCTD) and Fraser Milner Casgrain LLP v. M.N.R., [2002] 4 CTC 210 (FCTD).16 U.S. v. Textron Inc., 2009 U.S. App. LEXIS 1538, at p 36-37. q

The extent to which the CRa can compel disclosure of a taxpayer’s own assessment of tax risks has not been

tested in Canada.

the taxpayer’s own impressions are “relevant” to the administration or enforcement of the Act. This question has not yet been considered by a Canadian court.

Policy Note: CRA Access Will Impact Financial Reporting

There is an important public policy reason for large businesses to carefully and thoroughly analyze their tax risk. We all recall when public confidence in financial reporting collapsed after the bankruptcy of Enron and others. To rebuild public confidence, reporting issuers faced more stringent financial reporting standards, including an obligation to increase the quality and quantity of records related to the calculation of tax risk.

The records that the CRA now seeks include records generated in connection with the public policy goal of ensuring large businesses accurately calculate tax risks such that the financial statements accurately depict the financial position of the business. In order to calculate tax at risk, taxpayers must consider the strengths and weaknesses of their legal position, including the strength of witnesses and other evidence in the event that uncertain issues are litigated.

If the CRA can access records related to a taxpayer’s own risk assessment, the quality and quantity of records maintained in connection with internal tax risk will decline. As noted by the United States Court of Appeal, if tax advisors who identify “uncertainties in their clients’ tax returns know that putting such information in writing will result in discovery by the IRS, they will be more likely to avoid putting it in writing, thus diminishing


(Tax Changes, continued on page 14)

IReland

The Irish Government published the Finance Bill 2012 on February 8, 2012. The Bill contains further details on the proposals announced in the recent Budget that are aimed at further improving Ireland’s competitiveness for attracting strategic foreign direct investment.

The Bill now proceeds to the Committee and Report stages, where additional amendments may be tabled.

Some of the key details contained in the Bill, which will be relevant to inbound investors into Ireland, are discussed below.

Corporation Tax Measures—GeneralIrish Group Relief

In a move that codifies the recent UK case FCE Bank plc v HMRC, a provision is made to extend the definition of a group for the purposes of surrendering trading losses for tax purposes. The effect of this rule is to move towards an ability to trace the 75 percent required group relationship on a global basis. The application of these rules to each situation will need to be carefully considered. This provision will be effective for accounting periods ending on or after January 1, 2012.

Deduction for Foreign Withholding Taxes A specific provision is made for securing a corporate tax deduction for foreign withholding tax suffered on certain royalty and interest income, not otherwise qualifying for double tax relief or unilateral credit relief. The provision applies to income received after January 1, 2012.

Taxation of Foreign Dividends The Bill also extends the categories of foreign dividends received by Irish companies that can qualify for the 12.5 percent tax rate. At present dividends sourced out of the trading profits of subsidiaries resident in an EU Member State or country with which Ireland has a double tax treaty, are liable to corporation tax at the 12.5 percent rate rather than 25 percent. This will be extended to dividends sourced from the trading profits of subsidiaries

resident in a territory that has ratified the Convention on Mutual Assistance in Tax Matters. This would include countries such as Argentina and Brazil. The measure will apply to dividends received on or after January 1, 2012.

Start Up OperationsIreland currently provides a three-year exemption

from tax on certain trading profits and capital gains

Paul Fleming ([email protected]) is a Director, Norah Walsh ([email protected]) is a Tax Manager, and Tim Kiely ([email protected]) is International Tax Manager, with the Irish Tax Desk of Ernst & Young in New York. Joe Bollard ([email protected]) and Kevin McLoughlin ([email protected]) are Tax Partners with the Dublin office of Ernst & Young.

Irish Finance Bill 2012 PublishedContains Corporate Tax Changes; Benefits for Financial Industry

By Paul Fleming, Norah Walsh, Tim Kiely, Joe Bollard and Kevin McLoughlin (Ernst & Young)

The bill includes a deduction for foreign withholding tax on some royalties and

interest income.

