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Steve Towers /David Weisner/Kristy Ton May 9 – 10, 2012

International Tax Review Asia Tax Forum 2012 International Tax Developments: The Cross-Border Issues Making a Difference. Steve Towers /David Weisner/Kristy Ton May 9 – 10, 2012. Agenda. What hope for tax reform in the US? OECD developments: beneficial ownership, PE, intangibles

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Steve Towers /David Weisner/Kristy Ton May 9 – 10, 2012

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  1. International Tax Review Asia Tax Forum 2012International Tax Developments:The Cross-Border Issues Making a Difference Steve Towers /David Weisner/Kristy Ton May 9 – 10, 2012

  2. Agenda What hope for tax reform in the US? OECD developments: beneficial ownership, PE, intangibles 2011 Update to the UN Model Treaty and Commentary FATCA – It’s getter closer. What taxpayers need to know Recent international tax cases: the global top 10 Q & A

  3. 2012 ElectionsEconomy is driving election outcomes • Economic issues driving 2012 elections • Only Roosevelt re-elected (1936) with unemployment rate >8.3% • Only Eisenhower re-elected (1956) with GDP growth <2% Top Five Issues of Concern to Voters 45% % of Adults Surveyed 20% 10% Source: NBC/WSJ Survey, March 3, 2012

  4. 2012 ElectionsObama’s performance on the economy is up Obama Performance on the Economy • Obama approval rating on the economy has improved • Obama had a negative 18 point rating in the fall • It’s currently a negative 7 point rating % of Adults Surveyed Source: NBC/WSJ Survey, April 2012

  5. 2012 ElectionsObama’s approval ratings have improved significantly • Politicians usually in trouble with disapprovals > approvals • Last August, Obama was looking like a “dead duck” (-10.2%) • Today, he has a positive 1.2% rating Obama Approval/Disapproval Average Ratings 53.2 48.3 47.1 43.0

  6. 2012 ElectionsObama’s re-election looks likely today, but it’s a 50/50 race • Romney out-polled Obama slightly last October (+0.5%) • Now Obama is out-polling Romney (+3.1%) • Charlie Cook’s assessment: Obama wins…50/50 race Obama vs. Romney, Average Polling Data 47.5 46.1 45.6 44.4

  7. 2012 ElectionsElection dynamics in Congress • Leadership in both Houses suffer with weak majorities • Huge ideological struggle for elections • Republican strategy: cut spending, no tax increases, rollback regulation • Democratic strategy: grow jobs, protect entitlements, tax the wealthy • Conventional wisdom/political analysts projections: • House: Republican majority shrinks by 15 to 20 seats, but remains under GOP control • Senate: Democrats lose 3 to 5 seats, but Republican majority 50/50 competitive chance * 3 vacancies

  8. 2012 ElectionsElection dynamics in Congress • 51.8% likely Obama wins (average of last eight polls) • 60% likely GOP maintains majority in the House • 50% likely that GOP takes majority in the Senate

  9. 2012 Elections Impact on US Tax Legislative Reforms • GOP supports a territorial system with a low corporate tax rate, which Democrats oppose • Other issues which may impact tax reform, i.e. long-term budget deficits, unemployment, environmental. • If Obama wins and Congress is split or under GOP control • Obama will propose Tier 3 and protect it against a Republican attack • Congressional GOP will press Obama for a territorial system with a low corporate rate • If Romney wins and Congress is split or under Democratic control • Romney will drive for a territorial tax system with a low corporate rate that Senate Democrats and GOP House Members will support • But, Romney will kill Tier 3 • Unified control by one party, is unlikely Note: LEV III reduces emissions from LD vehicles for MY17-25 by 70%. Tier 3 will nationalize LEV III and cut sulfur content in gasoline from an average of 30ppm to 10ppm

