Border Crossing April 2014

Border Crossing
April 2014
Welcome to issue 26 of Border
Crossing - RSM International’s
newsletter covering technical
developments in taxation around
the globe.
In this issue:
Israel: Changes in Taxation of a
Controlled Foreign Corporation
Australia: Company PE Income
may not be exempt from tax
Brazil: Changes to Brazilian CFC
rules
New Zealand: Tax risk and IRD
compliance for multinationals
Europe: How European VAT
impacts US companies
US/Canada: Investing in
Canadian ULCs by US LLCs
Connect to rsmi.com and connect with success
Border Crossing - April 2014
Border Crossing - April 2014
Israel:
Changes in Taxation of a Controlled
Foreign Corporation
On 25 December 2013, the Amendment of the Income Tax Ordinance Law (the “Law”) was published. As part of the
Law, significant changes were made to some of the provisions of Section 75B of the Income Tax Ordinance (the
“Ordinance”), dealing with the taxation of a controlled foreign corporation (the “CFC”).
The purpose of the provisions of
Section 75B of the Ordinance is
to prevent a situation in which
an Israeli resident redirects their
passive income (interest, dividends,
royalties, rent and proceeds from
the sale of capital assets) earned
outside of Israel, to a legal entity
that is not an Israeli entity (e.g. a
foreign corporation), so that the
taxation date of that Israeli resident
is deferred to the date on which he
actually receives the income.
In general, the provisions of Section
75B of the Ordinance determine
that the controlling shareholder
(10% and above) in a CFC should
be considered to have received as a
dividend his relative share in such
income (Imputed Dividend), and shall
be taxed on the income.
The effective date of the new
provisions, the key principles of
which are detailed below, is
1 January 2014.
1. Reduction of the tax rate
applicable abroad
Section 75B(a)(1)(c) of the Ordinance
determines that one of the
conditions for applying the CFC
rules to an Israeli resident who is a
controlling shareholder in a foreign
corporation, is that the tax rate
abroad on the passive income of
such a company does not exceed
20% (this rate was set in 2003, when
the corporate tax rate in Israel was
36%, and corporate tax rates in
other countries were also relatively
high). In light of the decrease in the
corporate tax rate in Israel over the
years (in 2014 it was 26.5%), and in
parallel to the decrease in corporate
tax rates in other countries, the tax
rate which constitutes a condition
to the application of CFC rules was
adjusted to 15%.
The implication of this amendment
is that the CFC rules shall not apply
to foreign entities where the tax rate
imposed on passive income exceeds
15%.
3. Amendment of Tax Laws
Applicable to a CFC
Section 5(5)(c) of the Ordinance,
applied to CFCs in the past,
determined that the “applicable
tax laws” with respect to such a
company which is a resident of
a reciprocating country (a treaty
country) are the tax laws in that
country and, in the case of a nonreciprocating country, the generally
accepted accounting principles in
Israel. As part of the Law, Section
5(5)(c) of the Ordinance was revoked
and replaced by the following
provisions:
•
2. Revocation of Imputed Credit
The imputed credit was set in Section
75B(c) of the Ordinance, where
taxing the controlling shareholder
in a CFC, taxes which would have
been paid in the foreign country if
the dividend was actually distributed,
would be recognised as a tax credit
for the purposes of Israeli taxation.
As part of the amendments made
to the Law, Section 75B(c) of the
Ordinance was revoked, and with it
was revoked the imputed credit, and
in its place Section 75(B)(d1) set a
mechanism for recognising a credit
for foreign tax actually paid (as
explained below).
•
CFC that is a resident of a
non-reciprocating country –
Section 75B1 of the Ordinance
determines that the tax laws
of Israel shall be applied to a
CFC that is a resident of a nonreciprocating country.
CFC that is a resident of a
reciprocating country – for
a CFC that is a resident of a
reciprocating country, the tax
laws of that country shall be
applied (as in the past), but
calculation of the CFC’s income,
taxable income and profits shall
also include the items specified
below:
(1) A dividend or capital gain, even if
exempt from tax or not constituting
income pursuant to the tax laws of
that country (excluding capital gain
as part of a structural change that is
by nature deferral of a tax event)
(2) Amounts deducted for tax
purposes in that country, which are
not recognised as an expense or
deduction pursuant to the generally
accepted accounting principles, as
provided in Subsections (a) to (e)
below:
(a) imputed interest
(b) imputed royalties
(c) depreciation calculated on a new
cost basis, without such cost
being paid
(d) depreciation in excess of the
cost actually paid
(e) additional expenses as
determined by the Minister of
Finance, with the approval of the
Knesset’s Finance Committee
4. Company whose shares are
publicly traded
Section 75B(a)(1)(a) of the Ordinance
determines that a corporation shall
not constitute a CFC if:
•
•
its shares are listed for trade
on the stock exchange, and in
case only part of the company’s
shares were offered to the
public, shares constituting at
least 30% of the company’s
shares were offered
as part of the amendments
to the Ordinance, it was
determined that the fact that
a company’s shares were only
offered for sale to the public, but
were not actually issued to the
public or listed for trade, shall
not prevent the company from
meeting the definition of a CFC
5. Indirect holdings in an Entity in a
chain of companies
Section 75B(a)(1)(d)(2) of the
Ordinance determines the manner
of calculating the percentage of
indirect holdings in an Entity in a
chain of companies. The section
dealt with holdings exceeding 50%
and holdings below 50%, without
addressing holdings at the rate of
50%. Therefore, this section was
amended so that it now addresses
holdings of 50% or less.
