Best Practices in Tax

1
Best Practices in Tax Treasury
October 24, 2001 Orrick, Herrington Sutcliffe
LLP Greenwich Treasury Advisors LLC
2
Todays Presentations

• Background on speakers
• Tax issues and opportunities
• Treasury best practices and issues
• Tax Treasury working together

3
Peter Connors

• Tax partner at Orrick, Herrington Sutcliffe LLP
• Past Chairman, ABAs Tax Section Committee on
  Financial Transactions
• Most recent publications, The New Euro
  Regulations, Journal of Bank Taxation (1999)
  see also www.orrick.com
• Author, BNA Portfolio on Section 475
• U.S. Editor, Derivatives Financial Instruments
• Previously, Tax Partner at Baker McKenzie, and
  Director of International Capital Markets Tax
  Services at Ernst Young
• LL.M (Taxation) NYU Law School and J.D.,
  University of Richmond
• Phone [phone] Email pconnors_at_orrick.com

4
Jeff Wallace

• Managing partner, founded GTA in 1992.
• Formerly, VP International Treasury at American
  Express, Assistant Treasurer of Dun Bradstreet
  and of Seagram, CPA with Price Waterhouse
• Author of The G31 Report Core Principles for
  Managing Multinational FX Risk, (AFP, 1999)
• Editorial boards of International Treasurer,
  International Finance Treasury, and Treasury
  Management International
• Phone [phone]
• Email jeff.wallace_at_greenwichtreasury.com

5
Tax Issues and Opportunities

• Leveraging tax-favored investments
• Tax basics of foreign tax credit and impact on
  funding
• Impact of FX on offshore Treasury operations
• The offshore bank for vendor finance operations
• Importance of tax documentation for hedging
  transactions
• Repatriation issues

6
Treasury Best Practices Issues

• Core principles for managing FX risk
• Corporate governance and centralized treasury
  issues
• A compendium of international treasury structures
• In-house banks
• Purchasing receivables without recourse versus
  interco loans
• Virtual Euro cash consolidation via your
  interco netting system
• Agency treasury management (outsourcing)
• The 21st Century MNC Treasury

7
Tax and Treasury Working Together

• Tax Treasury are natural partners
• Common mistakes
• Recommendations

8
Tax Issues and Opportunities

• Peter Connors, Partner
• Orrick, Herrington Sutcliffe LLP

9
Tax Issues and Opportunities

• Leveraging Tax-Favored Investments
• Tax Basics of Foreign Tax Credit and Impact on
  Funding
• Impact of FX on Offshore Treasury Operations
• The Offshore Bank for Vendor Finance Operations
• Importance of Tax Documentation for Hedging
  Transactions
• Repatriation Issues

10
Leveraged Investments in Tax-Favored Investments
- 1

• Interest incurred to purchase or carry tax exempt
  investments is not deductible under IRC 265
• Rev. Proc. 72-18 sets guidelines for determining
  when interest expense is allocable to an
  investment
• The prohibition does not apply in certain de
  minimus situations,
• if the investment if less than 2.0 of assets,
  using adjusted tax basis, it will not apply.
• Should also be able to use excess cash created by
  borrowings to meet reasonable needs of business

11
Leveraged Investments in Tax-Favored Investments
- 2

• By analogy, should apply to money market
  preferred
• Double-up of dividends received deduction?
• Intercompany hybrid instruments

12
Tax Issues and Opportunities

• Leveraging Tax-Favored Investments
• Tax Basics of Foreign Tax Credit and Impact on
  Funding
• Impact of FX on Offshore Treasury Operations
• The Offshore Bank for Vendor Finance Operations
• Importance of Tax Documentation for Hedging
  Transactions
• Repatriation Issues

13
Impact of FTC on Funding 1

• Allocation of Interest Expense
• Interest expense is allocated based comparison of
  foreign and US assets
• Losses on certain interest expense equivalents
  that alter the cost of funds must be allocated
  in same manner as interest expense
• Taxpayers must elect to allocate gains from these
  transactions as a reduction of the cost of funds
  and thus reduce interest expense

