1 © baker tilly virchow krause, llp doing business in the u.s. an update and review of u.s.-canada...

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©Baker Tilly Virchow Krause, LLP

Doing Business in the U.S.An update and review of U.S.-Canada taxation for the Windsor-Essex Regional Chamber of Commerce

Wednesday, February 25, 2015

Windsor, Ontario

© 2015 Baker Tilly Virchow Krause, LLPBaker Tilly refers to Baker Tilly Virchow Krause, LLP,

an independently owned and managed member of Baker Tilly International.

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Introductions

Paul FinegoldSenior Manager, Baker Tilly

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This Morning’s Agenda

• Introductions

• State taxation and requirements

• Evolving topics in state taxation

• U.S. federal tax incentives

• Certain U.S. filing requirements of Canadian entities

• U.S. transfer taxes & ownership of U.S. property

• Current U.S. voluntary disclosure program

• Selected Canadian considerations

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> Multiple locations in different major regions of the country

> Specific industry capabilities

> Firm association or network affiliation extends around the world

> Clients in all parts of the country

> Reputation among peers for quality and ability to service clients nationally

> Leadership inside the profession through participation in key professional activities

A nationally recognized firm

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> A global brand

> Eighth largest global network

> Complete global coverage

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State taxation and requirements

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Each state has its own filing requirement rules!

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Requirement to file will depend on tax type

A state will typically have either or both of the following types of taxes:

1) Corporate income tax

- Based on taxable income (“old school” tax)

2) Privilege/franchise tax

- A tax for the right of doing business in the state

(“new school” tax)

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State Income Tax Computation

Federal Taxable Income

State Modifications

State Taxable Income

State ApportionmentTax RateTax

Income tax

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Privilege taxes – the wave of the future!

Types of privilege taxes:

1) Gross receipts tax (Ohio & Texas)

2) Net worth tax (Pennsylvania)

3) Capital stock tax (Delaware)

These are the more creative state taxes

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Why are states going to a privilege tax?

1) Tax is usually not based on net income so it is harder to develop tax strategies to reduce tax

2) More consistent revenue stream for the states

3) Allows states to tax out of state companies!

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What determines if I have a state filing requirement?

Nexus describes the amount and degree of business activity that must be present before a state can tax an entity's income.

If a taxpayer has nexus in a particular state, the taxpayer must pay and collect/remit taxes in that state.

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U.S. Congress to the rescue!

The Interstate Income Act of 1959, also known as Public Law 86-272, is a United States statute that allows a business to go, or send representatives, into a state to solicit orders for goods without being subject to a net income tax.

- only applies to taxes based on income

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Income tax nexus

Nexus is created for income tax purposes if an entity derives income from sources within the state, owns or leases property in the state, employs personnel in the state in activities that exceed "mere solicitation," or has capital or property in the state. The requirements vary from state to state.

It is really a physical presence test!

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Physical presence test

States are attacking the physical presence test.

MBNA America Bank, N.A v. Indiana Department of State Revenue

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Franchise tax nexus

Much more aggressive nexus standard.

Uses other factors to determine if you have a filing requirement.

More of an economic test.

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Franchise tax nexus

Nexus can be created by:

1) Having sales in excess of a certain threshold in the state (Michigan pre 2012)

2) Activity in the state (Ohio)

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Evolving topics in state taxation

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Abandoned and Unclaimed Property

“Generally refers to accounts in financial institutions and companies that have had no activity generated or contact with the owner for one year or longer.”

National Association of Unclaimed Property Administrators

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Unclaimed Property

The “Situation”

The various state unclaimed property administrators estimate that businesses currently have a compliance rate of only 20%

An analysis completed in 2005 revealed over 20 billion dollars of unclaimed property in state coffers. Only 20% is ever returned to the rightful owner.

