As your company experiences increasing global commercialization of products, services and technologies, you may face new tax challenges and uncertainties.
“Even the smallest of companies are experiencing some interaction with global suppliers or customers,” says George Koutouras, partner, international and transaction tax, at Moss Adams. “So that means they have the need to consider certain tax aspects associated with global transactions, on one end of the supply chain or the other.”
With a U.S. tax system based on global income, it may make sense for a company — transforming from predominantly domestic to global — to keep earnings offshore to reinvest in new growth for foreign jurisdiction subsidiaries, as opposed to taking U.S.-sourced capital and committing it to offshore operations, he says. However, you must have an economic or legal justification to organize your business that way, as solely tax-motivated transactions are not available in today’s environment.
Smart Business spoke with Koutouras about businesses experiencing increasing growth globally and the potential tax problems.
When migrating capital offshore, why are bank debt covenants important?
When a company decides to go offshore, setting up operations or buying facilities, the first question is not what does that do from a tax perspective, but what are the restrictions on your bank covenants? Lenders may place restrictions on a company’s ability to use lent funds offshore, recognizing the difficulty associated with returning that capital to the U.S.
Review your bank’s financing restrictions. If they limit your ability to migrate cash or capital, determine if you can re-negotiate some of the bank notes, which is not always easy. A company may need to replace certain financing with other debt financing — it’s not a matter to be taken lightly.
Ultimately, whenever sending capital offshore, businesses and their advisers need to understand the intended end result. Do they need to repatriate it at some point to service debt, or do they intend to keep that cash offshore indefinitely to finance offshore growth? The answers will influence the structure that is created from the outset.
How seriously should a company consider local financing options?
If a company migrates some activities offshore, you might need to obtain local financing to expand operations. However, certain jurisdictions, particularly in Europe, are experiencing a credit crisis and, as a result, bank financing is not readily available. Without local financing, question whether there is any ability to service U.S. bank debt, or will you need a mechanism for intercompany financing? Often cash-rich companies use intercompany loans to more freely transfer extra cash between jurisdictions.
But an inevitable hurdle with related-party transactions is the need for a secondary analysis to ensure those transactions are at arms length. Otherwise, the jurisdictions involved, such as the U.S. and Ireland, may attempt to re-characterize or re-price payments to be more consistent with market turns, creating some unanticipated tax consequences.
What intellectual property (IP) will you need within a foreign region?
IP is a relatively broad category of assets that not only consists of patents and trademarks but can also include know-how and processes, and companies should match the commercialization of IP with the development of the IP.
Often businesses take U.S.-developed IP and parse it up among various global commercial centers. However, if IP is being sold in Europe, there may be a need to manipulate or develop that IP in a European-centric way. Companies should identify centers of activity for offshore endeavors, including the development of IP. Areas, such as Ireland for Europe and Singapore for Asia, have a skilled work force, good technology infrastructure for research and development, and a relatively low tax rate when compared to the U.S.
IP is an area where the U.S. is vigilant about establishing policies to restrict companies’ ability to migrate assets offshore, so outright sales of IP offshore aren’t without their accompanying tax costs. Often, property, including IP, in its earliest stages of development and/or recently purchased is the easiest to convey offshore without the inclusion of taxes. To the extent IP and other U.S.-owned assets are needed offshore, consider both sides of related-party pricing to avoid unsupportable accumulations of income or loss in the relevant jurisdictions.
How should you quantify the support needed from domestic management, sales force, technical help or home office systems?
The cost for headquarter-support services needs to be chargebacked by the offshore entity. Companies that aren’t charging for management services and/or systems that go offshore are vulnerable. For example, the U.S. might assert that the foreign entity should be paying more back to the U.S. for the use of the U.S.-based management, thereby creating more potential U.S. tax income. This is something that needs to be reviewed periodically; the management chargebacks existing today might not be the chargebacks needed in a year’s time.
What tax considerations are important for how you sell goods within a region?
Pay attention to how your company conducts sales within the jurisdiction. Sending your domestic sales force into a foreign country will extend the taxable presence to that other jurisdiction. To avoid that, a company can compartmentalize sales by setting up a separate company or using a third-party, such as distributors, already within the country’s marketplace. Another mitigation is to avoid signing sales contracts within market and thereby creating a taxable presence. Ideally, in such cases, all sales are negotiated and executed remotely, and the salesperson is merely demonstrating the product with no authority to sell on behalf of company.
Also, when selling inventory, the placement of property within a jurisdiction could create a taxable presence. The U.S. will tax the income, and the foreign jurisdiction may assert tax liability for sales within its borders, creating the possibility that the same dollar could be taxed twice.
George Koutouras is a partner, international and transaction tax, at Moss Adams. Reach him at (415) 677-8212 or George.Koutouras@mossadams.com.