14
Impact of FTC on Funding 2

• Under the CFC netting rule, interest incurred on
  certain loans to controlled foreign corporations
  should be allocated directly to foreign income
• If not sufficient foreign income, may result in
  OFL
• The tax benefit associated with the interest
  deduction should include both state and federal
  taxes
• However, if interest expense is allocated to
  foreign source interest and the taxpayer is an
  excess credit situation, a reduction in tax
  benefit should be made

15
Impact of FTC on Funding 3

• Example
• Assume US CO has foreign to worldwide ratio of
  70
• Anticipates borrowing at a cost of 5 or 5
  million
• Tax benefit of 2 million (40 times 5 million)
  should be reduced by 70 to 0.6 million
• Consider strategies to reduce excess FTC
  position, including C-T-B planning and use of
  offshore finance company
• Consider deconsolidated finance company or
• Consider preferred share issuance

16
Tax Issues and Opportunities

• Leveraging Tax-Favored Investments
• Tax Basics of Foreign Tax Credit and Impact on
  Funding
• Impact of FX on Offshore Treasury Operations
• The Offshore Bank for Vendor Finance Operations
• Importance of Tax Documentation for Hedging
  Transactions
• Repatriation Issues

17
Impact of FX on Offshore Treasury Operations-1

• Foreign operations further complicate matters due
  to special rules for foreign source income
• Under the regime for controlled foreign
  corporations, certain categories (baskets) of
  passive income result in foreign personal holding
  company income (FPHCI)
• Gain from property sales
• Interest, dividends, etc.
• Commodities gains
• Foreign currency gain
• Income equivalent to interest (e.g., factoring
  income)

18
Impact of FX on Offshore Treasury Operations-2

• Importantly, losses from one category of
  transaction do not reduce income in the other
  category
• There are hedging regimes within the CFC rules
  that are applicable in addition to the business
  hedging rules.
• It is often necessary to utilize the complete
  integration regimes to avoid FPHCI basketing
  problems.

19
CFC Borrowing Hedged with Swap
US
Loan
CFC
Swap Counterparty
Floating
Floating Interest
Fixed
CFC has 100 of Subpart F income and 100 of
manufacturing income. Assume it has 60 in
interest expense and 20 in swap net income.
Subpart F Income Non-Subpart F
Income Amount 100 100 Int. Expense (
30) ( 30) Swap Income 20
0 Net 90 70
20
Foreign Base Company Sales No Election

Assume CFC has an FC receivable arising from a
foreign base sales activity. It also has 30 of
FX loss in year 1 and 30 of FX gain in year 2.
It has 100 of foreign base company sales income
and 100 of manufacturing income. Year 1 Subpart
F Income Non-Subpart F Income Amount 100 10
0 FX 0 ( 30) Net 100
70 Year 2 Amount 100 100 FX 30
0 Net 130 100
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Foreign Base Company Sales Election
Assume CFC has an FC receivable arising from a
foreign base sales activity. It also has 30 of
FX loss in year 1 and 30 of FX gain in year 2.
It has 100 of foreign base company sales income
and 100 of manufacturing income. Year 1 Subpart
F Income Non-Subpart F Income Amount 100
100 FX (30) 0 Net
70 100 Year 2 Amount 100 100 FX
30 0 Net 130 100
22
Impact of FX on Offshore Treasury Operations-3

• Euro Adoption Issues
• Issue is when is exchange gain or loss and
  translation gain or loss recognized with respect
  to legacy currency denominated transactions
• Generally deferred until repayment
• Planning permitted for receivables and payables
• Election to recognize gain or loss as of last day
  of year prior to the change
• Need to avoid double taxation
• Built-in translation gain/loss to be recognized
  over 4 years beginning with year of change
• Potential for additional changes in functional
  currency

23
Tax Issues and Opportunities

• Leveraging Tax-Favored Investments
• Tax Basics of Foreign Tax Credit and Impact on
  Funding
• Impact of FX on Offshore Treasury Operations
• The Offshore Bank for Vendor Finance Operations
• Importance of Tax Documentation for Hedging
  Transactions
• Repatriation Issues

