Top 5 TAX ChAllenges And strategies for multinational CompAnies www.cliftoncpa.com www.vantagepointglobaltax.com VantagePoint is a product of U.S. Tax Advantage, an affiliate of Clifton Gunderson.
TABle of ConTenTs introduction........................................................................... 1 TrAnsfer pricing........................................................................ 1 uncertain TAX positions...............................................................2 CAlCulATing And reporting income TAX on foreign earnings.....................3 repatriation of foreign source income.............................................3 TAX-relATed information management..............................................4 Closing..................................................................................4 ABouT vantage point And ClifTon gunderson......................................5 2011 Clifton Gunderson LLP All rights reserved.
introduction Everybody has accepted by now that change is unavoidable. But that still implies that change is like death and taxes it should be postponed as long as possible and no change would be vastly preferable. But in a period of upheaval, such as the one we are living in, change is the norm. Peter Drucker As the quantity, velocity and complexity of international business continues to expand, multinational firms need a tax system that facilitates multinational business and dispute resolution. On a daily basis these multinational companies deal with ambiguous, inconsistent and ever-changing tax rules. Consider the environment for U.S. companies with overseas operations: Economic situations vary greatly by country and region. Some are recovering from a downturn occurring a couple of years ago. Some are currently entering a downturn. Some have not experienced weakness at all, in fact their economies are growing at rates that outperform the rest of the world. More companies have entered global markets, increasing the level and intensity of competition. Foreign tax regulations, both at the national and local level, continually change, impacting overseas income and profitability. Chronic budget deficits, a heightened sense of fiscal urgency and a tax system full of loopholes and temporary extensions has increased the possibility of fundamental tax reform in the U.S. Whether its real reform or tax code modifications, there will be winners and losers. With national and local jurisdiction governments, both U.S. and abroad, enacting new laws to increase tax revenue or direct certain spending, a company s tax provisions and related tax positions require regular review and revision to ensure accurate financial reporting and tax filings. As President Obama and Congress look for new ways to create economic growth, more change is likely in the near future. International taxation of U.S.-based companies, at its core, is laden with complexity. To understand the effects of taxes on American multinational companies, one must have a grasp of U.S. tax rules, foreign tax rules, and the possible outcomes of their interaction. Beyond that there are additional trends and challenges in international taxation that only those intimately close to the regulations, transactions and nuances can understand with any level of depth. This paper discusses some of the key trends and challenges facing the tax departments of multinationals, as identified by Clifton Gunderson s international tax professionals. VantagePoint software is a web-based, integrated software solution offering dynamic tax analysis tools for multinational corporations. The system s comprehensive database supports tax planning, provision and compliance needs. TrAnsfer pricing Transfer pricing is arguably the number one area of interest for those involved with international taxation. Transfer pricing refers to the pricing of transactions by and between members of the same organization. Transfer pricing is receiving increased scrutiny from both U.S. and foreign tax authorities, and is a mounting concern for multinational companies. Issues of note include: Transfer pricing audits have been increasing steadily over the past decade. The trend is expected to continue in 2011 and beyond. Tax authorities around the globe are imposing new and stricter transfer-pricing documentation requirements. Noncompliance can produce hefty penalties. Fueled by the economic downturn, tax authorities are focused on protecting their domestic tax base from erosion through transfer pricing adjustments being made by the foreign tax authorities, which leads to greater opportunities for disputes to arise. At the same time tax authorities are placing increased emphasis on transfer pricing, the rules and regulations seem to be in a constant state of change. Companies must manage in a new era of regulations, penalties, transparency and disclosure. 2011 Clifton Gunderson LLP All rights reserved. 1
irs focused on international examinations Transfer pricing is also a growing concern for our federal government. In May of 2011, the IRS announced the selection of its first Transfer Pricing Director, Samuel Maruca. The IRS created the new transfer pricing position in August of 2010 as part of a realignment that established the Large and Mid-Size Business (LMSB) division. When announcing the reorganization, the IRS stated it expects the new division to grow by nearly 900 employees. Most of those people will come from current IRS employees, along with new hires. The new division, combined with previous announcements of hiring 800 agents in both fiscal 2010 and 2011 to focus on international examinations, highlights the increased risk of audit and the necessity for extensive documentation to support compliance with the arm s length pricing regulations. All multinationals are required to create and maintain transfer pricing documentation, including transfer pricing policies. The documentation usually includes transfer pricing studies for each country in which they do business. There are a number of methods to test