  10. Deficits and DebtImpact of alternative scenarios on deficits as percent of GDP Deficit Projections Under Alternative Scenarios • Budget Control Act set a course to reduce the deficits, assuming expiring provisions are not extended • If all the expiring provisions are extended, the deficits explode by factor of 4 -1.2% -3.0% Percent of GDP Deficit Averaged -2.8% Annually FY 1971-2011 -5.9% -8.7% Source: CBO

  11. Deficits and DebtImpact of alternative scenarios on debt as percent of GDP Debt Projections Under Alternative Scenarios • Budget Control Act reduces debt/GDP ratio by 16%,assuming expiring provisions are not extended • Assumption is flawed • Debt/GDP ratio explodes from 73% to 93% if provisions are extended • Impact: enormous pressure to increase taxes Debt Averaged 37% Annually FY 1971-2011 93.2% Percent of GDP 76.3.% 73.3% 61.3% Source: CBO

  12. Tax Reform • Tax reform will be discussed in context of deficit reduction and will be controversial • Obama/Democrats see it as a revenue raiser • Republicans see it as a way to cut tax rates and make the code more tax efficient • Ways & Means Chairman Camp pushing his tax reform package • Cuts the corporate rate to 25% • Converts the global system to a territorial system • Deems past foreign income subject to deferral repatriated and taxed at 5.25% • Subjects intangibles to a 15% tax • Business groups undecided on Camp proposal • Tax reform likely will not be enacted before the November 2012 elections (more likely will not be settled until 2013 or later). However, Congress will need to address high-profile tax issues by year-end, including scheduled expiration of Bush 2001/2003 individual tax cuts and status of tax extenders such as CFC look-through. • DANGER: deficit reduction in context of tax reform needs to raise revenue

  13. 20.9% 15.3% 12.0% 12.2% 7.7% 10.4% Tax Reform Deficit reduction will require increased revenue Revenues and Spending Under Budget Control Act, 2011-2021 Percentage of GDP Source: CBO

  14. President Obama Business Tax Reform Framework • President Obama’s Framework issued in February 2012 contained five key elements of business tax reform: • Broaden the base and reduce corporate tax rate from 35% to 28%. • Strengthen American manufacturing & innovation • Increase domestic manufacturing income deduction to 10.7%, effectively reducing corporate tax rate on manufacturing income to 25% • Expand, simplify and make permanent R&E tax credit • Extend, consolidate, and enhance clean energy tax incentives • Strengthen international tax system – limit deferral of foreign earnings by imposing minimum tax on foreign earnings, tax excess IP returns and limit interest deduction on overseas investment. • Simplify and cut taxes for small businesses. • Eliminate or making permanent temporary tax provisions.

  15. House Ways & Means Chairman Dave CampInternational Tax Reform Discussion Draft • Reduce corporate tax rate to 25% (base broadening provisions to be determined). • Shift to territorial based system • 95% dividend received deduction (DRD) • Subpart F inclusions on all accumulated E&P with 85% DRD. • Previously untaxed earnings are taxed twice: • As deemed repatriation of all accumulated E&P (85% DRD) • Again when actually repatriated (95% DRD) • Subpart F provisions maintained for FBCSI and FBCSvI (954(d)& 954(e); three alternatives for new subpart F categories to address base erosion – excess returns, low-tax foreign income (ETR < 10%), carrot & stick option • Previously tax income rules repealed. • FTCs repealed except for passive income (but not on exempted income).

  16. Territorial Tax System – Enzi vs. Camp • On February 9, 2012, Senator Michael Enzi introduced an international tax reform bill (“U.S. Job Creation & International Tax Reform Act of 2012”) that adopts a territorial tax system and makes significant changes to the subpart F and foreign tax credit (“FTC”) regime. • The bill has some similarities to the October 26, 2011, Discussion Draft release by House Ways and Means Committee Chairman Dave Camp (although it does not include a provision to lower the top corporate tax rate).

