Clients who are owner/managers of international businesses operate in multiple jurisdictions. Owner/managers need to navigate their businesses through the of laws and regulations in multiple jurisdictions. Clients do not have time to learn the laws and regulations of each jurisdiction they operate in or plan to operate in to be able to immediately apply it to their current/prospective business structure. Clients will usually pay for the services of qualified and experienced advisors to work with them to create or amend their cross-border structures and arrangements.
One area many clients seek advisors for is international tax. The area of international tax is vast due to the many jurisdictions involved. International tax advisors must not only be knowledgeable in the laws of multiple jurisdictions, they must also understand how to apply them to the client’s arrangements, be able to build a custom business structure and ensure the advice is implemented properly. International tax advisors must answer the question of “how does the law of a particular jurisdiction apply to an international business and how can the laws of each jurisdiction be practically and commercially applied to the client’s international business structure?”
When an international tax advisor sets off to apply the laws and regulations of a particular jurisdiction to a client’s arrangements, he/she should be aware of the interpretations of the law and the regulations as well as common legal tax issues which are faced by similar international businesses operating in said jurisdiction. Regulations give insight into the regulatory body’s (usually the jurisdiction’s tax authority) interpretation of the tax law of that jurisdiction. However, International tax advisors should go the necessary additional step and gain further insight. In this article we will be taking a look at two tax law cases from the US that provide insight into the challenges of implementing international tax advice for international businesses.
In the US there are multiple courts at the state and federal level. These courts can range from local state courts all the way up to the US Supreme Court, which is the highest court in the US. However, the US cases we will be analyzing were heard in the United States Tax Court. The US tax court is a federal trial court where persons, being the petitioners, sue the Commissioner of the Internal Revenue Service (IRS), usually to dispute claims made by the IRS in connection to US taxes. We will be analyzing two cases: Flume v. Commissioner and Whirlpool Fin. Corp. & Consol. Subsidiaries v. Commissioner, to showcase the difficulty even multinationals with all their resources have in implementing tax advice provided to them for their international businesses. Both cases involved US persons who own foreign companies which operate as international businesses. In both cases the IRS believes the non-US companies are considered US CFCs and thus owed federal corporation tax on their subpart F income and accuracy-related penalties.
Flume v. Commissioner, No. 31162-14., T.C. Memo. 2020-80, 2020 BL 215028, Court Opinion (06/09/2020)
In the case Flume v. Commissioner, the IRS determined deficiencies in the petitioners’ (Mr. and Mrs. Flume) Federal income tax and accuracy-related penalties pursuant to section 6662(a)(1) for the 2006, 2007, and 2008 taxable years. The petitioners owned a company called Wilshire Holdings Inc which was incorporated in the Bahamas. In 2001, Wilshire Holdings’ domicile was changed to Belize. Prior to 2001, Mr. and Mrs. Flume owned bearer share of Wilshire capital stock. In 2001, according to the petitioners they each held 9% of the shares of Wilshire holdings, their daughter held 9% of the shares and the petitioners’ business partner Mr. Tornell, owned 73% of Wilshire holdings. The evidence presented of said share distribution were “articles of association” which were back dated to 2001. Mr. Flume was president and director of Wilshire holdings, with Mrs. Flume as the vice president. Mr. Flume, Mrs. Flume and their daughter are all US citizens. Mr. Tornell was classified as a non-resident alien under section 7701(b)(1)(B).
The IRS claimed Wilshire Holdings Inc was a CFC for the taxable years 2006-2008. The IRS based their claim on the fact that upon incorporation of Wilshire Holdings, the petitioners each owned 50% of the shares of Wilshire Holdings. The definition of a CFC under section 957(a) is, “any foreign corporation if more than 50 percent of – (1) the total combined voting power of all classes of stock of such corporation entitled to vote, or (2) the total value of the stock of such corporation, is owned (within the meaning of section 958(a)), or is considered as owned by applying the rules of ownership of section 958(b), by United States shareholders on any day during the taxable year of such foreign corporation”. The petitioners are both US citizens which under section 7701(a)(30), they are both US persons and are thus US shareholders of Wilshire holdings. Thus, Wilshire Holdings would be classified as a CFC.
The petitioners however argued that Wilshire Holdings was not a CFC for the taxable years 2006-2008 because they each only held 9% of the shares of Wilshire Holdings, with their daughter owning 9% and their business partner Mr. Tornell owning 73% of the company. Since only 27% of Wilshire Holdings was owned by US shareholders and 73% was owned by a non-resident alien, the petitioners argued that Wilshire Holdings could not be classified as a CFC under section 957(a).
The petitioners’ evidence of such share structure, however, was an article of association which was back dated to 2001. The court determined that an article of association was not sufficient evidence to support the claim that the share structure had changed for Wilshire Holdings Inc.
It is therefore notable here that the petitioners failed not in the tax planning but in the administrative implementation of the international tax planning. Certainly, the failure to execute all corporate administrative paperwork and to begin such records ultimately has a high cost.