24
The Offshore Bank 1

• Normally interest income received is subpart F
  income
• Planning possible for related party interest
• Section 954(h)-- Exclusion for Banks, Insurance
  Companies, and Securities firms
• Banking income includes vendor finance
• Requirements
• 70 of income from a lending or finance business
  from unrelated customers
• Includes making of loans and discounting of
  receivables

25
The Offshore Bank 2

• Requirements (contd)
• 30 limitation on non-banking and non-securities
  Income
• Substantial activity requirement in home country
  for cross-border income
• 12 companies have set up operations in Ireland
• Proposed legislation would make section 954(h)
  permanent
• In todays environment, vendor financing may be a
  necessary component of the sales function

26
Tax Issues and Opportunities

• Leveraging Tax-Favored Investments
• Tax Basics of Foreign Tax Credit and Impact on
  Funding
• Impact of FX on Offshore Treasury Operations
• The Offshore Bank for Vendor Finance Operations
• Importance of Tax Documentation for Hedging
  Transactions
• Repatriation Issues

27
Hedging - Importance of Tax Documentation - 1

• The tax issues for hedging transactions are
• Character of G/(L) capital loss versus ordinary
  loss
• Timing of G/(L) recognition consistency of
  income recognition between hedged item and
  hedging instrument
• Two main types of tax hedging regimes
• Business hedging regime. This regime aims at
  solving both timing and character issues
  associated with hedges
• Complete integration regime. Under this regime,
  a transaction and a hedge are fully integrated
  for most purposes of the tax code
• There are, however, other tax hedging regimes
  related to derivatives and hedging activities

28
Hedging - Importance of Tax Documentation - 2

• The type of documentation varies depending on the
  hedging objective and the applicable statute or
  regulation.
• Unlike FAS 133, hedge treatment is not really an
  election
• The basic IRS hedge documentation is similar, but
  by no means identical to 133s
• Description of the hedging instrument
• Description of the hedged item
• Nature of risk being hedged
• Particular documentation requirements for the
  type of taxation regime used
• Description of US Tax accounting method used

29
Hedging - Importance of Tax Documentation - 3

• IRS examiners will routinely ask about the
  taxpayers hedging policies and procedures
• Auditors will have more info than in past
• A properly documented hedge will prevent
  application of the straddle provisions
• It prevents the IRS from having the ability to
  characterize derivative losses as capital and
  gains as ordinary
• In CFC context, avoids creation of foreign
  personal holding company income

30
Hedging - Importance of Tax Documentation - 4

• Improper Documentation Whipsaw
• Failure to identify a transaction as a hedge
• The failure is binding on the taxpayer
• If there is no reasonable basis for not making
  the identification, then gain from the hedging
  transaction is ordinary, but loss will be capital
• If a transaction is improperly identified as a
  hedge
• Identification is binding as to gain
• A loss on the transactions, will be a capital
  loss, however
• Similar rules apply in CFC context

31
Tax Issues and Opportunities

• Leveraging Tax-Favored Investments
• Tax Basics of Foreign Tax Credit and Impact on
  Funding
• Impact of FX on Offshore Treasury Operations
• The Offshore Bank for Vendor Finance Operations
• Importance of Tax Documentation for Hedging
  Transactions
• Repatriation Issues

32
Repatriation 1

• As long as deferral is maintained, taxpayers can
  use low interest tax rate associated with
  offshore operations to provide an EPS benefit
• However, the inability to utilize excess cash
  provides a funding cost
• Common strategies used to access cash
• Factor receivables (only foreign receivables
  though!) and other property sales,
• Foreign tax credit planning
• Short-term intercompany loans

33
Repatriation 2

• Factoring key issues
• Only foreign receivables avoid section 956
• What about receivables of U.S. branches of
  foreign affiliates?
• Need to avoid US trade or business

34
Repatriation 3

• Foreign tax credit planning
• Use interest planning and C-T-B planning to
  create chains of high and low taxed income
• Dividend or make section 956 loans from high tax
  chains

