ABA Tax Section Proposal to Expand the Definition of Domestic Corporations May 5, 2006

1. ABA Tax SectionProposal to Expand the Definition of Domestic CorporationsMay 5, 2006 A.W Granwell, (Moderator), Member, Ivins, Phillips and Barker, Chartered Chris Javens, Majority Tax Counsel, Senate Finance Committee Michael Kirsch, Associate Professor, Notre Dame Law School Ian Shane, Of Counsel, DLA Piper Rudnick Gray Cary Alexander Spitzer, Senior Vice President – Taxes, Nestle Holdings, Inc.

2. Background • Under US law, place of incorporation is the sole determinant of whether a corporation is US or foreign. • Domestic corporation. Incorporated under US law. • Taxable on worldwide income. • Dual Chartered or Dual Resident Company. A domestic corporation that also is chartered in another country or treated as a resident of another country under a “management or control” test continues to be a US corporation under US law. • Foreign Corporation. A corporation that is not domestic. • Income that has sufficient nexus to US is taxable. • Non-relevant factors: • Location of corporation’s management activities, • where Board of Directors meets, • location of employees, • location of business assets or operations, • revenue sources, • location or residency of a majority of company’s shareholders, or • In the case of public companies, the location of the exchanges on which company’s shares are traded.

3. Proposals – In General • To expand the definition of a US corporation. • JCT proposal: • Company incorporated in US continues to be considered a US corporation, as under current law. • A US corporation also would include publicly traded foreign-incorporated company if corporation’s primary place of management and control is in the United States. • Result. For US tax purposes, taxable on worldwide income. • Effective Date. Taxable years beginning at least two years after date of enactment. • Revenue Effect. Estimated to raise $900 over 10 years. • President’s Panel Proposal, ostensibly similar to JCT’s, but would encompass any foreign-incorporated corporation, even if not publicly traded. Not much detail provided in proposal.

4. Reasons for Proposals • Current law place of incorporation test is artificial and enables foreign corporations that are economically similar or identical to US corporation to avoid US taxation on worldwide income. • Determining corporate residency based on location of corporation’s management activities is a more meaningful standard. • Proposed rule would present a more comprehensive response to “inversion” type tax planning.

5. Inversions • Prior to enactment of section 7874 in the American Jobs Creation Act (“AJCA”), it generally was possible for a US parent corporation to reincorporate in a foreign jurisdiction, and reincorporation would be respected for US tax purposes, even in cases in which reincorporation had no significant non-tax purpose and corporate group had no significant business purpose in new country of incorporation. • US tax benefits: • Avoidance of subpart F provisions. • US base erosion through earnings stripping.

6. Section 7874Anti-Inversion Legislation • Created exception to place-of-incorporation test for determining corporate residency for defined inversion transactions. • Covers stock and asset acquisitions of US corporations and US partnerships. • Residence/nationality of ultimate owners is irrelevant. • US target’s business need not be in United States. • Encompasses both publicly traded and privately owned groups. • Note, Senate version of legislation would have applied only to publicly traded corporations. • Enacted Oct. 22, 2004; effective for taxable years ending after March 4, 2003. • Place of incorporation test continues to control for: • Newly incorporated businesses. • Corporations that inverted prior to effective date of AJCA.

7. Section 7874(a)(2)(B): Requirements • Three elements: • Direct or indirect acquisition by a foreign corporation of substantially all the assets of a US corporation or a trade or business of a US partnership. • At least 60% ownership of foreign corporation by former owners of US target by reason of former ownership. • Group does not have substantial business activities in foreign country of incorporation

8. Section 7874: Effect • Consequences if section 7874 applies are either: • “Red light”: If former owners own at least 80%, the foreign acquirer is treated as a US corporation for all Code purposes. (Section 7874(b)). • “Green light with toll”: If former owners own 60% to 79.99%, the income or gain recognized by reason of transfers of stock or other property by the US target cannot be offset by NOLs or certain other attributes, for 10 years. (Section 7874(a)(1), (d)(1) and (2)).

9. Proposal – New Test • If the primary place of management and control of a foreign-incorporated publicly traded corporation is in the United States, the company would be treated as a US corporation, taxable on its worldwide income.

10. Corporation’s Primary Place of Management and Control • This determination is made by reference by where corporation’s executive officers and senior management exercise day-to-day responsibility for strategic, financial and operational policy decision making for the company, including direct and indirect subsidiaries. • Decision making of all executive officers and senior management employees are taken into account. • Centralized structure. Individuals who have executive officer positions and report to the corporate HQ office. • Decentralized structure. Decision making activities of executives of subsidiary carrying on strategic, financial and operational policy decisions.

11. New Test is Based on Dutch Protocol • New test is similar to “substantial presence” test of recently ratified Netherlands protocol. • That test is as follows: The company’s primary place of management and control will be in the State of which it is resident only if executive officers and senior management employees exercise day-to-day responsibility for more of the strategic, financial and operational policy decision making for the company (including its direct and indirect subsidiaries) in that State than in any other state and the staffs conduct more of the day-to-day activities necessary for preparing and making those decisions in that State than in any other state.

