Country-by-Country Reporting: VIEs, PEs, Grantor Trusts and Other Nuances

International tax issues sit high on the political agenda for most countries.  Among those issues, few rank higher than transfer pricing policies.  Recent years have seen a trend toward Country-by-Country (CbC) reporting, with many countries adopting the OECD’s Base Erosion and Profit Shifting (BEPS) CbC reporting regime to target transfer pricing risks.  The United States, indeed, adopted a CbC reporting regime consistent with Action 13 of the OECD’s Final BEPS regime, requiring U.S. multinational enterprises (MNEs) to report high-level financial information to the IRS on a country-by-country basis.  In this Insight Post, we take a brief look at several structures that engender somewhat unique considerations for Country-by-Country reporting: Variable Interest Entities; Permanent Establishments; Grantor Trusts and Decedents’ Estates; and Deemed Domestic Corporations.

As background, U.S. Treasury regulations require that the ultimate parent entity of a U.S. MNE group report tax information, on a country-by-country basis, related to the group’s income and taxes paid, together with certain indicators of the location of the group’s economic activity. The IRS anticipates that CbC reports will shine light on high-level transfer pricing risks.  In other words, MNEs can expect to see increased transfer pricing scrutiny in years to come.

A U.S. MNE group is essentially defined as the ultimate parent entity of a U.S. MNE group and all of the business entities that are required to consolidate their accounts with the ultimate parent entity’s accounts under U.S. GAAP (or that would be so required if publicly traded), regardless of whether any such business entities could be excluded from consolidation solely on size or materiality grounds.  Thus, there are a number of “constituent entities” that flow up into the ultimate U.S. MNE group.

And what entities, exactly, make up the “constituent entities” that comprise a U.S. multinational enterprise (MNE) group?  With respect to a U.S. MNE group, a constituent entity is any separate business entity of the U.S. MNE group.  There are, however, some exceptions — such as foreign corporations or foreign partnerships for which information is not otherwise required to be furnished under section 6038(a) or any permanent establishment of the foreign corporation or foreign partnership.  Below, we look at several structures — such as variable interest entities and deemed domestic corporations — and address their current treatment under the tax law.

Variable Interest Entities

Variable interest entities fall within the constituent entities that are part of a U.S. MNE group.  In general, a variable interest entity may be consolidated with another entity for financial accounting purposes, even though that other entity may not control the variable interest entity within the meaning of section 6038(e).  Note that the Financial Accounting Standards Board (the “FASB”) generally defines a variable interest entity, for GAAP and financial accounting purposes, as an entity in which a public company has a variable interest that is not based on majority voting rights.

Permanent Establishments

Under Treasury regulations, the term “business entity” includes a permanent establishment that prepares financial statements separate from those of its owner for financial reporting, regulatory, tax reporting, or internal management control purposes.

For these purposes, the term permanent establishment includes:

• a branch or business establishment of a constituent entity in a tax jurisdiction that is treated as a permanent establishment under an income tax convention to which that tax jurisdiction is a party,
• a branch or business establishment of a constituent entity that is liable to tax in the tax jurisdiction in which it is located pursuant to the domestic law of such tax jurisdiction, or
• a branch or business establishment of a constituent entity that is treated in the same manner for tax purposes as an entity separate from its owner by the owner’s tax jurisdiction of residence.

Grantor Trusts and Decedents’ Estates

Treasury regulations exclude a decedent’s estate and an individual’s bankruptcy estate, as well as grantor trusts within the meaning of section 671, all of the owners of which are individuals, from the definition of a business entity.  The Service ultimately determined that given the nature of grantor trusts, decedents’ estates, and individuals’ bankruptcy estates and their close connection to individual grantors, decedents, and individual debtors, it was not appropriate to include grantor trusts with only individual owners, decedents’ estates, and individuals’ bankruptcy estates in the definition of business entity.

Deemed Domestic Corporations

For these purposes, the Treasury and IRS define a U.S. business entity as a business entity that is organized, or has its tax jurisdiction of residence, in the United States.  The final regulations expressly provide that foreign insurance companies that elect to be treated as domestic corporations under section 953(d) are U.S. business entities that have their tax jurisdiction of residence in the United States.

 

Transfer Pricing

When unrelated enterprises transact with one another, the underlying assumption is that market forces generally determine the commercial terms of their transaction—e.g., price and conditions of transfer.  But where associated enterprises transact with one another — including entities such as variable interest entities, permanent establishments, and deemed domestic corporations — tax authorities become concerned that the terms of their dealings may be determined by other considerations.  When transfer pricing (the pricing between or among the entities) does not reflect objective market forces, the tax liabilities of the enterprises may be distorted.

