Tax Executives InstituteNovember 2006 High Technology

Lester D. Ezrati Senior Vice President, TaxHewlett-Packardlester.ezrati@HP.com

Janet S. WongTax PartnerKPMG LLPjswong@KPMG.com

Mike Reichert Office Managing Tax PartnerGlobal Managing Tax Partner-TechnologyDeloitte Tax LLPmreichert@deloitte.com

November 6, 2006

2

Leveraged Financing

USP

Facts• USP directly owns Finco, a Country

A finance company and controlled foreign corporation (“CFC”)

• USP also directly owns CFC1 (Country B), CFC2 (Country C), and CFC3 (Country D), all CFCs and operating companies in their respective countries

• Finco is not subject to local country tax

• CFC1 and CFC3 are subject to local country tax rates of 20%, while CFC2 is taxed at the rate of 40% in Country C

• CFC1, CFC2 and CFC3 require cash to fund operating activities

Considerations• Local country withholding taxes on

interest payments made to Finco• Thin-cap restrictions prevent

additional leveraged financing at the Opco level

• Prior to recent Subpart F modifications under §954(c)(6), interest paid by CFC1, CFC2, and CFC3 to Finco resulted in Subpart F income.

CFC2(Opco)

CFC3(Opco)

Finco

CFC1(Opco)

(C) (B) (D)

(A)

20% 20%40%

0%

LoanLoanLoan

3

Leveraged Financing – Cont’d

USP Restructuring• Step 1: USP forms CFC Holdco, a

Country X CFC• Step 2: USP contributes Finco,

CFC1, CFC2, and CFC3 to CFC Holdco. Subsequently, Finco, CFC1, CFC2, and CFC3 make check-the-box (“CTB”) elections to be disregarded resulting in D reorganizations

• Step 3: CFC2 purchases the shares of CFC1 and CFC3 from CFC Holdco in exchange for a note

Result• Additional leverage at CFC2 in

connection with purchase of CFC1 and CFC3 reduces CFC2’s taxable income

• Interest paid by CFC2 to CFC Holdco is disregarded and therefore, is not Subpart F income

• Interest paid by CFC1 and CFC3 to Finco is also disregarded and is not Subpart F income

CFC Holdco

CFC2(Opco)

CFC3(Opco)

Finco

CFC1(Opco)

(C)

(B) (D)

(X)

(A)

20% 20%

40%

0%

0%

LoanLoan

Note

Loan

Shares of CFC1 and CFC3

4

Leveraged Financing – Cont’d

• Benefits:– Global cash management– Working capital enhancements– Effective tax rate enhancement on non-U.S. earnings

• Consider optimizing interest rates by country/region

5

CFC Look-Through Rule : Section 954(c)(6)

• Purpose: Allow U.S. companies to redeploy active foreign earnings without an additional tax burden

• Related party dividends, interest, rents and royalties• Received or accrued from a CFC and the payor is a

related person as to the recipient CFC. • But only to the extent amounts are attributable or

properly allocated to income of the payor CFC that is not Sub F income

• “Dividends” should include Section 302/304 dividends, less certainty regarding 964 (e) dividends

• “Interest” should include factoring income

6

CFC Look-Through Rule- Cont’d• Partnership payments – likely apply requirements at

CFC partner level• Gains attributable to the sale of assets that generate

look-through payments are not excepted from Sub F under section 954 (c)(6).

• 3 year provision; possible extension; possible CFC fiscal year change to gain one more year

• Opportunities to increase effective tax rates for 902 or Sub F high tax exception purposes

• Opportunities to uncover basis

7

Merger & Acquisitions

• Transaction Costs•Due Diligence•“Non-inherently Facilitative” Amounts Incurred

Prior to “Bright-Line” Date•“Success based fees” related to activities not

facilitating the transaction

• “Check-the-Box” Elections

8

Advance Payments

USP

Facts• CFC Manufacturer

licenses technical know-how from USP and makes royalty payments to USP

• CFC Holdco has a cost-sharing arrangement with USP for the development of intangible property and makes cost-sharing payments to USP

• CFC1, CFC2, and CFC3 are operating companies in their respective countries

CFC Holdco(IP)

CFC2(Opco)

CFC3(Opco)

CFC1(Opco)

(C) (B) (D)

(X)

CFCManufacturer

(Licensee)

Royalty Payments

Cost-Sharing Payments

30%30%

9

Advance Payments – Cont’d

Advance Payments• CFC Manufacturer

makes advance royalty payment to USP resulting in additional royalty expense

• CFC Holdco makes advance cost-sharing payments to USP resulting in additional cost-sharing expense

Considerations• Advance payments

must be at an arms length standard and term

Advance Royalty Payment

Advance Cost-Sharing Payment

USP

CFC Holdco(IP)

CFC2(Opco)

CFC3(Opco)

CFC1(Opco)

(C) (B) (D)

(X)

CFCManufacturer

(Licensee) 30%30%

10

Advance Payments – Cont’d

• Benefits– Global cash management– Effective tax rate enhancement through FTC utilization– Enhanced section 199 or ETI savings– FAS 123R APIC pool enhancement opportunity

11

Foreign Subsidies, Credits and Incentives• Spain: R&D credits for R&D conducted in Spain billed to U.S.• France: R&D credits for R&D conducted within the EU and

billed into France• Brazil: Exemption for non-recoverable state transaction tax on

service parts• Mexico: R&D tax credits• Singapore: a. 5% tax rate for intercompany

royalty income b. 10% tax rate for international

headquarters applies fro distribution an procurement functions. Possibly lower rates.

• Malaysia: Pioneer incentives with minimal investment

12

Research and Development Tax Credit

• California – Computation & California sales

• Federal – Affiliated gross receipts- CCA 200233011 (May 1, 2002)

- CCA 2006 (February 14, 2006)

• Federal – Extension update

13

Section 59(e) Planning• Annual election to capitalize and amortize section 174

expenditures over 10 years– Effective Tax Rate enhancement under: section 199, ETI, FTC

utilization, state apportionment planning or FAS 109 attribute optimization

– CFC E&P planning opportunities– Section 382 mitigation– FAS 123R APIC pool enhancement

• Amended tax return opportunities still exist

• Separate California elections allowed

14

Federal Telecom Excise: Notice 2006-50

• Tax no longer applies to time-only long distance service• Refund / Credit available

– Must follow notice– Services billed before 3/1/03 - Regular refund methods.

Statute must be open – Services billed after 2/28/03 and before 8/1/06 – claim on

2006 return– Services billed after 7/31/06 – refunds directly from carriers

• For corporations telecom bills will have to be examined. HP examined every invoice quarterly to support its litigation.

• State and city taxes

15

Compensation

• Section 162(m)– Consider conversion of restricted stock arrangements to

performance-based compensation – $1 million cap does not apply [per IRC 162 (m)(4)(C)]– Excessive compensation does not apply to US subsidiaries of

publicly-held foreign corporations [PLR 200537005]

• IRC 409A– Penalty Calculation– Notice 2006-79

16

Affirmative Tax Planning Opportunities

• If you are looking for some “last minute” tax return deductions, consider:– Lien date method for real property taxes– Section 263(a) “pre-paid expenditures”– Revenue recognition- Rev. Proc. 2002-34– Depreciable life classifications– Payroll tax on bonus accruals– State income tax accrual methodology

17

Questions

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.