12. Innovation in Proposals’ Standards • Proposal differs from the traditional management and control concept determined by reference to where the board of directors meets. • Perceived weakness of standard is that Board generally meets infrequently and venue of meetings is subject to manipulation. • E.g. Company could operate the majority of its business from United States but be treated as managed and controlled outside of United States if Board meets outside of United States. • Day-to-day management of a business is a more difficult test to manipulate. • Requires relocation of top executives and their families to an office in a foreign jurisdiction. • Requires movement of support staff and administrative functions to foreign jurisdiction.

13. Place of Management Is a Facts and Circumstances Determination • IRS would be required to gather data on foreign incorporated entities to ascertain whether they have substantial presence in United States. • Requires increase in IRS resources. • Raises issues for foreign-incorporated entities with respect to how they conduct business both within and without the United States.

14. Determining the Fiscal Residence of a Company • Tests • Incorporation. A company is regarded as a fiscal resident if it has been incorporated and registered or incorporated and organized in a particular country. • It is possible for a company to be dual chartered or dual resident. • Central Management and Controlling Power. Generally, control rests with the directors who carry out leading functions and manage the company’s business at the highest level. • One must distinguish superior management, which is the prerogative of the directors, from immediate management; i.e., the day-to-day management of the company’s business. The latter is not considered as forming part of the central management and controlling power. • Query, may a company have its central management and control in one jurisdiction or can it be divided?

15. Determining the Fiscal Residence of a Company (continued) • Corporate Seat or siege social. A number of countries have adopted the criterion of the company seat to determine fiscal residence. • A number of countries that have adopted the criterion of the company seat to determine fiscal residence have introduced a subsidiary criterion -- the management or effective management test. That can be phrased as the center of gravity of superior management. • One has to distinguish between the statutory seat and the actual seat of management. These may be in the same or different countries. • It is possible that a company which is incorporated in one country or that has its seat in one country may have its effective management in another country. The fiscal residence of that company will depend on the laws of the country making the determination, and there is a possibility of dual fiscal residence. • In certain countries, the statutory seat, the registered office and the central management are required to be in the same jurisdiction for that company to be a fiscal resident. • A company that is incorporated in one country and has its seat and effective management in another country may be considered dual chartered. • Head Office. In some countries, any company with its head office registered in the country is treated as a resident, irrespective of the law under which it is incorporated. • This may be defined as the center of administrative management.

16. Determining the Fiscal Residence of a Company (continued) • The Company’s Main Activity. In some countries, it is a matter of establishing whether the company’s main object; i.e., the main business it carries on, is located in that country. If most of the company’s activities are performed in the country, its “object: will take place in that country, and thereby the company will be considered as a resident. • Under this test, it makes no difference whether the company was incorporated abroad or whether its seat is located in another foreign country.

17. Determining the Fiscal Residence of a Company (continued) • Control. A few countries consider that the nationality of the majority shareholders or their place of residence are elements, in addition to other elements, that make it possible to determine the fiscal residence of the company they control. • Other elements include whether company carries on business in the country and the type of business that is carried on. • Query, how this type of test would apply if there is a publicly traded corporation with no controlling shareholders, but most shareholders are US persons? A proxy for this type of approach might be the exchange on which the company’s shares are listed.

18. Determining the Fiscal Residence of a Company (continued) • Domicile. In a number of countries, fiscal residence is determined by reference to domicile, which may mean place of incorporation, the registered office, the statutory seat or the company’s management. • Facts and Circumstances. Fiscal residence may depend on the following: (i) place of management activities, (ii) location of main office building, (iii) place where the most important books and records are kept, (iv) currency in which the accounts are maintained, (v) place where books and records are maintained, (vi) location of shareholder meetings, (vii) place of registration of company and (viii) statutory seat.

19. Service Centers • MNCs often establish centralized advisory departments that assist and render services to their subsidiaries. These functions usually are centralized in the parent company, but, in many cases, subsidiaries may render services to the whole group or to regional parts of the group. • Services may include (i) administrative services such as planning, coordination, supervision, budgetary control, financial or accounting advice, computer services, (ii) assistance in the areas of production, buying, distribution and marketing and (iii) HR and training. • Query whether these types of activities may transfer the fiscal residence of a company belonging to the group to the place where the service center is located? • Answer: Generally No. Services of an advisory nature will not cause a transfer of residence.

20. Dual Residence and Absence of Fiscal Residence • Dual residence can arise when: • The criteria chosen may lead to the existence of dual residence. • Two countries interpret the same criteria differently. • Two countries use different criteria. • Dual chartered entity issues also may arise; e.g., company incorporated in one country and has its statutory seat in another country.

21. Transfer of Fiscal Residence • Many issues arise when there is an actual or deemed transfer of residence. • Questions: • Do both states recognize legal existence of the company notwithstanding its transfer from one country to another. • If the laws of original country does not recognize continuances, the company may be deemed to be would up and re-incorporated, with the fiscal consequences this procedure entails in both countries.

