Overview of U.S. international tax compliance issues

1. Council for International Tax Education (CITE)Reporting the Results of Foreign OperationsJanuary 24, 2011Randy Free, Partner, SoCal International Tax Practice Leader

2. Circular 230 Disclosure To ensure compliance with requirements imposed by the IRS, any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

3. Reporting the Results of Foreign Operations Topics Obtaining the data from overseas for U.S. foreign informational forms Key issues in reviewing Form 5471 for foreign affiliates Computing earnings and profits – reconciliation with financial statement Other significant U.S. international reporting forms

4. Obtaining the data from overseas for U.S. foreign informational forms Identify sources of information Structural Information Financial data Include tax information request in financial statement “Reporting Package” Reorganizations Challenges Act early to overcome Failure to obtain

5. Structural Information Identify entities Critical because of penalties for failure to make the proper filings, Auditor's workpapers may ignore inactive companies for which no statutory financial statements are required Consult with the company's legal counsel for acquisitions or other changes Create and maintain a legal entity structure document that includes Full corporate name and address Country of incorporation Country of residence for tax purposes Corporate form, date of formation Capital structure and share ownership List of directors/officers Tax classification in country of tax residence (e.g., corporation, partnership, etc.) Classification for US tax purposes Function of each legal entity in the group

6. Financial Information needed Request early US GAAP income statement and balance sheet in local/functional currency Calculation of current and deferred income tax expense Local tax returns, with English translation, and supporting workpapers Receipts or other documentation supporting cash tax payments made Support for any foreign audit settlement Information about intercompany transactions including a description of the transaction, date entered into, payment made Transfer Pricing documentation report Information about changes in business and functions during the year. Best practice is to request as much of the tax compliance information as possible as part of financial reporting process to avoid multiple requests

8. If information cannot be obtained in time to meet filing deadlines Try to avoid by starting early with clear comprehensive requests and explanations There is no official guidance Best practices would suggest: File your best information Prepare the forms to set the stage to request abatement of penalties due to reasonable cause Consider disclosure that forms are incomplete on their face, but were completed using the best information available Document in the files why incomplete and what was done to obtain the missing information Writing “information available on request” is an audit trigger

9. Key issues in reviewing Form 5471 for foreign affiliates Form 5471 – Top 10 Mistakes Not filed or filed incompletely Wrong filing category used Income statement: Tax instead of GAAP Balance sheet reported in functional currency E&P ignored – income statement replicated Subpart F income worksheets not completed Accumulated E&P categories not tracked Indirect transfer pricing information omitted Officer/shareholder information incomplete Duplicate filing not made

10. Risks of mistakes Penaltiesfor not filing or incomplete filing $ 10,000 for each failure to furnish the required information within time prescribed Additional $ 10,000 for each 30 day period or fraction thereof up to $ 50,000 if IRS has mailed a notice of failure and such information is not furnished within 90 days after such request Possible reduction in the foreign taxes available for deduction or as a foreign tax credits Automatic penalty if filed with delinquent Form 1120 HIRE Act holding statute open assessment statute not expired by March 18, 2010 Willful neglect

11. Know when Form 5471is required Filed for each Controlled Foreign Corporation ("CFC") More than 50% Level of US Ownership in vote OR value Filed by US shareholder (10% or more voting power) Categories of filers No longer applicable Officer or director of foreign corporation in which a US person has acquired 10% or more Acquisition or disposition of stock in a foreign corporation of 10% or greater ownership of ANY foreign corporation Control (more than 50%) of a foreign corporation for an uninterrupted 30 day period during the tax year – directly or indirectly US shareholder of a CFC on the last day of the CFC's year Exceptions Dormant CFC Multiple filers for same CFC

13. Foreign currency convention: "divide by"

15. What’s the origin?

16. Who manufactured it?

17. What’s the destination?Currently taxable amount of Subpart F Income limited to current E&P

18. What to look for: Investment in US property (Sec. 956) Income taxable to US Shareholder as a “deemed dividend” On Schedule F – Balance Sheet Loans to US shareholder Receivables from US shareholder or US affiliates Netting rule Prepare worksheet B Sec. 956 taxable amount NOTlimited to current E&P Quarterly average increase in investment in U.S. property by CFC

20. Indicates what schedules need to be included

23. Computing earnings and profits – reconciliation with financial statement retained earnings Purpose for Controlled Foreign Corporations (CFC) Methods for E&P Adjustments When event requires computation Follows domestic concepts Annual and cumulative disclosure Maintain records Post-86 Pool Separate company Separate baskets Tier up when dividends distributed

24. Earnings and Profits Purpose : To determine taxable amount of distributions E&P represents a corporation's economic gains and losses, its capacity to distribute corporate earnings Different from both the accounting concept of net income and the corporation's taxable income E&P generally includes all income, expenses, gains and losses realized by the corporation E&P represents an increase or decrease in the amount of net assets of the corporation other than assets received from its shareholders as contributions to capital or distributions of assets to its shareholders

