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Nike State Aid case analysis: Would you pay $100 for a canvas sneaker designed the 20’s? (Where does the residual value for “Just Do it” and the ‘cool kids’ retro branding of All Stars belong?)

Posted by William Byrnes on July 19, 2019


I have received several requests this month about my initial thoughts on the EU Commission’s 56-page published (public version available here) State Aid preliminary decision with the reasoning that The Netherlands government provided Nike an anti-competitive subsidy via the tax system.  My paraphrasing of the following EU Commission statement [para. 87] sums up the situation:

The Netherlands operational companies are remunerated with a low, but stable level of profit based on a limited margin on their total revenues reflecting those companies’ allegedly “routine” distribution functions. The residual profit generated by those companies in excess of that level of profit is then entirely allocated to Nike Bermuda as an alleged arm’s length royalty in return for the license of the Nike brands and other related IP”

The question that comes to my mind is: “Would I pay $100 for a canvas sneaker designed the 20’s that I know is $12 to manufacture, distribute, and have enough markup for the discount shoe store to provide it shelf space?” My answer is: “Yes, I own two pair of Converse’s Chuck Taylor All Stars.” So why did I spend much more than I know them to be worth (albeit, I wait until heavily discounted and then only on clearance).  From a global value chain perspective: “To which Nike function and unit does the residual value for the ‘cool kids’ retro branding of All Stars belong?”

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U.S. international tax professionals operating in the nineties know that The Netherlands is a royalty conduit intermediary country because of its good tax treaty system and favorable domestic tax system, with the intangible profits deposited to take advantage of the U.S. tax deferral regime that existed until the TCJA of 2017 (via the Bermuda IP company).  Nike U.S., but for the deferral regime, could have done all this directly from its U.S. operations to each country that Nike operates in.  No other country could object, pre-BEPs, because profit split and marketing intangibles were not pushed by governments during transfer pricing audits.

The substantial value of Nike (that from which its profits derive) is neither the routine services provided by The Netherlands nor local wholesalers/distributors.  The value is the intangible brand created via R&D and marketing/promotion.  That brand allows a $10 – $20 retail price sneaker to sell retail for $90 – $200, depending on the country.  Converse All-Stars case in point.  Same  $10 shoe as when I was growing up now sold for $50 – $60 because Converse branded All-Stars as cool kid retro fashion.

Nike has centralized, for purposes of U.S. tax deferral leveraging a good tax treaty network, the revenue flows through NL.  The royalty agreement looks non-traditional because instead of a fixed price (e.g. 8%), it sweeps the NL profit account of everything but for the routine rate of return for the grouping of operational services mentioned in the State Aid opinion. If Nike was an actual Dutch public company, or German (like Addidas), or French – then Nike would have a similar result from its home country base because of the way its tax system allows exemption from tax for the operational foreign-sourced income of branches.  [Having worked back in the mid-nineties on similar type companies that were European, this is what I recall but I will need to research to determine if this has been the case since the nineties.]

I suspect that when I research this issue above that the NL operations will have been compensated within an allowable range based on all other similar situated 3rd parties.  I could examine this service by service but that would require much more information and data analysis about the services, and lead to a lesser required margin by Nike. The NL functions include [para 33]: “…regional headquarter functions, such as marketing, management, sales management (ordering and warehousing), establishing product pricing and discount policies, adapting designs to local market needs, and distribution activities, as well as bearing the inventory risk, marketing risk and other business risks.”

By example, the EU Commission states in its initial Nike news announcement:

Nike European Operations Netherlands BV and Converse Netherlands BV have more than 1,000 employees and are involved in the development, management and exploitation of the intellectual property. For example, Nike European Operations Netherlands BV actively advertises and promotes Nike products in the EMEA region, and bears its own costs for the associated marketing and sales activities.