  17. Territorial Tax System – Enzi vs. CampComparison of key provisions of the participation exemption system

  18. Territorial Tax System – Enzi vs. Camp (Cont’d)Comparison of key provisions of the participation exemption system

  19. Territorial Tax System – Enzi vs. Camp (Cont’d)Comparison of key provisions of the participation exemption system

  20. Territorial Tax System – Enzi vs. Camp (Cont’d)Comparison of key transitional provisions

  21. Territorial Tax System vs. Obama’s Int’l Tax ReformComparison of key modifications to Subpart F

  22. Territorial Tax System vs. Obama’s Int’l Tax Reform Comparison of key modifications to Foreign Tax Credits

  23. Territorial Tax System vs. Obama’s Int’l Tax ReformComparison of key modifications to Foreign Tax Credits (Cont’d)

  24. Territorial Tax System vs. Obama’s Int’l Tax Reform Comparison of key modifications to Foreign Tax Credits (Cont’d)

  25. Territorial Tax System vs. Obama’s Int’l Tax Reform Comparison of miscellaneous proposals

  26. Territorial Tax System vs. Obama’s Int’l Tax Reform Comparison of miscellaneous proposals (Cont’d)

  27. Territorial Tax System vs. Obama’s Int’l Tax Reform Comparison of miscellaneous proposals (Cont’d)

  28. Territorial Tax System vs. Obama’s Int’l Tax Reform Comparison of miscellaneous proposals (Cont’d)

  29. Tax Reform Comparison of Tax Reform Proposals

  30. Agenda What hope for tax reform in the US? OECD developments: beneficial ownership, PE, intangibles 2011 Update to the UN Model Treaty and Commentary FATCA – It’s getter closer. What taxpayers need to know Recent international tax cases: the global top 10 Q & A

  31. OECD developments : permanent establishment • 12 October 2011 : proposed changes to Commentary on Art. 5 issued for public comment (by 10 February 2012) • Sub-group of Working Party 1 • Final changes to be included in next update of the Model Convention & Commentary (scheduled 2014) • Included • “At the disposal” : principles & factors • Contract manufacturing (but no reference to toll manufacturing) • Home office • Secondment : cross-reference to Commentary on Art. 15(2) (but no reference to Art. 5(3)(b), UN model treaty) • Examples elaborating on existing Commentary • Not Included • Logistics company’s warehouse • Cloud computing • Situations in which subsidiary’s employees could be deemed to be employees of parent (Rolls Royce) • Express rejection of “Sidney Robert’s view” re agency PE1 • ¹ Sidney I. Roberts, “The Agency Element of Permanent Establishment : The OECD Commentaries from the Civil Law View”, 1993/ 9&10 Intertax.

  32. OECD developments : beneficial ownership • Current OECD Commentary on Arts. 10 (dividends), 11 (interest),and 12 (royalties) explains the meaning of “beneficial owner” interms of two alternative disqualifying conditions • Agency or nominee • Conduit company acting like mere fiduciary or administrator • First disqualifying condition (agency or nominee): introduced into Commentary in 1977 • 1986: OECD Report: “Double Taxation Conventions and the Use of Conduit Companies” • Second disqualifying condition (conduit company acting like a mere fiduciary or administrator): introduced into Commentary in 2003 • 29 April 2011: proposed changes to Commentary issued for public comment (by 15 July 2011)

  33. 4 key notions Not narrow technical sense First disqualifying condition Second disqualifying condition Look through 8 key notions Not narrow technical sense (amended) Domestic law meaning relevant(if consistent) First disqualifying condition Second disqualifying condition Look through Full right to use and enjoy the income unconstrained by a contractual or legal obligation Cross-reference to anti-avoidance rules Contextual meaning Proposed changes • In summary Existing Commentary New Commentary (after proposed changes) 1 2 3 2 4 3 4 5 1A 1B 6 7