6. Amendment of the definitions
of “passive income” and “unpaid
profits”
Profits from securities – The
definition of “passive income” does
not include income that, if produced
in Israel, would have constituted,
pursuant to Israeli tax laws, income
from a business or occupation. It
could have been argued, in certain
cases, that the income of the foreign
corporation abroad from the sale
of shares is business income. As a
result, CFC rules would not apply to
such a foreign corporation.
As part of the law, Section 75B(a)
(5)(a1) to the Ordinance was added,
providing that profits from the
sale of securities shall constitute
passive income, even when classified
as business income, unless the
security was held by the foreign
corporation for less than one year,
and the tax assessor is convinced
that it was used by it in a business or
occupation.
Income from dividends – Section
75B(a)(12) of the Ordinance
determines that the foreign
corporation’s dividend income
derived from income for which
foreign tax was paid at a rate
exceeding 15%, shall be excluded
from the definition of passive
income. The Law determines that
income from such dividend shall
be excluded, if and to the degree
that the percentage of direct or
indirect holdings in the dividend
paying company is at least 5%, when
referring to a company traded on a
stock exchange outside Israel, or at
least 10% in another company.
This amendment was also
simultaneously made to the
definition of unpaid profits.
7. Actual distribution of dividends
from the CFC
As part of the amendments made
to the Law, Section 75(B)(d) of the
Ordinance determines that at the
actual time of a dividend payment
from the CFC to the controlling
shareholder, the amount of the
imputed dividend (which was taxed in
the past) shall be deducted from the
dividend paid. Then it will be adjusted
by the rate of increase in the Israeli
Consumer Price Index from the end
of the tax year in which the imputed
dividend is considered to have
been received by the controlling
shareholder in the CFC, until the
date of actual payment (but no more
than the actual dividend amount), as
long as tax was paid on the imputed
dividend.
8. Sale of means of control in a CFC
Section 75B(e) of the Ordinance
provided in the past that when a
controlling shareholder sells their
means of control in the CFC, they
shall be given tax credit for the tax
Continued >>>>
2
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Border Crossing - April 2014
Israel:
Changes in Taxation of a
Controlled Foreign Corporation
Australia:
Company PE Income may not be exempt
from tax
applicable to the sale, at the amount
of the tax paid in the past for the
imputed dividend on unpaid profits,
which by the date of sale are yet to
be distributed as an actual dividend.
(2)Foreign tax was paid abroad for
the distribution of the actual
dividend, including by way of a
source tax deduction (Foreign Tax
Amount).
As part of the Law, the credit was
revoked and the foregoing section
determined that in selling means
of control in a CFC, the amount of
the imputed dividend considered
as if received by the controlling
shareholder shall be deducted from
the proceeds. The amount of the
imputed dividend shall be deducted
from the proceeds under the
condition that tax was paid on the
holding of the sold means of control,
and under the condition that by the
date of sale this amount was not
distributed as an actual dividend.
The foreign tax credit stages for
tax imposed on the income of the
controlling shareholder in a CFC:
Australia’s tax law exempts from
tax foreign income derived by
a company “in carrying on a
business, at or through a permanent
establishment (“PE”)”. Capital gains
are also exempt from tax where “the
company used the asset wholly or
mainly for the purpose of producing
foreign income in carrying on a
business at or through a PE”. These
provisions are contained in section
23AH of the Income Tax Assessment
Act, 1936.
9. Credit for foreign tax
As previously stated, the imputed
credit was cancelled, and in its place
Section 75B(d1) set a mechanism for
a credit for the foreign tax actually
paid.
Preconditions for a foreign tax credit:
(1)Foreign tax paid / source
deducted abroad shall be first
credited against the tax payable
on the income of the controlling
shareholder produced or accrued
outside of Israel during the tax
year.
(2)The net remaining foreign tax
credit shall be deducted from
the tax due on the income of the
controlling shareholder produced
or accrued in Israel during the tax
year.
(3)In the case that a foreign tax
balance remains, for which no
credit was taken, the balance shall
be returned to the controlling
shareholder at the end of the tax
year in which the foreign tax was
actually paid.
(1)The controlling shareholder was
paid an actual dividend, derived
from the profits for which tax was
paid as an imputed dividend.
For further information please contact

Shai Ben David
Tax Partner
RSM Shiff Hazenfratz & Co
T: +972 3 7919181
[email protected]
www.shifazen.co.il
4
A recent draft ruling from the
Australian Taxation Office provides
that this tax exemption would not
be available where a PE is deemed
to exist and the activities of the
enterprise do not amount to it
carrying on a business (TR 2013/
D8). TR 2013/D8 provides that
where a PE is deemed to exist under
either Australia’s domestic tax law
or under the definition contained
in a (comprehensive) double tax
agreement (“DTA”), it does not
automatically follow that a business
is being carried on.
An example of where a PE can be
deemed to exist is where substantial
equipment is used in a Contracting
State.
Australia’s domestic tax law defines
a PE to include “a place where the
person has, is using or is installing
substantial equipment or substantial
machinery”. This PE definition is
applicable for those countries with
whom Australia does not have a
DTA. Australia’s International Tax
Agreements Act 1953 operates to
substitute the domestic tax law
definition of PE with that contained
in an applicable DTA. With the
exception of Germany and Austria,
the Permanent Establishment Article
of each of Australia’s DTAs contain
a sub-article deeming a PE to exist
where substantial equipment is
used, operated or maintained. (The
substantial equipment sub-articles in
Australia’s DTAs contain a number of
variations but this is not relevant for
present purposes.)
