Basic (and Not So Basic)
International Tax Planning as
Viewed through the Eyes of BEPS
SEPTEMBER 17, 2015
TIMOTHY G. STEWART
LEWIS RICE LLC
St. Louis International Tax Group, Inc.
PHILIP B. WRIGHT
BRYAN CAVE LLP
International Income Tax Planning
Fundamental Principals
 Base of Taxation

Source Based Taxation


Define Source
Residence Based Taxation

Define Residence (Organized/Incorporated – Management and
Control)
 Treatment of Legal Entities as Separate Taxpayers


Fiscally Transparent Entities
Hybrid Entities
 Planning Techniques

Gross Income Earned In Lowest Tax Jurisdiction


E.g. – Migration of Intangibles
Deductions Incurred In Highest Tax Jurisdiction with low or no
offsetting withholding or Income Taxation

E.g. – Leverage
BEPS – Background
 Prologue
 Media Focus on MNE Tax Planning
 Senate Permanent Committee on Investigations
Offshore Profit Shifting and the U.S. Tax Code - Part 1 (Microsoft &
Hewlett-Packard) (Sept. 20, 2012) (S. Hrg. 112-781)
 Offshore Profit Shifting and the U.S. Tax Code - Part 2 (Apple Inc.)
(May 21, 2013) (S. Hrg. 113-90)
 Caterpillar’s Offshore Tax Strategy (April 1, 2014) (S. Hrg. 113-408)
 Impact of the U.S. Tax Code on the Market for Corporate Control
and Jobs (July 30, 2015)

BEPS – Background
 OECD Reports
 Prior OECD Reports
 BEPS Focus


OECD (2013) Addressing Base Erosion and Profit Shifting, OECD Publishing, Paris
DOI: http://dx.doi.org/10.1787/9789264192744-en
OECD (2013), Action Plan on Base Erosion and Profit Shifting, OECD Publishing, Paris
DOI: http://dx.doi.org/10.1787/9789264202719-en
 Country Unilateral Action
 U.S. Reaction
 Hatch, Ryan Call on Treasury to Engage Congress on OECD International Tax
Project (June 9, 2015)
 Senate Finance Committee - The International Tax Bipartisan Tax Working Group
Report (July 7, 2015)
 Treasury Department Priority Guidance Plan - Regulations under §§6011 and 6038
relating to the country-by-country reporting of income, earnings, taxes paid, and
certain economic activity for transfer pricing risk assessment (July 31, 2015)
 Hatch,
Ryan Question Treasury’s Planned Country-by-Country Reporting
Regulations (August 27, 2015)
BEPS - Overview
What is BEPS?
Base Erosion and Profit Shifting (“BEPS”)
•
Arrangements that result in low or no taxation
by:
•
•
shifting profits away from jurisdictions where the
activities related to those profits are performed, or
exploiting gaps in the interaction of domestic tax laws
in order to avoid taxation
What is BEPS’ focus?
• Focus on tax planning that shifts profits from high
taxed countries to low taxed countries without
materially changing the way in which the taxpayer
operates
• Examples include discrepancies where:
•
•
•
•
Products and services are produced;
Sales and distribution result;
Research and development is undertaken;
How a taxpayer’s capital and labor are used
What is the base being eroded?
The base is the net taxable income (i.e., pre-tax
income) in a particular country.
Key Pressure Areas Identified by the OECD
• Key pressure areas identified by the OECD that
create BEPS opportunities include:
•
•
•
•
•
•
Hybrids and mismatches that result in tax arbitrage
Residence-source tax (e.g., digital commerce)
Intragroup financing
Transfer pricing issues
Anti-avoidance rules
Preferential tax regimes
OECD BEPS - Actions
BEPS Actions
Action 1: Address the tax challenges of the digital
economy
Actions 8, 9 & 10: Assure that transfer pricing
outcomes are in line with value creation.
Action 2: Neutralize the effects of hybrid mismatch
arrangements
Action 11: Establish methodologies to collect and
analyze data on BEPS and the actions to address it
Action 3: Strengthen CFC rules
Action 12: Require taxpayers to disclose their
aggressive tax planning arrangements
Action 4: Limit base erosion via interest
deductions and other financial payments
Action 13: Re-examine transfer pricing
documentation
Action 5: Counter harmful tax practices more
effectively, taking into account transparency and
substance
Action 14: Make dispute resolution mechanisms
more effective
Action 6: Prevent treaty abuse
Action 15: Develop a multilateral instrument
Action 7: Prevent the artificial avoidance of PE
status
OECD Published Reports
 Action 1 – Addressing the Tax Challenges of the Digital






