International Structuring Involving Partnerships. November 6, 2015

Transcription

1 International Structuring Involving Partnerships November 6, 2015

2 Agenda IP Partnerships Leveraged Partnership Tiered Partnerships 2

3 IP Partnerships 3

4 Notice History Prior to 1997, outbound transfers of appreciated property were subject to excise tax under Sections 1491 through Congress repealed the excise tax in 1997, believing it was no longer necessary due to enhanced information reporting requirements (e.g., Sections 6038, 6038B, 6046A). In connection with this repeal, Congress granted the Secretary regulatory authority to issue regulations: Under Section 721(c) to override non-recognition treatment under Section 721(a) if the gain, when recognized, would be includable in the income of a foreign person; and Under Section 367(d)(3) to applying the rules of Section 367(d)(2) to transfers of intangible property to partnerships in circumstances inconsistent with the purposes of Section 367(d). 4

5 Notice Overview Notice , issued on August 6, 2015, announces the intent to issue regulations under Section 721(c) to ensure that, when a U.S. person transfers certain property to a partnership that has foreign partners related to the transferor, income or gain attributable to the property will be taken into account by the transferor either immediately or periodically (through the remedial Section 704(c) method). 5 The new regulations will have 2 main features: Significant new restrictions will apply if the U.S. partner and related foreign partner together own more than 50% of the partnership, and the U.S. partner contributes built-in gain property to the partnership. Immediate gain recognition will be required under Section 721(c) on the contribution unless the partnership adopts the remedial allocation method with respect to the property contributed by the U.S. transferor and certain other requirements are met. Section 482 Regulations will be issued to specify transfer pricing methods applicable to controlled transactions involving related-party partnerships. These specified methods, which may apply to partnership contributions, partnership distributions, and partnership allocations, will mirror the methods currently prescribed for costsharing arrangements and will include a periodic trigger feature similar to the costsharing periodic trigger.

6 Notice Reasons for Change The Notice reflects Treasury s and the IRS s concern that taxpayers are using partnerships to shift income or gain from U.S. persons to related foreign partners that are not subject to U.S. tax. In particular, the Notice reflects the view that this income shifting is facilitated by the use of Section 704(c) allocation methods other than the remedial method and the use of valuation techniques that are inconsistent with the arm s-length standard.. In addition, Treasury and IRS believe that non-arm s-length valuations of property contributed to a partnership could be combined with special allocations of income with respect to such property to achieve inappropriate tax results. 6

7 Notice General Rule Under the terms of the regulations described in the Notice, the transfer of property with built-in gain other than cash equivalents and certain securities (Section 721(c) Property) by a U.S. person other than a domestic partnership (a U.S. Transferor) to a Section 721(c) Partnership will result in immediate recognition of such built-in gain, unless the requirements of the Gain Deferral Method are met. Section 721(c) Partnership is any domestic or foreign partnership in which a U.S. Transferor and a related foreign person or persons together own more than 50% of the interests in partnership capital, profits, deductions, or losses. Built-In Gain is the excess Section 704(b) book value over the contributing partner s adjusted tax basis in the property at the time of the contribution (excluding gain created when a partnership revalues property). 7

8 Notice Gain Deferral Method The regulations will include an exception to the application of Section 721(c) (the Gain Deferral Method ) which may be used to the extent certain requirements are met. The Section 721(c) Partnership adopts the remedial allocation method described in (d) for Built-in Gain with respect to all Section 721(c) Property contributed to the Section 721(c) Partnership pursuant to the same plan by a U.S. Transferor and all other U.S. Transferors that are Related Persons; During any taxable year in which there is remaining Built-In Gain with respect to an item of Section 721(c) Property, the Section 721(c) Partnership allocates all items of Section 704(b) income, gain, loss, and deduction with respect to that Section 721(c) Property in the same proportion; Reporting requirements described in Section 4.06 of the Notice are satisfied. U.S. Transferor recognizes Built-in Gain with respect to any item of Section 721(c) upon an Acceleration Event described in Section 4.05 of the Notice; and The Gain Deferral Method is adopted for all Section 721(c) Property subsequently contributed by the U.S. Transferor and related U.S. Transferors until the earlier of: the date when no Built-in Gain remains with respect to any Section 721(c) Property to which the Gain Deferral Method first applied; or 8 60 months after the initial contribution of Section 721(c) Property to which the Gain Deferral Method first applied.