Where the substantial equipment is
being used, operated or maintained,
some of Australia’s DTAs not only
deem a PE to exist but also deem
the enterprise to be carrying on
a business through that PE. Two
examples include the Singapore
and UK DTAs. Where a DTA deems
an enterprise to be carrying on a
business through a PE, the draft
ruling provides that this has no
application to the section 23AH
exemption. For the section 23AH
exemption to apply, the taxpayer
must be actually carrying on a
business in the Contracting State.
Whether or not a taxpayer is carrying
on a business is a question of fact,
having regard to the activities of
the taxpayer. The draft ruling points
out that leasing transactions for
substantial equipment will invariably
involve the carrying on of a business
because of the complexities of
managing the lease (negotiating
and dealing with legal contracts,
financing, insurance and invoicing).
A couple of examples in the draft
ruling illustrate the point.
Example 1
An Australian company leases
equipment [ship] to a UK resident
company under a bareboat
lease entered into in the UK. The
Australian company would be
deemed to have a PE in the UK
pursuant to sub-article 5.3(b) of the
Australia / UK DTA. Notwithstanding
the Australia / UK DTA deems the
Australian company to be carrying
on a business through a PE, the
section 23AH exemption won’t apply.
The Australian company will be
taxable in Australia on the leasing
income but a foreign tax offset will
be allowed for any tax paid in the UK.
Example 2
Assume facts similar to Example 1
but an office is maintained in the
UK to actively manage the leasing
contract. The Australian company
would have a deemed PE in the UK
and also be carrying on a business
in the UK (which in itself would likely
result in a PE). The leasing income
derived from the UK would be
exempt from Australian tax but no
foreign tax offset would be allowed.
For further information, please contact
Simon Aitken, Director
RSM Bird Cameron
T: +61 (03) 9286 8148
[email protected]
www.rsmi.com.au
5
Border Crossing - April 2014
Border Crossing - April 2014
Brazil:
Changes to Brazilian CFC rules
On 12 November 2013, the Provisional Measure (“PM”) No 627 was published and brought several changes in the
Brazilian Income Tax Legislation, including provisions relating to the CFC rules.
The changes will be in force as of
January 2015, however, companies
may elect to adopt the new rules
from January 2014. As a provisional
measure, it has to be approved by
the Congress and then be converted
into law. Amendments to the original
text are expected to be made.
Until December 2013, the profits
arising from foreign affiliated
or controlled companies had to
be computed in the 9% Social
Contribution Tax (CSLL) and in the
25% Corporate Income Tax (IRPJ)
irrespective of their distribution
to the shareholders. There are
several pending administrative and
court cases in which companies are
challenging the moment when the
profit should have been taxed.
The main changes in the CFC rules
are the different tax treatments
provided for foreign controlled
and affiliated companies, the
consolidation of profits and losses
accrued by foreign controlled
companies, the moment when
the profits must be taxed and the
introduction in the Brazilian tax
legislation of the “active income”
concept.
Annually, the profits arising from
the investment in foreign direct
or indirect controlled companies
must be computed in the CSLL Tax
and IRPJ Tax taxable bases of the
Brazilian parent company. The losses
can only be offset against the future
profits of the same foreign controlled
entity and in the five subsequent
years. There is no statute limitation
to offset the losses accrued before
the new rules enter into force.
•
Until 2017, profits and losses
calculated by foreign controlled
entities can be consolidated,
provided that such results
correspond to “active income”.
The concept of active income was
introduced in the Brazilian tax
legislation by the PM No. 627/13.
As a general rule, it comprises the
income generated by the operational
activities and excludes the income
derived from royalties, interest,
dividends, shareholdings and other
financial transactions. In order
to adopt the consolidation, the
controlled entity cannot be in one of
these situations:
However, in the first year subsequent
to the year when the profits have
been accrued, a minimum of 25%
of the profits must be considered as
distributed and be taxed accordingly.
The remaining balance must be
computed in the taxable bases until
the fifth year subsequent to the year
when the profits have been accrued.
•
Foreign controlled companies
There was a doubt whether the prior
legislation was applied to direct and
indirect controlled foreign entities.
The PM No. 627/13 clearly stated that
the new provisions are applied to
both of the cases.
6
•
•
directly or indirectly controlled
by a company located in a lowtax jurisdiction or benefit from a
privileged tax regime
Brazilian parent companies can
choose to pay the CSLL Tax and the
IRPJ Tax on controlled companies
results proportionally to the profits
effectively received. Interest will be
added to the tax liabilities at the
Libor rate.
In order to adopt this tax procedure,
the Brazilian parent company must
desist from any administrative or
court case related to taxation of
foreign profits. Additionally, the
foreign controlled company:
•
domiciled in a country with
which Brazil has not signed
a tax information exchange
agreement
cannot be subject to a tax
regime in which the corporate
income tax rate is lower than
20%
•
subject to a tax regime where
the corporate income tax rate is
lower than 20%
cannot be located in a low-tax
jurisdiction or benefit from a
privileged tax regime
•
cannot be directly or indirectly
controlled by a company located
in a low-tax jurisdiction or
benefit from a privileged tax
regime
located in a low-tax jurisdiction
or benefit from a privileged tax
regime
•
must calculate active income
higher than 80% of its profit
The previous CFC rules allowed the
offsetting of the income tax paid
by the foreign subsidiaries against
the IRPJ Tax paid by the Brazilian
investor on their profits. The PM
No. 627/13 also allows the Brazilian
parent company to offset any
withholding income tax paid on the
profits distributed to the Brazilian
parent company.
