Hi, it’s Phil Hodgen. Merry Christmas. (And no, I am not writing this on Christmas Day.)
This is the biweekly Friday Edition, chock-full of international tax goodness. You signed up for this newsletter, but if you want to stop getting it, no problem — just click the Unsubscribe link at the bottom of the email.
January 8, 2016 — our regular monthly International Tax Lunch series returns after the Christmas break. Noon, Pacific time. In person or dial in.
I will be doing one hour on the foreign earned income exclusion and how to prepare Form 2555. Yes, even the housing allowance stuff.
If you are in Southern California, why not come by and hang out with us. Ask questions. We will buy you lunch.
Go to hodgen.com/lists and sign up for the International Tax Lunch list. You will get announcements, instructions on how to dial into the conference call or come to the event in person, and even get the handouts.
After you watch the tax press roll by for a few months, you start to wonder if there is a hidden trend.
First. Lots and lots of tax and information sharing agreements exist, and more are being signed every month. Here’s where my brain went. (References are toWorldwide Tax Daily for those of you who have Lexis accounts.)
Next. It is politically popular to chase “them”, especially when “they” have more money than you do. (Information sharing agreements help you do that.) Again, note that the transparency is a one-way street. The government wants to know more about you.
Finally. Cross-border (and domestic, because it is easier) information sharing will be automated.
Prediction. Financial data is all visible to the government, and tax collection is automatic. Because it is possible.
The same logic is true about tax administration. Transparency (translation: your government knows everything about you, but not vice versa) and the digitization of everything means a hidden tide is flowing:
This leads me to a couple of guiding principles:
- Choose Uncertainty. If you want to thrive, go where the complexity and confusion is greatest. E.g., being an entrepreneur is more confusing than working a corporate 40 hour/week job. If the government can’t get a decent handle on a particular aspect of human behavior, there is probably something intensely interesting, lucrative, and fun going on there.
- You are Insecure; Be Ready. As the government acquires more information about you (“Transparency!”) you lose control over your destiny. As data pools increase in size and value, the probability of breach approaches 1. Government-controlled data pools are no exception. When all data resided on paper, grabbing your tax information was expensive. When everything about you sits in a database, breaching your privacy costs zero. Prepare for this.
There was a lot of chatter in the tax press in the last couple of weeks about corporate inversions. The trigger du jour for all of this discussion was the Pfizer-Allergan merger of juggernaut pharma manufacturers.
There is nothing that actually happened — the chatter is just a bunch of people displaying their political affiliations and moral imperatives while coolly and professionally talking about tax esoterica. “Something Must Be Done” etc.
Nopes. It’s not politics, patriotism, or morality. It’s just economics.
Corporate inversions are the business equivalent of human expatriations. A U.S. corporation, through some complex legal maneuvers, reincarnates itself as a corporation based in a foreign country. It continues to do business exactly as before, except it pays less income tax worldwide.
U.S. multinationals are good at finding ways around the U.S. system’s “pay tax on all of your profits, no matter where you earned it, every year”. You need only look at Apple and Google for examples.
But life becomes a lot easier — and you pay less tax — when the corporation ceases to be a U.S. corporation.
The government started its fight against corporate expatriation in 2004, by enacting Section 7874 into the Internal Revenue Code. Through it all, inversions have continued.
It’s not surprising. A sane corporate executive will ask “What is the cost of inversion?” and “What is the benefit of inversion?” Over any considerable period of time, the benefits of taking a corporation offshore will outweigh the cost.
The government’s anti-inversion strategies are designed to make inversions more expensive. The benefit side of the equation, however, is untouched. And I suspect that any decent present value calculation will demonstrate this.
- Expect to hear about the evils of corporate inversions in the 2016 election rhetoric. Heh.
- Expect the government to continue to make corporate expatriation more difficult and more expensive. Yet corporations will continue to move abroad, and those that don’t will continue to hoard capital abroad rather than bring it home and pay tax.