(subject to conditions) to companies with a total corporation tax liability of less than €40,000 per year. The Bill further extends the relief to new companies that commence a trade by December 31, 2014.

Stimulus MeasuresEnhancing Research and Development (R&D)

Tax Credit Regime The Finance Bill introduces a number of enhancements to the R&D regime as follows:

• a volume basis of relief for the first €100K of R&D spent in each period;

• improving the cap on allowable outsourced activity to allow for the greater of either the existing caps or €100K; and

• a provision for certain companies to pass on their R&D tax credits to qualifying key R&D employees. These employees could use the credit to obtain refunds of their income tax (not USC or PRSI). The relief is capped such that the effective income tax rate payable by these key R&D employees cannot be less than 23 percent.

The Bill also makes a provision for a number of technical changes including:

• a welcome form of reorganization relief allowing excess credits to move between companies on certain intra-group trade transfers;

• exempting a clawback of credits for certain intra-group transfers of R&D buildings; and

• a provision for interest and penalties for erroneous claims.


Tax Changes (from page 13)

IReland

(Tax Changes, continued on page 15)

Employee-Related MeasuresSpecial Assignee Relief Program (SARP)

The Finance Bill sets out the detail of the Special Assignee Relief Program, which replaces the limited remittance basis available to non-Irish domiciled individuals on employment income until December 31, 2011.

The relief reduces the Irish income tax liability of individuals who are transferred into Ireland (when the transfer commences in 2012, 2013 or 2014) to work for an associated company. The relief is a welcome development as it will help to reduce the costs for employers assigning key employees and executives from abroad to Ireland.

Though there are some conditions to be satisfied, the relief, if applicable, will operate by granting an exemption

Asset Management The measures proposed by the Bill in relation to the asset management industry include:

• the implementation of facilitating legislation for UCITS IV cross-border mergers/amalgamations and reconstructions (including master/feeder structures) plus associated stamp duty exemptions and rollover of gains for Irish unitholders;

• the extension of simplification measures to the non-Irish resident declaration process to include intermediaries and fund migrations to Ireland; and

• stamp duty exemptions for exempt unit trusts.

Corporate Treasury The Bill contains a welcome measure in relation to the tax-deductibility of certain interest paid by cash pooling operations to non-EU/non-tax treaty jurisdictions that may have been regarded as putting Ireland at a competitive disincentive when it came to multinationals deciding where to locate such operations (although it remains to be seen how the proposed measure operates in practice).

Islamic Finance The Bill includes other facilitating measures that are designed to increase Ireland’s attractiveness as a location for Islamic Finance (allowing, in particular, for a broadening of income which a finance company within the regime may receive).

Aircraft Leasing The proposed extension of credit relief for foreign tax withheld on lease payments from non-tax treaty countries in respect of equipment (including planes and engines) should prove beneficial to the Irish aircraft leasing sector, as well as to other big-ticket lessors.

Insurance The Bill proposes the expansion of exemptions from exit tax on investments in life policies to include investment by certain pension funds bringing the exemptions broadly into line with those available for investment funds.

Capital Markets Certain amendments have been proposed to the residual charge to income tax on Irish publicly-listed debt.

Green IFSCThe Bill proposes additional measures aimed at

supporting the well-publicized “Green IFSC” initiative, including the broadening of the definition of “carbon offsets” within the Section 110 regime with an associated stamp duty exemption in respect of such assets.

The Bill proposes several specific measures to support the continued

success of the Irish financial services industry.

from income tax on 30 percent of employment income between €75,000 and €500,000. The relief can be claimed for the duration of the assignment up to a maximum of five years.