35
Repatriation 4

• Loans from CFCs
• Single Short-Term Loan
• must be less than 3 months and paid off before
  end of the quarter
• Successive loans
• not outstanding at end of quarter
• must be 6 and 1/2 month break between loans
• End of quarter loans
• must not paid off with 30 days and no other loan
  for 59 days by same CFC

36
Peter Connors

• Tax partner at Orrick, Herrington Sutcliffe LLP
• Past Chairman, ABAs Tax Section Committee on
  Financial Transactions
• Most recent publications, The New Euro
  Regulations, Journal of Bank Taxation (1999)
  see also www.orrick.com
• Author, BNA Portfolio on Section 475
• U.S. Editor, Derivatives Financial Instruments
• Previously, Tax Partner at Baker McKenzie, and
  Director of International Capital Markets Tax
  Services at Ernst Young
• LL.M (Taxation) NYU Law School and J.D.,
  University of Richmond
• Phone [phone] Email pconnors_at_orrick.com

37
Treasury Best Practices Issues
Jeffrey Wallace, Managing Partner Greenwich
Treasury Advisors LLC
38
Treasury Best Practices Issues

• Core principles for managing FX risk
• Corporate governance and centralized treasury
  issues
• A compendium of international treasury structures
• In-house banks
• Purchasing receivables without recourse versus
  interco loans
• Virtual Euro cash consolidation via your
  interco netting system
• Agency treasury management (outsourcing)
• The 21st Century MNC Treasury

39
GTAs FX Benchmarking

• Started in 1998 with the Group of 31 Study
  sponsored by General Motors
• 31 MNCs with average sales of 50 billion
• Validated by a 1999 with 36 American MNCs with
  average sales of 8 million
• GM saw a need for establishing worldwide FX risk
  standards for multinationals
• The Group of 30s 1993 derivative standards were
  written for banks
• For MNCs, FX hedging is a non-core, non-profit
  activity which needs different standards than
  those appropriate for banks and institu-tional
  investors.

40
The Group of 31
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G31 Summary Results

• We found that a majority often a large majority
  of the Group of 31 were following each of 12
  core risk management principles that promoted
• Measurable FX hedging objectives
• Accurate and timely information on how well those
  hedging objectives were being achieved
• Minimizing transactions costs
• Rigorous error and compliance checking
• Responsibility for senior management oversight

42
Implementing the Principles

• To provide guidance in implementing these 12 risk
  management principles, weve divided them into
  three categories
• Fundamental principles, which generally
  applicable to all companies involved in FX
  hedging
• Volume-related principles, whose degree of
  implementation is a function of how much trading
  volume is being done
• Risk-related principles, whose implementation is
  also a function of how much risk is being managed

43
12 Core Principles 1
44
12 Core Principles 2
45
Validation by 1999 Study

• The following year, we validated these principles
  with a second group of 36 American MNCs,
  including

46
Volume-Related Practices
47
Risk Categories

• We found we could use these risk dimensions to
  divide the both the 1998 and 199 groups into
  three risk categories

48
Risk-Related Practices
49
For More Information

• Go to www.greenwichtreasury.com to download
• The Group of 31 Report Core Principles for
  Managing Multinational FX Risk (1999, Association
  for Finance Professionals)
• Describes each principle in more detail, with
  benchmarking data from the Group of 31 study.

50
Treasury Best Practices Issues

• Core principles for managing FX risk
• Corporate governance and centralized treasury
  issues
• A compendium of international treasury structures
• Centralizing cash and funding
• In-house banks (IHBs)
• Purchasing receivables without recourse versus
  interco loans
• Virtual Euro cash consolidation via your
  interco netting system
• Agency treasury management (outsourcing)
• The 21st Century MNC Treasury

51
Corporate Governance Issues

• Four key questions about the allocation of
  treasury management between the local
  units/regional management and Parent Treasury
• Who owns the cash?
• Who is responsible for funding/liquidity?
• Who runs the foreign exchange?
• Who is responsible for bank relations?
• Two challenges
• Making treasury responsive to the needs of the
  operating units
• Making operating units responsive to treasury
  initiatives

