U.S. & Cross-Border Tax Breakfast
May 26, 2011
1
Introduction
• Larry Vicic
• Welcome
• Eddie Goldsberry
• Current U.S. Tax Developments
• Elaine Reynolds
• U.S. Vacation Property
• Rafael Carsalade & Bill Macaulay
• Canadian Business Expansion into the U.S.
• John Forrest
• Doing Business in Washington State
2
Tax Update: Things You Need to Know
About Doing Business in the U.S.
Edward N. Goldsberry
3
It’s the Debt/Deficit, Stupid!
• Debt just hit $14.294 trillion – the “debt ceiling”. No more
borrowing until it is raised.
• Federal government runs out of money on August 2.
• U.S. current and expected budget deficits:
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2010: $1.3 trillion
2011: $1.4 trillion (projected)
2012: $1.1 trillion
2013: $700 million to $950 million, depending
• Entitlements expected to increase as population ages.
• Latest CBO estimates show likely $7.2 trillion deficit over next
10 years without major changes.
4
Changed Political Landscape
• Republicans now have the majority in the House, and Democrats no longer
have 60 vote majority in the Senate.
• Obama still has veto power, and Republicans cannot override his veto.
• Republicans are split between Tea Party conservatives and moderates.
• Two immediate results - the last-minute, Lame Duck compromise that
extended the Bush tax cuts, and repaired several other broken tax
provisions, and repeal of expanded Form 1099 reporting.
• Republicans also captured majorities in most state legislatures. Huge
implications for Congressional “redistricting”.
• Example – Texas will get 4 new House seats allocated to it in 2012, and the
Republications largely control who will get them.
5
Busy Summer Ahead
• Democrats want more taxes to cut deficit.
• Moderate Republicans want to cut spending moderately and to make a
deal.
• Tea Party Republicans want to really cut spending, including entitlements
and are adamantly against tax increases.
• Deal has to be made by August 2nd or risk either shutting down the
government or possibly more loss of investor confidence in U.S. debt – or
both.
• Stalemate possible, but not likely. Almost certain that the U.S. will not run
risk of debt default.
• The good side of stalemate – less uncertainty.
6
Tax Legislation Crystal Ball
• Lots of talk about major reform. Not likely to happen soon.
• Pace of legislation will be much slower than in first two years of Obama
administration.
• Raising tax rates on the “rich” off the table until 2012.
• Near-term raising of taxes on the Big 5 oil companies is a real possibility.
Much more politically palatable than earlier proposals that would have
devastated smaller companies and domestic drilling.
• Possible repeal of the estate tax.
• Probably not much of a precedent on the state level, but Michigan just
repealed much of their draconian and anti-business tax system.
7
International Tax Policy Climate
• Very active and not particularly pro-business Administration (and Congress
through end of 2010).
• Offshore tax abuses estimated to cost U.S. government as much as $100
billion per year. May not be too far off.
• IRS clear position of increased scrutiny of international tax compliance for
recent past and expected future. UBS investigation & scrutiny of U.S.
taxpayers with foreign accounts – IRS now after HSBC in India.
• Enforcement of legislation already passed likely to be stringent.
Compliance costs for international business will continue to rise, but not
by as much as we feared.
• Continued interest in international corporate tax changes.
• Increased emphasis by IRS on transfer pricing.
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Good News
• U.S. needs foreign direct investment.
• U.S. federal tax policy will likely continue to favor SME’s where
they know most jobs are created.
• States and localities will continue to fight for jobs with tax
breaks.
• States and localities, even in the budget crunch, are
continuing to devote resources to providing services to assist
in-bound investment.
9
Costs of Doing Business
FOREIGN BANK ACCOUNT REPORTS
FATCA
1099 REPORTING (REPEALED)
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FBAR – U.S. Person
• U.S. Person is
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1. A citizen of resident of the U.S.
2. A domestic partnership
3. A domestic corporation
4. A domestic estate or trust
• But, only (so far) for years 2010 and prior
• May ultimately include non-residents engaged in U.S. trade or
business. To date, this has been suspended via IRS notices for
foreigners considered to be “in or doing business in the U.S.
Exemption does not apply to anyone considered a U.S. tax
resident.
