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6 th Asia/Africa IFA Conference International Tax Developments – Global and Regional Meeting at 6 th Asia/Africa IFA Conference International Tax Developments – Global and Regional Meeting at Hilton Hotel – Wolmar – Mauritius May 10 – 11, 2012 Marc M. Levey Partner - Baker & Mc. Kenzie, LLP 1114 Avenue of the Americas New York, New York 10036 Email: marc. [email protected] com Baker & Mc. Kenzie International is a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a “partner” means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an “office” means an office of any such law firm.

Outline I. Impact of FATCA Reporting Requirements II. Codification of the Economic Substance Doctrine Outline I. Impact of FATCA Reporting Requirements II. Codification of the Economic Substance Doctrine III. Certain Tax Reform Proposals in 2012 2

I. Impact of FATCA Reporting Requirements 3 I. Impact of FATCA Reporting Requirements 3

I. Impact of FATCA Reporting Requirements A. B. C. D. E. F. G. H. I. Impact of FATCA Reporting Requirements A. B. C. D. E. F. G. H. I. FATCA Reporting Requirements Impact of FATCA Reporting Requirements Reporting Thresholds Assets Required to be Reported Assets Not Required to be Reported US/Non-US Equity Plan Administrator / Record Keeper Valuation of Assets Foreign Exchange Conversion / Penalties FBAR 4

Impact of FATCA Reporting Requirements – IRC Section 6038 D Requirements – Impacts employers Impact of FATCA Reporting Requirements – IRC Section 6038 D Requirements – Impacts employers of both US and Non-US Issuers – Employees of Non-US Issuers such as AL bear the brunt of Section 6038 D – New IRS Form 8938 required for 2011 tax year > > Due date April 16, 2012 Temporary regulations issued in December 2011 Little IRS guidance on key issues Employers and employees unaware of filing requirement for 2011 tax year – Duplicative of Mandatory US tax withholding and reporting on Form W-2 5

Impact of FATCA Reporting Requirements – Expats and Inpats, Local hires – Employers of Impact of FATCA Reporting Requirements – Expats and Inpats, Local hires – Employers of Non-US Issuers such as AL: US employees who receive equity, pension or deferred compensation from a non-US employer or non-US parent company – Who’s affected > Individuals only > US citizens, US tax residents, certain non-resident aliens, and residents of certain US possessions 6

Reporting Thresholds Filing Status Individual Living Aggregate Value of Specified Non-US Assets Exceeds: On Reporting Thresholds Filing Status Individual Living Aggregate Value of Specified Non-US Assets Exceeds: On Last Day of Year At Any time during Year Single or Married filing Separate Return in US $50, 000 $75, 000 Married Filing Joint Return in US $100, 000 $150, 000 Single or Married filing Separate Return Outside US $200, 000 $300, 000 Married Filing Joint Return Outside US $400, 000 $600, 000 7

Assets Required to be Reported – Any financial account maintained by a non-US financial Assets Required to be Reported – Any financial account maintained by a non-US financial institution – Examples of non-US financial accounts required to be reported – Foreign financial assets held outside of a US or non-US financial account – Equity awards made by non-US issuer not held in a financial account required to be reported: > > > Stock purchase rights Stock options and SAR’s Restricted stock awards Restricted stock units Performance units and performance shares Capital or profits interest in a partnership 8

Assets Required to be Reported (cont’d) – Other non-US assets required to be reported Assets Required to be Reported (cont’d) – Other non-US assets required to be reported > > > Non-US pension and deferred compensation Certain cash incentive awards from non-US entity Interest in certain non-US trusts Certain insurance contracts Possibly deferred bonus and incentive pay from non-US entity 9

Assets Not Required to be Reported – Non-US assets held in a US financial Assets Not Required to be Reported – Non-US assets held in a US financial account – Financial account of a US branch of a non-US bank or insurance company or a non-US subsidiary of a US financial institution – Certain assets reported to the IRS on other forms (e. g. interest in a Canadian Registered Retirement Plan) – An interest in a non-US trust of which an individual is not aware – An interest in a social security, social insurance, or similar program of a foreign government – Most non-US severance pay 10

