On December 23rd, the IRS issued Rev. Proc. 2005-12, which announced revisions to the IRS’s relatively new program known as Pre-Filing Agreements ("PFA"), which provide potentially important benefits to foreign companies. The issues that come within the scope of the PFA program have been greatly expanded. They now include international tax issues, including the often challenging question of whether a foreign corporation’s presence in the United States has reached a level where the foreign corporation is subject to U.S. net income taxation because its activities rise to the level of being engaged in a U.S. trade or business (under U.S. domestic law) and, if so, whether its presence in the United States rises to the level of being a permanent establishment ("PE") under a relevant U.S. income tax treaty. These issues are matters that the IRS Office of Chief Counsel has typically refused to consider in the rulings process because of their highly factual nature.
The following outlines the highlights.
Specific international issues listed as "likely" to be eligible for the program include:
Whether a unit of a taxpayer’s trade or business is a "qualified business unit" for purposes of determining exchange gain or loss;
Whether the taxpayer is engaged in a trade or business within the United States;
The amount of gross income that is effectively connected with the conduct of a trade or business within the United States;
Factual determinations concerning the extent to which deductions are connected to a U.S. trade or business; and
Whether a taxpayer has a permanent establishment in the United States under an applicable tax convention and, if so, what profits are attributable to that permanent establishment.
The potential for a taxpayer to resolve the above issues prior to filing its tax return is a great step forward in providing certainty to taxpayers.
Transfer pricing issues are excluded from the PFA program. They will continue to be addressed in the Advance Pricing Agreement ("APA")program.
Tax Treaty Considerations
A PFA and any factual information contained in the background files are subject to exchange of information under income tax conventions. The procedure for the revised program states that "in cases where the exchange of information would be discretionary, information may be exchanged, to the extent consistent with sound tax administration and the practices of the relevant foreign competent authority." The procedure also encourages (but does not require) taxpayers to seek competent authority consideration under the mutual agreement procedure of an applicable income tax convention. Where competent authority consideration is requested, the consideration will be given after the PFA is concluded and the PFA may be modified to reflect the outcome of the mutual agreement procedure.
We contacted the IRS and spoke to the person who heads up the program. We discussed the following points:
- Can a taxpayer can come in on a "no names" basis?
- Can a taxpayer’s representative have a pre-filing meeting on a "no names" basis?
- What is the turnaround time?
The target is one month. However, they have not done a PFA for a foreign corporation and the process would take longer than one month.
- Can a taxpayer who enters negotiations for a PFA withdraw if it appears an agreement cannot be reached?
- Will a withdrawal lead to an audit of the issue?
There is no mechanism in place that would lead to an audit. However, an audit could occur pursuant to the normal process of selecting taxpayers for audits.
The expanded Pre-Filing Agreement procedure will enable a foreign company to determine, in a way that is binding on the I.R.S., whether they have a trade or business in the U.S., whether a permanent establishment exists and, if so, what profits should be attributed to it.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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