11
FATCA(T) – Withholding Imposed
• Targets U.S. persons failing to report/hiding income and assets
outside the U.S.
• Effective for payments after 1/1/2013.
• Imposes 30% withholding tax on any withholdable payment of
U.S. sourced income to any foreign financial institution
• Subject payments include any fixed or determinable annual or
periodic income (FDAP), and
• Gross proceeds from sale of property that could produce U.S.
source interest or dividends
• Withholding agent includes any person, an any capacity,
having control, receipt, custody, disposal or
payment of any withholdable payment
12
FATCA(T) Withholding Expansion
In addition, now also subject to withholding:
• proceeds from sale of property that produces
interest/dividend income (i.e. capital gain transaction)
• interest on deposit with foreign branch of U.S. bank
• Any payment of such income to an “unqualified” foreign
financial institution will be automatically subject to the 30%
withholding rate. Exception for “qualified” institutions.
• Any payment of such income to a foreign nonfinancial entity
also subject to the 30% withholding. Exception for cases
where certification exists, recipient is publicly traded or
subsidiary of a publicly traded corporation, governmental
entities, international organizations, and others.
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Foreign Financial Institutions
Qualified foreign financial institutions will need to:
• Obtain enough information on all account holders to determine which
ones are U.S. accounts.
• Follow IRS procedures to determine which are U.S. accounts.
• Report annually all U.S. accounts and its holders, account balances, gross
receipts, and withdrawals from the account.
• Withhold 30% on applicable payments
• Comply with information request by IRS on U.S. accounts
• Attempt to obtain waiver from foreign law where it would prevent such
disclosure on its account holders, and close the account if waiver is not
obtained.
• Agree to withhold on “recalcitrant” account holders.
14
FATCA(T) –
Non-Financial Foreign Entity
• Also applies to payments to non-financial foreign entities – any entity that
is not a foreign financial institution
• That has one or more “substantial U.S. owners”
• Substantial is ownership, directly or indirectly, of 10% or more of a
corporation, partnership or of a trust treated as a grantor trust, or holder
of 10% of more beneficial interest in a non-grantor trust
• 10% is reduced to zero if the foreign corporation or partnership is engaged
primarily in the business of investing
• To be exempt, must:
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Provide certification that there is no substantial U.S. ownership,
or provide name, TIN and address of each substantial U.S. owner
15
OTHER KEY POINTS – NOT NECESSARILY NEW
16
Treaty Based Return Disclosures
• A treaty based return position is any case where there is a
difference in tax liability due to a provision of a tax treaty –
common example is a position that business profits are not
taxable because there is no permanent establishment (PE) in
the U.S.
• Disclosed by attaching IRS Form 8833 to the tax return
• Penalties for failure to disclose
• Disclosure waived under most circumstances where U.S. payer
properly reports on From 1042-S
• Where payer and payee are unrelated and FDAP paid exceeds
$500,000, disclosure is required.
17
U.S. Inbound Individuals
• Most common error is failure to realize that foreign nationals
become taxed just as if they were U.S. citizens when they
become a U.S. tax resident. “Closer connection” tests in
U.S.-Canada tax treaty can provide limited relief.
• Biggest risk today is failure to comply with U.S. reporting
requirements for non-U.S. income and assets, including
trusts, companies and real property.
• Planning – everyone in the world is a U.S. taxpayer – they just
do not know it yet. Non-residents who become U.S. tax
residents are treated as if they have always been U.S.
taxpayers with some strange and, at times, counter-intuitive
results.
18
Circular 230 Legend
• Pursuant to U.S. Treasury Department Circular 230, unless we
expressly state otherwise, any tax advice contained in this
presentation is not intended or written to be used, and
cannot be used, by the recipient for the purpose of avoiding
penalties that may be imposed under the Internal Revenue
Code or applicable state or local tax law provisions.
19
Contacts
Eddie Goldsberry, Director, International Tax Services
Phone: (713) 860-1450
Email: egoldsberry@pkftexas.com
20
Canadian Business Expansion into the
U.S.
Rafael Carsalade
Bill Macaulay
21
Business Expansion into the U.S.