US/Non-US Equity Plan Administrator / Record Keeper – Non-US awards held by US administrator US/Non-US Equity Plan Administrator / Record Keeper – Non-US awards held by US administrator exempt? – US branch or subsidiary of non-US entity? 11

Valuation of Assets – Needed to determine whether reporting thresholds exceeded and to report Valuation of Assets – Needed to determine whether reporting thresholds exceeded and to report maximum value on Form 8938 – Fair Market Value standard; no appraisal required – Reliance on information from reliable sources or other verifiable sources – Not clear how to value unvested awards – No guidance on valuing stock options and other equity awards – Special rule for pensions and deferred compensation – No guidance on insurance and annuity contracts – Value on last day of year – Value less than zero – Effect of liabilities on value 12

Foreign Exchange Conversion / Penalties – Foreign Exchange Conversion > Treasury Department rate > Foreign Exchange Conversion / Penalties – Foreign Exchange Conversion > Treasury Department rate > Other forex rates – Information to be Reported on Form 8938 > Taxpayer must disclose if income from non-US assets reported on personal tax return – Penalties > > > $10, 000 penalty; may be increased to $50, 000 Penalty abated if failure due to reasonable cause and not willful neglect Accuracy related penalty increased to 40% Extended statute of limitations for assessing tax underpayments Extended period for assessing penalties 13

FBAR – FATCA reporting is in addition to FBAR Reports – Differences with FBAR FBAR – FATCA reporting is in addition to FBAR Reports – Differences with FBAR reporting 14

II. Codification of the Economic Substance Doctrine 15 II. Codification of the Economic Substance Doctrine 15

II. Codification of the Economic Substance Doctrine A. Overview of Economic Substance Common Law II. Codification of the Economic Substance Doctrine A. Overview of Economic Substance Common Law Test for Economic Substance Circuit Split on Economic substance B. Elements of Section 7701(o) C. Penalty Provisions 16

A. – – – Overview Economic substance doctrine codified by section 1409 of the A. – – – Overview Economic substance doctrine codified by section 1409 of the Health Care and Education Reconciliation Act of 2010, effective March 30, 2010 Adopts the conjunctive analysis of the economic substance doctrine. § 7701(o) Imposes a strict liability penalty for transactions that lack economic substance. § 6662(b)(6) 17

Common Law Test for Economic Substance – – – Common Law Test for Economic Common Law Test for Economic Substance – – – Common Law Test for Economic Substance Conjunctive test requires a taxpayer to establish the presence of both economic substance and business purpose in order for the transaction to survive judicial scrutiny Disjunctive test requires that either economic substance or business purpose is sufficient to respect the transaction Hybrid test in which economic substance and business purpose are mere factors to consider 18

Circuit Split on Economic Substance 1 2 9 8 6 7 3 10 DC Circuit Split on Economic Substance 1 2 9 8 6 7 3 10 DC 4 5 Fed 11 Conjunctive Test Disjunctive Test Other/Factors 19

B. Elements of Section 7701(o) – A three part test for application to a B. Elements of Section 7701(o) – A three part test for application to a transaction, or series of transactions: 1. 2. 3. Is the economic substance doctrine “relevant” to the transaction? Does the transaction change in a meaningful way, apart from any US Federal income tax effects, the taxpayer’s economic position? Does the taxpayer have a substantial purpose, apart from US Federal income tax effects, for entering into the transaction? 20

B. Elements of Section 7701(o) – When does the economic substance doctrine apply? > B. Elements of Section 7701(o) – When does the economic substance doctrine apply? > > > The determination of whether the economic substance doctrine is relevant to a transaction shall be made in the same manner as if the doctrine had not been codified – Reliance on prior common law – Facts and circumstance analysis Economic substance doctrine is not intended to alter the tax treatment of “certain basic business transactions that, under longstanding judicial and administrative practice are respected, merely because the choice between meaningful economic alternatives is largely or entirely based on comparative tax advantages. ” H. R. Rep. 111 -443 at 296 House Report provides a nonexclusive list of examples of “basic business transactions”: 21