52
Decentralized Treasury Management 1

• Decentralized treasury management incurs
  substantial costs in large MNCs
• Buy/sell spreads on unnecessary borrowing when
  there is excess cash in the group
• Buy/sell spreads on offsetting FX positions
• Higher interest, FX, and cash management costs
  due to non-professional management and
  diseconomies of scale
• Unnecessary taxes due to suboptimum unit capital
  structures and neglected cross-border tax
  arbitrage opportunities

53
Decentralized Treasury Management 2

• Decentralized treasury management is also
• An inefficient allocation of local management
  resources
• Except for proximity, local management provides
  little value-added to treasury management
• Reduces the ability of the corporation to fully
  mobilize all of its financial resources
• Arguably, the role of local management is to
  produce profits, not to manage profits

54
How Responsibilities are Allocated
Base 64, G31 and FX99 Companies
55
Treasury Best Practices Issues

• Core principles for managing FX risk
• Corporate governance and centralized treasury
  issues
• A compendium of international treasury structures
• Centralizing cash and funding
• In-house banks (IHBs)
• Purchasing receivables without recourse versus
  interco loans
• Virtual Euro cash consolidation via your
  interco netting system
• Agency treasury management (outsourcing)
• The 21st Century MNC Treasury

56
Centralized FX Management Structures
57
Cross-Unit Treasury Building Blocks
Distributed treasury staff, SPVs and banks
RTC Regional Treasury Center
58
Cash Concentration Methods
59
Treasury Best Practices Issues

• Core principles for managing FX risk
• Corporate governance and centralized treasury
  issues
• A compendium of international treasury structures
• Centralizing cash and funding
• In-house banks (IHBs)
• Purchasing receivables without recourse versus
  interco loans
• Virtual Euro cash consolidation via your
  interco netting system
• Agency treasury management (outsourcing)
• The 21st Century MNC Treasury

60
Centralizing Cash/Funding 1

• The traditional approach is to use intercompany
  advances and loans
• Arms length pricing
• Interest subject to withholding tax
• Since loans cant be made upstream to parent
  (imputed dividend), often intercompany loans are
  made within the the off-shore companies
• Multilateral lending can lead to a spaghetti
  interco loan structure that can be extremely
  difficult to manage
• Bilateral lending with in in-house bank is best
  practice

61
Reasons for In-House Banks

• Maximize internal cash recycling
• Centralize international cash and FX management
  in one unit with specialist expertise, reducing
  staff at local units
• Retain spreads in the IHB, instead of paying to
  banks
• Reduce transaction volume and bank charges

62
Centralizing Cash/Funding 2

• Purchasing trade receivables without recourse
• Selling unit continues to collect
• Immediate bad debt deduction by seller
• No W/H tax on discount income due to non-recourse
  nature (discount not considered interest)
• Monthly purchases effectively provide evergreen
  interco working capital funding
• Funding the receivables with dollars covered with
  forwards are often more cost-effective than local
  funding, especially in emerging market countries
• Minimizes thin cap problems due to reduced debt

63
Centralizing Cash/Funding 3
64
Overlay Bank Structure Issues

• Many, many accounts have to be set up
• Local red tape can be immense
• Need for daylight overdraft lines further
  complicates the implementation
• Parent guarantees
• Local units Board approvals
• No one will ever, ever do this again for another
  bank

65
Centralizing Cash/Funding 4

• Consolidate cash by piggy-backing off of the
  existing interco netting system
• Add the IHB to the netting system
• Units will excess cash make payments to IHB
• Units needing cash receive payments from IHB
• Monthly nettings with cash transfers and trade
  payables probably pick up at least 60 of the
  excess cash
• Use the process to book settle the interco
  payables
• Weekly nettings with cash transfers only will
  probably pick up 80 of the excess cash
• No muss, no fuss, immediately implementable

66
Agency Treasury Management 1

• Outsource the IHB transaction processing (not
  risk management)
• Major bank providers are AIB, BofA Citi, DB, JP
  Morgan Chase
• Non-bank providers include FTI, JM Huber
  Financial Services
• Internet providers are starting to develop
• Most are based in Dublin, having started with the
  Dublin Docks IFSC's