25. E&P Functional Currency Concept In 1981, Financial Accounting Standards No. 52 (FASB 52) introduced the “functional currency” approach, under which the currency of the economic environment in which a foreign entity operates is generally used as the unit of measure for exchange gains and losses Section 985(a) implements the functional currency concept and provides that “unless otherwise provided in regulations, all determinations under this subtitle must be made in the taxpayer's functional currency The adoption of, or the election to use a functional currency is a method of accounting, and any change in the functional currency is treated as a change in the taxpayer's method of accounting. Generally, the determination of the functional currency for a foreign entity will be obvious currency of the economic environment in which a significant part of the QBU's activities is conducted, provided the QBU keeps (or is presumed to keep under Reg. §1.985-1(c)(3)) books and records in that currency

26. Methods of calculating the E&P of a qualified business unit (QBU)

27. E&P and tax “pools” E&P and foreign taxes are calculated annually, and accumulated in separate pools For the purpose of determining the tax of a shareholder of a foreign corporation, the earnings and profits of the corporation are maintained in the corporation's functional currency. These earnings and profits are translated into dollars at the appropriate exchange rate when they are actually distributed to the shareholder, or are deemed distributed to the shareholder in the case of the subpart F income of a controlled foreign corporation or gain treated as a dividend under Code Sec. 1248.(Code Sec. 986(b)(1)) In determining the amount of foreign taxes paid by a taxpayer under Code Sec. 901 or deemed paid by a domestic corporation shareholder in a foreign corporation under Code Sec. 902 and Code Sec. 960, a foreign income tax is translated into U.S. dollars using the exchange rate in effect as of the time the current income taxes are accrued. (Code Sec. 986(a)(2)(A))

28. E&P of a CFC must be categorized into baskets, pools, and layers, and characterized by source The identification of E&P by categories is required to determine the following: Foreign tax credit basket classification of dividends US or foreign source of the dividend Taxability of actual distributions as dividends Amount of exchange gains or losses on distributions of PTI and the appropriate foreign tax credit basket classification Information required for reporting purposes Deemed-paid foreign tax credit Taxability of deemed dividends under the Subpart F income and investments of earnings in U.S. property rules Dividend recharacterization resulting from the sale or exchange of a CFC's stock Addition or attribution of E&P with respect to transactions under §367 E&P adjustments to the stock basis of a CFC for interest expense allocation purposes at the US shareholder level

29. E&P Adjustments Required for CFCs Code Sec. 964 E&P determined using rules similar to those applicable to domestic corporations Illegal bribes, kickbacks or other payments (as defined under the Foreign Corrupt Practices Act of 1977) may not be taken into account Steps to determine the earnings and profits of a CFC: A profit and loss statement must be prepared for a tax year from the books of account regularly maintained by the foreign corporation for the purposes of accounting to its shareholders Adjust for material items to conform the statement to US accounting principles the accounting principles to be applied are those generally accepted in the United States to reflect in the financial statement of a domestic corporation the operations of its foreign affiliates: clear reflection of income physical assets be taken into account at historical cost no systematic undervaluation of assets or overvaluation of liabilities income and expense taken into account without regard to equalization over more than one accounting period Adjust for tax accounting standards, with allowable elections

30. E&P Adjustments Required Elections by CFC An election or to adopt a taxable year or method of accounting shall not be required until the due date (including extensions) of the return for a controlling domestic shareholder's first taxable year with or within which ends the foreign corporation's first taxable year in which the computation of its E&P is significant for US tax purposes with respect to its controlling domestic shareholders When “significant”? Filing a Form 5471 is not a significant event For taxable years beginning after April 25, 2006, significant events include: A distribution from the foreign corporation to its shareholders with respect to their stock. An amount is includible in gross income with respect to such corporation under section 951(a). An amount is excluded from subpart F income of the foreign corporation or another foreign corporation by reason of section 952(c). Any event making the foreign corporation subject to tax under section 882. The use by the foreign corporation's controlling domestic shareholders of the tax book value (or alternative tax book value) method of allocating interest expense under section 864(e)(4). A sale or exchange of the foreign corporation's stock of the controlling domestic shareholders that results in the recharacterization of gain under section 1248.

32. Form 8865 Report of U.S. Persons With Respect to Certain Foreign Partnerships

33. Form 8858 Information Return of US Persons With Respect to Foreign Disregarded Entities

34. Form 926 Report by a U.S. Transferor of Property to a Foreign Corporation

35. Form 8838 Consent to Extend the Time to Assess Tax Under Section 367 - Gain Recognition Agreement

36. Form 8621 Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund

37. Form 5713 International Boycott Report

39. Form 8865Report of U.S. Persons With Respect to Certain Foreign Partnerships Purpose: To report information required under Sec 6038 - controlled foreign partnerships (CFP) Sec 6038B - transfers to foreign partnerships Sec 6046A - acquisitions, dispositions, and changes in foreign partnership interests Controlled Foreign Partnerships Where US persons, at any time during the partnership’s tax year end, possess a 10% or greater ownership interest (in either capital, profits, deductions or losses), including constructive ownership, where these US persons own more than a 50% interest in the foreign partnership A U.S. person is defined under Code Section 7701(a)(30) as a U.S. citizen or resident, a domestic partnership, a domestic corporation, and any estate or trust that is not foreign.

