H. Jacob Lager

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Planning on “pleading the Fifth”? Not when it comes to offshore banking

In Court decisions, Offshore Accounts, Uncategorized on September 7, 2012 at 12:45 pm

I have never actually heard someone take the Fifth.  Not as an advocate.  Not as opposing counsel.  Heck, not even as a juror.

Three years of law school and nearly 15 years of practice and I’ve never actually heard those magic words: “on advice of counsel, I respectfully refuse to answer on the grounds that to do so might incriminate myself.”

See.  I even know them by heart.

Sadly, On August 27, the Seventh Circuit made it even more unlikely that I’d hear them anytime soon.  The panel ruled that the Fifth Amendment privilege against self-incrimination does not apply to a taxpayer’s offshore banking records and that the taxpayer may not invoke the privilege to resist compliance with a subpoena seeking records kept pursuant to the Bank Secrecy Act.

In so ruling, the Seventh Circuit joined the Ninth Circuit in holding that the so-called “required records” exception to the Fifth Amendment privilege against self-incrimination applies to records of foreign bank accounts.

So, what is this exception and why haven’t they mentioned it on Law & Order?  According to the Ninth Circuit, the doctrine exists because “the Supreme Court has recognized that . . . the privilege does not extend to records required to be kept as a result of an individual’s voluntary participation in a regulated activity.”

What this essentially means is that if you voluntarily (remember that word – it’s important later) enter into a regulated activity that requires you to keep records, you can’t later prevent those records from being disclosed.

So how does this exception work?

Under the required records doctrine, a government inquiry does not impact your Fifth Amendment rights if:

(1) The government’s inquiry is essentially regulatory; [hmm… ok, but aren’t they all?]

(2) The information is a preserved record of a kind customarily retained; and

(3) The records have taken on public aspects making them analogous to a public document.

Ok, wait a minute!  If you’re wondering why your banking records are considered analogous to a “public document,” then you’ve been paying attention.  According to the Ninth Circuit, where “personal information is compelled in furtherance of a valid regulatory scheme, as is the case here, that information assumes a public aspect….  Similarly, disclosure of basic account information is an ‘essentially neutral’ act necessary for effective regulation of offshore banking.”

Does this mean if there is a regulation requiring that you maintain information, that information is automatically exempt from Fifth Amendment protection?  Doesn’t that exception swallow the entire rule?  Not exactly.

The trick here is that you must voluntarily enter into the activity itself in the first place.  Your individual tax returns remain protected in most respects because simply being a taxpayer does not involve a voluntary choice.  However, according to the Ninth Circuit, “no one is required to participate in the activity of offshore banking.”  Thus, the required records doctrine applies to offshore banking records because the taxpayer “enters upon a regulated activity knowing that the maintenance of extensive records available for inspection by the regulatory agency is one of the conditions of engaging in the activity….”

In short, if you bank offshore, you cede any Fifth Amendment protections related to that account.

Bet you didn’t see that in the application.

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The Internal Revenue Code and the Infield Fly Rule

In Foreign taxes, IRS regulations, Uncategorized on April 4, 2012 at 7:59 pm

In honor of tomorrow’s opening day festivities, I give you my favorite Law Review article ever.

http://scholarship.law.wm.edu/cgi/viewcontent.cgi?article=2058&context=wmlr&sei-redir=1&referer=http%3A%2F%2Fwww.google.com%2Fsearch%3Fq%3D482%2Binfield%2Bfly%2Brule%26ie%3DUTF-8%26oe%3DUTF-8%26hl%3Den%26client%3Dsafari#search=%22482%20infield%20fly%20rule%22

“PLAIN ENGLISH” TAKES UNLIKELY VICTORY AGAINST TAX CODE IN FOREIGN TAX CREDIT RULING

In Uncategorized on February 11, 2012 at 12:16 am

Some tax professionals are true artists. With poetic grace, they can demonstrate a client’s investment intent, business purpose, reasonable cause, or lack of willfulness.

One thing they can’t do is change the English language.

Which is what one taxpayer sadly realized last week, when the IRS published Chief Counsel Advice 201204008. There, the Service ruled that a taxpayer’s amended return/claim for refund was not timely where the taxpayer later elected to deduct instead of credit foreign taxes paid in an earlier year, thereby generating an increased net operating loss carryback from the earlier year.

In an inspired (?) bit of creativity, the taxpayer attempted to invoke Section 6511(d)(3)(A) to extend the normal three year statute of limitations for filing amended returns to ten years since that section is effective for refund claims related to foreign tax credits “allowable” to the taxpayer.