compliance with the arm s length standards adopted by most taxing authorities. Companies should be diligent in selecting a methodology that can maintain credibility upon scrutiny by tax authorities. In addition, multinationals should be proactive in their approach to transfer pricing policies, and be aware of the potentially beneficial planning opportunities in regard to placement of intangible property agreements, advanced pricing agreements, or placing business operations in lower tax jurisdictions. uncertain TAX positions Uncertain tax position reporting, commonly referred to as UTPs, dates to June 2006, when the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). FIN 48 intended to clarify the accounting for uncertain tax positions recognized in an enterprise s financial statements. Because of FIN 48, multinationals must identify, measure, evaluate and disclose all material uncertain tax positions for all tax jurisdictions (federal, state, and foreign). The identification, evaluation, measurement and reporting of uncertain tax positions is a complex process requiring extensive analysis of new, existing, and changed tax positions. Taxpayers must take into account all taxing jurisdictions and must ensure that all filing positions, as well as all non-filing positions, are considered and evaluated relative to applicable tax laws. UTP information must be updated and reported on a quarterly and annual basis with the filing of the 10Q and 10K. In addition to financial reporting requirements, taxpayers are now also required to disclose UTPs with their annual tax return filing. The IRS introduced Form UTP for 2010 tax return filings for corporations with $100 million or more in assets. Filing will be required in 2012 for corporations with $50 million or more in assets, and in 2014 for corporations with $10 million or more in assets. Companies with international operations, such as sales offices, distribution centers and foreign manufacturing facilities must assess a variety of potential FIN 48 UTP positions such as the existence of permanent establishments and related tax filing requirements, local tax authority audits and local tax statutes of limitations, Subpart F income and the use of foreign tax credits. In addition to local country and U.S. tax implications, related-party transactions that cross jurisdictions must also be carefully assessed to ensure that tax positions on both sides of each transaction are properly accounted for. Interest and penalties must also be determined for each UTP. Most taxpayers have already filed Form UTP for tax year 2010. For 2011 and future filings, we recommend that taxpayers keep a watchful eye on audits and IRS focus areas as the information from the first set of Schedule UTPs gets folded into the audit process. 2011 Clifton Gunderson LLP All rights reserved. 2
CAlCulATing And reporting income TAX on foreign earnings The U.S. has a worldwide income tax system that taxes U.S. multinationals on their worldwide income, as opposed to only taxing income from U.S. sources. In contrast, many foreign multinational companies do business without the burden of a worldwide income tax system. Their home countries, in contrast to the U.S., have territorial tax systems that offer a partial or complete exemption for foreign source income. To mitigate the double taxation that would otherwise be imposed on U.S. multinational corporations, the U.S. taxpayer is allowed a foreign tax credit, which may offset their foreign taxes paid. Note, however, that the Foreign Tax Credit can be limited and does not always eliminate the double taxation of foreign source income. Consequently, U.S. companies with overseas operations face significant issues in gathering the requisite foreign data, keeping current with sourcing rules, and finally, calculating the foreign tax credit and limitation. In order to calculate the Foreign Tax Credit, U.S. corporations doing business abroad need to track their foreign source income, applicable foreign source expenses and taxes paid within each foreign jurisdiction. The taxpayer should also track withholding taxes paid on any interest, rent, royalty, dividend or similar payment, as foreign withholding tax may also be considered in the Foreign Tax Credit calculation. Common data gathering methods include forwarding tax packages to all foreign enterprises, as well as obtaining foreign data via a detailed trial balance or worldwide financial reporting system. Regardless of the foreign source data available from electronic sources, the taxpayer should request copies of all tax payment receipts and income tax returns filed in each jurisdiction to substantiate the taxes paid. The IRS will disallow credit for any undocumented foreign taxes paid. The Foreign Tax Credit calculation can be complex and various rules and exceptions apply. Taxpayers should review the sourcing and expense apportionment regulations prior to determining their foreign tax credit to ensure the calculation is correct and complete. repatriation of foreign source income A basic tenet of U.S. international tax law is that income earned abroad by a U.S. corporation is not taxed in the U.S. unless or until the income is brought back (repatriated). A payment of dividends from a foreign subsidiary to the U.S. parent corporation is an example of such a repatriation. Repatriated income is potentially subject to the 35 percent U.S. corporate tax. However, the U.S. allows a foreign tax credit that reduces incremental U.S. tax and eliminates the possibility of double taxation on the repatriated income. Consequently, taxation of foreign income is often deferred. The IRS generally does not tax the offshore profits as long as they remain abroad. However, numerous exceptions do result in current taxation, such as in the case of Subpart F income. Since a subsidiary of a U.S. corporation can operate in a number of countries with lower corporate tax rates than domestic rates, it is economically beneficial to invest or use profits abroad rather than to repatriate