80/20 Companies and Foreign-Source Income: State Treatment State - PowerPoint PPT Presentation

presents presents 80/20 Companies and Foreign-Source Income: State Treatment State Treatment Navigating States' Tests for Shielding Income and Claiming Deductions A Live 110-Minute Teleconference/Webinar with Interactive Q&A Q& Today's panel features: Joe Neff, National Managing Director, State and Local Tax, RSM McGladrey , Los Angeles Mitchell Newmark, Of Counsel, Morrison & Foerster , New York Pilar Mata, Sutherland Asbill & Brennan , Washington, D.C. Pilar Mata Sutherland Asbill & Brennan Washington D C Thursday, October 21, 2010 The conference begins at: The conference begins at: 1 pm Eastern 12 pm Central 11 am Mountain 10 10 am Pacific P ifi You can access the audio portion of the conference on the telephone or by using your computer's speakers. Please refer to the dial in/ log in instructions emailed to registrants.

For Continuing Education purposes, g please let us know how many people are listening at your location by g y y • closing the notification box • and typing in the chat box your • and typing in the chat box your company name and the number of attendees attendees. • Then click the blue icon beside the box to send to send. For live event only

• If you are listening via your computer If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. lit f i t t ti • If the sound quality is not satisfactory and you are listening via your computer speakers, li t i i t k please dial 1-866-873-1442 and enter your PIN when prompted. Otherwise, please send e p o p ed O e se, p ease se d us a chat or e-mail sound@straffordpub.com immediately so we can address the problem. • If you dialed in and have any difficulties during the call, press *0 for assistance.

80/20 Companies And Foreign- Source Income: State Treatment Webinar Oct. 21, 2010 Oct. 21, 2010 Pilar Mata, Sutherland Asbill & Mitchell Newmark, Morrison & Foerster Brennan mnewmark@mofo pilar.mata@sutherland.com Joe Neff, RSM McGladrey , y jneff@rsmi.com

Today’s Program Today s Program General Environment, State Treatment Of Foreign Slides 6-30 Income ( P l ( Pilar Mata, Mitchell Newmark ) k ) M M h ll N State Treatment Of 80/20 Companies Slides 31-57 p ( Joe Neff, Mitchell Newmark, Pilar Mata ) 5

General Environment, State Treatment Of Foreign Income Treatment Of Foreign Income Pilar Mata, Sutherland Asbill & Brennan Mitchell Newmark, Morrison & Foerster 6

Foreign Commerce Clause Restrictions Foreign Commerce Clause Restrictions On State Taxing Authority • Foreign commerce clause is broader than the protection afforded to interstate commerce. • Criteria – Activity has substantial nexus with the taxing state – Fairly apportioned – Fairly apportioned – Does not discriminate against interstate commerce – Fairly related to services provided by the taxing state – Enhanced risk of multiple taxation a ced s o u p e a a o – No impairment of federal uniformity; speak with “one voice” Japan Line, Ltd. v. County of Los Angeles , 441 U.S. 434 (1979) 7

MTC Combined Reporting Group • Domestic corporations • Foreign unitary affiliates if: – Average of property, payroll and sales factors in the U.S. is greater g p p y, p y g or equal to 20% – Doing business in a tax haven country – DISCs/FISCs • Foreign unitary affiliates – Subpart F income – U.S.-source income (without regard to federal treaties) ( g ) – More than 20% of income from intangibles or services deductible against business income of other group members 8

Worldwide Combined Reporting • Water’s edge election must be made in at least five states: California, Idaho, Montana, North Dakota and Utah. • Excluded entities – Only foreign-organized corporations (Alaska, California, Idaho, Minnesota, Utah, West Virginia) – Also, 80/20 companies (Colorado, Illinois, Indiana, Michigan, Montana, New Hampshire, North Dakota, Vermont, Wisconsin) M N H hi N h D k V Wi i ) • Foreign corporations treated as U.S. branches for federal purposes generally included, except in Michigan, North Dakota and West Virginia Virginia Source: CCH, Multistate Corporate Income Tax Guide, 2009 9