Nike’s internal Advertising, Marketing, and Promotion (AMP) services can be benchmarked to its 3rd party AMP providers.  But by no means do the local NL AMP services rise to the level of Nike’s chief AMP partner (and arguably a central key to its brand build) Wieden + Kennedy (renown for creating many industry branding campaigns but perhaps most famously for Nike’s “Just Do it” – inspired by the last words of death row inmate Gary Gilmore before his execution by firing squad).

There is some value that should be allocated for the headquarters management of the combination of services on top of the service by service approach.  Plenty of competing retail industry distributors to examine though.  If by example the profit margin range was a low of 2% to a high of 8% for the margin return for the combination of services, then Nike based on the EU Commission’s public information falls within that range, being around 5%.

The Commission contends that Nike designed its transfer pricing study to achieve a result to justify the residual sweep to its Bermuda deferral subsidiary.  The EU Commission states an interesting piece of evidence that may support its decision [at para 89]: “To the contrary, those documents indicate that comparable uncontrolled transactions may have existed as a result of which the arm’s length level of the royalty payment would have been lower…”.  If it is correct that 3rd party royalty agreements for major brand overly compensate local distributors, by example provide 15% or 20% profit margin for local operations, then Nike must also.  [I just made these numbers up to illustrate the issue]

All the services seem, on the face of the EU Commission’s public document, routine to me but for “adapting designs to local market needs”.  That, I think, goes directly to product design which falls under the R&D and Branding.  There are 3rd parties that do exactly this service so it can be benchmarked, but its value I suspect is higher than by example ‘inventory risk management’.  We do not know from the EU document whether this ‘adapting product designs to local market’ service was consistent with a team of product engineers and market specialists, or was it merely occasional and outsourced.  The EU Commission wants, like with Starbucks, Nike to use a profit split method.  “…a transfer pricing arrangement based on the Profit Split Method would have been more appropriate to price…”.  Finally, the EU Commission asserts [para. 90]: “…even if the TNMM was the most appropriate transfer pricing method…. Had a profit level indicator been chosen that properly reflected the functional analysis of NEON and CN BV, that would have led to a lower royalty payment…”.

But for the potential product design issue, recognizing I have not yet researched this issue yet, based on what I know about the fashion industry, seems rather implausible to me that a major brand would give up part of its brand residual to a 3rd party local distributor.  In essence, that would be like the parent company of a well-established fashion brand stating “Let me split the brand’s value with you for local distribution, even though you have not borne any inputs of creating the value”.  Perhaps at the onset of a startup trying to create and build a brand?  But not Nike in the 1990s.  I think that the words of the dissenting Judge in Altera (9th Cir June 2019) are appropriate:

An ‘arm’s length result is not simply any result that maximizes one’s tax obligations’.

The EU Commission obviously does not like the Bermuda IP holding subsidiary arrangement that the U.S. tax deferral regime allows (the same issue of its Starbucks state aid attack), but that does not take away from the reality that legally and economically, Bermuda for purposes of the NL companies owns the Nike brand and its associated IP.  The new U.S. GILTI regime combined with the FDII export incentive regime addresses the Bermuda structure, making it much somewhat less comparably attractive to operating directly from the U.S. (albeit still produces some tax arbitrage benefit).  Perhaps the U.S. tax regime if it survives, in combination with the need for the protection of the IRS Competent Authority for foreign transfer pricing adjustments will lead to fewer Bermuda IP holding subsidiaries and more Delaware ones.

My inevitable problem with the Starbucks and Nike (U.S. IP deferral structures) state aid cases is that looking backward, even if the EU Commission is correct, it is a de minimis amount (the EU Commission already alleged a de minimis amount for Starbucks but the actual amount will be even less if any amount at all).  Post-BEPS, the concept and understanding of marketing intangibles including brands is changing, as well as allowable corporate fiscal operational structures based on look-through (GILTI type) regimes. More effective in the long term for these type of U.S. IP deferral structures is for the EU Commission is to spend its compliance resources on a go-forward basis from 2015 BEPS to assist the restructuring of corporations and renegotiation of APAs, BAPAs, Multilateral PAs to fit in the new BEPS reality.  These two cases seem more about an EU – U.S. tax policy dispute than the actual underlying facts of the cases.  And if as I suspect that EU companies pre-BEPS had the same outcome based on domestic tax policy foreign source income exemptions, then the EU Commission’s tax policy dispute would appear two-faced.