These new CFC rules will not apply
to foreign direct controlled entities
hired by Brazilian companies that
operate in the exploration of oil and
gas in the Brazilian territory.
Foreign affiliated companies
The PM No. 627/13 requires that the
Brazilian investor includes in the
9% CSLL Tax and the 25% IRPJ Tax
taxable bases the profits effectively
received from the foreign affiliated
companies. It clearly differs from
the tax treatment applicable to the
foreign controlled company’s results.
Profits will be considered as
distributed to the Brazilian investor
when credited or paid or under
specific circumstances provided by
the legislation (e.g. when a foreign
affiliated company provides a
loan to the Brazilian investor and,
concomitantly, presents balance
of distributable profits, an amount
equivalent to the loan will have to be
included in the Brazilian investor’s
taxable bases).
In order to tax the foreign profits
only upon the distribution, the
foreign affiliate cannot:
•
be subject to a tax regime where
the corporate income tax rate is
lower than 20%
•
be located in a low-tax
jurisdiction or benefit from a
privileged tax regime
•
be directly or indirectly
controlled by a company located
in a low-tax jurisdiction or
benefit from a privileged tax
regime
The withholding income tax that is
levied on dividends distributed by
foreign affiliated companies can be
deducted by the Brazilian investor
from the IRPJ Tax or the CSLL Tax
that is levied on their profits.
•
generate less than 80% of
active income
Individuals
Moreover, in the case that the
Brazilian investor along with other
related parties holds more than 50%
of the voting shares of a foreign
affiliated company, the respective
company will be considered as a
foreign controlled company. As a
consequence the respective profits
will be taxed accordingly.
Common provisions
In the case that the foreign
controlled or affiliated company
holds an investment in a Brazilian
company, the profit calculated by the
Brazilian investee can be deducted
from the foreign controlled or
affiliated company’s profit that will
be included in the CSLL Tax and
the IRPJ Tax taxable bases of the
Brazilian investor.
The transfer pricing and thin
capitalisation taxable adjustments
derived from transactions with
foreign controlled companies
can also be deducted from the
corresponding foreign controlled
company’s profit that will be included
in the CSLL Tax and the IRPJ Tax
taxable bases of the Brazilian
investor.
The Brazilian parent company can
deduct the corporate income tax paid
by the foreign controlled company
from the IRPJ Tax that is levied on
foreign profits. Any excess can be
deducted from the CSLL Tax.
The Brazilian individual, who is the
controlling shareholder of a foreign
company, will have to pay income tax
on the respective profits as they are
accrued, in the following cases:
•
The foreign controlled company
is subject to a tax regime where
the corporate income tax rate is
lower than 20%.
•
The foreign controlled
company is located in a low-tax
jurisdiction or benefits from a
privileged tax regime.
•
The individual does not have
the documentation related
to the incorporation of the
company, duly registered with
the appropriate authorities,
identifying the other
shareholders.
Marcelo Oliveira
RSM ACAL Consultoria e Auditoria S/S
Rio de Janeiro, Brasil
Tel : +55 (21) 22246431
[email protected]
www.acal.com.br
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Border Crossing - April 2014
New Zealand:
Tax Risk and IRD Compliance for
Multinationals
In late 2013, the IRD released their Multinational Enterprises Compliance Focus Document. This document outlines the
various areas the IRD will be focusing on for the next 12 months with regards to multinational enterprises (MNEs). This
article summarises the must read sections of the document. These are important issues MNEs need to consider when
assessing their tax risk and IRD audit risk.
7. Capital gains/tax credits –
have any untaxed profits been
derived (capital gains) or have
any unusually high foreign tax or
imputation credits been claimed
by the group?
In summary
8. Tax losses – have
uncharacteristic losses arisen
(or been utilised) across the
group as a whole?
The IRD is now obtaining more
information from MNEs directly
when their tax return is filed under
direct compliance management and
the Significant Enterprise Initiative.
This now includes 500 groups
who provide copies of financial
statements, tax reconciliations and
their group structure with their tax
return.
Familiar “red flags” have also been
included in the document. These are
issues the IRD specifically focuses on
when assessing MNEs’ tax returns.
These issues include transactions
with low/no tax jurisdictions, the
group’s effective tax rate, ownership
changes and complex transactions
such as group restructuring.
International financing arrangements
are another key focus for the IRD
and they are specifically watching
entities with inbound loans over $10
million, outbound loans where no or
low interest rates have been charged
and New Zealand’s thin capitalisation
rules.
Transfer pricing risk is the final
key focus for the IRD, this
includes transactions that have
no documentation, the payment
of unsustainable royalty and
management fees, transactions
with low/no tax jurisdictions and
MNEs with recurring losses. For
New Zealand exporters, the IRD is
8
focusing on benchmark commodity
prices and the recovery of New
Zealand costs such as research
and development and head office
overheads.
How the IRD manages multinational
compliance
The IRD now has 500 major groups
either under direct compliance
management or groups subject to
the Significant Enterprises Initiative.
This means the IRD now receives
copies of financial statements, tax
reconciliations and their group
structure when they file their tax
return.