Worldwide Combined Reporting Worldwide Combined Reporting - Domestic Parent • Worldwide combined reporting runs a risk of multiple taxation. – However, arm’s length pricing does as well, because of different rules and applications. – Not appropriate to require the adoption of arm’s length pricing N t i t t i th d ti f ’ l th i i when apportionment does not inevitably lead to double taxation • Worldwide combined reporting does not run afoul of “one voice” requirement. – Various factors argue against potential retaliation. – Treaties do not apply to state tax systems. – Congress has considered, but failed to pass, legislation. Container Corporation of America v. Franchise Tax Board , 463 U.S. 159 (1983) 10

Worldwide Combined Reporting - Worldwide Combined Reporting - Foreign Parent • Multiple taxation – Court dismissed proposition that foreign parent aggravated risk of double taxation because of inherently greater foreign operations d bl t ti b f i h tl t f i ti • One voice – Potential for retaliation was not persuasive – Potential for retaliation was not persuasive – Congress has shown no specific evidence of intent to preempt. • Rejection of U.S.-U.K. tax treaty • Debate, but no enactment of legislation eba e, bu o e ac e o eg s a o Barclays Bank PLC v. Franchise Tax Board , 512 U.S. 298 (1994) 11

Worldwide Combined Reporting - Worldwide Combined Reporting - Foreign Branch • Taxpayer was a branch of a foreign parent operating in New York. • Taxpayer filed on basis of U.S. income only and as a separate entity; p y y p y; NYS set up based on worldwide income • Taxpayer alleged that worldwide combined reporting violated U.S.- U.K. treaty requiring equivalent treatment of foreign and domestic companies. i • N.Y. Court of Appeals held that taxpayer was treated the same as a domestic entity with a branch in N.Y.; no violation of the treaty Reuters, Ltd. v. Tax Appeals Tribunal , 82 NY2d 112 (1994) l 82 NY2d 112 (1994) R t Ltd T A l T ib 12

Foreign-Source Income In re: Infosys Technologies (New York Tax Appeals Tribunal) • Facts – Taxpayer was incorporated and headquartered in India and provided software development and consulting services around the world. – The Division asserted that the taxpayer should have included its worldwide income in its entire net income. – The taxpayer argued that inclusion of worldwide income was improper, and that the p y g p p New York statute “is not intended to add back foreign source income of non-U.S. corporations.” • Issue: Whether the taxpayer should have computed its ENI allocable to New York using only its effectively connected income, or rather based on its worldwide income. • Holding – The Tax Appeals Tribunal upheld the ALJ’s determination that inclusion in entire net income of the taxpayer’s worldwide income was proper. – The TAT held that the statutory imposition of tax on worldwide income applies equally y p pp q y to foreign and domestic corporations. – The TAT rejected the taxpayer’s argument that inclusion of foreign source income in the entire net income of foreign corporations places an unconstitutional burden on interstate commerce. 13

Foreign Dividends – Water’s Edge • Issue 1: Whether dividends paid by foreign corporations in a W/E setting should be eliminated under RTC §25106 or deducted under RTC § 24402 – FTB applied LIFO approach to pro-rate dividends between §25106 and §24402. FTB li d LIFO h t t di id d b t §25106 d §24402 – Apple asserts that § 25106 and Fujitsu v. FTB (2004) mandate preferential ordering, and that all dividends should be eliminated. • Issue 2: Whether interest expense deductions should be disallowed under §24425, where Apple’s dominant purpose for its borrowing was not to provide funds to the foreign dividend payors. • On Jan. 26, 2010, trial court found in favor of FTB on Issue 1 and in favor of Apple on Issue 2. Case is on appeal. • Impact on DRD under § 24411 and proper application of foreign investment interest offset under § 24344 offset under § 24344 Apple Inc. v. Franchise Tax Board, Cal. Ct. App. Case No. A128091 (pending) 14

Water’s Edge Election • Rules vary by state but generally exclude foreign affiliates from a combined report. – Which foreign entities are included/excluded – Whether foreign entity should include only U.S. source income – Whether 80/20 rule should include domestic entities – Effect on inter-company transactions between domestic and foreign affiliates • California – Income and apportionment factors of unitary CFCs are included – Subpart F income over earnings and profits – Issues regarding extent to which Subpart F regime has been adopted ( Fujitsu v. Franchise Tax Board ) 15