I’ll need to undertake a research project or hear back from readers and then I will follow up with Nike Part 2 as a did with Starbucks on this Kluwer blog previously.  See Application of TNMM to Starbucks Roasting Operation: Seeking Comparables Through Understanding the Market and then My Starbucks’ State Aid Transfer Pricing Analysis: Part II.  See also my comments about Altera:  An ‘arm’s length result is not simply any result that maximizes one’s tax obligations’.

Want to help me in this research or have great analytical content for my transfer pricing treatise published by LexisNexis? Reach out on profbyrnes@gmail.com

Prof. William Byrnes (Texas A&M) is the author of a 3,000 page treatise on transfer pricing that is a leading analytical resource for advisors.

Posted in international taxation, Transfer Pricing | Tagged: , , , , | Leave a Comment »

EY Report: State of the Tax Industry and Tax Education

Posted by William Byrnes on March 21, 2016


“The central function of the tax office has evolved from strategy and planning into risk management”, says William Byrnes, professor of law and associate dean at Texas A&M University.  Read Full Report here E&Y tax industry report

E&Y reports that “According to a 2015 report by the Institute of Management Accountants (IMA), which launched a Competency Crisis website to deal with the talent gap in 2013, 90% of North American organizations cannot find the entry-level management accounting and finance talent they need.”

“The educational curriculum isn’t keeping up with the needs of business, and employers expect more advanced skills at entry level, according to the report.”

E&Y finds: “Texas A&M University is among the pioneers of change in tax education. …the State of Texas not only established a new law school at the university but also gave it carte blanche to create a new education model.”

 

Posted in Education Theory, international taxation, Taxation, Uncategorized | Tagged: | Leave a Comment »

IRS 2015 APA for Transfer Pricing Final Rev Proc 13 Key Differences from 2013 Version

Posted by William Byrnes on August 13, 2015


This morning the US Treasury released the long awaited Advanced Pricing Agreement Procedures.IRS_logo

The 13 principal differences between these final revenue procedures and the proposed version of Notice 2013-79 are:

1. The final revenue procedure clarifies that if APMA requires, as a condition of continuing with the APA process, that the taxpayer expand the proposed scope of its APA request to cover interrelated matters (interrelated issues in the same years, covered issues or interrelated issues in other years, and covered issues or interrelated issues in the same or other years as applied to other countries), APMA will do so with due regard to considerations of principled, effective, and efficient tax administration and only after considering the views of the taxpayer and the applicable foreign competent authority. Further, APMA will communicate to the taxpayer any concerns about interrelated matters and possible scope expansion as early as possible.

2. In the interest of efficient tax administration, rollback years may be formally covered within an APA. A rollback will be included in an APA when a rollback is either requested by the taxpayer and approved after coordination and collaboration between APMA and other offices within the IRS or, in some cases, is required by APMA, after coordination and collaboration with other offices within the IRS, as a condition of beginning or continuing the APA process.

3 The final revenue procedure provides expanded guidance as to when an APA request will be considered complete.

4. The required contents of APA requests that were specified in the Appendix of the proposed revenue procedure have generally been retained.

5. Taxpayers are required to execute consent agreements to extend the period of limitations for assessment of tax for each year of the proposed APA term, and the required consent could be either general or restricted.

6. User fees are increased for APA requests but provides that total user fees may be reduced for multiple APA requests filed by the same controlled group within a sixty-day period. Also, user fee for requests for discretionary LOB relief are increased.

7. The final revenue procedure limits the scope of requests to which mandatory -pre-filing procedures apply to requests involving taxpayer-initiated positions.