41. Description of the property transferred including the type of property and date of transfer

43. Form 8858 Information Return of US Persons With Respect to Foreign Disregarded Entities

46. If the FDE is owned directly or indirectly by a domestic corporation and the foreign disregarded entity incurred a net operating loss for the taxable year, is the FDE a “separate unit” as defined under the dual consolidated loss rules?

48. The tax rules for translating currency gains and losses are based on principles completely different from GAAP

49. Currency gain and loss is not recognized for tax purposes until there has been a “remittance” from a branch with a different functional currency.

50. Lack of regulatory authority

51. Section 987 has been in the statute since 1986, and the IRS views it as self-executing

52. Proposed regulations originally issued in 1991

53. In September 2006, the IRS withdrew 1991 proposed regulations

55. Transfers in a liquidation of a US corporation into a foreign parent under §332

56. Transfers to a foreign corporation in a tax-free reorganization, under §354, §356, or §361 (including certain deemed transfers)

57. Transfer of a foreign corporation in a tax-free spinoff, etc., under §355 — regardless, in some cases, of whether the transferee is a foreign corporation

58. Cash transfers to a foreign corporation if

59. The US persons holds directly or indirectly at least 10% of the total voting power or value of the foreign corporation

60. OR the amount of cash transferred by the US person ion during the 12-month entity and the income exceeds $100,000Transfers by a partnership must be filed by the partner Penalty for failure to file 10% of the fair market value of the transferred property Form 926 Report by a U.S. Transferor of Property to a Foreign Corporation

62. Identifying information about the transferor, (including identification of its controlling shareholders, if the transferor is a corporation that went out of existence, e.g., in a split-up or liquidation)

63. If the actual transfer was performed by a partnership, and the person filing the return is one of the partners, the partnership also must be identified

64. Part II - about the transferee

65. Identifying information about the transferee, including whether it is a controlled foreign corporation and how it is characterized (e.g., as a partnership or corporation) under foreign law.

66. Part III - about the transferred property

67. Information about the transfer itself. This includes the date, the type of transfer under U.S. law (e.g., §351 transfer to controlled subsidiary, §332 liquidation), a description of the transferred property, whether the transfer was the result of a “check-the-box” entity classification election, and whether any intangible property was transferred (and if so, a description of the rights transferred). In certain cases under §367(a), a person transferring property to a foreign corporation must include amounts in incomeSupplemental information also must be attached, as summarized in the Instructions, and described in far more detail in the regulations.

70. Form 8621 Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund Any level of ownership in a "PFIC" Direct or indirect A foreign corporation is a PFIC if: 75% or more of its gross income constitutes “passive income” or 50% or more of its assets produce, or are held for the production of, passive income. Once a PFIC, always a PFIC US persons who hold stock in a PFIC are subject to an adverse tax regime with respect to “excess distributions” from a PFIC, which includes gain on the disposition of stock of a PFIC, including a pledge of its stock. Excess distribution is taxable at highest marginal rate, pro rata over holding period of shares, plus an interest charge. To QEF or not to QEF To report ordinary income and capital gains currently (similar to a US mutual fund). Shareholder information statement from PFIC Timing is key to the pedigree

71. Form 8621Procedures Filed with tax return of shareholder A separate form is filed for each PFIC. Not required for US shareholder if PFIC is also a CFC. Elections generally made by first US person in chain of ownership QEF election Deemed sale election Deemed dividend election Extend the time to pay the tax for QEF Mark-to-Market election

72. Form 5713 International Boycott Report Filed by US person to report Operations in or related to "boycotting countries" Receipt of boycott requests or agreements made Participation in boycott may result in loss of tax benefits Foreign tax credit CFC deferral Filed in duplicate With US person's income tax return To IRS in Philadelphia Penalties for willful failure to file $25,000 fine Imprisonment up to one year Both

73. Form 5713Boycotting Countries List updated by Treasury Kuwait Lebanon Libya Qatar Saudi Arabia Syria United Arab Emirates Yemen Any other country that requires participation in an international boycott per Sec 999(a)(3)

74. Form TDF 90-22.1 Report of Foreign Bank and Financial Accounts Annual filing by each US Person with a financial interest in or signature authority or other authority Any financial account ( bank, securities, etc.) in a foreign country and The aggregate value exceeds $10,000 at any time during the tax year Due June 30th No extensions Sent to Department of the Treasury

75. Form TDF 90-22.1 U.S. "Ownership" Financial interest includes: Owner of record or legal title Acting as agent, nominee, attorney or other capacity on behalf of US Person Entity in which the US person owns directly or indirectly 50% or more of total value Signature or Other Authority Over an Account Control the disposition of money or other property by delivery of a document with signature to the bank or other institution.

76. Form TDF 90-22.1 Penalties

77. Contact Information Randy Free Partner – SoCal International Tax Practice Leader Grant Thornton LLP 18400 Von Karman Ave, Suite 900 Irvine, California 92612 949.608.5311 (office) 949.606.6859 (cell) Randy.Free@US.gt.com

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