Foreign Earnings Deduction (FED)The Finance Bill introduces a Foreign Earnings

Deduction (FED) as an incentive for companies expanding into Brazil, Russia, India, China and South Africa (BRICS countries) through assigning Irish-based employees to those markets. The relief provides a reduction in the Irish income tax liability for the individual reducing any tax equalization costs for the company.

The FED should allow individual employees to achieve a tax saving of €14,350 per annum where the maximum deduction is available.

Financial Services Industry Measures In addition to several other general measures, including those highlighted elsewhere in this article, which will be beneficial to the financial services industry (such as changes to the SARP, R&D tax credit, FED, group relief for losses, taxation of foreign source dividend income and stamp duty changes), the Bill proposes several specific measures to support the continued success of the Irish financial services industry. These are summarized below.


IReland

Tax Changes (from page 14)

Other Business Taxation MeasuresCapital Taxes

New Capital Gains Tax (CGT) Relief on PropertyThe Bill provides details of the new CGT incentive

for property purchased between midnight on December 6, 2011 and the end of 2013. Provided that a property acquired between December 7, 2011 and the end of 2013 is held for seven years, the proportion of the gain as seven years relates to the entire period of ownership shall be exempt. For example, on a disposal of property after ownership for seven years, the full gain would be exempt. If the property was held for 20 years, 7/20ths of the gain would be exempt.

The relief applies to property in any EEA State in compliance with EU law.

Stamp Duty The Bill gives effect to the announcement in the Budget that a new lower single rate of stamp duty of 2 percent will apply to instruments relating to non-residential property

(previously the maximum rate of stamp duty in respect of non-residential property was 6 percent). Certain reliefs such as associated companies’ relief will no longer require adjudication from Irish revenue. The Finance Bill introduces a number of exemptions from stamp duty in relation to financial services transactions to further strengthen Ireland’s position in the financial services market. These include:

• a provision for relief from stamp duty in respect of the reconstruction or amalgamation of unit trusts and offshore funds;

• the extension of the exemption in respect of the transfer of units in a unit trust to other unit trusts; and

• the extension of the provision of the stamp duty relief in respect of fund reorganizations.

The Bill also provides for a new exemption in respect of the merger and cross-border merger of companies. The Bill also provides for a new exemption in respect of the transfer of property held for the benefit of a pension scheme or charity in certain circumstances. This exemption is effective as of February 8, 2012.

© 2012 EYGM Limited q

RussIa

Russia’s finance ministry, pressured by borrowers and banks, said late on February 20 that it is scrapping plans to collect tax on corporate Eurobonds placed by January 1, 2013 and may apply only a partial levy to papers issued after that day. Some of Russia’s biggest corporate borrowers, including Russia’s top gas producer Gazprom and its second largest state bank VTB, had been facing large bills in relation to existing bond programs. Oil pipeline monopoly Transneft had threatened to redeem over $4 billion bonds at par in response to the proposals outlined by officials in recent months. “First, as regards interest income paid on Eurobonds issued prior to January 1, 2013, we propose to fully release Russian borrowers from any obligations to withhold tax, i.e., from obligations to act as tax agents (including interest income that has already been paid to investors),” the ministry said in a statement.

Tax to Start in January, but Only for Some Corporate Eurobonds issued after January 1 of the next year will be taxed only on interest income received by an intermediary located in an offshore jurisdiction that has no double tax treaty with Russia, the ministry said. Deputy Finance Minister Sergei Shatalov in a letter to tax officials at the end of last year advised that, by Russian law, companies issuing Eurobonds were obliged to pay 20 percent profits on interest at source. The finance ministry had also insisted that payments to foreign debt holders through offshore units called special purpose vehicles (SPV) are taxable under the existing Russian law, but this tax has not been collected in the past. Russian corporates, which have over $100 billion in Eurobonds outstanding, could face a back-tax bill for $600 million, Shatalov said earlier in February. q

Russia Drops Proposed Tax on Eurobonds—For NowBy Lidia Kelly (Reuters)