  34. Proposed changes (cont’d) Full right to use and enjoy the income unconstrained by a contractual or legal obligation “In these various examples (agent, nominee, conduit company acting as a fiduciary or administrator), the recipient of the dividend is not the ‘beneficial owner’ because that recipient does not have the full right to use and enjoythe dividend that it receives and this dividend is not its own; the powers of the recipient over that dividend are indeed constrainedin that the recipient is obliged (because of a contractual, fiduciary or other duty) to pass the payment received to another person. The recipient of a dividend is the ‘beneficial owner’ of that dividend where he has the full right to use and enjoythe dividend unconstrained by a contractual or legal obligationto pass the payment received to another person. Such an obligation will normally derive from relevant legal documentsbut may also be found to exist on the basis of facts and circumstances showing that, in substance, the recipient clearly does not have the full right to use and enjoy the dividends; also, the use and enjoyment of a dividend must be distinguished from the legal ownership, as well as the use and enjoyment, of the shares on which the dividend is paid.” (proposed new paragraph 12.4 to Commentary on Art. 10, all new text; bolding added) 5 Sentence #1 Sentence #2 Sentence #3

  35. OECD developments : intangibles • Working Party 6 : Transfer Pricing Aspects of Intangibles • Leading to a revision of Chapters VI and VIII of the OECD Transfer Pricing Guidelines • Meeting with Business representatives, 7-9 November 2011: • Definitional approach • Goodwill and going concern • Brands and brand value • Ownership issues • Synergies • Future

  36. What is the relevance of the OECD Commentary in Asia Pacific? • Only substantive, multi-lateral double tax treaty guidance available • UN Commentary? 90% the same as OECD Commentary • Views of non-members are included in OECD Commentary, including : China, Hong Kong, India, Indonesia, Malaysia, Philippines, Thailand & Vietnam. With the exception of India, areas of disagreement are relatively few • OECD members disagree with, or don’t apply, OECD Commentary, at times • Disagreements vs. interpretation issues • Substance over form / GAAR • Consider : Zimmer, Dell, Roche

  37. Relevance of OECD Commentary in Asia Pacific • OECD Commentary to Art. 5 • Disagreements • 1 Note: Other Asia Pacific jurisdictions are : Australia, China, Hong Kong, Indonesia, Japan, Korea, New Zealand, Philippines, Thailand. (OECD members & non-members) • ² Or position reserved

  38. Relevance of OECD Commentary in Asia Pacific • OECD Commentary to Art. 5 (cont’d) • Disagreements • 1 Note: Other Asia Pacific jurisdictions are : Australia, China, Hong Kong, Indonesia, Japan, Korea, New Zealand, Philippines, Thailand. (OECD members & non-members) • ² Or position reserved

  39. Relevance of OECD Commentary in Asia Pacific • OECD Commentary to Art. 5 (cont’d) • Disagreements • 1 Note: Other Asia Pacific jurisdictions are : Australia, China, Hong Kong, Indonesia, Japan, Korea, New Zealand, Philippines, Thailand. (OECD members & non-members) • ² Or position reserved

  40. Relevance of OECD Commentary in Asia Pacific • OECD Commentary to Art. 12 • Disagreements • 1 Note: Other Asia Pacific jurisdictions are : Australia, Hong Kong, Indonesia, Japan, Korea, New Zealand, Philippines, Thailand, Vietnam (OECD members & non-members) • ² Or position reserved

  41. Agenda What hope for tax reform in the US? OECD developments: beneficial ownership, PE, intangibles 2011 Update to the UN Model Treaty and Commentary FATCA – It’s getter closer. What taxpayers need to know Recent international tax cases: the global top 10 Q & A

  42. 2011 Update to the UN Model Treaty & Commentary • 2011 Update to UN Model double tax treaty & Commentary launched on 15 March 2012 (first update for 10 years) • Significant changes to the Commentary on Art.1 • Although the OECD Commentary to Art. 1 does discuss (and generally endorses) the use of domestic law or treaty-based anti-avoidance rules to combat treaty “abuse”, the 2011 Update adds significant original content to the UN Commentary on this issue

  43. UN Commentary to Art. 1 : Examples of improper use of tax treaties * Straightforward idea

  44. Agenda What hope for tax reform in the US? OECD developments: beneficial ownership, PE, intangibles 2011 Update to the UN Model Treaty and Commentary FATCA – It’s getter closer. What taxpayers need to know Recent international tax cases: the global top 10 Q & A