The amounts are only getting larger

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Dollars at Stake

States are holding $10 - $35 billion worth of unclaimed property

Some estimates place the amount of unclaimed property held by private businesses at $100 billion

California holds over $3.2 billion in unclaimed property

Florida has over $800 million Massachusetts is holding over $234 million

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Examples of UP

> Customer overpayments and credit balances> Payroll checks to employees> Gift certificates and cards> Credit memos> Tangible personal property under a custodial arrangement,

e.g., safe deposit box> Dividend checks to shareholders> Interest checks to bondholders

There are over 100 categories of “escheatable” property

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UP Exposure Risks Can be High

No statute of limitations Audits are generally multi-state Third party auditors paid on commission Lack of uniformity among states Large penalties and interest rates No administrative appeal Burden of proof is on the property holder NO NEXUS STANDARDS

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Unclaimed Property

> States are active and aggressive

Penalties, interest and fines can exceed the amount of the actual Unclaimed Property

In most states there is no statue of limitations

Every company has Unclaimed Property. It is now a cost of business. Every state has its own requirements.

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Penalties for Failing to Report UP

> Delaware: 0.5% of property value per month maximum of 5%. Interest 0.5%

per month maximum of 50%.

> Illinois: $500 per day, in addition $100 for each day report is late. Willful failure is

Class B misdemeanor.

> Michigan: $100 per day, maximum $5,000. Willful failure 25% of the property value.

> Minnesota: Misdemeanor

> Wisconsin: $100 per day, maximum $5,000. Willful failure 25% of property value.

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Sales & Use Tax

> State and local governments are pushing hard to require on-line retailers to collect tax

> Estimated state-local sales taxes “lost” on internet purchases ($24 billion in 2012)

> Legislation favorable to the states has been gaining steam as of late

> Amazon.com

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> Internet Sales

Not inherently exempt from tax Does the physical presence test still apply? New York’s “click through” nexus law and

litigation

Amazon.com presumed to be vendor required to collect sales tax on sales when it entered into commission agreements with internet “affiliates” or aggregators that referred potential NY customers to it for a commission.

Click-Through Nexus

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> “Click-Through” Nexus Nexus established through business relationship

between retailer and internet affiliates/aggregators Sales referred directly or indirectly via a link on

affiliates/aggregators website In-state customers “click through” to seller Must have a commission or similar agreement Active solicitation by affiliate/aggregator - “rebuttable

presumption” option? In-state gross receipts test: $10,000 / previous 12

months

Click-Through Nexus

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Click-Through Nexus: Developments

> States that have enacted a “click-through” nexus statute:

– Arkansas – Illinois* – Pennsylvania

– California – New York – Rhode Island

– Connecticut – North Carolina – Vermont

– Georgia

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U.S. federal tax incentives

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Tax Incentives

• U.S. R&D Tax Credit

• Domestic Production Activities Deduction (DPAD)

• Facility Review• Cost Segregation• Repairs & Maintenance Review• Section 179D Deduction

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Research Tax Credit Background

• Research tax credit is available to any company that develops new or improved products, processes, or designs

• Objective was to stimulate R&D spending in US and ensure US companies maintained technical edge

Established by the Economic Recovery Act of 1981

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R&D Tax Credit, What Qualifies: Project Identification

Development of a new or improved “business component”:

> Product

> Process

> Technique

> Formula

> Invention

> Computer Software

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Project Identification

The activities must meet each of the following:

• Engineering / Computer Science / Physical or Biological Sciences

Be technological in nature

• New or improved level of function, performance, reliability, quality, OR significant cost reduction

Project Goal is for a permitted purpose

• Technical uncertainty• Capability / Methodology / Design

Involve the Elimination of Uncertainty

• Evaluation of design alternatives• Simulation, modeling, testing, etc.

Involve a process of experimentation

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Examples of Qualified Research Activities

> New product development> New process development> New line development> New molds and new layouts> Certain trials/laboratory experimentation> Process optimization or cost reduction> Just about anything leading to a patent or certification> Design engineering applicable to multiple customers> Determining technical and functional specifications > Modeling, simulation, or testing to validate design

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Examples of Non Qualified Activities

> General and administrative activities> Non-technical managerial functions> General sales and marketing activities> Budgeting and scheduling> Financial and cost analysis> Service and installation> Travel time> Activities conducted outside of the U.S.

