HOW TO SELECT THE APPROPRIATE BUSINESS ENTITY

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HOW TO SELECT THE APPROPRIATE BUSINESS ENTITY

• by V. Susanne Cook and
• David Reams Jamieson
• Cohen Grigsby, P.C.

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TRAUM AG,a publicly-tradedGerman corporation
Carson Industries, LLC,a Pennsylvania limited
liability company
MEXICAN JOINT VENTURE COMPANY
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Carson Industries, LLC,a Pennsylvania limited
liability company
TRAUM AG,a publicly-tradedGerman corporation
NAFTA elimination of discrimination, vis-à-vis
U.S. companies
MEXICAN JOINT VENTURE COMPANY
Vehicles
Sociedad Anónima
Sociedad Anónima de Capital
Variable S.A. de C.V.
Sociedad de Responsabilidad Limitada
S.R.L.

Sociedad en Nombre Coletivo
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LETTER OF INTENT

• STATEMENT OF PURPOSE

• CAPITAL CONTRIBUTION

• TECHNOLOGY

• NON-COMPETITION

• DISPUTE RESOLUTION/EXIT STRATEGIES

• CONFIDENTIALITY

• DISTRIBUTION

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A Primer on International Taxation

• An Exercise in Futility or
• Tax Planning Utopia?

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The Two Most Commonly Asked Questions

• How do I get money out of my offshore company?
• What are the tax consequences of getting my money
  out - both in the United States and in the
  foreign jurisdiction?

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Basic Analytical Approach

• While the question of how to get money out of a
  foreign jurisdiction is critical, the answer to
  the tax consequences inquiry oftentimes will
  dictate the method(s) used to extract cash from
  abroad.

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The Tax Consequences Inquiry

• For purposes of considering the tax consequences
  of going international, a taxpayer must
  consider both
• The local tax consequences of the activity (i.e.
  the tax implications of doing business in the
  foreign jurisdiction), and
• The United States tax consequences of conducting
  the business abroad.

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The Tax Consequences Inquiry

• As is almost always the case when one considers a
  new offshore business, I would first like to
  focus on the local tax consequences of
  establishing a business outside the United
  States, and then we will turn our attention to
  how the United States will tax the owners of such
  new business.

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Local Tax Consequences

• For the most part, each jurisdiction (with the
  exception of certain so-called tax-havens)
  around the world will impose an income-like tax
  on business profits earned in such jurisdiction,
  so long as the profits are related to a
  permanent establishment.

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Local Tax ConsequencesSlide 2

• A taxpayer will have a permanent establishment in
  a local jurisdiction if
• It has an office or fixed place of business in
  such jurisdiction
• It maintains an inventory in such jurisdiction
  or
• It maintains an employee or dependent agent in
  such jurisdiction.

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Local Tax ConsequencesSlide 3

• Based on the facts presented, our client will
  have a permanent establishment, since it will
  have a plant located in Mexico (i.e. it will have
  an office or fixed place of business in Mexico).
  Therefore, our offshore company will be subject
  to income-like taxation in Mexico.

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Local Tax ConsequencesSlide 4

• In addition to local taxes on the business
  entity, most jurisdictions impose taxes on
  payments made from the local company to its
  owner(s) located abroad. These taxes typically
  take the form of withholding taxes on
• Dividend Payments
• Interest Payments
• Royalty Payments and/or License Fees

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Local Tax ConsequencesSlide 5

• The typical withholding tax ranges from 20 to
  40. These rates are oftentimes reduced under
  the vast income tax treaty network of the United
  States. Typical withholding tax rates under
  income tax treaties range from 0 to 15.

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United States Tax Consequences

• The U.S. tax consequences associated with going
  international depend on the type of entity used
  in the international endeavor. Since we have two
  businesses coming together for our endeavor, our
  entity choices for U.S. tax purposes are either a
  Corporation or a Partnership.

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United States Tax ConsequencesSlide 2

• Regardless of the entity, a taxpayer forming an
  offshore company to accommodate its international
  business must consider the following questions

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United States Tax ConsequencesSlide 3

• Are the business profits of the offshore company
  subject to current U.S. taxation, regardless of
  distributions?
• Can the taxpayer utilize losses generated in the
  foreign jurisdiction to offset its other U.S.
  income subject to U.S. income tax liability?

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United States Tax ConsequencesSlide 4

• Are there limitations on the business
  relationship between the U.S. taxpayer and the
  offshore company?
• What is the overall net impact of the payment of
  taxes in the foreign jurisdiction?

