2002: A Year in Review for International Tax Practitioners

1. Hot Issues In International Taxation November 4 & 5, 2002 Loews L'Enfant Plaza Hotel, Washington, DC 2002: A Year in Review for International Tax Practitioners

2. Overview:What has happened? What has not? • Legislation • Treaties • Subpart F • Check-the-box • Transfer Pricing • Foreign Tax Credits • Inbound • Other/Procedural/Etc.

3. ETI/Thomas Bill • WTO Developments • U.S. Legislative Developments • H.R. 5095 (the “Thomas Bill”) • Would repeal ETI rules • Subpart F amendments • Repeal of foreign personal holding company and foreign investment company rules • Foreign tax credit amendments • Interest expense allocation rules • Also provisions on shelters and inversions • Baucus-Grassley Working Group

4. Inversions • H.R. 3857, introduced by Rep. McInnis on March 6, 2002 • H.R. 3884, introduced by Rep. Neal and others on March 6, 2002. • H.R. 3922, introduced by Rep. Maloney on March 11, 2002 • S. 2050, introduced by Sen. Wellstone and others on March 21, 2002 • H.R. 4756, introduced by Rep. Johnson on May 16, 2002. • S. 2119, introduced by Sens. Baucus and Grassley and others on April 11, 2002 • H.R. 5095, introduced by Rep. Thomas, and others, on July 11, 2002 • Broadly consistent with Treasury approach, which targets • Earnings stripping • Treaty abuse • Transfer pricing • Reporting • Regulations establishing 1099 reporting requirements for inversion transactions will “be out shortly” -- Pam Olson, Oct. 18 ABA meeting.

5. Sarbanes-Oxley Act • Affects both in-house and outside tax advisors • Re your audit firm: Scope of practice/independence issues • Re your law firm: requirement to report “evidence of a material violation of securities law or breach of fiduciary duty or similar violation” • Rule is to establish “minimum standards of professional conduct” for attorneys “appearing and practicing” before the SEC “in any way” • Other issues • CEO tax return signature • What is a loan? Split dollar?

6. Patriot Act • Proposal by FATF (Financial Action Task Force) • Tax professionals may have to follow the same standards that apply to financial institutions for policing money laundering • Possible results • Due diligence requirements • Responsibility to report “suspicious” behavior • Follow and implement rules to prevent money laundering

7. UK Treaty Protocol Australia Protocol Netherlands Negotiation Japan Hungary Iceland Sri Lanka Protocol Bangladesh Treaty Initialing Italy Canada France Korea Chile Brazil Information Exchange Agreements Bahamas British Virgin Islands Cayman Islands Isle of Man Jersey Guernsey Netherlands Antilles OECD Model Treaty Update

8. U.K. treaty conduit test – differs from conduit regs________________________________________ • Income is part of a conduit arrangement if it is paid under, or as part of, a transaction or series of transactions that • Has as one of its main purposes obtaining such increased benefits as are available under the treaty and • Is structured so that • a treaty beneficiary receives income from the other jurisdiction, • but pays, directly or indirectly, • allorsubstantiallyall of that income, • at anytime or in anyform, • to a person who is not a beneficiary of the treaty and who would not be entitled to equivalent or better benefits under a treaty between that person’s jurisdiction and the jurisdiction in which the income arises

9. Treaty Related Developments • Rev. Proc. 2002-52 • UnionBanCal v. Commissioner, 113 T.C. 309 (1999) aff’d., 2002-2 USTC (CCH) ¶ 50,658 (9th Cir Sep. 18, 2002). • Air Liquide • American Air Liquide v. Commissioner, 116 T.C. 23 (2001) aff’d., 2002-2 USTC (CCH) ¶ 50,628 (9th Cir Aug. 29, 2002). • No Finalized Air Liquide Regulations • Impact of new IRS litigation policy re published guidance (CC-2002-043) • Schneider • French/Swiss Treaty case

10. Subpart F • Brown Group Regulations • Determination of whether items of partnership income are within a subpart F income category is made at the CFC partner level • Related person determinations made at the CFC partner level • Whether an activity occurred within or outside the country under the law of which the CFC is created or organized is determined at the CFC partner level • Applicability of manufacturing exception determined with reference to partnership activities.

11. Subpart F • Contract Manufacturing Developments • Brown Group Regulations • Contract manufacturing portion of the regs not issued • MedChem (P.R.), Inc. v. Commissioner, ___ F3d ___ (1st Cir. 2002) • Electronic Arts, Inc. v. Commissioner, 118 T.C. 13 (2002) • Suzy's Zoo v. Commissioner, 114 T.C. No. 1 (2000), aff’d. ___ F3d ___ (9th Cir. 2001) • FSA 200220005 • No attribution of contract manufacturer’s activities to CFC for purposes of the manufacturing exception • FSA 200152006 • Consistent position taken for purposes of section 863(b)

12. Subpart F • The Limited, Inc. v. Commissioner, 113 T.C. 169 (1999) rev’d. 286 F.3d 324 (6th Cir. 2002) • 956 meaning of “deposit with persons carrying on the banking business” • Planning opportunities? • FSA 200216022 • CFCs “indirectly guaranteed” U.S. parent’s debt by executing an agreement to, inter alia, pay dividends and take necessary steps to maintain parent’s net worth • Subpart F Hedging Regulations • Loosener for hedging by those who are not commodities producers but use commodities in manufacturing, construction, utilities or transport • Loosener for subpart F treatment of securities dealers’ currency gains • See also H.R. 5095 changes

13. Check the box • Check and sell • Regulations not finalized • Significance of administrative position outside 1.954-2(e)(3)(ii)? • ITA 199937038; • FSA 200046008; • FSA 200049002 • FSA 200226004 • Worthless stock deduction via check-the-box election denied • Targeted Regulations • Business entities owned by foreign governments: per se corps • Non-bank entity owned by foreign bank cannot be disregarded entity