B. Elements of Section 7701(o) – When does the economic substance doctrine apply? (cont. B. Elements of Section 7701(o) – When does the economic substance doctrine apply? (cont. ) – The choice between capitalizing a business enterprise with debt or equity; – A US person’s choice between utilizing a foreign corporation or a domestic corporation to make a foreign investment; – The choice to enter a transaction or series of transactions that constitute a corporate organization or reorganization under subchapter C; and – The choice to utilize a related-party entity in a transaction, provided that the arm’s length standard of section 482 and other applicable concepts are satisfied > “[i]f the realization of the tax benefits of a transaction is consistent with the Congressional purpose or plan that the tax benefits were designed by Congress to effectuate, it is not intended that such tax benefits be disallowed. ” JCT Report (emphasis added) 22

B. Elements of Section 7701(o) – Meaningful Change in Economic Position > Taxpayer does B. Elements of Section 7701(o) – Meaningful Change in Economic Position > Taxpayer does not have to prove pretax profit to establish economic substance > If taxpayer relies on profit potential to demonstrate economic substance, the present value of the reasonably expected pre-tax profit from the transaction must be substantial in relation to the present value of the expected net tax benefits that would be allowed if the transaction were respected – Benefits other than federal income tax effects > State or local income tax effect, which is related to a Federal income tax effect, shall be treated in the same manner as a Federal income tax effect > A financial accounting benefit is not taken into account as a permissible purpose for entering into a transaction if the origin of such financial accounting benefit is a reduction of Federal income tax 23

B. Elements of Section 7701(o) – What is a “Transaction”? > A transaction includes B. Elements of Section 7701(o) – What is a “Transaction”? > A transaction includes a “series of transactions” > House Report provides that the codified economic substance doctrine does not alter the court’s ability to aggregate, disaggregate, or otherwise recharacterize a transaction when applying the doctrine > Note that effective date is tied to when the “transaction” was entered into 24

C. Penalty Provisions – Penalty Amounts > Section 6662(b)(6) imposes a 20 percent penalty C. Penalty Provisions – Penalty Amounts > Section 6662(b)(6) imposes a 20 percent penalty for any underpayment attributable to disallowance of benefit by reason of failing to meet economic substance doctrine or “any similar rule of law” > Penalty is increased to 40 percent if transaction is not disclosed – Amended returns or supplements to disclose transaction must occur prior to first contact by the IRS regarding examination of the return (or such earlier date as is specified by the IRS) – When Does the Penalty Apply? > Disallowance must be because transaction lacked economic substance > Penalty can apply to any transaction that does not have economic substance or “any similar rule of law” – Intended to capture other doctrines the application of which entails similar factors and analysis as the economic substance doctrine – e. g. , Sham Transaction Doctrine > Strict Liability - No reasonable cause exception 25

III. Certain Tax Reform Proposals for 2012 26 III. Certain Tax Reform Proposals for 2012 26

III. Certain Tax Reform Proposals for 2012 A. Main Issues for Corporate Tax Reform III. Certain Tax Reform Proposals for 2012 A. Main Issues for Corporate Tax Reform OECD countries B. Current Baseline C. Obama’s FY 2013 Budget Tax Expenditures That Substantially Narrow the Corporate Tax Base What does base-broadening buy? Additional Sources of Revenue Are Necessary to Reduce the Rate Below 28% Tax reform winners and losers The President’s Framework for Business Tax Reform – The Candy for Small Businesses The President’s Framework for Business Tax Reform – the Pain The President’s Framework for Business Tax Reform – International D. Options for Preventing Base Erosion Taxing Excess IP Returns Excess Return/Low Taxing Low Tax Cross-Border Income U. S. Patent Box Anti-Stuffing/Thin Capitalization Rule 27