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Qualified Research Expenditures (QREs)

Employee Wages> Performing, supporting or supervising the research

> Efforts need to be directly tied to technical aspects of the project

Supplies> Materials used in the conduct of R&D

> Examples: prototypes, mock-ups, must be non-capital in nature

Contract Research> Payments to others (non-employees) to conduct contract research

> Examples: Engineering, testing, design services

> Must bear financial risk and retain research rights

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Substantiation Documentation

Project Tracking> Project Identification and related expense identification

> Develop comprehensive project list

> No set IRS rule – utilize existing documentation!

> Identify project name, duration, manager and summary

> Expense qualification

> Wages: Contemporaneous time tracking and documentation

> Supplies: General ledger accounts or other detail

> Contractor Expenses: Invoices, scope of work, T&M detail

> Other: engineering calculations, design drawings, proposals

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Domestic Producers Activities Deduction

Equal to 9.00% of the lesser of: qualified production activities income or taxable income

Is a permanent deduction, not a credit

Qualifying Activities if performed in the U.S.:• Manufacturing, growing, extracting, producing tangible

property• Construction activities• Engineering or architectural services for US projects

Possibility of missed deductions or allocation methodologies for companies not limited by taxable income (i.e., software development, engineering and construction)

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Facility Review

> New construction

> Remodeling or retrofit

> Rehabilitation of old/historic structure

> New space vs. lease renewal (including leasehold improvements)

> Transferring equipment or employees from another facility

> Acquiring a business

Some Tax Considerations: cost segregation, repairs

& maintenance review, 179D

deduction

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Certain U.S. filing requirements of Canadian entities

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> U.S. tax law provides that every corporation subject to taxation must file a return

> Foreign corporations engaged in a trade or business in the United States at any time during the taxable year must file Form 1120-F

> Filing requirement applies even when income is exempt from tax because of a treaty

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> In order to take a position that a treaty modifies U.S. tax law, a foreign corporation is required to disclose that position by making certain filings with the IRS

> Definition of engaged in trade of business

> This is a facts and circumstances determination

> The courts have looked at the level of the foreign person's actions in the U.S. to determine whether the person is engaged in a “trade or business,” i.e. , the extent to which the actions are considerable, continuous and regular

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> A foreign person holding substantial real estate in the U.S. was engaged in a U.S. business where its agent's management activities were considerable, continuous, and regular

> Holding board of director meetings in U.S. was not the operation of a business in the U.S.

> Collecting income from investments and sporadic sales was not the conduct of a business (single isolated transaction was not a business)

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> Engaged in trade or business within the U.S. implies something more than a single isolated act or transaction

> It means conducting and continuing business by carrying on progressively all the acts normally conducted with the business

> This determination is made by applying the regulations to the facts and circumstances of each case

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> General factors to consider:

- What activity does the foreign corporation have in the U.S.? Part of active business Percentage in relation to total sales Continuous and regular (i.e., not isolated, casual or occasional

transaction)

- Did corporation engage a dependent agent to conduct activity in U.S.?

- If independent agent has been engaged, what are the extent of his activities, and are they continuous and regular, percentage, etc?

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> Activities of persons subject to a high degree of control by the relevant foreign person, such as employees and so-called “dependent” agents acting exclusively or almost exclusively for an entity, are properly imputed to it

> Even activities of independent agents have sometimes been imputed to foreign persons if the relationship between the independent agent and the foreign person is characterized by some degree of regularity

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EXAMPLE: Sales Through a U.S. Person

Foreign Corporation retains a U.S. commission merchant and instructs it to attempt to sell its turpentine to retail hardware stores. On a regular basis, the merchant solicits orders from U.S. purchasers and remits them to Foreign Corporation in France which fills the orders and ships the product to the U.S. customers. During the course of the taxable year it sells 200 barrels of turpentine. No single order is larger than 6 barrels.

The activities of the U.S. commission merchant are most likely imputed to Foreign Corporation for purposes of determining whether it is engaged in a trade or business in the United States for that taxable year.