8. To ensure that taxpayers have broad access to the U.S. competent authority to resolve disputes under U.S. tax treaties, taxpayers will not be required under the final revenue procedure to expand the scope of a competent authority request to include interrelated issues as a condition of receiving competent authority assistance. Taxpayers may still be required to provide information that will allow the U.S. competent authority to evaluate the appropriateness of the relief sought under the applicable U.S. tax treaty in light of the taxpayer’s positions on interrelated issues.

9. The final revenue procedure clarifies that the U.S. competent authority may consult with taxpayers with respect to certain additional issues that may arise in connection with competent authority requests, such as issues relevant to the determination of foreign tax credits and repatriation payments.

10. The final revenue procedure provides additional guidance on requesting discretionary determinations under the limitation on benefits articles of U.S. tax treaties, including time frames for taxpayers to provide notification of material changes in fact or law and the introduction of a triennial statement procedure to maintain a favorable grant of discretionary benefits.

11. Consistent with the objective of providing taxpayers with broad access to the U.S. competent authority to resolve disputes under U.S. tax treaties, the U.S. competent authority will not condition assistance on the taxpayer’s notification of the U.S. competent authority, or on obtaining its concurrence, with respect to signing a standard Form 870 with IRS Examination.

Similarly, a taxpayer will not be required to obtain the U.S. competent authority’s agreement prior to entering into a closing agreement or similar agreement with IRS Examination, but in these cases the assistance provided by the U.S. competent authority will be limited to seeking correlative relief from the foreign competent authority, thus potentially not eliminating double taxation.

12. The final revenue procedure provides additional information about the process followed by the U.S. competent authority in conducting its review under the simultaneous appeals procedure.

13. The final revenue procedure clarifies and refines the bases on which the U.S. competent authority may decline to accept a competent authority request or may cease providing assistance, consistent with U.S. tax treaty policy that taxpayers should have broad access to the U.S. competent authority to resolve instances of taxation not in accordance with the applicable U.S. tax treaty.

Procedures for Advance Pricing Agreements  Download APA New Procedures Rev Proc 15-40

Procedures for Requesting Competent Authority Assistance under Tax Treaties  Download APA New MAP Procedures Rev Proc 15-41

William Byrnes is the primary author of Lexis’ Practical Guide to US Transfer Pricing which provides 3,000 pages of in-depth analysis and practical examples for the corporate transfer pricing counsel and risk manager.

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Fair Approaches for Taxing Previously Untaxed Foreign Income

Posted by William Byrnes on April 6, 2015


In connection with any transition to a new USA international tax system, we need an approach that effectively deals with the trillions of dollars of previously untaxed foreign income held by CFCs. There is logic and fairness in applying a rate on those earnings that is less than the 35 percent home country rate because the rules of the game are being changed significantly.  Guest Financial Law Prof Blogger Jeffery Kadet has written a three part series on the fair approaches for taxing previously untaxed foreign income that will be posted this week on Monday, Tuesday and Wednesday, available on International Financial Law Prof Blog.

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Welcome this week from University of Amsterdam Centre for Tax Law

Posted by William Byrnes on January 19, 2015


Logo_uva1 Welcome from Amsterdam !  Each year the Amsterdam Centre for Tax Law (of the University of Amsterdam Law Faculty) organizes its Winter Course on International Tax Law.

This year theme is “Tax treaty application“.  The Winter Course on International Tax Law focuses on the practical problems of tax treaty application. It aims at bringing the participants’ knowledge up-to-date with recent OECD developments, major issues on tax treaty interpretation, as well as relevant case-law on tax treaties around the world.

Prof. Dennis Weber, Director of the ACTL,  has assembled a leading program faculty including Prof. Peter Watel(UvA) (who lectured me at a UvA tax student 23 year ago); Prof. Hein Vermeulen (UvA/PwC);  Prof. Stef van Weeghel (UvA/PwC); Prof. Bruno De Silva (UvA); Prof. Otto Marres (UvA/KPMG); Prof. Joanna Wheeler(IBFD/UvA); Jasper Arendse (Directorate of International Affairs Dutch Ministry of Finance); Melinda Brown (OECD); and myself, Prof. William Byrnes.