22. Survey of Selected Other Countries • United Kingdom • Ireland • Luxembourg • The Netherlands • Spain

23. United Kingdom • Under UK law, a company is resident in the United Kingdom if: • It is incorporated in the United Kingdom, or • its central management and control is situated in the United Kingdom.

24. United Kingdom (continued) • United Kingdom case law has established that: • The residence of the company is usually where the directors meet, and • where the directors transact their business.

25. United Kingdom (continued) • The Board of Directors of a non-UK company must meet and transact business outside the United Kingdom in order to avoid UK tax resident status. • Caveat. If the Board of Directors do not meet but stand aside so that: • the function of the Board is “usurped” by someone else who is resident in the United Kingdom, then the non-UK company will become a UK tax resident. Wood v. Holden (2006).

26. United Kingdom (continued) • Today, the UK position is that: • Central management and control of a non-UK company lies where the management and control is exercised either through the Board of Directors or, if not exercised by the Board, where the shareholder or shareholders exercise control. • It does not matter that the Board of Directors are influenced by outsiders making proposals or giving advice, as long as it is not the outsiders who dictate the decisions whichare taken by the Board.

27. Ireland • Ireland follows the same principles on corporate residence as the United Kingdom. • Ireland has the same interpretation of “central management and control” as the United Kingdom. • Irish law is generally based on UK case law in this area.

28. Luxembourg • Under Luxembourg law, a company is resident in Luxembourg if its domicile is located in Luxembourg, even though the constitutive instrument may have been executed in a foreign jurisdiction. • The domicile of a company is located at its principal establishment. • The principal establishment of a company is deemed to be at its statutory seat or registered office, unless evidence to the contrary is given. • The term “principal establishment” means the place where the meetings of the board of directors and shareholders are normally held, the company’s day-to-day management is conducted and the books and records are kept.

29. The Netherlands • Under Dutch law, a company is resident in the Netherlands if: • company is organized under Dutch law, or • the “facts and circumstances” lead to that conclusion.

30. The Netherlands (continued) • The facts and circumstances test requires local administration of the company (although not a prerequisite under this test), some form of local office or address, local bank accounts and similar factual elements. • Great importance is attached to the place of the company’s “effective management,” which relates to short and medium term management within the Netherlands. • The company should have a person or persons within the Netherlands with sufficient independent authority to manage the company. • The mere holding of Board meetings in the Netherlands is not sufficient to establish tax residence.

31. Spain • Under Spanish law, a company is resident in Spain if: • The company is incorporated in Spain, or • The company’s legal seat is in Spain, or • The company’s effective management is in Spain. • Effective management is understood to be where the management and control of the company’s whole business takes place. In Spain, one must examine: • where the business decisions are taken, • where the administrative activity is carried on, and • where the Board of Directors meetings take place.

32. Evaluation:Place of Incorporation Test • Pro • Simple. • Certain • Easily administrable. • Con • Elective. • Perceived abuses. • Inversion type planning. • Does not provide meaningful measure of whether company is domestic or foreign.

33. Evaluation:Policy Considerations • Simplicity • Place of incorporation rule. • Certainty as to classification. • Affects basic regime of taxation. • Electivity and ability to “game” results. • Fairness. • Inversions and other problems with place of incorporation rule. • Query, whether proposal really is an expression of dissatisfaction with “exit” toll and taxing provisions of current law? • Efficiency. • Short-term & long-term effects on US economy if proposals adopted. • Administration by tax authorities. • A facts and circumstances test is inherently uncertain.

34. JCT Proposal -- Principal Income Tax Consequences • Foreign-incorporated publicly traded company treated as a US company for all Code purposes. • Company is taxable on its worldwide income. • Company may become a dual resident because of differences in standards under US and law of foreign jurisdiction. • Bilateral income tax treaty issues. • Foreign-controlled subsidiaries become CFCs or PFICs. • US withholding tax consequences. • US consolidated return consequences. • Estate tax exposure for foreign individuals holding shares in company.

35. JCT Proposal: Other Income Tax Consequences (continued) • US tax accounting issues. • US E&P Calculations. • US Basis Calculations. • US tax elections. • Exchange gain and loss. • Section 367 issues. • Dual consolidated loss issues. • Transfer pricing and documentation. • Pension Plans. • Federal compliance issues. • Foreign bank accounts, boycott reports. • Failure to file timely tax returns. • State compliance issues.

36. JCT Proposal: Audit Consequences • Timing and decision making. • Reserves. • Section 6038.

37. JCT Consequences: Other • Impact on decision making. • Impact on US economy. • Foreign country reciprocity – effect on US-based companies.

38. President’s Panel Proposals: Consequences • Essentially, apparently the same as JCT’s proposal, but has broader application as this proposal applies to any foreign-incorporated entity that effectively has its HQ in the United States. • Residence proposal needs to be considered in context of other proposals made by panel.

39. Conclusion • Where do we go from here?