We find that many owner managers after receiving sophisticated legal tax advice, sometimes from multiple counsel, quite often cut costs on implementation of the requisite administration and other supporting realities of the arrangements. This is a flawed approach especially in today’s era of information exchange and transparency. Thus, the Court held that the petitioners owned 100% of Wilshire Holdings and therefore Wilshire Holdings was a CFC for the years 2006 to 2008. The Court ordered the petitioners to pay the amount owed in taxes as well as the applicable tax penalties for the years 2006 and 2007.
No one knows what information or documents they will ultimately need as vital evidence at any point in the future or present. It is important therefore for Clients to ensure all arrangements are thoroughly implemented, administered and documented. The advice must be implemented in full.
Whirlpool Fin. Corp. & Consol. Subsidiaries v. Commissioner, No. 13986-17, 154 T.C. No. 9, 2020 BL 168706, 2020 Us Tax CT
Another example that shows failure to implement international tax advice into the business is shown by exploring this case regarding the IRC 954(d)(2) branch rules which can be found in the case Whirlpool Fin. Corp. & Consol. Subsidiaries (Petitioner) v. Commissioner (hereinafter “Whirlpool v commissioner”).
In Whirlpool v commissioner, Whirlpool Financial Corporation (Whirlpool USA) owned a Luxembourg company called Whirlpool Luxembourg S.a.r.l. Whirlpool Luxembourg S.a.r.l. qualifies as a CFC as the company was a wholly owned subsidiary of Whirlpool USA, according to IRC 957 (a). Whirlpool Luxembourg S.a.r.l owned Whirlpool Overseas Manufacturing, S.a.r.l (WOM).
Whirlpool Luxembourg and WOM are both collectively referred to as “Whirlpool Luxembourg” by the Court. Whirlpool Whirlpool Luxembourg owned as Mexican company, Whirlpool Internacional, S. de R.L. de C.V. (WIN). WIN was considered a separate entity for Mexican and Luxembourg tax purposes but for US federal tax purposes, WIN is considered as a disregarded entity under section 301.7701-2(a).
However, also due to section 301.7701-2(a), WIN is considered a Branch due to being a disregarded entity with a single owner. Whirlpool USA also owned a Mexican CFC called Whirlpool Mexico, S.A. de C.V. (Whirlpool Mexico). Whirlpool Mexico owned Industrias Acros S.A. de C.V. (IAW) and Commercial Acros S.A. de C.V. (CAW). IAW was the manufacturing arm of Whirlpool Mexico and CAW was the commercial and administrative arm.
Whirlpool Luxembourg entered into a manufacturing assembly services agreement with WIN in 2007 and 2008. Whirlpool would provide machinery, equipment, and raw materials and WIN would provide manufacturing services. IAW leased land and buildings that housed the Ramos and Horizon manufacturing plants in Mexico to WIN. IAW and CAW seconded their high-level employees and subcontracted Rank-and-file employees both to WIN. Then WIN manufactured products which were sold to Whirlpool USA, Whirlpool Mexico as well as a few third-party distributors.
The IRS made the claim that Whirlpool USA had US$50 million in taxable income under subpart F originating from Whirlpool Luxembourg’s Mexican branch. The IRS claimed Whirlpool Luxembourg’s sales income from its Mexican branch was FBCSI under IRC 954(d).
Whirlpool USA filed a motion for partial summary judgment, arguing that the sales income generated by the Mexican branch did not qualify as FBCSI under IRC 954(d)(1) as the appliances it sold were substantially transformed by its Mexican branch from the component parts and raw materials which were purchased.
The IRS argued that while Whirlpool Luxembourg’s Mexican branch did not have FBCSI under IRC 954(d)(1), the sales income did qualify as FBCSI under IRC 954(d)(2). The Tax Court held that Whirlpool Luxembourg’s Mexican branch would be considered as a wholly owned subsidiary under IRC 954(d)(2), and thus the Mexican branch’s sales income would be considered FBCSI. This case therefore shows a failure to grasp the court’s approach and factor that into the business planning of operations. The court “deemed” the Mexican branch to be a subsidiary and thus there was FBCSI. It appears as though:
- Whirlpool did not take into account the rule 954d2 – that the branch would be taxed as a subsidiary
- Whirlpool USA was advised of the branch rules but in implementing the structure Whirlpool did not follow the international tax advice when setting up the business.
- Whirlpool was aware of IRC 954(d)(2) and still operated the branch structure over time – they assumed the branch was a disregarded entity and the income would not be FBCSI. Another failure by management to follow international tax advice.
The Tax Court ordered Whirlpool USA to pay the US tax liabilities and associated penalties of its subpart F income from Whirlpool Luxembourg.
Clients need commercial international tax advisors who know how to both advise and ensure implementation and operations of international tax advice provided. Many large international tax consulting firms do not oversee, as part of the services they offer, the detailed implementation of international operations of their smaller client’s businesses.
Many of them do not even leave their offices to observe the day to day operations of the client’s business to be able to effectively advise them. It is important that clients obtain commercial international tax advisors who will work closely with them to ensure every aspect of their international tax advice in implemented and continue to work with them to ensure the arrangements continue to be operational.