Over time, a generally (though not universally) accepted consensus has developed in the international tax community of a concept of an “arm’s-length” transaction—a hypothetical measuring stick against which to measure the pricing and terms used by the related parties.  Where the actual terms deviate significantly from the terms that would have transpired if the transaction had been an “arm’s-length” transaction, tax authorities generally have the authority to recast the transaction and use the “arm’s-length” pricing.  CbC reporting is intended to provide the IRS and other tax authorities with information that provides insight into MNEs’ transfer pricing practices.  And yes, that means that MNEs can expect to see increased transfer pricing scrutiny in years to come.

 

Freeman Law International Tax Symposium

Readers may be interested in the Freeman Law International Tax Symposium scheduled to take place virtually on October 20 and 21, 2022.  Attendees will qualify for CLE, CPE, and CE and the slate of presenters includes well-recognized speakers and panelists, such as a prior Chief Counsel of the IRS, a former Acting Assistant Attorney General of the U.S. Department of Justice Tax Division, and many others in government and private practice.

To Register for the Freeman Law International Tax Symposium, please visit www.its2022.freemanlaw.com.

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Free Act & Deed – 11 Types of Real Estate Deeds in Texas

There are at least 11 types of deeds in Texas used in the transfer of real estate. Since deeds should be recorded in the deed records in the county where the property is located to give notice to the world, deeds should be notarized. The following are some of the types of deeds in Texas:

1. General Warranty Deed – Protects the buyer of real estate from all title defects incurred prior to the buyer’s purchase of the property – even if the seller didn’t know of the defect. Typically, the buyer is mostly concerned that there are no debts or liens against the property purchased, but there can be other defects as well. If there is a defect, then the purchaser can require the seller to solve the issue. As a result, title insurance is often purchased for the security of the purchaser.
2. Special Warranty Deed – Protects the buyer from title defects that occurred when the seller owned the property. So, if there was judgment against the property prior to seller owning the property, the purchaser would not be protected. Typically, special warranty deeds are used after a foreclosure or property seizure.
3. Quitclaim Deed – These deeds give the purchaser no protection or warranty at all. As a result, this would not be desired by title companies. There is no guarantee of full ownership of the property or that there are no debts or liens. Sometimes these deeds are used when money is not exchanged for property (although Gift deeds are sometimes used to give warranty of title). In Texas, quitclaim deeds are more of a release of a claim of title. The grantor may not even have an interest in title.
4. Deed without Warranty – This is a conveyance of property (unlike a quitclaim deed), but it also has no warranty of title. This is sometimes used to clear up title problems – although it is not used very often since it lacks warranties.
5. Grant Deed – This deed implies covenants of title (although not stated in the deed). The seller of the property guarantees there is no conveyance of the property to anyone other than the purchaser and that nothing could stop the transfer.
6. Transfer on Death Deed – This type of deed transfers property at the time of death of the owner. There are no warranties of title. The legislature passed the usage of this type of deed since so many Texans failed to have wills. It is simple to create, and you can cancel if you change your mind. However, there are many problems with transfer on death deeds. See our article “12 problems with TODD” by clicking here.
7. Deed with reservation of life estate – Unlike the TODD, a deed with reservation of life estate is made with warranty of title (either a special or general warranty deed). A Ladybird deed is a form of a life estate deed – the grantor just retains more powers. The grantor retains rights to sell, lease, mortgage or even change his or her mind as to whom the grantee would be – which is why Ladybird deeds are often referred to as enhanced life estate deeds. If the life estate deed is not a Ladybird deed, then the grantees have an immediate interest and the grantees could transfer their remainder interest.
8. Deed of Trust – This is not really a deed – it is more like a mortgage in Texas when the grantor borrows money to purchase the property. The grantor (as a borrower) of this deed grants a lien against the property to secure payment of a note by the grantor to the lender. The trustee (often a title company) of the deed of trust can foreclose on the property without going to court if the grantor is delinquent or fails to pay the lender or fails to otherwise comply with the covenants in the deed of trust to secure the lender.
9. Fee Simple Determinable Deed – When a condition (as set forth in the deed) is not met or is violated, a fee simple determinable automatically ends the interest in of the grantee and automatically reverts back to the owner (grantor).
10. Fee Simple Subject to Condition Subsequent Deed – Unlike a fee simple determinable deed (although it is a form of a fee simple determinable deed), the owner has the right to retake the property if the condition is violated – but is just an option (it doesn’t automatically revert to the owner).
11. Fee Simple Subject to Executory Limitation Deed – Similar to a fee simple determinable deed (although it is another type of fee simple determinable deed), except the property could go to some party other than the owner if the condition is not met or violated.

