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Exhibits


United States Tax Laws - A Perspective for Foreign Companies and Individuals Doing Business or Living in the United States

Exhibits

  1. Exhibit 1 -- Deferal of deduction on payments to related foreign persons

  2. Exhibit 2 -- Withholding tax on amounts paid to foreign persons

  3. Exhibit 3 -- Thin capitalization

  4. Exhibit 4 -- Low or no interest rate loans

  5. Exhibit 5 -- Selected tax accounting elections and disclosure

  6. Exhibit 6 -- Tax return filing requirements

  7. Exhibit 7 -- Survey of foreign direct investment in the U.S.

  8. Exhibit 8 -- Organisations and start-up expenditures

  9. Exhibit 9 -- Taxation of foreign employees

Exhibit 1

Deferal of deduction on payments to related foreign persons

The Internal Revenue Service, hereinafter referred to as "IRS", announced in Notice 89-84 that future regulations are going to be issued for guidance on the deductibility of U.S. payments to foreign persons. The regulations will probably require a U.S. payor to defer the tax deduction for an accrued amount of interest or other expense, that is later paid to a related foreign person, until the taxable year of the payment. The rule will probably be applicable whether or not a tax treaty reduces or eliminates the U.S. tax imposed on the related foreign person with respect to the amount.

It also appears that the rule requiring a deferral of a deduction until the time of payment would apply, in the case of interest, back to taxable years beginning after December 31, 1983.

We understand that the rule may be applied on a prospective-only basis for deductible payments other than interest. If the IRS releases regulations taking these positions, there will be, undoubtedly, a substantial negative reaction. There is no tax policy reason (other than revenue) for requiring a matching in cases where the recipient is exempt by treaty or otherwise.

In addition, it appears inequitable, if not an abuse of discretion, to apply a tough rule retroactively in circumstances where the statute does not appear to be self-implementing and many years have elapsed since the time of enactment.

Exhibit 2

Withholding tax on amounts paid to foreign persons

Withholding Tax

A 30% tax is required to be withheld and remitted to the United States Government on all payments deemed to be interest, dividends or royalties which are derived within the United States and paid to a resident of a foreign country that does not have a tax treaty with the US in effect.

The person making the payments should withhold the tax. The tax will typically be creditable against the foreign resident's tax due in his home country, although there exists numerous rules governing the application of this tax credit. We would recommend your consulting domestic tax advisors for further analysis of the use of this tax credit against tax in your country. On the other hand, payments that are deemed to be interest, dividends or royalties that are derived from a foreign country and paid to a resident of the United States would be subject to a withholding tax of that country. In the same manner as stated above, the tax would be withheld by the person making the payment and remitted to the respective foreign government.

This tax may be creditable against federal tax in the United States subject to numerous limitations.

Filing U.S. Withholding Tax Forms

In connection with the withholding tax imposed, the following steps should be completed:

  1. The foreign corporation to which interest or royalties are paid should complete Form 1001 (copy attached) to claim the reduced treaty rate (if applicable). Once completed, Form 1001 should be returned to the U.S. company and kept in its records. This form is not required to be filed with the IRS. Further, the form need only be completed for interest and royalties, but not for dividends.

  2. The tax withheld must be deposited with an authorized financial institution or a federal reserve bank using a federal tax deposit coupon, Form 8109. The taxes withheld should generally be deposited with the bank within three banking days from the date of payment. If the deposit is not made on time, the IRS may assess penalties on the late deposit.

  3. The U.S. company is required to file an annual withholding tax return on U.S. source income of foreign persons (Form 1042). The U.S. company must also complete Form 1042S, "Foreign Persons U.S. Source Income subject to Withholding." Copies of Form 1042S are attached to Form 1042, sent to the recipient of the payment, sent to the IRS, and kept in the withholding agent's records. These forms must be completed on a calendar year basis (January 1 to December 31) and filed within 2 1/2 months following the close of the calendar year.

We would be happy to assist you in filing the tax forms listed in this exhibit. If you would like us to prepare these forms on your behalf, please provide us with the following information by February 1st of each year.

  • Recipient's name and address.
  • Amounts paid to the recipient and tax withheld.
  • Dates amounts were paid to recipient.
  • Dates amounts withheld were deposited at the bank.

