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International Tax Lawyers Madison | Importance of Avoiding International Tax Mistakes

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Let’s begin by answering a philosophical question. Why should you care? I mean after all, all of you here are Business Lawyers; So what if you make a Tax Mistake intentionally or unintentionally? After all you’re not Tax Lawyers.

Let me pose that question to you because all of you are here today for a reason; why do you care? Why did you come here? Why do you think it’s important for Business Lawyers to know how to avoid making International Tax Mistakes?

Any takers?

Audience member answer: “To keep our Clients out of jail.”

Okay, Good one!

Any other….?

Second audience member answer: “The Tax Consequences will affect the Bottom Line…. of your Business.”

Third audience member answer: “It will keep us out of jail too. That helps; don’t you think?”

Other comment: “So far, so good.” (Laughter)

Unknown audience member comment: “I think just to do anything confidently, you’ve got to know a lot about everything.”

Perfect; and I think all of you are right! If I were to summarize it, I would say that a Client will not appreciate if a Business Deal that you pulled together, no matter how perfect it is from the Business World Perspective, results in a tremendous increase in the Client’s Tax Liability, exposing the Client to huge IRS Civil Penalties and potentially Criminal Penalties because the Client could end up in jail for International Tax Noncompliance.

From the tax perspective, a badly structured Business Deal will boomerang back to you; first, in the form of losing a Client (because the Client will not stay with you after that), second, you might be facing a Legal Malpractice Lawsuit (which was mentioned here earlier) and the third thing is that potentially, it could be an Ethical Violation because you would be advising in a very Specialized Area in which you have no knowledge or experience. You might be endangering your Attorney License at that point.

Every Business Transaction Has Tax Consequences | International Tax Lawyers Indianapolis

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Now that we have established why we should care about making International Tax Mistakes, let’s discuss the five strategic traps which would expose you as Business Lawyers to making International Tax Mistakes.

I will follow along in this handout that you all have; hopefully everyone has it. Let’s start with the Business Purity Trap. A Business Purity Trap is an assumption that there is a purely Business Transaction that has no connection to Tax Law whatsoever and because there’s no connection to International Tax Law; obviously, there is no need to ask a Tax Advisor about this Transaction.

You cannot imagine how many times I see this. In one area where I see this most often is Business Formation, when Business Lawyers advise their Clients to form Business Entities and structure Business Transactions in a way that would entail information of different Business Entities throughout the world. Obviously, this gets their Clients into trouble because every Business Transaction has Tax Consequences.

Let me repeat that: Every Business Transaction has Tax Consequences.

Example of the Business Purity Trap | International Tax Attorney Florida

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Let me give you an example from my practice; it’s a fairly recent example. I had a Client who was operating a business in one of the Southern states of the United States.

Let’s say he had a product and that product wasn’t doing that well in the United States; so what he decided to do was to go to China to see if he could find a Market there. He went to China and found some people interested in that product. He then went to his Business Lawyer and the Lawyer said, “If you are going to operate in China, you shouldn’t be operating from the United States. Why don’t you open up a Company in Hong Kong?”

So the Client said, “That sounds like a great idea; why not open a Company in Hong Kong?” He then opens a Company in Hong Kong, then he goes to Lithuania. In Lithuania he decided that this was another country where he could potentially find clients for his product. He again talked to the Business Lawyer and the Business Lawyer suggested that he open a Company in Lithuania. The Client then goes to Russia (this is a Russian speaking client) and meets a friend and the friend says, “I like your business; why don’t we operate together?” The Client responded, “The Company in Lithuania is mine and I don’t really want any Partners.”

They both go to the Client’s Business Lawyer and the Business Lawyer suggested, “Very easy; why don’t you form a Company, a joint venture in Russia and then operate from there.” So then they own this Company together. Then he gets interested in another product and creates another Company. Then he goes to Poland because he thinks that in order to operate in Europe he would be better off having Accounts in Poland. Without the advice of the Business Lawyer he opens another Company in Poland by himself – six Companies total.

