U.S. Taxation of International Mergers, Acquisitions, and Joint Ventures.

If you want to shrink something, you must first allow it to expand.

Lao-Tzu (Tao Te Ching: Book of the Way and of How It Manifests Itself in the World)

I.

Lao-Tzu's observation offers a unique insight into the phenomenon occurring today when things appear to be expanding in search of a new, perhaps less expansive, certainly less chaotic, state. We are transitioning into a New Era. At the forefront of this transition is the Communication Revolution. We are in the midst of a Revolution unparalleled in social, cultural, and economic magnitude. In my view, the Communications Revolution will find itself at the top of the Richter scale in social cultural, and economic significance, far exceeding the Industrial Revolution. A similar, but somewhat less Richterial, phenomenon occurred in the mid-15th Century when Gutenberg's printing press ushered in the Era of the Common Man. As observed by Federal Communications Commissioner Susan Ness earlier this year: "The communications revolution is a global phenomenon."

On a social plane, the Communications Revolution already dwarfs the Age of Enlightenment and Reason in its facilitation of the exchange and analysis of ideas. While the resulting social cleavage may be unsettling initially, it is productive in the long-run because the World Stage on which the communication of ideas and its accompanying discourse occurs is pregnant with opportunity for social progress. Clearly, the rapid growth and deployment of the technology that permits -- no, fosters -- communication across social boundaries are chiefly responsible for the exponentially increasing demand for broader arrays of information packaged to permit ready access and immediate use. As information becomes the oil of the 21st Century, information democracy is poised to become the clarion call of the self-respecting, politically correct, storm-trooping intelligentsia of the new millennium.

Culturally, the Revolution has taken on Joshuaian dimensions: walls of ignorance have been reduced to rubble. As the Revolution progresses, the world will become a Global Village with a new culture challenging the very existence of nation states. In this connection, consider the following observations:

* "The communications revolution is bringing European soap operas into mud-brick Arab shanties, even as Arab upper classes travel back and forth to the West and communicate on the Internet. All this, coupled with fast-forward urbanization and population growth, means Arab cultures are dramatically evolving: the Arab middle classes are more westernized, the Arab power more restive."

* "Europe will be a part of the global village. But instantaneous access to the rest of the world doesn't guarantee success..."; "the U.S. is setting the pace in almost every aspect of the communications revolution...."

* "[B]ecause the United States is a hub of the communications network, other cultures have been forced to at least partly Americanize themselves in order to succeed."

I share Economist Paul Romer's belief that the world is now poised on the edge of an unprecedented burst of innovation and wealth-creation as people break free of traditional economic thinking and industrial-age limitations.

The Global Village highlights yet another development driven by the Communications Revolution: the globalization phenomena. The rapid growth and deployment of communications technology has enabled money, goods, services, information, and people to cross borders rapidly and often instantly.' The Communications Revolution is not only responsible for the transformation of globalization from a buzzword to reality, but it also emphasizes innovation as the key to economic success. Innovation requires the elimination of internal barriers to the free movement of people and, particularly, ideas. Notwithstanding the huge advantages of both scale and speed that global standardization offers, the successful global competitor must acknowledge that "local knowledge can help Davids slay Goliaths and ignorance can fell Goliaths even if there are no Davids around." The failure of Phillips Electronics N.V. in introducing its compact disc interactive player in the U.S. market illustrates how cultural differences that the company's Dutch management did not appreciate can frustrate grand strategies. To be competitive, the multicultural multinational understands that it must hire people, buy inputs, and locate production, marketing, and decisionmaking on a worldwide. basis. In this milieu, cross-border alliances are commonplace.

Heightened global economic interdependence has profound implications for tax systems and tax professionals who must guide global business through the maze of oftentimes competing tax regimes. In this connection, D. Kevin Dolan's U.S. Taxation of International Mergers, Acquisitions, and Joint Ventures is, in large part, a Book of the Way and of How It Manifests Itself in the World.

II.

Kevin Dolan, whose international tax background and credentials are impeccable, has provided international tax practitioners with a tool for identifying the significant tax considerations of generally complex global business transactions and for assessing the efficiency and effectiveness with which structuring alternatives accomplish international business objectives. This Book of the Way lives up to its promise to discuss complex cross-border transaction issues and principles in the context of simple examples that make the subject matter comprehensible.

