Foreign tax strategies can be boon to multinationals: opportunities abound for multinational companies to take advantage of low-tax foreign jurisdictions to structure tax-advantaged programs. A number of countries provide major incentives to locate within their borders.
Moreover, this past July, the Financial Accounting Standards Board (FASB) issued an Exposure Draft under FASB 109 with regard to the valuation of certain tax positions; the draft is intended to set forth consistent standards when evaluating the recognition of tax benefits and the reversal of previously booked items. These new and existing accounting and legal standards should not, however, preclude a U.S.-based multinational from structuring its operations in accordance with tax laws to achieve the best results.
Admittedly, tax law has areas that are unclear and difficult to interpret, and in some cases the outcome of a given structure or position may not be entirely clear, even where there is enough support in the law to justify its legitimacy. When a U.S. multinational is faced with this and the outcome is not sufficiently certain to avoid adverse financial reporting, an assessment will have to be made as to whether the benefits of a given structure or position outweigh the risks, if any.
A U.S. multinational should, nevertheless, be able to continue structuring its business affairs and transactions so as to maximize tax savings and achieve the most efficient tax result (as opposed to engaging in tax evasion). Well thought-out and properly documented tax planning techniques will generally meet the standards for a supportable and legitimate tax position within the regulatory, accounting and tax standards.
Consider, too, that the overall effective corporate tax rate has a direct impact on the value of a company's stock. The financial markets recognize that the savings generated by a lower effective tax rate generally translate into larger cash resources, lower-cost financing of operations and increased dividends. In some cases, if operations or particular transactions are not structured to achieve the best tax result, the costs may be so severe that such a transaction would not be worth undertaking. It is imperative, then, that a U.S. multinational avails itself of legitimate tax planning--properly aligned with the business objectives and properly documented--or find itself at a disadvantage relative to its competitors.
U.S. multinationals, in fact, have increased opportunities to lower their effective tax rate by moving profits from higher-taxed jurisdictions to lower-taxed ones, and to take advantage of legitimate non-U.S. tax planning techniques aimed at reducing their effective foreign tax rate. While there are various techniques available (most of which are beyond the scope of this discussion), one practical and effective technique that illustrates the basic principle--and that should be considered--is migrating the multinational's intellectual property to an offshore intellectual property holding company ("IPCo") located in a tax-efficient jurisdiction.
Companies large and small have been doing this for years, and there is nothing in the law that would prohibit it. In fact, many jurisdictions encourage this by allowing for special reduced tax rates for IPCos formed in their jurisdiction. The U.S. transfer pricing rules also provide guidelines that are helpful in some cases in effectuating these types of transactions. An IPCo structure can provide a means to move the revenue stream associated with intangible property ("IP")--such as a valuable trade name, trade-mark, secret process or software, etc.--to a jurisdiction with a lower effective tax rate.
Moving intangibles to an IPCo can be accomplished in various ways; this often depends on the current location, development stage or type of intangible. For example, it may be possible to transfer the economic rights to currently existing IP (even without transferring legal title) and still achieve the same tax benefit. Moreover, intangibles not yet created can be developed by a subsidiary organized in a foreign jurisdiction.
Intangibles that are already in the development stage, on the other hand, may be effectively transferred via cost-sharing agreements. This is most helpful when the original ownership of the intangibles is with a U.S. corporation. Here, a cost-sharing agreement will allow the U.S. corporation to retain use of the intangibles, if needed, while transferring the right to use the intangibles outside the U.S. to an IPCo.
Moving the ownership of intangibles offshore--or, if already offshore, to the appropriate offshore jurisdiction--should allow the U.S. multinational to reduce effective tax rates (in some cases significantly) on non-U.S. profits. The basic idea is that the IP is licensed to the various foreign operating companies ("OPcos") in exchange for an arms-length royalty. The result is a royalty deduction in the high-tax operating jurisdictions and low-taxed royalty income in the hands of the IPCo. This is illustrated in the following example:
Assume that a U.S. multinational has an operating foreign subsidiary and has IP (a trade name, secret process, etc.) used by the foreign operating subsidiary. The tax rate in the foreign subsidiary's jurisdiction is 40 percent, and it has $1,000 of income annually; thus, it incurs a $400 tax burden each year. An IPCo in a jurisdiction with a 5 percent tax rate is then formed, and the IP is transferred to IPCo.
IPCo then licenses the IP to its foreign subsidiary in exchange for an arms-length royalty. Appropriate planning has been done to avoid any royalty withholding taxes on payment of such royalty to IPCo. Assume an arms-length royalty of $500 is paid annually, thereby reducing the annual taxable income to $500. The annual tax in the foreign subsidiary is now reduced by $200, and the tax cost in IPCo is only $40 per year, for a total tax cost of $240. This results in a net savings of $160.
Obviously, the choice of jurisdiction is critical, and additional planning must be undertaken to ensure that the U.S. multinational is in the best position to repatriate future earnings and/or maintain a tax-efficient exit strategy for some or all of its foreign operations. Many foreign jurisdictions have lower statutory tax rates than the U.S. In addition, certain jurisdictions will agree to lower rates than the regular stated rate, depending on the business plans created in those jurisdictions. For example, the Swiss tax rate (generally around 30 percent) may in some cases be negotiated down to 4 percent to 8 percent (or in some cases, zero).