My topic examines the protocols, mechanisms and expanding scope of information exchange via bilateral and multilateral agreements.  FATCA, OECD CRS and Global Initiatives, EU Expanded Savings Directive EOI, TIEAs fall within this topic, as well as tax certification forms and validation, data collection, discernment and distribution.

The Amsterdam Centre for Tax Law (ACTL) is the tax law research centre of the University of Amsterdam. ACTL members conduct research into various subjects of tax law, with a strong emphasis on Corporate Taxation, International Tax Law and European Tax Law.

Posted in Courses, FATCA, information exchange, international taxation | Tagged: | Leave a Comment »

Luxembourg’s Amazon Deal is State Aid Because of Lack of Diligence, EU Commission Preliminary Conclusion

Posted by William Byrnes on January 16, 2015


EU Commission Will Calculate State Aid via a Transfer Pricing Audit of the Difference of the Ruling from an Arm’s Length Benchmark – See today’s decision links and analysis in article)

decision and analysis with links available at  http://lawprofessors.typepad.com/intfinlaw/2015/01/luxembourgs-amazon-deal-is-state-aid-because-of-lack-of-diligence-eu-commission-preliminary-conclusi.html

(78) While tax rulings that merely contain an interpretation of the relevant tax provisions without deviating from administrative practice do not give rise to a presumption of a selective advantage, rulings that deviate from that practice have the effect of lowering the tax burden of the undertakings concerned as compared to undertakings in a similar legal and factual situation. To the extent the Luxembourgish authorities have deviated from the arm’s length principle as regards the contested tax ruling, the measure should also be considered selective.

(79) Since the contested tax ruling fulfils all four conditions under Article 107(1) TFEU, the Commission takes the view, at this stage, that it constitutes State aid within the meaning of that provision.

 

practical_guide_book

Lexis’ Practical Guide to U.S. Transfer Pricing (2015), 28 chapters from 50 expert contributors (3,000 pages) led by international tax Professor William Byrnes,  is designed to help multinationals cope with the U.S. transfer pricing rules and procedures, taking into account the international norms established by the Organisation for Economic Co-operation and Development (OECD). It is also designed for use by tax administrators, both those belonging to the U.S. Internal Revenue Service and those belonging to the tax administrations of other countries, and tax professionals in and out of government, corporate executives, and their non-tax advisors, both American and foreign.

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Tax Treatment of Offshore Real Estate Holdings and Foreign Housing Expenses

Posted by William Byrnes on October 6, 2014


AdvisorFYI » Tax Treatment of Offshore Real Estate Holdings and Foreign Housing Expenses.

by Mr. Edward D. Nieto

The Internal Revenue Service (IRS) does not require that offshore real estate be reported as a foreign financial asset such as a personal residence or a rental property held by an American expatriate or a United States Government employee working overseas.1It is only when the real estate is held through a foreign entity such as a corporation, partnership, trust or estate, that the interest in the entity needs to be specified and reported as foreign financial asset if the total value of all specified foreign financial assets is greater than the applicable reporting threshold.2

Read on at AdvisorFYI » Tax Treatment of Offshore Real Estate Holdings and Foreign Housing Expenses

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The IRS’ International Collection Efforts Not Up to Par, TIGTA Audit Finds

Posted by William Byrnes on October 1, 2014


International Financial Law Prof Blog.

International tax noncompliance remains a significant area of concern for the IRS. However, the IRS’s collection efforts need to be enhanced to ensure that delinquent international taxpayers become compliant with their U.S. tax obligations.