Unfortunately, the statute actually only applies to foreign tax credits that were “allowed” (i.e. taken by) the taxpayer. Citing the Dictionary (not even Black’s Legal Dictionary; just the regular old Dictionary), the Service noted the difference:

“The distinction between an ‘allowed’ credit and an ‘allowable’ credit is an important one. The term ‘allowable’ is defined as ‘that which may be allowed, legitimate, permissible.’ Random House Dictionary, Random House, Inc. 2011. The term ‘allowed,’ on the other hand, is defined as that which is permitted.”

Here, because the taxpayer filed an amended return in which it affirmatively elected to claim a foreign tax deduction, the option to use a credit was no longer “allowed.” No tax credit, no ten year statute of limitations, no net operating loss. Good day, Sir.

Care to test your reading comprehension? Like this post (include email address) and I’ll send you a copy of the ruling.

PacBell Case Highlights International Gains & Unitary Income

In Uncategorized on January 27, 2012 at 1:31 am

PacBell’s recent victory in California illustrates how international matters can impact state-level taxation. 

In Appeal of Pacific Bell Telephone Company and Affiliates (Case No. 521312), California sought tax a larger portion of the income of PacBell (a Texas taxpayer) by arguing that PacBell’s income from certain foreign investments constituted “business income.”  If upheld, such foreign income would have been subject to PacBell’s multistage apportionment and would have generated a higher California tax bill.

Got that?  California tried tax a Texas taxpayer on investment income earned in Belgium,  Denmark, Switzerland, Taiwan, Canada, and Mexico.  

According to the state, PacBell’s  investments were acquired in the course of, and so related to, its overall global telecommunications business that the dividends and capital gains arising from these investments constituted business income.   PacBell countered that income from foreign investments is nonbusiness income unless the investments “are so interwoven into the fabric of its business operations that the foreign investments become ‘indivisible’ or inseparable” from its domestic telecommunications business and both receive operating value from the relationship.  According to PacBell it was merely a regional domestic provider during the audit years and the foreign investments did not materially contribute to its domestic business. 

Unfortunately, the Board’s sparse decision does not divulge which particular fact or law ultimately persuaded the panel to side with PacBell.  A comprehensive issue briefing can be found at this link.  

http://www.boe.ca.gov/meetings/pdf/hearingsummaries/B_Pacific_Bell_Telephone_Co_521312_Sum.pdf

Nevertheless, clients with investments abroad in related industries (particularly those with influential positions) should take care when structuring these relationships.  It’s all too easy for a state taxing authority to saddle a passive investor with the responsibilities of an owner/operator.

 

 

New 871(m) Regulations Issued on US-Sourced Dividend Equivalents

In Uncategorized on January 16, 2012 at 1:23 am

The Treasury Department just released temporary regulations for Section 871(m), governing nonresident aliens and foreign corporations holding notional principal contracts which provide for payments determined by reference to the payment of US sourced dividends.

These rules treat as “dividend equivalents” arrangements that provide for a payment contingent upon or determined by reference to a U.S. source dividend.  These Section 871(m) regulations aim to apply the dividend withholding regime of sections 1441, 1442, and 1461 to these types of dividend substitutes.    

For payments made after March 18, 2012, any NPC will be a “specified NPC” unless Treasury and the IRS determined that the contract is of a type which does not have the potential for tax avoidance.

The new regulations do not adopt a safe harbor.  Indeed, the preamble notes that, notwithstanding the temporary regulations, the IRS may challenge transactions that are designed to avoid these rules under applicable judicial doctrines and may assert that an NPC other derivative is, in fact, an equity ownership interest.

 In sum, the proposed regulations:

  • Define which payments are US sourced dividend equivalents;
  • Define a “specified NPC” and allow a transition period for pre-1/1/2013 payments;
  • Set forth rules for what constitutes a “specified NPC” for post 1/1/2013 periods;
  • Define the term “underlying security”;
  • Amend the 1441 regulations to require a withholding agent to withhold tax owed on a dividend equivalent;
  • Treat dividend equivalents as income from investments in stock under section 892; and
  • Treat dividend equivalents as a “dividends” to determine the appropriate rate of withholding tax under a tax treaty. 

If your US business has any non-US participants in any arrangements like a phantom stock or stock appreciation right plan, I would highly recommend reviewing such terms before payment to determine if 871(m) applies.

Recent Rulings – PLRs

In Uncategorized on January 14, 2012 at 1:24 am

PLR 201202001 Release Date: 1/13/2012

Payments to foreign bankruptcy creditors on non-subordinated notes are treated as payments on the notes, subject to Section 1446 withholding to the extent these payments are attributable to interest.

http://www.irs.gov/pub/irs-wd/1202001.pdf

Recent IRS Rulings

In Uncategorized on January 12, 2012 at 1:08 am

Just a couple recent IRS rulings involving Subpart F and PFIC elections.

