Recent Global Developments in International Taxation

(1) United States

(i) IRS issues updated Publication 519 — US Tax Guide for Aliens

The US Internal Revenue Service (IRS) has released the 2012 revision of Publication 519 (US Tax Guide for Aliens). The publication is dated 7 February 2012 and is intended for use in preparing tax returns for 2011.

Publication 519 provides detailed guidance for resident and non-resident aliens to determine their liability for US federal income tax. Specifically, Publication 519 discusses:

• the rules for determining US residence status (e.g., the US green card test and the US substantial presence test);

• the rules for determining the source of income; ? exclusions from US gross income;

• the rules for determining and computing US tax liability;

• US tax liability for a dual-status tax year (i.e., where an individual has periods of residence and non-residence within the same tax year);

• filing information;

• paying tax through withholding tax or estimated tax;

• benefits under US income tax treaties and social security agreements;

• exemptions for employees of foreign governments and international organisations under US tax treaties and US tax law;

• sailing and departure permits for departing aliens; and

• how to get tax help from the IRS.

Publication 519 also includes:

• filled-in individual income tax returns (IRS Form 1040 and Form 1040NR) as illustrations of dualstatus returns;

• Table of US tax treaties (updated through 31 December 2011);

• Appendix A (Tax Treaty Exemption Procedure for Students), which contains the statements non-resident alien students and trainees must file with IRS Form 8233 [Exemption From Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Non-resident Alien Individual] to claim a tax treaty exemption from withholding of tax on compensation for dependent personal services; and

• Appendix B (Tax Treaty Exemption Procedure for Teachers and Researchers), which contains the statements non-resident alien teachers and researchers must file for the same purpose as Appendix A.

Revised Publication 519 provides information on relevant tax changes for 2011 and 2012, including:

• the requirement to file new IRS Form 8938 (Statement of Specified Foreign Financial Assets) to report certain foreign financial assets (for 2011);

• exclusion of interest paid on non-registered (bearer) bonds from portfolio interest (for 2012); and

• expiration of the exemptions for certain USsourced interest-related dividends and shortterm capital gain dividends that are received from a mutual fund or other regulated investment company (for 2012).

Additionally, Publication 519 refers to the other IRS publications that are relevant in this context, including:

• Publication 514 (Foreign Tax Credit for Individuals);

• Publication 515 (Withholding of Tax on Nonresident Aliens and Foreign Entities);

• Publication 597 (Information on the United States-Canada Income Tax Treaty); and

• Publication 901 (US Tax Treaties).

(ii) IRS Notice 2010-62: Application of codified economic substance doctrine

The Internal Revenue Service (IRS) has issued Notice 2010-62 with information on implementation of the economic substance doctrine. This doctrine previously applied under US common law and has now been codified by the Health Care and Education Act of 2010, effective for transactions entered on or after 31 March 2010.

The economic substance doctrine permits the IRS to deny tax benefits from a transaction unless (i) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and (ii) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into the transaction.

Notice 2010-62 provides information on how the IRS intends to apply the newly codified doctrine. Particular guidance is provided with respect to:

• the application of the two-part conjunctive test of the doctrine;

• the calculation of net present value of reasonably expected pre-tax profit (which is a necessary requirement for meeting the test); and

• the treatment of foreign taxes as expenses in appropriate cases.

Application of the US accuracy-related penalties is also discussed.

Notice 2010-62 provides, in general, that the IRS will apply the codified economic substance doctrine in the same manner as the doctrine was applied by the US courts under common law. The IRS states, however, that it does not intend to issue administrative guidance regarding the types of transactions to which the doctrine will or will not be applied.

(iii) Offshore Voluntary Disclosure Program reopened indefinitely

The US Internal Revenue Service (IRS) issued a News Release (IR-2012-5) on 9 January 2012 to announce reopening of the Offshore Voluntary Disclosure Program (OVDP) to allow taxpayers with undisclosed offshore accounts to report such accounts to the IRS and get current with their US taxes. The new OVDP is effective from 9 January 2012 and will remain open for an indefinite period until otherwise announced.

The new OVDP requires participants to pay a penalty of 27.5% of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the 8 full tax years prior to the disclosure. That is increased from 25% in the 2011 program. The new OVDP maintains the reduced 5% and 12.5% penalties that applied in limited situations under the 2011 program.