9 Notice Acceleration Events An Acceleration Event with respect to an item of Section 721(c) Property is any transaction that either would reduce the amount of remaining Built-in Gain that a U.S. Transferor would recognize under the Gain Deferral Method if the transaction had not occurred or could defer the recognition of the Built-in Gain. An Acceleration Event is deemed to occur with respect to all Section 721(c) Property of a Section 721(c) Partnership for the taxable year of the Section 721(c) Partnership in which any party fails to comply with all of the requirements for applying the Gain Deferral Method. Upon an Acceleration Event with respect to an item of Section 721(c) Property, a U.S. Transferor must recognize gain in an amount equal to the remaining Built-in Gain that would have been allocated to the U.S. Transferor. The regulations will provide for corresponding adjustments to the basis of the Section 721(c) Property and the U.S. Transferor s partnership interest to reflect the recognition of the remaining Built-In Gain. Exceptions exist for transfers to domestic corporations in a transaction to which either section 351(a) or section 381(a) applies and transfers of Section 721(c) Property to a domestic corporation by the partnership in a transaction to which section 351(a) applies. 9

10 Notice Tiered Partnerships The regulations described in the notice will apply to tiered partnerships if: i. A U.S. Transferor is a Direct or Indirect Partner in a partnership and that partnership contributes Section 721(c) property to a lower-tier partnership; or ii. A U.S. Transferor contributes an interest in a partnership that owns Section 721(c) property to a lower-tier partnership, the rules will apply as though the U.S. Transferor contributed its share of the Section 721(c) directly. Effective Dates The regulations described in the Notice with respect to the application of Section 721(c) will apply to transfers occurring on or after August 6, 2015, and to transfers occurring before August 6, 2015, resulting from entity classification elections made under Treas. Reg that are filed on or after August 6, 2015, and that are effective on or before August 6, The Section 482 and Section 6662 regulations described in the Notice will apply to transactions occurring on or after the date regulations are published. 10

11 Example 1 US or Foreign Parent Contribution of Foreign operations which includes IP Foreign Sub US Sub Contribution of IP Rights DE PRS DE DE DE 11

12 Notice Section 704(c) Remedial Allocations Example Amortizable Property Contributions : FMV=$500M, Tax Basis=0, BIG=$500M FS: FMV=$500M, Tax Basis=$100M, BIG=$400M Recovery Period=1 year, SL Traditional Remedial US Foreign US Foreign Section 704(b) Allocation Section 704(b) Allocation 704(b) Amortization: U.S. Property (b) Amortization: U.S. Property (b) Amortization: Foreign Property (b) Amortization: Foreign Property Total Section 704(b) Amortization 1, Total Section 704(b) Amortization 1, Tax Allocation US Foreign Tax Allocation US Foreign Tax Amortization/(Income): U.S. Property Tax Amortization/(Income): U.S. Property (250) 250 Tax Amortization/(Income): Foreign Property Tax Amortization/(Income): Foreign Property (150) Total Tax Amortization/ (Income) Total Tax Amortization/ (Income)

13 Example 2 US or Foreign Parent Contribution of Stock FMV=$500M Tax Basis=$100M Foreign Sub US Sub Contribution of Amortizable IP Rights FMV=$500M Tax Basis =0 DE PRS DE DE DE 13

14 Notice Section 704(c) Remedial Allocations Example Amortizable Property/Stock Contributions : Amortizable Property: FMV=$500M, Tax Basis=0, BIG=$500M FS: Stock : FMV=$500M, Tax Basis=$100M, BIG=$400M Recovery Period=1 year, SL Section 704(b) Allocation Traditional Remedial US Foreign US Foreign Section 704(b) Allocation 704(b) Amortization: U.S. Property (b) Amortization: U.S. Property (b) Amortization: Foreign Property 704(b) Amortization: Foreign Property Total Section 704(b) Amortization Total Section 704(b) Amortization Tax Allocation US Foreign Tax Allocation US Foreign Tax Amortization/(Income): U.S. Property Tax Amortization/(Income): U.S. Property (250) 250 Tax Amortization/(Income): Foreign Property Tax Amortization/(Income): Foreign Property Total Tax Amortization/(Income) Total Tax Amortization/(Income) (250)

15 Example 3 Tracking Allocations US Parent US Sub CFC High Tax CFC Low Tax CFC DE DE PRS 15

16 Example 4 Inbound Foreign Parent Contribution of Assets Subject to High Foreign Tax Foreign Sub US Sub Contribution of Assets DE PRS DE DE DE 16