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EXAMPLE: Agent with Exclusive Rights

Foreign Corporation manufactures devices in its home country for sale in the United States. It ships them to a warehouse located at a U.S. port. The devices are sold from the warehouse by a factory representative who has exclusive sales rights to sell them in the United States, and who is paid a commission.

The factory representative's activities are imputed to Foreign Corporation for purposes of determining whether it is engaged in a trade or business in the United States.

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> An important distinction is whether a relationship is a principal-agent relationship at all, as opposed to a purchaser-seller relationship

> If a foreign person sells goods to a U.S. person for independent resale, the U.S. purchaser is not the agent of the foreign person

> Likewise, if a U.S. person sells goods to a foreign person for independent resale by the foreign person, the U.S. person is not an agent for the foreign person. This may be the case even if the U.S. person arranges to have the goods shipped directly to the foreign person's customers

> An important element of this distinction is the economic independence of the two legs of the transactions, including that a genuine purchaser takes on the economic risk of loss of the goods

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> If engaged in a trade or business in the U.S., then effectively connected income has to be reported on Form 1120-F

> If a foreign corporation has a U.S. trade or business during the taxable year, whether the income is effectively connected depends upon the source of that income, it’s character, and whether the foreign corporation has an office or other fixed place of business in the U.S.

> All effectively connected trade or business income is subject to regular U.S. graduated income tax rates, the alternative minimum tax rates, the environment tax, or the alternative capital gains tax

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> All U.S. source income, except for certain capital gains and fixed, determinable, annual or periodic (“FDAP”) income, is treated as effectively connected income

> Capital gains and FDAP income may be effectively connected depending upon their relationship to the foreign corporation's U.S. activity

> If the foreign corporation has a U.S. trade or business that operates from an office or other fixed place of business in the U.S., then certain foreign source income, as well as U.S. source income, will be treated as effectively connected income

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> Permanent Establishment

- U.S.-Canada Income Tax Treaty

Under the treaty, the business profits of a resident of a State are taxed only in that State unless the resident carries or has carried on business in the other State through a permanent establishment situated in the other State in which case the business profits of the resident may be taxed in the other State but only so much of them as is attributable to that permanent establishment

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> Under the U.S.-Canada treaty, a “permanent establishment” is a fixed place of business through which the business of a resident of a State is wholly or partly carried on

> The term includes: a place of management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry, or any other place that removes natural resources

> A building site, construction or installation projects a permanent establishment if it lasts more than 12 months. The use of an installation or drilling rig or ship in a State to explore for or exploit natural resources constitutes a permanent establishment if, but only if, such use is for more than three months in any twelve-month period

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Permanent establishment

> A permanent establishment is deemed to exist in a State where a person (other than an independent agent) has the authority to sign contracts on behalf of a resident of the other State and habitually does so

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> However, a permanent establishment does not include a fixed place of business used solely for, or a person referred to in the previous paragraph engaged solely in, one or more of the following activities:

(1) the use of facilities solely to store, display, or deliver goods or merchandise of the enterprise

(2) the maintenance of inventory or merchandise belonging to the enterprise solely for storage, display, or delivery purposes;

(3) the maintenance of inventory or merchandise belonging to the enterprise solely to be processed by another enterprise;

(4) the purchase of goods or merchandise or the collection of information for the enterprise; and

(5) advertising, supplying information, scientific research or similar activities that are of a preparatory or auxiliary character. An enterprise does not have a permanent establishment in a State merely because it carries on business in that State through a broker,

general commission agent, or any other agent “of an independent status,” provided that person acts in the ordinary course of its business

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> Where an enterprise of Canada provides services in the U.S., if that enterprise is found not to have a permanent establishment in U.S., that enterprise will be treated as providing its services through a permanent establishment in U.S. if and only if:

(a) those services are performed in U.S. by an individual who is present in that other State for a period or periods aggregating 183 days or more in any twelve-month period, and, during that period or periods, more than 50% of the gross active business revenues of the enterprise consists of income derived from the services performed in that other State by that individual

(b) the services are provided in US an aggregate of 183 days or more in any twelve-month period regarding the same or connected project for customers who are either residents of US or who maintain a permanent establishment in U.S. and the services are provided regarding that permanent establishment