Participants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.

The IRS stated that more details will be released within the next month.

The IRS also announced in the press release that more than USD 4.4 billion have been collected so far from the two previous disclosure programs.

(iv) Joint Committee on Taxation issues report on taxation of financial instruments

The Joint Committee on Taxation of the US Congress has released a report on US Federal tax rules relating to financial instruments.

The report is entitled Present Law and Issues Related to the Taxation of Financial Instruments and Products. The report is dated 2 December 2011 and is designated JXC-56-11.

The report is divided into four sections, as follows:

• Section I describes economic, financial accounting, and regulatory considerations related to holding, issuing, and structuring financial instruments;

• Section II describes the basic US income tax principles of timing, character, and source that underlie the taxation of financial instruments;

• Section III provides an overview of the timing, character, and source rules for five types of financial instruments (i.e., equity, debt, options, forward contracts, and notional principal contracts), plus a description of the economic relationships among various financial instruments (including so-called put-call parity) and the financial accounting treatment of financial instruments; and

• Section IV discusses selected timing, character, source, and categorisation issues in taxation of financial instruments.

The report also includes an appendix with data on holdings and issuance of financial instruments.

(v)    IRS updates annual list of international no-ruling areas

The US Internal Revenue Service (IRS) has issued Revenue Procedure 2012-7 with its updated list of international tax issues on which it will not accept applications for private letter rulings and determination letters.

Revenue Procedure 2012-7 includes two lists of international no-ruling areas, i.e., (i) areas in which rulings or determination letters will not be issued, and (ii) areas in which rulings or determination letters will ‘not ordinarily be issued’.

Inclusion of an item on the ‘not ordinarily be issued’ list means that the IRS will not issue a private letter ruling or determination letter on the issue absent unique and compelling reasons given by the taxpayer that would justify a ruling or determination letter.

The 2012 lists have not changed from the 2011 lists, and include such no-ruling and ordinarily no-ruling areas as, among others:

•     whether a payment constitutes portfolio interest u/s.871(h) of the US Internal Revenue Code (IRC), regarding the US tax exemption on certain portfolio interest received by non-resident foreign individuals;

•     whether a taxpayer is eligible to claim benefits under the limitation on benefits provision (LOB) of a US income tax treaty;

•     whether a foreign individual is a non-resident of the United States;

•     issues that are the subject of a pending request for competent authority assistance under a US tax treaty;

•     whether a foreign taxpayer is engaged in a trade or business in the United States, and whether income is effectively connected to a US trade or business;

•    whether a foreign taxpayer has a permanent establishment in the United States, and whether income is attributable to a US permanent establishment;

•     whether a foreign levy meets the requirements of a creditable tax or in-lieu-of-tax in the United States; and

•     specified issues concerning conduit financing arrangements.

Revenue Procedure 2012-7 is effective from 3 January 2012.

(vi)    Final regulations issued for CSAs in transfer pricing

The US Treasury Department and Internal Revenue Service (IRS) have issued final regulations (TD 9568) on the transfer pricing rules for cost-sharing arrangements (CSAs). The final regulations were issued u/s.482 of the US Internal Revenue Code (IRC) and are effective from 16 December 2011.

The final regulations provide guidance on the determination of and compensation for economic contributions by controlled participants in connection with a CSA in accordance with the arm’s-length standard. The final regulations adopt with modifications the 2008 temporary and proposed regulations on this topic, which was published on 5 January 2009. The final regulations provide modifications and clarifications to the 2008 regulations, including:

•     treatment of research tools as platform contributions;

•    clarification on updating reasonably anticipated benefit (RAB) shares;

•     supplemental guidance on transfer pricing methods applicable to platform contribution transactions (PCTs);

•     supplemental guidance on application of the best method analysis and the income method;

•     clarifications with regard to the acquisition price and market capitalisation methods;

•     clarifications with regard to the residual profit split method;

•     clarifications regarding forms of payment; and

•     determinations of periodic adjustments.

The Treasury Department and the IRS state in the preamble to the final regulations that they continue to consider the matters regarding the valuation of stock options and other stock-based compensation and intend to address this issue in a subsequent regulations project.