PLR 201201016  – Majority of proceeds from sale of Controlled Foreign Corporation’s banking assets not foreign personal holding company or subpart F income.  http://www.irs.gov/pub/irs-wd/1201016.pdf

PLR  201152007 – Extension for late PFIC QEF election granted. http://www.irs.gov/pub/irs-wd/1152007.pdf

GE Pays No Taxes . . . Until It Does

In Uncategorized on January 10, 2012 at 1:07 am

Followers of the “GE Pays no Taxes” meme were handed a victory by the Second Circuit this week when the panel rejected an alleged abusive tax shelter in which a GE subsidiary purported to form a partnership with two Dutch banks.

The panel rules that the partnership agreement’s intricate terms caused the General Electric subsidiary to received most of the actual partnership income but, for tax purposes only, 98 percent of the taxable income was allocated to the Dutch partners, which were not subject to U.S. income taxes.  The government argued that GE used this structure to shelter over $300 million of its income from taxes in 1993 through 1998.  The Court agreed, finding that the Dutch banks were not true partners in the venture and therefore could not be allocated any of its taxable income. 

This case serves as a good reminder not to ignore the classic “debt or equity” analysis when structuring investment participation.   If the potential volatility of your client’s carried interest is too narrow or includes a guaranteed return, your client may be treated as a debt holder.  While not determinative in this week’s ruling, the foreign status of a holder will most likely garner further scrutiny.  International tax counsel should always be consulted in such cases.

Decision can be found here

http://taxprof.typepad.com/files/castle-harbour-ii-opinion-ca2.pdf

FATCA is Coming

In Uncategorized on January 6, 2012 at 8:58 pm

On March 18, 2010, the Hiring Incentives to Restore Employment Act of 2010 was enacted into lawbrush wring a host of new information reporting requirements imposed on foreign financial institutions, which are often referred to as the Foreign Account Tax Compliance Act rules or “FATCA.”   FATCA imposes a 30 percent withholding tax on certain outbound payments to a foreign financial institution (an “FFI”), unless the FFI agrees to provide the IRS to comply with various information reporting and withholding requirements with respect to “U.S. accounts.” 

In essence, FATCA forces each participating foreign financial institution into an information exchange arrangement with the IRS akin to tax treaties typically between sovereigns. 

FATCA is meant to bolster the Service’s ongoing effort to halt US tax evasion activities involving offshore accounts. 

For individual taxpayers, FATCA requires The disclosure of  foreign financial assets with an aggregate value exceeding $50,000 on a new form (Form 8938) attached to the taxpayer’s annual tax return.  For most taxpayers, the 2011 tax return to be filed this year will represent the first such mandated report. Failure to report may result in a penalty of up to $50,000. Underpayments of tax attributable to non-disclosed foreign financial assets will be subject to an additional substantial understatement penalty of 40 percent. 

For foreign financial institutions (“FFIs”), these institutions will have to report directly to the IRS certain information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. To comply with these new reporting requirements, an FFI must enter into a special agreement with the IRS by June 30, 2013. Under this agreement a FFI must: 

(1) undertake certain identification and due diligence procedures with respect to its accountholders;

(2) report annually to the IRS on its accountholders who are U.S. persons or foreign entities with substantial U.S. ownership; and

(3) withhold and pay over to the IRS 30-percent of any payments of U.S. source income, as well as gross proceeds from the sale of securities that generate U.S. source income, made to (a) non-participating FFIs, (b) individual accountholders who do not provide sufficient information to determine whether or not they are a U.S. person, or (c) foreign entity accountholders failing to provide sufficient information about the identity of its substantial U.S. owners.

Given the anticipated reach of FATCA, those US taxpayers with undisclosed foreign assets may want to take advantage of the IRS’s recently announced voluntary disclosure initiative.

SERVICES AND LOAN TRANSACTIONS MUST STAND ALONE FOR TRANSFER PRICING:INDIAN TRIBUNAL

In Uncategorized on January 6, 2012 at 1:13 am

In a case involving an Indian company’s provision of an interest-free loan and software services to its wholly owned U.S. subsidiary the Delhi Income Tax Appellate Tribunal has held that the loan was distinct from the supply of software and thus, the arm’s-length price of each transaction should be independantly determined.

 The Indian parent had argued that, when combined, the two transactions yielded a profit margin much higher than that of the average comparables for similar services.   According to the Indian parent, no comparable uncontrolled loans were available for transfer pricing study, so the intercompany loan was factored into the profit margin analysis of the software services and determined by thet axpayer to approximate arm’s length.

Nonetheless, the tribunal rejected this position and sided with the audit, ruling that the supply of software services and the provision of the loan were two distinct and separate transactions and could not be aggregated in the transfer pricing analysis.

The tribunal also ruled that uncontrolled cross-border comparables in US currency should be used to determine the arm’s-length price of the interest on the loan and requested that the audit officer and the Indian parent recompute the arm’s-length interest accordingly.