67
Agency Treasury Management 2

• Substantial care and forethought is needed in the
  operating agreement with the provider
• Must have service level guarantees
• Must be actively managed by Treasury, not
  forgotten
• Focus on output, not process
• Process is the providers job
• Treasury must be alert to changes in operating
  environment
• Cant expect provider to pro-active, looking for
  what needs to be done

68
Agency Treasury Management 3

• Use the providers system for parent treasury
  transactions
• Have them execute the FX hedging trades under
  your direction
• Have them do the FAS 133 accounting!
• And the performance analytics

69
The 21st Century MNC Treasury 1

• Treasury works with and supports the business
  units, not just another demander of information
  from them
• Risk management is disciplined and pro-active
  with active business unit participation with the
  hedging decision-making within policy
• Clearly defined risk performance measures show
  the value-added that Treasury provides
• Truly centralized cash management and funding via
  an IHB

70
The 21st Century MNC Treasury 2

• Close co-operation with Tax generates tax savings
  and lower after-tax cost of interest
• Treasury has a higher level of internal
  influence, no longer considered a cost center
• Treasury staff have greater career opportunities

71
Jeff Wallace

• Managing partner, founded GTA in 1992.
• Formerly, VP International Treasury at American
  Express, Assistant Treasurer of Dun Bradstreet
  and of Seagram, CPA with Price Waterhouse
• Author of The G31 Report Core Principles for
  Managing Multinational FX Risk, (AFP, 1999)
• Editorial boards of International Treasurer,
  Finance Treasury, and Treasury Management
  International
• Phone [phone]
• Email jeff.wallace_at_greenwichtreasury.com

72
About GTA

• Ninth year, over 200 clients
• Dedicated to corporate treasury consulting
• Not affiliated with Greenwich Associates
• Best known for our benchmarking studies

• Visit www.gtallc.com for more details

73
Tax Treasury Working Together
October 24, 2001 Orrick, Herrington Sutcliffe
LLP Greenwich Treasury Advisors LLC
74
Tax and Treasury Working Together

• Tax Treasury are natural partners
• Common mistakes
• Recommendations

75
Tax Treasury are Natural Partners

• Despite what Controllers may think, Tax and
  Treasury are the core of Finance, with major PL
  operating responsibilities
• Interest, FX and Taxes
• Together, they are the denominator of the EVA
  formula
• Firm value Future Cash Flow ? WACC
• Managing WACC improves Firm Value
• Treasury provides the raw fuel money
  necessary to execute many Tax planning
  arrangements
• Nearly all international transactions are an
  exercise in international tax arbitrage
• A focus on just reducing taxes can lead to
  structures that have immovable cash or unpayable
  debt

76
Common Mistakes

• The Inadvertent Dealer
• Hedging with the Wrong Instrument
• Failed Hedging Identifications
• Failed Interest Expense Allocation
• Back to Back Loans Through An Active Subsidiary
• Tax planning with no exit strategies

77
Tax Trap The Inadvertent Dealer
US
Hedge Co
US Subsidiary
Foreign Sub

• Transactions with US Subsidiary Probably not
  dealer
• Transaction with Foreign Subsidiary Hedge Co.
  becomes a dealer
• What if Hedge Co is an LLC?
• Protective Identification

78
Failed Hedging Identifications

• Consequences described earlier
• Over reliance on GAAP designations and
  determination of whether a transaction is a
  derivative
• Many designations are not elective for tax
  purposes
• Either adverse consequences for failed
  designations or IRS can designate for the
  taxpayer
• Designations must also be made at CFC level

79
CFC Functional Currency Borrowing

Loan
Bank
Interest
Assume CFC borrows from a third party bank. It
has 100 in Subpart F income and it has 100 in
operating income and 40 in interest
expense. Subpart F Income Non-Subpart F
Income Amount 100 100 Int. Expense (
20) ( 20) Net 80 80
80
CFC FX Borrowing - No Designation
US
Currency Swap
FX Loan
CFC
Swap Counterparty
Interest
Assume CFC borrows from a third party bank. It
has 100 in Subpart F income and it has 100 in
operating income and 40 in interest expense. It
also has a currency loss of 20 on retirement of
the obligation, but a gain of 20 on termination
of the swap. Subpart F
Income Non-Subpart F Income Interest
FX Amount 100 100 Int. Expense ( 20)
(20) Retire of Debt (FX) ( 10)
(10) Curr Swap Gain (principal)
20 ____ Net 70 20 70
81
Common Mistakes