14. Transfer Pricing • DHL v. Commissioner, 76 TCM 1122 (1998) aff’d., rev’d., rem’d. 285 F3d 1210 (9th Cir. 2002) • Domestic and foreign affiliates grow intangible simultaneously • Differences between 1968 and 1994 regulations significant? • Stock Options and Cost Sharing Agreements • Proposed regulations would treat “stock based compensation” as an operating expense for purposes of qualified cost sharing agreements • Regulations re related party services and cost-sharing rules • Will be issued by June – Barbara Angus, Oct. 18 ABA meeting • PATA project to streamline documentation • FSA 200230001 • Taxpayer’s services to JV were subject to transfer pricing rules

15. Foreign Tax Credits • Credit planning • No 98-5 regulations • Compaq v. Commissioner, 113 T. C. 214 (1999), rev'd. 277 F. 3d 778 (5th Cir. 2002) • Withholding tax prong of 98-5 dead? What about the arbitrage prong? • FSA 200233016 • Stapled stock reorg to isolate OFLs can be attacked under 269, 482, sham, business purpose and 907(a) • FSA 200210026 • FTC but no income (distribution was dividend for French purposes, return of capital for U.S. purposes) • General limitation treatment available because of “base difference” rule • ILM 200223022 • Section 960(a)(3) issue

16. Foreign Tax Credits • Sunoco v. Commissioner, 118 T.C. 11 (2002) • Interest expense cannot be netted against interest income for purposes of allocating interest in overall limitation category for FTC purposes • Bowater overruled • The Travelers Insurance Company v. United States, 46 Fed. Cl. 458 rev’d. 2002-2 USTC (CCH) ¶ 50,652 (Fed. Cir. 2002) • Income distributed to policy holders cannot be included in mutual life company’s taxable income for 904 purposes • H.R. 5095 • Overall domestic loss provisions • Simplification of basket system • 10 year FTC carryforward • Repeal of AMT FTC limitation • Look-through for 10/50 companies

17. Inbound Regulations • Domestic reverse hybrids • U.S. bank deposit interest reporting • Sourcing of aircraft and shipping income • Deduction disallowance on failure to timely file

18. Inbound IRS Positions • FSA 200222011 • Foreign Corp. licensed software to US sub that then sublicensed to another US corp that manufactured and sold computers • Royalties paid by prime licensee all U.S. source • Look at activities of licensee • Planning opportunity for outbound companies? • FSA 200224003 • On these facts, no US trade or business for foreign factor • National office recommends looking at economic substance, 482

19. Other Developments • Loss Sourcing Final Regulations • Dual Consolidated Loss Proposed Regulations • FSA 200221018 • Dual consolidated loss rules applicable to hybrid partnerships • ILM 200224007 • Step transaction analysis of JV liquidation • ILM 200232003 • Issue of who was the owner of property in a sale leaseback transaction • Interaction of legal ownership with burdens and benefits analysis

20. Procedural Developments • Litigation Policies • CC-2002-043 • IRS Attorneys reminded to follow positions established in published guidance • CC-2002-027 • IRS changed its litigation position re interest expense apportionment • No longer will challenge amendments to prior returns to value assets according to fair market value method • Section 367 Private Letter Rulings Issue • PFIC Mark-to-Market Proposed Regulations • Extension Of QI Transition Relief For Foreign Partnerships, etc. • Notice 2002-66 • QI Audit Guidelines • Rev. Proc. 2002-55 • TINs Required on FIRPTA Filings

21. Business Plan Items To Come • Subpart F • Guidance on previously taxed earnings and profits under section 959 • Guidance on PFIC provisions (but see PFIC Mark-to-Market Regulations) • Final regulations relating to commodities hedging/foreign currency gain or loss under section 954 (but see Subpart F hedging regulations) • Inbound Transactions • Final regulations under sections 874(a) and 882(c) (see Temp. Regulations) • Guidance under section 1441 (completed--see 10/31/02 Treasury First Quarterly update) • Guidance on securities lending • Final regulations relating to ITINs on expedited basis • Regulations relating to TINs under section 1445 (but see proposed FIRPTA regulations) • Guidance under section 1503(d) (but see proposed dual consolidated loss regulations) • Regulations relating to the reporting of bank deposit interest (but see proposed regulations)

22. Business Plan Items To Come • Outbound Transactions • Guidance on international restructurings • Guidance on “extraordinary transactions” • Foreign Tax Credits • Final regulations under sections 902 and 904 • Guidance on change of taxable year and foreign tax credits • Guidance on 10/50 company look-through • Transfer Pricing • Regulations relating to stock option compensation under section 482 (but see proposed cost sharing regulations) • Guidance on treatment of cross-border services • Guidance on cost sharing under section 482 • Guidance on APA process (see Rev. Proc. 96-53) • Guidance on global dealing

23. Business Plan Items To Come • Sourcing and Expense Allocation • Guidance on interest expense apportionment • Guidance relating to the treatment of fringe benefits • Regulations under section 883 • Guidance under section 863(d) and (e) • Other • Guidance on the taxation of foreign insurance companies (completed-- see 10/31/02 Treasury First Quarterly update of the 2002-2003 Priority Guidance Plan) • Proposed regulations regarding partner filing requirements for controlled foreign partnerships under section 6038B (new project added 10/31/02--see 10/31/02 Treasury First Quarterly update of the 2002-2003 Priority Guidance Plan) • Guidance on taxation of individuals in possessions • Guidance concerning the treatment of currency gain or loss • Proposed regulations under section 1446