- (This one will be hard to see because you’re looking for something that isn’t there, but it is real because I tell startups to do it right now). Expect new businesses to start as foreign-based companies rather than U.S. based companies, because if you’re a foreign corporation you don’t need to expatriate — you are already safe. So over time, expect entrepreneurs to be more and more willing to build their companies abroad, to the long-term detriment of the U.S. economy.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 (passed into law on December 17, 2015) opened a giant door for foreign investment in U.S. real estate through publicly traded REITs.
(Side note: do politicians think we are morons? What is with the ridiculous acronyms that they keep bolting onto Frankenstein legislation? “”PATH””? OMFG srsly no. And do they think we are so stupid as to imagine that they sit around in Congress figuring out how to protect us from Tax Hikes? I have a few un-PC things to say here but I won’t.)
There’s this tax law called “FIRPTA”, which dates from 1980. Whenever a “U.S. Real Property Interest” is sold by a foreign person, capital gain tax must be paid. If you have a corporation that owns a lot of real estate (like a REIT), then the sale of that stock is treated as the sale of a U.S. Real Property Interest, and capital gain tax must be paid.
If you are a nonresident investor, trying to decide between buying Apple stock or some publicly traded REIT, what do you choose? You can take your capital gain on Apple stock and not pay U.S. capital gain tax, or you can take your capital gain on the REIT shares and pay U.S. capital gain tax.
Previously, there was an exception for small shareholders in publicly traded REITS: if you owned less than 5% of the REIT, you did not have to pay the capital gain tax on sale of the shares. In the new law, that threshold is now 10%. Suddenly, big money can pour into REIT shares and enjoy more favorable tax treatment.
A second point. U.S. pension plans can buy REIT stock and sell it and not pay capital gains tax on the gain. The tax system allows them to do so because they are investing for workers’ pensions, and eventually (when the pension payouts are made) the money will be taxed.
Foreign pension plans did not (up to now) have that tax-free benefit if they bought REIT shares. Now they do. More money coming to U.S. real estate.
More foreign institutional money will pour into U.S. real estate investments. Prices for large properties (those favored by REITs especially) will go up. Cap rates go down.
Since 1980, when a nonresident investor in U.S. real estate sold out, the buyer has been required to withhold 10% of the purchase price as a withholding tax, and give it to the IRS. The nonresident seller would file a tax return, and that 10% withholding tax would be applied to whatever the actual tax liability was for the sale. In that way, the withholding worked exactly like the tax withheld from your paycheck every two weeks.
The new law changes the withholding rate to 15%. See Section 324 of the PATH Act.
- This will make it harder for some nonresident investors to sell. If 15% of the sales price is getting scraped off the top for withholding tax, and another 5% – 7% is going out to broker’s commissions and closing cost, this means a highly-leveraged property cannot be sold. There isn’t enough cash to pay off the mortgage, pay the tax, and pay the closing costs.
- We will be doing a LOT more work for withholding reduction certificates, seeking permission from the IRS to reduce withholding to a sane level. (Hint: go look at IRS Form 8288-B). More pointless expense for sellers, more pointless paperwork processing for the IRS. (Eventually this will be digitized away, of course.)
Last week I was driving back to Pasadena from some meetings in Beverly Hills. For kicks I took Sunset Boulevard all the way home. Somewhere in Silverlake, in wall-to-wall Friday afternoon rush hour traffic, a storefront caught my eye.
It was dusk, and the light shining through the large windows was bright and warm. I glanced over. Leather goods. Nice-looking stuff, I thought. Luckily there was a parking spot at 4:30 pm on the street, right out front. I went in.
The store is Killspencer, at 2522 West Sunset Boulevard, Los Angeles CA 90026. They manufacture everything right there in the store. Walk in and the whole space smells of leather. Wonderful. Their products are exquisite, and the workmanship immaculate.
I might have bought something. Just sayin’.
Oh, who cares. This email is going out on Christmas and by the time you read this my wife will have opened the box.
Tell me about a cool, indie store or product you know about. Tell me about things where humans do interesting stuff. It could be anywhere on the planet — I like getting on planes!
Merry Christmas and Happy New Year. Talk to you in a couple of weeks.