An excellent example of this lies in Chapter 6, which discusses special problems relating to contributions of intangible property to foreign joint ventures. By analyzing myriad business and tax considerations in the context of examples, a difficult area of tax planning is rendered much easier to understand. The treatise is also noteworthy for its discussion of foreign country tax considerations in dealing with the U.S. taxation of international business transactions. Chapter 1's discussion of special provisions of foreign law applicable to acquisitions of foreign corporations is also refreshing. Moreover, although policy is not the central focus of the treatise, it ably addresses it in appropriate circumstances to permit the practitioner to develop an appreciation for the logic -- or absence thereof -- of particular tax rules.

In discussing the use of holding companies to further foreign tax credit objectives in Chapter 1, the book misses an opportunity to analyze the policy of the "same country" dividend exception to Subpart F income in the context of the European Union Parent-Subsidiary directive and its international competitiveness ramifications. On the other hand, Chapter 6's observation that "there seems to be no policy reason for Section 1491 to apply to a transfer to a foreign partnership except to the extent that the Section 704(c) rules fail to tax precontribution appreciation to the contributing partner" is right on the money!

III.

This twenty-one chapter text covers a plethora of international merger, acquisition, and joint venture U.S. tax topics. Covered subjects range from taxable and tax-free acquisitions, dispositions, and reorganizations to intangibles development and ownership planning to transfer pricing to foreign losses, and structuring international joint ventures. Chapter 1 is an introduction to general issues relating to international acquisitions. It thereby eases the reader into the complex and often opposing considerations generally applicable to international acquisitions, leaving to Chapters 2 and 3 the development of more pointed Buyer and Seller issues, and to Chapter 18 the development of issues related to intangibles development and ownership.

Refreshingly full of useful tax planning pointers, this introductory chapter whets the appetite for more by providing concise, on-the-mark, analyses of international acquisition issues. Experienced practitioners who have dealt with the use of Dutch holding companies in international tax planning situations will be rewarded with as fine a summary of what I have found to be the very trying limitation-of-benefits provisions of Article 26 of the U.S.-Netherlands income tax treaty. The chapter is not without a blemish, however minor. Specifically, I believe its covenant-not-to-compete discussion may be misleading in its suggestion that the amortization period for a covenant acquired as part of the acquisition of a business is ". . . the period of the covenant (e.g., five years) for purposes of tax in its country of residence." While this may well be the case for non-U.S. jurisdictions, it clearly is not true with respect to the United States, where section 197 of the Internal Revenue Code provides for a 15-year amortization period. Nonetheless, the allocation point remains valid in a foreign tax credit planning context if for no other reason than the favorable earnings and profits results produced by the disparity in amortization periods for covenants not to compete.

As previously stated, Chapters 2 and 3 address Buyer and Seller considerations in taxable acquisitions of foreign businesses by a U.S. buyer from a U.S. or foreign U.S. Seller and by a foreign buyer from a U.S. or foreign seller. The text ably deals with the complexities of section 338 elections, section 1248 ramifications, section 304 opportunities, and foreign tax credit considerations. I found the conclusion that "any system of corporate taxation that does not accommodate intra-affiliated group restructuring without significant technical barriers is simply illogical" appealing in a policy context and was struck by the force of the ensuing conclusion that "if the approach of Notice 8764 makes sense in the context of Section 1248(f) distributions, then that approach is also sensible in the context of inter-affiliate distributions of stock that do not meet the technical requirements of Section 355 -- even with respect to stock held by or transferred to foreign members of the affiliated group."

Another of the tax planning nuggets found in these chapters is the suggested use of the pre-sale dividend technique -- commonly used in domestic acquisitions -- in an international context. When the discussion is updated, however, it could be enhanced by consideration of the Waterman Steamship and Litton Industries cases. The revision is necessary because, in an apparent end-run around Litton. the current section 865 proposed regulations (issued after the treatise was published) would preclude the employment of this technique in conjunction with the recognition of a loss on the disposition of foreign shares.

A central focus of international tax planning from a U.S. tax perspective is the foreign tax credit. The significant tax cost that the credit is intended to alleviate commands much attention for international tax practitioners. Although the topic is addressed throughout the treatise Chapter 4 s discussion of the principal issues relating to the structuring of acquisition and other indebtedness of a U.S.-owned multinational group is particularly germane. The chapter correctly identifies interest deductibility and applicability of the interest withholding tax as two universal tax issues relating to indebtedness. Homage here is paid to a chief ingredient of successful foreign tax credit planning: the reduction of foreign taxes. I found much food for thought in the discussion of the foreign tax credit netting rule and suggest that the alternatives for dealing with the netting rule are must reading for practitioners "caught in the netting."

