On Tuesday, May 23, 2017, the Internal Revenue Service (IRS) Large Business and International Division (LB&I) hosted its sixth in a series of eight webinars regarding LB&I Campaigns. Our previous coverage of LB&I Campaigns can be found here. The webinar focused on two cross-border activities campaigns: (1) the Repatriation Campaign and (2) the Form 1120-F Non-Filer Campaign. Below, we summarize LB&I’s comments on the new campaigns.

Repatriation Campaign

In general, the active earnings of foreign subsidiaries are not subject to tax until repatriated to the United States. Typically, those repatriations would be treated as dividends and would be subject to tax. LB&I stated that, through examination experience, it has observed that some taxpayers have engaged in techniques to permit repatriation from such entities while inappropriately avoiding US taxation.

LB&I developed the Repatriation Campaign with three goals in mind. First, LB&I was concerned with developing better objective techniques to identify risks across the broad taxpayer population. Second, LB&I is trying to improve sightlines into a broader segment of the LB&I population beyond the largest taxpayers under continuous audit. Third, LB&I intends to address any compliance risks related to repatriation in a way that increases voluntary compliance.

Unlike other campaigns, LB&I is not focused on a specific structure or techniques. LB&I is instead trying to identify objective indicators of opportunities to implement questionable planning (in the IRS’s view). Per LB&I, returns with those indicators are more likely to present compliance risks and are more likely to be selected. LB&I stated that it does not believe publicly identifying those indicators will increase voluntary compliance. Historically, when LB&I selected a return for examination, it did not necessarily start with any particular issue; any issue could be examined. If a return is selected under this campaign, LB&I’s initial focus will be narrower, but other compliance issues, if discovered, can still be added to the audit. Repatriation issues can also be raised outside of the Repatriation Campaign—possibly in a continuous audit or in an audit relating to another LB&I campaign. Continue Reading The View from Here: LB&I’s Cross-Border Activities Campaigns Webinar

Adoption of the base erosion and profit shifting (BEPS) action items in specific countries can be expected to alter traditional multi-national enterprises (MNE) tax strategy processes. In this regard, it is appropriate to note that tax authorities and the Organization for Economic Co-operation and Development (OECD) often seem to overlook, or conveniently ignore, that MNE strategies are often a function of the rules established by countries to develop their own tax base (at the expense of other countries). In other words, countries, in their respective self-interests, grant incentives of various sorts to encourage economic investment. MNEs take advantage of these incentives to minimize their tax liabilities, which the BEPS process views as, somehow, inappropriate behavior of MNEs denuding the tax base of other countries.

Like water going downhill, MNE planning strategies will utilize the most efficient path to achieve desired objectives. This is a fiduciary duty to shareholders. Effective tax rates are a major expense of all MNEs, which need to be managed as effectively as possible in a competitive world. For example, if Country A offers an incentive such that MNE #1 makes an investment in Country A, as opposed to Country B which offers no such incentive, the net result is that jobs and economic activity are created in Country A not B. Country B may perceive that its tax has been eroded. But who has done this? Country A via its incentive or MNE #1?

International tax disputes arise when Country B challenges the activity of MNE #1 asserting that it should have been paying tax in Country B. If there is a treaty between Countries A and B, there could be a mutual agreement procedure (MAP) proceeding. If that proceeding stalls for whatever reason, then all parties would benefit from processes that would lead to resolution.

The transparency demanded by the Country-by-Country (CbC) package and related matters evolving on a unilateral country basis (seeking, once again, to attract tax base away from other countries) will create new opportunities and paradigms for MNE effective tax rate strategies. It may be that these evolutions will drive planning and acquisition strategies toward treaty or non-treaty protected corporate structures designed to: (i) take advantage of new opportunities created by the new  regimes; and (ii) minimize transfer pricing exposures, imposition of exit or other taxes on the movement of intangibles or other assets, and so on. As these strategies evolve, the net result may not be an outcome that was anticipated by organizers of the BEPS project. This was certainly the case with respect to design of our current international tax system just after World War I.

These evolutions in the international tax world reflect, not surprisingly, what is evolving in the global political world. The popular press regularly addresses what is often described as globalism vs. populism, which reflects an apparent trend of voters and governments to focus less on the global good and more on local needs. The same phenomenon appears to be evolving in the world of cross-border taxation, which may be evolving as it did in 1926: idealistic visions of a globalized tax order (BEPS) vs. realism-populism on a CbC basis. Countries seem to be reacting to the former (BEPS) as they did to the League of Nations (The League) in 1926. The League assumed there would be consistent adoption of tax policy throughout the world, but countries pursued agendas to achieve their respective objectives. In contrast to the policies incorporated in the BEPS final actions, countries seem to be pursuing their own policies. Several countries have adopted, or are considering, an incremental tax on what are deemed excessive profits in other countries (the diverted profits tax or its equivalents in the UK, India, France and so on), declaring that taxes so collected are not subject to treaty relief (it is up to other countries to provide relief from double taxation). The US may be seriously addressing border adjustability, territorial, and related elements, as the EU is evolving toward the formulary allocation mechanism (the “CCCTB”). These are all elements that will need to be framed in MNE effective tax rate (ETR) strategy evolution (including compliance and controversy realities).

