2004 INTERNATIONAL TAX REFORM Presented By: Dixie A. Osteen February 16, 2005

2. 2004 INTERNATIONAL TAX REFORMPresented By:Dixie A. OsteenFebruary 16, 2005

3. American Jobs Creation Act • Revenue neutral • $145 billion in tax cuts offset by $50 billion saved by repealing the extraterritorial income exclusion and $95 billion in increased taxes/penalties/user fees • Signed into law on October 22,2004

4. What’s Behind the Act? • Resolves a trade dispute with the European Union. • Aids domestic manufacturers • Discourages businesses from moving abroad

5. Extraterritorial Income Exclusion Repeal

6. World Trade Organization Dispute • Foreign Sales Corp (FSC) declared a prohibited export subsidy by WTO in 2000 • FSC regime replaced by the Extraterritorial Income Exclusion (ETI) • Immediately challenged by the EU • WTO determined that ETI was also a prohibited export subsidy in 2002

7. Trade Sanctions • WTO authorized the EU to impose up to $4 billion a year in retaliatory trade sanctions on US exports. • March 2004 EU began imposing additional tariff of 5 percent on a list of more than 1,600 US exports. • Retaliatory tariffs were scheduled to escalate by 1 percent per month until it reached 17 percent on March 2005.

8. ETI Repealed • Exclusion applied to gross income attributable to foreign trading gross receipts • Transitional rule for transactions during 2005 and 2006 or pursuant to binding contract

9. Sanctions Removed • EU adopts regulation on February 1,2005 to suspend additional EU customs duties on US exports following the repeal of ETI • Regulation provides for suspension of EU duties until the later of January 1, 2006 or 60 days after WTO confirms the “incompatibility” of certain aspects of the American Jobs Creation Act

10. ETI Transition • Repealed for transaction entered into after 12/31/2004 • Phase-out of deduction for current recipients • 80% of benefit allowed for 2005 tax year • 60% of benefit allowed for 2006 tax year • Percentage based on actual ETI income not on prior year income as originally proposed • Binding contract exception for unrelated party transactions when contact was in effect on or before 9/17/2003

11. How Transition Period Benefits are Computed • Calculate ETI benefit under prior rules • Reduce benefit by transition period phase out

12. Planning Opportunities • In some instances, an export company may be able to double dip (claim both ETI benefits and domestic production incentives in 2005 and 2006) • Consider maximizing 2005 and 2006 ETI benefit

13. Production Activities Deduction

14. Production Activities DeductionNew Section 199 • Taxpayers may deduct a specified percentage of their qualified production activities income • Phased in starting with tax years beginning in 2005

15. New Definitions • Qualified Production Activity Income (QPAI) • Qualified Production Property (QPP) • Domestic Production Gross Receipts (DPGR)

16. Deduction Limitation • Deduction is limited to the lesser of: • Qualified production activities income or • Current year taxable income • Further limited to 50 percent of W-2 wages • Three methods for determining W-2 pages • In general, includes wages reported on W-2 plus certain elective deferrals minus unemployment benefits • Only applies to employees who receive W-2’s • Because the deduction for US production activities income is limited to wages, employers have an incentive to hire employees rather than independent contractors

17. Amount of the Production Activities Deduction

18. “Qualifying Production Activity ” Defined Tangible personal property Manufacture, production, growth or extraction in whole or “in significant part” in the US of tangible personal property, software development or music recordings Film production If at least 50 percent of the total compensation relating to the production of the film is compensation for certain services performed in the US Certain engineering, architectural and construction services performed in the US as well as production of electricity, natural gas or water in the US

19. “Qualified Production Activities Income (QPAI)” Defined “Qualified production activities income” includes a taxpayer’s domestic production gross receipts reduced by the following: • Cost of goods sold allocable to such receipts • Other deductions, expenses, and losses directly allocable to such receipts • A ratable portion of other deductions, expenses, and losses not directly allocable to such receipts or another class of income

20. QPAI • Determined on item by item basis • Cannot use • Division by division • Product line by product line • Transaction by transaction • Total income is determined by adding income from each item • Offset items with income against items with losses

21. “Domestic Production Gross Receipts” Defined • Domestic production gross receipts generally are gross receipts derived from any disposition of qualifying production property manufactured, produced, grown, or extracted in significant part within the US • Disposition includes sales, exchange, lease, rental, license or other disposition • Excludes dispositions to related parties

22. What Constitutes “In Significant Part”? • Two tests • Based on all facts and circumstances, the manufacturing, production, growth or extraction activity is performed by the taxpayer in the US or • Labor and factory overhead costs incurred by the taxpayer in the US for the manufacture, production, growth and extraction of the property is at least 20 percent of the taxpayer’s total cost of the property • Packaging, design and development activities do not qualify for the “in significant part” test • Exception for computer software

23. Example • Company A manufactures toy cars • Company purchases a small motor and various parts for $ 75 • Labor costs to assembly the car amount to $ 25 • Company also incurs packaging, selling and other cost for $ 2 • Taxpayer meets the “in significant part” test because labor costs are more than 20 percent of the total costs • ($25/($25 + $ 75)

24. Domestic Production Gross Receipts (DPGR) • Must determine the portion of gross receipts that are DPGR and the portion that are not DPGR • If all production takes place in the US by the taxpayer then 100 percent of gross receipts would be considered DPGR • Requires allocation of gross receipts when production takes place within and without the US • DPGR only applies to products produced by the taxpayer • Products acquired from another taxpayer for resale are considered non-DPGR • Intent is to limit the deduction to manufacturer only • Products manufactured under a contract manufacturing agreement • Owner of property during the manufacturing process is the taxpayer entitled to the deduction

25. Challenges in Calculating the Benefit? • Separation of income where production and service integrated with product delivery • Allocation and apportionment issues • Controlled groups treated as a single taxpayer

26. ExportingThings You Should Consider • Local country tax laws versus tax treaties • Business presence • Independent contractor • Employee • Employee issues • Occasional business trips to foreign location • Employee temporarily working at foreign location

27. Indirect Tax • Generally, foreign country sales tax • VAT, GST, etc • Applies to transfer of goods and services within the country as well as goods imported into the country but does not apply to goods exported • Paid by importer or record and collected at same time as payment of customs duties • Rational – ultimate consumer bears the burden • Collected at various points of sale • Input VAT-Paid on purchases • Output VAT -Collected on sale • Input VAT is generally offset by output VAT and any balance is refunded • Special rules apply to digitized products when the purchaser is the final consumer • ( generally individuals) • Over 100 countries have a VAT system with rates ranging from 10% to 25%

28. Refund Opportunities? • Expenditures where VAT may be refundable vary from country to country • Types of expenditures may include • Hotel accommodations, car rentals, meals, gas, conference and trade show costs, professional fees and training courses • In Canada, GST is recoverable only on hotel accommodations • Countries that refund • Austria, Belgium, Denmark, Finland, France, Greece, Ireland, Luxembourg, Monaco, Netherlands, Portugal, Sweden, UK, Canada, Iceland and Norway.

29. Minimize VAT Costs • Review contracts to determine who is liable for VAT • Require the purchaser to be the importer of record • Pass title to the goods outside of a VAT jurisdiction • Register for VAT and make sure that input VAT is offset by output VAT

30. Questions

31. If you have further questions, we may be reached at:Piascik & Associates, P.C.Dixie A. Osteen(804) 228-41804470 Cox RoadSuite 250Glen Allen, VA 23060www.piascik.com