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> Thus, if there is no permanent establishment based on the application of the U.S.-Canada income tax treaty, then a protective Form 1120-F should be filed to assert Treaty protection

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U.S. transfer taxes & ownershipof U.S. property

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U.S. transfer taxes & ownership of U.S. property

> Planning for globally-mobile/dual-jurisdiction individuals

- Frequency of moves increasing

- Ease of global asset ownership

- Increases in complexity of investments and continued use of strategic ownership structures

> Impact(s) on U.S. and/or Canadian taxation, and estate plans

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Certain Canadian Taxes

> Canadian transfer taxation

- No estate/inheritance tax- No gift tax

> Capital assets disposition tax

> Nonresidents of Canada passing-away with ownership of Canadian-situs property may have deemed sale

> Exit/departure tax upon ceasing to be resident

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U.S. transfer taxes & ownership of U.S. property

> U.S. transfer taxes

- Estate tax (at death)- Gift tax (during life)- Generation-skipping transfer tax (either/both)

> Other U.S. taxes

- “Exit” tax

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U.S. Transfer taxes: A historical perspective

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1916

1919

1922

1925

1928

1931

1934

1937

1940

1943

1946

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015

2018

2021

2024

Top Marginal Gift Tax Rate Top Marginal Estate Tax Rate

Sources: Tax Policy Center, Urban Institute and Brookings Institution, The Labyrinth of Capital Gains Tax Policy by Leonard E. Burman, CCH

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Estate, gift, and GST taxes post-ATRA

Year Estate tax exemption Basis method GST tax

exemptionTop estate/

GST tax rateGift tax

exemptionTop gift tax

rate

2009 $3.5 million Step up in basis $3.5 million 45% $1 million 45%

2010- 0 - Modified

carryover basis - 0 - 0%$1 million 35%

$5 million Step up in basis $5 million 35%

20111 $5 millionStep up in

basis

$5 million35%

$5 million35%

20122 $5.12 million(portable) $5.12 million $5.12 million

(portable)

2013 $1 million Step up in basis $1.36 million 55% $1 million 55%

2013 ATRA

$5.25 million(portable)

Step up in basis $5.25 million 40% $5.25 million 40%

1 Beginning in 2011, there was the introduction of the portability of the estate tax exemption between married couples (Note: not applicable to GST tax or state estate tax exemptions). Under ATRA, portability provision extended. 2 Estate, GST, and gift tax exemptions were indexed for inflation in 2013.

Annual exclusion for 2015 indexed for inflation to $14,000 (up from $13,000 in 2012)

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Current U.S. estate planning under ATRA for U.S. citizens and domiciles

> $5.43 million federal exemption ($10.86 million, if married)

> Portability of exemption/credit between spouses

> Value of many assets still low

> Current estate “freeze” techniques and family partnership discounts can’t be assumed to remain available indefinitely

- U.S. Congress considering changes to GRAT term and gift requirements, disallowance of discounts, etc.

> Estate planning is not only applicable to taxable estates: important not to forget the non-tax estate planning needs

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U.S. estate tax for non-citizens / non-domiciles

> U.S. estate tax on U.S.-situs property

- U.S. real property (e.g., land, buildings, fixtures, etc)- Tangible personal property situated in U.S.

Cash/currency generally considered tangible property- U.S. stock (irrespective of certificate location)

Different rule for lifetime gifts of U.S. stock- Certain U.S. life insurance and annuity contracts- Certain U.S. debt

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General rules: U.S. estate & gift taxes

> Estate tax exemption for non-U.S. person (non-citizen, non-resident) is $60,000 (versus current $5.25 million)

> Gift tax exemption for non-U.S. person is zero (versus current $5.43 million)

> No marital deduction for estate tax purposes for transfers to non-U.S. citizen spouses (versus unlimited)

> Lifetime gifts to non-U.S. citizen spouses are afforded enhanced annual exclusion, currently $147,000

> Annual gift tax exclusion of $14,000 per donee per year for present-interest gifts for both U.S. and non-U.S. persons

