Tax planning remains essential for cross-border businesses and transactions, despite recent pushback from taxing jurisdictions worldwide against what some have characterized as aggressive tax avoidance. Since 2013, the G20 and OECD have been pursuing the BEPS (base erosion and profit shifting) initiative to institute a coordinated response or minimum standards among member states for regulation of tax minimization opportunities. Governments have asserted that as capital has become increasingly mobile and different jurisdictions promulgate divergent tax rules, multinational enterprises have shifted profits to low-tax jurisdictions where the enterprises may not have substantial operations and “base erode” the high-tax jurisdictions in which they operate. Leading corporations’ disputes with governments regarding lightly taxed profits located offshore have made headlines in the popular press.
Despite the redoubled regulatory activity, planning within the rules to manage the tax burden and structure businesses and transactions in a tax-efficient manner is as imperative as ever. Governments continue to promote investment in desired sectors or jurisdictions using tax incentives and, within the bounds of international frameworks, seek to attract capital and job creation with differentiated features of their business and tax laws. U.S. companies investing or expanding overseas, for example, will wish to review the optimal structures and jurisdictions for operations and/or investment holdings from both business and tax perspectives, considering both U.S. and foreign rules affecting the outbound transaction, operations and repatriation of profits.
Navigating international tax laws and avoiding traps for the unwary
To begin with, it is critical to navigate the myriad of U.S. and foreign tax laws and regulations to achieve the intended results while avoiding traps for the unwary. For inbound investments into the U.S., a case in point is the potential denial of U.S. tax treaty benefits to dividend or interest income received “through” a limited liability company, limited partnership or other entity which is treated as a pass-through entity for U.S. tax purposes but as a corporation under the tax laws of the foreign jurisdiction. This is a thorny and not uncommon issue arising under U.S. Internal Revenue Code section 894 for investment from countries whose legal systems do not widely recognize entities that are pass-through for tax purposes.
As another example, in the context of outbound investments from the U.S., is the potential to be caught up in the passive foreign investment company (“PFIC”) rules. Many sophisticated taxpayers may be aware that there are special U.S. tax laws pertaining to investments in controlled foreign corporations (“CFCs”), which are foreign corporations in which certain U.S. shareholders own greater than 50% of the shares by vote or value. They may not be aware, however, that an investment by a U.S. person in a foreign corporation which does not meet the ownership threshold to be a CFC may be subject to punitive PFIC rules intended to prevent deferral of income from offshore passive investment.