• The Inadvertent Dealer
• Failed Hedging Identifications
• Hedging with the Wrong Instrument
• Failed Interest Expense Allocation
• Back to Back Loans Through An Active Subsidiary
• Tax planning with no exit strategies

82
CFC Functional Currency Borrowing Hedged with
Swap
Loan
Swap Counterparty
Floating
Floating Interest
Fixed
Assume it has 60 in interest expense and 20 in
swap net income. Subpart F Income Non-Subpart
F Income Interest Property Amount 100
100 Int. Expense ( 30) ( 30) Swap Income
20 0 Net
90 70
83
CFC Functional Currency Borrowings Hedged with
Forward Contract
Loan
Short FuturesContract
Interest
Assume CFC borrows from a third party bank. It
has 100 in Subpart F income and it has 100 in
operating income and 60 in interest expense.
Assume that it also has 20 in hedging gains from
futures contracts. Subpart F
Income Non-Subpart F Income Interest Property
Gains Amount 100 100 Hedging Gains
20 Int. Expense ( 30) _____ (
30) Net 70 20 70
84
Common Mistakes

• The Inadvertent Dealer
• Failed Hedging Identifications
• Hedging with the Wrong Instrument
• Failed Interest Expense Allocation
• Back to Back Loans Through An Active Subsidiary
• Tax planning with no exit strategies

85
Common Mistakes

• Failed Interest Expense Allocation
• An election must be made to allocate gain from
  hedging transactions against interest expense
• Without the election, hedging costs are treated
  like interest expense, but gains do not reduce
  it

86
Common Mistakes

• The Inadvertent Dealer
• Failed Hedging Identifications
• Hedging with the Wrong Instrument
• Failed Interest Expense Allocation
• Back to Back Loans Through An Active Subsidiary
• Tax planning with no exit strategies

87
Back-to-Back Loans
US
Loan
Loan
CFC
Interest
Interest
Assume CFC lends 2,000 to a non-CFC. It has 100
in Subpart F income and it has 100 in operating
income and 20 in interest income. It also
borrows 2,000 and incurs 100 of interest
expense. Subpart F Income Non-Subpart F
Income Amount 100 100 Int. Income
20 Int. Expense (10) (10) Net 110
90
88
Tax Planning with No Exit Strategies

• Creating international holding companies or
  selling technology/intellectual property rights
  to an entity in a tax haven or very low tax rate
  environment
• APB 23 is used to avoid providing for deferred US
  taxes on the income
• Money goes in tax-free for both book and tax, but
  cant come out to the US parent without incurring
  US taxes and book taxes
• The foreign affiliate cash flow is effectively
  locked in the entity meanwhile the US parent has
  substantial debt that cannot be repaid from
  domestic-sourced income, especially taking into
  account funding dividends
• Its a devils bargain

89
Recommendations 1

• Regular meetings between Tax and Treasury,
  especially on these topics
• Treasurys funding strategies
• Taxs planning strategies and objectives
• Tight coordination on derivative hedge
  documentation
• For both FAS 133 and IRS/local authorities
• Dedicated people in both departments responsible
  for the relationship
• Acts as an observer in the others departmental
  meetings
• Active Tax participation on the Companys
  Financial Risk Committee

90
Recommendations 2

• Annual joint planning on
• Utilizing excess FTC/managing FTC neutrality
• Repatriation issues
• After-tax cost of debt
• Interco leading and lagging
• Dealing with excess cash
• Domestic interest allocation to foreign
  investments
• Utilizing local affiliate tax-loss carrryforwards
• Thin cap issues

91
Recommendations 3

• Joint tax/treasury departmental targets
• Specific tax savings
• After-tax cost of interest savings
• Double counting of results in each departments
  goals