This information allows the IRD
to carry out macro-analysis of
industries and the IRD is using this
information to examine a wider
range of MNEs. With this in mind,
MNEs should expect to receive more
detailed information requests and
audit inquires.
The IRD’s expectation is to cover all
groups with a turnover of $30 million
and over with the above approach.
It is a matter of when, and not if, the
IRD information request arrives in
the post.
your group’s tax return you can
almost guarantee a letter from
the IRD requesting documentation
supporting the economic
justification of the result. If there
is no documentation economically
justifying the result, your group is at
high risk of an in-depth IRD audit.
The ten red flags are as follows:
1.
Effective tax rate – when a
group’s effective tax rate is
substantially below the statutory
rate of 28%.
2. Low/no tax jurisdictions – has
the group participated in
transactions with low or no tax
jurisdictions?
3. Differences in treatment – are
there material differences in
the treatment of major items
for financial reporting and tax
reporting purposes?
4. Large tax benefits – has
the group taken part in any
transactions where the
anticipated return is due to
projected tax benefits?
Familiar red flags
5. Cross-border mismatches – are
there differences in the tax
treatment of a transaction
between different jurisdictions?
The following issues have been
identified by the IRD as their red
flags when assessing MNEs’ tax
returns. If the IRD note one of
these red flags when assessing
6. Complexity – has the group been
involved in any complicated
arrangements e.g. major
restructures, innovative financial
arrangements?
9. Ownership changes – have there
been any ownership changes
that may affect continuity tests
for tax losses and imputation
credits?
10. Variances between years – are
there material variances in
profitability or tax payable from
year to year?
International financing
arrangements
Key issues with international
financing arrangements include the
pricing of interest, guarantee fees
at market rates and New Zealand’s
thin capitalisation rules. The IRD
pay close attention to the following
issues:
•
•
•
•
•
structured financing
arrangements
hybrid instruments (e.g.
mandatory convertible notes)
and hybrid entities (e.g. certain
foreign limited partnerships)
unusual financings (e.g. long
term subordinated debt
facilities)
exotic or novel financial
products
all inbound loans of more than
$10 million
•
outbound loans of all sizes
where there is no or low interest
rates and/or no fees charged for
guarantees.
The IRD will also question groups
where interest payments are made
with no corresponding non-resident
withholding tax or if the approved
issuer levy has been returned. The
IRD will also closely examine any
capital restructurings which result
in major reductions in New Zealand
tax paid.
Tax payers carrying a high level of
debt have a high risk of IRD audit if
the transaction would not have taken
place in the open market. The IRD
will then question the commerciality
of the transaction.
•
payment of unsustainable levels
of royalties and/or management
fees
•
transactions with no or low tax
jurisdictions
•
recurring losses.
New Zealand entities exporting
through overseas associates should
be aware of the following issues
identified by the IRD as areas of
focus:
•
use of correct commodity price
benchmarks
•
low or no interest loans
•
recovery of New Zealand costs
e.g. research and development
and head office overheads
•
offshore operations returning
abnormally high profits
Transfer pricing
The IRD’s main transfer pricing
focus is in the reported bottom
line of MNEs. The key question is,
has the MNE reported sufficient
profits in New Zealand? The major
transfer pricing risks and key focus
areas identified by the IRD are the
following:
•
no documentation to support
transfer prices
•
material levels of untested
transactions
•
major downwards shifts in
profitability of the New Zealand
entity when acquired by a
multinational
•
differing profits between the
New Zealand entity and the
other entities in the group
•
New Zealand management
accepting prices set by overseas
associates without question
In conclusion
The IRD has provided the compliance
focus document for MNEs to help
assist decision makers in assessing
their IRD audit risk.
For further information, please contact
Grant Hally, Managing Partner
RSM Prince
[email protected]
or
Brendon Read, Transfer Pricing Consultant
RSM Prince
[email protected]
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Europe:
How European VAT impacts US companies
When US companies deal with value added tax “VAT” challenges in Europe, whether newly established or well
established, they often fall into the same avoidable traps. These traps include: the assumption that VAT is similar
to US sales tax or GST (it is not), and a belief that VAT does not apply to non-European businesses (it does).
Sometimes, it is a combination of both.
Depending on the nature of the
business activities conducted in
Europe, a variety of tax matters
could become relevant such as
corporate income tax, wage taxes
and VAT. Unlike most other taxes,
no physical presence in Europe is
required to become VAT liable or
to be charged with VAT. Therefore,
the cost benefit of a cross-border
business transaction should always
take into account any potential VAT
impact. It is important to remember
that businesses are supposed
to be VAT tax collectors, not tax
payers. VAT is an end user tax, and
businesses are not intended to serve
as end users.
Defining Europe?
When expanding your business to
or when you are doing business
in Europe, it is essential to have
a thorough understanding of the
European market. Compared to
the US with its 50+ states, one
commonly spoken language, one
currency and local and federal
politics, the countries in the
continent of Europe are recognised in
different terms, for instance, through
the membership of the European
Union (EU), the European Monetary
Union (EMU) or the European
Economic Area (EEA). All of these
are umbrella terms for partnerships
between various countries in Europe
focusing on different goals. Beside
the participation in partnerships,
every European country has its own
politics, economy, legislation etc.
10
The EU is the most prominent
partnership in Europe. The EU is an
economic and political partnership
that currently consists of 28 Member
States. It is worth noting that
although large European economies
such as Switzerland and Norway are
not part of the EU, their politics and
internal regulations are very much
connected with it.