A detailed discussion of choice of jurisdiction for the IPCo is beyond the scope of this article, but there are three basic considerations. First, many of the jurisdictions where the foreign subsidiaries operate may have a with-holding tax on outgoing royalties. Because a favorable income tax treaty will often eliminate or minimize such taxes, it is often necessary to organize the IPCo in a jurisdiction with favorable tax treaties.
The ability for the IPCo to distribute profits without dividend with-holding taxes should also be factored in the analysis. Often, a top-tier overall international holding company is used to hold the stock of IPCo and the operating foreign subsidiaries to maintain overall efficiency of repatriating profits, as well as minimizing taxes on exit. Finally, the tax rate in the IPCo jurisdiction must be low enough to provide the desired benefit (see diagram on the following page).
Favored jurisdictions for such IPCos are Switzerland and Ireland. Both have a reasonably low tax rate and a strong tax treaty network. From a pure tax perspective, Switzerland is usually favored because (as discussed above) favorable tax rates can be negotiated with the Swiss tax authorities and Switzerland has a very strong treaty network. Ireland has a fixed tax rate of 12.5 percent.
Other legitimate tax planning opportunities to reduce effective tax rates can enhance the result achieved by moving IP to low-taxed jurisdictions. Such opportunities include moving profits from manufacturing or sales and distribution activities to a lower-taxed jurisdiction without substantially changing the nature of the underlying operations, and implementing debt financing structures to reduce effective tax rates through interest deductions.
Tax planning strategies are many and varied, due to such factors as the economy, the particular industry and the life cycle of the corporation, its products or a combination of such factors. As illustrated above with the IPCo, the basic concept of effective tax rate planning often involves moving or allocating profits to a low-tax jurisdiction in a way that does not disturb the basic business model.
During a company's life cycle, new or different business opportunities may arise that may help maximize profits and prompt consideration of tax planning strategies to maximize after-tax cash. For example, particular changes in the industry or expansion of the business may allow a sales company to terminate third-party distribution arrangements and establish its own sales entity in a particular jurisdiction in order to maximize profits. This, in turn, may prompt tax planning that will justify the use of structures designed to move profits from high-tax jurisdictions to low-tax ones.
As an example, a U.S. multinational that has increased profitability by doing its own distributing or manufacturing may want to consider establishing an offshore holding company structure, with a manufacturing or distribution company located in a low-tax jurisdiction. This can be implemented in connection with an IPCo structure or on a stand-alone basis. Basically, a new manufacturing company or distributing company ("Newco") would be incorporated in a low-tax jurisdiction. Newco would then contract with the local foreign operating subsidiaries that had historically done the manufacturing or distribution to do such work on its behalf.
The actual location of the manufacturing activities does not change. Instead, Newco maintains title to the unfinished and finished product and bears all risk associated with the inventory; in turn, it pays an arms-length fee to the local foreign subsidiary that does the actual manufacturing. Thus, a good portion of the profits can be shifted from the local high-tax jurisdiction to the low-tax manufacturing one.
With the distributing structure, the concept is similar: the Newco distributor would take title to all the inventory and pay an arms-length fee to the local operating company to act as sales agent, thereby reducing the profit in the local high-tax jurisdiction.
If properly structured, effective tax planning will provide the U.S. multinational with an accumulation of lower-taxed cash resources outside the U.S. that can be used to finance future operations. Other factors critical to the overall business and tax planning are price controls, value-added tax (VAT), Customs, sourcing and distribution, and, of course, local business practices. With proper planning, these are all considerations that can be managed and coordinated with the overall corporate business, tax and regulatory objectives; missed opportunities could be costly and result in unnecessarily high effective corporate tax rates.
It is up the financial executive to present valuable tax planning opportunities to management and work together with competent tax advisors and accountants to take advantage of such opportunities. Given the legitimate ability that U.S. multinationals have to reduce their effective tax rates, an executive who does not consider such opportunities is missing an important aspect of corporate financial management.
David Hryck and Brian Andreoli are partners in the International Tax Group in the New York office of DLA Piper Rudnick Gray Cary U.S. LLP, one of the largest international law firms in the world with nearly 3,000 lawyers and offices in over 50 cities in the U.S., Europe and Asia. The authors would like to thank Robert Rothman, Esq., of Counsel to DLA Piper's New York office, for his contributions to this article.
RELATED ARTICLE: takeaways
* Multinational companies need to assess the potential risks of a foreign tax strategy and the potential impact on the financial statement if the strategy is challenged.
* A number of foreign jurisdictions, such as Switzerland and Ireland, actively promote themselves as providing low-tax alternatives for foreign companies that locate facilities there.
* Among the strategies for companies to consider is migrating their intellectual property to an intellectual property holding company located in the low-tax jurisdiction.
* Another strategy is to incorporate a new manufacturing company or distributing company abroad that would contract with the local foreign operating subsidiaries.
|Printer friendly Cite/link Email Feedback|
|Title Annotation:||corporate taxes|
|Date:||Sep 1, 2005|
|Previous Article:||Linking real estate and strategy to realize gains: a real estate advisor argues that most companies tend to manage real estate as a cost center and...|
|Next Article:||Performance management: enabling smarter business; BPM solutions involve a closed-loop planning process that synchronizes modeling, measurement,...|