In short, our global tax world is plainly in a state of transition. The ultimate reality may be far different than was anticipated by the BEPS process.

Several notable court opinions were issued 2016 dealing with a variety of substantive and procedural matters. In our previous post – Tax Controversy 360 Year in Review: Court Procedure and Privilege – we discussed some of these matters. This post addresses some additional cases decided by the court during the year and highlights some other cases still in the pipeline.

Continue Reading Court Opinions – A Year In Review

Transfer pricing, the allocation of income or loss between members of a controlled group, (TP) continues to be the critical taxation issue in the cross-border world (international, federal or state), whether in planning, controversy or other purposes. Why is this case? Because the tax consequences of each entity begins with its income or loss posture.

Continue Reading Transfer Pricing Developments – A Year in Review

Facebook is in a protracted battle with the IRS related to its off-shoring of IP to an Irish affiliate. Read more here. The IRS issued an administrative summons for the documents, and Facebook has refused to comply with the summons. The IRS is asking the court to enforce the summons and force Facebook to turn over the requested documents. The court agreed that on its face, the summons was issued for a legitimate purpose. Facebook will now have to tell the court why it refuses to turn over the documents. Review the court order here. Assumedly, Facebook is asserting that it is not required to disclose the requested materials based upon a claim of privilege. The case demonstrates that the IRS is aggressively seeking documents and information from taxpayers and their representatives in cases involving international tax issues.

On July 12, 2016, the Internal Revenue Service (IRS) finalized regulations allowing third-party contractors (i.e., outside economists, engineers, consultants and attorneys) to participate in audits of taxpayers.  The regulations are not limited to allowing outside parties to review taxpayers’ books and records, but extend to the full participation in summons interviews.  The final regulations replace proposed and temporary regulations issued in 2014.

The IRS’s position is highly controversial and several organizations submitted comments arguing against finalization of the regulations.  Additionally, the IRS’s position was the subject of a dispute between Microsoft and the IRS relating to the IRS’s use of the law firm of Quinn Emmanuel in an audit of Microsoft’s transfer pricing.  It appears highly likely that taxpayers will challenge the validity of the final regulations in court, and at some point a court will be required to decide the issue.  In the wake of the final regulations, taxpayers that are currently under audit should consider requesting that the IRS provide a list of all third-parties, including outside contractors that are being consulted with during an examination.  It is a good practice to request in writing a list of the third-parties that the IRS contacts during the course of an examination.

The ABA recently issued comments to the IRS and Treasury regarding the new temporary regulations issued in TD 9738 concerning the aggregation of controlled transactions, under Section 482, which broaden (“clarify”) the scope of intangible value, to include “all the value provided” from a controlled transaction, and such other transactions that may occur before, during or after, that are so interrelated, as to require aggregate consideration. See attached. While the IRS does not explicitly mention goodwill or going concern—except by reference in one example—the regulations are intended to sweep in the consideration of any goodwill, including synergy, value that may relate to such transactions.

Given the inherent difficulty, and the persistent controversy, as exhibited in the past (i.e., the Veritas and Amazon cases) and as certainly more is yet to come (BEPS) in attempting to determine the value of intangibles generally, let alone goodwill, for the sake of good tax administration, the IRS would do well to provide more concrete/ explicit definitions, or at least boundaries, as to what or when this “extra” value may, or may not, be likely to apply.

This broader scope of consideration is now likely to make it easier for the IRS to recast transactions on economic substance or realistic alternatives grounds, leading to more controversy and disputes, not just with taxpayers, but with foreign governments as well.

We are proud to congratulate our Dallas colleague, Tracy Gomes, McDermott’s chief economist in transfer pricing, upon his appointment as chair of the American Bar Association Transfer Pricing Committee.  This position provides the opportunity to propose issues and comments, and to have access to US tax officials in the Internal Revenue Service and Treasury Department as part of the ABA’s leadership committee.  It expands upon McDermott’s already substantial knowledge, reputation and experience in the transfer pricing arena—an increasingly important area of IRS attention and focus.

This appointment reflects recognition of McDermott’s professionals as thought leaders in transfer pricing, as well as our commitment to furthering the collective knowledge-base, understanding and application of reasoned and cogent tax administration, and role in the shaping of tax policies, particularly in light of the changing international tax rules brought about by the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) action items.