17 Notice Highlights Section 721(c) property excludes securities as defined in section 475(c)(2), without regard to section 475(c)(4). Third-party JVs are subject to the Notice if the third party owns less than 50% of the interest in partnership capital, profits, deductions or losses. Deemed partnerships are also subject to the Notice. Special Allocations: Prohibits allocating items with respect to the Section 721(c) property in different ratios. Different allocations ratios with respect to different properties should not violate the same proportion rule (e.g., tracking allocations). Varying allocations between years should not violate the same proportion rule. Preferred Returns: Gross income preferred return violates the same proportion rule. Net income preferred return should not violate the same proportion rule. Acceleration Events The definition was drafted broadly to include any transaction that either would reduce or defer the amount of remaining Built-in Gain that a U.S. Transferor would recognize under the Gain Deferral Method (e.g., include Section 734(b) Adjustments, distributions of the Section 721(c) property). The remedial method can be applied to foreign contributed assets subject to the Section 704(c) anti-abuse. 17

18 Notice Traps Partnership conversions could trigger an acceleration event under the rules of the Notice. Regulatory allocations and corrective allocations related to FTCE could be an acceleration event under the rules of the Notice. Distributions of Section 721(c) property back to the contributor could trigger an acceleration event under the rules of the Notice. Deemed contributions that result from a technical termination (or division or merger) could be treated as contributions for purposes of section 721(c). A reduction to a portion of the gain that would be recognized by the US partner (e.g., a Section 734 adjustment) would trigger an acceleration event and could require the US partner to recognize the entire remaining built-in gain. To the extent the Section 721(c) property declines in value, the revaluation loss can not be netted against the original Section 704(c) gain to reduce the remedial income pick up. 18

19 The Notice TP Takeaways The Notice does not change anything from a TP perspective. IRS has the authority under the current IRC Section 482 to make adjustments on partnership transactions. IRS may use the concepts under the regulations (but not the -7 regs) and any of the available methods in the current regulations to evaluate any transactions. It is critical that the transfer pricing aspects of any transactions be considered and evaluated as part of structuring and/ or reviewing these types of transactions. The Notice indicates that new TP regulations will be issued to address transactions involving partnerships; these regulations will not be effective until the rules are issued. 19

20 Leveraged Partnership 20

21 Leveraged Partnership Leveraged Partnership Structure USS FHC1 FHC2 Foreign Subs US Finco Loan Concept US Finco loans money to Foreign Holding Company "FHC1" that is treated as a partnership for US federal income tax purposes Example Description Form 1120 US Source Interest Income Interest Expense *Assumes a foreign asset ratio of 25% Key Concepts Foreign Source $100 $0 $100 <$100> <$75>* <$25>* TOTAL $0 <$75> $75 Allocation and apportionment of partnership interest expense based on partner s assets. Treas. Reg T(e) Source of interest paid by FHC1 intended to be foreign source. Treas. Reg (a)(2) and (a)(1)(i) Basket of interest income received by US1: Look-through treatment: Treas. Reg (h) 21

22 Leveraged Partnership Leveraged Partnership Structure USS FHC1 FHC2 Foreign Subs US Finco Loan Key US Tax Considerations Partnership anti-abuse provisions Abuse of subchapter K: Treas. Reg (a), -2(b) and -2(c) Abuse of entity treatment: Treas. Reg (e) Business purpose for foreign partnership ( FHC1 ) Foreign tax savings (i.e. EHT, etc.) Foreign currency issues FAS 52, 987, 988 Dual consolidated issues Separate unit determination Domestic use election Potential recapture issues May be mitigated with non-taxable foreign partnership 902 / treaty issues (USS/ voting interest in FHC1 should be at least 10%) Debt service Debt equity issues Impact to Domestic Production ( 199 ) Deduction 22

23 Leveraged Partnership Leveraged Partnership Structure Key US Tax Considerations Tax implications of partnership formations 721 Deemed occurrence upon admission of second member Rev. Rul Disguised sale provisions Qualified v. non-qualified liability USS FHC1 US Finco Loan Recourse v. Nonrecourse Guarantee (If guarantee is not respected, share of liability after contribution would equal 50% of the amount of the liability. Treas. Reg (c)(1) and (b)(2)) FSA dated June 6, 1996 (1996 WL ) Confirms general operation of rules FHC2 Expresses concern regarding mismatch of source of interest income and deduction on loan to partnership Foreign Subs Notes potential application of Treas. Reg antiabuse rule if partnership is availed of for the principal purpose of reducing US tax Note of Partnership counted as an asset of Partner (foreign asset) Ambiguity from 1996 FSA? 23

24 Leveraged Partnership 1 Formation with Lending (Acquisition) Beginning Structure Ending Structure US1 CFC 1 US2 CFC 2 4 Loan US1 1 FHC1 US2 Steps 1. and US2 form FHC1. 2 CFC 1 CFC 2 3 FT 5 2. contributes CFC 1 to FHC1. 3. US2 contributes CFC 2 to FHC1. 4. US1 loans cash to FHC1. 5. FHC1 uses the funds from step 4 to acquire FT. 24