Exhibit 3

Thin capitalization

In the United States, repayments of a loan's principal create no taxable income to the lender. The interest income is, of course, taxable. On the other hand, payments by a corporation in connection with its stock, where the payment results in no change in the relative stock ownership, are generally characterized as dividends and are subject to tax to the shareholders. As a result of these outcomes, an abuse may be created where there is a single corporate shareholder. For example, where the shareholder funds the corporation with $1 of stock and $1,000,000 of debt, the shareholder may be able to return to itself $1,000,000 of future profits tax free by the repayment of the debt. Had the corporation been funded with $1 of debt and $1,000,000 of stock, the future payments would have to be returned to the shareholder as taxable dividends, assuming the corporation has $1,000,000 of earnings and profits. This problem has become known as "thin capitalization. " The IRS generally considers a corporation as being thinly capitalized if its debt to equity ratio is greater than 3 to 1. However, this ratio may change depending on the facts of each individual case. There is no "safe-harbor" ratio. If the IRS determines that a company is thinly capitalized, the debt may be re-characterized as equity. As a result, the repayment of principal and interest would be a dividend to the parent corporation to the extent of the earnings and profits of the subsidiary. In addition, the subsidiary would not be permitted to deduct payments that otherwise would have been considered interest expense.

Listed below are some major elements the IRS will examine when evaluating whether an item is debt or equity. The instrument will generally have a fixed principal repayment and interest payments.

  • An item that is subordinate to the corporation's general creditors is a characteristic of equity and not debt. Repayment of loans that are dependent on the fortunes of business are indicative of equity.
  • If the stockholders and the major creditors of the company are the same and the loans are in the same proportion as their stock holdings the loans will tend to be viewed as equity.
  • The IRS will also look at the economic reality of the loan. If a third party would not extend the loan under existing circumstances, the advance may be considered equity rather than debt.
  • If the debt to equity ratio is excessively high, related party loans may be reclassified as equity.
  • The courts have taken a somewhat different approach than the IRS with respect to loans from a parent to it subsidiary. Generally, in these cases the courts tend to place greater reliance on the business needs of the related corporation than on the formalities or on what a third party would do under similar circumstances. Thus, where reasonable and substantial business purposes are present, an advance from E3-2
  • a parent to a subsidiary is generally upheld as debt. Business purpose is not considered where the debtor subsidiary is insolvent or where the activities of the subsidiary are part of the parent's own business and not a separate venture.
  • The courts have accepted the following business purposes as appropriate:

    To conserve the borrowing corporation's business property.

    To ensure the borrowing corporation's existence.

    To expand the business of the borrowing corporation.

  • Tax motivated loans will not be upheld as possessing a substantial business purpose.
  • If the U.S. company is unable to pay interest on a loan to a foreign parent corporation, the failure to pay interest may be one element used to recharacterize debt as equity.
  • These lists of factors considered by the IRS and the courts should not be considered comprehensive or exclusive.

Exhibit 4

Low or no interest rate loans

When a loan is made between related parties, the general principles governing low and no interest rate loans require that an arms-length interest rate be charged. However, the Internal Revenue Code (IRC) contains a specific exception to this rule that states, that when a foreign corporation makes loans to its domestic subsidiary, it shall not be governed by this standard and the foreign corporation may charge no interest or apply an interest rate that is lower than the market rate. Unfortunately, there is yet another provision of the IRC which permits the IRS to override this last exception and assert that the interest rate associated with a loan is inappropriate and another rate should be charged. The rate that the IRS may use is governed by a table of rates which is published monthly. For example, the rate that would govern a three year loan that was entered into during April 1993 requiring annual payments would be 6.53 %.

It is important to note that this last provision is permissive on the part of the IRS. For this reason, it is impossible to predict the position the IRS may take with a no or low interest rate loan between a foreign parent corporation and a domestic subsidiary. Nevertheless, if we are to assume the IRS will take a position most beneficial to the United States Government, then two scenarios best illustrate the possible outcomes:

  1. If the United States subsidiary has and will continue to sustain tax losses, it is more likely the IRS will impose a market rate of interest on a no or low interest rate loan. This is because the domestic subsidiary is already paying no federal tax and the IRS, by imposing an interest element, or a higher interest charge to the loan repayment could subject the deemed interest to the 30% withholding tax.

  2. Alternatively, if the domestic subsidiary is tax profitable then it is far less likely the IRS will impose an interest rate or higher interest rate on the loan from the foreign parent corporation. This is because the higher rate of interest would create a tax deduction for the subsidiary at approximately a 34% rate while the interest payment would only be subject to a 30% withholding. This represents a net 4% loss to the United States.