Economy
Action 2 – Neutralising the Effects of Hybrid Mismatch
Arrangements
Action 5 – Countering Harmful Tax Practices More
Effectively, Taking into Account Transparency and Substance
Action 6 – Preventing the Granting of Treaty Benefits in
Inappropriate Circumstances
Action 8 – Guidance on Transfer Pricing Aspects of
Intangibles,
Action 13 – Guidance on Transfer Pricing Documentation
and Country-by-Country Reporting
Action 15 – Developing a Multilateral Instrument to Modify
Bilateral Tax Treaties
Digital Economy
 Primary conclusion
 Digital economy is so widespread that that it represents more
than a special part of the economy– it is the economy
 Not possible to isolate the digital economy for purposes of
creating separate tax rules
 Digital
Economy Task Force (“DETF”)
authority to propose its own solutions

given
DETF raised certain specific points but provided no specific
conclusions
Digital Economy
 Special points raised by the DETF include:
 The OECD model treaty PE article needs to be reviewed




Reliance on concluding a contract in one territory to avoid
taxation in another
Highlights the role of intangibles and the increasing
importance of data
Highlights the possibility of changing CFC rules to target
the types of income in a digital economy
Addresses consumption tax questions
MNE Tax Planning Structures
ANNEX C
OECD REPORT - ADDRESSING
BASE EROSION AND PROFIT
SHIFTING
E-Commerce structure
Transfer of Intangibles with Hybrid Entities
Transfer of rights to preexisting IP and IP from
new R&D.
“Buy-in” payment for pre-existing IP.
Contract R&D service payments for IP
from new R&D.
Sub-license
Royalty
(no withholding tax)
E Commerce Structure
Background
 Company A, organized in Country A, initially developed technology and
intangibles to support its business in Country A
 Rights to technology developed by Company A is licensed or transferred
to Company C under a cost sharing or cost contribution arrangement

Company C is resident outside of Country A
 Company C agrees to make a “buy in” payment equal to the value of the
existing technology
 Company C licenses all of its rights in the technology to Company D in
exchange for a royalty

Company D is organized and managed and controlled in Country D
 Company D sublicenses the technology to Company B
 Company B employs significant workforce in Country B in its operations
E-Commerce Structure Result
 Country B imposes corporate income tax on taxable profit in Country B




but the taxable profit is substantially “eroded” as a result of the royalty
payment from Company B to Company D
Country D taxes the profits of Company D such profits reduced by the
royalty it pays to Company C
Company D performs no functions and holds no assets so Company D is
allocated little income
Country D does not impose withholding tax on royalty payments under its
domestic law
Company C is managed and controlled in Country C. Country C does not
impose a corporate income tax. Company C has no presence in Country B.

The royalty income received by Company C is not taxed by Country D, Country C or Country B
Tax Residence – Residence Taxation
• Conflict among jurisdictions over the right to tax (i.e., potential double
tax) are resolved by treaty by either allocating exclusive taxing rights to
one of the contracting states or by allocating the primary right to tax
either to:
•
•
the country that is the source of the income, or
the country in which the profit earner is resident
 Where the taxing right is based on residency, the ideal corporate entity
for tax purposes is an entity that is a tax resident of a tax haven (i.e., no
tax country) or a nowhere resident, so that no jurisdiction has a taxing
right. Irish residency law provides asymmetry which provides planning
opportunities.
•
•
For U.S. tax purposes tax residence is based on the place of incorporation
For Irish tax purposes, tax residence is based on where the company is
“managed and controlled”
Apple Structure
“Double Irish”
Apple Structure
 Irish Holdco (Company C) is managed and controlled in
Bermuda. Ireland taxes only Irish source income generated
by Irish Holdco. Non-Irish source income is not subject to
tax in Ireland
 Netherlands does not tax the royalty income under the EU
and the Netherlands Royalty Directive. The Netherlands also
provides a favorable treaty to avoid withholding taxes on
royalty payments
 Result: Irish source income is subject to Ireland’s 12.5% tax
and non-Irish Source income is not taxed
 Apple’s effective tax rate on earnings through this structure is
reportedly less than 3% --approx. 2.4%
Google Structure
“Double Irish with a Dutch Sandwich”
“
-i ”
for preexisting IP and IP from new
R&D..
Transfer of rights to preexisting IP and IP from new
R&D.
Sub-license
Interco Royalty
*Incorporated in Ireland, managed and controlled in
Bermuda.
Google Structure
 The Irish Holdco (Company C) is managed and controlled
outside of Ireland. Ireland taxes only Irish source income.
Non Irish source income is treated as having no tax
residence and is not taxed.
 The Netherlands does not tax the royalty income under the
EU and the Netherlands Royalty Directive.
 The result – only Irish source income is subject to Ireland’s
12.5% tax and the result is not taxed.
Transfer of manufacturing operations and supporting intangibles
cost contribution arrangement
Company A holds rights to the
manufacture and sale of Group
products in Country A ((100-s)
percent of total Group sales).
Payments to Company C for
manufacture of Group
products to be sold in
Country A ((100-s)of total
Group sales). Payment
covers costs and risks
license
associated with
manufacture.
R&D
R&D carried out by Company A.
Costs of R&D and rights to IP
shared between Company A
and B, under R&D cost sharing
agreement (CSA).
Payments to Company A under CSA for
(s) percent of R&D costs, giving
Company B rights to the manufacture
and the sale of Group products outside
Contry A (s percent of the Group sales).
royalty
Cost-plus payments to Company D
for manufacture of Group products
(contract manufacturing agreement)
Principal operating company
responsible for manufacture of
Group products
Contract manufacturing
company
Transfer of Manufacturing Operations and Intangibles
Background
 Company A is a publicly traded company based in country A and parent of a
multinational group (“Group”).