(Transfer Pricing, continued on page 17)

RussIa

On January 1, 2012 Federal Law No. 227-FZ (Law), which completely revamps the Tax Code provisions on transfer pricing, came into force. The changes replace the previous outdated transfer pricing regulation system with more sophisticated controls, which are widely based on OECD Transfer Pricing Guidelines. The new rules are expected to lead to greater enforcement by the tax authorities; a special division was recently established within the federal headquarters of the Russian Tax Service in order to focus specifically on transfer pricing control and international cooperation (TP Tax Body). The previous Russian transfer pricing rules had been in effect since 1999, when the Tax Code entered into

Transactions in Focus The Law generally confirms the arm’s length principle: a transaction price may be reviewed and adjusted for tax purposes if (i) the parties to such a transaction are deemed related (with certain additional qualifications for parties that are all Russian related entities, described below); or (ii) a particular kind of transaction is specifically defined as controlled.

Related-Party Transactions: Definition of Related Parties Expanded Parties may be deemed related based either on formal criteria (i.e., the type of relation falls within the statutory list), or if the court, at its own discretion, finds that the parties are able to affect each other’s business operations (so-called “judicial criterion”). (Under the previous formal criteria, parties could be deemed related if (i) one party directly or indirectly held more than 20 percent of the other party’s share capital; (ii) the parties were both individuals and have an employer-employee relationship; or (iii) the parties were spouses or relatives under Russian family law. In practice, these criteria excluded any relations between sister companies, or between a company and its management, and many other common situations where individuals and/or entities in fact have significant influence over each other.) Under the new Law the general approach of referring to both formal and judicial criteria remains the same except that the participation threshold has been increased to 25 percent. The list of formal criteria in the previous law, however, has been significantly expanded. As a result, the following parties are deemed related under the new rules:

• legal entities (or a legal entity and an individual) if one entity (or individual) holds, directly or indirectly, more than 25 percent of the other entity’s share capital, as well as groups of legal entities, where more than 25 percent of each entity is directly or indirectly owned by the same person;

• legal entities (or a legal entity and an individual, including together with his or her spouse and certain relatives)1 if one entity (or individual) has the right to appoint the CEO or more than 50 percent of the board of directors/management board of the other entity, as well as legal entities when their CEO or more than 50 percent of their board of directors/management board is appointed by the same person;

• legal entities where more than 50 percent of the board of directors/management board of both entities are

Dmitri V. Nikiforov ([email protected]) and Alyona N. Kucher ([email protected]) are Partners, and Anna S. Eremina ([email protected]) is an Associate, with the Moscow office of Debevoise & Plimpton LLP. Mr. Nikiforov’s practice is focused on venture capital transactions, mergers & acquisitions, corporate financing and general corporate practice, and primarily within the sectors of energy (oil and gas), natural resources, and telecommunications. He is Chair of the Moscow office. Ms. Kucher’s practice is concentrated in infrastructure projects, real estate, oil and gas, and mergers and acquisitions. Ms. Eremina’s practice is concentrated in international and Russian tax, including tax planning and tax implications of particular transactions.

New Transfer Pricing Rules in RussiaSophisticated Controls Could Bring More Enforcement by Tax Authorities

By Dmitri V. Nikiforov, Alyona N. Kucher and Anna S. Eremina (Debevoise & Plimpton LLP)

The new rules are expected to lead to greater enforcement by the tax

authorities.

force, and were widely criticized for their incompleteness and ineffectiveness. This was due, on the one hand, to their vagueness which created a threat of unpredictable tax assessments to taxpayers, and on the other hand, to imperfections in the criteria for “relatedness” and the lack of agreed sources of acceptable market information. The absence of clear guidance often led to differing and inconsistent interpretations of the transfer pricing rules by the Russian tax authorities and courts. The new law was adopted only after extensive reworking by the Ministry of Finance, numerous public discussions, and rejections of several previous bills by the State Duma and has become one of the most noteworthy of recent tax developments.