25 Leveraged Partnership 2 Formation with Debt Assumption and Guarantee Beginning Structure Ending Structure 2 US1 Loan FHC1 US2 US1 US2 CFC 1 CFC 2 Loan FHC1 Steps 1. US2 contributes CFC 2 to FHC1. 2. guarantees US1 loan to FHC1. CFC 1 1 CFC 2 25

26 Leveraged Partnership 3 Formation with Equal Debt Assumption Beginning Structure Ending Structure Loan US1 Loan FHC1 US2 US1 US2 CFC 1 CFC 2 2 Loans FHC1 Steps 1. US2 contributes CFC 2 and payable to FHC1. CFC 1 CFC

27 Leveraged Partnership FOGI Partnership Structure 27 USS1 FP Foreign Subs USS2 Preferred Interest with Guaranteed Payment Concept Same as leveraged partnership, but guaranteed payments (unlike interest) may be classified as CFOGI for Section 907 purposes. Key US Tax Considerations Generally, the same as leveraged partnership structure with some additional considerations. Classification of payments as guaranteed payments within the meaning of 707(c). Classification of guaranteed payments as CFOGI. 907(c) distributive share vs. 704(b) distributive share. Interest Equivalent under T. Classification of guaranteed payment expense as an interest equivalent under Treas. Reg T(b). Cash contributions generally required. Consider foreign capital position/needs. Preferred partnership interest not included in asset basis for apportionment purposes under Treas. Reg T(e).

28 Leveraged Partnership FOGI Partnership Formation Beginning Structure Ending Structure USS1 USS2 USS1 USS2 3 Preferred Interest Foreign Subs Steps 1. USS1 contributes Foreign Subs to FP in exchange for a common partnership interest. 2. USS2 contributes cash to FP in exchange for a preferred partnership interest. 3. USS2 receives an annual guaranteed payment with respect to its preferred partnership interest. 1 FP Foreign Subs Cash 2 28

29 Leveraged Partnership Leveraged Partnership with CFC USS1 29 FHC1 FHC2 Foreign Subs Loan USS2 CFC Concept Same as leveraged partnership, but USS2 recognizes general category subpart F income instead of general category interest income. Key US Tax Considerations Generally the same as the leveraged partnership structure with some additional considerations. CFC interest income classified as subpart F income. 954(c)(3) and 954(c)(6) inapplicable. CFC will also be deemed to have an investment in U.S. property under section 956 however it is intended that the only E&P of the CFC will be interest income which is already being included in the income of USS2 as subpart F Incremental state tax benefit in states that exclude subpart F income from tax base. CFC interest income classified as general category under Treas. Reg (h) resulting in general category subpart F inclusion for USS2 under 904(d)(3)(B). CFC interest income increases E&P Bump ( 864(e)(4)) and must be monitored. Impact may be mitigated with PTI distributions.

30 Leveraged Partnership Contributing Corporations to a Partnership Scenario 1 Step 1: Form partnership basis in FP: $130 contributes F2 with a FMV of $10 and basis of $100 and $30 of cash to FP USS F2 FMV: 10 Basis: 100 's basis in FP is equal to $130 FP's basis in F2 stock is limited to its value of $10 ( 704(c)(1)(C)) F1 FMV: 100 Basis: 10 2 Contribution of F1 FP 1 Contribution of F2 and $30 cash USS contributes F1 with a FMV of $100 and basis of $10 in exchange for an interest in FP USS's basis in FP is equal to $10 FP's basis in F1 stock is equal to $10 USS's 704(c) gain in F1 is $90 FP's basis in F1 stock: $10 F1 F2 $30 Cash FP's basis in F2 stock: $10 704(c)(1)(C) 30

31 Leveraged Partnership Contributing Corporations to a Partnership Scenario 1 Step 2: FP contributes F1 and cash to F2 USS Pro-rata share of capital gain AB (Historical shares + cash): 40 AB (F1 shares): 10 FP Pro-rata share of capital gain Distribute $110 cash FP s basis in F2 is increased by the amount of cash and AB of F2 stock Under 704(c) (Treas. Reg (a)(8)), FP has a bifurcated basis in the F2 shares Step 3: F2 distributes $110 cash to FP Under 301(c)(2) and (3), $42 ROC and $68 capital gain to FP F2 E&P = 0 AB: 10 F1 31

