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March 7 — One result of the OECD's project to combat tax avoidance is that U.S. multinationals deciding to move intellectual property to such jurisdictions as Ireland and Singapore will need to move senior management employees there as well, three practitioners told a recent tax conference.
John Ryan of Morgan, Lewis & Bockius LLP in Palo Alto, Calif., said that in the wake of the Organization for Economic Cooperation and Development's action plan on base erosion and profit shifting, for which most of the work was concluded in October, companies creating new offshore operations that use principal structures must join their intellectual property and risk-bearing with significant management functions.
Ryan said March 4 that high-technology, high-value companies that haven't made an initial public offering—the new so-called unicorns—that have the funding and ambitions to expand internationally need to adopt a new approach to setting up principal structures abroad.
“Until you are ready to have fairly senior level people in the jurisdiction where you want your IP to be held, this isn't really something to contemplate.”
Ryan said Silicon Valley produces a significant number of start-ups that quickly become international companies. “There has been a well-worn path to how you do that from a tax planning point of view,” he said. But, Ryan added, “It is fairly clear that this path is not to be traveled anymore when setting up a principal structure offshore where the value comes from the intellectual property.”
The OECD launched its 15-point BEPS action plan in 2013 under a mandate from the Group of 20 countries. The plan—the most ambitious project undertaken by the OECD in decades—called for a rewrite of global tax rules to prevent the kind of tax planning that has allowed multinational companies to shift income from the locations where they operate into jurisdictions with low tax rates. The OECD released the bulk of its recommendations under the plan Oct. 5, 2015 (193 DTR GG-1, 10/6/15).
Ryan made his remarks at the Pacific Rim Tax Institute in Redwood City, Calif. Also speaking on the panel were Adam Halpern of Fenwick & West LLP in Mountain View, Calif. The moderator was Nate Carden of Skadden Arps, Slate, Meagher & Flom LLP in Chicago.
Ryan said companies now face an uncertain tax planning environment, with countries beginning to adopt the OECD's BEPS recommendations.
“We are not here to say, ‘here is the solution to the post-BEPS world planning' because we are not in a post-BEPS world—we are in a transition state, and we don't really know what it is.”
Some companies are putting temporary structures in place, he said.
“We know 18 months from now we will have a much clearer view of what you want to do, and that will involve certain functions being located outside the U.S. in the jurisdiction where you want the IP to be held if you need a principal structure,” Ryan said. “Ultimately you need to be looking at a jurisdiction that has the sort of infrastructures and workforce you need, and not be looking at it just from the tax structure.”
Market jurisdictions where structures are being operated “will be looking very closely at the structures,” the attorney said. The focus now isn't on “where the IP is being moved from and to,” he said. “Instead, the focus is on where is it being used.”
Ryan said companies will need to decide what kind of story they will tell to the market jurisdictions.
Halpern said companies setting up IP structures used to “automatically” go to a zero-tax location. More recently, one company transferring IP decided to go to Ireland, and “there was no question of trying to set up something less than the Irish tax,” he said.
“More and more people are starting to think in terms of ‘you know you have to have a real base in a real country somewhere,' ” he said, “and have the people there who are overseeing your foreign operations.”
Carden said his experience of tax planning in the wake of the BEPS recommendations mirrors Halpern's.
Local government authorities in many countries where U.S. companies would consider starting operations have given the companies help to set up their operations, Carden said.
He also said countries that are trying to attract foreign direct investment “are upping their game in terms of drawing people in and helping them.” The foreign investment authority in, for example, Dublin will help a company “get set up and put you in an office” and “tell you the best talent people to work with to try to get people who already have experience.”
Ryan noted that companies are having to react quickly to some rule changes. Australia's multinational anti-avoidance law, which came out at the end of 2015, required a number of companies to make changes to their structures by Dec. 31 to avoid falling foul of the new regime.
“That is very hard to do from a system point of view,” he said. “I think we have all experienced situations with clients that you can't just turn off a commission agent structure and turn it into buy-sell in a week or a month or six months,” he said. “The IT problems, the ERP”—enterprise resource planning—“system problems are huge,” he said.
Ryan said post-BEPS changes to multinational group structures that are “on the horizon” include changing commissionaire structures to buy-sell structures.
Ryan acknowledged that some companies moved from buy-sell structures to commission agent structures as an opportunity to lower the amount of their profits in the local country.
However, companies also use commissionaire structures for completely non-tax, non-base-eroding purposes, he said, with “one obvious reason being to minimize the number of revenue recognizing entities, which has IT implications, and control implications for financial statements.”
Ryan said companies are reluctant to change their structures in response to the BEPS final reports. “If people could get comfortable that this was just about transfer pricing, I think many people who have commissionaire structures would prefer to keep them in place.”
Changing to buy-sell structures would require companies to change their systems and to put a new financial and control infrastructure in place, and “have revenue recognition in every country.”
Halpern said the same issue arises with unrelated re-sellers. It's no simple feat for companies that have unrelated re-sellers acting on a commission basis “to switch that over to a buy-sell arrangement for business control reasons.”
Ryan noted that groups are collapsing their two-tier structures, including their “double Irish” and “CV-BV” structures, in response to the BEPS recommendations. If such structures survive, he said, the OECD's effort to combat BEPS will have been in vain.
Under a double Irish mechanism, companies collect profits through Irish subsidiaries—often with real operations and employees in the country. Those units then route those profits through royalties and other payments to a second Irish subsidiary, headquartered in a tax haven such as Bermuda, Grand Cayman or the Isle of Man. In a CV-BV structure, two U.S. resident subsidiaries of a U.S. multinational group are partners in a “closed” Dutch limited partnership (CV) that holds all the shares of a Dutch operating company (BV). The operating company acts as a holding company for the group's foreign subsidiaries, whose earnings are transmitted from the BV to the CV in the form of dividends, interest or royalties. The CV is not subject to either Dutch or U.S. corporate income tax.
Ryan cited a lack of clarity about how the BEPS guidance will affect the structures—as well as “what the best alternative is.” Advisers, he said, are being put in the position of recommending changes that give substance to the arrangements, saying, “You will have the substance, and our rate will go up 5 percent, 6 percent, 7 percent or 10 percent.”
Before going to the board of directors, “you'd better be sure that you need to do it,” Ryan said, “and you'd better be sure you are not coming back in six months and saying ‘this doesn't work, you'd better go somewhere else,' or saying ‘never mind, it turns out that this is a scare that didn't happen.' ”
Ryan said most companies that have two-tier structures—other than a few that are so visible that they feel they must act now—know that if BEPS doesn't fail, they will have to collapse structures at some point.
Pulling the Trigger?
“I don't think anyone is willing to pull the trigger yet” on restructuring operations, he said. “You have to be in the situation to go to the board and say, ‘We must act, and this is the best action.' ” While “we can't say yes to either of those statements yet,” he added, “I assume it will be here in a year, in 18 months.”
Carden agreed. “I don't think people have a real clear sense as to where things are going to shake out. If I have a tax rate of X, is my board of directors going to be saying ‘we have a lot of risk here' or will the board be saying ‘why aren't you in line with the other companies we are competing with?' ”
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