Transfer Pricing (from page 16)

RussIa


comprised of the same individuals (attribution rules apply for spouses and certain relatives);

• a legal entity and an individual acting as the entity’s CEO, as well as legal entities managed by the same person acting as CEO; and

• individuals where one is subordinate to the other as an employee or where they may be deemed close relatives under Russian family law.

Additional Prerequisites for Russian Related Entities In order for the new transfer pricing rules to apply to a transaction between related parties that are registered or tax resident in Russia (i.e., in a non-cross-border context), at least one of the following prerequisites must be met:

• aggregate revenue from all transactions between the two parties in any respective calendar year exceeds RUB 3 billion (approximately $100 million) (in 2012);2

• one of the related parties is a payer of mineral extraction tax (MET), the transaction concerns extracted minerals subject to a MET percentage rate, and the revenue from transactions between these related parties exceeds RUB 60 million in the respective calendar year;3

• at least one of the parties enjoys a special tax regime in the form of a Unified Agricultural Tax or Unified Tax on Imputed Income, while at least one of the parties does not apply either of these special regimes, provided that the aggregate revenue received from transactions between these related parties exceeds RUB 100 million in the respective calendar year;4

• at least one of the parties is exempt from profits tax or applies a 0 percent profits tax rate as a resident of the Skolkovo Innovative Center area, while the other party (or parties) does not apply such exemption or such tax benefit, provided that the aggregate revenue received from the transactions between these related parties exceeds RUB 60 million in the respective calendar year; or

• at least one of the parties enjoys profits tax benefits as a resident of a special economic zone, while the other party/parties is not resident in any special economic zone with a beneficial profits tax regime, provided that the aggregate revenue received from the transactions between these related parties exceeds RUB 60 million in the respective calendar year.5

These rules will exempt most domestic small- and medium-scale business transactions from transfer pricing control.

Given that Russian tax laws do not provide for any other pricing control mechanisms, starting from 2012 Russian tax authorities should not have any supervision powers with regard to “domestic” related-party transactions that do not reach these thresholds.

Other Controlled Transactions The Law specifically includes the following transactions as subject to transfer pricing control (even when the parties are not deemed related as described above):

• any series of transactions effectively carried out by related entities with the involvement of non-related intermediaries, but which do not perform any additional functions apart from arrangement of resale from one related party to another;

• foreign trade in international exchange commodities: oil and oil products, ferrous and non-ferrous metals, mineral fertilizers, precious metals and stones, provided that the amount of aggregate revenue received from the transactions with the same party exceeds RUB 60 million in the respective calendar year; and

• any transactions with persons registered or tax resident in jurisdictions on the so-called “black list” of the Russian Ministry of Finance (the list currently includes, for example, Cyprus, along with other popular jurisdictions for holdings in Russia, such as British Virgin Islands, Jersey and Guernsey), provided that the amount of aggregate revenue received from the transactions with the same party exceeds RUB 60 million in the respective calendar year.6

In addition, a court may, upon a claim filed by TP Tax Body, rule that a transaction must be subject to transfer pricing control if the court believes that such a transaction belongs to a series of similar transactions undertaken to avoid transfer pricing control.

Transactions Exempt from Transfer Pricing Control Importantly, certain transactions are outside of the scope of the new transfer pricing rules: some are specifically exempt and therefore relevant prices cannot be reviewed. Other transactions are subject to specific rules (e.g., transactions with securities and derivatives), and still others are not yet expressly subject to the Law (as described below). First, the Law provides for two types of transactions that are expressly not subject to transfer pricing control; both types of transactions relate to the specific status of the parties. Exempt from control are (i) transactions between parties that belong to the same consolidated group of taxpayers,7 and (ii) transactions between profitable parties that are registered in the same region of Russia, act exclusively within this region and pay profits tax (in its regional portion) only to the relevant budget, provided that they do not apply any exemptions and special tax regimes or are not subject to MET (as described above). According to the Law, with regard to these transactions Russian tax authorities have no power to review or revise relevant prices. Second, transactions with securities or financial instruments (derivatives) are still regulated by specific transfer pricing rules enacted in 2010 (which remain in