 

Posted in international taxation | Tagged: , , | Leave a Comment »

IRS Notice 2014-52 – Rules Regarding Inversions and Related Transactions

Posted by William Byrnes on September 23, 2014


12833-6a00d8341bfae553ef01a3fd3e6553970b-piSECTION 1.  OVERVIEW

The Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) are concerned that certain recent inversion transactions are inconsistent with the purposes of sections 7874 and 367 of the Internal Revenue Code (Code).  The Treasury Department and the IRS understand that certain inversion transactions are motivated in substantial part by the ability to engage in certain tax avoidance transactions after the inversion that would not be possible in the absence of the inversion.  In light of these concerns, this notice announces that the Treasury Department and the IRS intend to issue regulations under sections 304(b)(5)(B), 367, 956(e), 7701(l), and 7874 of the Code.

Section 2 of this notice describes regulations that the Treasury Department and the IRS intend to issue that will address transactions that are structured to avoid the purposes of sections 7874 and 367 by (i) for purposes of section 7874, disregarding certain stock of a foreign acquiring corporation that holds a significant amount of passive assets; (ii) for purposes of sections 7874 and 367, disregarding certain non-ordinary course distributions; and (iii) for purposes of section 7874, providing guidance on the treatment of certain transfers of stock of a foreign acquiring corporation (through a spin-off or otherwise) that occur after an acquisition.

Section 3 of this notice describes regulations that the Treasury Department and the IRS intend to issue that will address certain tax avoidance by (i) preventing the avoidance of section 956 through post-inversion acquisitions by controlled foreign corporations (CFCs) of obligations of (or equity investments in) the new foreign parent corporation or certain foreign affiliates; (ii) preventing the avoidance of U.S. tax on pre-inversion earnings and profits of CFCs through post-inversion transactions that otherwise would terminate the CFC status of foreign subsidiaries and/or substantially dilute the U.S. shareholders’ interest in those earnings and profits; and (iii) limiting the ability to remove untaxed foreign earnings and profits of CFCs through related party stock sales subject to section 304.

Section 4 of this notice provides the effective dates of the regulations described in this notice.  Section 5 of this notice requests comments and provides contact information for purposes of submitting comments.

Notice 2014-52, Rules Regarding Inversions and Related Transactions

Posted in international taxation, Tax Policy | Tagged: , | Leave a Comment »

International Financial Law Blog headlines

Posted by William Byrnes on August 21, 2014


 

SEC Charges Golfing Buddy with Insider Trading Ahead of Bank Acquisition

O’Neill tipped Robert H. Bray, a fellow golfer with whom he socialized at a local country club. In the two weeks preceding a public announcement about the planned acquisition, Bray sold his shares in other stocks to accumulate funds he used to purchase Wainwright securities.

Barclays Bank adds to its new global financial crime unit

Joe Smith, Wells Fargo’s deputy money-laundering reporting officer and financial crime reporting officer, will join Barclays as a vice-president in October.

Is the UK elimination of criminal intent for criminal prosecution of tax non-compliance sound ? Is tax non-compliance equal with ‘Cruelty to Animals’ and ‘Illegal Guns’?

The Government has announced its intention to introduce a new strict liability criminal offence. This consultation seeks views on the design of this offence.

S630_HMRC_sign__media_library__960_

The UK Government has announced its intention to introduce a new strict liability criminal offence, similar to the crime of cruelty to animals.

Strict liability offences 

2.5 A strict liability offence is a criminal offence where it is not necessary for the court to ascertain the state of mind of the defendant before convicting.

Box 1: Other strict liability offences 

There are several existing offences which can be construed to imply strict liability, including some carrying custodial sentences. These include, for example: …

Cruelty to animals, including the offences of causing unnecessary suffering while transporting an animal or holding it at a market; ….

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/345370/140819_Tackling_offshore_tax_evasion_-_A_new_criminal_offence.pdf

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/345236/140819_Tackling_offshore_tax_evasion_-_Strengthening_civil_deterrents.pdf

Posted in Financial Crimes, international taxation | Tagged: , , , | Leave a Comment »

 
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