Group invests heavily in research, product design and development
Company A carried out all of the R&D and it owns all of the resulting IP
Company A has sole responsibility for all risks associated with the manufacture and sale of products
throughout the world.
 Company A creates Company B in Country B and assigns to Company B its IP and
responsibility for the manufacture and sale of products outside Country A

Company A retained domestic IP rights related to the manufacture and sale of products
within Country A and continues to carry out R&D for the Group
 Group creates two additional foreign entities



Company C organized in Country C and serves as the principal company responsible for
the manufacture and sale of Group products outside of Country A
Company D is a manufacturing entity responsible for the production of Group products
outside of Country A
For U.S. tax purposes, both Company C and D are treated as disregarded for U.S. tax
purposes but they are considered corporations in Country C and Country D.
Transfer of Manufacturing Operations and Intangibles
Background
 Transfer of IP from Company A to Company B is taxable in Country A via a cost-
sharing arrangement (CSA)


Under CSA, Company B is required to make a buy-in payment to Company A for the preexisting IP
Buy-in payment is either a lump sum or running royalty
 Company B assumes responsibility to reimburse Company A for a share of
ongoing R&D expense reflecting its share of the anticipated benefit Company B
expects to derive from ongoing R&D


For example, if Company B is responsible for 45% of global revenues, it would be
expected to reimburse Company A for approximately 45% of product area R&D under
the CSA.
Even though Company B reimburses Company A for its R&D costs, Company A is
entitled to an R&D credit in Country A for the full amount of its R&D expenditures.
 Company B is treated as the owner of the non-Country A IP rights of the Group.
Company B licenses those rights to Company C and Company C contractually
assumes responsibility for producing and selling Group products outside Country
A.
Transfer of Manufacturing Operations and Intangibles
Result
 Company C engages Company D to serve as a contract manufacturer. Under
manufacturing agreement, Company D manufactures for a fee equal to direct
and indirect production costs plus a 5% mark-up. Manufacturing agreement
between Company C and Company D specifies that Company C bears the
principal risks associated with the production of the product.


Actual production may take place in Country D or in a branch of Company D in a low-cost
manufacturing country
Company D includes fee in its taxable income
 Manufactured products are the property of Company C, which sells the
products to or through related sales entities in high tax jurisdictions