Although all Member States of
the EU are required to comply
with the Union’s harmonised VAT
legislation, the tax authorities
of each Member State have a
certain degree of flexibility in the
implementation of VAT legislation
resulting in considerable differences
between the Member States. The
differences appear, for example,
in rates, exemptions, reverse
charge mechanisms and reporting
requirements. The time to comply
with local VAT regulations can also
differ significantly.
Overall, it is safe to say that when
US companies do business in
Europe, they should not only expect
a different business environment,
but also differences in cultures,
languages, economic conditions,
political climates, legal and tax
legislation and currency.
Although both VAT and sales tax
are consumption taxes, it is good
to realise that where sales tax is
collected on retail sales at the time
of sale to the final consumer, VAT
is imposed on all sales in a supply
chain involving the production
and the distribution of goods,
and the provision of services for
consumption within the territory
of the EU. Hence, both goods and
services are subject to VAT, and
where there is consumption of
these in the EU, there is a business
(irrespective of the place of principal
seat) liable to charge VAT.
In a supply chain VAT can never
accumulate and paying VAT over VAT
is prohibited. The ‘end user’ pays VAT
and the business charging it acts
as the collector. Since a business
cannot be considered as an end user,
businesses can reclaim VAT paid on
purchases.
On one hand, a business that is liable
for VAT should pay VAT collected
from end users to the tax authority,
and on the other hand a business
can reclaim any VAT paid to suppliers
and on import of goods at the same
time. In other words, VAT should not
create a cost of doing business.
What is VAT?
When US companies encounter
European VAT
Contrary to what many people
believe, VAT is not the same as US
sales tax.
When doing business in the territory
of the EU a company will deal with
VAT: when selling something, the
company will have to charge the
customer with VAT and when buying
something the company will be
charged with VAT.
US companies often encounter
European VAT when undertaking
activities such as:
•
importing goods into Europe for
onward supply in the EU
•
(importing and) holding
an inventory of goods in a
European location
•
selling electronically delivered
software, games or music to
private individuals in Europe
•
operating a local sales and
marketing subsidiary
•
importing evaluation units for
demonstration and subsequent
sale
payment of incorrectly charged
VAT is an important issue and
may result in non-reclaimable
VAT.
•
Outgoing invoices should
correctly state the VAT amounts;
incorrectly stated invoices may
lead to complicated and lengthy
discussions with the local tax
authorities and/or payment of
VAT without the ability to on
charge that VAT to the customer
(from a commercial perspective).
•
Having a proper administration
that includes all incoming
and outgoing invoices, import
documents and documents that
record border crossing supplies
of goods.
•
Timely file and meeting filing
deadlines (to avoid penalties).
•
In case of lack of physical
presence in Europe: appointing a
fiscal representative for VAT to
assist with local VAT compliance
obligations.
•
An ERP system that is aligned
with the European VAT
requirements.
What do we see in practice?
In practice a lot of questions arise in
relation to the importing of goods,
the possibility of submitting VAT
refund requests, and compliance
obligations.
As aforementioned, VAT should not
result in a cost when doing business.
However, to achieve that result it is
important to manage compliance
regulations and the cash flow effects
too since VAT may not always
be recovered quickly. Some key
considerations from a compliance
perspective are:
•
Incoming invoices should meet
all requirements for VAT; the
is correctly integrated in the business
models and internal administration
systems of companies.
In both existing and new situations,
it has never been more important
to make the time to examine the
company’s VAT structure and put
in place operating procedures that
will enable maximisation of VAT
recovery, cash flow and avoidance of
penalties for non-compliance.
For further information, please contact
Hans van Loenen, Head of Indirect Tax
RSM Nederland
[email protected]
or
Angela de Miranda, Tax Manager
RSM Nederland
[email protected]
www.rsmnederland.nl
Conclusion
For US companies doing business
in Europe, VAT can sometimes
be difficult to understand and
implement and becomes time
consuming to comply with
retroactively. Nevertheless, VAT
is manageable when dealt with
proactively beforehand. To safeguard
that, it is important that the balanced
VAT system (payment of VAT on
sales/deduction of VAT on purchases)
11
Border Crossing - April 2014
Border Crossing - April 2014
US / Canada:
Investing in Canadian ULCs by US LLCs
For many years, the US-Canada Income tax treaty (the “Treaty”) did not grant treaty benefits to US Limited Liability
Companies (“US LLCs”) because, in the view of the Canadian government, LLCs were not US tax residents since they
are typically exempt from US tax1. In the Fifth Protocol to the Treaty, the US and Canadian governments granted treaty
benefits to US LLCs2. However, one of the provisions of the Treaty unexpectedly eliminated treaty benefits for US
LLCs that invest in Canadian unlimited liability companies (“Canadian ULCs”). As a result, taxpayers should consider
alternative investment structures if a US LLC must be used to hold a Canadian investment.
The Treaty
Under the Treaty, US tax residents
may claim a variety of benefits with
respect to income otherwise subject
to tax in Canada, including reduced
rates of withholding and elimination
of tax on income not connected
with a Canadian permanent
establishment. Such benefits are
available to persons that qualify as
residents under Article IV of the
Treaty. Generally speaking, a US
company that is subject to US tax on
its income is a resident for purposes
of Article IV. However, Paragraph 6 of
Article IV provides special rules for
determining when an item of income
is derived by a US resident that earns
that item of income through a fiscally
transparent entity, e.g. a US LLC3.