32 Leveraged Partnership Contributing Corporations to a Partnership Scenario 2 Step 1: Combine F1 and F2 prior to forming the partnership contributes F2 to USS Step 1A: Contribution of F2 362(e) does not apply here. Treas. Reg (h) USS contributes F2 to F1 Step 1B: Contribution of F2 FMV: 110 AB: 110 USS F1 FMV: 100 Basis: 10 F2 FMV: 10 Basis: 100 F1 may issue non-voting stock to prevent the transaction from qualifying for both a 351 exchange and a B reorganization, in which case basis tracing will not apply Furthermore, USS and F1 will make a 362(e)(2)(C) election USS has a blended basis of $110 in the stock of F1 F2 FMV: 10 Basis:

33 Leveraged Partnership Contributing Corporations to a Partnership Scenario 2 Step 2: Form partnership contributes $30 cash to FP in exchange for an interest in FP USS AB: 30 Step 2A: Contribute $30 cash to FP USS contributes F1 stock to FP in exchange for an interest in FP No 704(c) gain/loss upon the contribution of F1 stock as the value ($110) is equal to the basis ($110) Step 2B: Contribute F1 stock to FP AB: 110 FP Step 3: FP Contributes $30 cash to F1 Step 3: FP contributes $30 cash to F1 Step 4: F1 distributes $110 cash to FP $140 ROC to FP $0 gain recognized by FP or the partners of FP Step 4: Distribute $140 cash AB: 140 F1 E&P = 0 AB: 10 F2 33

34 Tiered Partnership 34

35 Tiered Partnership Tiered Partnership Structure US Affiliate 3 Foreign Subs 35 US Affiliate 2 US Affiliate 1 US Pship 1 US Pship 2 US Assets Preferred Interest US NewCo Loan 79% 21% Bank Preferred Interest Bank Concept s third party interest expense allocated to unaffiliated subsidiary and not apportioned against s foreign source income. Key US Tax Considerations Interest expense allocated to US NewCo not apportionable interest expense of s US affiliated group. Structure may be implemented through tax-free partnership contributions. US Partnership 1 s debt should be recourse only to US Partnership 2 s assets. US NewCo s guaranteed payment sized to equal US Partnership 1 s net income for purposes of Treas. Reg (b)(1)(viii). Consider contributing assets that produce a fixed return to mitigate fluctuation in US Partnership 2 s income. Consider whether may debt fund a portion of its investment in US NewCo to minimize the investment needed from third party investors. Consider strategies to mitigate US tax leakage of US NewCo (e.g., debt funding, SRLY losses).

36 Tiered Partnership Tiered Partnership Structure Bank Key US Tax Considerations (Cont d) Variation available with wholly-owned CFC receiving guaranteed payment from US Partnership 1. 79% 21% Eliminates need for third party investors, US Affiliate 3 US Affiliate 1 US NewCo Gives rise to additional complexity (e.g., managing CFC s ECI for purposes of 864(e)(5)). Foreign Subs US Pship 1 Loan Preferred Interest Bank US Affiliate 2 Preferred Interest US Pship 2 US Assets 36

37 Tiered Partnership Tiered Partnership Formation Beginning Structure Ending Structure Loan Bank Bank 79% 21% US Affiliate 3 US Affiliate 1 US Affiliate 3 US Affiliate 1 US NewCo 1 Foreign Subs Steps US Affiliate 2 1. and third party investors form a new US subsidiary ( US NewCo ). 2. US Affiliate 1 and US NewCo form a US partnership ( US Partnership 1 ). Foreign Subs US Affiliate 2 2 US Pship 1 Preferred Interest Loan 3 Bank 3. refinances its third party debt through US Partnership US Partnership 1 and a member of s US affiliated group ( US Affiliate 2 ) form a US partnership ( US Partnership 2 ). 5. US Partnership 2 acquires the group s US assets through equity contributions. 37 US Pship 2 US Assets 4 5

38 Tiered Partnership Tiered Partnership Structure US Affiliate 3 Foreign Subs US Affiliate 2 US Affiliate 1 US Pship 1 Preferred Interest US NewCo Debt 79% 21% 3 Bank Preferred Interest 2 Bank 4 Illustrative Example 1. US Partnership 2 earns $500M in net income from US assets. 2. US Partnership 1 receives a $450M guaranteed payment from US Partnership US Partnership 1 incurs $400M of interest expense with respect to its third party debt. 4. US NewCo receives a guaranteed payment of $50M from US Partnership 1. Since US NewCo is allocated 100% of US Partnership 1 s net income, US NewCo should be allocated 100% of US Partnership 1 s gross income and expense (i.e., $450M of gross income and $400M of interest expense). US Pship 2 1 US Assets 38

39 Questions? 39

40 Thank you This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details. 40 Tax Leadership Conference 2015