A new paradigm: Global tax changes may snare companies of any size

Monitor international tax rules and regulations to stay in compliance

“We’re too small to be impacted” is an expression I commonly hear from private company leaders. Although, when it comes to international tax matters, it’s a saying that rarely applies and can lead unwitting businesses into trouble or to miss opportunities.

A new paradigm: Global tax changes may snare companies of any size

August 11, 2016

A blog post by Wolfe Tone, Partner, Deloitte Tax LLP

As our series of mid-market perspectives on international expansion highlights, private companies have a wide variety of goals in expanding their reach in overseas markets. They might be looking, for instance, to diversify their operations, access new customers, tap into new sources of materials and talent, or lower their tax base. But, regardless of the reason, private companies often overlook tax savings considerations or changes on the regulatory front that can add to their tax complexity instead of lightening the load.

Two recent examples are worth sharing. The first is what Deloitte is referring to as the global tax reset which in part has been caused by base erosion and profit sharing (BEPS) guidance, issued by the Organization for Economic Cooperation and Development (OECD) on October 5, 2015. The OECD’s goal in passing the guidance was straightforward: to help countries in an integrated basis address perceived gaps in the international tax and transfer pricing rules that allowed some companies to avoid paying taxes and in addition, to increase transparency with tax authorities. The OECD may not be a regulatory body with governing authority, but the organization does have significant influence over tax authorities across the majority of Australia, Canada, Europe, and Latin America.

While presumptively focused on larger multinational companies with sizable revenue streams, the BEPS regime also impacted a fair number of smaller, private companies doing business abroad. For instance, the European Commission began to focus on fiscal state aid programs as a result of the unfolding of its BEPS action plan in 2014. The commission advised countries to eliminate programs which provided certain forms of state aid to taxpayers without prior authorization. This prohibition was intended to ensure fair competition within the European Union and European Economic Area. However, unlike some of the later BEPS guidance, the prohibition on state aid applies to most all companies regardless of size, including family owned companies.

Recently proposed regulations under Section 385 released on April 4, 2016 are another development that may snare private companies in the future, forcing private companies to take inventory of intercompany loans (as of such date). Widely considered a response by treasury to weaken the benefit of corporate inversions, the proposed regulations are having a bigger impact on companies both big and small.

While multinational corporations looking to shift their corporate headquarters from the United States to overseas were clearly in the treasury’s sights, the implications of the proposed regulations are much greater. As provided in the proposed regulations, middle market companies may be required to recharacterize certain debt instruments as stock. For instance, the proposed rules impose documentation and characterization rules in certain instances in which related party loans (expanded group instruments (EGI)) exist between expanded group members. If the expanded group is public or has total assets exceeding $100 million or total annual revenue that exceeds $50 million, then proper documentation as defined in the regulations is required for all EGI. This is referred to as the small company exception. If neither this exception nor any other exceptions under IRC 385 apply, then failure to properly document these loans could result in reclassifying regular business debt to equity. In the case of an S corporation, the recharacterized debt may be treated as a second class of stock and a terminating event for the company irrespective of whether they have international operations or not.

As these examples reveal, international tax rules and regulations are changing virtually overnight in response to a global economy that is rapidly shifting and fundamentally altering the traditional ways many companies have done business. The pace of change requires constant monitoring if companies want to stay in compliance, take advantage of potential opportunities, and keep their overseas operations viable.

It might be tempting for private company leaders to think they can fly under the radar, but mounting evidence suggests that any US business operating overseas would be wise to stay on top of the latest developments. After all, a successful global expansion can open many windows of opportunity for a growing business, but they can just as easily erode such benefits if you run afoul of tax authorities.

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