• U.S. and Canadian tax considerations
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Business
Employees
• Evolution over time
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Independent sales agent
Employee working from home
Third party warehouse
Lease an office
Form a U.S. subsidiary
• Identify the issues and plan accordingly
22
Timeline Issues
• Questions that track the business evolution:
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Do I have a taxable presence in the U.S.?
What type of legal entity should I use?
In what State should I base my operations?
How do I finance my U.S. operations?
What do I need to consider when transferring employees
to the U.S.?
• What are some other common issues?
23
U.S. Taxable Presence
•
Non-U.S. entities will be subject to U.S. taxation on their operations if
they are deemed to be “conducting a trade or business within the U.S.”
•
Threshold for U.S. trade or business is low:
• personal services
• trading in securities and commodities
• selling of products through an agent
• export of goods from the U.S. and associated operations
• partner in a partnership doing business in the U.S.
• Ownership and transactions involving U.S. real property
• Other examples based on facts and circumstances of particular case.
24
Permanent Establishment
• Article V (Permanent Establishment) of the Canada-U.S. Tax Treaty has
higher threshold for level of activities giving rise to a taxable U.S.
presence.
• The Treaty trumps U.S. domestic tax law in determination of taxable
presence – so if no PE, no tax on business profits.
• Under Article V, PE generally includes: place of management, branch,
factory, office, workshop, mines, oil & gas wells and other natural resource
extraction site, construction site/project lasting more than 12 months, use
of agent, etc. …
• Article V also provides specific guidance for when physical presence while
performing services constitutes a PE.
25
Deemed PE -- Services
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Change to the Treaty starting 2010
A “temporal” rather than physical approach to “permanent”
Applies to service businesses
Deemed to provide services through PE if either:
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a) Services provided by an individual who is present for a period or periods
exceeding 183 days in any 12 month period and during those periods more
than 50% of gross revenue is from the services provided in the U.S. by that
individual, or
b) Services provided in the U.S. for 183 days or more in any 12 month period
with respect to the same or connected project for customers who are U.S.
residents or have a PE in the U.S. (and services related to that PE)
26
Does the Treaty Apply?
• Corporations with a foreign parent (other than U.S. or
Canada) must review the availability of treaty exemptions due
to the Limitation on Benefits rules in the changes to the Treaty
May lose key treaty benefits, for example:
• Carrying on business in the other country but not through a permanent
establishment
• Reductions in withholding tax rates
• Capital gains exemptions
27
U.S. Legal Entities
• Legal entities are formed at the State level, not Federal.
• Most common types of business legal entities available:
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Corporation (Corp)
Partnership, general and limited (GP and LP)
Limited Liability Company (LLC)
Limited Liability Partnership (LLP)
Most common types of business tax entities available:
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C-Corporation
S-Corporation
Partnership
Sole proprietorship
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Corporations & Partnerships
• S- Corporation: cannot have non-U.S. owners.
• C-Corporation:
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Federal income tax rate: 34%
State income/franchise taxes apply
Dividends taxable to recipients
Required for public companies
• Partnership:
• Income taxes deemed distributed yearly to partners who are
responsible for the tax.
• Flexibility in different allocations of income, losses, and capital for
partners.
29
Limited Liability Companies
• Legal liability advantages of a corporation, with more
flexibility in ownership structure and also on tax treatment.
• Tax treatments available:
• Partnership: the default tax treatment of an LLC will be a partnership.
• C-Corporation: the LLC may elect under “check-the-box” rules to be
treated as a c-corporation for tax purposes.
• Disregarded entity: a partnership requires at least two partners. Since
LLCs may have only one owner, such LLCs will be disregarded for
Federal income tax purpose.