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force); the amendments in the Law do not cover any specific issues associated with the sale of securities. At the same time, it is unclear but still possible that parties to securities and derivative transactions are now required to adhere to the new tax administration connected to the new transfer pricing rules (including reporting and audits, as described below). Notably, under the common treatment (that was in the past supported by the Ministry of Finance, tax authorities and courts) the previous transfer pricing rules did not apply to transactions with proprietary rights, such as shares in Russian limited liability companies, and could not be applied to royalties and interest. However, under the Law these transactions are not expressly exempt from transfer pricing control. When commenting on the Law, representatives of the Russian Ministry of Finance expressed their view that the new rules should also make these types of transactions subject to transfer pricing control, and it is expected that relevant amendments to the Law will be soon initiated.

Adjustment of Price Prices set in transactions between unrelated parties and other transactions not subject to transfer pricing control are presumed to be at a market level. For related-party and other controlled transactions prices can be compared to the market level and, if necessary, re-assessed by the TP Tax Body (but not by the local tax inspectorate) for the purposes of the following taxes:

• Russian profits tax; • personal income tax payable by individual

entrepreneurs, notaries, advocates and other individual practitioners;

• MET (if one of the parties is a MET payer and the transaction deals with minerals that are subject to a MET percentage rate);

• value added tax (VAT) chargeable on transactions where one party is a person exempt from VAT.Under the new law, income received other than at an

arm’s length basis can be re-assessed only if this leads to an increase in tax liability (except for adjustments made as a result of a corresponding adjustment). This provision conflicts with Art. 9 of the OECD Model Tax Treaty and similar provisions in tax treaties entered into by Russia. As of yet, the Russian Tax Administration has not indicated how it will deal with this conflict.

Before the enactment of new transfer pricing rules the tax authorities were tasked with determining whether the actual price deviated from the market level by more than 20 percent (if the difference was less than 20 percent no pricing adjustment was permissible). From 2012, this rule has been abolished, and the TP Tax Body is required to compare the reviewed transaction with one

or more comparable non-related-party transactions. In making its determination the TP Tax Body can use a range of five different methods (separately or in any combination) of recalculating the price, three of which (using the comparable market prices, transactional net margin method and profits split method) are new and are available along with the previously used resale minus and cost plus methods. In any event, the comparable market prices method should be given priority.

Comparability of Transactions The Law provides for numerous criteria that must be

taken into account when determining the comparability of transactions. For example, it is necessary to consider the characteristics of the goods, the functions performed by the parties, as well as their possessions, commercial strategies and risks taken. The terms and conditions of the contracts in question, as well as the nature and any peculiarities of the relevant markets should also be taken into account.

Information About Market PricesIn contrast with the previous transfer pricing rules, the

Law introduces a list of public information sources that can be officially used by TP Tax Bodies to compare the price in question with the applicable market price. The list includes quotations of Russian and foreign stock exchanges, foreign trade customs statistics, information officially published by Russian and foreign state authorities and provided by information and price assessment agencies. The tax authorities can also use information on prices that was previously used by the audited taxpayer. This list of sources is non-exhaustive but the authorities are not allowed to use any confidential information, apart from information concerning the audited taxpayer itself and its transactions with related parties.

Under the Law, it is the TP Tax Body that is required to prove that a price is not at a market level; at the same time, taxpayers remain responsible for their transfer pricing reporting and calculations.