A. Main Issues for Corporate Tax Reform – The statutory corporate tax rate – A. Main Issues for Corporate Tax Reform – The statutory corporate tax rate – The taxation of foreign income – “Extenders” > Extend 59 Tax provisions that expired at the end of 2011 (i. e. R&E credit etc) > Bush tax cuts that expire 12/31/2012 28

OECD countries OECD member countries shown. Source: Organization for Economic Cooperation and Development (OECD). OECD countries OECD member countries shown. Source: Organization for Economic Cooperation and Development (OECD). 29 29

B. Current Law Baseline – Assumes all current temporary tax provisions are allowed to B. Current Law Baseline – Assumes all current temporary tax provisions are allowed to revert to prior law, including: > > > Top Individual Tax Rate – 39. 6% Capital Gains – 20%; Dividends – Ordinary Income Marriage penalty returns; child tax credit no longer refundable Estate tax -- Exemption falls to $1 million with a 55% top rate AMT – Unpatched Extenders – Remains lapsed – According to CBO, this baseline would result in revenue of about 21% of GDP in 2022. 30

C. Obama’s FY 2013 Budget – Extends some of the expiring provisions, including individual C. Obama’s FY 2013 Budget – Extends some of the expiring provisions, including individual tax cuts for those with incomes under $200, 000 (single) / $250, 000 (married); Bush tax cuts expire for those with income above – Adds new tax cuts (e. g. , advanced manufacturing) and tax increases (e. g. , carried interest; oil and gas) – Net effect is that tax receipts in 2022 would total 20. 1% of GDP (according to OMB) – Tax cut of $220 billion against “Current Law” – Tax increase of $450 billion against “Current Policy” 31

Tax Expenditures That Substantially Narrow the Corporate Tax Base _______________________________________ FY 2011 -2021 Revenue Tax Expenditures That Substantially Narrow the Corporate Tax Base _______________________________________ FY 2011 -2021 Revenue from Repeal of Provisions for Corporations and Pass-through Entities Tax Provision (in billions) _______________________________________ MACRS $724 Deduction for U. S. production activities (section 199) $164 Expensing of R&E $160 LIFO $ 70 Low-income housing tax credit $ 39 Section 1031 (deferral of gain on like-kind exchanges) $ 18 Completed contract rules method $ 14 Cash accounting $ 14 Percentage depletion for oil, gas, coal and hard mineral fossil fuels $ 12 Exclusion of interest on private activity bonds $ 9 ___________________________________ Source: Joint Committee on Taxation, Revenue Estimates Memorandum, October 27, 2011 32

What does base-broadening buy? – Eliminating most corporate tax expenditures would reduce the corporate What does base-broadening buy? – Eliminating most corporate tax expenditures would reduce the corporate tax rate to 28% – Eliminating most corporate tax expenditures but maintaining accelerated depreciation would reduce the corporate tax rate to 31% – Substantially less money would be raised if the research credit, LIHTC, the charitable deduction, and certain green energy benefits were retained – Eliminating temporary provisions does not raise significant revenue unless the baseline is adjusted to current policy 33

Additional Sources of Revenue Are Necessary to Reduce the Rate Below 28% – Tax Additional Sources of Revenue Are Necessary to Reduce the Rate Below 28% – Tax “large” partnerships as corporations (WSJ, page A 1, 1/10/2012) – Reduce the deduction for interest – Tighten the territorial tax system to raise revenue, including strict expense allocation 34

Tax reform winners and losers Source: Martin Sullivan, Tax Notes 35 Tax reform winners and losers Source: Martin Sullivan, Tax Notes 35

The President’s Framework for Business Tax Reform – The Candy – Corporate tax rate The President’s Framework for Business Tax Reform – The Candy – Corporate tax rate is 28% – Other benefits for corporations > Permanent R&E Tax Credit with ASC increased from 14% to 17% > Increase section 199 deduction from 9% to 10. 7%, and increase to 18% for manufacture of advanced technology > Enhance, consolidate and extend key tax incentives for clean energy 36