them. repatriation holiday And TAX reform The American Jobs Creation Act of 2004 created a temporary repatriation holiday during which repatriated income of corporations from foreign sources was taxed at a rate of 5.25%, substantially below the top corporate rate of 35 percent. Some assert that a new repatriation holiday could bring in a trillion dollars of foreign earnings. Those earnings, in theory, could be used for providing capital investments and funding jobs. International tax reform has been a major topic of discussion during the debt-ceiling debate. Although the compromise bill lacks the specific tax reform proposals, there is a growing support in Congress to lower the U.S. tax rate and exempt offshore income from U.S. taxation. Taxpayers should ensure that the earnings and profits and tax pools of their Controlled Foreign Corporations (CFCs) are complete, accurate, and maintained on an annual basis. This will help ensure that earnings that are repatriated are properly identified for foreign tax credit impact and U.S. income tax inclusion. 2011 Clifton Gunderson LLP All rights reserved. 3
Identifying and tracking low tax and high tax jurisdictions allows taxpayers better planning opportunities and the ability to more effectively manage their global effective tax rate. Having foreign tax attributes and ownership information complete and current allows taxpayers to focus on maximizing repatriation opportunities. This will be an area of significant impact in the event that another repatriation holiday, or tax reform, are legislated. TAX-relATed information management Historically, corporations relied on the dedication and organizational skills of their tax departments to ensure that tax analysis and reporting was accurate and completed on time. The expanding international tax mandates have increased the workload on tax personnel and corporations are trying to take a more structured approach to their processes, and find ways to decrease the timeon-task aspects. Corporations suffer from a variety of process and technological shortcomings in their tax-related information management systems: A majority of corporate transactions systems (mostly ERP or accounting) are designed to support a management-structure view, not the legal-entity view needed to efficiently manage taxes. Because this view is often disregarded when accounting systems are constructed, tax departments must put in a considerable amount of extra effort to translate management-data views into tax-data views. Instead of a complete record of tax-related data in a single warehouse of records, many multinationals have information scattered among systems. This makes it difficult to recreate the calculations and demonstrate their soundness and consistency when defending tax positions. Corporations tend to over-rely on spreadsheets and use outdated technology and systems that lack integration between tax and finance systems. This hampers their tax departments ability to obtain and analyze the data they need for timely and accurate tax accounting and reporting. Enhanced use of technology, improved access to data and employing a workflow management methodology can reduce the risk that filings or the underlying analyses will go unnoticed or be delayed. Tax departments that do a better job aligning and integrating their processes and technology will spend less time on data processing and more time on tax analyses that can actually drive revenue. Closing We exist in a world where companies financial and tax reporting is highly scrutinized. For multinational companies, managing domestic and international tax issues can be challenging and time-consuming, even more so for corporations obliged to do more with less. They must be judicious in the risks they take, and must stay abreast of evolving tax regulations and competing corporate interests in order to minimize their effective global tax rates. While acknowledging that international tax regulations imposed on U.S. companies can sometimes be implausible, they can also be managed if careful tax and business planning consideration is undertaken. Prevention is usually better than the cure, and while it may be impossible to avoid every tax dispute or controversy, it is possible to take steps to limit the chance of an adverse audit that may result in a prolonged dispute. 2011 Clifton Gunderson LLP All rights reserved. 4
ABouT vantage point And ClifTon gunderson VantagePoint software is a web-based, integrated software solution offering dynamic tax analysis tools for multinational corporations. The system s comprehensive database supports tax planning, provision and compliance needs. VantagePoint is a product of U.S. Tax Advantage (www.taxadvantage.us), an affiliate of Clifton Gunderson (www.cliftoncpa.com), one of the nation s largest CPA and accounting firms. To learn more visit www.vantagepointglobaltax.com. Clifton Gunderson, ranked as one of the nation s largest certified public accounting and consulting firms and the largest U.S. member firm of HLB International, provides a wide range of assurance, tax and consulting services to clients in a variety of industries. Founded in 1960, Clifton Gunderson has a staff of more than 1,800 professionals serving clients from 47 offices across the country. Clifton Gunderson, and the separate and independent member firms of HLB International, provides personal and high quality service to clients in over 100 countries through the HLB International Global Care approach. For more information about Clifton Gunderson, visit www.cliftoncpa.com. The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting, or tax advice or opinion provided by Clifton Gunderson LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader s specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Clifton Gunderson LLP professional or other tax professional prior to taking any action based upon this information. Clifton Gunderson LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. 2011 Clifton Gunderson LLP All rights reserved. 5