Prices Presumed to be at Arm’s Length According to the new rules, certain prices are presumed to be at a market level:

• prices prescribed by antitrust authorities and other state regulated prices (if they fall within specifically established limits);

• prices set as a result of exchange auctions at Russian and foreign stock exchanges;

• the value of the property that is the subject of the transaction as determined in the course of the independent appraisal (when such appraisal is mandatory); and

• prices determined in accordance with an advance pricing agreement (see below).



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Tax AdministrationThe TP Tax Body is the authority exclusively

empowered to perform transfer pricing control by conducting specific transfer pricing audits (TP Audits) that will take place along with regular field and desk tax audits conducted by local tax inspectorates.

Reporting Requirements8 No later than May 20 of each year, a taxpayer is

required to notify its local tax inspectorate about any related-party or other controlled transactions (as described above) performed in the previous calendar year (the statutory form of such notification is yet to be approved). The local tax inspectorate must pass this information on to the TP Tax Body, together with any similar information revealed in the course of ordinary tax audits.

In addition to self-reporting duties, at the request of the TP Tax Body a taxpayer must provide information about particular transactions (or series of transactions), its counterparties (with indication of their tax residency, role in the transactions, used assets, risks taken, etc.), the terms and conditions, as well as pricing methods used by the taxpayer and adjustments of tax base. The TP Tax Body can request this information no earlier than June 1 of the year following the year when the transaction in question took place. The TP Tax Body is not entitled to request any documents concerning (i) transactions that are not related party or not otherwise controlled, (ii) prices that are state regulated or prescribed by antitrust authorities, (iii) transactions with securities or financial instruments quoted on a stock exchange, (iv) transactions regulated by pricing agreements.

Failure to comply with the above reporting requirements can lead to a fine of RUB 5,000.

Transfer Pricing Audits9

A decision to conduct a TP Audit must be issued no later than two years after the taxpayer is notified; the review period for a TP Audit cannot exceed three years prior to the year of the audit (i.e., the year when a decision to undertake the audit is made). Repetitive TP Audits (i.e., second transfer pricing audits concerning same transaction [or series of transactions] and the same calendar year) are not allowed. Moreover, once a TP Audit is performed with regard to one party to a transaction (or series of similar transactions) and the prices are found to be at a market level, other parties to such transactions cannot be subject to a separate TP Audit. A standard TP Audit will last no more than six months (other than exceptional cases where it can possibly be extended to nine months). It is remarkable that the TP Tax Body has significantly less power than a local tax inspectorate performing a regular tax audit; for example, the TP Tax Body cannot examine a taxpayer’s premises or seize documents.

If as a result of a TP Audit the TP Tax Body discovers any deviations from market level that lead to underpayment of tax, it is supposed to issue an act to summarize the findings and justification thereof. The taxpayer may then file a letter of disagreement.

In order to collect taxes assessed as a result of a TP Audit as described above, the TP Tax Body must apply to a court.

Corresponding AdjustmentsThe Law introduces the right to corresponding

adjustments: namely, if the TP Tax Body discovers any underpayment of tax and the audited party discharges the underpayment, other parties to the transaction in question that are Russian taxpayers can also adjust their tax liabilities accordingly. The TP Tax Body is required to notify other parties about such possibility.

The new rules exempt most domestic small- and medium-scale business transactions from transfer pricing

control.

Adjustments can be made within the limits indicated in the relevant notification (provided that the figures set in the notification are the same as those in the decision to charge underpayment). If the decision to charge underpayment is revoked or changed, the other parties are also required to reverse the corresponding adjustments. The Law does not provide for the right to make corresponding adjustments if the principal adjustment is made as a result of the taxpayer itself proactively adjusting the transfer pricing as distinct from the TP Tax Body requiring and making such adjustments.