(2)    Germany: Guidance on amended Anti-Treaty Shopping rules published

On 25 January 2012, the Ministry of Finance published official guidance (IV B 3 – S 2411/07/10016) on the application of the anti-treaty-shopping rules embodied in Article 50d(3) of the Income-tax Act as amended in 2011.

Under the revised rules, treaty benefits to a non-resident (intermediate) company are denied if:

•     as far as its shareholders would not be entitled to the treaty benefits if they would have invested directly; and

•     as far as the functional requirements of Article 50d(3) are not fulfilled, i.e., the company derives harmful revenue.

The functional requirements are met if:

•     as far as the company generates its gross income from its own active business activities; or

•     in regard to the company’s gross income that is not generated from its own business activities:

– there are economic or other important reasons for the use of the intermediate company in view of the respective income; and

– the foreign company is adequately equipped for carrying out its own business activities and for participating in the general commerce.

The amendments brought by the bill on the implementation of Directive 2010/24 and other tax laws were necessary in response to the infringement procedure initiated by the European Commission in 2010. Under the old rules, treaty benefits were denied to an intermediate company, inter alia, if the company did not generate more than 10% of its gross income from its own active business activities. The European Commission considered this all-or-nothing approach as disproportionate and going beyond what is necessary to attain the objective of preventing tax evasion. The amended rules provide for a pro-rata relief, to the extent the functional requirements of Article 50d(3) of the ITA are met and there is non-harmful gross income.

Article 50d(3) of the ITA imposes the burden of proof on the non-resident company in respect of the existence of economic or other important reasons for the interposition of the intermediate company as well as for its adequate business substance. The Guidance defines ‘own business activities’ as activities that exceed the mere management of assets and require a participation in general commerce. Further, the interposition of an EU entity can only qualify if the interposed company participates in general commerce within the Member State of its jurisdiction in an active, permanent and persistent fashion. Services for group companies qualify as business activities if invoiced at arm’s length.

Regarding the notion of ‘economic or other important reasons’ for the use of the intermediate company, the Guidance stipulates that an economic reason is given, if the intermediate company is used in order to start an own business activity and the respective activities can be clearly proven.

Other business reasons, relating to the concerns of the entire group (e.g., coordination and organisation, customer relationship building, cost reduction, location preferences or overriding group business objectives) do not qualify as sufficient economic reason. The Guidance further points out that the mere securitisation of assets or shareholders’ pensions in times of economic crisis, as well as the structuring of ancestral successions, do not qualify as an economic reason in this respect.

The amended rules generally apply as from 1 January 2012. However, the rules shall apply as well to all pending cases in which the application of the amended rules lead to more beneficial results for the taxpayer.

(3)    New Zealand: Exposure draft of interpretation statement on tax avoidance

An exposure draft of an interpretation statement, released by Inland Revenue on 19 December 2011, has invited comments from the public on tax avoidance and Inland Revenue’s interpretation of sections BG1 and GA1 of the Income Tax Act, 2007 (ITA). Following a number of significant court decisions on tax avoidance in recent years, the exposure draft discusses Inland Revenue’s interpretation of tax avoidance.

In Ben Nevis Forestry Ventures Ltd. & Ors. v. Commissioner of Inland Revenue; Accent Management Ltd. & Ors. v. Commissioner of Inland Revenue (2009) 24 NZTC 23, 188, the Supreme Court examined the approach between section BG1 and the rest of the Income Tax Act. Subsequently, the approach adopted in Ben Nevis was endorsed as the correct approach to apply section BG1 in Penny and Hooper v. Commissioner of Inland Revenue (2011) NZSC

95.    The exposure draft sets out the analysis to be undertaken to determine whether an arrangement is a tax avoidance arrangement, viz.:

•     identify the arrangement;

•    review all information to ensure all aspects and effects of the arrangement are understood;

•     identify the provisions of the ITA that were used or circumvented under the arrangement and its outcomes;

•     identify the commercial reality and economic effects of the arrangement;

•     ascertain Parliament’s purpose for the provisions of the ITA used or circumvented in the whole arrangement and its outcomes;

•     decide whether the arrangement, viewed in a commercially and economically realistic way, falls outside Parliament’s purpose; and

•     exclude any arrangements where the tax avoidance is ‘merely incidental’ to a non-tax purpose.

The deadline for comments on the exposure draft is 31st March, 2012.