The President’s Framework for Business Tax Reform – The Candy for Small Businesses – The President’s Framework for Business Tax Reform – The Candy for Small Businesses – Amounts raised from the repeal of business tax expenditures for pass -through entities would be used to benefit small businesses – Increase current expensing up to $1 million – Allow cash accounting for businesses with up to $10 million in gross receipts – Increase the deduction for start-up costs from $5, 000 to $10, 000 – Expand the health insurance tax credit for small businesses 37

The President’s Framework for Business Tax Reform – the Pain – Repeal most business The President’s Framework for Business Tax Reform – the Pain – Repeal most business tax expenditures – Slower depreciation – Reduce the bias toward debt financing, such as reducing the deductibility of interest for corporations (but not pass-throughs? ) – Establish greater parity between large corporations and large passthroughs – Improve transparency and reduce the gap between book and tax income 38

The President’s Framework for Business Tax Reform – International – Deferral in low tax The President’s Framework for Business Tax Reform – International – Deferral in low tax jurisdictions can lead to overinvestment abroad and underinvestment in the US > Can erode the US tax base > International tax system is overly complex and unfairly benefits sophisticated companies who are able to avoid paying taxes by manipulating rules – Should reduce the incentives to invest overseas – Should be guided by the sole criteria of promoting growth in the jobs and standard of living of American workers and their families 39

The President’s Framework for Business Tax Reform – International – Require companies to pay The President’s Framework for Business Tax Reform – International – Require companies to pay a minimum tax on overseas profits > What is the minimum tax rate? > Unclear how or whether the US will give credit for previously partially taxed income > This provision adds significant complexity, and it is unclear if it would collect significant revenue 40

D. Options for Preventing Base Erosion – Tax excess IP returns as subpart F D. Options for Preventing Base Erosion – Tax excess IP returns as subpart F income -- Obama Administration proposal – Tax low tax cross-border income as subpart F income – U. S. patent box coupled with subpart F treatment of intangibles income 41

Taxing Excess IP Returns – If … > US person transfers a covered intangible Taxing Excess IP Returns – If … > US person transfers a covered intangible to a related CFC > The CFC is subject to a low foreign effective tax rate > The CFC earns excessive intangibles income – Then … > The excessive return is treated as subpart F income > In a separate FTC limitation basket 42

Excess Return/Low Tax – Excess return -- excess over allocable “costs” + % mark-up Excess Return/Low Tax – Excess return -- excess over allocable “costs” + % mark-up - 50% – Low tax -- to be based on sliding scale of foreign tax rates -- 10 -15% > Effective tax rate calculated under U. S. E&P principles? * See attached commentary 43

Taxing Low Tax Cross-Border Income – New category of subpart F income for CFC Taxing Low Tax Cross-Border Income – New category of subpart F income for CFC income subject to effective foreign tax rate of less than 10% – Same country exception if meet all of: > Active trade or business in same country > Office or fixed place of business in same country > Income derived from services performed or products used or consumed in same country > Would essentially undo existing deferral structures 44

U. S. Patent Box – 40% deduction for: > A US corporation’s foreign intangible U. S. Patent Box – 40% deduction for: > A US corporation’s foreign intangible income, plus > CFC’s foreign base company intangibles income – Proposal would essentially eliminate benefit of earning income from exploitation of intangibles offshore and would apply to current structures – Proposal may violate WTO rules as export subsidy 45

Anti-Stuffing/Thin Capitalization Rule – The proposal limits the deductibility of interest of a U. Anti-Stuffing/Thin Capitalization Rule – The proposal limits the deductibility of interest of a U. S. corporation with foreign subs unless two tests are met: > Relative leverage test: Debt/Equity Ratio (DER) of U. S. corporations in the group cannot exceed DER of affiliated foreign corporations > Adjusted taxable income test: interest expense may not exceed a prescribed percentage of adjusted taxable income – Limits the ability of U. S. corporations to reduce their U. S. tax liability with interest deductions where the interest is incurred for the purpose of funding the activities of subsidiaries 46

Appendix 47 Appendix 47

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