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U.S.-Canada Income Tax Treaty

> U.S. and Canada do not have separate estate tax treaty

> However, U.S. transfer tax relief provided in U.S.-Canada income tax treaty

- Article XXIX B: Taxes Imposed by Reason of Death

Canadian citizens not U.S. citizens/residents at death U.S. citizens resident in Canada at death Ownership of U.S.- or Canadian-situs assets at death

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> Charitable estate tax deduction

> Pro-rata U.S. estate tax unified credit

> Marital estate tax credit

> Foreign death tax credit

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> U.S. citizen decedent’s estate, who is not a resident of Canada, owns Canadian real property- Likely to incur Canadian capital gains tax- Foreign death tax credit allowed in U.S. for amount paid

to Canada

> Canadian decedent owned U.S.-situs real property- May be able to offset Canadian income tax with credit of

amount equal to U.S. estate tax related to U.S. asset

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Structuring ownership of U.S. property

> Foreign (non-U.S.) corporation

- Foreign corporate stock not U.S.-situs property and out of U.S. gross estate

- Must follow formalities / not commingle- Canadian taxable shareholder benefit (income tax)- Costs of incorporation and annual administration

> “Single-purpose” Canadian corporations- U.S. securities

> Canadian trusts (or U.S. qualified domestic trust)

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Current U.S. voluntary disclosure programs

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U.S. voluntary disclosure initiatives

> U.S. citizens- Including dual-citizenship holders

> U.S. greencard holders (permanent residents)

> U.S. residents

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> As of June 2012, the U.S. offshore voluntary disclosure programs had collected over $5 billion from taxpayers

> Includes back taxes, interest, and penalties

> Over 33,000 voluntary disclosures at that time

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> Form 1040

> TD F 90-22.1 / FinCEN 114 (Foreign Bank Account Report)

> Form 8938

> Information reporting (Forms 5471, 8621, 926, etc)

> FATCA

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Selected Canadian Considerations

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Selected Canadian Considerations

> Important to comply with Canadian income tax foreign reporting obligations - T1134 Form – due 15 months after year-end- T106 Form – due 6 months after year-end

• Exercise care when reviewing form – each false statement or omission subject to a $24,000 penalty

> Transfer Pricing considerations- Specific documentation and evidence (“Contemporaneous

Documentation”) required to support non-arm’s length transactions with non-residents to mitigate the risk of penalties

- Penalty is computed as 10% of the total of the transfer pricing adjustments if this total exceeds the lesser of 10% of gross revenue or $5M

- Penalty applies to the full amount of the pricing adjustments (not just the tax on the pricing adjustments) if the appropriate documentation is not in place

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Tips and Traps with Doing Businessin the U.S.

> If U.S. operations are considered “active” business for tax purposes, significant deferral opportunity may be available to the extent individual shareholders do not extract any after-tax profits

> Intercompany transactions – “Low hanging fruit for the IRS”- Management fees- Reimbursement of costs – need to be very careful which costs are being

reimbursed

> Structure considerations- Need to exercise caution when introducing Limited Liability Companies

(“LLCs”) in your outbound structure- Commencing in 2009, outbound LLCs may be subject to 30% U.S.

Branch Tax• Results in an overall U.S. tax rate of up to 54.50% (plus state tax)!

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Presenters

For additional information, please contact us:

Scott Dupuis 519 258 5800 [email protected]

Dan Dwyer 519 258 5800 [email protected]

Paul Finegold 248 368 8828 [email protected]

Nachu Vellayappan 248 368 8812 [email protected]

Bryan Bussert 248 368 8858 [email protected]

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The content in this presentation is a resource for Baker Tilly Virchow Krause, LLP clients and prospective clients. Nothing contained in this presentation shall be construed as legal advice, opinion, or as an offer to buy or sell any property or services. Any tax advice contained in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code, nor may any such tax advice be used to promote, market or recommend to any person any transaction or matter that is the subject of this communication and any attachments.

The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

Disclosure

1 © baker tilly virchow krause, llp doing business in the u.s. an update and review of u.s.-canada...

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