If interested in learning more about this article or other estate planning, Medicaid and public benefits planning, probate, etc., attend one of our free upcoming Estate Planning Essentials workshops by clicking here or calling 214-720-0102. We make it simple to attend and it is without obligation.

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State Bar of Texas Executive Committee to meet September 13

The State Bar of Texas Executive Committee will meet at 10 a.m. CDT on September 13 at the Texas Law Center, 1414 Colorado St. in Austin. The meeting is open to the public and will be streamed live on the State Bar of Texas YouTube page.

The meeting agenda may be viewed here (find the backup materials here. To sign up to speak remotely during the meeting, please email lowell.brown@texasbar.com or call 512-427-1713 or 800-204-2222 (toll free) before 5 p.m. CDT on September 12. Please provide the agenda item number you wish to speak on.

Written comments regarding agenda items must be received by 5 p.m. CDT on September 8 for timely distribution to the committee members before the meeting. Please submit written comments by email to boardofdirectors@texasbar.com and indicate the agenda item you are referring to.

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Legal Humor

Sometimes lawyers really do have the best responses.  The following is just one example.

Rebuilding New Orleans after Katrina often caused residents to be challenged to prove home titles back hundreds of years. That is because of community history stretching back over two centuries during which houses were passed along through generations of family, sometimes making it quite difficult to establish a paper trail of ownership.

A New Orleans lawyer sought a FHA rebuilding loan for a client. He was told the loan would be granted upon submission of satisfactory proof of ownership of the parcel of property as it was being offered as collateral. It took the lawyer 3 months, but he was able to prove title to the property dating back to 1803. After sending the information to the FHA, he received the following reply.

Continue reading →

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Suit Over a Sand Pit Spawns Citizens Particpation Act Claim

Co-author Jeremy Walter

Ark Sand Co., Inc. v. Bradley Demolition & Constr., LLC, et al has the appearance of a Hatfield and McCoy-grade grudge match. As often happens when litigation gets personal, the Texas Citizens Participation Act was invoked. The TCPA is the statute that protects citizens’ First Amendment rights such as free speech and the right to petition the government. As we will see, the statute will not cure all insults, real or perceived.

Ark owned an industrial sand pit, which it leased to Bradley Demolition & Construction, LLC (“BD&C”).  Ark alleged the lease was oral only, for a term of five years with no option to renew.  BD&C showed a written lease with a term of ten years.  Ark claimed that the signature on the lease was a forgery and the lease was unenforceable. BD&C refused to vacate after the five-year term.

Ark sued BD&C for several causes of action, inflammatory and otherwise, and sought a declaratory judgment.  BD&C counterclaimed.

The parties tried the declaratory judgment claim first because whether the purported written lease was valid would determine whether Ark had other claims.  The jury found that Ark did not sign the purported written lease and that lease was not valid.  The trial court granted declaratory relief and granted possession of the sand pit to Ark.

Ark then amended its petition to reflect that it owned the sand pit and added BD&C’s president Edward Bradley and BD&C affiliate Bradley Sand and Concrete Crushing Company to the suit, alleging BD&C sold them sand without authority, adding conspiracy, conversion, and other claims.

Turning up the heat, Defendants filed third-party claims against the president of Ark and others, alleging the sand pit was worthless when Defendants took over.  Defendants alleged a handshake deal whereby the president tricked Defendants into revitalizing the sand pit by leading them to believe they would own and operate it for ten years.  They argued the president always secretly intended to evict Defendants once the pit was profitable and that he operated Ark as his alter ego.

Ark moved to dismiss all third-party claims under the TCPA, arguing those claims were based on Ark’s exercise of its right to petition because they complained of Ark’s conduct in the lawsuit, pleadings, and previous trial. Defendants argued that Ark lacked standing to dismiss the third-party claims, that the motion was premature because those parties had not yet answered the lawsuit, and that the TCPA did not apply. The trial court denied the TCPA motion.

Ark argued on appeal that the TCPA applied to the third-party claims, specifically that those claims were based on Ark’s exercise of its right to petition and that Defendants failed to provide prima facie evidence of their claims.

