U.K. Plans Corporate Tax Restructuring


U.K. Chancellor of the Exchequer George Osborne delivered his latest budget, which proposes to eventually cut the country’s corporate tax to 17%, the lowest in the Group of 20 major economies.

The U.K. plans to cut the corporate tax to 19% in 2017 and to 17% in 2020, supporting investment in the U.K., and “ensuring the U.K. has by far the lowest rate in the G-20,” Osborne said in his annual budget speech to parliament.

The budget also proposes:

  • Limiting interest expense deductions by April 2017 to prevent multinational enterprises (MNEs) from artificially shifting profits out of the U.K.,
  • Enacting new rules to target hybrid arrangements effective January 2017,
  • Strengthening U.K. tax withholding rules to apply to royalty payments (for access to intellectual property rights) that are made to low-taxed jurisdictions effective March 2016, and
  • Updating U.K. transfer pricing guidelines from April 2016.

Targeting Interest Deductions

In his annual budget speech, Osborne said the U.K. will deliver a low-tax regime to attract MNEs but ensure that they pay taxes in the U.K. He explained that some MNEs deliberately overborrow in the U.K. to finance activities outside the country, and then deduct the interest expense from their U.K. profits.

“So, from April next year, we will restrict interest deductibility for the largest companies at 30% of U.K. earnings, while making sure firms whose activities justify higher borrowing are protected with a group ratio rule,” Osborne said.

In addition, he indicated that new rules will be established to stop the complex hybrid structures that allow some MNEs to avoid paying any tax anywhere (“double nontaxation”) or to deduct the same expenses in more than one country (“double dips” or “triple dips”).

Reality of the Global Economy

The chancellor spoke of strengthening the U.K. withholding tax on royalty payments (for access to intellectual property rights) that are made to low-taxed jurisdictions. He also addressed the idea of modernizing the way the U.K. treats losses by letting companies use losses in more flexible ways. Like other countries, the U.K. would limit to 50% the maximum amount of profits that can be offset by losses, he said.

Mr. Osborne stated that these U.K. corporation tax reform measures, among the many others set forth in Budget 2016, will create a modern U.K. tax code that better reflects the reality of the global economy.

IRS Outlines Strategic Transfer Pricing Issues

In a new International Practice Unit (IPU), the IRS charted audit steps its examiners should follow in reviewing the transfer pricing documentation of U.S. taxpayers that transfer and provide tangible property, intangible property, and service to foreign affiliates in exchange for payments (that is, outbound transactions).

Limits on Housing Expenses

The IRS issued a notice of 2016 adjustments to the limitation on housing expenses for individuals working abroad. The notice recognizes that some taxpayers may elect to apply the 2016 limitation to tax years beginning in 2015.

Qualified individuals may elect to exclude from U.S. gross income their foreign earned income and housing cost amount. The maximum excludable housing cost amount is calculated by way of a complex formula.

The notice contains a table that:

  • Identifies locations within countries with high housing costs relative to U.S. housing costs, and
  • Provides an adjusted annual maximum and daily housing expense limitation for a qualified individual incurring housing expenses in one or more specified high-cost localities in 2016 to use (instead of the otherwise applicable annual housing expense limitation of $30,390, or the prorated daily amount) in determining his or her housing expenses.

A qualified individual who incurs housing expenses, in one or more of the high-cost localities identified in the table for the year 2016, may use the adjusted limit provided in the table (rather than $30,390 or the prorated daily amount) in determining the housing cost amount. This is reported on Form 2555, “Foreign Earned Income.”

While the high-cost area amounts for most cities didn’t change dramatically, there were large drops for some Canadian cities. For example, the amount for Toronto dropped to $41,400 from $49,700 in 2015, and the amount for Montreal fell to $43,900 from $52,000.

The full notice can be found here.

The review is an integral part of an IRS examiner’s analysis of transfer pricing risks and the assessment of any transfer pricing penalties.

The IPU notes that transfer pricing documentation should show that the pricing methodology is reasonable and meets the best method rule — that is, it provides the most reliable measure of an arm’s-length result and is the most reliable application of the method.