As previously noted, technological advances, improved communications, and the removal of traditional barriers to international trade and investment flows have all led to the globalization of economic activity. This, in turn, has made cross-border alliances commonplace. In this environment, Chapter 6's discussion of special issues in structuring international joint ventures is timely. The text is so well done that it is easy to spot potential improvement areas. For example, globalization has given rise to tax competition between countries, with each country, especially developing countries, trying to attract a larger share of the global base, especially by attracting a larger share of foreign direct investment. As a result, investment incentives such as tax holidays are fairly common. Thus, the book's review of the deferral considerations attendant to the choice of entity for foreign joint venture operations involving U.S. investors is a bit overbroad in its conclusion that "deferral is critical if the U.S. group has substantial U.S. losses, substantial overall foreign losses or separate limitation losses that are subject to recapture under Section 904(f)." Perhaps the point that deferral is not critical where foreign earnings are not subject to any foreign taxation as a result of a tax holiday, and in fact may be detrimental to the tax posture of the U.S. taxpayer with section 904(f) losses, was considered too obvious for textual presentation.

The choice-of-entity discussion in Chapter 6 misses a grand opportunity to question the absence of a policy underpinning for the section 1492(2)(B) requirement that the election to avoid the 35-percent excise tax on the gain on property contributed to a foreign partnership is made prior to the transfer. This trap for the unwary is ripe for critical analysis especially since application of the excise tax to transfers to foreign partnerships seems to have no policy foundation when considered with the section 704(c) tax on precontribution appreciation. In this connection, the treatise's reference to section 1494(b) relief implicitly on the same plane as the section 1492 election, while arguably valid at the time the book went to press, is now misleading in light of Technical Advice Memorandum 9619003. On a more positive note, the discussion of contractual arrangements and constructive partnerships is instructive and enlightening, and the treatment of contributions of intangibles property to foreign joint ventures is the best I have yet to review.

Chapter 21's discussion of foreign losses is replete with useful insight and planning suggestions. Although I found the discussion of overall foreign loss planning -- e.g., deconsolidate to isolate ML L or decontrol CFC to change character of earnings -- to be creative and practical, I must admit to some measure of disappointment with the discussion of realizing foreign subsidiary losses through recognition of a loss on foreign subsidiary stock. Recently issued proposed regulations under section 865 suggest that this point may be rendered moot, but I nevertheless expected the text to provide the arguments for and against domestic sourcing of the loss on subsidiary stock and conclude with the better view. The chapter closes with a thorough discussion of the U.S. tax issues arising from the payment of intragroup compensation to a loss affiliate by a profitable affiliate for use of losses as a means of transferring such loss. In this connection, I concur with the conclusion that "the IRS's view that the payment for use of losses is not a payment for value but, instead, is a gratuitous payment resulting in a constructive distribution or contribution (or both) does not reflect either economic reality or, arguably, the Tax Court's position adopted in the captive insurance cases, in which purported payments of insurance premiums that were held not to be insurance premiums were nevertheless considered to be payments for value with respect to the captive insurance company's assumption of economic or financial risk."

My parting thoughts regarding U.S. Taxation of International Mergers, Acquisitions, and Joint Ventures is that it is this practitioner's guide through the rough and tumble, highly complicated, overwhelmingly technical maze of tax rules and attendant considerations related to international mergers, acquisitions, and joint ventures. Without hesitation, I recommend it for international tax practitioners with a yearning for the Way!

Editor's Note: D. Kevin Dolan's U.S. Taxation of International Mergers, Acquisitions, and Joint Ventures is published by Warren, Gorham & Lamont. The treatise, which costs $345, will be updated semi-annually.

(1) See Glicklich, Goldberg & Levine, Internet Sales Pose International Tax Challenges, Journal of Taxation (June 1996), for an insightful view of some international tax issues raised by globalization.

JOSEPH S. TANN, Jr. is Manager, Tax Research and Planning for Ameritech Corporation. He is chair of Tax Executives Institute's International Tax Committee and a member of the Institutes' Chicago Chapter.