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United States Tax ConsequencesSlide 5

• Are the business profits of the offshore company
  subject to current U.S. taxation, regardless of
  distributions?
• Answer may depend on whether the offshore
  company is a partnership or corporation for U.S.
  tax purposes.
• Classification of an entity for U.S. tax purposes
  - check the box rules - except for per se
  corporations.

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United States Tax ConsequencesSlide 6

• Are the business profits of the offshore company
  subject to current U.S. taxation, regardless of
  distributions?
• Rules Applicable to Corporations
• Controlled Foreign Corporation Rules
• Defined - 50 of vote or value owned by 10 U.S.
  Shareholders
• Current inclusion (regardless of distributions)
  of lesser of Subpart F income or earnings and
  profits (generally computed under U.S. rules)
• Subpart F income includes most income earned
  outside the U.S. - does not include same country
  manufacturing income

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United States Tax ConsequencesSlide 7

• Rules Applicable to Corporations, continued
• Passive Foreign Investment Company Rules
• Defined - 50 or more of income from passive
  activities or 50 or more of assets invested in
  activities producing investment income - no
  shareholding limitation
• Current inclusion of pro rata share of income or
  defer with interest component
• Controlled foreign corporation rule kick-out

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United States Tax ConsequencesSlide 8

• Rules Applicable to Corporations, continued
• Foreign Personal Holding Company Rules
• Defined - A foreign corporation that earns 60 or
  more of its income from investment-type
  activities and 5 or fewer U.S. citizens and/or
  residents own more than 50 of its stock or value
• Current inclusion rules - A FPHCs U.S.
  shareholders are required to report their ratable
  share of a FPHCs undistributed income on a
  current basis

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United States Tax ConsequencesSlide 9

• Are the business profits of the offshore company
  subject to current U.S. taxation, regardless of
  distributions?
• Rules Applicable to Partnerships
• Like a partner in a U.S. based partnership, being
  a partner in an offshore partnership will result
  in the current inclusion of a proportional share
  of the companys income in the taxpayers U.S.
  income tax return.

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United States Tax ConsequencesSlide 10

• Rules Applicable to Partnerships, continued
• Unlike a corporation where some U.S. income tax
  deferral is possible (i.e. non-CFC, PFIC or FPHC
  or an exception to current inclusion within a
  regime), U.S. based partners in a non-U.S.
  partnership are subject to the basic tenet of
  U.S. taxation - taxable on worldwide income,
  wherever such income is derived.

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United States Tax ConsequencesSlide 11

• Can the taxpayer utilize losses generated in the
  foreign jurisdiction to offset U.S. income taxes?
• Rules Applicable to Corporations
• No consolidation of non-U.S. corporations, thus
  no loss utilization against U.S. income tax
  liability

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United States Tax ConsequencesSlide 12

• Can the taxpayer utilize losses generated in the
  foreign jurisdiction to offset U.S. income taxes?
• Rules Applicable to Partnerships
• As noted above, a partner cannot defer income tax
  from a partnership. The flip-side of this is
  also true - a partner is free to utilize its
  proportional share of a non-U.S. partnerships
  losses against its other U.S. income.

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United States Tax ConsequencesSlide 13

• Are there limitations on the business
  relationship between the U.S. taxpayer and the
  offshore company?
• Yes - Section 482 of the Internal Revenue Code
  requires that transactions between U.S. taxpayers
  that are related to non-U.S. taxpayers be
  conducted in an arms-length manner.
• This rule would apply to both non-U.S.
  partnerships and non-U.S. corporations, so long
  as the parties are related. For these
  purposes, parties are considered related if they
  are owned or controlled directly or indirectly by
  the same interests.
• Section 482 would not apply where a non-U.S.
  entity is disregarded for tax purposes or where
  the parties are not related.

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United States Tax ConsequencesSlide 14

• What is the overall net impact of the payment of
  taxes in the foreign jurisdiction?
• As noted above, both the offshore company and
  the owner of theoffshore company will be
  required to pay taxes in Mexico. Since this
  creates the potential for a significant cost
  imposed on doing business internationally, the
  net impact of such cost must be examined.

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United States Tax ConsequencesSlide 15

• In examining the net cost of the local taxes,
  the basic question becomes Are these additional
  costs simply lost, or can they be utilized for
  tax purposes?
• The simple answer is that these additional
  costs can be utilized in one of two ways -
  either a deduction or a credit on the taxpayers
  U.S. income tax return.