Exhibit 5

Selected tax accounting elections and disclosure

Each taxpayer must make accounting elections with respect to a variety of matters. Most important, perhaps, are the choice of accounting method (cash, accrual, etc.) and the choice of a method for valuing inventories (FIFO, LIFO, etc.).

There are also special elections that affect many items. Some are binding for subsequent years; other are not. In some cases, IRS permission is necessary to make the original election; in others it is required only when a change is desired.

Below is a checklist of the more important elections.

Accounting

Method of Accounting: A taxpayer can choose the cash, accrual, or any other method that clearly reflects income. If inventories are required, the cash method is not available. Other restrictions are imposed which prevent many larger corporations from using the cash method.

Change in Accounting Period: The election under IRS Section 442 is made by filing Form 1128.

Change in Accounting method: The election under IRS Section 446(e) is made by filing Form 3115. Change to

Percentage-Of-Conletion Method or Co-leted-Contract Method: The election under IRS Section 451 requires the consent of the IRS, and therefore, Form 3115 has to be filed in the first year of change.

Long-Term Contracts: A taxpayer has some limited options of reporting on the percentage-of-completion method or the completed-contract method.

Installment Sales: No permission is needed to go on the installment basis as a dealer, but permission is required to change from the installment basis to the accrual basis (Reg. Section 1.446-1). The election to report casual sales on the installment basis is made separately for each sale.

Inventory valuation: A taxpayer can elect, on its first return, the method of valuing inventory that conforms to the best accounting practice in the trade or business and that most clearly reflects income. The usual methods are (1) @;cost and (2) cost or market whichever is less.

A taxpayer can elect, on its first return, the method of measuring cost (by specific identification, first-in, first-out (FIFO), or average cost) (IRC Section 471). These elections can be changed only with the IRS's permission (Reg. Section 1.446-1).

The last-in-first-out (LIFO) can be elected with the IRS's approval (IRC Section 472(a)). The application to use LIFO is made on Form 970, filed in triplicate with the return for the first year the method is to be used (Reg. Section 1.472-03). The election is irrevocable (Reg. Section 1.472-05).

The simplified method for valuing inventory under the uniform capitalization rules of IRC Section 263A is made by attaching a statement to the corporation's initial tax return or, if the company is not a new company, by filing Form 3115 with the tax return. Any other reasonable method of valuing inventory under Section 263A is made in the same manner.

Amortization

Organizational Expenditure (Corporation): Section 248 permits treating organizational expenditures as deferred expenses. With the election made, the expenses are written off ratably over a period of 60 months or more, beginning with the month the corporation began business.

Election is made by a statement attached to the return; it must be filed not later than the date prescribed by law for filing the return for the year in which the election is made. The statement should show:

  1. a description of the expenditures;

  2. the amount of the expenditures; and

  3. the number of months over which the expenditures are to be deducted.

Start-Up Expenditures (Corporation): Section 195 permits treating organizational expenditures as deferred expenses. With the election made, the expenses are written off ratably over a period of 60 months or more, beginning with the month the corporation began business.

Election is made by a statement attached to the return; it must be filed not later than the date prescribed by law for filing the return for the year in which the election is made. The statement should show:

  1. a description of the expenditures;

  2. the amount of the expenditures; and

  3. the number of months over which the expenditures are to be deducted.

Corporations

Corporations Statement on Transfer of Property Under Code Section 351: Anytime a corporation transfers property (including cash) to a new corporation the company transferring the property and the company receiving the property are required to provide detail of the transfer as prescribed in Regulations Section 1.351-3(b). This is not elective.

Exhibit 6

Tax return filing requirements

Requirements to File:

All corporations doing business in the United States are required to file applicable federal and state income tax returns. The basic returns required and applicable due dates for a March 31, sca year end corporation are as follows:

Federal

Generally, for federal purposes, a corporation in existence during any portion of a taxable year is required to file a return. A corporation only in existence for part of the year would file its initial return for that part of the year for which is was in existence. If a corporation has received a charter but has never perfected its organization and has transacted no business and has no income form any source, it may, upon presentation of the facts to the district director, be relieved from the necessity of making a return. In the absence of a proper showing of such facts to the district director, a corporation will be required to make a return (Regulation 1.6012-2). Strict interpretation of the law would indicate that if a corporation is in existence during any portion of the taxable year, it is required to file a return even though it may not have transacted any business. However, the general practice is that if a corporation is only in existence for a short period of time and it transacts no business, a return is not generally filed for that short period of time. In any event, if the corporation transacts any business, i.e., earns income or incurs expenses, a return is required.