Holding:

Ark Sand was not a named party in the third-party petition and the TCPA only allows “parties” to move to dismiss.  Although the third-party petition alleged Ark’s president operated Ark as his alter ego, it did not seek to hold Ark liable for the president’s conduct (only vice versa).

The Court held that a party cannot avail itself of a TCPA motion to dismiss unless the target of the TCPA motion seeks relief from the moving party. “Because Ark [Sand] is not named as a third-party defendant and the third-party petition does not otherwise seek to hold Ark [Sand] liable, Ark [Sand] has no need of protection from the third-party action [under the TCPA].”, said the Court.

The Court upheld the denial of Ark’s TCPA motion.

Your musical interlude.

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ADA Mandates Deaf Access to the Criminal Justice System

Before we get to the blog entry of the week, a housekeeping matter. I will be out of the office from Friday evening and returning late Tuesday. So, a blog entry for the week after this will come up later in that week rather than earlier to middle of the week as is usually the case.

 

Our case of the day is Luke v. State of Texas, here, a published decision from August 19, 2022. The case asked the question about whether denying a culturally deaf individual, Deaf, an interpreter during his criminal proceedings violates the ADA. The Fifth Circuit holds that it does. As usual the blog entry is divided into categories and they are: facts; court’s reasoning on sovereign immunity and that Luke did adequately state a claim for violating title II of the ADA; and thoughts/takeaways. Of course, the reader is free to concentrate on any or all of the categories.

 

I

Facts

 

Like many Deaf individuals, Luke has trouble speaking and reading English. He also has difficulty lip reading. In order to effectively communicate, Luke requires an American Sign Language (ASL) interpreter.

 

Such an interpreter was never provided during Luke’s case for marijuana possession. No interpreter was provided the night of his arrest during a traffic stop, even though his mother, who was watching the scene via FaceTime, urged the officers to provide him with one. No interpreter was present when Luke was booked and detained at Lee County Jail. Nor was one present when a Lee County justice of the peace arraigned him and released him on bond. No interpreter ever explained to Luke his legal rights, the charges against him, or the terms and conditions of his bail.

 

The county court said that an interpreter would be provided for the hearing at which Luke was going to plead guilty in exchange for one year of probation. But the court did not follow through on that commitment. Instead, it insisted that Luke’s mother, who has only basic knowledge of sign language, interpret for her son during the hearing. Thus, no qualified interpreter ever explained to Luke the terms of his probation.

 

Luke’s experience on probation, which began with Lee County’s Community Supervision Corrections Department but was later transferred to San Jacinto County’s, was more of the same. Neither department provided Luke with an interpreter for his meetings with probation officers. Just like at the hearing, the probation officers instead had Luke’s mother interpret for him. No qualified interpreter ever explained to Luke what happened during those meetings or whether he was satisfying the terms of his probation.

 

Contending that the lack of interpreters left him “isolated and confused” during the criminal proceedings, Luke sued the following entities under Title II of the Americans with Disabilities Act: (1) Lee County, which operated the jail and court; (2) the Community Supervision and Corrections Departments of both Lee County and San Jacinto County (the “Supervision Departments”), the Texas state agencies that oversaw his probation; and (3) the State of Texas. Luke sought injunctive relief against the Supervision Departments and the State of Texas and compensatory and nominal damages from all defendants.

 

The District Court wound up concluding that the supervision department enjoyed sovereign immunity. It also granted Lee County’s motion for judgment on the pleadings for the same reason. It granted the state of Texas motion to dismiss for improper service of process because Luke serve the wrong Texas official. Luke appealed.

 

II

 

Court’s Reasoning on Sovereign Immunity and That Luke Did Adequately State a Claim for Violating Title II of the ADA

 

 