No Tax Advisor ever was consulted about opening up these Companies. Years go by, then he comes to me for a completely different issue but I’m a very detailed-oriented person as a Tax Attorney should be and I started asking about his other activities around the world and uncovering one Company after another. Then we realize that he’s got six Companies for three years and some of them for a little longer, for which no forms 5471 were filed: six Companies, six forms 5471 X 3, that’s eighteen X $10,000 penalties.

The Business Lawyer exposed his Client to $180,000 in penalties; for a Client with assets this size (this is not a Multinational company), that is a huge hit.

Remember, all Business Transactions have Tax Consequences.

Why You Should Not Dabble in International Tax Law | International Tax Lawyers Chicago

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Let’s go to the next one: the Tax Dabble Trap. This is basically a belief that the Business Lawyer can advise on some or any International Tax issues related to Business Transactions even though he’s not a practicing Tax Attorney.

Oftentimes this belief, comes from prior experience. Meaning a Business Lawyer perhaps was involved ten years ago in a similar deal and an Accountant was present and the Accountant advised on this as the Business Lawyer recalls that situation. He may think, “This is a similar deal; why do I need an Accountant? Why do I need an Attorney? I can do it myself.” He then starts advising on Tax Issues believing that his advice is exactly the same as it was ten years ago.

Perhaps the contributing factor to this belief is a bit of hubris which is present in all attorneys, myself included. If you remember the song, “Anything you can do, I can do better. I can do anything better than you.” It’s exactly that kind of attitude; it’s exactly that kind of attitude which is completely false in International Tax Law.

You cannot dabble in International Tax Law for two reasons. First, it’s extremely complex. You may think that this advice was given to you ten years ago by an Accountant or even a Tax Attorney is correct but perhaps there were some details, something in the facts of that particular case that influenced that advice. In a different situation, which might be very similar but yet slightly different and that slight difference might make a world of difference in terms of what kind of advice should be given.

The second reason is that this is a tremendously dynamic area of Law. International Tax Law changes all the time. Today, you don’t have to report this asset; tomorrow there are three reporting requirements. Yesterday, it was not taxed; today it is taxed. Yesterday it was entitled to a Long-Term Capital Gains treatment. Today it’s not or vice versa.

Example of the Tax Dabble Trap | Rochester MN International Tax Lawyer

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Some years ago a Client (he was not a client at that time) inherited a Foreign Corporation. It was a mid-sized Foreign Corporation, and he was not the only owner there, but a partial owner, a minority owner.

In a Foreign country, the classification of ‘Entity’ may not be exactly in line with the US Tax Classification. So to figure out whether this is a Corporation or a Partnership, you really have to look into how this company operates and what the law says (in) how it operates.

He came to a Business Lawyer and actually there was an Accountant involved in this case as well. (We’ll talk about the next trap after that and why the Accountant may not have been the best choice there). An Accountant was involved there but the chief role was played by the Business Lawyer. The Business Lawyer was involved some years before in another Transaction. In that transaction, he was advised by the Accountant that the Form 5471 had to be filed and about the penalties associated with the form.

He told the Client, “We don’t know what kind of Entity this is and I know about this Form 5471 and based on what the Accountant told me, I don’t think your Entity is actually a Corporation; I think it’s a Partnership. You are a minority owner; that means that Form 8865 doesn’t apply and you don’t have the 5471 form requirement. That will be an easier way to get rid of the IRS Penalties associated with Form 5471.”

What he forgot about… well, two things is – one little detail about income. If it’s a Partnership, it’s a Pass Through Entity. That means that this Client was in Income Tax Non-Compliance since the time he inherited the Company. For this Client, that would mean that he was underreporting about 90% of his income in each year.

The second issue, is obviously the one I have already mentioned. You have to look at what the law says, what the Local Law says. How did the Company operate before? You cannot just randomly say: this a Foreign Partnership and this is a Foreign Corporation just because some of the details are here or some of the details are not here.

In the end, we were able to go back. It was a Corporation, not a Partnership so we were able to file a 5471 Voluntary Disclosure and were able to end that issue without any penalties. But if the IRS had audited his tax returns and discovered that he underreported his income by 90%, tremendous penalties would have ensued.