California

For California purposes, a corporation which begins business after its incorporation may disregard a period of one-half month provided the corporation was not doing business and received no income from California sources during that one-half month period. For example, if a corporation incorporates on March 17th and doesn't begin business until April 1st, it may disregard the period between March 17 and April 1st. Therefore a corporation on a March 31st, year end would not be required to file a return for the initial one-half month March 17th to March 31st. (California Revenue and Taxation Regulation 23222). California currently imposes a minimum tax of $800 per tax return filing period.

Exhibit 7

Survey of foreign direct investment in the U.S.

The United States Department of Commerce, Bureau of Economic Analysis (BEA) requires that all U.S. companies which are foreign owned provided various financial data at specified time periods. Those forms which are required to be filed, as well as the specific details on who must file, are discussed below.

Form BE-13 Initial Report on a Foreign Person's Direct or Indirect Acquisition, Establishment, or purchase of the Operating Assets of a U.S. Business Enterprise

A Form BE-13 must be filed when any foreign person establishes or acquires directly, or indirectly through an existing U. S. affiliate, a 1 0 % or more voting interest in a U. S. business enterprise with a cost greater than $1 million or with assets in excess of $1 million. This form must be filed no later than 45 days after the investment transaction occurs. There are limited exemptions for filing Form BE-13 for acquisition of real estate for personal use, and acquisitions of affiliated or existing enterprises which have total assets less than $1 million and which own less than 200 acres of U.S. land.

Form BE-12 Benchmark Survey of Foreign Direct Investment in the United States

A BE-12 form report is required for each U.S. business enterprise in which a foreign person owned or controlled, directly or indirectly, 10% or more of the voting securities at the end of the business enterprise's fiscal year. Form BE-12 is filed every five years and is due no later than May 31 of the following year. The last BE-12 filing year was for fiscal years ending in 1987.

Form BE-15 Annual Survey of Foreign Direct Investment in the United States

A BE-15 report is required for each U.S. business enterprise in which a foreign person owned or controlled, directly or indirectly, 10% or more of the voting securities at the end of the business enterprise's fiscal year.

Form BE-15 is an annual report and is filed for each year except for years in which Form BE-12 is filed. Form BE-15 is due no later than May 31 of the following year.

A Form BE-15 must be completed by each U.S. enterprise that is an affiliate of a foreign person, if on fully consolidated basis either total assets, gross sales, or net income exceed $20 million.

A Form BE-15Form BE-15 (short-form) is required by each U.S. enterprise that is an affiliate of a foreign person, if on a fully consolidated basis either total assets, gross sales or net income exceed $10 million but no one item exceeds $20 million.

Neither form is required if,

  1. a U.S. affiliate is a bank or bank holding company, or
  2. on a fully consolidated basis neither total assets, gross sales, nor net income of the U.S. affiliate exceed $10 million.

Form BE-605 Transactions of U.S. Affiliate, Except an unincorporated Bank, with Foreign Parent

Generally, Form BE-605 must be filed by every U.S. business enterprise, except an unincorporated bank, in which a foreign person and a direct and/or indirect ownership interest of 10% or more of the voting stock of a business enterprise at any time during the reporting period. The following enterprises are not required to file this form:

  1. A U.S. affiliate that is indirectly foreign owned and had no direct transactions or positions with a foreign parent (or foreign affiliate of the foreign parent) at any time during the year. In such case, the U.S. affiliate must file a claim for exemption.
  2. A U.S. affiliate which, on a fully consolidated basis, has total assets, gross revenues, and net income of less than $20 million, either positive or negative.

Form BE-605 is a quarterly report. A single copy of each report should be filed within 30 days after the close of each quarter, except for the final quarterly report which must be filed within 45 days.

Form BE-607 Industry Classification Questionnaire

Form BE-607 is required for each U.S. affiliate (10% ownership) newly acquired, directly or indirectly, by a foreign person or for an existing U.S. affiliate filing Form BE-605 whose industry classification changes so that the previous BE-605 does not accurately reflect the current industry classification of the U.S. affiliate. This form should be completed from the viewpoint of a consolidated entity. For a new U.S. affiliate, the BE-607 report must accompany the initial filing of Form BE-13.

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