Page 88 - DCOM308_DCOM502_INDIRECT_TAX_LAWS

Unit 5: Clearances of Excisable Goods

 Can the company reduce its overall third party debt? Notes
 Can the company restructure its EMEA operations to take advantage of low-tax
income to service newly-aligned third party debt?
 Can the company manage the increased tax burden arising from its non-U.S.
operations?

Approach
KPMG helped the company develop an appropriate structure to achieve its long term
goals and address the issues described above.

The new structure created a principal European entity that assumed management
responsibilities for nearly all of the EMEA manufacturing, development and distribution
businesses thus eliminating the redundant functions performed by both the legacy entities
and the acquired company. This principal entity owned all contracts, as well as accepting
the risks associated with funding R&D activities in Europe and Asia.
The manufacturing entities received a fee based on costs incurred (‘contract manufacturing’
arrangement). Similar arrangements were concluded with entities providing R&D and
other support services. The principal European entity also bought the existing intellectual
property for an arm’s length amount. All these arrangements were supported by transfer
pricing studies between the various foreign entities and according to local law.
Prior to converting to the new arrangement the company needed to address its third party
debt issues. By taking advantage of IRC section 965 (which allowed for a one-year window
for an 85 percent dividend received deduction on earnings repatriated from CFCs), the
company was able to make significant distributions into the U.S., which were in turn used
for corporate capital expenditures pursuant to a dividend reinvestment plan. In addition,
as a result of the repatriated dividends, the U.S. company was in turn able to use its other
available cash to repay third party debt. The remaining U.S. debt could then be serviced by
the U.S. businesses income flow. Future funds needed in EMEA would be financed through
the foreign entities directly.

The European operations were reorganized so they could raise debt without parental
guarantees from the U.S. The reorganization was achieved by creating a partnership under
European law. In turn, this partnership sold the relevant entities to the principal European
entity in exchange for a note. The interest payable on this note created an interest deduction
that significantly reduced the taxable income of the principal European entity.
The European partnership was set up so that any interest earned was not subject to tax in
the jurisdiction of its formation, or in the U.S. unless repatriated. The earlier repayment of
U.S. debt also meant it was no longer necessary to repatriate debt from Europe.
Outcome

The reorganization consolidates all of the European functions and risks. The new operating
structure significantly decreases the amount of tax the company pays. By adopting a
permanent reinvestment position under APB 23 the company also reduces its overall
effective tax rate for financial statement purposes.

Question:
Analyse the case and discuss the case facts.

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