Under this paragraph an item of
Canadian source income paid to a US
entity that is fiscally transparent will
be treated as derived by a US person
that is an owner of the transparent
entity if that person is treated as
(1) earning the income through
the entity and (2) the treatment
of the item by the US is the same
as if the US person had earned
the income directly. This provision
would normally allow a US LLC to
claim benefits under the Treaty with
respect to Canadian source income
attributable to its US tax resident
owners.
However, if a fiscally transparent
entity earns an item of income from
a Canadian ULC, Paragraph 7(b) of
Article IV of the Treaty adds another
requirement that taxpayers must
satisfy to receive Treaty benefits with
respect to the income. Specifically,
Paragraph 7(b) provides that such
income is not derived by a resident
of a Contracting State where:
The person is considered under
the taxation of the law of [the
source] State to have received the
amount from an entity that is a
resident of the other State, but by
reason of the entity being treated
as fiscally transparent under the
laws of the [residence] State, the
treatment of the amount under
the taxation law of that State is
not the same as its treatment
would be if that entity were not
treated as fiscally transparent
under the laws of that State.
Thus, while Paragraph 6 of Article
IV of the Treaty allows fiscally
transparent entities to claim Treaty
benefits, Paragraph 7(b) may
eliminate these benefits under
certain conditions. For example,
assume that a Canadian ULC, which
the US disregards as a separate
entity, pays a dividend to a US LLC
owned entirely by US tax residents.
Under Paragraph 6 of Article IV,
the LLC could claim that the Treaty
reduces the normal Canadian tax
rate that applies to dividends paid
* see back page for footnotes and disclaimer related to this article.
12
to non-Canadian persons. However,
under Paragraph 7(b), the US LLC
could not claim the reduced Treaty
rate because the ULC is treated as
fiscally transparent under US law
and the US income tax treatment
of the dividend payment would
differ if the ULC were not fiscally
transparent for US tax purposes.
Specifically, the US disregards a
dividend payment made by a ULC
because it is fiscally transparent but
would treat the dividend payment
as income received by the LLC.
This difference in treatment results
in the loss of resident status with
respect to the dividend and the LLC’s
potential claim of Treaty benefits is
extinguished. This position, espoused
and articulated by the Canadian
Revenue Authority (CRA), came as
a surprise not only to the public but
to the US government since it was
clearly the intent of the US Treasury
team negotiating the Fifth Protocol
to grant Treaty benefits to US LLCs.
Two-Step Distribution
A possible solution approved by the
CRA was the so-called “two-step
distribution”.4
The two-step dividend distribution
involves (1) increasing the paid up
capital (“PUC”) of the Canadian ULC
and (2) distributing assets equal in
value to the amount of the PUC. The
mechanics of the two-step dividend
distribution are as follows:
1.
The Canadian ULC would
convert surplus into an increase
in the PUC of its outstanding
shares. The increase in
PUC would occur through a
corporate resolution where
the outstanding shares of
the Canadian ULC would be
increased by the ULCs income,
net of the corporate level tax.
From a Canadian tax perspective
the increase in PUC would be
treated as a deemed dividend
and a taxable event. This
deemed dividend would qualify
for treaty relief from the US –
Canada income tax treaty and
the reduced treaty withholding
rate would apply on this deemed
dividend.5
2. The second step is a distribution
of assets upon a reduction of
PUC by an amount equal to the
PUC that was increased in Step
1. From a US tax perspective this
is not a taxable event and the
distribution would be completely
disregarded.6
With the two-step distribution, Art IV
(7)(b) would not apply to deny treaty
benefits to the deemed dividend
that results from the increase in PUC
because the tax treatment of this
payment is the same regardless of
whether the Canadian ULC is treated
as a corporation or a disregarded
entity for US federal income tax
purposes. More specifically, the
deemed dividend resulting from the
two-step distribution is disregarded
in both cases. As a result the
provisions of Paragraph 7(b) do not
apply.
Application of Two-Step Distribution
by Canadian ULCs to US LLCs
Surprisingly, while the CRA has ruled
that US S Corporations may use
the two-step distribution process to
claim Treaty benefits,7 the CRA has
refused to allow US LLCs to utilise
the technique to claim benefits.8
The basis for this decision defies
the policy decision to grant Treaty
benefits to US LLCs and is highly
technical. Specifically, prior to the
adoption of the Fifth Protocol, the
CRA took the position that US LLCs
are not entitled to treaty benefits
because US LLCs are not tax resident
in the US since they are not subject
to US tax at an entity level. After
enactment of the Fifth Protocol, the
CRA still took the position (as they
currently do) that US LLCs are not
tax residents for purposes of the
Treaty.
