Check-the-box: European options, U.S. and European consequences.

From an international perspective, the new check-the-box regulations present U.S. multinational taxpayers with the opportunity not only to clean up their European structures in terms of electing partnership or branch treatment for a wide array of foreign entities, but also to present planning opportunities that include (among others) the alternatives illustrated in the charts on pages 80-81.

Although these charts offer interesting and perhaps tax-saving maneuvers for a U.S. entity with European operations, caution should be exercised from both a U.S. and European perspective.

Some of the charts indicate that all European operations would be consolidated into a single European entity with multiple branches located throughout Europe. This could cause an acceleration of U.S. income tax on European profits as a result of applying the de minimis, full inclusion rules of subpart F on a consolidated basis, as well as computing European earnings and profits on a consolidated (rather than on a company-by-company) basis when deficits exist in specific locations.

A recent European judicial decision may also affect European reorganizations tending towards a branch format. The Belgian Supreme Court ruled that losses realized by the Belgian operations of a Belgian company with a profitable permanent establishment in the Netherlands should be reduced by the amount of the profit exempt by virtue of the Belgian-Dutch Treaty. Although this case is specific to the two countries involved, it can have pan-European implications, since other jurisdictions within Europe often follow similar guidelines.

In this decision, the issue was the extent to which a Belgian company with a Dutch permanent establishment could deduct previously incurred losses in Belgium from profits later realized in Belgium. This issue can be illustrated by the following table:

        Belgian   Dutch     Total
Year    profits   profits   profits
19X1      -50      +30       -20
19X2      -20      +50       +30
19X3     +100      +70      +170
Total      30      150       180

The profit attributable to the Netherlands permanent establishment was taxable in the Netherlands under the Belgian-Netherlands Income Tax Treaty.

For 19X3, the company claimed a deduction for a net operating loss carry-forward of 70, thus reducing the taxable base to 30. However, the tax authorities disallowed the full deduction of these previously incurred losses.

Under Belgian domestic tax legislation, the Belgian taxable base is computed on the assumption that the Belgian company has income from foreign sources. Taxable income is split into three categories according to source: Belgian source profits, treaty country profits and nontreaty country profits. After determining the result in each category, there are specific set-off rules for negative results of one source category against the positive results of another category.

In this particular circumstance, losses sustained in Belgium must be set off first against Belgian-source profits, then against profits from the category of nontreaty countries, and finally against profits exempt by virtue of a treaty.

In addition, Belgian legislation provides that losses sustained by the Belgian operations which were reduced in previous taxable periods exempt by virtue of a treaty cannot be deducted from the profits of the Belgian operation realized in subsequent years.

Therefore, based on these provisions, the Belgian tax authorities allowed only the deduction of the amount of losses that was not previously reduced by the Dutch profits. Since there was a 30 offset in 19X1 and a 20 offset in 19X2, the local tax authorities allowed a deduction of losses amounting to 50, increasing the Belgian taxable base to 50. Thus, the difference of 20, which was already taxed in the Netherlands, was once again taxed in Belgium and resulted in international double taxation.

Although this decision is questionable from both a double tax treaty perspective and from a European perspective in terms of the removal of obstacles: in the creation of an internal market, U.S. taxpayers restructuring European operations in light of the check-the-box rules tending toward branch operations must keep this and other European decisions firmly in view.