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Canadian Issues for LLC
• Pitfalls of using an LLC to carry on your U.S. business
• LLC is a corporation for Canadian purposes; generally not for
U.S. purposes – timing and sourcing issues
– No foreign tax credit available to Canadian parent
– Can give rise to FAPI in Canadian parent, with no
underlying foreign accrual tax
– Potential loss of 5% treaty rate on U.S. branch tax– result
30% branch tax
31
Consideration for Canadian Parent Company
• Consider the impact of U.S. expansion on the “Small Business
Corporation” status of the Canadian corporation
• $750,000 lifetime capital gains exemption
• Exemption from corporate attribution rules
• Allowable business investment losses
•
Consider a sister corporation as the Canadian holding
company
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Canadian Issues
Canadian resident individual
Canadian
Opco
Shares
Active business in Canada
Loans
U.S. Subco
Lifetime capital gains exemption
Don’t want shares and loans to U.S. Subco to exceed 90% of
FMV of Parent’s total assets
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Sisterco Alternative
Canadian resident individual
Canadian
Opco
Active business
in Canada
Canadian
Sisterco
Shares
Loans
U.S. Subco
Lifetime capital gains exemption
Opco satisfies the 90% of FMV test
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State and Local Taxes
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In addition to Federal tax laws, 50 U.S. states exist each with their own set of local
income, franchise, sales, and property tax laws. Commonalities exist.
States do not necessarily respect the Treaty.
Tax rates:
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Income/franchise tax rates generally from 0% to 12%
Sales tax rates generally 4% - 9%
Property tax rates vary from county to county.
Generally, State taxable income is computed as:
Federal taxable income
+ State law adjustments (i.e. depreciation)
State allocable income
x State apportionment factor (sales/payroll/property)
State taxable income
35
Location Operations
• Delaware? Nevada? Where to locate company and operations?
• The adoption of unitary and combined filing by most states make
the choice less important from an income/franchise tax perspective
• Unitary and combined filing generally causes its U.S. operations to
be considered as a whole (regardless of legal entities) in computing
state income/franchise taxes. Then state taxable income calculated
based on activity in the state (i.e. sales, property, and payroll).
• Local incentives: where a physical facility will be setup and jobs
created, tax incentives may be obtained from the local authorities
interested in attracting the company.
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Financing U.S. Operations
• With 0% interest withholding under the Canada-U.S. treaty,
incentive to finance operations through debt.
• No specific debt-to-equity ratio required, the IRS will look at facts
and circumstances specific to the situation.
• Where debt is used, certain items common to third party debt
should be present: written loan agreement, reasonable interest rate
charged, clear repayment terms, respect to loan terms from year to
year, payment of interest and principal not tied to profitability of
company, etc.
• Even where debt-to-equity ratio is not challenged, limitation to the
deduction of interest paid to related parties may apply where ratio
is too high.
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Canadian Parent Company Consideration
• Deductibility of interest expense on funds borrowed by
shareholder and loaned into the Canadian parent company
and loaned to the U.S.
• Canadian parent company needs to consider charging interest
to have a good source of income
• Charging interest may help with deductibility of a capital loss
on the funds loaned to the Canadian parent company by
controlling shareholder
38
Employee Payroll
• Compliance with U.S. immigration law should be the first concern of
both employee and company.
• Once legally allowed to work in the U.S., obtaining a social security
number and starting to report compensation on U.S. payroll are
next steps.
• Option to be included on U.S. payroll, or to be kept in both U.S. and
Canadian payrolls in what is known as a “split payroll”.
• Certificate of coverage: obtaining one under the U.S.-Canada
Totalization Agreement could exempt employee from U.S. Social
Security and Medicare taxes for up to 5 years if they continue to
contribute to CPP/OAS.
39
Canadian Payroll Consideration
• Canadian residents are generally subject to Canadian payroll
withholdings on their worldwide employment income
• If working in the U.S. and duplication results, request waiver
from the CRA in respect of U.S. taxes being withheld
40
Employee Compensation
• What needs to be reported as compensation on the U.S. payroll?
• Base salary, bonus, and fringe benefits for the services rendered for the
U.S. employer, regardless of whether service is performed in the U.S. or
abroad.
• Common fringe benefit examples:
• Car and housing allowances
• Dependent education allowances
• Cost of family home travel
• Equity-based compensation (i.e. stock options)
• Employer contributions to deferred compensation
arrangements (i.e. pension funds).
41
Stock Option Compensation
• Statutory vs Nonstatutory stock options, or also called
• Qualified vs nonqualified stock options
• Statutory stock options are those drafted to meet specific
requirements of Internal Revenue Code sections that allow for the
deferral of income and recognition of part of gain as capital gains.