  45. FATCA Background • “Foreign Account Tax Compliance Act” or “FATCA” was signed into law on March 18, 2010 as a revenue raiser for the “Hiring Incentives to Restore Employment Act” or “HIRE” • Various effective dates. FATCA withholding on U.S. source income begins on January 1, 2014. • Objective is to combat offshore tax evasion by U.S. persons who invest • Directly through financial accounts maintained offshore • Indirectly through ownership of foreign entities • FATCA works by requiring foreign financial institutions (“FFIs”) and non-financial foreign entities (“NFFEs”) to provide this information • FATCA’s lever is a NEW 30% withholding tax levied on “withholdable payments” to non-participating FFIs and NFFEs

  46. FATCA Background: Withholding as an Enforcement Tool • 30 Percent FATCA withholding • Imposed on “withholdable payments”, including • U.S. source income from securities • Interest on bank deposit accounts maintained in the United States or in a foreign branch of a U.S. bank • Gross proceeds from the sale/redemption of U.S. securities • When made to foreign financial institutions (FFIs) or non-financial foreign entities (NFFEs) • Does not apply to payments made to individuals • Unless • the FFI enters into an agreement with the IRS (a participating FFI) • the NFFE discloses the identity of its U.S. owners or certifies to non-US ownership to the withholding agent

  47. The Role of Withholding Under Present US Tax Law 30 Percent U.S. Non-resident tax • Is a flat rate tax that imposed on foreign persons • Applies to U.S. source dividends, interest, royalties and other “income”, unless a reduced rate or an exemption applies • Does not apply to gross proceeds or gains from the sale of securities • Does not apply if FATCA withholding applies 28 Percent backup withholding • Applies to noncompliant U.S. non-exempt recipients • Can apply to any payments that are reportable on Forms 1099 • U.S. source and foreign source income • Gross proceeds from the sale/redemption of securities • Is a credit against the federal tax liability of U.S. taxpayers

  48. Illustration of Application of Passthru Payment Rule Foreign Bank • FATCA may apply for US indirect investments. • Foreign Bank makes investment in Participating FFI, which in turn invests in various US and non-US portfolio investments that generate US and non-US source investment income, respectively, and eventually proceeds from the exit. • If Foreign Bank does not enter in an agreement with the IRS, 30% tax would be withheld on payments from Participating FFI to Foreign Bank “related” to US investments of the Participating FFI determined as a function of US/total assets ratio of the Participating FFI. Income from FFI of US$ 10M US Withholding Tax of US$ 1.8M(US$ 10M x 60% x 30%) Participating FFI US Portfolio Investments Non-US Portfolio Investments Passthru Payment Percentage = 60%

  49. Initial Guidance on Passthru Payments • Why? • The primary purpose behind the passthru payment concept is to prevent an FFI to be used as a blocker for US persons trying to avoid US tax by making indirect investments in US assets. • The IRS also noted that the passthru payment rule is to encourage FFIs to enter into FFI agreements (i.e., a passthru payment paid to a PFFI is not subject to FATCA’s withholding requirement, whereas a passthru payment paid to a non-participating FFI would be subject to FATCA withholding). • What is it? • A passthru payment is defined in the statute and it includes withholdable payments from direct US investment and other payments from an indirect US investment through a PFFI. Direct US Investment Indirect US Investment Passthru Payment Percentage Withholdable Payment Non-withholdable Payment

  50. Foreign Financial Institution (FFI) Defined Under FATCA, the term FFI is quite broad Includes any foreign entity that • Accepts deposits in the ordinary course of a banking or similar business • Is in the business of holding financial assets for the account of others • Is engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest in such securities. FFI Examples: non-U.S. banks, custodian banks, securities brokers and dealers, hedge funds, collective and family investment vehicles. • Includes personal investment corporation (“PIC”) holding solely passive assets – the PIC is an FFI.

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