1. Lee County is a political subdivision of Texas and not an arm of the State. Therefore, it does not enjoy state sovereign immunity.
2. To make out a claim under title II of the ADA, Luke had to show: 1) that he is a qualified individual with a disability; 2) that he was excluded from participation in, or denied the benefits of, services, program, or activities for which the public entity is responsible, or was otherwise being discriminated against; and 3) that such discrimination is because of his disability.
3. Luke’s deafness makes him a qualified individual with a disability.
4. Luke can show that he was discriminated against because of his disability as both Lee County and the Supervision Departments knew he was Deaf yet failed to provide an accommodation despite multiple requests for an interpreter.
5. Title II regulations, 28 C.F.R. §35.160(b)(1), lists auxiliary aids, which include qualified interpreters, as reasonable accommodations that public entities have to provide when necessary.
6. Luke also alleged that he was denied the benefit of meaningful access to public services. In particular he alleged that he was not able to understand his legal rights or effectively communicate throughout his proceedings. Not being able to understand a court hearing or a meeting with the probation officer is by definition a lack of meaningful access to those public services.
7. Citing to Tennessee v. Lane, the court said that a core purpose of title II is for public entities to accommodate persons with disabilities in the administration of justice.
8. A theory that Luke was not denied a public service because he successfully completed his probation anyway is entirely inconsistent with the ADA. Nothing in the ADA’s text or the case law applying it requires Luke to have alleged a bad outcome. There is a good reason for that because lack of meaningful access itself is the harm under title II regardless of whether any additional injury follows. Luke’s title II injury is not being able to understand the judges and probation officers as a defendant who is not Deaf would.
9. Under the District Court’s reasoning, the state could refuse to provide an ASL interpreter for a culturally deaf individual’s trial and then avoid title II liability if the defendant is acquitted. It simply doesn’t work that way and courts have rightly rejected that position.
10. While it is true that the positive outcome of Luke’s criminal case may affect his damages, that does not allow courts to escape their ADA obligations.
11. The argument that Luke’s mother served as an interpreter means there was no ADA violation doesn’t wash either for several reasons: 1) his mother knows only basic sign language. So, his mother’s involvement would not have fully informed him of the proceedings or otherwise provide the meaningful access the ADA requires; and 2) if one considers 28 C.F.R. §35.160(c)(2) public entities cannot force a person with a disability’s family member to provide the interpretation services for which the entity is responsible.
12. Since Luke sufficiently stated a title II claim, his claim against Lee County gets past the pleading stage.
13. With respect to the Supervision Departments, Luke clearly satisfied the first step of the sovereign immunity abrogation elements in that he clearly stated violations of title II. However, it remains for the District Court on remand after full briefing and consideration to determine whether the misconduct also violated the 14^th amendment and if not, whether Congress’s abrogation of sovereign immunity to that particular conduct was nevertheless valid.
14. With respect to the State of Texas, Luke did indeed serve the wrong officer. Therefore, Texas is dismissed from the case.
15. The District Court erred when it said that Luke failed to specifically allege facts supporting compensatory damages. Luke alleged that not being able to understand the proceedings against him caused him fear, anxiety, indignity, and humiliation.
16. In a footnote, the court noted that it is a separate issue whether compensatory damages are available to title II plaintiffs at all because of Cummings v. Premier Rehab Keller, which we discussed here. It is up to the District Court on remand to decide what effect if any Cummings has on Luke’s ability to recover emotional distress damages under title II. Regardless, Luke also seeks nominal damages.
17. In another footnote, the court noted that meaningful access is a standard that comes from the Supreme Court in a Rehabilitation Act case. However, the ADA and Rehabilitation Act are interpreted the same way. So, that standard applies equally to the ADA.

 

III

Thoughts/Takeaways

 

1. For sovereign immunity to apply, an entity must be an arm of the State. Political subdivisions do not get the benefit of sovereign immunity.
2. Communication with a culturally deaf individual must be effective communication as we discussed in this blog entry.
3. Tennessee v. Lane did hold that when it comes to accessing the courts people with disabilities are at least in the intermediate scrutiny category if not higher with respect to equal protection jurisprudence.
4. The lack of meaningful access itself is the harm under title II and an injury is not required. So, by way of analogy you might also be able to argue that a failure to accommodate in a title I case does not require an adverse action.
5. Escaping damages under the ADA is not the same as escaping liability.
6. When we discussed Cummings v. Premier Rehab Keller, a question I raised was whether damages under title II are ever in play because title II’s remedies are hooked into the Rehabilitation Act remedies. This case specifically mentions that Cummings may preclude damages for violations of title II of the ADA. The court did note that nominal damages would still be in play even so. It will be interesting to see how this plays out.
7. Both title II and title III of the ADA work off a meaningful access standard.
8. Remember, as we discussed here, that ADA causation is undoubtedly not sole cause.
9. As we discussed here, the ADA is a nondelegable duty.

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What are the Common Factors Leading to a Will Contest?

Nobody wants to see their estate plan contested upon their passing, so can you tell in advance that your plan is likely to be contested? What most people think of as a Will contest is a disgruntled heir who receives substantially less than others contending that the Will is totally invalid. Unless you have made […]

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