• In general, unless stock option plan was drafted with the intent to
meet IRC requirements, stock options will be nonstatutory.
• Income is recognized upon exercise of nonstatutory stock option,
and treated as compensation for services rendered and so ordinary
income. Reportable on Form W-2 or 1099.
42
Stock Option Recognition
• To compute ordinary income:
• Grant date: no taxable event. Begin of vesting period.
• Vesting period: Determines the sourcing of the income,
U.S. or foreign, depending on where the employee
physically worked during this time.
• Exercise date: Taxable event. For U.S. tax resident
employee, entire amount of income will be recognized. For
U.S. tax nonresident, only U.S. source portion of income
will be recognized.
• Ordinary taxable income from exercise:
• Fair value of stock at exercise date – option price
43
Stock Options -- Canada
• Canada has similar computation of economic benefit
• Most arm’s length employees will only have 50% of their
benefit taxed – special rules
• Generally taxed on exercise or receipt of payment
• May be deferred to sale of stock if qualifying CCPC
• Withholdings required since Budget 2010
• Cross-border services will result in double withholding – get
waiver – some challenges with options
44
Personal Tax Rates
• 2011 personal tax rates
– B.C. (combined) 43.7%
– U.S. (federal only)
35.0% but FICA in the U.S.
– Withholding on salary could be huge
– Withholding on stock option benefit could be
• 50% of 43.7% plus 35% > 56% --still huge
45
Where Do You Want Your Profits Taxed?
• 2011 corporate tax rates
– B.C. (combined)
– U.S. (federal only)
26.5%
35.0%
• Shift profits home to the extent supportable
– Interest, management fees, royalties, reimbursements
46
Other Items
• TRANSFER PRICING: simply charging a “management fee” won’t be
acceptable. Transfer pricing methodology should be reasonable,
properly documented, and consistent from year to year.
• Tax authorities getting more aggressive in pursuing transfer pricing
in audits, and trend is to continue this way.
• FIRPTA: acquisition of U.S. real property (i.e. headquarters,
warehouse, etc…) causes additional tax concerns because of the
Foreiogn Investment in U.S. Real Property Tax Act (FIRPTA).
• Acquisition of U.S. real property, whether for operations or as
investment, should be properly planned to avoid surprises.
47
Other Items
•
Review all foreign cross-border interest payments for exemptions
and reductions
• Canada Revenue Agency has new non-resident withholding forms
to calculate the withholding tax required on payments to
partnerships, fiscally transparent entities such as limited liability
companies and S-Corporations. A look-through approach
• Interest
• Dividends
• Royalties
• Management fees, etc.
48
Contacts
Rafael Carsalade, Senior Manager, International Tax Services
Phone: (713) 860-5412
Email: rcarsalade@pkftexas.com
Bill Macaulay, Partner, Smythe Ratcliffe LLP
Phone: (604) 694 7536
Email: bmacaulay@smytheratcliffe.com
49
Doing Business in Washington State
John Forrest, CPA
50
Doing Business in Washington State
•
Business & Occupation (B&O) Tax
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Sales & Use Tax
•
Personal Property Tax
51
Business & Occupation Tax
Overview
• Gross Receipts tax
• B&O tax vs. GST
• B&O vs. State Income Tax
52
B&O Tax – Recent Developments
• Old rules – Cost apportionment
• New rules – Customer receives service
• Economic Nexus
• Physical Presence (based on activity)
vs. Permanent Establishment
• Targeted Credits
53
Sales & Use Tax
• Tax paid by end user consumer
• Remitted to the State by business collecting
tax
• Business can be liable for tax if not properly
collected
• Manufacturers exemption
• Business and individuals liable for Use Tax
54
Personal Property Tax
• Tax on business personal property
• Tax based upon depreciated value
• Collected by County
55
Contacts
John Forrest
Phone: (425) 629 1990
Email: jforrest@sweeneyconrad.com
56
Thank you
SmytheRatcliffe
CHARTERED ACCOUNTANTS
Smythe Ratcliffe LLP
Suite 700, Marine Building
355 Burrard St., Vancouver, BC V6C 2G8
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