However, the CRA, recognised that
US LLCs may be entitled to Treaty
benefits under Paragraph 6 of Article
IV of the Treaty to the extent items
of income paid to a US LLC are
attributable to any members that
are US tax residents. However, the
CRA’s position is that in order for
Paragraph 6 to apply, a US LLC must
receive an “amount” of income for
US tax purposes. But the US does
not recognise the deemed dividend
arising from the two-step distribution
procedure, and therefore the US
LLC does not receive an “amount”
of income for US tax purposes. As
a result, Paragraph 6 of Article IV
does not apply and the US LLC
fails to qualify as a resident for the
purposes of the Treaty according
to the CRA. Strangely, a US S
Corporation may use the two-step
distribution process to avoid losing
residence status under Paragraph 7
of Article IV because the CRA views
S Corporations as US tax residents
even though they are generally
exempt from US tax. Thus, because
an S Corporation need not rely on
Paragraph 6 of Article IV to qualify
as a US tax resident, its failure to
receive an “amount” of income as
a result of the two-step distribution
does not undermine its claim of
resident status.9
Possible Solution
The CRA’s position regarding US
LLCs has encouraged taxpayers
to develop alternative ways for US
LLCs to invest in Canada. A possible
solution may be to interpose a
holding company from a different
jurisdiction between the Canadian
ULC and the US LLC, such as a Dutch
BV or a Luxembourg SARL. The
Dutch BV and Luxembourg SARL
are each treated as corporations
for Canadian tax purposes but both
may elect to be disregarded for US
tax purposes. The use of non-US
intervening entities would avoid
the application of Article IV of the
Treaty to items of Canadian source
income paid by a ULC. Instead
such payments would be governed
not by the US-Canada Income tax
treaty but by any treaty in force
between Canada and the country
in which the intervening holding
company is resident. For example, if
a Luxembourg SARL were interposed
between a US LLC and a Canadian
ULC, the Canada-Luxembourg tax
treaty would apply because the SARL
is a resident of Luxembourg. Thus,
dividends paid by the Canadian ULC
would be taxed under the CanadaLuxembourg Treaty and not the USCanada treaty.10
Of course, the CRA could argue
that the US-Canada Treaty should
apply because the parties inserted
the SARL to take advantage of the
Canada-Luxembourg tax treaty.
However, provided the SARL has
substance, the CRA is unlikely
to prevail because the CanadaLuxembourg treaty has no antitreaty shopping provisions.11
In fact, the CRA has lost a number of
court cases where it has challenged
similar Luxembourg-based structures
on treaty shopping grounds12 and,
as a result, in November of 2013,
the CRA issued a position paper in
which it stated that it will continue to
challenge treaty shopping and may
seek to address the issue through a
legislative solution.
In summary, investing in Canada
through a US LLC presents a number
of technical issues under the USCanada tax treaty. Taxpayers should
carefully plan any such investment
and may need to consider an
alternative investment structure in
order to ensure the highest possible
after-tax investment returns.
Ramon Camacho
Principal, International Tax Technical Lead
McGladrey LLP
T: +1 202 370 8243
[email protected]
Terie Boutalis
International Tax Manager
McGladrey LLP
T: +1 617 241 1592
[email protected]
13
1
For U.S. Federal Income tax purposes, U.S. LLC and ULCs are treated as disregarded entities separate from its owner if they have a single owner or as a
partnership if they have more than one owner providing the owner does not make an entity classification election to be taxed as a corporation. See Regs.
section 301.7701-3(b). From a Canadian tax perspective both are treated as corporations.
2
The Fifth Protocol was signed in 2007 and generally came into force December 15, 2008. However paragraph 7 of Article 4 came into effect on January 1, 2010.
3
Under the Treaty, a resident may claim benefits only with respect to income that it derives.
4
Canada Revenue Agency, ( CRA), informally approved the two step distribution at the “2009 CRA roundtable”. See Cross Border Tax: Canada-US Tax Treaty
Update: CRA Views on Treaty Benefits on Dividends Paid by Canadian ULCs, by Lyne Gaulin, published in 2011 Lexpert. Also See CRA Ruling 2012-0436221I7
5
See Emerging Issues with Respect to Hybrids Under the Canada-U.S. Income Tax Treaty, Tax Management International Journal, April 9, 2010, Vol. 39, No. 04.
6
The two step distribution also effectively applies when the Canadian ULC is treated as a partnership from a U.S. tax perspective.
7
See CRA Ruling, 2009-0341681R3
8
See CRA Ruling 2012-0436221I7
9
See CRA Ruling, 2009-0341681R3.
10
The reduced rate of 5% is applicable if the beneficial owner of the payment is a company that controls directly or indirectly at least 10% of the voting power in
the company paying the dividends.
11
Prevost Car Inc. v Canada, 2009 D.T.C. 5053, aff’g 2008 D.T.C. 3080 (T.C.C.) , Canadian court decision allows for treaty shopping providing the company meets
substance requirements.=
12
See Mil (Investments S.A.) v. Her Majesty the Queen, 2006 D.T.C. 3307 and See Prevost Car Inc. v Canada, 2009 D.T.C. 5503
Disclaimer: The information contained herein is general in nature and based on authorities that are subject to change. McGladrey LLP
guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results
obtained by others as a result of reliance upon such information. McGladrey LLP assumes no obligation to inform the reader of any
changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to,
provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their
particular situations. Circular 230 Disclosure: This analysis is not tax advice and is not intended or written to be used, and cannot be
used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
Global International Tax Contacts
Africa
Dieter Schulze
+27 21 686 7890
[email protected]
Asia Pacific
Rob Mander
+61 2 8226 4705
[email protected]
Americas
Jeffry Seidel
+1 212 372 1300
[email protected]
Europe
Rudolf Winkenius
+31 23 530 0400
[email protected]
Jorge Pérez
+54 11 4811 1071
[email protected]
Francesco Gerla
+39 02 8909 5151
[email protected]
Caroline Walenkamp
+31 23 530 0400
[email protected]
Contact
Gillian Hawkes
PR & Communications Manager
RSM International
+44 (0)20 7601 1080
[email protected]
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