Define a “controlled transaction” or “controlled transfer”
Any transaction or transfer between two or more members of the same group of controlled taxpayers. (Basically parent<>sub, or sub<>sub.)
Define “controlled taxpayer”
Two or more taxpayers owned or controlled directly or indirectly by the same interests, and the definition includes a taxpayer that owns or controls the other taxpayers. (Basically it’s a subsidiary)
Define an “uncontrolled transaction”
Sales from a company to an outside purchaser. aka an arms-length transaction
A controlled taxpayer charges another in the same group less than typical prices in order to maximize the tax benefits. What does the IRS have the authority to do in that circumstance?
Make adjustments to controlled transactions or controlled transfers (transactions between related parties) to assure that reported prices yield results that are consistent with sales to outsiders (yield the same profit margin).
Which pricing methods are used by the IRS to justify an arms-length transaction adjustment.
METHODS OF COMPARING YOUR INTERNAL SALES TO OUTSIDER SALES
Comparable Uncontrolled Price (CUP): used for tangible property based on published market data
Comparable Uncontrolled Transaction (CUT): used for intangible property, such as royalty payments
Resale Price: used for tangible property
Cost Plus: used for tangible property
Comparable Profits Method: uses operating margin, gross margin, return on assets, or return on capital
Transfer pricing issues occur when a U.S.-based taxpayer ___[3 transaction types]___ to/from/with an affiliate that either is not subject to U.S. income tax or does not file a consolidated income tax return with the U.S. based taxpayer.
(1) Sells, transfers, purchases or leases tangible or intangible property
(2) Enters into loan agreements or service contracts
(3) Shares costs
What types of adjustments may the IRS make to ensure arms-length transactions or transfers among a controlled taxpayer group?
Modify the basis of assets
Require the taxpayer to recognize income on “tax-free” transactions
True / False: The controlled taxpayer, when filing a timely tax return, can make the same adjustments the IRS would likely make, but cannot later reduce the taxable income in an amended return.
True
How can a controlled taxpayer avoid any PENALTIES that the IRS may try to impose should the IRS adjust transactions or transfers to reflect an arms-length event? (They may not avoid the adjustment, but they could avoid the penalties.)
If the taxpayer documents a Section 482 study such that they prove the taxpayers methods were based on allowable pricing methods set forth by the U.S. Treasury, or another pricing method that clearly reflects income AND
The 482 study is completed no later than the date the taxpayer files the federal income tax return.
OR
Get an advance ruling from the IRS (Request for Competent Authority).
Define nexus.
The minimum level of contact a taxpayer may have with a STATE's jurisdiction to be subject to its tax.
This typically includes any company having property, payroll, or sales within a state.
What three conditions must be met for the federal government to override a state’s attempt to impose income tax on a company?
The only business activity in the state is to solicit orders for tangible personal property by a person who does not live in the state (like mail order).
The orders are sent outside the state for acceptance or rejection
The accepted orders are filled by shipment from a point outside the state
THIS DOES NOT APPLY TO OTHER TAXES THAT COULD BE IMPOSED BY THE STATE: sales tax, use tax, franchise tax, commercial activity tax
True / False: A company has nexus and is subject to state income taxes if the only presence in the state is to provide services within the state.
True
This includes the location where training is provided to employees, installation services are provided to customers, etc..
What is the difference between allocated and apportioned business income
Allocated income is income derived from activities NOT related to the primary business of the corp.
Apportioned income is income derived from activities that ARE related to the primary business of the corp.
What items are typically used by a state to determine the apportionment factor?
THE SUM OF
Property and rent expense within the state / total property
Payroll paid to employees within the state / total payroll
Sales from sources within the state / total sales
AVERAGED (DIVIDE BY 3)
MULTIPLY THE FACTOR TIMES THE APPORTIONABLE BUSINESS INCOME (total business income less allocated income) TO DETERMINE INCOME SUBJECT TO STATE INCOME TAX
Define a Foreign Branch of a company.
The U.S.-based company opens an office or retail shop in a foreign country. It is an extension of the domestic corporation, and not a separate legal entity. It is taxed both in the U.S. and by the foreign country.
Define a Foreign Subsidiary.
A separate legal entity, incorporated under the laws of the foreign host country.
What are the federal tax consequences for a Foreign Branch.
Profits/(losses) earned by the branch are treated as earned by the domestic company and are taxed in full when earned.
A credit against taxes is allowed for the lesser of the foreign tax imposed by the branch’s host country or the foreign tax credit limitation.
Remittance of branch profits back to the domestic corp are generally not taxable.
What are the federal tax consequences for a Foreign Subsidiary?
The earnings are taxed immediately by the foreign country.
The earnings are only taxed in the U.S. when brought back to the US in the form of a dividend.
Passive investment income is taxed immediately (cannot be deferred)
What are the 9 sources of income treated as “from within the U.S.” when dealing with a foreign subsidiary?
Interest: generated in the U.S. from bonds, notes, etc.
Dividends: paid by U.S.-based companies
Personal Services: labor or services performed in the U.S. by U.S. people (except for foreign individuals performing services who temporarily live in the U.S. <90 days and make <$3,000)
Rents and Royalties: obtained from properties owned in the U.S. OR Royalties generated from the use of patents, copyrights, trade secrets and formulas, goodwill, trademarks, brands, franchises, etc.
Disposition of U.S. Real Property Interest: gains/(losses) from disposall
Sales or Exchange of Inventory Property: gains/(losses) from purchasing property outside the U.S., but then selling it in the U.S.
Underwriting Income: derived from the issuing of any insurance or annuity contract
Social Security Benefits: ‘nuf said
Guarantees: amounts received, directly or indirectly, from blah blah
What are the 5 categories the sources of foreign income are put into to determine the foreign tax credit limitation?
Passive category income (interest, dividends, rents, royalties, annuities, gain on sale of property that produces passive income)
General category income (doesn’t fit anywhere else)
Section 901(j) income (income earned from activities in sanctioned countries)
Certain income resourced by treaty
Foreign source lump-sum distribution from a pension plan
What is the formula for calculating the foreign tax credit limitation by category? What amount of credit is allowed?
Pre-credit U.S. tax on total taxable income x (separate category foreign income / total taxable income)
Allowed: The lesser of the limitation for that category or the foreign taxes related to that category.
The total foreign tax credit is the sum of the credits allowed for all of the categories.
True / False: The foreign tax credit is calculated based on sales taxes paid to a foreign country.
False
It is only allowed against income taxes paid to a foreign country. It does not include sales tax, value added tax, property tax, or customs tax.
What is a Controlled Foreign Corporation?
When 50% or more of the foreign corporation’s stock is owned by U.S. shareholders (a person owning 10% or more of the CFC including constructive rules) on ANY day of the year.
When a Controlled Foreign Corporation also earns passive income, which rules take priority: Subpart F or Passive Foreign Investment Company (PFIC) anti-deferral rules?
Subpart F: resulting in immediate income recognition of this type of income at ordinary rates
When does a company qualify as a Passive Foreign Investment Company (PFIC)?
When 75% or more of income is from passive activities OR
50% or more of the average assets produce passive income