Principal Documentation

Auditors should request the following “principal documentation”:

1. An overview of the taxpayer’s business, including an analysis of the economic and legal factors that affect the pricing of its property or services,

2. A description of the taxpayer’s organizational structure (including an organization chart) covering all related domestic and foreign parties engaged in potentially relevant transactions, including foreign affiliates whose transactions directly or indirectly affect the pricing of property or services in the U.S.,

3. A description of the transfer pricing method selected and an explanation of why it was selected, including an evaluation of whether any regulatory conditions and requirements for application of that method were met,

4. A description of any alternative transfer pricing methods that were considered and an explanation of why they weren’t selected,

5. A description of the related party (controlled) transactions and any internal data used to analyze those transactions,

6. A description of the transfer pricing comparables that were used, how comparability was evaluated, and any adjustments made,

7. An explanation of the economic analysis and projections relied upon in developing the transfer pricing method,

8. A description or summary of any relevant data that the taxpayer obtained after the end of the tax year and before filing a tax return that would help determine if a specified method was selected and applied reasonably, and

9. A general index of the principal and background documents and a description of the recordkeeping system used for cataloging and accessing those documents.

Complete Understanding

The IPU notes that “complete documentation may not require all principal documentation to be provided.” Instead, IRS examiners should analyze whether the documentation provided gives a complete understanding of a taxpayer’s controlled transactions. Supplying all the principal documentation wouldn’t necessarily preclude the IRS from assessing the aforementioned transfer pricing penalties for a variety of reasons — for example, deficient documentation.

For additional guidance, the IPU asks IRS examiners to consult the Transfer Pricing Audit Roadmap, but cautions that the use of such guidance requires judgment, as every transfer pricing case is unique.

After receiving the requested transfer pricing documentation, IRS examiners are instructed to compare any related-party information reflected in the following types of U.S. returns to the transfer pricing documentation provided and identify any missing controlled transactions:

  • Schedules C, F, and M of Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations”;
  • Schedules C and F of Form 8858, “Information Return of U.S. Persons With Respect To Foreign Disregarded Entities”; and
  • Schedules B, L, and N of Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships.”

In addition, the IPU instructs IRS examiners to confirm that the taxpayer’s financial statements (including income statements and balance sheets) match the transfer pricing documentation provided.

In summary, the overall objective is to encourage taxpayers to document their transfer pricing transactions and provide the documentation to the IRS in a timely manner.

China Expands VAT to All Industries

China plans to apply its value added tax (VAT) to all industries starting May 1.

The VAT will replace the business tax and apply to the industries that were previously subject to that tax, including the construction, real estate, and finance and consumer services industries. China will be among the first countries in the world to apply the VAT broadly to the financial services industry.

The replacement of the business tax with the VAT will ensure that the indirect tax burdens on all industries in China are reduced, said Premier Li Keqiang in a government work report to the national legislature.

Loan Interest

The application of VAT broadly to the financial services industry means that interest on loans made to businesses and consumers will be subject to the tax.

China currently has a turnover tax system consisting of the following three taxes:

1. The VAT, applicable to the sale of goods and the provision of repairs, replacement, and processing services;

2. The business tax, applicable to the provision of other services and the transfer of intangible assets and immovable property; and

3. The consumption tax, applicable to the sale of luxury and environmentally unfriendly goods (for example, cigarettes).

To mitigate the multiple indirect tax issues associated with goods and services, China introduced a pilot program to replace the business tax with the VAT in 2012. From 2012 to the first half of 2015, the measure resulted in tax savings of more than $75 billion, accounting for 0.2% of gross domestic product (GDP) in the period, according to a report from China International Capital Corp. Ltd., a joint venture investment bank.

What the Move Could Mean

The European Union has spent years studying whether the VAT could be applied to financial services and hasn’t been able to implement it. It would not be a surprise to see other countries follow suit if the Chinese do it successfully, according to some observers.

While there will inevitably be some short-term challenges to businesses in getting ready for the transition to the VAT, over time the adoption of a more modern system is expected to benefit the economy as a whole, according to some analysts.