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It’s a common misconception that if you have income or assets offshore and it never touches U.S. soil, then you don’t have to report it. That belief is proved wrong with a new tax form, Form 8938, which seeks information on individuals’ foreign financial assets, with substantial penalties for failure to report. In future years, entities also will be required to fill out the form.
“This area is just ripe for people to misstep, and the penalties for noncompliance in this area are incredibly steep, starting at $10,000,” says Henry J. Grzes, CPA, director, international tax, at SS&G, Inc. “Many tax practitioners, as well as taxpayers, are unaware of these new rules.”
Smart Business spoke with Grzes about Form 8938, why it was created and some the challenges taxpayers may face in staying on the right side of the law.
What is tax Form 8938, Statement of Specified Foreign Financial Assets?
Form 8938 requires individuals — if they meet certain filing thresholds — to disclose the existence of foreign financial assets they have an ownership interest in, which can be individually or jointly owned. The form was first required to be filed with 2011 tax returns. The law that requires disclosure of assets is complex, so the IRS initially decided only individuals would be required to file, but once it finalizes regulations and provides additional guidance, corporations, trusts and partnerships will also have to comply.
Why did the IRS create Form 8938?
It was created to make sure taxpayers are properly reporting the existence of and any income from a bank account, ownership in a foreign corporation, whether public or private, and other offshore assets. The IRS has been focusing on taxpayers with offshore activities, especially if those activities aren’t being properly reported on their tax returns.
The recent U.S. pursuit of UBS, a global financial institution, brought the issue to the forefront. UBS employees allegedly attended high-profile events such as the Super Bowl and solicited people to invest money with them by saying they wouldn’t disclose the existence of the investment to other parties..
What are the penalties for failing to properly file Form 8938?
There’s an initial penalty of $10,000 for failure to file, which applies to both spouses if you file jointly, even if only one spouse has foreign financial assets. Failure to file or failure to disclose an asset will also extend the statute of limitations for a return. For example, if you don’t file Form 8938 for the 2011 return until tax year 2013, the statute may remain open for all or part of your income tax return until three years after the date in which the 2011 Form 8938 is filed. If there is unreported income from the assets included on the 2011 filing, the statute of limitations is extended even further.
What advice would you give individuals who aren’t sure if they qualify for Form 8938?
Seek qualified help and inquire whether your tax preparer has experience in international reporting. Some tax practitioners might not want to take on such a filing burden because they aren’t familiar with the area and could be liable for potential preparer penalties.
The form can be confusing because whether you have to file depends on whether you file separately or jointly and whether you live in the United States or abroad. In each circumstance, there is a different filing threshold. In addition, a specified foreign financial asset may not be what you think. For example, holding precious metals directly doesn’t need to be reported on Form 8938, but if you hold precious metals in an account in a foreign financial institution, the account must be reported. When in doubt, report it.
It’s also hard to determine the fair market value of some assets, such as ownership in a closely held business. The IRS requests that you use readily accessible information to determine the maximum value of the foreign asset. If you can’t determine the value, put it down on the form as a value of zero. This is often the case where a taxpayer is a beneficiary to a foreign estate and no distributions were received by the taxpayer in the reporting year.
If individuals have to file the Foreign Bank Account Report (FBAR), why do they need to fill out Form 8938?
The rules for filing the FBAR and Form 8938 are promulgated under different titles of the U.S. code. Form 8938 is part of the Income Tax Act, so only certain individuals can access the information without a subpoena or legal reason. FBAR is part of the Bank Secrecy Act and is a law enforcement tool used to detect money laundering or terrorism.
Filing and reporting requirements for the FBAR and Form 8938 requirements are different; if you file either Form 8938 or FBAR, it doesn’t mean you have to file the other, but you may have to file both.
What happens if someone failed to file the form for the 2011 tax year?
The IRS is playing hardball. There is a reasonable cause provision that allows a taxpayer to avoid any late filing penalties if the failure to file or to disclose an asset is due to reasonable cause and not due to willful neglect. If you have a reasonable argument to put forth, it’s still going to involve time and money. You may not end up having to pay any penalties that might be assessed, but to get to that point, you will have to affirmatively show to the IRS that the facts support a reasonable cause claim.
For taxpayers who determine they need to file this form and did not include it with their 2011 returns, it would be wise to address this failure as soon as possible. Such a voluntary admission of noncompliance and taking corrective action to immediately cure this filing deficiency will generally be to an individual’s benefit when attempting to negotiate any penalty abatements with the IRS as a way to demonstrate a good faith effort to be in compliance with these new filing obligations.
Henry J. Grzes, CPA, is a director, international tax, at SS&G, Inc. Reach him at (919) 651-1616 or HGrzes@SSandG.com.
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