Advance Pricing Agreements Advance pricing agreements (APA) are a new concept for Russian taxpayers. Starting from 2012 Russian legal entities that are “major taxpayers” have an opportunity to enter into APAs with the TP Tax Body (represented by its head or deputy head) and thus to agree on the pricing methods applicable to a related-party or other controlled transaction (or series of transactions) as well as on the sources of information on market prices. If the taxpayer plans to enter into a foreign trade transaction with a resident of any country that is a party to a double tax treaty with Russia, it can apply to the TP Tax Body with a request to enter into an APA with an authorized body of such a treaty country. A multilateral APA can also be concluded with a group of related entities that plan to enter into similar controlled transactions; in such cases the APA applies to all such related entities. An APA can be concluded for three years and possibly be extended for no more than two years. In order for the TP Tax Body


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to consider an application for conclusion of an APA, a taxpayer must pay a fixed state duty in the amount of RUB 1.5 million. As mentioned before, prices agreed on in the APAs are presumed to be at arm’s length. If a taxpayer complies with APA provisions, it cannot be charged with any underpayments, fines or late payment interest. In addition, the TP Tax Body is not entitled to request any documents relating to transactions entered into in accordance with the conditions set forth in an APA. Taxpayers that are parties to an APA are guaranteed that the agreed pricing methods will remain in effect regardless of any changes in Russian tax laws. Nonetheless, the APAs may not become a very popular tool, since they are available only to a small range of Russian legal entities and cannot be quickly entered into. TP Tax Bodies have six months to consider every application for APA conclusion, and any APA can enter into force no earlier than January 1 of the year following the execution thereof. In addition, the TP Tax Body has the right to terminate any APA if it believes that the terms of the APA were breached and that led to underpayment of tax.

Penalties Starting in 2017, any underpayment of taxes resulting from transfer pricing will be subject to a fine amounting to 40 percent of such underpayment (but in any event no less than RUB 30,000) and applicable late payment interest. Before that, the Law provides for a transition

period: in 2012-2013 fines will not be applicable at all, and in 2014-2016 fines will amount to 20 percent. A taxpayer will be relieved of fines if it provides the TP Tax Body with documents justifying its transaction pricing and proving its compliance with the methods provided for in the Tax Code. Therefore, transfer pricing monitoring and compliance and transfer pricing documentation are expected to become more relevant in Russia like it has in many other countries to avoid the imposition of stiff penalties.__________1Such relatives include parents, children, siblings and legal guardians.2According to the Law, a threshold of RUB 3 billion is set forth for 2012; for 2013 it is set at RUB 2 billion, and starting from 2014 RUB 1 billion.3In order to determine the aggregate annual revenue the TP Tax Body is entitled to examine all revenue received within the calendar year from the transfer pricing perspective.4This additional prerequisite will become applicable starting from 2014.5This additional prerequisite will become applicable starting from 2014.6The “black list” was ratified by the Order of the Ministry of Finance No. 108h, dated November 13, 2007, as amended, and includes 42 low-tax jurisdictions that do not require the disclosure and provision of information on financial operations.7The concept of consolidated group of taxpayers was enacted together with the new transfer pricing rules: at the end of November the President signed into law No. 321-FZ (Law On Tax Consolidation) to amend the Tax Code with relevant special provisions. According to this Law, consolidation for tax purposes is available only for Russian companies with inter-company participation of 90 percent or more, consolidated group

revenues of no less than RUB 100 billion, consolidated taxes of no less than RUB 15 billion, and consolidated asset value of no less than RUB 300 billion. Obviously, with these thresholds, tax consolidation is unavailable to the vast majority of taxpayers in Russia.8Reporting requirements addressed in this section will apply in 2012 if the aggregate annual income from related-party or other controlled transactions with the same counterparty exceeds RUB 100 million; in order for these requirements to apply in 2013 such amount must exceed RUB 80 million; starting from 2014 they will apply without limitations.9For the year 2012 tax audits addressed in this section will apply to taxpayers whose aggregate annual income from related-party or other controlled transactions with the same counterparty exceed RUB 100 million; in 2013 such amount must exceed RUB 80 million; starting from 2014 they will apply without limitations. q

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