Contractual arrangements between Company C and marketing companies specify that Company C
assumes the principal risks related to the marketing of the products
Sales and marketing companies are compensated on a basis reflecting their limited risk (Limited
Risk Distributor)
 Company C earns profit equal to its gross sales revenue on sales, less fees paid
to Company D for the manufacture of the goods, payments to any related
commission based marketing entities and less royalties paid to Company B
Transfer of Manufacturing Operations and Intangibles
Result
 Royalties paid to Company B by Company C for its foreign IP rights are
deductible by Company C. Country C does not impose withholding tax on
royalty payments and Country B does not impose corporate income tax; thus,
the royalty payment is free of withholding and income tax
 Country A taxation is avoided on the royalty payment from Company C to
Company B under Country A’s CFC rules due to “check the box” elections,
royalty payment from Company C to Company B is disregarded for Country A
tax purposes
 Group erodes Country C tax base with deductible royalty payments and avoid
Country A taxation on what would otherwise be passive royalty income
 Dividends paid to Company B are free of tax at source as Country B does not
tax dividend income and dividend payment is disregarded for Country A tax
purposes
Leveraged Acquisition
State P
Loan
EUR 400m
State L
Tax grouping
Hybrid Instrument
EUR 400 m
State T
Dividends/
Interest
Interest
Loan
EUR 600m
EUR 1 billion
Tax grouping
Leveraged Acquisition
Background
 MNE is headquarter in State P with operations in various countries,
including State L. MNE plans to acquire Target Co., a State T
manufacturing company The purchase price is EUR 1 billion, 60% to be
financed externally and 40% to be financed by MNE.
 MNE sets up a holding company in State L (L Hold Co) which receives
an intra-group loan for EUR 400 million. L Holdco, in turn, sets up a
company in State T (T Holdco). T Holdco is financed party by L Hold Co
through a hybrid instrument (EUR 400 million) and party with external
bank debt (EUR 600 million).
 T Holdco acquires Target Co and enters into a tax grouping with Target
Co for State T tax purposes.
Leveraged Acquisition
Benefit
 Debt push-down ensures that subject to interest expense limitations interest
expenses on the external bank debt are deducted from the target company’s
operating income through the applicable group tax regimes
 L Hold Co finances T Hold Co through a hybrid instrument, e.g., redeemable
preferred shares. Financing is treated as debt in State T while it is treated as
equity in State L.


Subject to applicable limitations, additional interest expense will be deducted against the income of Target
Co for tax purposes.
Payment will be treated as a dividend for State L purposes and be exempt from tax under State L local law.
 Interest L Hold Co. pays on the EUR 400 million intra-group loan can be
deducted against the income of other group companies in State L
 Upon exiting the investment, shares in T Hold Co can be sold tax-free to the
purchaser. State T may be prevented from taxing the income under relevant
double tax treaty, while State L exempts capital gain on shares under its
domestic law.
BEPS Impact on Structuring
and Planning Considerations
Residency Challenge
Response to Residency mismatch:
 In October 2013, in response to international pressure arising from the
media coverage of the Google arrangement, Ireland changed its domestic
law. Ireland’s law change is basically a “throw back” rule. If an Irish
incorporated entity fails the “management and control” test but it is not a
tax resident of another jurisdiction, it will be subject to tax in Ireland.
 In October 2014, Ireland’s Finance Minister proposed a new budget, which
includes a provision that would align its residency in line with
incorporation. The current proposal phases in over six years, from 2015
through 2020.
 Taxpayers need to monitor this proposal. Regardless of the success of this
proposal, residency reform is considered essential for the success of BEPs.
 Even assuming the proposal succeeds, the income “thrown back” to Ireland
would be taxed at a 12.5%, resulting in a 22.5% tax arbitrage (35% less
12.5%).
Planning Considerations
 MNEs can consider transferring the underlying intangibles to the
Netherlands and access the Innovation Box regime

If the intangible assets are considered by Ireland to be owned in Bermuda
(where the profit related to the intangibles has been attributed), a transfer to
the Netherlands should not give rise to local tax on the outbound asset
transfer. Even if Ireland considers the intangibles to be owned in Ireland,
gain on the transfer may be exempt from tax under the Irish group relief
provisions.
 Transfer of intangibles may impact royalty withholding rates. If the
intangibles are transferred to the Netherlands, the royalties attributed
to the intangibles should be taxed at 5%. While this rate is higher than
the effective tax rate from the current structure, it may still be an
acceptable rate increase in light of the substantial changes that may
result from international tax initiatives.
 Consider dual incorporation
Withholding tax challenge
 In the Dutch Sandwich structure, insertion of the Netherlands entity
reduces withholding tax on the royalty payments. A royalty payment
from Ireland to the Irish/Bermuda resident company would require
withholding tax.
 Within the EU, cross-border exemptions, such as the Royalties and
Interest Directives are a foundation of the region’s economic unity.
Adoption of anti-abuse rules to assess lower withholding tax on intragroup payments will quell certain structures, such as the Dutch
Sandwich (i.e., intra-company payments will little business purpose
other than tax avoidance would be subject to the anti-abuse rules).
Planning Considerations in Answer to Withholding Tax
Challenge
 The MNE could concentrate intangible assets in a patent box regime
(e.g., Netherlands or UK).
 Again, there may be no outbound capital gain tax on the transfer of the
IP (i.e., the IP could be considered owned by Bermuda or gain on the
transfer could be exempt under the Irish tax rules).
 Payments from sales companies in many jurisdictions for the right to
license the intangible should be distinguished from the Netherlands
acting merely as an intermediary entity.
 Locating the IP in a favorable withholding tax jurisdiction could
alleviate anti-abuse challenges related to a mere intermediary entity.