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United States Tax ConsequencesSlide 16

• The Internal Revenue Code permits U.S. taxpayers
  a tax deduction (worth about .35 per dollar) or
  tax credit (worth 1.00 per dollar) for
  income-like taxes paid, either directly or
  indirectly, to foreign jurisdictions. Since a
  tax credit is more valuable than a tax deduction,
  lets look at the foreign tax credit rules.

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United States Tax ConsequencesSlide 17

• Taxes paid directly to a foreign government
• These creditable taxes would include (i)
  withholding taxes on dividends, interest and
  royalty payments and license fees and (ii) income
  taxes imposed on business profits not associated
  with the offshore company.
• These creditable taxes do not include non-income
  related taxes like property taxes, value-added
  taxes and fees payable for privileges (i.e.
  licenses and the like).

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United States Tax ConsequencesSlide 18

• Taxes indirectly paid to a foreign government
• These taxes would include all income tax-like
  taxes paid by an appropriate conduit entity,
  including taxes on business profits.
• These taxes do not include non-income related
  taxes like property taxes, value-added taxes and
  fees payable for privileges (i.e. licenses and
  the like).

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United States Tax ConsequencesSlide 19

• For a U.S. taxpayer to utilize the indirect
  foreign tax credit, the entity actually paying
  the income tax in the foreign jurisdiction must
  be an appropriate conduit. Both corporations
  and partnerships can be an appropriate conduit.
  The real difference between the two is when the
  U.S. taxpayer can utilize the tax credit.

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United States Tax ConsequencesSlide 20

• Rules applicable where the offshore company
  paying the tax is a PARTNERSHIP for U.S. tax
  purposes.
• As was the case with both income and losses,
  foreign tax credits pass through foreign
  partnerships to their U.S. partners on a
  proportional basis.

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United States Tax ConsequencesSlide 21

• Rules applicable where the offshore company
  paying the tax is a CORPORATION for U.S. tax
  purposes.
• While there are certain exceptions, foreign tax
  credits pass through foreign corporations to
  their U.S. shareholders only to the extent to
  which such U.S. shareholder is required to
  recognize dividend income from the foreign
  corporation.

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United States Tax ConsequencesSlide 22

• In addition to the entity level limitations
  imposed on foreign tax credit utilization, the
  U.S. foreign tax credit system also contains
  certain formulaic limitations. This forum is not
  appropriate to discuss these other limitations,
  but note that the two most prominent limitations
  are referred to as (i) the overall limitation and
  (ii) the separate basket limitation.

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Conclusion

• No that we have examined what I consider the
  penultimate question regarding the flow of funds
  to and from an offshore company, I would like
  to return to where we began by asking
• How do I get money out of my offshore company?

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Conclusion

• The four most basic ways to repatriate cash to
  the United States are
• Take Equity Distributions
• Receive Interest and Principal Payments on Loans
• Charge Royalty and License Fees
• Manipulate Inter-Company Transactions

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Conclusion

• Equity Distributions
• Typically subject to local taxation (subject to
  treaty rate) - will generate a direct foreign tax
  credit.
• If from a partnership - typically no U.S.
  taxation since the tax has already been paid.
• If from a corporation subject to CFC, PFIC
  (without QEF election) or FPHC rules - typically
  no U.S. taxation, since tax has already been
  paid.
• If from a non-CFC or QEF PFIC - U.S. will impose
  taxes (will also typically trigger an indirect
  foreign tax credit).

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Conclusion

• Interest and Principal Payments on Loans
• Interest Payments
• Typically subject to local taxation - usually
  subject to very favorable treaty rates. Payment
  of local tax will generate direct foreign tax
  credit.
• Subject to U.S. tax.
• Principal Payments
• Typically not subject to local tax - unless
  earning stripping rules in effect.
• Not subject to U.S. taxation.

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Conclusion

• Royalty and License Fees
• Typically subject to local taxation - usually
  subject to favorable treaty rates. Payment of
  local tax will generate direct foreign tax
  credit.
• Subject to U.S. tax.

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Conclusion

• Inter-Company Transactions
• Unless the non-U.S. entity is disregarded for tax
  purposes, the Section 482 arms-length pricing
  standard will apply.
• Even a disregarded entity related party
  transaction can be subject to transfer pricing
  rules. While the U.S. will not impose the
  standard, the foreign jurisdiction may.

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The Final Word

• So, is international taxation an exercise in
  futility or tax planning Utopia?
• I think it is neither, it is simply an additional
  set of rules - at times complicated - that must
  be considered when a U.S. taxpayer is going
  international.

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cohengrigsby